Chapter 2

Managerial Accounting and Cost Concepts
Solutions to Questions
2-1 Managers carry out three major
activities in an organization: planning,
directing and motivating, and controlling.
Planning involves establishing a basic
strategy, selecting a course of action, and
specifying how the action will be
implemented. Directing and motivating
involves mobilizing people to carry out
plans and run routine operations.
Controlling involves ensuring that the
plan is actually carried out and is
appropriately modied as circumstances
change.
2-2 !he planning and control cycle
involves formulating plans, implementing
plans, measuring performance, and
evaluating di"erences between planned
and actual performance.
2-3 #n contrast to nancial accounting,
managerial accounting: $%& focuses on the
needs of managers rather than outsiders'
$(& emphasizes decisions a"ecting the
future rather than the nancial
conse)uences of past actions' $*&
emphasizes relevance rather than
objectivity and veriability' $+&
emphasizes timeliness rather than
precision' $,& emphasizes the segments of
an organization rather than summary data
concerning the entire organization' $-& is
not governed by .//P' and $0& is not
mandatory.
2-4 !he three major elements of
product costs in a manufacturing
company are direct materials, direct labor,
and manufacturing overhead.
2-5
a. Direct materials are an integral part
of a nished product and their costs can
be conveniently traced to it.
b. #ndirect materials are generally
small items of material such as glue and
nails. !hey may be an integral part of a
nished product but their costs can be
traced to the product only at great cost or
inconvenience.
c. Direct labor consists of labor costs
that can be easily traced to particular
products. Direct labor is also called 1touch
labor.2
d. #ndirect labor consists of the labor
costs of janitors, supervisors, materials
handlers, and other factory wor3ers that
cannot be conveniently traced to
particular products. !hese labor costs are
incurred to support production, but the
wor3ers involved do not directly wor3 on
the product.
e. Manufacturing overhead includes all
manufacturing costs e4cept direct
materials and direct labor. Conse)uently,
manufacturing overhead includes indirect
materials and indirect labor as well as
other manufacturing costs.
2-6 / product cost is any cost involved
in purchasing or manufacturing goods. #n
the case of manufactured goods, these
costs consist of direct materials, direct
labor, and manufacturing overhead. /
period cost is a cost that is ta3en directly
to the income statement as an e4pense in
the period in which it is incurred.
2-7 !he income statement of a
manufacturing company di"ers from the
income statement of a merchandising
company in the cost of goods sold
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9olutions Manual, Chapter ( %:
section. / merchandising company sells
nished goods that it has purchased from
a supplier. !hese goods are listed as
1purchases2 in the cost of goods sold
section. ;ecause a manufacturing
company produces its goods rather than
buying them from a supplier, it lists 1cost
of goods manufactured2 in place of
1purchases.2 /lso, the manufacturing
company identies its inventory in this
section as <inished .oods inventory,
rather than as Merchandise #nventory.
2- !he schedule of cost of goods
manufactured lists the manufacturing
costs that have been incurred during the
period. !hese costs are organized under
the three categories of direct materials,
direct labor, and manufacturing overhead.
!he total costs incurred are adjusted for
any change in the =or3 in Process
inventory to determine the cost of goods
manufactured $i.e. nished& during the
period.
!he schedule of cost of goods
manufactured ties into the income
statement through the cost of goods sold
section. !he cost of goods manufactured
is added to the beginning <inished .oods
inventory to determine the goods
available for sale. #n e"ect, the cost of
goods manufactured ta3es the place of
the Purchases account in a merchandising
rm.
2-! / manufacturing company usually
has three inventory accounts: >aw
Materials, =or3 in Process, and <inished
.oods. / merchandising company may
have a single inventory account?
Merchandise #nventory.
2-1" Product costs are assigned to units
as they are processed and hence are
included in inventories. !he @ow is from
direct materials, direct labor, and
manufacturing overhead to =or3 in
Process inventory. /s goods are
completed, their cost is removed from
=or3 in Process inventory and transferred
to <inished .oods inventory. /s goods are
sold, their cost is removed from <inished
.oods inventory and transferred to Cost
of .oods 9old. Cost of .oods 9old is an
e4pense on the income statement.
2-11 Aes, costs such as salaries and
depreciation can end up as part of assets
on the balance sheet if they are
manufacturing costs. Manufacturing costs
are inventoried until the associated
nished goods are sold. !hus, if some
units are still in inventory, such costs may
be part of either =or3 in Process inventory
or <inished .oods inventory at the end of
the period.
2-12 Bo. / variable cost is a cost that
varies, in total, in direct proportion to
changes in the level of activity. !he
variable cost per unit is constant. / 4ed
cost is 4ed in total, but the average cost
per unit changes with the level of activity.
2-13 / di"erential cost is a cost that
di"ers between alternatives in a decision.
/n opportunity cost is the potential
benet that is given up when one
alternative is selected over another. /
sun3 cost is a cost that has already been
incurred and cannot be altered by any
decision ta3en now or in the future.
2-14 Bo, di"erential costs can be either
variable or 4ed. <or e4ample, the
alternatives might consist of purchasing
one machine rather than another to ma3e
a product. !he di"erence between the
4ed costs of purchasing the two
machines is a di"erential cost.
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(8 Managerial /ccounting, %*th Cdition
#$ercise 2-1 $%8 minutes&
%. Directing and motivating
(. ;udgets
*. Planning
+. Precision' !imeliness
,. Managerial accounting' <inancial accounting
-. Managerial accounting
0 <inancial accounting' Managerial accounting
D. <eedbac3
:. Controller
%8. Performance report
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9olutions Manual, Chapter ( (%
#$ercise 2-2 $%8 minutes&
%. !he cost of a hard drive installed in a computer: direct
materials.
(. !he cost of advertising in the Puget Sound Computer User
newspaper: selling.
*. !he wages of employees who assemble computers from
components: direct labor.
+. 9ales commissions paid to the companyEs salespeople: selling.
,. !he wages of the assembly shopEs supervisor: manufacturing
overhead.
-. !he wages of the companyEs accountant: administrative.
0. Depreciation on e)uipment used to test assembled computers
before release to customers: manufacturing overhead.
D. >ent on the facility in the industrial par3: a combination of
manufacturing overhead, selling, and administrative. !he rent
would most li3ely be prorated on the basis of the amount of
space occupied by manufacturing, selling, and administrative
operations.
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(( Managerial /ccounting, %*th Cdition
#$ercise 2-3 $%, minutes&
Produc
t Cost
Perio
d
Cost
%. Depreciation on salespersonsE cars................ F
(. >ent on e)uipment used in the factory........... F
*. Gubricants used for machine maintenance..... F
+. 9alaries of personnel who wor3 in the
nished goods warehouse............................ F
,. 9oap and paper towels used by factory
wor3ers at the end of a shift......................... F
-. <actory supervisorsE salaries........................... F
0. 7eat, water, and power consumed in the
factory......................................................... F
D. Materials used for bo4ing products for
shipment overseas $units are not normally
bo4ed&......................................................... F
:. /dvertising costs............................................ F
%8. =or3ersE compensation insurance for factory
employees................................................... F
%%. Depreciation on chairs and tables in the
factory lunchroom........................................ F
%(. !he wages of the receptionist in the
administrative oHces................................... F
%*. Cost of leasing the corporate jet used by the
companyIs e4ecutives.................................. F
%+. !he cost of renting rooms at a <lorida resort
for the annual sales conference................... F
%,. !he cost of pac3aging the companyEs product F
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9olutions Manual, Chapter ( (*
#$ercise 2-4 $%, minutes&
Cyber.ames
#ncome 9tatement
9ales................................................. J%,+,8,88
8
Cost of goods sold:
;eginning merchandise inventory... J (+8,88
8
/dd: Purchases............................... :,8,888
.oods available for sale.................. %,%:8,888
Deduct: Cnding merchandise
inventory......................................
%08,888 %,8(8,88
8
.ross margin..................................... +*8,888
9elling and administrative
e4penses:
9elling e4pense............................... (%8,888
/dministrative e4pense................... %D8,888 *:8,88
8
Bet operating income........................ J +8,88
8
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(+ Managerial /ccounting, %*th Cdition
#$ercise 2-5 $%, minutes&
Gompac Products
9chedule of Cost of .oods Manufactured
Direct materials:
;eginning raw materials inventory.... J -8,88
8
/dd: Purchases of raw materials....... -:8,88
8
>aw materials available for use........ 0,8,888
Deduct: Cnding raw materials
inventory........................................
+,,88
8
>aw materials used in production..... J 08,,88
8
Direct labor......................................... %*,,888
Manufacturing overhead..................... *08,88
8
!otal manufacturing costs.................... %,(%8,888
/dd: ;eginning wor3 in process
inventory..........................................
%(8,88
8
%,**8,888
Deduct: Cnding wor3 in process
inventory..........................................
%*8,88
8
Cost of goods manufactured................ J%,(88,88
8
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9olutions Manual, Chapter ( (,
#$ercise 2-6 $%, minutes&
/ few of these costs may generate debate. <or e4ample, some
may argue that the cost of advertising a roc3 concert is a variable
cost because the number of people who come to the roc3 concert
depends on the amount of advertising. 7owever, one can argue
that if the price is within reason, any roc3 concert in Bew Aor3 City
will be sold out and the function of advertising is simply to let
people 3now the event will be happening. Moreover, while
advertising may a"ect the number of persons who ultimately buy
tic3ets, the causation is in one direction. #f more people buy
tic3ets, the advertising costs donEt go up.
Cost
Behavior
Cost (Measure of Activity) Variabl
e
i!e
d
%.!he cost of F6ray lm used in the radiology lab
at Kirginia Mason 7ospital in 9eattle $Bumber
of F6rays ta3en&................................................. F
(.!he cost of advertising a roc3 concert in Bew
Aor3 City $Bumber of roc3 concert tic3ets sold&. F
*.!he cost of renting retail space for a McDonaldEs
restaurant in 7ong Long $!otal sales at the
restaurant&........................................................ F
+.!he electrical cost of running a roller coaster at
Magic Mountain $Bumber of times the roller
coaster is run&................................................... F
,.Property ta4es paid by your local cinema
theater $Bumber of tic3ets sold&....................... F
-.!he cost of sales commissions paid to
salespersons at a Bordstrom store $!otal sales
at the store&...................................................... F
0.Property insurance on a Coca Cola bottling
plant $Bumber of cases of bottles produced&..... F
D.!he costs of synthetic materials used to ma3e a
particular model of running shoe $Bumber of
shoes of that model produced&.......................... F
:.!he costs of shipping Panasonic televisions to
retail stores $Bumber of televisions sold&.......... F
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(- Managerial /ccounting, %*th Cdition
%8.!he cost of leasing an ultra6scan diagnostic
machine at the /merican 7ospital in Paris
$Bumber of patients scanned with the
machine&.......................................................... F
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9olutions Manual, Chapter ( (0
#$ercise 2-7 $%, minutes&
Cost Cost "b#ect
$irect
Cost
%ndirec
t Cost
%
.
!he wages of
pediatric nurses
!he pediatric
department F
(
.
Prescription drugs / particular patient
F
*
.
7eating the hospital !he pediatric
department F
+
.
!he salary of the
head of pediatrics
!he pediatric
department F
,
.
!he salary of the
head of pediatrics
/ particular pediatric
patient F
-
.
7ospital chaplainEs
salary
/ particular patient
F
0
.
Gab tests by outside
contractor
/ particular patient
F
D
.
Gab tests by outside
contractor
/ particular
department F
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(D Managerial /ccounting, %*th Cdition
#$ercise 2- $%, minutes&
%tem
$i&erenti
al Cost
"pportunit
y Cost
Sun'
Cost
%
.
Cost of the old F6ray
machine............................. F
(
.
!he salary of the head of the
>adiology Department........
*
.
!he salary of the head of the
Pediatrics Department........
+
.
Cost of the new color laser
printer................................ F
,
.
>ent on the space occupied
by >adiology.......................
-
.
!he cost of maintaining the
old machine........................ F
0
.
;enets from a new DB/
analyzer............................. F
D
.
Cost of electricity to run the
F6ray machines................... F
Bote: !he costs of the salaries of the head of the >adiology
Department and Pediatrics Department and the rent on the space
occupied by >adiology are neither di"erential costs, nor
opportunity costs, nor sun3 costs. !hese costs do not di"er
between the alternatives and therefore are irrelevant in the
decision, but they are not sun3 costs because they occur in the
future.
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9olutions Manual, Chapter ( (:
#$ercise 2-! $%, minutes&
%. Product cost' variable cost
(. Conversion cost
*. Mpportunity cost
+. Prime cost
,. 9un3 cost
-. Period cost' variable cost
0. Product cost' period cost' 4ed cost
D. Product cost
:. Period cost
%8
.
<i4ed cost' product cost' conversion
cost
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*8 Managerial /ccounting, %*th Cdition
#$ercise 2-1" $%, minutes&
Selling and
Cost Behavior
Administrati
ve
Produc
t
Cost %tem Variable i!ed Cost Cost
%. 7amburger buns at
a =endyEs outlet. . F F
(. /dvertising by a
dental oHce......... F F
*. /pples processed
and canned by Del
Monte................... F F
+. 9hipping canned
apples from a Del
Monte plant to
customers............ F F
,. #nsurance on a
;ausch N Gomb
factory producing
contact lenses...... F F
-. #nsurance on #;MEs
corporate
head)uarters........ F F
0. 9alary of a
supervisor
overseeing
production of
printers at
7ewlett6Pac3ard. . . F F
D. Commissions paid
to Cncyclopedia
;ritannica
salespersons........ F F
:. Depreciation of
factory lunchroom
facilities at a
.eneral Clectric
plant..................... F F
%8. 9teering wheels F F
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9olutions Manual, Chapter ( *%
installed in ;M=s.
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*( Managerial /ccounting, %*th Cdition
#$ercise 2-11 $*8 minutes&
%.
Mason Company
9chedule of Cost of .oods Manufactured
Direct materials:
;eginning raw materials inventory........... J 0,888
/dd: Purchases of raw materials.............. %%D,888
>aw materials available for use............... %(,,888
Deduct: Cnding raw materials inventory. . %,,888
>aw materials used in production............ J%%8,88
8
Direct labor................................................ 08,888
Manufacturing overhead............................ D8,888
!otal manufacturing costs........................... (-8,888
/dd: ;eginning wor3 in process inventory. . %8,888
(08,888
Deduct: Cnding wor3 in process inventory. . ,,888
Cost of goods manufactured....................... J(-,,88
8
(. !he cost of goods sold section of Mason CompanyEs income
statement:
;eginning nished goods inventory...... J (8,888
/dd: Cost of goods manufactured......... (-,,888
.oods available for sale....................... (D,,888
Deduct: Cnding nished goods
inventory...........................................
*,,888
Cost of goods sold................................ J(,8,88
8
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9olutions Manual, Chapter ( **
#$ercise 2-12 $*8 minutes&
%. a.;atteries purchased................................................. D,888
;atteries drawn from inventory................................ 0,-88
;atteries remaining in inventory.............................. +88
Cost per battery....................................................... P J%8
Cost in >aw Materials #nventory at /pril *8.............. J+,888
b.;atteries used in production $0,-88 Q %88&............... 0,,88
Motorcycles completed and transferred to <inished
.oods $:8R P 0,,88&............................................ -,0,8
Motorcycles still in =or3 in Process at /pril *8......... 0,8
Cost per battery....................................................... P J%8
Cost in =or3 in Process #nventory at /pril *8........... J0,,88
c.Motorcycles completed and transferred to <inished
.oods $see above&................................................. -,0,8
Motorcycles sold during the month
$08R P -,0,8&....................................................... +,0(,
Motorcycles still in <inished .oods at /pril *8.......... (,8(,
Cost per battery....................................................... P J%8
Cost in <inished .oods #nventory at /pril *8............ J(8,(,8
d.Motorcycles sold during the month $above&............. +,0(,
Cost per battery....................................................... P J%8
Cost in Cost of .oods 9old at /pril *8...................... J+0,(,8
e.;atteries used in salespersonsE motorcycles............ %88
Cost per battery....................................................... P J%8
Cost in 9elling C4pense at /pril *8........................... J %,888
(. >aw Materials #nventory?balance sheet
=or3 in Process #nventory?balance sheet
<inished .oods #nventory?balance sheet
Cost of .oods 9old?income statement
9elling C4pense?income statement
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*+ Managerial /ccounting, %*th Cdition
%roble& 2-13 $*8 minutes&
Bote to the #nstructor: !here may be some e4ceptions to the answers below. !he purpose of
this problem is to get the student to start thin'ing about cost behavior and cost purposes'
try to avoid lengthy discussions about how a particular cost is classied.
Variable
or Selling
Administrativ
e
Manufacturin
g
(Product)
Cost
Cost %tem i!ed Cost Cost
$irec
t %ndirect
%. Property ta4es, factory.......................... < F
(. ;o4es used for pac3aging detergent
produced by the company.................. K F
*. 9alespersonsE commissions................... K F
+. 9upervisorEs salary, factory................... < F
,. Depreciation, e4ecutive autos............... < F
-. =ages of wor3ers assembling
computers.......................................... K F
0. #nsurance, nished goods warehouses. . < F
D. Gubricants for production e)uipment..... K F
:. /dvertising costs................................... < F
%8. Microchips used in producing
calculators.......................................... K F
%%. 9hipping costs on merchandise sold...... K F
%(. Magazine subscriptions, factory
lunchroom.......................................... < F
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9olutions Manual, Chapter ( *,
%*. !hread in a garment factory.................. K F
%+. ;illing costs........................................... K FS
%,. C4ecutive life insurance........................ < F
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*- Managerial /ccounting, %*th Cdition
%roble& 2-13 $continued&
Variable
or Selling
Administrativ
e
Manufacturin
g
(Product)
Cost
Cost %tem i!ed Cost Cost
$irec
t %ndirect
%-. #n3 used in te4tboo3 production............ K F
%0. <ringe benets, assembly6line wor3ers. . K FSS
%D. Aarn used in sweater production............ K F
%:. =ages of receptionist, e4ecutive
oHces................................................. < F
S Could be administrative cost.
SS Could be indirect cost.
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9olutions Manual, Chapter ( *0
%roble& 2-14 $*8 minutes&
Product Cost
Period
(Sellin
g
(ame of the Cost
Variabl
e Cost
i!e
d
Cost
$irect
Material
s
$irec
t
)abor
Manu*
facturing
"verhea
d
and
Admin
) Cost
"ppor
*
tunity
Cost
Sun
'
Cost
>ental revenue forgone,
J*8,888 per year................... F
Direct materials cost, JD8 per
unit........................................ F F
>ental cost of warehouse,
J,88 per month..................... F F
>ental cost of e)uipment,
J+,888 per month.................. F F
Direct labor cost, J-8 per unit. . F F
Depreciation of the anne4
space, JD,888 per year.......... F F F
/dvertising cost, J,8,888 per
year....................................... F F
9upervisorIs salary, J%,,88
per month.............................. F F
Clectricity for machines, J%.(8
per unit.................................. F F
9hipping cost, J: per unit......... F F
>eturn earned on F
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
*D Managerial /ccounting, %*th Cdition
investments, J*,888 per
year.......................................
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9olutions Manual, Chapter ( *:
%roble& 2-15 $*8 minutes&
Cost Behavior
+o Units of
Product
Cost %tem Variable i!ed $irect %ndirect
%. Clectricity to run production e)uipment............ F F
(. >ent on a factory building................................. F F
*. Cloth used to ma3e drapes............................... F F
+. Production superintendentEs salary................... F F
,. =ages of laborers assembling a product........... F F
-. Depreciation of air purication e)uipment used
to ma3e furniture............................................ F F
0. Tanitorial salaries............................................... F F
D. Peaches used in canning fruit........................... F F
:. Gubricants for production e)uipment................. F F
%8. 9ugar used in soft drin3 production................... F F
%%. Property ta4es on the factory............................ F F
%(. =ages of wor3ers painting a product................. F F
%*. Depreciation on cafeteria e)uipment................ F F
%+. #nsurance on a building used in producing
helicopters...................................................... F F
%,. Cost of rotor blades used in producing
helicopters...................................................... F F
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+8 Managerial /ccounting, %*th Cdition
%roble& 2-16 $+, minutes&
%.
9wift Company
9chedule of Cost of .oods Manufactured
<or the Month Cnded /ugust *%
Direct materials:
>aw materials inventory, /ugust %......... J D,88
8
/dd: Purchases of raw materials............. %-,,88
8
>aw materials available for use.............. %0*,888
Deduct: >aw materials inventory,
/ugust *%.............................................
%*,88
8
>aw materials used in production........... J%-8,888
Direct labor............................................... 08,888
Manufacturing overhead........................... D,,888
!otal manufacturing costs......................... *%,,888
/dd: =or3 in process inventory, /ugust %. %-,888
**%,888
Deduct: =or3 in process inventory,
/ugust *%...............................................
(%,888
Cost of goods manufactured..................... J*%8,888
(.
9wift Company
#ncome 9tatement
<or the Month Cnded /ugust *%
9ales......................................................... J+,8,88
8
Cost of goods sold:
<inished goods inventory, /ugust %........ J 
+8,888
/dd: Cost of goods manufactured........... *%8,88
8
.oods available for sale.......................... *,8,888
Deduct: <inished goods inventory,
/ugust *%.............................................
-8,88
8
(:8,888
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
9olutions Manual, Chapter ( +%
.ross margin............................................. %-8,888
9elling and administrative e4penses......... %+(,888
Bet operating income............................... J 
%D,888
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+( Managerial /ccounting, %*th Cdition
%roble& 2-16 $continued&
*. #n preparing the income statement for /ugust, 9am failed to
distinguish between product costs and period costs, and he also
failed to recognize the changes in inventories between the
beginning and end of the month. Mnce these errors have been
corrected, the nancial condition of the company loo3s much
better and selling the company may not be advisable.
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9olutions Manual, Chapter ( +*
%roble& 2-17 $%, minutes&
%. !he controller is correct that the salary cost should be classied
as a selling $mar3eting& cost. !he duties described in the
problem have nothing to do with manufacturing a product, but
rather deal with moving ,nished units from the factory to
distribution warehouses. 9elling costs include all costs
necessary to secure customer orders and to get the nished
product into the hands of customers. Coordination of shipments
of nished units from the factory to distribution warehouses
falls in this category.
(. Bo, the president is not correct. !he reported net operating
income for the year will di"er depending on how the salary cost
is classied. #f the salary cost is classied as a selling e4pense
all of it will appear on the income statement as a period cost.
7owever, if the salary cost is classied as a manufacturing
$product& cost, it will be added to =or3 in Process inventory
along with other manufacturing costs for the period. !o the
e4tent that goods are still in process at the end of the period,
part of the salary cost will remain with these goods in the =or3
in Process inventory account. Mnly that portion of the salary
cost that has been assigned to nished units will leave the =or3
in Process inventory account and be transferred into the
<inished .oods inventory account. #n li3e manner, to the e4tent
that goods are unsold at the end of the period, part of the
salary cost will remain with these goods in the <inished .oods
inventory account. Mnly the portion of the salary that has been
assigned to nished units that are sold during the period will
appear on the income statement as an e4pense $part of Cost of
.oods 9old& for the period. !he remainder of the salary costs
will be on the balance sheet as part of inventories.
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
++ Managerial /ccounting, %*th Cdition
%roble& 2-1 $+, minutes&
%.
Meriwell Company
9chedule of Cost of .oods Manufactured
Direct materials:
>aw materials inventory, beginning..... J  :,888
/dd: Purchases of raw materials.......... %(,,888
>aw materials available for use........... %*+,888
Deduct: >aw materials inventory,
ending............................................... -,888
>aw materials used in production........
J%(D,88
8
Direct labor............................................ 08,888
Manufacturing overhead........................ %8,,888
!otal manufacturing costs....................... *8*,888
/dd: =or3 in process inventory,
beginning............................................. %0,888
*(8,888
Deduct: =or3 in process inventory,
ending................................................. *8,888
Cost of goods manufactured...................
J(:8,88
8
(.
Meriwell Company
#ncome 9tatement
9ales...................................................... J,88,888
Cost of goods sold:
<inished goods inventory, beginning.... J (8,888
/dd: Cost of goods manufactured........ (:8,888
.oods available for sale....................... *%8,888
Deduct: <inished goods inventory,
ending............................................... +8,888 (08,888
.ross margin.......................................... (*8,888
9elling and administrative e4penses:
9elling e4penses.................................. D8,888
/dministrative e4penses...................... %%8,888 %:8,888
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
9olutions Manual, Chapter ( +,
Bet operating income............................. J +8,888
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
+- Managerial /ccounting, %*th Cdition
%roble& 2-1 $continued&
*. Direct materials: J%(D,888 U %8,888 units V J%(.D8 per unit.
<i4ed manufacturing overhead: J:8,888 U %8,888 units V J:.88
per unit.
+. Direct materials:
Wnit cost: J%(.D8 $unchanged&
!otal cost: %,,888 units P J%(.D8 per unit V J%:(,888.
<i4ed manufacturing overhead:
Wnit cost: J:8,888 U %,,888 units V J-.88 per unit.
!otal cost: J:8,888 $unchanged&
,. Wnit cost for 4ed manufacturing overhead dropped from J:.88
to J-.88, because of the increase in production between the
two years. ;ecause 4ed costs do not change in total as the
activity level changes, they will decrease on a unit basis as the
activity level rises.
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
9olutions Manual, Chapter ( +0
%roble& 2-1! $+, minutes&
%.
Cost Behavior
Selling or
Administrati
ve Product Cost
Cost %tem
Variabl
e i!ed Cost $irect
%ndirec
t
<actory labor, direct............... J%%D,88
8
J%%D,88
8
/dvertising............................ J,8,888 J,8,888
<actory supervision................
+8,888
J+8,88
8
Property ta4es, factory
building............................... *,,88 *,,88
9ales commissions................ D8,888 D8,888
#nsurance, factory................. (,,88 (,,88
Depreciation, administrative
oHce e)uipment................. +,888 +,888
Gease cost, factory
e)uipment.......................... %(,888 %(,888
#ndirect materials, factory..... -,888 -,888
Depreciation, factory
building............................... %8,888 %8,888
/dministrative oHce supplies *,888 *,888
/dministrative oHce salaries. -8,888 -8,888
Direct materials used............ :+,888 :+,888
Wtilities, factory..................... (8,88
8
(8,88
8
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
+D Managerial /ccounting, %*th Cdition
!otal costs............................. J*(%,88
8
J%D(,88
8 J%:0,888
J(%(,88
8
J:+,88
8
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
9olutions Manual, Chapter ( +:
%roble& 2-1! $continued&
(.
Direct............................................. J(%(,88
8
#ndirect........................................... :+,88
8
!otal............................................... J*8-,88
8
J*8-,888 U (,888 sets V J%,* per
set
*. !he average product cost per set would increase if the
production drops. !his is because the 4ed costs would be
spread over fewer units, causing the average cost per unit to
rise.
+. a. Aes, the president may e4pect a minimum price of J%,*,
which is the average cost to manufacture one set. 7e might
e4pect a price even higher than this to cover a portion of the
administrative costs as well. !he brother6in6law probably is
thin3ing of cost as including only direct materials, or, at most,
direct materials and direct labor. Direct materials alone would
be only J+0 per set, and direct materials and direct labor
would be only J%8-.
b. !he term is opportunity cost. !he full, regular price of a set
might be appropriate here, because the company is
operating at full capacity, and this is the amount that must
be given up $benet forgone& to sell a set to the brother6in6
law.
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
,8 Managerial /ccounting, %*th Cdition
%roble& 2-2" $*8 minutes&
%.
Product Cost
Period
(Sellin
g
(ame of the Cost
Variabl
e Cost
i!e
d
Cost
$irect
Materia
ls
$irec
t
)abo
r
Manuf-
"verhe
ad
and
Admin
) Cost
"ppor
*
tunity
Cost
Sun
'
Cost
9taciIs current salary,
J*,D88 per month............ F F
;uilding rent, J,88 per
month.............................. F F
Clay and glaze, J( per pot.. F F
=ages of production
wor3ers, JD per pot.......... F F
/dvertising, J-88 per
month.............................. F F
9ales commission, J+ per
pot................................... F F
>ent of production
e)uipment, J*88 per
month.............................. F F
Gegal and ling fees, J,88.. F F F
>ent of sales oHce, J(,8
per month........................ F F
Phone for ta3ing orders, F F
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
,% Managerial /ccounting, %*th Cdition
J+8 per month.................
#nterest lost on savings
account, J%,(88 per
year................................. F F
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
,( Managerial /ccounting, %*th Cdition
%roble& 2-2" $continued&
(. !he J,88 cost of incorporating the business is not a di"erential
cost. Cven though the cost was incurred to start the business, it
is a sun3 cost. =hether 9taci produces pottery or stays in her
present job, she will have incurred this cost.
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
9olutions Manual, Chapter ( ,*
%roble& 2-21 $-8 minutes&
%. 9uperior Company
9chedule of Cost of .oods Manufactured
<or the Aear Cnded December *%
Direct materials:
>aw materials inventory, beginning
$given&..............................................
J +8,888
/dd: Purchases of raw materials
$given&..............................................
(:8,888
>aw materials available for use........... **8,888
Deduct: >aw materials inventory,
ending $given&...................................
%8,888
>aw materials used in production........ J*(8,88
8
Direct labor............................................ :*,888 S
Manufacturing overhead $given&............ (08,888
!otal manufacturing costs $given&.......... -D*,888
/dd: =or3 in process inventory,
beginning............................................
+(,888 S
0(,,888
Deduct: =or3 in process inventory,
ending $given&.....................................
*,,888
Cost of goods manufactured.................. J-:8,88
8
!he cost of goods sold section of the income statement follows:
<inished goods inventory, beginning
$given&.................................................
J ,8,888
/dd: Cost of goods manufactured.......... -:8,888 S
.oods available for sale $given&............. 0+8,888
Deduct: <inished goods inventory,
ending.................................................
D8,888 S
Cost of goods sold $given&...................... J--8,88
8
S !hese items must be computed by wor3ing bac3wards up
through the statements.
(. Direct materials: J*(8,888 U +8,888 units V JD.88 per unit.
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
,+ Managerial /ccounting, %*th Cdition
Manufacturing overhead: J(08,888 U +8,888 units V J-.0, per
unit.
*. Direct materials: JD.88 per unit.
Manufacturing overhead: J(08,888 U ,8,888 units V J,.+8 per
unit.
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
9olutions Manual, Chapter ( ,,
%roble& 2-21 'continued(
+. !he average cost per unit for manufacturing overhead dropped
from J-.0, to J,.+8 because of the increase in production
between the two years. ;ecause 4ed costs do not change in
total as the activity level changes, the average cost per unit will
decrease as the activity level rises.
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
,- Managerial /ccounting, %*th Cdition
%roble& 2-22 $*8 minutes&
%. / cost that is classied as a period cost will be recognized on
the income statement as an e4pense in the current period. /
cost that is classied as a product cost will be recognized on the
income statement as an e4pense $i.e., cost of goods sold& only
when the associated units of product are sold. #f some units are
unsold at the end of the period, the costs of those unsold units
are treated as assets. !herefore, by reclassifying period costs as
product costs, the company is able to carry some costs forward
in inventories that would have been treated as current
e4penses.
(. !he discussion below is divided into two parts?.allantEs actions
to postpone e4penditures and the actions to reclassify period
costs as product costs.
!he decision to postpone e4penditures is )uestionable. #t is one
thing to postpone e4penditures due to a cash bind' it is )uite
another to postpone e4penditures in order to hit a prot target.
Postponing these e4penditures may have the e"ect of
ultimately increasing future costs and reducing future prots. #f
orders to the companyEs suppliers are changed, it may disrupt
the suppliersE operations. !he additional costs may be passed
on to .allantEs company and may create ill will and a feeling of
mistrust. Postponing maintenance on e)uipment is particularly
)uestionable. !he result may be brea3downs, ineHcient andXor
unsafe operations, and a shortened life for the machinery.
#nterestingly, in a survey of -+: managers reported in
Management Accounting, only %(R stated that it is unethical to
defer e4penses and thereby manipulate )uarterly earnings. !he
proportion who felt it was unethical increased to (+R when it
involved annual earnings. /nother +%R said that deferring
e4penses is a )uestionable practice when it involved )uarterly
reports and *,R said this when annual reports were involved.
<inally, +0R said that it is completely ethical to manipulate
)uarterly reports in this way and +%R gave the green light for
annual reports. $9ee =illiam T. ;runs, Tr. and Lenneth /.
Merchant, 1!he Dangerous Morality of Managing Carnings,2
Management Accounting, /ugust %::8, pp. ((6(,&
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
9olutions Manual, Chapter ( ,0
%roble& 2-22 $continued&
.allantEs decision to reclassify period costs is not ethical?
assuming that there is no intention of disclosing in the nancial
reports this reclassication. 9uch a reclassication would be a
violation of the principle of consistency in nancial reporting
and is a clear attempt to mislead readers of the nancial
reports. /lthough some may argue that the overall e"ect of
.allantEs action will be a 1wash2?that is, prots gained in this
period will simply be ta3en from the ne4t period?the trend of
earnings will be a"ected. 7opefully, the auditors would discover
any such attempt to manipulate annual earnings and would
refuse to issue an un)ualied opinion due to the lac3 of
consistency. 7owever, recent accounting scandals may lead to
some s3epticism about how forceful auditors have been in
enforcing tight accounting standards.
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
,D Managerial /ccounting, %*th Cdition
%roble& 2-24 $-8 minutes&
%.
Kisic Corporation
9chedule of Cost of .oods Manufactured
Direct materials:
>aw materials inventory, beginning.............. J 
(8,888
/dd: Purchases of raw materials................... +D8,888
>aw materials available for use.................... ,88,888
Deduct: >aw materials inventory, ending..... *8,888
>aw materials used in production................. J+08,88
8
Direct labor..................................................... :8,888
Manufacturing overhead................................. *88,888
!otal manufacturing costs............................... D-8,888
/dd: =or3 in process inventory, beginning...... ,8,888
:%8,888
Deduct: =or3 in process inventory, ending..... +8,888
Cost of goods manufactured........................... JD08,88
8
(. a. !o compute the number of units in the nished goods
inventory at the end of the year, we must rst compute the
number of units sold during the year.
!otal sales J%,*88,888
V V (-,888 units sold
Wnit selling price J,8 per unit sold
Wnits in the nished goods inventory,
beginning....................................................
8
Wnits produced during the year..................... (:,888
Wnits available for sale.................................. (:,888
Wnits sold during the year $above& ................ (-,888
Wnits in the nished goods inventory, ending *,888
b. !he average production cost per unit during the year is:
g Cost of oods manufactured JD08,888
V V J*8 per unit
Bumber of units produced (:,888 units
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
9olutions Manual, Chapter ( ,:
!hus, the cost of the units in the nished goods inventory at
the end of the year is: *,888 units P J*8 per unit V J:8,888.
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
-8 Managerial /ccounting, %*th Cdition
%roble& 2-24 $continued&
*. Kisic Corporation
#ncome 9tatement
9ales...................................................... J%,*88,888
Cost of goods sold:
<inished goods inventory, beginning.... J 8
/dd: Cost of goods manufactured........ D08,888
.oods available for sale....................... D08,888
<inished goods inventory, ending......... :8,888 0D8,888
.ross margin.......................................... ,(8,888
9elling and administrative e4penses...... *D8,888
Bet operating income............................. J  %+8,888
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
9olutions Manual, Chapter ( -%
%roble& 2-25 $+, minutes&
Case . Case / Case 0 Case 1
Direct materials................................. J +,,88 J -,888 J ,,888 J *,888
Direct labor....................................... :,888 S *,888 0,888 +,888
Manufacturing overhead................... ,,888 +,888 D,888 S :,888
!otal manufacturing costs.................. %D,,88 %*,888 S (8,888 %-,888 S
;eginning wor3 in process inventory. (,,88 (,888 S *,888 +,,88 S
Cnding wor3 in process inventory...... $*,888&S $%,888& $+,888& $*,888&
Cost of goods manufactured.............. J%D,888
J%+,88
8
J%:,88
8 S
J%0,,8
8
9ales................................................. J*8,888
J(%,88
8
J*-,88
8
J+8,88
8
;eginning nished goods inventory... %,888 (,,88 *,,88 S (,888
Cost of goods manufactured.............. %D,888 %+,888 %:,888 S %0,,88
.oods available for sale.................... %:,888 S %-,,88 S ((,,88 S %:,,88 S
Cnding nished goods inventory........ $(,888&S $%,,88& $+,888& $*,,88&
Cost of goods sold............................. %0,888 %,,888 S %D,,88 %-,888 S
.ross margin..................................... %*,888 -,888 S %0,,88 (+,888 S
9elling and administrative e4penses. $:,888&S $*,,88& $%(,,88&S $%,,888& S
Bet operating income........................ J +,888 J (,,88 S J ,,888 J :,888
S Missing data in the problem.
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
-( Managerial /ccounting, %*th Cdition
Case 2-26 $-8 minutes&
!he following cost items are needed before a schedule of cost of
goods manufactured can be prepared:
Materials used in production:
Prime cost............................................. J+%8,88
8
Gess direct labor cost............................ %D8,888
Direct materials cost............................. J(*8,88
8
Manufacturing overhead cost:
Direct labor cost J%D8,888
V
Percentage of conversion cost *8RS
V J-88,888 total conversion cost
S%88R Q 08R V *8R.
Conversion cost.................................... J-88,888
Gess direct labor cost............................ %D8,888
Manufacturing overhead cost................ J+(8,888
Cost of goods manufactured:
.oods available for sale........................ JD%8,888
Gess nished goods inventory,
beginning...........................................
+,,888
Cost of goods manufactured................. J0-,,888
!he easiest way to proceed from this point is to place all 3nown
amounts in a partially completed schedule of cost of goods
manufactured and a partially completed income statement. !hen
ll in the missing amounts by analysis of the available data.
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
9olutions Manual, Chapter ( -*
Case 2-26 $continued&
Direct materials:
>aw materials inventory, beginning................

%D,888
/dd: Purchases of raw materials.....................
(:8,88
8
>aw materials available for use...................... *8D,888
Deduct: >aw materials inventory, ending........ /
>aw materials used in production $see
above&.......................................................... (*8,888
Direct labor cost................................................
%D8,88
8
Manufacturing overhead cost $see above&.........
+(8,88
8
!otal manufacturing costs.................................. D*8,888
/dd: =or3 in process inventory, beginning........
-,,88
8
D:,,888
Deduct: =or3 in process inventory, ending........ ;
Cost of goods manufactured $see above&..........
J0-,,88
8
!herefore, 1/2 $>aw materials inventory, ending& is J0D,888'
and 1;2 $=or3 in process inventory, ending& is J%*8,888.
9ales..........................................................
J%,(88,88
8
Cost of goods sold:
<inished goods inventory, beginning........

+,,888
/dd: Cost of goods manufactured $see
above&................................................... 0-,,888
.oods available for sale........................... D%8,888
Deduct: <inished goods inventory,
ending................................................... C
0(8,88
8
.ross margin..............................................
J +D8,88
8
SJ%,(88,888 P $%88R Q +8R& V J0(8,888.
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
-+ Managerial /ccounting, %*th Cdition
!herefore, 1C2 $<inished goods inventory, ending& is J:8,888.
!he procedure outlined above is just one way in which the
solution to the case can be approached. 9ome may wish to start
at the bottom of the income statement $with gross margin& and
wor3 upwards from that point. /lso, the solution can be
obtained by use of !6accounts.
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
9olutions Manual, Chapter ( -,
Case 2-27 $-8 minutes&
%. Bo distinction has been made between period e4penses and
product costs on the income statement led by the companyEs
accountant. Product costs $e.g., direct materials, direct labor,
and manufacturing overhead& should be assigned to inventory
accounts and @ow through to the income statement as cost of
goods sold only when nished products are sold. ;ecause there
were ending inventories, some of the product costs should
appear on the balance sheet as assets rather than on the
income statement as e4penses.
(. 9olar !echnology, #nc.
9chedule of Cost of .oods Manufactured
<or the Yuarter Cnded March *%
Direct materials:
>aw materials inventory, beginning....... J 8
/dd: Purchases of raw materials............ *-8,888
>aw materials available for use............. *-8,888
Deduct: >aw materials inventory,
ending.................................................
%8,888
>aw materials used in production.......... J*,8,888
Direct labor.............................................. 08,888
Manufacturing overhead.......................... +%8,888
!otal manufacturing costs........................ D*8,888
/dd: =or3 in process inventory,
beginning..............................................
8
D*8,888
Deduct: =or3 in process inventory,
ending...................................................
,8,888
Cost of goods manufactured.................... J0D8,888
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
-- Managerial /ccounting, %*th Cdition
Case 2-27 $continued&
*. ;efore an income statement can be prepared, the cost of the
D,888 batteries in the ending nished goods inventory must be
determined. /ltogether, the company produced +8,888
batteries during the )uarter' thus, the production cost per
battery was:
Cost of goods manufactured J0D8,888
V VJ%:.,8 per unit
;atteries produced during the )uarter +8,888 units
;ecause D,888 batteries $+8,888 Q *(,888 V D,888& were in the
nished goods inventory at the end of the )uarter, the total
cost of this inventory was:
D,888 units P J%:.,8 per unit V J%,-,888.
=ith this and other data from the case, the companyEs income
statement for the )uarter can be prepared as follows:
9olar !echnology, #nc.
#ncome 9tatement
<or the Yuarter Cnded March *%
9ales $*(,888 batteries&....................... J:-8,88
8
Cost of goods sold:
<inished goods inventory, beginning. . J 8
/dd: Cost of goods manufactured ...... 0D8,88
8
.oods available for sale..................... 0D8,888
Deduct: <inished goods inventory,
ending.............................................
%,-,88
8
-(+,888
.ross margin........................................ **-,888
9elling and administrative e4penses..... (:8,888
Bet operating income........................... J +-,888
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
9olutions Manual, Chapter ( -0
Case 2-27 $continued&
+. Bo, the insurance company probably does not owe 9olar
!echnology J((-,888. !he 3ey )uestion is how 1cost2 was
dened in the insurance contract. #t is most li3ely that the
insurance contract limits reimbursement for losses to those
costs that would normally be considered product costs?in other
words, direct materials, direct labor, and manufacturing
overhead. !he J((-,888 is overstated because it includes
elements of selling and administrative e4penses as well as
product costs. !he J((-,888 also does not recognize that some
costs incurred during the period are in the ending >aw Materials
and =or3 in Process inventory accounts, as e4plained in part $%&
above. !he insurance companyEs liability is probably just
J%,-,888, which is the amount of cost associated with the
ending <inished .oods inventory as shown in part $*& above.
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
-D Managerial /ccounting, %*th Cdition
)esearch and Application 2-2
%. Dell succeeds because of its operational e4cellence customer
value proposition. Page % of the %86L $under the heading
;usiness 9trategy& lists the 3ey tenets of DellEs business
strategy. !he rst three tenets focus on operational e4cellence.
!he rst tenet discusses the direct business model, which
1eliminates wholesale and retail dealers that add unnecessary
time and cost or diminish DellEs understanding of customer
e4pectations.2 !he second tenet is DellEs build6to6order
manufacturing process that 1enables Dell to turn over inventory
every four days on average, and reduce inventory levels.2 !he
third tenet is 1DellEs relentless focus on reducing its costs
Zwhich[ allows it to consistently provide customers with superior
value.2 /lso, the rst bullet point on Page D of the %86L says
1DellEs success is based on its ability to protably o"er its
products at a lower price than its competitors.2
(. Dell faces numerous business ris3s as described in pages 06%8
of the %86L. 9tudents may mention other ris3s beyond those
specically mentioned in the %86L. 7ere are four ris3s faced by
Dell with suggested control activities:
• >is3: Prots may fall short if DellEs product, customer, and
geographic mi4 is substantially di"erent than anticipated.
Control activities: Maintain a budgeting program that
forecasts sales by product line, customer segment, and
geographic region. =hile the budget is not going to be
perfectly accurate, a reasonably accurate forecast would
help Dell manage investor e4pectations.
• >is3: Disruptions in component availability from suppliers
could reduce DellEs ability to meet customer orders. !his is of
particular concern for Dell because its lean production
practices result in minimal inventory levels and because Dell
relies on several single6sourced suppliers. Control activities:
Develop a plan with single6sourced suppliers to ensure that
they can produce the necessary components at more than
one plant location and to ensure that each location has more
than one means of delivering the parts to DellEs assembly
facilities.
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
9olutions Manual, Chapter ( -:
)esearch and Application 2-2 $continued&
• >is3: #nfrastructure failures $e.g., computer viruses,
intentional disruptions of #! systems and website outages&
may threaten DellEs ability to boo3 or process orders,
manufacture products, or ship products in a timely manner.
Control activities: #nstall controls such as physical security,
data storage bac3up sites, rewalls and passwords that
protect technology assets.
• >is3: Gosing government contracts could adversely a"ect the
companyEs revenues. Control activities: Develop a formal
review process, supervised by legal counsel, to ensure that
Dell complies with governmental regulations.
*. Pages *+6*, of DellEs <orm %86L contain the audit report issued
by PricewaterhouseCoopers $P=C&. !he audit report ma3es
reference to the role of the Public Company /ccounting
Mversight ;oard $PC/M;& that was created by the 9arbanes6
M4ley /ct of (88( $9MF&. !he audit report also contains two
opinions dealing with internal control. !he rst opinion relates to
managementEs assessment of its internal controls. !he second
opinion relates to the auditorEs assessment of the e"ectiveness
of DellEs internal controls. !hese two opinions were re)uired by
9MF at the time of this %86L ling. Page ,: includes
managementEs report on internal control over nancial
reporting. !his report includes a reference to 9MF. <inally, pages
0-60D contain signed certications from the CCM $Levin >ollins&
and the C<M $Tames 9chneider&. 9MF re)uires the CCM and C<M
to certify that the %86L and its accompanying nancial
statements do not contain any untrue statements and are fairly
stated in all material respects.
+. ;ased solely on the inventories number on the balance sheet,
students cannot determine the answer to this )uestion.
<urthermore, given that DellEs total amount of inventories is so
small, the company does not report the brea3 down of its
inventories between raw materials, wor36in6process, and
nished goods. Bonetheless, students should be able to readily
ascertain that Dell is a manufacturer. Page ( of the %86L says
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08 Managerial /ccounting, %*th Cdition
1Dell designs, develops, manufactures, mar3ets, sells, and
supports a wide range of products that are customized to
customer re)uirements.2 Page , states 1DellEs manufacturing
process consists of assembly,
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
9olutions Manual, Chapter ( 0%
)esearch and Application 2-2 $continued&
software installation, functional testing, and )uality control.2
Page 0 states that Dell has manufacturing facilities in /ustin,
!e4as, Cldorado do 9ul, ;razil, Bashville and Gebanon,
!ennessee, Gimeric3, #reland, Penang, Malaysia, and Fiamen,
China.
,. C4amples of direct inventoriable costs include the component
parts that go into ma3ing DellEs main product families, which
include enterprise systems, client systems, printing and
imaging systems, software, and peripherals. !he 1touch2
laborers that wor3 in each of the aforementioned plants would
also be a direct inventoriable cost. C4amples of indirect
inventoriable costs include the costs to sustain the
manufacturing plants that cannot be conveniently traced to
specic products. !he utility bills, insurance premiums, plant
management salaries, and e)uipment6related costs, etc. that
are incurred to sustain plant operations would all be indirect
inventoriable costs.
!he gross margin $in dollars& has steadily increased and the
gross margin as a percent of sales has remained fairly steady
for two reasons. <irst, the cost of goods sold consists largely of
variable costs $e.g., direct materials and direct labor costs&. /s
sales grow, these variable costs increase in total, but as a
percentage of sales, they remain fairly stable over time.
9ome students may as3 about the 4ed overhead costs that are
incurred to run the plants. 9preading 4ed overhead costs over
a higher volume of sales would increase the gross margin
percentage. 7owever, the 4ed overhead costs are relatively
small in relation to the dollar value of raw materials that @ows
through DellEs plants each year.
9econd, pages ((6(* mention that Dell plans to reduce product
costs in four areas: manufacturing costs, warranty costs, design
costs, and overhead costs. !he company says that its 1general
practice is to aggressively pass on declines in costs to its
customers in order to add customer value while increasing
global mar3et share.2 #n other words, rather than holding price
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
0( Managerial /ccounting, %*th Cdition
constant when costs decline, thereby increasing the gross
margin percentage, the company lowers prices. Wsing
terminology that will be dened in Chapter %(, Dell grows
prots by increasing turnover while holding margin reasonably
constant.
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9olutions Manual, Chapter ( 0*
)esearch and Application 2-2 $continued&
-. !he inventory balance on Tanuary (D, (88, is J+,: million. /s
discussed on Page ( of the %86L, the balance is low because of
DellEs build6to6order $lean& manufacturing process that enables
the company to 1turn over inventory every four days on
average, and reduce inventory levels.2 =hen units are built to
order rather than built to stoc3, it not only reduces nished
goods inventory, it reduces wor36in6process inventory because
large batches of partially completed goods do not accumulate
in front of wor3stations or in temporary storage areas. #t also
reduces raw materials inventory because suppliers provide just6
in6time delivery of the )uantities needed to satisfy customer
orders.
/s stated on page (, this o"ers Dell a competitive advantage
because it allows the company to 1rapidly introduce the latest
relevant technology more )uic3ly than companies with slow6
moving, indirect distribution channels, and to rapidly pass on
component cost savings directly to customers.2
!he negative cash conversion cycle is a good sign for Dell.
/lthough this term is not dened in the chapter, students can
ascertain from page (0 of the %86L that it is computed as
follows: days sales outstanding \ days of supply in inventory Q
days in accounts payable. /s stated on pages (-6(0, the
negative cash conversion cycle means that Dell is 1collecting
amounts due from customers before paying vendors, thus
allowing the company to generate annual cash @ows from
operating activities that typically e4ceed net income.2
0. /s shown on page (*, DellEs two main categories of operating
e4penses are selling, general, and administrative $J+,(:D
million& and research, development, and engineering $J+-*
million&. Page +( e4plains that DellEs selling, general, and
administrative e4penses 1include items such as sales
commissions, mar3eting and advertising costs, and contractor
services.2 #t also mentions that advertising costs totaled J,0-
million in scal (88,. .eneral and administrative costs include
1<inance, Gegal, 7uman >esources and information technology
support.2 DellEs website development costs are included in
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0+ Managerial /ccounting, %*th Cdition
>esearch, Development, and Cngineering costs along with
payroll, infrastructure, and administrative costs related directly
to research and development.
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9olutions Manual, Chapter ( 0,
)esearch and Application 2-2 $continued&
<or nancial reporting purposes, costs are classied as either
product costs or period costs. Product costs include those costs
involved with ma3ing or ac)uiring the product. Period costs
include all costs that are not product costs. !he e4penses
mentioned in the paragraph above are not involved with
ma3ing the product so they are e4pensed as incurred. =hen the
focus changes from e4ternal reporting to internal decision
ma3ing, the need to comply with .//P disappears. 9o for
e4ample, on page +( it says 1>esearch, development, and
engineering costs are e4pensed as incurred, in accordance with
9</9 Bo. (, Accounting for 2esearch and $evelopment Costs.2
7owever, for internal reporting purposes it may be entirely
appropriate to assign some research and development costs to
particular products.
D. 7ere are four e4amples of cost objects for Dell including one
direct and one indirect cost for each cost object.
• / product line, such as a particular type of server. / direct
cost would be the cost of raw material component parts and
an indirect cost would be factory utility costs.
• / particular product family, such as enterprise systems,
which according to page ( includes servers, storage,
wor3stations, and networ3ing products. / direct cost would
be the component parts used to ma3e these products and an
indirect cost would be factory insurance costs that are
assigned to these products.
• / particular geographic region, such as /sia Pacic6Tapan,
which is mentioned on page ,,. / direct cost would be the
salary of =illiam /melio, 9enior Kice6President, /sia Pacic6
Tapan $see page %%& and an indirect cost would be the salary
of Martin T. .arvin, 9enior Kice President, =orldwide
Procurement and .lobal Customer C4perience $see page %%&,
given that he oversees worldwide procurement operations.
• / particular customer segment, such as the government
segment as mentioned on page +. / direct cost would be a
sales representative who is dedicated to serving the
government segment and an indirect cost would be research
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
0- Managerial /ccounting, %*th Cdition
and development costs that are e4pended on products
purchased by more than one customer segment.
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9olutions Manual, Chapter ( 00
Appendi$ 2A
*urther Classi+cation o, -abor Costs
#$ercise 2A-1 $%8 minutes&
Direct labor $*+ hours P J%, per hour&.... J,%8
Manufacturing overhead
$idle time: - hours P J%, per hour&..... :8
!otal wages earned................................. J-88
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
0D Managerial /ccounting, %*th Cdition
#$ercise 2A-2 $%8 minutes&
Direct labor $+, hours P J%+ per hour&.... J-*8
Manufacturing overhead
$overtime: , hours P J0 per hour&....... *,
!otal wages earned................................. J--,
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
9olutions Manual, /ppendi4 (/ 0:
#$ercise 2A-3 $%, minutes&
%. Bo. #t appears that the overtime spent completing the job was
simply a matter of how the job happened to be scheduled.
Wnder these circumstances, an overtime premium probably
should not be charged to a customer whose job happens to fall
at the end of the dayEs schedule.
(. Direct labor $: hours P J%+ per hour&.......... J%(-
.eneral overhead $% hour P J0 per hour&. . . 0
!otal cost..................................................... J%**
*. / charge for an overtime premium might be justied if the
customer re)uested a 1rush2 order that caused the overtime.
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D8 Managerial /ccounting, %*th Cdition
#$ercise 2A-4 $%, minutes&
%. Direct labor $*% hours P J%+ per hour& J+*+
Manufacturing overhead
$idle time: : hours P J%+ per hour&... %(-
!otal cost............................................. J,-8
(. Direct labor $+D hours P J%+ per hour& J-0(
Manufacturing overhead
$overtime: D hours P J0 per hour&.... ,-
!otal cost............................................. J0(D
*. / company could treat the cost of fringe benets relating to
direct labor wor3ers as part of manufacturing overhead. !his
approach spreads the cost of such fringe benets uniformly
over all units of output. /lternatively, the company could treat
the cost of fringe benets relating to direct labor wor3ers as
additional direct labor cost. !his latter approach charges the
costs of fringe benets to specic jobs rather than to all units of
output.
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
9olutions Manual, /ppendi4 (/ D%
%roble& 2A-5 $*8 minutes&
%. !otal wages for the wee3:
>egular time $+8 hours P J(8 per hour&.......... JD88
Mvertime $- hours P J*8 per hour&.................. %D8
!otal wages........................................................ J:D8
/llocation of total wages:
Direct labor $+- hours P J(8 per hour&............ J:(8
Manufacturing overhead
$Mvertime: - hours P J%8 per hour&.............. -8
!otal wages........................................................ J:D8
(. !otal wages for the wee3:
>egular time $+8 hours P J(8 per hour&.......... J D88
Mvertime $D hours P J*8 per hour&.................. (+8
!otal wages...................................................... J%,8+8
/llocation of total wages:
Direct labor $+, hours P J(8 per hour&............ J :88
Manufacturing overhead:
$#dle time: * hours P J(8 per hour&............... J-8
$Mvertime: D hours P J%8 per hour&.............. D8 %+8
!otal wages...................................................... J%,8+8
*. !otal wages and fringe benets for the wee3:
>egular time $+8 hours P J(8 per hour&.......... J D88
Mvertime $%8 hours P J*8 per hour&................ *88
<ringe benets $,8 hours P J- per hour&......... *88
!otal wages and fringe benets........................ J%,+88
/llocation of wages and fringe benets:
Direct labor $+D hours P J(8 per hour&............ J :-8
Manufacturing overhead:
$#dle time: ( hours P J(8 per hour&............... J +8
$Mvertime: %8 hours P J%8 per hour&............ %88
$<ringe benets: ,8 hours P J- per hour&...... *88 ++8
!otal wages and fringe benets........................ J%,+88
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
D( Managerial /ccounting, %*th Cdition
%roble& 2A-5 $continued&
+. /llocation of wages and fringe benets:
Direct labor:
=age cost $+D hours P J(8 per hour&............ J:-8
<ringe benets $+D hours P J- per hour&....... (DD J%,(+D
Manufacturing overhead:
$#dle time: ( hours P J(8 per hour&............... +8
$Mvertime: %8 hours P J%8 per hour&............ %88
$<ringe benets: ( hours P J- per hour&........ %( %,(
!otal wages and fringe benets........................ J%,+88
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
9olutions Manual, /ppendi4 (/ D*
Appendi$ 2.
Cost o, Qualit/
#$ercise 2.-1 $%8 minutes&
%. Yuality of conformance
(. Yuality costs
*. Yuality circles
+. Prevention costs, appraisal costs
,. #nternal failure costs, e4ternal failure costs
-. C4ternal failure costs
0. /ppraisal costs
D. Prevention costs
:. #nternal failure costs
%8. C4ternal failure costs
%%. Prevention costs, appraisal costs
%(. Yuality cost report
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
D+ Managerial /ccounting, %*th Cdition
#$ercise 2.-2 $%, minutes&
%.
Preventio
n Cost
Appraisa
l Cost
%nternal
ailure
Cost
3!ternal
ailure
Cost
a. Product testing................ F
b. Product recalls................ F
c. >ewor3 labor and
overhead...................... F
d. Yuality circles................. F
e. Downtime caused by
defects......................... F
f. Cost of eld servicing...... F
g. #nspection of goods......... F
h. Yuality engineering........ F
i. =arranty repairs............. F
j. 9tatistical process
control.......................... F
3. Bet cost of scrap............. F
l. Depreciation of test
e)uipment.................... F
m. >eturns and allowances
arising from poor
)uality.......................... F
n. Disposal of defective
products....................... F
o. !echnical support to
suppliers....................... F
p. 9ystems development..... F
). =arranty replacements... F
r. <ield testing at customer
site............................... F
s. Product design................. F
(. Prevention costs and appraisal costs are incurred in an e"ort to
3eep poor )uality of conformance from occurring. #nternal and
e4ternal failure costs are incurred because poor )uality of
conformance has occurred.
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
9olutions Manual, /ppendi4 (; D,
%roble& 2.-3 $-8 minutes&
%. <lore4 Company
Yuality Cost >eport
)ast 4ear +his 4ear
Amount
(in
thousand
s)
Percen
t of
Sales
Amount
(in
thousand
s)
Percent
of
Sales
Prevention costs:
Yuality engineering..... J +(8 8.,- J ,08 8.0-
9ystems development. +D8 8.-+ 0,8 %.88
9tatistical process
control....................... 8 8.88 %D8 8.(+
!otal prevention costs..... :88 %.(8 %,,88 (.88
/ppraisal costs
#nspection.................... 0,8 %.88 :88 %.(8
Product testing............. D%8 %.8D %,(88 %.-8
9upplies used in
testing....................... *8 8.8+ -8 8.8D
Depreciation of
testing e)uipment..... (%8 8.(D (+8 8.*(
!otal appraisal costs..... %,D88 (.+8 (,+88 *.(8
#nternal failure costs:
Bet cost of scrap.......... -*8 8.D+ %,%(, %.,8
>ewor3 labor................ %,8,8 %.+8 %,,88 (.88
Disposal of defective
products.................... 0(8 8.:- :0, %.*8
!otal internal failure
costs............................ (,+88 *.(8 *,-88 +.D8
C4ternal failure costs:
Cost of eld servicing... %,(88 %.-8 :88 %.(8
=arranty repairs.......... *,-88 +.D8 %,8,8 %.+8
Product recalls............. (,%88 (.D8 0,8 %.88
!otal e4ternal failure
costs............................ -,:88 :.(8 (,088 *.-8
!otal )uality cost............ J%(,888 %-.88 J%8,(88 %*.-8
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
D- Managerial /ccounting, %*th Cdition
%roble& 2.-3 $continued&
(.
$0
$2,000
$4,000
$6,000
$8,000
$10,000
$12,000
$14,000
Last Year This Year
Q
u
a
l
i
t
y

C
o
s
t
s

(
i
n

t
h
o
u
s
a
n
d
s
)
External Failure
Internal Failure
Appraisal
Prevention
0
2
4
6
8
10
12
14
16
18
Last Year This Year
Q
u
a
l
i
t
y

C
o
s
t
s

a
s

a

P
e
r
c
e
n
t
a
g
e

o
f

S
a
l
e
s
External Failure
Internal Failure
Appraisal
Prevention
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
9olutions Manual, /ppendi4 (; D0
%roble& 2.-3 $continued&
*. !he overall impact of the companyEs increased emphasis on
)uality over the past year has been positive in that total )uality
costs have decreased from %-R of sales to %*.-R of sales.
Despite this improvement, the company still has a poor
distribution of )uality costs. !he bul3 of the )uality costs in both
years is traceable to internal and e4ternal failure, rather than to
prevention and appraisal. /lthough the distribution of these
costs is poor, the trend this year is toward more prevention and
appraisal as the company has given more emphasis on )uality.
Probably due to the increased spending on prevention and
appraisal activities during the past year, internal failure costs
have increased by one half, going from J(.+ million to J*.-
million. !he reason internal failure costs have gone up is that,
through increased appraisal activity, defects are being caught
and corrected before products are shipped to customers. !hus,
the company is incurring more cost for scrap, rewor3, and so
forth, but it is saving huge amounts in eld servicing, warranty
repairs, and product recalls. C4ternal failure costs have fallen
sharply, decreasing from J-.: million last year to just J(.0
million this year.
#f the company continues its emphasis on prevention and
appraisal?and particularly on prevention?its total )uality costs
should continue to decrease in future years. /lthough internal
failure costs are increasing for the moment, these costs should
decrease in time as better )uality is designed into products.
/ppraisal costs should also decrease as the need for inspection,
testing, and so forth decreases as a result of better engineering
and tighter process control.
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
DD Managerial /ccounting, %*th Cdition
%roble& 2.-4 $-8 minutes&
%. /n analysis of the companyEs )uality cost report is presented
below:
)ast 4ear +his 4ear
Amoun
t Percent5
Amoun
t Percent5
Prevention costs:
Machine
maintenance......... J08 %.0 %8.+ J %(8 (., (8.*
!raining suppliers..... 8 8.8 8.8 %8 8.( %.0
Yuality circles.......... 8 8.8 8.8 (8 8.+ *.+
!otal prevention
costs........................ 08 %.0 %8.+ %,8 *.% (,.+
/ppraisal costs:
#ncoming
inspection.............. (8 8., *.8 +8 8.D -.D
<inal testing............. D8 %.: %%.: :8 %.: %,.*
!otal appraisal costs. . . %88 (.+ %+.: %*8 (.0 ((.8
#nternal failure costs:
>ewor3..................... ,8 %.( 0., %*8 (.0 ((.8
9crap....................... +8 %.8 -.8 08 %., %%.:
!otal internal failure
costs........................ :8 (.% %*.+ (88 +.( **.:
C4ternal failure
costs:
=arranty repairs...... :8 (.% %*.+ *8 8.- ,.%
Customer returns..... *(8 0.- +0.D D8 %.0 %*.-
!otal e4ternal failure
costs........................ +%8 :.D -%.( %%8 (.* %D.-
!otal )uality cost........ J-08
%-.
8
%88.
8 J ,:8
%(.
*
%88.
8
!otal production cost. .
J+,(8
8
J+,D8
8
S Percentage gures may not add down due to rounding.
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
9olutions Manual, /ppendi4 (; D:
%roble& 2.-4 $continued&
<rom the above analysis it would appear that Mercury, #nc.Es
program has been successful.
• !otal )uality costs have declined from %-.8R to %(.*R as a
percentage of total production cost. #n dollar amount, total
)uality costs went from J-08,888 last year to J,:8,888 this
year.
• C4ternal failure costs, those costs signaling customer
dissatisfaction, have declined from :.DR of total production
costs to (.*R. !hese declines in warranty repairs and
customer returns should result in increased sales in the
future.
• /ppraisal costs have increased from (.+R to (.0R of total
production cost.
• #nternal failure costs have increased from (.%R to +.(R of
production costs. !his increase has probably resulted from
the increase in appraisal activities. Defective units are now
being spotted more fre)uently before they are shipped to
customers.
• Prevention costs have increased from %.0R of total
production cost to *.%R and from %8.+R of total )uality costs
to (,.+R. !he JD8,888 increase is more than o"set by
decreases in other )uality costs.
(. !he initial e"ect of emphasizing prevention and appraisal was
to reduce e4ternal failure costs and increase internal failure
costs. !he increase in appraisal activities resulted in catching
more defective units before they were shipped to customers. /s
a conse)uence, rewor3 and scrap costs increased. #n the future,
an increased emphasis on prevention should result in a
decrease in internal failure costs. /nd as defect rates are
reduced, resources devoted to appraisal can be reduced.
*. !o measure the cost of not implementing the )uality program,
management could assume that sales and mar3et share would
continue to decline and then calculate the lost prot. Mr,
management might assume that the company will have to cut
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
:8 Managerial /ccounting, %*th Cdition
its prices to hang on to its mar3et share. !he impact on prots
of lowering prices could be estimated.
5 !he Mc.raw67ill Companies, #nc., (8%8. /ll rights reserved.
9olutions Manual, /ppendi4 (; :%