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Cost Accounting

A Managerial Emphasis
thirteenth edition

Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

2009 Pearson Prentice Hall. All rights reserved.

1-1

This presentation includes:


Exercises 1-18, 1-21
Problem 1-25

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1-2

Exercise 1-18
Value chain and classification of costs Classify each of the cost
items (ah) as one of the business functions of the value chain
shown in Exhibit 1-2 (p. 7).
Burger King, a hamburger fast food restaurant, incurs the following
costs:
a. Cost of oil for the deep fryer

a. Production

b. Wages of the counter help who


give customers the food they
order

b. Production

c. Cost of the costume for the


King on the Burger King television
commercials
d. Cost of childrens toys given
away free with kids meals
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c. Distribution

d.

Marketing
1-3

Value chain and classification of costs


e. Cost of the posters indicating
the special two cheeseburgers for
$2

e. Marketing

f. Costs of frozen onion rings and


French fries

f. Production

g. Salaries of the food specialists


who create new sandwiches for the
restaurant chain

g. Design of products, services


or processes

h. Cost of to-go bags requested


by customers who could not finish
their meals in the restaurant

h. Customer service

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1-4

Exercise 1-21
Five-step decision-making process, manufacturing
Garnicki Foods makes frozen dinners that it sells through
grocery stores. Typical products include turkey dinners, pot
roast, fried chicken, and meat loaf.
The managers at Garnicki have recently introduced a line
of frozen chicken pies. They take the following actions with
regard to this decision.
Classify each action as a step in the five-step decisionmaking process (identify the problem and uncertainties,
obtain information, make predictions about the future,
choose among alternatives, implement the decision,
evaluate performance, and learn).
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1-5

Five-step decision-making process


a.Garnicki performs a taste test at the local shopping mall
to see if consumers like the taste of its proposed new
chicken pie product.
Obtain information

b. Garnicki sales managers estimate they will sell more


meat pies in their northern sales territory than in their
southern sales territory.
Make predictions about the future

c. Garnicki managers discuss the possibility of


introducing a new product.
Identify the problem and uncertainties
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1-6

Five-step decision-making process


d. Garnicki managers compare actual costs of making
chicken pies with their budgeted costs.

Implement the decision, evaluate performance, and learn


e. Costs for making chicken pies are budgeted.
Make predictions about the future

f. Garnicki decides to make chicken pies.


Make decisions by choosing among alternatives
g. The purchasing manager calls a supplier to check the
prices of chicken.

Obtain information
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1-7

Problem 1-25
Strategic decisions and management
accounting A series of independent situations in
which a firm is about to make a strategic decision
follow.
1. For each decision, state whether the company is
following a low price or a differentiated product
strategy.
2. For each decision, discuss what information the
management accountant can provide about the
source of competitive advantage for these firms.
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1-8

a. Roger Phones is about to decide whether to


launch production and sale of a cell phone with
standard features.
Low price strategy
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
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1-9

b. Computer Magic is trying to decide whether to


produce and sell a new home computer software
package that includes the ability to interface with a
sewing machine and a vacuum cleaner. There is
no such software currently on the market.
Differentiated product strategy
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
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1-10

c. Christina Cosmetics has been asked to provide


a store brand lip gloss that will be sold at
discount retail stores.
Low price strategy
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
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1-11

d. Marcus Meats is entertaining the idea of


developing a special line of gourmet bologna made
with sun dried tomatoes, pine nuts, and artichoke
hearts.
Differentiated product strategy
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
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1-12

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1-13

Cost Accounting
A Managerial Emphasis
thirteenth edition

Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

2009 Pearson Prentice Hall. All rights reserved.

2 -14

This presentation includes:


Exercises 2-17, 2-23, 2-27

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2 -15

Exercise 2-17
Direct, indirect, fixed and variable costs Ceramica
Company manufactures three kinds of hand painted
ceramic figurines in a two-step process.
The first step is automated; in the Baking Department a
machine presses the clay figurines into molds and bakes
them. In the Painting Department the baked figurines are
carefully removed from their molds and hand painted. After
they dry, the figurines are packed and shipped to
customers.
Ceramicas two departments, Baking and Painting, are in a
single factory building. Packaging takes place in the
Painting Department.

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2 -16

1. Costs involved in the process are listed below.


For each cost below, indicate whether it is a direct
variable, direct fixed, indirect variable or indirect
fixed cost, assuming units of production of each
kind of figurine is the cost object.
Costs:
a. Clay

a. Direct, variable

b. Paint

b. Direct, variable

c. Direct (or could be indirect if small


and not traced to each unit), variable
d. Depreciation on machinery and d. Indirect, fixed (unless units of
output depreciation, which then
molds
would be variable)
c. Packaging materials

e. Rent on factory

e. Indirect, fixed

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2 -17

More costs
f.

Indirect, fixed

g. Painters

g.

Direct, variable

h. Painting Department manager

h.

Indirect, fixed

i.

Indirect, fixed

j.

Depends on how they are paid. Most likely indirect


fixed if salaried

k. Custodian in factory

k.

Indirect, fixed

l. Night guard in factory

l.

Indirect, fixed

m. Machinist (running the baking machine)

m. Depends on how they are paid. Most likely indirect


fixed, if salaried

n. Machine maintenance personnel

n.

Indirect, probably fixed, if salaried, but may be


variable if paid only for time worked and
maintenance increases with increased production

o. Maintenance supplies for factory

o.

Indirect, variable

p. Cleaning supplies for factory

p.

Indirect, most likely fixed since the custodians


probably do the same amount of cleaning every
night

f. Insurance on factory

i. Baking Department manager


j. Materials handlers

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2 -18

2. If the cost object were Baking


Department rather than output, which costs
above would now be direct instead of
indirect costs?
Anything directly associated with the Baking
Department will be a direct cost.
Including:
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)
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.
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2 -19

Exercise 2-23
Variable costs, fixed costs, relevant range
Yumball Candies manufactures jaw-breaker
candies in a fully automated process. The machine
that produces candies was purchased recently and
can make 4,000 per month. The machine costs
$6,000 and is depreciated using straight line
depreciation over ten years assuming zero
residual value. Rent for the factory space and
warehouse, and other fixed manufacturing
overhead costs total $1,000 per month.
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2 -20

More information
Yumball currently makes and sells 3,000 jawbreakers per month. Yumball buys just enough
materials each month to make the jaw-breakers it
needs to sell. Materials cost 10 cents per
jawbreaker.
Next year Yumball expects demand to increase by
100%. At this volume of materials purchased, it will
get a 10% discount on price. Rent and other fixed
manufacturing overhead costs will remain the
same.
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2 -21

1. What is Yumballs current annual


relevant range of output?
The production capacity is 4,000 jaw
breakers per month, the current annual
relevant range of output is 0 to 48,000 jaw
breakers.
(4,000 12 months = 48,000)

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2 -22

2. What is the annual fixed manufacturing


cost within the relevant range? What is
the variable manufacturing cost?
Current annual fixed manufacturing costs within
the relevant range:
$1,000 12 = $12,000 for rent and other
overhead costs, plus $6,000 10 = $600 for
depreciation totaling $12,600.
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.

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2 -23

3. What will Yumballs relevant range of output


be next year? How if at all, will fixed and variable
manufacturing costs change next year?
If demand changes from 3,000 to 6,000 per month,
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.

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2 -24

3. What will Yumballs relevant range of output be


next year? How if at all, will fixed and variable
manufacturing costs change next year?
Assume the costs and depreciation of second machine are
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.
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2 -25

Exercise 2-27
Total and unit cost, decision making Grahams
Glassworks makes glass flanges for scientific use.
Materials cost $1 per flange, and the glass blowers
are paid a wage rate of $20 per hour. A glass
blower blows 10 flanges per hour. Fixed
manufacturing costs for flanges are $20,000 per
period. Period (non manufacturing) costs
associated with flanges are $10,000 per period,
and are fixed.

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2 -26

1. Graph the fixed, variable and total


manufacturing cost for flanges, using units
(number of flanges) on the x-axis.
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

Num ber 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 for direct manufacturing labor.
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2 -27

2. Assume Grahams Glassworks manufactures


and sells 5,000 flanges this period. Their
competitor, Freds Flasks, sells flanges for $8.25
each. Can Graham sell below Freds price and still
make a profit on the flanges?

Grahams Glassworks cannot sell below $8.25 per flange


and make a profit; the company will have an operating loss
of $3,750.
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2 -28

3. How would your answer to requirement 2 differ


if Grahams Glassworks made and sold 10,000
flanges this period? Why? What does this indicate
about the use of unit cost in decision making?

Grahams 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.
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2 -29

The reason the unit cost decreases significantly is


that inventoriable (manufacturing) fixed costs and
fixed period (non manufacturing) costs remain the
same regardless of the number of units produced.
As Grahams 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.

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2 -30

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2 -31

Cost Accounting
A Managerial Emphasis
thirteenth edition

Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

2009 Pearson Prentice Hall. All rights reserved.

3-32

This presentation includes:


Exercises 3-19, 3-20, 3-24

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3-33

Exercise 3-19
CVP exercises The Super Donut owns and
operates six doughnut outlets in and around
Kansas City.
You are given the following corporate budget data
for next year:
Revenues $10,000,000
Fixed costs $ 1,800,000
Variable costs $ 8,000,000
Variable costs change with respect to the number
of doughnuts sold.
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3-34

Compute the budgeted operating income for


each of the following deviations from the
original budget data. (Consider each case
independently.)
1. A 10% increase in contribution margin, holding
revenues constant
2. A 10% decrease in contribution margin,
holding revenues constant

G stands for given


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3-35

3. A 5% increase in fixed costs


4. A 5% decrease in fixed costs

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3-36

5. An 8% increase in units sold


6. An 8% decrease in units sold

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3-37

7. A 10% increase in fixed costs and a 10%


increase in units sold
8. A 5% increase in fixed costs and a 5%
decrease in variable costs

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3-38

Exercise 3-20
CVP exercises The Doral Company
manufactures and sells pens. Currently,
5,000,000 units are sold per year at $0.50
per unit. Fixed costs are $900,000 per year.
Variable costs are $0.30 per unit.
Consider each case separately.

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3-39

1a. What is the current annual operating


income?
[Units sold (Selling price Variable costs)] Fixed costs
= Operating income

[5,000,000 ($0.50 $0.30)] $900,000 = $100,000

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3-40

1b. What is the present breakeven point in


revenues?
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:

contribution margin ratio= selling price variable costs


selling price
= $0.50-$0.30 = 0.40
0.50
Fixed costs contribution margin ratio = breakeven revenues

$900,000 0.40 = $2,250,000


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3-41

2. Compute the new operating income for


each of the following changes:
a. A $0.04 per unit increase in variable costs
5,000 ($0.50-$0.34)-$900,000 = $(100,000)
b. A 10% increase in fixed costs and a 10% increase in units
sold
5,000,000 (1.1) ($0.50 $0.30)] [$900,000 (1.1)]
= $110,000

c. A 20% decrease in fixed costs, a 20% decrease in selling


price, a 10% decrease in variable cost per unit, and a 40%
increase in units sold
[5,000,000 (1.4) ($0.40 $0.27)] [$900,000 (0.8)]
= $190,000
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3-42

3. Compute the new breakeven point in


units for each of the following changes:
a. A 10% increase in fixed costs
$900,000 (1.1) ($0.50 $0.30)
=4,950,000 units
b. A 10% increase in selling price and a
$20,000 increase in fixed costs
($900,000 + $20,000) ($0.55 $0.30)
=3,680,000 units
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3-43

Exercise 3-24

CVP analysis, margin of safety Suppose


Lattin Corp.s breakeven point is revenues of
$1,500,000. Fixed costs are $600,000.

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3-44

1. Compute the contribution margin


percentage.
Breakeven point revenues =

Fixed costs

Contribution margin percentage

Contribution margin percentage = $600,000 = 0.40 or 40%


1,500,000

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3-45

2. Compute the selling price if variable costs


are $15 per unit.

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3-46

3. Suppose 80,000 units are sold. Compute


the margin of safety in units and dollars.

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3-47

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3-48

Cost Accounting
A Managerial Emphasis
thirteenth edition

Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

2009 Pearson Prentice Hall. All rights reserved.

4-49

This presentation includes:

Exercise 4-16, 17, 18

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4-50

Exercise 4-16
Job costing, process costing In each of the following
situations, determine whether job costing or process
costing would be more appropriate.
a)
b)
c)
d)
e)
f)
g)
h)

A CPA firm
An oil refinery
A custom furniture
manufacturer
A tire manufacturer
A textbook publisher
A pharmaceutical company
An advertising agency
An apparel manufacturing
plant

Job costing
Process costing
Job costing
Process costing
Job costing
Process costing
Job costing
Job costing (some process)

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4-51

Job costing, process costing


i)
j)
k)
l)
m)
n)
o)
p)
q)
r)
s)
t)
u)

A flour mill
A paint manufacturer
A medical care facility
A landscaping company
A cola-drink-concentrate producer
A movie studio
A law firm
A commercial aircraft manufacturer
A management consulting firm
A breakfast-cereal company
A catering service
A paper mill
An auto repair shop

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Process costing
Process costing
Job costing
Job costing
Process costing
Job costing
Job costing
Job costing
Job costing
Process costing
Job costing
Process costing
Job costing

4-52

Exercise 4-17
Actual costing, normal costing, accounting for manufacturing
overhead. Actual costing, normal costing, accounting for
manufacturing overhead.

Destin Products uses a job-costing system with two directcost categories (direct materials and direct manufacturing
labor) and one manufacturing overhead cost pool. Destin
allocates manufacturing overhead costs using direct
manufacturing labor costs. Destin provides the following
information:

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4-53

1. Compute the actual and budgeted


manufacturing overhead rates for 2009.
Budgeted Manufacturing
Overhead Rate

Actual Manufacturing
Overhead Rate

Budgeted Manufacturing
Overhead Costs
Budgeted Direct
Manufacturing Labor

$2,700,000
$1,500,000

= 1.80 or 180%

Actual Manufacturing
Overhead Costs
Actual Direct
Manufacturing Labor

$2,755,000
$1,450,000
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= 1.90 or 190%

4-54

2. During March, the job-cost record for Job 626


contained the following information:
Direct materials used $40,000
Direct manufacturing labor costs $30,000
Compute the cost of Job 626 using (a) actual costing and
(b) normal costing.
Actual
Normal
Cost
Cost
Direct materials
$40,000
$40,000
Direct manufacturing labor cost
30,000
30,000
Manufacturing overhead costs
$30,000 1.90; $30,000 1.80
Total manufacturing costs of Job 626

57,000
$127,000

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54,000
$124,000

4-55

3. At the end of 2009, compute the under- or overallocated


manufacturing overhead under normal costing. Why is there
no under- or overallocated overhead under actual costing?
Total manufacturing overhead

Actual manufacturing

=
There
is no
underor costing
labor costs
allocated
under
normal
overallocated overhead under
actual costing because
overhead is allocated under
= $1,450,000
actual costing by multiplying
actual manufacturing labor
= $2,610,000
costs and the actual
manufacturing overhead rate.
=
Underallocated manufacturing
= Actual manufacturing
overhead costs
This, of course
equals the
overhead
actual manufacturing overhead
costs. All actual overhead costs
are allocated to products.
= $2,755,000
Hence, there is no under- or
over allocated overhead.

Budgeted
overhead rate

1.80

Manufacturing
overhead allocated

$2,610,000

= $145,000

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4-56

Exercise 4-18
Job costing, normal and actual costing.
Anderson Construction assembles residential
houses. It uses a job-costing system with two
direct-cost categories (direct materials and direct
labor) and one indirect-cost pool (assembly
support).
Direct labor-hours is the allocation base for
assembly support costs. In December 2007,
Anderson budgets 2008 assembly-support costs
to be $8,000,000 and 2008 direct labor hours to
be 160,000.

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4-57

At the end of 2008, Anderson is comparing the costs of


several jobs that were started and completed in 2008.

Direct materials and direct labor are paid for on a contract


basis. The costs of each are known when direct materials are
used or when direct labor-hours are worked. The 2008 actual
assembly-support costs were $6,888,000, and the actual
direct labor-hours were 164,000.

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4-58

These rate
rates differ
1. Compute the (a) budgeted indirect-cost
and
because both the
(b) actual indirect-cost rate. Why do they
differ?
numerator
and the

Budgeted Indirect Cost Rate

Actual Indirect Cost Rate

denominator in the
two calculations are
Budgeted Indirect
differentone based
Costs
on budgeted
Budgeted Direct numbers and the
Labor Hours
other based on
actual numbers.

$8,000,000
160,000 hours

= $50 per dl hour

Actual Indirect
Costs
Actual Direct
Labor Hours

$6,888,000
164,000 hours

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= $42 per dl hour

4-59

2. What are the job costs of the Laguna Model and


the Mission Model using (a) normal costing and
(b) actual costing?

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4-60

3. Why might Anderson Construction prefer normal


costing over actual costing?
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.

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4-61

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4-62

Cost Accounting
A Managerial Emphasis
thirteenth edition

Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

2009 Pearson Prentice Hall. All rights reserved.

5-63

This presentation includes:


Exercise 5-17
Problems 5-28, 33

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5-64

Exercise 5-17
ABC, cost hierarchy, service. Plymouth Test
Laboratories does heat testing (HT) and stress
testing (ST) on materials and operates at capacity.
Under its current simple costing system, Plymouth
aggregates all operating costs of $1,280,000 into a
single overhead cost pool.
Plymouth calculates a rate per test-hour of $16
($1,280,000 80,000 total test-hours). HT uses
50,000 test-hours, and ST uses 30,000 test-hours.

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5-65

Gary Celeste, Plymouths controller, believes


that there is enough variation in test procedures
and cost structures to establish separate costing
and billing rates for HT and ST.
The market for test services is becoming
competitive. Without this information, any
miscosting and mispricing of its services could
cause Plymouth to lose business. Celeste
divides Plymouths costs into four activity-cost
categories.

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5-66

a. Direct-labor costs, $243,000. These costs can be


directly traced to HT, $183,000, and ST, $60,000.
b. Equipment-related costs (rent, maintenance,
energy, and so on), $400,000. These costs are
allocated to HT and ST on the basis of test-hours.
c. Setup costs, $385,000. These costs are allocated
to HT and ST on the basis of the number of setup
hours required. HT requires 13,500 setup-hours,
and ST requires 4,000 setup-hours.
d. Costs of designing tests, $252,000. These costs
are allocated to HT and ST on the basis of the time
required to design the tests. HT requires 2,800
hours, and ST requires 1,400 hours.

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5-67

1. Classify each activity cost as output unit-level,


batch-level, product- or service-sustaining, or
facility sustaining.

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.
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5-68

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.
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5-69

At a2.
cost
per test-hourthe
of $16,
the per
simple
costing system
heat
Calculate
cost
test-hour
forundercosts
HT and ST.
testing ($17.96) and overcosts stress testing ($12.73). The reason is that heat
Explain briefly the reasons why these numbers
testing uses direct labor, setup, and design resources per hour more intensively
than
stress from
testing.the
Heat$16
tests are
complex, take
to set up, and are
differ
permore
test-hour
thatlonger
Plymouth
more difficult to design. The simple costing system assumes that testing costs
using
itstesting
simple
system.
percalculated
hour are the same
for heat
and costing
stress testing.

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5-70

3. Explain the accuracy of the product costs


calculated using the simple costing system and the
ABC system.
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.

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5-71

How might Plymouths management use the


cost hierarchy and ABC information to better
manage its business?
Plymouths 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.
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5-72

Problem 5-28
Job costing with single direct-cost category, single
indirect-cost pool, law firm. Wigan Associates is a
recently formed law partnership. Ellery Hanley, the
managing partner of Wigan Associates, has just finished
a tense phone call with Martin Offiah, president of
Widnes Coal. Offiah strongly complained about the price
Wigan charged for some legal work done for Widnes
Coal.

Hanley also received a phone call from its only other


client (St. Helens Glass), which was very pleased with
both the quality of the work and the price charged on its
most recent job. Wigan Associates operates at capacity
and uses a cost-based approach to pricing (billing) each
job.
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5-73

Currently it uses a simple costing system with a single


direct-cost category (professional labor-hours) and a
single indirect-cost pool (general support). Indirect
costs are allocated to cases on the basis of
professional labor-hours per case. The job files show
the following:

Professional labor costs at Wigan Associates are $70 an


hour. Indirect costs are allocated to cases at $105 an
hour. Total indirect costs in the most recent period were
$21,000.

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5-74

1. Why is it important for Wigan Associates


to understand the costs associated with
individual jobs?
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.
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5-75

2. Compute the costs of the Widnes Coal


and St. Helens Glass jobs using Wigans
simple costing system.

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5-76

Problem 5-33
Choosing cost drivers, activity-based costing,
activity-based management. Annie Warbucks runs
a dance studio with childcare and adult fitness
classes. Annies budget for the upcoming year is as
follows:

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5-77

1. Determine which costs are direct costs and which costs


are indirect costs of different programs.
Direct Costs
Dance teacher salaries,
Child care teacher salaries,
Fitness instructor salaries

Indirect Costs
Supplies, rent, maintenance,
Administration salaries, utilities,
Marketing expenses

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5-78

2. Choose a cost driver for the indirect costs and


calculate the cost per unit of the cost driver. Explain
briefly your choice of cost driver.

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. Squarefootage is the only space-oriented 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.
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5-79

3. Calculate the budgeted costs of each program.

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5-80

4. How can Annie use this information for pricing?


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.

What other factors should she consider?


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.
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5-81

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5-82

Cost Accounting
A Managerial Emphasis
thirteenth edition

Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

2009 Pearson Prentice Hall. All rights reserved.

6-83

This presentation includes:

Exercises 6-16, 19
Problem 6-26

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6-84

Exercise 6-16
Sales budget, service setting. In 2009, McGrath & Sons,
a small environmental-testing firm, performed 11,000 radon
tests for $250 each and 15,200 lead tests for $200 each.
Because newer homes are being built with lead-free pipes,
lead-testing volume is expected to decrease by 10% next
year.
However, awareness of radon-related health hazards is
expected to result in a 5% increase in radon-test volume
each year in the near future. Jim McGrath feels that if he
lowers his price for lead testing to $190 per test, he will
have to face only a 5% decline in lead-test sales in 2010.

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6-85

1. Prepare a 2010 sales budget for McGrath & Sons


assuming that McGrath holds prices at 2009 levels.

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6-86

Expected revenues at the new 2010 prices are $5,631,100, which


2. Prepare a 2010 sales budget for McGrath & Sons
are greater than expected 2010 revenues of $5,623,500 if the prices
that
the pricesales
of a revenue
lead testand if
areassuming
unchanged.
So,McGrath
if the goallowers
is to maximize
$190. Should
McGrath
lower the
thecompany
price of ashould
lead test
JimtoMcGraths
forecasts
are reliable,
lowerinits
2010
its goal
maximize sales revenue?
price
for aif lead
test is
in to
2010.

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6-87

Exercise 6-19
Budgeting material purchases. The Mahoney Company
has prepared a sales budget of 45,000 finished units for a
three-month period. The company has an inventory of
16,000 units of finished goods on hand at December 31
and has a target finished goods inventory of 18,000 units at
the end of the succeeding quarter.

It takes three gallons of direct materials to make one unit of


finished product. The company has an inventory of 60,000
gallons of direct materials at December 31 and has a target
ending inventory of 50,000 gallons at the end of the
succeeding quarter. How many gallons of direct materials
should be purchased during the three months ending
March 31?
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6-88

Budgeting Materials Purchases

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6-89

Problem 6-26
Responsibility and controllability. For each of the
following independent situations: determine where (that is,
with whom) (a) responsibility and (b) controllability
lie. Suggest what might be done to solve the problem or to
improve the situation.
1. A very successful salesman at Amcorp Computers regularly
ignores the published sales catalog and offers lowered prices
to his customers in order to close sales. The VP of sales
notices that revenues are substantially lower than budgeted.
(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).
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6-90

2. Every special deal offered to a customer by any


salesperson at Amcorp Computers has to be cleared by the
VP of sales. Revenues for the second quarter have been
lower than budgeted.

(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
offeredare they really needed to close each sale? Are our
prices too high (i.e., uncompetitive)?

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6-91

3. The shipping department of Amcorp has limited capacity,


and sales orders are being cancelled by customers because
of delays in delivery. Revenues for the past month have been
lower than budgeted.

(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.

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6-92

4. At Planetel Corp., a manufacturer of telecommunications


equipment, the production supervisor notices that a significantly
larger number of direct manufacturing labor-hours were used
than had been budgeted. Investigation revealed that it was due
to a decline in educational standards required by the Human
Resources department when it interviewed applicants for hourly
production jobs six months earlier.
(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.
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6-93

5. At Planetel Corp., a relatively new production supervisor finds


that more direct manufacturing labor hour were used than had
been budgeted. Interviews revealed that workers were unhappy
with the supervisors management style and were intentionally
working slowly and inefficiently.

(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.

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6-94

6. At Planetel Corp., the production supervisor traces the


excessive consumption of direct materials (relative to the
budget) to the fact that waste was high on machines that
had not been properly maintained.

(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.

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6-95

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6-96

Cost Accounting
A Managerial Emphasis
thirteenth edition

Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

2009 Pearson Prentice Hall. All rights reserved.

7-97

This presentation includes:


Exercises 7-17, 7-18
Problem 7-35

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7-98

Exercise 7-17
Flexible budget Connor Companys budgeted
prices for direct materials, direct manufacturing
labor, and direct marketing (distribution) labor per
attach case are $40, $8, and $12, respectively.

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7-99

The president is pleased with the following


performance report:
Actual Costs
Variance
Direct materials
$364,000
$36,000 F
Direct manufacturing labor
78,000
2,000 F
Direct marketing (distribution) labor
110,000
10,000

Static Budget
$400,000

80,000
120,000

Actual output was 8,800 attach cases. Assume all three direct-cost items
above are variable costs.

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7-100

Question:
Is the presidents pleasure justified?
Prepare a revised performance report that uses a
flexible budget and a static budget.

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7-101

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 attach case of
$40.)

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7-102

Level 2 analysis that presents a flexiblebudget variance and a sales-volume


variance of each direct cost category

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7-103

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.
Each direct cost category has an actual unit variable cost
that exceeds its budgeted unit cost:

Therefore, the Presidents pleasure is not really


justified based on these results.
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7-104

Analysis of price and efficiency variances


for each cost category could assist in
further the identifying causes of these
more aggregated (Level 2) variances.

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7-105

Exercise 7-18

Flexible-budget preparation and analysis


Bank Management Printers, Inc., produces
luxury checkbooks with three checks and
stubs per page. Each checkbook is designed
for an individual customer and is ordered
through the customers bank.

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7-106

The companys operating budget for


September 2009 included these data:
Number of checkbooks
Selling price per book
Variable cost per book
Fixed costs for the month

15,000
$ 20
$8
$145,000

The actual results for September 2009 were:


Number of checkbooks
Selling price per book
Variable cost per book
Fixed costs for the month
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12,000
$ 21
$7
$150,000
7-107

1. Prepare a static-budget-based variance


analysis of the September performance
Variance Analysis for Bank Management Printers for
September 2009

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7-108

2. Prepare a flexible-budget-based variance


analysis of the September performance
Reminder: the sales volume variance is the difference between actual and
budged output times budgeted contribution margin or (3,000 x 12)

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7-109

3. Why might Bank Management find the


flexible-budget-based variance analysis
more informative than the static-budgetbased variance analysis?
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.
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7-110

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).

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7-111

Problem 7-35
Direct manufacturing labor and direct materials
variances, missing data
Morro Bay Surfboards manufactures fiberglass
surfboards. The standard cost of direct materials
and direct manufacturing labor is $100 per board.
This includes 20 pounds of direct materials, at the
budgeted price of $2 per pound, and five hours of
direct manufacturing labor, at the budgeted rate of
$12 per hour.

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7-112

Following are additional data for the month


of July:
Units completed
6,000 units
Direct material purchases
150,000 pounds
Cost of direct material purchases
$292,500
Actual direct manufacturing labor-hours
32,000
Actual direct-labor cost
$368,000
Direct materials efficiency variance $
12,500 U

There were no beginning inventories.

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7-113

1. Compute direct manufacturing labor


variances for July

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7-114

2. Compute the actual pounds of direct


materials used in production in July
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

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

The 6,250 excess units can


also be computed by dividing
the efficiency variance by the
standard price

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7-115

3. Calculate the actual price per pound of


direct materials purchased

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7-116

4. Calculate the direct materials price


variance

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7-117

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7-118

Cost Accounting
A Managerial Emphasis
thirteenth edition

Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

2009 Pearson Prentice Hall. All rights reserved.

8-119

This presentation includes:


Exercises 8-17, 8-19, 8-21

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8-120

Exercise 8-17

Fixed manufacturing overhead, variance


analysis Esquire Clothing allocates fixed
manufacturing overhead to each suit using
budgeted direct manufacturing labor-hours per suit.
Data pertaining to fixed manufacturing overhead
costs for June 2009 are budgeted, $62,400, and
actual, $63,916.

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8-121

1. Compute the spending variance for fixed


manufacturing overhead. Comment on the
results.
Therefore, Esquire spent $1,516 above the $62,400
budgeted amount for June 2009.

The fixed manufacturing overhead spending variance and the fixed


manufacturing flexible budget variance are the same$1,516 U.
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8-122

2. Compute the production-volume variance


for June 2009. What inferences can Esquire
Clothing draw from this variance?
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 over allocated 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?
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8-123

Exercise 8-19
Fixed manufacturing overhead variance
analysis The French Bread Company also
allocates fixed manufacturing overhead to
products on the basis of standard direct
manufacturing labor-hours.
For 2009, fixed manufacturing overhead was
budgeted at $4.00 per direct manufacturing laborhour.
Actual fixed manufacturing overhead incurred
during the year was $272,000.
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8-124

1. Prepare a variance analysis of fixed


manufacturing overhead cost. Use Exhibit 8-4
(p. 276) as a guide.
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

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8-125

Fixed Manufacturing Overhead Variance


Analysis for French Bread Company for
2009

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8-126

2. Is fixed overhead under allocated or over


allocated? By what amount?

The fixed manufacturing overhead is under


allocated by $48,000.

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8-127

3. Comment on your results. Discuss the variances


and explain what may be driving them.
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
producedthe 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 baguettemaking machines may have increased above those in
the budget for 2009.
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8-128

Exercise 8-21
4-variance analysis, fill in the blanks Pandom, Inc.
produces chemicals for large biotech companies. It has the
following data for manufacturing overhead costs during
August 2010:

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8-129

Variable MOH

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8-130

Fixed MOH

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8-131

An overview of the 4 overhead variances

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8-132

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8-133

Cost Accounting
A Managerial Emphasis
thirteenth edition

Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

2009 Pearson Prentice Hall. All rights reserved.

9-134

This presentation includes:


Exercises 9-16, 9-18, 9-21

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9-135

Exercise 9-16
Variable and absorption costing, explaining operatingincome differences Nascar Motors assembles and sells
motor vehicles and uses standard costing. Actual data
relating to April and May 2008 are:

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9-136

The following information is available:


The selling price per vehicle is $24,000. The
budgeted level of production used to calculate the
budgeted fixed manufacturing cost per unit is 500
units. There are no price, efficiency, or spending
variances. Any production-volume variance is
written off to cost of goods sold in the month in
which it occurs.

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9-137

1. Prepare April and May 2008 income


statements for Nascar Motors under:
(a) variable costing
(b) absorption costing

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9-138

(a) variable costing

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9-139

(b) absorption costing

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9-140

2. Prepare a numerical reconciliation and


explanation of the difference between operating
income for each month under variable costing and
absorption costing.

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).
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9-141

Exercise 9-18
Variable and absorption costing, explaining
operating-income differences BigScreen
Corporation manufactures and sells 50-inch
television sets and uses standard costing.
The selling price per unit is $2,500. The budgeted
level of production used to calculate the budgeted
fixed manufacturing cost per unit is 1,000 units.
There are no price, efficiency, or spending
variances.
Any production-volume variance is written off to
cost of goods sold in the month in which it occurs.
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9-142

Actual data relating to January, February,


and March of 2009 are:

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9-143

1. Prepare income statements for


BigScreen in January, February, and
March of 2009 under
(a) variable costing and

(b) absorption costing

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9-144

(a) variable costing

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9-145

(b) absorption costing

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9-146

2. Explain the difference in operating Income


for January, February, and March under
variable costing and absorption costing.
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).
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9-147

Exercise 9-21
Absorption and variable costing
Osawa, Inc., planned and actually manufactured 200,000
units of its single product in 2009, its first year of operation.
Variable manufacturing cost was $20 per unit produced.
Variable operating (non-manufacturing) cost was $10 per
unit sold.
Planned and actual fixed manufacturing costs were
$600,000. Planned and actual fixed operating (nonmanufacturing) costs totaled $400,000.

Osawa sold 120,000 units of product at $40 per unit.


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9-148

1. Osawas 2009 operating income using


absorption costing is:
(a) $440,000
(b) $200,000
(c) $600,000
(d) $840,000
(e) none of these

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9-149

Answer: (a)

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9-150

2. Osawas 2009 operating income using


variable costing is:

(a) $800,000
(b) $440,000
(c) $200,000
(d) $600,000
(e) none of these

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9-151

Answer: (c)

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9-152

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9-153

Cost Accounting
A Managerial Emphasis
thirteenth edition

Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

2009 Pearson Prentice Hall. All rights reserved.

10-154

This presentation includes:


Exercises 10-17, 10-18, 10-19

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10-155

Problem 10-17
Identifying variable-, fixed-, and mixed-cost
functions
The Pacific Corporation operates car
rental agencies at more than 20 airports.
Customers can choose from one of three contracts
for car rentals of one day or less:
Contract 1: $50 for the day
Contract 2: $30 for the day plus $0.20 per mile
traveled
Contract 3: $1 per mile traveled
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10-156

1. Plot separate graphs for each of the


three contracts, with costs on the vertical
axis and miles traveled on the horizontal
axis.

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10-157

2. Express each contract as a linear cost


function of the form y= a+bX.
Contract 1: y = $50
Contract 2: y = $30 + $0.20X
Contract 3: y = $1X
X is the number of miles traveled in the day.

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10-158

3. Identify each contract as a variable-,


fixed-, or mixed-cost function
Contract 1: Fixed
Contract 2: Mixed
Contract 3: Variable

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10-159

Exercise 10-18
Various cost-behavior patterns Select the graph
that matches the numbered manufacturing cost
data. Indicate by letter which graph best fits the
situation or item described.
The vertical axes of the graphs represent total cost, and the horizontal
axes represent units produced during a calendar year. In each case,
the zero point of dollars and production is at the intersection of the two
axes. The graphs may be used more than once.

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10-160

1.

Annual depreciation of
equipment, where the
amount of depreciation
charged is computed by
the machine-hours method.

2. Electricity billa flat fixed


charge, plus a variable cost
after a certain number of
kilowatt-hours are used, in
which the quantity of
kilowatt-hours used varies
proportionately with quantity
of units produced.

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10-161

3. City water bill computed as follows:


First 1,000,000 gallons or less
$1,000 flat fee
Next 10,000 gallons
$0.003 per gallon used
Next 10,000 gallons
$0.006 per gallon used
Next 10,000 gallons
$0.009 per gallon used
and so on
and so on
The gallons of water used vary proportionately with the
quantity of production output.

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10-162

4. Cost of direct materials, where direct material


cost per unit produced decreases with each pound
of material used (for example, if 1 pound is used,
the cost is $10; if 2 pounds are used, the cost is
$19.98; if 3 pounds are used, the cost is $29.94),
with a minimum cost per unit of $9.20.

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10-163

5. Annual depreciation of equipment, where the


amount is computed by the straight-line method.
When the depreciation schedule was prepared, it
was anticipated that the obsolescence factor
would be greater than the wear-and-tear factor.

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10-164

6. Rent on a manufacturing plant donated by the


city, where the agreement calls for a fixed-fee
payment unless 200,000 labor-hours are worked,
in which case no rent is paid.

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10-165

7. Salaries of repair
personnel, where one
person is needed for
every 1,000 machinehours or less (that is, 0 to
1,000 hours requires one
person, 1,001 to 2,000
hours requires two people,
and so on)

8. Cost of direct materials


used (assume no quantity
discounts).

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10-166

9. Rent on a manufacturing plant donated by the


county, where the agreement calls for rent of
$100,000 to be reduced by $1 for each direct
manufacturing labor-hour worked in excess of
200,000 hours, but a minimum rental fee of
$20,000 must be paid.

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10-167

Exercise 10-19
Matching graphs with descriptions of cost
and revenue behavior
The horizontal axis represents the units
produced over the year and the vertical axis
represents total cost or revenues.

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10-168

a. Direct material costs

b. Supervisors salaries
for one shift and two
shifts

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10-169

c. A cost-volume-profit
graph

d. Mixed costsfor
example, car rental fixed
charge plus a rate per
mile driven

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10-170

e. Depreciation of plant,
computed on a straightline basis

f. Data supporting the use


of a variable-cost rate,
such as manufacturing
labor cost of $14 per unit
produced

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10-171

g. Incentive bonus plan


that pays managers
$0.10 for every unit
produced above some
level of production

h. Interest expense on $2
million borrowed at a
fixed rate of interest

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10-172

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10-173

Cost Accounting
A Managerial Emphasis
thirteenth edition

Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

2009 Pearson Prentice Hall. All rights reserved.

11-174

This presentation includes:


Exercises 11-21, 11-23
Problem 11-33

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11-175

Exercise 11-21
Inventory decision, opportunity costs. Lawnox, a
manufacturer of lawn mowers, predicts that it will purchase
240,000 spark plugs next year. Lawnox estimates that
20,000 spark plugs will be required each month.

A supplier quotes a price of $9 per spark plug. The supplier


also offers a special discount option: If all 240,000 spark
plugs are purchased at the start of the year, a discount of
4% off the $9 price will be given.
Lawnox can invest its cash at 10% per year. It costs
Lawnox $200 to place each purchase order.

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11-176

What is the opportunity cost of interest forgone


from purchasing all 240,000 units at the start of
the year instead of in 12 monthly purchases of
20,000 units per order?
Unit cost, orders of 20,000
$9.00
Unit cost, order of 240,000 (0.96 $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
$1, 036,800
(b) ( 20,000 $9.00) 2
90,000
Difference in average investment
$ 946,800

Opportunity cost of interest forgone from 240,000-unit purchase at


start of year = $946,800 0.10 = $94,680
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11-177

Would this opportunity cost be recorded in


the accounting system? Why?

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.

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11-178

Should Lawnox purchase 240,000 units at


the start of the year or 20,000 units each
month?

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
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11-179
preferred
even more.

Exercise 11-23
Selection of most profitable product BodyBuilders, Inc., produces two basic types of
weightlifting equipment, Model 9 and Model 14.

The weight-lifting craze is such that enough of


either Model 9 or Model 14 can be sold to keep the
plant operating at full capacity.
Both products are processed through the same
production departments.
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11-180

Pertinent data

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11-181

Which products should be produced?


Only Model 14 should be produced.
Management should choose the product mix that
maximizes operating income for a given production
capacity (the scarce resource in this situation).
Notice Model 14 will yield a $9.50 contribution to fixed costs per
machine hour, and Model 9 will yield $9.00

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11-182

Problem 11-33
Product Mix, special order
Pandleton engineering operations. It makes
two types of tools: R3, a regular cutting tool,
and HP6, a high-precision cutting tool. R3 is
manufactured on a regular machine, but HP6
must be manufactured on both the regular
machine and a high-precision machine.

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11-183

The following information is available:

Selling Price
Variable Manufacturing Cost Per Unit
Variable Marketing Cost Per Unit
Budgeted Total Fixed Overhead Cost
Hours Required to Produce One Unit on the Regular Machine

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R3
$
100
$
60
$
15
$350,000
1.0

HP6
$
150
$
100
$
35
$550,000
0.5

11-184

Additional Information Includes:


a. Pendleton faces a capacity constraint on the regular
machine of 50,000 hours per year.
b. The capacity of the high precision machine is not a
constraint.
c. Of the 550,000 budgeted fixed overhead cost of HP6,
$300,000 are lease payments for the high precision machine.
This cost is charged entirely to HP6 because Pendleton
uses the machine exclusively to produce HP6. The lease
agreement for the high precision machine can be cancelled
at any time without penalties.
d. All other overhead costs are fixed and will not change.

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11-185

1. What product mix that is, how many


units of R3 and HP6 will maximize
Pendletons operating income.
First notice the
contribution
margin for
product: R3 is
higher
Next notice the CM per unit
of scarce resource is
higher for HP6

Finally, notice that R3 should be manufactured


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when all costs are considered

11-186

2. Suppose Pendleton can increase the annual


capacity of its regular machine by 15,000 machine
hours at a cost of $150,000.

Should the Pendleton increase the capacity of the


regular machines by 15,000 machine hours?
By how much will Pendletons operating income
increase?

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11-187

the extra
capacity
Pendletonbyshould
its entire
IfWith
capacity
of the
regularavailable
machinestoisit,increased
15,000use
machinecapacity
to produce
HP6. Using(50,000
all 65,000
hours of
capacity
to the net
hours
to 65,000
machine-hours
originally
+ 15,000
new),
producebenefit
HP6 rather
to produce
R3HP6
generates
additional
relevant
fromthan
producing
R3 and
is as follows:
contribution margin of $325,000 ($1,950,000 $1,625,000) which is
more than the additional cost of $300,000 to lease the high-precision
machine.

Investing in the additional capacity


increases Pendletons 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.
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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.
11-188

3. Suppose that the capacity of the regular machines has


been increased to 65,000 hours. Pendleton has been
approached by Carter Corporation to supply 20,000 units
of another cutting tool S3 for $120 per unit. Pendleton
must either accept the order for all 20,000 units or reject
it totally. S3 is exactly like R3 except that its variable
manufacturing cost is $70 per unit. It takes one hour to
produce one unit of S3 on the regular machine, and
variable marketing cost equals $15 per unit.

What product mix should Pendleton choose to maximize


operating income?

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11-189

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.

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11-190

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).

Pendleton should use


all the 45,000 hours of
available capacity to
produce 45,000 units
of R3.

Relative to question 2, operating income increases here by


$325,000 ($1,825,000 minus $1,500,000 calculated in
question 2). Hence, Pendleton should accept the Carter
Corporation business and supply 20,000 units of S3.
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11-191

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11-192

Cost Accounting
A Managerial Emphasis
thirteenth edition

Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

2009 Pearson Prentice Hall. All rights reserved.

12-193

This presentation includes:


Exercises 12-17, 12-18, 12-22

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12-194

Exercise 12-17
Relevant-cost approach to short-run pricing decisions The San
Carlos Company is an electronics business with eight product lines.
Income data for one of the products (XT-107) for June 2009 are:

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12-195

Additional information
Abrams, Inc., an instruments company, has a problem with
its preferred supplier of XT-107 components.
This supplier has had a three-week labor strike. Abrams
approaches the San Carlos sales representative, Sarah
Holtz, about providing 3,000 units of XT-107 at a price of
$75 per unit. Holtz informs the XT-107 product manager,
Jim McMahon, that she would accept a flat commission of
$8,000 rather than the usual 15% of revenues if this special
order were accepted.
San Carlos has the capacity to produce 300,000 units of
XT-107 each month, but demand has not exceeded
200,000 units in any month in the past year.

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12-196

1. If the 3,000-unit order from Abrams is


accepted, how much will operating income
increase or decrease?

(Assume the same cost structure as in June 2009.)

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12-197

Analysis of special order


Sales, 3,000 units $75
$225,000
Variable costs:
Direct materials, 3,000 units $35
105,000
Direct manufacturing labor, 3,000 units $10
30,000
Variable manufacturing overhead, 3,000 units $6 18,000
Other variable costs, 3,000 units $5
15,000
Sales commission
8,000
Total variable costs
176,000
Contribution margin
$ 49,000

If the special order is accepted, operating income would be


$1,000,000 + $49,000 = $1,049,000
Note that the variable costs, except for commissions, are affected by
production volume, not sales dollars.
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12-198

2. McMahon ponders whether to accept the


3,000-unit special order. He is afraid of the
precedent that might be set by cutting the
price. He says, The price is below our full
cost of $96 per unit. I think we should quote a
full price, or Abrams will expect favored
treatment again and again if we continue to
do business with it.
Do you agree with McMahon?

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12-199

Pricing decisions
Whether McMahons 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 Carloss operating
income by more than $49,000.
There is also the possibility that Abrams could become a longterm 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?
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12-200

Exercise 12-18
Short-run pricing, capacity constraints Vermont
Hills Dairy, maker of specialty cheeses, produces
a soft cheese from the milk of Holstein cows raised
on a special corn-based diet.
One kilogram of soft cheese, which has a
contribution margin of $8, requires 4 liters of milk.
A well-known gourmet restaurant has asked
Vermont Hills to produce 2,000 kilograms of a hard
cheese from the same milk of Holstein cows.

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12-201

Additional information
The dairy has sufficient unused capacity. Elise
Princiotti, owner of Vermont Hills, calculates the
costs of making one kilogram of the desired hard
cheese:

Milk (10 liters $1.50 per liter)


$15
Direct manufacturing labor
5
Variable manufacturing overhead
3
Fixed manufacturing cost allocated 6
Total manufacturing cost
$29
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12-202

1. Suppose Vermont Hills can acquire all the


Holstein milk that it needs. What is the
minimum price per kilogram it should charge
for the hard cheese?
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.
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12-203

2. Now suppose that the Holstein milk is


in short supply. Every kilogram of hard
cheese produced by Vermont Hills will
reduce the quantity of soft cheese that it
can make and sell.
What is the minimum price per kilogram it
should charge to produce the hard
cheese?

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12-204

Vermont should not agree to produce any


hard cheese unless the buyer is willing to
pay at least $43 per kilo.
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).
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
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12-205

Exercise 12-22
Target costs, effect of product-design changes on
product costs.
Medical Instruments uses a manufacturing costing system
with one direct-cost category (direct materials) and three
indirect-cost categories:

a. Setup, production order, and materials-handling costs


that vary with the number of batches
b. Manufacturing-operations costs that vary with machinehours
c. Costs of engineering changes that vary with the number
of engineering changes made
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12-206

More information
Medical Instruments used value-engineering
techniques to reduce manufacturing costs.
Actual information for 2008 and 2009 is:

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12-207

Target manufacturing cost per unit


The management of Medical Instruments wants to
evaluate whether value engineering has
succeeded in reducing the target manufacturing
cost per unit of one of its products, HJ6, by 10%.
Actual results for 2008 and 2009 for HJ6 are:

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12-208

1 & 2. Calculate the manufacturing cost per


unit of HJ6 in 2008 & 2009

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12-209

3. Did Medical Instruments achieve the


target manufacturing cost per unit for HJ6 in
2009?

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
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12-210

4. Explain how Medical Instruments


reduced the manufacturing cost per unit of
HJ6 in 2009
reduced the cost per unit in each of the four cost
categoriesdirect materials costs, batch-level costs,
manufacturing operations costs, and engineering change
costs.
reduced machine-hours and number of engineering
changes made. In 2008, used 6 machine-hours per unit
of HJ6 (21,000 machine-hours 3,500 units). In 2009,
used 5.5 (22,000 machine-hours 4,000 units).
reduced engineering changes from 14 in 2008 to 10 in
2009.
through value engineering activities that retained only
those product features that customers wanted while
eliminating nonvalue added activities and costs.
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12-211

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12-212

Cost Accounting
A Managerial Emphasis
thirteenth edition

Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

2009 Pearson Prentice Hall. All rights reserved.

13-213

This presentation includes:


Exercises 13-16, 13-18
Problem 13-37

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13-214

Exercise 13-16
Balanced scorecard La Quinta Corporation
manufactures corrugated cardboard boxes. It
competes and plans to grow by selling high-quality
boxes at a low price and by delivering them to
customers quickly after receiving customers
orders. There are many other manufacturers who
produce similar boxes.
La Quinta believes that continuously improving its
manufacturing processes and having satisfied
employees are critical to implementing its strategy
in 2009.
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13-215

1. Is La Quintas 2009 strategy one of


product differentiation or cost leadership?
La Quintas 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 Quintas boxes are not differentiated, and there are
many other manufacturers who produce similar boxes.

To succeed, La Quinta must achieve produce high-quality


boxes at lower costs relative to competitors through
productivity and efficiency improvements.
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13-216

2. Mesa Corporation, a competitor of La Quinta,


manufactures corrugated boxes with more
designs and color combinations than La Quinta
at a higher price. Mesas boxes are of high
quality but require more time to produce and so
have longer delivery times.
Draw a simple customer preference map as in
Exhibit 13-1 for La Quinta and Mesa using the
attributes of price, delivery time, quality, and
design.

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13-217

Customer Preference Map for


Corrugated Boxes

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13-218

3. Indicate two measures you would expect to see under


each perspective in La Quintas balanced scorecard for
2009. Use a strategy map as in Exhibit 13-3 to explain your
answer.
FINANCIAL
PERSPECTIVE

CUSTOMER
PERSEPCTIVE

Cost reduction in key


areas

Customer satisfaction

Productivity

INTERNALBUSINESSPROCESS
PERSEPCTIVE

LEARNING-ANDGROWTH
PERSEPCTIVE

On-time
delivery

Employeesatisfaction
ratings

Operating
income from
productivity
gain

Number of
new customers

Operating income
from growth

Market share in
corrugated boxes
market

Quality

Number of major
improvements in
manufacturing
process

Percentage of employees
trained in process
and quality management

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13-219

Measures that we would expect to see on a La


Quintas balanced scorecard for 2009
1/2
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.

Customer Perspective
(1) Market share in corrugated boxes market
(2) New customers
(3) Customer satisfaction index
(4) Customer retention
(5) Time taken to fulfill customer orders.
The logic is that improvements in these customer measures are leading
indicators of whether La Quintas cost leadership strategy is succeeding with its
customers and helping it to achieve superior financial performance.
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13-220

Measures that we would expect to see on a La


Quintas balanced scorecard for 2009
2/2
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, (3) number of major process
improvements..
Improvements in these measures aim to improve La Quintas 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.

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13-221

Exercise 13-18
Strategy, balanced scorecard,
merchandising operation
Oceano & Sons buys T-shirts in bulk,
applies its own trendsetting silk-screen
designs, and then sells the T-shirts to a
number of retailers. Oceano wants to be
known for its trendsetting designs, and it
wants every teenager to be seen in a
distinctive Oceano T-shirt.
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13-222

More information
Administrative costs depend on the number of
customers that Oceano has created capacity to
support, not on the actual number of customers
served. Oceano had 3,600 customers in 2008 and
3,500 customers in 2009.
At the start of each year, management uses its
discretion to determine the number of employees
on the design staff for the year. The design staff
and its costs have no direct relationship with the
number of T-shirts purchased and sold or the
number of customers to whom T-shirts are sold.

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13-223

1. Is Oceanos strategy one of product


differentiation or cost leadership?
Oceano & Sons follows a product differentiation strategy.

Oceanos 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.
To succeed, Oceano must continue to innovate and be
able to charge a premium price for its product.

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13-224

2. Describe briefly the key elements Oceano


should include in its balanced scorecard and
the reasons it should do so.
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 Oceanos Tshirts in the leading fashion magazines
Oceanos strategy should result in improvements in these customer
measures that help evaluate whether Oceanos product differentiation
strategy is succeeding with its customers. These measures are, in turn,
leading indicators of superior financial performance.

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13-225

More elements
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 Oceanos
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.

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13-226

Problem 13-37
Partial productivity measurement Guble Company
manufactures wallets from fabric. In 2008, Guble made
2,500,000 wallets using 1,875,000 yards of fabric. In 2009,
Guble plans to make 2,650,000 wallets and wants to make
fabric use more efficient. At the same time, Guble wants to
reduce capacity; capacity in 2008 was 3,000,000 wallets at
a total cost of $9,000,000. Guble wants to reduce capacity
to 2,800,000 wallets, at a total cost of $8,680,000 in 2009.
Suppose that in 2009 Guble makes 2,650,000 wallets, uses
1,669,500 yards of fabric, and reduces capacity to
2,800,000 units and costs to $8,680,000.

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13-227

1. Calculate the partial-productivity ratios for


materials and conversion (capacity costs)
for 2009.

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13-228

Compare the partial-productivity ratios for materials and


conversion to a benchmark for 2008 calculated based on
2009 output.
First calculate the inputs that would have been used in 2008 to
produce year 2009s 2,650,000 units of output

Then calculate partial productivity calculations for 2008 based on


year 2009 output

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13-229

Berkshire improved the partial productivity of


direct materials and conversion costs
between 2008 and 2009 via efficiency
improvements and by reducing unused
manufacturing capacity

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13-230

2. How can Guble Company use the


information from the partial-productivity
calculations?
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.
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.
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13-231

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13-232

Cost Accounting
A Managerial Emphasis
thirteenth edition

Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

2009 Pearson Prentice Hall. All rights reserved.

14-233

This presentation includes:


Exercises 14-16, 14-18, 14-28

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14-234

Exercise 14-16
Cost allocation in hospitals, alternative allocation
criteria Dave Meltzer vacationed at Lake Tahoe last winter.
Unfortunately, he broke his ankle while skiing and spent
two days at the Sierra University Hospital. Meltzers
insurance company received a $4,800 bill for his two-day
stay. One item that caught Meltzers attention was an
$11.52 charge for a roll of cotton. Meltzer is a salesman for
Johnson & Johnson and knows that the cost to the hospital
of the roll of cotton is in the $2.20 to $3.00 range.
Meltzer believes the overhead charge is obscene. He
comments, There was nothing I could do about it.
When they come in and dab your stitches, its not as if you
can say, Keep your cotton roll. I brought my own.

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14-235

A breakdown of the $11.52 charge

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14-236

1. Compute the overhead rate Sierra


University Hospital charged on the cotton
roll.
Direct costs:
Indirect costs

$2.40
$9.12 ( $11.52 $2.40 )

Overhead rate: $9.12 ( 380% )


$2.40

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14-237

2. What criteria might Sierra use to justify allocation


of the overhead items b through i in the preceding
list? Examine each item separately and use the
allocation criteria listed in Exhibit 14-2 (p. 503) in
your answer.

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14-238

3. What should Meltzer do about the $11.52


charge for the cotton roll?
Assuming that Meltzers 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.

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14-239

Exercise 14-18

Cost allocation to divisions Rembrandt


Hotel & Casino is situated on beautiful Lake
Tahoe in Nevada. The complex includes a
300-room hotel, a casino, and a restaurant.
As Rembrandts new controller, you are
asked to recommend the basis to be used
for allocating fixed overhead costs to the
three divisions in 2008.

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14-240

More information
Partial income statement for 2008:

You are also given the following data on the


three divisions

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14-241

In Addition:
Total fixed overhead costs for 2008 was
$14,550,000.
You are told that you may choose to allocate
indirect costs based on one of the following:
direct costs, or square feet, or the number of
employees.

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14-242

1. Calculate division margins in percentage


terms prior to allocating fixed overhead costs.

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14-243

2. Allocate indirect costs to the three


divisions using each of the three allocation
bases suggested. For each allocation base,
calculate division operating margins after
allocations in dollars and as a percentage
of revenues.

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14-244

Cost allocation based on direct cost

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14-245

Cost allocation based on floor space

Cost allocation based on number of employees

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14-246

3. Discuss the results. How would you


decide how to allocate indirect costs to the
divisions?
Requirement 2 shows the dramatic effect of
choice of cost allocation base on segment
pre-tax income as a percentage of revenues:

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14-247

Continued
The decision context should guide
(a)whether costs should be allocated, and
(b) the preferred cost allocation base

Performance measurement, may be made on a combination of


financial and non financial 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 shortrun 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.

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14-248

Exercise 14-28
Cost allocation to divisions Forber Bakery makes baked
goods for grocery stores, and has three divisions: Bread,
Cake, and Doughnuts. Each division is run and evaluated
separately, but the main headquarters incurs costs that are
indirect costs for the divisions. Costs incurred in the main
headquarters are:

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14-249

Information about the three divisions:

The Forber upper management currently


allocates this cost to the divisions equally.

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14-250

1. Allocate the indirect costs of Forber to


each division equally. Calculate division
operating income after allocation of
headquarter costs.

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14-251

2. Allocate headquarter costs to the individual


divisions using the proposed allocation bases.
Calculate the division operating income after
allocation.

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14-252

Comment on the allocation bases used to


allocate headquarter costs.
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.

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14-253

3. Which division manager do you think


suggested this new allocation? Explain
briefly. Which allocation do you think is
better?
The manager 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.
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14-254

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14-255

Cost Accounting
A Managerial Emphasis
thirteenth edition

Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

2009 Pearson Prentice Hall. All rights reserved.

15-256

This presentation includes:


Exercises 15-18, 15-19, 15-22

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15-257

Exercise 15-18
Dual-rate method, budgeted versus actual costs, and
practical capacity versus actual quantities (continuation
of 15-17). Chocolat, Inc. decides to examine the effect of
using the dual-rate method for allocating truck costs to each
round-trip.
At the start of 2009, the budgeted costs were:
Variable cost per round-trip $ 1,500
Fixed costs
$40,000
The actual results for the 45 round-trips made in 2009 were:
Variable costs
$60,750
Fixed costs
$36,000
Total
$96,750
Assume all other information to be the same as in Exercise
15-17.
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15-258

1. Using the dual-rate method, what are the costs

allocated to the Dark Chocolate Division and the Milk


Chocolate Division when (a) variable costs are allocated
using the budgeted rate per round-trip and actual roundtrips used by each division and when (b) fixed costs are
allocated based on the budgeted rate per round-trip and
round-trips budgeted for each division?

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15-259

2. From the viewpoint of the Dark Chocolate Division, what


are the effects of using the dual-rate method rather than the
single-rate methods?
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
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.
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15-260

Exercise 15-19
Support-department cost allocation; direct and
step-down methods. Phoenix Partners provides
management consulting services to government
and corporate clients. Phoenix has two support
departmentsAdministrative Services (AS) and
Information Systems (IS)and two operating
departmentsGovernment Consulting (GOVT)
and Corporate Consulting (CORP).

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15-261

For the first quarter of 2009, Phoenixs


cost records indicate the following:

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15-262

1. Allocate the two support departments


costs to the two operating departments
using the following methods:

a. Direct method

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15-263

b. Step-down method (allocate AS first)

c. Step-down method (allocate IS first)

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15-264

2. Compare and explain differences in the


support-department costs allocated to each
operating department.

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15-265

The direct method ignores any services to other support


departments.
The step-down method partially recognizes services to
other support departments. The IS 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 IS support group. When
the AS group is allocated first, a total of $2,550,000 is then
assigned out from the IS group. Given CORPs
disproportionate (2:1) usage of the services of IS, this
method then results in the highest overall allocation of
costs to CORP.
By contrast, GOVTs 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.
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15-266

3. What approaches might be used to decide the


sequence in which to allocate support departments
when using the step-down method?
Allocate on a ranking of
a. The percentage of their total services provided to other support
department
The approach in method (a)
AS 25%
typically better approximates
I S 10%
the theoretically preferred
b. Total dollar amount in the support department
reciprocal method. It results
in a higher percentage of
I S $2,400,000
support-department costs
AS $ 600,000
provided to other support
c. The dollar amounts of service provideddepartments
to other support
being
department
incorporated into the stepdown process than does
I S $ 240,000 (0.10 $2,400,000)
method (b) or (c).
AS $ 150,000 (0.25 $600,000)
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15-267

Exercise 15-22
Reciprocal cost allocation (continuation
of 15-21)
Consider E-books again. The controller of E-books
reads a widely used textbook that states that the
reciprocal method is conceptually the most
defensible. He seeks your assistance.

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15-268

1. Describe the key features of the


reciprocal method.
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.

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15-269

2. Allocate the support departments costs (Human


Resources and Information Systems) to the two
operating departments using the reciprocal method.

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15-270

Reciprocal method using repeated iterations

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15-271

3. In the case presented in this exercise, which


method (direct, step-down, or reciprocal) would
you recommend? Why?

The reciprocal method is more accurate than the direct and


step-down methods when there are reciprocal relationships
among support departments.
The reciprocal method is the preferred method, although
for September 2009 the numbers do not appear materially
different across the alternatives.
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15-272

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15-273

Cost Accounting
A Managerial Emphasis
thirteenth edition

Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

2009 Pearson Prentice Hall. All rights reserved.

16-274

This presentation includes:


Exercises 16-18, 16-19
Problem 16-27

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16-275

Exercise 16-18
Net realizable value method Convad Company is one of
the worlds leading corn refiners. It produces two joint
productscorn syrup and corn starchusing a common
production process.
In July 2009, Convad reported the following production and
selling-price information:

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16-276

Question: Allocate the $325,000 joint costs


using the NRV method.

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16-277

Exercise 16-19
Alternative joint-cost-allocation methods, furtherprocess decision.
The Wood Spirits Company produces two products
turpentine and methanol (wood alcohol)by a joint process.
Joint costs amount to $120,000 per batch of output. Each
batch totals 10,000 gallons: 25% methanol and 75%
turpentine. Both products are processed further without
gain or loss in volume.
Separable processing costs are methanol, $3 per gallon;
turpentine, $2 per gallon. Methanol sells for $21 per gallon.
Turpentine sells for $14 per gallon.
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16-278

1. How much of the joint costs per batch will be


allocated to turpentine and to methanol, assuming
that joint costs are allocated based on the number
of gallons at splitoff point?

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16-279

2. If joint costs are allocated on an NRV basis,


how much of the joint costs will be allocated to
turpentine and to methanol?

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16-280

3. Prepare product-line income statements per


batch for requirements 1 and 2. Assume no
beginning or ending inventories.

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16-281

4.
The company has discovered an additional process by
which the methanol (wood alcohol) can be made into a
pleasant-tasting alcoholic beverage. The selling price of
this beverage would be $60 a gallon.
Additional processing would increase separable costs $9
per gallon (in addition to the $3 per gallon separable cost
required to yield methanol). The company would have to
pay excise taxes of 20% on the selling price of the
beverage.
Assuming no other changes in cost, what is the joint cost
applicable to the wood alcohol (using the NRV method)?
Should the company produce the alcoholic beverage?

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16-282

Joint cost applicable to the wood alcohol

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16-283

The company should use the new process

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16-284

Problem 16-27
Alternative methods of joint-cost allocation, productmix decisions The Sunshine Oil Company buys crude
vegetable oil. Refining this oil results in four products at the
splitoff point: A, B, C, and D. Product C is fully processed
by the splitoff point. Products A, B, and D can individually
be further refined into Super A, Super B, and Super D. In
the most recent month (December), the output at the
splitoff point was:
Product A 300,000 gallons
Product B, 100,000 gallons
Product C, 50,000 gallons
Product D, 50,000 gallons
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16-285

More information 1/2


The joint costs of purchasing and processing the crude
vegetable oil were $100,000. Sunshine had no beginning or
ending inventories. Sales of product C in December were
$50,000.
Products A, B, and D were further refined and then sold.
Data related to December are:

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16-286

More information 2/2


Sunshine had the option of selling products A, B, and D at
the splitoff point. This alternative would have yielded the
following revenues for the December production:

Product A, $50,000
Product B, $30,000
Product C, $70,000

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16-287

1. Compute the gross-margin percentage for each


product sold in December, using the following
methods for allocating the $100,000 joint costs:
a. Sales value at splitoff

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16-288

b. Physical-measure

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16-289

c. NRV

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16-290

Summary of gross-margin percentages

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16-291

2. Could Sunshine have increased its December


operating income by making different decisions
about the further processing of products A, B, or D?

Operating income can be


increased by $50,000 if both B and
D are sold at their splitoff point
rather than processed further into
Super B and Super D

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16-292

SOLUTION EXHIBIT
Revenues at Splitoff
and Separable Costs

Joint Costs

A, 300000 gallons
Revenue = $50000
B, 100000 gallons
Revenue = $30000
Processing
$100000

Processing
$200000

Super A
$300000

Processing
$80000

Super B
$100000

Processing
$90000

Super D
$120000

C, 50000 gallons
Revenue = $50000
D, 50000 gallons
Revenue = $70000

Splitoff
Point

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16-293

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16-294

Cost Accounting
A Managerial Emphasis
thirteenth edition

Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

2009 Pearson Prentice Hall. All rights reserved.

17-295

This presentation includes:

Exercises 17-19, 20
Problem 17-21

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17-296

Exercise 17-19
Weighted-average method, equivalent units. Consider the
following data for the Assembly Division of Fenton Watches, Inc.:
The Assembly Division uses the weighted-average method of
process costing.

Compute equivalent units for direct materials and conversion


costs. Show physical units in the first column of your schedule.

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17-297

Under the weighted-average method, equivalent units are


calculated as the equivalent units of work done to date. The
equivalent units of work effort performed for the Assembly
Division for direct materials and conversion costs are:
STEP 1:
Summariz
e Output

in
Physical
Units

STEP 2:
Compute
Output in
Equivalent
Units
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17-298

Exercise 17-20
Weighted-average method, assigning costs (17-19 continued).
For the data in Exercise 17-19, summarize total costs to account
for, calculate cost per equivalent unit for direct materials and
conversion costs, and assign total costs to units completed
(and transferred out) and to units in ending work in process.
STEP 3:
Summariz
e Total
Costs to
STEP
4:
Account
Compute
For

STEPper
5:
Cost
Assign
Equivalen
Total Costs
t Unit
to
Units
Completed
and to
Units in
Ending
Work in
Process
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17-299

Exercise 17-21
FIFO method, equivalent units. Refer to 17-19. Suppose the
Assembly Division at Fenton Watches, Inc., uses the FIFO method
of process costing instead of the weighted-average method.
Compute equivalent units for direct materials and conversion
costs. Show physical units in the first column of your schedule.
STEP 1:
Summarize
Output in
Physical
Units

STEP 2:
Compute
Equivalent
Units done
in current
period
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17-300

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17-301

Cost Accounting
A Managerial Emphasis
thirteenth edition

Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

2009 Pearson Prentice Hall. All rights reserved.

18-302

This presentation includes:


Exercises 18-16, 18-21, 18-23

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18-303

Exercise 18-16
Normal and abnormal spoilage in units The
following data, in physical units, describe a
grinding process for January:

Inspection occurs at the 100% completion stage.


Normal spoilage is 5% of the good units passing
inspection.
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18-304

1. Compute the normal and abnormal


spoilage in units.
Total spoiled units
Normal spoilage in unites
(5%*132,000)
Abnormal spoilage in units

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12,000
6,600
5,400

18-305

2. Assume that the equivalent-unit cost of a


spoiled unit is $10. Compute the amount of
potential savings if all spoilage were
eliminated, assuming that all other costs
would be unaffected. Comment on your
answer.
Abnormal spoilage, 5,400 $10
Normal spoilage, 6,600 $10
Potential savings, 12,000 $10

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$ 54,000
66,000
$120,000

18-306

Regardless of the targeted normal spoilage,


abnormal spoilage is non-recurring and avoidable.
The targeted normal spoilage rate is subject to
change. Many companies have reduced their
spoilage to almost zero, which would realize all
potential savings.
Zero spoilage usually means higher-quality
products, more customer satisfaction, more
employee satisfaction, and various beneficial
effects on non manufacturing (for example,
purchasing) costs of direct materials.
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18-307

Exercise 18-21
Weighted-average method, spoilage Appleton
Company makes wooden toys in its Forming
Department, and it uses the weighted-average
method of process costing. All direct materials are
added at the beginning of the process, and
conversion costs are added evenly during the
process.
Spoiled units are detected upon inspection at the
end of the process and are disposed of at zero net
disposal value.

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18-308

More information
Summary data for August 2009 are:

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18-309

1. For each cost category, calculate equivalent


units.
Appleton Company for August 2009

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18-310

2. Summarize total costs to account for,


calculate cost per equivalent unit for each
cost category, and assign total costs to
units completed and transferred out
(including normal spoilage), to abnormal
spoilage, and to units in ending work in
process.

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18-311

Appleton Company, August 2009

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18-312

Exercise 18-23
Recognition of loss from spoilage Arokia
Electronics manufactures cell phone models in its
Walnut Creek plant. Suppose the company
provides you with the following information
regarding operations for September 2009:
Total cell phones manufactured
10,000
Phones rejected as spoiled units
500
Total manufacturing cost
$209,000
Assume the spoiled units have no disposal value.

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18-313

1. What is the unit cost of making the 10,000


cell phones?

The unit cost of making the 10,000 units is:


$209,000 10,000 units = $20.90 per unit

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18-314

2. What is the total cost of the 500 spoiled


units?

The total cost of the 500 spoiled units is:


$20.90 500 units = $10,450

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18-315

3. If the spoilage is considered normal, what


is the increase in the unit cost of good
phones manufactured as a result of the
spoilage?
The increase in the per-unit cost of goods
sold as a result of the normal spoilage is:
$10,450 9,500 good units = $1.10

Unit cost of goods sold for units remaining


after the spoilage = $20.90 + $1.10 = $22.00
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18-316

4. If the spoilage is considered abnormal,


prepare the journal entries for the spoilage
incurred.
The $10,450 cost for the 500 spoiled units is taken
out of manufacturing costs and expensed in the
period of the spoilage. The journal entry to record
the abnormal spoilage incurred is:
Loss from abnormal spoilage
Work-in-process control

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$10,450
$10,450

18-317

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18-318

Cost Accounting
A Managerial Emphasis
thirteenth edition

Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

2009 Pearson Prentice Hall. All rights reserved.

20-319

This presentation includes:


Exercises 20-18, 20-20, 20-32

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20-320

Exercise 20-18
EOQ for a retailer The Cloth Center sells fabrics
to a wide range of industrial and consumer users.
One of the products it carries is denim cloth, used
in the manufacture of jeans and carrying bags. The
supplier for the denim cloth pays all incoming
freight. No incoming inspection of the denim is
necessary because the supplier has a track record
of delivering high-quality merchandise.
The purchasing lead time is 2 weeks. The Cloth
Center is open 250 days a year (50 weeks for 5
days a week).
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20-321

The purchasing officer of the Cloth Center


has collected the following information:
Annual demand for denim cloth

20,000 yards

Ordering cost per purchase order


Carrying cost per year

$160
20% of purchase costs

Safety-stock requirements
Cost of denim cloth

None
$8 per yard

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20-322

1. Calculate the EOQ for denim cloth.

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20-323

2. Calculate the number of orders that will


be placed each year.

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20-324

3. Calculate the reorder point for denim cloth.

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20-325

Exercise 20-20
Sensitivity of EOQ to changes in relevant ordering and
carrying costs Alyia Companys annual demand for
Model X253 is 10,000 units. Alyia is unsure about the
relevant carrying cost per unit per year and the relevant
ordering cost per purchase order. This table presents six
possible combinations of carrying and ordering costs.

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20-326

1. Determine EOQ for Alyia for each of the


relevant ordering and carrying-cost
alternatives.

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20-327

2. How does your answer to requirement 1


give insight into the impact on EOQ of
changes in relevant ordering and carrying
costs?
For a given demand level, as relevant
carrying costs increase, EOQ becomes
smaller. For a given demand level, as
relevant order costs increase, EOQ
increases.

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20-328

Exercise 20-32
Supply chain effects on total relevant inventory
cost Cow Spot Computer Co. outsources the
production of motherboards for its computers.
It has narrowed down its choice of suppliers to two
companies: Maji and Induk. Maji is an older
company with a good reputation, while Induk is a
newer company with cheaper prices.
Given the difference in reputation, 5% of the
motherboards will be inspected if they are
purchased from Maji, but 25% of the motherboards
will be inspected if they are purchased from Induk.
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20-329

The following data refers to costs associated


with Maji and Induk:

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20-330

1. What is the relevant cost of purchasing


from Maji and Induk?

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20-331

2. What factors other than cost should Cow


Spot consider?
While Induk will save Cow Spot $6,980 ($935,930
$928,950), Cow Spot may still choose to use Maji for the
following reasons:
a. The savings are less than 1% of the total cost of the
mother boards.
b. With ten times the number of returns, Induk will probably
have a negative effect on Cow Spots reputation.
c. With Induks higher stockouts, Cow Spots reputation for
availability and on time delivery will be effected.
d. The increased number of inspections may necessitate
the hiring of additional personnel and the need for
additional factory space and equipment.
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20-332

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20-333

Cost Accounting
A Managerial Emphasis
thirteenth edition

Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

2009 Pearson Prentice Hall. All rights reserved.

21-334

This presentation includes:


Exercises 21-20, 21-24
Problem 21-29

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21-335

Exercise 21-20
Capital budgeting with uneven cash flows, no income
taxes. Southern Cola is considering the purchase of a
special-purpose bottling machine for $23,000. It is
expected to have a useful life of 4 years with no terminal
disposal value. The plant manager estimates the following
savings in cash operating costs:

Southern Cola uses a required rate of return of 16% in its


capital budgeting decisions. Ignore income taxes in your
analysis. Assume all cash flows occur at year-end except
for initial investment amounts.
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21-336

1. Calculate net present value for the


special-purpose bottling machine.

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21-337

2. Calculate the payback period for the


special-purpose bottling machine.

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21-338

3. Calculate the internal rate of return for the


special-purpose bottling machine.

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21-339

4. Calculate the accounting rate of return for


the special-purpose bottling machine.

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21-340

Exercise 21-24
New equipment purchase, income taxes. Annas
Bakery plans to purchase a new oven for its store. The
oven has an estimated useful life of 4 years. The
estimated pretax cash flows for the oven are as shown in
the table that follows, with no anticipated change in
working capital. Annas Bakery has a 12% after-tax
required rate of return and a 40% income tax rate.

Assume depreciation is calculated on a straight line basis


for tax purposes using the initial oven investment and
estimated terminal disposal value of the oven. Assume
all cash flows occur at year-end except for initial
investment amounts.
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21-341

1. Calculate (a) net present value, (b)


payback period, and (c) internal rate of return.

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21-342

(a) NPV is $7,013

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21-343

b. The Payback Period = $88,000 $29,600 =


2.97 years
c. The net present value of the project using
14% has a small positive NPV. At 16% it is a
small negative NPV. Therefore, the IRR, the
discount rate at which the NPV of the cash flows
is zero, must lie between 14% and 16%.

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21-344

2. Compare and contrast the capital


budgeting methods in requirement 1.
Both the net present value and internal rate of return methods
use a discounted cash flow approach in which all expected
future cash inflows and cash outflows of a project are
measured as if they occurred at a single point in time.
The payback method considers only cash flows up to the time
when the expected future cash inflows recoup the net initial
investment in a project. The payback method ignores
profitability and the time value of money.

However, the payback method is becoming increasingly


important in the global economy. When the local environment in
an international location is unstable and therefore highly risky
for a potential investment, a company would likely pay close
attention to the payback period for making its investment
decision. In general, the more unstable the environment, the
shorter the payback period desired.
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21-345

Exercise 21-29
DCF, sensitivity analysis, no income taxes. (CMA, adapted)
Landom Corporation is an international manufacturer of
fragrances for women. Management at Landom is considering
expanding the product line to mens fragrances.
From the best estimates of the marketing and production
managers, annual sales (all for cash) for this new line is
1,000,000 units at $25 per unit; cash variable cost is $10 per
unit; cash fixed costs is $5,000,000 per year. The investment
project requires $30,000,000 of cash outflow and has a project
life of 5 years. At the end of the five-year useful life, there will be
no terminal disposal value.
Assume all cash flows occur at year-end except for initial
investment. Mens fragrance is a new market for Landom,
management is concerned about the reliability of estimates. The
controller has proposed applying sensitivity analysis to selected
factors. Ignore income taxes in your computations. Landoms
required rate of return on this project is 14%.
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21-346

1. Calculate the net present value of this


investment proposal.

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21-347

2. Calculate the effect on the net present


value with a 5% reduction in the selling price.

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21-348

2. Calculate the effect on the net present value


with a 5% increase in the variable cost per unit.

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21-349

3. Discuss how management would use the data

developed in requirements 1 and 2 in its


consideration of the proposed capital investment.
Sensitivity analysis enables management to see
those assumptions for which input variations have
sizable impact on NPV. Extra resources could be
devoted to getting more informed estimates of those
inputs with the greatest impact on NPV.
Sensitivity analysis also enables management to
have contingency plans in place if assumptions are
not met. For example, if a 5% reduction in selling
price is viewed as occurring with 0.40 probability,
management may wish to line up bank loan facilities.

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21-350

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21-351

Cost Accounting
A Managerial Emphasis
thirteenth edition

Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

2009 Pearson Prentice Hall. All rights reserved.

22-352

This presentation includes:


Exercises 22-20, 22-23
Problem 22-35

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22-353

Exercise 22-20
Transfer-pricing methods, goal congruence.
British Columbia Lumber has a Raw Lumber
Division and a Finished Lumber Division. The
variable costs are:
Raw Lumber Division: $100 per 100 board-feet
of raw lumber
Finished Lumber Division: $125 per 100 boardfeet of finished lumber
Assume that there is no board-feet loss in
processing raw lumber into finished lumber.
Raw lumber can be sold at $200 per 100 boardfeet. Finished lumber can be sold at $275 per 100
board-feet.
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22-354

1. Should British Columbia Lumber process


raw lumber into its finished form?
British
Columbia
Lumber will
maximize its
total
contribution
margin by
selling lumber
in its raw form.

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22-355

2. Assume that internal transfers are made at 110% of

variable cost. Will each division maximize division


operating-income by adopting the action that is in the
best interest of British Columbia Lumber as a whole?
Transfer price at 110% of
variable costs:
= $100 + ($100 0.10)
= $110 per 100 board feet

The Raw Lumber Division will maximize


reported division operating income by
selling raw lumber, and is the action
preferred by company as a whole. The
Finished Lumber Division maximizes
division operating income by selling
finished lumber, and is contrary to the
action preferred by company as a whole.
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22-356

Since the Raw Lumber Division will be indifferent between selling the
3. Assume
internal
are made
at market
lumber
in raw orthat
finished
form, ittransfers
would be willing
to maximize
division
operating
by selling
raw lumber,
whichits
is operating-income
the action preferred by
prices.income
Will each
division
maximize
the company as a whole. The Finished Lumber Division will maximize
contribution by adopting the action that is in the best
division operating income by not further processing raw lumber and this is
interest
Columbia
as a at
whole?
preferred
byof
theBritish
company
as a whole.Lumber
Thus, transfer
market price will
result in division actions that are also in the best interest of the company as
Transfer price at market price = $200 per 100 board feet.
a whole.

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22-357

Exercise 22-23
Multinational transfer pricing, global tax minimization.
The Mornay Company manufactures telecommunications
equipment at its plant in Toledo, Ohio. The company has
marketing divisions throughout the world. A Mornay
marketing division in Vienna, Austria, imports 1,000 units of
Product 4A36 from the United States. The following
information is available:

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22-358

Suppose the U.S. and Austrian tax authorities only


allow transfer prices that are between the full
manufacturing cost per unit of $500 and a market
price of $650, based on comparable imports into
Austria. The Austrian import duty is charged on the
price at which the product is transferred into Austria.
Any import duty paid to the Austrian authorities is a
deductible expense for calculating Austrian income
taxes due.
1. Calculate the after-tax operating income earned by the U.S.

and Austrian divisions from transferring 1,000 units of Product


4A36 (a) at full manufacturing cost per unit and (b) at market
price of comparable imports. (Income taxes are not included in
the computation of the cost-based transfer prices.
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22-359

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22-360

Consider what happens every time the


transfer price is increased by $1 over, say,
the full manufacturing cost of $500. This
results in the following:

Hence, Mornay Company will minimize import duties and


income taxes by setting the transfer price at its minimum
level of $500, the full manufacturing cost.
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22-361

Problem 22-35
Transfer pricing, goal congruence, ethics. Whengon
Manufacturing makes electronic hearing aids. Department A
manufactures 10,000 units of part HR-7 and Department B uses
this part to make the finished product.
HR-7 is a specific part for a patented product that cannot be
purchased or sold outside of Whengon, so there is no outside
demand for this part. Variable costs of making HR-7 are $12 per
unit. Fixed costs directly traced to HR-7 equal $30,000.
Upper management has asked the two departments to negotiate
a transfer price for HR-7. The manager of Department A, Henry
Lasker, is worried that Department B will insist on using variable
cost as the transfer price because Department A has excess
capacity. Lasker asks Joe Bedford, his management accountant,
to show more costs as variable costs and fewer costs as fixed
costs. Lasker says, There are gray areas when distinguishing
between fixed and variable costs. I think the variable cost of
making HR-7 is $14 per unit.
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22-362

1. If Lasker is correct, calculate the benefit to


Department A from showing a variable cost of $14
per unit rather than $12 per unit.

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22-363

2. What cost-based transfer price


mechanism would you propose for HR-7?
The author recommends a lump sum transfer of $40,000
(say) from Department B to Department A plus a transfer
price equal to the variable cost per unit of $12 per unit.
This would generate some operating income for
Department A while Department A continues to make
transfers at variable costs. Such a transfer pricing
arrangement avoids the suboptimal decision making that
can result from full cost transfer prices.

Variable cost transfer prices often provide valuable


information for decision making. The fixed payment is
the price that Department B pays for using the capacity
of Department A.
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22-364

3. Evaluate whether Laskers comment to Bedford


about the variable cost of HR-7 is ethical. Would it
be ethical for Bedford to revise the variable cost
per unit? What steps should Bedford take to
resolve the situation?
Asking the management accountant to reclassify costs is unethical.
Lasker suggests that $14 per unit is a more appropriate variable
cost per unit. However, he does not substantiate his claim with any
costs that he thinks are misclassified.
In fact, his variable cost per unit number seems arbitrary and
specifically targeted to improve his transfer pricing negotiations. If
that is the reason for his request and there is no fundamental
problem with the current cost classifications, Bedford should not
change the variable cost per unit. To do so would be unethical. To
resolve this situation, Bedford should begin by explaining his
decision to Lasker. If Lasker insists on using a higher variable cost
per unit, then Bedford may need to alert Laskers supervisor in
Whengons upper management.
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22-365

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22-366

Cost Accounting
A Managerial Emphasis
thirteenth edition

Charles T. Horngren
Srikant M. Datar
George Foster
Madhav Rajan
Christopher Ittner

2009 Pearson Prentice Hall. All rights reserved.

23-367

This presentation includes:


Exercise 23-21
Problems 23-29, 23-35

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23-368

Exercise 23-21
Goal incongruence and ROI. Bleefl Corporation manufactures
furniture in several divisions, including the Patio Furniture
division. The manager of the Patio Furniture division plans to
retire in two years. The manager receives a bonus based on the
divisions ROI, which is currently 11%. One of the machines that
the Patio Furniture division uses to manufacture the furniture is
rather old, and the manager must decide whether to replace it.
The new machine would cost $30,000 and would last 10 years. It
would have no salvage value. The old machine is fully depreciated
and has no trade-in value. Bleefl uses straight-line depreciation
for all assets. The new machine, being new and more efficient,
would save the company $5,000 per year in cash operating costs.
The only difference between cash flow and net income is
depreciation. The internal rate of return of the project is
approximately 11%. Bleefl Corporations weighted average cost of
capital is 6%. Bleefl is not subject to any income taxes.
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23-369

1. Should Bleefl Corporation replace


the machine? Why or why not?
Bleefl would be better off if the
machine is replaced. Its cost of
capital is 6% and the IRR of the
investment is 11%, indicating that
this is a positive net present value
project.
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23-370

2. Assume that investment is defined as average net longterm assets after depreciation. Compute the projects ROI for
each of its first five years. If the Patio Furniture manager
wants to maximize his bonus, would he replace the machine
before he retires?

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23-371

3. What can Bleefl do to entice the manager to


replace the machine before retiring?
Bleefl could use long term rather than short term ROI, or
use ROI and some other long term measures to evaluate
Patio Furniture division to create goal congruence.
Evaluating the managers on residual income rather than
ROI would achieve goal congruence. For example,
replacing the machine increases residual income in Year 1.
Residual income = Operating income (6% Average net
assets)
= $2,000 (6% 28,500)
= $2,000 $1,710 = $290
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23-372

Exercise 23-29
Evaluating managers, ROI, DuPont method,
value-chain analysis of cost structure. Peach
Computer Corporation is the largest personal
computer company in the world. The CEO of
Peach is retiring, and the board of directors is
considering external candidates to fill the
position. The boards top two choices are CEOs
Peter Diamond (current CEO of NetPro) and
Norma Provan (current CEO of On Point). As a
board member on the search committee, you
collect the following information (in millions):
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23-373

In early 2009, a leading computer magazine gave On


Points main product five stars, its highest rating. NetPros
main product received three stars, down from five stars a
year earlier. Also, On Points new products received praise;
NetPros new products were judged as mediocre.
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23-374

1. Use the DuPont method to calculate NetPros


and On Points ROIs in 2007 and 2008. Comment
on the results. What can you tell from the DuPont
analysis that you might have missed from
calculating ROI itself?

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23-375

NetPros ROI has declined sizably from 2007 to 2008 largely


because of a decline in operating income to revenues
(return on sales or ROS). On Points ROI has more than
doubled from 2007 to 2008, in large part due to an increase
in operating income to revenues (return on sales or ROS).
The DuPont analysis tells us that NetPros ROI decline
arises from a serious degradation in its ROS, and not from
any significant problem in assets turns, i.e., its management
should probably examine and try to fix its eroding margins.
This insight would not be available from a direct calculation
of ROI.

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23-376

2. Compute the percentage of costs in each of the four


business-function cost categories for NetPro and
On Point in 2007 and 2008. Comment on the results.

Business functions with increases/decreases in the percentage of total


costs from 2007 to 2008 are:

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23-377

NetPro has decreased expenditures in two key


business functions that are critical in the
computer industry research and development
and customer service.
These costs are (using the chapters terminology)
discretionary and they can be reduced in the
short run without any short-run effect on
customers, but such action is likely to create
serious problems in the long run.
On Point, on the other hand, increased its
percentage of total costs in these two areas.
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23-378

3. Relate the results of requirements 1 and 2 to the


comments made by the computer magazine. Of
Diamond and Provan, whom would you suggest to be
the new CEO of Peach?
a) The ROI of On Point has increased from 2007 to 2008,
while that of NetPro has decreased.
b) The computer magazine has given the highest ranking
to On Points main product, while NetPros received a
lower ranking.
c) On Point has received high marks for new products
(the lifeblood of a computer company), while NetPro's
new-product introductions have been described as
mediocre.
It is likely that On Points better rating for its current
product is based on customer service and its better
rating for its new product is based on research and
development spending.
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23-379

Exercise 23-35
Ethics, managers performance evaluation. Hamilton
Semiconductors manufactures specialized chips that sell
for $20 each. Hamiltons manufacturing costs consist of
variable cost of $2 per chip and fixed costs of
$9,000,000. Hamilton also incurs $400,000 in fixed
marketing costs each year.
Hamilton calculates operating income using absorption
costingthat is, Hamilton calculates manufacturing cost
per unit by dividing total manufacturing costs by actual
production. Hamilton costs all units in inventory at this
rate and expenses the costs in the income statement at
the time when the units in inventory are sold. Next year,
2011, appears to be a difficult year for Hamilton. It
expects to sell only 500,000 units. The demand for these
chips fluctuates considerably, so Hamilton usually holds
minimal inventory.
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23-380

Calculate Hamiltons operating income in 2011


(a) if Hamilton manufactures 500,000 units and

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23-381

(b) if Hamilton manufactures 600,000 units.

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23-382

2. Would it be unethical for Randy Jones, the


general manager of Hamilton Semiconductors, to
produce more units than can be sold in order to
show better operating results? Joness
compensation has a bonus component based on
operating income. Explain your answer.
It would not be ethical for Jones to produce more units just
to show better operating results. Professional managers are
expected to take better operating actions that are in the best
interests of their shareholders. Joness action would benefit
him at the cost of shareholders. Joness actions would be
equivalent to cooking the books, even though he may
achieve this by producing more inventory than was needed,
rather than through fictitious accounting.
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23-383

Would it be unethical for Jones to ask distributors to


buy more product than they need? Hamilton follows
the industry practice of booking sales when products
are shipped to distributors. Explain.

Asking distributors to take more products than they need


is also equivalent to cooking the books. In effect,
distributors are being coerced into taking more product.
This is a particular problem if distributors will take less
product in the following year or alternatively return the
excess inventory next year.
Some might argue that Joness behavior is not
unethicalit is up to the distributors to decide whether to
take more inventory or not. So long as Jones is not
forcing the product on the distributors, it is not unethical
for Jones to push sales this year even if the excess
product will sit in the distributors inventory.
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