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Management Accounting by Cabrera
Management Accounting by Cabrera
TABLE OF CONTENTS
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Chapter 1 Management Accounting: An Overview
CHAPTER 1
I. Questions
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Management Accounting: An Overview Chapter 1
information is very prevalent which implies that its benefits exceed its
costs. Hence, successful managers will find it in their self-interest to
learn how to use accounting information in these organizations.
Clearly, this statement is incurred in those firms where accounting
information has very limited usefulness (e.g., if the accounting
information is often wrong or is not produced in a timely fashion). In
these organizations, managers do not find the accounting information to
have benefits in excess of its costs, will not use it, do not need to know
how to use it, and definitely do not need it.
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Chapter 1 Management Accounting: An Overview
4. Yes. Planning is really much more vital than control; that is, superior
control is fruitless if faulty plans are being implemented. However,
planning and control are so intertwined that it seems artificial to draw
rigid lines of separation between them.
5. Yes. The controller has line authority over the personnel in his own
department but is a staff executive with respect to the other departments.
8. Bettina Company
President
Controller Treasurer
Assistant Assistant
Controller Treasurer
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Management Accounting: An Overview Chapter 1
Clerk
11. Three guidelines that help management accountants increase their value
to managers are (a) employ a cost-benefit approach, (b) recognize
behavioral as well as technical considerations, and (c) identify different
costs for different purposes.
14. By reporting and interpreting relevant data, the controller exerts a force
or influence that impels management toward making better-informed
decisions.
15.
Financial Accounting
Audience: External: shareholders, creditors, tax
authorities
Purpose: Report on past performance to external
parties; basis of contracts with owners and
lenders
Timeliness: Delayed; historical
Restrictions: Regulated; rules driven by generally accepted
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Chapter 1 Management Accounting: An Overview
Managerial Accounting
Audience: Internal: Workers, managers, executives
Purpose: Inform internal decisions made by employees
and managers; feedback and control on
operating performance
Timeliness: Current, future oriented
Restrictions: No regulations; systems and information
determined by management to meet strategic
and operational needs
Type of Information: Financial, plus operational and physical
measurements on processes, technologies,
suppliers customers, and competitors
Nature of Information: More subjective and judgmental; valid,
relevant, accurate
Scope: Disaggregate; inform local decisions and
actions
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Management Accounting: An Overview Chapter 1
II. Exercises
Exercise 1
Exercise 2
a. (4) Marketing
b. (3) Production
c. (6) Customer service
d. (5) Distribution
Exercise 3
a. (4) Marketing
b. (3) Production
c. (5) Distribution
d. (4) Marketing
e. (5) Distribution
f. (3) Production
g. (1) Research and development
h. (2) Design
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Chapter 1 Management Accounting: An Overview
III. Problems
Because the accountant’s duties are often not sharply defined, some of these
answers might be challenged:
1. Scorekeeping
2. Attention directing
3. Scorekeeping
4. Problem solving
5. Attention directing
6. Attention directing
7. Problem solving
8. Scorekeeping (depending on the extent of the report) or attention
getting
9. This question is intentionally vague. The give-and-take of the
budgetary process usually encompasses all three functions, but it
emphasizes scorekeeping the least. The main function is attention
directing, but problem solving is also involved.
10. Problem solving
1. Inputs: b, g, i, m
2. Processes: a, d, f, j
3. Outputs: e, k, n
4. System objectives: c, h, l
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Management Accounting: An Overview Chapter 1
Jamie Reyes is staff. She is in a support role – she prepares reports and
helps explain and interpret them. Her role is to help the line managers more
effectively carry out their responsibilities.
Requirement 1
The possible motivations for the snack foods division wanting to play end-
of-year games include:
(a) Management incentives. Yummy Foods may have a division bonus
scheme based on one-year reported division earnings. Efforts to front-
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Chapter 1 Management Accounting: An Overview
end revenue into the current year or transfer costs into the next year can
increase this bonus.
(b) Promotion opportunities and job security. Top management of Yummy
Foods likely will view those division managers that deliver high reported
earnings growth rates as being the best prospects for promotion.
Division managers who deliver “unwelcome surprises” may be viewed
as less capable.
(c) Retain division autonomy. If top management of Yummy Foods adopts
a “management by exception” approach, divisions that report sharp
reductions in their earnings growth rates may attract a sizable increase in
top management supervision.
Requirement 2
The “Standards of Ethical Conduct…” require management accountants to:
Refrain from either actively or passively subverting the attainment of
the organization’s legitimate and ethical objectives, and
Communicate unfavorable as well as favorable information and
professional judgment or opinions.
The other “end-of-year games” occur in many organizations and may fall
into the “gray” to “acceptable” area. However, much depends on the
circumstances surrounding each one:
(a) If the independent contractor does not do maintenance work in
December, there is no transaction regarding maintenance to record. The
responsibility for ensuring that packaging equipment is well maintained
is that of the plant manager. The division controller probably can do
little more than observe the absence of a December maintenance charge.
(d) In many organizations, sales are heavily concentrated in the final weeks
of the fiscal year-end. If the double bonus is approved by the division
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Management Accounting: An Overview Chapter 1
Each of the (a), (d), (e) and (g) “end-of-year games” may well disadvantage
Yummy Foods in the long run. For example, lack of routine maintenance
may lead to subsequent equipment failure. The divisional controller is well
advised to raise such issues in meetings with the division president.
However, if Yummy Foods has a rigid set of line/staff distinctions, the
division president is the one who bears primary responsibility for justifying
division actions to senior corporate officers.
Requirement 3
If Tan believes that Ryan wants her to engage in unethical behavior, she
should first directly raise her concerns with Ryan. If Ryan is unwilling to
change his request, Tan should discuss her concerns with the Corporate
Controller of Yummy Foods. Tan also may well ask for a transfer from the
snack foods division if she perceives Ryan is unwilling to listen to pressure
brought by the Corporate Controller, CFO, or even President of Yummy
Foods. In the extreme, she may want to resign if the corporate culture of
Yummy Foods is to reward division managers who play “end-of-year
games” that Tan views as unethical and possibly illegal.
Problem 6
James Torres has come up with a scheme that involves a combination of data
falsification and smoothing! Not only has he made up the revenue numbers,
but also he has had the gall to defer some of them to the next period.
Making up such numbers is clearly illegal. Smoothing, in this example is
also illegal because the numbers are fictitious.
Problem 7
Clearly the vice-president will lose his or her job if you turn him or her in.
Given that this is a major violation of the code of ethics and a violation
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Chapter 1 Management Accounting: An Overview
patent law, the vice-president could go to jail. Your best course of action is
to check your information and if the vice-president is definitely involved, go
immediately to the VP’s superior (who is probably a senior VP or the
company president). The organization’s attorneys will take over from there.
Problem 8
One option is to do nothing and ignore what you saw, however, this may
violate your own code of ethics and your ethical responsibilities under the
organization’s code of ethics. Given that you want to do something, it is
probably best to start by talking to employees in your organization whose
job it is to deal with ethical issues. If no such employees exist or are
available, you might start by using a decision model. This model
incorporated the following steps:
1. Determine the Facts – What, Who, Where, How
2. Define the Ethical Issue
3. Identify Major Principles, Rule, Values
4. Specify the Alternatives.
5. Compare Values and Alternatives, See if Clear Decision
6. Assess the Consequences.
7. Make Your Decision.
IV. Cases
Requirement (a)
Other forward looking information desired in addition to the income
statement information are
1. Disclosure of the components of financial performance, i.e., nature
and source of revenues, various activities, transactions, and other
relevant events affecting the company.
2. Nature and function of the components of income and expenses
Requirement (b)
No. GAAP does not allow capitalization of employee training and
advertising costs even if management feels that they increase the value of the
company’s brand name. The reasons are uncertainty of the future benefits
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Management Accounting: An Overview Chapter 1
Requirement (c)
Detailed information that managers would likely request are analysis of the
significant increases in
1. Sales
2. Cost of sales
3. Payroll
4. Stock and option based compensation
5. Advertising and promotion.
Requirement (d)
Nonmonetary measures:
1. Change in number and profile of customers
2. Share in the market
3. Who, what and how many are the competitors
4. Product lines offered by the entity vs. Product lines of competitors
5. Sales promotion and advertising activities
Requirement (e)
1. Competitors
2. Employees
3. Prospective creditors
Requirement (a)
Increase in sales to new customers to sales
Too much emphasis on this ratio may lead the sales manager to spend more
time developing business with new customers and disregard the needs of
existing customers. It is therefore possible to lose the business of several
key accounts.
Requirement (b)
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Chapter 1 Management Accounting: An Overview
Requirement (c)
Decrease in selling and administrative expense to sales
Cost-cutting is generally advisable for as long as the quality of goods and
services are not compromised. Likewise, certain cost-saving measures could
demotivate sales people and other employees and could lead to counter-
productive activities.
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Management Accounting: An Overview Chapter 1
Generally, when we buy goods and services in the free market, we assume
we are buying from people who have a certain level of ethical standards. If
we could not trust people to maintain those standards, we would be reluctant
to buy. The net result of widespread dishonesty would be a shrunken
economy with a lower growth rate and fewer goods and services for sale at a
lower overall level of quality.
Requirement 1
Failure to report the obsolete nature of the inventory would violate the
Standards of Ethical Conduct as follows:
Competence
Perform duties in accordance with relevant technical standards.
Prepare complete reports using reliable information.
By failing to write down the value of the obsolete inventory, Perez would
not be preparing a complete report using reliable information. In addition,
generally accepted accounting principles (GAAP) require the write-down of
obsolete inventory.
Integrity
Avoid conflicts of interest.
Refrain from activities that prejudice the ability to perform duties
ethically.
Refrain from subverting the legitimate goals of the organization.
Refrain from discrediting the profession.
Members of the management team, of which Perez is a part, are responsible
for both operations and recording the results of operations. Since the team
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Chapter 1 Management Accounting: An Overview
Objectivity
Communicate information fairly and objectively.
Disclose all relevant information.
Hiding the obsolete inventory impairs the objectivity and relevance of
financial statements.
Requirement 2
As discussed above, the ethical course of action would be for Perez to insist
on writing down the obsolete inventory. This would not, however, be an
easy thing to do. Apart from adversely affecting her own compensation, the
ethical action may anger her colleagues and make her very unpopular.
Taking the ethical action would require considerable courage and self-
assurance.
Requirement 1
See the organization chart on page 17.
Requirement 2
Line positions would include the university president, academic vice-
president, the deans of the four colleges, and the dean of the law school. In
addition, the department heads (as well as the faculty) would be in line
positions. The reason is that their positions are directly related to the basic
purpose of the university, which is education. (Line positions are shaded on
the organization chart.)
All other positions on the organization chart are staff positions. The reason
is that these positions are indirectly related to the educational process, and
exist only to provide service or support to the line positions.
Requirement 3
All positions would have need for accounting information of some type. For
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Management Accounting: An Overview Chapter 1
example, the manager of central purchasing would need to know the level of
current inventories and budgeted allowances in various areas before doing
any purchasing; the vice president for admissions and records would need to
know the status of scholarship funds as students are admitted to the
university; the dean of the business college would need to know his/her
budget allowances in various areas, as well as information on cost per
student credit hour; and so forth.
Requirement 1
No, Santos did not act in an ethical manner. In complying with the
president’s instructions to omit liabilities from the company’s financial
statements he was in direct violation of the IMA’s Standards of Ethical
Conduct for Management Accountants. He violated both the “Integrity” and
“Objectivity” guidelines on this code of ethical conduct. The fact that the
president ordered the omission of the liabilities is immaterial.
Requirement 2
No, Santos’ actions can’t be justified. In dealing with similar situations, the
Securities and Exchange Commission (SEC) has consistently ruled that “…
corporate officers…cannot escape culpability by asserting that they acted as
‘good soldiers’ and cannot rely upon the fact that the violative conduct may
have been condoned or ordered by their corporate superiors.” (Quoted from:
Gerald H. Lander, Michael T. Cronin, and Alan Reinstein, “In Defense of
the Management Accountant,” Management Accounting, May, 1990, p. 55)
Thus, Santos not only acted unethically, but he could be held legally liable if
insolvency occurs and litigation is brought against the company by creditors
or others. It is important that students understand this point early in the
course, since it is widely assumed that “good soldiers” are justified by the
fact that they are just following orders. In the case at hand, Santos should
have resigned rather than become a party to the fraudulent misrepresentation
of the company’s financial statements.
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Case 6
Requirement 1
President
Vice
Vice Vice Vice
Academic
President, President, Vice President,
President,
Auxiliary Admissions & Physical
President Financial
Services Records Plant
Services
(Controller)
Dean,
Dean, Business Dean, Dean, Dean,
Engineering &
Humanities Fine Arts Law School
Quantitative
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MANAGEMENT ACCOUNTING - Solutions Manual
Requirement 1
Andres Romero has an ethical responsibility to take some action in the
matter of PhilChem, Inc. and the dumping of toxic wastes. The Standards
of Ethical Conduct for Management Accountants specifies that management
accountants should not condone the commission of acts by their organization
that violate the standards of ethical conduct. The specific standards that
apply are as follows.
• Competence. Management accountants have a responsibility to
perform their professional duties in accordance with relevant laws
and regulations.
• Confidentiality. Management accountants must refrain from
disclosing confidential information unless legally obligated to do so.
However, Andres Romero may have a legal responsibility to take
some action.
• Integrity. Management accountants have a responsibility to:
- refrain from either actively or passively subverting the
attainment of the organization’s legitimate and ethical
objectives.
- communicate favorable as well as unfavorable information and
professional judgments or opinions.
• Objectivity. Management accountants must fully disclose all
relevant information that could reasonably be expected to influence
an intended user’s understanding of the reports, comments, and
recommendations.
Requirement 2
The Standards of Ethical Conduct for Management Accountants indicates
that the first alternative being considered by Andres Romero, seeking the
advice of his boss, is appropriate. To resolve an ethical conflict, the first
step is to discuss the problem with the immediate superior, unless it appears
that this individual is involved in the conflict. In this case, it does not appear
that Romero’s boss is involved.
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Chapter 8 Cost Concepts and Classifications
action at this time. Romero should report the conflict to successively higher
levels within the organization and turn only to the Board of Directors if the
problem is not resolved at lower levels.
Requirement 3
Andres Romero should follow the established policies of the organization
bearing on the resolution of such conflict. If these policies do not resolve the
ethical conflict, Romero should report the problem to successively higher
levels of management up to the Board of Directors until it is satisfactorily
resolved. There is no requirement for Romero to inform his immediate
superior of this action because the superior is involved in the conflict. If the
conflict is not resolved after exhausting all courses of internal review,
Romero may have no other recourse than to resign from the organization and
submit an informative memorandum to an appropriate member of the
organization.
(CMA Unofficial Solution, adapted)
CHAPTER 2
MANAGEMENT ACCOUNTING
AND THE BUSINESS ENVIRONMENT
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I. Questions
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Chapter 8 Cost Concepts and Classifications
7. If customers who provide a company with the most profits are attracted,
satisfied, and retained, profits will increase as a result.
Quality: Customers are expecting higher levels of quality and are less
tolerant of low quality than in the past.
Time: Time has many components: the time taken to develop and
bring new products to market; the speed at which an
organization responds to customer requests; and the
reliability with which promised delivery dates are met.
Organizations are under pressure to complete activities faster
and to meet promised delivery dates more reliably than in
the past in order to increase customer satisfaction.
Innovation: There is now heightened recognition that a continuing flow
of innovative products or services is a prerequisite for the
ongoing success of most organizations.
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Cost Concepts and Classifications Chapter 8
11. Four themes for managers to attain success are customer focus, value-
chain and supply-chain analysis, key success factors, and continuous
improvement and benchmarking.
13. This phrase means that people will direct their attention to work
primarily on those tasks that management monitors and measures.
Employees may not pay as much attention (or no attention) to tasks that
are not measured. Often management will reward people based on how
well they perform relative to a specific measure. As an example, in a
manufacturing organization, if people are measured and rewarded based
on the number of outputs per hour, regardless of quality, employees will
focus their attention on producing as many units of output as possible.
A negative consequence is that the quality of output may suffer.
14. Some of these new measures are quality, speed to market, cycle time,
flexibility, complexity and productivity.
16.
Stakeholders Contribution Requirements
Employees Effort, skills, Rewards, interesting
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Cost Concepts and Classifications Chapter 8
19. Just-in-time means making a good or service only when the customer,
internal or external, requires it. Just-in-time requires a product layout
with a continuous flow (no delays) once production starts. It means that
setup costs must be reduced substantially to eliminate the need to
produce in batches, and it means that processing systems must be
reliable. Just-in-time production is based on the elimination of all
nonvalue-added activities to reduce cost and time. It is an approach to
improvement that is continuous and involves employee empowerment
and involvement.
CHAPTER 3
I. Questions
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Chapter 8 Cost Concepts and Classifications
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Cost Concepts and Classifications Chapter 8
10. A strong statement of cash flows is one that shows significant amounts
of cash generated from operating activities. This means that the
enterprise is generating cash from its ongoing activities and is not
required to rely on continuous debt and equity financing, or the sale of
its major assets.
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Chapter 8 Cost Concepts and Classifications
1.
1. d 3. a 5. e 7. f 9. c
2. g 4. j 6. h 8. b 10. i
2.
1. d 3. i 5. m 7. h 9. f 11. b 13. e
2. a 4. g 6. c 8. n 10. k 12. j 14. l
3.
a. F c. F e. I g. F I. I k. F
b. I d. I f. F h. F j. F l. I
III. Problems
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Cost Concepts and Classifications Chapter 8
Requirement (a)
SM Farms
Balance Sheet
September 30, 2005
* Total assets, P961,470, minus total liabilities, P618,050, less share capital,
P250,000.
Requirement (b)
The loss of an asset, Barns and Sheds, from a typhoon would cause a
decrease in total assets. When total assets are decreased, the balance sheet
total of liabilities and equity must also decrease. Since there is no change in
liabilities as a result of the destruction of an asset, the decrease on the right-
hand side of the balance sheet must be in the retained earnings account. The
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Chapter 8 Cost Concepts and Classifications
amount of the decrease in Barns and Sheds, in the equity, and in both
balance sheet totals, is P23,800.
Problem 2 (Preparing a Balance Sheet and Cash Flow Statement;
Effects of Business Transactions)
Requirement (a)
The Tasty Bakery
Balance Sheet
August 1, 2005
Requirement (b)
The Tasty Bakery
Balance Sheet
August 3, 2005
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Cost Concepts and Classifications Chapter 8
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Chapter 8 Cost Concepts and Classifications
activities:
Sale of share capital P25,000
Requirement (c)
The Tasty Bakery is in a stronger financial position on August 3 than it was
on August 1.
On August 1, the highly liquid assets (cash and accounts receivable) total
only P18,200, but the company has P25,100 in debts due in the near future
(accounts payable plus salaries payable).
On August 3, after additional infusion of cash from the sale of stock, the
liquid assets total P25,750, and debts due in the near future amount to
P16,100.
Requirement (a)
The First Malt Shop
Balance Sheet
September 30, 2005
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Cost Concepts and Classifications Chapter 8
P 7,400
Accounts receivable 1,250 Notes payable*
P 70,000
* Total assets, P132,590, less equity, P54,090, less accounts payable, P8,500,
equals notes payable.
Requirement (b)
The First Malt Shop
Balance Sheet
October 6, 2005
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Chapter 8 Cost Concepts and Classifications
Total Total
P173,590 P173,590
Revenues P 5,500
Expenses (4,000)
Net income P 1,500
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Cost Concepts and Classifications Chapter 8
share capital
Increase in cash P
22,000
Cash balance, October 1, 2005 7,400
Cash balance, October 6, 2005 P29,400
Requirement (c)
The First Malt Shop is in a stronger financial position on October 6 than on
September 30. On September 30, the company had highly liquid assets
(cash and accounts receivable) of P8,650, which barely exceeded the P8,500
in liabilities (accounts payable) due in the near future. On October 6, after
the additional investment of cash by shareholders, the company’s cash alone
exceeded its short-term obligations.
Requirement (1)
Fil-Cinema Scripts
Balance Sheet
November 30, 2005
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Chapter 8 Cost Concepts and Classifications
Share capital
5,000
Office furniture* 12,825 Retained earnings
3,535
Total Total
P114,735 P114,735
Requirement (2)
(1) The cash in Cruz’s personal savings account is not an asset of the
business entity Fil-Cinema Scripts and should not appear in the balance
sheet of the business. The money on deposit in the business bank
account (P3,400) and in the company safe (P540) constitute cash owned
by the business. Thus, the cash owned by the business at November 30
totals P3,940.
(2) The years-old IOU does not qualify as a business asset for two reasons.
First, it does not belong to the business entity. Second, it appears to be
uncollectible. A receivable that cannot be collected is not viewed as an
asset, as it represents no future economic benefit.
(3) The total amount to be included in “Office furniture” for the rug is
P9,400, the total cost, regardless of whether this amount was paid in
cash. Consequently, “Office furniture” should be increased by P6,500.
The P6,500 liability arising from the purchase of the rug came into
existence prior to the balance sheet date and must be added to the “Notes
payable” amount.
(4) The computer is no longer owned by Hollywood Scripts and therefore
cannot be included in the assets. To do so would cause an overstatement
of both assets and equity. The “Office furniture” amount must be
reduced by P2,525.
(5) The P22,400 described as “Other assets” is not an asset, because there is
no valid legal claim or any reasonable expectation of recovering the
income taxes paid. Also, the payment of income taxes by Cruz was not
a business transaction by Fil-Cinema Scripts. If a refund were obtained
from the government, it would come to Cruz personally, not to the
business entity.
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Cost Concepts and Classifications Chapter 8
(6) The proper valuation for the land is its historical cost of P39,000, the
amount established by the transaction in which the land was purchased.
Although the land may have a current fair value in excess of its cost, the
offer by the friend to buy the land if Cruz would move the building
appears to be mere conversation rather than solid, verifiable evidence of
the fair value of the land. The “cost principle,” although less than
perfect, produces far more reliable financial statements than would result
if owners could “pull figures out of the air” in recording asset values.
(7) The accounts payable should be limited to the debts of the business,
P32,700, and should not include Cruz’s personal liabilities.
I. Questions
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Chapter 8 Cost Concepts and Classifications
Measuring the change in sales over a period of several years would call
for use of trend percentages. The sales in the base year are assigned a
weight of 100%. The percentage for each later year is computed by
dividing that year’s sales by the sales in the base year.
13. Expenses (including the cost of goods sold) have been increasing at an
even faster rate than net sales. Thus Premiere is apparently having
difficulty in effectively controlling its expenses.
III. Problems
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Cost Concepts and Classifications Chapter 8
Requirement (a)
Computation of percentage changes:
1. Net sales increased 10% (P200,000 increase P2,000,000 = 10%
increase).
2. Total expenses increased 11% (P198,000 increase P1,800,000 = 11%
increase).
Requirement (b)
1. Total expenses grew faster than net sales. Net income cannot also have
grown faster than net sales, or the sum of the parts would exceed the size
of the whole.
2. Net income must represent a smaller percentage of net sales in 2006 than
it did in 2005. Again, the reason is that the expenses have grown at a
faster rate than net sales. Thus, total expenses represent a larger
percentage of total sales in 2006 than in 2005, and net income must
represent a smaller percentage.
Requirement 1
XYZ Corporation
Balance Sheet
As of December 31
Change
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Chapter 8 Cost Concepts and Classifications
Peso %
2005 2006
Assets
Cash and equivalents 14,000 16,000 2,000 14.29%
Receivables 28,800 55,600 26,800 93.06%
Inventories 54,000 85,600 31,600 58.52%
Prepayments and others 4,800 7,400 2,600 54.17%
Total current assets 101,600 164,600 63,000 62.01%
Property, plant & equipment - net
of dep. 30,200 73,400 43,200 143.05%
Total assets 131,800 238,000 106,200 80.58%
XYZ Corporation
Income Statement
Years ended December 31
(P thousands)
Change
Peso %
2005 2006
Net sales 266,400 424,000 157,600 59.16%
Cost of goods sold 191,400 314,600 123,200 64.37%
Gross profit 75,000 109,400 34,400 45.87%
Selling, general and administrative
expenses 35,500 58,400 22,900 64.51%
Income before income taxes 39,500 51,000 11,500 29.11%
Income taxes 12,300 16,400 4,100 33.33%
Net income 27,200 34,600 7,400 27.21%
Requirement 2
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Cost Concepts and Classifications Chapter 8
Unfavorable
2. Quick Current
increased by 62.40% while increased by 138.76%
Assets Liabilities
Unfavorable
3. Net Accounts
increased by 59.16% while increased by 93.06%
Sales Receivable
Unfavorable
4. Cost of Inventories
increased by 64.37% while increased by 58.52%
Goods Sold
Favorable
Leverage
5. Total Total
increased by 80.58% while increased by 138.76%
Assets Liabilities
Unfavorable
6. Total Total
increased by 138.76% while increased by 43.14%
Liabilities Equity
Unfavorable
Profitability
7. Net Cost of
increased by 59.16% while increased by 64.37%
Sales Goods Sold
Unfavorable
8. Net Selling,
Sales increased by 59.16% while General & increased by 64.51%
Administrativ
e Expenses
Unfavorable
9. Net Net
increased by 59.16% while increased by 27.21%
Sales Income
Unfavorable
10. Net Total
increased by 27.21% while increased by 80.58%
Income Assets
Unfavorable
Requirement (1)
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Chapter 8 Cost Concepts and Classifications
Requirement (2)
Sales: The sales are increasing at a steady rate, with a particularly
strong gain in Year 4.
Assets: Cash declined from Year 3 through Year 5. This may have
been due to the growth in both inventories and accounts
receivable. In particular, the accounts receivable grew far
faster than sales in Year 5. The decline in cash may reflect
delays in collecting receivables. This is a matter for
management to investigate further.
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Cost Concepts and Classifications Chapter 8
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Chapter 8 Cost Concepts and Classifications
31. D 36. A, C, D
32. A 37. B*
33. A 38. D
34. B
35. D
36. C
37. C
38. A
39. D
40. C
CHAPTER 5
I. Questions
8-46
Cost Concepts and Classifications Chapter 8
current earnings, but one might have a much higher price-earnings ratio
if investors view it to have superior future prospects. In some cases,
firms with very small current earnings enjoy very high price-earnings
ratios. This is simply because investors view these firms as having very
favorable prospects for earnings in future years. By definition, a stock
with current earnings of P4 and a price-earnings ratio of 20 would be
selling for P80 per share.
6. How a shareholder would feel would depend in large part on the stability
of the firm and its industry. If the firm is in an industry that experiences
wide fluctuations in earnings, then shareholders might be very pleased
that no interest-paying debt exists in the firm’s capital structure. In hard
times, interest payments might be very difficult to meet, or earnings
might be so poor that negative leverage would result.
7. No, the stock is not necessarily overpriced. Book value represents the
cumulative effects on the balance sheet of past activities evaluated using
historical prices. The market value of the stock reflects investors’ beliefs
about the company’s future earning prospects. For most companies
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Chapter 8 Cost Concepts and Classifications
10. The current ratio would probably be highest during January, when both
current assets and current liabilities are at a minimum. During peak
operating periods, current liabilities generally include short-term
borrowings that are used to temporarily finance inventories and
receivables. As the peak periods end, these short-term borrowings are
paid off, thereby enhancing the current ratio.
11. A 2-to-1 current ratio might not be adequate for several reasons. First,
the composition of the current assets may be heavily weighted toward
slow-turning inventory, or the inventory may consist of large amounts of
obsolete goods. Second, the receivables may be large and of doubtful
collectibility, or the receivables may be turning very slowly due to poor
collection procedures.
12. Expenses (including the cost of goods sold) have been increasing at an
even faster rate than net sales. Thus Sunday is apparently having
difficulty in effectively controlling its expenses.
13. If the company’s earnings are very low, they may become almost
insignificant in relation to stock price. While this means that the p/e
ratio becomes very high, it does not necessarily mean that investors are
optimistic. In fact, they may be valuing the company at its liquidation
value rather than a value based upon expected future earnings.
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Cost Concepts and Classifications Chapter 8
16. The investor is calculating the rate of return by dividing the dividend by
the purchase price of the investment (P5 P50 = 10%). A more
meaningful figure for rate of return on investment is determined by
relating dividends to current market price, since the investor at the
present time is faced with the alternative of selling the stock for P100
and investing the proceeds elsewhere or keeping the investment. A
decision to retain the stock constitutes, in effect, a decision to continue
to invest P100 in it, at a return of 5%. It is true that in a historical sense
the investor is earning 10% on the original investment, but this is
interesting history rather than useful decision-making information.
17. A corporate net income of P1 million would be unreasonably low for a
large corporation, with, say, P100 million in sales, P50 million in assets,
and P40 million in equity. A return of only P1 million for a company of
this size would suggest that the owners could do much better by
investing in insured bank savings accounts or in government bonds
which would be virtually risk-free and would pay a higher return.
On the other hand, a profit of P1 million would be unreasonably high for
a corporation which had sales of only P5 million, assets of, say, P3
million, and equity of perhaps one-half million pesos. In other words,
the net income of a corporation must be judged in relation to the scale of
operations and the amount invested.
III. Problems
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Chapter 8 Cost Concepts and Classifications
The changes from 2005 to 2006 are all favorable. Sales increased and the
gross profit per peso of sales also increased. These two factors led to a
substantial increase in gross profit. Although operating expenses increased
in peso amount, the operating expenses per peso of sales decreased from 29
cents to 28 cents. The combination of these three favorable factors caused
net income to rise from 4 cents to 6 cents out of each peso of sales.
Requirement (a)
Current assets:
Cash P 47,600
Marketable securities 175,040
Accounts receivable 230,540
Inventory 179,600
Unexpired insurance 4,500
Total current assets P637,280
Current liabilities:
Notes payable P 70,000
Accounts payable 125,430
Salaries payable 7,570
Income taxes payable 14,600
Unearned revenue 10,000
Total current liabilities P227,600
Requirement (b)
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Cost Concepts and Classifications Chapter 8
Requirement 1
2006 2005
Sales 100.0 % 100.0 %
Less cost of goods sold..........................................................................................................
63.2 60.0
Gross margin..........................................................................................................................
36.8 40.0
Selling expenses....................................................................................................................
18.0 17.5
Administrative expenses.......................................................................................................
13.6 14.6
Total expenses.......................................................................................................................
31.6 32.1
Net operating income............................................................................................................
5.2 7.9
Interest expense.....................................................................................................................
1.4 1.0
Net income before taxes........................................................................................................
3.8 % 6.9 %
Requirement 2
The company’s major problem seems to be the increase in cost of goods
sold, which increased from 60.0% of sales in 2005 to 63.2% of sales in
2006. This suggests that the company is not passing the increases in costs of
its products on to its customers. As a result, cost of goods sold as a
percentage of sales has increased and gross margin has decreased. Selling
expenses and interest expense have both increased slightly during the year,
which suggests that costs generally are going up in the company. The only
exception is the administrative expenses, which have decreased from 14.6%
of sales in 2005 to 13.6% of sales in 2006. This probably is a result of the
company’s efforts to reduce administrative expenses during the year.
Requirement (a)
Ms. Freeze,Inc. Industry Average
Sales (net) 100% 100%
Cost of goods sold 49 57
Gross profit on sales 51% 43%
Operating expenses:
Selling 21% 16%
General and administrative 17 20
Total operating expenses 38% 36%
Operating income 13% 7%
Income taxes 6 3
Net income 7% 4%
Requirement (b)
Ms. Freeze’s operating results are significantly better than the average
performance within the industry. As a percentage of sales revenue, Ms.
Freeze’s operating income and net income after nearly twice the average for
the industry. As a percentage of total assets, Ms. Freeze’s profits amount to
an impressive 23% as compared to 14% for the industry.
The key to Ms. Freeze’s success seems to be its ability to earn a relatively
high rate of gross profit. Ms. Freeze’s exceptional gross profit rate (51%)
probably results from a combination of factors, such as an ability to
command a premium price for the company’s products and production
efficiencies which lead to lower manufacturing costs.
As a percentage of sales, Ms. Freeze’s selling expenses are five points higher
than the industry average (21% compared to 16%). However, these higher
expenses may explain Ms. Freeze’s ability to command a premium price for
its products. Since the company’s gross profit rate exceeds the industry
average by 8 percentage points, the higher-than-average selling costs may be
part of a successful marketing strategy. The company’s general and
administrative expenses are significantly lower than the industry average,
which indicates that Ms. Freeze’s management is able to control expenses
effectively.
Requirement 1
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Cost Concepts and Classifications Chapter 8
2006 2005
Sales......................................................... 100.0% 100.0%
Less cost of goods sold............................ 65.0 60.0
Gross margin............................................ 35.0 40.0
Less operating expenses........................... 26.3 30.4
Net operating income............................... 8.7 9.6
Less interest expense................................ 1.2 1.6
Net income before taxes........................... 7.5 8.0
Less income taxes (30%)......................... 2.3 2.4
Net income............................................... 5.3% 5.6%
2006 2005
Current assets:
Cash................................................... 2.0% 5.1%
Accounts receivable, net.................... 15.0 10.1
Inventory........................................... 30.1 15.2
Prepaid expenses............................... 1.0 1.3
Total current assets...................... 48.1 31.6
Plant and equipment................................. 51.9 68.4
Total assets............................................... 100.0% 100.0%
Liabilities:
Current liabilities............................... 25.1% 12.7%
Bonds payable, 12%.......................... 20.1 25.3
Total liabilities............................ 45.1 38.0
Equity:
Preference shares, 8%, P10 par.......... 15.0 19.0
Ordinary shares, P5 par..................... 10.0 12.7
Retained earnings.............................. 29.8 30.4
Total equity................................. 54.9 62.0
Total liabilities and equity....................... 100.0% 100.0%
Note: Columns do not total down in all cases due to rounding differences.
Requirement 2
The company’s cost of goods sold has increased from 60 percent of sales in
2005 to 65 percent of sales in 2006. This appears to be the major reason the
company’s profits showed so little increase between the two years. Some
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Chapter 8 Cost Concepts and Classifications
Requirement (a)
(Pesos in
Millions)
Current assets:
Cash P 74.8
Receivables 152.7
Merchandise inventories 1,191.8
Prepaid expenses 95.5
Total current assets P1,514.8
Quick assets:
Cash P 74.8
Receivables 152.7
Total quick assets P 227.5
Requirement (b)
(1) Current ratio:
Current assets (Req. a) P1,514.8
Current liabilities P1,939.0
Current ratio (P1,514.8 P1,939.0) 0.8 to 1
Requirement (c)
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Cost Concepts and Classifications Chapter 8
Requirement (e)
Note to Instructor: Prior to the year in which the data for this problem was
collected, Alabang Supermarket had reported a negative retained earnings
balance in its balance sheet for several consecutive periods. The fact that
Alabang Supermarket has only recently removed the deficit from its financial
statements is also worrisome.
Requirement (a)
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Chapter 8 Cost Concepts and Classifications
Requirement (b)
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Cost Concepts and Classifications Chapter 8
Requirement (c)
(2) Long-term creditors also have little to worry about. Not only is the
company highly liquid, but creditors’ claims amount to only 23.1% of
total assets. If Bonbon Sweets’ were to go out of business and liquidate
its assets, it would have to raise only 23 cents from every peso of assets
for creditors to emerge intact.
Requirement 1
Requirement 2
Cash + Marketable securities + Accounts receivable
Acid-test ratio = Current liabilities
P80,000 + P0 + P460,000
Acid-test ratio
Requirement 3 = P520,000 = 1.04 to 1 (rounded)
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Chapter 8 Cost Concepts and Classifications
2. Current ratio:
Current assets P490,000
= = 2.45 to 1
Current liabilities P200,000
3. Acid-test ratio:
Quick assets P181,000
Current liabilities = P200,000 = 0.91 to 1 (rounded)
Sales P2,100,000
Average accounts receivables = P150,000 = 14 times
365 days
14 times = 26.1 days (rounded)
5. Inventory turnover:
Cost of goods sold P1,260,000
Average inventory = P280,000 = 4.5 times
365 days
= 81.1 days to turn (rounded)
4.5 times
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Cost Concepts and Classifications Chapter 8
6. Debt-to-equity ratio:
Total liabilities P500,000
Total equity = P800,000 = 0.63 to 1 (rounded)
* P100,000 total par value ÷ P5 par value per share = 20,000 shares
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Chapter 8 Cost Concepts and Classifications
P126,000
= P1,200,000 = 10.5%
3. Financial leverage was positive, since the rate of return to the ordinary
shareholders (13.8%) was greater than the rate of return on total assets
(10.5%). This positive leverage is traceable in part to the company’s
current liabilities, which may carry no interest cost, and to the bonds
payable, which have an after-tax interest cost of only 7%.
Requirement (1)
Current assets
(P80,000 + P460,000 + P750,000 + P10,000)....................................
P1,300,000
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Cost Concepts and Classifications Chapter 8
Requirement (2)
Requirement (3)
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Chapter 8 Cost Concepts and Classifications
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Cost Concepts and Classifications Chapter 8
12. Increase Since the company’s assets earn at a rate that is higher
than the rate paid on the bonds, leverage is positive,
increasing the return to the ordinary shareholders.
13. No effect Changes in the market price of a stock have no direct
effect on the dividends paid or on the earnings per share
and therefore have no effect on this ratio.
14. Decrease A decrease in net income would mean less income
available to cover interest payments. Therefore, the
times-interest-earned ratio would decrease.
15. No effect Write-off of an uncollectible account against the
Allowance for Bad Debts will have no effect on total
current assets. For this reason, the current ratio will
remain unchanged.
16. Decrease A purchase of inventory on account will increase current
liabilities, but will not increase the quick assets (cash,
accounts receivable, marketable securities). Therefore,
the ratio of quick assets to current liabilities will
decrease.
17. Increase The price-earnings ratio is obtained by dividing the
market price per share by the earnings per share. If the
earnings per share remains unchanged, and the market
price goes up, then the price-earnings ratio will increase.
18. Decrease Payments to creditors will reduce the total liabilities of a
company, thereby decreasing the ratio of total debt to
total equity.
a. The market price is going down. The dividends paid per share over the
three-year period are unchanged, but the dividend yield is going up.
Therefore, the market price per share of stock must be decreasing.
b. The earnings per share is increasing. Again, the dividends paid per share
have remained constant. However, the dividend payout ratio is
decreasing. In order for the dividend payout ratio to be decreasing, the
earnings per share must be increasing.
c. The price-earnings ratio is going down. If the market price of the stock is
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Chapter 8 Cost Concepts and Classifications
going down [see part (a) above], and the earnings per share are going up
[see part (b) above], then the price-earnings ratio must be decreasing.
d. In Year 1, leverage was negative because in that year the return on total
assets exceeded the return on ordinary equity. In Year 2 and in Year 3,
leverage was positive because in those years the return on ordinary
equity exceeded the return on total assets employed.
e. It is becoming more difficult for the company to pay its bills as they
come due. Although the current ratio has improved over the three years,
the acid-test ratio is down. Also note that the accounts receivable and
inventory are both turning more slowly, indicating that an increasing
portion of the current assets is being made up of those items, from which
bills cannot be paid.
f. Customers are paying their bills more slowly in Year 3 than in Year 1.
This is evidenced by the decline in accounts receivable turnover.
IV. Cases
Requirement 1
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Cost Concepts and Classifications Chapter 8
8-65
Chapter 8 Cost Concepts and Classifications
Liabilities:
Current liabilities 27.5 % 18.2 %
Bonds payable, 12% 18.8 22.7
Total liabilities 46.3 40.9
Equity:
Preference shares, P50 par, 8% 5.0 6.1
Ordinary shares, P10 par 12.5 15.2
Retained earnings 36.3 37.9
Total equity 53.8 59.1
Total liabilities and equity 100.0 % 100.0 %
Requirement 3
The following points can be made from the analytical work in parts (1) and
(2) above:
The company has improved its profit margin from last year. This is
attributable to an increase in gross margin, which is offset somewhat by an
increase in operating expenses. In both years the company’s net income as a
percentage of sales equals or exceeds the industry average of 4%.
Although the company’s working capital has increased, its current position
actually has deteriorated significantly since last year. Both the current ratio
and the acid-test ratio are well below the industry average, and both are
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Cost Concepts and Classifications Chapter 8
trending downward. (This shows the importance of not just looking at the
working capital in assessing the financial strength of a company.) Given the
present trend, it soon will be impossible for the company to pay its bills as
they come due.
The drain on the cash account seems to be a result mostly of a large buildup
in accounts receivable and inventory. This is evident both from the
common-size balance sheet and from the financial ratios. Notice that the
average age of the receivables has increased by 5 days since last year, and
that it is now 9 days over the industry average. Many of the company’s
customers are not taking their discounts, since the average collection period
is 27 days and collection terms are 2/10, n/30. This suggests financial
weakness on the part of these customers, or sales to customers who are poor
credit risks. Perhaps the company has been too aggressive in expanding its
sales.
The inventory turned only 5 times this year as compared to over 6 times last
year. It takes three weeks longer for the company to turn its inventory than
the average for the industry (71 days as compared to 50 days for the
industry). This suggests that inventory stocks are higher than they need to
be.
In the authors’ opinion, the loan should be approved on the condition that the
company take immediate steps to get its accounts receivable and inventory
back under control. This would mean more rigorous checks of
creditworthiness before sales are made and perhaps paring out of slow
paying customers. It would also mean a sharp reduction of inventory levels
to a more manageable size. If these steps are taken, it appears that sufficient
funds could be generated to repay the loan in a reasonable period of time.
Requirement 1
a. This Year Last Year
Net income P324,000 P240,000
Less preference dividends 16,000 16,000
Net income remaining for ordinary (a)
P308,000 P224,000
Average number of ordinary shares (b) 50,000 50,000
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Chapter 8 Cost Concepts and Classifications
A market price in excess of book value does not mean that the price of a
stock is too high. Market value is an indication of investors’ perceptions
of future earnings and/or dividends, whereas book value is a result of
already completed transactions and is geared to the past.
Requirement 2
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Cost Concepts and Classifications Chapter 8
Requirement 3
We would recommend keeping the stock. The stock’s downside risk seems
small, since it is selling for only 7.3 times current earnings as compared to 9
times earnings for the average firm in the industry. In addition, its earnings
are strong and trending upward, and its return on ordinary equity (16.6%) is
extremely good. Its return on total assets (10.4%) compares favorably with
that of the industry.
The risk, of course, is whether the company can get its cash problem under
control. Conceivably, the cash problem could worsen, leading to an eventual
reduction in profits through inability to operate, a reduction in dividends,
and a precipitous drop in the market price of the company’s stock. This does
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Chapter 8 Cost Concepts and Classifications
not seem likely, however, since the company can easily control its cash
problem through more careful management of accounts receivable and
inventory. If this problem is brought under control, the price of the stock
could rise sharply over the next few years, making it an excellent investment.
Requirement 1
This Year Last Year
a. Net income..............................................................................................................
P 280,000 P 168,000
Add after-tax cost of interest:
P120,000 × (1 – 0.30).........................................................................................
84,000
P100,000 × (1 – 0.30).........................................................................................
70,000
P 364,000 P 238,000
Total (a)..................................................................................................................
b. Net income..............................................................................................................
P 280,000 P 168,000
Less preference dividends.......................................................................................
48,000 48,000
P 232,000 P 120,000
Net income remaining for ordinary (a)....................................................................
c. Leverage is positive for this year, since the return on ordinary equity
(9.2%) is greater than the return on total assets (6.8%). For last year,
leverage is negative since the return on the ordinary equity (4.9%) is less
than the return on total assets (5.1%).
Requirement 2
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Cost Concepts and Classifications Chapter 8
Notice from the data given in the problem that the average P/E ratio for
companies in Helix’s industry is 10. Since Helix Company presently
has a P/E ratio of only 7.8, investors appear to regard it less well than
they do other companies in the industry. That is, investors are willing to
pay only 7.8 times current earnings for a share of Helix Company’s
stock, as compared to 10 times current earnings for
a share of stock for the average company in the
industry.
e. Equity P3,200,000 P3,040,000
Less preference shares 600,000 600,000
Ordinary equity (a) P2,600,000 P2,440,000
Note that the book value of Helix Company’s stock is greater than the
market value for both years. This does not necessarily indicate that the
stock is selling at a bargain price. Market value is an indication of
investors’ perceptions of future earnings and/or dividends, whereas book
value is a result of already completed transactions and is geared to the
past.
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Chapter 8 Cost Concepts and Classifications
Requirement 3
This Year Last Year
a. Current assets P2,600,000 P1,980,000
Current liabilities 1,300,000 920,000
Working capital P1,300,000 P1,060,000
Requirement 4
As stated by Meri Ramos, both net income and sales are up from last year.
The return on total assets has improved from 5.1% last year to 6.8% this
year, and the return on ordinary equity is up to 9.2% from 4.9% the year
before. But this appears to be the only bright spot in the company’s
operating picture. Virtually all other ratios are below the industry average,
and, more important, they are trending downward. The deterioration in the
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Cost Concepts and Classifications Chapter 8
In the author’s opinion, what the company needs is more equity—not more
debt. Therefore, the loan should not be approved. The company should be
encouraged to make another issue of ordinary stock in order to provide a
broader equity base on which to operate.
Bulacan Company
Income Statement
For the Year Ended December 31, 2005
Sales P140,800
Less: Cost of Sales (4) 84,480
Gross Profit P 56,320
Less: Expenses 46,320
Net Income (1) P 10,000
Bulacan Company
Balance Sheet
December 31, 2005
Assets
Current Assets:
Cash P 27,720
Accounts Receivable (5) 28,160
Merchandise Inventory (3) 21,120
Total Current Assets (2) P 77,000
Fixed Assets (8) 55,000
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Chapter 8 Cost Concepts and Classifications
Current Liabilities:
Accounts Payable (2) P 44,000
Equity:
Share Capital (issued 20,000 shares) (6) P40,000
Retained Earnings 48,000 88,000
Total Liabilities and Equity P132,000
Supporting Computations:
Net Income
(1) Earnings Per Share =
Ordinary Shares Outstanding
X
P0.50 =
20,000
X (Net Income) = P10,000
= P44,000
Current Assets
(3) Current Ratio =
Current Liabilities
X
1.27 =
44,000
X (Current Assets) = P77,000
Quick Assets
Quick Ratio =
Current Liabilities
X
1.27 =
44,000
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Cost Concepts and Classifications Chapter 8
Cost of Sales
(4) Inventory turnover = Ave. Inventory
X
4 =
P21,120
X (Cost of Sales) = P84,480
Quick Assets
(5) Average age of outstanding =
Accounts Receivable Current Liabilities
365
= 73 days (Average age of
5
receivables)
Net Sales
Average Receivables = 5
P140,800
= 5
X
X (Receivables) = P28,160
Another Method:
P140,800
= 73 days = P28,160 Accounts receivable
365
= 25%
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Chapter 8 Cost Concepts
P10,000and Classifications
Share Capital
Share Capital = P40,000
0.375X = P33,000
X = P88,000 Equity
(8) Fixed Assets to Equity
Fixed Assets
= 0.625
Equity
X
= 0.625
P140,800
X (Fixed Assets) = P55,000
Requirement 1
The loan officer stipulated that the current ratio prior to obtaining the loan
must be higher than 2.0, the acid-test ratio must be higher than 1.0, and the
interest on the loan must be no more than four times net operating income.
These ratios are computed below:
Current assets
Current ratio = Current liabilities
P290,000
Current rate = P164,000 = 1.8 (rounded)
P70,000 + P0 + P50,000
Acid-test ratio = P164,000 = 0.70 (rounded)
Net operating income P20,000
= = 5.0
Interest on the loan P80,000 x 0.10 x (6/12)
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Cost Concepts and Classifications Chapter 8
The company would fail to qualify for the loan because both its current ratio
and its acid-test ratio are too low.
Requirement 2
By reclassifying the P45 thousand net book value of the old machine as
inventory, the current ratio would improve, but there would be no effect on
the acid-test ratio. This happens because inventory is considered to be a
current asset but is not included in the numerator when computing the acid-
test ratio.
Current assets
Current ratio = Current liabilities
P290,000 + P45,000
Current rate = P164,000 = 2.0 (rounded)
Even if this tactic had succeeded in qualifying the company for the loan, we
strongly advise against it. Inventories are assets the company has acquired
for the sole purpose of selling them to outsiders in the normal course of
business. Used production equipment is not considered to be inventory—
even if there is a clear intention to sell it in the near future. Since the loan
officer would not expect used equipment to be included in inventories, doing
so would be intentionally misleading.
Nevertheless, the old equipment is an asset that could be turned into cash. If
this were done, the company would immediately qualify for the loan since
the P45 thousand in cash would be included in the numerator in both the
current ratio and in the acid-test ratio.
Current assets
Current ratio =
Current liabilities
P290,000 + P45,000
Current rate = = 2.0 (rounded)
P164,000
Cash + Marketable securities + Current receivables
Acid-test ratio = Current liabilities
P70,000 + P0 + P50,000 + P45,000
Acid-test ratio = P164,000 = 1.00 (rounded)
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Chapter 8 Cost Concepts and Classifications
However, other options may be available. After all, the old machine is being
used to relieve bottlenecks in the plastic injection molding process and it
would be desirable to keep this standby capacity. We would advise Rome to
fully and honestly explain the situation to the loan officer. The loan officer
might insist that the machine be sold before any loan is approved, but he
might instead grant a waiver of the current ratio and acid-test ratio
requirements on the basis that they could be satisfied by selling the old
machine. Or he may approve the loan on the condition that the equipment is
pledged as collateral. In that case, Rome would only have to sell the machine
if he would otherwise be unable to pay back the loan.
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Cost Concepts and Classifications Chapter 8
Requirement (4)
Requirement (5)
Requirement (6)
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Chapter 8 Cost Concepts and Classifications
Requirement (8)
Requirement (1)
Requirement (3)
Requirement (4)
= 8.5
Requirement (5)
Requirement (1)
P4,100
Acid-test ratio = = 5.1
P800
Requirement (2)
CHAPTER 6
I. Questions
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Cost Concepts and Classifications Chapter 8
6. The loss is added back to net income to avoid double counting since the
entire proceeds from the sale (net book value minus loss on sale) will
appear as a cash inflow from investing activities.
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Chapter 8 Cost Concepts and Classifications
These activities are uses of cash when cash is decreased as a result of the
particular activity.
10. While net loss is usually associated with a decrease in cash, it may be a
source of cash if noncash expenses are greater than the amount of the net
loss. For example, if a net loss of P100,000 included amortization and
depreciation of P125,000 and no noncash revenues existed, cash
provided by operating activities would be P25,000, computed as follows:
11. The change in cash is the difference between cash at the beginning and
end of the accounting period. The net amount of cash provided by or
used in operating, investing and financing activities must equal this
change in cash. For example, if cash increased by P150,000 during the
year, total sources from operating, investing, and financing activities
must exceed total uses by P150,000. Also, if cash decreased by P25,000
during the year, total uses of cash must exceed total sources by P25,000.
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Cost Concepts and Classifications Chapter 8
12. (a) The use of cash does not occur until the cash dividend is actually
paid in the next period. The declaration of the dividend does affect
financial position, however, and should be disclosed as a noncash
financing activity in a separate schedule accompanying the statement
of cash flows.
(b) Because the dividend was declared and paid in the same accounting
period, it appears in the statement of cash flows as a cash decrease in
the financing activities category.
14. The net income figure includes P150,000 as an expense. Only P112,500
of this amount resulted in a decrease in cash, because P37,500 represents
an increase in the deferred income tax liability account. In determining
cash provided by operating activities, the amount of income tax paid is
P112,500 (direct method). Alternatively, under the indirect method,
P37,500 must be added to net income to determine cash flows from
operating activities.
15. The loss is omitted when listing expenses requiring cash payment (direct
approach) or added back to net income (indirect approach) in
determining cash provided by operating activities. This eliminates the
impact of the transaction from cash provided by operating activities.
Then, the proceeds from the sale are included as a source of cash in the
investing activities category of the statement of cash flows. Any tax
effects of the transaction are included in the tax expense figure and
remain a part of cash flows from operating activities.
16. (1) Operating activities: Transactions that affect current assets, current
liabilities, or net income.
(2) Investing activities: Transactions that involve the acquisition or
disposition of noncurrent assets.
(3) Financing activities: Transactions (other than the payment of
interest) involving borrowing from creditors, and any transactions
(involving the owners of a company.
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Chapter 8 Cost Concepts and Classifications
18. Since the entire proceeds from a sale of an asset (including any gain)
appear as a cash inflow from investing activities, the gain must be
deducted from net income to avoid double counting.
19. The direct method reconstructs the income statement on a cash basis by
restating revenues and expenses in terms of cash inflows and outflows.
The indirect method starts with net income and adjusts it to a cash basis
to determine the cash provided by operating activities.
II. Exercises
Exercise 1
Net income.....................................................................................................................
P84,000
Adjustments to convert net income to a cash basis:
Depreciation charges for the year.............................................................................
P50,000
Increase in accounts receivable.................................................................................
(60,000)
Increase in inventory.................................................................................................
(77,000)
Decrease in prepaid expenses....................................................................................
2,000
Increase in accounts payable.....................................................................................
30,000
Decrease in accrued liabilities...................................................................................
(4,000)
Increase in deferred income taxes.............................................................................
6,000 (53,000)
Net cash provided by operating activities..................................................................... P31,000
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Cost Concepts and Classifications Chapter 8
Exercise 2
Sales.................................................................................................
P1,000,000
Adjustments to a cash basis:
– 60,000 P940,000
Less increase in accounts receivable.........................................
Cost of goods sold............................................................................
580,000
Adjustments to a cash basis:
Plus increase in inventory.........................................................
+ 77,000
– 30,000
Less increase in accounts payable............................................. 627,000
Selling and administrative expenses.................................................
300,000
Adjustments to a cash basis:
Less decrease in prepaid expenses............................................
– 2,000
Plus decrease in accrued liabilities...........................................
+ 4,000
– 50,000
Less depreciation charges......................................................... 252,000
Income taxes.....................................................................................
36,000
Adjustments to a cash basis:
– 6,000
Less increase in deferred income taxes..................................... 30,000
Net cash provided by operating activities.........................................P 31,000
Note that the P31,000 agrees with the cash provided by operating activities
figure under the indirect method in the previous exercise.
Exercise 3
Exercise 4
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Chapter 8 Cost Concepts and Classifications
Requirement (1)
Requirement (2)
Swan Company
Statement of Cash Flows
Operating activities:
Net cash provided by operating activities (see above).........................................
P 90
Investing activities:
Proceeds from sale of long-term investments......................................................
P 45
Proceeds from sale of land..................................................................................
70
Additions to long-term investments....................................................................
(20)
Additions to plant & equipment..........................................................................
(150)
Net cash used for investing activities..................................................................
(55)
Financing activities:
Decrease in bonds payable..................................................................................
(20)
Increase in ordinary shares..................................................................................
40
Cash dividends....................................................................................................
(35)
Net cash used by financing activities................................................................... (15)
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Cost Concepts and Classifications Chapter 8
Additional entries
Proceeds from sale of investments.............................. +45 +45 Investing
Loss on sale of investments......................................... +5 +5 Operating
Proceeds from sale of land........................................... +70 +70 Investing
Gain on sale of land..................................................... –40 –40 Operating
Total +20 0 +20
Exercise 5
Sales...........................................................................................
P600
Adjustments to a cash basis:
Decrease in accounts receivable......................................... +10 P610
Cost of goods sold.....................................................................250
Adjustments to a cash basis:
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Chapter 8 Cost Concepts and Classifications
Increase in inventory..........................................................+30
Increase in accounts payable.............................................. –20 260
Selling and administrative expenses..........................................280
Adjustments to a cash basis:
Decrease in prepaid expenses............................................. –5
Decrease in accrued liabilities............................................+10
Depreciation charges.......................................................... –40 245
Income taxes.............................................................................. 30
Adjustments to a cash basis:
Increase in taxes payable....................................................–10
Increase in deferred taxes................................................... –5 15
Net cash provided by operating activities.................................. P 90
Exercise 6
Stephenie Company
Statement of Cash Flows
For the Year Ended December 31, 2008
Operating activities:
Net income..............................................................................................
P 56
Adjustments to convert net income to cash basis:
Depreciation charges.......................................................................
25
Increase in accounts receivable.......................................................(80)
Decrease in inventory......................................................................
35
Increase in prepaid expenses........................................................... (2)
Increase in accounts payable...........................................................75
Decrease in accrued liabilities.........................................................
(10)
Gain on sale of investments............................................................ (5)
Loss on sale of equipment............................................................... 2
Increase in deferred income taxes................................................... 8 48
Net cash provided by operating activities............................................... 104
Investing activities:
Proceeds from sale of long-term investments.........................................
12
Proceeds from sale of equipment............................................................
18
Additions to plant and equipment...........................................................
(110)
Net cash used for investing activities...................................................... (80)
Financing activities:
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Cost Concepts and Classifications Chapter 8
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Chapter 8 Cost Concepts and Classifications
Additional entries
Proceeds from sale of equipment................................. +18 +18 Investing
Operatin
Loss on sale of equipment............................................ +2 +2 g
Proceeds from sale of long-term investments............... +12 +12 Investing
Operatin
Gain on sale of long-term investments......................... –5 –5 g
II. Problems
Problem 1
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Cost Concepts and Classifications Chapter 8
Requirement (a)
8-93
Chapter 8 Cost Concepts and Classifications
Requirement (b)
P130,000
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Cost Concepts and Classifications Chapter 8
8-95
Chapter 8 Cost Concepts and Classifications
Requirement (a)
*
Increase in retained earnings (P20,000 – P13,000) P7,000
Dividends declared 1,500
Net income P8,500
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Cost Concepts and Classifications Chapter 8
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Chapter 8 Cost Concepts and Classifications
7,000
Computations:
Cash received from customers:
Revenues P107,000
Deduct: Increase in accounts receivable
(P78,000 – P45,000) 33,000
P 74,000
Cash paid for expenses:
Expenses P 92,000
Add: Decrease in accrued expenses
(P7,500 – P7,000) 500
Deduct: Depreciation expense
(P33,600 – P27,100 + P18,000) (24,500)
Amortization (1,000)
P 67,000
Cash from sale of equipment:
Cost P 27,500
Deduct: Accumulated depreciation (18,000)
Cash received on sale at book value P 9,500
Cash paid to acquire equipment:
Increase in property, plant and equipment
(P118,100 – P92,600) P 25,500
Cost of machinery sold 27,500
P 53,000
Cash received on sale of shares:
Increase in ordinary shares amount
(P100,000 – P75,000) P 25,000
Increase in additional paid-in capital account
(P55,000 – P40,000) 15,000
P 40,000
Cash dividends:
Increase in retained earnings (P21,000 – P14,500) P 6,500
Net income (P107,000 – P92,000) (15,000)
P 8,500
Requirement (b)
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Cost Concepts and Classifications Chapter 8
Requirement (a)
Range, 2002-2005
Cash Cash Used
Provided
Ebony P125,000 – P115,000 –
Company P168,000 P170,000
Ivory P135,000 – P125,000 –
Company P160,000 P165,000
Requirement (b)
The two companies are dissimilar in the makeup of the sources of cash, as
indicated in the following analysis:
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Chapter 8 Cost Concepts and Classifications
Operations 80 37 77 21 70 (
Long-term debt 8 56 -- 10 --
Share capital -- -- 16 52 --
Asset 12 7 7 17 30
disposition
100 100 100 100 100 1
Ebony Company has relied much more heavily on operations to provide cash
and to a very limited extent on debt and equity financing and asset
disposition. On the other hand, Ivory Company has not been able to provide
cash from operations and has been required to rely on the alternatives of debt
and equity financing and asset disposition.
Requirement (c)
1. D 4. D 7. C 10. B
2. C 5. B 8. B 11. A
3. D 6. D 9. A 12. D
CHAPTER 7
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Cost Concepts and Classifications Chapter 8
I. Problems
Problem I
Increase in Sales:
Quantity Factor [(24,000) x P8] P(192,000)
Price Factor (105,000 x P3) 315,000
Quantity/Price Factor [(24,000) x P3] (72,000) P 51,000
Less: Increase (decrease) in Cost of Sales:
Quantity Factor [(24,000) x P9] P(216,000)
Cost Factor [105,000 x (P.50)] (52,500)
Quantity/Cost Factor [(24,000) x (P.50)] 12,000 (256,500)
Increase in Gross Profit P 307,500
Problem II
2. Cost Factor
Cost of Sales in 2006 P164,000
Less: Cost of Sales in 2006 at 2005 costs 176,000
Favorable P(12,000)
3. Quantity Factor
Increase in Sales
Sales in 2006 at 2005 prices P200,000
Less: Sales in 2005 150,000
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Chapter 8 Cost Concepts and Classifications
Favorable P 50,000
Less: Increase in Cost of Sales
Cost of Sales in 2006 at 2005 costs
(P132,000 x 133-1/3%) P176,000
Less: Cost of Sales in 2005 132,000
Unfavorable P 44,000
Net favorable quantity factor 6,000*
Increase in Gross Profit P 28,000
Problem III
Requirement A:
Tony Corporation
Statement Accounting for Gross Profit Variation
For 2006
Cost Factor
Cost of Sales this year P 165,400
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Cost Concepts and Classifications Chapter 8
Quantity Factor
Cost of Sales this year at last year’s
costs (115,500 x 140%) P 161,700
Less: Cost of Sales last year 115,500
(Favorable) Unfavorable P 46,200
Requirement B:
Problem IV
Quantity Factor
1. Decrease in Sales due to decrease in the number
of customers [(1,000) x 18 MCF x P2.50)] P(45,000)
Price Factor
3. Decrease in Sales due to the decrease in rate per
MCF [P(.05) x 520,000] (26,000)
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Chapter 8 Cost Concepts and Classifications
Supporting Computations:
Average Consumption:
(a) 2006 = 520,000 26,000 = 20 MCF/customer
2005 = 486,000 27,000 = 18 MCF/customer
Increase in Consumption
per customer 2 MCF/customer
Problem V
XYZ Corporation
Gross Profit Variation Analysis
For 2006
Price Factor
Sales in 2006 P 1,750
Less: Sales in 2006 at 2005 prices
A (25 x P10) P 250
B (75 x P20) 1,500 1,750
Increase (decrease) in gross profit P -
Cost Factor:
Cost of sales in 2006 P 875
Less: Cost of sales in 2006 at 2005 costs:
A (25 X P5) P 125
B (75 x P10) 750 875
Increase (decrease) in gross profit P -
Quantity Factor:
Increase (decrease) in total quantity
Multiplied by: Average gross profit
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Cost Concepts and Classifications Chapter 8
P875 = P8.75
100 (volume in 2006)
Number of Shares
Adjustment
for 25%
stock As Weighted
Date Unadjusted dividend Adjusted Multiplier Shares
1/1/2006 16,000 4,000 20,000 12/12 20,000
2/15/2006 3,200 800 4,000 10.5/12 3,500
4/1/2006 (3,000) (750) (3,750) 9/12 (2,812)
6/1/2006 1,400 350 1,750 7/12 1,020
9/1/2006 6,400 1,600 8,000 4/12 2,667
12/1/2006 6,000 (6,000) - - -
Total 30,000 - 30,000 24,375
1. Basic EPS =
= P0.90
Problem VIII
a
P122,000 = P150,500 (net income) - P28,500 (preference dividends)
b
Weighted average shares: 25,000 x 1.20 = 30,000 x 7/12 = 17,500
32,000 x 1.20 = 38,400 x 4/12 = 12,800
38,400 - 2,000 = 36,400 x 1/12 = 3,033
Weighted average shares 33,333
c
Increment due to stock options:
Issued 4,000
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Cost Concepts and Classifications Chapter 8
4,000 x ( P33 + P5 )
Reacquired = (3,707)
P41
Increment in shares 293
d
Impact on diluted earnings per share and ranking:
Impact Ranking
e
Dilutive effect on diluted earnings per share:
10% bonds: P3.02 impact < P3.63 (DEPS 1), therefore dilutive
7.5% preference: P3.06 impact < P3.56 (DEPS2), therefore dilutive
5.8% bonds: P3.50 impact > P3.46 (DEPS3), therefore exclude from EPS
Requirement 3
Fuego Company would report basic earnings per share of P3.66 and diluted
earnings per share of P3.46 on its 2005 income statement.
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Chapter 8 Cost Concepts and Classifications
I. Questions
1. The phrase “different costs for different purposes” refers to the fact that
the word “cost” can have different meanings depending on the context in
which it is used. Cost data that are classified and recorded in a particular
way for one purpose may be inappropriate for another use.
5. a. Uncontrollable cost
b. Controllable cost
c. Uncontrollable cost
6. Product costs are costs that are associated with manufactured goods until
the time period during which the products are sold, when the product
costs become expenses. Period costs are expensed during the time
period in which they are incurred.
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Cost Concepts and Classifications Chapter 8
8. Product costs are also called inventoriable costs because they are
assigned to manufactured goods that are inventoried until a later period,
when the products are sold. The product costs remain in the finished
goods inventory account until the time period when the goods are sold.
9. A sunk cost is a cost that was incurred in the past and cannot be altered
by any current or future decision. A differential cost is the difference in
a cost item under two decision alternatives.
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Chapter 8 Cost Concepts and Classifications
2. work in process inventory – accounts for all costs put into the
manufacturing of products that are started but not complete at the
financial statement date.
3. finished goods inventory – the cost of goods that are ready for sale.
14. Direct materials include the materials in the product and a reasonable
allowance for scrap and defective units, while indirect materials are
materials used in manufacturing that are not physically part of the
finished product.
16. Yes, costs such as salaries and depreciation can end up as part of assets
on the balance sheet if these are manufacturing costs. Manufacturing
costs are inventoried until the associated finished goods are sold. Thus,
if some units are still in inventory, such costs may be part of either Work
in Process inventory or Finished Goods inventory at the end of a period.
17. No. A variable cost is a cost that varies, in total, in direct proportion to
changes in the level of activity. A variable cost is constant per unit of
product. A fixed cost is fixed in total, but the average cost per unit
changes with the level of activity.
19.
Direct labor cost (34 hours P15 per hour).......................... P510
Manufacturing overhead cost (6 hours P15 per hour)........ 90
Total wages earned................................................................ P600
20.
Direct labor cost (45 hours P14 per hour)......................... P630
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Cost Concepts and Classifications Chapter 8
II. Exercises
Requirement 1
Direct material:
Raw-material inventory, January 1.................. P
60,000
Add: Purchases of raw material...................... 250,000
Raw material available for use......................... P310,00
0
Deduct: Raw-material inventory, 70,00
December 31.............................................. 0
Raw material used........................................... P240,00
0
Direct labor............................................................ 400,000
Manufacturing overhead:
Indirect material............................................... P
10,000
Indirect labor.................................................... 25,000
Depreciation on plant and equipment.............. 100,000
Utilities............................................................ 25,000
Other................................................................ 30,00
0
Total manufacturing overhead......................... 190,000
Total manufacturing costs...................................... P830,00
0
Add: Work-in-process inventory, January 1.......... 120,000
Subtotal.................................................................. P950,00
0
Deduct: Work-in-process inventory, 115,000
December 1......................................................
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Chapter 8 Cost Concepts and Classifications
Requirement 2
Requirement 3
Exercise 2
8-112
Cost Concepts and Classifications Chapter 8
1. a, d, g, i
2. a, d, g, j
3. b, f
4. b, d, g, k
5. a, d, g, k
6. a, d, g, j
7. b, c, f
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Chapter 8 Cost Concepts and Classifications
8. b, d, g, k
9. b, c and d*, e and f and g*, k*
* The building is used for several purposes.
10. b, c, f
11. b, c, h
12. b, c, f
13. b, c, e
14. b, c and d†, e and f and g†, k†
†
The building that the furnace heats is used for several purposes.
15. b, d, g, k
1. marginal cost
2. sunk cost
3. average cost
4. opportunity cost
5. differential cost
6. out-of-pocket cost
1. a, c, e, k
2. b, d, e, k
3. d, e, i
4. d, e, i
5. a, d, e, k
6. a, d, e, k
7. d, e, k
8. b, d†, e, k
†
Unless the dishwasher has been used improperly.
9. h
10. a, d, e*, j
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Cost Concepts and Classifications Chapter 8
* The hotel general manager may have some control over the total space
allocated to the kitchen.
11. i
12. j
13. a, c, e
14. e, k
Exercise 6
Exercise 7
Exercise 8
1. The wages of employees who build the sailboats: direct labor cost.
2. The cost of advertising in the local newspapers: marketing and selling
cost.
3. The cost of an aluminum mast installed in a sailboat: direct materials
cost.
4. The wages of the assembly shop’s supervisor: manufacturing overhead
cost.
5. Rent on the boathouse: a combination of manufacturing overhead,
administrative, and marketing and selling cost. The rent would most
8-115
Chapter 8 Cost Concepts and Classifications
8-116
Cost Concepts and Classifications Chapter 8
Exercise 7
Depreciatio
n of
machines
X X X*
used to
produce
tables
(P20,000
per year)
8-117
Chapter 8 Cost Concepts and Classifications
6. Salary of
the
company
X X
president
(P200,000
per year)
7. Advertising
expense
X X
(P500,000
per year)
8.
Commissio
ns paid to X X
salesperso
ns (P60 per
table sold)
9. Rental
income
forgone on X1
factory
space
*
This is a sunk cost because the outlay for the equipment was made in a previous period.
1
This is an opportunity cost because it represents the potential benefit that is lost or sacrificed as a result of using the factory space to produce tables. Opportunity
cost is a special category of cost that is not ordinarily recorded in an organization’s accounting books. To avoid possible confusion with other costs, we will not
attempt to classify this cost in any other way except as an opportunity cost.
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Chapter 8 Cost Concepts and Classifications
Exercise 9
Direc Indirec
t t
Cost Cost Object Cost Cost
1. The salary of the head chef The hotel’s restaurant X
2. The salary of the head chef A particular restaurant X
customer
3. Room cleaning supplies A particular hotel guest X
4. Flowers for the reception A particular hotel guest X
desk
5. The wages of the doorman A particular hotel guest X
6. Room cleaning supplies The housecleaning X
department
7. Fire insurance on the hotel The hotel’s gym X
building
8. Towels used in the gym The hotel’s gym X
III. Problems
Problem 1
The relevant costs for this decision are the differential costs. These are:
Room and board, clothing, car, and incidentals are not relevant because these
are presumed to be the same whether or not Francis goes to school. The
possibility of part-time work, summer jobs, or scholarship assistance could
be considered as reductions to the cost of school. If students are familiar
with the time value of money, then they should recognize that the analysis
calls for a comparison of the present value of the differential after-tax cash
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Chapter 8 Cost Concepts and Classifications
inflows with the present value of differential costs of getting the education
(including the opportunity costs of lost income).
Problem 2
Requirement (a)
Only the differential outlay costs need be considered. The travel and other
variable expenses of P22 per hour would be the relevant costs. Any amount
received in excess would be a differential, positive return to Pat.
Requirement (b)
Requirement (c)
In this situation Pat would have to consider the present value of the contract
and compare that to the present value of the existing consulting business.
The final rate may be more or less than the normal P100 rate depending on
the outcome of Pat’s analysis.
Problem 3
Problem 4
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Cost Concepts and Classifications Chapter 8
Problem 5
Requirement (a)
Sunk costs not shown could include lost book value on traded assets,
depreciation estimates for new investment, and interest costs on capital
needed during facilities construction.
Requirement (b)
The client might be used to differential cost as a decision tool, and believes
(correctly) that use of differential analyses has several advantages --- it is
quicker, requires less data, and tends to give a better focus to the decision.
The banker might suspect the client of hiding some material data in order to
make the proposal more acceptable to the financing agency.
Problem 6
Requirement (1)
EH Corporation
Schedule of Cost of Goods Manufactured
For the Year Ended December 31
Direct materials:
Raw materials, inventory, January 1 P
45,000
Add: Purchases of raw materials 375,0
00
Raw materials available for use 420,00
0
Deduct: Raw materials inventory, 30,0
December 31 00
Raw materials used in production P
390,000
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Chapter 8 Cost Concepts and Classifications
Requirement (2)
Requirement (3)
EH Corporation
Income Statement
For the Year Ended December 31
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Cost Concepts and Classifications Chapter 8
Sales P1,250,00
0
Cost of goods sold (above) 850,00
0
Gross margin 400,000
Selling and administrative expenses:
Selling expenses P
70,000
Administrative expenses 135,0 205,00
00 0
Net operating income P
195,000
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Chapter 8 Cost Concepts and Classifications
Problem 7
Adminis- Manufacturing
Variable or Selling trative (Product) Cost
Cost Item Fixed Cost Cost Direct Indirect
1. Depreciation, executive jet........................................................................... F X
2. Costs of shipping finished goods to customers............................................ V X
3. Wood used in manufacturing furniture......................................................... V X
4. Sales manager’s salary................................................................................. F X
5. Electricity used in manufacturing furniture.................................................. V X
6. Secretary to the company president.............................................................. F X
7. Aerosol attachment placed on a spray can produced by the company.......... V X
8. Billing costs................................................................................................. V X*
9. Packing supplies for shipping products overseas.......................................... V X
10. Sand used in manufacturing concrete........................................................... V X
11. Supervisor’s salary, factory.......................................................................... F X
12. Executive life insurance............................................................................... F X
13. Sales commissions....................................................................................... V X
14. Fringe benefits, assembly line workers........................................................ V X**
15. Advertising costs.......................................................................................... F X
16. Property taxes on finished goods warehouses.............................................. F X
17. Lubricants for production equipment........................................................... V X
*Could be an administrative cost.
**Could be an indirect cost.
Cost Concepts and Classifications Chapter 8
Problem 8
Requirement (1)
Period
(Selling
Product Cost and
Variable Fixed Direct Direct Mfg. Admin.) Opportunity Sunk
Name of the Cost Cost Cost Materials Labor Overhead Cost Cost Cost
Ling’s present salary of P400,000 per
month.......................................................................... X
Rent on the garage, P15,000 per month........................... X X
Rent of production equipment, P50,000 per
month.......................................................................... X X
Materials for producing flyswatters, at
P30.00 each.................................................................
X X
Labor cost of producing flyswatters, at
P50.00 each.................................................................
X X
Rent of room for a sales office, P7,500 per
month.......................................................................... X X
Answering device attachment, P2,000 per
month.......................................................................... X X
Interest lost on savings account, P100,000
per year........................................................................ X
Advertising cost, P40,000 per month.............................. X X
Sales commission, at P10.00 per flyswatter.................... X X
Legal and filing fees, P60,000......................................... X
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MANAGEMENT ACCOUNTING - Solutions Manual
Requirement (2)
The P60,000 legal and filing fees are not a differential cost. These legal and
filing fees have already been paid and are a sunk cost. Thus, the cost will not
differ depending on whether Ling decides to produce flyswatters or to stay
with the consulting firm. All other costs listed above are differential costs
since they will be incurred only if Ling leaves the consulting firm and
produces the flyswatters.
Problem 9
Requirement (1)
The third action was to ask the accounting department to delay recognition
of the delivery until the bill is paid in January. This action is dubious.
Asking the accounting department to ignore transactions strikes at the heart
of the integrity of the accounting system. If the accounting system cannot be
trusted, it is very difficult to run a business or obtain funds from outsiders.
However, in Ms. Rio’s defense, the purchase of the raw materials really
shouldn’t be recorded as an expense. He has been placed in an extremely
awkward position because the company’s accounting policy is flawed.
Requirement (2)
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Cost-Volume-Profit Relationships Chapter 13
of the year.
CHAPTER 9
I. Questions
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Chapter 13 Cost-Volume-Profit Relationships
c. Mixed cost: A mixed cost is a cost that contains both variable and
fixed cost elements.
4. Although the accountant recognizes that many costs are not linear in
relationship to volume at some points, he concentrates on their behavior
within narrow bands of activity known as the relevant range. The
relevant range can be defined as that range of activity within which
assumptions as relative to variable and fixed cost behavior are valid.
Generally, within this range an assumption of strict linearity can be used
with insignificant loss of accuracy.
5. The high-low method, the scattergraph method, and the least-squares
regression method are used to analyze mixed costs. The least-squares
regression method is generally considered to be most accurate, since it
derives the fixed and variable elements of a mixed cost by means of
statistical analysis. The scattergraph method derives these elements by
visual inspection only, and the high-low method utilizes only two points
in doing a cost analysis, making it the least accurate of the three
methods.
6. The fixed cost element is represented by the point where the regression
line intersects the vertical axis on the graph. The variable cost per unit is
represented by the slope of the line.
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Cost-Volume-Profit Relationships Chapter 13
8. No. High correlation merely implies that the two variables move
together in the data examined. Without economic plausibility for a
relationship, it is less likely that a high level of correlation observed in
one set of data will be found similarly in another set of data.
10. The relevant range is the range of the cost driver in which a specific
relationship between cost and cost driver is valid. This concept enables
the use of linear cost functions when examining CVP relationships as
long as the volume levels are within that relevant range.
11. A unit cost is computed by dividing some amount of total costs (the
numerator) by the related number of units (the denominator). In many
cases, the numerator will include a fixed cost that will not change despite
changes in the denominator. It is erroneous in those cases to multiply
the unit cost by activity or volume change to predict changes in total
costs at different activity or volume levels.
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g. when there is a shift in the data, as, for example, a new product is
introduced or when there is a work stoppage, the data will be
unreliable for future estimates.
15. The dependent variable is the cost object of interest in the cost
estimation. An important issue in selecting a dependent variable is the
level of aggregation in the variable. For example, the company, plant, or
department may all be possible levels of data for the cost object. The
choice of aggregation level depends on the objectives for the cost
estimation, data availability, reliability, and cost/benefit considerations.
If a key objective is accuracy, then a detailed level of analysis is often
preferred. The detail cost estimates can then be aggregated if desired.
16. Nonlinear cost relationships are cost relationships that are not adequately
explained by a single linear relationship for the cost driver(s). In
accounting data, a common type of nonlinear relationship is trend and
seasonality. For a trend example, if sales increase by 8% each year, the
plot of the data for sales with not be linear with the driver, the number of
years. Similarly, sales which fluctuate according to a seasonal pattern
will have a nonlinear behavior. A different type of nonlinearity is where
the cost driver and the dependent variable have an inherently nonlinear
relationship. For example, payroll costs as a dependent variable
estimated by hours worked and wage rates is nonlinear, since the
relationship is multiplicative and therefore not the additive linear model
assumed in regression analysis.
18. High correlation exists when the changes in two variables occur together.
It is a measure of the degree of association between the two variables.
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20. (a) Variable cost: A variable cost remains constant on a per unit basis,
but increases or decreases in total in direct relation to changes in
activity.
(b) Mixed cost: A mixed cost is a cost that contains both variable and
fixed cost elements.
(c) Step-variable cost: A step-variable cost is a cost that is incurred in
large chunks, and which increases or decreases only in response to
fairly wide changes in activity.
Mixed Cost
Variable Cost
Cost
Step-Variable Cost
Activity
21. The linear assumption is reasonably valid providing that the cost formula
is used only within the relevant range.
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24. The high-low method uses only two points to determine a cost formula.
These two points are likely to be less than typical since they represent
extremes of activity.
25. The term “least-squares regression” means that the sum of the squares of
the deviations from the plotted points on a graph to the regression line is
smaller than could be obtained from any other line that could be fitted to
the data.
II. Exercises
1. b
2. f
3. e
4. i
5. e
6. h
7. l
8. a
9. j
10. k
11. c or d
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12. g
Requirement (1)
Variable costs:
P4,700 – P2,800
4,050 – 2,375 = P1.134
Fixed costs:
Variable costs:
P4,700 – P2,800
19 – 11 = P237.50
Fixed costs:
Variable costs:
P4,700 – P2,875
19 – 10 = P202.78
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Fixed costs:
Predicted total cost for a 3,200 square foot house with 14 openings using
equation one:
Predicted total cost for a 3,200 square foot house with 14 openings using
equation two:
Predicted total cost for a 3,200 square foot house with 14 openings using
equation three:
Predicted cost for a 2,400 square foot house with 8 openings, using equation
one:
Requirement 2
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Figure 9-A shows that the relationship between costs and square feet is
relatively linear without outliers, while Figure 9-B shows a similar result for
the relationship between costs and number of openings. From this
perspective, both variables are good cost drivers.
Figure 9-A
P5,000
P4,500
P4,000
P3,500
P3,000
Cost
P2,500
P2,000
P1,500
P1,000
P500
P0
2,600
2,600
2,800
2,850
3,700
4,050
2,375
2,450
2,650
2,700
3,010
3,550
Square Feet
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Cost-Volume-Profit Relationships Chapter 13
Figure 9-B
P5,000
P4,500
P4,000
P3,500
P3,000
Cost
P2,500
P2,000
P1,500
P1,000
P500
P0
10 11 11 12 12 13 13 13 15 16 16 19
Num ber of Openings
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Requirement 1
Fixed Costs:
Rent P10,250
Depreciation 400
Insurance 750
Advertising 650
Utilities 1,250
Mr. Black’s salary 18,500
Total P31,800
Variable Costs:
Wages P17,800
CD Expense 66,750
Shopping Bags 180
Total P84,730
Requirement 2
Requirement 3
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= P137,010
P160,000
P140,000
P120,000
P100,000
Sales
P80,000
P60,000
P40,000
P20,000
P0
P2,500
P3,000
P3,500
P5,000
P5,500
P4,000
P4,500
Advertising Expense
Requirement 2
There seems to be a positive linear relationship for the data between P2,500
and P4,000 of advertising expense. Llanes’ analysis is correct within this
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Chapter 13 Cost-Volume-Profit Relationships
relevant range but not outside of it. Notice that the relationship between
advertising expense and sales changes at P4,000 of expense.
Requirement (1)
Cups of Coffee Served
in a Week
1,800 1,900 2,000
Fixed cost P11,000 P11,000 P11,000
Variable cost 4,680 4,940 5,200
Total cost P15,680 P15,940 P16,200
Cost per cup of coffee served * P8.71 P8.39 P8.10
* Total cost ÷ cups of coffee served in a week
Requirement (2)
The average cost of a cup of coffee declines as the number of cups of coffee
served increases because the fixed cost is spread over more cups of coffee.
Requirement (1)
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16,000
14,000
12,000
10,000
Total Cost
8,000
6,000
4,000
2,000
0
0 2,000 4,000 6,000 8,000 10,000
Units Processed
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Chapter 13 Cost-Volume-Profit Relationships
Requirement (2)
(Students’ answers will vary considerably due to the inherent imprecision
and subjectivity of the quick-and-dirty scattergraph method of estimating
variable and fixed costs.)
The approximate monthly fixed cost is P6,000—the point where the straight
line intersects the cost axis.
The variable cost per unit processed can be estimated as follows using the
8,000-unit level of activity, which falls on the straight line:
Total cost at the 8,000-unit level of activity............................................ P14,000
Less fixed costs.......................................................................................
6,000
Variable costs at the 8,000-unit level of activity..................................... P 8,000
P8,000 ÷ 8,000 units = P1 per unit.
Observe from the scattergraph that if the company used the high-low method
to determine the slope of the line, the line would be too steep. This would
result in underestimating the fixed cost and overestimating the variable cost
per unit.
Requirement (2)
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Electrical costs may reflect seasonal factors other than just the variation in
occupancy days. For example, common areas such as the reception area must
be lighted for longer periods during the winter. This will result in seasonal
effects on the fixed electrical costs.
Additionally, fixed costs will be affected by how many days are in a month.
In other words, costs like the costs of lighting common areas are variable
with respect to the number of days in the month, but are fixed with respect to
how many rooms are occupied during the month.
Other, less systematic, factors may also affect electrical costs such as the
frugality of individual guests. Some guests will turn off lights when they
leave a room. Others will not.
Intercept P2,29
6
Slope P3.74
RSQ 0.92
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Chapter 13 Cost-Volume-Profit Relationships
The intercept provides the estimate of the fixed cost element, P2,296 per
month, and the slope provides the estimate of the variable cost element,
P3.74 per rental return. Expressed as an equation, the relation between car
wash costs and rental returns is
Y = P2,296 + P3.74X
where X is the number of rental returns.
Note that the R 2 is 0.92, which is quite high, and indicates a strong linear
relationship between car wash costs and rental returns.
While not a requirement of the exercise, it is always a good to plot the data
on a scattergraph. The scattergraph can help spot nonlinearities or other
problems with the data. In this case, the regression line (shown below) is a
reasonably good approximation to the relationship between car wash costs
and rental returns.
Php25,000
Php20,000
Php15,000
Php10,000
P hp5,000
Php0
0 1,000 2,000 3,000 4,000 5,000 6,000
Rental Returns
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Cost-Volume-Profit Relationships Chapter 13
III. Problems
Problem 1
Problem 2
Requirement 1
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Requirement 2
P36,000
Salaries and comm. expense: 1,500 units = P24 per unit.
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Cost-Volume-Profit Relationships Chapter 13
Requirement 3
LILY COMPANY
Income Statement
For the Month Ended June 30
Problem 3
Requirement 1
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a = (Y) - b(X)
n
(54,500) - 1,700 (20)
=
5
= P4,100
Therefore, the variable cost per league is P1,700 and the fixed cost
is P4,100 per year.
Requirement 2
Y = P4,100 + P1,700X
Requirement 3
The problem with using the cost formula from (2) to derive this total cost
figure is that an activity level of 7 sections lies outside the relevant range
from which the cost formula was derived. [The relevant range is represented
by a solid line on the graph in requirement 4 below.]
Although an activity figure may lie outside the relevant range, managers will
often use the cost formula anyway to compute expected total cost as we have
done above. The reason is that the cost formula frequently is the only basis
that the manager has to go on. Using the cost formula as the starting point
should not present a problem so long as the manager is alert for any unusual
problems that the higher activity level might bring about.
Requirement 4 Y
P16,000
P14,000
P12,000
P10,000
P8,000 13-148
P6,000
P4,000
P2,000
X
P-
0 1 2 3 4 5 6 7 8
Cost-Volume-Profit Relationships Chapter 13
Requirement 1
Figure 9-C plots the relationship between labor-hours and overhead costs
and shows the regression line.
y = P48,271 + P3.93 X
Goodness of fit. The vertical differences between actual and predicted costs
are extremely small, indicating a very good fit. The good fit indicates a
strong relationship between the labor-hour cost driver and overhead costs.
Slope of regression line. The regression line has a reasonably steep slope
from left to right. The positive slope indicates that, on average, overhead
costs increase as labor-hours increase.
Requirement 2
The regression analysis indicates that, within the relevant range of 2,500 to
7,500 labor-hours, the variable cost per person for a cocktail party equals:
Food and beverages P15.00
Labor (0.5 hrs. x P10 per hour) 5.00
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Chapter 13 Cost-Volume-Profit Relationships
Requirement 3
Of course, Bobby Gonzales will consider other factors in developing his bid
including (a) an analysis of the competition – vigorous competition will limit
Gonzales’ ability to obtain a higher price (b) a determination of whether or
not his bid will set a precedent for lower prices – overall, the prices Bobby
Gonzales charges should generate enough contribution to cover fixed costs
and earn a reasonable profit, and (c) a judgment of how representative past
historical data (used in the regression analysis) is about future costs.
Figure 9-C
Regression Line of Labor-Hours on Overhead Costs for Bobby Gonzales’
Catering Company
P90,000
P80,000
P70,000
P60,000
Overhead Costs
P50,000
P40,000
P30,000
P20,000
P10,000
P0
0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000
Cost Driver: Labor-Hours
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Cost-Volume-Profit Relationships Chapter 13
Requirement 1
Difference in cost
Slope coefficient (b) =
Difference in labor-hours
P529,000 – P400,000
= = P43.00
7,000 – 4,000
No, the constant component of the cost function does not represent the fixed
overhead cost of the ABS Group. The relevant range of professional labor-
hours is from 3,000 to 8,000. The constant component provides the best
available starting point for a straight line that approximates how a cost
behaves within the 3,000 to 8,000 relevant range.
Requirement 2
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Chapter 13 Cost-Volume-Profit Relationships
The data are shown in Figure 9-D. The linear cost function overstates costs
by P8,000 at the 5,000-hour level and understates costs by P15,000 at the
8,000-hour level.
Requirement 3
Based on
Linear
Based on Cost
Actual Function
Contribution before deducting
incremental overhead P38,00 P38,00
0 0
Incremental overhead 35,000 43,000
Contribution after incremental P P
overhead 3,000 (5,000)
Figure 9-D
Linear Cost Function Plot of Professional Labor-Hours
on Total Overhead Costs for ABS Consulting Group
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Cost-Volume-Profit Relationships Chapter 13
P700,000
P600,000
Total Overhead Costs
P500,000
P400,000
P300,000
P200,000
P100,000
P0
0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000
Professional Labor-Hours Billed
Variable
costs
(@ P4 P
per hour) 20,000 P24,000 P28,000 P32,000
Fixed
costs 168,000 168,000 168,000 168,000
Total costs P188,000 P192,000 P196,000 P200,000
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Chapter 13 Cost-Volume-Profit Relationships
Variable
cost P4.00 P4.00 P4.00 P4.00
Fixed
cost 33.60 28.00 24.00 21.00
Total cost
per hour P37.60 P32.00 P28.00 P25.00
Observe that the total variable costs increase in proportion to the number of
hours of operating time, but that these costs remain constant at P4 if
expressed on a per hour basis.
In contrast, the total fixed costs do not change with changes in the level of
activity. They remain constant at P168,000 within the relevant range. With
increases in activity, however, the fixed cost per hour decreases, dropping
from P33.60 per hour when the boats are operated 5,000 hours a period to
only P21.00 per hour when the boats are operated 8,000 hours a period.
Because of this troublesome aspect of fixed costs, they are most easily (and
most safely) dealt with on a total basis, rather than on a unit basis, in cost
analysis work.
Requirement (1)
The first step in the high-low method is to identify the periods of the lowest
and highest activity. Those periods are November (1,100 patients admitted)
and June (1,900 patients admitted).
The second step is to compute the variable cost per unit using those two data
points:
Number Admitting
Month of Department
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Cost-Volume-Profit Relationships Chapter 13
Patients Costs
Admitted
High activity level 1,900 P15,20
(June) 0
Low activity level 1,100 12,800
(November)
Change 800 P
2,400
Change in cost
Variable cost =
Change in activity
P240,000
=
800 patients admitted
The third step is to compute the fixed cost element by deducting the variable
cost element from the total cost at either the high or low activity. In the
computation below, the high point of activity is used:
Fixed cost element = Total cost – Variable cost element
= P15,200 – (P3 per patient admitted
x 1,900 patients admitted)
= P9,500
Requirement (2)
The cost formula is Y = P9,500 + P3X.
Problem 8 (Scattergraph Analysis; Selection of an Activity Base)
Requirement (1)
The completed scattergraph for the number of units produced as the activity
base is presented below:
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Chapter 13 Cost-Volume-Profit Relationships
5,000
4,500
4,000
3,500
Janitorial Labor Cost
3,000
2,500
2,000
1,500
1,000
500
0
0 20 40 60 80 100 120 140
Units Produced
Requirement (2)
The completed scattergraph for the number of workdays as the activity base
is presented below:
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Cost-Volume-Profit Relationships Chapter 13
Requirement (3)
5,000
4,500
4,000
3,500
Janitorial Labor Cost
3,000
2,500
2,000
1,500
1,000
500
0
0 2 4 6 8 10 12 14 16 18 20 22 24
Number of Janitorial Workdays
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Chapter 13 Cost-Volume-Profit Relationships
The number of workdays should be used as the activity base rather than the
number of units produced. There are several reasons for this. First, the
scattergraphs reveal that there is a much stronger relationship (i.e., higher
correlation) between janitorial costs and number of workdays than between
janitorial costs and number of units produced. Second, from the description
of the janitorial costs, one would expect that variations in those costs have
little to do with the number of units produced. Two janitors each work an
eight-hour shift—apparently irrespective of the number of units produced or
how busy the company is. Variations in the janitorial labor costs apparently
occur because of the number of workdays in the month and the number of
days the janitors call in sick. Third, for planning purposes, the company is
likely to be able to predict the number of working days in the month with
much greater accuracy than the number of units that will be produced.
Note that the scattergraph in part (1) seems to suggest that the janitorial labor
costs are variable with respect to the number of units produced. This is false.
Janitorial labor costs do vary, but the number of units produced isn’t the
cause of the variation. However, since the number of units produced tends to
go up and down with the number of workdays and since the janitorial labor
costs are driven by the number of workdays, it appears on the scattergraph
that the number of units drives the janitorial labor costs to some extent.
Analysts must be careful not to fall into this trap of using the wrong measure
of activity as the activity base just because it appears there is some
relationship between cost and the measure of activity. Careful thought and
analysis should go into the selection of the activity base.
* Supporting Computations:
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Cost-Volume-Profit Relationships Chapter 13
CHAPTER 10
I. Questions
1. Job-order costing is used in those manufacturing situations where there
are many different products produced each period. Each product or job
is different from all others and requires separate costing. Process costing
is used in those manufacturing situations where a single, homogeneous
product, such as cement, bricks, or gasoline, is produced for long periods
at a time.
2. The job cost sheet is used in accumulating all costs assignable to a
particular job. These costs would include direct materials cost traceable
to the job, and manufacturing overhead cost allocable to the job. When a
job is completed, the job cost sheet is used to compute the cost per
completed unit. The job cost sheet is then used as a control document
for: (1) determining how many units have been sold and determining the
cost of these units; and (2) determining how many units are still in
inventory at the end of a period and determining the cost of these units
on the balance sheet.
3. Many production costs cannot be traced directly to a particular product
or job, but rather are incurred as a result of overall production activities.
Therefore, in order to be assigned to products, such costs must be
allocated to the products in some manner. Examples of such costs
would include utilities, maintenance on machines, and depreciation of
the factory building. These costs are indirect production costs.
4. A firm will not know its actual manufacturing overhead costs until after
a period is over. Thus, if actual costs were used to cost products, it
would be necessary either (1) to wait until the period was over to add
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Chapter 13 Cost-Volume-Profit Relationships
overhead costs to jobs, or (2) to simply add overhead cost to jobs as the
overhead cost was incurred day by day. If the manager waits until after
the period is over to add overhead cost to jobs, then cost data will not be
available during the period. If the manager simply adds overhead cost
to jobs as the overhead cost is incurred, then unit costs may fluctuate
from month to month. This is because overhead cost tends to be
incurred somewhat evenly from month to month (due to the presence of
fixed costs), whereas production activity often fluctuates. For these
reasons, most firms use predetermined overhead rates, based on
estimates of overhead cost and production activity, to apply overhead
cost to jobs.
5. An allocation base should act as a cost driver in the incurrence of the
overhead cost; that is, the base should cause the overhead cost. If the
allocation base does not really cause the overhead, then costs will be
incorrectly attributed to products and jobs and their costs will be
distorted.
6. A process costing system is appropriate in those situations where a
homogeneous product is produced on a continuous basis.
7. In a process costing system, costs are accumulated by department.
8. First, the activity performed in a department must be performed
uniformly on all units moving through it. Second, the output of the
department must be homogeneous.
9. The reason cost accumulation is simpler is that costs only need to be
identified by department - not by separate job. Usually there will be
only a few departments in a company, whereas there can be hundreds or
even thousands of jobs in a job-order costing system.
10. A quantity schedule shows the physical flow of units through a
department during a period. It serves several purposes. First, it provides
the manager with information relative to activity in his or her department
and also shows the manager the stage of completion of any in-process
units. Second, it serves as an essential guide in computing the
equivalent units and in preparing the other parts of the production report.
11. By definition, manufacturing overhead consists of costs that cannot be
practically traced to products or jobs. Therefore, if these costs are to be
assigned to products or jobs, they must be allocated rather than traced.
12. Assigning manufacturing overhead costs to jobs does not ensure a profit.
The units produced may not be sold and if they are sold, they may not be
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II. Exercises
Requirement 1
Company X:
Company Y:
Requirement 1
Milling Department:
Assembly Department:
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Requirement 2
Overhead Applied
Milling Department: 90 MHs × P8.50 per MH P765
Assembly Department: P160 × 125% 200
Total overhead cost applied P965
Requirement 3
Yes; if some jobs required a large amount of machine time and little labor
cost, they would be charged substantially less overhead cost if a plantwide
rate based on direct labor cost were being used. It appears, for example, that
this would be true of job 123 which required considerable machine time to
complete, but required only a small amount of labor cost.
Work in Process—Mixing......................................................................................
330,000
Raw Materials Inventory.................................................................................
330,000
Work in Process—Mixing......................................................................................
260,000
Work in Process—Baking.......................................................................................
120,000
Wages Payable................................................................................................
380,000
Work in Process—Mixing......................................................................................
190,000
Work in Process—Baking.......................................................................................
90,000
Manufacturing Overhead.................................................................................
280,000
Work in Process—Baking.......................................................................................
760,000
Work in Process—Mixing...............................................................................
760,000
Finished Goods.......................................................................................................
980,000
Work in Process—Baking...............................................................................
980,000
Requirement 1
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Weighted-Average Method
Quantity
Schedule
Gallons to be accounted for:
Work in process, May 1 (materials 80%
complete, labor and overhead 75%
complete) 80,000
Started into production 760,000
Total gallons accounted for 840,000
Equivalent Units
Material
s Labor Overhead
Gallons accounted for as follows:
Transferred to the next department............. 790,000 790,000 790,000 790,000
Work in process, May 31 (materials 60%
complete, labor and overhead 20%
complete)................................................ 50,000 30,000 10,000 10,000
Total gallons accounted for.............................. 840,000 820,000 800,000 800,000
Requirement 2
Requirement 1
FIFO Method
Quantity
Schedule
Gallons to be accounted for:
Work in process, May 1 (materials 80%
complete, labor and overhead 75%
complete) 80,000
Started into production 760,000
Total gallons accounted for 840,000
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Equivalent Units
Material
s Labor Overhead
Gallons accounted for as follows:
Transferred to the next department:
From the beginning inventory................ 80,000 16,000* 20,000* 20,000*
Started and completed this month**..... 710,000 710,000 710,000 710,000
Work in process, May 31 (materials 60%
complete, labor and overhead 20%
complete)................................................ 50,000 30,000 10,000 10,000
Total gallons accounted for.............................. 840,000 756,000 740,000 740,000
Requirement 2
Exercise 7
Requirement (1)
The direct materials and direct labor costs listed in the exercise would have
been recorded on four different documents: the materials requisition form for
Job KC123, the time ticket for Kristine, the time ticket for Clarisse, and the
job cost sheet for Job KC123.
Requirement (2)
The costs for Job KC123 would have been recorded as follows:
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Chapter 13 Cost-Volume-Profit Relationships
P8,960
Exercise 8
Exercise 9
Weighted-Average Method
Materials Labor Overhead Total
Work in process, May 1................................ P 14,550 P23,620 P118,100
Cost added during May................................. 88,350 14,330 71,650
Total cost (a).................................................
P102,900 P37,950 P189,750
Equivalent units of
production (b)............................................ 1,200 1,100 1,100
Cost per equivalent unit
(a) ÷ (b).....................................................P85.75 P34.50 P172.50 P292.75
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Exercise 10
FIFO Method
Materials Conversion
To complete beginning work in process:
Materials: 400 units x (100% – 75%).............................................................
100
Conversion: 400 units x (100% – 25%).......................................................... 300
Units started and completed during the period
(42,600 units started – 500 units in ending
inventory).........................................................................................................
42,100 42,100
Ending work in process
Materials: 500 units x 80% complete.............................................................
400
Conversion: 500 units x 30% complete.......................................................... 150
Equivalent units of production...............................................................................
42,600 42,550
III. Problems
Problem 1
Requirement 1
b. Work in Process...........................................................178,000
Manufacturing Overhead............................................. 12,000
Raw Materials Inventory......................................... 190,000
f. Work in Process...........................................................240,000
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g. Finished Goods............................................................520,000
Work in Process....................................................... 520,000
Accounts Receivable...................................................600,000
Sales........................................................................ 600,000
P480,000 × 1.25 = P600,000
Requirement 2
Problem 2
Requirement 1
The costing problem does, indeed, lie with manufacturing overhead cost, as
suggested. Since manufacturing overhead is mostly fixed, the cost per unit
increases as the level of production decreases. The problem can be solved by
use of predetermined overhead rates, which should be based on expected
activity for the entire year. Many students will use units of product in
computing the predetermined overhead rate, as follows:
Estimated manufacturing overhead cost, P840,000
= P4.20 per unit.
Estimated units to be produced, 200,000
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The predetermined overhead rate could also be set on the basis of either direct
labor cost or direct materials cost. The computations are:
Estimated manufacturing overhead cost, P840,000
= 350% of direct
Estimated direct labor cost, P240,000 labor cost
Requirement 2
Problem 3
Weighted-Average Method
Quantity
Schedule
Pounds to be accounted for:
Work in process, May 1
(all materials, 55% labor and
overhead added last month).......... 30,000
Started into production during
May................................................ 480,000
Total pounds............................ 510,000
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Equivalent Units
Labor &
Materials Overhead
Pounds accounted for as follows:
Transferred to Department 2............ 490,000* 490,000 490,000
Work in process, May 31
(all materials, 90% labor and
overhead added this month).......... 20,000 20,000 18,000
Total pounds............................ 510,000 510,000 508,000
* 30,000 + 480,000 - 20,000 = 490,000.
Problem 4 (Weighted-Average Method; Interpreting a Production
Report)
Requirement 1
Weighted-Average Method
Requirement 2
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Equivalent units of
production (b) – 220,000 214,000
Requirement 3
Requirement 4
No, the manager should not be rewarded for good cost control. The reason
for the Mixing Department’s low unit cost for April is traceable to the fact
that costs of the prior month have been averaged in with April’s costs in
computing the lower, P2.94 per unit figure. This is a major criticism of the
weighted-average method in that the figures computed for product costing
purposes can’t be used to evaluate cost control or measure performance for
the current period.
Requirement 1
Weighted-Average Method
Quantity
Schedule
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P P
0 2
. .
7 1
0 0
Cost Reconciliation
Requirement 2
1. D 6. D 11. A 16. A
2. D 7. A 12. D 17. D
3. D 8. C 13. B 18. A
4. C 9. C 14. D 19. C
5. D 10. B 15. C 20. D
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CHAPTER 11
I. Questions
1. The three levels available are: Level 1, in which a company uses a
plantwide overhead rate; Level 2, in which a company uses departmental
overhead rates; and Level 3, in which a company uses activity-based
costing.
2. New approaches to costing are needed because events of the last few
decades have made drastic changes in many organizations. Automation
has greatly decreased the amount of direct labor required to manufacture
products; product diversity has increased in that companies are
manufacturing a wider range of products and these products differ
substantially in volume, lot size, and complexity of design; and total
overhead cost has increased to the point in some companies that a
correlation no longer exists between it and direct labor.
3. The departmental approach to assigning overhead cost to products relies
solely on volume as an assignment base. Where diversity exists between
products (that is, where products differ in terms of number of units
produced, lot size, or complexity of production), volume alone is not
adequate for overhead costing. Overhead costing based on volume will
systematically overcost high-volume products and undercost low-volume
products.
4. Process value analysis (PVA) is a systematic approach to gaining an
understanding of the steps associated with a product or service. It
identifies all resource-consuming activities involved in the production
process and labels these activities as being either value-added or non-
value-added. Thus, it is the beginning point in designing an activity-
based costing system since management must know what activities are
involved with each product before activity centers can be designated and
cost drivers established. Also, PVA helps management to eliminate any
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III. Exercises
Exercise 1
Examples of Examples of
Activity Traceable Cost
Activity Classification Costs Drivers
a. Materials are Batch-level Labor cost; Number of
moved from the depreciation receipts;
receiving dock to pounds
of equipment;
product flow lines handled
space cost
by a material-
handling crew
b. Direct labor Unit-level Direct labor Direct labor-
workers assemble cost; indirect hours
various products labor cost;
labor benefits
c. Ongoing training is Facility-level* Space cost; Hours of
provided to all training costs; training time;
employees in the administration number
company costs trained
d. A product is Product-level Space cost; Hours of
designed by a supplies used; design time;
specialized design depreciation of number of
team design engineering
equipment change orders
e. Equipment setups Batch-level Labor cost; Number of
are performed on a supplies used; setups; hours
regular basis depreciation of or setup time
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equipment
f. Numerical control Unit-level Power; Machine-
(NC) machines are supplies used; hours; number
used to cut and maintenance; of units
shape materials depreciation
* Personnel administration and training costs might be traceable in part to the
facility-level and in part to other activity centers at the unit-level, product-
level, and batch-level.
Exercise 2
Exercise 3
Note: Some of these classifications are debatable and may depend on the
specific circumstances found in particular companies.
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Exercise 4
Exercise 5
Requirement 1
The unit product costs under the company’s traditional costing system are
computed as follows:
Special Regular
Direct materials................................................................................................................
P60.00 P45.00
Direct labor......................................................................................................................
9.60 7.20
Manufacturing overhead (0.8 DLH × P5.80 per DLH;
0.6 DLH × P5.80 per DLH)........................................................................................
4.64 3.48
Unit product cost..............................................................................................................
P74.24 P55.68
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Requirement 2
(a)
Estimate (b)
d
Overhead Total (a) ÷ (b)
Activities Cost Expected Activity Activity Rate
Supporting direct labor..............................
P150,000 50,000 DLHs P3 per DLH
Batch setups...............................................
P60,000 250 setup P24 per setup
s 0
Safety testing..............................................
P80,000 100 tests P80 per test
0
Special Product:
(a) (b) (a) × (b)
Activity Cost Pool Activity Rate Activity ABC Cost
Supporting direct labor........................................................ P3 per DLH 8,000 DLHs P24,000
Batch setups.........................................................................
P240 per setup 200 setups 48,000
Safety testing........................................................................
P800 per test 80 tests 64,000
Total P136,000
Regular Product:
(a) (b) (a) × (b)
Activity Cost Pool Activity Rate Activity ABC Cost
Supporting direct labor........................................................ P3 per DLH 42,000 DLHs P126,000
Batch setups.........................................................................
P240 per setup 50 setups 12,000
Safety testing........................................................................
P800 per test 20 tests 16,000
Total P154,000
Special Regular
Direct materials...................................................................................................
P60.00 P45.00
Direct labor.........................................................................................................
9.60 7.20
Manufacturing overhead (P136,000 ÷ 10,000 units; P154,000
÷ 70,000 units)...............................................................................................
13.60 2.20
Unit product cost.................................................................................................
P83.20 P54.40
IV. Problems
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Problem 1
Requirement 1
(a)
Total overhead = P200,000 + P32,000 + P100,000 + P120,000
= P452,000
Requirement 2
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Requirement 1
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The first-stage allocation of costs to the activity cost pools appears below:
Requirement 2
Requirement 3
Requirement 4
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Requirement 1
a. When direct labor-hours are used to apply overhead cost to products, the
company’s predetermined overhead rate would be:
Predetermined Manufacturing overhead cost
=
overhead rate Direct labor hours
P1,480,000
= = P74 per DLH
20,000 DLHs
b. Model
HY5 AS2
Direct materials......................................................................
P35.00 P25.00
Direct labor:
P20 per hour × 0.2 DLH, 0.4 DLH.................................... 4.00 8.00
Manufacturing overhead:
P74 per hour × 0.2 DLH, 0.4 DLH.................................... 14.80 29.60
Total unit product cost...........................................................
P53.80 P62.60
Requirement 2
(a) (b)
Estimated Estimated (a) ÷ (b)
Activity Cost Pool Total Cost Total Activity Activity Rate
Machine setups................P180,000 250 setups P720 per setup
Special milling.................P300,000 1,000 MHs P300 per MH
General factory................
P1,000,000 20,000 DLHs P50 per DLH
Model HY5
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Model AS2
(a) (a) × (b)
Predetermined (b) Overhead
Activity Cost Pool Overhead Rate Activity Applied
Machine setups....................................................................................
P720 per setup 100 setups P 72,000
Special milling....................................................................................
P300 per MH 0 MHs 0
General factory....................................................................................
P50 per DLH 16,000 DLHs 800,000
Total manufacturing overhead cost (a)............................................... P872,000
Number of units produced (b)............................................................. 40,000
Overhead cost per unit (a) ÷ (b).......................................................... P21.80
Comparing these unit cost figures with the unit costs in Part 1(b), we
find that the unit product cost for Model HY5 has increased from P53.80
to P69.40, and the unit product cost for Model AS2 has decreased from
P62.60 to P54.80.
Requirement 3
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Thus, the shift in overhead cost from the high-volume product (Model AS2)
to the low-volume product (Model HY5) occurred as a result of reassigning
only 32% of the company’s overhead costs.
The increase in unit product cost for Model HY5 can be explained as
follows: First, where possible, overhead costs have been traced to the
products rather than being lumped together and spread uniformly over
production. Therefore, the special milling costs, which are traceable to
Model HY5, have all been assigned to Model HY5 and none assigned to
Model AS2 under the activity-based costing approach. It is common in
industry to have some products that require special handling or special
milling of some type. This is especially true in modern factories that produce
a variety of products. Activity-based costing provides a vehicle for assigning
these costs to the appropriate products.
Second, the costs associated with the batch-level activity (machine setups)
have also been assigned to the specific products to which they relate. These
costs have been assigned according to the number of setups completed for
each product. However, since a batch-level activity is involved, another
factor affecting unit costs comes into play. That factor is batch size. Some
products are produced in large batches and some are produced in small
batches. The smaller the batch, the higher the cost per unit of the batch
activity. In the case at hand, the data can be analyzed as shown below.
Model HY5:
Cost to complete one setup [see 2(a)]....................................... P720 (a)
Number of units processed per setup
(20,000 units ÷ 150 setups)...................................................133.33 (b)
Setup cost per unit (a) ÷ (b)...................................................... P5.40
Model AS2:
Cost to complete one setup (above).......................................... P720 (a)
Number of units processed per setup
(40,000 units ÷ 100 setups)................................................... 400 (b)
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Thus, the cost per unit for setups is three times as great for Model HY5, the
low-volume product, as it is for Model AS2, the high-volume product.
Such differences in cost are obscured when direct labor-hours (or any other
volume measure) is used as the basis for applying overhead cost to
products.
In sum, overhead cost has shifted from the high-volume product to the low-
volume product as a result of more appropriately assigning some costs to
the products on the basis of the activities involved, rather than on the basis
of direct labor-hours.
1. A 11. B 21. D
2. D 12. D 21. A
3. C 13. C 22. B
4. B 14. A 23. A
5. A 15. C 24. B
6. D 16. D 25. D
7. A 17. D 26. B
8. B 18. C 27. C
9. D 19. B 28. A
10. C 20. A 29. C
CHAPTER 12
VARIABLE COSTING
I. Questions
1. The variable costing technique does not consider fixed costs as
unimportant or irrelevant, but it maintains that the distinction between
behaviors of different costs is crucial for certain decisions.
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2. The central issue in variable costing is what is the proper timing for
release of fixed manufacturing overhead as expense: at the time of
incurrence, or at the time the finished units to which the fixed overhead
relates are sold.
4. Marketing and administrative costs are treated as period costs under both
variable costing and absorption costing methods of product costing.
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10. If production exceeds sales, absorption costing will show higher net
operating income than variable costing. The reason is that inventories
will increase and therefore part of the fixed manufacturing overhead cost
of the current period will be deferred in inventory to the next period
under absorption costing. By contrast, all of the fixed manufacturing
overhead cost of the current period will be charged immediately against
revenues as a period cost under variable costing.
11. Absorption and variable costing differ in how they handle fixed
manufacturing overhead. Under absorption costing, fixed manufacturing
overhead is treated as a product cost and hence is an asset until products
are sold. Under variable costing, fixed manufacturing overhead is treated
as a period cost and is expensed on the current period’s income
statement.
12. Advocates of variable costing argue that fixed manufacturing costs are
not really the cost of any particular unit of product. If a unit is made or
not, the total fixed manufacturing costs will be exactly the same.
Therefore, how can one say that these costs are part of the costs of the
products? These costs are incurred to have the capacity to make products
during a particular period and should be charged against that period as
period costs according to the matching principle.
II. Exercises
Requirement 1
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Requirement 2
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Requirement 1
*Direct materials.......................................................................................................
P10
Direct labor.............................................................................................................
4
Variable manufacturing overhead...........................................................................
2
Total variable manufacturing cost...........................................................................
P16
Requirement 2
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Requirement 1
Under variable costing, only the variable manufacturing costs are included in
product costs.
Note that selling and administrative expenses are not treated as product
costs; that is, they are not included in the costs that are inventoried. These
expenses are always treated as period costs and are charged against the
current period’s revenue.
Requirement 2
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* The variable cost of goods sold could be computed more simply as: 9,000 units
sold × P1,000 per unit = P9,000,000.
Requirement 3
Requirement 2
Note: The company apparently has exactly zero net operating income even
though its sales are below the break-even point computed in Exercise 3. This
occurs because P300,000 of fixed manufacturing overhead has been deferred
in inventory and does not appear on the income statement prepared using
absorption costing.
Exercise 5 (Variable Costing Income Statement; Explanation of Difference in Net
Operating Income)
Requirement 1
Requirement 2
Sales.............................................................................. P4,000,000
Variable expenses:
Variable cost of goods sold:
Beginning inventory.............................................. P 0
Add variable manufacturing costs
(10,000 units× P310 per unit)........................... 3,100,000
Goods available for sale........................................ 3,100,000
Less ending inventory
(2,000 units × P310 per unit)............................. 620,000
Variable cost of goods sold*..................................... 2,480,000
Variable selling and administrative
(8,000 units × P20 per unit)................................... 160,000 2,640,000
Contribution margin...................................................... 1,360,000
Fixed expenses:
Fixed manufacturing overhead..................................600,000
Fixed selling and administrative............................... 400,000 1,000,000
Net operating income.................................................... P 360,000
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* The variable cost of goods sold could be computed more simply as: 8,000
units sold × P310 per unit = P2,480,000.
Requirement 1
a. By assumption, the unit selling price, unit variable costs, and total fixed
costs are constant from year to year. Consequently, variable costing net
operating income will vary with sales. If sales increase, variable costing
net operating income will increase. If sales decrease, variable costing net
operating income will decrease. If sales are constant, variable costing net
operating income will be constant. Because variable costing net
operating income was P16,847 each year, unit sales must have been the
same in each year.
The same is not true of absorption costing net operating income. Sales
and absorption costing net operating income do not necessarily move in
the same direction because changes in inventories also affect absorption
costing net operating income.
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Requirement 2
Requirement 3
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Common data:
Annual fixed manufacturing costs............................... P153,153
Contribution margin per unit...................................... P35,000
Annual fixed SGA costs............................................... P180,000
Part 1:
Year 1 Year 2 Year 3
Beginning inventory............................................................. 1 1 2
Production............................................................................ 10 11 9
Sales...................................................................................... 10 10 10
Ending................................................................................... 1 2 1
Part 2:
Year 1 Year 2 Year 3
Beginning inventory................................................... 1 1 4
Production.................................................................. 10 12 20
Sales........................................................................... 10 9 8
Ending........................................................................ 1 4 16
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Problem 1
Sales P20,700,000
Less: Variable Cost of Sales
Inventory, Jan. 1 P1,155,000
Current Production 7,700,000
Total Available for Sale P8,855,000
Inventory, Dec. 31 805,000 8,050,000
Contribution Margin P12,650,000
Less Fixed Costs and Expenses 6,000,000
Net Income P 6,650,000
Sales P26,100,000
Less Cost of goods sold:
Inventory, Jan. 1 P 1,380,000
Current Production 16,100,000
Total Available for Sale P17,480,000
Inventory, Dec. 31 747,500
Cost of Sales - Standard P16,732,500
Favorable Capacity Variance 900,000 15,832,500
Income from Manufacturing P10,267,500
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Problem 2
Requirement 1
Honey Company
Income Statement - Direct Costing
For the Year Ended December 31, 2005
Sales P280,000
Less Variable Cost of Sales:
Finished Goods Inventory, 1/1 P 4,000
Current Production 120,000
Total Available for Sale P124,000
Finished Goods Inventory, 12/31 12,000
Variable Cost of Sale - Standard P112,000
Unfavorable Variance 5,000 117,000
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Requirement 2
Honey Company
Income Statement - Absorption Costing
For the Year Ended December 31, 2005
Sales P280,000
Less: Cost of Sales
Finished goods inventory, Jan. 1 (1,000 x P5.50) P 5,500
Current production costs
Variable (30,000 x P4.00) P120,000
Fixed (30,000 x P1.50) 45,000 165,000
P170,500
Less: Finished goods inventory, Dec. 31
(3,000 x P5.50) 16,500
Cost of Sales - at Standard P154,000
Add (Deduct) Variance
Unfavorable variable manufacturing
costs variances 5,000
Underapplied fixed factory overhead
(6,000 x P1.50) 9,000
Cost of Sales - Actual P168,000
Gross Profit P112,000
Less: Selling and administrative expenses
Variable 28,000
Fixed 20,000
P 48,000
Net Income P 64,000
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Requirement 1
With this figure, the variable costing income statements can be prepared:
Year 1 Year 2
Sales........................................................................................................................
P1,000,000 P1,500,000
Less variable expenses:
Variable cost of goods sold @ P20 per unit........................................................
400,000 600,000
Variable selling and administrative
@ P3 per unit..................................................................................................
60,000 90,000
Total variable expenses...........................................................................................
460,000 690,000
Contribution margin................................................................................................
540,000 810,000
Less fixed expenses:
Fixed manufacturing overhead............................................................................
350,000 350,000
Fixed selling and administrative.........................................................................
250,000 250,000
Total fixed expenses................................................................................................
600,000 600,000
Net operating income (loss)....................................................................................
P (60,000) P 210,000
Requirement 2
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Requirement 1
Requirement 2
a.
Year 1 Year 2 Year 3
Variable manufacturing cost P 4 P 4 P 4
Fixed manufacturing cost:
P600,000 ÷ 50,000 units 12
P600,000 ÷ 60,000 units 10
P600,000 ÷ 40,000 units 15
Unit product cost P16 P14 P19
b.
Variable costing net operating income
(loss) P30,000 P(110,000) P 30,000
Add (Deduct): Fixed manufacturing
overhead cost deferred in inventory
from Year 2 to Year 3 under
absorption costing (20,000 units ×
P10 per unit) 200,000 (200,000)
Add: Fixed manufacturing overhead
cost deferred in inventory from Year
3 to the future under absorption
costing (10,000 units × P15 per
unit) 150,000
Absorption costing net operating P30,000 P 90,000 P(20,000)
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income (loss)
Requirement 3
Production went up sharply in Year 2 thereby reducing the unit product cost,
as shown in (2a). This reduction in cost, combined with the large amount of
fixed manufacturing overhead cost deferred in inventory for the year, more
than offset the loss of revenue. The net result is that the company’s net
operating income rose even though sales were down.
Requirement 4
Requirement 5
a. Several things would have been different if the company had been using
JIT inventory methods. First, in each year production would have been
geared to sales so that little or no inventory of finished goods would
have been built up in either Year 2 or Year 3. Second, unit product costs
probably would have been the same in all three years, since these costs
would have been established on the basis of expected sales (50,000 units)
for each year. Third, since only 40,000 units were sold in Year 2, the
company would have produced only that number of units and therefore
would have had some underapplied overhead cost for the year. (See the
discussion on underapplied overhead in the following paragraph.)
b. If JIT had been in use, the net operating income under absorption costing
would have been the same as under variable costing in all three years.
The reason is that with production geared to sales, there would have
been no ending inventory on hand, and therefore there would have been
no fixed manufacturing overhead costs deferred in inventory to other
years. Assuming that the company expected to sell 50,000 units
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Requirement 1 (a)
Under absorption costing, all manufacturing costs, variable and fixed, are
included in unit product costs:
Year 1 Year 2
Direct materials P11 P11
Direct labor 6 6
Variable manufacturing overhead 3 3
Fixed manufacturing overhead
(P120,000 10,000 units) 12
(P120,000 6,000 units) 20
Unit product cost P32 P40
Requirement 1 (b)
Year 1 Year 2
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Sales (8,000
units x P50 P400,00 P400,00
per unit) 0 0
Cost of goods
sold:
Beginning P P
inventory 0 64,000
Add cost of
goods
manufactur
ed (10,000
units x P32
per unit;
6,000 units
x P40 per 320,0 240,00
unit) 00 0
Goods
available for 320,00 304,00
sale 0 0
Less ending
inventory
(2,000 units
x P32 per
unit; 0 units
x P40 per 64,00 256,00 304,00
unit) 0 0 0 0
Gross margin 144,000 96,000
Selling and 102,00 102,00
administrativ 0 0
e expenses
(8,000 units
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x P4 per unit
+ P70,000)
Net operating P P
income 42,000 (6,000)
Requirement 2 (a)
Under variable costing, only the variable manufacturing costs are included in
unit product costs:
Year 1 Year 2
Direct materials P11 P11
Direct labor 6 6
Variable manufacturing overhead 3 3
Unit product cost P20 P20
Requirement 2 (b)
The variable costing income statements follow. Notice that the variable cost
of goods sold is computed in a simpler, more direct manner than in the
examples provided earlier. On a variable costing income statement, this
simple approach or the more complex approach illustrated earlier is
acceptable for computing the cost of goods sold.
Year 1 Year 2
Sales (8,000
units x P50 P400,00 P400,00
per unit) 0 0
Variable
expenses:
Variable cost P160,00 P160,00
of goods sold 0 0
(8,000 units
x P20 per
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unit)
Variable
selling and
administrati
ve (8,000
units x P4 32,00 192,00 32,00 192,00
per unit) 0 0 0 0
Contribution
margin 208,000 208,000
Fixed
expenses:
Fixed
manufacturin
g overhead 120,000 120,000
Fixed selling
and
administrati 70,00 190,00 70,00 190,00
ve expenses 0 0 0 0
Net operating P P
income 18,000 18,000
Requirement 3
The reconciliation of the variable and absorption costing net operating incomes
follows:
Year 1 Year 2
Variable costing net operating income P18,000 P18,000
Add fixed manufacturing overhead costs
deferred in inventory under absorption
costing (2,000 units x P12 per unit) 24,000
Deduct fixed manufacturing overhead
costs released from inventory under
absorption costing (2,000 units x P12
per unit) (24,000)
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Requirement 1
Fixed expenses:
Fixed manufacturing overhead..................................................
250,000
Fixed selling and administrative expenses................................
300,000 550,000
Net operating income.................................................................... P 40,000
Requirement 2
1. D 11. B
2. B 12. A
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3. B 13. C
4. B 14. D
5. B 15. B
6. C 16. A
7. A 17. C
8. B 18. C
9. A 19. B
10. A 20. C
CHAPTER 13
COST-VOLUME-PROFIT RELATIONSHIPS
I. Questions
1. The total “contribution margin” is the excess of total revenue over total
variable costs. The unit contribution margin is the excess of the unit
price over the unit variable costs.
2. Total contribution margin:
Selling price - manufacturing variable costs expensed -
nonmanufacturing variable costs expensed = Total contribution margin.
Gross margin:
Selling price - variable manufacturing costs expensed - fixed
manufacturing costs expensed = Gross margin.
3. A company operating at “break-even” is probably not covering costs
which are not recorded in the accounting records. An example of such a
cost is the opportunity cost of owner-invested capital. In some small
businesses, owner-managers may not take a salary as large as the
opportunity cost of forgone alternative employment. Hence, the
opportunity cost of owner labor may be excluded.
4. In the short-run, without considering asset replacement, net operating
cash flows would be expected to exceed net income, because the latter
includes depreciation expense, while the former does not. Thus, the cash
basis break-even would be lower than the accrual break-even if asset
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11. The sales mix is the relative proportions in which a company’s products
are sold. The usual assumption in cost-volume-profit analysis is that the
sales mix will not change.
12. A higher break-even point and a lower net operating income could result
if the sales mix shifted from high contribution margin products to low
contribution margin products. Such a shift would cause the average
contribution margin ratio in the company to decline, resulting in less
total contribution margin for a given amount of sales. Thus, net
operating income would decline. With a lower contribution margin
ratio, the break-even point would be higher since it would require more
sales to cover the same amount of fixed costs.
13. The contribution margin (CM) ratio is the ratio of the total contribution
margin to total sales revenue. It can be used in a variety of ways. For
example, the change in total contribution margin from a given change in
total sales revenue can be estimated by multiplying the change in total
sales revenue by the CM ratio. If fixed costs do not change, then a peso
increase in contribution margin will result in a peso increase in net
operating income. The CM ratio can also be used in break-even analysis.
Therefore, knowledge of a product’s CM ratio is extremely helpful in
forecasting contribution margin and net operating income.
14. Incremental analysis focuses on the changes in revenues and costs that
will result from a particular action.
15. All other things equal, Company B, with its higher fixed costs and lower
variable costs, will have a higher contribution margin ratio than
Company A. Therefore, it will tend to realize a larger increase in
contribution margin and in profits when sales increase.
16. (a) If the selling price decreased, then the total revenue line would rise
less steeply, and the break-even point would occur at a higher unit
volume. (b) If the fixed cost increased, then both the fixed cost line and
the total cost line would shift upward and the break-even point would
occur at a higher unit volume. (c) If the variable cost increased, then the
total cost line would rise more steeply and the break-even point would
occur at a higher unit volume.
II. Exercises
Requirement 1
13-211
Chapter 13 Cost-Volume-Profit Relationships
Requirement 2
Requirement 3
Requirement 4
Requirement 1
13-212
Cost-Volume-Profit Relationships Chapter 13
The fixed expenses of the Extravaganza total P8,000; therefore, the break-
even point would be computed as follows:
Alternative solution:
Break-even Fixed expenses
point = Unit contribution margin
in unit sales
P8,000
= P20 per person
= 400 persons
Requirement 2
Requirement 3
Cost-volume-profit graph:
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Chapter 13 Cost-Volume-Profit Relationships
P22,000
P20,000
P18,000
P10,000
P4,000
P2,000
P0
0 100 200 300 400 500 600
Number of Persons
Requirement 1
Alternative solution:
Break-even Fixed expenses
point = Unit contribution margin
in unit sales
P1,350,000
= P270 per lantern
= 5,000 lanterns
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Cost-Volume-Profit Relationships Chapter 13
Requirement 2
Requirement 3
Present: Proposed:
8,000 Lanterns 10,000 Lanterns*
Total Per Unit Total Per Unit
Sales P7,200,000 P900 P8,100,000 P810 **
Less variable expenses 5,040,000 630 6,300,000 630
Contribution margin 2,160,000 P270 1,800,000 P180
Less fixed expenses 1,350,000 1,350,000
Net operating income P 810,000 P 450,000
Requirement 4
Alternative solution:
Unit sales to Fixed expenses + Target profit
attain target profit = Unit contribution margin
P1,350,000 + P720,000
=
13-215P180 per lantern
= 11,500 lanterns
Chapter 13 Cost-Volume-Profit Relationships
Requirement 1
= 6
Requirement 2
Requirement 1
Model E700 Model J1500 Total Company
Amount % Amount % Amount %
Sales P700,000 100 P300,000 100 P1,000,000 100
Less variable expenses 280,000 40 90,000 30 370,000 37
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Cost-Volume-Profit Relationships Chapter 13
Requirement 2
= P950,000 in sales
Requirement 3
This answer assumes no change in selling prices, variable costs per unit,
fixed expenses, or sales mix.
Exercise 6 (Break-even Analysis; Target Profit; Margin of Safety)
Requirement 1
Alternatively:
= 12,500 units
Chapter 13 Cost-Volume-Profit Relationships
Requirement 2
Requirement 3
Unit sales to Fixed expenses + Target profit
attain target profit = Unit contribution margin
P150,000 + P18,000
= P12 per unit
= 14,000 units
Total Unit
Sales (14,000 units × P40 per unit).........................................................................
P560,000 P40
Less variable expenses
(14,000 units × P28 per unit)..............................................................................
392,000 28
Contribution margin
(14,000 units × P12 per unit)..............................................................................
168,000 P12
Less fixed expenses.................................................................................................
150,000
P 18,000
Net operating income..............................................................................................
Requirement 4
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Cost-Volume-Profit Relationships Chapter 13
= 16.7% (rounded)
Requirement 5
Alternative solution:
Since in this case the company’s fixed expenses will not change, monthly net
operating income will increase by the amount of the increased contribution
margin, P24,000.
Requirement (1)
The following table shows the effect of the proposed change in monthly
advertising budget:
Sales With
Additional
Current Advertising
Sales Budget Difference
Sales............................................. P225,000 P240,000 P15,000
Variable expenses......................... 135,000 144,000 9,000
Contribution margin..................... 90,000 96,000 6,000
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Chapter 13 Cost-Volume-Profit Relationships
Alternative Solution 1
Alternative Solution 2
Requirement (2)
The P3 increase in variable costs will cause the unit contribution margin to
decrease from P30 to P27 with the following impact on net operating
income:
Expected total contribution margin with the higher-quality
components:
3,450 units × P27 per unit...............................................................P93,150
Present total contribution margin:
3,000 units × P30 per unit............................................................... 90,000
Change in total contribution margin....................................................P 3,150
Assuming no change in fixed costs and all other factors remain the same, the
higher-quality components should be used.
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Cost-Volume-Profit Relationships Chapter 13
Requirement (1)
To compute the margin of safety, we must first compute the break-even unit
sales.
Requirement (2)
Requirement (1)
Requirement (2)
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Chapter 13 Cost-Volume-Profit Relationships
Requirement (3)
The new income statement reflecting the change in sales would be:
Percent of
Amount Sales
Sales............................................. P132,000 100%
Variable expenses......................... 92,400 70%
Contribution margin..................... 39,600 30%
Fixed expenses.............................. 24,000
Net operating income.................... P 15,600
Requirement (1)
= 80%
Requirement (2)
= P112,500
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Cost-Volume-Profit Relationships Chapter 13
Requirement (3)
Requirement (1)
Requirement (2)
13-223
Chapter 13 Cost-Volume-Profit Relationships
Alternative solution:
Let X = Break-even point in sales pesos.
X = 0.60X + P360,000 + P0
0.40X = P360,000
X = P360,000 ÷ 0.40
X = P900,000
In units: P900,000 ÷ P60 per unit = 15,000 units
P60Q = P36Q + P360,000 + P90,000
P24Q = P450,000
Q = P450,000 ÷ P24 per unit
Q = 18,750 units
Alternative solution:
X = 0.55X + P360,000 + P0
0.45X = P360,000
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Cost-Volume-Profit Relationships Chapter 13
X = P360,000 ÷ 0.45
X = P800,000
Requirement (3)
Break-even point Fixed expenses
a. in unit sales = Unit contribution margin
Alternative solution:
Break-even point Fixed expenses
in sales pesos = CM ratio
= 18,750 units
Alternative solution:
Peso sales to Fixed expenses + Target profit
attain target profit = CM ratio
= P1,125,000
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Chapter 13 Cost-Volume-Profit Relationships
Alternative solution:
Break-even point Fixed expenses
in sales pesos = CM ratio
= P360,000 0.45
= P800,000
In units: P800,000 ÷ P60 per unit = 13,333 (rounded)
Requirement (1)
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Cost-Volume-Profit Relationships Chapter 13
III. Problems
Requirement 1
Contribution margin P15
CM ratio = Selling price = P60 =
25%
Variable expense P45
Variable expense ratio = Selling price = P60 =
75%
Requirement 2
Alternative solution:
X = 0.75X + P240,000 + P0
0.25X = P240,000
X = P240,000 ÷ 0.25
X = P960,000; or at P60 per unit, 16,000 units
Requirement 3
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Chapter 13 Cost-Volume-Profit Relationships
Since the fixed expenses are not expected to change, net operating income
will increase by the entire P100,000 increase in contribution margin
computed above.
Requirement 4
Requirement 5
Requirement 6
Contribution margin P300,000
a. Degree of operating leverage Net operating = P60,000 = 5
= income
b. Expected increase in sales.......................................... 8%
Degree of operating leverage..................................... x 5
Expected increase in net operating income................ 40%
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Cost-Volume-Profit Relationships Chapter 13
Thus, the P84,000 expected net operating income for next year
represents a 40% increase over the P60,000 net operating income earned
during the current year:
P84,000 – P60,000 P24,000
P60,000 = P60,000 = 40% increase
Note from the income statement above that the increase in sales from
20,000 to 21,600 units has resulted in increases in both total sales and
total variable expenses. It is a common error to overlook the increase in
variable expense when preparing a projected income statement.
Requirement 7
a. A 20% increase in sales would result in 24,000 units being sold next
year: 20,000 units x 1.20 = 24,000 units.
Percent of
Total Per Unit Sales
Sales (24,000 units)............... P1,440,000 P60 100%
Less variable expenses........... 1,152,000 48* 80%
Contribution margin.............. 288,000 P12 20%
Less fixed expenses............... 210,000†
Net operating income............ P 78,000
Note that the change in per unit variable expenses results in a change in
both the per unit contribution margin and the CM ratio.
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Chapter 13 Cost-Volume-Profit Relationships
Break-even =
pointthe 17,500 units
Fixedshould
expenses
c. Yes, based on these data changes be made. The changes will
peso sales net =operating
increase theincompany’s CM ratio from the present P60,000
income
to P78,000 per year. Although the changes will also result in a higher
P210,000
break-even point (17,500 units= as compared
0.20 to the present 16,000 units),
the company’s margin of safety will actually be wider than before:
= P1,050,000
Margin of safety in pesos = Total sales – Break-even sales
= P1,440,000 – P1,050,000 = P390,000
Requirement 1
The CM ratio is 30%.
Total Per Unit Percentage
Sales (13,500 units) P270,000 P20 100 %
Less variable expenses 189,000 14 70
Contribution margin P 81,000 P 6 30 %
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Cost-Volume-Profit Relationships Chapter 13
Alternative solution:
Break-even point Fixed expenses
in unit sales = Contribution margin per unit
P90,000
= P6 per unit
= 15,000 units
Break-even point Fixed expenses
in sales pesos = CM ratio
P90,000
= 0.30
= P300,000 in sales
Requirement 2
Since the company presently has a loss of P9,000 per month, if the changes
are adopted, the loss will turn into a profit of P4,000 per month.
Requirement 3
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Chapter 13 Cost-Volume-Profit Relationships
Requirement 4
Alternative solution:
= 17,500 units
Requirement 5
= 16,000 units
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Cost-Volume-Profit Relationships Chapter 13
= P320,000 in sales
b. Comparative income statements follow:
c. Whether or not one would recommend that the company automate its
operations depends on how much risk he or she is willing to take, and
depends heavily on prospects for future sales. The proposed changes
would increase the company’s fixed costs and its break-even point.
However, the changes would also increase the company’s CM ratio
(from 30% to 65%). The higher CM ratio means that once the break-
even point is reached, profits will increase more rapidly than at present.
If 20,000 units are sold next month, for example, the higher CM ratio
will generate P22,000 more in profits than if no changes are made.
The greatest risk of automating is that future sales may drop back down
to present levels (only 13,500 units per month), and as a result, losses
will be even larger than at present due to the company’s greater fixed
costs. (Note the problem states that sales are erratic from month to
month.) In sum, the proposed changes will help the company if sales
continue to trend upward in future months; the changes will hurt the
company if sales drop back down to or near present levels.
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Chapter 13 Cost-Volume-Profit Relationships
If more than 16,857 units are sold, the proposed plan will yield the greatest
profit; if less than 16,857 units are sold, the present plan will yield the
greatest profit (or the least loss).
Requirement 1
Products
Sinks Mirrors Vanities Total
Percentage of total sales 32% 40% 28% 100%
Sales P160,000 100 % P200,000 100 % P140,000 100 % P500,000 100%
Less variable expenses 48,000 30 160,000 80 77,000 55 285,000 57
Contribution margin P112,000 70 % P 40,000 20 % P 63,000 45 % 215,000 43 %*
Less fixed expenses 223,600
Net operating income (loss)
P ( 8,600)
* P215,000 ÷ P500,000 = 43%.
Requirement 2
Break-even sales:
Break-even point Fixed expenses
in total peso sales = CM ratio
P223,600
= 0.43
Requirement 3
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Cost-Volume-Profit Relationships Chapter 13
Although the company met its sales budget of P500,000 for the month, the
mix of products sold changed substantially from that budgeted. This is the
reason the budgeted net operating income was not met, and the reason the
break-even sales were greater than budgeted. The company’s sales mix was
planned at 48% Sinks, 20% Mirrors, and 32% Vanities. The actual sales mix
was 32% Sinks, 40% Mirrors, and 28% Vanities.
As shown by these data, sales shifted away from Sinks, which provides our
greatest contribution per peso of sales, and shifted strongly toward Mirrors,
which provides our least contribution per peso of sales. Consequently,
although the company met its budgeted level of sales, these sales provided
considerably less contribution margin than we had planned, with a resulting
decrease in net operating income. Notice from the attached statements that
the company’s overall CM ratio was only 43%, as compared to a planned
CM ratio of 52%. This also explains why the break-even point was higher
than planned. With less average contribution margin per peso of sales, a
greater level of sales had to be achieved to provide sufficient contribution
margin to cover fixed costs.
Requirement 1
= P3,000,000 in sales
Requirement 3
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Chapter 13 Cost-Volume-Profit Relationships
Requirement 4
Contribution margin P2,160,000
a. Degree of operating leverage Net operating = P360,000 = 6
= income
b. 6 × 15% = 90% increase in net operating income.
Requirement 5
Last Year: Proposed:
28,000 units 42,000 units*
Total Per Unit Total Per Unit
Sales P4,200,000 P150.00 P5,670,000 P135.00**
Less variable expenses
1,680,000 60.00 2,520,000 60.00
Contribution margin 2,520,000 P 90.00 3,150,000 P 75.00
Less fixed expenses 1,800,000 2,500,000
Net operating income P 720,000 P 650,000
* 28,000 units × 1.5 = 42,000 units
** P150 per unit × 0.90 = P135.00 per unit
Requirement 6
Requirement 1
Selling price............................................................................................................
P30
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Cost-Volume-Profit Relationships Chapter 13
Since there are no fixed costs, the number of unit sales needed to yield the
desired P7,200 in profits can be obtained by dividing the target profit by the
unit contribution margin:
Target profit P7,200
= = 800 patches
Unit contribution margin P9 per patch
800 patches x P30 per patch = P24,000 in total sales
Requirement 2
Since an order has been placed, there is now a “fixed” cost associated with
the purchase price of the patches (i.e., the patches can’t be returned). For
example, an order of 200 patches requires a “fixed” cost (investment) of
P3,000 (200 patches × P15 per patch = P3,000). The variable costs drop to
only P6 per patch, and the new contribution margin per patch becomes:
Selling price............................................................................................................
P30
Less variable expenses (commissions only)............................................................ 6
Contribution margin................................................................................................
P24
Since the “fixed” cost of P3,000 must be recovered before Ms. Morales
shows any profit, the break-even computation would be:
Break-even Fixed expenses
point = Unit contribution margin
in unit sales
P3,000
= P24 per patch = 125 patches
If a quantity other than 200 patches were ordered, the answer would change
accordingly.
Problem 6
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Chapter 13 Cost-Volume-Profit Relationships
500,000
TC
400,000
(P)
Break-even
300,000 point
200,000
FC
100,000
13-238
250,000 Cost-Volume-Profit Relationships Chapter 13
P 200,000
R
O
F 150,000
I
T
100,000
Break-even
50,000
point
0
5,000 10,000 15,000 20,000 25,000 30,000
50,000
100,000
L
O
150,000
S
S
200,000
250,000
Requirement (1)
Hun Yun Total
Pesos % P % Euros %
Sales...............................................
P80,000 100 P48,000 100 P128,000 100
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Chapter 13 Cost-Volume-Profit Relationships
Variable expenses..........................
48,000 60 9,600 20 57,600 45
Contribution margin......................
P32,000 40 P38,400 80 70,400 55
Fixed expenses.............................. 66,000
Net operating income.................... P 4,400
Margin of safety
= Actual sales – Break-even sales
in pesos
= P128,000 – P120,000
= P8,000
= 6.25%
Requirement (2)
Margin of safety
= Actual sales – Break-even sales
in pesos
= P160,000 – P134,700
= P25,300
Margin of safety
= 13-240
percentage
= P25,300 P160,000
= 15.81%
Cost-Volume-Profit Relationships Chapter 13
Requirement (3)
The reason for the increase in the break-even point can be traced to the
decrease in the company’s average contribution margin ratio when the third
product is added. Note from the income statements above that this ratio
drops from 55% to 49% with the addition of the third product. This product,
called HY143, has a CM ratio of only 25%, which causes the average
contribution margin ratio to fall.
It should be pointed out to the president that even though the break-even
point is higher with the addition of the third product, the company’s margin
of safety is also greater. Notice that the margin of safety increases from
P8,000 to P25,300 or from 6.25% to 15.81%. Thus, the addition of the new
product shifts the company much further from its break-even point, even
though the break-even point is higher.
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Chapter 13 Cost-Volume-Profit Relationships
Requirement (1)
The total annual fixed cost of the Pediatric Ward can be computed as follows:
Requirement (2)
The “break-even” can be computed for each range of activity by dividing the total fixed cost for that range of activity by the contribution
margin per patient-day, which is P3,000 (=P4,800 revenue − P1,800 variable cost).
(a) (b)
Annual Total Fixed Contribution “Break-Even” Within Relevant
Patient-Days Cost Margin (a) ÷ (b) Range?
10,000-12,000 P40,900,000 P3,000 13,633 No
12,001-13,750 P41,260,000 P3,000 13,753 No
13,751-16,500 P42,960,000 P3,000 14,320 Yes
16,501-18,250 P43,320,000 P3,000 14,440 No
18,251-20,750 P44,660,000 P3,000 14,887 No
20,751-23,000 P45,600,000 P3,000 15,200 No
While a “break-even” can be computed for each range of activity (i.e., relevant range), all but one of these break-evens is bogus. For example,
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Cost-Volume-Profit Relationships Chapter 13
within the range of 10,000 to 12,000 patient-days, the computed break-even is 13,633 (rounded) patient-days. However, this level of activity
is outside this relevant range. To serve 13,633 patient-days, the fixed costs would have to be increased from P40,900,000 to P41,260,000 by
adding one more aide. The only “break-even” that occurs within its own relevant range is 14,320. This is the only legitimate break-even.
Requirement (3)
The level of activity required to earn a profit of P7,200,000 can be computed as follows:
Activity to
(a) (b) Attain Target
Annual Total Fixed Total Fixed Cost + Contribution Profit Within Relevant
Patient-Days Cost Target Profit Target Profit Margin (a) ÷ (b) Range?
10,000-12,000 P40,900,000 P7,200,000 P48,100,000 P3,000 16,033 No
12,001-13,750 P41,260,000 P7,200,000 P48,460,000 P3,000 16,153 No
13,751-16,500 P42,960,000 P7,200,000 P50,160,000 P3,000 16,720 No
16,501-18,250 P43,320,000 P7,200,000 P50,520,000 P3,000 16,840 Yes
18,251-20,750 P44,660,000 P7,200,000 P51,860,000 P3,000 17,287 No
20,751-23,000 P45,600,000 P7,200,000 P52,800,000 P3,000 17,600 No
In this case, the only solution that is within the appropriate relevant range is 16,840 patient-days.
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MANAGEMENT ACCOUNTING - Solutions Manual
CHAPTER 14
I. Questions
1. Cost centers are evaluated by means of performance reports. Profit
centers are evaluated by means of contribution income statements
(including cost center performance reports), in terms of meeting sales
and cost objectives. Investment centers are evaluated by means of the
rate of return which they are able to generate on invested assets.
2. Overall profitability can be improved (1) by increasing sales, (2) by
reducing expenses, or (3) by reducing assets.
3. ROI may lead to dysfunctional decisions in that divisional managers
may reject otherwise profitable investment opportunities simply because
they would reduce the division’s overall ROI figure. The residual
income approach overcomes this problem by establishing a minimum
rate of return which the company wants to earn on its operating assets,
thereby motivating the manager to accept all investment opportunities
promising a return in excess of this minimum figure.
4. A cost center manager has control over cost, but not revenue or
investment funds. A profit center manager, by contrast, has control over
both cost and revenue. An investment center manager has control over
cost and revenue and investment funds.
5. The term transfer price means the price charged for a transfer of goods
or services between units of the same organization, such as two
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18
departments or divisions. Transfer prices are needed for performance
evaluation purposes.
6. The use of market price for transfer purposes will create the actual
conditions under which the transferring and receiving units would be
operating if they were completely separate, autonomous companies. It is
generally felt that the creation of such conditions provides managerial
incentive, and leads to greater overall efficiency in operations.
7. Negotiated transfer prices should be used (1) when the volume involved
is large enough to justify quantity discounts, (2) when selling and/or
administrative expenses are less on intracompany sales, (3) when idle
capacity exists, and (4) when no clear-cut market price exists (such as a
sister division being the only supplier of a good or service).
8. Suboptimization can result if transfer prices are set in a way that benefits
a particular division, but works to the disadvantage of the company as a
whole. An example would be a transfer between divisions when no
transfers should be made (e.g., where a better overall contribution
margin could be generated by selling at an intermediate stage, rather than
transferring to the next division). Suboptimization can also result if
transfer pricing is so inflexible that one division buys from the outside
when there is substantial idle capacity to produce the item internally. If
divisional managers are given full autonomy in setting, accepting, and
rejecting transfer prices, then either of these situations can be created,
through selfishness, desire to “look good”, pettiness, or bickering.
II. Exercises
No. Although Department 3 does not cover all of the cost allocated to it. It
contributes P21,000 to the total operations over and above its direct costs.
Without Department 3, the company would earn P21,000 less as compared
with the original over-all income of P47,000.
Department
1 2 4 Total
Revenue P132,000 P168,000 P98,000 P398,000
Direct cost of department 82,000 108,000 61,000 251,000
Contribution of the
department P 50,000 P 60,000 P37,000 P147,000
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making -
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Allocated cost 121,000
Net income P 26,000
With the discontinuance of Department 3, the revenue and direct cost of the
department are eliminated, but there is no reduction in the total allocated
cost.
Requirement 1
ROI RI
Operating assets P400,000 P400,000
Operating income P100,000 P100,000
ROI (P100,000 P400,000) 25%
Minimum required income
(16% x P400,000) P64,000
RI (P100,000 - P64,000) P36,000
Requirement 2
The manager of the Cling Division would not accept this project under the ROI
approach since the division is already earning 25%. Accepting this project would
reduce the present divisional performance, as shown below:
Present New Overall
Project
Operating assets P400,000 P60,000 P460,000
Operating income P100,000 P12,000* P112,000
ROI 25% 20% 24.35%
* P60,000 x 20% = P12,000
Under the RI approach, on the other hand, the manager would accept this project
since the new project provides a higher return than the minimum required rate of
return (20 percent vs. 16 percent). The new project would increase the overall
divisional residual income, as shown below:
Present New Overall
Project
Operating assets P400,000 P60,000 P460,000
Operating income P100,000 P12,000 P112,000
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Minimum required
return at 16% 64,000 9,600* 73,600
RI P 36,000 P 2,400 P 38,400
* P60,000 x 16% = P9,600
Requirement 1
Requirement 2
Requirement 1
P630,000
Division A : = ROI
P9,000,000 X P9,000,000
P3,000,000
7% X 3 = 21%
P20,000,000
Division B :
P1,800,000 X P10,000,000 = ROI
P20,000,000
9% X 2 = 18%
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making -
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Requirement 2
Division A Division B
Average operating assets (a)......... P3,000,000 P10,000,000
Net operating income................... P 630,000 P 1,800,000
Minimum required return on average
operating assets - 16% x (a)..... 480,000 1,600,000
Residual income........................... P 150,000 P 200,000
Requirement 3
No, Division B is simply larger than Division A and for this reason one
would expect that it would have a greater amount of residual income. As
stated in the text, residual income can’t be used to compare the performance
of divisions of different sizes. Larger divisions will almost always look
better, not necessarily because of better management but because of the
larger peso figures involved. In fact, in the case above, Division B does not
appear to be as well managed as Division A. Note from Part (2) that
Division B has only an 18 percent ROI as compared to 21 percent for
Division A.
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18
a. Sales salaries and commissions
b. General office salaries
Requirement 1
Computation of ROI
Division A:
P300,000 P6,000,000
ROI = x = 5% x 4 = 20%
P6,000,000 P1,500,000
Division B:
P900,000 P10,000,000
ROI = x = 9% x 2 = 18%
P10,000,000 P5,000,000
Division C:
P180,000 P8,000,000
ROI = x = 2.25% x 4 = 9%
P8,000,000 P2,000,000
Requirement 2
Requirement 3
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Requirement 1
Division A Division B Total Company
1 2 3
Sales P3,500,000 P2,400,000 P5,200,000
Less expenses:
Added by the division 2,600,000 1,200,000 3,800,000
Transfer price paid — 700,000 —
Total expenses 2,600,000 1,900,000 3,800,000
Net operating income P 900,000 P 500,000 P1,400,000
1
20,000 units × P175 per unit = P3,500,000.
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18
2
4,000 units × P600 per unit = P2,400,000.
3
Division A outside sales (16,000 units × P175 per unit)......................................................
P2,800,000
Division B outside sales (4,000 units × P600 per unit)........................................................
2,400,000
Total outside sales.................................................................................................................
P5,200,000
Requirement 1
The lowest acceptable transfer price from the perspective of the selling
division is given by the following formula:
Total contribution margin
Variable on lost sales
Transfer price cost per unit
+ Number of units transferred
.
There is no idle capacity, so each of the 20,000 units transferred from
Division X to Division Y reduces sales to outsiders by one unit. The
contribution margin per unit on outside sales is P20 (= P50 – P30).
P20 x 20,000
Transfer price (P30 – P2) +
20,000
Transfer price = P28 + P20 = P48
The buying division, Division Y, can purchase a similar unit from an outside
supplier for P47. Therefore, Division Y would be unwilling to pay more
than P47 per unit.
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The requirements of the two divisions are incompatible and no transfer will
take place.
Requirement 2
In this case, Division X has enough idle capacity to satisfy Division Y’s
demand. Therefore, there are no lost sales and the lowest acceptable price as
far as the selling division is concerned is the variable cost of P20 per unit.
P0
Transfer price P20 + =
20,000
P20
The buying division, Division Y, can purchase a similar unit from an outside
supplier for P34. Therefore, Division Y would be unwilling to pay more
than P34 per unit.
In this case, the requirements of the two divisions are compatible and a
transfer will hopefully take place at a transfer price within the range:
Requirement 1
Requirement 2
The additional savings in Division B means that now Division A should buy
outside.
Requirement 3
Requirement (1)
Net operating income
Margin = Sales
P5,400,000
= P18,000,000 = 30%
Requirement (2)
Sales
Turnover = Average operating assets
P18,000,000
= P36,000,000 = 0.5
Requirement (3)
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ROI = Margin x Turnover
= 30% x 0.5 = 15%
III. Problems
Requirement (a)
Requirement (b)
The complaint of the manager of Product T is justified on the ground that his
product line shows a positive contribution margin and therefore, contributes
to the recovery of non-controllable fixed expenses. This observation is, of
course, made under the assumption that the preceding year’s figures (which
are not given) were less favorable than the current year.
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Requirement 1
Product
A B C
Incremental sales P71,000 P46,000 P117,000
Less: Incremental costs 42,000 15,000 96,000
Net income P29,000 P31,000 P 21,000
Requirement 2
The sunk costs are:
Depreciation of equipment P 6,400
Operating cost of the equipment 4,600
Total P11,000
Requirement 3
Opportunity cost of selling Product B is
From Product A P29,000
From Product C 21,000
Total P50,000
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Utilities P0.80 per hour P 3,600 P 3,360 P240
Supplies 1.80 7,400 7,560 (160)
Indirect labor 1.20 5,300 5,040 260
Total P3.80 P16,300 P15,960 P340
Fixed Overhead Costs:
Utilities P 1,600 P 1,600 -
Supplies 2,200 2,200 -
Depreciation 6,000 6,000 -
Indirect labor 5,400 5,400 -
Insurance 1,200 1,200 -
Total P16,400 P16,400 -
Total Factory Overhead Costs P32,700 P32,360 P340
Requirement 1
The cost of raw materials rose significantly, possibly because of (1) deficient
machinery due to the cutback in maintenance expenditures and/or (2) to the
lower labor cost, possibly due to the use of less-skilled workers. Supplies
decreased, indicating possible inadequacies for next period’s production run.
Requirement 2
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Production division 79,000 80,000 1,000 (F)
Personnel division 72,000 76,000 4,000 (F)
Other costs 68,800 70,000 1,200 (F)
Total P323,800 P328,000 P4,200 (F)
The marketing division is behind its cost allotment. The personnel division
came in somewhat under its budgeted costs. Perhaps there has been a
cutback in hiring, indicating possible reduction in future production.
Requirement 1
Requirement 2
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P800 P800 P800
Note how the change in income follows the change in revenues, as predicted
by operating leverage. Operating leverage multiplied times the percentage
change in sales gives the percentage change in income. Thus, the greater the
operating leverage ratio, the larger the effect on income and ROI of a given
percentage change in sales. This exercise provides an opportunity to review
the relationship between volume and profit. See the illustration below:
% change in income
If volume goes to 2,000 units: (P280 – P160) / P160 = 75%
If volume goes to 1,000 units: (P160 – P40) / P160 = 75%
% change in ROI
If volume goes to 2,000 units: (35% - 20%) / 20% = 75%
If volume goes to 1,000 units: (20% - 5%) / 20% = 75%
Requirement 1
ROI computations:
P1,800,000 P20,000,000
Quezon: x = 9% x 2 = 18%
P20,000,000 P10,000,000
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Requirement 2
Pasig Quezon
Average operating assets (a) P3,000,000 P10,000,000
Net operating income P 630,000 P 1,800,000
Minimum required return on average
operating assets—16% × (a) 480,000 P 1,600,000
Residual income P 150,000 P 200,000
Requirement 3
No, the Quezon Division is simply larger than the Pasig Division and for this
reason one would expect that it would have a greater amount of residual
income. Residual income can’t be used to compare the performance of
divisions of different sizes. Larger divisions will almost always look better,
not necessarily because of better management but because of the larger peso
figures involved. In fact, in the case above, Quezon does not appear to be as
well managed as Pasig. Note from Part (1) that Quezon has only an 18%
ROI as compared to 21% for Pasig.
Requirement 1
Since the Valve Division has idle capacity, it does not have to give up any
outside sales to take on the Pump Division’s business. Applying the formula
for the lowest acceptable transfer price from the viewpoint of the selling
division, we get:
Total contribution margin
Variable on lost sales
Transfer price cost per unit
+ Number of units transferred
P0
Transfer price P16 + 10,000 =
P16
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The Pump Division would be unwilling to pay more than P29, the price it is
currently paying an outside supplier for its valves. Therefore, the transfer
price must fall within the range:
Requirement 2
Since the Valve Division is selling all of the valves that it can produce on the
outside market, it would have to give up some of these outside sales to take
on the Pump Division’s business. Thus, the Valve Division has an
opportunity cost, which is the total contribution margin on lost sales:
Total contribution margin
Variable on lost sales
Transfer price cost per unit
+ Number of units transferred
= P16 + P14 =
P30
Since the Pump Division can purchase valves from an outside supplier at
only P29 per unit, no transfers will be made between the two divisions.
Requirement 3
Applying the formula for the lowest acceptable price from the viewpoint of
the selling division, we get:
Total contribution margin
Variable on lost sales
Transfer price cost per unit
+ Number of units transferred
= P13 + P14 =
P27
In this case, the transfer price must fall within the range:
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P27 Transfer price P29
To produce the 20,000 special valves, the Valve Division will have to give
up sales of 30,000 regular valves to outside customers. Applying the
formula for the lowest acceptable price from the viewpoint of the selling
division, we get:
Total contribution margin
Variable on lost sales
Transfer price cost per unit
+ Number of units transferred
= P20 + P21 =
P41
Problem 9 (Effects of Changes in Sales, Expenses, and Assets in ROI)
P800,000
= P8,000,000 = 10%
2. Sales
Turnover = Average operating assets
P8,000,000
= P3,200,000 = 2.5
3.
ROI = Margin x Turnover
= 10% x 2.5 = 25%
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Requirement (1)
a. The lowest acceptable transfer price from the perspective of the selling
division, the Electrical Division, is given by the following formula:
Because there is enough idle capacity to fill the entire order from the
Motor Division, there are no lost outside sales. And because the variable
cost per unit is P21, the lowest acceptable transfer price as far as the
selling division is concerned is also P21.
c. Combining the requirements of both the selling division and the buying
division, the acceptable range of transfer prices in this situation is:
P21 : Transfer price : P38
Assuming that the managers understand their own businesses and that
they are cooperative, they should be able to agree on a transfer price
within this range and the transfer should take place.
d. From the standpoint of the entire company, the transfer should take
place. The cost of the transformers transferred is only P21 and the
company saves the P38 cost of the transformers purchased from the
outside supplier.
Requirement (2)
a. Each of the 10,000 units transferred to the Motor Division must displace
a sale to an outsider at a price of P40. Therefore, the selling division
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would demand a transfer price of at least P40. This can also be computed
using the formula for the lowest acceptable transfer price as follows:
Transfer price = P21 + (P40 – P21) x 10,000
10,000
c. The requirements of the selling and buying divisions in this instance are
incompatible. The selling division must have a price of at least P40
whereas the buying division will not pay more than P38. An agreement
to transfer the transformers is extremely unlikely.
d. From the standpoint of the entire company, the transfer should not take
place. By transferring a transformer internally, the company gives up
revenue of P40 and saves P38, for a loss of P2.
Requirement (1)
The lowest acceptable transfer price from the perspective of the selling
division is given by the following formula:
Total contribution margin
Variable cost + on lost sales
Transfer price =
per unit Number of units transferred
The Tuner Division has no idle capacity, so transfers from the Tuner
Division to the Assembly Division would cut directly into normal sales of
tuners to outsiders. The costs are the same whether a tuner is transferred
internally or sold to outsiders, so the only relevant cost is the lost revenue of
P200 per tuner that could be sold to outsiders. This is confirmed below:
Therefore, the Tuner Division will refuse to transfer at a price less than P200
per tuner.
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The Assembly Division can buy tuners from an outside supplier for P200,
less a 10% quantity discount of P20, or P180 per tuner. Therefore, the
Division would be unwilling to pay more than P180 per tuner.
Requirement (2)
The price being paid to the outside supplier, net of the quantity discount, is
only P180. If the Tuner Division meets this price, then profits in the Tuner
Division and in the company as a whole will drop by P600,000 per year:
Requirement (3)
The Tuner Division has idle capacity, so transfers from the Tuner Division to
the Assembly Division do not cut into normal sales of tuners to outsiders. In
this case, the minimum price as far as the Assembly Division is concerned is
the variable cost per tuner of P11. This is confirmed in the following
calculation:
Transfer price = P110 + P0 = P110
30,000
The Assembly Division can buy tuners from an outside supplier for P180
each and would be unwilling to pay more than that in an internal transfer. If
the managers understand their own businesses and are cooperative, they
should agree to a transfer and should settle on a transfer price within the
range:
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P110 : Transfer price : P180
Requirement (4)
Yes, P160 is a bona fide outside price. Even though P160 is less than the
Tuner Division’s P170 “full cost” per unit, it is within the range given in
Part 3 and therefore will provide some contribution to the Tuner Division.
If the Tuner Division does not meet the P160 price, it will lose P1,500,000
in potential profits:
This P1,500,000 in potential profits applies to the Tuner Division and to the
company as a whole.
Requirement (5)
No, the Assembly Division should probably be free to go outside and get the
best price it can. Even though this would result in lower profits for the
company as a whole, the buying division should probably not be forced to
purchase inside if better prices are available outside.
Requirement (6)
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So long as the selling division has idle capacity and the transfer price is
greater than the selling division’s variable costs, profits in the company as a
whole will increase if internal transfers are made. However, there is a
question of fairness as to how these profits should be split between the
selling and buying divisions. The inflexibility of management in this
situation damages the profits of the Assembly Division and greatly enhances
the profits of the Tuner Division.
Requirement (1)
Thus, the Electronics Division should not supply the circuit board to the
Clock Division for P90 each. The Electronics Division must give up
revenues of P125.00 on each circuit board that it sells internally. Since
management performance in the Electronics Division is measured by ROI
and dollar profits, selling the circuit boards to the Clock Division for P9
would adversely affect these performance measurements.
Requirement (2)
The key is to realize that the P100 in fixed overhead and administrative costs
contained in the Clock Division’s P697.50 cost per timing device is not
relevant. There is no indication that winning this contract would actually
affect any of the fixed costs. If these costs would be incurred regardless of
whether or not the Clock Division gets the oven timing device contract, they
should be ignored when determining the effects of the contract on the
company’s profits. Another key is that the variable cost of the Electronics
Division is not relevant either. Whether the circuit boards are used in the
timing devices or sold to outsiders, the production costs of the circuit boards
would be the same. The only difference between the two alternatives is the
revenue on outside sales that is given up when the circuit boards are
transferred within the company.
Therefore, the company as a whole would be better off by P67.50 for each
timing device that is sold to the oven manufacturer.
Requirement (3)
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relevant in this decision since they would not be affected. Once this is
realized, it is evident that the Clock Division would be ahead by P67.50 per
timing device if it accepts the P125.00 transfer price.
Selling price of the timing devices.............................................................. P700.00
Less:
Purchased parts (from outside vendors)...................................................
P300.00
Circuit board KK8 (assumed transfer price)............................................
125.00
Other variable costs.................................................................................
207.50 632.50
Clock Division contribution margin............................................................ P 67.50
In fact, since the contribution margin is P62.50, any transfer price within the
range of P125.00 to P192.50 (= P125.00 + P67.50) will improve the profits
of both divisions. So yes, the managers should be able to agree on a transfer
price.
Requirement (4)
It is in the best interests of the company and of the divisions to come to an
agreement concerning the transfer price. As demonstrated in part (3) above,
any transfer price within the range P125.00 to P192.50 would improve the
profits of both divisions. What happens if the two managers do not come to
an agreement?
In this case, top management knows that there should be a transfer and could
step in and force a transfer at some price within the acceptable range.
However, such an action, if done on a frequent basis, would undermine the
autonomy of the managers and turn decentralization into a sham.
Our advice to top management would be to ask the two managers to meet to
discuss the transfer pricing decision. Top management should not dictate a
course of action or what is to happen in the meeting, but should carefully
observe what happens in the meeting. If there is no agreement, it is important
to know why. There are at least three possible reasons. First, the managers
may have better information than the top managers and refuse to transfer for
very good reasons. Second, the managers may be uncooperative and
unwilling to deal with each other even if it results in lower profits for the
company and for themselves. Third, the managers may not be able to
correctly analyze the situation and may not understand what is actually in
their own best interests. For example, the manager of the Clock Division
may believe that the fixed overhead and administrative cost of P100 per
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timing device really does have to be covered in order to avoid a loss.
If the refusal to come to an agreement is the result of uncooperative attitudes
or an inability to correctly analyze the situation, top management can take
some positive steps that are completely consistent with decentralization. If
the problem is uncooperative attitudes, there are many training companies
that would be happy to put on a short course in team building for the
company. If the problem is that the managers are unable to correctly analyze
the alternatives, they can be sent to executive training courses that emphasize
economics and managerial accounting.
CHAPTER 15
I. Questions
1. No. Planning and control are different, although related, concepts.
Planning involves developing objectives and formulating steps to
achieve those objectives. Control, by contrast, involves the means by
which management ensures that the objectives set down at the planning
stage are attained.
2. Budgets have a dual purpose, for planning and for following up the
implementation of the plan. The great benefits from budgeting lie in the
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quick investigation of deviations and in the subsequent corrective action.
Budgets should not be prepared in the first place if they are ignored,
buried in files, or improperly interpreted.
3. Two major features of a budgetary program are (1) the accounting
techniques which developed it and (2) the human factors which
administer it. The human factors are far more important. The success of
a budgetary system depends upon its acceptance by the company
members who are affected by the budget. Without a thoroughly
educated and cooperative management group at all levels of
responsibility, budgets are a drain on the funds of the business and are a
hindrance instead of help to efficient operations.
4. Manufacturing overhead costs are budgeted at normal operating capacity,
and the costs are applied to the products using a predetermined rate. The
predetermined rate is computed by dividing a factor that can be
identified with both the products and the overhead into the overhead
budgeted at the normal operating capacity. Budgets may also be used in
costing products in a standard cost accounting system.
5. The production division operates to produce the products that are sold.
Production and sales must be coordinated. Products must be
manufactured so that they will be available to meet sales delivery dates.
Activity of the production division will depend upon the sales that can
be made. Also, the sales division is limited by the capabilities of the
production department in manufacturing products. Successful operations
depend upon a coordination of sales and production.
6. Labor hour required for production can be translated into labor pesos by
multiplying the number of hours budgeted by the appropriate labor rates.
The rates to be used will depend upon the rates established for job
classifications and the policy with respect to premium pay for overtime
or shift differences.
7. A long-range plan for the acquisition of plant assets is broken down and
entered in the current budget as the plan unfolds. The portion of the plan
which is to be executed in the next year is included in the budget for that
year.
8. A budget period is not limited to any particular unit of time. At a
minimum, a budget should cover at least one operating cycle. For
example, a budget should not cover a period when purchasing activity is
high and omit the period when sales volume and cash collection are
relatively high. The budget period should encompass the entire cycle
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extending from the purchasing operation to the subsequent sale of the
products and the realization of the sales in cash. Ordinarily, a budget of
operations is prepared for a year which in turn is divided into quarters
and months. Long-term budgets, such as budgets for projects or capital
investments, may extend five to ten years or more into the future.
9. A rolling budget or a progressive budget or sometimes called continuous
budget, is a budget which is prepared throughout the year. As one
month elapses, a budget is prepared for one more month in the future.
At any one time for example, the company will have a budget for one
year into the future, when July of one year is over, a budget for the
following July will be added at the other end of the budget. This process
of adding a new month as a month expires is continuous.
10. Variances that are revealed by a comparison of actual results with a
budget are investigated if it appears that an investigation is warranted.
The investigation may show that stricter control measures are needed or
that some weaknesses in the operation should be corrected. It may also
reveal that the budget plan should be revised. The comparison is one
step in the control and direction of business operations.
11. A comparison of actual results with a budget can contribute information
that can be applied in the preparation of better budgets in the future.
Subsequent investigation of variances provides management with a
better knowledge of operations. This knowledge can be applied in the
preparation of more realistic budgets for subsequent fiscal periods.
12. A self-imposed budget is one in which persons with responsibility over
cost control prepare their own budgets, i.e., the budget is not imposed
from above. The major advantages are: (1) the views and judgments of
persons from all levels of an organization are represented in the final
budget document; (2) budget estimates generally are more accurate and
reliable, since they are prepared by those who are closest to the
problems; (3) managers generally are more motivated to meet budgets
which they have participated in setting; (4) self-imposed budgets reduce
the amount of upward “blaming” resulting from inability to meet budget
goals. One caution must be exercised in the use of self-imposed
budgets. The budgets prepared by lower-level managers should be
carefully reviewed to prevent too much slack.
13. No, although this is clearly one of the purposes of the cash budget. The
principal purpose is to provide information on probable cash needs
during the budget period, so that bank loans and other sources of
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financing can be anticipated and arranged well in advance of the actual
time of need.
14. Zero-based budgeting requires that managers start at zero levels every
year and justify all costs as if all programs were being proposed for the
first time. In traditional budgeting, by contrast, budget data are usually
generated on an incremental basis, with last year’s budget being the
starting point.
15. A budget is a detailed quantitative plan for the acquisition and use of
financial and other resources over a given time period. Budgetary control
involves the use of budgets to control the actual activities of a firm.
16. 1. Budgets communicate management’s plans throughout the
organization.
2. Budgets force managers to think about and plan for the future.
3. The budgeting process provides a means of allocating resources to
those parts of the organization where they can be used most
effectively.
4. The budgeting process can uncover potential bottlenecks before they
occur.
5. Budgets coordinate the activities of the entire organization by
integrating the plans of its various parts. Budgeting helps to ensure
that everyone in the organization is pulling in the same direction.
6. Budgets define goals and objectives that can serve as benchmarks for
evaluating subsequent performance.
17. A master budget represents a summary of all of management’s plans and
goals for the future, and outlines the way in which these plans are to be
accomplished. The master budget is composed of a number of smaller,
specific budgets encompassing sales, production, raw materials, direct
labor, manufacturing overhead, selling and administrative expenses, and
inventories. The master budget generally also contains a budgeted
income statement, budgeted balance sheet, and cash budget.
18. The flow of budgeting information moves in two directions—upward
and downward. The initial flow should be from the bottom of the
organization upward. Each person having responsibility over revenues or
costs should prepare the budget data against which his or her subsequent
performance will be measured. As the budget data are communicated
upward, higher-level managers should review the budgets for
consistency with the overall goals of the organization and the plans of
other units in the organization. Any issues should be resolved in
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discussions between the individuals who prepared the budgets and their
managers.
1. C 6. A
2. H 7. B
3. E 8. J
4. F 9. D
5. I 10. G
III. Exercises
Requirement 1
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Total cash collections P541,000 P654,000 P790,000 P1,985,000
Notice that even though sales peak in August, cash collections peak in
September. This occurs because the bulk of the company’s customers pay in
the month following sale. The lag in collections that this creates is even
more pronounced in some companies. Indeed, it is not unusual for a
company to have the least cash available in the months when sales are
greatest.
Requirement 2
Septembe
July August r Quarter
Budgeted sales in units 30,000 45,000 60,000 135,000
Add desired ending inventory*
4,500 6,000 5,000 5,000
Total needs 34,500 51,000 65,000 140,000
Less beginning inventory 3,000 4,500 6,000 3,000
Required production 31,500 46,500 59,000 137,000
* 10% of the following month’s sales
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Year 2
First Second Third Fourth Year
Production needs—chips 180,000 270,000 450,000 300,000 1,200,000
Add desired ending inventory—
chips 54,000 90,000 60,000 48,000 48,000
Total needs—chips 234,000 360,000 510,000 348,000 1,248,000
Less beginning inventory—chips
36,000 54,000 90,000 60,000 36,000
Required purchases—chips 198,000 306,000 420,000 288,000 1,212,000
Cost of purchases at P2 per chip
P396,000 P612,000 P840,000 P576,000 P2,424,000
Requirement 1
Requirement 2
Assuming that the direct labor workforce is not adjusted each quarter and
that overtime wages are paid, the direct labor budget would be:
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Wages for regular hours
(@ P11.00 per hour) P19,800 P19,800 P19,800 P19,800 P79,200
Overtime wages
(@ P11.00 per hour × 1.5)
3,300 - - 2,640 5,940
Total direct labor cost P23,100 P19,800 P19,800 P22,440 P85,140
Requirement 1
Kiko Corporation
Manufacturing Overhead Budget
Requirement 2
Helene Company
Selling and Administrative Expense Budget
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administrative expenses:
Advertising 12,000 12,000 12,000 12,000 48,000
Executive salaries 40,000 40,000 40,000 40,000 160,000
Insurance 6,000 6,000 12,000
Property taxes 6,000 6,000
Depreciation 16,000 16,000 16,000 16,000 64,000
Total fixed selling and
administrative expenses 68,000 74,000 74,000 74,000 290,000
Total selling and administrative
expenses 101,000 112,500 104,250 101,500 419,250
Less depreciation 16,000 16,000 16,000 16,000 64,000
Cash disbursements for selling
and administrative expenses
P 85,000 P 96,500 P 88,250 P 85,500 P355,250
Financing:
Borrowings 8 20 * — — 28
Repayments (including
interest) 0 0 (25) (7)* (32)
Total financing 8 20 (25) (7) (4)
Cash balance, ending P 5 P 5 P 5 P 6 P 6
*Given.
IV. Problems
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Problem 1 (Schedule of Expected Cash Collections and Disbursements)
Requirement 1
Requirement 2
Payments to suppliers:
August purchases (accounts payable)..................................................................
P16,000
September purchases: P25,000 × 20%................................................................
5,000
Total cash payments................................................................................................
P21,000
Requirement 3
COOKIE PRODUCTS
Cash Budget
For the Month of September
Requirement 1
Production budget:
Septembe
July August r October
Budgeted sales (units) 40,000 50,000 70,000 35,000
Add desired ending inventory 20,000 26,000 15,500 11,000
Total needs 60,000 76,000 85,500 46,000
Less beginning inventory 17,000 20,000 26,000 15,500
Required production 43,000 56,000 59,500 30,500
Requirement 2
Requirement 3
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* 30,500 units (October production) × 3 lbs. per unit= 91,500 lbs.; 91,500 lbs. ×
0.5 = 45,750 lbs.
Requirement 1
Cash sales—June....................................................................................................
P 60,000
Collections on accounts receivable:
May 31 balance...................................................................................................
72,000
June (50% × 190,000).........................................................................................
95,000
Total cash receipts...................................................................................................
P227,000
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Borrowings—note...............................................................................................
18,000
Repayments—note..............................................................................................
(15,000)
Interest................................................................................................................
(500)
Total financing........................................................................................................
2,500
Cash balance, ending..............................................................................................
P 7,500
Requirement 2
Sales........................................................................................................................
P250,000
Cost of goods sold:
P 30,000
Beginning inventory............................................................................................
Add purchases.....................................................................................................
200,000
Goods available for sale......................................................................................
230,000
Ending inventory.................................................................................................
40,000
Cost of goods sold...............................................................................................
190,000
Gross margin...........................................................................................................
60,000
Operating expenses (P51,000 + P2,000)................................................................. 53,000
Net operating income..............................................................................................
7,000
Interest expense.......................................................................................................
500
Net income..............................................................................................................
P 6,500
Requirement 3
Assets
Cash........................................................................................................................
P 7,500
Accounts receivable (50% × 190,000).................................................................... 95,000
Inventory.................................................................................................................
40,000
Buildings and equipment, net of depreciation
(P500,000 + P9,000 – P2,000)............................................................................
507,000
Total assets..............................................................................................................
P649,500
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Share capital............................................................................................................
420,000
Retained earnings (P85,000 + P6,500)....................................................................
91,500
Total liabilities and equity......................................................................................
P649,500
Requirement 1
Units Amount
First quarter 16,000 P 480,000
Second quarter 20,000 600,000
Third quarter 22,000 660,000
Fourth quarter 22,000 660,000
Total 80,000 P2,400,000
Requirement 2
Quarter
1st 2nd 3rd 4th Total
Units to be sold 16,000 20,000 22,000 22,000 80,000
Add: Desired ending inventory (20%) 4,000 4,400 4,400 5,000 5,000
Total units required 20,000 24,400 26,400 27,000 85,000
Less: Beginning inventory 3,000 4,000 4,400 4,400 3,000
Units to be produced 17,000 20,400 22,000 22,600 82,000
Requirement 3
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Quarter
1st 2nd 3rd 4th Total
Units required for production 51,000 61,200 66,000 67,800 246,000
Add: Desired ending inventory 12,240 13,200 13,560 15,000 15,000
Total units 63,240 74,400 79,560 82,800 261,000
Less: Beginning inventory 12,500 12,240 13,200 13,560 12,500
Raw Materials to be Purchased 50,740 62,160 66,360 69,240 248,500
Requirement 1
Month
April May June Quarter
From accounts receivable P141,000 P 7,200 P148,200
From April sales:
20% × 200,000 40,000 40,000
75% × 200,000 150,000 150,000
4% × 200,000 P 8,000 8,000
Requirement 2
Cash budget:
Month
April May June Quarter
Cash balance, beginning P 26,000 P 27,000 P 20,200 P 26,000
Add receipts:
Collections from
customers 181,000 217,200 283,000 681,200
Total available 207,000 244,200 303,200 707,200
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Less disbursements:
Merchandise purchases
108,000 120,000 180,000 408,000
Payroll 9,000 9,000 8,000 26,000
Lease payments 15,000 15,000 15,000 45,000
Advertising 70,000 80,000 60,000 210,000
Equipment purchases 8,000 — — 8,000
Total disbursements 210,000 224,000 263,000 697,000
Excess (deficiency) of
receipts over
disbursements (3,000) 20,200 40,200 10,200
Financing:
Borrowings 30,000 — — 30,000
Repayments — — (30,000) (30,000)
Interest — — (1,200) (1,200)
Total financing 30,000 — (31,200) (1,200)
Cash balance, ending P 27,000 P 20,200 P 9,000 P 9,000
Requirement 3
Capacity
100% 90% 80% 70% 60%
Machine Hours 200,000 180,000 160,000 140,000 120,000
Variable Overhead P1,300,000 P1,170,000 P1,040,000 P 910,000 P 780,000
Fixed Overhead 300,000 300,000 300,000 300,000 300,000
Total P1,600,000 P1,470,000 P1,340,000 P1,210,000 P1,080,000
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Manufacturing Overhead rate per machine hour P8.00
Capacity
100% 90% 80% 70% 60%
Direct Labor Hours 200,000 180,000 160,000 140,000 120,000
Machine Hours 400,000 360,000 320,000 280,000 240,000
Variable Overhead P1,400,000 P1,260,000 P1,120,000 P 980,000 P 840,000
Fixed Overhead 500,000 500,000 500,000 500,000 500,000
Total P1,900,000 P1,760,000 P1,620,000 P1,480,000 P1,340,000
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* P10,000 × 1% × 3 = P300
P4,000 × 1% × 2 = 80
P380
1. B 11. C 21. C
2. B 12. B 22. C
3. C 13. C 23. D
4. E 14. B 24. C
5. C 15. D 25. C
6. C 16. C 26. C
7. D 17. A 27. D
8. C 18. B 28. A
9. A 19. E 29. C
10. D 20. B 30. D
Supporting computations:
Questions 16 to 20:
January February
Cost of sales P1,400,000 P1,640,000
Add: Desired Minimum Inventory 492,000 456,000
Total 1,892,000 2,096,000
Less: Beginning Inventory (1,400,000 x 0.3)(17) 420,000 492,000
Gross Purchases (16) 1,472,000 1,604,000
Less: Cash discount 14,720 16,040
Net cost of purchases P1,457,280 P1,587,960
Payments of Purchases
60% - month of purchase P874,368 P 952,776
40% - following month 582,912
Total (18) P1,535,688
(19)
February
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Cash
Gross Discount Net
Current month’s sales (with
discount) 35% P595,000 P11,900 P583,100
Current month’s sales (without
discount) 15% 255,000 0 255,000
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(23)Cash Receipts for February 2005
From February sales (60% x 110,000) P 66,000
From January sales 38,000
Total P104,000
Questions 26 to 29:
Schedule I
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Total available 741,000
Less: Raw materials inventory, Dec. 31 300,000
Raw materials used P 441,000
Direct labor 588,000
Manufacturing overhead 441,000 (28)
Total Manufacturing Cost P1,470,000 (27)
Add: Work-in-process inventory, Jan. 1 200,000
Total P1,670,000
Less: Work-in-process inventory, Dec. 31 320,000
Cost of goods manufactured P1,350,000
CHAPTER 16
I. Questions
1. Standard costs are superior to past data for comparison with actual costs
because they ask the question “Is present performance better than the
past?”.
2. No. Cost control and cost reduction are not the same, but cost reduction
does affect the standards which are used as basis for cost control. Cost
reduction means finding ways to achieve a given result through
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improved design, better methods, new layouts and so forth. Cost
reduction results in setting new standards. On the other hand, cost
control is a process of maintaining performance at or as new existing
standards as is possible.
3. Managerial judgment is the basis for deciding whether a given variance
is large enough to warrant investigation. For some items, a small
amount of variance may spark scrutiny. For some items, 5%, 10% or
25% variances from standard may call for follow-up. Management may
also derive the standard deviation based on past cost data.
4. The techniques for overhead control differ because
1) The size of individual overhead costs usually does not justify
elaborate individual control systems;
2) The behavior of individual overhead item is either impossible or
difficult to trace to specific lots or operations; and
3) Various overhead items are the responsibility of different people.
5. In the year-to-year planning of fixed costs, managers must consider:
1) the projected maximum and minimum levels of activity,
2) prices of cost factors, and
3) changes in facilities and organization.
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8. A budget is usually expressed in terms of total pesos, whereas a standard
is expressed on a per unit basis. A standard might be viewed as the
budgeted cost for one unit.
9. Under management by exception, managers focus their attention on
operating results that deviate from expectations. It is assumed that
results that meet expectations do not require investigation.
10. Separating an overall variance into a price variance and a quantity
variance provides more information. Moreover, prices and quantities are
usually the responsibilities of different managers.
11. The materials price variance is usually the responsibility of the
purchasing manager. The materials quantity variance is usually the
responsibility of the production managers and supervisors. The labor
efficiency variance generally is also the responsibility of the production
managers and supervisors.
12. If used as punitive tools, standards can breed resentment in an
organization and undermine morale. Standards must never be used as an
excuse to conduct witch-hunts, or as a means of finding someone to
blame for problems.
13. Several factors other than the contractual rate paid to workers can cause
a labor rate variance. For example, skilled workers with high hourly
rates of pay can be given duties that require little skill and that call for
low hourly rates of pay, resulting in an unfavorable rate variance. Or
unskilled or untrained workers can be assigned to tasks that should be
filled by more skilled workers with higher rates of pay, resulting in a
favorable rate variance. Unfavorable rate variances can also arise from
overtime work at premium rates.
14. Poor quality materials can unfavorably affect the labor efficiency
variance. If the materials create production problems, a result could be
excessive labor time and therefore an unfavorable labor efficiency
variance. Poor quality materials would not ordinarily affect the labor
rate variance.
15. If labor is a fixed cost and standards are tight, then the only way to
generate favorable labor efficiency variances is for every workstation to
produce at capacity. However, the output of the entire system is limited
by the capacity of the bottleneck. If workstations before the bottleneck
in the production process produce at capacity, the bottleneck will be
unable to process all of the work in process. In general, if every
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workstation is attempting to produce at capacity, then work in process
inventory will build up in front of the workstations with the least
capacity.
16. A quantity standard indicates how much of an input should be used to
make a unit of output. A price standard indicates how much the input
should cost.
17. Chronic inability to meet a standard is likely to be demoralizing and may
result in decreased productivity.
18. A variance is the difference between what was planned or expected and
what was actually accomplished. A standard cost system has at least two
types of variances. A price variance focuses on the difference between
the standard price and the actual price of an input. A quantity variance is
concerned with the difference between the standard quantity of the input
allowed for the actual output and the actual amount of the input used.
1. E 3. C 5. A 7. J 9. I
2. G 4. H 6. D 8. B 10. F
III. Exercises
Requirement 1
Requirement 2
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Beta ML12 required per capsule as per bill of materials......................................... 6.00 grams
Add allowance for material rejected as unsuitable
(6 grams ÷ 0.96 = 6.25 grams;
6.25 grams – 6.00 grams = 0.25 grams)..............................................................
0.25 grams
Total........................................................................................................................
6.25 grams
Add allowance for rejected capsules
(6.25 grams ÷ 25 capsules)..................................................................................
0.25 grams
Standard quantity of Beta ML12 per salable capsule.............................................. 6.50 grams
Requirement 3
Requirement 1
Actual Quantity of Inputs, at Actual Quantity of Inputs, at Standard Quantity Allowed for
Actual Price Standard Price Output, at Standard Price
(AQ × AP) (AQ × SP) (SQ × SP)
P18,700 11,000 board feet × 10,000 board feet ×
P1.80 per board foot P1.80 per board foot
= P19,800 = P18,000
Price Variance, Quantity Variance,
P1,100 F P1,800 U
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Alternatively:
Materials Price Variance = AQ (AP – SP)
11,000 board feet (P1.70 per board foot* – P1.80 per board foot) =
P1,100 F
* P18,700 ÷ 11,000 board feet = P1.70 per board foot.
Requirement 1
Requirement 2
Actual Hours of Input, at Actual Hour of Input, at Standard Hours Allowed for
the Actual Rate Standard Rate Output, at the Standard Rate
(AH × AR) (AH × SR) (SH × SR)
P49,300 8,500 hours × P6 per hour 8,000 hours* × P6 per hour
= P51,000 = P48,000
Rate Variance, Efficiency Variance,
P1,700 F P3,000 U
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*20,000 units × 0.4 hour per unit = 8,000 hours
Alternative Solution:
Requirement 3
Actual Hours of Input, at Actual Hour of Input, at Standard Hours Allowed for
the Actual Rate Standard Rate Output, at the Standard Rate
(AH × AR) (AH × SR) (SH × SR)
P39,100 8,500 hours × P4 per hour 8,000 hours × P4 per hour
= P34,000 = P32,000
Spending Variance, Efficiency Variance,
P5,100 U P2,000 U
Alternative Solution:
Requirement 1
If the total variance is P330 unfavorable, and if the rate variance is P150
favorable, then the efficiency variance must be P480 unfavorable, since the
rate and efficiency variances taken together always equal the total variance.
Requirement 2
Knowing that 500 hours of labor time were used during the week, the actual
rate of pay per hour can be computed as follows:
Rate Variance = AH (AR – SR)
500 hours (AR – P6 per hour) = P150 F
500 hours × AR – P3,000 = –P150*
500 hours × AR = P2,850
AR = P5.70 per hour
* When used with the formula, unfavorable variances are positive and
favorable variances are negative.
2. Standard Hours
Actual Hours of Actual Hours of Input, at the Allowed for Output, at the
Input, at the Actual Rate Standard Rate Standard Rate
(AH×AR) (AH×SR) (SH×SR)
1,150 hours × 1,150 hours × 1,200 hours ×
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P10.00 per hour P9.50 per hour P9.50 per hour
= P11,500 = P10,925 = P11,400
Rate Variance, Efficiency Variance,
P575 U P475 F
2. Standard Hours
Actual Hours of Actual Hours of Input, at the Allowed for Output, at the
Input, at the Actual Rate Standard Rate Standard Rate
(AH×AR) (AH×SR) (SH×SR)
5,800 hours × 5,800 hours × 5,600 hours ×
P2.75 per hour* P2.80 per hour P2.80 per hour
= P15,950 = P16,240 = P15,680
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Variable overhead spending Variable overhead
variance, P290 F efficiency variance, P560 U
IV. Problems
Requirement 1
a.
Actual Quantity of Inputs, at Actual Quantity of Inputs, at Standard Quantity Allowed for
the Actual Price Standard Price Output, at the Standard Price
(AQ × AP) (AQ × SP) (SQ × SP)
25,000 pounds x 25,000 pounds x 20,000 pounds* x
P2.95 per pound P2.50 per pound P2.50 per pound
= P73,750 = P62,500 = P50,000
Price Variance,
P11,250 U
19,800 pounds x P2.50 per pound
= P49,500
Quantity Variance,
P500 F
* 5,000 metal molds × 4.0 pounds per metal mold = 20,000 pounds
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Alternatively:
Materials Price Variance = AQ (AP – SP)
25,000 pounds (P2.95 per pound – P2.50 per pound) = P11,250 U
Materials Quantity Variance = SP (AQ – SQ)
P2.50 per pound (19,800 pounds – 20,000 pounds) = P500 F
b.
Actual Hours of Input, at Actual Hours of Input, at Standard Hours Allowed for
the Actual Rate the Standard Rate Output, at the Standard Rate
(AH × AR) (AH × SR) (SH × SR)
3,600 hours x 3,600 hours x 3,000 hours* x
P8.70 per hour P9.00 per hour P9.00 per hour
= P31,320 = P32,400 = P27,000
Rate Variance, Efficiency Variance,
P1,080 F P5,400 U
c.
Actual Hours of Input, at Actual Hours of Input, at Standard Hours Allowed for
the Actual Rate the Standard Rate Output, at the Standard Rate
(AH × AR) (AH × SR) (SH × SR)
P4,320 1,800 hours × P2 per hour 1,500 hours* × P2 per hour
= P3,600 = P3,000
Spending Variance, Efficiency Variance,
P720 U P600 U
*5,000 metal molds × 0.3 hours per metal mold = 1,500 hours
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Alternatively:
Variable Overhead Spending Variance = AH (AR – SR)
1,800 hours (P2.40 per hour* – P2.00 per hour) = P720 U
* P4,320 ÷ 1,800 hours = P2.40 per hour
Variable Overhead Efficiency Variance = SR (AH – SH)
P2.00 per hour (1,800 hours – 1,500 hours) = P600 U
Requirement 2
Summary of variances:
The net unfavorable variance of P16,390 for the month caused the plant’s
variable cost of goods sold to increase from the budgeted level of P80,000 to
P96,390:
This P16,390 net unfavorable variance also accounts for the difference
between the budgeted net operating income and the actual net loss for the
month.
Requirement 3
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The two most significant variances are the materials price variance and the
labor efficiency variance. Possible causes of the variances include:
Problem 2
Problem 3
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Requirement 1
a.
Actual Quantity of Inputs, at Actual Quantity of Inputs, at Standard Quantity Allowed for
Actual Price Standard Price Output, at Standard Price
(AQ × AP) (AQ × SP) (SQ × SP)
21,120 yards x 21,120 yards x 19,200 yards* x
P3.35 per yard P3.60 per yard P3.60 per yard
= P70,752 = P76,032 = P69,120
Price Variance, Quantity Variance,
P5,280 F P6,912 U
Alternatively:
Materials Price Variance = AQ (AP – SP)
21,120 yards (P3.35 per yard – P3.60 per yard) = P5,280 F
Materials Quantity Variance = SP (AQ – SQ)
P3.60 per yard (21,120 yards – 19,200 yards) = P6,912 U
Requirement 2
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a.
Actual Hours of Input, at Actual Hours of Input, at Standard Hours Allowed for
the Actual Rate the Standard Rate Output, at the Standard Rate
(AH × AR) (AH × SR) (SH × SR)
6,720 hours* x 6,720 hours x 7,680 hours** x
P4.85 per hour P4.50 per hour P4.50 per hour
= P32,592 = P30,240 = P34,560
Rate Variance, Efficiency Variance,
P2,352 U P4,320 F
Alternatively:
Labor Rate Variance = AH (AR – SR)
6,720 hours (P4.85 per hour – P4.50 per hour) = P2,352 U
Labor Efficiency Variance = SR (AH – SH)
P4.50 per hour (6,720 hours – 7,680 hours) = P4,320 F
Requirement 3
Actual Hours of Input, at Actual Hours of Input, at Standard Hours Allowed for
the Actual Rate the Standard Rate Output, at the Standard Rate
(AH × AR) (AH × SR) (SH × SR)
6,720 hours x 6,720 hours x 7,680 hours x
P2.15 per hour P1.80 per hour P1.80 per hour
P14,448 = P12,096 = P13,824
Spending Variance, Efficiency Variance,
P2,352 U P1,728 F
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Alternatively:
Variable Overhead Spending Variance = AH (AR – SR)
6,720 hours (P2.15 per hour – P1.80 per hour) = P2,352 U
Variable Overhead Efficiency Variance = SR (AH – SH)
P1.80 per hour (6,720 hours – 7,680 hours) = P1,728 F
Requirement 4
Materials:
Price variance P5,280 F
Quantity variance 6,912 U P1,632 U
Labor:
Rate variance 2,352 U
Efficiency variance 4,320 F 1,968 F
Variable overhead:
Spending variance 2,352 U
Efficiency variance 1,728 F 624 U
Net unfavorable variance P 288 U
Requirement 5
The variances have many possible causes. Some of the more likely causes
include:
Materials variances:
Favorable price variance: Fortunate buy, inaccurate standards, inferior
quality materials, unusual discount due to quantity purchased, drop in market
price.
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Labor variances:
Unfavorable rate variance: Use of highly skilled workers, change in wage
rates, inaccurate standards, overtime.
CHAPTER 17
I. Questions
1. a. Decision tree analysis provides a systematic framework for
analyzing a sequence of interrelated decisions which may be made
over time. Decision making is formulated in terms of the
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consequence of acts, events and consequences because it is believed
that present decisions affect future profitability. The study and
understanding of alternative scenarios is encouraged with the use of
decision tree analysis.
b. Advantages of Decision Tree Analysis
1. Clarifies the choices, risks, and monetary gains involved in an
investment problem.
2. Presents the relevant information more clearly.
3. Combines action choices with different possible events or results
of action which are partially affected by chance or other
uncontrollable circumstances.
4. Encourages the focus on the relationship between current and
future decisions.
5. Utilizes such analytical techniques as present value and
discounted cash flow.
6. Considers various alternatives with greater ease.
Weaknesses of Decision Tree Analysis
1. Not all events that can happen can be/are identified.
2. Not all the decisions that must be made on a subject under
analysis are listed because choices are usually not restricted to
two or three.
3. If a large number of choices is involved, decision tree analysis
by hand becomes complicated.
4. Uncertain alternatives are generally treated as if they were
discrete, well-defined possibilities.
2. Refer to page 665 of the textbook.
II. Multiple Choice Questions
CHAPTER 18
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APPLICATION OF QUANTITATIVE TECHNIQUES IN
PLANNING, CONTROL AND DECISION MAKING - II
I. Questions
1. PERT is superior to Gantt Charts in complex projects because:
a. PERT charts are flexible and can reflect slippage or changes in
plans, but Gantt charts simply plot a bar chart against a calendar
scale.
b. PERT charts reflect interdependencies among activities; Gantt charts
do not.
c. PERT charts reflect uncertainties or tolerances in the time estimates
for various activities; Gantt charts do not.
2. The use of PERT provides a structured foundation for planning complex
projects in sufficient detail to facilitate effective control.
A workable sequence of events that comprise the project are first
identified. Each key event should represent a task; then the
interdependent relationships between the events are structured.
After the network of events is constructed, cost and time parameters are
established for each package. Staffing plans are reviewed and analyzed.
The “critical path” computation identifies sequence of key events with
total time equal to the time allotted for the project’s completion. Jobs
which are not on the critical path can be slowed down and the slack
resources available on these activities reallocated to activities on the
critical path.
Use of PERT permits sufficient scheduling of effort by functional areas
and by geographic location. It also allows for restructuring scheduling
efforts and redeployment of workers as necessary to compensate for
delays or bottlenecks. The probability of completing this complex
project on time and within the allotted budget is increased.
3. Time slippage in noncritical activities may not warrant extensive
managerial analysis because of available slack, but activity cost usually
increases with time and should be monitored.
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4. The critical path is the network path with the longest cumulative
expected activity time. It is critical because a slowdown along this path
delays the entire project.
5. Crashing the network means finding the minimum cost for completing
the project in minimum time in order to achieve an optimum tradeoff
between cost and time. The differential crash cost of an activity is the
additional cost of that activity for each period of time saved.
6. Slack is the amount of time an event can be delayed without affecting
the project’s completion date. Slack can be utilized by management as a
buffer against bottlenecks that may occur on the critical path.
7. Unit gross margin are typically computed with an allocation of fixed
costs. Total fixed costs generally will not change with a change in
volume within the relevant range. Unitizing the fixed costs results in
treating them as though they are variable costs when, in fact, they are
not. Moreover, when multiple products are manufactured, the relative
contribution becomes the criterion for selecting the optimal product mix.
Fixed costs allocations can distort the relative contributions and result in
a suboptimal decision.
8. This approach will maximize profits only if there are no constraints on
production or sales, or if both products use all scarce resources at an
equal rate. Otherwise management would want to maximize the
contribution per unit of scarce resource.
9. The opportunity cost of a constraint is the cost of not having additional
availability of the constrained resources. This is also called a shadow
price.
10. The feasible production region is the area which contains all possible
combinations of production outputs. It is bounded by the constraints
imposed on production possibilities. The production schedule which
management chooses must come from the feasible production region.
11. The accountant usually supplies the contribution margin data that is used
in formulating a profit-maximizing objective function. In addition, the
accountant participates in the analysis of linear programming outputs by
assessing the costs of additional capacity or of changes in product mix.
12. a. Hourly fee for inventory audit (C)
b. Salary of purchasing supervisor (N)
c. Costs to audit purchase orders and invoices (P)
d. Taxes on inventory (C)
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e. Stockout costs (P)
f. Storage costs charged per unit in inventory (C)
g. Fire insurance on inventory (C)
h. Fire insurance on warehouse (N)
i. Obsolescence costs on inventory (C)
j. Shipping costs per shipment (P)
13. Although the inventory models are developed by operations researchers,
statisticians and computer specialists, their areas of expertise do not
extend to the evaluation of the differential costs for the inventory
models. Generally, discussions of inventory models take the costs as
given. It is the role of the accountant to determine which costs are
appropriate for inclusion in an inventory model.
14. Cost of capital represents the interest expense on funds if they were
borrowed or opportunity cost if funds were provided internally or by
owners. It is included as carrying cost of inventory because funds are
tied up in inventory.
15. Costs that vary with the average number of units in inventory:
Inventory insurance P 2.80
Inventory tax 2.05 (P102.25 x 2%)
Total P 4.85
Costs that vary with the number of units purchased:
Purchase price P102.25
Insurance on shipment 1.50
Total P103.75
Total carrying cost = (25% x P103.75) cost of capital + P4.85 = P25.94
+ P4.85 = P30.79
Order costs:
Shipping permit P201.65
Costs to arrange for the shipment 21.45
Unloading 80.20
Stockout costs 122.00
Total P425.30
II. Problems
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18
Problem 2
Requirement (a)
The critical path through each of the three alternative paths calculated as the
longest is 0 - 1 - 6- 7- 8.
0-1-2-5-8 2 + 8 + 10 + 14 = 34
0-1-3-4-7-8 2+8+7+5+3 = 25
0-1-6-7-8 2 + 26 + 9 + 3 = 40*
________
* critical
Requirement (b)
40 - 3 - 5 = 32
Requirement (c)
Requirement (d)
The earliest time for reaching event 5 via 0 - 1 - 2 - 5 is 20, the sum of the
expected times.
Problem 3
No, they didn’t make a right decision, since they included fixed costs which
do not differ in the short run. If they had used contribution margin instead of
gross margin, they would have had P5 for G1 and P6.50 for G2, therefore
they would have decided to produce G2 exclusively.
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Problem 1
Requirement (a)
TASK 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28
S
___________
X Dead Time
Requirement (b)
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Problem 4
a. Carrying costs:
QS 250 x P109.40
2 = 2 = P13,675.00
Order costs:
AP 1,500 x P878
Q = 250 = P 5,268.00
Total P18,943.00
2 x 1,500 x P878
Q* = = 24,077 = 155 units
P109.40
Carrying costs:
QS 155 x P109.40
2 = 2 = P 8,478.50
Order costs:
AP 1,500 x P878
Q = 155 = P 8,496.77
Total P16,975.27
Problem 5
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Additional computations:
a
15 is the number of orders per year.
b
It should be evident that at this level the carrying costs alone exceed the total
costs at a safety stock of 175 units. Therefore, it is not possible for this or any
safety-stock level larger than 250 to be less costly than 175 units. Indeed, given
a total cost at 175 units of P5,507.5, stockout costs would have to occur with
probability zero for any safety stock greater than 225.72 units (i.e., P5,507.5 /
P24.40 = P225.72).
CHAPTER 19
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I. Questions
1. Quantitative factors are those which may more easily be reduced in
terms of pesos such as projected costs of materials, labor and overhead.
Qualitative factors are those whose measurement in pesos is difficult and
imprecise; yet a qualitative factor may be easily given more weight than
the measurable cost savings. It can be seen that the accountant’s role in
making decisions deals with the quantitative factors.
2. Relevant costs are expected future costs that will differ between
alternatives. In view of the definition of relevant costs, historical costs
are always irrelevant because they are not future costs. They may be
helpful in predicting relevant costs but they are always irrelevant costs
per se.
3. The differential costs in any given situation is commonly defined as the
change in total cost under each alternative. It is not relevant cost, but it
is the algebraic difference between the relevant costs for the alternatives
under consideration.
4. Analysis:
The original cost of the old truck is irrelevant but its disposal value is
relevant. It is recommended that the truck should be rebuilt because it
will involve lesser cash outlay.
5. No. Variable costs are relevant costs only if they differ in total between
the alternatives under consideration.
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8. Allocations of common fixed costs can make a product line (or other
segment) appear to be unprofitable, whereas in fact it may be profitable.
10. The price elasticity of demand measures the degree to which a change in
price affects unit sales. The unit sales of a product with inelastic demand
are relatively insensitive to the price charged for the product. In contrast,
the unit sales of a product with elastic demand are sensitive to the price
charged for the product.
12. The markup over variable cost depends on the price elasticity of demand.
A product whose demand is elastic should have a lower markup over
cost than a product whose demand is inelastic. If demand for a product is
inelastic, the price can be increased without cutting as drastically into
unit sales.
II. Exercises
Case 1 Case 2
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Not Not
Item Relevant Relevant Relevant Relevant
a. Sales revenue...................................
X X
b. Direct materials...............................
X X
c. Direct labor......................................
X X
d. Variable manufacturing
overhead..........................................
X X
e. Book value – Model E7000
machine...........................................
X X
f. Disposal value – Model E7000
machine...........................................
X X
g. Depreciation – Model E7000
machine...........................................
X X
h. Market value – Model F5000
machine (cost).................................
X X
i. Fixed manufacturing
overhead..........................................
X X
j. Variable selling expense.................
X X
k. Fixed selling expense......................
X X
l. General administrative
overhead..........................................
X X
Requirement 1
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* Depreciation...........................................................................................................
P2,000
Insurance................................................................................................................
960
Garage rent.............................................................................................................
480
Automobile tax and license....................................................................................
60
Total.......................................................................................................................
P3,500
Requirement 2
Requirement 3
When figuring the incremental cost of the more expensive car, the relevant
costs would be the purchase price of the new car (net of the resale value of
the old car) and the increases in the fixed costs of insurance and automobile
tax and license. The original purchase price of the old car is a sunk cost and
is therefore irrelevant. The variable operating costs would be the same and
therefore are irrelevant. (Students are inclined to think that variable costs are
always relevant and fixed costs are always irrelevant in decisions. This
requirement helps to dispel that notion.)
Requirement 1
Per Unit
Differential
Costs 15,000 units
Make Buy Make Buy
Cost of purchasing P200 P3,000,000
Direct materials P 60 P 900,000
Direct labor 80 1,200,000
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Requirement 2
Make Buy
Cost of purchasing (part 1)...................................................................................................
P3,000,000
Cost of making (part 1)........................................................................................................
P2,550,000
Opportunity cost—segment margin forgone on a
potential new product line...............................................................................................
650,000
Total cost..............................................................................................................................
P3,200,000 P3,000,000
Difference in favor of purchasing from the outside
supplier..............................................................................................................................
P200,000
Thus, the company should accept the offer and purchase the parts from the outside
supplier.
Only the incremental costs and benefits are relevant. In particular, only the
variable manufacturing overhead and the cost of the special tool are relevant
overhead costs in this situation. The other manufacturing overhead costs are
fixed and are not affected by the decision.
Per Total
Unit 10 bracelets
Incremental revenue P3,499.50 P34,995.00
Incremental costs:
Variable costs:
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Requirement 1
X Y Z
(1) Contribution margin per unit.................................................................................................
P18 P36 P20
(2) Direct labor cost per unit.......................................................................................................
P12 P32 P16
(3) Direct labor rate per hour......................................................................................................
8 8 8
(4) Direct labor-hours required per unit (2) ÷ (3).......................................................................
1.5 4.0 2.0
Contribution margin per direct labor-hour (1) ÷ (4).............................................................
P12 P 9 P10
Requirement 2
X Y Z
Contribution margin per direct labor-hour
P12 P9 P10
Direct labor-hours available × 3,000 × 3,000 × 3,000
Total contribution margin P36,000 P27,000 P30,000
Although product X has the lowest contribution margin per unit and the
second lowest contribution margin ratio, it has the highest contribution
margin per direct labor-hour. Since labor time seems to be the company’s
constraint, this measure should guide management in its production
decisions.
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Requirement 3
The amount Jaycee Company should be willing to pay in overtime wages for
additional direct labor time depends on how the time would be used. If there
are unfilled orders for all of the products, Jaycee would presumably use the
additional time to make more of product X. Each hour of direct labor time
generates P12 of contribution margin over and above the usual direct labor
cost. Therefore, Jaycee should be willing to pay up to P20 per hour (the P8
usual wage plus the contribution margin per hour of P12) for additional labor
time, but would of course prefer to pay far less. The upper limit of P20 per
direct labor hour signals to managers how valuable additional labor hours are
to the company.
If all the demand for product X has been satisfied, Jaycee Company would
then use any additional direct labor-hours to manufacture product Z. In that
case, the company should be willing to pay up to P18 per hour (the P8 usual
wage plus the P10 contribution margin per hour for product Z) to
manufacture more product Z.
Likewise, if all the demand for both products X and Z has been satisfied,
additional labor hours would be used to make product Y. In that case, the
company should be willing to pay up to P17 per hour to manufacture more
product Y.
Requirement 1
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* The junk food consumed during the trip may not be completely relevant.
Even if Shin were not going on the trip, he would still have to eat. The
amount by which the cost of the junk food exceeds the cost of the food he
would otherwise consume would be the relevant amount.
The other costs are sunk at the point at which the decision is made to go on
another fishing trip.
Requirement 2
If he fishes for the same amount of time as he did on his last trip, all of his
costs are likely to be about the same as they were on his last trip. Therefore,
it really doesn’t cost him anything to catch the last fish. The costs are really
incurred in order to be able to catch fish and would be the same whether one,
two, three, or a dozen fish were actually caught. Fishing, not catching fish,
costs money. All of the costs are basically fixed with respect to how many
fish are actually caught during any one fishing trip, except possibly the cost
of snagged lures.
Requirement 3
In a decision of whether to give up fishing altogether, nearly all of the costs
listed by Shin’s wife are relevant. If he did not fish, he would not need to
pay for boat moorage, new fishing gear, a fishing license, fuel and upkeep,
junk food, or snagged lures. In addition, he would be able to sell his boat,
the proceeds of which would be considered relevant in this decision. The
original cost of the boat, which is a sunk cost, would not be relevant.
These three requirements illustrate the slippery nature of costs. A cost that is
relevant in one situation can be irrelevant in the next. None of the costs are
relevant when we compute the cost of catching a particular fish; some of
them are relevant when we compute the cost of a fishing trip; and nearly all
of them are relevant when we consider the cost of not giving up fishing.
What is even more confusing is that CG is correct; the average cost of a
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salmon is P167, even though the cost of actually catching any one fish is
essentially zero. It may not make sense from an economic standpoint to have
salmon fishing as a hobby, but as long as Shin is out in the boat fishing, he
might as well catch as many fish as he can.
Requirement 1
No, the housekeeping program should not be discontinued. It is actually
generating a positive program segment margin and is, of course, providing a
valuable service to seniors. Computations to support this conclusion follow:
Depreciation on the van is a sunk cost and the van has no salvage value since
it would be donated to another organization. The general administrative
overhead is allocated and none of it would be avoided if the program were
dropped; thus it is not relevant to the decision.
The same result can be obtained with the alternative analysis below:
Difference:
Net
Total If Operating
House- Income
Current keeping Is Increase or
Total Dropped (Decrease)
Revenues......................................................................
P900,000 P660,000 P(240,000)
Variable expenses........................................................
490,000 330,000 160,000
Contribution margin....................................................
410,000 330,000 (80,000)
Fixed expenses:
Depreciation*..........................................................
68,000 68,000 0
Liability insurance..................................................
42,000 27,000 15,000
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Requirement 2
Requirement 1
Total for
Per 2,000
Unit Units
P12.0 P24,00
Incremental revenue........................................................................
0 0
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Incremental costs:
Variable costs:
Direct materials.......................................................................
2.50 5,000
Direct labor..............................................................................
3.00 6,000
Variable manufacturing overhead............................................ 0.50 1,000
3,00
Variable selling and administrative......................................... 1.50 0
Total variable cost.......................................................................
P 7.50 15,000
Fixed costs:
None affected by the special order........................................... 0
Total incremental cost..................................................................... 15,000
P
Incremental net operating income................................................... 9,000
Requirement 2
The relevant cost is P1.50 (the variable selling and administrative costs). All
other variable costs are sunk, since the units have already been produced.
The fixed costs would not be relevant, since they would not be affected by
the sale of leftover units.
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Requirement (1)
Cecile makes more money selling the ice cream cones at the lower price, as
shown below:
Sales...............................................................P15,394.00 P18,626.00
Cost of goods sold @ P4.10........................... 3,526.00 5,494.00
Contribution margin....................................... 11,868.00 13,132.00
Fixed expenses............................................... 425.00 425.00
Net operating income.....................................P11,443.00 P12,707.00
Requirement (2)
d =
In(1 + % change in quantity sold)
In(1 + % change in price)
1,340 – 860
In(1 + 860 )
=
13.90 – 17.90
In(1 + 17.90 )
In(1 + 0.55814)
=
In(1 – 0.22346)18-326
In(1.55814)
=
In(0.77654)
0.44349
= = –1.75
–0.25291
Management Accounting: An Overview Chapter 1
Requirement (3)
Profit-maximizing –1
=
markup on variable cost 1 + d
–1
= = 1.333
1 + (–1.75)
This price is much lower than the prices Cecile has been charging in the past.
Rather than immediately dropping the price to P9.60, it would be prudent to
drop the price a bit and see what happens to unit sales and to profits. The
formula assumes that the price elasticity is constant, which may not be the
case.
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The selling price of the new amaretto cappuccino product should at least
cover its variable cost and its opportunity cost. The variable cost of the new
product is P4.60 and its opportunity cost can be computed by multiplying
the opportunity cost of P34 per minute of order filling time by the amount of
time required to fill an order for the new product:
Selling price of
P4.60 + P34 per minute + 0.75 minute
the new product
Selling price of
P4.60 + P25.50 = P30.10
the new product
Hence, the selling price of the new product should at least cover both its variable
cost of P4.60 and its opportunity cost of P25.50, for a total of P30.10.
III. Problems
Product A Product B
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Requirement 1
Requirement 2
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Trampoline
Total Round Rectangular Octagonal
Sales...................................... P1,000,000 P140,000 P500,000 P360,000
Less variable expenses......... 410,000 60,000 200,000 150,000
Contribution margin............. 590,000 80,000 300,000 210,000
Less fixed expenses:
Advertising – traceable..... 216,000 41,000 110,000 65,000
Depreciation of special
equipment...................... 95,000 20,000 40,000 35,000
Line supervisors’
salaries........................... 19,000 6,000 7,000 6,000
Total traceable fixed
expenses............................ 330,000 67,000 157,000 106,000
Product-line segment
margin............................... 260,000 P 13,000 P143,000 P104,000
Less common fixed
expenses............................ 200,000
Net operating income
(loss).................................. P 60,000
Requirement 1
Product Line
A B C D
Selling price per unit P30 P25 P10 P8
Variable cost per unit 25 10 5 4
Contribution margin / unit P5 P15 P 5 P4
Divided by no. of hours required
for each unit 5 hrs. 10 hrs. 4 hrs. 1 hr.
Contribution per hour P1 P1.5 P1.25 P4
Product ranking:
1. D 2. B 3. C 4. A
Requirement 2
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Requirement 1
The company should accept the special order of 4,000 @ P10 each because
this selling price is still higher than the additional variable cost to be
incurred. Whether or not variable marketing expenses will be incurred, the
decision is still to accept the order.
Supporting computations:
(a) Assume no additional variable marketing cost will be incurred.
Selling price per unit P10.00
Less variable manufacturing costs:
Direct materials P5.00
Direct labor 3.00
Variable overhead 0.75 8.75
Contribution margin/unit P 1.25
Multiplied by number of units of order 4,000 units
Total increase in profit P5,000
(b) Assume additional variable marketing cost will be incurred.
Selling price per unit P10.00
Less variable costs (P8.75 + P0.25) 9.00
Contribution margin / unit P 1.00
Multiplied by number of units of order 4,000 units
Total increase in contribution margin P4,000
Requirement 2
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Requirement 3
Direct materials P5.00
Direct labor 3.00
Variable factory overhead 0.75
Total cost of inventory under direct costing P8.75
Requirement 4
Requirement (a)
Requirement (b)
Production
4,000 units 5,000 units 6,000 units
Sales (4,000 x P40) P160,000 P160,000 P160,000
Less variable costs
Production cost @ P25 100,000 125,000 150,000
Purchase cost @ P45 - - -
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Requirement (c)
Problem 6 (Pricing)
Requirement A:
Operating
Result at Full
2005 2006 Capacity
Sales P 100,000 P 400,000 P 480,000
Less Variable cost 130,000 520,000 624,000
Contribution margin (P 30,000) (P120,000) (P144,000)
Less Fixed cost 40,000 40,000 40,000
Net income (loss) (P 70,000) (P160,000) (P184,000)
The company had been operating at a loss because the product had been
selling with a negative contribution margin. Hence, the more units are sold,
the higher the loss will be.
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Requirement B: P60.14
Requirement C: P74.29
Requirement D: P56.58
Requirement 1
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Requirement 2
The Ortigas Store should not be closed. If the store is closed, overall
company net operating income will decrease by P9,800 per quarter.
Requirement 3
The Ortigas Store should be closed if P200,000 of its sales are picked up by
the Makati Store. The net effect of the closure will be an increase in overall
company net operating income by P76,200 per quarter:
Gross margin lost if the Ortigas Store is closed.......................................................................
P(228,000)
Gross margin gained at the Makati Store:
P200,000 × 43%...................................................................................................................
86,000
Net loss in gross margin...........................................................................................................
(142,000)
Costs that can be avoided if the Ortigas Store is closed (part 1)............................................. 218,200
Net advantage of closing the Ortigas Store..............................................................................
P 76,200
Requirement 1
Product KK-8 yields a contribution margin of P14 per gallon (P35 – P21 =
P14). If the plant closes, this contribution margin will be lost on the 22,000
gallons (11,000 gallons per month × 2 = 22,000 gallons) that could have
been sold during the two-month period. However, the company will be able
to avoid certain fixed costs as a result of closing down. The analysis is:
Contribution margin lost by closing the plant for two
months (P14 per gallon × 22,000 gallons).................................................P(308,000)
Costs avoided by closing the plant for two months:
Fixed manufacturing overhead cost
(P60,000 × 2 months = P120,000)..........................................................
P120,000
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Alternative Solution:
Difference—
Net
Operating
Income
Plant Kept Increase
Open Plant Closed (Decrease)
Sales (11,000 gallons × P35 per gallon × 2)........................... P 770,000 P 0 P(770,000)
Less variable expenses (11,000
gallons × P21 per gallon × 2).............................................. 462,000 0 462,000
Contribution margin................................................................
308,000 0 (308,000)
Less fixed costs:
Fixed manufacturing overhead cost
(P230,000 × 2;
P170,000 × 2)................................................................ 460,000 340,000 120,000
Fixed selling cost (P310,000 × 2; P310,000 ×
90% × 2).........................................................................
620,000 558,000 62,000
Total fixed cost........................................................................
1,080,000 898,000 182,000
Net operating loss before start-up costs.................................. (772,000) (898,000) (126,000)
Start-up costs...........................................................................
(14,000) (14,000)
Net operating loss....................................................................
P (772,000) P(912,000) P(140,000)
Requirement 2
Ignoring the additional factors cited in part (1) above, Kristin Company
should be indifferent between closing down or continuing to operate if the
level of sales drops to 12,000 gallons (6,000 gallons per month) over the
two-month period. The computations are:
Cost avoided by closing the plant for two months (see above).............................
P182,000
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= 12,000 gallons
Verification: Operate at
12,000 Close for
Gallons for Two
Two Months Months
Sales (12,000 gallons × P35 per gallon)............................................... P 420,000 P 0
Less variable expenses (12,000 gallons × P21 per gallon).................. 252,000 0
Contribution margin.............................................................................. 168,000 0
Less fixed expenses:
Manufacturing overhead (P230,000 and P170,000 × 2
months).........................................................................................
460,000 340,000
Selling (P310,000 and P279,000 × 2 months)................................. 620,000 558,000
Total fixed expenses.............................................................................
1,080,000 898,000
Start-up costs.........................................................................................
0 14,000
Total costs.............................................................................................
1,080,000 912,000
Net operating loss.................................................................................
P (912,000) P(912,000)
Requirement (1)
Requirement (2)
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d =
In(1 + % change in quantity sold)
In(1 + % change in price)
40,000 – 50,000
In(1 + )
50,000
=
600.00 – 500.00
In(1 + )
500.00
In(1 – 0.2000)
=
In(1 + 0.2000)
In(0.8000)
=
In(1.2000)
–0.2231
=
0.1823
= –1.2239
Requirement (3)
Profit-maximizing –1
=
markup on variable cost 1 + d
–1
= = 4.4663
1 + (–1.2239)
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The profit at each price in the above demand schedule can be computed as
follows:
Price Quantity Sales Cost of Sales Contribution
(a) Sold (b) (a) × (b) P60 × (b) Margin
P600 40,000 P24,000,000 P2,400,000 P21,600,000
P500 50,000 P250,00,000 P3,000,000 P22,000,000
P417 62,500 P26,062,500 P3,750,000 P22,312,500
P348 78,125 P27,187,500 P4,687,500 P22,500,000
P290 97,656 P28,320,200 P5,859,400 P22,460,800
P242 122,070 P29,540,900 P7,324,200 P22,216,700
P202 152,588 P30,822,800 P9,155,300 P21,667,500
P168 190,735 P32,043,500 P11,444,100 P20,599,400
P140 238,419 P33,378,700 P14,305,100 P19,073,600
P117 298,024 P34,868,800 P17,881,400 P16,987,400
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23,000,000
22,000,000
Contribution Margin
21,000,000
20,000,000
19,000,000
18,000,000
17,000,000
100.00 200.00 300.00 400.00 500.00 600.00
Selling Price
Requirement (4)
If the postal service wants to maximize the contribution margin and profit
from sales of souvenir sheets, the new price should be:
Profit-maximizing price = 5.4663 × P70 = P383
Note that a P100 increase in cost has led to a P55 (P383 – P328) increase in
the profit-maximizing price. This is because the profit-maximizing price is
computed by multiplying the variable cost by 5.4663. Since the variable cost
has increased by P100, the profit-maximizing price has increased by P100 ×
5.4663, or P55.
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Some people may object to such a large increase in price as “unfair” and
some may even suggest that only the P10 increase in cost should be passed
on to the consumer. The enduring popularity of full-cost pricing may be
explained to some degree by the notion that prices should be “fair” rather
than calculated to maximize profits.
Requirement (1)
This problem can be solved by first computing the profitability index of each
customer and then ranking the customers based on that profitability index:
Ji Eun’s
Incremental Time Profitability
Profit Required Index
Customer (A) (B) (A) ÷ (B)
Lalaine...........................
P1,400 4 P350
Emily.............................
1,240 4 P310
Anna..............................
1,600 5 P320
Catherine.......................
960 3 P320
Gee Ann.........................
1,900 5 P380
Lily 2,880 8 P360
Lourdes.........................
930 3 P310
Ma. Cecilia.....................
1,360 4 P340
Sheila Raya....................
2,340 6 P390
Jane..............................
2,040 6 P340
Cumulative
Ji Eun’s Amount of Ji
Profitability Time Eun’s Time
Customer Index Required Required
Sheila Raya...... P390 6 6
Gee Ann........... P380 5 11
Lily P360 8 19
Lalaine............. P350 4 23
Jane P340 6 29
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Requirement (2)
The total profit on wedding cakes for the weekend after canceling the four
reservations would be:
Notes:
● Both Ji Eun’s time and the cakes would have to be very carefully
scheduled to make sure that all cakes are completed on time. We have
assumed that the 33 hours of Ji Eun’s time that are available for cake
decorating do not include hours that have been set aside as a buffer to
provide protection from inevitable disruptions in the schedule.
● If the cumulative amount of Ji Eun’s time required did not exactly
consume the total amount of time available, some adjustment might be
required in which reservations are cancelled to ensure that the most
profitable plan is selected.
Requirement (3)
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accepted for any particular weekend after 33 hours of Ji Eun’s time have
been committed for that weekend’s cakes. To ensure that only the most
profitable cake reservations are accepted, a reservation for any cake with a
profitability index of less than P340 should probably not be accepted. This
was the cutoff point for the cakes in the first weekend in June. This cutoff
may need to be adjusted upward or downward over time—the cakes that
were reserved for the first weekend in June may not be representative of the
cakes that would be reserved for other weekends. If too many reservations
are turned down and Ji Eun’s time is not fully utilized, then the cutoff should
be adjusted downward. If too few reservations are turned down and Ji Eun’s
time is once again overbooked or profitable cake orders are turned away,
then the cutoff should be adjusted upward.
Requirement (4)
Ms. Hye Young should consider changing the way prices are set so that they
include a charge for Ji Eun’s time. On average, the prices may be the same,
but they should be based not only on the size of the cakes, but also on the
amount of cake decorating that the customer desires. The charge for Ji Eun’s
time should be her hourly rate of pay (including any fringe benefits) plus the
opportunity cost of at least P340 per hour. Because Ji Eun will not be
working more than 33 hours per week, if another cake reservation is
accepted, some other cake reservation will have to be cancelled. Ms. Hye
Young would have to give up at least P34 profit per hour to accept another
cake reservation.
Requirement (5)
Making Ji Eun happy involves not asking her to work more than 33 hours
per week decorating cakes. Making customers happy involves not canceling
their reservations, not raising prices, and providing top quality wedding
cakes. Ms. Hye Young can accomplish both of these objectives and increase
her profits by clever management of the constraint—Ji Eun’s time. The
possibilities include:
Ms. Hye Young should make sure that none of Ji Eun’s time is wasted
on unnecessary tasks. For example, Ji Eun should not be asked to cream
butter by hand for frostings if a machine could do the job as well with
less labor time.
Ms. Hye Young should make sure that none of Ji Eun’s time is wasted
on tasks that can be done by other persons. For example, an assistant can
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21. R S T
Sales (P16 x 15,000) P240,000 P240,000 P240,000
Less: Variable costs
R (P12 x 15,000) 180,000
S (P 8 x 15,000) 120,000
T (P 4 x 15,000) 60,000
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CHAPTER 20
I. Questions
1. A capital investment involves a current commitment of funds with the
expectation of generating a satisfactory return on these funds over a
relatively extended period of time in the future.
2. Cost of capital is the weighted minimum desired average rate that a
company must pay for long-term capital while discounted rate of return
is the maximum rate of interest that could be paid for the capital
employed over the life of an investment without loss on the project.
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1. A 6. H
2. C 7. D
3. F 8. G
4. B 9. J
5. I 10. E
III. Exercises
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3. The factor for 10% for 20 years is 8.514. Thus, the present value of
Tom’s winnings would be:
P50,000 × 8.514 = P425,700.
Whether or not Tom really won a million pesos depends on your point of
view. She will receive a million pesos over the next 20 years; however,
in terms of its value right now she won much less than a million pesos as
shown by the present value computation above.
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Amount of
12% Present Value
Year(s) Cash Flows
Factor of Cash Flows
Purchase of the stock....................
Now P(18,000)
1.000 P(18,000)
Annual dividends*........................1-4 P720
3.037 2,187
Sale of the stock............................
4 P22,500
0.636 14,310
Net present value.......................... P( 1,503)
*900 shares × P0.80 per share per year = P720 per year.
No, Ms. Cruz did not earn a 12% return on the share. The negative net
present value indicates that the rate of return on the investment is less than
the discount rate of 12%.
2. 16%
Amount of Facto Present Value
Item Year(s) Cash Flows r of Cash Flows
Initial investment..........................
Now P(136,700) 1.000 P(136,700)
Net annual cash inflows................
1-14 P25,000 5.468 136,700
Net present value.......................... P 0
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The reason for the zero net present value is that 16% (the discount rate)
represents the machine’s internal rate of return. The internal rate of return is
the rate that causes the present value of a project’s cash inflows to just equal
the present value of the investment required.
Yes, this is an acceptable investment. Its net present value is positive, which
indicates that its rate of return exceeds the minimum 15% rate of return
required by the company.
IV. Problems
Requirement 1
Total Present Value
A. New Situation:
Recurring cash operating costs (P26,500 x 2.69) P 71,285
Cost of new equipment 44,000
Disposal value of old equipment now (5,000)
Present value of net cash outflows P110,285
B. Present Situation:
Recurring cash operating costs (P45,000 x 2.69) P121,050
Disposal value of old equipment four years
hence (1,342)
(P2,600 x 0.516)
Present value of net cash inflows P119,708
Difference in favor of replacement P 9,423
Requirement 2
P44,000 – P5,000
Payback period for the new equipment =
P18,500
= 2.1 years
Requirement 3
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Another alternative way to get the same answer would be to divide the net
present value of P9,423 by 2.690.
Problem 2
After Tax
Cash Inflows PV Factor PV
Year 1 P42,000 x 0.909 P 38,178
Year 2 40,000 x 0.826 33,040
Year 3 38,400 x 0.750 28,800
Year 3 Salvage 20,000 x 0.750 15,000
Year 3 Tax loss 15,600* x 0.750 11,700
P126,718
Investment (I) 100,000
Net present value (NPV) P 26,718
_________________
* The P15,600 tax benefit of the loss on the disposal of the computer at the end
of year 3 is computed as follows:
Estimated salvage value P 20,000
Estimated book value:
Historical cost P100,000
Accumulated depreciation 48,800 51,200
Estimated loss P(31,200)
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Since the net present value is positive, the computer should be purchased
replacing the manual bookkeeping system.
Problem 3
Requirement 1
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- The cost of the market research study (P44,000) is a sunk cost because it
was incurred last year and will not change regardless of whether the
investment is made or not.
- The loss on the disposal of the existing equipment does not result in an
actual cash cost as shown by the sales manager. The loss on disposal
results in a reduction of taxes, which reduces the cost of the new
equipment.
Annual cash flows:
- The sales manager considered only the depreciation on the new equipment
rather than just the additional depreciation which would result from the
acquisition of the new equipment.
- The sales manager also failed to consider that the depreciation is a
noncash expenditure which provides a tax shield.
- The sales manager’s use of the discount rate (i.e., cost of capital) was
incorrect. The discount rate should be used to reduce the value of future
cash flows to their current equivalent at time period zero.
Requirement 2
Problem 4
Requirement 1: P(507,000)
Requirement 2: P(466,200)
Requirement 3: P(23,400)
Problem 5
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No, the etching machine should not be purchased. It has a negative net
present value at an 18% discount rate.
3. The intangible benefits would have to be worth at least P42,813 per year
as shown below:
Required increase in net present value P192,400
= = P42,813
Factor for 10 years 4.494
Thus, the new etching machine should be purchased if management
believes that the intangible benefits are worth at least P42,813 per year
to the company.
Problem 6
(1) × (2) Present
(2) After-Tax Value of
(1) Tax Cash 12% Cash
Items and Computations Year(s) Amount Effect Flows Factor Flows
Investment in new trucks..........................................
Now P(450,000) P(450,000) 1.000 P(450,000)
Salvage from sale of the old trucks..........................
Now P30,000 1 – 0.30 P21,000 1.000 21,000
Net annual cash receipts..........................................
1-8 P108,000 1 – 0.30 P75,600 4.968 375,581
Depreciation deductions*..........................................
1-8 P56,250 0.30 P16,875 4.968 83,835
Overhaul of motors...................................................
5 P(45,000) 1 – 0.30 P(31,500) 0.567 (17,861)
Salvage from the new trucks....................................
8 P20,000 1 – 0.30 P14,000 0.404 5,656
Net present value..................................................... P 18,211
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Since the project has a positive net present value, the contract should be
accepted.
Problem 7
2.
Factor of the internal Required investment
rate of return = Annual cash inflow
We know that the investment is P142,950, and we can determine the factor
for an internal rate of return of 14% by looking at the PV table along the 7-
period line. This factor is 4.288. Using these figures in the formula, we get:
P142,950
Annual cash inflow = 4.288
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The 10% return in part (a) is less than the 14% minimum return that Dr.
Blue wants to earn on the project. Of equal or even greater importance,
the following diagram should be pointed out to Dr. Blue:
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5. Since the cash flows are not even over the five-year period (there is an extra
P61,375 cash inflow from sale of the equipment at the end of the fifth year),
some other method must be used to compute the internal rate of return.
Using trial-and-error or more sophisticated methods, it turns out that the
actual internal rate of return will be 12%:
Amount of Present
Cash 12% Value of
Item Year(s) Flows Factor Cash Flows
Investment in the equipment............................
Now P(142,950) 1.000 P(142,950)
Annual cash inflow...........................................
1-5 P30,000 3.605 108,150
Sale of the equipment.......................................
5 P61,375 0.567 34,800
Net present value.............................................. P 0
Problem 8
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2. The initial investment in the simple rate of return calculations is net of the
salvage value of the old equipment as shown below:
Yes, the games would be purchased. The payback period is less than the 3
years.
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CHAPTER 21
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planning tool in the long run, when fixed costs will be changing, and as
a tool for evaluating long-run segment performance. One concept is no
more useful to management than the other; the two concepts simply
relate to different planning horizons.
5. A segment is any part or activity of an organization about which a
manager seeks cost, revenue, or profit data. Examples of segments
include departments, operations, sales territories, divisions, product
lines, and so forth.
6. Under the contribution approach, costs are assigned to a segment if and
only if the costs are traceable to the segment (i.e., could be avoided if
the segment were eliminated). Common costs are not allocated to
segments under the contribution approach.
7. A traceable cost of a segment is a cost that arises specifically because of
the existence of that segment. If the segment were eliminated, the cost
would disappear. A common cost, by contrast, is a cost that supports
more than one segment, but is not traceable in whole or in part to any
one of the segments. If the departments of a company are treated as
segments, then examples of the traceable costs of a department would
include the salary of the department’s supervisor, depreciation of
machines used exclusively by the department, and the costs of supplies
used by the department. Examples of common costs would include the
salary of the general counsel of the entire company, the lease cost of the
headquarters building, corporate image advertising, and periodic
depreciation of machines shared by several departments.
II. Problems
Requirement 1
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be fixed.
Requirement 2
b. The segment margin ratio rises and falls as sales rise and fall due to the
presence of fixed costs. The fixed expenses are spread over a larger base
as sales increase.
Requirement 1
Geographic Market
Total Company East Central West
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Requirement 2
Total CD DVD
Sales*............................................................................
P750,000 P300,000 P450,000
Variable expenses**......................................................
435,000 120,000 315,000
Contribution margin......................................................
315,000 180,000 135,000
Traceable fixed expenses............................................... 183,000 138,000 45,000
Product line segment margin......................................... 132,000 P 42,000 P 90,000
Common fixed expenses not traceable to
products.....................................................................
105,000
Net operating income....................................................
P 27,000
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1. B 6. A 11. A
2. C 7. C 12. B
3. B 8. B
4. B 9. D
5. B 10. C
CHAPTER 22
BUSINESS PLANNING
I. Questions
1. Strategy, plans, and budgets are interrelated and affect one another.
Strategy describes how an organization matches its own capabilities
with the opportunities in the marketplace to accomplish its overall
objectives. Strategy analysis underlies both long-run and short-run
planning. In turn, these plans lead to the formulation of budgets.
Budgets provide feedback to managers about the likely effects of their
strategic plans. Managers use this feedback to revise their strategic
plans.
2. Budgeted performance is better than past performance for judging
managers. Why? Mainly because the inefficiencies included in past
results can be detected and eliminated in budgeting. Also, new
opportunities in the future, which did not exist in the past, may be
ignored if past performance is used.
3. A company that shares its own internal budget information with other
companies can gain multiple benefits. One benefit is better
coordination with suppliers, which can reduce the likelihood of supply
shortages. Better coordination with customers can result in increased
sales as demand by customers is less likely to exceed supply. Better
coordination across the whole supply chain can also help a company
reduce inventories and thus reduce the costs of holding inventories.
4. The sales forecast is typically the cornerstone for budgeting, because
production (and, hence, costs) and inventory levels generally depend on
the forecasted level of sales.
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II. Problems
Globalcom Company
Budgeted Income Statement for 2006
(in thousands)
Requirement 1
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Requirement 2
Requirement 3
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Requirement 5
Requirement 6
P104,500
Budgeted manufacturing overhead rate: = P19.00 per hour
5,500
Requirement 7
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Requirement 8
Requirement 9
Requirement 10
From
Schedule Total
Beginning finished goods
inventory, January 1,
2006 Given P 37,480
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Requirement 11
6. A 11. A 11. D
7. B 12. B 12. D
8. C 13. D 13. B
9. D 14. A 14. C
10. D 15. C 15. A
CHAPTER 23
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I. Questions
1.
Strategy Weakness
Cost leadership The tendency to cut costs in a way that
undermines demand for the product or
service.
Differentiation The firm’s tendency to undermine its strength
by attempting to lower costs or by lacking a
continual and aggressive marketing plan to
reinforce the perceived difference.
Focus The market niche may suddenly disappear due
to technological change in the industry or
change in consumer tastes.
2. The balanced scorecard is an accounting report that includes the firm’s
critical success factors in four areas: customer satisfaction, financial
performance, internal business processes, and innovation and learning
(human resources). The primary objective of the balanced scorecard is
to serve as an action plan, a basis for implementing the strategy
expressed in the critical success factors.
3. The balanced scorecard is important to integrate both financial and non-
financial information into management reports. Financial measures
reflect only a partial- and short-term measure of the firm’s progress.
Without strategic non-financial information, the firm is likely to stray
from its competitive course and to make strategically wrong product
decisions – to choose the wrong products, the wrong customers. The
balanced scorecard provides a basis for a more complete analysis than is
possible with financial data alone.
4. An analyst can incorporate other factors such as the growth in the overall
market and reductions in selling prices resulting from productivity gains
into a strategic analysis of operating income. To do so, the analyst
attributes the sources of operating income changes to the particular
factors of interests. For example, the analyst will combine the operating
income effects of strategic price reductions and any resulting growth
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Requirement 1
a, b, and c
Month
1 2 3 4
Throughput time in days:
Process time...................................................
0.6 0.5 0.5 0.4
Inspection time...............................................
0.7 0.7 0.4 0.3
Move time......................................................
0.5 0.5 0.4 0.5
Queue time.....................................................
3.6 3.6 2.6 1.7
Total throughput time....................................
5.4 5.3 3.9 2.9
Manufacturing cycle efficiency
(MCE):
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Requirement 2
The general trend is favorable in all of the performance measures except for
total sales. On-time delivery is up, process time is down, inspection time is
down, move time is basically unchanged, queue time is down, manufacturing
cycle efficiency is up, and the delivery time is down. Even though the
company has improved its operations, it has not yet increased its sales. This
may have happened because management attention has been focused on the
factory – working to improve operations. However, it may be time now to
exploit these improvements to go after more sales – perhaps by increased
product promotion and better marketing strategies. It will ultimately be
necessary to increase sales so as to translate the operational improvements
into more profits.
Requirement 3
a and b
Month
5 6
Throughput time in days:
Process time................................................... 0.4 0.4
Inspection time............................................... 0.3
Move time...................................................... 0.5 0.5
Queue time.....................................................
Total throughput time.................................... 1.2 0.9
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100%. This will be achieved when all non-value-added activities have been
eliminated and process time equals throughput time.
11. D 16. C
12. D 17. D
13. C 18. C
14. A 19. D
15. A 20. A
CHAPTER 24
I. Questions
1. Return on investment (ROI) is the ratio of profit to amount invested for
the business unit.
2. The measurement issues for ROI are:
a. The effect of accounting policies, which affect the determination of
net income.
b. Other measurement issues for income, which include the handling of
non-recurring items in the income statement, differences in the effect
of income taxes across units, differential effect of foreign currency
exchange, and the effect of cost allocation when two or more units
share a facility or cost.
c. Measuring investment: which assets to include.
d. Measuring investment: allocating the cost of shared assets.
3. The advantages of return on investment are:
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II. Exercises
Requirement 1
A quick inspection of the data shows mortgage loans with a higher ROI to be
more successful. But see requirement 2 below.
Requirement 2
Division A Division B
(Mortgage Loans) (Consumer Loans)
Total Assets P2,000 P10,000
Operating Income 400 1,500
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Residual Income:
(a) * at 11% P180 P400
(b) ** at 15% 100 0
(c) ***at 17% 60 (200)
Requirement 1
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plant because, as shown below, return on investment for the plant of 19.2%
is lower than JSD’s current ROI of 24%.
Investing in the new plant would lower JSD’s ROI and, hence, limit Tan’s
bonus.
Requirement 2
Investing in the new plant would add P105,000 to JSD’s residual income.
Consequently, if Magic Industries could be persuaded to use residual income
to measure performance, Tan would be more willing to invest in the new
plant.
Requirement 3
Operating income 480,000
Return on Sales (ROS) = Sales = =2,400,000
20%
If Magic Industries uses ROS to determine Tan’s bonus, Tan will be more
willing to invest in the new plant because ROS for the new plant of 20%
exceeds the current ROS of 19%.
The advantages of using ROS are (a) that it is simpler to calculate and (b)
that it avoids the negative short-run effects of ROI measures that may induce
Tan to not make the investment in the new plant. Tan may favor ROS
because she believes that eventually increases in ROS will increase ROI and
RI.
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III. Problems
Requirement 1
Truck Rental Transportation
Division Division
Total assets P650,000 P950,000
Current liabilities 120,000 200,000
Investment
(Total assets – current 530,000 750,000
liabilities)
Required return (12% x 63,600 90,000
Investment)
Operating income before tax 75,000 160,000
Residual income
(Operating income before tax
– required return) 11,400 70,000
Requirement 2
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Requirement 3
Both the residual income and the EVA calculations indicate that the
Transportation Division is performing better than the Truck Rental Division.
The Transportation Division has a higher residual income (P70,000 versus
P11,400) and a higher EVA [P24,000 versus P(5,880)]. The negative EVA
for the Truck Rental Division indicates that, on an after-tax basis, the
division is destroying value – the after-tax economic return from the Truck
Rental Division’s assets is less than the required return. If EVA continues to
be negative, Lighthouse may have to consider shutting down the Truck
Rental Division.
Supporting Calculations:
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The biggest weakness of ROI is the tendency to reject projects that will
lower historical ROI even though the prospective ROI exceeds the required
ROI. RI achieves goal congruence because subunits will make investments
as long as they earn a rate in excess of the required return for investments.
The biggest weakness of residual income is it favors larger divisions in
ranking performance. The greater the amount of the investment (the size of
the division), the more likely that larger divisions will be favored assuming
that income grows proportionately.
Requirement 1
(a)
Operating income Operating income
Phil. Division’s ROI in 2005 = Total assets = P8,000,000 =
15%
Hence, operating income = 15% x P8,000,000 = P1,200,000.
(b)
9,180,000 kronas
Swedish Division’s ROI in 2005 in kronas = 60,000,000 kronas =
15.3%
Requirement 2
Convert total assets into pesos at December 31, 2004 exchange rate, the rate
prevailing when the assets were acquired (8 kronas = P1)
60,000,000 kronas
24,000,000 kronas = = P7,500,000
8 kronas per peso
Convert operating income into pesos at the average exchange rate prevailing
when during 2005 when operating income was earned equal to
9,180,000 kronas
= P1,080,000
8.5 kronas per peso
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P1,080,000
Comparable ROI for Swedish Division = P7,500,000 =
14.4%
The Swedish Division’s ROI calculated in kronas is helped by the inflation
that occurs in Sweden in 2005. Inflation boosts the division’s operating
income. Since the assets are acquired at the start of the year on 1-1-2005,
the asset values are not increased by the inflation that occurs during the year.
The net effect of inflation on ROI calculated in kronas is to use an inflated
value for the numerator relative to the denominator. Adjusting for
inflationary and currency differences negates the effects of any differences in
inflation rates between the two countries on the calculation of ROI. After
these adjustments, the Phil. Division shows a higher ROI than the Swedish
Division.
Requirement 3
Requirement 1
P130,000
Luzon Division = 38.24%
P340,000
P220,000
Visayas Division = 19.13%
P1,150,000
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P380,000
Mindanao Division = 23.46%
P1,620,000
Requirement 2
The gross book values (i.e., the original costs of the plants) under historical
cost are calculated as the useful life of each plant (12) x the annual
depreciation:
Step 1: Restate long-term assets from gross book value at historical costs to
gross book value at current cost as of the end of 2005.
Gross book value
Construction cost index in 2005
of long-term assets x
Construction cost index in year of construction
at historical cost
Luzon P 840,000 x (170 100) = P1,428,000
Visayas P1,200,000 x (170 136) = P1,500,000
Mindanao P1,440,000 x (170 160) = P1,530,000
Step 2: Derive net book value of long-term assets at current cost as of the
end of 2005. (Estimated useful life of each plant is 12 years).
Gross book value
of long-term assets Estimated useful life remaining
at current cost at x
Estimated total useful life
the end of 2005
Luzon P1,428,000 x (2 12) = P 238,000
Visayas P1,500,000 x (9 12) = P1,125,000
Mindanao P1,530,000 x (11 12) = P1,402,500
Step 3: Compute current cost of total assets at the end of 2005. (Assume
current assets of each plant are expressed in 2005 pesos.)
Current assets at the end Net book value of long-term assets at
of 2005 (given) + current cost at the end of 2005 (Step 2)
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Gross book value of long-term assets at current cost at the end of 2005
(from Step 1) x (1 12)
Step 6: Compute ROI using current-cost estimate for long-term assets and
depreciation.
Operating income for 2005 using 2005 current cost depreciation (Step 5)
Current cost of total assets at the end of 2005 (Step 3)
Luzon P 81,000 P 438,000 = 18.49%
Visayas P195,000 P1,375,000 = 14.18%
Mindanao P372,500 P1,702,500 = 21.88%
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Requirement 3
CHAPTER 25
I. Questions
1. Productivity is the relationship between the output and the input
resources required for generating the output.
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II. Problems
Requirement 1
Star Company
Comparative Income Statement
For the years 2005 and 2006
2005 2006
Sales 15,000 x P40 P600,00 18,000 x P40 P720,000
= 0 =
Variable cost of sales:
Materials 12,000 x P 8 P 12,600 x P10 P126,000
= 96,000 =
Labor 6,000 x P20 = 120,000 5,000 x P25 = 125,000
Power 1,000 x P 2 2,00 2,000 x P 2 4,00
= 0 = 0
Total variable costs of P218,00 P255,000
sales 0
Contribution margin P382,00 P465,000
0
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2006 2005
DM 18,000 / 12,600 = 15,000 / 12,000 =
1.4286 1.25
DL 18,000 / 5,000 = 3.6 15,000 / 6,000 = 2.5
Power 18,000 / 2,000 = 9 15,000 / 1,000 = 15
Requirement 3
2006 2005
DM 12,600 x P10 = P126,000 12,000 x P 8 =
P 96,000
DL 5,000 x P25 = P125,000 6,000 x P20 = P120,000
Power 2,000 x P 2 = P 4,000 1,000 x P 2 = P 2,000
2006 2005
DM 18,000 / 126,000 = 15,000 / 96,000 =
0.1429 0.15625
DL 18,000 / 125,000 = 15,000 / 120,000 =
0.144 0.125
Power 18,000 / 4,000 = 4.5 15,000 / 2,000 = 7.5
Requirement 4
Both direct materials and direct labor operation partial productivity improved
from 2005 to 2006. In 2006 the firm was able to manufacture more output
units for each unit of materials placed into production and for each hour
spent on production. The operational productivity of power in 2006
deteriorated from 2005. It is likely that the firm used more equipment in
production in 2006 that reduced consumption of materials and production
hours.
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The financial partial productivity for both direct materials and power
deteriorated from 2005 to 2006. Increases in direct materials costs were
more than the improvements in operational partial productivity for direct
materials. Like the operational partial productivity, the financial partial
productivity for direct labor also improved. The extent of improvements,
however, is much lower in financial partial productivity. The direct labor
operational partial productivity improved 44 percent in 2006 over those of
2005. The financial partial productivity, however, improved only 15.2
percent between the two years. The decrease in financial partial productivity
is likely a result of increases in direct labor wages.
Requirement 5
(1) Output
(unit):
18,000 18,000 18,000 15,000
(2) 1/Productivity
DM: 12,000/15,0 12,000/15,0 12,000/15,0
12,600/18,0 00 00 00
00 = 0.7 = 0.8 = 0.8 = 0.8
DL: 6,000/15,00 6,000/15,00 6,000/15,00
5,000/18,00 0 0 0
0 = 0.2778 = 0.4 = 0.4 = 0.4
Power: 1,000/15,00 1,000/15,00 1,000/15,00
2,000/18,00 0 0 0
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Decompositi
on
DM: 18,000 / 18,000 / 18,000 / 15,000 /
126,000 144,000 115,200 96,000
= 0.1429 = 0.125 = 0.15625 = 0.15625
DL: 18,000 / 18,000 / 18,000 / 15,000 /
125,010 180,000 144,000 = 120,000
= 0.1440 = 0.1 0.125 = 0.125
Power: 18,000 / 18,000 / 15,000 /
18,000 / 2,401 2,401 2,001
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Summary of
Result
Change as % of 2005 Productivity
Productivity Input Price Total Productivity Input Price Total
Change Change Change Change Change Change
DM: 0.0179 F 0.03125 0.01335 11.46% 20% U 8.54%
U U F U
DL: 0.044 F 0.025 0.019 35.2% 20% U 15.2%
U F F F
Power: 2.9969 U 0 2.9969 39.98% 0 39.98%
U U U
Requirement 6
Productivity for both direct materials and direct labor improved in 2006.
The percentages of improvements in productivity are 11.46 and 35.2 for
direct materials and direct labor, respectively, of the 2005 productivity.
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However, cost increases in direct materials and direct labor reduced the gains
in productivity on these two manufacturing factors
Requirement 1
2006:
Total actual direct labor hours: 20 x 20,000 = 400,000
Total standard direct labor hours: 21 x 20,000 = 420,000
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Recap:
Assembly Testing Department
Department
2005 2006 2005 2006
Rate P1,000,000 P400,00 P240,00 P200,00
variance U 0U 0F 0F
Efficiency P560,00 P700,00 P840,00 P500,00
variance 0U 0F 0F 0F
Requirement 2
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Requirement 3
Requirement 5
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Requirement 1
Requirement 2
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Sales volume variances for the period for each of the products and for the
firm
Premium Regular
Sales Sales
Flexible Master Volume Flexible Master Volume
Budget Budget Variance Budget Budget Variance
Barrels 180 180 540 360
Sales P27,000 P36,000 P64,800 P43,200
Variable
expenses 16,200 21,600 40,500 27,000
Contribution
margin P10,800 P14,400 P3,600 P24,300 P16,200 P8,100 F
U
Fixed
expenses 10,000 10,000 5,000 5,000
– –
Operating
income P 800 P 4,400 P3,600 P19,300 P11,200 P8,100 F
U
Requirement 3
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Sales quantity variances for the firm and for each of the products. (See next
page.)
Requirement 4
Sales mix variances for the period for each of the products and for the firm
(000 omitted).
Calculation for sales mixes:
Budgeted Actual
Total Sales Sales Total Sales Sales
in Units Mix in Units Mix
Premium 240 0.40 180 0.25
Regular 360 0.60 540 0.75
600 1.00 720 1.00
Premium
720 x 0.25 x P60 = 720 x 0.40 x P60 = 600 x 0.40 x P60 = P14,400
P10,800 P17,280
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= P3,600 U
Total
Sales mix variance = P6,480 U + P4,860 F = P1,620 U
Sales quantity variance = P2,880 U + P3,240 F = P6,120 F
Requirement 5
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Verification
Requirement 6
Requirement 7
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Requirement 8
The sum of market size variance and market share variance and verification
that this total equals the sales quantity variance.
Total market size variance Total market share Total quantity variance
+ variance =
P2,040 F P4,080 F P6,120 F
Requirement 1
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Requirement 2
Tan should not follow the order without following a consistent accounting
method. If the firm believes that certain cost items should be reclassified as
indirect costs, the same procedure should be followed for all years. Tan
should then go back and revise operating results of previous years.
Requirement 1
Budget Actual
Empress Empress
’ Industr ’ Industr
Designs y Share Designs y Share
WS 50 500 10.0 45 425 45/42
% 5
DH 25 200 12.5 35 150 35/15
% 0
Requirement 2
Requirement 3
Requirement 4
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Among possible reasons are quality changes, pricing changes, less producers
due to seasonal variations, and market no longer there.
Requirement 5
Supporting Computations:
2005 2006
Input Input
Resource Partial Resource Partial
Output Used Productivity Output Used Productivity
X-45 60,000 75,000 = 0.8 64,000 89,600 = 0.7143
(1)
Direct
labor 60,000 10,000 = 6.0 64,000 10,847 = 5.9002
(2)
Financial partial productivity
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2005 2006
Cost of Cost of
Input Input
Units of Resource Partial Units of Resource Partial
Output Used Productivity Output Used Productivity
X-45 60,000 P540,000= 0.1111 64,000 P609,280= 0.1050
(3)
Direct
labor 60,000 300,000 = 0.2 64,000 P347,104= 0.1844
Total productivity in units (4)
2005 2006
(a)Total units 60,000 64,000
manufactured
(b) Total variable
manufacturing costs P840,000 P956,384
incurred
(c)Total productivity (a) 0.071429 0.066919
(b) (5)
(d) Decrease in 0.071429 – 0.00451
productivity 0.066919 = (6)
Total productivity in sales pesos
2005 2006
(a)Total sales P1,500,000 P1,600,00
0
(b) Total variable
manufacturing costs P840,000 P956,384
incurred
(c)Total productivity (a) P1.7857 P1.6730
(b) (5)
(d) Decrease in P1.7857 – P0.1127 (6)
productivity P1.6730 =
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Market Share
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(13)
Product A Product B Total
Budgeted sales
unit 30,000 60,000 90,000
Budgeted
contribution x x
margin per unit P4.00 P10.00
Budgeted total
contribution P120,00 P600,00 P720,00
margin 0 0 0
Budgeted average
contribution
margin per unit P8.00
(14)
Product Product Total
A B
Actual units sold 35,000 65,000
Budgets sales unit – –
30,000 60,000
Differences in sales
units 5,000 5,000
Budgeted contribution x x
margin per unit P4.00 P10.00
Sales volume
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Sales mixes:
Budgeted Actual
Unit % Unit %
Product A 30,000 1/3 35,000 35
Product B 60,000 2/3 65,000 65
TOTAL 90,000 100 100,000 100
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CHAPTER 26
I. Questions
1. Incentive compensation is a monetary reward that is based on measured
performance. Organizations where employees have been given the
responsibility to make decisions are best suited for incentive
compensation systems.
2. The four guidelines are: fairness, participation, basic wage level, and
independent wage policy.
Fairness deals with the ratio of salaries of the highest paid to lowest paid
employees.
Participation states that all employees should be included in a
compensation plan. Although, they do not need to be included in the
same one.
Basic wage level states that a market wage should be paid, and incentive
compensation should not be used to adjust the market wage downward.
Independent wage policy states that the incentive compensation system
for the most senior levels of the organization should be set by a group
that is independent of senior management.
3. a. based on salary – easy to administer, likely to be considered fair,
and, to the extent that salary reflects the relative ability to contribute
to results, is based on contribution;
based on equal share – easy to administer, likely to be considered
fair, and reflects how people often divide up rewards when left to
their own devices;
based on position – same as based on salary;
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II. Problems
Problem 1
Requirement (a)
Requirement (b)
Problem 2
Requirement (a)
Requirement (b)
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35. B 30. B
CHAPTER 27
MANAGING ACCOUNTING IN
A CHANGING ENVIRONMENT
I. Questions
1. The American Heritage Dictionary defines quality as “1. a characteristic
or attribute of something; property; a feature. 2. the natural or essential
character of something. 3. excellence; superiority.”
Quality for a product or service can be defined as a “product or service
that conforms with a design which meets or exceeds the expectations of
customers at a price they are willing to pay.”
2. Procter & Gamble defines TQM as “the unyielding and continually
improving effort by everyone in an organization to understand, meet, and
exceed the expectations of customers.” Typical characteristics of TQM
include focusing on satisfying customers, striving for continuous
improvement, and involving the entire workforce.
TQM is a continual effort and never completes. Global competition,
new technology, and ever-changing customer expectations make TQM a
continual effort for a successful firm.
3. The core principles of TQM include (1) focusing on satisfying the
customer, (2) striving for continuous improvement, and (3) involving the
entire work force.
4. Continuous improvement (Kaizen) in total quality management is the
belief that quality is not a destination; rather, it is a way of life and firms
need to continuously strive for better products with lower costs.
In today’s global competition, where firms are forever trying to
outperform the competition and customers present ever-changing
expectations, a firm can never reach the ideal quality standard and needs
to continuously improve quality and reduce costs to remain competitive.
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22. At the final assembly stage in a JIT system, a signal is sent to the
preceding workstation as to the exact parts and materials that will be
needed over the next few hours for the final assembly of products. Only
those parts and materials are provided. The same signal is sent back
through each preceding workstation so that a smooth flow of parts and
materials is maintained with no buildup of inventories at any point.
Thus, all workstations respond to the “pull” exerted by the final
assembly stage.
The “pull” approach just described can be contrasted to the “push”
approach used in conventional systems. In a conventional system,
inventories of parts and materials are built up—often simply to keep
everyone busy. These semi-completed parts and materials are “pushed”
forward to the next workstation whether or not there is actually any
customer demand for the products they will become part of. The result is
large stockpiles of work in process inventories.
23. A number of benefits accrue from reduced setup time. First, reduced
setup time allows a company to produce in smaller batches, which in
turn reduces the level of inventories. Second, reduced setup time allows
a company to spend more time producing goods and less time getting
ready to produce. Third, the ability to rapidly change from making one
product to making another allows the company to respond more quickly
to customers. Finally, smaller batches make it easier to spot
manufacturing problems before they result in a large number of defective
units.
II. Exercises
Inter Exter
nal nal
Preven Apprai Failur Failur
tion sal e e
a. Warranty
repairs x
b. Scrap x
c. Allowance
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granted due to
blemish x
d. Contribution
margins of lost sales x
e. Tuition for
quality courses x
f. Raw materials
inspections x
g. Work-in-
process inspection x
h. Shipping cost
for replacements x
i. Recalls x
j. Attorney’s fee
for unsuccessful
defense of
complaints about
quality x
k. Inspection of
reworks x
l. Overtime
caused by reworking x
m. Machine
maintenance x
n. Tuning of
testing equipment x
Exercise 2 (Cost of Quality Report)
Requirements 1 & 2
Bali Company
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a. There were slight increases in both prevention and appraisal costs from
2005 to 2006. Each of these two cost of quality increased by
approximately 0.33 percent of the total sales. These two costs increased
by P40,000 over the two years.
b. Both internal failure costs and external failure costs decreased
substantially in 2006 as compared to those in 2005. The firm
experienced a 1.41 percent decrease in internal failure and a 4.34 percent
decrease in external failure costs with the total savings of P345,000. The
savings was 863 percent of the increases in prevention and appraisal
costs.
Requirement 3
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Requirement 1
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work in
process
Downtime 10,000
Product
liability
insurance 9,000
Quality audits 5,000
Continuous
improvement 1,000
Warranty 15,00
repairs 0
Requirement 2
Total spent by
category P25,000 P48,000 P42,000 P51,000
Requirement 3
Requirements 1 and 2
2006 2005
Revenues P12,500,000 P10,000,000
Costs of Quality Cost Percent Cost Percent
(1) age of (3) age of
Revenu Revenu
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es (2) = es (4) =
(1) (3)
P12,500 P10,000
,000 ,000
Prevention costs
Design P240,0 P100,0
engineering 00 00
Preventive
maintenance 90,000 35,000
Training 120,00
0 45,000
Supplier 50,0 20,0
evaluation 00 00
Total
prevention 500,0 200,0
costs 00 4.0% 00 2.0%
Appraisal costs
Line inspection 110,00
85,000 0
Product-testing
equipment 50,000 50,000
Incoming
materials
inspection 40,000 20,000
Product-testing 75,0 220,0
labor 00 00
Total 250,0 400,0
appraisal costs 00 2.0% 00 4.0%
Internal failure
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costs
Scrap 200,00 250,00
0 0
Rework 135,00 160,00
0 0
Breakdown 40,0 90,0
maintenance 00 00
Total internal
failure costs 375,0 500,0
00 3.0% 00 5.0%
External failure
costs
Returned 145,00
goods 0 60,000
Customer
support 30,000 40,000
Product liability 100,00 200,00
claims 0 0
Warranty repair 200 300
,000 ,000
475 600
,000 3.8% ,000 6.0%
Total costs of P1,600, P1,700,
quality 000 12.8% 000 17.0%
Between 2005 and 2006, Gabriel’s costs of quality have declined from 17%
of sales to 12.8% of sales. The analysis of individual costs of quality
categories indicates that Gabriel began allocating more resources to
prevention activities – design engineering, preventive maintenance, training
and supplier evaluations in 2006 relative to 2005. As a result, appraisal
costs declined from 4% of sales to 2%, costs of internal failure fell from 5%
of sales to 3%, and external failure costs decreased from 6% of sales to
3.8%. The one concern here is that, although external failure costs have
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Requirement 3
Requirements 1 and 2
Percentage of
Revenues
Costs (2) = (1)
Costs of Quality (1) P20,000,000
Prevention costs
Design engineering (P75 x
6,000 hours) P 450,000 2.25%
Appraisal costs
Testing and inspection
(P40 x 1 hour x 10,000
units) 400,000 2.00%
Internal failure costs
Rework (P500 x 5% x
10,000 units) 250,000 1.25%
External failure costs
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Repair (P600 x 4% x
10,000 units) 240,000 1.20%
Percentage of
Revenues
Costs (2) = (1)
Costs of Quality (1) P7,500,000
Prevention costs
Design engineering (P75 x
1,000 hours) P 75,000 1.00%
Appraisal costs
Testing and inspection
(P40 x 0.5 x 5,000
units) 100,000 1.33%
Internal failure costs
Rework (P400 x 10% x
5,000 units) 200,000 2.67%
External failure costs
Repair (P450 x 8% x 5,000
units) 180,000 2.40%
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Estimated forgone
contribution margin on
lost sales [(P1,500 –
P800) x 300] 210,000 2.80%
Total external failure
costs 390,000 5.20%
Requirement 3
III. Problems
Requirement 1
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Requirement 2
Requirement 3
Yes. The cost of the new process is P15,000,000 and the expected benefits is
P28,837,500 over three years. The firm can expect to earn a return of over
90%.
Requirement 4
The following factors should be considered before making the final decision:
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Requirement 5
The member of the board would be right if we ignore the financial payoff of
the new process and if the firm is going to be in business for only three
years. Having high quality products, especially for a high-end product such
as the one the firm is selling, is crucial for a long term success.
Increase
Costs (Decrease
Categories 2005 2006 )
Prevention
costs:
Training P P P
75,000 100,000 25,000
Product 150,00 175,00 25,0
design 0 0 00
Total 225,000 275,000 50,000
prevention
Appraisal
costs:
Testing 50,000 150,000 100,000
Calibration 75,00 100,00 25,0
0 0 00
Total 125,000 250,000 125,000
appraisal
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Internal
failure costs:
Rework 325,000 100,000 (225,000)
Retesting 250,00 200,00 (50,00
0 0 0)
Total 575,000 300,000 (275,000)
internal
failure
External
failure costs:
Warranty 150,000 75,000 (75,000)
repairs
Product 400,000 200,000 (200,000)
recalls
Product 125,00 75,00 (50,00
liability 0 0 0)
Total 675,00 350,00 (325,00
external 0 0 0)
failure
Total costs of P1,600,00 P1,175,00 P
quality 0 0 (425,000)
Problem 3 (JIT Production, Relevant Benefits, Relevant Costs)
Requirement 1
Incremental
Costs under Incremental
Current Costs under
Production JIT Production
Relevant Items System System
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Requirement 2
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Requirement 1
Incremental
Costs under Incremental
Current Costs under
Purchasing JIT Purchasing
System Policy
Required return on investment
20% per year x P600,000 of
average inventory per year P120,000
20% per year x P0 of
inventory per year P 0
Annual insurance costs 14,000 0
Warehouse rent 60,000 (13,500)a
Overtime costs
No overtime 0
Overtime premium 40,000
Stockout costs
No stockouts 0
P6.50b contribution margin
per unit x 20,000 units 130,000
Total incremental costs P194,000 P156,500
Difference in favor of JIT
purchasing P37,500
a
P(13,500) = Warehouse rental revenues, [(75% x 12,000) x P1.50].
b
Calculation of unit contribution margin
Selling price (P10,800,000 900,000 units) P12.00
Variable costs per unit:
Variable manufacturing costs per unit
(P4,050,000 900,000 units) P4.50
Variable marketing and distribution
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Note that the incremental costs of P40,000 for overtime premiums to make
the additional 15,000 units are less than the contribution margin from losing
these sales equal to P97,500 (P6.50 x 15,000). Josefina would rather incur
overtime than lose 15,000 units of sales.
Requirement 1
Zashi should invest in the modern jigs and tools because the benefit of
higher throughput contribution of P40,000 exceeds the cost of P30,000.
Requirement 2
Requirement 1
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Requirement 2
Requirement 1
Requirement 2
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Alternatively, the cost of 2,000 defective units at the finishing operation can
be calculated as the lost revenue of P72 x 2,000 = P144,000. This line of
reasoning takes the position that direct materials costs of P32 x 2,000 =
P64,000 and all fixed operating costs in the machining and finishing
operations would be incurred anyway whether a defective or good unit is
produced. The cost of producing a defective unit is the revenue lost of
P144,000.
Problem 8
Requirement (a)
Anthony Foods
Quality Costs
2005-2006
(Millions)
2005 2006
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
Quality assurance
administration P 6.20 P 6.52 P 6.86 P 7.19 P 7.93 P 8.74 P 9.61 P10.53
Training 13.10 14.39 15.90 17.46 21.12 25.50 30.37 36.35
Process
engineering 2.20 2.46 2.76 3.11 3.87 4.86 6.13 7.58
Prevention 21.50 23.37 25.52 27.76 32.92 39.10 46.11 54.46
Inspection 1.40 1.56 1.75 1.95 2.39 2.96 3.63 4.46
Testing 1.60 1.72 1.85 1.99 2.29 2.62 3.01 3.45
Appraisal 3.00 3.28 3.60 3.94 4.68 5.58 6.64 7.91
Rework 15.80 12.65 10.03 8.49 7.25 6.16 5.56 5.00
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Requirement (b)
From the preceding data we see that prevention and appraisal costs are
increasing while internal and external failure costs have been decreasing.
The following graph plots three series: prevention and appraisal costs,
failure costs, and total quality costs.
140
120
100
80
60
40
20
0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
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31. C 26. C
32. B 27. A
33. C 28. C
34. D 29. B
35. D 30. C
36. A 31. D
37. C 32. D
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38. C 33. D
39. D 34. A
40. D 35. A
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