Professional Documents
Culture Documents
TABLE OF CONTENTS
1-1
Chapter 1 Management Accounting: An Overview
1 Application of Quantitative
7 Techniques in Planning, Control 17-1 – 17-2
and Decision Making - I
1 Application of Quantitative
8 Techniques in Planning, Control 18-1 – 18-7
and Decision Making – II
1 Relevant Costs for Decision Making 19-1 – 19-33
9
2 Capital Budgeting Decisions 20-1 – 20-16
0
2 Decentralized Operations and 21-1 – 21-4
1 Segment Reporting
2 Business Planning 22-1 – 22-6
2
2 Strategic Cost Management; 23-1 – 23-4
3 Balanced Scorecard
2 Advanced Analysis and Appraisal of
4 Performance: Financial and 24-1 – 24-12
Nonfinancial
2 Managing Productivity and 25-1 – 25-19
5 Marketing Effectiveness
2 Executive Performance Measures 26-1 – 26-3
6 and Compensation
2 Managing Accounting in a 27-1 – 27-22
7 Changing Environment
CHAPTER 1
I. Questions
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Management Accounting: An Overview Chapter 1
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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
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
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Chapter 1 Management Accounting: An Overview
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
accounting principles and government
authorities
Type of Information: Financial measurements only
Nature of Information: Objective, auditable, reliable, consistent,
precise
Scope: Highly aggregate; report on entire
organization
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
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Chapter 1 Management Accounting: An Overview
e. (5) Distribution
f. (3) Production
g. (1) Research and development
h. (2) Design
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:
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Chapter 1 Management Accounting: An Overview
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.
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(d) In many organizations, sales are heavily concentrated in the final weeks
of the fiscal year-end. If the double bonus is approved by the division
marketing manager, the division controller can do little more than
observe the extra bonus paid in December.
(e) If TV spots are reduced in December, the advertising cost in December
will be reduced. There is no record falsification here.
(g) Much depends on the means of “persuading” carriers to accept the
merchandise. For example, if an under-the-table payment is involved, it
is clearly unethical. If, however, the carrier receives no extra
consideration and willingly agrees to accept the assignment, the
transaction appears ethical.
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
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Chapter 1 Management Accounting: An Overview
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
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
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Management Accounting: An Overview Chapter 1
company’s brand name. The reasons are uncertainty of the future benefits
that may be derived therefrom and difficulty and reliability of their
measurement.
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
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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
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
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
information jobs, economic
security, proper
treatment
Partners Goods, services, Financial rewards
information commensurate with
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Chapter 8 Cost Concepts and Classifications
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
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Cost Concepts and Classifications Chapter 8
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
Requirement (a)
SM Farms
Balance Sheet
September 30, 2005
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Cost Concepts and Classifications Chapter 8
* 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
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
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Chapter 8 Cost Concepts and Classifications
P 6,940
Accounts receivable 11,260 Notes payable
P 74,900
Requirement (b)
The Tasty Bakery
Balance Sheet
August 3, 2005
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Cost Concepts and Classifications Chapter 8
105,000
Retained earnings
40,700
Total Total
P236,700 P236,700
Requirement (c)
The Tasty Bakery is in a stronger financial position on August 3 than it was
on August 1.
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Chapter 8 Cost Concepts and Classifications
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
Total Total
P132,590 P132,590
* 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
Revenues P 5,500
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Chapter 8 Cost Concepts and Classifications
Expenses (4,000)
Net income P 1,500
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.
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Cost Concepts and Classifications Chapter 8
Requirement (1)
Fil-Cinema Scripts
Balance Sheet
November 30, 2005
* P8,850 + P6,500 –
P2,525.
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
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Chapter 8 Cost Concepts and Classifications
(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.
(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.
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Cost Concepts and Classifications Chapter 8
A
27. D 17. A 27. B 37. A
28. C 18. B 28. B 38. C
29. B 19. C 29. D
30. C 20. C 30. C
CHAPTER 4
I. Questions
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Cost Concepts and Classifications Chapter 8
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.
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Chapter 8 Cost Concepts and Classifications
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
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%
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Chapter 8 Cost Concepts and Classifications
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
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%
Administrative
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)
The trend percentages are:
Year 5 Year 4 Year 3 Year 2 Year 1
Sales 125.0 120.0 110.0 105.0 100.0
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
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Cost Concepts and Classifications Chapter 8
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
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Chapter 8 Cost Concepts and Classifications
CHAPTER 5
I. Questions
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Cost Concepts and Classifications Chapter 8
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
market value exceeds book value because investors anticipate future
growth in earnings.
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
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Chapter 8 Cost Concepts and Classifications
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.
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
8-48
Cost Concepts and Classifications Chapter 8
III. Problems
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
8-49
Chapter 8 Cost Concepts and Classifications
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.
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Chapter 8 Cost Concepts and Classifications
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
2006 2005
Current assets:
Cash 2.0% 5.1%
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Cost Concepts and Classifications Chapter 8
..........................................................
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
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
benefits were realized from the company’s cost-cutting efforts, as evidenced
by the fact that operating expenses were only 26.3 percent of sales in 2006 as
compared to 30.4 percent in 2005. Unfortunately, this reduction in operating
expenses was not enough to offset the increase in cost of goods sold. As a
result, the company’s net income declined from 5.6 percent of sales in 2005
to 5.3 percent of sales in 2006.
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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)
Requirement (c)
8-56
Cost Concepts and Classifications Chapter 8
(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)
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
6. Debt-to-equity ratio:
Total liabilities P500,000
Total equity = P800,000 = 0.63 to 1 (rounded)
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Cost Concepts and Classifications Chapter 8
* P100,000 total par value ÷ P5 par value per share = 20,000 shares
P126,000
= P1,200,000 = 10.5%
Chapter 8 Cost Concepts and Classifications
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
Current liabilities (P1,300,000 ÷ 2.5)..................................................... 520,000
P 780,000
Working capital.......................................................................................
Requirement (2)
P80,000 + P0 + P460,000 + P0
= = 1.04 (rounded)
P520,000
Requirement (3)
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Chapter 8 Cost Concepts and Classifications
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Cost Concepts and Classifications Chapter 8
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
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
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Chapter 8 Cost Concepts and Classifications
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
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
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Chapter 8 Cost Concepts and Classifications
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
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
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Cost Concepts and Classifications Chapter 8
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
Earnings per share (a) ÷ (b) P6.16 P4.48
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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 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
P 280,000 P 168,000
a. Net income..............................................................................................................
Add after-tax cost of interest:
P120,000 × (1 – 0.30)..........................................................................................
84,000
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Chapter 8 Cost Concepts and Classifications
P100,000 × (1 – 0.30)..........................................................................................
70,000
P 364,000 P 238,000
Total (a)...................................................................................................................
P 280,000 P 168,000
b. Net income..............................................................................................................
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.
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.
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
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Chapter 8 Cost Concepts and Classifications
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 gross
margin percentage, while not large, is worrisome. Sales and inventories have
increased substantially, which should ordinarily result in an improvement in
the gross margin percentage as fixed costs are spread over more units.
However, the gross margin percentage has declined.
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.
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Cost Concepts and Classifications Chapter 8
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
Ass ets
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
Total Assets P132,000
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
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Chapter 8 Cost Concepts and Classifications
P0.50 =
= 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
X (Current Assets) = P55,880
Cost of Sales
(4) Inventory turnover = Ave. Inventory
X
4 =
P21,120
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Cost Concepts and Classifications Chapter 8
Quick Assets
(5) Average age of outstanding = Current Liabilities
Accounts Receivable
365
= 73 days (Average age of
5
receivables)
Net Sales
Average Receivables = 5
P140,800
X = 5
X (Receivables) = P28,160
Another Method:
P140,800
365 = 73 days = P28,160 Accounts receivable
0.375X = P33,000
X = P88,000 Equity
(8) Fixed Assets to Equity
Fixed Assets
= 0.625
Equity
X
= 0.625
P140,800
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Chapter 8 Cost Concepts and Classifications
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)
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)
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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Chapter 8 Cost Concepts and Classifications
Requirement (5)
Requirement (6)
Requirement (1)
8-79
Chapter 8 Cost Concepts and Classifications
Requirement (3)
P1,080 + P0 + P9,000 + P0
Acid-test ratio = P19,400 = 0.52
Requirement (4)
Requirement (5)
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Cost Concepts and Classifications Chapter 8
Requirement (6)
Requirement (1)
Requirement (2)
8-81
Chapter 8 Cost Concepts and Classifications
CHAPTER 6
I. Questions
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.
These activities are uses of cash when cash is decreased as a result of the
particular activity.
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Chapter 8 Cost Concepts and Classifications
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.
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
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Cost Concepts and Classifications Chapter 8
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.
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.
8-85
Chapter 8 Cost Concepts and Classifications
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
Exercise 2
Sales.................................................................................................
P1,000,000
Adjustments to a cash basis:
– 60,000
Less increase in accounts receivable......................................... P940,000
Cost of goods sold............................................................................
580,000
Adjustments to a cash basis:
+ 77,000
Plus increase in inventory.........................................................
– 30,000
Less increase in accounts payable............................................. 627,000
Selling and administrative expenses.................................................
300,000
Adjustments to a cash basis:
– 2,000
Less decrease in prepaid expenses............................................
+ 4,000
Plus decrease in accrued liabilities............................................
– 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
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Cost Concepts and Classifications Chapter 8
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
Requirement (1)
Requirement (2)
Swan Company
Statement of Cash Flows
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Chapter 8 Cost Concepts and Classifications
Operating activities:
P 90
Net cash provided by operating activities (see above).........................................
Investing activities:
P 45
Proceeds from sale of long-term investments......................................................
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)
Cas
h
Sour Flo Adju
ce w st- Adjus
Chan or Effe men ted Classific
ge Use? ct ts Effect ation
Assets (except cash and cash equivalents)
Current assets:
Sourc + Operatin
Accounts receivable...........................–10 e 10 +10 g
+3 – Operatin
Inventory........................................... 0 Use 30 –30 g
Sourc + Operatin
Prepaid expenses.............................. –5 e 5 +5 g
Noncurrent assets:
Sourc +
Long-term investments......................–30 e 30 –50 –20 Investing
–
+1 15 –
Plant and equipment......................... 50 Use 0 150 Investing
Sourc +
Land..................................................–30 e 30 –30 0 Investing
8-88
Cost Concepts and Classifications Chapter 8
Additional entries
Proceeds from sale of investments........ +45 +45 Investing
Operatin
Loss on sale of investments.................. +5 +5 g
Proceeds from sale of land.................... +70 +70 Investing
– Operatin
Gain on sale of land............................... –40 40 g
+
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:
Increase in inventory..........................................................+30
Increase in accounts payable..............................................–20 260
Selling and administrative expenses...........................................280
Adjustments to a cash basis:
8-89
Chapter 8 Cost Concepts and Classifications
Stephenie Company
Statement of Cash Flows
For the Year Ended December 31, 2008
Operating activities:
P 56
Net income..............................................................................................
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:
Increase in bonds payable.......................................................................
25
Decrease in ordinary shares....................................................................
(40)
Cash dividends........................................................................................
(16)
Net cash used for financing activities..................................................... (31)
8-90
Cost Concepts and Classifications Chapter 8
8-91
Chapter 8 Cost Concepts and Classifications
Additional entries
+1 Investi
Proceeds from sale of equipment.......... 8 +18 ng
Operat
Loss on sale of equipment..................... +2 +2 ing
Proceeds from sale of long-term +1 Investi
investments....................................... 2 +12 ng
Gain on sale of long-term Operat
investments....................................... –5 –5 ing
II. Problems
Problem 1
8-92
Cost Concepts and Classifications Chapter 8
.....................................
10. Inventories decreased.... X X
11. Accounts receivable
increased X X
......................................
12. Depreciation charges
totaled P200,000 for the
year X X
......................................
Requirement (a)
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Chapter 8 Cost Concepts and Classifications
activities must reconcile with the change in cash in the statement of cash
flows.
Requirement (b)
P130,000
8-94
Cost Concepts and Classifications Chapter 8
8-95
Chapter 8 Cost Concepts and Classifications
Requirement (a)
8-96
Cost Concepts and Classifications Chapter 8
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:
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Chapter 8 Cost Concepts and Classifications
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)
Requirement (a)
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Cost Concepts and Classifications Chapter 8
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:
8-99
Chapter 8 Cost Concepts and Classifications
ions
Long- 8 56 -- 10 -- 44 9 --
term
debt
Share -- -- 16 52 -- 63 -- 56
capital
Asset 12 7 7 17 30 31 15 37
dispos
ition
100 100 100 100 100 100 100 100
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
8-100
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
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Chapter 8 Cost Concepts and Classifications
Problem III
Requirement A:
Tony Corporation
Statement Accounting for Gross Profit Variation
For 2006
Cost Factor
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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 (DEPS1), 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....................... 250,0
00
Raw material available for use......................... P310,
000
Deduct: Raw-material inventory, 70,0
December 31.............................................. 00
Raw material used............................................ P240,
000
Direct labor............................................................ 400,00
0
Manufacturing overhead:
Indirect material............................................... P
10,000
Indirect labor.................................................... 25,000
Depreciation on plant and equipment............... 100,00
0
Utilities............................................................ 25,000
Other................................................................ 30,0
00
Total manufacturing overhead.......................... 190,0
00
Total manufacturing costs...................................... P830,
000
Add: Work-in-process inventory, January 120,0
1 00
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Chapter 8 Cost Concepts and Classifications
Subtotal.................................................................. P950,
000
Deduct: Work-in-process inventory, 115,0
December 1...................................................... 00
Cost of goods manufactured................................... P835,
000
Requirement 2
Requirement 3
Exercise 2
8-112
Cost Concepts and Classifications Chapter 8
inventories V R
d. Salaries of top executives in the F P
company
e. Overtime premium for assembly workers V R
f. Sales commissions V P
g. Sales personnel office rental F P
h. Production supervisory salaries F R
i. Controller’s office supplies F P
Fixed (F) Period (P)
Cost Item Variable (V) Product (R)
j. Executive office heat and air F P
conditioning
k. Executive office security personnel F P
l. Supplies used in assembly work V R
m. Factory heat and air conditioning F R
n. Power to operate factory equipment V R
o. Depreciation on furniture for sales staff F P
p. Varnish used for finishing product V R
q. Marketing personnel health insurance F P
r. Packaging materials for finished product V R
s. Salary of the quality control manager
who checks work on the assembly line F R
t. Assembly-line workers’ dental insurance F R
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
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
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Chapter 8 Cost Concepts and Classifications
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
* 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
8-114
Cost Concepts and Classifications Chapter 8
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
likely be prorated on the basis of the amount of space occupied by
manufacturing, administrative, and marketing operations.
6. The wages of the company’s bookkeeper: administrative cost.
7. Sales commissions paid to the company’s salespeople: marketing and
selling cost.
8. Depreciation on power tools: manufacturing overhead cost.
8-115
Cost Concepts and Classifications Chapter 8
Exercise 7
P Product Cost
e
ri
o
d
Va F (Selling Dir D Manu S Opp
ri i and ec i factu u ortu
ab x Administra t r ring n nity
le e tive) Cost Ma e Over k Cost
Co d ter c head
st ial t C
C s L o
o a s
s b t
t o
r
1. Wood
used in
a table
X X
(P200
per
table)
2. Labor
cost to
assembl
X X
e a table
(P80 per
table)
3. Salary of X X
the
factory
supervis
or
(P76,000
8-116
Cost Concepts and Classifications Chapter 8
per
year)
4. Cost of
electricit
y to
produce
X X
tables
(P4 per
machine
-hour)
5.
Deprecia
tion of
machine
s used X
X X *
to
produce
tables
(P20,000
per
year)
6. Salary of
the
compan
y
presiden X X
t
(P200,00
0 per
year)
7. X X
Advertisi
ng
expense
(P500,00
8-117
Cost Concepts and Classifications Chapter 8
0 per
year)
8.
Commis
sions
paid to X X
salesper
sons
(P60 per
table
sold)
9. Rental
income
forgone
X1
on
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.
8-118
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
8-119
Cost Concepts and Classifications Chapter 8
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 375,00
0
Raw materials available for use 420,000
Deduct: Raw materials inventory, 30,00
December 31 0
Raw materials used in production P
390,000
Direct labor 75,000
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Cost Concepts and Classifications Chapter 8
Manufacturing overhead:
Utilities, factory 18,000
Depreciation, factory 81,000
Insurance, factory 20,000
Supplies, factory 7,500
Indirect labor 150,000
Maintenance, factory 43,50
0
Total manufacturing overhead cost 320,00
0
Total manufacturing cost 785,000
Add: Work in process inventory, January
1 90,000
875,000
Deduct: Work in process inventory,
December 31 50,000
Cost of goods manufactured P825,000
Requirement (2)
Requirement (3)
EH Corporation
Income Statement
For the Year Ended December 31
Sales P1,250,000
Cost of goods sold (above) 850,000
Gross margin 400,000
Selling and administrative expenses:
Selling expenses P
70,000
Administrative expenses 135,00 205,000
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Cost Concepts and Classifications Chapter 8
0
Net operating income P 195,000
8-123
Cost Concepts and Classifications Chapter 8
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
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)
Ms. Rio’s first action was to direct that discretionary expenditures be delayed
until the first of the new year. Providing that these “discretionary
expenditures” can be delayed without hampering operations, this is a good
business decision. By delaying expenditures, the company can keep its cash a
bit longer and thereby earn a bit more interest. There is nothing unethical
about such an action. The second action was to ask that the order for the parts
be cancelled. Since the clerk’s order was a mistake, there is nothing unethical
about this action either.
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
the year.
CHAPTER 9
I. Questions
13-127
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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Chapter 13 Cost-Volume-Profit Relationships
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.
Because correlation is determined from a sample of values, there is no
assurance that it measures or describes a cause and effect relationship
between the 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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Cost-Volume-Profit Relationships Chapter 13
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
12. g
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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
Fixed costs:
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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
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
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Chapter 13 Cost-Volume-Profit Relationships
Figure 9-A
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Cost-Volume-Profit Relationships Chapter 13
Figure 9-B
Requirement 1
Fixed Costs:
Rent P10,250
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Chapter 13 Cost-Volume-Profit Relationships
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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Cost-Volume-Profit Relationships Chapter 13
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
relevant range but not outside of it. Notice that the relationship between
advertising expense and sales changes at P4,000 of expense.
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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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Cost-Volume-Profit Relationships Chapter 13
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.
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Chapter 13 Cost-Volume-Profit Relationships
.............................. 3
November 2,106 P
.............................. 9,830
December 2,495 P11,08
.............................. 1
Intercept P2,29
6
Slope P3.74
RSQ 0.92
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 R2 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.
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Cost-Volume-Profit Relationships Chapter 13
III. Problems
Problem 1
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Chapter 13 Cost-Volume-Profit Relationships
Problem 2
Requirement 1
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
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Chapter 13 Cost-Volume-Profit Relationships
Insurance.................................................... 9,000
Depreciation............................................... 42,000 176,000
Net income...................................................... P 58,000
Problem 3
Requirement 1
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
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Cost-Volume-Profit Relationships Chapter 13
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
P16,0 Y
00
P14,0
00
P12,0
Total 00
P10,0
Cost
00
P8,00
P6,000
P4,000
P2,000 X
P-0
0 1 2 7 8
3 Number
4 5 of6 Selections
Requirement 1
Figure 9-C plots the relationship between labor-hours and overhead costs
and shows the regression line.
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Chapter 13 Cost-Volume-Profit Relationships
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
Variable overhead (0.5 hrs. x P3.93 per labor-hour) 1.97
Total variable cost per person P21.97
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.
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Figure 9-C
Regression Line of Labor-Hours on Overhead Costs for Bobby Gonzales’
Catering Company
Requirement 1
Difference in cost
Slope coefficient (b) =
Difference in labor-hours
P529,000 – P400,000
= = P43.00
7,000 – 4,000
Constant (a) = P529,000 – P43.00 (7,000)
= P228,000
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
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Chapter 13 Cost-Volume-Profit Relationships
available starting point for a straight line that approximates how a cost
behaves within the 3,000 to 8,000 relevant range.
Requirement 2
M M M M M M
o o o o o o
n n n n n n
t t t t t t
h h h h h h
1 2 3 4 5 6
Actual
total P P P P P P
overhe 3 4 4 4 5 5
ad 4 0 3 7 2 8
costs 0 0 5 7 9 7
, , , , , ,
0 0 0 0 0 0
0 0 0 0 0 0
0 0 0 0 0 0
Linear
approxi 3 4 4 4 5 5
mation 5 0 4 8 2 7
7 0 3 6 9 2
, , , , , ,
0 0 0 0 0 0
0 0 0 0 0 0
0 0 0 0 0 0
Actual
minus P P P P P P
linear ( 0 ( ( 0 1
approxi 1 8 9 5
mation 7 , , ,
, 0 0 0
0 0 0 0
0 0 0 0
0 ) )
)
Professio 3 4 5 6 7 8
nal , , , , , ,
labor- 0 0 0 0 0 0
hours 0 0 0 0 0 0
0 0 0 0 0 0
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Cost-Volume-Profit Relationships Chapter 13
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 P38,000 P38,000
Incremental overhead 35,000 43,000
Contribution after incremental P 3,000 P (5,000)
overhead
Figure 9-D
Linear Cost Function Plot of Professional Labor-Hours
on Total Overhead Costs for ABS Consulting Group
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Chapter 13 Cost-Volume-Profit Relationships
Variabl
e costs P P P P
(@
P4 per 20,0 24,0 28,0 32,0
hour) 00 00 00 00
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Cost-Volume-Profit Relationships Chapter 13
Variabl
e cost P P P P
4.00 4.00 4.00 4.00
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.
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Chapter 13 Cost-Volume-Profit Relationships
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 of Admitting
Month Patients Department
Admitted Costs
High activity level 1,900 P15,200
(June)
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.
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Cost-Volume-Profit Relationships Chapter 13
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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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 2 4 6 8 10 12 14 16 18 20 22 24
Number of Janitorial Workdays
Requirement
(3) 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
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Cost-Volume-Profit Relationships Chapter 13
* Supporting Computations:
11. (10,000 x 2) – (P3,000 x 2) – P5,000 = P9,000
12. [(P20 + P3 + P6) x 2,000 units] + (P10 x 1,000 units) = P68,000
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
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Cost-Volume-Profit Relationships Chapter 13
II. Exercises
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Chapter 13 Cost-Volume-Profit Relationships
Requirement 1
Company X:
Company Y:
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Cost-Volume-Profit Relationships Chapter 13
Requirement 1
Milling Department:
Assembly Department:
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
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Chapter 13 Cost-Volume-Profit Relationships
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
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
Materials 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
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Cost-Volume-Profit Relationships Chapter 13
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
Equivalent Units
Materials 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
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Chapter 13 Cost-Volume-Profit Relationships
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:
Exercise 8
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Cost-Volume-Profit Relationships Chapter 13
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
Exercise 10
FIFO Method
Material Conversio
s n
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
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Chapter 13 Cost-Volume-Profit Relationships
f. Work in Process...........................................................240,000
Manufacturing Overhead......................................... 240,000
30,000 MH x P8 per MH = P240,000.
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
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Cost-Volume-Profit Relationships Chapter 13
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
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
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Chapter 13 Cost-Volume-Profit Relationships
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
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
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Cost-Volume-Profit Relationships Chapter 13
Requirement 2
Equivalent
units of – 220,000 214,000
productio
n (b)
Cost per – P2.94 + P1.30 =
EU (a) P4
(b) .2
4
Requirement 3
Requirement 4
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Chapter 13 Cost-Volume-Profit Relationships
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
Pounds to be accounted for:
Work in process, May 1
(materials all complete, labor
and overhead 4/5 complete)..... 35,000
Started into production................ 280,000
Total pounds to be accounted for..... 315,000
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Cost-Volume-Profit Relationships Chapter 13
ent ead
Unit
Cost to
be
accoun
ted for:
Work in P 63,700 P 43,400 P 20,300
process
, May 1
Cost
adde 587,300 397,600 189,700
d
durin
g the
mont
h
Total cost
to be P651,000 P441,000 P210,000
accoun
ted for
(a)
Cost Reconciliation
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Chapter 13 Cost-Volume-Profit Relationships
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
CHAPTER 11
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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
non-value-added activities and thereby streamline operations and
minimize costs.
5. The four general levels of activities are:
1. Unit-level activities, which are performed each time a unit is
produced.
2. Batch-level activities, which are performed each time a batch of
goods is handled or processed.
3. Product-level activities, which are performed as needed to support
specific products.
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III. Exercises
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Chapter 13 Cost-Volume-Profit Relationships
Exercise 1
Examples of Examples of
Activity Traceable Cost
Activity Classification Costs Drivers
a. Materials are moved Batch-level Labor cost; Number of
from the receiving depreciation receipts;
dock to product pounds
of equipment;
flow lines by a handled
space cost
material-handling
crew
b. Direct labor workers Unit-level Direct labor Direct labor-
assemble various cost; indirect hours
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 trained
company costs
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
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
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Exercise 3
Note: Some of these classifications are debatable and may depend on the
specific circumstances found in particular companies.
Exercise 4
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Chapter 13 Cost-Volume-Profit Relationships
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
Requirement 2
(a)
Estimate (b)
d
Overhea Total (a) ÷ (b)
d
Activities Cost Expected Activity Rate
Activity
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
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Cost-Volume-Profit Relationships Chapter 13
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
Specia Regula
l r
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
Problem 1
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Chapter 13 Cost-Volume-Profit Relationships
Requirement 1
(a)
Total overhead = P200,000 + P32,000 + P100,000 + P120,000
= P452,000
Requirement 2
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Requirement 1
The first-stage allocation of costs to the activity cost pools appears below:
Requirement 2
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Chapter 13 Cost-Volume-Profit Relationships
Requirement 3
Requirement 4
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
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Cost-Volume-Profit Relationships Chapter 13
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
(a) (a) × (b)
Predetermined (b) Overhead
Activity Cost Pool Overhead Rate Activity Applied
Machine setups....................................................................................
P720 per setup 150 setups P108,000
Special milling.....................................................................................
P300 per MH 1,000 MHs 300,000
General factory....................................................................................
P50 per DLH 4,000 DLHs 200,000
Total manufacturing overhead cost (a)................................................. P608,000
Number of units produced (b).............................................................. 20,000
Overhead cost per unit (a) ÷ (b)........................................................... P30.40
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
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Chapter 13 Cost-Volume-Profit Relationships
b. The unit product cost of each model under activity-based costing would
be computed as follows:
Model
HY5 AS2
Direct materials.........................................................................................................
P35.00 P25.00
Direct labor (P20 per DLH × 0.2 DLH; P20 per DLH × 04.DLH)............................ 4.00 8.00
Manufacturing overhead (above)...............................................................................
30.40 21.80
Total unit product cost...............................................................................................
P69.40 P54.80
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
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.
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Cost-Volume-Profit Relationships Chapter 13
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)
Setup cost per unit (a) ÷ (b)....................................................... P1.80
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 6. A
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Chapter 13 Cost-Volume-Profit Relationships
3. C 13. C 7. B
4. B 14. A 8. A
5. A 15. C 9. B
6. D 16. D 10. D
7. A 17. D 11. B
8. B 18. C 12. C
9. D 19. B 13. A
10. C 20. A 14. 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.
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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Cost-Volume-Profit Relationships Chapter 13
manufacturing overhead cost that has been carried over with the units is
included as part of that period’s cost of goods sold.
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.
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Chapter 13 Cost-Volume-Profit Relationships
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
Requirement 2
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Requirement 1
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Chapter 13 Cost-Volume-Profit Relationships
*Direct materials.......................................................................................................
P10
Direct labor.............................................................................................................
4
Variable manufacturing overhead............................................................................
2
Total variable manufacturing cost...........................................................................
P16
Requirement 2
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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Cost-Volume-Profit Relationships Chapter 13
* 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
The break-even point in units sold can be computed using the contribution
margin per unit as follows:
Selling price per unit...............................................................................................
P2,000
Variable cost per unit...............................................................................................
1,200
P 800
Contribution margin per unit...................................................................................
Fixed expenses
Exercise 4 (Absorption
Break-even unitCosting
sales Unit
= Product Cost and Income Statement)
Unit contribution margin
P7,500,000
= P800 per unit
Requirement 1
= 9,375 units
Under absorption costing, all manufacturing costs (variable and fixed) are
included in product costs.
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Chapter 13 Cost-Volume-Profit Relationships
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
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Cost-Volume-Profit Relationships Chapter 13
P4,000,00
Sales.............................................................................. 0
Variable expenses:
Variable cost of goods sold:
Beginning inventory.............................................. P 0
Add variable manufacturing costs 3,100,00
(10,000 units × P310 per unit).......................... 0
Goods available for sale........................................3,100,000
Less ending inventory 620,00
(2,000 units × P310 per unit)............................. 0
Variable cost of goods sold*......................................2,480,000
Variable selling and administrative 160,00
(8,000 units × P20 per unit)................................... 0 2,640,000
Contribution margin...................................................... 1,360,000
Fixed expenses:
Fixed manufacturing overhead.................................. 600,000
400,00
Fixed selling and administrative................................ 0 1,000,000
Net operating income.................................................... P 360,000
* 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
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Chapter 13 Cost-Volume-Profit Relationships
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.
Requirement 2
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Requirement 3
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
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Chapter 13 Cost-Volume-Profit Relationships
5 6 7
Absorption costing net operating income.............................
P16,84 P29,37
7 8 P6,018
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
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
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Cost-Volume-Profit Relationships Chapter 13
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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Chapter 13 Cost-Volume-Profit Relationships
Total P10,842,500
Less Fixed Factory Overhead Inventory, 12/31 292,500
Net Income, direct costing P10,550,000
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
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
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Cost-Volume-Profit Relationships Chapter 13
Requirement 1
The unit product cost under the variable costing approach would be
computed as follows:
P 8
Direct materials.......................................................................................................
Direct labor.............................................................................................................
10
Variable manufacturing overhead............................................................................
2
Unit product cost.....................................................................................................
P20
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
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Chapter 13 Cost-Volume-Profit Relationships
Requirement 2
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
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Cost-Volume-Profit Relationships Chapter 13
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
income (loss) P30,000 P 90,000 P(20,000)
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
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Chapter 13 Cost-Volume-Profit Relationships
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 in each year
and that unit product costs were set on the basis of that level of expected
activity, the income statements under absorption costing would have
appeared as follows:
Year 1 Year 2 Year 3
Sales P1,000,000 P 800,000 P1,000,000
Less cost of goods sold:
Cost of goods manufactured @ P16 per unit 800,000 640,000 * 800,000
Add underapplied overhead 120,000 **
Cost of goods sold 800,000 760,000 800,000
Gross margin 200,000 40,000 200,000
Selling and administrative expenses 170,000 150,000 170,000
Net operating income (loss) P 30,000 P(110,000) P 30,000
Requirement 1 (a)
Under absorption costing, all manufacturing costs, variable and fixed, are
included in unit product costs:
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Cost-Volume-Profit Relationships Chapter 13
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
Sales (8,000
units x P50 P400,0 P400,0
per unit) 00 00
Cost of
goods sold:
Beginning P
inventory P 64,00
0 0
Add cost of
goods
manufact
ured
(10,000
units x
P32 per
unit;
6,000
units x
P40 per 320, 240,0
unit) 000 00
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Chapter 13 Cost-Volume-Profit Relationships
Goods
available 320,0 304,0
for sale 00 00
Less ending
inventory
(2,000
units x P32
per unit; 0
units x P40 64,0 256,0 304,0
per unit) 00 00 0 00
Gross 144,00
margin 0 96,000
Selling and
administrat
ive
expenses
(8,000
units x P4
per unit + 102,0 102,0
P70,000) 00 00
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
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Cost-Volume-Profit Relationships Chapter 13
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 P400,0 P400,0
per unit) 00 00
Variable
expenses:
Variable
cost of
goods sold
(8,000
units x P20 P160,0 P160,0
per unit) 00 00
Variable
selling and
administra
tive
(8,000
units x P4 32,0 192,0 32,0 192,0
per unit) 00 00 00 00
Contribution 208,00 208,00
margin 0 0
Fixed
expenses:
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Chapter 13 Cost-Volume-Profit Relationships
Fixed
manufacturi
ng 120,00 120,00
overhead 0 0
Fixed
selling and
administra
tive 70,0 190,0 70,0 190,0
expenses 00 00 00 00
Net
operating P P
income 18,000 18,000
Requirement 3
Requirement 1
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Cost-Volume-Profit Relationships Chapter 13
Variable expenses:
Variable cost of goods sold
(40,000 units × P16 per unit*)...............................................
P640,000
Variable selling and administrative expenses
(40,000 units × P3 per unit)...................................................
120,000 760,000
Contribution margin...................................................................... 590,000
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
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
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Chapter 13 Cost-Volume-Profit Relationships
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
replacement is ignored. However, if asset replacement costs are taken
into account, (i.e., on a “cradle to grave” basis), the long-run net cash
flows equal long-run accrual net income, and the long-run break-even
points are the same.
5. Both unit price and unit variable costs are expressed on a per product
basis, as:
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Cost-Volume-Profit Relationships Chapter 13
II. Exercises
Requirement 1
Total Per Unit
Sales (30,000 units × 1.15 = 34,500 units)..............................................................
P172,500 P5.00
Less variable expenses............................................................................................
103,500 3.00
Contribution margin................................................................................................
69,000 P2.00
Less fixed expenses.................................................................................................
50,000
P 19,000
Net operating income..............................................................................................
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Cost-Volume-Profit Relationships Chapter 13
Requirement 2
Requirement 3
Requirement 4
Requirement 1
The fixed expenses of the Extravaganza total P8,000; therefore, the break-
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Chapter 13 Cost-Volume-Profit Relationships
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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Cost-Volume-Profit Relationships Chapter 13
Total
Sales
Break-even point:
400 persons, or
P12,000 in sales
Total
Fixed
Expenses
Expenses
Requirement 1
Alternative solution:
Break-even Fixed expenses
point = Unit contribution margin
in unit sales
P1,350,000
= P270 per lantern
=13-2155,000 lanterns
Chapter 13 Cost-Volume-Profit Relationships
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
= 13-216P180 per lantern
= 11,500 lanterns
Cost-Volume-Profit Relationships Chapter 13
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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Chapter 13 Cost-Volume-Profit Relationships
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
Cost-Volume-Profit Relationships Chapter 13
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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Chapter 13 Cost-Volume-Profit Relationships
= 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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Cost-Volume-Profit Relationships Chapter 13
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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Chapter 13 Cost-Volume-Profit Relationships
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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Cost-Volume-Profit Relationships Chapter 13
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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Chapter 13 Cost-Volume-Profit Relationships
Requirement (3)
Requirement (1)
Requirement (2)
13-224
Cost-Volume-Profit Relationships Chapter 13
Alternative solution:
X = 0.55X + P360,000 + P0
0.45X = P360,000
X = P360,000 ÷ 0.45
X = P800,000
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Chapter 13 Cost-Volume-Profit Relationships
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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Cost-Volume-Profit Relationships Chapter 13
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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Chapter 13 Cost-Volume-Profit Relationships
b. Expected total peso net operating income for the next year is:
P 90,000
Present net operating income...............................................................
Expected increase in net operating income next year
(150% × P90,000)............................................................................
135,000
Total expected net operating income....................................................
P225,000
III. Problems
Requirement 1
Contribution margin P15
CM ratio= Selling price = P60 =25%
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
Since the fixed expenses are not expected to change, net operating income
will increase by the entire P100,000 increase in contribution margin
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Cost-Volume-Profit Relationships Chapter 13
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%
c. If sales increase by 8%, then 21,600 units (20,000 x 1.08 = 21,600) will
be sold next year. The new income statement will be as follows:
Percent of
Total Per Unit Sales
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Chapter 13 Cost-Volume-Profit Relationships
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.
c. Yes, based on these data the changes should be made. The changes will
increase the company’s net operating income from the present P60,000 to
P78,000 per year. Although the changes will also result in a higher
break-even point (17,500 units as compared to the present 16,000 units),
the company’s margin of safety will actually be wider than before:
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 %
Alternative solution:
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Chapter 13 Cost-Volume-Profit Relationships
= 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
Requirement 4
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Cost-Volume-Profit Relationships Chapter 13
Alternative solution:
= 17,500 units
Requirement 5
= 16,000 units
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.
Note to the Instructor: Although it is not asked for in the problem, if time
permits you may want to compute the point of indifference between the
two alternatives in terms of units sold; i.e., the point where profits will be
the same under either alternative. At this point, total revenue will be the
same; hence, we include only costs in our equation:
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Cost-Volume-Profit Relationships Chapter 13
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
Requirement 3 = 0.43
= P520,000 in sales
Memo to the president:
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
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Chapter 13 Cost-Volume-Profit Relationships
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
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.
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Cost-Volume-Profit Relationships Chapter 13
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
Less variable expenses:
Purchase cost of the patches................................................................................
P15
Commissions to the student salespersons............................................................6 21
P 9
Contribution margin................................................................................................
Since there are no fixed costs, the number of unit sales needed to yield the
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Chapter 13 Cost-Volume-Profit Relationships
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
600,0 TR
00 125 patches x P30 per patch = P3,750 in total sales
If 500,0
a quantity other than 200 patches were ordered, the answer would change
00
accordingly. TC
400,0
(P 00
Problem 6
) 300,0 Break-
Requirement
00 1:even
Break-even chart
point
200,0
00
100,0 FC
00
13-239
250,
000
P 200,
R 000
O 150,
F 000
I 100,
000
T 50,0 Break-
even
0013 Cost-Volume-Profit
Chapter0 point Relationships
5,0 10, 15, 20, 25, 30,
50,0 00 000 000 000 000 000
00
100,
000
L 150,
O
000
S 200,
S 000
250,
000
Requirement (1)
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Cost-Volume-Profit Relationships Chapter 13
Margin of safety
= Actual sales – Break-even sales
in pesos
= P128,000 – P120,000
= P8,000
Margin of safety
= Margin of safety in pesos Actual sales
percentage
= P8,000 P128,000
= 6.25%
Requirement (2)
Margin of safety
= Actual sales – Break-even sales
in pesos
= P160,000 – P134,700
= P25,300
Margin of safety
= Margin of safety in pesos Actual sales
percentage
= P25,300 P160,000
= 15.81%
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Chapter 13 Cost-Volume-Profit Relationships
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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Cost-Volume-Profit Relationships Chapter 13
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,
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
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Cost-Volume-Profit Relationships Chapter 13
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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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making - II
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
Allocated cost 121,000
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Application of Quantitative Techniques in Planning, Control and Decision Making – II Chapter 18
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 Project Overall
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 Project Overall
Operating assets P400,000 P60,000 P460,000
Operating income P100,000 P12,000 P112,000
Minimum required
return at 16% 64,000 9,600* 73,600
RI P 36,000 P 2,400 P 38,400
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making - II
Requirement 1
Requirement 2
Division X would reject this investment opportunity since the addition would
lower the present divisional ROI. Divisions Y and Z would accept it because
they would look better in terms of their divisional ROI.
Requirement 1
7% X 3 = 21%
9% X 2 = 18%
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
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Application of Quantitative Techniques in Planning, Control and Decision Making – II Chapter 18
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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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making - II
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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Application of Quantitative Techniques in Planning, Control and Decision Making – II Chapter 18
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.
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
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making - II
Division A should transfer the 1,000 additional units to Division B. Note that
Division B’s processing adds P425 to each unit’s selling price (B’s P600
selling price, less A’s P175 selling price = P425 increase), but it adds only
P300 in cost. Therefore, each tube transferred to Division B ultimately
yields P125 more in contribution margin (P425 – P300 = P125) to the
company than can be obtained from selling to outside customers. Thus, the
company as a whole will be better off if Division A transfers the 1,000
additional tubes to Division B.
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 + Number of units transferred
per unit
.
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.
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
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Application of Quantitative Techniques in Planning, Control and Decision Making – II Chapter 18
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
Assuming Division B has no outside sales, Division A should buy inside from
Division B for the benefit of the entire firm.
Requirement 2
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making - II
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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Application of Quantitative Techniques in Planning, Control and Decision Making – II Chapter 18
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.
Requirement 1
Product
A B C
Incremental sales P71,000 P46,000 P117,000
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making - II
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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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
Requirement 1
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making - II
Requirement 2
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:
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Application of Quantitative Techniques in Planning, Control and Decision Making – II Chapter 18
% 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
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
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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 cost on lost sales
Transfer price + Number of units transferred
per unit
P0
Transfer price P16 + 10,000 =P16
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 cost on lost sales
Transfer price + Number of units transferred
per unit
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 cost on lost sales
Transfer price + Number of units transferred
per unit
In this case, the transfer price must fall within the range:
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 cost on lost sales
Transfer price + Number of units transferred
per unit
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%
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.
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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
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.
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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:
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:
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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:
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:
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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)
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
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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)
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,
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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 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.
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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
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.
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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
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.
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1. C 6. A
2. H 7. B
3. E 8. J
4. F 9. D
5. I 10. G
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III. Exercises
Requirement 1
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
P 90,000
From August sales: P900,000 × 10%......................................................................
From September sales: P500,000 × (70% + 10%)...................................................
400,000
Total accounts receivable........................................................................................
P490,000
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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
Assuming that the direct labor workforce is adjusted each quarter, the direct
labor budget would be:
1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter Year
Units to be produced 5,000 4,400 4,500 4,900 18,800
Direct labor time per unit (hours)
× 0.40 × 0.40 × 0.40 × 0.40 × 0.40
Total direct labor hours needed 2,000 1,760 1,800 1,960 7,520
Direct labor cost per hour × P11.00 × P11.00 × P11.00 × P11.00 × P11.00
Total direct labor cost P 22,000 P 19,360 P 19,800 P 21,560 P 82,720
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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:
Requirement 1
Kiko Corporation
Manufacturing Overhead Budget
Requirement 2
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Helene Company
Selling and Administrative Expense Budget
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Financing:
Borrowings 8 20 * — — 28
Repayments (including interest) 0 0 (25) (7)* (32)
Total financing 8 20 (25) (7) (4)
Cash balance, ending P5 P 5 P 5 P 6 P 6
*Given.
IV. Problems
Requirement 1
P 7,400
September cash sales...............................................................................................
September collections on account:
July sales: P20,000 × 18%.....................................................................................
3,600
August sales: P30,000 × 70%................................................................................
21,000
September sales: P40,000 × 10%...........................................................................
4,000
Total cash collections..............................................................................................
P36,000
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
P 9,000
Cash balance, September 1......................................................................................
Add cash receipts:
Collections from customers...................................................................................
36,000
Total cash available before current financing..........................................................
45,000
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Less disbursements:
Payments to suppliers for inventory.......................................................................
P21,000
Selling and administrative expenses......................................................................
9,000 *
Equipment purchases.............................................................................................
18,000
Dividends paid.......................................................................................................
3,000
Total disbursements.................................................................................................
51,000
Excess (deficiency) of cash available over
disbursements......................................................................................................
(6,000)
Financing:
Borrowings............................................................................................................
11,000
Repayments...........................................................................................................
0
Interest...................................................................................................................
0
Total financing........................................................................................................
11,000
P 5,000
Cash balance, September 30....................................................................................
* P13,000 – P4,000 = P9,000.
Requirement 1
Production budget:
July August September 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
P 60,000
Cash sales—June....................................................................................................
Collections on accounts receivable:
May 31 balance......................................................................................................
72,000
June (50% × 190,000)............................................................................................
95,000
Total cash receipts...................................................................................................
P227,000
P 90,000
May 31 accounts payable balance...........................................................................
June purchases (40% × 200,000).............................................................................
80,000
Total cash payments................................................................................................
P170,000
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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
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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
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
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Requirement 3
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
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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
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
If the company needs a minimum cash balance of P20,000 to start each month,
the loan cannot be repaid in full by June 30. If the loan is repaid in full, the
cash balance will drop to only P9,000 on June 30, as shown above. Some
portion of the loan balance will have to be carried over to July, at which time
the cash inflow should be sufficient to complete repayment.
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Department 1
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
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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Financing:
Borrowings............................................... 10,000 4,000 14,000
Repayment............................................... 0 0 (14,000) (14,000)
Interest...................................................... 0 0 (380) (380)
Total financing........................................... 10,000 4,000 (14,380) (380)
P P
8,0 9,2
Cash balance, ending.................................
P 8,410 20 65 P 9,265
* 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
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Payments of Purchases
60% - month of purchase P874,368 P 952,776
40% - following month 582,912
Total (18) P1,535,688
(19)
February
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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Questions 26 to 29:
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Schedule I
CHAPTER 16
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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 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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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
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 1. H 6. D 6. B 6. F
III. Exercises
Requirement 1
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Requirement 2
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
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= P19,800 = P18,000
Alternatively:
Materials Price Variance = AQ (AP – SP)
11,000 board feet (P1.70 per board foot* – P1.80 per board foot) =
P1,100 F
P1,100 F Total P1,800 U
Variance,
Quantity
P1.80 per board foot (11,000 board feet – 10,000 board feet) = P1,800 U
Variance,
Price
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
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Efficiency
P1,300 U
Variance,
Variance,
Rate
Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making - II
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
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
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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.
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Standard Rate
(AH×AR) (AH×SR) (SH×SR)
1,150 hours × 1,150 hours × 1,200 hours ×
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
* 5,000 metal molds × 4.0 pounds per metal mold = 20,000 pounds
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Variance,
Quantity
P500 F
19,800 pounds x
P2.50 per pound
= P49,500
Variance,
P11,250
Price
U
Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making - II
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
* 5,000 metal molds × 0.6 hour per metal mold = 3,000 hours
Alternatively:
Labor Rate Variance = AH (AR – SR)
3,600 hours (P8.70 per hour – P9.00 per hour) = P1,080 F
Efficiency
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
Variance,
*5,000 metal molds × 0.3 hours per metal mold = 1,500 hours
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Efficiency
Variance,
P720 U Total P600 U
P1,320 U
Variance,
Spending
Variance,
Application of Quantitative Techniques in Planning, Control and Decision Making – II Chapter 18
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
Alternatively:
Materials Price Variance = AQ (AP – SP)
P5,280 F Total P6,912 U
Variance,
Requirement 2
a.
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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
Alternatively:
Efficiency
Variance,
P2,352 U Total 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
Alternatively:
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Efficiency
Variance,
P2,352 U Total P1,728 F
Variance,
P624 U
Spending
Variance,
Application of Quantitative Techniques in Planning, Control and Decision Making – II Chapter 18
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.
Labor variances:
Unfavorable rate variance: Use of highly skilled workers, change in wage
rates, inaccurate standards, overtime.
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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
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
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CHAPTER 18
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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.
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.
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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)
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
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making - II
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
Problem 2
Requirement (a)
The critical path through each of the three alternative paths calculated as the
longest is 0 - 1 - 6- 7- 8.
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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)
TASKS 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
Machini
X X X X Order 1 X X Order 3 X X X Order 4 Order 2
ng
___________
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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It is necessary to evaluate the annual carrying costs and expected stockout costs
at each safety-stock level. The carrying cost will be P24.40 for each unit in
safety stock. With the given order size, there are 15 orders placed a year
(i.e., 39,000/2,600 = 15). Based on these computations, we prepare the
following schedule:
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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7. Not necessarily. An apparent loss may be the result of allocated common
costs or of sunk costs that cannot be avoided if the product line is
dropped. A product line should be discontinued only if the contribution
margin that will be lost as a result of dropping the line is less than the
fixed costs that would be avoided. Even in that situation the product line
may be retained if its presence promotes the sale of other products.
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
Item Relevant Not Relevant Not
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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
Variable manufacturing overhead 10 150,000
Fixed manufacturing overhead, traceable1 20 300,000
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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:
Direct materials 1,430.00 14,300.00
Direct labor 860.00 8,600.00
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Variable manufacturing overhead 70.00 700.00
Special filigree 60.00 600.00
Total variable cost P2,420.00 24,200.00
Fixed costs:
Purchase of special tool 4,650.00
Total incremental cost 28.850.00
Incremental net operating income P 6.145.00
Even though the price for the special order is below the company’s regular price
for such an item, the special order would add to the company’s net operating
income and should be accepted. This conclusion would not necessarily
follow if the special order affected the regular selling price of bracelets or if
it required the use of a constrained resource.
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
P12 P 9 P10
Contribution margin per direct labor-hour (1) ÷ (4)..............................................................
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.
Requirement 3
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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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Fuel and upkeep on boat per trip............................. P25
Junk food consumed during trip*............................ 8
Snagged fishing lures.............................................. 7
Total........................................................................ P40
* 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
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
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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:
Total If Net 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
Program administrators’ salaries................................ 115,000 78,000 37,000
General administrative overhead................................ 180,000 180,000 0
Total fixed expenses.....................................................
405,000 353,000 52,000
Net operating income (loss).........................................
P 5,000 P(23,000) P (28,000)
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*Includes pro-rated loss on disposal of the van if it is donated to a charity.
Requirement 2
Requirement 1
Total for
Per 2,000
Unit Units
P12.0 P24,00
Incremental revenue........................................................................
0 0
Incremental costs:
Variable costs:
Direct materials..........................................................................
2.50 5,000
Direct labor................................................................................
3.00 6,000
Variable manufacturing overhead............................................... 0.50 1,000
Variable selling and administrative............................................. 1.50 3,000
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Management Accounting: An Overview Chapter 1
Fixed costs:
None affected by the special order............................................. 0
Total incremental cost......................................................................15,000
P
9,0
Incremental net operating income................................................... 00
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.
The costs that are relevant in a make-or-buy decision are those costs that can be
avoided as a result of purchasing from the outside. The analysis for this
exercise is:
Per Unit
Differential
Costs 20,000 Units
Make Buy Make Buy
Cost of purchasing........................................................ P23.50 P470,000
Cost of making:
P 4.80
Direct materials........................................................... P 96,000
Direct labor.................................................................
7.00 140,000
Variable manufacturing overhead............................... 3.20 64,000
Fixed manufacturing overhead................................... 4.00 * 80,000
Total cost.....................................................................
P19.00 P23.50 P380,000 P470,000
* The remaining P6 of fixed manufacturing overhead cost would not be relevant, since it
will continue regardless of whether the company makes or buys the parts.
The P150,000 rental value of the space being used to produce part R-3 represents
an opportunity cost of continuing to produce the part internally. Thus, the
completed analysis would be:
Make Buy
Total cost, as above..........................................................................................
P380,000 P470,000
Rental value of the space (opportunity cost)....................................................
150,000
Total cost, including opportunity cost..............................................................
P530,000 P470,000
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Net advantage in favor of buying.....................................................................
P60,000
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)
In(1 + 0.55814)
=
In(1 – 0.22346)
In(1.55814)
=
In(0.77654)
0.44349
= = –1.75
–0.25291
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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.
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:
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Selling price of Variable cost of
the new product the new product +
Selling price of
the new product P4.60 + P34 per minute + 0.75 minute
Selling price of
the new product P4.60 + P25.50 = P30.10
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
Selling price per unit P1.20 P1.40
Less Variable costs/unit:
Materials 0.50 0.70
Labor 0.20 0.24
Factory overhead (25%) 0.10 0.14
0.80 1.08
Contribution margin/unit P0.40 P0.32
Multiplied by number of units to be sold 21,000 units 30,000 units
Total contribution margin P8,400 P9,600
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Management Accounting: An Overview Chapter 1
Requirement 1
No, production and sale of the round trampolines should not be discontinued.
Computations to support this answer follow:
Requirement 2
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
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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
Based on the above analysis, first priority should be given to Product D. The
company should use 4,000 out of the available 96,000 hrs. to produce 4,000
units of product D. The remaining 92,000 hrs. should be used to produce
9,200 units of Product B. Hence, the best product combination is 4,000 units
of Product D and 9,200 units of Product B.
Requirement 2
If there were no market limitations on any of the products, the company should
use all the available 96,000 hours in producing 96,000 units of product D
only.
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Management Accounting: An Overview Chapter 1
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
P8.75, the total variable manufacturing cost.
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
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Present contribution margin
[10,000 units x (P15 - P9)] P60,000
Less proposed contribution margin
[(P14 - P9) x 11,000 units] 55,000
Decrease in contribution margin P 5,000
The company should not reduce the selling price from P15 to P14 even if volume
will go up because total contribution margin will decrease.
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 - - -
Total P100,000 P125,000 P150,000
Contribution margin P 60,000 P 35,000 P 10,000
Sales (5,000 x P40) P200,000 P200,000 P200,000
Less variable costs
Production cost @ P25 100,000 125,000 150,000
Purchase cost @ P45 45,000 - -
Total P145,000 P125,000 P150,000
Contribution margin P 55,000 P 75,000 P 50,000
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Management Accounting: An Overview Chapter 1
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.
Requirement B: P60.14
Requirement C: P74.29
Requirement D: P56.58
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Direct labor 30,000
Variable manufacturing overhead 10,000
Fixed manufacturing overhead* 15,000
Total cost P70,000 P90,000
Requirement 1
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.
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Management Accounting: An Overview Chapter 1
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
Fixed selling costs
(P310,000 × 10% × 2 months)................................................................
62,000 182,000
Net disadvantage of closing, before start-up costs.......................................... (126,000)
Add start-up costs............................................................................................ (14,000)
Disadvantage of closing the plant....................................................................P(140,000)
No, the company should not close the plant; it should continue to operate at
the reduced level of 11,000 gallons produced and sold each month. Closing
will result in a P140,000 greater loss over the two-month period than if the
company continues to operate. Additional factors are the potential loss of
goodwill among the customers who need the 11,000 gallons of KK-8 each
month and the adverse effect on employee morale. By closing down, the
needs of customers will not be met (no inventories are on hand), and their
business may be permanently lost to another supplier.
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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
Less start-up costs....................................................................................................
14,000
Net avoidable costs..................................................................................................
P168,000
=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
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Management Accounting: An Overview Chapter 1
Requirement (1)
The postal service makes more money selling the souvenir sheets at the
lower price, as shown below:
P500 Price P600 Price
Unit sales.................................................. 50,000 40,000
Requirement (2)
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
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= –1.2239
Requirement (3)
Profit-maximizing –1
=
markup on variable cost 1+d
–1
= = 4.4663
1 + (–1.2239)
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Management Accounting: An Overview Chapter 1
P500.
§
The quantity sold in each cell of the table is computed by multiplying the
quantity sold just above it in the table by 50,000/40,000. For example, 62,500
is computed by multiplying 50,000 by the fraction 50,000/40,000.
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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The contribution margin is plotted below as a function of the selling price:
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 ×
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Management Accounting: An Overview Chapter 1
5.4663, or P55.
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 2,340 6 P390
Raya........................
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
18-341
Jane P340 6 29
Ma. Cecilia...... P340 4 27
Anna................ P320 5 38
Catherine......... P320 3 41
Emily............... P310 4 45
Lourdes............ P310 3 48
Given that Ji Eun should not be asked to work more than 33 hours, the four
customers below the line in the above table should be told that their
reservations have to be cancelled.
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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Management Accounting: An Overview Chapter 1
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
18-343
tasks that can be done by other persons. For example, an assistant can be
assigned to prepare frosting and to clean up, relieving Ji Eun of those
tasks. As long as the cost of the assistant’s time is less than P34 per hour,
the result will be higher profits and more pleased customers.
Ms. Hye Young should consider assigning an apprentice to Ji Eun. The
apprentice could relieve Ji Eun of some of her workload while learning
the skills to eventually expand the company’s cake decorating capacity.
Ms. Hye Young might consider subcontracting some of the less
demanding cake decorating to another baker. This would be profitable as
long as the charge is less than P340 per hour.
IV. Multiple Choice Questions
1. C 11. D 21. D 31. A
2. C 12. A 22. A 32. D
3. B 13. D 23. D 33. C
4. B 14. A 24. E 34. A
5. A 15. D 25. B 35. C
6. B 16. C 26. D
7. C 17. A 27. D
8. B 18. C 28. C
9. A 19. B 29. A
10. B 20. C 30. A
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Management Accounting: An Overview Chapter 1
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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Contribution margin P 300,000
Less: Fixed costs
Factory overhead P 50,000
Marketing expenses 30,000
Administrative expenses 20,000
Increase in fixed costs 10,000 110,000
Profit P 190,000
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Management Accounting: An Overview Chapter 1
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.
3. The basic principles in capital budgeting are:
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1. Capital investment models are focused on the future cash inflows
and outflows - rather than on net income.
2. Investment proposals should be evaluated according to their
differential effects on the company’s cash flows as a whole.
3. Financing costs associated with the project are excluded in the
analysis of incremental cash flows in order to avoid the “double-
counting” of the cost of money.
4. The concept of the time value of money recognizes that a peso of
present return is worth more than a peso of future return.
5. Choose the investments that will maximize the total net present value
of the projects subject to the capital availability constraint.
4. The major classifications as to purpose are:
1. Replacement projects
- those involving replacements of worn-out assets to avoid
disruption of normal operations, or to improve efficiency.
2. Product or process improvement
- projects that aim to produce additional revenue or to realize cost
savings.
3. Expansion
- projects that enhance long-term returns due to increased
profitable volume.
5. Greater amounts of capital may be used in projects whose combined
returns will exceed any alternate combination of total investment.
6. No. This implies that any equity funds are cost free and this is a
dangerous position because it ignores the opportunity cost or alternative
earnings that could be had from the fund.
7. Yes, if there are alternative earnings foregone by stockholders.
8. Capital budgeting screening decisions concern whether a proposed
investment project passes a preset hurdle, such as a 15% rate of return.
Capital budgeting preference decisions are concerned with choosing
from among two or more alternative investment projects, each of which
has passed the hurdle.
9. The “time value of money” refers to the fact that a peso received today is
more valuable than a peso received in the future. A peso received today
can be invested to yield more than a peso in the future.
10. Discounting is the process of computing the present value of a future
cash flow. Discounting gives recognition to the time value of money and
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Management Accounting: An Overview Chapter 1
1. A 6. H
2. C 7. D
3. F 8. G
4. B 9. J
5. I 10. E
III. Exercises
18-349
The annual incremental net operating income is determined by comparing the
operating cost of the old machine to the operating cost of the new machine
and the depreciation that would be taken on the new machine:
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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Management Accounting: An Overview Chapter 1
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
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
18-351
the present value of the investment required.
3.
Factor of the internal Required investment
rate of return = Annual cash inflow
Exercise 6 (Basic Net Present Value and Internal Rate of Return Analysis)
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.
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Management Accounting: An Overview Chapter 1
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
If the annual cash savings decrease from P18,850 to P14,997 or by P3,503, the
point of indifference will be reached.
Another alternative way to get the same answer would be to divide the net
present value of P9,423 by 2.690.
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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)
Since the net present value is positive, the computer should be purchased
replacing the manual bookkeeping system.
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Management Accounting: An Overview Chapter 1
Problem 3
Requirement 1
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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
2. Using this cost savings figure, and other data provided in the text, the net
present value analysis is:
Present
Amount of 18% Value of
Year(s) Cash Flows Factor Cash Flows
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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
12%
(1) × F
(2) a
After- c Present
(1) (2) Tax t Value of
Amoun Tax Cash o Cash
Items and Computations Year(s) t Effect Flows r Flows
P(450,00 P(450,00 1.00 P(450,00
Investment in new trucks................... Now 0) 0) 0 0)
Salvage from sale of the old P30,00 1– 1.00
trucks.............................................
Now 0 0.30 P21,000 0 21,000
P108,0 1– 4.96
Net annual cash receipts....................1-8 00 0.30 P75,600 8 375,581
P56,25 4.96
Depreciation deductions*................... 1-8 0 0.30 P16,875 8 83,835
P(45,000 1 – 0.56
Overhaul of motors............................5 ) 0.30 P(31,500) 7 (17,861)
Salvage from the new P20,00 1– 0.40 5,65
trucks.............................................
8 0 0.30 P14,000 4 6
P 18,21
Net present value............................... 1
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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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b. The expected annual cash inflow would be:
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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5. A 15. C 25. C 35. D
6. C 16. D 26. C 36. B
7. D 17. D 27. D 37. B
8. B 18. B 28. B 38. B
9. B 19. A 29. D 39. D
10. A 20. A 30. A 40. B
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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Requirement 2
Segments
Total Company Manila Cebu
Amount % Amount % Amount %
Sales.............................................
P800,000 100.0% P200,000 100% P600,000 100%
Less variable expenses................. 420,000 52.5 60,000 30 360,000 60
Contribution margin..................... 380,000 47.5 140,000 70 240,000 40
Less traceable fixed
expenses...................................168,000 21.0 78,000 39 90,000 15
Office segment margin................. 212,000 26.5 P 62,000 31% P150,000 25%
Less common fixed
expenses not traceable to
segments...................................120,000 15.0
Net operating income................... P 92,000 11.5%
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
Amount % Amount % Amount % Amount %
Sales P1,500,000 100.0 P400,000 100 P600,000 100 P500,000 100
Less variable expenses 588,000 39.2 208,000 52 180,000 30 200,000 40
Contribution margin 912,000 60.8 192,000 48 420,000 70 300,000 60
Less traceable fixed expenses 770,000 51.3 240,000 60 330,000 55 200,000 40
Geographic market segment margin
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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
P 27,000
Net operating income....................................................
1. B 6. A 11. A
2. C 7. C 12. B
3. B 8. B
4. B 9. D
5. B 10. C
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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.
5. Sensitivity analysis adds an extra dimension to budgeting. It enables
managers to examine how budgeted amounts change with changes in
the underlying assumptions. This assists managers to monitor those
assumptions that are most critical to a company attaining its budget or
make timely adjustments to plans when appropriate.
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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
Requirement 8
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Direct materials
Wood P30.00 5.00 P150.00
Fiberglass 5.00 6.00 30.00
Direct manufacturing labor 25.00 5.00 125.00
Total manufacturing overhead 95.00
P400.00
a
cost is per board foot, yard or per hour
b
inputs is the amount of input per board
Requirement 9
Requirement 10
From
Schedule Total
Beginning finished goods
inventory, January 1,
2006 Given P 37,480
Direct materials used 3A P193,800
Direct manufacturing labor 4 137,500
Manufacturing overhead 5 104,500
Cost of goods 435,800
manufactured
Cost of goods available for
sale 473,280
Deduct ending finished
goods inventory,
December 31, 2006 6B 80,000
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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
I. Questions
1.
Strategy Weakness
Cost The tendency to cut costs in a way that
leadership undermines demand for the product or
service.
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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
with the productivity component to evaluate a company’s cost leadership
strategy.
5. A company’s balanced scorecard should be derived from and support its
strategy. Since different companies have different strategies, their
balanced scorecards should be different.
6. The difference between the delivery cycle time and the throughput time
is the waiting period between when an order is received and when
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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):
Process time Throughput 11.1% 9.4% 12.8% 13.8%
time................................................................
Delivery cycle time in days:
Wait time........................................................
9.6 8.7 5.3 4.7
Total throughput time.....................................
5.4 5.3 3.9 2.9
Total delivery cycle time................................
15.0 14.0 9.2 7.6
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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
11. D 16. C
12. D 17. D
13. C 18. C
14. A 19. D
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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:
a. It is intuitive and easily understood.
b. It provides a useful basis for comparison among SBUs.
c. It is widely used.
The limitations of return on investment are:
a. It has an excessive short-term focus.
b. Investment planning uses discounted cash flow analysis while
managers are evaluated on ROI.
c. It contains a disincentive for new investment by the most profitable
units.
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4. The key advantage of residual income is that it deals effectively with the
limitation of ROI, that is ROI has a disincentive for the managers of the
most profitable units to make new investments. With residual income,
no matter how profitable the unit, there is still an incentive for new
profitable investment. In contrast, a key limitation is that since residual
income is not a percentage, it suffers the same problem of profit SBUs in
that it is not useful for comparing units of significantly difference sizes.
It favors larger units that would be expected to have larger residual
incomes, even with relatively poor performance. Moreover, relatively
small changes in the desired minimum rate of return can dramatically
affect the residual income for different size units. And, in contrast to
ROI, some managers do not find residual income to be as intuitive and as
easily understood.
5. Economic value added (EVA) is a business unit’s income after taxes and
after deducting the cost of capital. The idea is very similar to what we
have explained as residual income. The objectives of the measures are
the same – to effectively motivate investment SBU managers and to
properly measure their performance. In contrast to residual income, EVA
uses the firm’s cost of capital instead of a desired rate of return. For
many firms the desired rate of return and the cost of capital will be
nearly the same, with small differences due to adjustments for risk and
for strategic goals such as the desired growth rate for the firm. Also,
while residual income is intended to deal with the undesirable effects of
ROI, EVA is used to focus managers’ attention on creating value for
shareholders, by earning profits greater than the firm’s cost of capital.
6. Examples of financial and nonfinancial measures of performance are:
Financial: ROI, residual income, and return on sales.
Nonfinancial: Manufacturing lead time, on-time performance, number
of new product launches, and number of new patents
filed.
7. The six steps in designing an accounting-based performance measure
are:
a. Choose performance measures that align with top management’s
financial goal(s).
b. Choose the time horizon of each performance measure in Step 1.
c. Choose a definition of the components in each performance measure
in Step 1.
d. Choose a measurement alternative for each performance measure in
Step 1.
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d. Divisions operating in different countries keep score of their
performance in different currencies.
13. a. Consider each activity and the organization itself from the
customer’s perspective,
b. Evaluate each activity using customer-validated measures of
performance,
c. Consider all facets of activity performance that affect customers and
are comprehensive, and
d. Provide feedback to help organization members identify problems
and opportunities for improvement.
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
Return on 25% 15%
Investment
Residual Income:
(a) * at 11% P180 P400
(b) ** at 15% 100 0
(c) *** at 17% 60 (200)
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Management Accounting: An Overview Chapter 1
P100 P 0
*** P400 – (P2,000 x 0.17) = P1,500 – (P10,000 x 0.17) =
P 60 P(200)
Requirement 1
Investing in the new plant would lower JSD’s ROI and, hence, limit Tan’s bonus.
Requirement 2
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Operating income for new plant P 480,000
Charge for funds
(Investment, P2,500,000 x 15%) 375,000
Residual income P 105,000
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.
III. Problems
Requirement 1
Truck Rental Transportatio
Division n Division
Total assets P650,000 P950,000
Current liabilities 120,000 200,000
Investment
(Total assets – current 530,000 750,000
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Management Accounting: An Overview Chapter 1
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
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
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Rental Division.
Supporting Calculations:
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
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Management Accounting: An Overview Chapter 1
(a)
Operating income Operating income
Phil. Division’s ROI in 2005 = Total assets = P8,000,000 =15%
(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
P1,080,000
Comparable ROI for Swedish Division= P7,500,000 =14.4%
Requirement 3
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= P1,200,000 – P960,000 = P240,000
Requirement 1
P130,000
Luzon Division = 38.24%
P340,000
P220,000
Visayas Division = 19.13%
P1,150,000
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.
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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)
Luzon P200,000 + P238,000 = P 438,000
Visayas P250,000 + P1,125,000 = P1,375,000
Mindanao P300,000 + P1,402,500 = P1,702,500
Gross book value of long-term assets at current cost at the end of 2005
(from Step 1) x (1 12)
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Luzon P130,000 – (P119,000 – P70,000) = P 81,000
Visayas P220,000 – (P125,000 – P100,000) = P195,000
Mindanao P380,000 – (P127,500 – P120,000) = P372,500
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%
Requirement 3
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Management Accounting: An Overview Chapter 1
CHAPTER 25
I. Questions
1. Productivity is the relationship between the output and the input
resources required for generating the output.
2. A critical success factor for a firm that competes as a cost leader is to be
the low cost provider. A low cost provider needs to perform the required
tasks for the same output with fewer resources than its competitors.
3. Among criteria that often are used in assessing productivity and their
advantages and disadvantages are:
Using a prior year’s productivity as the criterion
Advantages:
Data readily available
Facilitates monitoring of continuous improvements
Disadvantages:
Difficult to assess adequacy of productivity improvements
Hard to compare productivity improvements between the years
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Motivates people to strive for the maximum potential
Disadvantages:
The standard can be too high for the operation and frustrating to
workers
Data may be difficult to obtain
The criteria on which the operation is based may not be comparable
4. An operational productivity is the ratio of the output to the number of
units of an input resource.
A financial productivity measures the relationship between the output
and the cost of one or more of the input resources.
5. A partial productivity is a productivity measure that focuses only on the
relationship between the amount of one of the input resources and the
output attained.
A total productivity measures the relationship between the output and the
total input costs of all the required input resources for the output.
6. Manufacturing personnel often prefer operational productivity measures
over financial productivity measures because all the input data for
computing operational productivity measures are either results of their
activities or resources consumed for these activities. Financial
productivity measures use costs of resources that often are results of
activities by personnel outside of manufacturing functions.
7. Measurements of marketing effectiveness include market share, sales
price, sales mix, and sales quantity variances.
8. Sales quantity variance is a component of sales volume variance. A sales
volume variance can be the result of both sales mix and sales quantity
variances.
9. A market size variance measures the effect on the contribution margin
and operating income of a firm because of changes in the total market
size for all firms in the same industry or product segment. A market
share variance examines the effect on the contribution margin and
operating income of a firm because of deviations of the firm’s actual
market shares from its budgeted market shares.
10. a. No. A multi-product firm can still have an unfavorable sales volume
variance even if it sells more than the budgeted units of sales. The
unfavorable sales volume variance is a result of selling more of less
profitable products and less of more profitable products.
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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 P600,00 18,000 x P720,00
P40 = 0 P40 = 0
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Variable cost of sales:
Materials 12,000 x P P 12,600 x P126,00
8= 96,000 P10 = 0
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 P255,00
sales 0 0
Contribution margin P382,00 P465,00
0 0
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 = 12,000 x P 8
P126,000 = P 96,000
DL 5,000 x P25 = 6,000 x P20=
P125,000 P120,000
Power 2,000 x P 2 = 1,000 x P 2= P
P 4,000 2,000
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Management Accounting: An Overview Chapter 1
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 = 15,000 / 2,000 =
4.5 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.
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
18-391
1/2006 1/2005 1/2005 1/2005
Productivit Productivit Productivit Productivit
y y y y
2006 Input 2006 Input 2005 Input 2005 Input
cost cost cost cost
(1) Output
(unit):
18,000 18,000 18,000 15,000
(2) 1/Productivity
DM: 12,000/15, 12,000/15, 12,000/15,
12,600/1 000 000 000
8,000 = 0.8 = 0.8 = 0.8
= 0.7
DL: 6,000/15,0 6,000/15,0 6,000/15,0
5,000/18 00 00 00
,000 = = 0.4 = 0.4 = 0.4
0.2778
Power: 1,000/15,0 1,000/15,0 1,000/15,0
2,000/18 00 00 00
,000 = = 0.0667 = 0.0667 = 0.0667
0.1111
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Management Accounting: An Overview Chapter 1
10 10 = P115,200 = P96,000
= P126,000 = P144,000
DL: 18,000 x 0.2778 18,000 x 0.4 x 18,000 x 0.4 x 15,000 x 0.4 x
x 25 25 20 20
= P125,010 = P180,000 = P144,000 = P120,000
Power: 18,000 x 18,000 x 0.0667
18,000 x 0.0667 x 215,000 x 0.0667 x 2
0.1111 x 2 = x2 = P2,401 = P2,001
P4,000 = P2,401
Total P255,010 P326,401 P261,601 P218,001
Decompos
ition
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 / 15,000 /
18,000 / 180,000 144,000 = 120,000
125,010 = 0.1 0.125 = 0.125
= 0.1440
Power: 18,000 / 18,000 / 15,000 /
18,000 / 2,401 2,401 2,001
4,000 = 7.4969 = 7.4969 = 7.4963
= 4.5
18-393
DM: 0.1429 0.125 – 0.15625 –
– 0.125 0.15625 0.15625
= 0.0179 = 0.03125 U =0
F
DL: 0.144 – 0.1 – 0.125 0.125 – 0.125
0.1 = 0.025 U =0
= 0.044 F
Power: 4.5 – 7.4969 – 7.4969 –
7.4969 7.4969 7.4963
= 2.9969 =0 = 0.0006
U (rounding)
Summary of
Result
Change as % of 2005
Productivity
Productivity Input PriceTotal ChangeProductivity Input PriceTotal Change
Change Change Change Change
DM: 0.0179 0.03125 0.01335 11.46% 20% U 8.54%
F 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 0 2.9969 39.98% 0 39.98%
U 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. However,
cost increases in direct materials and direct labor reduced the gains in
productivity on these two manufacturing factors
18-394
Management Accounting: An Overview Chapter 1
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
18-395
Rate variance Efficiency variance
= P240,000 F = P840,000 F
2006:
Total actual direct labor hours: 10 x 20,000 = 200,000
Total standard direct labor hours: 11 x 20,000 = 220,000
Recap:
Assembly Testing
Department Department
2005 2006 2005 2006
Rate P1,000,000 U P400,00 P240,00 P200,00
variance 0U 0F 0F
Efficienc P560,00 P700,00 P840,00 P500,00
y 0U 0F 0F 0F
variance
Requirement 2
18-396
Management Accounting: An Overview Chapter 1
Requirement 3
Requirement 5
18-397
Productivity measures use as the criterion the productivity of a prior year without
adjusting for changes occurred or the expected changes for the current year.
As a result, assessments of productivity may depict an entirely different
picture than those of variance analyses in a standard costing system.
Requirement 1
Requirement 2
Sales volume variances for the period for each of the products and for the firm
18-398
Management Accounting: An Overview Chapter 1
Premium Regular
Sales
Volume
Flexible Master
Sales Volume Flexible Master Varianc
Budget Budget Variance Budget Budget e
Barrels 18 18 54 36
0 0 0 0
Sales P27,00 P36,00 P64,80 P43,20
0 0 0 0
Variable
expenses 16,20 21,60 40,50 27,00
0 0 0 0
Contributio
n margin P10,80 P14,40 P3,600 P24,30 P16,20 P8,100
0 0 U 0 0 F
Fixed
expenses 10,00 10,00 5,00 5,00
0 0 – 0 0 –
Operating
income P P P3,600 P19,30 P11,20 P8,100
800 4,400 U 0 0 F
18-399
Total sales volume variance of the firm = P3,600 U + P8,100 F = P4,500
F
Requirement 3
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
18-400
Management Accounting: An Overview Chapter 1
= P6,480 U = P2,880 F
18-401
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
Verification
Requirement 6
Requirement 7
18-402
Management Accounting: An Overview Chapter 1
Requirement 8
The sum of market size variance and market share variance and verification that
this total equals the sales quantity variance.
18-403
Problem 4 (Productivity and Ethics)
Requirement 1
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
Empres Empres
s’ s’
Design Industr Shar Design Industr
s y e s y Share
W 50 500 10.0 45 425 45/42
S % 5
D 25 200 12.5 35 150 35/15
H % 0
Requirement 2
18-404
Management Accounting: An Overview Chapter 1
Requirement 3
Requirement 4
Among possible reasons are quality changes, pricing changes, less producers due
to seasonal variations, and market no longer there.
Requirement 5
Among alternatives are improving costs through adopting activity based costing,
making different signs, using less expensive wood, finding competitive
advantage.
Supporting Computations:
2005 2006
Input Partial Input Partial
Resource Productivi Resource Productivi
Output Used ty Output Used ty
18-405
X-45 0.8
60,00 75,00 64,00 89,60 0.714
0 0 = 0 0 = 3
(1)
Direct
labo 6.0
60,00 10,00 64,00 10,84 5.900
r
0 0 = 0 7 = 2
2005 2006
Cost of Input Partial Cost of Input Partial
Units of Resource Productivi Units of Resource Productivi
Output Used ty Output Used ty
X-45 0.1111
60,00 P540, 64,00 P609, 0.105
0 000 = 0 280 = 0
(3)
Direct
labo 0.2
r 60,00 300,0 64,00(4) P347, 0.184
0 00= 0 104 = 4
Total productivity in units
2005 2006
(a) Total units 60,000 64,000
manufactured
(b) Total variable
manufacturing P840,000 P956,384
costs incurred
(c) Total 0.071429 0.066919
productivity (a) (5)
(b)
(d) Decrease in 0.071429 – 0.0045
18-406
Management Accounting: An Overview Chapter 1
18-407
productivity (1) (4) 1.5385 1.44
Market Share
(13)
Product Product Total
A B
Budgeted sales
unit 30,000 60,000 90,000
Budgeted x
contribution x P10.0
margin per unit P4.00 0
Budgeted total
contribution P120,00 P600,00 P720,00
margin 0 0 0
18-408
Management Accounting: An Overview Chapter 1
Budgeted
average
contribution
margin per unit P8.00
(14)
Produc Produc Total
tA tB
Actual units sold 35,00 65,00
0 0
Budgets sales unit – –
30, 60,
000 000
Differences in sales
units 5,000 5,000
Budgeted x x
contribution P4. P10
margin per unit 00 .00
Sales volume
contribution P20,00 P50,00 P70,00
margin variance 0F 0F 0F
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
18-409
(15)Sales mix contribution margin variance:
Product A: (0.35 – 1/3) x 100,000 x P4 = P 6,667 F
Product B: (0.65 – 2/3) x 100,000 x P10 = 16,667 U
Total sales mix contribution margin variance P10,000 U
18-410
Management Accounting: An Overview Chapter 1
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.
18-411
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;
based on individual performance – ties reward most closely to
performance and likely to have the highest motivational impact.
b. based on salary – may convince lower level employees that they
have little to contribute, does not necessarily reflect contributions;
based on equal share – may have little motivational effect, may lead
to feeling of inequity if some people contribute nothing;
based on position – same as based on salary;
based on individual performance – may be difficult and costly to
administer, may lead to arguments about interpreting the
performance measure.
4. A cash bonus is a cash reward tied to measured performance. A cash
bonus is a bonus that is best related to activities oriented to short-run
performance that should be rewarded immediately to provide a
reinforcement effect. Cash bonuses are best tied to measures of achieved
operating performance such as quality improvement, sales increases, and
success at short-run cost control.
18-412
Management Accounting: An Overview Chapter 1
II. Problems
Problem 1
Requirement (a)
Requirement (b)
Problem 2
Requirement (a)
18-413
P30,000,000 – (0.18 x P72,000,000) = P17,040,000
P17,040,000 x 0.25 = P4,260,000
Therefore, P4,260,000 would be larger.
Requirement (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
18-414
Management Accounting: An Overview Chapter 1
18-415
very powerful stimuli to promote TQM. Efforts and progress will most
likely be short-lived if no change is made to the compensation / appraisal
/ recognition systems to make them in line with the objectives of the
firm’s TQM.
7. The purposes of conducting a quality audit are to identify strengths and
weaknesses in quality practices and levels of a firm’s quality and to help
the firm identify the target areas for quality improvements.
8. A gap analysis is a type of benchmarking that includes analyzing the
differences in practices between the firm and the best-in-class. The
objective of gap analyses is to identify strengths, weaknesses, and target
areas for quality improvement.
9. Some examples of costs associated with cost of quality categories are:
Prevention costs: Training costs such as instructors’ fees, purchase of
training equipment, tuition for external training, training wages and
salaries; salaries for quality planning and executions, cost of preventive
equipment, printing and promotion costs for quality programs, awards
for quality.
Appraisal costs: Costs of raw materials, work-in-process, and finished
goods inspections.
Internal failure costs: Scrap, rework, loss due to downgrades,
reinspection costs, and loss due to work interruptions.
External failure costs: Sales returns and allowance due to quality
deficiency, warranty cost, and canceled sales orders due to quality
deficiency.
10. Prevention costs rise during the early years of implementing TQM as the
firm engages in education to prepare its employees and in the planning
and promotion of the quality program. Appraisal costs will also likely
rise during the early years of TQM, because the firm needs to ensure that
quality is actually being achieved. The increase in appraisal cost,
however, is most likely to occur at a slower pace than those of the
prevention costs because at the beginning of a TQM program there will
be substantial increases in quality training and in promotion to raise
awareness on the importance of quality.
The firm may see some decreases in internal and external failure costs in
the early years of implementing a TQM. However, these two costs most
likely will remain at about the same level as before during the first
several years of TQM. Many firms may actually see internal failure cost
18-416
Management Accounting: An Overview Chapter 1
rise, because of the higher standard demanded by the TQM or the higher
level of employees’ awareness on the critical importance of perfection in
every step of the process. As the firm makes progress in TQM, both
internal failure and external failure costs should decrease.
11. Costs of conformance are costs incurred to ensure that products or
services meet quality standards and include prevention costs and
appraisal costs.
Internal and external failure costs are costs of non-conformance. They
are costs incurred or opportunity costs because of rejection of products or
services.
12. Better prevention of poor quality often reduces all other costs of quality.
With fewer problems in quality, appraisal is needed because the products
are made right the first time. Fewer defective units also reduce internal
and external failure costs as the occasion for repairs, rework, and recalls
decrease.
It is easier to design and build quality in than try to inspect or repair
quality in. Theoretically, if prevention efforts are completely successful,
there will be no need to incur appraisal costs and there will be no internal
failure or external failure costs. In practice, appraisal costs usually do
not decrease, partly because management needs to ensure that quality is
there as expected. Nonconformance costs, however, decrease at a much
faster pace than prevention costs increase.
13. The role of management accountants in total quality management
includes gathering all relevant quality information, participating actively
in all phases of the quality program, and reviewing and disseminating
quality cost reports.
14. To meet the challenges of total quality management, management
accountants need to have a clear understanding of TQM methodology.
They must be able to design, create, or modify information systems that
measure and monitor quality and evaluate progress toward total quality
as expected of each organizational unit and the total enterprise.
15. Just-in-time (JIT) purchasing is the purchase of goods or materials such
that a delivery immediately precedes demand or use. Benefits include
lower inventory holdings (reduced warehouse space required and less
money tied up in inventory) and less risk of inventory obsolescence and
spoilage.
18-417
16. The sequence of activities involved in placing a purchase order can be
facilitated by use of the Internet. A company can streamline the
procurement process for its customers – e.g., having online a complete
price list, information about expected shipment dates, and a service order
capability that is available 24 hours a day with email or fax confirmation.
17. Just-in-time (JIT) production is a “demand-pull” manufacturing system
that has the following features:
Organize production in manufacturing cells,
Hire and retain workers who are multiskilled,
Aggressively pursue total quality management (TQM) to
eliminate defects,
Place emphasis on reducing both setup time and manufacturing
lead time, and
Carefully select suppliers who are capable of delivering quality
materials in a timely manner.
18. Reengineering is the fundamental rethinking and redesign of business
processes to achieve improvements in critical measures of performance
such as cost, quality, service, speed, and customer satisfaction.
19. The three main measures used in the theory of constraints are:
a. Throughput contribution equal to sales revenue minus direct
materials costs.
b. Investments (inventory) equal to the sum of materials costs of direct
materials inventory, work-in-process inventory and finished goods
inventory, research and development costs, and costs of equipment
and buildings.
c. Other operating costs equal to all operating costs (other than direct
materials) incurred to earn throughput contribution.
20. The four key steps in managing bottleneck resources are:
Step 1: Recognize that the bottleneck operation determines throughput
contribution.
Step 2: Search for, and find the bottleneck.
Step 3: Keep the bottleneck busy, and subordinate all nonbottleneck
operations to the bottleneck operation.
Step 4: Increase bottleneck efficiency and capacity.
21. (a) Product warranty costs should be lower because a world-class
manufacturer (WCM) will make fewer defectives.
18-418
Management Accounting: An Overview Chapter 1
18-419
II. Exercises
Inter Exte
nal rnal
Preventi
Apprais Failu Failu
on al re re
a. Warranty
repairs x
b. Scrap x
c. Allowance
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 x
fee for
unsuccessful
defense of
18-420
Management Accounting: An Overview Chapter 1
complaints about
quality
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
Cost of Quality Report
For 2005 and 2006
Prevention costs:
Quality manual P 40,000 P 50,000
Product design 300,000P 340,000 5.67 270,000 P320,000 5.33
Appraisal costs:
Testing P 80,000 80,000 1.33 P 60,000 60,000 1.00
Internal failure costs:
Rework P200,000 P250,000
Retesting 50,000 90,000
Disposal of defective
units 90,000 340,000 5.67 85,000 425,000 7.08
External failure costs:
Product recalls P360,000 P500,000
Field service 230,000 590,000 9.83 350,000 850,000 14.17
18-421
Total cost of quality P1,350,000 22.50 P1,655,000 27.58
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
Requirement 1
Intern Extern
Costs of Preven Apprai al al
Quality tion sal Failure Failure
Rework P
6,000
18-422
Management Accounting: An Overview Chapter 1
Recalls P15,00
0
Reengineeri P
ng efforts 9,000
Repair 12,000
Replacemen
ts 12,000
Retesting 5,000
Supervision P18,00
0
Scrap 9,000
Training 15,000
Testing of
incoming
materials 7,000
Inspection
of work in
process 18,000
Downtime 10,000
Product
liability
insurance 9,000
Quality
audits 5,000
Continuous
improveme
nt 1,000
Warranty 15,00
repairs 0
Requirement 2
18-423
by
category 0 0 0 0
Requirement 3
Requirements 1 and 2
2006 2005
Revenues P12,500,000 P10,000,000
Percenta Percentag
ge of e of
Reven Revenu
ues (2) es (4)
= (1) = (3)
Cost P12,50 Cost P10,00
Costs of Quality (1) 0,000 (3) 0,000
Prevention
costs
Design P240, P100,
engineering 000 000
Preventive 90,00 35,00
maintenance 0 0
Training 120,0 45,00
00 0
Supplier 50, 20,
evaluation 000 000
18-424
Management Accounting: An Overview Chapter 1
Total
prevention 500, 200,
costs 000 4.0% 000 2.0%
Appraisal
costs
Line 85,00 110,0
inspection 0 00
Product-
testing 50,00 50,00
equipment 0 0
Incoming
materials 40,00 20,00
inspection 0 0
Product- 75, 220,
testing labor 000 000
Total
appraisal 250, 400,
costs 000 2.0% 000 4.0%
Internal failure
costs
Scrap 200,0 250,0
00 00
Rework 135,0 160,0
00 00
Breakdown
maintenanc 40, 90,
e 000 000
Total 375, 3.0% 500, 5.0%
internal 000 000
18-425
failure
costs
External
failure costs
Returned 145,0 60,00
goods 00 0
Customer 30,00 40,00
support 0 0
Product
liability 100,0 200,0
claims 00 00
Warranty 20 30
repair 0,000 0,000
47 60
5,000 3.8% 0,000 6.0%
Total costs P1,60 P1,70
of quality 0,000 12.8% 0,000 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 decreased,
the cost of returned goods has increased. Gabriel’s management should
investigate the reasons for this and initiate corrective action.
Requirement 3
18-426
Management Accounting: An Overview Chapter 1
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
Repair (P600 x 4% x
10,000 units) 240,000 1.20%
18-427
Revenues, Costs of Quality and Costs of Quality as a
Percentage of Revenues for Vancouver
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%
Estimated forgone
contribution margin
on lost sales
[(P1,500 – P800) x
300] 210,000 2.80%
Total external failure
costs 390,000 5.20%
18-428
Management Accounting: An Overview Chapter 1
Requirement 3
III. Problems
Requirement 1
Requirement 2
18-429
Contribution margin per unit P12,000 x 85% - P2,500 = P7,700
Lost sales 3,000 0.8 – 3,000 = x 750 5,775,000
Total current cost of quality P10,050,000
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:
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.
18-430
Management Accounting: An Overview Chapter 1
Increase
Costs (Decreas
Categories 2005 2006 e)
Prevention
costs:
Training P P P
75,000 100,00 25,00
0 0
Product 150,0 175,0 25,0
design 00 00 00
Total 225,000 275,000 50,000
prevention
Appraisal
costs:
Testing 50,000 150,000 100,000
75,0 100,0 25,0
Calibration 00 00 00
Total 125,000 250,000 125,000
appraisal
Internal
failure
costs:
Rework 325,000 100,000 (225,00
0)
18-431
250,0 200,0 (50,0
Retesting 00 00 00)
Total 575,000 300,000 (275,00
internal 0)
failure
External
failure
costs:
Warranty 150,000 75,000 (75,000)
repairs
Product 400,000 200,000 (200,00
recalls 0)
Product 125,0 75,0 (50,0
liability 00 00 00)
Total 675,0 350,0 (325,0
external 00 00 00)
failure
Total costs P1,600,0 P1,175,0 P
of quality 00 00 (425,
000)
Problem 3 (JIT Production, Relevant Benefits, Relevant Costs)
Requirement 1
Incremental Incremental
Costs under Costs under
Current JIT
Production Production
Relevant Items System System
Annual tooling costs – P150,000
Required return on
18-432
Management Accounting: An Overview Chapter 1
investment
12% per year x P900,000 of
average inventory per year P108,000
12% per year x P200,000 of
average inventory per year 24,000
Insurance, space, materials
handling, and setup costs 200,000 140,000a
Rework costs 350,000 280,000b
Incremental revenues from
higher selling prices – (90,000)c
Total net incremental costs P658,000 P504,000
Annual difference in favor of
JIT production P154,000
a
P200,000 (1 – 0.30) = P140,000
b
P350,000 (1 – 0.20) = P280,000
c
P3 x 30,000 units = P90,000
Requirement 2
18-433
Requirement 1
Incremental Incremental
Costs under Costs under
Current JIT
Purchasing 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
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Management Accounting: An Overview Chapter 1
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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Increase in throughput contribution (P72 – P32) x 12,000 P480,000
Incremental contracting costs P10 x 12,000 120,000
Net benefit of contracting 12,000 units of finishing P360,000
Requirement 2
Requirement 1
Requirement 2
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Management Accounting: An Overview Chapter 1
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 Q3Q4
Quality
assurance P 6.20 P 6.52 P 6.86 P 7.19 P 7.93 P 8.74 P 9.61 P10.53
administrati
on
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
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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
Scrap 17.60 14.48 11.92 10.32 8.92 7.72 7.00 6.34
Internal 33.40 27.13 21.95 18.81 16.17 13.88 12.56 11.34
failure
Returns 26.90 21.09 16.35 13.53 11.32 9.50 8.43 7.52
Customer
complaint 3.90 3.45 3.03 2.76 2.50 2.27 2.14 2.01
dept.
Lost sales 49.20 40.31 33.11 28.42 24.45 21.08 19.20 17.44
External 80.00 64.85 52.49 44.71 38.27 32.85 29.77 26.97
failure
Total costs P137.90
P118.63
P103.56 P95.22 P92.04 P91.41 P95.08
P100.68
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.
1
4
1
0
2
1
0
0
8
C 0
0
6
o 0
4
st 0
2
(
0
P
m Q Q Q Q Q Q Q Q
ill 1 2 2 3 4 Qu 1 2 2 3 4
io 0 art 0
n 0 ers 0
s) 5 6
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Management Accounting: An Overview Chapter 1
31. C 26. C
32. B 27. A
33. C 28. C
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34. D 29. B
35. D 30. C
36. A 31. D
37. C 32. D
38. C 33. D
39. D 34. A
40. D 35. A
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