Chapter 1 Solutions

Chapter 1
SOLUTIONS

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ACCT2001 Managerial AC
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01-01 Direct & Indirect Costs

Exercise 1-1 (Static) Identifying Direct and Indirect Costs [LO1-1]

Northwest Hospital is a full-service hospital that provides everything from major surgery and
emergency room care to outpatient clinics.

Required:
For each of the following costs incurred at Northwest Hospital, indicate whether it would most likely
be a direct cost or an indirect cost of the specified cost object.

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01-02 Manufacturing & Non-manufacturing Costs

1. Exercise 1-2 (Static) Classifying Manufacturing Costs [LO1-2]
The PC Works assembles custom computers from components supplied by various manufacturers.
The company is very small and its assembly shop and retail sales store are housed in a single
facility in a Redmond, Washington, industrial park. Listed below are some of the costs that the
company incurs.

Required:
For each cost, indicate whether it would most likely be classified as direct materials, direct labor,
manufacturing overhead, selling, or an administrative cost.

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01-03 Product and Period, Prime and Conversion Costs

1. Exercise 1-3 Classifying Costs as Product or Period Costs [LO1-3]

Suppose that you have been given a summer job as an intern at Issac Aircams, a company that
manufactures sophisticated spy cameras for remote-controlled military reconnaissance aircraft. The
company, which is privately owned, has approached a bank for a loan to help finance its growth. The
bank requires financial statements before approving the loan.

Required:
Classify each cost listed below as either a product cost or a period cost for the purpose of preparing
financial statements for the bank.

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2. Extra 1-0 Cost Terminology for Manufacturers [LO2-2, LO2-3]

Arden Company reported the following costs and expenses for the most recent month:

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01-03 – Variable, Fixed and Mixed Costs

Exercise 1-4

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Exercise 1-17

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3. Problem 1-20 Variable and Fixed Costs; Subtleties of Direct and

Indirect Costs [LO1-1, LO1-4]

Madison Seniors Care Center is a nonprofit organization that provides a variety of health services to
the elderly. The center is organized into a number of departments, one of which is the Meals-On-
Wheels program that delivers hot meals to seniors in their homes on a daily basis.

Required:
A number of costs of the center and the Meals-On-Wheels program are listed below. For each cost
listed below, indicate whether it is a direct or indirect cost of the Meals-On-Wheels program, whether
it is a direct or indirect cost of particular seniors served by the program, and whether it is variable or
fixed with respect to the number of seniors served.

Explanation:
b.
These costs could be direct costs of serving particular seniors.

g.
The cost of the care giver who drives the van is classified as an indirect cost with respect to
particular seniors. However, under certain conditions this cost can be classified as a direct cost with
respect to specific seniors.

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01-05 Relevant & Irrelevant Costs (Differential, Sunk, Opportunity)

1. Exercise 1-5 Differential, Sunk, and Opportunity Costs [LO1-5]

Northeast Hospital’s Radiology Department is considering replacing an old inefficient X-ray machine
with a state-of-the-art digital X-ray machine. The new machine would provide higher quality X-rays in
less time and at a lower cost per X-ray. It would also require less power and would use a color laser
printer to produce easily readable X-ray images. Instead of investing the funds in the new X-ray
machine, the Laboratory Department is lobbying the hospital’s management to buy a new DNA
analyzer.

Required:
Classify each item as a differential cost, a sunk cost, or an opportunity cost in the decision to replace
the old X-ray machine with a new machine. If none of the categories apply for a particular item,
select "None".

Explanation:
Note: The costs of the salaries of the head of the Radiology Department and Laboratory Department
and the rent on the space occupied by Radiology are neither differential costs, nor opportunity costs,
nor sunk costs. These costs do not differ between the alternatives and therefore are irrelevant in the
decision, but they are not sunk costs because they occur in the future.

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2. Exercise 1-16 Cost Classifications for Decision Making [LO1-5]

Warner Corporation purchased a machine 7 years ago for $319,000 when it launched product P50.
Unfortunately, this machine has broken down and cannot be repaired. The machine could be
replaced by a new model 300 machine costing $313,000 or by a new model 200 machine costing
$275,000. Management has decided to buy the model 200 machine. It has less capacity than the
model 300 machine, but its capacity is sufficient to continue making product P50. Management also
considered, but rejected, the alternative of dropping product P50 and not replacing the old machine.
If that were done, the $275,000 invested in the new machine could instead have been invested in a
project that would have returned a total of $374,000.

Required:
1. What is the total differential cost regarding the decision to buy the model 200 machine rather than
the model 300 machine?
2. What is the total sunk cost regarding the decision to buy the model 200 machine rather than the
model 300 machine?
3. What is the total opportunity cost regarding the decision to invest in the model 200 machine?

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01-06 Income Statements

Exercise 1-6

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2. Exercise 1-11 Cost Behavior; Contribution Format Income

Statement [LO1-4, LO1-6]

Harris Company manufactures and sells a single product. A partially completed schedule of the company’s
total costs and costs per unit over the relevant range of 30,000 to 50,000 units is given below:
Required:
1. Complete the schedule of the company’s total costs and costs per unit as given in the relevant tab below.
2. Assume that the company produces and sells 45,000 units during the year at a selling price of $16 per unit.
Prepare a contribution format income statement for the year.

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3. Problem 1-21 Traditional & Contribution Income Statements [LO1-6]

Marwick’s Pianos, Inc., purchases pianos from a large manufacturer for an average cost of $2,450 per unit
and then sells them to retail customers for an average price of $3,125 each. The company’s selling and
administrative costs for a typical month are presented below:

During August, Marwick’s Pianos, Inc., sold and delivered 40 pianos.

Required:
1. Prepare a traditional format income statement for August.

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2. Prepare a contribution format income statement for August. Show costs and revenues on both a total and
a per unit basis down through contribution margin.

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4. Exercise 1-15 Traditional and Contribution Income Statements [LO1-6]

The Alpine House, Inc., is a large retailer of snow skis. The company assembled the information shown below
for the quarter ended March 31:

Required:
1. Prepare a traditional income statement for the quarter ended March 31.

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2. Prepare a contribution format income statement for the quarter ended March 31.

3. What was the contribution margin per unit?

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5. Problem 1-19 Traditional and Contribution Income Statements [LO1-6]

Todrick Company is a merchandiser that reported the following information based on 1,000 units sold:

Required:
1. Prepare a contribution format income statement.

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2. Prepare a traditional format income statement.

3. Calculate the selling price per unit.

4. Calculate the variable cost per unit.
5. Calculate the contribution margin per unit.

6. Which income statement format (traditional format or contribution format) would be more useful to managers
in estimating how net operating income will change in responses to changes in unit sales?

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6. Problem 1-25 Traditional and Contribution Income Statements [LO1-6]

Milden Company is a merchandiser that plans to sell 12,000 units during the next quarter at a selling price of
$100 per unit. The company also gathered the following cost estimates for the next quarter:

Required:
1. Prepare a contribution format income statement for the next quarter.

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2. Prepare a traditional format income statement for the next quarter.

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05-10 High Low Method

1. Exercise 5A-1 (Static) High-Low Method [LO5-10]
The Cheyenne Hotel in Big Sky, Montana, has accumulated records of the total electrical costs of the hotel and
the number of occupancy-days over the last year. An occupancy-day represents a room rented for one day.
The hotel's business is highly seasonal, with peaks occurring during the ski season and in the summer.

Required:
1. Using the high-low method, estimate the fixed cost of electricity per month and the variable cost of
electricity per occupancy-day. (Do not round your intermediate calculations. Round your
Variable cost answer to 2 decimal places and Fixed cost element answer to nearest whole
dollar amount.)

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2. What other factors in addition to occupancy-days are likely to affect the variation in electrical costs from
month to month? (You may select more than one answer. Single click the box with the question mark to
produce a check mark for a correct answer and double click the box with the question mark to empty
the box for a wrong answer. Any boxes left with a question mark will be automatically graded as
incorrect.)

2.
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 than in the summer. This will result in seasonal fluctuations in the fixed electrical costs.
Additionally, fixed costs will be affected by the number of days 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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2. Problem 5A-7 Cost Behavior; High-Low Method; Contribution Format

Income Statement [LO5-10]
Morrisey & Brown, Ltd., of Sydney is a merchandising company that is the sole distributor of a
product that is increasing in popularity among Australian consumers. The company’s income
statements for the three most recent months follow:

Required:
1. By analyzing the data from the company's income statements, classify each of its expenses
(including cost of goods sold) as either variable, fixed, or mixed.

2. Using the high-low method, separate each mixed expense into variable and fixed elements.
Express the variable and fixed portions of each mixed expense in the form Y = a + bX.

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3. Redo the company’s income statement at the 5,000-unit level of activity using the contribution format.

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3. Exercise 5A-3 (Static) Cost Behavior; High-Low Method [LO5-10]

Hoi Chong Transport, Ltd., operates a fleet of delivery trucks in Singapore. The company has
determined that if a truck is driven 105,000 kilometers during a year, the average operating cost is
11.4 cents per kilometer. If a truck is driven only 70,000 kilometers during a year, the average
operating cost increases to 13.4 cents per kilometer.

Required:
1. Using the high-low method, estimate the variable operating cost per kilometer and the annual
fixed operating cost associated with the fleet of trucks.

2. Express the variable and fixed costs in the form Y = a + bX.

3. If a truck were driven 80,000 kilometers during a year, what total operating cost would you expect
to be incurred?

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4. Exercise 5A-4 High-Low Method; Scattergraph Analysis [LO5-10]

Archer Company is a wholesaler of custom-built air-conditioning units for commercial buildings. It
gathered the following monthly data relating to units shipped and total shipping expense:

2. Using the high-low method, estimate the cost formula for shipping expense.

4. What factors, other than the number of units shipped, are likely to affect the company’s shipping
expense? (You may select more than one answer. Single click the box with the question mark to produce
a check mark for a correct answer and double click the box with the question mark to empty the box for a
wrong answer. Any boxes left with a question mark will be automatically graded as incorrect.)

4.The cost of shipping units is likely to depend on the weight and volume of the units shipped and the
distance traveled as well as on the number of units shipped. In addition, higher cost shipping might be
necessary to meet a deadline.

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6. Problem 5A-9 High-Low Method; Contribution Format Income

Statement [LO5-10]
Milden Company is a distributor who wants to start using a contribution format income statement for
planning purposes. The company has analyzed its expenses and developed the following cost
formulas:

Because shipping expense is a mixed cost, the company needs to estimate the variable shipping
expense per unit sold and the fixed shipping expense per quarter using the following data:

Required:
1. Using the high-low method, estimate a cost formula for shipping expense in the form Y = a + bX.

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2. In the first quarter of Year 3, the company plans to sell 12,000 units at a selling price of $100 per
unit. Prepare a contribution format income statement for the quarter.

2.
Sales (12,000 units × $100 per unit) = $1,200,000
Cost of goods sold (12,000 units × $35 per unit) = $420,000
Sales commission (6% × $1,200,000) = $72,000
Shipping expense (12,000 units × $9.10 per unit) = $109,200

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Exercises 4

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ACCT2001 Managerial AC