CHAPTER 9

INVENTORY COSTING AND CAPACITY ANALYSIS

9-16 In comparing the absorption and variable cost methods, each of the following statements is true except:
a. SG&A fixed expenses are not included in inventory in either method.
b. Only the absorption method may be used for external financial reporting.
c. Variable costing charges fixed overhead costs to the period they are incurred.
d. When inventory increases over the period, variable net income will exceed absorption net income.

9-17 Queen Sales, Inc. has just completed its first year of operations. The company has not had any sales to
date. Queen has incurred the following costs associated with its production as of December 31, Year 1:

Direct materials $45,000

Production labor 35,000
Bookkeeper salary 28,000
Factory utilities 18,500
Office rent 12,000
Factory supervisor salary 9,600
Machine maintenance contract 7,500

Under absorption costing, what is the inventory amount shown on the balance sheet at December 31, Year 1?
a. $155,600
b. $115,600
c. $98,500
d. $80,000

9-18 King Tooling has produced and sold the following number of units of their only product during their
first two years in business:

Produced Sold
Year ended December 31, Year 1 50,000 40,000
Year ended December 31, Year 2 50,000 55,000

Production costs per unit have not changed over the two-year period. Under variable costing, what is the
amount of cost of sales relative to the cost of sales shown on the GAAP income statement of the company?
Year 1 Year 2
a. Higher Higher
b. Higher Lower
c. Lower Higher
d. Lower Lower

9-19 The following information relates to Drexler Inc.’s Year 3 financials:

Direct labor $420,000

 Direct materials 210,000
Variable overhead 205,000
Fixed overhead 355,000
Variable SG&A expenses 150,000
Fixed SG&A expenses 195,000

Year 3 period costs for Drexler, under both the absorption and variable cost methods, will be

Absorption Cost Method Variable Cost Method

a. $345,000 $700,000
b. $345,000 $905,000
c. $550,000 $700,000
d. $550,000 $905,000

9-20 Which of the following statements is not true regarding the use of variable and absorption costing for
performance measurement?
a. The net income reported under the absorption method is less reliable for use in performance evaluations
because the cost of the product includes fixed costs, which means the level of inventory affects net
income.
b. The net income reported under the contribution income statement is more reliable for use in
performance evaluations because the product cost does not include fixed costs.
c. Variable costing isolates contribution margins to aid in decision making.
d. The Internal Revenue Service allows either absorption or variable costing as long as the method is not
changed from year to year, while U.S. GAAP only allows absorption costing.

9-21 Variable and absorption costing, explaining operating-income differences. Nascar Motors
assembles and sells motor vehicles and uses standard costing. Actual data relating to April and May 2017 are
as follows:

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

Required:
1. Prepare April and May 2017 income statements for Nascar Motors under (a) variable costing and (b)
absorption costing.
2. Prepare a numerical reconciliation and explanation of the difference between operating income for each
 month under variable costing and absorption costing.

9-23 Variable and absorption costing, explaining operating-income differences. EntertainMe Corporation
manufactures and sells 50-inch television sets and uses standard costing. Actual data relating to January,
February, and March 2017 are as follows:

January February March

Unit data:
Beginning inventory 0 150 150
Production 1,500 1,400 1,520
Sales 1,350 1,400 1,530
V ariable costs:
Manufacturing cost per unit produced $ $ 1,000 $
1,000 1,00
0
Operating (marketing) cost per unit $ $ 800 $
sold 800 800
F ixed costs:
Manufacturing costs $525,00 $525,000 $525,0
0 00
Operating (marketing) costs $130,00 $130,000 $130,0
0 00

The selling price per unit is $3,300. The budgeted level of production used to calculate the budgeted fixed
manufacturing cost per unit is 1,500 units. There are no price, efficiency, or spending variances. Any -
production-volume variance is written off to the cost of goods sold in the month in which it occurs.

1. Prepare income statements for EntertainMe in January, February, and March 2017 under (a) variable
costing and (b) absorption costing.
2. Explain the difference in operating income for January, February, and March under variable costing and
absorption costing.

9-25 Variable versus absorption costing. The Tomlinson Company manufactures trendy, high-quality,
moderately priced watches. As Tomlinson’s senior financial analyst, you are asked to recommend a method of
inventory costing. The CFO will use your recommendation to prepare Tomlinson’s 2017 income statement.
The following data are for the year ended December 31, 2017:

Beginning inventory, January 1, 2017 90,000 units

Ending inventory, December 31, 2017 34,000 units
2017 sales 433,000 units
Selling price (to the distributor) $24.00 per unit
Variable manufacturing cost per unit, including
$5.40 per unit
direct materials
Variable operating (marketing) cost per unit sold $1.20 per unit sold Fixed
 manufacturing costs $1,852,200
Denominator-level machine-hours 6,300
Standard production rate 60 units per machine-hour
Fixed operating (marketing) costs $1,130,000

Required:
Assume standard costs per unit are the same for units in the beginning inventory and units produced during the
year. Also, assume no price, spending, or efficiency variances. Any production-volume variance is written off
to cost of goods sold.

1. Prepare income statements under variable and absorption costing for the year ended December 31, 2017.
2. What is Tomlinson’s operating income as a percentage of revenues under each costing method?
3. Explain the difference in operating income between the two methods.
4. Which costing method would you recommend to the CFO? Why?

CHAPTER 3 COST–VOLUME–PROFIT ANALYSIS

3-16 Jack’s Jax has total fixed costs of $25,000. If the company’s contribution margin is 60%, the income tax rate is
25% and the selling price of a box of Jax is $20, how many boxes of Jax would the company need to sell to
produce a net income of $15,000?
a. 5,625 b. 4,445
c. 3,750 d. 3,333

3-17 During the current year, XYZ Company increased its variable SG&A expenses while keeping fixed SG&A
expenses the same. As a result, XYZ’s:
a. Contribution margin and gross margin will be lower.
b. Contribution margin will be higher, while its gross margin will remain the same.
c. Operating income will be the same under both the financial accounting income statement and
contribution income statement.
d. Inventory amounts booked under the financial accounting income statement will be lower than under
the contribution income statement.

3-18 Under the contribution income statement, a company’s contribution margin will be:
a. Higher if fixed SG&A costs decrease.
b. Higher if variable SG&A costs increase.
c. Lower if fixed manufacturing overhead costs decrease.
d. Lower if variable manufacturing overhead costs increase.

3-19 A company needs to sell 10,000 units of its only product in order to break even. Fixed costs are
$110,000, and the per unit selling price and variable costs are $20 and $9, respectively. If total sales are
$220,000, the company’s margin of safety will be equal to:
a. $0 b. $20,000
c. $110,000 d. $200,000

3-20 Once a company exceeds its breakeven level, operating income can be calculated by multiplying:
a. The sales price by unit sales in excess of breakeven units.
b. Unit sales by the difference between the sales price and fixed cost per unit.
c. The contribution margin ratio by the difference between unit sales and breakeven sales.
d. The contribution margin per unit by the difference between unit sales and breakeven sales.

3-21 CVP computations. Fill in the blanks for each of the following independent cases.
3-23 CVP analysis, changing revenues and costs. Sunset Travel Agency specializes in flights between Toronto
and Jamaica. It books passengers on Hamilton Air. Sunset’s fixed costs are $23,500 per month. Hamilton Air
charges passengers $1,500 per round-trip ticket.

Calculate the number of tickets Sunset must sell each month to (a) break even and (b) make a target operating
income of $10,000 per month in each of the following independent cases.
Required:
1. Sunset’s variable costs are $43 per ticket. Hamilton Air pays Sunset 6% commission on ticket price.
2. Sunset’s variable costs are $40 per ticket. Hamilton Air pays Sunset 6% commission on ticket price.
3. Sunset’s variable costs are $40 per ticket. Hamilton Air pays $60 fixed commission per ticket to Sunset.
Comment on the results.
4. Sunset’s variable costs are $40 per ticket. It receives $60 commission per ticket from Hamilton Air. It
charges its customers a delivery fee of $5 per ticket. Comment on the results.

3-24 CVP exercises. The Deli-Sub Shop owns and operates six stores in and around Minneapolis. You are given
the following corporate budget data for next year:

Revenues $11,000,000
Fixed costs $ 3,000,000
Variable costs $ 7,500,000

Variable costs change based on the number of subs sold.

Compute the budgeted operating income for each of the following deviations from the original budget data.
(Consider each case independently.)
Required:
1. A 10% increase in contribution margin, holding revenues constant
2. A 10% decrease in contribution margin, holding revenues constant
3. A 5% increase in fixed costs
4. A 5% decrease in fixed costs
5. A 5% increase in units sold
6. A 5% decrease in units sold
7. A 10% increase in fixed costs and a 10% increase in units sold
8. A 5% increase in fixed costs and a 5% decrease in variable costs
 9. Which of these alternatives yields the highest budgeted operating income? Explain why this is the case.
3-26 CVP analysis, income taxes. Westover Motors is a small car dealership. On average, it sells a car for
$32,000, which it purchases from the manufacturer for $28,000. Each month, Westover Motors pays $53,700 in
rent and utilities and $69,000 for salespeople’s salaries. In addition to their salaries, salespeople are paid a
commission of $400 for each car they sell. Westover Motors also spends $10,500 each month for local
advertisements. Its tax rate is 40%.

Required:
1. How many cars must Westover Motors sell each month to break even?
2. Westover Motors has a target monthly net income of $69,120. What is its target monthly operating
income? How many cars must be sold each month to reach the target monthly net income of $69,120?

3-28 CVP analysis, sensitivity analysis. Perfect Fit Jeans Co. sells blue jeans wholesale to major retailers
across the country. Each pair of jeans has a selling price of $50 with $35 in variable costs of goods sold. The
company has fixed manufacturing costs of $2,250,000 and fixed marketing costs of
$250,000. Sales commissions are paid to the wholesale sales reps at 10% of revenues. The company has an
income tax rate of 20%.
Required:
1. How many jeans must Perfect Fit sell in order to break even?
2. How many jeans must the company sell in order to reach:
a. a target operating income of $420,000?
b. a net income of $420,000?
3. How many jeans would Perfect Fit have to sell to earn the net income in requirement 2b if:
(Consider each requirement independently.)
a. the contribution margin per unit increases by 10%.
b. the selling price is increased to $51.50.
c. the company outsources manufacturing to an overseas company increasing variable costs per unit by
$2.00 and saving 70% of fixed manufacturing costs.

3-29 CVP analysis, margin of safety. Suppose Morrison Corp.’s breakeven point is revenues of
$1,100,000. Fixed costs are $660,000.

Required:
1. Compute the contribution margin percentage.
2. Compute the selling price if variable costs are $16 per unit.
3. Suppose 75,000 units are sold. Compute the margin of safety in units and dollars.
4. What does this tell you about the risk of Morrison making a loss? What are the most likely reasons for this
risk to increase?

CHAPTER 11
DECISION MAKING AND RELEVANT INFORMATION
11-16 Qualitative and quantitative factors. Which of the following is not a qualitative factor that Atlas
Manufacturing should consider when deciding whether to buy or make a part used in manufacturing their
product?
a. Quality of the outside producer’s product.
b. Potential loss of trade secrets.
c. Manufacturing deadlines and special orders.
d. Variable cost per unit of the product.
11-17 Special order, opportunity cost. Chade Corp. is considering a special order brought to it by a new
client. If Chade determines the variable cost to be $9 per unit, and the contribution margin of the next best
alternative of the facility to be $5 per unit, then if Chade has:
a. Full capacity, the company will be profitable at $4 per unit.
b. Excess capacity, the company will be profitable at $6 per unit.
c. Full capacity, the selling price must be greater than $5 per unit.
d. Excess capacity, the selling price must be greater than $9 per unit.

11-18 Special order, opportunity cost. In order to determine whether a special order should be accepted at
full capacity, the sales price of the special order must be compared to the per unit:
a. Contribution margin of the special order.
b. Variable cost and contribution margin of the special order.
c. Variable cost and contribution margin of the next best alternative.
d. Variable cost of current production and the contribution margin of the next best alternative.

11-19 Keep or drop a business segment. Lees Corp. is deciding whether to keep or drop a small segment of
its business. Key information regarding the segment includes:
Contribution margin: 35,000
Avoidable fixed costs: 30,000
Unavoidable fixed costs: 25,000
Given the information above, Lees should:
a. Drop the segment because the contribution margin is less than total fixed costs.
b. Drop the segment because avoidable fixed costs exceed unavoidable fixed costs.
c. Keep the segment because the contribution margin exceeds avoidable fixed costs.
d. Keep the segment because the contribution margin exceeds unavoidable fixed costs.

11-20 Relevant costs. Ace Cleaning Service is considering expanding into one or more new market
areas. Which costs are relevant to Ace’s decision on whether to expand?

11-22 Relevant and irrelevant costs. Answer the following questions.

1. Robinson Computers makes 5,700 units of a circuit board, CB76, at a cost of $230 each. Variable cost per
unit is $180 and fixed cost per unit is $50. Peach Electronics offers to supply 5,700 units of CB76 for $210.
If Robinson buys from Peach, it will be able to save $20 per unit in fixed costs but continue
to incur the remaining $30 per unit. Should Robinson accept Peach’s offer? Explain.
2. RT Manufacturing is deciding whether to keep or replace an old machine. It obtains the following
information:
RT Manufacturing uses straight-line depreciation. Ignore the time value of money and income taxes. Should
RT Manufacturing replace the old machine? Explain.

11-24 Special order, activity-based costing. (CMA, adapted) The Reward One Company manufactures
windows. Its manufacturing plant has the capacity to produce 12,000 windows each month. Current production
and sales are 10,000 windows per month. The company normally charges $250 per window. Cost information
for the current activity level is as follows:

Reward One has just received a special one-time-only order for 2,000 windows at $225 per window.
Accepting the special order would not affect the company’s regular business or its fixed costs. Reward One
makes windows for its existing customers in batch sizes of 100 windows (100 batches  100 windows per
batch = 10,000 windows). The special order requires Reward One to make the windows in 25 batches of 80
windows.

Required:
1. Should Reward One accept this special order? Show your calculations.
2. Suppose plant capacity were only 11,000 windows instead of 12,000 windows each month. The special
order must either be taken in full or be rejected completely. Should Reward One accept the special order?
Show your calculations.
3. As in requirement 1, assume that monthly capacity is 12,000 windows. Reward One is concerned that
if it accepts the special order, its existing customers will immediately demand a price discount of $20 in
the month in which the special order is being filled. They would argue that Reward One’s capacity costs
are now being spread over more units and that existing customers should get the benefit of these lower
costs. Should Reward One accept the special order under these conditions? Show your calculations.

11-25 Make versus buy, activity-based costing. The Svenson Corporation manufactures cellular modems.
It manufactures its own cellular modem circuit boards (CMCB), an important part of the cellular
modem. It reports the following cost information about the costs of making CMCBs in 2017 and the
expected costs in 2018:

Svenson manufactured 8,000 CMCBs in 2017 in 40 batches of 200 each. In 2018, Svenson anticipates
needing 10,000 CMCBs. The CMCBs would be produced in 80 batches of 125 each.
The Minton Corporation has approached Svenson about supplying CMCBs to Svenson in 2018 at
$300 per CMCB on whatever delivery schedule Svenson wants.

Required:
 1. Calculate the total expected manufacturing cost per unit of making CMCBs in 2018.
2. Suppose the capacity currently used to make CMCBs will become idle if Svenson purchases CMCBs from
Minton. On the basis of financial considerations alone, should Svenson make CMCBs or buy them from
Minton? Show your calculations.
3. Now suppose that if Svenson purchases CMCBs from Minton, its best alternative use of the capacity
currently used for CMCBs is to make and sell special circuit boards (CB3s) to the Essex Corporation.
Svenson estimates the following incremental revenues and costs from CB3s:

On the basis of financial considerations alone, should Svenson make CMCBs or buy them from Minton?
Show your calculations.

11-27 Relevant costs, contribution margin, product emphasis. The Beach Comber is a take-out food store at
a popular beach resort. Sara Miller, owner of the Beach Comber, is deciding how much refrigerator space to
devote to four different drinks. Pertinent data on these four drinks are as follows:

Miller has a maximum front shelf space of 12 feet to devote to the four drinks. She wants a minimum of 1 foot
and a maximum of 6 feet of front shelf space for each drink.

Required:
1. Calculate the contribution margin per case of each type of drink.
2. A coworker of Miller’s recommends that she maximize the shelf space devoted to those drinks with
the highest contribution margin per case. Do you agree with this recommendation? Explain briefly.
3. What shelf-space allocation for the four drinks would you recommend for the Beach Comber? Show your
calculations.

CHAPTER 13
PRICING DECISIONS AND COST MANAGEMENT
13-16 Which of the following statements regarding price elasticity is incorrect?
a. A product with a perfectly inelastic demand would have the same demand even as prices change.
b. A product with a perfectly inelastic demand would see demand change as prices change.
c. When demand is price elastic, lower prices stimulate demand.
d. When demand is price elastic, higher prices reduce demand.

13-17 Value-added, non-value-added costs. The Magill Repair Shop repairs and services machine tools.
A summary of its costs (by activity) for 2017 is as follows:

1. Classify each cost as value-added, non-value-added, or in the gray area between.

2. For any cost classified in the gray area, assume 60% is value-added and 40% is non-value-added. How
 much of the total of all seven costs is value-added and how much is non-value-added?
3. Magill is considering the following changes: (a) introducing quality-improvement programs whose net
effect will be to reduce rework and expediting costs by 40% and materials and labor costs for servicing
machine tools by 5%; (b) working with suppliers to reduce materials-procurement and inspection costs by
20% and materials-handling costs by 30%; and
(c) increasing preventive-maintenance costs by 70% to reduce breakdown-maintenance costs by 50%.
Calculate the effect of programs (a), (b), and (c) on value-added costs, non-value-added costs, and total
costs. Comment briefly.

13-18 Target operating income, value-added costs, service company. Calvert Associates prepares
architectural drawings to conform to local structural-safety codes. Its income statement for 2017 is as follows:

The percentage of time spent by professional staff on various activities follows:

Assume administrative and support costs vary with professional-labor costs. Consider each requirement
independently.

Required:
1. How much of the total costs in 2017 are value-added, non-value-added, or in the gray area between?
Explain your answers briefly. What actions can Calvert take to reduce its costs?
2. What are the consequences of misclassifying a non-value-added cost as a value-added cost? When in
doubt, would you classify a cost as a value-added or non-value-added cost? Explain briefly.
3. Suppose Calvert could eliminate all errors so that it did not need to spend any time making corrections
and, as a result, could proportionately reduce professional-labor costs. Calculate Calvert’s operating
income for 2017.
4. Now suppose Calvert could take on as much business as it could complete, but it could not add more
professional staff. Assume Calvert could eliminate all errors so that it does not need to spend any time
correcting errors. Assume Calvert could use the time saved to increase revenues proportionately. Assume
travel costs will remain at $15,000. Calculate Calvert’s operating income for 2017.

13-19 Target prices, target costs, activity-based costing. Snappy Tiles is a small distributor of marble tiles.
Snappy identifies its three major activities and cost pools as ordering, receiving and storage, and shipping, and
it reports the following details for 2016:

For 2016, Snappy buys 250,000 marble tiles at an average cost of $3 per tile and sells them to retailers at an
average price of $4 per tile. Assume Snappy has no fixed costs and no inventories.

Required:
1. Calculate Snappy’s operating income for 2016.
2. For 2017, retailers are demanding a 5% discount off the 2016 price. Snappy’s suppliers are only willing to
give a 4% discount. Snappy expects to sell the same quantity of marble tiles in 2017 as in 2016. If all
other costs and cost-driver information remain the same, calculate Snappy’s operating income for 2017.
3. Suppose further that Snappy decides to make changes in its ordering and receiving-and-storing practices.
By placing long-run orders with its key suppliers, Snappy expects to reduce the number of orders to 200
and the cost per order to $25 per order. By redesigning the layout of the warehouse and reconfiguring the
crates in which the marble tiles are moved, Snappy expects to reduce the number of loads moved to 3,125
and the cost per load moved to $28. Will Snappy achieve its target operating income of $0.30 per tile in
2017? Show your calculations.

13-20 Target costs, effect of product-design changes on product costs. Neuro Instruments uses a
manufacturing costing system with one direct-cost category (direct materials) and three indirect-cost
categories:
a. Setup, production-order, and materials-handling costs that vary with the number of batches
b. Manufacturing-operations costs that vary with machine-hours
c. Costs of engineering changes that vary with the number of engineering changes made
In response to competitive pressures at the end of 2016, Neuro Instruments used value-engineering
techniques to reduce manufacturing costs. Actual information for 2016 and 2017 is as follows:

The management of Neuro Instruments wants to evaluate whether value engineering has succeeded in
reducing the target manufacturing cost per unit of one of its products, HJ6, by 5%.
Actual results for 2016 and 2017 for HJ6 are:

Required:
1. Calculate the manufacturing cost per unit of HJ6 in 2016.
2. Calculate the manufacturing cost per unit of HJ6 in 2017.
3. Did Neuro Instruments achieve the target manufacturing cost per unit for HJ6 in 2017? Explain.
4. Explain how Neuro Instruments reduced the manufacturing cost per unit of HJ6 in 2017.
5. What challenges might managers at Neuro Instruments encounter in achieving the target cost? How might
they overcome these challenges?

13-21 Target costs, effect of process-design changes on service costs. Solar Energy Systems (SES) sells
solar heating systems in residential areas of eastern Pennsylvania. A successful sale results in the homeowner
purchasing a solar heating system and obtaining rebates, tax credits, and financing for which SES completes
all the paperwork. The company has identified three major activities that drive the cost of selling heating
systems: identifying new contacts (varies with the number of new contacts); traveling to and between
appointments (varies with the number of miles driven); and preparing and filing rebates and tax forms (varies
with the number of solar systems sold). Actual costs for each of these activities in 2016 and 2017 are:

After experiencing high costs in 2016, SES used value engineering to reduce the cost of selling solar heating
systems. Managers at SES want to evaluate whether value engineering has succeeded in reducing the selling
cost per sale by the targeted 8% in 2017.
Actual results for 2016 and 2017 for SES are:

Required:
1. Calculate the cost per sale in 2016.
2. Calculate the cost per sale in 2017.
3. Did SES achieve the target cost per sale in 2017? Explain.
4. What challenges might managers at SES encounter in achieving the target cost and how might they
overcome these challenges?

13-22 Cost-plus target return on investment pricing. Jason Brady is the managing partner of a business
that has just finished building a 60-room motel. Brady anticipates that he will rent these rooms for 15,000
nights next year (or 15,000 room-nights). All rooms are similar and will rent for the same price. Brady
estimates the following operating costs for next year:

The capital invested in the motel is $1,500,000. The partnership’s target return on investment is 20%. Brady
expects demand for rooms to be uniform throughout the year. He plans to price the rooms at full cost plus a
markup on full cost to earn the target return on investment.
Required:
1. What price should Brady charge for a room-night? What is the markup as a percentage of the full cost of a
room-night?
2. Brady’s market research indicates that if the price of a room-night determined in requirement 1 is reduced
by 10%, the expected number of room-nights Brady could rent would increase by 10%. Should Brady
reduce prices by 10%? Show your calculations.

13-23 Cost-plus, target pricing, working backward. KidsPlay, Inc., manufactures and sells table sets. In
2016, it reported the following:
Required:
1. What was KidsPlay’s operating income in 2016? What was the full cost per unit? What was the selling
price? What was the percentage markup on variable cost to achieve the selling price? What are the total
fixed costs?
2. KidsPlay is considering increasing the annual spending on advertising by $200,000. The managers believe
that the investment will translate into a 10% increase in unit sales. Should the company make the
investment? Show your calculations.
3. Refer back to the original data. In 2017, KidsPlay believes that it will be able to sell only 2,700 units
at the price calculated in requirement 1. Management has identified $185,000 in fixed cost that can be
eliminated. If KidsPlay wants to maintain a 10% markup on full cost, what is the target variable cost per
unit?