ACCT 3503 TEST 2 FORMAT, INSTUCTIONS AND REVIEW

Please read the instructions clearly and carefully before writing the test:

 Test 1 covers Chapters 11,13,15, 21,and 23.

 It is worth 15% of your final grade.
 The test has 45 multiple choice questions including both numerical and
theory.
 The questions are simple and straight forward and are based on the material
covered in the class.
 A calculator is required.
 The exam is 90 minutes duration.
 Accessing notes, books, conversation with anyone, taking a picture of the
screen, use of cell phones etc. will be considered plagiarism, and any
violation of these rules will result in zero grade, and the case will be
referred to Associate Dean for further action.
 No restroom break is allowed for the duration of the exam. Please make
sure that you go to the restroom before you start your exam.
 As per the guidelines posted under welcome note, the tests are not returned
to the students, however, they can review the test within two weeks from the
date the grades are posted on the blackboard.
 No extra time is granted if you arrive late for the test.

TEST 2 REVIEW
Please note that this is not a sample exam. The information provided here is to
help you in consolidating the chapter material to prepare you well for the test.
Please do not memorize either the questions or the answers. The questions in the
test will be based on this material but will not be the same.
1. As the test is based on multiple choice questions, you should practice
multiple choice questions on Pearsons’ MyAccountinglab.
2. You should review all class activity questions.
3. You should review and practice the end of the chapter questions done in the
class.
4. You should read and understand the PowerPoint slides for each slide and
supplement them with the chapter material.

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 5. The questions in the test could be based on material not covered in the
review.

Q1. Creative enterprises. wants to automate one of its production processes. The new equipment will cost
$180,000. In addition, Saturn will incur installation and testing costs of $5,000 and $8,500 respectively. The
expected life of the equipment is 8 years and the salvage value of the equipment is estimated at $18,000.
The annual cash savings are estimated at $32,000. The company uses straight-line depreciation and has a
required rate of return of 14%. Ignore income taxes.

Required:

a. What is the payback period for the investment Creative enterprises. is considering?
$193,500/$32,000 = 6.05 years

b. What is the accrual accounting rate of return for the investment Creative enterprises.. is
considering?

Annual depreciation is ($193,500 - $18,000)/8 years = $21,937.50

AARR = ($32,000 - $21,937.50)/$193,500 = 5.2%

Q2. Batman Abstract Company has three divisions that operate autonomously. Their results for the
current year were as follows:

Riddler Joker Penguin

Sales $5,000,000 $7,000,000 $10,000,000
Contribution margin 1,440,000 1,700,000 3,500,000
Operating income 1,000,000 1,750,000 2,520,000
Investment base 9,000,000 10,000,000 14,000,000

The company's desired rate of return is 20%.

Required:
a. Compute each division's ROI.
b. Compute each division's residual income.

Answer:
a.
Riddler ROI = $1,000,000/$9,000,000 = 0.111
Joker ROI = $1,750,000/$10,000,000 = 0.175
Penguin ROI = $2,520,000/$14,000,000 = 0.180

b.
Riddler Joker Penguin
Investment base $9,000,000 $10,000,000 $14,000,000
Minimum rate × 0.20 × 0.20 × 0.20
Minimum return $1,800,000 $2,000,000 $2,800,000

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Income $1,000,000 $1,750,000 $2,520,000
Minimum return 1,800,000 2,000,000 2,800,000
Residual income $(800,000) $(250,000) $(280,000)

Q3. Tractor Company allows its divisions to operate as autonomous units. Their results for the current
year were as follows:

Plows Tractors Combines

Revenues $2,250,000 $500,000 $4,800,000
Current assets 800,000 152,500 1,435,000
Capital assets 1,000,000 400,000 1,750,000
Current liabilities 350,000 75,000 540,000
Net operating income 220,000 60,000 480,000
After-tax income 143,000 39,000 312,000
Weighted average cost of capital 8.5% 8.5% 8.5%

Required:
For each division compute the
a. return on sales
b. return on investment based on total assets employed
c. economic value added
d. residual income based on net operating income

Answer:
a. Return on Sales:
Plows = $220,000/$2,250,000 = 0.10
Tractors = $60,000/$500,000 = 0.12
Combines = $480,000/$4,800,000 = 0.10

b. ROI:
Plows = $220,000/$1,800,000 = 12.2%
Tractors = $60,000/$552,500 = 10.9%
Combines = $480,000/$3,185,000 = 15.1%

c. EVA:
Plows Tractors Combines

After-tax income $143,000 $39,000 $312,000

Less: sub-totals* $123,250 $40,588 $244,825
Economic value-added $19,750 $(1,588) $87,175

Total assets - current liabilities $1,450,000 $477,500 $2,645,000

WACC 8.5% 8.5% 8.5%
*Sub-totals $123,250 $40,588 $244,825

d. Residual income:
Plows = $220,000 - (.085 × $1,800,000) = $ 67,000
Tractors = $60,000 - (.085 × $552,500) = $ 13,038
Combines = $480,000 - (.085 × $3,185,000) = $ 209,275

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Q4. Provide the missing data for the following situations:

Red White Blue

Division Division Division
Sales $? $10,000,000 $?
Net operating income $200,000 $400,000 $288,000
Total assets $? $? $1,600,000
Return on investment 0.16 0.10 ?
Return on sales 0.04 ? 0.12

Answer: Red Division:

$200,000 ÷ 0.16
Total assets = $1,250,000

ROS = Income/Sales
0.04 = $200,000/Sales
Sales = $5,000,000

White Division:
ROS = $400,000/$10,000,000
= 0.04

TA = NI ÷ ROI
= $400,000 ÷ 0.10
= $4,000,000

Blue Division:
Sales = NI ÷ ROS
= 288,000 ÷ 0.12
= $2,400,000

ROI = (2,400,000 ÷ 1,600,000) × (288,000 ÷ 2,400,000) = 0.18

Asset Turnover X PM

Net Profit Margin= Net Income / Revenue

AT=Asset turnover = Sales /Total Assets

Q5. A company is considering making a $550,000 investment in new equipment. The expected
cash flows are as follows. Calculate the payback period.

Year 1 = $75,000
Year 2 = $140,000
Year 3 = $200,000
Year 4 = $110,000
Year 5 = $60,000

Calculation:

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Year 0 : -$550,000
Year 1 : -$550,000 + $75,000 = -$475,000
Year 2 : -$475,000 + $140,000 = -$335,000
Year 3 : -$335,000 + $200,000 = -$135,000
Year 4 : -$135,000 + $110,000 = -$25,000
Year 5 : -$25,000 + $60,000 = $35,000

Year 4 is the last year with negative cash flow, so the payback period equation is:

4 + ($25,000 / $60,000) = 4.42

So the payback period is 4.42 years.

Q6: A company is considering making a $550,000 investment in new equipment. The expected
cash flows are as follows. Calculate the payback period.

Year 1 = $125,000
Year 2 = $125,000
Year 3 = $125,000
Year 4 = $125,000
Year 5 = $125,000

Calculation:

Year 0 : -$550,000
Year 1 : -$550,000 + $125,000 = -$425,000
Year 2 : -$425,000 + $125,000 = -$300,000
Year 3 : -$300,000 + $125,000 = -$175,000
Year 4 : -$175,000 + $125,000 = -$50,000
Year 5 : -$50,000 + $125,000 = $75,000

Year 4 is the last year with negative cash flow, so the payback period equation is:

4 + ($50,000 / $125,000) = 4.40

So the payback period is 4.42 years.

Q7. Fisher Ltd. is considering the purchase of new equipment. Details of the investment follow:

Net initial investment $1,025,000

Estimated Useful life 8 years
Estimated terminal disposal price $120,000
Estimated annual cash sales $520,000
Estimated annual cash operating expenses $295,000
Required rate of return 12%
Depreciation method: straight line

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Required:
a. Calculate the payback period.
b. Calculate the accrual accounting rate of return based on the initial investment.
c. Calculate the net present value.
Answer:
a.
Annual cash flows = $520,000 - $295,000 = $225,000
Payback = $1,025,000/$225,000 = 4.56 years

b.
Annual depreciation = ($1,025,000 - $120,000)/8 = $113,125
AARR = ($225,000 - $113,125)/$1,025,000 = 10.91%

c.
NPV = $141,184.93
CF0 = - $1,025,000 CF 1 to 7 = $225,000 CF8 = $345,000
or PV of ACF of $225,000 for 8 years at 12% = $1,117,718.95
PV of salvage value of $120,000 = $48,465.99
NPV = -$1,025,000 + $1,117,718.95 + $48,465.99 = $141,184.94

Q8. Crazy Mama manufactures baby furniture, clothing, strollers, and

accessories. In the current year the company plans on purchasing a new
machine to improve the quality and efficiency of production. Crazy Mama has
prepared estimates of future cash flows over the following four years, at
which point it will sell the machine for $10,000. The company focuses on tax
minimization and calculated depreciation over the four years using the
straight-line method, a useful life of four years, and a residual value of $0.

Required:
 Calculate the NPV of the investment.

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 Should the company purchase the new machine?

Estimated cash flows, tax minimization, calculated depreciation.

1. Present Cash Flow Discounted

Value Factor Cash Flows
Initial investment (222,000) 1 (222,000)
Recurring after-tax
operating savings* 14,950 3.170 47,392
Tax shield from
CCA** 49,445 1 49,445
Proceeds from disposal
of machine 10,000 0.683 6,830
Tax shield lost from
disposal*** (2,333) 0.683 (1,594)
NPV (119,927)

*23,000 × (1-0.35)
**(222,000 × 0.35) × (0.20/(0.20 + 0.10)) × ((2 + 0.10)/(2(1 + 0.10)))
***(−10,000 × 0.35) × (0.2/(0.20 + 0.10))

2. The company should not purchase the machine as NPV is negative. The future cash flows
(expected benefits as a result of the investment) are not enough to offset the cost of the new
machine.
Q9. Presumption Inc. is considering purchasing a new machine for $82,000. It will
require additional working capital of $13,000. Its anticipated eight-year life will generate
additional client revenue of $33,000 annually with operating costs, excluding
depreciation, of $15,000. At the end of eight years, it will have a salvage value of $9,500
and return $5,000 in working capital. Taxes are not considered.

Required:
a. Calculate NPV of the proposed investment assuming a required rate of return of
14%.
b. Calculate internal rate of return?

Answer:
a.
Predicted PV of Cash
Cash Flows Year(s) PV Factor Flows
Initial investment $(95,000) 0 1.000 $(95,000)
Annual operations, net 18,000 1 - 8 4.639 83,502
Salvage value, work cap 14,500 8 0.351 5,090
Net present value $(6,408)

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b. Use financial calculator to calculate IRR
The internal rate of return is approximately 12%.

Q10. Computeronics purchased a new piece of equipment at a cost of $60,000 at the

beginning of the year. For tax purposes the machine is a Class 8 asset (15% declining
balance). The company has a 32 percent income tax rate. Assume that the company
has no other Class 8 assets during the period.

Required:
a. Compute the amount of tax savings from CCA for the first three years.
b. Compute the amount of tax savings from CCA for the first three years using a
required rate of return of 12 percent.
Answer:
a. Tax savings = total CCA × tax rate

Calculation of CC
Ending
Opening Half Yr CCA UCC
year UCC Addition Rule Rate CCA balance
1 nil $60,000 0.5 .15 4500 $55,500
2 55,500 0 n/a .15 8325 47175
3 47175 0 n/a .15 7076 40,098
Total CCA $19,901

Therefore, tax savings = $19,901 × 0.32 = $6,368.32

b. Calculation of present value of tax savings

Present Value
year Tax savings Pv factor Tax Savings
1 $1440 0.893 $1,286
2 2664 0.797 $2,123
3 2264 0.712 $1612
Total $5,021

Q11. Wechsler Company produces three products: A130, B324, and C587. All three products
use the same direct material, Brac. Unit data for the three products are

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 The demand for the products far exceeds the direct materials available to produce the products.
Brac costs $9 per pound, and a maximum of 5,000 pounds is available each month. Wechsler
must produce a minimum of 200 units of each product.

Required

1. How many units of product A130, B324, and C587 should Wechsler produce?
2. What is the maximum amount Wechsler would be willing to pay for another 1,200
pounds of Brac?

Answer:

1.
A130 B324 C587
Selling price $252 $ 168 $210
Variable costs:
Direct materials (DM) 72 45 27
Labour and other costs 84 81 120
Total variable costs 156 126 147
Contribution margin $ 96 $ 42 $ 63
Pounds of DM per unit ÷8 lbs. ÷5 lbs. ÷ 3 lbs.
Contribution margin per lb. $ 12 per lb. $8.40 per lb. $ 21 per lb.

First, satisfy minimum requirements.

A130 B324 C587 Total
Minimum units 200 200 200

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Times pounds per unit ×8 ×5 ×3
Pounds needed to produce min. units 1,600 1,000 600 3,200 lb.

 The remaining 1,800 pounds (5,000 – 3,200) should be devoted to C587 because it has
the highest contribution margin per pound of direct material.
 Because each unit of C587 requires3 pounds of Brac, the remaining 1,800 pounds can be
used to produce another 600 units of C587. The following combination yields the highest
contribution margin given the 5,000 pounds constraint on availability of Brac.

A130: 200 units

B324: 200 units
C587: 800 units (200 minimum + 600 extra)

2. The demand for Wechsler’s products exceeds the materials available. Assuming that fixed
costs are covered by the original product mix, Wechsler would be willing to pay up to an
additional $21 per pound (the contribution margin per pound of C587) for another 1,200
pounds of Brac.
 That is, Wechsler would be willing to pay $9 + $21 = $30 per pound of Brac for the
pounds of Brac that will be used to produce C587.1
 If sufficient demand does not exist for 400 units (1,200 pounds ÷ 3 pounds per unit)
of C587, then the maximum price Wechsler would be willing to pay is an additional
$12 per pound (the contribution margin per pound of A130) for the pounds of
Wechsler that will be used to produce A130.
 In this case Wechsler would be willing to pay $9 + $12 = $21 pound. If all the 1,200
pounds of Brac are not used to satisfy the demand for C587 and A130, then the
maximum price Wechsler would be willing to pay is an additional $8.40 per pound
(the contribution margin per pound of B324) for the pounds of Brac that will be used
to produce B324. Wechsler would be willing to pay $8.40 + $9 = $17.40 per pound
of Brac.
Q12.
39) Axle and Wheel Manufacturing is approached by a European customer to fill a one-time-only special
order for a product similar to one offered to domestic customers. The following per unit data apply for
sales to regular customers:

Direct materials $33

Direct labour 15
Variable manufacturing support 24
Fixed manufacturing support 52
Total manufacturing costs $124
Markup (50%) 62
Targeted selling price $186

Axle and Wheel Manufacturing has excess capacity.

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Required:
a. What is the full cost of the product per unit?
b. What is the contribution margin per unit?
c. Which costs are relevant for making the decision regarding this one-time-only special order? Why?
d. For Axle and Wheel Manufacturing, what is the minimum acceptable price of this one-time-only
special order?
e. For this one-time-only special order, should Axle and Wheel Manufacturing consider a price of $100
per unit? Why or why not?

Answer:
a. $124
b. $114 = Selling price $186 - Variable costs ($33 + $15 + $24).
c. Relevant costs for decision making are those costs that differ between alternatives, which in this
situation are the incremental costs. The incremental costs total $72 = Variable costs ($33 + $15 + $24).
d. The minimum acceptable price is $72 = Variable costs ($33 + $15 + $24), which are the incremental
costs in the short term.
e. Yes, because this price is greater than the minimum acceptable price of this special order determined
in (d).

Q13
34) Speed Auto Company manufactures a part for use in its production of automobiles. When 10,000
items are produced, the costs per unit are:

Direct materials $12

Direct manufacturing labour 60
Variable manufacturing overhead 24
Fixed manufacturing overhead 32
Total $128

Monty Company has offered to sell Speed Auto Company 10,000 units of the part for $120 per unit. The
plant facilities could be used to manufacture another part at a savings of $180,000 if Speed Auto accepts
the supplier's offer. In addition, $20 per unit of fixed manufacturing overhead on the original part would
be eliminated.

Required:
a. What is the relevant per unit cost for the original part?
b. Which alternative is best for Speed Auto Company? By how much?
Answer:
a.
Direct materials $12
Direct manufacturing labour 60
Variable manufacturing overhead 24
Avoidable fixed manufacturing overhead 20
Total relevant per unit costs $116

b.
Make Buy Effect of Buying
Purchase price $1,200,000 $(1,200,000)
Savings in space (180,000) 180,000
Direct materials $120,000 120,000
Direct manufacturing labour 600,000 600,000

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Variable overhead 240,000 240,000
Fixed overhead saved (200,000) 200,000
Totals $960,000 $820,000 $140,000

The best alternative is to buy the part.

Q14. Answer the following questions.

1. A company has an inventory of 1,000 assorted parts for a line of missiles that has been
discontinued. The inventory cost is $88,000. The parts can be either (a) re-machined at
total additional costs of $33,000 and then sold for $37,000 or (b) sold as scrap for $4,400.
Which action is more profitable? Show your calculations.

2. A truck, costing $110,000 and uninsured, is wrecked on its first day in use. It can be
either (a) disposed of for $11,000 cash and replaced with a similar truck costing $112,200
or (b) rebuilt for $93,500, and thus be brand-new as far as operating characteristics and
looks are concerned. Which action is less costly? Show your calculations.

1. This is an unfortunate situation, yet the $88,000 costs are irrelevant regarding the decision to
remachine or scrap. The only relevant factors are the future revenues and future costs. By
ignoring the accumulated costs and deciding on the basis of expected future costs, operating
income will be maximized (or losses minimized). The difference in favour of not remachining
is $400:

(a) (b)
Remachine Scrap
Future revenues $37,000 $4,400
Deduct future costs 33,000 —
Operating income $ 4,000 $4,400

Difference in favour of not remachining $400

2. This too is an unfortunate situation. But the $110,000 original cost is irrelevant to this decision.
The difference in favour of rebuilding is $7,700:

(a) (b)
Replace Rebuild
New truck $112,200 —
Deduct current disposal
price of existing truck 11,000 —
Rebuild existing truck — $93,500
$101,200 $93,500

Difference in favour of rebuilding $7,700

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 Note here that the current disposal price of $11,000 is relevant, but the original cost (or book
value, if the truck were not brand new) is irrelevant.

Q15. Answer the following questions.

1. Ewing Computers makes 5,000 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. HT Electronics offers to
supply 5,000 units of CB76 for $210. If Ewing buys from HT, it will be able to save $20
per unit of fixed costs but continues to incur the remaining $30 per unit. Should Ewing
accept HT’s offer? Explain.

2. AP Manufacturing is deciding whether to keep or replace an old machine. It obtains the

following information:

1.
Make Buy
Relevant costs
Variable costs $180
Avoidable fixed costs 20
Purchase price ____ $210
Unit relevant cost $200 $210

 Ewing Computers should reject HT’s offer.

 The $30 of fixed costs are irrelevant because they will be incurred regardless of this
decision.
 When comparing relevant costs between the choices, HT’s offer price is higher than
the cost to continue to produce.
2.
Keep Replace Difference
Cash operating costs (4 years) $80,000 $48,000 $32,000
Current disposal value of old machine (2,500) 2,500
Cost of new machine ______ 8,000 (8,000)
Total relevant costs $80,000 $53,500 $26,500

 AP Manufacturing should replace the old machine.

 The cost savings are far greater than the cost to purchase the new machine.

Q16. Knowledge Transfer Associates is in the process of evaluating its new client services for the
business systems consulting division.
∙ Server Planning, a new service, incurred $250,000 in development costs.
∙ The direct costs of providing the service, which is all labour, averages $50 per hour.

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∙ Other costs for this service are estimated at $300,000 per year.
∙ The current program for server planning is expected to last for two years. At that time,
expected new operating systems are likely to make the service non viable.
∙ Customer service expenses average $250 per client, with each job lasting an average of 40
hours. The current staff expects to bill 15,000 hours for each of the two years the program is in
effect. Billing averages $90 per hour.

Required: What is the estimated life-cycle operating income for both years combined?

Explanation: Year 1 Year 2 Totals

Life-cycle revenue $1,350,000 $1,350,000 $2,700,000
Life-cycle costs:
Development 250,000 250,000
Direct costs 750,000 750,000 1,500,000
Indirect costs 300,000 300,000 600,000
Customer service 93,750 93,750 187,500

Total costs $1,393,750 $1,143,750 $2,537,500

Life-cycle operating income $162,500

Q17. Q5. Bolin Inc. has budgeted sales of $150,000 with the following budgeted costs:
Direct materials $31,500
Direct labour 20,500
Factory overhead:
Variable 18,500
Fixed 28,000
Selling and administrative expenses:
Variable 12,000
Fixed 16,000

Required: Compute the target profit percentage for setting prices as a percentage of:
a. Total costs
b. Total variable costs
c. Variable manufacturing costs
d. Total manufacturing costs
Answer:
a. $31,500 + $20,500 + $18,500 + $28,000 + $12,000 + $16,000 = $126,500
($150,000 - $126,500)/$126,500 = 19 percent
b. $31,500 + $20,500 + $18,500 + $12,000 = $82,500
($150,000 - $82,500)/$82,500 = 82 percent
c. $31,500 + $20,500 + $18,500 = $70,500
($150,000 - $70,500)/$70,500 = 113 percent

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d. $31,500 + $20,500 + $18,500 + $28,000 = $98,500
($150,000 - $98,500)/$98,500 = 52 percent

Q17. After conducting a market research study, Chen Manufacturing decided to produce a new interior
door to complement its exterior door line. It is estimated that the new interior door can be sold at a target
price of $80. The annual target sales volume for interior doors is 20,000. Chen has a target operating
income of 20% of sales.
Calculate the following:

a. target sales revenues

Explanation: $80 × 20,000 = $1,600,000

b. target operating income?

Explanation: $1,600,000 × 20% = $320,000

c. target cost?
Explanation: $1,600,000 - ($1,600,000 × 20%) = $1,280,000

d. target cost for each interior door?

Explanation: [$1,600,000 - ($1,600,000 × 20%)]/20,000 = $64

Q18. Central Medical Clinic has two Service Departments—Building Services and Energy—and three
Operating Departments—Pediatrics, Geriatrics, and Surgery. Central allocates the cost of Building
Services on the basis of square metres and Energy on the basis of patient days. Budgeted operating data
for the year just completed follow:

Service Departments Operating Departments

Building Energy Pediatrics Geriatrics Surgery
Services
Budgeted $20,000 $10,000 $90,000 $60,000 $100,000
Costs before
allocation
Square metres 1,000 4,000 6,000 18,000 12,000

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Patient days - - 5,500 7,700 8,800

Required:

Prepare a schedule to allocate Service Department costs to Operating Departments by the step-down
method, allocating Building Services first, and rounding all amounts to the nearest whole dollar.

Answer:

b)

Step-down method:

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Q 19. Data Source Media manufactures cassettes and CDs in separate divisions utilizing one plant
location. The following data have been prepared for review.

Fixed operation costs $550,000

Practical capacity 1,250 hours
Budgeted usage:
Cassette Division 1,000 hours
CD Division 175 hours
Budgeted variable cost per hour $600 per hour

Required:
a. What is the total cost per hour of use for the Cassette Division assuming budgeted usage is the
allocation base and a single-rate method is used?

Explanation: Cost per hour = [($550,000/1,175) + $600] = $1068.09

= $982.98 per hour used

b. 28. What is the total cost per hour of use for the CD Division assuming the budgeted rate is used
for variable costs and practical capacity is the allocation base for fixed costs?

Explanation: ($550,000/1,250 hours) + $600 = $1040.00

Q20. General Media manufactures cassettes and CDs in separate divisions utilizing one plant location.
The following data have been prepared for review.

Fixed operation costs $950,000

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Practical capacity 2,500 hours
Budgeted usage:
Cassette Division 2,000 hours
CD Division 350 hours
Budgeted variable cost per hour $400 per hour

a. What is the fixed cost per year and the variable cost per hour, respectively, for the General Media
Cassette Division using the dual-rate method, assuming that the allocation bases are capacity for
fixed costs and budgeted capacity for variable costs?
$760,000 and $400.

b. What are the fixed costs per year and the variable cost per hour for the General Media CD Division if
the dual-rate method is used? Assume that the allocation bases are budgeted usage for fixed costs and for
variable costs.
Explanation: Fixed cost per year = [(350/2,350) × 950,000] = $141,489
Variable cost per hour = $400 per hour used

Q 21. Landmark Systems Inc. designs and manufactures global positioning navigation systems for all-
terrain vehicles and water craft. It has two support departments: Design and Engineering; and, two
production departments, Vehicle Systems and Water Craft Systems.

The budgeted level of service relationships at the start of the year was:

Used by:
Design Engineering Vehicles Water Craft
Supplied by:
Design 0.10 0.40 0.50
Engineering 0.05 0.35 0.60

Landmark Systems Inc. collects fixed costs and variable costs of each support department in separate
pools. The budgeted costs for the year were:

Fixed-Cost Variable-Cost
Pools Pools
Design $800,000 $960,000
Engineering $2,200,000 $2,500,000

Support department pools are combined BY COST BEHAVIOR for allocation purposes.

Production statistics (actual) are as follows:

Vehicles Water Craft

Design hours 9,000 12,800
Engineering hours 25,600 19,400
Units produced 45,000 28,000

Required:
a. Allocate the support department VARIABLE costs using the dual-rate method. The company policy is
to use design and engineering hours as the allocation base for variable costs; and, units produced for fixed
costs. (round to the nearest cent)
b. Allocate the support department VARIABLE costs using the reciprocal method.
c. Comment on the effect from combining the variable cost pools as opposed to considering them

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separately when applying the allocation methods.

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Answer:
a. Dual-rate method

VC Pool ($960,000 + $2,500,000)/(9,000 + 12,800 + 25,600 + 19,400) = $51.80

Vehicles (9,000 + 25,600) × $51.80 = $1,172,280
Water Craft (12,800 + 19,400) × $51.80 = 1,667,960
$3,460,240

b. Reciprocal method

E = $2,500,000 +0.10D
D = $960,000 + 0.05E
E = $2,500,000 + 0.10 ($960,000 + 0.05E)
E = $2,596,000 + 0.005E
0.995E = $2,596,000
E = $2,596,000 ÷ 0.995
E = $2,609,045
D = $960,000 + 0.05($2,609,045)
D = $1,090,452

Design Engineering Vehicles Water Craft

VC Pool $960,000 $2,500,000
Design (0.10, 0.40, 0.50) (1,090,452) 109,045 $436,181 $545,226
Engineering (0.05, 0.35,
0.60) 130,452 (2,609,045) 913,166 1,565,427
$0 $0 $1,349,347 $2,110,653

Q22. A company produces two basic types of weight-lifting equipment, Model 9 and Model 14.
Pertinent data are as follows:

The weight-lifting craze suggests that Body Image can sell enough of either Model 9 or Model
14 to keep the plant operating at full capacity. Both products are processed through the same
production departments.

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Required
Which product should the company produce? Briefly explain your answer.

ANSWER

 Only Model 9 should be produced. The key to this problem is the relationship of
manufacturing overhead to each product.
 Note that it takes twice as long to produce Model 9; machine-hours for Model 9 are twice
that for Model 14.
 Management should choose the product mix that maximizes operating income for a given
production capacity (the scarce resource in this situation).
 In this case, despite the fact that model 9 requires twice the number of machine hours to
produce each unit, its contribution margin per unit is so great that it still has a higher
contribution margin per machine-hour.
 Model 14 will yield a $29 contribution to fixed costs per machine hour, and Model 9 will
yield $40:

Model 9 Model 14

Selling price $150.00 $85.00

Variable cost per unit*
($23 + $16 + $18 + $13; $13 + $19 + $9 + $15) 70.00 56.00
Contribution margin per unit $ 80.00 $29.00
Relative use of machine-hours per unit of product ÷ 2 ÷ 1
Contribution margin per machine hour $ 40.00 $29.00

*Variable cost per unit = Direct material cost per unit + Direct manufacturing labour cost per
unit + Variable manufacturing cost per unit + Variable marketing cost per unit.

Q23. Data Source Media manufactures cassettes and CDs in separate divisions utilizing one plant
location. The following data have been prepared for review.

Fixed operation costs $550,000

Practical capacity 1,250 hours
Budgeted usage:
Cassette Division 1,000 hours
CD Division 175 hours
Budgeted variable cost per hour $600 per hour

Instructions: Calculate the following:

a. What is the total cost per hour of use for the Cassette Division assuming budgeted usage is the
allocation base and a single-rate method is used?

Cost per hour = [($550,000/1,175) + $600] = $1068.09

= $982.98 per hour used

b. What is the total cost per hour of use for the CD Division assuming the budgeted rate is used for

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 variable costs and practical capacity is the allocation base for fixed costs?

($550,000/1,250 hours) + $600 = $1040.00

Q24. General Media manufactures cassettes and CDs in separate divisions utilizing one plant location.
The following data have been prepared for review.

Fixed operation costs $950,000

Practical capacity 2,500 hours
Budgeted usage:
Cassette Division 2,000 hours
CD Division 350 hours
Budgeted variable cost per hour $400 per hour

Instructions: Calculate the following:

a. What is the fixed cost per year and the variable cost per hour, respectively, for the General Media
Cassette Division using the dual-rate method, assuming that the allocation bases are capacity for
fixed costs and budgeted capacity for variable costs?

Fixed cost per year = ($950,000/2,500 hours) × 2,000 hours = $760,000

Variable cost per hour = $400 per hour used

b. What are the fixed cost per year and the variable cost per hour for the General Media CD Division
if the dual-rate method is used? Assume that the allocation bases are budgeted usage for fixed
costs and for variable costs.

Fixed cost per year = [(350/2,350) × 950,000] = $141,489

Variable cost per hour = $400 per hour used

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