ACCTG 311A – SUMMER, 2003 – WIDDISON
ACCTG 505 – SUMMER, 2008 – WIDDISON
Assignment Solutions
Table of Contents: (Arranged in order of class presentation.)
Chapter 2. Cost Terms 2
Chapter 4. Job-Order Costing 5
Chapter 5. Activity-Based Costing/Management 8
Chapter 17. Process Costing 13
Chapter 15. Cost Allocation – Support Departments 17
Chapter 16. Cost Allocation – Joint and Byproducts 18
Chapter 3. Cost-Volume-Profit Analysis 20
Chapter 6. Master Budget and Responsibility Accounting 23
Chapter 7. Flexible Budgets and Variance Analysis I 26
Chapter 8. Flexible Budgets and Variance Analysis II 29
Chapter 11. Selected Relevance Models 33
Chapter 21. Capital Budgeting 37
Chapter 22. Control Systems: Transfer Pricing 40
Chapter 23. Performance Measurement and Compensation 43
If you find any errors or omissions in this packet, please notify the instructor by email -- widdison@u.washington.edu -- so that she may make the appropriate corrections or additions.
Chapter 2. Cost Terms and Concepts
.2-16 (15 min.) Computing and interpreting manufacturing unit costs.
1. (in millions)
Supreme Deluxe Regular Total
Direct material cost $ 84.00 $ 54.00 $ 62.00 $200.00
Direct manuf. labor costs 14.00 28.00 8.00 50.00
Indirect manuf. costs 42.00 84.00 24.00 150.00
Total manuf. costs $140.00 $166.00 $ 94.00 $400.00
Fixed costs allocated at a rate
of $20M[pic]$50M (direct mfg.
labor) equal to $0.40 per
dir. manuf. labor dollar
(0.40 [pic] $14; 28; 8) 5.60 11.20 3.20 20.00
Variable costs $134.40 $154.80 $ 90.80 $380.00
Units produced (millions) 80 120 100
Cost per unit (Total manuf.
costs ÷ units produced) $1.7500 $1.3833 $0.9400
Variable manuf. cost per unit
(Variable manuf. costs
[pic]Units produced) $1.6800 $1.2900 $0.9080
(in millions)
Supreme Deluxe Regular Total
2. Based on total manuf. cost
per unit ($1.75 [pic]120;
$1.3833 [pic]160; $0.94 [pic]180) $210.00 $221.33 $169.20 $600.53
Correct total manuf. costs based
on variable manuf. costs plus
fixed costs equal
Variable costs ($1.68 [pic]120; $201.60 $206.40 $163.44 $571.44
$1.29 [pic]160; $0.908 [pic]180)
Fixed costs 20.00
Total costs $591.44
The total manufacturing cost per unit in Requirement 1 above includes $20 million of indirect manufacturing costs that are fixed irrespective of changes in the volume of output per month, while the remaining variable indirect manufacturing costs change with the production volume. Given the unit volume changes for August 2007, the use of total manufacturing cost per unit from the past month at a different unit volume level (both in aggregate and at the individual product level) will yield incorrect estimates of total costs of $600.53 million in August 2007 relative to the correct total manufacturing costs of $591.44 million calculated using variable manufacturing cost per unit times units produced plus the fixed costs of $20 million.
2-17 (15 min.) Direct and indirect costs, effect of changing the classification of a cost item (continuation of 2-16).
1. MOP’s managers might prefer that energy costs be directly traced to various products because in general, the greater the proportion of economically traceable costs, the more accurate will be the estimated cost of each cost object and hence the better the managerial decisions (like product pricing) based on those cost estimates. Since energy costs were substantial ($90 million out of $150 million of manufacturing overhead), tracing them directly to cost objects would significantly increase the accuracy of the cost estimates.
2. (in millions)
Supreme Deluxe Regular
Direct materials costs $ 84.0 $ 54.0 $62.0
Direct manufacturing labor costs 14.0 28.0 8.0
Direct energy costs 39.8 40.7 9.5
Other manufacturing overhead costs 16.8 33.6 9.6
Total manufacturing costs $154.6 $156.3 $89.1
Units produced (millions) 80 120 100
Cost per unit $ 1.93 $ 1.30 $0.89
3.
Cost per unit (before analysis) $1.75 $ 1.38 $0.94
Cost per unit (after analysis) $1.93 $ 1.30 $0.89
Effect of analysis on cost per unit higher lower lower
Before Shore’s analysis, the Deluxe and Regular product lines were being over-costed and the Supreme line was being under-costed. Shore’s analysis resulted in $60 million of the $150 million of “overhead costs” becoming directly traceable to products. It showed that the Supreme line consumes the most energy relative to the volume of production. With more accurate direct costs, and therefore a more accurate allocation of the overheads of $60 million, Supreme’s cost per unit is more than in the old cost system, while the cost per unit of Deluxe and Regular is less than in the old cost system.
2-20 (15-20 min.) Classification of costs, manufacturing sector.
Cost object: Type of car assembled (Corolla or Geo Prism)
Cost variability: With respect to changes in the number of cars assembled
(There may be some debate over classifications of individual items, especially with regard to cost variability.)
|Cost Item |D or I |V or F |
|A |D |V |
|B |I |F |
|C |D |F |
|D |D |F |
|E |D |V |
|F |I |V |
|G |D |V |
|H |I |F |
2-27 (20–30 min.) Inventoriable costs versus period costs.
1. Manufacturing-sector companies purchase materials and components and convert them into different finished goods.
Merchandising-sector companies purchase and then sell tangible products without changing their basic form.
Service-sector companies provide services or intangible products to their customers—for example, legal advice or audits.
Only manufacturing and merchandising companies have inventories of goods for sale.
2. Inventoriable costs are all costs of a product that are regarded as an asset when they are incurred and then become cost of goods sold when the product is sold. These costs for a manufacturing company are included in work-in-process and finished goods inventory (they are “inventoried”) to build up the costs of creating these assets.
Period costs are all costs in the income statement other than cost of goods sold. These costs are treated as expenses of the period in which they are incurred because they are presumed not to benefit future periods (or because there is not sufficient evidence to conclude that such benefit exists). Expensing these costs immediately best matches expenses to revenues.
3. (a) Mineral water purchased for resale by Safeway—inventoriable cost of a merchandising company. It becomes part of cost of goods sold when the mineral water is sold.
b) Electricity used at GE assembly plant—inventoriable cost of a manufacturing company. It is part of the manufacturing overhead that is included in the manufacturing cost of a refrigerator finished good.
c) Depreciation on Google’s computer equipment—period cost of a service company. Google has no inventory of goods for sale and, hence, no inventoriable cost.
d) Electricity for Safeway’s store aisles—period cost of a merchandising company. It is a cost that benefits the current period and it is not traceable to goods purchased for resale.
e) Depreciation on GE’s assembly testing equipment—inventoriable cost of a manufacturing company. It is part of the manufacturing overhead that is included in the manufacturing cost of a refrigerator finished good.
f) Salaries of Safeway’s marketing personnel—period cost of a merchandising company. It is a cost that is not traceable to goods purchased for resale. It is presumed not to benefit future periods (or at least not to have sufficiently reliable evidence to estimate such future benefits).
g) Bottled water consumed by Google’s engineers—period cost of a service company. Google has no inventory of goods for sale and, hence, no inventoriable cost.
h) Salaries of Google’s marketing personnel—period cost of a service company. Google has no inventory of goods for sale and, hence, no inventoriable cost.
Chapter 4 Job Order Costing
16. (10 min) Job order costing, process costing.
a. Job costing l. Job costing
b. Process costing m. Process costing
c. Job costing n. Job costing
d. Process costing o. Job costing
e. Job costing p. Job costing
f. Process costing q. Job costing
g. Job costing r. Process costing
h. Job costing (but some process costing) s. Job costing
i. Process costing t. Process costing
j. Process costing u. Job costing
k. Job costing
4-27 (15 min.) Job costing, unit cost, ending work in progress.
1.
|Direct manufacturing labor rate per hour |$25 | |
|Manufacturing overhead cost allocated |$20 | |
|per manufacturing labor-hour | | |
| |Job M1 |Job M2 |
|Direct manufacturing labor costs |$275,000 |$200,000 |
|Direct manufacturing labor hours ($275,000[pic]$25; | 11,000 | 8,000 |
|$200,000[pic]$25) | | |
|Manufacturing overhead cost allocated (11,000 [pic] $20; |$220,000 |$160,000 |
|8,000 [pic] $20) | | |
| | | |
|Job Costs May 2007 |Job M1 |Job M2 |
|Direct materials |$ 75,000 |$ 50,000 |
|Direct manufacturing labor | 275,000 | 200,000 |
|Manufacturing overhead allocated | 220,000 | 160,000 |
|Total costs |$570,000 |$410,000 |
2.
|Number of pipes produced for Job M1 |1,500 | |
|Cost per pipe ($570,000 [pic]1,500) |$380 | |
3.
Finished Goods Control 570,000
Work-in-Process Control 570,000
4. Raymond Company began May 2007 with no work-in-process inventory. During May, it started and finished M1. It also started M2, which is still in work-in-process inventory at the end of May. M2’s manufacturing costs up to this point, $410,000, remain as a debit balance in the Work-in-Process Inventory account at the end of May 2007.
4-36 (35 min.) General ledger relationships, under- and overallocation.
The solution assumes all materials used are direct materials. A summary of the T-accounts for Needham Company before adjusting for under- or overallocation of overhead follows:
| Direct Materials Control Work-in-Process Control |
|1-1-2006 30,000 |Material used for |1-1-2006 20,000 |Transferred to |
|Purchases 400,000 |manufacturing 380,000 |Direct materials 380,000 |finished goods 940,000 |
|12-31-2006 50,000 | |Direct manuf. | |
| | |Labor 360,000 | |
| | |Manuf. overhead | |
| | |Allocated 480,000 | |
| | |12-31-2006 300,000 | |
| | | | |
|Finished Goods Control |Cost of Goods Sold |
|1-1-2006 10,000 |Cost of goods |Finished goods | |
|Transferred in |sold 900,000 |Sold 900,000 | |
|from WIP 940,000 | | | |
|12-31-2006 50,000 | | | |
| | | | |
|Manufacturing Overhead Control |Manufacturing Overhead Allocated |
|Manufacturing | | |Manufacturing |
|Overhead | | |overhead |
|Costs 540,000 | | |allocated to |
| | | |work in |
| | | |process 480,000 |
1. From Direct Materials Control T-account,
Direct materials issued to production = $380,000 that appears as a credit.
2. Direct manufacturing labor-hours = [pic]
= [pic]= 24,000 hours
[pic] = [pic] ( [pic]
= 24,000 hours ( $20 = $480,000
3. From the debit entry to Finished Goods T-account,
Cost of jobs completed and transferred from WIP = $940,000
4. From Work-in-Process T-account,
[pic] = $20,000 + $380,000 + $360,000 + $480,000 – $940,000 = $300,000
5. From the credit entry to Finished Goods Control T-account, Cost of goods sold (before proration) = $900,000
6. [pic] = [pic] – [pic]
= $540,000 – $480,000
= $60,000 underallocated
7. a. Write-off to Cost of Goods Sold will increase (debit) Cost of Goods Sold by $60,000. Hence, Cost of Goods Sold = $900,000 + $60,000 = $960,000.
b. Proration based on ending balances (before proration) in Work in Process, Finished Goods, and Cost of Goods Sold.
Account balances in each account after proration follows:
| | |Proration of $60,000 Underallocated | |
| | |Manufacturing Overhead |Account Balance |
|Account |Account Balance |(3) |(After Proration) |
|(1) |(Before Proration) | |(4)=(2)+(3) |
| |(2) | | |
|Work in Process | $ 300,000 (24%) |0.24 ( $60,000 = $14,400 |$ 314,400 |
|Finished Goods | 50,000 ( 4%) |0.04 ( $60,000 = 2,400 |52,400 |
|Cost of Goods Sold | 900,000 (72%) |0.72 ( $60,000 = 43,200 | 943,200 |
| | $1,250,000 100% | $60,000 |$1,310,000 |
8. Needham’s operating income using write-off to Cost of Goods Sold and Proration based on ending balances (before proration) follows:
Write-off to Proration Based
Cost of Goods on Ending
Sold Balances
Revenues $1,090,000 $1,090,000
Cost of goods sold 960,000 943,200
Gross margin 130,000 146,800
Marketing and distribution costs 140,000 140,000
Operating income/(loss) $ (10,000) $ 6,800
9. If the purpose is to report the most accurate inventory and cost of goods sold figures, the preferred method is to prorate based on the manufacturing overhead allocated component in the inventory and cost of goods sold accounts. Proration based on the balances in Work in Process, Finished Goods, and Cost of Goods Sold will equal the proration based on the manufacturing overhead allocated component if the proportions of direct costs to manufacturing overhead costs are constant in the Work in Process, Finished Goods and Cost of Goods Sold accounts. Even if this is not the case, the prorations based on Work in Process, Finished Goods, and Cost of Goods Sold will better approximate the results if actual cost rates had been used rather than the write-off to Cost of Goods Sold method.
Another consideration in Needham’s decision about how to dispose of underallocated manufacturing overhead is the effects on operating income. The write-off to Cost of Goods Sold will lead to an operating loss. Proration based on the balances in Work in Process, Finished Goods, and Cost of Goods Sold will help Needham avoid the loss and show an operating income.
The main merit of the write-off to Cost of Goods Sold method is its simplicity. However, accuracy and the effect on operating income favor the preferred and recommended proration approach.
Chapter 5 Activity-based Costing
5-16 (20 min.) Cost Hierarchy
1. a. Indirect manufacturing labor costs of $1,000,000 support direct manufacturing labor and are output unit-level costs. Direct manufacturing labor generally increases with output units, and so will the indirect costs to support it.
b. Batch-level costs are costs of activities that are related to a group of units of a product rather than each individual unit of a product. Purchase order-related costs (including costs of receiving materials and paying suppliers) of $500,000 relate to a group of units of product and are batch-level costs.
c. Cost of indirect materials of $250,000 generally changes with labor hours or machine hours which are unit-level costs. Therefore, indirect material costs are output unit-level costs.
d. Setup costs of $600,000 are batch-level costs because they relate to a group of units of product produced after the machines are set up.
e. Costs of designing processes, drawing process charts, and making engineering changes for individual products, $800,000, are product-sustaining because they relate to the costs of activities undertaken to support individual products regardless of the number of units or batches in which the product is produced.
f. Machine-related overhead costs (depreciation and maintenance) of $1,100,000 are output unit-level costs because they change with the number of units produced.
g. Plant management, plant rent, and insurance costs of $900,000 are facility-sustaining costs because the costs of these activities cannot be traced to individual products or services but support the organization as a whole.
2. The complex boom box made in many batches will use significantly more batch-level overhead resources compared to the simple boom box that is made in a few batches. In addition, the complex boom box will use more product-sustaining overhead resources because it is complex. Because each boom box requires the same amount of machine-hours, both the simple and the complex boom box will be allocated the same amount of overhead costs per boom box if Teledor uses only machine-hours to allocate overhead costs to boom boxes. As a result, the complex boom box will be undercosted (it consumes a relatively high level of resources but is reported to have a relatively low cost) and the simple boom box will be overcosted (it consumes a relatively low level of resources but is reported to have a relatively high cost).
3. Using the cost hierarchy to calculate activity-based costs can help Teledor to identify both the costs of individual activities and the cost of activities demanded by individual products. Teledor can use this information to manage its business in several ways:
a. Pricing and product mix decisions. Knowing the resources needed to manufacture and sell different types of boom boxes can help Teledor to price the different boom boxes and also identify which boom boxes are more profitable. It can then emphasize its more profitable products.
b. Teledor can use information about the costs of different activities to improve processes and reduce costs of the different activities. Teledor could have a target of reducing costs of activities (setups, order processing, etc.) by, say, 3% and constantly seek to eliminate activities and costs (such as engineering changes) that its customers perceive as not adding value.
c. Teledor management can identify and evaluate new designs to improve performance by analyzing how product and process designs affect activities and costs.
d. Teledor can use its ABC systems and cost hierarchy information to plan and manage activities. What activities should be performed in the period and at what cost?
5-19 (20 min.) Plantwide, department and ABC indirect cost rates.
1.
|Actual plant-wide variable MOH rate based on | | |
|machine hours, $308,600[pic]4,000 | | |
| | |$77.15 per machine hour |
| | | |
| | | |United Motors |Holden Motors |Leland Vehicle|Total |
|Variable manufacturing overhead, allocated based on machine hours ($77.15|$9,258 |$216,020 |$83,322 |$308,600 |
|[pic] 120; $77.15 [pic] 2,800; $77.15 [pic] 1,080) | | | | |
2.
| |Variable MOH in 2007 |Total |Rate | | | |
|Department | |Driver Units | | | | |
|Design |$39,000 |390 |$100 |per CAD-design hour |
|Production | 29,600 |370 |$ 80 |per engineering hour |
|Engineering |240,000 |4,000 |$ 60 |per machine hour | |
| | | | | | | |
| | | |United |Holden |Leland |Total |
| | | |Motors |Motors |Vehicle | |
|Design-related overhead, allocated on CAD-design hours |$11,000 |$ 20,000 |$ 8,000 |$ 39,000 |
|(110 [pic] $100; 200 [pic] $100; 80 [pic] $100) | | | | |
|Production-related overhead, allocated on engineering hours | 5,600 | 4,800 |19,200 | 29,600 |
|(70 [pic] $80; 60 [pic] $80; 240 [pic] $80) | | | | |
|Engineering-related overhead, allocated on machine hours | 7,200 | 168,000 | 64,800 | 240,000 |
|(120 [pic] $60; 2,800 [pic] $60; 1,080 [pic] $60) | | | | |
|Total | | |$23,800 |$192,800 |$92,000 |$308,600 |
3.
| |United |Holden |Leland |
| |Motors |Motors |Vehicle |
|a. Department rates | | | |
|(Requirement 2) |$23,800 |$192,800 |$92,000 |
|b. Plantwide rate | | | |
|(Requirement 1) |$ 9,258 |$216,020 |$83,322 |
|Ratio of (a) ÷ (b) |2.57 |0.89 |1.10 |
The variable manufacturing overhead allocated to United Motors increases by 157% under the department rates, the overhead allocated to Holden decreases by about 11% and the overhead allocated to Leland increases by about 10%.
The three contracts differ sizably in the way they use the resources of the three departments.
The percentage of total driver units in each department used by the companies is:
| |Cost |United |Holden |Leland |
|Department |Driver |Motors |Motors |Vehicle |
|Design |CAD-design hours |28% |51% |21% |
|Engineering |Engineering hours |19 |16 |65 |
|Production |Machine hours |3 |70 |27 |
The United Motors contract uses only 3% of total machines hours in 2004, yet uses 28% of CAD design-hours and 19% of engineering hours. The result is that the plantwide rate, based on machine hours, will greatly underestimate the cost of resources used on the United Motors contract. This explains the 157% increase in indirect costs assigned to the United Motors contract when department rates are used.
In contrast, the Holden Motors contract uses less of design (51%) and engineering (16%) than of machine-hours (70%). Hence, the use of department rates will report lower indirect costs for Holden Motors than does a plantwide rate.
Holden Motors was probably complaining under the use of the simple system because its contract was being overcosted relative to its consumption of MOH resources. United, on the other hand was having its contract undercosted and underpriced by the simple system. Assuming that AP is an efficient and competitive supplier, if the new department-based rates are used to price contracts, United will be unhappy. AP should explain to United how the calculation was done, and point out United’s high use of design and engineering resources relative to production machine hours. Discuss ways of reducing the consumption of those resources, if possible, and show willingness to partner with them to do so. If the price rise is going to be steep, perhaps offer to phase in the new prices.
4. Other than for pricing, AP can also use the information from the department-based system to examine and streamline its own operations so that there is maximum value-added from all indirect resources. It might set targets over time to reduce both the consumption of each indirect resource and the unit costs of the resources. The department-based system gives AP more opportunities for targeted cost management.
5. It would not be worthwhile to further refine the cost system into an ABC system if there wasn’t much variation among contracts in the consumption of activities within a department. If, for example, most activities within the design department were, in fact, driven by CAD-design hours, then the more refined system would be more costly and no more accurate than the department-based cost system. Even if there was sufficient variation, considering the relative sizes of the 3 department cost pools, it may only be cost-effective to further analyze the engineering cost pool, which consumes 78% ($240,000[pic]$308,600) of the manufacturing overhead.
5-26 (20(25 min.) Activity-based costing, job-costing system.
1. An overview of the activity-based job-costing system is:
2. Activity Area Indirect Manufacturing
Costs Allocated
1. Axial insertion $ 0.08 [pic] 45 = $ 3.60
2. Dip insertion 0.25 [pic] 24 = 6.00
3. Manual insertion 0.50 [pic] 11 = 5.50
4. Wave solder 3.50 [pic] 1 = 3.50
5. Backload 0.70 [pic] 6 = 4.20
6. Test 90.00 [pic] .25 = 22.50
7. Defect analysis 80.00 [pic] .10 = 8.00
Total $53.30
Direct manufacturing costs:
Direct materials $75.00
Direct manufacturing labor 15.00 $ 90.00
Indirect manufacturing costs:
Manufacturing overhead (see above) 53.30
Total manufacturing costs $143.30
3. The manufacturing manager likely would find the ABC job-costing system useful in cost management. Unlike direct manufacturing labor costs, the seven indirect cost pools are systematically linked to the activity areas at the plant. The result is more accurate product costing. Productivity measures can be developed that directly link to the management accounting system.
Marketing managers can use ABC information to price jobs as well as to advise customers about how selecting different product features will affect price.
Chapter 17 – Process Costing
17-35 (25 min.) Weighted-average method.
Solution Exhibit 17-35A shows equivalent units of work done to date of
Direct materials 2,500 equivalent units
Conversion costs 2,125 equivalent units
Note that direct materials are added when the Forming Department process is 10% complete. Both the beginning and ending work in process are more than 10% complete and hence are 100% complete with respect to direct materials.
Solution Exhibit 17-35B calculates cost per equivalent unit of work done to date for direct materials and conversion costs, summarizes the total Forming Department costs for April 2004, and assigns these costs to units completed (and transferred out), and to units in ending work in process using the weighted-average method.
SOLUTION EXHIBIT 17-35A
Steps 1 and 2: Summarize Output in Physical Units and Compute Equivalent Units
Weighted-Average Method of Process Costing, Forming Department of Star Toys for April 2007
(Step 1) (Step 2)
Physical Equivalent Units
Units Direct Conversion
Flow of Production (given) Materials Costs
Work in process, beginning 300
Started during current period 2,200
To account for 2,500
Completed and transferred out
during current period 2,000 2,000 2,000
Work in process, ending* 500
500 ( 100%; 500 ( 25% 500 125
Accounted for 2,500
Work done to date 2,500 2,125
*Degree of completion in this department: direct materials, 100%; conversion costs, 25%.
SOLUTION EXHIBIT 17-35B
Steps 3, 4, and 5: Compute Equivalent Unit Costs, Summarize Total Costs to Account For, and Assign Costs to Units Completed and to Units in Ending Work in Process
Weighted-Average Method of Process Costing, Forming Department of Star Toys for April 2007
| |Total | | |
| |Production |Direct |Conversion |
| |Costs |Materials |Costs |
|(Step 3) Work in process, beginning (given) |$ 9,625 |$ 7,500 |$ 2,125 |
| Costs added in current period (given) | 112,500 | 70,000 | 42,500 |
| Costs incurred to date | |$77,500 |$44,625 |
|Divide by equivalent units of work done to | | | |
|date (Solution Exhibit 17-35A) | |( 2,500 |( 2,125 |
|Cost per equivalent unit of work done to date | |$ 31 |$ 21 |
|(Step 4) Total costs to account for |$122,125 | | |
|(Step 5) Assignment of costs: | | |
|Completed and transferred out (2,000 units) |$104,000 |2,000* ( $31 + 2,000* ( $21 |
| Work in process, ending (500 units) | | |
|Direct materials |15,500 |500†[pic]$31 |
| Conversion costs | 2,625 | 125†[pic]$21 |
|Total work in process, ending |18,125 | |
|Total costs accounted for |$122,125 | |
*Equivalent units completed and transferred out from Solution Exhibit 17-35A, Step 2.
†Equivalent units in work in process, ending from Solution Exhibit 17-35A, Step 2.
38. (30 min.) Transferred-in costs, weighted average
1. Solution Exhibit 17-38A computes the equivalent units of work done to date in the Spinning Department for transferred-in costs, direct materials, and conversion costs.
Solution Exhibit 17-38B calculates the cost per equivalent unit of work done to date in the Spinning Department for transferred-in costs, direct materials, and conversion costs, summarizes total Spinning Department costs for April 2007, and assigns these costs to units completed and transferred out and to units in ending work in process using the weighted-average method.
2. Journal entries:
a. Work in Process––Spinning Department 96,000
Work in Process––Drawing Department 96,000
Cost of goods completed and transferred out
during April from the Drawing Department
to the Spinning Department
b. Finished Goods 166,008
Work in Process––Spinning Department 166,008
Cost of goods completed and transferred out
during April from the Spinning Department
to Finished Goods inventory
SOLUTION EXHIBIT 17-38A
Steps 1 and 2: Summarize Output in Physical Units and Compute Output in Equivalent Units;
Weighted-Average Method of Process Costing,
Spinning Department of Jhirmack Woolen Mills for April 2007.
| |(Step 1) |(Step 2) |
| | |Equivalent Units |
|Flow of Production |Physical Units|Transferred-in |Direct |Conversion Costs|
| | |Costs |Materials | |
|Work in process, beginning (given) | 600 | | | |
|Transferred-in during current period (given) |1,800 | | | |
|To account for |2,400 | | | |
|Completed and transferred out during current period: |2,000 |2,000 |2,000 |2,000 |
|Work in process, endinga (given) | 400 | | | |
| (400 [pic] 100%; 400 [pic] 0%; 400 [pic] 60%) | | 400 | 0 | 240 |
|Accounted for |2,400 | | | |
|Work done to date | |2,400 |2,000 |2,240 |
| | | | | |
|aDegree of completion in this department: transferred-in costs, 100%; direct materials, 0%; conversion costs, 60%. |
For solution Exhibit 38B, please see next page.
SOLUTION EXHIBIT 17-38B
Steps 3, 4, and 5: Compute Cost per Equivalent Unit, Summarize Total Costs to Account For, and Assign Total Costs to Units Completed and to Units in Ending Work in Process;
Weighted-Average Method of Process Costing,
Spinning Department of Jhirmack Woolen Mills for April 2007.
| | |Total Production |Transferred-in Costs |Direct Materials |Conversion Costs |
| | |Costs | | | |
|(Step 3) |Work in process, beginning (given) |$ 31,850 | $ 21,850 |$ 0 | $10,000 |
| |Costs added in current period (given) | 159,800 | 96,000 | 17,800 | 46,000 |
| |Costs incurred to date | |$117,850 |$17,800 | $56,000 |
| |Divide by equivalent units of work done to date (Solution Exhibit 17-38A) | | 2,400 | 2,000 | 2,240 |
| |Cost per equivalent unit of work done to date | | $ 49.104 |$ 8.90 | $ 25 |
|(Step 4) |Total costs to account for |$191,650 | | | |
|(Step 5) |Assignment of costs: | | | | |
| |Completed and transferred out (2,000 units) |$166,008 | (2,000a[pic]$49.104) + (2,000a [pic]$8.90) + (2,000a [pic]$25) |
| |Work in process, ending (400 units): | 25,642 | (400b [pic]$49.104) + (0b [pic]$8.90) + (240b |
| | | |[pic]$25) |
| |Total costs accounted for |$191,650 | | | |
| | | | | | |
|a Equivalent units completed and transferred out from Sol. Exhibit 17-38A, step 2. |
|b Equivalent units in ending work in process from Sol. Exhibit 17-38A, step 2. |
Chapter 15. Cost Allocation – Support Departments
15-21 (40 min.) Direct and step-down allocation.
1.
| |Support Departments |Operating Departments | |
| |HR |Info. Systems |Corporate |Consumer |Total |
|Costs Incurred |$72,700 |$234,400 |$ 998,270 |$489,860 |$1,795,230 |
|Alloc. of HR costs | | | | | |
| (42/70, 28/70) |(72,700) | |43,620 |29,080 | |
|Alloc. of Info. Syst. costs | | | | | |
| (1,920/3,520, 1,600/3,520) | | (234,400) | 127,855 | 106,545 | |
| |$ 0 |$ 0 |$1,169,745 |$625,485 |$1,795,230 |
2. Rank on percentage of services rendered to other support departments.
Step 1: HR provides 23.077% of its services to information systems:
[pic] = [pic] = 23.077%
This 23.077% of $72,700 HR department costs is $16,777.
Step 2: Information systems provides 8.333% of its services to HR:
[pic] = [pic] = 8.333%
This 8.333% of $234,400 information systems department costs is $19,533.
| |Support Departments |Operating Departments | |
| |HR |Info. Systems |Corporate |Consumer |Total |
|Costs Incurred |$72,700 |$234,400 |$ 998,270 |$489,860 |$1,795,230 |
|Alloc. of HR costs | | | | | |
| (21/91, 42/91, 28/91) | (72,700) | 16,777 | 33,554 |22,369 | |
| |$ 0 |251,177 | | | |
|Alloc. of Info. Syst. costs | | | | | |
| (1,920/3,520, 1,600/3,520) | |(251,177) | 137,006 | 114,171 | |
| | |$ 0 |$1,168,830 |$626,400 |$1,795,230 |
3. An alternative ranking is based on the dollar amount of services rendered to other support departments. Using numbers from requirement 2, this approach would use the following sequence:
Step 1: Allocate Information Systems first ($19(533 provided to HR).
Step 2: Allocate HR second ($16(777 provided to Information Systems).
Chapter 16. Cost Allocation – Joint and Byproducts
22. (30 min.) Joint-cost allocation, sales value, physical measure, NRV methods.
1a.
|PANEL A: Allocation of Joint Costs using Sales Value at |Ricito |Pancito |Total |
|Splitoff | | | |
|Sales value of total production at splitoff point | | | |
| (25,000 tons [pic] $10 per ton; 50,000 [pic] $15 per ton) |$250,000 |$750,000 |$1,000,000 |
|Weighting ($250,000; $750,000 ÷ $1,000,000) |0.25 |0.75 | |
|Joint costs allocated (0.25; 0.75 [pic] $600,000) |$150,000 |$450,000 |$600,000 |
| |Ricito |Pancito |Total |
|PANEL B: Product-Line Income Statement for June 2006 | | | |
|Revenues | | | |
| (25,000 tons [pic]$10 per ton; 50,000 [pic]$15 per ton) |$250,000 |$750,000 |$1,000,000 |
|Joint costs allocated (from Panel A) | 150,000 | 450,000 | 600,000 |
|Gross margin |$100,000 |$300,000 |$ 400,000 |
|Gross margin percentage |40% |40% |40% |
1b.
|PANEL A: Allocation of Joint Costs using Physical Measure |Ricito |Pancito |Total |
|Method | | | |
|Physical measure of total production (tons) |25,000 |50,000 |75,000 |
|Weighting (25,000 tons; 50,000 tons ÷ 75,000 tons) |33% |67% | |
|Joint costs allocated (0.33; 0.67 [pic] $600,000) |$200,000 |$400,000 |$600,000 |
| |Ricito |Pancito |Total |
|PANEL B: Product-Line Income Statement for June 2006 | | | |
|Revenues | | | |
| (25,000 tons [pic] $10 per ton; 50,000 [pic] $15 per ton) |$250,000 |$750,000 |$1,000,000 |
|Joint costs allocated (from Panel A) | 200,000 | 400,000 | 600,000 |
|Gross margin |$ 50,000 |$350,000 |$ 400,000 |
|Gross margin percentage |20% |47% |40% |
1c.
|PANEL A: Allocation of Joint Costs using Net Realizable |Rilaf |Pilaf |Total |
|Value | | | |
|Final sales value of total production during accounting period | | | |
| (30,000 tons [pic] $18 per ton; 60,000 tons [pic] $25 per ton) |$540,000 |$1,500,000 |$2,040,000 |
|Deduct separable costs | 120,000 | 420,000 | 540,000 |
|Net realizable value at splitoff point |$420,000 |$1,080,000 |$1,500,000 |
|Weighting ($420,000; $1,080,000 ÷ $1,500,000) |28% |72% | |
|Joint costs allocated (0.28; 0.72 [pic] $600,000) |$168,000 |$432,000 |$600,000 |
| |Rilaf |Pilaf |Total |
|PANEL B: Product-Line Income Statement for June 2006 | | | |
|Revenues (30,000 tons [pic] $18 per ton; 60,000 tons [pic] $25 per ton) |$540,000 |$1,500,000 |$2,040,000 |
|Joint costs allocated (from Panel A) |168,000 |432,000 |600,000 |
|Separable costs | 120,000 | 420,000 | 540,000 |
|Gross margin |$252,000 |$ 648,000 |$ 900,000 |
|Gross margin percentage |46.7% |43.2% |44.1% |
2. Shel Brown probably performed the analysis shown below to arrive at the net loss of $5,571 from marketing the sludge:
|PANEL A: Allocation of Joint Costs using |Ricito |Pancito |Sludge |Total |
|Sales Value at Splitoff | | | | |
|Sales value of total production at splitoff point | | | | |
| (25,000 tons [pic] $10 per ton; 50,000 [pic] $15 per |$250,000 |$750,000 |$50,000 |$1,050,000 |
|ton; 10,000 [pic] $5 per ton) | | | | |
|Weighting | | | | |
| ($250,000; $750,000; $50,000 ÷ $1,050,000) |23.8095% |71.4286% |4.7619% |100% |
|Joint costs allocated |$142,857 |$428,571 |$28,571 |$600,000 |
|(0.238095; 0.714286; 0.047619 [pic] $600,000) | | | | |
| |Ricito |Pancito |Sludge |Total |
|PANEL B: Product-Line Income Statement | | | | |
|for June 2006 | | | | |
|Revenues | | | | |
| (25,000 tons [pic]$10 per ton; 50,000 [pic] $15 per ton; |$250,000 |$750,000 |$50,000 |$1,050,000 |
|10,000 [pic]$5 per ton) | | | | |
|Joint costs allocated (from Panel A) | 142,857 | 428,572 | 28,571 | 600,000 |
|Gross margin |107,143 |321,428 | 21,429 | 450,000 |
|Deduct marketing costs | | | 27,000 | 27,000 |
|Operating income | | |($5,571) | $ 423,000 |
| | | | | |
In this (misleading) analysis, the $600,000 of joint costs are re-allocated between Ricito, Pancito and the sludge. Irrespective of the method of allocation, this analysis is wrong. Joint costs are always irrelevant in a process-further decision. Only incremental costs and revenues past the splitoff point are relevant. In this case, the correct analysis is much simpler: the incremental revenues from selling the sludge are $50,000, and the incremental costs are the marketing costs of $27,000. So, Armstrong Foods should sell the sludge—this will increase its operating income by $23,000 ($50,000 – $27,000).
Chapter 3 Cost-Volume-Profit Analysis
3-17 (10-15 min.) CVP computations.
1a. Sales ($25 per unit × 180,000 units) $4,500,000
Variable costs ($20 per unit × 180,000 units) 3,600,000
Contribution margin $ 900,000
1b. Contribution margin (from above) $ 900,000
Fixed costs 800,000
Operating income $ 100,000
2a. Sales (from above) $4,500,000
Variable costs ($10 per unit × 180,000 units) 1,800,000
Contribution margin $2,700,000
2b. Contribution margin $2,700,000
Fixed costs 2,500,000
Operating income $ 200,000
3. Operating income is expected to increase by $100,000 if Ms. Schoenen’s proposal is accepted.
Management would consider other factors before making the final decision. It is likely that product quality would improve as a result of using state-of-the -rt equipment. Due to increased automation, probably many workers will have to be laid off. Patel’s management will have to consider the impact of such an action on employee morale. In addition, the proposal increases the company’s fixed costs dramatically. This will increase the company’s operating leverage and risk.
3-22 (20–25 min.) CVP analysis, income taxes.
1. Variable cost percentage is $3.20 ( $8.00 = 40%
Let R = Revenues needed to obtain target net income
R – 0.40R – $450,000 = [pic][pic]
0.60R = $450,000 + $150,000
R = $600,000 ( 0.60
R = $1,000,000
or,
Fixed costs +[pic]
Contribution margin percentage
Proof: Revenues $1,000,000
Variable costs (at 40%) 400,000
Contribution margin 600,000
Fixed costs 450,000
Operating income 150,000
Income taxes (at 30%) 45,000
Net income $ 105,000
2.a. Customers needed to earn net income of $105,000:
Total revenues ( Sales check per customer
$1,000,000 ( $8 = 125,000 customers
b. Customers needed to break even:
Contribution margin per customer = $8.00 – $3.20 = $4.80
Breakeven number of customers = Fixed costs ( Contribution margin per customer
= $450,000 ( $4.80 per customer
= 93,750 customers
3. Using the shortcut approach:
Change in net income = ( ( (1 – Tax rate)
= (150,000 – 125,000) ( $4.80 ( (1 – 0.30)
= $120,000 ( 0.7 = $84,000
New net income = $84,000 + $105,000 = $189,000
The alternative approach is:
Revenues, 150,000 ( $8.00 $1,200,000
Variable costs at 40% 480,000
Contribution margin 720,000
Fixed costs 450,000
Operating income 270,000
Income tax at 30% 81,000
Net income $ 189,000
3-25 (25 min.) Operating leverage.
1a. Let Q denote the quantity of carpets sold
Breakeven point under Option 1
$500Q ( $350Q = $5,000
$150Q = $5,000
Q = $5,000 ( $150 = 34 carpets (rounded up)
1b. Breakeven point under Option 2
$500Q ( $350Q ( (0.10 ( $500Q) = 0
100Q = 0
Q = 0
2. Operating income under Option 1 = $150Q ( $5,000
Operating income under Option 2 = $100Q
Find Q such that $150Q ( $5,000 = $100Q
$50Q = $5,000
Q = $5,000 ( $50 = 100 carpets
For Q = 100 carpets, operating income under both Option 1 and Option 2 = $10,000
3a. For Q > 100, say, 101 carpets,
Option 1 gives operating income = ($150 ( 101) ( $5,000 = $10,150
Option 2 gives operating income = $100 ( 101 = $10,100
So Color Rugs will prefer Option 1.
3b. For Q < 100, say, 99 carpets,
Option 1 gives operating income = ($150 ( 99) ( $5,000 = $9,850
Option 2 gives operating income = $100 ( 99 = $9,900
So Color Rugs will prefer Option 2.
4. Degree of operating leverage = [pic]
Under Option 1, degree of operating leverage = [pic]= 1.5
Under Option 2, degree of operating leverage = [pic]= 1.0
5. The calculations in requirement 4 indicate that when sales are 100 units, a percentage change in sales and contribution margin will result in 1.5 times that percentage change in operating income for Option 1, but the same percentage change in operating income for Option 2. The degree of operating leverage at a given level of sales helps managers calculate the effect of fluctuations in sales on operating incomes.
END OF HOMEWORK ASSIGNED THROUGH MIDTERM
BEGIN HOMEWORK ASSIGNED FOR SECOND HALF OF MODULE
Chapter 6 The Master Budget
6-27 (30 min.) Cash flow analysis, Chapter Appendix.
1. The cash that TabComp Inc. can expect to collect during April 2006 is calculated below.
|April cash receipts: | |
| April cash sales ($400,000 ( .25) |$100,000 |
| April credit card sales ($400,000 ( .30 ( .96) | 115,200 |
|Collections on account: | |
| March ($480,000 ( .45 ( .70) | 151,200 |
| February ($500,000 ( .45 ( .28) | 63,000 |
|January (uncollectible-not relevant) | 0 |
|Total collections |$429,400 |
| | |
2. (a) The projected number of the MZB-33 computer hardware units that TabComp Inc. will order on January 25, 2006, is calculated as follows.
| |MZB-33 |
| |Units |
|March sales |110 |
|Plus: Ending inventorya | 27 |
|Total needed |137 |
|Less: Beginning inventoryb | 33 |
|Projected purchases in units |104 |
|a 0.30 ( 90 unit sales in April | |
|b 0.30 x 110 units sales in March | |
(b) Purchase price =
|$3,000 selling price per unit (see next page) | |
| ( 60% | $ 1,800 |
| ( Projected unit purchases | 104 |
|Total MZB-33 purchases |$187,200 |
|Selling price = $2,025,000 ( 675 units, or for March, $330,000 (110 units |
| = $3,000 per unit |
3. Monthly cash budgets are prepared by companies such as TabComp Inc. in order to plan for their cash needs. This means identifying when both excess cash and cash shortages may occur. A company needs to know when cash shortages will occur so that prior arrangements can be made with lending institutions in order to have cash available for borrowing when the company needs it. At the same time, a company should be aware of when there is excess cash available for investment or for repaying loans.
Chapter 7 Flexible Budgets and Variance Analysis
7-32 (30 min.) Flexible budget, direct materials and direct manufacturing labor variances.
Flexible- Sales-
1. Actual Budget Flexible Volume Static
Results Variances Budget Variances Budget
(1) (2) = (1) – (3) (3) (4) = (3) – (5) (5)
Units sold 6,000a 0 6,000 1,000 F 5,000a
Direct materials $ 594,000 $ 6,000 F $ 600,000 b $100,000 U $ 500,000c
Direct manufacturing labor 950,000a 10,000 F 960,000d 160,000 U 800,000e
Fixed costs 1,005,000a 5,000 U 1,000,000a 0 1,000,000a
Total costs $2,549,000 $11,000 F $2,560,000 $260,000 U $2,300,000
$11,000 F $260,000 U
Flexible-budget variance Sales-volume variance
$249,000 U
Static-budget variance
a Given
b $100 × 6,000 = $600,000
c $100 × 5,000 = $500,000
d $160 × 6,000 = $960,000
e $160 × 5,000 = $800,000
2.
Flexible Budget
(Budgeted Input
Actual Incurred Qty. Allowed for
(Actual Input Qty. Actual Input Qty. Actual Output ×
× Actual Price) × Budgeted Price Budgeted Price)
Direct materials $594,000a $540,000b $600,000c
$54,000 U $60,000 F
Price variance Efficiency variance
$6,000 F
Flexible-budget variance
Direct manufacturing labor $950,000a $1,000,000e $960,000f
$50,000 F $40,000 U
Price variance Efficiency variance
$10,000 F
Flexible-budget variance
a 54,000 pounds × $11/pound = $594,000
b 54,000 pounds × $10/pound = $540,000
c 6,000 statues × 10 pounds/statue × $10/pound = 60,000 pounds × $10/pound = $600,000
d 25,000 pounds × $38/pound = $950,000
e 25,000 pounds × $40/pound = $1,000,000
f 6,000 statues × 4 hours/statue × $40/hour = 24,000 hours × $40/hour = $960,000
7-38 (20–30 min.) Direct materials and manufacturing labor variances, solving unknowns.
All given items are designated by an asterisk.
| | | | |Flexible Budget |
| |Actual Costs | | |(Budgeted Input |
| |Incurred | | |Qty. Allowed for |
| |(Actual Input Qty. |Actual Input Qty. | |Actual Output |
| |× Actual Price) |× Budgeted Price | |× Budgeted Price) |
| | | | | |
| |(1,900 × $21) | | | |
| |$39,900 | | | |
|Direct | | | | |
|Manufacturing | |(1,900 × $20*) | |(4,000* × 0.5* × $20*) |
|Labor | |$38,000 | |$40,000 |
$1,900 U* $2,000 F*
Price variance Efficiency variance
Purchases Usage
Direct (13,000 × $5.25) (13,000 × $5*) (12,500 × $5*) (4,000* × 3* × $5*)
Materials $68,250* $65,000 $62,500 $60,000
$3,250 U* $2,500 U*
Price variance Efficiency variance
1. 4,000 units × 0.5 hours/unit = 2,000 hours
2. Flexible budget – Efficiency variance = $40,000 – $2,000 = $38,000
Actual dir. manuf. labor hours = $38,000 ÷ Budgeted price of $20/hour = 1,900 hours
3. $38,000 + Price variance, $1,900 = $39,900, the actual direct manuf. labor cost
Actual rate = Actual cost ÷ Actual hours = $39,000 ÷ 1,900 hours = $21/hour (rounded)
4. Standard qty. of direct materials = 4,000 units × 3 pounds/unit = 12,000 pounds
5. Flexible budget + Dir. matls. effcy. var. = $60,000 + $2,500 = $62,500
Actual quantity of dir. matls. used = $62,500 ÷ Budgeted price per lb
= $62,500 ÷ $5/lb = 12,500 lbs
6. Actual cost of direct materials, $68,250 – Price variance, $3,250 = $65,000
Actual qty. of direct materials purchased = $65,000 ÷ Budgeted price, $5/lb = 13,000 lbs.
7. Actual direct materials price = $68,250 ÷ 13,000 lbs = $5.25 per lb.
7-39 (20 min.) Responsibility for variances.
1.
| |Actual Results |Price Variance |Actual Quantity |Efficiency Variance |Flexible Budget |
| | | |[pic] Budgeted Price| | |
| |(1) |(2) = (1) – (3) |(3) |(4) = (3) – (5) |(5) |
|Cases | 10,000 | | | | | 10,000 |
|Direct materials | $127,800a |$14,200 |F |$142,000b |$22,000 |U |$120,000 c |
|Direct manuf. labor |$ 78,000 |$13,000 |F |$ 91,000d |$21,000 |U |$ 70,000 e |
a 71,000 lbs. [pic]$1.80 per lb. = $127,800
b 71,000 lbs. [pic]$2 per lb. = $142,000
c 10,000 cases [pic]6 lbs. per case[pic]$2 per lb. = $120,000
d 6,500 dir. manuf. labor-hours [pic]$14 per dir. manuf. labor-hour = $91,000
e 10,000 cases [pic]0.5 hrs. per case [pic]$14 per hr. = $70,000
2.a. If the favorable price and unfavorable efficiency variance for direct materials were due to purchase of poor-quality materials, the purchase manager is responsible for both variances. The favorable direct material price variance of $14,200 is more than offset by the unfavorable direct materials efficiency variance of $22,000, resulting in an overall flexible-budget direct materials variance of $7,800 unfavorable. If the poor quality of the direct materials caused workers to be inefficient, the supervisor may also want to assign the unfavorable direct manufacturing labor efficiency variance of $21,000 to the purchasing manager. The goal is not to allocate blame but rather to assign variances to managers most responsible for them. In this way, the purchasing manager can fully understand the consequences of purchasing poor-quality materials and the benefits of taking actions to prevent such events from recurring. The production manager and the human resource manager should be assigned the favorable direct manufacturing labor price variance to make them aware of the beneficial actions they took and to see if these actions can be repeated.
2.b. If the favorable price and unfavorable efficiency variance for direct manufacturing labor was due to the use of less-skilled workers, the production manager is responsible for both variances. The favorable direct manufacturing labor price variance of $13,000 is more than offset by the unfavorable direct manufacturing labor efficiency variance of $21,000, resulting in an overall flexible-budget direct manufacturing labor variance of $8,000 unfavorable. Furthermore, if the less-skilled workers caused the direct materials to be used inefficiently, the supervisor may also want to assign the unfavorable direct materials efficiency variance of $22,000 to the production manager. Holding the production manager accountable for these variances makes the production manager aware of the full consequences of hiring less-skilled workers, as well as the benefits of remedial actions. The purchasing manager should be assigned the favorable direct materials price variance to encourage her to continue to achieve lower direct material prices.
Chapter 8 Overhead Variances
8-16 (20 min.) Variable manufacturing overhead, variance analysis.
1.
| | |Flexible Budget : |Allocated: |
| | |Budgeted Input |Budgeted Input |
| | |Allowed for |Allowed for |
|Actual Costs |Actual Inputs |Actual Output |Actual Output |
|Incurred |× Budgeted Rate |× Budgeted Rate |× Budgeted Rate |
|(1) |(2) |(3) |(4) |
|(4,536 × $11.50) |(4,536 × $12) |(4 × 1,080 × $12) |(4 × 1,080 × $12) |
|$52,164 |$54,432 |$51,840 |$51,840 |
| | | | |
2. Esquire had a favorable spending variance of $2,268 because the actual variable overhead rate was $11.50 per direct manufacturing labor-hour versus $12 budgeted. It had an unfavorable efficiency variance of $2,592 U because each suit averaged 4.2 labor-hours (4,536 hours ÷ 1,080 suits) versus 4.0 budgeted.
8-17 (20 min.) Fixed-manufacturing overhead, variance analysis
(continuation of 8-16).
1 & 2. = [pic]
= [pic]
= $15 per hour
| | | | |
| |Same Budgeted |Flexible Budget: |Allocated: |
| |Lump Sum |Same Budgeted |Budgeted Input |
| |(as in Static Budget) |Lump Sum |Allowed for Actual Output |
|Actual Costs Incurred |Regardless of |(as in Static Budget) |× Budgeted Rate |
|(1) |Output Level |Regardless of |(4) |
| |(2) |Output Level | |
| | |(3) | |
| | | |(4 × 1,080 × $15) |
|$63,916 |$62,400 |$62,400 |$64,800 |
| | | | |
$1,516 U $2,400 F
Spending variance Never a variance Production-volume variance
$1,516 U $2,400 F
Flexible-budget variance Production-volume variance
The fixed manufacturing overhead spending variance and the fixed manufacturing flexible budget variance are the same––$1,516 U. Esquire spent $1,516 above the $62,400 budgeted amount for June 2004.
The production-volume variance is $2,400 F. This arises because Esquire utilized its capacity more intensively than budgeted (the actual production of 1,080 suits exceeds the budgeted 1,040 suits). This results in overallocated fixed manufacturing overhead of $2,400 (4 × 40 × $15). Esquire would want to understand the reasons for a favorable production-volume variance. Is the market growing? Is Esquire gaining market share? Will Esquire need to add capacity?
8-26 (30 min.) Overhead variances, missing information.
1. In the columnar presentation of variable overhead variance analysis shown on the next page, all numbers shown in bold are calculated from the given information, in the order (a) – (e).
|VARIABLE MANUFACTURING OVERHEAD |
| | | | | |Flexible Budget: |
| | | | |Budgeted Input Qty. | |
|Actual Costs Incurred |Actual Input Qty. | Allowed for Budgeted |
| |[pic]Budgeted Rate |Actual Output [pic] Rate |
|(b) | |(a) | | | (c) | |
| | |10,000 |[pic] |$6.00 |9,900 |[pic] | $6.00 |
| | |mach. hrs. | |per mach. hr. |mach. hrs. | |per mach. hr. |
|$59,750 |$60,000 |$59,400 |
$250 F $600 U (d)
Spending variance Efficiency variance
$350 U (e)
Flexible-budget variance
a. 10,000 machine-hours [pic] $6 per machine-hour = $60,000
b. Actual VMOH = $60,000 – $250F (VOH spending variance) = $59,750
c. 9,900 machine-hours [pic] $6 per machine-hour = $59,400
d. VOH efficiency variance = $60,000 – $59,400 = $600U
e. VOH flexible budget variance = $600U – $250F = $350U
Allocated variable overhead will be the same as the flexible budget variable overhead of $59,400. The actual variable overhead cost is $59,750. Therefore, variable overhead is underallocated by $350.
2. In the columnar presentation of fixed overhead variance analysis shown on the next page, all numbers shown in bold are calculated from the given information, in the order (a) – (e).
|FIXED MANUFACTURING OVERHEAD |
| | |Flexible Budget: |Allocated: |
|Actual Costs |Static Budget Lump Sum |Budgeted Input Qty. Allowed for| |Budgeted |
| |Regardless of Output | | | |
|Incurred |Level | Actual Output [pic] Rate |
|(a) |(b) | | | |
| | | | | |9,900 |[pic] |$1.60* (c) |
| | | | | |mach. hrs. | |per mach. hr. |
|$20,250 |$19,200 |$15,840 |
$1,050 U $3,360 U (d)
Spending variance Production-volume variance
$1,050 U (e)
Flexible-budget variance
a. Actual FOH costs = $80,000 total overhead costs – $59,750 VOH costs = $20,250
b. Static budget FOH lump sum = $20,250 – $1,050 spending variance = $19,200
c. *FOH allocation rate = $19,200 FOH static-budget lump sum [pic]12,000 static-budget machine-hours = $1.60 per machine-hour
Allocated FOH = 9,900 machine-hours [pic] $1.60 per machine-hour = $15,840
d. PVV = $19,200 – $15,840 = $3,360U
e. FOH flexible budget variance = FOH spending variance = $1,050 U
Allocated fixed overhead is $15,840. The actual fixed overhead cost is $20,250. Therefore, fixed overhead is underallocated by $4,410.
Chapter 11 Selected Relevance Models
11-18 (15 min.) Multiple choice.
1. (b) Special order price per unit $6.00
Variable manufacturing cost per unit 4.50
Contribution margin per unit $1.50
Effect on operating income = $1.50 ( 20,000 units
= $30,000 increase
2. (b) Costs of purchases, 20,000 units ( $60 $1,200,000
Total relevant costs of making:
Variable manufacturing costs, $64 – $16 $48
Fixed costs eliminated 9
Costs saved by not making $57
Multiply by 20,000 units, so total
costs saved are $57 ( 20,000 1,140,000
Extra costs of purchasing outside 60,000
Minimum overall savings for Reno 25,000
Necessary relevant costs that would have
to be saved in manufacturing Part No. 575 $ 85,000
11-23 (10 min.) Selection of most profitable product.
Only Model 14 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, Model 14 will yield a $9.50 contribution to fixed costs per machine hour, and Model 9 will yield $9.00:
| |Model 9 |Model 14 |
| | | |
|Selling price |$100.00 |$70.00 |
|Variable costs per unit |82.00 |60.50 |
|Contribution margin per unit |$ 18.00 |$ 9.50 |
|Relative use of machine-hours per unit of product |÷ 2 |÷ 1 |
|Contribution margin per machine hour |$ 9.00 |$ 9.50 |
| | | |
| | | |
11-27 (30–40 min.) Relevance of equipment costs.
1a. Statements of Cash Receipts and Disbursements
| |Keep |Buy New Machine |
| | |Each |Four | |Each |Four Years |
| | |Year |Years | |Year |Together |
| |Year 1 |2, 3, 4 |Together |Year 1 |2, 3, 4 | |
|Receipts from operations: | | | | | | |
|Revenues |$150,000 |$150,000 |$600,000 |$150,000 |$150,000 |$600,000 |
|Deduct disbursements: | | | | | | |
|Other operating costs |(110,000) |(110,000) |(440,000) |(110,000) |(110,000) |(440,000) |
|Operation of machine |(15,000) |(15,000) |(60,000) |(9,000) |(9,000) |(36,000) |
|Purchase of “old” machine |(20,000)* | |(20,000) |(20,000) | |(20,000) |
|Purchase of “new” equipment | | | |(24,000) | |(24,000) |
|Cash inflow from sale of old equipment | | | | | | |
|Net cash inflow | | | |8,000 | |8,000 |
| |$ 5,000 |$ 25,000 |$ 80,000 |$ (5,000) |$ 31,000 |$ 88,000 |
*Some students ignore this item because it is the same for each alternative. However, note that a statement for the entire year has been requested. Obviously, the $20,000 would affect Year 1 only under both the “keep” and “buy” alternatives.
The difference is $8,000 for four years taken together. In particular, note that the $20,000 book value can be omitted from the comparison. Merely cross out the entire line; although the column totals are affected, the net difference is still $8,000.
1b. Again, the difference is $8,000:
Income Statements
| |Keep |Buy New Machine |
| |Each |Four | |Each |Four Years Together|
| |Year |Years | |Year | |
| |1, 2, 3, 4 |Together |Year 1 |2, 3, 4 | |
|Revenues |$150,000 |$600,000 |$150,000 |$150,000 |$600,000 |
|Costs (excluding disposal): | | | | | |
|Other operating costs |110,000 |440,000 |110,000 |110,000 |440,000 |
|Depreciation |5,000 |20,000 |6,000 |6,000 |24,000 |
|Operating costs of machine |15,000 |60,000 |9,000 |9,000 |36,000 |
|Total costs (excluding disposal) |130,000 |520,000 |125,000 |125,000 |500,000 |
|Loss on disposal: | | | | | |
|Book value (“cost”) | | |20,000 | |20,000* |
|Proceeds (“revenue”) | | |(8,000) | |(8,000) |
|Loss on disposal | | |12,000 | |12,000 |
|Total costs |130,000 |520,000 |137,000 |125,000 |512,000 |
|Operating income |$ 20,000 |$ 80,000 |$ 13,000 |$ 25,000 |$ 88,000 |
*As in part (1), the $20,000 book value may be omitted from the comparison without changing the $8,000 difference. This adjustment would mean excluding the depreciation item of $5,000 per year (a cumulative effect of $20,000) under the “keep” alternative and excluding the book value item of $20,000 in the loss on disposal computation under the “buy” alternative.
1c. The $20,000 purchase cost of the old equipment, the revenues, and the other costs are irrelevant because their amounts are common to both alternatives.
2. The net difference would be unaffected. Any number may be substituted for the original $20,000 figure without changing the final answer. Of course, the net cash outflows under both alternatives would be high. The Auto Wash manager really blundered. However, keeping the old equipment will increase the cost of the blunder to the cumulative tune of $8,000 over the next four years.
3. Book value is irrelevant in decisions about the replacement of equipment, because it is a past (historical) cost. All past costs are down the drain. Nothing can change what has already been spent or what has already happened. The $20,000 has been spent. How it is subsequently accounted for is irrelevant. The analysis in requirement (1) clearly shows that we may completely ignore the $20,000 and still have a correct analysis. The only relevant items are those expected future items that will differ among alternatives.
Despite the economic analysis shown here, many managers would keep the old machine rather than replace it. Why? Because, in many organizations, the income statements of part (2) would be a principal means of evaluating performance. Note that the first-year operating income would be higher under the “keep” alternative. The conventional accrual accounting model might motivate managers toward maximizing their first-year reported operating income at the expense of long-run cumulative betterment for the organization as a whole. This criticism is often made of the accrual accounting model. That is, the action favored by the “correct” or “best” economic decision model may not be taken because the performance-evaluation model is either inconsistent with the decision model or because the focus is on only the short-run part of the performance-evaluation model.
There is yet another potential conflict between the decision model and the performance evaluation model. Replacing the machine so soon after it is purchased may reflect badly on the manager’s capabilities and performance. Why didn’t the manager search and find the new machine before buying the old machine? Replacing the old machine one day later at a loss may make the manager appear incompetent to his or her superiors. If the manager’s bosses have no knowledge of the better machine, the manager may prefer to keep the existing machine rather than alert his or her bosses about the better machine.
11-32 (20 min.) Opportunity costs.
1. The opportunity cost to Wolverine of producing the 2,000 units of Orangebo is the contribution margin lost on the 2,000 units of Rosebo that would have to be forgone, as computed below:
|Selling price | $20 |
|Variable costs per unit: | |
|Direct materials |$ 2 |
|Direct manufacturing labor |3 |
|Variable manufacturing overhead |2 |
|Variable marketing costs |4 11 |
|Contribution margin per unit |$ 9 |
| | |
|Contribution margin for 2,000 units |$ 18,000 |
The opportunity cost is $18,000. Opportunity cost is the maximum contribution to operating income that is forgone (rejected) by not using a limited resource in its next-best alternative use.
2. Contribution margin from manufacturing 2,000 units of Orangebo and purchasing 2,000 units of Rosebo from Buckeye is $16,000, as follows:
| |Manufacture |Purchase | |
| |Orangebo |Rosebo |Total |
|Selling price |$15 |$20 | |
|Variable costs per unit: | | | |
|Purchase costs |– |14 | |
|Direct materials |2 | | |
|Direct manufacturing labor |3 | | |
|Variable manufacturing costs |2 | | |
|Variable marketing overhead |2 |4 | |
|Variable costs per unit |9 |18 | |
|Contribution margin per unit |$ 6 |$ 2 | |
|Contribution margin from selling 2,000 units of Orangebo and 2,000 | | | |
|units of Rosebo |$12,000 |$4,000 |$16,000 |
As calculated in requirement 1, Wolverine’s contribution margin from continuing to manufacture 2,000 units of Rosebo is $18,000. Accepting the Miami Company and Buckeye offer will cost Wolverine $2,000 ($16,000 – $18,000). Hence, Wolverine should refuse the Miami Company and Buckeye Corporation’s offers.
3. The minimum price would be $9, the sum of the incremental costs as computed in requirement 2. This follows because, if Wolverine has surplus capacity, the opportunity cost = $0. For the short-run decision of whether to accept Orangebo’s offer, fixed costs of Wolverine are irrelevant. Only the incremental costs need to be covered for it to be worthwhile for Wolverine to accept the Orangebo offer.
Chapter 21 Capital Budgeting
21-18 (30 min.) Capital budgeting methods, no income taxes.
The table for the present value of annuities (Appendix C, Table 4) shows: 10 periods at 14% = 5.216
1a. Net present value = $28,000(5.216) – $110,000
= $146,048 – $110,000 = $36,048
b. Payback period = [pic]= 3.93 years
c. Internal rate of return:
$110,000 = Present value of annuity of $28,000 at R% for 10 years, or what factor (F) in the table of present values of an annuity (Appendix C, Table 4) will satisfy the following equation.
$110,000 = $28,000F
F = [pic]= 3.929
On the 10-year line in the table for the present value of annuities (Appendix C, Table 4), find the column closest to 3.929; 3.929 is between a rate of return of 20% and 22%.
Interpolation can be used to determine the exact rate:
Present Value Factors
20% 4.192 4.192
IRR rate –– 3.929
22% 3.923 ––
Difference 0.269 0.263
Internal rate of return = 20% + [pic](2%)
= 20% + (0.978) (2%) = 21.96%
d. Accrual accounting rate of return based on net initial investment:
Net initial investment = $110,000
Estimated useful life = 10 years
Annual straight-line depreciation = $110,000 ÷ 10 = $11,000
Accrual accounting rate of return = [pic]
= [pic]= 15.46%
2. Factors City Hospital should consider include:
a. Quantitative financial aspects.
b. Qualitative factors, such as the benefits to its customers of a better eye-testing machine and the employee-morale advantages of having up-to-date equipment.
c. Financing factors, such as the availability of cash to purchase the new equipment. Note, however, that the selection of which financing alternative to choose is a separate analysis from the determination of the acceptability of buying the asset.
21-23 (22–30 min.) DCF, accrual accounting rate of return, working
capital, evaluation of performance, no income taxes.
1. A summary of cash inflows and outflows (in thousands) are:
[pic]
Present value of annuity of savings in cash operating costs
($25,000 per year for 8 years at 14%): $25,000 ( 4.639 $115,975
Present value of $30,000 terminal disposal price of machine at
end of year 8: $30,000 ( 0.351 10,530
Present value of $8,000 recovery of working capital at
end of year 8: $8,000 ( 0.351 2,808
Gross present value 129,313
Deduct net initial investment:
Special-purpose machine, initial investment $110,000
Additional working capital investment 8,000 118,000
Net present value $ 11,313
2. (a) If you have a financial calculator, the IRR is easily solved for as follows:
Determine I where N = 8, future value = $38,000 (terminal value of $30,000 + $8,000 release of working capital), present value = $118,000 cost ($110,000 cost of machine + $8,000 working capital increase required), and payment = $25,000 (cash savings.)
IRR = 16.5%
(b) If you do not have a financial calculator and you are practical, you will not mess with this, but simply acknowledge that, since NPV is positive (from Part a above). The IRR is greater than the Hammerlink’s required 14% rate of return. However, if you are a glutton for punishment, the following is a trial-and-error approach.
First, try a 16% discount rate:
$25,000 ( 4.344 $108,600
($30,000 + $8,000) ( 0.305 11,590
Gross present value 120,190
Deduct net initial investment (118,000)
Net present value $ 2,190
Second, try an 18% discount rate:
$25,000 ( 4.078 $101,950
($30,000 + $8,000) ( .266 10,108
Gross present value 112,058
Deduct net initial investment (118,000)
Net present value $ (5,942)
By interpolation:
Internal rate of return = 16% + [pic]
= 16% + (.2693 ( 2%)
= 16.54%
3. Accrual accounting rate of return based on net initial investment:
Net initial investment = $110,000 + $8,000
= $118,000
Annual depreciation
($110,000 – $30,000) ÷ 8 years = $10,000
Accrual accounting rate of return = [pic] = 12.71%
4. If your decision is based on the DCF model, the purchase would be made because the net present value is positive and the 16.54% internal rate of return exceeds the 14% required rate of return. However, you may believe that your performance may actually be measured using accrual accounting. This approach would show a 12.71% return on the initial investment, which is below the required rate. Your reluctance to make a "buy" decision would be quite natural unless you are assured of reasonable consistency between the decision model and the performance evaluation method. This highlights the problem of analyzing capital budgeting opportunities on a cash flows approach if management evaluation is based on accrual accounting rate of return targets. (Echoes the issues discussed in solution of Problem 11-27, Part 3.)
Chapter 22 – Decentralization Issues and Transfer Pricing
22-27 (20min.) General guideline, transfer pricing.
1. The minimum transfer price that the SD would demand from the AD is the net price it could obtain from selling its screens on the outside market: $120 minus $5 marketing and distribution cost per screen, or $115 per screen. The SD is operating at capacity. The incremental cost of manufacturing each screen is $80. Therefore, the opportunity cost of selling a screen to the AD is the contribution margin the SD would forego by transferring the screen internally instead of selling it on the outside market.
Contribution margin per screen = $115 – $80 = $35
Using the general guideline,
[pic] = [pic] + [pic]
= $80 + $35 = $115
2. The maximum transfer price the AD manager would be willing to offer SD is its own total cost for purchasing from outside, $120 plus $3 per screen, or $123 per screen.
3a. If the SD has excess capacity (relative to what the outside market can absorb), the minimum transfer price using the general guideline is: for the first 2,000 units (or 20% of output), $80 per screen because opportunity cost is zero; for the remaining 8,000 units (or 80% of output), $115 per screen because opportunity cost is $35 per screen.
3b. From the point of view of Shamrock’s management, all of the SD’s output should be transferred to the AD. This would avoid the $3 per screen variable purchasing cost that is incurred by the AD when it purchases screens from the outside market and it would also save the $5 marketing and distribution cost the SD would incur to sell each screen to the outside market.
3c. If the managers of the AD and the SD could negotiate the transfer price, they would settle on a price between $115 per screen (the minimum transfer price the SD will accept) and $123 per screen (the maximum transfer price the AD would be willing to pay). From requirements 1 and 2, we see that any price in this range would be acceptable to both divisions for all of the SD’s output, and would also be optimal from Shamrock’s point of view. The exact transfer price between $115 and $123 will depend on the bargaining strengths of the two divisions. Of course, Shamrock's management could also mandate a particular transfer price between $115 and $123 per screen.
22-28 (20–30 min.) Pertinent transfer price.
This problem again explores the "general transfer-pricing guideline" discussed in the chapter.
1. No, transfers should not be made to Division B if there is no excess capacity in Division A.
An incremental (outlay) cost approach shows a positive contribution for the company as a whole.
Selling price of final product $300
Incremental costs in Division A $120
Incremental costs in Division B 150 270
Contribution $ 30
However, if there is no excess capacity in Division A, any transfer will result in diverting products from the market for the intermediate product. Sales in this market result in a greater contribution for the company as a whole. Division B should not assemble the bicycle since the incremental revenue Europa can earn, $100 per unit ($300 from selling the final product – $200 from selling the intermediate product) is less than the incremental costs of $150 to assemble the bicycle in Division B. Alternatively put, Europa’s contribution margin from selling the intermediate product exceeds Europa’s contribution margin from selling the final product.
Selling price of intermediate product $200
Incrementral (outlay) costs in Division A 120
Contribution $ 80
Using the general guideline described in the chapter
= +
= $120 + ($200 – $120)
= $200, which is the market price
The market price is the transfer price that leads to the correct decision; that is, do not transfer to Division B unless there are extenuating circumstances for continuing to market the final product. Therefore, B must either drop the product or reduce the incremental costs of assembly from $150 per bicycle to less than $100.
2. If (a) A has excess capacity, (b) there is intermediate external demand for only 800 units at $200, and (c) the $200 price is to be maintained, then the opportunity costs per unit to the supplying division are $0. The general guideline indicates a minimum transfer price of: $120 + $0 = $120, which is the incremental or outlay costs for the first 200 units. B would buy 200 units from A at a transfer price of $120 because B can earn a contribution of $30 per unit [$300 – ($120 + $150)]. In fact, B would be willing to buy units from A at any price up to $150 per unit because any transfers at a price of up to $150 will still yield B a positive contribution margin.
Note, however, that if B wants more than 200 units, the minimum transfer price will be $200 as computed in requirement 1 because A will incur an opportunity cost in the form of lost contribution of $80 (market price, $200 – outlay costs of $120) for every unit above 200 units that are transferred to B.
The following schedule summarizes the transfer prices for units transferred from A to B.
Units Transfer Price
0–200 $120–$150
200–1,000 $200
For an exploration of this situation when imperfect markets exist, see the next problem.
3. Division B would show zero contribution, but the company as a whole would generate a contribution of $30 per unit on the 200 units transferred. Any price between $120 and $150 would induce the transfer that would be desirable for the company as a whole. A motivational problem may arise regarding how to split the $30 contribution between Division A and B. Unless the price is below $150, B would have little incentive to buy.
Note: The transfer price that may appear optimal in an economic analysis may, in fact, be totally unacceptable from the viewpoints of (1) preserving autonomy of the managers, and (2) evaluating the performance of the divisions as economic units. For instance, consider the simplest case discussed previously, where there is idle capacity and the $200 intermediate price is to be maintained. To direct that A should sell to B at A's variable cost of $120 may be desirable from the viewpoint of B and the company as a whole. However, the autonomy (independence) of the manager of A is eroded. Division A will earn nothing, although it could argue that it is contributing to the earning of income on the final product.
If the manager of A wants a portion of the total company contribution of $30 per unit, the question is: How is an appropriate amount determined? This is a difficult question in practice. The price can be negotiated upward to somewhere between $120 and $150 so that some "equitable" split is achieved. A dual transfer-pricing scheme has also been suggested, whereby the supplier gets credit for the full intermediate market price and the buyer is charged with only
variable or incremental costs. In any event, when there is heavy interdependence between divisions, such as in this case, some system of subsidies may be needed to deal with the three problems of goal congruence, management effort, and subunit autonomy. Of course, where heavy subsidies are needed, a question can be raised as to whether the existing degree of decentralization is optimal.
Chapter 23 Performance Evaluation
23-20 (25 min.) Financial and nonfinancial performance measures, goal
congruence.
1. Operating income is a good summary measure of short-term financial performance. By itself, however, it does not indicate whether operating income in the short run was earned by taking actions that would lead to long-run competitive advantage. For example, Summit's divisions might be able to increase short-run operating income by producing more product while ignoring quality or rework. Harrington, however, would like to see division managers increase operating income without sacrificing quality. The new performance measures take a balanced scorecard approach by evaluating and rewarding managers on the basis of direct measures (such as rework costs, on-time delivery performance, and sales returns). This motivates managers to take actions that Harrington believes will increase operating income now and in the future. The nonoperating income measures serve as surrogate measures of future profitability.
2. The semiannual installments and total bonus for the Charter Division are calculated as follows:
Charter Division Bonus Calculation
For Year Ended December 31, 2006
|January 1, 2006 to June 30, 2006 |
|Profitability |(0.02 ( $462,000) |$ 9,240 |
|Rework |(0.02 × $462,000) – $11,500 |(2,260) |
|On-time delivery |No bonus—under 96% |0 |
|Sales returns |[(0.015 × $4,200,000) – $84,000] × 50% |(10,500) |
|Semiannual installment |$ (3,520) |
|Semiannual bonus awarded |$ 0 |
| | |
| |
|July 1, 2006 to December 31, 2006 |
|Profitability |(0.02 ( $440,000) |$ 8,800 |
|Rework |(0.02 × $440,000) – $11,000 |(2,200) |
|On-time delivery |96% to 98% |2,000 |
|Sales returns |[(0.015 × $4,400,000) – $70,000] × 50% |(2,000) |
|Semiannual installment |$ 6,600 |
|Semiannual bonus awarded |$ 6,600 |
|Total bonus awarded for the year |$ 6,600 |
23-20 (Cont’d.)
The semiannual installments and total bonus for the Mesa Division are calculated as follows:
Mesa Division Bonus Calculation
For Year Ended December 31, 2006
|January 1, 2006 to June 30, 2006 |
|Profitability |(0.02 ( $342,000) |$ 6,840 |
|Rework |(0.02 × $342,000) – $6,000 |0 |
|On-time delivery |Over 98% |5,000 |
|Sales returns |[(0.015 × $2,850,000) – $44,750] × 50% |(1,000) |
|Semiannual bonus installment |$10,840 |
|Semiannual bonus awarded |$10,840 |
| | |
|July 1, 2006 to December 31, 2006 |
|Profitability |(0.02 ( $406,000) |$ 8,120 |
|Rework |(0.02 × $406,000) – $8,000 |0 |
|On-time delivery |No bonus—under 96% |0 |
|Sales returns |[(0.015 × $2,900,000) – $42,500] which is greater than zero, | |
| |yielding a bonus of |3,000 |
|Semiannual bonus installment |$11,120 |
|Semiannual bonus awarded |$11,120 |
|Total bonus awarded for the year |$21,960 |
3. The manager of the Charter Division is likely to be frustrated by the new plan, as the division bonus is more than $20,000 less than the previous year. However, the new performance measures have begun to have the desired effect––both on-time deliveries and sales returns improved in the second half of the year, while rework costs were relatively even. If the division continues to improve at the same rate, the Charter bonus could approximate or exceed what it was under the old plan.
The manager of the Mesa Division should be as satisfied with the new plan as with the old plan, as the bonus is almost equivalent. On-time deliveries declined considerably in the second half of the year and rework costs increased. However, sales returns decreased slightly. Unless the manager institutes better controls, the bonus situation may not be as favorable in the future. This could motivate the manager to improve in the future but currently, at least, the manager has been able to maintain his bonus with showing improvement in only one area targeted by Harrington.
Ben Harrington's revised bonus plan for the Charter Division fostered the following improvements in the second half of the year despite an increase in sales:
• increase of 1.9% in on-time deliveries.
• $500 reduction in rework costs.
• $14,000 reduction in sales returns.
However, operating income as a percent of sales has decreased (11 to 10%).
The Mesa Division's bonus has remained at the status quo as a result of the following effects
• increase of 2.0 % in operating income as a percent of sales (12% to 14%).
• decrease of 3.6% in on-time deliveries.
• $2,000 increase in rework costs.
• $2,250 decrease in sales returns.
This would suggest that there needs to be some revisions to the bonus plan. Possible changes include:
• increasing the weights put on on-time deliveries, rework costs, and sales returns in the performance measures while decreasing the weight put on operating income.
• a reward structure for rework costs that are below 2% of operating income that would encourage managers to drive costs lower.
• reviewing the whole year in total. The bonus plan should carry forward the negative amounts for one six-month period into the next six-month period incorporating the entire year when calculating a bonus.
• developing benchmarks, and then giving rewards for improvements over prior periods and encouraging continuous improvement.
23-21 (15 min.) ROI, RI, EVA® (D. Solomons, adapted).
Requirements 1 and 2 are answered together:
| |
| |Atlantic Division |Pacific Division |
| | | |
|Total assets |$1,000,000 |$5,000,000 |
|Operating income |$ 200,000 |$ 750,000 |
|Return on investment |$200,000 ÷ 1,000,000 = 20% |$750,000 ÷ $5,000,000 = 15% |
| | | |
|Residual income at 12% required rate of | | |
|return* |$80,000 |$150,000 |
| |
|*$200,000 – (0.12 × $1,000,000) = $80,000; $750,000 – (0.12 × $5,000,000) = $150,000 |
23-21 (Cont'd.)
The tabulation shows that, while the Atlantic Division earns the higher return on investment, the Pacific Division earns the higher residual income at the 12% required rate of return.
3. After-tax cost of debt financing = (1 – 0.4) × 10% = 6%
After-tax cost of equity financing = 14%
The weighted-average cost of capital (WACC) is given by
WACC =[pic] = = 0.10 or 10%
Economic value added (EVA) calculations are as follows:
| | | | | | | | | | |
| |After-Tax |– |Weighted-Average Cost |× |Total Assets Minus Current | | |= |Economic |
| |Operating | |of Capital | |Liabilities | | | |Value Added |
|Division |Income | | | | | | | |(EVA) |
|Atlantic |$200,000 × 0.6 |– |[10% |×× |($1,000,000 – $250,000)] |== |$120,000 – $75,000 |== |$ 45,000 |
|Pacific |$750,000 × 0.6 |– |[10% | |($5,000,000 – $1,500,000)] | |$450,000 – $350,000 | |$100,000 |
Potomac should use the EVA measure for evaluating the economic performance of its divisions for two reasons: (a) It is a residual income measure and, so, does not have the dysfunctional effects of ROI-based measures. That is, if EVA is used as a performance evaluation measure, divisions would have incentives to make investments whenever after-tax operating income exceeds the weighted-average cost of capital employed. These are the correct incentives to maximize firm value. ROI-based performance evaluation measures encourage managers to invest only when the ROI on new investments exceeds the existing ROI. That is, managers would reject projects whose ROI exceeds the weighted average cost of capital but is less than the current ROI of the division; using ROI as a performance evaluation measure creates incentives for managers to reject projects that increase the value of the firm simply because they may reduce the overall ROI of the division; (b) EVA calculations incorporate tax effects that are costs to the firm. It, therefore, provides an after-tax comprehensive summary of the effects of various decisions on the company and its shareholders.
Chapter 16. Strategy and Balanced Scorecard
13-18 (20 min.) Strategy, balanced scorecard, merchandising operation.
1. Oceano & Sons follows a product differentiation strategy. Oceano’s designs are “trendsetting,” its T-shirts are distinctive, and it aims to make its T-shirts a “must have” for each and every teenager. These are all clear signs of a product differentiation strategy, and, to succeed, Oceano must continue to innovate and be able to charge a premium price for its product.
2. Possible key elements of Oceano’s balance scorecard, given its product differentiation strategy:
Financial Perspective
(1) Increase in operating income from charging higher margins, (2) price premium earned on products.
These measures will indicate whether Oceano has been able to charge premium prices and achieve operating income increases through product differentiation.
Customer Perspective
(1) Market share in distinctive, name-brand T-shirts, (2) customer satisfaction, (3) new customers, (4) number of mentions of Oceano’s T-shirts in the leading fashion magazines
Oceano’s strategy should result in improvements in these customer measures that help evaluate whether Oceano’s product differentiation strategy is succeeding with its customers. These measures are, in turn, leading indicators of superior financial performance.
Internal Business Process Perspective
(1) Quality of silk-screening (number of colors, use of glitter, durability of the design), (2) frequency of new designs, (3) time between concept and delivery of design
Improvements in these measures are expected to result in more distinctive and trendsetting designs delivered to its customers and in turn, superior financial performance.
Learning and Growth Perspective
(1) Ability to attract and retain talented designers (2) improvements in silk-screening processes, (3) continuous education and skill levels of marketing and sales staff, (4) employee satisfaction.
Improvements in these measures are expected to improve Oceano’s capabilities to produce distinctive designs that have a cause-and-effect relationship with improvements in internal business processes, which in turn lead to customer satisfaction and financial performance.
13-31 (20 min.) Balanced scorecard.
1. Caltex’s strategy is to focus on “service-oriented customers” who are willing to pay a higher price for services. Even though gasoline is largely a commodity product, Caltex wants to differentiate itself through the service it provides at its retailing stations.
Does the scorecard represent Caltex’s strategy? By and large it does. The focus of the scorecard is on measures of process improvement, quality, market share, and financial success from product differentiation and charging higher prices for customer service. There are some deficiencies that the subsequent assignment questions raise but, abstracting from these concerns for the moment, the scorecard does focus on implementing a product differentiation strategy.
Having concluded that the scorecard has been reasonably well designed, how has Caltex performed relative to its strategy in 2006? It appears from the scorecard that Caltex was successful in implementing its strategy in 2006. It achieved all targets in the financial, internal business, and learning and growth perspectives. The only target it missed was the market
share target in the customer perspective. At this stage, students may raise some questions about whether this is a good scorecard measure. Requirement 3 gets at this issue in more detail. The bottom line is that measuring “market share in the overall gasoline market” rather than in the “service-oriented customer” market segment is not a good scorecard measure, so not achieving this target may not be as big an issue as it may seem at first.
2. Yes, Caltex should include some measure of employee satisfaction and employee training in the learning and growth perspective. Caltex’s differentiation strategy and ability to charge a premium price is based on customer service. The key to good, fast, and friendly customer service is well trained and satisfied employees. Untrained and dissatisfied employees will have poor interactions with customers and cause the strategy to fail. Hence, training and employee satisfaction are very important to Caltex for implementing its strategy. These measures are leading indicators of whether Caltex will be able to successfully implement its strategy and should be measured on the balanced scorecard.
3. Caltex’s strategy is to focus on the 60% of gasoline consumers who are service-oriented, not on the 40% price-shopper segment. To evaluate if it has been successful in implementing its strategy, Caltex needs to measure its market share in its targeted market segment, “service-oriented customer,” not its market share in the overall market. Given Caltex’s strategy, it should not be concerned if its market share in the price-shopper segment declines. In fact, charging premium prices will probably cause its market share in this segment to decline. Caltex should replace “market share in overall gasoline market” with “market share in the service-oriented customer segment” in its balanced scorecard customer measure. Caltex may also want to consider putting a customer satisfaction measure on the scorecard. This measure should capture an overall evaluation of customer reactions to the facility, the convenience store, employee interactions, and quick turnaround. The customer satisfaction measure would serve as a leading indicator of market share in the service-oriented customer segment.
4. Although there is a cause-and-effect link between internal business process measures and customer measures on the current scorecard, Caltex should add more measures to tighten this linkage. In particular, the current scorecard measures focus exclusively on refinery operations and not on gas station operations. Caltex should add measures of gas station performance such as cleanliness of the facility, turnaround time at the gas pumps, the shopping experience at the convenience store, and the service provided by employees. Many companies do random audits of their facilities to evaluate how well their branches and retail outlets are performing. These measures would serve as leading indicators of customer satisfaction and market share in Caltex’s targeted segments.
5. Caltex is correct in not measuring changes in operating income from productivity improvements on its scorecard under the financial perspective. Caltex’s strategy is to grow by charging premium prices for customer service. The scorecard measures focus on Caltex’s success in implementing this strategy. Productivity gains per se are not critical to Caltex’s strategy and therefore, should not be measured on the scorecard.
Chapter 19. Cost of Quality Concepts
16. (30 min.) Costs of quality.
1. The ratios of each COQ category to revenues and to total quality costs for each period are as follows:
Costen, Inc.: Semi-annual Costs of Quality Report
(in thousands)
| |6/30/2006 |12/31/2006 |6/30/2007 |12/31/2007 |
|Actual |% of Revenues |% of Total Quality Costs |Actual |% of Revenues |% of Total Quality Costs |Actual |% of Revenues |% of Total Quality Costs |Actual |% of Revenues |% of Total Quality Costs | | |(1) |(2) = |(3) = |(4) |(5) = |(6) = |(7) |(8) = |(9) = |(10) |(11) = |(12) = | | | |(1) ÷ $8,240 |(1) ÷ $2,040 | |(4) ÷ $9,080 |(4) ÷ $2,159 | |(7) ÷ $9,300 |(7) ÷ $1,605 | |(10) ÷ $9,020 |(10) ÷ $1,271 | |Prevention costs | | | | | | | | | | | | | | Machine maintenance |$ 440 | | |$ 440 | | |$ 390 | | |$ 330 | | | | Supplier training |20 | | |100 | | |50 | | |40 | | | | Design reviews | 50 | | | 214 | | | 210 | | | 200 | | | | Total prevention costs | 510 | 6.2% | 25.0% | 754 | 8.3% | 34.9% | 650 | 7.0% | 40.5% | 570 | 6.3% | 44.9% | |Appraisal costs | | | | | | | | | | | | | | Incoming inspection |108 | | |123 | | |90 | | |63 | | | | Final testing | 332 | | | 332 | | | 293 | | | 203 | | | | Total appraisal costs | 440 | 5.3% | 21.6% | 455 | 5.0% | 21.1% | 383 | 4.1% | 23.9% | 266 | 3.0% | 20.9% | |Internal failure costs | | | | | | | | | | | | | | Rework |231 | | |202 | | |165 | | |112 | | | | Scrap | 124 | | | 116 | | | 71 | | | 67 | | | | Total internal failure costs | 355 | 4.3% | 17.4% | 318 | 3.5% | 14.7% | 236 | 2.5% | 14.7% | 179 | 2.0% | 14.1% | |External failure costs | | | | | | | | | | | | | | Warranty repairs |165 | | |85 | | |72 | | |68 | | | | Customer returns | 570 | | | 547 | | | 264 | | | 188 | | | | Total external failure costs | 735 | 8.9% | 36.0% | 632 | 7.0% | 29.3% | 336 | 3.6% | 20.9% | 256 | 2.8% | 20.1% | |Total quality costs |$2,040 |24.7% |100.0% |$2,159 |23.8% |100.0% |$1,605 |17.2% |100.0% |$1,271 |14.1% |100.0% | |Total production and revenues |$8,240 | | |$9,080 | | |$9,300 | | |$9,020 | | | |
2. From an analysis of the Cost of Quality Report, it would appear that Costen, Inc.’s program has been successful because:
• Total quality costs as a percentage of total revenues have declined from 24.7% to 14.1%.
• External failure costs, those costs signaling customer dissatisfaction, have declined from 8.9% of total revenues to 2.8% of total revenues and from 36% of all quality costs to 20.1% of all quality costs. These declines in warranty repairs and customer returns should translate into increased revenues in the future.
• Internal failure costs as a percentage of revenues have been halved from 4.3% to 2%.
• Appraisal costs have decreased from 5.3% to 3% of revenues. Preventing defects from occurring in the first place is reducing the demand for final testing.
• Quality costs have shifted to the area of prevention where problems are solved before production starts: total prevention costs (maintenance, supplier training, and design reviews) have risen from 25% to 44.9% of total quality costs. The $60,000 increase in these costs is more than offset by decreases in other quality costs.
• Because of improved designs, quality training, and additional pre-production inspections, scrap and rework costs have almost been halved while increasing sales by 9.5%.
• Production does not have to spend an inordinate amount of time with customer service since they are now making the product right the first time and warranty repairs and customer returns have decreased.
3. To estimate the opportunity cost of not implementing the quality program and to help her make her case, Jessica Tolmy could have assumed that:
• Sales and market share would continue to decline if the quality program was not implemented and then calculated the loss in revenue and contribution margin.
• The company would have to compete on price rather than quality and calculated the impact of having to lower product prices.
Opportunity costs are not recorded in accounting systems because they represent the results of what might have happened if the company had not improved quality. Nevertheless, opportunity costs of poor quality can be significant. It is important for Costen to take these costs into account when making decisions about quality..
-----------------------
DIRECT COSTS
Direct Manufacturing Labor
$2,268 F
Spending variance
Never a variance
$2,592 U
Efficiency variance
$324 U
Flexible-budget variance
Never a variance
$450,000 + [pic]
0.60
Breakeven revenues =
= $1,000,000
=
................
................
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