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COURSE: Accounting 505 DATE: XXXXXXXX

QUARTER: Summer 2006 – Mid-module

TEST: Selected sample questions and study guidance.

NOTE: (1) THIS IS A SAMPLE OF QUESTION TYPE AND HOW SOME ASPECTS OF THE TOPICS HAVE BEEN TESTED IN THE PAST. ACTUAL EXAM QUESTIONS MAY COVER THE SAME OR DIFFERENT ASPECTS OF A TOPIC AREA. (2) IN YOUR EXAM, SPACE WILL BE PROVIDED AFTER EACH QUESTION FOR YOUR SOLUTION/ANSWER.

The bulleted instructions below will be on your exam. If you read through them now, you will save yourself some time in the actual exam.

• All questions are to be answered in the spaces provided.

• Where calculations are needed to arrive at a solution, you are advised to show enough work so I can understand how you arrived at your answer. Partial credit is available on some computational questions. However, unless your work is shown, it is not possible to determine if partial credit points are appropriate.

• Please confine your work to the examination paper.

• You have approximately 120 minutes to complete this test. In the interests of maximizing your grade, I recommend you skim through the entire exam before you start to answer any question so you can plan your strategy.

• If you need clarification (e.g. definition of words, unclear instructions, unclear problem) during the test, raise your hand and I will come to you and provide clarification where appropriate and allowable. I will not re-teach any point.

• Space has been provided below each question for your response. Write complete answers. For example, if asked to identify and explain, a list of items with no explanations is not a complete answer.

• Point values for each question are indicated in parentheses at the end of each question.

• There are 9 pages (including this title page) on this examination. Count your pages and confirm that you have a complete package and that no pages are duplicated or missing.

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Introduction, Cost Concepts and Terminology

1. Management accounting

a. focuses on estimating future revenues, costs, and other measures to forecast activities and their results.

b. provides information about the company as a whole.

c. reports information that has occurred in the past that is verifiable and reliable.

d. provides information that is generally available only on a quarterly or annual basis.

2. What is meant be a firm’s business strategy? How can management accounting help in formulating such a strategy?

A firm’s business strategy is a formulated plan of action in which the objectives isi to achieve the long-term profitability goals of a company.

Management accounting can help formulate strategy by providing information about a firm’s sources of competitive advantage. Possibilities range from capitalizing on low-cost or efficiency advantage relative to competitors so as to be able to charge lower prices, to capitalizing on the ability to charge premium prices through providing distinctive features that consumers value.

3. What is meant by (a) a firm’s value chain, and (b) its supply chain? What is management accounting’s function with respect to these chains?

A firm’s value chain is the sequence of business processes in which utility/usefulness is added to a product or service in the eyes of the customer. For a manufacturing concern, production is at the heart of the chain. Upstream links are R&D and design; downstream links are distribution, marketing, and product support. Not all firms engage in all activities in the chain. Some links are “outsourced” (e.g. Boeing manufacturing of 787) and some are vertically integrated with other companies (e.g. use of distributors in the soft-drink industry.)

A firm’s supply chain is the flow of goods, services, and information from the firm’s suppliers, through production, to the delivery of products and services to the firm’s customers.

The most significant function of management accounting with respect to these chains is the providing of relevant cost information so that the “links” in which the firm actively participates so that managers can make appropriate cost-benefit analyses of the options available to them. With respect to the supply chain, management accounting plays an important role in the integration of activities across companies in the chain.

4. Archambeau Products Company manufactures custom office furniture. Recently, the company decided to develop a formal cost accounting system and classify all costs into three categories. Categorize each of the following items as being appropriate for (1) direct cost tracing to the finished furniture, (2) allocation of an indirect manufacturing cost to the finished furniture, or (3) as a nonmanufacturing item – i.e. a period cost. Additionally, speculate as to the most likely behavior of this cost: variable, fixed, or mixed.

Cost Cost Period Cost

Item Tracing Allocation Cost Behavior

Carpenter’s wages ___X____ ________ _________ ____V___

Depreciation - office building ________ ________ ___X____ ____F___

Glue for assembly ________ ____X____ ________ ____V___

Lathe department supervisor’s

salary ________ ____X___ ________ ____F___

Lathe depreciation ________ ____X____ ________ ____F____

Lathe maintenance ________ ____X____ ________ ____V*___

Lathe operator wages ___X____ ________ ________ ____V____

Lumber ___X_____ ________ ________ ____V____

Metal brackets for drawers ________ ____X____ ________ ____V____

Power for lathe dept. ________ ___X____ ________ ____M___

Factory washroom supplies ________ ____X____ ________ ____V____

* Depends on process. If scheduled routinely, then there is a fixed component. However, it would be reasonable to assume that the higher the production volume, the more maintenance would be needed. Answer could also be M for mixed.

Job Costing

5. (a) Describe the essential elements of the mechanics of a job costing system. Include, but do not limit your description to, an explanation of how job cost sheets are used and their role in keeping track of costs. (b) Under what circumstances would a company use a job-costing rather than a process-costing system?

a. In a job costing system, direct costs (materials and labor) are recorded on job cost sheets (one for each job) on a daily basis as incurred/used. Overhead is applied upon job completion based on a predetermined overhead application rate. Costs of individual jobs are moved between inventories (WIP, FG, and COGS) as the jobs move/sell. Summary entries to transfer total materials, labor, and overhead costs applied into WIP from the appropriate accounts are made at the end of each month. Any over/underapplied overhead is closed out periodically. [5 points]

b. Job costing is used when high-value, somewhat customized products are being made, often to customer specification. It identifies the costs relating to each specific job rather than relying on an averaging approach. [3 points]

6. Job-cost records for Boucher Company contained the following data:

Total Cost

Date Date Date of Job

Job No. Started Finished Sold at June 30

220 May 18 June 12 June 20 $6,000

221 May 20 June 19 June 21 4,000

222 June 7 July 5 July 12 7,000

223 June 10 June 28 July 1 6,500

224 June 19 July 16 July 25 8,000

Required:

a. Provide the journal entry to record cost of goods manufacture for June.

a. Compute WIP inventory at June 30.

b. Compute finished goods inventory at June 30.

c. Compute cost of goods sold for June.

Solution:

a. Goods completed and moved to finished goods during June were Jobs Nos. 220, 221, and 223. The total cost of these jobs is $16,500

Debit: Finished goods 16,500

Credit: Work in process 16,500

b. 7,000 + $8,000 = $15,000

c. $6,500

d. $6,000 + $4,000 = $10,000

7. Peterson’s Plastic Products Company manufactures pipes and applies manufacturing costs to production at a budgeted indirect-cost rate of $8 per direct labor-hour. The following data are obtained from the accounting records for June 20x2:

Direct materials $400,000

Direct labor (8,000 hours @ $21/hour) $168,000

Indirect labor $ 22,000

Plant facility rent $ 10,000

Depreciation on plant machinery and equipment $ 15,000

Other indirect manufacturing costs $ 12,000

Sales commissions $ 30,000

Administrative expenses $ 40,000

Required:

a. What actual amount of manufacturing overhead costs was incurred during June 20x2? $59,000. See highlighted items in list above.

b. What amount of manufacturing overhead was allocated to all jobs during June 20x2?

$64,000. (8,000 DL hours @ $8 per hour.)

c. For June 20x2, was manufacturing overhead under-allocated or over-allocated? Explain. MOH was over-allocated by $5,000 because $64,000 applied is greater than the $59,000 MOH actually incurred.

d. What are some possible reasons for overhead allocated to be different from overhead actually incurred?

Numerator error. Poor estimation of budgeted overhead for the coming period, resulting in an application rate that was too high.

Denominator error: Actual labor hours incurred during the period was greater than anticipated for planned production. In this scenario, the application rate of $8 per hour might have been a reasonable estimation, but excess labor hours worked led to over-application of overhead.

e. Assume that the ratios of MOH in the ending balances of WIP, FG, and COGS were 10%, 20%, and 70% respectively. What approach would you recommend be taken to clearing out the misallocation amount that you have identified in (c)? Why?

Adjust the entire $5,000 directly to Cost of Goods Sold. If the proration approach were used, COGS would be reduced by 70% of the $5,000 (i.e. $3,500). This is only $1,500 less than the direct adjustment amount and is not materially different. Additionally, the effect of proration on both WIP and FG is not material because of the low amount of MOH remaining in those balances. A cost-benefit position supports direct write-down.

If you believe that accuracy of reporting is of supreme importance, you would argue for proration. However, you would need to justify this approach from a cost-benefit point of view.

Activity-based Costing

8. (a) How is an Activity Based Costing (ABC) system different from a traditional costing system? (b) What is a significant advantage it provides over a traditional system? (c) Give an example of a management decision that can be enhanced by the use of activity-based costing information. (d) Identify two difficulties associated with ABC. (Note there are 4 parts to this question for you to address – see highlighting. Please be sure you address all parts in your answer.) (10 points)

a. ABC sorts overhead into individual, homogeneous cost pools that relate to several activities undertaken to manufacture a product or provide a service. The cost pool dollars are allocated to cost objects based on their relative consumption of the underlying driver of each cost pool. In a traditional system, all indirect costs are accumulated in a single cost pool, and only one cost base is used for allocation. This cost base was generally a labor or materials number, which bore no relationship to the overhead. [3 points]

b. ABC allocates indirect costs on more of a cause-and-effect basis, allowing management to determine the “true” costs being consumed by the cost objects. [3 points]

c. Examples could include pricing decisions; product-mix decisions; determination of elimination of activities (evaluation), planning decisions.. [2 points]

d. Difficulties: Requires identifying and analyzing a large amount of data. Needs a sophisticated information system. It is costly to implement and manage. [ 1 point each disadvantage, total 2 points]

9. Nichols Inc. manufactures remote controls. Currently the company uses a plant-wide rate for allocating manufacturing overhead. The plant manager believes it is time to refine the method of cost allocation and has the accounting department identify the primary production activities which generate indirect costs and their cost drivers:

Activities Cost driver Allocation Rate

Materials handling Number of parts $2 per part

Assembly Labor hours $20 per hour

Inspection Time at inspection station $3 per minute

What is the total indirect manufacturing cost per remote control assuming an activity-based-costing method is used and a batch of 50 remote controls is produced? The batch requires the assembly of 100 parts, the use of 6 direct manufacturing labor hours, and total inspection time of 2.5 minutes.

Materials handling: 100 parts x $2 per part = $200

Assembly 6 hours x $20 per hour = 120

Inspection 2.5 mins. x $3 per min. = 7.50

Total indirect costs $327.50 (+3 points)

Divided by 50 remotes $6.55 per remote (+3 points)

Process Costing

10. Assume that direct materials are added at the start of the process. If there was no beginning work-in-process inventory and no ending work-in-process inventory, under the weighted-average process costing method, the number of equivalent units for direct materials would be

a. equal to the units started or transferred in.

b. equal to the units completed.

c. less than the units completed.

d. both (a) and (b).

e. none of the above.

11. The president of the Gulf Coast Refining Corporation wants to know why his golfing partner, who is the chief financial officer of a large construction company, calculates his costs by the job when his own corporation calculates costs by average units rather than by individual barrel of oil.

Construction companies “manufacture” highly individualized “products” which have high value; therefore, it is necessary to track costs relating to each individual job. This requires a job-order system. Refining corporations, however, produce large quantities of like units of product from a barrel of oil. There is no need for differentiation of costs relating to the different batches produced. This calls for a processing costing system.

THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 12 through 15.

Injection Molding, Inc., manufactures plastic moldings for car seats. Its costing system utilizes two cost categories, direct materials and conversion costs. Each product must pass through Department A and Department B. Direct materials are added at the beginning of production. Conversion costs are allocated evenly throughout production.

Data for Department A for February 20x3 are:

Work in process, beginning inventory, 40% converted 1,000 units

Units started during February 7,000 units

Work in process, ending inventory, 30% converted 500 units

Costs for Department A for February 20x3 are:

Work in process, beginning inventory:

Direct materials $100,000

Conversion costs $100,000

Direct materials costs added during February $1,000,000

Conversion costs added during February $1,250,000

12. How many units were completed and transferred out of Department A during February?

7500. (1000 beginning inventory + 7000 units started – 500 ending inventory)

13 What is the unit cost per equivalent unit in Department A?

Determine EU for materials and conversion:

| |Materials |Conversion |

|Units completed |7500 |7500 |

|Ending inventory, complete as to materials; 30% | | |

|converted |500 |150 |

|WA Equivalent Units |8000 |7650 |

Materials cost per EU ($1,100,000/8000 units) $137.50

Conversion cost per EU $1,350,000/7650 units) 176.47

Total cost per EU $313.97

14. Provide the journal entry to transfer the units finished and transferred to Dept. B at the end of February.

WIP – Department B 2,354,775

WIP – Department A 2,354,775

15. What was the balance of WIP of Dept. A at the end of February?

500 EU as to materials at $137.50/EU $68,750.00

150 EU as to conversion at $176.47/EU 26,480.50

Balance of WIP Dept. A end of Feb. $95,220.50

Note that the total of costs transferred out and ending WIP are not quite equal to total costs to be accounted for of $2,450,000. The small difference is due to rounding of conversion cost per EU

16. Munir Hassan, controller, gathered data on overhead costs and direct labor-hours over the past 12 months. List and discuss the different approaches Munir can use to estimate a cost function for overhead costs using direct labor-hours as the cost driver. Include in your discussion an assessment of the reliability and applicability of each approach.

The four approaches to cost estimation are:

1. Industrial engineering method

2. Conference method

3. Account analysis method

4. Quantitative analysis of cost relationships and behavior

The industrial engineering method, also called the work-measurement method, estimates cost functions by analyzing the relationship between inputs and outputs in physical term.s This method is quite reliable when applied to measurement of easily traceable costs. It is applicable to cost estimation for new projects.

The conference method estimates cost functions on the basis of analysis and opinions about costs and their drivers gathered from various departments of an organization (purchasing, process engineering, manufacturing, employee relations, etc.). It is not a very reliable method since it incorporates judgmental opinions. It is applicable to cost estimation for new projects.

The account analysis method estimates cost functions by classifying cost accounts in the ledger as variable, fixed, or mixed with respect to the identified cost driver. The reliability of this method is dependent on the experience and expertise of the estimate in relation to this cost. It can be highly effective, but is subject to individual judgment. It is applicable to estimation of continuing costs which have a historical record.

Quantitative analysis of cost relationships and behavior are formal methods, such as the high-low method or regression, to fit linear cost functions to past data observations. Although these methods are generally the most reliable, some are less reliable than others. The high-low method is quick and easy, but ignores all but two data observations. Graph methods rely on subjective estimation for the line of best fit. Least-squares regression is the most reliable method since it takes into account all historical data observations. It is applicable in any cost estimation where there are historical data observations.

Cost-Volume-Profit Analysis

17. The Tessmer Company has fixed costs of $400,000 and variable costs are 75% of the selling price. Its tax rate is 35%. If Tessmer plans to sell 500,000 units and wants to realize an after-tax profit of $130,000, what must the unit selling price be? (Give your answer in dollars and cents, please.)

Let X be unit selling price

500,000X – 0.75(500,000X) – 400,000 = 130,000/(1-.35)

125,000X = $200,000 + $400,000

X = $4.80

18. (CPA adapted) The strategy most likely to reduce the breakeven point would be to

a. increase both the fixed costs and the contribution margin.

b. decrease both the fixed costs and the contribution margin.

c. decrease the fixed costs and increase the contribution margin.

d. increase the fixed costs and decrease the contribution margin.

19. Why is the cost-volume-profit decision model described as “fragile?” Identify and describe two of the underlying assumptions that support your answer. (Please confine your answer to the space provided.)

The CVP model is fragile because its underlying assumptions are simplistic and not often actually realized.

Any two of the following items identified in Chapter 3 lecture notes. The comments in parentheses address the reason for the fragility in the assumption.

➢ Volume of units produced and sold is the only driver affecting changes in revenue and costs. (Many activities have more than one driver.)

➢ Total costs can be divided into fixed and variable components. (Some costs are mixed and regardless of the analytical method used to separate the fixed and variable components, such data are only estimates.)

➢ All costs and revenues are linear,( but this is not always the case. It is, therefore, critical that the analysis be confined to the range of activity and time period over which the costs are linear.)

➢ Unit SP, VC, and total fixed costs are known and constant. (This is not always the case – particularly the constant aspect of this assumption.)

➢ Sales mix, if multi-product company, remains constant.(This is subject to the whims of the consumer and sales mix can be widely different in practice than what was estimated.)

➢ Inventories are kept constant or at zero. (This is difficult to manage and maintain, even in a just-in-time environment.)

➢ There is a relevant range of volume within which the above assumptions are valid .(Hopefully, this relevant range has been correctly estimated.)

20. Northwestern Business College is planning to hold a fundraising banquet at one of the local country clubs. It has two options for the banquet:

OPTION 1: Crestview Country Club

a. Fixed rental cost of $1,000.

b. $12 per person for food.

OPTION 2: Tallgrass Country Club

a. Fixed rental cost of $3,000.

b. A caterer who charges $8.00 per person for food.

In addition to the above costs, regardless of which site is selected, Northwestern expects to incur $1,800 for administrative and marketing expenses. It also plans to hire a band, which will cost another $800. Tickets are expected to be $30 per person. Local business supporters will donate any other items required for the event.

(a) At what number of ticket sales would Northwestern generate the same amount of “profits,” regardless of which option it selects?

Contribution margin for Option 1 is $30 - $12 = $18; for Option 2 is $30 - $8 = $22 (Partial credit of 1 point each is available if each CM is shown.)

Let X be the number of ticket sales at indifference point.

18X – ($1,000 + $1,800 + $800) = 22X – ($3,000 + $1,800 + $800)

18X – $3,600 = 22X – $ 5,600

X = 500 tickets

(Note that full credit is awarded if you used simply the fixed cost for each option in your equation above. Since the other fixed costs are the same in either option, they are essentially irrelevant, and the answer is the same in terms of tickets at indifference point.)

(b) Which option has the lower level of risk? What is the disadvantage of this option? (Provide calculations that will support your answer.)

The lower-risk option is Option 1, the one with the lower break-even point. Even though its contribution margin per ticket is lower than that of Option 2, the lower total fixed costs provide a break-even point at lower ticket sales. +2 points

Disadvantage is that, once the break-even point has been reached, the profit per ticket is smaller than Option 2. +2 points

Contribution margins: Option 1 is 200 tickets ($3,600/$18). Option 2 is 255 tickets ($5,600/$22) +1 point to show calculation.

(Note that the total fixed costs must be used to determine actual break-even points. If only the fixed costs for each option are used, the break-even points will be incorrect.)

(c) Which option has more “profit” potential? What is the disadvantage of this option? Again, please provide calculations to support your answer.

Option 2 has more profit potential. Once breakeven point is reached, profit is generated at the rate of $22 per ticket as opposed to $18 per ticket for Option 1. +2 points

The disadvantage is that the break-even is higher, and so this option is more risky. +2 points

Calculation of break-even point for Option 2 needs to be presented either here or shown in your response to (b) above. +2 point

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