Exercise 2-6 Identifying Direct and Indirect Costs Given: The Empire Hotel is a four-star hotel located in downtown

Seattle. Required: For each of the following costs incurred at the Empire Hotel, indicate whether it would most likely be a direct cost or an indirect cost of the specified cost object by placing an x in the appropriate column. Direct cost -- A cost that can be easily and conveniently traced to a specified cost object. Indirect cost -- A cost that cannot be easily and conveniently traced to a specified cost object. Type of Cost Direct Indirect X X X X X X X X X

Cost Item Ex. 1 2 3 4 5 6 7 8 Room service beverages The salary of the head chef The salary of the head chef Room cleaning supplies Flowers for the reception desk The wages of the doorman Room cleaning supplies Fire Insurance on the hotel building Towels used in the gym

Cost Object A particular hotel quest The hotel's restaurant A particular restaurant customer A particular hotel guest A particular hotel guest A particular hotel guest The housecleaning department The hotel's gym The hotel's gym

Exercise 2-7: Identifying Differential, Opportunity, and Sunk Given: The Sorrento Hotel is a four-star hotel located in downtown Seattle. The hotel's operations vice president would like to replace the hotel's antiquated computer terminals at the registration desk with attractive state-of-the-art flat-panel displays. The new displays would take less space, would consume less power than the old computer terminals, and would provide additional security since they can only be viewed from a restrictive angle. The new computer displays would not require any new wiring. The hotel's chef believes the funds would be better spent on a new bulk freezer for the kitchen. Required: For each of the items below, indicate by placing an X in the appropriate column whether it should be considered a differential cost, an opportunity cost, or a sunk cost in the decision to replace the old computer terminals with new flat-panel displays. If none of the categories apply for a particular item, leave all columns blank. Differential cost -- a difference in cost between two alternatives. Opportunity cost -- The potential benefit that is given up when one alternative is selected over another. Sunk cost -- A cost that has already been incurred and that cannot be changed by any decision made now or in the future. Type of Cost Differential Opportunity X X X X

Cost Item Ex. Cost of electricity to run the terminals 1 Cost of the new flat-panel displays 2 Cost of the old computer terminals 3 Rent on the space occupied by the registration desk 4 Wages of the registration desk personnel 5 Benefits from a new freezer 6 Costs of maintaining the old computer terminals 7 Cost of removing the old computer terminals 8 Cost of existing registration desk wiring

Sunk

X X X X

Exercise 2-9: Classification of Quality Costs Given: Below are listed a number of activities that are part of a company's quality control systems. Required: 1. Classify the costs associated with each of these activities into one of the following categories: Prevention costs -- Costs that are incurred to keep defects from occurring. Appraisal costs -- Costs that are incurred to identify defective products before the products are shipped to customers. Internal failure costs -- Costs that are incurred as a result of identifying defective products before they are shipped to customers. External failure costs -- Costs that are incurred when a product or service that is defective is delivered to a customer Type of Quality Cost Prevention Appraisal Internal Cost Cost Failure

Cost Item a Repairs of goods still under warranty b Customer returns due to defects c Statistical process control d Disposal of spoiled goods e Maintaining testing equipment f Inspecting finished goods g Downtime caused by quality problems h Debugging errors in software i Recall of defective products j Training quality engineers k Re-entry data due to typing errors l Inspecting materials received from suppliers m Audits of the quality systems n Supervision of testing personnel

X X X X X X

X X X X X

0 Rework labor

2. Which of the four types of quality costs listed in (1) above are incurred to keep poor quality of conformance from occurring? Which of the four types of costs are incurred because poor quality of conformance has occurred? Quality of conformance -- The degree to which a product or service meets or exceeds its design specifications and is free of defects or other problems that mar its appearance or degrade performance. Prevention costs & appraisal make up cost of conformance, while the costs associated with non-conformance are internal and external failure costs.

Quality Cost External Failure X X

Exercise 2-10 (Modified to Include Appendix 2A): High-Low Method; Scattergraph Analysis; Regression Given: Zerbel Company, a wholesaler of large, custom-built air conditioning units for commercial buildings, has noticed considerable fluctuation in its shipping expense from month to month, as shown below: Total Shipping Expense $2,200 $3,100 $2,600 $1,500 $2,200 $3,000 $3,600

Month January February March April May June July

Units Shipped 4 7 5 2 3 6 8

Summary Assuming 6 units are expected to be shipped)

1 2 3 4

Average Cost: High-Low Scattergraph Regression Values: Intercept: Slope: RSQ:

$2,600 $2,900 $2,920 $2,918 1010.714286 317.8571429 0.962220603

1. Using the high-low method, estimate the cost formula for shipping expense. Cost formula: where Y = a + bX Y = Total shipping costs X = Units shipped b = Variable cost per unit a = Fixed portion of total shipping cost

Dependent variable Independent variable

Estimate b:

b = Change in Y / Change in X Y X High X Value $3,600 8 Low X Value $1,500 2 Difference $2,100 6 b = $2,100 / 6 = Estimate a: a = Y - TVC Y $3,600 $1,500 TVC $2,800 $700 TFC $800 $800 $350 per unit

High X Value Low X Value

Cost formula: Y = $350X + $800 2. The president has no confidence in the high-low method and would like you to "check out' your results using the scattergraph method. a. Prepare a scattergraph using the data given above. Plot cost on the vertical axis and activity on the horizontal axis. Fit a straight line to your plots.

Total Shipping Expense Scattergraph

$4,000 $3,500

y = 317.86x +

$3,500 Total Shipping Expense $3,000 $2,500 $2,000 $1,500 $1,000 $500 $0 0 1 2 3 4 5 6 7

Units Shipped

b. Using your scattergraph, estimate the approximate variable cost per unit shipped and the approximate fixed cos per month with the quick-and-dirty method. Right click on trend line. Click on format. Select options. Forecast backwards two units, Estimate Y intercept as $1,000.

Select plotted point (5, $2,600) which lies on the trend line. The variable cost can be quickly estimated by subtracting the estimated fixed cost ($1,000) from the total cost at the poin lying on the straight line. The total variable cost = $2,600 - $1,000 = $1,600 Estimate variable cost per unit by taking TVC and dividing it by the number for the selected point (5). Estimated variable cost per unit = $1,600 / 5 = $320. Estimated cost formula = $1,000 + $320X 3. What factors, other than the number of units shipped, are likely to affect the company's shipping expense? a. The weight and volume of the units shipped. b. The distance shipped. c. The speed of the shipping process -- delivery deadlines. Appendix 2A: Least-Squares Regression 1. Using the least-squares regression method, estimate the cost formula for shipping expense. Estimated cost formula = $1,010.71 + $317.857X (See regression output below.) 320

Note: the R-squared is 0.96, which means that 96% of the variation in shipping costs is explained by

knowing the number of units shipped. This is a very high R-squared and indicates a very good fit. SUMMARY OUTPUT Regression Statistics Multiple R 0.980928439 R Square 0.962220603 Adjusted R Square 0.954664723 Standard Error 149.0445763 Observations 7 ANOVA df Regression Residual Total SS MS F Significance F 1 2828928.571 2828928.571 127.3472669 9.54922E-05 5 111071.4286 22214.28571 6 2940000

To find the regression function: Click on Data Tab, then click on icon in the Data Analysis s

Intercept X Variable 1

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% 1010.714286 151.6827382 6.663344147 0.001149119 620.8013943 1400.627177 317.8571429 28.16677736 11.28482463 9.54922E-05 245.4521366 390.2621491

RESIDUAL OUTPUT Observation 1 2 3 4 5 6 7 Predicted Y Residuals 2282.142857 -82.1428571 3235.714286 -135.714286 2600 0 1646.428571 -146.428571 1964.285714 235.7142857 2917.857143 82.14285714 3553.571429 46.42857143

2. Prepare a simple table comparing the variable and fixed cost elements of shipping expense as computed under the quick-and-dirty scattergraph method, the high-low method, and the least-squares regression method. Fixed Cost Variable Cost Element (a) per Unit (b) $800 $350 $1,000 $320 $1,010.714 $317.857

Method High-Low Quick & Dirty Regression

Regression

cted to be shipped)

y = 317.86x + 1010.7 R = 0.9622

he approximate fixed cost

om the total cost at the point

hipping expense?

n icon in the Data Analysis section.

Lower 95.0% Upper 95.0% 620.8013943 1400.627177 245.4521366 390.2621491

se as computed under ession method.

Problem 2-14: Contribution Format versus Traditional Income Statement Given: House of Organs, Inc., purchases organs from a well-known manufacturer and sells them at the retail level. The organs sell, on the average, for $2,500 each. The average cost of an organ from the manufacturer is $1,500. $2,500 $1,500 House of Organs, Inc., has always kept careful records of its costs. The costs that the company incurs in a typical month are presented below in the form of a spreadsheet: Costs
Selling: Advertising Delivery of Organs Sales Salaries and Commissions Utilities Depreciation of Sales Facilities Administrative: Executive Salaries Depreciation of Office Equipment Clerical Insurance $950 $60 $4,800 $650 $5,000 $13,500 $900 $2,500 $700

Cost Formula
per month per organ sold per month, plus 4% of sales per month per month per month per month per month, plus $40 per organ sold per month

0.04

$100

$40

During November, the company sold and delivered 60 organs.

60

Required: 1. Prepare an income statement for November using the traditional format with costs organized by function. House of Organs, Inc. Traditional Formated Income Statement For the Month of November Sales (60 organs X $2,500 per organ) Cost of Goods Sold (60 organs X $1,500) Gross Margin Selling and Administrative Expenses: Selling Expenses: Advertising Delivery of Organs (60 organs X $60 per organ) Sales Salaries and Commissions $4,800 Utilities Depreciation of Sales Facilities Total Selling Expense Administrative Expenses: Executive Salaries Depreciation of Office Equipment Clerical $2,500 Insurance Total Administrative Expense Total Selling and Administrative Expenses Net Operating Income $150,000 90,000 $60,000

$6,000

$950 3,600 10,800 650 5,000 $21,000 $13,500 900 4,900 700 $20,000 41,000 $19,000

$2,400

2. Redo (1) above, this time using the contribution margin format with costs organized by behavior. Show costs and revenues on both a total and a per unit basis down through CM. House of Organs, Inc. CM Format Income Statement For the Month of November Total Sales (60 organs X $2,500 per organ) Variable Expenses: Cost of Goods Sold ($1,500 per Organ) Delivery of Organs ($60 per Organ) Sales Commissions (4% of Sales) Clerical ($40 per Organ) Contribution Margin Fixed Expenses: Advertising Sales Salaries Utilities Depreciation of Sales Facilities Executive Salaries Depreciation of Office Equipment Clerical Insurance Total Fixed Expenses Net Operating Income Total $150,000 Per Unit

$90,000 3,600 6,000 2,400

102,000 $48,000

$1,500 60 100 40

$950 4,800 650 5,000 13,500 900 2,500 700 29,000 $19,000

3. Refer to the income statement you prepared in (2) above. Why might it be misleading to show the fixed costs on a per unit basis? Fixed costs remain constant in total but change on a per unit basis with changes in activity level. Showing fixed costs on a per unit basis on the income statement makes them appear to be variable costs which might mislead managers.

Per Unit $2,500

1,700 $800 $15.83 $80.00 $10.83 $83.33 $225.00 $15.00 $41.67 $11.67 $15.57

483.3333

Problem 2-18: Cost Behavior: High-Low Method; C/M Format Income Statement Given: Frankel Ltd., a British merchandising company, is the exclusive distributor of a product that is gaining rapid market acceptance. The company's revenues and expenses (in British pounds) for the last three months are given below. Frankel Ltd. Comparative Income Statements For the Three Months Ended. June 30
Sales in units Sales Revenue Cost of Goods Sold Gross Margin Selling and Administrative Expense Shipping Expense Advertising Expense Salaries and Commissions Insurance Expense Depreciation Expense Total Selling and Administrative Expenses Net Operating Income (Loss)

April May June 3,000 Per Unit 3,750 Per Unit 4,500 420,000 140 525,000 140 630,000 168,000 56 210,000 56 252,000 252,000 84 315,000 84 378,000 44,000 70,000 107,000 9,000 42,000 272,000 -20,000 14.67 50,000 23.33 70,000 35.67 125,000 3.00 9,000 14.00 42,000 90.67 296,000 -6.67 19,000 13.33 56,000 18.67 70,000 33.33 143,000 2.40 9,000 11.20 42,000 78.93 320,000 5.07 58,000

1. Identify each of the company's expenses (including cost of goods sold) as either variable, fixed, or mixed. (See Above) 2. Using the High-Low Method, separate each mixed expense into variable and fixed elements. State the cost formula for each mixed expense. Shipping Expense Mixed Cost Volume Fixed Cost Cost formula Salaries and Commissions Mixed Cost Volume Fixed Cost Cost formula High Low Diff. 56,000 44,000 12,000 4,500 3,000 1,500 20,000 20,000 y = 20,000 + 8.00(X) High Low Diff. 143,000 107,000 36,000 4,500 3,000 1,500 35,000 35,000 y = 35,000 + 24.00(X) Rate 8.00 per unit

Rate 24.00 per unit

3. Redo the Company's income statement at the 4,500- unit level of activity using the C/M format. Frankel Ltd. Contribution Format Income Statements For the Month Ended. June 30 Sales revenue (4,500 units X 140 per unit) Variable expenses: 630,000

Cost of goods sold (4,500 units X 56 per unit) Shipping Expense (4,500 units X 8 per unit) Salaries and Commission Expense (4,500 units X 24 per unit) Contribution Margin (4,500 units X (140 - 88) per unit) Fixed Expenses: Shipping Expense Advertising Expense Salaries and Commissions Insurance Expense Depreciation Expense Net Operating Income

252,000 36,000 108,000

396,000 234,000

20,000 70,000 35,000 9,000 42,000

176,000 58,000

June Per Unit 140 56 V 84 12.44 15.56 31.78 2.00 9.33 71.11 12.89 M F M F F M

52 52