BYP4-3

Ideal Manufacturing Company of Sycamore, Illinois, has supported a research and development
(R&D) department that has for many years been the sole contributor to company's new farm
machinery products. The R&D activity is an overhead cost center that provides services only to
in-house manufacturing departments (four different product lines), all of which produce
agricultural/farm/ranch-related machinery products.
The department has never sold its service outside, but because of its long history of
success, larger manufacturers of agricultural products have approached Ideal to hire its R&D
department for special projects. Because the costs of operating the R&D department have been
spiraling uncontrollably, Ideal's management is considering entertaining these outside approaches
to absorb the increasing cost. But, (1) management doesn't have any cost basis for charging R&D
services to outsiders, and (2) it needs to gain control of its R&D costs. Management decides to
implement an activity-based costing system in order to determine the charges for both outsiders
and the in-house users of the department's services.
R&D activities fall into four pools with the following annuals costs
Market analysis

$1,050,000

Product design

2,350,000

Product development

3,600,000

Prototype testing

1,400,000

Activity analysis determines that the appropriate cost drivers and their usage for the four
activities are:

Total
Activities

Cost Drivers

Estimated Drivers

Market analysis

Hour of analysis

15,000 hours

Product design

Number of designs

2,500 designs

Product development

Number of products

Prototype testing

Number of tests

90 products
500 tests

Instructions
a) Compute the activity-based overhead rate for each activity cost pool.
Answer
Activities

Cost Drivers

Market analysis
Product design
Product
development
Prototype testing

Hour of analysis
Number of designs
Number of
products
Number of tests

Estimated
Overhead
$1,050,000
2,350,000
3,600,000

Expected use of
cost drivers
15,000 hours
2,500 designs
90 products

Overhead rate

1,400,000

500 tests

$2,800

$70
$940
$40,000

Estimated overhead Expected use of cost drivers = Overhead rate

b) How much cost would be charged to an in-house manufacturing department that

consumed 1800 hours of market analysis time, was provided 280 designs relating to 10
products, and requested 92 engineering tests?
Answer
Activities
Market analysis
Product design
Product
development
Prototype testing
Total

Cost Drivers
Hour of analysis
Number of
designs
Number of
products
Number of tests

Overhead rate
$70
$940

Cost Drivers
1800 hours
280 designs

Cost Assigned
$126,000
263,200

$40,000

10 products

400,000

$2,800

92 tests

257,600
$1,046,800

Overhead rate Cost driver = Cost assigned

c) How much cost would serve as the basis for pricing an R&D bid with an outside
company on a contract that would consume 800 hours of analysis time, require 178
designs relating to three products, and result in 70 engineering tests?
Answer
Activities
Market analysis
Product design

Cost Drivers
Hour of analysis
Number of

Overhead rate
$70
$940

Cost Drivers
800 hours
178 designs

Cost Assigned
$56,000
167,320

Product

designs
Number of

$40,000

3 products

120,000

products
Number of tests

$2,800

70 tests

196,000
$539,320

development
Prototype testing
Total

Overhead rate Cost driver = Cost assigned

d) What is the benefit to Ideal Manufacturing of applying activity-based costing to its R&D
activity for both in-house and outside charging purposes?
Answer
Activity-based costing graduated companies to identify R & D costs to activities that
cause costs ABC allowed closer study of the reasons for the restriction costs. By
imposing internal manufacturing department fair share of the cost of R & D Company,
the department can apply their own control over any cost. Activity-based costing allows
Ideal for compile realistic cost for bidding and service charges users outside the R & D
department.

BYP5-3
3

Managerial Analysis the condensed income statement for the Peri and Paul partnership for 2014
is as follows.
Peri and Paul Company
Income statement
For the year ended December 31, 2014
Sales (240,000 units)

$ 1,200,000

Cost of goods sold

800,000

Gross profit

400,000

Operating expenses
Selling

$ 280,000

Administrative

150,000

Net loss

430,000
($ 30,000)

A cost behavior analysis indicates that 75% of the cost of goods sold are variable,42% of the
selling expenses are variable, and 40% of the administrative expenses are variable.

Instructions
a) Compute the break-even point in total sales dollar and in units for 2014.
Answer
The variable costs per units:
Cost of goods sold (75% $800,000 240,000)

$2.5

Selling expenses (42% $280,000 240,000)

0.49

Administrative expenses (40% $150,000 240,000)

0.25

Total

$3.24

Fixed costs are:

Cost of goods sold ($800,000 0.40)

$320,000
4

Selling expenses ($280,000 0.42)

117,600

Administrative expenses ($150,000 0.75)

112,500

Total

$550,100

The break-even points are:

X = [$3.24 ($1,200,000 240,000)] X + $550,100
X = ($3.24 $5) X + $550,100
X = $0.65 X + $550,100
0.35 X = $550,100
X = $550,100 $0.35
X = $1,571,714.29 or $1,571,714

$5 X = $3.24 X + $550,100
$5 X - $3.24 X = $550,100
$1.76 X = $550,100
X = 312,556.82 or 312,557 units

b) Peri has proposed a plan to get the partnership out of the red and improve its
profitability. She feels that the quality of the product could be substantially improved by
spending $0.25 more per unit on better raw materials. The selling price per unit could be
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increased to only $5.25 because of competitive pressures. Peri estimates that sales
volume will increase by 25%. What effect would Peris plan have on the profits and the
break-even point in dollars of the partnership?
Answer
Variable unit cost of goods sold = ($600,000 240,000) = $2.5
$2.5 + $0.25 = $2.75
Sales volume = 25% 240,000 = 60,000
240,000 + 60,000 = 300,000 units
Total sales = 300,000 $5.25
= $1,575,000

Net income computation:

Sales

$1,575,000

Variable expenses
Cost of good sales (300,000 $2.5)

$ 750,000

Selling expenses (300,000 $0.49)

147,000

Administrative expenses (300,000 $0.25)

75,000

Total variable expenses

(972,000)

Contribution margin

$603,000

Fixed expenses
Cost of good sales

$320,000

Selling expenses

117,600

Administrative expenses

112,500

Total fixed expenses

(550,100)

Net income

$52,900

The break-even points are:

X = ($972,000 $1,575,000) X + $550,100
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X = $0.62 X + $550,100
0.38 X = $550,100
X = $1,447,631.58 or $1,447,632

Profits and the break-even points would both increases.

c) Paul was marketing major in college. He believes that sales volume can be increased only
by intensive advertising and promotional campaigns. He therefore proposed the following
plan as an alternative to Peris: (1) increase variable selling expenses to $0.59 per unit,
(2) lower theby $40,000. Paul quoted an old marketing research report that said that sales
volume would increase by 60% if these changes were made. What effect would Pauls
plan have on the profits and the break-even point in dollars of the partnership?
Answer
Sales [240,000 + (60% 240,000) = 384,000 ($5 - $0.25)

$1,824,000

Variable expenses
Cost of good sales (384,000 $2.5)

$960,000

Selling expenses (384,000 $0.59)

226,560

Administrative expenses (384,000 $0.25)

96,000

Total variable expenses

(1,282,560)

Contribution margin

$541,440

Fixed expenses
Cost of good sales

$320,000

Selling expenses ($117,600 + $40,000)

157,600

Administrative expenses

112,500

Total Fixed expenses

(590,100)

Net income

($48,660)

Sales volume = 60% 240,000 = 144,000

= 144,000 + 240,000
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= 384,000

The break-even points are:

X = ($1,282,560 1,824,000) X + $590,100
X = 0.70 X + $590,100
0.30 X = $590,100
X = $1,967,000

d) Which plan should be accepted? Explain your answer.

Answer
Peris plan should be accepted. It produces a higher net income and a lower break-even point
than Pauls plan.

BE7-3

At Jaymes Company, it costs $30 per unit ( $20 variable and $10 fixed ) to make a product at full
capacity that normally sells for $45. A foreign wholesaler offers to buy 3,000 units at $25 each.
Jaymes will incur special shipping costs of $2 per unit. Assuming that Jaymes has excess
operating capacity, indicate the net income (loss) Jaymes would realize by accepting the special
order.

Answer
Reject Order
Revenues
Costs variable manufacturing
shipping
Net income

$0
0
0
0

Accept order
$ 75,000*
60,000**
6,000***
$ 9,000

Net Income
Increase (Decrease)
$ 75,000
(60,000)
(6,000)
$ 9,000

* 3,000 $25 = 75,000

** (3,000 $20) = 60,000
*** (3,000 $2) = 6,000

The analysis indicates net income will increase by $ 9000, therefore, Jaymes Company
should accept the special order.

BE7-4
9

Manson Industries incurs unit costs of $8 ($5 variable and $3 fixed) in making a subassembly
part for its finished products. A supplier offers to make 10,000 of the assembly part at $6 per
unit. If the offer is accepted, Manson will save all variable costs but no fixed costs. Prepare an
analysis showing the total cost saving, if any, Manson will realize by buying the part.

Answer

Incremental Analysis - Make or buy

Per unit

Purchase
price
Applied
variable
cost
Applied
fixed cost
Total cost

Net income
Increase
(Decrease)

Make
$0

Buy
$6

$5

$0

$5

$6

($6)
$5

($1)

Total cost

Net income
Increase
(Decrease)

Make
$0

Buy
$60,000

$50,000

$0

$50,000

$60,000

($60,000)
$50,000

($10,000
)

This analysis indicates that Manson will save $10,000 of cost. It showing that if Manson
buys the subassembly part from the supplier, it will incur an additional coat of $10,000.
Therefore, Manson should make the subassembly part and reject to buy the assembly
part.

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BE7-5
Chudrick Inc. makes unfinished bookcases that it sells for $62. Production costs are $36 variable
and $10 fixed. Because it has unused capacity, Chudrick is considering finishing the bookcases
and selling them for $70. Variable finishing costs are expected to be $7 per unit with no increase
in fixed costs. Prepare an analysis on a per unit basis showing whether Chudrick should sell
unfinished or finished bookcases.

Answer

The manufacturer such as Chudrick Inc. has the option of selling products at a given point in the
production cycle or continuing to process with the expectation of selling them later at a higher
price. Since Chudrick Inc. has unused capacity, it should make a decision whether to sell its
unfinished products or make further the production process.
In order to make these decisions, the process further is going to be chosen as long as the
incremental revenue from such processing is greater than the incremental processing costs.
Here is the basic decision rule:
Process further = Incremental revenue from processing > Incremental processing costs
By using the rule, should the company sell the unfinished bookcases or should it process them
further? Therefore, in order to make the decision, the incremental analysis on a per unit need to
be done as below:

Sales price per unit

Cost per unit
Variable manufacturing
overhead
Fixed manufacturing
overhead

Sell unfinished

Process further

Net income
Increase ( Decrease)

$62

$70

$8

$36

$43

$(7)

$10

$10

$0

Total
$46
$53
$(7)
Net income per unit
$16
$17
$1
By looking at the incremental analysis, it would be advantageous for Chudrick Inc. to process the
bookcases further. This is because the incremental revenue which is $8 from the additional
processing is $1 higher than the incremental cost which is $7.
So, the company should process the bookcases further.

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