Professional Documents
Culture Documents
TABLE OF CONTENTS
Chapter 1 1-1 1-19
MANAGEMENT ACCOUNTING: AN OVERVIEW
2 Management Accounting and the Business Environment 2-1 2-5
3 Understanding of Financial Statements 3-1 3-10
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Chapter 1 Management Accounting: An Overview
CHAPTER 1
I. Questions
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Management Accounting: An Overview Chapter 1
4. Yes. Planning is really much more vital than control; that is, superior
control is fruitless if faulty plans are being implemented. However,
planning and control are so intertwined that it seems artificial to draw
rigid lines of separation between them.
5. Yes. The controller has line authority over the personnel in his own
department but is a staff executive with respect to the other departments.
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Chapter 1 Management Accounting: An Overview
8. Bettina Company
President
Controller Treasurer
Assistant Assistant
Controller Treasurer
11. Three guidelines that help management accountants increase their value to
managers are (a) employ a cost-benefit approach, (b) recognize behavioral
as well as technical considerations, and (c) identify different costs for
different purposes.
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Management Accounting: An Overview Chapter 1
14. By reporting and interpreting relevant data, the controller exerts a force or
influence that impels management toward making better-informed
decisions.
15.
Financial Accounting
Audience: External: shareholders, creditors, tax
authorities
Purpose: Report on past performance to external parties;
basis of contracts with owners and lenders
Timeliness: Delayed; historical
Restrictions: Regulated; rules driven by generally accepted
accounting principles and government
authorities
Type of Information: Financial measurements only
Nature of Information: Objective, auditable, reliable, consistent,
precise
Scope: Highly aggregate; report on entire organization
Managerial Accounting
Audience: Internal: Workers, managers, executives
Purpose: Inform internal decisions made by employees
and managers; feedback and control on
operating performance
Timeliness: Current, future oriented
Restrictions: No regulations; systems and information
determined by management to meet strategic
and operational needs
Type of Information: Financial, plus operational and physical
measurements on processes, technologies,
suppliers customers, and competitors
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Chapter 1 Management Accounting: An Overview
II. Exercises
Exercise 1
Exercise 2
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Management Accounting: An Overview Chapter 1
a. (4) Marketing
b. (3) Production
c. (6) Customer service
d. (5) Distribution
Exercise 3
a. (4) Marketing
b. (3) Production
c. (5) Distribution
d. (4) Marketing
e. (5) Distribution
f. (3) Production
g. (1) Research and development
h. (2) Design
III. Problems
Because the accountants duties are often not sharply defined, some of these
answers might be challenged:
1. Scorekeeping
2. Attention directing
3. Scorekeeping
4. Problem solving
5. Attention directing
6. Attention directing
7. Problem solving
8. Scorekeeping (depending on the extent of the report) or attention
getting
9. This question is intentionally vague. The give-and-take of the
budgetary process usually encompasses all three functions, but it
emphasizes scorekeeping the least. The main function is attention
directing, but problem solving is also involved.
10. Problem solving
1. Inputs: b, g, i, m
2. Processes: a, d, f, j
3. Outputs: e, k, n
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Chapter 1 Management Accounting: An Overview
4. System objectives: c, h, l
Jamie Reyes is staff. She is in a support role she prepares reports and helps
explain and interpret them. Her role is to help the line managers more
effectively carry out their responsibilities.
Requirement 1
The possible motivations for the snack foods division wanting to play end-of-
year games include:
(a) Management incentives. Yummy Foods may have a division bonus
scheme based on one-year reported division earnings. Efforts to front-end
revenue into the current year or transfer costs into the next year can
increase this bonus.
(b) Promotion opportunities and job security. Top management of Yummy
Foods likely will view those division managers that deliver high reported
earnings growth rates as being the best prospects for promotion. Division
managers who deliver unwelcome surprises may be viewed as less
capable.
(c) Retain division autonomy. If top management of Yummy Foods adopts a
management by exception approach, divisions that report sharp
reductions in their earnings growth rates may attract a sizable increase in
top management supervision.
Requirement 2
The Standards of Ethical Conduct require management accountants to:
Refrain from either actively or passively subverting the attainment of
the organizations legitimate and ethical objectives, and
Communicate unfavorable as well as favorable information and
professional judgment or opinions.
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Chapter 1 Management Accounting: An Overview
The other end-of-year games occur in many organizations and may fall into
the gray to acceptable area. However, much depends on the
circumstances surrounding each one:
(a) If the independent contractor does not do maintenance work in December,
there is no transaction regarding maintenance to record. The
responsibility for ensuring that packaging equipment is well maintained is
that of the plant manager. The division controller probably can do little
more than observe the absence of a December maintenance charge.
(d) In many organizations, sales are heavily concentrated in the final weeks of
the fiscal year-end. If the double bonus is approved by the division
marketing manager, the division controller can do little more than observe
the extra bonus paid in December.
(e) If TV spots are reduced in December, the advertising cost in December
will be reduced. There is no record falsification here.
(g) Much depends on the means of persuading carriers to accept the
merchandise. For example, if an under-the-table payment is involved, it is
clearly unethical. If, however, the carrier receives no extra consideration
and willingly agrees to accept the assignment, the transaction appears
ethical.
Each of the (a), (d), (e) and (g) end-of-year games may well disadvantage
Yummy Foods in the long run. For example, lack of routine maintenance may
lead to subsequent equipment failure. The divisional controller is well advised
to raise such issues in meetings with the division president. However, if
Yummy Foods has a rigid set of line/staff distinctions, the division president is
the one who bears primary responsibility for justifying division actions to
senior corporate officers.
Requirement 3
If Tan believes that Ryan wants her to engage in unethical behavior, she
should first directly raise her concerns with Ryan. If Ryan is unwilling to
change his request, Tan should discuss her concerns with the Corporate
Controller of Yummy Foods. Tan also may well ask for a transfer from the
snack foods division if she perceives Ryan is unwilling to listen to pressure
brought by the Corporate Controller, CFO, or even President of Yummy
Foods. In the extreme, she may want to resign if the corporate culture of
Yummy Foods is to reward division managers who play end-of-year games
that Tan views as unethical and possibly illegal.
Problem 6
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Management Accounting: An Overview Chapter 1
James Torres has come up with a scheme that involves a combination of data
falsification and smoothing! Not only has he made up the revenue numbers,
but also he has had the gall to defer some of them to the next period. Making
up such numbers is clearly illegal. Smoothing, in this example is also illegal
because the numbers are fictitious.
Problem 7
Clearly the vice-president will lose his or her job if you turn him or her in.
Given that this is a major violation of the code of ethics and a violation patent
law, the vice-president could go to jail. Your best course of action is to check
your information and if the vice-president is definitely involved, go
immediately to the VPs superior (who is probably a senior VP or the company
president). The organizations attorneys will take over from there.
Problem 8
One option is to do nothing and ignore what you saw, however, this may
violate your own code of ethics and your ethical responsibilities under the
organizations code of ethics. Given that you want to do something, it is
probably best to start by talking to employees in your organization whose job
it is to deal with ethical issues. If no such employees exist or are available,
you might start by using a decision model. This model incorporated the
following steps:
1. Determine the Facts What, Who, Where, How
2. Define the Ethical Issue
3. Identify Major Principles, Rule, Values
4. Specify the Alternatives.
5. Compare Values and Alternatives, See if Clear Decision
6. Assess the Consequences.
7. Make Your Decision.
IV. Cases
Requirement (a)
Other forward looking information desired in addition to the income statement
information are
1. Disclosure of the components of financial performance, i.e., nature
and source of revenues, various activities, transactions, and other
relevant events affecting the company.
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Chapter 1 Management Accounting: An Overview
Requirement (b)
No. GAAP does not allow capitalization of employee training and advertising
costs even if management feels that they increase the value of the companys
brand name. The reasons are uncertainty of the future benefits that may be
derived therefrom and difficulty and reliability of their measurement.
Requirement (c)
Detailed information that managers would likely request are analysis of the
significant increases in
1. Sales
2. Cost of sales
3. Payroll
4. Stock and option based compensation
5. Advertising and promotion.
Requirement (d)
Nonmonetary measures:
1. Change in number and profile of customers
2. Share in the market
3. Who, what and how many are the competitors
4. Product lines offered by the entity vs. Product lines of competitors
5. Sales promotion and advertising activities
Requirement (e)
1. Competitors
2. Employees
3. Prospective creditors
Requirement (a)
Increase in sales to new customers to sales
Too much emphasis on this ratio may lead the sales manager to spend more
time developing business with new customers and disregard the needs of
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Management Accounting: An Overview Chapter 1
Requirement (b)
Decrease in cost of goods sold to sales
This performance measure could create the following problems:
1. Purchasing goods with poor quality at lower cost and selling them for
the same price.
2. Indiscriminately increasing selling price to widen the profit margin
without regard to competitors current prices.
3. If the entity is manufacturing its own goods, managers could try to
economize on costs, i.e., buying poorer quality of materials,
employing unskilled workers, etc. thereby causing deterioration of the
quality of the finished products.
Requirement (c)
Decrease in selling and administrative expense to sales
Cost-cutting is generally advisable for as long as the quality of goods and
services are not compromised. Likewise, certain cost-saving measures could
demotivate sales people and other employees and could lead to counter-
productive activities.
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Chapter 1 Management Accounting: An Overview
Generally, when we buy goods and services in the free market, we assume we
are buying from people who have a certain level of ethical standards. If we
could not trust people to maintain those standards, we would be reluctant to
buy. The net result of widespread dishonesty would be a shrunken economy
with a lower growth rate and fewer goods and services for sale at a lower
overall level of quality.
Requirement 1
Failure to report the obsolete nature of the inventory would violate the
Standards of Ethical Conduct as follows:
Competence
Perform duties in accordance with relevant technical standards.
Prepare complete reports using reliable information.
By failing to write down the value of the obsolete inventory, Perez would not
be preparing a complete report using reliable information. In addition,
generally accepted accounting principles (GAAP) require the write-down of
obsolete inventory.
Integrity
Avoid conflicts of interest.
Refrain from activities that prejudice the ability to perform duties
ethically.
Refrain from subverting the legitimate goals of the organization.
Refrain from discrediting the profession.
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Management Accounting: An Overview Chapter 1
Objectivity
Communicate information fairly and objectively.
Disclose all relevant information.
Hiding the obsolete inventory impairs the objectivity and relevance of financial
statements.
Requirement 2
As discussed above, the ethical course of action would be for Perez to insist
on writing down the obsolete inventory. This would not, however, be an easy
thing to do. Apart from adversely affecting her own compensation, the ethical
action may anger her colleagues and make her very unpopular. Taking the
ethical action would require considerable courage and self-assurance.
Requirement 1
See the organization chart on page 17.
Requirement 2
Line positions would include the university president, academic vice-president,
the deans of the four colleges, and the dean of the law school. In addition, the
department heads (as well as the faculty) would be in line positions. The
reason is that their positions are directly related to the basic purpose of the
university, which is education. (Line positions are shaded on the organization
chart.)
All other positions on the organization chart are staff positions. The reason is
that these positions are indirectly related to the educational process, and exist
only to provide service or support to the line positions.
Requirement 3
All positions would have need for accounting information of some type. For
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Chapter 1 Management Accounting: An Overview
example, the manager of central purchasing would need to know the level of
current inventories and budgeted allowances in various areas before doing any
purchasing; the vice president for admissions and records would need to know
the status of scholarship funds as students are admitted to the university; the
dean of the business college would need to know his/her budget allowances in
various areas, as well as information on cost per student credit hour; and so
forth.
Requirement 1
No, Santos did not act in an ethical manner. In complying with the presidents
instructions to omit liabilities from the companys financial statements he was
in direct violation of the IMAs Standards of Ethical Conduct for
Management Accountants. He violated both the Integrity and Objectivity
guidelines on this code of ethical conduct. The fact that the president ordered
the omission of the liabilities is immaterial.
Requirement 2
No, Santos actions cant be justified. In dealing with similar situations, the
Securities and Exchange Commission (SEC) has consistently ruled that
corporate officerscannot escape culpability by asserting that they acted as
good soldiers and cannot rely upon the fact that the violative conduct may
have been condoned or ordered by their corporate superiors. (Quoted from:
Gerald H. Lander, Michael T. Cronin, and Alan Reinstein, In Defense of the
Management Accountant, Management Accounting, May, 1990, p. 55) Thus,
Santos not only acted unethically, but he could be held legally liable if
insolvency occurs and litigation is brought against the company by creditors
or others. It is important that students understand this point early in the
course, since it is widely assumed that good soldiers are justified by the fact
that they are just following orders. In the case at hand, Santos should have
resigned rather than become a party to the fraudulent misrepresentation of the
companys financial statements.
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Case 6
Requirement 1
President
Vice
Vice Vice Academic Vice
Vice
President, President, President,
President President,
Auxiliary Admissions & Physical
Financial Plant
Services Records Services
(Controller)
Dean,
Dean, Business Dean, Dean, Dean,
Engineering &
Humanities Fine Arts Law School
Quantitative
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MANAGEMENT ACCOUNTING - Solutions Manual
Requirement 1
Andres Romero has an ethical responsibility to take some action in the matter
of PhilChem, Inc. and the dumping of toxic wastes. The Standards of Ethical
Conduct for Management Accountants specifies that management
accountants should not condone the commission of acts by their organization
that violate the standards of ethical conduct. The specific standards that apply
are as follows.
Competence. Management accountants have a responsibility to
perform their professional duties in accordance with relevant laws and
regulations.
Confidentiality. Management accountants must refrain from
disclosing confidential information unless legally obligated to do so.
However, Andres Romero may have a legal responsibility to take
some action.
Integrity. Management accountants have a responsibility to:
- refrain from either actively or passively subverting the attainment
of the organizations legitimate and ethical objectives.
- communicate favorable as well as unfavorable information and
professional judgments or opinions.
Objectivity. Management accountants must fully disclose all relevant
information that could reasonably be expected to influence an
intended users understanding of the reports, comments, and
recommendations.
Requirement 2
The Standards of Ethical Conduct for Management Accountants indicates
that the first alternative being considered by Andres Romero, seeking the
advice of his boss, is appropriate. To resolve an ethical conflict, the first step
is to discuss the problem with the immediate superior, unless it appears that
this individual is involved in the conflict. In this case, it does not appear that
Romeros boss is involved.
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Cost Concepts and Classifications Chapter 8
Requirement 3
Andres Romero should follow the established policies of the organization
bearing on the resolution of such conflict. If these policies do not resolve the
ethical conflict, Romero should report the problem to successively higher
levels of management up to the Board of Directors until it is satisfactorily
resolved. There is no requirement for Romero to inform his immediate
superior of this action because the superior is involved in the conflict. If the
conflict is not resolved after exhausting all courses of internal review, Romero
may have no other recourse than to resign from the organization and submit an
informative memorandum to an appropriate member of the organization.
(CMA Unofficial Solution, adapted)
CHAPTER 2
MANAGEMENT ACCOUNTING
AND THE BUSINESS ENVIRONMENT
I. Questions
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Chapter 8 Cost Concepts and Classifications
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Cost Concepts and Classifications Chapter 8
7. If customers who provide a company with the most profits are attracted,
satisfied, and retained, profits will increase as a result.
Quality: Customers are expecting higher levels of quality and are less
tolerant of low quality than in the past.
Time: Time has many components: the time taken to develop and
bring new products to market; the speed at which an
organization responds to customer requests; and the reliability
with which promised delivery dates are met. Organizations
are under pressure to complete activities faster and to meet
promised delivery dates more reliably than in the past in order
to increase customer satisfaction.
Innovation: There is now heightened recognition that a continuing flow of
innovative products or services is a prerequisite for the
ongoing success of most organizations.
11. Four themes for managers to attain success are customer focus, value-
chain and supply-chain analysis, key success factors, and continuous
improvement and benchmarking.
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Chapter 8 Cost Concepts and Classifications
13. This phrase means that people will direct their attention to work primarily
on those tasks that management monitors and measures. Employees may
not pay as much attention (or no attention) to tasks that are not measured.
Often management will reward people based on how well they perform
relative to a specific measure. As an example, in a manufacturing
organization, if people are measured and rewarded based on the number of
outputs per hour, regardless of quality, employees will focus their
attention on producing as many units of output as possible. A negative
consequence is that the quality of output may suffer.
14. Some of these new measures are quality, speed to market, cycle time,
flexibility, complexity and productivity.
16.
Stakeholders Contribution Requirements
Employees Effort, skills, Rewards, interesting
information jobs, economic
security, proper
treatment
Partners Goods, services, Financial rewards
information commensurate with the
risk taken
Owners Capital Financial rewards
Community Allows the Conformance to laws,
organization to operate good corporate
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Cost Concepts and Classifications Chapter 8
19. Just-in-time means making a good or service only when the customer,
internal or external, requires it. Just-in-time requires a product layout
with a continuous flow (no delays) once production starts. It means that
setup costs must be reduced substantially to eliminate the need to produce
in batches, and it means that processing systems must be reliable. Just-in-
time production is based on the elimination of all nonvalue-added
activities to reduce cost and time. It is an approach to improvement that
is continuous and involves employee empowerment and involvement.
CHAPTER 3
I. Questions
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Cost Concepts and Classifications Chapter 8
6. The going concern assumption states that in the absence of evidence to the
contrary (i.e., bankruptcy proceedings), an enterprise is expected to
continue to operate in the foreseeable future. This means, for example,
that it will continue to use the assets it has in its financial statements for
the purpose for which they were acquired.
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Chapter 8 Cost Concepts and Classifications
10. A strong statement of cash flows is one that shows significant amounts of
cash generated from operating activities. This means that the enterprise is
generating cash from its ongoing activities and is not required to rely on
continuous debt and equity financing, or the sale of its major assets.
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Cost Concepts and Classifications Chapter 8
income statement, all expenses are combined and deducted from total
revenue in a single step. Both formats result in the same amount of net
income.
1.
1. d 3. a 5. e 7. f 9. c
2. g 4. j 6. h 8. b 10. i
2.
1. d 3. i 5. m 7. h 9. f 11. b 13. e
2. a 4. g 6. c 8. n 10. k 12. j 14. l
3.
a. F c. F e. I g. F I. I k. F
b. I d. I f. F h. F j. F l. I
III. Problems
Requirement (a)
SM Farms
Balance Sheet
September 30, 2005
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Chapter 8 Cost Concepts and Classifications
* Total assets, P961,470, minus total liabilities, P618,050, less share capital,
P250,000.
Requirement (b)
The loss of an asset, Barns and Sheds, from a typhoon would cause a decrease
in total assets. When total assets are decreased, the balance sheet total of
liabilities and equity must also decrease. Since there is no change in liabilities
as a result of the destruction of an asset, the decrease on the right-hand side of
the balance sheet must be in the retained earnings account. The amount of the
decrease in Barns and Sheds, in the equity, and in both balance sheet totals, is
P23,800.
Problem 2 (Preparing a Balance Sheet and Cash Flow Statement; Effects
of Business Transactions)
Requirement (a)
The Tasty Bakery
Balance Sheet
August 1, 2005
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Cost Concepts and Classifications Chapter 8
Share capital
80,000
Retained earnings
40,700
Total Total
P220,700 P220,700
Requirement (b)
The Tasty Bakery
Balance Sheet
August 3, 2005
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Chapter 8 Cost Concepts and Classifications
Requirement (c)
The Tasty Bakery is in a stronger financial position on August 3 than it was on
August 1.
On August 1, the highly liquid assets (cash and accounts receivable) total only
P18,200, but the company has P25,100 in debts due in the near future
(accounts payable plus salaries payable).
On August 3, after additional infusion of cash from the sale of stock, the liquid
assets total P25,750, and debts due in the near future amount to P16,100.
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Cost Concepts and Classifications Chapter 8
Requirement (a)
The First Malt Shop
Balance Sheet
September 30, 2005
* Total assets, P132,590, less equity, P54,090, less accounts payable, P8,500, equals
notes payable.
Requirement (b)
The First Malt Shop
Balance Sheet
October 6, 2005
18,000
Land
55,000 Total liabilities
P 88,000
Building 45,500 Equity:
Share capital
80,000
Furniture & fixtures 38,000 Retained earnings
5,590
Total Total
P173,590 P173,590
Revenues P 5,500
Expenses (4,000)
Net income P 1,500
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Cost Concepts and Classifications Chapter 8
Requirement (c)
The First Malt Shop is in a stronger financial position on October 6 than on
September 30. On September 30, the company had highly liquid assets (cash
and accounts receivable) of P8,650, which barely exceeded the P8,500 in
liabilities (accounts payable) due in the near future. On October 6, after the
additional investment of cash by shareholders, the companys cash alone
exceeded its short-term obligations.
Requirement (1)
Fil-Cinema Scripts
Balance Sheet
November 30, 2005
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Chapter 8 Cost Concepts and Classifications
32,700
Land
39,000 Total liabilities
P106,200
Building 54,320 Equity:
Share capital
5,000
Office furniture* 12,825 Retained earnings
3,535
Total Total
P114,735 P114,735
Requirement (2)
(1) The cash in Cruzs personal savings account is not an asset of the
business entity Fil-Cinema Scripts and should not appear in the balance
sheet of the business. The money on deposit in the business bank account
(P3,400) and in the company safe (P540) constitute cash owned by the
business. Thus, the cash owned by the business at November 30 totals
P3,940.
(2) The years-old IOU does not qualify as a business asset for two reasons.
First, it does not belong to the business entity. Second, it appears to be
uncollectible. A receivable that cannot be collected is not viewed as an
asset, as it represents no future economic benefit.
(3) The total amount to be included in Office furniture for the rug is
P9,400, the total cost, regardless of whether this amount was paid in cash.
Consequently, Office furniture should be increased by P6,500. The
P6,500 liability arising from the purchase of the rug came into existence
prior to the balance sheet date and must be added to the Notes payable
amount.
(4) The computer is no longer owned by Hollywood Scripts and therefore
cannot be included in the assets. To do so would cause an overstatement
of both assets and equity. The Office furniture amount must be reduced
by P2,525.
(5) The P22,400 described as Other assets is not an asset, because there is
no valid legal claim or any reasonable expectation of recovering the
income taxes paid. Also, the payment of income taxes by Cruz was not a
business transaction by Fil-Cinema Scripts. If a refund were obtained
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Cost Concepts and Classifications Chapter 8
(6) The proper valuation for the land is its historical cost of P39,000, the
amount established by the transaction in which the land was purchased.
Although the land may have a current fair value in excess of its cost, the
offer by the friend to buy the land if Cruz would move the building
appears to be mere conversation rather than solid, verifiable evidence of
the fair value of the land. The cost principle, although less than perfect,
produces far more reliable financial statements than would result if
owners could pull figures out of the air in recording asset values.
(7) The accounts payable should be limited to the debts of the business,
P32,700, and should not include Cruzs personal liabilities.
A
27. D 17. A 27. B 37. A
28. C 18. B 28. B 38. C
29. B 19. C 29. D
30. C 20. C 30. C
CHAPTER 4
I. Questions
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Chapter 8 Cost Concepts and Classifications
b. To maintain solvency
c. To attain stability
12. Trend percentages are used to show the increase or decrease in a financial
statement amount over a period of years by comparing the amount in each
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Chapter 8 Cost Concepts and Classifications
Measuring the change in sales over a period of several years would call
for use of trend percentages. The sales in the base year are assigned a
weight of 100%. The percentage for each later year is computed by
dividing that years sales by the sales in the base year.
13. Expenses (including the cost of goods sold) have been increasing at an
even faster rate than net sales. Thus Premiere is apparently having
difficulty in effectively controlling its expenses.
III. Problems
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Cost Concepts and Classifications Chapter 8
Requirement (a)
Computation of percentage changes:
1. Net sales increased 10% (P200,000 increase P2,000,000 = 10%
increase).
2. Total expenses increased 11% (P198,000 increase P1,800,000 = 11%
increase).
Requirement (b)
1. Total expenses grew faster than net sales. Net income cannot also have
grown faster than net sales, or the sum of the parts would exceed the size
of the whole.
2. Net income must represent a smaller percentage of net sales in 2006 than
it did in 2005. Again, the reason is that the expenses have grown at a
faster rate than net sales. Thus, total expenses represent a larger
percentage of total sales in 2006 than in 2005, and net income must
represent a smaller percentage.
Requirement 1
XYZ Corporation
Balance Sheet
As of December 31
Change
Peso %
2005 2006
Assets
Cash and equivalents 14,000 16,000 2,000 14.29%
Receivables 28,800 55,600 26,800 93.06%
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Chapter 8 Cost Concepts and Classifications
XYZ Corporation
Income Statement
Years ended December 31
(P thousands)
Change
Peso %
2005 2006
Net sales 266,400 424,000 157,600 59.16%
Cost of goods sold 191,400 314,600 123,200 64.37%
Gross profit 75,000 109,400 34,400 45.87%
Selling, general and administrative
expenses 35,500 58,400 22,900 64.51%
Income before income taxes 39,500 51,000 11,500 29.11%
Income taxes 12,300 16,400 4,100 33.33%
Net income 27,200 34,600 7,400 27.21%
Requirement 2
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Cost Concepts and Classifications Chapter 8
4. Cost of Inventories
increased by 64.37% while increased by 58.52%
Goods Sold
Favorable
Leverage
5. Total Total
increased by 80.58% while increased by 138.76%
Assets Liabilities
Unfavorable
6. Total Total
increased by 138.76% while increased by 43.14%
Liabilities Equity
Unfavorable
Profitability
7. Net Cost of
increased by 59.16% while increased by 64.37%
Sales Goods Sold
Unfavorable
8. Net Selling,
Sales increased by 59.16% while General & increased by 64.51%
Administrative
Expenses
Unfavorable
9. Net Net
increased by 59.16% while increased by 27.21%
Sales Income
Unfavorable
10. Net Total
increased by 27.21% while increased by 80.58%
Income Assets
Unfavorable
Requirement (1)
Requirement (2)
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Chapter 8 Cost Concepts and Classifications
Assets: Cash declined from Year 3 through Year 5. This may have been
due to the growth in both inventories and accounts receivable.
In particular, the accounts receivable grew far faster than sales
in Year 5. The decline in cash may reflect delays in collecting
receivables. This is a matter for management to investigate
further.
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Cost Concepts and Classifications Chapter 8
31. D 36. A, C, D
32. A 37. B*
33. A 38. D
34. B
35. D
36. C
37. C
38. A
39. D
40. C
8-43
Chapter 8 Cost Concepts and Classifications
CHAPTER 5
I. Questions
8-44
Cost Concepts and Classifications Chapter 8
6. How a shareholder would feel would depend in large part on the stability
of the firm and its industry. If the firm is in an industry that experiences
wide fluctuations in earnings, then shareholders might be very pleased that
no interest-paying debt exists in the firms capital structure. In hard
times, interest payments might be very difficult to meet, or earnings might
be so poor that negative leverage would result.
7. No, the stock is not necessarily overpriced. Book value represents the
cumulative effects on the balance sheet of past activities evaluated using
historical prices. The market value of the stock reflects investors beliefs
about the companys future earning prospects. For most companies
market value exceeds book value because investors anticipate future
growth in earnings.
10. The current ratio would probably be highest during January, when both
current assets and current liabilities are at a minimum. During peak
operating periods, current liabilities generally include short-term
borrowings that are used to temporarily finance inventories and
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Chapter 8 Cost Concepts and Classifications
receivables. As the peak periods end, these short-term borrowings are paid
off, thereby enhancing the current ratio.
11. A 2-to-1 current ratio might not be adequate for several reasons. First, the
composition of the current assets may be heavily weighted toward slow-
turning inventory, or the inventory may consist of large amounts of
obsolete goods. Second, the receivables may be large and of doubtful
collectibility, or the receivables may be turning very slowly due to poor
collection procedures.
12. Expenses (including the cost of goods sold) have been increasing at an
even faster rate than net sales. Thus Sunday is apparently having
difficulty in effectively controlling its expenses.
13. If the companys earnings are very low, they may become almost
insignificant in relation to stock price. While this means that the p/e ratio
becomes very high, it does not necessarily mean that investors are
optimistic. In fact, they may be valuing the company at its liquidation
value rather than a value based upon expected future earnings.
15. The length of operating cycle of the two companies cannot be determined
from the fact the one companys current ratio is higher. The operating
cycle depends on the relationships between receivables and sales, and
between inventories and cost of goods sold. The company with the higher
current ratio might have either small amounts of receivables and
inventories, or large sales and cost of sales, either of which would tend to
produce a relatively short operating cycle.
16. The investor is calculating the rate of return by dividing the dividend by
the purchase price of the investment (P5 P50 = 10%). A more
meaningful figure for rate of return on investment is determined by
relating dividends to current market price, since the investor at the present
time is faced with the alternative of selling the stock for P100 and
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Cost Concepts and Classifications Chapter 8
III. Problems
The changes from 2005 to 2006 are all favorable. Sales increased and the
gross profit per peso of sales also increased. These two factors led to a
substantial increase in gross profit. Although operating expenses increased in
peso amount, the operating expenses per peso of sales decreased from 29 cents
to 28 cents. The combination of these three favorable factors caused net
income to rise from 4 cents to 6 cents out of each peso of sales.
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Chapter 8 Cost Concepts and Classifications
Requirement (a)
Current assets:
Cash P 47,600
Marketable securities 175,040
Accounts receivable 230,540
Inventory 179,600
Unexpired insurance 4,500
Total current assets P637,280
Current liabilities:
Notes payable P 70,000
Accounts payable 125,430
Salaries payable 7,570
Income taxes payable 14,600
Unearned revenue 10,000
Total current liabilities P227,600
Requirement (b)
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Cost Concepts and Classifications Chapter 8
Administrative expenses........................................................................................................
13.6 14.6
Total expenses........................................................................................................................
31.6 32.1
Net operating income............................................................................................................
5.2 7.9
Interest expense.....................................................................................................................
1.4 1.0
Net income before taxes.........................................................................................................
3.8 % 6.9 %
Requirement 2
The companys major problem seems to be the increase in cost of goods sold,
which increased from 60.0% of sales in 2005 to 63.2% of sales in 2006. This
suggests that the company is not passing the increases in costs of its products
on to its customers. As a result, cost of goods sold as a percentage of sales
has increased and gross margin has decreased. Selling expenses and interest
expense have both increased slightly during the year, which suggests that costs
generally are going up in the company. The only exception is the
administrative expenses, which have decreased from 14.6% of sales in 2005 to
13.6% of sales in 2006. This probably is a result of the companys efforts to
reduce administrative expenses during the year.
Ms. Freezes operating results are significantly better than the average
performance within the industry. As a percentage of sales revenue, Ms.
Freezes operating income and net income after nearly twice the average for
the industry. As a percentage of total assets, Ms. Freezes profits amount to
an impressive 23% as compared to 14% for the industry.
The key to Ms. Freezes success seems to be its ability to earn a relatively
high rate of gross profit. Ms. Freezes exceptional gross profit rate (51%)
probably results from a combination of factors, such as an ability to command
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Chapter 8 Cost Concepts and Classifications
a premium price for the companys products and production efficiencies which
lead to lower manufacturing costs.
As a percentage of sales, Ms. Freezes selling expenses are five points higher
than the industry average (21% compared to 16%). However, these higher
expenses may explain Ms. Freezes ability to command a premium price for
its products. Since the companys gross profit rate exceeds the industry
average by 8 percentage points, the higher-than-average selling costs may be
part of a successful marketing strategy. The companys general and
administrative expenses are significantly lower than the industry average,
which indicates that Ms. Freezes management is able to control expenses
effectively.
Requirement 1
2006 2005
Current assets:
Cash 2.0% 5.1%
..........................................................
Accounts receivable, net 15.0 10.1
..........................................................
Inventory 30.1 15.2
..........................................................
Prepaid expenses 1.0 1.3
..........................................................
Total current assets 48.1 31.6
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Cost Concepts and Classifications Chapter 8
Note: Columns do not total down in all cases due to rounding differences.
Requirement 2
The companys cost of goods sold has increased from 60 percent of sales in
2005 to 65 percent of sales in 2006. This appears to be the major reason the
companys profits showed so little increase between the two years. Some
benefits were realized from the companys cost-cutting efforts, as evidenced
by the fact that operating expenses were only 26.3 percent of sales in 2006 as
compared to 30.4 percent in 2005. Unfortunately, this reduction in operating
expenses was not enough to offset the increase in cost of goods sold. As a
result, the companys net income declined from 5.6 percent of sales in 2005 to
5.3 percent of sales in 2006.
Requirement (a)
(Pesos in
Millions)
Current assets:
Cash P 74.8
Receivables 152.7
Merchandise inventories 1,191.8
Prepaid expenses 95.5
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Chapter 8 Cost Concepts and Classifications
Requirement (b)
(1) Current ratio:
Current assets (Req. a) P1,514.8
Current liabilities P1,939.0
Current ratio (P1,514.8 P1,939.0) 0.8 to 1
Requirement (c)
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Cost Concepts and Classifications Chapter 8
Requirement (e)
Note to Instructor: Prior to the year in which the data for this problem was
collected, Alabang Supermarket had reported a negative retained earnings
balance in its balance sheet for several consecutive periods. The fact that
Alabang Supermarket has only recently removed the deficit from its financial
statements is also worrisome.
Requirement (a)
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Chapter 8 Cost Concepts and Classifications
Requirement (b)
Requirement (c)
(2) Long-term creditors also have little to worry about. Not only is the
company highly liquid, but creditors claims amount to only 23.1% of
total assets. If Bonbon Sweets were to go out of business and liquidate
its assets, it would have to raise only 23 cents from every peso of assets
for creditors to emerge intact.
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Cost Concepts and Classifications Chapter 8
Requirement 1
Requirement 2
Cash + Marketable securities + Accounts receivable
Acid-test ratio = Current liabilities
P80,000 + P0 + P460,000
Acid-test ratio
Requirement 3 = P520,000 = 1.04 to 1 (rounded)
2. Current ratio:
Current assets P490,000
= P200,000 = 2.45 to 1
Current liabilities
3. Acid-test ratio:
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Chapter 8 Cost Concepts and Classifications
Sales P2,100,000
Average accounts receivables = P150,000 = 14 times
365 days
14 times = 26.1 days (rounded)
5. Inventory turnover:
Cost of goods sold P1,260,000
Average inventory = P280,000 = 4.5 times
365 days
4.5 times = 81.1 days to turn (rounded)
6. Debt-to-equity ratio:
Total liabilities P500,000
Total equity = P800,000 = 0.63 to 1 (rounded)
* P100,000 total par value P5 par value per share = 20,000 shares
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Cost Concepts and Classifications Chapter 8
P126,000
= P1,200,000 = 10.5%
= P105,000
(P725,000 + P800,000)
P105,000
= = 13.8% (rounded)
P762,500
3. Financial leverage was positive, since the rate of return to the ordinary
shareholders (13.8%) was greater than the rate of return on total assets
(10.5%). This positive leverage is traceable in part to the companys
current liabilities, which may carry no interest cost, and to the bonds
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Chapter 8 Cost Concepts and Classifications
Requirement (1)
Current assets
(P80,000 + P460,000 + P750,000 + P10,000).................................... P1,300,000
Current liabilities (P1,300,000 2.5)...................................................... 520,000
P 780,000
Working capital.......................................................................................
Requirement (2)
Cash + Marketable securities
Acid-test ratio + Accounts receivable + Short-term notes
=
Current liabilities
P80,000 + P0 + P460,000 + P0
= = 1.04 (rounded)
P520,000
Requirement (3)
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Cost Concepts and Classifications Chapter 8
8-59
Chapter 8 Cost Concepts and Classifications
a. The market price is going down. The dividends paid per share over the
three-year period are unchanged, but the dividend yield is going up.
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Cost Concepts and Classifications Chapter 8
b. The earnings per share is increasing. Again, the dividends paid per share
have remained constant. However, the dividend payout ratio is decreasing.
In order for the dividend payout ratio to be decreasing, the earnings per
share must be increasing.
c. The price-earnings ratio is going down. If the market price of the stock is
going down [see part (a) above], and the earnings per share are going up
[see part (b) above], then the price-earnings ratio must be decreasing.
d. In Year 1, leverage was negative because in that year the return on total
assets exceeded the return on ordinary equity. In Year 2 and in Year 3,
leverage was positive because in those years the return on ordinary equity
exceeded the return on total assets employed.
e. It is becoming more difficult for the company to pay its bills as they come
due. Although the current ratio has improved over the three years, the
acid-test ratio is down. Also note that the accounts receivable and
inventory are both turning more slowly, indicating that an increasing
portion of the current assets is being made up of those items, from which
bills cannot be paid.
f. Customers are paying their bills more slowly in Year 3 than in Year 1.
This is evidenced by the decline in accounts receivable turnover.
IV. Cases
Requirement 1
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Chapter 8 Cost Concepts and Classifications
8-62
Cost Concepts and Classifications Chapter 8
Liabilities:
Current liabilities 27.5 % 18.2 %
Bonds payable, 12% 18.8 22.7
Total liabilities 46.3 40.9
Equity:
Preference shares, P50 par, 8% 5.0 6.1
Ordinary shares, P10 par 12.5 15.2
Retained earnings 36.3 37.9
Total equity 53.8 59.1
Total liabilities and equity 100.0 % 100.0 %
Requirement 3
The following points can be made from the analytical work in parts (1) and (2)
above:
The company has improved its profit margin from last year. This is
attributable to an increase in gross margin, which is offset somewhat by an
increase in operating expenses. In both years the companys net income as a
percentage of sales equals or exceeds the industry average of 4%.
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Chapter 8 Cost Concepts and Classifications
Although the companys working capital has increased, its current position
actually has deteriorated significantly since last year. Both the current ratio
and the acid-test ratio are well below the industry average, and both are
trending downward. (This shows the importance of not just looking at the
working capital in assessing the financial strength of a company.) Given the
present trend, it soon will be impossible for the company to pay its bills as
they come due.
The drain on the cash account seems to be a result mostly of a large buildup in
accounts receivable and inventory. This is evident both from the common-size
balance sheet and from the financial ratios. Notice that the average age of the
receivables has increased by 5 days since last year, and that it is now 9 days
over the industry average. Many of the companys customers are not taking
their discounts, since the average collection period is 27 days and collection
terms are 2/10, n/30. This suggests financial weakness on the part of these
customers, or sales to customers who are poor credit risks. Perhaps the
company has been too aggressive in expanding its sales.
The inventory turned only 5 times this year as compared to over 6 times last
year. It takes three weeks longer for the company to turn its inventory than the
average for the industry (71 days as compared to 50 days for the industry).
This suggests that inventory stocks are higher than they need to be.
In the authors opinion, the loan should be approved on the condition that the
company take immediate steps to get its accounts receivable and inventory
back under control. This would mean more rigorous checks of
creditworthiness before sales are made and perhaps paring out of slow paying
customers. It would also mean a sharp reduction of inventory levels to a more
manageable size. If these steps are taken, it appears that sufficient funds
could be generated to repay the loan in a reasonable period of time.
Requirement 1
a. This Year Last Year
Net income P324,000 P240,000
Less preference dividends 16,000 16,000
Net income remaining for ordinary (a)
P308,000 P224,000
Average number of ordinary shares (b) 50,000 50,000
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Cost Concepts and Classifications Chapter 8
A market price in excess of book value does not mean that the price of a
stock is too high. Market value is an indication of investors perceptions
of future earnings and/or dividends, whereas book value is a result of
already completed transactions and is geared to the past.
Requirement 2
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Chapter 8 Cost Concepts and Classifications
P 294,000
Total (a)...................................................................................................................
P 378,000
Average total assets (b)............................................................................................
P3,650,000 P3,000,000
Return on total assets (a) (b)................................................................................
10.4% 9.8%
Requirement 3
We would recommend keeping the stock. The stocks downside risk seems
small, since it is selling for only 7.3 times current earnings as compared to 9
times earnings for the average firm in the industry. In addition, its earnings
are strong and trending upward, and its return on ordinary equity (16.6%) is
extremely good. Its return on total assets (10.4%) compares favorably with
that of the industry.
The risk, of course, is whether the company can get its cash problem under
control. Conceivably, the cash problem could worsen, leading to an eventual
reduction in profits through inability to operate, a reduction in dividends, and
a precipitous drop in the market price of the companys stock. This does not
seem likely, however, since the company can easily control its cash problem
through more careful management of accounts receivable and inventory. If
this problem is brought under control, the price of the stock could rise sharply
over the next few years, making it an excellent investment.
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Cost Concepts and Classifications Chapter 8
Requirement 1
This Year Last Year
a. Net income..............................................................................................................
P 280,000 P 168,000
Add after-tax cost of interest:
P120,000 (1 0.30).........................................................................................
84,000
P100,000 (1 0.30).........................................................................................
70,000
P 364,000 P 238,000
Total (a)...................................................................................................................
b. Net income..............................................................................................................
P 280,000 P 168,000
Less preference dividends........................................................................................
48,000 48,000
P 232,000 P 120,000
Net income remaining for ordinary (a).....................................................................
c. Leverage is positive for this year, since the return on ordinary equity
(9.2%) is greater than the return on total assets (6.8%). For last year,
leverage is negative since the return on the ordinary equity (4.9%) is less
than the return on total assets (5.1%).
Requirement 2
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Chapter 8 Cost Concepts and Classifications
Notice from the data given in the problem that the average P/E ratio for
companies in Helixs industry is 10. Since Helix Company presently has
a P/E ratio of only 7.8, investors appear to regard it less well than they do
other companies in the industry. That is, investors are willing to pay only
7.8 times current earnings for a share of Helix Companys stock,
as compared to 10 times current earnings for a
share of stock for the average company in the
industry.
e. Equity P3,200,000 P3,040,000
Less preference shares 600,000 600,000
Ordinary equity (a) P2,600,000 P2,440,000
Note that the book value of Helix Companys stock is greater than the
market value for both years. This does not necessarily indicate that the
stock is selling at a bargain price. Market value is an indication of
investors perceptions of future earnings and/or dividends, whereas book
value is a result of already completed transactions and is geared to the
past.
Requirement 3
This Year Last Year
a. Current assets P2,600,000 P1,980,000
Current liabilities 1,300,000 920,000
Working capital P1,300,000 P1,060,000
Requirement 4
As stated by Meri Ramos, both net income and sales are up from last year.
The return on total assets has improved from 5.1% last year to 6.8% this year,
and the return on ordinary equity is up to 9.2% from 4.9% the year before.
But this appears to be the only bright spot in the companys operating picture.
Virtually all other ratios are below the industry average, and, more important,
they are trending downward. The deterioration in the gross margin
percentage, while not large, is worrisome. Sales and inventories have
increased substantially, which should ordinarily result in an improvement in
the gross margin percentage as fixed costs are spread over more units.
However, the gross margin percentage has declined.
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Chapter 8 Cost Concepts and Classifications
In the authors opinion, what the company needs is more equitynot more
debt. Therefore, the loan should not be approved. The company should be
encouraged to make another issue of ordinary stock in order to provide a
broader equity base on which to operate.
Bulacan Company
Income Statement
For the Year Ended December 31, 2005
Sales P140,800
Less: Cost of Sales (4) 84,480
Gross Profit P 56,320
Less: Expenses 46,320
Net Income (1) P 10,000
Bulacan Company
Balance Sheet
December 31, 2005
As s e t s
Current Assets:
Cash P 27,720
Accounts Receivable (5) 28,160
Merchandise Inventory (3) 21,120
Total Current Assets (2) P 77,000
Fixed Assets (8) 55,000
Total Assets P132,000
Current Liabilities:
Accounts Payable (2) P 44,000
Equity:
Share Capital (issued 20,000 shares) (6) P40,000
Retained Earnings 48,000 88,000
Total Liabilities and Equity P132,000
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Cost Concepts and Classifications Chapter 8
Supporting Computations:
Net Income
(1) Earnings Per Share =
Ordinary Shares Outstanding
X
P0.50 =
20,000
X (Net Income) = P10,000
= P44,000
Current Assets
(3) Current Ratio =
Current Liabilities
X
1.27 =
44,000
X (Current Assets) = P77,000
Quick Assets
Quick Ratio =
Current Liabilities
X
1.27 =
44,000
X (Current Assets) = P55,880
Cost of Sales
Ave. Inventory
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Chapter 8 Cost Concepts and Classifications
Quick Assets
(5) Average age of outstanding =
Accounts Receivable Current Liabilities
365
= 73 days (Average age of
5 receivables)
Net Sales
Average Receivables = 5
P140,800
X = 5
X (Receivables) = P28,160
Another Method:
P140,800
365 = 73 days = P28,160 Accounts receivable
0.375X = P33,000
X = P88,000 Equity
(8) Fixed Assets to Equity
Fixed Assets
= 0.625
Equity
X
P140,800 8-72
Cost Concepts and Classifications Chapter 8
= 0.625
Requirement 1
The loan officer stipulated that the current ratio prior to obtaining the loan
must be higher than 2.0, the acid-test ratio must be higher than 1.0, and the
interest on the loan must be no more than four times net operating income.
These ratios are computed below:
Current assets
Current ratio = Current liabilities
P290,000
Current rate = P164,000 = 1.8 (rounded)
P70,000 + P0 + P50,000
Acid-test ratio = P164,000 = 0.70 (rounded)
Net operating income P20,000
= P80,000 x 0.10 x (6/12) = 5.0
Interest on the loan
The company would fail to qualify for the loan because both its current ratio
and its acid-test ratio are too low.
Requirement 2
By reclassifying the P45 thousand net book value of the old machine as
inventory, the current ratio would improve, but there would be no effect on the
acid-test ratio. This happens because inventory is considered to be a current
asset but is not included in the numerator when computing the acid-test ratio.
Current assets
Current ratio = Current liabilities
P290,000 + P45,000
Current rate = P164,000 = 2.0 (rounded)
Even if this tactic had succeeded in qualifying the company for the loan, we
strongly advise against it. Inventories are assets the company has acquired for
the sole purpose of selling them to outsiders in the normal course of business.
Used production equipment is not considered to be inventoryeven if there is
a clear intention to sell it in the near future. Since the loan officer would not
expect used equipment to be included in inventories, doing so would be
intentionally misleading.
Nevertheless, the old equipment is an asset that could be turned into cash. If
this were done, the company would immediately qualify for the loan since the
P45 thousand in cash would be included in the numerator in both the current
ratio and in the acid-test ratio.
Current assets
Current ratio =
Current liabilities
P290,000 + P45,000
Current rate = = 2.0 (rounded)
P164,000
However, other options may be available. After all, the old machine is being
used to relieve bottlenecks in the plastic injection molding process and it
would be desirable to keep this standby capacity. We would advise Rome to
fully and honestly explain the situation to the loan officer. The loan officer
might insist that the machine be sold before any loan is approved, but he might
instead grant a waiver of the current ratio and acid-test ratio requirements on
the basis that they could be satisfied by selling the old machine. Or he may
approve the loan on the condition that the equipment is pledged as collateral.
In that case, Rome would only have to sell the machine if he would otherwise
be unable to pay back the loan.
Requirement (2)
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Chapter 8 Cost Concepts and Classifications
Requirement (1)
Requirement (3)
P1,080 + P0 + P9,000 + P0
Acid-test ratio = P19,400 = 0.52
Requirement (4)
Requirement (5)
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Chapter 8 Cost Concepts and Classifications
Requirement (7)
Requirement (1)
Requirement (2)
8-78
Cost Concepts and Classifications Chapter 8
CHAPTER 6
I. Questions
3. The most important source of cash for many successful companies is from
operating activities. A large positive operating cash flow is a good sign
because it means funds have been internally generated with no fixed
obligations or commitment to return such to anybody.
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Chapter 8 Cost Concepts and Classifications
6. The loss is added back to net income to avoid double counting since the
entire proceeds from the sale (net book value minus loss on sale) will
appear as a cash inflow from investing activities.
These activities are uses of cash when cash is decreased as a result of the
particular activity.
10. While net loss is usually associated with a decrease in cash, it may be a
source of cash if noncash expenses are greater than the amount of the net
loss. For example, if a net loss of P100,000 included amortization and
depreciation of P125,000 and no noncash revenues existed, cash provided
by operating activities would be P25,000, computed as follows:
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Cost Concepts and Classifications Chapter 8
11. The change in cash is the difference between cash at the beginning and end
of the accounting period. The net amount of cash provided by or used in
operating, investing and financing activities must equal this change in
cash. For example, if cash increased by P150,000 during the year, total
sources from operating, investing, and financing activities must exceed
total uses by P150,000. Also, if cash decreased by P25,000 during the
year, total uses of cash must exceed total sources by P25,000.
12. (a) The use of cash does not occur until the cash dividend is actually paid
in the next period. The declaration of the dividend does affect
financial position, however, and should be disclosed as a noncash
financing activity in a separate schedule accompanying the statement
of cash flows.
(b) Because the dividend was declared and paid in the same accounting
period, it appears in the statement of cash flows as a cash decrease in
the financing activities category.
14. The net income figure includes P150,000 as an expense. Only P112,500
of this amount resulted in a decrease in cash, because P37,500 represents
an increase in the deferred income tax liability account. In determining
cash provided by operating activities, the amount of income tax paid is
P112,500 (direct method). Alternatively, under the indirect method,
P37,500 must be added to net income to determine cash flows from
operating activities.
15. The loss is omitted when listing expenses requiring cash payment (direct
approach) or added back to net income (indirect approach) in determining
cash provided by operating activities. This eliminates the impact of the
transaction from cash provided by operating activities. Then, the
proceeds from the sale are included as a source of cash in the investing
activities category of the statement of cash flows. Any tax effects of the
transaction are included in the tax expense figure and remain a part of
cash flows from operating activities.
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Chapter 8 Cost Concepts and Classifications
16. (1) Operating activities: Transactions that affect current assets, current
liabilities, or net income.
(2) Investing activities: Transactions that involve the acquisition or
disposition of noncurrent assets.
(3) Financing activities: Transactions (other than the payment of interest)
involving borrowing from creditors, and any transactions (involving
the owners of a company.
18. Since the entire proceeds from a sale of an asset (including any gain)
appear as a cash inflow from investing activities, the gain must be
deducted from net income to avoid double counting.
19. The direct method reconstructs the income statement on a cash basis by
restating revenues and expenses in terms of cash inflows and outflows.
The indirect method starts with net income and adjusts it to a cash basis to
determine the cash provided by operating activities.
II. Exercises
Exercise 1
Net income......................................................................................................................
P84,000
Adjustments to convert net income to a cash basis:
Depreciation charges for the year..............................................................................
P50,000
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Cost Concepts and Classifications Chapter 8
Exercise 2
Sales.................................................................................................
P1,000,000
Adjustments to a cash basis:
60,000
Less increase in accounts receivable.......................................... P940,000
Cost of goods sold.............................................................................
580,000
Adjustments to a cash basis:
Plus increase in inventory..........................................................
+ 77,000
30,000
Less increase in accounts payable............................................. 627,000
Selling and administrative expenses..................................................
300,000
Adjustments to a cash basis:
Less decrease in prepaid expenses.............................................
2,000
Plus decrease in accrued liabilities............................................
+ 4,000
50,000
Less depreciation charges.......................................................... 252,000
Income taxes.....................................................................................
36,000
Adjustments to a cash basis:
6,000
Less increase in deferred income taxes...................................... 30,000
Net cash provided by operating activities..........................................P31,000
Note that the P31,000 agrees with the cash provided by operating activities
figure under the indirect method in the previous exercise.
Exercise 3
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Chapter 8 Cost Concepts and Classifications
Sale of equipment.............................................
P8,000 gain X
Sale of long-term investments...........................
P12,000 loss X
Exercise 4
Requirement (1)
Requirement (2)
Swan Company
Statement of Cash Flows
Operating activities:
Net cash provided by operating activities (see above)..........................................
P90
Investing activities:
Proceeds from sale of long-term investments........................................................
P45
Proceeds from sale of land...................................................................................
70
Additions to long-term investments......................................................................
(20)
Additions to plant & equipment...........................................................................
(150)
Net cash used for investing activities...................................................................
(55)
Financing activities:
Decrease in bonds payable...................................................................................
(20)
Increase in ordinary shares...................................................................................
40
Cash dividends.....................................................................................................
(35)
Net cash used by financing activities.................................................................... (15)
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Cost Concepts and Classifications Chapter 8
Source Cash
or Flow Adjust Adjuste
Change Use? Effect -ments d Effect Classification
Assets (except cash and cash equivalents)
Current assets:
Accounts receivable................................................ 10 Source +10 +10 Operating
Inventory................................................................. +30 Use 30 30 Operating
Prepaid expenses.................................................... 5 Source +5 +5 Operating
Noncurrent assets:
Long-term investments............................................ 30 Source +30 50 20 Investing
Plant and equipment............................................... +150 Use 150 150 Investing
Land........................................................................ 30 Source +30 30 0 Investing
Additional entries
Proceeds from sale of investments.............................. +45 +45 Investing
Loss on sale of investments......................................... +5 +5 Operating
Proceeds from sale of land........................................... +70 +70 Investing
Gain on sale of land..................................................... 40 40 Operating
Total +20 0 +20
Exercise 5
Sales...........................................................................................
P600
Adjustments to a cash basis:
8-85
Chapter 8 Cost Concepts and Classifications
Stephenie Company
Statement of Cash Flows
For the Year Ended December 31, 2008
Operating activities:
Net income..............................................................................................P56
Adjustments to convert net income to cash basis:
Depreciation charges.......................................................................
25
Increase in accounts receivable........................................................(80)
Decrease in inventory......................................................................
35
Increase in prepaid expenses............................................................ (2)
Increase in accounts payable........................................................... 75
Decrease in accrued liabilities..........................................................
(10)
Gain on sale of investments............................................................. (5)
Loss on sale of equipment................................................................ 2
Increase in deferred income taxes.................................................... 8 48
Net cash provided by operating activities................................................ 104
Investing activities:
Proceeds from sale of long-term investments...........................................
12
Proceeds from sale of equipment.............................................................
18
Additions to plant and equipment............................................................
(110)
Net cash used for investing activities....................................................... (80)
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Cost Concepts and Classifications Chapter 8
Financing activities:
Increase in bonds payable........................................................................
25
Decrease in ordinary shares.....................................................................
(40)
Cash dividends........................................................................................
(16)
Net cash used for financing activities...................................................... (31)
Additional entries
Proceeds from sale of equipment................................. +18 +18 Investing
Loss on sale of equipment............................................ +2 +2 Operating
Proceeds from sale of long-term investments............... +12 +12 Investing
Gain on sale of long-term investments......................... 5 5 Operating
Total 7 0 7
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Chapter 8 Cost Concepts and Classifications
II. Problems
Problem 1
8-88
Cost Concepts and Classifications Chapter 8
Requirement (a)
The eight items should be presented in the statement of cash flows as follows:
1. Net income is the basis for the calculation of cash flows from operating
activities by starting with that number and adjusting for noncash revenue
and expense transactions (indirect method) or by computing by the direct
method the positive cash flows from revenues, less the negative cash flows
from expenses. The cash flows from the transaction giving rise to the
extraordinary loss is reclassified as an investing activity.
2. The acquisition of intangibles is a negative cash flow from investing
activities. The amortization is a noncash expense in determining cash
flows from operating activities.
3. The payment of a cash dividend is a negative cash flow that is presented
in the financing activities section of the statement.
4. The purchase of treasury share is a negative cash flow in the financing
activities section of the statement.
5. The depreciation expense recognized during the year is a noncash expense
in determining cash flows from operating activities.
6. The conversion of convertible bonds into ordinary shares is a noncash
financing activity that requires disclosure in a separate schedule.
7. The changes in plant asset accounts land, equipment, and building
represent activities whose cash flow effects are presented in the investing
activities section of the statement.
8. The increase in working capital also represents the change in cash because
all other current assets and current liabilities remained constant. The net
of all cash flows from operating, investing and financing activities must
reconcile with the change in cash in the statement of cash flows.
Requirement (b)
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Chapter 8 Cost Concepts and Classifications
P130,000
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Cost Concepts and Classifications Chapter 8
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Chapter 8 Cost Concepts and Classifications
activities
Requirement (a)
Computations:
Cash received from customers:
Revenues P107,000
Deduct: Increase in accounts receivable
(P78,000 P45,000) 33,000
P 74,000
Cash paid for expenses:
Expenses P 92,000
Add: Decrease in accrued expenses
(P7,500 P7,000) 500
Deduct: Depreciation expense
(P33,600 P27,100 + P18,000) (24,500)
Amortization (1,000)
P 67,000
Cash from sale of equipment:
Cost P 27,500
Deduct: Accumulated depreciation (18,000)
Cash received on sale at book value P 9,500
Cash paid to acquire equipment:
*
Net increase during 2005 (P33,600 P27,100) P 6,500
Accumulated depreciation on assets sold 18,000
Depreciation expense for 2005 P24,500
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Chapter 8 Cost Concepts and Classifications
Requirement (b)
Requirement (a)
Range, 2002-2005
Cash Cash Used
Provided
Ebony P125,000 P115,000
Company P168,000 P170,000
Ivory P135,000 P125,000
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Cost Concepts and Classifications Chapter 8
Requirement (b)
The two companies are dissimilar in the makeup of the sources of cash, as
indicated in the following analysis:
Ebony Company has relied much more heavily on operations to provide cash
and to a very limited extent on debt and equity financing and asset disposition.
On the other hand, Ivory Company has not been able to provide cash from
operations and has been required to rely on the alternatives of debt and equity
financing and asset disposition.
Requirement (c)
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Chapter 8 Cost Concepts and Classifications
1. D 4. D 7. C 10. B
2. C 5. B 8. B 11. A
3. D 6. D 9. A 12. D
CHAPTER 7
I. Problems
Problem I
Increase in Sales:
Quantity Factor [(24,000) x P8] P(192,000)
Price Factor (105,000 x P3) 315,000
Quantity/Price Factor [(24,000) x P3] (72,000) P 51,000
Less: Increase (decrease) in Cost of Sales:
Quantity Factor [(24,000) x P9] P(216,000)
Cost Factor [105,000 x (P.50)] (52,500)
Quantity/Cost Factor [(24,000) x (P.50)] 12,000 (256,500)
Increase in Gross Profit P 307,500
Problem II
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Cost Concepts and Classifications Chapter 8
Favorable P 10,000
2. Cost Factor
Cost of Sales in 2006 P164,000
Less: Cost of Sales in 2006 at 2005 costs 176,000
Favorable P(12,000)
3. Quantity Factor
Increase in Sales
Sales in 2006 at 2005 prices P200,000
Less: Sales in 2005 150,000
Favorable P 50,000
Less: Increase in Cost of Sales
Cost of Sales in 2006 at 2005 costs
(P132,000 x 133-1/3%) P176,000
Less: Cost of Sales in 2005 132,000
Unfavorable P 44,000
Net favorable quantity factor 6,000*
Increase in Gross Profit P 28,000
Problem III
Requirement A:
Tony Corporation
Statement Accounting for Gross Profit Variation
For 2006
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Chapter 8 Cost Concepts and Classifications
Quantity Factor
Sales this year at last years
prices (P210,210 78%) P269,500
Less: Sales last year 192,500
Favorable (Unfavorable) P 77,000
Net Increase (decrease) in sales P 17,710
Increase (decrease) in Cost of Sales accounted for as follows:
Cost Factor
Cost of Sales this year P 165,400
Less: Cost of Sales this year at last
years costs 161,700
(Favorable) Unfavorable P 3,700
Quantity Factor
Cost of Sales this year at last years
costs (115,500 x 140%) P 161,700
Less: Cost of Sales last year 115,500
(Favorable) Unfavorable P 46,200
Requirement B:
Problem IV
Quantity Factor
1. Decrease in Sales due to decrease in the number
of customers [(1,000) x 18 MCF x P2.50)] P(45,000)
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Cost Concepts and Classifications Chapter 8
Price Factor
3. Decrease in Sales due to the decrease in rate per
MCF [P(.05) x 520,000] (26,000)
Increase in operating revenues P 59,000
Supporting Computations:
Average Consumption:
(a) 2006 = 520,000 26,000 = 20 MCF/customer
2005 = 486,000 27,000 = 18 MCF/customer
Increase in Consumption
per customer 2 MCF/customer
Problem V
XYZ Corporation
Gross Profit Variation Analysis
For 2006
Price Factor
Sales in 2006 P 1,750
Less: Sales in 2006 at 2005 prices
A (25 x P10) P 250
B (75 x P20) 1,500 1,750
Increase (decrease) in gross profit P -
Cost Factor:
Cost of sales in 2006 P 875
Less: Cost of sales in 2006 at 2005 costs:
A (25 X P5) P 125
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Chapter 8 Cost Concepts and Classifications
Quantity Factor:
Increase (decrease) in total quantity
Multiplied by: Average gross profit
per unit in 2005 (P750 100) P 7.50
P875 = P8.75
100 (volume in 2006)
Number of Shares
Adjustment
for 25%
stock As Weighted
Date Unadjusted dividend Adjusted Multiplier Shares
1/1/2006 16,000 4,000 20,000 12/12 20,000
2/15/2006 3,200 800 4,000 10.5/12 3,500
4/1/2006 (3,000) (750) (3,750) 9/12 (2,812)
6/1/2006 1,400 350 1,750 7/12 1,020
9/1/2006 6,400 1,600 8,000 4/12 2,667
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Cost Concepts and Classifications Chapter 8
= P0.90
Problem VIII
8-101
Chapter 8 Cost Concepts and Classifications
c
Increment due to stock options:
Issued 4,000
4,000 x ( P33 + P5 )
Reacquired P41 = (3,707)
e
Dilutive effect on diluted earnings per share:
10% bonds: P3.02 impact < P3.63 (DEPS 1), therefore dilutive
7.5% preference: P3.06 impact < P3.56 (DEPS2), therefore dilutive
5.8% bonds: P3.50 impact > P3.46 (DEPS3), therefore exclude from EPS
Requirement 3
Fuego Company would report basic earnings per share of P3.66 and diluted
earnings per share of P3.46 on its 2005 income statement.
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Cost Concepts and Classifications Chapter 8
CHAPTER 8
I. Questions
1. The phrase different costs for different purposes refers to the fact that
the word cost can have different meanings depending on the context in
which it is used. Cost data that are classified and recorded in a particular
way for one purpose may be inappropriate for another use.
5. a. Uncontrollable cost
b. Controllable cost
c. Uncontrollable cost
6. Product costs are costs that are associated with manufactured goods until
the time period during which the products are sold, when the product costs
become expenses. Period costs are expensed during the time period in
which they are incurred.
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Chapter 8 Cost Concepts and Classifications
8. Product costs are also called inventoriable costs because they are assigned
to manufactured goods that are inventoried until a later period, when the
products are sold. The product costs remain in the finished goods
inventory account until the time period when the goods are sold.
9. A sunk cost is a cost that was incurred in the past and cannot be altered by
any current or future decision. A differential cost is the difference in a
cost item under two decision alternatives.
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Cost Concepts and Classifications Chapter 8
2. work in process inventory accounts for all costs put into the
manufacturing of products that are started but not complete at the
financial statement date.
3. finished goods inventory the cost of goods that are ready for sale.
14. Direct materials include the materials in the product and a reasonable
allowance for scrap and defective units, while indirect materials are
materials used in manufacturing that are not physically part of the finished
product.
16. Yes, costs such as salaries and depreciation can end up as part of assets
on the balance sheet if these are manufacturing costs. Manufacturing costs
are inventoried until the associated finished goods are sold. Thus, if some
units are still in inventory, such costs may be part of either Work in
Process inventory or Finished Goods inventory at the end of a period.
17. No. A variable cost is a cost that varies, in total, in direct proportion to
changes in the level of activity. A variable cost is constant per unit of
product. A fixed cost is fixed in total, but the average cost per unit
changes with the level of activity.
19.
Direct labor cost (34 hours P15 per hour).......................... P510
Manufacturing overhead cost (6 hours P15 per hour)......... 90
Total wages earned................................................................. P600
20.
Direct labor cost (45 hours P14 per hour)......................... P630
Manufacturing overhead cost (5 hours P7 per hour)......... 35
Total wages earned............................... P665
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Chapter 8 Cost Concepts and Classifications
II. Exercises
Requirement 1
Direct material:
Raw-material inventory, January 1................... P
60,000
Add: Purchases of raw material....................... 250,000
Raw material available for use......................... P310,00
0
Deduct: Raw-material inventory, 70,00
December 31 0
Utilities 25,000
.............................................................
.............................................................
Other 30,00
............................................................. 0
.............................................................
Total manufacturing overhead 190,000
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Cost Concepts and Classifications Chapter 8
0
Deduct: Work-in-process inventory, December 115,000
1.......................................................................
Cost of goods manufactured................................... P835,00
0
Requirement 2
Requirement 3
Exercise 2
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Chapter 8 Cost Concepts and Classifications
1. a, d, g, i
2. a, d, g, j
3. b, f
4. b, d, g, k
5. a, d, g, k
6. a, d, g, j
7. b, c, f
8. b, d, g, k
9. b, c and d*, e and f and g*, k*
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Cost Concepts and Classifications Chapter 8
1. marginal cost
2. sunk cost
3. average cost
4. opportunity cost
5. differential cost
6. out-of-pocket cost
1. a, c, e, k
2. b, d, e, k
3. d, e, i
4. d, e, i
5. a, d, e, k
6. a, d, e, k
7. d, e, k
8. b, d, e, k
Unless the dishwasher has been used improperly.
9. h
10. a, d, e*, j
* The hotel general manager may have some control over the total space
allocated to the kitchen.
11. i
12. j
13. a, c, e
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Chapter 8 Cost Concepts and Classifications
14. e, k
Exercise 6
Exercise 7
Exercise 8
1. The wages of employees who build the sailboats: direct labor cost.
2. The cost of advertising in the local newspapers: marketing and selling
cost.
3. The cost of an aluminum mast installed in a sailboat: direct materials cost.
4. The wages of the assembly shops supervisor: manufacturing overhead
cost.
5. Rent on the boathouse: a combination of manufacturing overhead,
administrative, and marketing and selling cost. The rent would most likely
be prorated on the basis of the amount of space occupied by
manufacturing, administrative, and marketing operations.
6. The wages of the companys bookkeeper: administrative cost.
7. Sales commissions paid to the companys salespeople: marketing and
selling cost.
8. Depreciation on power tools: manufacturing overhead cost.
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Cost Concepts and Classifications Chapter 8
Exercise 7
Depreciatio
n of
machines
X X X*
used to
produce
tables
(P20,000
per year)
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Chapter 8 Cost Concepts and Classifications
6. Salary of
the
company
X X
president
(P200,000
per year)
7. Advertising
expense
X X
(P500,000
per year)
8.
Commissio
ns paid to X X
salesperso
ns (P60 per
table sold)
9. Rental
income
forgone on X1
factory
space
*
This is a sunk cost because the outlay for the equipment was made in a previous period.
1
This is an opportunity cost because it represents the potential benefit that is lost or sacrificed as a result of using the factory space to produce tables. Opportunity cost
is a special category of cost that is not ordinarily recorded in an organizations accounting books. To avoid possible confusion with other costs, we will not attempt to
classify this cost in any other way except as an opportunity cost.
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Chapter 8 Cost Concepts and Classifications
Exercise 9
Direc Indirec
t t
Cost Cost Object Cost Cost
1. The salary of the head chef The hotels restaurant X
2. The salary of the head chef A particular restaurant X
customer
3. Room cleaning supplies A particular hotel guest X
4. Flowers for the reception desk A particular hotel guest X
5. The wages of the doorman A particular hotel guest X
6. Room cleaning supplies The housecleaning X
department
7. Fire insurance on the hotel The hotels gym X
building
8. Towels used in the gym The hotels gym X
Note: The room cleaning supplies would most likely be considered an indirect
cost of a particular hotel guest because it would not be practical to keep track
of exactly how much of each cleaning supply was used in the guests room.
III. Problems
Problem 1
The relevant costs for this decision are the differential costs. These are:
Room and board, clothing, car, and incidentals are not relevant because these
are presumed to be the same whether or not Francis goes to school. The
possibility of part-time work, summer jobs, or scholarship assistance could be
considered as reductions to the cost of school. If students are familiar with the
time value of money, then they should recognize that the analysis calls for a
comparison of the present value of the differential after-tax cash inflows with
the present value of differential costs of getting the education (including the
opportunity costs of lost income).
Problem 2
Requirement (a)
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Chapter 8 Cost Concepts and Classifications
Only the differential outlay costs need be considered. The travel and other
variable expenses of P22 per hour would be the relevant costs. Any amount
received in excess would be a differential, positive return to Pat.
Requirement (b)
Requirement (c)
In this situation Pat would have to consider the present value of the contract
and compare that to the present value of the existing consulting business. The
final rate may be more or less than the normal P100 rate depending on the
outcome of Pats analysis.
Problem 3
Problem 4
Problem 5
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Cost Concepts and Classifications Chapter 8
Requirement (a)
Sunk costs not shown could include lost book value on traded assets,
depreciation estimates for new investment, and interest costs on capital needed
during facilities construction.
Requirement (b)
The client might be used to differential cost as a decision tool, and believes
(correctly) that use of differential analyses has several advantages --- it is
quicker, requires less data, and tends to give a better focus to the decision. The
banker might suspect the client of hiding some material data in order to make
the proposal more acceptable to the financing agency.
Problem 6
Requirement (1)
EH Corporation
Schedule of Cost of Goods Manufactured
For the Year Ended December 31
Direct materials:
Raw materials, inventory, January 1 P
45,000
Add: Purchases of raw materials 375,0
00
Raw materials available for use 420,00
0
Deduct: Raw materials inventory, 30,0
December 31 00
Raw materials used in production P
390,000
Direct labor 75,000
Manufacturing overhead:
Utilities, factory 18,000
Depreciation, factory 81,000
Insurance, factory 20,000
Supplies, factory 7,500
Indirect labor 150,00
0
Maintenance, factory 43,5
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Chapter 8 Cost Concepts and Classifications
00
Total manufacturing overhead cost 320,0
00
Total manufacturing cost 785,000
Add: Work in process inventory, January 1 90,00
0
875,000
Deduct: Work in process inventory, 50,00
December 31 0
Cost of goods manufactured P825,00
0
Requirement (2)
Requirement (3)
EH Corporation
Income Statement
For the Year Ended December 31
Sales P1,250,00
0
Cost of goods sold (above) 850,00
0
Gross margin 400,000
Selling and administrative expenses:
Selling expenses P
70,000
Administrative expenses 135,0 205,00
00 0
Net operating income P
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Cost Concepts and Classifications Chapter 8
195,000
8-117
Chapter 8 Cost Concepts and Classifications
Problem 7
Adminis- Manufacturing
Variable or Selling trative (Product) Cost
Cost Item Fixed Cost Cost Direct Indirect
1. Depreciation, executive jet............................................................................ F X
2. Costs of shipping finished goods to customers.............................................. V X
3. Wood used in manufacturing furniture.......................................................... V X
4. Sales managers salary.................................................................................. F X
5. Electricity used in manufacturing furniture................................................... V X
6. Secretary to the company president............................................................... F X
7. Aerosol attachment placed on a spray can produced by the company............ V X
8. Billing costs.................................................................................................. V X*
9. Packing supplies for shipping products overseas........................................... V X
10. Sand used in manufacturing concrete............................................................ V X
11. Supervisors salary, factory........................................................................... F X
12. Executive life insurance................................................................................ F X
13. Sales commissions........................................................................................ V X
14. Fringe benefits, assembly line workers.......................................................... V X**
15. Advertising costs........................................................................................... F X
16. Property taxes on finished goods warehouses................................................ F X
17. Lubricants for production equipment............................................................ V X
*Could be an administrative cost.
**Could be an indirect cost.
Cost Concepts and Classifications Chapter 8
Problem 8
Requirement (1)
Period
(Selling
Product Cost and
Variable Fixed Direct Direct Mfg. Admin.) Opportunity Sunk
Name of the Cost Cost Cost Materials Labor Overhead Cost Cost Cost
Lings present salary of P400,000 per
month........................................................................... X
Rent on the garage, P15,000 per month........................... X X
Rent of production equipment, P50,000 per
month........................................................................... X X
Materials for producing flyswatters, at
P30.00 each.................................................................
X X
Labor cost of producing flyswatters, at
P50.00 each.................................................................
X X
Rent of room for a sales office, P7,500 per
month........................................................................... X X
Answering device attachment, P2,000 per
month........................................................................... X X
Interest lost on savings account, P100,000
per year........................................................................ X
Advertising cost, P40,000 per month............................... X X
Sales commission, at P10.00 per flyswatter..................... X X
Legal and filing fees, P60,000......................................... X
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MANAGEMENT ACCOUNTING - Solutions Manual
Requirement (2)
The P60,000 legal and filing fees are not a differential cost. These legal and
filing fees have already been paid and are a sunk cost. Thus, the cost will not
differ depending on whether Ling decides to produce flyswatters or to stay
with the consulting firm. All other costs listed above are differential costs
since they will be incurred only if Ling leaves the consulting firm and
produces the flyswatters.
Problem 9
Requirement (1)
Ms. Rios first action was to direct that discretionary expenditures be delayed
until the first of the new year. Providing that these discretionary
expenditures can be delayed without hampering operations, this is a good
business decision. By delaying expenditures, the company can keep its cash a
bit longer and thereby earn a bit more interest. There is nothing unethical
about such an action. The second action was to ask that the order for the parts
be cancelled. Since the clerks order was a mistake, there is nothing unethical
about this action either.
The third action was to ask the accounting department to delay recognition of
the delivery until the bill is paid in January. This action is dubious. Asking the
accounting department to ignore transactions strikes at the heart of the
integrity of the accounting system. If the accounting system cannot be trusted,
it is very difficult to run a business or obtain funds from outsiders. However,
in Ms. Rios defense, the purchase of the raw materials really shouldnt be
recorded as an expense. He has been placed in an extremely awkward position
because the companys accounting policy is flawed.
Requirement (2)
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Cost-Volume-Profit Relationships Chapter 13
CHAPTER 9
I. Questions
4. Although the accountant recognizes that many costs are not linear in
relationship to volume at some points, he concentrates on their behavior
within narrow bands of activity known as the relevant range. The relevant
range can be defined as that range of activity within which assumptions as
relative to variable and fixed cost behavior are valid. Generally, within
this range an assumption of strict linearity can be used with insignificant
loss of accuracy.
5. The high-low method, the scattergraph method, and the least-squares
regression method are used to analyze mixed costs. The least-squares
regression method is generally considered to be most accurate, since it
derives the fixed and variable elements of a mixed cost by means of
statistical analysis. The scattergraph method derives these elements by
visual inspection only, and the high-low method utilizes only two points in
doing a cost analysis, making it the least accurate of the three methods.
6. The fixed cost element is represented by the point where the regression
line intersects the vertical axis on the graph. The variable cost per unit is
represented by the slope of the line.
8. No. High correlation merely implies that the two variables move together
in the data examined. Without economic plausibility for a relationship, it
is less likely that a high level of correlation observed in one set of data will
be found similarly in another set of data.
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Cost-Volume-Profit Relationships Chapter 13
10. The relevant range is the range of the cost driver in which a specific
relationship between cost and cost driver is valid. This concept enables
the use of linear cost functions when examining CVP relationships as long
as the volume levels are within that relevant range.
11. A unit cost is computed by dividing some amount of total costs (the
numerator) by the related number of units (the denominator). In many
cases, the numerator will include a fixed cost that will not change despite
changes in the denominator. It is erroneous in those cases to multiply the
unit cost by activity or volume change to predict changes in total costs at
different activity or volume levels.
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Chapter 13 Cost-Volume-Profit Relationships
15. The dependent variable is the cost object of interest in the cost estimation.
An important issue in selecting a dependent variable is the level of
aggregation in the variable. For example, the company, plant, or
department may all be possible levels of data for the cost object. The
choice of aggregation level depends on the objectives for the cost
estimation, data availability, reliability, and cost/benefit considerations. If
a key objective is accuracy, then a detailed level of analysis is often
preferred. The detail cost estimates can then be aggregated if desired.
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Cost-Volume-Profit Relationships Chapter 13
16. Nonlinear cost relationships are cost relationships that are not adequately
explained by a single linear relationship for the cost driver(s). In
accounting data, a common type of nonlinear relationship is trend and
seasonality. For a trend example, if sales increase by 8% each year, the
plot of the data for sales with not be linear with the driver, the number of
years. Similarly, sales which fluctuate according to a seasonal pattern
will have a nonlinear behavior. A different type of nonlinearity is where
the cost driver and the dependent variable have an inherently nonlinear
relationship. For example, payroll costs as a dependent variable estimated
by hours worked and wage rates is nonlinear, since the relationship is
multiplicative and therefore not the additive linear model assumed in
regression analysis.
18. High correlation exists when the changes in two variables occur together.
It is a measure of the degree of association between the two variables.
Because correlation is determined from a sample of values, there is no
assurance that it measures or describes a cause and effect relationship
between the variables.
20. (a) Variable cost: A variable cost remains constant on a per unit basis, but
increases or decreases in total in direct relation to changes in activity.
(b) Mixed cost: A mixed cost is a cost that contains both variable and
fixed cost elements.
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Chapter 13 Cost-Volume-Profit Relationships
Mixed Cost
Variable Cost
Cost
Step-Variable Cost
Activity
21. The linear assumption is reasonably valid providing that the cost formula
is used only within the relevant range.
24. The high-low method uses only two points to determine a cost formula.
These two points are likely to be less than typical since they represent
extremes of activity.
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Cost-Volume-Profit Relationships Chapter 13
25. The term least-squares regression means that the sum of the squares of
the deviations from the plotted points on a graph to the regression line is
smaller than could be obtained from any other line that could be fitted to
the data.
II. Exercises
1. b
2. f
3. e
4. i
5. e
6. h
7. l
8. a
9. j
10. k
11. c or d
12. g
Requirement (1)
Variable costs:
P4,700 P2,800
4,050 2,375 = P1.134
Fixed costs:
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Variable costs:
P4,700 P2,800
19 11 = P237.50
Fixed costs:
Variable costs:
P4,700 P2,875
19 10 = P202.78
Fixed costs:
Predicted total cost for a 3,200 square foot house with 14 openings using
equation one:
Predicted total cost for a 3,200 square foot house with 14 openings using
equation two:
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Predicted total cost for a 3,200 square foot house with 14 openings using
equation three:
Predicted cost for a 2,400 square foot house with 8 openings, using equation
one:
Requirement 2
Figure 9-A shows that the relationship between costs and square feet is
relatively linear without outliers, while Figure 9-B shows a similar result for
the relationship between costs and number of openings. From this perspective,
both variables are good cost drivers.
Figure 9-A
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Figure 9-B
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Requirement 1
Fixed Costs:
Rent P10,250
Depreciation 400
Insurance 750
Advertising 650
Utilities 1,250
Mr. Blacks salary 18,500
Total P31,800
Variable Costs:
Wages P17,800
CD Expense 66,750
Shopping Bags 180
Total P84,730
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Requirement 2
Requirement 3
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Requirement 2
There seems to be a positive linear relationship for the data between P2,500
and P4,000 of advertising expense. Llanes analysis is correct within this
relevant range but not outside of it. Notice that the relationship between
advertising expense and sales changes at P4,000 of expense.
Requirement (1)
Cups of Coffee Served
in a Week
1,800 1,900 2,000
Fixed cost P11,000 P11,000 P11,000
Variable cost 4,680 4,940 5,200
Total cost P15,680 P15,940 P16,200
Cost per cup of coffee served * P8.71 P8.39 P8.10
* Total cost cups of coffee served in a week
Requirement (2)
The average cost of a cup of coffee declines as the number of cups of coffee
served increases because the fixed cost is spread over more cups of coffee.
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Requirement (1)
16,000
14,000
12,000
10,000
Total Cost
8,000
6,000
4,000
2,000
0
0 2,000 4,000 6,000 8,000 10,000
Units Processed
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Requirement (2)
(Students answers will vary considerably due to the inherent imprecision and
subjectivity of the quick-and-dirty scattergraph method of estimating variable
and fixed costs.)
The approximate monthly fixed cost is P6,000the point where the straight
line intersects the cost axis.
The variable cost per unit processed can be estimated as follows using the
8,000-unit level of activity, which falls on the straight line:
Total cost at the 8,000-unit level of activity............................................. P14,000
Less fixed costs........................................................................................6,000
Variable costs at the 8,000-unit level of activity....................................... P8,000
P8,000 8,000 units = P1 per unit.
Observe from the scattergraph that if the company used the high-low method
to determine the slope of the line, the line would be too steep. This would
result in underestimating the fixed cost and overestimating the variable cost
per unit.
Requirement (2)
Electrical costs may reflect seasonal factors other than just the variation in
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occupancy days. For example, common areas such as the reception area must
be lighted for longer periods during the winter. This will result in seasonal
effects on the fixed electrical costs.
Additionally, fixed costs will be affected by how many days are in a month. In
other words, costs like the costs of lighting common areas are variable with
respect to the number of days in the month, but are fixed with respect to how
many rooms are occupied during the month.
Other, less systematic, factors may also affect electrical costs such as the
frugality of individual guests. Some guests will turn off lights when they leave
a room. Others will not.
Intercept P2,29
6
Slope P3.74
RSQ 0.92
The intercept provides the estimate of the fixed cost element, P2,296 per
month, and the slope provides the estimate of the variable cost element, P3.74
per rental return. Expressed as an equation, the relation between car wash
costs and rental returns is
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Y = P2,296 + P3.74X
where X is the number of rental returns.
Note that the R2 is 0.92, which is quite high, and indicates a strong linear
relationship between car wash costs and rental returns.
While not a requirement of the exercise, it is always a good to plot the data on
a scattergraph. The scattergraph can help spot nonlinearities or other problems
with the data. In this case, the regression line (shown below) is a reasonably
good approximation to the relationship between car wash costs and rental
returns.
III. Problems
Problem 1
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Driven Cost*
High level of activity.......................... 120,000 P13,920
Low level of activity........................... 80,000 10,880
Difference...................................... 40,000 P 3,040
Problem 2
Requirement 1
Requirement 2
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P36,000
Salaries and comm. expense: 1,500 units = P24 per unit.
Requirement 3
LILY COMPANY
Income Statement
For the Month Ended June 30
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Problem 3
Requirement 1
a = (Y) - b(X)
n
(54,500) - 1,700 (20)
=
5
= P4,100
Therefore, the variable cost per league is P1,700 and the fixed cost is
P4,100 per year.
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Requirement 2
Y = P4,100 + P1,700X
Requirement 3
The problem with using the cost formula from (2) to derive this total cost
figure is that an activity level of 7 sections lies outside the relevant range from
which the cost formula was derived. [The relevant range is represented by a
solid line on the graph in requirement 4 below.]
Although an activity figure may lie outside the relevant range, managers will
often use the cost formula anyway to compute expected total cost as we have
done above. The reason is that the cost formula frequently is the only basis
that the manager has to go on. Using the cost formula as the starting point
should not present a problem so long as the manager is alert for any unusual
problems that the higher activity level might bring about.
Requirement 4
P16,000 Y
P14,000
P12,000
P10,000
P8,000
P6,000
P4,000
P2,000
X
P-
0 1 2 3 4 5 6 7 8
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Requirement 1
Figure 9-C plots the relationship between labor-hours and overhead costs and
shows the regression line.
y = P48,271 + P3.93 X
Goodness of fit. The vertical differences between actual and predicted costs
are extremely small, indicating a very good fit. The good fit indicates a strong
relationship between the labor-hour cost driver and overhead costs.
Slope of regression line. The regression line has a reasonably steep slope
from left to right. The positive slope indicates that, on average, overhead
costs increase as labor-hours increase.
Requirement 2
The regression analysis indicates that, within the relevant range of 2,500 to
7,500 labor-hours, the variable cost per person for a cocktail party equals:
Food and beverages P15.00
Labor (0.5 hrs. x P10 per hour) 5.00
Variable overhead (0.5 hrs. x P3.93 per labor-hour) 1.97
Total variable cost per person P21.97
Requirement 3
Of course, Bobby Gonzales will consider other factors in developing his bid
including (a) an analysis of the competition vigorous competition will limit
Gonzales ability to obtain a higher price (b) a determination of whether or not
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his bid will set a precedent for lower prices overall, the prices Bobby
Gonzales charges should generate enough contribution to cover fixed costs and
earn a reasonable profit, and (c) a judgment of how representative past
historical data (used in the regression analysis) is about future costs.
Figure 9-C
Regression Line of Labor-Hours on Overhead Costs for Bobby Gonzales
Catering Company
Requirement 1
Difference in cost
Slope coefficient (b) =
Difference in labor-hours
= P529,000 P400,000 = P43.00
7,000 4,000
Constant (a) = P529,000 P43.00 (7,000)
= P228,000
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No, the constant component of the cost function does not represent the fixed
overhead cost of the ABS Group. The relevant range of professional labor-
hours is from 3,000 to 8,000. The constant component provides the best
available starting point for a straight line that approximates how a cost
behaves within the 3,000 to 8,000 relevant range.
Requirement 2
The data are shown in Figure 9-D. The linear cost function overstates costs
by P8,000 at the 5,000-hour level and understates costs by P15,000 at the
8,000-hour level.
Requirement 3
Based on
Linear
Based on Cost
Actual Function
Contribution before deducting
incremental overhead P38,00 P38,00
0 0
Incremental overhead 35,000 43,000
Contribution after incremental P P
overhead 3,000 (5,000)
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Figure 9-D
Linear Cost Function Plot of Professional Labor-Hours
on Total Overhead Costs for ABS Consulting Group
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Total costs:
Variable
costs
(@ P4 P
per hour) 20,000 P24,000 P28,000 P32,000
Fixed
costs 168,000 168,000 168,000 168,000
Total costs P188,000 P192,000 P196,000 P200,000
Variable
cost P4.00 P4.00 P4.00 P4.00
Fixed
cost 33.60 28.00 24.00 21.00
Total cost
per hour P37.60 P32.00 P28.00 P25.00
Observe that the total variable costs increase in proportion to the number of
hours of operating time, but that these costs remain constant at P4 if
expressed on a per hour basis.
In contrast, the total fixed costs do not change with changes in the level of
activity. They remain constant at P168,000 within the relevant range. With
increases in activity, however, the fixed cost per hour decreases, dropping
from P33.60 per hour when the boats are operated 5,000 hours a period to
only P21.00 per hour when the boats are operated 8,000 hours a period.
Because of this troublesome aspect of fixed costs, they are most easily (and
most safely) dealt with on a total basis, rather than on a unit basis, in cost
analysis work.
Requirement (1)
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The first step in the high-low method is to identify the periods of the lowest
and highest activity. Those periods are November (1,100 patients admitted)
and June (1,900 patients admitted).
The second step is to compute the variable cost per unit using those two data
points:
Number Admitting
Month of Department
Patients Costs
Admitted
High activity level 1,900 P15,20
(June) 0
Low activity level 1,100 12,800
(November)
Change 800 P
2,400
Change in cost
Variable cost =
Change in activity
= P240,000
800 patients admitted
= P3 per patient admitted
The third step is to compute the fixed cost element by deducting the variable
cost element from the total cost at either the high or low activity. In the
computation below, the high point of activity is used:
Fixed cost element = Total cost Variable cost element
= P15,200 (P3 per patient admitted
x 1,900 patients admitted)
= P9,500
Requirement (2)
The cost formula is Y = P9,500 + P3X.
Problem 8 (Scattergraph Analysis; Selection of an Activity Base)
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Requirement (1)
The completed scattergraph for the number of units produced as the activity
base is presented below:
5,000
4,500
4,000
3,500
Janitorial Labor Cost
3,000
2,500
2,000
1,500
1,000
500
0
0 20 40 60 80 100 120 140
Units Produced
Requirement (2)
The completed scattergraph for the number of workdays as the activity base is
presented below:
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Requirement (3)
5,000
4,500
4,000
3,500
Janitorial Labor Cost
3,000
2,500
2,000
1,500
1,000
500
0
0 2 4 6 8 10 12 14 16 18 20 22 24
Number of Janitorial Workdays
The number of workdays should be used as the activity base rather than the
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number of units produced. There are several reasons for this. First, the
scattergraphs reveal that there is a much stronger relationship (i.e., higher
correlation) between janitorial costs and number of workdays than between
janitorial costs and number of units produced. Second, from the description of
the janitorial costs, one would expect that variations in those costs have little
to do with the number of units produced. Two janitors each work an eight-
hour shiftapparently irrespective of the number of units produced or how
busy the company is. Variations in the janitorial labor costs apparently occur
because of the number of workdays in the month and the number of days the
janitors call in sick. Third, for planning purposes, the company is likely to be
able to predict the number of working days in the month with much greater
accuracy than the number of units that will be produced.
Note that the scattergraph in part (1) seems to suggest that the janitorial labor
costs are variable with respect to the number of units produced. This is false.
Janitorial labor costs do vary, but the number of units produced isnt the cause
of the variation. However, since the number of units produced tends to go up
and down with the number of workdays and since the janitorial labor costs are
driven by the number of workdays, it appears on the scattergraph that the
number of units drives the janitorial labor costs to some extent. Analysts must
be careful not to fall into this trap of using the wrong measure of activity as
the activity base just because it appears there is some relationship between
cost and the measure of activity. Careful thought and analysis should go into
the selection of the activity base.
* Supporting Computations:
11. (10,000 x 2) (P3,000 x 2) P5,000 = P9,000
12. [(P20 + P3 + P6) x 2,000 units] + (P10 x 1,000 units) = P68,000
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CHAPTER 10
I. Questions
1. Job-order costing is used in those manufacturing situations where there
are many different products produced each period. Each product or job is
different from all others and requires separate costing. Process costing is
used in those manufacturing situations where a single, homogeneous
product, such as cement, bricks, or gasoline, is produced for long periods
at a time.
2. The job cost sheet is used in accumulating all costs assignable to a
particular job. These costs would include direct materials cost traceable
to the job, and manufacturing overhead cost allocable to the job. When a
job is completed, the job cost sheet is used to compute the cost per
completed unit. The job cost sheet is then used as a control document for:
(1) determining how many units have been sold and determining the cost
of these units; and (2) determining how many units are still in inventory at
the end of a period and determining the cost of these units on the balance
sheet.
3. Many production costs cannot be traced directly to a particular product or
job, but rather are incurred as a result of overall production activities.
Therefore, in order to be assigned to products, such costs must be
allocated to the products in some manner. Examples of such costs would
include utilities, maintenance on machines, and depreciation of the factory
building. These costs are indirect production costs.
4. A firm will not know its actual manufacturing overhead costs until after a
period is over. Thus, if actual costs were used to cost products, it would
be necessary either (1) to wait until the period was over to add overhead
costs to jobs, or (2) to simply add overhead cost to jobs as the overhead
cost was incurred day by day. If the manager waits until after the period
is over to add overhead cost to jobs, then cost data will not be available
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during the period. If the manager simply adds overhead cost to jobs as
the overhead cost is incurred, then unit costs may fluctuate from month to
month. This is because overhead cost tends to be incurred somewhat
evenly from month to month (due to the presence of fixed costs), whereas
production activity often fluctuates. For these reasons, most firms use
predetermined overhead rates, based on estimates of overhead cost and
production activity, to apply overhead cost to jobs.
5. An allocation base should act as a cost driver in the incurrence of the
overhead cost; that is, the base should cause the overhead cost. If the
allocation base does not really cause the overhead, then costs will be
incorrectly attributed to products and jobs and their costs will be distorted.
6. A process costing system is appropriate in those situations where a
homogeneous product is produced on a continuous basis.
7. In a process costing system, costs are accumulated by department.
8. First, the activity performed in a department must be performed uniformly
on all units moving through it. Second, the output of the department must
be homogeneous.
9. The reason cost accumulation is simpler is that costs only need to be
identified by department - not by separate job. Usually there will be only
a few departments in a company, whereas there can be hundreds or even
thousands of jobs in a job-order costing system.
10. A quantity schedule shows the physical flow of units through a department
during a period. It serves several purposes. First, it provides the manager
with information relative to activity in his or her department and also
shows the manager the stage of completion of any in-process units.
Second, it serves as an essential guide in computing the equivalent units
and in preparing the other parts of the production report.
11. By definition, manufacturing overhead consists of costs that cannot be
practically traced to products or jobs. Therefore, if these costs are to be
assigned to products or jobs, they must be allocated rather than traced.
12. Assigning manufacturing overhead costs to jobs does not ensure a profit.
The units produced may not be sold and if they are sold, they may not be
sold at prices sufficient to cover all costs. It is a myth that assigning costs
to products or jobs ensures that those costs will be recovered. Costs are
recovered only by selling to customersnot by allocating costs.
13. (a) Job-order costing and process costing have the same basic purposes
to assign materials, labor, and overhead cost to products and to
provide a mechanism for computing unit product costs.
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II. Exercises
Requirement 1
Company X:
Predetermined Estimated total manufacturing overhead cost
= Estimated total amount of the allocation base
overhead rate
P432,000
= 60,000 DLHs = P7.20 per DLH
Company Y:
Company Z:
Requirement 1
Milling Department:
Assembly Department:
Requirement 2
Overhead Applied
Milling Department: 90 MHs P8.50 per MH P765
Assembly Department: P160 125% 200
Total overhead cost applied P965
Requirement 3
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Yes; if some jobs required a large amount of machine time and little labor cost,
they would be charged substantially less overhead cost if a plantwide rate
based on direct labor cost were being used. It appears, for example, that this
would be true of job 123 which required considerable machine time to
complete, but required only a small amount of labor cost.
Work in ProcessMixing.......................................................................................
330,000
Raw Materials Inventory.................................................................................
330,000
Work in ProcessMixing.......................................................................................
260,000
Work in ProcessBaking........................................................................................
120,000
Wages Payable.................................................................................................
380,000
Work in ProcessMixing.......................................................................................
190,000
Work in ProcessBaking........................................................................................
90,000
Manufacturing Overhead.................................................................................
280,000
Work in ProcessBaking........................................................................................
760,000
Work in ProcessMixing................................................................................
760,000
Finished Goods........................................................................................................
980,000
Work in ProcessBaking................................................................................
980,000
Requirement 1
Weighted-Average Method
Quantity
Schedule
Gallons to be accounted for:
Work in process, May 1 (materials 80%
complete, labor and overhead 75%
complete) 80,000
Started into production 760,000
Total gallons accounted for 840,000
Equivalent Units
Materials Labor Overhead
Gallons accounted for as follows:
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Requirement 2
Total Costs Materials Labor Overhead Whole Unit
Cost to be accounted for:
Work in process, May 1...............................................
P 146,600 P 68,600 P30,000 P 48,000
Cost added during the month.......................................
1,869,200 907,200 370,000 592,000
Total cost to be accounted for (a)......................................
P2,015,800 P975,800 P400,000 P640,000
Equivalent units (b)...........................................................
820,000 800,000 800,000
Cost per equivalent unit (a) (b)...................................... P1.19 + P0.50 + P0.80 = P2.49
Requirement 1
FIFO Method
Quantity
Schedule
Gallons to be accounted for:
Work in process, May 1 (materials 80%
complete, labor and overhead 75%
complete) 80,000
Started into production 760,000
Total gallons accounted for 840,000
Equivalent Units
Materials Labor Overhead
Gallons accounted for as follows:
Transferred to the next department:
From the beginning inventory................. 80,000 16,000* 20,000* 20,000*
Started and completed this month**...... 710,000 710,000 710,000 710,000
Work in process, May 31 (materials 60%
complete, labor and overhead 20%
complete)................................................ 50,000 30,000 10,000 10,000
Total gallons accounted for............................... 840,000 756,000 740,000 740,000
Requirement 2
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Exercise 7
Requirement (1)
The direct materials and direct labor costs listed in the exercise would have
been recorded on four different documents: the materials requisition form for
Job KC123, the time ticket for Kristine, the time ticket for Clarisse, and the
job cost sheet for Job KC123.
Requirement (2)
The costs for Job KC123 would have been recorded as follows:
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P9,665.00
Exercise 8
Exercise 9
Weighted-Average Method
Materials Labor Overhead Total
Work in process, May 1................................. P 14,550 P23,620 P118,100
Cost added during May.................................88,350 14,330 71,650
Total cost (a)..................................................
P102,900 P37,950 P189,750
Equivalent units of
production (b)............................................ 1,200 1,100 1,100
Cost per equivalent unit
(a) (b).....................................................P85.75 P34.50 P172.50 P292.75
Exercise 10
FIFO Method
Materials Conversion
To complete beginning work in process:
Materials: 400 units x (100% 75%).............................................................
100
Conversion: 400 units x (100% 25%).......................................................... 300
Units started and completed during the period
(42,600 units started 500 units in ending
inventory).........................................................................................................
42,100 42,100
Ending work in process
Materials: 500 units x 80% complete..............................................................
400
Conversion: 500 units x 30% complete........................................................... 150
Equivalent units of production...............................................................................
42,600 42,550
III. Problems
Problem 1
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Requirement 1
Requirement 2
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Problem 2
Requirement 1
The costing problem does, indeed, lie with manufacturing overhead cost, as
suggested. Since manufacturing overhead is mostly fixed, the cost per unit
increases as the level of production decreases. The problem can be solved by
use of predetermined overhead rates, which should be based on expected
activity for the entire year. Many students will use units of product in
computing the predetermined overhead rate, as follows:
Estimated manufacturing overhead cost, P840,000 = P4.20 per unit.
Estimated units to be produced, 200,000
The predetermined overhead rate could also be set on the basis of either direct
labor cost or direct materials cost. The computations are:
Estimated manufacturing overhead cost, P840,000 = 350% of direct
Estimated direct labor cost, P240,000 labor cost
Requirement 2
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Problem 3
Weighted-Average Method
Quantity
Schedule
Pounds to be accounted for:
Work in process, May 1
(all materials, 55% labor and
overhead added last month).......... 30,000
Started into production during
May................................................ 480,000
Total pounds............................. 510,000
Equivalent Units
Labor &
Materials Overhead
Pounds accounted for as follows:
Transferred to Department 2............ 490,000* 490,000 490,000
Work in process, May 31
(all materials, 90% labor and
overhead added this month).......... 20,000 20,000 18,000
Total pounds............................. 510,000 510,000 508,000
* 30,000 + 480,000 - 20,000 = 490,000.
Problem 4 (Weighted-Average Method; Interpreting a Production Report)
Requirement 1
Weighted-Average Method
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Requirement 2
Equivalent units of
production (b) 220,000 214,000
Requirement 3
Requirement 4
No, the manager should not be rewarded for good cost control. The reason for
the Mixing Departments low unit cost for April is traceable to the fact that
costs of the prior month have been averaged in with Aprils costs in computing
the lower, P2.94 per unit figure. This is a major criticism of the weighted-
average method in that the figures computed for product costing purposes
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cant be used to evaluate cost control or measure performance for the current
period.
Requirement 1
Weighted-Average Method
Quantity
Schedule
Pounds to be accounted for:
Work in process, May 1
(materials all complete, labor
and overhead 4/5 complete)...... 35,000
Started into production................ 280,000
Total pounds to be accounted for...... 315,000
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Cost Reconciliation
Requirement 2
In computing unit costs, the weighted-average method mixes costs of the prior
period with current period costs. Thus, under the weighted-average method,
unit costs are influenced to some extent by what happened in a prior period.
This problem becomes particularly significant when attempting to measure
performance in the current period. Good (or bad) cost control in the current
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period might be concealed to some degree by the costs that have been brought
forward in the beginning inventory.
1. D 6. D 11. A 16. A
2. D 7. A 12. D 17. D
3. D 8. C 13. B 18. A
4. C 9. C 14. D 19. C
5. D 10. B 15. C 20. D
CHAPTER 11
I. Questions
1. The three levels available are: Level 1, in which a company uses a
plantwide overhead rate; Level 2, in which a company uses departmental
overhead rates; and Level 3, in which a company uses activity-based
costing.
2. New approaches to costing are needed because events of the last few
decades have made drastic changes in many organizations. Automation
has greatly decreased the amount of direct labor required to manufacture
products; product diversity has increased in that companies are
manufacturing a wider range of products and these products differ
substantially in volume, lot size, and complexity of design; and total
overhead cost has increased to the point in some companies that a
correlation no longer exists between it and direct labor.
3. The departmental approach to assigning overhead cost to products relies
solely on volume as an assignment base. Where diversity exists between
products (that is, where products differ in terms of number of units
produced, lot size, or complexity of production), volume alone is not
adequate for overhead costing. Overhead costing based on volume will
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15. Unit-level activities are performed for each unit that is produced. Batch-
level activities are performed for each batch regardless of how many units
are in the batch. Product-level activities must be carried out to support a
product regardless of how many batches are run or units produced.
Customer-level activities must be carried out to support customers
regardless of what products or services they buy. Organization-sustaining
activities are carried out regardless of the companys precise product mix
or mix of customers.
16. Organization-sustaining costs, customer-level costs, and the costs of idle
capacity should not be assigned to products. These costs represent
resources that are not consumed by the products.
III. Exercises
Exercise 1
Examples of Examples of
Activity Traceable Cost
Activity Classification Costs Drivers
a. Materials are moved Batch-level Labor cost; Number of
from the receiving depreciation receipts;
dock to product flow pounds handled
of equipment;
lines by a material-
space cost
handling crew
b. Direct labor workers Unit-level Direct labor Direct labor-
assemble various cost; indirect hours
products labor cost;
labor benefits
c. Ongoing training is Facility-level* Space cost; Hours of
provided to all training costs; training time;
employees in the administration number trained
company costs
d. A product is Product-level Space cost; Hours of
designed by a supplies used; design time;
specialized design depreciation of number of
team design engineering
equipment change orders
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Cost-Volume-Profit Relationships Chapter 13
Exercise 2
Exercise 3
Note: Some of these classifications are debatable and may depend on the
specific circumstances found in particular companies.
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Chapter 13 Cost-Volume-Profit Relationships
Exercise 4
Exercise 5
Requirement 1
The unit product costs under the companys traditional costing system are
computed as follows:
Special Regular
Direct materials................................................................................................................
P60.00 P45.00
Direct labor......................................................................................................................
9.60 7.20
Manufacturing overhead (0.8 DLH P5.80 per DLH;
0.6 DLH P5.80 per DLH)........................................................................................
4.64 3.48
Unit product cost..............................................................................................................
P74.24 P55.68
Requirement 2
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Cost-Volume-Profit Relationships Chapter 13
(a)
Estimated (b)
Overhead Total (a) (b)
Activities Cost Expected Activity Activity Rate
Supporting direct labor...............................
P150,000 50,000 DLHs P3 per DLH
Batch setups...............................................
P60,000 250 setups P240 per setup
Safety testing..............................................
P80,000 100 tests P800 per test
Special Product:
(a) (b) (a) (b)
Activity Cost Pool Activity Rate Activity ABC Cost
Supporting direct labor.......................................................... P3 per DLH 8,000 DLHs P24,000
Batch setups..........................................................................
P240 per setup 200 setups 48,000
Safety testing.........................................................................
P800 per test 80 tests 64,000
Total P136,000
Regular Product:
(a) (b) (a) (b)
Activity Cost Pool Activity Rate Activity ABC Cost
Supporting direct labor.......................................................... P3 per DLH 42,000 DLHs P126,000
Batch setups..........................................................................
P240 per setup 50 setups 12,000
Safety testing.........................................................................
P800 per test 20 tests 16,000
Total P154,000
Special Regular
Direct materials...................................................................................................
P60.00 P45.00
Direct labor.........................................................................................................
9.60 7.20
Manufacturing overhead (P136,000 10,000 units; P154,000
70,000 units)..................................................................................................
13.60 2.20
Unit product cost.................................................................................................
P83.20 P54.40
IV. Problems
Problem 1
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Chapter 13 Cost-Volume-Profit Relationships
ABC system
Labor 10% P10,000 P 1,000
Machining P25/hour 800 hours 20,000
Setup P10/hour 100 hours 1,000
Production order P100/order 12 orders 1,200
Material handling P20/requisition 5 requisitions 100
Parts administration P40/part 18 parts 720
P24,020
Problem 2
Requirement 1
(a)
Total overhead = P200,000 + P32,000 + P100,000 + P120,000
= P452,000
Requirement 2
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Cost-Volume-Profit Relationships Chapter 13
Requirement 1
The first-stage allocation of costs to the activity cost pools appears below:
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Chapter 13 Cost-Volume-Profit Relationships
overhead
Total cost P280,000 P310,000 P100,000 P110,000 P800,000
Requirement 2
Requirement 3
Requirement 4
Requirement 1
a. When direct labor-hours are used to apply overhead cost to products, the
companys predetermined overhead rate would be:
Predetermined Manufacturing overhead cost
=
overhead rate Direct labor hours
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P1,480,000
= = P74 per DLH
20,000 DLHs
Cost-Volume-Profit Relationships Chapter 13
b. Model
HY5 AS2
Direct materials......................................................................
P35.00 P25.00
Direct labor:
P20 per hour 0.2 DLH, 0.4 DLH.................................... 4.00 8.00
Manufacturing overhead:
P74 per hour 0.2 DLH, 0.4 DLH.................................... 14.80 29.60
Total unit product cost............................................................
P53.80 P62.60
Requirement 2
(a) (b)
Estimated Estimated (a) (b)
Activity Cost Pool Total Cost Total Activity Activity Rate
Machine setups.................P180,000 250 setups P720 per setup
Special milling..................P300,000 1,000 MHs P300 per MH
General factory.................
P1,000,000 20,000 DLHs P50 per DLH
Model HY5
(a) (a) (b)
Predetermined (b) Overhead
Activity Cost Pool Overhead Rate Activity Applied
Machine setups....................................................................................
P720 per setup 150 setups P108,000
Special milling.....................................................................................
P300 per MH 1,000 MHs 300,000
General factory....................................................................................
P50 per DLH 4,000 DLHs 200,000
Total manufacturing overhead cost (a)................................................ P608,000
Number of units produced (b)............................................................. 20,000
Overhead cost per unit (a) (b).......................................................... P30.40
Model AS2
(a) (a) (b)
Predetermined (b) Overhead
Activity Cost Pool Overhead Rate Activity Applied
Machine setups....................................................................................
P720 per setup 100 setups P 72,000
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Chapter 13 Cost-Volume-Profit Relationships
Special milling.....................................................................................
P300 per MH 0 MHs 0
General factory....................................................................................
P50 per DLH 16,000 DLHs 800,000
Total manufacturing overhead cost (a)................................................ P872,000
Number of units produced (b)............................................................. 40,000
Overhead cost per unit (a) (b).......................................................... P21.80
Comparing these unit cost figures with the unit costs in Part 1(b), we find
that the unit product cost for Model HY5 has increased from P53.80 to
P69.40, and the unit product cost for Model AS2 has decreased from
P62.60 to P54.80.
Requirement 3
Thus, the shift in overhead cost from the high-volume product (Model AS2) to
the low-volume product (Model HY5) occurred as a result of reassigning only
32% of the companys overhead costs.
The increase in unit product cost for Model HY5 can be explained as follows:
First, where possible, overhead costs have been traced to the products rather
than being lumped together and spread uniformly over production. Therefore,
the special milling costs, which are traceable to Model HY5, have all been
assigned to Model HY5 and none assigned to Model AS2 under the activity-
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Cost-Volume-Profit Relationships Chapter 13
Second, the costs associated with the batch-level activity (machine setups)
have also been assigned to the specific products to which they relate. These
costs have been assigned according to the number of setups completed for
each product. However, since a batch-level activity is involved, another factor
affecting unit costs comes into play. That factor is batch size. Some products
are produced in large batches and some are produced in small batches. The
smaller the batch, the higher the cost per unit of the batch activity. In the
case at hand, the data can be analyzed as shown below.
Model HY5:
Cost to complete one setup [see 2(a)]......................................... P720 (a)
Number of units processed per setup
(20,000 units 150 setups)...................................................133.33 (b)
Setup cost per unit (a) (b)....................................................... P5.40
Model AS2:
Cost to complete one setup (above)............................................ P720 (a)
Number of units processed per setup
(40,000 units 100 setups)................................................... 400 (b)
Setup cost per unit (a) (b)....................................................... P1.80
Thus, the cost per unit for setups is three times as great for Model HY5, the
low-volume product, as it is for Model AS2, the high-volume product. Such
differences in cost are obscured when direct labor-hours (or any other
volume measure) is used as the basis for applying overhead cost to products.
In sum, overhead cost has shifted from the high-volume product to the low-
volume product as a result of more appropriately assigning some costs to the
products on the basis of the activities involved, rather than on the basis of
direct labor-hours.
1. A 11. B 21. D
2. D 12. D 21. A
3. C 13. C 22. B
4. B 14. A 23. A
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Chapter 13 Cost-Volume-Profit Relationships
5. A 15. C 24. B
6. D 16. D 25. D
7. A 17. D 26. B
8. B 18. C 27. C
9. D 19. B 28. A
10. C 20. A 29. C
CHAPTER 12
VARIABLE COSTING
I. Questions
1. The variable costing technique does not consider fixed costs as
unimportant or irrelevant, but it maintains that the distinction between
behaviors of different costs is crucial for certain decisions.
2. The central issue in variable costing is what is the proper timing for
release of fixed manufacturing overhead as expense: at the time of
incurrence, or at the time the finished units to which the fixed overhead
relates are sold.
4. Marketing and administrative costs are treated as period costs under both
variable costing and absorption costing methods of product costing.
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Cost-Volume-Profit Relationships Chapter 13
10. If production exceeds sales, absorption costing will show higher net
operating income than variable costing. The reason is that inventories will
increase and therefore part of the fixed manufacturing overhead cost of
the current period will be deferred in inventory to the next period under
absorption costing. By contrast, all of the fixed manufacturing overhead
cost of the current period will be charged immediately against revenues as
a period cost under variable costing.
11. Absorption and variable costing differ in how they handle fixed
manufacturing overhead. Under absorption costing, fixed manufacturing
overhead is treated as a product cost and hence is an asset until products
are sold. Under variable costing, fixed manufacturing overhead is treated
as a period cost and is expensed on the current periods income statement.
12. Advocates of variable costing argue that fixed manufacturing costs are not
really the cost of any particular unit of product. If a unit is made or not,
the total fixed manufacturing costs will be exactly the same. Therefore,
how can one say that these costs are part of the costs of the products?
These costs are incurred to have the capacity to make products during a
particular period and should be charged against that period as period costs
according to the matching principle.
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Chapter 13 Cost-Volume-Profit Relationships
II. Exercises
Requirement 1
Requirement 2
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Cost-Volume-Profit Relationships Chapter 13
Requirement 1
*Direct materials.......................................................................................................
P10
Direct labor.............................................................................................................
4
Variable manufacturing overhead.............................................................................
2
Total variable manufacturing cost............................................................................
P16
Requirement 2
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Chapter 13 Cost-Volume-Profit Relationships
Requirement 1
Under variable costing, only the variable manufacturing costs are included in
product costs.
Note that selling and administrative expenses are not treated as product costs;
that is, they are not included in the costs that are inventoried. These expenses
are always treated as period costs and are charged against the current periods
revenue.
Requirement 2
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Cost-Volume-Profit Relationships Chapter 13
per unit)...................................................
Variable cost of goods sold*................................ 9,000,000
Variable selling and administrative (9,000 units
P200 per unit)..................................................... 1,800,000 10,800,000
Contribution margin................................................ 7,200,000
Less fixed expenses:
Fixed manufacturing overhead................................ 3,000,000
Fixed selling and administrative.............................. 4,500,000 7,500,000
Net operating loss.................................................... P (300,000)
* The variable cost of goods sold could be computed more simply as: 9,000 units
sold P1,000 per unit = P9,000,000.
Requirement 3
Exercise 4 (Absorption
Fixed expenses
Break-even unit Costing
sales Unit
= Product Cost and Income Statement)
Unit contribution margin
P7,500,000
= P800 per unit
Requirement 1
= 9,375 units
Under absorption costing, all manufacturing costs (variable and fixed) are
included in product costs.
Requirement 2
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Chapter 13 Cost-Volume-Profit Relationships
Note: The company apparently has exactly zero net operating income even
though its sales are below the break-even point computed in Exercise 3. This
occurs because P300,000 of fixed manufacturing overhead has been deferred
in inventory and does not appear on the income statement prepared using
absorption costing.
Exercise 5 (Variable Costing Income Statement; Explanation of Difference in Net
Operating Income)
Requirement 1
Requirement 2
Sales.............................................................................. P4,000,000
Variable expenses:
Variable cost of goods sold:
Beginning inventory............................................... P 0
Add variable manufacturing costs
(10,000 units P310 per unit)........................3,100,000
Goods available for sale.........................................3,100,000
Less ending inventory
(2,000 units P310 per unit)............................. 620,000
Variable cost of goods sold*.......................................2,480,000
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Cost-Volume-Profit Relationships Chapter 13
* The variable cost of goods sold could be computed more simply as: 8,000
units sold P310 per unit = P2,480,000.
Requirement 1
a. By assumption, the unit selling price, unit variable costs, and total fixed
costs are constant from year to year. Consequently, variable costing net
operating income will vary with sales. If sales increase, variable costing
net operating income will increase. If sales decrease, variable costing net
operating income will decrease. If sales are constant, variable costing net
operating income will be constant. Because variable costing net operating
income was P16,847 each year, unit sales must have been the same in
each year.
The same is not true of absorption costing net operating income. Sales and
absorption costing net operating income do not necessarily move in the
same direction because changes in inventories also affect absorption
costing net operating income.
Requirement 2
Requirement 3
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Cost-Volume-Profit Relationships Chapter 13
Common data:
Annual fixed manufacturing costs............................... P153,153
Contribution margin per unit...................................... P35,000
Annual fixed SGA costs............................................... P180,000
Part 1:
Year 1 Year 2 Year 3
Beginning inventory............................................................. 1 1 2
Production............................................................................. 10 11 9
Sales...................................................................................... 10 10 10
Ending................................................................................... 1 2 1
Part 2:
Year 1 Year 2 Year 3
Beginning inventory................................................... 1 1 4
Production.................................................................. 10 12 20
Sales........................................................................... 10 9 8
Ending........................................................................ 1 4 16
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Chapter 13 Cost-Volume-Profit Relationships
Problem 1
Sales P20,700,000
Less: Variable Cost of Sales
Inventory, Jan. 1 P1,155,000
Current Production 7,700,000
Total Available for Sale P8,855,000
Inventory, Dec. 31 805,000 8,050,000
Contribution Margin P12,650,000
Less Fixed Costs and Expenses 6,000,000
Net Income P 6,650,000
Sales P26,100,000
Less Cost of goods sold:
Inventory, Jan. 1 P 1,380,000
Current Production 16,100,000
Total Available for Sale P17,480,000
Inventory, Dec. 31 747,500
Cost of Sales - Standard P16,732,500
Favorable Capacity Variance 900,000 15,832,500
Income from Manufacturing P10,267,500
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Cost-Volume-Profit Relationships Chapter 13
Problem 2
Requirement 1
Honey Company
Income Statement - Direct Costing
For the Year Ended December 31, 2005
Sales P280,000
Less Variable Cost of Sales:
Finished Goods Inventory, 1/1 P 4,000
Current Production 120,000
Total Available for Sale P124,000
Finished Goods Inventory, 12/31 12,000
Variable Cost of Sale - Standard P112,000
Unfavorable Variance 5,000 117,000
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Chapter 13 Cost-Volume-Profit Relationships
Requirement 2
Honey Company
Income Statement - Absorption Costing
For the Year Ended December 31, 2005
Sales P280,000
Less: Cost of Sales
Finished goods inventory, Jan. 1 (1,000 x P5.50) P 5,500
Current production costs
Variable (30,000 x P4.00) P120,000
Fixed (30,000 x P1.50) 45,000 165,000
P170,500
Less: Finished goods inventory, Dec. 31
(3,000 x P5.50) 16,500
Cost of Sales - at Standard P154,000
Add (Deduct) Variance
Unfavorable variable manufacturing
costs variances 5,000
Underapplied fixed factory overhead
(6,000 x P1.50) 9,000
Cost of Sales - Actual P168,000
Gross Profit P112,000
Less: Selling and administrative expenses
Variable 28,000
Fixed 20,000
P 48,000
Net Income P 64,000
Requirement 1
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Cost-Volume-Profit Relationships Chapter 13
With this figure, the variable costing income statements can be prepared:
Year 1 Year 2
Sales........................................................................................................................
P1,000,000 P1,500,000
Less variable expenses:
Variable cost of goods sold @ P20 per unit..........................................................
400,000 600,000
Variable selling and administrative
@ P3 per unit...................................................................................................
60,000 90,000
Total variable expenses............................................................................................
460,000 690,000
Contribution margin................................................................................................
540,000 810,000
Less fixed expenses:
Fixed manufacturing overhead.............................................................................
350,000 350,000
Fixed selling and administrative...........................................................................
250,000 250,000
Total fixed expenses................................................................................................
600,000 600,000
Net operating income (loss).....................................................................................
P (60,000) P 210,000
Requirement 2
Requirement 1
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Chapter 13 Cost-Volume-Profit Relationships
Requirement 2
a.
Year 1 Year 2 Year 3
Variable manufacturing cost P4 P4 P4
Fixed manufacturing cost:
P600,000 50,000 units 12
P600,000 60,000 units 10
P600,000 40,000 units 15
Unit product cost P16 P14 P19
b.
Variable costing net operating income
(loss) P30,000 P(110,000) P 30,000
Add (Deduct): Fixed manufacturing
overhead cost deferred in inventory
from Year 2 to Year 3 under
absorption costing (20,000 units
P10 per unit) 200,000 (200,000)
Add: Fixed manufacturing overhead
cost deferred in inventory from Year
3 to the future under absorption
costing (10,000 units P15 per unit)
150,000
Absorption costing net operating income
(loss) P30,000 P 90,000 P(20,000)
Requirement 3
Production went up sharply in Year 2 thereby reducing the unit product cost,
as shown in (2a). This reduction in cost, combined with the large amount of
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Cost-Volume-Profit Relationships Chapter 13
fixed manufacturing overhead cost deferred in inventory for the year, more
than offset the loss of revenue. The net result is that the companys net
operating income rose even though sales were down.
Requirement 4
The fixed manufacturing overhead cost deferred in inventory from Year 2 was
charged against Year 3 operations, as shown in the reconciliation in (2b). This
added charge against Year 3 operations was offset somewhat by the fact that
part of Year 3s fixed manufacturing overhead costs was deferred in inventory
to future years [again see (2b)]. Overall, the added costs charged against Year
3 were greater than the costs deferred to future years, so the company reported
less income for the year even though the same number of units was sold as in
Year 1.
Requirement 5
a. Several things would have been different if the company had been using
JIT inventory methods. First, in each year production would have been
geared to sales so that little or no inventory of finished goods would have
been built up in either Year 2 or Year 3. Second, unit product costs
probably would have been the same in all three years, since these costs
would have been established on the basis of expected sales (50,000 units)
for each year. Third, since only 40,000 units were sold in Year 2, the
company would have produced only that number of units and therefore
would have had some underapplied overhead cost for the year. (See the
discussion on underapplied overhead in the following paragraph.)
b. If JIT had been in use, the net operating income under absorption costing
would have been the same as under variable costing in all three years.
The reason is that with production geared to sales, there would have been
no ending inventory on hand, and therefore there would have been no fixed
manufacturing overhead costs deferred in inventory to other years.
Assuming that the company expected to sell 50,000 units in
each year and that unit product costs were set on
the basis of that level of expected activity, the
income statements under absorption costing would
have appeared as follows:
Year 1 Year 2 Year 3
Sales P1,000,000 P 800,000 P1,000,000
Less cost of goods sold:
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Chapter 13 Cost-Volume-Profit Relationships
Requirement 1 (a)
Under absorption costing, all manufacturing costs, variable and fixed, are
included in unit product costs:
Year 1 Year 2
Direct materials P11 P11
Direct labor 6 6
Variable manufacturing overhead 3 3
Fixed manufacturing overhead
(P120,000 10,000 units) 12
(P120,000 6,000 units) 20
Unit product cost P32 P40
Requirement 1 (b)
Year 1 Year 2
Sales (8,000
units x P50 P400,00 P400,00
per unit) 0 0
Cost of goods
sold:
Beginning P P
inventory 0 64,000
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Cost-Volume-Profit Relationships Chapter 13
Add cost of
goods
manufactur
ed (10,000
units x P32
per unit;
6,000 units
x P40 per 320,0 240,00
unit) 00 0
Goods
available for 320,00 304,00
sale 0 0
Less ending
inventory
(2,000 units
x P32 per
unit; 0 units
x P40 per 64,00 256,00 304,00
unit) 0 0 0 0
Gross margin 144,000 96,000
Selling and
administrativ
e expenses
(8,000 units
x P4 per unit 102,00 102,00
+ P70,000) 0 0
Net operating P P
income 42,000 (6,000)
Requirement 2 (a)
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Chapter 13 Cost-Volume-Profit Relationships
Under variable costing, only the variable manufacturing costs are included in
unit product costs:
Year 1 Year 2
Direct materials P11 P11
Direct labor 6 6
Variable manufacturing overhead 3 3
Unit product cost P20 P20
Requirement 2 (b)
The variable costing income statements follow. Notice that the variable cost
of goods sold is computed in a simpler, more direct manner than in the
examples provided earlier. On a variable costing income statement, this
simple approach or the more complex approach illustrated earlier is
acceptable for computing the cost of goods sold.
Year 1 Year 2
Sales (8,000
units x P50 P400,00 P400,00
per unit) 0 0
Variable
expenses:
Variable cost
of goods sold
(8,000 units
x P20 per P160,00 P160,00
unit) 0 0
Variable
selling and
administrati
ve (8,000
units x P4 32,00 192,00 32,00 192,00
per unit) 0 0 0 0
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Cost-Volume-Profit Relationships Chapter 13
Contribution
margin 208,000 208,000
Fixed
expenses:
Fixed
manufacturin
g overhead 120,000 120,000
Fixed selling
and
administrati 70,00 190,00 70,00 190,00
ve expenses 0 0 0 0
Net operating P P
income 18,000 18,000
Requirement 3
The reconciliation of the variable and absorption costing net operating incomes
follows:
Year 1 Year 2
Variable costing net operating income P18,000 P18,000
Add fixed manufacturing overhead costs
deferred in inventory under absorption
costing (2,000 units x P12 per unit) 24,000
Deduct fixed manufacturing overhead
costs released from inventory under
absorption costing (2,000 units x P12
per unit) (24,000)
Absorption costing net operating income P42,000 P(6,000)
Requirement 1
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Chapter 13 Cost-Volume-Profit Relationships
Fixed expenses:
Fixed manufacturing overhead...................................................
250,000
Fixed selling and administrative expenses..................................
300,000 550,000
Net operating income..................................................................... P 40,000
Requirement 2
1. D 11. B
2. B 12. A
3. B 13. C
4. B 14. D
5. B 15. B
6. C 16. A
7. A 17. C
8. B 18. C
9. A 19. B
10. A 20. C
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Cost-Volume-Profit Relationships Chapter 13
CHAPTER 13
COST-VOLUME-PROFIT RELATIONSHIPS
I. Questions
1. The total contribution margin is the excess of total revenue over total
variable costs. The unit contribution margin is the excess of the unit price
over the unit variable costs.
2. Total contribution margin:
Selling price - manufacturing variable costs expensed - nonmanufacturing
variable costs expensed = Total contribution margin.
Gross margin:
Selling price - variable manufacturing costs expensed - fixed
manufacturing costs expensed = Gross margin.
3. A company operating at break-even is probably not covering costs
which are not recorded in the accounting records. An example of such a
cost is the opportunity cost of owner-invested capital. In some small
businesses, owner-managers may not take a salary as large as the
opportunity cost of forgone alternative employment. Hence, the
opportunity cost of owner labor may be excluded.
4. In the short-run, without considering asset replacement, net operating cash
flows would be expected to exceed net income, because the latter includes
depreciation expense, while the former does not. Thus, the cash basis
break-even would be lower than the accrual break-even if asset
replacement is ignored. However, if asset replacement costs are taken into
account, (i.e., on a cradle to grave basis), the long-run net cash flows
equal long-run accrual net income, and the long-run break-even points are
the same.
5. Both unit price and unit variable costs are expressed on a per product
basis, as:
= (P1 - V1) X1 + (P2 - V2) X2 + + (Pn - Vn) Xn - F,
for all products 1 to n where:
= operating profit,
P = average unit selling price,
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Chapter 13 Cost-Volume-Profit Relationships
II. Exercises
Requirement 1
Total Per Unit
Sales (30,000 units 1.15 = 34,500 units)..............................................................
P172,500 P5.00
Less variable expenses.............................................................................................
103,500 3.00
Contribution margin................................................................................................
69,000 P2.00
Less fixed expenses.................................................................................................
50,000
P19,000
Net operating income...............................................................................................
Requirement 2
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Chapter 13 Cost-Volume-Profit Relationships
Requirement 3
Requirement 4
Requirement 1
The fixed expenses of the Extravaganza total P8,000; therefore, the break-
even point would be computed as follows:
Alternative solution:
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Cost-Volume-Profit Relationships Chapter 13
= 400 persons
Requirement 2
Requirement 3
Cost-volume-profit graph:
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Chapter 13 Cost-Volume-Profit Relationships
Total Sales
Total Expenses
Fixed Expenses
Requirement 1
Alternative solution:
Break-even point Fixed expenses
in unit sales = Unit contribution margin
P1,350,000
= P270 per lantern
= 5,000 lanterns
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Cost-Volume-Profit Relationships Chapter 13
Requirement 2
Requirement 3
Present: Proposed:
8,000 Lanterns 10,000 Lanterns*
Total Per Unit Total Per Unit
Sales P7,200,000 P900 P8,100,000 P810 **
Less variable expenses 5,040,000 630 6,300,000 630
Contribution margin 2,160,000 P270 1,800,000 P180
Less fixed expenses 1,350,000 1,350,000
Net operating income P810,000 P450,000
Requirement 4
Alternative solution:
Unit sales to attain Fixed expenses + Target profit
target profit = Unit contribution margin
P1,350,000 + P720,000
= P180 per lantern
= 11,500 lanterns
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Chapter 13 Cost-Volume-Profit Relationships
Requirement 1
= 6
Requirement 2
Requirement 1
Model E700 Model J1500 Total Company
Amount % Amount % Amount %
Sales P700,000 100 P300,000 100 P1,000,000 100
Less variable expenses
280,000 40 90,000 30 370,000 37
Contribution margin P420,000 60 P210,000 70 630,000 63 *
Less fixed expenses 598,500
Net operating income P 31,500
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Cost-Volume-Profit Relationships Chapter 13
Requirement 2
= P950,000 in sales
Requirement 3
The additional contribution margin from the additional sales can be computed
as follows:
P50,000 63% CM ratio = P31,500
This answer assumes no change in selling prices, variable costs per unit, fixed
expenses, or sales mix.
Exercise 6 (Break-even Analysis; Target Profit; Margin of Safety)
Requirement 1
Alternatively:
Break-even point Fixed expenses
in unit sales = Unit contribution margin
P150,000
= P12 per unit
= 12,500 units
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Chapter 13 Cost-Volume-Profit Relationships
Requirement 2
Requirement 3
Unit sales to attain Fixed expenses + Target profit
target profit = Unit contribution margin
P150,000 + P18,000
= P12 per unit
= 14,000 units
Total Unit
Sales (14,000 units P40 per unit).........................................................................
P560,000 P40
Less variable expenses
(14,000 units P28 per unit)...............................................................................
392,000 28
Contribution margin
(14,000 units P12 per unit)...............................................................................
168,000 P12
Less fixed expenses.................................................................................................
150,000
P18,000
Net operating income...............................................................................................
Requirement 4
= 16.7% (rounded)
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Cost-Volume-Profit Relationships Chapter 13
Requirement 5
Alternative solution:
Since in this case the companys fixed expenses will not change, monthly net
operating income will increase by the amount of the increased contribution
margin, P24,000.
Requirement (1)
The following table shows the effect of the proposed change in monthly
advertising budget:
Sales With
Additional
Current Advertising
Sales Budget Difference
Sales.............................................. P225,000 P240,000 P15,000
Variable expenses.......................... 135,000 144,000 9,000
Contribution margin...................... 90,000 96,000 6,000
Fixed expenses.............................. 75,000 83,000 8,000
Net operating income..................... P 15,000 P 13,000 P(2,000)
Alternative Solution 1
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Chapter 13 Cost-Volume-Profit Relationships
Alternative Solution 2
Requirement (2)
The P3 increase in variable costs will cause the unit contribution margin to
decrease from P30 to P27 with the following impact on net operating income:
Expected total contribution margin with the higher-quality
components:
3,450 units P27 per unit................................................................P93,150
Present total contribution margin:
3,000 units P30 per unit................................................................ 90,000
Change in total contribution margin.....................................................P 3,150
Assuming no change in fixed costs and all other factors remain the same, the
higher-quality components should be used.
Requirement (1)
To compute the margin of safety, we must first compute the break-even unit
sales.
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Cost-Volume-Profit Relationships Chapter 13
Requirement (2)
Requirement (1)
Requirement (2)
Requirement (3)
The new income statement reflecting the change in sales would be:
Percent of
Amount Sales
Sales.............................................. P132,000 100%
Variable expenses.......................... 92,400 70%
Contribution margin...................... 39,600 30%
Fixed expenses.............................. 24,000
Net operating income..................... P 15,600
Requirement (1)
= 80%
Requirement (2)
= P112,500
Requirement (3)
Requirement (1)
Requirement (2)
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Chapter 13 Cost-Volume-Profit Relationships
X = P450,000 0.40
X = P1,125,000
Alternative solution:
X = 0.55X + P360,000 + P0
0.45X = P360,000
X = P360,000 0.45
X = P800,000
Requirement (3)
Break-even point Fixed expenses
a. in unit sales = Unit contribution margin
Alternative solution:
Break-even point Fixed expenses
in sales pesos = CM ratio
= 18,750 units
In sales pesos: 18,750 units P60 per unit = P1,125,000
Alternative solution:
Peso sales to Fixed expenses + Target profit
attain target profit = CM ratio
= P1,125,000
In units: P1,125,000 P60 per unit = 18,750 units
Alternative solution:
Break-even point Fixed expenses
in sales pesos = CM ratio
= P360,000 0.45
= P800,000
In units: P800,000 P60 per unit = 13,333 (rounded)
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Chapter 13 Cost-Volume-Profit Relationships
Requirement (1)
Requirement (2)
III. Problems
Requirement 1
Contribution margin P15
CM ratio = Selling price = P60 =
25%
Variable expense P45
Variable expense ratio = Selling price = P60 =
75%
Requirement 2
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Cost-Volume-Profit Relationships Chapter 13
P15Q = P240,000
Q = P240,000 P15 per unit
Q = 16,000 units, or at P60 per unit, P960,000
Alternative solution:
X = 0.75X + P240,000 + P0
0.25X = P240,000
X = P240,000 0.25
X = P960,000; or at P60 per unit, 16,000 units
Requirement 3
Since the fixed expenses are not expected to change, net operating income will
increase by the entire P100,000 increase in contribution margin computed
above.
Requirement 4
Requirement 5
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Chapter 13 Cost-Volume-Profit Relationships
Requirement 6
Thus, the P84,000 expected net operating income for next year represents
a 40% increase over the P60,000 net operating income earned during the
current year:
P84,000 P60,000 P24,000
P60,000 = P60,000 = 40% increase
Note from the income statement above that the increase in sales from
20,000 to 21,600 units has resulted in increases in both total sales and
total variable expenses. It is a common error to overlook the increase in
variable expense when preparing a projected income statement.
Requirement 7
a. A 20% increase in sales would result in 24,000 units being sold next year:
20,000 units x 1.20 = 24,000 units.
Percent of
Total Per Unit Sales
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Cost-Volume-Profit Relationships Chapter 13
Note that the change in per unit variable expenses results in a change in
both the per unit contribution margin and the CM ratio.
Break-even
c. Yes, based data =
on these point 17,500 units be made. The changes will
Fixedshould
the changes expenses
in peso sales = CM
increase the companys net operating incomeratiofrom the present P60,000 to
P78,000 per year. Although the changes
P210,000will also result in a higher break-
even point (17,500 units as =compared 0.20 the present 16,000 units), the
to
companys margin of safety will actually be wider than before:
= P1,050,000
Margin of safety in pesos = Total sales Break-even sales
= P1,440,000 P1,050,000 = P390,000
Requirement 1
The CM ratio is 30%.
Total Per Unit Percentage
Sales (13,500 units) P270,000 P20 100 %
Less variable expenses 189,000 14 70
Contribution margin P81,000 P6 30 %
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Chapter 13 Cost-Volume-Profit Relationships
Alternative solution:
Break-even point Fixed expenses
in unit sales = Contribution margin per unit
P90,000
= P6 per unit
= P300,000 in sales
Requirement 2
Since the company presently has a loss of P9,000 per month, if the changes
are adopted, the loss will turn into a profit of P4,000 per month.
Requirement 3
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Cost-Volume-Profit Relationships Chapter 13
Requirement 4
Alternative solution:
= 17,500 units
** P6.00 P0.60 = P5.40.
Requirement 5
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Chapter 13 Cost-Volume-Profit Relationships
= 16,000 units
= P320,000 in sales
b. Comparative income statements follow:
c. Whether or not one would recommend that the company automate its
operations depends on how much risk he or she is willing to take, and
depends heavily on prospects for future sales. The proposed changes
would increase the companys fixed costs and its break-even point.
However, the changes would also increase the companys CM ratio (from
30% to 65%). The higher CM ratio means that once the break-even point
is reached, profits will increase more rapidly than at present. If 20,000
units are sold next month, for example, the higher CM ratio will generate
P22,000 more in profits than if no changes are made.
The greatest risk of automating is that future sales may drop back down to
present levels (only 13,500 units per month), and as a result, losses will be
even larger than at present due to the companys greater fixed costs.
(Note the problem states that sales are erratic from month to month.) In
sum, the proposed changes will help the company if sales continue to
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Cost-Volume-Profit Relationships Chapter 13
trend upward in future months; the changes will hurt the company if sales
drop back down to or near present levels.
Note to the Instructor: Although it is not asked for in the problem, if time
permits you may want to compute the point of indifference between the
two alternatives in terms of units sold; i.e., the point where profits will be
the same under either alternative. At this point, total revenue will be the
same; hence, we include only costs in our equation:
If more than 16,857 units are sold, the proposed plan will yield the greatest
profit; if less than 16,857 units are sold, the present plan will yield the greatest
profit (or the least loss).
Requirement 1
Products
Sinks Mirrors Vanities Total
Percentage of total sales 32% 40% 28% 100%
Sales P160,000 100 % P200,000 100 % P140,000 100 % P500,000 100%
Less variable expenses 48,000 30 160,000 80 77,000 55 285,000 57
Contribution margin P112,000 70 % P 40,000 20 % P 63,000 45 % 215,000 43%*
Less fixed expenses 223,600
Net operating income (loss)
P ( 8,600)
* P215,000 P500,000 = 43%.
Requirement 2
Break-even sales:
Break-even point Fixed expenses
in total peso sales = CM ratio
13-223
P223,600
= 0.43
= P520,000 in sales
Chapter 13 Cost-Volume-Profit Relationships
Requirement 3
As shown by these data, sales shifted away from Sinks, which provides our
greatest contribution per peso of sales, and shifted strongly toward Mirrors,
which provides our least contribution per peso of sales. Consequently,
although the company met its budgeted level of sales, these sales provided
considerably less contribution margin than we had planned, with a resulting
decrease in net operating income. Notice from the attached statements that the
companys overall CM ratio was only 43%, as compared to a planned CM
ratio of 52%. This also explains why the break-even point was higher than
planned. With less average contribution margin per peso of sales, a greater
level of sales had to be achieved to provide sufficient contribution margin to
cover fixed costs.
Requirement 1
= P3,000,000 in sales
Requirement 3
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Cost-Volume-Profit Relationships Chapter 13
Requirement 4
Requirement 5
Last Year: Proposed:
28,000 units 42,000 units*
Total Per Unit Total Per Unit
Sales P4,200,000 P150.00 P5,670,000 P135.00**
Less variable expenses
1,680,000 60.00 2,520,000 60.00
Contribution margin 2,520,000 P90.00 3,150,000 P 75.00
Less fixed expenses 1,800,000 2,500,000
Net operating income P720,000 P650,000
* 28,000 units 1.5 = 42,000 units
** P150 per unit 0.90 = P135.00 per unit
No, the changes should not be made.
Requirement 6
Requirement 1
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Chapter 13 Cost-Volume-Profit Relationships
Selling price.............................................................................................................
P30
Less variable expenses:
Purchase cost of the patches................................................................................
P15
Commissions to the student salespersons.............................................................6 21
P9
Contribution margin................................................................................................
Since there are no fixed costs, the number of unit sales needed to yield the
desired P7,200 in profits can be obtained by dividing the target profit by the
unit contribution margin:
Target profit P7,200
=
Unit contribution margin P9 per patch = 800 patches
800 patches x P30 per patch = P24,000 in total sales
Requirement 2
Since an order has been placed, there is now a fixed cost associated with the
purchase price of the patches (i.e., the patches cant be returned). For
example, an order of 200 patches requires a fixed cost (investment) of
P3,000 (200 patches P15 per patch = P3,000). The variable costs drop to
only P6 per patch, and the new contribution margin per patch becomes:
Selling price.............................................................................................................
P30
Less variable expenses (commissions only)............................................................. 6
Contribution margin................................................................................................
P24
Since the fixed cost of P3,000 must be recovered before Ms. Morales shows
any profit, the break-even computation would be:
Break-even point Fixed expenses
in unit sales = Unit contribution margin
P3,000
= P24 per patch = 125 patches
If a quantity other than 200 patches were ordered, the answer would change
accordingly.
Problem 6
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Cost-Volume-Profit Relationships Chapter 13
500,000
TC
400,000
(P)
Break-even
300,000 point
200,000
FC
100,000
13-227
250,000
Break-even
50,000
point
0
5,000 10,000 15,000 20,000 25,000 30,000
50,000
100,000
L
O
S 150,000
S
200,000
250,000
Requirement (1)
Hun Yun Total
Pesos % P % Euros %
Sales...............................................
P80,000 100 P48,000 100 P128,000 100
Variable expenses.......................... 48,000 60 9,600 20 57,600 45
Contribution margin...................... P32,000 40 P38,400 80 70,400 55
Fixed expenses............................... 66,000
Net operating income.................... P 4,400
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Cost-Volume-Profit Relationships Chapter 13
Margin of safety
= Actual sales Break-even sales
in pesos
= P128,000 P120,000
= P8,000
= 6.25%
Requirement (2)
Hun Yun HY143 Total
Pesos % Pesos % Pesos % Pesos %
Sales P80,000 100 P48,000 100 P32,000 100 P160,000 100
Variable expenses 48,000 60 9,600 20 2,4000 75 81,600 51
Contribution margin P32,000 40 P38,400 80 P 8,000 25 78,400 49
Fixed expenses 66,000
Net operating income P 12,400
Margin of safety
= Actual sales Break-even sales
in pesos
= P160,000 P134,700
= P25,300
= 15.81%
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Chapter 13 Cost-Volume-Profit Relationships
Requirement (3)
The reason for the increase in the break-even point can be traced to the
decrease in the companys average contribution margin ratio when the third
product is added. Note from the income statements above that this ratio drops
from 55% to 49% with the addition of the third product. This product, called
HY143, has a CM ratio of only 25%, which causes the average contribution
margin ratio to fall.
It should be pointed out to the president that even though the break-even point
is higher with the addition of the third product, the companys margin of safety
is also greater. Notice that the margin of safety increases from P8,000 to
P25,300 or from 6.25% to 15.81%. Thus, the addition of the new product
shifts the company much further from its break-even point, even though the
break-even point is higher.
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Cost-Volume-Profit Relationships Chapter 13
Requirement (1)
The total annual fixed cost of the Pediatric Ward can be computed as follows:
Requirement (2)
The break-even can be computed for each range of activity by dividing the total fixed cost for that range of activity by the contribution margin
per patient-day, which is P3,000 (=P4,800 revenue P1,800 variable cost).
(b)
Annual (a) Contribution Break-Even Within Relevant
Patient-Days Total Fixed Cost Margin (a) (b) Range?
10,000-12,000 P40,900,000 P3,000 13,633 No
12,001-13,750 P41,260,000 P3,000 13,753 No
13,751-16,500 P42,960,000 P3,000 14,320 Yes
16,501-18,250 P43,320,000 P3,000 14,440 No
18,251-20,750 P44,660,000 P3,000 14,887 No
20,751-23,000 P45,600,000 P3,000 15,200 No
While a break-even can be computed for each range of activity (i.e., relevant range), all but one of these break-evens is bogus. For example,
within the range of 10,000 to 12,000 patient-days, the computed break-even is 13,633 (rounded) patient-days. However, this level of activity is
outside this relevant range. To serve 13,633 patient-days, the fixed costs would have to be increased from P40,900,000 to P41,260,000 by
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Chapter 13 Cost-Volume-Profit Relationships
adding one more aide. The only break-even that occurs within its own relevant range is 14,320. This is the only legitimate break-even.
Requirement (3)
The level of activity required to earn a profit of P7,200,000 can be computed as follows:
Activity to
(a) (b) Attain Target
Annual Total Fixed Cost + Contribution Profit Within Relevant
Patient-Days Total Fixed Cost Target Profit Target Profit Margin (a) (b) Range?
10,000-12,000 P40,900,000 P7,200,000 P48,100,000 P3,000 16,033 No
12,001-13,750 P41,260,000 P7,200,000 P48,460,000 P3,000 16,153 No
13,751-16,500 P42,960,000 P7,200,000 P50,160,000 P3,000 16,720 No
16,501-18,250 P43,320,000 P7,200,000 P50,520,000 P3,000 16,840 Yes
18,251-20,750 P44,660,000 P7,200,000 P51,860,000 P3,000 17,287 No
20,751-23,000 P45,600,000 P7,200,000 P52,800,000 P3,000 17,600 No
In this case, the only solution that is within the appropriate relevant range is 16,840 patient-days.
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MANAGEMENT ACCOUNTING - Solutions Manual
CHAPTER 14
I. Questions
1. Cost centers are evaluated by means of performance reports. Profit
centers are evaluated by means of contribution income statements
(including cost center performance reports), in terms of meeting sales and
cost objectives. Investment centers are evaluated by means of the rate of
return which they are able to generate on invested assets.
2. Overall profitability can be improved (1) by increasing sales, (2) by
reducing expenses, or (3) by reducing assets.
3. ROI may lead to dysfunctional decisions in that divisional managers may
reject otherwise profitable investment opportunities simply because they
would reduce the divisions overall ROI figure. The residual income
approach overcomes this problem by establishing a minimum rate of
return which the company wants to earn on its operating assets, thereby
motivating the manager to accept all investment opportunities promising a
return in excess of this minimum figure.
4. A cost center manager has control over cost, but not revenue or investment
funds. A profit center manager, by contrast, has control over both cost
and revenue. An investment center manager has control over cost and
revenue and investment funds.
5. The term transfer price means the price charged for a transfer of goods or
services between units of the same organization, such as two departments
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or divisions. Transfer prices are needed for performance evaluation
purposes.
6. The use of market price for transfer purposes will create the actual
conditions under which the transferring and receiving units would be
operating if they were completely separate, autonomous companies. It is
generally felt that the creation of such conditions provides managerial
incentive, and leads to greater overall efficiency in operations.
7. Negotiated transfer prices should be used (1) when the volume involved is
large enough to justify quantity discounts, (2) when selling and/or
administrative expenses are less on intracompany sales, (3) when idle
capacity exists, and (4) when no clear-cut market price exists (such as a
sister division being the only supplier of a good or service).
8. Suboptimization can result if transfer prices are set in a way that benefits
a particular division, but works to the disadvantage of the company as a
whole. An example would be a transfer between divisions when no
transfers should be made (e.g., where a better overall contribution margin
could be generated by selling at an intermediate stage, rather than
transferring to the next division). Suboptimization can also result if
transfer pricing is so inflexible that one division buys from the outside
when there is substantial idle capacity to produce the item internally. If
divisional managers are given full autonomy in setting, accepting, and
rejecting transfer prices, then either of these situations can be created,
through selfishness, desire to look good, pettiness, or bickering.
II. Exercises
No. Although Department 3 does not cover all of the cost allocated to it. It
contributes P21,000 to the total operations over and above its direct costs.
Without Department 3, the company would earn P21,000 less as compared
with the original over-all income of P47,000.
Department
1 2 4 Total
Revenue P132,000 P168,000 P98,000 P398,000
Direct cost of department 82,000 108,000 61,000 251,000
Contribution of the
department P 50,000 P 60,000 P37,000 P147,000
Allocated cost 121,000
Net income P 26,000
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Application of Quantitative Techniques in Planning, Control and Decision Making II Chapter
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With the discontinuance of Department 3, the revenue and direct cost of the
department are eliminated, but there is no reduction in the total allocated cost.
Requirement 1
ROI RI
Operating assets P400,000 P400,000
Operating income P100,000 P100,000
ROI (P100,000 P400,000) 25%
Minimum required income
(16% x P400,000) P64,000
RI (P100,000 - P64,000) P36,000
Requirement 2
The manager of the Cling Division would not accept this project under the ROI
approach since the division is already earning 25%. Accepting this project would
reduce the present divisional performance, as shown below:
Present New Project Overall
Operating assets P400,000 P60,000 P460,000
Operating income P100,000 P12,000* P112,000
ROI 25% 20% 24.35%
* P60,000 x 20% = P12,000
Under the RI approach, on the other hand, the manager would accept this project
since the new project provides a higher return than the minimum required rate of
return (20 percent vs. 16 percent). The new project would increase the overall
divisional residual income, as shown below:
Present New Project Overall
Operating assets P400,000 P60,000 P460,000
Operating income P100,000 P12,000 P112,000
Minimum required
return at 16% 64,000 9,600* 73,600
RI P 36,000 P 2,400 P 38,400
* P60,000 x 16% = P9,600
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making -
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Requirement 1
Requirement 2
Division X would reject this investment opportunity since the addition would
lower the present divisional ROI. Divisions Y and Z would accept it because
they would look better in terms of their divisional ROI.
Requirement 1
Division A : P630,000
P9,000,000 X P9,000,000 = ROI
P3,000,000
7% X 3 = 21%
Division B : P20,000,000
P1,800,000 X P10,000,000 = ROI
P20,000,000
9% X 2 = 18%
Requirement 2
Division A Division B
Average operating assets (a).......... P3,000,000 P10,000,000
Net operating income.................... P 630,000 P 1,800,000
Minimum required return on average
operating assets - 16% x (a)..... 480,000 1,600,000
Residual income............................ P 150,000 P 200,000
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Application of Quantitative Techniques in Planning, Control and Decision Making II Chapter
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Requirement 3
No, Division B is simply larger than Division A and for this reason one would
expect that it would have a greater amount of residual income. As stated in
the text, residual income cant be used to compare the performance of
divisions of different sizes. Larger divisions will almost always look better,
not necessarily because of better management but because of the larger peso
figures involved. In fact, in the case above, Division B does not appear to be
as well managed as Division A. Note from Part (2) that Division B has only
an 18 percent ROI as compared to 21 percent for Division A.
Requirement 1
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Computation of ROI
Division A:
P300,000 P6,000,000
ROI = x = 5% x 4 = 20%
P6,000,000 P1,500,000
Division B:
P900,000 P10,000,000
ROI = x = 9% x 2 = 18%
P10,000,000 P5,000,000
Division C:
P180,000 P8,000,000
ROI = P8,000,000 x P2,000,000 = 2.25% x 4 = 9%
Requirement 2
Requirement 3
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Application of Quantitative Techniques in Planning, Control and Decision Making II Chapter
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If performance is being measured by ROI, both Division A and Division B
probably would reject the 17% investment opportunity. The reason is that
these companies are presently earning a return greater than 17%; thus, the
new investment would reduce the overall rate of return and place the divisional
managers in a less favorable light. Division C probably would accept the
17% investment opportunity, since its acceptance would increase the
Divisions overall rate of return.
Requirement 1
Division A Division B Total Company
Sales P3,500,000 1
P2,400,000 2
P5,200,000 3
Less expenses:
Added by the division 2,600,000 1,200,000 3,800,000
Transfer price paid 700,000
Total expenses 2,600,000 1,900,000 3,800,000
Net operating income P 900,000 P 500,000 P1,400,000
1
20,000 units P175 per unit = P3,500,000.
2
4,000 units P600 per unit = P2,400,000.
3
Division A outside sales (16,000 units P175 per unit).......................................................
P2,800,000
Division B outside sales (4,000 units P600 per unit)........................................................
2,400,000
Total outside sales..................................................................................................................
P5,200,000
Observe that the P700,000 in intracompany sales has been eliminated.
Requirement 2
Division A should transfer the 1,000 additional units to Division B. Note that
Division Bs processing adds P425 to each units selling price (Bs P600
selling price, less As P175 selling price = P425 increase), but it adds only
P300 in cost. Therefore, each tube transferred to Division B ultimately yields
P125 more in contribution margin (P425 P300 = P125) to the company than
can be obtained from selling to outside customers. Thus, the company as a
whole will be better off if Division A transfers the 1,000 additional tubes to
Division B.
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making -
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Exercise 8 (Transfer Pricing Situations)
Requirement 1
The lowest acceptable transfer price from the perspective of the selling
division is given by the following formula:
Total contribution margin
Variable cost on lost sales
Transfer price per unit + Number of units transferred
.
There is no idle capacity, so each of the 20,000 units transferred from
Division X to Division Y reduces sales to outsiders by one unit. The
contribution margin per unit on outside sales is P20 (= P50 P30).
P20 x 20,000
Transfer price (P30 P2) + 20,000
Transfer price = P28 + P20 = P48
The buying division, Division Y, can purchase a similar unit from an outside
supplier for P47. Therefore, Division Y would be unwilling to pay more than
P47 per unit.
The requirements of the two divisions are incompatible and no transfer will
take place.
Requirement 2
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Application of Quantitative Techniques in Planning, Control and Decision Making II Chapter
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In this case, the requirements of the two divisions are compatible and a
transfer will hopefully take place at a transfer price within the range:
Requirement 1
Assuming Division B has no outside sales, Division A should buy inside from
Division B for the benefit of the entire firm.
Requirement 2
The additional savings in Division B means that now Division A should buy
outside.
Requirement 3
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Requirement (1)
Net operating income
Margin = Sales
P5,400,000
= P18,000,000 = 30%
Requirement (2)
Sales
Turnover = Average operating assets
P18,000,000
= P36,000,000 = 0.5
Requirement (3)
III. Problems
Requirement (a)
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For the Year Ended December 31, 2005
Requirement (b)
The complaint of the manager of Product T is justified on the ground that his
product line shows a positive contribution margin and therefore, contributes to
the recovery of non-controllable fixed expenses. This observation is, of
course, made under the assumption that the preceding years figures (which
are not given) were less favorable than the current year.
Requirement 1
Product
A B C
Incremental sales P71,000 P46,000 P117,000
Less: Incremental costs 42,000 15,000 96,000
Net income P29,000 P31,000 P 21,000
Requirement 2
The sunk costs are:
Depreciation of equipment P 6,400
Operating cost of the equipment 4,600
Total P11,000
Requirement 3
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Opportunity cost of selling Product B is
From Product A P29,000
From Product C 21,000
Total P50,000
Requirement 1
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The cost of raw materials rose significantly, possibly because of (1) deficient
machinery due to the cutback in maintenance expenditures and/or (2) to the
lower labor cost, possibly due to the use of less-skilled workers. Supplies
decreased, indicating possible inadequacies for next periods production run.
Requirement 2
Requirement 1
Requirement 2
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making -
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Units 1,500 2,000 1,000
Revenues P810 P1,080 P540
Note how the change in income follows the change in revenues, as predicted
by operating leverage. Operating leverage multiplied times the percentage
change in sales gives the percentage change in income. Thus, the greater the
operating leverage ratio, the larger the effect on income and ROI of a given
percentage change in sales. This exercise provides an opportunity to review
the relationship between volume and profit. See the illustration below:
% change in income
If volume goes to 2,000 units: (P280 P160) / P160 = 75%
If volume goes to 1,000 units: (P160 P40) / P160 = 75%
% change in ROI
If volume goes to 2,000 units: (35% - 20%) / 20% = 75%
If volume goes to 1,000 units: (20% - 5%) / 20% = 75%
Requirement 1
ROI computations:
Net operating income Sales
Sales Average operating assets
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ROI = x
Requirement 2
Pasig Quezon
Average operating assets (a) P3,000,000 P10,000,000
Net operating income P 630,000 P1,800,000
Minimum required return on average
operating assets16% (a) 480,000 P 1,600,000
Residual income P 150,000 P 200,000
Requirement 3
No, the Quezon Division is simply larger than the Pasig Division and for this
reason one would expect that it would have a greater amount of residual
income. Residual income cant be used to compare the performance of
divisions of different sizes. Larger divisions will almost always look better,
not necessarily because of better management but because of the larger peso
figures involved. In fact, in the case above, Quezon does not appear to be as
well managed as Pasig. Note from Part (1) that Quezon has only an 18% ROI
as compared to 21% for Pasig.
Requirement 1
Since the Valve Division has idle capacity, it does not have to give up any
outside sales to take on the Pump Divisions business. Applying the formula
P0
Transfer price P16 + =
10,000
P16
The Pump Division would be unwilling to pay more than P29, the price it is
currently paying an outside supplier for its valves. Therefore, the transfer
price must fall within the range:
Requirement 2
Since the Valve Division is selling all of the valves that it can produce on the
outside market, it would have to give up some of these outside sales to take on
the Pump Divisions business. Thus, the Valve Division has an opportunity
cost, which is the total contribution margin on lost sales:
Total contribution margin
Variable cost on lost sales
Transfer price per unit + Number of units transferred
= P16 + P14 =
P30
Since the Pump Division can purchase valves from an outside supplier at only
P29 per unit, no transfers will be made between the two divisions.
Requirement 3
Applying the formula for the lowest acceptable price from the viewpoint of the
selling division, we get:
Total contribution margin
Variable cost on lost sales
Transfer price per unit + Number of units transferred
= P13 + P14 =
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In this case, the transfer price must fall within the range:
To produce the 20,000 special valves, the Valve Division will have to give up
sales of 30,000 regular valves to outside customers. Applying the formula for
the lowest acceptable price from the viewpoint of the selling division, we get:
Total contribution margin
Variable cost on lost sales
Transfer price per unit + Number of units transferred
= P20 + P21 =
P41
Problem 9 (Effects of Changes in Sales, Expenses, and Assets in ROI)
P800,000
= P8,000,000 = 10%
2. Sales
Turnover = Average operating assets
P8,000,000
= P3,200,000 = 2.5
3.
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ROI = Margin x Turnover
= 10% x 2.5 = 25%
Requirement (1)
a. The lowest acceptable transfer price from the perspective of the selling
division, the Electrical Division, is given by the following formula:
Because there is enough idle capacity to fill the entire order from the
Motor Division, there are no lost outside sales. And because the variable
cost per unit is P21, the lowest acceptable transfer price as far as the
selling division is concerned is also P21.
c. Combining the requirements of both the selling division and the buying
division, the acceptable range of transfer prices in this situation is:
P21 : Transfer price : P38
Assuming that the managers understand their own businesses and that they
are cooperative, they should be able to agree on a transfer price within this
range and the transfer should take place.
d. From the standpoint of the entire company, the transfer should take place.
The cost of the transformers transferred is only P21 and the company
saves the P38 cost of the transformers purchased from the outside
supplier.
Requirement (2)
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a. Each of the 10,000 units transferred to the Motor Division must displace a
sale to an outsider at a price of P40. Therefore, the selling division would
demand a transfer price of at least P40. This can also be computed using
the formula for the lowest acceptable transfer price as follows:
Transfer price = P21 + (P40 P21) x 10,000
10,000
c. The requirements of the selling and buying divisions in this instance are
incompatible. The selling division must have a price of at least P40
whereas the buying division will not pay more than P38. An agreement to
transfer the transformers is extremely unlikely.
d. From the standpoint of the entire company, the transfer should not take
place. By transferring a transformer internally, the company gives up
revenue of P40 and saves P38, for a loss of P2.
Requirement (1)
The lowest acceptable transfer price from the perspective of the selling
division is given by the following formula:
Total contribution margin
Variable cost + on lost sales
Transfer price =
per unit Number of units transferred
The Tuner Division has no idle capacity, so transfers from the Tuner Division
to the Assembly Division would cut directly into normal sales of tuners to
outsiders. The costs are the same whether a tuner is transferred internally or
sold to outsiders, so the only relevant cost is the lost revenue of P200 per tuner
that could be sold to outsiders. This is confirmed below:
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The Assembly Division can buy tuners from an outside supplier for P200, less
a 10% quantity discount of P20, or P180 per tuner. Therefore, the Division
would be unwilling to pay more than P180 per tuner.
Requirement (2)
The price being paid to the outside supplier, net of the quantity discount, is
only P180. If the Tuner Division meets this price, then profits in the Tuner
Division and in the company as a whole will drop by P600,000 per year:
Requirement (3)
The Tuner Division has idle capacity, so transfers from the Tuner Division to
the Assembly Division do not cut into normal sales of tuners to outsiders. In
this case, the minimum price as far as the Assembly Division is concerned is
the variable cost per tuner of P11. This is confirmed in the following
calculation:
Transfer price = P110 + P0 = P110
30,000
The Assembly Division can buy tuners from an outside supplier for P180 each
and would be unwilling to pay more than that in an internal transfer. If the
managers understand their own businesses and are cooperative, they should
agree to a transfer and should settle on a transfer price within the range:
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Requirement (4)
Yes, P160 is a bona fide outside price. Even though P160 is less than the
Tuner Divisions P170 full cost per unit, it is within the range given in Part
3 and therefore will provide some contribution to the Tuner Division.
If the Tuner Division does not meet the P160 price, it will lose P1,500,000 in
potential profits:
This P1,500,000 in potential profits applies to the Tuner Division and to the
company as a whole.
Requirement (5)
No, the Assembly Division should probably be free to go outside and get the
best price it can. Even though this would result in lower profits for the
company as a whole, the buying division should probably not be forced to
purchase inside if better prices are available outside.
Requirement (6)
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So long as the selling division has idle capacity and the transfer price is
greater than the selling divisions variable costs, profits in the company as a
whole will increase if internal transfers are made. However, there is a question
of fairness as to how these profits should be split between the selling and
buying divisions. The inflexibility of management in this situation damages the
profits of the Assembly Division and greatly enhances the profits of the Tuner
Division.
Requirement (1)
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Division for P90 each. The Electronics Division must give up revenues of
P125.00 on each circuit board that it sells internally. Since management
performance in the Electronics Division is measured by ROI and dollar
profits, selling the circuit boards to the Clock Division for P9 would adversely
affect these performance measurements.
Requirement (2)
The key is to realize that the P100 in fixed overhead and administrative costs
contained in the Clock Divisions P697.50 cost per timing device is not
relevant. There is no indication that winning this contract would actually
affect any of the fixed costs. If these costs would be incurred regardless of
whether or not the Clock Division gets the oven timing device contract, they
should be ignored when determining the effects of the contract on the
companys profits. Another key is that the variable cost of the Electronics
Division is not relevant either. Whether the circuit boards are used in the
timing devices or sold to outsiders, the production costs of the circuit boards
would be the same. The only difference between the two alternatives is the
revenue on outside sales that is given up when the circuit boards are
transferred within the company.
Therefore, the company as a whole would be better off by P67.50 for each
timing device that is sold to the oven manufacturer.
Requirement (3)
As shown in part (1) above, the Electronics Division would insist on a transfer
price of at least P125.00 for the circuit board. Would the Clock Division make
any money at this price? Again, the fixed costs are not relevant in this decision
since they would not be affected. Once this is realized, it is evident that the
Clock Division would be ahead by P67.50 per timing device if it accepts the
P125.00 transfer price.
Selling price of the timing devices................................................................
P700.00
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Less:
Purchased parts (from outside vendors)....................................................
P300.00
Circuit board KK8 (assumed transfer price).............................................
125.00
Other variable costs.................................................................................
207.50 632.50
Clock Division contribution margin............................................................. P 67.50
In fact, since the contribution margin is P62.50, any transfer price within the
range of P125.00 to P192.50 (= P125.00 + P67.50) will improve the profits of
both divisions. So yes, the managers should be able to agree on a transfer
price.
Requirement (4)
It is in the best interests of the company and of the divisions to come to an
agreement concerning the transfer price. As demonstrated in part (3) above,
any transfer price within the range P125.00 to P192.50 would improve the
profits of both divisions. What happens if the two managers do not come to an
agreement?
In this case, top management knows that there should be a transfer and could
step in and force a transfer at some price within the acceptable range.
However, such an action, if done on a frequent basis, would undermine the
autonomy of the managers and turn decentralization into a sham.
Our advice to top management would be to ask the two managers to meet to
discuss the transfer pricing decision. Top management should not dictate a
course of action or what is to happen in the meeting, but should carefully
observe what happens in the meeting. If there is no agreement, it is important
to know why. There are at least three possible reasons. First, the managers
may have better information than the top managers and refuse to transfer for
very good reasons. Second, the managers may be uncooperative and unwilling
to deal with each other even if it results in lower profits for the company and
for themselves. Third, the managers may not be able to correctly analyze the
situation and may not understand what is actually in their own best interests.
For example, the manager of the Clock Division may believe that the fixed
overhead and administrative cost of P100 per timing device really does have to
be covered in order to avoid a loss.
If the refusal to come to an agreement is the result of uncooperative attitudes
or an inability to correctly analyze the situation, top management can take
some positive steps that are completely consistent with decentralization. If the
problem is uncooperative attitudes, there are many training companies that
would be happy to put on a short course in team building for the company. If
the problem is that the managers are unable to correctly analyze the
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alternatives, they can be sent to executive training courses that emphasize
economics and managerial accounting.
CHAPTER 15
I. Questions
1. No. Planning and control are different, although related, concepts.
Planning involves developing objectives and formulating steps to achieve
those objectives. Control, by contrast, involves the means by which
management ensures that the objectives set down at the planning stage are
attained.
2. Budgets have a dual purpose, for planning and for following up the
implementation of the plan. The great benefits from budgeting lie in the
quick investigation of deviations and in the subsequent corrective action.
Budgets should not be prepared in the first place if they are ignored,
buried in files, or improperly interpreted.
3. Two major features of a budgetary program are (1) the accounting
techniques which developed it and (2) the human factors which administer
it. The human factors are far more important. The success of a
budgetary system depends upon its acceptance by the company members
who are affected by the budget. Without a thoroughly educated and
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cooperative management group at all levels of responsibility, budgets are a
drain on the funds of the business and are a hindrance instead of help to
efficient operations.
4. Manufacturing overhead costs are budgeted at normal operating capacity,
and the costs are applied to the products using a predetermined rate. The
predetermined rate is computed by dividing a factor that can be identified
with both the products and the overhead into the overhead budgeted at the
normal operating capacity. Budgets may also be used in costing products
in a standard cost accounting system.
5. The production division operates to produce the products that are sold.
Production and sales must be coordinated. Products must be
manufactured so that they will be available to meet sales delivery dates.
Activity of the production division will depend upon the sales that can be
made. Also, the sales division is limited by the capabilities of the
production department in manufacturing products. Successful operations
depend upon a coordination of sales and production.
6. Labor hour required for production can be translated into labor pesos by
multiplying the number of hours budgeted by the appropriate labor rates.
The rates to be used will depend upon the rates established for job
classifications and the policy with respect to premium pay for overtime or
shift differences.
7. A long-range plan for the acquisition of plant assets is broken down and
entered in the current budget as the plan unfolds. The portion of the plan
which is to be executed in the next year is included in the budget for that
year.
8. A budget period is not limited to any particular unit of time. At a
minimum, a budget should cover at least one operating cycle. For
example, a budget should not cover a period when purchasing activity is
high and omit the period when sales volume and cash collection are
relatively high. The budget period should encompass the entire cycle
extending from the purchasing operation to the subsequent sale of the
products and the realization of the sales in cash. Ordinarily, a budget of
operations is prepared for a year which in turn is divided into quarters and
months. Long-term budgets, such as budgets for projects or capital
investments, may extend five to ten years or more into the future.
9. A rolling budget or a progressive budget or sometimes called continuous
budget, is a budget which is prepared throughout the year. As one month
elapses, a budget is prepared for one more month in the future. At any
one time for example, the company will have a budget for one year into
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the future, when July of one year is over, a budget for the following July
will be added at the other end of the budget. This process of adding a new
month as a month expires is continuous.
10. Variances that are revealed by a comparison of actual results with a
budget are investigated if it appears that an investigation is warranted.
The investigation may show that stricter control measures are needed or
that some weaknesses in the operation should be corrected. It may also
reveal that the budget plan should be revised. The comparison is one step
in the control and direction of business operations.
11. A comparison of actual results with a budget can contribute information
that can be applied in the preparation of better budgets in the future.
Subsequent investigation of variances provides management with a better
knowledge of operations. This knowledge can be applied in the
preparation of more realistic budgets for subsequent fiscal periods.
12. A self-imposed budget is one in which persons with responsibility over
cost control prepare their own budgets, i.e., the budget is not imposed
from above. The major advantages are: (1) the views and judgments of
persons from all levels of an organization are represented in the final
budget document; (2) budget estimates generally are more accurate and
reliable, since they are prepared by those who are closest to the problems;
(3) managers generally are more motivated to meet budgets which they
have participated in setting; (4) self-imposed budgets reduce the amount
of upward blaming resulting from inability to meet budget goals. One
caution must be exercised in the use of self-imposed budgets. The budgets
prepared by lower-level managers should be carefully reviewed to prevent
too much slack.
13. No, although this is clearly one of the purposes of the cash budget. The
principal purpose is to provide information on probable cash needs during
the budget period, so that bank loans and other sources of financing can
be anticipated and arranged well in advance of the actual time of need.
14. Zero-based budgeting requires that managers start at zero levels every
year and justify all costs as if all programs were being proposed for the
first time. In traditional budgeting, by contrast, budget data are usually
generated on an incremental basis, with last years budget being the
starting point.
15. A budget is a detailed quantitative plan for the acquisition and use of
financial and other resources over a given time period. Budgetary control
involves the use of budgets to control the actual activities of a firm.
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16. 1. Budgets communicate managements plans throughout the
organization.
2. Budgets force managers to think about and plan for the future.
3. The budgeting process provides a means of allocating resources to
those parts of the organization where they can be used most
effectively.
4. The budgeting process can uncover potential bottlenecks before they
occur.
5. Budgets coordinate the activities of the entire organization by
integrating the plans of its various parts. Budgeting helps to ensure
that everyone in the organization is pulling in the same direction.
6. Budgets define goals and objectives that can serve as benchmarks for
evaluating subsequent performance.
17. A master budget represents a summary of all of managements plans and
goals for the future, and outlines the way in which these plans are to be
accomplished. The master budget is composed of a number of smaller,
specific budgets encompassing sales, production, raw materials, direct
labor, manufacturing overhead, selling and administrative expenses, and
inventories. The master budget generally also contains a budgeted income
statement, budgeted balance sheet, and cash budget.
18. The flow of budgeting information moves in two directionsupward and
downward. The initial flow should be from the bottom of the organization
upward. Each person having responsibility over revenues or costs should
prepare the budget data against which his or her subsequent performance
will be measured. As the budget data are communicated upward, higher-
level managers should review the budgets for consistency with the overall
goals of the organization and the plans of other units in the organization.
Any issues should be resolved in discussions between the individuals who
prepared the budgets and their managers.
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II. Matching Type
1. C 6. A
2. H 7. B
3. E 8. J
4. F 9. D
5. I 10. G
III. Exercises
Requirement 1
Notice that even though sales peak in August, cash collections peak in
September. This occurs because the bulk of the companys customers pay in
the month following sale. The lag in collections that this creates is even more
pronounced in some companies. Indeed, it is not unusual for a company to
have the least cash available in the months when sales are greatest.
Requirement 2
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Septembe
July August r Quarter
Budgeted sales in units 30,000 45,000 60,000 135,000
Add desired ending inventory* 4,500 6,000 5,000 5,000
Total needs 34,500 51,000 65,000 140,000
Less beginning inventory 3,000 4,500 6,000 3,000
Required production 31,500 46,500 59,000 137,000
* 10% of the following months sales
Year 2
First Second Third Fourth Year
Production needschips 180,000 270,000 450,000 300,000 1,200,000
Add desired ending inventory
chips 54,000 90,000 60,000 48,000 48,000
Total needschips 234,000 360,000 510,000 348,000 1,248,000
Less beginning inventorychips 36,000 54,000 90,000 60,000 36,000
Required purchaseschips 198,000 306,000 420,000 288,000 1,212,000
Cost of purchases at P2 per chip P396,000 P612,000 P840,000 P576,000 P2,424,000
Requirement 1
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Direct labor time per unit (hours)
0.40 0.40 0.40 0.40 0.40
Total direct labor hours needed 2,000 1,760 1,800 1,960 7,520
Direct labor cost per hour P11.00 P11.00 P11.00 P11.00 P11.00
Total direct labor cost P 22,000 P 19,360 P 19,800 P 21,560 P 82,720
Requirement 2
Assuming that the direct labor workforce is not adjusted each quarter and that
overtime wages are paid, the direct labor budget would be:
Requirement 1
Kiko Corporation
Manufacturing Overhead Budget
Requirement 2
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Predetermined overhead rate for the year (a) (b) P 8.61
Helene Company
Selling and Administrative Expense Budget
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Financing:
Borrowings 8 20 * 28
Repayments (including
interest) 0 0 (25) (7)* (32)
Total financing 8 20 (25) (7) (4)
Cash balance, ending P5 P 5 P 5 P 6 P 6
*Given.
IV. Problems
Requirement 1
Requirement 2
Payments to suppliers:
August purchases (accounts payable)..................................................................
P16,000
September purchases: P25,000 20%.................................................................
5,000
Total cash payments................................................................................................
P21,000
Requirement 3
COOKIE PRODUCTS
Cash Budget
For the Month of September
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Selling and administrative expenses.....................................................................
9,000 *
Equipment purchases...........................................................................................
18,000
Dividends paid.....................................................................................................
3,000
Total disbursements.................................................................................................
51,000
Excess (deficiency) of cash available over
disbursements......................................................................................................
(6,000)
Financing:
Borrowings..........................................................................................................
11,000
Repayments.........................................................................................................
0
Interest.................................................................................................................
0
Total financing.........................................................................................................
11,000
P5,000
Cash balance, September 30....................................................................................
* P13,000 P4,000 = P9,000.
Requirement 1
Production budget:
Septembe
July August r October
Budgeted sales (units) 40,000 50,000 70,000 35,000
Add desired ending inventory 20,000 26,000 15,500 11,000
Total needs 60,000 76,000 85,500 46,000
Less beginning inventory 17,000 20,000 26,000 15,500
Required production 43,000 56,000 59,500 30,500
Requirement 2
Requirement 3
* 30,500 units (October production) 3 lbs. per unit= 91,500 lbs.; 91,500 lbs.
0.5 = 45,750 lbs.
Requirement 1
Cash salesJune.....................................................................................................
P60,000
Collections on accounts receivable:
May 31 balance...................................................................................................
72,000
June (50% 190,000).........................................................................................
95,000
Total cash receipts...................................................................................................
P227,000
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Total cash available.................................................................................................
235,000
Less disbursements:
Purchase of inventory (above)..............................................................................
170,000
Operating expenses..............................................................................................
51,000
Purchases of equipment.......................................................................................
9,000
Total cash disbursements.........................................................................................
230,000
Excess of receipts over disbursements.....................................................................
5,000
Financing:
Borrowingsnote................................................................................................
18,000
Repaymentsnote...............................................................................................
(15,000)
Interest.................................................................................................................
(500)
Total financing.........................................................................................................
2,500
Cash balance, ending...............................................................................................
P 7,500
Requirement 2
Sales........................................................................................................................
P250,000
Cost of goods sold:
P 30,000
Beginning inventory.............................................................................................
Add purchases.....................................................................................................
200,000
Goods available for sale.......................................................................................
230,000
Ending inventory..................................................................................................
40,000
Cost of goods sold...............................................................................................
190,000
Gross margin...........................................................................................................
60,000
Operating expenses (P51,000 + P2,000).................................................................. 53,000
Net operating income...............................................................................................
7,000
Interest expense.......................................................................................................
500
Net income..............................................................................................................
P 6,500
Requirement 3
Assets
Cash........................................................................................................................
P 7,500
Accounts receivable (50% 190,000)..................................................................... 95,000
Inventory.................................................................................................................
40,000
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Buildings and equipment, net of depreciation
(P500,000 + P9,000 P2,000)............................................................................
507,000
Total assets..............................................................................................................
P649,500
Requirement 1
Units Amount
First quarter 16,000 P 480,000
Second quarter 20,000 600,000
Third quarter 22,000 660,000
Fourth quarter 22,000 660,000
Total 80,000 P2,400,000
Requirement 2
Quarter
1st 2nd 3rd 4th Total
Units to be sold 16,000 20,000 22,000 22,000 80,000
Add: Desired ending inventory (20%) 4,000 4,400 4,400 5,000 5,000
Total units required 20,000 24,400 26,400 27,000 85,000
Less: Beginning inventory 3,000 4,000 4,400 4,400 3,000
Units to be produced 17,000 20,400 22,000 22,600 82,000
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Requirement 3
Quarter
1st 2nd 3rd 4th Total
Units required for production 51,000 61,200 66,000 67,800 246,000
Add: Desired ending inventory 12,240 13,200 13,560 15,000 15,000
Total units 63,240 74,400 79,560 82,800 261,000
Less: Beginning inventory 12,500 12,240 13,200 13,560 12,500
Raw Materials to be Purchased 50,740 62,160 66,360 69,240 248,500
Requirement 1
Month
April May June Quarter
From accounts receivable P141,000 P 7,200 P148,200
From April sales:
20% 200,000 40,000 40,000
75% 200,000 150,000 150,000
4% 200,000 P 8,000 8,000
Requirement 2
Cash budget:
Month
April May June Quarter
Cash balance, beginning P 26,000 P 27,000 P 20,200 P 26,000
Add receipts:
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Collections from
customers 181,000 217,200 283,000 681,200
Total available 207,000 244,200 303,200 707,200
Less disbursements:
Merchandise purchases
108,000 120,000 180,000 408,000
Payroll 9,000 9,000 8,000 26,000
Lease payments 15,000 15,000 15,000 45,000
Advertising 70,000 80,000 60,000 210,000
Equipment purchases 8,000 8,000
Total disbursements 210,000 224,000 263,000 697,000
Excess (deficiency) of
receipts over
disbursements (3,000) 20,200 40,200 10,200
Financing:
Borrowings 30,000 30,000
Repayments (30,000) (30,000)
Interest (1,200) (1,200)
Total financing 30,000 (31,200) (1,200)
Cash balance, ending P 27,000 P 20,200 P 9,000 P 9,000
Requirement 3
Capacity
100% 90% 80% 70% 60%
Machine Hours 200,000 180,000 160,000 140,000 120,000
Variable Overhead P1,300,000 P1,170,000 P1,040,000 P 910,000 P 780,000
Fixed Overhead 300,000 300,000 300,000 300,000 300,000
Total P1,600,000 P1,470,000 P1,340,000 P1,210,000 P1,080,000
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Capacity
100% 90% 80% 70% 60%
Direct Labor Hours 200,000 180,000 160,000 140,000 120,000
Machine Hours 400,000 360,000 320,000 280,000 240,000
Variable Overhead P1,400,000 P1,260,000 P1,120,000 P 980,000 P 840,000
Fixed Overhead 500,000 500,000 500,000 500,000 500,000
Total P1,900,000 P1,760,000 P1,620,000 P1,480,000 P1,340,000
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P P P
Cash balance, ending..................................8,410 8,020 9,265 P 9,265
* P10,000 1% 3 = P300
P4,000 1% 2 = 80
P380
1. B 11. C 21. C
2. B 12. B 22. C
3. C 13. C 23. D
4. E 14. B 24. C
5. C 15. D 25. C
6. C 16. C 26. C
7. D 17. A 27. D
8. C 18. B 28. A
9. A 19. E 29. C
10. D 20. B 30. D
Supporting computations:
Questions 16 to 20:
January February
Cost of sales P1,400,000 P1,640,000
Add: Desired Minimum Inventory 492,000 456,000
Total 1,892,000 2,096,000
Less: Beginning Inventory (1,400,000 x 0.3) (17) 420,000 492,000
Gross Purchases (16) 1,472,000 1,604,000
Less: Cash discount 14,720 16,040
Net cost of purchases P1,457,280 P1,587,960
Payments of Purchases
60% - month of purchase P874,368 P 952,776
40% - following month 582,912
Total (18) P1,535,688
(19)
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February
Cash
Gross Discount Net
Current months sales (with
discount) 35% P595,000 P11,900 P583,100
Current months sales (without
discount) 15% 255,000 0 255,000
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(23)Cash Receipts for February 2005
From February sales (60% x 110,000) P 66,000
From January sales 38,000
Total P104,000
Questions 26 to 29:
Schedule I
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Less: Raw materials inventory, Dec. 31 300,000
Raw materials used P 441,000
Direct labor 588,000
Manufacturing overhead 441,000 (28)
Total Manufacturing Cost P1,470,000 (27)
Add: Work-in-process inventory, Jan. 1 200,000
Total P1,670,000
Less: Work-in-process inventory, Dec. 31 320,000
Cost of goods manufactured P1,350,000
CHAPTER 16
I. Questions
1. Standard costs are superior to past data for comparison with actual costs
because they ask the question Is present performance better than the
past?.
2. No. Cost control and cost reduction are not the same, but cost reduction
does affect the standards which are used as basis for cost control. Cost
reduction means finding ways to achieve a given result through improved
design, better methods, new layouts and so forth. Cost reduction results
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in setting new standards. On the other hand, cost control is a process of
maintaining performance at or as new existing standards as is possible.
3. Managerial judgment is the basis for deciding whether a given variance is
large enough to warrant investigation. For some items, a small amount of
variance may spark scrutiny. For some items, 5%, 10% or 25% variances
from standard may call for follow-up. Management may also derive the
standard deviation based on past cost data.
4. The techniques for overhead control differ because
1) The size of individual overhead costs usually does not justify
elaborate individual control systems;
2) The behavior of individual overhead item is either impossible or
difficult to trace to specific lots or operations; and
3) Various overhead items are the responsibility of different people.
5. In the year-to-year planning of fixed costs, managers must consider:
1) the projected maximum and minimum levels of activity,
2) prices of cost factors, and
3) changes in facilities and organization.
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9. Under management by exception, managers focus their attention on
operating results that deviate from expectations. It is assumed that results
that meet expectations do not require investigation.
10. Separating an overall variance into a price variance and a quantity
variance provides more information. Moreover, prices and quantities are
usually the responsibilities of different managers.
11. The materials price variance is usually the responsibility of the purchasing
manager. The materials quantity variance is usually the responsibility of
the production managers and supervisors. The labor efficiency variance
generally is also the responsibility of the production managers and
supervisors.
12. If used as punitive tools, standards can breed resentment in an
organization and undermine morale. Standards must never be used as an
excuse to conduct witch-hunts, or as a means of finding someone to blame
for problems.
13. Several factors other than the contractual rate paid to workers can cause a
labor rate variance. For example, skilled workers with high hourly rates
of pay can be given duties that require little skill and that call for low
hourly rates of pay, resulting in an unfavorable rate variance. Or
unskilled or untrained workers can be assigned to tasks that should be
filled by more skilled workers with higher rates of pay, resulting in a
favorable rate variance. Unfavorable rate variances can also arise from
overtime work at premium rates.
14. Poor quality materials can unfavorably affect the labor efficiency
variance. If the materials create production problems, a result could be
excessive labor time and therefore an unfavorable labor efficiency
variance. Poor quality materials would not ordinarily affect the labor rate
variance.
15. If labor is a fixed cost and standards are tight, then the only way to
generate favorable labor efficiency variances is for every workstation to
produce at capacity. However, the output of the entire system is limited
by the capacity of the bottleneck. If workstations before the bottleneck in
the production process produce at capacity, the bottleneck will be unable
to process all of the work in process. In general, if every workstation is
attempting to produce at capacity, then work in process inventory will
build up in front of the workstations with the least capacity.
16. A quantity standard indicates how much of an input should be used to
make a unit of output. A price standard indicates how much the input
should cost.
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17. Chronic inability to meet a standard is likely to be demoralizing and may
result in decreased productivity.
18. A variance is the difference between what was planned or expected and
what was actually accomplished. A standard cost system has at least two
types of variances. A price variance focuses on the difference between the
standard price and the actual price of an input. A quantity variance is
concerned with the difference between the standard quantity of the input
allowed for the actual output and the actual amount of the input used.
1. E 3. C 5. A 7. J 9. I
2. G 4. H 6. D 8. B 10. F
III. Exercises
Requirement 1
Requirement 2
Beta ML12 required per capsule as per bill of materials.......................................... 6.00 grams
Add allowance for material rejected as unsuitable
(6 grams 0.96 = 6.25 grams;
6.25 grams 6.00 grams = 0.25 grams)..............................................................
0.25 grams
Total........................................................................................................................
6.25 grams
Add allowance for rejected capsules
(6.25 grams 25 capsules)..................................................................................
0.25 grams
Standard quantity of Beta ML12 per salable capsule............................................... 6.50 grams
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Requirement 3
Requirement 1
Actual Quantity of Inputs, at Actual Quantity of Inputs, at Standard Quantity Allowed for
Actual Price Standard Price Output, at Standard Price
(AQ AP) (AQ SP) (SQ SP)
P18,700 11,000 board feet 10,000 board feet
P1.80 per board foot P1.80 per board foot
= P19,800 = P18,000
Price Variance, Quantity Variance,
P1,100 F P1,800 U
Alternatively:
Materials Price Variance = AQ (AP SP)
11,000 board feet (P1.70 per board foot* P1.80 per board foot) =
P1,100 F
* P18,700 11,000 board feet = P1.70 per board foot.
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P1.80 per board foot (11,000 board feet 10,000 board feet) = P1,800 U
Requirement 1
Requirement 2
Actual Hours of Input, at Actual Hour of Input, at Standard Hours Allowed for
the Actual Rate Standard Rate Output, at the Standard Rate
(AH AR) (AH SR) (SH SR)
P49,300 8,500 hours P6 per hour 8,000 hours* P6 per hour
= P51,000 = P48,000
Rate Variance, Efficiency Variance,
P1,700 F P3,000 U
Alternative Solution:
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Requirement 3
Actual Hours of Input, at Actual Hour of Input, at Standard Hours Allowed for
the Actual Rate Standard Rate Output, at the Standard Rate
(AH AR) (AH SR) (SH SR)
P39,100 8,500 hours P4 per hour 8,000 hours P4 per hour
= P34,000 = P32,000
Spending Variance, Efficiency Variance,
P5,100 U P2,000 U
Requirement 1
If the total variance is P330 unfavorable, and if the rate variance is P150
favorable, then the efficiency variance must be P480 unfavorable, since the
rate and efficiency variances taken together always equal the total variance.
Knowing that the efficiency variance is P480 unfavorable, one approach to the
solution would be:
Efficiency Variance = SR (AH SH)
P6 per hour (AH 420 hours*) = P480 U
P6 per hour AH P2,520 = P480**
P6 per hour AH = P3,000
AH = 500 hours
* 168 batches 2.5 hours per batch = 420 hours
** When used with the formula, unfavorable variances are positive and
favorable variances are negative.
Requirement 2
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Knowing that 500 hours of labor time were used during the week, the actual
rate of pay per hour can be computed as follows:
Rate Variance = AH (AR SR)
500 hours (AR P6 per hour) = P150 F
500 hours AR P3,000 = P150*
500 hours AR = P2,850
AR = P5.70 per hour
* When used with the formula, unfavorable variances are positive and
favorable variances are negative.
2. Standard Hours
Actual Hours of Actual Hours of Input, at the Allowed for Output, at the
Input, at the Actual Rate Standard Rate Standard Rate
(AHAR) (AHSR) (SHSR)
1,150 hours 1,150 hours 1,200 hours
P10.00 per hour P9.50 per hour P9.50 per hour
= P11,500 = P10,925 = P11,400
Rate Variance, Efficiency Variance,
P575 U P475 F
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2. Standard Hours
Actual Hours of Actual Hours of Input, at the Allowed for Output, at the
Input, at the Actual Rate Standard Rate Standard Rate
(AHAR) (AHSR) (SHSR)
5,800 hours 5,800 hours 5,600 hours
P2.75 per hour* P2.80 per hour P2.80 per hour
= P15,950 = P16,240 = P15,680
Variable overhead spending Variable overhead
variance, P290 F efficiency variance, P560 U
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= P560 U
IV. Problems
Requirement 1
a.
Actual Quantity of Inputs, at Actual Quantity of Inputs, at Standard Quantity Allowed for
the Actual Price Standard Price Output, at the Standard Price
(AQ AP) (AQ SP) (SQ SP)
25,000 pounds x 25,000 pounds x 20,000 pounds* x
P2.95 per pound P2.50 per pound P2.50 per pound
= P73,750 = P62,500 = P50,000
Price Variance,
P11,250 U
19,800 pounds x P2.50 per pound
= P49,500
Quantity Variance,
P500 F
* 5,000 metal molds 4.0 pounds per metal mold = 20,000 pounds
Alternatively:
Materials Price Variance = AQ (AP SP)
25,000 pounds (P2.95 per pound P2.50 per pound) = P11,250 U
Materials Quantity Variance = SP (AQ SQ)
P2.50 per pound (19,800 pounds 20,000 pounds) = P500 F
b.
Actual Hours of Input, at Actual Hours of Input, at Standard Hours Allowed for
the Actual Rate the Standard Rate Output, at the Standard Rate
(AH AR) (AH SR) (SH SR)
3,600 hours x 3,600 hours x 3,000 hours* x
P8.70 per hour P9.00 per hour P9.00 per hour
= P31,320 = P32,400 = P27,000
Rate Variance, Efficiency Variance,
P1,080 F P5,400 U
* 5,000 metal molds 0.6 hour per metal mold = 3,000 hours
Alternatively:
Labor Rate Variance = AH (AR SR)
3,600 hours (P8.70 per hour P9.00 per hour) = P1,080 F
Labor Efficiency Variance = SR (AH SH)
P9.00 per hour (3,600 hours 3,000 hours) = P5,400 U
c.
Actual Hours of Input, at Actual Hours of Input, at Standard Hours Allowed for
the Actual Rate the Standard Rate Output, at the Standard Rate
(AH AR) (AH SR) (SH SR)
P4,320 1,800 hours P2 per hour 1,500 hours* P2 per hour
= P3,600 = P3,000
Spending Variance, Efficiency Variance,
P720 U P600 U
*5,000 metal molds 0.3 hours per metal mold = 1,500 hours
Alternatively:
Variable Overhead Spending Variance = AH (AR SR)
1,800 hours (P2.40 per hour* P2.00 per hour) = P720 U
* P4,320 1,800 hours = P2.40 per hour
Variable Overhead Efficiency Variance = SR (AH SH)
P2.00 per hour (1,800 hours 1,500 hours) = P600 U
Requirement 2
Summary of variances:
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The net unfavorable variance of P16,390 for the month caused the plants
variable cost of goods sold to increase from the budgeted level of P80,000 to
P96,390:
This P16,390 net unfavorable variance also accounts for the difference
between the budgeted net operating income and the actual net loss for the
month.
Requirement 3
The two most significant variances are the materials price variance and the
labor efficiency variance. Possible causes of the variances include:
Problem 2
Problem 3
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Material A (8,000 x P0.30) P2,400
Material B (2,400 x P0.20) 480
Material C (2,800 x P0.425) 1,190 P4,070
Less: Total actual input x Average
Standard price (13,200 x 0.30*) 3,960
Unfavorable Mix Variance P 110
P 720
* Average Standard price = 2,400 = P0.30
Requirement 1
a.
Actual Quantity of Inputs, at Actual Quantity of Inputs, at Standard Quantity Allowed for
Actual Price Standard Price Output, at Standard Price
(AQ AP) (AQ SP) (SQ SP)
21,120 yards x 21,120 yards x 19,200 yards* x
P3.35 per yard P3.60 per yard P3.60 per yard
= P70,752 = P76,032 = P69,120
Price Variance, Quantity Variance,
P5,280 F P6,912 U
Alternatively:
Materials Price Variance = AQ (AP SP)
21,120 yards (P3.35 per yard P3.60 per yard) = P5,280 F
Materials Quantity Variance = SP (AQ SQ)
P3.60 per yard (21,120 yards 19,200 yards) = P6,912 U
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Raw Materials (21,120 yards @ P3.60 per yard)....................................................
76,032
Materials Price Variance
(21,120 yards @ P0.25 per yard F).............................................................
5,280
Accounts Payable
(21,120 yards @ P3.35 per yard).................................................................
70,752
Requirement 2
a.
Actual Hours of Input, at Actual Hours of Input, at Standard Hours Allowed for
the Actual Rate the Standard Rate Output, at the Standard Rate
(AH AR) (AH SR) (SH SR)
6,720 hours* x 6,720 hours x 7,680 hours** x
P4.85 per hour P4.50 per hour P4.50 per hour
= P32,592 = P30,240 = P34,560
Rate Variance, Efficiency Variance,
P2,352 U P4,320 F
Alternatively:
Labor Rate Variance = AH (AR SR)
6,720 hours (P4.85 per hour P4.50 per hour) = P2,352 U
Labor Efficiency Variance = SR (AH SH)
P4.50 per hour (6,720 hours 7,680 hours) = P4,320 F
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Wages Payable (6,720 hours @ P4.85 per
hour)............................................................................................................
32,592
Requirement 3
Actual Hours of Input, at Actual Hours of Input, at Standard Hours Allowed for
the Actual Rate the Standard Rate Output, at the Standard Rate
(AH AR) (AH SR) (SH SR)
6,720 hours x 6,720 hours x 7,680 hours x
P2.15 per hour P1.80 per hour P1.80 per hour
P14,448 = P12,096 = P13,824
Spending Variance, Efficiency Variance,
P2,352 U P1,728 F
Requirement 4
No. This total variance is made up of several quite large individual variances,
some of which may warrant investigation. A summary of variances is shown
on the next page.
Materials:
Price variance P5,280 F
Quantity variance 6,912 U P1,632 U
Labor:
Rate variance 2,352 U
Efficiency variance 4,320 F 1,968 F
Variable overhead:
Spending variance 2,352 U
Efficiency variance 1,728 F 624 U
Net unfavorable variance P 288 U
Requirement 5
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The variances have many possible causes. Some of the more likely causes
include:
Materials variances:
Favorable price variance: Fortunate buy, inaccurate standards, inferior quality
materials, unusual discount due to quantity purchased, drop in market price.
Labor variances:
Unfavorable rate variance: Use of highly skilled workers, change in wage
rates, inaccurate standards, overtime.
CHAPTER 17
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APPLICATION OF QUANTITATIVE TECHNIQUES IN
PLANNING, CONTROL AND DECISION MAKING - I
I. Questions
1. a. Decision tree analysis provides a systematic framework for analyzing
a sequence of interrelated decisions which may be made over time.
Decision making is formulated in terms of the consequence of acts,
events and consequences because it is believed that present decisions
affect future profitability. The study and understanding of alternative
scenarios is encouraged with the use of decision tree analysis.
b. Advantages of Decision Tree Analysis
1. Clarifies the choices, risks, and monetary gains involved in an
investment problem.
2. Presents the relevant information more clearly.
3. Combines action choices with different possible events or results
of action which are partially affected by chance or other
uncontrollable circumstances.
4. Encourages the focus on the relationship between current and
future decisions.
5. Utilizes such analytical techniques as present value and
discounted cash flow.
6. Considers various alternatives with greater ease.
Weaknesses of Decision Tree Analysis
1. Not all events that can happen can be/are identified.
2. Not all the decisions that must be made on a subject under
analysis are listed because choices are usually not restricted to
two or three.
3. If a large number of choices is involved, decision tree analysis by
hand becomes complicated.
4. Uncertain alternatives are generally treated as if they were
discrete, well-defined possibilities.
2. Refer to page 665 of the textbook.
II. Multiple Choice Questions
CHAPTER 18
I. Questions
1. PERT is superior to Gantt Charts in complex projects because:
a. PERT charts are flexible and can reflect slippage or changes in plans,
but Gantt charts simply plot a bar chart against a calendar scale.
b. PERT charts reflect interdependencies among activities; Gantt charts
do not.
c. PERT charts reflect uncertainties or tolerances in the time estimates
for various activities; Gantt charts do not.
2. The use of PERT provides a structured foundation for planning complex
projects in sufficient detail to facilitate effective control.
A workable sequence of events that comprise the project are first
identified. Each key event should represent a task; then the interdependent
relationships between the events are structured.
After the network of events is constructed, cost and time parameters are
established for each package. Staffing plans are reviewed and analyzed.
The critical path computation identifies sequence of key events with
total time equal to the time allotted for the projects completion. Jobs
which are not on the critical path can be slowed down and the slack
resources available on these activities reallocated to activities on the
critical path.
Use of PERT permits sufficient scheduling of effort by functional areas
and by geographic location. It also allows for restructuring scheduling
efforts and redeployment of workers as necessary to compensate for
delays or bottlenecks. The probability of completing this complex project
on time and within the allotted budget is increased.
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3. Time slippage in noncritical activities may not warrant extensive
managerial analysis because of available slack, but activity cost usually
increases with time and should be monitored.
4. The critical path is the network path with the longest cumulative expected
activity time. It is critical because a slowdown along this path delays the
entire project.
5. Crashing the network means finding the minimum cost for completing the
project in minimum time in order to achieve an optimum tradeoff between
cost and time. The differential crash cost of an activity is the additional
cost of that activity for each period of time saved.
6. Slack is the amount of time an event can be delayed without affecting the
projects completion date. Slack can be utilized by management as a
buffer against bottlenecks that may occur on the critical path.
7. Unit gross margin are typically computed with an allocation of fixed
costs. Total fixed costs generally will not change with a change in volume
within the relevant range. Unitizing the fixed costs results in treating them
as though they are variable costs when, in fact, they are not. Moreover,
when multiple products are manufactured, the relative contribution
becomes the criterion for selecting the optimal product mix. Fixed costs
allocations can distort the relative contributions and result in a suboptimal
decision.
8. This approach will maximize profits only if there are no constraints on
production or sales, or if both products use all scarce resources at an
equal rate. Otherwise management would want to maximize the
contribution per unit of scarce resource.
9. The opportunity cost of a constraint is the cost of not having additional
availability of the constrained resources. This is also called a shadow
price.
10. The feasible production region is the area which contains all possible
combinations of production outputs. It is bounded by the constraints
imposed on production possibilities. The production schedule which
management chooses must come from the feasible production region.
11. The accountant usually supplies the contribution margin data that is used
in formulating a profit-maximizing objective function. In addition, the
accountant participates in the analysis of linear programming outputs by
assessing the costs of additional capacity or of changes in product mix.
12. a. Hourly fee for inventory audit (C)
b. Salary of purchasing supervisor (N)
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c. Costs to audit purchase orders and invoices (P)
d. Taxes on inventory (C)
e. Stockout costs (P)
f. Storage costs charged per unit in inventory (C)
g. Fire insurance on inventory (C)
h. Fire insurance on warehouse (N)
i. Obsolescence costs on inventory (C)
j. Shipping costs per shipment (P)
13. Although the inventory models are developed by operations researchers,
statisticians and computer specialists, their areas of expertise do not
extend to the evaluation of the differential costs for the inventory models.
Generally, discussions of inventory models take the costs as given. It is
the role of the accountant to determine which costs are appropriate for
inclusion in an inventory model.
14. Cost of capital represents the interest expense on funds if they were
borrowed or opportunity cost if funds were provided internally or by
owners. It is included as carrying cost of inventory because funds are tied
up in inventory.
15. Costs that vary with the average number of units in inventory:
Inventory insurance P 2.80
Inventory tax 2.05 (P102.25 x 2%)
Total P 4.85
Costs that vary with the number of units purchased:
Purchase price P102.25
Insurance on shipment 1.50
Total P103.75
Total carrying cost = (25% x P103.75) cost of capital + P4.85 = P25.94 +
P4.85 = P30.79
Order costs:
Shipping permit P201.65
Costs to arrange for the shipment 21.45
Unloading 80.20
Stockout costs 122.00
Total P425.30
II. Problems
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Problem 2
Requirement (a)
The critical path through each of the three alternative paths calculated as the
longest is 0 - 1 - 6- 7- 8.
0-1-2-5-8 2 + 8 + 10 + 14 = 34
0-1-3-4-7-8 2+8+7+5+3 = 25
0-1-6-7-8 2 + 26 + 9 + 3 = 40*
________
* critical
Requirement (b)
40 - 3 - 5 = 32
Requirement (c)
If path 4 - 7 has an unfavorable time variance of 10, this means it takes a total
time of 15 to finish this activity rather than 5. This gives the path 0 - 1 - 3 - 4
- 7 - 8 a total time of 35, but since this is less than the critical path of 40, it
has no effect.
Requirement (d)
The earliest time for reaching event 5 via 0 - 1 - 2 - 5 is 20, the sum of the
expected times.
Problem 3
No, they didnt make a right decision, since they included fixed costs which do
not differ in the short run. If they had used contribution margin instead of
gross margin, they would have had P5 for G1 and P6.50 for G2, therefore
they would have decided to produce G2 exclusively.
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Problem 1
Requirement (a)
TASKS 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28
___________
X Dead Time
Requirement (b)
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Problem 4
a. Carrying costs:
QS 250 x P109.40
2 = 2 = P13,675.00
Order costs:
AP 1,500 x P878
= = P 5,268.00
Q 250
Total P18,943.00
2 x 1,500 x P878
Q* = = 24,077 = 155 units
P109.40
Carrying costs:
QS 155 x P109.40
2 = 2 = P 8,478.50
Order costs:
AP 1,500 x P878
= = P 8,496.77
Q 155
Total P16,975.27
Problem 5
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unit in safety stock. With the given order size, there are 15 orders placed a
year (i.e., 39,000/2,600 = 15). Based on these computations, we prepare the
following schedule:
Additional computations:
a
15 is the number of orders per year.
b
It should be evident that at this level the carrying costs alone exceed the total
costs at a safety stock of 175 units. Therefore, it is not possible for this or any
safety-stock level larger than 250 to be less costly than 175 units. Indeed, given a
total cost at 175 units of P5,507.5, stockout costs would have to occur with
probability zero for any safety stock greater than 225.72 units (i.e., P5,507.5 /
P24.40 = P225.72).
CHAPTER 19
I. Questions
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Management Accounting: An Overview Chapter 1
1. Quantitative factors are those which may more easily be reduced in terms
of pesos such as projected costs of materials, labor and overhead.
Qualitative factors are those whose measurement in pesos is difficult and
imprecise; yet a qualitative factor may be easily given more weight than
the measurable cost savings. It can be seen that the accountants role in
making decisions deals with the quantitative factors.
2. Relevant costs are expected future costs that will differ between
alternatives. In view of the definition of relevant costs, historical costs are
always irrelevant because they are not future costs. They may be helpful
in predicting relevant costs but they are always irrelevant costs per se.
3. The differential costs in any given situation is commonly defined as the
change in total cost under each alternative. It is not relevant cost, but it is
the algebraic difference between the relevant costs for the alternatives
under consideration.
4. Analysis:
The original cost of the old truck is irrelevant but its disposal value is
relevant. It is recommended that the truck should be rebuilt because it
will involve lesser cash outlay.
5. No. Variable costs are relevant costs only if they differ in total between the
alternatives under consideration.
6. Only those costs that would be avoided as a result of dropping the product
line are relevant in the decision. Costs that will not differ regardless of
whether the product line is retained or discontinued are irrelevant.
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8. Allocations of common fixed costs can make a product line (or other
segment) appear to be unprofitable, whereas in fact it may be profitable.
10. The price elasticity of demand measures the degree to which a change in
price affects unit sales. The unit sales of a product with inelastic demand
are relatively insensitive to the price charged for the product. In contrast,
the unit sales of a product with elastic demand are sensitive to the price
charged for the product.
12. The markup over variable cost depends on the price elasticity of demand.
A product whose demand is elastic should have a lower markup over cost
than a product whose demand is inelastic. If demand for a product is
inelastic, the price can be increased without cutting as drastically into unit
sales.
II. Exercises
Case 1 Case 2
Not Not
Item Relevant Relevant Relevant Relevant
a. Sales revenue...................................
X X
b. Direct materials...............................
X X
c. Direct labor......................................
X X
d. Variable manufacturing
overhead..........................................
X X
e. Book value Model E7000 X X
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machine...........................................
f. Disposal value Model E7000
machine...........................................
X X
g. Depreciation Model E7000
machine...........................................
X X
h. Market value Model F5000
machine (cost).................................
X X
i. Fixed manufacturing
overhead..........................................
X X
j. Variable selling expense..................
X X
k. Fixed selling expense......................
X X
l. General administrative
overhead..........................................
X X
Requirement 1
* Depreciation............................................................................................................
P2,000
Insurance.................................................................................................................
960
Garage rent.............................................................................................................
480
Automobile tax and license.....................................................................................
60
Total........................................................................................................................
P3,500
Requirement 2
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any decrease in the resale value of the car due to its use would be relevant.
The automobile tax and license costs would be incurred whether Ingrid decides
to drive her own car or rent a car for the trip during summer break and are
therefore irrelevant. It is unlikely that her insurance costs would increase as a
result of the trip, so they are irrelevant as well. The garage rent is relevant
only if she could avoid paying part of it if she drives her own car.
Requirement 3
When figuring the incremental cost of the more expensive car, the relevant
costs would be the purchase price of the new car (net of the resale value of the
old car) and the increases in the fixed costs of insurance and automobile tax
and license. The original purchase price of the old car is a sunk cost and is
therefore irrelevant. The variable operating costs would be the same and
therefore are irrelevant. (Students are inclined to think that variable costs are
always relevant and fixed costs are always irrelevant in decisions. This
requirement helps to dispel that notion.)
Requirement 1
Per Unit
Differential
Costs 15,000 units
Make Buy Make Buy
Cost of purchasing P200 P3,000,000
Direct materials P60 P900,000
Direct labor 80 1,200,000
Variable manufacturing overhead 10 150,000
Fixed manufacturing overhead, traceable1
20 300,000
Fixed manufacturing overhead, common
0 0 0 0
Total costs P170 P200 P2,550,000 P3,000,000
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Requirement 2
Make Buy
Cost of purchasing (part 1)...................................................................................................
P3,000,000
Cost of making (part 1)........................................................................................................
P2,550,000
Opportunity costsegment margin forgone on a
potential new product line................................................................................................
650,000
Total cost...............................................................................................................................
P3,200,000 P3,000,000
Difference in favor of purchasing from the outside
supplier..............................................................................................................................
P200,000
Thus, the company should accept the offer and purchase the parts from the outside
supplier.
Only the incremental costs and benefits are relevant. In particular, only the
variable manufacturing overhead and the cost of the special tool are relevant
overhead costs in this situation. The other manufacturing overhead costs are
fixed and are not affected by the decision.
Per Total
Unit 10 bracelets
Incremental revenue P3,499.50 P34,995.00
Incremental costs:
Variable costs:
Direct materials 1,430.00 14,300.00
Direct labor 860.00 8,600.00
Variable manufacturing overhead 70.00 700.00
Special filigree 60.00 600.00
Total variable cost P2,420.00 24,200.00
Fixed costs:
Purchase of special tool 4,650.00
Total incremental cost 28.850.00
Incremental net operating income P 6.145.00
Even though the price for the special order is below the companys regular
price for such an item, the special order would add to the companys net
operating income and should be accepted. This conclusion would not
necessarily follow if the special order affected the regular selling price of
bracelets or if it required the use of a constrained resource.
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Requirement 1
X Y Z
(1) Contribution margin per unit................................................................................................
P18 P36 P20
(2) Direct labor cost per unit.......................................................................................................
P12 P32 P16
(3) Direct labor rate per hour......................................................................................................
8 8 8
(4) Direct labor-hours required per unit (2) (3).......................................................................
1.5 4.0 2.0
Contribution margin per direct labor-hour (1) (4).............................................................
P12 P9 P10
Requirement 2
X Y Z
Contribution margin per direct labor-hour
P12 P9 P10
Direct labor-hours available 3,000 3,000 3,000
Total contribution margin P36,000 P27,000 P30,000
Although product X has the lowest contribution margin per unit and the
second lowest contribution margin ratio, it has the highest contribution margin
per direct labor-hour. Since labor time seems to be the companys constraint,
this measure should guide management in its production decisions.
Requirement 3
The amount Jaycee Company should be willing to pay in overtime wages for
additional direct labor time depends on how the time would be used. If there
are unfilled orders for all of the products, Jaycee would presumably use the
additional time to make more of product X. Each hour of direct labor time
generates P12 of contribution margin over and above the usual direct labor
cost. Therefore, Jaycee should be willing to pay up to P20 per hour (the P8
usual wage plus the contribution margin per hour of P12) for additional labor
time, but would of course prefer to pay far less. The upper limit of P20 per
direct labor hour signals to managers how valuable additional labor hours are
to the company.
If all the demand for product X has been satisfied, Jaycee Company would
then use any additional direct labor-hours to manufacture product Z. In that
case, the company should be willing to pay up to P18 per hour (the P8 usual
wage plus the P10 contribution margin per hour for product Z) to manufacture
more product Z.
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Likewise, if all the demand for both products X and Z has been satisfied,
additional labor hours would be used to make product Y. In that case, the
company should be willing to pay up to P17 per hour to manufacture more
product Y.
Requirement 1
* The junk food consumed during the trip may not be completely relevant.
Even if Shin were not going on the trip, he would still have to eat. The
amount by which the cost of the junk food exceeds the cost of the food he
would otherwise consume would be the relevant amount.
The other costs are sunk at the point at which the decision is made to go on
another fishing trip.
Requirement 2
If he fishes for the same amount of time as he did on his last trip, all of his
costs are likely to be about the same as they were on his last trip. Therefore, it
really doesnt cost him anything to catch the last fish. The costs are really
incurred in order to be able to catch fish and would be the same whether one,
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two, three, or a dozen fish were actually caught. Fishing, not catching fish,
costs money. All of the costs are basically fixed with respect to how many fish
are actually caught during any one fishing trip, except possibly the cost of
snagged lures.
Requirement 3
In a decision of whether to give up fishing altogether, nearly all of the costs
listed by Shins wife are relevant. If he did not fish, he would not need to pay
for boat moorage, new fishing gear, a fishing license, fuel and upkeep, junk
food, or snagged lures. In addition, he would be able to sell his boat, the
proceeds of which would be considered relevant in this decision. The original
cost of the boat, which is a sunk cost, would not be relevant.
These three requirements illustrate the slippery nature of costs. A cost that is
relevant in one situation can be irrelevant in the next. None of the costs are
relevant when we compute the cost of catching a particular fish; some of them
are relevant when we compute the cost of a fishing trip; and nearly all of them
are relevant when we consider the cost of not giving up fishing. What is even
more confusing is that CG is correct; the average cost of a salmon is P167,
even though the cost of actually catching any one fish is essentially zero. It
may not make sense from an economic standpoint to have salmon fishing as a
hobby, but as long as Shin is out in the boat fishing, he might as well catch as
many fish as he can.
Requirement 1
No, the housekeeping program should not be discontinued. It is actually
generating a positive program segment margin and is, of course, providing a
valuable service to seniors. Computations to support this conclusion follow:
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Depreciation on the van is a sunk cost and the van has no salvage value since
it would be donated to another organization. The general administrative
overhead is allocated and none of it would be avoided if the program were
dropped; thus it is not relevant to the decision.
The same result can be obtained with the alternative analysis below:
Difference:
Total If Net Operating
House- Income
Current keeping Is Increase or
Total Dropped (Decrease)
Revenues......................................................................
P900,000 P660,000 P(240,000)
Variable expenses.........................................................
490,000 330,000 160,000
Contribution margin....................................................
410,000 330,000 (80,000)
Fixed expenses:
Depreciation*..........................................................
68,000 68,000 0
Liability insurance...................................................
42,000 27,000 15,000
Program administrators salaries............................ 115,000 78,000 37,000
General administrative overhead............................ 180,000 180,000 0
Total fixed expenses.....................................................
405,000 353,000 52,000
Net operating income (loss).........................................
P 5,000 P(23,000) P (28,000)
Requirement 2
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Requirement 1
Total for
Per 2,000
Unit Units
Incremental revenue.........................................................................
P12.00 P24,000
Incremental costs:
Variable costs:
Direct materials........................................................................
2.50 5,000
Direct labor..............................................................................
3.00 6,000
Variable manufacturing overhead............................................. 0.50 1,000
Variable selling and administrative........................................... 1.50 3,000
Total variable cost........................................................................
P 7.50 15,000
Fixed costs:
None affected by the special order............................................ 0
Total incremental cost...................................................................... 15,000
Incremental net operating income..................................................... P9,000
Requirement 2
The relevant cost is P1.50 (the variable selling and administrative costs). All
other variable costs are sunk, since the units have already been produced. The
fixed costs would not be relevant, since they would not be affected by the sale
of leftover units.
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Differential
Costs
Make Buy Make Buy
Cost of purchasing....................................................... P23.50 P470,000
Cost of making:
Direct materials.......................................................
P4.80 P96,000
Direct labor..............................................................
7.00 140,000
Variable manufacturing overhead........................... 3.20 64,000
Fixed manufacturing overhead................................ 4.00 * 80,000
Total cost..................................................................
P19.00 P23.50 P380,000 P470,000
* The remaining P6 of fixed manufacturing overhead cost would not be relevant, since
it will continue regardless of whether the company makes or buys the parts.
Requirement (1)
Cecile makes more money selling the ice cream cones at the lower price, as
shown below:
Sales...............................................................P15,394.00 P18,626.00
Cost of goods sold @ P4.10............................ 3,526.00 5,494.00
Contribution margin........................................ 11,868.00 13,132.00
Fixed expenses................................................ 425.00 425.00
Net operating income...................................... P11,443.00 P12,707.00
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Requirement (2)
d =
In(1 + % change in quantity sold)
In(1 + % change in price)
1,340 860
In(1 + 860 )
=
13.90 17.90
In(1 + 17.90 )
In(1 + 0.55814)
=
In(1 0.22346)
In(1.55814)
=
In(0.77654)
0.44349
= = 1.75
0.25291
Requirement (3)
Profit-maximizing 1
=
markup on variable cost 1 + d
1
= = 1.333
1 + (1.75)
This price is much lower than the prices Cecile has been charging in the past.
Rather than immediately dropping the price to P9.60, it would be prudent to
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drop the price a bit and see what happens to unit sales and to profits. The
formula assumes that the price elasticity is constant, which may not be the
case.
The selling price of the new amaretto cappuccino product should at least cover
its variable cost and its opportunity cost. The variable cost of the new product
is P4.60 and its opportunity cost can be computed by multiplying the
opportunity cost of P34 per minute of order filling time by the amount of time
required to fill an order for the new product:
Selling price of
the new product P4.60 + P34 per minute + 0.75 minute
Selling price of
the new product P4.60 + P25.50 = P30.10
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Hence, the selling price of the new product should at least cover both its variable
cost of P4.60 and its opportunity cost of P25.50, for a total of P30.10.
III. Problems
Product A Product B
Selling price per unit P1.20 P1.40
Less Variable costs/unit:
Materials 0.50 0.70
Labor 0.20 0.24
Factory overhead (25%) 0.10 0.14
0.80 1.08
Contribution margin/unit P0.40 P0.32
Multiplied by number of units to be sold 21,000 units 30,000 units
Total contribution margin P8,400 P9,600
Requirement 1
No, production and sale of the round trampolines should not be discontinued.
Computations to support this answer follow:
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Requirement 2
Trampoline
Total Round Rectangular Octagonal
Sales...................................... P1,000,000 P140,000 P500,000 P360,000
Less variable expenses.......... 410,000 60,000 200,000 150,000
Contribution margin............. 590,000 80,000 300,000 210,000
Less fixed expenses:
Advertising traceable..... 216,000 41,000 110,000 65,000
Depreciation of special
equipment...................... 95,000 20,000 40,000 35,000
Line supervisors
salaries........................... 19,000 6,000 7,000 6,000
Total traceable fixed
expenses............................ 330,000 67,000 157,000 106,000
Product-line segment
margin............................... 260,000 P 13,000 P143,000 P104,000
Less common fixed
expenses............................ 200,000
Net operating income
(loss).................................. P 60,000
Requirement 1
Product Line
A B C D
Selling price per unit P30 P25 P10 P8
Variable cost per unit 25 10 5 4
Contribution margin / unit P5 P15 P 5 P4
Divided by no. of hours required
for each unit 5 hrs. 10 hrs. 4 hrs. 1 hr.
Contribution per hour P1 P1.5 P1.25 P4
Product ranking:
1. D 2. B 3. C 4. A
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Based on the above analysis, first priority should be given to Product D. The
company should use 4,000 out of the available 96,000 hrs. to produce 4,000
units of product D. The remaining 92,000 hrs. should be used to produce
9,200 units of Product B. Hence, the best product combination is 4,000 units
of Product D and 9,200 units of Product B.
Requirement 2
Requirement 1
The company should accept the special order of 4,000 @ P10 each because
this selling price is still higher than the additional variable cost to be incurred.
Whether or not variable marketing expenses will be incurred, the decision is
still to accept the order.
Supporting computations:
(a) Assume no additional variable marketing cost will be incurred.
Selling price per unit P10.00
Less variable manufacturing costs:
Direct materials P5.00
Direct labor 3.00
Variable overhead 0.75 8.75
Contribution margin/unit P 1.25
Multiplied by number of units of order 4,000 units
Total increase in profit P5,000
(b) Assume additional variable marketing cost will be incurred.
Selling price per unit P10.00
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Requirement 2
P8.75, the total variable manufacturing cost.
Requirement 3
Direct materials P5.00
Direct labor 3.00
Variable factory overhead 0.75
Total cost of inventory under direct costing P8.75
Requirement 4
Requirement (a)
Requirement (b)
Production
4,000 units 5,000 units 6,000 units
Sales (4,000 x P40) P160,000 P160,000 P160,000
Less variable costs
Production cost @ P25 100,000 125,000 150,000
Purchase cost @ P45 - - -
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Requirement (c)
Problem 6 (Pricing)
Requirement A:
Operating
Result at Full
2005 2006 Capacity
Sales P 100,000 P 400,000 P 480,000
Less Variable cost 130,000 520,000 624,000
Contribution margin (P 30,000) (P120,000) (P144,000)
Less Fixed cost 40,000 40,000 40,000
Net income (loss) (P 70,000) (P160,000) (P184,000)
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The company had been operating at a loss because the product had been
selling with a negative contribution margin. Hence, the more units are sold,
the higher the loss will be.
Requirement B: P60.14
Requirement C: P74.29
Requirement D: P56.58
Requirement 1
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Requirement 2
The Ortigas Store should not be closed. If the store is closed, overall company
net operating income will decrease by P9,800 per quarter.
Requirement 3
The Ortigas Store should be closed if P200,000 of its sales are picked up by
the Makati Store. The net effect of the closure will be an increase in overall
company net operating income by P76,200 per quarter:
Gross margin lost if the Ortigas Store is closed.......................................................................
P(228,000)
Gross margin gained at the Makati Store:
P200,000 43%...................................................................................................................
86,000
Net loss in gross margin...........................................................................................................
(142,000)
Costs that can be avoided if the Ortigas Store is closed (part 1).............................................. 218,200
Net advantage of closing the Ortigas Store..............................................................................
P 76,200
Requirement 1
Product KK-8 yields a contribution margin of P14 per gallon (P35 P21 =
P14). If the plant closes, this contribution margin will be lost on the 22,000
gallons (11,000 gallons per month 2 = 22,000 gallons) that could have been
sold during the two-month period. However, the company will be able to avoid
certain fixed costs as a result of closing down. The analysis is:
Contribution margin lost by closing the plant for two
months (P14 per gallon 22,000 gallons).................................................P(308,000)
Costs avoided by closing the plant for two months:
Fixed manufacturing overhead cost
(P60,000 2 months = P120,000)..........................................................
P120,000
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Alternative Solution:
Difference
Net
Operating
Income
Plant Kept Increase
Open Plant Closed (Decrease)
Sales (11,000 gallons P35 per gallon 2)............................ P 770,000 P 0 P(770,000)
Less variable expenses (11,000
gallons P21 per gallon 2).............................................. 462,000 0 462,000
Contribution margin................................................................. 308,000 0 (308,000)
Less fixed costs:
Fixed manufacturing overhead cost
(P230,000 2;
P170,000 2)................................................................ 460,000 340,000 120,000
Fixed selling cost (P310,000 2; P310,000
90% 2).........................................................................
620,000 558,000 62,000
Total fixed cost.........................................................................
1,080,000 898,000 182,000
Net operating loss before start-up costs................................... (772,000) (898,000) (126,000)
Start-up costs........................................................................... (14,000) (14,000)
Net operating loss....................................................................
P (772,000) P(912,000) P(140,000)
Requirement 2
Ignoring the additional factors cited in part (1) above, Kristin Company
should be indifferent between closing down or continuing to operate if the level
of sales drops to 12,000 gallons (6,000 gallons per month) over the two-month
period. The computations are:
Cost avoided by closing the plant for two months (see above)............................... P182,000
Less start-up costs....................................................................................................
14,000
Net avoidable costs..................................................................................................
P168,000
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= 12,000 gallons
Verification: Operate at
12,000 Close for
Gallons for Two
Two Months Months
Sales (12,000 gallons P35 per gallon)............................................... P 420,000 P 0
Less variable expenses (12,000 gallons P21 per gallon)................... 252,000 0
Contribution margin.............................................................................. 168,000 0
Less fixed expenses:
Manufacturing overhead (P230,000 and P170,000 2
months).........................................................................................
460,000 340,000
Selling (P310,000 and P279,000 2 months)................................. 620,000 558,000
Total fixed expenses..............................................................................1,080,000 898,000
Start-up costs......................................................................................... 0 14,000
Total costs..............................................................................................
1,080,000 912,000
Net operating loss..................................................................................
P (912,000) P(912,000)
Requirement (1)
Requirement (2)
d =
In(1 + % change in quantity sold)
In(1 + % change in price)
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40,000 50,000
In(1 + )
50,000
= 600.00 500.00
In(1 + 500.00 )
In(1 0.2000)
=
In(1 + 0.2000)
In(0.8000)
=
In(1.2000)
= 0.2231
0.1823
= 1.2239
Requirement (3)
Profit-maximizing 1
=
markup on variable cost 1 + d
1
= = 4.4663
1 + (1.2239)
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P600 40,000
P500 50,000
P417 62,500
P348 78,125
P290 97,656
P242 122,070
P202 152,588
P168 190,735
P140 238,419
P117 298,024
*
The price in each cell in the table is computed by taking 5/6 of the price just
above it in the table. For example, P500 is 5/6 of P600 and P417 is 5/6 of
P500.
The quantity sold in each cell of the table is computed by multiplying the
quantity sold just above it in the table by 50,000/40,000. For example, 62,500
is computed by multiplying 50,000 by the fraction 50,000/40,000.
The profit at each price in the above demand schedule can be computed as
follows:
Price Quantity Sales Cost of Sales Contribution
(a) Sold (b) (a) (b) P60 (b) Margin
P600 40,000 P24,000,000 P2,400,000 P21,600,000
P500 50,000 P250,00,000 P3,000,000 P22,000,000
P417 62,500 P26,062,500 P3,750,000 P22,312,500
P348 78,125 P27,187,500 P4,687,500 P22,500,000
P290 97,656 P28,320,200 P5,859,400 P22,460,800
P242 122,070 P29,540,900 P7,324,200 P22,216,700
P202 152,588 P30,822,800 P9,155,300 P21,667,500
P168 190,735 P32,043,500 P11,444,100 P20,599,400
P140 238,419 P33,378,700 P14,305,100 P19,073,600
P117 298,024 P34,868,800 P17,881,400 P16,987,400
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23,000,000
22,000,000
Contribution Margin
21,000,000
20,000,000
19,000,000
18,000,000
17,000,000
100.00 200.00 300.00 400.00 500.00 600.00
Selling Price
Requirement (4)
If the postal service wants to maximize the contribution margin and profit
from sales of souvenir sheets, the new price should be:
Profit-maximizing price = 5.4663 P70 = P383
Note that a P100 increase in cost has led to a P55 (P383 P328) increase in
the profit-maximizing price. This is because the profit-maximizing price is
computed by multiplying the variable cost by 5.4663. Since the variable cost
has increased by P100, the profit-maximizing price has increased by P100
5.4663, or P55.
Some people may object to such a large increase in price as unfair and some
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may even suggest that only the P10 increase in cost should be passed on to the
consumer. The enduring popularity of full-cost pricing may be explained to
some degree by the notion that prices should be fair rather than calculated to
maximize profits.
Requirement (1)
This problem can be solved by first computing the profitability index of each
customer and then ranking the customers based on that profitability index:
Ji Euns
Incremental Time Profitability
Profit Required Index
Customer (A) (B) (A) (B)
Lalaine...........................
P1,400 4 P350
Emily.............................
1,240 4 P310
Anna..............................
1,600 5 P320
Catherine.......................
960 3 P320
Gee Ann.........................
1,900 5 P380
Lily 2,880 8 P360
Lourdes.........................
930 3 P310
Ma. Cecilia.....................
1,360 4 P340
Sheila Raya....................
2,340 6 P390
Jane..............................
2,040 6 P340
Cumulative
Ji Euns Amount of Ji
Profitability Time Euns Time
Customer Index Required Required
Sheila Raya...... P390 6 6
Gee Ann........... P380 5 11
Lily P360 8 19
Lalaine............. P350 4 23
Jane P340 6 29
Ma. Cecilia...... P340 4 27
Anna................ P320 5 38
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Catherine.......... P320 3 41
Emily............... P310 4 45
Lourdes............ P310 3 48
Given that Ji Eun should not be asked to work more than 33 hours, the four
customers below the line in the above table should be told that their
reservations have to be cancelled.
Requirement (2)
The total profit on wedding cakes for the weekend after canceling the four
reservations would be:
Notes:
Both Ji Euns time and the cakes would have to be very carefully
scheduled to make sure that all cakes are completed on time. We have
assumed that the 33 hours of Ji Euns time that are available for cake
decorating do not include hours that have been set aside as a buffer to
provide protection from inevitable disruptions in the schedule.
If the cumulative amount of Ji Euns time required did not exactly
consume the total amount of time available, some adjustment might be
required in which reservations are cancelled to ensure that the most
profitable plan is selected.
Requirement (3)
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point for the cakes in the first weekend in June. This cutoff may need to be
adjusted upward or downward over timethe cakes that were reserved for the
first weekend in June may not be representative of the cakes that would be
reserved for other weekends. If too many reservations are turned down and Ji
Euns time is not fully utilized, then the cutoff should be adjusted downward.
If too few reservations are turned down and Ji Euns time is once again
overbooked or profitable cake orders are turned away, then the cutoff should
be adjusted upward.
Requirement (4)
Ms. Hye Young should consider changing the way prices are set so that they
include a charge for Ji Euns time. On average, the prices may be the same,
but they should be based not only on the size of the cakes, but also on the
amount of cake decorating that the customer desires. The charge for Ji Euns
time should be her hourly rate of pay (including any fringe benefits) plus the
opportunity cost of at least P340 per hour. Because Ji Eun will not be working
more than 33 hours per week, if another cake reservation is accepted, some
other cake reservation will have to be cancelled. Ms. Hye Young would have
to give up at least P34 profit per hour to accept another cake reservation.
Requirement (5)
Making Ji Eun happy involves not asking her to work more than 33 hours per
week decorating cakes. Making customers happy involves not canceling their
reservations, not raising prices, and providing top quality wedding cakes. Ms.
Hye Young can accomplish both of these objectives and increase her profits by
clever management of the constraintJi Euns time. The possibilities include:
Ms. Hye Young should make sure that none of Ji Euns time is wasted on
unnecessary tasks. For example, Ji Eun should not be asked to cream
butter by hand for frostings if a machine could do the job as well with less
labor time.
Ms. Hye Young should make sure that none of Ji Euns time is wasted on
tasks that can be done by other persons. For example, an assistant can be
assigned to prepare frosting and to clean up, relieving Ji Eun of those
tasks. As long as the cost of the assistants time is less than P34 per hour,
the result will be higher profits and more pleased customers.
Ms. Hye Young should consider assigning an apprentice to Ji Eun. The
apprentice could relieve Ji Eun of some of her workload while learning the
skills to eventually expand the companys cake decorating capacity.
Ms. Hye Young might consider subcontracting some of the less demanding
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21. R S T
Sales (P16 x 15,000) P240,000 P240,000 P240,000
Less: Variable costs
R (P12 x 15,000) 180,000
S (P 8 x 15,000) 120,000
T (P 4 x 15,000) 60,000
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CHAPTER 20
I. Questions
1. A capital investment involves a current commitment of funds with the
expectation of generating a satisfactory return on these funds over a
relatively extended period of time in the future.
2. Cost of capital is the weighted minimum desired average rate that a
company must pay for long-term capital while discounted rate of return is
the maximum rate of interest that could be paid for the capital employed
over the life of an investment without loss on the project.
3. The basic principles in capital budgeting are:
1. Capital investment models are focused on the future cash inflows and
outflows - rather than on net income.
2. Investment proposals should be evaluated according to their
differential effects on the companys cash flows as a whole.
3. Financing costs associated with the project are excluded in the
analysis of incremental cash flows in order to avoid the double-
counting of the cost of money.
4. The concept of the time value of money recognizes that a peso of
present return is worth more than a peso of future return.
5. Choose the investments that will maximize the total net present value
of the projects subject to the capital availability constraint.
4. The major classifications as to purpose are:
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1. Replacement projects
- those involving replacements of worn-out assets to avoid
disruption of normal operations, or to improve efficiency.
2. Product or process improvement
- projects that aim to produce additional revenue or to realize cost
savings.
3. Expansion
- projects that enhance long-term returns due to increased profitable
volume.
5. Greater amounts of capital may be used in projects whose combined
returns will exceed any alternate combination of total investment.
6. No. This implies that any equity funds are cost free and this is a
dangerous position because it ignores the opportunity cost or alternative
earnings that could be had from the fund.
7. Yes, if there are alternative earnings foregone by stockholders.
8. Capital budgeting screening decisions concern whether a proposed
investment project passes a preset hurdle, such as a 15% rate of return.
Capital budgeting preference decisions are concerned with choosing from
among two or more alternative investment projects, each of which has
passed the hurdle.
9. The time value of money refers to the fact that a peso received today is
more valuable than a peso received in the future. A peso received today
can be invested to yield more than a peso in the future.
10. Discounting is the process of computing the present value of a future cash
flow. Discounting gives recognition to the time value of money and makes
it possible to meaningfully add together cash flows that occur at different
times.
11. Accounting net income is based on accruals rather than on cash flows.
Both the net present value and internal rate of return methods focus on
cash flows.
12. One simplifying assumption is that all cash flows occur at the end of a
period. Another is that all cash flows generated by an investment project
are immediately reinvested at a rate of return equal to the discount rate.
13. No. The cost of capital is not simply the interest paid on long-term debt.
The cost of capital is a weighted average of the individual costs of all
sources of financing, both debt and equity.
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14. The internal rate of return is the rate of return on an investment project
over its life. It is computed by finding that discount rate that results in a
zero net present value for the project.
15. The project profitability index is computed by dividing the net present
value of the cash flows from an investment project by the investment
required. The index measures the profit (in terms of net present value)
provided by each peso of investment in a project. The higher the project
profitability index, the more desirable is the investment project.
16. Neither the payback method nor the simple rate of return method
considers the time value of money. Under both methods, a peso received in
the future is weighed the same as a peso received today. Furthermore, the
payback method ignores all cash flows that occur after the initial
investment has been recovered.
1. A 6. H
2. C 7. D
3. F 8. G
4. B 9. J
5. I 10. E
III. Exercises
3. The factor for 10% for 20 years is 8.514. Thus, the present value of
Toms winnings would be:
P50,000 8.514 = P425,700.
Whether or not Tom really won a million pesos depends on your point of
view. She will receive a million pesos over the next 20 years; however, in
terms of its value right now she won much less than a million pesos as
shown by the present value computation above.
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No, Ms. Cruz did not earn a 12% return on the share. The negative net present
value indicates that the rate of return on the investment is less than the
discount rate of 12%.
The reason for the zero net present value is that 16% (the discount rate)
represents the machines internal rate of return. The internal rate of return is
the rate that causes the present value of a projects cash inflows to just equal
the present value of the investment required.
3.
Factor of the internal Required investment
rate of return = Annual cash inflow
P136,700
The 6.835 factor is closest to 6.982, the factor for the 11% rate of return.
= the internal rate =of return
P20,000 6.835is 11%.
Thus, to the nearest whole percent,
Exercise 6 (Basic Net Present Value and Internal Rate of Return Analysis)
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Initial investment.....................
Now P(40,350) 1.000 P(40,350)
Annual cash inflows................1-4 P15,000 2.855 42,825
Net present value.................... P 2,475
Yes, this is an acceptable investment. Its net present value is positive, which
indicates that its rate of return exceeds the minimum 15% rate of return
required by the company.
IV. Problems
Requirement 1
Total Present Value
A. New Situation:
Recurring cash operating costs (P26,500 x 2.69) P 71,285
Cost of new equipment 44,000
Disposal value of old equipment now (5,000)
Present value of net cash outflows P110,285
B. Present Situation:
Recurring cash operating costs (P45,000 x 2.69) P121,050
Disposal value of old equipment four years hence
(P2,600 x 0.516) (1,342)
Present value of net cash inflows P119,708
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Requirement 2
P44,000 P5,000
Payback period for the new equipment = P18,500
= 2.1 years
Requirement 3
Another alternative way to get the same answer would be to divide the net
present value of P9,423 by 2.690.
Problem 2
After Tax
Cash Inflows PV Factor PV
Year 1 P42,000 x 0.909 P 38,178
Year 2 40,000 x 0.826 33,040
Year 3 38,400 x 0.750 28,800
Year 3 Salvage 20,000 x 0.750 15,000
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Since the net present value is positive, the computer should be purchased
replacing the manual bookkeeping system.
Problem 3
Requirement 1
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Requirement 2
Problem 4
Requirement 1: P(507,000)
Requirement 2: P(466,200)
Requirement 3: P(23,400)
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Problem 5
No, the etching machine should not be purchased. It has a negative net
present value at an 18% discount rate.
3. The intangible benefits would have to be worth at least P42,813 per year
as shown below:
Required increase in net present value P192,400
=
Factor for 10 years 4.494 = P42,813
Thus, the new etching machine should be purchased if management
believes that the intangible benefits are worth at least P42,813 per year to
the company.
Problem 6
Items and Computations Year(s) (1) (2) (1) (2) 12% Present
Amount Tax After-Tax Factor Value of
Effect Cash Cash
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Flows Flows
Investment in new trucks..........................................
Now P(450,000) P(450,000) 1.000 P(450,000)
Salvage from sale of the old trucks..........................
Now P30,000 1 0.30 P21,000 1.000 21,000
Net annual cash receipts..........................................
1-8 P108,000 1 0.30 P75,600 4.968 375,581
Depreciation deductions*..........................................
1-8 P56,250 0.30 P16,875 4.968 83,835
Overhaul of motors...................................................
5 P(45,000) 1 0.30 P(31,500) 0.567 (17,861)
Salvage from the new trucks....................................
8 P20,000 1 0.30 P14,000 0.404 5,656
Net present value..................................................... P 18,211
Since the project has a positive net present value, the contract should be
accepted.
Problem 7
2.
Factor of the internal Required investment
rate of return = Annual cash inflow
We know that the investment is P142,950, and we can determine the factor for
an internal rate of return of 14% by looking at the PV table along the 7-period
line. This factor is 4.288. Using these figures in the formula, we get:
P142,950
Annual cash inflow = 4.288
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The 10% return in part (a) is less than the 14% minimum return that Dr.
Blue wants to earn on the project. Of equal or even greater importance, the
following diagram should be pointed out to Dr. Blue:
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Reading along the 7-period line of the PV table, a factor of 3.177 is closest
to 3.161, the factor for 25%, and is between that factor and the factor for
24%. Thus, to the nearest whole percent, the internal rate of return is 25%.
Reading along the 7-period line of the PV table, a factor of 4.765 is closest
to 4.712, the factor for 11%. Thus, to the nearest whole percent, the
internal rate of return is 11%.
5. Since the cash flows are not even over the five-year period (there is an extra
P61,375 cash inflow from sale of the equipment at the end of the fifth year),
some other method must be used to compute the internal rate of return. Using
trial-and-error or more sophisticated methods, it turns out that the actual
internal rate of return will be 12%:
Amount of Present
Cash 12% Value of
Item Year(s) Flows Factor Cash Flows
Investment in the equipment............................
Now P(142,950) 1.000 P(142,950)
Annual cash inflow...........................................
1-5 P30,000 3.605 108,150
Sale of the equipment.......................................
5 P61,375 0.567 34,800
Net present value.............................................. P 0
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Problem 8
2. The initial investment in the simple rate of return calculations is net of the
salvage value of the old equipment as shown below:
Simple Annual incremental net operating income
rate of return = Initial investment
Yes, the games would be purchased. The payback period is less than the 3
years.
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CHAPTER 21
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when fixed costs dont change. The segment margin is most useful as a
planning tool in the long run, when fixed costs will be changing, and as a
tool for evaluating long-run segment performance. One concept is no
more useful to management than the other; the two concepts simply relate
to different planning horizons.
5. A segment is any part or activity of an organization about which a
manager seeks cost, revenue, or profit data. Examples of segments
include departments, operations, sales territories, divisions, product lines,
and so forth.
6. Under the contribution approach, costs are assigned to a segment if and
only if the costs are traceable to the segment (i.e., could be avoided if the
segment were eliminated). Common costs are not allocated to segments
under the contribution approach.
7. A traceable cost of a segment is a cost that arises specifically because of
the existence of that segment. If the segment were eliminated, the cost
would disappear. A common cost, by contrast, is a cost that supports
more than one segment, but is not traceable in whole or in part to any one
of the segments. If the departments of a company are treated as
segments, then examples of the traceable costs of a department would
include the salary of the departments supervisor, depreciation of
machines used exclusively by the department, and the costs of supplies
used by the department. Examples of common costs would include the
salary of the general counsel of the entire company, the lease cost of the
headquarters building, corporate image advertising, and periodic
depreciation of machines shared by several departments.
II. Problems
Requirement 1
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Requirement 2
b. The segment margin ratio rises and falls as sales rise and fall due to the
presence of fixed costs. The fixed expenses are spread over a larger base
as sales increase.
Requirement 1
Geographic Market
Total Company East Central West
Amount % Amount % Amount % Amount %
Sales P1,500,000 100.0 P400,000 100 P600,000 100 P500,000 100
Less variable expenses 588,000 39.2 208,000 52 180,000 30 200,000 40
Contribution margin 912,000 60.8 192,000 48 420,000 70 300,000 60
Less traceable fixed expenses 770,000 51.3 240,000 60 330,000 55 200,000 40
Geographic market segment margin
142,000 9.5 P(48,000) (12) P90,000 15 P100,000 20
Less common fixed expenses not
traceable to geographic markets*
175,000 11.7
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Requirement 2
Total CD DVD
Sales*............................................................................
P750,000 P300,000 P450,000
Variable expenses**.......................................................
435,000 120,000 315,000
Contribution margin.......................................................
315,000 180,000 135,000
Traceable fixed expenses............................................... 183,000 138,000 45,000
Product line segment margin.......................................... 132,000 P42,000 P90,000
Common fixed expenses not traceable to
products.....................................................................
105,000
Net operating income.....................................................
P27,000
1. B 6. A 11. A
2. C 7. C 12. B
3. B 8. B
4. B 9. D
5. B 10. C
CHAPTER 22
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BUSINESS PLANNING
I. Questions
1. Strategy, plans, and budgets are interrelated and affect one another.
Strategy describes how an organization matches its own capabilities with
the opportunities in the marketplace to accomplish its overall objectives.
Strategy analysis underlies both long-run and short-run planning. In
turn, these plans lead to the formulation of budgets. Budgets provide
feedback to managers about the likely effects of their strategic plans.
Managers use this feedback to revise their strategic plans.
2. Budgeted performance is better than past performance for judging
managers. Why? Mainly because the inefficiencies included in past
results can be detected and eliminated in budgeting. Also, new
opportunities in the future, which did not exist in the past, may be
ignored if past performance is used.
3. A company that shares its own internal budget information with other
companies can gain multiple benefits. One benefit is better coordination
with suppliers, which can reduce the likelihood of supply shortages.
Better coordination with customers can result in increased sales as
demand by customers is less likely to exceed supply. Better coordination
across the whole supply chain can also help a company reduce
inventories and thus reduce the costs of holding inventories.
4. The sales forecast is typically the cornerstone for budgeting, because
production (and, hence, costs) and inventory levels generally depend on
the forecasted level of sales.
5. Sensitivity analysis adds an extra dimension to budgeting. It enables
managers to examine how budgeted amounts change with changes in the
underlying assumptions. This assists managers to monitor those
assumptions that are most critical to a company attaining its budget or
make timely adjustments to plans when appropriate.
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II. Problems
Globalcom Company
Budgeted Income Statement for 2006
(in thousands)
Requirement 1
Requirement 2
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Requirement 3
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Requirement 5
Requirement 6
P104,500
Budgeted manufacturing overhead rate: 5,500 = P19.00 per hour
Requirement 7
Requirement 8
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a
cost is per board foot, yard or per hour
b
inputs is the amount of input per board
Requirement 9
Requirement 10
From
Schedule Total
Beginning finished goods
inventory, January 1,
2006 Given P 37,480
Direct materials used 3A P193,800
Direct manufacturing labor 4 137,500
Manufacturing overhead 5 104,500
Cost of goods manufactured 435,800
Cost of goods available for
sale 473,280
Deduct ending finished
goods inventory,
December 31, 2006 6B 80,000
Cost of goods sold P393,280
Requirement 11
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6. A 11. A 11. D
7. B 12. B 12. D
8. C 13. D 13. B
9. D 14. A 14. C
10. D 15. C 15. A
CHAPTER 23
I. Questions
1.
Strategy Weakness
Cost leadership The tendency to cut costs in a way that
undermines demand for the product or
service.
Differentiation The firms tendency to undermine its strength
by attempting to lower costs or by lacking a
continual and aggressive marketing plan to
reinforce the perceived difference.
Focus The market niche may suddenly disappear due
to technological change in the industry or
change in consumer tastes.
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mean that 40% of the throughput time consists of actual processing, and
that the other 60% consists of moving, inspection, and other non-value-
added activities.
Requirement 1
a, b, and c
Month
1 2 3 4
Throughput time in days:
Process time...................................................
0.6 0.5 0.5 0.4
Inspection time...............................................
0.7 0.7 0.4 0.3
Move time......................................................
0.5 0.5 0.4 0.5
Queue time.....................................................
3.6 3.6 2.6 1.7
Total throughput time.....................................
5.4 5.3 3.9 2.9
Manufacturing cycle efficiency
(MCE):
Process time Throughput 11.1% 9.4% 12.8% 13.8%
time................................................................
Delivery cycle time in days:
Wait time........................................................
9.6 8.7 5.3 4.7
Total throughput time.....................................
5.4 5.3 3.9 2.9
Total delivery cycle time.................................
15.0 14.0 9.2 7.6
Requirement 2
The general trend is favorable in all of the performance measures except for
total sales. On-time delivery is up, process time is down, inspection time is
down, move time is basically unchanged, queue time is down, manufacturing
cycle efficiency is up, and the delivery time is down. Even though the
company has improved its operations, it has not yet increased its sales. This
may have happened because management attention has been focused on the
factory working to improve operations. However, it may be time now to
exploit these improvements to go after more sales perhaps by increased
product promotion and better marketing strategies. It will ultimately be
necessary to increase sales so as to translate the operational improvements
into more profits.
Requirement 3
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a and b
Month
5 6
Throughput time in days:
Process time................................................... 0.4 0.4
Inspection time............................................... 0.3
Move time...................................................... 0.5 0.5
Queue time.....................................................
Total throughput time..................................... 1.2 0.9
11. D 16. C
12. D 17. D
13. C 18. C
14. A 19. D
15. A 20. A
CHAPTER 24
I. Questions
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firms cost of capital instead of a desired rate of return. For many firms
the desired rate of return and the cost of capital will be nearly the same,
with small differences due to adjustments for risk and for strategic goals
such as the desired growth rate for the firm. Also, while residual income
is intended to deal with the undesirable effects of ROI, EVA is used to
focus managers attention on creating value for shareholders, by earning
profits greater than the firms cost of capital.
6. Examples of financial and nonfinancial measures of performance are:
Financial: ROI, residual income, and return on sales.
Nonfinancial: Manufacturing lead time, on-time performance, number
of new product launches, and number of new patents
filed.
7. The six steps in designing an accounting-based performance measure are:
a. Choose performance measures that align with top managements
financial goal(s).
b. Choose the time horizon of each performance measure in Step 1.
c. Choose a definition of the components in each performance measure
in Step 1.
d. Choose a measurement alternative for each performance measure in
Step 1.
e. Choose a target level of performance.
f. Choose the timing of feedback.
8. Yes. Residual income (RI) is not identical to return on investment (ROI).
ROI is a percentage with investment as the denominator of the
computation. RI is an absolute amount in which investment is used to
calculate an imputed interest charge.
9. Economic value added (EVA) is a specific type of residual income
measure that is calculated as follows:
Economic After tax Weighted Total Assets
value added = operating Average Cost x minus Current
(EVA) income of Capital Liabilities
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11. Present value is the asset measure based on DCF estimates. Current cost
is the cost of purchasing an asset today identical to the one currently held
if identical assets can currently be purchased; it is the cost of purchasing
the services provided by that asset if identical assets cannot currently be
purchased. Historical-cost-based measures of ROI compute the asset
base as the original purchase cost of an asset minus any accumulated
depreciation.
Some commentators argue that present value is future-oriented and
current cost is oriented to current prices, while historical cost is past-
oriented.
12. Special problems arise when evaluating the performance of divisions in
multinational companies because
a. The economic, legal, political, social, and cultural environments differ
significantly across countries.
b. Governments in some countries may impose controls and limit selling
prices of products.
c. Availability of materials and skilled labor, as well as costs of
materials, labor, and infrastructure may differ significantly across
countries.
d. Divisions operating in different countries keep score of their
performance in different currencies.
13. a. Consider each activity and the organization itself from the customers
perspective,
b. Evaluate each activity using customer-validated measures of
performance,
c. Consider all facets of activity performance that affect customers and
are comprehensive, and
d. Provide feedback to help organization members identify problems and
opportunities for improvement.
II. Exercises
Requirement 1
A quick inspection of the data shows mortgage loans with a higher ROI to be
more successful. But see requirement 2 below.
Requirement 2
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Division A Division B
(Mortgage Loans) (Consumer Loans)
Total Assets P2,000 P10,000
Operating Income 400 1,500
Return on 25% 15%
Investment
Residual Income:
(a) * at 11% P180 P400
(b) ** at 15% 100 0
(c) ***at 17% 60 (200)
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Requirement 1
Investing in the new plant would lower JSDs ROI and, hence, limit Tans
bonus.
Requirement 2
Investing in the new plant would add P105,000 to JSDs residual income.
Consequently, if Magic Industries could be persuaded to use residual income
to measure performance, Tan would be more willing to invest in the new plant.
Requirement 3
Operating income 480,000
Return on Sales (ROS) = Sales = =
2,400,000
20%
If Magic Industries uses ROS to determine Tans bonus, Tan will be more
willing to invest in the new plant because ROS for the new plant of 20%
exceeds the current ROS of 19%.
The advantages of using ROS are (a) that it is simpler to calculate and (b)
that it avoids the negative short-run effects of ROI measures that may induce
Tan to not make the investment in the new plant. Tan may favor ROS because
she believes that eventually increases in ROS will increase ROI and RI.
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III. Problems
Requirement 1
Truck Rental Transportation
Division Division
Total assets P650,000 P950,000
Current liabilities 120,000 200,000
Investment
(Total assets current 530,000 750,000
liabilities)
Required return (12% x 63,600 90,000
Investment)
Operating income before tax 75,000 160,000
Residual income
(Operating income before tax
required return) 11,400 70,000
Requirement 2
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Requirement 3
Both the residual income and the EVA calculations indicate that the
Transportation Division is performing better than the Truck Rental Division.
The Transportation Division has a higher residual income (P70,000 versus
P11,400) and a higher EVA [P24,000 versus P(5,880)]. The negative EVA for
the Truck Rental Division indicates that, on an after-tax basis, the division is
destroying value the after-tax economic return from the Truck Rental
Divisions assets is less than the required return. If EVA continues to be
negative, Lighthouse may have to consider shutting down the Truck Rental
Division.
Supporting Calculations:
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The biggest weakness of ROI is the tendency to reject projects that will lower
historical ROI even though the prospective ROI exceeds the required ROI. RI
achieves goal congruence because subunits will make investments as long as
they earn a rate in excess of the required return for investments. The biggest
weakness of residual income is it favors larger divisions in ranking
performance. The greater the amount of the investment (the size of the
division), the more likely that larger divisions will be favored assuming that
income grows proportionately.
Requirement 1
(a)
Operating income Operating income
Phil. Divisions ROI in 2005 = Total assets = P8,000,000 =
15%
Hence, operating income = 15% x P8,000,000 = P1,200,000.
(b)
9,180,000 kronas
Swedish Divisions ROI in 2005 in kronas = 60,000,000 kronas =
15.3%
Requirement 2
Convert total assets into pesos at December 31, 2004 exchange rate, the rate
prevailing when the assets were acquired (8 kronas = P1)
60,000,000 kronas
24,000,000 kronas = = P7,500,000
8 kronas per peso
Convert operating income into pesos at the average exchange rate prevailing
when during 2005 when operating income was earned equal to
9,180,000 kronas
8.5 kronas per peso = P1,080,000
P1,080,000
Comparable ROI for Swedish Division = P7,500,000 =
14.4%
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Requirement 3
Requirement 1
P130,000
Luzon Division P340,000 = 38.24%
P220,000
Visayas Division P1,150,000 = 19.13%
P380,000
Mindanao Division P1,620,000 = 23.46%
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Requirement 2
The gross book values (i.e., the original costs of the plants) under historical
cost are calculated as the useful life of each plant (12) x the annual
depreciation:
Step 1: Restate long-term assets from gross book value at historical costs to
gross book value at current cost as of the end of 2005.
Gross book value of
Construction cost index in 2005
long-term assets at x
Construction cost index in year of construction
historical cost
Luzon P 840,000 x (170 100) = P1,428,000
Visayas P1,200,000 x (170 136) = P1,500,000
Mindanao P1,440,000 x (170 160) = P1,530,000
Step 2: Derive net book value of long-term assets at current cost as of the
end of 2005. (Estimated useful life of each plant is 12 years).
Gross book value of
long-term assets at Estimated useful life remaining
current cost at the x
Estimated total useful life
end of 2005
Luzon P1,428,000 x (2 12) = P 238,000
Visayas P1,500,000 x (9 12) = P1,125,000
Mindanao P1,530,000 x (11 12) = P1,402,500
Step 3: Compute current cost of total assets at the end of 2005. (Assume
current assets of each plant are expressed in 2005 pesos.)
Current assets at the end Net book value of long-term assets at
of 2005 (given) + current cost at the end of 2005 (Step 2)
Luzon P200,000 + P238,000 = P 438,000
Visayas P250,000 + P1,125,000 = P1,375,000
Mindanao P300,000 + P1,402,500 = P1,702,500
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Gross book value of long-term assets at current cost at the end of 2005
(from Step 1) x (1 12)
Step 6: Compute ROI using current-cost estimate for long-term assets and
depreciation.
Operating income for 2005 using 2005 current cost depreciation (Step 5)
Current cost of total assets at the end of 2005 (Step 3)
Use of current cost results in the Mindanao Division appearing to be the most
efficient. The Luzon ROI is reduced substantially when the ten-year-old plant
is restated for the 70% increase in construction costs over the 1995 to 2005
period.
Requirement 3
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of current cost also will increase the willingness of managers, evaluated on the
basis of ROI, to move from divisions with assets purchased many years ago to
division with assets purchased in recent years.
CHAPTER 25
I. Questions
1. Productivity is the relationship between the output and the input resources
required for generating the output.
2. A critical success factor for a firm that competes as a cost leader is to be
the low cost provider. A low cost provider needs to perform the required
tasks for the same output with fewer resources than its competitors.
3. Among criteria that often are used in assessing productivity and their
advantages and disadvantages are:
Using a prior years productivity as the criterion
Advantages:
Data readily available
Facilitates monitoring of continuous improvements
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Disadvantages:
Difficult to assess adequacy of productivity improvements
Hard to compare productivity improvements between the years
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II. Problems
Requirement 1
Star Company
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Management Accounting: An Overview Chapter 1
2005 2006
Sales 15,000 x P40 P600,00 18,000 x P40 P720,000
= 0 =
Variable cost of sales:
Materials 12,000 x P 8 P 12,600 x P10 P126,000
= 96,000 =
Labor 6,000 x P20 = 120,000 5,000 x P25 = 125,000
Power 1,000 x P 2 2,00 2,000 x P 2 4,00
= 0 = 0
Total variable costs of P218,00 P255,000
sales 0
Contribution margin P382,00 P465,000
0
2006 2005
DM 18,000 / 12,600 = 15,000 / 12,000 =
1.4286 1.25
DL 18,000 / 5,000 = 3.6 15,000 / 6,000 = 2.5
Power 18,000 / 2,000 = 9 15,000 / 1,000 = 15
Requirement 3
2006 2005
DM 12,600 x P10 = P126,000 12,000 x P 8 =
P 96,000
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2006 2005
DM 18,000 / 126,000 = 15,000 / 96,000 =
0.1429 0.15625
DL 18,000 / 125,000 = 15,000 / 120,000 =
0.144 0.125
Power 18,000 / 4,000 = 4.5 15,000 / 2,000 = 7.5
Requirement 4
Both direct materials and direct labor operation partial productivity improved
from 2005 to 2006. In 2006 the firm was able to manufacture more output
units for each unit of materials placed into production and for each hour spent
on production. The operational productivity of power in 2006 deteriorated
from 2005. It is likely that the firm used more equipment in production in
2006 that reduced consumption of materials and production hours.
The financial partial productivity for both direct materials and power
deteriorated from 2005 to 2006. Increases in direct materials costs were more
than the improvements in operational partial productivity for direct materials.
Like the operational partial productivity, the financial partial productivity for
direct labor also improved. The extent of improvements, however, is much
lower in financial partial productivity. The direct labor operational partial
productivity improved 44 percent in 2006 over those of 2005. The financial
partial productivity, however, improved only 15.2 percent between the two
years. The decrease in financial partial productivity is likely a result of
increases in direct labor wages.
Requirement 5
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Management Accounting: An Overview Chapter 1
(1) Output
(unit):
18,000 18,000 18,000 15,000
(2) 1/Productivity
DM: 12,000/15,0 12,000/15,0 12,000/15,0
12,600/18,0 00 00 00
00 = 0.7 = 0.8 = 0.8 = 0.8
DL: 6,000/15,00 6,000/15,00 6,000/15,00
5,000/18,00 0 0 0
0 = 0.2778 = 0.4 = 0.4 = 0.4
Power: 1,000/15,00 1,000/15,00 1,000/15,00
2,000/18,00 0 0 0
0 = 0.1111 = 0.0667 = 0.0667 = 0.0667
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Decompositi
on
DM: 18,000 / 18,000 / 18,000 / 15,000 /
126,000 144,000 115,200 96,000
= 0.1429 = 0.125 = 0.15625 = 0.15625
DL: 18,000 / 18,000 / 18,000 / 15,000 /
125,010 180,000 144,000 = 120,000
= 0.1440 = 0.1 0.125 = 0.125
Power: 18,000 / 18,000 / 15,000 /
18,000 / 2,401 2,401 2,001
4,000 = 7.4969 = 7.4969 = 7.4963
= 4.5
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Management Accounting: An Overview Chapter 1
= 2.9969 U (rounding)
Summary of
Result
Change as % of 2005 Productivity
Productivity Input Price Total Productivity Input Price Total
Change Change Change Change Change Change
DM: 0.0179 F 0.03125 0.01335 11.46% 20% U 8.54%
U U F U
DL: 0.044 F 0.025 0.019 35.2% 20% U 15.2%
U F F F
Power: 2.9969 U 0 2.9969 39.98% 0 39.98%
U U U
Requirement 6
Productivity for both direct materials and direct labor improved in 2006. The
percentages of improvements in productivity are 11.46 and 35.2 for direct
materials and direct labor, respectively, of the 2005 productivity. However,
cost increases in direct materials and direct labor reduced the gains in
productivity on these two manufacturing factors
Requirement 1
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2006:
Total actual direct labor hours: 20 x 20,000 = 400,000
Total standard direct labor hours: 21 x 20,000 = 420,000
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Management Accounting: An Overview Chapter 1
= P200,000 F = P500,000 F
Recap:
Assembly Testing Department
Department
2005 2006 2005 2006
Rate P1,000,000 P400,00 P240,00 P200,00
variance U 0U 0F 0F
Efficiency P560,00 P700,00 P840,00 P500,00
variance 0U 0F 0F 0F
Requirement 2
Requirement 3
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Requirement 5
Requirement 1
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Requirement 2
Sales volume variances for the period for each of the products and for the firm
Premium Regular
Sales Sales
Flexible Master Volume Flexible Master Volume
Budget Budget Variance Budget Budget Variance
Barrels 180 180 540 360
Sales P27,000 P36,000 P64,800 P43,200
Variable
expenses 16,200 21,600 40,500 27,000
Contribution
margin P10,800 P14,400 P3,600 P24,300 P16,200 P8,100 F
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Fixed
expenses 10,000 10,000 5,000 5,000
Operating
income P 800 P 4,400 P3,600 P19,300 P11,200 P8,100 F
U
Requirement 3
Sales quantity variances for the firm and for each of the products. (See next
page.)
Requirement 4
Sales mix variances for the period for each of the products and for the firm
(000 omitted).
Calculation for sales mixes:
Budgeted Actual
Total Sales Sales Total Sales Sales
in Units Mix in Units Mix
Premium 240 0.40 180 0.25
Regular 360 0.60 540 0.75
600 1.00 720 1.00
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Premium
720 x 0.25 x P60 = 720 x 0.40 x P60 = 600 x 0.40 x P60 = P14,400
P10,800 P17,280
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Total
Sales mix variance = P6,480 U + P4,860 F = P1,620 U
Sales quantity variance = P2,880 U + P3,240 F = P6,120 F
Requirement 5
Verification
Requirement 6
Requirement 7
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Management Accounting: An Overview Chapter 1
Requirement 8
The sum of market size variance and market share variance and verification
that this total equals the sales quantity variance.
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making -
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Total market size variance Total market share Total quantity variance
+ variance =
P2,040 F P4,080 F P6,120 F
Requirement 1
Requirement 2
Tan should not follow the order without following a consistent accounting
method. If the firm believes that certain cost items should be reclassified as
indirect costs, the same procedure should be followed for all years. Tan
should then go back and revise operating results of previous years.
Requirement 1
Budget Actual
Empress Empress
Industr Industr
Designs y Share Designs y Share
WS 50 500 10.0 45 425 45/42
% 5
DH 25 200 12.5 35 150 35/15
% 0
Requirement 2
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Requirement 3
Requirement 4
Among possible reasons are quality changes, pricing changes, less producers
due to seasonal variations, and market no longer there.
Requirement 5
Supporting Computations:
2005 2006
Output Input Partial Output Input Partial
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Resource Resource
Used Productivity Used Productivity
X-45 60,000 75,000 = 0.8 64,000 89,600 = 0.7143
(1)
Direct
labor 60,000 10,000 = 6.0 64,000 10,847 = 5.9002
(2)
Financial partial productivity
2005 2006
Cost of Cost of
Input Input
Units of Resource Partial Units of Resource Partial
Output Used Productivity Output Used Productivity
X-45 60,000 P540,000= 0.1111 64,000 P609,280= 0.1050
(3)
Direct
labor 60,000 300,000 = 0.2 64,000 P347,104= 0.1844
Total productivity in units (4)
2005 2006
(a)Total units 60,000 64,000
manufactured
(b) Total variable
manufacturing costs P840,000 P956,384
incurred
(c)Total productivity (a) 0.071429 0.066919
(b) (5)
(d) Decrease in 0.071429 0.00451
productivity 0.066919 = (6)
Total productivity in sales pesos
2005 2006
(a)Total sales P1,500,000 P1,600,00
0
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making -
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Market Share
(13)
Product A Product B Total
Budgeted sales
unit 30,000 60,000 90,000
Budgeted
contribution x x
margin per unit P4.00 P10.00
Budgeted total
contribution P120,00 P600,00 P720,00
margin 0 0 0
Budgeted average
contribution
margin per unit P8.00
(14)
Product Product Total
A B
Actual units sold 35,000 65,000
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Management Accounting: An Overview Chapter 1
Sales mixes:
Budgeted Actual
Unit % Unit %
Product A 30,000 1/3 35,000 35
Product B 60,000 2/3 65,000 65
TOTAL 90,000 100 100,000 100
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Management Accounting: An Overview Chapter 1
CHAPTER 26
I. Questions
1. Incentive compensation is a monetary reward that is based on measured
performance. Organizations where employees have been given the
responsibility to make decisions are best suited for incentive compensation
systems.
2. The four guidelines are: fairness, participation, basic wage level, and
independent wage policy.
Fairness deals with the ratio of salaries of the highest paid to lowest paid
employees.
Participation states that all employees should be included in a
compensation plan. Although, they do not need to be included in the same
one.
Basic wage level states that a market wage should be paid, and incentive
compensation should not be used to adjust the market wage downward.
Independent wage policy states that the incentive compensation system for
the most senior levels of the organization should be set by a group that is
independent of senior management.
3. a. based on salary easy to administer, likely to be considered fair, and,
to the extent that salary reflects the relative ability to contribute to
results, is based on contribution;
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making -
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18-394
Management Accounting: An Overview Chapter 1
II. Problems
Problem 1
Requirement (a)
Requirement (b)
Problem 2
Requirement (a)
Requirement (b)
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CHAPTER 27
MANAGING ACCOUNTING IN
A CHANGING ENVIRONMENT
I. Questions
1. The American Heritage Dictionary defines quality as 1. a characteristic
or attribute of something; property; a feature. 2. the natural or essential
character of something. 3. excellence; superiority.
Quality for a product or service can be defined as a product or service
that conforms with a design which meets or exceeds the expectations of
customers at a price they are willing to pay.
2. Procter & Gamble defines TQM as the unyielding and continually
improving effort by everyone in an organization to understand, meet, and
exceed the expectations of customers. Typical characteristics of TQM
include focusing on satisfying customers, striving for continuous
improvement, and involving the entire workforce.
TQM is a continual effort and never completes. Global competition, new
technology, and ever-changing customer expectations make TQM a
continual effort for a successful firm.
3. The core principles of TQM include (1) focusing on satisfying the
customer, (2) striving for continuous improvement, and (3) involving the
entire work force.
4. Continuous improvement (Kaizen) in total quality management is the
belief that quality is not a destination; rather, it is a way of life and firms
need to continuously strive for better products with lower costs.
In todays global competition, where firms are forever trying to
outperform the competition and customers present ever-changing
expectations, a firm can never reach the ideal quality standard and needs
to continuously improve quality and reduce costs to remain competitive.
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making -
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18-400
Management Accounting: An Overview Chapter 1
II. Exercises
Inter Exter
nal nal
Preven Apprai Failur Failur
tion sal e e
a. Warranty
repairs x
b. Scrap x
c. Allowance
granted due to
blemish x
d. Contribution
margins of lost sales x
e. Tuition for
quality courses x
f. Raw materials x
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making -
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inspections
g. Work-in-
process inspection x
h. Shipping cost
for replacements x
i. Recalls x
j. Attorneys fee
for unsuccessful
defense of
complaints about
quality x
k. Inspection of
reworks x
l. Overtime
caused by reworking x
m. Machine
maintenance x
n. Tuning of
testing equipment x
Exercise 2 (Cost of Quality Report)
Requirements 1 & 2
Bali Company
Cost of Quality Report
For 2005 and 2006
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Management Accounting: An Overview Chapter 1
a. There were slight increases in both prevention and appraisal costs from
2005 to 2006. Each of these two cost of quality increased by
approximately 0.33 percent of the total sales. These two costs increased
by P40,000 over the two years.
b. Both internal failure costs and external failure costs decreased
substantially in 2006 as compared to those in 2005. The firm experienced
a 1.41 percent decrease in internal failure and a 4.34 percent decrease in
external failure costs with the total savings of P345,000. The savings was
863 percent of the increases in prevention and appraisal costs.
Requirement 3
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Requirement 1
18-404
Management Accounting: An Overview Chapter 1
Requirement 2
Total spent by
category P25,000 P48,000 P42,000 P51,000
Requirement 3
The company is currently spending the least on preventive costs. They should
concentrate their efforts on preventive costs because they prevent poor quality
products from being manufactured.
Requirements 1 and 2
2006 2005
Revenues P12,500,000 P10,000,000
Percent Percent
age of age of
Revenu Revenu
es (2) = es (4) =
(1) (3)
Cost P12,500 Cost P10,000
Costs of Quality (1) ,000 (3) ,000
Prevention costs
Design P240,0 P100,0
engineering 00 00
Preventive
maintenance 90,000 35,000
Training 120,00
0 45,000
Supplier 50,0 20,0
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making -
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evaluation 00 00
Total
prevention 500,0 200,0
costs 00 4.0% 00 2.0%
Appraisal costs
Line inspection 110,00
85,000 0
Product-testing
equipment 50,000 50,000
Incoming
materials
inspection 40,000 20,000
Product-testing 75,0 220,0
labor 00 00
Total 250,0 400,0
appraisal costs 00 2.0% 00 4.0%
Internal failure
costs
Scrap 200,00 250,00
0 0
Rework 135,00 160,00
0 0
Breakdown 40,0 90,0
maintenance 00 00
Total internal
failure costs 375,0 500,0
00 3.0% 00 5.0%
External failure
costs
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Management Accounting: An Overview Chapter 1
Returned 145,00
goods 0 60,000
Customer
support 30,000 40,000
Product liability 100,00 200,00
claims 0 0
Warranty repair 200 300
,000 ,000
475 600
,000 3.8% ,000 6.0%
Total costs of P1,600, P1,700,
quality 000 12.8% 000 17.0%
Between 2005 and 2006, Gabriels costs of quality have declined from 17% of
sales to 12.8% of sales. The analysis of individual costs of quality categories
indicates that Gabriel began allocating more resources to prevention activities
design engineering, preventive maintenance, training and supplier
evaluations in 2006 relative to 2005. As a result, appraisal costs declined
from 4% of sales to 2%, costs of internal failure fell from 5% of sales to 3%,
and external failure costs decreased from 6% of sales to 3.8%. The one
concern here is that, although external failure costs have decreased, the cost of
returned goods has increased. Gabriels management should investigate the
reasons for this and initiate corrective action.
Requirement 3
Requirements 1 and 2
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making -
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Percentage of
Revenues
Costs (2) = (1)
Costs of Quality (1) P20,000,000
Prevention costs
Design engineering (P75 x
6,000 hours) P 450,000 2.25%
Appraisal costs
Testing and inspection
(P40 x 1 hour x 10,000
units) 400,000 2.00%
Internal failure costs
Rework (P500 x 5% x
10,000 units) 250,000 1.25%
External failure costs
Repair (P600 x 4% x
10,000 units) 240,000 1.20%
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Management Accounting: An Overview Chapter 1
Percentage of
Revenues
Costs (2) = (1)
Costs of Quality (1) P7,500,000
Prevention costs
Design engineering (P75 x
1,000 hours) P 75,000 1.00%
Appraisal costs
Testing and inspection
(P40 x 0.5 x 5,000
units) 100,000 1.33%
Internal failure costs
Rework (P400 x 10% x
5,000 units) 200,000 2.67%
External failure costs
Repair (P450 x 8% x 5,000
units) 180,000 2.40%
Estimated forgone
contribution margin on
lost sales [(P1,500
P800) x 300] 210,000 2.80%
Total external failure
costs 390,000 5.20%
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making -
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Requirement 3
III. Problems
Requirement 1
Requirement 2
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Management Accounting: An Overview Chapter 1
Requirement 3
Yes. The cost of the new process is P15,000,000 and the expected benefits is
P28,837,500 over three years. The firm can expect to earn a return of over
90%.
Requirement 4
The following factors should be considered before making the final decision:
Requirement 5
The member of the board would be right if we ignore the financial payoff of
the new process and if the firm is going to be in business for only three years.
Having high quality products, especially for a high-end product such as the
one the firm is selling, is crucial for a long term success.
Increase
Costs (Decrease
Categories 2005 2006 )
Prevention
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making -
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costs:
Training P P P
75,000 100,000 25,000
Product 150,00 175,00 25,0
design 0 0 00
Total 225,000 275,000 50,000
prevention
Appraisal
costs:
Testing 50,000 150,000 100,000
Calibration 75,00 100,00 25,0
0 0 00
Total 125,000 250,000 125,000
appraisal
Internal
failure costs:
Rework 325,000 100,000 (225,000)
Retesting 250,00 200,00 (50,00
0 0 0)
Total 575,000 300,000 (275,000)
internal
failure
External
failure costs:
Warranty 150,000 75,000 (75,000)
repairs
Product 400,000 200,000 (200,000)
recalls
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Management Accounting: An Overview Chapter 1
Requirement 1
Incremental
Costs under Incremental
Current Costs under
Production JIT Production
Relevant Items System System
Annual tooling costs P150,000
Required return on investment
12% per year x P900,000 of
average inventory per year P108,000
12% per year x P200,000 of
average inventory per year 24,000
Insurance, space, materials
handling, and setup costs 200,000 140,000a
Rework costs 350,000 280,000b
Incremental revenues from
higher selling prices (90,000)c
Total net incremental costs P658,000 P504,000
Annual difference in favor of JIT
production P154,000
a
P200,000 (1 0.30) = P140,000
b
P350,000 (1 0.20) = P280,000
c
P3 x 30,000 units = P90,000
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Requirement 2
Requirement 1
Incremental
Costs under Incremental
Current Costs under
Purchasing JIT Purchasing
System Policy
Required return on investment
20% per year x P600,000 of
average inventory per year P120,000
20% per year x P0 of
inventory per year P 0
Annual insurance costs 14,000 0
Warehouse rent 60,000 (13,500)a
Overtime costs
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Management Accounting: An Overview Chapter 1
No overtime 0
Overtime premium 40,000
Stockout costs
No stockouts 0
P6.50b contribution margin
per unit x 20,000 units 130,000
Total incremental costs P194,000 P156,500
Difference in favor of JIT
purchasing P37,500
a
P(13,500) = Warehouse rental revenues, [(75% x 12,000) x P1.50].
b
Calculation of unit contribution margin
Selling price (P10,800,000 900,000 units) P12.00
Variable costs per unit:
Variable manufacturing costs per unit
(P4,050,000 900,000 units) P4.50
Variable marketing and distribution
costs per unit
(P900,000 900,000 units) 1.00
Total variable costs per unit 5.50
Contribution margin per unit P6.50
Note that the incremental costs of P40,000 for overtime premiums to make the
additional 15,000 units are less than the contribution margin from losing these
sales equal to P97,500 (P6.50 x 15,000). Josefina would rather incur
overtime than lose 15,000 units of sales.
Requirement 1
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making -
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Zashi should invest in the modern jigs and tools because the benefit of higher
throughput contribution of P40,000 exceeds the cost of P30,000.
Requirement 2
Requirement 1
Requirement 2
Requirement 1
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Management Accounting: An Overview Chapter 1
Requirement 2
Alternatively, the cost of 2,000 defective units at the finishing operation can be
calculated as the lost revenue of P72 x 2,000 = P144,000. This line of
reasoning takes the position that direct materials costs of P32 x 2,000 =
P64,000 and all fixed operating costs in the machining and finishing
operations would be incurred anyway whether a defective or good unit is
produced. The cost of producing a defective unit is the revenue lost of
P144,000.
Problem 8
Requirement (a)
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making -
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Anthony Foods
Quality Costs
2005-2006
(Millions)
2005 2006
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
Quality assurance
administration P 6.20 P 6.52 P 6.86 P 7.19 P 7.93 P 8.74 P 9.61 P10.53
Training 13.10 14.39 15.90 17.46 21.12 25.50 30.37 36.35
Process
engineering 2.20 2.46 2.76 3.11 3.87 4.86 6.13 7.58
Prevention 21.50 23.37 25.52 27.76 32.92 39.10 46.11 54.46
Inspection 1.40 1.56 1.75 1.95 2.39 2.96 3.63 4.46
Testing 1.60 1.72 1.85 1.99 2.29 2.62 3.01 3.45
Appraisal 3.00 3.28 3.60 3.94 4.68 5.58 6.64 7.91
Rework 15.80 12.65 10.03 8.49 7.25 6.16 5.56 5.00
Scrap 17.60 14.48 11.92 10.32 8.92 7.72 7.00 6.34
Internal failure 33.40 27.13 21.95 18.81 16.17 13.88 12.56 11.34
Returns 26.90 21.09 16.35 13.53 11.32 9.50 8.43 7.52
Customer
complaint dept. 3.90 3.45 3.03 2.76 2.50 2.27 2.14 2.01
Lost sales 49.20 40.31 33.11 28.42 24.45 21.08 19.20 17.44
External failure 80.00 64.85 52.49 44.71 38.27 32.85 29.77 26.97
Total costs P137.90 P118.63 P103.56 P95.22 P92.04 P91.41 P95.08 P100.68
Requirement (b)
From the preceding data we see that prevention and appraisal costs are
increasing while internal and external failure costs have been decreasing. The
following graph plots three series: prevention and appraisal costs, failure
costs, and total quality costs.
140
120
100
80
60
40
20 18-418
0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
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Chapter 18 Application of Quantitative Techniques in Planning, Control and Decision Making -
II
31. C 26. C
32. B 27. A
33. C 28. C
34. D 29. B
35. D 30. C
36. A 31. D
37. C 32. D
38. C 33. D
39. D 34. A
40. D 35. A
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