Chapter 1
An Introduction to Managerial
Accounting
Solutions to Questions
1-1
Managerial accounting is concerned with providing information primarily to
managers for their use internally in the organization for the purposes of
strategy, planning, implementation and control. Financial accounting is
concerned with providing information primarily to investors, creditors, and
others outside of the organization.
1-2
Essentially, the manager carries out three major activities in an
organization: planning, implementation, and control. All three activities
involve decision-making and use managerial accounting information. This
is depicted in Exhibit 1-1.
1-3
The Planning, Implementation and Control Cycle involves the following
steps: (1) formulating plans which often includes preparing budgets, (2)
overseeing day-to-day activities which includes organizing, directing and
motivating people, resource allocation and decision making, and (3)
controlling which includes providing feedback via performance reports.
1-4
In contrast to financial accounting, managerial accounting: (1) focuses on
the needs of the manager; (2) places more emphasis on the future; (3)
emphasizes relevance and timeliness, rather than verifiability and
precision; (4) emphasizes the segments of an organization; (5) is not
governed by IFRS or ASPE; and (6) is not mandatory.
1-5
The lean business model focuses on continuous improvement by
eliminating waste in the organization. Companies that adopt the lean
business model usually implement one or more of the following
management practices.



Just-in-time (JIT): A production and inventory control system in
which materials are purchased and units are produced only as
needed to meet actual customer demand.
Total quality management (TQM): An approach to continuous
improvement that focuses on serving customers and uses teams of
front-line workers to systematically identify and solve problems.
Process re-engineering: An approach to improvement that
involves completely redesigning business processes in order to
eliminate unnecessary steps, reduce errors, and reduce costs.
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Solutions Manual, Chapter 1
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
1-6
Pros





Theory of constraints (TOC): A management approach that
emphasizes the importance of managing constraints.
Funds tied up in maintaining inventory can be used elsewhere
Areas previously used to store inventories are made available for
other more productive uses
The time required to fill an order is reduced, resulting in quicker
response to customers and consequentially greater potential sales
Defect rates are reduced resulting in less waste and greater
customer satisfaction
More effective operations
Cons

Increased number of purchase orders to buy raw materials and/or
other components used in manufacturing products

There is little room for errors and defects in products because this
could throw the production facility off schedule

There is a high reliance and dependence on suppliers to meet
delivery deadlines as well as supply products that have no defects
and require minimal inspection
1-7
Agree. Ethical behaviour is the foundation of a successful market
economy. If we cannot trust people to act ethically in their business
dealings with us, we will be inclined to invest less, scrutinize more and
waste money and time (scarce resources) trying to protect ourselves.
Ethical standards and Codes of Conduct aid the smooth running of the
economy. In addition, the lack of regulatory requirements (IFRS, ASPE)
regarding managerial accounting makes ethical behaviour even more
critical.
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2
Introduction to Managerial Accounting, Fifth Canadian Edition
Solutions to Exercises
Exercise 1-1 (LO1 CC2)
Item
Financial
Accounting
Managerial
Accounting
a) Preparing a cash budget for the
next quarter
X
b) Analyzing the profitability of a
request from a potential
customer
X
c) Accumulating the transactions
for the previous six months to
prepare an income statement
X
d) Preparing a weekly
performance report for the
branch manager
X
e) Preparing an announcement to
be released to the financial
analysts
X
Exercise 1-2 (LO1 CC1)
Planning
a) Doing a “cost-benefit”
analysis of adding a new
branch versus installing new
ATMs
X
b) Estimating the cost of raw
materials to be purchased
during the next quarter
X
c) Analyzing market demand
X
Implementation
Control
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Solutions Manual, Chapter 1
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to assist in the preparation
of the sales budget
d) Compiling the labour report
for the past week
e) Outlining the changes to a
process based on a process
reengineering team report
f) Documenting the savings
from reductions in raw
materials inventory
resulting from the adoption
of a just-in-time inventory
system
X
X
X
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Introduction to Managerial Accounting, Fifth Canadian Edition
Solutions to Problems
Problem 1-1 (LO3 CC5)
a) This has ethical implications because the code of ethics mandates that all
professional accountants will abide by the fundamental principles. There
are two possible issues here – confidentiality and integrity. By sending
the reports to the analyst Cleo will be violating the principle of
confidentiality, she cannot “…disclose any such information to third parties
without proper and specific authority, unless there is a legal or
professional right or duty to disclose, nor use the information for the
personal advantage of the professional accountant or third parties.” One
might argue that there is also an issue of personal integrity here; as a
professional accountant she is required “to be straightforward and honest
in all professional and business relationships.”
b) The main ethical implication here is the issue of confidentiality of client
data. The code mandates that a member will not disclose any confidential
information concerning his/her employer unless acting in the course of
his/her duties or when required to be disclosed in a lawsuit. As such
informing ones parents of the folly of their investment choice would be
unethical.
Problem 1-2 (LO3 CC5)
There is an ethical dilemma associated with the student’s request. There
is the need for fairness among all the students who wrote the exam, and
ignoring the mid-semester exam result for one student is unfair to the
other students. As a student aiming to become a manager, it is important
that the student does not engage in any activity considered as
incompatible with the conduct of a manager. A request for special
treatment that would be unfair to other students could be considered a
violation of the principles of Integrity (the dealings are not straightforward
and honest), Objectivity (a bias is introduced to the relative grading in the
course), and Professional Behaviour (special treatment for some, does not
comply with school rules, and could discredit the reputation of the school’s
standards).
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Solutions Manual, Chapter 1
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Bringing in a doctor’s note one month after writing an exam and using
that as a reason to explain his/her poor performance would also not be
considered ethical. Presenting a note one month after an event, to
address a matter that should have been dealt with contemporaneously,
violates the principle of Integrity (the dealings are not straightforward),
and Professional Competence and Due Care (the obligation to act
diligently in accordance with standards).
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Introduction to Managerial Accounting, Fifth Canadian Edition
Chapter 2
Cost Concepts
Solutions to Questions
2-1
Cost behaviour refers to how a cost will
react or respond to changes in the level of
business activity.
2-2
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 the activity level (e.g., number of beds
occupied). A fixed cost is fixed in total, but will
vary inversely on a per-unit basis with changes
in the level of activity.
2-3
When fixed costs are involved, the cost
per unit of activity will depend on the activity
volume (or level). For example, as production
increases, the cost per unit will fall because the
fixed cost is spread over more units. Conversely,
as production declines, the cost per unit will rise
since a constant fixed cost figure will be spread
over fewer units.
2-4
The cost of direct materials included in a
product is a variable cost; similarly, sales
commissions paid out on a per unit basis or as a
percentage of sales dollars is a variable cost.
On the other hand, costs such as building rent
and the salary of a general manager are fixed
costs.
2-5
Fixed costs in total do not vary with
volume within a relevant range. However, fixed
costs per unit of volume decrease as volume
increases and increases as volume decreases.
Therefore, an inverse relationship exists
between volume and fixed costs per unit of
volume.
2-6
Manufacturing overhead is an indirect
cost since these costs cannot be easily and
conveniently traced to individual products.
2-7
A differential cost is a cost that differs
between alternatives in a decision. An
opportunity cost is the potential benefit that is
given up when one alternative is selected over
another. A sunk cost is a cost that has already
been incurred and cannot be altered by any
decision taken now or in the future.
2-8
No; differential costs can be either
variable or fixed. For example, the alternatives
might consist of purchasing one computer
software program over another to simplify the
accounts receivable process. The difference in
the fixed costs of purchasing the two programs
would be a differential cost.
2-9
The three major elements of product
costs in a manufacturing company are direct
materials, direct labour, and manufacturing
overhead.
2-10
a. Direct materials: Direct materials are an
integral part of a finished product and can be
conveniently traced into it.
b. Indirect materials: Indirect materials are
generally small items of material such as glue
and nails. They may become an integral part of
a finished product but are traceable into the
product only at great cost or inconvenience.
Indirect materials are ordinarily classified as part
of manufacturing overhead.
c. Direct labour: Direct labour includes those
labour costs that can be easily traced to
particular products. Direct labour is also called
“touch labour.”
d. Indirect labour: Indirect labour includes
the labour costs of workers who do not directly
work on products but provide a support
function. Examples of such labour include
janitors, supervisors, materials handlers, and
other factory workers that cannot be
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Solutions Manual, Chapter 2
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conveniently traced directly to particular
products.
e. Manufacturing overhead: Manufacturing
overhead includes all manufacturing costs
except direct materials and direct labour.
2-11 PC = DM + DL
CC = DL + MOH
PC = DM + CC - MOH
2-12 A product cost is any cost incurred for
the purchase or the manufacture of goods. In
the case of manufactured goods, these costs
consist of direct materials, direct labour, and
manufacturing overhead. A period cost is a cost
that is taken directly to the income statement as
an expense in the period in which it is incurred.
Examples include selling (marketing) and
administrative expenses.
2-13 The income statement of a
manufacturing firm differs from the income
statement of a merchandising firm in the cost of
goods sold section. The merchandising firm sells
finished goods that it has purchased from a
supplier. These goods are listed as “Purchases”
in the cost of goods sold section. Since the
manufacturing firm produces its goods rather
than buying them from a supplier, it lists “Cost
of Goods Manufactured” in place of “Purchases.”
Also, the manufacturing firm identifies its
inventory in this section as “Finished Goods
Inventory,” rather than as “Merchandise
Inventory.”
2-14 The schedule of cost of goods
manufactured is used to list and organize the
manufacturing costs that have been incurred.
These costs are organized under the three major
headingsof direct materials, direct labour, and
manufacturing overhead. The total costs
incurred are adjusted for any change in the
Work in Process inventory to determine the cost
of goods manufactured (i.e., finished) during the
period.
The schedule of cost of goods
manufactured ties into the income statement
through the Cost of Goods Sold section. The
cost of goods manufactured is added to the
beginning Finished Goods inventory to
determine the goods available for sale. In effect,
the cost of goods manufactured takes the place
of the “Purchases” account in a merchandising
firm.
2-15 A manufacturing firm has three
inventory accounts: Raw Materials, Work in
Process, and Finished Goods. The merchandising
firm generally identifies its inventory account
simply as Merchandise Inventory.
2-16 Since product costs follow units of
product into inventory, they are sometimes
called inventoriable costs. The flow is from
direct materials, direct labour, and
manufacturing overhead into Work in Process.
As goods are completed, their cost is removed
from Work in Process and transferred into
Finished Goods. As goods are sold, their cost is
removed from Finished Goods and transferred
into Cost of Goods Sold. Cost of Goods Sold is
an expense on the income statement.
2-17 Yes, costs such as salaries
anddepreciationcan end up as assets on the
balance sheet if these are manufacturing costs.
Manufacturing costs are inventoried until the
associated finished goods are sold. Thus, such
costs may be part of either Work in Process
inventory or Finished Goods inventory at the end
of a period if there are unsold units.
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Introduction to Managerial Accounting,Fifth Canadian Edition
Solutions to Foundational 15
The Foundational 15 (LO1 – CC1; LO2 – CC2; LO3 – CC3; LO4 – CC4,
5, 6, 7)
1. Direct materials ................................................................$ 6.00
Direct labour ................................................................
3.50
Variable manufacturing overhead ................................
1.50
Variable manufacturing cost per unit ................................ $11.00
Variable manufacturing cost per unit (a) ................................
$11.00
Number of units produced (b) ...............................................
10,000
Total variable manufacturing cost (a) × (b) ............................
Fixed manufacturing overhead per unit (c) .............................
$4.00
Number of units produced (d) ...............................................
10,000
Total fixed manufacturing cost (c) × (d) ................................
Total product (manufacturing) cost ................................
$110,000
40,000
$150,000
$1.00
2. Sales commissions ................................................................
Variable administrative expense .............................................0.50
Variable selling and administrative per unit .............................
$1.50
Variable selling and admin. per unit (a) ................................$1.50
Number of units sold (b) .......................................................
10,000
Total variable selling and admin. expense
(a) × (b) ................................................................
Fixed selling and administrative expense per unit
($3 fixed selling + $2 fixed admin.) (c) ...............................
$5.00
Number of units sold (d) .......................................................
10,000
Total fixed selling and administrative expense (c) ×
(d) ....................................................................................
Total period (nonmanufacturing) cost ................................
$15,000
50,000
$65,000
3. Direct materials ................................................................$ 6.00
Direct labour ................................................................
3.50
Variable manufacturing overhead ................................
1.50
Sales commissions ................................................................1.00
Variable administrative expense .............................................0.50
Variable cost per unit sold .....................................................
$12.50
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Solutions Manual, Chapter 2
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The Foundational 15 (continued)
4.
Direct materials ................................................................
$ 6.00
Direct labour ................................................................
3.50
Variable manufacturing overhead ................................
1.50
Sales commissions ................................................................
1.00
Variable administrative expense ................................
0.50
Variable cost per unit sold .....................................................
$12.50
5.
Variable cost per unit sold (a) ................................................
$12.50
Number of units sold (b) .......................................................
8,000
Total variable costs (a) × (b) .................................................
$100,000
6.
Variable cost per unit sold (a) ................................................
$12.50
Number of units sold (b) .......................................................
12,500
Total variable costs (a) × (b) .................................................
$156,250
7.
Total fixed manufacturing cost
(see requirement 1) (a)......................................................
$40,000
Number of units produced (b) ................................
8,000
Average fixed manufacturing cost per unit
produced (a) ÷ (b) ............................................................
$5.00
8.
Total fixed manufacturing cost
(see requirement 1) (a)......................................................
$40,000
Number of units produced (b) ................................
12,500
Average fixed manufacturing cost per unit
produced (a) ÷ (b) ............................................................
$3.20
9.
Total fixed manufacturing cost
(see requirement 1) ...........................................................
$40,000
10. Total fixed manufacturing cost
(see requirement 1) ...........................................................
$40,000
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Introduction to Managerial Accounting,Fifth Canadian Edition
The Foundational 15 (continued)
11. Variable overhead per unit (a) ...............................................
$1.50
Number of units produced (b) ...............................................
8,000
Total variable overhead cost (a) × (b) ................................
Total fixed overhead (see requirement 1) ...............................
Total manufacturing overhead cost ................................
Total manufacturing overhead cost (a) .............................
Number of units produced (b) .........................................
Manufacturing overhead per unit (a) × (b) .......................
$1.50
12. Variable overhead per unit (a) ...............................................
Number of units produced (b) ...............................................
12,500
Total variable overhead cost (a) × (b) ................................
Total fixed overhead (see requirement 1) ...............................
Total manufacturing overhead cost ................................
Total manufacturing overhead cost (a) .............................
Number of units produced (b) .........................................
Manufacturing overhead per unit (a) × (b) .......................
$12,000
40,000
$52,000
$52,000
8,000
$6.50
$18,750
40,000
$58,750
$58,750
12,500
$4.70
13. Sales revenue (@$22.00 per unit)................................ $220,000
Less: Cost of goods sold
(same as product costs in requirement 1) ...........................
150,000
Gross margin ................................................................$ 70,000
14. Direct materials per unit ........................................................
$6.00
Direct labour per unit ............................................................
3.50
Direct manufacturing cost per unit (a) ................................$9.50
Number of units produced (b) ...............................................
11,000
Total direct manufacturing cost (a) × (b) ...............................
$104,500
Variable overhead per unit (a) ......................................... $1.50
Number of units produced (b) ......................................... 11,000
Total variable overhead cost (a) × (b) ..............................
Total fixed overhead (see requirement 1) .........................
Total indirect manufacturing cost ................................
$16,500
40,000
$56,500
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5
The Foundational 15 (continued)
15. Direct materials per unit ........................................................
$6.00
Direct labour per unit ............................................................
3.50
Variable manufacturing overhead per unit ..............................
1.50
Incremental manufacturing cost per unit ................................
$11.00
Solutions to Brief Exercises
Brief Exercise 2-1(LO3 CC3) (10 minutes)
The cost concept that best applies to Bill’s response is the concept of opportunity cost.
Bill’s response of “no free lunch” suggests that the cost of the lunch is the time
foregone which he could have utilized in completing the report. For Bill, the
alternatives are time required to complete the financial performance report and time
required to attend the company lunch. If Bill attends the lunch he will have less time
available to finish the report and if he stays to finish the report he would miss the
company lunch.
Brief Exercise 2-2(LO1 CC1) (15 minutes)
Note to the instructor: A few of these costs may generate lively debate. For example,
some may argue that the cost of advertising a U2 rock concert is a variable cost since
the number of people who come to the rock concert depends on the amount of
advertising. However, one can argue that if the price is within reason, any U2 rock
concert in Vancouver will be sold out, and the function of advertising is simply to let
people know the event will be happening. Moreover, while advertising may affect the
number of people who ultimately buy tickets, the causation is in one direction. If more
people buy tickets, the advertising costs don’t go up.
Cost Behaviour
Variable
Fixed
1. The costs of advertising a U2 rock concert in
Vancouver …………………………………………..
2. Depreciation on the Hard Rock Cafe building in Ottawa ..................
3. The electrical costs of running a roller coaster at the
West Edmonton Mall ................................................................
X
X
X
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Introduction to Managerial Accounting,Fifth Canadian Edition
4. Property taxes on your local cinema ................................
5. The costs of synthetic materials used to make Reebok
running shoes ................................................................ X
6. The costs of shipping Apple iPods to retail stores ..........................
X
7. The cost of leasing a CT-scan diagnostic machine at
the American Hospital in Paris....................................................
X
X
Brief Exercise 2-3(LO3 CC3) (15 minutes)
Item
Differential
Cost
1. Cost of the old printing machine
2. The salary of the head of the
Printing Department
3. The salary of the head of the
Finance Department
4. Rent on the space occupied by
the Printing department
5. The cost of maintaining the old
printer
6. Benefits from a new state-ofthe-art scanner
7. Cost of electricity to run the
printing machine
Opportunity
Cost
Sunk Cost
X
X
X
X
Note: The costs of the salaries of the heads of the Printing and the Finance
Departments and the rent on the space occupied by Printing are neither differential
costs, nor opportunity costs, nor sunk costs. These are costs that do not differ between
the alternatives and are therefore irrelevant in the decision, but they are not sunk costs
since they occur in the future. The opportunity cost of the foregone benefit from a new
state-of-the-art scanner is not a differential cost in the decision to replace the old
printer with a new printer, but if the decision were instead whether to acquire a scanner
or a printer, this opportunity cost would also be a differential cost.
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Solutions Manual, Chapter 2
7
Brief Exercise 2-4 (LO4 CC4, 5, 6) (15 minutes)
1. Monthly salary of the company’s accountant: Administrative cost.
2. The cost of a fan installed in a computer: Direct Materials cost.
3. Rental on equipment used to assemble computers: Manufacturing Overhead
4. The cost of advertising in the local community newspaper: Marketing and Selling
cost.
5. Monthly charge paid to an outside company for quality testing (20% of the
computers assembled are sent for testing): Manufacturing Overhead
6. The wages of employees who assemble computers from components: Direct
Labourcost.
7. The salary of the assembly shop’s supervisor: Manufacturing Overhead.
8. Sales commissions paid to the company’s salespeople: Marketing and Sellingcost.
9.Rent on the facility: Manufacturing Overhead.
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Introduction to Managerial Accounting,Fifth Canadian Edition
Brief Exercise 2-5(LO4 CC7) (15 minutes)
Product
(Inventoriable)
Cost
1. Depreciation on salespersons’ cars ................................
X
2. Rent on equipment used in the factory ................................
3. Lubricants used for maintenance of factory
equipment ................................................................
X
4. Salaries of finished goods warehouse
personnel ................................................................
5. Soap and paper towels used by factory
workers at the end of a shift................................ X
6. Salessupervisors’ salaries ................................
X
7. Property taxes on the factory building ................................
8. Materials used in boxing units of finished
product for shipment overseas (units are
not normally boxed) ................................................................
9. Advertising outlays................................................................
10. Workers’ compensation insurance on
factory employees................................................................
X
11. Depreciation on chairs and tables in the
administrative boardroom ................................
12. The salary of the production quality
supervisor for the company ................................
13. Depreciation on a Learjet used by the
company's executives................................
14. Rent on rooms at a Florida resort for
manufacturing conference ................................
X
15. Attractively designed box for packaging
breakfast cereal ................................................................
X
Period
(Non-inventoriable)
Cost
X
X
X
X
X
X
X
X
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9
Brief Exercise 2-6(LO5 CC9, 10; LO6 CC 11) (15 minutes)
Bims
Income Statement
Sales ...........................................................................................
Cost of goods sold:
Beginning merchandise inventory ................................
$ 250,000
Add: Purchases ................................................................
950,000
1,200,000
Goods available for sale..............................................................
Deduct: Ending merchandise inventory................................
100,000
Gross margin ................................................................
Less operating expenses:
Selling expense ................................................................
315,000
Administrative expense...............................................................
385,000
Net income ................................................................
$3,000,000
1,100,000
1,900,000
700,000
$1,200,000
Brief Exercise 2-7(LO6 CC11, 12) (15 minutes)
Lompac Products
Schedule of Cost of Goods Manufactured
Direct materials:
Beginning raw materials inventory ................................
$170,000
Add: Purchases of raw materials ................................870,000
Raw materials available for use ................................
$1,040,000
Deduct: Ending raw materials inventory ................................
150,000
Raw materials used in production ................................
Direct labour ................................................................
Manufacturing overhead ................................................................
Total manufacturing costs .............................................................
Add: Beginning work in process inventory ................................
Deduct: Ending work in process inventory ................................
Cost of goods manufactured ..........................................................
$ 890,000
245,000
560,000
$1,695,000
210,000
$1,905,000
340,000
$ 1,565,000
Solutions to Exercises
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10
Introduction to Managerial Accounting,Fifth Canadian Edition
Exercise 2-1(LO1 CC1; LO3 CC3; LO4 CC4, 5, 6, 7) (45 minutes)
Product Cost
Name of the Cost
Variable
Cost
Fixed
Cost
Rental revenue foregone,
$50,000 per year ................................
Direct materials cost, $60 per
unit ................................................................
X
Rental cost of warehouse,
$1,000 per month ................................
X
Rental cost of equipment,
$15,000 per month ................................
X
Direct labour cost, $80 per unit ................................
X
Depreciation of the annex
space, $5,000 per year ................................ X
Advertising cost, $150,000 per
X
year ................................................................
Supervisor's salary, $3,500 per
month ................................................................
X
Electricity for machines, $1.80
per unit ................................................................
X
Shipping cost, $12 per unit ................................
X
Return earned on investments,
$5,000 per year ................................
Direct
Materials
Direct
Labour
Mfg.
Overhead
Period
(Selling
and
Admin.)
Cost
Opportunity
Cost
Sunk
Cost
X
X
X
X
X
X
X
X
X
X
X
X
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11
Exercise 2-2(LO1 CC1; LO3 CC3; LO4 CC7) (15 minutes)
1.
2.
3.
4.
5.
Product; variable
Conversion
Opportunity
Prime
Sunk
6.
7.
8.
9.
10.
Period; variable
Product; period; fixed
Product
Period
Fixed; product; conversion
Exercise 2-3(LO1 CC 1; LO2 CC2) (15 minutes)
Cost Item
Cost Behaviour
Variable
Fixed
1. Account manager’s salary ................................ X
2. Rent on building ................................
X
3. Flour used in the making of
croissants ................................ X
4. Bakery manager’s salary ................................ X
X
5. Wages of bakers ................................
6. Depreciation of commercial
ovens used in baking ................................ X
7. Insurance on the building ................................ X
To Quantity of Baked
Goods Produced
Direct
Indirect
X
X
X
X
X
X
X
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Introduction to Managerial Accounting,Fifth Canadian Edition
Exercise 2-4(LO1 CC1; LO4 CC7) (30 minutes)
Cost Behaviour
Variable
Fixed
Cost Item
1. Advertising by a dental office ................................X
2. Shipping canned apples from a
Del Monte plant to customers ................................
X
3. Apples processed and canned by
X
Del Monte Corporation ................................
4. Insurance on IBM’s corporate
headquarters ................................
X
5. Commissions paid to Future
Shop salespersons ................................
X
6. Hamburger buns in a
McDonald’s outlet ................................
X
7. Depreciation of factory
lunchroom facilities at a
General Electric plant ................................
X
8. Insurance on a Bausch & Lomb
factory producing contact
lenses ................................................................
X
9. Salary of a supervisor
overseeing production of
circuit boards at HewlettPackard ................................................................
X
10. Steering wheels installed in
BMWs ................................................................
X
Selling and
Administrative
Cost
Product
Cost
X
X
X
X
X
X
X
X
X
X
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Solutions Manual, Chapter 2
13
Exercise 2-5(LO5 CC10; LO6 CC11, 12) (45 minutes)
1.
Mason Company
Schedule of Cost of Goods Manufactured
Direct materials:
Raw materials inventory, beginning ................................
$18,000
Add: Purchases of raw materials .................................................
120,000
Raw materials available for use ...................................................
138,000
Deduct: Raw materials inventory, ending................................12,500
Raw materials used in production ...............................................
Direct labour .................................................................................
Manufacturing overhead:
Indirect labour ................................................................
45,000
Maintenance, factory equipment .................................................
6,000
Insurance, factory equipment .....................................................
1,900
Rent, factory facilities ................................................................
24,000
Supplies ....................................................................................
3,600
Depreciation, factory equipment .................................................
17,000
Total overhead costs ................................................................
Total manufacturing costs .............................................................
Add: Work in process, beginning ....................................................
Deduct: Work in process, ending ...................................................
Cost of goods manufactured ..........................................................
$125,500
70,000
97,500
293,000
10,300
303,300
15,150
$288,150
2. The cost of goods sold section of Mason Company’s income statement:
Finished goods inventory, beginning ................................
Add: Cost of goods manufactured ..................................................
Goods available for sale................................................................
Deduct: Finished goods inventory, ending ................................
Cost of goods sold ................................................................
$ 23,000
288,150
311,150
18,100
$293,050
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14
Introduction to Managerial Accounting,Fifth Canadian Edition
Exercise 2-6(LO4 CC8) (30 minutes)
1.a) Bolts of polyester purchased .........................................................
Bolts drawn from inventory ...........................................................
Bolts remaining in inventory..........................................................
Cost per bolt ................................................................................
Cost in Raw Materials Inventory at June 30 ...................................
10,000
9,200
800
× $80
$ 64,000
b)Bolts of polyester used in production (9,200 – 200)
Linens completed and transferred to Finished Goods (90% ×
9,000) ......................................................................................
Linens still in Work in Process at June 30 .......................................
Cost per bolts ..............................................................................
Cost in Work in Process Inventory at June 30 ................................
9,000
8,100
900
× $80
$ 72,000
c) Linens completed and transferred to Finished Goods (above)..........
Linens sold during the month (70% × 8,100) ................................
Linens still in Finished Goods at June 30 ........................................
Cost per bolts ..............................................................................
Cost in Finished Goods Inventory at June 30..................................
8,100
5,670
2,430
× $80
$194,400
d)Linens sold during the month (above) ...........................................
Cost per bolts ..............................................................................
Cost in Cost of Goods Sold at April 30............................................
5,670
× $80
$453,600
e) Bolts used for customer samples ...................................................
Cost per bolts ..............................................................................
Cost in Selling Expense at June 30 ................................................
200
× $80
$ 16,000
2. a)
b)
c)
d)
e)
Raw Materials Inventory—balance sheet
Work in Process Inventory—balance sheet
Finished Goods Inventory—balance sheet
Cost of Goods Sold—income statement
Selling Expense—income statement
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Solutions Manual, Chapter 2
15
EXERCISE 2-7 (LO6 CC12) (15 minutes)
Direct material used =
Direct labour costs =
Manufacturing overhead =
Total Manufacturing costs=
Opening inventory of work in process =
Less:Ending inventory of work in process =
Cost of goods manufactured =
$ 62,000
$ 15,000
$ 6,500
$ 83,500
$ 3,000
$ 12,000
$ 74,500
EXERCISE 2-8 (LO5 CC10; LO6 CC11, 12) (7 minutes)
Cost of goods sold = Sales – Gross margin
= $1,700,000 – (40% × $1,700,000)
= $1,700,000 - $680,000
= $1,020,000
Cost of goods manufactured = Cost of goods sold + Ending inventory of finished
goods – Opening inventory of finished goods
= $1,020,000 + $85,000 – $130,000 = $975,000
Solutions to Problems
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16
Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 2-1 (LO1 CC1; LO4 CC4, 5, 7)(30 minutes)
Product Cost
1.
Name of the Cost
Variable
Cost
Fixed
Cost
Direct
Materials
Staci's present salary,
$70,000/year ................................
Building rent, $2,500/
month ................................
X
Clay and glaze, $3.50/pot ................................
X
Wages of production
workers, $12/pot ................................
X
Advertising, $2,600/month ................................
X
Sales commission, $4/pot ................................
X
Rent of production
equipment,
$1,300/month ................................
X
Legal and filing fees,
$5,0001 ................................
X
Rent of sales office,
$1,250/month ................................
X
Phone for taking orders,
$40/month ................................
X
Interest lost on savings
account, $1,200/year ................................
1
Direct
Labour
Mfg.
Overhead
Period
(Selling
and
Admin.)
Cost
Opportunity
Cost
Sunk
Cost
X
X
X
X
X
X
X
X
X
X
X
X
Not a fixed cost per se because they are not a recurring expense.
2. The $5,000 cost of incorporating the business is not a differential cost. Even though the cost was incurred to start the
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Solutions Manual, Chapter 2
17
business, it is a sunk cost. Whether Staci produces pottery or stays in her present job, she will have incurred this cost.
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18
Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 2-2 (LO1 CC 1; LO2 CC2; LO4 CC4, 5, 6) (30 minutes)
Note to the instructor: There may be several exceptions to the answers below. The
purpose of this problem is to get the students to start thinking about cost behaviour
and cost purposes; therefore, try to avoid lengthy discussions about how a particular
cost is classified.
Variable
or
Fixed
Cost Item
Selling
Cost
1. Property taxes, factory ................................
F
2. Boxes used for packaging
detergent ................................ V
3. Salespersons’ commissions ................................
V
X
4. Supervisor’s salary, factory ................................
F
5. Depreciation, executive
automobiles ................................ F
6. Wages of workers assembling
computers ................................ V
7. Packing supplies for out-ofprovince shipment................................
V
X
8. Insurance, finished goods
warehouses ................................ F
X
9. Lubricants for machines ................................
V
10. Advertising costs ................................
F
X
11. “Chips” used in producing
calculators ................................ V
12. Shipping costs on
merchandise sold ................................
V
X
13. Magazine subscriptions,
F
factory lunchroom ................................
14. Thread in a garment factory ................................
V
Administrative
Cost
Manufacturing
(Product) Cost
Direct Indirect
X
X
X
X
X
X
X
X
X
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Solutions Manual, Chapter 2
19
Problem 2-2 (continued)
Cost Item
Variable
or
Fixed
Selling
Cost
15. Billing costs ................................ V
X*
16. Executive life insurance ................................
F
17. Ink used in textbook
production ................................ V
18. Fringe benefits, assembly line
V
workers ................................................................
19. Yarn used in sweater
production ................................ V
20. Wages of receptionist,
executive offices ................................
F
Administrative
Cost
Manufacturing
(Product) Cost
Direct Indirect
X
X
X**
X
X
* Could be administrative cost.
** Could be indirect cost.
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20
Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 2-3(LO1 CC1; LO2 CC2; LO4 CC4, 6) (60 minutes)
1.
Cost Behaviour
Variable
Fixed
Cost Item
Factory labour, direct ................................
$168,000
Advertising ................................................................
$ 50,000
Factory supervision ................................
50,000
Property taxes, factory building................................
4,500
Sales commissions ................................80,000
Insurance, factory ................................
3,500
Depreciation, office equipment ................................ 14,000
6,000
Lease cost, factory equipment ................................
Indirect materials, factory................................
6,000
Depreciation, factory building ................................
8,000
4,000
General office supplies (billing) ................................
General office salaries ................................
50,000
Direct materials used (wood,
114,000
bolts, etc.) ................................................................
Utilities, factory ................................
30,000
Total costs ................................................................
$402,000
$186,000
Selling or
Administrative
Cost
Product Cost
Direct
Indirect
$168,000
$ 50,000
$50,000
4,500
80,000
3,500
14,000
6,000
6,000
8,000
4,000
50,000
114,000
$198,000
$282,000
30,000
$108,000
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Solutions Manual, Chapter 2
21
Problem 2-3 (continued)
2.
Direct ................................................................ $282,000
Indirect ................................................................ 108,000
Total ............................................................................................
$390,000
$390,000 ÷ 2,000 sets = $195 per set
3. The average product cost per set would increase. This is because the fixed costs
would be spread over fewer units, causing the cost per unit to rise.
4. a) Yes, the president may expect a minimum price of $195, which is the average
cost to manufacture one set. He might expect a figure even higher than this to
cover a portion of the administrative costs as well. The brother-in-law probably
will be thinking of “cost” as including only direct materials used, or, at most,
direct materials and direct labour. Direct materials alone would be only $57 per
set, and direct materials and direct labour would be only $141.
b) The term is opportunity cost. The full, regular price of a set might be appropriate
here, since the company is operating at full capacity, and this is the amount that
must be given up (benefit foregone) in order to sell a set to the brother-in-law.
Problem 2-4 (LO4 CC7) (30 minutes)
1. The controller is correct in his viewpoint that the salary cost should be classified as a
selling (marketing) cost. The duties described in the problem have nothing to do
with the manufacture of a product, but rather deal with movement of finished units
from the factory to distribution warehouses. As stated in the text, selling costs
would include all costs necessary to secure customer orders and get the finished
product into the hands of customers. Coordination of shipments of finished units
from the factory to distribution warehouses fall in this category.
2. No, the president is not correct; from the point of view of the reported net income
for the year, it does make a difference how the salary cost is classified. If the salary
cost is classified as a selling expense, all of it will appear on the income statement
as a period cost. However, if the salary cost is classified as a manufacturing
(product) cost, then it will be added to Work in Process Inventory along with other
manufacturing costs for the period. To the extent that goods are still in process at
the end of the period, part of the salary cost will remain with these goods in the
Work in Process Inventory account. Only that portion of the salary cost that has
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22
Introduction to Managerial Accounting,Fifth Canadian Edition
been assigned to finished units will leave the Work in Process Inventory account and
be transferred into the Finished Goods Inventory account. In like manner, to the
extent that goods are unsold at the end of the period, part of the salary cost will
remain with these goods in the Finished Goods Inventory account. Only the portion
of the salary that has been assigned to finished units that are sold during the period
will appear on the income statement as an expense (part of Cost of Goods Sold) for
the period.
Problem 2-5 (LO5 CC10; LO6 CC11, 12) (45 minutes)
Case 1
Case 2
Direct materials ................................
$ 14,500
$ 60,000
Direct labour ................................
19,000 *
23,000
Manufacturing overhead ................................
25,000
44,000
Total manufacturing costs ................................
58,500
127,000 *
Beginning work in process
inventory ................................
3,500
8,000 *
Ending work in process
inventory ................................
(4,000) *
(4,000)
Cost of goods manufactured ................................
$58,000
$131,000
Sales ................................................................
$80,000
$201,000
Beginning finished goods
inventory ................................
10,000
12,500
Cost of goods manufactured ................................
58,000 *
131,000 *
Goods available for sale................................
68,000 *
143,500 *
Ending finished goods
inventory ................................
(1,000) *
(11,500)
Cost of goods sold ................................
67,000
132,000 *
Gross margin ................................ 13,000
69,000 *
Operating expenses ................................
(9,000) *
(33,500)
Net income ................................
$ 4,000
$ 35,500 *
* Missing data in the problem.
Case 3
Case 4
$ 5,000
$ 23,000
7,000
14,000
8,000 *
19,000
20,000
56,000 *
3,000
0 *
(4,000)
$19,000 *
$36,000
(8,500)
$47,500 *
$90,000
3,500 *
19,000 *
22,500 *
12,000
47,500
59,500 *
(4,000)
18,500
17,500
(12,500) *
$ 5,000
(3,500)
56,000 *
34,000 *
(25,000) *
$ 9,000
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Solutions Manual, Chapter 2
23
Problem 2-6 (LO5 CC9, 10; LO6 CC11, 12) (75 minutes)
1.
SWIFT COMPANY
Schedule of Cost of Goods Manufactured
For the Month Ended August 31
Direct materials:
Raw materials inventory, August 1 ................................$ 31,000
Add: Purchases of raw materials ................................ 226,000
Raw materials available for use ...................................................
257,000
Deduct: Raw materials inventory, August 31................................
78,000
Raw materials used in production ................................
Direct labour ................................................................
Manufacturing overhead:
Indirect labour cost ................................................................
9,000
Utilities (50% × $25,000) ...........................................................
12,500
Depreciation, factory equipment ................................
21,000
Insurance (80% × $8,000) .........................................................
6,400
Rent on facilities (75% × $80,000) ................................ 60,000
Total overhead costs ................................................................
Total manufacturing costs .............................................................
Add: Work in process inventory, August 1 ................................
Deduct: Work in process inventory, August 31 ................................
Cost of goods manufactured ..........................................................
$179,000
80,000
108,900
367,900
18,000
385,900
10,000
$375,900
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Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 2-6 (continued)
2.
SWIFT COMPANY
Income Statement
For the Month Ended August 31
Sales ............................................................................................
Less cost of goods sold:
Finished goods inventory, August 1 .............................................
$ 55,000
Add: Cost of goods manufactured ...............................................
375,900
Goods available for sale..............................................................
430,900
Deduct: Finished goods inventory, August 31 ..............................50,000
Gross margin ................................................................................
Less operating expenses:
Utilities (50% × $25,000) ...........................................................12,500
Depreciation, sales equipment .................................................... 8,000
Insurance (20% × $8,000) ......................................................... 1,600
Rent on facilities (25% × $80,000) ............................................20,000
Selling and administrative salaries ...............................................22,000
Advertising ................................................................................65,000
Net income (loss) ..........................................................................
$530,000
380,900
149,100
129,100
$ 20,000
3. In preparing the income statement for August, Sam failed to distinguish between
product costs and period costs, and he also failed to recognize the changes in
inventories between the beginning and end of the month. Once these errors have
been corrected, the financial condition of the company looks much better (although
the income is still only marginally above zero) and selling the company may not yet
be advisable.
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Solutions Manual, Chapter 2
25
Problem 2-7 (LO1 CC1; LO5 CC10; LO6 CC11, 12) (75 minutes)
1.
MERIWELL COMPANY
Schedule of Cost of Goods Manufactured
For the year just completed
Direct materials:
Raw materials inventory, beginning ................................$ 9,000
Add: Purchases of raw materials ................................ 125,000
Raw materials available for use ................................
134,000
Deduct: Raw materials inventory, ending................................
6,000
Raw materials used in production ................................
Direct labour ................................................................
Manufacturing overhead:
Depreciation, factory ................................................................
27,000
Utilities, factory ................................................................ 8,000
Maintenance, factory ................................................................
40,000
Supplies, factory ................................................................
11,000
Insurance, factory ................................................................
4,000
Indirect labour ................................................................15,000
Total overhead costs ................................................................
Total manufacturing costs .............................................................
Add: Work in process inventory, beginning ................................
Deduct: Work in process inventory, ending ................................
Cost of goods manufactured ..........................................................
$128,000
70,000
105,000
303,000
17,000
320,000
30,000
$290,000
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Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 2-7 (continued)
2.
MERIWELL COMPANY
Income Statement
For the year just completed
Sales ............................................................................................
Cost of goods sold:
Finished goods inventory, beginning ................................
$ 20,000
Add: Cost of goods manufactured ................................ 290,000
Goods available for sale..............................................................
310,000
Deduct: Finished goods inventory, ending ................................
40,000
Gross margin ................................................................
Less operating expenses:
Selling expenses ................................................................
80,000
Administrative expenses .............................................................
110,000
Net income ................................................................
$500,000
270,000
230,000
190,000
$ 40,000
3. Direct materials: $128,000 ÷ 10,000 units = $12.80 per unit.
Factory Depreciation: $27,000 ÷ 10,000 units = $2.70 per unit.
4. Direct materials:
Average cost per unit: $12.80 (unchanged)
Total cost: 15,000 units × $12.80 per unit = $192,000.
Factory Depreciation:
Average cost per unit: $27,000 ÷ 15,000 units = $1.80 per unit.
Total cost: $27,000 (unchanged)
5. Average cost per unit for depreciation dropped from $2.70 to $1.80, because of the
increase in production between the two years. Since fixed costs do not change in
total as the activity level changes, they will decrease on a per unit basis as the
activity level rises.
The average cost per unit for direct materials remained the same because a direct
material is variable cost which remains constant on a per-unit basis.
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Solutions Manual, Chapter 2
27
Problem 2-8 (LO1 CC1; LO5 CC9, 10; LO6 CC11, 12) (90 minutes)
1.
SUPERIOR COMPANY
Schedule of Cost of Goods Manufactured
For the Year Ended December 31
Direct materials:
Raw materials inventory, beginning ................................
$ 30,000
Add: Purchases of raw materials ................................ 390,000
Raw materials available for use ................................
420,000
Deduct: Raw materials inventory, ending................................
10,000
Raw materials used in production ................................
Direct labour ................................................................
Manufacturing overhead:
Insurance, factory ................................................................
8,000
Utilities, factory ................................................................
65,000
Indirect labour ................................................................60,000
Cleaning supplies, factory ...........................................................
7,000
Rent, factory building ................................................................
90,000
40,000
Maintenance, factory ................................................................
Total overhead costs ................................................................
Total manufacturing costs .............................................................
Add: Work in process inventory, beginning ................................
Deduct: Work in process inventory, ending ................................
Cost of goods manufactured ..........................................................
$410,000
73,000 *
270,000
753,000 (given)
37,000 *
790,000
20,000
$770,000
The cost of goods sold section of the income statement follows on the next page.
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Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 2-8 (continued)
Finished goods inventory, beginning ................................
Add: Cost of goods manufactured................................
Goods available for sale ................................................................
Deduct: Finished goods inventory, ending ................................
Cost of goods sold ................................................................
$ 20,000
770,000
790,000
50,000
$740,000
*
(given)
*
(given)
* These items must be computed by working backwards up through the statements.
An effective way of doing this is to place the form and known balances on the
chalkboard, and then to work toward the unknown figures.
2. Direct materials: $410,000 ÷ 40,000 units = $10.25 per unit.
Rent, factory building: $90,000 ÷ 40,000 units = $2.25 per unit.
3.
Per Unit
Direct materials ................................
$10.25 (Same)
Rent, factory building ................................
$ 1.80 * (Changed)
Total
$512,500 ** (Changed)
$ 90,000
(Same)
* $90,000 ÷ 50,000 units = $1.80 per unit.
** $10.25 × 50,000 units = $512,500.
4. The average cost per unit for rent dropped from $2.25 to $1.80, because of the
increase in production between the two years. Since fixed costs do not change in
total as the activity level changes, they will decrease on a per unit basis as the
activity level rises.
The average cost per unit for direct materials remained the same because direct
materials is a variable cost which remains constant on a per-unit basis.The total
changeis in relation to amount of goods produced.
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Solutions Manual, Chapter 2
29
PROBLEM 2-9 (LO1 – CC1; LO2 – CC2; LO4 – CC5, CC6, CC7; LO5 – CC9) (40 minutes)
1.
Direct materials & components
Direct production wages
Production supervisory salaries
Salaries paid to sales
representatives
Advertising
Insurance
Building rent
Behaviour
VARIABLE
FIXED
$ 3,200,000
$ 1,448,000
$ 261,400
$ 348,000
Other salaries
Honorarium to the members of the
Board
Production quality control
Market research
$ 200,000
$ 548,000
$ 675,300
$ 115,670
$ 258,640
$ 675,300
$1,160,000
$ 52,260
$ 554,190
$ 144,136
$ 137,610
$ 78,390
$ 346,200
$1,326,700
$ 884,230
$ 685,600
$196,500
$ 298,410
$ 216,204
$ 779,790
$5,884,196 $7,913,234
$13,797,430
ADMIN
$ 75,186
$155,184
$ 38,796
$ 40,484
$ 64,660
$ 580,000
$ 232,000
$348,000
$ 430,200
Depreciation
Facilities management
Legal
Personnel department
Utilities - production
Utilities - other
Customer service
MFG
$3,200,000
$1,448,000
$ 261,400
Function
SALES/MKT
$430,200
$ 130,650
$ 346,200
$ 796,020
$ 265,340
$353,692
$265,340
$530,538
$685,600
$196,500
$ 852,600
$7,852,732
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30
Introduction to Managerial Accounting,Fifth Canadian Edition
$ 180,170
$ 917,400
$180,170
$ 3,203,206
$ 13,797,430
$2,741,492
Note that the amounts are calculated using the percentage breakdowns given in the data.
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Solutions Manual, Chapter 2
31
Problem 2-9 (continued)
2.
Product costs (manufacturing costs from table in Part 1)
= $7,852,732
Period costs (sales/marketing + administration from table in Part 1)
= $3,203,206 + $2,741,492 = $5,944,698
Product costs are classified as direct and indirect as follows:
Product costs
Direct
Direct materials & components
√
Direct production wages
√
Indirect
Production supervisory salaries
√
Insurance
√
Building rent
√
Other salaries
√
Production quality control
√
Depreciation
√
Facilities management
√
Utilities - production
√
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32
Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 2-9 (continued)
3.
CRATER CORPORATION - NORTH AMERICAN DIVISION
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2015
Sales Revenues
$
23,200,000
$
3,200,000
$
$
$
$
$
$
$
$
$
$
1,448,000
261,400
75,186
155,184
580,000
130,650
796,020
353,692
852,600
15,347,269
$
$
$
$
$
$
$
$
$
$
$
$
$
$
548,000
675,300
40,485
103,456
580,000
430,200
346,200
530,680
530,538
685,600
196,500
360,340
917,400
9,402,570
Less: Cost of goods sold
Materials & components
Production wages
Production supervisory salaries
Insurance
Building rent
Other salaries
Production quality control
Depreciation
Facilities management
Utilities - production
Gross margin
Less: Selling & administrative expenses
Salaries paid to sales representatives
Advertising
Insurance
Building rent
Other salaries
Honorarium to the members of the Board
Market research
Depreciation
Facilities management
Legal
Personnel department
Utilities - other
Customer service
Net income
Gross margin per unit = $15,347,269 ÷ 40,000 ≈ $383.68
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Solutions Manual, Chapter 2
33
PROBLEM 2-10 (LO4 CC7; LO5 CC10) (30 minutes)
1. The income statement includes several conceptual errors including:




The amount of purchases instead of direct materials used
Inventories do not seem to have been considered in computing the cost of
goods manufactured and goods sold
Annual insurance amount included rather than a quarterly amount
Format of the income statement does not follow the conventional classification
of the cost of goods sold, gross margin and selling & administrative costs
2.
COST OF GOODS MANUFACTURED STATEMENT
Direct Materials:
Beginning inventory
+ Purchases
- Ending inventory
Direct materials used
Direct labour
Overhead
Indirect materials
Indirect labour
Utilities
Facility rental
Depreciation
Insurance
Management salaries
Total manufacturing costs
Add: Beginning WIP inventory
Deduct: Ending WIP inventory
Cost of Goods Manufactured
$ 6,870
$ 196,512
$ 7,860
$ 195,522
$ 186,750
$ 49,128
$ 80,036
$ 49,400
$ 81,000
$ 47,625
$ 10,000
$ 155,200
$ 472,389
$ 854,661
$
8,070
$
9,120
$ 853,611
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Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 2-10 (continued)
Notes:
1. Purchase of direct materials
2. Indirect materials
3. Direct labour
4. Indirect labour
5. Facility rental
6. Depreciation
7. Management salaries
=
=
=
=
=
=
=
$245,640
$245,640
$266,786
$266,786
$90,000
$63,500
$388,000
× 80%
× 20%
× 70%
× 30%
× 90%
× 75%
× 40%
3.
RUSSELL COMPANY
INCOME STATEMENT
FOR THE QUARTER ENDING DECEMBER 31, 2016
Sales
$ 1,367,600
Cost of Goods Sold:
Beginning FG inventory
$ 11,280
$ 853,611
+ Cost of goods manufactured
= Goods available for sale
$ 864,891
$ 7,420
- Ending FG inventory
$ 857,471
= Cost of goods sold
Gross margin
$ 510,129
Deduct: S & A expenses
Advertising
$ 37,000
Administrative travel
$ 27,600
Facility rental
$ 9,000
Depreciation
$ 15,875
Sales commissions
$ 41,000
Office utilities
$ 22,400
$ 232,800 $ 385,675
Management salaries
$ 124,454
Net income
Notes:
1. Facility rental
2. Depreciation
3. Management salaries
= $90,000 × 10%
= $63,500 × 25%
= $388,000 ×60%
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Solutions Manual, Chapter 2
35
Problem 2-11 (LO4 CC5; LO5 CC 9, 10; LO6 CC11, 12) (20 minutes)
1.
Discon Corporation
Income Statement
For the Year Ended December 31, XXXX
Sales (242,000 dolls @ $20 per doll)
Cost of goods sold (242,000 @ $12 per doll) 2,904,000
Gross margin
Selling and administrative expenses:
Commissions ($2 per doll)
$484,000
Advertising
350,000
Administration
270,000
Net income
$4,840,000
1,936,000
1,104,000
$832,000
Note: The number of dolls sold is computed as:
Beginning finished goods inventory
+ Number of units produced
- Ending finished goods inventory
=
2
a. Prime cost ($2.00 + $0.50)
b. Conversion cost ($0.50 + $2.50 + $7.00)$10.00
c. Variable cost ($2.00 + $0.50 + $2.50 + 2.00)
10,000
240,000
8,000
242,000
$2.50
$7.00
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Introduction to Managerial Accounting,Fifth Canadian Edition
Comprehensive Problem (LO1 CC1; LO3 CC3; LO4 CC4, 5, 6, 7) (60 minutes)
1.
Behaviour
Cost Item
Variable
Function
Fixed
Product
Relevance
Period
Lost rental income (₹1,800,000 per year)
Opportunity
Sunk
√
Direct materials (₹4,000 per unit)
√
√
Direct labour (₹2,200 per unit)
√
√
Equipment rental (₹250,000 per month)
√
√
Warehouse space rental (₹26,500 per month)
√
Manufacturing facility depreciation (₹300,000 per year)
√
√
Production supervisor salary (₹52,000 per month)
√
√
Electricity for machines (₹54 per unit)
√
Delivery costs (₹390 per unit)
√
Advertising (₹3,100,000 per year)
√
√
√
√
Annual return (₹92,000 per year)
√
√
√
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Solutions Manual, Chapter 2
37
2.
Product Cost (₹)
Per unit
Direct materials
4,000.00
Direct labour
2,200.00
Manufacturing overhead:
Equipment rental (₹250,000 ÷ 1,800 units)
138.89
Manufacturing facility depreciation ((₹300,000/12) ÷ 1,800)
13.89
Production supervisor salary (₹52,000 ÷ 1,800)
28.89
54.00
Electricity
Total product costs per unit (using 1,800 units production)
235.67
6,435.67
3.
Incremental Costs for 300 Additional Units (₹)
Per unit
Direct materials
4,000
Direct labour
2,200
Electricity
Delivery costs
Total costs per unit
Total costs for 300 units
54
390
6,644
1,993,200
Note that all the variable costs are incremental costs; however, fixed costs areassumed
to remain constant within a certain relevant range. The only issue is that currently the
capacity is 2,000 units and producing additional 300 units will result in a capacity
utilization of 105% (2,100 ÷ 2,000 units). This in turn means that production is outside
of the relevant range and may require the incurrence of additional fixed costs.
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Introduction to Managerial Accounting,Fifth Canadian Edition
Thinking Analytically(LO3CC5, 7; LO5CC9, 10; LO6CC11, 12) (30
minutes)
Schedule of Cost of Goods Manufactured
Direct Materials
Beg. Inventory
+ Purchases
= Cost of direct materials available for use
- End inventory
= Direct materials used
Direct Labour
Manufacturing overhead
Total manufacturing costs
+ Beginning WIP inventory
= Cost of WIP inventory
- Ending WIP inventory
= Cost of goods manufactured
$
24,000
$ 16,403,000
$ 16,427,000
$
20,000
$ 16,407,000
$ 12,375,000
$ 24,750,000
$ 53,532,000
$
48,000
$ 53,580,000
$
40,000
$ 53,540,000
Notes:
Computing Total Manufacturing Costs
Cost of goods manufactured (given)
= $53,540,000
+ Ending inventory
=$
40,000
- Beginning inventory
=$
48,000
= Total manufacturing costs
= $53,532,000
Computing Manufacturing Overhead cost
We are told that applied overhead = two-third of conversion costs. Therefore the
remaining third must be direct labour cost. OH = DL + OC This means overhead cost is
twice that of direct labour
Therefore, overhead cost = $12,375,000 × 2
= $24,750,000
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Solutions Manual, Chapter 2
39
Thinking Analytically (continued)
Computing Cost of Direct Materials Used
Total manufacturing costs
= $53,532,000
- Direct labour
= $12,375,000
- Manufacturing overhead
= $24,750,000
= Direct materials used
= $16,407,000
Computing Cost of Direct Materials Purchased
Direct materials used
= $16,407,000
+ Ending inventory
=$
20,000
- Beginning inventory
=$
24,000
= Direct materials purchased
= $16,403,000
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Introduction to Managerial Accounting,Fifth Canadian Edition
Thinking Analytically (continued)
Income Statement
Sales
- Cost of goods sold
Beginning finished goods inventory
+ Cost of goods manufactured
= Cost of goods available for sale
- Ending finished goods inventory
= Cost of goods sold
= Gross margin
- SG &A expenses
= Net income
$ 76,500,000
$
40,000
$ 53,540,000
$ 53,580,000
$
30,000
$ 53,550,000
$ 22,950,000
$ 15,300,000
$ 7,650,000
Notes:
Computing Net Income
Net income
= 10% of sales revenues
= 0.10 × $76,500,000
= $7,650,000
Computing SG & A Expenses
Gross margin
= $22,950,000
-
Net income
= $ 7,650,000
= SG & Expenses
= $15,300,000
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41
Communicating in Practice (LO4 CC7, 8; LO5 CC9, 10; LO6 CC11, 12)
(90 minutes)
1. Memorandum to president:
Date:
To:
From:
Subject:
Current date
Brittany Patel, President
Student
Income Statement
I reviewed the income statement for Sun Power Communications, Inc. and noted
that no distinction has been made between period expenses and product costs.
Period expenses should be included on the income statement when incurred.
However, product costs (that is, direct materials, direct labour, and manufacturing
overhead) should be assigned to inventory (that is, capitalized or recorded as
inventory on the balance sheet) when incurred and flow through to the income
statement as cost of goods sold only when finished products are sold.
All of the direct materials purchased and the direct labour and manufacturing
overhead costs incurred during the period are included on the income statement
that I reviewed for the quarter ended March 31. This treatment would be
appropriate only if the inventory level does not change during the period (that is,
the ending inventory is the same as the beginning inventory which is not the case in
this question). As such, this income statement does not reflect the results of the
company’s operations and should be revised.
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Introduction to Managerial Accounting,Fifth Canadian Edition
Communicating in Practice (continued)
2.
SUN POWER COMMUNICATIONS, INC.
Schedule of Cost of Goods Manufactured
For the Quarter Ended March 31
Direct materials:
Raw materials inventory, beginning ................................$ –0–
Add: Purchases of raw materials ................................ 460,000
Raw materials available for use ................................
460,000
Deduct: Raw materials inventory, ending................................
10,000
Raw materials used in production ................................
Direct labour ................................................................
Manufacturing overhead:
Maintenance, production ............................................................
73,000
Indirect labour ................................................................
120,000
Cleaning supplies, production .....................................................
7,000
Rental cost, facilities (80% × $95,000) ................................
76,000
Insurance, production ................................................................
18,000
Utilities (90% × $100,000) .........................................................
90,000
Depreciation, production equipment ................................
140,000
Total overhead costs ................................................................
Total manufacturing costs .............................................................
Add: Work in process inventory, beginning ................................
Deduct: Work in process inventory, ending ................................
Cost of goods manufactured ..........................................................
$450,000
90,000
524,000
1,064,000
–0–
1,064,000
50,000
$1,014,000
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Solutions Manual, Chapter 2
43
Communicating in Practice(continued)
3. Before an income statement can be prepared, the cost of the 8,000 phones in the
ending finished goods inventory must be determined. Altogether, the company
produced 40,000 phones during the quarter; thus, the production cost per phone
would be:
Cost of goods manufactured
$1,014,000
=
= $25.35 per unit
Phones produced during the quarter 40,000 units
Since 8,000 phones (40,000 – 32,000 = 8,000) were in the finished goods inventory
at the end of the quarter, the total cost of this inventory would be:
8,000 phones × $25.35 per phone = $202,800.
With this figure and other data from the case, the company’s income statement for
the quarter can be prepared as follows:
SUN POWER COMMUNUCATIONS, INC.
Income Statement
For the Quarter Ended March 31
Sales (32,000 phones) ................................................................ $1,280,000
Less cost of goods sold:
Finished goods inventory, beginning ................................
$ –0–
Add: Cost of goods manufactured ................................
1,014,000
Goods available for sale .............................................................
1,014,000
Deduct: Finished goods inventory, ending ................................
202,800
811,200
Gross margin ................................................................
468,800
Less operating expenses:
Selling and administrative salaries ................................150,000
Advertising ................................................................ 90,000
Rental cost, facilities (20% × $95,000) ................................
19,000
Depreciation, office equipment ................................
47,000
Utilities (10% × $100,000) .........................................................
10,000
Travel, salespersons ................................................................
40,000
356,000
Net income................................................................
$ 112,800
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Introduction to Managerial Accounting,Fifth Canadian Edition
Communicating in Practice(continued)
4. Memorandum to president:
Date:
To:
From:
Subject:
Current date
Brittany Patel, President
Student
Insurance Claim
On April 3, 8,000 unsold phones were destroyed by fire. The insurance policy
indicates that the company will be reimbursed for the cost of any finished phones
destroyed or stolen. The key question is how “cost” is defined in the insurance
contract. Typically, insurance contracts limit reimbursement for losses to those costs
that would normally be considered product costs—in other words, the direct
materials, direct labour, and manufacturing overhead costs that were incurred to
manufacture the units that were insured.
The 8,000 unsold phones were in the company’s ending finished goods inventory on
March 31. As you know, the income statement for the quarter ended March 31 was
recently revised. That income statement shows an ending finished goods inventory
of $202,800. Accordingly, assuming cost is defined as set forth above the insurance
company owes Sun Power Communications, Inc. $202,800 for the 8,000 phones
that were destroyed.
This amount is considerably less than the $286,000 that was computed by the
company’s accountant. The $286,000 figure is overstated for two reasons. First, it
includes period costs (that is, selling and administrative expenses) as well as product
costs. Period costs may not be included in inventory. Second, it includes some costs
incurred during the period that were in the raw materials and work in process
inventories on March 31. Those inventories were not destroyed and, as such, may
not be part of the loss claimed.
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Solutions Manual, Chapter 2
45
Ethics Challenge (LO4 CC7) (45 minutes)
1. A cost that is classified as a period cost will be recognized on the income statement
as an expense in the current period. A cost that is classified as a product cost will be
recognized on the income statement as an expense (i.e., cost of goods sold) only
when the associated units of product are sold. If some units are unsold at the end of
the period, the costs of those unsold units are treated as assets. Therefore, by
reclassifying period costs as product costs, the company is able to carry forward in
inventories some costs that would have been treated as current expenses.
2. The discussion below is divided into two parts—Gallant’s actions to postpone
expenditures and the actions to reclassify period costs as product costs.
The decision to postpone expenditures is highly questionable. It is one thing to
postpone expenditures due to a cash bind; it is quite another to postpone
expenditures in order to hit a profit target. Postponing these expenditures may have
the effect of ultimately increasing future costs and reducing future profits. If orders
to the company’s suppliers are changed, it may disrupt the suppliers’ operations.
The additional costs may be passed on to Gallant’s company and may create ill-will
and a feeling of mistrust. Postponing maintenance on equipment is particularly
questionable. The result may be breakdowns, inefficient and/or unsafe operations,
and a shortened life for the machinery.
Interestingly, in a survey of 649 managers reported in Management Accounting,
only 12% stated that it is unethical to defer expenses and thereby manipulate
quarterly earnings. The proportion who felt it was unethical increased to 24% when
it involved annual earnings. Another 41% said that deferring expenses is a
questionable practice when it involved quarterly reports and 35% said this when
annual reports were involved. Finally, 47% said that it is completely ethical to
manipulate quarterly reports in this way and 41% gave the green light for annual
reports. (See William J. Bruns, Jr. and Kenneth A. Merchant, “The Dangerous
Morality of Managing Earnings,” Management Accounting, August 1990, pp. 22-25)
Gallant’s decision to reclassify period costs is not ethical—assuming that there is no
intention of disclosing in the financial reports this reclassification. Such a
reclassification would be a violation of the principle of consistency in financial
reporting and is a clear attempt to mislead readers of the financial reports. Although
some may argue that the overall effect of Gallant’s action will be a “wash”—that is,
profits gained in this period will simply be taken from the next period—the trend of
earnings will be affected. Hopefully, the auditors would discover any such attempt to
manipulate annual earnings and would refuse to issue an unqualified opinion due to
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46
Introduction to Managerial Accounting,Fifth Canadian Edition
the lack of consistency.
Teamwork in Action(LO1 CC1)
1. A fixed cost is normally defined as a cost that remains constant, in total, for changes
in activity within the relevant range. A variable cost is normally defined as a cost
that varies, in total, in direct proportion to changes in the level of activity within the
relevant range.
2. a) Fixed costs for a steel company consist of items such as factory rent or
depreciation, insurance, and periodic equipment depreciation. Variable costs
include items such as the cost of raw materials and certain supplies. Labour may
or may not be a variable cost. The relevant measure of production is the volume
of steel produced. As production of steel increases within the relevant range,
total fixed costs and unit variable costs remain constant, while total variable costs
increase and unit fixed costs decrease.
b) Fixedcosts for a hospital include items such as property taxes, supervisory
salaries, and insurance. Variable costs include supplies, drugs, and perhaps some
nursing and other labour. A relevant measure of production might be the number
of patients treated. As the number of patients treated increase within the
relevant range, total fixed costs and unit variable costs remain constant, while
total variable costs increase and unit fixed costs decrease.
c) Fixed costs for a university include property taxes, salaries, and advertising.
Variable costs depend on the measure of activity. If the measure of activity is
students enrolled, the variable costs are limited to the costs of handouts and
other supplies (such as in science laboratories). As the number of students
enrolled increases within the relevant range, total fixed costs and unit variable
costs remain constant, while total variable costs increase and unit fixed costs
decrease.
d) Fixed costs for an auto manufacturer would include items such as factory rent or
depreciation, insurance, supervisory salaries, and periodic equipment
depreciation. Variable costs include raw materials and perhaps some labour cost.
A relevant measure of productive activity would be the number of cars produced.
As the number of cars produced increases within the relevant range, total fixed
costs and unit variable costs remain constant, while total variable costs increase
and unit fixed costs decrease.
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Solutions Manual, Chapter 2
47
3. As the volume of steel produced increases within the relevant range, total fixed
costs remain the same; the fixed cost per unit decreases; total variable costs
increase; the variable cost per unit remains the same; total cost increases (due to
the increase in total variable cost); and the average unit cost declines (due to the
presence of fixed costs).
4.
550
Cost
Total fixed costs
Total variable
costs
Total costs
0
0
1000
Tonnes produced
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Introduction to Managerial Accounting,Fifth Canadian Edition
Teamwork in Action (continued)
5.
2.50
2.25
2.00
Cost per unit
1.75
1.50
Fixed costs per unit
1.25
Variable costs per unit
1.00
Total costs per unit
0.75
0.50
0.25
0
1000
Tonnes produced
6. Once capacity has been set, total costs increase with increases in demand due to
the presence of variable costs while per unit costs drop due to the presence of fixed
costs.
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Solutions Manual, Chapter 2
49
Chapter 3
Systems Design: Job-Order Costing
Solutions to Questions
3-1
By definition, overhead consists of costs
that cannot practically be traced to products or
jobs. Therefore, overhead costs must be
allocated rather than traced if they are to be
assigned to products or jobs.
3-2
Job-order costing is used in situations
where there are many different products or
services produced each period. Each product (or
job) is different from all others and requires
separate costing. Process costing is used in
situations where a single, homogeneous
product, such as cement, bricks, or gasoline, is
produced for long periods at a time.
3-3
The job cost sheet is used to record all
costs that are assigned to a particular job. These
costs include direct materials cost traced to the
job, direct labour cost traced to the job, and
manufacturing overhead cost applied 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 also a control document
for: (1) determining how many units have been
produced 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.
3-4
A predetermined overhead rate is used
to apply overhead to jobs. It is determined
before a period begins and is computed by
dividing the estimated total manufacturing
overhead for the period by the estimated total
units in the allocation base. Thereafter,
overhead is applied to jobs by multiplying the
predetermined overhead rate by the actual
amount of the allocation base that is incurred
for each job. The most common allocation base
is direct labour hours.
3-5
A sales order is issued after a firm
agreement has been reached with a customer
on matters relating to quantities, prices, and
shipment dates for goods. This sales order then
forms the basis for the production department
to issue a production order. The production
order summarizes the specifications of the
goods involved, and forms the basis for the
accounting department’s preparation of a job
cost sheet. The job cost sheet, in turn, is used
to summarize the various production costs
incurred in completing the job. These costs are
entered on the job cost sheet by means of
materials requisition forms, direct labour time
tickets, and allocations of overhead via the
predetermined overhead rate.
3-6
Many production costs cannot be traced
to a particular product or job, but rather are
incurred as a result of overall production
activities. Therefore, in order to assign 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, as explained in Chapter 1.
3-7
A firm will not know its actual
manufacturing overhead costs until a period is
over. Thus, if actual costs were used to cost
products, it would be necessary either (1) to
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Solutions Manual, Chapter 3
1
wait until the period is over to add overhead
cost 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 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 to apply
overhead cost to jobs.
3-8
An allocation base should be a cost
driver 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.
3-9
Assigning overhead costs to jobs does
not ensure that there will be a profit. The units
produced may not be sold and if they are sold,
they may not in fact 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 customers—not by allocating costs.
3-10 The Manufacturing Overhead account is
credited when overhead cost is applied to Work
in Process. Generally, the amount of overhead
applied will not be the same as the amount of
actual cost incurred, since the predetermined
overhead rate figure which is used in applying
overhead is based on estimates.
3-11 Underapplied overhead occurs when the
actual overhead cost exceeds the amount of
overhead cost applied to Work in Process
inventory during the period. Overapplied
overhead occurs when the actual overhead cost
is less than the amount of overhead cost applied
to Work in Process inventory during the period.
Under-applied or overapplied overhead is
disposed of by either closing out the amount to
Cost of Goods Sold or allocating the amount
among Cost of Goods Sold and ending
inventories in proportion to the applied overhead
in each account. The adjustment for
underapplied overhead increases Cost of Goods
Sold (and ending inventories), whereas the
adjustment for overapplied overhead decreases
Cost of Goods Sold (and ending inventories).
3-12 Overhead may be underapplied for a
number of reasons. One reason might be that
there was not good control over overhead
spending and as a result, actual overhead costs
exceeded estimated overhead costs. Another
reason might be that some of the overhead is
fixed and the actual amount of the allocation
base was less than estimated at the beginning
of the period. The amount of overhead applied
to Work in Process will decline in proportion to a
decline in the allocation base. However, if there
is any fixed cost in the overhead, it will not
decline as much as the volume declines and
hence overhead will be underapplied.
3-13 Underapplied overhead is added to cost
of goods sold since underapplied overhead
implies that not enough overhead was assigned
to jobs during the period and therefore cost of
goods sold is understated. Likewise, overapplied
overhead is deducted from cost of goods sold.
3-14 Yes, overhead should be applied in
order to properly value the Work in Process
inventory at year-end. Since $6,000 of overhead
was applied to Job A on the basis of $8,000 of
direct labour cost, the company’s predetermined
overhead rate must be 75% of direct labour
cost. Thus, $3,000 of overhead should be
applied to Job B at year-end: $4,000 direct
labour cost  75% = $3,000 overhead costs
applied.
3-15
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Introduction to Managerial Accounting, Fifth Canadian Edition
Direct material ..................................................
$10,000
Direct labour.....................................................
12,000
Manufacturing overhead:
overhead rates, rather than plantwide rates, to
more appropriately allocate overhead costs
among products. Multiple overhead rates should
be used, for example, in situations where one
department is machine intensive and another
department is labour intensive.
$12,000 × 125% ................................ 15,000
Total manufacturing cost ................................
$37,000
Cost per unit: $37,000 ÷ 1,000 units .................
$37
3-16 A plantwide overhead rate is a single
overhead rate used throughout all departments
of a company. Some companies use multiple
3-17 When direct labour is replaced by
automated equipment, overhead increases and
direct labour decreases. This results in an
increase in the predetermined overhead rate if it
is based on direct labour. In such situations, a
more representative allocation base must be
used.
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Solutions Manual, Chapter 3
3
The Foundational 15 (LO2 – CC4; LO3 – CC5; LO4 – CC8; LO5 – CC 10;
LO6 – CC13; LO7 – CC14; LO8 – CC18)
3-1.
The estimated total manufacturing overhead cost is computed as follows:
Y = $10,000 + ($1.00 per DLH) ˣ (2,000 DLHs)
Estimated fixed manufacturing overhead ................................
$10,000
Estimated variable manufacturing overhead:
$1.00 per DLH × 2,000 DLHs .............................................
2,000
Estimated total manufacturing overhead cost .........................
$12,000
The predetermined overhead rate is computed as follows:
Estimated total manufacturing overhead (a) ...............
$12,000
Estimated total direct labour hours (DLHs) (b) ...........
2,000 DLHs
Predetermined overhead rate (a) ÷ (b) ......................
$6.00 per DLH
3-2.
The manufacturing overhead applied to Jobs P and Q is computed as follows:
Job P
Job Q
Actual direct labor hours worked (a) ..........................
1,400
500
Predetermined overhead rate per DLH (b) ..................
$6.00
$6.00
Manufacturing overhead applied (a) × (b) ..................
$8,400
$3,000
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Introduction to Managerial Accounting, Fifth Canadian edition
Foundational Fifteen (continued)
3-3. The direct labour hourly wage rate can be computed by focusing on either Job P
or Job Q as follows:
Job P
Job Q
Direct labour cost (a) ................................................
$21,000
$7,500
Actual direct labour hours worked (b).........................
1,400
500
Direct labour hourly wage rate (a) ÷ (b).....................
$15.00
$15.00
3-4. Job P’s unit product cost and Job Q’s assigned manufacturing costs are
computed as follows:
Total manufacturing cost assigned to Job P:
Direct materials .........................................
$13,000
Direct labour .............................................
21,000
Manufacturing overhead applied
($6 per DLH × 1,400 DLHs) ....................
8,400
Total manufacturing cost............................
$42,400
Unit product cost for Job P:
Total manufacturing cost (a) ......................
$42,400
Number of units in the job (b) ....................
20
Unit product cost (a) ÷ (b) .........................
$2,120
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Solutions Manual, Chapter 3
5
Foundational Fifteen (continued)
Total manufacturing cost assigned to Job Q:
3-5.
Direct materials .........................................
$ 8,000
Direct labour .............................................
7,500
Manufacturing overhead applied
($6 per DLH × 500 DLHs) .......................
3,000
Total manufacturing cost............................
$18,500
The journal entries are recorded as follows:
Raw Materials...............................
22,000
Accounts Payable ...............
22,000
Work in Process............................
21,000
Raw Materials.....................
21,000
3-6.
The journal entry is recorded as follows:
Work in Process............................
28,500
Wages Payable ...................
28,500
3-7.
The journal entry is recorded as follows:
Work in Process ................................................
11,400
Manufacturing Overhead ................................
11,400
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6
Introduction to Managerial Accounting, Fifth Canadian edition
Foundational Fifteen (continued)
3-8.
The Schedule of Cost of Goods Manufactured is as follows:
Direct materials:
Raw materials inventory, beginning ..........................
Add: Purchases of raw materials ...............................
Total raw materials available ....................................
Deduct: Raw materials inventory, ending ..................
Raw materials used in production .............................
Direct labour ................................................................
Manufacturing overhead applied to work in process
inventory ...................................................................
Total manufacturing costs .............................................
Add: Beginning work in process inventory ......................
$
0
22,000
22,000
1,000
$21,000
28,500
11,400
60,900
0
60,900
18,500
$42,400
Deduct: Ending work in process inventory ......................
Cost of goods manufactured ..........................................
3-9.
The journal entry is recorded as follows:
Finished Goods .................................................
42,400
Work in Process .............................................
3-10.
42,400
The completed T-account is as follows:
Work in Process
Beg. Bal.
(a)
(b)
(c)
(d)
0
(a)
21,000
(b)
28,500
(c)
11,400 (d)
End. Bal.
18,500
42,400
Raw Materials used in production
Direct Labour
Manufacturing Overhead applied to work in process inventory
Cost of goods manufactured
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Solutions Manual, Chapter 3
7
Foundational Fifteen (continued)
3-11.
The Schedule of Cost of Goods Sold is as follows:
Finished goods inventory, beginning ..............................
Add: Cost of goods manufactured ..................................
Cost of goods available for sale .....................................
Deduct: Finished goods inventory, ending ......................
Unadjusted cost of goods sold .......................................
$
0
42,400
42,400
0
$42,400
3-12. The journal entry is recorded as follows:
Cost of Goods Sold ................................
42,400
Finished Goods ..............................................
42,400
3-13. The amount of underapplied overhead is computed as follows:
Actual direct labour-hours (a) ...............................
1,900
Predetermined overhead rate (b) ..........................
$6.00
Manufacturing overhead applied (a) × (b) .............
$11,400
Actual manufacturing overhead ............................
$12,500
Deduct: Manufacturing overhead applied ..............
11,400
Underapplied overhead ........................................
$ 1,100
3-14. The journal entry is recorded as follows:
Cost of Goods Sold ................................
1,100
Manufacturing Overhead ................................
1,100
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8
Introduction to Managerial Accounting, Fifth Canadian edition
Foundational Fifteen (continued)
3-15. The income statement is as follows:
Sales (2,000 x 30) ......................................................
$60,000
Cost of goods sold ($42,400 + $1,100) ........................
43,500
Gross margin ..............................................................
16,500
Selling and administrative expenses .............................
14,000
Net operating income ..................................................
$ 2,500
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Solutions Manual, Chapter 3
9
Solutions to Brief Exercises
Brief Exercise 3-1 (15 minutes) (LO1 – CC1)
1. Process costing
7. Job-order costing
2. Job-order costing
8. Process costing*
3. Process costing
9. Job-order costing
4. Process costing
10. Process costing*
5. Process costing
11. Job-order costing
6. Job-order costing
12. Job-order costing
* Some of the companies listed might use either a job-order or a process costing
system, depending on how operations are carried out. For example, a chemical
manufacturer would typically operate with a process costing system, but a job-order
costing system could be employed if products were manufactured in relatively small
batches. The same thing might be true of the tire manufacturing plant in item “j.”
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10
Introduction to Managerial Accounting, Fifth Canadian edition
Brief Exercise 3-2 (15 minutes) (LO2 – CC5)
1. These costs would have been recorded on five different documents: the two
materials requisition forms pertaining to Job W456 (#15673 and #15678), the time
ticket for Jamie Unser, the time ticket for Melissa Chan, and the job cost sheet for
Job W456.
2. The costs would have been recorded as follows:
Materials requisition form (#15673):
Quantity
Blanks
40
Unit cost
Total
cost
$15.00
$600
Materials requisition form (#15678):
Quantity
Unit cost
Total
cost
420
$1.25
$525
Nibs
Time ticket for Jamie Unser:
Started
Ended
11:00 AM 2:45 PM
Time
Consumed
Rate
Amount
Job Number
3.75
$12.60
$47.25
W456
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Solutions Manual, Chapter 3
11
Brief Exercise 3-2 (continued)
Time ticket for Melissa Chan:
Started
Ended
Time
Consumed
8:15 AM
11:30 AM
3.25
Rate
Amount
Job Number
$13.20
$42.90
W456
Partial Job Cost Sheet for Job W456:
Direct Materials
Direct Labour
Req. No.
Amount
Name
Hours
Amount
15673
$600.00
Unser
3.75
$47.25
15678
525.00
Chan
3.25
42.90
$1,125.00
$90.15
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12
Introduction to Managerial Accounting, Fifth Canadian edition
Brief Exercise 3-3 (10 minutes) (LO3 – CC5)
The predetermined overhead rate is computed as follows:
Estimated total manufacturing overhead ................................$540,000
÷ Estimated total direct labour hours (DLHs) ................................
30,000 DLHs
= Predetermined overhead rate .....................................................
$18.00 per DLH
Brief Exercise 3-4 (15 minutes) (LO4 CC8)
a.
Raw Materials ................................
180,000
Accounts Payable ................................
180,000
b. Work in Process ................................ 152,000
Manufacturing Overhead ................................
19,000
Raw Materials ................................
c.
171,000
Work in Process ................................ 201,000
Manufacturing Overhead ................................
20,000
Wages Payable ................................
221,000
d. Manufacturing Overhead ................................
375,000
Various Accounts ................................
375,000
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Solutions Manual, Chapter 3
13
Brief Exercise 3-5 (10 minutes) (LO5 – CC10)
Actual direct labour-hours..............................................................
19,800
× Predetermined overhead rate .....................................................
$13.40
= Manufacturing overhead applied ................................ $265,320
Brief Exercise 3-6 (30 minutes) (LO6 – CC12; LO7 – CC14)
Parts 1 and 2.
Cash
Raw Materials
114,000
(a)
146,000
(c)
103,000
(d)
(a)
Work in Process
(b)
88,000
(c)
132,000
(e)
112,000
332,000
(f)
11,000
(c)
14,000
(d)
103,000
16,000
112,000
(b)
332,000
332,000
332,000
99,000
Finished Goods
332,000
(f)
(f)
Manufacturing Overhead
(b)
114,000
Cost of Goods Sold
(e)
(f)
332,000
(g)
16,000
348,000
16,000
(g)
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14
Introduction to Managerial Accounting, Fifth Canadian edition
2: Cost of Goods Sold: $348,000
Brief Exercise 3-7 (15 minutes) (LO7 – CC14)
1. Actual direct labour-hours .............................................................
11,500
× Predetermined overhead rate ................................
$28.20
= Manufacturing overhead applied ................................
$324,300
Less: Manufacturing overhead incurred ................................
315,000
Overapplied manufacturing overhead ................................
$ 9,300
2. Since manufacturing overhead is overapplied, the cost of goods sold would be
decreased by $9,300 and the gross margin would increase by $9,300.
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Solutions Manual, Chapter 3
15
Solutions to Exercises
Exercise 3-1 (30 minutes) (LO2 – CC4)
1.
Overhead allocation rate for 2016:
Estimated overhead =
$590,000
Estimated direct labour cost =
$472,000
Predetermined overhead rate =
$125% of direct labour cost
2.
Direct materials =
$890 + $1,750 + $200 = $2,840
Direct labour =
$230 + $530 + $700 =
$1,460
Overhead =
$1,460 × 125% =
$1,825
Exercise 3-1 (continued)
3.
Number
KS2016-337
Department
Description
Commercial
Pesticide testing
Direct Materials
Req. No.
Amount
JOB COST SHEET
Date initiated
Date Completed
Units Completed
Direct Labour
Time-sheet Hours
Amount
M-3316
$
890
L-4423
$
230
M-3399
$
1,750
L-4437
$
530
M-3407
$
200
L-4509
$
700
$
2,840
$
1,460
Cost Summary
Direct Materials
$ 2,840.00
Date
1-Dec-16
23-Dec-16
5
DL cost
$
1,460
Overhead
Rate
Amount
125%
$ 1,825.00
Job Completion Status
Progress to date
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16
Introduction to Managerial Accounting, Fifth Canadian edition
Direct Labour
$ 1,460.00
Overhead
$ 1,825.00
Total Cost
$ 6,125.00
Unit Cost
$ 1,225.00
24-Dec-16
Completed and shipped to
customer
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Solutions Manual, Chapter 3
17
Exercise 3-2 (30 minutes) (LO3 – CC5)
1. Since $234,300 of studio overhead was applied to Work in Process on the basis of
$165,000 of direct staff costs, the apparent predetermined overhead rate is 142% of
direct staff costs incurred:
Studio overhead applied $234,300
=
=142%
Direct staff costs incurred $165,000
2. The Lexington Gardens Project is the only job remaining in Work in Process at the
end of the month; therefore, the entire $29,300* balance in the Work in Process
account at that point must apply to it. Recognizing that the predetermined overhead
rate is 142% of direct staff costs, the following computation can be made:
Total cost in the Lexington Gardens Project ................................
Less:
$29,300
Direct staff costs ................................................................
$ 4,000
Studio overhead cost ($4,000 × 142%) ................................
5,680
Costs of subcontracted work .........................................................
9,680
$19,620
With this information, we can now complete the job cost sheet for the Lexington
Gardens Project:
Costs of subcontracted work ................................
$19,620
Direct staff costs ................................................................
4,000
Studio overhead ................................................................
5,680
Total cost to January 31 ................................
$29,300
* [$520,000 + $165,000 + $234,300 - $890,000]
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18
Introduction to Managerial Accounting, Fifth Canadian edition
Exercise 3-3 (30 minutes) (LO3 – CC5)
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
$1,040,000
=
= $5.20 per
unit.
Estimated units to be produced
200,000 units
The predetermined overhead rate could also be set on the basis of either direct
labour cost or direct materials cost. The computations are:
Estimated manufacturing overhead cost $1,040,000 208% of direct
=
=
Estimated direct labour cost
$500,000 labour cost.
Estimated manufacturing overhead cost $1,040,000 160% of direct
=
=
Estimated direct materials cost
$650,000 materials cost.
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Solutions Manual, Chapter 3
19
Exercise 3-3 (continued)
2. Using a predetermined overhead rate based on units produced, the unit product
costs would be:
Quarter
First
Second
Third
Fourth
Direct materials ................................
$260,000
$130,000
$ 65,000
$195,000
Direct labour ................................ 200,000
100,000
50,000
150,000
Manufacturing overhead:
Applied at $5.20 per unit,
208% of direct labour cost
or 160% of direct materials
cost ................................................................
416,000
208,000
104,000
312,000
$438,000
$219,000
$657,000
Number of units produced ................................
80,000
40,000
20,000
60,000
Unit product cost ................................
$10.95
$10.95
$10.95
$10.95
Total cost ................................
$876,000
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20
Introduction to Managerial Accounting, Fifth Canadian edition
Exercise 3-4 (30 minutes) (LO3 – CC5; LO4 – CC8; LO5 – CC10; LO6 –CC12)
1.
a. Raw Materials Inventory
Accounts Payable
3000,000
b. Work in Process
Manufacturing Overhead
Raw Materials Inventory
228,000
62,000
c. Work in Process
Manufacturing Overhead
Salaries and Wages Payable
110,000
90,000
d. Manufacturing Overhead
Accumulated Depreciation
300,000
290,000
200,000
70,000
70,000
e. Manufacturing Overhead
Accounts Payable
140,000
f.
378,000
Work in Process
Manufacturing Overhead
140,000
378,000
[ 30,000 MH × $12.60 per MH = $378,000. ]
g. Finished Goods
Work in Process
720,000
h. Cost of Goods Sold
Finished Goods
Accounts Receivable
Sales
680,000
720,000
680,000
850,000
850,000
[ $680,000 × 1.25 = $850,000. ]
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Solutions Manual, Chapter 3
21
Exercise 3-4 (Continued)
2.
Manufacturing Overhead
378,000
Work in Process
(b)
62,000
(f)
(c)
90,000
(b)
228,000
(d)
70,000
(c)
110,000
(e)
140,000
(f)
378,000
16,000
Bal.
Bal.
42,000
720,000
(g)
38,000
(Overapplied
overhead)
Exercise 3-5 (15 minutes) (LO4 – CC8; LO7 – CC14)
1. Item (a):
2.
Actual manufacturing overhead costs for the year.
Item (b):
Overhead cost applied to work in process for the year.
Item (c):
Cost of goods manufactured for the year.
Item (d):
Cost of goods sold for the year.
70,000
Cost of Goods Sold ................................................................
Manufacturing Overhead ............................................................ 70,000
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22
Introduction to Managerial Accounting, Fifth Canadian edition
Exercise 3-6 (30 minutes) (LO6 – CC13; LO7 – CC14)
1. Actual manufacturing overhead costs ................................
Manufacturing overhead cost applied: 20,000 MH
× $25 per MH................................................................
$479,500
500,000
Overapplied overhead cost ............................................................ $ 20,500
2.
Chang Company
Schedule of Cost of Goods Manufactured
Direct materials:
Raw materials inventory, beginning ................................
$ 30,000
Add purchases of raw materials ................................ 500,000
Raw materials available for use ................................ 530,000
Deduct raw materials inventory, ending................................
40,000
Raw materials used in production ................................
490,000
34,000
Less indirect materials ................................................................
Direct labour ................................................................
Manufacturing overhead cost applied to work in
process ................................................................
$456,000
85,000
500,000
Total manufacturing costs ............................................................. 1,041,000
Add: Work in process, beginning ................................
50,000
1,091,000
Deduct: Work in process, ending ................................
80,000
Cost of goods manufactured .......................................................... 1,011,000
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Solutions Manual, Chapter 3
23
Exercise 3-7 (30 minutes) (LO3 – CC5; LO7 – CC14)
1. Predetermined overhead rates:
Company X:
Estimated overhead cost
$536,000
=
=$6.70 per DLH
Estimated direct labour-hours 80,000 DLHs
Company Y:
Estimated overhead cost
$520,000
=
=$4.16 per MH
Estimated machine-hours 125,000 MHs
Company Z:
Estimated overhead cost
$480,000 160% of direct
=
=
Estimated direct materials cost $300,000 materials cost
2. Actual overhead costs incurred ......................................................
$530,000
Overhead cost applied to Work in Process:
82,000* actual DLH × $6.70 per DLH .........................................
549,400
Overapplied overhead cost ............................................................
$ 19,400
*18,000 hours + 26,000 hours + 38,000 hours = 82,000 hours
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24
Introduction to Managerial Accounting, Fifth Canadian edition
Exercise 3-8 (15 minutes) (LO2 – CC4; LO3 – CC5; LO7 – CC14)
1. Budgeted labour hours = ($300,000 ÷ $24) =12,500 DLH
Budgeted manufacturing overhead
= Budgeted labour hours × predetermined overhead rate
=12,500 × $18.00 = $225,000
2.
Total Direct Cost = 13 × $65 =
$
845
Total Indirect Cost = [13 × ($7,500 ÷ 150)]
$
650
Total Job Cost
$ 1,495
3. The journal entry would be:
Manufacturing overhead Control .................. $122
Cost of Goods Sold ................ $122
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Solutions Manual, Chapter 3
25
Exercise 3-9 (20 minutes) (LO3 – CC5; LO5 – CC10; LO7 – CC14)
1.
Predetermined overhead rate =
$4,000,000 ÷ 250,000 MH = $16 per MH
Actual machine hours consumed during the year =
$4,192,000 ÷ $16 = 262,000
(Note: actual machine hours are used to compute applied overhead; however
the applied overhead amount is already given and equals $4,192,000 shown
on the credit side of the T-account.)
2.
Actual overhead is the amount shown on the debit side of the T-account $3,832,546.
3.
Applied overhead is greater than actual overhead which means that the
company overapplied overhead. The amount of overapplied overhead is
$359,454 ($4,192,000 - $3,832,546).
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26
Introduction to Managerial Accounting, Fifth Canadian edition
Exercise 3-10 (45 minutes) (LO2 – CC4; LO3 – CC5; LO4 – CC8; LO6 – CC12)
1. a. Raw Materials................................................................
452,000
Accounts Payable ................................................................
452,000
b. Work in Process................................................................
312,000
Manufacturing Overhead ...............................................................
78,000
Raw Materials................................................................
390,000
c. Work in Process................................................................
60,000
Manufacturing Overhead ...............................................................
120,000
Wages and Salaries Payable ................................
180,000
d. Manufacturing Overhead ...............................................................
175,000
Accumulated Depreciation .......................................................... 175,000
e. Manufacturing Overhead ...............................................................
92,000
Accounts Payable ................................................................
92,000
f. Work in Process................................................................
360,000
Manufacturing Overhead ............................................................ 360,000
Estimated overhead cost
$4,800,000
=
=$24 per MH
Estimated machine-hours 200,000 MHs
15,000 MH × $24 per MH = $360,000.
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Solutions Manual, Chapter 3
27
Exercise 3-10 (continued)
2.
Manufacturing Overhead
(b)
78,000
(c)
360,000
Work in Process
(f)
(b)
312,000
120,000
(c)
60,000
(d)
175,000
(f)
360,000
(e)
92,000
3. The cost of the completed job would be $732,000 as shown in the Work in Process
T-account above. The entry would be:
Finished Goods ................................................................
732,000
Work in Process ................................................................ 732,000
4. The cost per unit on the job cost sheet would be:
$732,000 ÷ 12,000 units = $61 per unit.
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28
Introduction to Managerial Accounting, Fifth Canadian edition
Exercise 3 -11 (20 minutes) (LO 7 – CC14)
1.
Underapplied. A debit balance in the Manufacturing Overhead Control Taccount means that actual overhead is greater than applied overhead.
2.
In order to compute the actual overhead amount we must first compute
applied overhead.
Applied overhead
= $24.80 × 167,000 direct labour hours
= $4,141,600
Actual overhead
3.
= $4,141,600 + $183,550 = $4,325,150
Adjusting the underapplied overhead amount to COGS will result in a debit to
the COGS account. This, in turn, will decrease gross margin and net income.
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Solutions Manual, Chapter 3
29
Solutions to Problems
Problem 3-1 (15 minutes) (LO2 – CC4; LO3 – CC5)
1.
Overhead allocation rate
= $7,510,000 ÷ 500,000 DLH
= $15.02 per DLH
Overhead applied to the three jobs:
School = 66,400 DLH × $15.02 = $997,328
Residential
= 37,200 DLH × $15.02 = $558,744
Cinema
= 18,500 DLH × $15.02 = $277,870
2.
Direct materials
Direct labour*
Overhead
Total job cost
School
Residential
Cinema
$ 824,000
$1,034,600
$1,425,000
1,301,440
729,120
362,600
997,328
558,744
277,870
$ 3,122,768
$2,322,464
$2,065,470
*Direct labour is calculated by multiplying the direct labour hours required for each job
by the labour rate of $19.60 per DLH, which is computed as $9,800,000 ÷ 500,000
DLH. As an example, the direct labour cost for School ($1,301,440) is computed as
66,400 DLH × $19.60 per DLH.
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30
Introduction to Managerial Accounting, Fifth Canadian edition
Problem 3-2 (30 minutes) (LO3 – CC5, 7; LO7 – CC17)
1. Cutting Department:
Estimated overhead cost
$382,500
=
=$8.50 per MH
Estimated machine-hours 45,000 MHs
Finishing Department:
Estimated overhead cost
$499,500 185% of direct
=
=
Estimated direct labour cost $270,000 labour cost
2.
Overhead
Applied
Cutting Department: 90 MHs × $8.50 per MH ................................
$ 765.00
Finishing Department: $250 × 185%................................
462.50
Total overhead cost applied .......................................................
$1,227.50
3. Yes; if some jobs required a large amount of machine time and little labour cost,
they would be charged substantially less overhead cost if a plantwide rate based on
direct labour cost were being used. It appears, for example, that this would be true
of Job 203 which required considerable machine time to complete, but required
only a small amount of labour cost.
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Solutions Manual, Chapter 3
31
Problem 3-3 (45 minutes) (LO3 – CC6, 7; LO4 – CC11; LO5 – CC14; LO6 – CC16; LO7
– CC18, 19)
1.
Estimated manufacturing overhead cost
$192,000
=
=$2.40 per MH
Estimated machine-hours
80,000 MHs
2. The amount of overhead cost applied to Work in Process for the year would be:
75,000 machine-hours × $2.40 per machine-hour = $180,000. This amount is
shown in entry (a) below:
Manufacturing Overhead
(Maintenance)
19,000
(Indirect materials)
180,000
(a)
6,000
(Indirect labour)
60,000
(Utilities)
30,000
(Insurance)
7,000
(Depreciation)
54,000
(Property taxes)
8,000
Balance
4,000
Work in Process
(Direct materials)
710,000
(Direct labour)
(Overhead)
90,000
(a)
180,000
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32
Introduction to Managerial Accounting, Fifth Canadian edition
Problem 3-3 (continued)
3. Overhead is underapplied by $4,000 for the year, as shown in the Manufacturing
Overhead account above. The entry to close out this balance to Cost of Goods Sold
would be:
Cost of Goods Sold ................................................................
4,000
Manufacturing Overhead ............................................................ 4,000
4.
When overhead is applied using a predetermined rate based on machine-hours,
it is assumed that overhead cost is proportional to machine-hours. So when the actual
machine-hours turn out to be 75,000, the costing system assumes that the overhead
will be 75,000 machine-hours × $2.40 per machine-hour, or $180,000. This is a drop of
$12,000 from the initial estimated manufacturing overhead cost of $192,000. However,
the actual manufacturing overhead did not drop by this much. The actual
manufacturing overhead was $184,000—a drop of $8,000 from the estimate. The
manufacturing overhead did not decline by the full $12,000 because of the existence of
fixed costs and/or because overhead spending was not under control. These issues will
be covered in more detail in later chapters.
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Solutions Manual, Chapter 3
33
Problem 3-4 (45 minutes) (LO3 – CC5; LO5 – CC10; LO6 CC12; LO7 – CC14; LO8 –
CC18)
1. The transactions will be posted to T-accounts as follows:
Beginning inventory
Costs added during the quarter
Direct materials
Direct professional labour
Applied overhead
$
Jobs in Process Control
410,578 $
4,084,082 Transferred to Cost of jobs billed
$
$
$
149,580
1,706,290
2,389,160
$
571,526
Transferred from Jobs in Process Control
$
Direct professional labour - consulting
Direct professional labour - design
$
$
Consulting supprt incurred
Design suppoer incurred
$
$
Cost of Jobs Billed
4,084,082 $
4,084,082 Transferred to income statement
Direct Professional Labour Control
930,060 $
1,706,290 Transferred to Jobs-in-Process
776,230
Support overhead Control
982,110 $
2,389,160 Applied overhead
1,317,564
$
Cash Control
$
$
$
89,486 overapplied overhead
149,580 Direct materials
1,706,290 Direct professional labour
2,299,674 Overhead incurred
The preliminary computations for determining the above amounts are as follows:
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34
Introduction to Managerial Accounting, Fifth Canadian edition
POHR (consulting support)
POHR (design support)
115% of direct professional labour (Consulting)
170% of direct professional labour (Design)
Beginning Jobs In Amounts assigned
to JIP in the third
Process (JIP)
quarter
Dierect materials
Direct professional labour (Consulting)
Direct professional labour (Design)
Applied consulting support
Applied design support
$
$
$
$
$
22,460
180,520
207,598
-
Total amounts assigned
$
410,578 $
$
$
$
$
$
149,580
930,060
776,230
1,069,569
1,319,591
Ending Jobs In
Process (JIP)
$
$
$
$
$
36,764
198,060
336,702
4,245,030 $
571,526
Notes:
POHRs are computed as follows:
$2,875,000 ÷ $2,500,000 = 115% of direct professional labour (consulting)
$3,060,000 ÷ $1,800,000 = 170% of direct professional labour (design)
Applied overhead is calculated as follows:
Assigned to
Assigned to
Beginning
Jobs-in-Process
Jobs-in-Process (Quarter 3)
(Quarter 3)
Applied
Consulting
Support
115% ×
$180,520
$207,598
115% ×
$930,060
$1,069,569
115% × $0
170% × $0
Applied Design
Support
$0
$0
170% ×
$776,230
$1,319,591
170% ×
$198,060
Total
Assigned to
Ending Jobs-inProcess
(Quarter 3)
$336,702
$207,598
$2,389,160
$336,702
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Solutions Manual, Chapter 3
35
Problem 3-4 (continued)
2. The amounts are shown above (in the T-account); the computation is shown in the
table above. Beginning WIP = $410,578 and Ending WIP = $571,526.
3. The over- or under-allocated overhead would be computed as follows:
Actual:
$2,299,674 (from the support overhead control account)
Applied:
$2,389,160 (from the support overhead control account)
Difference:
$
89,486 over-applied
Applied overhead is greater than actual overhead; therefore, we must credit (decrease)
the Cost of Jobs Billed by that much amount. The appropriate journal entry would be
as follows:
Support Overhead Control
$89,486
Cost of Jobs Billed
$89,486
This amount would show up as a credit entry in the t-account for Cost of Jobs Billed
(Note: The Cost of Jobs Billed account is similar to the Cost of Goods Sold account.)
4.
Sales
Less: Cost of Jobs Billed
Cost of jobs billed
Less over-applied overhead
Gross margin
Less: SG&A expenses
Operating income
$
$
$
4,853,000
4,084,082
89,486 $
$
$
$
3,994,596
858,404
858,404
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Introduction to Managerial Accounting, Fifth Canadian edition
Problem 3-5 (75 minutes) (LO6 – CC12; LO7 – CC14)
1. The cost of raw materials put into production would be:
Raw materials inventory, 1/1 .........................................................
$ 15,000
Debits (purchases of materials) ................................
140,000
Materials available for use .............................................................
155,000
Raw materials inventory, 12/31 ................................
35,000
Materials requisitioned for production ................................
$120,000
2. Of the $120,000 in materials requisitioned for production, $90,000 was debited to
Work in Process as direct materials. Therefore, the difference of $30,000 would have
been debited to Manufacturing Overhead as indirect materials.
3. Total factory wages accrued during the year (credits to the
Factory Wages Payable account) ................................................
$180,000
Less direct labour cost (from Work in Process) ...............................
160,000
Indirect labour cost ................................................................ $ 20,000
4. The cost of goods manufactured would have been $470,000—the credits to the
Work in Process account.
5. The Cost of Goods Sold for the year would have been:
Finished goods inventory, 1/1 ........................................................
$ 40,000
Add: Cost of goods manufactured (from Work in Process) ...............
470,000
Goods available for sale ................................................................
510,000
Deduct Finished goods inventory, 12/31 ................................
Cost of goods sold ................................................................
60,000
$450,000
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Solutions Manual, Chapter 3
37
Problem 3-5 (continued)
6. The predetermined overhead rate would have been:
Manufacturing overhead cost applied $240,000 150% of direct
=
=
Direct labour cost
$160,000 labour cost.
7.
Manufacturing overhead would have been overapplied by $10,000, computed as
follows:
Actual manufacturing overhead cost for the year (debits) ................
$250,000
Applied manufacturing overhead cost (from Work in
Process—this would have been the credits to the
Manufacturing Overhead account) ..............................................
240,000
Underapplied overhead ................................................................
$ 10,000
8. The ending balance in Work in Process is $30,000. Direct materials make up
$10,000 of this balance, and manufacturing overhead makes up $12,000. The
computations are:
Balance, Work in Process, 12/31 ....................................................$30,000
Less: Direct labour cost (given) ..................................................... (8,000)
Manufacturing overhead cost ($8,000 × 150%) ....................(12,000)
Direct materials cost (remainder) ...................................................$10,000
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Introduction to Managerial Accounting, Fifth Canadian edition
Problem 3-6 (75 minutes) (LO3 – CC5; LO6 – CC13; LO7 – CC14)
1. a.
Estimated overhead cost
$800,000
=
= 160%
Estimated direct materials used $500,000
b. Before the under- or overapplied overhead can be computed, we must determine
the amount of direct materials used in production for the year.
Raw materials inventory, beginning ...............................................
$ 20,000
Add, Purchases of raw materials ...................................................
510,000
Raw materials available ................................................................
530,000
Deduct: Raw materials inventory, ending ................................
80,000
Raw materials used in production ..................................................
$450,000
Since no indirect materials are identified in the problem, these would all be direct
materials. With this figure, we can proceed as follows:
Actual manufacturing overhead costs:
Indirect labour ..........................................................................
$170,000
Property taxes ..........................................................................48,000
Depreciation of equipment .........................................................
260,000
Maintenance .............................................................................95,000
Insurance ................................................................................. 7,000
Rent, building ...........................................................................
180,000
Total actual costs ................................................................
760,000
Applied manufacturing overhead costs:
$450,000 × 160% ................................................................ 720,000
Underapplied overhead................................................................
$ 40,000
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Solutions Manual, Chapter 3
39
Problem 3-6 (continued)
2.
GITANO PRODUCTS
Schedule of Cost of Goods Manufactured
Direct materials:
Raw materials inventory, beginning ................................$ 20,000
Add purchases of raw materials................................
510,000
Total raw materials available ......................................................
530,000
Deduct raw materials inventory, ending ................................
80,000
Raw materials used in production ................................
$ 450,000
Direct labour ................................................................
90,000
Manufacturing overhead applied to work in process........................
720,000
Total manufacturing costs .............................................................
1,260,000
Add: Work in process, beginning ...................................................
150,000
1,410,000
Deduct: Work in process, ending ...................................................
70,000
Cost of goods manufactured .........................................................
$1,340,000
3. Cost of goods sold:
Finished goods inventory, beginning ...........................................
$ 260,000
Add cost of goods manufactured ................................................
1,340,000
Goods available for sale .............................................................
1,600,000
Deduct finished goods inventory, ending................................
400,000
Cost of goods sold ................................................................ $1,200,000
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Introduction to Managerial Accounting, Fifth Canadian edition
Problem 3-6 (continued)
4. Direct materials ............................................................................
$ 8,500
Direct labour ................................................................................ 2,700
Overhead applied ($8,500 × 160%)...............................................13,600
Total manufacturing cost...............................................................
$24,800
$24,800 × 125% = $31,000 price to the customer.
5. The amount of overhead cost in Work in Process would be:
$24,000 direct materials cost × 160% = $38,400.
The amount of direct labour cost in Work in Process would be:
Total ending work in process ................................
$70,000
Deduct: Direct materials ................................ $24,000
Manufacturing overhead................................
38,400
62,400
Direct labour cost ................................................................$ 7,600
The completed schedule of costs in Work in Process would be:
Direct materials ................................................................
$24,000
Direct labour ................................................................
7,600
Manufacturing overhead ...............................................................
38,400
Total Work in Process ................................................................
$70,000
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Solutions Manual, Chapter 3
41
Problem 3-7 (30 minutes) (LO3 – CC5; LO5 – CC10, 11; LO8 – CC18)
1.
Predetermined overhead allocation rate for 2016:
$960,000 ÷ $3,000,000 = 32% of direct labour cost
2.
Cost of jobs completed for the month of July:
Beginning jobs in process inventory:
$
22,800
Add costs incurred in July:
Direct materials:
$50,000
Direct labour ($970,000 - $170,000)
800,000
Applied overhead: (32% of $800,000)
256,000
1,106,000
Less: ending jobs in process inventory:
34,600
Cost of jobs completed
$1,094,200
Income Statement
Sales revenues
Less: Cost of jobs completed
$2,325,000
*
1,134,200
Gross profit
$1,190,800
Less: Selling & administration
640,000
Net profit
$ 550,800
* Includes $40,000 underapplied overhead
Actual overhead (6,000+1700,00+120,000) = 296,000
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42
Introduction to Managerial Accounting, Fifth Canadian edition
Problem 3-8 (45 minutes) (LO2 – CC4; LO3 – CC6, 7; LO7 – CC18)
1. Moulding Department predetermined overhead rate:
Estimated overhead cost
$602,000 $8.60 per
=
=
Estimated machine-hours 70,000 MHs machine-hour.
Painting Department predetermined overhead rate:
Estimated overhead cost
$735,000 175% of direct
=
=
Estimated direct labour cost $420,000 labour cost.
2. Moulding Department overhead applied:
90 machine-hours × $8.60 per machine-hour ..............................
$ 774
Painting Department overhead applied:
$660 direct labour cost × 175% .................................................1,155
Total overhead cost ................................................................ $1,929
3. Total cost of job 205:
Moulding
Painting
Dept.
Dept.
Direct materials ................................................................
$ 480
$ 340
Direct labour ................................................................
280
Total
$ 820
660
940
Manufacturing overhead applied ................................
774
1,155
1,929
Total cost ................................................................
$1,534
$2,155
$3,689
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Solutions Manual, Chapter 3
43
Problem 3-8 (continued)
Cost per unit for job 205:
Total cost, $3,689
= $73.78 per unit
50 units
4.
Moulding
Painting
Dept.
Dept.
Manufacturing overhead incurred ................................$620,000
$705,000
Manufacturing overhead applied:
68,000 machine-hours × $8.60 per machinehour ................................................................
584,800
$436,000 direct labour cost × 175% ................................
Underapplied (or overapplied) overhead................................
$ 35,200
763,000
$ (58,000)
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Introduction to Managerial Accounting, Fifth Canadian edition
Problem 3-9 (90 minutes) (LO4 – CC8; LO6 – CC12; LO7 – CC14; LO8 – CC18)
1. a. Raw Materials ................................................................170,000
Accounts Payable ................................................................
170,000
b. Work in Process ................................................................
160,000
Manufacturing Overhead ...............................................................
40,000
Raw Materials ................................................................
200,000
c. Work in Process ................................................................
200,000
Manufacturing Overhead ...............................................................
82,000
Salaries Expense ................................................................
120,000
Salaries and Wages Payable ................................
402,000
d. Manufacturing Overhead ...............................................................
75,000
Accounts Payable ................................................................
75,000
e. Advertising Expense ................................................................
90,000
Accounts Payable ................................................................
90,000
f. Manufacturing Overhead ...............................................................
14,000
Insurance Expense................................................................
6,000
Prepaid Insurance ................................................................
20,000
g. Manufacturing Overhead ...............................................................
120,000
Depreciation Expense ................................................................
30,000
Accumulated Depreciation ................................
150,000
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Solutions Manual, Chapter 3
45
h. Work in Process ................................................................
320,000
Manufacturing Overhead ................................
320,000
$200,000 actual direct labour cost × 160% = $320,000 overhead applied
i. Finished Goods ................................................................
700,000
Work in Process ................................................................
700,000
j. Accounts Receivable ................................................................
1,000,000
Sales ................................................................
1,000,000
Cost of Goods Sold ................................................................
720,000
Finished Goods ................................................................
720,000
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46
Introduction to Managerial Accounting, Fifth Canadian edition
Problem 3-9 (continued)
2.
Raw Materials
Bal.
52,000
(a)
170,000
Bal.
22,000
200,000
Finished Goods
(b)
Bal.
(i)
Bal.
Work in Process
Bal.
40,000
(b)
700,000
48,000
720,000
(j)
700,000
28,000
Manufacturing Overhead
(i)
(b)
40,000
160,000
(c)
82,000
(c)
200,000
(d)
75,000
(h)
320,000
(f)
14,000
Bal.
20,000
(g)
120,000
Bal.
11,000
320,000
(h)
Cost of Goods Sold
(j)
720,000
3. Overhead is underapplied by $11,000 for the year. The entry to close this balance to
Cost of Goods Sold would be:
Cost of Goods Sold ................................................................
11,000
Manufacturing Overhead ............................................................
11,000
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Solutions Manual, Chapter 3
47
Problem 3-9 (continued)
4.
ALMEDA PRODUCTS, INC.
Income Statement
For the Year Ended March 31
Sales ............................................................................................
$1,000,000
Less cost of goods sold ($720,000 + $11,000)................................
731,000
Gross margin ................................................................
269,000
Less selling and administrative expenses:
Salary expense ................................................................
$ 120,000
Advertising expense ................................................................
90,000
Insurance expense ................................................................
6,000
Depreciation expense ................................................................
30,000
Net income ...................................................................................
246,000
$
23,000
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48
Introduction to Managerial Accounting, Fifth Canadian edition
Problem 3-10 (75 minutes) (LO2 – CC4; LO3 – CC5; LO5 – CC10; LO7 – CC14)
1.
Prime costs incurred by each job during the month.
Job 2018-K001
Job 2018-S001
Job 2018-M001
4501
200
300
Direct materials/unit
$86.00
$112
$38
Total materials cost
$38,700
$22,400
$11,400
12
9
7
$97,200
$32,4002
$37,800
3
2
1.5
Direct labour cost
(Finishing) @ $12/hour
$16,200
$4,800
$5,4003
Total prime costs
$152,100
$59,600
$54,600
Number of cars
Direct labour hours/unit
(Assembly)
Direct labour cost
(Assembly) @ $18/hour
Direct labour hours/unit
(Finishing)
1 – 75% of 600
= 450
2 – 200 × 9 × $18
= $32,400
3 – 300 × 1.50 × $12
= $ 5,400
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Solutions Manual, Chapter 3
49
Problem 3-10 (continued)
2.
Amount of overhead that would have been applied (allocated) to the jobs during
the month in the Assembly and Finishing departments.
Assembly
Finishing
Estimated overhead
$409,600
$637,650
Estimated Direct Labour Hours
128,400
Estimated Machine-hours
18,220
Predetermined overhead
allocation rate
$3.19 per DLH
$35.00 per MH
Overhead applied to each job:
Job 2018K001
Job 2018S001
Job 2018M001
450
200
300
12.0
9.0
7.0
$17,2261
$5,742
$6,699
1.8
1.5
2.0
Finishing department
overhead applied
$28,3502
$10,500
$21,000
$59,850
Total overhead applied
$45,576
$16,242
$27,699
$89,517
Number of cars
Total
Direct labour hours/unit
(Assembly)
Assembly department
overhead applied
$29,667
Machine hours/unit
(Finishing)
1- 450 × 12 × $3.19
= $17,226
2- 450 × 1.8 × $35.00
= $28,350
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50
Introduction to Managerial Accounting, Fifth Canadian edition
Problem 3-10 (continued)
3.
Total cost of jobs completed during the month (jobs S001 and M001 only):
Job S001
Job M001
Total
Prime costs
$59,600
54,600
$114,200
Applied overhead
16,242
27,699
43,941
Total job cost
$75,842
$82,299
$158,141
Cost of ending WIP (job K001 which is only 75% complete and therefore
considered WIP)
Prime costs
= $152,100
Applied overhead
=
Total cost
= $197,676
45,576
4.
Assembly
Finishing
Applied overhead
$29,667
$59,850
$ 89,517
Actual overhead
$38,260
$66,560
$104,820
Difference
$ 8,593
$ 6,710
$ 15,303
underapplied
underapplied
underapplied
Underapplied overhead can be adjusted by debiting COGS (or Cost of Jobs
Completed) and crediting overhead.
First and foremost, overhead allocation rates are estimates. Two factors can
change during the year thereby causing actual overhead to be different from the
applied – prices that are paid to acquire overhead resources, changes in the
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Solutions Manual, Chapter 3
51
quantity of overhead resources that are consumed. Moreover, overhead was
allocated using two allocation bases; these may not be the right bases to allocate
overhead.
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52
Introduction to Managerial Accounting, Fifth Canadian edition
Problem 3-11 (40 minutes) (LO2 – CC4; LO3 – CC%; LO7 – CC17)
1. Job Cost Sheet
Number
Prospective
Department
Description
Mineral Chelate
Potassium Asparate
Direct Materials
Item
Amount
Aspartic Acid
$1,121.25
Citric Acid
$
K2CO3
Rice
$ 563.76
$
12.90
JOB COST SHEET
Date initiated
Date Completed
Units Completed
Direct Labour
Time-sheet Hours
Amount
16
$
296.00
30.30
$1,728.21
$
Cost Summary
Direct Materials
$1,728.21
Direct Labour
$ 296.00
Overhead
$1,026.63
Total Cost
$3,050.84
Cost per kilogram
$
Date
300
Overhead
Base
Rate
Amount
$
$1,728.21 32%
553.03
$
$ 296.00 160%
473.60
296.00
$1,026.63
Job Completion Status
Progress to date
Quote submitted
10.17
POHR - materials based overhead
$586,000 ÷ $1,831,250 =
Direct labour based overhead
$1,960,000 ÷ $1,225,000 =
32% per dollar of direct materials cost
160% per dollar of direct labour cost
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Solutions Manual, Chapter 3
53
Problem 3-11 (continued)
Notes:
* Direct materials costs are calculated using the price and quantitity of individual
materials.
* Direct labour cost is calculated using 16 hours of direct labour time and the labour
cost of $18.50 per hour ($16.50 + $2.00).
The total expected job cost is $3,050.84 for the job (300 kilograms) or $10.17 per kilo.
The expected price for the job as per the company’s formula is approximately $3,966
($3,050.84 × 1.30) or about $13.22 per kilogram. The offer price of $12.40 is well
below the expected price as per the formula and management may consider rejecting
the offer especially because the industry is doing well and the company is operating at
capacity.
2. Agreed price = $3,050.84 × 1.25 = $3,813.55 or approximately $12.71 per kilo.
At this price the expected gross margin is 25% of the job cost, and this is equal
to $762.71 or approximately $2.54 per kilo.
3. If the actual production is only 280 kilograms, this has several consequences.
 Customer may refuse to accept the order
 Cost per kilogram will increase to approximately $10.90 per kilogram ($3,050.84
÷ 280), a 7% increase in costs
 This will reduce gross margin because the customer will pay only $3,559.31
($3,813.55 × (280/300)).
 There is the possibility of a loss of customer goodwill.
 Potential theft or errors in the lab will need to be investigated
 Lab will be required to produce the missing 20 kg without receiving any
additional revenue
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54
Introduction to Managerial Accounting, Fifth Canadian edition
Comprehensive Problem (75 minutes) (LO3 – CC5; LO4 – CC8; LO5 – CC10; LO7 –
CC14)
1.
Predetermined Overhead Rates are as follows:
Consulting overhead:
POHR (C)
= $622,080 ÷ 128,000 consultant hours
= $4.86 per consultant hour
Processing overhead:
POHR (P)
= $1,654,200 ÷ 91,900 processing hours
= $18.00 per processing hour
Overhead applied to the jobs as follows:
Job 12-1:
Consulting overhead
= 9,580 × $4.86
= $ 46,558.80
Processing overhead
= 6,950 × $18.00
= $125,100.
Total overhead
= $171,658.80
Job 12-2:
Consulting overhead
= 7,140 × $4.86
= $ 34,700.40
Processing overhead
= 7,140 × $18.00
= $128,520.
Total overhead
= $163,220.40
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Solutions Manual, Chapter 3
55
Comprehensive Problem (continued)
Job 12-3:
Consulting overhead
= 7,490 × $4.86
= $ 36,401.40
Processing overhead
= 9,150 × $18.00
= $164,700.
Total overhead
= $201,101.40
Total overhead applied during the month
= $535,980.60
Alternatively, this may be computed as follows:
Consulting overhead
= (9,580 + 7,140 + 7,490) × $4.86 = $117,660.60
Processing overhead
= (6,950 + 7,140 + 9,150) × $18 = $418,320
Total overhead applied = $535,980.60
2.
Two jobs were completed during the month; 12-1 and 12-3. The direct materials,
labour (consultant) and overhead costs for these two jobs would be transferred to the
Cost of Jobs Completed account.
Job 12-1
Direct materials1
Job 12-3
$ 10,460
$ 13,880
Consultant labour2
431,100
337,050
Applied overhead3
171,659
201,101
$613,219
$552,031
Total cost
1 – given in the question
2 – using $45 per hour as the rate for consultants
3 – from requirement #1 above
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56
Introduction to Managerial Accounting, Fifth Canadian edition
Comprehensive Problem (continued)
Total amount transferred to the Cost of Jobs Completed account is $1,165,250
($613,219 + $552,031)
Estimated beginning balance in this account = ZERO
There are two reasons for this:
 Cost of Jobs Completed account is similar to Cost of Goods Sold, which is not an
asset account
 Service organizations do not carry finished goods inventory
3.
Cost transferred to Jobs in Process account:
Costs incurred during the month for all the three jobs would have been transferred
to this account.
Direct materials ($10,460 + $7,664 + $13,880)
=$
32,004
Direct labour (9,580 + 7,140 + 7,490 hours) × $45
= $1,089,450
Applied overhead (from requirement #1 above)
= $ 535,981
Total cost
= $1,657,435
Of this amount, $1,165,250 would have been transferred to the Cost of Jobs
Completed account. Therefore, the ending balance in the Jobs in Process account
would be ($1,657,435 - $1,165,250) = $492,185.
The estimated beginning balance in the Jobs in Process account is ZERO, as per the
information given in the question.
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Solutions Manual, Chapter 3
57
Comprehensive Problem (continued)
4.
Consulting Overhead:
Actual overhead (debit)
= $123,450
Applied overhead (credit) = $117,661
Debit balance
= $ 5,789 (underapplied overhead)
Processing Overhead:
Actual overhead (debit)
= $413,920
Applied overhead (credit) = $418,320
Debit balance
= $ 4,400 (overapplied overhead)
Overall, overhead was underapplied by $1,389 ($5,789 - $4,400). At the end of the
period the underapplied overhead will be debited to the Cost of Jobs Completed
account. Therefore, this entry will lower the income by $1,389.
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58
Introduction to Managerial Accounting, Fifth Canadian edition
Thinking Analytically (75 minutes) (LO2 – CC4; LO3 – CC5, 6, 7; LO8 –C18)
1. The revised predetermined overhead rate is determined as follows:
$3,402,000
Original estimated total manufacturing overhead ............................
Plus: Lease cost of the new machine .............................................
348,000
Plus: Cost of new technician/programmer ................................
50,000
Estimated total manufacturing overhead ................................ $3,800,000
Original estimated total direct labour-hours ................................
63,000
Less: Estimated reduction in direct labour-hours............................. 6,000
Estimated total direct labour-hours (DLH) ................................
57,000
Estimated total manufacturing overhead $3,800,000
=
Estimated total direct labour-hours
57,000 DLHs
=$66.67 per DLH
The revised predetermined overhead rate is higher than the original rate because
the automated milling machine will increase the overhead for the year (the
numerator in the rate) and will decrease the direct labour-hours (the denominator in
the rate). This double-whammy effect increases the predetermined overhead rate.
2. Acquisition of the automated milling machine will increase the apparent costs of all
jobs—not just those that use the new facility. This is because the company uses a
plantwide overhead rate. If there was a different overhead rate for each
department, this would not happen.
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Solutions Manual, Chapter 3
59
Thinking Analytically (continued)
3. The predetermined overhead rate is now considerably higher than it was. This will
penalize products that continue to use the same amount of direct labour-hours.
Such products will now appear to be less profitable and the managers of these
products will appear to be doing a poorer job. There may be pressure to increase
the prices of these products even though there has in fact been no increase in their
real costs.
4.
While it may have been a good idea to acquire the new equipment because of its
greater capabilities, the calculations of the cost savings were in error. The original
calculations implicitly assumed that overhead would decrease because of the reduction
in direct labour-hours. In reality the overhead increased because of the additional costs
of the new equipment. A differential cost analysis would reveal that the automated
equipment would increase total cost by about $316,000 a year if the labour reduction is
only 2,000 hours.
Cost consequences of leasing the automated equipment:
Increase in manufacturing overhead cost:
Lease cost of the new machine ...............................................
$348,000
Cost of new technician/programmer ........................................
50,000
398,000
Less: labour cost savings (2,000 hours × $41 per hour)...............
82,000
Net increase in annual costs .......................................................
$316,000
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60
Introduction to Managerial Accounting, Fifth Canadian edition
Thinking Analytically (continued)
Even if the entire 6,000 hour reduction in direct labour-hours had happened, that
would have added only $164,000 (4,000 hours × $41 per hour) in cost savings. The
net increase in annual costs would have been $152,000 and the machine would still
be an unattractive proposal. The entire 6,000-hour reduction may ultimately be
realized as workers retire or quit. However, this is by no means automatic.
There are two morals to this tale. First, predetermined overhead rates should not be
misinterpreted as variable costs. They are not. Second, a reduction in direct labour
requirements does not necessarily lead to a reduction in direct labour hours paid. It
is often very difficult to actually reduce the direct labour force and may be virtually
impossible except through natural attrition in some countries.
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61
Communicating in Practice (90 minutes) (LO1 – CC1; LO3 – CC5, 7; LO7 – CC18)
Date:
Current date
To:
Instructor
From: Student’s Name
Subject:
Talk with a Controller
The student’s memorandum should address the following:

The name, title and job affiliation of the individual interviewed. (Note: Not
specifically required in problem but essential and, as such, a good topic for class
discussion, if appropriate.)

A list of the company’s main products.

Identification of the type of costing system in use (job order, process or other).

Brief description of how overhead is assigned to products (including basis for
allocation and whether more than one overhead rate is in use).

Indication as to whether any changes have been made to or are being
considered in relation to the company’s costing system, and, if applicable, a brief
description of the changes.
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62
Introduction to Managerial Accounting, Fifth Canadian edition
Ethics Challenge (60 minutes) (LO3 – CC5, 7; LO8 – CC18)
1. Shaving 5% off the estimated direct labour-hours in the predetermined overhead
rate will result in an artificially high overhead rate. The artificially high
predetermined overhead rate is likely to result in overapplied overhead for the year.
The cumulative effect of overapplying the overhead throughout the year is all
recognized in December when the balance in the Manufacturing Overhead account
is closed out to Cost of Goods Sold. If the balance were closed out every month or
every quarter, this effect would be dissipated over the course of the year.
2. This question may generate lively debate. Where should Terri Ronsin’s loyalties lie?
Is she working for the general manager of the division or for the corporate
controller? Is there anything wrong with the “Christmas bonus”? How far should
Terri go in bucking her boss on a new job?
While individuals can certainly disagree about what Terri should do, some of the
facts are indisputable. First, the practice of understating direct labour-hours results
in artificially inflating the overhead rate. This has the effect of inflating the cost of
goods sold figures in all months prior to December and overstating the costs of
inventories. In December, the huge adjustment for overapplied overhead provides a
big boost to net income. Therefore, the practice results in distortions in the pattern
of net income over the year. In addition, since all of the adjustment is taken to Cost
of Goods Sold, inventories are still overstated at year-end. This means, of course,
that the net income for the entire year is also overstated.
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Solutions Manual, Chapter 3
63
Ethics Challenge (continued)
While Terri is in an extremely difficult position, her responsibilities under the CMA’s
Standards of Ethical Conduct for Management Accountants seem to be clear. The
Objectivity Standard states that “management accountants have a responsibility to
disclose fully all relevant information that could reasonably be expected to influence an
intended user’s understanding of the reports, comments, and recommendations
presented.” In our opinion, Terri should discuss this situation with her immediate
supervisor in the controller’s office at corporate headquarters. This step may bring her
into direct conflict with the general manager of the division, so it would be a very
difficult decision for her to make.
In the actual situation that this case is based on, the corporate controller’s staff were
aware of the general manager’s accounting tricks, but top management of the company
supported the general manager because “he comes through with the results” and could
be relied upon to hit the annual profit targets for his division. Personally, we would be
very uncomfortable supporting a manager who will resort to deliberate distortions to
achieve “results.” If the manager will pull tricks in this area, what else might he be
doing that is questionable or even perhaps illegal?
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64
Introduction to Managerial Accounting, Fifth Canadian edition
Teamwork In Action (120 minutes) (LO3 – CC5; LO4 – CC8; LO5 – CC10; LO6 –
CC12; LO7 – CC14)
Information set forth below is keyed to the location of the information in the problem.
1. The types of transactions that are posted to the accounts may be summarized in Taccount form as follows:
Raw Materials
Beginning balance
Direct materials used
Purchases
(transferred to work in process)
Ending balance
Accounts Payable
Payments to suppliers
Beginning balance
Purchases of raw materials
Ending balance
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Solutions Manual, Chapter 3
65
Teamwork in Action (continued)
Work in Process
Beginning balance
Cost of goods manufactured
Direct materials used
(transferred to Finished Goods)
(transferred from raw materials)
Direct labour
Manufacturing overhead applied
Ending balance
Manufacturing Overhead
Actual manufacturing costs
Overhead applied
Finished Goods
Cost of goods sold (transferred to Cost of
goods sold account)
Beginning balance
Cost of goods manufactured
(transferred from work in
process)
Ending balance
Cost of Goods Sold
Cost of goods sold
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Introduction to Managerial Accounting, Fifth Canadian edition
Teamwork in Action (continued)
2.
Overhead cost applied to work in process during June:
Actual overhead costs for June (per factory ledger) .......................
$79,000
Add overapplied overhead (all of this amount relates to June’s
activity per information in item g) ..............................................
6,100
Overhead cost applied to work in process during June ....................
$85,100
Or
Manufacturing Overhead
Actual costs (given)
79,000
Overhead applied
must be
85,100
Overapplied overhead
(given)
6,100
Predetermined overhead rate:
11,500 DLHs (item f) times predetermined overhead rate = $85,100
Divide both sides of the equation by 11,500 DLHs
Predetermined overhead rate
= $85,100 ÷ 11,500 DLHs = $7.40 per DLH
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Solutions Manual, Chapter 3
67
Teamwork in Action (continued)
3. Work in process inventory, June 30:
Materials (item c) ................................................................$6,600
Direct labour (500 hrs. @ $11 per hr per item c)
5,500
Overhead applied (500 DLH per item f
@ $7.40 per DLH from part 1 above) ................................ 3,700
Work in process balance at June 30 ................................
$15,800
4.
Work in Process
Bal. 6/1 (given)
7,200
Direct labour (item f –
11,500 hrs. @ $11)
Cost of goods
126,500
manufactured (item d) 313,000
Overhead applied
(from part 1 above)
Direct materials (plug)
Bal. 6/30
85,100
110,000
15,800
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Introduction to Managerial Accounting, Fifth Canadian edition
Teamwork in Action (continued)
5.
Finished Goods
Bal. 6/1 (item e)
36,000
Cost of goods
Cost of goods sold
manufactured (item d) 313,000
Bal. 6/30 (given)
must be
328,000
21,000
6.
Cost of Goods Sold
Cost of goods sold
(from part 5 above)
328,000
7.
Accounts Payable
Payments to suppliers
(item a)
Bal. 6/1 (part a)
119,000
Purchases must be
Bal. 6/30 (given)
20,000
115,000
16,000
8.
Raw Materials
Bal. 6/1 (given)
8,000
Purchases
(from part 7 above)
Bal. 6/30
Direct materials used
(from part 4 above)
110,000
115,000
13,000
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Solutions Manual, Chapter 3
69
Chapter 4
Process Costing
Solutions to Questions
4-1
A process costing system is appropriate
in situations where a homogeneous product is
produced on a continuous basis.
4-2
1. The same basic purposes exist in both
systems, which are to assign materials,
labour, and overhead cost to products and
to provide a mechanism for computing unit
costs.
2. Both systems maintain and use the same
basic manufacturing accounts.
3. Cost flows through the accounts in (2)
above move in basically the same way in
both systems.
4-3
In a process costing system, costs are
accumulated by department.
4-4
Cost accumulation is simpler under
process costing because 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.
4-5
A Work in Process account is maintained
for each separate processing department.
4-6
The journal entry would be:
Work in Process, Firing ................................
XXXX
Work in Process, Mixing ..............................
XXXX
4-7
The costs that might be added would
include: (1) cost transferred in from the mixing
department, (2) added materials cost, (3) added
labour cost, and (4) added overhead cost.
4-8
Under the weighted-average method,
the equivalent units of production are the sum
of the number of fully completed units and the
number of equivalent units in ending work in
process inventories.
4-9
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 about
activity in his or her department and also shows
the manager the stage of completion of any inprocess units. Second, it provides data for
computing the equivalent units and in preparing
the other parts of the production report.
4-10 A unit of product accumulates cost in
each department that it passes through, with
the costs of one department added to the costs
of the preceding department in a snowballing
fashion.
4-11 You should advise the company to use a
process costing system. By using process
costing separate processing departments can be
set up for each of the three raw materials
(bronze, silver, and gold), which will greatly
reduce the risk of the medallions being
contaminated by any other raw material.
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Solutions Manual, Chapter 4
1
The Foundational 15 (LO2-CC6, LO3-CC11, LO4-CC13, 14)
4-1. The journal entries would be recorded as follows:
Work in Process—Mixing ...............................................................
120,000
Raw Materials Inventory .........................................................
120,000
Work in Process—Mixing ...............................................................
79,500
Wages Payable................................................................
79,500
4-2. The journal entry would be recorded as follows:
Work in Process—Mixing ...............................................................
97,000
Manufacturing Overhead.........................................................
97,000
4-3. The “units completed and transferred to finished goods” is computed as follows:
Pounds
Work in process, June 1 ........................................................
Started into production during the month ...............................
Total pounds in process .........................................................
Deduct work in process, June 30............................................
Completed and transferred out during the month ....................
5,000
37,500
42,500
8,000
34,500
4-4. and 4-5.
The equivalent units of production for materials and conversion are computed as
follows:
Equivalent Units
Materials
Conversion
Units transferred out ...............................................
Work in process, ending:
8,000 units × 100% ..............................................
8,000 units × 40% ................................................
Equivalent units of production ................................
34,500
34,500
8,000
42,500
3,200
37,700
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Introduction to Managerial Accounting,FifthCanadian Edition
The Foundational 15 (continued)
4-6. and 4-7.
Materials
Cost of beginning work in process ............................
Cost added during the period ...................................
Total cost ................................................................
Conversion
$ 16,000
120,000
$136,000
$ 12,000
176,500*
$188,500
* $79,500 + $97,000 = $176,500
4-8. and 4-9.
The cost per equivalent unit for materials and conversion is computed as follows:
Total cost (a) ....................................................
Equivalent units of production (b) ......................
Cost per equivalent unit (a) ÷ (b).......................
$136,000
42,500
$3.20
$188,500
37,700
$5.00
4-10. and 4-11.
The cost of ending work in process inventory for materials and conversion is
computed as follows:
Materials Conversion
Equivalent units of production (a) ............
8,000
Cost per equivalent unit (b) .....................
$3.20
Cost of ending work in process
inventory (a) × (b)............................. $25,600
Total
3,200
$5.00
$16,000 $41,600*
* $41,600 is the June 30 balance in the Work in Process—Mixing Department Taccount.
4-12. and 4-13.
The cost of materials and conversion transferred to finished goods is computed as
follows:
Materials Conversion
Units transferred out (a) ................................34,500
Cost per equivalent unit (b) .............................$3.20
Cost of units transferred to finished
goods (a) × (b) .........................................
$110,400
Total
34,500
$5.00
$172,500 $282,900
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Solutions Manual, Chapter 4
3
The Foundational 15 (continued)
4-14. The journal entry to record the transfer of costs from Work in Process to Finished
Goods would be recorded as follows:
Finished Goods ......................................................
Work in Process—Mixing .................................
282,900
282,900
4-15. The total cost to be accounted for and the total cost accounted for is:
Costs to be accounted for:
Cost of beginning work in process inventory....................
Costs added to production during the period ...................
Total cost to be accounted for ........................................
$ 28,000
296,500
$324,500
Costs accounted for:
Cost of ending work in process inventory ........................
Cost of units completed and transferred out ....................
Total cost accounted for .................................................
$ 41,600
282,900
$324,500
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Introduction to Managerial Accounting,FifthCanadian Edition
Brief Exercise 4-1 (30 minutes) (LO2 – CC6)
a. To record issuing raw materials for use in production:
Work in Process—Moulding Department ..................
Work in Process—Firing Department .......................
Raw Materials.................................................
25,000
10,000
b. To record direct labour costs incurred:
Work in Process—Moulding Department ..................
Work in Process—Firing Department .......................
Wages Payable ...............................................
15,000
10,000
c. To record applying manufacturing overhead:
Work in Process—Moulding Department ..................
Work in Process—Firing Department .......................
Manufacturing Overhead .................................
29,000
40,000
35,000
25,000
69,000
d. To record transfer of unfired, moulded bricks from the Moulding Department to the
Firing Department:
Work in Process—Firing Department .......................
61,000
Work in Process—Moulding Department ...........
61,000
e. To record transfer of finished bricks from the Firing Department to the finished
goods warehouse:
Finished Goods ......................................................
110,000
Work in Process—Firing Department ................
110,000
f. To record Cost of Goods Sold:
Cost of Goods Sold .................................................
Finished Goods ...............................................
107,000
107,000
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Solutions Manual, Chapter 4
5
Brief Exercise 4-2 (10 minutes) (LO3 –CC11)
Weighted-Average Method
Equivalent Units (EU)
Materials
Conversion
Units accounted for as follows:
Units transferred out ................................................................
200,000
200,000
Work in process, ending:
10,000
20,000 units × 50% ................................
20,000 units × 20% ................................
4,000
Equivalent units of production ................................
210,000
204,000
Brief Exercise 4-3 (15 minutes) (LO4 CC12)
Weighted-Average Method
Tonnes
1.
Work in process, June 1 ...............................................................
Started into production during the month ......................................
Total tonnes in process ................................................................
Deduct work in process, June 30...................................................
Completed and transferred out during the month ...........................
20,000
190,000
210,000
30,000
180,000
2.
Tonnes to be accounted for:
Work in process, June 1 (90% materials, 80% labour and
overhead added last month) ...................................................
Started into production during the month ...................................
Total tonnes .............................................................................
20,000
190,000
210,000
Tonnes accounted for as follows:
Transferred out during the month ..............................................
Work in process, June 30 (60% materials, 40% labour and
overhead added this month) ...................................................
Total tonnes .............................................................................
180,000
30,000
210,000
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Introduction to Managerial Accounting,FifthCanadian Edition
Brief Exercise 4-4 (20 minutes) (LO6–CC17)
FIFO Method
Tonnes
Tonnes to be accounted for:
Work in process, June 1 (90% materials, 80% labour and
overhead added last month) ...................................................
Started into production during the month ...................................
Total tonnes .............................................................................
Tonnes accounted for as follows:
Work in process, June 1 (10% materials, 20% labour and
overhead added this month) ...................................................
Tonnes brought into production and fully completed ...................
Work in process, June 30 (60% materials, 40% labour and
overhead added this month) ...................................................
Total tonnes and equivalent units of production ..........................
20,000
190,000
210,000
20,000
160,000 *
30,000
210,000
* 190,000 tonnes started – 30,000 tons in ending inventory = 160,000 tonnes started
and completed.
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Solutions Manual, Chapter 4
7
Brief Exercise 4-5(15 minutes) (LO4 –CC13)
1.
Materials
Work in process, May 1 ................................ $ 55,000
Cost added during May ................................ 338,900
Total cost (a) ................................................................
$ 393,900
Equivalent units of production (b) ................................
54,450
Cost per equivalent unit (a) ÷ (b) ................................
$7.234
Labour
Overhead
$ 11,000
80,300
$ 91,300
$ 36,000
285,000
$ 321,000
44,380
$2.057
44,380
$7.233
2.
Cost per EU for materials ................................
$7.234
Cost per EU for labour ................................
2.057
Cost per EU for overhead ................................
7.233
Total cost per EU ................................ $16.524
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Introduction to Managerial Accounting,FifthCanadian Edition
Brief Exercise 4-6(30 minutes) (LO4–CC13)
1. Computation of the total cost per EU:
Cost per EU for materials ................................
$12.50
Cost per EU for labour ................................3.20
Cost per EU for overhead ................................
6.40
Total cost per EU ................................ $22.10
2. Computation of equivalent units in ending inventory:
Materials
Units in ending inventory................................
3,000
Percentage completed ................................ 80%
2,400
Equivalent units of production ................................
Labour
Overhead
3,000
60%
1,800
3,000
60%
1,800
3. Cost Reconciliation
Total Cost
Materials
Labour
Overhead
Cost accounted for as follows:
(Equivalent units)
Transferred to the next department:
25,000 units at $22.10 per unit................................
$552,500
25,000 25,000 25,000
Work in process, ending:
Materials, at $12.50 per EU ................................
30,000
2,400
Labour, at $3.20 per EU ................................
5,760
1,800
Overhead, at $6.40 per EU ................................
11,520
1,800
Total work in process ................................47,280
Total cost ................................................................
$599,780
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Solutions Manual, Chapter 4
9
Brief Exercise 4-7(15 minutes) (LO6–CC18)
Completed and transferred out
Ending work in process inventory, EU
Total equivalent units
Materials
4,750
500 x 50% = 250
5,000
Conversion
4,750
500 x 40% = 200
4,950
$25,000
$5.00
$19,800
$4.00
Costs incurred in the month
Cos per equivalent unit
Cost of ending inventory: ($5.00 x 250 + $4.00 × 200 = $1,250 + $800 =
$2,050.Itwill not matter whether FIFO or WACM is used because there is no
inventory at the beginning of June.
Brief Exercise 4-8 (minutes) (LO3 –CC10; LO5 –CC16; LO6 –CC18)
The correct answer is #2. Because the percentage of completion of opening WIP
inventory was largerthan what it should have been, the company is led to believe that
the percentage of work to be completed during the current period is lowerthan what it
should be. This leads to an understatement of the equivalent units produced. As for
costs per equivalent unit, this amount is overstated because the company will divide the
total costs incurred by a loweramount of equivalent units.
Brief Exercise 4-9(10 minutes) (LO4 –CC13)
Beginning Direct materials cost =
+ Direct materials cost incurred =
$ 40,000
$140,000
$180,000
Cost per equivalent unit for materials for May
= $180,000 ÷ 12,000 = $15.00
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Introduction to Managerial Accounting,FifthCanadian Edition
Exercise 4-1 (15 minutes) (LO2 –CC6)
Work in Process—Cooking ................................42,000
Raw Materials Inventory ................................
42,000
Work in Process—Cooking ................................50,000
Work in Process—Moulding................................36,000
Wages Payable ................................................................
86,000
Work in Process—Cooking ................................75,000
Work in Process—Moulding................................45,000
Manufacturing Overhead ................................
120,000
Work in Process—Moulding................................
160,000
Work in Process—Cooking ................................
160,000
Finished Goods ................................................................
240,000
Work in Process—Moulding................................
240,000
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Solutions Manual, Chapter 4
11
Exercise 4-2 (20 minutes) (LO3 –CC11; LO4 –CC12)
Weighted-Average Method
Quantity
Schedule
Pounds to be accounted for:
Work in process, July 1 (all
materials, 30% conversion cost
added last month) ................................ 20,000
Started into production during July ................................
380,000
Total pounds ................................................................
400,000
Equivalent Units (EU)
Materials
Conversion
Pounds accounted for as follows:
Transferred to Department 2 during
July ................................................................
375,000 *
Work in process, July 31 (all
materials, 60% conversion cost
added this month) ................................ 25,000
Total pounds and equivalent units of
production ................................................................
400,000
375,000
375,000
25,000
15,000
400,000
390,000
* 20,000 + 380,000 – 25,000 = 375,000
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Introduction to Managerial Accounting,FifthCanadian Edition
Exercise 4-3 (30 minutes) (LO5 –CC16; LO6 –CC17)
Physical Units
Equivalent Units Processed
To account
Accounted
Direct Materials
Conversion Cost
for
for
(EU = DOC x Physical units)
(EU = DOC x Physical
units)
DOC
Beginning work in
20,000
EU
DOC
EU
100%
20,000
30%
6,000
0%
0
70%
14,000
100%
355,000
100%
355,000
process
Production activity in
the period:
Beginning Work in
20,000
Process
Units introduced
380,000
Started and
355,000
completed
Completed units
375,000
375,000
375,000
Ending work in
25,000
100%
25,000
60%
15,000
400,000
WACM
400,000
WACM
390,000
process
Total volume
400,000
processed
Less
EU from
20,000
6,000
beginning of period
Production volume in
FIFO
380,000
FIFO
384,000
EU for the period
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Solutions Manual, Chapter 4
13
If students end up using the format of Exhibit 4-10 the schedule should look as follows.
FIFO Method
Quantity
Schedule
Pounds to be accounted for:
Work in process, July 1 (all
materials, 30% conversion cost
added last month) ................................ 20,000
Started into production during July ................................
380,000
Total pounds ................................................................
400,000
Equivalent Units (EU)
Materials
Conversion
Pounds accounted for as follows:
Work in process, July 1 (no
materials, 70% conversion cost
added during July)* ................................ 20,000
0
Pounds brought into production and
fully completed during July(ΐ)................................
355,000
355,000
Work in process, July 31 (all
materials, 60% conversion cost
added during July) ................................ 25,000
25,000
Total pounds and equivalent units of
production ................................................................
400,000
380,000
14,000
355,000
15,000
384,000
* Materials: 20,000 × (100% – 100%) = 0 equivalent units.
Conversion: 20,000 × (100% – 30%) = 14,000 equivalent units.
ΐ 380,000 pounds started – 25,000 pounds in ending inventory = 355,000 pounds
brought into production and fully completed.
Copyright © 2017 McGraw-Hill Education. All rights reserved.
14
Introduction to Managerial Accounting,FifthCanadian Edition
Exercise 4-4(30 minutes) (LO3 –CC11; LO4 –CC13)
Weighted-Average Method
1. For the sake of brevity, only the portion of the quantity schedule from which the
equivalent units are computed is shown below.
Quantity
Schedule
Equivalent Units (EU)
Materials
Conversion
Units accounted for as follows:
Transferred to the next process ................................
190,000
190,000
Work in process, May 31 (all
materials, 60% conversion cost
added this month) ................................10,000
10,000
Total units and equivalent units of
production ................................................................
200,000
200,000
190,000
6,000
196,000
2.
Total Cost
Cost to be accounted
for:
Work in process, May
1 ................................
$ 18,200
Cost added by the
process ................................
416,360
Total cost (a)................................
$434,560
Materials
Conversion
$ 4,000
$ 14,200
56,000
$60,000
360,360
$374,560
Equivalent units of
production (b) ................................ 200,000
Cost per EU (a) ÷ (b) ................................$0.300 +
196,000
$1.911
Whole
Unit
= $2.211
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 4
15
Exercise 4-5(20 minutes) (LO4 –CC14)
Weighted-Average Method
Total
Cost
Cost accounted for as follows:
Transferred to the next process
(190,000 units × $2.211) ................................
$420,090
Work in process, May 31:
Materials, at $0.30 per EU ................................
3,000
Conversion, at $1.911 per EU ................................
11,466
Total work in process ................................
14,466
Total cost ................................................................
$434,556 *
Equivalent Units (EU)
Materials
Conversion
190,000
190,000
10,000
6,000
* The difference of $4 ($434,560 - $434,556) is due to rounding when
calculatingconversion cost per EU to 3 decimal places..
Copyright © 2017 McGraw-Hill Education. All rights reserved.
16
Introduction to Managerial Accounting,FifthCanadian Edition
Exercise 4-6 (60 minutes) (LO2 – CC11, 12, 13)
We use the format of Exhibit 4-9 in the text since all the calculations for both FIFO and
WACM are available in a single table. Students may do the calculations in Excel.
1. The equivalent units for WACM is the total EU processed in the period. This is 48,000
EU and 46,000 EU for direct materials and conversion cost respectively.
2. The cost to allocate under WACM is the total cost to account for, $57,300 and
$56,875 respectively for direct materials and conversion respectively. The cost per
EU is therefore:
Direct materials:
Conversion:
Total cost per EU:
$57,300/48,000
$56,875/46,000
=
=
$1.1938
$1.2364
$2.4302
3. The FIFO EU = WACM EU – EU in BWIP = 44,000 for direct materials. And for
conversion the FIFO EU = WACM EU – EU in BWIP = 43,000.
4. The cost to allocate is the current period costs NOT the total costs to allocate. Thus
$52,800 and $53,750 will be allocated by FIFO method for direct materials and
conversion respectively. The cost per EU for each input will be:
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 4
17
Exercise 4-6 (continued)
Direct materials:
Conversion:
Total cost per EU:
$52,800/44,000
$53,750/43,000
=
=
$1.20
$1.25
$2.45
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18
Introduction to Managerial Accounting,FifthCanadian Edition
Exercise 4-7 (20 minutes) (LO3 –CC11; LO4 –CC13)
The worksheet for this exercise is shown below.
Quantity
Schedule
Units to be accounted for:
Work in process, beginning
(100% materials, 50%
conversion) ................................
500
Started into production................................
1,600
Total units ................................
2,100
Equivalent Units (EU)
Materials
Conversion
Units accounted for as follows:
Units completed ................................ 1,800
1,800
Work in process, ending (100%
materials, 75% conversion) ................................
300
300
Total units and equivalent units
of production ................................
2,100
2,100
1,800
225
2,025
1. Cost per equivalent unit for direct materials, September
= ($360,000 + $2,000,000) ÷ 2,100 = $1,123.81
2. Equivalent units for conversion, September = 2,025 units
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Solutions Manual, Chapter 4
19
Exercise 4-8 (20 minutes) (LO5 –CC15; LO6 –CC18)
WACM EU, Direct materials = Completed units + EU in EWIP = 60,000 + 60% x 22,500
= 60,000 + 13,500 = 73,500 EU
WACM EU, Conversion = Completed units + EU in EWIP = 60,000 + 30% x 22,500 =
60,000 + 6,750 = 66,750 EU.
less
=
WACM EU
EU in BWIP
FIFO EU
Direct materials
73,500
30,000 x 0.80 = 24,000
49,500
Conversion
66,750
30,000 x 40% = 12,000
54,750
The quantity schedule following the format of Exhibit 4-10 is shown below.
Copyright © 2017 McGraw-Hill Education. All rights reserved.
20
Introduction to Managerial Accounting,FifthCanadian Edition
Exercise 4-8 (continued)
Computation of equivalent units
Quantity
Schedule
Units to be accounted for:
Work in process, beginning
(80% materials, 40%
conversion) ................................ 30,000
Started into production................................
52,500
Total units Ϋ ................................ 82,500
Equivalent Units (EU)
Materials
Conversion
Units accounted for as follows:
Work in process, beginning
(20% materials, 60%
conversion cost added during
the month)* ................................ 30,000
6,000
Units brought into production
and fully completed during
the month ΐ ................................
30,000
30,000
Work in process, Dec. 31 (60%
materials, 30% conversion
22,500
13,500
cost added during the month ................................
Total units and equivalent units
of production ................................ 82,500
49,500
18,000
30,000
6,750
54,750
Ϋ (60,000 units transferred to finished goods + 22,500 units in ending WIP =
82,500 units)
* (80% complete, therefore 20% remaining to complete for direct materials; 40%
complete, therefore 60% remaining to complete for conversion).
ΐ (60,000 units transferred to finished goods inventory – 30,000 units from previous
period = 30,000 units started and completed in the current period)
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Solutions Manual, Chapter 4
21
Exercise 4-9 (30 minutes) (LO4 –CC16; LO5 –CC18)
1. We recommend that the quantity schedule be patterned after Exhibit 4-9. This is not
mentioned in the problem in the text however. Presumably students will recognize that
the format of Exhibit 4-9 will make the job of responding to the required of the
question. The schedule is shown below.
The schedule shows that because there are no inventories at the beginning of the
period both WACM and FIFO methods will give the same values for the EU.
2. The total cost per EU is $4.20 + $2.00= $6.20. The cost of 150,000 units completed
and transferred out is: 150,000 x $6.20 = $930,000.
3. The cost of ending inventory will be the total costs of the period less the cost
transferred out: $1,190,000 - $930,000 = $260,000. This can be also calculated as
50,000 x $4.20 + 25,000 x $2.00 = $210,000 + $50,000 = $260,000.
Copyright © 2017 McGraw-Hill Education. All rights reserved.
22
Introduction to Managerial Accounting,FifthCanadian Edition
Exercise 4-10(30 minutes) (LO4 –CC14)
1. This question requires solving for the DOC from the formula to calculate the WACM
EU.
WACM EU = Completed units + DOC x EWIP
Direct materials:
Solving for DOC:
100,000 EU = 90,000 + DOC x 10,000.
DOC = 10,000/10,000 = 1 or 100%
Conversion:
Solving for DOC:
95,000 EU = 90,000 + DOC x 10,000
DOC = 5,000/10,000 = 0.5 or 50%.
2. Since the cost per EU is already provided, the computation of the cost of completed
units and the value of ending inventory, using the DOC previously calculated is as
follows:
Cost of units completed and transferred out
= 90,000 × ($0.48 + $0.40) = $79,200
Cost of ending work in process inventory
= (10,000 × $0.48) + (10,000 × 50% = 5,000 × $0.40) = $6,800
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 4
23
Exercise 4-11(20 minutes) (LO3 –CC11; LO4 –CC12, 13)
Students can speed through the question if they realize that since the degree of
completion is the identical for materials and conversion in both beginning and ending
inventories, the costs can be combined into a single category:
BWIP
Started into production
Costs added in December
Total costs to account for
Completed units
Ending inventory
Units (DOC)
4,000 (60%)
68,000
60,000
12,000 (75%)
Cost
$20,000
$320,000
$340,000
?
?
1.
WACM EU = Completed units + EU in EWIP = 60,000 + 75% x 12,000 = 69,000 EU.
Cost per EU = $340,000/69,000 = $4.93
Value of ending inventory is 12,000 x 4.93 = $59,131.20
2.
BWIP
Started into production
Costs added in December
Total costs to account for
Completed units
Ending inventory
Units (DOC)
4,000 (60%)
70,800
60,000
14,800 (75%)
Cost
$20,000
$320,000
$340,000
?
?
WACM EU = 60,000+ (14,800 × 75% = 11,100) = 71,100 equivalent units.
The cost per EU for DM is $159,000/71,100 = $2.2363 per EU. Value of DM in the EWIP
is 14,800 x 0.75 x $2.2363 = $24,822.93.
3.
If 71,100 EU were completed, this means that EWIP = 72,000 – 71,100 = 900
units.
Copyright © 2017 McGraw-Hill Education. All rights reserved.
24
Introduction to Managerial Accounting,FifthCanadian Edition
Exercise 4-12(20 minutes) (LO3 –CC11; LO5 –CC16)
1. Weighted-average Method
Quantity
Schedule
Units to be accounted for:
Work in process, beginning
3,600
(50% conversion) ................................
Started into production................................
12,000
Total units ................................
15,600
Units accounted for as follows:
Units completed ................................ 10,800
Work in process, ending (40%
conversion) ................................
4,800
Total units and equivalent units
of production ................................ 15,600
Equivalent Units (EU)
Conversion
10,800
1,920
12,720
2. We show the solution using the format of Exhibit 4-9. Note that both the WACM and
FIFO EU can be directly read off the schedule. As can be seen from the schedule,
FIFO EU = WACM EU – EU in BWIP = 12,720 – 50% x 3,600 = 10,920 EU.
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 4
25
Exercise 4-12 (continued)
Some students may use the format of Exhibit 4-10 to determine the FIFO EU, although
this is not what has been asked in the question.
Quantity
Schedule
Units to be accounted for:
Work in process, beginning
(50% conversion) ................................
3,600
Started into production................................
12,000
Total units ................................
15,600
Equivalent Units (EU)
Conversion
Units accounted for as follows:
Work in process, beginning
(50% conversion cost added
3,600
during the month)* ................................
Units brought into production
and fully completed during
7,200
the month ΐ ................................
Work in process, ending (40%
conversion cost added during
4,800
the month ................................
Total units and equivalent units
of production ................................ 15,600
1,800
7,200
1,920
10,920
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26
Introduction to Managerial Accounting,FifthCanadian Edition
Exercise 4-13 (20 minutes) (LO3 CC11; LO4 CC12,13)
The total number of equivalent units is as follows:
Physical Units
Equivalent Units
Completed and transferred out
Ending work in progress (75%
complete)
8,000
3,000 (DOC is
75%)
Equivalent
Units
8,000
4,000 (DOC
is 100%)
11,000
12,000
8,000
4,000*
Total
Conversion cost per equivalent unit is
Direct materials cost per equivalent unit is
Total cost per equivalent unit is
$21,200/11,000 = $1.93
$24,000/12,000 = $2.00
$3.93
* (0 + 12,000 – 8,000 = 4,000)
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 4
27
Exercise 4-14(20 minutes) (LO3 CC11; LO4 CC12)
Note that beginning inventory for May is 0.
a.
Total Equivalent Units for Direct Material:
$12,000,000/$10,000 = 1,200
May Ending WIP = 1,200 – 800 = 400
Since 800 units were completed and transferred out and units in ending WIP are 100%
completed, ending WIP is 400 units.
b.
Total Equivalent Units = 800 + (0% x 400) = 800
Cost per Equivalent Unit = $8,000,000/800 = $10,000
2. FIFO EU = WACM EU – EU in BWIP. Since there are no BWIP, FIFO EU = WACM EU.
Therefore the results will be the same as calculated for WACM.
The key is when there are no BWIP, both methods will yield the same result.
Copyright © 2017 McGraw-Hill Education. All rights reserved.
28
Introduction to Managerial Accounting,FifthCanadian Edition
Problem 4-1 (70 minutes) (LO3 –CC 11; LO4 –CC14)
Weighted-Average Method
1. The computation of equivalent units would be:
Quantity
Schedule
Equivalent Units (EU)
Materials
Labour
Overhead
Units accounted for as follows:
Transferred to the next
department ................................................................
96,000
96,000
Work in process, June 30 (all
materials, 40% labour and
10,000
10,000
overhead added this month) ................................
Total units and equivalent units of
production ................................................................
106,000
106,000
96,000
96,000
4,000
4,000
100,000
100,000
2. The cost reconciliation follows:
Total
Cost
Equivalent Units (EU)
Materials Labour
Overhead
Cost accounted for as follows:
Transferred to the next
department: 96,000 units ×
$1.28 ................................................................
$122,880
96,000
Work in process, June 30:
6,500
10,000
Materials, at $0.65 per EU (1) ................................
Labour, at $0.21 per EU (2) ................................
840
Overhead, at $0.42 per EU (3) ................................
1,680
Total work in process ................................9,020
Total cost ................................................................
$131,900
(1)
68,900/106,000
(2)
21,000/100,000
(3)
42,000/100,000
96,000
96,000
4,000
4,000
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 4
29
Problem 4-2 (45 minutes) (LO3 –CC11; LO4 –CC12, 13, 14)
Weighted-Average Method
1. The equivalent units for the month would be:
Quantity
Schedule
Equivalent Units (EU)
Materials
Conversion
Units accounted for as follows:
Transferred to next department ................................
170,000
Work in process, April 30 (80%
materials, 90% conversion cost
added this month) ................................
30,000
Total units and equivalent units of
production ................................................................
200,000
170,000
170,000
24,000
27,000
194,000
197,000
2.
Total
Cost
Materials
Conversion
Work in process, April 1 ................................
$ 98,000 $ 67,800
Cost added during the
month ................................
827,000 579,000
Total cost (a) ................................
$925,000 $646,800
$ 30,200
Equivalent units of
production (b) ................................ 194,000
Cost per EU (a) ÷ (b) ................................
$3.334 +
Whole Unit
248,000
$278,200
197,000
$1.412 = $4.746
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30
Introduction to Managerial Accounting,FifthCanadian Edition
Problem 4-2 (continued)
3.
Total units transferred................................................................
170,000
Less units in the beginning inventory ................................20,000
Units started and completed during April ................................
150,000
4. No, the manager should not be rewarded for good cost control. The reason for the
Mixing Department’s low unit cost for April is traceable to the fact that costs of the
prior month have been averaged in with April’s costs in computing the lower, $3.334
per unit figure. This is a major criticism of the weighted-average method in that the
figures computed for product costing purposes can’t be used to evaluate cost control
or measure performance for the current period.
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 4
31
Problem 4-3 (60 minutes) (LO3 –CC11; LO4 –CC12, 13, 14)
Weighted-Average Method
Quantity Schedule and Equivalent Units
Quantity
Schedule
Units to be accounted for:
Work in process, June 1 (all materials,
75% conversion cost added last
month) ................................................................
20,000
Started into production................................ 180,000
Total units ................................................................
200,000
Equivalent Units (EU)
Materials
Conversion
Units accounted for as follows:
Transferred to bottling: ................................160,000
160,000
Work in process, June 30 (all materials,
25% conversion cost added this
month) ................................................................
40,000
40,000
Total units and equivalent units of
production ................................................................
200,000
200,000
160,000
10,000
170,000
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32
Introduction to Managerial Accounting,FifthCanadian Edition
Problem 4-3 (continued)
Costs per Equivalent Unit
Total
Cost
Materials
Cost to be accounted
for:
Work in process, June
1 ................................$ 50,000 $ 25,200
Cost added during
June ................................
573,500 334,800
Total cost (a)................................
$623,500 $360,000
Equivalent units of
production (b) ................................ 200,000
Cost per EU (a) ÷ (b) ................................
$1.80 +
Conversion
Whole Unit
$ 24,800
238,700
$263,500
170,000
$1.55
=
$3.35
Cost Reconciliation
Total
Cost
Cost accounted for as follows:
Transferred to bottling:
160,000 units × $3.35 per unit ................................$536,000
Work in process, June 30:
Materials, at $1.80 per EU .......................................................
72,000
Conversion, at $1.55 per EU ................................
15,500
Total work in process ................................................................
87,500
Total cost ................................................................ $623,500
Equivalent Units (EU)
Materials
Conversion
160,000
160,000
40,000
10,000
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 4
33
Problem 4-4 (120 minutes) (LO3 –CC11; LO4 –CC12, 13, 14; LO5 –CC16; LO6 –CC17)
1., 2., and 3.
The Quantity Schedule and Cost per Equivalent Unit
Quantity
Schedule
Units to be accounted for:
Work in process, May 1 (all
materials, 80% labour and
overhead added last month) ................................
15,000
Started into production................................
110,000
Total units ................................................................
125,000
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34
Introduction to Managerial Accounting,FifthCanadian Edition
Problem 4-4 (continued)
Equivalent Units (EU)
Materials
Labour
Overhead
Units accounted for as follows:
Transferred out................................ 100,000
100,000
Work in process, May 31 (60%
materials, 20% labour and
overhead added this month) ................................
25,000
15,000
Total units and equivalent units
of production ................................ 125,000
115,000
100,000
100,000
5,000
5,000
105,000
105,000
Cost per Equivalent Unit
Total
Cost
Materials
Labour
Overhead
Work in process, May 1 ................................
$ 10,400 $ 2,000
$ 2,400
$ 6,000
160,000
24,000
70,000
Total cost (a) ................................
$264,400 $162,000
$26,400
$76,000
105,000
105,000
Whole Unit
Cost to be accounted for:
Cost added during the
month ................................
254,000
Equivalent units of
production (b) ................................
115,000
Cost per EU (a) ÷ (b) ................................ $1.409 + $0.251 +
$0.724 =
$2.384
Cost Reconciliation, WACM
Total
Cost
Equivalent Units (EU)
Materials
Conversion
Cost accounted for as follows:
Transferred out:
100,000 units × $2.384 per
unit ................................................................
$238,400 100,000
Work in process, May 31:
Materials, at $1.409 per EU ................................
21,135
15,000
Conversion, at $0.975 per EU ................................
4,875
Total work in process ................................
26,010
Total cost * ................................................................
$264,410
* Difference of $10 due to rounding.
100,000
5,000
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 4
35
Problem 4-4 (continued)
FIFO Method
Quantity Schedule and Equivalent Units: See above, for the schedule that follows the
format of Exhibit 4-9. The alternative format of Exhibit 4-10 is shown below.
Quantity
Schedule
Units to be accounted for:
Work in process, May 1 (all
materials, 80% labour and
overhead added last month) ................................
15,000
Started into production................................
110,000
Total units ................................................................
125,000
Equivalent Units (EU)
Materials
Overhead
Units accounted for as follows:
Work in process, May 1 (no
materials, 20% labour and
15,000
0
overhead added this month)* ................................
Units brought into production and
fully completed during the
month+ ................................................................
85,000
85,000
Work in process, May 31 (60%
materials, 20% labour and
overhead added during the
month ................................................................
25,000
15,000
Total units and equivalent units of
production ................................................................
125,000
100,000
3,000
85,000
5,000
93,000
* Materials: 15,000 × (100% – 100%) = 0 equivalent units. Conversion: 15,000 ×
(100% – 80%) = 3,000 equivalent units. + 110,000 units started – 25,000 units in
ending inventory = 85,000 units brought into production and fully completed.
Copyright © 2017 McGraw-Hill Education. All rights reserved.
36
Introduction to Managerial Accounting,FifthCanadian Edition
Problem 4-4 (continued)
Cost per Equivalent Unit, FIFO
Total
Cost
Material
s
Cost to be accounted for:
Prior period cost in Work
$
in Process, May 1 ................................
10,400
Costs incurred during
160,00
254,000
the month (a) ................................
0
Total cost ................................
$264,400
Equivalent units of
production (b) ................................ 100,000
Cost per EU (a) ÷ (b) ................................
$1.60 +
Conversio
n
Whole Unit
94,000
+
93,000
$1.01 =
$2.61
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 4
37
Problem 4-4 (continued)
Cost Reconciliation, FIFO:
Total
Cost
Equivalent Units (EU)
Materials
Conversion
Cost accounted for as follows:
Prior period cost in Work in
Process, May 1 (a) ................................
$ 10,400
Cost incurred during May:
To complete units in Work in
Process, May 1
Materials, at $1.60 per EU ................................
0
0
Conversion, at $1.01 per
.EU ................................
3,030
Total (b) ................................................................
3,030
To bring into production and fully
complete 85,000 units during
June at $2.611 per unit (c) ................................
221,935
85,000
To partially complete units in Work
in Process, May 31
Materials, at $1.60 per EU ................................
24,000
15,000
Conversion, at $1.01 per
.EU ................................
5,050
Total (d) ................................................................
29,050
$264,415
Total cost (a) + (b) + (c) + (d) * ................................
Cost transferred out, May 31 (a)
+ (b) + (c) ................................................................
$235,368
3,000
85,000
5,000
* Difference of due to rounding error.
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38
Introduction to Managerial Accounting,FifthCanadian Edition
Problem 4-5 (75 minutes) (LO3 –CC11; LO4 –CC12, 13, 14)
Weighted-Average Method
1. A completed production report follows:
Quantity Schedule and Equivalent Units
Quantity
Schedule
Kilograms to be accounted for:
Work in process, May 1 (all materials,
1/3 labour and overhead added last
month) ................................................................
20,000
Started into production................................160,000
Total kilograms ................................................................
180,000
Equivalent Units (EU)
Labour &
Materials
Overhead
Kilograms accounted for as follows:
165,000
Transferred to mixing * ................................165,000
Work in process, May 31
(all materials, 2/3 labour and
overhead added this month) ................................
15,000
15,000
Total kilograms and equivalent units
of production ................................................................
180,000
180,000
*
165,000
10,000
175,000
180,000 – 15,000 = 165,000 kilograms
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 4
39
Problem 4-5 (continued)
Costs per Equivalent Unit
Total
Cost
Material
s
Labour &
Overhead
Cost to be accounted for:
Work in process, May 1 ................................
$ 25,000 $ 16,600
Cost added during May ................................
440,000 154,400
Total cost (a) ................................
$465,000 $171,000
$ 8,400
285,600
$294,000
Equivalent units of production
180,000
(b) ................................................................
Cost per EU (a) ÷ (b) ................................
$0.95 +
Whole
Unit
175,000
$1.68 = $2.63
Copyright © 2017 McGraw-Hill Education. All rights reserved.
40
Introduction to Managerial Accounting,FifthCanadian Edition
Problem 4-5 (continued)
Cost Reconciliation
Total Cost
Equivalent Units (EU)
Labour &
Materials
Overhead
Cost accounted for as follows:
Transferred to mixing: 165,000
units × $2.63 per unit ................................
$433,950
165,000
Work in process, May 31:
Materials, at $0.95 per EU ................................
14,250
15,000
Labour and overhead, at $1.68
per EU................................................................
16,800
Total work in process ................................31,050
Total cost ................................................................
$465,000
165,000
10,000
2. In computing unit costs, the weighted-average method mixes costs of the prior
period in 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 cost control in the current period might be concealed to
some degree by the unit costs that have been brought forward in the beginning
inventory. The reverse could also be true in that poor cost control during a period
might be concealed somewhat (or entirely) by the costs of the prior period that have
been brought forward and added in with current period costs.
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Solutions Manual, Chapter 4
41
Problem 4-6 (90 minutes) (LO2 CC8; LO3 CC11; LO4 CC12, 13, 14)
In this problem the original values recorded in the accounting system for the inventories
and cost of goods sold are incorrect. The task is to therefore to compute the value
of the production using WACM and then adjust the original values to obtain the
correct figures.
Weighted-Average Method
1. The equivalent units would be:
Materials
Labour
Units completed during
the year ................................750,000
750,000
Work in process, Dec. 31:
250,000 units × 100% ................................
250,000
250,000 units × 50% ................................ 125,000
Total equivalent units (a) ................................
1,000,000
875,000
Overhead
750,000
125,000
875,000
The costs per equivalent unit would be:
Materials
Labour
Work in process,
January 1 ................................
$ 200,000
$ 315,000
Cost added during the
year ................................1,300,000
1,985,000
Total costs (b) ................................
$1,500,000
$2,300,000
Cost per EU (b) ÷ (a) ................................
$1.50 +
$2.63 +
Overhead
Whole
Unit
$ 220,500 *
1,389,500 **
$1,610,000
$1.84 =
$5.97
* $315,000 ×70% = $220,500
** $1,985,000 ×70% = $1,389,500
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Introduction to Managerial Accounting,FifthCanadian Edition
Problem 4-6 (continued)
2. The amount of cost that should be assigned to the ending inventories is:
Work in
Process
Finished
Goods
Work in process:
Materials: 250,000 units × $1.50 per
unit ................................................................
$375,000
Labour: 125,000 EU × $2.63 per EU ................................
328,750
Overhead: 125,000 EU × $1.84 per
230,000
EU ................................................................
Finished goods: 150,000 units ×
$5.97per unit ................................................................ $895,500
Total cost that should be assigned to
inventories ................................................................
$933,750
$895,500
Total
$ 375,000
328,750
230,000
895,500
$1,829,250
3. The necessary adjustments would be:
Work in
Process
Finished
Goods
Cost that should be assigned to
inventories (above) ................................ $933,750
$895,500
Year-end balances in the accounts ................................
700,000
1,000,000
Difference ................................................................
$233,750
$ (104,500)
Debit
Work in Process Inventory ................................
233,750
Finished Goods Inventory ................................
Cost of Goods Sold ................................................................
Total
$1,829,250
1,700,000
$ 129,250
Credit
104,500
129,250
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Solutions Manual, Chapter 4
43
Problem 4-6 (continued)
4. The simplest computation of the cost of goods sold would be:
Beginning finished goods inventory ................................................
0
Units completed during the year ....................................................
750,000
Units available for sale ................................................................750,000
Less units in ending finished goods inventory ................................150,000
Units sold during the year .............................................................
600,000
Cost per equivalent unit (from part 1) ............................................× $5.97
Cost of goods sold ................................................................ $3,582,000
Alternative computation:
Total manufacturing cost incurred (including beginning
WIP):
Materials (part 1) ................................................................ $1,500,000
Labour (part 1) ................................................................
2,300,000
Overhead (part 1) ................................................................ 1,610,000
Total manufacturing cost ...............................................................
5,410,000
Less cost assigned to inventories (part 2) ................................ 1,829,250
Cost of goods sold * ................................................................$3,580,750
*Difference of 1,250 due to rounding
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44
Introduction to Managerial Accounting,FifthCanadian Edition
Problem 4-7 (150 minutes) (LO2 –CC8; LO3 –CC11; LO4 –CC12, 13, 14; LO5 –CC15,
16; LO6 –CC17, LO7- 18)
Weighted-Average Method
495,000
1. a. Work in Process—Refining Department ................................
Work in Process—Blending Department ................................
115,000
Raw Materials ................................................................
610,000
b. Work in Process—Refining Department ................................
72,000
Work in Process—Blending Department ................................
18,000
Salaries and Wages Payable ................................
90,000
c. Manufacturing Overhead ...............................................................
225,000
Accounts Payable ................................................................
225,000
d. Work in Process—Refining Department ................................
181,000
Work in Process—Blending Department ................................
42,000
Manufacturing Overhead .........................................................
223,000
e. Work in Process—Blending Department ................................
740,000
Work in Process—Refining Department ................................
740,000
f. Finished Goods ................................................................950,000
Work in Process—Blending Department ................................
950,000
g. Accounts Receivable ................................................................
1,500,000
Sales ...................................................................................... 1,500,000
Cost of Goods Sold ................................................................
900,000
Finished Goods ................................................................
900,000
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Solutions Manual, Chapter 4
45
Problem 4-7 (continued)
2.
(g)
Accounts Receivable
1,500,000
Bal.
(a)
(b)
(d)
Bal.
Work in Process
Refining Department
38,000
740,000
495,000
72,000
181,000
46,000
Bal.
(f)
Bal.
Finished Goods
20,000
900,000
950,000
70,000
Accounts Payable
225,000
(e)
(g)
Bal.
Bal.
Raw Materials
618,000
610,000
8,000
Bal.
(a)
(b)
(d)
(e)
Bal.
Work in Process
Blending Department
65,000
950,000
115,000
18,000
42,000
740,000
30,000
(c)
Bal.
Manufacturing Overhead
225,000
223,000
2,000
(c)
Salaries and Wages Payable
90,000
(g)
Cost of Goods Sold
900,000
Sales
1,500,000
(g)
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46
Introduction to Managerial Accounting,FifthCanadian Edition
(a)
(f)
(d)
(b)
Problem 4-7 (continued)
3. The production report for the Refining Department follows:
The quantity schedule and the cost per equivalent unit, as per the format of Exhibit 4-9
follows. Note that the information for both WACM and FIFO approaches are
available in a single schedule.
Quantity Schedule and Cost per Equivalent Unit
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Solutions Manual, Chapter 4
47
Alternative format for Quantity Schedule (Exhibit 4-10) follows:
Quantity Schedule and Equivalent Units
Quantity
Schedule
Litres to be accounted for:
Work in process, March 1 (all
materials, 90% labour and
overhead added last month) ................................
20,000
Started into production................................
390,000
Total litres ................................................................
410,000
Equivalent Units (EU)
Materials
Labour
Overhead
Litres accounted for as follows:
Transferred to blending:
370,000 *
370,000
Work in process, March 31
(75% materials, 25% labour
and overhead added this
month) ................................................................
40,000
30,000
Total litres and equivalent
units of production ................................
410,000
400,000
370,000
370,000
10,000
10,000
380,000
380,000
* 410,000 litres – 40,000 litres = 370,000 litres
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48
Introduction to Managerial Accounting,FifthCanadian Edition
Problem 4-7 (continued)
Costs per Equivalent Unit, WACM
Total
Cost
Material
s
Cost to be accounted
for:
Work in process,
$ 38,000 $ 25,000
March 1 ................................
Cost added during
March ................................
748,000 495,000
Total cost (a) ................................
$786,000 $520,000
Labour
Overhead
$
4,000
$ 9,000
72,000
$76,00
0
Whole
Unit
181,000
$190,000
Equivalent units of
380,00
production (b) ................................400,000
0
380,000
Cost per EU (a) ÷ (b) ................................
$1.30 + $0.20 +
$0.50 = $2.00
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Solutions Manual, Chapter 4
49
Problem 4-7 (continued)
Cost Reconciliation, WACM
Note that this schedule must be prepared regardless of which format is chosen for the
quantity schedule.
Total
Cost
Equivalent Units (EU)
Materials
Labour
Overhead
Cost accounted for as follows:
Transferred to blending: 370,000
litres × $2.00 per litre ................................
$740,000
370,000
Work in process, March 31:
Materials, at $1.30 per EU ................................
39,000
30,000
2,000
Labour, at $0.20 per EU ................................
Overhead, at $0.50 per EU ................................
5,000
Total work in process ................................
46,000
Total cost ................................................................
$786,000
370,000
370,000
10,000
10,000
4.
FIFO Method
Refer to the previously presented quantity schedule for the cost per EU under FIFO, if
following the format of Exhibit 4-9. The report as per the format of Exhibit 4-10 follows.
Quantity Schedule and Equivalent Units, FIFO
Quantity
Schedule
Litres to be accounted for:
Work in process, March 1 (all
materials, 90% labour and
overhead added last month) ................................
20,000
Started into production................................
390,000
Total litres ................................................................
410,000
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Introduction to Managerial Accounting,FifthCanadian Edition
Problem 4-7 (continued)
Quantity
Schedule
Equivalent Units (EU)
Materials
Labour
Overhead
Litres accounted for as follows:
Work in process, March 1 (no
materials, 10% labour and
overhead added this month)* ................................
20,000
0
2,000
2,000
Litres brought into production and
fully completed during the
350,000
350,000 350,000
350,000
month+ ................................................................
Work in process, March 31 (75%
materials, 25% labour and
overhead added during the
month ................................................................
40,000
30,000
10,000
10,000
Total litres and equivalent units of
production ................................................................
410,000
380,000 362,000
362,000
* Materials: 20,000 × (100% – 100%) = 0 equivalent units. Labour: 20,000 × (100%
– 90%) = 2,000 equivalent units. Overhead: 20,000 × (100% – 90%) = 2,000
equivalent units.
+390,000 litres started – 40,000 litres in ending inventory = 350,000 litres brought into
production and fully completed.
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Solutions Manual, Chapter 4
51
Problem 4-7 (continued)
Cost per Equivalent Unit, FIFO
Total
Cost
Material
s
Labour
Overhead
Cost to be accounted for:
Prior period cost in Work
in Process, March 1 ................................
$ 38,000
Costs incurred during
495,00
748,000
72,000
181,000
the month (a) ................................
0
Total cost ................................
$786,000
Equivalent units of
production (b) ................................ 380,000
362,000
362,000
Cost per EU (a) ÷ (b) ................................
$1.303 + $0.199 + $0.500 =
Whole
Unit
$2.002
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Introduction to Managerial Accounting,FifthCanadian Edition
Problem 4-7 (continued)
Cost Reconciliation, FIFO: (This schedule is required, regardless of the format for the
quantity schedule)
Total
Cost
Equivalent Units (EU)
Materials
Labour
Overhead
Cost accounted for as follows:
Prior period cost in Work in
Process, March 1 (a) ................................
$ 38,000
Cost incurred during March:
To complete litres in Work in
Process, March 1
0
0
Materials, at $1.303 per EU ................................
Labour, at $0.199 per EU ................................
398
Overhead, at $0.500 per
.EU ................................
1,000
1,398
Total (b) ................................................................
To bring into production and fully
complete 350,000 litres during
March at $2.002 per litre (c)* ................................
700,522
350,000
To partially complete litres in Work
in Process, March 31
Materials, at $1.303 per EU ................................
39,090
30,000
Labour, at $0.199 per EU ................................
1,990
Overhead, at $0.500 per
.EU ................................
5,000.
Total (d) ................................................................
46,080
Total cost (a) + (b) + (c) + (d) ................................
$786,000
Cost transferred out, March 31 (a)
+ (b) + (c) ................................................................
$739,920
2,000
2,000
350,000
350,000
10,000
10,000
* Actually, the amount is $700,700; the figure has been adjusted downward to avoid a
discrepancy in the column totals. The discrepancy is due to rounding error.
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Solutions Manual, Chapter 4
53
Problem4-8(40 minutes) (LO4 –CC13, 14)
1.
Conversion cost per unit (last period)
= $16,500 ÷ (18,750 × 0.8)
Conversion cost per unit (this period)
= $123,750 ÷ 97,5001
1
= $ 1.10
= $ 1.27
Calculation of equivalent units (75,000 + ((18,750+101,250-75,000) * 0.5))
Quantity Schedule and Equivalent Units
Quantity
Schedule
Units to be accounted for:
Work in process, March 1 (80%
conversion added last month) ................................
18,750
Started into production................................
101,250
Total litres ................................................................
120,000
Quantity
Schedule
Equivalent Units (EU)
Conversion
Units accounted for as follows:
Transferred to Mixing ................................
75,000
Work in process, November 31
(50% conversion added during
45,000
the month Ϊ ................................
Total litres and equivalent units of
production ................................................................
120,000
75,000
22,500
97,500
Ϊ 120,000 total units (18,750 + 101, 250) – 75,000 units transferred out = 45,000
units.
2. 22,500 × $1.27 = $28,575
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Introduction to Managerial Accounting,FifthCanadian Edition
Problem 4-9(75 minutes) (LO3 –CC11; LO4 –CC12, 13, 14)
Quantity Schedule and Equivalent Units
Quantity
Schedule
Units to be accounted for:
Work in process, beginning (75%
materials, 70% conversion
added last month) ................................16,000
Started into production ................................
27,000
Total units ................................................................
43,000
Quantity
Schedule
Equivalent Units (EU)
Materials
Conversion
Units accounted for as follows:
Units transferred out during the
month+ ................................................................
33,000
33,000
Work in process, ending (60%
materials, 50% conversion
added during the month ................................
10,000
6,000
Total units and equivalent units of
production ................................................................
43,000
39,000
33,000
5,000
38,000
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Solutions Manual, Chapter 4
55
Problem 4-9 (continued)
Cost per Equivalent Unit
Total Cost
Materials
Cost to be accounted
for:
Prior period cost in
Work in Process,
beginning ................................
$ 296,000 $132,000
Costs incurred
during the month
(a) ................................
692,000 252,000
Total cost ................................
$988,000 $384,000
Equivalent units of
production (b) ................................ 39,000
Cost per EU (a) ÷ (b) ................................
$9.846 +
Conversion
Whole Unit
$164,000
440,000
$604,000
38,000
$15.895 =
$25.741
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Introduction to Managerial Accounting,FifthCanadian Edition
Problem 4-9 (continued)
Cost Reconciliation:
Total
Cost
Equivalent Units (EU)
Materials
Conversion
Cost accounted for as follows:
Transferred to next department:
33,000 units at $25.741 per unit
(a) ................................................................
$849,453
To partially complete units in
Work in Process, ending
Materials, at $9.846 per EU ................................
59,076
79,475
Conversion, at $15.895 per EU ................................
Total (b) ................................................................
138,551
Total cost (a) + (b) * ................................
$988,004
33,000
33,000
6,000
5,000
* $4 difference ($988,000 - $988,004) is due to rounding error.
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Solutions Manual, Chapter 4
57
Problem 4-10 (40 minutes) (LO5 – CC16; LO6 –CC17)
1, 2, & 3 Quantity Schedule and Equivalent Units
Quantity
Schedule
Units to be accounted for:
Work in process, October 1 (0%
materials, 80% conversion
added last month) ................................50,000
Transferred into production ................................
200,000
Total units ................................................................
250,000
Quantity
Schedule
Equivalent Units (EU)
Materials
Conversion
Units accounted for as follows:
Work in process, October 1
(100% materials, 20%
conversion added this month)* ................................
50,000
50,000
Units transferred into production
and fully completed during the
month+ ................................................................
160,000
160,000
Work in process, October 31 (0%
materials, 40% conversion
added during the month** ................................
40,000
0
Total units and equivalent units of
production ................................................................
250,000
210,000
10,000
160,000
16,000
186,000
* Materials: 50,000 × (100% – 0%) = 50,000 equivalent units. Conversion: 50,000 ×
(100% – 80%) = 10,000 equivalent units.
+210,000 units transferred out – 50,000 units from beginning inventory = 160,000 units
transferred into production during the month and fully completed.
** 250,000 total units – 210,000 transferred out = 40,000 units.
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Introduction to Managerial Accounting,FifthCanadian Edition
Problem 4-11 (75 minutes) (LO6 –CC19)
Quantity Schedule and Equivalent Units
Quantity
Schedule
Units to be accounted for:
Work in process, May 1 (100%
materials, 60% labour and 36%
overhead added last month) ................................
25,000
Started into production ................................
305,000
Total units ................................................................
330,000
Quantity
Schedule
Equivalent Units (EU)
Materials
Labour
Overhead
Units accounted for as follows:
Work in process, May 1 (0%
materials, 40% labour and 64%
overhead added this month)* ................................
25,000
0
10,000
16,000
Units brought into production and
fully completed during the
month+ ................................................................
275,000
275,000 275,000
275,000
Work in process, May 31 (100%
materials, 50% labour and 40%
overhead added during the
month ................................................................
30,000
30,000
15,000
12,000
Total litres and equivalent units of
production ................................................................
330,000
305,000 300,000
303,000
* Materials: 25,000 × (100% – 100%) = 0 equivalent units.
Labour: 25,000 × (100% – 60%) = 10,000 equivalent units. Overhead: 25,000 ×
(100% – 36%) = 16,000 equivalent units.
+305,000 units started – 30,000 units in ending inventory = 275,000 units started and
fully completed.
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Solutions Manual, Chapter 4
59
Problem 4-11 (continued)
Cost per Equivalent Unit
Total
Cost
Materials
Labour
Overhead
Cost to be accounted
for:
Prior period cost in
Work in Process,
May 1................................
$ 2,717
Costs incurred during
the month (a) ................................
49,380
16,200
15,000
18,180
Total cost ................................
$52,097
Equivalent units of
production (b) ................................ 305,000
300,000
303,000
Cost per EU (a) ÷ (b) ................................
$0.053 + $0.050 + $0.060 =
Whole
Unit
$0.163
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Introduction to Managerial Accounting,FifthCanadian Edition
Problem 4-11 (continued)
Cost Reconciliation:
Total
Cost
Equivalent Units (EU)
Materials
Labour
Overhead
Cost accounted for as follows:
Prior period cost in Work in
Process, May 1 (a) ................................
$2,717
Cost incurred during March:
To complete units in Work in
Process, May 1
Materials, at $0.053 per EU ................................
0
0
Labour, at $0.05 per EU ................................
500
Overhead, at $0.06 per
.EU ................................
960
Total (b) ................................................................
1,460
To bring into production and fully
complete 275,000 units during
May at $0.163 per unit (c) ................................
44,825
275,000
To partially complete units in
Work in Process, May 31
Materials, at $0.053 per EU ................................
1,590
30,000
750
Labour, at $0.05 per EU ................................
Overhead, at $0.06 per
.EU ................................
720
Total (d) ................................................................
3,060
$52,062
Total cost (a) + (b) + (c) + (d) * ................................
Cost transferred out, March 31
(a) + (b) + (c) ................................ $49,002
10,000
16,000
275,000
275,000
15,000
12,000
* Difference of $35 ($52,097 - $52,062) due to rounding error.
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Solutions Manual, Chapter 4
61
Problem 4-11 (continued)
The worksheet below shows the set up of the calculations using the format of Exhibit 49.
The cost per EU, FIFO and the EU for each cost category is shown in the bottom portion
of the table. The cost accounting is done using this information. For example, the cost
of ending inventory is: 30,000 x $0.05 + 15,000 x $0.05 + 12,000 x $0.06 = $3,063.44.
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62
Introduction to Managerial Accounting,FifthCanadian Edition
Comprehensive Problem(180 minutes) (LO2 –CC8; LO3 –CC11; LO4 –CC12, 13, 14;
LO5 –CC16; LO6 –CC17)
Weighted-Average Method
570,000
1. a. Work in Process—Cooking Department................................
Work in Process—Bottling Department ................................
130,000
Raw Materials ................................................................
700,000
b. Work in Process—Cooking Department................................
100,000
Work in Process—Bottling Department ................................
80,000
Salaries and Wages Payable ................................
180,000
c. Manufacturing Overhead ...............................................................
400,000
Accounts Payable ................................................................
400,000
d. Work in Process—Cooking Department................................
235,000
Work in Process—Bottling Department ................................
158,000
Manufacturing Overhead .........................................................
393,000
e. Work in Process—Bottling Department ................................
900,000
Work in Process—Cooking Department................................
900,000
f. Finished Goods ................................................................
1,300,000
Work in Process—Bottling Department ................................
1,300,000
g. Accounts Receivable ................................................................
2,000,000
Sales ................................................................
2,000,000
Cost of Goods Sold ................................................................
1,250,000
Finished Goods ................................................................
1,250,000
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Solutions Manual, Chapter 4
63
Comprehensive Problem (continued)
2.
(g)
Accounts Receivable
2,000,000
Bal.
(a)
(b)
(d)
Bal.
Work in Process
Cooking Department
61,000
900,000
570,000
100,000
235,000
66,000
Bal.
(f)
Bal.
Finished Goods
45,000
1,250,000
1,300,000
95,000
Accounts Payable
400,000
(e)
(g)
Bal.
Bal.
Raw Materials
710,000
700,000
10,000
Bal.
(a)
(b)
(d)
(e)
Bal.
Work in Process
Bottling Department
85,000
1,300,000
130,000
80,000
158,000
900,000
53,000
(c)
Bal.
Manufacturing Overhead
400,000
393,000
7,000
Salaries and Wages Payable
180,000
(c)
Sales
2,000,000
(g)
(g)
Cost of Goods Sold
1,250,000
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64
Introduction to Managerial Accounting,FifthCanadian Edition
(a)
(f)
(d)
(b)
Comprehensive Problem(continued)
3. The production report for the cooking department follows: (The solution using the
format of Exhibit 4-9 is presented at the end). Encourage candidates to follow
whichever format they prefer.
Students must determine the flow of physical units correctly to do the remainder of this
problem properly.
Quantity Schedule and Equivalent Units
Quantity
Schedule
Litres to be accounted for:
Work in process, March1 (60%
materials, 30% labour and
overhead added last month) ................................
70,000
Started into production................................
380,000 *
Total litres ................................................................
450,000
Equivalent Units (EU)
Materials
Labour
Overhead
Litres accounted for as follows:
Transferred to bottling: ................................
400,000
400,000
Work in process, March31
(70% materials, 40% labour
and overhead added this
month) ................................................................
50,000
35,000
Total litres and equivalent units
of production ................................ 450,000
435,000
400,000
400,000
20,000
20,000
420,000
420,000
* (400,000 litres + 50,000 litres) – 70,000 litres
= 380,000 litres started
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Solutions Manual, Chapter 4
65
Comprehensive Problem(continued)
Costs per Equivalent Unit
Total
Cost
Material
s
Cost to be accounted
for:
Work in process,
$ 61,000 $ 39,000
March1 ................................
Cost added during
March ................................
905,000 570,000
Total cost (a) ................................
$966,000 $609,000
Labour
$
Overhead
5,00
0
$ 17,000
100,000
$105,000
235,000
$252,000
Equivalent units of
production (b) ................................
435,000
420,000
Cost per EU (a) ÷ (b) ................................
$1.40 +
$0.25 +
Whole
Unit
420,000
$0.60 = $2.25
Cost Reconciliation
Total
Cost
Equivalent Units (EU)
Materials
Labour
Overhead
Cost accounted for as follows:
Transferred to bottling: 400,000
litres at $2.25 per litre ................................
$900,000
400,000
Work in process, March31:
Materials, at $1.40 per EU ................................
49,000
35,000
Labour, at $0.25 per EU ................................
5,000
Overhead, at $0.60 per EU ................................
12,000
Total work in process ................................
66,000
Total cost ................................................................
$966,000
400,000
400,000
20,000
20,000
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Introduction to Managerial Accounting,FifthCanadian Edition
Comprehensive Problem (continued)
4.
FIFO Method
Quantity Schedule and Equivalent Units
Quantity
Schedule
Litres to be accounted for:
Work in process, May 1 (60%
materials, 30% labour and
overhead added last month) ................................
70,000
Started into production * ................................
380,000
Total litres ................................................................
450,000
Quantity
Schedule
Equivalent Units (EU)
Materials
Labour
Overhead
Litres accounted for as follows:
Work in process, March1 (40%
materials, 70% labour and
70,000
28,000
49,000
49,000
overhead added this month)** ................................
Litres brought into production and
fully completed during the
330,000
330,000 330,000
330,000
month+ ................................................................
Work in process, March 31 (70%
materials, 40% labour and
overhead added during the
month ................................................................
50,000
35,000
20,000
20,000
Total litres and equivalent units of
production ................................................................
450,000
393,000 399,000
399,000
* (400,000 litres + 50,000 litres) – 70,000 litres = 380,000 litres started
** Materials: 70,000 × (100% – 60%) = 28,000 equivalent units. Labour: 70,000 ×
(100% – 30%) = 49,000 equivalent units. Overhead: 70,000 × (100% – 30%) =
49,000 equivalent units.
+380,000 litres started – 50,000 litres in ending inventory = 330,000 litres brought into
production and fully completed.
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Solutions Manual, Chapter 4
67
Comprehensive Problem (continued)
Cost per Equivalent Unit
Total
Cost
Material
s
Labour
Overhead
Cost to be accounted
for:
Prior period cost in
Work in Process,
March1 ................................
$ 61,000
Costs incurred
during the month
570,00
(a) ................................
905,000
100,000
235,000
0
Total cost ................................
$966,000
Equivalent units of
production (b) ................................
393,000
399,000
399,000
Cost per EU (a) ÷ (b) ................................
$1.450 + $0.251 + $0.589 =
Whole
Unit
$2.290
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Introduction to Managerial Accounting,FifthCanadian Edition
Comprehensive Problem (continued)
Cost Reconciliation:
Total
Cost
Equivalent Units (EU)
Materials
Labour
Overhead
Cost accounted for as follows:
Prior period cost in Work in
Process, March1 (a) ................................
$ 61,000
Cost incurred during March:
To complete litres in Work in
Process, March1
Materials, at $1.45 per EU ................................
40,600
28,000
Labour, at $0.251 per EU ................................
12,299
Overhead, at $0.589 per
.EU ................................................................
28,861
81,760
Total (b) ................................................................
To bring into production and fully
complete 330,000 litres during
March at $2.290 per litre (c) *................................
755,690
330,000
To partially complete litres in
Work in Process, March 31
Materials, at $1.45 per EU ................................
50,750
35,000
Labour, at $0.251 per EU ................................
5,020
Overhead, at $0.589 per
.EU ................................................................
11,780
Total (d) ................................................................
67,550
Total cost (a) + (b) + (c) + (d) ................................
$966,000
Cost transferred out, March 31
(a) + (b) + (c) ................................ $898,450
49,000
49,000
330,000
330,000
20,000
20,000
* Actually, the amount is $755,700; the figure has been adjusted downward to avoid a
discrepancy in the column totals. The discrepancy is due to rounding error.
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Solutions Manual, Chapter 4
69
Comprehensive Problem (continued)
The worksheet below, sets out the production reports using WACM and FIFO using the
quantity schedule prepared as per Exhibit 4-9. Students should be able to read the
cost reconciliation presented and satisfy themselves that all the pertinent
information is presented. Only the breakdown of the cost by input category is not
provided to reduce the clutter.
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Introduction to Managerial Accounting,FifthCanadian Edition
Thinking Analytically(90 minutes) (LO3 –CC11; LO4 –CC12, 13, 14)
Weighted-Average Method
1. The production report follows:
Quantity Schedule and Equivalent Units
Quantity
Schedule
Units to be accounted for:
Work in process, March1
(all materials, 60%
conversion costs added
last month)................................ 450
Received from the
preceding department ................................
1,950
Total units ................................ 2,400
Equivalent Units (EU)
Transferred In Materials
Conversion
Units accounted for as
follows:
Transferred to finished
1,800
goods ................................
Work in process, March 31
(no materials, 35%
conversion costs added
this month) ................................ 600
Total units and equivalent
units of production ................................
2,400
1,800
600
2,400
1,800
—
1,800
1,800
210
2,010
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Solutions Manual, Chapter 4
71
Thinking Analytically(continued)
Costs per Equivalent Unit
Total
Cost
Transferred
In
Cost to be accounted
for:
Work in process,
$ 8,208 $ 4,068
March1 ................................
Cost transferred in or
added ................................
38,070
17,940
Total cost (a) ................................
$46,278 $22,008
Equivalent units of
production (b) ................................
—
2,400
Cost per EU (a) ÷ (b) ................................
—
$9.17
+
Material
s
Conversio
n
$1,980
$ 2,160
6,210
$8,190
13,920
$16,080
1,800
$4.55 +
2,010
$8.00
Whole
Unit
= $21.72
Cost Reconciliation
Total Cost
Equivalent Units (EU)
Transferred
In
Materials
Conversion
Cost accounted for as
follows:
Transferred to finished
goods:
1,800 units × $21.72
per unit ................................
$39,096
1,800
Work in process,
March31:
Transferred in cost,
at $9.17 per EU ................................
5,502
600
Materials, at $4.55
per EU................................
—
Conversion, at $8.00
per EU................................1,680
Total work in process ................................
7,182
Total cost ................................
$46,278
1,800
1,800
—
210
2. The unit cost figure in the report prepared by the new assistant controller is high
because none of the cost incurred during the month was assigned to the units in the
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72
Introduction to Managerial Accounting,FifthCanadian Edition
ending work in process inventory. This type of mistake is mentioned in the text; this
is an example when the all the burden is shifted to the units transferred out. The
units in ending inventory do not have any costs assigned.
Alternative presentation of the analysis using the format of Exhibit 4-6.
Note that the FIFO treatment is also presented. Instructors can assign the problem
requiring FIFO method to be applied.
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Solutions Manual, Chapter 4
73
Communicating in Practice (30 minutes) (LO2 –CC8; LO5 –CC16)
Date:
Current Date
To:
Minesh Patel
From: Student’s Name
Subject:
Production Report
Please perform the following steps by reference to Production Report for the Shaping
and Milling Department for May (as shown in Exhibit 4-8 in the text) that you recently
received:
1. Ensure that the current balance in the Shaping and Milling Department Work in
Process account is currently $148,000, which is the total cost to be accounted for in
the Cost Reconciliation section of the Production Report.
2. Prepare the following entry to record the transfer of costs relating to the 4,800 units
(i.e., $144,067§) that were transferred during the month from the Shaping and
Milling Department to the Graphics Application Department:
Work in Process, Graphics Application ................................144,067
Work in Process, Shaping and Milling ................................
144,067
3. After this entry is posted to the ledger, the Shaping and Milling Department account
should have an ending account balance of $3,933§, which is the total work in
process, May 31 amount reflected in the Cost Reconciliation section of the
Production Report.
If you have any questions, please do not hesitate to contact me.
(§: Both the amounts are found in the Cost Reconciliation portion of Exhibit 5-8.)
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74
Introduction to Managerial Accounting,FifthCanadian Edition
Ethics Challenge (120 minutes) (LO3 –CC9; LO5 –CC16)


This case is difficult—particularly part 3, which requires considerable analytical skills.
Since there are no beginning inventories, it makes no difference whether the
weighted-average or FIFO method is used by the company. Your students may
worry about this omission, so you may want to specify which method you want
them to use.
1. The computation of the cost of goods sold follows:
Transferred In
Estimated completion ................................
Conversion
100%
30%
Computation of equivalent units:
Completed and transferred out ................................
200,000
Work in process, ending:
Transferred in, 10,000 units ×
100% ................................................................
10,000
Conversion, 10,000 units × 30%................................
Total equivalent units of production ................................
210,000
Transferred In
200,000
3,000
203,000
Conversion
Whole Unit
Cost to be accounted for:
Work in process ................................
-0-0Cost added during the month ................................
$39,375,000
$20,807,500
Total cost (a) ................................................................
$39,375,000
$20,807,500
Equivalent units of production
(above) (b) ................................................................
210,000
Cost per EU, (a) ÷ (b) ................................ $187.50

203,000
$102.50
= $290.00
Cost of goods sold = 200,000 × $290 = $58,000,000
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Solutions Manual, Chapter 4
75
Ethics Challenge (continued)
2. The estimate of the percentage completion of ending work in process inventories
affects the unit costs of finished goods and therefore of the cost of goods sold. Gary
Stevens would like the estimated percentage completion figures to be increased.
The higher the percentage of completion of ending work in process, the higher the
equivalent units for the period and the lower the unit costs.
3. Increasing the percentage of completion can increase net income by reducing the
cost of goods sold. To increase net income by $200,000, the cost of goods sold
would have to be decreased by $200,000 from $58,000,000 down to $57,800,000.
The percentage of completion, X, affects the cost of goods sold by its effect on the
unit cost, which can be determined as follows:
Unit cost = $187.50 +
$20,807,500
200,000 + 10,000X
And the cost of goods sold can be computed as follows:
Cost of goods sold = 200,000 × Unit cost
Since cost of goods sold must be reduced down to $57,800,000, the unit cost must
be $289.00 ($57,800,000 ÷ 200,000 units). Thus, the required percentage
completion, X, to obtain the $200,000 reduction in cost of goods sold can be found
by solving the following equation:
$187.50 +
$20,807,500
= $289.00
200,000 + 10,000X
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76
Introduction to Managerial Accounting,FifthCanadian Edition
Ethics Challenge (continued)
$20,807,500
= $289.00 - $187.50
200,000 + 10,000X
$20,807,500
= $101.50
200,000 + 10,000X
200,000 + 10,000X
1
=
$20,807,500
$101.50
200,000 + 10,000X =
$20,807,500
$101.50
200,000 + 10,000X = 205,000
10,000X = 205,000 - 200,000
10,000X = 5,000
X=
5,000
= 50%
10,000
Thus, changing the percentage completion to 50% will decrease cost of goods sold
and increase net income by $200,000 as verified on the next page.
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Solutions Manual, Chapter 4
77
Ethics Challenge (continued)
3.
(continued)
Transferred In
Conversion
Estimated completion ................................................................
100%
50%
Computation of equivalent units:
Completed and transferred out................................
200,000
Work in process, ending: ...........................................................
Transferred in, 10,000 units × 100%................................
10,000
Conversion, 10,000 units × 50% ................................
Total equivalent units of production................................ 210,000
Transferred In
200,000
5,000
205,000
Conversion
Cost to be accounted for:
Work in process ................................................................ -0Cost added during the month ................................ $39,375,000
Total cost (a) ................................................................
$39,375,000
-0$20,807,500
$20,807,500
Equivalent units of production (above) (b) ................................
210,000
Cost per EU, (a) ÷ (b) ................................................................
$187.50
205,000
$101.50

Whole Unit
Cost of goods sold = 200,000 × $289 = $57,800,000
The following is an alternative approach to solving this problem:
o The additional income needed = $200,000 / 200,000 units = $1 per unit
o The cost transferred in cannot be changed, so the conversion cost must be
reduced from $102.50 to $101.50 per EU.
o Therefore, the equivalent units for conversion need to be: $20,807,500 /
$101.50 per EU = 205,000 EUs.
o 205,000 EUs – 200,000 units transferred out = 5,000 EU in WIP
o 5,000 EU / 10,000 units in WIP = 50% complete
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78
Introduction to Managerial Accounting,FifthCanadian Edition
=$289.00
Ethics Challenge (continued)
4. Mary is in a very difficult position. Collaborating with Gary Stevens in subverting the
integrity of the accounting system is unethical by almost any standard. To put the
situation in its starkest light, Stevens is suggesting that the production managers lie
in order to get more money. Having said that, the peer pressure to go along in this
situation may be intense. It is difficult on a personal level to ignore such peer
pressure. Moreover, Mary probably prefers not to risk alienating people she might
need to rely on in the future. On the other hand, Mary should be careful not to
accept at face value Gary Stevens’ assertion that all of the other managers are
“doing as much as they can to pull this bonus out of the hat.” Those who engage in
unethical or illegal acts often rationalize their own behaviour by exaggerating the
extent to which others engage in the same kind of behaviour. Other managers may
actually be very uncomfortable “pulling strings” to make the target profit for the
year.
From a broader perspective, if the net profit figures reported by the managers in a
division cannot be trusted, then the company would be foolish to base bonuses on
the net profit figures. A bonus system based on divisional net profits presupposes
the integrity of the accounting system. However, the company should perhaps
reconsider how it determines the bonus. It is quite common for companies to pay an
“all or nothing” bonus contingent on making a particular target. This inevitably
creates powerful incentives to bend the rules when the target has not quite been
attained. It might be better to have a bonus without this “all or nothing” feature. For
example, managers could be paid a bonus of x% of profits above target profits
rather than a bonus that is a present percentage of their base salary. Under such a
policy, the effect of adding that last dollar of profits that just pushes the divisional
net profits over the target profit will add a few pennies to the manager’s
compensation rather than thousands of dollars. Therefore, the incentives to misstate
the net income are reduced. Why tempt people unnecessarily?
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Solutions Manual, Chapter 4
79
Teamwork in Action (LO3 –CC11; LO4 –CC14, 15; LO5 –CC16)
Reports similar to the following should be prepared by the Expert Teams and shared
with the Learning Teams:
a. Quantity Schedule and Equivalent Units
The Quantity Schedule and Equivalent Units section of the production report: (1)
accounts for all of the units that were in production during the period, and (2)
computes the equivalent units of production. Imagine that you are the manager of a
department in a factory. You are responsible for the units that pass through your
department during the month. This section of the report summarizes that activity. In
addition, it converts the information into equivalent units.
The “work in process, beginning of the period” represents the number of units that are
sitting in your department when you arrive at work on the first day of the month. These
units were started last month. During the month, the department just before yours in
the production process will transfer units into your department (or, if you are the first
department in the process, raw materials will be transferred into your department
during the month). These units are “started into production.” Also, during the month,
your department will work on (or process) units. The units that have been completely
processed are “transferred to the next department.” It is important to note that the
units on hand at the beginning of the month plus the units that were transferred in
must equal the units that were transferred out plus the units that were still on hand at
the end of the period.
To determine the department’s output for the period, the equivalent units of production
are computed for both materials and conversion (labour and overhead). The equivalent
units of production are determined by adding the number of completed units that were
transferred to the next department and the equivalent units that are in the ending work
in process inventory. The number of equivalent units in the ending work in process
inventory is computed by multiplying the number of units on hand times the percent
complete (that is, the materials or work that were added during the period).
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Introduction to Managerial Accounting,FifthCanadian Edition
Teamwork in Action (continued)
b. Cost per Equivalent Unit
The Cost per Equivalent Unit section of the production report: (1) summarizes the total
costs that must be accounted for, and (2) documents the cost per equivalent unit.
The “costs to be accounted for” section represents the debits reflected in the
department’s work in process account during the period. The “work in process,
beginning of period” is the beginning balance in the inventory account for this
department. Note that this balance is broken out into its two components: materials
and conversion. The “costs added” represent the materials and conversion costs that
were debited to the work in process account during the period. Materials requisitions
generate the amount used in the entry to record the material costs. The conversion
costs are comprised of: (1) the direct labour wages paid to the employees who worked
in the department during the period and (2) the overhead that was applied (using the
department’s predetermined overhead rate) to the units that passed through the
department during the period.
The “materials cost per equivalent unit” is determined by dividing the total materials
costs (the total of materials in the beginning inventory and the costs that were added
during the period) by the number of equivalent units of production for materials (which
is calculated in the Quantity Schedule and Equivalent Units section of the report). The
“conversion cost per equivalent unit” is determined by dividing the total conversion
costs (the total of conversion costs in the beginning inventory and the labour and
overhead that were added during the period) by the number of equivalent units of
production for conversion (which is calculated in the Quantity Schedule and Equivalent
Units section of the report). The “whole unit cost per equivalent unit” is the total of the
“material cost per equivalent unit” and the “conversion cost per equivalent unit.”
c. Cost Reconciliation
The Cost Reconciliation section of the production report summarizes the total costs that
have been accounted for. This section determines the amount that will be used in the
entry to transfer units from this department’s work in process account to the next. This
is referred to as
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Solutions Manual, Chapter 4
81
Teamwork in Action (continued)
“transferred to the next department” in this section of the report. Also, in addition to
showing the components (materials and conversion) of the ending balance in this
department’s work in process account (for use in preparing next month’s Production
Report), this section proves that ending balance.
The amount that is “transferred to the next department” is determined by multiplying
the number of units transferred to the next department (which appears in the Quantity
Schedule and Equivalent Units section of the report) by the whole unit cost per
equivalent unit (which is calculated in the Costs per Equivalent Unit section of the
report).
The amount of “materials” in the ending work in process inventory for this department
is determined by multiplying the number of equivalent units (for materials) that are in
the ending work in process (which appears in the Quantity Schedule and Equivalent
Units section of the report) by the materials cost per equivalent unit (which is calculated
in the Costs per Equivalent Unit section of the report).
The amount of “conversion” in the ending work in process inventory for this department
is determined by multiplying the number of equivalent units (for conversion) that are in
the ending work in process (which appears in the Quantity Schedule and Equivalent
Units section of the report) by the conversion cost per equivalent unit (which is
calculated in the Costs per Equivalent Unit section of the report).
The “total work in process” is the sum of the amounts just calculated for “materials”
and “conversion.” After all journal entries are made, this amount should appear as the
ending balance in this department’s work in process account.
Finally, the “total cost” is the sum of the costs transferred to the next department and
the ending work in process inventory for this department. Note that this total must
equal the total of the “costs to be accounted for” that appears in the Costs per
Equivalent Unit section of the report.
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Introduction to Managerial Accounting,FifthCanadian Edition
Chapter 5
Activity-Based Costing
Solutions to Questions
5-1 The most common methods of
assigning overhead costs to products
are plant wide overhead rates,
departmental overhead rates, and
activity-based costing.
5-2 The major drawback with
traditional costing is that such systems
allocate overhead costs using a single
allocation base or very few bases that
make flawed assumptions about the
relationship between overhead costs
and the allocation bases. The last few
decades have witnessed dramatic
changes that have made traditional
costing systems obsolete in many
organizations. Automation has
decreased the amount of direct labour,
overhead costs have increased, and
companies now handle many more
products that differ substantially in
volume, lot size, and complexity. The
assumption, implicit in traditional
costing systems, that overhead cost is
proportional to a single allocation base
such as direct labour, is being
increasingly questioned. Activity-based
costing is an attempt to assign overhead
costs more accurately to products based
on the activities required to make
products and the resources consumed
by those activities.
5-3 The departmental approach to
assigning overhead cost to products
relies solely on volume as an
assignment base. This approach
assumes that overhead costs are
proportional to volume. However,
overhead costs are often driven by other
factors that are only loosely related, if at
all, to volume. A few examples of such
Solutions Manual, Chapter 5
costs are material handling, design
engineering, and factory rent. Activitybased costing attempts to assign
overhead costs more accurately to
products based on the activities that
they cause rather than just on the
number of units produced or direct
labour-hours required.
5-4 The four general levels of
activities are:
1. Unit-level activities, which are
performed each time a unit is produced.
2. Batch-level activities, which are
performed each time a batch of goods
are handled or processed.
3. Product-level activities, which are
performed as needed to support specific
products.
4. Facility-level activities, which
sustain an organization’s general
manufacturing capabilities.
5-5 Activity-based costing involves
two stages of overhead cost
assignments. In the first stage, costs
are assigned to activity cost pools. In
the second stage, costs are allocated
from the activity cost centres to
products.
5-6 In a traditional costing system,
overhead costs are allocated to products
using some measure of volume such as
direct labour-hours or machine-hours.
Consequently, the high-volume
products, which have the largest
amount of direct labour-hours or
machine-hours, are allocated most of
the overhead cost. In activity-based
costing, some of the overhead costs are
typically allocated using batch-level or
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1
product-level allocation bases. For
example, if each product is allocated a
total of $10,000 in product-level costs
irrespective of its volume, then a highvolume product will be allocated exactly
the same total overhead as a lowvolume product. In contrast, if a
measure of volume like direct labourhours or machine-hours were used to
allocate this cost, the high-volume
product would be allocated a larger total
sum than the low-volume product.
5-7 Activity-based costing improves
the accuracy of product costs in three
ways. First, activity-based costing
increases the number of cost pools used
to accumulate overhead costs. Rather
than accumulating all overhead costs in
a single, plantwide pool, or
accumulating them in departmental
pools, costs are accumulated for each
major activity. Second, the activity cost
pools are more homogeneous than
departmental cost pools. In principle, all
of the costs in an activity cost pool
pertain to a single activity. In contrast,
departmental cost pools contain the
costs of many different activities carried
out in the department. Third, activity-
based costing changes the bases used
to assign overhead costs to products.
Rather than assigning costs on the basis
of direct labour or some other measure
of volume, costs are assigned on the
basis of activity measures that gauge
how much of the overhead resource has
been consumed by a particular activity.
5-8 While the product costs
computed using activity-based costing
are almost certainly more accurate than
those computed using traditional costing
methods, activity-based costing
nevertheless rests on some questionable
assumptions about cost behaviour. In
particular, activity-based costing
assumes that costs are proportional to
activity. In reality, costs appear to
increase in less than proportion to
increases in activity. This implies that
activity-based product costs will be
overstated for purposes of making
decisions. (The same criticism can be
levelled at traditional product costs.)
Second, the costs of implementing and
maintaining an activity-based costing
system can be high and the benefits
may not justify this cost.
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2
Introduction to Managerial Accounting, Fifth Canadian Edition
The Foundational 15 (40 minutes) (LO 2, CC 6, 7, 8)
1. The plantwide overhead rate is computed as follows:
Total estimated overhead cost (a) ......................
Total expected direct labor-hours (b) ..................
Predetermined overhead rate (a) ÷ (b) ...............
$684,000
12,000 DLHs
$57.00 per DLH
(a) (200,000+100,000+84,000+300,000)
2. The overhead cost assignments to Products Y and Z are as follows:
Product Y
Total direct labor hours (a) .................................
Plantwide overhead rate per DLH (b) ..................
Manufacturing overhead assigned (a) × (b)
Product Z
8,000
$57.00
$456,000
4,000
$57.00
$228,000
3-6.
The activity rates are computed as follows:
Activity Cost Pool
Machining ....................
Machine setups ............
Product design .............
General factory .............
(a)
Estimated
Overhead
Cost
$200,000
$100,000
$84,000
$300,000
(b)
Expected
Activity
10,000
200
2
12,000
MH
setups
products
DLHs
(a) ÷ (b)
Activity
Rate
$20
$500
$42,000
$25
per
per
per
Per
MH
setup
product
DLH
7. Machine setups is a batch-level activity. A setup is performed to run a batch of units.
The cost of the setup is determined by the resources consumed performing the
setup and it is not influenced by the number of units processed once the setup is
complete.
8. The product design activity is a product-level activity. The product design cost is
determined by the number of products supported and it is not influenced by the
number of batches or units processed.
Solutions Manual, Chapter 5
Copyright © 2017 McGraw-Hill Education. All rights reserved.
3
The Foundational 15 (continued)
9-10.
Using the ABC system, the total overhead assigned to Products Y and Z is computed as follows:
Product Y
Expected
Activity
Amount
Machining, at $20.00 per machine-hour............................
Machine setups, at $500.00 per setup ..............................
Product design, at $42,000 per product ............................
General factory, at $25.00 per direct labor-hour................
Total overhead cost assigned...........................................
7,000
50
1
8,000
$140,000
25,000
42,000
200,000
$407,000
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4
Introduction to Managerial Accounting, Fifth Canadian Edition
Product Z
Expected
Activity
Amount
3,000
150
1
4,000
$ 60,000
75,000
42,000
100,000
$277,000
The Foundational 15 (continued)
11-15. The percentages of overhead assigned using the plantwide and ABC approaches are computed as follows:
Product Y
Plantwide Approach
Manufacturing overhead ................
Product Z
Total
(a)
Amount
$456,000
(a) ÷ (c)
%
66.7%
(b)
Amount
$228,000
(b) ÷ (c)
%
33.3%
(c)
Amount
$684,000
$140,000
25,000
42,000
200,000
$407,000
70.0%
25.0%
50.0%
66.7%
$ 60,000
75,000
42,000
100,000
$277,000
30.0%
75.0%
50.0%
33.3%
$200,000
100,000
84,000
300,000
$684,000
Activity-Based Costing System
Machining .....................................
Machine setups .............................
Product design ..............................
General factory .............................
Total cost assigned to products
The Machining allocation percentages used in the ABC system are similar to the plantwide allocation percentages
because the Machining cost pool uses a unit-level activity measure (machine-hours). Since the plantwide cost pool
also uses a unit-level allocation base (direct labor-hours), it is reasonable to expect these cost allocations percentages
to be comparable.
Under the ABC system, 25% and 75% of the Machine Setups cost is allocated to Products Y and Z, respectively,
whereas the plantwide approach allocates 67% and 33% of all overhead costs to the two products. These allocation
percentages are different because Machine Setups is a batch-level cost pool. Although Product Y is the high-volume
product (14,000 units) and Product Z is the low-volume product (6,000 units), Product Y only consumes 25% of the
total machine setups and Product Z consumes 75% of the total machine setups. The conventional system is allocating
too much of the machine setup costs to Product Y and too little of these costs to Product Z.
Solutions Manual, Chapter 5
Copyright © 2017 McGraw-Hill Education. All rights reserved.
5
The Foundational 15 (continued)
Under the ABC system, 50% of the Product Design cost is allocated to each product,
whereas the plantwide approach allocates 67% and 33% of all overhead costs to
Products Y and Z, respectively. These percentages are different because Product Design
is a product-level cost pool. Although Product Y is the high volume product (14,000
units) and Product Z is the low-volume product (6,000 units), both products consume
50% of the product design resources. The conventional system is allocating too much
of the product design costs to Product Y and too little of these costs to Product Z.
Under the ABC system, the General Factory allocation percentages are the same as the
plantwide allocation percentages because the General Factory cost pool is allocated to
products using the same unit-level activity measure (direct labor-hours) as the
plantwide approach.
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6
Introduction to Managerial Accounting, Fifth Canadian Edition
Brief Exercise5-1 (10 minutes) (LO2 – CC4, 5)
a)
Receive raw materials from suppliers: Batch-level
b)
Manage parts inventories: Product-level
c)
Do rough milling work on products: Unit-level
d)
Interview and process new employees in the human resources department:
Facility-level
e)
Design new products: Product-level
f)
Perform periodic preventative maintenance on general-use equipment: Facilitylevel
g)
Use the general factory building: Facility-level
h)
Issue purchase orders for a job: Batch-level
Some of these classifications are debatable and depend on the specific circumstances
found in particular companies.
Solutions Manual, Chapter 5
Copyright © 2017 McGraw-Hill Education. All rights reserved.
7
Brief Exercise5-2 (15 minutes) (LO1 – CC1; LO2 – CC6)
1. The activity rates are computed as follows:
Activity Cost Pool
(a)
Estimated
Overhead
Cost
(b)
Expected
Activity
Labour related ................................
$
48,000
10,000 DLHs
Machine related ................................
67,500
30,000 MHs
Machine setups ................................
84,000
600 setups
Production orders ................................
112,000
4,000 orders
Product testing ................................
58,500
1,800 tests
Packaging ................................
90,000
4,500 packages
672,000
10,000 DLHs
General factory ................................
Total ................................$1,132,000
(a) ÷ (b)
Activity
Rate
$ 4.80
2.25
140.00
28.00
32.50
20.00
67.20
per
per
per
per
per
per
per
DLH
MH
setup
order
test
package
DLH
Note to instructor: The first and the last activity cost pools can be combined for
ease of allocation because they are both allocated using the same activity measure
(direct labour hours). However, the ‘General Factory’ activity cost pool is most likely
a facility-level cost and quite different from the ‘Labour related’ activity cost pool.
Keeping the two activity cost pools separate provides valuable information to
management for cost management purposes.
2. The predetermined overhead rate based entirely on direct labour-hours would be
computed as follows:
Total estimated overhead cost (a) ................................
$1,132,000
Total expected direct labour-hours (b) ................................10,000 DLHs
Predetermined overhead rate (a) ÷ (b) ................................
$
113.20 per DLH
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8
Introduction to Managerial Accounting, Fifth Canadian Edition
Brief Exercise 5-3 (30 minutes) (LO1 – CC2; LO2 – CC3, 6, 7)
The unit product costs for the products are a combination of direct materials, direct
labour, and overhead costs. The overhead costs assigned to each product would be
computed as follows:
K425
Expected
Activity
Amount
M67
Expected
Activity
Amount
Labour related, at $18.00 per direct
labour hour................................................................
160
$2,880
Machine related, at $18.00 per
machine hour ................................................................
200
3,600
Machine setups, at $50.00 per setup ................................
2
100
Production orders, at $120.00 per
order ................................................................
2
240
Shipments, at $18.00 per shipment ................................
2
36
General factory, at $38.00 per direct
labour hour................................................................
160
6,080
Total overhead cost assigned (a) ................................
$12,936
Number of units produced (b) ................................
400
Overhead cost per unit (a) ÷ (b) ................................ $32.34
1,000
$18,000
3,000
8
54,000
400
8
20
960
360
1,000
38,000
$111,720
4,000
$27.93
Note to instructor: The first and the last activity cost pools can be combined for ease
of allocation because they are both allocated using the same activity measure (direct
labour hours). However, the ‘General Factory’ activity cost pool is most likely a facilitylevel cost and quite different from the ‘Labour related’ activity cost pool. Keeping the
two activity cost pools separate provides valuable information to management for cost
management purposes.
The unit product costs combine direct materials, direct labour, and overhead costs as
follows:
K425
Direct materials ................................................................
$126.00
Direct labour ................................................................
7.20
Manufacturing overhead (see above) ................................32.34
Unit product cost ................................................................
$165.54
Solutions Manual, Chapter 5
M67
$212.00
4.50
27.93
$244.43
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9
Brief Exercise5-4 (30 minutes) (LO1 – CC2; LO2 – CC3, 6, 7)
1. Using the company's traditional costing system, the overhead costs applied to the
products would be computed as follows:
Product H
Number of units produced (a) ................................30,000
Direct labour hours per unit (b) ................................ 0.20
Total direct labour hours (a) × (b) ................................
6,000
Product L
Total
50,000
0.20
10,000
16,000
Total manufacturing overhead (a) ................................
$2,920,000
Total direct labour hours (b) ..........................................................
16,000 DLHs
Predetermined overhead rate (a) ÷ (b) ................................
$ 182.50 per DLH
Product H
Product L
Total
Manufacturing overhead applied per unit
0.20 DLH per unit × $182.50 per DLH (a)................................
$
36.50
$ 36.50
Number of units produced (b) ................................ 30,000
50,000
Total manufacturing overhead applied (a) x
(b) ................................................................
$1,095,000
$1,825,000 $2,920,000
2. Using the proposed ABC system, overhead costs would be applied as follows:
Product H
Product L
Total manufacturing overhead applied (a) ................................
$1,460,000 $1,460,000
Number of units produced (b) ........................................................
30,000
50,000
Manufacturing overhead per unit
(a) ÷ (b) ......................................................................................
$ 48.67
$ 29.20
Note: Total amount allocated = $1,460,000 + $1,460,000 = $2,920,000.
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Introduction to Managerial Accounting, Fifth Canadian Edition
Brief Exercise 5-4 (continued)
3. Under the company’s old method of allocating overhead costs, the high-volume
product, Product L, was allocated most of the overhead cost. This occurred simply
because the high-volume product is responsible for most of the direct labour-hours.
When the overhead is split evenly between the two products, $365,000 of overhead
cost is shifted from the high-volume product, Product L, to the low-volume product,
Product H ($1,825,000 - $1,460,000 = $365,000). Consequently, the shift from
direct labour-hours as an allocation base to an even split of the overhead costs
between the two products favours the high-volume product, Product L, and
penalizes the low-volume product, Product H. Note that on a per unit basis, the
impact is much greater for the low-volume product, Product H, than for the highvolume product, Product L. This is because the impact per unit of shifting the
$365,000 in overhead costs is much greater for the low-volume product than for the
high-volume product.
Solutions Manual, Chapter 5
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11
Exercise 5-1 (15 minutes) (LO1 – CC2; LO2 – CC3, 4, 5)
1. & 2.
Note: The activity measures suggested below should not be regarded as the only
possible correct answers. Other activity measures are possible.
Activity
a)
b)
c)
d)
e)
f)
g)
Direct labour workers
assemble a product.
Engineers design a new
product.
A machine is set up to
process a batch.
Automated machines
cut and shape
materials.
The HR department
trains new employees
concerning company
policies.
Raw materials are
moved from the
receiving dock to the
production line.
A random sample of 10
units is inspected for
defects in each batch.
Level
Unit-level
Activity Measure(s)
Direct labour hours
Product-level
Engineering design
hours
Batch-level
Batch set-up time;
number of batches
Unit-level
Number of units
processed; machine
hours
Facility-level or perhaps Number of new
product-level
employees; training
hours
Batch-level or perhaps
unit-level
Number of moves;
number of batches;
number of units;
Batch-level
Number of batches;
inspection time
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12
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 5-2 (45 minutes) (LO1 – CC1, 2; LO2 – CC6, 7)
1. The unit product costs under the company's traditional costing system would be
computed as follows:
Rascon
Parcel
Total
Number of units produced (a) ........................................................
30,000 120,000
Direct labour hours per unit (b) ................................
0.80
0.30
Total direct labour hours (a) × (b) ................................24,000
36,000
60,000
Total manufacturing overhead (a) ................................ $864,000
Total direct labour hours (b) ..........................................................
60,000 DLHs
Predetermined overhead rate (a) ÷ (b) ................................
$ 14.40 per DLH
Rascon
Direct materials ................................................................
$29.50
Direct labour ................................................................ 18.00
Manufacturing overhead applied:
0.80 DLH per unit × $14.40 per DLH ................................
11.52
0.30 DLH per unit × $14.40 per DLH ................................
Unit product cost ................................................................
$59.02
Parcel
$23.00
4.50
4.32
$31.82
2. The unit product costs with the proposed ABC system can be computed as follows:
Activity Cost
Pool
Estimated
Overhead
Cost*
(b)
Expected
Activity
direct labour
Labour-related ................................
$432,000
60,000 hours
Engineering
engineering
design................................
$432,000
9,000 hours
$864,000
Solutions Manual, Chapter 5
(a) ÷ (b)
Activity
Rate
per direct labour
$ 7.20 hour
per engineering
$48.00 hour
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13
Exercise 5-2 (continued)
*The total overhead cost is split evenly between the two activity cost pools.
Rascon
Expected
Amount
Activity
Parcel
Expected
Activity
Labour related, at $7.20 per
direct labour hour ................................
24,000
$ 172,800
Engineering design, at $48.00
6,000
288,000
per engineering hour ................................
Total overhead cost assigned
(a) ................................................................ $460,800
Number of units produced (b) ................................ 30,000
Overhead cost per unit
(a) ÷ (b) ................................................................ $15.36
Amount
36,000
$259,200
3,000
144,000
$403,200
120,000
The unit product costs combine direct materials, direct labour, and overhead costs:
Rascon
Parcel
Direct materials ................................................................
$29.50 $23.00
18.00
4.50
Direct labour ................................................................
Manufacturing overhead (see above) ................................
15.36
3.36
Unit product cost ................................................................
$62.86 $30.86
3. The unit product cost of the high-volume product, Parcel, declines under the
activity-based costing system, whereas the unit product cost of the low-volume
product, Rascon, increases. This occurs because half of the overhead is applied on
the basis of engineering design hours instead of direct labour hours. When the
overhead was applied on the basis of direct labour hours, most of the overhead was
applied to the high-volume product. However, when the overhead is applied on the
basis of engineering hours, more of the overhead cost is shifted over to the lowvolume product. The number of engineering hours is a product-level activity, so the
higher the volume, the lower the unit cost, and the lower the volume, the higher the
unit cost.
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14
Introduction to Managerial Accounting, Fifth Canadian Edition
$3.36
Exercise 5-3 (30 minutes) (LO2 – CC6, 7; CHAPTER 4 LO7 – CC18)
1. Entry (a) is the amount of actual manufacturing overhead cost incurred during the
year. Debits to Manufacturing Overhead represent actual overhead costs incurred
and credits represent overhead applied to products.
2. The activity rates would be computed as follows:
Activity Cost Pool
(a)
Estimated
Overhead
Cost
(b)
Expected
Activity
Labour-related ................................
$560,000 40,000 DLHs
45,000
1,500 orders
Purchase orders ................................
Parts management ................................
360,000
400 part types
Board etching ................................
450,000
2,000 boards
General factory ................................
600,000 80,000 MHs
(a) ÷ (b)
Activity
Rate
$ 14
30
900
225
7.50
per
per
per
per
per
DLH
order
part type
board
MH
3. Computation of the manufacturing overhead cost applied to production:
Activity Cost Pool
(a)
Activity
Rate
(b)
Actual
Activity
Labour-related ................................
$14/DLH
Purchase orders ................................
$30/order
Parts management ................................
$900/part type
Board etching ................................
$225/board
General factory ................................
$7.50/MH
Total ................................
41,000
1,300
420
2,150
82,000
DLHs
orders
part types
boards
MHs
(a) × (b)
Applied
Overhead
$ 574,000
39,000
378,000
483,750
615,000
$2,089,750
4. The overhead over- or under-applied can be computed as follows:
Actual overhead incurred ................................
$2,402,000
Overhead applied ................................ 2,089,750
Overhead under-applied................................
$ 312,250
Solutions Manual, Chapter 5
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15
Exercise 5-4 (30 minutes) (LO2 – CC7)
The activity rates would be computed as follows:
Activity Cost Pool
(a)
Estimated
Overhead
Cost
(b)
Expected
Activity
(a) ÷ (b)
Activity
Rate
Labour-related ................................
$560,000 40,000 DLHs
Purchase orders ................................
45,000
1,500 orders
Parts management ................................
360,000
400 part types
Board etching ................................
450,000
2,000 boards
General factory ................................
600,000 80,000 MHs
$ 14
30
900
225
7.50
per
per
per
per
per
DLH
order
part type
board
MH
The overhead applied to each product can be computed as follows:
Product A
Activity Cost Pool
(a)
Activity
Rate
(b)
Actual
Activity
Labour related ................................
$14/DLH
Purchase orders ................................
$30/order
Parts management ................................
$900/part type
Board etching ................................
$225/board
General factory ................................
$7.50/MH
Total ................................
13,500
90
70
450
24,000
DLHs
orders
part types
boards
MHs
(a) × (b)
Applied
Overhead
$189,000
2,700
63,000
101,250
180,000
$535,950
Product B
Activity Cost Pool
(a)
Activity
Rate
Labour related ................................
$14/DLH
Purchase orders ................................
$30/order
Parts management ................................
$900/part type
Board etching ................................
$225/board
General factory ................................
$7.50/MH
Total ................................
(b)
Actual
Activity
7,500
350
115
1,000
20,000
DLHs
orders
part types
boards
MHs
(a) × (b)
Applied
Overhead
$105,000
10,500
103,500
225,000
150,000
$594,000
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16
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 5-4 (continued)
Product C
Activity Cost Pool
(a)
Activity
Rate
(b)
Actual
Activity
Labour related ................................
$14/DLH
Purchase orders ................................
$30/order
Parts management ................................
$900/part type
Board etching ................................
$225/board
General factory ................................
$7.50/MH
Total ................................
10,500
310
110
500
20,000
DLHs
orders
part types
boards
MHs
(a) × (b)
Applied
Overhead
$147,000
9,300
99,000
112,500
150,000
$517,800
Product D
Activity Cost Pool
(a)
Activity
Rate
Labour related ................................
$14/DLH
Purchase orders ................................
$30/order
Parts management ................................
$900/part type
Board etching ................................
$225/board
General factory ................................
$7.50/MH
Total ................................
(b)
Actual
Activity
9,500
550
125
200
18,000
DLHs
orders
part types
boards
MHs
(a) × (b)
Applied
Overhead
$133,000
16,500
112,500
45,000
135,000
$442,000
Note that the sum of the overhead costs applied to the individual products ($535,950 +
$594,000 + $517,800 + $442,000) equals the total amount of overhead applied
($2,089,750).
Solutions Manual, Chapter 5
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17
Exercise 5-5 (45 minutes) (LO1 – CC1, 2; LO2 – CC6, 7, 8)
1. The cost per customer under the company's traditional costing system would be
computed as follows:
Total ordering and delivery costs (a) ................................ $3,830,000
Total order value (b) ................................................................
6,600,000
Predetermined overhead rate (a) ÷ (b) ................................ $ 0.5803
Residential
$
per $ of sales
Business
Ordering and delivery costs applied (a):
$3,600,000 × $0.5803/$ of sales ................................
$2,089,080
$3,000,000 × $0.5803/$ of sales ................................
Number of customers (b)....................... ................................
3,000
Cost per customer (a) ÷ (b) ................................
$ 696.36
$1,740,900
750
$ 2,321.20
2. The activity rates would be computed as follows:
Activity Cost Pool
(a)
Estimated
Cost
Order processing ................................
$ 960,000
Getting sales ................................
750,000
Sales follow-up ................................
810,000
Processing change
orders ................................ 60,000
Delivery................................
1,250,000
(b)
Expected
Activity
(a) ÷ (b)
Activity
Rate
8,000 Orders
6,000 sales calls
$ 120 per order
125 per sales call
500 follow-ups
change
400 orders
1,620 per follow-up
per change
150 order
10,000 deliveries
125 per delivery
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18
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 5-5 (continued)
The ordering and delivery costs applied to each customer group can be computed as
follows:
Residential Customers
Activity Cost Pool
(a)
Activity
Rate
(b)
Actual
Activity
Order processing................................
$120/order
Getting sales................................
$125/sales call
Sales follow-up ................................
$1,620/follow-up
Processing change
orders ................................
$150/change order
Delivery ................................ $125/delivery
Total ................................
6,000 orders
2,000 sales calls
100 follow-ups
change orders
200
6,000 deliveries
(a) × (b)
Applied
Overhead
$720,000
250,000
162,000
30,000
750,000
$1,912,000
Business Customers
Activity Cost Pool
(a)
Activity
Rate
(b)
Actual
Activity
Order processing................................
$120/order
Getting sales................................
$125/sales call
Sales follow-up ................................
$1,620/follow-up
Processing change
orders ................................
$150/change order
Delivery ................................ $125/delivery
Total ................................
Solutions Manual, Chapter 5
2,000 orders
4,000 sales calls
400 follow-ups
change
200 orders
4,000 deliveries
(a) × (b)
Applied
Overhead
$240,000
500,000
648,000
30,000
500,000
$1,918,000
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19
Exercise 5-5 (continued)
The cost per customer with the proposed ABC system can be computed as follows:
Residential
Ordering and delivery costs applied (a):
Business
$1,912,000
$1,918,000
Number of customers (b).......................... ................................
3,000
Cost per customer (a) ÷ (b) ................................
$637.33
750
$2,557.33
3. The cost per customer of the smaller customer group, (business customer group),
increases. When the ordering and delivery costs were applied on the basis of order
value, most of the costs were applied to the residential customer group because it
had a higher order value. However, when other activities are taken into account,
such as getting sales and sales follow-ups, which make up approximately 50% of
the costs, more of the ordering and delivery costs are shifted over to the smaller
customer group.
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20
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 5-6 (15 minutes) (LO2 – CC3, 6, 7)
The allocation rates are computed as follows:
Material Requisitions
Total cost
Total number of requisitions
Allocation rate
= $594,000
= 460 + 620 = 1,080
= $594,000 ÷ 1,080 = $550 per requisition
Product Inspections
Total cost
Total number of inspections
Allocation rate
= $82,000
= 170 + 240 = 410
= $82,000 ÷ 410 = $200 per inspection
Orders Shipped
Total cost
Total number of inspections
Allocation rate
=
=
=
=
$185,000
167 + 129 = 296
$185,000 ÷ 296
$625 per order shipped
Costs are allocated as follows:
Thunderbolt
Based on Materials Requisitions:
460 × $550
620 × $550
Based on Product Inspections:
170 × $200
240 × $200
Based on Orders Shipped:
167 × $625
129 × $625
Total costs allocated
.
Solutions Manual, Chapter 5
Earthquake
$253,000
$341,000
34,000
48,000
104,375
$391,375
80,625
$469,625
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21
Exercise 5-7 (15 minutes) (LO1 – CC1, 2; LO2 – CC3, 6, 7; LO3 – CC9)
1. In an activity-based costing system, there are four steps:
 All resource-consuming activities in the manufacturing of a product or the
provision of a service are identified.
 Related activities are grouped into activity centres.
 Costs are assigned to the activity centres.
 Costs are assigned from the activity centres to products or services.
2. Benefits of ABC compared to a traditional costing system:
 More accurate product costs.
 Better decisions relating to product retention, marketing strategies, product
profitability, and so on.
 Better cost control.
3. Limitations of ABC:
 Risk of arbitrary allocations of costs if there is a low degree of correlation
between the cost of the activity and the chosen cost driver.
 High measurement costs associated with multiple activity centres and multiple
cost drivers.
 Like traditional costing systems, unit costs under an ABC system treat unit
overhead costs as if they are variable, as if they will vary proportionally with
output. In fact, many overhead costs are fixed costs, and treating them as
variable can lead to poor decisions.
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22
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 5-1 (15 minutes) (LO2 – CC3, 4, 5)
Activity
a. Machines are set up between batches of
different products.
b. The company’s grounds crew maintains
planted areas surrounding the factory.
c. A percentage of all completed goods are
inspected on a random basis.
d. Milling machines are used to make
components for products.
e. Employees are trained in general
procedures.
f.
Purchase orders are issued for materials
required in production.
g. The maintenance crew does routine
periodic maintenance on general-purpose
equipment.
h. The plant controller prepares periodic
accounting reports.
i. Material is received on the receiving dock
and moved to the production area.
j. The engineering department makes
modifications in the designs of products.
k. The human resources department
screens and hires new employees.
l. Production orders are issued for jobs.
Level
Possible Activity Measures
Batch
Number of setups; Setup
time
Arbitrary*
Facility
Unit
Unit
Facility
or
Product
Batch
Number of units inspected;
Inspection time
Number of units processed;
Machine-hours
Arbitrary if facility-level*
Number of purchase orders
Facility
Arbitrary*
Facility
Arbitrary*
Batch or
Unit
Product
Number of material moves
Facility
Arbitrary*
Batch
Number of production
orders
Engineering time
* Facility-level costs are commonly allocated using an arbitrary allocation base
such as direct labour hours.
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23
Problem 5-2 (75 minutes) (LO1 – CC1; LO2 – CC3, 6, 7)
1. The company’s estimated total direct labour hours for the year can be computed as
follows:
Deluxe model: 5,000 units × 3.2 DLH per unit................................
16,000
Regular model: 40,000 units × 0.8 DLH per unit.............................
32,000
Total direct labour hours ...............................................................
48,000
Using direct labour hours as the allocation base, the predetermined overhead rate
would be:
Predetermined
overhead rate
=
Total manufacturing overhead
Total direct labour-hours
= $5,184,000 ÷ 48,000 = $108 per DLH
The unit product costs are computed as follows:
Deluxe
Regular
Direct materials ................................
$150.00 $112.00
Direct labour* ................................ 44.80
12.80
Manufacturing overhead:
$108 per DLH × 3.2 DLHs ................................
345.60
$108 per DLH × 0.8 DLHs ................................
86.40
Unit product cost ................................
$540.40 $211.20
* (3.2 DLH × $14 for Deluxe; 0.80 DLH × $16 for Regular)
2. Activity rates can be computed as follows:
Activity Cost Pool
(a)
Estimated
Overhead
Cost
Purchase orders ................................
$ 476,800
562,400
Rework requests................................
Product testing ................................
908,000
Machine related ................................
3,236,800
$ 5,184,000
(b)
Expected
Activity
2,384
2,250
11,350
40,460
orders
requests
tests
MHs
(a) ÷ (b)
Activity
$200.00
249.96
80.00
80.00
Rate
per order
per request
per test
per MH
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 5-2 (continued)
3. a) Calculate the activity rates and then apply them to activity volume consumed by
each product (rates have been rounded before application)
Deluxe
Expected
Activity
Regular
Amount
Expected
Activity
Amount
$
Purchase orders, at $200 per order ................................
1,184
$236,800
Rework requests, at $249.96 per
request................................................................
810
202,467
Product testing, at $80 per test................................
5,000
400,000
1,200
Machine related, at $80 per MH ................................
15,240
1,219,200
25,220
1,440
6,350
Total overhead cost assigned (a) ................................
$2,058,467
Number of units produced (b) ................................
5,000
Overhead cost per unit
(a) ÷ (b) ................................................................ $411.69
240,00
0
359,942
508,000
2,017,60
0
$3,125,542
40,000
$78.14
b) Using activity-based costing, the unit product costs would be:
Deluxe
Regular
Direct materials ................................................................
$150.00
$112.00
Direct labour ................................................................
44.80
12.80
Manufacturing overhead (see above) ................................
411.69
78.14
Unit product cost ................................................................
$606.49
$202.94
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25
Problem 5-2 (continued)
4. Unit product costs are distorted as a result of using direct labour-hours as the base
for applying overhead costs to products. Although the deluxe model requires four
times as much labour time as the regular model, it still is not being assigned enough
overhead cost according to the activity-based costing system.
According to the activity-based costing system, the deluxe model is more expensive
to manufacture than the company thought. Note that although the deluxe model
accounts for just over 11% of total output it consumes between 36% and 49.7% of
the volume of the different activities.
When activity-based costing is used in place of direct labour-hours as the basis for
assigning overhead cost to products, the unit product cost of the deluxe model
jumps up from $540.40 to $606.49. If the $540.40 figure is being used as the basis
for pricing, then the selling price may be too low for the deluxe model. This may be
the reason why profits have been declining for the last several years. It may also be
the reason why sales of the deluxe model have been increasing rapidly.
Problem 5-3 (75 minutes) (LO2 – CC6, 7; LO4 – CC10A, 11A)
1. The activity rates are computed as follows:
Activity Cost Pool
(a)
Estimated
Overhead
Cost
Labour related ................................
$405,000
Production orders................................
90,000
Material receipts ................................
270,000
Relay assembly ................................
480,000
General factory ................................
1,260,000
$2,505,000
(b)
Expected
Activity
45,000
1,125
1,800
12,000
90,000
DLHs
orders
receipts
relays
MHs
(a) ÷ (b)
Activity
Rate
$ 9
80
150
40
14
per
per
per
per
per
DLH
order
receipt
relay
MH
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 5-3 (continued)
2. a) The journal entry to record actual manufacturing overhead costs is:
Manufacturing Overhead ................................
2,541,000
Accounts Payable................................
(2a)
2,541,000
Manufacturing Overhead
2,541,000
b) The manufacturing overhead applied is computed as follows:
(a)
Activity
Rate
Activity Cost Pool
Labour related ................................
$9/DLH
Production orders................................
$80/order
Material receipts ................................
$150/receipt
Relay assembly ................................
$40/relay
General factory ................................
$14/MH
Total ................................
(b)
Actual
Activity
48,000
1,050
1,950
11,850
91,500
DLHs
orders
receipts
relays
MHs
(a) × (b)
Applied
Overhead
$ 432,000
84,000
292,500
474,000
1,281,000
$2,563,500
c. The journal entry to record applied manufacturing overhead is:
Work in Process ................................
2,563,500
Manufacturing Overhead ................................
(2a)
Solutions Manual, Chapter 5
2,563,500
Manufacturing Overhead
2,541,000
2,563,500 (2c)
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27
Problem 5-3 (continued)
d. The overhead is over-applied by $22,500. This can be determined from the Taccount or directly:
(2a)
Manufacturing Overhead
2,541,000
2,563,500 (2c)
22,500
Actual overhead incurred ................................
$2,541,000
Overhead applied ................................ 2,563,500
Overhead over-applied ................................
$ (22,500)
3. a) Overhead cost is applied to the products as follows:
Product A
Activity Cost Pool
(a)
Activity
Rate
Labour-related ................................
$9/DLH
Production orders................................
$80/order
Material receipts ................................
$150/receipt
Relay assembly ................................
$40/relay
General factory ................................
$14/MH
Total ................................
(b)
Actual
Activity
12,000
240
150
4,050
19,500
DLHs
orders
receipts
relays
MHs
(a) × (b)
Applied
Overhead
$108,000
19,200
22,500
162,000
273,000
$584,700
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 5-3 (continued)
Product B
Activity Cost Pool
(a)
Activity
Rate
Labour-related ................................
$9/DLH
Production orders................................
$80/order
Material receipts ................................
$150/receipt
Relay assembly ................................
$40/relay
General factory ................................
$14/MH
Total ................................
(b)
Actual
Activity
16,500
300
690
0
27,000
DLHs
orders
receipts
relays
MHs
(a) × (b)
Applied
Overhead
$148,500
24,000
103,500
-0378,000
$654,000
Product C
Activity Cost Pool
(a)
Activity
Rate
Labour-related ................................
$9/DLH
Production orders................................
$80/order
Material receipts ................................
$150/receipt
Relay assembly ................................
$40/relay
General factory ................................
$14/MH
Total ................................
(b)
Actual
Activity
6,000
195
360
7,800
21,000
DLHs
orders
receipts
relays
MHs
(a) × (b)
Applied
Overhead
$ 54,000
15,600
54,000
312,000
294,000
$729,600
Product D
Activity Cost Pool
(a)
Activity
Rate
Labour-related ................................
$9/DLH
Production orders................................
$80/order
Material receipts ................................
$150/receipt
Relay assembly ................................
$40/relay
General factory ................................
$14/MH
Total ................................
(b)
Actual
Activity
13,500
315
750
0
24,000
DLHs
orders
receipts
relays
MHs
(a) × (b)
Applied
Overhead
$121,500
25,200
112,500
-0336,000
$595,200
b. The total amount applied to the products ($584,700 + $654,000 + $729,600 +
$595,200 = $2,563,500) is the same as the total manufacturing overhead applied
that appears as the credit entry in the manufacturing overhead T-account.
Solutions Manual, Chapter 5
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29
Problem 5-4 (75 minutes) (LO1 – CC1; LO2 – CC3, 6, 7)
1.
a)
The company’s predetermined overhead rate would be:
Predetermined
overhead rate
=
Total estimated manufacturing
overhead
Total estimated construction labour
hours
= $7,510,000 ÷ 500,000 = $15.02 per CLH
Cost of construction labour per CLH = $9,800,000 ÷ 500,000 CLH = $19.60 per
CLH
School
Residential
Cinema
Direct Material
$ 824,000
$ 1,034,600
$1,425,000
Construction Labour @
$19.60 per hour
1,301,440
729,120
362,600
Overhead @ $15.02 per
CLH
997,328
558,744
277,870
$3,122,768
2,322,464
2,065,470
Total cost
2. a) Activity rates can be computed as follows:
Activity Cost Pool
(a)
Estimated
Overhead
Cost
(b)
Expected
Activity
Foundation laying ................................
$1,685,000 421,250
Building construction................................
1,740,000 500,000
Painting ................................................................
1,760,000 550,000
Finishing ................................
2,325,000 750,000
FLHs
CLHs
PHs
FHs
(a) ÷ (b)
Activity
Rate
$4.00
3.48
3.20
3.10
per
per
per
per
FLH
CLH
PH
FH
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 5-4 (continued)
b) The cost of each job would now be computed as follows,
School
Residential
Cinema
Construction Labour:
$3.48 per hour × 66,400 CLHs ................................
$231,072
129,456
$3.48 per hour × 37,200 CLHs................................
$3.48 per hour x 18,500 CLHs ................................
Foundation Laying Hours:
$4 per FLH × 39,550 FLHs................................
158,200
$4 per FLH × 38,500 FLHs................................
$4 per FLH x 44,250 FLHs ................................
Painting Hours:
$3.20 per PH × 49,380 PHs ................................
158,016
$3.20 per PH × 36,120 PHs ................................
$3.20 per PH x 47,660 PHs ................................
Finishing Hours:
$3.10 per FH x 41,460 FHs ................................
128,526
$3.10 per FH x 60,600 FHs ................................
$3.10 per FH x 94,000 FHs ................................
Total overhead cost (a) ................................$675,814
64,380
154,000
177,000
115,584
152,512
187,860
$586,900
291,400
$685,292
Residential
School
Cinema
Direct materials ................................
$ 824,000
Construction labour ................................ 1,301,440
$1,034,600
729,120
$1,425,000
362,600
Manufacturing overhead (see
above) ................................................................
675,814
586,900
685,292
$2,350,620
$2,472,892
Cost per job ................................................................
$2,801,254
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31
Problem 5-4 (continued)
c) It is important to remember that the predetermined overhead rate is based on
estimates, rather than actual results. This is because the predetermined overhead
rate is computed before the period begins and is used to apply overhead cost to
jobs throughout the period. The same is the case with activity rates because they
are also computed before the period begins.
Thus, the use of ABC will not always result in zero under- or over-applied overhead.
However, to the extent that activity costs and activity volumes can be more
accurately predicted the over- or under-applied overhead amount will decrease.
Problem 5-5 (75 minutes) (LO2 – CC6, 7; LO4 – CC10A, 11A)
1. The activity rates are computed as follows:
Activity Cost Pool
(a)
Estimated
Overhead
Cost
Labour-related ................................
$214,200
55,080
Purchase orders ................................
Product testing ................................
121,380
Template etching ................................
321,300
General factory ................................
892,500
$1,604,460
(b)
Expected
Activity
29,750
765
1,200
8,950
59,500
(a) ÷ (b)
Activity
Rate
DLHs
orders
tests
templates
MHs
$ 7.20
72.00
101.15
35.90
15.00
per
per
per
per
per
DLH
order
test
template
MH
2. a) The journal entry to record actual manufacturing overhead costs is:
Manufacturing Overhead................................
1,608,795
Accounts Payable ................................
(2a)
1,608,795
Manufacturing Overhead
1,608,795
b) The manufacturing overhead applied is computed as follows
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 5-5 (continued)
Activity Cost Pool
(a)
Activity
Rate
(b)
Actual
Activity
Labour related ................................
$7.20/DLH
Purchase orders ................................
$72.00/order
Product testing ................................
$101.15/test
Template etching ................................
$35.90/template
General factory ................................
$15.00/MH
Total ................................
30,200
760
1,105
8,775
57,800
(a) × (b)
Applied
Overhead
DLHs
orders
tests
templates
MHs
$ 217,440
54,720
111,771
315,023
867,000
$1,565,954
c) The journal entry to record applied manufacturing overhead is:
Work in Process ................................ 1,565,954
Manufacturing Overhead................................
(2a)
1,565,954
Manufacturing Overhead
1,608,795
1,565,954 (2c)
d) The overhead is under-applied by $42,841. This can be determined from the Taccount or directly:
(2a)
Manufacturing Overhead
1,608,795
1,565,954 (2c)
42,841
$1,608,795
Actual overhead incurred ................................
Overhead applied ................................................................
1,565,954
Overhead under-applied ................................
$ 42,841
Solutions Manual, Chapter 5
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33
Problem 5-5 (continued)
3. a) Overhead cost is applied to the products as follows:
Product A
Activity Cost Pool
(a)
Activity
Rate
Labour-related……..
$7.20/DLH
Purchase orders ................................
$72/order
Product testing ................................
$101.15/test
Template etching ................................
$35.90/template
General factory ................................
$15/MH
Total ................................
(b)
Actual
Activity
3,200
140
310
3,750
16,580
DLHs
orders
tests
templates
MHs
(a) × (b)
Applied
Overhead
$ 23,040
10,080
31,357
134,625
248,700
$447,802
Product B
Activity Cost Pool
(a)
Activity
Rate
Labour-related ................................
$7.20/DLH
Purchase orders ................................
$72/order
Product testing ................................
$101.15/test
Template etching ................................
$35.90/template
General factory ................................
$15/MH
Total ................................
(b)
Actual
Activity
8,800
205
160
1,270
12,590
DLHs
orders
tests
templates
MHs
(a) × (b)
Applied
Overhead
$ 63,360
14,760
16,184
45,593
188,850
$328,747
Product C
Activity Cost Pool
(a)
Activity
Rate
Labour-related ................................
$7.20/DLH
Purchase orders ................................
$72/order
Product testing ................................
$101.15/test
Template etching ................................
$35.90/template
General factory ................................
$15/MH
Total ................................
(b)
Actual
Activity
9,500
120
145
860
6,800
DLHs
orders
tests
templates
MHs
(a) × (b)
Applied
Overhead
$ 68,400
8,640
14,667
30,874
102,000
$224,581
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 5-5 (continued)
Product D
Activity Cost Pool
(a)
Activity
Rate
Labour-related ................................
$7.20/DLH
Purchase orders ................................
$72/order
Product testing ................................
$101.15/test
Template etching ................................
$35.90/template
General factory ................................
$15/MH
Total ................................
(b)
Actual
Activity
8,700
295
490
2,895
21,830
DLHs
orders
tests
templates
MHs
(a) × (b)
Applied
Overhead
$ 62,640
21,240
49,564
103,931
327,450
$564,825
3. b) The total amount applied to the products ($447,802 + $328,747 + $224,581 +
$564,825 = $1,565,955) is the same as the total manufacturing overhead
applied which appears as the credit entry in the manufacturing overhead Taccount (the differences come from rounding).
Solutions Manual, Chapter 5
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35
Problem 5-6 (75 minutes) (LO2 – CC3, 6, 7)
1. Pre-determined cost allocation rates are computed as follows:
Operating costs for
department
Research Dept
$822,000
Information system
$268,000 x 60%
$268,000 x 40%
160,800
Administration
$347,000 x 30%
$347,000 x 70%
104,100
Legal
$192,000 x 50%
$192,000 x 50%
Total cost
Preparation Dept
$590,000
107,200
242,900
96,000
$1,182,900
96,000
$1,036,100
Research Dept:
Cost per hour = $1,182,900 ÷ 9,000 = $131.43 per hour
Preparation Dept:
Cost per hour = $1,036,100 ÷ 7,500 = $138.15 per hour
2: Cost per job
L123
Research costs
340 x $131.43
480 x $131.43
Preparation costs
600 x $138.15
750 x $138.15
Total Cost per job
L342
$44,686.20
$63,086.40
82,890.00
$127,576.20
103,612.50
$166,698.90
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 5-6 (continued)
3. Activity rates can be computed as follows:
Activity Cost Pool
(a)
Estimated
Overhead
Cost
(b)
Expected
Activity
Information Systems ................................
$268,000
Administration
347,000
Legal ................................
192,000
Research ................................822,000
590,000
Preparation ................................
14,970 hours
40 consultan
ts
8,000,000 sales $
value
9,000 hours
7,500 hours
(a) ÷ (b)
Activity
Rate
$17.90 per hour
$8,675 per
consultant
0.024 per sales $
value
91.33 per hour
78.67 per hour
4.
L123
L342
Information Systems at $17.90 per
hour
$6,266
$2,685
Administration at $8,675 per
consultant
17,350
17,350
Legal at $0.024 per sales value
32,400
21,600
Research at $91.33 per hour
31,052
43,838
Preparation at $78.67 per hour
47,200
59,000
Total cost per job
$134,268
$144,473
Solutions Manual, Chapter 5
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37
Problem 5-7 (60 minutes) (LO1 – CC1; LO2 – CC3, 6, 7, 8)
1. The first step is to determine the activity rates:
Serving a
Party
Serving a
Diner
Total cost (a) ................................................................
$58,000
Total activity (b) ................................................................
7,250 parties
Cost per unit of activity (a)÷(b) ................................
$8.00 per
party
$161,000
17,500
diners
$9.20 per
diner
Serving
Drinks
$35,000
14,000
drinks
$2.50 per
drink
2. According to the ABC system, the cost of serving each of the parties can be
computed as follows:
Serving a
Party
Cost per unit of activity ................................
$8.00 per
party
a.
b.
c.
Serving a
Diner
$9.20 per
diner
Serving
Drinks
Total
$2.50 per
drink
Party of four diners who order
three drinks ................................
1 party
4 diners
Cost ................................................................
$8.00
$36.80
3
drinks
$7.50
$52.30
Party of two diners who order
no drinks ................................
1 party
2 diners
Cost ................................................................
$8.00
$18.40
0
drinks
$-0-
$26.40
Party of one diner who orders
1
two drinks ................................
1 party
diner
Cost ................................................................
$8.00
$9.20
2
drinks
$5.00
$22.20
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 5-7 (continued)
3. The average cost per diner for each party can be computed by dividing the total cost
of the party by the number of diners in the party as follows:
a. $52.30 ÷ 4 diners = $13.075 per diner
b. $26.40 ÷ 2 diners = $13.20 per diner
c. $22.20 ÷ 1 diner = $22.20 per diner
4. The average cost per diner differs from party to party under the activity-based
costing system for two reasons. First, the cost of serving a party ($8.00) does not
depend on the number of diners in the party. Therefore, the average cost per diner
of this activity decreases as the number of diners in the party increases. With only
one diner, the cost is $8.00. With two diners, the average cost per diner is cut in
half to $4.00. With five diners, the average cost per diner would be only $1.60. And
so on. Second, the average cost per diner differs also because of the differences in
the number of drinks ordered by the diners. If a party does not order any drinks, as
was the case with the party of two, no costs of serving drinks are assigned to the
party.
The average cost per diner differs from the overall average cost of $14.51 per diner
because this amount does not recognize differences in the diners’ demands on
resources. It does not recognize that some diners order more drinks than others nor
does it recognize that there are some economies of scale in serving larger parties.
(The batch-level costs of serving a party can be spread over more diners if the party
is larger.)
We should note that the activity-based costing system itself does not recognize all of
the differences in diners’ demands on resources. For example, there are
undoubtedly differences in the costs of preparing the various meals on the menu. It
may or may not be worth the effort to build a more detailed activity-based costing
system that would take such nuances into account.
Solutions Manual, Chapter 5
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39
Problem 5-8 (40 minutes) (LO2 – CC7)
1.
Overhead applied to Mops:
Activity Cost Pool
(a)
Activity
Rate
Materials handling ................................
$1.00/part
Machining ................................
$15.00/MH
Assembly ................................
$1.60/unit
Inspection ................................
$2.00/unit
Total ................................
(b)
Actual
Activity
2,000 Parts
200 MH
1,000 Units
started
100 Units tested
(a) × (b)
Applied
Overhead
$2,000
3,000
1,600
200
$6,800
Total manufacturing cost = Direct materials ($5,200) + direct labour ($12,000) +
overhead ($6,800) = $24,000
Units manufactured is units assembled = 1,000
Cost per unit = $24,000 ÷ 1,000 = $24.00
Overhead applied to Dusters:
Activity Cost Pool
(a)
Activity
Rate
Materials handling ................................
$1.00/part
Machining ................................
$15.00/MH
Assembly ................................
$1.60/unit
Inspection ................................
$2.00/unit
Total ................................
(b)
Actual
Activity
1,300 Parts
300 MH
1,125 Units
started
1,200 Units tested
(a) × (b)
Applied
Overhead
$1,300
4,500
1,800
2,400
$10,000
Total manufacturing cost = Direct materials ($2,600) + direct labour ($12,000) +
overhead ($10,000) = $24,600
Units manufactured is units assembled = 1,125
Cost per unit = $24,600 ÷ 1,125 = $21.87
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 5-8 (continued)
2. Over- or under-costing of individual products can be determined only by computing
costs under the old method of costing and comparing these product costs with the
ABC-based product costs.
Given that both products use the same number of direct labour hours, the same
amount of overhead would have been applied to the two products under the old
method. This amount can be calculated as follows:
($6,800 + $10,000)
= $16,800 ÷ 2
= $8,400 (rounded to $8,400)
Total product cost under the old system:
Dusters
$ 2,600
12,000
8,400
$23,000
Mops
$ 5,200
12,000
8,400
$25,600
Direct materials
Direct labour
Overhead
Total product cost
3. Comparing the costs from the two approaches we see:
ABC System
Old System
$24,000
$25,600
$24,000
$23,000
The old system over-costed Mops and under-costed Dusters. The reason that there is a
difference in the product costs between the two systems is because the old system
allocates overhead as if these costs are incurred due to the consumption of labour
hours. The ABC system is based on the understanding that the overhead costs are
incurred due to unit level, batch level and facility level activities. The costs are
driven by a variety of cost drivers; and the costs are assigned to the products in
proportion to each product’s consumption of the cost driver. Unless the proportion
of labour hours consumed is the same as that for all the cost drivers the costs will
not be allocated in the same manner.
Solutions Manual, Chapter 5
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41
Problem 5-8 (continued)
4. The allocation rate will be developed as follows:
Step 1: The cost pool is created and budgeted overhead costs are assigned to the pool.
Step 2: The activity driver is identified and the budgeted quantity for the activity is
specified.
Step 3. The allocation rate is the quotient of the amount from step1 divided by amount
from step 2.
5. No. The overhead costs should be assigned according to the normal costing system.
This means the rate is determined at the outset of the operating period and is
applied to actual activity data as the production occurs throughout. Managers
cannot wait for actual costs to be known since that would mean that overhead costs
won’t be assigned until the end of the period and product costs will not be available
until then. This is the reason the normal costing system is used and the accounting
system reconciles applied overhead with actual overhead costs using the overapplied and under-applied overhead at the end of period.
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 5-9 (60 minutes) (LO1 – CC1; LO2 – CC3, 6, 7)
Note: The calculations should take 30 minutes. The writing of the memo will
require time and 30 minutes are allocated for this activity.
Students should recognize that this problem is about comparing the ABC costing
approach with that of the traditional costing approach based on a single plant-wide
overhead rate. Therefore students should determine product costs using each
approach first and then prepare the memorandum to management.
1. Product costing when overhead is allocated using direct labour hours as the activity
driver.
Direct materials
Direct labour*
Overhead**
Total product cost
Economy
$22,880
8,800
14,586
$46,266
Deluxe
$14,600
18,000
29,835
$62,435
Supreme
$8,000
32,000
53,040
$93,040
* $16 × 550 = $8,800; $16 × 1,125 = $18,000; $16 × 2,000 = $32,000
** Pre-determined overhead allocation rate
= $1,060,920 ÷ 40,000 DLH = $26.52 per DLH
$26.52 × 550 = $14,586; $26.52 × 1,125 = $29,835; $26.52 × 2,000 = $53,040
2. Product costing when overhead is allocated using the ABC approach.
Direct materials
Direct labour*
Overhead**
Total product cost
Economy
$ 22,880
8,800
78,600
$110,280
Deluxe
$14,600
18,000
33,120
$65,720
Supreme
$ 8,000
32,000
19,900
$59,900
* $16 × 550 = $8,800; $16 × 1,125 = $18,000; $16 × 2,000 = $32,000
** See tables below
Solutions Manual, Chapter 5
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43
Problem 5-9 (continued)
Overhead allocation (activity) rates determined as follows:
Activity
Order processing
Materials handling
Machine depreciation and
maintenance
Quality control
Total Cost
$ 160,000
514,920
322,000
64,000
Activity Vol.
100 orders
122,640 kilos
Activity Rate
$1,600/order
4.20/kilogram
(rounded)
16,100 MH
$20.00/MH
40 inspections $1,600/inspection
Overhead allocated as follows:
Activity
Order processing
Materials handling
Machine depreciation and
maintenance
Quality control
Total overhead cost
Note:
Economy
$ 9,600
$1,600 x 6
37,800
$4.20 x 9,000
26,400
$20 x 1,320
4,800
$1,600 x 3
Deluxe
$ 6,400
$1,600 x 4
15,120
$4.20 x 3,600
6,800
$20 x 340
4,800
$1,600 x 3
Supreme
$4,800
$1,600 x 3
6,300
$4.20 x 1,500
4,000
$20 x 200
4,800
$1,600 x 3
$78,600
$33,120
$19,900
Overhead is allocated by multiplying the activity rate by the corresponding
activity volume for each product (e.g., $1,600 per order multiplied by 6, 4 and
3 orders respectively for each model).
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 5-9 (continued)
Memorandum
To:
MotoMover Management
Subject: Analysis of product costs from using ABC instead of the Current approach
Please refer to the calculations shown above. The overhead charged (allocated) to the
three products is different under the two methods. In the first case, only a single
allocation base (direct labour hours) is used to allocate overhead. In the second
case, multiple overhead rates are used. Moreover, the multiple overhead rates use
unit-level and batch-level activity measures as allocation bases.
Cost System
ABC
Current
Economy
$110,280
$46,266
Deluxe
$65,720
$62,435
Supreme
$59,900
$93,040
The reason that there is a difference in the product costs between the two systems is
because the old system allocates overhead as if these costs are incurred due to the
consumption of labour hours. Since the economy model consumes least amount of
labour hours it is allocated the smallest amount of the overhead and largest amount
is allocated to the supreme model.
The ABC system is based on the understanding that the overhead costs are incurred
due to unit level, batch level and facility level activities. The costs are driven by a
variety of cost drivers; and the costs are assigned to the products in proportion to
each product’s consumption of the cost driver. Unless the proportion of labour hours
consumed is the same as that for all the cost drivers the costs will not be allocated
in the same manner. As seen by the distribution of the cost driver consumption
across the three products for each activity pool, the relative consumption of each
driver by the three products differs from their consumption of the labour hours.
The implication is that if we believe the data to be reliable and accurate, the overhead
costs allocated using the ABC system is indicative of the true burden that should be
assigned to each product. Product prices based on ABC product costs will be more
accurate and likely be competitive. Distorted prices because of distorted product
costs will result in undesirable sales mix and also in a production mix that will
exacerbate the cost distortion.
These matters should be carefully studied and the implications should be further
analysed. The evidence from the analysis so far strongly suggests that the costs are
distorted.
Solutions Manual, Chapter 5
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45
Problem 5-10 (40 minutes) (LO1 – CC1; LO2 – CC3, 6, 7)
1. Overhead cost allocations using the predetermined rate:
The predetermined overhead rate per hour and on a per unit must be calculated.
Direct labour cost is $600,000 and the wage rate is $20. Therefore 30,000 direct labour
hours have been used.
Direct labour cost per unit is $10 for Model A. And given the volume of production of
40,000 units implies that this model has used $10 x 40,000 = $400,000. Since the wage
rate is $20 per hour, model A has consumed 20,000 hours and thus each unit of A
requires 20,000hours/40,000 = 0.5 hours.
Similarly, model B consumes 10,000 hours: $200,000/$20.
And each unit of B require 10,000H/20,000 units = 0.5 hours.
Since total overhead cost is $300,000. The rate per hour is $300,000/30,000 =
$10/hour.
The overhead cost per unit will be 0.5 hour and $10/hour = $5 per unit.
Analog Model: 40,000 units × $5
Digital Model: 20,000 units × $5
Total allocated overhead
$ 200,000
100,000
$ 300,000
Product cost:
Direct materials
Direct labour
Factory overhead
Product cost per unit
Analog
$6
$10
$5
$21
Digital
$10
$10
$5
$25
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 5-10 (continued)
2. a) Overhead cost rates:
Activity
Setups
Material handling
Total Cost
$ 20,000
60,000
Equipment operations
220,000
Activity Vol.
160 setups
120,000
kilograms
44,000 MH
Activity Rate
$125/setup
0.50/kilogram
5.00/MH
b) Product costs
Assignable overhead costs under ABC:
100 setups × $125
60 setups × $125
60,000 kg × $0.50
60,000 kg × $0.50
14,000 MH × $5.00
30,000 MH × $5.00
Total
ANALOG Model
$ 12,500
Units of product
Factory overhead per unit
Solutions Manual, Chapter 5
DIGITAL Model
$
7,500
30,000
30,000
70,000
$ 112,500
150,000
$ 187,500
40,000
$ 2.81
20,000
$ 9.38
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47
Problem 5-10 (continued)
Cost per unit, ABC approach:
Analog
$ 6.00
10.00
2.81
$18.81
Direct materials
Direct labour
Factory overhead
Total activity-based product cost
Digital
$10.00
10.00
9.38
$29.38
Problem 5-11 (45 minutes) (LO2 – CC3, 6, 7)
NOTE: Parts 3 and 4 are very challenging. Instructors might wish to take these up as
discussion questions in class instead of assigning them as homework. Our experience
suggests that most students will be unable to prepare a satisfactory response. Note also
however that the issue raised is critical and students themselves often ask about how to
deeply understand the distinction between batch and unit level activities.
1. Overhead allocation (activity) rates:
Activity
Materials purchasing
Machine setups
Inspection
Machine operations
Total Cost
$240,000
800,000
360,000
600,000
Activity Vol.
120,000 kg
400 setups
3,600 hours
20,000 MH
Activity Rate
$2/kilogram
$2,000/setup
$100/hour
$30/MH
Model S
$12,000
20,000
20,000
45,000
$97,000
Model T
$ 8,000
60,000
20,000
15,000
$103,000
Allocation of overhead using activity rates:
Activity
Materials purchasing
Machine setups
Inspection
Machine operations
Total overhead cost
Note:
Activity rate
$
2
2,000
100
30
Overhead is allocated by multiplying the activity rate by the activity consumed
by each product (e.g., $2 per kilogram multiplied by 6,000 and 4,000 kilograms
respectively for each product).
For comparison purposes, we can also compute total overhead costs using machinehours as the basis of allocation.
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48
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 5-11 (continued)
Overhead allocation rate
= $2,000,000/20,000 MH = $100 per machine-hour
Overhead allocated to:
Standard product
Deluxe product
($100 × 1,500 MH)
($100 × 500 MH)
= $ 150,000
=
50,000
$ 200,000
We can see that by using machine-hours as the allocation basis, the company allocates
a much higher amount to the standard product compared to the deluxe product.
2. The use of a predetermined overhead indicates that the normal costing system is in
use. Therefore there can be over or under applied overhead.
3. The inspection activity is a unit level activity in this production setting. Look at the
data provided on activities and the activity measure. Setup is a batch level activity and
is presumed to be independent of batch size (i.e the number of units of output
comprising a batch). The independence between the cost and unit level driver, namely,
production volume is the key here. Now return to the inspection activity; it is very
difficult to imagine the activity to be independent of the batch size. Consider the
alternative activity measures like number of inspections performed. The reasonable
assumption is that inspection is performed on each unit and it is performed once. This
is a unit level activity measure. The time taken to perform the inspection is another
activity measure and is the one chosen in this problem. The time taken to perform each
inspection is the resource triggering the cost. The assumption is that the cost per unit
of time is constant. The cost is $100 per hour. Also the assumption is that each unit of
product will take the same time for it to be inspected, regardless of whether it passes or
fails inspection. These are also assumptions regarding machine hours and direct labour
hours which makes direct labour and machine hour direct inputs in production and their
costs direct costs.
Solutions Manual, Chapter 5
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49
Problem 5-11 (continued)
4. For inspection to be a batch level activity, it must be performed once when a batch is
processed. The cost should be independent of the number of units in a batch. The total
cost should be vary with the number of batches. With this constraints it is not possible
to develop a batch level inspection policy and protocol that focuses on the units of
product. But is there a quality attribute that relates to the batch? If yes, and
inspection is about testing this attribute you would have a batch level inspection
activity. The easiest way to see this is to consider setups. Following a setup, suppose
the inspection is necessary to obtain assurance that the setup has been done properly
(equipment setting has been verified to be in compliance for the product that is going
to be produced). Now inspection is a batch level activity driven by number of
inspections performed. It is also possible to measure activity in terms of inspection
time, but note the time is related to the inspecting the setup; time is not related or
consumed by the number of units in the batch.
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 5-12 (150 minutes) (LO1 – CC1, 2; LO2 – CC3, 6, 7)
1. Overhead rates:
(a)
Estimated
Overhead
Costs
(a)  (b)
Predetermined
Overhead Rate
(b)
Expected
Activity
Purchasing (orders)................................$12,750
300
Material handling (receipts) ................................
15,000
300
Production orders and equipment
setup (setup hours) ................................
22,500
225
Inspection (inspection hours) ................................
16,000
800
Frame assembly (assembly
hours) ................................................................
8,000
1,600
Machine related (machine-hours) ................................
27,000
9,000
1
2
$42.50/order
$50/receipt
3
4
5
$100/hour
$20/hour
$5/hour
$3/hour
170
+ 130 + 100 = 300 orders.
+ 80 + 160 = 300 receipts.
3Standard: 45 setups × 1 hour per setup ................................ 45
Specialty: 90 setups × 2 hours per setup ................................ 180
Total setup hours ................................................................ 225
4300 + 500 = 800 hours.
5Standard:9,000 units × 0.5 hours per unit ................................
4,500
Specialty: 2,250 units × 2 hours per unit................................4,500
Total machine-hours ................................................................
9,000
260
Solutions Manual, Chapter 5
hours
hours
hours
hours
hours
hours
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51
Problem 5-12 (continued)
Overhead cost charged to each product:
Standard
Activit
y
Amount
Specialty
Activit
y
Amount
Purchasing, at $42.50/order:
Leather ................................................................
24
$ 1,020
Fabric ................................................................
51
2,168
Synthetic ................................................................
—
—
Material handling, at $50/receipt:
Leather ................................................................
46
2,300
Fabric ................................................................
70
3,500
Synthetic ................................................................
—
—
Production orders and equipment
setup, at $100/hour ................................
45
4,500
Inspection, at $20/hour ................................
300
6,000
Frame assembly, at $5/hour ................................
800
4,000
Machine related, at $3/hour................................
4,500
13,500
Total overhead cost ................................
$36,988
46
79
100
$ 1,955
3,358
4,250
14
10
160
700
500
8,000
180
500
800
4,500
18,000
10,000
4,000
13,500
$64,263
Overhead cost per unit of product:
Standard: $36,988 ÷ 9,000 units = $4.11/unit (rounded)
Specialty: $64,263 ÷ 2,250 units = $28.56/unit (rounded)
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 5-12 (continued)
2. The unit product cost of each product line under activity-based costing is given
below. For comparison, the costs computed by the company’s accounting
department using traditional costing are also provided.
Direct LabourHour Base
Standard
Specialty
Activities Base
Standard
Specialty
Direct materials ................................$20.00
Direct labour................................
6.00
Manufacturing overhead ................................
4.11
Total unit product cost ................................
$30.11
$17.50
6.00
28.56
$52.06
$20.00
6.00
9.00
$35.00
$17.50
6.00
9.00
$32.50
3. The president was probably correct in being concerned about the profitability of the
products, but the problem is apparently with the specialty product line rather than
the standard product line. Traditional overhead cost assignment using a volumebased measure has resulted in the high-volume product subsidizing the low-volume
product. Thus, unit costs for both products are badly distorted. These distorted costs
have had a major impact on management’s pricing policies and on management’s
perception of the margin being realized on each product. The specialty briefcases
are apparently being sold at a loss even without considering non-manufacturing
costs:
Standard
Briefcases
Selling price per unit ................................$36.00
Unit product cost ................................
30.11
Gross margin (loss) per unit ................................
$ 5.89
Specialty
Briefcases
$50.00
52.06
$(2.06)
Based on these data, the company should not shift its resources entirely to the
production of specialty briefcases. Whether or not the specialty briefcases can be
made profitable depends on a number of factors including the sensitivity of the
market to an increase in the selling price of the specialty line.
Note to the Instructor: You may want to mention to your class that before any
decision can be made regarding dropping a product, a careful analysis will have to
be made of the potential avoidable costs. Some of the costs included in the unit
product costs are probably costs of idle capacity and organization-sustaining costs
that are not relevant.
Solutions Manual, Chapter 5
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53
Problem 5-12 (continued)
4. The competition hasn’t been able to touch CarryAll’s price perhaps because CarryAll
has been selling its specialty items at a price that may be below its cost. Thus,
rather than “gouging” its customers, CarryAll’s competitor is probably just pricing its
specialty items at a normal markup over its cost. Indeed, if CarryAll is to realize a
profit on its specialty items it may need to charge a price more in line with its
competitor’s price.
When a company sells a product at a price substantially below that of its
competitors, the company’s management should take a careful look at the costing
system to be sure that the product is being assigned all the costs for which it is
responsible.
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54
Introduction to Managerial Accounting, Fifth Canadian Edition
Comprehensive Problem (LO1 – CC1, 2; LO2 – CC3, 6, 7)
1.
Overhead allocation (activity) rates:
Activity
Window Making
Order Processing
Customer Relations
Other
Total Cost
$535,000
232,000
284,000
319,000
Activity Vol.
100,000 DLH
2,000 orders
100 customers
Not applicable
Activity Rate
$5.35/DLH
$116/order
$2,840/customers
none
Allocation of overhead using activity rates:
Activity
Window Making
Order Processing
Customer Relations
Other
Total overhead cost
Note:
Activity rate
$5.35
116
2,840
none
Kusczik Builders Western Homes
$16,050
$ 107,000
5,800
5,800
2,840
2,840
n/a
n/a
$24,690
$115,640
Overhead is allocated by multiplying the activity rate by the activity consumed
by each customer (e.g., $5.35/DLH multiplied by ($54,000 ÷ 18) and
($360,000 ÷ 18) hours respectively for each customer).
Solutions Manual, Chapter 5
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55
Comprehensive Problem (continued)
Kusczik Builders
Sales revenue
Western Homes
$125,000
$680,000
Direct Materials
42,000
185,000
Direct Labour
54,000
360,000
Overhead
24,690
115,640
$4,310
$19,360
Less:
Income (margin)
2. The overhead charged (allocated) to the two customers is different under the two
methods. In the first case, only a single allocation base (direct labour hours) is used to
allocate overhead, and in this case, overhead charged to Western Homes is 6.7 times
the amount of overhead charged to Kusczik Builders. In the second case, multiple
overhead rates are used, and in this case, overheads charged to Western Homes is only
4.7 times the amount of overhead charged to Kusczik Builders.
Note: The profit from the two customers add up to $23,670 under the ABC system, but
adds up to ($151,100) under the traditional system. This difference of $174,770 is the
result of not assigning the costs from the "Other" activity cost pool to the two
customers.
3.Based on the numbers computed above it indicates that both customers generate a
positive margin but the amounts may not be sufficient to cover the costs of the "Other"
activity cost pool. Although the ABC system provides additional information to
managers it may not be sufficient to allow managers to make meaningful decisions.
Ms. Lukey must attempt to understand costs better in terms of cost behaviour (variable
versus fixed with respect to individual activities) as well as increase revenues so that
the fixed costs can be spread over higher revenues.
4. It will be appropriate to allocate the other costs to the customers if they are directly
related to the customers. However, additional information regarding the composition of
the cost pool is required to decide how to allocate the costs to individual customers. It
is important to note that this cost pool accounts for over 23% of the total overhead
costs which is significant.
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56
Introduction to Managerial Accounting, Fifth Canadian Edition
Thinking Analytically (150 minutes) (LO1 – CC1, 2; LO2 – CC3, 6, 7)
The data collected by Sarah Price suggests that activity costs can be allocated using
transactions as the activity measure (e.g., number of shipments) or time as the activity
measure (e.g., inspection time).
Using transactions as the activity measure, the rates are as follows:
Activity
Amount
Order taking
Inspection
Packaging
Shipping
$
$
$
$
$
Transactions
1,685,000
1,740,000
1,760,000
2,325,000
7,510,000
28,720
36,810
452,500
186,450
Rate
$58.67
$47.27
$ 3.89
$12.47
per
per
per
per
order
inspection
package
shipment
Using these rates activity costs are allocated as:
A*
Order taking
Inspection
Packaging
Shipping
$ 560,884
$ 307,253
$ 383,505
$ 635,961
$1,887,603
B
$ 434,157
$ 431,100
$ 488,833
$ 510,016
$1,864,106
C
D
$ 305,084
$ 352,160
$ 329,052
$ 702,675
$1,688,971
$ 384,875
$ 649,487
$ 558,610
$ 476,348
$2,069,320
* The overhead amounts allocated to Customer A are computed as follows:
Order taking = 9,560 orders × $58.67/order
= $560,884
Inspection
= $307,253
= 6,500 inspections × $47.27/inspection
Packaging = 98,600 packages × $3.89/package
= $383,505
Shipping = 51,000 shipments × $12.47/shipment
= $635,961
Solutions Manual, Chapter 5
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57
Thinking Analytically (continued)
Using time as the activity measure, the rates are as follows:
Activity
Amount
Transactions
Order taking
$ 1,685,000
421,250
Inspection
$ 1,740,000
500,000
Packaging
$ 1,760,000
550,000
Shipping
$ 2,325,000
750,000
Rate
per order
taking hour
per hour of
$3.48
inspection
per hour of
$3.20
packaging
per hour of
$3.10
shipment
$4.00
$ 7,510,000
Using the above rates the activity costs are allocated as
A*
Order taking
Inspection
Packaging
Shipping
$ 320,800
$ 307,249
$ 305,472
$ 638,910
$1,572,431
B
$ 523,200
$ 431,068
$ 593,472
$ 505,114
$2,052,854
C
D
$ 441,840
$ 352,176
$ 401,344
$ 702,770
$1,898,130
$ 399,160
$ 649,507
$ 459,712
$ 478,206
$1,986,585
* The overhead amounts allocated to Customer A are computed as follows:
Order taking = 80,200 hours × $4.00/order taking hour
= $320,800
Inspection
= $307,249
= 88,290 hours × $3.48/hour of inspection
Packaging = 95,460 hours × $3.20/hour of packaging = $305,472
Shipping = 206,100 hour × $3.10/hour of shipment
= $638,910
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58
Introduction to Managerial Accounting, Fifth Canadian Edition
Thinking Analytically (continued)
The amounts allocated to the four customers are different under the two allocation
methods. For example, Customers A and D are allocated a higher amount when
transactions is used as the base but opposite is true for the remaining two customers.
The main reason for this is that the average times required to perform the activities for
the four different customers are different. Consider the order taking activity. Customer
A, on average, requires 8.39 hours per order (80,200 hours ÷ 9,560 orders) whereas
Customer C requires 21.24 hours per order (110,460 hours ÷ 5,200 orders). This
difference does not exist for the inspection activity. The average time required per
inspection is 13.58 hours and is consistent across the four customers. When the hours
are different across the customers the resource requirements will also vary. It is
important for managers to be aware of these differences for the purposes of activity
planning, allocation, decision making and pricing.
Solutions Manual, Chapter 5
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59
Communicating in Practice (45 minutes) (LO1 – CC1, 2)
Date:
Current Date
To:
Maria Graham
From: Student’s Name
Subject:
Overhead Allocation
I understand that you are contemplating the purchase of a small manufacturing
concern that assembles and packages its many products by hand. You plan to automate
the company’s factory. The company currently uses direct labour hours to allocate
overhead to its products. You have asked me to comment on whether this technique
should be continued.
When direct labour is used as an allocation base for overhead, it is assumed that
overhead cost is directly related to direct labour. In a factory that has high direct labour
costs in relation to total product costs, this assumption may be reasonably accurate.
However, when a factory is automated, direct labour tends to decrease in relation to
total product costs while overhead costs increase. Direct labour costs decrease because
machines replace direct labourers. Overhead costs increase as a result of additional
depreciation, power costs, insurance and other related costs.
This suggests that there will no longer be a direct relationship between overhead and
direct labour (that is, when overhead costs increase there is not a related increase in
direct labour costs). In this situation, the overhead cost may be driven (or caused) by
factors such as product diversity and complexity as well as by volume. As such, given
your plans for automation, you should consider whether the use of direct labour hours
to allocate overhead would provide accurate product cost information.
Activity-based costing is an attempt to more accurately assign overhead costs to
products. Basically, overhead costs are allocated based on the activities required to
make the products and the resources that are consumed by these activities. This
technique is more complex than the approach the company is currently using. In
addition, implementation and ongoing recordkeeping costs result from the adoption of
activity-based costing. However, you may find that the benefits of having more
accurate product costs will likely outweigh these costs. As such, I would recommend
that you consider the use of activity-based costing.
I would be pleased to assist you in implementing an activity-based costing system after
the purchase has been consummated. In the meantime, feel free to contact me with
any other questions or concerns.
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60
Introduction to Managerial Accounting, Fifth Canadian Edition
Ethics Challenge (30 minutes) (LO1 – CC1; LO2 – CC8)
1. Shaving 5% off the estimated direct labour-hours in the predetermined overhead
rate will result in an artificially high overhead rate. The artificially high
predetermined overhead rate is likely to result in overapplied overhead for the year.
The cumulative effect of overapplying the overhead throughout the year is all
recognized in December when the balance in the Manufacturing Overhead account
is closed out to Cost of Goods Sold. If the balance were closed out every month or
every quarter, this effect would be dissipated over the course of the year.
2. This question may generate lively debate. Where should Sherri Rowland’s loyalties
lie? Is she working for the division’s president or for the corporate controller? Is
there anything wrong with the “Christmas bonus”? How far should Sherri go in
bucking her boss on a new job?
While individuals can certainly disagree about what Sherri should do, some of the
facts are indisputable. First, the practice of understating direct labour-hours results
in artificially inflating the overhead rate. This has the effect of inflating the cost of
goods sold figures in all months prior to December and overstating the costs of
inventories. In December, the huge adjustment for overapplied overhead provides a
big boost to net income. Therefore, the practice results in distortions in the pattern
of net income over the year. In addition, since all of the adjustment is taken to Cost
of Goods Sold, inventories are still overstated at year-end. This means, of course,
that the net income for the entire year is also overstated.
She read the standards once again but found no further guidance on how to allocate
costs. At the present time overhead costs are allocated using direct labour hours as
a base but she knew that she could have chosen machine-hours as a base or even
chosen multiple bases (or drivers) based on the nature of the overhead. This was
certainly puzzling her as she pondered further.
She asked herself the following questions: “Companies may have different methods
of allocating overhead that they can choose from. If a company changes the
current allocation method to other acceptable methods, would (or should it) impact
income and by how much? Can companies change the allocation method every year
or every quarter? Are there situations when a company should definitely consider
changing its allocation method?” These questions become even more important in
the new context especially when the “White House” is breathing down on the
divisions’ throats.
Solutions Manual, Chapter 5
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61
Ethics Challenge (continued)
While Sherri is in an extremely difficult position, her responsibilities under the CMA’s
Standards of Ethical Conduct for Management Accountants seem to be clear. The
Objectivity Standard states that “management accountants have a responsibility to
disclose fully all relevant information that could reasonably be expected to influence
an intended user’s understanding of the reports, comments, and recommendations
presented.” In our opinion, Sherri should discuss this situation with her immediate
supervisor in the controller’s office at corporate headquarters. This step may bring
her into direct conflict with the president of the division, so it would be a very
difficult decision for her to make.
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62
Introduction to Managerial Accounting, Fifth Canadian Edition
Teamwork in Action (LO1 – CC2)
1. Activity-based costing typically involves the use of a number of activity cost pools. In
theory, all of the overhead costs in a selected activity pool would pertain to a single
activity. An activity rate is developed for each activity pool by dividing the estimated
overhead cost in that activity pool by the expected activity. The overhead costs in
each activity pool are assigned to products by multiplying the pool’s activity rate
times the actual activity measured for each product.
2. The four general levels of activities are:
a. Unit-level activities are performed each time a unit is produced. This level would
include activities such as running production equipment.
b. Batch-level activities are performed each time a batch of goods is handled or
processed. This level would include activities such as setting up a machine in a
factory.
c. Product-level activities are performed as needed to support specific products.
This level would include activities such as maintaining inventories of parts for a
given product.
d. Facility-level activities sustain an organization’s general manufacturing
capabilities. This level would include such activities as maintaining insurance on
the factory.
Solutions Manual, Chapter 5
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63
Chapter 6
Cost Behaviour: Analysis and Use
Solutions to Questions
6-2
a. Unit fixed costs will decrease as volume
increases.
b. Unit variable costs will remain constant as
volume increases.
c. Total fixed costs will remain constant as
volume increases.
d. Total variable costs will increase as volume
increases.
6-3
a. Cost behaviour: Cost behaviour can be
defined as the way in which costs change in
response to changes in some underlying
activity, such as sales volume, production
volume, or orders processed.
b. Relevant range: The relevant range can be
defined as that range of activity within
which assumptions relative to variable and
fixed cost behaviour are valid.
6-4
An activity base is a measure of
whatever causes the incurrence of a variable
cost. Examples of activity bases include units
produced, units sold, letters typed, beds in a
hospital, meals served in a cafe, service calls
made, etc.
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Solutions Manual, Chapter 6
6-5
(See the exhibit below.)
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.
c. Step-variable cost: A step-variable cost is a
cost that is not strictly proportional to a unit
change in activity level. Instead it increases
or decreases only in response to more than
a unitchange in activity level.
Y
$5,000
$4,500
$4,000
$3,500
$3,000
Total Cost
6-1
a. Variable cost: A variable cost remains
constant on a per unit basis, but changes in
total in direct relation to changes in volume.
b. Fixed cost: A fixed cost remains constant in
total amount, but changes, if expressed on a
per unit basis, inversely with changes in
volume.
c. Mixed cost: A mixed cost contains both
variable and fixed cost elements.
$2,500
$2,000
$1,500
$1,000
$500
$0
0
1
2
3
4
5
6
7
8
9
10
11
12
Total Mileage (000)
6-6
The linear assumption is reasonably
valid providing the cost formula is used only
within the relevant range.
6-7
A discretionary fixed cost is one that has
a fairly short planning horizon—usually a year.
Such costs arise from annual decisions by
management to spend in certain fixed cost
areas, such as advertising, research, and
management development. A committed fixed
cost is one that has a long planning horizon—
generally many years. Such costs relate to a
1
13
14
15
16
X
company’s investment in facilities, equipment,
and basic organization. Once such costs have
been incurred, a company becomes “locked in”
to the decision for many years.
6-8
a. Committed
b. Discretionary
c. Discretionary
d. Committed
e. Committed
f. Discretionary
6-9
Yes. As the anticipated level of activity
changes, the level of fixed costs needed to
support operations will also change. In essence,
fixed costs should be viewed as going upward
and downward in broad steps, rather than being
absolutely fixed at one level for all ranges of
activity.
6-10 The major disadvantage of the high-low
method is that it uses only two points in
determining a cost formula and these two points
are likely to be less than typical since they
represent extremes of activity. If one or both of
the points are outliers it can cause a distorted
formula.
6-11 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.
6-12 The regression line is a line that is fitted
to an array of plotted points. A regression line
can be expressed in formula form as Y = a +
bX. In cost analysis, the “a” term represents the
fixed cost element, and the “b” term represents
the variable cost element per unit of activity.
the regression line is smaller than could be
obtained from any other line that could be fitted
to the data.
6-15 The least-squares regression method,
compared to the high-low method, has two main
advantages: (1) it considers all the data points
(observations) instead of just the high and the
low observations, and (2) it is a statistical
technique, and gives an objective measure of
the “goodness of fit” of the regression line.
6-16 The main difference between the leastsquares regression method and the scattergraph
method is that the regression method uses a
statistical technique to fit the regression line and
compute the coefficients of the constant term
and the variable of interest. In contrast, the
scattergraph employs a visual fit
(approximation) method to draw the regression
line which is then used to compute the values of
the coefficients.
6-17 True. A higher R2 means that a greater
proportion of the variation in the dependent
variable (Y) is explained by the variation in the
independent variable of interest (X).
6-18 The contribution margin is total sales
revenue less total variable expenses.
6-19 The contribution approach to the
income statement organizes costs by behaviour,
first deducting variable expenses to obtain
contribution margin, and then deducting fixed
expenses to obtain net income. The traditional
approach organizes costs by function, such as
production, selling, and administration. Within a
functional area, fixed and variable costs are
intermingled.
6-13 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.
6-14 The term “least-squares regression”
means that the sum of the squares of the
deviations from the plotted points on a graph to
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Introduction to Managerial Accounting,FifthCanadian Edition
Foundational Fifteen (LO1 – CC1, 3, 6; LO2 – CC7, 9; LO3 – CC12)
The following table shows the cost per unit for each of the three months. This table,
along with the table in the question, will help in developing the cost equations and
computing the required amounts.
July
Sales in units
Sales revenue
Direct materials
Direct labour
Manufacturing
overhead
Sales commission
Other selling expenses
Administrative
expenses
August September
4,000
$100.00
$ 18.50
$ 22.15
4,200
$100.00
$ 18.50
$ 22.15
4,800
$100.00
$ 18.50
$ 22.15
$ 15.87
$ 7.50
$ 10.49
$ 15.51
$
7.50
$ 10.39
$ 14.73
$
7.50
$
9.24
$ 7.89
$
$
7.51
6.57
6-1. $100 per unit
6-2. Y = $18.50X (variable cost)1
6-3. Y = $22.15X(variable cost)1
6-4. Y = $27,480 + $9.00X (mixed cost)2
6-5. Y = $7.50X (variable cost)1
6-6. Y = $29,960 + $3.00X (mixed cost)2
6-7. Y = $31,550 (fixed cost)3
6-8. $18.50 + $22.15 + $9.00 = $49.65
6-9. $7.50 + $3.00 = $10.50
6-10. $7.50 x 4,100 = $30,750
6-11. $27,480 + ($9.00 x 4,500) = $67,980
6-12. $88,990 + (60.15 x 4,700) = $371,6954
6-13. $100 - $60.15 = $39.85
6-14. $39.85 x 4,000 = $159,400
6-15. ($39.85 x 4,600) - $88,990 = $94,3205
Notes:
1. As shown in the table above the cost per unit for these three cost items is
constant across all months. Therefore, these cost items are classified as variable
costs.
2. The cost per unit for these items is inversely proportional to the sales in units.
However, the total cost per month is directly proportional with the sales in units.
Therefore, these cost items are classified as mixed costs.
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Solutions Manual, Chapter 6
3
The variable portion for each of the two mixed cost items is computed as shown
below.
Sales Units
High activity –
September
Low activity July
Difference
Observed Costs
Manufacturing
Other Selling
Overhead
Expenses
4,800
$70,680
$44,360
4,000
$63,480
$41,960
800
$ 7,200
$2,400
The variable cost portion for Manufacturing Overhead and Other Selling Expenses,
respectively, are computed as shown below:
Change in cost
$7,200
=
=$9 per unit
Change in activity 800 units
Change in cost
$2,400
=
=$3 per unit
Change in activity 800 units
The fixed portion for Manufacturing Overhead and Other Selling Expenses, respectively,
are computed as shown below:
$70,680 – ($9 ˣ 4,800)
$41,960 – ($3 ˣ 4,000)
= $27,480
= $29,960
3. The total cost is constant across all months; therefore this cost item is classified
as a fixed cost.
4. The fixed portion of this cost equation is computed as follows:
$27,480 + $29,960 + 31,550
The variable portion of this cost equation is computed as follows:
$18.50 + $22.15 + $9.00 +7.50 + $3.00
5. Income is computed as total contribution margin for the 4,600 units sold
(@$39.85 per unit as shown in #13 above, multiplied by 4,600) minus the total
fixed costs of $88,990 (as shown in #12 above and also Note #4 above).
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Introduction to Managerial Accounting,FifthCanadian Edition
Solutions to Brief Exercises
Brief Exercise6-1 (15 minutes) (LO1 CC1, 3)
1.
Cups of Coffee Served
in a Week
3,000
3,200
3,400
Fixed cost ................................................................
$2,200
$2,200
Variable cost ................................................................
540
576
Total cost ................................................................
$2,740
$2,776
Cost per cup of coffee served * ................................
$0.913
$0.868
$2,200
612
$2,812
$0.827
* Total cost ÷ cups of coffee served in a week.
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.
Brief Exercise 6-2 (20 minutes) (LO2 CC9)
1.
Month
OccupancyDays
Electrical
Costs
High activity level (March) ................................
2,536
224
Low activity level (October) ................................
Change ................................................................
2,312
$5,383
1,988
$3,395
Variable cost = Change in cost ÷ Change in activity
= $3,395 ÷ 2,312 occupancy-days
= $1.47 per occupancy-day.
Total cost (March).........................................................................$5,383
Variable cost element
3,728
($1.47 per occupancy-day × 2,536 occupancy-days) ....................
Fixed cost element ........................................................................$1,655
Cost equation for electrical costs can be stated as follows:
Electrical costs (Y) = $1,655 per month + $1.47 per occupancy-day
2. Electrical costs may reflect seasonal factors other than just the variation in
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 fluctuations
in the fixed electrical costs. Additionally, the fixed costs will be affected by the
number of days 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
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Solutions Manual, Chapter 6
5
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.
Brief Exercise 6-3 (30 minutes) (LO2 CC10)
1. See the scattergraph on the following page.
2. Students’ answers will vary, depending on their placement of the regression line.
The variable cost per unit processed is:
Total cost at the 10,000-unit level of activity [approximate
amount based on visual inspection] ............................................
$48,750
Total cost at the 5,000-unit level of activity [approximate
amount based on visual inspection] ............................................
$36,250
Change in cost
$12,500
Variable cost element per unit produced
[$12,500 ÷ 5,000 units produced]...............................................$2.50
Fixed cost element [where the regression line intersects
the Y-axis] ................................................................................
25,000
Therefore, the cost formula is $25,000 per month plus $2.50 per unit processed.
(Observe from the scattergraph that if the company used the high-low method to
determine the slope of the regression line, the line would be too parallel to the line
shown in the plot but below it, causing estimated fixed costs to be lower than they
should be, and the variable cost per unit to be close to what is computed above.)
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Introduction to Managerial Accounting,FifthCanadian Edition
Brief Exercise 6-3 (continued)
$70,000
Processing Cost
$60,000
$50,000
$40,000
$30,000
Series1
$20,000
$10,000
$0
0
5,000
10,000
15,000
20,000
Units Produced
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Solutions Manual, Chapter 6
7
Brief Exercise 6-4 (20 minutes) (LO2 CC11)
The estimates of the fixed and variable costs using least-squares regression is as
follows:
Fixed cost:
$25,193 per month
Variable cost: $2.42 per unit produced.
The R2 is about 92%, which means that the cost manager of Oki Products can be fairly
confident that units produced is a reliable basis for estimating processing costs.
Students can be asked to compare these estimates with those from the scattergraph
method in the previous exercise.
The INTERCEPT and SLOPE functions can be used in Excel to calculate the fixed and
variable cost numbers, and the RSQ function to calculate R2.
Brief Exercise 6-5 (10 minutes)(LO1 CC1, 3; LO3 CC12)
Contribution margin income statement.
Sales
Less: variable costs1
Contribution margin
Less: fixed expenses2
Net income
$45,000
27,000
$18,000
12,000
$ 6,000
1
Using sales revenue and average selling price, we can compute the number of units
sold as 3,000 ($45,000 ÷ $15). Therefore, total variable costs = 3,000 × $9 =
$27,000.
2
Fixed expenses = $39,000 - $27,000 = $12,000
Brief exercise 6-6 (10 minutes) (LO1 CC6; LO2 CC7, 8)
Cost functions 1, 2, 3, and 4 are linear functions (although 3 is simply a constant
function, which means the value of the dependent variable will not vary with any
variation in the value of the independent variable). Cost function 5 is a non-linear
function.
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Introduction to Managerial Accounting,FifthCanadian Edition
Cost functions 1, 2, and 5 are mixed cost functions in that they include a constant term
and a variable term. The remaining two cost functions are not mixed (#3 has only a
fixed cost element and #4 has only a variable cost element).
Brief Exercise 6-7 (15 minutes) (LO2 CC9)
Pizzas
Cost
High activity level
Low activity level
Change
Variable portion
32,000
24,000
12,520
8,000 3,520
16,040
= Change in cost÷change in activity
= $3,520 ÷ 8,000 = $0.44 per pizza.
Fixed portion:
High
Total cost
$16,040
Less variable portion @$0.44 per pizza 14,080
Fixed cost element
$ 1,960
Low
$12,520
10,560
$ 1,960
Cost equation can be stated as follows:
Utilitycosts (Y) = $1,960 per month + $0.44 per pizza
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Solutions Manual, Chapter 6
9
Brief Exercise 6-8 (20 minutes) (LO3 CC12)
1.
THE ALPINE HOUSE, INC.
Income Statement—Ski Department
For the Quarter Ended March 31
Sales ............................................................................................
Less variable expenses:
Cost of goods sold ($450 per pair × 800 pairs*) ..........................
$360,000
Selling expenses ($50 per pair × 800 pairs) ................................
40,000
Administrative expenses (20% × $20,000) ................................ 4,000
Contribution margin ................................................................
Less fixed expenses:
Cost of goods sold
[$390,000 – ($450 per pair × 800 pairs]
30,000
Selling expenses
[$60,000 – ($50 per pair × 800 pairs)]................................ 20,000
Administrative expenses (80% × $20,000) ................................16,000
Net income ...................................................................................
$560,000
404,000
156,000
66,000
$ 90,000
*$560,000 ÷ $700 per pair = 800 pairs.
2. Since 800 pairs of skis were sold and the contribution margin totalled $156,000 for
the quarter, the contribution of each pair of skis toward covering fixed costs and
toward profits was $195 ($156,000 ÷ 800 pairs).
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Introduction to Managerial Accounting,FifthCanadian Edition
Solutions to Exercises
Exercise 6-1 (30 minutes) (LO2 CC9)
1.
GuestDays
High activity level (June) ................................
28,500
Low activity level (April) ................................12,500
Change ................................................................
16,000
Custodial
Supplies
Expense
$28,850
19,250
$ 9,600
Variable cost portion:
Change in expense ÷Change in activity = $9,600÷16,000 = $0.60 per guest day
Fixed cost portion:
Custodial supplies expense at high activity level .............................
$28,850
Less variable cost element
28,500 guest-days × $0.60 per guest-day................................ 17,100
Total fixed cost .............................................................................
$11,750
The cost formula is $11,750 per month plus $0.60 per guest-day or
Y = $11,750 + $0.60x.
2. Custodial supplies expense for 13,000 guest-days:
Variable cost
13,000 guest-days × $0.60 per guest-day ................................
$ 7,800
Fixed cost ................................................................
11,750
Total cost ................................................................
$19,550
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Solutions Manual, Chapter 6
11
Exercise 6-2 (30 minutes) (LO2 CC11)
The use of a spreadsheet to conduct the least-squares regression analysis returns the
following results:
Fixed cost:
$11,591
Variable cost: $0.62 per guest-day occupied.
Cost formula: Y = $11,591 + $0.62x.
Custodial supplies expense for 13,000 guest-days:
Variable cost
13,000 guest-days × $0.62 per guest-day ................................
$ 8,060
Fixed cost ................................................................
11,591
Total cost ................................................................
$19,651
The estimated cost for 13,000 guest-days using least-squares regression is slightly
higherthan the estimate using high-low method. Least-squares regression is a superior
method because it uses all data points in the computation of the cost estimates.
The R2 of the cost estimates is 98.6% which means only 1.4% of the variation in
custodial expenses is not explained by variation in guest-days.
The INTERCEPT and SLOPE functions can be used in Excel to calculate the fixed and
variable cost numbers, and the RSQ function to calculate R2.
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Introduction to Managerial Accounting,FifthCanadian Edition
Exercise 6-3 (45 minutes) (LO2 CC8, 9, 10)
1.
The scattergraph would be:
Custodial Supplies Expense versus Occupancy-Days
$35,000
Custodial Supplies Expense
$30,000
$25,000
$20,000
$15,000
$10,000
$5,000
$-
5,000
10,000
15,000
20,000
25,000
30,000
Guest Occupany Days
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Solutions Manual, Chapter 6
13
Exercise 6-3 (continued)
Note: Students’ answers will vary, depending on how they visually fit the regression line
to the data.
2. Total costs at 15,000 guest-days per month [approximate
amount] .................................................................................... $20,900
Total costs at 25,000 guest-days per month [approximate
amount] .................................................................................... $27,100
Change in cost
$ 6,200
Variable cost element per guest-day
[$6,200 ÷ 10,000 guest-days] ..................................................... $0.62
Fixed cost element [where the regression line intersects the Yaxis]
$12,000
The cost formula is therefore $12,000 per month, plus $0.62 per guest-day or
Y = $12,000 + $0.62X.
3. The high-low method would not provide an accurate cost formula in this situation,
since a regression line cutting the high and low points would have a flatter slope
than both the scattergraph and least square regression lines, and would be placed
too high, cutting the cost axis at about $12,500 per month. Although the high and
low points are not representative of all of the data in this situation, the high-low
regression line in this case is not too far different from the result that the least
square regression method yields. The high and low points are not considered
outliers. If they were, calculating the high-low method would result in a considerable
difference between that and the square regression method and scattergraph
method.
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Introduction to Managerial Accounting,FifthCanadian Edition
Exercise 6-4 (45 minutes) (LO2 CC9, 10)
1.
Units Shipped
High activity level (June) ................................
8
Low activity level (July) ................................
2
Change ................................................................
6
Shipping Expense
$2,700
1,200
$1,500
Variable cost element:
Change in expense $1,500
=
=$250 per unit.
Change in activity 6 units
Fixed cost element:
Shipping expense at high activity level ........................................... $2,700
Less variable cost element ($250 per unit × 8 units) ...................... 2,000
Total fixed cost ............................................................................. $ 700
The cost formula is $700 per month plus $250 per unit shipped or
Y = $700 + $250X.
2. a) See the graph on the following page.
b) Note: Students’ answers will vary, depending on how they visually fit the
regression line to the data.
Total cost at 4 units shipped per month [approximate
amount] ...................................................................................
Total cost at 6 units shipped per month [approximate
amount] ...................................................................................
Change in cost .............................................................................
Variable cost per unit [$430 ÷ 2 units]
Fixed cost element (where the regression line intersects the
Y axis) ......................................................................................
$ 1,700
$2,130
$ 430
$ 215
$ 820
The cost formula is $820per month plus $215 per unit shipped or
Y = $820+ $215X.
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Solutions Manual, Chapter 6
15
Exercise 6-4 (continued)
2. a) The scattergraph would be:
Y
$3,000
Shipping Expense
$2,500
$2,000
$1,500
$1,000
$500
$0
0
2
4
6
Units Shipped
8
10
X
3. The cost of shipping units is likely to depend on the weight and volume of the units
and the distance traveled as well as on the number of units shipped.
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16
Introduction to Managerial Accounting,FifthCanadian Edition
Exercise 6-5 (30 minutes) (LO2 CC7, 9)
Kilometres
Driven
1.
Total Annual
Cost*
High level of activity................................................................
105,000
$13,298
Low level of activity ................................................................
70,000
10,150
Change ................................................................
35,000
$ 3,148
* 105,000 kilometres × $0.12665 per kilometre= $13,298
70,000 kilometres × $0.145 per kilometre = $10,150
Variable cost per kilometre:
Change in cost
$3,148
=
=$0.09 per kilometer.
Change in activity 35,000 kilometers
Fixed cost per year:
Total cost at 70,000 kilometres......................................................
$10,150
Less variable portion
70,000 kilometres × $0.09 per kilometre ................................6,300
Fixed cost per year ................................................................$ 3,850
2. Y = $3,850 + $0.009X.
3. Fixed cost.....................................................................................
$ 3,850
Variable cost
80,000 kilometres × $0.09 per kilometre ................................ 7,200
Total annual cost ................................................................
$11,050
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Solutions Manual, Chapter 6
17
Exercise 6-6 (15 minutes) (LO1 CC1, 3; LO2 CC7; LO3 CC12)
1. The company’s variable cost per unit would be:
DM + DL + VOH + Sales commission = $12 + $7 + $3+ $31= $25.00
1Sales
Commission ($60 * 5%) = $3
Cost equation = Y = a + bX
Y = $38,000 + $25X
2. The contribution margin per bike:
Sales ..........................................................................................
$60
Less variable expenses ................................................................25
Contribution margin ................................................................ $35
For each bike, contribution margin = $35, and
Contribution margin percentage = $35 ÷ $ 60 ≈ 58.33%
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18
Introduction to Managerial Accounting,FifthCanadian Edition
Exercise 6-7 (30 minutes) (LO1 CC1, 3; LO3 CC12)
1. The company’s variable cost per unit would be:
$180,000
=$6 per unit.
30,000 units
The company’s average fixed cost per unit at 40,000 units of volume is $7.50. This
means that total fixed cost amounts to $300,000 (40,000 ˣ $7.50 per unit).
In accordance with the behaviour of variable and fixed costs, the completed schedule
would be:
Units produced and sold
30,000
40,000
50,000
Total costs:
Variable costs @ 6/unit ................................
$180,000
$240,000
Fixed costs ................................
300,000
300,000
Total costs ................................
$480,000
$540,000
Cost per unit:
Variable cost ................................
$ 6.00
$ 6.00
Fixed cost ................................ 10.00
7.50
Total cost per unit ................................
$16.00
$13.50
$300,000
300,000
$600,000
$ 6.00
6.00
$12.00
2. The company’s income statement in the contribution format would be:
Sales (45,000 units × $16 per unit) ................................ $720,000
Less variable expenses
(45,000 units × $6 per unit) .......................................................
270,000
Contribution margin ................................................................
450,000
Less fixed expense................................................................
300,000
Net income ................................................................ $150,000
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Solutions Manual, Chapter 6
19
Problem 6-1(LO2 CC9) (30 minutes)
1. a) Change in cost:
Monthly operating costs at 90% occupancy (high level of
activity):
450 beds × 90% = 405 beds;
405 beds × 30 days × $29 per bed-day ...................................... $352,350
Monthly operating costs at 50% occupancy (low level, given).......... 326,700
Change in cost ............................................................................. $ 25,650
Change in activity:
90% occupancy (450 beds × 90% × 30 days) ............................
50% occupancy (450 beds × 50% × 30 days) ............................
Change in activity ......................................................................
12,150
6,750
5,400
Change in cost
$25,650
=
=$4.75 per bed-day.
Change in activity 5,400 bed-days
b) Monthly operating costs at 90% occupancy (above)........................$352,350
Less variable costs
405 beds × 30 days × $4.75 per bed-day ................................
57,713
Fixed operating costs per month ....................................................$294,637
2. 450 beds × 70% = 315 beds occupied.
Fixed costs ...................................................................................
Variable costs: 315 beds × 30 days × $4.75 per bed-day ................
Total expected costs .....................................................................
$294,637
44,888
$339,525
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20
Introduction to Managerial Accounting,FifthCanadian Edition
Problem 6-2(LO2 CC10) (45 minutes)
1. The scattergraph is presented below.
Y
Total cost
Total cost, 15,
Total
cost,
Total18400
cost, 13,
14,
18100
18000
Total cost, 12,
Total cost,
11,
17000
16500
Total cost, 8,
Total cost,
7,
15700
Total cost, 10,
15300
15000
Total cost, 6,
14300
4
Total cost, 4,
13000
8
7
12
6
11
14
10
13
15
X
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Solutions Manual, Chapter 6
21
Problem 6-2 (continued)
2. (Note: Students’ answers will vary, depending on how they draw their regression
line.)
The fixed cost element can be obtained by noting the point where the regression
line intersects the vertical (cost) axis. As shown on the scattergraph, this point is at
approximately $2,500 per month. Given this figure, the variable cost element can be
obtained by the following computation:
Total cost at 10,000 kilometres driven per month
[approximate amount] ...............................................................
$16,110
Total cost at 5,000 kilometres driven per month
[approximate amount] ...............................................................
$13,730
Change in cost .............................................................................$ 2,380
Variable cost per kilometre [$2,380 ÷ 5,000 kilometre] ..................$ 0.476
Fixed cost (where the regression line intersects the Y axis) .............
$11,350
Therefore, the cost of operating the autos can be expressed as $11,350 per month
plus $0.476 per kilometre driven or
Y = $11,350 + $0.476X.
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22
Introduction to Managerial Accounting,FifthCanadian Edition
Problem 6-3(LO2 CC8, 9, 10) (60 minutes)
1. High-low method:
Number of
Scans
High level of activity ................................
260
Low level of activity ................................
40
Change ................................ 220
Variable rate:
Fixed cost:
Utilities Cost
$16,000
4,250
$11,750
Change in cost
$11,750
=
=$53.41 per scan .
Change in activity 220 scans
Total cost at high level of activity ................................
$16,000
Less variable element:
260 scans × $53.41 per scan ................................13,887
Fixed cost element................................................................
$2,113
Therefore, the cost formula is: Y = $2,113 + $53.41X.
2. Scattergraph method (see the scattergraph on the following page):
(Note: Students’ answers will vary according to their placement of the regression
line.)
Total cost at 200 scans [approximate amount] ............................... $13,250
Total cost at 100 scans [approximate amount] ............................... $ 7,290
Change in cost
$5,960
Variable element per scan [$5,960 ÷ 100 scans]
$59.60
Fixed cost element [where the regression line intersects the Yaxis] ......................................................................................... $ 1,530
Therefore, the cost formula is: Y = $1,530 + $59.60X.
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Solutions Manual, Chapter 6
23
Problem 6-3 (continued)
The completed scattergraph:
$18,000
U
t
i
l
i
t
i
e
s
$16,000
$14,000
$12,000
C
o $10,000
s $8,000
t
$6,000
$4,000
$2,000
$-
50
100
150
200
250
300
Number of scans
3. Least-squares Regression
Cost formula:
Y = $1,716 + $59.92X.
4. The cost formulas from the three methods are as follows:
High-low method:
Y = $2,113 + $53.41X.
Scattergraph:
Y = $1,530 + $59.60X.
Least-squares regression: Y = $1,716 + $59.92X.
The estimates from the scattergraph and least-squares regression are close but the
estimates from the high-low method are significantly different. This one again shows
that using only two end points to compute the cost estimates can be problematic.
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24
Introduction to Managerial Accounting,FifthCanadian Edition
Problem 6-4(LO1 CC1, 3, 6; LO2 CC9; LO3 CC12) (45 minutes)
Variable
1. Cost of goods sold ................................
Advertising expense ................................
Fixed
Shipping expense ................................
Mixed
Salaries and commissions ................................
Mixed
Insurance expense................................
Fixed
Depreciation expense ................................
Fixed
2. Analysis of the mixed expenses:
Shipping
Expense
Units
High level of activity ................................
5,000
A$38,000
Low level of activity ................................
4,000
34,000
Change ................................................................
1,000
A$ 4,000
Salaries and
Commission
Expense
A$90,000
78,000
A$12,000
Variable cost element:
Variable rate=
Change in cost
Change in activity
Shipping expense:
A$4,000
=A$4 per unit.
1,000 units
Salaries and Commission Expense:
A$12,000
=A$12 per unit.
1,000 units
Fixed cost element:
Shipping
Expense
Cost at high level of activity ................................
A$38,000
Less variable cost element:
20,000
5,000 units × A$4 per unit ................................
5,000 units × A$12 per unit ................................
Fixed cost element ................................ A$18,000
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Solutions Manual, Chapter 6
Salaries and
Commission
Expense
A$90,000
60,000
A$30,000
25
Problem 6-4 (continued)
The cost formulas are:
Shipping expense:
A$18,000 per month plus A$4 per unit
or
Y = A$18,000 + A$4X.
Salaries and commission expense:
A$30,000 per month plus A$12 per unit
or
Y = A$30,000 + A$12X.
3.
Morrisey& Brown, Ltd.
Income Statement
For the Month Ended September 30
Sales in units ................................................................
Sales revenue (@ A$100 per unit) ................................
Less variable expenses:
Cost of goods sold (@ A$60 per unit) ................................
A$300,000
Shipping expense (@ A$4 per unit) ................................ 20,000
Salaries and commissions expense
(@ A$12 per unit) ................................................................
60,000
Contribution margin ................................................................
Less fixed expenses:
Advertising expense ................................................................
21,000
Shipping expense ................................................................
18,000
Salaries and commissions expense................................ 30,000
Insurance expense................................................................
6,000
Depreciation expense ................................................................
15,000
Net income................................................................
5,000
A$500,000
380,000
120,000
90,000
A$30,000
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26
Introduction to Managerial Accounting,FifthCanadian Edition
Problem 6-5 (LO1 CC1, 2, 3, 6)(30 minutes)
1.
a.
b.
3
6
c.
d.
11
1
e.
f.
4
10
g.
h.
2
7
i. 9
2. Without knowledge of the underlying cost behaviour patterns, it would be difficult if
not impossible for a manager to properly analyze the firm’s cost structure. The
reason is that all costs don’t behave in the same way. One cost might move in one
direction as a result of a particular action, and another cost might move in an
opposite direction. Unless the behaviour pattern of each cost is clearly understood,
the impact of a firm’s activities on its costs will not be known until after the activity
has occurred.
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Solutions Manual, Chapter 6
27
Problem 6-6(LO2 CC9)(60 minutes)
1. Maintenance cost at the 150,000 direct labour-hour level of activity can be isolated
as follows:
Level of Activity
100,000 DLH
150,000 DLH
Total factory overhead cost................................ ¥12,450,000
Deduct:
Indirect materials @ ¥42 per DLH* ................................
(4,200,000)
Rent ................................................................ (5,500,000)
Maintenance cost ................................................................
¥ 2,750,000
¥15,275,000
(6,300,000)
(5,500,000)
¥ 3,475,000
* ¥4,200,000 ÷ 100,000 DLH = ¥42 per DLH.
2. High-low analysis of maintenance cost:
Direct LabourHours
Maintenance Cost
High level of activity ................................
150,000
100,000
Low level of activity ................................
Change ................................................................
50,000
¥3,475,000
2,750,000
¥ 725,000
Variable cost element:
Change in cost
¥725,000
=
=¥14.50 per DLH .
Change in activity 50,000 DLH
Fixed cost element:
Total cost at the high level of activity ................................
¥3,475,000
Less variable cost element
(¥14.50 per DLH × 150,000 DLH) ...............................................
2,175,000
Fixed cost element ................................................................ ¥1,300,000
Therefore, the cost formula for maintenance is: ¥1,300,000 per year plus ¥14.50 per
direct labour-hour or
Y = ¥1,300,000 + ¥14.50X.
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28
Introduction to Managerial Accounting,FifthCanadian Edition
Problem 6-6 (continued)
3. Total factory overhead cost at 70,000 direct labour-hours would be:
Indirect materials
(70,000 DLH × ¥42 per DLH) ................................
¥ 2,940,000
Rent ............................................................................................
5,500,000
Maintenance:
Variable cost element
(70,000 DLH × ¥14.50 per DLH)................................
¥1,015,000
Fixed cost element................................................................
1,300,000
2,315,000
Total factory overhead cost ........................................................... ¥10,755,000
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Solutions Manual, Chapter 6
29
Problem 6-7(LO2 CC9)(60 minutes)
1. Maintenance cost at the 90,000 machine-hour level of activity can be isolated as
follows:
Level of Activity
60,000 MHs
90,000 MHs
Total factory overhead cost................................
$174,000
$246,000
Deduct:
Utilities cost @ $0.80 per MH* ................................
48,000
72,000
Supervisory salaries ................................
21,000
21,000
Maintenance cost ................................................................
$105,000
$153,000
*$48,000 ÷ 60,000 MHs = $0.80 per MH.
2. High-low analysis of maintenance cost:
MachineHours
Maintenance
Cost
High activity level ................................ 90,000
Low activity level ................................ 60,000
Change ................................................................
30,000
$153,000
105,000
$ 48,000
Variable rate:
Change in cost
$48,000
=
=$1.60 per MH.
Change in activity 30,000 MHs
Total fixed cost:
Total maintenance cost at the high activity level .............................
$153,000
Less variable cost element
(90,000 MHs × $1.60 per MH) ...................................................
144,000
Fixed cost element ................................................................ $ 9,000
Therefore, the cost formula for maintenance is: $9,000 per month plus $1.60 per
machine-hour or
Y = $9,000 + $1.60X.
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30
Introduction to Managerial Accounting,FifthCanadian Edition
Problem 6-7 (continued)
3.
Variable Rate
per MachineHour
Maintenance cost ................................$1.60
Utilities cost................................
0.80
Supervisory salaries cost ................................
Totals ................................................................
$2.40
Fixed Cost
$ 9,000
21,000
$30,000
Thus, the cost formula would be: Y = $30,000 + $2.40X.
4. Total overhead cost at an activity level of 75,000 machine-hours:
Fixed costs ...................................................................................
$ 30,000
Variable costs: $2.40 per MH × 75,000 MHs ................................
180,000
Total overhead costs ................................................................
$210,000
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Solutions Manual, Chapter 6
31
Problem 6-8 (LO2 CC9; CHAPTER 2 LO6 CC12) (75 minutes)
1.
March—Low
5,000 Units
Direct materials cost @ $10.00 per unit ................................
$ 50,000
Direct labour cost @ $12.00 per unit................................
60,000
Manufacturing overhead cost* ................................ 144,000
Total manufacturing costs ................................
254,000
Add: Work in process, beginning................................ 29,000
283,000
Deduct: Work in process, ending ................................ 15,000
Cost of goods manufactured ................................ $268,000
June—High
9,000 Units
$ 90,000
108,000
168,000
366,000
52,000
418,000
21,000
$397,000
*Computed by working upwards through the statements.
2.
Units
Produced
June—High level of activity ................................
9,000
March—Low level of activity ................................
5,000
Change ................................................................
4,000
Cost
Observed
$168,000
144,000
$ 24,000
Change in cost
$24,000
=
=$6 per unit .
Change in activity
4,000 units
Total cost at the high level of activity ................................ $168,000
Less variable cost element
($6 per unit × 9,000 units) .........................................................
54,000
Fixed cost element ................................................................
$ 114,000
Therefore, the cost formula is: $114,000 per month, plus $6.00 per unit produced or
Y = $114,000 + $6.00X.
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32
Introduction to Managerial Accounting,FifthCanadian Edition
Problem 6-8 (continued)
3. The cost of goods manufactured if 7,000 units are produced:
Direct materials cost ($10.00 per unit × 7,000 units).......................
Direct labour cost ($12.00 per unit × 7,000 units) ...........................
Manufacturing overhead cost:
Fixed portion ................................................................ $114,000
Variable portion ($6.00 per unit × 7,000 units) ............................
42,000
Total manufacturing costs ..............................................................
$ 70,000
84,000
Cost of goods manufactured ..........................................................
$310,000
156,000
310,000
Note: The question states that there is no change in work-in-process inventory;
therefore the Cost of goods manufactured will be the same as the Total manufacturing
costs.
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Solutions Manual, Chapter 6
33
Problem 6-9 (LO1 CC5; LO2 CC9, 11) (60 minutes)
1.
We can use the equation format Y= a + bX, where
y = customer service costs,
a = fixed cost portion
b = variable cost per customer
x = number of customers
b = ($679,440 - $479,280) ÷ (498 - 318)
= $200,160 ÷ 180 = $1,112 per customer
a = $679,440 - ($1,112 X 498)
= $679,440 - $553,776 = $125,664 per month
Monthly cost equation: Y = $125,664 + $1,112X per customer
2.
Y550 = $125,664 + $1,112 × 550 = $737,264
Although this calculation may provide a rough estimate of the costs at the level of 550
customers the estimate suffers from the limitation that 550 customers is outside of the
high-low range of customers which were used to perform the computations. It is quite
possible that the cost structure could be different when operating outside of the
relevant range of operations (e.g., fixed costs may increase).
3.
Least-squares Regression
Cost formula:
Y = $82,231 + $1,227.02X
The R2 is 91.5%, which means that only 8.5% of the variation in customer service costs
is not explained by the number of customers. This would suggest that number of
customers in the month is a reliable basis for estimating customer service cost.
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34
Introduction to Managerial Accounting,FifthCanadian Edition
Problem 6-10 (LO3 CC12) (30 minutes)
1.
Variable portion of the cost of goods sold (COGS) = 65%
= 65% × $3,840,000
= $2,496,000
On a per unit basis, variable cost
= $2,496,000 ÷ 2,500 units
= $998.40 per unit
Therefore, fixed portion of GOGS
= $3,840,000 - $2,496,000
= $1,344,000
Therefore the cost formula for COGS is as follows:
Y = $1,344,000 per quarter + $998.40X
Where X = number of units
Fixed portion of selling expenses = $800,000
Therefore, variable portion
= $1,024,000 - $800,000
= $224,000
On a per unit basis, variable cost
= $224,000 ÷ 2,500 units
= $89.60 per unit
Therefore the cost formula for selling expenses is as follows:
Y = $800,000 per quarter + $89.60X
Administrative expenses of $1,000,000 are entirely fixed.
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Solutions Manual, Chapter 6
35
Problem 6-10 (continued)
2.
The contribution margin income statement will be as follows:
Sales (2,500 units@$2,800 per
unit)
Less: Variable Costs
COGS
Selling expenses
Contribution margin
Less: fixed expenses
COGS
Selling expenses
Administrative expenses
Income
$ 2,496,000
$
224,000
$ 1,344,000
$
800,000
$ 1,000,000
$
7,000,000
$
2,720,000
$
4,280,000
$
$
3,144,000
1,136,000
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36
Introduction to Managerial Accounting,FifthCanadian Edition
Problem 6-11 (LO1 – CC1, 3, 6; LO2 – CC7, 9; LO3 – CC12) (40 minutes)
1.
Three of the six expense items are fixed in nature: Advertising; Insurance and
Depreciation. The cost equations for these expenses are as follows:
Advertising:
Insurance:
Depreciation:
Y= $70,000
Y=$9,000
Y=$42,000
The remaining three are mixed in nature. We can use the high-low method to separate
the variable and fixed components of these mixed costs.
The variable component can be computed as shown below:
Observed Costs
Sales Units
High activity –
June
Low activity April
Difference
COGS
Shipping
Salaries &
Commissions
6,000
$426,000
$71,000
$180,500
4,500
$342,000
$56,000
$143,000
1,500
$ 84,000
$15,000
$ 37,500
The variable cost portion for COGS, Shipping & Salaries and Commissions, respectively,
are computed as shown below:
Change in cost
$84,000
=
=$56 per unit
Change in activity 1,500 units
Change in cost
$15,000
=
=$10 per unit
Change in activity 1,500 units
Change in cost
$37,500
=
=$25 per unit
Change in activity 1,500 units
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 6
37
Problem 6-11 (continued)
The fixed cost portion is computed as follows:
COGS:
Fixed cost
= $426,000 – (6,000ˣ $56) =
= $342,000 – (4,500 ˣ $56) =
$90,000
$90,000
= $71,000 – (6,000ˣ $10) =
= $71,000 – (4,500 ˣ $10) =
$11,000
$11,000
Shipping:
Fixed cost
Salaries and Commissions:
Fixed cost
= $180,500 – (6,000ˣ $25) =
= $143,000 – (4,500 ˣ $25) =
$30,500
$30,500
The cost equations are as follows:
COGS:
Y= $90,000 + 56X
Shipping:
Y=$11,000 + 10X
Salaries and commissions:
Y=$30,500 + 25X
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38
Introduction to Managerial Accounting,FifthCanadian Edition
Problem 6-11 (continued)
2.
Central Valley Company
Contribution Income Statement
For the month ended September 30
Sales (5,500 ˣ $1401)
Variable costs:
COGS
(5,500 ˣ $56)
Shipping (5,500 ˣ $10)
Commissions2 (5,500 ˣ $25)
Contribution margin
Less fixed costs:
Cost of goods sold
Shipping
Advertising
Salaries2
Insurance
Depreciation
Net income
$770,000
$308,000
55,000
137,500
90,000
11,000
70,000
30,500
9,000
42,000
500,500
269,500
252,500
$ 17,000
1
Average sales price is computed by dividing the sales revenue by the number of units
sold for any of the four months for which data is provided (e.g., $840,000 ÷ 6,000 =
$140).
2
Of the Salaries & Commissions expense, it is assumed that ‘commissions’ is the
variable portion and ‘salaries’ is the fixed portion.
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Solutions Manual, Chapter 6
39
Comprehensive Problem (LO1CC5; LO2CC9, 10)(60 minutes)
1. High-low method:
Year 1
Hours
Cost
High level of activity ................................
84,000
$990,450
Low level of activity ................................
35,000
645,000
Change................................................................
49,000
$345,450
Variable element: $345,450 ÷ 49,000 DLH = $7.05 per DLH.
Fixed element:
Total cost at 84,000 DLH ..............................................................
$990,450
Less variable element:
84,000 DLH × $7.05 per DLH ................................
592,200
Fixed element ................................................................
$398,250
Therefore, the cost formula is: Y = $398,250 + $7.05X.
Year 2
Hours
Cost
High level of activity ................................
87,500
$928,450
Low level of activity ................................
42,000
675,000
Change................................................................
45,500
$253,450
Variable element: $253,450 ÷ 45,500 DLH ≈ $5.57 per DLH.
Fixed element:
Total cost at 87,500 DLH...............................................................
$928,450
Less variable element:
87,500 DLH × $5.57 per DLH ................................487,375
Fixed element ................................................................
$441,075
Therefore, the cost formula is: Y = $441,075 + $5.57X.
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40
Introduction to Managerial Accounting,FifthCanadian Edition
Combined
Hours
Cost
High level of activity ................................
87,500
$928,450
Low level of activity ................................
35,000
645,000
Change................................................................
52,500
$283,450
Variable element: $283,450 ÷ 52,500 DLH ≈ $5.40 per DLH.
Fixed element:
Total cost at 87,500 DLH...............................................................
$928,450
Less variable element:
472,500
87,500 DLH × $5.40 per DLH ................................
Fixed element ................................................................
$455,590
Therefore, the cost formula is: Y = $455,590 + $5.40X.
2. Least-squares regression method:
Year 1
Variable cost
Fixed cost
≈ $6.00 per DLH
≈ $410,307
Therefore, the cost formula is as follows: Y = $410,307 + $6.00X (Adjusted R2 =
80.8%)
Year 2
Variable cost
Fixed cost
≈ $6.09 per DLH
≈ $397,315
Therefore, the cost formula is as follows: Y = $397,315 + $6.09X (Adjusted R2 =
87.8%)
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Solutions Manual, Chapter 6
41
Comprehensive Problem (continued)
Combined
Variable cost
Fixed cost
≈ $6.04 per DLH
≈ $404,522
Therefore, the cost formula is as follows: Y = $404,522 + $6.04X (Adjusted R2 =
84.7%)
3. a) High-low method:
Variable (@$5.40 per DLH)
Fixed
Total
78,750 labour hours
$425,250
455,590
$880,840
54,500 labour hours
$294,300
455,590
$749,890
b) Least-squares regression method:
Variable (@$6.04 per DLH)
Fixed
Total
4.
78,750 labour hours
$475,650
404,522
$880,172
54,500 labour hours
$329,180
404,522
$733,702
It is interesting to note that the total costs are very similar for an estimated
78,750 direct labour hours but not for 54,500 direct labour hours. This clearly
indicates that management has to be careful about the method that is chosen to
develop a cost equation. This may be a good example of why ascattergraph
should be the starting point in all cost analysis work – it is a visual method. The
problem also states that at least one overhead cost item (equipment lease) has a
cost pattern where the amount is fixed up to 70,000 direct labour hours, whereas
a cost formula does not necessarily recognize such a pattern. Therefore in this
particular case neither of the two methods may be very reliable.
Moreover the high-low method is always suspect since it relies on only two points
(which in this case gives the regression line too steep of a slope). In contrast,
the least-squares regression method uses all data points.
5. The relevant range concept is particularly important in this company due to the flat
fee on lease equipment up to a certain volume of direct labour hours.
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42
Introduction to Managerial Accounting,FifthCanadian Edition
Analytical Thinking (LO2 CC9, 11) (60 minutes)
1. High-low method (using number of orders):
Orders
Cost
High level of activity ................................
1,650
$25,000
Low level of activity ................................
900
15,000
Change................................................................
750
$10,000
Variable element: $10,000 ÷ 750 orders = $13.333 per order.
Fixed element:
Total cost—1,650 orders ...............................................................
$25,000
Less variable element:
1,650 orders × $13.333 per order ................................
22,000
Fixed element ................................................................
$3,000
Therefore, the cost formula is: Y = $3,000 + $13.333X.
High-low method (using kilograms of materials):
Kgs.
Cost
High level of activity ................................
55,000
$25,500
Low level of activity ................................
23,000
15,240
Change................................................................
32,000
$10,260
Variable element: $10,260 ÷ 32,000 kgs. = $0.321 per kg.
Fixed element:
Total cost—55,000 kgs. ................................................................
$25,500
Less variable element:
55,000 orders × $0.321 per kg ................................
17,634
Fixed element ................................................................
$7,866
Therefore, the cost formula is: Y = $7,866 + $0.321X.
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Solutions Manual, Chapter 6
43
Analytical Thinking Question (continued)
2.
Least Squares Regression Method (using number of orders)
The cost formula is Y = $1,364 per month + $15.219X
Least Squares Regression Method (using kilograms of materials)
The cost formula is Y = $10,958 per month + $0.268X
Note to instructor = The above formulas were developed based on regression results
computed using Excel.
3.
Cost estimation based on number of orders:
Month
1 (1,200 orders)
2 (1,200 orders)
1
2
High-Low Method
$19,0001
$19,000
Regression Method
$19,6272
$19,627
$3,000 + $13.333 × 1,200 orders ≈$19,000
$1,364 + $15.219 × 1,200 orders ≈$19,627
Cost estimation based on kilograms of materials:
Month
1 (40,000 kilograms)
2 (50,000 kilograms)
1
2
3
4
High-Low Method
$20,6911
$23,8972
Regression Method
$21,6783
$24,3584
$7,866 + $0.321 × 40,000 kilograms = $20,691
$7,866 + $0.321 × 50,000 kilograms = $23,897
$10,958 + $0.268 × 40,000 kilograms = $21,678
$10,958 + $0.268 × 50,000 kilograms = $24,358
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44
Introduction to Managerial Accounting,FifthCanadian Edition
Analytical Thinking Question (continued)
4.
Clearly, there is a difference in the cost formulas when using the different methods and
the different activity bases. Conceptually, the least-squares regression method is
superior to the high-low method because it uses all the data points in calculating the
slope (variable portion) and the intercept (fixed portion).
As to whether number of orders or kilograms of materials is a better activity base, it
would be useful to look at the R2 for the two regressions. The adjusted R2,when
number of orders is used, is about 94.8% which means that just 5.2% of the variation
in Y is not explained by the variation in X. On the other hand the adjusted R2, when
kilograms of materials is used, is just 45% which means close to 55% of the variation in
Y is not explained by the variation in X. This clearly suggests that number of orders is a
superior independent variable (activity base) for the set of data used in the calculations.
Note to the instructor: This question can provide a good discussion of activity-based
costing covered in Chapter 5.
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Solutions Manual, Chapter 6
45
Communicating in Practice(LO1 CC1, 2, 3, 5, 6)(45 minutes)
Note to the instructor: The issues raised in this assignment will challenge your students
to think about the application of the concepts covered in this chapter.
Date:
To:
From:
Subject:
Current Date
Maria Chavez
Student’s Name
Cost Estimate
You must consider cost behaviour when estimating future costs, such as the cost of
catering a cocktail party. A variable cost is a cost whose total dollar amount varies in
direct proportion to changes in the activity level (in your case, the number of guests). A
fixed cost is a cost whose total dollar amount remains constant within a relevant range
of activity. A mixed cost is one that contains both variable and fixed cost elements.
Food and beverage and labour are examples of variable costs. These costs increase in
total as the number of guests increases. On the other hand, overhead cost is an
example of a mixed cost. It has both variable and fixed cost elements. The personnel
costs that increase as you take on additional jobs are an example of a variable cost,
while the annual office rent is an example of a fixed cost.
Before you make a decision about what to bid on this event, you should remove the
amount of fixed overhead from your total estimated cost per guest to arrive at your
total estimated variable cost per guest. To do this, you need to break your overhead
cost down into its variable and fixed components. There are a variety of methods that
you can use to break down this mixed cost.
Finally, you noted that you are not willing to lose money on the fund-raising cocktail
party. Because this cocktail party will not require you to incur any additional fixed
expenses, your bid just needs to cover your variable expenses in order for the party to
be profitable. (Note: This assumes that your other orders generate enough revenue to
cover your fixed expenses and generate a profit.) As such, any bid amount that exceeds
your total variable cost per guest will generate a contribution margin that will help you
cover fixed expenses and generate a profit. When all your fixed expenses are fully
covered, the contribution margin generated by an additional order will directly increase
your profit.
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46
Introduction to Managerial Accounting,FifthCanadian Edition
Ethics Challenge(LO1 – CC1, 3; LO2 – CC9, 10, 11; LO3 – CC12)
1. Unlike the high-low and least squares regression method, the scatter-graph
method relies on the analyst’s interpretation of the scatter-plots of the data, and
this can introduce an element of subjectivity in terms of how the analyst may
draw the line to compute the slope and the intercept. Altering the slope can lead
to reporting a higher (lower) variable cost which then affects the contribution
margin. This has the potential to affect decisions that a manager may make.
2. Any manager who knowingly alters the cost pattern to influence decisions may
be in violation of the ‘integrity’ and ‘competence’ elements of professional
conduct.
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Solutions Manual, Chapter 6
47
Teamwork in Action
1.
A variable cost is a cost whose total dollar amount varies in direct proportion to changes
in the activity level.A fixed cost remains constant in total dollar amount within a certain
relevant range of activity.A mixed cost is one that includes both a variable portion and a
fixed portion.
2.
The costs necessary to manufacture chocolate chip cookies might include, but would
not be limited to, the following:
Product Components and Costs
Type of
Product Cost
Ingredients (such as flour, chocolate,
chips, sugar, salt, etc.) ................................Direct materials
Packages ................................................................
Direct materials
Corrugated shipping boxes ................................
Direct materials
Assembly line workers (mixers, bakers,
packagers, etc.) ................................................................
Direct labour
Depreciation on building ................................ Overhead
Depreciation on machinery ................................
Overhead
Insurance ................................................................
Overhead
Factory supplies ................................................................
Overhead
Lubricants ................................................................
Overhead
Property taxes on building ................................
Overhead
Supervisors................................................................
Overhead
Telephone ................................................................
Overhead
Utilities (electricity, water, etc.) ................................
Overhead
Type of
Cost Behaviour
Variable
Variable
Variable
Variable (1)
Fixed
Fixed (2)
Fixed
Mixed
Variable
Fixed
Fixed (if salaried)
Mixed
Mixed
1.
Assumed; however, see related discussion of whether direct labour is a variable
or fixed cost in the text.
2.
Unless units of production method is used to calculate depreciation expense, then
variable.
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48
Introduction to Managerial Accounting,FifthCanadian Edition
Chapter 7
Budgeting
Solutions to Questions
7-1
A budget is a quantitative plan for
acquiring and using financial and other
resources. Budgetary control involves the use of
budgets to guide and coordinate activities across
the firm to ensure that objectives are attained.
The master budget generally also contains a
budgeted income statement, balance sheet, and
cash flow data. It should also be noted that the
master budget is the principal output of the
profit planning process.
7-2
1. Budgets force managers to think about
and plan for the future systematically.
2. The budgeting process can uncover
potential impediments to achieving goals and
objectives such as resource constraints and
bottlenecks.
3. Budgets communicate plans carefully and
clearly.
4. Budgets coordinate the planned actions
across the various parts of the organization.
5. Budgets ensure that scarce resources are
employed in uses that best benefit the
organization.
6. Budgets define goals and objectives that
can serve as benchmarks for subsequent
performance.
7-5
The level of sales impacts virtually every
other aspect of the firm’s activities. It
determines the production budgets, cash
collections, cash disbursements, and selling and
administrative budgets, that in turn determine
the cash budget and budgeted income
statement and balance sheet.
7-3
Responsibility accounting is a system in
which a manager is held responsible for those
items of revenues and costs—and only those
items—that the manager can control to a
significant extent. Each line item in the budget
is made the responsibility of a manager who is
then held responsible for differences between
budgeted and actual results.
7-4
A master budget represents a summary
of all of management’s 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 labour,
manufacturing overhead, selling and
administrative expenses, and inventories.
7-6
No. Planning and control are different,
although related, concepts. Planning involves
developing objectives and the various budgets
to achieve these objectives. Control, by contrast,
involves the means by which management
assures that the objectives and targets
described in the budgets are attained and to
ensure that all parts of the organization function
in a manner consistent with organizational
policies.
7-7
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) selfimposed budgets reduce the amount of upward
“blaming” resulting from inability to meet budget
goals. One caution that must be exercised in the
use of self-imposed budgets is to have a system
of formal review of the budgets that the various
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Solutions Manual, Chapter 7
1
managers have established for themselves, to
prevent these managers from building in too
much slack.
7-8
Budgeting can assist a firm in its
employment policies by providing information on
probable future staffing needs. Budgeting can
also assist in stabilizing a company’s work force.
By careful planning through the budget process,
a company can often “smooth out” its activities,
thereby avoiding hiring and laying off
employees.
7-9
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
required bank loans and other sources of
financing can be anticipated and arranged well
in advance of the actual time of need.
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2
Introduction to Managerial Accounting, Fifth Canadian Edition
Foundational 15 (LO2-CC5 6, 7, 8, 9, 10, 11, 12; LO3-CC13, 14)
7-1. The budgeted sales for July are computed as follows:
Unit sales (a) ......................................
Selling price per unit (b) ......................
Total sales (a) × (b) ............................
10,000
$70
$700,000
7-2. The expected cash collections for July are computed as follows:
July
June sales:
$588,000 × 60% ...........................
July sales:
$700,000 × 40% ...........................
Total cash collections ........................
$352,800
280,000
$632,800
7-3. The accounts receivable balance at the end of July is:
July sales (a).......................................
Percent uncollected (b) ........................
Accounts receivable (a) × (b) ...............
$700,000
60%
$420,000
7-4. The required production for July is computed as follows:
July
Budgeted sales in units ..........................
Add desired ending inventory* ...............
Total needs ...........................................
Less beginning inventory** ....................
Required production ..............................
10,000
2,400
12,400
2,000
10,400
*August sales of 12,000 units × 20% = 2,400 units.
** July sales of 10,000 units × 20% = 2,000 units.
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Solutions Manual, Chapter 7
3
The Foundational 15 (continued)
7-5. The raw material purchases for July are computed as follows:
July
Required production in units .........................................
Raw materials needed per unit (pounds)........................
Raw materials needed to meet production .....................
Add desired ending raw materials inventory* .................
Total raw material needs ...............................................
Less beginning raw materials inventory ** .....................
Raw materials to be purchased (pounds) .......................
10,400
5
52,000
6,100
58,100
5,200
52,900
* 61,000 pounds × 10% = 6,100 pounds.
** 52,000 pounds × 10% = 5,200 pounds.
7-6. The cost of raw material purchases for July is computed as follows:
Raw materials to be purchased (pounds) (a) ..................
Cost per pound (b) .......................................................
Cost of raw material purchases (a) × (b) .......................
52,900
$2.00
$105,800
7-7. The estimated cash disbursements for materials purchases in July is computed as
follows:
July
June purchases:
$88,880 × 70%..............................
July purchases:
$105,800 × 30% ............................
Total cash disbursements ...................
$62,216
31,740
$93,956
7-8. The accounts payable balance at the end of July is:
July purchases (a) ...............................
Percent unpaid (b) ..............................
Accounts payable (a) × (b) ..................
$105,800
70%
$74,060
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4
Introduction to Managerial Accounting, Fifth Canadian Edition
The Foundational 15 (continued)
7-9. The estimated raw materials inventory balance at the end of July is computed as
follows:
Ending raw materials inventory (pounds) (a) ..................
Cost per pound (b) .......................................................
Raw material inventory balance (a) × (b) ......................
6,100
$2.00
$12,200
7-10. The estimated direct labor cost for July is computed as follows:
July
Required production in units .......................
10,400
Direct labor hours per unit ..........................
× 2.0
Total direct labor-hours needed (a)..............
20,800
Direct labor cost per hour (b) ......................
$15
Total direct labor cost (a) × (b) ................... $312,000
7-11. The estimated unit product cost is computed as follows:
Quantity
Direct materials ...............................
Direct labor .....................................
Manufacturing overhead ..................
Unit product cost .............................
5 pounds
2 hours
2 hours
Cost
$2 per pound
$15 per hour
$10 per hour
Total
$10.00
30.00
20.00
$60.00
7-12. The estimated finished goods inventory balance at the end of July is computed
as follows:
Ending finished goods inventory in units (a)...................
Unit product cost (b) ....................................................
Ending finished goods inventory (a) × (b) .....................
2,400
$60.00
$144,000
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Solutions Manual, Chapter 7
5
The Foundational 15 (continued)
7-13. The estimated cost of goods sold for July is computed as follows:
Unit sales (a) ...............................................................
Unit product cost (b) ....................................................
Estimated cost of goods sold (a) × (b) ..........................
10,000
$60.00
$600,000
The estimated gross margin for July is computed as follows:
Total sales (a) ..............................................................
Cost of goods sold (b) ..................................................
Estimated gross margin (a) – (b)...................................
$700,000
600,000
$100,000
7-14. The estimated selling and administrative expense for July is computed as follows:
July
Budgeted unit sales .............................................
Variable selling and administrative........................
expense per unit ..............................................
Total variable expense .........................................
Fixed selling and administrative expenses .............
Total selling and administrative expenses .............
10,000
× $1.80
$18,000
60,000
$78,000
7-15. The estimated net operating income for July is computed as follows:
Gross margin (a) ..........................................................
Selling and administrative expenses (b) .........................
Net operating income (a) – (b)......................................
$100,000
78,000
$ 22,000
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6
Introduction to Managerial Accounting, Fifth Canadian Edition
Brief Exercise 7-1 (10 minutes) (LO1 CC1, 2, LO4 CC15)
1. Motivation is generally higher when an individual participates in setting his or her
own goals than when the goals are imposed from above.
2. If a manager is not able to meet the budget and it has been imposed from above,
the manager can always say that the budget was unreasonable or unrealistic to start
with and therefore was impossible to meet.
3. A budget is a detailed quantitative plan for acquiring and using financial and other
resources over a specified time period.
4. Planning involves developing objectives and preparing various budgets to achieve
those objectives.
5. The budgeting process can uncover potential bottlenecks before they occur.
6. Control involves the steps taken by management to increase the likelihood that the
goals and targets set down in the budgeting stage are attained.
7. Budgets define goals and objectives that can serve as benchmarks for evaluating
subsequent performance.
8. In responsibility accounting, a manager is held accountable for those items, and only
those items, over which he or she has significant control.
9. A self-imposed budget is one that is prepared with the full cooperation and
participation of managers at all levels of the organization.
10. A budget committee is usually responsible for overall policy matters relating to the
budget program and for coordinating the preparation of the budget itself.
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Solutions Manual, Chapter 7
7
Brief Exercise 7-2 (30 minutes) (LO2 CC5)
1.
Silver Company
Schedule of Expected Cash Collections
April
May
February sales:
$380,000 × 10% ................................
38,000
March sales:
$360,000 × 65%, 10% ................................
234,000
36,000
April sales:
$400,000 × 25%, 65%, 10% ................................
100,000
260,000
May sales:
$600,000 × 25%, 65% ................................ 150,000
June sales:
$300,000 × 25% ................................
Total cash collections ................................
372,000
446,000
June
Total
38,000
270,000
40,000
400,000
390,000
540,000
75,000
505,000
75,000
1,323,000
Observe that even though sales peak in May, cash collections peak in June. This
occurs because the bulk of the company’s 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.
2. Accounts receivable at June 30:
From May sales: $600,000 × 10% .................................................
$ 60,000
From June sales: $300,000 × (65% + 10%) ................................
225,000
Total accounts receivable at June 30 ..............................................
$285,000
Brief Exercise 7-3 (15 minutes) (LO2 CC6)
Down Under Products, Ltd.
Production Budget
April
May
Budgeted sales in units ................................
50,000
75,000
Add desired ending inventory* ................................
7,500
9,000
Total needs ................................................................
57,500
84,000
Less beginning inventory ................................
5,000
7,500
Required production ................................ 52,500
76,500
June
90,000
8,000
98,000
9,000
89,000
Quarter
215,000
8,000
223,000
5,000
218,000
*10% of the following month’s sales in units.
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8
Introduction to Managerial Accounting, Fifth Canadian Edition
Brief Exercise 7-4 (20 minutes) (LO2 CC7)
Materials Purchases Budget
First
Required production in
bottles ................................60,000
Number of grams, per
bottle................................
× 3
Total production needs—
grams ................................180,000
First
Production needs—grams
(above) ................................
180,000
Year 2
Second
Third
90,000 150,000
Fourth
Year 3
First
100,000
70,000
× 3
× 3
× 3
270,000 450,000
300,000
210,000
× 3
Second
Year 2
Third
Fourth
270,000 450,000
Year
300,000
1,200,000
60,000
42,000
42,000
Total needs—grams ................................
234,000 360,000 510,000
342,000
1,242,000
90,000
60,000
36,000
Raw materials to be
purchased—grams ................................
198,000 306,000 420,000
282,000
1,206,000
42,300
180,900
Add desired ending
inventory—grams................................
54,000
90,000
Less beginning inventory—
grams ................................ 36,000
Cost of raw materials to be
purchased at 150 roubles
per gram (in thousands
of roubles) ................................
29,700
54,000
45,900
63,000
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Solutions Manual, Chapter 7
9
Brief Exercise 7-5 (30 minutes) (LO2 CC8)
1. Assuming that the direct labour workforce is adjusted each quarter, the direct labour
budget would be:
1st
Quarter
2nd
Quarter
Units to be produced ................................
9,000
7,500
3rd
Quarter
4th
Quarter
Year
8,000
8,500
33,000
Direct labour time per
× 0.55
unit (hours) ................................
× 0.55
× 0.55
× 0.55
× 0.55
Total direct labourhours needed ................................
4,950
4,125
4,400
4,675
18,150
Direct labour cost per
hour ................................× $12.00
× $12.00
× $12.00
× $12.00
× $12.00
Total direct labour cost ................................
$59,400
$49,500
$52,800
$56,100
$217,800
2. Assuming that the direct labour workforce is not adjusted each quarter and that
overtime wages are paid, the direct labour budget would be:
1st
Quarter
2nd
Quarter
Units to be produced ................................
9,000
7,500
3rd
Quarter
4th
Quarter
Year
8,000
8,500
33,000
Direct labour time per
unit (hours) ................................
× 0.55
× 0.55
× 0.55
× 0.55
× 0.55
Total direct labourhours needed ................................
4,950
4,125
4,400
4,675
18,150
Regular hours paid ................................
2,800
2,800
2,800
2,800
11,200
Overtime hours paid ................................
2,150
1,325
1,600
1,875
6,950
$33,600
$33,600
$33,600
$134,400
23,850
28,800
33,750
125,100
Total direct labour cost ................................
$72,300
$57,450
$62,400
$67,350
$259,500
Wages for regular
hours (@ $12.00 per
hour) ................................$33,600
Overtime wages (@
$12.00 per hour ×
1.5) ................................
38,700
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10
Introduction to Managerial Accounting, Fifth Canadian Edition
Brief Exercise 7-6 (20 minutes) (LO2 CC9)
1.
Yuvwell Corporation
Manufacturing Overhead Budget
1st
2nd
3rd
Quarter
Quarter
Quarter
Budgeted direct labourhours ................................ 8,000
8,200
Variable overhead rate ................................
× $3.25
× $3.25
Variable manufacturing
$26,000 $26,650
overhead ................................
Fixed manufacturing
overhead ................................
48,000
48,000
Total manufacturing
overhead ................................
74,000
74,650
Less amortization ................................
16,000
16,000
Cash disbursements for
manufacturing
overhead ................................
$58,000 $58,650
2.
4th
Quarter
Year
8,500
× $3.25
7,800
× $3.25
32,500
× $3.25
$27,625
$25,350
$105,625
48,000
48,000
192,000
75,625
16,000
73,350
16,000
297,625
64,000
$59,625
$57,350
$233,625
Total budgeted manufacturing overhead for the year (a) .....................
Total budgeted direct labour-hours for the year (b) .............................
Manufacturing overhead rate for the year (a) ÷ (b) .............................
$297,625
32,500
$
9.16
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Solutions Manual, Chapter 7
11
Brief Exercise 7-7 (20 minutes) (LO2 CC11)
Weller Company
Selling and Administrative Expense Budget
1st
Quarter
2nd
Quarter
Budgeted unit sales ................................
15,000
16,000
Variable selling and
administrative expense
per unit ................................ × $2.50
× $2.50
Variable expense................................
$ 37,500 $ 40,000
Fixed selling and
administrative expenses:
Advertising ................................8,000
8,000
Executive salaries................................
35,000
35,000
Insurance ................................ 5,000
Property taxes ................................
8,000
Amortization ................................
20,000
20,000
Total fixed expense ................................
68,000
71,000
Total selling and
administrative expenses ................................
105,500
111,000
Less amortization ................................
20,000
20,000
Cash disbursements for
selling and
$ 85,500 $ 91,000
administrative expenses ................................
3rd
Quarter
4th
Quarter
Year
14,000
13,000
58,000
× $2.50
$ 35,000
× $2.50
$ 32,500
× $2.50
$145,000
8,000
35,000
5,000
20,000
68,000
8,000
35,000
20,000
63,000
32,000
140,000
10,000
8,000
80,000
270,000
103,000
20,000
95,500
20,000
415,000
80,000
$ 83,000
$ 75,500
$335,000
Alternative Solution (Matching principle): This exercise has two expense items—
Insurance and Property taxes— which are typically assigned to various periods of the
year in acknowledgement of the matching principle of accounting. Thus although the
cash flow occurs as above, some students might want to allocate the annual expense
amounts of 10,000 and 8,000 equally to each quarter. If this is done the budget is no
longer on a cash basis. This complication is not addressed in the text books since the
implicit assumption is that the budgets are on a cash basis in the sense the dollar
amounts shown for a particular period are expected to occur in
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12
Introduction to Managerial Accounting, Fifth Canadian Edition
Brief Exercise 7-7 (continued)
that same period (excluding amortization). Note that to obtain the cash disbursements,
the accruals have to be reversed. Here is the budget obtained when the expense is
allocated equally to each quarter.
Weller Company
Selling and Administrative Expense Budget
1st
Quarter
2nd
Quarter
Budgeted unit sales ................................
15,000
16,000
Variable selling and
administrative expense
× $2.50
per unit ................................ × $2.50
Variable expense................................
$ 37,500 $ 40,000
Fixed selling and
administrative expenses:
Advertising ................................8,000
8,000
Executive salaries................................
35,000
35,000
Insurance ................................ 2,500
2,500
Property taxes ................................
2,000
2,000
Amortization ................................
20,000
20,000
Total fixed expense ................................
67,500
67,500
Total selling and
administrative expenses ................................
105,000
107,500
Less amortization ................................
20,000
20,000
Less insurance and
property tax expense
accrual
4,500
4,500
Plus insurance and
property taxes paid
5,000
8,000
Cash disbursements for
selling and
administrative expenses ................................
$ 85,500 $ 91,000
3rd
Quarter
4th
Quarter
Year
14,000
13,000
58,000
× $2.50
$ 35,000
× $2.50
$ 32,500
× $2.50
$145,000
8,000
35,000
2,500
2,000
20,000
67,500
8,000
35,000
2,500
2,000
20,000
67,500
32,000
140,000
10,000
8,000
80,000
270,000
102,500
20,000
100,000
20,000
415,000
80,000
4,500
4,500
18,000
5,000
0
18,000
$ 83,000
$ 75,500
$335,000
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Solutions Manual, Chapter 7
13
Brief Exercise 7-8 (20 minutes) (LO2 CC12)
Garden Depot
Cash Budget
1st
Quarter
2nd
Quarter
3rd
Quarter
Cash balance, beginning ................................
$ 20,000 $ 10,000 $ 35,800
Total cash receipts ................................
180,000 330,000
210,000
Total cash available ................................
200,000 340,000
245,800
Less total cash
disbursements ................................
260,000 230,000
220,000
Excess (deficiency) of cash
available over
disbursements ................................
(60,000) 110,000
25,800
Financing:
Borrowings (at
beginning)* ................................
70,000
Repayments (at ending) ................................
(70,000)
§
Interest ................................
(4,200)
Total financing ................................
70,000
(74,200)
Cash balance, ending ................................
$ 10,000 $ 35,800 $ 25,800
4th
Quarter
Year
$ 25,800
230,000
255,800
$ 20,000
950,000
970,000
240,000
950,000
15,800
20,000
$ 15,800
70,000
(70,000)
(4,200)
(4,200)
$ 15,800
* Since the deficiency of cash available over disbursements is 60,000, the company
must borrow $70,000 to maintain the desired ending cash balance of $10,000.
§
$70,000 × 12% × (2/4) = $4,200.
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14
Introduction to Managerial Accounting, Fifth Canadian Edition
Brief Exercise 7-9 (15 minutes) (LO3 CC13)
Gig Harbour Boating
Budgeted Income Statement
Sales (460 units @ $1,950 each)....................................................
$897,000
Less cost of goods sold (460 units @ $1,575 each) .........................
724,500
Gross margin ................................................................................
172,500
Less selling and administrative expenses* ................................ 139,500
Net operating income ................................................................ 33,000
Less interest expense ................................................................ 14,000
Net income ...................................................................................
$ 19,000
* 460 × $75 + $105,000 = $139,500.
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Solutions Manual, Chapter 7
15
Brief Exercise 7-10 (20 minutes)(LO3 CC14)
Mecca Copy
Budgeted Balance Sheet
Assets
Current assets:
Cash*................................................................ $12,200
Accounts receivable ................................................................
8,100
Supplies inventory ................................................................
3,200
Total current assets ................................................................ $23,500
Plant and equipment:
Equipment ................................................................
34,000
Accumulated amortization ................................
(16,000)
Plant and equipment, net ..............................................................
18,000
Total assets ................................................................
$41,500
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable ................................................................ $ 1,800
Shareholders' equity:
Common shares ................................................................
$ 5,000
Retained earnings# ................................................................
34,700
Total shareholders' equity..............................................................
39,700
Total liabilities and shareholders' equity................................
$41,500
* Plug figure.
# Retained earnings are computed as follows:
Retained earnings, beginning balance ................................
$28,000
Add net income ................................................................
11,500
39,500
Deduct dividends ................................................................
4,800
Retained earnings, ending balance ................................
$34,700
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16
Introduction to Managerial Accounting, Fifth Canadian Edition
Brief Exercise 7-11 (15 minutes) (LO2 CC5,7,12)
Cash balance, September 1
Add: Cash collections
Proceeds from sale of equipment
Total cash available
Less: Cash disbursements
$16,000
36,000
6,800
$58,800
Operating expenses
Payments for merchandise purchases
Total cash disbursements
15,800
22,000
$37,800
Cash balance, September 30
$ 21,000
Notes:
 Dividends declared is not cash flow until paid
 Depreciation is not expense
 Proceeds from equipment sale is Book value minus loss on sale
Brief Exercise 7-12 (10 minutes) (LO2 CC6)
Production Budget
January
Budgeted sales in units ................................ 4,000
Add desired ending inventory* ................................
600
Total needs ................................................................
4,600
Less beginning inventory ................................ 200
Required production ................................
4,400
February
12,000
800
12,800
600
12,200
*5% of the following month’s sales in units.
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Solutions Manual, Chapter 7
17
Brief Exercise 7-13 (15 minutes) (LO2 CC5, 7, 12)
1. Change in inventory* + Purchases = COGS
Purchases for September = ($10,000) + $420,000
= $410,000.
2. Cash disbursements for September =
= 80% of September purchases + Disbursement for prior period purchases
= 0.8 × $410,000 + $110,000
= $438,000
*Change in inventory = Ending Balance – Opening balance
3.
Ending balance = Change in inventory balance + Opening balance
= ($10,000) + $90,000 = $80,000.
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18
Introduction to Managerial Accounting, Fifth Canadian Edition
Brief Exercise 7-14 Cash Budget (LO2 CC5)
Column1
Column2
Column3
Column4
Column5
Column6 Column7 Column8
Cash Budget
For the Year Ended December 31, 20X1
Cash balance, beginning
Excess(deficiency) of cash available over disbursements
Cash balance before reserve requirement
less minimum required reserve
Q1
$0
($121,140)
($121,140)
$0
Q2
$860
($41,680)
($40,820)
$0
Q3
$180
$177,680
$177,860
$0
Balance available for repayment (required borrowing)
Financing
Amount borrowed (beginning of period)
Principal repaid
Interest paid
2%
Total financing (or repayments for the period)
Cash balance after financing--Free cash balance
Add: minimum balance
Cash balance, ending
($121,140)
($40,820)
$177,860
$122,000
$41,000
$122,000
$860
$0
$860
$41,000
$180
$0
$180
Column9
Note
$0
$163,000 a)
$8,960 b)
($171,960)
$5,900
$0
$5,900
Column10
Q4
$5,900
$2,160
$8,060
$0
Year
$0
$17,020
$17,020
$0
$8,060
$17,020
$0 $163,000
$0 $163,000
$0
$8,960
$0 ($8,960)
$8,060
$8,060
$0
$0
$8,060
$8,060
Notes:
a) The cash balance available is sufficient to cover all borrowings from Q1 and Q2
in their entirety.
b) ($122,000 x 2% x 3) + ($41,000 x 2% x 2) = $7,320 + $1,640 = $8,960.
Excess cash available at the end of Q3, therefore interest payments must be
made including Q3. IE) 3 Quarters of interest on the Q1 borrowed amount and 2
for Q2’s borrowed amount.
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Solutions Manual, Chapter 7
19
Exercise 7-1 (30 minutes) (LO2 CC5, 7, 12)
$ 83,000
1. December cash sales ................................................................
Collections on account:
October sales: $400,000 × 18% ................................
72,000
November sales: $525,000 × 60%................................ 315,000
December sales: $600,000 × 20% ................................ 120,000
Total cash collections ................................................................
$590,000
2. Payments to suppliers:
November purchases (accounts payable)................................
$161,000
December purchases: $280,000 × 30% ................................
84,000
Total cash payments ................................................................
$245,000
3.
Ashton Company
Cash Budget
Cash balance, beginning ...............................................................
Add cash receipts: Collections from customers................................
Total cash available before current financing ................................
Less disbursements:
Payments to suppliers for inventory ................................ $245,000
Selling and administrative expenses ................................ 380,000 *
New web server................................................................ 76,000
Dividends paid ................................................................
9,000
Total disbursements ................................................................
Excess (deficiency) of cash available over
disbursements ................................................................
Financing:
Borrowings ................................................................................
Repayments ................................................................
Interest .....................................................................................
Total financing ................................................................
Cash balance, ending ................................................................
$ 40,000
590,000
630,000
710,000
(80,000)
100,000
—
—
100,000
$ 20,000
*$430,000 – $50,000 = $380,000.
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20
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 7-2 (45 minutes) (LO2 CC5, 6)
Jessi Corporation
1.
Sales Budget
1st
Quarter
2nd
Quarter
3rd
Quarter
4th
Quarter
Year
Budgeted unit sales ................................
8,000
10,000
12,000
11,000
41,000
Selling price per unit ................................
× $20.00
× $20.00
× $20.00
× $20.00
× $20.00
Total sales ................................
$160,000
$240,000
$220,000
$820,000
$200,000
Schedule of Expected Cash Collections
Accounts receivable,
$ 80,500
beginning balance ................................
$ 80,500
st
1 Quarter sales:
$160,000 × 65%,
30% ................................
104,000
2nd Quarter sales:
$200,000 × 65%,
30% ................................
$ 48,000
130,000
152,000
$ 60,000
190,000
rd
3 Quarter sales:
$240,000 × 65%,
30% ................................
156,000
$ 72,000
228,000
143,000
143,000
$215,000
$793,500
th
4 Quarter sales:
$220,000 × 65% ................................
-
-
Total cash collections ................................
$184,500
$178,000
$216,000
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Solutions Manual, Chapter 7
21
Exercise 7-2 (continued)
2.
Jessi Corporation
Production Budget
1st
Quarter
2nd
Quarter
3rd
Quarter
4th
Quarter
Year
Budgeted sales
(units) ................................
8,000
10,000
12,000
11,000
41,000
Add desired ending
1,500
inventory ................................
1,800
1,650
2,250
2,250
Total units needed................................
9,500
11,800
13,650
13,250
43,250
1,500
1,800
1,650
2,000
Required production ................................
7,500
10,300
11,850
11,600
41,250
Year
Less beginning
inventory ................................
2,000
Exercise 7-3 (45 minutes) (LO2 CC6, 7)
1.
Gaeber Industries
Production Budget
1st
Quarter
2nd
Quarter
3rd
Quarter
4th
Quarter
Budgeted sales
8,000
(units) ................................
7,000
6,000
7,000
28,000
Add desired ending
1,400
inventory ................................
1,200
1,400
1,700
1,700
Total units needed................................
9,400
8,200
7,400
8,700
29,700
Less beginning
1,600
inventory ................................
1,400
1,200
1,400
1,600
Required production ................................
7,800
6,800
6,200
7,300
28,100
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22
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 7-3 (continued)
2.
Gaeber Industries
Direct Materials Budget
1st
Quarter
2nd
Quarter
Required production ................................
7,800
6,800
3rd
Quarter
4th
Quarter
Year
6,200
7,300
28,100
×2
×2
×2
×2
Production needs ................................
15,600
13,600
12,400
14,600
56,200
Raw materials per
unit ................................
×2
Add desired ending
2,720
inventory ................................
2,480
2,920
3,140
3,140
Total needs................................
18,320
16,080
15,320
17,740
59,340
Less beginning
inventory ................................
3,120
2,720
2,480
2,920
3,120
Raw materials to be
purchased ................................
15,200
13,360
12,840
14,820
56,220
Cost of raw materials
to be purchased at
$4.00 per kilogram ................................
$60,800
$53,440
$51,360
$59,280
$224,880
Schedule of Expected Cash Disbursements for Materials
Accounts payable,
beginning balance ................................
$14,820
$ 14,820
st
1 Quarter purchase:
$60,800 × 75%,
45,600
25% ................................
$15,200
60,800
nd
2
Quarter purchase:
$53,440 × 75%,
25% ................................
40,080
$13,360
53,440
rd
3 Quarter purchase:
$51,360 × 75%,
25% ................................
4th Quarter purchase:
$59,280 × 75% ................................
Total cash
disbursements for
materials ................................
$60,420
-
$55,280
38,520
$12,840
51,360
-
44,460
44,460
$57,300
$224,880
$51,880
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Solutions Manual, Chapter 7
23
Exercise 7-4 (45 minutes) (LO2 CC7, 8)
1.
Hareston Company
Direct Materials Budget
1st
Quarter
2nd
Quarter
Required production ................................
7,000
8,000
3rd
Quarter
4th
Quarter
Year
6,000
5,000
26,000
×2
×2
×2
×2
Production needs ................................
14,000
16,000
12,000
10,000
52,000
Raw materials per
unit ................................
×2
Add desired ending
1,600
inventory ................................
1,200
1,000
1,500
1,500
Total needs................................
15,600
17,200
13,000
11,500
53,500
Less beginning
inventory ................................
1,400
1,600
1,200
1,000
1,400
Raw materials to be
purchased ................................
14,200
15,600
11,800
10,500
52,100
Cost of raw materials
to be purchased at
$1.40 per kilogram ................................
$19,880
$21,840
$16,520
$14,700
$72,940
Schedule of Expected Cash Disbursements for Materials
Accounts payable,
beginning balance ................................
$ 2,940
$ 2,940
st
1 Quarter purchase:
$19,880 × 80%,
15,904
20% ................................
$ 3,976
19,880
nd
2
Quarter purchase:
$21,840 × 80%,
20% ................................
17,472
$ 4,368
21,840
rd
3 Quarter purchase:
$16,520 × 80%,
20% ................................
4th Quarter purchase:
$14,700 × 80% ................................
Total cash
disbursements for
materials ................................
$18,844
-
$21,448
13,216
$ 3,304
16,520
-
11,760
11,760
$15,064
$72,940
$17,584
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24
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 7-4 (continued)
2.
Hareston Company
Direct Labour Budget
1st
Quarter
2nd
Quarter
Units to be produced ................................
7,000
8,000
3rd
Quarter
4th
Quarter
Year
6,000
5,000
26,000
× 0.60
× 0.60
× 0.60
× 0.60
4,800
3,600
3,000
15,600
Direct labour cost per
hour................................
× $14.00
× $14.00
× $14.00
× $14.00
× $14.00
Total direct labour
cost ................................
$ 58,800
$ 67,200
$ 50,400
$ 42,000
$218,400
Direct labour time per
unit (hours) ................................
× 0.60
Total direct labour4,200
hours needed ................................
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Solutions Manual, Chapter 7
25
Exercise 7-5 (45 minutes) (LO2 CC8, 9)
1.
Raredon Corporation
Direct Labour Budget
1st
Quarter
2.
2nd
Quarter
3rd
Quarter
4th
Quarter
Year
Units to be produced ................................
24,000
28,000
26,000
22,000
100,000
Direct labour time per
unit (hours) ................................
× 1.40
× 1.40
× 1.40
× 1.40
× 1.40
Total direct labour33,600
hours needed ................................
39,200
36,400
30,800
140,000
Direct labour cost per
hour................................× $21
× $21
× $21
× $21
× $21
Total direct labour
cost ................................
$705,600
$823,200
$764,400
$646,800
$2,940,000
4th
Quarter
Year
Raredon Corporation
Manufacturing Overhead Budget
1st
Quarter
Budgeted direct
labour-hours ................................
33,600
2nd
Quarter
3rd
Quarter
39,200
36,400
30,800
140,000
Variable overhead
rate ................................
× $1.30
× $1.30
× $1.30
× $1.30
× $1.30
Variable
manufacturing
43,680
overhead ................................
50,960
47,320
40,040
182,000
Fixed manufacturing
overhead ................................
160,000
160,000
160,000
160,000
640,000
Total manufacturing
overhead ................................
203,680
210,960
207,320
200,040
822,000
Less amortization ................................
44,000
44,000
44,000
44,000
176,000
$163,320
$156,040
$646,000
Cash disbursements
for manufacturing
overhead ................................
$159,680
$166,960
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26
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 7-6 (30 minutes) (LO2 CC12)
1
Quarter (000 omitted)
2
3
Cash balance, beginning................................
$ 6*
$ 5
$ 5
Add collections from customers................................
65
70
96 *
Total cash available before current
financing ................................................................
71*
75
101
Less disbursements:
Purchase of inventory................................
35*
45 *
48
Operating expenses ................................
28
30 *
30 *
Equipment purchases ................................
8*
8*
10 *
Dividends ................................................................
2*
2*
2*
Total disbursements ................................
73
85 *
90
Excess (deficiency) of cash
available over disbursements ................................
(2)*
(10 )
11 *
Financing:
Borrowings ................................................................
7
15 *
—
Repayments (including interest)
—
—
(6 )
Total financing ................................................................
7
15
(6 )
Cash balance, ending ................................
$ 5
$ 5
$ 5
4
$
Year
5
92
$ 6
323*
97
329
35 *
25
10
2*
72
163
113*
36*
8
320
25
—
(17 )*
(17 )
$ 8
9
22
(23)
(1)
$ 8
*Given.
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Solutions Manual, Chapter 7
27
Exercise 7-7 (30 minutes) (LO2 CC12)
1.
Arrowroot Company
Cash Budget for July 201X
Cash balance, beginning ...............................................................
Add cash receipts: Collections from customers................................
Total cash available before current financing ................................
Less disbursements:
Payments to suppliers for merchandise ................................
$112,400
Operating expenses ................................................................
73,600
Equipment.................................................................................
41,000
Dividends paid ……………………………………………………
24,000
Total disbursements ................................................................
Excess (deficiency) of cash available over
disbursements ................................................................
Financing:
Borrowings ................................................................................
Repayments ................................................................
Interest .....................................................................................
Total financing ................................................................
Cash balance, ending ................................................................
$ 90,000
178,000
268,000
251,000
17,000
13,000
—
—
13,000
$ 30,000
2. Cash budgeting allows cash shortfalls or excesses to be predicted. The budget will
indicate the periods in which there will be excess and deficiency of cash. Since the
timing of future cash shortfalls and excesses is known, arrangements to borrow funds
or a plan to repay borrowings can be made well in advance, which often means that
interest rates may be more favourable than if the funds are needed on short notice.
Moreover, in such situations, the company can take steps to expedite collections (to the
extent possible) thereby minimizing the need to borrow (or reducing the amount of
borrowing). Also by ensuring that borrowings are repaid promptly, the company can
maintain good credit ratings.
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28
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 7-8 (30 minutes) (LO2 CC5, 7, 12)
1.
Collections in September from sales in August will be made up of:
Sales from August not paid by customers in that month
= $450,000 × 0.18
= $81,000
Sales from September paid by customers in the month
= $300,000 × 0.80 × 0.98 (net of 2% discount)
= $235,200
Total collections in September
= $81,000 + $235,200 = $316,200
2.
Accounts receivable collections in August of July sales:
= $450,000 × 0.18
= $81,000
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Solutions Manual, Chapter 7
29
Exercise 7-8 (continued)
3. Purchases in July will be as follows
$337,500
Budgeted cost of sales* ...............................................................
84,375
Add desired ending inventory Ϊ ................................
$253,125
Total purchases needed ................................................................
75,000
Less beginning inventory** ..........................................................
$178,125
Required purchases................................................................
*
Ϊ
**
$450,000 × (0.75)
= $337,500
$450,000 × (0.75) × 25% = $ 84,375
$400,000 × (0.75) × 25% = $ 75,000
Purchases in August would be computed as follows:
$337,500
Budgeted cost of sales* ...............................................................
56,250
Add desired ending inventory Ϊ ................................
$281,250
Total purchases needed ................................................................
84,375
Less beginning inventory** ..........................................................
$196,875
Required purchases................................................................
*
Ϊ
**
$450,000 × (0.75)
= $337,500
$300,000 × (0.75) × 25% = $ 56,250
$450,000 × (0.75) × 25% = $ 84,375
4. Cash disbursements in August:
For purchases in July ………………………………….
For purchases in August ……………………………..
Total disbursements
Collections made in August:
For sales from July ……………………………………..
For sales from August …………………………………
Total collections
5.
Net cash flow, August
Collections – Disbursements
$89,062.50
98,437.50
$187,500
$81,000
352,800
$433,800
$433,800 - $196,875 = $236,925
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30
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 7-9 (50 minutes) (LO2 CC12)
Cash Budget
For the Year Ended December 31, 20X1
Q1
Q2
Q3
Note
Q4
Note
Cash balance, beginning
$780
$680
$600
$608
Excess(deficiency) of cash available over disbursements
($123,300) ($41,680) $127,780
$42,300
($122,520) ($41,000) $128,380
$42,908
Cash balance before reserve requirement
less minimum required reserve
$600
$600
$600
$600
Year
$780
$5,100
$5,880
$600
Balance available for repayment (required borrowing)($123,120) ($41,600) $127,780
Financing
Amount borrowed (beginning of period)
$123,200 $41,600
$0
Principal repaid
$114,000 a)
Interest paid
4%
$13,772 b)
Total financing (or repayments for the period)
$123,200 $41,600 ($127,772)
Cash balance after financing--Free cash balance
$80
$0
$8
Add: minimum balance
$600
$600
$600
Cash balance, ending
$680
$600
$608
$5,280
$42,308
$0
$37,300 c)
$4,936 d)
($42,236)
$72
$600
$672
$164,800
$151,300
$18,708
($5,208)
$72
$600
$672
Notes:
a) Since $2,392 is the balance in the line of credit inclusive of accrued interest at
the end of the fourth quarter of the previous year, the principal outstanding must
be $2,392/1.04 = $2,300. In Q3 of the 20X1, a total of 4 quarters of interest will
have accrued on the $2,300 equaling $2,300 x 16% = $368. With $127,780
available for repaying prior period borrowings, the $2,300 owing from the
previous year will be the first loan principal to be repaid. The total outlay is
$2,668. With this amount deducted from $127,780, it leaves $125,112 available.
Addressing the loan from Q1, $125,112 will support a maximum repayment of
$125,112/(1.12) = $111,707 of principal. Since repayment of principal must be
in round $100 amounts, the principal repaid will be $111,700. The accrued
interest on this amount which must be paid in Q3 will be 12% x $111,700 (note
any borrowing from Q1 will have accrued 3 quarters of interest at the end of Q3
equalling $13,404. Total principal paid is $2,300 + $111,700 = $114,000.
b) The interest payment will be $368 + $13,404 = $13,772.
c) In Q4, the available cash is $42,308. The oldest outstanding borrowing is from
quarter 1 (remaining balance will be $123,200 - $111,700 = $11,500).
Calculating 4 quarters of accrued interest of $11,500 x 16% = $1,840, a total of
$11,500 + $1,840 = $13,340 will be required to retire the remaining balance of
.Q1 borrowing. This is less than the cash available so this loan will be retired.
The remaining cash after this is done is $42,308 - $13,340 = $28,968. The next
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 7
31
loan is the $41,600 borrowed in Q2. This amount exceeds the available cash of
$28,968 but a partial payment can be made. How much? The available cash will
support a maximum repayment of principal from Q2 of $28,968/1.12 = $25,864
(note that three quarters of accrued interest is involved—12%). The amount of
principal repaid will be $25,800 (in round $100 amounts). The accrued interest
will be 12% x $25,800 = $3,096. The remaining balance on the Q2 loan will be
$41,600 - $25,800 = $15,800. The accrued interest on this balance will be
$1,896. In sum, the total principal repaid in Q4 will be $11,500 + $25,800 =
$37,300.
d) The total interest paid in Q4 will be $1,840 + $3,096 = $4,936. On the balance
sheet at the end of Q4, there will be accrued interest of $1,896.
The annual interest expense on the line of credit will be the interest paid plus the
accrued interest at the end of 20X1: $13,772 + $4,936 + $1,896 = $20,604.
See the spreadsheet showing the breakdown of the financing calculations below.
Note students may use alternative ways to lay out the calculations on a
spreadsheet, what is shown below is one possible way to structure the
calculations.
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32
Introduction to Managerial Accounting, Fifth Canadian Edition
1
($123,120)
Cash available for repayment (required borrowing)
Amount borrowed in the period
$123,200
Accrued interest on Q1 borrowing
$4,928
Accrued interest on Q2 borrowing
Accrued interest on Q3 borrowing
Accrued interest on Q4 borrowing
Total accrued interest for the quarter before repayment
$4,928
Repayment of principal for previous year borrowing
Accrued interest owing on the repaid principal
Total amount paid on prior year borrowing
Maximum principal repayment possible of Q1 borrowing
$0
Principal repaid of Q1 borrowing
$0
Interest paid on Q1 repaid principal
$0
Total amount repaid for Q1 borrowing
$0
Cash available for repayment of Q2 borrowing
n/a
Maximum repayment of principal of Q2 borrowing possible
n/a
Principal repaid of Q2 borrowing
n/a
Interest paid on amount of Q2 principal repaid
n/a
Total amount repaid for Q2 borrowing
n/a
Balance from previous year
$2,300
Remaining balance of Q1 borrowing
$123,200
Remaining balance of Q2 borrowing
n/a
Remaining balance of Q3 borrowing
Remaining balance of Q4 borrowing
Accrued interest at the end of period
$4,928
Financing Worksheet
Quarter
2
3
4
($41,600) $127,780 $42,308
$41,600
$0
$0
$9,856 $14,784
$1,840
$1,664
$3,328
$4,992
$0
$0
$11,520 $18,112
$6,832
$2,300
$368
$2,668
$0 $111,707 $36,472
$0 $111,700 $11,500
$0 $13,404
$1,840
$0 $125,104 $13,340
$0
$8 $28,968
$0
$7 $25,864
$0
$0 $25,800
$0
$0
$3,096
$0
$0 $28,896
$2,300
$0
$0
$123,200 $11,500
$0
$41,600 $41,600 $15,800
$0
$0
$11,520
$4,708
$1,896
Year
$164,800
$6,832
$2,300
$368
$2,668
$123,200
$15,244
$138,444
$25,800
$3,096
$28,896
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Solutions Manual, Chapter 7
33
Problem 7-1 (60 minutes) (LO2 CC5, 7, 12)
1. Collections on sales:
Cash sales .......................................
Credit sales:
May: $30,000 × 80% × 20% ........
June: $36,000 × 80% × 70%,
20% .........................................
July: $40,000 × 80% × 10%,
70%, 20% ................................
Aug.: $70,000 × 80% × 10%,
70% .........................................
Sept.: $50,000 × 80% × 10% .......
Total cash collections .......................
July
$ 8,000
August
$14,000
Sept.
$10,000
4,800
Quarter
$ 32,000
4,800
20,160
5,760
3,200
22,400
6,400
32,000
5,600
39,200
4,000
$59,600
44,800
4,000
$143,520
$36,160
$47,760
25,920
2. a. Merchandise purchases budget:
July
Budgeted cost of goods sold ............
Add desired ending inventory* .........
Total needs .....................................
Less beginning inventory ..................
Required inventory purchases ...........
$24,000
31,500
55,500
18,000
$37,500
August
$42,000
22,500
64,500
31,500
$33,000
Sept.
$30,000
20,250
50,250
22,500
$27,750
Oct.
$27,000
*75% of the next month’s budgeted cost of goods sold.
b. Schedule of expected cash disbursements for merchandise purchases:
July
Accounts payable, June 30 ...............
July purchases .................................
August purchases ............................
September purchases ......................
Total cash disbursements .................
$11,700
18,750
$30,450
August
$18,750
16,500
$35,250
Sept.
Quarter
$16,500
13,875
$30,375
$11,700
37,500
33,000
13,875
$96,075
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34
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 7-1 (continued)
3.
Janus Products, Inc.
Cash Budget
For the Quarter Ended September 30
July
Cash balance, beginning ...............
Add collections from sales
Total cash available ....................
Less disbursements:
For inventory purchases .............
For selling expenses...................
For administrative expenses (1) ..
For land ....................................
For dividends .............................
Total disbursements ......................
Excess (deficiency) of cash
available over disbursements ......
Financing:
Borrowings ................................
Repayment ................................
Interest .....................................
Total financing ..............................
Cash balance, ending ....................
August
Sept.
Quarter
$ 8,000
36,160
44,160
$ 8,410
47,760
56,170
$ 8,020
59,600
67,620
$ 8,000
143,520
151,520
30,450
7,200
3,600
4,500
0
45,750
35,250
11,700
5,200
0
0
52,150
30,375
8,500
4,100
0
1,000
43,975
96,075
27,400
12,900
4,500
1,000
141,875
4,020
23,645
9,645
(1,590)
10,000
0
0
10,000
$ 8,410
4,000
0
0
4,000
$ 8,020
(14,000)
(380)
(14,380)
$ 9,265
14,000
(14,000)
(380)
(380)
$ 9,265
* $10,000 × 1% × 3 =
$4,000 × 1% × 2 =
$300
80
$380
(1) Excludes 2,000 in depreciation as it is not a cash expense
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Solutions Manual, Chapter 7
35
Problem 7-2 (60 minutes) (LO2 CC6, 7)
Daisy Products Limited
1. Production budget:
July
August
Budgeted sales (units) ................................
43,750 50,000
Add desired ending inventory ................................
13,750 16,250
Total needs ................................................................
57,500 66,250
Less beginning inventory ................................
12,500 13,750
Required production................................
45,000 52,500
September
October
62,500
11,250
73,750
16,250
57,500
37,500
8,750
46,250
11,250
35,000
2. During July and August the company is building inventories in anticipation of peak
sales in September. Therefore, production exceeds sales during these months. In
September and October inventories are being reduced in anticipation of a decrease
in sales during the last months of the year. Therefore, production is less than sales
during these months to cut back on inventory levels.
3. Raw materials purchases budget:
July
August
Required production (units) ................................
45,000
52,500
Solvent Q80 production needs per
unit................................................................
× 3 cc
× 3 cc
Production needs (cc) ................................
135,000 157,500
Add desired ending
inventory (cc) ................................ 78,750
86,250
Total Solvent Q80 needs ................................
213,750 243,750
Less beginning inventory (cc) ................................
67,500
78,750
Solvent Q80 purchases (cc) ................................
146,250 165,000
Third
Quarter
September
57,500
155,000
× 3 cc
172,500
× 3 cc
465,000
52,500
225,000
86,250
138,750
*
52,500
517,500
67,500
450,000
* 35,000 units (October production) × 3 cc per unit =105,000 cc; 105,000 cc
× 1/2 =52500 cc.
As shown in part (1), production is greatest in September; however, as shown in the
raw material purchases budget, purchases of materials are greatest a month
earlier—in August. The reason for the large purchases of materials in August is that
the materials must be on hand to support the heavy production scheduled for
September.
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36
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 7-3 (90 minutes) (LO2 CC5, 7, 12, LO3 CC13, 14)
1. Schedule of cash receipts:
Cash sales—May ................................................................ $ 60,000
Collections on account:
April 30 balance ................................................................
54,000
May sales (50% × $140,000) .....................................................
70,000
Total cash receipts ................................................................ $184,000
Schedule of cash payments for purchases:
April 30 accounts payable balance...............................................
$ 63,000
May purchases ($120,000 × 40%) ..............................................
48,000
Total cash payments ................................................................
$111,000
Minden Company
Cash Budget
For the Month Ended May 31
Cash balance, beginning................................................................
$ 9,000
Add receipts from customers (above) .............................................
184,000
Total cash available ................................................................ 193,000
Less disbursements:
Purchase of inventory (above) ....................................................
111,000
Operating expenses ................................................................72,000
Purchases of equipment .............................................................
6,500
Total cash disbursements ..............................................................
189,500
Excess of receipts over disbursements................................
3,500
Financing:
Borrowings—note ................................................................ 20,000
Repayments—note ................................................................(14,500)
Interest .....................................................................................(100)
Total financing ..............................................................................
5,400
Cash balance, ending ................................................................
$ 8,900
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Solutions Manual, Chapter 7
37
Problem 7-3 (continued)
2.
Minden Company
Budgeted Income Statement
For the Month Ended May 31
Sales............................................................................................ $200,000
Cost of goods sold:
Beginning inventory ................................................................
$ 30,000
Add purchases ................................................................
120,000
Goods available for sale .............................................................
150,000
Ending inventory................................................................
40,000
Cost of goods sold ................................................................
110,000
Gross margin ................................................................
90,000
Operating expenses ($72,000 + $2,000) ................................
74,000
Net operating income ................................................................
16,000
Interest expense................................................................
100
Net income................................................................
$ 15,900
3.
Minden Company
Budgeted Balance Sheet
May 31
Assets
Cash ............................................................................................ $ 8,900
Accounts receivable (50% × $140,000)..........................................
70,000
Inventory .....................................................................................
40,000
Buildings and equipment, net of amortization ($207,000 +
$6,500 – $2,000) ....................................................................... 211,500
Total assets .................................................................................. $330,400
Liabilities and Equity
Accounts payable (60% × 120,000) ............................................... $ 72,000
Note payable ................................................................................
20,000
Capital shares ............................................................................... 180,000
Retained earnings ($42,500 + $15,900) .........................................
58,400
Total liabilities and equity .............................................................. $330,400
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38
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 7-4 (90 minutes) (LO2 CC5, 6, 7)
1.
Milo Company
Sales Budget
Month
August
July
Budgeted sales in units ................................
30,000
70,000
Selling price per unit ................................
× $12
× $12
Budgeted sales ................................
$360,000
$840,000
September
50,000
× $12
$600,000
Schedule of Expected Cash Collections from Sales
Accounts receivable, June
$195,000
30: $300,000 × 65% ................................
July sales: $360,000 × 30%,
65%................................................................
108,000 $234,000
August sales: $840,000 ×
30%, 65%................................
252,000
$546,000
September sales: $600,000
× 30% ................................
180,000
Total cash collections ................................
$303,000 $486,000
$726,000
Quarter
150,000
× $12
$1,800,000
$ 195,000
342,000
798,000
180,000
$1,515,000
2.
Milo Company
Production Budget for July-October
July
August
Budgeted sales in units ................................
30,000
70,000
Add desired ending inventory ................................
10,500
7,500
Total needs ................................................................
40,500
77,500
Less beginning inventory ................................
4,500
10,500
Required production ................................
36,000
67,000
September
50,000
3,000
53,000
7,500
45,500
October
20,000
1,500
21,500
3,000
18,500
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Solutions Manual, Chapter 7
39
Problem 7-4 (continued)
3.
Milo Company
Materials Budget
July
Month
August
Required production (above) ................................
36,000
67,000
Raw material needs per unit
(metres) ................................
×4
×4
Production needs (mets.) ................................
144,000
268,000
Add desired ending inventory
(metres) ................................ 134,000
91,000
Total needs (metres) ................................
278,000
359,000
Less beginning inventory
(metres) ................................ 72,000
134,000
Raw materials to be
purchased ................................206,000
225,000
Cost of raw materials to be
purchased at $0.80 per
$164,800
$180,000
metre ................................................................
September
Quarter
45,500
148,500
×4
182,000
×4
594,000
37,000 *
219,000
37,000 *
631,000
91,000
72,000
128,000
559,000
$102,400
$447,200
*18,500 units (October) × 4 metres per unit = 74,000 metres;
74,000 metres × 1/2 = 37,000 metres.
Schedule of Expected Cash Payments
July
August
Accounts payable,
June
30 ................................................................
$ 76,000
July purchases: $164,800 ×
50%, 50%................................ 82,400
$ 82,400
August purchases: $180,000
90,000
× 50%, 50% ................................
September purchases:
$102,400 × 50% ................................
Total cash payments ................................
$158,400 $172,400
September
Quarter
$ 76,000
164,800
$ 90,000
180,000
51,200
$141,200
51,200
$472,000
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40
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 7-5 (90 minutes) (LO2 CC5, 7, 12)
1. Collections on sales:
April
May
Cash sales ................................ $ 96,000 $ 144,000
Sales on account:
Feb.: $160,000 × 80% ×
20% ................................................................
25,600
March: $240,000 × 80% ×
70%, 20% ................................
134,400
38,400
April: $480,000 × 80% ×
10%, 70%, 20% ................................
38,400
268,800
May: $720,000 × 80% ×
10%, 70% ................................
57,600
June: $400,000 × 80% ×
10% ................................................................
Total cash collections ................................
$ 294,400
$508,800
June
$ 80,000
Quarter
$ 320,000
25,600
172,800
76,800
384,000
403,200
460,800
32,000
$592,000
32,000
$1,395,200
2. (a)
Garden Sales, Inc.
Inventory Purchases Budget
April
May
Budgeted cost of goods sold ................................
$336,000 $504,000
Add desired ending
inventory* ................................ 100,800
56,000
Total needs ................................ 436,800
560,000
Less beginning inventory ................................
67,200
100,800
Required inventory purchases ................................
$369,600 $459,200
June
$280,000
July
$224,000
44,800
324,800
56,000
$268,800
*20% of the next month’s budgeted cost of goods sold.
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Solutions Manual, Chapter 7
41
Problem 7-5 (continued)
2. (b)
Garden Sales, Inc.
Schedule of Expected Cash Disbursements for Inventory
April
May
Accounts payable,
March 31 ................................
$100,800
April purchases:
$369,600 × 50%,
50%................................ 184,800
$184,800
May purchases:
$459,200 × 50%,
229,600
50%................................
June purchases:
$268,800 × 50% ................................
Total cash
disbursements ................................
$285,600
$414,400
June
Quarter
$100,800
369,600
$229,600
459,200
134,400
134,400
$364,000
$1,064,000
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42
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 7-5 (continued)
3.
Garden Sales, Inc.
Cash Budget
For the Quarter Ended June 30
April
May
Cash balance, beginning................................
$ 41,600
$32,000
Add collections from sales ................................
294,400
508,800
Total cash available ................................
336,000
540,800
Less disbursements:
Purchases for inventory ................................
285,600
414,400
Selling expenses ................................
63,200
96,000
Administrative expenses (1)................................
16,000
21,600
Equipment purchases ................................
—
12,800
Dividends paid ................................
39,200
—
Total disbursements ................................
404,000
544,800
Excess (deficiency) of cash ................................
(68,000)
(4,000)
Financing:
Borrowings ................................ 100,000
36,000
Repayments ................................ —
—
Interest ................................
—
—
Total financing ................................100,000
36,000
Cash balance, ending ................................
$32,000
$32,000
* $100,000 × 12% × 3/12 =
$ 36,000 × 12% × 2/12 =
June
Quarter
$32,000
592,000
624,000
$ 41,600
1,395,200
1,436,800
364,000
49,600
12,800
—
—
426,400
197,600
1,064,000
208,800
50,400
12,800
39,200
1,375,200
61,600
—
(136,000)
(3,720)*
(139,720)
$57,880
136,000
(136,000
(3,720)
(3,720)
$57,880
$3,000
720
$3,720
(1) Exclude depreciation of $20K/month
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Solutions Manual, Chapter 7
43
Problem 7-6 (120 minutes) (LO2 CC5, 7, 11, 12)
1. (a)
Westex Products
Schedule of Expected Cash Collections
20X1 Quarter
First
Second
Third
Fourth
Total
20X0—Fourth-quarter
sales:
$200,000 × 33% ................................
$ 66,000
$ 66,000
20X1—First-quarter
sales:
$300,000 × 65% ................................
195,000
195,000
$300,000 × 33% ................................
$ 99,000
99,000
20X1—Secondquarter sales:
$400,000 × 65% ................................
260,000
$400,000 × 33% ................................
260,000
$132,000
132,000
325,000
325,000
20X1—Third-quarter
sales:
$500,000 × 65% ................................
$500,000 × 33% ................................
$165,000
165,000
130,000
130,000
Total cash collections ................................
$261,000 $359,000 $457,000 $295,000
$1,372,000
20X1—Fourth-quarter
sales:
$200,000 × 65% ................................
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44
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 7-6 (continued)
1. (b)
Westex Products
Schedule of Budgeted Cash Disbursements for Merchandise Purchases
20X1 Quarter
First
Second
Third
Fourth
Total
20X0—Fourth-quarter
purchases:
$126,000 × 20% ................................
$ 25,200
$ 25,200
20X1—First-quarter
purchases:
$186,000 × 80% ................................
148,800
148,800
$186,000 × 20% ................................
$ 37,200
37,200
20X1—Secondquarter purchases:
$246,000 × 80% ................................
196,800
$246,000 × 20% ................................
196,800
$ 49,200
49,200
244,000
244,000
20X1—Third-quarter
purchases:
$305,000 × 80% ................................
$305,000 × 20% ................................
$ 61,000
61,000
100,800
100,800
Total cash payments ................................
$174,000 $234,000 $293,200 $161,800
$863,000
20X1—Fourth-quarter
purchases:
$126,000 × 80% ................................
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Solutions Manual, Chapter 7
45
Problem 7-6 (continued)
2. Budgeted operating expenses for 20X1:
First
20X1 Quarter
Second
Third
Fourth
Budgeted sales ................................
$300,000 $400,000 $500,000 $200,000
Year
$1,400,000
Variable expense rate ................................
× 15%
× 15%
× 15%
× 15%
× 15%
Variable expenses ................................
45,000
60,000
75,000
30,000
210,000
Fixed expenses ................................
50,000
50,000
50,000
50,000
200,000
Total expenses ................................
95,000
110,000
125,000
80,000
410,000
20,000
20,000
20,000
80,000
Net cash payments ................................
$ 75,000 $ 90,000 $105,000
$ 60,000
$ 330,000
Less depreciation ................................
20,000
Westex Products
3.
Cash Budget for year 20X1
First
20X1Quarter
Second
Third
Fourth
Cash balance, beginning................................
$ 10,000 $ 12,000 $ 10,000 $ 10,800
Year
$
10,000
Add collections from sales ................................
261,000 359,000
457,000
295,000
1,372,000
Total cash available ................................
271,000 371,000
467,000
305,800
1,382,000
Merchandise purchases ................................
174,000 234,000
293,200
161,800
863,000
Operating expenses ................................
75,000
90,000
105,000
60,000
330,000
10,000
40,000
Less disbursements:
Dividends................................
10,000
10,000
10,000
Equipment ................................
-0-
75,000
48,000
-0-
Total disbursements ................................
259,000 409,000
456,200
231,800
1,356,000
10,800
74,000
26,000
Excess (deficiency) of
receipts over
disbursements ................................
12,000
(38,000)
123,000
Financing:
Borrowings ................................
-0-
48,000
-0-
-0-
48,000
Repayments ................................
-0-
-0-
-0-
(48,000)
(48,000)
Interest ................................ -0-
-0-
-0-
(3,600)
(3,600)
-0-
(51,600)
(3,600)
Total financing ................................
-0-
48,000
Cash balance, ending ................................
$ 12,000 $ 10,000 $ 10,800 $ 22,400
$
22,400
*48,000 × 10% × 9/12 = $3,600.
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46
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 7-7 (180 minutes) (LO2 CC5, 7, 11, 12, LO3 CC13, 14)
1. Schedule of expected cash collections:
January
February
Cash sales ................................$ 80,000 * $120,000
Credit sales ................................
224,000
320,000
Total cash collections ................................
$304,000
$440,000
March
$ 60,000
480,000
$540,000
Quarter
$ 260,000
1,024,000
$1,284,000
*Given.
2. (a) Inventory purchases budget:
January
February
Budgeted cost of goods
sold1 ................................$240,000
$360,000
Add desired ending
inventory2 ................................
90,000
45,000
Total needs ................................
330,000
405,000
Less beginning
inventory ................................
60,000 *
90,000
Required purchases ................................
$270,000
$315,000
March
Quarter
$180,000
$780,000
30,000
210,000
30,000
810,000
45,000
$165,000
60,000
$750,000
1For
January sales: $400,000 × 60% cost ratio = $240,000.
January 31: $360,000 × 25% = $90,000. At March 31: $200,000 April sales
× 60% cost ratio × 25% = $30,000.
*Given.
2At
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Solutions Manual, Chapter 7
47
Problem 7-7 (continued)
2. (b) Schedule of cash disbursements for purchases:
January
February
December purchases................................
$ 93,000 *
January purchases
135,000
$135,000
($270,000) ................................
February purchases
($315,000) ................................
157,500
March purchases
($165,000) ................................
Total cash
disbursements for
purchases ................................
$228,000
$292,500
March
Quarter
$ 93,000 *
270,000
$157,500
315,000
82,500
82,500
$240,000
$760,500
March
Quarter
$ 27,000
70,000
15,000
9,000
$ 81,000
210,000
65,000
39,000
$121,000
$395,000
*Given.
3. Schedule of cash disbursements for operating expenses:
January
February
Salaries and wages ................................
$ 27,000 *
$ 27,000
Advertising ................................ 70,000 *
70,000
Shipping................................
20,000
30,000
Other expenses ................................
12,000
18,000
Total cash disburse-ments
for operating expenses................................
$129,000
$145,000
*Given.
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48
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 7-7 (continued)
4. Cash budget:
January
February
Cash balance, beginning................................
$ 48,000 *
$ 30,000
Add cash collections ................................
304,000
440,000
Total cash available ................................
352,000
470,000
Less disbursements:
Purchases of inventory ................................
228,000
292,500
Operating expenses ................................
129,000
145,000
Purchases of equipment ................................
—
1,700
Cash dividends ................................
45,000 *
—
Total disbursements ................................
402,000
439,200
Excess (deficiency) of cash ................................
(50,000)
30,800
Financing:
Borrowings ................................80,000
—
Repayments ................................
—
—
Interest ................................
—
—
Total financing ................................
80,000
—
Cash balance, ending ................................
$ 30,000
$ 30,800
March
Quarter
$ 30,800
540,000
570,800
$ 48,000
1,284,000
1,332,000
240,000
121,000
84,500
—
445,500
125,300
760,500
395,000
86,200
45,000
1,286,700
45,300
—
(80,000)
(2,400)**
(82,400)
$ 42,900
80,000
(80,000)
(2,400)
(2,400)
$ 42,900
* Given.
** $80,000 × 12% × 3/12 = $2,400.
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Solutions Manual, Chapter 7
49
Problem 7-7 (continued)
5. Income statement:
Hillyard Company
Income Statement
For the Quarter Ended March 31
Sales ............................................................................................
Less cost of goods sold:
Beginning inventory (given) ........................................................
$ 60,000
Add purchases (Part 2) ...............................................................
750,000
Goods available for sale ..............................................................
810,000
Ending inventory (Part 2) ...........................................................
30,000
Gross margin ................................................................
Less operating expenses:
Salaries and wages (Part 3) ........................................................
81,000
Advertising (Part 3) ................................................................
210,000
Shipping (Part 3)................................................................
65,000
Depreciation ($14,000 × 3) ........................................................
42,000
Other expenses (Part 3) .............................................................
39,000
Net operating income ................................................................
Less interest expense (Part 4)........................................................
Net income ................................................................
$1,300,000
780,000 *
520,000
437,000
83,000
2,400
$ 80,600
*A simpler computation would be: $1,300,000 × 60% = $780,000.
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50
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 7-7 (continued)
6. Balance sheet:
Hillyard Company
Balance Sheet
March 31
Assets
Current assets:
Cash (Part 4) .............................................................................
Accounts receivable (80% × $300,000) .......................................
Inventory (Part 2) ......................................................................
Total current assets .......................................................................
Buildings and equipment, net
($370,000 + $84,500 + $1,700 – $42,000) .................................
Total assets ..................................................................................
$ 42,900
240,000
30,000
312,900
414,200
$727,100
Liabilities and Equity
Current liabilities:
Accounts payable
(Part 2: 50% × $165,000) .......................................................
Shareholders’ equity:
Capital shares ................................................................
$500,000
Retained earnings* ................................................................
144,600 *
Total liabilities and equity ..............................................................
$ 82,500
644,600
$727,100
* Retained earnings, beginning ................................ $109,000
Add net income ................................................................
80,600
Total ............................................................................................
189,600
Deduct cash dividends ................................................................
45,000
Retained earnings, ending.............................................................
$144,600
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Solutions Manual, Chapter 7
51
Problem 7-8 (180 minutes) (LO2 CC5, 7, 11, 12, LO3 CC13, 14)
1. Schedule of expected cash collections:
April
Cash sales ................................ $36,000
Credit sales1 ................................ 20,000
Total collections ................................
$56,000
140%
May
$43,200
24,000
$67,200
June
$54,000
28,800
$82,800
Quarter
$133,200
72,800
$206,000
of the preceding month’s sales.
2. Inventory purchases budget:
April
May
sold1
Budgeted cost of goods
................................
$45,000
$ 54,000
Add desired ending inventory2 ................................
43,200
54,000
Total needs ................................ 88,200
108,000
Less beginning inventory ................................
36,000 *
43,200
Required purchases ................................
$52,200
$ 64,800
1For
June
$67,500
28,800
96,300
54,000
$42,300
Quarter
$166,500
28,800
195,300
36,000
$159,300
April sales: $60,000 sales × 75% cost ratio = $45,000.
2At
April 30: $54,000 × 80% = $43,200.
At June 30: July sales $48,000 × 75% cost ratio × 80% = $28,800.
*Given.
Schedule of Expected Cash Disbursements—Purchases
April
May
March purchases ................................
$21,750 *
April purchases ................................
26,100
May purchases ................................
June purchases ................................
$26,100
32,400
Total disbursements ................................
$47,850
$58,500
June
Quarter
$32,400
21,150
$ 21,750 *
52,200
64,800
21,150
$53,550
$159,900
*Given.
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52
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 7-8 (continued)
3. Schedule of Expected Cash Disbursements—Operating Expenses
April
Salaries and wages ................................
$ 7,200
Rent ................................................................
2,500 *
Other expenses ................................ 3,600
Total disbursements ................................
$13,300
May
June
$ 8,640
2,500
4,320
$15,460
$10,800
2,500
5,400
$18,700
Quarter
$26,640
7,500
13,320
$47,460
*Given.
4. Cash budget:
April
May
Cash balance, beginning................................
$ 8,000 *
$ 4,350
Add cash collections ................................
56,000
67,200
Total cash available ................................
64,000
71,550
Less disbursements:
For inventory ................................ 47,850
58,500
For expenses ................................ 13,300
15,460
For equipment ................................ 1,500 *
—
Total disbursements ................................
62,650
73,960
Excess (deficiency) of cash ................................
1,350
(2,410)
Financing:
Borrowings ................................
3,000
7,000
Repayments ................................ —
—
Interest ................................................................
—
—
Total financing ................................ 3,000
7,000
Cash balance, ending ................................
$ 4,350
$ 4,590
1
$3,000 × 12% × 3/12 =
7,000 × 12% × 2/12 =
Total interest
June
Quarter
$ 4,590
82,800
87,390
$ 8,000
206,000
214,000
53,550
18,700
—
72,250
15,140
159,900
47,460
1,500
208,860
5,140
—
(10,000)
(230)1
(10,230)
$ 4,910
10,000
(10,000)
(230)
(230)
$ 4,910
$ 90
140
$230
* Given.
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Solutions Manual, Chapter 7
53
Problem 7-8 (continued)
5.
Shilow Company
Income Statement
For the Quarter Ended June 30
Sales ($60,000 + $72,000 + $90,000) ................................
$222,000
Less cost of goods sold:
Beginning inventory (Given) .......................................................
$ 36,000
Add purchases (Part 2) ...............................................................
159,300
Goods available for sale ..............................................................
195,300
Ending inventory (Part 2) ...........................................................
28,800
166,500 *
Gross margin ................................................................
55,500
Less operating expenses:
Salaries and wages (Part 3) ........................................................
26,640
Rent (Part 3) ................................................................7,500
Depreciation ($900 × 3) .............................................................
2,700
Other expenses (Part 3) .............................................................
13,320
50,160
Net operating income ................................................................
5,340
Less interest expense (Part 4)........................................................
230
Net income ................................................................
$ 5,110
*A simpler computation would be: $222,000 × 75% = $166,500.
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54
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 7-8 (continued)
6.
Shilow Company
Balance Sheet
June 30
Assets
Current assets:
Cash (Part 4) .............................................................................
Accounts receivable ($90,000 × 40%).........................................
Inventory (Part 2) ......................................................................
Total current assets .......................................................................
Fixed assets—net ($120,000 + $1,500 – $2,700) ............................
Total assets ..................................................................................
$ 4,910
36,000
28,800
69,710
118,800
$188,510
Liabilities and Equity
Accounts payable (Part 2: $42,300 × 50%) ................................
Shareholders’ equity:
Capital shares (Given) ................................................................
$150,000
Retained earnings ................................................................
17,360 *
Total liabilities and equity ..............................................................
$ 21,150
167,360
$188,510
* Retained earnings, beginning.........................................................
$12,250
Add net income ................................................................
5,110
Retained earnings, ending .............................................................
$17,360
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Solutions Manual, Chapter 7
55
Problem 7-9 (60 minutes) (LO2 CC7, 12)
1.
Kat Ltd.
Merchandise Purchases Budget
October
Budgeted sales
November
$350,000
December
$420,000
Budgeted cost of goods sold
(60%) ................................................................
210,000
252,000
Add desired ending
inventory* ................................ 21,000
25,200
Total needs ................................ 231,000
277,200
Less beginning inventory ................................
26,250
21,000
Required inventory purchases ................................
$204,750
$256,200
$312,500
187,500
18,750
206,250
25,200
$181,050
*10% of the current month’s budgeted cost of goods sold.
2.
Kat Ltd.
Cash Budget
October
Cash balance, beginning................................
$37,500
Add collections from sales* ................................
333,200
Total cash available ................................
$370,700
Less disbursements:
Purchases for inventory ................................
204,750
Monthly expenses ................................
43,750
Total disbursements ................................
$248,500
Excess (deficiency) of cash ................................
$122,200
Financing:
Investments………………
$81,250**
Borrowings ................................
Repayments ................................
Interest ................................
Total financing ................................ (81,250)
Cash balance, ending ................................
$ 40,950
November
$ 40,950
388,500
$429,450
256,200
43,750
$299,950
$ 129,500
$87,500**
(87,500)
$ 42,000
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56
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 7-9 (continued)
* Collections on sales:
October
November
Sales on account:
Sep.: ................................................................
$123,200
Oct.: $350,000 × 60%,
39% ................................................................
210,000
$136,500
Nov.: $420,000 × 60%
252,000
Total cash collections ................................
$333,200
$388,500
Note: The collection of $123,200 in October, from September sales, is the accounts
receivable amount ($126,000) net of the allowance for doubtful accounts ($2,800).
** Note that since there is excess cash, it will be invested. The total amount invested
must be in increments of $6,250 and after the amount invested is netted from the
excess cash, the ending balance must equal or exceed $37,500. Trial and error will lead
to the above values; there is no systematic method that can be provided. For example
in November, there is $129,500 - $37,500 = $92,000 available for investment. Dividing
by $6,250 yields 14.72 investment units and 14 x $6,250 is invested: $87,500.
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Solutions Manual, Chapter 7
57
Problem 7-10 (120 minutes) (LO2 CC5, 7, 12)
1. Schedule of Expected Cash Collections:
March
April
Sales on account:
A/R................................................................
$2,660,000
$144,000
March: $4,000,000 ×
20%, 75%, 4% ................................
800,000
3,000,000
April: $6,000,000 ×
20%, 75% ................................
1,200,000
May: $5,000,000 × 20%
................................................................
Total cash collections ................................
$3,460,000
$4,344,000
May
Quarter
$2,804,000
$160,000
3,960,000
4,500,000
5,700,000
1,000,000
$5,660,000
1,000,000
$13,464,000
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58
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 7-10 (continued)
2. Cash Budget
March
April
Cash balance,
beginning ................................
$520,000 $ 240,000
Equipment sale
proceeds
May
$ 104,000
Total
$
160,000
Add collections from
sales ................................
3,460,000
520,000
160,000
4,344,000
5,660,000
13,464,000
Total cash available ................................
4,140,000 $4,584,000
$5,764,000
$ 14,144,000
Purchases for
inventory ................................
2,160,000 2,400,000
3,200,000
7,760,000
Expenses ................................
2,040,000
2,080,000
1,660,000
5,620,000
Total disbursements ................................
$4,200,000 $4,480,000
$4,860,000
$13,540,000
Excess (deficiency)
of cash ................................
(60,000) $
$ 904,000
$
Less disbursements:
104,000
604,000
Financing:
Borrowings ................................
300,000
300,000
Repayments ................................
(300,000)
(300,000)
Interest ................................
( 24,000)
( 24,000)
($ 324,000)
( 24,000)
Total financing ................................
$ 300,000
Cash balance,
ending ................................
$ 240,000 $ 104,000
$ 580,000
$580,000
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Solutions Manual, Chapter 7
59
Problem 7-10 (continued)
The company is able to maintain a healthy ending cash balance even after repaying the
loan.
3. With the requirement of a $400,000 minimum cash balance, the company would be
able to repay the loan in December, but in this situation, the company would be
required to borrow much more than $300,000 in order to satisfy its cash needs in
October and November.
4. The current policy entails paying for purchases on the 15th of each month for
purchases between the 15th of the preceding month and the 14th of the current month.
The actual date of the payment and the period over which purchases are accumulated
and paid for is not critical if we assume purchases occur uniformly over time. Thus this
is really a policy of paying for purchases inside a month. Unless there is a discount for
early payment, it is probably better to match the disbursements to the collections to
maximize the net cash flow before other expenses and proceeds are considered.
Spreading the payment period to two months will likely result in a better match against
the collections although this will be an imperfect match unless the collection pattern is
matched exactly to the payment pattern. Cumulatively these month to month cash
balances will smooth out but the essence of cash budgeting is to ensure we have
adequate cash when needed even if on a cumulative basis the net cash balance is
positive. Therefore a company should investigate if spreading payments leads to a
better result insofar as the ending cash balances are reasonable.
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60
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 7-11 (90 minutes) (LO2 CC 5, 7, 12)
Note: This problem will likely to be challenging for many students because of the
unusual presentation of the information. If students have not taken an introductory
course in financial accounting they will need assistance. This problem is suitable for a
group assignment and is an excellent review of accounting concepts.
1. To perform the calculation without determining merchandise purchases, consider the
information on sales and cost of sales in June.
Quantity of Sales
= Sales revenue/selling price = $64,000/$16 = 4,000 units
Cost per unit of purchases = Cost of sales/units sold = $16,000/4,000 = $4
Note: Some students may also try to do the quantity schedule first to determine the
May purchases by applying the company’s purchase policy which is to “purchase
sufficient quantity of product to ensure that each month’s ending inventory is 50% of
the following month’s expected sales quantity”:
May Sales + Ending inventory (50% of June sales) - Beginning inventory (50% of May
sales) = May purchases
$48,000/$16 + 0.5 x $64,000/$16 – 0.5 x $48,000/$16 = 3,000 + 2,000 – 1,500 =
3,500 units purchased in May.
May purchase expenditures/ units purchased = cost per unit
$14,000/3,500 = $4.
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Solutions Manual, Chapter 7
61
Problem 7-11 (continued)
2. When preparing the schedule the company’s purchase policy should be properly
understood. Ending inventory will be 50% of the following period’s sales quantity and
the beginning inventory will 50% that period’s sales quantity.
May
June
July
August
Sales ($/$16)
3,000
4,000
3,500
4,500
Ending
inventory
2,000
1,750
2,250
Beginning
inventory
1,500
2,000
1,750
Purchases
3,500
3,750
4,000
Cost (x $4)
$14,000
$15,000
$16,000
3. From the above table, the cost of purchases is $14,000, $15,000 and $16,000 for
May, June and July respectively.
4. Collections can be analysed by considering the sales on account and the entries
involving cash and accounts receivable. Starting in April we work our way down month
by month. It should be apparent that April sales collection experience is the only month
for which data is available.
April sales = $32,000 and $15,680 is converted to cash: This implies that
$15,680/$32,000 = 49% of a month’s sales is collected in the month of the sale.
Confirmation: May sales collected in May = $23,520/$48,000 = 49%
April sales collected in May $12,800. This implies that $12,800/$32,000 = 40% is
collected in the month following the sales.
April sales collected in June $2,240. This implies that $2,240/$32,000 = 7%.
April sales estimated uncollectible = Bad debt expense/sales revenue = $1,280/$32,000
= 4%.
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62
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 7-11 (continued)
Summarizing:
April sales:
%collected in April 49%
% collected in May 40%
% collected in June 7%
% uncollectible
4%
Total
100%
5. The expenditure for purchases have been previously calculated in part 3. The journal
entries involving accounts payable and cash indicate the payments being made to
purchases. Combining these two bits of information, the disbursement percentages can
be computed. The month of May is the period for which data is provided.
Disbursement in May for purchases made in May = $10,500/$14,000 = 75%
Disbursement in June for purchases made in May = 3,500/$14,000 = 25%
Note: The analysis of part 3 of the question is not needed to answer this part, because
the calculation can be made using the journal entries for May and June involving
purchases and payments.
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Solutions Manual, Chapter 7
63
Problem 7-11 (continued)
6. A T-account is used to determine the balance in the accounts receivable account.
The collection percentages calculated previously must be applied to the sales in April
and May and June correctly.
Accounts Receivable, June Transactions
Bal. June 1
$27,200
Collection for April sales
$2,240
June sales
$64,000
Collection for May sales
(40% x $48,000)
$19,000
Collection for June sales
(49% x $64,000)
$31,360
Bal. June 30
$38,600
7. The collections made to retire accounts receivable represent cash flow. Disbursement
for purchases in June will pertain to May purchases (25%) and June purchases (75%).
Finally disbursements for variable and fixed period expenses will also be made. The
fixed portion can be found in the entry for August. This applies to June since the fixed
expenses in each month is assumed to be same for every month of the year. The
variable expense is a percent of the sales. This percentage is calculated from the
August’s projected expense: $7,560/$72,000 = 10.5%
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64
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 7 -11 (continued)
Cash balance for June
Beginning cash balance
Collections in June
April sales
May sales
June sales
Payments in June
May purchases
June purchases
Selling and administrative expenses
Variable cost1
Fixed cost2
Ending cash balance
1
2
$ 3,500
2,240
19,200
31,360
52,800
3,500
11,250
(14,750)
6,720
1,500
(8,220)
$ 33,330
0.105 × $64,000 = $6,720
$2,000 – $500 = $1,500
8.
Cash budget for July
Cash Budget
Month ended July 31, 20XX
Opening cash balance
$ 33,330
July cash collections
May sales (7% of $48,000)
June sales (40% of 64,000)
July sales (49% × 56,000)
3,360
25,600
27,440
July cash disbursements for merchandise purchases
June purchases (25% of $15,000)
3,750
July purchases (75% of $16,000)
12,000
Selling and administration expenses
Variable expense (10.5% of $56,000)
Fixed expense ($2,000 – $500)
Ending cash balance
5,880
1,500
56,400
(15,750)
(7,380)
$ 66,600
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Solutions Manual, Chapter 7
65
Problem 7-12 (60 minutes) (LO2 CC5, 7, 9, LO3 CC13)
1.
Variable overhead cost, budgeted ($25 x 10,000 DLH) ………..
Fixed overhead
Depreciation
Other fixed Mfg. OH
Total
Total DLH
Overhead rate
$250,000
240,000
140,000
$630,000
10,000
$63/DLH
Each unit of product requires 10,000 DLH/100,000 units = 0.10DLH. Thus the OH cost
per unit of product is $63 x 0.10 = $6.30.
2.
Direct labour
Manufacturing overhead (from part (1))
Direct materials cost
Manufacturing costs incurred
Production quantity
Cost per unit
Ending finished goods inventory (2,500 units × $26.30)
Year
$ 400,000.00
630,000.00
1,600,000.00
$ 2,630,000.00
100,000
$ 26.30
$ 65,750.00
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 7 -12 (continued)
3.
Cash disbursements—Manufacturing (Quarter 4)
Direct labour
$98,200
Manufacturing overhead, excludes amortization
96,375 4
Direct materials purchases
399,200 5
$593,775
Cash disbursement for manufacturing
$
4
($25 × 2,455) + $140,000/4 = $96,375
Purchases = Ending inventory – Opening inventory + Quantity used
Because inventory of materials does not change throughout the year,
materials used for production.
Materials required and used per unit of product = 2 materials units.
Materials required and used for 3rd quarter production = production x
Materials required and used for 4th quarter production = production x
5
(assume constant prices)
purchases will equal the
2 = 25,350 x 2 = 50,700
2 = 24,550 x 2 = 49,100
Materials purchase cost, Qtr 3 = 50,700 x $8 = $405,600
Materials purchase cost, Qtr 4 = 49,100 x $8 = $392,800
Quarter 4, disbursement for materials purchases = $405,600 x 0.5 + $392,800 x 0.5 =
$399,200
4. The cost of goods sold is not cash flow because the cost per unit of product will
include fixed overhead which will also include a charge for depreciation which is a non
cash expense.
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Solutions Manual, Chapter 7
67
Problem 7- 12 (continued)
5.
Variable manufacturing overhead (part (1))
Unit cost (part (2))
$ 250,000.00
$
26.30
RED COMPANY
Budgeted Income Statement, Absorption Approach
year ended December 31, 20YY
Sales revenue
Cost of goods manufactured:
Direct materials used in production
Beginning inventory, materials
Purchases, direct materials
Ending inventory, materials
Direct labour
Manufacturing overhead
Cost of goods manufactured
Add: Beginning inventory, finished goods
Less: Ending inventory
Cost of goods sold
Gross margin
Selling and administrative expenses
Net income (loss)
1
2
3
$ 3,998,000
$ 78,560 1
1,600,000
(78,560)2 1,600,000
400,000
630,000 3
2,630,000
62,475
(65,750)
2,626,725
1,371,275
1,639,860
$ (268,585)
9,820 × ($390,560 / 48,820) = $78,560
9,820 × ($1,600,000 / 200,000) = $78,560
($25 × 10,000) + $380,000 = $630,000
(all other figures are either given or are calculated items on the income statement)
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68
Introduction to Managerial Accounting, Fifth Canadian Edition
PROBLEM 7-13 (60 minutes) (LO2 CC 5, 9, 12)
1. Collections on sales:
Cash sales .......................................
Credit sales:
May: $30,000 × 80% × 20% ........
June: $36,000 × 80% × 70%,
20% .........................................
July: $40,000 × 80% × 25%,
60%, 15% ................................
August: $70,000 × 80% × 25%,
60% .........................................
September: $50,000 × 80% ×
25% .........................................
Total cash collections .......................
July
$ 8,000
August
Sept.
Quarter
$14,000
$10,000
$ 32,000
4,800
4,800
20,160
5,760
8,000
19,200
4,800
32,000
14,000
33,600
47,600
$52,960
10,000
$58,400
10,000
$152,320
August
Sept.
$40,960
25,920
2. a. Merchandise purchases budget:
July
Budgeted cost of goods sold ............
Add desired ending inventory* .........
Total needs .....................................
Less beginning inventory ..................
Required inventory purchases ...........
$24,000
10,500
34,500
18,000
$16,500
$42,000
7,500
49,500
10,500
$39,000
$30,000
6,750
36,750
7,500
$29,250
Oct.
$27,000
*25% of the next month’s budgeted cost of goods sold.
b. Schedule of expected cash disbursements for merchandise purchases:
July
Accounts payable, June 30 ...............
July purchases .................................
August purchases ............................
September purchases ......................
Total cash disbursements .................
$11,700
8,250
$19,950
August
$ 8,250
19,500
$27,750
Sept.
Quarter
$19,500
14,625
$34,125
$11,700
16,500
39,000
14,625
$81,825
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69
Problem 7-13 (continued)
3.
Janus Products, Inc.
Cash Budget
For the Quarter Ended September 30
July
Cash balance, beginning ...............
Add collections from sales
Total cash available ....................
Less disbursements:
For inventory purchases .............
For selling expenses...................
For administrative expenses .......
For land ....................................
For dividends .............................
Total disbursements ......................
Excess (deficiency) of cash
available over disbursements ......
Financing:
Borrowings ................................
Repayment ................................
Interest .....................................
Total financing ..............................
Cash balance, ending ....................
August
Sept.
Quarter
$ 8,000
40,960
48,960
$13,710
52,960
66,670
$22,020
58,400
80,420
$ 8,000
152,320
160,320
19,950
7,200
3,600
4,500
0
35,250
27,750
11,700
5,200
0
0
44,650
34,125
8,500
4,100
0
1,000
47,725
81,825
27,400
12,900
4,500
1,000
127,625
13,710
22,020
32,695
32,695
0
0
0
0
$13,710
0
0
0
0
$22,020
0
0
0
0
$32,695
0
0
0
0
$ 32,695
4. Collecting accounts receivable sooner and reducing inventory levels eliminated the
company’s need to borrow money and pay interest during the third quarter.
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Introduction to Managerial Accounting, Fifth Canadian Edition
Comprehensive Problem (120+ minutes) (LO2 CC5, 7, 12, LO3 CC13, 14)
1. a. Sales budget:
Budgeted sales in units .....
Selling price per unit .........
Total sales ........................
April
35,000
× $8
$280,000
b. Schedule of expected cash collections:
February sales ..................
$ 48,000
March sales ......................
112,000
April sales ........................
70,000
May sales .........................
June sales ........................
Total cash collections ........
$230,000
c. Merchandise purchases budget:
Budgeted sales in units .....
35,000
Add budgeted ending
inventory* .....................
40,500
Total needs.......................
75,500
Less beginning inventory ...
31,500
Required unit purchases ....
44,000
Unit cost ..........................
× $5
Required dollar purchases .
$220,000
May
45,000
× $8
$360,000
June
60,000
× $8
$480,000
Quarter
140,000
× $8
$1,120,000
$
$286,000
$ 70,000
180,000
120,000
$370,000
48,000
168,000
280,000
270,000
120,000
$ 886,000
45,000
60,000
140,000
54,000
99,000
40,500
58,500
× $5
$292,500
36,000
96,000
54,000
42,000
× $5
$210,000
36,000
176,000
31,500
144,500
× $5
$ 722,500
$ 56,000
140,000
90,000
*90% of the next month’s sales in units.
d. Budgeted cash disbursements for merchandise purchases:
April
March purchases .............
April purchases ...............
May purchases................
June purchases ...............
Total cash payments ....
$ 85,750
110,000
$195,750
May
$110,000
146,250
$256,250
June
$146,250
105,000
$251,250
Quarter
$ 85,750
220,000
292,500
105,000
$703,250
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71
Comprehensive Problem (continued)
2.
Cravat Sales Company
Cash Budget
For the Three Months Ending June 30
April
Cash balance, beginning .........
Add receipts from customers
(Part 1 b.)...........................
Total cash available ................
Less disbursements:
Purchase of inventory (Part
1 d.) ................................
Sales commissions ..............
Salaries and wages .............
Utilities ...............................
Miscellaneous .....................
Dividends paid ....................
Land purchases...................
Total disbursements ...............
Excess (deficiency) of receipts
over disbursements .............
Financing:
Borrowings .........................
Repayments* ......................
Interest* ............................
Total financing .......................
Cash balance, ending .............
May
June
Quarter
$ 14,000
$ 10,250
$ 10,000
$ 14,000
230,000
244,000
286,000
296,250
370,000
380,000
886,000
900,000
195,750
35,000
22,000
14,000
3,000
12,000
0
281,750
256,250
45,000
22,000
14,000
3,000
0
25,000
365,250
251,250
60,000
22,000
14,000
3,000
0
0
350,250
703,250
140,000
66,000
42,000
9,000
12,000
25,000
997,250
(37,750)
(69,000)
48,000
0
0
48,000
$ 10,250
79,000
0
0
79,000
$ 10,000
29,750
0
(16,000)
(3,020)
(19,020)
$ 10,730
(97,250)
127,000
(16,000)
(3,020)
107,980
$ 10,730
* This is the maximum amount (in increments of $1,000) that the company could
repay to the bank and still have at least a $10,000 ending balance.
** $48,000 × 1% × 3
$79,000 × 1% × 2
Total interest
=
=
=
$1,440
1,580
$3,020
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Introduction to Managerial Accounting, Fifth Canadian Edition
Comprehensive Problem (continued)
3.
Cravat Sales Company
Budgeted Income Statement
For the Three Months Ended June 30
Sales revenue (Part 1 a.) ..............................
Variable expenses:
Cost of goods sold
(140,000 ties @ $5 per tie) ....................
Commissions
(140,000 ties @ $1 per tie) ....................
Contribution margin .....................................
Fixed expenses:
Wages and salaries ...................................
Utilities ....................................................
Insurance expired .....................................
Depreciation .............................................
Miscellaneous ...........................................
Net operating income ...................................
Interest expense..........................................
Net income..................................................
$1,120,000
$700,000
140,000
66,000
42,000
3,600
4,500
9,000
840,000
280,000
125,100
154,900
3,020
$ 151,880
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Solutions Manual, Chapter 7
73
Comprehensive Problem (continued)
4.
Cravat Sales Company
Budgeted Balance Sheet
June 30
Assets
Cash (Part 2) ........................................................................
Accounts receivable (see below) ............................................
Inventory (36,000 ties @ $5 per tie) ......................................
Unexpired insurance ($14,400 – $3,600) ................................
Fixed assets, net of depreciation
($172,700 + $25,000 – $4,500)..........................................
Total assets ..........................................................................
$ 10,730
450,000
180,000
10,800
193,200
$844,730
Liabilities and Stockholders’ Equity
Accounts payable, purchases (50% × $210,000.) ...................
Dividends payable .................................................................
Loans payable, bank ($127,000 – $16,000) ............................
Common stock, no par ..........................................................
Retained earnings (see below)...............................................
Total liabilities and equity ......................................................
Accounts receivable at June 30:
25% × May sales of $360,000 ...........................
75% × June sales of $480,000 ..........................
Total ................................................................
$ 90,000
360,000
$450,000
Retained earnings at June 30:
Balance, March 31 ............................................
Add net income (Part 3) ....................................
Total ................................................................
Less dividends declared.....................................
Balance, June 30 ..............................................
$176,850
151,880
328,730
12,000
$316,730
$105,000
12,000
111,000
300,000
316,730
$844,730
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Introduction to Managerial Accounting, Fifth Canadian Edition
Analytical Thinking (75 minutes) (LO1 CC1, 2, 3, 4, LO4 CC15)
1. Stokes is using the budget as a club to pressure employees and as a way to find
someone to blame rather than as a legitimate planning and control tool. His
planning seems to consist of telling everyone to increase sales volume by 40%. This
kind of “planning” requires no analysis, no intelligence, no business insight, and is
very likely viewed with contempt by the employees of the company.
2. The way in which the budget is being used is likely to breed hostility, tension,
mistrust, lack of respect, and actions designed to meet targets using any means
available. Unreasonable targets imposed from the top, coupled with a “no excuses”
policy and the threat of being fired, create an ideal breeding ground for
questionable business practices. Managers who would not, under ordinary
circumstances, cheat or cut corners may do so if put under this kind of pressure.
3. As the old saying goes, Keri Kalani is “between a rock and a hard place.” The
Statement of Ethical Professional Practice established by the Institute of
Management Accountants states that management accountants have a responsibility
to “disclose all relevant information that could reasonably be expected to influence
an intended user’s understanding of the reports, analyses, or recommendations.”
Assuming that Keri helps prepare the Production Department’s reports to top
management, collaborating with her boss in hiding losses due to defective disk
drives would clearly violate this standard. Apart from the misrepresentation on the
accounting reports, the policy of shipping defective returned units to customers is
bound to have a negative effect on the company’s reputation. If this policy were to
become widely known, it would very likely have a devastating effect on the
company’s future sales. Moreover, this practice may be illegal under statutes
designed to protect consumers.
Having confronted her boss with no satisfactory resolution of the problem, Keri must
now decide what to do. The Statement of Ethical Professional Practice suggests that
Keri go to the next higher level in management to present her case. Unfortunately,
in the prevailing moral climate at PrimeDrive, she is unlikely to win any blue ribbons
for blowing the whistle on her boss. All of the managers below Stokes are likely to
be in fear of losing their own jobs and many of them may have taken actions to
meet Stokes’s targets that they are not proud of either.
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75
Analytical Thinking (continued)
It would take tremendous courage for Keri to take the problem all the way up to
Stokes himself—particularly in view of his less-than-humane treatment of
subordinates. And going to the Board of Directors is unlikely to work either because
Stokes and his venture capital firm apparently control the Board. Resigning, with a
letter of memorandum to the individual who is most likely to be concerned and to be
able to take action, may be the only ethical course of action that is available to Keri
in this situation. Of course, she must pay her rent, so hopefully she has good
alternative employment opportunities.
Note: This problem is very loosely based on the MiniScribe scandal reported in the
December, 1992 issue of Management Accounting as well as in other business
publications. After going bankrupt, it was discovered that managers at MiniScribe
had perpetrated massive fraud as a result of the unrelenting pressure to meet
unrealistic targets. Q. T. Wiles, the real chairman of MiniScribe, was reported to have
behaved much as described in this problem. Keri Kalani is, alas, a fabrication.
Hopefully, there were people like Keri at MiniScribe who tried to do something to
stop the fraud.
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Introduction to Managerial Accounting, Fifth Canadian Edition
Communicating in Practice (20 minutes) (LO1 CC1, LO2 CC2, 12)
Memorandum to president:
Date:
To:
From:
Subject:
Current date
Laura Dennan, President
Student
Cash Budget
Cash budgeting is particularly important for a rapidly expanding company such as Risky
Rolling. As sales grow, so do expenditures for inputs (such as direct materials, direct
labour and manufacturing overhead) and expenses (such as administrative and selling
expenses). The expenditures generally precede cash receipts. That is, the company’s
vendors and suppliers must be paid when the goods and services are received and its
employees paid as work is performed. On the other hand, our inventory must be sold,
delivered and then invoiced before cash is collected from customers. In fact, the time
period between expenditures and cash collections is often considerable, and a growing
company must have plans for dealing with the gap.
Although the process can be time-consuming, cash budgeting is essential because it will
forewarn our managers of any impending cash shortages. We may learn that the
company will be forced to arrange for financing at one or more points during the year.
If we can forecast the timing and amount of cash shortages well in advance, we should
be able to negotiate better terms than if we simply come up short at some point next
year and are forced to approach our lenders when a crisis is looming. In addition,
lenders often request a cash budget. Including the budget in the package we present to
the lenders will make a more favourable impression as we start negotiations.
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Solutions Manual, Chapter 7
77
Ethics Challenge (60 minutes) (LO1 CC1, 2, LO4 CC15)
1.
(a)
The reasons that managers use budgetary slack include the following:
•
Protect against the unexpected (reducing uncertainty/risk).
•
Demonstrate having met or exceeded expectations and/or show consistent
performance. This is particularly important when performance is evaluated on
the basis of actual results versus budget.
•
Present a positive report of managerial performance since good performance
generally leads to higher salaries, promotions, and bonuses.
(b) The use of budgetary slack can adversely affect managers because it robs the
budget of its power as a control mechanism:
•
the usefulness of the budget to motivate their employees to top performance will
be hampered.
•
the managers’ ability to use budget variances to to identify trouble spots and
take appropriate corrective action is hampered because the original budget
numbers are compromised by the budgetary slack.
•
managers’ credibility in the eyes of senior management can be impaired since
numerous adjustments to budget will be necessitated throughout the operating
cycle and call into question the budget’s role as a planning device and the
managers’ ability to develop stable and reliable budgets.

Management decision-making is adversely affected as the budgets will show
lower contribution margins (lower sales, higher expenses). Decisions regarding
the profitability of product lines, staffing levels, incentives, etc., will be made on
distorted financial information and could have an adverse effect on sales and
production departments.
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Introduction to Managerial Accounting, Fifth Canadian Edition
Ethics Challenge (continued)
2. The use of budgetary slack, particularly if it has a detrimental effect on the
company, may be unethical. In assessing the situation, the following competencies
of a professional accountant are affected:
Professional Competence
Codes of professional conduct typically contain statements referencing that clients
and users expect the accountant will exhibit competence in the conduct of the
engagement and on the preparation of analyses and reports. Clear reports using
relevant and reliable information should be prepared. Otherwise the work does not
represent “competent professional services...[diligent] in accordance with applicable
technical and professional standards.” Clearly budgetary slack distorts the “real
number” since its purpose is to protect the preparer of the budget from the
consequences of failing to meet targets. This is contrary to the expectation the
information used and supplied by an accountant is reliable, complete and accurate
to the best of the accountant’s abilities.
Integrity
•
Any activity that subverts the legitimate goals of the company should be avoided.
•
Favourable as well as unfavourable information should be communicated.

Fudging the numbers to create slack does not satisfy the standard of being
“straightforward and honest in all business relationships”.
Objectivity
•
Information should be fairly and objectively communicated.
•
All relevant information should be disclosed.

An objective approach does “not allow bias, conflict of interest or undue
influence of others to override professional or business judgments.”
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79
Teamwork in Action (45 minutes) (LO1 CC1, 2, LO4 CC15)
1. The budgetary control system of Ferguson & Son appears to have several very
important shortcomings that reduce its effectiveness and may in fact cause it to
interfere with good performance. Some of the shortcomings are itemized and
explained below.
(a) Lack of Coordinated Goals. Emory had been led to believe high quality output is
the goal; it now appears low cost is the goal. The employees do not know what
the goals are and thus cannot make decisions that lead toward reaching the
goals.
(b) Influence of Uncontrollable Factors. The actual performance relative to budget is
greatly influenced by uncontrollable factors (i.e., rush orders, lack of prompt
maintenance). Thus, the variance reports serve little purpose for evaluation of
performance or for locating controllable factors to improve performance. As a
result, the system does not encourage coordination among departments.
(c) The Short-Run Perspective. The monthly evaluation and the budget tightening on
a monthly basis results in a very short-run perspective by the supervisors. This
will result in inappropriate decisions (i.e., inspect the forklift trucks rather than
repair inoperative equipment, fail to report supplies usage).
(d) System Does Not Motivate. The budgetary system appears to focus on evaluation
of performance even though most of the essential factors for the purpose are
missing. The focus on evaluation and the weaknesses take away an important
benefit of the budgetary system—motivation of management employees.
2. The improvements in the budgetary control system should correct the deficiencies
described above. The system should:
(a) more clearly define the company’s objectives.
(b) develop an accounting reporting system that better matches controllable factors
with supervisor responsibility and authority.
(c) establish budgetary values for appropriate time periods that do not change
monthly simply as a result of a change in the prior month’s performance.
The entire company from top management down should be educated in sound
budgetary procedures so that all parties will understand the total process and
recognize the benefit to be gained.
(Unofficial CMA Solution)
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80
Introduction to Managerial Accounting, Fifth Canadian Edition
Chapter 8
Cost-Volume-Profit Relationships
Solutions to Questions
8-1
The contribution margin (CM) ratio is
the ratio of contribution margin to total sales
revenue. The CM ratio shows the change in
contribution margin that will result from
increases and decreases in sales revenue. A
dollar increase in contribution margin will result
in a dollar increase in net income. Therefore, for
planning purposes, a product’s CM ratio is
extremely helpful in projecting potential
contribution margin and potential net income.
8-2
An incremental analysis focuses on the
changes in revenue, cost, and volume that will
result from a particular action.
8-3
Company B will tend to realize the most
rapid increase in profits. The reason is that
Company B will have a higher contribution
margin ratio than Company A due to its lower
variable costs. Thus, contribution margin (and
net income) will increase more rapidly as sales
increase.
8-4
Operating leverage measures the impact
on net income of a given percentage change in
sales. The degree of operating leverage at a
given level of sales is computed by dividing the
contribution margin at that level of sales by the
net income.
8-5
No. A ten percent decrease in the selling
price will have a greater impact on profits than a
ten percent increase in variable expenses, since
the selling price is a larger figure than the
variable expenses. Mathematically, the same
percentage applied to a larger base will yield a
larger result. In addition, the selling price affects
how much of the product will be sold.
also be defined as the point where total
revenues equal total costs, and as the point
where the total contribution margin equals total
fixed costs.
8-7
Three approaches to break-even
analysis are (a) the equation method, (b) the
contribution margin method, and (c) the
graphical method. In the equation method, the
equation is: Sales = Variable expenses + Fixed
expenses + Profits, where profits are zero at the
break-even point. The equation is solved to
determine the break-even point in units or dollar
sales. In the contribution margin method, the
total fixed costs are divided by the contribution
margin per unit to obtain the break-even point
in units. Alternatively, the total fixed costs can
be divided by the contribution margin ratio to
obtain the break-even point in sales dollars. In
the graphical method, total cost and total
revenue data are plotted on a two-axis graph.
The intersection of the total cost and the total
revenue lines indicates the break-even point.
The graph shows the break-even point in both
units and dollars of sales.
8-8
(a) The total revenue line would rise
less steeply, and the break-even point would
occur at a higher volume of units. (b) Both the
fixed cost line and the total cost line would shift
upward; the break-even point would occur at a
higher volume of units. (c) The total cost line
would rise more steeply, and the break-even
point would occur at a higher volume of units.
8-6
The break-even point can be defined as
the level of sales at which an organization
neither earns a profit nor incurs a loss. It can
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Solutions Manual, Chapter 8
1
8-9
Sales revenue per car washed ...........................
$4.00
Variable expenses per car:
15%  $4.00 ................................
0.60
Contribution margin per car ...............................
$3.40
Total fixed expenses
$1,700 500
=
=
Contribution margin per car $3.40 cars
8-10 The margin of safety is the excess of
budgeted (or actual) sales over the break-even
volume of sales. It states the amount by which
sales can drop before losses begin to be
incurred.
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2
Introduction to Managerial Accounting,Fifth Canadian Edition
The Foundational 15 (LO1 – CC2, 3; LO2 – CC5, 6, 7, 8, 10)
8-1.
The contribution margin per unit is calculated as follows:
Total contribution margin (a) .........................
Total units sold (b) ............. ......... ...............
Contribution margin per unit (a) ÷ (b) ...........
$8,000
1,000 units
$8.00 per unit
The contribution margin per unit ($8) can also be derived by calculating the selling
price per unit of $20 ($20,000 ÷ 1,000 units) and deducting the variable expense
per unit of $12 ($12,000 ÷ 1,000 units).
8-2.
The contribution margin ratio is calculated as follows:
Total contribution margin (a) .........................
Total sales (b) .................... ......... ...............
Contribution margin ratio (a) ÷ (b) ................
8-3.
The variable expense ratio is calculated as follows:
Total variable expenses (a) .
Total sales (b) .................... ......... ...............
Variable expense ratio (a) ÷ (b) ....................
8-4.
$8,000
$20,000
40%
$12,000
$20,000
60%
The increase in net operating is calculated as follows:
Contribution margin per unit (a) ................................
Increase in unit sales (b) .....
Increase in net operating income (a) × (b) ....
8-5.
$8.00 per unit
1 unit
$8.00
If sales decline to 900 units, the net operating would be computed as follows:
Sales (900 units) .................
Variable expenses ...............
Contribution margin ............
Fixed expenses ...................
Net operating income ..........
Total
Per Unit
$18,000
10,800
7,200
6,000
$ 1,200
$20.00
12.00
$ 8.00
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Solutions Manual, Chapter 8
3
The Foundational 15 (continued)
8-6.
The new net operating income would be computed as follows:
Sales (900 units) .................
Variable expenses ...............
Contribution margin ............
Fixed expenses ...................
Net operating income ..........
8-7.
$19,800
10,800
9,000
6,000
$ 3,000
$22.00
12.00
$10.00
Total
Per Unit
$25,000
16,250
8,750
7,500
$ 1,250
$20.00
13.00
$ 7.00
The equation method yields the break-even point in unit sales, Q, as follows:
Profit
$0
$0
$8Q
Q
Q
8-9.
Per Unit
The new net operating income would be computed as follows:
Sales (1,250 units) ..............
Variable expenses ...............
Contribution margin ............
Fixed expenses ...................
Net operating income ..........
8-8.
Total
=
=
=
=
=
=
Unit CM × Q − Fixed expenses
($20 − $12) × Q − $6,000
($8) × Q − $6,000
$6,000
$6,000 ÷ $8
750 units
The equation method yields the dollar sales to break-even as follows:
Profit
$0
0.40 × Sales
Sales
Sales
=
=
=
=
=
CM ratio × Sales − Fixed expenses
0.40 × Sales − $6,000
$6,000
$6,000 ÷ 0.40
$15,000
The dollar sales to break-even ($15,000) can also be computed by multiplying the
selling price per unit ($20) by the unit sales to break-even (750 units).
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4
Introduction to Managerial Accounting,Fifth Canadian Edition
The Foundational 15 (continued)
8-10.
The equation method yields the target profit as follows:
Profit
$5,000
$5,000
$8Q
Q
Q
=
=
=
=
=
=
Unit CM × Q − Fixed expenses
($20 − $12) × Q − $6,000
($8) × Q − $6,000
$11,000
$11,000 ÷ $8
1,375 units
8-11. The margin of safety in dollars is calculated as follows:
Sales..........................................................................
Break-even sales (at 750 units) ...................................
Margin of safety (in dollars).........................................
$20,000
15,000
$ 5,000
The margin of safety as a percentage of sales is calculated as follows:
Margin of safety (in dollars) (a) ............................
Sales (b) .............................................................
Margin of safety percentage (a) ÷ (b) ...................
$5,000
$20,000
25%
8-12. The degree of operating leverage is calculated as follows:
Contribution margin (a)....... ...........................
Net operating income (b) ................................
Degree of operating leverage (a) ÷ (b) ............
$8,000
$2,000
4.0
8-13. A 5% increase in sales should result in a 20% increase in net operating income,
computed as follows:
Degree of operating leverage (a) ...........................................
Percent increase in sales (b) ..................................................
Percent increase in net operating income (a) × (b) .................
4.0
5%
20%
8-14. The degree of operating leverage is calculated as follows:
Contribution margin (a) ...... ...........................
Net operating income (b) ................................
Degree of operating leverage (a) ÷ (b)............
$14,000
$2,000
7.0
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Solutions Manual, Chapter 8
5
The Foundational 15 (continued)
8-15. A 5% increase in sales should result in 35% increase in net operating income,
computed as follows:
Degree of operating leverage (a) ...........................................
Percent increase in sales (b) ..................................................
Percent increase in net operating income (a) × (b) .................
7.0
5%
35%
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6
Introduction to Managerial Accounting,Fifth Canadian Edition
Brief Exercise8-1(30 minutes)(LO1 CC1)
1. The new income statement would be:
Total
Sales (13,500 units) ................................
$486,000
Less variable expenses ................................
270,000
Contribution margin ................................
216,000
Less fixed expenses ................................
185,000
Net income (loss) ................................
$31,000
Per Unit
$36.00
20.00
$16.00
You can get the same net income using the following approach.
Original net income................................$15,000
Change in contribution margin
(1,000 units × $16.00 per unit) ................................
16,000
New net income ................................................................
$31,000
2. The new income statement would be:
Total
Sales (11,500 units) ................................
$414,000
Less variable expenses ................................
230,000
Contribution margin ................................
184,000
Less fixed expenses ................................
185,000
Net income (loss) ................................
($ 1,000)
Per Unit
$36.00
20.00
$16.00
You can get the same net income using the following approach.
Original net income................................................................
$15,000
Change in contribution margin
(-1,000 units × $16.00 per unit) ................................
(16,000)
New net income (loss) ................................................................
($1,000)
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Solutions Manual, Chapter 8
7
Brief Exercise 8-1(continued)
3. The new income statement would be:
Total
Sales (9,250units)................................
$333,000
Less variable expenses ................................
185,000
Contribution margin ................................
148,000
Less fixed expenses ................................
185,000
$
Net income (loss) ................................
(37,000)
Per Unit
$36.00
20.00
$16.00
Brief Exercise 8-2 (15 minutes) (LO1 CC2, 3)
1. The company's contribution margin (CM) ratio is:
Total sales................................................................
$200,000
Total variable expenses ................................
120,000
= Total contribution margin................................
80,000
÷ Total sales ................................................................
$200,000
= CM ratio ................................................................
40%
2. The change in net income from an increase in total sales of $1,100 can be estimated
by using the CM ratio as follows:
Change in total sales ................................................................
$1,100
× CM ratio ................................................................
40 %
= Estimated change in net income ................................
$ 440
This computation can be verified as follows:
Total sales................................ $200,000
÷ Total units sold ................................
50,000 units
= Selling price per unit................................
$4.00 per unit
Increase in total sales ................................
$1,100
÷ Selling price per unit................................
$4.00 per unit
= Increase in unit sales................................
275 units
Original total unit sales ................................
50,000 units
New total unit sales ................................
50,275 units
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8
Introduction to Managerial Accounting,Fifth Canadian Edition
Original
New
Total unit sales ................................
50,000
50,275
Sales................................................................
$200,000
$201,100
Less variable expenses ................................
120,000
120,660
Contribution margin ................................
80,000
80,440
Less fixed expenses ................................
65,000
65,000
Net income................................ $ 15,000
$ 15,440
Brief Exercise 8-3 (30 minutes) (LO2 CC5)
1. The following table shows the effect of the proposed change in monthly advertising
budget:
Current
Sales
Sales With
Additional
Advertising
Budget
Difference
Sales................................................................
$180,000
$189,000
Less variable expenses ................................
126,000
132,300
Contribution margin ................................
54,000
56,700
Less fixed expenses ................................
40,000
44,000
Net income................................$ 14,000
$ 12,700
$ 9,000
6,300
2,700
4,000
$(1,300)
Assuming no other important factors need to be considered, the increase in the
advertising budget should not be approved since it would lead to a decrease in net
income of $1,300.
Alternative Solution 1
Expected total contribution margin:
$189,000 × 30% CM ratio ................................ $56,700
Present total contribution margin:
$180,000 × 30% CM ratio ................................
54,000
Incremental contribution margin ................................ 2,700
Change in fixed expenses:
Less incremental advertising expense ................................
4,000
Change in net income ................................................................
$(1,300)
Alternative Solution 2
Incremental contribution margin:
$ 2,700
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Solutions Manual, Chapter 8
9
$9,000 × 30% CM ratio ............................................................
Less incremental advertising expense ................................
4,000
Change in net income ................................................................
$(1,300)
2. The $2.00 increase in variable costs will cause the unit contribution margin to
decrease from $27 to $25.00 with the following impact on net income:
Expected total contribution margin with the higherquality components:
2,200 units × $25.00per unit ......................................................
$55,000
Present total contribution margin:
54,000
2,000 units × $27 per unit .........................................................
Change in total contribution margin ...............................................
$1,000
Assuming no change in fixed costs and all other factors remain the same, the
higher-quality components should be used.
NOTE: This question is a nice illustration that an incremental approach is not always a
preferable approach to finding a solution. The solution is not determinable by a simple
inspection of the information. The reason is that there are two variables that are
changing: the unit CM and the sales volume. The best approach is to compare the
status quo to the new situation which will have BOTH changes incorporated.
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10
Introduction to Managerial Accounting,Fifth Canadian Edition
Brief Exercise 8-4 (30 minutes) (LO2 CC6)
1. The equation method yields the break-even point in unit sales, Q, as follows:
Sales
$54Q
$9Q
Q
Q
=
=
=
=
=
Variable expenses + Fixed expenses + Profits
$45Q + $26,550 + $0
$26,550
$26,550 ÷ $9 per basket
2,950 baskets
2. The equation method can be used to compute the break-even point in sales dollars,
X, as follows:
Per Unit
Percent of
Sales
Sales price ................................ $54
100.00%
Less variable expenses ................................
45
83.33%
Contribution margin ................................
$9
16.67%
Sales
X
0.1667X
X
X
=
=
=
=
≈
Variable expenses + Fixed expenses + Profits
0.8333X + $26,550 + $0
$26,550
$26,550 ÷ 0.1667
$159,268
3. The contribution margin method gives an answer that is identical to the equation
method for the break-even point in unit sales:
Break-even point in units sold = Fixed expenses ÷ Unit CM
= $26,550 ÷ $9 per basket
= 2,950 baskets
4. The contribution margin method also gives an answer that is identical to the
equation method for the break-even point in dollar sales:
Break-even point in sales dollars = Fixed expenses ÷ CM ratio
= $26,550 ÷ 0.1667
= $159,268*
* differs from $54 x 2,950 = $159,300 due to rounding
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Solutions Manual, Chapter 8
11
Brief Exercise 8-5 (30 minutes) (LO1 CC4)
1. The CVP graph can be plotted using the three steps outlined in the text. The graph
appears on the next page.
Step 1. Draw a line parallel to the volume axis to represent the total fixed
expense. For this company, the total fixed expense is $24,000.
Step 2. Choose some volume of sales and plot the point representing total
expenses (fixed and variable) at the activity level you have selected. We'll use the
sales level of 8,000 units.
Fixed expense ..............................................................................
$ 24,000
Variable expense (8,000 units × $18 per unit) ................................
144,000
Total expense ...............................................................................
$168,000
Step 3. Choose some volume of sales and plot the point representing total sales
dollars at the activity level you have selected. We'll use the sales level of 8,000 units
again.
Total sales revenue (8,000 units × $24 per unit) ............................
$192,000
2. The break-even point is the point where the total sales revenue and the total
expense lines intersect. This occurs at sales of 4,000 units. This can be verified by
solving for the break-even point in unit sales, Q, using the equation method as
follows:
Sales
$24Q
$6Q
Q
Q
=
=
=
=
=
Variable expenses + Fixed expenses + Profits
$18Q + $24,000 + $0
$24,000
$24,000 ÷ $6 per unit
4,000 units
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12
Introduction to Managerial Accounting,Fifth Canadian Edition
Brief Exercise 8-5 (continued)
CVP Graph
$200,000
Dollars
$150,000
$100,000
$50,000
$0
0
2,000
4,000
6,000
8,000
Volume in Units
Fixed Expense
Total Expense
Total Sales Revenue
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Solutions Manual, Chapter 8
13
Brief Exercise 8-6 (15 minutes) (LO2 CC7)
1. The equation method yields the required unit sales, Q, as follows:
Sales
$180Q
$80Q
Q
Q
=
=
=
=
=
Variable expenses + Fixed expenses + Profits
$100Q +$60,000+ $10,000
$70,000
$70,000 ÷ $80 per unit
875 units
2. The contribution margin yields the required unit sales as follows:
Units sold to attain the target profit=
Fixed expenses + Target profit
Unit contribution margin
=($60,000 + $15,000)/$80
= 938 units (rounded up)
The dollar sales required = 938 x $180 = $168,840.
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14
Introduction to Managerial Accounting,Fifth Canadian Edition
Brief Exercise 8-7 (25 minutes) (LO2 CC7)
1. The equation method yields the required unit sales, Q, as follows:
Sales
$180Q
$80Q
Q
Q
=
=
=
=
=
Variable expenses + Fixed expenses + Profits
$100Q +$60,000+ $16,667*
$76,667
$76,667 ÷ $80 per unit
959units (rounded up)
* This amount represents the before-tax profit and is calculated as follows:
Before tax income
= (After tax income) ÷ (1 – income tax rate)
= ($10,000) ÷ (1 – 0.40)
= $10,000 ÷ 0.60
= $16,667 (rounded)
2. The contribution margin yields the required unit sales as follows:
Units sold to attain the target profit=
Fixed expenses + Target profit
Unit contribution margin
= ($60,000 + $25,000*) ÷ $80 per unit
= 1,063 units (rounded up)
The dollar sales required = 1,063 x $180 = $191,340.
* Target profit in the above equation is the before-tax profit computed as $15,000 ÷
0.60 = $25,000.
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Solutions Manual, Chapter 8
15
Brief Exercise 8-8(15 minutes) (LO2 CC8)
1. To compute the margin of safety, we must first compute the break-even unit sales.
Sales
$48Q
$20Q
Q
Q
=
=
=
=
=
Variable expenses + Fixed expenses + Profits
$28Q + $30,000 + $0
$30,000
$30,000 ÷ $20 per unit
1,500 units
Sales (at the budgeted volume of 2,000 units) ...............................
$96,000
Break-even sales (at 1,500 units) ..................................................
72,000
Margin of safety (in dollars)...........................................................
$ 24,000
* Alternatively, margin of safety of 500 units x $48 = $24,000.
2. The margin of safety as a percentage of sales is as follows:
Margin of safety (in dollars)...........................................................
$24,000
÷ Sales ........................................................................................
$96,000
Margin of safety as a percentage of sales ................................
25.0%
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16
Introduction to Managerial Accounting,Fifth Canadian Edition
Brief Exercise 8-9 (15 minutes) (LO1 CC2; LO2 CC8)
1.
Margin of safety
Margin of safety
= Actual number of units sold – Break-even sales (in units)
= 204,000* – 183,200** = 20,800 units
* $7,752,000 ÷ $38
= 204,000
** 45,800 (per quarter) × 4
2.
= 183,200
Contribution margin
At break-even sales, total contribution margin = total fixed costs
Therefore total contribution margin per quarter = $618,250
Therefore contribution margin per unit = $618,250 ÷ 45,800 ≈ $13.50
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Solutions Manual, Chapter 8
17
Brief Exercise 8-10(30 minutes) (LO2 CC10)
1. The company's degree of operating leverage would be computed as follows:
Contribution margin ................................
$38,400
÷ Net income ................................................................
$10,400
Degree of operating leverage ................................
3.69
2. A 10% decrease in sales should result in a 36.9% decrease (3.69 × 10%) in net
income.
3. The new income statement reflecting the change in sales would be:
Amount
Percent of
Sales
Sales................................................................
$86,400
100%
Less variable expenses ................................
51,840
60%
Contribution margin ................................
34,560
40%
Less fixed expenses ................................
28,000
Net income................................ $6,560
Net income reflecting change in sales ................................
$6,560
Original net income................................................................
$10,400
Percent change in net income................................36.9%
Brief Exercise 8-11 (10 minutes) (LO1 CC1; LO2CC6)
Annual fixed cost
= total contribution margin earned at the break-even point
= 80,000 × $120 × 36% = $3,456,000
Contribution margin per unit
= $120 × 36% = $43.20
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18
Introduction to Managerial Accounting,Fifth Canadian Edition
Brief Exercise 8-12 (15 minutes) (LO2 CC8)
At the break-even point, contribution margin
Contribution margin per unit
= fixed costs = $860,000
= $860,000 ÷ 50,000* units
= $17.20
* $2,450,000 ÷ $49 = 50,000 (break-even point)
Actual sales (in units) = 50,000 + (50,000 × 24%) = 62,000 units
Annual income = 12,000 × $17.20 = $206,400
Note: Only the sales units beyond the break-even point produce income for the year,
and this is equal to the contribution margin per unit of sales. We do not consider fixed
costs beyond the break-even point, because these are already absorbed by the sale of
50,000 units.
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Solutions Manual, Chapter 8
19
Exercises
Exercise 8-1 (30 minutes) (LO1 CC1, 3, 4)
Total
Per Unit
1. Sales (20,000 units × 1.15 = 23,000 units) ................................
$345,000
Less variable expenses ................................................................
207,000
Contribution margin ................................................................
138,000
Less fixed expenses ................................................................
70,000
Net income................................................................ $ 68,000
$ 15.00
9.00
$ 6.00
2. Sales (20,000 units × 1.25 = 25,000 units) ................................
$337,500
Less variable expenses ................................................................
225,000
Contribution margin ................................................................
112,500
Less fixed expenses ................................................................
70,000
Net income................................................................ $ 42,500
$13.50
9.00
$ 4.50
3. Sales (20,000 units × 0.95 = 19,000 units) ................................
$313,500
Less variable expenses ................................................................
171,000
Contribution margin ................................................................
142,500
Less fixed expenses ................................................................
90,000
Net income................................................................ $ 52,500
$16.50
9.00
$ 7.50
4. Sales (20,000 units × 0.90 = 18,000 units) ................................
$302,400
Less variable expenses ................................................................
172,800
Contribution margin ................................................................
129,600
Less fixed expenses ................................................................
70,000
Net income................................................................ $ 59,600
$16.80
9.60
$ 7.20
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20
Introduction to Managerial Accounting,Fifth Canadian Edition
Exercise 8-2 (30 minutes) (LO1 CC1; LO2CC6)
Break-even sales in dollars
= Fixed expenses ÷ Contribution margin ratio
= $800,000 ÷ 0.42 ≈ $1,904,762
Option 1
Current variable cost per unit
= $80 × (1 – 0.42) = $46.40
New variable cost per unit
= $46.40 × 90%
New contribution margin ratio
= ($80 - $41.76) ÷ $80 = 47.8%
Break-even sales in dollars
= $800,000 ÷ 0.478 ≈ $1,673,641
= $41.76
Option 2
New level of fixed expenses
= $800,000 × 90% = $720,000
Break-even sales in dollars
= $720,000 ÷ 0.42 ≈ $1,714,286
The first option of lowering variable costs is a better option because it lowers the breakeven point in sales.
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Solutions Manual, Chapter 8
21
Exercise 8-3 (30 minutes) (LO1 CC1;LO2 CC10)
1. The income statement would be:
Total
Sales (15,000 games) ................................................................
$300,000
Less variable expenses ................................................................
90,000
Contribution margin ................................................................
210,000
Less fixed expenses ................................................................
182,000
Net income ................................................................ $ 28,000
Per
Unit
$20
6
$14
The degree of operating leverage would be:
Degree of operating leverage =
Contribution margin
Net income
$210,000
= 7.5
$28,000
2. a. Sales of 18,000 games would represent a 20% increase over last year’s sales.
Since the operating leverage is 7.5, net income should increase by 7.5 times as
much, or by 150% (7.5 × 20%).
b. The expected total dollar amount of net income for next year would be:
Last year’s net income ................................................................
$28,000
Expected increase in net income next year
(150% × $28,000) ................................................................
42,000
Total expected net income ............................................................
$70,000
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22
Introduction to Managerial Accounting,Fifth Canadian Edition
Exercise 8-4 (45 minutes)(LO2 CC5,6)
1. The contribution margin per person would be:
Price per ticket .............................................................................
Less variable expenses:
Dinner ......................................................................................
$28
Favours and program ................................................................
2
Contribution margin per person .....................................................
$55
30
$25
The fixed expenses of the dinner-dance total $10,200. The break-even point would
be:
Sales
$55Q
$25Q
Q
Q
=
=
=
=
=
Variable expenses + Fixed expenses + Profits
$30Q + $10,200 + $0
$10,200
$10,200 ÷ $25 per person
408 persons; or, at $55 per person, $22,440
$30
2. Variable cost per person ($28 + $2) ..............................................
Fixed cost per person ($10,200 ÷ 300) ..........................................34
Ticket price per person to break even ............................................
$64
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Solutions Manual, Chapter 8
23
Exercise 8-4 (continued)
3. Cost-volume-profit graph:
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24
Introduction to Managerial Accounting,Fifth Canadian Edition
Exercise 8-5 (30 minutes) (LO1 CC2, 3; LO2 CC6, 7, 8)
1.
Profit
$0
$0
$12Q
Q
Q
=
=
=
=
=
=
Unit CM × Q − Fixed expenses
($40 − $28) × Q − $146,520
$12Q − $146,520
$146,520
$146,520 ÷ $12 per unit
12,210 units per quarter or, at $40 per unit, $488,400
Alternatively:
Fixed expenses
Unit sales/quarter =
to break even
Unit contribution margin
=
$146,520
=12,210 units
$12 per unit
or, at $40 per unit, $488,400.
Monthly break-even sales = 4,070 units (12,210 ÷ 3) or $162,800 (4,070 × $40)
2. The contribution margin at the break-even point is $146,520 because at that point it
must equal the fixed expenses.
3.
Units sold to attain = Target profit + Fixed expenses
target profit/quarter
Unit contribution margin
=
$18,000 + $146,520
=13,710 units
$12 per unit
Total
Sales (13,710 units × $40 per unit) .........................
Variable expenses
(13,710 units × $28 per unit) ...............................
Contribution margin
(13,710 units × $12 per unit) ...............................
Fixed expenses .......................................................
Net operating income ..............................................
Unit
$548,400
$40
383,880
28
164,520
146,520
$ 18,000
$12
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Solutions Manual, Chapter 8
25
Exercise 8-5 (continued)
4. Margin of safety in dollar terms:
Margin of safety = Total sales - Break-even sales
in dollars
= $600,000 - $488,400 = $111,600
Margin of safety in percentage terms:
Margin of safety = Margin of safety in dollars
percentage
Total sales
=
$111,600
= 18.6%
$600,000
5. The CM ratio is 30% ($12 ÷ $40).
Expected total contribution margin: $680,000 × 30% .................
Present total contribution margin: $600,000 × 30%....................
Increased contribution margin ...................................................
$204,000
180,000
$ 24,000
Alternative solution:
$80,000 incremental sales × 30% CM ratio = $24,000
Given that the company’s fixed expenses will not change, monthly net
operating income will increase by the amount of the increased contribution margin,
$24,000.
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26
Introduction to Managerial Accounting,Fifth Canadian Edition
Exercise 8-6 (45 minutes) (LO2 CC5, 6, 7)
1.
Profit
$0
$0
$27Q
Q
Q
=
=
=
=
=
=
Unit CM × Q − Fixed expenses
($90 − $63) × Q − $135,000
$27Q − $135,000
$135,000
$135,000 ÷ $27 per lantern
5,000 lanterns, or at $90 per lantern, $450,000 in sales
Alternative solution:
Fixed expenses
Unit sales =
to break even
Unit contribution margin
=
$135,000
= 5,000 lanterns,
$27 per lantern
or at $90 per lantern, $450,000 in sales
2. An increase in variable expenses as a percentage of the selling price would result in
a higher break-even point. If variable expenses increase as a percentage of sales,
then the contribution margin will decrease as a percentage of sales. With a lower
CM ratio, more lanterns would have to be sold to generate enough contribution
margin to cover the fixed costs.
Present:
8,000 Lanterns
Total
Per Unit
3.
Sales.....................................
Variable expenses ..................
Contribution margin ...............
Fixed expenses ......................
Net operating income.............
$720,000
504,000
216,000
135,000
$ 81,000
$90
63
$27
Proposed:
10,000 Lanterns*
Total
Per Unit
$810,000
630,000
180,000
135,000
$ 45,000
$81 **
63
$18
* 8,000 lanterns × 1.25 = 10,000 lanterns
** $90 per lantern × 0.9 = $81 per lantern
As shown above, a 25% increase in volume is not enough to offset a 10% reduction
in the selling price; and, net operating income decreases.
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Solutions Manual, Chapter 8
27
Exercise 8-6 (continued)
4.
Profit
$72,000
$72,000
$18Q
Q
Q
=
=
=
=
=
=
Unit CM × Q − Fixed expenses
($81 − $63) × Q − $135,000
$18Q − $135,000
$207,000
$207,000 ÷ $18 per lantern
11,500 lanterns
Alternative solution:
Unit sales to attain = Target profit + Fixed expenses
target profit
Unit contribution margin
=
$72,000 + $135,000
= 11,500 lanterns
$18 per lantern
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28
Introduction to Managerial Accounting,Fifth Canadian Edition
Exercise 8-7(45minutes) (LO1 CC4)
1. The numbered components are as follows:
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
Dollars of revenue and costs.
Volume of output, expressed in units, % of capacity, sales, or some
other measure of activity.
Total expense line.
Variable expense area.
Fixed expense area.
Break-even point.
Loss area.
Profit area.
Revenue line.
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Solutions Manual, Chapter 8
29
Exercise8-7 (continued)
2. a. Line 3:
Line 9:
Break-even point:
Remain unchanged.
Have a flatter slope.
Increase.
b. Line 3:
Line 9:
Break-even point:
Have a steeper slope.
Remain unchanged.
Increase.
c. Line 3:
Line 9:
Break-even point:
Shift downward.
Remain unchanged.
Decrease.
d. Line 3:
Line 9:
Break-even point:
Remain unchanged.
Remain unchanged.
Remain unchanged.
e. Line 3:
Line 9:
Break-even point:
Shift upward and have a flatter slope.
Remain unchanged.
Probably change, but the direction is uncertain.
f. Line 3:
Line 9:
Break-even point:
Have a flatter slope.
Have a flatter slope.
Remain unchanged in terms of units; decrease in
terms of total dollars of sales.
g. Line 3:
Line 9:
Break-even point:
Shift upward.
Remain unchanged.
Increase.
h. Line 3:
Line 9:
Break-even point:
Shift downward and have a steeper slope.
Remain unchanged.
Probably change, but the direction is uncertain.
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30
Introduction to Managerial Accounting,Fifth Canadian Edition
Exercise 8-8 (30 minutes) (LO2 CC5, 6)
1.
Sales
$S
$0.5S
S
S
=
=
=
=
=
Variable expenses + Fixed expenses + Profits
$0.50S + ($208,000 + $72,000) + $0
$280,000
$280,000 ÷ 0.50
$560,000 in sales.
Alternative solution:
Break-even point = Fixed expenses ÷ Contribution margin per unit
$280,000 ÷ $15 ≈ 18,667 units, or at $30 per unit, $560,010 in sales
2.
New fixed product cost
= $208,000× 1.1 = $228,800
Existing break-even sales = $560,000
New contribution margin ratio to maintain existing break-even sales
= ($228,800 + $72,000) ÷$560,000
≈ 0.537 (or 53.7%)
This means that the variable cost of $15 per unit must equal 46.3% of sales.
Therefore, new sale price = $15 ÷ 0.463 ≈ $32.40 per unit
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Solutions Manual, Chapter 8
31
Exercise 8-9(LO1 CC1, 4)
Sales revenue (30,000 units)
Less: Variable costs
Cost of goods sold
Sales commission
Contribution margin
Less: Fixed costs
Cost of goods sold
Selling & administrative
expenses
$378,000
60,000
208,600
124,600
$930,000
$31.00
100.0%
438,000
$492,000
14.60
$16.40
47.1%
52.8%
333,200
$158,800
Notes:
1. Quarterly fixed COGS
= $834,400 ÷ 4 = $208,600
2. Quarterly variable COGS
= $586,600 - $208,600 = $378,000
3. Quarterly sales commission
= $2 × 30,000 units = $60,000
4. Quarterly fixed selling & administrative expenses
= $184,600 - $60,000 = $124,600
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32
Introduction to Managerial Accounting,Fifth Canadian Edition
Exercise 8-10 (25 minutes) (LO2 CC5, 6, 7)
1.
Sales
$60Q
$32Q
Q
Q
=
=
=
=
=
Variable expenses + Fixed expenses + Target profits
$28Q + $384,000 + $32,000+
$416,000
$416,000 ÷ $32
13,000 pens
Alternative solution:
Sales required to earn $22,400 =
Fixed expenses + Target profit
Unit contribution margin
$384,000 + $32,000 =13,000 pens
$32
+
$22,400 ÷ (1 – 0.70) = $32,000
2.
When the tax rate changes to 40%, the required before-tax income will increase to
approximately $37,334* (rounded-up).
Sales required to earn $22,400 =
Fixed expenses + Target profit
Unit contribution margin
$384,000 + $37,334 » 13,167 pens
$32
* $22,400 ÷ (1 – 0.60) = $37,334
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Solutions Manual, Chapter 8
33
Exercise 8-11 (15 minutes) (LO1 CC2; LO2CC8, 10)
Sales price
Less: Variable costs
Direct materials
Direct labour
Variable overhead
Commissions
Contribution margin
$200.00
$50.00
30.00
25.00
15.00
120.00
$80.00
1.
Contribution margin ratio = $80 ÷ $200 = 40%
Breakeven quantity = FC÷unit contribution margin = $1,000,000*÷$80 = 12,500 units
Breakeven sales = FC÷CM ratio = $1,000,000÷40% = $2,500,000
*FC = $50×20,000 = $1,000,000.
2.
Margin of safety = Current sales – Breakeven sales = 6,250 units or $1,250,000.
Degree of operating leverage
= Contribution margin ÷ Income
= $1,600,000 ÷ $600,000
≈ 2.67
Notes:
Contribution margin = $80 × 20,000 units
Income
= $1,600,000 - $1,000,000
= $1,600,000
= $ 600,000
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34
Introduction to Managerial Accounting,Fifth Canadian Edition
Exercise 8-12 (15 minutes) (LO2 CC5, 6, 7)
Sales = Variable costs + Fixed costs + Profits
1.
Break-even sales
S
0.4S
S
=
=
=
=
0.6S + $480,000 + 0
$480,000
$480,000 ÷ 0.4
$1,200,000
2.
Sales required to achieve profit = 20% of sales revenue
S
0.2S
S
=
=
=
=
0.6S + $480,000 + 0.2S
$480,000
$480,000 ÷ 0.2
$2,400,000
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Solutions Manual, Chapter 8
35
Problems
Problem 8-1 (90 minutes) (LO1 CC4;LO2 CC6, 7, 10)
1. The CM ratio is 60%:
Selling price .............................
Variable expenses ....................
Contribution margin .................
$15
6
$9
100%
40%
60%
2.
Break-even point in = Fixed expenses
total sales dollars
CM ratio
=
$180,000
=$300,000 sales
0.60
3. $45,000 increased sales × 60% CM ratio = $27,000 increase in contribution margin.
Since fixed costs will not change, net operating income should also increase by
$27,000.
4. a.
Degree of operating leverage =
=
Contribution margin
Net operating income
$216,000
=6
$36,000
b. 6 × 15% = 90% increase in net operating income. In dollars, this increase would
be 90% × $36,000 = $32,400.
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36
Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 8-1 (continued)
Last Year:
28,000 units
Total
Per Unit
5.
Sales..................................
Variable expenses ...............
Contribution margin ............
Fixed expenses ...................
Net operating income..........
$420,000
168,000
252,000
180,000
$ 72,000
$15.00
6.00
$ 9.00
Proposed:
42,000 units*
Total
Per Unit
$567,000
252,000
315,000
250,000
$ 65,000
$13.50**
6.00
$ 7.50
* 28,000 units × 1.5 = 42,000 units
** $15 per unit × 0.90 = $13.50 per unit
No, the changes should not be made.
6. Expected total contribution margin:
28,000 units × 200% × $7 per unit* .............................
Present total contribution margin:
28,000 units × $9 per unit ............................................
Incremental contribution margin, and the amount by which
advertising can be increased with net operating income
remaining unchanged ...................................................
$392,000
252,000
$140,000
*$15 – ($6 + $2) = $7
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Solutions Manual, Chapter 8
37
Problem 8-2 (90 minutes) (LO1 CC3; LO2,CC5, 6, 7, 9)
1. The CM ratio is 30%.
Total
Sales (13,500 units) ...............
Variable expenses ..................
Contribution margin ...............
Per Unit
$270,000
189,000
$ 81,000
$20
14
$ 6
Percentage
100%
70%
30%
The break-even point is:
Profit
$0
$0
$6Q
Q
Q
=
=
=
=
=
=
Unit CM × Q − Fixed expenses
($20 − $14) × Q − $90,000
$6Q − $90,000
$90,000
$90,000 ÷ $6 per unit
15,000 units
15,000 units × $20 per unit = $300,000 in sales.
Alternative solution:
Fixed expenses
Unit sales =
to break even
Unit contribution margin
=
$90,000
= 15,000 units
$6 per unit
Dollar sales = Fixed expenses
to break even
CM ratio
=
$90,000
= $300,000 in sales
0.30
2. Incremental contribution margin:
$70,000 increased sales × 30% CM ratio .......................
Less increased fixed costs:
Increased advertising cost .............................................
Increase in monthly net operating income .........................
$21,000
8,000
$13,000
Since the company presently has a loss of $9,000 per month, if the changes are
adopted, the loss will turn into a profit of $4,000 per month.
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38
Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 8-2 (continued)
3. Sales (27,000 units × $18 per unit*)..........................
Variable expenses
(27,000 units × $14 per unit) .................................
Contribution margin ..................................................
Fixed expenses ($90,000 + $35,000) .........................
Net operating loss.....................................................
$486,000
378,000
108,000
125,000
$(17,000)
*$20 – ($20 × 0.10) = $18
4.
Profit
$4,500
$4,500
$5.40Q
Q
Q
=
=
=
=
=
=
Unit CM × Q − Fixed expenses
($20.00 − $14.60*) × Q − $90,000
$5.40Q − $90,000
$94,500
$94,500 ÷ $5.40 per unit
17,500 units
*$14.00 + $0.60 = $14.60.
Alternative solution:
Unit sales to attain = Target profit + Fixed expenses
target profit
CM per unit
=
$4,500 + $90,000
$5.40 per unit**
= 17,500 units
**$6.00 – $0.60 = $5.40.
5. a. The new CM ratio would be:
Per Unit
Sales ...................................................
Variable expenses ................................
Contribution margin .............................
$20
7
$13
Percentage
100%
35%
65%
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Solutions Manual, Chapter 8
39
Problem 8-2 (continued)
The new break-even point would be:
Fixed expenses
Unit sales =
to break even
Unit contribution margin
=
$208,000
= 16,000 units
$13 per unit
Dollar sales = Fixed expenses
to break even
CM ratio
=
$208,000
= $320,000 in sales
0.65
b. Comparative income statements follow:
Not Automated
Total
Per Unit
Sales (20,000 units) ..........
Variable expenses .............
Contribution margin ..........
Fixed expenses .................
Net operating income ........
$400,000
280,000
120,000
90,000
$ 30,000
$20
14
$6
%
100
70
30
Automated
Total
Per Unit
$400,000
140,000
260,000
208,000
$ 52,000
$20
7
$13
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40
Introduction to Managerial Accounting,Fifth Canadian Edition
%
100
35
65
Problem 8-2(continued)
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 company’s
fixed costs and its break-even point. However, the changes would also increase
the company’s 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 $22,000 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 company’s 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 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:
Let Q
$14Q + $90,000
$7Q
Q
Q
=
=
=
=
=
Point of indifference in units sold
$7Q + $208,000
$118,000
$118,000 ÷ $7 per unit
16,857 units (rounded)
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).
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Solutions Manual, Chapter 8
41
Problem 8-3 (90 minutes) (LO1 CC4;LO2CC6)
1.
Sales
$30.00Q
$12.00Q
Q
Q
=
=
=
=
=
Variable expenses + Fixed expenses + Profits
$18.00Q + $150,000 + $0
$150,000
$150,000 ÷ $12.00 per pair
12,500 pairs
12,500 pairs × $30.00 per pair = $375,000 in sales.
Alternatively:
Fixed expenses
$150,000
=
= 12,500 pairs
CM per unit
$12.00 per pair
Fixed expenses
$150,000
=
= $375,000 in sales
CM ratio
0.40
Note: CM Ratio = ($30 - $18) / $30 = 0.40
2.
$700
Total Dollars (000s)
$600
Total Sales Revenue
Break-Even Point:
12,500 pairs of shoes or
$375,000 in total sales
$500
$400
Total Expenses
$300
Total Fixed
Expenses
$200
$100
00
,0
20
,5
17
15
,0
00
00
00
12
,5
00
,0
0
10
7,
50
0
5,
00
0
50
2,
0
$0
Number of Pairs of Shoes
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42
Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 8-3 (continued)
3. The simplest approach is:
Break-even sales ................................ 12,500 pairs
Actual sales ................................................................
12,000 pairs
Sales short of break-even................................
500 pairs
500 pairs × $12.00 contribution margin per pair = $6,000 loss
Alternative solution:
Sales (12,000 pairs × $30.00 per pair) ................................
$360,000
Less variable expenses
(12,000 pairs × $18.00 per pair) ................................
216,000
Contribution margin ................................................................
144,000
Less fixed expenses ................................................................
150,000
Net loss ................................................................ $ (6,000)
4. The variable expenses will now be $18.75 per pair, and the contribution margin will
be $11.25 per pair.
Sales
$30.00Q
$11.25Q
Q
Q
=
=
=
=
=
Variable expenses + Fixed expenses + Profits
$18.75Q + $150,000 + $0
$150,000
$150,000 ÷ $11.25 per pair
13,334 pairs (rounded up)
13,334 pairs × $30.00 per pair = $400,020 in sales
Alternative solution:
Fixed expenses =
CM per unit
Fixed expenses =
CM ratio
$150,000
$11.25 per pair
$150,000
0.375
= 13,334 pairs
= $400,000 in sales
Note: CM Ratio = ($30 - $18.75) / $30 = 0.375
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Solutions Manual, Chapter 8
43
Problem 8-3 (continued)
5. The simplest approach is:
Actual sales ................................................................
15,000 pairs
Break-even sales ................................................................
12,500 pairs
Excess over break-even sales................................
2,500 pairs
2,500 pairs × $11.50 per pair* = $28,750 profit
*$12.00 present contribution margin – $0.50 commission = $11.50
Alternative solution:
Sales (15,000 pairs × $30.00 per pair) ................................ $450,000
Less variable expenses (12,500 pairs × $18.00 per pair;
2,500 pairs × $18.50 per pair) ...................................................
271,250
Contribution margin ................................................................178,750
Less fixed expenses ................................................................ 150,000
Net income ..................................................................................
$ 28,750
6. The new variable expenses will be $13.50 per pair.
Sales
$30.00Q
$16.50Q
Q
Q
=
=
=
=
=
Variable expenses + Fixed expenses + Profits
$13.50Q + $181,500 + $0
$181,500
$181,500 ÷ $16.50 per pair
11,000 pairs
Break-even $sales = 11,000 pairs × $30.00 per pair
= $330,000 in sales.
Although the change will lower the break-even point from 12,500 pairs to 11,000
pairs, the company must consider whether this reduction in the break-even point is
more than offset by the possible loss in sales arising from having the sales staff on a
salaried basis. Under a salary arrangement, the sales staff has less incentive to sell
than under the present commission arrangement, resulting in a potential loss of
sales and a reduction of profits. Although it is generally desirable to lower the breakeven point, management must consider the other effects of a change in the cost
structure. The break-even point could be reduced dramatically by doubling the
selling price but it does not necessarily follow that this would improve the company’s
profit.
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44
Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 8-4 (45 minutes) (LO2 CC6, 10)
1. Variable cost of goods sold as a percentage of revenues =
Variable selling & marketing as a percentage of revenues =
Total variable costs as a percentage of sales
Contribution margin ratio
$11,700,000 = 45%
$26,000,000
$4, 680, 000
= 18%
$26, 000, 000
= 63%
= 37%
Let breakeven revenues be denoted by $R, then
$R =
Fixed costs ÷ Contribution margin ratio
$R = ($2,870,000 + $3,420,000) ÷ 0.37
2.
= $17,000,000
With its own sales force, Marston’s fixed marketing costs would increase to
$3,420,000 + $2,080,000 = $5,500,000.
Variable cost of marketing
as a percentage of sales
Total variable costs as a percentage of sales
Contribution margin ratio
= 10% of Revenues
= 55%
= 45%
Let breakeven revenues be denoted by $R, then
$R = ($2,870,000 + $5,500,000) ÷ 0.45
= $18,600,000
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Solutions Manual, Chapter 8
45
Problem 8-4 (continued)
3.
Revenues
Variable manufacturing costs
$26,000,000  0.45; 0.45
Variable marketing costs
$26,000,000  0.18; 0.10
Contribution margin
Fixed costs
Fixed manufacturing costs
Fixed marketing costs
Total fixed costs
Operating income
Degree of
operating leverage

Using Sales
Agents
$26,000,000
Employing Own
Sales Staff
$26,000,000
11,700,000
11,700,000
4,680,000
9,620,000
2,600,000
11,700,000
2,870,000
3,420,000
6,290,000
$ 3,330,000
2,870,000
5,500,000
8,370,000
$ 3,330,000
Contribution margin $9, 620, 000
$11, 700, 000
 2.89
 3.51
Operating income $3,330, 000
$3, 330, 000
The calculations indicate that at sales of $26,000,000, a percentage change in
sales and contribution margin will result in 2.89 times that percentage change in
operating income if Marston continues to use sales agents, and 3.51 times that
percentage change in operating income if Marston employs its own sales staff. The
higher contribution margin per dollar of sales and higher fixed costs gives Marston
more operating leverage, that is greater benefits (increases in operating income) if
revenues increase but greater risks (decreases in operating income) if revenues
decrease.
4.
Variable costs of marketing = 15% of Revenues
Fixed marketing costs
= $5,500,000
Denote the revenues required to earn $3,330,000 of operating income by $R, then
Operating income = Revenues –
Variable
Fixed
Variable
Fixed

 marketing  marketing
manuf. costs manuf. costs
costs
costs
$3,330,000 = $R – $0.45R – $2,870,000 – $0.15R – $5,500,000
$3,330,000 + $2,870,000 +$5,500,000 =$R-$0.45R – $0.15R
$11,700,000
=$0.40R
R=
$11,700,000 ÷ 0.40
=$29,250,000
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46
Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 8-5 (45 minutes) (LO1 CC2, 3; LO2 CC5, 6, 7)
1. a. Selling price ............................
Variable expenses ...................
Contribution margin ................
Profit
$0
$15Q
Q
Q
=
=
=
=
=
$37.50
22.50
$15.00
100%
60%
40%
Unit CM × Q − Fixed expenses
$15 × Q − $480,000
$480,000
$480,000 ÷ $15 per skateboard
32,000 skateboards
Alternative solution:
Unit sales = Fixed expenses
to break even
Unit CM
=
$480,000
$15 per skateboard
= 32,000 skateboards
b. The degree of operating leverage would be:
Degree of operating leverage =
=
Contribution margin
Net operating income
$600,000
= 5.0
$120,000
2. The new CM ratio will be:
Selling price ..................................
Variable expenses .........................
Contribution margin ......................
$37.50
25.50
$12.00
100%
68%
32%
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Solutions Manual, Chapter 8
47
Problem 8-5 (continued)
The new break-even point will be:
Profit
$0
$12Q
Q
Q
=
=
=
=
=
Unit CM × Q − Fixed expenses
$12 × Q − $480,000
$480,000
$480,000 ÷ $12 per skateboard
40,000 skateboards
Alternative solution:
Unit sales = Fixed expenses
to break even
Unit CM
=
$480,000
$12 per skateboard
= 40,000 skateboards
3.
Profit
$120,000
$12Q
Q
Q
=
=
=
=
=
Unit CM × Q − Fixed expenses
$12 × Q − $480,000
$120,000 + $480,000
$600,000 ÷ $12 per skateboard
50,000 skateboards
Alternative solution:
Unit sales to attain = Target profit + Fixed expenses
target profit
Unit CM
=
$120,000 + $480,000
$12 per skateboard
= 50,000 skateboards
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Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 8-5 (continued)
Thus, sales will have to increase by 10,000 skateboards (50,000 skateboards, less
40,000 skateboards currently being sold) to earn the same amount of net operating
income as earned last year. The computations above and in part (2) show the
dramatic effect that increases in variable costs can have on an organization. These
effects from a $3 per unit increase in labor costs for Tyrene Company are
summarized below:
Present
Break-even point (in skateboards) .....................
Sales (in skateboards) needed to earn net
operating income of $120,000 ........................
Expected
32,000
40,000
40,000
50,000
Note that if variable costs do increase next year, then the company will just break
even if it sells the same number of skateboards (40,000) as it did last year.
4. The contribution margin ratio last year was 40%. If we let P equal the new selling
price, then:
P
0.60P
P
P
=
=
=
=
To verify:
$25.50 + 0.40P
$25.50
$25.50 ÷ 0.60
$42.50
Selling price ....................................
Variable expenses ............................
Contribution margin .........................
$42.50
25.50
$17.00
100%
60%
40%
Therefore, to maintain a 40% CM ratio, a $3 increase in variable costs would require
a $5 increase in the selling price.
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Solutions Manual, Chapter 8
49
Problem 8-5 (continued)
5. The new CM ratio would be:
Selling price ................................
Variable expenses .......................
Contribution margin.....................
$37.50
13.50 *
$24.00
100%
36%
64%
*$22.50 – ($22.50 × 40%) = $13.50
The new break-even point would be:
Profit
$0
$24Q
Q
Q
=
=
=
=
=
Unit CM × Q − Fixed expenses
$24 × Q − $912,000*
$912,000
$912,000 ÷ $24 per skateboard
38,000 skateboards
*$480,000 × 1.9 = $912,000
Alternative solution:
Unit sales = Fixed expenses
to break even
Unit CM
=
$912,000
$24 per skateboard
= 38,000 skateboards
Although this break-even figure is greater than the company’s present break-even
figure of 32,000 skateboards [see part (1) above], it is less than the break-even
point will be if the company does not automate and variable labor costs rise next
year [see part (2) above].
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50
Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 8-5 (continued)
6.
a.
Profit
$120,000
$24Q
Q
Q
=
=
=
=
=
Unit CM × Q − Fixed expenses
$24 × Q −$912,000*
$120,000 + $912,000
$1,032,000 ÷ $24.00 per skateboard
43,000 skateboards
*480,000 × 1.9 = $912,000
Alternative solution:
Unit sales to attain = Target profit + Fixed expenses
target profit
Unit CM
=
$120,000 + $912,000
$24 per skateboard
= 43,000 skateboards
Thus, the company will have to sell 3,000 more skateboards (43,000 – 40,000 =
3,000) than now being sold to earn a profit of $120,000 each year. However, this
is still less than the 50,000 skateboards that would have to be sold to earn a
$120,000 profit if the plant is not automated and variable labor costs rise next
year [see part (3) above].
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Solutions Manual, Chapter 8
51
Problem 8-5 (continued)
b. The contribution income statement would be:
Sales
(40,000 skateboards × $37.50 per skateboard)...............
Variable expenses
(40,000 skateboards × $13.50 per skateboard) ..............
Contribution margin .........................................................
Fixed expenses ................................................................
Net operating income .......................................................
$1,500,000
540,000
960,000
912,000
$ 48,000
Degree of operating = Contribution margin
leverage
Net operating income
=
$960,000
= 20
$48,000
c. This problem shows the difficulty faced by some companies. When variable
labour costs increase, it is often difficult to pass these cost increases along to
customers in the form of higher prices. Thus, companies are forced to automate,
resulting in higher operating leverage, often a higher break-even point, and
greater risk for the company. However, with the rising labour costs a concern,
automation would help alleviate this potential problem. Automation will also help
reduce human errors and waste, as well as help create a more standardized
product. With the decision being construct a new plant using automation or not
construct at all, it seems management should consider in favour of constructing
the new plant.
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52
Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 8-6 (75 minutes) (LO1 CC4; LO2CC5, 6, 7, 10)
1.
Sales = Variable expenses + Fixed expenses + Profits
$40Q = $16Q + $60,000 + $0
$24Q = $60,000
Q = $60,000 ÷ $24 per pair
Q = 2,500 pairs
2,500 pairs × $40 per pair = $100,000 in sales
Alternative solution:
Fixed expenses
$60,000
=
= 2,500 pairs
CM per unit
$24.00 per pair
Fixed expenses
$60,000
=
= $100,000 in sales
CM ratio
0.600
CM Ratio = ($40 - $16) ÷ $40 = 0.60
2. See the graph at the end of this solution.
3.
Sales
$40Q
$24Q
Q
=
=
=
=
Variable expenses + Fixed expenses + Profits
$16Q + $60,000 + $9,000 ($108,000 ÷ 12)
$69,000
$69,000 ÷ $24 per pair
2,875pairs
4. Incremental contribution margin:
$60,000 increased sales × 60% CM ratio ................................$36,000
Incremental fixed salary cost .........................................................
36,000
Increased net income ................................................................ $ 0.00
No, the position need not be converted to a full-time basis. Judging by an
incremental net income, Angie would be indifferent between the two options.
However, as full-time workers require more benefits, there normally would be some
type of additional incremental cost of benefits from switching a worker from parttime to full-time.
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Solutions Manual, Chapter 8
53
Problem 8-6 (continued)
5. a.
Contribution margin ÷ Net income = Degree of operating leverage
= $864,000÷ $144,000 = 6
b. 6 ×20% sales increase = 120% increase in net income. Thus, net income next
year would be: $144,000 + ($144,000 × 120%) = $316,800. Note that the
operating leverage focuses on the increase in income resulting from the increase
in sales.
2. Cost-volume-profit graph:
$200
Total Sales
$180
Total Dollars (000s)
$160
$140
Break-even point:
2,500 pairs of sandals or
$100,000 total sales
$120
Total
Expenses
$100
$80
Total
Fixed
Expenses
$60
$40
$20
$0
0
500
1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,500 5,000
Number of Pairs of Sandals Sold
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54
Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 8-7 (30 minutes) (LO2 CC6, 8)
1.
Direct materials
Direct labour:
Variable mfg. overhead
Sales commission
$ 9.00
6.00
8.25 (½ hour per unit of labour required)
2.75
Total variable costs
$26.00
Contribution margin per unit
Contribution margin ratio
= $24
= 48% ($24 ÷ $50)
2.
Total fixed costs: $148,200 + $32,000 + 24,000
Annual breakeven sales
= $204,200 per month
= $2,450,400 per year
= $2,450,400 ÷ $24 = 102,100 bottles
= $2,450,400 ÷ 0.48 = $5,105,000
3.
Margin of safety = $7,500,000 - $5,105,000 = $2,395,000
= approximately 32% of budgeted sales
4.
Margin of safety provides a measure of the room available to the marketing
manager to managehis or her marketing efforts. From a planning point of view, the
manager can perform sensitivity analysis assuming different scenarios of market and
internal conditions.
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Solutions Manual, Chapter 8
55
Problem 8-8 (75 minutes) (LO2 CC5, 6)
1.
Sales price = $700,000 ÷ 5,000 units = $140 per unit
It is easy to verify that this price is constant across the four months
It is clear that the following three expense items are fixed costs: (1) Advertising $70,000; (2) Insurance - $9,000; and (3) Amortization (or depreciation) - $42,000
The remaining three cost items can be examined using the high-low method outlined in
Chapter 6.
Sales units
High (June)
Low (April)
Difference
Slope (variable
cost per unit
Fixed cost per
month
6,000
4,500
1,500
Cost of goods
sold
$426,000
$342,000
$ 84,000
$71,000
$56,000
$15,000
Salaries &
Commission
$180,500
$143,000
$ 37,500
$56.00
$10.00
$25.00
$90,000
$11,000
$30,500
Shipping
The cost equations for the three mixed costs are as follows:
Cost of goods sold
Shipping
Salaries & commission
= $90,000 + $56 per unit
= $11,000 + $10 per unit
= $30,500 + $25 per unit
2.
Total variable costs
= $56 + $10 + $25 = $91 per unit
Contribution margin
= $140 - $91
= $49 per unit
Monthly fixed costs = $70,000 + $9,000 + $42,000 + $90,000 + $11,000 + $30,500
= $252,500
Annual fixed costs = $252,000 × 12 = $3,030,000
Break-even sales
= $3,030,000 ÷ $49 ≈ 61,837 units
Annual profit (66,000 units)
= 66,000 × $49
= $3,234,000 - $3,030,000
= $204,000
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56
Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 8-8 (continued)
3.
Original contribution margin
New contribution margin
= $3,234,000 (as shown above)
= ($49 - $4) × 71,000 units = $3,195,000
Decrease in contribution margin = $39,000
Decrease in profit
= $39,000
4.
Incremental contribution margin = $49 × 5,000
Incremental fixed cost
Incremental profit
= $245,000
= $100,000
= $145,000
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Solutions Manual, Chapter 8
57
Problem 8-9 (60minutes) (LO1 CC3;LO2CC5, 6, 8, 9, 10)
1. The income statements would be:
Amount
Sales .....................................
Variable expenses ..................
Contribution margin ...............
Fixed expenses ......................
Net operating income .............
$800,000
560,000
240,000
192,000
$ 48,000
Amount
Sales .....................................
Variable expenses* ................
Contribution margin ...............
Fixed expenses ......................
Net operating income .............
$800,000
320,000
480,000
432,000
$ 48,000
Present
Per Unit
$20
14
$6
%
100%
70%
30%
Proposed
Per Unit
$20
8
$12
%
100%
40%
60%
*$14 – $6 = $8
2. a. Degree of operating leverage:
Present:
Contribution margin
Degree of
=
operating leverage
Net operating income
=
$240,000
=5
$48,000
Proposed:
Contribution margin
Degree of
=
operating leverage
Net operating income
=
$480,000
= 10
$48,000
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58
Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 8-9 (continued)
b. Dollar sales to break even:
Present:
Dollar sales to = Fixed expenses
break even
CM ratio
=
$192,000
= $640,000
0.30
Proposed:
Dollar sales to = Fixed expenses
break even
CM ratio
=
$432,000
= $720,000
0.60
c. Margin of safety:
Present:
Margin of safety = Actual sales - Break-even sales
= $800,000 - $640,000 = $160,000
Margin of safety = Margin of safety in dollars
percentage
Actual sales
=
$160,000
= 20%
$800,000
Proposed:
Margin of safety = Actual sales - Break-even sales
= $800,000 - $720,000 = $80,000
Margin of safety = Margin of safety in dollars
percentage
Actual sales
=
$80,000
= 10%
$800,000
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Solutions Manual, Chapter 8
59
Problem 8-9(continued)
3. The major factor would be the sensitivity of the company’s operations to cyclical
movements in the economy. Because the new equipment will increase the CM ratio,
in years of strong economic activity, the company will be better off with the new
equipment. However, the company will be worse off with the new equipment in
years in which sales drop. The fixed costs of the new equipment will result in losses
being incurred more quickly and they will be deeper. Thus, management must
decide whether the potential for greater profits in good years is worth the risk of
deeper losses in bad years.
4. No information is given in the problem concerning the new variable expenses or the
new contribution margin ratio. Both of these items must be determined before the
new break-even point can be computed. The computations are:
New variable expenses:
Profit = (Sales − Variable expenses) − Fixed expenses
$60,000** = ($1,200,000* − Variable expenses) − $240,000
Variable expenses = $1,200,000 − $240,000 − $60,000
= $900,000
* New level of sales: $800,000 × 1.5 = $1,200,000
** New level of net operating income: $48,000 × 1.25 = $60,000
New CM ratio:
Sales ............................................
Variable expenses .........................
Contribution margin.......................
$1,200,000
900,000
$ 300,000
100%
75%
25%
With the above data, the new break-even point can be computed:
Dollar sales = Fixed expenses = $240,000 =$960,000
to break even
CM ratio
0.25
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60
Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 8-9 (continued)
The greatest risk is that the increases in sales and net operating income predicted
by the marketing manager will not happen and that sales will remain at their present
level. Note that the present level of sales is $800,000, which is well below the breakeven level of sales under the new marketing strategy.
It would be a good idea to compare the new marketing strategy to the current
situation more directly. What level of sales would be needed under the new method
to generate at least the $48,000 in profits the company is currently earning each
month? The computations are:
Dollar sales to attain = Target profit + Fixed expenses
target profit
CM ratio
=
$48,000 + $240,000
0.25
= $1,152,000 in sales each month
Thus, sales would have to increase by at least 44% ($1,152,000 is 44% higher than
$800,000) in order to make the company better off with the new marketing strategy
than with the current approach. This appears to be extremely risky and unlikely.
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Solutions Manual, Chapter 8
61
Problem 8-10 (45 minutes) (LO1 CC1, 3; LO2CC6, 12A)
a.
Case #1
Case #2
Number of units sold ................................
15,000 *
4,000
Sales ................................................................
$180,000 * $12
$100,000 *
$25
Less variable expenses ................................
120,000 *
8
60,000
15
Contribution margin ................................
60,000
$4
40,000
$10 *
Less fixed expenses ................................
50,000 *
32,000 *
Net income ................................
$ 10,000
$ 8,000 *
*Given
Case #3
Number of units sold ................................
10,000 *
Sales ................................................................
$200,000
$20
Less variable expenses ................................
70,000 *
7
Contribution margin ................................
130,000
$13 *
118,000
Less fixed expenses ................................
Net income ................................$ 12,000 *
*Given
b.
Case #4
6,000
$300,000
210,000
90,000
100,000
$(10,000)
Case #1
Sales ................................................................
$500,000 *
100%
Less variable expenses ................................
400,000
80
Contribution margin ................................
100,000
20% *
Less fixed expenses ................................
93,000
Net income ................................$ 7,000 *
*Given
Case #3
Sales ................................................................
$250,000
100%
Less variable expenses ................................
100,000
40
Contribution margin ................................
150,000
60% *
Less fixed expenses ................................
130,000 *
Net income ................................$ 20,000 *
*Given
*
*
$50
35
$15
*
*
Case #2
$400,000 *
260,000 *
140,000
100,000 *
$ 40,000
100%
65
35%
Case #4
$600,000 *
420,000 *
180,000
185,000
$ (5,000) *
100%
70
30%
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62
Introduction to Managerial Accounting,Fifth Canadian Edition
Comprehensive Problem(90 minutes) (LO1 CC3; LO2 CC5, 6, 7)
1. Classification:
Fixed expenses:
Advertising
Rental
Salaries
Insurance
Utilities*
Depreciation
Total
$
88,000
422,000
821,000
44,000
16,700
205,000
$1,596,700
*While utilities may vary for a manufacturing company, they likely will not vary for this
service organization as sales increase.
Variable
expenses:
Repair
Fuel
Commissions
Tires, oil, lube
Wages*
Maintenance
Packing materials
Cargo loss claims
Fuel taxes
Bad debt
Total
$ 220,000
352,000
102,000
20,500
1,584,000
293,000
557,000
234,000
132,000
193,000
$3,687,500
*Given the policy of employment stability, one could argue that wages are more fixed
than variable. In reality, however, as sales increase, more wages must be paid, and, as
sales decrease, the implication is that wages may also decrease through reductions of
wages rather than layoffs.
Note: There is always some ambiguity with respect to classifying costs.
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Solutions Manual, Chapter 8
63
Comprehensive Problem (continued)
Contribution Margin Income Statement:
Revenues
Variable expenses
Contribution
margin
Fixed expenses
Net income
$5,493,000
3,687,500
$1,805,500
100.00%
67.00%
33.00%
1,596,700
$ 208,800
2. Variable cost ratio = 67% (see above)
Break-even Revenue: = Fixed expenses ÷
contribution margin ratio
= $1,596,700 ÷ 0.33
= $4,838,485
Revenue to generate 12% sales
margin:
Income = Contribution margin –
Fixed expenses
0.12R = 0.33R - $1,596,700
.21R = $1,596,700
R = $1,596,700 ÷ 0.21
= $7,603,333
3. Let A = max additional advertising expenditure
F = original fixed expenses
I = Contribution margin – Fixed expenses – Additional advertising
$208,800 = 0.33 * $6,591,600 - $1,596,700 – A
208,800 = $578,528 – A
A = $578,528 - $208,800 = $369,728
Increase in profits due to $88,000 increase in advertising:
$369,728 - $88,000 = $281,728
Thus, the suggestion should be adopted.
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64
Introduction to Managerial Accounting,Fifth Canadian Edition
Comprehensive Problem (continued)
4. R = Fixed expenses / contribution margin ratio
R = $200,000 / 0.33
= $606,061
Margin of safety = Expected sales – break-even sales
= $500,000 - $606,061 = ($106,061)
Entry is not recommended. The margin of safety is negative and the profit potential
small. The company has no experience in this market and the estimate of increased
sales may be too optimistic. At the very least, more careful research into this market
and its potential should be conducted before a decision to enter is made.
5. Increase in sales:
International
Additional
advertising
Total (10%
increase)
$340,000
209,300
$549,300
a. Change in profits:
Incremental contribution margin (0.33 x
$549,300)
Increase in advertising
International market related fixed expenses
Incremental profits
$ 181,269
(88,000)
(200,000)
$(106,731)
b. Change in profits:
International: 0.33 x $340,000 - $200,000 = ($87,800)
Advertising: 0.33 x $209,300 - $88,000 = ($18,931)
Neither strategy delivered the promised return. If the same performance is expected
for the coming year, then the company should reduce its advertising and withdraw from
the international market. If, however, a delayed effect from the advertising is
expected, then perhaps the company ought to try one additional year before reducing
this expenditure. Similarly, the first year in the international market could have been a
learning experience with a significant increase in sales expected for the coming year.
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Solutions Manual, Chapter 8
65
Comprehensive Problem (continued)
c.
Note:
I
$725,076
$2,609,776
CM%
=
=
=
=
=
Variable cost ratio
=
CM % × R – Fixed expenses
CM% × $6,042,300 - $1,884,700
CM % × $6,042,300
$2,609,776 ÷ $6,042,300
0.432 (43.2%)
1-0.432 = 0.568 (56.8%)
$6,042,300 = 1.1 × $5,493,000
$725,076 = 0.12 × $6,042,300
$1,884,700 = original fixed costs + $288,000
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66
Introduction to Managerial Accounting,Fifth Canadian Edition
Thinking Analytically(120 minutes) (LO2 CC5, 6,9, 10)
1. Revised contribution margin income statement:
Contribution Margin Income Statement
Perunit
Sales (300,000 units)
Percentage
$ 78,000,000
$260.00
100%
$ 58,500,000
$195.00
75%
$ 19,500,000
$ 65.00
25%
Less: Variable costs
Cost of goods sold
$ 35,100,000
Selling & administrative
$ 23,400,000
Contribution margin
Less: Fixed costs
Manufacturing
$ 9,560,000
Selling & administrative
$ 2,783,000
Net income
Break-even point
$ 12,343,000
$ 7,157,000
= Fixed costs ÷ contribution margin per unit
= $12,343,000 ÷ $65.00
≈ 189,893 units
Break-even point (in sales dollars) ≈ 189,893 ×$260
≈ $49,372,180
The break-even point is well below the actual sales of $78 million.
Operating leverage = Contribution margin ÷ Net income
= $19,500,000 ÷ $7,157,000
= 2.725 (rounded)
This means that for every 1% increase in sales, net income will increase by 2.725%.
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Solutions Manual, Chapter 8
67
Thinking Analytically (continued)
2.
Proposal 1
Contribution Margin Income Statement (Proposal 1)
Perunit
Sales (300,000 units)
Percentage
$ 78,000,000
$260.00
100%
$ 52,260,000
$174.20
67%
$ 25,740,000
$ 85.80
33%
Less: Variable costs
Cost of goods sold
$ 35,100,000
Selling & administrative
$ 17,160,000
Contribution margin
Less: Fixed costs
Manufacturing
$ 9,560,000
Selling & administrative
$ 12,353,500
Net income
$ 21,913,500
$ 3,826,500
Notes:
 The entire 8% decrease in variable costs is attributable to the variable selling
and administrative expenses.
 The entire amount of the $9,570,500 increase in fixed costs are added to the
fixed selling & administrative expenses.
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68
Introduction to Managerial Accounting,Fifth Canadian Edition
Thinking Analytically(continued)
Proposal 2
Contribution Margin Income Statement (Proposal 2)
Perunit
Sales (300,000 units)
Percentage
$ 78,000,000
$260.00
100%
$ 49,920,000
$166.40
64%
$ 28,080,000
$ 93.60
36%
Less: Variable costs*
Cost of goods sold
$ 30,810,000
Selling & administrative
$ 19,110,000
Contribution margin
Less: Fixed costs**
Manufacturing
$ 15,200,000
Selling & administrative
$ 8,423,000
Net income
$ 23,623,000
$ 4,457,000
Notes:
* Both the variable cost of goods sold and the variable selling & administrative
expenses will decrease by an amount equal to 5½% of sales ($78 million) The
decrease in variable costs is attributable to the variable selling and administrative
expenses.
**Thefixed cost of goods sold and the fixed selling & administrative expenses will
each increase by $5.64 million.
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 8
69
Thinking Analytically (continued)
Contribution Margin Income Statement (Proposal 3)
Perunit
Sales (300,000 units)
Percentage
$ 78,000,000
$260.00
100%
$ 58,500,000
$195.00
75%
$ 19,500,000
$ 65.00
25%
Less: Variable costs
Cost of goods sold
$ 35,100,000
Selling & administrative
$ 23,400,000
Contribution margin
Less: Fixed costs
Manufacturing
$ 9,560,000
Selling & administrative
$ 3,527,000
Net income
$ 13,087,000
$ 6,413,000
Note: Only the fixed selling & administrative expenses change. The new amount is
computed as follows:
$2,783,000 + $1,800,000 – (33 × $32,000) = $3,527,000
Although students are not asked to compare the three proposals, the statements
show that all three of them will reduce net income.
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70
Introduction to Managerial Accounting,Fifth Canadian Edition
Thinking Analytically(continued)
3.
The break-even sales and degree of operating leverage for the three proposals are
shown in the table below.
Proposal 1
Proposal 2
Proposal 3
Total fixed costs
$ 21,913,500
$ 23,623,000
$ 13,087,000
Contribution margin per unit
$
85.80
$
93.60
$
65.00
Contribution margin ratio
33%
36%
25%
Break-even sales in units
255,402
252,383
201,339
Break-even sales in dollars
$ 66,404,545
$ 65,619,444
$ 52,348,000
Total contribution margin
$ 25,740,000
$ 28,080,000
$ 19,500,000
Total net income
$ 3,826,500
$ 4,457,000
$ 6,413,000
6.73
6.30
3.04
Degree of operating leverage
The original break-even sales level is approximately 189,893 units or $49,372,180. All
the three proposals will result in both the break-even sales and degree of operating
leverage goingup. The significant increases in fixed costs cause the net income to
decrease which, in turn, cause the break-even sales and degree of operating leverage
to increase. In addition, in the first two proposals, the contribution ratio also increases
leading to an increase in the total contribution margin.
Proposal 1 has the highest degree of operating leverage which means that
implementing this proposal will result in the highest percentage increase in net income
for every 1% increase in sales.
Proposal 2 has the highest contribution margin ratio and will result in the highest total
contribution margin.
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 8
71
Communicating In Practice (90 minutes) (LO1 CC1, 3, 4; LO2 CC5, 6)
1. The contribution format income statements (in thousands of dollars) for the three alternatives are:
Sales ...........................................................
Variable expenses:
Variable cost of goods sold ........................
Commissions ............................................
Total variable expense ..................................
Contribution margin .....................................
Fixed expenses:
Fixed cost of goods sold ............................
Fixed advertising expense..........................
Fixed marketing staff expense ...................
Fixed administrative expense .....................
Total fixed expenses .....................................
Net operating income ...................................
18% Commission
20% Commission
$30,000
100%
$30,000
76%
24%
17,400
6,000
23,400
6,600
17,400
5,400
22,800
7,200
2,800
800
3,200
6,800
$ 400
2,800
800
3,200
6,800
$ (200)
* $800,000 + $500,000 = $1,300,000
** $700,000 + $400,000 + $200,000 = $1,300,000
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72
Introduction to Managerial Accounting,Fifth Canadian Edition
Own Sales Force
100%
$30,000
100%
78%
22%
17,400
3,000
20,400
9,600
68%
32%
2,800
1,300 *
1,300 **
3,200
8,600
$ 1,000
Communicating in Practice(continued)
2. Given the data above, the break-even points can be determined using total fixed
expenses and the CM ratios as follows:
a.
Dollar sales = Fixed expenses = $6,800,000 = $28,333,333
to break even
CM ratio
0.24
b.
Dollar sales = Fixed expenses = $6,800,000 = $30,909,091
to break even
CM ratio
0.22
c.
Dollar sales = Fixed expenses = $8,600,000 = $26,875,000
to break even
CM ratio
0.32
3. Dollar sales to attain
target profit
=
Target profit + Fixed expenses
CM ratio
=
-$200,000 + $8,600,000
0.32
= $26,250,000
X = Total sales revenue
4.
Net operating income = 0.32X - $8,600,000
with company sales force
Net operating income
= 0.22X - $6,800,000
with the 20% commissions
The two net operating incomes are equal when:
0.32X – $8,600,000
0.10X
X
X
=
=
=
=
0.22X – $6,800,000
$1,800,000
$1,800,000 ÷ 0.10
$18,000,000
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 8
73
Communicating in Practice(continued)
Thus, at a sales level of $18,000,000 either plan will yield the same net operating
income. This is verified below (in thousands of dollars):
Sales .................................
Total variable expense ........
Contribution margin ............
Total fixed expenses ...........
Net operating loss ..............
20% Commission
Own Sales Force
$ 18,000
14,040
3,960
6,800
$ (2,840)
$ 18,000 100%
12,240
68%
5,760
32%
8,600
$ (2,840)
100%
78%
22%
5. A graph showing both alternatives appears below:
$6,000
$4,000
$2,000
$0
$0
$5,000 $10,000 $15,000 $20,000 $25,000 $30,000 $35,000 $40,000
-$2,000
-$4,000
Hire Own Sales Force
-$6,000
Use Sales Agents
-$8,000
-$10,000
Sales
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74
Introduction Managerial Accounting, Fifth Canadian Edition
Communicating in Practice(continued)
6.
To:President of Marston Corporation
From:Student’s name
Assuming that a competent sales force can be quickly hired and trained and the new
sales force is as effective as the sales agents, this is the better alternative. Using the
data provided by the controller, unless sales fall below $18,000,000 net operating
income is higher when the company has its own sales force. At that level of sales
and below, the company would be losing money, so it is unlikely that this would be
the normal situation.
The major concern I have with this recommendation is the assumption that the new
sales force will be as effective as the sales agents. The sales agents have been
selling our product for a number of years, so they are likely to have more field
experience than any sales force we hire. And, our own sales force would be selling
just our product instead of a variety of products. On the one hand, that will result in
a more focused selling effort. On the other hand, that may make it more difficult for
a salesperson to get the attention of a hospital’s purchasing agent.
The purchasing agents may prefer to deal through a small number of salespersons,
each of whom sells many products, rather than a large number of salespersons each
of whom sells only a single product. Even so, we can afford some decrease in sales
because of the lower cost of maintaining our own sales force. For example,
assuming that the sales agents make the budgeted sales of $30,000,000, we would
have a net operating loss of $200,000 for the year. We would do better than this
with our own sales force as long as sales are greater than $26,250,000. In other
words, we could afford a fall-off in sales of $3,750,000, or 12.5%, and still be better
off with our own sales force. If we are confident that our own sales force could do at
least this well relative to the sales agents, then we should certainly switch to using
our own sales force.
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 8
75
Teamwork in Action (LO1CC1; LO2 CC9)
1. The answer to this question will vary from school to school.
2. Managers will hire more support staff, such as security and vending personnel, for
big games that predictably draw more people. These costs are variable with respect
to the number of expected attendees, but are fixed with respect to the number of
people who actually buy tickets. Normally there is a minimum number of support
staff that is fixed for all events. Most other costs are fixed with respect to both the
number of expected and actual tickets sold—including the costs of the coaching
staff, athletic scholarships, uniforms and equipment, facilities, and so on.
3. The answer to this question will vary from school to school, but a clear distinction
should be drawn between the costs that are variable with respect to the number of
tickets sold (i.e., actual attendees) versus the costs that are variable with respect to
the expected number of tickets sold. The costs that are variable with respect to the
number of tickets actually sold, given the number of expected tickets sold, are
probably inconsequential since, as discussed above, staffing is largely decided based
on expectations.
4. The answer to this question will vary from school to school. The lost profit is the
difference between the ticket price and the variable cost of filling a seat multiplied
by the number of unsold seats.
5. The answer to this question will vary from school to school.
6. The answer to this question will vary from school to school, but should be based on
the answers to parts (4) and (5) above.
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76
Introduction Managerial Accounting, Fifth Canadian Edition
Appendix 8A
Multi-product Break-Even Analysis
Questions
8A-1
The term sales mix means the relative proportion in which a company’s
products are sold. The usual assumption in cost-volume-profit analysis is that
the sales mix will not change.
8A-2
A higher break-even point and a lower net income could result if the sales
mix shifted from high contribution margin products to low contribution margin
products. Such a shift would cause the average contribution margin ratio in
the company to decline, resulting in less total contribution margin for a given
amount of sales. Thus, net income would decline. With a lower contribution
margin ratio, the break-even point would be higher since it would require
more sales to cover the same amount of fixed costs.
Brief Exercises
Brief Exercise 8A-1 (30 minutes) (LO2 CC 11A, 12A)
1. The overall contribution margin ratio can be computed as follows:
Overall CM ratio =
Total contribution margin
Total sales
=
$45,000
= 30%
$150,000
2. The overall break-even point in sales dollars can be computed as follows:
Overall break-even =
Total fixed expenses
Overall CM ratio
=
$36,000
= $120,000
30%
3. To construct the required income statement, we must first determine the relative
sales mix for the two products:
Claimjumper
Original dollar sales ................................
$65,000
Percent of total ................................
43.333%
Sales at break-even* ................................
$52,000
Solutions Manual, Appendix 8A
Makeover
$85,000
56.667%
$68,000
Total
$150,000
100%
$120,000
Copyright © 2017 McGraw-Hill Education. All rights reserved.
1
Claimjumper
Makeover
Sales................................................................
$52,000
Less variable expenses** ................................
36,000
Contribution margin ................................
$16,000
Less fixed expenses ................................
Net income................................
$68,000
48,000
$20,000
Total
$120,000
84,000
36,000
36,000
$ -
*Break even sales: Brake even sales × % of total ($120,000 × 43.333%; $120,000 ×
56.667%)
**Claimjumper variable expenses: ($45,000/$65,000) × $52,000 = $36,000
Makeover variable expenses: ($60,000/$85,000) × $68,000 = $48,000
Brief Exercise 8A-2 (15 minutes) (LO2 CC12A)
X
$36.00
21.00
$15.00
60%
Sales price per unit
Less: Variable cost per unit
Contribution margin per unit
Ratio of sales
Y
$24.00
12.00
$12.00
40%
Weighted-average sales
= ($36 × 60%) + ($24 × 40%) = $31.20
Weighted-average contribution margin
= ($15 × 60%) + ($12 × 40%) = $13.80
Weighted-average contribution margin ratio
= $13.80 ÷ $31.20 ≈ 44.23%
Overall break-even sales
= $276,000 ÷ 0.4423
≈ $624,011
The exact amount is $624,000 (the $11 difference is due to a rounding error).
Solutions Manual, Appendix 8A
Copyright © 2017 McGraw-Hill Education. All rights reserved.
2
Brief Exercise 8A-3 (10 minutes) (LO1 CC2; LO2 CC12A)
1.
Budgeted sales mix is computed as follows:
Gamma:
Delta:
Total:
12,000 units
18,000 units
30,000 units
Gamma =
Delta =
12,000 ÷ 30,000 = 40%
18,000 ÷ 30,000 = 60%
2.
Contribution margin per unit is as follows:
Gamma =
Delta =
$42 - $22 = $20
$28 - $18 = $10
Weighted-average contribution margin
= ($20 × 40%) + ($10 × 60%)
= $8 + $6 = $14
Brief Exercise 8A-4 (10 minutes) (LO2 CC25A)
The sales mix may be restated as 10%, 30%, 40% and 20% for the four products,
using the given data (1:3:4:2).
Weighted-average contribution margin
= ($42 × 1/10) + ($36 × 3/10) + ($50 × 4/10) + ($20 × 2/10)
= $39
Break-even sales
= $273,000 ÷ $39 = 7,000 units
The break-even unoits for each of the four products using given sales mix will result in
700, 2,100, 2,800 and 1,400 units respectively. This is computed as 10% of 7,000
units and so on.
Solutions Manual, Appendix 8A
Copyright © 2017 McGraw-Hill Education. All rights reserved.
3
Exercises
Exercise 8A-1 (45 minutes) (LO2 CC15A)
1.
Flight Dynamic
Amount
%
Sales
P300,000 100
Less variable
90,000
30
expenses................................
Contribution
margin ................................
P210,000
70
Less fixed
expenses................................
Net income ................................
Sure Shot
Amount
%
Total Company
Amount
%
P500,000 100
P800,000
100.0
45.0*
270,000
54
360,000
P230,000
46
440,000
55.0
327,500
P112,500
*P360,000 ÷ P800,000 = 45%.
2. The break-even point for the company as a whole would be:
Fixed expenses
Overall CM ratio
= P327,500 = P595,455
0.55
3. Incremental contribution margin:
P82,500
P150,000 × 55% CM ratio ................................
Assuming no change in fixed expenses, all of the incremental contribution margin of
P82,500 should carry forward to the bottom line as increased net income.
This answer assumes no change in selling prices, variable costs per unit, fixed
expense, or sales mix.
Solutions Manual, Appendix 8A
Copyright © 2017 McGraw-Hill Education. All rights reserved.
4
Problems
Problem 8A-1 (60 minutes) (LO1 CC1; LO2 CC15A)
1.
Percentage
White
Fragrant
Loonzain
Total
40%
24%
36%
100%
of total sales
Sales
Less variable
B600,000
100%
B360,000
100%
B540,000
100%
B1,500,000
100%
432,000
72%
72,000
20%
216,000
40%
720,000
48%
B168,000
28%
B288,000
80%
B324,000
60%
B 780,000
52%*
expenses
Contribution
margin
Less fixed
898,560
expenses
Net income
B 118,560
(loss)
*B780,000 ÷B1,500,000 = 52%.
2. Break-even sales would be:
Fixed expenses B898,560
=
= B1,728,000
CM ratio
0.52
3. Memo to the president:
Although the company met its sales budget of B1,500,000 for the month, the mix of
products changed substantially from that budgeted. This is the reason the budgeted
net income was not met, and the reason the break-even sales were greater than
budgeted. The company’s sales mix was planned at 20% White, 52% Fragrant, and
28% Loonzain. The actual sales mix was 40% White, 24% Fragrant, and 36%
Loonzain.
As shown by these data, sales shifted away from Fragrant Rice, which provides our
greatest contribution per dollar of sales, and shifted toward White Rice, which
Solutions Manual, Appendix 8A
Copyright © 2017 McGraw-Hill Education. All rights reserved.
5
provides our least contribution per dollar of sales. 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 income. Notice from the
attached statements that the company’s overall CM ratio was only 52%, as
compared to a planned CM ratio of 64%. This also explains why the break-even
point was higher than planned. With less average contribution margin per dollar of
sales, a greater level of sales had to be achieved to provide sufficient contribution
margin to cover fixed costs.
Problem 8A-2 (60 minutes) (LO2 CC7, 12A)
1.
(fixed costs for
5,000 units)
Price
$629.99
Variable costs:
Materials
$700,000
Labour
$175,000
Overhead
$600,000
Shipping
$295.00
$ 10.99
Contribution margin
$324.00
Fixed costs:
Manufacturing
$755,000
Advertising
$200,000
Break-even sales =
$955,000
$955,000
$324
≈ 2,948 units
Solutions Manual, Appendix 8A
Copyright © 2017 McGraw-Hill Education. All rights reserved.
6
Problem 8A-2 (continued)
2.
Gold Model
Silver Model
(fixed costs for 5,000 units)
Price
(fixe costs for 5,000 units)
$629.99
$549.99
Variable costs:
Materials
$700,000
$500,000
Labour
$175,000
$175,000
Overhead
$600,000 $295.00
$500,000 $235.00
$ 10.99
$ 10.99
$324.00
$304.00
Shipping
Contribution margin
Fixed costs:
Manufacturing
$755,000
$500,000
Advertising
$200,000 $955,000
$150,000 $650,000
Weighted-average sales price
= ($629.99 × 70%) + ($549.99 × 30%)
= $605.99 per unit
Weighted-average contribution margin
= ($324 × 70%) + ($304 × 30%)
= $318 per unit
Solutions Manual, Appendix 8A
Copyright © 2017 McGraw-Hill Education. All rights reserved.
7
Problem 8A-2 (continued)
Weighted-average contribution margin ratio
= $318 ÷ $605.99
= 52.48%
Overall break-even sales
= Total fixed expenses ÷ Weighted-average contribution margin ratio
= ($955,000 + $650,000) ÷ 0.5248
≈ $3,058,308 (rounded up)
3.
In computing the overall break-even sales, we use the total fixed costs. The total fixed costs will not change
regardless of how they are allocated to the two products. Therefore, the overall break-even sales dollars will
remain the same. If the sales mix changes to 50:50 the contribution margin ratio will change to 53.22%, and the
break-even sales will change to $3,015,784 (rounded up).
Solutions Manual, Appendix 8A
Copyright © 2017 McGraw-Hill Education. All rights reserved.
8
Problem 8A-3 (75 minutes) (LO2 CC8, 11A, 12A)
1. a)
Hawaiian Fantasy
Amount
%
Tahitian Joy
Amount
%
Sales ................................
$900,000 100.0 $1,500,000 100.0
Less variable
expenses ................................
540,000 60.0
300,000 20.0
Contribution
margin ................................
$360,000 40.0 $1,200,000 80.0
Less fixed
expenses ................................
Net income ................................
Total
Amount
%
$2,400,000
100.0
840,000
35.0
1,560,000
65.0
1,427,400
$ 132,600
b)
Fixed expenses $1,427,400
=
=$2,196,000 in sales
CM ratio
0.650
Margin of safety:
Margin of safety
$2,400,000 – $2,196,000
Margin of safety in percentage
$204,000 ÷ $2,400,000
=
=
=
=
actual sales – break-even sales
$204,000
margin of safety in dollars ÷ actual sales
8.5%
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Appendix 8A
Problem 8A-3 (continued)
2. a)
Hawaiian Fantasy
Amount
%
Sales ................................ $900,000 100.0
Less variable expenses ................................
540,000
60.0
Contribution margin ................................
$360,000
40.0
Less fixed expenses ................................
Net income ................................
Tahitian
Joy
Amount
%
$1,500,000
300,000
$1,200,000
100.0
20.0
80.0
Samoan
Delight
Amount
%
$1,350,000
1,080,000
$ 270,000
100.0
80.0
20.0
Total
Amount
$3,750,000
1,920,000
1,830,000
1,427,400
$ 402,600
%
100.0
51.2
48.8
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Appendix 8A
10
Problem 8A-3 (continued)
2. b)
Fixed expenses $1,427,400
=
= $2,925,000
CM ratio
0.488
Margin of safety:
Margin of safety=Actual sales - Break-even sales
$3,750,000 - $2,925,000=$825,000
Margin of safety in percentage= Margin of safety in dollars
Actual sales
$825,000
=22%
$3,750,000
3. The reason for the increase in the break-even point can be traced to the decrease in
the company’s overall contribution margin ratio when the third product is added.
Note from the income statements above that this ratio drops from 65% to 48.8%
with the addition of the third product. This product (the Samoan Delight) has a CM
ratio of only 20%, which causes the average contribution margin per dollar of sales
to shift downward.
This problem shows the somewhat tenuous nature of break-even analysis when the
company has more than one product. The manager must be very careful of his or
her assumptions regarding sales mix, including the addition (or deletion) of new
products.
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 company’s margin of safety is also
greater. Notice that the margin of safety increases from $204,000 to $825,000 or
from 8.5% to 22%. 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.
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Appendix 8A
Problem 8A-4 (90 minutes) (CC12A)
a.
MITCHELL CO. LTD.
MULTI-PRODUCT BREAK-EVEN SALES ANALYSIS
(All dollar amounts are in thousands)
Economy
Standard
Amount Percent
Amount Percent
Fancy
Amount
Percent
Total
Amount
Percent
Budgeted Sales and Income
Sales (units)
Sales
Less: variable expenses
Contribution margin
875
$157,500
$
81,900
$
75,600
450
350
1,675
100.0
$ 99,000
100.0
$112,000
100.0
$368,500
100.0
52.0
$ 49,500
50.0
$ 44,800
40.0
$176,200
47.8
48.0
$ 49,500
50.0
$ 67,200
60.0
$192,300
52.2
Less: fixed expenses
$170,300
Net income
$ 22,000
Break-even Sales
Overall break-even sales
Fixed expenses, $170,300,000
Weighted-average contribution margin ratio, 52.2%
Sales price per unit ($’000s)
Variable cost per unit ($’000s)
$180
$93.60
$220
$110
≈
$ 326,245,211
(rounded up)
$320
$128
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Appendix 8A
12
b.
MITCHELL CO. LTD.
MULTI-PRODUCT BREAK-EVEN SALES ANALYSIS
(All dollar amounts are in thousands)
Model I
Model II
Percen
Percen
Amount
Amount
t
t
Model III
Percen
Amount
t
Total
Amount
Percen
t
Actual Sales and Income
Sales (units)
Sales
Less: variable expenses
775
$139,500
$ 72,540
100.0
52.0
550
$121,000
$ 60,500
100.0
50.0
350
$112,000
$ 44,800
100.0
40.0
1,675
$372,500
$177,840
100.0
47.7
Contribution margin
$ 66,960
48.0
$ 60,500
60.0
$ 67,200
60.0
$194,660
52.3
Less: fixed expenses
$ 170,300
Net income
$ 24,360
Break-even Sales
Overall break-even sales
Fixed expenses, $170,300,000
≈
Weighted-average contribution margin ratio, 52.3%
Notes:
Selling price per unit (from #1)
$
180
$
220
$325,621,41
5
$
320
Note: The appendix uses sales dollars as the basis for computing sales mix; therefore actual units have been converted
into sales dollars in order to compute sales mix percentage.
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Appendix 8A
13
Problem 8A-5 (50 minutes) (LO2 CC 12A)
1.
Party Animal
Study Mate
Total
60%
40%
100%
12,000
8,000
20,000
Selling price per unit
$400
$260
Contribution margin/unit
$124
$ 70
Sales proportion
Sales units
Weighted-average sales price/unit
= ($400 × 60% + $260 × 40%)
= $344.00
Weighted-average contribution margin per unit = ($124 × 60% + $70 × 40%)
= $102.40
Weighted-average contribution margin ratio
= $102.40 ÷ $344 = 29.77%
Break-even sales in dollars = ($950,000 + $604,430) ÷ 0.2977
≈ $5,224,824 (rounded up)
Break-even sales in units
= ($950,000 + $604,430) ÷ $102.40
≈ 15,180 (rounded up)
Break-even sales for individual products can be computed as follows:
Party Animal
= 15,180 × 60% = 9,108 units
Study Mate
= 15,180 × 40% = 6,072 units
Solutions Manual, Appendix 8A
Copyright © 2017 McGraw-Hill Education. All rights reserved.
14
Problem 8A-5 (continued)
2.
Party Animal
Study Mate
$400.00
$260.00
Direct materials
$100.00
$ 78.00
Direct labour
$ 80.00
$ 60.00
Overhead
$ 64.00
$ 40.00
Selling
$ 32.00
$ 22.00
$124.00
$ 60.00
Selling price
Variable costs:
Contribution margin/unit
Fixed costs:
Manufacturing
$ 950,000
Selling & Administrative
$ 804,430
$1,754,430
Sales mix (based on sales in
units)
Solutions Manual, Appendix 8A
50%
50%
Copyright © 2017 McGraw-Hill Education. All rights reserved.
15
Problem 8A-5 (continued)
Weighted-average sales price/unit
= ($400 × 50% + $260 × 50%)
= $330.00
Weighted-average contribution margin per unit = ($124 × 50% + $60 × 40%)
= $92.00
Weighted-average contribution margin ratio
= $92.00 ÷ $330 = 27.88%
Break-even sales in dollars = ($950,000 + $804,430) ÷ 0.2788
≈ $6,292,791 (rounded up)
Break-even sales in units
= ($950,000 + $804,430) ÷ $92.00
≈ 19,070 (rounded up)
Break-even sales for individual products can be computed as follows:
Party Animal
= 19,070 × 50% = 9,535 units
Study Mate
= 19,070 × 50% = 9,535 units
From a profitability standpoint this change does not make much sense because
additional money is being spent to increase sales of the product with a lower
contribution margin ratio. The break-even sales increases by over 25%.
Solutions Manual, Appendix 8A
Copyright © 2017 McGraw-Hill Education. All rights reserved.
16
Problem 8A-5 (continued)
3.
Party Animal
Study Mate
$400.00
$260.00
Direct materials
$ 80.00
$ 62.40
Direct labour
$ 64.00
$ 48.00
Overhead
$ 64.00
$ 40.00
Selling
$ 32.00
$ 12.00
$160.00
$ 97.60
Selling price
Variable costs:
Contribution margin/unit
Fixed costs:
Manufacturing
$1,400,000
Selling & Administrative
$ 604,430
$2,004,430
Sales mix (based on sales in
units)
Solutions Manual, Appendix 8A
60%
40%
Copyright © 2017 McGraw-Hill Education. All rights reserved.
17
Problem 8A-5 (continued)
Weighted-average sales price/unit
= ($400 × 60% + $260 × 40%)
= $344.00
Weighted-average contribution margin per unit = ($160 × 60% + $97.60 × 40%)
= $135.04
Weighted-average contribution margin ratio
= $135.04 ÷ $344 = 39.25%
Break-even sales in dollars = ($1,400,000 + $604,430) ÷ 0.3925
≈ $5,106,828
Break-even sales in units
= ($1,400,000 + $604,430) ÷ $135.04
≈ 14,844 (rounded up)
Break-even sales for individual products can be computed as follows:
Party Animal
= 14,844 × 60% = 8,907 units
Study Mate
= 14,844 × 40% = 5,937 units
From a profitability standpoint this change appears to make sense because the
investment results in a much lower break-even sales level. The increase in the fixed
costs is more than offset by the higher contribution margin achieved with the new
machine. Both the weighted-average contribution margin per unit and contribution
margin ratio increases substantially.
Solutions Manual, Appendix 8A
Copyright © 2017 McGraw-Hill Education. All rights reserved.
18
Appendix 8B
Absorption versus Costing and Variable
Costing
Questions
8B-1
Under absorption costing, fixed manufacturing overhead costs are considered
to be part of product costs. Under variable costing, fixed manufacturing
overhead costs are considered to be period expenses. Consequently, under
absorption costing some fixed manufacturing costs will appear on the balance
sheet as part of the cost of ending inventory, rather than on the income
statement as an expense.
Brief Exercises
Brief Exercise 8B-1 (10 minutes) (LO3 CC 13B)
Fixed manufacturing cost per unit = $380,000 ÷ 1,000 units
= $380 per unit
Difference between the two incomes
= Ending finished goods inventory
× Fixed manufacturing cost per unit
= 100 × $380 = $38,000
Absorption costing income will be higher because production is greater than sales.
Solutions Manual, Appendix 8B
Copyright © 2017 McGraw-Hill Education. All rights reserved.
1
Brief Exercise 8B-2 (10 minutes) (LO3 CC 13B, 14B)
The arguments in favour of the two methods are as follows:
Absorption Costing


In compliance with GAAP
Inventories are more accurately valued on the balance sheet
Variable Costing


Useful for management decision making
Easy to prepare (avoids the fixed cost allocation problem)
The variable costing approach expenses both product and period fixed costs in the year
when they are incurred. In contrast absorption costing statements follow the matching
principle and expense only that portion of the fixed product costs which can be matched
against sales revenues. The remaining unmatched portion is carried forward to
inventory. The financial impact of this difference can be significant, with absorption
costing income being higher when the ending inventory levels of especially work-inprogress and finished goods are higher than beginning inventory levels.
Solutions Manual, Appendix 8B
Copyright © 2017 McGraw-Hill Education. All rights reserved.
2
Exercises
Exercise 8B-1 (40 minutes) (LO3 CC 13B, 14B)
1.
Absorption Costing Income Statement
20X1
Sales Revenue (40,000; 30,000 units @ $40)
Cost of goods sold:
Beginning inventory (0; 5,000 units @ $33*)
Add: Cost of goods manufactured (35,000 units @ $33)
Deduct: Ending finished goods inventory (5,000; 0 units @ $33)
$
1,600,000
$
$ 1,155,000
$
Fixed marketing costs
Net income
$1,200,000 $2,800,000
$
$
$
990,000
610,000
$
60,000
$
550,000
$ 1,320,000 $2,310,000
($ 120,000) $ 490,000
$
60,000 $ 120,000
($ 180,000) $ 370,000
* Fixed MOH per unit = $105,000 / 35,000 units produced = $3 per unit
Solutions Manual, Appendix 8B
Total
$ 165,000
$ 1,155,000
165,000
Cost of goods sold
Gross margin
Less: Selling & administrative expenses
20X2
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3
Exercise 8B-1 (continued)
2.
Variable Costing Income Statement
20X1
Sales Revenue (40,000; 30,000 units @ $40)
Variable cost of goods sold:
Beginning inventory (0; 5,000 units @ $30)
Add: Cost of goods manufactured (35,000 units @ $30)
Deduct: Ending finished goods inventory (5,000; 0 units @ $30)
$
$
1,050,000
$
150,000
$
Cost of goods sold
Contribution margin
Less: Fixed costs
Manufacturing
Marketing
Net income
Solutions Manual, Appendix 8B
$
105,000
$
60,000
20X2
1,600,000
Total
$1,200,000 $2,800,000
$ 150,000
$ 1,050,000
$
-
$
900,000
$1,200,000 $2,100,000
$
700,000
$ 0,000 $ 700,000
$ 105,000
$
165,000
$
535,000
$
60,000
$ 165,000 $ 330,000
($ 165,000) $ 370,000
Copyright © 2017 McGraw-Hill Education. All rights reserved.
4
Exercise 8B-1 (continued)
3.
Reconciliation
20X1
20X2
Variable costing income
$ 535,000 $ (165,000)
+ (Ending inventory in units × fixed manufacturing costs per unit) - 5,000; 0 @ $3
$
15,000
$
– (Beginning inventory in units × fixed manufacturing costs per unit) - 0; 5,000 @ $3
$
- $ (15,000)
= Absorption costing income
Solutions Manual, Appendix 8B
$
550,000 ($
180,000)
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5
Problems
Problem 8B-1 (35 minutes) (LO3 CC 13B, 14B)
1.
Variable Costing Income Statement
January 2018
Sales Revenue (4,500 units @ $85)
Variable cost of goods sold:
Beginning inventory (0 units)
Add: Cost of goods manufactured (5,000 units @ $56*)
Deduct: Ending finished goods inventory (500 units @ $56)
$382,500
$
$280,000
$ 28,000
Cost of goods sold
$252,000
Other variable costs (4,500 units @ $4)
$ 18,000
Contribution margin
Less: Fixed costs
$112,500
Manufacturing
$60,000
Marketing
$40,000
Net income
$100,000
$ 12,500
* Cost per unit = $40 + $10 + $6 = $56 per unit
Solutions Manual, Appendix 8B
Copyright © 2017 McGraw-Hill Education. All rights reserved.
6
Problem 8B-1 (continued)
Absorption Costing Income Statement
2018
Sales Revenue (4,500 units @ $85)
Cost of goods sold:
Beginning inventory (0 units)
Add: Cost of goods manufactured (5,000 units @ $68*)
$382,500
$
$340,000
Deduct: Ending finished goods inventory (500 units @ $68)
$ 34,000
Cost of goods sold
$306,000
Gross margin
Less: Selling & administrative expenses
Variable marketing costs
$ 76,500
$ 18,000
Fixed marketing costs
$ 40,000
Net income
$ 58,000
$ 18,500
* Cost per unit = $40 + $10 + $6 + ($60,000 ÷ 5,000 units produced) = $68 per unit
Solutions Manual, Appendix 8B
Copyright © 2017 McGraw-Hill Education. All rights reserved.
7
Problem 8B-1 (continued)
2.
Reconciliation
Variable costing income
+ (Ending inventory in units × fixed manufacturing costs per unit) - 500 @ $12*
– (Beginning inventory in units × fixed manufacturing costs per unit) - 0 @ 12
$12,500
$ 6,000
$
-
= Absorption costing income
$18,500
* Fixed MOH per unit = $60,000 ÷ 5,000 units produced = $12 per unit
Solutions Manual, Appendix 8B
Copyright © 2017 McGraw-Hill Education. All rights reserved.
8
Problem 8B-2 (20 minutes) (LO3 CC13B, 14B)
1. The company is using variable costing. The computations are:
Variable
Costing
Direct materials .......................................
Direct labour ...........................................
Variable manufacturing overhead .............
Fixed manufacturing overhead
($90,000 ÷ 30,000 units)......................
Unit product cost.....................................
Total cost, 5,000 units .............................
Absorption
Costing
$10
5
2
$10
5
2
—
$17
$85,000
3
$20
$100,000
2. a. No, $85,000 is not the correct figure to use, because variable costing is not
generally accepted for external reporting purposes or for tax purposes.
b. The finished goods inventory account should be stated at $100,000, which
represents the absorption cost of the 5,000 unsold units. Thus, the account
should be increased by $15,000 for external reporting purposes. This $15,000
consists of the amount of fixed manufacturing overhead cost that is allocated to
the 5,000 unsold units under absorption costing (5,000 units × $3 per unit fixed
manufacturing overhead cost = $15,000).
Solutions Manual, Appendix 8B
Copyright © 2017 McGraw-Hill Education. All rights reserved.
9
Problem 8B-3 (30 minutes) (LO3 CC13B, 14B)
1 a. Under variable costing, only the variable manufacturing costs are included in
product costs.
Direct materials ...............................................
Direct labour ...................................................
Variable manufacturing overhead .....................
Variable costing unit product cost .....................
Year 1
Year 2
$20
12
4
$36
$20
12
4
$36
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.
1 b.
Year 1
(40,000 units)
Sales (@ $50 per unit) ...........................................
Variable expenses:
Variable cost of goods sold @ $36 per unit ...........
Variable selling and administrative @ $3 per unit ..
Total variable expenses ..........................................
Contribution margin ...............................................
Fixed expenses:
Fixed manufacturing overhead .............................
Fixed selling and administrative ...........................
Total fixed expenses ...............................................
Net operating income (loss) ....................................
Year 2
(50,000
units)
$2,000,000
$2,500,000
1,440,000
120,000
1,560,000
440,000
1,800,000
150,000
1,950,000
550,000
200,000
80,000
280,000
$ 160,000
200,000
80,000
280,000
$ 270,000
2 a. The unit product costs under absorption costing:
Year 1 Year 2
Direct materials ...............................................
Direct labour ...................................................
Variable manufacturing overhead .....................
Fixed manufacturing overhead .........................
Absorption costing unit product cost .................
$20
12
4
*4
$40
$20
12
4
**5
$41
* $200,000 ÷ 50,000 units = $4 per unit.
** $200,000 ÷ 40,000 units = $5 per unit.
Solutions Manual, Appendix 8B
Copyright © 2017 McGraw-Hill Education. All rights reserved.
10
Problem 8B-3 (continued)
2 b. The absorption costing income statements appears below:
Year 1
Sales ................................................................
Cost of goods sold ............................................
Gross margin ....................................................
Selling and administrative expenses ...................
Net operating income ........................................
$2,000,000
*1,600,000
400,000
200,000
$ 200,000
Year 2
$2,500,000
**2,040,000
460,000
230,000
$ 230,000
* 40,000 units × $40 per unit = $1,600,000
** (40,000 units × $41 per unit) + (10,000 units × $40 per unit) = $2,040,000
3. The net operating incomes are reconciled as follows:
Year 1
Variable costing net operating income (loss)............
Add: Fixed manufacturing overhead cost deferred
in inventory under absorption costing (10,000
units × $4 per unit) ............................................
Deduct: Fixed manufacturing overhead cost
released from inventory under absorption costing
(10,000 units × $4 per unit) ................................
Absorption costing net operating income .................
Solutions Manual, Appendix 8B
$ 160,000
Year 2
$ 270,000
40,000
$
200,000
(40,000)
$ 230,000
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11
Problem 8B-4 (20 minutes) (LO3 CC13B, 14B)
1. Sales (40,000 units × $33.75 per unit) .......................
Variable expenses:
Variable cost of goods sold
(40,000 units × $16 per unit*) ............................
Variable selling and administrative expenses
(40,000 units × $3 per unit) ................................
Contribution margin ..................................................
Fixed expenses:
Fixed manufacturing overhead................................
Fixed selling and administrative expenses................
Net operating income ................................................
* Direct materials .......................................
Direct labour ...........................................
Variable manufacturing overhead .............
Total variable manufacturing cost .............
$1,350,000
$640,000
120,000
250,000
300,000
760,000
590,000
550,000
$ 40,000
$10
4
2
$16
2. The difference in net operating income can be explained by the $50,000 in fixed
manufacturing overhead deferred in inventory under the absorption costing method:
Variable costing net operating income .........................................
Add fixed manufacturing overhead cost deferred in inventory
under absorption costing (10,000 units × $5* per unit in fixed
manufacturing overhead cost) .................................................
Absorption costing net operating income .....................................
$40,000
50,000
$90,000
* Fixed MOH per unit = $250,000 ÷ 50,000 units produced = $5 per unit
Solutions Manual, Appendix 8B
Copyright © 2017 McGraw-Hill Education. All rights reserved.
12
Problem 8B-5 (45 minutes) (LO3 CC13B, 14B)
1. a. The unit product cost under absorption costing is:
Direct materials ...............................................
Direct labour ...................................................
Variable manufacturing overhead .....................
Fixed manufacturing overhead
($640,000 ÷ 40,000 units) ............................
Absorption costing unit product cost .................
$15
7
2
16
$40
b. The absorption costing income statement is:
Sales (35,000 units × $60 per unit) ........................................
Cost of goods sold (35,000 units × $40 per unit) ....................
Gross margin ........................................................................
Selling and administrative expenses
(35,000 units × $2 per unit) + $560,000 .............................
Net operating income ............................................................
$2,100,000
1,400,000
700,000
630,000
$ 70,000
2. a. The unit product cost under variable costing is:
Direct materials ...............................................
Direct labour ...................................................
Variable manufacturing overhead .....................
Variable costing unit product cost .....................
$15
7
2
$24
b. The variable costing income statement is:
Sales (35,000 units × $60 per unit) .........................
Variable expenses:
Variable cost of goods sold
(35,000 units × $24 per unit)............................
Variable selling expense
(35,000 units × $2 per unit) .............................
Contribution margin................................................
Fixed expenses:
Fixed manufacturing overhead .............................
Fixed selling and administrative expense...............
Net operating loss ..................................................
Solutions Manual, Appendix 8B
$2,100,000
$840,000
70,000
640,000
560,000
910,000
1,190,000
1,200,000
$ (10,000)
Copyright © 2017 McGraw-Hill Education. All rights reserved.
13
Problem 8B-5 (continued)
3. The difference in the ending inventory relates to a difference in the handling of fixed
manufacturing overhead costs. Under variable costing, these costs have been
expensed in full as period costs. Under absorption costing, these costs have been
added to units of product at the rate of $16 per unit ($640,000 ÷ 40,000 units
produced = $16 per unit). Thus, under absorption costing a portion of the $640,000
fixed manufacturing overhead cost of the month has been added to the inventory
account rather than expensed on the income statement:
Added to the ending inventory
(5,000 units × $16 per unit) ....................................................
Expensed as part of cost of goods sold
(35,000 units × $16 per unit) ..................................................
Total fixed manufacturing overhead cost for the month ................
$ 80,000
560,000
$640,000
Because $80,000 of fixed manufacturing overhead cost has been deferred in
inventory under absorption costing, the net operating income reported under that
costing method is $80,000 higher than the net operating income under variable
costing, as shown in parts (1) and (2) above.
Solutions Manual, Appendix 8B
Copyright © 2017 McGraw-Hill Education. All rights reserved.
14
Problem 8B-6 (45 minutes) (LO3 CC13B, 14B)
1. The break-even point in units sold can be computed using the contribution margin
per unit as follows:
Selling price per unit..............................
Variable cost per unit .............................
Contribution margin per unit ..................
$56
48
$8
Break-even unit sales = Fixed expenses ÷ Unit contribution margin
= $480,000 ÷ $8 per unit
= 60,000 units
2 a. Under variable costing, only the variable manufacturing costs are included in
product costs.
Direct materials ...............................................
Direct labour ...................................................
Variable manufacturing overhead .....................
Variable costing unit product cost .....................
Year 1
Year 2
Year 3
$25
16
5
$46
$25
16
5
$46
$25
16
5
$46
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.
Solutions Manual, Appendix 8B
Copyright © 2017 McGraw-Hill Education. All rights reserved.
15
Problem 8B-6 (continued)
2 b. The variable costing income statements appear below:
Year 2
Year 3
Year 1
(60,000 units) (50,000 units) (65,000 units)
Sales (@ $56 per unit) ...........................................................
Variable expenses:
Variable cost of goods sold @ $46 per unit ...........................
Variable selling and administrative @ $2 per unit ..................
Total variable expenses ..........................................................
Contribution margin ...............................................................
Fixed expenses:
Fixed manufacturing overhead .............................................
Fixed selling and administrative ...........................................
Total fixed expenses...............................................................
Net operating income (loss)....................................................
$3,360,000
$2,800,000
$3,640,000
2,760,000
120,000
2,880,000
480,000
2,300,000
100,000
2,400,000
400,000
2,990,000
130,000
3,120,000
520,000
300,000
180,000
480,000
$
0
$
300,000
180,000
480,000
(80,000)
300,000
180,000
480,000
$ 40,000
3 a. The unit product costs under absorption costing:
Year 1 Year 2
Direct materials ...............................................
Direct labor .....................................................
Variable manufacturing overhead .....................
Fixed manufacturing overhead .........................
Absorption costing unit product cost .................
* $300,000 ÷ 60,000 units = $5 per unit.
** $300,000 ÷ 75,000 units = $4 per unit.
*** $300,000 ÷ 40,000 units = $7.50 per unit.
Solutions Manual, Appendix 8B
$25
16
5
*5
$51
$25
16
5
**4
$50
Year 3
$25.00
16.00
5.00
***7.50
$53.50
Copyright © 2017 McGraw-Hill Education. All rights reserved.
16
Problem 8B-6 (continued)
3 b. The absorption costing income statements appears below:
Year 1
(60,000
units)
Sales ................................................................
Cost of goods sold ............................................
Gross margin ....................................................
Selling and administrative expenses ...................
Net operating income (loss)...............................
$3,360,000
3,060,000
300,000
300,000
$
0
Year 2
(50,000
units)
Year 3
(65,000 units)
$2,800,000
2,500,000
300,000
280,000
$ 20,000
$3,640,000
3,390,000
250,000
310,000
$ (60,000)
Cost of goods sold computations:
Year 1: 60,000 units × $51 per unit = $3,060,000
Year 2: 50,000 units × $50 per unit = $2,500,000
Year 3: (25,000 × $50 per unit) + (40,000 × $53.50 per unit) = $3,390,000
4.
Year 1
Year 2
Year 3
Units sold ........................................................................
Break-even point in units ..................................................
Units above (below) break-even point ...............................
60,000
60,000
0
50,000
60,000
(10,000)
65,000
60,000
5,000
Variable costing net operating income (loss) ......................
Absorption costing net operating income (loss) ..................
$0
$0
$(80,000)
$ 20,000
$ 40,000
$(60,000)
The absorption costing net operating incomes in years 2 and 3 are counterintuitive. In year 2, the number of units
sold is below the break-even point; however, absorption costing reports a net operating income greater than zero. In year
3, the number of units sold is above the break-even point; however, absorption costing reports a negative net operating
income (loss).
Solutions Manual, Appendix 8B
Copyright © 2017 McGraw-Hill Education. All rights reserved.
17
Problem 8B-7 (30 minutes) (LO3 CC13B, 14B)
1. The unit product cost under the variable costing is computed as follows:
Direct materials ...............................................
Direct labour ...................................................
Variable manufacturing overhead .....................
Variable costing unit product cost .....................
$ 8
10
2
$20
With this figure, the variable costing income statements can be prepared:
Year 1
(20,000
units)
Sales (@ $50 per unit) ...........................................
Variable expenses:
Variable cost of goods sold @ $20 per unit ...........
Variable selling and administrative @ $3 per unit ..
Total variable expenses ..........................................
Contribution margin ...............................................
Fixed expenses:
Fixed manufacturing overhead .............................
Fixed selling and administrative ...........................
Total fixed expenses ...............................................
Net operating income (loss) ....................................
Year 2
(30,000 units)
$1,000,000
$1,500,000
400,000
60,000
460,000
540,000
600,000
90,000
690,000
810,000
350,000
250,000
600,000
$ (60,000)
350,000
250,000
600,000
$ 210,000
2. The reconciliation of absorption and variable costing follows:
Year 1
Variable costing net operating income (loss) ............
Add (deduct) fixed manufacturing overhead
deferred in (released from) inventory under
absorption costing (5,000 units × $14 per unit in
Year 1; 5,000 units × $14 per unit in Year 2)........
Absorption costing net operating income .................
Solutions Manual, Appendix 8B
Year 2
$(60,000)
$210,000
70,000
$ 10,000
(70,000)
$140,000
Copyright © 2017 McGraw-Hill Education. All rights reserved.
18
Problem 8B-8 (45 minutes) (LO3 CC13B, 14B)
1. a. and b.
Direct materials ..............................................
Variable manufacturing overhead .....................
Fixed manufacturing overhead
($240,000 ÷ 4,000 units produced) ..............
Unit product cost ............................................
Absorption
Costing
Variable
Costing
$ 86
4
$86
4
60
$150
—
$90
2. Absorption costing income statement:
Sales (3,200 units × $250 per unit)...................................
Cost of goods sold (3,200 units × $150 per unit) ...............
Gross margin ...................................................................
Selling and administrative expenses
(15% × $800,000 + $160,000) ......................................
Net operating income .......................................................
$800,000
480,000
320,000
280,000
$ 40,000
3. Variable costing income statement:
Sales (3,200 units × $250 per unit)....................
Variable expenses:
Variable cost of goods sold (3,200 units × $90
per unit) ....................................................
Variable selling and administrative expense
($800,000 × 15%) ......................................
Contribution margin ..........................................
Fixed expenses:
Fixed manufacturing overhead ........................
Fixed selling and administrative ......................
Net operating loss .............................................
Solutions Manual, Appendix 8B
$800,000
288,000
120,000
240,000
160,000
408,000
392,000
400,000
$ (8,000)
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19
Problem 8B-8 (continued)
4. A manager may prefer to take the statement prepared under the absorption
approach in part (2), because it shows a profit for the month. As long as inventory
levels are rising, absorption costing will report higher profits than variable costing.
Notice in the situation above that the company is operating below its theoretical
break-even point [$816,327 = $400,000 ÷ ($392,000/$800,000)], but yet reports a
profit under the absorption approach. The ethics of this approach are debatable.
5. Variable costing net operating loss ......................................................
Add fixed manufacturing overhead cost deferred in inventory under
absorption costing (800 units × $60 per unit)...................................
Absorption costing net operating income .............................................
Solutions Manual, Appendix 8B
$ (8,000)
48,000
$40,000
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20
Problem 8B-9 (45 minutes) (LO3 CC13B, 14B)
Absorption
Costing
1. a. and b.
Direct materials ..............................................
Direct labour ..................................................
Variable manufacturing overhead .....................
Fixed manufacturing overhead
($240,000 ÷ 30,000 units produced) ............
Unit product cost ............................................
Variable
Costing
$ 6
12
4
$ 6
12
4
8
$30
—
$22
2.
May
Sales......................................................................
Variable expenses:
Variable cost of goods sold @ $22 per unit ............
Variable selling and administrative expense @ $3
per unit ............................................................
Total variable expenses ...........................................
Contribution margin ................................................
Fixed expenses:
Fixed manufacturing overhead..............................
Fixed selling and administrative expenses..............
Total fixed expenses ...............................................
Net operating income (loss) ....................................
$1,040,000
$1,360,000
572,000
748,000
78,000
650,000
390,000
102,000
850,000
510,000
240,000
180,000
420,000
$ (30,000)
3.
May
Variable costing net operating income (loss) ............
Add fixed manufacturing overhead cost deferred in
inventory under absorption costing (4,000 units ×
$8 per unit) ........................................................
Deduct fixed manufacturing overhead cost released
from inventory under absorption costing (4,000
units × $8 per unit) ............................................
Absorption costing net operating income .................
Solutions Manual, Appendix 8B
June
$ (30,000)
240,000
180,000
420,000
$ 90,000
June
$ 90,000
32,000
$
2,000
(32,000)
$ 58,000
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21
Problem 8B-9 (continued)
4. As shown in the reconciliation in part (3) above, $32,000 of fixed manufacturing
overhead cost was deferred in inventory under absorption costing at the end of May,
because $8 of fixed manufacturing overhead cost “attached” to each of the 4,000
unsold units that went into inventory at the end of that month. This $32,000 was
part of the $420,000 total fixed cost that has to be covered each month in order for
the company to break even. Because the $32,000 was added to the inventory
account, and thus did not appear on the income statement for May as an expense,
the company was able to report a small profit for the month even though it sold less
than the break-even volume of sales. In short, only $388,000 of fixed cost
($420,000 – $32,000) was expensed for May, rather than the full $420,000, as
contemplated in the break-even analysis. As stated in the text, this is a major
problem with the use of absorption costing internally for management purposes. The
method does not harmonize well with the principles of cost-volume-profit analysis,
and can result in data that are unclear or confusing.
Solutions Manual, Appendix 8B
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22
Problem 8B-10 (60 minutes) (LO3 CC13B, 14B)
1. a. Absorption costing unit product cost is:
Direct materials .....................................................
Direct labour .........................................................
Variable manufacturing overhead ............................
Fixed manufacturing overhead
($75,000 ÷ 50,000 units produced) .....................
Absorption costing unit product cost .......................
$1.00
0.80
0.20
1.50
$3.50
b. The absorption costing income statement is:
Sales (40,000 units) ..............................................................
Cost of goods sold (40,000 units × $3.50 per unit) .................
Gross margin ........................................................................
Selling and administrative expenses
($20,000 + 40,000 units × $0.75 per unit) ..........................
Net operating income ............................................................
$200,000
140,000
60,000
50,000
$ 10,000
c. The reconciliation is as follows:
Variable costing net operating loss .........................................
Add fixed manufacturing overhead cost deferred in inventory
under absorption costing
(10,000 units × $1.50 per unit) ..........................................
Absorption costing net operating income ................................
$ (5,000)
15,000
$ 10,000
2. Under absorption costing, the company did earn a profit for the month. However,
before the question can really be answered, one must first define what is meant by
a “profit.” The central issue here relates to timing of release of fixed manufacturing
overhead costs to expense. Advocates of variable costing would argue that all such
costs should be expensed immediately, and that no profit is earned unless the
revenues of a period are sufficient to cover the fixed manufacturing overhead costs
in full. From this point of view, then, no profit was earned during the month,
because the fixed costs were not fully covered.
Solutions Manual, Appendix 8B
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23
Problem 8B-10 (continued)
Advocates of absorption costing would argue, however, that fixed manufacturing
overhead costs attach to units of product as they are produced, and that such costs
do not become expense until the units are sold. Therefore, if the selling price of a
unit is greater than the unit cost (including a proportionate amount of fixed
manufacturing overhead), then a profit is earned even if some units produced are
unsold and carry some fixed manufacturing overhead with them to the following
period. A difficulty with this argument is that “profits” will vary under absorption
costing depending on how many units are added to or taken out of inventory. That
is, profits will depend not only on sales, but on what happens to inventories. In
particular, profits can be consciously manipulated by increasing or decreasing a
company’s inventories.
3. a. The variable costing income statement is:
Sales (60,000 units × $5 per unit) .............................
Variable expenses:
Variable cost of goods sold
(60,000 units × $2 per unit) ................................
Variable selling and administrative expenses
(60,000 units × $0.75 per unit) ...........................
Contribution margin ..................................................
Fixed expense:
Fixed manufacturing overhead ................................
Fixed selling and administrative expense .................
Net operating income ................................................
Solutions Manual, Appendix 8B
$300,000
$120,000
45,000
75,000
20,000
165,000
135,000
95,000
$ 40,000
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24
Problem 8B-10 (continued)
b. The absorption costing income statement would be constructed as follows:
The absorption costing unit product cost will remain at $3.50, the same as in
part (1).
Sales (60,000 units × $5 per unit) ..............................................
Cost of goods sold (60,000 units × $3.50 per unit) ......................
Gross margin .............................................................................
Selling and administrative expenses
(60,000 units × $0.75 per unit + $20,000) ...............................
Net operating income .................................................................
$300,000
210,000
90,000
65,000
$ 25,000
c. The reconciliation is as follows:
Variable costing net operating income .........................................
Deduct fixed manufacturing overhead cost released from
inventory under absorption costing (10,000 units × $1.50 per
unit) ......................................................................................
Absorption costing net operating income .....................................
Solutions Manual, Appendix 8B
$ 40,000
15,000
$ 25,000
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25
Problem 8B-11 (75 minutes) (LO3 CC13B, 14B)
1.
Year 1
Year 2
Year 3
Unit sales ...........................................
50,000
40,000
50,000
Sales..................................................
Variable expenses:
Variable cost of goods sold @ $4 per
unit..............................................
Variable selling and administrative @
$2 per unit ...................................
Total variable expenses .......................
Contribution margin ............................
Fixed expenses:
Fixed manufacturing overhead..........
Fixed selling and administrative ........
Total fixed expenses ...........................
Net operating income (loss) ................
$1,000,000
$ 800,000
$1,000,000
200,000
160,000
200,000
100,000
300,000
700,000
80,000
240,000
560,000
100,000
300,000
700,000
Solutions Manual, Appendix 8B
600,000
70,000
670,000
$ 30,000
600,000
70,000
670,000
$(110,000)
600,000
70,000
670,000
$ 30,000
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26
Problem 8B-11 (continued)
2. a.
Year 1
Variable manufacturing cost .....................
Fixed manufacturing cost:
$600,000 ÷ 50,000 units .......................
$600,000 ÷ 60,000 units .......................
$600,000 ÷ 40,000 units .......................
Absorption costing unit product cost .........
b. Variable costing net operating income
(loss) ...................................................
Add (deduct) fixed manufacturing
overhead cost deferred in (released
from) inventory from Year 2 to Year 3
under absorption costing (20,000 units
× $10 per unit) .....................................
Add fixed manufacturing overhead cost
deferred in inventory from Year 3 to the
future under absorption costing (10,000
units × $15 per unit).............................
Absorption costing net operating income
(loss) ...................................................
$ 4
Year 2
Year 3
$ 4
$ 4
12
10
$16
$14
15
$19
$30,000
$(110,000)
$ 30,000
200,000
(200,000)
150,000
$30,000
$ 90,000
$(20,000)
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 fixed
manufacturing overhead cost deferred in inventory for the year, more than offset the
loss of revenue. The net result is that the company’s net operating income
increased.
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
3’s 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 were sold as in Year 1.
Solutions Manual, Appendix 8B
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27
Problem 8B-11 (continued)
5. a. With lean production, production would have been geared to sales in each year
so that little or no inventory of finished goods would have been built up in either
Year 2 or Year 3.
b. If lean production had been in use, the net operating income under absorption
costing would have been the same as under variable costing in all three years.
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. If the predetermined overhead rate is
based on 50,000 units in each year, the income statements under absorption
costing would have appeared as follows:
Year 1
Year 2
Year 3
Unit sales .........................................
50,000
40,000
50,000
Sales ................................................
Cost of goods sold:
Cost of goods manufactured @ $16
per unit ......................................
Add underapplied overhead ............
Cost of goods sold ............................
Gross margin ....................................
Selling and administrative expenses ...
Net operating income (loss) ...............
$1,000,000
$ 800,000
$1,000,000
800,000
800,000
200,000
170,000
$ 30,000
640,000 *
120,000 **
760,000
40,000
150,000
$(110,000)
800,000
800,000
200,000
170,000
$ 30,000
* 40,000 units × $16 per unit = $640,000.
** 10,000 units not produced × $12 per unit fixed manufacturing overhead cost =
$120,000 fixed manufacturing overhead cost not applied to products.
Solutions Manual, Appendix 8B
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28
Problem 8B-12 (30 minutes) (LO3 CC13B, 14B)
1. Because of soft demand for the Australian Division’s product, the inventory should
be drawn down to the minimum level of 1,500 units. Drawing inventory down to the
minimum level would require production as follows during the last quarter:
Desired inventory, December 31 .......................
Expected sales, last quarter .............................
Total needs .....................................................
Less inventory, September 30 ..........................
Required production ........................................
1,500
18,000
19,500
12,000
7,500
units
units
units
units
units
This plan would save inventory carrying costs such as storage (rent, insurance),
interest, and obsolescence.
The number of units scheduled for production will not affect the reported net
operating income or loss for the year if variable costing is in use. All fixed
manufacturing overhead cost will be treated as an expense of the period regardless
of the number of units produced. Thus, no fixed manufacturing overhead cost will
be shifted between periods through the inventory account and income will be a
function of the number of units sold, rather than a function of the number of units
produced.
2. To maximize the Australian Division’s operating income, Mr. Constantinos could
produce as many units as storage facilities will allow. By building inventory to the
maximum level, Mr. Constantinos will be able to defer a portion of the year’s fixed
manufacturing overhead costs to future years through the inventory account, rather
than having all of these costs appear as charges on the current year’s income
statement. Building inventory to the maximum level of 30,000 units would require
production as follows during the last quarter:
Desired inventory, December 31 .......................
Expected sales, last quarter .............................
Total needs .....................................................
Less inventory, September 30 ..........................
Required production ........................................
Solutions Manual, Appendix 8B
30,000
18,000
48,000
12,000
36,000
units
units
units
units
units
Copyright © 2017 McGraw-Hill Education. All rights reserved.
29
Problem 8B-12 (continued)
Thus, by producing enough units to build inventory to the maximum level that
storage facilities will allow, Mr. Constantinos could relieve the current year of fixed
manufacturing overhead cost and thereby maximize the current year’s net operating
income.
3. By setting a production schedule that will maximize his division’s net operating
income—and maximize his own bonus—Mr. Constantinos will be acting against the
best interests of the company as a whole. The extra units aren’t needed and will be
expensive to carry in inventory. Moreover, there is no indication that demand will be
any better next year than it has been in the current year, so the company may be
required to carry the extra units in inventory a long time before they are ultimately
sold.
The company’s bonus plan undoubtedly is intended to increase the company’s
profits by increasing sales and controlling expenses. If Mr. Constantinos sets a
production schedule as shown in part (2) above, he will obtain his bonus as a result
of producing rather than as a result of selling. Moreover, he will obtain it by creating
greater expenses—rather than fewer expenses—for the company as a whole.
In sum, producing as much as possible so as to maximize the division’s net
operating income and the manager’s bonus would be unethical because it subverts
the goals of the overall organization.
Solutions Manual, Appendix 8B
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30
Chapter 9
Relevant Costs: The KeytoDecision Making
Solutions to Questions
9-1
A relevant cost in a decision is a cost
that differs between alternatives.
9-2
An incremental cost (or revenue) is the
change in cost (or revenue) that will result from
some proposed action. An opportunity cost is
the benefit that is lost or sacrificed in rejecting
some course of action. A sunk cost is a cost that
has already been incurred, and that cannot be
changed by any future decision.
9-3
No. Variable costs are relevant costs
only if they differ between the alternatives under
consideration.
9-4
The original cost of a machine that the
company already owns is a sunk cost that
cannot differ between alternatives, and hence
cannot be a relevant cost.
9-5
No. Not all fixed costs are sunk—only
those for which a cost outlay has already been
made. A variable cost can be a sunk cost, if it
has already been incurred.
9-6
No. A variable cost is a cost that varies
in total amount in direct proportion to changes
in the level of activity. A differential cost
measures the difference in cost between two
alternatives. A variable cost could be the same
between two alternatives and thus is not a
differential cost.
9-7
No. Only those future costs that differ
between the alternatives under consideration
are relevant costs in decisions.
9-8
Only those costs that can be avoided as
a result of dropping the product line are relevant
in the decision. Sunk costs and costs that will
not differ regardless of whether the line is
retained or discontinued are irrelevant.
Solutions Manual, Chapter 9
9-9
No. If a product line shows a loss it may
be the result of allocated common costs or of
sunk costs that will continue even if the product
line were eliminated. A product line should be
discontinued only if the contribution margin that
will be lost as a result of dropping the line is less
than the fixed costs that can be avoided. Even
then there may be arguments in favour of
retaining the product line if its presence
promotes the sale of other products.
9-10 The danger is that such allocations can
make a product line (or other segment of an
organization) appear to be unprofitable,
whereas in fact the line may be profitable.
9-11 If a company decides to make a part
internally rather than to buy it from an outside
supplier, then a portion of the company’s
facilities has to be turned over to the production
of the part. The company’s opportunity cost is
measured by the benefits that could be derived
from the best alternative use of the facilities.
9-12 There are many possible examples of
constraints including: machine time, direct
labour time, floor space, raw materials,
investment capital, supervisory time, computer
time, and storage space.
9-13 Assuming no change in fixed costs,
profits are maximized when total contribution
margin is maximized. A firm can maximize its
contribution margin by focusing on those
products that promise the greatest amount of
contribution margin per unit of the constrained
resource.
9-14 Most costs of a flight are either sunk
costs, or costs that will not change regardless of
the number of passengers present.
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1
Depreciationof the aircraft, salaries of personnel
on the ground and in the air, and fuel costs, for
example, are largely a function of making the
flight itself rather than a function of the number
of persons occupying seats. Therefore, adding
more passengers at reduced fares at certain
times of the week (usually during “off times”
when seats otherwise would go unoccupied)
does little to increase the total costs of making
the flight, but can do much to increase the total
contribution.
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2
Introduction to Managerial Accounting,Fifth Canadian Edition
The Foundational 15 (LO1 – CC1, 3, 4, 5; LO2 – CC8)
9-1. The total traceable fixed manufacturing overhead for Alpha and Beta is computed
as follows:
Traceable fixed overhead per unit (a) ....................
Level of activity in units (b) ..................................
Total traceable fixed overhead (a) × (b) ................
9-2.
Alpha
Beta
$16
100,000
$1,600,000
$18
100,000
$1,800,000
The total common fixed expenses is computed as follows:
Common fixed expenses per unit (a) .....................
Level of activity in units (b) ..................................
Total common fixed expenses (a) × (b).................
Alpha
Beta
$15
100,000
$1,500,000
$10
100,000
$1,000,000
The company’s total common fixed expenses would be $2,500,000.
9-3.
The profit impact is computed as follows:
Per
Unit
Incremental revenue ......................................
Incremental costs:
Variable costs:
Direct materials ........................................
Direct labor ..............................................
Variable manufacturing overhead ..............
Variable selling expenses ..........................
Total variable cost .......................................
Incremental net operating income ...................
Solutions Manual, Chapter 9
Total
10,000 units
$80
$800,000
30
20
7
12
$69
300,000
200,000
70,000
120,000
690,000
$110,000
Copyright © 2017 McGraw-Hill Education. All rights reserved.
3
The Foundational 15 (continued)
9-4.
The profit impact is computed as follows:
Per
Unit
Incremental revenue ......................................
Incremental costs:
Variable costs:
Direct materials ........................................
Direct labor ..............................................
Variable manufacturing overhead ..............
Variable selling expenses ..........................
Total variable cost .......................................
Incremental net operating income ...................
9-5.
Total
5,000 units
$39
$195,000
12
15
5
8
$40
60,000
75,000
25,000
40,000
200,000
$ (5,000)
The profit impact is computed as follows:
Incremental revenue
(10,000 units × $80) (a) .......................................................
Incremental variable costs:
Direct materials (5,000 units × $30) ................................
$150,000
Direct labor (5,000 units × $20) ................................
100,000
Variable manufacturing overhead
35,000
(5,000 units × $7) ..........................................................
Variable selling expenses
(5,000 units × $12) ........................................................
60,000
Total incremental variable cost (b) ................................
Foregone sales to regular customers (5,000
units × $120) (c) ................................................................
Incremental net operating income
(a) − (b) – (c) ................................................................
$800,000
345,000
600,000
$(145,000)
Note to instructors: Emphasize to students that the incremental production is 5,000
units only. However, 10,000 units will be sold @$80 per unit to the new customers
but this will also reduce sales to regular customers by 5,000 units (@$120 per unit).
Therefore, the relevant variable costs are for 5,000 units only.
Copyright © 2017 McGraw-Hill Education. All rights reserved.
4
Introduction to Managerial Accounting,Fifth Canadian Edition
The Foundational 15 (continued)
9-6.
The profit impact of dropping the Beta product line is computed as follows:
Contribution margin lost if the Beta product line is dropped* ........
Traceable fixed manufacturing overhead .....................................
Decrease in net operating income if Beta is dropped ..........
$(3,600,000)
1,800,000
$(1,800,000)
* Beta’s contribution margin per unit is $40 ($80 − $40). Therefore, the decrease in
contribution margin if Beta is dropped would be $3,600,000 (90,000 units × $40).
Note to instructors: Emphasize that the traceable fixed manufacturing overhead is
avoidable and the common fixed expenses are not.
9-7.
The profit impact of dropping the Beta product line is computed as follows:
Contribution margin lost if the Beta product line is dropped* .........
Traceable fixed manufacturing overhead ......................................
Increase in net operating income if Beta is dropped ...........
$(1,600,000)
1,800,000
$ 200,000
* Beta’s contribution margin per unit is $40 ($80 − $40). Therefore, the decrease in
contribution margin if Beta is dropped would be $1,600,000 (40,000 units × $40).
9-8.
The profit impact of dropping the Beta product line is computed as follows:
Contribution margin lost if the Beta product line is dropped ...........
Traceable fixed manufacturing overhead ......................................
Contribution margin on additional Alpha sales* ...........................
Increase in net operating income if Beta is dropped ...........
$(2,400,000)
1,800,000
765,000
$ 165,000
* Alpha’s contribution margin per unit is $51 ($120 − $69). Therefore, the increase
in Alpha’s contribution margin if Beta is dropped would be $765,000 (15,000 units ×
$51).
Solutions Manual, Chapter 9
Copyright © 2017 McGraw-Hill Education. All rights reserved.
5
The Foundational 15 (continued)
9-9.
The profit impact of buying 80,000 Alphas from a supplier rather than making
them is computed as follows:
Make
Cost of purchasing (80,000 units × $80) ...................
Direct materials (80,000 units × $30) .......................
Direct labor (80,000 units × $20) .............................
Variable manufacturing overhead
(80,000 units × $7) ..............................................
Traceable fixed manufacturing overhead ...................
Total costs ...............................................................
Buy
$6,400,000
$2,400,000
1,600,000
560,000
1,600,000
$6,160,000
Difference in favor of continuing to
make the Alphas ................................
$6,400,000
$240,000
Note to instructors: Emphasize that the variable selling expenses are irrelevant to
this decision because they will be incurred regardless of whether the company
makes or buys its Alphas.
9-10. The profit impact of buying 50,000 Alphas from a supplier rather than making
them is computed as follows:
Make
Cost of purchasing (50,000 units × $80) ...................
Direct materials (50,000 units × $30) .......................
Direct labor (50,000 units × $20)..............................
Variable manufacturing overhead
(50,000 units × $7) ..............................................
Traceable fixed manufacturing overhead ...................
Total costs ...............................................................
Difference in favor of buying
Alphas from the supplier ...................
Buy
$4,000,000
$1,500,000
1,000,000
350,000
1,600,000
$4,450,000
$4,000,000
$450,000
Note to instructors: Emphasize that the variable selling expenses are irrelevant to
this decision because they will be incurred regardless of whether the company
makes or buys its Alphas.
Copyright © 2017 McGraw-Hill Education. All rights reserved.
6
Introduction to Managerial Accounting,Fifth Canadian Edition
The Foundational 15 (continued)
9-11. The pounds of raw material per unit are computed as follows:
Direct material cost per unit (a) .........................................
Cost per pound of direct materials (b) ................................
Pounds of direct materials per unit (a) ÷ (b) .......................
Alpha
Beta
$30
$6
5
$12
$6
2
9-12. The contribution margins per pound of raw materials are computed as follows:
Selling price per unit..........................................
Variable cost per unit.........................................
Contribution margin per unit (a) .........................
Pounds of direct material required to produce
one unit (b) ...................................................
Contribution margin per pound (a) ÷ (b) ............
Alpha
Beta
$120
69
$ 51
$80
40
$40
5 pounds
$10.20
2 pounds
$20.00
9-13. The optimal number of units to produce would be computed as follows:
Product
Beta ..........................................
Alpha.........................................
Total pounds available ................
Pounds
Per Unit
2
5
Units
Produced
60,000
8,000
Total
Pounds
120,000
40,000
160,000
The company should produce Beta first because it earns the highest contribution
margin per pound of raw materials (as shown above in 9-12). After customer
demand for Beta has been satisfied by producing 60,000 units, there are 40,000
pounds of raw materials remaining to use for making Alphas. Since each Alpha
requires 5 pounds of raw materials, the company would be able to produce 8,000
Alphas (40,000 pounds ÷ 5 pounds per unit) before running out of raw materials.
Solutions Manual, Chapter 9
Copyright © 2017 McGraw-Hill Education. All rights reserved.
7
The Foundational 15 (continued)
9-14. The total contribution margin would be computed as follows:
Alpha
Beta
Number of units produced (a) ................................
8,000
Contribution margin per unit (b) ................................
$51
Total contribution margin (a) × (b) ................................$408,000
60,000
$40
$2,400,000
The company’s total contribution margin would be $2,808,000 ($408,000 +
$2,400,000).
9-15. The maximum price per pound is computed as follows:
Alpha
Regular direct material cost per pound ...........................................
Contribution margin per pound of direct materials ...........................
Maximum price to be paid per pound..............................................
$ 6.00
10.20
$16.20
Because the company has satisfied all demand for Betas, it would use additional
raw materials to produce Alphas.
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Introduction to Managerial Accounting,Fifth Canadian Edition
Brief Exercises
Brief Exercise9-1 (20 minutes) (LO1 CC1)
Case 1
Item
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
m.
Relevant
Case 2
Not
Relevant
Sales revenue ................................X
Direct materials ................................
X
Direct labour ................................ X
Variable manufacturing
overhead ................................ X
Depreciation— Model B100
machine ................................
Book value— Model B100
machine ................................
Disposal value— Model B100
machine ................................
Market value—Model B300
machine (cost) ................................
X
Depreciation— Model B300
machine ................................ X
Fixed manufacturing
overhead (general) ................................
X
Variable selling expense................................
Fixed selling expense................................
X
General administrative
overhead ................................ X
Relevant
Not
Relevant
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
Brief Exercise 9-2 (15 minutes) (LO1 CC2)
Cost savings if the high-speed wheel grinder is purchased:
($26,250 – $12,250 = $14,000; $14,000 × 5 years = $70,000) .......
Incremental cost:
Cost of the high-speed wheel grinder ..........................................$62,500
Less salvage from the standard wheel grinder ............................. 21,750
Net advantage of purchasing the high-speed wheel grinder .............
Solutions Manual, Chapter 9
$70,000
40,750
$29,250
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9
Brief Exercise 9-3 (15 minutes) (LO1 CC3)
Contribution margin lost if the Linen Department is dropped:
Lost from the Linen Department .............................................................. $600,000
Lost from the Hardware Department (10% × $2,100,000) ........................ 210,000
Total lost contribution margin ..................................................................... 810,000
Less fixed costs that can be avoided ($800,000 – $340,000) ........................ 460,000
Decrease in profits for the company as a whole ........................................... $350,000
Brief Exercise 9-4 (20 minutes) (LO1 CC4)
The target production level is 40,000 starters per period, as shown by the relations
between per-unit and total fixed costs.
“Cost”
Per
Differential Costs
Unit
Make
Buy
Direct materials ................................
$4.65 $4.65
Direct labour ................................
4.05
4.05
Variable
manufacturing
overhead ................................
0.90
0.90
2.25
2.25
Supervision ................................
Depreciation ................................
1.50
—
—
Rent ................................ 0.45
Outside purchase price................................
—
$12.60
Total cost ................................
$13.80 $11.85 $12.60
Explanation
Can be avoided by buying
Can be avoided by buying
Can be avoided by buying
Can be avoided by buying
Sunk Cost
Allocated Cost
The company should make the starters, rather than continuing to buy from the
outside supplier. Making the starters will result in a cost saving of $0.75 ($12.60$11.85) per starter, or a total savings of $30,000 per period:
$0.75 per starter × 40,000 starters = $30,000
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Introduction to Managerial Accounting,Fifth Canadian Edition
Brief Exercise 9-5 (20 minutes) (LO1 CC5)
1. Annual profits will increase by $24,000, as shown below
Per Unit
15,000
Units
Incremental sales ................................................................
$16.00 $240,000
Incremental costs:
Direct materials ................................................................
6.10
91,500
Direct labour ................................................................
3.80
57,000
Variable manufacturing overhead ................................
2.00
30,000
Variable selling and administrative ................................
2.50
37,500
Total incremental costs ................................................................
14.40
216,000
Incremental profits ................................................................
$ 1.60 $ 24,000
The fixed costs are not relevant to the decision, since they will be incurred
regardless of whether the special order is accepted or rejected.
2. The relevant cost figure is $2.50 (the variable selling and administrative expenses).
All other variable costs are sunk, since the units have already been produced. The
fixed costs would not be relevant, since they will not change in total regardless of
the price charged for the left-over units.
Solutions Manual, Chapter 9
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11
Brief Exercise 9-6 (20 minutes) (LO2 CC7, 8)
The company should accept orders first for C, second for A, and third for B. The
computations are:
A
(1)
(2)
(3)
(4)
(5)
B
C
Direct materials required per unit ................................
$39.60 $24.75 $14.85
Cost per kilogram ................................................................
$4.95
$4.95
$4.95
Kilograms required per unit (1) ÷ (2) ................................
8.00
5.00
3.00
Contribution margin per unit ................................
$52.80 $23.10 $34.65
Contribution margin per kilogram of
materials used (4) ÷ (3) ................................
$ 6.60 $ 4.62 $11.55
Since product C uses the least amount of material per unit of the three products, some
students may immediately assume that this is an infallible relationship. That is, they will
assume that the way to spot the most profitable product is to find the one using the
least amount of the constrained resource. The way to dispel this notion is to point out
that product A uses more material (the constrained resource) than does product B, but
yet it is preferred over product B. The key factor is not how much of a constrained
resource a product uses, but rather how much contribution margin the product
generates per unit of the constrained resource. In this example, Product C not only
uses the least amount of material but also provides the highest contribution margin per
kilogram of raw material (this may not be the case in other situations).
Brief Exercise 9-7 (10 minutes) (LO1 CC5)
The only out-of-pocket costs are the variable costs that the company will incur to
produce the 100 units of the special order. In this situation the special order will
generate a contribution margin of $300 (100 × $3 per unit). The current level of
production of 3,800 units represents 90% of the existing capacity. This means that
capacity is 4,000 units (3,800 ÷ 0.90), and therefore the company has excess capacity
equivalent to 200 units per month. The fixed costs are sunk because excess capacity
exists and no additional costs will be incurred. Moreover, there are no opportunity costs
because excess capacity exists, meaning that existing sales will not be affected. The
incremental contribution margin of $300 will increase income and therefore accepting
the special order makes sense at least from a financial point of view.
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Introduction to Managerial Accounting,Fifth Canadian Edition
Brief Exercise9-8 (5 minutes) (LO1 CC1)
Two items are not relevant:
1. Original purchase price of the storage barn
2. Allocation of administrative salaries
Brief Exercise9-9(5 minutes) (LO1 CC4)
The relevant cost of making the required part is $31 ($15 + $12 + $4) per unit, which
is lower than the outside supplier’s offer of $36 per unit.
Brief Exercise 9-10 (10 minutes) (LO3 CC11)
Evamantium should be processed further into adamantium:
Sales value after further processing .............................
Sales value at the split-off point ...................................
Incremental revenue from further processing ...............
Cost of further processing ...........................................
Profit from further processing ......................................
$60,000
40,000
20,000
13,000
$ 7,000
The $10,000 in allocated common costs (1/3 × $30,000) will be the same regardless of
which alternative is selected, and hence is not relevant to the decision.
Solutions Manual, Chapter 9
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13
Exercises
Exercise 9-1 (30 minutes)(LO1 CC1)
1. The relevant costs of a hunting trip would be:
Travel expense (100 kilometres @ $0.07 per
kilometre)................................................................ $ 7
Shotgun shells ................................................................ 20
One bottle of Old Grandad .............................................................
8
Total ............................................................................................
$35
This answer assumes that Bill would not be drinking the bottleof Old Grandad
anyway. It also assumes that the resale values of the camper, pickup truck, and boat
are not affected by taking one more hunting trip.
The money lost in the poker game is not relevant because Bill would have played
poker even if he did not go hunting. He plays poker every weekend.
The other costs are sunk at the point at which the decision is made to go on another
hunting trip.
2. If Bill gets lucky and bags another two ducks using the same two boxes of shotgun
shells, all of his costs are likely to be the same as they were on his last trip. All of
the costs, are basically fixed with respect to how many ducks are actually bagged
during any one hunting trip.Therefore, it really does not cost him anything to shoot
the last two ducks.
3. In a decision of whether to give up hunting entirely, more of the costs listed by John
are relevant. If Bill did not hunt, he would not need to pay for: gas, oil, and tires;
shotgun shells; the hunting license; and the bottlesof Old Grandad. In addition, he
would be able to sell his camper, equipment, boat, and possibly pickup truck, the
proceeds of which would be considered relevant in this decision. The original costs
of these items are not relevant, but their resale values are 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 costsis relevant when we
compute the cost of bagging an extra duck in a hunting trip; some of them are
relevant when we compute the cost of a hunting trip; and more of them are relevant
when we consider the possibility of giving up hunting.
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14
Introduction to Managerial Accounting,Fifth Canadian Edition
Exercise 9-2 (30 minutes) (LO1 CC1)
$0.10
1. Fixed cost per kilometre ($7,250* ÷ 72,500 kilometres) ..................
Variable cost per kilometre ............................................................
0.10
Average cost per kilometre ............................................................
$0.20
$2,320.00
* Insurance ................................................................
Licenses ................................................................
362.50
Taxes................................................................
217.50
Garage rent ................................
1,740.00
Depreciation ................................ 2,610.00
Total ................................................................
$7,250.00
This answer assumes the resale value of the truck does not decline because of the
wear and tear that comes with use.
2. The insurance, the licenses, and the variable costs (gasoline, oil, tires, and repairs)
would all be relevant to the decision, since these costs are avoidable by not using
the truck. (However, the owner of the garage might insist that the truck be insured
and licensed if it is left in the garage. In that case, the insurance and licensing costs
would not be relevant since they would be incurred regardless of the decision.) The
taxes would not be relevant, since they must be paid regardless of use; the garage
rent would not be relevant, since it must be paid to park the truck; and the
depreciation would not be relevant, since it is a sunk cost. However, any decrease in
the resale value of the truck due to its use would be relevant.
3. Only the variable costs of $0.10 would be relevant, since they are the only costs that
can be avoided by having the delivery done commercially. The total variable costs
that can be avoided must be compared with the cost of having it commercially
delivered.
4. In this case, only the fixed costs associated with the second truck would be relevant.
The variable costs would not be relevant, since they would not differ between
having one or two trucks. (Students are inclined to think that variable costs are
always relevant in decision-making, and to think that fixed costs are always
irrelevant. This requirement helps to dispel that notion.)
Solutions Manual, Chapter 9
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15
Exercise 9-3 (30 minutes) (LO1 CC3)
No, the bilge pump product line should not be discontinued. The computations are:
Contribution margin lost if the line is dropped ................................
Fixed costs that can be avoided:
Advertising ................................................................ €290,000
Salary of the product line manager ................................ 38,000
Insurance on inventories ............................................................
18,000
Net disadvantage of dropping the line ................................
€(550,000)
346,000
€(204,000)
The same solution can be obtained by preparing comparative income statements:
Keep
Product
Line
Drop
Product
Line
Sales ................................................................€950,000
€ -0Less variable expenses:
Variable manufacturing expenses ................................
340,000
-0Sales commissions ................................................................
46,000
-0Shipping ................................................................
14,000
-0Total variable expenses ................................
400,000
-0Contribution margin ................................................................
550,000
-0Less fixed expenses:
Advertising ................................................................
290,000
-0Depreciationof equipment................................ 90,000
90,000
General factory overhead ................................ 115,000
115,000
Salary of product line manager ................................
38,000
-0Insurance on inventories ................................ 18,000
-0Purchasing department expenses ................................
65,000
65,000
Total fixed expenses ................................................................
616,000
270,000
Net operating loss ................................................................
€ (66,000) €(270,000)
Difference:
Net Income
Increase or
(Decrease)
€(950,000)
340,000
46,000
14,000
400,000
(550,000)
290,000
-0-038,000
18,000
-0346,000
€(204,000)
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Introduction to Managerial Accounting,Fifth Canadian Edition
Exercise 9-4 (20 minutes) (LO1 CC4)
The costs that are relevant in a make-or-buy decision are those costs that can be
avoided as a result of purchasing from the outside. The analysis for this exercise is:
Per Unit Differential
Costs
Make
Buy
Cost of purchasing ................................
Cost of making:
Direct materials ................................
$ 6.66
Direct labour................................
18.50
Variable overhead ................................
4.44
Fixed overhead ................................
5.55 *
Total cost ................................$35.15
55,500 Units
Make
Buy
$38.85
$38.85
$2,156,175
$ 369,630
1,026,750
246,420
308,025
$1,950,825
$2,156,175
* The remaining $11.10 of fixed overhead cost is not relevant, since it will be
incurred regardless of whether the company makes or buys the parts.
The $148,000 rental value of the space being used to produce part S-6 represents an
opportunity cost of continuing to produce the part internally. Thus, the completed
analysis would be:
Make
Total cost, as above ................................................................
$1,950,825
Rental value of the space (opportunity cost) ................................
Total cost, including opportunity cost ................................ $1,950,825
Buy
$2,156,175
(148,000)
$2,008,175
Net advantage in favour of making ................................................ $57,350
Solutions Manual, Chapter 9
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17
Exercise 9-5 (30 minutes) (LO1 CC5)
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 Unit
Total for 20
Bracelets
Incremental revenue ................................................................
$169.95
$3,399.00
Incremental costs:
Variable costs:
Direct materials ................................................................
$ 84.00
1,680.00
Direct labour ................................................................
45.00
900.00
Variable manufacturing overhead ................................
8.00
160.00
Special filigree ................................................................
2.00
40.00
Total variable cost ................................................................
$139.00
2,780.00
Fixed costs:
Purchase of special tool ................................
250.00
Total incremental cost ................................................................
3,030.00
Incremental net operating income................................
$ 369.00
Even though the price for the special order is below the company's regular price for
such an item, the special order would add to the company's 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. Although it is stated that this order will not affect regular sales, the company
must be sure that this will indeed be the case.
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Introduction to Managerial Accounting,Fifth Canadian Edition
Exercise 9-6 (30 minutes) (LO2CC7, 8)
1.
A
(1)
(2)
(3)
(4)
(5)
B
C
Contribution margin per unit .........................................................
$27
$54
$30
Direct material cost per unit ..........................................................
$12
$36
$16
Direct material cost per kilogram ...................................................
$4
$4
$4
Kilos of material required per unit (2) ÷ (3) ................................
3
9
4
Contribution margin per kilogram (1) ÷ (4) ................................
$9
$6 $7.50
2. The company should concentrate its available material on product A:
A
B
Contribution margin per kilo (above) ................................
$
9
$
6
Kilogramsof material available................................ × 5,000
× 5,000
Total contribution margin...............................................................
$45,000
$30,000
C
$ 7.50
× 5,000
$37,500
Although product A has the lowest contribution margin per unit and the second
lowest contribution margin ratio, it is preferred over the other two products since it
has the greatest amount of contribution margin per kilogramof material, which is the
company’s constrained resource.
3. The price Barlow Company would be willing to pay per kilogram for additional raw
materials depend on how the materials would be used. If there are unfilled orders
for all of the products, Barlow would presumably use the additional raw materials to
make more of product A. Each kilogram of raw materials used in product A
generates $9 of contribution margin over and above the usual cost of raw materials.
Therefore, Barlow should be willing to pay up to $13 per kilogram ($4 usual price
plus $9 contribution margin per kilogram) for the additional raw material, but would
of course prefer to pay far less. The upper limit of $13 per kilogram to manufacture
more of product A signals to managers how valuable additional raw materials are to
the company.
If all of the orders for product A have been filled, Barlow Company would use
additional raw materials to manufacture product C. The company should be willing
to pay up to $11.50 per kilogram ($4 usual price plus $7.50 contribution margin per
kilogram) for the additional raw materials to manufacture more product C, and up to
$10 per kilogram ($4 usual price plus $6 contribution margin per kilogram) to
manufacture more product B if all of the orders for product C have been filled as
well.
Solutions Manual, Chapter 9
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19
Exercise 9-7 (30 minutes) (LO1 CC4)
1.
100,000 packs
Per unit Make
Purchase
$1.80
$
Direct materials
$1.00
Direct labour
Variable overhead
Buy
-
Difference
$180,000
$180,000
$100,000
$
-
$(100,000)
$0.40
$40,000
$
-
$( 40,000)
$0.25
$ 25,000
$
-
$ (25,000)
Fixed overhead (lease costs)
$ 12,000
$
-
$ (12,000)
Common costs
$ 35,000
$35,000
$
-
Total costs
$212,000
$215,000
$
3,000
It will cost the company more to buy than to continue to make. Based simply on the
financial analysis shown above, the company should continue to make.
2.
Let x be the point of indifference (i.e., the point at which the company will likelybe
indifferent between making and buying the golfballs).
This is the point at which the relevant costs willbe the same, and can be computed as
follows:
Buy:
$1.80 × x or $1.80x
Make: $1.65x + $12,000 (fixed cost of leasing the machine)
$1.80x= $1.65x + $12,000
Therefore, ($1.80x - $1.65x)
x
= $12,000
= $12,000 ÷ $0.15 ≈ 80,000packs
The point of indifference is that volume at which relevant costs of making and buying
from an outside supplier will be the same. When the volume increases (decreases)
beyond (below) 80,000 packs the cost of manufacturing per pack will decrease
(increase) because fixed costs will spread over a larger (smaller) production quantity.
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Introduction to Managerial Accounting,Fifth Canadian Edition
Exercise 9-7 (continued)
3. Factors that GI should consider before making the final decision:
 Quality of the balls as well as uninterrupted and on-time delivery from the
supplier.
 Price guarantee from the supplier (this is a critical assumption because the above
financial analysis is based on the cost and price remaining steady).
 The opportunity to use the freed up resources. It is important, however, to note
that the freed up resources do not include the machine specifically leased for
manufacturing the golf balls.
Solutions Manual, Chapter 9
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21
Exercise 9-8 (25 minutes) (LO1 CC3)
KEEP
ACCESORIESPRODUCT LINE
DROP ACCESORIES
PRODUCT LINE
Sales
$2,800,000
$
-
Less: variable expenses
$1,200,000
$
-
Contribution margin
$1,600,000
$
-
Less: fixed costs
Wages
$1,100,000
Insurance on inventory
$ 60,000
Advertising
$600,000
Net operating income
Alternative method:
Loss of contribution margin
Savings:
Wages
Insurance on inventory
Advertising
Increase (decrease) in operating income
$80,000
$1,760,000
$(160,000)
$
-
$
-
$ 80,000
$(80,000)
$(1,600,000)
$1,020,000
60,000
600,000
1,680,000
$80,000
Based on this analysis, the Ladies Accessories product linemaybe dropped because the
overall company net operating income would increase by $80,000.
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Introduction to Managerial Accounting,Fifth Canadian Edition
Exercise 9-9 (20 minutes) (LO1 CC4)
500 units
Per unit
Purchase
$45.00
Variable cost
$28.00
Make
$
Buy
Difference
- $ 22,500
$(22,500)
$14,000
$ 14,000
Fixed manufacturing overhead
$ 4,250 $
2,125
Common costs
$ 6,560 $
6,560
Total costs
$24,810 $ 31,185
$
2,125
$
-
$(6,375)
Alternative solution using only the relevant information:
Outside purchase price for 500 units
Relevant costs of internal production:
Variable cost
$14,000
Traceable fixed manufacturing overhead 2,125
Total relevant costs for 500 units
Difference in favour of making the part
$22,500
$16,125
$ 6,375
Based on this analysis, the company is better off if it continues to manufacturethis part
internally.
Solutions Manual, Chapter 9
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23
Exercise 9-10 (15 minutes) (LO3 CC11)
1. The data that are relevant to this analysis are the price of milk, the price of butter and
the costs of further processing milk into butter. The cost of processing up to the point
when milk is identified as a separate product (i.e., $4.40) is irrelevant because that is the
cost to produce milk which is the basic ingredient for butter.
2.
Per ½ kg of
butter
Revenue from further processing:
Selling price of ½ kilo butter (1/2 × $15.60 per kilogram) .......
Less revenue from 4-litres of milk .............................................
Incremental revenue from further processing ............................
Less cost of further processing (1/2 × $3 per kilogram) .............
Profit per ½ kilogram from further processing ...........................
$7.80
5.30
2.50
1.50
$1.00
It is certainly profitable to further processmilk into butter. However, it will be
irresponsible on the part of the Dairy to convert all of its milk to butter because milk is a
basic food and an important source of nourishment especially for children.
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Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 9-1 (30 minutes) (LO1 CC2)
1. a. and b.
Keep Old
Machine
5 Year Summary
Buy New
Machine
Difference
Sales ($100,000 × 5 years) ................................
$500,000
$500,000
Selling and administrative
expenses ($63,000 × 5 years) ................................
315,000
315,000
Operating costs ................................ 105,000
35,000
Depreciation of the old machine,
or loss write-off ................................ 25,000
25,000 *
Salvage value—old machine ................................
—
(5,000)*
Depreciation—new machine ................................
45,000
Total expenses ................................
445,000
415,000
Net operating income ................................
$ 55,000
$ 85,000
$ -0-070,000
-05,000
(45,000)
30,000
$ 30,000
* In a formal income statement, these two items should be shown as a
single $20,000 “loss from disposal” figure.
The new machine should be purchased. The savings in operating costs over the next
five years will exceed the net investment by $30,000.
2. Reduction in annual operating costs
($14,000 × 5 years)................................................................
Investment in the new machine:
Original cost ..............................................................................
$45,000
Less salvage value of the old machine................................
5,000
Net advantage of purchasing the new machine ...............................
$70,000
40,000
$ 30,000
All other costs are either sunk or do not differ between the alternatives.
Solutions Manual, Chapter 9
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25
Problem 9-2 (60 minutes) (LO1 CC3)
1. Only the avoidable costs are relevant in a decision to drop the Model C3 lawnchair
product. The avoidable costs are:
Direct materials ............................................................................
R122,000
Direct labour.................................................................................72,000
Fringe benefits (20% of direct labour) ............................................14,400
Variable manufacturing overhead ................................................... 3,600
Product manager’s salary ..............................................................10,000
Sales commissions (5% of sales) ...................................................15,000
Fringe benefits (20% of salaries and commissions) ......................... 5,000
Shipping .......................................................................................10,000
Total avoidable cost ................................................................ R252,000
The following costs are not relevant in this decision:
Cost
Building rent and maintenance
Depreciation
General administrative expenses
Reason not relevant
All products use the same facilities;
no space would be freed if a
product were dropped.
All products use the same equipment
so no equipment can be sold.
Furthermore, the equipment does
not wear out through use.
Dropping the Model C3 lawnchair
would have no effect on total
general administrative expenses.
Having determined the costs that can be avoided if the Model C3 lawnchair is
dropped, we can now make the following computation:
Sales revenue lost if the Model C3 lawnchair is dropped .................
Less costs that can be avoided (see above) ...................................
Decrease in overall company net operating income if the Model
C3 lawnchair is dropped ............................................................
R300,000
252,000
R 48,000
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Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 9-2 (continued)
Thus, the Model C3 lawnchair should not be dropped unless the company can find
more profitable uses for the resources consumed by the Model C3 lawnchair.
2. To determine the minimum acceptable level of sales, we must first classify the
avoidable costs into variable and fixed costs as follows:
Variable
Direct materials ................................................................R122,000
Direct labour ................................................................
72,000
Fringe benefits (20% of direct labour)................................ 14,400
Variable manufacturing overhead ...................................................
3,600
Product managers’ salaries ............................................................
Sales commissions (5% of sales) ...................................................
15,000
Fringe benefits (20% of salaries and commissions) .........................
3,000
Shipping .......................................................................................
10,000
Total costs ....................................................................................
R240,000
Fixed
R10,000
2,000
R12,000
The Model C3 lawnchair should be retained as long as its contribution
margin covers its avoidable fixed costs. Break-even analysis can be used to find the
sales volume where the contribution margin just equals the avoidable fixed costs.
The contribution margin ratio is computed as follows:
CM ratio =
=
Contribution margin
Sales
R300,000-R240,000
= 20%
R300,000
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27
Problem 9-2 (continued)
The break-even sales volume can be found using the break-even
formula:
Break-even point =
=
Fixed costs
CM ratio
R12,000
= R60,000
0.20
Therefore, as long as the sales revenue from the Model C3 lawnchair exceeds
R60,000, it is covering its own avoidable fixed costs and is contributing toward
covering the common fixed costs and toward the profits of the entire company.
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Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 9-3 (45 minutes) (LO1 CC3)
1. Contribution margin lost if the flight is discontinued ........................
Flight costs that can be avoided if the flight is
discontinued:
Flight promotion ................................................................ $ 1,500
Fuel for aircraft ..........................................................................
13,600
Liability insurance (1/3 × $8,400) ...............................................
2,800
Salaries, flight assistants ............................................................
1,000
Overnight costs for flight crew and assistants ..............................
600
Net decrease in profits if the flight is discontinued ..........................
$(25,900)
19,500
$ (6,400)
The following costs are not relevant to the decision:
Cost
Reason
Salaries, flight crew
Fixed annual salaries, which will not
change.
Depreciation of aircraft
Sunk cost.
Liability insurance (two-thirds)
Two-thirds of the liability insurance is
unaffected by this decision.
Baggage loading and flight
preparation
This is an allocated cost that will
continue even if the flight is
discontinued.
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29
Problem 9-3 (continued)
Alternative Solution:
Keep the
Flight
Drop the
Flight
Ticket revenue ................................................................
$28,000
$ -0Less variable expenses ................................
2,100
-0Contribution margin ................................................................
25,900
-0Less flight expenses:
Salaries, flight crew ................................................................
3,600
3,600
Flight promotion ................................................................
1,500
-0Depreciation of aircraft ................................
3,100
3,100
Fuel for aircraft ................................................................
13,600
-0Liability insurance ................................................................
8,400
5,600
Salaries, flight assistants ................................ 1,000
-0Baggage loading and flight preparation ................................
3,400
3,400
Overnight costs for flight crew and
assistants at destination ................................ 600
-0Total flight expenses ................................................................
35,200
15,700
Net operating loss ................................................................
$ (9,300) $(15,700)
Difference:
Net Income
Increase or
(Decrease)
$(28,000)
2,100
(25,900)
-01,500
-013,600
2,800
1,000
-0600
19,500
$ (6,400)
2. The flights that are eliminated might have an average seat occupancy of 40% or
less. By eliminating these flights and keeping the flights with a higher average seat
occupancy, the overall average seat occupancy for the company as a whole would
be improved. This could reduce profits, however, in at least two ways. First, the
flights that are eliminated could have a contribution margin that is greater than their
avoidable costs (such as in the case of Flight 482 in part 1). If so, then eliminating
these flights would reduce the company’s total contribution margin more than it
would reduce total costs, and profits would decline. Second, these flights might be
acting as “feeder” flights, bringing passengers to cities where connections to more
profitable flights are made.
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Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 9-4 (30 minutes) (LO1 CC4)
Per Unit
Differential
Costs
Make Buy
1.
15,000 units
Make
Buy
Cost of purchasing ................................................................
$35
Direct materials ................................................................
$14
$210,000
Direct labour ................................................................
10
150,000
Variable manufacturing overhead ................................
3
45,000
Fixed manufacturing overhead,
traceable1 ................................................................
2
30,000
Fixed manufacturing overhead,
common ................................................................
—
—
Total costs ................................................................
$29 $35
$435,000
Difference in favour of continuing to
$6
make the parts ................................................................
1
$525,000
$525,000
$90,000
Only the supervisory salaries can be avoided if the parts are purchased. The
remaining book value of the special equipment is a sunk cost; hence, the $4 per
unit depreciation expense is not relevant to this decision.
Based on these data, the company should reject the offer and should
continue to produce the parts internally.
2.
Make
Cost of purchasing (part 1) ...........................................................
Cost of making (part 1) ................................................................
$435,000
Opportunity cost—segment margin foregone on a
potential new product line ..........................................................
150,000
Total cost .....................................................................................
$585,000
Buy
$525,000
$525,000
Difference in favour of purchasing from the outside
$60,000
supplier .....................................................................................
Thus, the company should accept the offer and purchase the parts from the outside
supplier.
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31
Problem 9-5 (45 minutes) (LO1 CC5)
1. Since the fixed costs will not change as a result of the order, they are not relevant to
the decision. The cost of the new machine is relevant, and this cost will have to be
recovered by the current order since there is no assurance of future business from
the retail chain.
Unit
Total—5,000
units
Revenue from the order ($50 × $84%) ................................ $42
Less costs associated with the order:
Direct materials ................................................................ 15
Direct labour .............................................................................
8
Variable manufacturing overhead ................................................
3
Variable selling expense ($4 × 25%) ................................
1
Special machine ($10,000 ÷ 5,000 units) ................................2
Total costs ....................................................................................
29
Net increase in profits ................................................................
$13
2. Revenue from the order:
Reimbursement for costs of production (variable production
costs of $26, plus fixed manufacturing overhead cost of $9
= $35 per unit; $35 per unit × 5,000 units) .............................
Fixed fee ($1.80 per unit × 5,000 units) .....................................
Total revenue ...............................................................................
Less incremental costs—variable production costs
($26 per unit × 5,000 units).......................................................
Net increase in profits ...................................................................
$210,000
75,000
40,000
15,000
5,000
10,000
145,000
$ 65,000
$175,000
9,000
184,000
130,000
$ 54,000
3. Sales revenue
From the Canadian Forces (above) ...................................................$184,000
From regular channels ($50 per unit × 5,000 units) ........................... 250,000
Net decrease in revenue ................................................................
(66,000)
Less variable selling expenses avoided if the Army’s order is
accepted ($4 per unit × 5,000 units) ................................................ 20,000
Net decrease in profits if the Army’s order is accepted ..........................$(46,000)
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Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 9-5 (continued)
Alternate solution to Part #3:
Increase in profits from the order (from part #2)
$ 54,000
Deduct: decrease in contribution margin from lost sales*
$100,000
Net increase (decrease) in profits
($46,000)
* 5,000
Rets × $20 CM per Ret
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33
Problem 9-6 (60 minutes) (LO2 CC7, 8)
1.
Softy
Friendl
y
Goody
Direct labour cost per unit................................
$ 4.80 $3.00
Direct labour rate per hour
$12.00 $12.00
Direct labour hours per unit*
(a) ................................................................
0.40
0.25
Besty
Lovey
$ 8.40
$12.00
$ 6.00
$12.00
$ 2.40
$12.00
0.70
0.50
0.20
* Direct labour cost per unit ÷ Direct labour rate per hour.
Direct labour hours required to meet the demand:
Product
Estimated
DLH Per Unit Sales (units)
Softy ................................................................
0.40 hours
70,000
Friendly ................................ 0.25 hours
58,800
Goody ................................................................
0.70 hours
49,000
Besty ................................................................
0.50 hours
56,000
Lovey ................................................................
0.20 hours
100,000
Total hours required ................................
2.
Softy
Friendl
y
Goody
Selling price ................................$26.00 $11.00
Less variable costs:
Direct materials ................................
10.75
2.75
Direct labour ................................4.80
3.00
Variable overhead ................................
1.60
1.00
Total variable costs ................................
17.15
6.75
Contribution margin (b) ................................
$ 8.85 $4.25
Contribution margin per DLH
(b) ÷ (a) ................................ $22.13 $17.00
Total
Hours
28,000
14,700
34,300
28,000
20,000
125,000
Besty
Lovey
$42.00
$20.00
$16.00
16.10
8.40
2.80
27.30
$14.70
5.00
6.00
2.00
13.00
$ 7.00
8.00
2.40
0.80
11.20
$ 4.80
$21.00
$14.00
$24.00
The recommended product mix is as follows:
1. Produce 100,000 units of Lovely (20,000 DLH), 70,000 units of Softy (28,000
DLH), 49,000 units of Goody (34,300 DLH) and 58,500 units of Friendly (14,400
DLH). This production mix will consume 97,000 direct labour hours.
2. The remaining 3,000 hours can be used to produce 6,000 units of Besty.
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Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 9-6 (continued)
3. Since the additional capacity would be used to produce the Bestydoll, the company
should be willing to pay up to $26 per hour ($12 usual rate plus $14 contribution
margin per hour) for added labour time. At this rate the incremental contribution
margin from the sale of additional 50,000 units of Betsy would be zero. This would
not affect profitability, but the company will be able to satisfy its customers.
4. Additional output could be obtained in a number of ways including working
overtime, adding another shift, expanding the workforce, contracting out some work
to outside suppliers, and eliminating wasted labour time in the production process.
The first four methods are costly, but the last method can add capacity at very low
cost.
Note: Some would argue that direct labour is a fixed cost in this situation and should
be excluded when computing the contribution margin per unit. However, when
deciding which products to emphasize, no harm is done by misclassifying a fixed
cost as a variable cost—providing that the fixed cost is the constraint. If direct
labour were removed from the variable cost category, the net effect would be to
bump up the contribution margin per direct labour-hour by $12 for each of the
products. The products will be ranked exactly the same—in terms of the contribution
margin per unit of the constrained resource—whether direct labour is considered
variable or fixed.
Solutions Manual, Chapter 9
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35
Problem 9-7 (75 minutes) (LO1 CC2, 3)
1. The Afl5.60 per drum general overhead cost is not relevant to the decision, since
this cost will be the same regardless of whether the company decides to make or
buy the drums. Also, the present depreciation figure of Afl3.20 per drum is not a
relevant cost, since it represents a sunk cost (in addition to the fact that the old
equipment is worn out and must be replaced). The cost (depreciation) of the new
equipment is a relevant cost, since the new equipment will not be purchased if the
company decides to accept the outside supplier’s offer. The cost of supervision is
relevant to the decision, since this cost can be avoided by buying the drums.
Differential Costs Per
Drum
Make
Buy
Outside supplier’s price ................................ Afl36.00
Direct materials ................................
Afl20.70
Direct labour
(Afl12.00 × 70%) ................................
8.40
Variable overhead (Afl3.00
× 70%) ................................
2.10
Supervision................................ 1.50
Depreciation ................................ 2.25 *
Total cost ................................ Afl34.95
Afl36.00
Total Differential Costs—
120,000 Drums
Make
Buy
Afl4,320,000
Afl2,484,000
1,008,000
252,000
180,000
270,000
Afl4,194,000
Afl4,320,000
* Afl1,620,000 ÷ 6 years = fl270,000 per year;
Afl270,000 per year ÷ 120,000 drums = Afl2.25 per drum.
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Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 9-7 (continued)
2. a. Notice that unit costs for both supervision and depreciation will change if the
company needs 150,000 drums each year. The reason is that these fixed costs
will be spread over a greater number of units, thereby reducing the cost per unit.
Differential Cost
Per Drum
Make
Buy
Outside supplier’s price ................................
Afl36.00
Direct materials ................................
Afl20.70
Direct labour................................ 8.40
Variable overhead ................................
2.10
Supervision (Afl180,000 ÷
150,000 drums) ................................
1.20
*
Depreciation (Afl270,000 ÷
150,000 drums) ................................
1.80
Total cost ................................................................
Afl34.20 Afl36.00
Total Differential Cost—
150,000 Drums
Make
Buy
Afl5,400,000
Afl3,105,000
1,260,000
315,000
180,000
270,000
Afl5,130,000
Afl5,400,000
The company should purchase the new equipment and make the drums if 150,000
units per year are needed.
* Afl1,620,000÷
6 years = Afl270,000 per year
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Problem 9-7 (continued)
b. Again, notice that the unit costs for both supervision and depreciation decrease
with the greater volume of units.
Differential Costs
Per Drum
Make
Buy
Outside supplier’s price ................................
Afl36.00
Direct materials ................................
Afl20.70
Direct labour................................ 8.40
Variable overhead ................................
2.10
Supervision (Afl180,000 ÷
1.00
180,000 drums) ................................
*
Depreciation (Afl270,000 ÷
180,000 drums) ................................
1.50
Total cost ................................................................
Afl33.70 Afl36.00
Total Differential Cost—
180,000 Drums
Make
Buy
Afl6,480,000
Afl3,726,000
1,512,000
378,000
180,000
270,000
Afl6,066,000 Afl6,480,000
The company should purchase the new equipment and make the drums if
180,000 units per year are needed.
* Afl1,620,000÷
6 years = Afl270,000 per year
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Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 9-7 (continued)
3. Other factors that the company should consider include:
a. Will volume in future years be increasing, or will it remain constant at 120,000
units per year? (If volume increases, then buying the new equipment becomes
more desirable, as shown in the computations above.)
b. Can quality control be maintained if the drums are purchased from the outside
supplier?
c. Will costs for materials and labour increase in future years, thereby increasing the
cost of making the drums? (The supplier will be locked in to an Afl36 price.)
d. Will the outside supplier be dependable in meeting shipping schedules?
e. Can the company begin making the drums again if the supplier proves to be
undependable, or are there alternative suppliers?
f. What is the labour outlook in the supplier’s industry (e.g., are frequent labour
strikes likely)?
g. If the outside supplier’s offer is accepted and the need for drums increases in
future years, will the supplier have the added capacity to provide more than
120,000 drums per year?
Solutions Manual, Chapter 9
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39
Problem 9-8 (45 minutes) (LO1 CC3)
1. Product RG-6 yields a contribution margin of $8 per unit ($22 – $14 = $8). If the
plant closes, this contribution margin will be lost on the 16,000 units (8,000 units×
2) 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 ($8 per unit × 16,000 units) ................................
Costs avoided by closing the plant for two months:
Fixed manufacturing overhead cost ($150,000 –
$105,000 = $45,000; $45,000 × 2 months = $90,000) .............
$90,000
Fixed selling costs ($30,000 × 10% × 2 months) .........................
6,000
Net disadvantage of closing, before start-up costs ..........................
Add start-up costs ................................................................
Disadvantage of closing the plant...................................................
$(128,000)
96,000
(32,000)
( 8,000)
$ (40,000)
No, the company should continue to operate at the reduced level of 8,000 units
produced and sold each month. Closing will result in a $40,000 greater loss over the
two-month period than if the company continues to operate. An additional factor is
the potential loss of goodwill among the customers who need the 8,000 units of RG6 each month. By closing down, the needs of these customers will not be met (no
inventories are on hand), and their business may be permanently lost to another
supplier.
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Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 9-8 (continued)
Alternative Solution:
Plant Kept
Open
Plant
Closed
Sales (8,000 units × $22 × 2)................................
$ 352,000
$ -0Less variable expenses
224,000
-0(8,000 units × $14 × 2) ................................
Contribution margin ................................ 128,000
-0Less fixed costs:
Fixed manufacturing overhead
costs ($150,000 × 2) ................................
300,000
210,000 *
Fixed selling costs
($30,000 × 2)................................
60,000
54,000 **
Total fixed costs ................................
360,000
264,000
Net loss before start-up costs ................................
(232,000)
(264,000)
Start-up costs ................................................................
-0(8,000)
Net operating loss ................................$(232,000)
$(272,000)
Difference:
Net Income
Increase or
(Decrease)
$(352,000)
224,000
(128,000)
90,000
6,000
96,000
(32,000)
(8,000)
$ (40,000)
* $105,000 × 2 = $210,000.
** $30,000 × 90% = $27,000 × 2 = $54,000.
Solutions Manual, Chapter 9
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41
Problem 9-8(continued)
2. Birch Company will be indifferent at a level of 11,000 total units sold over the twomonth period. The computations are:
Cost avoided by closing the plant for two months (see above) ........$96,000
Less start-up costs ....................................................................... 8,000
Net avoidable costs ......................................................................$88,000
Net avoidable costs
$88,000
=
= 11,000 units
Per unit contribution margin $8 per unit
Verification:
Operate at
11,000 Units
for Two
Months
Sales (11,000 units × $22 per unit) ................................
$ 242,000
Less variable expenses (11,000 units × $14 per
unit) .........................................................................................
154,000
Contribution margin ................................................................
88,000
Less fixed expenses:
Manufacturing overhead ($150,000 and
$105,000, × 2 months) ..........................................................
300,000
Selling ($30,000 and $27,000, × 2 months) ................................
60,000
Total fixed expenses ................................................................
360,000
Start-up costs ................................................................ -0Total costs ................................................................ 360,000
Net operating loss ................................................................
$(272,000)
Close for
Two Months
$ -0-0-0-
210,000
54,000
264,000
8,000
272,000
$(272,000)
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Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 9-9 (60 minutes) (LO1 CC1, 4, 5)
1. Selling price per unit ................................................................$32
Less variable expenses per unit .....................................................
18 *
Contribution margin per unit..........................................................
$14
*$10.00 + $4.50 + $2.30 + $1.20 = $18.00.
15,000
Increased sales in units (60,000 units × 25%) ................................
Contribution margin per unit ..........................................................
× $14
Incremental contribution margin ....................................................
$210,000
Less added fixed selling expenses ..................................................
80,000
Incremental net operating income..................................................
$130,000
Yes, the increase in fixed selling expenses would be justified.
2. Variable manufacturing cost per unit ..............................................
$16.80 *
Import duties per unit ................................................................1.70
Permits and licenses ($9,000 ÷ 20,000 units) ................................
0.45
Shipping cost per unit ................................................................3.20
Break-even price per unit ..............................................................
$22.15
*$10 + $4.50 + $2.30 = $16.80.
3. The relevant cost figure is $1.20 per unit, which is the variable selling expense per
Dak. Since the irregular units have already been produced, all production costs
(including the variable production costs) are sunk. The fixed selling expenses are not
relevant since they will not change regardless of whether or not the irregular units
are sold. Depending on how the irregular units are sold, the variable expense of
$1.20 per unit may not even be relevant. For example, the units may be disposed of
through a liquidator without incurring the normal variable selling expense.
4. If the plant operates at 30% of normal levels, then only 3,000 units will be produced
and sold during the two-month period:
60,000 units per year × 2/12 = 10,000 units.
10,000 units × 30% = 3,000 units produced and sold.
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43
Problem 9-9 (continued)
Given this information, the simplest approach to the solution is:
Contribution margin lost if the plant is closed (3,000
units × $14 per unit*) ................................................................
Fixed costs that can be avoided if the plant is closed:
Fixed manufacturing overhead cost ($300,000 × 2/12
= $50,000; $50,000 × 40%) ...................................................
$20,000
Fixed selling cost ($210,000 × 2/12 = $35,000;
$35,000 × 20%) ................................................................7,000
Net disadvantage of closing the plant ................................
$(42,000)
27,000
$(15,000)
*$32.00 – ($10.00 + $4.50 + $2.30 + $1.20) = $14.00.
Some students will take a longer approach such as that shown below:
Continue to
Operate
Sales (3,000 units × $32 per unit) ................................ $ 96,000
Less variable expenses
(3,000 units × $18 per unit) .......................................................
54,000
Contribution margin ................................................................
42,000
Less fixed expenses:
Fixed manufacturing overhead cost:
$300,000 × 2/12 ................................................................
50,000
$300,000 × 2/12 × 60% .........................................................
Fixed selling expense:
$210,000 × 2/12 ................................................................
35,000
$210,000 × 2/12 × 80% .........................................................
Total fixed expenses ................................................................
85,000
Net operating income (loss) ...........................................................
$(43,000)
Close the
Plant
$ -0-0-0-
30,000
28,000
58,000
$(58,000)
The net difference between the two alternatives (close the plant minus continue to
operate) is ($58,000) – ($43,000) = ($15,000). This implies closing the plant leads to
an additional loss of $15,000. Note, some students might include a third column
(Difference: Net Operating Income Increase (or Decrease) and indicate the difference,
row by row. The final answer, of course will be the same as above.
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Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 9-9 (continued)
5. The relevant costs are those that can be avoided by purchasing from the outside
manufacturer. These costs are:
Variable manufacturing costs ........................................................ $16.80
Fixed manufacturing overhead cost ($300,000 × 75% =
$225,000; $225,000 ÷ 60,000 units) ..........................................
3.75
Variable selling expense ($1.20 × 1/3) ..........................................
0.40
Total costs avoided ....................................................................... $20.95
To be acceptable, the outside manufacturer’s quotation must be less than $20.95
per unit.
Solutions Manual, Chapter 9
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45
Problem 9-10 (30 minutes) (LO1 CC4)
1. Relevant costs of making are as follows:
Direct materials:
Direct labour:
Variable overhead:
Supervision:
Depreciation:
$600,000/40,000))
$30.00
31.50 (75% of $42)
4.50 (75% of $6.00)
8.00
15.00 (($4,000,000 - $1,000,000)/5 =
Total cost:
$89.00
This is less than the $90 amount it costs to buy from the outside supplier;
therefore should continue to make based purely on the financial analysis.
2.
The point of indifference will be when the relevant costs of manufacturing are
equal to the cost of buying, i.e., $90. This means fixed supervision and
depreciation costs (together) can go up to $24 per unit ($90 - $66).
If fixed costs are $24 per unit, annual activity level = $920,000 ÷ $24 = 38,334
units (rounded up).
The point of indifference is an annual demand of 38,334 units (rounded up).
3.
If demand drops below 40,000 units, depreciation cost per unit will increase.
This is because the total annual depreciation cost is fixed. Any drop in demand
will result in the fixed costs having to be spread over a smaller number of units
and will result in the relevant costs of production going up. If the probability of
a drop in demand is high it might be better to buy the engines from an outside
supplier.
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Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 9-11 (20 minutes) (LO1 CC1, 2)
Savings in annual operating costs
=$72,000 – $36,000 = $36,000 per year
Savings over the useful life of the machine
= $36,000 × 7 = $252,000
Increase in maintenance costs
= ($5,000 × 3) + ($7,000 × 2) + ($9,000 × 2) = $47,000
Net savings = $252,000 - $47,000 = $205,000
The analysis of the relevant costs is as follows:
Savings in operating costs
+ Disposal value of the current
machine
– Cost of the new machine
= $205,000
= 175,000
= Overall benefit of buying the
new machine
= $(20,000)
= 400,000
In other words, the company is better off keeping the existing machine. This assumes
that there will be no additional maintenance-related expenses on the existing machine
as it becomes older, other than what is indicated in the question. It also assumes that
efficiency of both the new and existing equipment will not diminish in any manner.
Note: The $175,000 loss on disposal of the existing machine is based on the book-value
(50% of $350,000) and is not relevant.
Solutions Manual, Chapter 9
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47
Problem 9-12 (40 minutes) (LO1 CC5)
1.
Units sold – regular sales
Units sold – special order
Sales revenue – regular sales (@$10.50 / unit)
Sales revenue – special order (@$7.50 / unit)
Total sales revenue
Less: variable costs
Direct materials
Direct labour
Variable overhead
Sales commissions
Contribution margin
Less: fixed costs
Fixed overhead
Income
Without special
order
24,000
0
$252,000
0
$252,000
With special
order
20,000
10,000
$210,000
75,000
$285,000
60,000
72,000
18,000
12,000
$ 90,000
75,000
90,000
22,500
10,000
$ 87,500
30,000
$60,000
30,000
$57,500
Notes:
Units sold
Currently 6,000 (80% of 7,500) machine hours are utilized per month; each unit
requires ½ machine hour. This means that 12,000 units are currently being produced
per month (24,000 over a two month period).
If special order is accepted, the 10,000 units will consume 5,000 machine hours over
two months. The remaining capacity will be 10,000 machine hours (15,000 – 5,000),
which can be used to produce 20,000 units for regular sales.
Direct materials and direct labour
Per-unit costs are given.
Variable overhead
The rate is $1.50 per direct labour hour. Given that each product requires only ½ hour
of direct labour, only $0.75 (½ of $1.50) will be assigned as variable overhead per unit.
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48
Introduction to Managerial Accounting,Fifth Canadian Edition
Fixed overhead
Fixed overhead is computed as $2.00 - $0.75 = $1.25 per unit.
Given that fixed overhead costs do not change in total, they are really not relevant to
the decision.
Decision
Based on financial considerations, Anchor should not accept the special order.
2.
Anchor should consider the following issues as well:
 Impact on regular sales when existing customers when they know that a new
customer is getting a lower price.
 JCL might become a regular customer in the future thereby allowing Anchor to
use all of its production capacity (this may be good or bad depending on how the
two parties negotiate on a future price).
 Impact on employee morale if they perceive that management might try to
introduce the policy of overtime.
 Impact on product quality when working at full capacity (no flexibility or
breathing room available to employees) – management may have to introduce
initiatives to ensure consistent quality.
Solutions Manual, Chapter 9
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49
Problem 9-13 (30 minutes) (LO1 CC2)
1.
The differential cost analysis is as follows (3-year period):
Capital cost (in favour of purchasing new moulds, $800,000 - $400,000): $400,000
Variable costs (savings of $2 per unit, 60,000 units per year for 3 years): ($360,000)
Disposal value of the existing moulds:
($100,000)
Net cost of buying new moulds:
($ 60,000)
At the level of 60,000 annual sales, the company is better off to replace (buy new)
moulds because this results in a saving of $60,000 over the 3-year period.
2.
Assume that y is the point of indifference between the two options over the 3-year
period.
The differential cost equation would be as follows:
2y = ($800,000 - $100,000) - $4000,000
The left hand side of the above equation shows the saving in variable costs that
SpeedCar will realize if it buys the new moulds, whereas the right hand side shows the
incremental costs associated with purchasing the new moulds.
Therefore 2y = $300,000, or y = 150,000 over 3 years
The point of indifference = 50,000 units annually.
Conclusion: At a sales volume of 50,000 units per year, SpeedCar will be indifferent
between the two options of replacing versus refurbishing moulds.
For volumes of less than 50,000 units per year, it is better to refurbish rather than
replace.For volumes greater than 50,000 units per year, it is better to replace rather
than refurbish.
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50
Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 9-14 (45 minutes) (LO1 CC3)
1.
If Standard Model is the only product and 3,000 units are produced each month, net
income will be $750,000 per month:
Sales revenue (3,000 × $800)
Variable cost (3,000 × ($250 + $50))
Contribution margin
Fixed costs ($350,000 + $400,000)
Operating income
$ 2,400,000
900,000
1,500,000
750,000
$ 750,000
If the company produces 1,250 Economy Model, and 600 Deluxe Model, then 3,000
(maximum capacity) – 1,250 Economy – 600 Deluxe = 1,150 Standard will be
produced. Therefore:
Standard Economy
Deluxe
Total
Sales revenue
$ 920,000 $ 837,500
$ 540,000
$ 2,297,500
Variable cost, manufacturing
287,500 187,500
294,000
769,000
Variable cost, marketing
57,500 68,750__60,000186,250
Contribution margin
$ 75,000$ 581,250 $ 186,000
1,342,250
Fixed costs
750,000
Operating income
$ 592,250
The company’s operating income (or, alternatively, total contribution margin) has fallen
with the new production mix and therefore it is not recommended that the company
expand the product line under the present terms.
2.
The contribution margin per unit for each of the three products is as follows:
Standard
Economy
Deluxe
($575,000 ÷ 1,150 units) = $500
($581,250 ÷ 1,250 units) = $465
($186,000 ÷ 600 units) = $310
The supplier’s offer will also result in the company earning the same contribution
margin of $500 per unit.
As such the contribution margin per unit of Standard Model is the highest. Therefore, if
there is unlimited demand for this model, the company should produce the Standard
Model in order to maximize profit. However if the demand for this model is limited to
say 1,500 units, the company can buy 600 units from the supplier and produce 900
units in-house. The company should then produce enough of the Economy Model to
satisfy the demand and finally produce the Deluxe Model using the remaining
production capacity.
Solutions Manual, Chapter 9
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51
Problem 9-15 (60 minutes) (LO1 CC4, 5)
1.
Special order:
The analysis below uses the following:
• The contribution margin per unit for units sold to regular customers is $1,260 −
$160− $200 − $40 −$60 = $800.
• Fixed manufacturing cost is 1,000 × $200 = $200,000. For an activity level of 2,000
units (full capacity), the fixed cost per unit is $100.
If the contract is accepted:
Foregone contribution from the 300 units not sold to regular customers ($800 × 300)
=$ (240,000)
Contribution from government:
Revenue from Provincial Bus Company
Variable cost of manufacture recovery (300 × $400)
Fixed cost share recovery (300 × $100)
Fixed fee
$ 120,000
30,000
480,000
630,000
Cost incurred on behalf of the Provincial Bus Company
Variable manufacturing cost
120,000
510,000
Foregone CM from units not sold to regular customers240,000
Incremental benefit of the contract
$270,000
The Provincial Bus Company’s contract should be accepted.
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52
Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 9-15 (continued)
2.
Make versus buy:
Buy
$ 300,000
Purchase cost
Variable manufacturing
Fixed manufacturing
(For buy, 0.8 × $200,000)
Variable marketing
(For buy, 0.6 × $60 × 500)
Fixed marketing
Cost of option
Make
$0
200,000
200,000
160,000
30,000
18,000
140,000
$ 618,000
Difference in favour the of make option
140,000
$570,000
$ (48,000)
The make option costs less. The Engine Guys should not accept the offer.
Alternative solution
Purchase cost
Save variable cost (mfg) (500 × $400)
Save marketing-variable cost (500 × $60 × 40%)
Save fee (mfg) (20% × $200,000)
Net savings
Solutions Manual, Chapter 9
$ 300,000
(200,000)
(12,000)
(40,000)
$ (48,000)
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53
Problem 9-16 (15 minutes) (LO1 CC4)
The relevant costs of making the game board are:
Direct material
Direct labour
Factory overhead (1.98 × 50%)
Cost of game board
$ 3.20
0.80
0.99
$ 4.99
The benefit of making the game boards per month are ($5.60 – $4.99) × 50,000 units
is $30,500 in additional profit per month for TBT.
Conclusion: TBT should make the game boards.
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54
Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 9-17 (60 minutes) (LO1 CC3)
1.
This is a shutdown or operate decision. There are several ways to set up the
solution.
Cost of not offering the tour:
Severance costs
$ 3,800
Profit (loss) of operating the tour:
Promotion costs are irrelevant. Insurance on the office and equipment is paid before
the tour is planned and thus have also been incurred. Depreciation is not a cash flow,
thus the original net operating loss should be adjusted as follows:
Revised net operating income = ($23,000) + $12,000 +$ 8,000 + $2,000 = ($1,000)
The loss from operating is less than the cost of shutting down: the advantage of
offering the tour is $2,800.
Alternative solution (differential approach):
This approach compares the revenue and expenses under each choice.
Revenue
Expenses
Tour guide salaries
Promotion
Gratuities
Insurance, office
Insurance, group
Tour support staff
Bicycle maintenance
Customer meals
Hotel and camping costs
Administrative and office
expenses
Tour coordinator salary
Total expenses
Net Operating Income
Solutions Manual, Chapter 9
With Tour (a)
Without Tour (b)
$ 170,000
$0
Difference (a –
b)
$ 170,000
48,000
2,400
45,600
Sunk
8,000
Sunk
7,000
28,000
7,000
20,000
20,000
3,000
Sunk
0
Sunk
0
1,400
0
0
0
0
Sunk
0
Sunk
7,000
26,600
7,000
20,000
20,000
3,000
30,000
171,000
0
3,800
30,000
159,200
$ (1,000)
$ (3,800)
$ (2,800)
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55
Problem 9 -17 (continued)
2.From part 1, the cost of not offering the tour exceeds the cost of operating by $3,800
– $1,000 = $2,800; thus if revenue were to decline by more than $2,800, it would be
best to not offer the tour. Therefore, minimum sales revenue required to offer the tour
must be greater than $170,000 – $2,800 = $167,200.
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56
Introduction to Managerial Accounting,Fifth Canadian Edition
Problem 9-18 (60 minutes) (LO3 CC11)
1. A product should be processed further if the incremental revenue from the further
processing exceeds the incremental costs. The incremental revenue from further
processing of the honey is:
Selling price of a container of honey drop candies .................
Selling price of three-quarters of a kilogram of honey ($6.60
× 3/4) .............................................................................
Incremental revenue per container .......................................
$9.60
4.95
$4.65
The incremental variable costs are:
Decorative container............................................................
Other ingredients ................................................................
Direct labour .......................................................................
Variable manufacturing overhead .........................................
Commissions (5% × $9.60) .................................................
Incremental variable cost per container ................................
$0.90
0.55
0.45
0.20
0.48
$2.58
Therefore, the incremental contribution margin is $2.07 per container ($4.65 –
$2.58). The cost of purchasing the honeycombs is not relevant because those costs
are incurred regardless of whether the honey is sold outright or processed further
into candies.
The only avoidable fixed costs of the honey drop candies are the master candy
maker’ssalary and the fixed portion of the salesperson’s compensation. Therefore,
the number of containers of the candy that must be sold each month to justify
continued processing of the honey into candies is determined as follows:
Master candy maker’s salary ............................
Salesperson’s fixed compensation .....................
Avoidable fixed costs .......................................
$4,180
2,750
$6,930
Avoidable fixed costs
$5,880
=
=6,000 containers
Incremental CM per container $0.98 per container
Solutions Manual, Chapter 9
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57
Problem 9-18 (continued)
If the company can sell at least 3,348 containers of the candies each month, then
profits will be higher than if the honey were simply sold outright. If the company
cannot sell that minimum number of containers of the candies each month, then
profits will be higher if the company discontinues making honey drop candies. To
verify this, we show below the total contribution to profits of sales of 3,300, 3,348,
and 3,400containers of candies, contrasted to sales of equivalent amounts of honey.
For example, instead of selling 2,475 pounds of honey, this same amount of honey
can be processed into 3,300 containers of candy.
Sales of candies:
Containers sold per month ............................
Incremental contribution margin (@$2.07 per
container) .................................................
Less avoidable fixed costs .............................
Total contribution to profits ...........................
3,300
3,348
3,400
$6,831
6,930
$ (99)
$6,930
6,930
$
0
$7,038
6,930
$108
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58
Introduction to Managerial Accounting,Fifth Canadian Edition
Thinking Analytically(120 minutes) (LO1 CC1, 3, 4)
1. The product margins computed by the accounting department for the drums and
mountain bike frames should not be used in the decision of which product to make.
The product margins are lower than they should be due to the presence of allocated
fixed common costs that are irrelevant in this decision. Moreover, even after the
irrelevant costs have been removed, what matters is the profitability of the two
products in relation to the amount of the constrained resource—welding time—that
they use. A product with a very low margin may be desirable if it uses very little of
the constrained resource. In short, the financial data provided by the accounting
department are pretty much useless for making this decision.
2. Students may have answered this question assuming that direct labouris a variable
cost, even though the case strongly hints that direct labouris a fixed cost. The
solution is shown here assuming that direct labouris fixed. The solution assuming
that direct labouris variable will be shown in part (4).
Solution assuming direct labouris fixed
Purchased
XSX Drums
Selling price ...........................................
Variable costs:
Direct materials ...................................
Variable manufacturing overhead ..........
Variable selling and administrative ........
Total variable cost ...................................
Contribution margin ................................
Solutions Manual, Chapter 9
Manufactured
XSX
Mountain
Drums
Bike Frames
$154.00
$154.00
$65.00
120.00
0.00
0.85
120.85
$ 33.15
44.50
1.05
0.85
46.40
$107.60
17.50
0.60
0.40
18.50
$46.50
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59
Thinking Analytically (continued)
3. Because the demand for the welding machine exceeds the 2,000 hours that are
available, products that use the machine should be prioritized based on their
contribution margin per welding hour. The computations are carried out below
under the assumption that direct labouris a fixed cost and then under the
assumption that it is a variable cost.
Solution assuming direct labouris fixed
Manufactured
Mountain
Bike
Frames
XSX Drums
Contribution margin per unit (from part 2) (a) ..............
Welding hours per unit (b) ..........................................
Contribution margin per welding hour (a) ÷ (b) ............
$107.60
0.8 hour
$134.50
per hour
$46.50
0.2 hour
$232.50
per hour
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Introduction to Managerial Accounting,Fifth Canadian Edition
Thinking Analytically (continued)
Because the contribution margin per unit of the constrained resource (i.e., welding time) is larger for the mountain bike
frames than for the XSX drums, the frames make the most profitable use of the welding machine. Consequently, the
company should manufacture as many mountain bike frames as possible up to demand and then use any leftover capacity
to produce XSX drums. Buying the drums from the outside supplier can fill any remaining unsatisfied demand for XSX
drums. The necessary calculations are carried out below.
Analysis assuming direct labouris a fixed cost
(a)
Quantity
Total hours available............................
Mountain bike frames produced ...........
XSX Drums—make ..............................
XSX Drums—buy .................................
Total contribution margin .....................
Less: Contribution margin from
present operations: 2,500 drums ×
$107.60 CM per drum .......................
Increased contribution margin and net
operating income .............................
Solutions Manual, Chapter 9
3,500
1,625
1,375
(b)
Unit
Contribution
Margin
$ 46.50
107.60
33.15
(c)
(a) × (c)
Welding
Time per
Unit
Total
Welding
Time
Balance
of
Welding
Time
700
1,300
2,000
1,300
0
0.20
0.80
(a) × (b)
Total
Contribution
$162,750
174,850
45,581
383,181
269,000
$114,181
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61
Thinking Analytically (continued)
4. The computation of the contribution margins and the analysis of the best product
mix are repeated here under the assumption that direct labourcosts are variable.
Solution assuming direct labouris a variable cost
Purchased
XSX Drums
Selling price ..............................................
Variable costs:
Direct materials ......................................
Direct labour ..........................................
Variable manufacturing overhead .............
Variable selling and administrative ...........
Total variable cost ......................................
Contribution margin ...................................
Manufactured
XSX
Mountain
Drums
Bike Frames
$154.00
$154.00
$65.00
120.00
0.00
0.00
0.85
120.85
$ 33.15
44.50
4.50
1.05
0.85
50.90
$103.10
17.50
22.50
0.60
0.40
41.00
$24.00
Solution assuming direct labouris a variable cost
Manufactured
Mountain
Bike
Frames
XSX Drums
Contribution margin per unit (above) (a) .........................
Welding hours per unit (b) .............................................
Contribution margin per welding hour (a) ÷ (b) ...............
$103.10
0.8 hour
$128.88
per hour
$24.00
0.2 hour
$120.00
per hour
When direct labouris assumed to be a variable cost, the conclusion is reversed from
the case in which direct labouris assumed to be a fixed cost—the XSX drums appear
to be a better use of the constraint than the mountain bike frames. The assumption
about the behavior of direct labourreally does matter.
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62
Introduction to Managerial Accounting,Fifth Canadian Edition
Thinking Analytically (continued)
Solution assuming direct labouris a variable cost
(a)
Quantity
Total hours available.............................
XSX Drums—make ...............................
Mountain bike frames produced ............
XSX Drums—buy ..................................
Total contribution margin ......................
Less: Contribution margin from
present operations: 2,500 drums ×
$103.10 CM per drum .......................
Increased contribution margin and net
operating income ..............................
Solutions Manual, Chapter 9
2,500
0
500
(b)
Unit
Contribution
Margin
$103.10
24.00
33.15
(c)
(a) × (c)
Welding
Time per
Unit
Total
Welding
Time
Balance
of
Welding
Time
2,000
0
2,000
0
0
0.80
0.20
(a) × (b)
Total
Contribution
$257,750
0
16,575
274,325
257,750
$ 16,575
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63
Thinking Analytically (continued)
5. The case strongly suggests that direct labouris fixed: “The mountain bike frames
could be produced with existing equipment and personnel.” Nevertheless, it would
be a good idea to examine how much labourtime is really needed under the two
opposing plans.
Production
Direct Labour-Hours
Per Unit
Total Direct
Labour-Hours
Plan 1:
Mountain bike frames ........
XSX drums ........................
3,500
1,625
1.25*
0.25**
4,375
406
4,781
Plan 2:
XSX drums ........................
2,500
0.25**
625
* $22.50 ÷ $18.00 per hour = 1.25 hours
** $4.50 ÷ $18.00 per hour = 0.25 hour
Some caution is advised. Plan 1 assumes that direct labouris a fixed cost. However,
this plan requires over 4,000 more direct labour-hours than Plan 2 and the present
situation. A full-time employee works about 1,900 hours a year, so the added
workload is about equivalent to two full-time employees. Does the plant really have
that much idle time at present? If so, and if shifting workers over to making
mountain bike frames would not jeopardize operations elsewhere, then Plan 1 is
indeed the better plan. However, if taking on the mountain bike frame as a new
product would lead to pressure to hire two more workers, more analysis is in order.
It is still best to view direct labouras a fixed cost, but taking on the frames as a new
product would lead to a jump in fixed costs of about $68,400 (1,900 hours × $18
per hour × 2). This must be covered by the additional contribution margin or the
plan should be rejected. See the additional analysis on the next page.
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64
Introduction to Managerial Accounting,Fifth Canadian Edition
Thinking Analytically (continued)
Contribution margin from Plan 1:
Mountain bike frames produced (3,500 × $46.50) ...................
XSX Drums—make (1,625 × $107.60) ....................................
XSX Drums—buy (1,375 × $33.15) ........................................
Total contribution margin .......................................................
Less: Additional fixed labourcosts ..............................................
Net effect of Plan 1 on net operating income .............................
$162,750
174,850
45,581
383,181
68,400
$314,781
Contribution margin from Plan 2: ..............................................
XSX Drums—make (2,500 × $107.60) ....................................
XSX Drums—buy (500 × $33.15) ...........................................
Net effect of Plan 2 on net operating income .............................
$269,000
16,575
$285,575
Net advantage of Plan 1 ...........................................................
$ 29,206
Plan 1, introducing the new product, would still be optimal even if two more direct
labouremployees would have to be hired. The reason for this is subtle. If the
company does not make the XSX drums itself, it can still buy them. Thus, using an
hour of welding time to make the mountain bike frames does not mean giving up a
contribution margin of $128.88 on drums (assuming direct labouris a variable cost).
The opportunity cost of using the welding machine to produce mountain bike frames
is less than this since a purchased drum can replace a manufactured drum. An
amended analysis using the opportunity cost concept appears on the next page.
Copyright © 2017 McGraw-Hill Education Limited. All rights reserved.
Solutions Manual, Chapter 9
65
Thinking Analytically (continued)
Amended solution assuming direct labouris fixed
Manufactured
Mountain
Bike
Frames
XSX Drums
Contribution margin per unit (from part 2) (a) .................
Welding hours per unit (b) .............................................
Contribution margin per welding hour (a) ÷ (b) ...............
$74.45*
0.8 hour
$93.06
per hour
$46.50
0.2 hour
$232.50
per hour
Amended solution assuming direct labouris a variable cost
Manufactured
Mountain
Bike
Frames
XSX Drums
Contribution margin per unit (from part 2) (a) .................
Welding hours per unit (b) .............................................
Contribution margin per welding hour (a) ÷ (b) ...............
$69.95*
0.8 hour
$87.44
per hour
$24.00
0.2 hour
$120.00
per hour
* Net of the $33.15 contribution margin of a purchased drum. If the company does
not make a drum, it can purchase one, so the lost contribution from making bike
frames rather than drums is less than it otherwise would be.
With this amended approach, assuming direct labouris variable points to the same
solution as when direct labouris assumed to be fixed—place the highest priority on
making mountain bike frames. This won’t always happen.
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66
Introduction to Managerial Accounting,Fifth Canadian Edition
Communicating in Practice (70 minutes) (LO1 CC4, 5; LO3 CC11)
The suggested time for this problem is based on the fact that it is unstructured. Students
have to identify the relevant alternatives and analyze them to arrive at a set of
recommendations. It is recommended that this problem is best taken up as a review
problem in class by the instructor. If the instructors wish they may assign the following
questions to lead the students to a solution:
1. Should Rasoi Equipment buy the exhaust fans from the supplier instead of making
them?
2. Should Rasoi Equipment make the industrial ovens or not? Hint: the supplier’s offer
to provide the exhaust fans at $150 is not dependent on whether or not the
industrial oven is produced by Rasoi Equipment.
3. Should the industrial ovens be put through the special finishing process?
4. What will be the annual profit for Rasoi Equipment under the different options?
Copyright © 2017 McGraw-Hill Education Limited. All rights reserved.
Solutions Manual, Chapter 9
67
Communicating in Practice (continued)
Memo
To:
President, Rasoi Equipment
From:
Maria A Student
Subject:
Production decisions for the
current year
The company has two options to consider:
1. Should it continue to make the exhaust fans?
2. Should it use its production capacity to make industrial ovens and buy the exhaust
fans from the outside supplier?
If the company decides to choose the second option it then has the option of selling its
ovens to the government agency or in the external market.
It is recommended that the company choose the second option, i.e., use its production
capacity to make industrial ovens and buy the exhaust fans from an outside supplier.
However, further special processing for sale to the government agency is not
recommended. This recommendation results in an annual profit of $1,140,000. The
following points highlight the factors underlying the above recommendation.
1. Both exhaust fans and industrial ovens provide the same contribution margin of
$120 per unit. However the option to produce industrial ovens also allows for the
exhaust fans to be purchased from an outside supplier, thereby resulting in a
contribution margin of $90 per unit. This leads to an incremental contribution
margin of $540,000 {[($120 × 7,000 ovens) + ($90 × 10,000 exhaust fans)] –
[$120 × 10,000 exhaust fans]}. The fixed costs are irrelevant to this decision.
2. The option to further process the industrial ovens in order to supply to the
government agency results in $80,000 of incremental revenue [($400 × 6,500
ovens) – ($360 × 7,000 ovens)]. However, this increase in revenue is offset by a
$270,000 increase in variable costs [($300 × 6,500 ovens) – ($240 × 7,000
ovens)], and a $78,000 increase in fixed costs ($12 × 6,500 ovens). Only the
incremental fixed costs are relevant to this decision and are considered.
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68
Introduction to Managerial Accounting,Fifth Canadian Edition
Communicating in Practice (continued)
Appendix:
1. Exhaust Fans: make or buy? Since the fixed costs are committed costs at least
for the current operating year, these costs are irrelevant to the decision. The
contribution margin (CM) per unit of the make option is $120 ($240 - $120) and
the CM per unit of the buy option is $90 ($240 - $150). Making the exhaust fan
enables the company to be better off by $300,000. Another way to see this is as
follows:
Make Option:
CM[$120 x 10,000]
Fixed costs (in total)
Profit (loss)
[$60 x 10,000]
$1200,000
$600,000
$600,000
Buy Option:
CM
[10,000 x $90]
Fixed costs (in total)
Profit (loss)
$900,000
$600,000
$300,000
Incremental profit (loss) if buy option is chosen ($300,000)
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69
Communicating in Practice (continued)
2. Outsource exhaust fan and make the industrial oven or only make the exhaust
fan?
Revenue
Costs:
Purchase
Variable
Fixed cost
Profit
Make Oven
Make Fan
Difference
$2,400,000
$2,520,000
$2,400,000
--
$2,520,000
($1,500,000)
($1680,000)
($ 600,000)
$ 1,140,000
-($1200,000)
($ 600,000)
$ 600,000
($1,500,000)
($ 480,000)
0
$ 540,000
3. Should the industrial oven be further processed to meet government standards?
Revenue
Var. cost
Fixed cost
Profit
Fan CM
Total profit
Process further
Do not Process
Difference
$2,600,000
[6,500 x $400]
($1,950,000)
[6,500 x ($240 + $60)]
($678,000)*
($28,000)
$900,000
$872,000
$2,520,000
[7,000 x $360]
($1,680,000)
$ 80,000
($600,000)
$240,000)
$900,000
$1,140,000
($ 78,000)
($268,000)
-($268,000)
($270,000)
* Includes incremental cost of $78,000 ($12 × 6,500 ovens)
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70
Introduction to Managerial Accounting,Fifth Canadian Edition
Ethics Challenge (75 minutes) (LO1 CC3)
1. The original cost of the facilities at Owen Sound is a sunk cost and should be
ignored in any decision. The decision being considered here is whether to continue
operations at Owen Sound. The only relevant costs are the future facility costs that
would be affected by this decision. If the facility were shut down, the Owen Sound
facility has no resale value. In addition, if the Owen Sound facility were sold, the
company would have to rent additional space at the remaining processing centers.
On the other hand, if the facility were to remain in operation, the building should
last indefinitely, so the company does not have to be concerned about eventually
replacing it. But there is the issue of the Facility Expense of $1,100,000. This is a
critical element. If this cost is avoidable by shutting the facility down then the costs
that are relevant in the decision to shut down the Owen Sound facility are:
Increase in rent at Kingston and Burlington ................................ $600,000
Decrease in local administrative expenses ................................
(90,000)
Facility expense avoided …………………………………….
(1,100,000)
Net decrease in costs ................................................................ ($590,000)
In addition, there would be costs of moving the equipment from Owen Sound and
there might be some loss of revenues due to disruption of services. These are not
likely to offset the cost savings entirely. In sum, closing down the Owen Sound
facility would almost certainly lead to an improvement in BSC’s profits.
If the facility expense is not avoidable, then this cost will remain regardless of the
decision to shutdown Owen Sound. In that case, shutting down Owen Sound will
lead to an increase of $510,000 (obtained by adding $1,100,000 to the decrease of
$590,000 shown above). The facility should not be shut down.
From a performance reporting standpoint the following “report” for the Great Lakes
Region can be constructed (ignoring the costs of moving equipment and potential
loss of revenues from the disruption of service to customers):
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Solutions Manual, Chapter 9
71
Ethics Challenge (continued)
Financial Performance
After Shutting Down the Owen Sound Facility
Great Lakes Region
Total
Revenues .....................................................................................
$50,000,000
Operating expenses:
Direct labour ................................................................ 32,000,000
Variable overhead ................................................................ 850,000
Equipment depreciation ..............................................................
3,900,000
Facility expense* ................................................................2,300,000
Local administrative expense** ...................................................
360,000
Regional administrative expense ................................
1,500,000
Corporate administrative expense ................................
4,750,000
Total operating expense ................................................................
45,660,000
Net operating income ................................................................
$ 4,340,000
* $2,800,000 – $1,100,000 + $600,000 = $2,300,000.
** $450,000 – $90,000 = $360,000.
The issue for students to grasp is that if the $1,100,000 is a true cost that is avoided
by shutting down the facility, then the report’s bottom line is a proper reflection of
the performance and the facility should be shut down. If the $1,100,000 is merely
an allocation and unavoidable, the above report shows a profit from shutdown which
is incorrect, since as was shown before there is an increase of $510,000 stemming
from shutting down Owen Sound. Students should be encouraged to be consistent
in their assumptions and the analysis leading from those assumptions.
2. The Standards of Ethical Conduct for Management Accountants can provide a useful
framing device for structuring student responses. Students should ask if Romeros’s
actions violate the Competence, Integrity, and Objectivity Standards. Assuming that
the facility expense is not avoidable but is presented in the performance report as
though it is, the following analysis can be made. If the Owen Sound facility is shut
down and assuming that the facility expense is not avoidable, BSC’s profits will
appear to improve, but some employees will lose their jobs,
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72
Introduction to Managerial Accounting,Fifth Canadian Edition
Ethics Challenge (continued)
and customers will at least temporarily suffer some decline in service. Therefore,
Romeros is willing to sacrifice the interests of the company, its employees, and its
customers just to make her performance report look better.
From the perspective of the Standards of Ethical Conduct for Management
Accountants the following conclusions can be reached.
a) By recommending closing the Owen Sound facility, Romeros would violate the
Competence Standard that stipulates recommendations should be based on
appropriate analysis of relevant and reliable information.
b) The Integrity Standard requires that management accountants “avoid actual or
apparent conflicts of interest and advise all appropriate parties of any potential
conflict.” Romeros has a conflict of interest in this case, since her
recommendation will serve to make her own performance look better while
actually leading to a decline in the company’s profits.
c) The Integrity Standard is also violated in that her recommendation to close down
the Owen Sound facility would “subvert the attainment of the organization’s
legitimate and ethical objectives.”
d) Romeros would also be violating the Objectivity Standard that requires a
management accountant to “disclose fully all relevant information that could
reasonably be expected to influence an intended user’s understanding of the
reports, comments, and recommendations presented.” Presumably, if the
corporate board were fully informed of the consequences of this action, they
would disapprove.
In sum, the recommendation to close the Owen Sound facility can be viewed as
unethical behaviour. In Romeros’ defence, however, it is not fair to hold her
responsible for the mistake made by her predecessor.
It should be noted that the performance report required by corporate headquarters
is likely to lead to other problems such as the one illustrated here. The arbitrary
allocations of corporate and regional administrative expenses to processing centers
may make other processing centers appear to be unprofitable even though they are
not.
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Solutions Manual, Chapter 9
73
Ethics Challenge (continued)
In this case, the problems created by these arbitrary allocations were compounded
by using an irrelevant facilities expense figure on the performance report.
3. Prices should be set ignoring the depreciation on the Owen Sound facility. Any
attempt to recover the sunk cost of the original cost of the building by charging
higher prices than the market will bear will lead to less business and lower profits.
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74
Introduction to Managerial Accounting,Fifth Canadian Edition
Teamwork in Action (LO1 CC4; LO2CC7, 8)
1. The number of direct labour-hours per year being used to manufacture tackle boxes
can be computed as follows:
Labour cost per pair of mirrors (a) ................................
$41.25
Cost per direct labour-hour (b) ................................$15.00
Direct labour time per box (a) ÷ (b) ................................
2.75 hours
40,000 boxes × 2.75 hours per box = 110,000 total hours.
2. a., b., and c.
Before the contribution margin can be computed, we must first determine the
amount of variable overhead cost per unit for the manufacture ofone pair of mirrors
and one pack of floor mats.
First, we present the computations to separate the manufacturing overhead cost
into its fixed and variable components.
Manufacturing overhead per unit (a)...........................................$27.50
Direct labour-hours per unit (Part 1) (b)................................
2.75
Manufacturing overhead rate per hour (a) ÷ (b) ..........................$10.00
hours
Total manufacturing overhead cost per year:
110,000 direct labour-hours (Part 1) × $10.00 .........................
$1,100,000
Less fixed manufacturing overhead cost ................................ 440,000
Variable manufacturing overhead cost ................................$ 660,000
Variable manufacturing overhead rate per hour:
660,000 ÷ 110,000 hours ....................................................... $ 6.00
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75
Teamwork in Action (continued)
With these variable overhead amounts, the contribution margins can be computed:
Purchased
Mirrors
Manufactured
Floor
Mirrors
Mats
Selling price ................................................................
$188.00
$188.00
Less variable costs:
Material (total) ................................................................
150.00
37.40
Direct labour ................................................................
—
41.25
Variable manufacturing overhead................................
—
16.50
Variable selling and admin. Cost * ................................
8.00
27.40
Total variable cost ................................................................
158.00
122.55
Contribution margin ................................................................
$30.00
$65.45
$90.00
25.50
16.50
6.60
6.00
54.60
$35.40
+ Manufactured mirrors: $6.00 × 2.75 labour hours = $16.50
Manufactured floor mats: $6:00 × 1.10 labour hours = $6.60
* Purchased mirrors: $18 – $10 = $8.
Manufactured mirrors: $37.40 – $10 = $27.40.
Manufactured floor mats: $16 – $10 = $6.
3. Since the Plastics Department has only 110,000 labour-hours available per year, it
must schedule its production in such a way as to maximize the contribution margin
per labour hour. The contribution margin figures per labour-hour for the various
products are given below:
Purchased
Mirrors
Contribution margin per unit (above)
(a) ................................................................
$30.00
Direct labour-hours per unit (b) ................................
—
Contribution margin per hour (a) ÷
(b) ................................................................
—
Manufactured
Mirrors
Floor Mats
$65.45
2.75 hours
$35.40
1.10 hours
$23.80
$32.18
Thus, the company should manufacture as many floor matsas possible in its
available capacity. Sufficient capacity is available to manufacture all 75,000 floor
matsplus 10,000 pairs of mirrors. The computations are on the following page.
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76
Introduction to Managerial Accounting,Fifth Canadian Edition
Teamwork in Action (continued)
(a)
Quantity
Total hours
available
Floor
Matsproduced
Mirrors –
make
Mirrors – buy
Total
contribution
margin
Less:
contribution
from present
operations:
5,000 tackle
boxes x
$65.45 CM
per box
Contribution
margin
resulting from
the above
combination
Contribution
margin from
the current
operations
Increase in
contribution
margin and
net income
(b)
(c)
(a) x (c)
(a) x (b)
Unit
DLH per Total
Balance
Total
Contribution unit
DLH
of DLH
Contribution
110,000
75,000
$35.40
1.10
82,500
27,500
$2,655,000
10,000
25,000
65.45
30.00
2.75
—
27,500
—
—
—
654,500
750,000
$4,059,500
327,250
$3,732,250
40,000
$65.45
—
—
— $2,618,000
$1,114,250
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77
Teamwork in Action (continued)
Note that the fixed costs are not relevant in any of the computations above since they
will not change regardless of which product is produced. This is true of both the
traceable fixed costs and the allocated fixed costs. Thus, the increased contribution
margin will result in an equivalent amount of increased net income for the company.
Also note that direct labour may be considered a fixed cost in this situation and could
be excluded from the calculation of the contribution margins. However, skateboards
would still be the favoured product and the net advantage of the above plan over the
current operations would still be $236,250.
Note: Some would argue that direct labour is a fixed cost in this situation and it
therefore should be excluded when computing the contribution margin per unit.
However, when deciding which products to emphasize, no harm is done by
misclassifying a fixed cost as a variable cost—providing that the fixed cost is the cost of
the constraint. If direct labour were removed from the variable cost category, the net
effect would be to bump up the contribution margin per direct labour-hour by $15 for
both the tackle box and skateboard. If there were other products, their contribution
margins per direct labour-hour would also be increased by $15. Therefore, if direct
labour has been misclassified as a variable cost, the distortion affects the absolute
levels of the contribution margin per direct labour-hour, but the products will
nevertheless be ranked correctly in order of their profitability with respect to the
utilization of the constrained resource. In other words, whether direct labour is variable
or fixed will not affect the conclusion that skateboards are the more profitable product
when direct labour-hours are the constraint.
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78
Introduction to Managerial Accounting,Fifth Canadian Edition
Chapter 10
Capital Budgeting Decisions
Solutions to Questions
10-1 Capital budgeting screening decisions
concern whether a proposed investment project
meets some present standard for acceptance,
such as a positive net present value. Capital
budgeting preference decisions relate to
choosing between several competing courses of
action, such as which of two machines to
purchase.
10-2 The term “time value of money” means
that a dollar received today is more valuable
than a dollar received in the future. A dollar
received today can be invested to generate a
return, yielding more than a dollar in a future
period.
10-3 Discounting is the process of computing
the present value of a future cash flow. The
concept gives specific recognition to the time
value of money in investment decisions.
10-4 The net present value method is
superior because it gives specific recognition to
the time value of money.
10-5 Net present value is the present value of
cash inflows promised by an investment project
less the present value of the cash outflows
associated with the project. The net present
value can be negative if the present value of the
outflows is greater than the present value of the
inflows.
10-6 No. Cost of capital is not simply the
interest paid on long-term debt. Cost of capital
involves a weighted average of the individual
costs of all sources of financing, both debt and
equity.
10-7 The internal rate of return is the rate of
return of an investment project over its useful
life. It is computed by finding the discount rate
that equates the present value of a project’s
cash inflows with the present value of its cash
outflows.
10-8 The cost of capital serves as a hurdle
that must be cleared before an investment
project will be accepted. The cost of capital is
used as the discount rate. If the net present
value of the project is positive, then the project
is acceptable, since its rate of return will be
greater than the cost of capital.
10-9 No. As the discount rate increases, the
present value of a given future cash flow
decreases. For example, the factor for a
discount rate of 12% for cash to be received ten
years from now is 0.322, whereas the factor for
a discount rate of 14% over the same period is
0.270. If the cash to be received in ten years
was $10,000, the present value in the first case
would be $3,220, but only $2,700 in the second
case. Thus, as the discount rate increases, the
present value of a given cash flow decreases.
10-10 The return is slightly more than 20%.
This is apparent since the net present value is
positive. In order for the rate of return to be
exactly 20%, the net present value would have
to be zero.
10-11 Preference decisions are sometimes
called rationing decisions since funds available
for investment are often limited, and it is
necessary to ration these funds among many
competing investment opportunities.
10-12 The profitability index is computed by
dividing the present value of the cash inflows
from an investment project by the present value
of the investment required. The index measures
the amount of cash inflow provided by each
dollar of investment in a project.
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1
10-13 The higher the profitability index, the
more desirable the investment project.
10-14 No. If the profitability index is less than
1.00, then the net present value of the project is
negative, indicating that it does not provide the
required minimum rate of return.
10-15 The payback period is the length of time
that it takes for an investment to recoup its own
initial cost out of the cash receipts that it
generates. The payback period is calculated by
dividing the investment required by the net
annual cash flow.
10-16 The payback period tells a manager how
long it will take for a project to recover its
investment. Unfortunately, a project that has a
shorter payback relative to another project
might not always be also more profitable than
the other project.
10-17 Neither method considers the time value
of money. A dollar received today is weighed
equally with a dollar received in the future.
Furthermore, the payback method ignores all
cash flows that occur after the cut-off date.
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Introduction to Managerial Accounting, Fifth Canadian Edition
The Foundational 15 (LO1-CC3,4; LO2-C10,13,14)
10-1. The depreciation expense of $535,000 is the only non-cash expense.
10-2. The annual net cash inflows are computed as follows:
Net operating income ...........................................
Add: Noncash deduction for depreciation ...............
Annual net cash inflow .........................................
$ 465,000
535,000
$1,000,000
10-3. The present value of the annual net cash inflows is computed as follows:
Item
Year(s)
Annual net cash inflows .
1-5
Cash Flow
14%
Factor
$1,000,000
Present Value
of Cash
Flows
3.433
$3,433,000
10-4. The present value of the equipment’s salvage value is computed as follows:
Item
Year(s)
Salvage value of the
equipment .................
5
Cash Flow
14%
Factor
$300,000
Present Value
of Cash
Flows
0.519
$155,700
10-5. The project’s net present value is computed as follows:
Item
Year(s)
Cost of the equipment ........................
Now
Annual net cash inflows ......................
1-5
Salvage value of the
equipment ................................ 5
Net present value...............................
Amount of
Cash Flows
$(2,975,000)
$1,000,000
$300,000
14%
Factor
1.000
3.433
Present Value of
Cash Flows
$(2,975,000)
3,433,000
0.519
$
155,700
613,700
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Solutions Manual, Chapter 10
3
The Foundational 15 (continued)
10-6. The project profitability index for the project is:
Item
Net Present
Value
(a)
Investment
Required
(b)
Project
Profitability
Index
(a) ÷ (b)
Project
$613,700
$2,975,000
0.21*
* The answer of 0.2063 was rounded to 0.21.
10-7. The payback period is determined as follows:
Year
Investment
1
2
3
4
5
$2,975,000
Cash
Inflow
Unrecovered
Investment
$1,000,000
$1,000,000
$1,000,000
$1,000,000
$1,300,000
$1,975,000
$975,000
$0
$0
$0
The investment in the project is fully recovered in the 3rd year. To be more exact,
the payback period is approximately 2.98 years.
10-8. The simple rate of return is computed as follows:
Cost of the equipment ............................................. $2,975,000
Less scrap value of equipment ................................
300,000
Initial investment .................................................... $2,675,000
Simple rate = Annual incremental net operating income
of return
Initial investment
=
$465,000
= 17.38%
$2,675,000
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Introduction to Managerial Accounting, Fifth Canadian Edition
The Foundational 15 (continued)
10-9. If the discount rate was 16% instead of 14% the project’s net present value
would be lower because the discount factors would be smaller.
10-10. The payback period would be the same because the initial investment was
recovered at the end of three years. The salvage value at the end of five years is
irrelevant to the payback calculation.
10-11. The net present value would be higher because a higher salvage value translates
into a larger cash inflow at the end of five years. If we hold the discount factor
constant (at 0.519) and discount a larger sum of money to its present value it will
increase the project’s net present value.
10-12. The first step in computing the simple rate of return is to realize that if the
salvage value increases by $200,000, then the annual depreciation expense will
decrease by $40,000 ($200,000 ÷ 5 year useful life). The $40,000 decrease in
annual depreciation expense increases the annual net operating income from
$465,000 to $505,000. The remaining computations are performed as follows:
Cost of the equipment............................................. $2,975,000
Less scrap value of equipment................................
500,000
Initial investment .................................................... $2,475,000
Simple rate = Annual incremental net operating income
of return
Initial investment
=
$505,000
= 20.4%
$2,475,000
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Solutions Manual, Chapter 10
5
The Foundational 15 (continued)
10-13. The new contribution margin would be $2,735,000 × 55% = $1,504,250. The
new net operating income would be $1,504,250 – $1,270,000 = $234,250. The
remaining calculations are as follows:
Net operating income ...........................................
Add: Noncash deduction for depreciation ...............
Annual net cash inflow .........................................
Item
Year(s)
Cost of the equipment ........................
Now
Annual net cash inflows ......................
1-5
Salvage value of the
equipment ................................ 5
Net present value...............................
Amount of
Cash Flows
$(2,975,000)
$769,250
$300,000
$234,250
535,000
$769,250
14%
Factor
Present Value of
Cash Flows
1.000
3.433
$(2,975,000)
2,640,835
0.519
155,700
$ (178,465)
10-14. The payback period is computed as follows:
Year
Investment
1
2
3
4
5
$2,975,000
Cash
Inflow
Unrecovered
Investment
$769,250
$769,250
$769,250
$769,250
$1,069,250
$2,205,750
$1,436,500
$667,250
$0
$0
The investment in the project is fully recovered in the 4th year. To be more exact,
the payback period is approximately 3.87 years.
10-15. The simple rate of return is computed as follows:
Simple rate = Annual incremental net operating income
of return
Initial investment
=
$234,250
= 8.76%
$2,675,000
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6
Introduction to Managerial Accounting, Fifth Canadian Edition
Brief Exercise 10-1 (15 minutes) (LO1 – CC4)
1.
Item
Annual cost savings
Initial investment
Net present value
Year(s)
1-8
Now
12%
Cash Flow Factor
$ 7,000
4.968
(40,000) 1.000
Present
Value of
Cash Flows
$ 34,776
(40,000)
$ (5,224)
2.
Item
Annual cost savings
Initial investment
Net cash flow
Cash Flow Years
$ 7,000
8
(40,000) 1
Total Cash
Flows
$ 56,000
(40,000)
$ 16,000
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Solutions Manual, Chapter 10
7
Brief Exercise 10-2 (20 minutes) (LO2 – CC8)
Item
Year(s)
Amount of
Cash Flows
Project X:
Initial investment ................................
Now
$(122,500)
Annual cash inflow ................................
1-10
31,500
Net present value................................
16%
Factor
1.000
4.833
Present Value
of Cash Flows
$(122,500)
152,240
$ 29,740
Project Y:
Now
$(122,500)
Initial investment ................................
Single cash inflow ................................
10
525,000
Net present value................................
1.000
0.227
(122,500)
119,175
($3,325)
Project X should be selected. Project Y does not provide the required 16% return, as
shown by its negative net present value.
Alternatively, the profitability indexes of the projects can be computed.
Profitability = Present value of cash inflows
index
Investment required
Project X:
Profitability =
$152,240
Index
122,500
= 1.24
Project Y:
Profitability =
$119,175
Index
122,500
= 0.97
Project X is preferred since its profitability index is higher.
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8
Introduction to Managerial Accounting, Fifth Canadian Edition
Brief Exercise 10-3 (15 minutes) (LO2 – CC10)
1. The profitability index for each proposal would be:
Proposal
Number
Present Value of
Cash Inflows
(a)
Investment
Required (b)
Profitability
Index
(a)  (b)
A
B
C
D
$63,000
45,000
52,500
80,000
$ 45,000
50,000
35,000
60,000
1.40
0.90
1.50
1.33
2. The ranking would be:
Proposal
Number
Profitability
Index
C
A
D
B
1.50
1.40
1.33
0.90
Two points should be noted about the ranking. First, proposal B is not an acceptable
proposal at all, since it has a profitability index of less than 1.0 (negative net present
value). Second, proposal D has the highest net present value, but it ranks lowest of
the three acceptable proposals in terms of the profitability index.
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Solutions Manual, Chapter 10
9
Brief Exercise 10-4 (15 minutes) (LO2 – CC11)
1. The payback period is determined as follows:
Year
1
2
3
4
5
6
7
8
9
10
Beginning
Unrecovered
Investment
$ –
9,000
12,000
8,000
5,000
1,000
–
–
–
–
Investment Cash Inflow
$15,000
8,000
–
–
–
–
–
–
–
–
$6,000
5,000
4,000
3,000
4,000
5,000
2,000
3,000
2,000
2,500
Ending
Unrecovered
Investment
$9,000
12,000
8,000
5,000
1,000
–
–
–
–
–
The investment in the project is fully recovered in the 6th year. To be more exact,
the payback period is approximately 5.2 years.
2. Since the investment is recovered much earlier than the last year of the project, the
amount of the cash inflow in the last year has no effect on the payback period.
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10
Introduction to Managerial Accounting, Fifth Canadian Edition
Brief Exercise 10-5 (15 minutes) (LO2 – CC15)
This is a cost reduction project, so the simple rate of return would be computed as
follows:
Cost of the new machine ................................ $120,000
Scrap value of old machine ................................ 40,000
Initial investment................................................................
$ 80,000
Operating cost of old machine ................................
$ 30,000
Operating cost of new machine ................................12,000
Annual cost savings ................................................................
$ 18,000
Cost of new machine ................................................................
$120,000
Less salvage value ................................................................
Depreciable cost of new machine ................................
120,000
10 Years
Useful life of new machine ................................
Annual depreciation on new machine ................................
$ 12,000 per year
Simple rate = Cost savings - Depreciation on new equipment
of return
Initial investment
=
$18,000 - $12,000
= 7.5%
$80,000
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Solutions Manual, Chapter 10
11
Brief Exercise 10-6 (15 minutes) (LO2 – CC11)
(numbers in thousands)
Year
0
1
2
3
Cash
Savings
$—
100
(100 × 1.40) = 140
(140 × 1.50) = 210
Cumulative
Savings
$—
100
240
450
Investment −
Cum. Savings
$ 330
230
90
–120
Payback period = 2 years + ($90/$210) = 2.4 years
Brief Exercise 10-7 (15 minutes) (LO2 – CC11)
Investment = PV factor x CF
PV Factor = Investment/CF
$100,000/$27,740 = 3.6049
For 5 years, this factor is close to 3.6048 corresponding to 12%. Thus IRR is
approximately 12%.
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12
Introduction to Managerial Accounting, Fifth Canadian Edition
Brief Exercise 10-8 (20 minutes) (LO2 – CC11, LO4 – 20C)
Note to Instructors: Please see the note below before assigning this problem to
students.
Net income before tax and depreciation
Less: Depreciation expense
Net income before tax
Less: Tax (30%)
Net income
Plus: Noncash expenses (depreciation)
Cash flow
$ 10,500
(10,000)
500
(150)
350
10,000
$ 10,350
Payback period = Net Investment ÷ Cash flow when the annual cash flow is level.
However, in this case there is cash flow from salvage in year 5.
After 4 years, the unrecovered investment will be:
$70,000 – 4($10,350)
= $70,000 − $41,400
= $28,600
In year 5 the total cash flow will be:
$10,350 + $20,000 = $30,350
It will take 12 x ($28,600 ÷ $30,350) = 11.31 months to recover this balance. Thus the
payback period is 4 years and 11.31 months.
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Solutions Manual, Chapter 10
13
Brief Exercise 10-8 (continued)
Note to instructors: This problem requires students to determine cash flow. Either an
approach that builds up cash flows from net income can be used as in the above (i.e.,
the Indirect Method) or the approach that separates the Depreciation tax shields as
illustrated in the demonstration problem in the Appendix 10C may be used. This latter
approach (the tax shield approach) is as follows:
Cash Flow = (cash outlays for investment) + after-tax revenues – after-tax expenses –
increases in working capital needs + release of working capital + salvage value +
Depreciation tax shield
The tax shield = Depreciation x tax rate
Since Depreciation is $10,000 and the tax rate is 30%, the tax shield is 10,000 × 0.3 =
$3,000. The after-tax income from savings in costs is:
(1 – 0.3) × $10,500 = $7,350.
Thus cash flow each year will be:
Cash flow
= after-tax cost savings + tax shield
= $7,350 + $3,000
= $10,350.
All other terms in the cash flow equation are zero in this problem and thus not relevant.
A review of this material can be helpful to students, since some of the exercises and
problems in this chapter will require students to determine cash flow in this manner.
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14
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 10-1 (30 minutes) (LO1 – CC4; LO2 – CC8)
Item
Amount of
Year(s) Cash Flows
Cost of new equipment ................................
Now
R(206,250)
Working capital required................................
Now
(75,000)
Net annual cash receipts ................................
1–4
90,000
Cost to construct new roads ................................
3
(30,000)
Salvage value of equipment ................................
4
48,750
Working capital released................................
4
75,000
Net present value................................
20%
Factor
1.000
1.000
2.589
0.579
0.482
0.482
Present Value
of Cash
Flows
R(206,250)
(75,000)
233,010
(17,370)
23,498
36,150
R (5,962)
No, the project should not be accepted; it has a negative net present value at a 20%
discount rate.
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Solutions Manual, Chapter 10
15
Exercise 10-2 (30 minutes) (LO2 – CC8)
Item
Year(s)
Amount of Cash
Inflows
14%
Factor
Project A:
Cost of equipment ................................
Now
$(325,000)
Annual cash inflows ................................
1–6
67,650
Salvage value of the
6
21,200
equipment ................................
Net present value................................
Project B:
Working capital
investment ................................
Now
$(325,000)
1-6
54,400
Annual cash inflows ................................
Working capital
released ................................
6
325,000
Net present value................................
Present Value
of Cash Flows
1.000
3.889
$(325,000)
263,091
0.456
9,667
$ (52,242)
1.000
3.889
$(325,000)
211,562
0.456
148,200
$ 34,762
Project B is the better project. Project A is not acceptable at all, since it has a negative
net present value.
Alternatively, the profitability indexes of the projects can be computed.
Profitability = Present value of cash inflows
index
Investment required
Project A:
Profitability = $263,091+$9,667 = $272,758 = 0.84
Index
$325,000
$325,000
Project B:
Profitability =
$211,562+$148,200 = $359,762 = 1.11
Index
$325,000
$325,000
Project B is preferred since its profitability index is higher and is greater than 1.
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16
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 10-3 (30 minutes) (LO2 – CC8)
Item
Amount of Cash
Inflows
Year(s)
18%
Factor
Project X:
Initial investment ................................
Now
$(35,000)
Annual cash inflows ................................
1–10
9,000
Net present value................................
Project Y:
Initial investment ................................
Now
Cash flow at the end of
10 years ................................
10
Net present value................................
Present Value
of Cash Flows
1.000
4.494
$(35,000)
40,446
$ 5,446
$(35,000)
1.000
$(35,000)
150,000
0.191
28,650
(6,350)
$
Project X is the better project. Project Y is not acceptable at all, since it has a negative
net present value.
Alternatively, the profitability indexes of the projects can be computed.
Profitability = Present value of cash inflows
index
Investment required
Project X:
Profitability =
Index
$40,446 = 1.1556
$35,000
Project Y:
Profitability =
Index
= $28,650 = 0.82
$35,000
Project X is preferred since its profitability index is higher and is greater than 1.0
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Solutions Manual, Chapter 10
17
Exercise 10-4 (20 minutes) (LO2 – CC10)
1. The formula for the profitability index is:
Profitability index =
Present value of cash inflows
Investment required
The index for the projects under consideration would be:
Project
Project
Project
Project
Project
1:
2:
3:
4:
5:
$336,140 ÷ $270,000 = 1.24
$522,970 ÷ $450,000 = 1.16
$379,760 ÷ $400,000 = 0.95
$433,400 ÷ $360,000 = 1.20
$567,270 ÷ $480,000 = 1.18
2. (a) and (b)
Net Present
Value
First preference ................................
5
Second preference ................................
4
Third preference ................................
2
Fourth preference ................................
1
Fifth preference ................................
3
Profitability
Index
1
4
5
2
3
3. On balance, the profitability index is generally regarded as the most dependable
method of ranking competing projects. The net present value is inferior to the
profitability index as a ranking device, since it looks only at the total amount of net
present value from a project and does not consider the amount of investment
required. For example, it ranks project #1 as fourth in terms of preference because
of its low net present value; yet this project is the best available in terms of the
amount of cash inflow generated for each dollar of investment (as shown by the
profitability index).
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18
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 10-5 (20 minutes) (LO2 – CC11, 15)
1. The payback period would be:
Payback Period
=
Investment required_
Net annual cash inflow
=
¥216,000
¥45,000
=
4.8 years
No, the equipment would not be purchased, since the payback period (4.8 years)
exceeds the company’s maximum payback time (4.0 years).
2.
The simple rate of return would be:
Simple rate of return = Cost savings-Depreciation
Initial investment
= ¥45,000 – ¥18,000
¥216,000
= 12.5%
*¥216,000 ÷ 12 years = ¥18,000 per year.
No, the equipment would not be purchased, since the rate of return that it promises
(12.5%) is less than the company’s required rate of return (14%).
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Solutions Manual, Chapter 10
19
Exercise 10-6 (15 minutes) (LO2 – CC8)
Year(s)
Amount of
Cash Flows
Purchase of the shares ................................
Now
$(20,000)
Annual cash dividends ................................
1-3
620
Sale of the stock ................................
3
22,000
Net present value................................
14%
Factor
1.000
2.322
0.675
Present Value
of Cash
Flows
$(20,000)
1,440
14,850
$ (3,710)
No, Kathy did not earn a 14% return on the Malti Company shares. She would only
receive at least a 14% return if the present value of cash flows was >0.
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20
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 10-7 (30 minutes) (LO2 – CC8, 13)
1.
Factor of the internal = Investment in the project
rate of return
Annual cash inflow
=
$136,700
= 5.468
$25,000
Looking in Exhibit 10-2 and scanning along the 14-period line, a factor of 5.468
represents an internal rate of return of 16%.
2.
Item
Year(s)
Amount of
Cash Flows
Initial investment ................................
Now
$(136,700)
Net annual cash
inflows ................................
1-14
25,000
Net present value ................................
16%
Factor
Present Value of
Cash Flows
1.000
$(136,700)
5.468
136,700
$
0
The reason for the zero net present value is that 16% (the discount rate we have
used) represents the machine’s internal rate of return. The internal rate of return is
the rate that causes the present value of a project’s cash inflows to just equal the
present value of the investment required.
3.
Factor of the internal = Investment in the project
rate of return
Annual cash inflow
=
$136,700
= 6.835
$20,000
Looking in Exhibit 10-2 and scanning along the 14-period line, the 6.835 factor is
closest to 6.982, the factor for the 11% rate of return. Thus, to the nearest whole
percent, the internal rate of return is 11%.
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Solutions Manual, Chapter 10
21
Exercise 10-8 (20 minutes) (LO2 – CC13)
In this problem the cash flows are a mixture of an annuity (Cost savings for 4 years)
and a lump sum ($10,000 salvage in year 4) and the initial investment of $90,000).
Therefore either a trial and error approach or the use of Excel is recommended.
First determine the annual after-tax cash flows. This is:
EBITDA (i.e earnings before interest, tax and depreciation) x (1-T) + depreciation tax
shields
EBITDA per year, from the new machine are:
$1,000 + (500,000 bars × $0.05/bar) = $26,000.
After-tax this is $26,000 x 0.80 = $20,800.
Depreciation tax shields are: Annual depreciation x tax rate = ($90,000 - $10,000)/8 x
0.2 = $2,000. The after tax cash flows are
$20,800 + $2,000 = $22,800.
Trial and Error approach
Given cash flow of $22,800 per year for 4 years, trial and error shows
If i = 6%, NPV = –$90,000 + ($22,800 × 3.465*) + ($10,000 × 0..792**) = – 3,078.
If i = 4%, NPV = $-90,000 + ($22,800 x 3.63**) + (10,000 x 0.855) = $1,314.
*4-year annuity factor is from Exhibit 10-2
**4-year present value factor is from Exhibit 10-1
The IRR should be below 6%. It will be higher than 4%. This is all that can be said on
the basis of the present value tables.
Excel Solution
Cash Flows
Year 0
Year 1
Year 2
Year 3
Year 4
-90,000
22,800
22,800
22,800
32,800
IRR
4.5812%
NOTE: The annual cash flow can be also determined by determining the net
income after tax and adding back depreciation.
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22
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 10-9 (20 minutes) (LO2 – CC11, 15)
1.
Payback Period
Step 1: Net income
Add: Noncash deduction for depreciation
Net annual cash inflow
$40,000
35,000
$75,000
Step2: Cost of new equipment
$300,000
Total Investment required
$300,000
Payback period = Investment required ÷ Net annual cash inflow
= $300,000 ÷ $75,000
= 4 years
Nick’s Novelties should purchase the equipment as it has a payback period of 4 years
which is less than 5.
2.
Simple rate of return
Simple rate of return = Cost savings-Depreciation
Initial investment
= $75,000 – $35,000
$300,000
= 13.3%
Yes, the equipment should be purchased, since the rate of return that it promises (13.3%)
is more than the company’s required rate of return (12%).
3.
Item
Year(s)
Amount of
Cash Flows
Initial investment ................................
Now
$(300,000)
Net annual cash
inflows ................................
1-8
75,000
Salvage value of
equipment
8
20,000
Net present value ................................
18%
Factor
1.000
Present Value of
Cash Flows
$(300,000)
4.078
305,850
0.266
$
4,980
11,170
Yes, Nick’s novelties should purchase the machine as it has a positive NPV.
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Solutions Manual, Chapter 10
23
Problem 10-1 (30 minutes) (LO2 – CC8)
1. The net annual cash inflows would be:
Reduction in annual operating costs:
Operating costs, present hand method ................................ $30,000
Operating costs, new machine ...................................................7,000
Annual savings in operating costs ...............................................
23,000
Increased annual contribution margin:
6,000 boxes × $1.50 per box .....................................................9,000
Total net annual cash inflows ........................................................
$32,000
2.
Item
Year(s)
Amount of
Cash Flows
Cost of the machine ................................
Now
$(120,000)
Replacement of parts ................................
6
(9,000)
Annual cash inflows (above) ................................
1-12
32,000
Salvage value of the machine ................................
12
7,500
Net present value ................................
20%
Factor
1.000
0.335
4.439
0.112
Present Value
of Cash Flows
$(120,000)
(3,015)
142,048
840
$ 19,873
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24
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 10-2 (45 minutes) (LO2 – CC8)
1. Average weekly use of the auto wash and the vacuum will be:
Auto wash: $2,700 = 900 uses
$3
Vacuum: 900 × 70% = 630 uses
The expected net annual cash receipts will be:
Auto wash cash receipts ($2,700 × 52) ................................
$140,400
Vacuum cash receipts (630 × $0.50 × 52) ................................
16,380
Total cash receipts................................................................
$156,780
Less cash disbursements:
Water (900 × $0.46 × 52) .........................................................
$21,528
Electricity (630 × $0.20 × 52) ....................................................
6,552
Rent ($3,400 × 12) ................................................................
40,800
Cleaning ($900 × 12) ................................................................
10,800
Insurance ($150 × 12) ..............................................................
1,800
Maintenance ($1,000 × 12) .......................................................
12,000
Total cash disbursements ..............................................................
93,480
Net annual cash receipts ............................................................... $63,300
2.
Item
Year(s)
Amount of
Cash Flows
Cost of equipment ................................
Now
$(300,000)
Now
(4,000)
Working capital needed ................................
Net annual cash receipts (above) ................................
1-8
63,300
Salvage of equipment ................................
8
30,000
8
4,000
Working capital released ................................
Net present value ................................
10%
Factor
1.000
1.000
5.335
0.467
0.467
Present Value
of Cash Flows
$(300,000)
(4,000)
337,706
14,010
1,868
$ 49,584
Yes, Mr. Duncan should open the auto wash. It promises more than a 10% rate of
return.
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Solutions Manual, Chapter 10
25
Problem 10-3 (45 minutes) (LO2 – CC8)
1. The total-cost approach:
Item
Year(s)
Amount of
Cash Flows
Purchase the new truck:
Initial investment— new truck ................................
Now
$(55,000)
Salvage of the old truck ................................
Now
14,000
Annual cash operating costs ................................
1-8
(8,500)
Salvage of the new truck ................................
8
4,000
Present value of the net cash
outflows ................................................................
Keep the old truck:
Overhaul needed now ................................
Now
$ (8,000)
Annual cash operating costs ................................
1-8
(11,000)
Salvage of the old truck ................................
8
1,000
Present value of the net cash
outflows ................................................................
Net present value in favour of
keeping the old truck ................................
16%
Factor
1.000
1.000
4.344
0.305
Present Value
of Cash
Flows
$(55,000)
14,000
(36,924)
1,220
$(76,704)
1.000
4.344
0.305
$ (8,000)
(47,784)
305
$ (55,479)
$21,225
The company should keep the old truck, since it has the lowest present value of total
cost.
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26
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 10-3 (continued)
2. The incremental-cost approach:
Item
Year(s)
Amount of
Cash Flows
Incremental investment—new
Now
$(47,000) *
truck ................................................................
Salvage of the old truck ................................
Now
14,000
Savings in annual cash
operating costs................................
1-8
2,500
Difference in salvage value in 8
8
3,000
years ................................................................
Net present value in favour of
purchasing the new truck................................
Present Value
16%
of Cash
Factor
Flows
1.000
1.000
$(47,000) *
14,000
4.344
10,860
0.305
915
$(21,225)
*$55,000 – $8,000 = $47,000. The $14,000 salvage value now of the old truck could
also be deducted, leaving an incremental investment for the new truck of only
$33,000.
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Solutions Manual, Chapter 10
27
Problem 10-4 (45 minutes) (LO2 – CC8)
The net annual cash inflow from rental of the property would be:
Net income, as shown in the problem ................................
$32,000
Add back Depreciation ................................................................
16,000
Net annual cash inflow ................................................................
$48,000
Given this figure, the present value analysis would be as follows:
Item
Year(s)
Amount of
Cash Flows
12%
Factor
Present
Value of
Cash Flows
Keep the property:
Annual mortgage payment ................................
1-8
$(12,000)
Net annual cash inflow ................................
1–15
48,000
Resale value of the property ................................
15
230,000 *
Present value of cash flows ................................
4.968
6.811
0.183
$ (59,616)
326,928
42,090
$309,402
Sell the property:
Pay-off of mortgage ................................
Now
$(90,000)
Down payment received ................................
Now
175,000
Annual payments received................................
1–15
26,500
Present value of cash flows ................................
1.000
1.000
6.811
$(90,000)
175,000
180,492
$265,492
Net present value in favour of
keeping the property................................
$ 43,910
*Land, $50,000 × 3 = $150,000, plus building, $80,000 = $230,000.
Thus, Professor Martinas should be advised to keep the property. Note that even if the
property were worth nothing at the end of 15 years, it would still be more desirable to
keep the property rather than sell it under the terms offered by the realty company.
(309,402 – 42,090 = 267,312 vs 265,492)
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28
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 10-5 (30 minutes) (LO2 – CC8, 10)
1. The formula for the profitability index is:
Profitability = Present value of cash inflows
index
Investment required
The profitability index for each project would be:
Project A:
$480,000 + $132,969 = $612,969;
$612,969 ÷ $480,000 = 1.28
Project B:
$405,000 + $126,000 = $531,000;
$531,000 ÷ $405,000 = 1.31
Project C:
$300,000 + $105,105 = $405,105;
$405,105 ÷ $300,000 = 1.35
Project D: $525,000 + $114,408 = $639,408;
$639,408 ÷ $525,000 = 1.22
Project E:
$450,000 + $(26,088) = $423,912;
$423,912 ÷ $450,000 = 0.94
Note that investment required + NPV of project = PV of cash inflows.
2. (a) and (b)
Net Present Value
First preference ................................ A
Second preference ................................
B
Third preference ................................D
Fourth preference ................................
C
Fifth preference ................................ E
Profitability Index
C
B
A
D
E
3. The profitability index is generally regarded as the most dependable method of
ranking competing projects. The net present value is inferior to the profitability
index as a ranking device, since it looks only at the total amount of net present
value from a project and does not consider the amount of investment required. For
example, it ranks project C as fourth in terms of preference because of its low net
present value; yet this project is the best in terms of the amount of cash inflow
generated for each dollar of investment (as shown by the profitability index).
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 10
29
Problem 10-6 (30 minutes) (LO2 – CC11, 15)
1. The incremental income statement would be:
Ticket revenue (50,000 × $3.60) ................................
$180,000
Less operating expenses:
Salaries ................................................................ $85,000
Insurance ................................................................ 4,200
Utilities ................................................................ 13,000
Depreciation ................................................................
27,500 *
Maintenance ................................................................
9,800
Total operating expenses .............................................................. 139,500
Net income ................................................................
$ 40,500
*$330,000 ÷ 12 years = $27,500 per year.
2. The simple rate of return would be:
Net income
Simple rate =
of return
Initial investment - Salvage from old equipment
=
$40,500
$40,500
=
= 15.0%
$330,000 - $60,000
$270,000
Yes, the water slide would be constructed. It is return is greater than the specified
hurdle rate of 14%.
3. The payback period would be:
Payback = Initial investment - Salvage from old equipment
period
Net annual cash inflow
=
$330,000 - $60,000
$270,000
=
= 3.97 years (rounded)
$68,000*
$68,000*
*$40,500 net income + $27,500 depreciation = $68,000.
Yes, the water slide would be constructed. The payback period is within the
maximum 5 years required by Mr. Sharkey.
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30
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 10-7 (60 minutes) (LO2 – CC11, 15)
1. (a) Sales revenue ................................................................
Less variable production expenses (@ 20%)................................
Contribution margin ................................................................
Less fixed expenses:
Advertising ................................................................$ 40,000
Salaries .....................................................................................
110,000
Utilities ......................................................................................
5,200
Insurance ................................................................
800
Depreciation ................................................................ 29,077 *
Total fixed expenses ................................................................
Net income ................................................................
$300,000
60,000
240,000
185,077
$ 54,923
* [$420,000 – (10% × $420,000)] ÷ 13 years = $29,077.
(b) The formula for the simple rate of return is:
Incremental - Incremental expenses,
including depreciation
Simple rate = revenue
of return
Initial Investment
=
Incremental net income
Initial investment
=
$54,923
= 13.1%
$420,000
(c) The formula for the payback period is:
Payback period =
=
Investment required
Net annual cash inflow
$420,000
= 5 years
$84,000*
*$54,923 net income + $29,077 depreciation = $84,000.
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Solutions Manual, Chapter 10
31
Problem 10-7 (continued)
2. (a) A cost reduction project is involved here, so the formula for the
simple rate of return would be:
Simple rate of return =
Cost savings - Depreciation
Initial
- Salvage from
investment old equipment
The reduction in costs with the new equipment would be:
Annual costs, old equipment ................................
$78,000
Annual costs, new equipment:
Salary of operator ................................................................
$16,350
Maintenance ................................................................
5,400
21,750
Annual savings in costs ................................................................
$56,250
Thus, the simple rate of return would be:
$56,250 - $18,000*
$38,250
=
= 17%
$234,000 - $9,000
$225,000
*$234,000 ÷ 13 years = $18,000.
(b) The formula for the payback period remains the same as in Part 1, except we
must reduce the investment required by the salvage from sale of the old
equipment:
Investment - Salvage from
required
old equipment
Payback period =
Net Annual Cash Inflow
=
$234,000 - $9,000
$225,000
=
= 4 years
$56,250*
$56,250*
*See Part 2(a) above.
3. According to the company’s criteria, machine B should be purchased. Machine A
does not meet either the required minimum rate of return or the 4-year payback
period or the required rate of return of 15%.
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32
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 10-8 (60 minutes) (LO2 – CC8)
1. A net present value computation for each investment follows:
Item
Year(s)
Common shares:
Purchase of the shares ................................
Now
Sale of the shares ................................
3
Net present value................................
Amount of
Cash Flows
16%
Factor
Present
Value of
Cash Flows
$ (95,000)
160,000
1.000
0.641
$ (95,000)
102,560
$
7,560
Preferred shares:
Purchase of the shares ................................
Now
$ (30,000)
Annual cash dividend (6%)................................
1-3
1,800
Sale of the shares ................................
3
27,000
Net present value................................
1.000
2.246
0.641
$ (30,000)
4,043
17,307
$ (8,650)
Bonds:
Purchase of the bonds................................
Now
$ (50,000)
Semi-annual interest received ................................
1-6*
3,000
Sale of the bonds ................................
6*
52,700
Net present value................................
1.000
4.623**
0.630**
$ (50,000)
13,869
33,201
$ (2,930)
* 6 semi-annual interest periods.
** Factors for 6 periods at 8%. (As stated in the text, we must halve the
discount rate and double the number of periods.)
Linda earned a 16% rate of return on the common shares, but not on the preferred
shares or the bonds.
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Solutions Manual, Chapter 10
33
Problem 10-8 (continued)
2. Considering all three investments together, Linda did not earn a 16% rate of return.
The computation is:
Net Present
Value
Common shares ................................................................
$ 7,560
Preferred shares ................................
(8,650)
Bonds ................................................................
(2,930)
Overall net present value ................................
$(4,020)
The defect in the broker’s computation is that it does not consider the time value of
money and therefore has overstated the rate of return earned.
3.
Factor of the internal = Investment required
rate of return
Annual cash inflow
Substituting the $239,700 investment and the factor for 14% for 12 periods into this
formula, we get:
$239,700
= 5.660
Annual cash inflow
Therefore, the required net annual cash inflow would be:
$239,700 ÷ 5.660 = $42,350.
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34
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 10-9 (40 minutes) (LO2 – CC13)
1.
Factor of the internal = Investment in the project
rate of return
Annual cash inflow
=
$358,950
= 4.10
$87,500
From Exhibit 10-2, reading along the 7-period line, a factor of 4.10 equals a rate of just
below 16%.
Verification of the 16% rate of return:
Item
Year(s)
Amount of
Cash Flows
Investment in equipment ................................
Now $(358,950)
Annual cash inflows ................................
1–7
87,500
Net present value................................
16%
Factor
1.000
4.039
Present Value
of Cash Flows
$(358,950)
353,413
$ (5,537)
At the 14% rate, the NPV works out to $16,250. This means the rate of return is
between 14% and 16% but closer to 16% (approximately 15.5%).
2. (a) 5-year life for the equipment:
The factor for the internal rate of return would still be 4.10 (as computed in question 1
above). From Exhibit 10-2, reading this time along the 5-period line, a factor of 4.10 is
the factor for 7%.
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 10
35
Problem 10-9 (continued)
2. (b)
9-year life for the equipment:
The factor of the internal rate of return would again be 4.10. From Exhibit 10-2,
reading along the 9-period line, a factor of 4.10 is closest to 4.163, the factor for
19%. Thus, to the nearest whole percent, the internal rate of return is 19%.
The 7% return in part (a) is less than the 14% minimum return that Dr. Floss
wants to earn on the project. Of equal or even greater importance, the following
diagram should be pointed out to Dr. Floss:
2 years shorter
5
years
7%
2 years longer
7
years
15%
A reduction of 8%
9
years
19%
An increase of only 4%
As this illustration shows, a decrease in years has a much greater impact on the
rate of return than an increase in years. This is because of the time value of
money; added cash inflows far into the future do little to enhance the rate of
return, but loss of cash inflows in the near term can do much to reduce it.
Therefore, Dr. Floss should be very concerned about any potential decrease in
the life of the equipment, while at the same time realizing that any increase in
the life of the equipment will do little to enhance her rate of return.
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36
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 10-9 (continued)
3. Since the cash flows are not even over the five-year period (there is an extra
$101,375 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-anderror or more sophisticated methods, it turns out that the actual internal rate of
return will be about 3%:
Item
Year(s)
Amount of
Cash Flows
Investment in the equipment ................................
Now
$(358,950)
Annual cash inflow ................................1-5
60,000
Sale of the equipment ................................
5
101,375
Net present value................................
3%
Present Value
Factor of Cash Flows
1.000
4.580
0.863
$(358,950)
274,800
87,487
$ 3,337
The net present value is zero at the IRR. The exact IRR is around 3.27%.
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 10
37
Problem 10-10 (45 minutes) (LO2 – CC11, 13, 15)
€190,000
1. Labour savings................................................................
Ground mulch savings ................................................................
10,000
€200,000
Less out-of-pocket costs:
Operators ................................................................
70,000
Insurance ................................................................1,000
Fuel ................................................................
9,000
Maintenance contract ................................................................
12,000
92,000
Annual savings in cash operating costs ................................
€108,000
2. The formula for the simple rate of return when a cost reduction project is involved is
as follows:
Simple rate of return =
=
Cost savings – Depreciation on new equipment
Initial investment
€108,000 – €40,000*
= 14.2% (rounded)
€480,000
*Depreciation is calculated as follows:
€480,000
= €40,000 per year
12 years
3. The formula for the payback period is:
Payback period =
=
Investment required
Net annual cash inflow
€480,000
= 4.4 years (rounded)
108,000*
* In this case, the cash inflow is measured by the annual savings in cash
operating costs.
The harvester meets Mr. Despinoy’s payback criterion since its payback period is less
than 5 years.
Copyright © 2017 McGraw-Hill Education. All rights reserved.
38
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 10-10 (continued)
4. The formula for the internal rate of return is:
Factor of the internal = Investment required
rate of return
Net annual cash inflow
=
€480,000
= 4.4 (rounded)
€108,000
Looking at Exhibit 10-2, and reading along the 12-period line, a factor of 4.4 would
represent an internal rate of return of approximately 20%.
Note that the payback and internal rate of return methods would indicate that the
investment should be made. The simple rate of return method indicates the opposite
since the simple rate of return is less than 16%. The simple rate of return method
generally is not an accurate guide in investment decisions.
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 10
39
Problem 10-11 (50 minutes) (LO2 – CC8)
1.
Item
Year(s)
Amount of
Cash Flows
Purchase of fleet:
Initial payment— cars ................................
Now
$(170,000)
Annual cost of servicing, taxes
and licensing ................................ 1–3
(3,000)
Repairs – Year 1
1
(1,500)
Repairs – Year 2
2
(4,000)
Repairs – Year 3
3
(6,000)
3
85,000
Resale value of the fleet ................................
Present value of cash outflows ................................
Lease of cars:
Initial deposit................................ Now
$ (10,000)
Lease payments ................................ 1-3
(55,000)
Return of deposit ................................3
10,000
Present value of cash outflows ................................
Net present value in favour of
leasing the cars ................................
18%
Factor
Present Value
of Cash Flows
1.000
$(170,000)
2.174
0.847
0.718
0.609
0.609
(6,522)
(1,271)
(2,872)
(3,654)
51,765
$(132,554)
1.000
2.174
0.609
$ (10,000)
(119,570)
6,090
$(123,480)
$
9,074
This is a least-cost decision.
2. The company should consider leasing the fleet of cars based on the calculation
above.
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40
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 10-12 (40 minutes) (LO2 – CC13, 15; Chapter 3 LO3 – CC16)
1. The incremental income statement would be:
Sales revenue ................................................................
$300,000
Less operating expenses:
Rent ($3,500 × 12) ................................................................
$42,000
Ingredients ($300,000 × 20%) ................................ 60,000
Commission ................................................................
37,500
Depreciation ................................................................
16,800 *
Operating costs ................................................................
100,500
Total operating expenses .............................................................. 256,800
Net income ................................................................
$ 43,200
*($270,000 - $18,000) ÷ 15 years = $16,800 per year.
2. The simple rate of return would be:
Simple rate of return = Net income ÷ (Initial investment – salvage value)
= $43,200 ÷ ($270,000 – $18,000)
= $43,200 ÷ $252,000 = 17.14%
Yes, the franchise should be acquired. Its return is greater than the specified hurdle
rate of 12%.
3. The payback period would be:
Payback period = Initial Investment / Net annual cash inflow
= $270,000 ÷ $60,000
= 4.5 years
No, the franchise should not be acquired. The payback period is greater than the
maximum 4 years required by Mr. Swanson.
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Solutions Manual, Chapter 10
41
Comprehensive Problem (LO2 – CC8, 10, 11, 13; Chapter 9 LO1 – CC3)
Note to the instructor: This question resembles Problem 9-1.
1. a. and b.
Keep Old
Machine
5 Year Summary
Buy New
Machine
Sales ($2,500,000 × 5
years) ................................ $12,500,000
$12,500,000
Selling and administrative
expenses ($1,575,000
× 5 years) ................................7,875,000
7,875,000
Operating costs ................................
2,625,000
875,000
Depreciation of the old
machine, or loss writeoff ................................................................
625,000
625,000 *
Salvage value—old
machine ................................ —
(125,000)*
Depreciation—new
machine ................................
1,125,000
Total expenses ................................
11,125,000
10,375,000
Net operating income ................................
$ 1,375,000
$ 2,125,000
Difference
$ -0-
-01,750,000
-0125,000
(1,125,000)
750,000
$ 750,000
* In a formal income statement, these two items should be shown as a
single $500,000 “loss from disposal” figure.
The new machine should be purchased. The savings in operating costs over the next
five years will exceed the net investment by $750,000.
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42
Introduction to Managerial Accounting, Fifth Canadian Edition
Comprehensive Problem (continued)
2.
The results of the analysis are shown below.
Notes:
1. Annual operating cost savings = $525,000 - $175,000. From Chapter 9 we can
recollect that the cost of the old machine is irrelevant because it is a sunk cost.
2.
At 16% discount rate, the cumulative present value factor for five years (from
Exhibit 10-2) is 3.274. This results in total present value of cash flows to be
$350,000 × 3.274 = $1,145,900. This amount can also be computed by adding
the discounted cash flows from years 1 through 5 (Row 10; Columns D through
H).
3.
The cumulative cash flow is $50,000 at the end of 3 years. This means that it
requires less than 3 years for the cumulative cash flow to reach 0. This is why
the payback period is just under 3 years.
4.
IRR was computed using the IRR function in Microsoft Excel.
5.
Total present value of cash flows received = $1,145,900. Therefore profitability
index = $1,145,900 ÷ $1,000,000 = 1.146.
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Solutions Manual, Chapter 10
43
Comprehensive Problem (continued)
The three different analyses suggest that the president should invest in the new
machine. The net present value is positive; the IRR exceeds the discount rate of 16%
and the profitability index is greater than 1.
Thinking Analytically (60 minutes) (LO2 – CC8)
1. Some students will have difficulty organizing the data into a coherent format.
Perhaps the clearest approach is as follows:
Item
Year(s)
Amount of
Cash Flows
16%
Factor
Present Value
of Cash Flows
Purchase of facilities:
Initial payment— property ................................
Now
$(350,000)
Annual payments— property ................................
1–4
(175,000)
Annual cash operating costs ................................
1–18
(20,000)
18
500,000
Resale value of the property ................................
Present value of cash outflows ................................
1.000
2.798
5.818
0.069
$(350,000)
(489,650)
(116,360)
34,500
$(921,510)
Lease of facilities:
Initial deposit................................ Now
$ (8,000)
Now
(120,000)
First lease payment ................................
Remaining lease payments ................................
1–17
(120,000)
Annual cost of repairs, etc. ................................
1–18
(4,500)
Return of deposit ................................18
8,000
Present value of cash outflows ................................
1.000
1.000
5.749
5.818
0.069
$ (8,000)
(120,000)
(689,880)
(26,181)
552
$(843,509)
Net present value in favour of
leasing the facilities ................................
$ 78,001
This is a least-cost decision, and, as shown above, the simplest way to handle the
data is by means of the total-cost approach. The problem with Sam Watkin’s
approach, in which he simply added up the payments, is that it ignores the time
value of money. The purchase option ties up large amounts of funds that could be
earning a return elsewhere which is why the present value is better for the lease
option.
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44
Introduction to Managerial Accounting, Fifth Canadian Edition
Thinking Analytically (continued)
Another way to organize the data is by means of the incremental-cost-approach,
although this approach is harder to follow and would not be as clear in a
presentation to the executive committee. The data could be arranged as follows
(students will have many variations):
Buy rather than lease:
Item
Year(s)
Incremental initial payment ................................
Now
$(230,000)
Deposit avoided by purchasing ................................
Now
8,000
Annual payments— property ................................
1-4
(175,000)
1-17
120,000
Lease payments avoided ................................
Additional cash operating costs ................................
1-18
(15,500)
Difference between resale value
and deposit at end ................................
18
492,000
Net present value................................
1
2
3
16%
Factor
Amount of
Cash Flows
1
2
3
Present Value
of Cash Flows
1.000
1.000
2.798
5.749
5.818
$(230,000)
8,000
(489,650)
689,880
(90,179)
0.069
33,948
$ (78,001)
$350,000 – $120,000 = $230,000.
$20,000 – $4,500 = $15,500.
$500,000 – $8,000 = $492,000.
2. If Sam Watkins brings up the issue of the building’s future sales value, then it should
be pointed out that a property that can be sold for $500,000 in 18 years has a
present value of only $34,500 if a company can invest money at 16%. In other
words, a high future sale value is often worth very little in terms of present value
when money can be invested at a high rate of return, such as in the case of TopQuality Stores. Note that the building’s resale value could be three times as high in
18 years (i.e., $1,500,000) and the lease alternative would still be the best course to
follow.
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Solutions Manual, Chapter 10
45
Communication in Practice (LO1 – CC4; LO2 – CC13, 15)
Date:
Current date
To:
Instructor
From: Student’s Name
Subject:
Capital Budgeting Discussion with
Controller or Chief Financial Officer
Even though not specifically required, the student’s memorandum should include the
name, title and job affiliation of the individual interviewed. Also, in addition to
summarizing general information about the company (that was obtained from the
company’s web site), each student’s memorandum should address the following:
1. The nature of the capital project.
2. The total cost of the capital project.
3. Whether or not the project costs stayed within budget.
4. The financial criteria used to evaluate the project.
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46
Introduction to Managerial Accounting, Fifth Canadian Edition
Teamwork in Action (LO1 – CC4; LO2 – CC8, 10)
1. This is a least-cost problem; it can be worked either by the total-cost approach or by
the incremental-cost approach. Both solutions are given below. Regardless of which
approach is used, we must first compute the annual production costs that would
result from each of the machines. The computations are:
Year
1
2
Units produced ................................
40,000
60,000
$32,000
$48,000
Model 400: Total cost
at $0.80 per unit ................................
Model 800: Total cost
$24,000
$36,000
at $0.60 per unit ................................
3
4–10
80,000
$64,000
90,000
$72,000
$48,000
$54,000
Using this data, the solution by the total-cost approach would be:
Item
Year(s)
Amount of
Cash
Flows
Alternative 1: Purchase the
model 400 machine:
Now
$(170,000)
Cost of a new machine................................
Cost of a new machine................................
7
(200,000)
Market value of the
10
140,000
replacement machine ................................
Production costs (above) ................................
1
(32,000)
Production costs (above) ................................
2
(48,000)
Production costs (above) ................................
3
(64,000)
Production costs (above) ................................
4-10
(72,000)
Repairs and maintenance ................................
1-10
(5,000)
Present value of cash
flows ................................
20%
Factor
Present
Value of
Cash
Flows
1.000
0.279
0.162
$(170,000)
(55,800)
22,680
0.833
0.694
0.579
2.086 *
4.192
(26,656)
(33,312)
(37,056)
(150,192)
(20,960)
$(471,296)
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 10
47
Teamwork in Action (continued)
Item
Year(s)
Amount of
Cash
Flows
Alternative 2: Purchase the
model 800 machine:
Cost of a new machine................................
Now
$(300,000)
Production costs (above) ................................
1
(24,000)
2
(36,000)
Production costs (above) ................................
Production costs (above) ................................
3
(48,000)
Production costs (above) ................................
4-10
(54,000)
1-10
(3,800)
Repairs and maintenance ................................
Present value of cash
flows ................................
Net present value in favour
of purchasing the model
400 machine ................................
20%
Factor
1.000
0.833
0.694
0.579
2.086 *
4.192
Present
Value of
Cash
Flows
$(300,000)
(19,992)
(24,984)
(27,792)
(112,644)
(15,930)
$(501,342)
$ 30,046
* Present value factor for 10 periods ................................................................
4.192
Present value factor for 3 periods ................................................................
2.106
Present value factor for 7 periods starting 4 periods in the
future ................................................................................................
2.086
When doing an analysis by the incremental-cost approach, it is necessary to proceed
from a perspective of one of the two alternatives. Since the model 800 is the more
costly of the two, we will proceed from the perspective of this alternative. The
computations are provided on the following page.
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48
Introduction to Managerial Accounting, Fifth Canadian Edition
Teamwork in Action (continued)
Item
Year(s)
Amount of
Cash
Flows
Incremental cost of the
Now
$(130,000)
model 800 machine:
Cost avoided on a
7
200,000
replacement model 400
machine ................................
Market value foregone on
10
(140,000)
the replacement ................................
1
8,000
Savings in production costs ................................
Savings in production costs ................................
2
12,000
Savings in production costs ................................
3
16,000
Savings in production costs ................................
4-10
18,000
Savings on repairs and
1-10
1,200
maintenance costs ................................
Net present value ................................
20%
Factor
1.000
Present
Value of
Cash Flows
$(130,000)
0.279
55,800
0.162
(22,680)
0.833
0.694
0.579
2.086
4.192
6,664
8,328
9,264
37,548
5,030
$(30,046)
Therefore, the company should purchase a second model 400 machine, rather
than purchase the model 800 machine.
2. An increase in labour costs would make the model 800 machine more desirable. The
reason is that labour cost per unit of product is only $0.16 on the model 800
machine, as compared to $0.49 per unit on the model 400 machine.
3. An increase in materials cost would make the model 800 machine less desirable. The
reason is that materials cost per unit of product is $0.40 on the model 800 machine,
as compared to only $0.25 per unit on the model 400 machine.
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Chapter 10
49
Appendix 10A
The Concept of Present Value
Brief Exercises
Brief Exercise 10A-1 (30 minutes) (LO1 CC3A)
1. (a)
From Exhibit 10-2, the factor for 16% for 8 periods is 4.344. Therefore,
the maximum purchase price would be:
$7,000 × 4.344 = $30,408
(b)
From Exhibit 10-2, the factor for 20% for 8 periods is 3.837. Therefore,
the maximum purchase price would be:
$7,000 × 3.837 = $26,859
2. (a)
From Exhibit 10-2, the factor for 12% for 20 periods is 7.469. Thus, the
present value of Mr. Ormsby’s winnings is:
$80,000 × 7.469 = $597,520
(b)
Whether or not it is correct to call him the state’s newest millionaire
depends on your point of view. He will receive more than a million
dollars over the next 20 years; however, he is not a millionaire at this
point in time as shown by the present value computation above, nor will
he ever be a millionaire if he spends his winnings rather than investing
them.
3. (a)
From Exhibit 10-1, the factor for 10% for 5 periods is 0.621. Therefore,
the company must invest:
$500,000 × 0.621 = $310,500
(b)
From Exhibit 10-1, the factor for 14% for 5 periods is 0.519. Therefore,
the company must invest:
$500,000 × 0.519 = $259,500
Solutions Manual, Appendix 10A
Copyright © 2017 McGraw-Hill Education. All rights reserved.
1
Appendix 10C
Income taxes in Capital Budgeting Decisions
Brief Exercises
Brief Exercise 10C-1 (10 minutes) (LO4 – CC21C)
CCA tax shield:
Cdt x 1+ .5k – Sdt x (1+k)-n
d +k 1+k
d+k
12,400×0.17×0.33 1+0.5×0.08
×
-0=2,679.50
0.17+0.08
1.08
Exercises
Exercise 10C-1 (15 minutes) (LO4 – CC20C, 21C)
1. Management consulting fee ................................
$100,000
Multiply by (1 – 0.30) ................................
× 0.70
After-tax cost ................................................................
$ 70,000
2. Increased revenues ................................
$40,000
Multiply by (1 – 0.30) ................................
× 0.70
After-tax cash flow (benefit) ................................
$28,000
3.
Year
Undepreciated
Capital Cost
1
2
3
Solutions Manual, Appendix 10C
$210,000
178,500
124,950
CCA
31,500
53,550
37,485
Tax
Saving
9,450
16,065
11,246
PV Factor
10%
.909
.826
.751
PV of Tax
Savings
8,590.05
13,269.69
8,445.75
Copyright © 2017 McGraw-Hill Education. All rights reserved.
1
Exercise 10C-2 (20 minutes) (LO4 – CC21C, 22C)
Items and
Computations
Year(s)
(1)
Amount
(2)
Tax
Effect
Project A:
Investment in
photocopier ................................
Now
$(62,500)
—
1-8
11,250 1 – 0.30
Net annual cash inflows ................................
Salvage value of the
photocopier ................................
8
6,250
(1) × (2)
After-Tax
Cash
Flows
$(62,500)
7,875
6,250
Presen
t Value
10% of Cash
Factor Flows
1.000 $(62,500)
5.335 42,013
0.467
CCA tax shield:
_Cdt_ x 1+ .5k – _Sdt_ x (1+k)-n
d+k
1+k
d+k
= $62,500 x .2 x .3 x 1.05 – $6,250 x .2 x .3 x .467
.2 + .10
1.10
.2+.10
= ($12,500 x .9545) – ($1,250 x .467) = $11,348
______
$ (6,220)
Net present value……...........
Project B:
Investment in working
capital ................................Now
$(62,500)
—
Net annual cash inflows ................................
1-8
11,250 1 – 0.30
Release of working
capital ................................ 8
62,500
—
Net present value ................................
Solutions Manual, Appendix 10C
2,919
11,348
$(62,500)
7,875
62,500
1.000 $(62,500)
5.335 42,013
0.467
29,188
$ 8,701
Copyright © 2017 McGraw-Hill Education. All rights reserved.
2
Exercise 10C-3 (20 minutes) (LO4 – CC22C)
1. Annual cost of student help in collating ................................
Annual cost of the new collating machine:
Operator ...................................................................................
$18,000
Maintenance ................................................................
7,000
Net annual cost savings (cash inflow) ................................
$60,000
25,000
$35,000
2. The net present value analysis follows:
Items and Computations
(1)
Amount
Year(s)
Cost of the new collating
Now
machine ................................
Net annual cost savings
(above) ................................
1–15
Salvage value of the new
machine ................................15
Cost of the new roller
pads ................................ 8
CCA tax shield:
(2)
Tax Effect
$(170,000)
35,000
(1) × (2)
After-Tax
Cash Flows
$(170,000)
1 – 0.40
40,000
(20,000) 1 – 0.40
14%
Factor
Present
Value of
Cash Flows
1.000
$(170,000)
21,000
6.142
128,982
40,000
0.140
5,600
(12,000)
0.351
(4,212)
41,990
_Cdt_ x 1+ .5k – Sdt x (1+k)-n
d +k
1+k
d+k
= $170,000 x .3 x .4 x 1.07 – $40,000 x .3 x .4 x .14
.3 + .14
1.14
.3+.14
= ($46,363.64 x .9386) – ($10,909.09 x .14)
= $43,516.91 + $1,527.27 ≈$41,990
Net present value ................................
_______
$ 2,360
Yes, the new collating machine should be purchased.
Solutions Manual, Appendix 10C
Copyright © 2017 McGraw-Hill Education. All rights reserved.
3
Exercise 10C-4 (15 minutes) (LO2 – CC11; LO4 – 21C, 22C)
1. Present value of cash inflows (after taxes):
= ($180,000)(1 – 0.4)(6.811) = $735,588
2. Present value of CCA tax saving (since salvage is 0, the tax shields extend into
perpetuity):
= ($800,000)(0.1)(0.4) × 1+0.5(0.12)
0.10 + 0.12
1+ 0.12
= $137,662
3. The investment required is the cost of the machine and the cost to train the
staff. The after-tax cost of training will be 60% × $90,000 = $54,000. Therefore
the investment required is $800,000 + $54,000 = $854,000. The payback period
is:
$854,000/[$180,000(1 – 0.40)] = 7.91 years
Solutions Manual, Appendix 10C
Copyright © 2017 McGraw-Hill Education. All rights reserved.
4
Exercise 10C-5 (30 minutes) (LO2 – CC11, 15; LO4 – 22C)
1. Total net investment:
Investment for the new vat
Sale of the old vat
Total net investment
Annual net cash flow:
Net income before taxes and depreciation
Less: Depreciation expense
Net income before taxes
Less: Income tax (30%)
Net income
Plus: Non-cash expenses
Annual net cash flow
Payback period
=
=
=
$20,000
(2,000)
$18,000
$8,000
(4,000)
4,000
(1,200)
2,800
4,000
$6,800
Net investment / Annual net cash flow
$18,000 / $6,800
2.65 years
2. Simple rate of return:
SRR
= Annual net income ÷ Net original investment outlay
= $2,800 ÷ $18,000
= 15.56%
Solutions Manual, Appendix 10C
Copyright © 2017 McGraw-Hill Education. All rights reserved.
5
Exercise 10C-5 (continued)
3. Net present value:
Item
Net
Investment
Cash flow
PV of CCA
tax shield*
NPV
Years
0
1–5
Amount
10% PV of Cash
Factor
Flow
$ (18,000) 1.0000
$8,000(1 – 0.3)
3.791
$(18,000)
21,230
3,436
$6,666
* CCA tax shield:
Cdt × 1+ .5k – Sdt × (1+k)-n
d+k
1+k
d+k
= $18,000×0.20×0.30 × 1 + 0.5(0.10) – $0 = $3,436
0.20 + 0.10
1 + 0.10
4. The new vat should be purchased because the net present value is positive.
Solutions Manual, Appendix 10C
Copyright © 2017 McGraw-Hill Education. All rights reserved.
6
Exercise 10C-6 (40 minutes) (LO2 – CC8, 13; LO4 – CC22C)
1. Net present value (NPV):
Cost of the new machine
Installation costs
Proceeds from old equipment
Training cost = $50,000(1 – 0.4)
Contribution margin lost on the 125 units:
[125] x 102 x (1 – 0.4)
PV of cost savings, year 1:
$225,000 (8/12) (1 – 0.4)(0.909)
PV of cost savings, years 2–10:
$225,000(1 – 0.4)(5.7590)(0.909)
PV of tax saving from CCA*
Net present value
$ (950,000)
(15,500)
500
(30,000)
$(995,000)
(7,650)
81,810
706,716
245,636
$ 31,512
*CCA tax shield is:
($950,000 + $15,500 – $500)(0.2)(0.4) x 1 + 0.5(0.1)
0.1 + 0.2
1 + 0.1
= $245,636
The company should purchase the machine since the NPV is positive.
Solutions Manual, Appendix 10C
Copyright © 2017 McGraw-Hill Education. All rights reserved.
7
Exercise 10C-6 continued
2.
The IRR is 10.9%. In order to compute the IRR we first list the after-tax cash flows as follows:
0
1
2
3
4
5
6
7
8
9
10
Cost of equipment
Installation
Proceeds from sale of old equipment
Training
Lost contribution margin
Cost savings
CCA tax shield
$
$
$
$
$
(950,000)
(15,500)
500
(30,000)
(7,650)
Net after-tax cash flows
$ (1,002,650) $128,600 $ 204,480 $ 190,584 $ 179,467 $ 170,574 $ 163,459 $ 157,767 $ 153,214 $ 149,571 $ 193,284
$ 90,000 $ 135,000 $ 135,000 $ 135,000 $ 135,000 $ 135,000 $ 135,000 $ 135,000 $ 135,000 $ 135,000
$ 38,600 $ 69,480 $ 55,584 $ 44,467 $ 35,574 $ 28,459 $ 22,767 $ 18,214 $ 14,571 $ 58,284
The internal rate of return is 10.9%, calculated using the IRR formula in Microsoft Excel. This is consistent with the fact
that the investment has a positive NPV (as shown in part 1).
Notes:
1. The year 0 numbers are computed as shown above in Part 1.
2. The after-tax cost savings are 60% of $225,000 for the years 2 to 10. In the first year, the savings is for 8 months
rather than the full year ($135,000 ˣ 8/12).
3. The PV of tax shield formula used above cannot be used because we need a discount rate in order to complete the
formula. Therefore, the CCA tax shield amounts for each year is calculated as shown in the table below. Note
that in the tenth year the entire UCC is considered as the depreciation amount (or the CCA amount).
Copyright © 2017 McGraw-Hill Education. All rights reserved.
Solutions Manual, Appendix 10C
8
Exercise 10C-6 (continued)
UCC
$
$
$
$
$
$
$
$
$
$
CCA rate CCA amount
965,000
868,500
694,800
555,840
444,672
355,738
284,590
227,672
182,138
145,710
10%
20%
20%
20%
20%
20%
20%
20%
20%
20%
$
$
$
$
$
$
$
$
$
$
96,500
173,700
138,960
111,168
88,934
71,148
56,918
45,534
36,428
145,710
CCA tax shield
$
$
$
$
$
$
$
$
$
$
38,600
69,480
55,584
44,467
35,574
28,459
22,767
18,214
14,571
58,284
Note: The CCA tax shield is 40% of the CCA amount.
Solutions Manual, Appendix 10C
Copyright © 2017 McGraw-Hill Education. All rights reserved.
9
Exercise 10C-7 (30 minutes) (LO2 – CC8; LO4 – CC22C)
Initial investment outlay
Proceeds from old equipment
Total net investment
$ 1,249,000
(95,000)
$ 1,154,000
Annual net cash flow, years 1 and 2:
Income before income taxes and depreciation
($3,450,000 – $3,320,000)
Less: Depreciation expense*
Income before income taxes
Less: Income tax (35%)
Net income
Plus: Noncash expenses
Annual net cash flow, years 1 and 2
$ 130,000
(100,583)
29,417
(10,296)
19,121
100,583
$ 119,704
Annual net cash flow, years 3 to 12:
Income before income taxes and depreciation
($3,320,000 – $3,118,000 + $130,000)
Less: Depreciation expense*
Income before income taxes
Less: Income tax (35%)
Net income
Plus: Noncash expenses
Annual net cash flow, years 3 to 12
$332,000
(100,583)
231,417
(80,996)
150,421
100,583
$251,004
*($1,249,000 − $42,000) ÷ 12 = $100,583
NPV = -$1,154,000 + $119,704(1.69) + $251,004(5.65)(0.797)
= $178,583.33
The company should purchase the new machine.
Solutions Manual, Appendix 10C
Copyright © 2017 McGraw-Hill Education. All rights reserved.
10
Exercise 10C-7 (continued)
Alternative Solution Approach
Item
Outlay 0
Income
Income
Years
10%
PV of Cash
Factor
Flow
(1,154,000)
1
(1,154,000)
1–2
130,000(0.65)
1.69
142,805
3–12
332,000(0.65)
5.65
971,758.19
0.797
CCA Tax
Shields
1–12
Present value
Amount
100,583(0.35)
6.194
_218,053.89_
$178,617.08
(The difference of $34 is due to rounding.)
Solutions Manual, Appendix 10C
Copyright © 2017 McGraw-Hill Education. All rights reserved.
11
Exercise 10C-8 (45 minutes) (LO2 – CC8, 13; LO4 – CC22C)
Note: Instructors might not want to assign part (b) if students are not experienced in
using a spreadsheet.
(a) Net Present Value (NPV)
Net investment ($155,000 – $23,000)
PV of cash flow, years 1 to 3
[$20,000 (1 – 0.40) × 2.322]
PV of cash flow, years 4 to 12
[($20,000 + $5,000)(1 – 0.40)(4.946#)(0.675*)]
PV of tax saving from Depreciation:
$132,000(0.2)(0.4) ×
1 + (0.5)(0.14)
0.2 + 0.14
1 + .14
PV of loss of tax saving due to salvage value:
[($30,000)(0.2)(0.4) ÷ (0.2 + 0.14)] × (1.14)-12
PV of salvage value
[$30,000 × (1.14)-12]
NPV
$ (132,000)
27,864
50,078
29,152
(1,465)
6,227
$ (20,144)
#This is the 9-year annuity factor at a discount rate of 14% and provides the value of
the annuity in year 3.
*This is the 3-year present value factor, which discounts the value of the annuity in
year 3 to year 0.
The company should not purchase the new equipment since the NPV is negative.
(b) Determination of IRR:
We recommend that a trial and error approach be used. A spreadsheet to calculate the
NPV for various values of the discount rate should be set up. We recommend that the
format of the answer for part a. be followed.
The IRR will be approximately 10.5% (the NPV is $10.22). See below for screen shot of
the Excel spreadsheet showing that NPV is $10.22 when the discount rate is 10.5%.
Solutions Manual, Appendix 10C
Copyright © 2017 McGraw-Hill Education. All rights reserved.
12
Exercise 10C-8 (continued)
Spreadsheet showing NPV of Project at a cost of capital of 10.5%:
Items and computations
Cost of Equipment
Net operating cash flow after tax
Net operating cash flow after tax
CCA Tax shields:
Equipment
Salvage proceeds, Equipment
Net present value
Supporting Calculations:
CCA tax shield Calculations
Present value of CCA tax shield
assuming asset is kept forever
less
the present value of CCA tax shield
lost on disposal
Present value of CCA tax shield
Present
value of
after-tax
cash flows
(132,000.00)
29,581.48
62,772.61
Year(s)
Now
1--3
4-12
Amount
($132,000)
$20,000
$25,000
Tax
effect
Nil
0.6
0.6
After-tax
cash flow
($132,000)
$12,000
$15,000
10.5%
factor
1
2.47
4.18#
Now
10
$30,603.51
$30,000.00
Nil
Nil
$30,603.51
$30,000.00
1
0.302
Now
$32,977.97
Nil
$32,977.97
1.00
$32,977.97
12
$7,868.85
Nil
$7,868.85
0.30
2,374.46
$30,603.51
30,603.51
9,052.61
$10.22
Note to Instructors:
# Note that this factor adjusts for the fact that the cash flows from years 4 to 12 is an
9 year annuity which must be discounted three years from year 3 to year 0. It is
calculated as follows:
PV factor = 9-year annuity factor × 3-year present value factor
These factors are not available in the present value tables. They were calculated using
Excel’s financial functions. Students may require assistance in using these functions.
Solutions Manual, Appendix 10C
Copyright © 2017 McGraw-Hill Education. All rights reserved.
13
Problems
Problem 10C-1 (30 minutes) (LO4 – CC22C)
(2)
Tax
(1)
Effect
Items and Computations Year(s) Amount
Investment in new
trucks ................................
Now $(900,000)
Salvage from sale of the
old trucks ................................
Now
60,000
Net annual cash
receipts ................................
1-8
216,000 1 – 0.30
CCA tax shield:
(1) × (2)
After-Tax
Cash Flows
$(900,000)
12%
Factor
1.000
Present
Value of
Cash Flows
$(900,000)
60,000
1.000
60,000
151,200
4.968
751,162
166,889
(63,000)
0.567
(35,721)
40,000
0.404
PV = _Cdt_ x 1+ .5k – _Sdt_ x (1+k)-n
d +k
1+k
d+k
($900,000 - $60,000) x .3 x .3 x _1.06_ – $40,000 x .3 x .3 x .404
.3 + .12
1.12
.3+.12
= ($180,000 x .9464) – ($8,571.43 x .404) =$166,889
Overhaul of motors................................
5
(90,000) 1 – 0.30
Salvage from the new
8
40,000
trucks ................................
Net present value ................................
16,160
$ 58,490
Since the project has a positive net present value, the contract should be accepted.
Solutions Manual, Appendix 10C
Copyright © 2017 McGraw-Hill Education. All rights reserved.
14
Problem 10C-2 (30 minutes) (LO4 – CC22C)
1. The net present value analysis would be:
Items and Computations Year(s)
(1)
Amount
(2)
Tax Effect
Investment in
equipment ................................
Now
$(600,000)
Now
(85,000)
Working capital needed................................
Net annual cash
receipts ................................
1–10
110,000 1 – 0.30
CCA tax shield:................................
1–10
(1) × (2)
After-Tax
Cash Flows
Present
Value of
10%
Factor Cash Flows
$(600,000) 1.000
(85,000) 1.000
77,000
6.145
$(600,000)
(85,000)
473,165
107,592
Cdt_ x 1+ .5k – _Sdt_ x (1+k)-n
d+k
1+k
d+k
= 600,000 x .2 x .3 x 1.05 – 90,000 x .2 x .3 x .386
.2 + .10
1.10
.2 +.10
= ($120,000 x .954) – ($24,000 x .386) =$107,592
Cost of restoring land ................................
10
(70,000) 1 – 0.30
Salvage value of the
10
90,000
equipment ................................
Working capital
released ................................
10
85,000
Net present value ................................
(49,000) 0.386
90,000
0.386
85,000
0.386
(18,914)
34,740
32,810
$ (55,607)
2.
No, the investment project should not be undertaken. It has a negative net
present value when the company’s cost of capital is used as the discount rate.
Solutions Manual, Appendix 10C
Copyright © 2017 McGraw-Hill Education. All rights reserved.
15
Problem 10C-3 (30 minutes) (LO4 – CC22C)
Items and Computations
Year(s)
Investment in the
business ................................
Now
Net annual cash receipts
($200,000 – $185,000
= $15,000)................................
1–12
CCA tax shield
(1) × (2)
After-Tax
Cash
(2)
(1)
Flows
Amount Tax Effect
$(97,500)
—
15,000
1 – 0.35
8%
Factor
$(97,500) 1.000
Present
Value of
Cash
Flows
$(97,500)
9,750
7.536
73,476
10,232
55,000
0.397
21,835
$ 8,043
Cdt x 1+ .5k – Sdt x (1+k)-n
d+k 1+k
d+k
= $42,500 x .2 x .35 x 1.04 – $0 x 0.2 x 0.35 x 397
.2 + .08
1.08
.2 + .08
= ($10,625 x .963) – $0 = $10,232
Recovery of working
capital
($97,500 – $42,500 =
$55,000) ................................
12
55,000
Net present value ................................
—
The net present value is $8,043. This suggests that the store should be purchased.
However, Lee should also carefully consider the qualitative factors of owning a business.
Solutions Manual, Appendix 10C
Copyright © 2017 McGraw-Hill Education. All rights reserved.
16
Problem 10C-4 (40 minutes) (LO2 – CC11; LO4 – CC22C)
1.
Initial investment:
Cost of new equipment
Sale of old equipment
Total initial investment
$ 2,850,000
(200,000)
$ 2,650,000
2.
Total net savings:
Savings on operating costs less cost of hiring
another operator
Years 1–3:
[($1,500,000 × 30%) – $30,000] × (1 – 0.4)
= $252,000 × 3
Years 4–10:
[($1,500,000 × 40%) – $30,000] × (1 – 0.4)
= $342,000 × 7
Total net savings
3.
Net present value:
Initial investment
Present value of operating savings:
Years 1–3:
$252,000 × 2.4018
Years 4–10:
$342,000 × 4.5638 × (1.12)-3
Present value of tax shield#
Present value of lost tax shield##
Present value of salvage value:
$525,000 × (1.12)-10
Net present value of the project
$ 756,000
2,394,000
$ 3,150,000
$ (2,650,000)
605,254
1,110,961
716,581
(48,300)
169,050
$ (96,933)
This project has a negative present value.
Solutions Manual, Appendix 10C
Copyright © 2017 McGraw-Hill Education. All rights reserved.
17
Problem 10C-4 (continued)
3. (continued)
# Present value of CCA Tax Shield:
(1,650,000) X 0.3 x 0.4 x (0.42)^-1 x (1.12)^-1 X (1.06) = 716,581.64
## Present value of lost tax shield from disposal:
525,000×0.3×0.4
×1.1210  48,300
0.3+0.12
4.
Initial investment
Net annual savings:
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Year 7
Year 8
$ 2,650,000
$252,000
252,000
252,000
342,000
342,000
342,000
342,000
342,000
$ 2,466,000
RW2 should reject this project because the payback period for the equipment is longer
than 8 years—i.e., at the end of the 8th year only $2,466,000 of the initial investment of
$2,650,000 has been recovered.
Alternative solution format for part (c) is presented on the following page.
Solutions Manual, Appendix 10C
Copyright © 2017 McGraw-Hill Education. All rights reserved.
18
Problem 10C-4 (continued)
Alternative solution format: (difference is due to rounding)
Items and
computations
Outlay
Net operating cash
flow after tax
Net operating cash
flow after tax
CCA Tax shields:
Equipment
Salvage proceeds,
Equipment
Net present value
Supporting
Calculations:
CCA tax shields
Calculations
Present value of CCA
tax shields assuming
asset is kept forever
less the present value
of CCA tax shields lost
on disposal
Present value of CCA
tax shields
Solutions Manual, Appendix 10C
After-tax
cash flow
(2,700,000)
12%
factor
1
Present value
of after-tax
cash flows
(2,650,000)
Year(s)
Now
Amount
(2,650,000)
Tax
effect
nil
1--3
420,000
(1 - .40)
252,000
2.402
605,304
4-10
570,000
(1 - .40)
342,000
3.250
1,111,500
Now
681,806
nil
681,806
1
10
525,000
nil
525,000
0.322
Now
$716,581
nil
$716,581
1.00
$716,581
12
$150,000.00
nil
$150,000.00
0.32
48,295.99
668,285
169,050
($95,860)
$668,285
Copyright © 2017 McGraw-Hill Education. All rights reserved.
19
Problem 10C-5 (25 minutes) (LO4 – CC22C)
1. Project Net Present Value
Investment in new equipment:
Cost ($1,170,000 + $30,000)
Sale of old equipment
Net investment
$ (1,200,000)
210,000
(990,000)
Present value of net income increase:
$250,000(1 – 0.35)(5.216)
847,600
Present value of CCA tax shield#
Net present value of the project
208,477
$ 66,077
# Present value of tax shield:
990,000×0.250.35 1.07
×
 208,477
0.25+0.14
1.14
Watertransport Inc. should invest in the new high-technology equipment because the
net present value is positive.
2. ROI performance
500,000
 20%
2,500,000
This is simply the ratio of net income to assets.
Actual ROI =
With the project, ROI will be:
Year 1:
Income will increase by $250,000(1 – 0.35) to $500,000 + $162,500 = $662,500.
Assets will increase by a net amount of $990,000 – $990,000(0.25) to $2,500,000 +
$742,500 = $3,242,500.
Therefore, ROI will be $662,500 ÷ $3,242,500 = 20.4%.
Solutions Manual, Appendix 10C
Copyright © 2017 McGraw-Hill Education. All rights reserved.
20
Problem 10C-5 (continued)
2. (continued)
Year 2
Income in year 2 will be $662,500, and assets will be $2,500,000 + $742,500 –
$742,500(0.25) = $3,056,875.
Therefore, ROI will be $662,500 ÷ $3,056,875 = 21.7% (rounded up).
Interpretation
Mr. V’s performance will vary over the next two years. In year 1, the project will have
an ROI comparable to the actual, and the canoe division will not show much
improvement. However, beginning in year 2, its ROI will be higher. Mr. V will then
benefit from the investment.
Solutions Manual, Appendix 10C
Copyright © 2017 McGraw-Hill Education. All rights reserved.
21
Problem 10C-6 (40 minutes) (LO2 – CC8; LO4 – CC22C)
After-tax cost of capital: 9%
Investment
Cost of the new sewing machine
Market value of the old machine
Training costs $85,000(1 – 0.40)
Net investment
Item
Outlay
Cash Flows
Maint. Cost
PV of Salvage
PV of CCA tax
shield1
PV of lost CCA
tax shield on
salvage value2
Net Present
Value
Year
0
1
2
3
4
5
6
7
5
7
Amount
$(2,291,000)
390,000
400,000
411,000
426,000
434,000
435,000
436,000
(95,000)
380,000
$(2,500,000)
260,000
(51,000)
$(2,291,000)
Tax
Effect
—
(1 – 0.40)
(1 – 0.40)
(1 – 0.40)
(1 – 0.40)
(1 – 0.40)
(1 – 0.40)
(1 – 0.40)
(1 – 0.40)
—
After-Tax
Cash Flow
$(2,291,000)
234,000
240,000
246,600
255,600
260,400
261,000
261,600
(57,000)
380,000
9%
PV of
Factor
Cash Flow
1.0000 $(2,291,000)
0.9174
214,672
0.8417
202,008
0.7722
190,425
0.7084
181,067
0.6499
169,234
0.5963
155,634
0.5470
143,095
0.6499
(37,044)
0.5470
207,860
592,420
(57,344)
$(328,973)
CCA Tax Shield Computations:
1. PV of CCA tax shield
($2,500,000 – $260,000)(0.2)(0.4) × 1 + 0.5(0.09) = $592,420
0.2 + 0.09
1.09
2. PV of CCA tax shield lost due to salvage
380,000×0.2×0.4
×(1.09)7 =57,344
0.2+0.09
Recommendation: The new sewing machine should not be purchased because the net
present value is negative.
Solutions Manual, Appendix 10C
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22
Chapter 11
Standard Costs and Variance Analysis
Solutions to Questions
11-1 A quantity standard indicates how much
of an input should be used to make a unit of
output. A price standard indicates what the cost
of the input should be.
11-2 Ideal standards do not allow for any
imperfections or inefficiencies. Thus, ideal
standards are rarely, if ever, attained. Practical
standards allow for normal inefficiency, machine
breakdown time, etc., and can be attained by
employees working at a reasonable, though
efficient pace.
11-3 A variance is any deviation from the
standard where actual costs are compared with
standard costs. In a standard cost system, there
are at least two types of variances. The price
variance focuses on the difference between
standard and actual prices. The quantity
variance is concerned with the difference
between the standard quantity of input allowed
for the actual output and the actual amount of
the input used.
11-4 Under the management by exception
approach, a manager’s attention should be
directed toward those parts of the organization
where the actual results are significantly
different from the plans.
11-5 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 labour efficiency variance
generally is also the responsibility of the
production managers and supervisors.
11-6 The materials price variance can be
computed either when materials are purchased
or when they are placed into production. It is
better to compute the variance when materials
Solutions Manual, Chapter 11
are purchased. This permits earlier recognition
of the variance, since materials can remain in
the warehouse for some time before being used
in production. In addition, this allows the
company to carry its raw materials in the
inventory accounts at standard cost, which
greatly simplifies bookkeeping.
11-7 If used as punitive tools, standards can
undermine goal setting and can breed
resentment toward the organization. Standards
must never be used as an excuse to conduct
witch-hunts, or as a means of finding someone
to blame for problems.
11-8 Poor quality materials can unfavourably
affect the labour efficiency variance. If the
materials are unsuitable for production, the
result could be an excessive use of labour time
and therefore an unfavourable labour efficiency
variance. Poor quality materials would not
ordinarily affect the labour rate variance.
11-9 The variable overhead efficiency
variance and the direct labour efficiency variance
will always be favourable or unfavourable
together. Both are dependent on the number of
direct labour-hours actually worked as compared
to the standard hours allowed. That is, in each
case the formula is:
SR (AH – SH) = Efficiency Variance
Only the “SR” part of the formula differs for the
two variances.
11-10 If labour is a fixed cost and standards
are tight, then the only way to generate
favourable labour 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
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1
production process produce at capacity, the
bottleneck will be unable to process all of the
work-in-process. In general if a workstation with
higher capacity precedes a work station with
lower capacity, work-in-process inventories will
build up in front of the work station with lower
capacity if every work station is attempting to
produce at capacity.
11-11 A static budget is a budget geared
toward a single planned level of activity as
determined at the beginning of the period. It
remains unchanged even if the activity level
changes.
11-12 A flexible budget is a budget that is
geared to a range of activity, rather than to a
single level. Since a flexible budget is geared to
a range of activity, it is dynamic in nature. A
budget can be tailored for any level of activity
within the relevant range, even on an after-thefact basis. By contrast, a static budget is geared
for only one activity level.
11-13 If flexible budget data are based on
actual hours worked, then only a spending
variance will be produced on the performance
report. Both a spending and an efficiency
variance will be produced if flexible budget data
are based on both actual hours and standard
hours.
11-14 Standard hours allowed means the time
that should have been taken to complete the
period’s output.
11-15 The materials price variance consists
entirely of differences in price paid from
standard. The variable overhead spending
variance consists of two elements. One element
is like a price variance and results from
differences between actual and standard prices
for variable overhead inputs. The other element
is like a quantity variance and results from
differences between the amount of variable
overhead inputs that should have been used and
the amounts that were actually used. Ordinarily
these two elements are not separated.
11-16 The overhead efficiency variance does
not really measure efficiency in the use of
overhead. It actually measures efficiency in the
use of the base underlying the flexible budget.
This base could be direct labour-hours, machinehours, and so forth.
11-17 The denominator level of activity is the
denominator used in the calculation of the
predetermined overhead rate.
11-18 In the job-order costing chapter we
were dealing with a normal cost system,
whereas in this chapter we are dealing with a
standard cost system. Standard costing ensures
that each unit of product bears the same
amount of overhead cost regardless of any
variations in efficiency of the use of the
application base.
11-19 The fixed overhead budget variance
compares actual to budgeted costs for fixed
overhead items. If actual costs exceed budgeted
costs, the variance is labelled unfavourable.
11-20 The volume variance is favourable when
the activity for a period, at standard, is greater
than the denominator activity level. Conversely,
if the activity level, at standard, is less than the
denominator level of activity, the volume
variance is unfavourable. The variance does not
measure deviations in spending. It measures
deviations in actual activity from the
denominator level of activity.
11-21 The under- or over-applied overhead
can be factored into variable overhead spending
and efficiency variances and fixed overhead
budget and volume variances.
11-22 The total overhead variances would be
favourable, since over-applied overhead is
equivalent to a favourable variance.
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2
Introduction to Managerial Accounting, Fifth Canadian Edition
The Foundational 15 (LO2-CC12, LO3-CC15, 16, 17, 18, LO4-CC21, 22, 23, 24)
11-1, 11-2, and 11-3.
The raw materials cost included in the flexible budget (SQ × SP = $1,200,000), the
materials quantity variance ($80,000 U), and the materials price variance ($80,000 F)
can be computed using the general model for cost variances as follows:
Actual Quantity of Input,
at Actual Price
(AQ × AP)
160,000 pounds ×
$7.50 per pound
= $1,200,000
Actual Quantity of Input,
at Standard Price
(AQ × SP)
160,000 pounds ×
$8.00 per pound
= $1,280,000
Standard Quantity Allowed
for Actual Output,
at Standard Price
(SQ × SP)
150,000 pounds* ×
$8.00 per pound
= $1,200,000
Materials price variance =
Materials quantity
$80,000 F
variance = $80,000 U
Flexible budget variance = $0
*30,000 units × 5 pounds per unit = 150,000 pounds
Alternatively, the variances can be computed using the formulas:
Materials quantity variance = SP (AQ – SQ)
= $8.00 per pound (160,000 pounds – 150,000 pounds)
= $80,000 U
Materials price variance = AQ (AP – SP)
= 160,000 pounds ($7.50 per pound – $8.00 per pound)
= $80,000 F
Solutions Manual, Chapter 11
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3
The Foundational 15 (continued)
11-4 and 11-5.
The materials quantity variance ($80,000 U), and the materials price variance ($85,000
F) can be computed as follows:
Actual Quantity
of Input,
at Actual Price
(AQ × AP)
170,000 pounds ×
$7.50 per pound
= $1,275,000
Actual Quantity
of Input,
at Standard Price
(AQ × SP)
(Purchases)
170,000 pounds ×
$8.00 per pound
= $1,360,000
Standard Quantity Allowed
for Actual Output,
at Standard Price
(SQ × SP)
150,000 pounds* ×
$8.00 per pound
= $1,200,000
Materials price variance
= $85,000 F
160,000 pounds ×
$8.00 per pound
= $1,280,000
(Usage)
Materials quantity variance
= $80,000 U
*30,000 units × 5 pounds per unit = 150,000 units
Alternatively, the variances can be computed using the formulas:
Materials quantity variance = SP (AQ – SQ)
= $8.00 per pound (160,000 pounds – 150,000 pounds)
= $80,000 U
Materials price variance = AQ (AP – SP)
= 170,000 pounds ($7.50 per pound – $8.00 per pound)
= $85,000 F
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Introduction to Managerial Accounting, Fifth Canadian Edition
The Foundational 15 (continued)
11-6, 11-7, and 11-8.
The direct labor cost included in the flexible budget (SH × SR = $840,000), the labor
efficiency variance ($70,000 F), and the labor rate variance ($55,000 U) can be
computed using the general model for cost variances as follows:
Standard Hours Allowed
Actual Hours of Input,
Actual Hours of Input,
for Actual Output,
at Actual Rate
at Standard Rate
at Standard Rate
(AH × AR)
(AH × SR)
(SH × SR)
55,000 hours ×
55,000 hours ×
60,000 hours* ×
$15 per hour
$14.00 per hour
$14.00 per hour
= $825,000
= $770,000
= $840,000
Labor rate variance
Labor efficiency variance
= $55,000 U
= $70,000 F
Flexible budget variance = $15,000 F
*30,000 units × 2.0 hours per unit = 60,000 hours
Alternatively, the variances can be computed using the formulas:
Labor efficiency variance = SR (AH – SH)
= $14.00 per hour (55,000 hours – 60,000 hours)
= $70,000 F
Labor rate variance = AH (AR – SR)
= 55,000 hours ($15.00 per hour – $14.00 per hour)
= $55,000 U
Solutions Manual, Chapter 11
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5
The Foundational 15 (continued)
11-9, 11-10, and 11-11.
The variable overhead cost included in the flexible budget (SH × SR = $300,000), the
variable overhead efficiency variance ($25,000 F), and the variable overhead rate
variance ($55,000 U) can be computed using the general model for cost variances as
follows:
Actual Hours of Input,
at Actual Rate
(AH × AR)
= $280,500
Actual Hours of Input,
at Standard Rate
(AH × SR)
55,000 hours ×
$5.00 per hour
= $275,000
Standard Hours Allowed
for Actual Output,
at Standard Rate
(SH × SR)
60,000 hours* ×
$5.00 per hour
= $300,000
Variable overhead rate
Variable overhead
variance
efficiency variance
= $5,500 U
= $25,000 F
Flexible budget variance = $19,500 F
*30,000 units × 2.0 hours per unit = 60,000 hours
Alternatively, the variances can be computed using the formulas:
Variable overhead efficiency variance = SR (AH – SH)
= $5.00 per hour (55,000 hours – 60,000 hours)
= $25,000 F
Variable overhead rate variance = AH (AR* – SR)
= 55,000 hours ($5.10 per hour – $5.00 per hour)
= $5,500 U
*$280,500 ÷ 55,000 hours = $5.10 per hour
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6
Introduction to Managerial Accounting, Fifth Canadian Edition
The Foundational 15 (continued)
11-12. The amounts included in the flexible budget are computed as follows:
Preble Company
Flexible Budget
For the Month Ended March 31
Units sold (q) ................................................................
30,000
Expenses:
Advertising (all fixed) ($200,000) ................................$200,000
Sales salaries and commissions
($100,000 + $12.00q) (mixed) ................................ $460,000
Shipping expenses ($3.00q) (all variable) ...............................
$90,000
11-13. The fixed overhead cost in the flexible budget will be the same as that in the
planning or static budget, assuming that the actual output as well as the planned
output are within the relevant range. Fixed costs are assumed to be invariant for output
volumes within the relevant range.
11-14. The fixed overhead budget or spending variance is:
Actual fixed overhead
$580,000
Budgeted fixed overhead
$585,000
= $(5,000) F
Fixed overhead volume variance is computed as follows:
Applied Fixed Overhead
Actual overhead
Budgeted Overhead
Cost
(based on 25,000 units)
OHR x SQ*
$11.70 x 60,000 hours
$580,000
$585,000
= $702,000
Overhead volume variance = $585,000 - $702,000 =
$117,000 F
*OHR = $585,000/25,000 units x 2 DLH = $11.70 per DLH
*SQ = Actual output volume x standard hours allowed per unit = 30,000 units x 2 DLH
per unit = 60,000 hours
Solutions Manual, Chapter 11
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7
The Foundational 15 (continued)
11-15. The fixed overhead over or under applied amount is the difference between
Actual Cost and the Applied Cost:
-
Actual fixed overhead
Applied fixed overhead
$580,000
$702,000
= $(122,000) over-applied
Note: the amount $122,000 is the total fixed overhead variance, comprised of the
$5,000 favourable spending and the $117,000 favourable volume variances.
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8
Introduction to Managerial Accounting, Fifth Canadian Edition
Brief Exercise 11-1 (20 minutes) (CC1, 2, 3)
1. The standard price of a kilogram of white chocolate is determined as follows:
Purchase price, finest grade white chocolate .......................................... $10.50
Less: purchase discount, 5% of the purchase price of $10.50 .................. (0.525)
Shipping cost from the supplier in Belgium .............................................
0.50
Receiving and handling cost ..................................................................
0.10
Standard price per kilogram of white chocolate ...................................... $10.575
2. The standard quantity, in kilograms, of white chocolate in a dozen truffles is
computed as follows:
Material requirements ................................................................
0.80
Allowance for waste ................................................................
0.04
Allowance for rejects................................................................
0.02
Standard quantity of white chocolate ................................
0.86
3. The standard cost of the white chocolate in a dozen truffles is determined as
follows:
Standard quantity of white chocolate (a) ................................
0.86 kilogram
Standard price of white chocolate (b)................................
$10.575 per kilogram
Standard cost of white chocolate (a) × (b) ................................
$ 9.095
Solutions Manual, Chapter 11
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9
Brief Exercise 11-2 (30 minutes) (LO3 CC15)
1.
70,000
Number of helmets ................................................................
Standard kilograms of plastic per helmet ................................
× 0.6
Total standard kilograms allowed ..................................................42,000
Standard cost per kilogram ........................................................... × RM8
Total standard cost ................................................................RM336,000
Actual cost incurred (given) ..........................................................
RM342,000
Total standard cost (above) ..........................................................
336,000
Total material variance—unfavourable ................................
RM 6,000
2. Actual Quantity of
Inputs, at Actual
Price
(AQ × AP)
RM342,000
Actual Quantity of
Inputs, at Standard
Price
(AQ × SP)
45,000 kilograms
× RM8 per kilogram
= RM360,000

Standard Quantity
Allowed for Output,
at Standard Price
(SQ × SP)
42,000 kilograms*
× RM8 per kilogram
= RM336,000

Price Variance,
RM18,000 F

Quantity Variance,
RM24,000 U
Total Variance, RM6,000 U
*70,000 helmets × 0.6 kilograms per helmet = 42,000 kilograms.
Alternatively:
Materials price variance = AQ (AP – SP)
45,000 kilograms (RM7.60 per kilogram* – RM8.00 per kilogram)
= RM18,000 F
* RM342,000 ÷ 45,000 kilograms = RM7.60 per kilogram.
Materials quantity variance = SP (AQ – SQ)
RM8 per kilogram (45,000 kilograms – 42,000 kilograms)
= RM24,000 U
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Introduction to Managerial Accounting, Fifth Canadian Edition
Brief Exercise 11-3 (30 minutes) (LO3 CC17)
1.
4,000
Number of meals prepared ...........................................................
Standard direct labour-hours per meal ................................
× 0.25
Total direct labour-hours allowed ................................1,000
Standard direct labour cost per hour ................................
× $9.75
Total standard direct labour cost ................................$9,750
Actual cost incurred ................................................................
$9,600
Total standard direct labour cost (above)................................
9,750
Total direct labour variance ................................
$ 150 Favourable
2. Actual Hours of Input, at
the Actual Rate
(AH×AR)
960 hours ×
$10.00 per hour
= $9,600
Actual Hours of Input, at
the Standard Rate
(AH×SR)
960 hours ×
$9.75 per hour
= $9,360
Standard Hours Allowed
for Output, at the
Standard Rate
(SH×SR)
1,000 hours ×
$9.75 per hour
= $9,750



Rate Variance,
$240 U
Efficiency Variance,
$390 F
Total Variance, $150 F
The total variance is called the flexible budget variance for direct labour.
Alternatively, the variances can be computed using the formulas:
Labour rate variance = AH (AR – SR)
= 960 hours ($10.00 per hour – $9.75 per hour)
= $240 U
Labour efficiency variance = SR (AH – SH)
= $9.75 per hour (960 hours – 1,000 hours)
= $390 F
Solutions Manual, Chapter 11
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11
Brief Exercise 11-4 (40 minutes) (LO3 CC18; LO4 CC21, 22, 23)
1.
300,000
Number of items shipped ..............................................................
Standard direct labour-hours per item ................................ × 0.02
Total direct labour-hours allowed ..................................................
6,000
Standard variable overhead cost per hour ................................
× $6.25
Total standard variable overhead cost ................................$ 37,500
Actual variable overhead cost incurred ................................$37,860
Total standard variable overhead cost (above) ...............................
37,500
Total variable overhead variance ...................................................
$ 360 Unfavourable
2. Actual Quantity of Input,
at the Actual Rate
(AQ×AR)
5,800 hours ×
$6.527 per hour*
= $37,860
Actual Quantity of Input,
at the Standard
Rate
(AQ×SR)
5,800 hours ×
$6.25 per hour
= $36,250
Standard Quantity Allowed
for Output, at the
Standard Rate
(SQ×SR)
6,000 hours ×
$6.25 per hour
= $37,500



Variable overhead spending Variable overhead efficiency
variance, $1,610 U
variance, $1,250 F
Total variance, $360 U
*$37,860 ÷ 5,800 hours = $6.527 per hour.
Alternatively, the variances can be computed using the formulas:
Variable overhead spending variance = AQ (AR – SR)
5,800 hours ($6.527 per hour – $6.25 per hour) = $1,610U
Variable overhead efficiency variance = SR (AQ – SQ)
$6.25 per hour (5,800 hours – 6,000 hours) = $1,250 F
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Introduction to Managerial Accounting, Fifth Canadian Edition
Brief Exercise 11-4 (continued)
3. We will assume that the denominator activity level in terms of output—items shipped
is 295,000. This means the denominator activity level in terms of the cost driver, labour
hours, will be 0.02 labour hours per item × 295,000 items = 5,900 hours. The budgeted
fixed overhead cost is given as $23,600. The predetermined rate, PDR, for fixed
overhead is:
PDR = $23,600 ÷ 5,900 = $4/hour
4.
Actual Fixed Overhead
Cost
Budgeted Fixed Overhead
Cost*
Lump sum
Lump sum
= $23,200
= $23,600
Standard Quantity Allowed
for Output, at the
Standard Rate
(SQ×PDR)
6,000 hours ×
$4 per hour **
= $24,000


Lump sum or SR × DV

Fixed overhead budget
variance, $400 F
Fixed overhead volume
variance, $400 F
Total variance, $800 F
*Assumes that the planned volume of 295,000 items is the denominator activity level in
terms of items shipped. In terms of labour hours, the denominator level (DV) is 0.02
hours per item × 295,000 = 5,900 hours. The predetermined rate for fixed overhead,
SR, is $23,600 ÷ 5,900 hours = $4 per hour.
** 0.02 × 300,000 items = 6,000 standard quantity of hours allowed for output of
300,000 items.
5. In this question we have assumed that the normal volume of activity is the same as
the planned volume of 295,000 items. It is important to realize that the normal volume
is what the firm typically expects as its activity level. Ideally the denominator activity
level should be the normal volume and thus the predetermined rate is based on the
normal volume. When there is no explicit information regarding the normal volume as
compared to the planned volume, the planned volume can be used as the denominator
level. Thus if we were now told that the normal volume is a different quantity of
shipments than 295,000 the predetermined rate will not be $4 any longer.
Solutions Manual, Chapter 11
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13
Brief Exercise 11-5 (LO3 CC17)
Donald Trump’s (or that of his management team) intended strategy seems to be
one of reducing labour costs. Total labour costs consist of two components: labour
(wage) rate, and the amount of labour hours used. The political issue is that the
wage rates paid to foreign (to the US) temporary workers were found to be less
than the wages paid to comparable American workers. Also these workers were
allegedly made to work many more hours per day since they did not have any
protection from the labour market institutions and were also vulnerable to be sent
back by management. In this example, it is suggested that the Trump team was
able to hire the replacement workers at a lower wage rate which accounts for the
favourable labour rate variance. The favourable labour efficiency variance results
from more labour hours being consumed and from the better productivity of the
foreign workers who it can be inferred worked harder and more effectively due to
fear of being fired and sent back. This will contribute to the labour cost decreasing.
Consequently, one might question the social cost of the success of the short-term
strategy to use temporary foreign workers instead of American Workers.
The attacks on Trump based on the above analysis would likely focus on the
vulnerability of the workers to abuse: forced to accept lower wages and to worker
longer hours and demonstrating higher productivity under duress. The resulting
reduction in labour costs which all else equal would increase net income—and profits
of the owner could be seen to result from greed and power as opposed to better
management skills.
Note: The issue of temporary foreign workers also fared prominently in Canada in
2015 when the Canadian government sought to toughen the rules for bringing these
workers in the face of complaints that the workers were “crowding out” Canadian
permanent residents out of the labour market. Many employers vainly complained
that the policy greatly increased hardship for them since according to them the
labour market was not responsive to their hiring needs.
Another issue to consider is the potential implications of hiring replacement workers
on the quality of the product, any delays in production and any potential impact on
sales resulting from these factors.
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14
Introduction to Managerial Accounting, Fifth Canadian Edition
Brief Exercise 11-6 (20 minutes) (LO2 CC9, 10)
1. The flexible budget amount for overhead at the denominator level of activity must
be determined before the predetermined overhead rate can be computed.
Total fixed overhead cost per year ................................................
Variable overhead cost per DLH (a) ...............................................
$2.50
Denominator level of activity (DLHs) (b) ................................ 40,000
Total variable overhead cost (a) × (b) ................................
Total overhead cost at the denominator level of activity .................
Predetermined Overhead rate
$350,000
100,000
$450,000
=
Overhead at the denominator level of activity ÷ Denominator level of activity
= $450,000 ÷ 40,000 DLH = $11.25 per DLH
2. Standard direct labour-hours allowed for the
actual output (a) ................................................................
42,000 DLHs
Predetermined overhead rate (b) ................................ $11.25 per DLH
Overhead applied (a) × (b) ...........................................................
$472,500
Solutions Manual, Chapter 11
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15
Brief Exercise 11-7 (20 minutes) (LO2 – CC11, 12)
1.
Fixed overhead
Fixed portion of the
=
predetermined overhead rate Denominator level of activity
$500,000
50,000 DLHs
=$10.00 per DLH
=
2.
Budget = Actual fixed - Budgeted fixed
variance overhead cost
overhead cost
= $508,000 - $500,000
= $8,000 U
Fixed portion of
Volume = the predetermined× Denominator - Standard hours
variance
hours
allowed
overhead rate
(
)
= $10.00 per DLH (50,000 DLHs - 52,000 DLHs)
= $20,000 F
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Introduction to Managerial Accounting, Fifth Canadian Edition
Brief Exercise 11-8 (10 minutes) (LO1 CC2, 3)
Total flexible budget variance (income) = $3,000 U
Flexible budget variance is the difference between the actual income at a certain level
of operations (e.g., sales) during a period and the flexible budget income for the same
level of operations in that period. Using this definition, it means that Nick Company’s
actual income in December was less than the flexible budget income by $3,000.
We know that the actual income is $3,000, which means that the flexible budget would
have shown an income of $3,000 + $3,000 = $6,000.
Since the static budget variance is $7,000 and the actual income was $3,000, the
planned income target would have been $7,000 better than the amount achieved, i.e.
$3,000 + $7,000 = $10,000.
Solutions Manual, Chapter 11
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17
Brief Exercise 11-9 (30 minutes) (LO2 CC10, 11, 12)
1. Fixed overhead variances
Actual Fixed Overhead
Cost
Flexible Budget Fixed
Overhead Cost
$160,000
$160,000
↑
Applied Fixed
Overhead Cost
12,307.4 standard
direct labour hours ×
$12 per direct labour
hour
$147,688.61
↑
Budget variance,
$0 F
↑
Production volume variance,
$12,311.4 U
Total variance, $12,311.4 U
2. False. The overhead volume arises from the difference between the activity level
of the cost driver for the planned activity level of output and the activity level
allowed for the actual output achieved in the period.
The planned activity level of the cost driver—labour hours—is 13,333 hours for an
output volume of 6,500 units. The actual output level was 6,000 units. The allowed
quantity of labour hours is (13,333/6,500) x 6,000 = 12,307.4 direct labour hours.
The predetermined overhead rate is $160,000/13,333 = $12 per hour. And the
applied fixed overhead is $12 x 12,307.4 hours = $147,688.6. The volume variance
is $160,000 - $147,688 = $12,311.4 U.
3. Total variable overhead variance
Actual variable overhead
= $310,600
Applied variable overhead
= $27.50 × 6,000 units × 2.0512 DLH
= $338,453
Total variable overhead variance = $27,853 F
The variance breakdown is given below:
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18
Introduction to Managerial Accounting, Fifth Canadian Edition
Brief Exercise 11-9 (Continued)
Variable Manufacturing Cost Variance
Actual Quantity of Actual Quantity of Standard Quantity
Input,
Input,
of Input Allowed
at Actual Rate
at Standard Rate for Actual Output,
(AQ × AR)
12,500 hours
x
$24.85 per hr**
(AQ × SR)
12,500 hours
x
$27.50 per hour
(SQ × SR)
12,307 hours*
x
$27.50 per hour
$343,750
$338,453
$310,600
Input rate variance Input efficiency
($33,150) F
$5,297 U
Flexible budget variance
=
*Actual output
x Standard input quantity
= Standard qty of input allowed
($27,853)
F
6,000
2.0512
12,307
** The actual hourly rate is imputed from actual hours and actual labour cost.
Note: The standard quantity of labour hours per unit of output is 13,333 hours /
6,500 units = 2.0512 hours per unit.
Solutions Manual, Chapter 11
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19
Exercise 11-1 (30 minutes) (LO1 CC1, 2, 3, 6)
$130.00
1. Cost per 30-litre container .............................................................
Less: 3% cash discount................................................................
(3.90)
Net cost .......................................................................................
126.10
Add shipping cost per container ($200 ÷ 100) ................................2.00
Total cost per 30-litre container .....................................................
$128.10 (a)
Number of litres per container ....................................................... 30 (b)
Standard cost per litre purchased (a) ÷ (b) ................................ $4.27
2. Content per bill of materials ..........................................................
15.2 litres
Add allowance for evaporation and spillage
(15.2 litres ÷ 0.95 =16 litres;
0.8 litres
16 litres – 15.2 litres = 0.8 litres) ................................
Total ............................................................................................
16.0 litres
Add allowance for rejected units
(16.0 litres ÷ 40 bottles) ............................................................
0.4 litres
Standard quantity per saleable bottle of solvent..............................
16.4 litres
3.
Item
Standard
Quantity
Echol
16.4 litres
Standard Price
$4.27 per litre
Standard Cost per
Bottle
$70.03
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20
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 11-2 (45 minutes) (LO3 CC15, 17, 18; LO4 CC22, 23)
1.
Actual Quantity of
Inputs, at Actual Price
(AQ × AP)
9,000 kilograms
× $2.20 per kilogram
= $19,800
Actual Quantity of
Inputs, at Standard
Price
(AQ × SP)
9,000 kilograms
× $2.00 per kilogram
= $18,000

Standard Quantity
Allowed for Output, at
Standard Price
(SQ × SP)
8,400 kilograms*
× $2.00 per kilogram
= $16,800

Price Variance,
$1,800 U

Quantity Variance,
$1,200U
Total Variance, $3,000 U
*2,000 units × 4.2 kilograms per unit = 8,400 kilograms.
Alternatively:
Materials price variance = AQ (AP – SP)
9,000 kilograms ($2.20 per kilogram – $2.00 per kilogram) = $1,800 U
Materials quantity variance = SP (AQ – SQ)
$2.00 per kilogram (9,000 kilograms – 8,400 kilograms) = $1,200 U
Solutions Manual, Chapter 11
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21
Exercise 11-2 (continued)
2. Actual Hours of Input, at
the Actual Rate
(AH × AR)
$9,265
Actual Hours of Input, at
the Standard
Rate
(AH × SR)
850 hours
× $12.00 per hour
= $10,200
Standard Hours Allowed
for Output, at the
Standard Rate
(SH × SR)
800 hours*
× $12.00 per hour
= $9,600



Rate Variance,
$935 F
Efficiency Variance,
$600 U
Total Variance, $335 F
*2,000 units × 0.4 hours per unit = 800 hours.
Alternatively:
Labour rate variance = AH (AR – SR)
850 hours ($10.90 per hour* – $12.00 per hour) = $935 F
*9,265 ÷ 850 hours = $10.90 per hour.
Labour efficiency variance = SR (AH – SH)
$12.00 per hour (850 hours – 800 hours) = $600 U
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22
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 11-2 (continued)
3.
Actual Quantity of
Input, at the Actual Rate
(AQ × AR)
$1,650 given as a total
Actual Quantity of Input,
at the Standard
Rate
(AQ × SR)
850 hours
× $2.00 per hour
= $1,700
Standard Quantity
Allowed for Output, at the
Standard Rate
(SQ × SR)
800 hours*
× $2.00 per hour
= $1,600



Spending Variance,
$50 F
Efficiency Variance,
$100 U
Total Variance, $50 U
*2,000 units × 0.4 hours per unit = 800 hours.
Alternatively:
Overhead spending variance = AH (AR – SR)
850 hours × ($1.94 per hour* – $2.00 per hour) = $50F
*$1,650 ÷ 850 hours = $1.94 per hour. This is an average rate per hour and is
not observable in practice.
Variable overhead efficiency variance = SR (AH – SH)
$2.00 per hour × (850 hours – 800 hours) = $100 U
Solutions Manual, Chapter 11
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23
Exercise 11-2 (concluded)
4.
Actual Fixed Overhead
Cost
Budgeted Fixed Overhead
Cost*
Lump sum
Lump sum
= $15,890
= $15,800
Standard Quantity Allowed
for Output, at the
Standard Rate
(SQ×PDR)
800 hours** ×
$19.75 per hour
= $15,800


Lump sum or SR x DV

Fixed overhead budget
variance, $90 U
Fixed overhead volume
variance, $0
Total variance, $90 U
*The denominator activity level is 800 hours and budgeted cost is $15,800. The
predetermined rate for fixed overhead, PDR = $15,800 ÷ 800 hours = $19.75 per hour.
** 0.4 × 2,000 units = 800 standard quantity of hours allowed for output of 2,000
items.
5. The total overhead variance is $50 U + $90 U = $140 U. The total under applied
overhead is $140. Note an unfavourable overhead variance is equivalent to underapplied overhead.
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24
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 11-3 (20 minutes) (LO3 CC16)
Notice in the solution below that the materials price variance is computed on the
entire amount of materials purchased, whereas the materials quantity variance is
computed only on the amount of materials used in production.
Actual Quantity of
Inputs, at Actual Price
(AQ × AP)
9,000 kilograms
× $2.20 per kilogram
= $19,800

Actual Quantity of
Inputs, at Standard
Price
(AQ × SP)
9,000 kilograms
× $2.00 per kilogram
= $18,000
Standard Quantity
Allowed for Output, at
Standard Price
(SQ × SP)
6,300 kilograms*
× $2.00 per kilogram
= $12,600

Price Variance,
$1,800 U
6,500 kilograms × $2.00 per kilogram
= $13,000


Quantity Variance, $400 U
*1,500 units × 4.2 kilograms per unit = 6,300 kilograms.
Alternatively:
Materials price variance = AQ (AP – SP)
9,000 kilograms × ($2.20 per kilogram – $2.00 per kilogram) = $1,800 U
Materials quantity variance = SP (AQ – SQ)
$2.00 per kilogram × (6,500 kilograms – 6,300 kilograms) = $400 U
2. The overhead volume variance does not depend on the actual volume of production.
Thus there will be no change in its value from that calculated in Exercise 11-2. It is not
necessary to have performed the calculation in Exercise 11-2 to reach this answer.
Solutions Manual, Chapter 11
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25
Exercise 11-4 (50 minutes) (LO3 CC17, 18; LO4 CC22, 23, 24)
20,000
1. Number of units manufactured ......................................................
Standard labour time per unit ........................................................
× 0.3*
Total standard hours of labour time allowed ................................
6,000
Standard direct labour rate per hour ................................ × $12
Total standard direct labour cost ................................
$72,000
*18 minutes ÷ 60 minutes per hour =
0.3 hours.
Actual direct labour cost ................................................................
$73,600
Standard direct labour cost ............................................................
72,000
Total variance ................................................................ $ 1,600 Unfavourable
2. Actual Hours of Input,
at the Actual Rate
(AH × AR)
$73,600
Actual Hours of Input, at
the Standard
Rate
(AH × SR)
5,750 hours
× $12.00 per hour
= $69,000

Standard Hours Allowed for
Output, at the Standard
Rate
(SH × SR)
6,000 hours*
× $12.00 per hour
= $72,000

Rate Variance,
$4,600 U

Efficiency Variance,
$3,000 F
Total Variance, $1,600 U
*20,000 units × 0.3 hours per unit = 6,000 hours.
Alternate Solution:
Labour rate variance = AH (AR – SR)
5,750 hours × ($12.80 per hour* – $12.00 per hour) = $4,600 U
*$73,600 ÷ 5,750 hours = $12.80 per hour.
Labour efficiency variance = SR (AH – SH)
$12.00 per hour × (5,750 hours – 6,000 hours) = $3,000 F
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26
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 11-4 (continued)
3. Actual Quantity of Input,
at the Actual Rate
(AQ × AR)
$21,850
Actual Quantity of Input,
at the Standard
Rate
(AQ × SR)
5,750 hours
× $4.00 per hour
= $23,000

Standard Quantity Allowed
for Output, at the Standard
Rate
(SQ × SR)
6,000 hours
× $4.00 per hour
= $24,000

Spending Variance,
$1,150 F

Efficiency Variance,
$1,000 F
Total Variance, $2,150 F
Alternate Solution:
Variable overhead spending variance = AQ (AR – SR)
5,750 hours × ($3.80 per hour* – $4.00 per hour) = $1,150 F
*$21,850 ÷ 5,750 hours = $3.80 per hour.
Variable overhead efficiency variance = SR (AQ – SQ)
$4.00 per hour × (5,750 hours – 6,000 hours) = $1,000 F
4. The pre-determined fixed overhead rate is:
PDR = $31,500 ÷ [(18/60) × 19,000] =$5.5263.
The denominator hours is based on the normal volume of 19,000 players and the
standard hours per player of 0.3 (= 18/60).
Budgeted fixed overhead cost = $31,500
Applied fixed overhead cost = $5.5263 × 6,000 hours* = $33,158.
Volume variance = $31,500 - $33,158 = $1,658 F
* SQ allowed for actual output of 20,000 players = (18/60) × 20,000 = 6,000 hours.
Solutions Manual, Chapter 11
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27
Exercise 11-4 (continued)
5. The total variable overhead in the static budget is $25,200 and from the standard
cost card, the cost per player is $1.20, therefore the static budget volume is:
$25,200 ÷ $1.20 = 21,000 players.
This means that the denominator hours will be different from before since the normal
volume is now 21,000. The new predetermined fixed overhead allocation rate is:
$31,500 ÷ [(18/60) × 21,000] = $31,500 ÷ 6,300 = $5 per hour
The volume variance, using the formula is:
(Denominator hours – SH) × PDR = (6,300 – 6,000) × $5 = $1,500 U.
The budget variance = Actual cost – Budgeted cost = $32,000 - $31,500 = $500 U.
The total variance = $1,500 + $500 = $2,000 U. This is the amount of the underapplied fixed overhead.
The answer using the columnar approach is shown below.
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28
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 11-4 (concluded)
5.
Actual Fixed Overhead
Cost
Budgeted Fixed Overhead
Cost*
Lump sum
Lump sum
= $32,000
= $31,500
Standard Quantity Allowed
for Output, at the
Standard Rate
(SQ×PDR)
6,000 hours** ×
$5 per hour
= $30,000


Lump sum or SR x DV

Fixed overhead budget
variance, $500 U
Fixed overhead volume
variance, $1,500 U
Total variance, $2,000 U
*The denominator activity level is $25,200 ÷ $1.20 = 21,000 players which means
21,000 × 18/60 = 6,300 hours. Alternatively, $21,500 ÷ $4 per hour = 6,300 hours.
The predetermined rate for fixed overhead, PDR = $31,500 ÷ 6,300 hours = $5 per
hour.
** (18/60) × 20,000 units = 6,000 standard quantity of hours allowed for output of
20,000 items.
Solutions Manual, Chapter 11
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29
Exercise 11-5 (60 minutes) (LO3 CC16, 17, 18; LO4 CC22, 23)
1. a. Notice in the solution below that the materials price variance is computed on the
entire amount of materials purchased, whereas the materials quantity variance is
computed only on the amount of materials used in production.
Actual Quantity of
Inputs, at Actual
Price
(AQ × AP)
25,000 microns
× $0.60 per micron
= $15,000

Actual Quantity of Inputs, at
Standard Price
Standard Quantity Allowed
for Output, at Standard Price
(AQ × SP)
25,000 microns
× $0.75 per micron
= $18,750
(SQ × SP)
33,600 microns*
× $0.75 per micron
= $25,200

Price Variance,
$3,750 F
20,000 microns × $0.75 per micron
= $15,000


Quantity Variance,
$10,200 F
* 4,200 toys × 8 microns per toy = 33,600 microns.
Alternatively:
Materials price variance = AQ (AP – SP)
25,000 microns × ($0.60 per micron – $0.75 per micron) = $3,750 F
Materials quantity variance = SP (AQ – SQ)
$0.75 per micron × (20,000 microns – 33,600 microns) = $10,200 F
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30
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 11-5 (continued)
b. Direct labour variances:
Actual Hours of Input, at
the Actual Rate
(AH × AR)
$52,000
Actual Hours of Input, at
the Standard Rate
(AH × SR)
4,000 hours
× $12.00 per hour
= $48,000

Standard Hours Allowed for
Output, at the Standard
Rate
(SH × SR)
3,780 hours*
× $12.00 per hour
= $45,360

Rate Variance,
$4,000 U

Efficiency Variance,
$2,640 U
Total Variance, $6,640 U
*4,200 toys × 0.9 hours per toy = 3,780 hours.
Alternatively:
Labour rate variance = AH (AR – SR)
4,000 hours ($13 per hour* – $12 per hour) = $4,000 U
*$52,000 ÷ 4,000 hours = $13.00 per hour.
Labour efficiency variance = SR (AH – SH)
$12.00 per hour × (4,000 hours – 3,780 hours) = $2,640 U
2. A variance usually has many possible explanations. In particular, we should always
keep in mind that the standards themselves may be incorrect. Some of the other
possible explanations for the variances observed at Dawson Toys appear below:
Materials Price Variance Since this variance is favourable, the actual price paid per
unit for the material was less than the standard price. This could occur for a variety of
reasons including the purchase of a lower grade material at a discount, buying in an
unusually large quantity to take advantage of quantity discounts, a change in the
market price of the material, or particularly sharp bargaining by the purchasing
department.
Solutions Manual, Chapter 11
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31
Exercise 11-5 (continued)
Materials Quantity Variance Since this variance is favourable, less materials were used
to produce the actual output than were called for by the standard. This could also
occur for a variety of reasons. Some of the possibilities include well trained or
supervised workers, properly adjusted machines, and materials with no defects, which
will result in less wasted materials.
Labour Rate Variance Since this variance is unfavourable, the actual average wage
rate was higher than the standard wage rate. Some of the possible explanations
include an increase in wages that has not been reflected in the standards,
unanticipated overtime, and a shift toward more highly paid workers.
Labour Efficiency Variance This variance is highly favourable, because the actual
number of labour-hours was less than the standard labour-hours allowed for the actual
output. As with the other variances, this variance could have been caused by any of a
number of factors. Some of the possible explanations include adequate supervision,
trained workers, high quality materials requiring less labour time to process, and no
machine breakdowns.
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32
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 11-5 (Continued)
3. Actual Hours of Input, at
the Actual Rate
(AH × AR)
$12,340 given as a total
Actual Hours of Input, at
the Standard
Rate
(AH × SR)
4,000 hours
× $3.05 per hour
= $12,200
Standard Hours Allowed
for Output, at the
Standard Rate
(SH × SR)
3,780 hours*
× $3.05 per hour
= $11,529



Rate Variance,
$140 U
Efficiency Variance,
$671 U
Total Variance, $811 U
*4,200 toys × 0.9 hours per unit = 3,780 hours.
Alternatively:
Overhead spending variance = AH (AR – SR)
4,000 hours × ($3.085 per hour* – $3.05 per hour) = $140 U
*$12,340 ÷ 4,000 hours = $3.085 per hour. This is an average rate per hour and
is not observable in practice.
Variable overhead efficiency variance = $3.05 × (4,000 – 3,780) = $671.
It is not possible to conclude that inefficiencies in operations are the reason for the
unfavourable efficiency variance. The only conclusion that can be made is that the
cause is the inefficient use of labour. If this is not correlated with variable overhead
cost incidence another cost driver would have to be found.
Solutions Manual, Chapter 11
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33
Exercise 11-5 (continued)
5.
Actual Fixed Overhead
Cost
Budgeted Fixed Overhead
Cost*
Lump sum
Lump sum
= $44,000
= $44,000
Standard Quantity Allowed
for Output, at the
Standard Rate
(SQ×PDR)
3,780 hours** ×
$11.924 per hour
= $45,073


Lump sum or SR × DV

Fixed overhead budget
variance, $0
Fixed overhead volume
variance, $1,073 F
Total variance, $1,073 F
*The denominator activity level is 4,100 toys or 4,100 × 0.9 = 3,690 labour hours.
Since the budget variance is 0, the budgeted cost equals the actual cost, $44,000. The
predetermined rate for fixed overhead, PDR = $44,000 ÷ 3,690 hours = $11.92412 per
hour.
** 0.9 hours × 4,200 toys = 3,780 the standard quantity of hours allowed for output of
4,200 toys.
The overhead is over-applied and it is comprised entirely of the volume variance.
Copyright © 2017 McGraw-Hill Education. All rights reserved.
34
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 11-6 (60 minutes) (LO3 CC15, 17; LO4 CC22, 23)
1.
Variance
Direct
materials price
Direct
materials
quantity
Direct labour
rate
Direct labour
efficiency
Variable
overhead
spending
(rate)
Variable
overhead
efficiency
Fixed
overhead
AR
SR
?
$8/kg
$251,720/31,000
$28.50 per DLH
? $42,700/4,800
hours
AQ
SQ
31,000 kg
?
45 kg x 720
units
4,800 hours
? 6 hours x
720 units
4,800 hours
? 6 hours x
720 units
$30 per DLH
$10 per DLH
Actual cost
$38,000
Budgeted
Planned
6 hours x 720
amount = $45 volume: 750 x units
x 750 hours
6 hours
The only variances that can be specified without a calculation is the labour rate variance
and the volume variance. DL rate variance will be a favourable variance since the
actual rate is less than the standard rate. The volume variance will be unfavourable
because planned output of 750 is more than the actual volume of 720. Applied
overhead will be smaller than the budgeted cost.
All other variances likely exist, but we cannot tell until the indicated arithmetic is carried
out.
NOTE: Students may ask why “N/A” is used in some of the cells in the question in the
main text. The reason is that to tell if the variance will exist and its nature, you do
not need the amount of the AQ in the case of a rate variance or the amount SR in
the case of the efficiency variance. These are simply scaling variables. The root
cause of a rate variance is the difference AR – SR and the cause for an efficiency
variance is AQ – SQ.
Solutions Manual, Chapter 11
Copyright © 2017 McGraw-Hill Education. All rights reserved.
35
Exercise 11-6 (continued)
2. Actual Hours of Input, at
the Actual Rate
(AH × AR)
4,800 hours
× $28.50 per hour
= $136,800
Actual Hours of Input, at
the Standard
Rate
(AH × SR)
4,800 hours
× $30.00 per hour
= $144,000
Standard Hours Allowed
for Output, at the
Standard Rate
(SH × SR)
4,320 hours*
× $30.00 per hour
= $129,600



Rate Variance,
$7,200 F
Efficiency Variance,
$14,400 U
Total Variance, $7,200 U
* 720 units × 6 hours per unit = 4,320 hours.
Alternatively:
Labour rate variance = AH (AR – SR)
4,800 hours × ($28.50 per hour – $30.00 per hour) = $7,200 F
Labour efficiency variance = SR (AH – SH)
$30.00 per hour × (4,800 hours – 4,320 hours) = $14,400 U
Copyright © 2017 McGraw-Hill Education. All rights reserved.
36
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 11-6 (continued)
3.
Actual Quantity of
Inputs, at Actual Price
(AQ × AP)
31,000 kilograms
× $8.12 per kilogram
= $251,720
Actual Quantity of
Inputs, at Standard
Price
(AQ × SP)
31,000 kilograms
× $8.00 per kilogram
= $248,000

Standard Quantity
Allowed for Output, at
Standard Price
(SQ × SP)
32,400 kilograms*
× $8.00 per kilogram
= $259,200

Price Variance,
$3,720 U

Quantity Variance,
$11,200 F
Total Variance, $7,480 F
*720 units × 45 kilograms per unit = 32,400 kilograms.
Alternatively:
Materials price variance = AQ (AP – SP)
31,000 kilograms × ($8.12 per kilogram – $8 per kilogram) = $3,720 U
Materials quantity variance = SP (AQ – SQ)
$8 per kilogram × (31,000 kilograms – 32,400 kilograms) = $11,200 F
Solutions Manual, Chapter 11
Copyright © 2017 McGraw-Hill Education. All rights reserved.
37
Exercise 11-6 (continued)
4. Actual Quantity of Input,
at the Actual Rate
(AQ × AR)
$42,700 given as a total
Actual Quantity of Input,
at the Standard
Rate
(AQ × SR)
4,800 hours
× $10 per hour
= $48,000
Standard Quantity Allowed
for Output, at the
Standard Rate
(SQ × SR)
4,320 hours*
× $10 per hour
= $43,200



Spending Variance,
$5,300 F
Efficiency Variance,
$4,800 U
Total Variance, $500 F
*720 units × 6 hours per unit = 4,320 hours.
Alternatively:
Variable overhead efficiency variance = $10 × (4,800 – 4,320) = $4,800.
Copyright © 2017 McGraw-Hill Education. All rights reserved.
38
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 11-6 (continued)
5.
Actual Fixed Overhead
Cost
Budgeted Fixed Overhead
Cost*
Lump sum
$45 × 750
= $38,000
= $33,750
Standard Quantity Allowed
for Output, at the
Standard Rate
(SQ×PDR)
4,320 hours** ×
$7.50 per hour
= $32,400


Lump sum or SR × DV

Fixed overhead budget
variance, $4,250 U
Fixed overhead volume
variance, $1,350 U
Total variance, $5,600 U
*The denominator activity level is 750 units or 750 × 6 = 4,500 labour hours. The
predetermined rate for fixed overhead, PDR = $33,750 ÷ 4,500 hours = $7.50 per
hour.
Note that an alternative approach would be to compute the rate of fixed overhead
per hour as $45 ÷ 6 hours = $7.50 per hour. And the budgeted fixed overhead as 750
units × 6 hours × $7.50 = $33,750.
** 6 hours × 720 units = 4,320 the standard quantity of hours allowed for output of
720 units.
Solutions Manual, Chapter 11
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39
Exercise 11-7 (20 minutes) (LO2 CC12)
TOASTTOE INC.
Flexible Budget
Cost Formula
(per toaster)
Revenues:
Activity (toasters)
100,000
90,000
110,000
$12.00
$1,080,000
$ 1,200,000
$1,320,000
Manufacturing ................................
6.00
540,000
600,000
660,000
Administrative ................................
3.00
270,000
300,000
330,000
90,000
100,000
110,000
900,000
1,000,000
$1,100,000
$ 2.00
$ 180,000
$ 200,000
$ 220,000
Manufacturing ................................
100,000
100,000
100,000
Administrative ................................
80,000
80,000
80,000
Total fixed costs................................
$ 180,000
$ 180,000
$ 180,000
Total cost ................................
$1,080,000
$1,180,000
$1,280,000
$0
$20,000
$40,000
Variable costs:
Selling ................................
1.00
Total variable costs ................................
10.00
Contribution margin
Fixed costs:
Income from operations
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40
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 11-8 (20 minutes) (LO2 CC8)
Static budget performance report:
BEMIDJI COMPANY
Static Budget Performance Report
For the Month Ended June 30
Actual
Sales (units)
Revenue
Variable
expenses
Contribution
margin
Fixed expenses
Income
9,600
$278,400
230,400
Flexible
Budget
Variance
Flexible
Budget
Sales
Volume
Variance
Static
Budget
Static Variance
(Actual –
Static)
$ 48,000
9,600
9,000
$288,000 $ 18,000 F $270,000
220,800 $13,800 U
207,000
$ 19,200 $ 67,200
$ 4,200 F
63,000
$15,000 U
18,200
$ 29,800
600 U
$ 18,600
600 F
$14,400 U
$ 9,600 U
9,600 U
18,800
$ 48,400
0F
$4,200 F
18,800
$ 44,200
$ 8,400 F
23,400 U
2. The usefulness of the flexible budget is that it helps managers to separate variances
that arise due to activity level changes i.e. because the company made and sold 9,600
units instead of 9,000 from the variances due to the purchase of and use of resources
from making and selling the actual volume of output of 9,600 units.
Solutions Manual, Chapter 11
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41
Exercise 11-9 (20 minutes) (LO3 CC18; LO4 22, 23)
1. Variable overhead variances:
Variable Manufacturing Cost Variance
Actual Quantity of
Actual Quantity of
Standard Quantity of
Input,
Input,
Input Allowed
for Actual Output, at
at Actual Rate
at Standard Rate
Standard Rate
(AQ × AR)
4,540 hours
x
$11.50 per hr**
(AQ × SR)
4,540 hours
x
$12.00 per hour
(SQ × SR)
4,400 hours*
x
$12.00 per hour
$54,480
$52,800
$52,200
Input rate variance
$2,280 F
Input efficiency
(quantity) variance
$1,680 U
Flexible budget variance
=
*Actual output
Standard input
x quantity
= Standard qty of input allowed
$600
F
1,100
4.0000
4,400
** The actual hourly rate is imputed from actual hours and actual labour
cost.
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42
Introduction to Managerial Accounting, Fifth Canadian Edition
Exercise 11-9 (continued)
2. Fixed overhead variances
The predetermined overhead rate is Budgeted cost/Budgeted volume = $60,000/4,000
= $15 per DLH.
The standard number of hours allowed for the actual output volume of 1,100 units is 4
dlh x 1,100 = 4,400 hours.
Actual Fixed Overhead Cost
$63,000
Budgeted Overhead Cost
$60,000
Applied Overhead
$15 x 4,400 hours
= $66,000
The budget variance is $3,000 U. We overspent by $3,000.
The volume variance is $6,000 F. We over applied by $6,000.
The following is alternate depiction using the format of EXH 11-16 in the text.
Data Area
Budgeted output volume
Standard quantity of input per unit of output
Standard quantity of input --Denominator volume
1000.00
4.00
4000.00
Actual volume of output
Standard quantity of input allowed for actual volume of output
1100.00
4400.00
Budgeted cost
Predetermined overhead rate (Budget/Denominator volume)
60,000.00
15.00
Actual cost
63,000.00
Actual Fixed
Overhead Cost
Budgeted Fixed
Overhead Cost
Applied Fixed
Overhead Cost
$63,000.00
$60,000.00
$66,000.00
Budget Variance
$3,000.00
U
Solutions Manual, Chapter 11
Volume Variance
$6,000.00
F
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43
Exercise 11-10 (15 minutes) (LO4 CC23)
Company A:
A favourable volume variance since the standard hours allowed for the
actual production are greater than the denominator hours.
Company B:
An unfavourable volume variance since the standard hours allowed for
the actual production are less than the denominator hours.
Company C:
No volume variance, since the standard hours allowed for the actual
production and the denominator hours are the same.
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44
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-1 (75 minutes) (LO3 CC15, 17, 18)
1. The standard quantity of plates allowed for tests performed during the month would
be:
Blood tests................................................................
1,800
Smears ................................................................
2,400
Total ................................................................4,200
Plates per test ................................................................
× 2
Standard quantity allowed ................................8,400
The variance analysis for plates would be:
Actual Quantity of
Inputs, at Actual Price
Actual Quantity of
Inputs, at Standard Price
(AQ × AP)
(AQ × SP)
12,000 plates
× $2.50 per plate
= $30,000
$28,200

Standard Quantity
Allowed for Output, at
Standard Price
(SQ × SP)
8,400 plates
× $2.50 per plate
= $21,000

Price Variance,
$1,800 F
10,500 plates × $2.50 per plate
= $26,250


Quantity Variance, $5,250 U
Alternate Solution:
Materials price variance = AQ (AP – SP)
12,000 plates × ($2.35 per plate* – $2.50 per plate) = $1,800 F
*$28,200 ÷ 12,000 plates = $2.35 per plate.
Materials quantity variance = SP (AQ – SQ)
$2.50 per plate × (10,500 plates – 8,400 plates) = $5,250 U
Solutions Manual, Chapter 11
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45
Problem 11-1 (continued)
2. a. The standard hours allowed for tests performed during the month would be:
Blood tests: 0.3 hours per test × 1,800 tests ................................
540 hours
Smears: 0.15 hours per test × 2,400 tests ................................
360 hours
Total standard hours allowed ........................................................
900 hours
The variance analysis would be:
Actual Hours of Input, at
the Actual Rate
Actual Hours of
Input, at the Standard Rate
(AH × AR)
$13,800
(AH × SR)
1,150 hours
× $14.00 per hour
= $16,100

Standard Hours Allowed
for Output, at the
Standard Rate
(SH × SR)
900 hours
× $14.00 per hour
= $12,600

Rate Variance,
$2,300 F

Efficiency Variance,
$3,500 U
Total Variance, $1,200 U
Alternate Solution:
Labour rate variance = AH (AR – SR)
1,150 hours × ($12.00 per hour* – $14.00 per hour) = $2,300 F
*$13,800 ÷ 1,150 hours = $12.00 per hour.
Labour efficiency variance = SR (AH – SH)
$14.00 per hour × (1,150 hours – 900 hours) = $3,500 U
b. The policy probably should not be continued. Although the hospital is saving $2
per hour by employing more assistants than senior technicians, this savings is
more than offset by other factors. Too much time is being taken in performing
lab tests, as indicated by the large unfavourable labour efficiency variance. And,
it seems likely that most (or all) of the hospital’s unfavourable quantity variance
for plates is traceable to inadequate supervision of assistants in the lab.
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46
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem11-1 (continued)
Note that all of the price variance is due to the hospital’s 6% quantity discount.
Also note that the $5,250 quantity variance for the month is equal to 25% of the
standard cost allowed for plates. This variance may be a result of using too many
assistants in the lab.
3.
Actual Quantity of Input,
at the Actual Rate
Actual Quantity of Input,
at the Standard
Rate
(AH × AR)
$7,820
(AH × SR)
1,150 hours
× $6.00 per hour
= $6,900

Standard Quantity of
Input Allowed for Actual
Output, at the Standard
Rate
(SH × SR)
900 hours
× $6.00 per hour
= $5,400

Spending Variance,
$920 U

Efficiency Variance,
$1,500 U
Total Variance, $2,420 U
Alternate Solution:
Variable overhead spending variance = AQ (AR – SR)
1,150 hours × ($6.80 per hour* – $6.00 per hour) = $920 U
*$7,820 ÷ 1,150 hours = $6.80 per hour.
Variable overhead efficiency variance = SR (AQ – SQ)
$6.00 per hour × (1,150 hours – 900 hours) = $1,500 U
Yes, there is a close relation between the two variances. Both are computed by
comparing actual labour time to the standard hours allowed for the output of the
period (variable overhead is allocated using labour hours as the allocation base).
Thus, if there is an unfavourable labour efficiency variance, there will also be an
unfavourable variable overhead efficiency variance.
Solutions Manual, Chapter 11
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47
Problem 11-2 (75 minutes) (LO3 CC15, 17, 18; LO4 CC22, 23, 24)
1. a. In the solution below, the materials price variance is computed on the entire
amount of materials purchased whereas the materials quantity variance is
computed only on the amount of materials used in production:
Actual Quantity of
Inputs, at Actual Price
Actual Quantity of Inputs,
at Standard Price
(AQ × AP)
$225,000
(AQ × SP)
12,000 ml.
× $20.00 per ml.
= $240,000

Standard Quantity
Allowed for Output, at
Standard Price
(SQ × SP)
9,375 ml.*
× $20.00 per ml.
= $187,500

Price Variance,
$15,000 F
9,500 ml. × $20.00 per ml.
= $190,000


Quantity Variance, $2,500 U
*3,750 units × 2.5 ml. per unit = 9,375 ml.
Alternatively:
Materials price variance = AQ (AP – SP)
12,000 ml. × ($18.75 per ml.* – $20.00 per ml.) = $15,000 F
*$225,000 ÷ 12,000 ml. = $18.75 per ml.
Materials quantity variance = SP (AQ – SQ)
$20.00 per ml. × (9,500 ml. – 9,375 ml.) = $2,500 U
b. Yes, the contract probably should be signed. The new price of $18.75 per ml. is
substantially lower than the standard price of $20.00 per ml., resulting in a
favourable price variance of $15,000 for the month. The material from the new
supplier appears to cause little or no problem in production as shown by the
small materials quantity variance for the month. The variance is $2,500 ÷
$187,500 = 1.33% of the standard and is well under the cut-off percent. The net
result of the two is a favourable variance $12,500.
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48
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-2 (continued)
2. a.
Actual Hours of Input, at
the Actual Rate
Actual Hours of Input, at
the Standard Rate
(AH × AR)
5,600 hours*
× $12.00 per hour
= $67,200
(AH × SR)
5,600 hours
× $12.50 per hour
= $70,000

Standard Hours Allowed
for Output, at the
Standard Rate
(SH × SR)
5,250 hours**
× $12.50 per hour
= $65,625

Rate Variance,
$2,800 F

Efficiency Variance,
$4,375 U
Total Variance, $1,575 U
*35 technicians × 160 hours per technician = 5,600 hours.
**3,750 units × 1.4 hours per technician = 5,250 hrs.
Alternatively:
Labour rate variance = AH (AR – SR)
5,600 hours × ($12.00 per hour – $12.50 per hour) = $2,800 F
Labour efficiency variance = SR (AH – SH)
$12.50 per hour × (5,600 hours – 5,250 hours) = $4,375 U
b. No, the new labour mix probably should not be continued. Although it decreases
the average hourly labour cost from $12.50 to $12.00, thereby causing a $2,800
favourable labour rate variance, this savings is more than offset by a large
unfavourable labour efficiency variance for the month ($4,375). Thus, the new
labour mix increases overall labour cost by $1,575 (4,375-2,800).
Solutions Manual, Chapter 11
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49
Problem 11-2 (continued)
3. Actual Quantity of Input,
at the Actual Rate
(AQ × AR)
$18,200
Actual Quantity of Input,
at the Standard Rate
(AQ × SR)
5,600 hours*
× $3.50 per hour
= $19,600

Standard Quantity of
Input Allowed for Actual
Output, at the Standard
Rate
(SQ × SR)
5,250 hours**
× $3.50 per hour
= $18,375

Spending Variance,
$1,400 F

Efficiency Variance,
$1,225 U
Total Variance, $175 F
* Based on direct labour-hours:
35 technicians × 160 hours per technician = 5,600 hours.
** 3,750 units × 1.4 hours per unit = 5,250 hours.
Alternatively:
Variable overhead spending variance = AQ (AR – SR)
5,600 hours × ($3.25 per hour* – $3.50 per hour) = $1,400 F
*$18,200 ÷ 5,600 hours = $3.25 per hour.
Variable overhead efficiency variance = SR (AQ – SQ)
$3.50 per hour × (5,600 hours – 5,250 hours) = $1,225 U
Both the labour efficiency variance and the variable overhead efficiency variance are
computed by comparing actual labour-hours to standard labour-hours (note that
variable overhead is allocated using labour hours as the allocation base). Thus, if the
labour efficiency variance is unfavourable, then the variable overhead efficiency
variance will be unfavourable as well.
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50
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-2 (continued)
4.
Actual Fixed Overhead
Cost
Budgeted Fixed Overhead
Cost*
Lump sum
Lump sum or SR x DV
= $14,000 (given)
Standard Quantity Allowed
for Output, at the
Standard Rate
(SQ×PDR)
5,250 hours** ×
$2.50 per hour
= $13,125


$13,125 + $675
= $13,800

Fixed overhead budget
variance, $ 200 F
Fixed overhead volume
variance, $875 U
Total variance, $675 U (Given data)
*The denominator activity level is 1.4 hours × 4,000 units = 5,600 hours. The
predetermined rate for fixed overhead, PDR = $14,000 ÷ 5,600 hours = $2.50 per
hour.
** 1.4 × 3,750 units = 5,250 the standard quantity of hours allowed for output of
3,750 units.
NOTE: This problem is a good example of how to work backwards from variance
information to find unknowns.
Solutions Manual, Chapter 11
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51
Problem 11-3 (110 minutes) (LO2 CC14; LO3 CC15, 16, 17, 18; LO4 CC22, 23, 24)
1. a. Notice in the solution below that the materials price variance is computed on the
entire amount of materials purchased, whereas the materials quantity variance is
computed only on the amount of materials used in production. It is important to
note that the total variance cannot be computed in this situation, since the amount
of materials purchased (30,000 kilograms) differs from the amount of materials used
in production (24,600 kilograms).
Actual Quantity of
Inputs, at Actual Price
(AQ × AP)
30,000 kilograms
× $3.90 per kilogram
= $117,000

Actual Quantity of
Inputs, at Standard
Price
(AQ × SP)
30,000 kilograms
× $4.00 per kilogram
= $120,000
Standard Quantity
Allowed for Output, at
Standard Price
(SQ × SP)
22,500 kilograms*
× $4.00 per kilogram
= $90,000

Price Variance,
$3,000 F
24,600 kilograms × $4.00 per kilogram
= $98,400


Quantity Variance,
$8,400 U
*15,000 pools × 1.5 kilograms per pool = 22,500 kilograms.
Alternate Solution:
Materials price variance = AQ (AP – SP)
30,000 kilograms × ($3.90 per kilogram – $4.00 per kilogram) = $3,000 F
Materials quantity variance = SP (AQ – SQ)
$4.00 per kilogram × (24,600 kilograms – 22,500 kilograms) = $8,400 U
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52
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-3 (continued)
b.
Actual Hours of Input,
at the Actual Rate
(AH × AR)
11,800 hours
× $7.00 per hour
= $82,600
Actual Hours of Input, at
the Standard
Rate
(AH × SR)
11,800 hours
× $6.00 per hour
= $70,800
Standard Hours Allowed
for Output, at the
Standard Rate
(SH × SR)
12,000 hours*
× $6.00 per hour
= $72,000



Rate Variance,
$11,800 U
Efficiency Variance,
$1,200 F
Total Variance, $10,600 U
*15,000 pools × 0.8 hours per pool = 12,000 hours.
Alternate Solution:
Labour rate variance = AH (AR – SR)
11,800 hours × ($7.00 per hour – $6.00 per hour) = $11,800 U
Labour efficiency variance = SR (AH – SH)
$6.00 per hour × (11,800 hours – 12,000 hours) = $1,200 F
Solutions Manual, Chapter 11
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53
Problem 11-3 (continued)
c.
Actual Quantity of Input,
at the Actual
Rate
Actual Quantity of
Input, at the Standard
Rate
(AQ × AR)
$18,290
(AQ × SR)
5,900 hours
× $3.00 per hour
= $17,700

Standard Quantity
Allowed for Actual
Output, at the Standard
Rate
(SQ × SR)
6,000 hours*
× $3.00 per hour
= $18,000


Spending Variance,
$590 U
Efficiency Variance,
$300 F
Total Variance, $290 U
*15,000 pools × 0.4 hours per pool = 6,000 hours.
Alternate Solution:
Variable overhead spending variance = AQ (AR – SR)
5,900 hours × ($3.10 per hour* – $3.00 per hour) = $590 U
*$18,290 ÷ 5,900 hours = $3.10 per hour.
Variable overhead efficiency variance = SR (AQ – SQ)
$3.00 per hour × (5,900 hours – 6,000 hours) = $300 F
2. The variances are summarized as follows:
Favourable variances:
Materials price variance
Labour efficiency variance
Variable overhead efficiency variance
$ 3,000
1,200
300
Total favourable variances
$ 4,500
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54
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-3 (continued)
Unfavourable variances:
Materials quantity variance
$ 8,400
Labour rate variance
11,800
Variable overhead spending variance
Total unfavourable variances
590
$20,790
Overall, there is an unfavourable variance of $16,290. This will cause the Cost of
Goods Sold to go up, thereby decreasing net income by that amount.
NOTE: Because there is ending inventory of materials the price variance will not flow to
the inventory accounts if the variance is written off to the cost of goods sold as soon
as isolated. Consequently the impact on net income shown above is accurate. For
additional discussion we recommend student be assigned Appendix 11A as
supplementary reading.
3. The two most significant variances are the materials quantity variance and the
labour rate variance. Possible causes of the variances include:
Materials quantity variance: Outdated standards, unskilled workers, poorly
adjusted machines, carelessness, poorly
trained workers, inferior quality materials.
Labour rate variance:
Solutions Manual, Chapter 11
Outdated standards, change in pay scale,
overtime pay.
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55
Problem 11-3 (Continued)
4.
Actual Fixed Overhead
Cost
Budgeted Fixed Overhead
Cost*
Lump sum
Lump sum or SR x DV
= $130,290 (given)
= $130,290 (given)
Standard Quantity Allowed
for Output, at the
Standard Rate
(SQ×PDR)
6,000 hours** ×
$21.50 per hour
= $129,000



Fixed overhead budget
variance, $ 0 F
Fixed overhead volume
variance, $1,290 U
Total variance, $1,290 U (Given data)
*The denominator activity level is 0.4 hours × 15,150 units = 6,060 hours. The
predetermined rate for fixed overhead, PDR = $130,290 ÷ 6,060 hours = $21.50 per
hour.
** 0.4 × 15,000 = 6,000 the standard quantity of hours allowed for output of 15,000
units.
The unfavorable volume variance is due to the fact that actual number of pools is less
than the normal production volume. Consequently the fixed costs are applied to fewer
units that the denominator volume. Since the deviation from the planned volume is
minor, it is unlikely to be of significance operationally for Ms. Dunn.
5. The proper comparison budget is the flexible budget which is the budget based on
the actual volume of production. The static budget is the wrong budget because this
budget mixes the effects of activity level and operation activity together. In other words
if a static budget variance will be due to both a volume difference (actual and planned)
and also due to purchase and use of the resources.
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56
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-4 (90 minutes) ( LO2 CC14; LO3 15, 17, 18; LO6 CC27A, 28A)
1. a.
Actual Quantity of Inputs,
at Actual
Price
(AQ × AP)
32,000 feet
× $4.80 per foot
= $153,600
Actual Quantity of
Inputs, at Standard
Price
(AQ × SP)
32,000 feet
× $5.00 per foot
= $160,000

Standard Quantity
Allowed for Output, at
Standard Price
(SQ × SP)
29,600 feet*
× $5.00 per foot
= $148,000

Price Variance,
$6,400 F

Quantity Variance,
$12,000 U
Total Variance, $5,600 U
*8,000 footballs × 3.7 ft. per football = 29,600 feet.
Alternative Solution:
Materials price variance = AQ (AP – SP)
32,000 feet ($4.80 per foot – $5.00 per foot) = $6,400 F
Materials quantity variance = SP (AQ – SQ)
$5.00 per foot (32,000 feet – 29,600 feet) = $12,000 U
b. Raw Materials (32,000 feet × $5.00 per foot) ................................
160,000
Materials Price Variance
(32,000 feet × $0.20 per foot F) ................................
Accounts Payable
(32,000 feet × $4.80 per foot) ................................
153,600
Work in Process
(29,600 feet × $5.00 per foot) ...................................................
148,000
Materials Quantity Variance
(2,400 feet U × $5.00 per foot) ................................
12,000
Raw Materials
(32,000 feet × $5.00 per foot) ................................
160,000
Solutions Manual, Chapter 11
6,400
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57
Problem 11-4 (continued)
2. a.
Actual Hours of Input, at
the Actual Rate
Actual Hours of Input, at
the Standard Rate
(AH × AR)
6,400 hours*
× $8.00 per hour
= $51,200
(AH × SR)
6,400 hours
× $7.50 per hour
= $48,000

Standard Hours Allowed
for Output, at the
Standard Rate
(SH × SR)
7,200 hours**
× $7.50 per hour
= $54,000

Rate Variance,
$3,200 U

Efficiency Variance,
$6,000 F
Total Variance, $2,800 F
*8,000 footballs × 0.8 hours per football = 6,400 hours.
**8,000 footballs × 0.9 hours per football = 7,200 hours.
Alternate Solution:
Labour rate variance = AH (AR – SR)
6,400 hours ($8.00 per hour – $7.50 per hour) = $3,200 U
Labour efficiency variance = SR (AH – SH)
$7.50 per hour (6,400 hours – 7,200 hours) = $6,000 F
b. Work in Process (7,200 hours × $7.50 per hour) ............................
54,000
Labour Rate Variance
(6,400 hours × $0.50 per hour U) ..............................................
3,200
Labour Efficiency Variance
(800 hours F × $7.50 per hour) ................................
Wages Payable
(6,400 hours × $8.00 per hour) ................................
6,000
51,200
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58
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-4 (continued)
3. Actual Quantity of Input,
at the Actual Rate
(AQ × AR)
6,400 hours
× $2.75 per hour
= $17,600
Actual Quantity of Input,
at the Standard Rate
(AQ × SR)
6,400 hours
× $2.50 per hour
= $16,000

Standard Quantity of
Input Allowed for Actual
Output, at the Standard
Rate
(SH × SR)
7,200 hours
× $2.50 per hour
= $18,000

Spending Variance,
$1,600 U

Efficiency Variance,
$2,000 F
Total Variance, $400 F
Alternate Solution:
Variable overhead spending variance = AQ (AR – SR)
6,400 hours ($2.75 per hour – $2.50 per hour) = $1,600 U
Variable overhead efficiency variance = SR (AQ – SQ)
$2.50 per hour (6,400 hours – 7,200 hours) = $2,000 F
4. No. He is not correct in his statement. The company has a large, unfavourable
materials quantity variance that should be investigated. Also, the overhead spending
variance equals 10% of standard, which should also be investigated.
It appears that the company’s strategy to increase output by giving raises was
effective. Although the raises resulted in an unfavourable rate variance, this variance
was more than offset by a large, favourable efficiency variance.
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59
Problem 11-4 (continued)
5. The variances have many possible causes. Some of the more likely causes include
the following:
Materials variances:
Favourable price variance: Fortunate buy, outdated standards, inferior quality
materials, unusual discount due to quantity purchased, drop in market price, less
costly method of freight.
Unfavourable quantity variance: Carelessness, poorly adjusted machines, unskilled
workers, inferior quality materials, outdated standards, higher waste from errors.
Labour variances:
Unfavourable rate variance: Use of highly skilled workers, change in pay scale,
outdated standards, overtime.
Favourable efficiency variance: Use of highly skilled workers, high quality materials,
new equipment, outdated or inaccurate standards.
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-5 (45 minutes) (LO1 CC1, 2, 3, 4, 5, 6)
1.
2.
3.
4.
Syrup quantity standard:
Required per 10-litre batch (9.6 litres ÷ 0.8) ..............................
12.0 litres
Loss from rejected batches (1/5 × 12 litres)................................
2.4 litres
Total quantity per good batch .....................................................
14.4 litres
Ingredient X quantity standard:
15.0 kilograms
Required per 10-litre batch (12 kilograms ÷ 0.8) .........................
Loss from rejected batches (1/5 × 15 kilograms).........................
3.0 kilograms
Total quantity per good batch .....................................................
18.0 kilograms
Ingredient Y quantity standard:
Required per 10-litre batch.........................................................
5.0 kilograms
Loss from rejected batches (1/5 × 5 kilograms) ..........................
1.0 kilograms
Total quantity per good batch .....................................................
6.0 kilograms
5.
Total minutes per 8-hour day ........................................................
480 minutes
Less rest breaks and cleanup ........................................................60 minutes
Productive time each day ..............................................................
420 minutes
Productive time each day 420 minutes per day
=
Time required per batch 35 minutes per batch
= 12 batches per day
6.
Time required per batch .............................................................
35
Rest breaks and clean up time
(60 minutes ÷ 12 batches) ......................................................5
Total .........................................................................................
40
Loss from rejected batches (1/5 × 40 minutes) ...........................8
Total time per good batch ..........................................................
48
Solutions Manual, Chapter 11
minutes
minutes
minutes
minutes
minutes
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61
Problem 11-5 (continued)
7. Standard cost card:
Standard Quantity
or Time
Syrup ................................
14.4 litres
Ingredient X ................................
18.0 kilograms
Ingredient Y ................................
6.0 kilograms
Labour time ................................
48 minutes,
or 0.8 hours
Total standard cost................................
Standard Price or
Rate
Standard
Cost
$1.50/litre
$2.80/kilogram
$3.00/kilogram
$21.60
50.40
18.00
$9.00/hour
7.20
$97.20
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-6 (30 minutes) (LO3 CC17)
1. If the total variance is $96 unfavourable, and the rate variance is $90 favourable,
then the efficiency variance must be $186 unfavourable, since the rate and efficiency
variances taken together always equal the total variance. Knowing that the efficiency
variance is $186 unfavourable, one approach to the solution would be:
Efficiency variance = SR (AH – SH)
$9.00 per hour (AH – 150 hours*) = $186 U
($9.00 per hour × AH) – $1,350 = $186**
$9.00 per hour × AH = $1,536
AH = $1,536 ÷ $9.00 per hour
AH = 171 hours (rounded)
*50 jobs × 3 hours per job = 150 hours.
**When used with the formula, unfavourable variances are positive and favourable
variances are negative.
2.
Rate variance = AH (AR – SR)
171 hours × (AR – $9.00 per hour) = $90 F
(171 hours × AR) – $1,539 = –$90*
171 hours × AR = $1,449
AR = $1,449 ÷ 171 hours
AR = $8.47 per hour (rounded)
*When used with the formula, unfavourable variances are positive and favourable
variances are negative.
Solutions Manual, Chapter 11
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63
Problem 11-6 (continued)
An alternative approach to each solution would be to work from known to unknown
data in the columnar model for variance analysis:
Actual Hours of Input, at
the Actual
Rate
(AH × AR)
171 hours
× $8.47 per hour
= $1,446
Actual Hours of Input, at
the Standard
Rate
(AH × SR)
171 hours
× $9.00 per hour*
= $1,536

Standard Hours Allowed
for Output, at the
Standard Rate
(SH × SR)
150 hours1
× $9.00 per hour*
= $1,350

Rate Variance,
$90 F*

Efficiency Variance,
$186 U
Total Variance, $96 U*
150
tune-ups* × 3 hours per tune-up* = 150 hours.
*Given.
(Note: Actual hours should be 170.67; rounded to 171.)
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-7 (60 minutes) (LO3 CC15, 17)
1. a. Materials quantity variance = SP (AQ – SQ)
$7.00 per metre × (AQ – 9,600 metres*) = $4,500 U
($7.00 per metre × AQ) – $67,200 = $4,500**
$7.00 per foot × AQ = $71,700
AQ = 10,243 metres
*3,200 units × 3 metres per unit = 9,600 metres.
**When used with the formula, unfavourable variances are positive
and favourable variances are negative.
Therefore, $55,650 ÷ 10,243 metre = $5.43 per metre.
b. Materials price variance = AQ (AP – SP)
10,243 metres × ($5.43 per metre – $7.00 per metres) = $16,082 F
The total variance for materials would be:
Materials price variance ................................ $16,082 F
Materials quantity variance ................................ 4,500 U
Total variance ................................................................
$11,582 F
Alternate approach to parts (a) and (b):
Actual Quantity of
Inputs, at Actual Price
(AQ × AP)
10,243 metres
× $5.43 per metre
= $55,650
Actual Quantity of
Inputs, at Standard
Price
(AQ × SP)
10,243 metres
× $7.00 per metre*
= $71,707

Standard Quantity
Allowed for Output, at
Standard Price
(SQ × SP)
9,600 metres**
× $7.00 per metre*
= $67,200

Price Variance,
$16,057 F

Quantity Variance,
$4,507 U
Total Variance, $11,550 F
* Given.
** 3,200 units × 3 foot per metre = 9,600 metres.
(Note: There are some errors due to rounding. The correct amount for the total
variance is $11,550 F ($67,200 - $55,650).)
Solutions Manual, Chapter 11
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65
Problem 11-7 (continued)
2. a. Labour rate variance = AH (AR – SR)
4,900 hours × ($7.50 per hour* – SR) = $3,000 F**
$36,750 – (4,900 hours × SR) = –$3,000***
4,900 hours × SR = $39,750
SR = $8.11
*$36,750 ÷ 4,900 hours = $7.50.
**$2,000 F = Labour rate variance + $1,000 U
Therefore, labour rate variance = $3,000 F
***When used with the formula, unfavourable cost variances
are positive and favourable cost variances are negative.
b. Labour efficiency variance = SR (AH – SH)
$8.11 per hour × (4,900 hours – SH) = $1,000 U
$39,750 – ($8.11 per hour × SH) = $1,000*
$8.11 per hour × SH = $38,750
SH = 4,778 hours
*When used with the formula, unfavourable cost variances
are positive and favourable cost variances are negative.
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-7 (continued)
Alternate approach to parts (a) and (b):
Actual Hours of Input, at
the Actual Rate
(AH × AR)
$36,750*
Actual Hours of Input, at
the Standard
Rate
(AH × SR)
4,900 hours*
× $8.11 per hour
= $39,750

Standard Hours Allowed
for Output, at the
Standard Rate
(SH × SR)
4,778 hours
× $8.11 per hour
= $38,750

Rate Variance,
$3,000 F

Efficiency Variance,
$1,000 U
Total Variance, $2,000 F
*Given.
(Note: The variance amounts are slightly different than the amounts given due to
rounding errors in the computations.)
c. The standard hours allowed per unit of product would be:
4,778 hours ÷ 3,200 units = 1.493 hours per unit (rounded).
Solutions Manual, Chapter 11
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67
Problem 11-8 (60 minutes) (LO1 CC6; LO3 CC15, 16, 17, 18)
Note: This is a challenging problem.
1.
a. $9,600/$6 = 1,600. This is the standard quantity of labour hours allowed for 3,000
units of output.
b. Since the standard cost of labour to make 3,000 units is $48,000 and 1,600 hours
are allowed, the standard wage rate is $48,000/1,600 = $30 per hour.
c. Standard cost of materials = Actual cost + Favourable total materials variance
Standard cost of materials = $130,000 + $1,400 = $131,400.
d.
$63.42 x 3,000 = $190,260. This is the actual total variable cost of production
e.
Actual cost of 3,000 sails (3,000 × $63.42)
Less actual direct materials cost
Less actual variable overhead cost
Actual direct labour cost
$ 190,260
(130,000)
(9,720)
$ 50,540
Alternatively, on a per-unit cost basis, direct labour cost is $16.85 (that is, $63.42 –
$130,000 / 3,000 – $9,720 / 3,000). Actual cost of direct labour is 3,000 × $16.85 =
$50,550 (difference is due to rounding).
f.
Materials price variance = Total materials variance – Material quantity variance
= $1,400 − (–$2,400)
= $3,800 F
g..
Labour rate variance = (AH × AR) − (AH × SR)
= (1,700 × 29.729) − (1,700 × $30)
= $50,540 − $51,000
= $460 F, or alternatively ($50,550 – $51,000 = $450 F)
h.
Labour efficiency variance = (AH × SR) − (SH × SR)
= $51,000 − $48,000
= $3,000 U
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-8 (continued)
2.
The standard cost card for one unit is as follows:
Input
Direct
materials
Direct labour
Variable
overhead
Standard
amount of
input per unit
2.7375 metres
per unit*
0.533 hours
per unit**
0.533 hours
per unit***
Standard price
per unit of
input
$16 per metre
Standard cost
per unit of
output
$43.8
Standard cost
to make 3,000
units
$131,400
$30 per hour
$16 per unit of
output
$3.20 per unit
of output
$48,000
$6 per hour
$9,600
*Standard cost of materials for 3,000 units/Standard price per metre = $131,400/$16 =
8,212 metres of materials allowed for 3,000 units. Thus 8,212/3000 = 2.7375
metres per unit is the standard quantity of materials per unit.
**1,600 hours are allowed for 3,000 units. Thus 1,600/3,000 = 0.533 hours per unit is
the standard quantity of labour per unit of output.
***Same as for direct labour.
3. The denominator volume is the amount of direct labour hours in the static budget for
the volume of 3,200 units. Since 0.5333 hours are required per unit, the volume of
hours allowed for 3,200 units is 0.5333 x 3,200 = 1,706.56 hours.
Given the predetermined overhead rate of $20 per direct labour hour, the budgeted
fixed overhead cost is $20 x 1,706 hours = $34,131.20.
Finally, the standard hours allowed for 3,000 units is 1,600. Thus applied fixed overhead
cost is $20 x 1,600 = $32,000.
Solutions Manual, Chapter 11
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69
Problem 11-8 (continued)
Pulling all of the above together we have:
Data Area
Budgeted output volume
Standard quantity of input per unit of output
Standard quantity of input --Denominator volume
3,200.00
0.53
1,706.56
Actual volume of output
Standard quantity of input allowed for actual volume of output
3,000.00
1,599.90
Budgeted cost
Predetermined overhead rate (Budget/Denominator volume)
34,131.20
20.00
Actual cost
33,200.00
Actual Fixed
Overhead Cost
Budgeted Fixed
Overhead Cost
Applied Fixed
OverheadCost
$33,200.00
$34,131.20
$31,998.00
Budget Variance
-$931.20
F
Volume Variance
$2,133.20
U
(Numbers are subject to rounding errors)
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-9 (90 minutes) (LO3 CC15, 16, 17, 18; LO6 CC27A, 28A)
1. a. Before the variances can be computed, we must first compute the standard and
actual quantities of material per hockey stick. The computations are:
Direct materials added to work in process (a) ................................
$115,200
Standard direct materials cost per foot (b)................................
$3.00
Standard quantity of direct materials—last year (a) ÷
(b) ............................................................................................
38,400 feet
Standard quantity of direct materials—last year (c) .........................
38,400 feet
Number of sticks produced last year (d) ................................ 8,000
Standard quantity of direct materials per stick
4.8 feet
(c) ÷ (d)....................................................................................
Actual quantity of direct materials used per stick last year:
4.8 feet + 0.2 feet = 5.0 feet.
With these figures, the variances can be computed as follows:
Actual Quantity of
Inputs, at Actual
Price
(AQ × AP)
$174,000

Actual Quantity of Inputs, at
Standard Price
Standard Quantity Allowed
for Output, at Standard Price
(AQ × SP)
60,000 feet
× $3.00 per foot
= $180,000
(SQ × SP)
38,400 feet
× $3.00 per foot
= $115,200

Price Variance,
$6,000 F
40,000 feet* × $3.00 per foot
= $120,000


Quantity Variance, $4,800 U
*8,000 units × 5.0 feet per unit = 40,000 feet.
Solutions Manual, Chapter 11
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71
Problem 11-9 (continued)
Alternate Solution:
Materials price variance = AQ (AP – SP)
60,000 feet ($2.90 per foot* – $3.00 per foot) = $6,000 F
*$174,000 ÷ 60,000 feet = $2.90 per foot.
Materials quantity variance = SP (AQ – SQ)
$3.00 per foot (40,000 feet – 38,400 feet) = $4,800 U
b. Raw Materials (60,000 feet × $3.00 per foot) ................................
180,000
Materials Price Variance
(60,000 feet × $0.10 per foot F) ................................
Accounts Payable
(60,000 feet × $2.90 per foot) ................................
174,000
Work in Process (38,400 feet × $3.00 per foot) ..............................
115,200
Materials Quantity Variance
(1,600 feet U × $3.00 per foot) ..................................................
4,800
Raw Materials
(40,000 feet × $3.00 per foot) ................................
120,000
6,000
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-9 (continued)
2. a. Before the variances can be computed, we must first determine the actual direct
labour-hours worked for last year. This can be done through the variable
overhead efficiency variance, as follows:
Variable overhead efficiency variance = SR (AH – SH)
$1.30 per hour × (AH – 16,000 hours*) = $650 U
$1.30 per hour × AH – $20,800 = $650**
$1.30 per hour × AH = $21,450
AH = $21,450 ÷ 1.30 per hour
AH = 16,500 hours
* 8,000 units × 2.0 hours per unit = 16,000 hours.
** When used in the formula, an unfavourable cost variance is positive.
We must also compute the standard rate per direct labour hour. The computation
is:
Labour rate variance = (AH × AR) – (AH × SR)
$79,200 – (16,500 hours × SR) = $3,300 F
$79,200 – 16,500 SR = –$3,300*
16,500 SR = $82,500
SR = $82,500 ÷ 16,500
SR = $5.00
* When used in the formula, a favourable cost variance is negative.
Solutions Manual, Chapter 11
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73
Problem 11-9 (continued)
Given these figures, the variances are:
Actual Hours of Input, at
the Actual Rate
(AH × AR)
$79,200
Actual Hours of Input, at
the Standard
Rate
(AH × SR)
16,500 hours
× $5.00 per hour
= $82,500
Standard Hours Allowed
for Output, at the
Standard Rate
(SH × SR)
16,000 hours
× $5.00 per hour
= $80,000



Rate Variance,
$3,300 F
Efficiency Variance,
$2,500 U
Total Variance, $800 F
Alternate Solution:
Labour rate variance = AH (AR – SR)
16,500 hours ($4.80 per hour* – $5.00 per hour) = $3,300 F
*79,200 ÷ 16,500 hours = $4.80 per hour.
Labour efficiency variance = SR (AH – SH)
$5.00 per hour (16,500 hours – 16,000 hours) = $2,500 U
b. Work in Process
80,000
(16,000 hours × $5.00 per hour) ...............................................
Labour Efficiency Variance
(500 hours U × $5.00 per hour) .................................................
2,500
Labour Rate Variance
(16,500 hours × $0.20 per hour F) ................................
Wages Payable
(16,500 hours × $4.80 per hour) ................................
3,300
79,200
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74
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-9 (continued)
3. Actual Quantity of Input,
at the Actual Rate
(AQ × AR)
$19,800
Actual Quantity of Input,
at the Standard
Rate
(AQ × SR)
16,500 hours
× $1.30 per hour
= $21,450

Standard Quantity of Input
Allowed for Actual Output,
at the Standard Rate
(SQ × SR)
16,000 hours
× $1.30 per hour
= $20,800

Spending Variance,
$1,650 F

Efficiency Variance,
$650 U
Total Variance, $1,000 F
Alternate Solution:
Variable overhead spending variance = AQ (AR – SR)
16,500 hours ($1.20 per hour* – $1.30 per hour) = $1,650 F
*$19,800 ÷ 16,500 hours = $1.20 per hour.
Variable overhead efficiency variance = SR (AQ – SQ)
$1.30 per hour (16,500 hours – 16,000 hours) = $650 U
Solutions Manual, Chapter 11
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75
Problem 11-9 (continued)
4. For materials:
Favourable price variance: Decrease in outside purchase price; fortunate buy;
inferior quality materials; unusual discounts due to quantity purchased; less
costly method of freight; inaccurate standards.
Unfavourable quantity variance: Inferior quality materials; carelessness; poorly
adjusted machines; unskilled workers; inaccurate standards.
For labour:
Favourable rate variance: Unskilled workers (paid lower rates); piecework;
inaccurate standards.
Unfavourable efficiency variance: Poorly trained workers; poor quality materials;
faulty equipment; work interruptions; fixed labour and insufficient demand to fill
capacity; inaccurate standards.
5.
Standard
Quantity or
Hours
Direct materials ................................
4.8 feet
Direct labour................................ 2.0 hours
Variable overhead ................................
2.0 hours
Total standard cost................................
Standard Price or
Rate
$3.00 per foot
$5.00 per hour
$1.30 per hour
Standard
Cost
$14.40
10.00
2.60
$27.00
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-10 (45 minutes) (LO1 CC2, 3, 4, 5, 6; LO3 CC15, 17)
1. Practical Standards
To yield 47 kilograms of soil (which is the ideal standard of input required to provide
standard service), the company must acquire a standard quantity (SQ) of 52.50
kilograms of soil; the calculation is as follows:
For every 10 kilos of useable soil 0.5 is thrown away; therefore 10.5 kilograms of
soil must be purchased in order to be able to use 10 kilos. This is calculated as
follows:
(10.5 ÷ 10.0) × 47 = 49.35 kilograms
Of every 100 kilograms purchased 6 kilograms is blown away. This means that
100 kilograms must be purchased to be able to use 94 kilograms. This is
calculated as follows:
(100 ÷ 94) × 49.35 = 52.50 kilograms
To yield 20 bunches of foliage (which is the ideal standard of input required to
provide standard service), the company must acquire a standard quantity (SQ) of 22
bunches, before 10% wastage in use is taken into account. This is calculated as
follows:
1.10 × 20 = 22.0 bunches
To realize 10.8 direct labour hours of effort (which is the ideal standard of input
required to provide standard service), the company must pay for standard hours
(SH) of 14 hours of labour, before taking into account that 1 hour in 7 (i.e. 14.29%)
of paid hours is not productive time, and 10% of the resulting productive work is
wasted due to “redoing” portions of the work. This is calculated as follows:
90% × (SH – (SH × 14.29%)) = 10.8
SH = 14
Solutions Manual, Chapter 11
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77
Problem 11-10 (continued)
2. Standard cost per standard service
Direct material:
Soil
(52.50 kg × $7.20)
Foliage
(22 bunches × $3.50)
Direct labour (14 hours × $12)
Standard cost per service
$378.00
77.00
168.00
$623.00
2. a. Generally, the purchasing manager is held responsible for unfavourable material
price variances. Causes of these variances include the following:
• Incorrect standards.
• Failure to correctly forecast price increases.
• Purchasing in non-standard or uneconomical lots.
• Failure to take purchase discounts available.
• Failure to control transportation costs.
• Purchasing from suppliers other than those offering the most favourable
terms.
However, failure to meet price standards may be caused by a rush of orders or
changes in production schedules. In this case, the responsibility for unfavourable
material price variances should rest with the sales manager or the manager of
production planning. There may also be times when variances are caused by
external events and are therefore uncontrollable, e.g., a strike at a supplier’s
plant.
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-10 (continued)
b. In general, the production manager or foreman is held responsible for
unfavourable labour efficiency variances. Causes of these variances include the
following:
• Incorrect standards.
• Poorly trained labour.
• Substandard or inefficient equipment.
• Inadequate supervision.
• Machine breakdowns from poor maintenance.
• Poorly motivated employees/absenteeism.
• Fixed labour force with demand less than capacity.
Failure to meet labour efficiency standards may also be caused by the use of
inferior materials or poor production planning. In these cases, responsibility
should rest with the purchasing manager or the manager of production planning.
There may also be times when variances are caused by external events and are
therefore uncontrollable, e.g., lack of skilled workers caused by low
unemployment.
Solutions Manual, Chapter 11
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79
Problem 11-11 (75 minutes) (LO2 CC14; LO3 CC15, 16, 17, 18; LO4 CC22, 23, 24)
NOTE: This is a challenging problem. Please ask students to attempt the
questions in the order listed due to the fact that later parts depend on earlier
calculations. This is an excellent final exam review problem.
1.
We know that materials cost is AQ x AP = $264,000. Thus AQ = $264,000/0.528 =
500,000 units.
2. This is AQ x SP. Using the previous calculation, AQ x SP = 500,000 x SP = AQ x AP +
Materials price variance. Thus,
AQ x SP = $264,000 - $14,000U = $250,000.
And,
SP = $250,000/500,000 = $0.50.
3. The flexible budget will report SQ x SP for direct materials cost. Note that SQ is the
amount of direct materials allowed by the standards for making the actual volume of
output. SQ is 200,000 units. Thus,
SP x SQ = $0.5 x 200,000 = $100,000.
4. SP X SQ - SP x AQ = Materials quantity variance. This approach gives
SP x AQ = $100,000 + $10,000U = $110,000.
5. AQ used = SP x AQ/SP = $110,000/0.50 = 220,000 units of direct materials was
used.
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-11 (continued)
6. We can use the three-columnar approach to record the information given to us as
follows:
Actual Hours of Input, at Actual Hours of Input, at
Standard Hours Allowed
the Actual Rate
the Standard
for Output, at the
Rate
Standard Rate
(AH × AR)
(AH × SR)
(SH × SR)
10,000 hours
× $? per hour
= $199,680
?
?


Rate Variance,
$8,320 F

Efficiency Variance,
$48,000 U
?
From



the above information, we can compute the following:
The total amount in the middle column is $208,000 ($199,680 + $8,320)
The total amount in the last column is $160,000 ($208,000 - $48,000)
Therefore, SR = $160,000 ÷ 10,000 hours = $16 per hour
We can now calculate AH as $208,000 ÷ $16 = 13,000 hours
7. Standard costs for 20,000 units (actual output):
Standard quantity
Direct materials
Direct labour
Variable overhead
200,000 units
10,000 hours
10,000 hours
Standard
price/rate
$0.50 per unit
$16.00 per hour
$10.00 per hour
Standard cost
$100,000
$160,000
$100,000
$360,000
÷ 20,000 units
=$18 per unit
8. The normal volume is 16,000 units. The standard quantity of hours per unit of output
is:
SQI
= SQ allowed for actual output ÷ Q
= 10,000 hours ÷ 20,000 units
= 0.5 hours
Solutions Manual, Chapter 11
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81
Problem 11-11 (continued)
And, SQ for 16,000 units = 0.5 × 16,000 = 8,000 hours
This is the denominator hours. The budgeted fixed cost is $PDR × 8,000 hours
The allocated fixed cost is = SQ for actual output × the allocation rate
= 10,000 hours × PDR
Since the volume variance is $43,800F, the following must be true:
Allocated fixed cost – Budgeted fixed cost = $43,800
10,000 x PDR – 8,000 x PDR = $43,800
PDR = $43,800/2,000 = $21.90.
9.
The
The
The
The
Allocated fixed cost is 10,000 hours x $21.90 = $219,000
Budgeted fixed cost is 8,000 hours x $21.90 = $175,200
Budget Variance is $3,000 U
Actual Fixed Overhead cost is $178,200.
10. The total variance is Actual fixed overhead cost – Applied fixed overhead cost =
$178,200 - $219,000 = ($40,800) F. Or directly from the question add the budget and
volume variances: 3,000U + 43,800F = $40,800F. This favourable variance is overapplied fixed overhead.
Thus the over-applied fixed overhead is $40,800.
Note: The fixed overhead analysis can also be set up using the columnar
display similar to exhibit 11-16 in the text. This is shown below. DV in the
graphic is “denominator volume.”
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-11 (continued)
Actual Fixed Overhead
Cost
Budgeted Fixed Overhead
Cost
Lump sum
Lump sum or SR × DV
Add budget variance
= $178,200
$21.90* × DV
= $21.90 × 8,000 =
$175,200

Standard Quantity Allowed
for Output, at the
Standard Rate
(SQ×PDR)
10,000** ×
$21.90 per hour
= $219,000

Fixed overhead budget
variance, $ 3,000 U

Fixed overhead volume
variance 43,800F
Total variance, $40,800 F
* The predetermined rate for fixed overhead, $21.90 is calculated after the DV since it
is not provided. It is calculated below as 8,000 hours.
** 10,000 hours is given.
DV calculation:
The denominator activity level is
DV hours = SQ for normal volume ÷ SQI.
It is calculated as follows:
SQ = 10,000 hours for actual output of 20,000 (Given)
But,
SQ = SQI × 20,000 = 10,000 hours
Thus,
SQI = 0.5 hours.
And,
DV = SQI × 16,000 hours = 0.5 × 16,000 = 8,000.
PDR calculation:
10,000 hours x PDR – 8,000 hours x PDR = $43,800
Thus,
PDR = $43,800/2,000 hours = $21.90 per hour.
Solutions Manual, Chapter 11
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83
Problem 11-12 (45 minutes) (LO3 CC17)
1.
Actual
Budget
$
Hours
The reason for the trend in the variances is due to the fact that actual direct labour cost
is computed using a variable cost formula of $10 per direct labour hour which kicks in
at 15,625 hours, whereas the budgeted labour cost is calculated using a mixed cost
formula. This formula assumes that each worker is paid hourly right from the first hour
worked as well as being paid the fixed amount. In the diagram the effect of this
difference between the actual remuneration and the budget formula can be seen. At
low hours the actual is below the budget and at high hours, the budget line is below the
actual. This difference in the cost behaviour causes the pattern of the variance.
2. A result of the contract provision is that $156,250 per month is a fixed cost. Using a
rate of $10 per direct labour hour, this translates into 15,625 direct labour hours per
month bearing a fixed cost. ONLY the additional labour hours (over 15,625) are paid at
$10 per hour. Therefore, a more appropriate budgeting formula would be as follows:
$156,250 + [$10 × (Monthly direct labour hours – 15,625)]
Using this formula, the budgeted labour costs are:
April: $156,250 + [$10 × (27,500 – 15,625)] = $275,000
May: $156,250 + [$10 × (40,000 – 15,625)] = $400,000
June: $156,250 + [$10 × (60,000 – 15,625)] = $600,000
These amounts are the same as the actual labour costs incurred, thereby resulting in a
zero variance for each of the three months.
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-13 (45 minutes) (LO3 CC15, 16, 17)
1. a.
Actual Quantity of Input,
at Actual Price
(AQ × AP)
21,000 feet** ×
$3.20 per foot
= $67,200
Actual Quantity of Input,
at Standard Price
(AQ × SP)
21,000 feet** ×
$3.00 per foot
= $63,000
Standard Quantity Allowed
for Actual Output,
at Standard Price
(SQ × SP)
21,600 feet* ×
$3.00 per foot
= $64,800
Materials price variance =
Materials quantity
$4,200 U
variance = $1,800 F
Flexible budget variance = $2,400 U
* 12,000 units × 1.80 feet per unit = 21,600 feet
** 12,000 units × 1.75 feet per unit = 21,000 feet
Alternatively, the variances can be computed using the formulas:
Materials quantity variance = SP (AQ – SQ)
= $3.00 per foot (21,000 feet – 21,600 feet)
= $1,800 F
Materials price variance = AQ (AP – SP)
= 21,000 feet ($3.20 per foot – $3.00 per foot)
= $4,200 U
Solutions Manual, Chapter 11
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85
Problem 11-13 (continued)
1. b.
Actual Hours of Input,
at Actual Rate
(AH × AR)
11,400 hours** ×
$17.40 per hour
= $198,360
Actual Hours of Input,
at Standard Rate
(AH × SR)
11,400 hours** ×
$18.00 per hour
= $205,200
Standard Hours Allowed
for Actual Output,
at Standard Rate
(SH × SR)
10,800 hours* ×
$18.00 per hour
= $194,400
Labor rate variance
Labor efficiency variance
= $10,800 U
= $6,840 F
Flexible budget variance = $3,960 U
* 12,000 units × 0.90 hours per unit = 10,800 hours
** 12,000 units × 0.95 hours per unit = 11,400 hours
Alternatively, the variances can be computed using the formulas:
Labor efficiency variance = SR (AH – SH)
= $18.00 per hour (11,400 hours – 10,800 hours)
= $10,800 U
Labor rate variance = AH (AR – SR)
= 11,400 hours ($17.40 per hour – $18.00 per hour)
= $6,840 F
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-13 (continued)
1. c.
Actual Hours of Input,
at Actual Rate
(AH × AR)
11,400 hours** ×
$4.60 per hour
= $52,440
Actual Hours of Input,
at Standard Rate
(AH × SR)
11,400 hours** ×
$5.00 per hour
= $57,000
Standard Hours Allowed
for Actual Output,
at Standard Rate
(SH × SR)
10,800 hours* ×
$5.00 per hour
= $54,000
Variable overhead rate
Variable overhead
variance
efficiency variance
= $4,560 F
= $3,000 U
Flexible budget variance = $1,560 F
* 12,000 units × 0.90 hours per unit = 10,800 hours
** 12,000 units × 0.95 hours per unit = 11,400 hours
Alternatively, the variances can be computed using the formulas:
Variable overhead efficiency variance = SR (AH – SH)
= $5.00 per hour (11,400 hours – 10,800 hours)
= $3,000 U
Variable overhead rate variance = AH (AR – SR)
= 11,400 hours ($4.60 per hour – $5.00 per hour)
= $4,560 F
2.
Materials:
Quantity variance ($1,800 ÷ 12,000 units) .................
Price variance ($4,200 ÷ 12,000 units) .......................
Labor:
Efficiency variance ($10,800 ÷ 12,000 units) ..............
Rate variance ($6,840 ÷ 12,000 units) .......................
Variable overhead:
Efficiency variance ($3,000 ÷ 12,000 units) ................
Rate variance ($4,560 ÷ 12,000 units) .......................
Excess of actual over standard cost per unit ....................
Solutions Manual, Chapter 11
$0.15 F
0.35 U
$0.20 U
0.90 U
0.57 F
0.33 U
0.25 U
0.38 F
0.13 F
$0.40 U
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87
Problem 11-13 (continued)
3. Both the labor efficiency and variable overhead efficiency variances are affected by
inefficient use of labor time.
Excess of actual over standard cost per unit ...................
Less portion attributable to labor inefficiency:
Labor efficiency variance ...............................................
Variable overhead efficiency variance .............................
Portion due to other variances .......................................
$0.40 U
0.90 U
0.25 U
1.15 U
$0.75 F
In sum, had it not been for the apparent inefficient use of labor time, the total
variance in unit cost for the month would have been favorable by $0.75 rather than
unfavorable by $0.40.
4.
Although the excess of actual cost over standard cost is only $0.40 per
unit, the total amount of $4,800 (= $0.40 per unit × 12,000 units) is substantial.
Moreover, the details of the variances are significant. The materials price variance is
$4,200 U, the labor efficiency variance is $10,800 U, the labor rate variance is $6,840 F,
the variable overhead efficiency variance is $3,000 U, and the variable rate variance is
$4,560 F. Taken together, the two variances that reflect apparent inefficient use of the
labor time total $13,800 U. Each of these variances may warrant further investigation.
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-14 (60 minutes) (LO3 CC15, 17, 18; LO4 CC22, 23)
1.
Actual Quantity of
Inputs, at Actual Price
(AQ × AP)
12,000 metres
× $8.50 per metre
= $102,000
Actual Quantity of
Inputs, at Standard
Price
(AQ × SP)
12,000 metres
× $9.00 per kilogram
= $108,000

Standard Quantity
Allowed for Output, at
Standard Price
(SQ × SP)
12,000 metres*
× $9.00 per kilogram
= $108,000

Price Variance,
$6,000 F

Quantity Variance,
0
Total Variance, $6,000 F
*2,000 covers × 6 metres per unit = 12,000 metres
2. Actual Hours of Input, at
the Actual Rate
(AH × AR)
525 hours
× ? per hour
= $7,875
Actual Hours of Input, at
the Standard
Rate
(AH × SR)
525 hours
× $15.00 per hour
= $7,875
Standard Hours Allowed
for Output, at the
Standard Rate
(SH × SR)
500 hours*
× $15.00 per hour
= $7,500



Rate Variance,
0
Efficiency Variance,
$375 U
Total Variance, $375U
*2,000 units × 0.25 hours per unit = 500 hours.
Note: In the problem, the total direct labour cost variance is entirely due to the labour
efficiency variance.
Solutions Manual, Chapter 11
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89
Problem 11-14 (continued)
3. First compute all the overhead variances and determine the total overhead variance.
This is the amount of over-applied (if F) overhead or the amount of under-applied (if U)
overhead.
Variable Overhead Variances:
Actual Hours of Input, at
the Actual Rate
(AH × AR)
$3,800 given as a total
Actual Hours of Input, at
the Standard
Rate
(AH × SR)
525 hours × $7
= $3,800
= $3,675
Standard Hours Allowed
for Output, at the
Standard Rate
(SH × SR)
500 hours*
× $7 per hour
= $3,500



Rate Variance,
$125 U
Efficiency Variance,
$175 U
Total Variance, $300 U
*2,000 covers × 0.25 hours per cover = 500 hours.
Fixed Overhead Variances (See below):
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-14 (continued)
Actual Fixed Overhead
Cost
Budgeted Fixed Overhead
Cost*
Lump sum
Lump sum or SR x DV
Given
Lump sum, given
= $17,500
= $17,700
Standard Quantity Allowed
for Output, at the
Standard Rate
(SQ×PDR)
500** ×
$32.403 per hour
= $16,201.50



Fixed overhead budget
variance, $ 200 F
Fixed overhead volume
variance, $1,498.50 U
Total variance, $1,298.50 U
*The denominator activity level is DV = 2,185 × 0.25 = 546.25 and budgeted cost is
$17,700. The predetermined rate for fixed overhead, PDR = $17,700 ÷ 546.25 =
$32.40275.
** 0.25 × 2,000 covers = 500 hours.
The total overhead variance is $300 U + $1,298.50 U = $1,598.50 U which is underapplied overhead.
4. The statement is false. An increase in SP will not change the quantity difference (AQ
– SQ) but the dollar value of the difference will be higher. Thus the quantity variance is
affected. And the difference (AP – SP) will become smaller in absolute value and thus
the price variance will improve. We are assuming that the purchases and uses are
equal.
5. The correct choice is b). The impact of an improvement in productivity will be
captured by AQ x SP and the variance AQ x SP – SQ x SP will indicate the magnitude of
the improvement. Choice a) is not the best place since it is possible for quantity
purchased to be different from the quantity used.
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91
Problem 11-15 (45 minutes) (LO2 CC10, 11, 12, 13)
1.
The cost formulas in the flexible budget report above were obtained by dividing the
costs on the static budget in the problem statement by the budgeted level of activity
(500 litres). The fixed costs are carried over from the static budget.
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-15 (continued)
2. The overall variance is favourable and none of the unfavourable variances is
particularly large. Nevertheless, the large favourable variance for lab tests is
worrisome. Perhaps the blood bank has not been doing all of the lab tests for HIV,
hepatitis, and other blood-transmittable diseases that it should be doing. This is well
worth investigating; it points out that favourable variances may warrant attention as
much as unfavourable variances.
Some may wonder why there is a variance for amortization. Fixed costs can change;
they just do not vary with the level of activity. Amortization may have increased
because of the acquisition of new equipment or because of a loss on equipment that
must be scrapped. (This assumes that the loss flows through the depreciation
account on the performance report.)
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93
Problem 11-16 (60 minutes) (LO1 CC6; LO3 CC15, 17, 18; LO4 CC22, 23)
1. Direct materials, 3 metres at $4.80 per metre ............................................ $14.40
Direct labour, 2 DLHs at $7 per DLH........................................................... 14.00
Variable manufacturing overhead, 2 DLHs at $3.00 per DLH* ......................
6.00
Fixed manufacturing overhead, 2 DLHs at $6.80 per DLH** ....................... 13.60
Standard cost per unit............................................................................ $48.00
* $60,000 ÷ 20,000 DLHs = $3.00 per DLH.
** $136,000 ÷ 20,000 DLHs = $6.80 per DLH.
2. Materials variances:
Materials price variance = AQ (AP – SP)
24,000 metres ($5.10 per metre – $4.80 per metre) = $7,200 U
Materials quantity variance = SP (AQ – SQ)
$4.80 per metre (18,500 metres – 18,000 metres*) = $2,400 U
*6,000 units × 3 metres per unit = 18,000 metres.
Labour variances:
Labour rate variance = AH (AR – SR)
11,600 DLHs ($7.50 per DLH – $7.00 per DLH) = $5,800 U
Labour efficiency variance = SR (AH – SH)
$7 per DLH (11,600 DLHs – 12,000 DLHs*) = $2,800 F
*6,000 units × 2 DLHs per unit = 12,000 DLHs.
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-16 (continued)
3. Variable overhead variances:
Actual Quantity of Input,
at the Actual Rate
Actual Quantity of Input,
at the Standard Rate
(AQ × AR)
$34,580
(AQ × SR)
11,600 hours
× $3.00 per hour
= $34,800

Standard Quantity
Allowed for Output, at
the Standard Rate
(SQ × SR)
12,000 hours
× $3.00 per hour
= $36,000

Spending Variance,
$220 F

Efficiency Variance,
$1,200 F
Total Variance, $1,420 F
Alternate solution for the variable overhead variances:
Variable overhead spending variance = (AQ × AR) – (AQ × SR)
($34,580) – (11,600 hours × $3.00 per hour) = $220 F
Variable overhead efficiency variance = SR (AQ – SQ)
$3.00 per hour (11,600 hours – 12,000 hours) = $1,200 F
Fixed overhead variances:
Actual Fixed
Overhead Cost
$69,400
Flexible Budget Fixed
Overhead Cost
$136,000

Applied Fixed Overhead
Cost
12,000 hours
× $6.80 per hour
= $81,600

Budget Variance,
$66,600 F
Solutions Manual, Chapter 11

Volume Variance,
$54,400 U
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95
Problem 11-16 (continued)
Alternative approach to the budget variance:
Budget variance = Actual fixed overhead cost – Flexible budget fixed
overhead cost
= $69,400 - $136,000
= $66,600 F
Alternative approach to the volume variance:
Fixed portion of
Volume
 the predetermined
variance
overhead rate
 Denominator Standard hours 


hours
allowed 

 $6.80 per hour (20,000 hours - 12,000 hours)
 $54,400 U
4. The choice of a denominator activity level affects standard unit costs in that the
higher the denominator activity level chosen, the lower standard unit costs will be.
The reason is that the fixed portion of overhead costs is spread over more units as
the denominator activity rises.
The volume variance cannot be controlled by controlling spending. The volume
variance simply reflects whether actual activity was greater than or less than the
denominator activity and it is controllable only through activity. In this particular
situation the company budgeted to produce 10,000 units (20,000 direct labour hours
÷ 2 direct labour hours per unit) but ended up producing only 6,000 units. This is
the cause for the large unfavourable volume variance. Management must review its
estimates to ensure that such a large variation in activity does not get repeated.
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-17 (75 minutes) (LO3 CC18; LO4 CC21, 22, 23, 24)
1.
Total rate:
PZ595,000
=PZ8.50 per hour
70,000 hours
Variable rate:
PZ175,000
=PZ2.50 per hour
70,000 hours
Fixed rate:
PZ420,000
=PZ6.00 per hour
70,000 hours
2. 64,000 standard hours × PZ8.50 per hour = PZ544,000
3. Variable overhead variances:
Actual Quantity of Input,
at the Actual Rate
(AQ × AR)
PZ156,000
Actual Quantity of Input,
at the Standard
Rate
(AQ × SR)
60,000 hours
× PZ2.50 per hour
= PZ150,000

Standard Quantity Allowed
for Output, at the
Standard Rate
(SQ × SR)
64,000 hours
× PZ2.50 per hour
= PZ160,000

Spending Variance,
PZ6,000 U

Efficiency Variance,
PZ10,000 F
Alternate solution:
Variable overhead spending variance = (AQ × AR) – (AQ × SR)
(PZ156,000) – (60,000 hours × PZ2.50 per hour) = PZ6,000 U
Variable overhead efficiency variance = SR (AQ – SQ)
PZ2.50 per hour (60,000 hours – 64,000 hours) = PZ10,000 F
Solutions Manual, Chapter 11
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97
Problem 11-17 (continued)
Fixed overhead variances:
Actual Fixed
Overhead Cost
PZ418,800
Flexible Budget Fixed
Overhead Cost
PZ420,000

Applied Fixed Overhead Cost
64,000 hours ×
PZ6 per hour = PZ384,000

Budget Variance,
PZ1,200 F

Volume Variance,
PZ36,000 U
Alternative solution:
Budget variance:
Budget = Actual fixed - Flexible budget fixed
variance
overhead cost
overhead cost
= PZ418,800 - PZ420,000
= PZ1,200 F
Volume variance:
Fixed portion of
Volume
 Denominator Standard hours 
 the predetermined 

variance
hours
allowed 

overhead rate
 PZ 6.00 per hour (70,000 hours - 64,000 hours)
 PZ36,000 U
Verification:
Variable overhead:
Spending variance................................................................
PZ 6,000
Efficiency variance ................................................................
10,000
Fixed overhead:
Budget variance ................................................................
1,200
Volume variance ................................................................
36,000
Underapplied overhead ..............................................................
PZ 30,800
U
F
F
U
U
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-17 (continued)
4. Variable Overhead
Spending variance: This variance includes both price and quantity elements. The
overhead spending variance reflects differences between actual and standard prices
for variable overhead items. It also reflects differences between the amounts of
variable overhead inputs that were actually used and the amounts that should have
been used for the actual output of the period. Since the variable overhead spending
variance is unfavourable, either too much was paid for variable overhead items or
too many of them were used.
Efficiency variance: The term “variable overhead efficiency variance” is a misnomer,
since the variance does not measure efficiency in the use of overhead items. It
measures the indirect effect on variable overhead of the efficiency or inefficiency
with which the activity base is utilized. In this company, labour-hours is the activity
base. If variable overhead is really proportional to labour-hours, then more effective
use of labour-hours has the indirect effect of reducing variable overhead. Since
2,000 fewer labour-hours were required than indicated by the labour standards, the
indirect effect was presumably to reduce variable overhead spending by about PZ
5,000 (PZ 2.50 per hour  2,000 hours).
Fixed Overhead
Budget variance: This variance is simply the difference between the budgeted fixed
cost and the actual fixed cost. In this case, the variance is favourable which
indicates that actual fixed costs were lower than anticipated in the budget.
Volume variance: This variance occurs as a result of actual activity being different
from the denominator activity in the predetermined overhead rate. In this case, the
variance is unfavourable, so actual activity was less than the denominator activity. It
is difficult to place much of a meaningful economic interpretation on this variance. It
tends to be large, so it often swamps the other, more meaningful variances if they
are simply netted against each other.
Solutions Manual, Chapter 11
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99
Problem 11-18 (75 minutes) (LO3 CC15, 17, 18; LO4 CC22, 23, 24)
1. Direct materials price and quantity variances:
Materials price variance = AQ (AP – SP)
64,000 metres ($8.55 per metre – $8.45 per metre) = $6,400 U
Materials quantity variance = SP (AQ – SQ)
$8.45 per metre (64,000 metres – 60,000 metres*) = $33,800 U
*30,000 units × 2 metres per unit = 60,000 metres.
2. Direct labour rate and efficiency variances:
Labour rate variance = AH (AR – SR)
45,000 hours ($7.80 per hour – $8.00 per hour) = $9,000 F
Labour efficiency variance = SR (AH – SH)
$8 per hour (45,000 hours – 42,000 hours*) = $24,000 U
*30,000 units × 1.4 hours per unit = 42,000 hours.
3. a) Variable overhead spending and efficiency variances:
Actual Quantity of Input,
at the Actual Rate
Actual Quantity of Input,
at the Standard Rate
(AQ × AR)
$108,000
(AQ × SR)
45,000 hours
× $2.50 per hour
= $112,500

Standard Quantity
Allowed for Output, at
the Standard Rate
(SQ × SR)
42,000 hours
× $2.50 per hour
= $105,000

Spending Variance,
$4,500 F

Efficiency Variance,
$7,500 U
Alternate solution:
Variable overhead spending variance = (AQ × AR) – (AQ × SR)
($108,000) – (45,000 hours × $2.50 per hour) = $4,500 F
Variable overhead efficiency variance = SR (AQ – SQ)
$2.50 per hour (45,000 hours – 42,000 hours) = $7,500 U
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-18 (continued)
b) Fixed overhead budget and volume variances:
Actual Fixed
Overhead Cost
$211,800
Flexible Budget Fixed
Overhead Cost
$210,000*

Applied Fixed Overhead Cost
42,000 hours × $6 per hour
= $252,000


Budget Variance,
$1,800 U
Volume Variance,
$42,000 F
*As originally budgeted. This figure can also be expressed as: 35,000 denominator
hours × $6 per hour = $210,000.
Alternative solution:
Budget variance:
Budget = Actual fixed - Flexible budget fixed
variance
overhead cost
overhead cost
= $211,800 - $210,000
= $1,800 U
Volume variance:
Fixed portion of
Volume  the predetermined Denominato r  Standard hours 
hours
allowed
variance


overhead rate 
 $6.00 per hour (35,000 hours - 42,000 hours)
 $42,000 F
Solutions Manual, Chapter 11
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101
Problem 11-18 (continued)
4. The total of the variances would be:
Direct materials variances:
Price variance ...........................................................................
$ 6,400
Quantity variance ................................................................ 33,800
Direct labour variances:
Rate variance ............................................................................9,000
Efficiency variance ................................................................ 24,000
Variable manufacturing overhead variances:
Spending variance ................................................................ 4,500
Efficiency variance ................................................................ 7,500
Fixed manufacturing overhead variances:
Budget variance ................................................................
1,800
Volume variance ................................................................ 42,000
Total of variances ................................................................ $18,000
U
U
F
U
F
U
U
F
U
Note: This agrees with the $18,000 mentioned by the president.
It appears that not everyone should be given a bonus for good cost control. The
materials quantity variance and the labour efficiency variance are 6.7% and 7.1%,
respectively, of the standard cost allowed and thus would warrant investigation. In
addition, the variable overhead spending variance is 4.3% of the standard cost
allowed. The favourable spending variance should also be investigated since a
favourable spending variance may signal a problem such as not doing scheduled
maintenance.
The company’s large unfavourable variances (for materials quantity and labour
efficiency) do not show up more clearly because they are offset for the most part by
the favourable volume variance. This favourable volume variance is a result of the
company operating at an activity level that is well above the denominator activity
level used to set predetermined overhead rates. (The company operated at an
activity level of 42,000 standard hours; the denominator activity level set at the
beginning of the year was 35,000 hours.) As a result of the large favourable volume
variance, the unfavourable quantity and efficiency variances have been concealed in
a small “net” figure. The large favourable volume variance may have resulted by
building up inventories.
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Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-19 (30 minutes) (LO4 CC22, 23)
1. 9,500 units × 3 hours per unit = 28,500 hours.
2. and 3.
Actual Fixed
Overhead Cost
$148,700*
Flexible Budget Fixed
Overhead Cost
$150,000

Applied Fixed Overhead Cost
28,500 hours × $5 per hour*
= $142,500

Budget Variance,
$1,300 F

Volume Variance,
$7,500 U*
*Given.
4.
Fixed element of the
Predetermined overhead rate
=
=
Flexible budget
fixed overhead cost
Denominator activity
$150,000
Denominator activity
= $5 per hour
Therefore, the denominator activity is: $150,000 ÷ $5 per hour =
30,000 hours.
Solutions Manual, Chapter 11
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103
Problem 11-20 (30 minutes) (LO4 CC22, 23)
1. 12,000 units produced × 3 hours per unit = 36,000 standard hours.
2. Actual fixed overhead costs ...........................................................
$267,000
Add: Favourable budget variance ...................................................3,000
Flexible budget fixed overhead cost ...............................................
$270,000
Flexible budget
fixed overhead cost
Fixed element of the
=
predetermined overhead rate Denominator activity
=
$270,000
30,000 MHs
=$9 per MH
3.
Fixed portion of
Volume
 Denominator Standard hours 
 the predetermined 

variance
hours
allowed 

overhead rate
 $9.00 per hour (30,000 hours - 36,000 hours)
 $54,000 F
Alternate solution to parts 1-3:
Actual Fixed
Overhead Cost
Flexible Budget Fixed
Overhead Cost
$267,000* (given)
$270,0001

36,000 hours2 ×
$9 per hour3 = $324,000

Budget Variance,
$3,000 F*
1$267,000
212,000
Applied Fixed Overhead Cost

Volume Variance,
$54,000 F
+ $3,000 = $270,000.
units × 3 hours per unit = 36,000 hours.
3$270,000
÷ 30,000 denominator hours = $9 per hour.
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104
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-21 (45 minutes) (LO2 CC14; LO3 CC18, LO4 22, 23)
1.
FAB COMPANY
Flexible Budget
For the Month Ended March 31
Cost
Formula
(per MH)
Overhead Costs
Variable costs:
Utilities ................................
$0.90
Maintenance................................ 1.60
Machine setup ................................ 0.30
Indirect labour................................ 0.70
Total variable cost ................................
$3.50
Fixed costs:
Maintenance................................
Indirect labour................................
Depreciation ................................
Total fixed cost ................................
Total overhead cost ................................
Solutions Manual, Chapter 11
10,000
units
12,500
15,000
units
units
Machine hours
20,000
25,000
30,000
$ 18,000
32,000
6,000
14,000
70,000
$ 22,500
40,000
7,500
17,500
87,500
$ 27,000
48,000
9,000
21,000
105,000
40,000
130,000
70,000
240,000
40,000
130,000
70,000
240,000
40,000
130,000
70,000
240,000
$310,000
$327,500
$345,000
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105
Problem 11-21 (continued)
2.
FAB COMPANY
OVERHEAD PERFORMANCE REPORT
FOR THE MONTH ENDED MARCH 31
VARIANCE
Flex
Cost
Actual
#1
Budget
formula
(per
Activity-level (machine-hours)
machinehour)
-
26,000
Static
Budget
30,000
26,000
Variable overhead costs:
Utilities
$
0.90
$ 24,200
$
Maintenance
$
1.60
$ 38,100
$ 3,500
Machine setup
$
0.30
$
$
Indirect labour
$
0.70
$ 19,600
$ 1,400
$
3.50
$ 90,300
$
700
Maintenance
$ 40,000
$
-
$ 40,000
Indirect labour
$ 130,000
$
-
$ 130,000
Depreciation
$ 71,500
$ 1,500
Total fixed overhead costs
$ 241,500
$ 1,500
Total overhead costs
$ 331,800
$
Total variable overhead costs
8,400
800
600
U
F
U
U
F
$ 23,400
$
27,000
$ 41,600
$
48,000
$
9,000
$
21,000
$
7,800
$ 18,200
$ 91,000
$
105,000
Fixed overhead costs:
800
U
U
U
$ 70,000
$
40,000
$
130,000
$
70,000
$ 240,000
$
240,000
$ 331,000
$
345,000
Spending or
Budget
Variance
Notes regarding some of the computations:
1. Actual fixed overhead costs relating to Maintenance and Indirect Labour were the
same as budgeted amounts (given).
2. Actual variable overhead costs of maintenance = $78,100 - $40,000 = $38,100.
A similar calculation can be done to compute the variable portion of Indirect
Labour.
3. In order to compute an overhead efficiency variance, it would be necessary to know
the actual hours worked for the 13,000 units produced during March. This will
enable you to calculate AH × SR in the middle column in the variance diagram).
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106
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-22 (45 minutes) (LO2 CC12, 13; LO3 CC15, 17, 18; LO4 CC22, 23)
1. The company is using a static budget approach, and is comparing budgeted
performance at one level of activity to actual performance at a higher level of
activity. This mismatching of activity levels is why the variable overhead variances
are all unfavourable. The report in this format is not useful for measuring either
operating efficiency or cost control. The only accurate piece of information it gives is
that the department worked more than the 35,000 machine-hours budgeted for the
month. It does not tell whether the actual output for the month was produced
efficiently, nor does it tell whether overhead spending has been controlled during
the month.
2. See the next page for the performance report.
3. The stolen supplies would be included as part of the variable overhead spending
variance for the month. Unlike the price variance for materials and the rate variance
for labour, the spending variance measures both price and quantity (waste, theft)
elements. This is why the variance is called a “spending” variance; total spending
can be affected as much by waste or theft as it can be by greater (or lesser) prices
paid for items.
Solutions Manual, Chapter 11
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107
Problem 11-22 (continued)
2.
Total variance = $2,500 U + $9,000 F + $30,000 F = $36,500 F
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108
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-22 (continued)
Notes:
Overhead is applied using the 40,000 standard hours allowed for actual production
(16,000 units × 2.5 hours per unit).
Pre-determined fixed overhead rate
= $210,000 ÷ 35,000 machine-hours
= $6.00 per machine-hour
Therefore, applied fixed overhead
= $6.00 × 40,000 machine-hours
= $240,000
Solutions Manual, Chapter 11
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109
Problem 11-23 (75 minutes) (LO3 CC18; LO4 CC22, 23)
1.
Total rate:
$640,000
80,000 DLHs
=$8 per DLH
Variable rate:
$160,000
80,000 DLHs
=$2 per DLH
Fixed rate:
$480,000
80,000 DLHs
=$6 per DLH
2. Direct materials: 1.5 kilograms at $14 per kilogram ........................
$21
Direct labour: 2.0 hours at $4.50 per hour ................................ 9
Variable overhead: 2.0 hours at $2 per hour ................................ 4
Fixed overhead: 2.0 hours at $6 per hour................................ 12
Standard cost per unit................................................................
$46
3. a) 42,000 units × 2 hours per unit = 84,000 standard hours.
b)
Actual costs
Manufacturing Overhead
$646,500 $672,000 * Applied costs
$25,500
Over-applied
overhead
*84,000 standard hours × $8 per hour = $672,000.
4. Variable overhead variances:
Actual Quantity of Input,
at the Actual Rate
(AQ × AR)
$163,500
Actual Quantity of Input, at
the Standard
Rate
(AQ × SR)
85,000 hours ×
$2 per hour
= $170,000

Standard Quantity Allowed
for Output, at the Standard
Rate
(SQ × SR)
84,000 hours ×
$2 per hour
= $168,000

Spending Variance,
$6,500 F

Efficiency Variance,
$2,000 U
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110
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-23 (continued)
Alternate solution:
Variable overhead spending variance = (AQ × AR) – (AQ × SR)
($163,500) – (85,000 hours × $2 per hour) = $6,500 F
Variable overhead efficiency variance = SR (AQ – SQ)
$2 per hour (85,000 hours – 84,000 hours) = $2,000 U
Fixed overhead variances:
Actual Fixed
Overhead Cost
$483,000
Flexible Budget Fixed
Overhead Cost
$480,000*

Applied Fixed Overhead Cost
84,000 hours × $6 per hour
= $504,000


Budget Variance,
$3,000 U
Volume Variance,
$24,000 F
*Can be expressed as: 80,000 denominator hours × $6 per hour = $480,000.
Alternative solution:
Budget variance:
Budget = Actual fixed - Flexible budget fixed
variance
overhead cost
overhead cost
= $483,000 - $480,000
= $3,000 U
Volume variance:
Fixed portion of
Volume
Denominator Standard hours
 the predetermined 

variance
hours
allowed 

overhead rate
 $6.00 per hour (80,000 hours - 84,000 hours)
 $24,000 F
Solutions Manual, Chapter 11
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111
Problem 11-23 (continued)
The company’s overhead variances can be summarized as follows:
Variable overhead:
Spending variance ................................................................
$ 6,500 F
Efficiency variance ................................................................
2,000 U
Fixed overhead:
Budget variance ................................................................
3,000 U
Volume variance ................................................................
24,000 F
Over-applied overhead—see part 3 ................................
$25,500 F
5. Only the volume variance would have changed. It would have been unfavourable
since the standard hours allowed for the year’s production (84,000 hours) would
have been less than the denominator hours (85,000 hours). This would indicate
that less than the planned level of production would have actually been achieved,
thereby suggesting that the overhead costs would have to be absorbed by a lower
output volume.
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112
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-24 (60 minutes) (LO4 CC 21, 22, 23)
1. and 2.
Per Direct Labor-Hour
Variable
Fixed
Total
Denominator of 40,000 DLHs:
$2.50
$8.00
$ 2.50
8.00
$10.50
$6.40
$ 2.50
6.40
$ 8.90
Total predetermined rate ..............................
Denominator of 50,000 DLHs:
$2.50
Total predetermined rate ..............................
Denominator Activity:
40,000 DLHs
3.
Direct materials, 3 yards ×
$5.00 per yard ....................
Direct labor, 2.5 DLHs ×
$20.00 per DLH ..................
Variable overhead, 2.5 DLHs
× $2.50 per DLH ................
Fixed overhead, 2.5 DLHs ×
$8.00 per DLH ....................
Total standard cost per unit ....
Denominator Activity:
50,000 DLHs
$15.00 Same ......................................
$15.00
50.00 Same ......................................
50.00
6.25 Same ......................................
Fixed overhead, 2.5 DLHs ×
20.00
$6.40 per DLH......................
$91.25 Total standard cost per unit .....
6.25
16.00
$87.25
4. a. 18,500 units × 2.5 DLHs per unit = 46,250 standard DLHs
b.
Actual costs
Manufacturing Overhead
446,500 Applied costs (46,250 standard
DLHs* × $10.50 per DLH)
Overapplied overhead
485,625
39,125
*Determined in (a).
Solutions Manual, Chapter 11
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113
Problem 11-24 (continued)
4. c.
Actual Hours of Input,
at Actual Rate
(AH × AR)
$124,800
Actual Hours of Input,
at Standard Rate
(AH × SR)
48,000 DLHs ×
$2.50 per DLH
= $120,000
Variable overhead rate
variance
= $4,800 U
Standard Hours Allowed
for Actual Output,
at Standard Rate
(SH × SR)
46,250 DLHs ×
$2.50 per DLH
= $115,625
Variable overhead
efficiency variance
= $4,375 U
Alternative solution:
Variable overhead efficiency variance = SR (AH – SH)
= $2.50 per DLH (48,000 DLHs – 46,250 DLHs)
= $4,375 U
Variable overhead rate variance = (AH × AR) – (AH × SR)
= ($124,800) – (48,000 DLHs × $2.50 per DLH)
= $4,800 U
Fixed overhead variances:
Actual Fixed Overhead
Budgeted Fixed
Overhead
$321,700
$320,000*
Budget variance
= $1,700 U
Fixed Overhead Applied
to Work in Process
46,250 standard DLHs ×
$8.00 per DLH
= $370,000
Volume variance
= $50,000 F
*40,000 denominator DLHs × $8 per DLH = $320,000.
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114
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-24 (continued)
Alternative solution:
Budget = Actual Fixed - Flexible Budget Fixed
Variance
Overhead Cost
Overhead Cost
= $321,700 – $320,000
= $1,700 U
Fixed Portion of
Volume = the Predetermined × Denominator - Standard Hours
Variance
Hours
Allowed
Overhead Rate
(
)
= $8.00 per DLH (40,000 DLHs – 46,250 DLHs)
= $50,000 F
Summary of variances:
Variable overhead efficiency ...............
Variable overhead rate variance ..........
Fixed overhead volume ......................
Fixed overhead budget .......................
Overapplied overhead ........................
Solutions Manual, Chapter 11
$ 4,375
4,800
50,000
1,700
$39,125
U
U
F
U
F
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115
Problem 11-24 (continued)
5. The major disadvantage of using normal activity as the denominator in the
predetermined rate is the large volume variance that ordinarily results. This occurs
because the denominator activity used to compute the predetermined overhead rate
is different from the activity level that is anticipated for the period. In the case at
hand, the company has used the normal activity of 40,000 direct labor-hours to
compute the predetermined overhead rate, whereas activity for the period was
expected to be 50,000 DLHs. This has resulted in a large favorable volume variance
that may be difficult for management to interpret. In addition, the large favorable
volume variance in this case has masked the fact that the company did not achieve
the budgeted level of activity for the period. The company had planned to work
50,000 DLHs, but managed to work only 46,250 DLHs (at standard). This
unfavorable result is concealed due to using a denominator figure that is out of step
with current activity.
On the other hand, by using normal activity as the denominator unit costs are stable
from year to year. Thus, management’s decisions are not clouded by unit costs that
jump up and down as the activity level rises and falls.
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116
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-25 (40 minutes) (LO3 CC18; LO4 CC22, 23)
1. Variable overhead variances:
Actual Quantity of Input,
at the Actual Rate
Actual Quantity of Input,
at the Standard Rate
(AQ × AR)
330,000 × ?
(AQ × SR)
330,000 hours
× $4.00 per hour
= $1,320,000
=$1,236,000*

Standard Quantity
Allowed for Output, at
the Standard Rate
(SQ × SR)
320,000 hours**
× $4.00 per hour
= $1,280,000

Spending Variance,
$84,000 F

Efficiency Variance,
$40,000 U
Total Variance, $44,000 F
* Given
** 160,000 units × 2 hours per unit = 320,000 hours
2. Fixed overhead variances:
Actual Fixed
Overhead Cost
$1,720,000

Flexible Budget Fixed
Overhead Cost
$2,000,000
Applied Fixed Overhead
Cost
320,000 hours
× $5.00 per hour
= $1,600,000

Budget Variance,
Volume Variance,
$280,000 F
$400,000 U
Total variance, $120,000 U
Solutions Manual, Chapter 11

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117
Problem 11-25 (continued)
3. The company consumed 10,000 more labour hours compared to the standard
allowed for the production of 160,000 units. This resulted in an unfavourable
variable overhead efficiency variance.
The company used its capacity of 400,000 direct labour hours as the denominator
level. At this level, it can produce 200,000 units ($400,000 ÷ 2). However, it
produced only 160,000 units, thereby applying fixed overhead to a lower number of
units. The inefficient use of available resources (less than 100% capacity utilization)
resulted in an unfavourable production volume variance.
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118
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-26 (50 minutes) (LO4 CC21, 22, 23)
1.
Total rate:
£31,500 + £72,000
=£5.75 per MH
18,000 MHs
Variable element:
£31,500
=£1.75 per MH
18,000 MHs
Fixed element:
£72,000
=£4.00 per MH
18,000 MHs
2. 16,000 standard MHs × £5.75 per MH = £92,000
3. Variable manufacturing overhead variances:
Actual Hours of Input,
at Actual Rate
(AH × AR)
£26,500
Actual Hours of Input,
at Standard Rate
(AH × SR)
15,000 MHs ×
£1.75 per MH
= £26,250
Variable overhead rate
variance
= £250 U
Standard Hours Allowed
for Actual Output,
at Standard Rate
(SH × SR)
16,000 MHs ×
£1.75 per MH
= £28,000
Variable overhead
efficiency variance
= £1,750 F
Alternative solution:
Variable overhead efficiency variance = SR (AH – SH)
= £1.75 per MH (15,000 MHs – 16,000 MHs)
= £1,750 F
Variable overhead rate variance = (AH × AR) – (AH × SR)
= (£26,500) – (15,000 MHs × £1.75 per MH)
= £250 U
Solutions Manual, Chapter 11
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119
Problem 11-26 (continued)
Fixed overhead variances:
Actual Fixed Overhead
Budgeted Fixed
Overhead
£70,000
£72,000
Budget variance
= £2,000 F
Fixed Overhead Applied
to Work in Process
16,000 MHs ×
£4 per MH
= £64,000
Volume variance
= £8,000 U
Alternative solution:
Fixed Portion of
Volume = the Predetermined Denominator - Standard Hours
Variance
Hours
Allowed
Overhead Rate
(
)
= £4 per MH (18,000 MHs – 16,000 MHs)
= £8,000 U
Budget = Actual Fixed - Flexible Budget Fixed
Variance
Overhead Cost
Overhead Cost
= £70,000 – £72,000
= £2,000 F
Verification of variances:
Variable overhead efficiency variance ...........................
Variable overhead rate variance ...................................
Fixed overhead volume variance ..................................
Fixed overhead budget variance...................................
Underapplied overhead ...............................................
£1,750
250
8,000
2,000
£4,500
F
U
U
F
U
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120
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-26 (continued)
4. Variable overhead
Variable overhead rate variance: The variable overhead rate variance reflects
differences between actual and standard prices for variable overhead items. Because
the variable overhead rate variance is unfavorable, it appears too much was paid for
variable overhead items.
Variable overhead efficiency variance: The term “variable overhead efficiency
variance” is a misnomer, because the variance does not measure efficiency in the
use of overhead items. It measures the indirect effect on variable overhead of the
efficiency or inefficiency with which the activity base is utilized. In this company,
machine-hours is the activity base. If variable overhead is really proportional to
machine-hours, then more effective use of machine-hours has the indirect effect of
reducing variable overhead. Because 1,000 fewer machine-hours were required than
indicated by the standards, the indirect effect was presumably to reduce variable
overhead spending by about £1,750 (£1.75 per machine-hour × 1,000 machinehours).
Fixed overhead
Fixed overhead budget variance: This variance is simply the difference between the
budgeted fixed cost and the actual fixed cost. In this case, the variance is favorable,
which indicates that actual fixed costs were lower than anticipated in the budget.
Fixed overhead volume variance: This variance occurs as a result of actual activity
being different from the denominator activity that was used in the predetermined
overhead rate. In this case, the variance is unfavorable, so actual activity was less
than the denominator activity. It is difficult to place much of a meaningful economic
interpretation on this variance. It tends to be large, so it often swamps the other,
more meaningful variances if they are simply netted against each other.
Solutions Manual, Chapter 11
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121
Problem 11-27 (40 minutes) (LO3 CC18; LO4 CC22, 23)
1. Direct materials, 4 pounds × $2.60 per pound .......................................
Direct labor, 2 DLHs × $9.00 per DLH ...................................................
Variable manufacturing overhead, 2 DLHs × $3.80 per DLH* .................
Fixed manufacturing overhead, 2 DLHs × $7.00 per DLH** ....................
Standard cost per unit..........................................................................
$10.40
18.00
7.60
14.00
$50.00
* $34,200 ÷ 9,000 DLHs = $3.80 per DLH
** $63,000 ÷ 9,000 DLHs = $7.00 per DLH
2. Materials variances:
Materials quantity variance = SP (AQ – SQ)
= $2.60 per pound (20,000 pounds – 19,200 pounds*)
= $2,080 U
*4,800 units × 4 pounds per unit = 19,200 pounds
Materials price variance = AQ (AP – SP)
= 30,000 pounds ($2.50 per pound – $2.60 per pound)
= $3,000 F
Labor variances:
Labor efficiency variance = SR (AH – SH)
= $9.00 per DLH (10,000 DLHs – 9,600 DLHs*)
= $3,600 U
*4,800 units × 2 DLHs per unit = 9,600 DLHs
Labor rate variance = AH (AR – SR)
= 10,000 DLHs ($8.60 per DLH – $9.00 per DLH)
= $4,000 F
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122
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-27 (continued)
3. Variable manufacturing overhead variances:
Actual Hours of Input,
at Actual Rate
(AH × AR)
Actual Hours of Input,
at Standard Rate
(AH × SR)
10,000 DLHs ×
$3.80 per DLH
= $38,000
$35,900
Variable overhead rate
variance
= $2,100 F
Standard Hours Allowed
for Actual Output,
at Standard Rate
(SH × SR)
9,600 DLHs ×
$3.80 per DLH
= $36,480
Variable overhead
efficiency variance
= $1,520 U
Flexible budget variance = $580 F
Alternative solution:
Variable overhead efficiency variance = SR (AH – SH)
= $3.80 per DLH (10,000 DLHs – 9,600 DLHs)
= $1,520 U
Variable overhead rate variance = (AH × AR) – (AH × SR)
= ($35,900) – (10,000 DLHs × $3.80 per DLH)
= $2,100 F
Fixed manufacturing overhead variances:
Actual Fixed Overhead
Budgeted Fixed
Overhead
$64,800
$63,000
Budget variance
= $1,800 U
Solutions Manual, Chapter 11
Fixed Overhead Applied
to Work in Process
9,600 DLHs ×
$7 per DLH
= $67,200
Volume variance
= $4,200 F
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123
Problem 11-27 (continued)
Alternative solution:
Fixed Portion of
Volume = the Predetermined Denominator - Standard Hours
Variance
Hours
Allowed
Overhead Rate
(
)
= $7 per DLH (9,000 DLHs – 9,600 DLHs )
= $4,200 F
Budget = Actual Fixed - Budgeted Fixed
Variance
Overhead Cost Overhead Cost
= $64,800 – $63,000
= $1,800 U
4. The choice of a denominator activity level affects standard unit costs in that the
higher the denominator activity level chosen, the lower standard unit costs will be.
The reason is that the fixed portion of overhead costs is spread over more units as
the denominator activity increases.
The volume variance cannot be controlled by controlling spending. The volume
variance simply reflects whether actual activity was greater or less than the
denominator activity. Thus, the volume variance is controllable only through activity.
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124
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-28 (60 minutes) (LO3 CC15, 17, 18; LO4 CC22, 23)
1.
Actual Quantity of
Inputs, at Actual Price
(AQ × AP)
36,000 kilograms
× $6.30 per kilogram
$226,800

Actual Quantity of
Inputs, at Standard
Price
(AQ × SP)
36,000 kilograms
× $6 per kilogram
= $216,000
Standard Quantity
Allowed for Output,
at Standard Price
(SQ × SP)
30,000 kilograms*
× $6 per kilogram
= $180,000

Price Variance,
Quantity Variance,
$10,800 U
$36,000 U
Total Variance, $46,800 U

*6,000 units × 5 kilograms per unit = 30,000 kilograms.
Alternatively:
Materials price variance = AQ (AP – SP)
36,000 kilograms ($6.30 per kilogram – $6.00 per kilogram)
= $10,800 U
Materials quantity variance = SP (AQ – SQ)
$6 per kilogram (36,000 kilograms – 30,000 kilograms)
= $36,000 U
Solutions Manual, Chapter 11
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125
Problem 11-28 (continued)
2. Actual Hours of Input, at
the Actual Rate
(AH×AR)
17,800 hours ×
$15.60 per hour
= $277,680
Actual Hours of Input, at
the Standard Rate
(AH×SR)
17,800 hours ×
$15 per hour
= $267,000
Standard Hours Allowed
for Output, at the
Standard Rate
(SH×SR)
18,000 hours ×
$15 per hour
= $270,000



Rate Variance,
$10,680 U
Efficiency Variance,
$3,000 F
Total Variance, $7,680 U
Alternatively, the variances can be computed using the formulas:
Labour rate variance = AH (AR – SR)
= 17,800 hours ($15.60 – $15.00)
= $10,680 U
Labour efficiency variance = SR (AH – SH)
= $15 per hour (17,800 – 18,000)
= $3,000 F
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126
Introduction to Managerial Accounting, Fifth Canadian Edition
Problem 11-28 (continued)
3. Variable overhead variances:
Actual Quantity of Input,
at the Actual Rate
Actual Quantity of Input,
at the Standard Rate
(AQ × AR)
(AQ × SR)
17,800 hours
× $6.00 per hour
= $106,800
= $102,000

Standard Quantity
Allowed for Output, at
the Standard Rate
(SQ × SR)
18,000 hours
× $6.00 per hour
= $108,000

Spending Variance,
Efficiency Variance,
$4,800 F
$1,200 F
Total Variance, $6,000 F

Alternate solution for the variable overhead variances:
Variable overhead spending variance = (AQ × AR) – (AQ × SR)
($102,000) – (17,800 hours × $6.00 per hour) = $4,800 F
Variable overhead efficiency variance = SR (AQ – SQ)
$6.00 per hour (17,800 hours – 18,000 hours) = $1,200 F
Fixed manufacturing overhead variances:
Actual Fixed Overhead
Budgeted Fixed
Overhead
$186,000
$36 x 6,200 $223,200
Budget variance
= $37,200 F
Solutions Manual, Chapter 11
Fixed Overhead Applied
to Work in Process
3 DLHs × 6,000 x
$12 per DLH
= $216,000
Volume variance
= $7,200 U
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127
Comprehensive Problem 11-1 (110 minutes) (LO2 CC12, 13; LO3 CC15, 17, 18;
LO4 CC22, 23)
Parts 1 and 2
Before we can calculate the profit, we need to calculate the budgeted labour hours,
budgeted machine hours and budgeted overhead rates:
Budgeted overhead:
Variable (67.5%)
Fixed (32.5%)
Budgeted labour hours:
Product A
Produce B
Budgeted machine hours:
Product A
Product B
Budgeted (predetermined)
overhead rates based on
MH
Variable
Fixed
Actual overhead
Variable
Fixed
a. $3,117,150 ÷ 1,248,000
$ 3,117,150
$ 1,500,850
$
4,618,000
33,000
8,800
41,800
1,200,000
48,000
1,248,000
$2.50 / MH (a)
$1.20 / MH (b)
$
3,122,620
1,338,266
$
4,460,886
b. $1,500,850 ÷ 1,248,000
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128
Introduction to Managerial Accounting, Fifth Canadian Edition
Comprehensive Problem 11-1 (continued)
To calculate the standard selling price, we must compute the standard cost and then
mark it up by 12%:
Standard Cost
Direct materials
Direct labour
Variable overhead
Fixed overhead
Total
$
$
$
$
$
Product A
SQI × SP
462.00
0.26
2.00
0.96
465.22
Price (1.12 × SC)
$
522.00
$
$
$
$
$
Product B
SQI × SQ
414.00
5.28
5.99
2.89
428.16
$
480.00
Further calculations:
Actual
AQ
Direct materials (kg)
Product A
Product B
Direct labour (hrs)
Product A
Product B
Machine hours
Product A
Product B
Solutions Manual, Chapter 11
Flexible Budget
SQ for actual
allowed for actual
output
Static Budget
SQ for
budgeted
volume
18,432,640
1,767,360
17,280,600
1,893,600
18,000,000
1,800,000
25,921
9,889
31,681
9,258
33,000
8,800
1,224,043
50,496
1,152,040
50,496
1,200,000
48,000
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129
Comprehensive Problem 11-1 Parts 1 and 2 (continued)
Actual
AQ × AP
Revenues
Product A
Product B
Less: Variable
costs
Direct materials
Product A
Product B
Direct labour
Product A
Product B
Variable
overhead
$734,425,500
$ 9,657,360
$704,126,848
8,660,064
$
305,867
132,510
Flexible Budget
SQ for actual
volume × SP
$ 744,082,860
$ 751,706,100
$ 10,099,200
$ 712,786,912
$ 665,303,100
$ 8,710,560
$
438,377
$
$
$
3,122,620
380,173
111,091
Static Budget
SQ for normal
volume × SP
$ 761,805,300
$783,000,000
$ 9,600,000
$ 792,600,000
$ 674,013,660
$ 693,000,000
$ 8,280,000
$701,280,000
$
491,264
$
$
$
$
3,003,594
$ 3,117,150
396,000
105,600
501,600
Contribution
margin
$ 27,734,951
$ 84,296,782
$ 87,701,250
Fixed costs
$
$
1,500,850
$ 1,500,850
$
82,795,932
$ 86,200,400
1,338,266
$
Income
26,396,68
6
Total profit variance:
Price & cost variances:
(i.e. Flexible budget Variance)
Sales volume variance:
$(59,803,714)
$(56,399,246)
$(3,404,468)
[actual income – static budget income]
[actual income – flexible budget income]
[flexible budget income – static budget income]
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130
Introduction to Managerial Accounting, Fifth Canadian Edition
Comprehensive Problem 11-1 (continued)
3. Manufacturing Variances:
Direct materials variances
Direct materials Product A:
Actual Quantity of
Inputs, at Actual Price
(AQ × AP)
$704,126,848
Actual Quantity of
Standard Quantity Allowed
Inputs, at Standard
for Output, at Standard
Price
Price
(AQ × SP)
(SQ × SP)
$709,656,640
$665,303,100
Price Variance,
Quantity Variance,
$5,529,792 F
$44,353,540 U
Total Variance, $38,823,748 U
Direct materials Product B:
Actual Quantity of
Inputs, at Actual Price
(AQ × AP)
$8,660,064
Actual Quantity of
Standard Quantity Allowed
Inputs, at Standard
for Output, at Standard
Price
Price
(AQ × SP)
(SQ × SP)
$8,129,856
$8,710,560
Price Variance,
Quantity Variance,
$530,208 U
$580,704 F
Total Variance, $50,496 F
Total direct materials:
Price Variance,
$4,999,584 F
Quantity Variance,
$43,772,836 U
Total Variance, $38,773,252 U
Solutions Manual, Chapter 11
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131
Comprehensive Problem 11-1 (continued)
Direct labour variances
Direct labour Product A:
Actual Quantity of
Inputs, at Actual Rate
(AH × AR)
$305,867
Actual Quantity of
Standard Quantity Allowed
Inputs, at Standard
for Output, at Standard
Rate
Rate
(AH × SR)
(SH × SR)
$311,051
$380,173
Rate Variance,
Efficiency Variance,
$5,184 F
$69,122 F
Total Variance, $74,306 F
Direct labour Product B:
Actual Quantity of
Inputs, at Actual Rate
(AH × AR)
$132,510
Actual Quantity of
Standard Quantity Allowed
Inputs, at Standard
for Output, at Standard
Rate
Rate
(AH × SR)
(SH × SR)
$118,666
$111,091
Rate Variance,
Efficiency Variance,
$13,844 U
$7,575 U
Total Variance, $21,419 U
Total direct labour:
Rate Variance,
$8,660 U
Efficiency Variance,
$61,548 F
Total Variance, $52,888 F
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132
Introduction to Managerial Accounting, Fifth Canadian Edition
Comprehensive Problem 11-1 (continued)
Overhead Variances
Variable Overhead Product A:
Actual Quantity of
Actual Quantity of
Standard Quantity Allowed
Input, at Actual Rate
Inputs, at Standard
for Output, at Standard
Rate
Rate
(AQ x AR)
(AQ X SR)
(SQ X SR)
$2,998,905
$3,057,311
$2,877,469
Spending Variance,
Efficiency Variance,
$58,406 F
$179,842 U
Total Variance, $121,436 U
Variable Overhead Product B:
Actual Quantity of
Actual Quantity of
Standard Quantity Allowed
Input, at Actual Rate
Inputs, at Standard
for Output, at Standard
Rate
Rate
(AQ × AR)
(AQ × SR)
(SQ × SR)
$123,715
$126,125
$126,125
Spending Variance,
Efficiency Variance,
$2,410 F
Total Variance, $2,410 F
Total variable overhead:
Spending Variance,
$60,816 F
Efficiency Variance,
$179,842 U
Total Variance, $119,026 U
Fixed Overhea