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Multiple Choice
Topic: Fixed Costs
LO: 1
1. Which of the following costs is best classified as fixed costs with respect to volume?
A) Parts used in manufacturing digital cameras
B) Electricity used to heat, light, and cool a hospital
C) Depreciation of a copy machine in the Human Resource Department
D) Salaries of quality inspectors in a production facility
Answer: C
Rationale: Typically, depreciation cost on assets (buildings and equipment) in a staff department such
as Human Resources remains constant irrespective of the volume of output.
Topic: Step Costs
LO: 1
2. Step costs:
A) Are constant within certain ranges of activity but differ outside those ranges of activity
B) Are variable within narrowly defined ranges of activity, but constant over wider ranges of activity
C) Increase with each additional unit produced
D) Have no relation to number of units produced
Answer: A
Rationale: Step costs behave as fixed costs within a relatively narrow range, but increase to a higher
level when that range is exceeded. A typical example of step costs is an inspection cost where each
inspector can handle a fixed volume of product.
Topic: Fixed Costs
LO: 1
3. Fixed costs do not respond to:
A) Capital expenditures made by the company
B) Short-term changes in the amount of activity
C) Changes in committed expenditures
D) Discretionary investments in the company
Answer: B
Rationale: Over the short term, fixed costs are indifferent to activity level changes. For example the
cost of property taxes on a building would not change based on activity volume differences.
Topic: Relevant Range
LO: 2
4. The range of operations that falls within the capacity of the current level of fixed costs is referred to as
the:
A) Linear average
B) Relevant range
C) Marginal range
D) Operating range
Answer: B
Rationale: When developing a cost model for a firm or segment of a firm, that model is only relevant
within the range of capacity of the fixed costs. For example if the current level of fixed cost of $10
million represents a capacity of 2 million units of output, that cost model cannot be used to estimate
the cost of producing more than 2 million units.
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Topic: Discretionary Fixed Costs
LO: 2
5. Discretionary fixed costs are also known as:
A) Committed fixed costs
B) Capacity costs
C) Managed fixed costs
D) Mixed costs
Answer: C
Rationale: Management decides during each budget period how much it will spend on discretionary
items such as charitable contributions and training. These costs are not related to the capacity of
operations.
Topic: Discretionary Fixed Costs
LO: 2
6. Which of the following is an example of a discretionary fixed cost?
A) Depreciation of manufacturing facilities
B) Donations to charitable organizations
C) Salaries of production supervisors
D) Property taxes on manufacturing facilities
Answer: B
Rationale: Donations are not related to the capacity of operations, but are determined by the discretion
of management.
Topic: Cost Estimation
LO: 3
7. The determination of the mathematical relationship between activity level and cost is known as:
A) Cost control
B) Cost estimation
C) Cost prediction
D) Regression analysis
Answer: B
Rationale: A mathematical equation that models the relationship between cost (the dependent
variable) and activity level (the independent variable) is used in estimating costs for different levels of
activity.
Topic: Scatter Diagram Method
LO: 3
8. The scatter diagram method of cost estimation:
A) Is influenced by extreme observations
B) Is superior to other methods in its ability to distinguish between discretionary and committed fixed
costs
C) Requires the use of judgment
D) Provides a measure of the goodness of fit
Answer: C
Rationale: The scatter diagram method depends of visual observation of the data points on a graph to
fit the cost curve to the data. The position of the curve on the graph depends on the judgment of the
person observing the data points.
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Topic: High-Low Method
LO: 3
9. Nick Andrewson uses gas to heat his home. He has accumulated the following information regarding
his monthly gas bill and monthly heating degree-days. The heating degree-days value for a month is
found by first subtracting the average temperature for each day from 65 degrees and then summing
these daily amounts together for the month.
Month
February
April
Heating Degree-Days
850
300
Gas Bill
$129
$52
What will be the increase in Nick’s monthly gas bill per heating degree-day using the high-low
method?
A) $0.14
B) $6.59
C) $0.17
D) $5.77
Answer: A
Rationale: ($129 – $52) / (850 – 300) = $0.14
Topic: Cost Estimation
LO: 3
10. Sofia Smith uses gas to heat her home. She has accumulated the following information regarding her
monthly gas bill and monthly heating degree-days. The heating degree-days value for a month is found
by first subtracting the average temperature for each day from 65 degrees and then summing these
daily amounts together for the month.
Month
February
April
Heating Degree-Days
850
300
Gas Bill
$129
$52
The equation representing the relationship between the gas bill (Y) and heating degree-days (X) is:
A) Y = $0.14
B) Y = $10 + $0.14X
C) Y = $10 – $0.14X
D) Y = $60 + $0.14X
Answer: B
Rationale: ($129 – $52) / (850– 300) = $0.14 = variable cost per heating degree day
$129 – (850 × $0.14) = $10 or $52 – (300 × $0.14) = $10 = fixed costs
Therefore, Y = $10 + $0.14X
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Topic: Cost Estimation
LO: 3
11. The Mayfield Delivery Service has the following information about its truck fleet miles and operating
costs:
Year
2018
2019
2020
Miles
125,000
150,000
175,000
Operating Costs
$80,000
$87,500
$105,000
What is the best estimate of fixed costs for fleet operating expenses in 2020 using the high-low
method?
A) $50,000
B) $17,000
C) $17,500
D) $25,000
Answer: C
Rationale: ($105,000 – $80,000) / (175,000 – 125,000) = $0.50 per mile variable cost
$105,000 – (175,000 × $0.50) = $17,500
Topic: Cost Estimation
LO: 3
12. The Kentucky Tools Machine Shop wants to develop a cost estimating equation for its monthly cost of
electricity. It has the following data:
Month
January
April
July
October
Cost of Electricity (Y)
$7,000
$7,500
$8,500
$7,250
Direct Labor-Hours (X)
750
850
1,000
800
What would be the best equation using the high-low method?
A) Y = $2,000 + $4X
B) Y = $2,500 + $6X
C) Y = $1,500 + $8X
D) Y = $500 + $6X
Answer: B
Rationale: ($8,500 – $7,000) / (1,000 – 750) = $6 variable cost period hour
$8,500 – (1,000 × $6) = $2,500 fixed cost.
Therefore, Y = $2,500 + $6X
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Topic: Estimating Fixed Costs
LO: 3
13. The following information pertains to Mark Company’s weekly activity and total costs:
Volume of Activity
55 units
60 units
80 units
Total Cost
$600
$750
$800
What are Mark’s weekly fixed costs?
A) $ -0B) $ 150
C) $ 160
D) $ 800
Answer: C
Rationale: ($800 – $600) / (80 – 55) = $8 variable cost per unit
$800 – (80 × $8) = $160 fixed costs
Topic: Least Squares versus High-Low
LO: 3
14. Comparing least-squares regression to high-low estimation:
A) Least-squares regression is preferred to high-low estimation because with this method, the
computer can make all the decisions after data entry
B) Least-squares regression provides superior estimates to high-low estimation when using
unreliable data
C) Least-squares regression provides a means of estimating how well the data fit the model
D) All of the above
Answer: C
Rationale: Least-squares regression is a mathematical model that not only uses the data points to
determine the cost curve, but it provides statistics to enable the user to know how well the data fit the
cost curve and how reliable the model is in estimating costs.
Topic: Least Squares versus High-Low
LO: 3
15. Comparing least-squares regression to high-low estimation:
A) Least-squares regression better predicts costs outside the range of past observations
B) Least-squares regression makes fuller use of the data
C) Least-squares regression requires fewer calculations
D) All of the above
Answer: B
Rationale: The high-low method only uses two data points in establishing the cost estimation equation;
whereas, least squares regression uses all of the available data to provide the best fit of the cost
estimation equation to the data.
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Topic: Difficulties in Cost Estimation
LO: 4
16. Which one of the following statements about difficulties in cost estimation is true?
A) Changes in the company’s production technology make estimating the company’s production
costs easier
B) The shorter the time period, the higher the probability of inappropriately matching activity and cost
C) The stronger the economy, the harder it is to accurately match activity and cost
D) When prices of a company’s raw materials or labor are rapidly increasing, cost estimations based
on previous periods will overestimate future costs
Answer: B
Rationale: One of the difficulties in collecting data for time periods is making sure that the cost data
and the activity data are related to the same time period. Often there are lags between the end of the
time period and the measurement of cost. If the time period is short, any errors related to establishing
the year-end cutoff are magnified. For longer periods, the effect of the errors is diluted.
Topic: Difficulties in Cost Estimation
LO: 4
17. Which one of the following statements about difficulties of cost estimation is true?
A) Data may not be based on normal operating conditions
B) Linear relationships between total costs and activity levels may exist
C) Both A and B
D) None of the above
Answer: A
Rationale: When collecting data for cost estimation, it is important that activity and cost data are
representative of typical operations. If data are collected for an operating period when conditions were
not similar to expected future conditions, estimates of future costs will not be reliable.
Topic: Difficulties in Cost Estimation
LO: 4
18. This creates difficulties in cost estimations:
A) Changes in technology or prices
B) Identifying cost drivers
C) Matching activity and cost within each observation
D) All of the above
Answer: D
Rationale: All of the above were discussed in the text as possible difficulties in cost estimation.
Topic: Difficulties in Cost Estimation
LO: 4
19. In cost estimation:
A) Care must be taken to make sure that data used in developing cost estimates are based on
currently employed technology
B) Changes in technology and prices make cost estimation difficult
C) Only data reflecting a single price level should be used in cost estimation
D) All of the above
Answer: D
Rationale: All of the above were discussed in the text as possible difficulties in cost estimation.
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Topic: Difficulties in Cost Estimation
LO: 4
20. In cost estimation:
A) Old price data of cost elements should be used cautiously, if at all
B) Only data reflecting historical price levels should be used in cost estimation
C) The prices of various cost elements are likely to change at the same rates and at the same times
D) All of the above
Answer: A
Rationale: It may be necessary to make adjustments to the cost estimation equation for changes in
prices levels that have occurred since the time periods of the data used to develop the cost estimation
equation.
Topic: Difficulties in Cost Estimation
LO: 4
21. The development of accurate cost-estimating equations requires the matching of the activity to:
A) Changes in technology and prices
B) Production
C) Related costs within each observation
D) All of the above
Answer: C
Rationale: The first requirement in estimating future costs is collecting accurate data regarding past
activity. It is crucial that accurate costs for past activity levels are determined; otherwise, the cost
estimation equation will not be reliable.
Topic: Alternate Cost Drivers
LO: 5
22. As a consequence of automation and product diversity, in cost estimation:
A) A facility level approach to estimating costs is increasingly important
B) Companies no longer need to pay attention to estimating overhead
C) Cost estimation is improved with the inclusion of non-unit cost drivers
D) Direct labor is playing an increasingly important role in cost determination
Answer: C
Rationale: With modern production methods, many variable costs may be driven by activities not
related to units of production, but rather to non-unit activities such as the number of batches produced,
or the number of different products supported by the production facility.
Topic: Facility-Level Activities
LO: 5
23. Facility level activities of an organization would not include:
A) Building maintenance
B) Machine set up
C) Property taxes
D) The production supervisor’s salary
Answer: B
Rationale: Machine set-up is typically a batch-level activity since there is normally not a set-up of
equipment for each unit, but for batches of units. Building maintenance, property taxes, and
supervisors’ salaries are typical facility-level costs that exist because of the existence of the facility.
They are the same as fixed costs in a unit-level cost estimation model.
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Topic: Batch-Level Activities
LO: 5
24. The following procedure performed at the United States mint is not a batch level activity:
A) Inspecting the first units produced to verify proper set-up
B) Movement of manufactured coins to finishing stations
C) Setting up machinery for the stamping process
D) Stamping each individual coin
Answer: D
Rationale: Stamping each individual coin is an example of a unit-level activity since it occurs for each
coin produced. All of the other items are examples of batch-level activities.
Topic: Unit-Level Activities
LO: 5
25. The following procedure performed by a dairy is the best example of a unit level activity within a
manufacturing cost hierarchy:
A) Delivering dairy products to a grocery store
B) Filling milk into half-gallon cartons
C) Homogenizing milk in specially designed tanks
D) Receiving milk from farms
Answer: B
Rationale: Filling half-gallon cartons is a unit-level activity; whereas, the other items listed are batchlevel activities.
Topic: Product-Level Activities
LO: 5
26. The following procedure performed by a candy manufacturer is the best example of a product level
activity within a manufacturing cost hierarchy:
A) Cleaning the mixing machine for the next production run of candy, a special Halloween candy
B) Developing an advertising campaign for a special Halloween candy
C) Inspecting the quality of the candy produced during one of the special Halloween package
production runs
D) Resetting the packaging equipment to wrap a special 36-count Halloween package
Answer: B
Rationale: A product-level activity is one that occurs as a result of producing a new product, such as
product design activities, or developing an advertising campaign for a new product.
Topic: Customer Cost Hierarchy
LO: 5
27. The following procedure performed by a food wholesaler is the best example of a unit level activity
within a customer cost hierarchy:
A) Calling a retail customer to inquire if the customer is satisfied with the wholesaler’s service
B) Driving the delivery truck to the retail customer’s store
C) Sending the retail customer a bill for a recent order
D) Stacking items on the shelf of a retail customer’s store
Answer: D
Rationale: In a customer cost hierarchy, activities are classified based on units, orders, customers,
and facilities. A unit-level activity is one that is performed for each unit sold. Therefore, stacking items
on the shelf is unit-level activity. Calling a customer is customer-level, and driving a truck to the
customer’s store and sending a bill for a recent order are both order-level activities.
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Topic: Customer Cost Hierarchy
LO: 5
28. The following procedure performed by a home oil delivery company is the best example of a unit level
activity within a customer cost hierarchy:
A) Opening an account for a new customer
B) Processing monthly customer billings
C) Pumping home heating oil into a customer’s oil tank
D) Purchasing a new delivery truck
Answer: C
Rationale: In a customer cost hierarchy, activities are classified based on units, orders, customers,
and facilities. A unit-level activity is one that is performed for each unit sold. Therefore, pumping home
heating oil into a customer’s oil tank is a unit-level activity. Opening an account for a new customer,
and processing customer billings are either customer-level or order-level activities, and purchasing a
new truck is a facility level activity.
Topic: Cost Behavior Patterns
LO: 1
29. Depreciation of a copy machine in the Human Resource Department would best be classified as what
type of cost?
A) Variable Cost
B) Fixed cost
C) Mixed cost
D) Step cost
Answer: B
Topic: Cost Behavior Patterns
LO: 1
30. Parts used in manufacturing digital cameras would best be classified as what type of cost?
A) Variable cost
B) Fixed cost
C) Mixed cost
D) Step cost
Answer: A
Topic: Cost Behavior Patterns
LO: 1
31. Electricity used to heat, light, and cool a manufacturing facility would best be classified as what type
of cost?
A) Variable cost
B) Fixed cost
C) Mixed cost
D) Step cost
Answer: C
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Topic: Cost Behavior Patterns
LO: 1
32. A cost that is constant within a relevant range but differs outside the relevant range of activity is best
classified as what type of cost?
A) Variable cost
B) Fixed cost
C) Mixed cost
D) Step cost
Answer: D
Topic: Cost Behavior Patterns
LO: 1
33. Which of the following mathematical expressions best describes a mixed cost?
A) Y = bX
B) Y = a
C) Y = a + bX
D) Y = ai
Answer: C
Topic: Cost Behavior Patterns
LO: 1
34. Over the short term, which type of costs is indifferent to activity level changes?
A) Variable costs
B) Fixed costs
C) Mixed costs
D) Step costs
Answer: B
Topic: Cost Behavior Patterns
LO: 1, 2
35. In the following equation for total cost, Y = a + bX, the slope of the total cost line is an approximation
of which of the following?
A) Total Cost
B) Fixed Cost
C) Variable Cost
D) Volume
Answer: C
Topic: Relevant Range
LO: 2
36. When developing a cost model for a firm or segment of a firm, the cost model is only applicable within
the
range of capacity of fixed costs.
A) Operating
B) Average
C) Marginal
D) Relevant
Answer: D
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Topic: Cost Behavior Patterns
LO: 1
37. As volume increases, which of the following statements is not correct?
A) Variable cost per unit will remain the same.
B) Total fixed will remain the same.
C) Average cost per unit will increase.
D) Total variable costs will increase.
Answer: C
Topic: Discretionary Fixed Costs
LO: 2
38. Which of the following would be classified as a discretionary fixed cost?
A) Depreciation
B) Research and Development
C) Property Taxes
D) Interest on Bonds
Answer: B
Topic: Committed Fixed Costs
LO: 2
39. Committed fixed costs are also known as:
A) Capacity costs
B) Managed fixed costs
C) Mixed costs
D) Step costs
Answer: A
Topic: Cost Behavior Patterns
LO: 1
40. As volume increases, average cost per unit decreases because:
A) Total fixed costs increase
B) Total variable costs increase
C) Total fixed costs stay the same
D) Total variable costs stay the same
Answer: C
Topic: Cost Estimation
LO: 3
41. Which of the following methods of cost estimation utilizes all observations and relies on statistical
measures to determine the cost estimation model?
A) High-Low Method
B) Scatter Diagram
C) Least-Squares Regression
D) Linear Programming
Answer: C
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Topic: Cost Estimation
LO: 3
42. Which of the following methods of cost estimation utilizes judgment to determine the cost estimation
model?
A) High-Low Method
B) Scatter Diagram
C) Least-Squares Regression
D) Linear Programming
Answer: B
The following information applies to questions 43-45.
Super Speedy Delivery Services has the collected the following information about operating expenditures
for its delivery truck fleet for the past five years:
Year
2016
2017
2018
2019
2020
Miles
55,000
70,000
50,000
65,000
85,000
Operating Costs
$195,000
$210,000
$180,000
$205,000
$225,150
Topic: High-Low Cost Estimation
LO: 3
43. Using the high-low method, what is the cost estimate for variable costs for 2021?
A) $1.29
B) $2.00
C) $1.60
D) $1.50
Answer: A
Rationale: ($225,150 – $180,000) / (85,000 – 50,000) = $1.29
Topic: High-Low Cost Estimation
LO: 3
44. Using the high-low method, what is the cost estimate for fixed costs for 2021?
A) $100,000
B) $ 70,000
C) $115,500
D) $109,650
Answer: C
Rationale: $225,150 - (85,000 x $1.29) = $115,500 (using high observation)
$180,000 - (50,000 x $1.29) = $115,500 (using low observation)
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Topic: High-Low Cost Estimation
LO: 3
45. What is the best estimate of total operating expenses for 2021 using the high-low method based on
total expected miles of 60,000?
A) $192,900
B) $195,000
C) $196,000
D) $201,000
Answer: A
Rationale: $115,500 + (60,000 x $1.29) = $192,900
Topic: High-Low Cost Estimation
LO: 3
46. The following information pertains to Kristina Coffee Company’s monthly activity and total costs:
Volume of Activity
550 units
600 units
750 units
Total Cost
$5,200
$5,500
$5,800
What would be the best equation for predicting total costs using the high-low method?
A) Y = $3 + $2,100X
B) Y = $3,550 + $3X
C) Y = $3 + $1,500X
D) Y = $2,250 + $3X
Answer: B
Rationale: ($5,800 – $5,200) / (750 – 550) = $3.00
$5,800 – (750 x $3.00) = $3,550
The following information relates to questions 47-50:
Luisa Rentals offers machine rental services for concrete cutting. Consider the following costs of the
company over the relevant range of 4,000 to 10,000 hours of operating time for its concrete cutting
equipment.
4,000
Total Costs:
Variable Costs
Fixed Costs
Total Costs
Cost per hour:
Variable cost
Fixed cost
Total cost per hour
Hours of Operating Time
5,000
8,000
10,000
$ 20,000
82,000
$102,000
?
?
?
?
?
?
?
?
?
?
?
?
?
?
?
?
?
?
?
?
?
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Topic: Cost Estimation
LO: 3
47. What are the estimated total costs at a volume of 5,000 hours?
A) $ 94,000
B) $107,000
C) $108,000
D) $100,000
Answer: B
Rationale: $20,000 / 4,000 = $5.00/hr.
($5 x 5,000) + $82,000 = $107,000
Topic: Cost Estimation
LO: 3
48. What is the estimated total cost per hour at a volume of 8,000 hours?
A) $12.50
B) $14.25
C) $18.00
D) $15.25
Answer: D
Rationale: (8,000 x $5.00) + $82,000 = $122,000 / 8,000 = $15.25
Topic: Cost Estimation
LO: 3
49. What are the estimated total fixed costs at a volume of 10,000 hours?
A) $100,000
B) $94,000
C) $95,000
D) $82,000
Answer: D
Topic: Cost Estimation
LO: 3
50. What is the estimated total fixed cost per hour at a volume 8,000 hours?
A) $10.25
B) $28.00
C) $24.00
D) $37.60
Answer: A
Rationale: $82,000 / 8,000 = $10.25
Topic: High-Low Cost Estimation
LO: 3
51. The primary advantage of the High-Low method over other cost estimation methods is that:
A) It utilizes only two data points rather all data points within a relevant range
B) It relies on judgment to determine the cost estimation model
C) It is a more straightforward approach to determining the variable and fixed elements of mixed costs
D) It can only be applied within the relevant range of observations of the independent variable
Answer: C
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The following information applies to questions 52-55.
The following data was input into a spreadsheet program to determine the Intercept, Slope and R2 (RSQ)
for Patient Days and Maintenance Costs for a local hospital:
Month
Maintenance Costs
(Y)
$4,450
$4,750
$4,200
$4,600
$5,050
$5,400
$4,400
Patient Days (X)
January
February
March
April
May
June
July
3,300
4,050
3,000
3,750
4,150
4,500
2,600
Intercept
Slope
RSQ
$2,734
$0.541
0.793
Topic: Least-Squares Regression
LO: 3
52. The estimated fixed maintenance cost for the hospital is:
A) $5,468
B) $2,734
C) $0.793
D) $0.541
Answer: B
Rationale: Fixed cost = Vertical axis intercept
Topic: Least-Squares Regression
LO: 2, 3
53. The estimated variable maintenance cost per patient day for the hospital is:
A) $5,468
B) $2,734
C) $0.541
D) $0.793
Answer: C
Rationale: Variable cost per unit = Slope of the total cost line
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Topic: Least-Squares Regression
LO: 3
54. The estimated total maintenance cost for August based on an estimated 4,000 patient days is:
A) $4,898
B) $3,092
C) $2,734
D) $4,509
Answer: A
Rationale: $2,734 + ($0.541 x 4,000) = $4,898
Topic: Least-Squares Regression
LO: 3
55. The coefficient of determination for the estimated cost model for maintenance is represented by:
A) Slope
B) Intercept
C) The dependent variable (Y)
D) R2
Answer: D
Topic: Least-Squares Regression
LO: 3
56. The coefficient of determination for estimating packaging costs for a local shipper was determined to
be 0.84. Which of the following statement is not correct?
A) The coefficient of determination is a measure of the percent of variation in the independent
variable that is explained by variations in the dependent variable.
B) Coefficient of determination is often referred to as R-squared by statisticians.
C) The coefficient of determination can have values between zero and one.
D) Coefficient of determination values close to zero suggesting that the equation is not very useful.
Answer: A
Topic: Cost Behavior Pattern
LO: 1
57. An increase in volume within the relevant range will cause:
A) Unit fixed costs to increase.
B) Unit variable costs to decrease.
C) Total fixed costs to stay the same.
D) Total variable costs to decrease.
Answer: C
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Topic: Cost Behavior Patterns
LO: 1, 2
58. The graph of an estimated cost represented by cost equation, Y = a + bX, would be best described by
which of the following descriptions:
A) A positive slope starting at the point of origin
B) A positive slope starting at the y-intercept
C) A horizontal line starting at the y-intercept
D) A negative slope starting at the y-intercept
Answer: B
Topic: Changes in Technology
LO: 4
59. The introduction of production technology to replace labor in a manufacturing process would likely
result in which of the following?
A) A shift in costs from variable costs to fixed costs.
B) A shift in costs from fixed costs to variable costs.
C) An increase in total manufacturing costs.
D) A decrease in total manufacturing costs.
Answer: A
Topic: Activity Cost Drivers
LO: 4
60. The introduction of production technology in a manufacturing process would:
A) Decrease the probability of inappropriately matching activity and costs in the short run
B) Make cost estimation and prediction easier
C) Require the identification of the most appropriate activity that matches costs
D) Increase the probability that the coefficient of determination will decrease in the short run
Answer: C
Topic: Composition of Total Manufacturing Costs
LO: 5
61. Over the past decade, the composition of total manufacturing costs has resulted in which of the
following?
A) Manufacturing overhead decreasing as a percent of total manufacturing costs.
B) Direct labor decreasing as a percent of total manufacturing costs.
C) Direct materials decreasing as a percent of total manufacturing costs.
D) Direct labor increasing as a percent of total manufacturing costs.
Answer: B
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Topic: Manufacturing Cost Hierarchy
LO: 5
62. The cost of raw materials would best be classified as what type of activity?
A) A unit-level activity
B) A batch-level activity
C) A product-level activity
D) A facility-level activity
Answer: A
Topic: Manufacturing Cost Hierarchy
LO: 5
63. The cost of issuing and tracking a work order would best be classified as what type of activity?
A) A unit-level activity
B) A batch-level activity
C) A product-level activity
D) A facility-level activity
Answer: B
Topic: Manufacturing Cost Hierarchy
LO: 5
64. The cost of maintaining general facilities such as buildings and grounds would best be classified as
what type of activity?
A) A unit-level activity
B) A batch-level activity
C) A product-level activity
D) A facility-level activity
Answer: D
Topic: Manufacturing Cost Hierarchy
LO: 5
65. The cost of product marketing such as advertising would best be classified as what type of activity?
A) A unit-level activity
B) A batch-level activity
C) A product-level activity
D) A facility-level activity
Answer: C
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The following information relates to questions 66-69.
Stone Cold Brew is a successful brewery engaged in the development and production of specialty micro
brews. It uses manufacturing cost hierarchy to allocate costs to various activities. During the past year, it
has incurred:
Cost
$ 725,000
$ 475,000
$1,250,000
$ 450,000
$ 250,000
$ 875,000
Description
product development costs
materials handling costs
production line labor costs
production setup costs
power costs (for cooling beer and running equipment)
manufacturing facility management costs
Topic: Manufacturing Cost Hierarchy
LO: 5
66. Using the manufacturing cost hierarchy, what is the total cost that would be classified as unit-level
activity costs?
A) $ 425,000
B) $1,250,000
C) $1,975,000
D) $1,945,000
Answer: C
Rationale: $475,000 + $1,250,000 + $250,000 = $1,975,000
Topic: Manufacturing Cost Hierarchy
LO: 5
67. Using the manufacturing cost hierarchy, what is the total cost that would be classified as batch-level
activity costs?
A) $ 450,000
B) $ 350,000
C) $ 600,000
D) $ 625,000
Answer: A
Topic: Manufacturing Cost Hierarchy
LO: 5
68. Using the manufacturing cost hierarchy, what is the total cost that would be classified as product-level
activity costs?
A) $ 460,000
B) $1,250,000
C) $1,825,000
D) $ 725,000
Answer: D
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Topic: Manufacturing Cost Hierarchy
LO: 5
69. Using the manufacturing cost hierarchy, what is the total cost that would be classified as facility-level
activity costs?
A) $ 500,000
B) $1,750,000
C) $ 875,000
D) $2,000,000
Answer: C
Topic: Cost Drivers
LO: 5
70. Number of employees is most appropriate as a cost driver for which of the following types of activity
costs?
A) Machining
B) Purchasing
C) Assembly
D) Payroll
Answer: D
Topic: Cost Drivers
LO: 5
71. Number of parts per unit is most appropriate as a cost driver for which of the following types of activity
costs?
A) Machining
B) Purchasing
C) Assembly
D) Payroll
Answer: C
Topic: Cost Drivers
LO: 5
72. Number of invoices is most appropriate as a cost driver for which of the following types of activity
costs?
A) Machining
B) Purchasing
C) Assembly
D) Payroll
Answer: B
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Topic: Cost Drivers
LO: 5
73. Number of machine hours is most appropriate as a cost driver for which of the following types of
activity costs?
A) Machining
B) Purchasing
C) Assembly
D) Payroll
Answer: A
The following information relates to questions 74-78.
Gleeson Manufacturing Company uses an activity-based costing system.
manufacturing activity areas, related cost drivers and cost allocation rates:
Activity
Machine setup
Materials handling
Machining
Assembly
Inspection
Cost Driver
Number of setups
Number of parts
Machine hours
Direct labor hours
Number of finished units
It has the following
Cost Allocation Rate
$50.00
0.50
13.00
22.00
14.00
During the month, 100 units were produced, with no defects, requiring three setups. Each unit consisted
of 17 parts, 3 direct labor hours and 2.5 machine hours. Direct materials cost $50 per finished unit.
Topic: Cost Drivers
LO: 5
74. What is the total manufacturing cost for machine setups?
A) $150
B) $500
C) $250
D) $300
Answer: A
Rationale: (3 x $50) = $150
Topic: Cost Drivers
LO: 5
75. What is the total manufacturing cost for materials handling?
A) $375
B) $500
C) $850
D) $750
Answer: C
Rationale: (17 x $0.50) x 100 = $850
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Topic: Cost Drivers
LO: 5
76. What is the total manufacturing cost for inspections?
A) $1,100
B) $1,400
C) $ 900
D) $ 700
Answer: B
Rationale: 100 x $14 = $1,400
Topic: Cost Drivers
LO: 5
77. What is the total manufacturing cost for the period?
A) $80,675
B) $10,625
C) $32,100
D) $17,250
Answer: D
Rationale: 100 x [(17 x $0.50) + (3 x $22) + (2.5 x $13) + $50 + $14] + (3 x $50) materials handling
= $17,250
Topic: Cost Drivers
LO: 5
78. What is the per unit manufacturing cost for the period?
A) $806.75
B) $106.25
C) $321.00
D) $172.50
Answer: D
Rationale: $17,250 / 100 = $172.50
Topic: Multiple Regression
LO: 3
79. Office Supplies Only store costs are expressed as a function of the unit sales of its two products: office
chairs and task desks. Assume fixed costs are $9,000 per month and the variable costs are $60 per
office chair and $125 per task desk.
What are Office Supplies Only’s estimated costs for the month if 100 office chairs and 52 task desks
are sold?
A) $21,500
B) $25,000
C) $22,000
D) $20,500
Answer: A
Rationale: $9,000 + ($60 x 100) + ($125 x 52) = $21,500
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Topic: Coefficient of Determination
LO: 3
80. Given the equation, Y= 4,000 + 2.5X. The coefficient of determination (R-Squared) is calculated to be
0.70 (or 70%). This equation implies
A)
B)
C)
D)
70% of the variation in Y is explained in X
70% of the variation in X is explained in Y
There is no relationship between X and Y, since it not 90% or 95%
Since 30% (100% – 70%) is closer to zero there is strong direct relationship between X and Y
Answer: A
Rationale: Coefficient of determination explains the relationship of the independent variable (X) by the
dependent variable (Y). The closer the number is to 1 or 100%, the stronger the relationship. 70%
change in Y can be explained by change in X.
Topic: Topic: Manufacturing Cost Hierarchy
LO: 5
81. Martin Manufacturers produces a product with the following manufacturing cost hierarchy for its only
current product.
Activity Level
Unit
Batch
Product
Facility
Cost
10 per unit
250 per batch
5,000 per year
25,000 per year
Next year Martin plans to manufacture 25,000 units of product, in batches of 250 units.
Axe’s predicted manufacturing cost for next year is:
A) $735,500
B) $750,000
C) $330,000
D) $305,000
Answer: D
Rationale:
Unit Cost = $10 per unit X 25,000 unit =
Batch = (25,000 units ÷ 250 units per batch) x $250 per batch =
Product
Facility
Total Manufacturing cost
$250,000
25,000
5,000
25,000
$305,000
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Topic: Topic: Manufacturing Cost Hierarchy
LO: 5
82. Kathleen sells specialized products produced by electronics companies to engineering firms. Kathleen
sells these products at a price based on Kathleen’s purchase price. Kathleen’s customer cost hierarchy
is as follows:
Activity Level
Unit
Batch
Customer
Facility
Cost
40% of selling price
$200 per sales order
$500 per customer per
year
$60,000 per year
Next year Kathleen plans to sell $4,000,000 of product to the 100 engineering firms they serve. They
anticipate that each firm will place an average of 4 orders.
Kathleen’s predicted customer costs for next year are:
A. $ 80,000
B. $ 300,000
C. $1,790,000
D. $3,500,000
Answer: C
Rationale:
Unit
Batch
Customer
Facility
40% of ($4,000,000)
$200 per 4 orders x 100 firms
$500 x 100
$1,600,000
80,000
50,000
60,000
$1,790,000
Topic: Average Cost
LO: 2
83. At a sales volume of 25 units the average cost is $205 per unit and the variable cost is $5 per unit.
Assuming a linear cost behavior pattern, if sales double to 50 units the average cost will be:
A) $110
B) $105
C) $205
D) $210
Answer: B
Rationale:
Variable cost = $5 x 25 units = $125
Total cost = $205 x 25 units = $5,125
Fixed cost = $5,125 - $125 = $5,000
Variable cost for 50 units = $5 x 50 units = $250
Fixed cost = $5,000
Total cost = $5,000 + $250 = $5,250
Average per unit cost = $5,250 / 50 units = $105
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Exercises
Topic: Classifying Cost Behavior
LO: 1
1. Classify the total costs of each of the following as variable, fixed, mixed, or step. Sales volume is the
cost driver.
a. Wages of machine operator who is paid based on number of units produced on the
machine
b. Keyboards purchased from a subcontract supplier in a computer assembly plant
c. Property taxes
d. Salaries of quality inspectors when each inspector can evaluate a maximum of 500
units per day
e. Annual salary for the vice president of manufacturing
f. Electric power in a factory
g. Raw materials used in production
h. Water consumed by the plant, which is based on a flat fee plus actual consumption
i. Overhead costs in the factory for incidental components such as small screws and
rivets.
j. Fire insurance on factory building
Answer:
Variable
Variable
a. Wages of machine operator who is paid based on number of units produced on the
machine
b. Keyboards purchased from a subcontract supplier in a computer assembly plant
Fixed
c. Property taxes
Step
Fixed
d. Salaries of quality inspectors when each inspector can evaluate a maximum of 500
units per day
e. Annual salary for the vice president of manufacturing
Mixed
f. Electric power in a factory
Variable
g. Raw materials used in production
Mixed
h. Water consumed by the plant, which is based on a flat fee plus actual consumption
Variable
i. Overhead costs in the factory for incidental components such as small screws and
rivets.
Fixed
j. Fire insurance on factory building
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Topic: Cost Behavior Patterns
LO: 1
2. Fanning Company had the following costs for the past three years in which it produced 40,000,
48,000, and 60,000 units, respectively.
Year1
$80,000
44,000
12,000
6,000
60,000
22,000
Direct Materials
Utilities Expense
Property Taxes
Travel Expense
Direct Labor
Maintenance Expense
Year 2
$96,000
98,000
12,000
6,000
72,000
26,000
Year 3
$120,000
104,000
12,000
6,000
90,000
32,000
Identify which of the costs were variable, fixed, and mixed.
Answer:
Direct Materials:
Utilities Expense:
Property Taxes:
Travel Expense:
Direct Labor:
Maintenance Expense
Variable
Mixed
Fixed
Fixed
Variable
Mixed
Topic: Computing Average Unit Costs
LO: 2
3. The total monthly operating costs of Juliana’s Yogurt Ice Cream Shack are:
$3,500 + $0.90X, where X = 12 ounce serving
a.
Calculate the average cost per serving at each of the following monthly volumes: 1,000,
2,000, 3,000 and 5,000, and
b.
Determine the monthly volume at which the average cost per serving is $1.90
Answer:
a) Average cost @ 1,000 units = [$3,500 + ($0.90 x 1,000)] /1,000 = $4.40
Average cost @ 2,000 units = [$3,500 + ($0.90 x 2,000)] /2,000 = $2.65
Average cost @ 3,000 units = [$3,500 + ($0.90 x 3,000)] /3,000 = $2.07
Average cost @ 5,000 units = [$3,500 + ($0.90 x 5,000)] /5,000 = $1.60
b) Desired average cost per serving
Less Variable cost per serving
Fixed cost per serving
$1.90
(0.90)
$1.00
$3,500 (total fixed cost) / $1.00 (per unit fixed cost) = 3,500 units
Proof: [$3,500 + ($0.90 X 3,500)] / 3,500 = $1.90 average cost per serving
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Topic: Committed and Discretionary Fixed Costs
LO: 2
4. Indicate whether each of the following fixed costs are committed or discretionary.
a.
b.
c.
d.
e.
f.
g.
Depreciation on the factory
Cancellable lease on the corporate jet
Super Bowl TV advertisement
Annual scheduled maintenance on the air conditioning system
Annual donation to the local Boys and Girls Clubs
Salary of the director of training who is on a three-year contract
Travel for employees to attend professional development seminars
Answer:
a. Committed
b. Discretionary
c. Discretionary
d. Discretionary
e. Discretionary
f. Committed
g. Discretionary
Topic: High-Low Cost Estimation
LO: 3
5. Assume MCA Cable Company has the following information available about fleet miles and operating
costs for its service department:
Year
2016
2017
Fleet Miles
123,500
181,500
Operating Costs
$114,350
$157,850
Using the high-low method, develop a cost-estimating equation for total annual operating costs.
Answer:
Variable costs = ($157,850 – $114,350) / (181,500 – 123,500) = $0.75 per mile.
Fixed costs = $157,850 – ($0.75 x 181,500) = $21,725 or $114,350 – ($0.75 x 123,500) = $21,725.
Total annual costs = $21,725 + $0.75X, where X = annual fleet miles
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Topic: Scatter Diagrams and High-Low Cost Estimation
LO: 3
6. Assume the Anthony’s Custom Paint Shop has the following information on the number of sales
orders received and order-processing costs.
Month
Jan
Feb
Mar
Apr
May
Jun
Jul
Sales Orders
450
225
690
420
345
150
300
Order-Processing Costs
$6,000
4,200
9,750
5,850
4,800
3,000
4,500
Plot the data on a scatter diagram. Using the information from representative high- and low- volume
months, and develop a cost-estimating equation for monthly production costs.
Answer:
$12,000
Order-Porcessing Costs
$10,000
$8,000
$6,000
$4,000
$2,000
$0
200
400
Sales Orders
600
800
Variable costs = ($9,750 – $3,000) / (690 – 150) = $12.50 per sales order
Fixed costs = $9,750 – ($12.50 x 690) = $1,125 or $3,000 – ($12.50 x 150) = $1,125
Monthly order processing costs = $1,125 + $12.50X, where X = sales orders
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Topic: Cost Classification Hierarchy
LO: 5
7. Cooper and Kaplan developed the framework used to classify manufacturing activities. List the four
categories of activities and provide an example of each activity level.
Answer:
Unit level:

Cost of raw materials

Cost of inserting a component

Utilities cost of operating equipment

Costs of packaging

Sales commissions
Batch level:

Cost of processing a sales order

Cost of issuing and tracking a work order

Cost of equipment set-up

Cost of moving batches between workstations

Cost of inspection
Product level:

Cost of product development

Cost of product marketing such as advertising

Cost of specialized equipment

Cost of maintaining specialized equipment
Facility level:

Cost of maintaining general faculties such as buildings and grounds

Cost of nonspecialized equipment

Cost of maintaining nonspecialized equipment

Cost of real property taxes

Cost of general advertising

Cost of general administration salaries
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Topic: Cost Behavior
LO: 1
8. Classify each of the following costs as variable, fixed, mixed, or step by writing an X under one of the
following headings (Sales volume is the cost driver).
Variable
Fixed
Mixed
Step
Variable
Fixed
Mixed
Step
1. Total selling and administrative costs
2. Salaries of supervisors (each supervisor is in
charge of five production employees)
3.
4.
5.
6.
Raw materials used in production
Power consumption in a restaurant
Cost of goods sold in a restaurant
Salaries of employees who handle 20 claims
per month
7. Pulpwood in a paper mill
8. Salaries of two secretaries in the corporate
office
9. Total current manufacturing costs
10. The cost of an automobile rented on the
basis of a daily charge plus $0.50 per mile
Answer:
1. Total selling and administrative costs
2. Salaries of supervisors (each supervisor is in
charge of five production employees)
X
X
3. Raw materials used in production
4. Power consumption in a restaurant
X
5. Cost of goods sold in a restaurant
6. Salaries of employees who handle 20 claims
per month
X
7. Pulpwood in a paper mill
8. Salaries of two secretaries in the corporate
office
9. Total current manufacturing costs
X
X
X
10. The cost of an automobile rented on the
basis of a daily charge plus $0.50 per mile
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X
X
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Topic: Committed and Discretionary Fixed Costs
LO: 2
9. Identify each of the following costs as fixed-committed or fixed-discretionary by writing an “X” under
one of the following headings:
Fixed Committed
Fixed Discretionary
Fixed Committed
Fixed Discretionary
1. Cost of entertainment at the company awards banquet
2. Research and development staff salaries
3. Cost of placing an ad in a corporate magazine
4. Rent on an exhibition at a trade show
5. Depreciation on manufacturing equipment
6. Depreciation on the corporate jet
7. Interest on bonds payable
8. Exclusivity fee paid by a franchise
9. Corporate charitable contributions
10. Employee training workshops
Answer:
1. Cost of entertainment at the company awards banquet
2. Research and development staff salaries
3. Cost of placing an ad in a corporate magazine
4. Rent on an exhibition at a trade show
5. Depreciation on manufacturing equipment
6. Depreciation on the corporate jet
7. Interest on bonds payable
8. Exclusivity fee paid by a franchise
9. Corporate charitable contributions
10. Employee training workshops
X
X
X
X
X
X
X
X
X
X
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Topic: High-Low Method
LO: 3
10. Kaiya Company manufactures and sells specialty items. The following representative direct laborhours and production costs are provided for a four-month period:
Month
January
February
March
April
Total
Hrs. Direct Labor
1,500
2,000
3,500
2,000
9,000
Production Costs
$ 22,500
26,250
40,500
22,500
$111,750
a = fixed production costs per month
b = variable production costs per direct labor hour
n = number of months
X = direct labor-hours per month
Y = total monthly production costs
Using the symbols above, indicate the cost estimation equation based on number of direct labor hours
per month, and calculate total monthly production costs for May using the high-low method, assuming
the direct labor hours for May are expected to be 2,250.
Answer:
Y = a + bX
b = ($40,500 – $22,500) / (3,500 – 1,500) = $9.00 variable production cost per direct labor hour
a = $40,500 – ($9.00 x 3,500) = $9,000 or $22,500 – ($9.00 x 1,500) = $9,000
Y = $9,000 + $9.00X
Total Production Costs for May = $9,000 + ($9.00 x 2,250) = $29,250
Topic: Cost Behavior
LO: 1
11. The Lessman Furniture Company has the following information available regarding costs at various
levels of monthly production:
Production volume (units)
Direct materials
Direct labor
Indirect materials
Supervisors’ salaries
Depreciation on plant and equipment
Maintenance
Utilities
Insurance on plant and equipment
Property taxes on plant and equipment
Total
8,000 Units
$35,000
33,000
10,500
6,000
5,000
16,000
7,500
800
1,000
$114,800
11,000 Units
$50,000
45,000
15,000
6,000
5,000
22,000
10,500
800
1,000
$155,300
Identify each of the costs above as being variable, fixed, or mixed.
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Answer:
Direct materials
Direct labor
Indirect materials
Supervisors’ salaries
Depreciation on plant and equipment
Maintenance
Utilities
Insurance on plant and equipment
Property taxes on plant and equipment
Variable
X
X
X
Fixed
Mixed
X
X
X
X
X
X
Topic: Cost Estimation Using the High-Low Method
LO: 3
12. The Lessman Furniture Company has the following information available regarding costs at various
levels of monthly production:
Production volume (units)
Direct materials
Direct labor
Indirect materials
Supervisors’ salaries
Depreciation on plant and equipment
Maintenance
Utilities
Insurance on plant and equipment
Property taxes on plant and equipment
Total
8,000 Units
$35,000
33,000
10,500
6,000
5,000
16,000
7,500
800
1,000
$114,800
11,000 Units
$50,000
45,000
15,000
6,000
5,000
22,000
10,500
800
1,000
$155,300
Develop an equation for total monthly production costs using the high-low method of cost estimation,
and predict total costs for a monthly production volume of 18,000 units.
Answer:
Variable costs = ($155,300 – $114,800) / (11,000 – 8,000) = $13.50 per unit
Fixed costs = $114,800 – $13.50(8,000) = $6,800 or $155,300 – $13.50(11,000) = $6,800
Total monthly production costs = $6,800 + $13.50(No. of Units)
Total monthly production costs for 18,000 units = $6,800 + $13.50(18,000) = $249,800
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Topic: Cost Estimation Using the High-Low Method
LO: 3
13. The Classy Logo Products Company needs to predict the labor cost in producing specialty coffee
mugs. The following production information is available:
Year
2012
2013
2014
2015
2016
2017
Production Volume
1,250
1,700
1,200
3,075
1,600
1,400
Labor Hours
850
975
750
1,500
950
875
Labor Dollars
$6,375
8,775
9,000
16,875
12,825
13,125
Wage rates have steadily increased since 2012; however, management expects no further increases
in 2018.
a. Select the appropriate independent variable for estimating labor cost. Explain the reason for your
selection.
b. Develop an equation to predict for 2018 the labor cost of producing specialty mugs. Use the highlow method.
Answer:
a. In periods of changing prices, unadjusted cost data should not be used as the dependent variable.
Assuming that the technology has not changed, labor-hours used in coffee mug production can
be substituted for labor-dollars in developing the estimating equation:
b. Total labor hours = a constant + b(Number of mugs produced)
Using labor hours:
b = (1,500 – 750) / (3,075 – 1,200) = 0.40 labor hours per coffee mug.
a = 1,500 – (0.40 x 3,075) = 270 fixed labor hours per year.
Total labor hours = 270 + 0.40(Number of mugs produced)
The wage rate for 2018 is the same as 2017.
For 2017, $13,125 / 875 = $15
Total labor costs = $15 x [Total Labor Hours] = $15 x [270 + 0.40 x (No. of Mugs produced)]
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Topic: Estimating Fixed and Variable Cost Components
LO: 3
14. The Lumber Products manufactures small tables. The overhead incurred in manufacturing the tables
has both a fixed component and a variable component. The company’s management wishes to explain
variable overhead as a percentage of direct labor costs. Management has obtained the following cost
data pertaining to the production of the small tables:
Units Produced
150
200
500
300
50
Direct Labor Costs
$1,900
$2,500
$4,500
$2,700
$1,500
Overhead Costs
$1,200
$1,350
$2,700
$1,450
$1,050
Compute the fixed and variable components of the overhead costs using the high-low method.
Answer:
b = ($2,700 – $1,050) / ($4,500 – $1,500) = 55%; Variable overhead is 55% of Direct Labor Costs.
a = $2,700 – (0.55 x $4,500) = $225 fixed overhead costs
Overhead costs = $225 + (0.55 x Direct Labor Cost)
Topic: Estimating Fixed and Variable Cost Components
LO: 3
15. The following data was obtained from the books of the Beta Office Decorating Company:
Month
January
February
March
April
May
Overhead Costs
$1,200
1,875
900
2,125
550
Direct Labor Hours
300
400
250
450
100
Compute the fixed and variable components of the monthly overhead costs using the high-low
method.
Answer:
b = ($2,125 – $550) / (450 – 100) = $4.50 per Direct Labor Hour (DLH)
a = $2,125 – ($4.50 x 450) = $100 or $550 – ($4.50 x 100) = $100
Total Overhead Cost = $100 + $4.50(DLH)
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Topic: Cost Estimation Using the High-Low Method
LO: 3
16. The Ferb Products Company needs to predict the labor cost in producing made-to-order mugs. The
following production information is available:
Year
2015
2016
2017
2018
2019
2020
Mugs Produced
1,150
1,600
1,100
2,100
1,500
1,300
Labor-Hours
850
975
800
1,150
950
875
Labor Cost
$ 8,400
$ 9,000
$ 7,900
$10,700
$ 9,700
$ 9,900
a. Select the appropriate independent variable for estimating labor cost. Explain the reason for your
selection.
b. Develop an equation for labor costs using the high-low method of cost estimation, and predict
total costs for an annual usage of 2,500 labor hours.
Answer:
a. The independent variable should be labor hours.
relationship with labor cost.
Labor-hours has the most logical causal
b. Variable costs = ($10,700 – $7,900) / (1,150 – 800) = $8.00 per labor hour.
Fixed costs = $10,700 – ($8.00 x 1,150) = $1,500 per month
Total annual labor cost = $1,500 + ($8.00 x (No. labor hours))
Total costs for 2,500 labor hours = $1,500 + ($8.00 x 2,500) = $21,500
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Essay Questions
Topic: Least-Squares Regression
LO: 3
1. Your company has just performed a least-squares regression analysis of the monthly costs of
manufacturing a new product. What are some considerations that should be made before making a
decision based on the results of this analysis?
Answer:
First of all, there are some factors relating to the manufacturing of a new product that should be
considered. With a new product, data used in the analysis may not be representative of future costs
because the process of producing a new product will likely undergo significant changes during the
initial year. Also, new products are likely to be initially manufactured at low levels of production due
to the preliminary development of the product’s market. At low levels of production, variable costs per
unit are likely to be higher than they would at normal levels of production. The least-squares regression
assumes a linear relationship throughout the entire range. Therefore, results could be questionable
for this reason.
In any event, results should be measured against other available knowledge and data for reasonability.
The real-world processes generating the data are constantly in a state of change. Consequently,
common sense and prior expectations should consistently be applied to the interpretation of any
results.
One tool that provides assistance in assessment of the degree to which the regression is wellspecified is a scatter diagram. A scatter diagram can provide a visual assessment as to the degree to
which the data are arranged in a straight line, and are thus suited for regression analysis. A scatter
diagram can also direct attention to “outlier” observations, which represent months that are not
necessarily representative of typical months of operations.
Topic: Alternative Cost Estimation Methods
LO: 3
2. Identify the three different cost estimation methods discussed in this course and provide a description
of the strengths and weaknesses of each.
Answer:
Scatter Diagrams: Scatter diagrams help identify representative high and low volumes. They are also
useful in determining if costs can be reasonably approximated by a straight line. Scatter diagrams are
simple to use, but professional judgment is required to draw a representative straight line through the
plot of historical data. This method is subjective in nature, and probability intervals cannot be
developed.
High-Low Cost Estimation: This method uses data from two time periods to estimate fixed and variable
costs. This is a good method to use when data are limited. It is a subjective method, and probability
intervals cannot be developed. It is very important that the high and low volumes represent the normal
operating conditions of all observations. Again, professional judgment is required to select the
appropriate data.
Least-Squares Method: This method uses all available data. It uses a mathematical criterion, which
provides for an objective approach to cost estimation. In addition, this method can provide information
on how well the cost estimating equation fits the historical cost data and information needed to
construct probability intervals for cost estimates. It can also be used to develop equations that are not
linear in nature. This method requires more data points than do the high-low or scatter diagram
methods.
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Topic: Changing Technology and Cost Estimation
LO: 4
3. Briefly explain why changes in technology and prices make cost estimation difficult.
Answer:
Care must be taken to make sure that data used in developing cost estimates are based on the existing
technology. When this is not possible, professional judgment is required to make appropriate
adjustments. In addition, only data reflecting a single price level should be used in cost estimation.
The prices for various cost elements are likely to change at different rates and at different times. Old
data should always be used cautiously. If data from different price levels are used, an attempt should
be made to restate them to a single price level.
Topic: Difficulties Regarding Cost Estimation
LO: 4
4. Identify some of the areas of concern that make cost estimation difficult.
Answer:
Several items to be wary of when developing cost estimating equations include:

Data that are not based on normal operating conditions

Nonlinear relationships between total costs and activity

Obtaining a high R-squared purely by chance

Changes in technology and prices

Matching activity and cost within each observation

Identifying activity cost drivers
Topic: Changing Cost Structures
LO: 5
5. Describe the changes in composition of total manufacturing costs during the last century, using the
three major cost categories: direct materials, direct labor, and manufacturing overhead.
Answer:
1. Direct materials, the cost of primary raw materials converted into finished goods, have increased
slightly as organizations purchase components they formerly fabricated.
2. Direct labor, the wages earned by production employees for the time they spend converting raw
materials into finished products, has decreased significantly as employees spend less time
physically working on products and more time supporting automated production activities.
3. Manufacturing overhead, which includes all manufacturing costs other than direct materials and
direct labor, has increased significantly due to automation, product diversity, and product
complexity.
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Topic: Unit Level Cost Behavior Analysis
LO: 5
6. Describe the unit level approach to cost behavior analysis. Discuss the appropriateness of this
approach.
Answer:
The unit level approach to cost analysis assumes changes in an organization’s costs are best
explained by changes in the number of units or sales dollars (or some other measure of business
volume). Because of its relative simplicity, unit level analysis has been widely used and accepted. In
many circumstances this approach may provide acceptable results. However, in many other
circumstances, this approach may be insufficient to capture the critical drivers of cost. This is especially
true in organizations offering multiple products of various complexities, which vary in their consumption
of the organization’s resources. In these situations, an analysis that includes additional variables for
considerations such as the influence of number of batch runs on costs and the influence of the number
of products offered on costs would provide more accurate estimation.
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Chapter 15
Cost-Volume-Profit
Analysis and Planning
Learning Objectives – Coverage by question
True/False Multiple Choice
Exercises
Problems
LO1 – Identify the uses and
limitations of traditional costvolume-profit analysis.
1-4
1, 2,
37-43
LO2 – Prepare and contrast
contribution and functional
income statements.
5, 6
3-12,
44-55, 58, 67,
69, 87, 88
1
5, 6
LO3 – Apply cost-volume-profit
analysis to find a break-even
point and for preliminary profit
planning.
3, 7, 8
13-28,
56, 57, 59-66,
70, 91, 92
2-4,
12, 13, 15
1-5
LO4 – Analyze the profitability
and sales mix of a multiple
product firm.
9
16, 29, 30, 68,
71-75, 89, 90
14, 15
LO5 – Apply operating leverage
ratio to assess opportunities for
profit and the risks of loss.
10
31-36,
76-86
5-11, 15
Essays
1, 2
3, 4
5, 6
LO6 – Perform profitability
analysis with unit and nonunit
cost drivers (Appendix 15A).
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Chapter 15: Cost-Volume-Profit Analysis and Planning
True/False
Topic: Purpose of Cost-Volume-Profit Analysis
LO: 1
1. Cost-volume-profit analysis is most useful for determining costs.
Answer: False
Rationale: Cost-volume-profit analysis is not intended for estimating cost, but to provide an analytical
framework for profit planning, especially during the early stages of planning.
Topic: Profitability Analysis
LO: 1
2. Fixed costs, variable costs, and revenues are all included in profitability analysis?
Answer: True
Rationale: Profit is the difference between revenue and total costs, which includes both variable and
fixed costs.
Topic: Break Even Analysis
LO: 1, 3
3. Cost-volume-profit analysis is not typically used to determine the break-even point.
Answer: False
Rationale: Indeed, one of the key reasons for cost-volume-profit analysis is to determine the point of
break even.
Topic: Assumptions Underlying Cost-Volume-Profit Analysis
LO: 1
4. One of the basic assumptions underlying the cost-volume-profit analysis model is that the total
revenue function is curvilinear, reflecting changing prices as volume changes.
Answer: False
Rationale: The total revenue function is assumed to be linear, within the relevant range, not curvilinear.
CVP analysis assumes selling price per unit is constant throughout the range of the model.
Topic: Contribution Margin
LO: 2
5. Contribution margin is the difference between total revenue and total variable costs.
Answer: True
Rationale: Contribution margin is the profit contribution available to cover fixed costs and provide a
profit.
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Topic: Functional Format Income Statements
LO: 2
6. Functional income statements that classify expenses based on business function (production, sales,
administration), and are typically found in corporate annual reports.
Answer: True
Rationale: Corporate annual reports include income statements that follow the functional format.
Topic: Cost-Volume-Profit Graph
LO: 3
7. A cost-volume-profit graph includes lines for total revenues, total fixed cost, total variable cost, and
total profit.
Answer: False
Rationale: Total profit is not show as a plotted line on a cost-volume-profit graph. It is the area
between the lines for total revenues and total costs.
Topic: Effects of Changes on CVP Graph
LO: 3
8. If prices are assumed to increase by 10%, the slope of the cost line will increase (be steeper) by 10%,
but there will be no changes in the cost line.
Answer: True
Rationale: Changing sales prices affect the revenue line but not the cost line on a CVP graph.
Topic: Sales Mix Analysis
LO: 4
9. The break-even point for a company with multiple products cannot be determined using a unit
contribution margin calculation since there are multiple products each of which has a different unit
contribution margin.
Answer: False
Rationale: One method for calculating break-even point for a multi-product firm is to calculate a
weighted average unit contribution margin, which is divided into total fixed costs to determine breakeven point.
Topic: Operating Leverage
LO: 5
10. A company that has only fixed cost has no operating leverage.
Answer: False
Rationale: Operating leverage is best described as a measure of the extent to which an organization’s
costs are fixed.
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Multiple Choice
Topic: Assumptions of CVP Analysis
LO: 1
1. A basic assumption of the cost-volume-profit model is that:
A) All costs can be accurately classified as either fixed or variable
B) Cost drivers can be organized into unit-level, batch-level, product-level and facility-level factors
C) Higher volumes of product require lower prices
D) The mix of products changes over time
Answer: A
Rationale: The basic CVP model requires all cost to be treated as either fixed or variable.
Topic: Assumptions of CVP Analysis
LO: 1
2. Which of the following is an assumption used in cost-volume-profit analysis?
A) All costs are classified as fixed or variable
B) The total cost function is linear
C) The total revenue function is linear
D) All of the above
Answer: D
Rationale: The CVP model assumes linearity of both the revenue and cost functions, and it assumes
that all costs are either fixed or variable.
Topic: Contribution Margin
LO: 2
3. The contribution margin is:
A) The difference between sales price and total variable cost
B) The difference between total sales and total cost of goods sold
C) The difference between total revenue and total variable cost
D) Total sales minus total cost of goods sold
Answer: C
Rationale: Contribution margin is calculated as revenues minus variable costs. It can be calculated
on either an aggregate or per-unit basis.
Topic: Unit Contribution Margin
LO: 2
4. A unit contribution margin measures:
A) The difference between unit selling price and variable cost per unit
B) The difference between sales and cost of goods sold on a unit basis
C) The difference between unit sales and total costs per unit
D) The percentage difference between sales and cost of goods sold
Answer: A
Rationale: Unit selling price minus unit variable cost is the definition of unit contribution margin.
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Topic: Contribution Margin Ratio
LO: 2
5. The portion of each dollar that can be used to cover fixed costs and provide a profit is known as:
A) Contribution margin ratio
B) Gross margin percent
C) Margin of safety
D) Operating leverage
Answer: A
Rationale: Contribution margin ratio is the portion (or percent) of revenues available for covering fixed
costs and providing a profit. It is calculated as contribution margin dollars divided by sales.
Topic: Contribution Income Statement Format
LO: 2
6. In a contribution income statement:
A) All fixed costs are grouped together and subtracted from gross profit.
B) Net income plus all fixed expenses equal the contribution margin.
C) The contribution margin is computed as the difference between sales revenue and fixed costs.
D) The gross margin is computed as the difference between sales revenue and the cost of goods
sold.
Answer: B
Rationale: Contribution margin minus fixed costs equals net income; therefore net income plus fixed
costs equals contribution margin.
Topic: Income Statement Format
LO: 2
7. Costs are classified according to behavior on a(n):
A) Abrams-Ingram cost grid
B) Contribution income statement
C) Functional income statement
D) Statement of financial position
Answer: B
Rationale: The definition of a contribution income statement is that it classifies costs by variable and
fixed, and shows both contribution margin and net income.
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Topic: Unit Contribution Margin Calculation
LO: 2
8. Lorri’s income statement is as follows:
Sales (5,000 units)
Less variable costs
Contribution margin
Less fixed costs
Net income
$75,000
(24,000)
$51,000
(12,000)
$ 39,000
What is the unit contribution margin?
A) $12.00
B) $ 7.20
C) $10.20
D) $ 5.10
Answer: C
Rationale: Contribution margin of $51,000 divided by 5,000 units equals a unit contribution margin of
$10.20.
Topic: Contribution Margin Ratio
LO: 2
9. Lorri’s income statement is as follows:
Sales (5,000 units)
Less variable costs
Contribution margin
Less fixed costs
Net income
$75,000
(24,000)
$51,000
(12,000)
$ 39,000
What is the contribution margin ratio?
A) 167 percent
B) 68 percent
C) 40 percent
D) 60 percent
Answer: B
Rationale: $51,000 divided by $75,000 equals 68 percent.
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Topic: Profitability Analysis
LO: 2
10. Lorri’s income statement is as follows:
Sales (5,000 units)
Less variable costs
Contribution margin
Less fixed costs
Net income
$75,000
(24,000)
$51,000
(12,000)
$ 39,000
If sales increase by 1,000 units, profits will:
A) Increase by $10,200
B) Increase by $12,000
C) Increase by $2,400
D) Increase by $5,000
Answer: A
Rationale: The unit contribution margin is the $51,000 Contribution Margin divided by 5,000 units, or
$10.20 per unit. If sales increase by 1,000 units, total contribution margin and total profits will
increase by 1,000 units times $10.20, or $10,200, because fixed costs will remain unchanged.
Topic: Profitability Analysis
LO: 2
11. Lorri’s income statement is as follows:
Sales (10,000 units)
Less variable costs
Contribution margin
Less fixed costs
Net income
$40,000
(24,000)
$16,000
(12,000)
$ 4,000
If sales increase by $10,000, profits will:
A) Increase by $500
B) Increase by $4,000
C) Increase by $3,000
D) Increase by $10,000
Answer: B
Rationale: Contribution margin will increase by $4,000, which is equal to $10,000 of increased sales
times the 40% contribution margin percentage (calculated as contribution margin of $16,000 divided
by $40,000 of sales). Since fixed costs will remain unchanged, net income also increases by $4,000.
Topic: Contribution Margin Calculation
LO: 2
12. Total contribution margin is calculated by subtracting:
A) Cost of goods sold from total revenues
B) Fixed costs from total revenues
C) Total manufacturing costs from total revenues
D) Total variable costs from total revenues
Answer: D
Rationale: Contribution margin is defined as total revenues minus total variable costs.
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Topic: Profit-Volume Graph
LO: 3
13. A profit-volume graph:
A) Is most useful in situations where there are multiple cost drivers
B) Plots both revenue and total cost on the Y axis
C) Plots contribution margin on the Y axis and volume on the X axis
D) Plots total profit on the Y axis against total volume on the X axis
Answer: D
Rationale: A profit-volume graph plots total activity volume on the X axis and total profit on the Y axis.
Topic: Profit-Volume Graph
LO: 3
14. A profit-volume graph differs from a cost-volume-profit graph in that:
A) A profit-volume graph ignores the effect of cost on profit
B) The cost-volume-profit graph is not as practical because it cannot be seen two-dimensionally
C) The cost-volume-profit graph shows revenues and costs separately
D) The profit-volume graph has only two lines: one for profit and one for volume
Answer: C
Rationale: The profit-volume graph shows total profit as a separate line; whereas, the cost-profitvolume graph shows profit only as the area represented by the distance between the total revenue
line and the total cost line.
Topic: Cost-Profit-Volume Graph
LO: 3
15. In a cost-volume-profit graph:
A) An increase in unit variable costs would decrease the slope of the total costs line
B) An increase in the unit selling price would shift the break-even sales point to the left
C) An increase in the unit selling price would shift the break-even sales point to the right
D) The total revenues line crosses the horizontal axis at the break-even point
Answer: B
Rationale: An increase in selling price increases the slope of the total revenue line, thereby causing
its intersection with the total cost line to shift to the left.
Topic: Cost-Volume-Profit Analysis
LO: 3, 4
16. Using cost-volume-profit analysis, we can conclude that a 20 percent reduction in variable costs will:
A) Not affect the break-even sales volume if there is an offsetting 20 percent increase in fixed costs
B) Reduce the break-even sales volume by 20 percent
C) Reduce total costs by 20 percent
D) Reduce the slope of the total costs line by 20 percent
Answer: D
Rationale: The slope of the total cost line is equal to the variable cost per unit of activity; therefore, if
the variable cost per unit is decreased by 20%, the slope of the total cost line will decrease by 20%.
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Topic: Cost-Volume-Profit Graph
LO: 3
17. The point where the total costs and the total revenues lines intersect provides information about the:
A) Budgeted income
B) Center point in the relevant range
C) Number of units that must be sold to break even
D) Profit maximizing sales volume
Answer: C
Rationale: Break-even point is defined as the activity level where total revenue equals total cost.
Topic: Break-Even
LO: 3
18. The break-even point is:
A) The volume of activity where all of the variable costs, but none of the fixed costs are recovered
B) Where total fixed costs equal total variable costs
C) Where total revenues equal total costs
D) All of the above
Answer: C
Rationale: Break-even point is defined as the activity level where total revenue equals total cost.
Topic: Cost-Volume-Profit Graph
LO: 3
19. In a cost-volume-profit graph:
A) The slope of the total cost line is dependent on the variable cost per unit
B) The slope of the total revenues line is the contribution margin per unit
C) The total costs line normally begins at zero
D) The total revenue line is plotted above the total cost line
Answer: A
Rationale: The slope of the total cost line is equal to the variable cost per unit of activity; therefore,
the slope of the total cost line is dependent upon the variable cost per unit.
Topic: Contribution Margin
LO: 3
20. The total contribution margin at the break-even point:
A) Equals total fixed costs
B) Is zero
C) Is greater than total variable costs
D) Plus total fixed costs equal total revenues
Answer: A
Rationale: Contribution margin is defined as total revenue minus total variable costs; therefore, at
break-even point contribution margin is sufficient to cover fixed costs but provide no profit.
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Topic: Break-Even Point in Sales Dollars
LO: 3
21. The break-even point in sales dollars may be computed as:
A) Fixed costs divided by contribution margin per unit
B) The difference between total contribution margin and operating profit divided by the contribution
margin ratio
C) Fixed costs divided by the difference in unit price and unit variable costs
D) Total contribution margin divided by the unit contribution margin per unit
Answer: B
Rationale: The difference between contribution margin and operating profit is equal to fixed costs, and
fixed costs divided by the contribution margin ratio (or percent) equals break-even point in sales dollars.
Topic: Break-Even Calculation
LO: 3
22. Dana Company sells one product at a price of $50 per unit. Variable expenses are 40 percent of
sales, and fixed expenses are $50,000. The sales dollars level required to break even are:
A) $ 2,500
B) $10,000
C) $83,333
D) $41,667
Answer: C
Rationale: Break even in sales dollars = Fixed costs divided by contribution margin percentage
= $50,000 / (100% – 40%) = $83,333.34
Topic: Break-Even Calculation
LO: 3
23. Determine the unit break-even point, assuming fixed costs are $30,000 per period, variable costs are
$19.00 per unit, and the sales price is $25.00 per unit.
A) 6,000
B) 6,667
C) 5,000
D) 12,000
Answer: C
Rationale: $30,000 / ($25 – $19) = 5,000 units at break-even
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Topic: Break-Even Calculation
LO: 3
24. The following information pertains to Supersupper’s 2020 operations:
Selling price per unit
Variable costs per unit
Total fixed costs
$50
$10
$55,000
Supersupper’s break-even point in units is:
A) 2,000 units
B) 3,333 units
C) 1,334 units
D) 1,375 units
Answer: D
Rationale: $55,000 / ($50 – $10) = 1,375 units at break-even
Topic: Profit Planning
LO: 3
25. The following information pertains to Supersupper’s 2020 operations:
Selling price per unit
Variable costs per unit
Total fixed costs
$50
$10
$55,000
The sales dollars required to obtain a target pretax profit of $17,000 is:
A) $75,000
B) $104,333
C) $90,000
D) $133,333
Answer: C
Rationale: ($55,000 + $17,000) / ($50 – $10) = 1,800 x $50 = $90,000 sales dollars
Topic: Break-Even in Sales Dollars Calculation
LO: 3
26. The following information pertains to Ashley’s 2020 operations:
Selling price per unit
Variable costs per unit
Total fixed costs
Tax rate
$50
$30
$50,000
40%
Ashley’s break-even point in sales dollars is:
A) $320,500
B) $125,000
C) $312,500
D) $500,000
Answer: B
Rationale: $50,000 / ($50 – $30) = 2,500 x $50 = $125,000
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Topic: Profit Planning Calculation
LO: 3
27. The following information pertains to Springfield Inc.:
Selling price per unit
Variable costs per unit
Total fixed costs
Tax rate
$50
$30
$212,500
40%
The sales volume required to obtain a target after-tax profit of $54,000 is:
A) 15,125 units
B) 4,572 units
C) 6,500 units
D) 5,000 units
Answer: A
Rationale: Pre-tax profit = After-tax profit / (1- tax rate)
$54,000 / 0.6 = $90,000
($212,500 + $90,000) / ($50 – $30) = $302,500 / $20 = 15,125 units
Topic: Break-Even in Sales Dollars Calculation
LO: 3
28. The following information pertains to Springfield Inc.:
Selling price per unit
Variable costs per unit
Total fixed costs
Tax rate
$50
$30
$212,500
40%
The pretax break-even point in sales dollars is:
A) $531,205
B) $427,000
C) $600,000
D) $700,00
Answer: A
Rationale: $212,500 / ($50 – $30) = 10,625 x $50 = $531,250
Topic: Sales Mix
LO: 4
29. Sales mix refers to:
A) The portion of unit variable costs that are consumed by each product
B) The absolute portion of total variable costs consumed by each product
C) The relative portion of unit or dollar sales that are derived from each product
D) None of the above
Answer: C
Rationale: Sales mix is a term defined as the percentage of total sales generated by each product for
a company that offers multiple products to customers.
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Topic: Sales Mix
LO: 4
30. Which of the following statements regarding sales mix is true?
A) A shift in the sales mix can have a significant impact on the bottom line.
B) One of the limiting assumptions of the basic cost-volume-profit model is that the analysis is for a
single product or the sales mix is constant.
C) Sales mix analysis is important in multiple-product or service organizations.
D) All of the above are true
Answer: D
Rationale: All of the above statements regarding sale mix are true.
Topic: Operating Leverage
LO: 5
31. Operating leverage is best described as:
A) A measure of the extent to which an organization’s costs are fixed
B) A measure of the extent to which an organization’s contribution margin is sensitive to levels of
debt
C) A measure of the extent to which an organization’s operations are financed by debt
D) A measure of the extent to which an organization’s profits contribute to reductions in debt
Answer: A
Rationale: Operating leverage is created by the existence of fixed costs; therefore, it is a measure of
the extent to which a company has fixed costs.
Topic: Operating Leverage Calculation
LO: 5
32. Operating leverage is computed as:
A) Contribution margin divided by income before taxes
B) Fixed costs divided by income before taxes
C) Income before taxes divided by total debt
D) Operating income divided by total debt
Answer: A
Rationale: Operating leverage is calculated by dividing the dollar amount of contribution margin for a
given level of operations by the amount of operating profit or the profit before taxes.
Topic: Effect of Operating Leverage
LO: 5
33. All else being equal, this is true about a firm with high operating leverage relative to a firm with low
operating leverage:
A) A higher percentage of the high operating leverage firm’s costs are fixed
B) The debt payments limit the high operating leverage firm’s opportunities to turn a big profit
C) The high operating leverage firm has more debt
D) The high operating leverage firm is exposed to less risk
Answer: A
Rationale: Increased leverage is created by having a higher portion of total costs consisting of fixed
costs.
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Topic: Reducing Operating Leverage
LO: 5
34. The best way to reduce operating leverage is to:
A) Substitute direct materials for direct labor
B) Substitute direct labor for automated equipment
C) Substitute equity for debt
D) Substitute in-house direct labor with outsourced labor
Answer: B
Rationale: Operating leverage is reduced by reducing fixed costs; therefore, by replacing automated
equipment (i.e., depreciation, etc.) which is a fixed cost, with direct labor which is a variable cost, the
portion of fixed costs will be reduced and operating leverage will be reduced.
Topic: Operating Leverage Calculation
LO: 5
35. Dippin Cookie Corporation had the following income statement for 2020:
Sales
Less variable costs
Contribution margin
Less fixed costs
Net income
$25,000
(15,000)
$10,000
(8,000)
$ 2,000
Dippin Cookie’s 2020 operating leverage is:
A) 0.333
B) 2.500
C) 3.667
D) 5.000
Answer: D
Rationale: $10,000 / $2,000 = 5.000
Topic: Operating Leverage Calculation
LO: 5
36. The Happy Corporation has the following data for 2020:
Selling price per unit
Variable costs per unit
Fixed costs
Units sold
$5
$3
$10,000
6,000
Happy’s 2020 operating leverage is:
A) 0.50
B) 6.00
C) 4.00
D) 1.71
Answer: B
Rationale: [6,000 × ($5 – $3)] = $12,000 contribution margin – $10,000 = $2,000 Profit.
$12,000 / $2,000 = 6.0 Operating leverage
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Topic: Profitability Analysis
LO: 1
37. Profitability analysis involves examining the relationships among all of the following except:
A) Revenues
B) Costs
C) Profits
D) Products
Answer: D
Topic: CVP Analysis Assumptions
LO: 1
38. A basic assumption of the cost-volume-profit model is that:
A) All costs are classified as mixed costs
B) The total cost function is linear outside of the relevant range
C) The sales mix of multiple products remains constant
D) More than one cost driver is required
Answer: C
Topic: Variable Manufacturing Costs
LO: 1
39. Which of the following would be classified as a variable manufacturing cost?
A) Depreciation
B) Sales commissions
C) Property taxes
D) Lubricants for machinery
Answer: D
Topic: Fixed Costs
LO: 1
40. Which of the following would be classified as a fixed selling and administrative cost?
A) Sales Commissions
B) Depreciation on office equipment
C) Depreciation on factory equipment
D) Wages of production supervisor
Answer: B
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Topic: Profit Formula
LO: 1
41. The following costs relate to Muffin Bag Company for a relevant range of up to 10,000 units annually:
Variable Costs:
Direct materials
Direct labor
Manufacturing Overhead
Selling and administrative
Fixed Costs:
Manufacturing overhead
Selling and Administrative
$1.25
0.75
1.00
1.00
$20,000
10,000
Muffin Bag sells each unit for $10.00.
Which of the following equations best describes the equation to determine total profit for a sales
volume of 8,000 units?
A) Profit = $10.00X – ($30,000 + $4.00X)
B) Profit = $30,000 + $4.00X
C) Profit = $10.00X – ($10,000 – $4.00X)
D) Profit = $10X
Answer: A
Topic: Profit Formula
LO: 1
42. The following costs related to Summertime Company for a relevant range of up to 20,000 units
annually:
Variable Costs:
Direct materials
Direct labor
Manufacturing Overhead
Selling and administrative
Fixed Costs:
Manufacturing overhead
Selling and Administrative
$2.50
0.75
1.25
1.50
$10,000
5,000
The selling price per unit of product is $15.00.
At a sales volume of 15,000 units, what is the total cost for Summertime Company?
A) $155,000
B) $150,000
C) $100,000
D) $105,000
Answer: D
Rationale: $10,000 + $5,000 + ($2.50 + $0.75 + $1.25 + $1.50) x 15,000 = Total cost
$15,000 + ($6 x 15,000) = Total cost
$105,000 = Total cost
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Topic: Profit Formula
LO: 1
43. The following costs related to Summertime Company for a relevant range of up to 20,000 units
annually:
Variable Costs:
Direct materials
Direct labor
Manufacturing Overhead
Selling and administrative
Fixed Costs:
Manufacturing overhead
Selling and Administrative
$2.50
0.75
1.25
1.50
$10,000
5,000
The selling price per unit of product is $15.00.
At a sales volume of 15,000 units, what is the total profit for Summertime Company?
A) $ 130,000
B) $ 120,000
C) $225,000
D) $150,000
Answer: B
Rationale: ($15.00 x 15,000) – [$10,000 + $5,000 + (($2.50 + $0.75 + $1.25 + $1.50) x 15,000)] =
$225,000 – [$15,000 + ($6 x 15,000)] =
$225,000 – $105,000 =
$120,000
Topic: Contribution Income Statement
LO: 2
44. The difference between total revenue and total variable cost is called:
A) Gross Profit
B) Gross Margin
C) Contribution Margin
D) Profit
Answer: C
Topic: Contribution Income Statement
LO: 2
45. Costs are classified according to behavior on which of the following?
A) Contribution Income Statement
B) Functional Income Statement
C) Cost of Goods Sold
D) Cost of Goods Manufactured
Answer: A
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Topic: Contribution Income Statement
LO: 2
46. Contribution margin measures:
A) The difference between total sales and total cost of goods sold
B) The difference between total sales and total costs
C) The difference between sales and variable manufacturing costs
D) The difference between total sales and total variable costs
Answer: D
Topic: Contribution Margin Ratio
LO: 2
47. The contribution margin ratio is:
A) The difference between price and variable cost per unit
B) The percentage difference between sales and cost of goods sold
C) The portion (or percent) of revenues available for covering fixed costs and providing a profit
D) The percentage difference between total revenues and total costs
Answer: C
Topic: Contribution Margin Ratio
LO: 2
48. The following information is available for Spruce Corporation for a sales volume of 500 stereo
speakers for the past month:
Sales
Less: variable expenses
Contribution margin
Less: fixed expenses
Net operating income
Total
$112,500
$40,000
$72,500
$17,500
$55,000
Per Unit
$225
$80
$145
What is the contribution margin ratio?
A) 54.4%
B) 32.2%
C) 40.0%
D) 64.4%
Answer: D
Rationale: $72,500 / $112,500 = 64.44%
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Topic: Analysis Using Contribution Margin Ratio
LO: 2
49. The following information is available for Spruce Corporation for a sales volume of 500 stereo
speakers for the past month:
Sales
Less: Variable expenses
Contribution margin
Less: Fixed expenses
Net operating income
Total
$112,500
40,000
72,500
17,500
$ 55,000
Per Unit
$225
80
$145
If sales increase by $51,750, net income will increase by what amount?
A) $ 22,000
B) $30,000
C) $20,000
D) $33,350
Answer: D
Rationale: $51,750 / $225 = 230 units
$51,750 – 230($80) = $33,350
Topic: Contribution Margin
LO: 2
50. Barrington Corporation reported the following on their contribution format income statement:
Sales (12,000 units)
Less: Variable expenses
Contribution margin
Less: Fixed expenses
Net operating income
$175,000
100,000
75,000
62,500
$ 12,500
What is the unit contribution margin?
A) $17.00
B) $10.00
C) $ 6.25
D) $ 6.75
Answer: C
Rationale: $75,000 / 12,000 = $6.25
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Topic: Contribution Margin Ratio
LO: 2
51. Barrington Corporation reported the following on their contribution format income statement:
Sales (12,000 units)
Less: variable expenses
Contribution margin
Less: fixed expenses
Net operating income
$175,000
100,000
75,000
62,500
$ 12,500
What is the contribution margin ratio?
A) 38.57%
B) 42.86%
C) 57.14%
D) 43.30%
Answer: B
Rationale: $75,000 / $175,000 = 0.42857 = 42.86%
Topic: Contribution Margin
LO: 2
52. Barrington Corporation reported the following on their contribution format income statement:
Sales (12,000 units)
Less: variable expenses
Contribution margin
Less: fixed expenses
Net operating income
$175,000
100,000
75,000
62,500
$ 12,500
For each additional unit of sales, net operating income will increase by:
A) $17.50
B) $ 6.25
C) $ 7.50
D) $ 5.00
Answer: B
Rationale: $6.25 (contribution margin)
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Topic: Contribution Margin
LO: 2
53. Barrington Corporation reported the following on their contribution format income statement:
Sales (12,000 units)
Less: variable expenses
Contribution margin
Less: fixed expenses
Net operating income
$175,000
100,000
75,000
62,500
$ 12,500
If sales increase by 10%, net operating income will increase by what amount?
A) $-0B) $ 1,500
C) $ 7,500
D) $30,000
Answer: C
Rationale: 12,000 units x 10% = 1,200 units x $6.25* = $7,500
*contribution margin
Topic: Contribution Margin
LO: 2
54. Contribution margin is calculated by subtracting:
A) Total variable costs from total revenues
B) Total manufacturing costs from total revenues
C) Fixed costs from total revenues
D) Cost of goods sold from total revenues
Answer: A
Topic: Gross Margin
LO: 2
55. Gross margin is calculated by subtracting:
A) Total variable costs from total revenues
B) Total manufacturing overhead costs from total revenues
C) Fixed costs from total revenues
D) Cost of goods sold from total revenues
Answer: D
Topic: Cost-Volume-Profit Graph
LO: 3
56. A cost-volume-profit graph:
A) Plots both revenue and total cost on the Y-axis
B) Plots both revenue and total cost on the X-axis
C) Plots contribution margin on the Y-axis and volume on the X-axis
D) Plots contribution margin on the X-axis and volume on the Y-axis
Answer: A
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Topic: Cost-Volume-Profit Graph
LO: 3
57. If a company decreases the variable expense per unit while increasing the total fixed expenses, the
total expense line relative to its previous position will:
A) Shift downward and have a steeper slope
B) Shift downward and have a flatter slope
C) Shift upward and have a flatter slope
D) Shift upward and have a steeper slope
Answer: C
Topic: Contribution Margin
LO: 2
58. Soil Company sells a single product. If the selling price per unit and the variable expense per unit
both increase by 10% and fixed expenses do not change, then:
A) Contribution margin per unit increases
B) Contribution margin per unit decreases
C) Breakeven-even in units increase
D) Contribution margin decreases
Answer: A
Topic: Margin of Safety
LO: 3
59. The margin of safety is:
A) The excess of sales over variable expenses.
B) The excess of sales over fixed expenses.
C) The excess of sales over the break-even volume of sales.
D) The excess of net operating income over actual net operating income.
Answer: C
Topic: Break-Even Point
LO: 3
60. Skye Company sells a single product at a selling price of $32 per unit. Variable expenses are $12
per unit and fixed expenses are $41,400.
Sally’s break-even point is:
A) 1,380 units
B) 2,300 units
C) 2,070 units
D) 6,900 units
Answer: C
Rationale: $32X = $41,400 + $12X
20 X = $41,400
X = 2,070
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Topic: Break-Even Point
LO: 3
61. The following information pertains to Boyd Company:
Sales (25,000 units)
Manufacturing expenses:
Variable
Fixed
$250,000
$85,000
$17,500
Selling and general expenses:
Variable
Fixed
$27,500
$14,950
Boyd’s break-even point in number of units is:
A) 4,900
B) 5,000
C) 5,900
D) 9,200
Answer: C
Rationale: Sales =$250,000 / 25,000 = $10 per unit;
Var. Exp. = ($85,000 + $27,500) / 25,000 = $4.50 per unit
$10X = ($17,500 + $14,950) + $4.50X
$5.50X = $32,450
X = 5,900
Topic: Margin of Safety
LO: 3
62. The following monthly data are available for the Sumslow Company and its only product:
Unit selling price
Unit variable expenses
Total fixed expenses
Actual sales for the month of March
$36
$28
$51,000
7,000 units
The margin of safety for the company during March was:
A) $12,000
B) $22,500
C) $ 5,000
D) $15,000
Answer: B
Rationale: $51,000 / ($36 - $28) = 6,375 break-even units
Then (7,000 units sold - 6,375 break-even units) x $36 = $22,500
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Topic: Break-Even Point
LO: 3
63. Sunny Company sells a single product. The product has a selling price of $45 per unit and variable
expenses of $15 per unit. The company’s fixed expenses total $15,000 per year.
The company’s break-even point in terms of total sales dollars is:
A) $22,500
B) $45,000
C) $15,000
D) $48,000
Answer: A
Rationale: $45X = $15,000 + $15X
$30X = $15,000
X = 500 units x $45 = $22,500
Topic: Profit Planning
LO: 3
64. Dwight Company sells its product for $10 a unit. Next year, fixed expenses are expected to be
$200,000 and variable expenses are estimated at $6 per unit.
How many units must Dwight sell to generate net operating income of $50,000?
A) 50,000 units
B) 60,000 units
C) 62,500 units
D) 120,000 units
Answer: C
Rationale: $10X= 50,000 + 200,000 + $6X
X = 62,500 units
Topic: Profit Planning
LO: 3
65. Last year, Angela Company reported a profit of $70,000 when sales totaled $520,000 and the
contribution margin ratio was 35%.
If fixed expenses increase by $20,000 next year, what will sales have to be for the company to earn a
profit of $80,000?
A) $562,500
B) $570,000
C) $605,714
D) $577,143
Answer: C
Rationale: Contribution Margin ($520,000 x 35%) – $70,000 (profit) = $112,000 Fixed exp.
New Fixed exp: $112,000 + $20,000 = $132,000
Desired Profit:
X = $80,000 + $132,000 + 0.65X
0.35X = $212,000
X = 605,714
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Topic: Margin of Safety
LO: 3
66. If sales volume increases and all other factors remain constant, then the:
A) Contribution margin ratio will increase
B) Break-even point will decrease
C) Margin of safety will increase
D) Net operating income will decrease
Answer: C
Topic: Contribution Margin
LO: 2
67. All other things being the same, which of the following statements would be true of the contribution
margin and variable expenses of a capital-intensive company with high fixed costs and low variable
costs as compared to a labor-intensive company with low fixed costs and high variable costs?
A)
B)
C)
D)
Higher contribution margin and higher variable costs
Lower contribution margin and higher variable costs
Higher contribution margin and lower variable costs
Lower contribution margin and lower variable costs
Answer: C
Topic: Break-Even Point
LO: 4
68. In calculating the break-even point for a multi-product company, which of the following assumptions
are commonly made?
1) Sales volume equals production volume
2) Variable expenses are constant per unit.
3) A given sales mix is maintained for all volume changes.
A)
B)
C)
D)
1 and 2
1 and 3
2 and 3
1, 2, and 3
Answer: D
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Topic: Contribution Income Statement
LO: 2
69. Cloudy Corporation has provided the following cost data for last year when 50,000 units were
produced and sold:
Raw materials
Direct labor
Manufacturing overhead
Selling and administrative expense
$200,000
100,000
200,000
150,000
All costs are variable except for $100,000 of manufacturing overhead and $100,000 of selling and
administrative expense.
If the selling price is $12 per unit, the net operating income from producing and selling 120,000 units
would be:
A) $460,000
B) $160,000
C) $85,000
D) $105,000
Answer: B
Rationale:
Variable Costs = ($200,000 + $100,000 + $100,000 + $50,000) = $450,000 ÷ 50,000 = $9 per unit
Net Operating Income = ($12 x 120,000) – [$200,000 + ($9 x 120,000)] = $160,000
Topic: Break-Even Point
LO: 3
70. Delaware Company’s break-even point in sales is $950,000, and its variable expenses are 60% of
sales. If the company lost $34,000 last year, sales must have amounted to:
A) $628,000
B) $772,000
C) $814,000
D) $865,000
Answer: D
Rationale: $950,000 = (0.60 x $950,000) + FC
$380,000 = FC
X – 0.60X – $380,000 = -$34,000
0.40X = $346,000
X = $865,000
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Topic: Multiple-Product Cost-Volume-Profit Analysis
LO: 4
71. Constance Company sells two products, as follows:
Product Y
Product Z
Selling Price per Unit
$300
700
Variable Expense per Unit
$ 150
300
Fixed expenses total $500,000 annually. The expected sales mix in units is 60% for Product Y and
40% for Product Z.
How much is Constance Company’s expected break-even sales in dollars?
A) $920,000
B) $414,000
C) $900,000
D) $555,882
Answer: A
Rationale: BEP in sales dollars = Fixed Costs / CM Ratio
The weighted average CM = ($150 x 0.60) + ($400 x 0.40) = $250
The weighted average Sales Price = ($300 x 0.60) + ($700 x 0.40) = $460
Weighted Average CM ratio = $250 / $460 = 0.543478
BEP in $ = $500,000 / 0.543478 = $920,000 (rounded)
Topic: Sales Mix
LO: 4
72. Sales mix refers to:
A) The portion of unit variable costs that are consumed by each product
B) The relative portion of unit or dollar sales that are derived from each product
C) The portion of manufacturing costs allocated to each product
D) The portion of selling and general administrative costs allocated to each product
Answer: B
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Topic: Multiple-Product Cost-Volume-Profit Analysis
LO: 4
73. Point Company sells three different products that are similar, but are differentiated by various product
features. Budgeted sales by product and in total for the coming year are shown below:
Product
Percentage of total sales
Sales
Less: Variable costs
Contribution margin
Less: Fixed expenses
Net operating income
Standard
48%
$120,000
36,000
$84,000
Deluxe
20%
$50,000
40,000
$10,000
Premium
32%
$80,000
44,000
$36,000
Total
100%
$250,000
120,000
$130,000
$117,000
$ 13,000
The break-even point in sales dollars for Point Company is:
A) $250,000
B) $225,000
C) $449,231
D) $500,000
Answer: B
Rationale: Contribution Margin Ratio = $130,000 / $250,000 = 0.52
BEP in sales dollars = Fixed Costs / CM Ratio = $117,000 / 0.52 = $225,000
Topic: Multiple-Product Cost-Volume-Profit Analysis
LO: 4
74. Point Company sells three different products that are similar, but are differentiated by various product
features. Budgeted sales by product and in total for the coming year are shown below:
Product
Percentage of total sales
Sales
Less: variable costs
Contribution margin
Less: fixed expenses
Net operating income
Standard
58%
$120,000
36,000
$84,000
Deluxe
10%
$50,000
40,000
$ 10,000
Premium
32%
$80,000
44,000
$ 36,000
Total
100%
$250,000
120,000
$130,000
$117,000
$ 13,000
If the actual percentage of sales for the year were Standard, 50%; Deluxe, 40%; and Premium, 10%,
than:
A) The overall contribution margin would decrease and break-even sales would increase
B) The overall contribution margin would increase and break-even sales would decrease.
C) The overall contribution margin would increase and break-even sales would increase.
D) The overall contribution margin would decrease and break-even sales would decrease.
Answer: A
Rationale: Overall contribution margin (CM) ratio: Sum of original CM ratio, by products x respective
actual sales percentages = (0.50 x 0.70) + (0.40 x 0.20) + (0.10 x 0.45) = 0.475.
Original CM ratio, per problem #73 = 0.52, therefore overall CM DECREASE
Revised break-even (BE) sales dollars: $117,000 / 0.475 = $246,315.79.
Original BE sales dollars, per Problem #73 = $225,000, therefore break even sales dollars
INCREASE.
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Topic: Multiple-Product Cost-Volume-Profit Analysis
LO: 4
75. Point Company sells three different products that are similar, but are differentiated by various product
features. Budgeted sales by product and in total for the coming year are shown below:
Product
Percentage of total sales
Sales
Less: variable costs
Contribution margin
Less: fixed expenses
Net operating income
Standard
58%
$120,000
36,000
$84,000
Deluxe
10%
$50,000
40,000
$ 10,000
Premium
32%
$80,000
44,000
$ 36,000
Total
100%
$250,000
120,000
$130,000
$117,000
$ 13,000
If customers are indifferent to which of the products to purchase from Point Company, which product
line should sales personnel recommend to customers that would most improve overall operating
income?
A) Product line with the highest sales price
B) Product line with the lowest variable cost
C) Product line with the highest percentage of total budgeted sales
D) Product line with the highest contribution margin ratio
Answer: D
Topic: Operating Leverage
LO: 5
76. Operating leverage is best described as:
A) A measure of the extent to which an organization’s costs are financed by equity
B) A measure of the extent to which an organization’s contribution margin is affected by sales mix of
products
C) A measure of the extent to which an organization’s operations are financed by debt
D) A measure of the extent to which an organization’s costs are fixed
Answer: D
Topic: Operating Leverage
LO: 5
77. Operating leverage is computed as:
A) Contribution margin divided by before-tax profit
B) Contribution margin divided by net income
C) Fixed costs divided by before-tax profit
D) Operating income divided by total debt
Answer: A
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Topic: Operating Leverage
LO: 5
78. Jefferson Company has sales of 2,000 units at $30 per unit. Variable expenses are 40% of the
selling price. If total fixed expenses are $20,000, the degree of operating leverage is:
A) 2.25
B) 3.16
C) 2.50
D) 5.00
Answer: A
Rationale: Net Income = ($30 x 2,000) – [0.4 x ($30 x 2,000)] – $20,000 = $16,000
Contribution Margin = ($30 x 2,000) x (1 - 0.4) = $36,000
$36,000 / $16,000 = 2.25
Topic: Operating Leverage
LO: 2, 5
79. Purple Company’s contribution margin ratio is 30%. If the degree of operating leverage is 6 at the
$250,000 sales level, before-tax profit at the $125,000 sales level must equal:
A) $1,500
B) $6,250
C) $3,125
D) $2,700
Answer: B
Rationale: X = 0.30($125,000) / 6 = $6,250
Topic: Operating Leverage
LO: 5
80. Karen Company has sales of 1,500 units at $35 per unit. Variable expenses are 40% of the selling
price. If total fixed expenses are $27,000, the degree of operating leverage is:
A) 1.75
B) 3.00
C) 7.00
D) 3.50
Answer: C
Rationale: X = [0.60 x (1,500 x $35)] / [0.6 x (1,500 x $35) – $27,000] = 7.00
Topic: Operating Leverage
LO: 5
81. A firm can reduce is operating leverage by substituting:
A) Direct materials for direct labor
B) Direct labor for robotic equipment
C) Equity for debt
D) Debt for equity
Answer: B
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Topic: Operating Leverage
LO: 5
82. Tim Company’s contribution margin ratio is 30%. If the degree of operating leverage is 12 at the
$125,000 sales level, before-tax profit at the $125,000 sales level must equal:
A) $3,125
B) $3,000
C) $4,167
D) $6,750
Answer: A
Rationale: (0.30 x $125,000) / 12 = 3,125
Topic: Operating Leverage
LO: 5
83. Anthony Corporation’s variable expenses are 60% of sales. At a $200,000 sales level, the degree of
operating leverage is 5. If sales increased by $20,000, the new degree of operating leverage will be
(rounded):
A) 2.86
B) 3.67
C) 1.83
D) 4.20
Answer: B
Rationale: (0.4 x $200,000) / 5 = $16,000 before-tax profits (BTP)
Increase in Sales: $20,000 / $200,000 = 0.10 = 10%
Increase in BTP = 10% x 5 (degree of operating leverage) = 50% x $16,000 = $8,000
New BTP = $16,000 + $8,000 = $24,000
New degree of operating leverage = (0.4 x $220,000) / $24,000 = 3.67
Topic: Operating Leverage
LO: 5
84. Other things being equal, the higher the degree of operating leverage, the
opportunity with increased sales and
risk of loss with a decrease in sales.
A) Lower; higher
B) Higher; lower
C) Lower; lower
D) Higher; higher
profit
Answer: D
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Topic: Operating Leverage
LO: 5
85. At its current level of sales, a company has a degree of operating leverage of 6. This means that a
10% increase in sales would result in a:
A) 6% Increase in before-tax profit
B) 10% Increase in before-tax profit
C) 60% Increase in before-tax profit
D) 60% Increase in contribution margin
Answer: C
Topic: Operating Leverage
LO: 5
86. Company X has a degree of operating leverage of 10, whereas, Company Y has a degree of
operating leverage of 5. Each company has the same level of sales.
Which of the following statements is true?
A) If sales increase by 10%, Company Y would have a higher increase in before-tax profit
B) Company X has a higher relative amount of fixed costs in its cost structure than does Company Y.
C) If sales decrease by 10%, Company X would have a lower decrease in before-tax profit.
D) Company Y has a higher relative amount of fixed costs in its cost structure than does Company X.
Answer: B
Topic: Functional Income Statement
LO: 2
87. Presented is Violet Company’s Contribution Income Statement:
VIOLET COMPANY
Contribution Income Statement
For the Month Ending January 31, 2020
Sales
Less variable costs:
Direct materials
Direct labor
Variable factory overhead
Variable S&A expenses
Contribution margin
Less fixed costs:
Factory overhead
Fixed S&A expenses
Net income
$200,000
$50,000
20,000
60,000
_12,000
$ 13,000
12,000
(142,000)
$58,000
(25,000)
$ 33,000
With a functional income statement, Violet would have reported a gross margin of:
A) $57,000
B) $58,000
C) $33,000
D) $70,000
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Answer: A
Rationale:
Sales ($5 x 40,000 units)
Cost of goods sold:
Direct materials
Direct labor
Variable factory overhead
Fixed factory overhead
Gross margin
$200,000
$50,000
20,000
60,000
13,000
(143,000)
$57,000
Topic: Contribution Income Statement
LO: 2
88. Presented is Jack Company’s Contribution Income Statement:
JACK COMPANY
Contribution Income Statement
For the Month Ending January 31, 2020
Sales
Less variable costs:
Direct materials
Direct labor
Variable factory overhead
Variable S&A expenses
Contribution margin
Less fixed costs:
Factory overhead
Fixed S&A expenses
Net income
$200,000
$50,000
20,000
60,000
_12,000
$ 13,000
12,000
(142,000)
$58,000
(25,000)
$ 33,000
Based on the contribution margin above, if Jack Company had $100,000 increase in sales, profit
would increase by:
A) $35,000
B) $29,000
C) $39,000
D) $28,000
Answer: B
Rationale: (CM) $58,000 / (Sales) $200,000 = 0.29 CM Ratio
CM Ratio x Increase in sales = 0.29 x $100,000 = $29,000 increase in net income
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Topic: Sales Mix Analysis, Sales Unit
LO: 4
89. FIELD sports store sells 1 World Cup soccer ball for every 4 regular style balls.
World Cup
Soccer Ball
$20
$10
Sale price per ball
Variable cost per ball
Regular
Style Ball
$10
$ 5
Total Fixed Cost for FIELD sports $12,000. Assuming a constant sales mix. The break-even unit
sales volume is:
A) 7,200
B) 3,840
C) 2,000
D) 9,023
Answer: C
Rationale:
World Cup
Soccer Ball
20%
$20
10
Sales %
Sale price per unit
Variable cost per unit
CM per unit
CM per unit based on sales %
Regular
Style Ball
80%
$10
5
$10
$ 2
$ 5
$ 4
$12,000 / $6 = 2,000 units
Topic: Sales Mix Analysis, Sales Dollars
LO: 4
90. A new bar, Debo’s Bar, has opened in a Panther Square village that sells various wine and beer
beverages. Further, suppose it has added cocktails to its product line. Below are the assumed sales
and cost data for the bar:
Sales price per glass
Variable cost per glass
Wine
$4
$2
Beer
$3
$1
Cocktails
$5
$3
Fixed costs per month are $14,000.
Suppose Debo’s Bar sells each month an average of:
 5,000 servings of wine
 3,000 servings of beer
 2,000 servings of cocktails
Using a sales dollar analysis, the monthly break-even point in sales dollars assuming the sales mix
does not change will be:
A) $20,000
B) $39,000
C) $27,300
D) $18,500
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Answer: C
Rationale:
Wine
Beer
Cocktails
Total
Monthly unit sales
Selling price
Sales
Variable cost
5,000
$4.00
$20,000
$10,000
3,000
$3.00
$ 9,000
$ 3,000
2,000
$5.00
$10,000
$ 6,000
$39,000
$19,000
Contribution margin
Contribution margin ratio
$10,000
0.50000
$
$ 4,000
0.40000
$20,000
0.51282
6,000
0.66667
Break-even point in Sales Dollars = $14,000 / 0.51282 = $27,300
Topic: Profit Planning
LO: 3
91. Yellow Line Corporation produces a product that sold for $20 per unit. Following are the variable and
fixed costs:
Variable Costs per Unit
Fixed Costs per Month
Manufacturing
Selling and administration
Total
$4
1
$5
Manufacturing
Selling and administration
Total
$14,500
8,000
$22,500
The sales volume required for a monthly profit of $12,000 is:
A) 1,500 units
B) 2,300 units
C) 2,000 units
D) 1,800 units
Answer: B
Rationale: Contribution Margin per unit = $20 - $5 = $15
Sales volume for target profit of $12,000 = ($22,500 + $12,000) ÷ $15 = 2,300 units
Topic: Impact of Taxes
LO:3
92. Rodger Corporation is selling its product at unit price of $15, variable cost per unit is $7, fixed cost is
$12,000 and it is subjected to 40 percent tax rate (includes federal and state income tax). The desired
after tax profit is $3,000, the number of units required to be sold is:
A) 2,125 units
B) 1,875 units
C) 2,152 units
D) 1,500 units
Answer: A
Rationale:
Desired Profit before tax = After Tax profit ÷ (1 - tax rate) = $3,000÷ (1 - 0.40) = $5,000
Contribution Margin per unit = $15 - $7 = $8
Sales volume for desired profit before tax of $5,000 (or $3,000 desired profit after tax) =
($5,000+$12,000) ÷ $8 = 2,125 units
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Exercises
Topic: Contribution Income Statement
LO: 2
1. Albert, Inc. had the following income statement for last period:
Sales
Cost of Sales (manufacturing)
Selling and General Administrative
Net Income
$27,000
11,000
2,000
$14,000
If costs of sales was 75% variable and 25% fixed, and Selling and General Expense was 60% variable
and 40% fixed, prepare a contribution format income statement and calculate its contribution margin
percentage.
Answer:
Sales
Variable costs:
Manufacturing
Selling and general administrative
Contribution margin
Fixed costs:
Manufacturing
Selling and general administrative
Net Income
$27,000
$8,250
1,200
$2,750
800
(9,450)
$17,550
3,550
$14,000
Contribution margin ratio = Contribution Margin / Sales = $17,550 / $27,000 = 0.65 = 65%
Topic: Break-Even Calculation
LO: 3
2. KV Inc. had a contribution margin of $14,000 on sales of $20,000 and had fixed costs of $8,750.
Calculate its break-even point in sales dollars.
Answer:
Contribution margin percent = $14,000 / $20,000 = 0.7 or 70%
Break-even = $8,750 / 0.70 = $12,500
Proof: $12,500 x 0.70 = $8,750 – $8750 = $0
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Topic: Profit Planning
LO: 3
3. Tina Company has a variable cost percentage of 20% on a product that sells for $25 per unit. Fixed
costs are $12,500. Tina wants to know how many units must be sold to:
a. Break even
b. Earn a profit of $14,000
Ignore income taxes.
Answer:
Contribution margin per unit = (1.00 – 0.20) X $25 = $20.00 per unit
a. Break-even = $12,500 / $20.00 = 625 units
b. To earn a profit of $14,000 = (12,500 + 14,000) / $20.00 = 1,325 units
Topic: Break-Even Calculation
LO: 3
4. Maggie Company had the following functional income statement for the month of May, 2020:
MAGGIE COMPANY
Functional Income Statement
For the Month Ending May 31, 2020
Sales (30,000 units)
Cost of goods sold:
Direct materials
Direct labor
Variable manufacturing overhead
Fixed factory overhead
Gross profit
Selling and administrative expenses:
Variable
Fixed
Net income
$300,000
$30,000
22,500
18,750
20,000
$ 3,750
10,000
91,250
$208,750
13,750
$195,000
Calculate Maggie’s break-even sales in units.
Answer:
Unit variable costs = $1 (materials) + $0.75 (labor) + $0.625 (overhead) + $0.125 (selling and admin)
= $2.50
Contribution margin = $10.00 (Sales) – $2.50 (variable costs) = $7.50
Fixed costs = $20,000 (factory overhead) + $10,000 (S&A) = $30,000
Break-even = $30,000 (fixed costs) / $2.50 (contribution margin) = 12,000 units
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Topic: Operating Leverage
LO: 5
5. Orange Corporation’s income statement is presented below.
Sales
Less variable costs
Contribution margin
Less fixed costs
Net income
$ 70,000
(35,000)
$ 35,000
(32,500)
$ 2,500
Calculate Orange’s operating leverage.
Answer:
$35,000 (contribution margin) / $2,500 (before tax profits) = 14
Topic: Operating Leverage
LO: 5
6. The Rachel Corporation has the following current data:
Selling price per unit
Variable costs per unit
Fixed costs
Units sold
$20
$8
$60,000
10,000
Calculate Alexis Corporation’s current operating leverage.
Answer:
Contribution margin = ($20 – $8) × 10,000 = $120,000
Net income = Contribution margin of $120,000 less fixed cost of $60,000 = $60,000
Operating leverage = $120,000 ÷ $60,000 = 2
Topic: Operating Leverage
LO: 5
7. Maroon sells tiling grout and reports the following data:
Kilograms produced and sold
Sales revenue
Variable manufacturing expense
Fixed manufacturing expense
Variable selling and administrative expense
Fixed selling and administrative expense
Net operating income
625,000 kg
$5,625,000
1,875,000
1,000,500
625,000
562,000
$ 1,562,500
Calculate the company’s degree of operating leverage.
Answer:
Contribution margin = $5,625,000 (sales) – $1,875,000 (variable manufacturing expense) – $625,000
(variable selling and administrative expense) = $3,125,000
Operating leverage = $3,125,000 (contribution margin) / $1,562,500 (net operating income) = 2
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Topic: Effect of Decrease in Sales on Operating Margin
LO: 5
8. The Rachel Corporation has the following data for 2020:
Selling price per unit
Variable costs per unit
Fixed costs
Units sold
$20
$8
$60,000
10,000
Calculate Rachel’s operating leverage at the end of 2020, assuming that 2020 sales decrease to
7,500 units.
Answer:
Contribution margin = ($20 – $8) x 7,500 = $90,000
Net income = Contribution margin of $90,000 less fixed costs of $60,000 = $30,000
Operating leverage = $90,000 / $30,000 = 3
Topic: Effects of Decrease in Sales on Operating Margin
LO: 5
9. Maroon sells tiling grout and reports the following data:
Kilograms produced and sold
Sales revenue
Variable manufacturing expense
Fixed manufacturing expense
Variable selling and administrative expense
Fixed selling and administrative expense
Net operating income
625,000 kg
$5,625,000
1,875,000
1,000,500
625,000
562,000
$ 1,562,500
Calculate the company’s operating leverage if sales decrease by 10%.
Answer:
Contribution margin = $5,625,000 (sales) – $1,875,000 (variable manufacturing expense) – $625,000
(variable selling and administrative expense) = $3,125,000
Decrease in contribution margin = $3,125,000 (1 – 0.10) = $2,812,500
Operating Income = $2,812,500– $1,000,500 (fixed manufacturing overhead) – $562,000 (fixed
selling and admin expense) = $1,250,000
New degree of operating leverage = $2,812,500 (contribution margin) / $1,250,000 (operating
income) = 2.25
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Topic: Change in Operating Leverage
LO: 5
10. The Cole Corporation has the following data for 2020:
Selling price per unit
Variable costs per unit
Fixed costs
Units sold
$75
$45
$160,000
8,000
Calculate Cole’s current operating leverage at the end of 2020, and its operating leverage at the end
of 2021, assuming 2021 unit sales are only 6,000 units.
Answer:
At the end of 2020:
Contribution margin = ($75 – $45) x 8,000 = $240,000
Operating income = $240,000 – $160,000 (fixed costs) = $80,000
Operating leverage = $240,000 / $80,000 = 3.0
At the end of 2021:
Contribution margin = $30 x 6,000 units = $180,000
Operating income = $180,000 (contribution margin) – $160,000 (fixed cost) = $20,000
Operating leverage = $180,000 / $20,000 = 9
Topic: Operating Leverage Effect on Net Income
LO: 5
11. If before-tax profit is $35,000 and operating leverage is 1.50 at the end of the most recent period, a
20% increase in sale will increase net income by what percent and what dollar amount?
Answer:
Net income will increase by 30%, which is the increase in sales percent of 20% times the current
operating leverage of 1.50. Therefore, net income will increase by 30% of $35,000, or $10,500 to
$45,500.
Topic: Cost Estimation and Cost-Volume-Profit Analysis
LO: 3
12. Clover Manufacturing had the following data for the past three months.
Sales in units
Operating expenses
January
3,000
$300,000
February
3,250
$296,000
March
4,500
$360,000
Using the high-low method, estimate Clover’s
a. Total fixed costs
b. Contribution margin ratio
c. Break-even point in sales dollars for April
Clover expects to sell 10,000 units for $50 per unit.
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Answer:
a. ($360,000 – $300,000) / (4,500 – 3,000) = $40 variable cost per unit
$360,000 – ($40 x 4,500 units) = $180,000 fixed costs
or $180,000 – ($40 x 3,000 units) = $180,000 fixed costs
b. Contribution Margin = $50 – $40 = $10
Contribution Margin Ratio = $10 / $50 = 0.20 or 20%
c.
Break-even point in sales = $180,000 / 0.20 = $900,000
Topic: Cost Estimation and Cost-Volume-Profit Analysis
LO: 3
13. Jerry Manufacturing had the following data for 2020 and 2021:
Revenues
Operating Expenses
Operating Income
2021
$475,000
327,000
$ 148,000
2020
$400,000
300,000
$ 100,000
Using the high-low method, calculate Jerry’s:
a. Variable cost ratio
b. Contribution margin ratio
c. Total fixed costs
d. Break-even point in sales dollars
Answer:
a. Using revenues as the measure of activity volume, the difference in operating expenses between
2021 and 2020 divided by the difference in revenues equals the variable cost ratio:
Variable cost ratio = ($327,000 – $300,000) / ($475,000 – $400,000) = 0.36
b. Contribution margin ratio = 1 – 0.36 = 0.64
c.
Fixed costs equals total costs less variable costs: $327,000 – ($475,000 x 0.36) = $156,000
d. Break-even sales equals fixed costs divided by contribution margin ratio
$156,000 / 0.64 = $243,750
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Topic: Multi-Product Contribution Margin
LO: 4
14. Assume the Cornbelt Furniture Company sells two kinds of picnic tables, pine and redwood. At a 3:1
unit sales mix in which Cornbelt sells three pine tables for every redwood table, the following revenue
and cost information is available.
Pine Table
Unit selling price
Unit variable costs
Unit contribution margin
$200
$125
$75
Redwood Table
$600
$ 275
$ 325
Fixed costs per month: $18,150
Assuming a 3:1 sales mix, calculate Cornbelt Furniture’s current monthly average unit contribution
margin, break-even sales volume, and number of units of Pine and Redwood tables at break-even
point.
Answer:
Average unit contribution margin: ($75 x 3/4) + ($325 x 1/4) = $137.50
Break-even sales volume: $18,150 (fixed costs) / $137.50 (average contribution margin) = 132
With a 3:1 sales mix, at break-even, there will be 99 pine tables and 33 redwood tables.
Pine tables: 132 x 3/4 = 99 tables
Redwood tables: 132 x 1/4 = 33 tables
Topic: Operating Leverage
LO: 3, 4, 5
15. During the most recent fiscal period, North Company had sales of $80,000. Variable costs are 20%
of sales and fixed costs amounted to $48,000 for the year.
Calculate the following:
a.
b.
c.
d.
Contribution margin ratio
Operating leverage
Break-even sales in dollars
Operating profit if sales increase by 20% next year
Answer:
a. Contribution margin ratio = Contribution Margin / Sales
Variable costs = $80,000 x 20% = $16,000
Contribution margin = $80,000 – $16,000 = $64,000
Contribution margin ratio = $64,000 / $80,000 = 0.80 or 80.0%
b. Operating income = Contribution Margin – Fixed Costs = $64,000 – $48,000 = $16,000
Operating Leverage = Contribution Margin / Operating Income; $64,000 / $16,000 = 4
c.
Break-even sales = Fixed costs / Contribution margin ratio = $48,000 / 0.8= $60,000
d. Increase in sales of 20% would increase operating income by 20% x 4 = 80.0%
Operating income = $16,000 x 1.80 = $28,800.
Proof
Sales ($80,000 x 1.20) = $96,000
Variable Costs = ($96,000 x 20%) = $19,200
Contribution Margin = $96,000 – $19,200 = $76,800
Operating Profit = $76,800 – $48,000 = $28,800
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Problems
Topic: Break-Even Analysis and Profit Planning
LO: 3
1. Ontario Outdoors is a manufacturer of outdoor items. The company is considering the possibility of
offering a new sleeping bag that would sell for $75 each. Cost to manufacture these sleeping bags
includes $20 in materials and $17 in direct labor for each sleeping bag. Variable marketing and selling
costs would be $8 each. In order to manufacture these sleeping bags, the company would need to
incur $60,000 in fixed costs for new equipment.
Required:
a. Compute the break-even point of the sleeping bag in units sold.
b. What would be the total revenue at the break-even point?
c. How many units would Ontario need to sell to earn a profit of $12,000?
d. If fixed costs in fact are $70,500 rather than $60,000, how many units would need to be sold in
order to earn $12,000?
Answer:
a. The breakeven point is $60,000 / ($75 – $20 – $17 – $8) = 2,000 units
b. Total revenue at the break-even point would be 2,000 units times $75 = $150,000
c. To earn $12,000, it would need to sell [$72,000 / ($75 – $45)] = 2,400 units
d. To earn $12,000, with fixed costs of$ 70,500, it would need to sell [$82, 500 / ($75 – $45)] =
2,750 units
Topic: Break-Even Analysis and Profit Planning
LO: 3
2. The Green Food Market is a merchandiser of organic food items. The company is considering the
possibility of selling pomegranates that would sell for $0.30 each. Pomegranates can be acquired in
unlimited quantities for $0.22 each. There are no additional variable costs associated with acquiring
and selling pomegranates since labor is on a salaried basis. However, in order to acquire
pomegranates at this price, Green Food Market must pay $1,000 per year for membership in an
International co-op.
Required:
a. How many pomegranates would Green Food Market need to sell annually to justify joining the coop (break-even)?
b. What would be the total revenue at the break-even point?
c. How many pomegranates would the company need to sell to earn a profit of $1,000?
d. If pomegranates cost were $0.26 instead of $0.22, how many pomegranates would need to be
sold in order to earn the same $1,000?
Answer:
a. The break-even point is $1,000 / ($0.30 – $0.22) = 12,500 units
b. Total revenue at the break-even point would be 12,500 units times $0.30 = $3,750
c. To earn $1,000, it would need to sell: $2,000 / $0.08 = 25,000 units
d. To earn $1,000, it would need to sell: $2,000 / ($0.30 - $0.26) = 50,000 units. Twice as many
units!
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Topic: Cost-Volume-Profit Analysis
LO: 3
3. Supply the missing data in each independent case.
Unit sales
Sales revenue
Variable cost per unit
Contribution Margin
Fixed costs
Operating income
Unit contribution margin
Break-even point (units)
Margin of Safety
Case A
350
$17,500
$20
?
$3,750
?
?
?
?
Case B
150
?
$2
$600
?
-$200
?
?
?
Case C
?
?
$7
?
$30,000
?
?
2,500
1,000
Case D
?
$45,000
?
?
?
?
$2
7,500
7,500
Case E
?
$25,000
?
$10,000
?
?
$2
?
1,400
Case A
Case B
Case C
Case D
Case E
350
$17,500
$20
$10,500
$3,750
$6,750
$30
125
225
150
$900
$2
$600
$800
-$200
$4
200
-50
3,500
$66,500
$7
$42,000
$30,000
$12,000
$12
2,500
1,000
15,000
$45,000
$1
$30,000
$15,000
$15,000
$2
7,500
7,500
5,000
$25,000
$3
$10,000
$7,200
$2,800
$2
3,600
1,400
Answer:
Unit sales
Sales revenue
Variable cost per unit
Contribution Margin
Fixed costs
Operating income
Unit contribution margin
Break-even point (units)
Margin of Safety
Case A:
Price = $17,500 / 350 = $50
Case B:
Revenue = $600 + (150 x $2) = $900
Unit C. M. = $50 – $20 = $30
Total C. M. = ($30) x (350) = $10,500
Op. Inc. = $10,500 – $3,750 = -$6,750
B. E. point = $3,750 / $30= 125
Margin Safety = 350 – 125 = 225
Fixed Costs = $200 + $600 = $800
Unit C. M. = $600 / 150 = $4
B. E. point = $800 / $4 = 200
Margin Safety = 150 – 200 = -50
Case C:
Unit Sales = 2,500 + 1,000 = 3,500
Unit CM = Fixed Cost/breakeven point
Unit CM = 30,000/2,500 = 12
Price = $12 + $7 = $19
Revenue = ($19) x (3,500) = $66,500
C. M. = $66,500 – (3,500 x $7) = $42,000
Op. Inc. = $42,000 – $30,000 = $12,000
Price = ($42,000 / 3,500) + ($7) = $19
Case D:
Unit Sales = 5,000 + 7,500 = 15,000
Fixed Costs = (7,500) x ($2) = $15,000
Price = $45,000 / 15,000 = $3
V. C. per unit = $3 – $2 = $1
C. M. = ($2) x (15,000) = $30,000
Op. Inc. = $30,000 - $15,000 = $15,000
Case E:
Unit Sales = $10,000 / $2 = 5,000 units
Price = $25,000 / 5,000 = $5
V. C. per unit = $5 – $2 = $3
B. E. point = 5,000 – 1,400 = 3,600
Fixed Costs = (3,600) x ($2) = $ 7,200
Op. Inc. = $10,000– $7,200 = $2,800
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Topic: Cost Estimation and Cost-Volume-Profit Analysis
LO: 3
4. Presented below are condensed data from the 2020 and 2021 Alexis Hardware Corporation’s income
statements (in millions):
Revenues
Operating Expenses
Operating Income
2020
$15,060
9,660
$5,400
2021
$12,260
8,120
$4,140
Required: Analyze Alexis Harware’s cost-volume-profit relationships by applying the high-low method
of cost estimation to the above information and complete the following:
a.
b.
c.
d.
e.
f.
Estimate the variable cost ratio.
Estimate annual fixed costs.
Compute the contribution margin ratio.
Compute the annual break-even point in dollars.
Applying these calculations, predict Alexis Hardware’s operating income if 2021 revenues are
predicted as $15,000 million.
What factors make the above analysis appropriateness for Alexis Hardware?
What
circumstances would make it inappropriate for Alexis Hardware?
Answer:
a. The variable cost ratio is the difference in total costs ($9,660 - $8,120) divided by the difference in
revenues ($15,060 - $12,260). This equals ($1,540 / $2,800) = 55%
b. The estimated annual fixed cost: $9,660 - (0.55 x $15,060) = $1,377 million
c.
The contribution margin ratio: 1 - 0.55 = 0.45 = 45%
d. Break-even point: $1,377 / 0.45 = $3,060 million
e. Contribution margin $15,000 x (1.00 – 0.055) = $6,750
Fixed costs =
- 1,377
Operating income =
$ 5,373 million
f.
Assuming stable prices, costs, and technology, the analysis is appropriate for Alexis Hardware. If
there were changes in prices, costs, or technology, the analysis might not be appropriate.
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Topic: Contribution Income Statements and CVP Analysis
LO: 2, 3
5. The Computer Supply manufactures memory cards that sell to wholesalers for $2.00 each. Variable
and fixed costs are as follows:
Variable Costs per card:
Manufacturing
Direct materials
Direct labor
Factory overhead
Selling and admin.
Total
$0.30
0.25
0.25
$0.80
0.15
$0.95
Fixed Costs per Month:
Factory overhead
Selling and admin.
Total
$7,000
3,000
$10,000
Computer Supply produced and sold 10,000 cards during October 2021. There were no beginning or
ending inventories.
Required:
a. Prepare a contribution income statement for the month of October.
b. Determine Computer Supply’s monthly break-even point in units.
c. Determine the effect on monthly profit of a 1,000 unit increase in monthly sales.
d. If Computer Supply is subject to an income tax of 40 percent, determine the dollar sales volume
required to earn a monthly after-tax profit of $15,000.
Answer:
a.
COMPUTER SUPPLY COMPANY
Contribution Income Statement
For the Month Ending October 31, 2021
Sales ($2 x 10,000)
Less variable costs:
Direct materials ($0.30 x 10,000)
Direct labor ($0.25 x 10,000)
Variable factory overhead ($0.25 x 10,000)
Variable S & A exp. ($0.15 x 10,000)
Contribution margin
Less fixed costs:
Factory overhead
Selling and administrative
Profit
b. Unit selling price
Less unit variable costs
Unit contribution margin
$20,000
$3,000
2,500
2,500
1,500
$7,000
3,000
-$9,500
$10,500
- 10,000
$500
$2.00
- 0.95
$1.05
Break-even point = $10,000 / $1.05 = 9,524 units
c.
Increase in unit sales
Unit contribution margin
Increase in monthly profits
1,000
x $1.05
$1,050
d. Desired before-tax profit = $15,000 / (1 - 0.40) = $25,000
Contribution margin percentage = $1.05 / $2.00= 52.5 percent
Required sales volume = ($10,000 + $25,000) / 0.525 = $66,667 (rounded)
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Topic: Contribution Margin
LO: 2
6. The Friday Company had the following functional income statement for the month of January 2021:
Sales ($10 x 40,000 units)
Cost of goods sold:
Direct materials
Direct labor
Variable factory overhead
Fixed factory overhead
Gross profit
Selling and administrative expenses:
Variable
Fixed
Net income
$400,000
$100,000
40,000
120,000
26,000
$ 24,000
24,000
- 286,000
$114,000
- 48,000
$ 66,000
There were no beginning and ending inventories.
Required:
a. Prepare a contribution income statement.
b. Calculate the contribution margin per unit.
c. Calculate the contribution margin ratio.
Answer:
a.
FRIDAY COMPANY
Contribution Income Statement
For the Month Ending January 31, 2021
Sales
Less variable costs:
Direct materials
Direct labor
Variable factory overhead
Variable S & A expenses
Contribution margin
Less fixed costs:
Factory overhead
Fixed S & A expenses
$400,000
$100,000
40,000
120,000
_24,000
$ 26,000
24,000
Net income
-284,000
$116,000
- 50,000
$ 66,000
b. $116,000 / 40,000 units = $2.90 per unit
c.
$116,000 / $400,000 = 29 percent
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Essay Questions
Topic: Cost-Volume-Profit Analysis Model
LO: 1
1. Briefly describe the cost-volume-profit analysis model and discuss how it can be used.
Answer:
Cost-volume-profit analysis is a technique used to examine the relationships among the total volume
of some cost driver (usually volume), total costs, total revenues, and consequently, profits during a
defined period of time (typically a month, a quarter or a year).
Cost-Volume-Profit analysis is widely used in service, manufacturing, merchandising, and even nonprofit organizations. Cost-Volume-Profit analysis is most useful in the early stages of planning because
it provides an easily understood framework for discussing planning issues and organizing relevant
data. The analysis is used to address a variety of issues. These include (1) determining a breakeven
point in sales units or sales dollars; (2), determining the amount of sales (units or dollars) necessary
to earn a target profit; (3) determining sensitivity of profit to changes in price or costs.
Topic: Assumptions of Cost-Volume-Profit Analysis
LO: 1
2. Cost-volume-profit analysis is subject to a number of assumptions. List five assumptions necessary
to make cost-volume-profit analysis tractable (feasible).
Answer:
The text discusses five assumptions that facilitate cost-volume-profit. These assumptions are:
1. All costs are classified as either fixed or variable (with respect to the cost driver analyzed).
2. The variable cost function, and consequently, the total cost function are linear within the range
relevant to analysis.
3. The total revenue function is linear within the range relevant to analysis.
4. The analysis is either for a single product (or service) or multiple products with a known constant
sales mix.
5. The analysis considers only one cost driver (most commonly sales volume).
Topic: Contribution versus Functional Income Statement
LO: 2
3. Briefly compare and contrast a contribution income statement with a functional income statement.
Answer:
In a contribution income statement, costs are classified according to behavior as variable or fixed, and
the contribution margin (the difference between total revenues and total variable costs) that goes
toward covering fixed costs and providing a profit is emphasized. In a functional income statement,
costs are classified according to function (rather than behavior), such as manufacturing, selling, and
administrative. This is the type of income statement typically included in corporate annual reports.
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Topic: Contribution Margin
LO: 2
4. Briefly explain the terms (1) contribution margin and (2) contribution margin ratio and why they are
useful (two to three sentences each).
Answer:
(1) Contribution margin is defined as the difference between total revenues and total variable costs.
Unit contribution margin is defined as the difference between the unit selling price and the unit
variable costs. In either case, contribution margin identifies the portion of revenues or selling price
that goes toward covering fixed costs and providing a profit. Contribution margin is widely used in
sensitivity analysis, which is the study of the responsiveness of a model to changes in one or more
of its independent variables.
(2) When expressed as a ratio to sales, the contribution margin is identified as the contribution margin
ratio. It is the portion of each dollar of sales revenue contributed toward covering fixed costs and
earning a profit. The contribution margin ratio is especially useful in situations involving several
products or when unit sales information is not available.
Topic: Limitations Of CVP Analysis and Sales Mix
LO: 4
5. Briefly explain the limitation of basic cost-volume-profit analysis as it relates to an organization’s sales
mix.
Answer:
Sales mix refers to the relative portion of unit or dollar sales derived from each product or service. One
of the limiting assumptions of the basic cost-volume-profit model is that the analysis is for a single
product or the sales mix is constant. When the sales mix is constant, managers of multiple- product
organizations can use the average unit contribution margin, or the average contribution margin ratio,
to determine the break-even point or sales volume required for a desired profit. Often, however,
management is interested in the effect of a change in the sales mix rather than a change in sales
volume at a constant mix.
Topic: Sales Mix Analysis
LO: 4
6. Explain the importance of sales mix analysis in a multiple-product organization.
Answer:
Sales mix analysis is important in multiple-product or service organizations. Management is just as
concerned with the mix of products as with the total unit or dollar sales volume. A shift in the sales
mix can have a significant impact on the bottom line. Profits may decline, even when sales increase,
if the mix shifts toward products or services with lower unit margins. Conversely, profits may increase,
even when sales decline, if the mix shifts toward products or services with higher unit margins. Other
things being equal, managers of for-profit organizations strive to increase sales of high-margin
products or services.
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Topic: Absorption/Variable Costing
LO: 6
15. Inventory values calculated using variable costing as opposed to absorption costing will generally be
higher.
Answer: False
Rationale: Inventory values are generally lower under variable costing because they do not include
any fixed overhead costs.
Topic: Variable Costing
LO: 6
16. Under variable costing, fixed manufacturing costs are classified a period expense.
Answer: True
Rationale: Variable costing treats all fixed costs a period expense.
Topic: Advantage of Variable Costing
LO: 6
17. The ability to present an income statement in a contribution format is one of the primary advantages
of the absorption costing approach.
Answer: False
Rationale: The variable costing approach classifies cost by cost behavior making it possible to prepare
a contribution income statement. The absorption approach combines variable and fixed costs for cost
of goods sold, making it impossible to prepare a contribution income statement.
Topic: Absorption/Variable Income Differences
LO: 6
18. When production is less than sales volume, net income under absorption costing will be greater than
net income using variable costing procedures.
Answer: False
Rationale: When production is less than sales volume, inventories are falling, and absorption costing
will have higher expense for cost of goods sold and lower net income than variable costing.
Topic: Fixed Costs as Expense
LO: 6
19. Variable assumes fixed overhead costs only expire when product is sold.
Answer: False
Rationale: Variable costing assumes fixed overhead costs expire in the period they are incurred.
Topic: Opponents of Variable Costing
LO: 6
20. Opponents of variable costing argue that in the long run all costs are variable.
Answer: True
Rationale: Opponents of variable costing argue that both variable and fixed manufacturing costs
should be included in the cost of the product, because in the long run they are all variable.
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Multiple Choice
Topic: Inventory Cost
LO: 1, 2
1. Which of the following inventories results in recording an expense when its asset account is reduced
in the accounting system?
A) Raw materials
B) Work in process
C) Finished goods inventory
D) Both A and B
Answer: C
Rationale: When inventories are sold from finished goods, the account Finished Goods Inventory is
reduced and Cost of Goods Sold Expense is recorded.
Topic: Work-in-Process Inventory
LO: 1
2. Partially completed goods that are in the process of being converted into a finish product are defined
as:
A) Work-in-process inventories
B) Conversion inventories
C) Raw materials inventories
D) Operational inventories
Answer: A
Rationale: Goods in process that have not been completed are referred to as work-in-process
inventories.
Topic: Product Costs in Financial Reporting
LO: 2
3. Which of the following views of product costs is consistent with financial reporting requirements?
A) Product costs are all costs incurred in the process of manufacturing products, even if they are
only indirectly related to the production process.
B) Product costs are all labor and materials costs that are incurred in the process of manufacturing
products.
C) Product costs are all costs directly incurred in the manufacturing and selling of the product.
D) Product costs include all costs incurred throughout the value chain.
Answer: A
Rationale: Product costs in the financial statements include all cost related to the manufacturing
function, including both direct and indirect manufacturing costs. Non-manufacturing costs are
considered to be period costs.
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Topic: Period Costs
LO: 2
4. Which of the following statements most accurately describes financial accounting’s view of period
costs?
A) Period costs are all costs incurred in the current financial reporting period.
B) Period costs are all direct costs incurred in the current financial reporting period.
C) Period costs are all non-manufacturing expenses incurred in the current financial reporting period.
D) Period costs are a component of fully absorbed costs.
Answer: C
Rationale: All non-manufacturing costs that expire during the accounting period are recorded as an
expense of the period, not as an increase in the cost of a product.
Topic: Manufacturing Depreciation
LO: 2
5. How is depreciation on the manufacturing building and equipment classified in financial reporting?
A) As an irrelevant cost because it has already been incurred
B) As a current expense
C) As part of the cost of the products produced
D) As a period cost
Answer: C
Rationale: Depreciation on manufacturing assets is recorded as a product cost as part of
manufacturing overhead.
Topic: Manufacturing Expense
LO: 2
6. When is the cost of manufacturing equipment recognized as an expense?
A) When equipment depreciation is recorded
B) When inventory processing is completed and finished goods are recorded
C) When finished goods inventory is sold
D) None of the above
Answer: C
Rationale: Depreciation on manufacturing equipment is a product cost that is recognized as an
expense as part of cost of goods sold only when the product produced by the equipment is sold
Topic: Product Costs
LO: 2
7. Which of the following costs are treated as part of the cost of product?
A) Wages of plant security guards
B) Insurance on the plant building and equipment
C) Depreciation on the kitchen sink in the plant cafeteria
D) All of the above are product costs
Answer: D
Rationale: All expired costs associated with the manufacturing function are treated as product costs.
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Topic: Product Costs
LO: 2
8. Which of the following is not a period cost?
A) The president’s salary
B) Sales commissions
C) Depreciation on the mainframe computer in the Information Systems Department
D) Subsidy of the plant cafeteria
Answer: D
Rationale: Items A through C are not related to the manufacturing function; therefore, they are not a
product cost. The cafeteria in the plant is related to the manufacturing function, so the subsidy of the
cafeteria is a product cost.
Topic: Absorption Costing
LO: 2
9. The method of accounting for inventory that assigns all manufacturing costs to inventory is
sometimes referred to as:
A) Prime costing
B) FIFO
C) The weighted average cost method
D) Absorption costing
Answer: D
Rationale: Absorption costing is defined as the method of cost accounting by which all manufacturingrelated costs are assigned to inventory.
Topic: Components of Product Cost
LO: 2
10. Which of the following is one of the three major components of product costs?
A) Research and development expenses
B) Manufacturing overhead
C) Marketing costs related to specific products
D) Selling, general and administrative expenses
Answer: B
Rationale: The three major components of product cost are direct materials, direct labor, and
manufacturing overhead.
Topic: Predetermined Overhead Rates
LO: 2
11. What is the purpose for using predetermined overhead rates?
A) Delays in product costing can be avoided
B) Variation in cost assignment due to seasonality can be prevented
C) Variation in cost assignment due to short-term variations in volume can be prevented
D) Use of predetermined overhead rates serves all the above purposes
Answer: D
Rationale: As stated in the text, predetermined overhead rates serve to (a) enable accountants to
determine costs earlier than if using actual costs, (b) prevent variations in costs due to the uneven
occurrence of cost throughout the year, and (c) prevent short-term variations in unit cost due to volume
variations.
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Topic: Direct Materials
LO: 2
12. Which of the following is the most reasonable cost driver for direct material costs?
A) The quantity of direct materials used
B) Purchasing department activity
C) Direct labor hours
D) Square footage of the warehouse used to store raw materials
Answer: A
Rationale: A cost driver is the thing that causes cost to be incurred. For direct materials, the cost
driver is quantity of materials used.
Topic: Process Costing
LO: 3
13. A single product produced by a continuous manufacturing process is an example of:
A) Process management
B) Job Costing
C) Process manufacturing
D) Process reengineering
Answer: C
Rationale: Process manufacturing is the method of costing typically used when a company produces
one or more products in continuous processes.
Topic: Job Costing
LO: 4
14. When a job is completed in a job order costing system, the final cost of the job is determined by
summing up:
A) The work-in-process inventory subsidiary ledgers
B) The statement of costs of goods manufactured
C) The finished goods activities report
D) The various costs on the job cost sheet
Answer: D
Rationale: A job cost sheet is used in a job costing system to accumulate all of the costs incurred to
complete the job.
Topic: Job Order Production
LO: 3
15. Which of the following is an appropriate setting for job order production?
A) Products are produced in batches of identical units.
B) Products are produced in single units.
C) Neither A nor B are examples of job order production.
D) Both A and B are examples of job order production.
Answer: D
Rationale: Job costing can be used when either a unique unit of product (a house) is produced or
when a batch of identical units (a batch of shoes) is produced.
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Topic: Job Order Records
LO: 3, 5
16. Which of the following is not a record required for operating a job cost system?
A) Production orders
B) Job cost sheets
C) Equivalent units calculations
D) Materials requisition forms
Answer: C
Rationale: Job costs may be calculated without calculating equivalent units if process costing is not
used.
Topic: Job Order Costing
LO: 3
17. For which of the following products would job order costing be least likely to be used?
A) Residential building
B) Textbook printing
C) Mortgage loan processing
D) Newsprint paper Manufacturing
Answer: D
Rationale: A newsprint manufacturing facility produces continuous rolls of paper for newspapers and
uses process costing; whereas the cost of residential dwellings, textbooks, and mortgages tend are
more likely to be accounted for using a job order cost system.
Topic: Process Costing
LO: 3
18. For which of the following manufactured products would job costing be more appropriate than
process costing?
A) Baseball hats
B) Designer dresses sold to celebrities
C) Chemicals
D) Liquid soap
Answer: B
Rationale: Designer dresses are more likely to use a job cost system because they are by nature oneof-a-kind; whereas baseball hats, chemicals, and soap are more likely to be produced in a continuous
process.
Topic: Job Costing
LO: 2, 4, 5
19. Which of the following tasks does not pertain to job-costing?
A) Computing equivalent units
B) Computing predetermined overhead rates
C) Computing cost of goods sold
D) Computing ending work-in-process inventory
Answer: A
Rationale: Equivalent units calculation is a characteristic of process costing, not job costing.
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Topic: Statement of Cost of Goods Manufactured
LO: 4
20. The purpose of the statement of cost of goods manufactured is to:
A) Calculate the cost of goods transferred to finished goods inventory during the period.
B) Calculate cost of goods sold.
C) Calculate net income.
D) Both A and B
Answer: A.
Rationale: The statement of cost of goods manufactured is used by a manufacturing company to
calculate the cost of goods completed and transferred to finished goods inventory during the period.
Topic: Work-in-Process Inventory
LO: 4
21. Which of the following results in an increase in work-in-process inventory?
A) Purchasing raw materials
B) Using direct manufacturing labor hours
C) Finishing a job in process
D) Selling finished goods inventory
Answer: B
Rationale: The use of direct labor hours during the period is recorded as an increase in the balance
the Work-in-Process Inventory account. Direct materials used and factory overhead applied also
increase the account.
Topic: Sale of Finished Goods
LO: 4
22. When finished goods are sold, there is an increase in which of the following accounts?
A) Cost of Goods Sold
B) Cost of Goods Manufactured
C) Finished Goods Inventory
D) Work-in-Process
Answer: A
Rationale: The sale of finished goods is recorded as an increase in the Cost of Goods Sold account
balance and a decrease in the Finished Inventory Account balance.
Topic: Change in Raw Materials
LO: 4
23. Which of the following accounts increases when raw materials are used?
A) Finished Goods Inventory
B) Raw Materials Expense
C) Raw Materials Inventory
D) Work-in-Process Inventory
Answer: D
Rationale: Using raw materials is recorded as a decrease in Raw Materials Inventory and an increase
in Work-in-Process Inventory.
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Topic: Calculating Raw Materials Used
LO: 4
24. Paris Corp. obtained the following information from the Raw Materials Inventory account and
purchasing records for the second quarter of the current year:
Beginning Raw Materials
Ending Raw Materials
April Purchases
May Purchases
June Purchases
$5,000
$3,000
$4,000
$2,000
$2,000
The amount of Raw Materials used this period was:
A) $15,000
B) $10,000
C) $17,000
D) Some other amount
Answer: B
Rationale: Beginning Raw Materials ($5,000) + Purchases for the quarter ($4,000 + $2,000 + $2,000)
= Raw Materials Available ($13,000) – Ending Raw Materials ($3,000)
= Raw Materials Used ($10,000)
Topic: Period Costs Calculation
LO: 2
25. Gleeson Corp. obtained the following information from its absorption costing accounting records:
Operating Income
Total Product Costs incurred during the period
Value of Beginning Work-in-Process and Finished Goods Inventories
Value of Ending Work-in-Process and Finished Goods Inventories
Sales
$24,000
$16,000
$0
$0
$50,000
The total Period Costs incurred this period equals:
A) $15,000
B) $20,000
C) $48,000
D) $10,000
Answer: D
Rationale: Because there were no beginning or ending Work-in-Process
or Finished Goods
Inventories, the total product costs of $16,000 also equals total cost of goods sold.
Sales ($50,000) – Cost of Goods Sold ($16,000) – Operating Income ($24,000)
= Period Costs ($10,000)
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Topic: Cost of Goods Manufactured Calculation
LO: 4
26. Fieldman Corp. obtained the following information from its accounting records:
Sales
Beginning Finished Goods Inventory
Ending Finished Goods Inventory
Cost of Goods Sold
$19,000
$12,000
$8,000
$9,000
The Cost of Goods Manufactured this period equals:
A) $11,000
B) $10,000
C) $6,000
D) $5,000
Answer: D
Rationale: Ending Finished Goods Inventory ($8,000) + Cost of Goods Sold ($9,000) – Beginning
Finished Goods Inventory ($12,000) = Cost of Goods Manufactured ($5,000).
Topic: Weighted Average Method
LO: 5
27. When computing equivalent units of production, the method that averages the cost of partially
completed units in beginning inventory with current period production is the:
A) FIFO method
B) LIFO average method
C) Specific identification method
D) Weighted average method
Answer: D
Rationale: The weighted average method does not recognize any differences in costs for units
partially produced in one period and completed in another period.
Topic: Components of Work-in-Process
LO: 5
28. Which of the following is not included in work-in-process inventory?
A) Direct materials costs
B) Applied manufacturing overhead
C) Direct manufacturing labor costs
D) Sales commissions
Answer: D
Rationale: Direct materials, direct labor, and applied manufacturing overhead are all product costs that
are part of work-in-process. However, sales commissions cost is a period cost that is expensed in the
period incurred.
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Topic: Cost per Equivalent Unit
LO: 5
29. The cost per equivalent unit for materials using the weighted average method is calculated as:
A) Total materials costs in process during the period divided by equivalent units in process for
materials
B) Materials costs added during the period divided by equivalent units in process for materials
C) Total materials costs to account for divided by the number of equivalent units completed for
materials
D) Materials costs added during the period divided by the number of equivalent units completed for
materials
Answer: A
Rationale: Under the weighted average method the cost per equivalent unit for Direct Materials is
calculated as Direct Materials Cost in Process (i.e., Direct Materials Cost in beginning inventory plus
Direct Materials Cost added during the period) divided by the equivalent units of direct materials in
process during the period.
Topic: Calculation of Equivalent Units
LO: 5
30. The following information pertains to the Don Company:
Work-in-process, April 1 (35 percent complete)
Started in June
Work-in-process, April 30
Units
4,500
20,000
6,000
Materials are added at the beginning of the process. If equivalent units in process for conversion
using the weighted average method were 20,000, ending work-in-process at Apri 30:
A)
B)
C)
D)
Was 15.0 percent complete
Was 31.7 percent complete
Was 25.0 percent complete
Was 32.5 percent complete
Answer: C
Rationale: Units in Process were 4,500 + 20,000 = 24,500, and units in ending inventory were 6,000
units; therefore, 18,500 (or 24,500 – 6,000) units were completed and transferred to finished goods.
Consequently, if the equivalent units in process were 20,000 and 18,500 were entirely completed
during the period, the difference of 1,500 represents the equivalent value of the 6,000 units in ending
inventory. 1,500 divided by 6,000 units equals 25% completed.
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Topic: Costing for Services
LO: 5
31. Which of the following statements is not true regarding costing for services?
A) Generally, the use of process costing techniques for service organizations is easier than it is for
manufacturing organizations because services generally cannot be inventoried.
B) Process costing for services is similar to job costing for batches in that an average cost for
similar or identical services performed during a given time period.
C) The difficulty in many service situations is defining the appropriate cost objective.
D) In process costing, the amount of goods completed always increases finished goods inventory.
Answer: D
Rationale: Since services completed cannot be held in inventory from one period to the next, the cost
of services completed during the period is always accompanied by an increase in Cost of Goods
(Services) Sold, not an increase in Finished Goods Inventory.
Topic: Equivalent Units
LO: 5
32. The number of fully completed units that equates with a given number of partially completed units is
referred to as the:
A) Number of units in ending finished goods inventory
B) Equivalent completed units
C) The number of units sold this period
D) The number of units in ending Work-in-Process inventory
Answer: B
Rationale: Process costing calculates costs based on equivalent units of completed production, which
is the number of finished units this is equivalent to a given number of partially completed units. For
example, two units 50% completed are equivalent to 1 equivalent completed unit.
Topic: Weighted Average Equivalent Units
LO: 5
33. Using the weighted average method, whenever units in process are produced to a different
percentage of completion for materials and labor, this creates a condition where:
A) The number of equivalent units in process will invariably be different for materials and conversion
costs.
B) The cost per equivalent unit for materials and conversion will be equal.
C) It is inappropriate to use the process costing method.
D) None of the above
Answer: A
Rationale: Anytime the percentage of completed is different for materials and conversion costs for the
units in process during the period, the equivalent completed units will be different for these two cost
components. Often all materials costs are added at the beginning of the process, but conversion costs
(labor and overhead) are added throughout the process, so it is common for the number of equivalent
units for materials cost to be larger than the equivalent units for conversion costs.
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Topic: Process Service Costing
LO: 5
34. Process service costing measures the average cost of:
A) All services performed by the company in a given period
B) Identical or similar services performed by the company in a given period
C) Activities for activity based costing overhead rates
D) Services received from the company’s vendors
Answer: B
Rationale: In process costing, costs are averaged for a given period, as opposed to being calculated
for a given job or batch. Therefore, in costing services using process costing (such as a bank
calculating the cost of processing deposits or checks), the average cost per unit is calculated for all
such services performed during the period (week, month, etc.)
Topic: Process Costing Environment
LO: 5
35. For which of the following manufactured products would process costing be more appropriate?
A) Modular homes
B) Luxury liners
C) Nylon fiber production
D) Special order printing
Answer: C
Rationale: Of the products listed, the only one likely to be produced in a continuous process is nylon
fiber production. The others are likely to use job costing.
Topic: Process Costing Environment
LO: 5
36. For which of the following manufactured products would process costing be more appropriate?
A) Bridge construction
B) Crude oil refining
C) Custom-made jewelry
D) High rise buildings
Answer: B
Rationale: Of the products listed, only crude oil refining is likely to be produced using a continuous
processing method. The others are likely to use job costing.
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Topic: Equivalent Units Calculation
LO: 5
37. The following information is available:
Units in process, Dec. 1 (60 percent converted)
Units in process, Dec. 31 (30 percent converted)
Units started during the month
2,000 units
1,000 units
7,500 units
Materials are added at the beginning of the process.
How many equivalent units in process for conversion were there in December using the weighted
average method?
A) 18,000
B) 15,200
C) 17,600
D) 8,800
Answer: D
Rationale: During the period there were 9,500 actual units in process (2,000 beginning plus 7,500
started) at some stage of completion and there were 1,000 units in ending inventory; therefore, 8,500
of the 9,500 units were completed during the period. The 1,000 ending units were 30% complete,
representing 300 equivalent units in process, so the total equivalent units in process for conversion
were 8,500 units completed plus 300 equivalent ending units, for a total of 8,800 equivalent units in
process.
Topic: Weighted Average Process Costing
LO: 5
38. Which of the following statements is true about the weighted average process costing method?
A) If all raw materials are added to production at the beginning of the process, the number of
equivalent units in process will equal the total number of individual units worked on during the
period.
B) The cost of the units in beginning work-in-process is accounted for separately from the units
started in the current period.
C) The method is applicable to any situation where the cost of a specific job is needed.
D) All the above statements are true.
Answer: A
Rationale: If all raw materials costs are incurred at the beginning of the process, all units in process
are 100% completed with regard to raw materials costs.
Topic: Absorption Costing
LO: 6
39. Which of the following types of costs are classified as period costs under absorption costing, but not
under variable costing?
A) All non-manufacturing costs
B) Only fixed non-manufacturing costs
C) The cost of purchasing long-lived assets for use in manufacturing
D) None of the above
Answer: D
Rationale: There are no costs that are treated as period costs under absorption costing but not under
variable costing. However, fixed overhead costs are treated as period costs under variable costing but
not under absorption costing.
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Topic: Absorption Costing Cost Components
LO: 6
40. All of the following costs are included in inventory under absorption costing except:
A) Direct materials
B) Direct labor
C) Fixed manufacturing expenses
D) Variable selling expenses
Answer: D
Rationale: Under absorption costing, all non-manufacturing expenses are treated as period costs and
are not assigned to inventory.
Topic: Variable Costing Cost Components
LO: 6
41. Under variable costing, which of the following costs are assigned to inventory?
A) Fixed manufacturing costs
B) Variable non-manufacturing costs
C) Variable manufacturing costs
D) None of the above
Answer: C
Rationale: Variable costing inventory does not include any costs that are not related to manufacturing
or any fixed manufacturing costs.
Topic: Non-manufacturing Period Costs
LO: 6
42. Which of the following inventory valuation approaches treats nonmanufacturing costs as period
costs?
A) Absorption
B) Variable
C) Both absorption and variable
D) None of the above
Answer: C
Rationale: Non-manufacturing costs are never treated as product costs of inventory.
Topic: Fixed Factory Overhead
LO: 6
43. Fixed manufacturing overhead is recorded initially as an asset (inventory) under
costing but as an operating expense under
costing.
A) Absorption; indirect
B) Variable; absorption
C) Absorption; variable
D) Variable; direct
Answer: C
Rationale: Fixed overhead is a product cost and is initially recorded as part of the asset Work-inProcess Inventory under absorption costing, but it is a period expense under variable costing.
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Topic: Changing Sales Volume Constant Production
LO: 6
44. When monthly production volume is constant and sales volume is less than production, net income
determined with variable costing procedures will:
A) Always be greater than net income determined using absorption costing
B) Always be less than net income determined using absorption costing
C) Be equal to net income determined using absorption costing
D) Be equal to contribution margin per unit times units sold
Answer: B
Rationale: When more units are produced than sold, variable costing expenses more fixed cost than
absorption costing resulting in less income under variable costing.
Topic: Inventory Calculation Under Variable Costing
LO: 6
45. The following information pertains to Jennifer Corporation:
Beginning Inventory
Ending Inventory
Direct labor per unit
Direct materials per unit
Fixed overhead per unit
Fixed SG&A costs per unit
Variable overhead per unit
Variable SG&A costs per unit
1,000 units
10,000 units
$13
5
7
5
2
1
What is the value of the ending inventory using the variable costing method?
A) $150,000
B) $240,000
C) $200,000
D) $208,000
Answer: C
Rationale: 10,000 x ($13 + $5 + $2) = $200,000
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Topic: Inventory Calculation under Absorption Costing
LO: 6
46. The following information pertains to Alexander Corporation:
Beginning Inventory
Ending Inventory
Direct labor per unit
Direct materials per unit
Fixed overhead per unit
Fixed SG&A costs per unit
Variable overhead per unit
Variable SG&A costs per unit
1,000 units
10,000 units
$13
5
7
5
2
1
What is the value of the ending inventory using the absorption costing method?
A) $240,000
B) $270,000
C) $290,000
D) $343,000
Answer: B
Rationale: 10,000 x ($13 + $5 + $7 + $2) = $270,000
Topic: Absorption and Variable Costing Income Compared
LO: 6
47. Assuming sales prices and cost behavior remain unchanged, when variable costing is used, when
does net income change in response to changes in unit sales?
A) Only when number of units sold exceeds number of units produced
B) Only when number of units produced exceeds number of units sold
C) Only when number of units sold exactly equals number of units produced
D) Under all the above conditions
Answer: D
Rationale: Under variable costing, income always changes in response to sales, and never in
response to production.
Topic: Overproducing With Absorption Costing
LO: 6
48. Assuming sales prices and cost behavior remain unchanged, when absorption costing is used,
overproducing creates all of the following situations except?
A) A buildup of inventory levels
B) Higher net income
C) Less fixed costs on the income statement
D) Less variable cost on the balance sheet
Answer: D
Rationale: Overproducing when using absorption costing results in more variable and fixed cost in
inventory on the balance sheet.
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Topic: Predetermined Overhead Rate
LO: 2
49. K&N Jewelry Shop estimated overhead cost for the coming year will be $15,000 and 5,000 direct labor
hours will be worked. The amount of overhead cost applied by K&N Jewelry Shop to one of its jobs if
the jobs required 10 direct labors hours to complete, would be:
A) $150
B) $ 30
C) $ 50
D) $ 15
Answer: B
Rationale:
Predetermined overhead rate = $15,000 ÷ 5,000 direct labor hours = $3 per labor hour
Jobs overhead applied = $3 x 10 direct labor hours = $30
Topic: Statement of Cost of Goods Manufactured
LO: 4
50. Given is selected information from Lorri’s Service Shop’s June Income Statement and Statement of
Cost of Goods Manufactured:
Cost of goods sold
Cost of goods manufactured
Finished goods inventory, June 30
$115,000
$105,000
$ 20,000
Lorri’s Service Shop’s finished goods inventory, on June 1, was:
A) 40,000
B) 30,000
C) 35,000
D) 20,000
Answer: B
Rationale: Beginning Finished Goods = Ending Finished Goods + Cost of Goods sold - Cost of goods
manufactured
Beginning Finished Goods = $20,000 + $115,000 - $105,000 = $30,000
Topic: Process Costing
LO: 5
51. The beginning inventory consisted of 10,000 units, 30 percent complete and the ending inventory
consisted of 8,000 units, 40 percent complete. There were 22,000 units started during the period.
Determine the equivalent units of conversion in process
A) 27,200 units
B) 20,800 units
C) 25,200 units
D) 17,800 units
Answer: A
Rationale:
Completed Units = Beginning Inventory + Started – Ending Inventory = 10,000+ 22,000 – 8000
= 24,000 units.
Completed + Ending Inventory = 24,000 Units + (40%)(8,000) = 27,200 units
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Topic: Process Costing
LO: 5
52. Below is selected information from Kristi’s cost of production report:
Cost per equivalent unit in process
Units completed
Total costs in process
Equivalent units of materials in ending inventory
Cost per equivalent unit of materials
$
20
15,000
$333,000
2,000
$
6
The ending inventory of work-in-process is complete as to materials.
The cost of conversion in the ending inventory is:
A) $300,000
B) $333,000
C) $ 21,000
D) $ 12,000
Answer: C
Rationale:
Total cost to account for: $333,000
Cost of transferred out units ($20 X 15,000) = $300,000
Cost of Equivalent Units of material in Ending Inventory = $6 x 2,000 = $12,000
$333,000 - $300,000 - $12,000 = $21,000
Topic: Income Under Absorption and Variable Costing
LO: 6
53. Emma Speaker Company sells its product for $70 per unit. Variable manufacturing costs per unit are
$20, and fixed manufacturing costs at the normal operating level of 5,000 units are $35,000. Variable
expenses are $8 per unit sold. Fixed administration expenses total $40,000. Emma Speaker Company
had no beginning inventory in 2021. During 2021, the company produced 5,000 units and sold 2,000.
What would the net income be for Emma Speaker Company in 2021 using both variable costing and
absorption costing?
A) Variable costing $9,000; absorption costing $30,000
B) Variable costing $30,000; absorption costing $30,000
C) Variable costing $21,000; absorption costing $9,000
D) Variable costing $30,000; absorption costing $9,000
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Answer: A
Rationale:
Sales
Cost of goods sold
Variable expenses
Contribution margin
Fixed mfg. cost
Fixed admin. expense
Net income
Variable Income Stat ement
Units
Per unit cost
2,000
$70.00
20.00
8.00
Units produced
Units sold
Ending inventory
Total
$140,000
40,000
16,000
84,000
35,000
40,000
$ 9,000
5,000
2,000
3,000
Per unit Fixed mfg. cost = $35,000 / 5,000 units = $7 per unit
Absorption income would increase by = 3,000 units x $7 = $21,000
Therefore, Absorption Net Income = $9,000 + $21,000 = $30,000
Topic: Basic Production Cost Flow
LO: 2
54. The balance in the Work in Process Inventory account on April 1 was $26,800, and the balance on
April 30 was $22,600. Costs incurred during the month were as follows: direct materials, $41,250;
direct labor, $21,300; and overhead, $32,600.
What amount was transferred to the Finished Goods Inventory account for April?
A) $ 99,350
B) $ 4,200
C) $ 90,350
D) $121,950
Answer: A
Rationale:
Beginning Work-in-Process
Direct Material
Direct labor
Overhead
Less: Ending Work-in-Process
Transferred to Finished Goods
$26,800
41,250
21,300
32,600
95,150
(22,600)
$99,350
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Exercises
Topic: Types of Inventories in Various Organizations
LO: 1
1. Indicate which of the following inventories are typically found in service, merchandising, and
manufacturing organizations:

Supplies Inventories
Merchandise Inventories
Raw Materials Inventories
Work-in-Process Inventories
Finished Goods Inventories




Answer:
Service Organizations
Supplies Inventories
Merchandise Organizations
Supplies Inventories
Merchandise Inventories
Manufacturing Organizations
Supplies Inventories
Raw Materials Inventories
Work-in-Process Inventories
Finished Goods Inventories
Topic: Product and Period Costs
LO: 2
2. Indicate whether each of the following costs, incurred by a manufacturer, are period or product costs.
1.
2.
Vice president of manufacturing salary
Vice president for human Resources salary
3.
4.
Plant janitorial costs
Corporate jet operating expense
5.
6.
Depreciation on the sales office
Depreciation on the production equipment
7.
8.
Manufacturing overhead
Direct materials
9.
10.
Advertising expense
Entertainment costs of vice president of manufacturing
Answer:
1.
Vice president of manufacturing salary
Product cost
2.
3.
Vice president for human Resources salary
Plant janitorial costs
Period cost
Product cost
4.
5.
6.
7.
Corporate jet operating expense
Depreciation on the sales office
Depreciation on the production equipment
Manufacturing overhead
Period cost
Period cost
Product cost
Product cost
8.
9.
10.
Direct materials
Advertising expense
Entertainment costs of vice president of manufacturing
Product cost
Period cost
Product cost
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Topic: Calculation of Predetermined Overhead
LO: 2
3. Orcasa, Inc., which uses a predetermined overhead rate based on direct labor hours, estimated total
overhead for the year to be $12,000,000 and total direct labor hours to be 320,000 hours. Calculate
Orcasa’s predetermined overhead rate.
In April, Orcasa incurred actual overhead costs of $1,050,000 and used 30,000 hours. How much
was Orcasa’s over- or under-applied overhead for the month of April?
Answer:
Orcasa’s predetermined overhead rate is $12,000,000 / 320,000 = $37.50 per direct labor hour.
In April, Orcasa incurred actual overhead costs of $1,050,000 and applied $1,125,000 (30,000 ×
$37.50); therefore, Orcasa had $75,000 (or $1,125,000 – $1,050,000) of over-applied overhead for
the month of April.
Topic: Product versus Period Costs
LO: 2
4. Classify the following costs incurred in the manufacturing of cookie bars as either (a) Product CostDirect Materials, (b) Product Cost- Conversion, or (c) Period Cost.
a.
b.
Cost Incurred in Manufacturing of Cookies
Depreciation on Automated Wrapping Machine
Cookie Dough
c.
d.
Peanut Butter
Plant Manager’s Salary of $85,000
e.
f.
Overtime Pay of Production Workers
Cost of Air Time for New Radio Advertising
g.
h.
Salary of Plant Security Guard
Salary of Company Controller
i.
j.
Depreciation on Computers in Legal Staff Office
Manufacturing Department’s Allocation of Cafeteria Costs
Classification
Answer:
Cost Incurred in Manufacturing of Cookies
a. Depreciation on Automated Wrapping Machine
b. Cookie Dough
c. Peanut Butter
d. Plant Manager’s Salary of $85,000
e. Overtime Pay of Production Workers
f.
Cost of Air Time for New Radio Advertising
g. Salary of Plant Security Guard
h. Salary of Company Controller
i.
Depreciation on Computers in Legal Staff Office
j.
Classification
(b) Product Cost-Conversion
(a) Product Cost-Direct Materials
(a) Product Cost-Direct Materials
(b) Product Cost-Conversion
(b) Product Cost-Conversion
(c) Period Cost
(b) Product Cost-Conversion
(c) Period Cost
(c) Period Cost
Manufacturing Department’s Allocation of Cafeteria Costs
(b) Product Cost-Conversion
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Topic: Job Order versus Process Costing
LO: 4, 5
5. For each of the following independent manufacturing situations, indicate whether job-order or process
costing is more appropriate and why.
a. A manufacturer of customized vans
b. A shoe manufacturer
c.
A newsprint paper mill
d. A one-time order of 60,000 identical clips
e. A manufacturer of upscale men’s suits
f. A building contractor for $800,000 homes
g. A manufacturer of airplanes
h. A maker of commercial chemicals
i. A one-size-fits-all hosiery mill
j.
A manufacturer of yarn for the hosiery mill
Answer:
a. A manufacturer of customized vans
b. A shoe manufacturer
c. A newsprint paper mill
d. A one-time order of 60,000 identical clips
e.
f.
g.
h.
i.
j.
A manufacturer of upscale men’s suits
A building contractor for $800,000 homes
A manufacturer of airplanes
A maker of commercial chemicals
A one-size-fits-all hosiery mill
A manufacturer of yarn for the hosiery mill
Job Order – each is unique
Job Order – made in a batch for each size & style
Process – a continuous manufacturing process
Job Order – because made as a batch
Job Order – made in a batch for each size and style
Job Order – each house has its own cost and features
Job Order – each plane has its own cost and features
Process – a continuous manufacturing process
Process – if made on a continuous basis
Process – a continuous manufacturing process
Topic: Calculation of Total Period Costs
LO: 2
6. Golden Leaf Corp obtained the following information from its absorption costing accounting records:
Operating Income
Total Product Costs incurred during the period
Value of Beginning Work-in-Process and Finished Goods Inventories
Value of Ending Work-in-Process and Finished Goods Inventories
Sales
$1,000
$18,000
$0
$0
$30,000
Calculate the total Period Costs incurred this period.
Answer:
Since there were no beginning or ending inventories in work-in-process or finished goods, the total
product costs incurred during the period equals cost of goods sold for the period. The difference
between sales of $30,000 and operating income of $1,000 equals total product plus period costs of
the period of $29,000. With total costs of $29,000, total period costs equal $29,000 minus $18,000,
or $11,000.
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Topic: Cost of Goods Manufactured
LO: 4
7. SouthEast Corp. obtained the following information from its accounting records:
Sales
Beginning Finished Goods Inventory
Ending Finished Goods Inventory
Cost of Goods Sold
Ending Work-in-Process Inventory
$70,000
$10,000
$46,000
$22,000
$30,000
Calculate the Cost of Goods Manufactured for the period.
Answer:
Beginning Finished Goods Inventory
Plus Cost of Goods Manufactured
Goods available for sale
Less Ending Finished Goods Inventory
Cost of Goods Sold
$10,000
X
68,000
- 46,000
$22,000
X = $22,000 + $46,000 - $10,000 = $58,000 cost of goods manufactured
Topic: Raw Materials Used Calculation
LO: 4
8. Chicago Corp. obtained the following information from the Raw Materials Inventory account and
purchasing records for the first quarter of the current year:
Beginning Raw Materials
Ending Raw Materials
Jan. Purchases
Feb. Purchases
Mar. Purchases
$10,000
$12,000
$6,000
$4,000
$5,000
Calculate the amount of Raw Materials used for this quarter.
Answer:
Beginning Raw Materials Inventory
Purchases for this quarter
Raw materials available for sale
Ending Raw Materials Inventory
Raw materials used during the quarter
$10,000
15,000
25,000
- 12,000
$13,000
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Topic: Equivalent Units
LO: 5
9. Beginning inventory in April consisted of 10,000 units (60 percent converted) and ending inventory
consisted of 20,000 units (30 percent converted). In addition, 50,000 units were started during the
period.
How many equivalent units for conversion costs were in process in April using the weighted average
method?
Answer:
 If 10,000 units were in beginning inventory and 50,000 units were started, 60,000 units were
worked on during the period.
 Therefore, if 20,000 units were in ending inventory, there had to be 40,000 units completed.
 Ending inventory of 20,000 units @ 30% completed represented 6,000 equivalent units in process
plus the 40,000 units completed equals 46,000 total equivalent units in process during the period.
Topic: Units Completed Calculation
LO: 5
10. Viking Company had the following data for the current fiscal period:
Units in process at the beginning of the month
Units in process at the end of the month
Units started during the month
6,000
4,000
20,000
Materials are added at the beginning of the process. Beginning work-in-process was 40 percent
complete as to conversion. Ending work-in-process was 70 percent complete as to conversion.
Calculate the number of units completed and transferred out during the period?
Answer:
Units in process at the beginning of the month
Units started during the month
Total units in process during the month
Units in process at the end of the month
Units completed and transferred out during the month
6,000
20,000
26,000
- 4,000
22,000
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Topic: Cost per Equivalent Unit Calculation
LO: 5
11. The following information is available for Rhymes, Inc. for the month of January:
Work-in-process, January 1 (70% complete)
Direct materials
Direct labor
Manufacturing overhead
Work-in-process, January 1
Started in production during January
Units
5,000
Cost
$12,000
6,000
15,000
$33,000
25,000
Cost Added:
Direct materials
Direct labor
Manufacturing overhead
Total costs added during January
Work-in-process, January 31 (80% complete)
$36,000
7,800
15,600
$59,400
2,000
Materials are added at the beginning of the process.
Calculate the cost per equivalent unit in process for conversion using the weighted average method.
Answer:
Equivalent units in process for conversion equals 29,600 units completed (5,000 + 25,000 – 2,000)
plus the equivalent units in ending inventory of 1,600 units (or 2,000 x 80%) equals 29,600 units.
Total conversion cost in process equals conversion cost in beginning inventory of $21,000 (or $6,000
+ $15,000) plus conversion cost added of $23,400 (or $7,800 + 15,600) for a total of $44,400. Total
conversion cost in process of $44,400 divided by equivalent units in process for conversion of 29,600
equals $1.50 cost per equivalent unit in process for conversion.
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Topic: Current Costs in Work-in-Process
LO: 4, 5
12. The Dave Company has the following information for December of this year:
Raw materials purchases
Raw materials used
Direct labor
Actual manufacturing overhead
Cost of goods completed
$30,000
27,000
20,000
28,000
60,000
Overhead rate is 150 percent of direct labor costs. The Dave Company uses a process costing
system.
Calculate the total amount of cost added to Work-in-Process Inventory for December.
Answer:
Raw materials used
Direct labor
Manufacturing overhead applied (20,000 x 150%)
Total cost added to Work-in-Process
$27,000
20,000
30,000
$77,000
Topic: Cost of Completed Goods Calculation
LO: 4
13. The Dave Company has the following information December of this year:
Raw materials purchases
Raw materials used
Direct labor
Actual manufacturing overhead
Work-in-Process, beginning
Work-in-Process, ending
$30,000
27,000
20,000
28,000
30,000
29,500
The overhead rate is 150 percent of direct labor costs. The Dave Company uses a job costing
system.
Prepare the journal entry to record the cost of goods completed and transferred to Finished Goods
Inventory.
Answer:
Raw materials used
Direct labor
Manufacturing overhead applied (20,000 × 150%)
Total cost added to Work-in-Process
Work-in-Process Inventory, beginning
Total cost in process
Work-in-Process Inventory, ending
Cost of completed
$ 27,000
20,000
30,000
77,000
30,000
107,000
- 29,500
$ 77,500
Journal Entry:
Finished Goods Inventory
Work-in-Process Inventory
To record cost of inventory completed and transferred to Finished Goods.
77,500
77,500
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Topic: Equivalent Units in Process Calculation
LO: 5
14. Idaho Company manufactures a product through a process where all manufacturing costs are added
uniformly. Information for October beginning work-in-process follows.
Units (35 percent complete)
Direct materials
Direct labor
Overhead
Costs incurred during October:
10,000
$6,000
$7,000
$5,000
Direct materials
Direct labor
Overhead (applied)
$25,000
60,000
15,125
During October, 50,000 units were completed. Also, 5,000 units that were 50 percent complete
remained in process at the end of the day on October 31.
Calculate the equivalent units in process and the total cost per equivalent unit using the weighted
average method.
Answer:
Equivalent units in process consisted of the 50,000 units completed plus the equivalent units in
ending inventory of 2,500 (or 5,000 x 50%), for a total of 52,500 units.
Total cost in process consisted of beginning inventory of $18,000 (or $6,000 + $7,000 + $5,000) and
current costs were $100,125 (or $25,000 + 60,000 + 15,125) for a total of $118,125.
Total cost per equivalent unit in process was $2.25 (or $118,125 / 52,500 units).
Beg. inventory units
Units completed
Current costs
Ending inventory units
%
Completed
35%
100%
Units
10,000
50,000
Equivalent
Units
Total Cost
$ 18,000
Cost per
Equivalent
Unit
50,000
100,125
50%
5,000
2,500
52,500
$118,125
$2.25
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Topic: Process Costing Calculations
LO: 5
15. Idaho Company manufactures a product through a process where all manufacturing costs are added
uniformly. Information for October beginning work-in-process follows.
Units (35 percent complete)
Direct materials
Direct labor
Overhead
10,000
$6,000
$7,000
$5,000
Costs incurred during October:
Direct materials
Direct labor
Overhead (applied)
$25,000
60,000
15,125
During October, 50,000 units were completed. Also, 5,000 units that were 50 percent complete
remained in process at the end of the day on October 31.
Calculate the cost of goods completed and the cost assigned to ending inventory.
Answer:
Equivalent units in process consisted of the 50,000 units completed plus the equivalent units in
ending inventory of 2,500 (or 5,000 x 50%), for a total of 52,500 units.
Total cost in process consisted of beginning inventory of $18,000 (or $6,000 + $7,000 + $5,000) and
current costs were $100,125 (or $25,000 + 60,000 + 15,125) for a total of $118,125.
Total cost per equivalent unit in process was $2.25 (or $118,125 / 52,500 units). Cost assigned to
goods completed is $2.25 x 50,000 = $112,500 and the cost assigned to ending inventory is $2.25 x
2,500 = $5,625.
Beg. inventory units
Units completed
Current costs
Ending inventory units
%
Completed
35%
100%
Units
10,000
50,000
Equivalent
Units
Total Cost
$ 18,000
Cost per
Equivalent
Unit
50,000
100,125
50%
5,000
2,500
52,500
$118,125
$2.25
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Topic: Absorption Costing Income
LO: 6
16. The following information pertains to Kari Company:
Beginning Inventory
Ending Inventory
Direct labor per unit
Direct materials per unit
Fixed overhead per unit
Fixed SG&A costs per unit
Variable overhead per unit
Variable SG&A costs per unit
2,000 units
10,000 units
$10
5
12
3
2
2
Calculate the difference between absorption costing net income and variable costing net income.
Answer:
Absorption costing deferred into inventory $12 per unit fixed overhead assigned to the 8,000 units of
increase in inventory in the current period (10,000 units less 2,000 units); whereas, variable costing
expensed this fixed overhead. Hence, variable costing income is less than absorption costing income
by $96,000 (or 8,000 x $12).
Topic: Variable Costing Inventory Valuation
LO: 6
17. Andrew Corporation has the following information for October, November, and December of the
current year:
Units produced
Units sold
October
5,000
3,000
November
5,000
4,500
December
5,000
6,000
Production costs per unit (based on 5,000 units) are as follows:
Direct labor
Direct materials
Fixed factory overhead
Fixed SG&A expenses
Variable factory overhead
Variable SG&A expenses
$4
6
2
2
3
4
There were no beginning inventories for October, and all units were sold for $25. Costs are stable
over the three months.
Calculate Andrew’s December ending inventory using the variable costing method.
Answer:
15,000 units produced – 13,500 units sold = 1,500 units in ending inventory
1,500 units x ($4 + $6 + $3) = $19,500
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Topic: Absorption Costing Inventory Valuation
LO: 6
18. Andrew Corporation has the following information for October, November, and December of the
current year:
Units produced
Units sold
October
5,000
3,000
November
5,000
4,500
December
5,000
13,500
Production costs per unit (based on 10,000 units) are as follows:
Direct labor
Direct materials
Fixed factory overhead
Fixed SG&A expenses
Variable factory overhead
Variable SG&A expenses
$4
6
2
2
3
4
There were no beginning inventories for October, and all units were sold for $25. Costs are stable
over the three months.
Calculate Andrew’s December ending inventory using the absorption costing method.
Answer:
15,000 units produced – 13,500 units sold = 1,500 units in ending inventory
1,500 units x ($4 + $6 + $2 + $3) = $22,500
Topic: Absorption and Variable Costing Incomes
LO: 6
19. Andrew Corporation has the following information for October, November, and December of the
current year:
Units produced
Units sold
October
5,000
3,000
November
5,000
4,500
December
5,000
6,000
Production costs per unit (based on 5,000 units) are as follows:
Direct labor
Direct materials
Fixed factory overhead
Fixed SG&A expenses
Variable factory overhead
Variable SG&A expenses
$4
6
2
2
3
4
There were no beginning inventories for October, and all units were sold for $25. Costs are stable
over the three months.
Calculate the difference between Andrew’s December income under absorption and variable costing.
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Answer:
Inventory decreased by 1,000 units in December; therefore, absorption costing expensed as cost of
goods sold, $2 per unit, or $2,000.
That amount was expensed as a fixed expense in prior periods under variable costing.
Absorption costing income was lower by $2,000 than variable costing income for December.
Topic: Variable Costing Cost Calculation
LO: 6
20. Marley Company incurred the following costs in manufacturing phone chargers:
Direct labor
Direct materials
Fixed factory overhead
Fixed selling expenses
Indirect labor (variable)
Indirect materials (variable)
Other variable factory overhead
Variable selling expenses
$7
6
16
8
3
2
5
10
During the period, the company produced and sold 1,000 units.
Calculate the cost per unit using variable costing.
Answer:
Direct labor ($7) + Direct materials ($6) + Indirect labor ($3) + Indirect materials ($2) + Variable
factory overhead ($5) = Total variable costing inventory cost per unit ($23)
Topic: Absorption Costing Cost Calculation
LO: 6
21. Marley Company incurred the following costs in manufacturing phone chargers:
Direct labor
Direct materials
Fixed factory overhead
Fixed selling expenses
Indirect labor (variable)
Indirect materials (variable)
Other variable factory overhead
Variable selling expenses
$7
6
16
8
3
2
5
10
During the period, the company produced and sold 1,000 units.
What is the cost per unit using absorption costing?
Answer:
Direct labor ($7) + Direct materials ($6) + Indirect labor ($3) + Indirect materials ($2) + Variable factory
overhead ($5) + Fixed factory overhead ($16) = Total absorption costing inventory cost per unit ($39)
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Topic: Variable Costing Income
LO: 6
22. Tina Tin Company reported the following units of production and sales for October and November of
this year:
Month
October
November
Produced
50,000
50,000
Sold
45,000
51,000
Net income under absorption costing for October was $22,000.
Net income under variable costing for November was $32,000.
Fixed manufacturing costs were $300,000 for each month.
Calculate net income for October using variable costing.
Answer:
Fixed overhead per unit is $300,000 / 50,000 = $6 per unit.
Absorption income for October is more than variable costing income by the amount of the increase in
inventory units (5,000) times the fixed cost per unit ($6), or a total of $30,000.
Therefore, variable costing income (loss) in October is $22,000 - $30,000 = $(8,000).
Topic: Absorption Costing Income
LO: 6
23. Tina Tin Company reported the following units of production and sales for October and November of
this year:
Month
October
November
Produced
50,000
50,000
Sold
45,000
51,000
Net income under absorption costing for October was $22,000.
Net income under variable costing for November was $32,000.
Fixed manufacturing costs were $300,000 for each month.
Calculate net income for November using absorption costing.
Answer:
Fixed overhead per unit is $300,000 / 50,000 = $6 per unit.
Absorption income for November is less than variable costing income by the amount of the decrease
in inventory units (1,000) times the fixed cost per unit ($6), or a total of $6,000.
Therefore, absorption costing income in November is $32,000 - $6,000 = $26,000.
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Problems
Topic: Cost of Goods Manufactured
LO: 4
1. Presented below is selected information from the Ted Company’s current period accounting records
(in $000s):
Sales
Raw Materials Used
Direct Labor Costs
Period Costs (Selling and Administrative)
Beginning Raw Material Inventory
Ending Raw Material Inventory
Net Income
Beginning Work-in-Process Inventory
Ending Work-in-Process Inventory
Beginning Finished Goods Inventory
Ending Finished Goods Inventory
$12,000
2,500
1,000
2,500
300
1,000
300
0
300
700
400
NOTE: All raw materials used were direct materials.
Required: Determine the following (in dollars):
a. Raw Material Purchases
b. Gross Profit
c. Cost of Goods Manufactured
d. Manufacturing Overhead
Answer:
a. Beginning Raw Materials + Raw Material Purchases – Raw Materials Used = Ending Raw Materials
$300 + Raw Material Purchases – $2,500 = $1,000
Raw Materials Purchases = $3,200
b. Gross Profit – Period Costs = Net Income
Gross Profit – $2,500 = $300
Gross Profit = $2,800
c.
Sales – Cost of Goods Sold = Gross Profit
and...
Cost of Goods Sold = Beg. Finished Goods + Cost of Goods Manufactured – End. Finished Goods
So,
Sales – Beg. Finished Goods – Cost of Goods Manufactured + End. Finished Goods = Gross Profit
$12,000 – $700 – Cost of Goods Manufactured + $400 = $2,800
Cost of Goods Manufactured = $8,900
d. Beg. Work-in-Process + Direct Raw Mat. Used + Direct Labor + Mfg. Overhead – Cost of Goods Mfg.
= Ending Work-in-Process
$0 + $2,500 + $1,000 + Mfg. Overhead – $8,900 = $300
Manufacturing Overhead = $5,700
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Topic: Inventory and Cost of Sales Calculations
LO: 4
2. Information from The Crossword Company is given below in $000s for this period:
Sales
Selling and administrative costs
Purchases of raw materials
Direct labor
Manufacturing overhead
Raw materials used (all direct cost)
Cost of goods manufactured
Beginning raw materials inventory
Beginning work-in-process inventory
Beginning finished goods inventory
Ending finished goods inventory
$350
26
9
11
105
11
68
30
103
90
75
Required: Determine the following amounts in dollars:
a. Ending Raw Materials assuming all Raw Materials costs are classified as direct costs
b. Ending Work-in-Process Inventory
c. Cost of Goods Sold
Answer:
a. Beg. Raw Materials + Purchases – Raw Materials Used = End Raw Materials
$30 + $9 – $11 = $?
Ending Raw Materials = $28
b. Beg. Work-in-Process + Direct Materials Used + Direct Labor + Mfg. Overhead – Cost of Goods Mfg.
= Ending Work-in-Process
$103 + $11 + $11 + $105 – $68 = $?
End Work-in-Process = $162
c.
Beg. Finished Goods + Cost of Goods Mfg. – Cost of Goods Sold = Ending Finished Goods
$90 + $68 – $? = $75
Cost of Goods Sold = $83
Topic: Equivalent Units Calculations
LO: 5
3. Palermo Manufacturing Company began July with 25,000 units of inventory in process, 30 percent
completed. During the month, 125,000 units were completed and transferred to the finished goods
warehouse. Ending inventory consisted of 20,000 units, 70 percent completed. Materials were added
at the beginning of the process.
Required: Calculate the equivalent units in process for:
a. Materials equivalent units under the weighted average process cost method
b. Conversion equivalent units under the weighted average process cost method
Answer:
Units completed
Plus Equivalent units in ending inventory
Equals Equivalent units in process
Materials
125,000
20,000
145,000
Conversion
125,000
14,000
139,000
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Topic: Units in Process and Equivalent Units Calculations
LO: 5
4. Southern Company manufactures a product that passes through two processes.
information is available for the first department for August:
The following

Beginning work-in-process consisted of 12,000 units that were 85 percent complete
with respect to conversion.

Ending work-in-process consisted of 7,500 units that were 30 percent complete with
respect to conversion.


70,500 units were started in process during the month.
All materials are added at the beginning of the process.
Required:
a. Prepare a detailed summary of units in process during the month.
b. Compute equivalent units in process for Materials and Conversion using the weighted average
method.
Answer:
a. Summary of Units in Process:
Units in beginning work-in-process
Units started
Total units in process:
12,000
70,500
82,500
Units to account for:
Completed from beginning inventory
Both started and completed
Total completed and transferred
Units in ending work-in-process
12,000
63,000
75,000
7,500
Total units accounted for:
82,500
b. Equivalent units:
Units completed
Units EWIP x fraction complete:
Materials (7,500 x 100 %)
Conversion (7,500 x 30%)
Equivalent in process
Materials
75,000
Conversion
75,000
7,500
2,250
77,250
82,500
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Topic: Process Costing Calculations
LO: 5
5. Clark Corporation produces a product that passes through two departments. For October, the
following equivalent unit schedule was prepared for the first department:
Units completed
Units EWIP x fraction complete:
Materials (12,000 x 100 percent)
Conversion (12,000 x 30 percent)
Equivalent units in process
Materials
75,000
Conversion
75,000
12,000
87,000
3,600
78,600
Costs assigned to beginning work-in-process:
Materials
$38,840
Conversion
14,802
Manufacturing costs incurred during the month:
Materials
$32,500
Conversion
30,000
Required:
a. Compute the unit cost for October using the weighted average method.
b. Determine the cost of goods transferred out.
c. Determine the cost of ending work-in-process.
Answer:
a. Cost per equivalent unit:
Materials = ($38,840 + $32,500) / 87,000= $0.82
Conversion = ($14,802 + $30,000) / 78,600 = $0.57
Total unit cost = $1.39 per equivalent unit in process
b. Cost of goods transferred out = $1.39 x 75,000 = $104,250
c.
Cost of ending work-in-process = (12,000 × $0.82) + (3,600 × $0.57) = $11,892
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Topic: Process Costing
LO: 5
6. Carlson Company manufactures a product that passes through two processes:
Packaging. The costs incurred for the Mixing Department for September follow:
Work-in-process, Sept. 1:
Units (40 percent complete)
Direct materials
Direct labor
Overhead
Mixing and
7,500
5,000
3,000
2,000
During Sept., 75,000 units were completed and transferred to Packaging. The following costs were
incurred by the Mixing Department during September:
Direct materials
Direct labor
Overhead
50,000
30,000
12,000
There were 9,000 units that were 70 percent complete remaining in the Mixing Department at Sept. 30.
Use the weighted average method and round unit costs to 2 decimal places.
Required:
a. Determine the equivalent units in process for September.
b. Determine the Total Costs To Account For in September.
c. Determine the costs per equivalent unit assuming all costs are added uniformly during the mixing
process.
d. Determine the Accounting for Total Costs.
Answer:
a. Units accounted for:
Units completed
Units in EWIP (70 percent complete)
Total units in Process
b. Costs to account for:
Beginning work-in-process
Costs added
Total costs to account for:
Physical Flow
75,000
9,000
84,000
Equivalent Units
75,000
6,300
81,300
$ 10,000
92,000
$102,000
c. Cost per equivalent unit in process:
Total costs to account for / Equivalent units in Process
$102,000 / 81,300 = $1.25 (rounded)
d. Accounting for total costs:
Transferred out (75,000 × $1.25)
Ending work-in-process (9,000 × $1.25)
Total cost accounted for
$ 93,750
11,250
$105,000
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Topic: Profit Comparisons: Absorption and Variable Costing
LO: 6
7. The Lansing Corporation has two identical divisions: Eastern and Southern. Their sales, production
volume, and fixed manufacturing costs have been the same for both divisions for the last five years
and are as follows:
Units produced
Units sold
Fixed manufacturing costs
Year 1
Year 2
Year 3
Year 4
Year 5
50,000
40,000
$250,000
50,000
45,000
$250,000
50,000
55,000
$250,000
50,000
50,000
$250,000
50,000
55,000
$250,000
Eastern uses absorption costing and Southern uses variable costing. Both use FIFO inventory
methods. Variable manufacturing costs are $5 per unit. Both have identical selling prices and selling
and administrative expenses. There were no Year 1 beginning inventories.
Determine the difference in profits for each division for Years 1 through 5. Explain why profits differ
between the two divisions.
Answer:
Fixed manufacturing per unit is $250,000 / 50,000 = $5 per unit
Eastern Division has the higher income when production units exceed sales units. This is the case
for Years 1 and 2. When sales units exceed production units, Southern Division has the higher income,
Years 3 and 5. When sales units equal production units, the incomes are the same, Year 4.
Beginning Inventory in units
Units produced
Units sold
Ending inventory in units
Fixed cost per unit
Fixed cost in ending inventory
Fixed cost in beginning inventory
Amount by which absorption income
exceeds variable costing income
Year 1
0
50,000
40,000
10,000
$5.00
$50,000
0
Year 2
10,000
50,000
45,000
15,000
$5.00
$75,000
50,000
Year 3
15,000
50,000
55,000
10,000
$5.00
$50,000
75,000
Year 4
10,000
50,000
50,000
10,000
$5.00
$50,000
50,000
Year 5
10,000
50,000
55,000
5,000
$5.00
$25,000
50,000
$50,000
$25,000
$(25,000)
$
$(25,000)
0
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LO: 6
8. Petunia Company produced 15,000 units and sold 13,000 units during the current fiscal period.
Beginning inventory was zero. During the period, the following costs were incurred:
Direct labor per unit
Direct materials per unit
Variable selling expense per unit
Fixed administrative expenses
Fixed manufacturing overhead
Fixed selling expenses
Indirect labor (all variable)
Indirect materials (all variable)
Other variable overhead
$50
12
20
75,000
90,000
60,000
60,000
30,000
90,000
Required: Compute the dollar amount of ending inventory using (a) absorption costing and (b)
variable costing.
Answer:
a. Variable costs:
Direct materials
Direct labor
Indirect labor
Indirect materials
Other variable overhead
Variable product costs per unit:
$ 12.00
50.00
4.00
2.00
6.00
$74.00
Variable product costs per unit
Fixed manufacturing overhead
Total product costs per unit
$74.00
6.00
$80.00
Total product costs per unit
Inventory units
Inventory value
$80.00
x 2,000
$160,000
b. Variable product costs per unit
Inventory units
Inventory value
$74.00
x 2,000
$148,000
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Topic: Absorption and Variable Costing
LO: 6
9. Buster Corporation wants to change to the variable costing method of inventory valuation for making
internal decisions. The LIFO method is being used. The absorption statements of income for Years
1 and 2 are as follows:
Year 1
Year 2
$150,000
$150,000
Sales (5,000 units)
Cost of Goods Sold
90,000
85,000
Gross Profit
$60,000
$65,000
SG&A expenses*
Net Income
25,000
$ 35,000
25,000
$ 40,000
*Selling and administrative expenses include variable costs of $2 per unit sold.
Production data are as follows:
Production units
Variable costs per unit
Fixed overhead costs
Year 1
4,000
$15
$24,000
Year 2
3,000
$15
$24,000
Required:
a. Compute the absorption cost per unit manufactured in Years 1 and 2.
b. Explain why the net income for Year 1 was higher than the net income for Year 2 when the same
number of units was sold in each year.
c. Prepare income statements for both years using variable costing.
d. Reconcile the absorption costing and variable costing net income figures for each year. Start with
variable costing net income.
Answer:
a. For Year 1, absorption costs per unit manufactured are $90,000 / 5,000 = $18
For Year 2, absorption costs per unit manufactured are $85,000 / 5,000 = $17
b. The cost per unit manufactured increased by $1 and total costs increased by $1 x 5,000 units, or
$5,000. This increase in costs was due to a reduction in units produced, which in turn caused the
fixed costs per unit to be greater by $1.
c.
BUSTER CORPORATION
Variable Costing Income Statements
For Years 1 and 2
Sales
Variable manufacturing expenses
Variable SG&A expenses
Contribution Margin
Year 1
$150,000
75,000
10,000
$65,000
Year 2
$150,000
75,000
10,000
$65,000
Fixed manufacturing overhead
Fixed SG&A expenses
Net income
24,000
15,000
$ 26,000
24,000
15,000
$ 26,000
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d.
Variable Costing Net Income
Fixed expenses in inventory*
Absorption Costing Net Income
Year 1
$ 26,000
6,000
$32,000
Year 2
$26,000
16,000
$42,000
Note: Calculations assume no beginning inventory.
*Fixed manufacturing expenses in inventory were computed as (1,000 × $6) and (2,000 × $8).
Topic: Absorption Income Statement
LO: 6
10. The variable costing income statement for Bolt Company for this quarter is as follows:
BOLT CORPORATION
Variable Costing Income Statements
For the current quarter
Sales (5,000 units)
Cost of Goods Sold (variable)
Variable selling (10% of sales)
Contribution Margin
$150,000
50,000
$500,000
Fixed manufacturing overhead
Fixed administrative expenses
$120,000
72,000
Net income
200,000
$ 300,000
192,000
$ 108,000
Selected data for the quarter concerning the operations of the company are as follows:
Beginning inventory
Units produced
Direct manufacturing labor
Direct manufacturing materials
Variable manufacturing overhead
0 units
8,000 units
$15 per unit
$8 per unit
$7 per unit
Required: Prepare an absorption costing income statement for the quarter.
Answer:
BOLT CORPORATION
Absorption Costing Income Statement
For the quarter just ended
Sales
Cost of Goods Sold*
Gross Profit
$500,000
225,000
$275,000
Selling Expenses
Administrative Expenses
$ 50,000
72,000
Net Income
$153,000
*COGS = 5,000 x [$15 + $8 + $7 + ($120,000 / 8,000)]
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Topic: Absorption and Variable Costing Income Statements
LO: 6
11. Ava Candy Company produced 5,000 cases of candies this year. It sold 4,000 cases for $18 each.
There were no beginning inventories. Variable manufacturing costs were $30,000, and fixed
manufacturing expenses were $20,000. Selling and administrative expenses were $5,000, all fixed.
Required:
a. Prepare income statements using the variable costing and absorption costing.
b. Reconcile the net income under absorption and variable costing.
Answer:
a.
AVA CANDY COMPANY
Variable Costing Income Statement
For the Year just ended
Sales (4,000 units)
Cost of Goods Sold (variable)
Contribution Margin
Fixed manufacturing overhead
Fixed administrative expenses
$72,000
24,000
$48,000
$20,000
5,000
Net income
25,000
$ 23,000
AVA CANDYCOMPANY
Absorption Costing Income Statement
For the Year just ended
Sales (4,000 units)
Cost of Goods Sold (variable)
Cost of Goods Sold (fixed)
Gross Margin
$72,000
24,000
16,000
Fixed administrative expenses
40,000
$32,000
5,000
Net income
$27,000
b. Variable costing net income
Increase in units in inventory
Fixed cost per unit in inventory
Absorption costing net income
$23,000
1,000
x $4
4,000
$27,000
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Essay Questions
Topic: Costing in Various Type Organizations
LO: 1
1. Compare the challenge of determining unit production costs among service, merchandising and
manufacturing organizations. Specifically, in which type of organizations is obtaining accurate
inventory costs a more important issue? In which type of organization does obtaining accurate
inventory costs present the greatest challenge?
Answer:
The ability to obtain accurate unit production costs is important for service, merchandising and
manufacturing organizations. Merchandising and manufacturing organizations typically have large
amounts of resources tied up in inventory; hence, inventory measurements are very important for them
because they comprise a large portion of total assets. The greatest challenges with inventory costs
certainly arise in manufacturing organizations, where judgments and estimates influence the value of
inventories. Also, manufacturing organizations maintain three separate inventory accounts (raw
materials, work-in-process, and finished goods), thereby adding to the complexity of costing issues.
Topic: Types of Organizations
LO: 1
2. Briefly discuss and give examples of the three classifications of organizations discussed in this
chapter.
Answer:
Organizations may be classified generally as service, merchandising, or manufacturing organizations.
Service organizations perform work for others. Included in this category are Bank of America,
Supercuts hair salon, The Shriners’ Children’s Hospitals, Pizza Hut restaurants, the City of New York,
Delta Airlines, and others. Merchandising organizations buy and sell goods and include companies
such as Safeway grocery stores, L.L. Bean, Ace Hardware, and Wal-Mart. Manufacturing
organizations process raw materials into finished products for sale to others and include BMW,
Birmingham Steel, and Dell Computer.
Topic: Differences between Job-Order and Process Costing
LO: 3, 4, 5
3. Describe the difference between job-order and process costing in terms of the primary cost objective
and time period for which costs are accumulated.
Answer:
In a job-order costing system, costs are accumulated for each job during the entire life of the job, and
unit costs are determined when each job is finished. In process costing, costs are accumulated for
each department or process for each period (e.g., month or year), and average unit costs for the
department or process are determined at the end of each accounting period.
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Topic: Absorption and Variable Costing Compared
LO: 6
4. Compare and contrast absorption and variable costing.
Answer:
Absorption and variable costing methods are similar in that they both treat nonmanufacturing costs
incurred during the period, such as selling and administration costs, as expenses (period costs). The
difference between absorption and variable costing is how they treat manufacturing costs. Whereas
absorption costing treats both variable and fixed manufacturing costs as inventoriable product costs,
variable costing treats only variable manufacturing costs as inventoriable product costs; fixed
manufacturing costs are treated as period costs.
Topic: Fixed Cost as Period or Product Cost
LO: 6
5. Since fixed product costs are eventually recorded as expenses under both variable and absorption
costing by the time the inventory is sold, why does it matter whether fixed overhead is treated as a
product cost or a period cost?
Answer:
It matters whether fixed overhead is treated as a product cost or a period cost because the way it is
treated affects the measurement of income for a particular period as well as the valuation assigned to
inventory on the balance sheet at the end of the period. It could also have a behavioral effect on
management decisions.
Topic: Pros and Cons of Absorption and Variable Costing
LO: 6
6. Provide an argument in favor of using variable costing and an argument against the use of variable
costing.
Answer:
Variable costing essentially assumes that fixed manufacturing costs do not add value to products.
Rather fixed manufacturing costs are incurred to provide the capacity to produce during a given period.
Fixed manufacturing costs are not relevant based on the fact that these costs are incurred regardless
of the degree to which the available capacity was utilized. Likewise, inventory can be viewed as
valuable only to the extent that it eliminates incurrence of future costs. However, since inventory levels
do not affect the incurrence of fixed manufacturing costs, it follows that these costs should not be
reflected in inventory. On the other hand, fixed manufacturing costs are a necessary condition for
manufacturing the product. For this reason, it seems reasonable to match these costs to products.
Viewing the matter from a long-term perspective, all costs are variable. If these costs are not reflected
in the costs of products, over time product costs will be understated.
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Chapter 18
Activity-Based Costing,
Customer Profitability, and
Activity-Based Management
Learning Objectives – Coverage by question
True/False
Multiple Choice
Exercises
Problems
Essays
LO1 – Explain the changes in
the modern production
environment that have affected
cost structures.
1, 2
LO2 –Outline the concept of
activity-based costing (ABC)
and how it is applied.
3-5
1-13, 16, 18
1, 2
1-3
1
LO3 – Perform product costing
using both traditional and
activity-based costing methods.
6
15, 22,
26-30
3-7
3
2, 3
LO4 – Compare activity-based
costing to traditional methods.
Assess implementation issues
involved in activity-based
costing systems.
7, 8
14, 17,
19-21
4
LO5 – Analyze customer
profitability using activity based
costing.
9, 10
31
5
11
23-25
LO6 – Explain the difference
between ABC and activitybased management.
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Chapter 18: Activity-Based Costing, Customer Profitability, and
Activity-Based Management
True/False
Topic: Changing Cost Environment
LO: 1
1. The twentieth century saw an accelerating shift from traditional manufacturing activities to production
procedures requiring large investments in raw materials and labor.
Answer: False
Rationale: The shift was from traditional labor-based techniques to large investments in automated
equipment.
Topic: Changing Cost Environment
LO: 1
2. Over the past century, overhead costs have increased as a percentage of total product cost.
Answer: True
Rationale: Production employees spend significantly less time on actual production and more time on
scheduling, setting up, maintaining, and moving materials. In combination with increased automation,
the result is an increase in manufacturing overhead costs.
Topic: Activity-Based Costing
LO: 2
3. Activity-based costing determines the cost of activities and traces their costs to cost objects on the
basis of the cost object’s utilization of units of activity.
Answer: True
Rationale: Activity-based costing is a system of analysis that identifies and measures the cost of key
activities, and then traces these activity costs to products or other cost objects based on the quantity
of activity consumed by the cost object.
Topic: Purchasing Department Cost Allocation
LO: 2
4. The number of purchase orders is a reasonable basis for allocating to jobs the purchasing
department costs.
Answer: True
Rationale: This is a reasonable basis for allocating purchasing department costs. The dollar value of
purchase orders is also a reasonable basis.
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Topic: Activity-Based Costing
LO: 2
5. Activity-Based Costing (ABC) is a two-stage method of cost assignment that assigns overhead costs
to key activities, and then assigns those costs to products or services based on their use of those
activities.
Answer: True
Rationale: ABC determines the major activities (such as machine setups or materials moves) that drive
overhead costs, and it measures the cost for each unit of activity. Production is then charged for the
use of those activities at the ABC rate.
Topic: Plantwide Allocation Rate
LO: 3
6. The plantwide rate approach is the simplest to apply, but it is also the most costly to implement,
compared to a departmental or activity-based cost allocation system.
Answer: False
Rationale: The plantwide rate approach is the simplest, and least costly, to apply, but it provides the
least precise measurement of product costs.
Topic: ABC Implementation
LO: 4
7. ABC is generally more costly to implement than traditional costing.
Answer: True
Rationale: Often companies maintain traditional costing for external purposes and ABC for pricing and
other internal decision-making purposes. In addition, ABC systems must be built facility by facility rather
than being embedded in a software system that can be used by all facilities within the company.
Topic: ABC Implementation
LO: 4
8. ABC is particularly useful when product lines differ greatly in volume and in manufacturing complexity.
Answer: True
Rationale: Traditional systems tend to over cost high-volume, low-complexity products and they tend
to under cost low-volume, high-complexity products.
Topic: Customer Profitability
LO: 5
9. ABC is useful for product costing, but traditional costing is superior for customer profitability.
Answer: False
Rationale: One of the most beneficial applications of ABC is in the analysis of the profitability of
customers.
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Topic: Customer Profitability
LO: 5
10. If products are being sold to customers A and B above costs and the company is earning a profit,
then customers A and B must both be profitable.
Answer: False
Rationale: Profitability of individual customers depends on whether the gross profit from sales to those
customers exceeds the customer-specific costs of serving those customers. Some customers are
simply more costly than other customers and some may be even unprofitable.
Topic: Activity-Based Management
LO: 6
11. Activity-based management (ABM) focuses on reducing costs and maximizing value to consumers.
Answer: True
Rationale: ABM is defined as the identification and selection of activities to maximize the value of
activities and processes while minimizing their cost from the perspective of the final consumer.
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Multiple Choice
Topic: Activities and Cost Drivers
LO: 2
1. The most appropriate cost driver for the activity of clearing tables in a restaurant is:
A) The number of cooks in the kitchen
B) The number of tables cleared
C) The number of employees assigned to the job of clearing tables
D) The amount of money deposited to the bank each day
Answer: B
Rationale: On the basis of logical analysis the number of tables cleaned is the most appropriate cost
driver.
Topic: Activity-Based Costing
LO: 2
2. Which of the following statements about activity based costing is true?
A) The most widely used approach to activity-based costing involves the use of a two-stage model.
B) Activity-based costing involves tracing the cost of activities used by the various cost objects.
C) Activity-based costing involves determining the cost of activities.
D) All of the above
Answer: D
Rationale: Activity based costing is a system of analysis that identifies and measures the cost of key
activities and then traces these activity costs to products or other cost objects based on the quantity
of activity consumed by cost objects. ABC is used widely through the two stage costing model.
Topic: Cost Object
LO: 2
3. An object to which costs are assigned is called:
A) A value chain
B) A cost object
C) A cost pool
D) Overhead
Answer: B
Rationale: A cost object is an object to which costs are assigned. Examples include departments,
products, and services.
Topic: Activity-Based Costing
LO: 2
4. Which of the following procedures best describes activity-based costing?
A) All overhead costs are recorded as expenses as incurred.
B) Overhead costs are assigned directly to products.
C) Overhead costs are assigned to activities; then costs are assigned to products.
D) Overhead costs are assigned to departments; then costs are assigned to products.
Answer: C
Rationale: In activity based costing, indirect costs including overhead are assigned to activities; then
activity costs are assigned to products or other cost objects.
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Topic: Two-Stage Activity-Based Costing Model
LO: 2
5. Which of the following tasks is not required when using a two-stage activity-based costing model?
A) Identifying activities
B) Assigning costs to activities
C) Determining how much direct labor each cost object consumes
D) Determining the cost per unit of activity
Answer: C
Rationale: Direct labor and direct materials are direct product costs that are directly assigned to
products and excluded from activity cost pools in a two stage ABC model.
Topic: Two-Stage Activity-Based Costing
LO: 2
6. In a two-stage activity-based costing model, stage one involves:
A) Assigning activity costs to cost objects
B) Measuring the various indirect resource costs and determining resource drivers
C) Assigning indirect resource costs to activity pools
D) Assigning direct costs to cost objects
Answer: C
Rationale: In Stage one, indirect resource costs are assigned to activity pools. In Stage two, activity
costs are reassigned to cost objects using activity drivers. Direct costs such as direct materials and
labor are assigned directly to cost objects.
Topic: Activity-Based Costing
LO: 2
7. In an activity-based costing model, total costs assigned to cost objects may include:
A) Only direct costs
B) Both direct costs and resource costs
C) Both activity costs and resource costs
D) Both direct costs and activity costs
Answer: D
Rationale: Total costs assigned to cost objects may include the direct costs of material and labor plus
indirect costs assigned via activity cost pools.
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Topic: Job Costing with Activity-Based Costing
LO: 2
8. Puggle, Inc. has two categories of overhead: maintenance and inspection. Costs expected for these
categories for the coming year are as follows:
Maintenance
Inspection
$400,000
200,000
The following data have been assembled for use in developing a bid for a proposed job:
Direct materials
Direct labor
Machine-hours
Number of inspections
Direct labor-hours
$3,000
$8,000
200
2
400
The practical capacity of machine-hours for all jobs during the year is 12,500, and for inspections is
400. These are the cost drivers for maintenance and inspection costs, respectively.
Using the appropriate cost drivers, the total cost of the potential job is:
A) $11,000
B) $18,400
C) $16,300
D) $36,800
Answer: B
Rationale: The activity rate for maintenance is $400,000 /12,500 machine hours or $32 per machine
hour. The rate for inspections is $200,000 / 400 inspections or $500 per inspection. Overhead for
the job is $32 x 200 machine hours = $6,400 + $500 x 2 inspections = $1,000. Total overhead of
$7,400 + Direct materials $3,000 + Direct labor $8,000 = $18,400 total job cost.
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Topic: Product Costing with Activity-Based Costing
LO: 2
9. Sunflower, Inc. uses activity-based costing. The company produces two products, A and B.
Information relating to the two products is as follows:
A
19,000
7,500
8,000
4,000
5,000
Units produced
Machine-hours
Direct labor-hours
Materials handling (number of moves)
Setups
B
25,000
8,500
12,000
6,000
7,000
The following costs are reported:
Materials handling
Labor-related overhead
Setups
$160,000
480,000
300,000
Setup costs assigned to B are:
A) $140,000
B) $112,000
C) $175,000
D) $144,000
Answer: C
Rationale: Total setup costs of $300,000 / 12,000 total setups = $25 per set up. Product B setups of
7,000 x $25 = $175,000.
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Topic: Product Costing with Activity-Based Costing
LO: 2
10. Laura, Inc. uses activity-based costing. The company produces 001 and 002. Information relating to
the two products is as follows:
Units produced
Machine-hours
Direct labor-hours
Materials handling (number of moves)
Setups
001
19,000
7,500
8,000
4,000
5,000
002
25,000
8,500
12,000
6,000
7,000
The following costs are reported:
Materials handling
Labor-related overhead
Setups
$160,000
280,000
240,000
Labor-related overhead costs assigned to product 001 are:
A) $192,000
B) $232,000
C) $112,000
D) $224,000
Answer: C
Rationale: Labor-related overhead of $280,000 / 20,000 total direct labor hours = $14 per labor hour.
Product 001 labor hours of 8,000 x $14 = $112,000.
Topic: Activity-Based Costing
LO: 2
11. Which of the following is a true characteristic of activity-based costing?
A) Activity-based costing uses a smaller number of cost pools than does organizational-based
costing.
B) Relative to traditional costing methods, activity-based costing is more concerned with identifying
processes and less concerned with causal factors of overhead costs.
C) Activity-based costing removes the use of judgment from the allocation process.
D) Activity-based costing cannot be used to assign costs unless the activity cost drivers of those
costs are identified.
Answer: D
Rationale: Activity-based costing uses cost drivers to assign activity-cost pools to cost objects;
therefore, it is necessary to identify the cost drivers for each activity-cost pool.
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Topic: Two-Stage Activity-Based Costing Model
LO: 2
12. The second stage of an activity-based costing two-stage product costing model includes:
A) Assignment of cost pools to products
B) Assignment of cost pools to cost centers
C) Assignment of resource costs to cost pools
D) All of the above
Answer: A
Rationale: The first stage of an ABC product costing system is to determine the resource costs that
should be assigned to each cost pool, and the second stage is to assign the activity cost pools to the
products.
Topic: Stage Two Activity-Based Costing
LO: 2
13. Assume that total costs assigned to the setup activity cost pool in June are $60,000 and 50 setups
were completed in June. Further, assume that during June machines were setup 10 times to make
product K12.
The total setup cost that would be assigned to product K12 would be:
A) $ 1,600
B) $12,000
C) Cannot be determined
D) $24,000
Answer: B
Rationale: Cost per setup is $60,000 /50, or $1,200, and the setup cost assigned to product K12 is
$1,200 x 10 = $12,000
Topic: Practical Capacity
LO: 4
14. The practical capacity for a particular production facility is best described as:
A) The highest level of activity possible allowing for normal repairs and maintenance
B) The highest level of activity possible under any circumstance
C) The highest level of activity at which average costs are minimized
D) The level of activity that makes the most practical sense within the framework of a given situation
Answer: A
Rationale: Practical capacity is the maximum volume of activity, while allowing for normal downtime
for repairs and maintenance. Practical capacity is generally regarded as better than actual capacity
because it does not hide the cost of idle capacity.
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Topic: Calculating a Plantwide Rate
LO: 3
15. The following information is available pertaining to Ian Division that uses a plantwide overhead rate
based on machine hours:
Overhead
Direct labor-hours
Machine-hours
Mixing Dept.
$30,000
4,000
1,500
Finishing Dept.
$73,500
1,250
3,000
Total
$103,500
5,250
4,500
Finishing Dept.
$0
0
4
0
Total
$5,000
125
9
250
Production information pertaining to Job 302:
Prime costs
Direct Labor-hours
Machine-hours
Units produced
Mixing Dept.
$5,000
125
5
250
What are the total overhead costs assigned to Job 302?
A) $240
B) $207
C) $360
D) $180
Answer: B
Rationale: The plantwide rate for Evan is $103,500 of overhead / 4,500 machine hours = $23 per
machine hour. The number of machine hours used to produce Job 501 was 9 hours x $23 per machine
hour of overhead = $207 of overhead assigned to Job 302.
Activity-Based Costing
LO: 2
16. Which of the following product costing methods produces the most precise product costing
information?
A) Activity-based costing
B) Departmental overhead rate methods
C) Organization-based costing
D) Plantwide overhead rates
Answer: A
Rationale: Activity-based costing provides the most precise product costing information because unlike
the other methods, it produces information about the activities, the quantities of activities, and the cost
of activities that go into producing a product.
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Applications of Activity-Based Costing
LO: 4
17. Activity-based costing is a technique for more precisely measuring the cost and profitability of:
A) Products
B) Customers
C) Distribution channels
D) All of the above
Answer: D
Rationale: In addition to using ABC for product costing and profitability purposes, other important uses
for ABC have also been found such as evaluating costs and profitability of customers and distribution
channels. Any process, function, or activity with indirect costs performed in an organization is a
candidate for ABC analysis.
Topic: Implementation of Activity-Based Costing
LO: 2
18. Which of the following aspects of manufacturing must be understood in order to implement activity
based costing in a production setting?
A) The production process
B) The activities that occur in the production process must be known
C) The cost drivers that generate activities within the production process
D) All of the above
Answer: D
Rationale: To implement an ABC system in a production setting an understanding of items A through
C are all essential.
Topic: Activity-Based Costing Implementation
LO: 4
19. Which of the following statements describes the typical effect of creating a large number of refined
activity cost pools for a given costing application?
A) A complex ABC system with numerous cost pools provides substantial cost improvement over a
smaller system with only seven to ten cost pools.
B) A system containing a large number of cost pools will not tend to exhibit substantial cost accuracy
over a system containing seven to ten cost pools.
C) With the aid of a computer, every public company should strive to develop as many cost pools as
possible because there is virtually no disadvantage of so doing.
D) Employees normally develop a deep appreciation for the complexity of a large, tedious ABC
system.
Answer: B
Rationale: Research on ABC systems has shown that refining the cost measurements by increasing
the number of cost pools beyond a reasonable point does not result in significant increase in cost
accuracy.
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Topic: Activity-Based Costing Implementation
LO: 4
20. Activity-based costing systems tend to
products.
A) Undercost
B) Overcost
C) Accurately cost
D) None of the above
high-volume, low-complexity
Answer: C
Rationale: ABC systems tend to more accurately cost high-volume, low-complexity products as well
as low volume, high-complexity products. Traditional cost systems tend to overcost high-volume, lowcomplexity products and undercost low volume, high-complexity products.
Topic: Activity-Based Costing Implementation
LO: 4
21. Although adding more activity cost pools to an activity-based costing system may improve the
precision of product costing, this increase in precision must be judged against:
A) The cost of the product
B) The price of the product
C) The cost of developing and maintaining the additional cost pools
D) All of the above
Answer: C
Rationale: When developing cost systems, the cost-benefit of more precision should always be
considered. At some point increasing precision may come at a cost that exceeds its benefits.
Topic: Benefits of ABC
LO: 3
22. Activity-based costing’s primary benefit is that it provides:
A) Absolutely accurate product costing information
B) Data for external financial reporting purposes
C) More precise cost data for internal decision-making purposes
D) All of the above
Answer: C
Rationale: The primary benefit of ABC is that is improves cost precision which is useful for a variety of
internal decision purposes such as pricing and for evaluating internal processes.
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Topic: Activity-Based Management
LO: 6
23. Which of the following statements concerning activity-based management is true?
A) Activity-based management is concerned with maximizing the value of activities.
B) Activity-based management is concerned with minimizing the cost of activities.
C) Activity-based management is concerned with improving processes.
D) All of the above statements are true.
Answer: D
Rationale: Activity based management is a process that analyzes and evaluates the cost and the
individual elements of an activity to manage the activity by redesigning the process, lowering the cost,
and adding value.
Topic: Activity-Based Management
LO: 6
24.
is defined as the identification and selection of activities to maximize the
value of the activities while minimizing their cost from the perspective of the final consumer.
A) Activity-based costing
B) Activity-based management
C) Strategic cost management
D) None of the above
Answer: B
Rationale: Definition
Topic: Activity-Based Management
LO: 6
25. Which of the following statements about activity-based management (ABM) is true?
A) ABM is concerned with how to effectively and efficiently manage activities and processes to
provide value to the final consumer.
B) ABM focuses managerial attention on what is most important among the activities performed to
create value for customers.
C) Defining processes and identifying key activities helps management better understand the
business and to evaluate whether activities performed add value to the customer.
D) All of the above are true.
Answer: D
Rationale: ABM is concerned with helping managers understand the business and to evaluate which
activities are the most important in managing the activities and processes to provide value to the final
consumer.
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Topic: ABC Activity Rate
LO: 3
26. Jack, Inc. has three activity pools which have the following costs:
Machine Setups
Material Moves
Machine Operations
$15,000
$22,000
$14,000
The activity cost drivers (and driver quantity) for the three pools are, respectively, number of setups
(100), number of material moves (220), and number of machine hours (175).
Product V4 used the following quantity of activity drivers to produce 100 units of final product:



12 setups
20 material moves, and
32 machine hours.
The total ABC cost and unit ABC cost assigned to Product V4 is:
A) $ 3,630 total ABC cost and $ 36.30 unit ABC cost
B) $10,300 total ABC cost and $103.00 unit ABC cost
C) $ 6,360 total ABC cost and $ 63.60 unit ABC cost
D) $ 3,300 total ABC cost and $330.00 unit ABC cost
Answer: C
Rationale:
Activity
Cost Driver
Cost
Machine setups
Material moves
Machine operations
$15,000
22,000
14,000
100
220
175
Product V4
Activity
Cost Rate
Activity
$150
12
100
20
80
32
Total product activity cost
ABC cost per unit
Cost of Activity
$1,800
2,000
2,560
$6,360
$63.60
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Topic: Plantwide Rate
LO: 3
27. Deca Electronics Company produces two products, Resistors and Transistors in a small manufacturing
plant which had total manufacturing overhead of $21,000 in June and used 300 direct labor hours. The
factory has two departments, Design, which incurred $10,000 of manufacturing overhead, and
Production which incurred $11,000 of manufacturing overhead. Design used 200 hours of direct labor
and Production used 80 machine hours.
During June, 150 direct labor hours were used in making 100 units of Resistors, and 150 direct labor
hours were used in making 100 units of Transmitters.
If Deca Electronics Company uses a plantwide rate based on direct labor hours to assign
manufacturing costs to products, the total manufacturing overhead assigned to each unit of Resistors
and Transistors in June were:
A)
B)
C)
D)
$105 for Resistors and $105 for Transistors
$225 for Resistors and $225 for Transistors
$250 for Resistors and $200 for Transistors
$107.14 for Resistors, and $42.86 for Transistors
Answer: A
Rationale: $21,000 / 300 direct labor hours = $70 overhead rate;
Resistors 150 direct labor hours x $70 = $10,500 / 100 units = $105 MOH per unit;
Transistors: 150 direct labor hours x $70 = $10,500 / 100 units = $105 MOH per unit.
Topic: Department Rates Calculation
LO: 3
28. Deca Electronics Company produces two products, Resistors and Transistors in a small manufacturing
plant which had total manufacturing overhead of $21,000 in June. The factory has two departments,
Design, which incurred $10,000 of manufacturing overhead, and Production which incurred $11,000
of manufacturing overhead. Design used 200 hours of direct labor and Production used 80 machine
hours.
During June, 150 direct labor hours were used in making 100 units of Resistors, and 150 direct labor
hours were used in making 100 units of Transistors.
If Deca Electronics Company uses a department rate based on direct labor hours for the Design
Department and machine hours for the Production Department, the department overhead rates for the
Design and Production Departments in June were:
A)
B)
C)
D)
$ 50 per direct labor hour for both Design and Production
$ 62.50 per direct labor hour for Design, and $125 per machine hour for Production
$125 per direct labor hour for Design, and $62.50 per machine hour for Production
$ 50 per direct labor hour for Design, and $137.50 per machine hour for Production
Answer: D
Rationale: Design Dept.: $10,000 / 200 = $50.00; Processing Dept.: $11,000 / 80 = $137.50
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Topic: Department Rates Calculation and Application
LO: 3
29. Duke Electric Company produces two products, Resistors and Transistors in a small manufacturing
plant which had total manufacturing overhead of $21,000 in June. The factory has two departments,
Design, which incurred $10,000 of manufacturing overhead, and Production which incurred $11,000
of manufacturing overhead. Design used 250 hours of direct labor and Production used 80 machine
hours.
Assume that Resistors used 100 direct labor hours to make 100 units and Transistors used 150 direct
labor hours to make 100 units in the Design Department. Also, assume that Resistors used 50
machine hours and Transistors used 30 machine hours in the Production Department.
The overhead costs assigned to each unit of Resistors and Transistors using department overhead
rate were:
A) $ 40 for Resistors and $137.50 for Transistors
B) $177.50 for Resistors and $177.50 for Transistors
C) $108.75 for Resistors and $101.25 for Transistors
D) $234.30 for Resistors and $215.60 for Transistors
Answer: C
Rationale:
Design Department: $10,000 / 250 = $40.00
Processing Department: $11,000 / 80 = $137.50
Resistors
Transistors
100 direct labor hrs. x $40
50 machine hrs. x $137.50
$ 4,000
6,875
$10,875
$10,875 / 100 units = $108.75 per unit
150 direct labor hrs. x $40
30 machine hrs. x $137.50
$ 6,000
4,125
$10,125
$10,125 / 100 units = $101.25 per unit
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Topic: Activity Based Costing
LO: 3
30. Sofia Clothing Company produces two products, Jackets and Pants in a small manufacturing plant.
During June, Sofia Clothing produced 100 units of Jackets and 100 units of Pants incurring a total
manufacturing overhead cost of $21,000. Assume Sofia Clothing uses Activity Based Costing and that
its total manufacturing overhead costs of $21,000 were assigned to the following:
ABC cost pools:
Material inspections & preparation ($10,000)
Material moves ($2,000)
Machine setups ($3,000)
Machine operations ($6,000)
$ 10 per pound of raw materials
$ 25 per move
$150 per setup
$ 40 per machine hour
Jackets and Pants used the following quantities of the four activity drivers:
Jackets
Pounds of raw materials
Material moves
Setups
Machine hours
Pants
500
50
12
90
500
30
8
60
The overhead costs assigned to each unit of Jackets and Pants using the Activity based costing
were:
A) $93.50 for Jackets and $116.50 for Pants
B) $116.50 for Jackets and $93.50 for Pants
C) $11,650 for Jackets and $9,350 for Pants
D) $225 for Jackets and $225 for Pants
Answer: B
Rationale:
Jackets
Lbs. of raw materials
Material moves
Setups
Machine hours
500
50
12
90
Pants
$ 10.00
25.00
150.00
40.00
$ 5,000
1,250
1,800
3,600
$11,650
$116.50 per unit
500
30
8
60
$ 10.00
25.00
150.00
40.00
$5,000
750
1,200
2,400
$9,350
$93.50 per unit
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Topic: Customer Profitability Analysis
LO: 5
31. Perfect Painting Services, Inc. provides residential painting services for three home building
companies, Glen Oaks, Streamwood, and Buckington, and it uses a job costing system for determining
the costs for completing each job. The job cost system does not capture any cost incurred by Perfect
for return touchups and refinishes after the homeowner occupies the home. Perfect paints each house
on a square footage contract price, which includes painting as well as all refinishes and touchups
required after the homes are occupied.
Each year, the company generates about one-third of its total revenues and gross profits from each of
the three builders. The Perfect owner has observed that the builders, however, require substantially
different levels of support following the completion of jobs.
The following data have been gathered:
Support Activity
Driver
Major refinishes
Touchups
Communication
Hours on jobs
Number of visits
Number of calls
Builder
Glen Oaks
Streamwood
Buckington
Cost per Driver Unit
$ 40
$ 60
$ 12
Major Refinishes
Touchups
70
125
305
125
105
180
Communication
39
180
175
Assume that each of the three customers produces Gross Profit of $50,000.
The profitability from each builder after taking into account the support activity required for each
builder is:
A) $39,232 Glen Oaks, $36,540 Streamwood, $24,900 Buckington
B) $35,540 Glen Oaks, $40,140 Streamwood, $36,040 Buckington
C) $40,140 Glen Oaks, $35,540 Streamwood, $36,540 Buckington
D) $40,000 Glen Oaks, $35,000 Streamwood, $38,000 Buckington
Answer: A
Rationale:
Activity
Major Refinishes
Touchups
Communication
$40
$60
$12
Total support
Gross profit
Customer profit
Glen Oaks
Streamwoo
d
Buckingto
n
$ 2,800
7,500
468
$10,768
50,000
$39,232
$ 5,000
6,300
2,160
$13,460
50,000
$36,540
$12,200
10,800
2,100
$25,100
50,000
$24,900
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Exercises
Topic: Unit Activity Costs and ABC
LO: 2
1. Johnson Company manufactures two products: 001 and 002. The overhead costs have been divided
into four activity pools that use the following cost drivers:
Product
Product 001
Product 002
Number of
Materials
Requisitions
12
8
Number of
Machine
Setups
35
115
Hours of
Machine
Operation
3,000
1,500
Number of
Product
Inspections
25
55
Cost per Pool
$10,000
$90,000
$135,000
$22,000
Required:
a. Compute the unit activity costs for each of the cost drivers listed.
b. Assign the overhead costs to products 001 and 002 using activity-based costing.
Answer:
a. Unit activity cost calculations:
Unit cost per Materials Requisition = $10,000 / 20 requisitions = $500 per requisition
Unit cost per Machine Setup = $90,000 / 150 setups = $600 per setup
Unit cost per Hour of Machine Operation = $135,000 / 4,500 hours = $30 per hour
Unit cost per Product Inspection = $22,000 / 80 inspections = $275 per inspection
b. Assignment of overhead based on calculations in Part a:
Product 001
Materials Requisitions = (12 requisitions) ($500 per requisition) = $6,000
Machine Setups = (35 setups) ($600 per setup) = $21,000
Machine Operation = (3,000 hours) ($30 per hour) = $90,000
Product Inspection = (25 inspections) ($275 per inspection) = $6,875
Total cost of Product A = $123,875
Product 002
Materials Requisitions = (8 requisitions)($500 per setup) = $4,000
Machine Setups = (115 setups)($600 per run) = $69,000
Machine Operation = (1,500 hours)($30 per hour) = $45,000
Product Inspection = (55 inspections)($275 per order) = $15,125
Total cost of Product B = $133,125
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Topic: Unit Activity Costs and ABC
LO: 2
2. Poncho Corporation manufactures two products: X and Y. The total indirect manufacturing overhead
resource costs of $100,350 have been assigned to four activity cost pools that use the following cost
drivers:
Product
Product X
Product Y
Cost per Pool
Number of Setups
20
10
Machine Runs
35
70
Packing Hours
1,000
1,500
Orders
75
125
$8,100
$5,100
$65,000
$22,000
Required:
a. Compute the unit activity costs for each of the cost drivers listed.
b. Assign the overhead costs to products X and Y using activity-based costing.
Answer:
a. Unit activity cost calculations:
Unit cost per Setup = $8,100 / 30 = $270.00 per setup
Unit cost per Machine Run = $5,250 / 105 = $50 per run
Unit cost per hour of Packing = $65,000 / 2,500 = $26 per hour
Unit cost per Order = $22,000 / 200 = $110 per order
b. Assignment of overhead based on calculations in Part a:
Product X
Setups = (20 setups)($270 per setup) = $5,400
Machine Runs = (35 runs)($50 per run) = $1,750
Packing = (1,000 hours)($26 per hour) = $26,000
Orders = (75 orders)($110 per order) = $8,250
Total cost of Product A = $41,400
Product Y
Setups = (10 setups)($270 per setup) = $2,700
Machine Runs = (70 runs)($50 per run) = $3,500
Packing = (1,500 hours)($26 per hour) = $39,000
Orders = (125 orders)($110 per order) = $13,750
Total cost of Product B = $58,950
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Topic: Departmental Overhead Rates
LO: 3
3. Copper Snap Company manufactures two products, F3 and F4, and incurs overhead costs in two
production departments, Mixing and Filling. The annual overhead costs in each production department
are as follows:

Mixing Dept. overhead = $155,000 + $25 per machine-hour


Filling Dept. overhead = $280,000 + $60 per machine-hour
Each unit of Product F3 requires 1 machine-hour in the Mixing Department and 3 hours in the
Filling Department.
Each unit of Product F4 requires 5 hours in the Mixing Department and 2 hours in the Filling
Department.

During 2020, 30,000 units of F3 and 25,000 units of F4 were produced.
Calculate the total overhead costs assigned to a unit of Product F4, assuming departmental overhead
rates based on machine-hours are used.
Answer:
Each unit of Product F3 used:
1 hour of Mixing × 30,000 units produced = 30,000 hours,
3 hours of Filling × 30,000 units produced = 90,000 hours.
Total hours = 120,000
Each unit of Product F4 used:
5 hours of Mixing × 25,000 units produced = 125,000 hours,
2 hours of Filling × 25,000 units produced = 50,000 hours.
Total hours = 175,000
The total hours of Mixing was 30,000 hours for Product F3 plus 125,000 hours for Product F4 =
155,000 total hours of Mixing.
The total hours of Filling was 90,000 hours for Product F3 and 50,000 hours for Product F4 = 140,000
total hours of Filling.
The cost per hour of Mixing was $155,000 / 155,000 hours + $25 = $26
The cost per hour of Filling was $280,000 / 140,000 hours + $60 = $62
Product F4 uses 5 hours of Mixing × $26 per hour = $130 and 2 hours of Filling × $62 = $124, for a
total overhead cost of $130 + $124 = $254.
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Topic: Plantwide Overhead Cost Calculations
LO: 3
4. Nester Corp. produces three products: Pencils, Staplers, and Crayons. Nester uses a plantwide
overhead rate based on machine hours. The following information is available for the next period:
Product
Units Produced
Machine Hours (Assembly)
Machine Hours (Packing)
Direct Labor hours (per unit)
Direct Materials cost (per unit)
Pencils
1,500
1
1
2
$10.00
Staplers
1,000
3
1
4
$90.00
Crayons
2,000
2
1
3
$30.00
Note that the direct labor wage rate is a flat $25 per hour with no overtime incurred. Also, total
overhead costs are $400,000 for the Assembly Department and $250,000 for the Packing Department.
Calculate the total product cost per unit of Crayons.
Answer:
The total overhead cost is $400,000 (Assembly) + $250,000 (Packing) = $650,000 / Total machine
hours of (1,500 × 2) for pencils + (1,000 × 4) for staplers + (2,000 × 3) for crayons = 13,000 total
machine hours.
The plantwide overhead rate per machine hour = $650,000 / 13,000 = $50 per hour.
The unit cost of crayons is $30 (materials) + (3 × $25) (labor) + (3 × $50) (overhead) = $255 total cost
per crayon.
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Topic: Department Overhead Calculations
LO: 3
5. Nester Corp. produces three products: Pencils, Staplers, and Crayons. Nester uses department
overhead rates for Assembly and Packing, both of which are based on machine hours. The following
information is available for the next period:
Product
Units Produced
Machine Hours (Assembly)
Machine Hours (Packing)
Direct Labor hours (per unit)
Direct Materials cost (per unit)
Pencils
1,000
1
1
2
$10.00
Staplers
1,000
3
1
2
$90.00
Crayons
2,000
2
1
2
$30.00
Note that the direct labor wage rate is a flat $25 per hour with no overtime incurred. Also, total
overhead costs are $400,000 for the Assembly Department and $240,000 for the Packing Department.
Calculate the total product cost per unit of Crayons.
Answer:
The overhead rate for Assembly is $400,000 / [(1,000 × 1) + (1,000 × 3) + (2,000 × 2)] = $50 per
machine hour.
The overhead rate for Packing is $240,000 / [(1,000 × 1) + (1,000 × 1) + (2,000 × 1)] = $60 per machine
hour.
The unit cost of pens is $30 (materials) + (2 × $25) (labor) + (2 × $50) (Assembly overhead) + (1 ×
$60) (Packing overhead) = $240 total unit cost of crayons.
Topic: Plantwide versus Departmental Overhead Rates
LO: 3
6. Nester Corp. produces three products: Pencils, Staplers, and Crayons. Nester uses department
overhead rates for Assembly and Packing, both of which are based on machine hours. The following
information is available for the next period:
Product
Units Produced
Machine Hours (Assembly)
Machine Hours (Packing)
Direct Labor hours (per unit)
Direct Materials cost (per unit)
Pencils
1,000
1
1
2
$10.00
Staplers
1,000
3
1
2
$90.00
Crayons
2,000
2
1
2
$30.00
Note that the direct labor wage rate is a flat $25 per hour with no overtime incurred. Also, total
overhead costs are $420,000 for the Assembly Department and $240,000 for the Packing Department.
Calculate the effect of using a plantwide rate as opposed to departmental overhead rates on the three
products. (Round to two decimal places, when necessary.)
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Answer:
First, calculate the overhead cost of the three products using departmental overhead rates.
The overhead rate for Assembly is $420,000 / [(1,000 × 1) + (1,000 × 3) + (2,000 × 2)]
= $52.50 per machine hour.
The overhead rate for Packing is $240,000 / [(1,000 × 1) + (1,000 × 1) + (2,000 × 1)]
= $60 per machine hour.
The unit overhead cost of pencils is (1 × $52.50) (Assembly overhead) + (1× $60) (Packing overhead)
= $112.50 total unit overhead cost of pencils.
The unit overhead cost of staplers is (3 × $52.50) (Assembly overhead) + (1 × $60) (Packing
overhead) = $217.50 total unit overhead cost of staplers.
The unit overhead cost of crayons is (2 × $52.50) (Assembly overhead) + (1 × $60) (Packing
overhead) = $165 total unit overhead cost of crayons.
Second, calculate the overhead cost of the three products using a plantwide overhead rate.
The total overhead cost is $420,000 (Assembly) + $240,000 (Packing) = $660,000 / Total machine
hours of (1,000 × 2) for pencils + (1,000 × 4) for staplers + (2,000 × 3) for crayons = 12,000 total
machine hours.
The plantwide overhead rate per machine hour = $660,000 / 12,000 = $55 per hour.
The unit overhead cost is 2 × $55 = $110 for pencils, 4 × $55 = $220 for staplers, and 3 × $55 = $165
for crayons.
In this case, the unit overhead cost is more using departmental overhead rates than it is with using
plantwide overhead rates for pencils and less using departmental overhead rates than it is with using
plantwide overhead rates for staplers, and identical for crayons; therefore, there is no crosssubsidization.
Rate/Product
Departmental
Plantwide
Pencils
$112.50
$110.00
Staplers
$217.50
$220.00
Crayons
$165.00
$165.00
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Topic: Plantwide Overhead Rates
LO: 3
7. Gold Company manufactures two products, L6 and L7, and incurs overhead costs in two production
departments, Mixing and Filling. The annual overhead costs in each production department are as
follows:

Mixing Dept. overhead = $175,000 + $25 per machine-hour


Filling Dept. overhead = $235,000 + $60 per machine-hour
Each unit of Product L6 requires 1 machine-hour in the Mixing Department and 3 hours in the
Filling Department.
Each unit of Product L7 requires 5 hours in the Mixing Department and 2 hours in the Filling
Department.

During 2020, 30,000 units of L6 and 25,000 units of L7 were produced.
Calculate the total overhead costs assigned to a unit of Product L6, assuming plantwide overhead
rates based on machine-hours are used. (Round to two decimal places, when necessary.)
Answer:
Each unit of Product L6 used:
1 hour of Mixing × 30,000 units produced = 30,000 hours, and
3 hours of Filling × 30,000 units produced = 90,000 hours.
Each unit of Product L7 used:
5 hours of Mixing × 25,000 units produced = 125,000 hours, and
2 hours of Filling × 25,000 units produced = 50,000 hours.
Total Hours of Mixing = 30,000 hours + 125,000 hours = 155,000 hours
Total Hours of Filling = 90,000 hours + 50,000 hours = 140,000 hours
The total hours of Mixing was 30,000 hours for Product L6 plus 125,000 hours for Product L7 =
155,000 total hours of Mixing.
The total hours of Filling was 90,000 hours for Product L6 and 50,000 hours for Product L7 = 140,000
total hours of Filling.
The total cost incurred in Mixing was $175,000 + (155,000 hours × $25) = $4,050,000, and the total
cost incurred in Filling was $235,000 + (140,000 hours × $60) = $8,635,000.
The total overhead incurred in both Mixing and Filling was $4,050,000 + $8,635,000 = $12,685,000.
Total Mixing and Filling machine hours was 155,000 + 140,000 = 295,000 hours.
The plantwide overhead rate per hour was $12,685,000/ 295,000 hours = $43.00 per hour.
Each unit of Product L6 used 1 machine hour in Mixing and 3 machine hours in Filling for a total of 4
machine hours.
At $43.00 per hour, the total overhead cost assigned to a unit of Product L6 was $172.00.
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Problems
Total: Activity-Based Costing
LO: 2
1. Lion Company has identified the following overhead costs and cost drivers for next year:
Overhead Item
Setup costs
Ordering costs
Maintenance
Power
Expected Costs
$583,200
270,000
928,000
90,000
Cost Driver
Number of setups
Number of orders
Machine-hours
Kilowatt-hours
Maximum Quantity
2,400
20,000
32,000
200,000
The following are two of the jobs completed during the year:
Job 626
$9,000
$12,000
750
45
6
8
180
90
Direct materials
Direct labor
Units completed
Direct labor-hours
Number of setups
Number of orders
Machine-hours
Kilowatt-hours
Job 627
$10,000
7,000
600
110
7
15
150
120
Determine the unit cost for each job using the four cost drivers. (Round amounts to 2 decimal places.)
Answer:
Unit cost for Job 626: $37.10
Unit cost for Job 627: $68.65
Setup: $583,200 / 2,400 = $243/setup
Ordering: $270,000 / 20,000 = $13.50/order
Maintenance: $928,000 / 32,000 = $29/hour
Power: $90,000 / 200,000 = $0.45/kilowatt-hour
Job 626
$9,000
12,000
Direct materials
Direct labor
Overhead assigned:
$243 per setup x 6 setups
1,458
$13.50 per order times 8 orders
$29 per hour times 180 hours
$0.45 per kwh times 90 kwh
Total cost
Unit cost
108
5,220
41
$55,653
$37.10
Job 627
$10,000
15,000
Direct materials
Direct labor
Overhead assigned:
$243 per setup x 7 setups
1,701
$13.50 per order times 15 orders
$29 per hour times 150 hours
$0.45 per kwh times 120 kwh
Total cost
Unit cost
203
4,350
54
$31,308
$52.18
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Total: Activity-Based Costing
LO: 2
2. Halo Manufacturing Company has developed the following activity cost information for its
manufacturing activities:
Assembly
Drilling
Inspection
Machine setup
Movement
Shaping
Welding
$15 per hour
$4 per hole
$2 per inspection
$200 per batch
$15 per batch plus $0.20 per lb.
$25 per hour
$5 per inch
Filling a batch order for 45 units with a combined weight of 200 pounds required:





Three sets of inspections per unit
Drilling four holes in each unit
Completing 20 inches of welds on each unit
0.6 hour of shaping for each unit
One hour of assembly per unit
Calculate the total cost to produce a batch of 45 units.
Answer:
Assembly ($15 x 45)
Drilling ($4 x 4 x 45)
Inspection ($2 x 3 x 45)
Machine setup ($200 x 1)
Movement [$15 + ($0.20 x 200)]
Shaping ($25 x 0.6 x 45)
Welding ($5 x 20 x 45)
Total
$ 675
720
270
200
55
675
4,500
$7,095
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Total: Traditional and Activity-Based Costing
LO: 2, 3
3. Oxford Corporation has four categories of overhead. The expected overhead costs for each category
for next year are as follows:
Maintenance
Materials handling
Setups
Inspection
$210,000
90,000
75,000
150,000
The company has been asked to submit a bid for a proposed job. The plant manager believes that
obtaining this job would result in new business in future years. Bids are usually based upon full
manufacturing cost plus 30 percent. Estimates for the proposed job are as follows:
Direct materials
Direct labor (375 hours)
Number of material moves
Number of inspections
Number of setups
Number of machine-hours
$5,000
$7,500
4
3
2
150
Expected activity for the four activity-based cost drivers that would be used is:
Machine-hours
Material moves
Setups
Quality inspections
10,000
2,000
100
4,000
Required:
a. Determine the amount of overhead that would be allocated to the proposed job if 20,000 direct
labor-hours are used as the volume-based cost driver. Determine the total costs of the proposed
job. Determine the company's bid, if the bid is based upon full manufacturing cost plus 30 percent.
(Round amounts to 2 decimal places.)
b. Determine the amount of overhead that would be applied to the proposed project if activity-based
costing is used. Determine the total costs of the proposed job if activity-based costing is used.
Determine the company's bid if activity-based costing is used and the bid is based upon full
manufacturing cost plus 30 percent. (Round amounts to 2 decimal places.)
c.
Which product costing method produces the more competitive bid?
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Answer:
a. Amount of overhead allocation: ($210,000 + $90,000 + $75,000 + $150,000) / 20,000
= $26.25 / DLH $26.25  375 DLH = $9,843.75
Total cost of job: ($5,000 + $7,500 + $9,843.75) = $22,343.75
Company bid: ($22,343.75 x 130%) = $29,046.88
b. Amount of overhead allocation:
Maintenance: $210,000 / 10,000 = $21/MH
Materials handling: $90,000 / 2,000 = $45/move
Setups: $75,000 / 100 = $750/setup
Inspection: $150,000 / 4,000 = $37.50/inspection
Overhead assigned:
$21/MH times 150 MH
$45 per move times 4 moves
$750 per setup times 2 setups
$37.50 per inspection times 3 inspections
$3,150.00
180.00
1,500.00
112.50
$4,942.50
Total cost of job: $5,000 + $7,500 + $4,942.50 = $17,442.50
Company bid: $17,442.50  130% = $22,675.25
c.
Presumably, activity-based costing produces more precise cost information because it tracks the
actual drivers of cost and provides more detailed information. To the extent this presumption is
true, the activity-based costing produces a more competitive bid.
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Essay Questions
Topic: Activity-Based Costing Concepts
LO: 2
1. The most critical step in activity-based costing is identifying cost drivers. Explain this statement.
Answer:
The activity cost driver for a particular cost (or cost pool) is the characteristic selected for measuring
the quantity of the activity for a particular period of time. It is critical that the activity measure used
has a logical causal relationship to the costs in the pool. Statistical methods such as regression
analysis and correlation analysis can be very useful in selecting activity cost drivers; however, analysis
of processes and activities that make up those processes (including interviews with people involved in
those processes) often provides more useful insight into what is the most appropriate cost driver for a
given activity cost pool.
Topic: Cross-Subsidization
LO: 3
2. What is cross-subsidization and when is it most likely to occur?
Answer:
Cross-subsidization is essentially the assignment of indirect, or overhead, costs to the wrong product.
This occurs when one product is assigned too much cost as a result of another being assigned too
little. The product receiving too much cost assignment subsidizes the product that should have
received the cost assignment. Cross-subsidization is most likely to occur when multiple products are
produced using a variety of production procedures.
Topic: Importance of Accurate Cost Measurements
LO: 3
3. Why is it important to have a product costing system that produces reasonably accurate and precise
cost measurements?
Answer:
It is important to have a costing system that provides external users of financial statements with reliable
information about earnings and net worth and to provide internal managers with the information they
need for decision making. For financial reporting purposes, highly generalized costs systems are often
used which are accurately applied, but they are generally inadequate for evaluating the profitability of
individual products, or making decisions about the future of those products in the product line, because
these generalized cost systems do not provide a high level of precision in measuring actual costs.
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Topic: Traditional Costing Distortions
LO: 4
4. Comment on cost distortions commonly observed in traditional costing systems.
Answer:
Studies have shown that distortions occur regularly in traditional costing systems in which a significant
variation exists in the volume and complexity of products and services produced. Traditional systems
tend to overcost high-volume, low-complexity products, and they tend to undercost low-volume, highcomplexity products. In companies with a large number of different products, traditional costing can
show that most products are profitable, but after changing to activity- based costing (ABC), these
companies might find that they are actually losing money on products they previously thought were
profitable, and that they are making money on products they previously thought were losers. Adopting
ABC often leads to increased profits merely by changing the product mix to minimize the number of
unprofitable products.
Topic: Customer Profitability
LO: 5
5. How can ABC used to improve customer profitability analysis?
Answer:
Customers make varying demands on companies with some customers requiring little support and
others requiring substantial amounts. Using ABC, companies can determine the amount of its various
customer support activities, and their related costs, that are incurred for the benefit of each customer.
Customer profitability can be determined by deducting customer-specific support costs from customer
generated gross profit. Some customers may be revealed as unprofitable and other customers may
be more or less profitable than others.
ABC should reveal how much of various support costs are used by less profitable customers.
Management should investigate these data and perhaps discuss the usage with the customer.
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