Review for Exam II
Problem 1: Quarterly budget preparation
•
Milo Company manufactures beach umbrellas. The company is preparing detailed
budgets for the third quarter and has assembled the following information to assist in the
budget preparation:
•
The Marketing Department has estimated sales as follows for the remainder of the year
(in units):
July
30,000
August
70,000
September
50,000
October
20,000
November
10,000
December
10,000
•
The budgeted selling price of the beach umbrella is $12 per unit. Company aims to
maintain finished goods inventory of 15% of the following month’s sales.
•
Each umbrella requires 4 feet of Gilden and the company’s policy is to maintain 50% of
the following month’s production needs (Sometimes it is hard to get this material and
hence the hefty amount of inventory). Budgeted purchase price for Gilden is $0.80 per
foot.
•
While the company has a stated inventory policy, because of the uncertainty, the actual
inventory can differ. The actual inventory on July 1 for the finished goods and Gilden are
5,000 units and 60,000 feet respectively.
•
Derive the sales budget, production budget and the purchase budget for Gilden for the 3rd
quarter, month by month as well as for the total 3rd quarter.
1
Solution:
Sequence matters: Sales budget  Production Budget  RM budget
Sales budget:
Units budgeted
to be sold
Budgeted sales
dollars
July
30,000
August
70,000
September
50,000
$360,000
$840,000
$600,000
3rd Quarter
Production budget:
•
Use the inventory equation: # of units to be produced = # of units to be sold + Budgeted
change in the inventory of finished goods.
•
# of units to be sold + (15% of next month’s sales - 15% of current sales)
•
For July # of units of production = 30,000 + (15% of 70,000 – 15% of 30,000)
July
Budgeted sales
units
Add: Desired
ending inventory
Less: Desired
beg. inventory
Budgeted
production units
3rd Quarter
150,000
30,000
August
70,000
September
50,000
10,500
7,500
3,000
3,000
4,500
10,500
7,500
4,500
36,000
67,000
45,500
148,500
RM Budget (output = 1 umbrella; input = 4 feet of gilden)
Input output relationship: 1 unit of output requires 4 gilden
For July, budgeted consumption of gilden = 36,000 x 4 feet per unit = 144,000
Inventory policy for RM: Ending inventory = 50% of next month’s quantity of gilden to be
consumed
Budgeted beg inventory of gilden for July = 0.5 x 144,000 = 72,000
Actual inventory of gilden = 60,000 (given data)
Budgeted consumption of gilden for August = 67,000 x 4 = 268,000
Budgeted End. Inventory of gilden for July = 0.5 x 268,000 = 134,000
2
Budgeted purchase qty of gilden for July = Budgeted consumption of gilden + budgeted changed
of gilden during July
Raw materials Budget:
Budgeted
production units
(umbrellas)
Budgeted
consumption of
gilden
Add: Desired
end. Inventory
of gilden
Less: Desired
beg. Inventory
of gilden
Budgeted
purchase of
gilden (in feet)
Purchase budget
(in $) for gildent
July
36,000
August
67,000
September
45,500
3rd Quarter
148,000
144,000
268,000
182,000
592,000
134,000
91,000
37,000
37,000
60,000
134,000
91,000
60,000
218,000
225,000
128,000
569,000
$174,400
$180,000
$102,400
$455,200
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Problem 2: The FeelGood company manufactures vitamins. Each bottle contains 100 tablets, and
each tablet contains 500 mg. of Vitamin C. FeelGood has prepared the following budget for
producing one bottle of Vitamin C.
Direct Materials 52,500 mg @ $0.0001 per mg
Direct Labor
6 minutes @ $12.00 per hour
•
For the most recent month, FeelGood produced 2,500 bottles of Vitamin C and reported
the following variance data:
DM price variance
$3,000 Favorable
DM Qty. variance
$1,875 Unfavorable
DL price variance
$188 Unfavorable
DL Qty. variance
$180 Favorable
•
Find the actual quantity of DM used, actual price paid for DM, actual DL hours
consumed, actual wage rate for DL.
•
Also find the total DM, total DL variances.
Solution:
Step 1: Find the flexible budget for the month

Flexible budget should be based on actual output for the month = 2,500

Flexible budget quantity of DM = (2,500 * 52.5gm = 131,250g)

Flexible budget cost = (131,250g *$0.1 = $13,125)
•
Let SQ, AQ, SP, AP represent budgeted and actual quantity and budgeted and actual
price of DM respectively.
•
DM quantity variance = $1,875 U  What is the relationship between AQ and SQ?
• (AQ- 131,250) X $0.1 = 1,875  AQ = (13,125 + 1,875)/0.1 = 150,000 gms.
150,000,000 gms.
•
DM price variance = $3,000 F  What is the relationship between AP and SP?
• ($0.1 – AP) 150,000 = 3,000  AP = $0.08 per gm = $0.00008 per mg.
•
•
Total DM variance = $1,875 U + $3,000 F = $1,125 F
This should be the difference between FB DM cost (=$13,125) and actual DM cost
(=$12,000)
4
DL cost variances:
•
Flexible budget for the month based on the actual output for the month:
Flexible budget qty 2,500 X 0.1 = 250 hours
Flexible budget cost 250 X $12.00 = $3,000
•
•
•
•
•
Let SH, AH, SR, AR represent budgeted and actual DL hours and wage rate respectively.
DL quantity variance = $180 F  SH must be greater than AH
• (250 - AH) X $12 = 180  AH = 250 – (180/12) = 235 hours
DL Rate variance = $188 U  AR must be greater than SR
• (AR – $12) 235 = 188  AR = $12.80 per DLH.
Total DL variance = $180 F + $188 U = $8 U
This should be the difference between actual DL cost (=$3,008) and FB DL cost
(=$3,000).
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Problem 3
•
Bradshaw Industries makes two varieties – Standard and Deluxe – of one of its products.
The following information is available:
# of units
Standard
Deluxe
250,000
50,000
DL hrs. /
unit
2
4
Price per
unit
$14
$18
Var. costs
per unit
$8
$9
UCM per
unit
$6
$9
•
•
The fixed costs for Bradshaw is $1,400,000.
Bradshaw is considering a proposal to change the product mix between standard and
Deluxe to 1:1 but keep the total units of production at the same level.
Required:
A) Allocate fixed costs using # of units. Calculate the expected profit under the new product
mix.
B) Allocate the fixed costs using # of DLH. Calculate the expected profit under the new
product mix.
C) Which of the two estimates above seem reasonable? Why?
Solution
First calculate the current operating income
 Current income = 250,000($6) + 50,000($9) = $1,950,000 - $1,400,000 = $550,000
Compute the fixed cost allocation rate using @ of units as cost allocation driver.
•
•
Fixed cost per unit = $1,400,000/300,000 units = $4.666667 per unit.
Notice that since the total # of units don’t change after the product mix change, the total
fixed cost (projected based on the above cost allocation rate) will remain the same. Since
the new product mix has more units of Deluxe, operating profit will go up.
• Profit before product mix change:
Profit from Standard = 250,000 ($14-$8) – 250,000($4.666667) = $333,333
Profit from Deluxe = 50,000($18-$9) – 50,000 ($4.666667) = $216,667
Total profit
= $550,000
• Operating income with the new product mix =
150,000($6) + 150,000($9) – (300,000) $4.66667 = $850,000
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Now compute the allocation rate using DL hours.
$1,400,000
•
Cost allocation rate =
•
Suppose the fixed costs change when product mix changes. What would be the new level
of fixed costs?
DL hours after product mix was changed = 150,000 (2) + 150,000(4) = 900,000 hours.
In other words, DL hours increase by 28.6%
If we believe in a robust relationship between DL hours and fixed costs, then the
operating income after product mix has changed can be obtained as:
Contribution margin = 150,000 ($6) + 150,000($9) = $2,250,000
Predicted fixed costs = 900,000 X $2 = $1,800,000
Predicted operating income after product mix change = $450,000
•
•
•
700,000
= $2 per DL hour.
Problem 4:
Precision Manufacturing Inc. makes two types of hydraulic valves: EX300 and TX500. Relevant data
about production and cost are provided below:
# of units produced
Direct materials cost
Direct Labor cost
EX200
60,000
$366,325
$120,000
TX500
12,500
$162,500
$42,500
•
The company currently allocates overhead cost using direct labor dollars. Implementation
of ABC is under consideration.
Activity measure
Activity Cost Pool (and activity
Mfg. OH
EX300
TX500
measure)
Machining (machine-hours)
$198,250 90,000
62,500
Machine
hours
Setup (setup hours)
150,000
75
300
Setups
Product level (# of batches)
100,250
1
1
# of products
General factory (Direct Labor
60,125 $120,000 $42,500
dollars)
Total mfg. Oh cost
$508,625
•
•
•
Use the current allocation method and compute the cost of the products.
Use ABC to compute the cost of products.
Calculate the extent of over/undercosting under conventional costing system.
7
Solution:
Step 1: Calculate product cost under existing system
Mfg. OH cost allocation rate under current system =
$508,625
$162,500
= $3.13 per DL $
EX300
TX500
Direct Materials
$366,325 $162,550
Direct Labor
120,000
42,500
Mfg. OH applied @$3.13 per DL $ 375,600 133,025
$861,925 $338,075
Divide by # of units produced
60,000
12,500
Cost per unit
$14.37
$27.05
Step 2: Calculate product cost under proposed system
Activity cost pool
Machining
Setup
Product level
General factory
Cost in the pool
$198,250
150,000
100,250
60,125
Direct materials
Direct labor
Machining
Setups
Product sustaining
General factory
Cost per unit
Total Activity
152,500 M/c hrs.
375 setup hours
2 products
162,500 DL $
EX300
$366,325
120,000
117,000
30,000
50,125
44,400
$727,850
$12.13
Activity Rate
$1.30 per M/c hr.
$400 per setup hr.
$50,125 per product
$0.37 per DL$
TX500
$162,550
42,500
81,250
120,000
50,125
15,725
$472,150
$37.77
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Problem 5
•
Provident Company (PC) has several divisions. Mining division refines toldine which is
used as an input by the metal division in the production of an alloy. Metal division sells
this alloy to customers @ a price of $150 per unit. Mining division is required to transfer
its entire output of 400,000 units of toldine to the metals division @ a transfer price of
full manufacturing cost plus 10% markup. Unlimited quantities of toldine can be
purchased and sold in the open market at $90 per unit. If the mining division opts to sell
toldine in the outside market, it would incur a variable selling cost of $5 per unit. The
cost structure for both divisions are provided below:
Mining division
Metals division
Direct material
$12
$6
Direct labor
16
20
Variable manufacturing
8
12
overhead
Fixed manufacturing
24
13
overhead
•
The direct material cost for the metals division (given in the table above) excludes the
transfer price paid by the metals division to the mining division for todline.
A. Compute the transfer price that is used by PC.
B. Use the ideal transfer price rule to find the appropriate transfer price that should be used
by PC assuming the Mining division can sell a maximum of 760,000 units of todline in
external market.
i.
Assume that the capacity of Mining division is 400,000 units.
ii.
Assume that the capacity of Mining division is 1,000,000 units.
C. Assume that PC follows the full cost plus 10% transfer price and Mining division’s
capacity is 2,000,000 units. A customer is approaching the metal division with a special
order for a quantity of 100,000 units @ a special order price of $100 per unit. Assume
that Metals division has enough capacity to execute this special order and has the
authority to make a decision for the special order. Will his decision result in goal
congruence? Why or Why not?
D. Assume everything as in (C) but transfer price is as per ideal TP rule. Is there goal
congruence?
9
Solution:
• Characterize the cost details for both divisions:
•
Variable cost for internal transfer = Variable manufacturing cost for Mining = $12
+ $16 +$8 = $36
•
Variable cost for Mining for external sales =
•
Variable cost for Metals (excluding the transfer price) = $6 +$ 20 + $12 = $38
A. Find the transfer price in vogue today:
• Full manufacturing cost of todline for the Mining division (for internal transfer) =
Variable cost of manufacturing + Fixed manufacturing overhead cost
•
Transfer price = $60 + 10% of $60 = $66
B. Ideal transfer price = incremental cost of transfer plus opportunity cost of transfer
B(i): In part B(i), as per the data in the problem, Mining is operating @ capacity. For
every unit of transfer, Mining loses an opportunity to sell todline @ $90 per unit in
external market.
Incremental cost of transfer = Variable mfg. cost =
Opportunity cost of transfer =
Ideal transfer price =
10
B. (ii) Incremental cost of transfer is the same as in B(i) =
What is the opportunity cost of transfer now?
Metals has a capacity of 1,000,000 units and can sell in external market only 760,000. It can
transfer up to 240,000 without losing any external sales. If Metals has to transfer 400,000 units
internally, then it loses the opportunity of selling 160,000 units in the external market.
Opportunity cost of transfer =
Average opportunity cost of transfer =
Ideal TP =
C. Metal division has capacity of 2,000,000 units. After selling 750,000 in external market,
it can transfer 400,000 units to Mining without any opportunity cost. In addition, it can
transfer 100,000 units required by the special order without any opportunity cost.
 Let us first evaluate the special order from the perspective of the Metal division manager
who has the authority to make this decision.
Variable cost of executing the special order = $38 + $66 = $104. What would the Metal
division manager decide?

Now evaluate the special order from the perspective of Provident Corporation.
Variable cost of executing the special order = $36 + $38 = $74
Contribution from the special order = $100 – 74 = $26 per unit  incremental profit from the
special order = 100,000 ($26) = $2,600,000
Corporation would want the Metals division manager to accept the special order.
Is there goal congruence ?
11
D. Ideal TP rule would suggest the following transfer price:
TP = outlay cost + opportunity cost = $36 + 0 = $36
Now, the perspective of the Metals division manager would change. The relevant cost of
executing the special order = Transfer price for todline + $38 = $74
Notice that the relevant cost of executing the special order from the perspective of the divisional
manager converges with the relevant cost of executing the special order from the perspective of
the Corporation.
Since the special-order price exceeds the relevant cost of special order, Metals division manager
would ACCEPT the special order.
Goal Congruence WILL OCCUR.
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