Problem 2-19
1
Name of the Cost
Staci's current salary, $3,800 per
month........................................
Building rent, $500 per month ........
Clay and glaze, $2 per pot .............
Wages of production workers, $8
per pot.......................................
Advertising, $600 per month ..........
Sales commission, $4 per pot .........
Rent of production equipment,
$300 per month..........................
Legal and filing fees, $500 .............
Rent of sales office, $250 per
month........................................
Phone for taking orders, $40 per
month........................................
Recording device added to phone
Interest lost on savings account,
$1,200 per year ..........................
Period
(sellin
Product Cost
g
Vari
Direct
Mfg.
and
Opport
able Fixed Material Direct Overh admin) unity
Cost Cost
s
Labour ead
Cost
Cost
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
Sunk
Cost
X
X
2. The $500 cost of incorporating the business is not a differential cost. Even though the cost was incurred
to start the business, it is a sunk cost. Whether Staci produces pottery or stays in her present job, she will
have incurred this cost.
1
Case 2-31
1. No distinction has been made between period expenses and product
costs on the income statement filed by the company’s accountant.
Product costs (e.g., direct materials, direct labour, and manufacturing
overhead) should be assigned to inventory accounts and flow through to
the income statement as cost of goods sold only when finished products
are sold. Since there were ending inventories, some of the product costs
should appear on the balance sheet as assets rather than on the income
statement as expenses.
2.
Solar Technology, Inc.
Schedule of Cost of Goods Manufactured
For the Quarter Ended March 31
Direct materials:
Raw materials inventory, beginning .............. $
0
Add: Purchases of raw materials................... 360,000
Raw materials available for use .................... 360,000
Deduct: Raw materials inventory, ending ......
10,000
Raw materials used in production .................
$350,000
Direct labour .................................................
70,000
Manufacturing overhead:
Maintenance, production..............................
43,000
Indirect labour ............................................ 120,000
Cleaning supplies, production .......................
7,000
Rental cost, facilities (80% x $75,000) ..........
60,000
Insurance, production..................................
8,000
Utilities (90% x $80,000) .............................
72,000
Depreciation, production equipment.............. 100,000
Total overhead costs ......................................
410,000
Total manufacturing costs ..............................
830,000
Add: Work in process inventory, beginning ......
0
830,000
Deduct: Work in process inventory, ending ......
50,000
Cost of goods manufactured ...........................
$780,000
2
Case 2-31 (continued)
3. Before an income statement can be prepared, the cost of the 8,000
batteries in the ending finished goods inventory must be determined.
Altogether, the company produced 40,000 batteries during the quarter;
thus, the production cost per battery would be:
Cost of goods manufactured
Batteries produced during the quarter
=
$780,000
40,000 units
=$19.50 per unit
Since 8,000 batteries (40,000 x 32,000 = 8,000) were in the finished
goods inventory at the end of the quarter, the total cost of this
inventory would be:
8,000 units x $19.50 per unit = $156,000.
With this figure and other data from the case, the company’s income
statement for the quarter can be prepared as follows:
Solar Technology, Inc.
Income Statement
For the Quarter Ended March 31
Sales (32,000 batteries) ..............................
Less cost of goods sold:
Finished goods inventory, beginning..........
Add: Cost of goods manufactured ............
Goods available for sale............................
Deduct: Finished goods inventory, ending..
Gross margin .............................................
Less operating expenses:
Selling and administrative salaries .............
Advertising ..............................................
Rental cost, facilities (20% x $75,000).......
Depreciation, office equipment..................
Utilities (10% x $80,000)..........................
Travel, salespersons.................................
Net operating income .................................
3
$960,000
$
0
780,000
780,000
156,000
110,000
90,000
15,000
27,000
8,000
40,000
624,000
336,000
290,000
$ 46,000
Case 2-31 (continued)
4.
No, the insurance company probably does not owe Solar Technology
$226,000. The key question is how “cost” was defined in the insurance
contract. It is most likely that the insurance contract limits reimbursement
for losses to those costs that would normally be considered product costs—
in other words, direct materials, direct labour, and manufacturing
overhead. The $226,000 figure is overstated since it includes elements of
selling and administrative expenses as well as all of the product costs. The
$226,000 figure also does not recognize that some costs incurred during
the period are in the ending Raw Materials and Work in Process inventory
accounts, as explained in part (1) above. The insurance company’s liability
is probably just $156,000, which is the amount of cost associated with the
ending Finished Goods inventory as shown in part (3) above.
4
Problem 5-16
1. a. 3
b. 6
c. 11
d. 1
e. 4
f. 10
g. 2
h. 7
i. 9
2. Without a knowledge of the underlying cost behaviour patterns, it would
be difficult if not impossible for a manager to properly analyze the firm’s
cost structure. The reason is that all costs don’t behave in the same
way. One cost might move in one direction as a result of a particular
action, and another cost might move in an opposite direction. Unless the
behaviour pattern of each cost is clearly understood, the impact of a
firm’s activities on its costs will not be known until after the activity has
occurred.
5
Problem 6-19
1. The CM ratio is 30%.
Total
Sales (19,500 units) ..........$585,000
Less variable expenses ...... 409,500
Contribution margin...........$175,500
Per Unit Percent of Sales
$30.00
21.00
$ 9.00
100%
70
30%
The break-even point is:
Sales
$30.00Q
$9.00Q
Q
Q
=
=
=
=
=
Variable expenses + Fixed expenses + Profits
$21.00Q + $180,000 + $0
$180,000
$180,000 ÷ $9.00 per unit
20,000 units
20,000 units x $30.00 per unit = $600,000 in sales.
Alternative solution:
Fixed expenses
Break-even point =
in unit sales
Unit contribution margin
=
$180,000
$9.00 per unit
=20,000 units
Break-even point = Fixed expenses
in sales dollars
CM ratio
=
$180,000
0.30
= $600,000 in sales
2. Incremental contribution margin:
$80,000 increased sales x 0.30 CM ratio ................. $24,000
Less increased advertising cost .............................. 16,000
Increase in monthly operating income .................... $ 8,000
Since the company is now showing a loss of $4,500 per month, if the
changes are adopted, the loss will turn into a profit of $3,500 each
month ($8,000 less $4,500 = $3,500).
6
Problem 6-19 (continued)
3. Sales (39,000 units @ $27.00 per unit*) ............ $1,053,000
Less variable expenses
(39,000 units @ $21.00 per unit)....................
819,000
Contribution margin .........................................
234,000
Less fixed expenses ($180,000 + $60,000) ........
240,000
Operating loss ................................................. $
(6,000)
*$30.00 – ($30.00 x 0.10) = $27.00
4.
Sales
$30.00Q
$8.25Q
Q
Q
=
=
=
=
=
Variable expenses + Fixed expenses + Profits
$21.75Q* + $180,000 + $9,750
$189,750
$189,750 ÷ $8.25 per unit
23,000 units
*$21.00 + $0.75 = $21.75
Alternative solution:
Unit sales to attain = Fixed expenses + Target profit
target profit
CM per unit
=
$180,000 + $9,750
$8.25 per unit**
=23,000 units
**$30.00 – $21.75 = $8.25
5. a. The new CM ratio would be:
Per Unit
Sales ............................. $30.00
Less variable expenses.... 18.00
Contribution margin ........ $12.00
7
Percent of Sales
100%
60
40%
Problem 6-19 (continued)
The new break-even point would be:
Fixed expenses
Break-even point =
in unit sales
Unit contribution margin
=
$180,000 + $72,000
$12.00 per unit
=21,000 units
Break-even point = Fixed expenses
in sales dollars
CM ratio
=
$180,000 + $72,000
0.40
=$630,000
b. Comparative income statements follow:
Not Automated
Per
Total
%
Unit
Sales (26,000
units) ............ $780,000 $30.00 100%
Less variable
expenses ....... 546,000 21.00 70
Contribution
margin .......... 234,000 $ 9.00 30%
Less fixed
expenses ....... 180,000
Operating
income .......... $ 54,000
Automated
Per
Total
Unit
%
$780,000 $30.00 100%
468,000
18.00
312,000 $12.00
60
40%
252,000
$ 60,000
c. Whether or not the company should automate its operations depends
on how much risk the company is willing to take and on prospects for
future sales. The proposed changes would increase the company’s
fixed costs and its break-even point. However, the changes would
also increase the company’s CM ratio (from 0.30 to 0.40). The higher
CM ratio means that once the break-even point is reached, profits will
increase more rapidly than at present. If 26,000 units are sold next
month, for example, the higher CM ratio will generate $6,000 more in
profits than if no changes are made.
8
Problem 6-19 (continued)
The greatest risk of automating is that future sales may drop back
down to present levels (only 19,500 units per month), and as a
result, losses will be even larger than at present due to the
company’s greater fixed costs. (Note the problem states that sales
are erratic from month to month.) In summary, the proposed
changes will help the company if sales continue to trend upward in
future months; the changes will hurt the company if sales drop back
down to or near present levels.
Note to the Instructor: Although it is not asked for in the problem,
if time permits you may want to compute the point of indifference
between the two alternatives in terms of units sold; i.e., the point
where profits will be the same under either alternative. At this point,
total revenue will be the same; hence, we include only costs in our
equation:
Let Q
$21.00Q + $180,000
$3.00Q
Q
Q
= Point of indifference in units sold
= $18.00Q + $252,000
= $72,000
= $72,000 ÷ $3.00 per unit
= 24,000 units
If more than 24,000 units are sold in a month, the proposed plan will
yield the greater profits; if less than 24,000 units are sold in a month,
the present plan will yield the greater profits (or the least loss).
9