RSM222 Winter 2014 Solutions for Self-Study...

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RSM222 Winter 2014

Solutions for Self-Study Questions

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Exercise 2-10

1.

Eccles Company Schedule of Cost of Goods Manufactured

For the year ended xxx

Direct materials: Raw materials inventory, beginning .............. $ 8,000 Add: Purchases of raw materials .................. 132,000 Raw materials available for use .................... 140,000 Deduct: Raw materials inventory, ending ..... 10,000 Raw materials used in production ................ $130,000

Direct labour ................................................. 90,000 Manufacturing overhead:

Rent, factory building .................................. $ 80,000 Indirect labour ............................................ 56,300 Utilities, factory ........................................... 9,000 Maintenance, factory equipment .................. 24,000 Supplies, factory ......................................... 700 Depreciation, factory equipment .................. 40,000 Total manufacturing overhead costs ............. 210,000

Total manufacturing costs .............................. 430,000 Add: Work in process, beginning .................... 5,000 435,000 Deduct: Work in process, ending .................... 20,000 Cost of goods manufactured .......................... $415,000

2. The cost of goods sold section would be:

Finished goods inventory, beginning ............... $ 70,000 Add: Cost of goods manufactured .................. 415,000 Goods available for sale ................................. 485,000 Deduct: Finished goods inventory, ending ....... 25,000 Cost of goods sold ......................................... $460,000

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Problem 2-26

1. Hickey Corporation

Schedule of Cost of Goods Manufactured For the year ended xxxx

Direct materials: Raw materials inventory, beginning ................ $ 20,000 Add: Purchases of raw materials .................... 160,000 Raw materials available for use ...................... 180,000 Deduct: Raw materials inventory, ending ....... 10,000 Raw materials used in production .................. $170,000

Direct labour ................................................... 80,000 Manufacturing overhead:

Indirect labour .............................................. 60,000 Building rent (80% × $50,000) ..................... 40,000 Utilities, factory ............................................. 35,000 Royalty on patent

($1 per unit × 30,000 units) ...................... 30,000 Maintenance, factory ..................................... 25,000 Rent on equipment:

$6,000 + ($0.10 per unit × 30,000 units) ... 9,000 Other factory overhead costs ......................... 11,000

Total overhead costs ....................................... 210,000 Total manufacturing costs ................................ 460,000 Add: Work in process inventory, beginning ....... 30,000 490,000 Deduct: Work in process inventory, ending ....... 40,000 Cost of goods manufactured ............................ $450,000

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Problem 2-26 (continued)

2. a. To compute the number of units in the finished goods inventory at the end of the year, we must first compute the number of units sold during the year.

Total sales $650,000 = = 26,000 units sold

Unit selling price $25 per unit

Units in the finished goods inventory, beginning ....... 0 Units produced during the year ............................... 30,000 Units available for sale ............................................ 30,000 Units sold during the year (above) .......................... 26,000 Units in the finished goods inventory, ending ........... 4,000

b. The average production cost per unit during the year would be:

gCost of oods manufactured $450,000= = $15 per unit.

Number of units produced 30,000 units

Thus, the cost of the units in the finished goods inventory at the end of the year would be: 4,000 units × $15 per unit = $60,000.

3. Hickey Corporation Income Statement

For the year ended xxxx

Sales ................................................................... $650,000 Cost of goods sold:

Finished goods inventory, beginning ................... $ 0 Add: Cost of goods manufactured ....................... 450,000 Goods available for sale...................................... 450,000 Finished goods inventory, ending ........................ 60,000 390,000

Gross margin ........................................................ 260,000 Selling and administrative expenses:

Advertising ........................................................ 50,000 Building rent (20% × $50,000) ........................... 10,000 Selling and administrative salaries ....................... 140,000 Other selling and administrative expense ............. 20,000 220,000

Operating income ................................................. $ 40,000

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Problem 6-15

1. Maintenance cost at the 140,000 machine-hour level of activity can be isolated as follows:

Level of Activity

80,000 MH 140,000 MH Total factory overhead cost ............. $340,400 $483,200 Deduct:

Utilities cost @ $1.30 per MH* ...... 104,000 182,000 Supervisory salaries ..................... 120,000 120,000

Maintenance cost ........................... $116,400 $181,200

*$104,000 ÷ 80,000 MHs = $1.30 per MH 2. High-low analysis of maintenance cost:

Maintenance

Cost Machine-

Hours High activity level .............. $181,200 140,000 Low activity level ............... 116,400 80,000 Change ............................. $ 64,800 60,000

Note: in this problem the high level of activity (140,000 hours) does not correspond to the highest level of total overhead costs, which occurs in November.

Variable cost per unit of activity:

Total fixed cost:

Total maintenance cost at the low activity level ............ $116,400 Less the variable cost element

(80,000 MHs × $1.08 per MH) .................................. 86,400 Fixed cost element ..................................................... $30,000

Therefore, the cost formula is $30,000 per month plus $1.08 per machine-hour or Y = $30,000 + $1.08X, where X represents machine-hours.

Change in cost = $64,800 = $1.08 per MH Change in activity 60,000 MHs

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3.

Variable Rate per

Machine-Hour Fixed Cost Maintenance cost .............. $1.08 $ 30,000

Utilities cost:

$104,000/80,000 ............... 1.30 Supervisory salaries cost .... 120,000 Totals ............................... $2.38 $150,000

Therefore, the cost formula would be $150,000 plus $2.38 per machine-hour, or Y = $150,000 + $2.38X.

4. Fixed costs .......................................................... $150,000 Variable costs: $2.38 per MH × 90,000 MHs.......... 214,200 Total overhead costs ............................................ $364,200

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Problem 6-16

1. July—Low October—High 9,000 Units 12,000 Units Direct materials cost @ $15 per unit $135,000 $180,000 Direct labour cost @ $6 per unit ...... 54,000 72,000 Manufacturing overhead cost .......... 107,000 * 131,000 * Total manufacturing costs ............... 296,000 383,000 Add: Work in process, beginning ..... 14,000 22,000 310,000 405,000 Deduct: Work in process, ending ..... 25,000 15,000 Cost of goods manufactured ........... $285,000 $390,000

*Computed by working backwards from cost of goods manufactured. 2.

Units

Produced Cost

Observed October—High level of activity .......... 12,000 $131,000 July—Low level of activity ................. 9,000 107,000 Change ............................................ 3,000 $ 24,000

Change in costVariable cost =

Change in activity

$24,000= = $8 per unit

3,000 units

Total cost at the high level of activity .................. $131,000 Less variable cost element

($8 per unit × 12,000 units) ............................ 96,000 Fixed cost element ............................................. $ 35,000

Therefore, the cost formula is: $35,000 per month plus $8 per unit produced, or Y = $35,000 + $8X, where X represents the number of units produced.

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3. The cost of goods manufactured if 9,500 units are produced:

Direct materials cost (9,500 units × $15 per unit).. $142,500 Direct labour cost (9,500 units × $6 per unit) ....... 57,000 Manufacturing overhead cost:

Fixed portion .................................................... $35,000 Variable portion (9,500 units × $8 per unit) ........ 76,000 111,000

Total manufacturing costs .................................... 310,500 Add: Work in process, beginning .......................... 16,000 326,500 Deduct: Work in process, ending .......................... 19,000 Cost of goods manufactured ................................ $307,500

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Exercise 3-13

1. Item (a): Actual manufacturing overhead costs for the year. Item (b): Overhead cost applied to work in process for the year. Item (c): Cost of goods manufactured for the year. Item (d): Cost of goods sold for the year.

2. Manufacturing Overhead ............................. 30,000 Cost of Goods Sold ................................ 30,000 3. The overapplied overhead will be allocated to the other accounts on the

basis of the amount of overhead applied during the year in the ending balance of each account:

Work in process ................................ $ 32,800 8 % Finished goods .................................. 41,000 10 Cost of goods sold ............................ 336,200 82 Total cost ......................................... $410,000 100 %

Using these percentages, the journal entry would be as follows:

Manufacturing Overhead ........................... 30,000 Work in Process (8% × $30,000) .......... 2,400 Finished Goods (10% × $30,000) ......... 3,000 Cost of Goods Sold (82% × $30,000) .... 24,600

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Problem 3-19

1. and 2.

Cash Accounts Receivable Bal. 8,000 (l) 190,000 Bal. 13,000 (k) 197,000 (k) 197,000 (j) 200,000 Bal. 15,000 Bal. 16,000

Raw Materials Work in Process Bal. 7,000 (b) 40,000 Bal. 18,000 (i) 130,000 (a) 45,000 (b) 32,000 Bal. 12,000 (e) 40,000 (h) 60,000 Bal. 20,000

Finished Goods Prepaid Insurance Bal. 20,000 (j) 120,000 Bal. 4,000 (f) 3,000 (i) 130,000 Bal. 30,000 Bal. 1,000

Plant and Equipment Accumulated Depreciation Bal. 230,000 Bal. 42,000 (d) 28,000 Bal. 70,000

Manufacturing Overhead Accounts Payable (b) 8,000 (h)* 60,000 (l) 100,000 Bal. 30,000 (c) 14,600 (a) 45,000 (d) 21,000 (c) 14,600 (e) 18,000 (g) 18,000 (f) 2,400 Bal. 4,000 (m) 4,000 Bal. 7,600

*$40,000 × 150% = $60,000.

Salaries & Wages Payable Retained Earnings (l) 90,000 (e) 93,400 Bal. 78,000 Bal. 3,400

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Capital Stock Sales Commissions Expense Bal. 150,000 (e) 10,400

Administrative Salaries Expense Depreciation Expense (e) 25,000 (d) 7,000

Insurance Expense Miscellaneous Expense (f) 600 (g) 18,000

Cost of Goods Sold Sales (j) 120,000 (j) 200,000 (m) 4,000 3. Overhead is underapplied by $4,000. Entry (m) above records the

closing of this underapplied overhead balance to Cost of Goods Sold. 4.

Durham Company Income Statement

For the Year Ended December 31

Sales ............................................................ $200,000 Cost of goods sold ($120,000 + $4,000) ......... 124,000 Gross margin ................................................. 76,000 Selling and administrative expenses:

Depreciation expense .................................. $ 7,000 Sales commissions expense ......................... 10,400 Administrative salaries expense ................... 25,000 Insurance expense ...................................... 600 Miscellaneous expense ................................ 18,000 61,000

Operating income .......................................... $ 15,000

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Problem 4-14

Weighted-Average Method 1. The equivalent units are:

Materials Conversion Units completed during the year ..................... 790,000 790,000 Work in process, Dec. 31:

Materials: 30,000 units × 100% complete .... 30,000 Conversion: 30,000 units × 50% complete ... 15,000

Equivalent units of production ........................ 820,000 805,000 The costs per equivalent unit are:

Materials Conversion Work in process, Jan. 1 .................................. $ 22,000 $ 48,000 Cost added during the year ............................ 880,000 2,367,000 Total cost (a) ................................................ $902,000 $2,415,000 Equivalent units of production (b) ................... 820,000 805,000 Cost per equivalent unit (a) ÷ (b) ................... $1.10 $3.00

2. The amount of cost that should be assigned to the ending inventories is:

Materials Conversion Total Ending work in process inventory: Equivalent units of production

(see above) ....................... 30,000 15,000 Cost per equivalent unit ....... $1.10 $3.00 Cost of ending work in process

inventory ........................... $33,000 $45,000 $78,000

Finished goods inventory: Equivalent units ................... 50,000 50,000 Cost per equivalent unit ....... $1.10 $3.00 $4.10 Cost of units completed and

transferred out ................... $55,000 $150,000 $205,000

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3. The necessary adjustments would be:

Work in Process

Finished Goods Total

Total cost that should be assigned to inventories (see above) ............................................ $ 78,000 $205,000 $283,000

Year-end balances in the accounts .................................. 95,000 201,000 296,000 Error .............................................................................. $(17,000) $ 4,000 $(13,000)

Finished Goods Inventory ................................................ 4,000 Cost of Goods Sold ......................................................... 13,000

Work in Process Inventory ......................................... 17,000 4. The cost of goods sold can be determined as follows:

Beginning finished goods inventory.................................. 0 Units completed during the year ...................................... 790,000 Units available for sale .................................................... 790,000 Less units in ending finished goods inventory ................... 50,000 Units sold during the year ............................................... 740,000 Cost per whole unit ($1.10 + $3.00) ................................ × $4.10 Cost of goods sold .......................................................... $3,034,000

Alternative computation: Total manufacturing cost incurred:

Materials (part 1. above) .............................................. $ 902,000 Conversion (part 1. above) ........................................... 2,415,000

Total manufacturing cost ................................................ 3,317,000 Less cost assigned to inventories (part 3. above).............. 283,000 Cost of goods sold .......................................................... $3,034,000

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Problem 4-15

Weighted-Average Method

1. a. Work in Process—Blending .............................................

495,000

Work in Process—Bottling 115,000

Raw Materials ........................................................... 610,000

b. Work in Process—Blending ............................................. 72,000 Work in Process—Bottling ............................................... 18,000 Salaries and Wages Payable ...................................... 90,000

c. Manufacturing Overhead ................................................ 225,000 Accounts Payable ...................................................... 225,000

d. Work in Process—Blending ............................................. 181,000 Manufacturing Overhead ........................................... 181,000 Work in Process—Bottling ............................................... 42,000 Manufacturing Overhead ........................................... 42,000

e. Work in Process—Bottling ............................................... 740,000 Work in Process—Blending ........................................ 740,000

f. Finished Goods .............................................................. 950,000 Work in Process—Bottling .......................................... 950,000

g. Accounts Receivable ....................................................... 1,500,000 Sales ........................................................................ 1,500,000 Cost of Goods Sold ......................................................... 890,000 Finished Goods ......................................................... 890,000

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2. Work in Process—Bottling Work in Process—Blending

Bal. 65,000 (f) 950,000

Bal. 38,000

(e) 740,000

(a) 115,000

(a) 495,000

(b) 18,000 (b) 72,000

(d) 42,000 (d) 181,000

(e) 740,000

Bal. 30,000 Bal. 46,000

Manufacturing Overhead Finished Goods

(c) 225,000 (d) 181,000

Bal. 20,000 (g) 890,000

(d) 42,000

(f) 950,000

Bal. 2,000 Bal. 80,000

Raw Materials Accounts Payable

Bal. 681,000 (a) 610,000

(c) 225,000

Bal. 71,000

Salaries and Wages Payable Sales

(b) 90,000 (g) 1,500,000

Accounts Receivable Cost of Goods Sold

(g) 1,500,000 (g) 890,000

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Exercise 5-16

1. Potential benefits of adopting an ABC system that arise from having more accurate product (or service) costs include:

a. Improved product (or service) pricing decisions b. Improved product (or service) mix decisions c. Ability to target process improvements in key activities that can

result in cost savings

2. Quantifying any of the benefits listed in part 1 is an inherently subjective exercise but it can be done. For example, the revised product costs generated by an ABC system could lead management to change prices on one or more of its existing products. Estimates would then be required of the change in demand that would arise from a change in the product prices. The change in demand would depend on the price elasticity of demand, which depends on the number of substitute products available to consumers.

Similarly, management could estimate the cost savings that would result from process improvements made to key activities. One approach to developing the estimates would be to compare the current level of performance on a key activity (e.g., the time taken to set-up production equipment) to benchmark data from leading competitors. An estimate could then be made of the cost savings that would arise if the set-up time could be reduced to the benchmark level. This would be computed as the cost per set-up hour multiplied by the targeted reduction in hours.

3. Dealing with uncertainty is covered in detail in Appendix 7A but the basic approach is to use an expected value approach to calculating the financial impact of various alternatives. For example, management could estimate the subjective probabilities of different levels of demand that may arise from a change in prices suggested by more accurate product costs generated by an ABC system. The income effect of each alternative would be calculated as: (price per unit x estimated volume) – (variable cost per unit × estimated volume) – fixed expenses. This operating income level would then be multiplied by

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Exercise 5-16 continued the subjective probability of achieving the predicted volume level given the new price. These steps would be repeated for other possible sales volume levels and the results summed to come up with the expected profit margin given the change in sales price. The expected profit margin could then be compared to the current profit margin to determine if the benefits exceed the costs of adopting the ABC system.

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Problem 5-20

1. The first-stage allocation of costs to activity cost pools for the AIA operation appears below. All figures below are in euros.

Meal Preparatio

n Flight-Related

Customer Service Other Totals

Cooks and delivery personnel wages .............................

€2,250,000

€600,000

€ 0

€150,000

€3,000,000

Kitchen supplies ................................. 37,500 0 0 0 37,500 Chef salaries ...................................... 67,500 45,000 90,000 22,500 225,000 Equipment depreciation ...................... 45,000 0 0 30,000 75,000 Administrative wages

and salaries ..................................... 0 37,500 112,500 37,500 187,500

Building costs ..................................... 0 0 0 150,00

0 150,000

Total cost .......................................... €2,400,00

0 €682,50

0 €202,50

0 €390,0

00 €3,675,0

00

According to the data in the problem, 75% of the cooks and delivery personnel wages are attributable to meal preparation activities.

75% of €3,000,000 = €2,250,000

Other entries in the table are determined in a similar manner.


2. The activity rates at the AIA operation are:

Meal

Preparation Flight-Related

Customer Service

Activity at AIA 1,000,000 meals

5,000 flights

10 airlines

Cooks and delivery personnel wages ...............................................

€2.2500 € 120.00

Kitchen supplies ................................... 0.0375 Chef salaries ........................................ 0.0675 9.00 € 9,000 Equipment depreciation ........................ 0.0450 Administrative wages and

salaries ............................................. 7.50 11,250 Building costs ....................................... Total cost ............................................ € 2.40 €136.50 €20,250

Example: €2,250,000 ÷ 1,000,000 meals = €2.25 per meal

Cooks and delivery personnel wages attributable to meal preparation from the first-stage allocation.


3. Managers should be cautious when comparing operations using activity-based costing data—particularly when the activity-based costing data rely on interviews. Nevertheless, comparisons of the data can provide insights and may suggest where it would be fruitful to investigate further. In this case, side-by-side comparison of the Corfu and AIA activity rates reveals that the cost per meal and cost per flight is less at AIA than at Corfu, but the cost per airline for customer service activities is higher at AIA than at Corfu. This suggests that Corfu might have something to learn from AIA concerning meal preparation and flight-related activities, but AIA may be able to learn from Corfu concerning customer service activities.

Overall, AIA seems to be more efficient than Corfu by about €37,500 as shown in the table below.

AIA Corfu Difference Activity at

AIA

Difference ×

Activity at AIA

Meal preparation (per meal) .......... €2.40 €2.48 €0.08

1,000,000 meals

€80,000

Flight-related (per flight) ............... €136.50 €144.50 €8.00 5,000 flights €40,000

Customer service (per airline) ........ €20,250 €12,000 (€8,250) 10 airlines (€82,500)

Total ............................................ €37,500

Exercise 7-10

1. Sales = Variable expenses + Fixed expenses + Profits $40Q = $28Q + $150,000 + $0 $12Q = $150,000 Q = $150,000 ÷ $12 per unit Q = 12,500 units, or at $40 per unit, $500,000 Alternatively:

Fixed expensesBreak-even point=in unit sales Unit contribution margin

$150,000= =12,500 units

$12 per unit

or, at $40 per unit, $500,000.

2. The contribution margin at the break-even point is $150,000 since at that point it must equal the fixed expenses.

3. Fixed expenses + Target profitUnits sold to attain =

target profit Unit contribution margin

$150,000 + $18,000= =14,000 units

$12 per unit

Total Unit Sales (14,000 units × $40 per unit) .............. $560,000 $40 Variable expenses

(14,000 units × $28 per unit) .................... 392,000 28 Contribution margin

(14,000 units × $12 per unit) .................... 168,000 $12 Fixed expenses ........................................... 150,000 Operating income ........................................ $ 18,000

Exercise 7-10 (continued)

4. Margin of safety in dollar terms:

Margin of safety = Total sales - Break-even sales in dollars

= $600,000 - $500,000 = $100,000

Margin of safety in percentage terms:

Margin of safety in dollarsMargin of safety = percentage Total sales

$100,000= = 16.7% (rounded)

$600,000

5. The CM ratio is 30%.

Expected total contribution margin: $680,000 × 30% .... $204,000 Present total contribution margin: $600,000 × 30% ...... 180,000 Increased contribution margin ...................................... $ 24,000

Alternative solution: $80,000 incremental sales × 30% CM ratio = $24,000

Since in this case the company’s fixed expenses will not change, monthly operating income will increase by the amount of the increased contribution margin, $24,000.

Problem 7-20

1. Product Sinks Mirrors Vanities Total

Percentage of total

sales ......................... 32% 40% 28% 100% Sales ........................... $160,000 100 % $200,000 100 % $140,000 100 % $500,000 100 % Variable expenses ........ 48,000 30 % 160,000 80 % 77,000 55 % 285,000 57 % Contribution margin ...... $112,000 70 % $ 40,000 20 % $ 63,000 45 % 215,000 43 %* Fixed expenses ............ 223,600

Operating income

(loss) ........................ $( 8,600)

*$215,000 ÷ $500,000 = 43%.


2. Break-even sales:

Fixed expensesBreak-even point = in total dollar sales CM ratio

$223,600= = $520,000 in sales

0.43

3. Memo to the president:

Although the company met its sales budget of $500,000 for the month, the mix of products sold changed substantially from that budgeted. This is the reason the budgeted operating income was not met, and the reason the break-even sales were greater than budgeted. The company’s sales mix was planned at 48% Sinks, 20% Mirrors, and 32% Vanities. The actual sales mix was 32% Sinks, 40% Mirrors, and 28% Vanities.

As shown by these data, sales shifted away from Sinks, which provides our greatest contribution per dollar of sales, and shifted strongly toward Mirrors, which provides our least contribution per dollar of sales. Consequently, although the company met its budgeted level of sales, these sales provided considerably less contribution margin than we had planned, with a resulting decrease in operating income. Notice from the attached statements that the company’s overall CM ratio was only 43%, as compared to a planned CM ratio of 52%. This also explains why the break-even point was higher than planned. With less average contribution margin per dollar of sales, a greater level of sales had to be achieved to provide sufficient contribution margin to cover fixed costs.

Problem 8-10

1. The unit product cost under the variable costing approach would be computed as follows:

Direct materials .................................... $ 8 Direct labour ........................................ 10 Variable manufacturing overhead .......... 2 Unit product cost .................................. $20

With this figure, the variable costing income statements can be prepared:

Year 1 Year 2 Sales ......................................................... $1,000,000 $1,500,000 Variable expenses:

Variable cost of goods sold @ $20 per unit 400,000 600,000 Variable selling and administrative @ $3

per unit ................................................ 60,000 90,000 Total variable expenses ............................... 460,000 690,000 Contribution margin .................................... 540,000 810,000 Fixed expenses:

Fixed manufacturing overhead .................. 350,000 350,000 Fixed selling and administrative ................ 250,000 250,000

Total fixed expenses ................................... 600,000 600,000 Operating income (loss) .............................. $ (60,000) $ 210,000

2. Variable costing operating income (loss) ...... $ (60,000) $ 210,000

Add: Fixed manufacturing overhead cost deferred in inventory under absorption costing (5,000 units × $14 per unit) ......... 70,000

Deduct: Fixed manufacturing overhead cost released from inventory under absorption costing (5,000 units × $14 per unit) ......... (70,000)

Absorption costing operating income ........... $ 10,000 $ 140,000

Problem 8-14

1. a. and b. Absorption Costing

Variable Costing

Direct materials .................................... $ 6 $ 6 Direct labour ........................................ 12 12 Variable manufacturing overhead .......... 4 4

Fixed manufacturing overhead

($240,000 ÷ 30,000 units) ................. 8 — Unit product cost .................................. $30 $22

2. May June Sales (26,000 units, 34,000 units) ............... $1,040,000 $1,360,000 Variable expenses: Variable production costs @ $22 per unit .. 572,000 748,000

Variable selling and administrative @ $3

per unit ................................................ 78,000 102,000 Total variable expenses ............................... 650,000 850,000 Contribution margin .................................... 390,000 510,000 Fixed expenses: Fixed manufacturing overhead .................. 240,000 240,000 Fixed selling and administrative ................ 180,000 180,000 Total fixed expenses ................................... 420,000 420,000 Operating income (loss) .............................. $ (30,000) $ 90,000

3. May June Variable costing operating income (loss) ...... $ (30,000) $ 90,000

Add: Fixed manufacturing overhead cost deferred in inventory under absorption costing (4,000 units × $8 per unit) ........... 32,000

Deduct: Fixed manufacturing overhead cost released from inventory under absorption costing (4,000 units × $8 per unit) ........... (32,000)

Absorption costing operating income ........... $ 2,000 $ 58,000

4. As shown in the reconciliation in part (3) above, $32,000 of fixed manufacturing overhead cost was deferred in inventory under absorption costing at the end of May, because $8 of fixed manufacturing overhead cost “attached” to each of the 4,000 unsold units that went into inventory at the end of that month. This $32,000 was part of the $420,000 total fixed cost that has to be covered each month in order for the company to break even. Because the $32,000 was added to the inventory account, and thus did not appear on the income statement for May as an expense, the company was able to report a small profit for the month even though it sold less than the break-even volume of sales. In short, only $388,000 of fixed cost ($420,000 – $32,000) was expensed for May, rather than the full $420,000 as contemplated in the break-even analysis. As stated in the text, this is a major problem with the use of absorption costing internally for management purposes. The method does not harmonize well with the principles of cost-volume-profit analysis, and can result in data that are unclear or confusing to management.

Problem 9-17

1. Schedule of expected cash collections:

Month April May June Quarter From accounts receivable . $141,000 $ 7,200 $148,200 From April sales: 20% × 200,000 ............ 40,000 40,000 75% × 200,000 ............ 150,000 150,000 4% × 200,000 .............. $ 8,000 8,000 From May sales: 20% × 300,000 ............ 60,000 60,000 75% × 300,000 ............ 225,000 225,000 From June sales: 20% × 250,000 ............ 50,000 50,000 Total cash collections ....... $181,000 $217,200 $283,000 $681,200


2. Cash budget:

Month April May June Quarter

Cash balance,

beginning .................. $ 26,000 $ 27,000 $ 20,200 $ 26,000 Add receipts:

Collections from

customers ............... 181,000 217,200 283,000 681,200 Total available .............. 207,000 244,200 303,200 707,200 Less disbursements:

Merchandise

purchases ............... 108,000 120,000 180,000 408,000 Payroll ....................... 9,000 9,000 8,000 26,000 Lease payments ......... 15,000 15,000 15,000 45,000 Advertising ................ 70,000 80,000 60,000 210,000 Equipment purchases . 8,000 — — 8,000 Total disbursements ..... 210,000 224,000 263,000 697,000

Excess (deficiency) of receipts over disbursements ........... (3,000) 20,200

40,200 10,200

Financing: Borrowings ................ 30,000 — — 30,000 Repayments .............. — — (30,000) (30,000) Interest ..................... — — (1,200) (1,200) Total financing ............. 30,000 — (31,200) (1,200) Cash balance, ending ... $ 27,000 $ 20,200 $ 9,000 $ 9,000

3. If the company needs a minimum cash balance of $20,000 to start each month, the loan cannot be

repaid in full by June 30. If the loan is repaid in full, the cash balance will drop to only $9,000 on June 30, as shown above. Some portion of the loan balance will have to be carried over to July, at which time the cash inflow should be sufficient to complete repayment.

Problem 9-22

1. Collections on sales: July August Sept. Quarter Cash sales .............................. $ 8,000 $14,000 $10,000 $ 32,000 Credit sales: May: $30,000 × 80% × 20% .. 4,800 4,800

June: $36,000 × 80% × 70%,

20% .................................. 20,160 5,760 25,920

July: $40,000 × 80% × 10%,

70%, 20% ......................... 3,200 22,400 6,400 32,000

Aug.: $70,000 × 80% × 10%,

70% .................................. 5,600 39,200 44,800 Sept.: $50,000 × 80% × 10% 4,000 4,000 Total cash collections ............... $36,160 $47,760 $59,600 $143,520 2. a. Merchandise purchases budget:

July August Sept. Oct. Budgeted cost of goods sold* .. $24,000 $42,000 $30,000 $27,000 Add desired ending inventory** 31,500 22,500 20,250 Total needs ............................. 55,500 64,500 50,250 Less beginning inventory ......... 18,000 31,500 22,500 Required inventory purchases .. $37,500 $33,000 $27,750

*Cost of goods sold is 60% of sales, based on income statements provided in the problem. *75% of the next month’s budgeted cost of goods sold.

b. Schedule of expected cash disbursements for merchandise purchases:

July August Sept. Quarter Accounts payable, June 30 ....... $11,700 $11,700 July purchases ........................ 18,750 $18,750 37,500 August purchases .................... 16,500 $16,500 33,000 September purchases .............. 13,875 13,875 Total cash disbursements ......... $30,450 $35,250 $30,375 $96,075


3. Scott Products, Inc. Cash Budget

For the Quarter Ended September 30

July August Sept. Quarter Cash balance, beginning ........ $ 8,000 $ 8,410 $ 8,020 $ 8,000 Add collections from sales 36,160 47,760 59,600 143,520

Total cash available ............. 44,160 56,170 67,620 151,520 Less disbursements:

For inventory purchases ...... 30,450 35,250 30,375 96,075 For selling expenses ........... 7,200 11,700 8,500 27,400 For administrative expenses 3,600 5,200 4,100 12,900 For land ............................. 4,500 0 0 4,500 For dividends...................... 0 0 1,000 1,000

Total disbursements .............. 45,750 52,150 43,975 141,875

Excess (deficiency) of cash available over disbursements ............ (1,590) 4,020 23,645 9,645

Financing: Borrowings ......................... 10,000 4,000 14,000 Repayment......................... 0 0 (14,000) (14,000) Interest* ............................ 0 0 (380) (380)

Total financing ...................... 10,000 4,000 (14,380) (380) Cash balance, ending ............ $ 8,410 $ 8,020 $ 9,265 $ 9,265

* $10,000 × 1% × 3 = $300 $4,000 × 1% × 2 = 80 $380

Exercise 10-13

1. Overall rate = $33,200 8,000 MHs = $4.15 per MH Variable rate = $8,400 8,000 MHs = $1.05 per MH Fixed rate = $24,800 8,000 MHs = $3.10 per MH 2. The standard hours per unit of product are: 8,000 MHs ÷ 3,200 units = 2.5 MHs per unit

The standard hours allowed for the actual production would be: 3,500 units × 2.5 MHs per unit = 8,750 MHs 3. Variable overhead

spending variance = (AH × AR) – (AH × SR) = ($9,860) – (8,500 MHs x $1.05 per MH) = ($9,860) – ($8,925) = $935 U

Variable overhead efficiency variance = SR (AH – SH)

= $1.05 per MH (8,500 MHs – 8,750 MHs) = -$262.50 F

Exercise 10-13 (continued) Fixed overhead budget and volume variances:

Actual Fixed

Overhead Cost

Budgeted Fixed Overhead Cost

Fixed Overhead Cost Applied to

Work in Process $25,100 $24,800* 8,750 standard MHs × $3.10 per MH

= $27,125

Budget Variance, $300 U

Volume Variance, -$2,325 F

Total Variance, $2,025 F

*8,000 denominator MHs × $3.10 per MH = $24,800. Alternative approach to the budget variance:

Budget variance = Actual fixed overhead cost – budgeted fixed overhead cost = $25,100 – $24,800 = $300 U

Alternative approach to the volume variance: Volume variance = Fixed portion

of the predetermined × (Denominator hours - rate standard hours allowed)

= $3.10 per MH (8,000 MHs – 8,750 MHs) = -$2,325 F

Reconciliation of overhead variances to overapplied overhead: Variable OH spending variance $935.00 U Variable OH efficiency variance 262.50 F Fixed OH budget variance 300.00 U Fixed OH volume variance 2,325.00 F Total $1,352.50 F Actual OH (variable + fixed) $34,960.00 ($9,860 + $25,100)

Applied OH (variable + fixed) 36,312.50 ($9,187.50 + $27,125) Overapplied OH $ 1,352.50

Exercise 10-16

Pay Loans Company Overhead Performance Report

For the Month Ended October 31 Budgeted labour-hours ................................................................................ 1,300 Actual labour-hours ..................................................................................... 1,290 Standard labour-hours allowed for the actual number of checks processed ..... 1,320

Overhead costs

Cost Formula

(per labour-hour)

(1) Actual Costs

Incurred for

1,290 Labour-Hours (AH × AR)

(2) Flexible Budget

Based on 1,290

Labour-Hours (AH × SR)

(3) Flexible Budget

Based on 1,320

Labour-Hours (SH × SR)

Total Variance (1) – (3)

Breakdown of the Total Variance

Spending

(Budget) Variance (1) – (2)

Efficiency

Variance

(2) – (3)

Variable overhead costs: Office supplies ............ $0.30 $ 219 $ 387 $ 396 $177 F $168 F $ 9 F Staff coffee

lounge ..................... 0.10 186 129 132 54 U 57 U 3 F

Indirect labour ............ 3.90 3,348 5,031 5,148 1,80

0 F 1,68

3 F 117 F

Total variable overhead cost .......... $4.30 3,753 5,547 5,676 1,923 F 1,794 F 129 F

Fixed overhead costs: Supervisory

salaries.. 6,300 6,000 6,000 300 U 300 U Total overhead

cost $10,05

3 $11,54

7 $11,676 $1,62

3 F $1,4

94 F $129 F

NOTE: In the solution above students may get confused with the fact that the fixed overhead flexible budget amount is $6,000 for both columns (2) and (3). An explanation can be found on page 430 and in exhibit 10-13. This fixed amount is not the same thing as fixed overhead applied at standard as you would compute in your variance analysis. The volume variance is not part of the measurement of performance.

Exercise 12-16

The costs that are relevant in a make-or-buy decision are those costs that can be avoided as a result of purchasing from the outside. The analysis for this exercise is:

Per Unit Differential

Costs 20,000 Units Make Buy Make Buy Cost of purchasing ....................... $23.50 $470,000 Cost of making:

Direct materials ......................... $ 4.80 $ 96,000 Direct labour ............................. 7.00 140,000 Variable manufacturing overhead 3.20 64,000 Fixed manufacturing overhead ... 4.00 * 80,000 Total cost .................................. $19.00 $23.50 $380,000 $470,000

* The remaining $6 of fixed manufacturing overhead cost would not be relevant, since it will continue regardless of whether the company makes or buys the parts.

The $150,000 rental value of the space being used to produce part R-3 represents an opportunity cost of continuing to produce the part internally. Thus, the completed analysis would be:

Make Buy Total cost, as above ........................................... $380,000 $470,000 Rental value of the space (opportunity cost) ........ 150,000 Total cost, including opportunity cost .................. $530,000 $470,000

Net advantage in favour of buying ...................... $60,000

Profits would increase by $60,000 if the outside supplier’s offer is accepted.

Problem 12-22

1. Product MJ-7 yields a contribution margin of $14 per litre ($35 – $21 = $14). If the plant closes, this contribution margin will be lost on the 22,000 litres (11,000 litres per month × 2 = 22,000 litres) that could have been sold during the two-month period. However, the company will be able to avoid certain fixed costs as a result of closing down. The analysis is:

Contribution margin lost by closing the plant for two months ($14 per litre × 22,000 litres) ........

$(308,000)

Costs avoided by closing the plant for two months: Fixed manufacturing overhead cost

($60,000 × 2 months = $120,000) ................ $120,000 Fixed selling costs

($310,000 × 10% × 2 months) ..................... 62,000 182,000 Net disadvantage of closing, before start-up

costs .............................................................. (126,000) Add start-up costs ............................................. (14,000) Disadvantage of closing the plant ....................... $(140,000)

No, the company should not close the plant; it should continue to operate at the reduced level of 11,000 litres produced and sold each month. Closing will result in a $140,000 greater loss over the two-month period than if the company continues to operate. Additional factors are the potential loss of goodwill among the customers who need the 11,000 litres of MJ-7 each month and the adverse effect on employee morale. By closing down, the needs of customers will not be met (no inventories are on hand), and their business may be permanently lost to another supplier.


Alternative Solution:

Plant Kept

Open Plant

Closed

Difference— Operating Income Increase

(Decrease) Sales (11,000 litres × $35 per litre ×

2) ............................................... $ 770,000 $ 0 $(770,000) Less variable expenses (11,000

litres × $21 per litre × 2) ............. 462,000 0 462,000 Contribution margin ....................... 308,000 0 (308,000) Less fixed costs:

Fixed manufacturing overhead cost ($230,000 × 2; $170,000 × 2) ......................... 460,000 340,000 120,000

Fixed selling cost ($310,000 × 2; $310,000 × 90% × 2) .............. 620,000 558,000 62,000

Total fixed cost .............................. 1,080,000 898,000 182,000 Operating loss before start-up costs (772,000) (898,000) (126,000) Start-up costs ................................ (14,000) (14,000) Operating loss ............................... $ (772,000) $(912,000) $(140,000)


2. Ignoring the additional factors cited in part (1) above, Nicholas Company should be indifferent between closing down or continuing to operate if the level of sales drops to 12,000 litres (6,000 litres per month) over the two-month period. The indifference point computations are:

Cost avoided by closing the plant for two months (see above) ........................................................ $182,000

Less start-up costs ................................................. 14,000 Net avoidable costs ............................................... $168,000

Indifference point = Net avoidable costs ÷ Per unit contribution margin

= $168,000 ÷ ($35 - $21)

= 12,000 litres

Verification:

Operate at 12,000

Litres for Two Months

Close for Two Months

Sales (12,000 litres × $35 per litre) ............. $ 420,000 $ 0 Less variable expenses (12,000 litres × $21

per litre) .................................................. 252,000 0 Contribution margin .................................... 168,000 0 Less fixed expenses:

Manufacturing overhead ($230,000 and $170,000 × 2 months) ........................... 460,000 340,000

Selling ($310,000 and $279,000 × 2 months) ................................................ 620,000 558,000

Total fixed expenses ................................... 1,080,000 898,000 Start-up costs ............................................. 0 14,000 Total costs .................................................. 1,080,000 912,000 Operating loss ............................................ $ (912,000) $(912,000)

Exercise 11-12

Company A Company B Company C Sales ......................................... $400,000 * $750,000 * $600,000 * Operating income ...................... $32,000 $45,000 * $24,000 Average operating assets ............ $160,000 * $250,000 $150,000 * Return on investment (ROI) ........ 20% * 18% * 16% Minimum required rate of return:

Percentage .............................. 15% * 20% 12% * Dollar amount ......................... $24,000 $50,000 * $18,000

Residual income ......................... $8,000 ($5,000) $6,000 *

*Given.

Problem 11-26

1. Present New Line Total (1) Sales ........................ $21,000,000 $9,000,000 $30,000,000 (2) Operating income ...... $1,680,000 $630,000 * $2,310,000 (3) Operating assets ........ $5,250,000 $3,000,000 $8,250,000 (4) Margin (2) ÷ (1) ........ 8.0% 7.0% 7.7% (5) Turnover (1) ÷ (3) ..... 4.00 3.00 3.64 (6) ROI (4) × (5) ............ 32% 21% 28%

* Sales ............................................................. $9,000,000 Variable expenses (65% x $9,000,000) ........... 5,850,000 Contribution margin ....................................... 3,150,000 Fixed expenses .............................................. 2,520,000 Operating income .......................................... $ 630,000

2. Stefan Grenier will be inclined to reject the new product line, since accepting it would reduce his

division’s overall rate of return. 3. The new product line promises an ROI of 21%, whereas the company’s overall ROI last year was only

18%. Thus, adding the new line would increase the company’s overall ROI.

4. a. Present New Line Total Operating assets ..................... $5,250,000 $3,000,000 $8,250,000 Minimum required return ......... × 15% × 15% × 15% Minimum operating income ...... $787,500 $450,000 $1,237,500 Actual operating income .......... $1,680,000 $ 630,000 $2,310,000

Minimum net operating income

(above) ................................ 787,500 450,000 1,237,500 Residual income ...................... $ 892,500 $ 180,000 $1,072,500

b. Under the residual income approach, Stefan Grenier would be inclined to accept the new product

line, since adding the product line would increase the total amount of his division’s residual income, as shown above.

RSM222 Winter 2014 Solutions for Self-Study...

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