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Select Solutions to Chapter 7

7-14 East Company, which is highly automated, will have a cost structure dominated by fixed costs. West Company's cost structure will include a larger proportion of variable costs than East Company's cost structure.

A firm's operating leverage factor, at a particular sales volume, is defined as its total contribution margin divided by its net income. Since East Company has proportionately higher fixed costs, it will have a proportionately higher total contribution margin. Therefore, East Company's operating leverage factor will be higher.

7-15 When sales volume increases, Company X will have a higher percentage increase in profit than Company Y. Company X's higher proportion of fixed costs gives the firm a higher operating leverage factor. The company's percentage increase in profit can be found by multiplying the percentage increase in sales volume by the firm's operating leverage factor.

7-16 The sales mix of a multiproduct organization is the relative proportion of sales of its products.

The weighted-average unit contribution margin is the average of the unit contribution margins for a firm's several products, with each product's contribution margin weighted by the relative proportion of that product's sales.

7-17 The car rental agency's sales mix is the relative proportion of its rental business associated with each of the three types of automobiles: subcompact, compact, and full-size. In a multi-product CVP analysis, the sales mix is assumed to be constant over the relevant range of activity.

7-18 Cost-volume-profit analysis shows the effect on profit of changes in expenses, sales prices, and sales mix. A change in the hotel's room rate (price) will change the hotel's unit contribution margin. This contribution-margin change will alter the relationship between volume and profit.

7-21 The statement makes three assertions, but only two of them are true. Thus the statement is false. A company with an advanced manufacturing environment typically will have a larger proportion of fixed costs in its cost structure. This will result in a higher break-even point and greater operating leverage. However, the firm's higher break-even point will result in a reduced safety margin.

7-22 Activity-based costing (ABC) results in a richer description of an organization's cost behavior and CVP relationships. Costs that are fixed with respect to sales volume may not be fixed with respect to other important cost drivers. An ABC system recognizes these nonvolume cost drivers, whereas a traditional costing system does not.

EXERCISE 7-24 (25 MINUTES)

Sales Revenue

Variable Expenses

Total Contribution

MarginFixed

ExpensesNet

Income

Break-Even Sales

Revenue1 $360,000 $120,000 $240,000 $90,000 $150,000 $135,000 a

2 55,000 11,000 44,000 25,000 19,000 31,250b

3 320,000 c 80,000 240,000 60,000 180,000 80,0004 160,000 130,000 30,000 30,000d -0- 160,000

Explanatory notes for selected items:

a$135,000 = $90,000 ¸ (2/3), where 2/3 is the contribution-margin ratio.b$31,250 = $25,000/.80, where .80 is the contribution-margin ratio.cBreak-even sales revenue................................................................................ $80,000 Fixed expenses.................................................................................................. 60,000 Variable expenses............................................................................................. $20,000

Therefore, variable expenses are 25 percent of sales revenue.

When variable expenses amount to $80,000, sales revenue is $320,000.

d$160,000 is the break-even sales revenue, so fixed expenses must be equal to the contribution margin of $30,000 and profit must be zero.


1. Profit-volume graph:

Dollars per year

$300,000

$200,000

$100,000

0

$(100,000)

$(200,000)

$(300,000)

$(360,000)

Annual fixed expenses

Tickets sold per year

Break-even point:20,000 tickets Profit

area

Loss area

5,000 10,000 15,000 20,000 25,000

EXERCISE 7-26 (CONTINUED)

2. Safety margin:

Budgeted sales revenue(10 games 6,000 seats .45 full $20)............................................. $540,000

Break-even sales revenue(20,000 tickets $20)................................................................................ 400,000

Safety margin................................................................................................... $140,000

3. Let P denote the break-even ticket price, assuming a 10-game season and 40 percent attendance:

(10)(6,000)(.40)P – (10)(6,000)(.40)($2) – $360,000 = 024,000P = $408,000

P = $17 per ticket


1. (a) Traditional income statement: PACIFIC RIM PUBLICATIONS, INC.

INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 20XX

Sales .......................................................................... $1,000,000Less: Cost of goods sold.......................................... 750,000Gross margin................................................................ $ 250,000Less: Operating expenses:

Selling expenses............................................. $75,000Administrative expenses................................ 75,000 150,000

Net income..................................................................... $ 100,000

(b) Contribution income statement: PACIFIC RIM PUBLICATIONS, INC.

INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 20XX

Sales .......................................................................... $1,000,000Less: Variable expenses:

Variable manufacturing.................................. $500,000Variable selling................................................ 50,000Variable administrative................................... 15,000 565,000

Contribution margin..................................................... $ 435,000Less: Fixed expenses:

Fixed manufacturing....................................... $ 250,000Fixed selling.................................................... 25,000Fixed administrative....................................... 60,000 335,000

Net income..................................................................... $ 100,000

2.


3.

= 12% 4.35= 52.2%

4. Most operating managers prefer the contribution income statement for answering this type of question. The contribution format highlights the contribution margin and separates fixed and variable expenses.

PROBLEM 7-34 (30 MINUTES)

1. Break-even point in sales dollars, using the contribution-margin ratio:

2. Target net income, using contribution-margin approach:

3. New unit variable manufacturing cost = $12 110%= $13.20

Break-even point in sales dollars:

PROBLEM 7-34 (CONTINUED)

4. Let P denote the selling price that will yield the same contribution-margin ratio:

Check: New contribution-margin ratio is:


1. Break-even point in units, using the equation approach:

$24X – ($15 + $3)X – $1,800,000 = 0$6X = $1,800,000

X =

= 300,000 units

2. New projected sales volume = 400,000 110%= 440,000 units

Net income = (440,000)($24 – $18) – $1,800,000

= (440,000)($6) – $1,800,000

= $2,640,000 – $1,800,000 = $840,000

3. Target net income = $600,000 (from original problem data)

New disk purchase price = $15 130% = $19.50

Volume of sales dollars required:

Volume of sales dollars required


4. Let P denote the selling price that will yield the same contribution-margin ratio:

Check: New contribution-margin ratio is:

5. The electronic version of the Solutions Manual “BUILD A SPREADSHEET SOLUTIONS” is available on your Instructors CD and on the Hilton, 8e website: www.mhhe.com/hilton8e.


1. Unit contribution margin:Sales price…………………………………

$32.00

Less variable costs:Sales commissions ($32 x 5%)…… $ 1.60System variable costs……………… 8.00 9.60

Unit contribution margin………………..

$22.40

Break-even point = fixed costs ÷ unit contribution margin= $1,971,200 ÷ $22.40= 88,000 units

2. Model A is more profitable when sales and production average 184,000 units.

Model A Model B

Sales revenue (184,000 units x $32.00)……... $5,888,000 $5,888,000Less variable costs:

Sales commissions ($5,888,000 x 5%)… $ 294,400 $ 294,400System variable costs:……………………

184,000 units x $8.00…………………. 1,472,000184,000 units x $6.40…………………. 1,177,600

Total variable costs……………………….. $1,766,400 $1,472,000Contribution margin…………………………... $4,121,600 $4,416,000Less: Annual fixed costs…………………….. 1,971,200 2,227,200

http://www.mhhe.com/hilton8e

Net income………………………………………

$2,150,400 $2,188,800

3. Annual fixed costs will increase by $180,000 ($900,000 ÷ 5 years) because of straight-line depreciation associated with the new equipment, to $2,407,200 ($2,227,200 + $180,000). The unit contribution margin is $24 ($4,416,000 ÷ 184,000 units). Thus:

Required sales = (fixed costs + target net profit) ÷ unit contribution margin = ($2,407,200 + $1,912,800) ÷ $24 = 180,000 units

4. Let X = volume level at which annual total costs are equal$8.00X + $1,971,200 = $6.40X + $2,227,200$1.60X = $256,000X = 160,000 units


1. Closing of mall store:

Loss of contribution margin at Mall Store......................................................$(108,000)

Savings of fixed cost at Mall Store (75%)....................................................... 90,000Loss of contribution margin at Downtown Store (10%)................................

(14,400)Total decrease in operating income................................................................$

(32,400)

2. Promotional campaign:

Increase in contribution margin (10%)............................................................ $10,800Increase in monthly promotional expenses ($180,000/12)............................ (15,000)Decrease in operating income......................................................................... $(4,200)

3. Elimination of items sold at their variable cost:

We can restate the November 20x4 data for the Mall Store as follows:

Mall StoreItems Sold at

Their Variable Cost Other Items

Sales.................................................................................... $180,000* $180,000*Less: variable expenses.................................................... 180,000 72,000Contribution margin........................................................... $ -0 - $108,000

If the items sold at their variable cost are eliminated, we have:Decrease in contribution margin on other items (20%)............................... $(21,600)Decrease in fixed expenses (15%)................................................................. 18,000Decrease in operating income....................................................................... $ (3,600 )

*$180,000 is one half of the Mall Store's dollar sales for November 20x4.



1. Sales mix refers to the relative proportion of each product sold when a company sells more than one product.

2. (a) Yes. Plan A sales are expected to total 65,000 units (19,500 + 45,500), whichcompares favorably against current sales of 60,000 units.


(b) Yes. Sales personnel earn a commission based on gross dollar sales. As the following figures show, Cold King sales will comprise a greater proportion of total sales under Plan A. This is not surprising in light of the fact that Cold King has a higher selling price than Mister Ice Cream ($43 vs. $37).

Current Plan A

UnitsSales Mix Units

Sales Mix

Mister Ice Cream.......... 21,000 35% 19,500 30%Cold King..................... 39,000 65% 45,500 70%

Total........................ 60,000 100% 65,000 100%

(c) Yes. Commissions will total $267,800 ($2,678,000 x 10%), which compares favorably against the current flat salaries of $200,000.

Mister Ice Cream sales: 19,500 units x $37............... $ 721,500Cold King sales: 45,500 units x $43.......................... 1,956,500

Total sales............................................................ $2,678,000


(d) No. The company would be less profitable under the new plan.

Current Plan ASales revenue:

Mister Ice Cream: 21,000 units x $37; 19,500 units x $37................ $ 777,000 $ 721,500Cold King: 39,000 units x $43; 45,500 units x $43........................... 1,677,000 1,956,500

Total revenue............................................................................... $2,454,000 $2,678,000Less variable cost:

Mister Ice Cream: 21,000 units x $20.50; 19,500 units x $20.50...... $ 430,500 $ 399,750Cold King: 39,000 units x $32.50; 45,500 units x $32.50................. 1,267,500 1,478,750Sales commissions (10% of sales revenue)....................................... 267,800

Total variable cost........................................................................ $1,698,000 $2,146,300Contribution margin................................................................................ $ 756,000 $ 531,700Less fixed cost (salaries).......................................................................... 200,000 ----___ Net income............................................................................................... $ 556,000 $ 531,700

3. (a) The total units sold under both plans are the same; however, the sales mix has shifted under Plan B in favor of the more profitable product as judged by the contribution margin. Cold King has a contribution margin of $10.50 ($43.00 - $32.50), and Mister Ice Cream has a contribution margin of $16.50 ($37.00 - $20.50).

Plan A Plan B

UnitsSales Mix Units

Sales Mix

Mister Ice Cream............... 19,500 30% 39,000 60%Cold King.......................... 45,500 70% 26,000 40%

Total............................. 65,000 100% 65,000 100%


(b) Plan B is more attractive both to the sales force and to the company. Salespeople earn more money under this arrangement ($274,950 vs. $200,000), and the company is more profitable ($641,550 vs. $556,000).

Current Plan BSales revenue:

Mister Ice Cream: 21,000 units x $37; 39,000 units x $37.................................................................................................................

$ 777,000 $1,443,000

Cold King: 39,000 units x $43; 26,000 units x $43.................................................................................................................

1,677,000 1,118,000

Total revenue.................................................................................................................

$2,454,000 $2,561,000

Less variable cost:Mister Ice Cream: 21,000 units x $20.50; 39,000 units x $20.50

.................................................................................................................$ 430,500 $ 799,500

Cold King: 39,000 units x $32.50; 26,000 units x $32.50.................................................................................................................

1,267,500 845,000

Total variable cost.................................................................................................................

$1,698,000 $1,644,500

Contribution margin................................................................................ $ 756,000 $ 916,500Less: Sales force compensation:

Flat salaries.................................................................................................................

200,000

Commissions ($916,500 x 30%).................................................................................................................

274,950

Net income.............................................................................................. $ 556,000 $ 641,550


1. Break-even sales volume for each model:

(a) Standard model:

(b) Super model:

(c) Giant model:


2. Profit-volume graph:

Dollars per year (in thousands)

$40

$20

0

($20)

($40)

10 20 30 40 50Tubs sold per year

(in thousands)

Break-even point:40,816 tubs

Fixed rental cost: $40,000 per year

Prof

itLo

ss

Loss area

Profit area


3. The sales price per tub is the same regardless of the type of machine selected. Therefore, the same profit (or loss) will be achieved with the Standard and Super models at the sales volume, X, where the total costs are the same.

ModelVariable Cost

per TubTotal

Fixed CostStandard...................................................... $2.86 $16,000Super........................................................... 2.70 22,000

This reasoning leads to the following equation: 16,000 + 2.86X = 22,000 + 2.70X

Rearranging terms yields the following: (2.86 – 2.70)X = 22,000 – 16,000 .16X = 6,000

X = 6,000/.16 X = 37,500Or, stated slightly differently:

Volume at which both machines produce the same profit

Check: the total cost is the same with either model if 37,500 tubs are sold.

Standard SuperVariable cost:

Standard, 37,500 $2.86.......................... $107,250Super, 37,500 $2.70................................ $101,250

Fixed cost:Standard, $16,000....................................... 16,000Super, $22,000............................................ 22,000

Total cost.......................................................... $123,250 $123,250

Since the sales price for popcorn does not depend on the popper model, the sales revenue will be the same under either alternative.


1. Plan A break-even point = fixed costs ÷ unit contribution margin = $33,000 ÷ $33* = 1,000 units

Plan B break-even point = fixed costs ÷ unit contribution margin = $99,000 ÷ $45** = 2,200 units

* $120 - [($120 x 10%) + $75]** $120 - $75

2. Operating leverage refers to the use of fixed costs in an organization’s overall cost structure. An organization that has a relatively high proportion of fixed costs and low proportion of variable costs has a high degree of operating leverage.


3. Calculation of contribution margin and profit at 6,000 units of sales:

Plan A Plan B

Sales revenue: 6,000 units x $120………………. $720,000 $720,000Less variable costs:

Cost of purchasing product: 6,000 units x $75…………………….

……$450,000 $450,000

Sales commissions: $720,000 x 10%……... 72,000 ----__ Total variable cost……………………….. $522,000 $450,000

Contribution margin………………………………

$198,000 $270,000

Fixed costs………………………………………….

33,000 99,000

Net income………………………………………….

$165,000 $171,000

Plan A has a higher percentage of variable costs to sales (72.5%) compared to Plan B (62.5%). Plan B’s fixed costs are 13.75% of sales, compared to Plan A’s 4.58%.

Operating leverage factor = contribution margin ÷ net incomePlan A: $198,000 ÷ $165,000 = 1.2Plan B: $270,000 ÷ $171,000 = 1.58 (rounded)

Plan B has the higher degree of operating leverage.

4 & 5. Calculation of profit at 5,000 units:Plan A Plan B

Sales revenue: 5,000 units x $120……………….

$600,000 $600,000

Less variable costs:Cost of purchasing product: 5,000 units x

$75…………………………..$375,000 $375,000

Sales commissions: $600,000 x 10%……... 60,000 ---- __

Total variable cost………………………..

$435,000 $375,000

Contribution margin………………………………

$165,000 $225,000

Fixed costs…………………………………………

33,000 99,000

Net income………………………………………….

$132,000 $126,000


Plan A profitability decrease:$165,000 - $132,000 = $33,000; $33,000 ÷ $165,000 = 20%

Plan B profitability decrease:$171,000 - $126,000 = $45,000; $45,000 ÷ $171,000 = 26.3% (rounded)

PneumoTech would experience a larger percentage decrease in income if it adopts Plan B. This situation arises because Plan B has a higher degree of operating leverage. Stated differently, Plan B’s cost structure produces a greater percentage decline in profitability from the drop-off in sales revenue.

Note: The percentage decreases in profitability can be computed by multiplying the percentage decrease in sales revenue by the operating leverage factor. Sales dropped from 6,000 units to 5,000 units, or 16.67%. Thus:

Plan A: 16.67% x 1.2 = 20.0%Plan B: 16.67% x 1.58 = 26.3% (rounded)

6. Heavily automated manufacturers have sizable investments in plant and equipment, along with a high percentage of fixed costs in their cost structures. As a result, there is a high degree of operating leverage.

In a severe economic downturn, these firms typically suffer a significant decrease in profitability. Such firms would be a more risky investment when compared with firms that have a low degree of operating leverage. Of course, when times are good, increases in sales would tend to have a very favorable effect on earnings in a company with high operating leverage.

CASE 7-55 (50 MINUTES)

1. Break-even point for 20x4, based on current budget:

2. Break-even point given employment of sales personnel:New fixed expenses:

Previous fixed expenses......................................................................... $ 150,000Sales personnel salaries (3 x $45,000)................................................... 135,000Sales managers’ salaries (2 $120,000).............................................. 240,000 Total........................................................................................................... $ 525,000

New contribution-margin ratio:

Sales...................................................................................................................................................................................................$15,000,000

Cost of goods sold................................................................................... 9,000,000 Gross margin............................................................................................ $

6,000,000Commissions (at 5%)............................................................................... 750,000 Contribution margin................................................................................. $ 5,250,000

CASE 7-55 (CONTINUED)

1. Assuming a 25% sales commission:

New contribution-margin ratio:

Sales...................................................................................................................................................................................................$15,000,000

Cost of goods sold................................................................................... 9,000,000 Gross margin............................................................................................ $ 6,000,000Commissions (at 25%)............................................................................. 3,750,000 Contribution margin................................................................................. $ 2,250,000

Sales volume in dollars required to earn after-tax

net income

Check:

Sales..................................................................... $ 20,000,000Cost of goods sold (60% of sales)..................... 12,000,000 Gross margin....................................................... $

8,000,000Selling and administrative expenses:

Commissions................................................. $ 5,000,000All other expenses (fixed)............................. 150,000 5,150,000

Income before taxes............................................ $2,850,000

Income tax expense (30%).................................. 855,000 Net income........................................................... $ 1,995,000

CASE 7-55 (CONTINUED)

2. Sales dollar volume at which Lake Champlain Sporting Goods Company is indifferent:

Let X denote the desired volume of sales.

Since the tax rate is the same regardless of which approach management chooses, we can find X so that the company’s before-tax income is the same under the two alternatives. (In the following equations, the contribution-margin ratios of .35 and .15, respectively, were computed in the preceding two requirements.)

.35X – $525,000 = .15X – $150,000.20X = $375,000

X = $375,000/.20X = $1,875,000

Thus, the company will have the same before-tax income under the two alternatives if the sales volume is $1,875,000.

Check:

AlternativesEmploy Sales

PersonnelPay 25%

CommissionSales.............................................................................. $1,875,000 $1,875,000Cost of goods sold (60% of sales).............................. 1,125,000 1,125,000 Gross margin................................................................ $ 750,000 $ 750,000Selling and administrative expenses:

Commissions............................................................ 93,750* 468,750†

All other expenses (fixed)....................................... 525,000 150,000 Income before taxes..................................................... $ 131,250 $ 131,250Income tax expense (30%)........................................... 39,375 39,375 Net income.................................................................... $ 91,875 $ 91,875

*$1,875,000 5% = $93,750 †$1,875,000 25% = $468,750

SOLUTIONS TO PROBLEMSPROBLEM 8-21 (45 MINUTES)

1. a. Absorption-costing income statements:

Year 1 Year 2 Year 3Sales revenue (at $25 per case) $2,000,000 $1,500,000 $2,250,000Less: Cost of goods sold (at absorption cost of $21 per case) * 1,680,000 1,260,000 1,890,000Gross margin $ 320,000 $ 240,000 $ 360,000Less: Selling and administrative expenses:

Variable (at $ .50 per case) 40,000 30,000 45,000Fixed 37,500 37,500 37,500

Operating income $ 242,500 $ 172,500 $ 277,500

*The absorption cost per case is $21, calculated as follows:

+

+ $16

$5 + $16 = $21


b. Variable-costing income statements:

Year 1 Year 2 Year 3Sales revenue (at $25 per case) .............................................................$2,000,000 $1,500,000 $2,250,000Less: Variable expenses:

Variable manufacturing costs (at variable cost of $16 per case) 1,280,000 960,000 1,440,000Variable selling and administrative costs (at $ .50 per case) ........................................................... 40,000 30,000 45,000

Contribution margin ................................................................................$ 680,000 $ 510,000 $ 765,000Less: Fixed expenses:

Fixed manufacturing overhead ..................................................400,000 400,000 400,000Fixed selling and administrative expenses .................................................................................... 37,500 37,500 37,500

Operating income ....................................................................................$ 242,500 $ 72,500 $ 327,500

2. Reconciliation:

Year

Reported Income Differencein

ReportedIncome

Change inInventory(in units)

Predetermined

FixedOverhead

Rate*

Difference InFixed OverheadExpensed UnderAbsorption andVariable Costing

AbsorptionCosting

VariableCosting

1 $242,500 $242,500 -0- -0- $5 02 172,500 72,500 $100,000 20,000 5 $100,0003 277,500 327,500 (50,000) (10,000) 5 (50,000)

*Predetermined fixed manufacturing overhead rate =


3. a. In year 4, the difference in reported operating income will be $50,000, calculated as follows:

Change ininventory(in units)

Predeterminedfixed overhead

rate

(10,000) $5 = $(50,000)

Income reported under absorption costing will be lower, because inventory will decline during year 4.

b. Over the four-year period, the total of all reported operating income will be the same under absorption and variable costing. This result will occur because inventory does not change over the four-year period. It starts out at zero on January 1 of year 1, and it ends up at zero on December 31 of year 4.


Throughput-costing income statements:

Year 1 Year 2 Year 3Sales revenue (at $25 per case) .............................. $2,000,000 $1,500,000 $2,250,000Less: Cost of goods sold (at throughput cost,

equal to direct-material cost of $7.50 per case)

600,000 450,000 675,000 Gross margin ............................................................ $1,400,000 $1,050,000 $1,575,000Less: Operating costs: Direct labora.............................................. 200,000 200,000 200,000 Variable overheadb.................................. 480,000 480,000 480,000

Variable selling and administrative costs (at $ .50 per unitc)............................................................. 40,000 30,000 45,000

Fixed manufacturing overhead.............. 400,000 400,000 400,000Fixed selling and administrative costs 37,500 37,500 37,500

Net income $ 242,500 $ (97,500 ) $ 412,500

a Assumes that management has committed to direct labor sufficient to produce the planned production volume of 80,000 units; direct labor is used at the rate of $2.50 per unit produced.

b Assumes that management has committed to support resources sufficient to produce the planned production volume of 80,000 units; variable-overhead cost is used at the rate of $6 per unit produced.

c Variable selling and administrative costs amount to $ .50 per unit sold.PROBLEM 8-27 (35 MINUTES)

1. Total cost:

Direct material (10,000 units x $36)…………...

$ 360,000

Direct labor………………………………………..

135,000

Variable manufacturing overhead……………. 195,000Fixed manufacturing overhead……………….. 660,000Variable selling and administrative costs

(9,600 units x $24)……………………………

230,400

Fixed selling and administrative costs……… 354,000Total………………………………………

…….$1,934,400

2. The cost of the year-end inventory of 400 units (10,000 units produced – 9,600 units sold) is computed as follows:

AbsorptionCosting

VariableCosting

ThroughputCosting

Direct material…………………………..

$ 360,000 $360,000 $360,000

Direct labor………………………………

135,000 135,000

Variable manufacturing overhead….. 195,000 195,000Fixed manufacturing overhead……… 660,000 _______

_________

Total product cost…………………

$1,350,000 $690,000 $360,000

Cost per unit (total ÷ 10,000 units)… $135 $69 $36 Year-end inventory (400 units x cost

per unit)……………………………...

$ 54,000 $ 27,600 $ 14,400

3. The total costs would be allocated between the current period’s income statement and the year-end inventory on the balance sheet. Thus:

Absorption costing: $1,934,400 - $54,000 = $1,880,400Variable costing: $1,934,400 - $27,600 = $1,906,800Throughput costing: $1,934,400 - $14,400 = $1,920,000

PROBLEM 8-27 (CONTINUED

Alternatively, these amounts can be derived as follows:

AbsorptionCosting

VariableCosting

ThroughputCosting

Cost of goods sold:9,600 units x $135...............................9,600 units x $69.................................9,600 units x $36.................................

$1,296,000$662,400

$345,600Direct labor............................................... 135,000Variable manufacturing overhead............. 195,000Fixed manufacturing overhead.................. 660,000 660,000Variable selling and administrative costs..

230,400 230,400 230,400Fixed selling and administrative costs...... 354,000 354,000 354,000

Total..................................................... $1,880,400 $1,906,800 $1,920,000

1. Throughput-costing income statement:

Sales revenue (9,600 units x $216)....................... $2,073,600Less: Cost of goods sold....................................... 345,600 Gross margin......................................................... $1,728,000 Less: Operating costs:

Direct labor...................................................... $ 135,000Variable manufacturing overhead................... 195,000Fixed manufacturing overhead........................ 660,000Variable selling and administrative costs........ 230,400Fixed selling and administrative costs............. _ 354,000

Total operating costs................................. $1,574,400 Net income............................................................ $ 153,600 *

*As a check: Net income = sales revenue - all costs expensed = $2,073,600 - $1,920,000 (from req. 3)

= $153,600



1. Reported income will be higher under absorption costing, because inventory is expected to increase by 1,000 units during the year. (Twenty thousand units will be produced in the last two months, but 19,000 units will be sold.)

2. a. Variable costing: Total contribution during first 10 months is equal to the fixed costs plus profit for that period.


Fixed costs during first 10 months ....................................................... $3,000,000Profit during first 10 months .................................................................. 300,000 Total contribution margin ....................................................................... $3,300,000

Contribution margin per unit = = $33 per unit

Projected total sales for the year are 119,000 units (100,000 in first 10 months plus 19,000 units in last 2 months). We can compute projected income for the year as follows. (There are no variances or selling and administrative costs.)

Projected total contribution margin ($33 119,000) .......................... $3,927,000Less: Projected fixed costs ($300,000 12) ....................................... 3,600,000Projected income .................................................................................... $ 327,000

The net income projected for the year under variable costing is $327,000.Note: The problem states that the prior period’s cost rates are the same as those of the current period. There are 10,000 units on hand at October 31, and production equals sales in the first 10 months. Thus, 10,000 units were on hand at January 1.

b. Absorption costing: The gross margin for the first 10 months is $300,000. Notice that income and gross margin are the same, since there are no selling or administrative expenses. Therefore, during the first 10 months:

Gross margin per unit = = $3 per unit


Projected sales for the year are 119,000 units, so we can compute the projected gross margin for the year as follows:

Projected gross margin ($3 119,000) ............................................... $357,000

There were no selling and administrative expenses. Therefore, the projected gross margin and projected income are the same.So projected net income for the year under absorption costing is $357,000.Check: Our conclusions can be checked by noting the following relationship:

–

= increase in inventory fixed-overhead rate

= 1,000 units $30 per unit = $30,000Therefore, reported income will be $30,000 higher under absorption costing than under variable costing.

3. The advantages and disadvantages of variable and absorption costing are summarized as follows:

(a) Pricing decisions: Many managers prefer to use absorption-costing data in cost-based pricing decisions. They argue that fixed manufacturing overhead is a necessary cost incurred in the production process. To exclude this fixed cost from the inventoried cost of a product, as is done under variable costing, is to understate the cost of the product. For this reason, most companies that use cost-based pricing base their prices on absorption-costing data.

Proponents of variable costing argue that a product’s variable cost provides a better basis for pricing decisions. They point out that any price above a product’s variable cost makes a positive contribution to covering fixed cost and profit.

(b) Definition of an asset: Another controversy about absorption and variable costing hinges on the definition of an asset. An asset is a thing of value owned by the organization with future service potential. By accounting convention, assets are valued at their cost. Since fixed costs comprise part of the cost of production, advocates of absorption costing argue that inventory (an asset) should be valued at its full (absorption) cost of production. Moreover, they argue that these costs have future service potential since the inventory can be sold in the future to generate sales revenue.

Proponents of variable costing argue that the fixed-cost component of a product’s absorption-costing value has no future service potential. Their reasoning is that the fixed manufacturing-overhead costs during the current period will not prevent these costs from having to be incurred again next period. Fixed-overhead costs will be incurred every period, regardless of production levels. In contrast, the incurrence of variable costs in manufacturing a product does allow the firm to avoid incurring these costs again.

(c) Cost-volume-profit analysis: Some managers find the inconsistency between absorption costing and CVP analysis troubling enough to warrant using variable costing for internal income reporting. Variable costing dovetails much more closely than absorption costing with any operational analyses that require a separation between fixed and variable costs.

(d) External reporting: For external reporting purposes, generally accepted accounting principles require that income reporting be based on absorption costing. Federal tax laws also require the use of absorption costing in reporting income for tax purposes.

CH. 9 solutions

This comment is occasionally heard from people who have started and run their own small business for a long period of time. These individuals have great knowledge in their minds about running their business. They feel that they do not need to spend a great deal of time on the budgeting process, because they can essentially run the business by feel. This approach can result in several problems. First, if the person who is running the business is sick or traveling, he or she is not available to make decisions and implement plans that could have been clarified by a budget. Second, the purposes of budgeting are important to the effective running of an organization. Budgets facilitate communication and coordination, are useful in resource allocation, and help in evaluating performance and providing incentives to employees. It is difficult to achieve these benefits without a budgeting process.

9-18 In developing a budget to meet your college expenses, the primary steps would be to project your cash receipts and your cash disbursements. Your cash receipts could come from such sources as summer jobs, jobs held during the academic year, college funds saved by relatives or friends for your benefit, scholarships, and financial aid from your college or university. You would also need to carefully project your college expenses. Your expenses would include tuition, room and board, books and other academic supplies, transportation, clothing and other personal needs, and money for entertainment and miscellaneous expenses.

9-19 Firms with international operations face a variety of additional challenges in preparing their budgets. A multinational firm's budget must reflect the translation of foreign currencies into

U.S. dollars. Almost all the world's currencies fluctuate in their values relative to the dollar, and this fluctuation makes budgeting for those translations difficult.

It is difficult to prepare budgets when inflation is high or unpredictable. Some foreign countries have experienced hyperinflation, sometimes with annual inflation rates well over 100 percent. Predicting such high inflation rates is difficult and complicates a multinational's budgeting process.

The economies of all countries fluctuate in terms of consumer demand, availability of skilled labor, laws affecting commerce, and so forth. Companies with foreign operations face the task of anticipating such changing conditions in their budgeting processes.

9-20 The five phases in a product's life cycle are as follows:(a) Product planning and concept design(b) Preliminary design(c) Detailed design and testing(d) Production(e) Distribution and customer serviceIt is important to budget these costs as early as possible in order to ensure that the revenue a product generates over its life cycle will cover all of the costs to be incurred. A large portion of a product's life-cycle costs will be committed well before they are actually incurred.


1. Cash collections in October:

Month of Sale Amount Collected in OctoberJuly................................................................ $150,000 4% $ 6,000August.......................................................... 175,000 10% 17,500September.................................................... 200,000 15% 30,000October......................................................... 225,000 70% 157,500Total.............................................................. $211,000

Notice that the amount of sales on account in June, $122,500 was not needed to solve the exercise.

2. Cash collections in fourth quarter from credit sales in fourth quarter.

Amount Collected

Month of SaleCredit Sales October November December

October............................................. $225,000 $157,500 $ 33,750 $ 22,500November......................................... 250,000 – 175,000 37,500December......................................... 212,500 – – 148,750 Total.................................................. $157,500 208,750 $208,750 Total collections in fourth quarter

from credit sales in fourth quarter.......................................... $575,000

3. THE ELECTRONIC VERSION OF THE SOLUTIONS MANUAL “BUILD A SPREADSHEET SOLUTIONS” IS AVAILABLE ON YOUR INSTRUCTORS CD AND ON THE HILTON, 8E WEBSITE: www.mhhe.com/hilton8e.


1. Budgeted cash collections for December:

Month of Sale Collections in DecemberNovember.............................................................. $400,000 38% $152,000December............................................................... 440,000 60% 264,000Total cash collections.......................................... $416,000

2. Budgeted income (loss) for December:

Sales revenue......................................................................... $440,000Less: Cost of goods sold (75% of sales)............................. 330,000 Gross margin (25% of sales)................................................ $110,000Less: Operating expenses:...................................................

Bad debts expense (2% of sales).............................. $ 8,800Depreciation ($432,000/12)......................................... 36,000Other expenses........................................................... 45,200Total operating expenses........................................... 90,000

Income before taxes.............................................................. $ 20,000



3. Projected balance in accounts payable on December 31:

The December 31 balance in accounts payable will be equal to December's purchases of merchandise. Since the store's gross margin is 25 percent of sales, its cost of goods sold must be 75 percent of sales.

Month Sales

Cost of Goods Sold Amount Purchased in December

December.................... $440,000 $330,000 $330,000 20% $ 66,000January....................... 400,000 300,000 300,000 80% 240,000 Total December

purchases................. $306,000

Therefore, the December 31 balance in accounts payable will be $306,000.


Memorandum

Date: Today

To: President, East Bank of Mississippi

From: I.M. Student and Associates

Subject: Budgetary slack

Budgetary slack is the difference between a budget estimate that a person provides and a realistic estimate. The practice of creating budgetary slack is called padding the budget. The primary negative consequence of slack is that it undermines the credibility and usefulness of the budget as a planning and control tool. When a budget includes slack, the amounts in the budget no longer portray a realistic view of future operations.

The bank's bonus system for the new accounts manager tends to encourage budgetary slack. Since the manager's bonus is determined by the number of new accounts generated over the budgeted number, the manager has an incentive to understate her projection of the number of new accounts. The description of the new accounts manager's behavior shows evidence of such understatement. A 10 percent increase over the bank's current 10,000 accounts would mean 1,000 new accounts in 20x5. Yet the new accounts manager's projection is only 800 new accounts. This projection will make it more likely that the actual number of new accounts will exceed the budgeted number.

Problem 9-32 (40 minutes)

1. Production and direct-labor budgets

SHADY SHADES, INC.BUDGET FOR PRODUCTION AND DIRECT LABOR

FOR THE FIRST QUARTER OF 20X1Month

January February March QuarterSales (units)...................................................... 20,000 24,000 16,000 60,000Add: Ending inventory*.................................... 32,000 25,000 27,000 27,000 Total needs........................................................ 52,000 49,000 43,000 87,000Deduct: Beginning inventory.......................... 32,000 32,000 25,000 32,000 Units to be produced........................................ 20,000 17,000 18,000 55,000Direct-labor hours per unit..............................

1 1 .75

Total hours of direct labortime needed.................................................. 20,000 17,000 13,500 50,500

Direct-labor costs:Wages ($16.00 per DLH)†............................. $320,000 $272,000 $216,000 $808,000Pension contributions

($.50 per DLH).......................................... 10,000 8,500 6,750 25,250Workers' compensation

insurance ($.20 per DLH)........................ 4,000 3,400 2,700 10,100

Employee medical insurance($.80 per DLH).......................................... 16,000 13,600 10,800 40,400

Employer's social security(at 7%)....................................................... 22,400 19,040 15,120 56,560

Total direct-labor cost...................................... $372,400 $316,540 $251,370 $940,310

*100 percent of the first following month's sales plus 50 percent of the second following month's sales.†DLH denotes direct-labor hour.

Problem 9-32 (Continued)

2. Use of data throughout the master budget:

Components of the master budget, other than the production budget and the direct-labor budget, that would also use the sales data include the following:

Sales budget

Cost-of-goods-sold budget

Selling and administrative expense budget

Components of the master budget, other than the production budget and the direct-labor budget, that would also use the production data include the following:

Direct-material budget

Manufacturing-overhead budget


Components of the master budget, other than the production budget and the direct-labor budget, that would also use the direct-labor-hour data include the following:

Manufacturing-overhead budget (for determining the overhead application rate)

Components of the master budget, other than the production budget and the direct-labor budget, that would also use the direct-labor cost data include the following:

Manufacturing-overhead budget (for determining the overhead application rate)


Cash budget


3. Manufacturing overhead budget:

SHADY SHADES, INC.MANUFACTURING OVERHEAD BUDGET

FOR THE FIRST QUARTER OF 20X1

Month

January February March Quarter

Shipping and handling............... $ 60,000 $ 72,000 $48,000 $180,000Purchasing, material handling, and inspection............................. 90,000 76,500 81,000 247,500Other overhead............................ 210,000 178,500 141,750 530,250 Total manufacturing overhead... $360,000 $327,000 $270,750 $957,750


1. Niagra Chemical Company’s production budget (in gallons) for the three products for 20x2 is calculated as follows:

Yarex Darol Norex

Sales for 20x2............................................. 120,000 80,000 50,000Add: Inventory, 12/31/x2

(.08 × 20x3 sales)................................... _10,400 _5,600 _4,800 Total required.............................................. 130,400 85,600 54,800Deduct: Inventory, 12/31/x1

(.08 × 20x2 sales).................................. 9,600 6,400 4,000 Required production in 20x2..................... 120,800 79,200 50,800

2. The company’s conversion cost budget for 20x2 is shown in the following schedule:

Conversion hours required:Yarex (120,800 × .07).................................. 8,456Darol (79,200 × .10)..................................... 7,920Norex (50,800 × .16).................................... _8,128 Total hours.................................................. 24,504

Conversion cost budget (24,504 x $20).... $490,080


3. Since the 20x1 usage of Islin is 200,000 gallons, the firm’s raw-material purchases budget (in dollars) for Islin for 20x2 is as follows:

Quantity of Islin required for production in 20x2 (in gallons):Yarex (120,800 × 1)....................................................................Darol (79,200 × .7).....................................................................Norex (50,800 × .5)....................................................................

120,800 55,440 25,400

Subtotal………………………………………………………………….. 201,640Add: Required inventory, 12/31/x2 (201,640 × .10)...................... 20,164 Subtotal............................................................................................ 221,804Deduct: Inventory, 1/1/x2 (200,000 × .10)...................................... 20,000 Required purchases (gallons)....................................................... 201,804

Purchases budget (201,804 gallons × $5 per gallon).................. $1,009,020

4. The company should continue using Islin, because the cost of using Philin is $152,632 greater than using Islin, calculated as follows:

Change in material cost from substituting Philin for Islin:20x2 production requirements:

Philin (201,640 × $5 × 1.2).........................................................Islin (201,640 × $5)....................................................................

$1,209,840 1,008,200

Increase in cost of raw material.................................................... $ 201,640 Change in conversion cost from substituting Philin for Islin:

Philin (24,504 × $20 × .9)........................................................... $ 441,072Islin (24,504 × $20).................................................................... 490,080

Decrease in conversion cost......................................................... $ (49,008 ) Net increase in production cost.................................................... $ 152,632


1. Sales budget:

20x0 20x1

December January February MarchFirst

QuarterTotal sales........................ $800,000 $880,000 $968,000 $1,064,800 $2,912,800Cash sales*....................... 200,000 220,000 242,000 266,200 728,200Sales on account†............ 600,000 660,000 726,000 798,600 2,184,600

*25% of total sales.†75% of total sales.

2. Cash receipts budget:

20x1

January February MarchFirst

QuarterCash sales.............................................. $220,000 $242,000 $266,200 $ 728,200Cash collections from credit

sales made during currentmonth*................................................ 66,000 72,600 79,860 218,460

Cash collections from creditsales made during precedingmonth†................................................ 540,000 594,000 653,400 1,787,400

Total cash receipts................................ $826,000 $908,600 $999,460 $2,734,060

*10% of current month's credit sales.†90% of previous month's credit sales.


3. Purchases budget:

20x0 20x1

December January February MarchFirst

QuarterBudgeted cost of

goods sold.................. $560,000 $616,000 $677,600 $745,360 $2,038,960

Add: Desiredending inventory......... 308,000 338,800 372,680 372,680 * 372,680 †

Total goodsneeded......................... $868,000 $954,800 $1,050,280 $1,118,040

$2,411,640

Less: Expectedbeginninginventory..................... ††280,000 308,000 338,800 372,680 308,000 **

Purchases......................... $588,000 $646,800 $711,480 $745,360 $2,103,640

*Since April's expected sales and cost of goods sold are the same as the projections for March, the desired ending inventory for March is the same as that for February.

†The desired ending inventory for the quarter is equal to the desired ending inventory on March 31, 20x1.

**The beginning inventory for the quarter is equal to the December ending inventory.

††50% x $560,000 (where $560,000 = December cost of goods sold = December sales of $800,000 x 70%)


4. Cash disbursements budget:

20x1


QuarterInventory purchases:Cash payments for purchases

during the current month*........ $258,720 $284,592 $298,144 $ 841,456Cash payments for purchases

during the precedingmonth†......................................... 352,800 388,080 426,888 1,167,768

Total cash payments forinventory purchases........................ $611,520 $672,672 $725,032 $2,009,224

Other expenses:Sales salaries................................... $ 42,000 $ 42,000 $ 42,000 $ 126,000Advertising and promotion............. 32,000 32,000 32,000 96,000Administrative salaries................... 42,000 42,000 42,000 126,000Interest on bonds**.......................... 30,000 -0- -0- 30,000Property taxes**............................... -0- 10,800 -0- 10,800Sales commissions......................... 8,800 9,680 10,648 29,128

Total cash payments for other expenses........................................... $154,800 $136,480 $126,648 $ 417,928

Total cash disbursements.................... $766,320 $809,152 $851,680 $2,427,152

*40% of current month's purchases [see requirement (3)].

†60% of the prior month's purchases [see requirement (3)].

**Bond interest is paid every six months, on January 31 and July 31. Property taxes also are paid every six months, on February 28 and August 31.


5. Summary cash budget:

20x1


QuarterCash receipts [from req. (2)]................ $ 826,000 $ 908,600 $ 999,460 $2,734,060Cash disbursements

[from req. (4)].................................... (766,320 ) (809,152 ) (851,680 ) (2,427,152 ) Change in cash balance

during period due to operations.... $ 59,680 $ 99,448 $147,780 $ 306,908Sale of marketable securities

(1/2/x1)............................................... 30,000 30,000Proceeds from bank loan

(1/2/x1)............................................... 200,000 200,000Purchase of equipment......................... (250,000) (250,000)Repayment of bank loan

(3/31/x1)............................................. (200,000) (200,000)Interest on bank loan*........................... (5,000) (5,000)Payment of dividends........................... (100,000) (100,000 )

Change in cash balance duringfirst quarter....................................... $ (18,092)

Cash balance, 1/1/x1............................. 70,000 Cash balance, 3/31/x1........................... $ 51,908

*$200,000 10% per year 1/4 year = $5,000

6. Analysis of short-term financing needs:

Projected cash balance as of December 31, 20x0....................................... $ 70,000

Less: Minimum cash balance........................................................................ 50,000 Cash available for equipment purchases..................................................... $ 20,000

Projected proceeds from sale of marketable securities............................. 30,000 Cash available................................................................................................. $ 50,000

Less: Cost of investment in equipment........................................................ 250,000 Required short-term borrowing..................................................................... $(200,000)


7. GLOBAL ELECTRONICS COMPANYBUDGETED INCOME STATEMENT


Sales revenue.......................................................................... $2,912,800Less: Cost of goods sold....................................................... 2,038,960Gross margin........................................................................... $ 873,840Selling and administrative expenses:

Sales salaries..................................................................... $126,000Sales commissions........................................................... 29,128Advertising and promotion.............................................. 96,000Administrative salaries..................................................... 126,000Depreciation....................................................................... 150,000Interest on bonds.............................................................. 15,000Interest on short-term bank loan..................................... 5,000Property taxes................................................................... 5,400

Total selling and administrative expenses........................... 552,528Net income............................................................................... $ 321,312

8. GLOBAL ELECTRONICS COMPANYBUDGETED STATEMENT OF RETAINED EARNINGS


Retained earnings, 12/31/x0.......................................................................... $ 215,000Add: Net income............................................................................................ 321,312Deduct: Dividends......................................................................................... 100,000 Retained earnings, 3/31/x1............................................................................ $ 436,312


9. GLOBAL ELECTRONICS COMPANYBUDGETED BALANCE SHEET

MARCH 31, 20X1

Cash.................................................................................................................. $ 51,908Accounts receivable*...................................................................................... 718,740Inventory.......................................................................................................... 372,680Buildings and equipment (net of accumulated depreciation)†................... 1,352,000 Total assets...................................................................................................... $2,495,328

Accounts payable**......................................................................................... $ 447,216Bond interest payable..................................................................................... 10,000Property taxes payable................................................................................... 1,800Bonds payable (10%; due in 20x6)................................................................ 600,000Common Stock................................................................................................ 1,000,000Retained earnings........................................................................................... 436,312 Total liabilities and stockholders' equity...................................................... $2,495,328

*Accounts receivable, 12/31/x0...................................................................... $ 540,000Sales on account [req. (1)]............................................................................. 2,184,600Total cash collections from credit sales

[(req. (2)] ($218,460 + $1,787,400).............................................................. (2,005,860)Accounts receivable, 3/31/x1......................................................................... $ 718,740

†Buildings and equipment (net), 12/31/x0..................................................... $1,252,000Cost of equipment acquired........................................................................... 250,000Depreciation expense for first quarter.......................................................... (150,000 )Buildings and equipment (net), 3/31/x1........................................................ $1,352,000

**Accounts payable, 12/31/x0......................................................................... $ 352,800Purchases [req. (3)]......................................................................................... 2,103,640Cash payments for purchases [req. (4)]....................................................... (2,009,224)Accounts payable, 3/31/x1............................................................................. $ 447,216


1. Tuition revenue budget:Current student enrollment…………………….

12,000

Add: 5% increase in student body…………… 600Total student body……………………………….

12,600

Less: Tuition-free scholarships………………. 180Tuition-paying students…………………………

12,420

Credit hours per student per year……………. x 30Total credit hours………………………………..

372,600

Tuition rate per hour…………………………….

x $75

Forecasted tuition revenue……………………. $27,945,000

2. Faculty needed to cover classes:Total student body…………………………………….

12,600

Classes per student per year [(15 credit hours ÷ 3 credit hours) x 2 semesters]…………………. x 10

Total student class enrollments to be covered…. 126,000

Students per class…………………………………….

÷ 25

Classes to be taught………………………………….

5,040

Classes taught per professor………………………. ÷ 5Faculty needed…………………………………………

1,008

3. Possible actions might include: Hire part-time instructors Use graduate teaching assistants Increase the teaching load for each professor Increase class size and reduce the number of sections to be offered Have students take an Internet-based course offered by another university Shift courses to a summer session

4. No. While the number of faculty may be a key driver, the number of faculty is highly dependent on the number of students. Students (and tuition revenue) are akin to sales—the starting point in the budgeting process.


1. Sales budget

July August SeptemberSales (in sets)............................................... 5,000 6,000 7,500Sales price per set....................................... $60 $60 $60 Sales revenue............................................... $300,000 $360,000 $450,000

2. Production budget (in sets)

July August SeptemberSales............................................................. 5,000 6,000 7,500Add: Desired ending inventory.................. 1,200 1,500 1,500 Total requirements...................................... 6,200 7,500 9,000Less: Projected beginning inventory........ 1,000 1,200 1,500 Planned production..................................... 5,200 6,300 7,500

3. Raw-material purchases

July August SeptemberPlanned production (sets)............................. 5,200 6,300 7,500Raw material required per set

(board feet).................................................. 10 10 10 Raw material required for production

(board feet).................................................. 52,000 63,000 75,000Add: Desired ending inventory of raw

material (board feet)................................... 6,300 7,500 8,000 Total requirements......................................... 58,300 70,500 83,000Less: Projected beginning inventory of

raw material (board feet)............................ 5,200 6,300 7,500 Planned purchases of raw material

(board feet).................................................. 53,100 64,200 75,500Cost per board foot........................................ $.60 $.60 $.60 Planned purchases of raw material

(dollars)....................................................... $ 31,860 $ 38,520 $ 45,300


4. Direct-labor budget

July August SeptemberPlanned production (sets)............................. 5,200 6,300 7,500Direct-labor hours per set.............................. 1.5 1.5 1.5 Direct-labor hours required........................... 7,800 9,450 11,250Cost per hour.................................................. $21 $21 $21 Planned direct-labor cost............................... $163,800 $198,450 $236,250




1. Sales are collected over a two-month period, 40% in the month of sale and 60% in the following month. December receivables of $108,000 equal 60% of December’s sales; thus, December sales total $180,000 ($108,000 ÷ .6). Since the selling price is $20 per unit, Dakota Fan sold 9,000 units ($180,000 ÷ $20).

2. Since the company expects to sell 10,000 units, sales revenue will total $200,000 (10,000 units x $20).

3. Dakota Fan collected 40% of February’s sales during February, or $78,400. Thus, February’s sales total $196,000 ($78,400 ÷ .4). Combining January sales ($76,000 + $114,000), February sales ($196,000), and March sales ($200,000), the company will report revenue of $586,000.

4. Sixty percent of March’s sales will be outstanding, or $120,000 ($200,000 x 60%).

5. Finished-goods inventories are maintained at 20% of the following month’s sales. January sales total $190,000 ($76,000 + $114,000), or 9,500 units ($190,000 ÷ $20). Thus, the December 31 inventory is 1,900 units (9,500 x 20%).

6. February sales will total 9,800 units ($196,000 ÷ $20), giving rise to a January 31 inventory of 1,960 units (9,800 x 20%). Letting X denote production, then:

12/31/x0 inventory + X – January 20x1 sales = 1/31/x1 inventory1,900 + X - 9,500 = 1,960X – 7,600 = 1,960X = 9,560

7. Financing required is $3,500 ($15,000 minimum balance less ending cash balance of $11,500):

Cash balance, January 1…………………………

$ 22,500

Add: January receipts ($108,000 + $76,000).. 184,000Subtotal……………………………………

……$206,500

Less: January payments…………………………

195,000

Cash balance before financing………………….

$ 11,500


1. The benefits that can be derived from implementing a budgeting system include the following:

The preparation of budgets forces management to plan ahead and to establish goals and objectives that can be quantified.

Budgeting compels departmental managers to make plans that are in congruence with the plans of other departments as well as the objectives of the entire firm.

The budgeting process promotes internal communication and coordination.

Budgets provide directions for day-to-day control of operations, clarify duties to be performed, and assign responsibility for these duties.

Budgets help in measuring performance and providing incentives.

Budgets provide a vehicle for resource allocation.


2.a. Schedule b. Subsequent Schedule

Sales Budget Production BudgetSelling Expense BudgetBudgeted Income Statement

Ending Inventory Budget (units) Production BudgetProduction Budget (units) Direct-Material Budget

Direct-Labor BudgetManufacturing-Overhead Budget

Direct-Material Budget Cost-of-Goods-Manufactured BudgetDirect-Labor Budget Cost-of-Goods-Manufactured BudgetManufacturing-Overhead Budget Cost-of-Goods-Manufactured BudgetCost-of-Goods-Manufactured Budget Cost-of-Goods-Sold BudgetCost-of-Goods-Sold Budget (includes

ending inventory in dollars)Budgeted Income StatementBudgeted Balance Sheet

Selling Expense Budget Budgeted Income Statement

Research and Development Budget Budgeted Income StatementAdministrative Expense Budget Budgeted Income Statement

Budgeted Income Statement Budgeted Balance SheetBudgeted Statement of Cash Flows

Capital Expenditures Budget Cash Receipts and Disbursements BudgetBudgeted Balance SheetBudgeted Statement of Cash Flows

Cash Receipts and DisbursementsBudget

Budgeted Balance SheetBudgeted Statement of Cash Flows

Budgeted Balance Sheet Budgeted Statement of Cash FlowsBudgeted Statement of Cash Flows

Select Solutions to Ch 10

10-26 Responses will vary widely on this question. Here are some possibilities for a bank:• Financial: (a) profit; (b) cost of back-office (i.e., administrative) operations.• Internal operations: (a) number of transaction errors; (b) employee retention

and advancement.

• Customer: (a) local market share; (b) number of repeat customers.• Innovation and learning: (a) new financial products; (b) employee suggestions

received and implemented.Lead measures, such as market share or new financial products, show how well the bank is doing now in areas that will affect financial performance in the future. Lag measures, such as the bank’s profits, measure the bank’s financial performance. Lag measures are the result of previous efforts in the bank’s customer, internal operations, and learning and innovation perspectives.


DIRECT-MATERIAL PRICE AND QUANTITY VARIANCES

ACTUAL MATERIAL COST STANDARD MATERIAL COSTActual

Quantity Actual Price

Actual Quantity

Standard Price

Standard Quantity

Standard Price

240,000 kilograms purchased

$.62per

kilogram

240,000 kilograms purchased

$.60per

kilogram

200,000kilograms allowed

$.60per

kilogram

$148,800 $144,000 $120,000

$4,800 UnfavorableDirect-materialprice variance

210,000 kilograms

used $.60per

kilogram

$126,000

$6,000Unfavorable

Direct-material quantity variance


DIRECT-LABOR RATE AND EFFICIENCY VARIANCES

ACTUAL LABOR COST STANDARD LABOR COSTActualHours

Actual Rate

Actual Hours

Standard Rate

Standard Hours

Standard Rate

13,000 hoursused

$12.20

perhour

13,000hoursused

$12.00

perhour

12,500hours

allowed

$12.00per

hour

$158,600 $156,000 $150,000

$2,600 Unfavorable $6,000 UnfavorableDirect-laborrate variance

Direct-laborefficiency variance

$8,600 UnfavorableDirect-labor variance


1. Direct-material price variance = (PQ AP) – (PQ SP)= (36,000 $1.38) – (36,000 $1.35)= $49,680 – $48,600= $1,080 Unfavorable

2. Direct-material quantity variance = (AQ SP) – (SQ SP)= (19,000 $1.35) – (20,000* $1.35)= $25,650 - $27,000= $1,350 Favorable

*1,000 units 20 yards per unit = 20,000 yards

3. Direct-labor rate variance = (AH AR) – (AH SR)= (4,200 $9.15) – (4,200 $9.00)= $38,430 – $37,800= $630 Unfavorable

4. Direct-labor efficiency variance = (AH SR) – (SH SR)= (4,200 $9.00) – (4,000* $9.00)= $37,800 – $36,000= $1,800 Unfavorable

*1,000 units 4 hours per unit = 4,000 hours


DirectMaterial

InitialMix

UnitCost

Standard Material

CostNyclyn...................................................................... 12 kg 4.35real 52.20real

Salex........................................................................ 9.6 ltr 5.40real 51.84real

Protet....................................................................... 5 kg 7.20real 36.00 real

Standard material cost

for each 10-liter container................................... 140.04 real

The real is Brazil’s national currency.


1. Type I fertilizer:Price variance:

Actual quantity purchased x actual price5,000 pounds x

$ .53………………………………$2,650

Actual quantity purchased x standard price5,000 pounds x

$ .50……………………………… 2,500

Direct-material price variance……………………….

$ 150 Unfavorable

Quantity variance:Actual quantity used x standard price

3,700 pounds x $ .50………………………………

$1,850

Standard quantity allowed x standard price4,400 pounds* x

$ .50…………………………….. 2,200

Direct-material quantity variance……………………

$ 350 Favorable

* 40 pounds x 55 clients x 2 applications

Type II fertilizer:Price variance:


$ .40…………………………….$4,000


$ .42……………………………. 4,200


$ 200 Favorable



7,800 pounds x $ .42………………………………

$3,276


$ .42…………………………….. 3,696


$ 420 Favorable

* 40 pounds x 55 clients x 4 applications

2. Direct-labor variances:Rate variance:

Actual hours used x actual rate165 hours x

$11.50……………………..$1,897.50

Actual hours used x standard rate165 hours x

$9.00……………………… 1,485.00

Direct-labor rate variance…………………

$ 412.50 Unfavorable

Efficiency variance:Actual hours used x standard rate

165 hours x $9.00……………………….

$1,485.00

Standard hours allowed x standard rate220 hours* x

$9.00……………………... 1,980.00

Direct-labor efficiency variance…………. $ 495.00 Favorable

* 2/3 hours x 55 clients x 6 applications

3. Actual cost of applications:Type I fertilizer:

Actual quantity used x actual price (3,700 pounds x $ .53)…. $1,961.00

Type II fertilizer:Actual quantity used x actual price (7,800 pounds x $ .40)….

3,120.00Direct labor:

Actual hours used x actual rate (165 hours x $11.50)………... 1,897.50

Total actual cost………………………………………………………….

$6,978.50

Yes, the service was a financial success. Wolfe charged clients $40 per application, generating revenue of $13,200 (55 clients x 6 applications x $40). With costs of $6,978.50, the fertilization service produced a profit of $6,221.50.


4. (a) Yes, the service was a success. Overall costs were controlled as indicated bya total favorable variance of $902.50. In addition, each of the three cost components (Type I fertilizer, Type II fertilizer, and direct labor) produced a net favorable variance. Wolfe did have a sizable unfavorable labor-rate variance as a result of his having to pay $11.50 per hour when a more typical wage rate would have been $9.00 per hour. This inflated rate is attributable to the tight labor market, which is beyond his control. Note: Part of the variance may have been caused by a standard rate that was set too low, especially given the fact that this is a new service.

Type I fertilizer:Price

variance…………………………………..$150.00 Unfavorable

Quantity variance………………………………

350.00 Favorable

Type II fertilizer:Price

variance………………………………….. 200.00 Favorable

Quantity variance………………………………

420.00 Favorable

Direct labor:Rate

variance…………………………………… 412.50 Unfavorable

Efficiency variance……………………………

495.00 Favorable

Total material and labor variances $902.50 Favorable

(b) In this case, several of the favorable variances may have come back to haunt Wolfe. The favorable labor efficiency variance means that less time is being spent on the job than originally anticipated. This may indicate that the part-time employee is rushing and doing sloppy work. Also, less fertilizer used than budgeted (i.e., favorable quantity variances for both Type I and Type II) would likely give rise to an increased occurrence of weeds as well as a lack of greening in the lawn.

5. This is a management judgment for Wolfe to make. If the service is continued, Wolfe should consider hiring a full-time employee and insisting on the standard amount of fertilizer being applied to each lawn.


1. a. Machine hours x 4 = standard direct-labor hours165.5 x 4 = 662

b. Direct-labor efficiency variance= (AH-SH)SR= (374-662)$15.08= $4,343 F

2.a. Standard Direct-Labor

Cost*

b. 20% of the Standard Direct-

Labor Cost*January.............................................................. $ 9,983 $1,997February............................................................ 6,050 1,210March................................................................. 33,297 6,659April.................................................................... 43,056 8,611May..................................................................... 9,651 1,930June................................................................... 13,994 2,799July..................................................................... 6,273 1,255August............................................................... 5,791 1,158September......................................................... 5,791 1,158October.............................................................. 4,343 869

*Rounded.

3. The variances for all of the months except August and September exceed 20% of the standard direct-labor cost and would therefore be investigated.


4. Statistical control chart for direct-labor efficiency variances:


5. The variances for March, April, and June will be investigated, since they exceed one standard deviation.

6. The production volume was much greater in March, April, and June.


1. Schedule of standard production costs:

VALPORT VALVE COMPANY: SHREVEPORT PLANTSCHEDULE OF STANDARD PRODUCTION COSTS: BASED ON 15,600 UNITS

FOR THE MONTH OF MARCH

Standard Costs

Direct material....................................................... 15,600 units 3 lbs. $5.00 $ 234,000Direct labor............................................................ 15,600 units 5 hrs.

$11.25 877,500

Total standard production costs......................... $1,111,500

2. Variances:

a. Direct-material price variance = (PQ AP) – (PQ SP)= (50,000 $5.20) – (50,000 $5.00)= $10,000 Unfavorable

b. Direct-material quantity variance = (AQ SP) – (SQ SP)= (46,200 $5.00) – (46,800* $5.00)= $3,000 Favorable

*15,600 units 3 lbs. per unit = 46,800 lb.

c. Direct-labor rate variance = (AH AR) – (AH SR)= (80,200 $10.95) – (80,200 $11.25)= $24,060 Favorable

d. Direct-labor efficiency variance = (AH SR) – (SH SR)= (80,200 $11.25) – (78,000* $11.25)= $24,750 Unfavorable

*15,600 units 5 hours per unit = 78,000 hr.





1. No. The variances are favorable and small, with each being less than 2% of budgeted cost amounts ($350,000). However, by simply reporting total variances for material and labor, one cannot get a totally clear picture of performance. Price, quantity, rate, and efficiency variances should be calculated for further insight.

2. Direct-material variances:Price variance:


$7.70…………………………….$346,500


$8.80……………………………. 396,000


$ 49,500 Favorable


45,000 pounds x $8.80……………………………

$396,000


$8.80………………………….. 351,120


$ 44,880 Unfavorable

* 9,500 units x 4.2 pounds

Total direct-material variance:$49,500F + $44,880U = $4,620F


Direct-labor variances:Rate variance:

Actual hours used x actual rate20,900 hours x

$16.25………………….$339,625

Actual hours used x standard rate20,900 hours x

$14.00…………………. 292,600

Direct-labor rate variance…………………

$ 47,025 Unfavorable

Efficiency variance:Actual hours used x standard rate

20,900 hours x $14.00………………….

$292,600

Standard hours allowed x standard rate24,700 hours* x

$14.00………………... 345,800

Direct-labor efficiency variance…………. $ 53,200 Favorable

* 9,500 units x 2.6 hours

Total direct-labor variance:$47,025U + $53,200F = $6,175F

3. Yes. Although the combined variances are small, a more detailed analysis reveals the presence of sizable, offsetting variances (all in excess of 12% of budgeted cost amounts). A variance investigation should be undertaken if the likely benefits of the investigation appear to exceed the costs.

4. No, things are not going as smoothly as the vice president believes. With regard to the new supplier, SolarPrime is paying less than expected for direct materials. However, the quality may be poor, as indicated by the unfavorable quantity variance and increased usage.

Turning to direct labor, the favorable efficiency variance means that the company is producing units by consuming fewer hours than expected. This may be the result of the team-building/morale-boosting exercises, as a contented, well-trained work force tends to be more efficient. However, another plausible explanation could be that Solar Prime is paying premium wages (as indicated by the unfavorable rate variance) to hire laborers with above-average skill levels.


As a side note, the favorable direct-labor efficiency variance may partially explain the unfavorable material quantity variance. That is, laborers may be rushing through their jobs and using more material than the standards allow.

5. Yes. Hoctor is the production supervisor. The prices paid for materials and the quality of material acquired are normally the responsibility of the purchasing manager. The change to the new supplier may introduce problems of dealing with the unknown—the supplier’s reliability, ability to deliver quality goods, etc. Finally, direct-labor wage rates are often a function of market conditions, which would likely be uncontrollable from Hoctor’s perspective.


1. a. Responsibility for setting standards:

Materials:

The development of standard prices for material is primarily the responsibility of the materials manager.

Operating departmental managers and engineers should be involved in setting standards for material quantities.

Labor:

The personnel manager or payroll manager would be involved in setting standard labor rates.

Operating department managers with input from production supervisors and engineers would be involved in setting standards for labor usage.


b. The factors that should be considered in establishing material standards include the following:

Price studies, including expected general economic conditions, industry prospects, demand for the materials, and market conditions.

Product specifications from descriptions, drawings, and blueprints.

Past records on raw-material cost, usage, waste, and scrap.

Factors in establishing labor standards:

Engineering studies of the time required to complete various tasks.

Learning.

Expected wage rates.

Expected labor mix (e.g., skilled versus unskilled).

2. The basis for assignment of responsibility under a standard-costing system is controllability. Judgments about whether departments or department managers are performing efficiently should not be affected by items over which they have no control.

The responsibility for a variance should be assigned to the department or individual that has the greatest responsibility for deciding whether a specific cost should be incurred. Some variances, however, are interdependent and responsibility must be shared.


1. The standard cost per 10-gallon batch of strawberry jam is determined as follows:

Strawberries (7.5 qts.* $1.60)........................................... $12.00 Other ingredients (10 gal. $.90)....................................... 9.00 Sorting labor (3/60 hr. 6 qt. $18.00)............................ 5.40Blending labor (12/60 hr. $18.00)..................................... 3.60Packaging (40 qt.† $.76).................................................... 30.40 Total standard cost per 10-gallon batch............................. $60.40

*6 quarts 5/4 = 7.5 qt., needed to produce 6 good quarts.†4 qt. per gal. 10 gal. = 40 qt.

2. Joe Adams’ behavior regarding the cost information is unethical because it violates the following ethical standards:

Competence. Prepare complete and clear reports and recommendations after appropriate analyses of relevant and reliable information.

Integrity. Avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflicts. Refrain from either actively or passively subverting the attainment of the organization’s legitimate and ethical objectives. Refrain from engaging in or supporting any activity that would discredit the profession.

Objectivity. Communicate information fairly and objectively.

3. a. In general, the purchasing manager is held responsible for unfavorable material price variances. Causes of these variances include the following:

Failure to forecast price increases correctly.

Purchasing nonstandard or uneconomical lots.

Purchasing from suppliers other than those offering the most favorable terms.


b. In general, the production manager is held responsible for unfavorable labor efficiency variances. Causes of these variances include the following:

Poorly trained labor.

Substandard or inefficient equipment.

Substandard material.


1. At California Housewares’ Merced Division, the standard cost per cutting board is calculated as follows:

Direct material:Lumber (1.5 board ft.* $4.00 per board ft.).............. $6.00Footpads (4 pads $.10 per pad)................................ .40 $6.40

Direct labor:Prepare and cut (14.4†/60 hr. $8.00 per hr.)............. $1.92Assemble and finish (15/60 hr. $8.00 per hr.)......... 2.00 3.92

Total standard unit cost........................................................ $10.32

2. a. The role of the purchasing manager in the development of standards includes establishing the standard cost for material required by the bill of materials, determining if the company should take advantage of price reductions available through economic order size, and obtaining data regarding the availability of materials.

b. The role of the industrial engineer in the development of standards includes preparing the bill of materials that specifies the types and quantities of material required; establishing, in conjunction with the production supervisor, any allowances for scrap, shrinkage, and waste; and participating in time studies and test runs to facilitate the establishment of time standards.

c. The role of the managerial accountant in the development of standards includes reviewing all information regarding material and labor standards received from other departments, establishing the labor rate standards based on the type of labor required, determining application rates for indirect costs such as material handling and manufacturing overhead, and converting physical standards such as hours and quantities to monetary equivalents.


3. a. Standard costing allows for management by exception. Timely reporting of variances allows management to take corrective action before costs get out of hand. The breakdown of variances into various components helps management trace the source of potential cost problems. Standard costing may also motivate employees to operate more efficiently if they are allowed to participate in setting the standards.

b. The standard costing system can have a negative impact on the motivation of employees if the standards are too easily attainable or too difficult to reach. If the standards are too easy, employees may tend to reduce productivity. If they are too difficult, production workers may become frustrated and ignore the standards. Also, standards that are set without production employee input may not be accepted as realistic by those employees.


1. Categories of measures:

Area of Manufacturing Performance

Cycle time (days)......................................................................... aNumber of defective finished products..................................... bManufacturing-cycle efficiency.................................................. aCustomer complaints.................................................................. b,cUnresolved complaints............................................................... cProducts returned....................................................................... b,cWarranty claims........................................................................... b,cIn-process products rejected..................................................... dAggregate productivity............................................................... a,eNumber of units produced per day per employee................... a,ePercentage of on-time deliveries............................................... fPercentage of orders filled......................................................... fInventory value/sales revenue................................................... g,hMachine downtime (minutes)..................................................... iBottleneck machine downtime (minutes)................................. iOvertime (minutes) per employee............................................. a,eAverage setup time (minutes).................................................... a


2. Memorandum

Date: Today

To: Management, Diagnostic Technology, Inc.

From: I. M. Student

Subject: Performance of Albany plant during 1st quarter

The performance of the Albany plant is evaluated in nine key areas:

a. Production processing:

Cycle time, manufacturing-cycle efficiency, and productivity measures all point to consistency and high-level performance throughout the measurement period. Both cycle time and manufacturing-cycle efficiency exhibit slight, favorable trends.

b. Product quality:

The number of defective finished products, number of products returned, and warranty claims all show improvement over the period. All three measures suggest excellent performance in quality control.

c. Customer acceptance:

Customer complaints are steady with an average of 5.5 complaints during a two-week period. The number of unresolved complaints improved during the period from 2 to 0. Performance in this area is very high, but there is a little room for improvement.

d. In-process quality control:

The number of products rejected in process has increased. This speaks well for the in-process inspection effort. The cause of these defective in-process units should be investigated and corrected.


e. Productivity:

Both the aggregate productivity measure and the number of units produced per day per employee remained relatively steady throughout the period. The latter of these two measures exhibited a slight, favorable trend.

f. Delivery performance:

Both performance measures (percentages of on-time deliveries and orders filled) were very high through the period, finishing at 100 percent in period 6.

g. & h. Raw material and scrap; inventory:

Inventory value/sales revenue remained consistently low through the period (average of 1.83 percent).

i. Machine maintenance:

Machine downtime was low through the period (average of 84 minutes each two-week period). Bottleneck machine downtime was low except in period 5. The cause of that incident should be investigated.

Overall evaluation:

The Albany plant has performed at a very high level of efficiency in virtually every phase of its operations during the 1st quarter.


MemorandumDate: Today

To: President, Southern Plastics Corporation

From: I. M. Student

Subject: Performance of Baton Rouge Plant

1. The Baton Rouge Plant's performance for the period January through June is summarized as follows:

a. Production processing and productivity:

The plant's cycle time (or throughput time) has improved over the period from 19 hours to 16 hours (average of 17.8 hours). This indicates that the efficiency of the actual processing of products has improved. Consistent with this observation is the reduction in setup time from 69 to 61 hours (average of 64.5). However, the plant's manufacturing cycle efficiency has declined through the period, indicating that too much time is being spent on inspection time, waiting time, and move time, relative to actual processing time. Overtime hours have increased, possibly due to higher demand late in the period. Power consumption has remained stable.

b. Product quality and customer acceptance:

The plant's quality control program appears to be paying off. The number of defective units in finished goods declined dramatically, and no products were returned. This is the result of the plant's inspectors more effectively identifying defective units while still in process. Effort should be devoted in the future to the reduction of the in-process defective rate.

c. Delivery performance:

Delivery performance is good, but could be improved. All orders were filled, but only an average of 95 percent of the orders were filled on time in May and June. This might reflect increased demand, as evidenced by the increase in overtime hours.

problem 10-56 (continued)

d. Raw material, scrap and inventory:

The rate of defective raw materials has declined to zero. The purchasing team is doing a good job by ensuring delivery of high-quality raw materials. Inventory value has been steady through the period with an average of 4.8 percent of sales. This is probably as low as can reasonably be expected in this industry.

e. Machine maintenance:

Machine downtime improved during the period from 30 hours to 10 hours (average of 21.7 hours), but bottleneck machine downtime was too high, particularly in May. Also, unscheduled machine maintenance calls were up in May and June.

2. Recommended actions:

a. Investigate the reasons behind the decline in manufacturing-cycle efficiency. Concentrate on the elimination of non-value-added activities, such as move time and wait time.

b. Maintain inspections in process. Try to reduce the in-process defective rate by emphasizing the importance of quality to the work force.

c. Investigate causes of bottleneck machine downtime and correct the situation.

select solutions to chapter 7 - middle east technical …users.metu.edu.tr/mugan/hilton ch 7-10...

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