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By

Mphil, MBA

Lecturer of Accounting & Finance PAF-KIET

Table of Content

1. Introduction ....................................................................................................................02 2. Cost Accounting Systems...................................................................................................14 Job Order Cost Flow.............................................................................................14 Assignment of Manufacturing Costs..................................................................................26 Production Cost Report.......................................................................................................28 5. STANDARD COSTS AND BALANCED SCORECARD...................................................37 6. MANAGERIAL ACCOUNTING...................................................................................45 9. Assignment # 3 Process costing ...................................................................................31 10. Activity base costing ...................................................................................................32 11. Standard costs and balanced scorecard.....................................................................33 12. Quiz # 3 Standard costs and balanced scorecard......................................................38 13. Assignment # 4 Standard costs and balanced scorecard.........................................40 14. Managerial accounting.................................................................................................41 15. Quiz # 4 Managerial accounting...................................................................................45 16. Assignment # 5 Managerial accounting......................................................................47 17. Cost-volume-profit........................................................................................................49 18. Quiz # 5 Cost-volume-profit..........................................................................................54 19. Assignment # 6 Cost-volume-profit..............................................................................56 20. Incremental Analysis and Capital Budgeting .............................................................59 21. Quiz # 6 Incremental Analysis and Capital Budgeting ..............................................64 22. Assignment # 7 Incremental Analysis and Capital Budgeting ..................................66

Cost Accounting Systems...................................................................................................14 Job Order Cost Flow.............................................................................................14 Assignment of Manufacturing Costs..................................................................................26 Production Cost Report.......................................................................................................28 5. STANDARD COSTS AND BALANCED SCORECARD...................................................37

6. MANAGERIAL ACCOUNTING...................................................................................45

COST & MANAGERAL ACCOUNTING INTRODUCTION: Business has become more complex due to rapidly evolving changes in technology and information need. Large and new types of business complexes have been set up for mass production as well as for special kinds of products/jobs, and now it is absolutely necessary for a business concern to conduct its activities with utmost efficiency. The professional management is entrusted with large amounts of finances for business and is expected to make a reasonable amount of return on owners investment. Naturally todays management has to be much more alert, sensitive and in possession of detailed and vital information about the business. It is, therefore, imperative that reporting channels and system of information should be established within the business which will keep the management fully informed as to the trend of costs and expenses incurred and the revenues earned by the enterprise. The management in order to meet its obligation is seriously interested in knowing: Whether the business is competitive or not Whether the business is making profit on each product being produced Whether the financial resources are being utilized to the maximum with beneficial results to business Whether by using the alternatives sources the profitability can be improved or not Whether business policies should under go a change in the future

In answering these and a lot of other questions, cost accounting serves as an excellent tool in the hands of management by providing detailed and analytical information.

Nature of Cost Accounting:

Cost accounting is that part of the accounting procedure of an enterprise which deals with the task of determining, reporting, analyzing and controlling the cost of a particular process, job, service, unit or department.

Cost accounting furnishes management with the necessary accounting tools for planning and controlling activities.

In the planning phase, cost accounting deals with the future. It helps management to budget the future or predetermined material cost, wages and salaries and other cost of manufacturing and marketing products. These costs might be used to assist in setting prices and disclosing the profit that will result, considering competition and other economics conditions. Cost information is also provided to aid management in decision making regarding capital expenditures. Make or buy products, purchase or lease machineries, and expansion of facilities for increased sales or production.

In the control phase, cost accounting deals with present, comparing current results with predetermined standards and budgets. Effective cost control depends upon proper cost planning for each activity, factions and the management remains well informed through cost accounting media of those operating functions that fail to contribute their share to the total profit or that perform inefficiently, thereby leading to profit erosion. 4

SCOPE OF COST ACCOUNTING: Cost Accounting is generally considered applicable only to manufacturing operations. This opinion is not valid. The need for cost information, however, is much broader than this.

It is true that cost accounting in the field of manufacturing operation has reached its highest development, but the procedures and techniques development by cost accounting have also been found useful in the field of banking, insurance, public utilities, transportation, hospitals, hotels, educational institutions, etc. Another useful area of its application is the field of marketing and administration. Briefly it may be said that cost accounting has a universal appeal. It has a vast area of usefulness apart from the all important part it plays in manufacturing field.

OBJECTIVES/PURPOSES OF COST ACCOUNTING:

The objectives of cost accounting are as follows:

Ascertainment of cost of each product, process or operation. Control of costs by comparing actual cost, with budgets and standards already setup. Special cost studies and investigation for formulating business plans for profitable operations.

DISTINCTION BETWEEN COST AND EXPENSE: In a non-technical sense the words cost and expenses are used interchangeably, but in cost accounting difference is recognized between the two.

The term cost refers to that part of the acquisition price of a product or a service, which is expected to be useful later- useful in the sense of obtaining sales revenue. In the other words, cost represents the amount invested in obtaining a product or service which has not yet been utilized or consumed in connection with the realization of revenues.

Expense refers to that cost which has expired or which has been charged against revenue of a period. In other words, expense represent that portion of the acquisition costs of goods property or service which have been consumed , or utilized in connection with the realization of revenues.

TYPES OF COST ACCOUNTING SYSTEMS:

From cost accounting view point, there are two systems of production i.e., the job or lot method, and the continuous process method. 5

In job production, the product is run through the factory in lots or jobs. It is necessary that one unit or group of units of the product or products should be distinguishable and made to the specification of the customers.

In continuous process or mass production, raw material passes through one more sequence of processes or operations, before the finished product comes out. The units of the product are not and need not be distinguished.

For accumulation of cost information under the above two methods of production, two cost accounting systems are used, i.e.,

Job Order Cost System, and Process Cost System

JOB ORDER COST SYSTEM:

In general, a job order cost system is applicable when each product or batch of product is significantly different. This system is most appropriate where the product is made to customers order or specifications and the identity of each job or order is kept separately. it is also appropriate when standard products are manufactured in batches rather than on a continuous basis. A job order cost system is used in the construction industry, aerospace, machine tools, job printing, motion pictures, locomotives and ship-building industries.

In job order cost system, through the use of various subsidiary cost records, the cost of raw materials, direct labor, and factory overhead applicable to each job is recorded on a job cost sheet, so that when the job is finished the total and the average unit cost of the job can be computed.

PROCESS COST SYSTEM:

Process costs are particularly suitable for mass production operations of all types. They are used in such industries as cement, sugar, chemicals, dairy products, petroleum, textiles, cigarettes, sugar, paper, soap, food products etc.

Under this system, each process or operation is designated as a cost centre. For each cost centre average unit cost is determined by dividing the total manufacturing cost (i.e. direct material, direct labor and overhead applicable to the process) by the number of units completed in that process during a given period of time. The total cost of one process is transferred to the next until the product is finished. The total cost of a product is known only after the last process (operation) is completed.

CLASSIFICATION OF COSTS:

Costs are classified in different ways having regard to the objective for which these are being classified. Costs classifications are needed for the development of cost data that will aid management in achieving its objectives. These classifications are based on the relationship of costs to:

The Product Volume of production Manufacturing Departments An Accounting Period Other Classifications

COSTS IN RELATION TO A PRODUCT:

Manufacturing Costs Direct Materials Direct Labor Factory Overhead Commercial Expenses Marketing Expenses (Distribution or Selling) Administrative Expenses (General & Administrative)

COSTS IN RELATION TO VOLUME:

Fixed Costs Variable costs Semi variable Costs

COSTS IN RELATION TO MANUFACTURING DEPARTMENTS:

Direct Costs Indirect Costs

COSTS IN RELATION TO AN ACCOUNTING PERIOD:

Capital Expenditure Revenue Expenditure

OTHER CLASSIFICATIONS OF COSTS:

From the view point of controllability: Controllable costs Uncontrollable Costs

From the view point of time of determination: Standard or Budgeted costs Historical Costs

CLASSIFICATION OF MANUFACTURING COST:

The costs incurred on manufacturing a product are classified into the following three groups:

Raw material cost Labor cost Factory overhead cost

RAW MATERIAL COST:

Manufacturing of goods or products require materials as the first basic element. These materials fall into following two categories

Direct Material ; b) Indirect Material

DIRECT MATERIAL/PRODUCTIVE MATERIAL:

Direct materials are the raw materials and competent parts that become an integral part of finished product and can be traced directly and conveniently to products manufactured. e.g. flour bread, wood in furniture, metal in manufacture of fans, automobiles, machines etc., leather in shoes, cloth in tailoring garments, clay in bricks.

INDIRECT MATERIAL: Indirect material are those which are used in the process of manufacture but whose cost can not be directly and conveniently measured and charged to an article, process or 8

order. They serve only to facilitate the manufacturing process e.g., oil, grease, lubricants, small perishable tools, nails, sand paper, cleanings rags, factory supplies, wash room supplies.

LABOUR COST: Labor forces employed by an enterprise will generally fall into following two categories:

Direct Labor ; b) Indirect Labor

DIRECT LABOUR / PRODUCTIVE LABOUR:

Direct labor is that labor which can be conveniently identified to a particular job, product or process. Direct labor cost is the wages paid to the labor directly engaged to convert the raw materials into finished goods either by hand or with machines. E.g. payroll cost of machine operators, cutters, assemblers, welders, painters, payment made to carpenter in furniture industry and to weaver in cloth manufacturing etc.

INDIRECT LABOUR:

Indirect labor is employed to perform general service and not on any particular job. Usually they perform the following jobs: Sweeping & Cleaning Supervising & inspecting Issuing of materials Internal transportation Repairing of plant & machinery Indirect labor cost includes the payment made to production executives, supervisors, inspectors, foremen, security guards, janitors and firemen.

FACTORY OVERHEAD/ MANUFACURING OVERHEAD:

All manufacturing costs other than direct material and direct labor are classified as factory overhead. Following costs are included in the factory overhead: Indirect Materials

E.g. Lubricants, Fuel, Oil, Coal, Small tools, Factory supplies, etc.

Indirect Labor

E.g. Payment to supervisor, Inspector, store keeper, Time keeper, Guards, etc.

Special Service Department costs E.g. Purchasing Department, Receiving Department, inspecting Department, Store room, Cafeteria, Cost Accounting Department, etc. Heat, Light and power Factory Travelling Expenses Factory Communication Expenses Depreciation of Plant & Machinery Depreciation of Factory Building Depreciation of Delivery & Transportation Equipment Repair & Maintenance of plant Machinery Repair & Maintenance of plant Building Repair & Maintenance of Delivery Equipment Factory Rent, Insurance, Property tax. Spoiled work losses Defective Work Losses

1. MANUFACTURIG ACCOUNTING
Problem # 1: The information listed below is taken from the accounting records of Pioneer Manufacturing Company for the month of January, 2008. Raw material inv. (Jan 1) ------- Rs. 10,000 Raw Material Inv. (Jan 31) ------- Rs. 20,000 Raw material Purchases -------- Rs. 75,000 Purchase Returns ------------------ Rs. 5,000 Direct Labor Cost --------------- Rs. 50,000 Indirect Labor Cost -------------- Rs. 10,000 Heat, Light, Power -------------- Rs. 15,000 Factory Insurance & Taxes ------ Rs. 9,000 Depreciation Machinery ------ Rs. 6,000 Office Salaries Expense ---------- Rs. 20,000 Office Supplies used --------------Rs. 4,000 Audit Fees Expense ---------------Rs. 6,000 Sales Salaries Expense ----------- Rs. 8,000 Salesmens Commission -------- Rs. 5,000 Advertising Expense -------------- Rs. 7,000 Instructions: Prepare cost sheet for the month of January, 2008. Problem # 2: Khyber Manufacturing Company supplies the following information for the month ended on February 28, 2008. Raw Material Inventory Feb 1 ---------- Rs. 15,000 Work in Process Inventory Feb 1 -----10,000 Finished Goods Inventory - Feb 1 -------20,000 Raw material Purchases ------------------------------------------------ Rs. 38, 000 Transportation in on raw material --------------------------------2,000 Raw Material returned to suppliers -----------------------------------3,500 Raw Material Purchases discount --------------------------------------1,500 Direct Labor Cost ---------------------------------------------------------- 26,000 Indirect Labor cost --------------------------------------------------------3,000 10

Heat, Light, Power ----------------------------------------------------------4,000 Factory Insurance and Taxes ---------------------------------------------6,000 Maintenance & Repairs ---------------------------------------------------5,000 Sales during the month ----------------------------------------------------- 105,000 Sales Returns & Allowances ------------------------------------------------- 5,000 Selling Expense Control --------------------------------------------------6,000 General & Admin. Expenses Control ------------------------------------ 4,000 Raw Material Inventory Feb 28 ---------------------- Rs. 10,000 Work in Process Inventory Feb 28 ---------------20,000 Finished Goods Inventory Feb 28 ----------30,000 DATA FOR ADJUSTMENTS: 1) Accrued Direct wages for the last week of month amounted to Rs. 4,000 2) Depreciation of Plant & Machinery estimated at Rs. 2,000. Instructions: Prepare the statement of: a) Raw Material Used c) Cost of Good Sold ; ; b) Costs of Goods Manufactured d) Net income / Loss for the month

PROBLEM # 3: The accounting record of Lahore manufacturing company supplied the following information for the month of March, 2008: Work in Process Inventory March 01. ------------------- Rs. 15,000 Raw Material Inventory March 01. -------------------8,000 Raw Material Inventory March 31. -------------------10,000 Raw Material purchases --------------------------------------22,000 Direct Labor ---------------------------------------------------15,000 Indirect Labor --------------------------------------------------4,000 Maintenance & Repairs ---------------------------------------3,000 Heat, Light, Power ---------------------------------------------1,500 Depreciation Factory Building & Equipment ------------1,000 Other Factory Overhead Cost ---------------------------------2,500 The factory superintendent reports that raw materials costing Rs. 9,400 and Direct Labor of Rs. 7,000 are applicable to unfinished goods in process at the close of business on March 31. Instructions: a) Compute the Factory Overhead Rate for the month of March based on direct labor cost. b) Determine the Work in Process Inventory on March 31. c) Prepare a statement of Cost of Goods Manufactured.

Problem # 4: Following information have been taken from the accounting record of umair products Limited for the month ended on April 30, 2008: Material Purchased ----------------------------------------- Rs. 70,000 Direct Labor Cost ----------------------------------------50,000 Factory Overhead ------------------------------------------40,000 Selling Expense -------------------------------------------25,000 General & Administrative Expense ----------------------17,000 Sales during the period (1,400 Units) -------------------- 208,000 INVENTORIES APRIL 1: 11

Materials ------------------------------------------------------- Rs. 20,000 Finished Goods (100 Units) ------------------------------------ 8,000 INVENTORIES APRIL 30: Materials ------------------------------------------------- Rs. 30,000 Finished Goods (200 Units) ---------------------------? Instructions: 1) Compute the unit cost of goods manufactured. 2) Prepare Income Statement for the period 3) Gross profit per unit sold. 4) Net income per unit sold PROBLEBM # 5: The information below is taken from the financial statement of Noor Corporation at the end of year 1: Work in process Ending -------------------------------- Rs. 100,000 Cost of Raw Material used ----------------------------300,000 Cost of Goods Manufactured ------------------------600,000 Factory Overhead (75% of Direct Labor Cost) --150,000 Instructions: Compute the cost of work in process inventory at January 1. PROBLEM # 6: The following data is related to XYZ Manufacturing Company for the month ended February 28, 2008. Raw Material consumed ------------------------------ Rs. 30,000 Transportation in -----------------------------------2,000 Raw Material INV. -Feb 01 ----------------------------10,000 Raw Material INV. - Feb 28 ----------------------------15,000 Returns of Raw materials ----------------------------7,000 Instructions: 1) Determine the amount of gross purchases/Original purchase of raw materials during the month.

PROBLEM # 7: The following is taken from the accounting records of Ahsan Manufacturing Company for the first quarter of 2008: INVENTORIES JAN. 1: Raw Materials ------------------- Rs. 40,000 Work in process ------------------ 33,000 Finished Goods ------------------- 75,000 INVENTORIES MARCH 31: ITEMS GOODS Raw material Direct Labor Overhead Total Rs. 35,000 Rs. 35,000 Rs. 25,000 20,000 ? ? Rs. 43,000 30,000 27,000 Rs. 100,000 RAW MAT. WORK IN PROCESS FINISHED

DATA FOR THE QUARTER ENDED MARCH 31, 2008:

12

Cost of Goods Manufactured ------------------------------- Rs. 600,000 Factory Overhead cost incurred -------------------------- Rs. 180,000 The company also paid transportation in on raw material purchased Rs. 5,000 and received credit of Rs. 10,000 for materials returned to suppliers. Instructions: Prepare statement of cost of goods manufactured for the quarter ended March 31, 2008.

COGM-ASSIGNMENT # 1 LIST- A 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Product cost Period cost Cost Accounting Financial Accounting Manufacturing cost for the period Factory overhead Applied Fixed cost Variable cost Factory ledger General Ledger Gross Profit Plus COGS Direct Material and labor Manufacturing Overheads Total Manufacturing cost Prime cost Minus Direct labor Utility cost Work in Process COGS Estimated D/M , D/L and FOH Accrued Payroll IS RS 100,000 LIST- B a. Manufacturing cost b. Traceable c .Standard costing d. Semi variable e. Sales f. As Total fixed g. Per unit fixed h. Operating expenses i. Normal costing j. Internal reporting k. Indirect cost l. Factory m. External reporting n. Expense o. Direct material p. Conversion cost Plus Direct material q. COGAM r. At Head office s. Asset t. Gross Payroll = ?, Assume Taxes =20% 13

2. JOB ORDER COSTING Cost Accounting Systems 1. Cost accounting involves the measuring, recording, and reporting of product costs. From the data accumulated, both the total cost and unit cost of each product is determined. A cost accounting system consists of accounts for the various manufacturing costs. These accounts are fully integrated into the general ledger of a company. An important feature of a cost accounting system is the use of a perpetual inventory system. Such a system provides information immediately on the cost of a product. The two basic types of cost accounting systems are (a) a job order cost system and (b) a process cost system. Under a job order cost system, costs are assigned to each job or to each batch of goods. A process cost system is used when a large volume of similar products are manufactured. Process costing accumulates product-related costs for a period of time instead of assigning costs to specific products or job orders.

2.

3.

4.

Job Order Cost Flow

14

5.

The flow of costs in job order cost accounting parallels the physical flow of the materials as they are converted into finished goods. There are two major steps in the flow of costs: (a) accumulating the manufacturing costs incurred and (b) assigning the accumulated costs to the work done. No effort is made when costs are incurred to associate the costs with specific jobs. The assignment of manufacturing costs involves entries to Work in Process Inventory, Finished Goods inventory, and Cost of Goods Sold. The costs of raw materials purchased are debited to Raw Materials Inventory when materials are received. This account is a control account. The subsidiary ledger consists of individual materials inventory records (stores ledger cards) for each item of raw materials. Factory labor costs are debited to Factory Labor when they are incurred. The cost of factor labor consists of (1) gross earnings of factory workers, (2) employer payroll taxes on the earnings, and (3) fringe benefits incurred by the employer. Manufacturing overhead costs are recognized daily as incurred and periodically through adjusting entries. The costs are debited to Manufacturing Overhead.

6. 7.

8.

9.

10.

Assigning Manufacturing Costs to Work in Process 11. The assignment of manufacturing overhead costs to work in process involves debits to Work in Process Inventory and credits to: a. Raw Materials Inventory. b. Factory Labor. c. Manufacturing Overhead.

15

Job Cost Sheet 12. A job cost sheet is a form used to record the costs chargeable to a specific job and to determine the total and unit cost of the completed job. A separate job cost sheet is kept for each job. Each entry to Work in Process Inventory must be accompanied by a corresponding posting to one or more job cost sheets. Raw materials costs are assigned when the materials are issued by the storeroom. Work in Process Inventory is debited for direct materials used, Manufacturing Overhead is debited for indirect materials used, and Raw Materials Inventory is credited. Factory Labor costs are assigned to jobs on the basis of time tickets prepared when the work is performed. Work in Process Inventory is debited for direct labor costs, Manufacturing Overhead is debited for indirect labor costs, and Factory Labor is credited.

13.

14.

Manufacturing Overhead Costs 15. Manufacturing overhead relates to production operations as a whole and therefore cannot be assigned to specific jobs on the basis of actual costs incurred. Instead, manufacturing overhead is assigned to work in process and to specific jobs on an estimated basis through the use of a predetermined overhead rate. The predetermined overhead rate is based on the relationship between estimated annual overhead costs and expected annual operating activity. This relationship is expressed in terms of a common activity base such as direct labor costs, direct labor hours, or machine hours. a. The formula for the predetermined overhead rate is: Estimated Expected Annual Annual Operating Overhead Costs Activity b. c. Predetermined Overhead Rate

16.

The use of a predetermined overhead rate enables the company to determine the approximate total cost of each job when the job is completed. In recent years, more companies are using machine hours as the activity base due to increased reliance on automation in manufacturing operations.

17.

At the end of each month, the balance in Work in Process Inventory should equal the sum of the costs shown on the job cost sheets for unfinished jobs.

Assigning Costs to Finished Goods 18. When a job is completed, the total cost is debited to Finished Goods Inventory and credited to Work in Process Inventory. Finished Goods Inventory is a control account that controls individual finished goods records in a finished goods subsidiary ledger. Cost of goods sold is recognized when the sale occurs by a debit to Cost of Goods Sold and a credit to Finished Goods Inventory. Job order costing is also commonly used by service companies. The techniques of job order costing are quite useful in many service-industry environments. A service company using job order costing uses an account (called Service Contracts in Process) to record job costs prior to completion.

19.

20.

16

21.

At the end of a period, financial statements are prepared that present aggregate data on all jobs manufactured and sold. a. The cost of goods manufactured schedule has one new feature: in determining total manufacturing costs, manufacturing overhead applied is used instead of actual overhead costs. b. The cost of goods manufactured schedule is prepared directly from the Work in Process Inventory account.

Under- or Over applied Manufacturing Overhead 22. Manufacturing overhead may be under- or over applied. When Manufacturing Overhead has a debit balance, overhead is said to be under applied. Under applied overhead means that the overhead assigned to work in process is less than the overhead incurred. When manufacturing overhead has a credit balance, overhead is over applied. Over applied overhead means that the overhead assigned to work in process is greater than the overhead incurred. At the end of the year, any balance in Manufacturing Overhead is eliminated through an adjusting entry, usually to Cost of Goods Sold. a. Under applied overhead is debited to Cost of Goods Sold. b. Over applied overhead is credited to Cost of Goods Sold.

23.

JOURNAL ENTRIES:
JOURNAL ENTRIES RELATED TO MATERIALS 1. FOR DIRECT OR INDIRECT MATERIALS PURCHASED Materials XXX Accounts Payable 2. FOR MATERIALS RETURNED TO THE SUPPLIERS Accounts Payable XXX Materials 3. FOR DIRECT MATERIALS ISSUED TO PRODUCTION Work in process XXX Materials 4. FOR DIRECT MATERIAL RETURNED FROM PRODUCTION Materials XXX Work in process 5. FOR INDIRECT MATERIALS ISSUED TO PRODUCTION Factory overhead control XXX Materials 6. FOR INDIRECT MATERIAL RETURNED FROM PRODUCTION Materials XXX Factory overhead control JOURNAL ENTRIES RELATED TO LABOUR 1. FOR RECORDING OF TOTAL PAYROLL Payroll/Salary expense XXX Accrued Payroll/Salary Payable Income Tax Payable Other Funds Payable 2. FOR PAYMENT OF ACCRUED PAYROLL Accrued Payroll XXX Cash/Bank 3. FOR DIRECT LABOUR CHARGED TO PRODUCTION Work in Process Payroll 4. FOR INDIRECT LABOUR CHARGED TO PRODUCTION Factory Overhead Control Payroll XXX XXX XXX XXX

XXX

XXX XXX XXX XXX XXX

XXX XXX XXX XXX

5. FOR LABOUR USED FOR SELLING & ADMINISTRATIVE ACTIVITIES 17

Selling Expense XXX Administrative Expense XXX Payroll JOURNAL ENTRIES RELATED TO FACTORY OVERHEAD 1. FOR FACTORY OVERHEAD APPLIED TO PRODUCTION Work in Process XXX Factory overhead applied 2. For Actual Overhead Cost Incurred Factory Overhead Control XXX Cash/Accounts Payable Factory Overhead Control XXX Accumulated Depreciation (Plant & Machinery) Factory Overhead Control XXX Accumulated Depreciation (Factory Building) JOURNAL ENTRIES RELATEDB TO FINISHED GOODS 1. FOR JOBS COMPLETED Finished Goods XXX Work in Process 2. FOR SALES TO CUSTOMERS Cash/Accounts Receivable XXX Sales 3. FOR COST OF GOODS SOLD Cost of Goods Sold XXX Finished Goods ADJUSTING AND CLOSING ENTRIES 1. CLOSING OF FOH APPLIED TO YHE FOH CONTROL Factory Overhead Applied XXX Factory Overhead Control 2. CLOSING OF FOH CONTROL ACCOUNT If FOH Control shows credit balance (Over Applied FOH), then Factory Overhead Control XXX Cost of Goods Sold If FOH Control shows debit balance (Under Applied FOH), then Cost of Goods Sold XXX Factory Overhead Control 3. CLOSING OF SALES ACCOUNT Sales XXX Expense & Revenue Summary 4. CLOSING OF COST OF GOODS SOLD & OPERATING EXPENSES Expense & Revenue Summary XXX Cost of Goods Sold Selling Expense Administrative Expenses 5. CLOSING OF EXPENSE & REVENUE SUMMARY If Expense & Revenues Summary shows Credit Balance (Net income), then Expense & Revenue Summary XXX Retained Earnings If Expense & Revenues Summary shows Debit Balance (Net Loss), then Above entry would be reversed.

XXX

XXX XXX XXX XXX

XXX XXX XXX

XXX

XXX XXX

XXX XXX XXX XXX

XXX

PROBLEM # 1 The XYZ Manufacturing Company uses a job order cost system and completed the following transaction during the month of January, 2008: a. Purchased raw materials on account --------------------------------- Rs. 60,000 b. Returned Defective materials to the supplier ---------------------5,000 c. Direct material issued to the job/Factory/Site --------------------42,000 d. Direct material returned from the job ------------------------------2,000 e. Indirect material issued to the job ----------------------------------6,000 f. Indirect material returned from the job ----------------------------1,000 g. Direct labor cost for the month -------------------------------------25,000 h. Indirect labor cost for the month ----------------------------------6,000 18

i. j. k. l. m. n. o. p.

Depreciation of Plant & Machinery estimated at -----------------Paid for repairing of Plant & Machinery ----------------------------Other factory overhead cost incurred on account ---------------Factory Overhead cost applied amounted to ---------------------Cost of goods completed and transferred -------------------------Sales on account amounted to ---------------------------------------Cost of goods sold amounted to -------------------------------------Selling & General Expenses paid ------------------------------------REQUIRED:

3,000 4,000 10,000 30,000 80,000 100,000 60,000 15,000

Give entries to record the above transactions including closing entries. PROBLEM # 2 Builder Bug Company allocates overhead at $9 per direct labor hour. Job A45 required 4 boxes of direct materials at a cost of $30 per box and took employees 15 hours to complete. Employees earn $15 per hour. Instructions Compute the total cost of Job A45. PROBLEM # 3: Colby Company estimates that annual manufacturing overhead costs will be $600,000. Estimated annual operating activity bases are: direct labor cost $460,000, direct labor hours 40,000 and machine hours 80,000. The actual manufacturing overhead cost for the year was $601,000 and the actual direct labor cost for the year was $456,000. Actual direct labor hours totaled 40,200 and machine hours totaled 79,000. Colby applies overhead based on direct labor hours. Instructions Compute the predetermined overhead rate and determine the amount of manufacturing overhead applied. Determine if overhead is over- or under applied and the amount PROBLEM # 4 Martin Company applies manufacturing overhead based on direct labor hours. Information concerning manufacturing overhead and labor for the year follows: Actual manufacturing overhead Estimated manufacturing overhead Direct labor hours incurred Direct labor hours estimated Instructions Compute the predetermined overhead rate. PROBLEM # 5 The following amounts were reported by Burke Company before adjusting its immaterial over applied manufacturing overhead of $8,000. Raw Materials Inventory Finished Goods Inventory Work in Process Inventory Cost of Goods Sold $ 40,000 60,000 100,000 770,000 $150,000 $140,000 4,800 5,000

Instructions Compute what amount Burke will report as cost of goods sold after it disposes of its over applied overhead. 19

PROBLEM # 6 During 2012, Arb Company incurred the following direct labor costs: January $20,000 and February $30,000. Arb uses a predetermined overhead rate of 120% of direct labor cost. Estimated overhead for the 2 months, respectively, totaled $19,500 and $35,700. Actual overhead for the 2 months, respectively, totaled $24,500 and $32,500. Instructions 1. Determine if overhead over- is or under applied for each of the two months and the respective amounts. 2. Prepare the entry to adjust the over and under applied overhead amount. PROBLEM # 7 Jensen Manufacturing Company makes specialty tools. In January, Jensen incurs manufacturing costs of $12,000,000 for direct materials, direct labor, and overhead. 20% of the total costs represents overhead applied. The overhead rate is $1 for every $2 of direct labor costs incurred. Inventory balances were: January 1 Raw materials Work in process Finished goods $300,000 600,000 400,000 January 31 $500,000 400,000 200,000

At the end of January, there was $1,000 of over applied overhead. Instructions (a) (b) (c) Determine the cost of raw materials purchased in January. Prepare a cost of goods manufactured schedule for January 2012. Compute the cost of goods sold for January.

PROBLEM # 8 A job cost sheet of Fugate Company is given below. Job Cost Sheet JOB NO. 172 FOR Date 5/10 12 15 22 24 27 31 James Company Direct Materials 1,030 1,120 Direct Labor Quantity 1,500

Date Completed 5/31 Manufacturing Overhead

550 480 1,000 1,870 670

825 720

1,005 ________ ________ ________ ________ ________

Cost of completed job: Direct materials Direct labor Manufacturing Overhead Total cost Unit cost 20

Instructions: (a) Answer the following questions. (1) What is the predetermined manufacturing overhead rate? (2) What are the total cost and the unit cost of the completed job? (b) Prepare the entry to record the completion of the job.

QUIZ # 1 Circle the correct answer. True/False

1.

(JOB ORDER COSTING)

Under a job order system, the company assigns costs to each job, or each batch of goods, to fill a specific customer order or replenish inventory. True False

2.

Manufacturing costs incurred in a job order system are accumulated by debits to Purchases, Factory Labor, and Manufacturing Overhead. True False

3.

Each debit to Work in Process Inventory must be accompanied by a corresponding posting to one or more job cost sheets. True False

4.

The techniques of job order costing are quite useful in many service-industry environments. True False

5.

The requisition of factory supplies to production requires a debit to the Manufacturing Overhead account. True False

6.

Actual overhead costs are debited to the Manufacturing Overhead account. True False

7.

The entry to record the cost of goods sold includes a debit to Finished Goods Inventory. True False

8.

A debit balance in the Manufacturing Overhead Account at the end of the period indicates that overhead has been over applied. True False

9.

In preparing the costs of goods manufactured schedule in job order costing, manufacturing costs include direct materials used, direct labor used, and manufacturing overhead applied. True False

10.

A job cost sheet is a form used to record the costs chargeable to a specific job and to determine the total and unit cost of the completed job. 21

True

False

22

Multiple Choices
1. A job order cost sheet includes a. the selling price of the job. b. a total when a job is completed and transferred to cost of goods sold. c. all manufacturing costs for a job. d. all manufacturing overhead costs for the period. In a job order cost system the following accounts are used as a control account except a. Raw Materials Inventory. b. Factory Labor. c. Manufacturing Overhead. d. all of the above. In a job order cost system, debits to Work in Process Inventory originate from all of the following except a. applying the predetermined overhead rate. b. assigning direct labor from time tickets. c. assigning actual manufacturing overhead costs to jobs. d. assigning direct materials from requisition slips. The predetermined overhead rate is computed by dividing estimated a. level of activity by estimated overhead costs. b. level of activity by expected overhead costs. c. overhead costs by estimated cost of jobs. d. overhead costs by expected activity base. If annual overhead costs are expected to be $1,000,000 and 200,000 total labor hours are anticipated (80% direct, 20% indirect), the overhead rate based on direct labor hours is a. $6.25. b. $5.00. c. $25.00. d. $4.00.

2.

3.

4.

5.

23

ASSIGNMENT # 2 (JOB ORDER COSTING) MATCHING

Q1 Match the items in the two columns below by entering the appropriate code letter in the space provided. A. Cost accounting B. Materials requisition slip C. Time ticket D. Cost accounting system E. Job order cost system F. Process cost system G. Job cost sheets H. Predetermined overhead rate I. Over applied overhead J. Under applied overhead

_____ 1. Used to apply manufacturing overhead to jobs. _____ 2. Measures, records, and reports product costs. _____ 3. When actual manufacturing overhead costs are greater than the overhead applied to products. _____ 4. Manufacturing cost accounts are fully integrated into the general ledger. _____ 5. Source document which authorizes issuance of raw materials to production. _____ 6. Appropriate when products have distinguishing and heterogeneous characteristics. _____ 7. Constitute a subsidiary ledger for Work in Process Inventory. _____ 8. Indicates number of hours that employees work and the account to be charged. _____ 9. Appropriate when products are similar and are produced continuously. _____ 10. When actual manufacturing overhead costs are less than the overhead applied to products.

Q2 The following information is available for Marks Company at December 31, 2012: 1. Inventory balance Finished Goods Work in Process Raw Materials Beginning of Year $14,000 6,000 10,300 End of Year $10,000 12,000 6,500

2. Debit postings to Work in Process Inventory during the year were: Direct materials Direct labor Manufacturing overhead applied 3. Sales totaled $315,000 for the year. Instructions (a) Prepare a condensed cost of goods manufactured schedule. (b) Prepare an income statement for the year through gross profit. $90,000 50,000 75,000

24

Q3 Fort Corporation had the following transactions during its first month of operations: 1. Purchased raw materials on account, $85,000. 2. Raw Materials of $30,000 were requisitioned to the factory. An analysis of the materials requisition slips indicated that $6,000 was classified as indirect materials. 3. Factory labor costs incurred were $150,000 of which $120,000 pertained to factory wages payable and $30,000 pertained to employer payroll taxes payable. 4. Time tickets indicated that $126,000 was direct labor and $24,000 was indirect labor. 5. Overhead costs incurred on account were $168,000. 6. Manufacturing overhead was applied at the rate of 150% of direct labor cost. 7. Goods costing $115,000 are still incomplete at the end of the month; the other goods were completed and transferred to finished goods. 8. Finished goods costing $100,000 to manufacture were sold on account for $130,000. Instructions Journalize the above transactions for Fort Corporation.

25

3. PROCESS COSTING Process Manufacturing and Accounting 1. Process cost systems are used to apply costs to similar products that are mass-produced in a continuous fashion, such as the production of ice cream, steel or soft drinks. In comparison, costs in a job order cost system are assigned to a specific job, such as the construction of a customized home, the making of a motion picture, or the manufacturing of a specialized machine. Job order cost and process cost systems are similar in that (a) both use the same three manufacturing cost elements of direct materials, direct labor, and manufacturing overhead; (b) both accumulate costs of raw materials by debiting Raw Materials Inventory, factory labor by debiting Factory Labor, and manufacturing overhead costs by debiting Manufacturing Overhead; and (c) both flow costs to the same accounts of Work in Process, Finished Goods Inventory, and Cost of Goods Sold. The major differences between a job order cost system and a process cost system are as follows: Job Order Cost System One for each job Process Cost System One for each process

2.

3.

Feature Work in process accounts Documents used Determination of total manufacturing costs Unit-cost computations

Job cost sheets Each job

Production cost reports Each period

Cost of each job Units produced for the job

Total manufacturing costs Units produced during the period

Process Cost Flow 4. In the Tyler Company example in the text book, manufacturing consists of two processes: machining and assembly. In the Machining Department, the raw materials are shaped, honed, and drilled. In the Assembly Department, the parts are assembled and packaged. Materials, labor, and manufacturing overhead can be added in both the Machining and Assembly Departments. When the Machining Department finishes its work, the partially completed units are transferred to the Assembly Department. In the Assembly Department, the goods are finished and are then transferred to the finished goods inventory. Upon sale, the goods are removed from the finished goods inventory.

5.

Assignment of Manufacturing Costs 6. All raw materials issued for production are a materials cost to the producing department. Materials requisitions slips may be used in a process cost system, but fewer requisitions are generally required than in a job order cost system, because the materials are used for processes rather than for specific jobs. The entry to record the materials used is: Work in ProcessMachining...................................................... XXXX Work in ProcessAssembly....................................................... XXXX Raw Materials Inventory..................................................... XXXX Time tickets may be used in determining the cost of labor assignable to the production departments. The labor cost chargeable to a process can be obtained from the payroll register or departmental payroll summaries. All labor costs incurred within a producing 26

7.

department are a cost of processing the raw materials. The entry to assign the labor costs is: Work in ProcessMachining..................................................... Work in ProcessAssembly...................................................... Factory Labor..................................................................... 8. XXXX XXXX XXXX

The basis for allocating the overhead costs to the production departments in an objective and equitable manner is the activity that drives or causes the costs. A primary driver of overhead costs in continuous manufacturing operations is machine time used, not direct labor. Thus, machine hours are widely used in allocating manufacturing overhead costs. The entry to allocate overhead is: Work in ProcessMachining..................................................... Work in ProcessAssembly...................................................... Manufacturing Overhead................................................... XXXX XXXX XXXX

9.

At the end of the period, the following transfer entries are needed: Work in ProcessAssembly...................................................... Work in ProcessMachining............................................ Finished Goods Inventory........................................................... Work in ProcessAssembly............................................. Cost of Goods Sold..................................................................... Finished Goods Inventory.................................................. XXXX XXXX XXXX XXXX XXXX XXXX

Equivalent Units 10. A major step in process cost accounting is the calculation of equivalent units. Equivalent units of production measure the work done during the period, expressed in fully completed units. This concept is used to determine the cost per unit of completed product. The formula to compute equivalent units of production is as follows: Unit Completed and + Transferred Out 12. Equivalent Units of Ending Work in = Process Equivalent Units of Production

11.

The method of computing equivalent units here is referred to as the weighted-average method. It considers the degree of completion (weighting) of the units completed and transferred out and the ending work in process. A lesser used method, called the FIFO method, is discussed in advanced accounting courses. To illustrate the computation of equivalent units using the weighted-average method, assume that materials are entered at the beginning of the process and the following information is provided for the Processing Department of Silva Company: Percentage Complete Work in process, Beg. Started into production Total units Units transferred out Work in process, End. Total units Physical Units 2,500 4,500 7,000 6,000 1,000 7,000 Materials 100% Conversion Costs 80%

13.

100%

60%

14.

The two equivalent unit computations are as follows: 27

Units transferred out Work in process, End 1,000 X 100% 1,000 X 60% Total equivalent units Production Cost Report 15.

Equivalent Units Conversion Materials Costs 6,000 6,000 1,000 7,000 600 6,600

A production cost report is the key document used by management to understand the activities in a department because it shows the production quantity and cost data related to that department. In order to be ready to complete a production cost report, the company must perform four steps: a. Compute the physical unit flow. b. Compute the equivalent units of production. c. Compute unit production costs. d. Prepare a cost reconciliation schedule. The computation of physical units involves: a. adding the units started (or transferred) into production during the period to the units in process at the beginning of the period to determine the total units to be accounted for; and b. accounting for these units by determining the output for the periodwhich consists of units transferred out during the period and units in process at the end of the period. In the example above, the total units to be accounted for and the units accounted for are both equal to 7,000 units for Silva Company.

16.

17.

In computing unit costs, production costs are expressed in terms of equivalent units of production. When equivalent units are different for materials and conversion costs, the formulas for computing unit costs are as follows: Total Materials Equivalent Units of Unit Materials = Cost Materials Cost Total Conversion Equivalent Units of Unit Conversion = Costs Conversion Costs Cost Unit Materials Cost Unit Conversion Cost = Total Manufacturing Cost per Unit

18.

The cost reconciliation schedule shows that the total costs accounted for equal the total costs to be accounted for as follows: Costs to be accounted for Transferred out........................................................... Work in process, End Materials................................................................. Conversion costs.................................................... Total costs......................................................................

$XXXX $XXXX XXXX

XXXX $XXXX

19.

Assume the Processing Department of Silva Company has the following additional cost information: Work in process, Beg. Direct materials: 100% complete............................................................ Conversion costs: 80% complete........................................................... Cost of work in process, Beg.......................................................................... 28 $ 24,000 19,620 $ 43,620

Costs incurred during production Direct materials....................................................................................... Conversion costs..................................................................................... Costs incurred................................................................................................. 20.

$200,000 150,000 $350,000

Silva Companys Processing Department Production Cost Report at the end of the period is as follows: Processing Department Production Cost Report For the Period Ended Equivalent Units Conversion Materials Costs

Physical Units QUANTITIES Units to be accounted for Work in process, Beg. Started into production Total units Units accounted for Transferred out Work in process, End. 60%) Total units

2,500 4,500 7,000 6,000 1,000 7,000 6,000 1,000 7,000 6,000 600 (1,000 6,600 Conversion Costs

Materials COSTS Unit costs Costs during the period Equivalent units Unit costs (a) (b) Costs to be accounted for Work in process, Beg. Started into production Total costs Cost Reconciliation Schedule Costs accounted for Transferred out (6,000 X $57.70) Work in process, End. Materials (1,000 X $32.00) Conversion costs (600 X $25.70) Total costs Operations Costing

Total

(a) $224,000 (b) 7,000 $32.00

$169,620 6,600 $25.70

$393,620 $57.70

$ 43,620 350,000 $393,620

$346,200 $ 32,000 15,420

47,420 $393,620

21. Companies often use a combination of a process cost and a job order cost system, called operations costing. Operations costing is similar to process costing in that standardized methods are used to manufacture the product. At the same time, the product may have some customized, individual features that require the use of a job order cost system. Just-in-Time Processing 22. Just-in-Time (JIT) manufacturing is dedicated to having the right amount of materials, products, or parts at the time they are needed. Under JIT processing, raw materials are 29

received just in time for use in production, subassembly parts are completed just in time for use in finished goods, and finished goods are completed just in time to be sold. 23. The major benefits of JIT processing are: a. Significant reduction or elimination of manufacturing inventories. b. Enhanced product quality. c. Reduction or elimination of rework costs and inventory storage costs. d. Production cost savings from the improved flow of goods through the processes. 24. Under JIT the raw materials and work in process inventory accounts are combined into one Raw and In-Process Inventory account.

PROBLEM # 1: Tip Top Painting Company has the following production data for January: Beginning work in process, 0 units Units transferred out, 35,000 Units in ending work in process, 8,000, which are 30% complete for conversion costs

Materials are added only at the beginning of the process. Instructions Compute equivalent units of production for both materials and conversion costs. PROBLEM # 2: Lowman Painting Company has the following production data for March: Beginning work in process, 2,000 units Units transferred out, 42,000 Units in ending work in process, 10,000, which are 80% complete for conversion costs

Materials are added only at the beginning of the process. Instructions Compute equivalent units of production for both materials and conversion costs. PROBLEM # 3 Apoly Manufacturing Company has the following production data for January. Ending Work in Process Beginning Work in Process -0Units Started into Production 8,500 % Complete as to Units 900 Conversion Cost 30%

Instructions Compute the physical units for January. PROBLEM # 4: Sequal Company has the following production data for June: units transferred out 50,000, and ending work in process 6,000 units that are 100% complete for materials and 30% complete for conversion costs. Unit materials cost is $5 and unit conversion cost is $9. Instructions Determine the costs to be assigned to the units transferred out and the units in ending work in process. PROBLEM # 5

30

Hardy Company manufactures a single product by a continuous process, involving two production departments. The records indicate that $120,000 of direct materials were issued to and $200,000 of direct labor was incurred by Department 1 in the manufacture of the product. The factory overhead rate is $25 per machine hour; machine hours were 5,000 in Department 1. Work in process in the department at the beginning of the period totaled $35,000; and work in process at the end of the period was $25,000. Instructions Prepare entries to record (a) The flow of costs into Department 1 for (1) direct materials (2) direct labor (3) overhead (b) The transfer of production costs to Department 2

PROBLEM # 6 The general ledger of Oates Company has the following work in process account. 6/1 6/30 6/30 6/30 6/30 Balance Materials Labor Overhead Balance WORK IN PROCESSFINISHING 8,000 6/30 Transferred out 1,800 3,800 2,800 ? ?

Production records show that there were 2,000 units in beginning inventory, 50% complete; 6,000 units started, and 4,500 units transferred out. The beginning work in process had conversion costs of $3,300. The units in ending inventory were 60% complete. Materials are added at the beginning of the process. Instructions Answer the following questions. (a) How many units are in process at June 30? (b) What is the unit conversion cost for June? (c) What is the conversion cost in the June 30 inventory? PROBLEM # 7 The Finishing Department of Edwards Manufacturing has the following production and cost data for July: 1. Transferred out, 4,000 units. 2. Started 2,000 units that are 40% completed at July 31. 3. Materials added, $30,000; conversion costs incurred, $19,200. Materials are entered at the beginning of the process. Conversion costs are incurred uniformly during the process. Instructions (a) Compute the equivalent units of production for materials and conversion costs for the month of July. (b) Compute unit costs and prepare a cost reconciliation schedule.

31

PROBLEM # 8 Materials at the beginning of the process and conversion costs are incurred uniformly throughout the process. Work in process on May 1 was 75% complete and work in process on May 31 was 40% complete. Instructions Complete the Production Cost Report for the Molding Department for the month of May using the above information and the information below.

MAYER MANUFACTURING COMPANY Molding Department Production Cost Report For the Month Ended May 31, 2012 QUANTITIES Units to be accounted for Work in process, May 1 Started into production Total units Units accounted for Transferred out Work in process, May 31 Total units Physical Units 8,000 27,000 35,000 Equivalent Units Materials Conversion Costs

30,000 5,000 35,000

COSTS Unit costs Costs in May Equivalent units Unit costs Costs to be accounted for Work in process, May 1 Started into production Total costs Cost Reconciliation Schedule Costs accounted for Transferred out Work in process, May 31 Materials Conversion costs Total costs Materials $140,000 $ Conversion Costs $160,000 $ Total $300,000 $

$ 60,000 240,000 $300,000

$ $ $300,000

32

QUIZ # 2
Circle the correct answer. True/False 1.

(PROCESS COSTING)

Costs are assigned to each specific job in a process cost system. True False

2.

In a process cost system, total costs are determined at the end of a period of time, such as a month. True False

3.

In a process cost system, the unit cost is total manufacturing costs divided by the units produced during the period. True False

4.

The accumulation of the costs of materials, labor, and manufacturing overhead is the same in a process cost system as in a job order cost system. True False

5.

More materials requisitions are generally required in a process cost system than in a job order cost system. True False

6.

Equivalent units of production equals units completed and transferred out + units in beginning work in process. True False

7.

Two equivalent unit computations are necessaryone for materials and the other for conversion costs. True False

8.

The first step in preparing a production cost report is to compute the equivalent units of production. True False

9.

The cost reconciliation schedule shows that the total costs accounted for equal the total costs to be accounted for. True False

10.

JIT strives to eliminate inventories by using a pull approach in manufacturing. True False

33

Multiple Choice
1. Which of the following is not a step in preparing a production cost report? a. b. c. d. 2. Prepare a cost reconciliation schedule. Compute equivalent units of production. Compute the physical unit flow. Assign costs to particular jobs.

A department has no beginning work in process, has started 80,000 units and completed 50,000 units. Its ending work in process is 30,000 units, 60% complete as to conversion costs and fully complete as to materials. Its equivalent units for conversion costs are a. b. c. d. 50,000. 80,000. 68,000. 44,000.

3.

In process costing, the computation of unit production costs requires a. b. c. d. the accumulation of material and conversion costs in work in process for each department or process. the computation of equivalent units for material and conversion costs. both a and b. neither a nor b.

4.

Which of the following is not included in a production cost report? a. b. c. d. Costs accounted for. Entries to assign cost. Units accounted for. Units to be accounted for.

5.

Unit costs for materials and conversion costs amount to $4 and $5 respectively. The ending work in process costs for 8,000 units (100% complete as to material and 70% complete as to conversion costs) amount to a. b. c. d. $60,000. $72,000. $44,000. $40,000.

34

ASSIGNMENT # 3 (PROCESS COSTING)

Q1 The ledger of Kinsler Company has the following work in process account. Work in ProcessPainting 5,390 5/31 Transferred out 7,740 4,110 2,470 ?

5/1 5/31 5/31 5/31 5/31

Balance Materials Labor Overhead Balance

Production records show that there were 700 units in the beginning inventory, 30% complete, 2,900 units started, and 3,100 units transferred. The beginning work in process had materials cost of $3,060 and conversion costs of $2,330. The units in ending inventory were 40% complete. Materials are entered at the beginning of the painting process. Instructions (a) How many units are in process at May 31? (b) What is the unit materials cost for May? (c) What is the unit conversion cost for May? (d) What is the total cost of units transferred out in May? (e) What is the cost of the May 31 inventory? Q2 The Assembly Department of Nitz Company has the following production and cost data at the end of May, 2012. Production: 25,000 units started into production; 20,000 units transferred out and 5,000 units 100% completed as to materials and 40% completed as to conversion costs. Manufacturing Costs: Materials added at beginning of process, $90,000; labor, $72,000; overhead $60,000. Instructions Prepare a production cost report for the month of May. Q3 Match the items in the two columns below by entering the appropriate code letter in the space provided. A. B. C. D. E. ____ ____ ____ ____ ____ ____ ____ ____ ____ 1. 2. 3. 4. 5. 6. 7. 8. 9. Just-in-time processing Equivalent units of production Total units accounted for Production cost report Cost reconciliation schedule F. G. H. I. J. Units transferred out Activity-based costing Physical units Unit production costs Total manufacturing cost per unit

A summary of both production quantity and cost data for a production department. Shows that the total costs accounted for equal the total costs to be accounted for. Work done during a period expressed in fully completed units. Focuses on the activities performed in manufacturing a specific product. Actual units to be accounted for during a period, irrespective of any work performed. Units transferred out during the period plus units in ending work in process. Unit materials costs plus unit conversion costs. Total units accounted for minus units in ending work in process. Costs expressed in terms of equivalent units of production. Uses a pull approach in manufacturing. 35

____ 10.

4. ACTIVITY BASE COSTING

Activity-based costing (ABC) is a method of product costing that focuses on the activities performed to produce specific products. An ABC system is similar to conventional costing systems in accounting for direct materials and direct labor but differs in regard to manufacturing overhead. In ABC, the cost of a product is equal to the sum of the costs of all activities performed to manufacture it. In selecting a basis, ABC seeks to identify the cost drivers that measure the activities performed on the product. For example, a possible cost driver for ordering raw materials is the number of times an order is placed. ABC involves the following steps: a. Identify the major activities that pertain to the manufacture of specific products. b. Accumulate manufacturing overhead costs by activities. c. Identify the cost driver(s) that accurately measure(s) each activitys contribution to the finished product. d. Assign manufacturing overhead costs for each activity to products, using the cost driver(s). ABC provides the following benefits: a. More accurate product costing. b. Enhanced control over overhead costs. c. Better management decisions.

36

5. STANDARD COSTS AND BALANCED SCORECARD

Standards and Budgets 1. In concept, standards and budgets are essentially the same. Both are predetermined costs and both contribute significantly to management planning and control. a. A standard is a unit amount, whereas a budget is a total amount. b. Standard costs may be incorporated into a cost accounting system. Why Standard Costs? 2. Standard costs offer the following advantages to an organization: a. They facilitate management planning. b. They promote greater economy by making employees more cost conscious. c. They are useful in setting selling prices. d. They contribute to management control by providing a basis for the evaluation of cost control. e. They are useful in highlighting variances in management by exception. f. They simplify the costing of inventories and reduce clerical costs.

Setting Standard Costs 3. Setting standards requires input from all persons who have responsibility for costs and quantities. Standards may be set at one of two levels. Ideal standards represent optimum levels of performance under perfect operating conditions. Normal standards represent efficient levels of performance that are attainable under expected operating conditions. To establish the standard cost of producing a product, it is necessary to establish standards for each manufacturing cost elementdirect materials, direct labor, and manufacturing overhead. The standard for each element is derived from the standard price to be paid and the standard quantity to be used.

4.

Direct Materials 5. The direct materials price standard is the cost per unit of direct materials that should be incurred. a. This standard is based on the purchasing departments best estimate of the cost of raw materials. b. This standard should include an amount for related costs such as receiving, storing, and handling. The direct materials quantity standard is the quantity of direct materials that should be used per unit of finished goods. a. This standard is expressed as a physical measure, such as pounds, barrels, or board feet. b. This standard should include allowances of unavoidable waste and normal storage. The standard direct materials cost per unit is the standard direct materials price times the standard direct materials quantity.

6.

7.

Direct Labor 8. The direct labor price standard is the rate per hour that should be incurred for direct labor. a. This standard is based on current wage rates adjusted for anticipated changes, such as cost of living adjustments included in many union contracts. b. This standard generally includes employer payroll taxes and fringe benefits. The direct labor quantity standard is the time that should be required to make one unit of the product. a. This standard is especially critical in labor-intensive companies. b. In setting this standard, allowances should be made for rest periods, cleanup, machine setup and machine downtime.

9.

37

10.

The standard direct labor cost per unit is the standard direct labor rate times the standard direct labor hours.

Manufacturing Overhead 11. The manufacturing overhead standard is based on a standard predetermined overhead rate. a. This overhead rate is determined by dividing budgeted overhead costs by an expected standard activity index. b. The standard manufacturing overhead rate per unit is the predetermined overhead rate times the activity index quantity standard.

Variances
12. A variance is the difference between total actual costs and total standard costs. An unfavorable variance suggests that too much was paid for materials, labor, and manufacturing overhead or that there were inefficiencies in using materials, labor, and manufacturing overhead. Favorable variances indicate efficiencies in incurring costs and in using materials, labor, and manufacturing overhead. Analyzing variances begins with a determination of the cost elements that comprise the variance. For each manufacturing cost element, a total dollar variance is computed. Then this variance is analyzed into a price variance and a quantity variance.

13.

Direct Materials Variances 14. The formulas for the direct materials variances are: Actual Quantity X Actual Price (AQ) X (AP) Actual Quantity X Actual Price (AQ) X (AP) Actual Quantity X Standard Price (AQ) X (SP) 15. 16. Standard Quantity X Standard Price (SQ) X (SP) Actual Quantity X Standard Price (AQ) X (SP) Standard Quantity X Standard Price (SQ) X (SP) Total Materials Variance (TMV) Materials Price Variance (MPV) Materials Quantity Variance (MQV)

A variance matrix can be used in analyzing variances. In such cases, the formulas for each cost element are computed first and then the variances. Materials price variances are usually the responsibility of the purchasing department, whereas materials quantity variances are usually attributable to the production department.

Direct Labor Variances

17. The formulas for the direct labor variances are: Actual Hours X Actual Rate (AH) X (AR) Actual Hours X Actual Rate (AH) X (AR) Actual Hours X Standard Rate (AH) X (SR) Standard Hours X Standard Rate (SH) X (SR) Actual Hours X Standard Rate (AH) X (SR) Standard Hours X Standard Rate (SH) X (SR) Total Labor Variance (TLV) Labor Price Variance (LPV) Labor Quantity Variance (LQV)

38

18.

Labor price variances usually result from paying workers higher wages than expected and/or misallocation of workers. Labor quantity variances relate to the efficiency of the workers and are the responsibility of the production department.

Manufacturing Overhead Variances 19. The total overhead variance is the difference between the actual overhead costs and overhead costs applied based on standard hours allowed. To find the total overhead variance in a standard costing system, we determine the overhead costs applied based on standard hours allowed. Standard hours allowed are the hours that should have been worked for the units produced. The total overhead variance formula is as follows: Actual Overhead 21. Overhead Applied = Total Overhead Variance

20.

One reason for an overhead variance relates to over- or under-spending on overhead items. Generally the responsibility for these variances rests with the production department. The overhead variance can also result from inefficient use of overhead. The responsibility for these variances rests on either the production or sales departments.

Reporting of Variances 22. All variances should be reported to appropriate levels of management as soon as possible. Variance reports facilitate the principle of management by exception. Rather than analyze every variance, top management will normally look for significant variances.

Statement Presentation of Variances 23. In income statements prepared for management under a standard cost accounting system, cost of goods sold is stated at standard cost and the variances are separately disclosed. In financial statements prepared for stockholders and other external users, standard costs may be used. Standard costs may be used in costing inventories in financial statements prepared for stockholders when there are no significant differences between actual and standard costs. However, if the difference is material, the inventories and cost of goods sold must be reported at actual costs.

24.

Balanced Scorecard 25. Many companies use both financial and nonfinancial measures to evaluate performance. This approach is known as the balanced scorecard. The four most commonly employed perspectives are as follows: a. The financial perspective employs financial measures of performance used by most firms. b. The customer perspective evaluates how well the company is performing from the viewpoint of those people who buy and use its products or services. c. The internal process perspective evaluates the internal operating processes critical to success. d. The learning and growth perspective evaluates how well the company develops and retains its employees. The different perspectives are linked together so a company can better understand how to achieve its goals and what measures to use to evaluate performance.

39

Standard Cost Accounting System *26. A standard cost accounting system is a double-entry system of accounting in which standard costs are used in making entries and variances are formally recognized in the accounts. A standard cost system may be used with either job order or process costing. *27. As an example, the purchase of raw materials inventory for $5,000 when the standard cost is $6,000 would be recorded as follows: Raw Materials Inventory..................................................................... Materials Price Variance............................................................. Accounts Payable....................................................................... a. b. A debit balance in a variance account indicates an unfavorable variance. A credit balance in a variance account indicates a favorable variance. 6,000 1,000 5,000

Overhead Variances *28. The computation of the manufacturing overhead variances is conceptually the same as the computation of the materials and labor variances. For manufacturing overhead, however, both variable and fixed overhead must be considered. The formulas are: Actual Overhead Actual Overhead Overhead Applied* Overhead Budgeted* Normal Standard Capacit Hours y Hours Allowed Total Overhead Variance Overhead Controllable Variance Overhead Volume Variance

Fixed Overhead Rate

*29. The overhead controllable variance shows whether overhead costs were effectively controlled. a. Budgeted costs are determined from the flexible manufacturing overhead budget for standard hours allowed. b. Most controllable variances are associated with variable costs which are controllable costs. *30. The overhead volume variance indicates whether plant facilities were efficiently used during the period. a. This variance relates solely to fixed costs. b. It measures the amount that fixed overhead costs are under- or overapplied. *31. In computing the overhead variances, a. Standard hours allowed are used in each of the variances. b. Budgeted costs are derived from the flexible budget. c. The controllable variance generally pertains to variable costs. d. The volume variance pertains solely to fixed costs. PROBLEM # 1 Loomis Company uses both standards and budgets. The company estimates that production for the year will be 200,000 units of Product Fast. To produce these units of Product Fast, the company expects to spend $600,000 for materials and $800,000 for labor. Instructions Compute the estimates for (a) a standard cost and (b) a budgeted cost. PROBLEM # 2 40

Labor data for making one pound of finished product in Ortiz Company are as follows: (1) Price hourly wage rate $11.00, payroll taxes $1.80, and fringe benefits $1.20. (2) Quantityactual production time 1.1 hours, rest periods and clean up 0.25 hours, and setup and downtime 0.15 hours. Instructions Compute the following. (a) Standard direct labor rate per hour. (b) Standard direct labor hours per pound. (c) Standard labor cost per pound. PROBLEM # 3 Greinke Company is planning to produce 2,500 units of product in 2012. Each unit requires 3 pounds of materials at $6 per pound and a half hour of labor at $16 per hour. The overhead rate is 75% of direct labor. Instructions (a) Compute the budgeted amounts for 2012 for direct materials to be used, direct labor, and applied overhead. (b) Compute the standard cost of one unit of product. PROBLEM # 4 Malone, Inc. manufactures one product called tybos. The company uses a standard cost system and sells each tybo for $8. At the start of monthly production, Malone estimated 9,500 tybos would be produced in March. Malone has established the following material and labor standards to produce one tybo: Standard Quantity Standard Price Direct materials 2.5 pounds $3 per pound Direct labor 0.6 hours $10 per hour During March 2012, the following activity was recorded by the company relating to the production of tybos: 1. 2. 3. 4. The company produced 9,000 units during the month. A total of 24,000 pounds of materials were purchased at a cost of $66,000. A total of 24,000 pounds of materials were used in production. 5,000 hours of labor were incurred during the month at a total wage cost of $55,000.

Instructions Calculate the following variances for March for Malone, Inc. (a) Materials price variance (b) Materials quantity variance (c) Labor price variance (d) Labor quantity variance PROBLEM # 5 Benton Company produces one product, a putter called PAR-putter. Benton uses a standard cost system and determines that it should take one hour of direct labor to produce one PARputter. The normal production capacity for this putter is 100,000 units per year. The total budgeted overhead at normal capacity is $500,000 comprised of $200,000 of variable costs and $300,000 of fixed costs. Benton applies overhead on the basis of direct labor hours. During the current year, Benton produced 85,000 putters, worked 89,000 direct labor hours, and incurred variable overhead costs of $160,000 and fixed overhead costs of $300,000. Instructions (a) Compute the predetermined variable overhead rate and the predetermined fixed overhead rate. (b) Compute the applied overhead for Benton for the year. (c) Compute the total overhead variance.

41

QUIZ # 3 (STANDARD COSTS AND BALANCED SCORECARD)

Circle the correct answer. True/False 1. The primary difference between standards and budgets is that a standard is a unit amount, whereas a budget is a total amount. True False

2. An advantage of standard costs is that standard costs facilitate management planning by establishing expected future costs. True False

3. Ideal standards represent an efficient level of performance that is attainable under expected operating conditions. True False

4. The direct labor price standard generally includes employer payroll taxes and fringe benefits, such as paid holidays and vacations. True False

5. (Actual Quantity X Standard Price) (Standard Quantity X Actual Price) = Materials Price Variance. True False

6. (Actual Hours X Actual Rate) (Actual Hours X Standard Rate) = Labor Price Variance. True False

7. Standard hours allowed are the hours that should have been worked for the units produced. True False

8. Variance reports facilitate the principle of management by exception. True False

9. In income statements prepared under a standard cost accounting system, cost of goods sold is stated at standard cost. True False

*10. The overhead controllable variance is the difference between the actual overhead costs incurred and the overhead applied. True False

42

Multiple Choice 1. Which of the following is an advantage of standard costs? a. b. c. d. 2. Contribution to management control. Promotion of greater economy and efficiency. Simplification of the costing of inventories and reduction of clerical costs. All of the above.

If the predetermined overhead rate per hour is $6 for variable and $2 for fixed overhead, standard direct labor hours per unit is 2 hours and actual direct labor hours per unit was 1.5 hours, then the overhead standard per unit is a. b. c. d. $4 per unit. $8 per unit. $16 per unit. $12 per unit.

3.

The formula for the labor quantity (or efficiency) variance is a. b. c. d. (Actual Hours X Actual Rate) (Actual Hours X Standard Rate). (Actual Hours X Standard Rate) (Standard Hours X Standard Rate). (Standard Hours X Actual Rate) (Standard Hours X Standard Rate). none of the above.

*4.

If actual overhead is $70,000, overhead applied is $67,000 and overhead budgeted for the standard hours allowed is $78,000, then the overhead controllable variance is a. b. c. d. $3,000 F. $11,000 U. $8,000 F. $8,000 U.

*5.

In a standard cost accounting system, a company purchased raw materials on account for $46,500 when the standard cost was $44,000. The journal entry would not include a a. b. c. d. debit to Raw Materials Inventory for $44,000. debit to Materials Price Variance for $2,500. credit to Materials Price Variance for $2,500. credit to Accounts Payable for $46,500.

43

ASSIGNMENT # 4 (STANDARD COSTS AND BALANCED SCORECARD)

Q1 Match the items in the two columns below by entering the appropriate code letter in the space provided. A. B. C. D. E. ____ ____ ____ ____ ____ ____ ____ ____ ____ Variances Standard costs Standard cost accounting system Normal standards Ideal standards F. G. H. I. J. Materials price variance Labor quantity variance Overhead controllable variance Overhead volume variance Standard hours allowed

1. The difference between actual overhead incurred and overhead budgeted for the standard hours allowed. 2. The hours that should have been worked for the units produced. 3. The difference between the actual quantity times the actual price and the actual quantity times the standard price. 4. The difference between total actual costs and total standard costs. 5. The difference between actual hours times the standard rate and standard hours times the standard rate. 6. Predetermined unit costs that are measures of performance. 7. The difference between normal capacity hours and standard hours allowed times the fixed overhead rate. 8. Standards based on an efficient level of performance that are attainable under expected operating conditions. 9. Standards based on the optimum level of performance under perfect operating conditions.

____ 10. A double-entry system of accounting in which standard costs are used in making entries and variances are recognized in the accounts. Q2 The following direct labor data pertain to the operations of Hainey Manufacturing Company for the month of November: Standard labor rate Actual hours incurred and used $10.00 per hr. 9,000

The standard cost card shows that 2.5 hours are required to complete one unit of product. The actual labor rate incurred exceeded the standard rate by 10%. Four thousand units were manufactured in November. Instructions (a) Calculate the price, quantity, and total labor variances. (b) Journalize the entries to record the labor variances. Q3 Jamison Industries provided the following information about its standard costing system for 2012: Standard Data Actual Data Labor 2 hrs. @ $21 per hr. Produced 9,000 units Budgeted fixed overhead $100,000 Labor worked 17,000 hrs. costing $340,000 Budgeted variable overhead $30 per unit Actual overhead $375,000 Budgeted production 10,000 units Jamison applies fixed overhead at $10 per unit produced. Instructions Determine the amounts of the overhead variances. 44

6. MANAGERIAL ACCOUNTING
Managerial Accounting Basics 1. Managerial accounting is a field of accounting that provides economic and financial information for managers and other internal users. Managerial accounting applies to all types of businessesservice, merchandising, and manufacturingand to all forms of business organizationsproprietorships, partnerships and corporations. Moreover, managerial accounting is needed in not-for-profit entities as well as in profit-oriented enterprises.

Comparing Managerial and Financial Accounting 2. There are both similarities and differences between managerial and financial accounting. a. Both fields of accounting deal with the economic events of a business and require that the results of that companys economic events be quantified and communicated to interested parties. b. The principal differences are the (1) primary users of reports, (2) types and frequency of reports, (3) purpose of reports, (4) content of reports, and (5) verification process. The role of the managerial accountant has changed in recent years. Whereas in the past their primary concern used to be collecting and reporting costs to management, today they also evaluate how well the company is using its resources and providing information to crossfunctional teams comprised of personnel from production, operations, marketing, engineering, and quality control.

3.

Management Functions 4. Management performs three broad functions within an organization: a. Planning requires managers to look ahead and to establish objectives. b. Directing involves coordinating a companys diverse activities and human resources to produce a smooth-running operation. c. Controlling is the process of keeping the firms activities on track.

Organizational Structure 5. In order to assist in carrying out management functions, most companies prepare organization charts to show the interrelationships of activities and the delegation of authority and responsibility within the company. Stockholders own the corporation but manage the company through a board of directors. The chief executive officer (CEO) has overall responsibility for managing the business. The chief financial officer (CFO) is responsible for all of the accounting and finance issues the company faces. The CFO is supported by the controller and the treasurer. Business Ethics 6. All employees are expected to act ethically in their business activities and an increasing number of organizations provide their employees with a code of business ethics. 7. Due to many fraudulent activities in recent years, U.S. Congress passed the SarbanesOxley Act of 2002 which resulted in many implications for managers and accountants. CEOs and CFOs must certify the fairness of financial statements, top management must certify they maintain an adequate system of internal controls, and other matters.

45

Manufacturing Costs 8. Manufacturing consists of activities and processes that convert raw materials into finished goods. 9. Manufacturing costs are typically classified as either (a) direct materials, (b) direct labor or (c) manufacturing overhead.

10. Direct materials are raw materials that can be physically and conveniently associated with the finished product during the manufacturing process. Indirect materials are materials that (a) do not physically become a part of the finished product or (b) cannot be traced to their physical association with the finished product is too small in terms of cost to trace. Indirect materials are accounted for as part of manufacturing overhead. 11. The work of factory employees that can be physically and conveniently associated with converting raw materials into finished goods is considered direct labor. In contrast, the wages of maintenance people, timekeepers, and supervisors are usually identified as indirect labor because their efforts have no physical association with the finished product, or it is impractical to trace the costs to goods produced. Indirect labor is classified as manufacturing overhead. Manufacturing overhead consists of costs that are indirectly associated with the manufacture of the finished product. Manufacturing overhead includes indirect materials, indirect labor, depreciation on factory buildings and machinery, insurance, taxes, and maintenance of factory facilities.

12.

Product Versus Period Costs 13. Product costs are costs that are a necessary and integral part of producing the finished product. Period costs are costs that are matched with the revenue of a specific time period rather than included as part of the cost of a salable product. These are nonmanufacturing costs. Period costs include selling and administrative expenses.

Manufacturing Income Statement 14. The income statements of a merchandising company and a manufacturing company differ in the cost of goods sold section. The cost of goods sold section of the income statement for a manufacturing company shows: Beginning Finished Goods + Inventory Cost of Goods Manufactured 16. The determination of the cost of goods manufactured consists of the following: a. Beginning Work in Process + Inventory Total Cost of Work in Process Total Manufacturing Costs Total Cost of Work in Process Cost of Goods Manufactured Ending Finished Goods Inventory Cost of Goods Sold

15.

b.

Ending Work in Process = Inventory

Cost of Goods Manufactured

46

17.

The costs assigned to the beginning work in process inventory are the manufacturing costs incurred in the prior period. Total manufacturing costs is the sum of the direct materials costs, direct labor costs, and manufacturing overhead incurred in the current period. Because a number of accounts are involved, the determination of costs of goods manufactured is presented in a Cost of Goods Manufactured Schedule. The cost of goods manufactured schedule shows each of the cost factors above. The format for the schedule is: Beginning work in process............................................................ Direct materials used..................................................................... Direct labor.................................................................................... Manufacturing overhead................................................................ Total manufacturing costs............................................................. Total cost of work in process......................................................... Less: Ending work in process...................................................... Cost of goods manufactured......................................................... $XXXX $XXXX XXXX XXXX XXXX XXXX XXXX $XXXX

18.

19.

Manufacturing Balance Sheet 20. The balance sheet for a manufacturing company has three inventory accounts: finished goods inventory, work in process inventory, and raw materials inventory. The manufacturing inventories are reported in the current assets section of the balance sheet. a. The inventories are generally listed in the order of their expected realization in cash. b. Thus, finished goods inventory is listed first. Each step in the accounting cycle for a merchandising company is applicable to a manufacturing company. a. For example, prior to preparing financial statements, adjusting entries are required. b. Adjusting entries are essentially the same as those of a merchandising company. c. The closing entries for a manufacturing company are also similar to those of a merchandising company.

21.

22.

Managerial Accounting Today 23. Managerial accounting has experienced many changes in recent years. Among these are a shift toward addressing the needs of service companies and improving practices to better meet the needs of managers. Many companies have significantly lowered inventory levels and costs using just-in-time (JIT) inventory methods. Under a just-in-time method, goods are manufactured or purchased just in time for use. In addition, many companies have installed total quality management (TQM) systems to reduce defects in finished products. Activity-based costing (ABC) is a popular method for allocating overhead that obtains more accurate product costs. The theory of constraints is a specific approach used to identify and manage constraints in order to achieve the company goals. The balanced scorecard is a performance-measurement approach that uses both financial and nonfinancial measures to evaluate all aspects of a companys operations in an integrated fashion.

24.

25.

PROBLEM # 1 Determine whether each of the following costs should be classified as direct materials (DM), direct labor (DL), or manufacturing overhead (MO). a. ____ Depreciation on factory equipment 47

b. ____ Table legs used in manufacturing tables c. ____ Wages paid to assembly line workers d. ____ Factory rent PROBLEM # 2 Identify whether each of the following is classified as a product cost or a period cost. ______________ 1. Direct labor ______________ 2. Direct materials ______________ 3. Factory utilities ______________ 4. Repairs to office equipment ______________ 5. Property taxes on factory building ______________ 6. Sales salaries PROBLEM # 3 Determine whether each of the following is classified as: DM: Direct materials DL: Direct labor MO: Manufacturing overhead _____1. Assembly line workers' wages. _____2. Factory supervisors' salaries. _____3. Steel used in manufacturing product. _____4. Insurance on factory building. _____5. Rivets and screws used in production. _____6. Tires used in manufacturing vehicles. PROBLEM # 4 For each item, identify all applicable cost labels. Use the following code in your answer: 1 Product Cost 2 Period Cost a. b. c. d. e. f. g. h. Advertising Direct materials used Sales salaries Indirect factory labor Repairs to office equipment Factory manager's salary Direct labor Indirect materials __________ __________ __________ __________ __________ __________ __________ __________

PROBLEM # 5 Kennedy Company reports the following costs and expenses in May. Factory utilities $ 13,500 Depreciation on factory equipment 12,650 Depreciation on delivery trucks 3,800 48 Direct labor Sales salaries Property taxes on factory building $79,100 48,400 2,500

Indirect factory labor Indirect materials Direct materials used Factory manager's salary

48,900 70,800 157,600 8,000

Repairs to office equipment Factory repairs Advertising Office supplies used

1,300 2,000 23,000 2,640

Instructions From the information, determine the total amount of: (a) Manufacturing overhead. (b) Product costs. (c) Period costs.

QUIZ # 4 MANAGERIAL ACCOUTING

Circle the correct answer. True/False 1. Managerial accounting is a field of accounting that provides economic information for external users. True 2. False

The primary users of managerial accounting information are external users who are stockholders, creditors, and regulatory agencies. True False

3.

The purpose of reports in managerial accounting is to provide special-purpose information for a particular user for a specific decision. True False

4.

Manufacturing Inventory is one of the three inventory accounts a manufacturing company may have. True False

5.

Finished Goods Inventory plus Work in Process Inventory constitutes Cost of Goods Available for Sale. True False

6.

Indirect materials, indirect labor, and maintenance on factory facilities are all included in manufacturing overhead. True False

7.

Selling and administrative expenses are product costs. True False

8.

The sum of the direct materials costs, direct labor costs, and manufacturing overhead incurred in the current year is the total manufacturing costs for the current period. True False

49

9.

Cost of goods manufactured for a manufacturing company is the equivalent of cost of goods sold for a merchandising company. True False

10.

The finished goods inventory for a manufacturing company is the equivalent of the merchandise inventory for a merchandising company. True False

Multiple Choice 1. Which of the following does not apply to the content of managerial reports? a. b. c. d. 2. Reporting standard is relevance to the decision to be made. May extend beyond double-entry accounting system. Pertains to subunits of the entity and may be very detailed. Pertains to the entity as a whole and is highly aggregated.

Management functions include a. b. c. d. planning. directing. controlling. all of the above.

3.

Which of the following inventory accounts is not applicable to a manufacturing company? a. b. c. d. Finished Goods Inventory. Inventory. Raw Materials Inventory. Work in Process Inventory.

4.

If direct materials for one unit of product are $9.00, direct labor for one hour is $15.00, manufacturing overhead costs are $5.00 per direct labor hour, and one-fourth hour of direct labor is required to produce one unit of product, how much are the conversion costs for one unit of product? a. b. c. d. $5.00. $2.50. $20.00. $15.00.

5.

Direct materials and direct labor are a. b. c. d. period costs. product costs. overhead costs. indirect costs.

50

ASSIGNMENT # 5 MANAGERIAL ACCOUTING

Q1 Indicate whether each of the following costs of a pencil manufacturer would be classified as direct materials (DM), direct labor (DL), or manufacturing overhead (MO). a. ____ Depreciation of pencil painting machinery b. ____ Lead inserted into pencils c. ____ Factory utilities d. ____ Wages of assembly line worker e. ____ Salary of supervisor f. ____ Factory machinery maintenance g. ____ Wood h. ____ Eraser compound Q2 Financial accounting information and managerial accounting information have a number of distinguishing characteristics. For each of the characteristics listed below, indicate which characteristics are more closely related to financial accounting by placing the letter "F" in the space to the left of the item and indicate those characteristics which are more closely associated with managerial accounting by placing the letter "M" to the left of the item. _____ 1. ____ ____ ____ ____ ____ ____ ____ ____ 2. 3. 4. 5. 6. 7. 8. 9. General-purpose reports Reports are used internally Prepared in accordance with generally accepted accounting principles Special purpose reports Limited to historical cost data Reporting standard is relevance to the decision to be made Financial statements Reports generally pertain to the business as a whole Reports generally pertain to subunits Reports issued quarterly or annually

____ 10.

Q3 Kwik Delivery Service reports the following costs and expenses in June 2012. Indirect materials Depreciation on delivery equipment Dispatcher's salary Property taxes on office building CEO's salary Gas and oil for delivery trucks Instructions Determine the total amount of (a) delivery service (product) costs and (b) period costs. Q4 For each item listed below, indicate in the space to the left whether the item would be considered a product cost or a period cost for a manufacturing company. Use the following code: Pr = Product cost Pe = Period cost $ 8,400 11,200 5,000 870 12,000 3,200 Driver's salaries Advertising Delivery equipment repairs Office supplies Office utilities Repairs on office equipment $14,000 5,100 300 650 1,490 180

51

____ ____ ____ ____ ____ ____ ____ ____ ____

1. Factory supervisory salaries 2. Sales commissions 3. Income tax expense 4. Indirect materials used 5. Indirect labor 6. Office salaries expense 7. Property taxes on factory building 8. Sales manager's salary 9. Factory wages expense

____ 10. Direct materials used Q5 Match the items in the two columns below by entering the appropriate code letter in the space provided. A. B. C. D. E. _____ 1. _____ 2. _____ 3. _____ 4. Managerial accounting Financial accounting Planning Directing Controlling F. G. H. I. J. Work in process inventory Direct materials Manufacturing overhead Period costs Value chain

The cost of products that are partially complete. The function of keeping activities in accordance with plans. Primarily concerned with internal users and reports pertain to subunits of the entity. Materials that can be physically and directly associated with manufacturing a product. The function of setting goals and objectives. Indirect costs of manufacturing a product. Primarily concerned with external users and reports pertain to the entity as a whole. Costs that are non Inventoriable. All activities associated with providing a product or service.

_____ 5. _____ 6. _____ 7.

_____ 8. _____ 9.

_____ 10. The function of coordinating diverse activities to produce a smooth-running operation.

52

7. Cost-Volume-Profit
Cost Behavior Analysis
1. Cost behavior analysis is the study of how specific costs respond to changes in the level of business activity. A knowledge of cost behavior helps management plan operations and decide between alternative courses of action. The activity index identifies the activity that causes changes in the behavior of costs; examples include direct labor hours, sales dollars, and units of output. Once an appropriate activity index is chosen, costs can be classified as variable, fixed or mixed.

2.

Variable and Fixed Costs

3. Variable costs are costs that vary in total directly and proportionately with changes in the activity level. Examples of variable costs include direct materials and direct labor, cost of goods sold, sales commissions, and freight out. A variable cost may also be defined as a cost that remains the same per unit at every level of activity. Fixed costs are costs that remain the same in total regardless of changes in the activity level. Examples include property taxes, insurance, rent, supervisory salaries, and depreciation. Fixed costs per unit vary inversely with activity; as volume increases, unit cost declines and vice versa.

4.

Relevant Range
5. The range over which a company expects to operate during the year is called the relevant range. Within the relevant range a straight-line relationship exists for both variable and fixed costs.

Mixed Costs 6. Mixed costs are costs that contain both a variable element and a fixed element; they increase in total as the activity level increases, but not proportionately. For purposes of CVP analysis, mixed costs must be classified into their fixed and variable elements. The high-low method uses the total costs incurred at the high and low levels of activity. The difference in costs represents variable costs, since only the variable cost element can change as activity levels change. The steps in computing fixed and variable costs under the high-low method are: a. Determine variable cost per unit from the following formula: Change in High minus Low Variable Cost per = Total Costs Activity Level Unit b. Determine the fixed cost by subtracting the total variable cost at either the high or the low activity level from the total cost at that activity level.

7.

8.

Cost-Volume-Profit Analysis 9. Cost-volume-profit (CVP) analysis is the study of the effects of changes in costs and volume on a companys profits. It is a critical factor in such management decisions as profit planning, setting selling prices, determining the product mix, and maximizing use of production facilities. CVP analysis considers the interrelationships among the following components: (a) volume or level of activity, (b) unit selling prices, (c) variable cost per unit, (d) total fixed costs, and (e) sales mix. 53

10.

Basic CVP Components 11. The following assumptions underlie each CVP analysis: a. The behavior of both costs and revenues is linear throughout the relevant range of the activity index. b. Costs can be classified accurately as either variable or fixed. c. Changes in activity are the only factors that affect costs. d. All units produced are sold. e. When more than one type of product is sold, the sales mix will remain constant.

Contribution Margin 12. Contribution margin is the amount of revenue remaining after deducting variable costs. The formula for contribution margin per unit is: Unit Selling Unit Variable Contribution = Price Cost Margin per Unit 13. Contribution margin per unit indicates the amount available to cover fixed costs and contribute to income. The formula for the contribution margin ratio is: Contribution Unit Selling Contribution = Margin per Unit Price Margin Ratio The ratio indicates the portion of each sales dollar that is available to apply to fixed costs and to contribute to income. Break-Even Analysis 14. The break-even point is the level of activity at which total revenue equals total costs both fixed and variable. Knowledge of the break-even point is useful to management when it decides whether to introduce new product lines, change sales prices on established products, or enter new market areas. A common equation used for CVP analysis is as follows: Sales = Variable Costs + Fixed Costs + Net Income 16. Under the contribution margin technique, the break-even point can be computed by using either the contribution margin per unit or the contribution margin ratio. The formula, using unit contribution margin, is: Fixed Contribution Break-even = Costs Margin per Unit Point in Units 18. The formula using the contribution margin is: Fixed Contribution Break-Even = Costs Margin Ratio Point in Dollars 19. A chart (or graph) can also be used as an effective means to determine and illustrate the break-even point. A cost-volume-profit (CVP) graph is as follows:

15.

17.

54

Dollars (000) 900 800 700 600 500 400 300 200 100 0

Sales Line

Total Cost Line

Break-even Point Variable Costs

Fixed Cost Line Fixed Costs 200 400 600 800 1000 1200 1400 1600 1800 Units of Sales

Target Net Income 20. Target net income is the income objective for individual product lines. The following equation is used to determine required sales to meet target net income: Required Sales = Variable Costs + Fixed Costs + Target Net Income Margin of Safety 21. Margin of safety is the difference between actual or expected sales and sales at the break-even point. a. The formula for stating the margin of safety in dollars is: Actual Break-Even Margin of Safety (Expected) = Sales in Dollars Sales b. The formula for determining the margin of safety ratio is: Actual Margin of Safety in Margin of Safety (Expected) = Dollars Ratio Sales The higher the dollars or the percentage, the greater the margin of safety. CVP Income Statement 22. The cost-volume-profit (CVP) income statement classifies costs and expenses as variable or fixed and specifically reports contribution margin in the body of the statement.

Absorption and Variable Costing *23. There are two approaches to product costing. a. Under full or absorption costing all manufacturing costs are charged to the product. b. Under variable costing, only direct materials, direct labor, and variable manufacturing overhead costs are product costs; fixed manufacturing overhead costs are recognized as period costs (expenses) when incurred. *24. The income statement under variable costing is prepared in the cost-volume-profit format. *25. The effects of the alternative costing methods on income from operations are: 55

Circumstance Units produced exceed units sold

Effects on Income From Operations Income under absorption costing is higher than under variable costing Income under absorption costing is lower than under variable costing Income will be equal under both approaches

Units produced are less than units sold Units produced equal units sold

*26. The use of variable costing is acceptable only for internal use by management. It cannot be used in determining product costs in financial statements prepared in accordance with generally accepted accounting principles because it understates inventory costs. PROBLEM # 1: Nease Company accumulates the following data concerning a mixed cost, using miles as the activity level. Miles Driven January February 10,000 8,000 Total Cost $15,000 $14,500 March April Miles Driven 9,000 7,500 Total Cost $12,500 $12,000

Instructions Compute the variable and fixed cost elements using the high-low method. PROBLEM # 2: Mitchell Cabinets has fixed costs totaling $132,000. Its contribution margin per unit is $1.50, and the selling price is $5.50 per unit. Instructions Compute the break-even point in units. PROBLEM # 3: Bess Donuts sells boxes of donuts each with a variable cost percentage of 35%. Its fixed costs are $54,600 per year. Instructions Determine the sales dollars Bess needs to break even per year PROBLEM # 4: Fillmore Cookery reported actual sales of $2,000,000, and fixed costs of $350,000. The contribution margin ratio is 25%. Instructions Compute the margin of safety in dollars and the margin of safety ratio. PROBLEM # 5: Sam Hummel is considering opening a Kwik Oil Change Center. He estimates that the following costs will be incurred during his first year of operations: Rent $9,200, Depreciation on equipment $7,000, Wages $16,400, Motor oil $2.00 per quart. He estimates that each oil change will require 5 quarts of oil. Oil filters will cost $3.00 each. He must also pay The Kwik Corporation a franchise fee of $1.10 per oil change, since he will operate the business as a franchise. In addition, utility costs are expected to behave in relation to the number of oil changes as follows: Number of Oil Changes 4,000 6,000 9,000 12,000 14,000 Utility Costs $ 6,000 $ 7,300 $ 9,600 $12,600 $15,000

Mr. Hummel anticipates that he can provide the oil change service with a filter at $25.00 each. 56

Instructions (a) Using the high-low method, determine variable costs per unit and total fixed costs. (b) Determine the break-even point in number of oil changes and sales dollars. (c) Without regard to your answers in parts (a) and (b), determine the oil changes required to earn net income of $10,000, assuming fixed costs are $32,000 and the contribution margin per unit is $8. PROBLEM # 6 Keys Company accumulates the following data concerning a mixed cost, using miles as the activity level. Miles Driven Total Cost May 10,000 $17,000 June 8,000 13,500 July 9,000 14,400 August 7,000 12,500 Instructions Compute the variable and fixed cost elements using the high-low method. PROBLEM # 7 Prentice Manufacturing's sales slumped badly in 2012 due to so many people purchasing gifts online. The company's income statement showed the following results from selling 500,000 units of product: net sales $2,125,000; total costs and expenses $2,500,000; and net loss $375,000. Costs and expenses consisted of the following: Cost of goods sold Selling expenses Administrative expenses Total $2,000,000 200,000 300,000 $2,500,000 Variable $1,300,000 50,000 150,000 $1,500,000 Fixed $ 700,000 150,000 150,000 $1,000,000

Management is considering the following alternative for 2013: Purchase new automated equipment that will change the proportion between variable and fixed expenses sold to 45% variable and 55% fixed. Instructions (a) Compute the break-even point in dollars for 2012. (b) Compute the break-even point in dollars under the alternative course of action. PROBLEM # 8 Kohler Company developed the following information for the product it sells: Sales price Variable cost of goods sold Fixed cost of goods sold Variable selling expense Variable administrative expense Fixed selling expense Fixed administrative expense $50 per unit $28 per unit $650,000 10% of sales price $2.00 per unit $400,000 $300,000

For the year ended December 31, 2012, Kohler Company produced and sold 100,000 units of product. Instructions (a) (b) (c) Prepare a CVP income statement using the contribution margin format for Wayman Company for 2012. What was the company's break-even point in units in 2012? Use the contribution margin technique. What was the company's margin of safety in dollars in 2012?

57

QUIZ # 5 (Cost-Volume-Profit)
Circle the correct answer. True/False 1. The range over which a company is expected to operate is called the relevant range of the activity index. True 2. False

A mixed cost contains both selling and administrative cost elements. True False

3.

Variable costs are costs that remain the same per unit at every level of activity. True False

4.

If a salesperson incurs $2,000 of expenses in servicing two customers and $4,000 of expenses in servicing four customers, the fixed costs are $1,000. True False

5.

If revenue = $80 and variable cost = 40% of revenue, then contribution margin = $48. True False

6.

The contribution margin is the amount of revenue remaining after deducting fixed costs. True False

7.

Sales mix is the relative combination in which a companys products are sold. True False

8.

If the unit contribution margin is $300 and fixed costs are $240,000 then the break-even point in units would be 800 units. True False

9.

In a CVP income statement, contribution margin is reported in the body of the statement. True False

10.

Margin of safety is the difference between actual sales and contribution margin. True False

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Multiple Choice 1. Which of the following is a false statement regarding assumptions of CVP analysis? a. b. c. d. 2. Total fixed costs remain constant over the relevant range. Unit selling prices are constant. Changes in volume or level of activity increase variable costs per unit. All units produced are sold.

Mixed costs may be separated into fixed costs and variable costs by using a. b. c. d. the variable costing method. the high-low method. the contribution margin method. all of the above.

3.

If the unit selling price is $500, the unit variable cost is $300, and the total monthly fixed costs are $300,000, then the contribution margin ratio is a. b. c. d. 30%. 40%. 50%. 60%.

4.

If activity level increases 25% and a specific cost increases from $40,000 to $50,000, this cost would be classified as a a. b. c. d. variable cost. mixed cost. fixed cost. none of the above.

5.

If total fixed costs are $900,000 and variable costs as a percentage of unit selling price are 40%, then the break-even point in dollars is a. b. c. d. $1,500,000. $360,000. $2,250,000. not determinable with the information given.

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ASSIGNMENT # 6 (Cost-Volume-Profit)
Q1 Cos t Name the Graphs of the cost behavior patterns: Cos t

a. __________ Cos t

Activ ity Cos t

b. ______________

Activ ity

Cos t

Activ c. ity _________________

Cos t

Activ d. ity __________________

Activ e. ity _________________

f. __________

Activ ity

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Q2 Match the items in the two columns below by entering the appropriate code letter in the
space provided. A. Activity index B. Variable costs C. Fixed costs D. High-low method E. Relevant range F. Mixed costs G. H. I. J. K. L. Break-even point Contribution margin Margin of safety Contribution margin ratio Variable costing Absorption costing

____ 1. The amount of revenue remaining after deducting variable costs. ____ 2. Costs that contain both a variable and a fixed element. ____ 3. The percentage of sales dollars available to cover fixed costs and produce income. ____ 4. Identifies the activity which causes changes in the behavior of costs. ____ 5. The difference between actual or expected sales and sales at the break-even point. ____ 6. Costs that vary in total directly and proportionately with changes in the activity level. ____ 7. The level of activity at which total revenues equal total costs. ____ 8. The range over which the company expects to operate during the year. ____ 9. Costs that remain the same in total regardless of changes in the activity level. ____ 10. A costing approach in which all manufacturing costs are charged to the product. ____ 11. A method that uses the total costs incurred at the high and low levels of activity. ____ 12. A costing approach in which only variable manufacturing costs are product costs and fixed manufacturing costs are period costs (expenses).

Q3 Nott Company has prepared the following cost-volume-profit graph:

I B E A F H

C D

Instructions For the items listed below, enter to the left of the item, the letter in the graph which best corresponds to the item. ____ ____ ____ ____ ____ ____ ____ ____ ____ 1. Activity base 2. Break-even point 3. Dollars 4. Fixed costs 5. Loss 6. Profit 7. Revenues 8. Total costs 9. Variable costs 61

Q4 Jordan Company developed the following information for 2012: Selling and Administrative Expenses Variable Fixed Units in beginning inventory Units sold Direct materials used Direct labor Units produced Manufacturing overhead Variable Fixed $30,000 $50,000 -026,000 $75,000 $95,000 30,000 $40,000 $90,000

Instructions Answer the following questions. (a) What would be the amount of the cost of goods sold under the absorption costing approach? (b) What would be the cost of the ending inventory under the variable costing approach? (c) Which approach would show the greater income for 2012 and by how much?

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8. Incremental Analysis and Capital Budgeting

Incremental Analysis 1. Managements decision-making process frequently involves the following steps: a. Identify the problem and assign responsibility. b. Determine and evaluate possible courses of action. c. Make a decision. d. Review results of the decision. Business decisions involve a choice among alternative courses of action. In making such decisions, management ordinarily considers both financial and nonfinancial information. The process used to identify the financial data that change under alternative courses of action is called incremental analysis. a. Incremental analysis identifies the probable effects of the decision on future earnings. b. Data for incremental analysis involves estimates and uncertainty. c.Gathering data may involve market analysts, engineers, and accountants. In incremental analysis, both costs and revenues may change. However, in some cases (1) variable costs may not change under the alternative courses of action, and (2) fixed costs may change.

2.

3.

Accept an Order at a Special Price 4. An order at a special price should be accepted when the incremental revenue from the order exceeds the incremental costs. a. It is assumed that sales in other markets will not be affected by the special order. b. If the units can be produced within existing plant capacity, generally only variable costs will be affected.

Make or Buy 5. In a make or buy decision, management must determine the costs which are different under the two alternatives. If there is an opportunity to use the productive capacity for another purpose, opportunity cost should be considered. Opportunity cost is the potential benefit that may be obtained by following an alternative course of action. This cost is an additional cost of making the component.

Sell or Process Further 6. The basic decision rule in a sell or process further decision is: Process further as long as the incremental revenue from such processing exceeds the incremental processing costs. Incremental revenue is the increase in sales which results from processing the product further.

Retain or Replace Equipment 7. In a decision to retain or replace equipment, management compares the costs which are affected by the two alternatives. Generally, these are variable manufacturing costs and the cost of the new equipment. 63

a. b.

The book value of the old machine is a sunk cost which does not affect the decision. A sunk cost is a cost that cannot be changed by any present or future decision. However, any trade-in allowance or cash disposal value of the existing asset must be considered.

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Eliminate an Unprofitable Segment 8. In deciding whether to eliminate an unprofitable segment, management should choose the alternative which results in the highest net income. Often fixed costs allocated to the unprofitable segment must be absorbed by the other segments. It is possible, therefore, for net income to decrease when an unprofitable segment is eliminated.

Allocate Limited Resources 9. When a company has limited resources (floor space, raw materials, or machine hours), management must decide which products to make and sell. In an allocation of limited resources decision, it is necessary to find the contribution margin per unit of limited resource. a. This is obtained by dividing the contribution margin per unit of each product by the number of units of the limited resource required for each product. For example, if the unit contribution margin for a product is $6 and three machine hours are required, the contribution margin per unit of limited resource is $2 ($6 3). b. Production should be geared to the product with the highest contribution margin per unit of limited resource.

Capital Budgeting 10. The process of making capital expenditure decisions is known as capital budgeting. The three most commonly used capital budgeting techniques are (a) annual rate of return, (b) cash payback, and (c) discounted cash flow.

Annual Rate of Return 11. The annual rate of return technique is based directly on accrual-accounting data. It indicates the profitability of a capital expenditure. The formula is: Expected Annual Net Income Average Investment = Annual Rate of Return Average investment is based on the following: Original Investment + Value at End of Useful Life = Average Investment 2 12. A project is acceptable if its rate of return is greater than managements required rate of return. a. The required rate of return rate is based on the companys cost of capital, which is the rate of return management expects to pay on all borrowed and equity funds. b. When choosing among several acceptable projects, the higher the annual rate of return, the more attractive the investment. c. This technique is simple and familiar, but it does not consider the time value of money.

Cash Payback 13. The cash payback technique identifies the time period required to recover the cost of the capital investment from the annual cash inflow produced by the investment. The formula for computing the cash payback period is: Cost of Capital Investment Annual Cash Inflow = Cash Payback Period Net annual cash flow is approximated by adding depreciation expense to net income. 14. The evaluation of the payback period is often related to the expected useful life of the asset. 65

a. b. c.

With this technique, the shorter the payback period, the more attractive the investment. This technique is useful as an initial screening tool. This technique ignores both the expected profitability of the investment and the time value of money.

Discounted Cash Flow 15. The discounted cash flow technique is generally recognized as the best conceptual approach to making capital budgeting decisions. This technique considers both the estimated total Net cash flows and the time value of money. Two methods are used with the discounted cash flow technique: net present value and internal rate of return.

Net Present Value Method 16. Under the net present value method, cash flows are discounted to their present value and then compared with the capital outlay required by the investment. The difference between these two amounts is the net present value (NPV). a. The interest rate used in discounting the future net cash flows is the required minimum rate of return. b. A proposal is acceptable when NPV is zero or positive. c. The higher the positive NPV, the more attractive the investment. When there are equal annual cash flows, the table showing the present value of an annuity of 1 can be used in determining present value. When there are unequal annual cash flows, the table showing the present value of a single future amount must be used in determining present value.

17.

Internal Rate of Return Method 18. The internal rate of return method results in finding the interest yield of the potential investment. This is the interest rate that will cause the present value of the proposed capital expenditure to equal the present value of the expected net annual cash flows. Determining the true interest rate involves two steps: a. An internal rate of return factor is computed by dividing the capital investment by the net annual cash flows. b. The factor is then used with the annuity of 1 table to find the internal rate of return. The decision rule is: Accept the project when the internal rate of return is equal to or greater than the required rate of return, and reject the project when the internal rate of return is less than the required rate. The internal rate of return method is widely used in practice because most managers find it easy to interpret.

19.

20.

PROBLEM # 1 R&O Inc. produces several models of clocks. An outside supplier has offered to produce the commercial clocks for R&O for $270 each. R&O needs 1,500 clocks annually. R&O has provided the following unit costs for its commercial clocks: Direct materials Direct labor Variable overhead Fixed overhead (60% avoidable) Instructions Prepare an incremental analysis which shows the effect of the make-or-buy decision. $100 110 30 150

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PROBLEM # 2 Abita Quail Farm, Inc. produces a crop of heritage quail at a total cost of $66,000. The production generates 15,000 quail which can be sold for $4 each to restaurants, or the quail can be processed in house and then sold for $9 each. It costs $55,000 more to process the quail . Instructions If Abita Quail Farm processes the quail, determine how much incremental profit or loss it would report. What should Abita Quail Farm do? PROBLEM # 3 Fromherz Company produced and sold 50,000 units of product and is operating at 80% of plant capacity. Unit information about its product is as follows: Sales Price Variable manufacturing cost Fixed manufacturing cost ($500,000 50,000) Profit per unit $68 $42 10 52 $16

The company received a proposal from a Danish company to buy 10,000 units of Fromherz Company's product for $49 per unit. This is a one-time only order and acceptance of this proposal will not affect the company's regular sales. The president of Fromherz Company is reluctant to accept the proposal because he is concerned that the company will lose money on the special order. Instructions Prepare a schedule reflecting an incremental analysis of this proposal and indicate the effect the acceptance of this order might have on the company's income. PROBLEM # 4 Charleston Company produces golf discs which it normally sells to retailers for $6 each. The cost of manufacturing 25,000 golf discs is: Materials Labor Variable overhead Fixed overhead Total $ 10,000 30,000 20,000 40,000 $100,000

Charleston also incurs 5% sales commission ($0.30) on each disc sold. Lundy Corporation offers Charleston $4.25 per disc for 5,000 discs. Lundy would sell the discs under its own brand name in foreign markets not yet served by Charleston. If Charleston accepts the offer, its fixed overhead will increase from $50,000 to $55,000 due to the purchase of a new imprinting machine. No sales commission will result from the special order. Instructions (a) Prepare an incremental analysis for the special order. (b) Should Charleston accept the special order? Why or why not? PROBLEM # 5 Kaizen Inc. budgeted to produce 10,000 widgets during 2010. Kaizen has capacity to produce 12,000 units. Fixed factory overhead is allocated to production. The following estimated costs were provided: Direct material ($7/unit) Direct labor ($15/hr. 2 hrs./unit) Variable manufacturing overhead ($3/unit) Fixed factory overhead costs ($5/unit) Total Cost per unit = $45 67 $ 70,000 300,000 30,000 50,000 $450,000

Instructions Answer each of the following independent questions: 1. Kaizen received an order for 1,000 units from a new customer in a country in which Kaizen has never done business. This customer has offered $43 per widget. Should Kaizen accept the order? 2. Kaizen received an offer from another company to manufacture the same quality widgets for $39. Should Kaizen let someone else manufacture all 10,000 widgets and focus only on distribution? PROBLEM # 6 Go Light Bikes could sell its bicycles to retailers either assembled or unassembled. The cost of an unassembled bike is as follows. Direct materials Direct labor Variable overhead (70% of direct labor) Fixed overhead (30% of direct labor) Manufacturing cost per unit The unassembled bikes are sold to retailers at $400 each. Go Light currently has unused productive capacity that is expected to continue indefinitely; management has concluded that some of this capacity can be used to assemble the bikes and sell them at $440 each. Assembling the bikes will increase direct materials by $5 per bike, and direct labor by $10 per bike. Additional variable overhead will be incurred at the normal rates, but there will be no additional fixed overhead as a result of assembling the bikes. Instructions (a) Prepare an incremental analysis for the sell-or-process-further decision. (b) Should Go Light sell or process further? Why or why not? PROBLEM # 7 Texas Forest Corporation operates two divisions, the Commercial Division and the Consumer Division. The Commercial Division manufactures and sells logs to paper manufacturers. The Consumer Division operates retail lumber mills which sell a variety of products in the do-ityourself homeowner market. The company is considering disposing of the Consumer Division since it has been consistently unprofitable for a number of years. The income statements for the two divisions for the year ended December 31, 2012 are presented below: $150 70 49 21 $290

Sales Cost of goods sold Gross profit Selling & administrative expenses Net income

Commercial $1,500,000 900,000 600,000 250,000 $ 350,000

Consumer $500,000 350,000 150,000 180,000 $ (30,000)

Total $2,000,000 1,250,000 750,000 430,000 $ 320,000

In the Consumer Division, 70% of cost of goods sold are variable costs and 25% of selling and administrative expenses are variable costs. The management of the company feels it can save $45,000 of fixed cost of goods sold and $60,000 of fixed selling expenses if it discontinues operation of the Consumer Division. Instructions (a) Determine whether the company should discontinue operating the Consumer Division. (b) If the company had discontinued the division for 2012, determine what net income would have been.

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QUIZ # 6 (Incremental Analysis and Capital Budgeting)

Circle the correct answer. True/False 1. Determining and evaluating possible courses of action is a step in managements decision-making process. True 2. False

In incremental analysis fixed costs may not change under alternative courses of action, while variable costs may change. True False

3.

The relevant factors to consider in accepting an order at a special price are the additional manufacturing costs incurred and expected revenues. True False

4.

The basic decision rule to sell or process further is: process further as long as the incremental revenue from such processing exceeds the incremental processing costs. True False

5.

Book value is a sunk cost and is therefore relevant in incremental analysis of retain or replace equipment. True False

6.

Contribution margin per unit of limited resource is obtained by dividing the contribution margin per unit of each product by the number of units of the limited resource required for each product. True False

7.

A major limitation of the annual rate of return approach is that it does not consider the time value of money. True False

8.

The cash payback technique recognizes the time value of money plus expected profitability of a project, and is therefore the most desirable approach to making capital budgeting decisions. True False

9.

Net present value and internal rate or return are both methods used with the discounted cash flow technique. True False

10.

The net present value method results in finding the interest yield of the potential investment. True False 69

Multiple Choice 1. Which of the following is not a step in managements decision-making process? a. b. c. d. 2. Identify the problem and assign responsibility. Determine possible courses of action. Review the results of the decision. Prepare financial statements.

If revenues are $1,050,000 under alternative A and $1,080,000 under alternative B, and costs are $950,000 for A and $1,020,000 for B, then using the basic approach in incremental analysis, incremental revenues, costs, and net income, in comparing B to A are respectively a. b. c. d. $30,000, $70,000, $(40,000). $(30,000), $70,000, $40,000. $30,000, $70,000, $40,000. $(30,000), $(70,000), $(40,000).

3.

The cost to manufacture an unfinished unit is $160 ($120 variable, $40 fixed). The selling price per unit is $200. The company has unused productive capacity and has determined that units could be finished and sold for $260 with an increase in variable costs of 40%. What is the additional net income per unit to be gained by finishing the unit? a. b. c. d. $12.00. $40.00. $60.00. $48.00.

4.

Which of the following is generally recognized as the most informative and best conceptual approach to making capital budgeting decisions? a. b. c. d. Annual rate of return technique. Cash payback technique. Discounted cash flow technique. None of the above.

5.

If capital investment is $200,000 and equal annual cash inflows are $40,000, the internal rate of return factor is a. b. c. d. 20.0. 5.0. 4.0. .25.

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ASSIGNMENT # 7 (Incremental Analysis and Capital Budgeting)

Q1 Good Home Company manufactures cappuccino makers. For the first ten months of 2012, the company reported the following operating results while operating at 80% of plant capacity: Sales (500,000 units) Cost of goods sold Gross profit Operating expenses Net income $90,000,000 54,000,000 36,000,000 24,000,000 $12,000,000

An analysis of costs and expenses reveals that variable cost of goods sold is $95 per unit and variable operating expenses are $35 per unit. In November, Good Home Company receives a special order for 30,000 machines at $135 each from a major coffee shop franchise. Acceptance of the order would result in $10,000 of shipping costs but no increase in fixed expenses. Instructions (a) Prepare an incremental analysis for the special order. (b) Should Good Home Company accept the special order? Justify your answer Q2 Wilmington Company manufactured 5,000 units of a component part that is used in its product and incurred the following costs: $35,000 25,000 20,000 15,000 $95,000 Another company has offered to sell the same component part to the company for $17.50 per unit. The fixed manufacturing overhead consists mainly of depreciation on the equipment used to manufacture the part and would not be reduced if the component part was purchased from the outside firm. If the component part is purchased from the outside firm, Wilmington Company has the opportunity to use the factory equipment to produce another product which is estimated to have a contribution margin of $19,000. Instructions Prepare an incremental analysis report for Wilmington Company which can serve as informational input into this make or buy decision. Q3 Tri-Cities Inc. has three divisions: Boone, Lenoir, and Hickory. The results of August, 2012 are presented below. Boone Lenoir Hickory Total Units sold 3,000 5,000 2,000 10,000 Revenue $70,000 $50,000 $40,000 $160,000 Less variable costs 32,000 26,000 16,000 74,000 Less direct fixed costs 14,000 19,000 12,000 45,000 Less allocated fixed costs 6,000 10,000 4,000 20,000 Net income $18,000 $ (5,000) $ 8,000 $ 21,000 All of the allocated costs will continue even if a division is discontinued. Tri-Cities allocates indirect fixed costs based on the number of units to be sold. Since the Lenoir division has a net loss, Tri-Cities feels that it should be discontinued. Tri-Cities feels if the division is closed, that sales at the Boone division will increase by 10%, and that sales at the Hickory division will stay the same. Instructions (a) Prepare an analysis showing the effect of discontinuing the Lenoir division. (b) Should Tri-Cities close the Lenoir division? Briefly indicate why or why not. 71 Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead

Q4 Match the items below by entering the appropriate code letter in the space provided. A. B. C. D. E. Incremental analysis Opportunity cost Discounted cash flow technique Capital budgeting Annual rate of return technique F. G. H. I. J. Cash payback technique Hurdle or cutoff rate Net present value method Sunk cost Internal rate of return method

____ ____

1. A cost that cannot be changed by any present or future decision. 2. A capital budgeting technique that considers both the estimated total cash inflows from the investment and the time value of money. 3. A method used in capital budgeting in which cash inflows are discounted to their present value and then compared to the capital outlay required by the capital investment. 4. The process of identifying the financial data that change under alternative courses of action. 5. A method used in capital budgeting that results in finding the interest yield of the potential investment. 6. The minimum rate of return management requires on an investment. 7. The determination of the profitability of a capital expenditure by dividing expected annual net income by the average investment. 8. The potential benefit that may be lost from following an alternative course of action. 9. The process of making capital expenditure decisions in business.

____

____

____

____ ____

____ ____

____ 10. A capital budgeting technique that identifies the time period required to recover the cost of a capital investment from the annual cash inflow produced by the investment.

72