1.

direct and variable

2. indirect and fixed
3. indirect and variable
4. indirect and fixed
5. direct and variable
6. indirect and fixed
7. indirect and variable

Solution

a
b
c
d
e
f
g

Cost Object
product line or customer
product line
product line
product line
product line or customer order
each product
product line

h
I
j

customer
each product
product line

Cost Driver
each product line, or each custom order requiring design
number of customer orders
number of customer orders
number of purchase orders
number of orders
units produced
cannot be traced to product or customer; must be
allocated using some reasonable method, for example,
materials cost in each order
number of customers
units produced
cannot be traced to product or customer; must be
allocated using some reasonable method, for example,
the number of units produced

The observations made by the consultant show that the manufacturer was incurring large costs in
operations, distribution, and administration due to the high level of complexity in its products. Maintaining
relationships with 10 vendors for a single item contributed to high purchasing and stocking costs.
Similarly, most of the firms volume was made up of products with five color combinations, with the result
that manufacturing, warehousing, shipping and selling costs were high relative to fewer color
combinations. Also, the high product variety required smaller batch production and more frequent setups, which caused increased manufacturing costs. And the variety of different customers, prices, and
promotional programs created increased manufacturing, shipping and customer service costs as well as
increased costs in accounting for the customers invoices and account balances.

The solution? Reduce complexity. This was done by reducing the number of customers; the low value
customers were reviewed and some were not continued. Also, a process of review was developed for
the introduction of new products or new variations on existing products, to ensure the likely profitability o
the new product. Further, the complexity of equipment set-ups was reduced so that the firm could meet
the customers demands for smaller batch sizes without increasing overall costs. The result of the
program was that overall profit margins improved. The firm had found a way to deal with the cost
consequences of its strategic initiative.

Also, the firm adopted new cost management practices that included new non-financial measures such
as set-up time and frequency, percent of orders shipped on time, percent of orders on just-in-time, and
number of vendors for the top 20 commodity raw materials items. In addition, the firm began to calculate

3-37 Average and Total Costs (15 min)

1. Total cost:
$ 250 (fixed cost of night club)
+ 100 (variable cost of refreshments = $1 x 100)
$ 350
Average cost: $350/100 people = $3.50 per person
2. Total cost:
$ 250 (fixed cost of night club)
+ 200 (variable cost of refreshments = $1 x 200)
$ 450
Average cost: $450/200 people = $2.25 per person
3. Average costs decrease as attendance increases because the fixed cost component to total costs
is now spread over 100 extra people.
Fixed cost per person: $250/100 people =
$250/200
=
Decrease in fixed cost per person

$2.50
$1.25
$1.25

3-38 Cost Classification for Dance Studio (15 min)

1. While a variety of possible cost objects are possible for the dance studio, the most reasonable
choice is the studio since managements goal is to analyze the profitability of the studios.
2. Studios as the cost object
1. a,c,e
2. a,c,f
3. a,c,e
4. a,c,e
5. a,c,e
6. b,c,f
7. a,c,e
8. a,d,e
Or,
Lessons as the cost object
1. a,d,e
2. b,d,f
3. b,d,e
4. b,d,e
5. b,d,e

Solution

Department A
Department B

fixed
variable

In recognition of this problem, and of the large number of contract appeals it has caused, the various
federal boards of contract appeals have ruled in favor of treating certain indirect costs as direct costs
in these situations:

1) In an appeal filed by Fiesta Leasing & Sales, Inc., the board allowed depreciation on buses
purchased for a bus leasing contract when the Defense Department terminated the contract. The
board allowed depreciation costs because the costs were incurred for the contract and because these
costs could not be discontinued after the contract was terminated.

2) In an appeal brought by Essex Electric Engineers, Inc., the Department of Transportation (DOT)
Contract Appeals Board allowed recovery of the full cost of equipment remaining at a plant when the
contract was terminated for the convenience of the DOT. The reason for the ruling is that the
equipment purchased by Essex for the DOT contract was far beyond its needs for its other business.

Solution

This question is based upon an article in the January 1997, Journal of Accountancy, How Does Your
Finance Department Measure Up? pp 50-51.
The main point of this exercise, as for 3-32 above, is to help the student understand the importance of
taking activity levels into account when interpreting average cost information.
The Journal of Accountancy article shows, as represented by the information presented in the exercise,
that average fixed costs decline with higher levels of activity. Larger companies, with higher levels of
transaction volume, will have higher total fixed costs, but average fixed costs should be lower due to
economies of scale (as noted in the article, p 50). Looked at another way, if a given firm were to grow,
and its volume of transactions grew as well, then average fixed costs (or in this case the ratio of total
accounting costs to total revenue) would have to fall. Average fixed cost would continue to fall with
increasing numbers of transactions, until the firm felt it necessary to increase capacity in the accounting
department, thereby increasing fixed costs. (Note there is a controversy in microeconomics about
whether the long run average cost curve is flat or U-shaped. See Karl Case and Ray Fair, Principles of
Microeconomics, Fourth Ed, 1996, page 239.)

Requirements
Determine the cost of goods manufactured

Solution
Beginning work in process inventory
Current costs:
Direct materials used
Direct labor
Overhead
TOTAL current manufacturing costs
TOTAL manufacturing costs available
Less: ending work in process
Cost of goods manufactured

$75,000
$95,000
$85,000
$130,000
$310,000
$385,000
$65,000
$320,000

Requirements
1. What is the total amount of product and period costs?
2. a. Which of the additional costs are product costs?
b. Which costs are relevant to the decision whether to expand into the U.S.?

Solution

1.
Direct Labor for Galletas Americanas
Salaries & Wages
Labor fringe benefits
TOTAL

15,000
1,000
16,000

Direct Materials for Galletas Americanas

Ingredients for cookies

27,000

Factory Overhead for Galletas Americanas

Indirect Material
Paper
Indirect Labor
Manager Salary
Manufacturing Costs
Depreciation of Plant & Equipment
Insurance
Utilities
Equipment maintenance
Overtime Premiums
Idle time
Uniforms
Boxes, Bags
TOTAL Factory Overhead

70
10,000
1,500
600
1,600
600
2,000
400
300
700
17,770

TOTAL Product Cost

60,770

Period Costs
Rent
Administrative Costs
Advertising
TOTAL Period Costs

13,200
800
1,500
15,500

2. Assume that Galletas is planning to expand into the United States and Canada, initially targeting the United
States. This expansion will not require additional baking facilities, but labor and materials costs will increase, and
advertising costs and packaging costs will increase substantially. Also, U.S. authorities will require certain documentation and
inspections that will be an added cost for Galletas.
a. Which of the additional costs are product costs?
All the additional costs are likely to be product costs, except for the increase in advertising, which is a period cost.

b. Which costs are relevant for the decision whether to expand into the United States?
The baking facilities costs are not relevant since they will not change, but all other costs are relevant (the increase in materials
and labor, the increase in advertising and packing, and the increase in documentation and inspection costs).

Solution

Case A: A key structural issue for Food Fare is complexity. As the menu has changed, so will
costs and service. More complexity means higher food purchasing costs, higher operating costs,
and more complex operations. This will require new types of training for employees and perhaps
additional employees. Moreover, it will be a challenge for Food Fare to continue to provide the
speed of service that was possible with the shorter menu. The change will require careful attention
to operations and to cost management issues for the firm to continue to be profitable. Employee
training and new uses of technology to streamline the process of order taking and order filling are
likely to be necessary. Scale might also be an important issue in this casehow large must each
restaurant become, and how many restaurants must the chain have in order to justify the
increased purchasing and stocking costs, and the new training and technology costs?
Case B: A key issue in this case is the speed with which Gilman can provide customer service.
The speed of service provides value to the customer and also increases profitability. In order to
increase the speed of service, Gilman needs effective communication and coordination among the
service teams. This is probably being accomplished now by cell phone or CB radio. Gilman can
research new and more effective ways to accomplish this, perhaps using hand-held internet
access devices or modem-equipped notebook computers. The advantage of computer-based
access is that computer based tools can be used in the scheduling and assignment of the service
teams. Additionally, the computer can be used by each service team to quickly determine the
availability of parts in the firms warehouse or in other service vehicles, thereby allowing faster
service time. Also, the computer can be used to develop real time analyses of customer demand
and profitabilityin order to better understand which services and which types of customers are
most profitable. Is it in installation or service, Brand X or Brand Y, residential or commercial, etc.?

Requirements
1. Prepare a statement of cost of goods manufactured.
2. Calculate cost of goods sold.

3-50 Requirements
Prepare a schedule of cost of goods manufactured and an income statement for Duvernoy Company similar
to those in Exhibit 3.15a

Solution
Duvernoy Company
Statement of Cost of Goods Manufactured
December 31, 2007
Direct Materials Used
Direct Materials Inventory, Beginning
Direct Materials Purchases
Total Direct Materials Available
Direct Materials Inventory, Ending
Direct Materials Used
Direct Labor-Wages
Factory Overhead
Repair and Maintenance
Factory Insurance
Depreciation Expense-Plant
Indirect Labor-Wages
Total Factory Overhead
Total Manufacturing Cost Incurred During Year
Work-in-Process Inventory, Beginning
Total Manufacturing Costs to Account for
Work-in-Process Inventory, Ending
Cost of Goods Manufactured

$20,000
$60,000
$80,000
$35,000
$45,000
$45,000
$15,000
$12,000
$80,000
$25,000
$132,000
$222,000
$33,000
$255,000
$35,000
$220,000

Duvernoy Company
Income Statement
For the Year Ended December 31, 2007
Sales Revenue
Cost of Goods Sold
Finished Goods Inventory, Beginning
Cost of Goods Manufactured
Total Goods Available for Sale
Finished Goods Inventory, Ending

$500,000
$23,000
$220,000
$243,000
$20,000

Cost of Goods Sold

Gross Margin
Marketing Expenses
General and Administrative
Total Selling & Administrative
Net Income

$223,000
$277,000
$66,000
$55,000
$121,000
$156,000

3-51 Requirements
Prepare a statement of cost of goods manufactured and an income statement for Household
Furnishings for the year ended December 31, 2007, similar to the one in Exhibit 3.15a.
Solution

3-52 Requirements
Prepare a statement of cost of goods manufactured and an income statement for Blue Water
Equipment, Inc., for the year ended December 31, 2007.
Solution

Blue Water Equipment, Inc.

Statement of Cost of Goods Manufactured
December 31, 2007
Direct Materials Used
Direct Materials Inventory, Beginning
Direct Materials Purchases
Total Direct Materials Available
Direct Materials Inventory, Ending
Direct Materials Used
Direct Labor
Factory Overhead
Insurance on Plant
Supplies--Plant
Repairs on Plant Building
Depreciation Expense--Plant & Equip.
Heat and Light for Plant
Indirect Labor
Supervisor's Salary Plant
Total Factory Overhead
Total Manufacturing Cost Incurred during year
Work-in-Process Inventory, Beginning
Total Manufacturing Costs to Account for
Work-in-Process Inventory, Ending
Cost of Goods Manufactured

$33,000
$190,000
$223,000
$28,000
$195,000
$345,000
$44,000
$21,000
$34,000
$197,000
$23,000
$128,000
$85,000
$532,000
$1,072,000
$14,000
$1,086,000
$11,000
$1,075,000

Blue Water Equipment, Inc.

Income Statement
For the Year Ended December 31, 2007
Sales Revenue
Cost of Goods Sold
Finished Goods Inventory, Beginning
Cost of Goods Manufactured
Total Goods Available for Sale
Finished Goods Inventory, Ending

$1,675,000
$66,000
$1,075,000
$1,141,000
$43,000

Cost of Goods Sold

Gross Margin
Advertising Expenses
Sales Representatives' Salaries
Supplies--Administrative Office
Depreciation Expense--Admin. Office
Depreciation Expense - Delivery Trucks
Total Selling & Administrative
Net Income

$1,098,000
$577,000
$16,000
$216,000
$42,000
$73,000
$34,000
$381,000
$196,000

3-53 Requirements
Calculate the unknowns indicated by question marks

Solution

3-54 Requirements
Based on Exhibit 3.15, prepare the following: Statement of cost of goods manufactured for
Norton Industries for May 2007 and an Income statement for Norton Industries for May 2007.

Solution
Norton Industries
Statement of Cost of Goods Manufactured
For the Month Ended May 31, 2007
($000) omitted
Direct Materials Used
Direct Materials Inventory, April 30
Direct Materials Purchases
Freight in
Total Direct Materials Available
Direct Materials Inventory, May 31
Direct Materials Used
Direct Labor-Wages
Factory Overhead
Indirect factory labor
Utilities
Property taxes--Plant
Insurance
Depreciation
Total Factory Overhead
Total Manufacturing Cost Incurred During Year
Work-in-Process Inventory, April 30
Total Manufacturing Costs to Account for
Work-in-Process Inventory, May 31
Cost of Goods Manufactured

$28
$510
$15
$553
$23
$530
$260
$90
$108
$60
$12
$50
$320
$1,110
$150
$1,260
$220
$1,040

Norton Industries
Income Statement
For the Month Ended May 31, 2007
($000) omitted
Sales Revenue
Less: Sales Discounts
Net Sales
Cost of Goods Sold:
Finished Goods Inventory, April 30
Cost of Goods Manufactured
Total Goods Available for Sale
Finished Goods Inventory, May 31

$1,488
$20
$1,468

$247
$1,040
$1,287
$175

Cost of Goods Sold

Gross Margin

$1,112
$356

General, Selling, & Administrative Expense:

Office Salaries
$122
Sales Salaries
$42
Insurance
$8
Utilities
$27
Rent
$9
Depreciation
$4
Interest
$6
Total General, Selling, & Administrative Expense

$218

Income from operations

Other revenue
Net Income

$138
$2
$140