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Australian

School of Business
ACCT1501 Accounting and Financial Management 1A
Session 1 2013

TUTORIAL WEEK 12 Solutions to Tutorial Questions


Tutorial Questions
v Problem 16.6 part 1 only (i.e. do not do 2 and 3)
v Case Study: Vincents Cappuccino Express

Problem 16.6

1.
Statement of Cost of Goods Manufactured



Direct materials:


Beginning inventory
$ 4,000
Add: Purchases
8,000
Materials available
$12,000
Less: Ending inventory
2,000

Direct materials used

$10,000
Direct labour

13,000
Manufacturing overhead:


Material handling
$ 2,745

Supplies used
675

Insurance
350

Supervision
1,230

Total overhead costs

5,000
Total Manufacturing Costs

$28,000
Add: Beginning work in process

12,500


$40,500
Less: Ending work in process

14,250
Cost Of Goods Manufactured

$26,250


This has been provided in case a student asks for the solution they were not required to
do it

2.
Cost of Goods Sold Statement



Beginning finished goods inventory

$ 5,685
Add: Cost of goods manufactured

26,250
Goods available for sale

$31,935
Less: Ending finished goods inventory

3,250
Cost of goods sold

$28,685


Vincents Cappuccino Express
Three years ago, Vincent Chow completed his degree in accounting. The economy was in a
depressed state at that time, and Vincent managed to get an offer of only $30,000 per year as a
bookkeeper. In addition to its relatively low pay, this job had limited advancement potential.
Since Vincent was an enterprising and ambitious young man, he declined this offer and started a
business of his own. He was convinced that because of changing lifestyles, a drive-through coffee
establishment would be profitable. He was able to obtain backing from his parents to open such
an establishment close to the industrial park area in town. Vincent named his business The
Cappuccino Express and decided to sell only two types of coffee: cappuccino and decaffeinated.
As Vincent had expected, The Cappuccino Express was very well received. Within three years,
Vincent had added another outlet north of town. He left the day-to-day management of each site
to a manager and focused his own attention on overseeing the entire enterprise. He also hired an
assistant to do the record keeping and selected other chores.
Discussion Questions:

(1)

What factors can be expected to have a major impact on the success of The
Cappuccino Express? Which success factors can be influenced by Vincent
himself and why?

(2)

What major tasks does Vincent have to undertake in managing The Cappuccino
Express? Can he do all tasks by himself?

(3)

What are the major costs of operating The Cappuccino Express? How might
the figures be different from the expenses as reported in the financial
statements?

(4)

Vincent would like to monitor the performance of each site manager.


Profitability is one measure he could use but what might cause a problem here?
Do you think alternative performance measures such as employee turnover,
service and product quality, and customer satisfaction would reflect managers
performance more accurately?

(5)

Looking at the performance measures suggested in (4), which of these should


Vincent select if he could use only one? (think about what information would be
useful)

(6)

Suppose that last year, the original site had yielded total revenues of $146,000,
total costs of $120, 000, hence a profit of $26,000. Also assume that Vincent had
judged this profit level to be satisfactory. For the coming year, Vincent expects
that due to factors like increased name recognition and demographic changes,
the total revenues of this site will increase by 20 percent to $175,200. What
amount of profit should he expect from the site? What actions can a site
manager take to increase his/her site's profitability?

(Source: Chow, C.W. in Issues in Accounting Education, Vol. 10, No. 1, Spring 1995, p. 173-174)
Copyright American Accounting Association Spring 1995

TEACHING NOTES
Increasingly, students in accounting and business courses are expected to actively engage
with the instructor and other students and to integrate new knowledge with old. The objective
of this teaching case is to assist instructors of management accounting to promote such
interactive and integrative learning and to increase students' mastery of basic cost terms and
concepts.
This case reduces psychological and technical barriers to student participation by (1) using a
small business with which students are likely to be familiar, and by (2) keeping technical
details to a minimum. The case is simple enough so that you may explain it verbally in the
tutorial again in case students have not read it before hand.
As the students discuss the case questions, you can write their points on the board.
The first question is aimed at getting the students to view the situation from a manager's (as
opposed to accountant's) perspective:
1) What factors can be expected to have a major impact on the success of The Cappuccino
Express? Which success factors can be influenced by Vincent himself and why?
The aim of this question is to get students differentiate between costs that are controllable and
other costs that are non-controllable.
Students typically have no difficulty coming up with a rather long list of such factors,
including location, the price that The Cappuccino Express charges per cup, the cost of coffee
beans, the extent of competition (e.g., other coffee outlets in the vicinity), lease/rental cost,
the cost of equipment, the serving capacity (e.g., ups per hour) of the establishment, and
wage costs. As each new factor is suggested, I ask the students to explain how they think it
would affect the success of The Cappuccino Express. Students will explain, for example, that
location affects the number of potential customers and the ease with which they can make
their purchases.
I usually close this part of the discussion after putting up six to eight of the students'
suggested factors. I summarize the discussion by noting that some of these factors, such as
location and pricing, are within Vincent's control. Others, such as the extent of competition
and the cost of coffee beans, are substantially non-controllable by him. Thus, Vincent needs
both to monitor the external environment for impending threats and opportunities and to align
the factors within his control to respond to these factors.

2) What major tasks does Vincent have to undertake in managing The Cappuccino
Express? Can he do all tasks by himself?
This question starts to focus attention on the factors within the firm manager's control. While
the prior question covered both controllable and non-controllable costs, this question only
looks at the controllable costs. The following items are among the most often suggested:
a) Evaluating whether he should stay in business (that is, whether the business is sufficiently
profitable)
b) Evaluating each site to make sure that it continues to be profitable
c) Evaluating new sites or expansions to current sites
d) Evaluating changes in product offerings
e) Pricing
f) Deciding on the amount and types of promotions
g) Ensuring employee efficiency
h) Maintaining service and product quality
Now refer to the second question "If you were Vincent, would you make all of these
decisions yourself, or would you delegate some of them to the site managers?" Invariably, the
students choose to delegate some decisions to each site manager, such as supervising
employees and maintaining service and product quality.
Now refer to the fact that Vincents further very important tasks are the monitoring and
motivating of each site manager.
The next question follows logically from the preceding discussion:
3) Keeping in mind the major decisions required to run The Cappuccino Express, what
are the major operations costs that need to be incurred? How might the figures be
different from the expenses as reported in the financial statements?
The students' responses will vary across class sections, as will the way that they label some
cost items. Nevertheless, the suggested list generally includes the following items:
a) Vincent's assistant's salary
b) Rent a teach site
c) Business license for each site
d) Insurance for each site
e) Employee wages at each site

f) Promotion/advertising
g) Equipment cost at each site
h) Utilities at each site
i) Cost of coffee beans
j) Cost of supplies
Sometimes the students correctly include Vincent's forgone salary as a cost of The
Cappuccino Express. If they do not, then I prompt them in this direction by asking: "If
Vincent were to seek employment with another company, what level of compensation might
he command given his experience and track record?" After the students have suggested a
dollar figure, I ask whether this amount is a cost of operating The Cappuccino Express. This
discussion helps the students to appreciate the nature and relevance of opportunity costs.
I further ask: "Do you think that running one's own business is the same as working for
someone else?" The students usually suggest differences such as the greater satisfaction from
being one's own boss, the less intrusive nature (upon one's personal life) of working as
somebody else's employee, and the potential financial risks and gains of being in business for
oneself.
This discussion helps the students to understand that there are monetary costs which typically
are excluded from (financial) accounting records, but which nevertheless are relevant to
management decision-making (e.g., Vincent's forgone salary). Further, there are nonrecorded,
nonmonetary costs and benefits (e.g., the psychological costs and benefits from running one's
own business), which also are relevant.
Letting the students develop these points helps them appreciate the need for managerial
information systems which go beyond simply following a set of rules developed for a
different purpose (e.g., generally accepted accounting principles for external reporting).
The next question moves the discussion to yet another level of detail:
4) Vincent would like to monitor the performance of each site manager. Profitability is
one measure he could use but what might cause a problem here? Do you think
alternative performance measures such as employee turnover, service and product
quality, and customer satisfaction would reflect managers performance more
accurately?
Regarding profitability as a measure you need to discuss the need to differentiate between the
performance of the site and that of its manager. Problems might be that each site's
profitability is likely to be affected by factors that are within the manager's control (e.g.,

speed of service) but it also is a function of factors not controllable by him or her (e.g.,
location). Profitability can be a biased measure for performance
For the alternative performance measures, ask the students why it is relevant, and how they
propose to measure it. The students often explain, for example, that high turnover among the
hourly employees may imply higher hiring costs and worse service due to disgruntled or
inexperienced employees, and that lower customer satisfaction will likely lead to lower future
sales. Related to measuring customer satisfaction, their suggestions may range from
conducting surveys to giving out discount coupons for repeat purchases and then counting the
number of such coupons redeemed.
Two points emerge from this discussion. The first is that accounting numbers often lag other
measures in reflecting some aspects of operating conditions. Thus, while customer
dissatisfaction and high employee turnover ultimately will reduce profits, the periodic profit
measures may not reveal this downward trend until it is too late for corrective action. The
second point is that accounting data capture only a subset of the information needed for
effective management. It is important to collect and consider nonfinancial data, some of
which are not easily quantified (e.g., customers' written feedback on comment forms).

(5)

Looking at the performance measures suggested in (4), which of these should Vincent
select if he could use only one? (think about what information would be useful)

Without fail, the students select profitability. At this point, I put up the simple profit formula:
Profit = Total revenues minus total costs
and ask whether it would be difficult to determine the total revenues from each site. The
answer is obviously "no" since the two sites are operated independently. Thus, the focus
quickly shifts to determining each site's costs. Returning to the list of costs already on the
board, I ask the students to identify those costs that can be readily traced to each site. The
students will agree that many items, such as rent, utilities, coffee bean costs and employee
salaries are easily traced. They also will recognize some items as being indirect costs of each
site. For example, since Vincent is overseeing the entire business, how should his opportunity
cost be attributed to each site? What about his assistant's salary? Discussing these general
administrative costs helps to bring out the ideas of direct and indirect costs.

After briefly discussing how general administrative costs might be allocated to each site, I
ask the class to assume that such costs are relatively small for The Cappuccino Express;
therefore, Vincent has decided to only consider each site's total revenues and direct costs. I
also tell the students that since The Cappuccino Express advertises only in each site's
neighborhood newspaper, advertising expenses are substantially traceable to each site.
Then I ask how the typical accounting system would treat each site's advertising expenses.
The students will readily respond that advertising would be treated as a period expense. I then
ask whether the effects of advertising in a given period (a month or a year) totally dissipate
when the period ends. Invariably, the students agree that while the effects of advertising do
decay over time, this process may occur over a number of periods.
Since this discussion supports capitalizing a portion of each period's advertising expenses as
an asset, it is useful to briefly consider how Vincent might decide on the expense and asset
components. I generally conclude this discussion by noting that the choice is between being
precisely wrong (i.e., expensing the entire advertising expenditures) and being only
approximately right.
The treatment of advertising expenses also can be used to introduce another important role of
accounting data. I ask the students: "Suppose that you were manager of the original site and
that your site's advertising expenditures are treated as a period expense. It is getting close to
the end of the year and you believe that at the current rate, your site's profit will fail to meet
Vincent's expectations. What are you likely to do regarding advertising?" Reducing
advertising is invariably suggested, thus providing a powerful reminder that accounting data
can significantly affect managerial incentives via its role in performance evaluation.
Finally, I wrap up the discussion with this question:
6) Suppose that last year, the original site had yielded total revenues of $146,000, total
costs of $120, 000, hence a profit of $26,000. Also assume that Vincent had judged this
profit level to be satisfactory. For the coming year, Vincent expects that due to factors
like increased name recognition and demographic changes, the total revenues of this
site will increase by 20 percent to $175,200. What amount of profit should he expect
from the site? What actions can a site manager take to increase his/her site's
profitability?
First question: What amount of profit should he expect from the site?

If time is a concern, I focus this question by asking whether $31,200 (17.8% of total revenues,
the same proportion as the past year) would be an appropriate figure. If the students respond
"no," then I ask them to explain why. If they respond "yes," I pick a fixed cost from the list
(e.g., rent), and ask them whether this cost, along with all of the other direct costs for the site,
would increase by 20 percent also. The students quickly realize from this question the need to
reconsider their answer.
Since the correct answer is likely to be "no," I ask the students to help me construct costvolume graphs for several costs. I often use rent to illustrate fixed costs and the cost of coffee
beans to illustrate variable costs. I also plot the salary cost of employees to illustrate step
costs and the relevant range. With the graphs on the board, I ask whether fixed costs are
beyond the manager's control. Students typically respond that such costs can be changed
given a long enough time horizon (e.g., rent can be changed by relocating and/or
renegotiating the lease).
This discussion helps the students to appreciate that variable and fixed costs do not
necessarily translate into controllable vs. non-controllable costs. Fixed costs are fixed only
with respect to some variable (in this case sales volume), but may vary with respect to some
other variables (e.g., whether or not to relocate).
Second question: What actions can a site manager take to increase his/her site's
profitability?
The suggestions typically include special promotions, improving service, and increased
advertising. After writing a number of suggestions on the board, I note that many involve the
incurrence of cost to increase sales. For example, increasing service speed by adding
employees may attract more customers. To evaluate these alternatives' effects on revenues
and costs, the site manager needs to determine the profit contribution, hence unit costs, of
each product. Thus, it is natural to ask how The Cappuccino Express can determine the per
cup cost of each type of coffee which it sells.
Since the class had already agreed on the direct costs of each site, the discussion can
immediately focus on attributing these costs to each type of coffee, and in turn to each cup of
each type. Asking how several of the direct costs should be handled can further strengthen
students' grasp of the concepts of direct and indirect costs. For example, the students will see
that rental cost and employees' wages are direct to the site but indirect to each type of coffee.
In contrast, the cost of coffee beans can be unambiguously traced to each site, each type of
coffee, and each cup.

If time permits, the treatment of fixed overhead costs, such as rent, can be used to motivate a
discussion of variable costing vs. full absorption costing. At this early point in the course I
only briefly cover the concepts of contribution margin, gross margin, and product vs. period
costs. Here again, the emphasis is on distinguishing between rule-based financial reporting
and reporting for internal management purposes.

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