Week

Key Concepts

Distinguish between financial and managerial accounting.

Define cost terms used in planning, control, and decision making.

Distinguish between manufacturing and nonmanufacturing costs and between product and
period costs.

Describe the flow of product costs in a manufacturing firm's accounts.

Explain the relationship between the cost of jobs and the Work in Process Inventory,
Finished Goods Inventory, and Cost of Goods Sold accounts.

American Insurance Group (AIG) Scandal of 2005 was a multinational insurance

corporation that committed massive insurance fraud in the amount of (allegedly)
$3.9 billion dollars, as well as participating in bid-rigging and stock price
manipulation. It has been alleged that CEO Hank Greenberg booked loans as
revenue, and lead clients to insurers that AIG had pay off agreements with, and had
traders to inflate the stock prices. Greenberg was fired and I don't believe he faced
any criminal charges. AIG settled with the Stock Exchange Commission (SEC) for
$10 million in 2003, $1.64 million in 2006.

Our company promotes an ethical environment by having employee's reading and

signing our companies Standards of Excellence and certificate of compliance. The
Standards of Excellence is details of what's expected of your as an employee and
the certificate of compliance is stating is a disclosure describing an entities in which
employee or member of their household has a significant financial interest/position
with competitor or that person maybe in a position that would have conflict when
doing business with our company.

I found a really interesting website of the worlds top ten most unethical companies
in the world. Some I have heard of some I haven't. I am truly surprised at some of
them. Here they are:
1. Monsanto Co. - an agricultural company, mostly know for the herbicide Roundup
2. Halliburton - an oilfield services corporation

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3. Chevron - an oil and gas company
4. Freeport-McMoran - a copper and gold company
5. Phillip Morris - cigarette manufacturer
6. Occidental Petroleum - an oil and gas corporation
7. Ryanair - an Irish airline
8. Syngenta - a Swiss agricultural and chemical company
9. Grupo Mexico - the Mexican mining enterprise
10. Total - a French oil and gas corporation
Isn't it a little bizarre that most of the unethical companies in the world are oil and
gas and large mining companies? I find that very interesting.
http://www.actionforourplanet.com/#/top-10-unethical-companies/4545796858
As most of you wrote:
Class:
The following is from your lecture:
Costs can be classified in regard to how they respond to changes in the activity level. Total variable costs
change in proportion to changes in the activity level. If production decreases 20%, variable costs will also
decrease 20%. However, the unit variable cost remains the same regardless of the production level. For
example, if it costs $5 to produce one unit of Product X, total variable costs are $10,000 if 2,000 units are
produced. If production decreases to 1,000 units, total variable costs decrease to $5,000. Notice that
while the total variable costs decreased in proportion to the decrease in production, unit variable costs
remained the same at $5 per unit.
Total fixed costs are not affected by a change in the activity level. However, the unit fixed cost varies
inversely with changes in the activity level. As production decreases, unit fixed costs increase because
there are fewer units to absorb the cost. For example, assume the rent on a production facility is $5,000
per month. The total cost for rent will be $5,000, regardless of whether the company produces 2,000 or
1,000 units. However, the unit fixed cost is $2.50 if 2,000 units are produced and $5.00 if 1,000 units are
produced. As you can see, the unit fixed cost increases as production decreases.
Question:
If the 1000 units costs our company $11,000 made of $8 per unit plus fixed cost of $3000 what
would 2000 units cost? SHOW ALL WORK.

RE: #2 Cost Behaviors

Variable: 2,000 units * $8/unit = $16,000
$16,000 + $3,000 fixed cost = $19,000 Total Cost

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Class: #3
Which of the following are considered "Direct Product Cost"? WHY?
1) Shipping
2) Wages of assembly workers
3) salary of office accountant
4) Advertising
5) factory insurance
6) Material to make the product
7) Automobiles for the salesmen
8) Tickets to Cubs games for clients
Solution to Problem #3
Firstly, Insurance on the FACTORY is part of INDIRECT Manufacturing cost. So it does not qualify as
DIRECT.
Therefore, only 2 and 6 are DIRECT manufacturing cost.
Post YOUR work even though I may have posted a solution.
Shipping could depend on who pays for the shipping.
Of course, Insurance is a fixed cost and shipping is a variable cost.

CLASS: PROBLEM #4

This problem emphasizes how variable and fixed costs work. EVERYONE should work
on this even if others have completed it. Share your work with the class-- even if
you are not sure.

Week
1) Sarah's Toys projects Material costs of $375,000 and labor costs of $125,000 in a
period when 25,000 toys are produced.

a) What is the variable cost per unit? b) If production is expected to drop to 20,000
toys in the next period, what is the expected labor cost in the next period? Why?

2) If Sarah's Toys also had rent expense of $30,000 a) What is the fixed cost per
unit? b) What would be the rent expense when the units drop to 20,000? c) What is
the fixed cost per unit at 20,000 units? Why?

3) What is the combined variable plus fixed cost PER UNIT at a)25,000 units? b) At
20,000 units? c) Why did it change? d) By what amount did it change? Why?

(Note that this is not a quiz. I am hoping we all can SHARE and SHOW our work on
this important problem. Comment on other students work.

Class: Problem #4 SOLUTION.

Don't review until you have worked on the problem. Many of you have done a great (and correct) job!

SHARE your work EVEN THOUGH I have posted the solution.

The answers to the problems are as follows:
1). A variable cost is (375,000 +125,000=500,000) (500,000/25000=$20.00) The variable cost per unit is $20.00
B. There was a decrease of 5000 units.(5,000/25000=.20)
So there was a percentage decrease of 20%. (125,000*.20=25,000) (125,000-25000=100,000)
The expected labor cost in the next period dropped to $100,000 because
not as many hours of labor needed to produce less product.
2).a (30,000/25,000=1.20 per unit) the fixed cost per unit would be 1.20 per unit.
B. rent expense still would be 30,000 because it is a fixed cost.
C. (30,000/20,000=1.50) the fixed unit cost would be $1.50 because rent is a constant
and divided by the units produced.
3). ...............25,000........................ 20,000
.Per unit ..............Per Unit
materials cost ..... 375,000 15.00 ... 300,000 15.00
Labor cost..........125,000 5.00....... 100,000 5.00
rent cost......... $30,000 1.20........$30,000 1.50

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Variable plus fixed cost per unit at 25,000 units is $21.20.

Variable plus fixed cost per unit at 20,000 units is $21.50.
The variable cost per unit stayed the same because variables dropped all around by 20 percent,
however the rent stayed the same which increased the cost per unit
because the company has to pay the same rent for less units.
Please comment on parts that you do not understand or parts that you now understand.

Basic concepts
1)Variable expenses
Example: Material is always exactly the same per unit but always increases as you produce more.
Never changes per unit for that problem.
2)Fixed expenses do not change in TOTAL.
Rent is always the same for that company. Always stay the same for that problem.
3) Managerial Acctg is directed at INTERNAL; Financial Acctng is directed to outsiders.
4) Managerial Acctng does not have GAAP.
5)Managerial is often non-monetary and places an emphasis on the future not the past.
Insurance on Manufacturing Plant (to manufacturer) is an
INDIRECT Manufacturing cost; Insurance on office is an Indirect Administrative cost.
Fixed cost but thats not the issue here. It is an INDIRECT cost meaning it is not a
DIRECT manufacturing cost.
Materials and Direct Labor are DIRECT Manufacturing costs.
Any questions on this?
Class, One of the main points of this week is that total fixed costs are not affected by a change in the activity level.
However, the unit fixed cost varies inversely with changes in the activity level.
As production decreases, unit fixed costs increase because there are fewer units to absorb the cost.
For example, assume the rent on a production facility is $5,000 per month.
The total cost for rent will be $5,000, regardless of whether the company produces 2,000 or 1,000 units.
However, the unit fixed cost is $2.50 if 2,000 units are produced and $5.00 if 1,000 units are produced.
As you can see, the unit fixed cost increases as production decreases.

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TCO2
Given a job costing accounting system, prepare the entries, tracking the cost flow from material
purchases to cost of goods sold; close out of over- or under-applied overhead, and explain the
importance of the applied overhead rate

Key Concepts

Discuss the three inventory accounts of a manufacturing firm.

Discuss the types of product costing systems.

Describe how direct material, direct labor, and manufacturing overhead are assigned to jobs.

Explain the role of a predetermined overhead rate in applying overhead to jobs.

Explain why the difference between actual overhead and overhead allocated to jobs using a
predetermined rate is closed to Cost of Goods Sold or is apportioned among Work In
Process Inventory, Finished Goods Inventory, and Cost of Goods Sold.

TCO3
Given a process costing environment, determine the value of goods transferred out of the
department using equivalent units of production, and prepare the entries to assign costs to the next
production department and to ending inventory.

Key Concepts

Describe how products flow through departments and how costs flow through accounts.

Discuss the concept of an equivalent unit.

Calculate the cost per equivalent unit.

Calculate the cost of goods completed and the ending work in process balance in a
processing department.

Describe a production cost report.

Week

CLASS: Problem #1 for EVERYONE to try to work On:

Kit Company uses a predetermined overhead rate of $8.00 per machine hour. 60,000 machine hours
were worked this year and actual overhead costs of $465,000 were incurred.
What was the amount of under-applied or over-applied overhead?
Indicate if it is over-applied or under applied.
Share your work.
Class: Solution to Problem #1:
Everyone should work on this and share their answer even though I posted the solution.
The correct answer is $15,000 over applied.
As you wrote they applied 480,000 but only spent 465,000. Therefore they need to reduce the
COGS since they expensed $480,000.
If it helps, you might want to prepare T accounts. However, it is not necessary.
Note that: The $480,000 went into the COGS as an expense even though they only actually spent
$465,000. Therefore the Cost of Goods Sold needs to be reduced by $15,000, so it will be
credited for the $15,000.

Class: Problem #2
Note that this problem looks very confusing because it has a great deal of extraneous information. It
is actually not difficult if you eliminate extraneous material.
It is very important to see that all that is being asked for is the application rate. Focus on that and
ignore all the information that has nothing to do with the application rate.
Devonshire Corp. uses a budgeted factory overhead rate to apply overhead to production. The
following data is available as of the year ended 12/31/13:
Budgeted Factory Overhead $888,800
Actual Factory Overhead $765,000
Budgeted Direct Labor Cost $444,400
Actual Direct Labor Cost $550,000
Certain end of year balances are as follows:
Raw Material Inventory $333,000
Work in Process Inventory $642,000
Finished Goods Inventory $911,000
Cost of Goods Sold $677,000
If the company uses direct labor cost to allocate overhead, compute the application rate.
Note that it is based on COST not hours.
Please SHARE your work with the class.

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Solution to #2: CLASS,
The problem only asked for the application rate. The estimated overhead is $888,800 and the
allocation base is $444,400- therefore most of you were correct that the application rate is $2 PER
DOLLAR of LABOR COST. For every dollar of Labor cost we will add (apply) $2 of overhead cost.
Some problems use hours as a base and some problems use dollars as a base. You need to clearly
see what the base is.
If anyone does not follow please post.

Class: Problem #3 (a bit easier than #2)

Happy Co estimates that its employees will work 500,000 direct labor hours during
the coming year. Total overhead costs are estimated to be $9,600,000 and direct
labor costs are estimated to be $12,500,000. If Happy Co. allocates overhead based
on direct labor COST (per dollar, NOT per hour), what is the predetermined
overhead rate?
Try to do this problem even if others have answered or even if I answered the
problem.

The formula of predetermined overhead rate is written above and so yes I would like to agree
with Christopher as It relates to the equation calculated. Also, I realized the formula of
predetermined overhead rate is entirely based on estimates. The overhead applied to products
or job orders would, therefore, be different from the actual overhead incurred by jobs or
products. This difference is eliminated at the end of the period. The elimination of difference
between applied overhead and actual overhead is known as disposition of over or under applied
overhead.
Solution to Problem #3:CLASS: Many of you eventually were able to get this right. Very nice work.
The problem says that the cost is based on Labor COST not Labor hours so the rate is
9,600,000/12,500,000=.768 per dollar of labor Cost. (.77 is fine) The key is understanding that the
rate is not per hour but rather per dollar.
My suggestion would be to remember that the allocation base can be different things depending on
the particular organization and what they want to know. Since in this problem it was specified the
labor cost was the allocation base, we should use the labor cost. Other problems may specify per
hour.
Class: Problem #4
(I will post the answer Friday so you can see it. HOWEVER: Try to post your solution. The best way

Week
to learn the week 2 material is to work on problems. You do not have to do all the problems but try
to understand all the problems. Future weeks will not have as many problems):
Green Co. incurred costs of $900,000 for direct materials (raw)purchased. Direct labor was $10,000
and factory overhead was $10,000 for March.
Inventories were as follows:
raw materials beginning $1,000;raw materials ending $2,000
work in process beginning $190,000;work in process end $170,000
finished goods beginning $10,000;finished goods ending $10,500
What is the cost of goods manufactured?
This problem is a bit more difficult than it appears as the student needs to calculate many different
items and complete a Cost of Goods Manufactured Statement. It is not enough to just calculate the
last step.
SHARE your work so all can see.

A little help on Problem #4 We start with the Raw materials used. Beginning was
1,000, plus 900,000 minus 2000; therefore the materials used were 899,000.
Class: SOLUTION to Problem#4:
(Please post your solution for all to share before you review this solution. That is the best way for all
of us to learn this material.)
We start with the Raw materials used. Beginning was 1,000, plus 900,000 minus 2000; therefore the
materials used were 899,000.
Then what about the Work in Process? The beginning $190,000 plus the 899,000 , plus the Labor
$10,000 plus the Overhead $10,000, MINUS THE END $170,000 = CURRENT MANUFACTURING
COSTS of $939,000.
Therefore the Cost of Goods Manufactured= $939,000.
The problem asks for the cost of goods manufactured. We have the answer.
(Then we add COG Manufactured plus the beginning Finished goods of $10,000 minus the ending
finished goods of $10,500; we get $938,500 and that is the Cost of Goods Sold. This was not
required as part of the problem but hopefully it will help you see the entire flow of the goods. It may
be helpful to put this into a few T accounts.)
Please review
Class: Problem #5

Week
At December 31, 2013, TE Inc. has a balance in the Work in Process Inventory account of
$60,000. At January 1, 2013, the balance was $46,000. Current manufacturing costs for the
year are $300,000. How much is cost of goods manufactured?
Beginning Work in Process: $46,000
Ending Work in process: $60,000
Current Manufacturing Costs: $300,000
$46,000 + $300,000 - $60,000 = 286,000 (Cost of goods Manufactured)

You all got the right answer!!

To get the Cost of Goods Manufactured you take
Beginning $46,000 +
Current Manufacturing $300,000 Ending $60,000. So Cost of Goods Manufactured = $286,000

Class,
One of the main points of this week is that: Once a relevant allocation base has been selected, we
calculate the overhead allocation rate. This predetermined rate is based on estimates of both the
manufacturing overhead and the quantity of the allocation base for the coming period.
Predetermined Overhead Rate = Estimated Manufacturing Overhead Costs Estimated
Allocation Base
We use estimated data to calculate the predetermined overhead rate for several reasons. First,
actual costs and activity are unknown until the end of the period. Because the price charged for a job
often depends on the cost, we cannot wait until the end of the period to allocate overhead. Estimates
are also used so that the allocation rate remains the same from one month to another. Seasonal
fluctuations, such as increased utilities in summer months, would cause the costs of identical jobs to
differ if the rate were calculated every month.
Now that we have selected an allocation base and calculated the predetermined overhead rate, we
can apply manufacturing overhead to jobs by multiplying this rate by the actual amount of the
allocation base used by the job.
Can you share other important items we learned this week?
The difference between cost of manufacture and total item cost. The cost of manufactured items
does not take into account the starting and ending manufactured goods. cost of goods on hand
would be the goods manufactured that period plus the goods that were in process at the end of last
period minus the goods in process at the end of the current period. This is a good point. The
beginning and ending are necessary to find out how much was used.
TCO 4
Given a firm's cost-volume-profit structure, determine the break-even point in terms of the units and
revenue dollars to achieve a targeted pre-tax and after-tax profit goal, and analyze the impact on risk
and reward factors resulting from changes in the cost structure, sales price, and volume.
Key Concepts

Identify common cost behavior patterns.

Week

Estimate the relationship between cost and activity using account analysis and the high-low
method.

Perform cost-volume-profit analysis for single products.

Perform cost-volume-profit analysis for multiple products.

Discuss the effect of operating leverage.

Use the contribution margin per unit of the constraint to analyze situations involving a
resource constraint.

TCO5
Given a firm's breakdown of product and period costs, compare and contrast the absorption costing
method and the variable costing method, detailing differences related to planning, production
strategy decisions, and performance evaluation.
Key Concepts

Explain the difference between full (absorption) and variable costing.

Prepare an income statement using variable costing.

Discuss the effect of production on full and variable costing income.

Explain the impact of JIT (just-in-time) on the difference between full and variable costing
income.

Discuss the benefits of variable costing for internal reporting purposes.

CLASS:
Since the break-even point represents the point at which the company makes zero profit, why would
a company have any interest in it? How could managers use the break-even point when introducing
a new product?
The break-even point is where the cost of doing business and the income from the business is at the
"0" point. The business neither makes a profit or a loss.
The break-even point is the point where the revenue generated from the sale of product is equal to
the costs of production and materials. There is no profit or loss. A company would have interest in
the break-even point to ensure the product is generating enough sales to generate a profit. If the
sales are sluggish then the company may need to do additional marketing or discontinue the
production of the product if it not selling. A manager would be interested in the break-even point for
the product to ensure sales are high enough to generate a profit and the manager would be in

Week
charge of production so they need to be aware of the break-even point and number of units sold to
make sure they are accounting for unusable or damaged units which will impact the break-even
point.
CLASS: Problem#2: This problem uses the ideas we have learned in week 1 and now week 3.
You just started to work for a new company that sells tee shirts that reads " I Passed Accounting".
Selling price is $10 per shirt; variable cost is $4 per shirt and fixed costs are $36,000. Compute the
number of tee shirts to A) break-even; and the number B) to earn a profit of $24,000.
(HELP: I hope you can see that every shirt needs exactly $4 of materials and labor and other variable expenses. That
won't change per unit but will increase in total as we make more shirts. Our fixed cost of rent and other fixed costs
won't change in total but will change per unit as we make more units. The rent and insurance and other Fixed
expenses will stay at exactly $36,000 in this problem.)

Profit=SP(x)VC(x)TFC
SP = $10, VC = $4, TFC = 36,000
Break Even Point = 6,000 Units
0 = 10(x) - 4(x) - 36,000
0 = 6(x) - 36,000
X = 6000
Profit of $24,000 = 10,000 Units
24,000 = 10(x) - 4(x) - 36,000
24,000 = 6(x) 36,000
60,000 = 6(x)
10,000 = X

Class: Solution to #2
(most of you were able to figure this out. Review only after you have tried it. Post
your work even though an answer is already posted.)
Profit = SP(x) - VC(x) - TFC
a) break-even: (point where the profit is zero)
0= 10(x)-4(x)-36,000---> 0=10x-4x-36,000 ---> 0=6x-36,000
6x= 36,000 ---> x=6,000
6,000 T-Shirts made and sold.
B) To earn a profit of $24,000:
24,000 = 10(x)-4(x) - 36,000 ---> 24,000 = 6(x)-36,000 ---> 24,000+36,000 = 6x
---> x=10,000
the company would have to sell 10,000 T-Shirts to earn a profit of $24,000

Week

Problem #3assume we are manufacturing a product.

Assume the sales price per unit is $60 and the variable cost is $20 per unit and the fixed cost is
$80,000; a) how many units would we need to sell to breakeven? b) How many units would we need
to sell to earn a profit of $120,000? c) How many units do we need to sell to double that profit to
$240,000? d) Why didn't the number of units double from Part B to Part C? What do we (the
manufacturing company) learn about our costs from this?

Class: Solution to Problem # 3: (Please post your solution before reviewing even
though I posted my solution. Share your work). This is what I would put on a
blackboard--Step by step.
Profit = SP(x) - VC(x) - TFC
where "x" = Quantity of units produced and sold
SP = Selling price per unit
VC = Variable cost per unit
TFC = Total fixed cost
A: Compute the # of sales needed to break even
Here we set profit = to zero, because the break-even point is where no loss is
incurred and no profit is earned.
$0.00 = $60(x) - $20(x) - $80,000.00
$0.00 = $40(x) - $80,000.00
+ $80,000.00 + $80,000.00
---------------- ---------------$80,000.00 = $40(x)
__________ _________ <---Divide both sides by the $40.00
$40.00..............$40.00
Selling 2,000 UNITS will allow this company to break-even
B) Compute the number of UNITS to sell to earn a profit of $120,000.00
Here we set profit = $120,000.00

Week
$120,000.00 = $60.00(x) - $20.00(x) - $80,000.00
$120,000.00 = $40.00(x) - $80,000.00
+ $80,000.00 + $80,000.00
-------------- ---------------$80,000.00 = $40.00(x)
__________ _________ <---Divide both sides by the $40.00
$40.00..............$40.00
Selling 5,000 UNITS will cause this company to turn a profit of $120,000
C) Compute the number of UNITS to double profit of $120,000.00 to $240,000.
Here we set profit = $240,000.00
$240,000.00 = $60.00(x) - $20.00(x) - $80,000.00
$240,000.00 = $40.00(x) - $80,000.00
+ $80,000.00 + $80,000.00
-------------- ---------------$320,000.00 = $40.00(x)
__________ _________ <---Divide both sides by the $40.00
$40.00..............$40.00
Selling 8,000 UNITS will cause this company to double profit from $120,000 to
$240,000.
D) It makes sense that if the fixed costs stays the same, we no longer worry about
covering the Fixed Costs. We do not have to increase our fixed costs. They have
already been covered.
Class: Problem #4
(This is an important problem. Everyone should try it and share your answer with the class)
You are provided with production activity information for Bistro, Inc. Calculate the companys breakeven point in Revenues. (Help: The problem asks for the answer in Revenue and NOT in Units.
Therefore we need to calculate the Contribution Margin Ratio first)
Vanguard, Inc., July Production Activity
Direct materials .................$ 11.00 per unit
Direct labor....................... $ 8.00 per unit
Variable overhead.............. $ 10.00 per unit
Variable selling ..................$ 1.00 per unit
ixed overhead........... $ 5.00 per unit
(HELP: This can be misleading as fixed overhead is not really per unit. This number is based
only on the actual units produced which is given below at 20,000. Therefore it must really be
that the fixed overhead was $100,000 and when we spread the amount to the 20,000 units we

Week
happened to wind up at $5)
Fixed general and administrative $ 7.00 per unit (same as above-the amount was really $140,000;
when spread out it came to $7)
Units produced 20,000 per month
Units in beginning finished goods 0
Units sold 20,000
Selling price $ 75.00 per unit

Class: Solution to #4
As many of you wrote, the answer to part A is $400,000.
(Break Even Point = Total Fixed + Target Profit/ Contribution Margin Ratio. Contribution Margin Ratio
= Contribution Margin / Revenue.
Total Fixed: $5 (20,000) + $7 (20000) = $240,000
Contribution Margin Ratio: $75 - 11-8-10-1 / 75 = .6
BEP = $240,000 + 0 / .6.
Break Even Point = $400,000 in sales).
At that level the company will breakeven since we divided the Fixed expenses by the Contribution
Margin ratio of 60%. (240,000/.6= $400,000).
But-- how do I know it is correct? I will test it. If the company's sales are $400,000 then the variable
expenses will be 40% of that amount or $160,000; since the Fixed will be $240,000 they will
combine to be total expenses of $400,000 when the sales are $400,000. Therefore at that point the
sales and the expenses will be the same and it will be the breakeven point. I hope this makes sense.

Post questions if this is unclear

Class: HELP on Problem #4

(Only refer to this if you are confused)

Week
First: We add up the variable expenses and we get $30.
If we divide the variable expenses by the sales price of $75 we get 40%. One of the keys to
your understanding this problem is that the variable expenses will ALWAYS (in this problem)
remain exactly 40% of the sales price.
We now need to know what the Fixed expenses are. The fixed expenses are NOT $5 and $7
per unit all the time. Therefore we need to know what the Fixed costs would be IN TOTAL.
$12x 20,000 units means that the Fixed will ALWAYS (in this problem) be exactly $240,000.
Therefore what sales DOLLAR amount will generate breakeven based on understanding the
40% relationship and the FIXED total of $240,000?

One of the main points of this week is that: total variable costs change in proportion to changes
in volume. If production increases 20%, total variable costs also increase 20%. For example, if it
costs $5 of variable costs to produce one unit and 1,000 units are produced; total variable costs
are $5,000 ($5 x 1,000 units). If production increases by 20% to 1,200 units, total variable costs
increase to $6,000 ($5 x 1,200 units). Notice that while the total variable cost increased in
proportion to the increase in the number of units produced, the cost per unit remained the same
($5).
Can you think of other important items?

Class Problem #1: When would a company choose to use a full costing income statement and when
would it use a variable costing income statement? What are the ramifications of each?
Why doesn't GAAP allow variable costing financial statements for external use?
The difference between full-costing and variable-costing income statements had to do with way that
each deals with fixed manufacturing overhead costs. Each has its own benefits and drawbacks, but
company must decide which method provides the best information for internal decision-makers and
what they are trying to accomplish by using variable costing methods. ( I believe that, publicly
traded companies are required to include the full-costing format by the Financial Accounting
Standards Board -FASB). Also, variable costing is not accepted by GAAP because it reports a lower
taxable figure as inventory increases.

CLASS: Problem #2 emphasizing the difference between full costing and variable costing:

Week
A company has fixed manufacturing costs of $2,000,000 and produces 600,000 units and sells
500,000 units. There is no beginning inventory. (Of course the ending inventory is the difference of
600,000-500,000 or 100,000 units.)
SOLUTION to #2
Only check after you have posted your solution.
What differences, using numbers, not concepts, would we see in the variable and full costing
statements? WHY?(Be sure to review the concepts in the chapter.)

CLASS, We would see a difference of $3.333 per unit ($2,000,000 divided by the
600,000 units) times the 100,000 units which were not sold as of the end of the
year; or $333,333.
I know this is not easy.

Under variable costing only variable costs are included in unit product cost. All fixed
manufacturing costs are treated as period costs and are expensed in this period.
Under absorption costing both variable and fixed manufacturing costs are included
in unit product cost therefore if an item was not sold it would include both of the
costs. Therefore if we ask "Which way would it go" (which statement would have a
higher net income?) it is clear that the absorption will have a higher net income
because the items not sold will have a higher cost in the ending inventory because
it would include more of these costs. The variable method will have expensed these
costs. I hope this is clear. Review the material.

Class: Problem #3
a) Re-do this Income Statement (SHOW ALL YOUR WORK) to calculate the Contribution Margin:
Revenue $ 9,600,000
Costs:
Production workers wages $ 400,000
Factory Depreciation and Maintenance $ 700,000
Metal, rubber, etc. $ 2,000,000
Electricity, water for factory (flat-rate for month) $ 800,000
Equipment Depreciation and Fixed Maintenance $ 400,000
Net Income $ 5,300,000
B) What is the Contribution Margin RATIO?
C) If the sales go up 20% what would be the new Net Income?
(HELP: Be careful here and think through what EXPENSE goes up and what does not go up. Fixed do not go up and
variable go up.)

SHARE YOUR WORK Class: Solution to Problem #3

Part A) Revenue............................................................$9,600,000

Week
Less Variable Costs (These stay the same % of the income):
Metal, Rubber, etc..............2,000,000
Production Workers Wages.....400,000
Total variable expenses...........................................2,400,000
Contribution Margin(Sales-Variable) ..................................................7,200,000
Less Fixed Costs:
Equip.Deprec. &Fixed Main...400,000
Electric,Water for Factory...800,000
Factory Deprec. and Main...700,000
Total FIXED expenses...........................................1,900,000
Net Income.........................................................5,300,000

Part B) Simply divide

7,200,000/9,600,000=.75 or 75%
Problem #2 (C) Solution.
If sales increase by 20%, then Variable Cost will also increase by 20%; but fixed
costs do not change.
Sales 9,600,000 + (9,600,000 X 20%) ...11,520,000
Less Variable cost
Production workers wages ...........480,000
Metal, rubber etc. ...................2,400,000
Total variable Cost ............................2,880,000
Contribution margin (selling price - variable cost) 8,640,000
Less Fixed cost
Factory Depreciation & Main. .......700,000
Electricity, water .......................800,000
Equipment depreciation ...............400,000
Total Fixed Cost .............................................1,900,000
Net Income ...........................................6,740,000
Hope you follow this. --Contribution margin = 8,640,000 and the Contribution
margin ratio still is= 8,640,000/11,520,000 = 0.75; this has to stay the same

Class: Problem #4
Trill Co. manufactures and sells one product. For the year, they started with no opening inventory;
produced 100,000 units but only sold 70,000 units. The selling price per each unit is $60.
The variable costs per unit were:
Direct materials......................... 7
Direct Labor .............................6

Week
variable manufacturing overhead ....5
variable selling and administrative..6
Fixed costs per year:
Fixed manufacturing Overhead ................$700,000
Fixed Selling and Administrative expenses.. $300,000
a) Prepare the Income Statement using Absorption Costing
b) Prepare the Income Statement using Variable Costing.

Class:Solution to Problem #4
a) Income Statement using Absorption Costing
Sales ($60 * 70,000).............................$4,200,000
Cost of Goods Sold ($25 * 70,000)........$1,750,000
--------------------------------------------------------Gross Margin........................................$2,450,000

(HELP You add variable 18 per unit and then add the fixed overhead when divided by the number of units to get 25)

Less Fixed Costs

Variable selling and admin ($6 * 70,000)....$420,000.....
_Fixed Selling and Admin expenses...... $300,000
Total Selling and Administrative
---------------------------------------------------------Net Income.......................................$1,730,000

$720,000

*Note: unit cost= total production costs/number of units produced

unit cost=($18 total vc * 100,000 units) + $700,000 fixed manufacturing overhead/ 100,000 units produced
unit cost=$1,800,000 + $700,000/ 100,000
...........=$2,500,000/100,000
...........=$25 per unit

b) Income Statement using Variable Costing

Sales ($60 * 70,000)........................................................$4,200,000
Less Variable Costs
_Direct materials ($7 * 70,000).....................$490,000

Week

_Direct Labor ($6 * 70,000)..........................$420,000

_Variable manufact overhead ($5 * 70,000)..$350,000
_Variable selling and admin ($6 * 70,000)....$420,000.....$1,680,000
----------------------------------------------------------------Contribution Margin........................................................$2,520,000
Less Fixed costs
_Fixed manufacturing Overhead ....................$700,000
_Fixed Selling and Administrative expenses...$300,000....$1,000,000
----------------------------------------------------------------Net Income..................................................................$1,520,000

Class, one of the important rules we learned this week is that a portion of manufacturing overhead is
fixed costs, so the full cost method includes both fixed and variable costs. However, for internal use by the
managers, a firm may choose to prepare those financial statements utilizing variable costing, where only
variable costs are included in inventory.

TCO6
Given relevant data regarding activities and costs, refine a cost allocation system using ActivityBased Costing to improve product level and pricing decisions.

Key Concepts

Explain why indirect costs are allocated.

Describe the cost allocation process.

Discuss allocation of service department costs.

Identify potential problems with cost allocation.

Discuss activity-based costing (ABC) and cost drivers.

Week

Distinguish activity-based costing (ABC) from activity-based management (ABM).

TCO7
Given a firm's alternative courses of action, explain how relevant costs, incremental costs, and the
theory of constraints can be used to aid decision-making, and pricing, planning, and control
strategies.

Key Concepts

Explain the role of incremental analysis (analysis of incremental costs and revenues) in
management decisions.

Define sunk cost, avoidable cost, and opportunity cost, and understand how to use these
concepts in analyzing decisions.

Analyze decisions involving joint costs.

Discuss the importance of qualitative considerations in management decision

CLASS: What are cost allocations? What are 4 main reasons companies allocate costs to products?
Choose ONE and explain how this process would benefit management.

Cost allocations are the process of assigning indirect costs to several cost objects.
The 4 main reasons companies allocate costs to products:
1. Provide information for decision making Having accurate detailed information is very
important to make better decision, identify issues and fix them by allocating, redirecting and
assigning funds or costs for companies. Knowledge is Power".
2. To reduce frivolous use of common resources
3. Encourage evaluation of services
4. Provide Full cost information
Managerial Accounting, Jiambalvo, pgs. 206-208

CLASS: PROBLEM #1. Activity Based Costing (ABC):

(EVERYONE should do this problem and post a solution even if others already have.)
Michelle Company makes two products and is implementing an Activity Based Costing (ABC)
system. Previously, all overhead had been applied on the basis of machine hours. The Company
produces 400,000 units of product A and 20,000 units of product B.
The problem is based on the following categories:
Cost Pool
a)Driver and Level
b)Cost in Pool

Week
c) Use of Driver by Product A
d) Use of Driver by Product B
I Equipment Setup
a) 2500 setups
b) $2,000,000
c) 1,350 setups
d) 1,150 setups
II Materials Ordering
a) 50,000 orders
b) $5,000,000
c)20,000 orders
d)30,000 orders
III Quality Control
a)40,000 inspections
b) $900,000
c) 15,000 inspections
d) 25,000 inspections
IV Machining
a) 50,000 machine hours
b) $6,000,000
c) 10,000 machine hours
d) 40,000 machine hours
A) Using ABC what is the cost per machine hour in the Machining pool?
B) Using ABC what is the cost per setup in the Equipment Setup Pool?
(Note that the problem looks difficult but actually is not difficult if you reviewed the textbook. You just
have to find the relevant information.)

Using ABC
A) IV Machining
6,000,000/50,000 = 120 per machine hour
B) I Equipment Setup
2,000,000/2,500 = 800 per set up.
Class: Solution to problem #1. (Post your solution first and review AFTER you have posted your
answer)
A). Using ABC what is the cost per machine hour in the Machining pool?
10,000 + 40,000 = 50,000 Total Machine Hours
6,000,000 (Cost)/50,000 (Total Machine Hours)
= $120.00 per machine hour.
B) Using ABC what is the cost per setup in the Equipment Setup Pool?

Week
1,350 + 1,150 = 2,500
2,000,000 (Cost) /2,500 (Total Setups)
= $800.00 per setup.
The nice thing about working on the problem this way, is that the problem seems very difficult when
we start. We then try our method and then compare our answer to other students. After we are done,
the problem doesn't seem so difficult.
Keep up the good work
Class: Problem #2
The Bonus Corp. is attempting to get a better estimate of the cost of their products. As a first step,
they are attempting to allocate overhead by defining three activity cost pools and three
corresponding cost drivers. They believe that the cost drivers of each of these pools correlate with
the costs of that activity pool. The estimated overhead costs and activity levels for each activity are
given below:
Activity.....Estimated Cost......Driver OH costs...Est. Activity level
Supervision.... Direct Labor..... $120,000..............$300,000
Inspection..... # Inspections....... $90,000............... 2,000
Machine use.... Machine hours.... $1,000,000............ 40,000
Activity data for the two products manufactured by the company at year end are as follows:
....................Product A...............Product B
Direct Labor....... $200,000........... $100,000
# Inspections........2000 ..................6,600
Machine hours ......9,000 ...............9,000
The following are the direct costs associated with each product and the units manufactured:
..................................."A"........... "B"
Direct Material .....$3,500,000..... $1,500,000
Direct Labor...... $620,000...........$120,000
Units produced .....50,000.......... 40,000
a) What amount of overhead will be applied to Each of the two Products?
b) What is the unit cost of each product? (include all costs)
CLASS: Solution to Problem #2
a)To determine the amount of overhead that will be applied to each of the two products, we first
divide the Driver OH costs by the Est. activity level of each activity.
Supervision $120,000 / $300,000 = $.40 Per Direct Labor Hour
Inspection $90,000 / 2,000 = $45 Per Inspection
Machine Use $1,000,000 / $40,000 = $25 Per Machine Hour

Week
Product A - 395,000
Product B - 562,000
To get the overhead applied we multiply the activity rates by the activity data:
Product A
.4*2,000 = 80,000
45*2,000 = 90,000
25*9,000 = 225,000
overhead applied = 395,000
Product B
.4*100,000 = 40,000
45*6,600 = 297,000
25*9,000 = 225,000
overhead applied = 562,000
b)
Product A
$3,500,000 (Direct Material)
$620,000 (Direct Labor)
$200,000 x .40 = $80,000 (Supervision of Labor)
2000 X $45 = $90,000 (Inspections)
9000 x $25 = $225,000 (Machine Hours)
TOTAL OVERHEAD: $395,000
----------------------$4,515,000 / 50,000 = $90.30
Product B
$1,500,000 (Direct Material)
$120,000 (Direct Labor)
$100,000 x .40 = $40,000 (Supervision of Labor)
6600 X $45 = $297,000 (Inspections)
9000 x $25 = $225,000 (Machine Hours)
TOTAL OVERHEAD $562,000
----------------------$2,182,000 / 40,000 = $54.55
CLASS: Problem #3:
Sweet Company allocates the net cost of the company cafeteria to production departments using the
direct method based on the number of employees in each department. The four production
departments in the company have the following number of employees: molding 77; polishing 88;
engraving 123; and packaging 22. The cafeteria's net costs total $400,000.
(There are 25 employees in the cafeteria, but that is not relevant to the question.)

Week
a) What amount will be allocated to the molding department?
b) What amount is allocated to the engraving department?
Class: Solution to Problem #3. (Note that because of rounding you may be off a few dollars.
Although it is not crucial to this problem, you should use 4 decimals).
Total employees: 77+88+123+22 = 310
a) amount allocated to the molding dept: 77/310=.2484 or 24.84%
400,000*.2484 = 99,360
b) amount allocated to the engraving dept: 123/310=.3968 or 39.68%
400,000*.3968 = 158,720
(NOTE it doesn't add up to the full $400,000 because I only asked you to allocate to 2 out of the 4
departments. The remainder goes to the last 2 depts.)
SHARE YOUR WORK.

Activity based costing differ from traditional costing approach

because traditional costing assigns manufacturing overhead based
on the volume of a cost driver, like the amount of direct labor hours
needed to produce an item. Activity-based costing allocates the
costs of manufacturing a product according to the activities needed
to produce the item.
A cost driver is a factor that causes cost to incur, like machine
hours, direct labor hours and direct material hours.
Relevant Costs CLASS: What is meant by relevant costs? What is meant by differential
costs? How do constraints relate to manufacturing companies? How would you tie all these ideas
together with costs that need to be included in the decision making process?
Relevant costs are those costs that will make a difference in a decision. Relevant costs are future
costs that will differ among alternatives. You might use the past costs to help you predict those
future costs, but the past costs are otherwise irrelevant to the decision. Accountants refer to the
past costs as sunk costs.

CLASS: Problem (#1) for everyone to work on.

Eric Company's market for the Model #987654 has changed significantly, and Eric has had to drop
the sales price per unit from $1,000 to $625. There are 1000 units in the work in process inventory

Week
that have costs of $670 per unit. Eric could sell these units in their current state for $280 each. It will
cost Eric $208 per unit to complete these units so that they can be sold for $625.
a) Which of these amounts were not relevant in this problem? WHY?
b) Which amounts are relevant to any decision? WHY?
c) Which costs are "sunk" costs? WHY?
d) If we are dealing with 1000 units, what is the total dollar difference by re-working the units instead
of not re-working them? SHARE your calculation
CLASS: SOLUTION to Problem #1 (review after you have posted)
A. $1,000 and $670 are BOTH not relevant to the decision making process. They do not factor into
this decision. They do not change no matter what decision is made.
B. $625, $280, $208, (and 1,000 units), are all relevant to consider for the two alternatives. These
numbers do factor into the decision.
C. $670 is the sunk cost because it has already been incurred and will not change no matter which
choice is made.
D.
units = 1,000
Sale price = $625
Price to sell in current state = $280
Price to rework units = $208 (per unit)
What if units are reworked?
1,000 x $208 = $208,000
1,000 x $625 = $625,000
$625,000 - $208,000 = $417,000 revenue from reworked units
What if units are sold as is?
1,000 x $280 = $280,000 revenue from selling as is
Net dollar difference between two alternatives
$417,000 - $280,000 = $137,000
Eric is better off to rework the unit than sell them as is.
Class: Problem #2
Highland Company, a retail company, has two departments, "G" and "S". The company's most recent
monthly contribution format income statement is presented below.
......................Total........................G...............................S
Sales.............. $ 6,000,000 ............$ 2,000,000 ..........$ 4,000,000
Variable Expenses ...3,000,000...........1,400,000 .......1,600,000
Contribution
Margin ...........3,000,000............... 600,000...........2,400,000
Fixed expenses 1,800,000,..............800,000 .........1,000,000
Net operating
income (loss) $1,200,000.............$(200,000)............$1,400,000
A study indicates that $350,000 of the fixed expenses being charged to "G" department are sunk
costs, or allocated costs that will continue (that is the other department will have to absorb those
costs) even if the "G" department is dropped. In addition, the elimination of the "G" department would
result in
a 10% increase in the sales of the "S" department.

Week

Ignore the impact of income taxes in your calculation.

Required: If "G" department is dropped, what will be the effect on the net operating income of the
company as a whole?
HELP: The key here is understanding how fixed costs operate and how variable costs
operate. The best way is to set up a new income statement only using department "S".
Remember that the Fixed do not increase but variable do.
Since G had sales of $2,000,000 and S had sales of $4,000,000.
If we drop G, our sales of S will be $4,000,000 x 110% = $4,400,000.
We then subtract our NEW variable expenses and then our NEW Fixed. HOWEVER our Fixed
expenses do not change.
Class: Solution for Problem #2 (Review after you post your work)
As many of you wrote:
The sales increase to $4,400,00 but the variable expenses increase also by 10% to $1,760,000. We
subtract the variable from the sales.
We then have Contribution Margin of $2,640,000.
We then look at our fixed expenses-- it is the $1,000,000 PLUS the $350,000 from "G" which cannot
be eliminated. Total Fixed is $1,350,000 is subtracted to get net income of $1,290,000.
We then look at our old income of $1,200,000 and find that we increase our income by $90,000
if we drop G.
It is set up as follows:
...................................G....................S.............New S (alone)
Sales......................2,000,000..........4,000,000........4,400,000
Var Exp...................1,400,000..........1,600,000........1,760,000
Contrib Marg..............600,000...........2,400,000........2,640,000
Fixed Exp...................800,000...........1,000,000........1,350,000
Net Inc (Loss)...........(200,000)..........1,400,000........1,290,000
Net income with both G and S = (200,000) + 1,400,000 = 1,200,000
Net income with only S = 1,290,000
Answer: we increase our income by $90,000 if we drop G.

CLASS: Problem #3 (Make or Buy decision)

Durable Company produces a small part that it uses in the production of its Product "H". The
company's unit product cost for the part, based on a production of 100,000
parts per year, is as follows:

Week
Items................................................Per part ....................Total
Direct Materials................................. $7.00........$700,000
Direct Labor .....................................$6.00......$600,000
Variable Manufacturing Overhead $2.00.....$200,000
Fixed manufacturing Overhead, (Traceable as if it were per unit 4.00 )$400,000
Fixed manufacturing Overhead,( Common---allocated on basis of labor-hours 5.00) $500,000
Unit Product Cost........................... $24.00
An outside supplier has offered to supply parts to the Durable Company for only $21.25 per part.(it
appears to the President of the company that he could save $2.75 per unit; but the President has not
taken a Managerial Accounting course and he does not understand fixed costs and variable costs
like you do.)
Fifty percent of the traceable fixed manufacturing cost is supervisor salaries and other costs that can
be ELIMINATED if the parts are purchased. The other 50% of the traceable fixed manufacturing
costs consist of depreciation and special equipment that has no resale value. The decision to buy
the parts from the outside supplier would have no effect on the common fixed costs of the company,
and the space being used to produce the parts
would otherwise be idle.
Ignore the impact of income taxes in your calculation.
A) How much would profits increase or decrease as a result of purchasing the parts from the
outside supplier rather than making them inside the company???
Help:
Set up columns for "MAKE" and "BUY". Under MAKE we have 100,000 units costing $24 per unit for
a total of $2,400,000. Then calculate what the TOTAL costs would be if we BUY the product. Note
that it will be more than just $21.25 x 100,000.
B) (This part is a bit more difficult.) If we need 150,000 Units-- How much would profits increase or
decrease as a result of purchasing the parts from the outside supplier rather than making them
inside the company? (You need to carefully set up columns for Make and Buy and carefully
Solution; Part A; Problem #3 Class:
If we make this part (that goes into the product H) We spend $15 (variable per unit ) x 100,000 plus
400,000 plus 500,000= 2,400,000.
If we buy we pay 21.25 x 100,000=2,125,000 plus Fixed of 200,000 (half of 400,000) plus 500,000=
2,825,000.
Therefore it will cost us $425,000 MORE to Buy than to make because $700,000 of the fixed costs
stay.
(Cheaper to Make than to buy)
USING COLUMNS:
(a) 100,000 parts per year
..................................To Make......................To Buy..............

Week
D/Material ...7X100,000....700,000.........................................0
D/Labor.......6X100,000....600,000.........................................0
O/Head.......2X100,000.....200,000.........................................0
Fixed O/H (traceable).......400,000 ......50%(400,000)......200,000
Fixed O/H (common).........500,000................................500,000
Purchase.................................0.......21.25X100,000...2,125,000
Total cost....................2,400,000..............................2,825,000
$425,000 more will be incurred if units are bought from the outsider. Hence, profit will decrease by
$425,000. So we should MAKE the part.
Solution: Part B, Problem #3 Class,
I hope you followed Part A of this problem. If not, ask questions.
Costs to MAKE:
Now, We take the variable per unit of $15x 150,000 units= $2,250,000; plus ALL the Fixed expenses
pf $900,000= $3,150,000.
Costs to BUY:
$21.25x 150,000 units = $3,187,500; PLUS the Fixed which stay of $700,000 = 3,887,500.
Therefore it would be cheaper to MAKE the part by $737,500.
USING COLUMNS:
.......................To Make..............................To Buy..........
D/Material ..........1,050,000.............................0
D/Labor.................900,000.............................0
O/Head..................300,000.............................0
Fixed (traceable)......400,000.......................200,000
Fixed (common)........500,000.......................500,000
Purchase..........................0.....................3,187,500
Total cost ..........3,150,000.......................3,887,500
$737,500 more will be incurred if we bought from the outsider. As such profit will decrease by
$737,500. It will be better to make the parts.

Incremental Analysis is the analysis of the incremental revenue and incremental costs incurred when
one alternative is chosen over another.
Incremental Analysis can be extended to more than two alternatives for the following reasons:
a) To calculate profit for each alternative.
b) The alternative with the highest profit is the best alternative.

Given a firm's market conditions of perfect or imperfect competition, use target pricing, cost plus
pricing, time and materials pricing, and internal transfer pricing, to establish desired prices for
goods and services.

Week
Key Concepts

Compute the profit-maximizing price for a product or service.

Perform incremental analysis related to pricing a special order.
Explain the cost-plus approach to pricing and why it is inherently circular for manufacturing firms.
Explain the target costing process for a new product.
Analyze customer profitability.
Explain the activity-based pricing approach

Given investment opportunity data, use evaluation methods (for example, net present value,
internal rate of return) to develop recommendations to further the firm's goals of profit
maximization and operating efficiencies.

Key Concepts

Define capital expenditure decisions and capital budgets.

Evaluate investment opportunities using the net present value approach.

Evaluate investment opportunities using the internal rate of return approach.

Calculate the depreciation tax shield, and explain why depreciation is important in
investment analysis, only because of income taxes.

Use the payback period and the accounting rate of return methods to evaluate investment
opportunities.

Explain why managers may concentrate erroneously on the short-run profitability of

investments rather than their net present values.

Class: What are the alternatives when considering a "special order"? What does "incremental
revenue" mean?
How do you decide between the alternatives? Give examples of a special order (as discussed in our
textbook) and give examples of a special order coming into your company. What factors do you look
at and what factors should you not look at?

Week

Pricing Techniques (graded)

Class: Problem #1
Cushion Company is launching a new line of cushions. The company invests $4,000,000 in
operating assets, such as production equipment, and plans to produce and sell 400,000 units per
year.
Cushion wants to make a return on investment of 25% each year.
Cushion needs to know what price to charge for this product.
Use the absorption costing approach to determine the markup necessary make the desired return on
investment.
Cost information is provided below.
REQUIRED: CALCULATE THE SELLING PRICE.
Round your answer to two decimal places.
Per Unit cost:
Direct Materials $30.00
Direct Labor $ 8.00
Variable Manufacturing Overhead $2.00
Fixed Manufacturing Overhead $600,000 (total)
Variable Selling and Admin. Expense is $ 2.00 per unit
Fixed Selling and Admin. Expense $120,000 (total)
{Help: Since they invested $4,000,000 and they want to earn 25% on their investment, then the
desired profit is $4,000,000x25% or $1,000,000.}

Class: Problem #1Answer

Cushion Company is launching a new line of cushions. The company invests $4,000,000 in
operating assets, such as production equipment, and plans to produce and sell 400,000 units per
year.
Cushion wants to make a return on investment of 25% each year.

Cushion needs to know what price to charge for this product.

Use the absorption costing approach to determine the markup necessary make the desired return on
investment.

Week

Cost information is provided below.

REQUIRED: CALCULATE THE SELLING PRICE.

Round your answer to two decimal places.

Per Unit cost:

Direct Materials $30.00
Direct Labor $ 8.00
Variable Manufacturing Overhead $2.00

Fixed Manufacturing Overhead $600,000 (total)

Variable Selling and Admin. Expense is $ 2.00 per unit

Fixed Selling and Admin. Expense $120,000 (total)

{Help: Since they invested $4,000,000 and they want to earn 25% on their investment, then the
desired profit is $4,000,000x25% or $1,000,000.}
So the production cost is:
$30+$8+$2+$1.50 = $41.50 unit
Total production cost: $41.50 x 400,000 = $16,600,000

Cushion Company wants 25% return, or $1,000,000 + $16,600,000 = $17,600,000 target revenue
goal.

To meet the $17,600,000 target revenue goal:

Week
X = $16,600,000 = $17,600,000 X $41.50
X = $16,600,000 = $730,400,000
X = $44 per unit (new price to meet target revenue goal)

Target Revenue goal: $44 X 400,000 = $17,600,000

$17,600,000 is the new revenue goal

CLASS: Problem #2 (SPECIAL ORDER)

Slow Manufacturing produces a single product, "G".
Budgeted amounts for the coming year are as follows:
Sales (120,000 units @ $10 each) $1,200,000
Direct material $360,000 ($3 per unit)
Direct Labor $240,000 ($2 per unit)
Variable overhead $120,000 ($1 per unit)
Fixed overhead $240,000 (MANAGEMENT MIGHT INCORRECTLY THINK OF THIS AS $2 PER
UNIT BUT THAT IS NOT HOW FIXED EXPENSES WORK)
Fast Industries has offered to purchase 1,000 units of "G" at a price of $7.25 per unit. These will
have additional variable costs of $0.25 per unit over the old variable costs. . Slow has the capacity to
produce this order and will not affect any of their other operations.
a) What is the incremental revenue associated with accepting this special order?
b) What is the incremental cost associated with the special order?
c) What is the incremental profit or loss expected to be generated?(net of Revenue -Expenses)

Class: Solution to Problem #2 (Review after you post your solution)

(Note that the .25 is definitely an important cost.)

Week
therefore:

Incremental Revenue: 1,000 * $7.25 = $7,250

Less incremental costs:
.......Direct Material: 1,000 * $3.00 = $3,000
.......Direct Labor: 1,000 * $2.00 = $2,000
.......Variable Overhead: 1,000 * $1.00 = $1,000
.......Add'l Variable Costs: 1,000 * $0.25 = $250
Net benefit of Special Order = $7,250 - $6,250 = $1,000

A: Incremental Revenue = $7,250

B: Incremental Cost: $6,250
C: Incremental Profit or Loss: Incremental Profit of $1,000. Therefore we should ACCEPT the offer. It
is profitable.

Class: (Easier) Problem #3

A company has $20.00 per unit in variable costs and $10,000,000 per year in fixed costs. If the
company expects to sell 1,000,000 units and wishes to earn a profit of $2,000,000, what markup
percentage (to the nearest whole %) must be applied to the total cost?
Again, everyone should work on these problems even if others have. You can do this!!!
Calculate your answer and then check on the work of others. Also, comment on the work of others. I
will post a solution on Friday.

Class: Solution to #3

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Estimated quantity 1,000,000

Expected profit $2,000,000

Total fixed costs $10,000,000

Total variable costs ($20 x 1,000,000) $20,000,000

Total costs ($10,000,000 + $20,000,000) $30,000,000

Markup = Expected profit / Total costs

Markup = $2,000,000 / $30,000,000
Markup = 0.067 or rounded up to 7%

Hopefully, we all feel that this is a forum where we can learn together. I often need to correct
students so other students don't think that the wrong answer is correct, but I welcome you trying the
problems here. All students get full credit for trying.

Capital Budgeting Techniques (graded)

CLASS: Firstly, what is the time value approach to capital budgeting? Give an example of how it
would work in the following case:
Assume you are thinking about investing $1000, and that the investment will return to you $1400
(once) five years in the future: Assume you have a 10% Required rate of return. WOULD YOU
MAKE THE INVESTMENT? SHOW ALL MATHEMATICAL BACK UP.
(Help: Explain the relationship between a dollar today and a dollar which will be received a year or
more from now. How do you value the dollar that will not be received for 5 years? )
Secondly, What does the IRR tell us? How is NPV different from IRR?

Net present value (NPV) is an investment measure that tells an investor whether the investment
is achieving a target yield at a given initial investment. NPV also quantifies the adjustment to the

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initial investment needed to achieve the target yield assuming everything else remains the
same. Formally, the net present value is simply the summation of cash flows (C) for each period
(n) in the holding period (N), discounted at the investors required rate of return, whereas
Internal rate of return (IRR) for an investment is the percentage rate earned on each dollar
invested for each period it is invested. IRR is also another term people use for interest.
Ultimately, IRR gives an investor the means to compare alternative investments based on their
yield.

Class: FUN question:

In Michael Jordan's last year with the Bulls, Dennis Rodman wanted approximately $14,000,000 and
the Bulls offered $7,000,000. They were very far apart. They compromised. The Bulls deposited a
little more than $7,000,000 into an account that Rodman could not touch for 10 years and would be
worth $14,000,000 at the end. Rodman told everyone he was earning $14,000,000 but it only cost
the Bulls a little over $7,000,000! Rodman went on TV and bragged he was paid $14,000,000.
What was he really paid (at the moment that he received the contract) based on present value
computations of 10 years, 6%?
Please discuss how this relates to our material on Present Value. What was the APPROXIMATE
PRESENT VALUE (at the time of the payment) of the amount that he would receive in 10 years at an
interest rate of 6%?
(Please understand that Rodman's agent was brilliant. Rodman got exactly what he wanted and the
Bulls paid Rodman approximately what they wanted to in the beginning. Show how this is true. )

Class: Problem #1:

Recently on the Golf Channel there was a film report of a person hitting a hole-in-one and winning
$1 million. He went crazy in the film. HOWEVER, it was $50,000 every year paid out over the next
20 years. He wasn't offered the lump sum.
Questions: A) If the money is valued at 14% what was the REAL PRESENT VALUE of his winnings?
(What was it worth that day?) Explain your answer. If you use a TABLE be careful which Table you
are using. This is an annuity. NOT a payment once. Make sure your answer is logical.
B) If the money is valued at 6% what was the REAL PRESENT VALUE of his winnings? (What was it
worth that day?) Explain your answer.
C) Note that the rule is that the higher the interest rate the Lower the Present Value and the lower
the interest rate the Higher the Present Value. (As you should see from your answers to parts A and
B) Can you explain why this rule is true?
We use the annuity present value table to look up the internal rate of return. These are the value
today of the SAME payments which will be received for a number of years in the future.

A. $50,000 x 6.6231=$331,155. THAT IS ALL IT WORTH TODAY AT THAT INTEREST RATE.

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B. $50,000 x 11.4699=$573,495. It has a much higher value because the lower the interest rate the
higher the Present value. Money which will be received in the future has a lower value to us today
since we don't have it today.

C. It is better to receive a dollar today than in the future. That dollar can be invested and it can grow
to a greater amount. If we can earn interest at a higher amount then the money in the future is worth
less to us today.

CLASS: Problem #2. EVERYONE should do this problem.

Lauren Corp buys equipment for $194,000 that will last for 9 years. The equipment will generate
cash flows of $36,000 per year and will have no salvage value at the end of its life. Ignore taxes. Use
10% required rate of return.
a) What is the Present Value (PV) of this investment? (This is asking "what is the PV of $36,000 per
year for 9 years")
B) What is the NET Present Value (NPV) of this investment? (It is important to note that NPV is the
PV less the cost.)
c) What is the Internal Rate of Return (IRR) of this investment?
d) What is the payback period?
CLASS: Solution to Problem #2
(work on it on your own and show your work. Just use this for reference). You can use Excel if you
prefer. I am showing the answer here using the Table that is on Page 356.

Present Value-- Note that we use the Table for the Present Value of an Annuity since we receive the
exact same amount every year. You could use the Table for the Present value of $1 but then you
have to use 9 different calculations.

a) PVa=36,000*5.7590=$207,324. You can also use Excel and it will be almost the exact same.

Net Present Value

b) If we subtract $207,324-$194,000 cost we get $13,324.

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IRR
c) 12% (calculated using IRR formula in Excel) or we use a FACTOR of 194,000/36000=5.39 and
then using that FACTOR we get a rate of 12%. We go to the annuity Table using the Factor we get
when we divide 194,000/36,000 and get 5.3889 FACTOR not a Rate. (It is the same as the Payback
period.) Then we find the rate closest to 5.3889 on the 9 year line (because it was 9 years of
payments). It comes closest to 12%. This is from the Annuity Table.

Payback Period
d) $194,000/36,000= 5.39 years.

CLASS---3rd (similar) problem

A new investment costs $380,000. It will save $60,000 per year for 10 years and we need a return of
8%.
Note that the investment does not give it's principal back at the end of the life and therefore we need
to know if it is returning our desired rate of return despite no principal return. (If I put my money in
the bank I would get a lower return per year plus all my money back whenever I want it. Here I don't
get my money back.)

a) What is the PV of the amounts we receive? Use the annuity table on page 356 or Excel.
b) What is the NPV of this investment?
c) Do we reach our desired return of 8%? (Is IRR at least 8%?) What is the IRR?
d) What is the Payback period?

Class: Solution to Problem #3

A) Present Value = $60,000 * 6.7101 (This is from the Annuity Present Value table. You can also use
the individual year calculation but then you would add up 10 years present value.) = $402,606 (this is
the Total Value of all the Cash Inflows from this investment.) You can also use Excel but be careful
that the answer is logical.

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B) NPV = $402,606 - $380,000 = $22,606. We subtract the cost from the total Present values of
what we receive to determine if it is positive or negative.

C) In this case it is positive so we should invest.

IRR = $380,000 / $60,000 = 6.33; this is our FACTOR NOT OUR INTEREST RATE; from table 2 = a
little over 9%

One of the most confusing parts of this chapter is knowing when to use table 1 or table 2. You use
Table 1 when it is one payment ONCE. You use the Annuity Table when you receive the same
amount EVERY year for a certain number of years. You can also use Excel but I wanted to show this
step by step using the Table.

Modified:10/4/2013 8:16 AM
Phil File, the owner of Fun Family Films, is considering the addition of a service center his lot. The
building and equipment are estimated to cost $2,000,000, and both the building and equipment will
be depreciated over 10 years using the straight-line method. The building and equipment have zero
estimated residual value at the end of 10 years. Fun Familys required rate of return for this project is
10%. Net income related to EVERY year (for each of the 10 years) of the investment is as follows.

Revenue
$770,000
Less:
Material Cost $30,000
Labor30,000
Depreciation 200,000
Other10,000 270,000
Income before taxes
Taxes at 40%
Net Income

500,000
200,000
$300,000

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(A) Determine the net present value (The present value of the earnings at 10% over 10 years minus
the original cost of of the investment in the service center, $2,000,000). Should they invest in the
service center, considering that they need 10%?
(B) Calculate the internal rate of return of the investment to the nearest 0.5%.
(C) Calculate the payback period of the investment.

Please try this. I will post a solution Saturday night.

This is a very important problem. Please review the solution and become familiar enough to do it on
your own.

A): NPV=(300,000+ 200,000 deprec) *6.1446= $3,072,300

Then 2,000,000(cost of investment)-3072,300=$1,072,300 This number is positive so it would be a

good investment and would hit the 10% required return.

B: IRR= 8% 2,000,000/500,000= 4.0 We then compare this to the 10 year line on the annuity table
to find the closest % and it is almost 20%

C: Payback period=4.0 Years 2,000,000(cost of investment)/500,000(return per year)= 4 years

PV = $300,000 *6.1446
PV = $1,843,380
NPV = $1,843,380 - $2,000,000
NPV = ($156,620)

PVF = $2,000,000/$300,000
PVF = 6.6667

IRR = 8%

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$ (2,000,000.00)
$ 300,000.00 $ 300,000.00 $ 300,000.00 $ 300,000.00 $ 300,000.00
$ 300,000.00 $ 300,000.00 $ 300,000.00 $ 300,000.00 $ 300,000.00
IRR

8%

Payback Period = $2,000,000/$300,000

Payback Period = 6.6667 years
The internal rate of return is the discount rate that makes the NPV equal to zero. IRR must be
greater than the cost of capital for a new project to add value to the firm.
Given a firm's objectives and data, develop budgets (e.g., flexible, master, capital) for planning
10 purposes and performance evaluation, using techniques such as standard costs, variance
analysis, and financial statement analysis.

Key Concepts

Discuss the use of budgets in planning and control.

Prepare the budget schedules that make up the master budget.

Discuss the conflict between the planning and control uses of budgets.

Explain how standard costs are developed.

Calculate and interpret variances for direct material, direct labor, and overhead.

Chapter 10: Budgetary Planning and Control

Chapter 11: Standard Costs and Variance Analysis
CLASS: PROBLEM #1.

Gel Inc, a retailer, expects sales to be as follows

January $500,000

February $800,000

March $600,000

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April $700,000

Cost of Sales is 60% of sales. Ending inventory is expected to equal 30% of the next month's sales.
What would the purchases of inventory in February be?

The problem is VERY TRICKY and requires some careful calculations.

NOTE: The problem states "Ending inventory is expected to equal 30% of the next month's sales"
the problem implies but definitely does not clearly state, that we need to have enough inventory to
be able to sell some of next months sales. If I buy something for $5 and sell it for $20 and want 30%
of next month I would not need to have 30% of what I sell it to you for (which would be 30% of 20 or
$6) but rather 30% of my cost to get that item to you (or 30% of $5 which is only $1.50) ---30% of my
cost. This is why I give you the fact that the cost of the sales is 60% of what I sell it for.

CLASS: SOLUTION to Problem #1

This is a difficult problem. Comment on my solution if you do not get this. The purpose of the
discussions is that you discuss these problems here and are able to follow them.
Let's try it this way. First, Cost of Sales is 60% of total sales, so I am taking this as the cost of goods
sold, or the cost of the inventory, and the 40% is the profit.
We start by looking at 3 months here, January, February and March. But really we only need Feb
and March. January is only necessary to give us Feb's beginning. So, I am going to convert these
month's sales into inventory costs. This gives us the amount required for each month's production.
February: $800,000 x .60 = $480,000
March: $600,000 x .60 = $360,000
Desired ending inventory is 30% of the next month, so beginning inventory in February based on
January ending, is $480,000 x .30 = $144,000 and ending inventory in February is $360,000 x .30 =
$108,000
The formula is Required Purchases of Direct Material = Amount Required for Production + Desired
Ending Inventory of Direct Materials - Beginning Inventory of Direct Materials.
Required Purchases of Direct Material = $480,000 + $108,000 - $144,000
Required Purchases of Direct Material = $444,000.
(Again, note: The problem states "Ending inventory is expected to equal 30% of the next month's

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sales" the problem implies but definitely does not clearly state, that we need to have enough
inventory to be able to sell some of next months sales. If I buy something for $5 and sell it for $20
and want 30% of next month I would not need to have 30% of what I sell it to you for (which would
be 30% of 20 or $6) but rather 30% of my cost to get that item to you (or 30% of $5 which is only
$1.50) ---30% of my cost. This is why I give you the fact that the cost of the sales is 60% of what I
sell it for.)

CLASS: Problem #2:

Frank Company's budgeted overhead for 2008 was $360,000 for FIXED overhead ($30,000 a
month) and variable overhead at $5.00 per unit. Planned production was 120,000 units for the year
at the rate of 10,000 units a month. During July the company produced 9,600 units and total
overhead was $87,000.
A) What was the amount of overhead (expected) in the flexible budget for July?
B) What was the Controllable Overhead Variance for July? (HELP: Fixed is not considered
controllable).
C) What was the overhead volume Variance? Be sure to indicate if Favorable or Unfavorable.
I will post the answers on friday so work on these!

Class: Solution to Problem #2

Let's take each part slowly.
a) In the Flexible budget we are adjusting to the changed volume. Therefore: we multiply $5 x 9600
units and get $48,000. Plus the Fixed, which does not get adjusted for units, of $30,000. Total
therefore is $78,000.
B) For this part we multiply 9600 units x$5=$48,000 ; plus the fixed of $30,000; we get $78,000. We
spent $87,000. Therefore we spent $9,000 more than we budgeted and it is $9,000 unfavorable.
Whew!
c) We need to get the Volume Variance. If we take the total fixed budgeted (30,000/10,000) we get
$3 plus the $5 variable; we get $8 per unit. If we multiply this x 9600 units we get 76,800.
The expected overhead in the flexible budget is 78,000 (Part A). Therefore there is a $1200
unfavorable variance. ($78,000-$76,800)
It definitely can get confusing the first time you see this.
Work at this and print out this problem if necessary

Week
Class: Problem #3
Debbie Corp sells it products on both credit and cash basis. Monthly sales are sold 20% for
cash, 80% for credit. Credit sales are collected 65% in the month of sale and 35% the
following month. Sales for the first quarter are BUDGETED as follows: January $200,000;
February $300,000; March $300,000.
Compute cash collections Budgeted for February.
How much cash was collected in the month?

Solution to Problem #3
In February we will collect:
20% of Feb.'s sales in CASH= 300,000x 20%= 60,000; Of the remaining 80% we expect to collect
65% this month (and of course 35% next month). So 300,000 x.8 x .65= 156,000
Of January's sales we already collected 20% of it in Jan so we are not interested in that. That leaves
80% 200,00 = 160,000. We collected 65% of that already and we expect to collect 35% of that in
Feb. = 56,000.

Total is 60,000 + 156,000 + 56,000 = 272,000.

According to the lecture, budgets are used to improve communication and coordination between
departments. Budgeting is important to help management validate responsibilities for planning the
company direction, set the expectations for evaluations, coordinate and communicate goals of the
company to employees.

The difference between static budget and a flexible budget is;

A static budget does not change with the output, remains at one amount regardless of the volume of
activity. This is a forecast.
A flexible budget adjusts and incorporates the different expense levels into the budget depending on
the changes in the amount of actual revenue generated and volume of activity.

These relationships are used for managers to compare the results they achieved to what was listed
in the static budget. This tells the managers what costs should have been. The result is the flexible
budget. Flexible budgets adjust the static budget for what actually happened. In addition, because
management usually ends up working off the adjusted budget, the adjusted budget essentially
becomes the new static budget, which managers will adjust again later. Some managers see flexible
budgets as merely a series of static budgets for these reasons.

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Managerial Accounting, Jiambalvo, pgs. 385-386

CLASS: Why do we try to get a standard cost for items going into the products we manufacture?
What do we see when we analyze the variances?
The core reason for using standard costs is that there are a number of applications where it is too
time-consuming to collect actual costs, so standard costs are used as a close approximation to
actual costs.
Variance analysis, in budgeting (or management accounting in general), is a tool of budgetary
control by evaluation of performance by means of variances between budgeted amount, planned
amount or standard amount and the actual amount incurred/sold.
When actual results are better than expected results given variance is described as favorable
variance.
When actual results are worse than expected results given variance is described as adverse
variance, or unfavorable variance.

CLASS, PROBLEM #1 FOR EVERYONE:

Erroll Company produces Basketballs. The standard cost for each Basketball is:
Direct material, 4 ft @ $6.00/ft = $24.00
Direct labor, 4 hours at $15.00/hr = $60.00
During December 4,000 basketballs were produced. 19,600 ft of leather were purchased at $5.85/ft
and 18,600 ft were used in production. Direct labor costs incurred were $270,000 for 20,000 hours.
a)What is the direct material price variance
b) What is the material usage variance?
c) What is the Labor rate variance?
d) What is the labor efficiency variance?
Be sure to indicate if FAVORABLE or UNFAVORABLE. That is crucial

(review AFTER you post YOUR solution.) Share YOUR work even though I posted a solution.
The formulas for these calculations can be found on page 431 in illustration 11-4.
a). Material Price Variance = (Actual price per unit of material - standard price per unit of material)

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actual quantity of material purchased. So, ($5.85 - $6.00)19,600 = ($2,940) favorable.
b). Material Quantity Variance = (Actual quantity of material used - standard quantity of material
used) standard price per unit of material. So, (18,600 - 16,000)$6.00 = $15,600 unfavorable.
c). Labor Rate Variance = (Actual labor rate per hour - standard labor rate per hour)actual hours
worked. So, ($13.50 - $15.00)20,000 = ($30,000) favorable.
d). Labor Efficiency Variance = (Actual hours worked - standard hours of labor for the actual level of
production)standard labor rate per hour. So, (20,000 - 16,000)$15.00 = $60,000 unfavorable.
SUMMARY:
Material price variance = (2,940) favorable
Material quantity variance = $15,600 unfavorable
Labor rate variance = ($30,000) favorable
Labor efficiency variance = $60,000 unfavorable
Total (not asked for but useful) = $42,660 unfavorable.
I hope this is clear.

Class: Problem #2
Cabin, Inc. manufactures CD's. The standard and actual costing information is provided below.
Cabin uses direct labor hours to allocate overhead.
REQUIRED: Calculate Cabin's:
Part 1) variable manufacturing overhead spending variance and
Part 2) variable overhead efficiency variance.
Also specify whether each variance is favorable or unfavorable.
INFORMATION:
Standard Price and Quantities
Labor 3 hours per unit..... 16.00 per DL hour
Variable Overhead Application Rate $ 10.00 per DL hour
Budgeted and Actual Information:
Planned Production 2,000 units
Actual Production 1860 units

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DL hours used 5800 hours
DL Hours Budgeted for Period 6,000 hours
Actual DL cost $98,550
Total Variable Manufacturing Overhead $ 51,400
Actual Fixed Overhead $69,900
Total Budgeted Fixed Overhead $67,700

CLASS: Solution for #2, Part 1-- Variable Manufacturing Overhead Spending Variance.

There is a lot of extraneous material given in the problem. I gave you the problem as you would see
it on the Test.

For this part we look at what we thought we would spend in overhead in a FLEXIBLE Budget.

We actually used 5800 Hours of Direct Labor. We set up a rate of $10 in Variable overhead per each
Direct Labor Hour. THEREFORE we should have SPENT in variable overhead 5800*$10 or $58,000.

We actually spent $51,400 in Variable Manufacturing Overhead therefore we SPENT less than was
budgeted based upon the budget we had set up. We take the difference and get a FAVORABLE
Spending variance of $6600.

CLASS: Solution for #2, Part 2-- Variable Manufacturing Overhead EFFICIENCY Variance.

For this part we look at what we thought we would USE in overhead in a FLEXIBLE Budget.

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We actually MADE 1860 units. We set up a rate of 3 HOURS per each Unit. THEREFORE we
should have USED 1860* 3 hours or =5580 HOURS.

We actually used 5800 HOURS. Therefore we USED 220 MORE HOURS than was budgeted based
upon the budget we had set up.

We take the difference of 220 HOURS and multiply it by the variable overhead rate of $10 that was
set up in our flexible budget. Therefore 220*$10 = 2200 UNFAVORABLE because we used 220
MORE hours than our budget allowed us to use.

WHEW!
I know this is very confusing the first (and second) time you see it. This is the wording so study it and
post questions and answer other students questions.

Class: Problem #3
Reeba Inc. manufactures chairs. The company uses standard costing and has developed the
following information about standards for its product:

Materials: 10 pounds per unit; $15 per yard

Labor: 2 DL hour per unit; $16 per hour

During October, the company experienced an unanticipated drop in demand and decreased
production. Although planned production was for 6,000 units, the company actually produced 5,000
units. In anticipation of the original production volume, 60,000 yards were purchased, at a total cost
of $870,000.

During the month, 57,000 yards of material were used, and 11,000 direct labor hours were worked.
Direct labor cost for the month totaled $173,800.

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Compute 1) the direct labor rate variance and 2) the direct labor efficiency variance. Specify if each
is favorable or unfavorable.

(HELP: ignore any references to material since this problem only asks for LABOR variances.)
HELP Class:
PART 1,
Standard direct labor = $16.00
Actual DL = $15.80 ($173,800 / 11,000)
Variance per hour = $0.20 (Standard DL less Actual DL) We multiply this by what?

Problem #3, Solutions,

PART 1,
Standard direct labor = $16.00
Actual DL = $15.80 ($173,800 / 11,000)
Variance per hour = $0.20 (Standard DL less Actual DL) We multiply this by 11,000 hours.
Total labor variance = $2,200 favorable because we spent less per hour on those hours.

PART 2
In this case we anticipated 10,000 hours for 5000 units but used 11,000 so we used MORE than we
anticipated so that is Unfavorable.

Direct Labor Efficiency Variance

(11,000-10,000) hours = 1000 unfavorable hours.
We multiply this by our standard rate of $16= $16,000

(Can everyone see that to get 10,000 we took 2 Direct Labor hours per unit X 5000 which was the
units that were actually produced?)

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Therefore: $16(1000)=+/-16,000 Unfavorable

Given a firm's objectives and data, develop budgets (for example, flexible, master, capital) for
10 planning purposes and performance evaluation using techniques, such as standard costs,
variance analysis, and financial statement analysis.
Key Concepts

List and explain the advantages and disadvantages of decentralization.

Explain why companies evaluate the performance of subunits and subunit managers.

Identify cost centers, profit centers, and investment centers.

Calculate and interpret return on investment (ROI), residual income (RI), and economic
value added (EVA).

Explain why managers analyze financial statements.

Perform horizontal and vertical analysis of the balance sheet and the income statement.

Calculate and interpret profitability, turnover, and debt-related ratios.

Class: What do each of the "centers" represent?

How do they measure performance?

It is important to understand how managers are evaluated since you may be evaluated by these
same methods someday. Discuss your experiences with the way you are evaluated in your
company, and how the managers in your company are evaluated.
Centers or Responsibility Centers are considered divisions, subunits, and departments of
organizational units responsible for the generation of incurred costs and revenues.

These centers are:

Cost center responsible for controlling cost not generating revenues. Compare actual cost with
standard or budgeted cost.
Profit center responsible for generating revenues and controlling cost. Evaluation of profit center
are sometimes used to help management focus on ways to maximizing profit-center profitability.

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Investment center responsible for generating revenues, controlling cost and investing in assets.
Investment center determine the level of inventory, accounts receivable, the investment in equipment
and other assets held.

Performance is measured by how well all costs, budgets and assets are used or controlled in
divisions, subunits, and departments of organizational units.

Managerial Accounting, Jiambalvo, pgs. 456-459

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CLASS: problem #1:

A) Assume WAX Inc has net income $7,000,000, interest expense of $1,500,000 and a tax rate of
40%. Calculate the NOPAT.
b)If this (same) company had sales of $10,000,000 what is the company's profit margin?
C) What do these amounts tell us?

(For part A.)

Calculated as: 7,000,000 + 1,500,000 - (40% * 1,500,000)= $7,900,000
Net Income
Plus Interest Expense
Less Tax Savings
NOPAT

$7,000,000
$1,500,000
$600,000
$7,900,000

($1,500,000*.40)

(For part B.)

Profit Margin (PM) = Income / Sales (expressed in %)
PM =($7,000,000 / $10,000,000)= .70 or 70%

Calculated as:
NOPAT = Operating Income x (1 - Tax Rate) NOPAT shows the operating profit after Taxes, or
the company's potential cash earnings if its capitalization were unleveraged (that is, if it had no
debt).
Profit Margin is the ratio of profitability calculated as net income divided by revenues, or net profits
divided by sales. It measures how much out of every dollar of sales a company actually keeps in
earnings.

Book Defines as
Profit Margin is the ratio of income to sales. Managers use this information to improve income
earned on each dollar of sales. Such as, generate more sales for each dollar invested.

Managerial Accounting, Jiambalvo, pgs. 460-461

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Class: Problem #2
Sam Co. specializes in selling shavers.
In the most recent year, the company had net operating income of
$6,000,000 on sales of $90,000,000. The company's average operating assets for the year were
$30,000,000 and its minimum rate of return is 18%.
Ignore the impact of income taxes in your calculation.
Compute the company's residual income for the year.
(A little help on Problem #2:
Residual Income is the income we have in excess of our minimum desired. Just calculate the
desired income --in this case it is at 18%-- and any amount over that is "residual".)

Class: Solution to Problem #2:

To determine the required profit we multiply the rate of return required by the investment. So:
30,000,000 x 18% =$5,400,000, desired Net Income. Any amount over this would be "residual".

Net Income is actually $6,000,000. So $6,000,000 - $5,400,000 = $600,000 Residual Income

Problem #3:
Current Assets:.....................year 1........year 2
Cash and marketable securities 160,000 ..150,000
Accounts receivable, net .......175,000... 170,000
Inventory ..........................140,000 ...150,000
Total current assets ............475,000 ......470,000
Current Liabilities:
Accounts payable ................150,000 ....140,000
Accrued liabilities ................50,000 .......60,000
Notes payable, short term ......140,000 .....140,000
Total current liabilities ...........340,000 ......340,000

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Sales ..........................$5,500,000
Cost of goods sold .........$2,750,000
Required: Calculate the Inventory Turnover ratio.
What does this ratio tell management?

Class: Solution to Problem #3:

As many of you wrote,
COGS = $2,750,000.
You then average both inventories and get $290,000/2= $145,000
The formula for Inventory Turnover Ratio is the Cost of Goods sold divided by Average Inventory
$2,750,000 / $145,000 = 18.9655 or 19 times
What does this ratio tell management? Is this good or bad? WHY?
This ratio tells management to determine how they can increase or decrease their sales through
inventory control.

Class: What are the differences between the "current ratio" and the "acid-test ratio"? What do these
ratios tell management?

Suppose net income is much higher than cash flows from operations. Why is this potentially
indicative of earnings manipulation?

Current ratio is similar to the acid-test ratio except that the acid-test ratio does not include inventory
and assets that can be liquidated.

The components of current ratio (current assets and current liabilities) can be used to derive working
capital (difference between current assets and current liabilities).

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The acid-test ratio is far more strenuous than the working capital ratio, primarily because the working
capital ratio allows for the inclusion of inventory assets.

Also, if the acid-test ratio is much lower than the working capital ratio, it means current assets are
highly dependent on inventory.
Class: problem #1
The Lance Company, provides various services.
Financial information concerning the most recent
year appears below:
Sales $12,000,000
Net operating income $3,300,000
Average operating assets $30,000,000
Ignore the impact of income taxes in your calculation.
Compute the return on investment (ROI) for the company

Solution to Problem #1
The long way is:
Return On Investment (ROI) = Profit Margin * Investment Turnover
Profit Margin =$3,300,000 (Net Operating Income) / $12,000,000 (Sales) = 27.5%
Investment Turnover = $12,000,000 (Sales) / $30,000,000 (Average Operating Assets) = 40%
Return On Investment (ROI) = $3,300,000 / $12,000,000 (Profit Margin) * $12,000,000 / $30,000,000 (Investment
Turnover)= 0.275 * 0.400 = 0.11 = 11%
Shortcut:
Divide Net Income by Avg. Operating Assets
3,300,000/30,000,000 = .11 or 11%
Answer:11% Return On Investment (ROI)

Note: the long way is technically more correct but the shortcut is fine.

Class: Problem #2 (similar to #1)

The Young Co., provides various services.
Financial information concerning the most recent
year (not a successful year) appears below:
Sales $80,000,000

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Net operating income $500,000
Average operating assets $100,000,000
Ignore the impact of income taxes in your calculation.
a) Compute the return on investment (ROI) for the company.
b) Discuss what you think about their year
Class: Solution to Problem #2
Since: Sales are $80,000,000;
Net operating income is $500,000; and Average operating assets $100,000,000
Formula:
ROI = net operating income /average operating assets
ROI= $500,000/100,000,000= 0.005 (same as 0.5%). This is one half of 1%. This is a very low % but
it is still a positive return.
(Longer method:
margin = $500,000/$80,000,000=63
Turnover = $80,000,000/$100,000,000=.80
therefore: ROI = .63*.80=.5%)
Question b): Discuss what you think about their year-- Class: Discuss.
The Young Co. Class Discuss.

Sine Sales: $80,000,000

Net Operating Income: $500,000
Average Operating Assets: $100,000,000

Return on Investment = Net Operating Income / Average Operating Assets

Return on Investment = $500,000/$100,000,000= 0.005 Which comes out to one half of 1%.
Although half of 1% of returns is a little low, it's still not a loss which could be considered still a great
year for the business.

Class:
Describe the formula for one debt-related ratio (you choose) and explain how to interpret the ratio. Also,
give a mathematical example of how it works.

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Class:
Describe the formula for one debt-related ratio (you choose) and explain how to interpret the ratio.
Also, give a mathematical example of how it works.

total debt
total assets
so that would make it 10M / 300M = .0333 = 3.33%

Great pick of formula for debt in company balance sheets. Debt to equity ratio is used to describe
the companys financial affairs. When a company increases its debt, the organization is in higher risk
for failure in the companys financial structure.
Value=liabilities + stockholder's equity
= $390,000 + $1,200,000= $1,590,000(companies value)

Debt to Equity Ratio = Total Liabilities / Stockholders Equity

The debt to equity ratio looks at the amount of debt an organization has in relation the amount of
capital. This ratio can be used to determine if an organization has too much debt. The higher the
ratio the higher the organizations debt is.
Total Liabilities = $390,000
Stockholders Equity = $1,200,000
Debt to Equity Ratio = $390,000/$1,200,000
Debt to Equity Ratio = 0.325 or 32.5%

Debt/EBITDA Ratio is the comparison of financial borrowings and earnings before

interest, taxes, depreciation and amortization. It is a measure of the ability of a company
to pay off its debts. It compares the financial obligations of a company, inclusive of debt
and other liabilities, to the actual cash earnings exclusive of the non-cash expenses.
The debt/EBITDA ratio is calculated by dividing the debts by the Earnings before
Interest, Taxes, Depreciation and Amortization (EBITDA).
Debt/EBITDA ratio = Liabilities / EBITDA