1-1 Managerial accounting is concerned with providing
information to managers for their use internally in the organization.
Financial accounting is concerned with providing information to
stockholders, creditors, and others outside of the organization.
1-2 Essentially, the manager carries out three major activities in
an organization: planning, directing and motivating, and controlling. All
three activities involve decision making.
1-3 The Planning and Control Cycle involves the following steps:
formulating plans, implementing plans, measuring performance, and
evaluating differences between planned and actual performance.
1-4 The manager relies on feedback to assure that activities are
under control; that is, to assure that things are going according to
plan.
1-5 A line position is directly related to the achievement of the
basic objectives of the organization. A staff position is not directly
related to the achievement of those objectives; rather, it is supportive,
providing services and assistance to other parts of the organization.
1-6 In contrast to financial accounting, managerial accounting:
(1) focuses on the needs of the manager; (2) places more emphasis
on the future; (3) emphasizes relevance and flexibility, rather than
precision; (4) emphasizes the segments of an organization; (5) is not
governed by GAAP; and (6) is not mandatory.
1-7 At the final assembly stage in a JIT system, a signal is sent
to the preceding workstation as to the exact parts and materials that
will be needed over the next few hours for the final assembly of
products. Only those parts and materials are provided. The same
signal is sent back through each preceding workstation so that a
smooth flow of parts and materials is maintained with no buildup of
inventories at any point. Thus, all workstations respond to the pull
exerted by the final assembly stage.
The pull approach just described can be contrasted to the
push approach used in conventional systems. In a conventional
system, inventories of parts and materials are built upoften simply to
keep everyone busy. These semi-completed parts and materials are
pushed forward to the next workstation whether or not there is
actually any customer demand for the products they will become part
of. The result is large stockpiles of work in process inventories.
1-8 A number of benefits accrue from reduced setup time. First,
reduced setup time allows a company to produce in smaller batches,
which in turn reduces the level of inventories. Second, reduced setup
time allows a company to spend more time producing goods and less
time getting ready to produce. Third, the ability to rapidly change from
making one product to making another allows the company to respond
more quickly to customers. Finally, smaller batches make it easier to
spot manufacturing problems before they result in a large number of
defective units.
1-9 The main benefits of a successful JIT system are reductions
in: (1) funds tied up in inventories; (2) space requirements; (3)
throughput time; and (4) defects.
1-10 In the Plan phase, data are analyzed to identify a possible
cause for a problem and a solution is proposed. In the Do phase, an
experiment is conducted. In the Check phase, data from the
experiment are analyzed. In the Act phase, the solution is
implemented if the experiment was successful. If the experiment was
not successful, the Plan phase is restarted. This cycle closely parallels
the scientific method.
1-11 TQM generally approaches improvement in a series of small
steps that are planned and implemented by teams of front-line
workers. Process Reengineering involves completely redesigning
business processes from the ground upoften with the use of outside
consultants.
2-1 The three major elements of product costs in a
manufacturing company are direct materials, direct labor, and
manufacturing overhead.
2-2
a. Direct materials are an integral part of a finished product and
can be conveniently traced to it.
b. Indirect materials are generally small items of material such as
glue and nails. They may be an integral part of a finished product but
can be traced to the product only at great cost or inconvenience.
Indirect materials are ordinarily classified as manufacturing overhead.
c. Direct labor includes those labor costs that can be easily
traced to particular products. Direct labor is also called touch labor.
d. Indirect labor includes the labor costs of janitors, supervisors,
materials handlers, and other factory workers that cannot be
conveniently traced to particular products. These labor costs are
incurred to support production, but the workers involved do not
directly work on the product.
e. Manufacturing overhead includes all manufacturing costs
except direct materials and direct labor.
2-3 A product cost is any cost involved in purchasing or
manufacturing goods. In the case of manufactured goods, these costs
consist of direct materials, direct labor, and manufacturing overhead. A
period cost is a cost that is taken directly to the income statement as
an expense in the period in which it is incurred.
2-4 The income statement of a manufacturing company differs
from the income statement of a merchandising company in the cost of
goods sold section. The merchandising company sells finished goods
that it has purchased from a supplier. These goods are listed as
Purchases in the cost of goods sold section. Since the manufacturing
company produces its goods rather than buying them from a supplier,
it lists Cost of Goods Manufactured in place of Purchases. Also, the
manufacturing company identifies its inventory in this section as
Finished Goods Inventory, rather than as Merchandise Inventory.
2-5 The schedule of cost of goods manufactured lists the
manufacturing costs that have been incurred during the period. These
costs are organized under the three major categories of direct
materials, direct labor, and manufacturing overhead. The total costs
incurred are adjusted for any change in the Work in Process inventory
to determine the cost of goods manufactured (i.e. finished) during the
period.
The schedule of cost of goods manufactured ties into the
income statement through the Cost of Goods Sold section. The cost of
goods manufactured is added to the beginning Finished Goods
inventory to determine the goods available for sale. In effect, the cost
of goods manufactured takes the place of the Purchases account in a
merchandising firm.
2-6 A manufacturing company has three inventory accounts:
Raw Materials, Work in Process, and Finished Goods. A merchandising
company generally identifies its inventory account simply as
Merchandise Inventory.
2-7 Since product costs follow units of product into inventory,
they are sometimes called inventoriable costs. The flow is from direct
materials, direct labor, and manufacturing overhead to Work in
Process. As goods are completed, their cost is removed from Work in
Process and transferred to Finished Goods. As goods are sold, their
cost is removed from Finished Goods and transferred to Cost of Goods
Sold. Cost of Goods Sold is an expense on the income statement.
2-8 Yes, costs such as salaries and depreciation can end up as
assets on the balance sheet if these are manufacturing costs.
Manufacturing costs are inventoried until the associated finished goods
are sold. Thus, such costs may be part of either Work in Process
inventory or Finished Goods inventory at the end of a period if there
are unsold units.
2-9 Cost behavior refers to how a cost will react or respond to
changes in the level of business activity.
2-10 No. A variable cost is a cost that varies, in total, in direct
proportion to changes in the level of activity. A variable cost is
constant per unit of product. A fixed cost is fixed in total, but will vary
inversely on an average per-unit basis with changes in the level of
activity.
2-11 When fixed costs are involved, the average cost of a unit of
product will depend on the number of units being manufactured. As
production increases, the average cost per unit will fall as the fixed
cost is spread over more units. Conversely, as production declines, the
average cost per unit will rise as the fixed cost is spread over fewer
units.
2-12 Manufacturing overhead is an indirect cost since these costs
cannot be easily and conveniently traced to particular products.
2-13 A differential cost is a cost that differs between alternatives
in a decision. An opportunity cost is the potential benefit that is given
up when one alternative is selected over another. A sunk cost is a cost
that has already been incurred and cannot be altered by any decision
taken now or in the future.
2-14 No; differential costs can be either variable or fixed. For
example, the alternatives might consist of purchasing one machine
rather than another to make a product. The difference in the fixed
costs of purchasing the two machines would be a differential cost.
2-17 Costs associated with the quality of conformance can be
broken down into prevention costs, appraisal costs, internal failure
costs, and external failure costs. Prevention costs are incurred in an
effort to keep defects from occurring. Appraisal costs are incurred to
detect defects before they can create further problems. Internal and
external failure costs are incurred as a result of producing defective
units.
2-18 Total quality costs are usually minimized by increasing
prevention and appraisal costs in order to reduce internal and external
failure costs. Total quality costs usually decrease as prevention and
appraisal costs increase.
2-19 Shifting the focus to prevention and away from appraisal is
usually the most effective way to reduce total quality costs. It is
usually more effective to prevent defects than to attempt to fix them
after they have already occurred.
2-20 First, a quality cost report helps managers see the financial
consequences of defects. Second, the report may help managers
identify the most important areas for improvement. Third, the report
helps managers see whether their quality costs are appropriately
distributed among prevention, appraisal, internal failure, and external
failure costs.
2-21 Most accounting systems do not track and accumulate the
costs of quality. It is particularly difficult to get a feel for the
magnitude of quality costs since they are incurred in many
departments throughout the organization.
3-1 By definition, overhead consists of costs that cannot
practically be traced to products or jobs. Therefore, overhead costs
must be allocated rather than traced if they are to be assigned to
products or jobs.
3-2 Job-order costing is used in situations in which many
different products or services are produced each period. Each product
(or job) is different from all others and requires separate costing.
Process costing is used in situations where a single, homogeneous
product, such as cement, bricks, or gasoline, is produced for long
periods.
3-3 The job cost sheet is used to record all costs that are
assigned to a particular job. These costs include direct materials cost
traced to the job, direct labor cost traced to the job, and
manufacturing overhead cost applied to the job. When a job is
completed, the job cost sheet is used to compute the cost per
completed unit. The job cost sheet is also a control document for: (1)
determining how many units have been sold and determining the cost
of these units; and (2) determining how many units are still in
inventory at the end of a period and determining the cost of these
units on the balance sheet.
3-4 A predetermined overhead rate is used to apply overhead to
jobs. It is determined before a period begins by dividing the estimated
total manufacturing overhead for the period by the estimated total
units in the allocation base. Thereafter, overhead is applied to jobs by
multiplying the predetermined overhead rate by the actual amount of
the allocation base that is incurred for each job. The most common
allocation base is direct labor hours.
3-5 A sales order is issued after a firm agreement has been
reached with a customer on matters relating to quantities, prices, and
shipment dates for goods. This sales order then forms the basis for the
production department to issue a production order. The production
order specifies what is to be produced and forms the basis for the
accounting departments preparation of a job cost sheet. The job cost
sheet, in turn, is used to summarize the various production costs
incurred in completing the job. These costs are entered on the job cost
sheet by means of materials requisition forms, direct labor time tickets,
and allocations of overhead via the predetermined overhead rate.
3-6 Many production costs cannot be traced to a particular
product or job, but rather are incurred as a result of overall production
activities. Therefore, to be assigned to products, such costs must be
allocated to the products in some manner. Examples of such costs
would include utilities, maintenance on machines, and depreciation of
the factory building. These costs are indirect production costs.
3-7 If actual manufacturing overhead cost is applied to jobs,
then either the firm must wait until the end of the period to apply
overhead or it must compute actual overhead rates more frequently. If
it waits to the end of the period to apply overhead, it will be unable to
cost jobs until the end of the period. If the company computes the
actual overhead rates more frequently, they may fluctuate widely.
Overhead cost tends to be incurred somewhat evenly from month to
month (due to the presence of fixed costs), whereas production
activity often fluctuates. The result would be high overhead rates in
periods with low activity and low overhead rates in periods with high
activity. For these reasons, most firms use predetermined overhead
rates to apply overhead cost to jobs.
3-8 The measure of activity that is used as the allocation base
should drive the overhead cost; that is, the base should cause the
overhead cost. If the allocation base does not really cause the
overhead, then costs will be incorrectly attributed to products and jobs
and their costs will be distorted.
3-9 Assigning overhead costs to jobs does not ensure that there
will be a profit. The units produced may not be sold and if they are
sold, they may not in fact be sold at prices sufficient to cover all costs.
It is a myth that assigning costs to products or jobs ensures that those
costs will be recovered. Costs are recovered only by selling to
customersnot by allocating costs.
3-10 The Manufacturing Overhead account is credited when
overhead cost is applied to Work in Process. Generally, the amount of
overhead applied will not be the same as the amount of actual cost
incurred, since the predetermined overhead rate that is used in
applying overhead is based on estimates.
3-11 Underapplied overhead occurs when the actual overhead
cost exceeds the amount of overhead cost applied to Work in Process
inventory during the period. Overapplied overhead occurs when the
actual overhead cost is less than the amount of overhead cost applied
to Work in Process inventory during the period. Under- or overapplied
overhead is disposed of by either closing out the amount to Cost of
Goods Sold or allocating the amount among Cost of Goods Sold and
ending inventories in proportion to the applied overhead in each
account. The adjustment for underapplied overhead increases Cost of
Goods Sold (and inventories) whereas the adjustment for overapplied
overhead decreases Cost of Goods Sold (and inventories).
3-12 Overhead may be underapplied for a number of reasons.
One reason might be that there was not good control over overhead
spending and as a result actual overhead costs exceeded estimated
overhead costs. Another reason might be that some of the overhead is
fixed and actual amount of the allocation base was less than estimated
at the beginning of the period. The amount of overhead applied to
Work in Process will decline in proportion to a decline in the allocation
base. However, if there is any fixed cost in the overhead, it will not
decline as much as the volume declines and hence overhead will be
underapplied.
3-13 Underapplied overhead is added to cost of goods sold since
underapplied overhead implies that not enough overhead was assigned
to jobs during the period and therefore cost of goods sold is
understated. Likewise, overapplied overhead is deducted from cost of
goods sold.
3-14 Yes, overhead should be applied in order to properly value
the Work in Process inventory at year-end. Since $6,000 of overhead
was applied to Job A on the basis of $8,000 of direct labor cost, the
companys predetermined overhead rate must be 75% of direct labor
cost. Thus, $3,000 of overhead should be applied to Job B at year-
end: $4,000 direct labor cost 75% = $3,000 overhead costs applied.
3-16 A plantwide overhead rate is a single overhead rate used
throughout all production departments in a plant. Some companies use
multiple overhead rates, rather than plantwide rates, to more
appropriately allocate overhead costs among products. Multiple
overhead rates should be used, for example, in situations where one
department is machine intensive and another department is labor
intensive.
3-17 When direct labor is replaced by automated equipment,
overhead increases and direct labor decreases. This results in an
increase in the predetermined overhead rate if it is based on direct
labor.
5-1
a. Variable cost: A variable cost remains constant on a per unit
basis, but changes in total in direct relation to changes in volume.
b. Fixed cost: A fixed cost remains constant in total amount, but
changes, if expressed on a per unit basis, inversely with changes
in volume.
c. Mixed cost: A mixed cost contains both variable and fixed cost
elements.
5-2
a. Unit fixed costs decrease as volume increases.
b. Unit variable costs remain constant as volume increases.
c. Total fixed costs remain constant as volume increases.
d. Total variable costs increase as volume increases.
5-3
a. Cost behavior: Cost behavior refers to the way in which costs
change in response to changes in some underlying activity, such
as sales volume, production volume, or orders processed.
b. Relevant range: The relevant range is the range of activity within
which assumptions relative to variable and fixed cost behavior are
valid.
5-4 An activity base is a measure of whatever causes the
incurrence of a variable cost. Examples of activity bases include units
produced, units sold, letters typed, beds in a hospital, meals served in
a cafe, service calls made, etc.
5-5 (See the exhibit below.)
a. Variable cost: A variable cost remains constant on a per unit
basis, but increases or decreases in total in direct relation to
changes in activity.
b. Mixed cost: A mixed cost is a cost that contains both variable and
fixed cost elements.
c. Step-variable cost: A step-variable cost is a cost that is incurred in
large chunks, and which increases or decreases only in response
to fairly wide changes in activity.
Mixed Cost
Variable Cost
Cost
Step-Variable Cost
Activity
5-6 The linear assumption is reasonably valid providing the cost
formula is used only within the relevant range.
5-7 A discretionary fixed cost is one that has a fairly short
planning horizonusually a year. Such costs arise from annual
decisions by management to spend in certain fixed cost areas, such as
advertising, research, and management development. A committed
fixed cost is one that has a long planning horizongenerally many
years. Such costs relate to a companys investment in facilities,
equipment, and basic organization. Once such costs have been
incurred, a company becomes locked in to the decision for many
years.
5-8
a. Committed d. Committed
b. Discretionary e. Committed
c. Discretionary f. Discretionary
5-9 Yes. As the anticipated level of activity changes, the level of
fixed costs needed to support operations will also change. In essence,
fixed costs should be viewed as being adjustable upward and
downward in broad steps, rather than being absolutely fixed at one
level for all ranges of activity.
5-10 The major disadvantage of the high-low method is that it
uses only two points to determine a cost formula and these two points
are likely to be less than typical since they represent extremes of
activity.
5-11 A regression line can be expressed in formula form as Y = a
+ bX. In cost analysis, the a term represents the fixed cost element,
and the b term represents the variable cost element per unit of
activity.
5-12 The term least-squares regression means that the sum of
the squares of the deviations from the plotted points on a graph to the
regression line is smaller than could be obtained from any other line line would rise more steeply, and the break-even point would occur at
that could be fitted to the data. a higher volume of units.

5-13 Ordinary single least-squares regression analysis is used
when a variable cost is a function of only a single factor. If a cost is a
function of more than one factor, then multiple regression analysis
must be used to accurately analyze the behavior of the cost.
5-14 The contribution approach to the income statement
organizes costs by behavior, first deducting variable expenses to obtain
contribution margin, and then deducting fixed expenses to obtain net
operating income. The traditional approach organizes costs by
function, such as production, selling, and administration. Within a
functional area, fixed and variable costs are intermingled.
5-15 The contribution margin is total sales revenue less total
variable expenses.
6-1 The contribution margin (CM) ratio is the ratio of
contribution margin to total sales revenue. The CM ratio shows the
change in contribution margin that will result from a change in total
sales. If fixed costs do not change, then a dollar increase in
contribution margin will result in a dollar increase in net operating
income. Therefore, for planning purposes, knowledge of a products
CM ratio is extremely helpful in forecasting contribution margin and net
operating income.
6-2 An incremental analysis focuses on the changes in revenue,
cost, and volume that will result from a particular action.
6-3 All other things equal, Company B, with its higher fixed costs
and lower variable costs, will have a higher contribution margin ratio.
Therefore, it will tend to realize the most rapid increase in contribution
margin and in profits when sales increase.
6-4 Operating leverage measures the impact on net operating
income of a given percentage change in sales. The degree of operating
leverage at a given level of sales is computed by dividing the
contribution margin at that level of sales by the net operating income.
6-10 The margin of safety is the excess of budgeted (or actual)
sales over the break-even volume of sales. It states the amount by
which sales can drop before losses begin to be incurred.
6-11 Company X, with its higher fixed costs and lower variable
costs, would have a higher break-even point than Company Y. Hence,
Company X would also have the lower margin of safety.
6-12 The sales mix is the relative proportions in which a
companys products are sold. The usual assumption in cost-volume-
profit analysis is that the sales mix will not change.
6-13 A higher break-even point and a lower net operating income
could result if the sales mix shifted from high contribution margin
products to low contribution margin products. Such a shift would cause
the average contribution margin ratio in the company to decline,
resulting in less total contribution margin for a given amount of sales.
Thus, net operating income would decline. With a lower contribution
margin ratio, the break-even point would be higher since it would
require more sales to cover the same amount of fixed cost.
A number of assumptions commonly underlie CVP analysis:
1. Selling price is constant. The price of a product or service will not
change as volume
changes.
2. Costs are linear and can be accurately divided into variable and
fixed elements. The
variable element is constant per unit, and the fixed element is constant
in total over
the entire relevant range.
3. In multiproduct companies, the sales mix is constant.
4. In manufacturing companies, inventories do not change. The
number of units produced equals the number of units sold.

6-5 No. A 10% decrease in the selling price will have a greater
impact on profits than a 10% increase in variable expenses, since the
selling price is a larger figure than the variable expenses.
Mathematically, the same percentage applied to a larger base will yield
a larger result. In addition, the selling price affects how much of the
product will be sold.

6-6 The break-even point is the level of sales at which an

organization neither earns a profit nor incurs a loss. It can also be
defined as the point where total revenue equals total cost, and as the
point where total contribution margin equals total fixed cost.

6-7 Three approaches to break-even analysis are (a) the

equation method, (b) the contribution margin method, and (c) the
graphical method. In the equation method, the equation is: Sales =
Variable expenses + Fixed expenses + Profits, where profits are zero
at the break-even point. The equation is solved to determine the
break-even point in units or dollar sales.
In the contribution margin method, total fixed cost is divided
by the contribution margin per unit to obtain the break-even point in
units. Alternatively, total fixed cost can be divided by the contribution
margin ratio to obtain the break-even point in sales dollars.
In the graphical method, total cost and total revenue data
are plotted on a two-axis graph. The intersection of the total cost and
the total revenue lines indicates the break-even point. The graph
shows the break-even point in both units and dollars of sales.

6-8 (a) The total revenue line would rise less steeply, and the
break-even point would occur at a higher volume of units. (b) Both the
fixed cost line and the total cost line would shift upward; the break-
even point would occur at a higher volume of units. (c) The total cost