COMPREHENSIVE CASE 2

Chapters 5–10
Metcalf Furniture Corporation produces sofas, recliners, and lounge chairs. Metcalf is located in a
medium-sized community in the northwestern part of the United States. It is a major employer in the
community. In fact, the economic well-being of the community is tied very strongly to Metcalf.
Metcalf operates a sawmill, a fabric plant, and a furniture plant in the same community.
The sawmill buys logs from independent producers. The sawmill then processes the logs into four
grades of lumber: firsts and seconds, No. 1 common, No. 2 common, and No. 3 common. All costs
incurred in the mill are common to the four grades of lumber. All four grades of lumber are used by the
furniture plant. The mill transfers everything it produces to the furniture plant, and the grades are
transferred at cost. Trucks are used to move the lumber from the mill to the furniture plant. Although
no outside sales exist, the mill could sell to external customers, and the selling prices of the four
grades are known.
The fabric plant is responsible for producing the fabric that is used by the furniture plant. To
produce three totally different fabrics (identified by fabric ID codes: FB60, FB70, and FB80,
respectively), the plant has three separate production operations—one for each fabric. Thus,
production of all three fabrics occurs at the same time in different locations in the plant. Each fabric’s
production operation has two processes: the weaving and pattern process and the coloring and bolting
process. In the weaving and pattern process, yarn is used to create yards of fabric with different
designs. In the next process, the fabric is dyed, cut into 25-yard sections, and wrapped around
cardboard rods to form 25-yard bolts. The bolts are transported by forklift to the furniture plant’s
Receiving Department. All of the output of the fabric plant is used by the furniture plant (to produce
the sofas and chairs). For accounting purposes, the fabric is transferred at cost to the furniture plant.
The furniture plant produces orders for customers on a special-order basis. The customers specify
the quantity, style, fabric, lumber grade, and pattern. Typically, jobs are large (involving at least 500
units). The plant has two production departments: Cutting and Assembly. In the Cutting Department,
the fabric and wooden frame components are sized and cut. Other components are purchased from
external suppliers and are removed from stores as needed for assembly. After the fabric and wooden
components are finished for the entire job, they are moved to the Assembly Department. The
Assembly Department takes the individual components and assembles the sofas (or chairs).
Metcalf Furniture has been in business for over two decades and has a good reputation. However,
during the past five years, Metcalf experienced eroding profits and declining sales. Bids were
increasingly lost (even aggressive bids) on the more popular models. Yet, the company was winning
bids on some of the more-difficult-to-produce items. Sean Williams, the owner and manager, was
frustrated. He simply couldn’t understand how some of his competitors could sell for such low prices.
On a common sofa job involving 500 units, Metcalf’s bids were running $25 per unit or $12,500 per
job more than the winning bids (on average). Yet, on the more difficult items, Metcalf’s bids were
running about $60 per unit less than the next closest bid. Debbie Lochner, vice president of finance,
was assigned the task of preparing a cost analysis of the company’s product lines. Sean wanted to
know if the company’s costs were excessive. Perhaps the company was being wasteful, and it was
simply costing more to produce furniture than it was costing its competitors.
Debbie prepared herself by reading recent literature on cost management and product costing and
attending several conferences that explored the same issues. She then reviewed the costing procedures
of the company’s mill and two plants and did a preliminary assessment of their soundness. The
production costs of the mill were common to all lumber grades and were assigned using the physical
units method. Since the output and production costs were fairly uniform throughout the year, the mill

1
used an actual costing system. Although Debbie had no difficulty with actual costing, she decided to
explore the effects of using the sales-value-at-split-off method. Thus, cost and production data for the
mill were gathered so that an analysis could be conducted. The two plants used normal costing
systems. The fabric plant used process costing, and the furniture plant used job-order costing. Both
plants used plantwide overhead rates based on direct labor hours. Based on her initial reviews, she
concluded that the costing procedures for the fabric plant were satisfactory. Essentially, there was no
evidence of product diversity. A statistical analysis revealed that about 90 percent of the variability in
the plant’s overhead cost could be explained by direct labor hours. Thus, the use of a plantwide
overhead rate based on direct labor hours seemed justified. What did concern her, though, was the
material waste that she observed in the plant. Maybe a standard cost system would be useful for
increasing the overall cost efficiency of the plant. Consequently, as part of her report to Sean, she
decided to include a description of the fabric plant’s costing procedures—at least for one of the fabric
types. She also decided to develop a standard cost sheet for the chosen fabric. The furniture plant,
however, was a more difficult matter. Product diversity was present and could be causing some
distortions in product costs. Furthermore, statistical analysis revealed that only about 40 percent of the
variability in overhead cost was explained by the direct labor hours. She decided that additional
analysis was needed so that a sound product costing method could be recommended. One possibility
would be to increase the number of overhead rates. Thus, she decided to include departmental data so
that the effect of moving to departmental rates could be assessed. Finally, she also wanted to explore
the possibility of converting the sawmill and fabric plant into profit centers and changing the existing
transfer pricing policy.
With the cooperation of the cost accounting manager for the mill and each plant’s controller, she
gathered the following data for last year:

Sawmill:
Joint manufacturing costs: $900,000

Quantity Produced Price at Split-Off

Grade (Board Feet) (per 1,000 Board Ft.)
Firsts and seconds 1,500,000 $300
No. 1 common 3,000,000 225
No. 2 common 1,875,000 140
No. 3 common 1,125,000 100
Total 7,500,000

Fabric Plant:
Budgeted overhead: $1,200,000 (50% fixed)
Practical volume (direct labor hours): 120,000 hours
Actual overhead: $1,150,000 (50% fixed)
Actual hours worked:

Weaving and Pattern Coloring and Bolting Total

2
 Fabric FB60 20,000 12,000 32,000
Fabric FB70 28,000 14,000 42,000
Fabric FB80 26,000 18,000 44,000
Total 74,000 44,000 118,000

Departmental data on Fabric FB70 (actual costs and actual outcomes):

Weaving and Pattern Coloring and Bolting

Beginning inventories:
Units* 20,000 400
Costs:
Transferred in $0 $100,000
Materials $80,000 $8,000
Labor $18,000 $6,600
Overhead $22,000 $9,000
Current production:
Units started 80,000 ?
Units transferred out 80,000 3,200
Costs:
Transferred in $0 ?
Materials $320,000 $82,000
Labor $208,000 $99,400
Overhead ? ?
Percentage completion:
Beginning inventory 30% 40%
Ending inventory 40% 50%
*-Units are measured in yards for the Weaving and Pattern Department and in bolts for the
Coloring and Bolting Department._Note: With the exception of the cardboard bolt rods,
materials are added at the beginning of each process. The cost of the rods is relatively
insignificant and is included in overhead.

Proposed standard cost sheet for Fabric FB70 (for the Coloring and Bolting Department only):

Transferred in materials (25 yards @ $10) $250.00

Other materials (100 ounces @ $0.20) 20.00
Labor (3.1 hours @ $8) 24.80
Fixed overhead (3.1 hours @ $5) 15.50
Variable overhead (3.1 hours @ $5) 15.50
Standard cost per unit $325.80

3
Furniture Plant:
Departmental data (budgeted):

Producing
Service Departments Departments
General
Receiving Power Maintenance Factory Cutting Assembly
Overhead $450,000 $600,000 $300,000 $525,000 $750,000 $375,000
Machine hours — — — — 60,000 15,000
Receiving orders — — — — 13,500 9,000
Square feet 1,000 5,000 4,000 — 15,000 10,000
Direct labor hours — — — — 50,000 200,000

After some discussion with the furniture plant controller, Debbie decided to use machine hours to
calculate the overhead rate for the Cutting Department and direct labor hours for the Assembly
Department rate (the Cutting Department was more automated than the Assembly Department). As
part of her report, she wanted to compare the effects of plantwide rates and departmental rates on the
cost of jobs. She wanted to know if overhead costing could be the source of the pricing problems the
company was experiencing.
To assess the effect of the different overhead assignment procedures, Debbie decided to examine
two prospective jobs. One job, Job A500, could produce 500 sofas, using a frequently requested style
and fabric FB70. Bids on this type of job were being lost more frequently to competitors. The second
job, Job B75, would produce 75 specially designed recliners. This job involved a new design and was
more difficult for the workers to build. It involved some special cutting requirements and an unfamiliar
assembly. Recently, the company seemed to be winning more bids on jobs of this type. To compute the
costs of the two jobs, Debbie assembled the following information on the two jobs:

Job A500:
Direct materials:
Fabric FB70 180 bolts @ $350
Lumber (No. 1 common) 20,000 board feet @ $0.12
Other components $26,600
Direct labor:
Cutting Department 400 hours @ $10
Assembly Department 1,600 hours @ $8.75
Machine time:
Cutting Department 350 machine hours
Assembly Department 50 machine hours

4
 Job B75:
Direct materials:
Fabric FB70 26 yards @ $350
Lumber (first and seconds) 2,200 board feet @ $0.12
Other components $3,236
Direct labor:
Cutting Department 70 hours @ $10
Assembly Department 240 hours @ $8.75
Machine time:
Cutting Department 90 machine hours
Assembly Department 15 machine hours

Required:
1. Allocate the joint manufacturing costs to each grade, and calculate the cost per board foot for
each grade: (a) using the physical units method of allocation and (b) using the sales-value-at-
split-off method. Which method should the mill use? Explain. What is the effect on the cost of
each proposed job if the mill switches to the sales-value-at-split-off method?
2. Calculate the plantwide overhead rate for the fabric plant.
3. Calculate the amount of under- or overapplied overhead for the fabric plant.
4. Using the weighted average method, calculate the cost per bolt for Fabric FB70.
5. Assume that the weaving and pattern process is not a separate process for each fabric. Also,
assume that the yarn used for each fabric differs significantly in cost. In this case, would process
costing be appropriate for the weaving and pattern process? What costing approach would you
recommend? Describe your approach in detail.
6. In the Bolting and Coloring Department, 400,000 ounces of other materials were used to produce
the output of the period. Using the proposed standard cost sheet, calculate the following variances
for the Coloring and Bolting Department:
a.Materials price variance (for other materials only)
b. Materials usage variance (for other materials only)
c.Labor rate variance
d. Labor efficiency variance
In calculating the variances, which method did you use to compute the actual output of the period
—FIFO or weighted average? Explain.
7. Assume that the standard hours allowed for the actual total output of the fabric plant are 115,000.
Calculate the following variances:
a.Fixed overhead spending variance
b. Fixed overhead volume variance
c.Variable overhead spending variance
d. Variable overhead efficiency variance
8. Suppose that the fabric plant has 500 bolts of FB70 in beginning finished goods inventory. The
current-year plan is to have 1,000 bolts of FB70 in finished goods inventory at the end of the
year. This fabric has an external market price of $400 per bolt. If the fabric plant is set up as a
profit center, it could sell 3,000 bolts per year to outside customers and supply 2,000 bolts per
year internally to Metcalf’s furniture plant. If the fabric plant were designated as a profit center,

5
 the plant would transfer all goods internally at market price. Using the proposed standard cost
sheet (as needed) and any other relevant data, prepare the following for Fabric FB70:
a.Sales budget
b. Production budget
c.Direct labor budget
d. Cost of goods sold budget
9. Calculate the following overhead rates for the furniture plant: (1) plantwide rate and (2)
departmental rates. Use the direct method for assigning service costs to producing departments.

10. For each of the overhead rates computed in Requirement 9, calculate unit bid prices for Jobs
A500 and B75. Assume that the company’s aggressive bidding policy is unit cost plus 50
percent. Did departmental overhead rates have any effect on Metcalf’s winning or losing bids?
What recommendation would you make? Explain. Now, adjust the costs and bids for
departmental rate bids using the proposed standard costs for the Coloring and Bolting
Department. Did this make a difference? What does this tell you?

11.Suppose that the fabric plant is set up as a profit center. Bolts of fabric FB70 sell for $400 (or can
be bought for $400 from outside suppliers). The fabric plant and the furniture plant both have
excess capacity. Assume that job A500 is a special order. The fabric and furniture plants have
sufficient excess capacity to satisfy the demands of job A500. What is the minimum transfer price
for a bolt of FB70? If the maximum transfer price is $400, by how much do the fabric plant’s
profits increase if the two profit centers negotiate a transfer price that splits the joint benefit?

6
COMPREHENSIVE CASE 4

Chapters 17–21
Lacey Weinberg is founder and CEO of Golden Care, Inc., which owns and operates several assisted-
living facilities. The facilities are apartment-style buildings with 25 to 30 one- or two-bedroom
apartments. While each apartment has its own complete kitchen, in every building Golden Care offers
communal dining options and an on-site nurse who is available 24 hours a day. Residents can choose
monthly meal options that include one or two meals per day in the dining room. Residents who require
nursing services (e.g., blood pressure monitoring and injections) can receive those services from the
nurse. However, Golden Care facilities are not nursing homes, all residents are ambulatory, and
custodial care is not an option. In the five years it has been in operation, the company has expanded
from one facility to five, located in southwestern cities. The income statement for last year follows.

Golden Care, Inc.

Income Statement For Last Year

Revenue $2,880,000
Cost of services 2,016,000
Gross profit $ 864,000
Marketing and
administrative expenses 500,000
Operating income $ 364,000

Lacey originally got into the business because she had trouble finding adequate facilities for her
mother. The concept worked well, and income over the past five years had grown nicely at 20 percent
per year. However, Lacey sensed clouds on the horizon. She knew that the population was aging and
that her current clients would be moving to more traditional forms of nursing care. As a result, Lacey
wanted to consider adding one or more nursing homes to Golden Care. These nursing homes would be
staffed around the clock with RNs and LPNs. The residents would likely have more severe medical
problems and would be confined to beds or wheelchairs. Lacey knew that quality care of this type was
needed. So, she contacted Dave Sheridan, her marketing manager, and Shauna Braden, her accountant,
for a brainstorming session.

Dave: “Lacey, I really like the concept. As you know, several of our facilities have faced seeing their
long-term residents move out to local nursing homes. Not only are these homes of lower quality than
what we could provide, but losing a resident is heartrending for the staff, as well as for the remaining
residents. I like the idea of providing a transition from less care to more.”
Shauna: “I agree with you, Dave. But let’s not forget the differences between assisted-living and full-
time, nursing-home-type care. Our expenses will really increase.”
Lacey: “That’s why I wanted to talk with both of you. As you know, Golden Care’s mission statement
emphasizes the need to make a profit. We can’t continue to serve our residents and provide high-
quality care if we don’t make enough money to pay our staff a living wage and earn enough of a profit

7
to smooth over the rough patches and continue to improve our business. Could the two of you look
into this idea, and get back to me in a week or so?”

Throughout the following week, the three communicated by e-mail. By the end of the week, a
number of possibilities had surfaced, and these were summarized in a message from Shauna to the
others.

TO: LaceyW@goldencare.com, DaveS@goldencare.com

FROM: ShaunaB@goldencare.com
MESSAGE:
I’ve compiled the ideas from all of our e-mails into the following list. This may be a good starting
point for our meeting tomorrow.
1. Buy an existing nursing home in one of Golden Care’s current locations.
2. Buy an existing nursing home in another city.
3. Build a new nursing home facility in one of Golden Care’s current locations.
4. Build a new nursing home facility in another city.
5. Build a wing on to an existing Golden Care facility. The Apache Junction facility has sufficient
open land for an addition.

The next day, Lacey, Dave, and Shauna met again in Lacey’s office.

Lacey: “I didn’t realize there were so many possibilities. Are we going to have to work up numbers on
each of them?”
Shauna: “No, I think we can eliminate a few of them pretty quickly. For example, building a new
facility would cost more than the other options, and it would involve the most risk.”
Dave: “I agree, and I also think we might eliminate the purchase of an existing nursing home for the
same reasons. Also, existing homes would not give us the option of building a facility that is state of
the art and meets our needs, and it would lock us into a preexisting patient mix.”
Lacey: “I like that thinking. Let’s restrict our attention to Option 5.”
Shauna: “I thought you might like that option, so Dave and I sketched out two alternatives for an
extension of the Apache Junction building. We call the alternatives Basic Care and Lifestyle Care.”
Dave: “There are different markets for each type of care. If we want to concentrate on Medicare and
Medicaid patients, the reimbursement is lower, and we would want to offer the Basic Care option.
Private insurance and private-pay patients could afford more services; if we are marketing to these
patients, we could offer the Lifestyle Care option. Both alternatives provide high-quality nursing care.
Basic Care concentrates on the quality nursing and maintenance activities. For example, the addition
would have 25 double rooms, two nursing stations, two recreation rooms, a treatment room, and an
office. The Lifestyle Care option adds physical and recreational therapy with a specially-equipped gym
and pool. That addition would have 30 single rooms, two nursing stations, a recreation room, a
swimming pool, a hydrotherapy spa and gym, a treatment room, and an office. In each case, there
would be cable TV and telephone hookups in each room and a buffer area between the nursing home
and the apartments.”

8
Lacey: “Why the buffer area? Won’t that add unnecessary cost?”
Dave: “It adds cost, but it will be well worth it. Lacey, you must remember that the nursing home
patients are different from the apartment residents. Some of the patients will have Alzheimer’s disease,
and quite frankly, they can’t mingle with the healthier residents of our apartment house. We’ll lose
apartment residents in a hurry if they have to be reminded every day of what might be in store for
them later on.”
Lacey: “I see your point. Shauna, what will these two plans cost? I’ll tell you right now that I like the
Lifestyle Care option better. It fits with our history of doing whatever we can to make life better for
our residents.”
Shauna: “I’ve checked into the costs of putting on a new wing and operating both alternatives. Here’s
a listing.”

Basic Care: Lifestyle Care:

Construction $1,500,000 Construction $2,000,000
Annual operating expenses: Annual operating expenses:
Staff: Staff:
RNs (3 × $30,000) 90,000 RNs (3 × $30,000) 90,000
LPNs (6 × $22,000) 132,000 LPNs (6 × $22,000) 132,000
Aides (6 × $20,000) 120,000 Aides (6 × $20,000) 120,000
Cooks (2 × $15,000) 30,000 Physical and recreational
Janitors (2 × $18,000) 36,000 therapists (2 × $25,000) 50,000
Other* (60% variable) 300,000 Cooks (1.5 × $15,000) 22,500
Debt service 150,000 Janitors (2 × $18,000) 36,000
Depreciation (over 20 years) 75,000 Other* (60% variable) 360,000
Debt service 200,000
Depreciation (over 20 years) 100,000
*Other includes supplies, utilities, food, and so on.

“In both cases, total administrative costs for Golden Care would increase by $30,000 per year. This
seems high, but the increased legal and insurance requirements will add significantly more paperwork
and accounting.”

Lacey: “All this sounds reasonable, but why is reimbursement such an important factor?”
Dave: “Well, if you admit Medicaid patients, the state will reimburse at most $30,000 per year. Private
insurance policies will pay roughly $46,000 per year. We can charge up to about $65,000 for private
patients, but this type of care is so expensive that many of these patients exhaust their funds and go on
Medicaid. The nice aspect of Medicaid is that we can be virtually assured that we will operate at
capacity.”
Lacey: “Can we cross that bridge when we come to it?”
Dave: “No, not really. Once the patient is a resident of our facility, it is hard to evict him or her. Also,
while it is legal to force patients out before they go on Medicaid and to refuse to accept Medicaid

9
patients, once we do accept Medicaid patients, we are prevented by law from evicting them—no
matter how high our costs go.”
Lacey: “OK, it looks as if we have some hard work ahead of us to decide whether or not to get into
this line of business.”

Required:
1. How did Lacey, Shauna, and Dave use the tactical decision making model of Chapter 18?

2. Categorize each of the expenses for the Basic Care and Lifestyle Care options as flexible or
committed. Further categorize the committed expenses as committed fixed or committed step
costs.

3. Calculate the break-even number of patients (in total and for each type of reimbursement) for each
of the following scenarios.
a.Basic Care option, 20 percent private insurance and 80 percent Medicaid
b. Basic Care option, no Medicaid patients
c.Lifestyle Care option, no Medicaid, 75 percent insurance, 25 percent private pay
d. Lifestyle Care option, all insurance reimbursement

4. What is the markup percent of cost of services charged on the assisted-living expenses? What
would the price per month for a Basic Care patient be if the same markup were used? For a
Lifestyle Care patient? (Assume in both cases that occupancy is at 80 percent of capacity.)

5. What is the payback period for the new addition?

6. Research Assignment: Recently, laws were passed restricting the ability of nursing homes to
evict Medicaid patients. What led to the passing of these laws? Why would nursing homes accept
Medicaid patients and later evict them? Discuss the legal and ethical issues in a nursing home’s
decision on whether to accept Medicaid patients.

10