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Module 3 - Management Accounting

Pricing !

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Pricing

!!

major inuences on pricing:! customer demand! competitor s actions! cost of the product! competitive environment: company is a price taker and will not have much exibility in making pricing decisions! cost based pricing:! consider xed costs when setting long-term pricing decisions! rationale: xed costs are differential over the long run! beware of variable cost pricing!
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Module 3 - Management Accounting

Target Costing!

target price = the estimated price for a product that potential customers will be willing to pay! target cost is the long-run cost of a product that when sold enables the company to achieve targeted prots! goal: design costs out of the RD&E stage of a product s life cycle, rather than trying to reduce costs during the manufacturing stage! once the target cost has been set, the company must determine the target costs for each components!

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Contractual Settings!

cost information determined prices in the following situations:! cost plus contracts! insurance claims! legal settings, I.e. predatory pricing (prices approaching or falling below VC are viewed as predatory)! bidding! international transfer pricing!
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Module 3 - Management Accounting

Budgeting !

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The Master Budget!

Sales Budget Production Budget Direct Materials Purchase Budget Direct Labour Budget Overhead Budget Cash Collections Budget

Cash Budget

Cash Disbursement Budget

Budgeted Financial Statements

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Module 3 - Management Accounting

The Master Budget - cont d!

production budget:! Needs = COGS + Ending FG Inventory! Less Opening FG Inventory! assumes an ending inventory policy!

direct materials purchase budget:! Needs = Production Requirements + Ending DM Inventory! Less Opening DM inventory!

cash disbursement budget assumes a payment pattern! cash collections budget assumes a cash collection pattern!

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The Master Budget - cont d!

cash budget -! Cash balance, beginning! Add collections! Less disbursements! = Cash Balance before nancing! - Interest! Borrowings / Repayments! = Cash balance, end! proforma nancial statements: income statement and balance sheet!

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Problem 19 - Budgeting The Hurley Companys actual November and December unit sales and estimated unit sales for the following four months as follows: November Actual December - Actual January - Estimated February March April 6,700 9,800 6,200 8,900 6,600 7,100

The companys inventory policy is to hold enough inventory at the end of the month to meet 30% of next months sales requirements. Each inventory item costs $1.75. Cash disbursement on purchases is made as follows: 40% is paid in the month of purchase and 60% is paid in the month following purchase. Each items sells for $4.00 and cash collection patterns are as follows: % of sales made for cash Credit sales are collected as follows In the month of sale In the month following sale In the second month following sale Uncollectible Required a) b) c) Estimate the purchases (in units) for the months of January through March. Estimate the cash disbursements on purchases for the months of January through March. What is the accounts payable at the end of March? Estimate the cash collections for the months of January through March. What is the accounts receivable at the end of March? 20% 35% 40% 23% 2%

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Problem 20 - Budgeting You are given the following information for XYZ Company. 1. Monthly Sales November 20x1 (Actual) December 20x1 (Actual) January 20x2 (Forecasted) February 20x2 March 20x2 April 20x2 2. Cash collection pattern: 30% in the month of sale 50% in the next month 18% in the month following 2% uncollected Cost of goods sold = 60% of sales Desired ending inventory = 20% of next months sales Payment pattern: 40% of purchases paid in the month of purchase 60% paid next month Other Cash in Bank, Jan 20x2 Expected purchase of equipment in January 20x2 Dividends March 20x2 Selling and administrative expense per month, paid in month Equipment balance as at Dec 31, 19x1 Accumulated depreciation (Straight line 10 years) Common stock $10,000 50,000 30,000 40,000 200,000 50,000 100,000 $100,000 150,000 175,000 160,000 120,000 100,000

3. 4.

5.

6.

The company has access to a line of credit with the bank with the following terms: the interest rate is 1% per month payable on the first day of the next month, the interest payable is calculated as 1% of the previous months outstanding balance borrowings in a given month are taken out at the beginning of the month any repayments are made at the end of the month The company wants to maintain a minimum cash balance of $10,000 at all times.

7.

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Required a. b. Prepare a balance sheet as at December 31, 20x1 Prepare the following schedules for the first quarter of 20x2: Cash Collections Schedule Purchase Schedule Cash disbursement on purchases schedule Cash budget Prepare a Statement of Income and Retained Earnings for the quarter ended March 31, 20x2. Prepare a Balance Sheet as at March 31, 20x2.

c. d.

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Cash Collections Schedule Nov: $100,000 x 18% Dec: 150,000 x 50% | 18% Jan: 175,000 x 30% | 50% | 18% Feb: 160,000 x 30% | 50% Mar: 120,000 x 30% Jan $18,000 75,000 52,500 $145,500 Purchases Schedule Needs: COGS Desired ending inventory Less opening inventory Purchases Payments Schedule Dec: Jan: 103,200 x 40% | 60% Feb: 91,200 x 40% | 60% Mar: 69,600 x 40% Feb $27,000 87,500 48,000 $162,500 Mar $31,500 80,000 36,000 $147,500

105,000 19,200 -21,000 103,200

96,000 14,400 -19,200 91,200

72,000 12,000 -14,400 69,600

55,800 41,280 97,080

61,920 36,480 98,400

54,720 27,840 82,560

Cash Budget Cash balance, beginning Cash Collections Cash Disbursements On purchases Selling and Administrative Equipment purchases Dividends Cash balance before financing Interest Borrowing/Repayment Cash balance after financing * $41,580 x 1% = $416

$10,000 145,500 -97,080 -40,000 -50,000 -31,580 41,580 $10,000

$10,000 162,500 -98,400 -40,000 34,100 -416* -23,684 10,000

$10,000 147,500 -82,560 -40,000 -30,000 4,940 -416* 5,476 $10,000

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XYZ Company Pro-Forma Income Statement and Statement of Retained Earnings For the quarter ended March 31, 19x2 Sales Cost of goods sold Opening inventory Purchases Ending inventory (Alternatively: $455,000 x 60%) Gross margin Operating expenses Selling and administrative Depreciation (250,000 10 x 3/12) Bad debts (455,000 x 2%) Interest (416 + 416 + 23,372 x 1% Payable) Net income Retained earnings, beginning Dividends Retained earnings, ending XYZ Company Pro-Forma Balance Sheet As at March 31, 19x2 Cash Accounts receivable (note 1) Inventories Equipment Accumulated depreciation Accounts payable (69,600 x 60% + 234 Interest) Line of credit Common stock Retained Earnings $10,000 110,400 12,000 250,000 -56,250 $326,150 $41,994 23,372 100,000 160,784 $326,150 28,800 81,600 110,400 $455,000 21,000 264,000 -12,000 273,000 182,000 120,000 6,250 9,100 1,066 136,416 45,584 145,200 -30,000 $160,784

Note 1 - Accounts receivable February sales: 160,000 x 18% March sales: 120,000 x 68%

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Problem 17 CVP Analysis The following statement of income for Davann Company represents the operating results for the fiscal year just ended. Davann had sales of 1,800 tons during the current year. The manufacturing capacity of Davann's facilities is 3,000 tons. Davann Company Variable Costing Income Statement for the Year Ended December 31, 20x5 Sales Variable costs: Manufacturing Selling costs Contribution margin Fixed costs: Manufacturing Selling Administration Income before income taxes Income taxes (40%) Net income Required
a. b. c. What is the break-even volume in tons for 20x5? If the sales volume is estimated to be 2,100 tons in the next year, and if prices and costs stay at the same levels and amounts next year, what can Davann expect aftertax net income to be? Davann plans to market its product in a new territory. Davann estimates that an advertising and promotion program costing $61,500 annually would need to be undertaken for the next two or three years. In addition, a $25 per ton sales commission over and above the current commission would be required for the sales force in the new territory. How many tons would have to be sold in the new territory to maintain Davann's current aftertax income of $94,500?
Davann is considering replacing a highly labor-intensive process with an automatic machine. This would result in an increase of $58,500 annually in manufacturing fixed costs. The variable manufacturing costs would decrease $25 per ton. What would the new breakeven volume in tons be?

$900,000 315,000 180,000 495,000 405,000 90,000 112,500 45,000 247,500 157,500 63,000 $ 94,500

d.

e.

Ignore the facts presented in Requirement (d) and now assume that Davann estimates that the per-ton selling price would decline 10% next year. Variable costs would increase $40 per ton, and the fixed costs would not change. What sales volume in dollars would be required to earn an aftertax net income of $94,500 next year?

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Problem 18 CVP Analysis Hewtex Electronics manufactures two products - tape recorders and electronic calculators - and sells them nationally to wholesalers and retailers. The Hewtex management is very pleased with the company's performance for the current fiscal year. Projected sales through December 31,20x7, indicate that 70,000 tape recorders and 140,000 electronic calculators will be sold this year. The projected earnings statement follows: Hewtex Electronics Projected Earnings Statement For The Year Ended December 31, 20x7 Tape Recorders Total Amount (000's) Sales $1,050 Per Unit $15.00 4.00 2.00 2.00 1.00 9.00 $ 6.00 Electronic Calculators Total Amount (000's) $3,150 630 420 280 210 1,540 $1,610 Per Unit $22 50 4.50 3.00 2.00 1.50 11.00 $11.50 Total (000's) $4,200.00 910.00 560.00 420.00 280.00 2,170.00 2,030.00 1,040.00 990.00 544.50 $ 445.50

Production costs: Direct materials 280 Direct labor 140 Variable overhead 140 Fixed overhead 70 630 Gross margin $ 420

Fixed selling and administrative Net income before income taxes Income taxes (55 %) Net income

It shows that Hewtex will exceed its earnings goal of 9% on sales after income taxes. The tape recorder business has been fairly stable the last few years, and the company does not intend to change the tape recorder price. Competition among manufacturers of electronic calculators has been increasing, however. Hewtex's calculators have been very popular with consumers. In order to sustain this interest in their calculators and to meet the price reductions expected from competitors, management has decided to reduce the wholesale price of its calculator from $22.50 to $20.00 per unit effective January 1, 20x8.

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At the same time, the company plans to spend an additional $57,000 on advertising during fiscal year 20x8. As a consequence of these actions, management estimates that 80% of its total revenue will be derived from calculator sales compared to 75% in 20x7. As in prior years, the sales mix is assumed to be the same at all volume levels. The total fixed overhead costs will not change in 20x8, nor will the variable overhead cost rates (applied on a direct labor hour base). However, the cost of materials and direct labor is expected to change. The cost of solid-state electronic components will be cheaper in 20x8. Hewtex estimates that material costs will drop 10% for the tape recorders and 20% for the calculators in 20x8. Direct labor costs for both products will increase 10% in the coming year, however. Required: a. b. c. How many tape recorder and electronic calculator units did Hewtex Electronics have to sell in 20x7 to break even? What volume of sales is required if Hewtex Electronics is to earn a profit in 20x8 equal to 9% on sales after income taxes? How many tape recorder and electronic calculator units will Hewtex have to sell in 20x8 to break even?

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Problem 21 - Corporate Finance Review Problems a. The Walburne Companys partial statement of financial position as at December 31, 20x6 is as follows: Bonds payable, 6% Preferred shares, $5, 300,000 shares outstanding Common shares, 1,500,000 shares outstanding Retained earnings $53,641,697 30,000,000 52,435,678 24,430,500

Additional Information the bonds payable were issued on December 31, 20x1 to yield 5.4%. The bonds mature on December 31, 20x21. Bonds of similar risk are currently yielding 5%. The face value of the bonds is $50,000,000. each preferred share is currently trading for $92 per share the common shares are currently trading for $71 per share the risk free rate is 3%, the expected rate of return on the market is 8% and the firms beta is 1.3 the tax rate is 40% Calculate the Walburne company WACC. b. The JH Companys current credit terms are 2/10, n30. In order to increase sales, they are considering relaxing their credit terms to 2/15, net 45. They estimate that current annual sales of $10,000,000 will increase by 20%, that bad debts will increase to 3% of total sales from the current level of 2%. The current days sales in accounts receivable is 25 days and it is expected that it will increase to 35 days. The contribution margin ratio is 25% and the gross profit ratio is 40%. The companys incremental borrowing rate is 9%. Calculate the incremental impact on operating income of the above proposal. c. The Peter Corporations 2,000,000 shares are currently trading at $35 per share. The company wants to raise $10,000,000 through a rights offering. The subscription price will be $20. Calculate the value of one right.

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d.

The Kripps Companys current income statement for the year ending December 31, 20x2 is as follows: Sales Cost of goods sold Operating expenses Depreciation expense Interest expense Income tax expense Net income $12,000,000 8,000,000 1,800,000 300,000 400,000 525,000 $975,000

The companys current level of working capital is $1,200,000 and the company has found that the level of working capital varies with sales. The cost of goods sold is 80% variable and the operating expenses are 30% variable. The company expects sales to grow by 15% in 20x3, 10% in 20x4, 8% in 20x5 and to remain at the 20x5 levels in perpetuity. The annual capital expenditures (net of tax shield) for each year is expected to be $250,000. The company's WACC is 10% and there are 1,000,000 common shares outstanding. Based on the above, what should the market value of each share be?

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c. Before After

Market Capitalization $70,000,000 80,000,000

Number of Shares 2,000,000 2,500,000

Price per Share $35 32

Value per right = $35 - 32 = $3

d. Working capital Sales Variable Costs Cost of goods sold Operating expenses Fixed costs Cost of goods sold Operating expenses Depreciiation EBIT EBIT(1-t) Add depreciation Less capital expenditures Less increase in W/C Free Cash Flow Present Value (10%) Value (20x3 - 20x5) Terminal Value 20x6 / 0.10 PV (N = 3, I = 10) Total value Number of shares Value per share

20x2 1,200,000 12,000,000 6,400,000 540,000 1,600,000 1,260,000 300,000 1,900,000 1,235,000

20x3 1,380,000 13,800,000 7,360,000 621,000 1,600,000 1,260,000 300,000 2,659,000 1,728,350 300,000 250,000 180,000 1,598,350 1,453,045

20x4 1,518,000 15,180,000 8,096,000 683,100 1,600,000 1,260,000 300,000 3,240,900 2,106,585 300,000 250,000 138,000 2,018,585 1,668,252

20x5 1,639,440 16,394,400 8,743,680 737,748 1,600,000 1,260,000 300,000 3,752,972 2,439,432 300,000 250,000 121,440 2,367,992 1,779,107

20x6

2,439,432 300,000 250,000 0 2,489,432

4,900,405

18,703,470 23,603,874 1,000,000 $23.60

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Problem 22 - CVP Analysis Hospital Supply, Inc., produces hydraulic hoists that hospitals use to move bedridden patients. The costs to manufacture and market the hydraulic hoists at the company's normal volume of 3,000 units per month are as follows: Unit manufacturing costs Variable materials Variable labour Variable overhead Fixed overhead Total unit manufacturing costs Unit marketing costs Variable Fixed Total unit marketing costs Total Unit Costs $100 150 50 120 420 50 140 190 $610

Unless otherwise stated, assume that no connection exists between the situations described in the questions; each is independent. Unless otherwise stated, assume a regular selling price of $740 per unit. a. Market research estimates that volume could be increased to 3,500 units, which is well within production capacity limitations if the price were cut from $740 to $650 per unit. Would you recommend taking this action? What would be the impact on monthly sales, costs, and income? On March 1, the federal government offers Hospital Supply a contract to supply 500 units to hospitals for a March 31 delivery. Because of an unusually large number of rush orders from its regular customers, Hospital Supply plans to produce 4,000 units during March, which will use all available capacity. The government contract would reimburse its "share of March manufacturing costs" plus pay a $50,000 fixed fee (profit). (No variable marketing costs would be incurred on the government's units.) What impact would accepting the government contract have on March income? Hospital Supply has an opportunity to enter a foreign market in which price competition is keen. An attraction of the foreign market is that its demand is greatest when the domestic market's demand is quite low; thus, idle production facilities could be used without affecting domestic business. An order for 1,000 units is being sought at a below-normal price to enter this market. For this order, shipping costs will total $75 per unit; total (marketing) costs to obtain the contract will be $4,000. No other variable marketing costs

b.

c.

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would be required on this order, and it would not affect domestic business. What is the minimum unit price that Hospital Supply should consider for this order of 1,000 units? d. An inventory of 230 units of an obsolete model of the hoist remains in inventory. These must be sold through regular channels at reduced prices or the inventory will soon be worthless. What is the minimum acceptable selling price for these units? A proposal is received from an outside supplier who will make and ship the hoists directly to the Hospital Supply's customers as sales orders are forwarded from Hospital Supply's sales staff. Hospital Supply's fixed marketing costs will be unaffected, but its variable marketing costs will be slashed by 20%. Hospital Supply 's plant will be idle, but its fixed manufacturing overhead will continue at 50% of present levels. How much per unit would the company be able to pay the supplier without decreasing operating income? Assume that, as in requirement (e), a proposal is received from an outside supplier who will make and ship hydraulic hoists directly to the Hospital Supply's customers as sales orders are forwarded from Hospital Supply 's sales staff. If the supplier's offer is accepted, the present plant facilities will be used to make a new digital hoist whose unit costs will be: Variable manufacturing costs Fixed manufacturing costs Variable marketing costs Fixed marketing costs for the new hoist Total costs $500 240 70 252 $1,062

e.

f.

Total fixed manufacturing overhead will be unchanged from the original level given at the beginning of the problem. Fixed marketing costs for the new digital hoists are over and above the fixed marketing costs incurred for marketing the hoist at the beginning of the problem. The reduction of 20% in variable marketing costs carries over to this part. The new digital hoist will sell for $1,110. The minimum desired operating income on the two hoists taken together is $100,000 per year. New digital hoist sales will be 18,000 units per year. What is the maximum purchase cost per unit that Hospital Supply would be willing to pay for subcontracting the production of the hydraulic hoists?

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Problem 23 - Joint and By-Products Alderon Industries is a manufacturer of chemicals for various purposes. One of the processes used by Alderon produces SPL-3, a chemical used in swimming pools; PST-4, a chemical used in pesticides; and RJ-5, a by-product sold to fertilizer manufacturers. The by product is inventoried at its net realizable value, and this value is used to reduce the joint production costs before the joint costs are allocated to the main products. Data regarding Alderon's operations for the month of November 19x9 follow. During this month, Alderon incurred joint production costs of $1,702,000 in the manufacture of SPL-3, PST-4, and RJ-5. SPL-3 November sales in litres November production at split-off point November final production in litres Sales value per litre at split-off Additional processing costs Final sales value per gallon 600,000 650,000 700,000 $2.35 $874,000 $4.00 PST-4 325,000 400,000 350,000 $3.20 $816,000 $6.00 RJ-5 150,000 170,000 $ 0.70*

*Disposal costs of 10 cents per litre are incurred to sell the by-product. Assume no inventories. Required 1. Determine the cost per litre for each product assuming that the following methods are used to allocate joint costs: a. Sales value at split off b. Physical Units c. Net Realizable Value What other method can be used to account for by-products?

2.

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Problem 23 1. Under each method the amount of joint costs to be allocated is: $1,702,000 - [170,000 x (0.70 - 0.10)] = $1,702,000 - 102,000 = $1,600,000

Sales Value Method:

Sales Value at Split-off $1,527,500 1,280,000 $2,807,500 Allocation of Joint Costs $870,400 729,600 $1,600,000 Separable Costs $874,000 816,000 Total Costs $1,744,400 1,545,600 Cost per Litre $2.492 4.416

Product SPL-3 PST-4

% 54.4% 45.6% 100.0%

Production 700,000 350,000

Physical Units
Physical Units 650,000 400,000 1,050,000 Allocation of Joint Costs $990,400 609,600 $1,600,000 Separable Costs $874,000 816,000 Total Costs $1,864,400 1,425,600 Cost per Litre $2.663 4.073

Product SPL-3 PST-4

% 61.9% 38.1% 100.0%

Production 700,000 350,000

NRV
Allocation of Joint Costs $960,000 640,000 $1,600,000 Separable Costs $874,000 816,000 Total Costs $1,834,000 1,456,000 Cost per Litre $2.62 4.16

Product SPL-3 PST-4

NRV $1,926,000 1,284,000 $3,210,000

% 60.0% 40.0% 100.0%

Production 700,000 350,000

SPL-3 ($4.00 x 700,000) - 874,000 = $1,926,000 PST-4 ($6.00 x 350,000) - 816,000 = $1,284,000 2. Do not record it as inventory; record sales as sold.

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Accelerated Program Week 17

Suggested study plan for this week: Primary List 1. 2. 3. Review what we did in class on Saturday. Pricing (ch 10) MCQ, Q1, 8 Budgeting (ch 11) MCQ, Q2-7 Q2, 3, 4, 5, 6, 7 Q1 Secondary List

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