1-1 Management accounting measures, analyzes and reports financial and nonfinancial information that helps managers make

decisions to fulfill the goals of an organization. It focuses on internal reporting and is not restricted by generally accepted accounting principles (GAAP). Financial accounting focuses on reporting to external parties such as investors, government agencies, and banks. It measures and records business transactions and provides financial statements that are based on generally accepted accounting principles (GAAP). Other differences include (1) management accounting emphasizes the future (not the past), and (2) management accounting influences the behavior of managers and other employees (rather than primarily reporting economic events). 1-3 Management accountants can help to formulate strategy by providing information about the sources of competitive advantagefor example, the cost, productivity, or efficiency advantage of their company relative to competitors or the premium prices a company can charge relative to the costs of adding features that make its products or services distinctive. 1-6 Management accounting deals only with costs. This statement is misleading at best, and wrong at worst. Management accounting measures, analyzes, and reports financial and nonfinancial information that helps managers define the organizations goals, and make decisions to fulfill them. Management accounting also analyzes revenues from products and customers in order to assess product and customer profitability. Therefore, while management accounting does use cost information, it is only a part of the organizations information recorded and analyzed by management accountants. 1-13 The controller is the chief management accounting executive. The corporate controller reports to the chief financial officer, a staff function. Companies also have business unit controllers who support business unit managers or regional controllers who support regional managers in major geographic regions. 1-16 Value chain and classification of costs, computer company. Cost Item a. b. c. d. e. f. g. h. Value Chain Business Function Production Distribution Design of products and processes Research and Development Customer Service or Marketing Design of products and processes (or Research and Development) Marketing Production

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1-22

Five-step decision-making process, service firm. Action a. b. c. d. e. f. Step in Decision-Making Process Obtain information Identify the problem and uncertainties Obtain information and/or make predictions about the future Make predictions about the future Obtain information Make decisions by choosing among alternatives

1-24 1.

Planning and control decisions, Internet company. Planning decisions a. Decision to raise monthly subscription fee c. Decision to upgrade content of online services (later decision to inform subscribers and upgrade online services is an implementation part of control) e. Decision to decrease monthly subscription fee starting in November. Control decisions b. Decision to inform existing subscribers about the rate of increasean implementation part of control decisions d. Dismissal of VP of Marketingperformance evaluation and feedback aspect of control decisions

2. Other planning decisions that may be made at WebNews.com: decision to raise or lower advertising fees; decision to charge a fee from on-line retailers when customers click-through from WebNews.com to the retailers websites. Other control decisions that may be made at WebNews.com: evaluating how customers like the new format for the weather information, working with an outside vendor to redesign the website, and evaluating whether the waiting time for customers to access the website has been reduced. 1-29 Professional ethics and end-of-year actions.

1. The possible motivations for the snack foods division wanting to take end-of-year actions include: (a) Management incentives. Gourmet Foods may have a division bonus scheme based on one-year reported division earnings. Efforts to front-end revenue into the current year or transfer costs into the next year can increase this bonus. (b) Promotion opportunities and job security. Top management of Gourmet Foods likely will view those division managers that deliver high reported earnings growth rates as being the best prospects for promotion. Division managers who deliver unwelcome surprises may be viewed as less capable. (c) Retain division autonomy. If top management of Gourmet Foods adopts a management by exception approach, divisions that report sharp reductions in their earnings growth rates may attract a sizable increase in top management supervision. 2. The Standards of Ethical Conduct . . . require management accountants to
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Perform professional duties in accordance with relevant laws, regulations, and technical standards. Refrain from engaging in any conduct that would prejudice carrying out duties ethically. Communicate information fairly and objectively. Several of the end-of-year actions clearly are in conflict with these requirements and should be viewed as unacceptable by Taylor. (b) The fiscal year-end should be closed on midnight of December 31. Extending the close falsely reports next years sales as this years sales. (c) Altering shipping dates is falsification of the accounting reports. (f) Advertisements run in December should be charged to the current year. The advertising agency is facilitating falsification of the accounting records. The other end-of-year actions occur in many organizations and fall into the gray to acceptable area. However, much depends on the circumstances surrounding each one, such as the following: (a) If the independent contractor does not do maintenance work in December, there is no transaction regarding maintenance to record. The responsibility for ensuring that packaging equipment is well maintained is that of the plant manager. The division controller probably can do little more than observe the absence of a December maintenance charge. (d) In many organizations, sales are heavily concentrated in the final weeks of the fiscal year-end. If the double bonus is approved by the division marketing manager, the division controller can do little more than observe the extra bonus paid in December. (e) If TV spots are reduced in December, the advertising cost in December will be reduced. There is no record falsification here. (g) Much depends on the means of persuading carriers to accept the merchandise. For example, if an under-the-table payment is involved, or if carriers are pressured to accept merchandise, it is clearly unethical. If, however, the carrier receives no extra consideration and willingly agrees to accept the assignment because it sees potential sales opportunities in December, the transaction appears ethical. Each of the (a), (d), (e), and (g) end-of-year actions may well disadvantage Gourmet Foods in the long run. For example, lack of routine maintenance may lead to subsequent equipment failure. The divisional controller is well advised to raise such issues in meetings with the division president. However, if Gourmet Foods has a rigid set of line/staff distinctions, the division president is the one who bears primary responsibility for justifying division actions to senior corporate officers. 3. If Taylor believes that Ryan wants her to engage in unethical behavior, she should first directly raise her concerns with Ryan. If Ryan is unwilling to change his request, Taylor should discuss her concerns with the Corporate Controller of Gourmet Foods. She could also initiate a confidential discussion with an IMA Ethics Counselor, other impartial adviser, or her own attorney. Taylor also may well ask for a transfer from the snack foods division if she perceives Ryan is unwilling to listen to pressure brought by the Corporate Controller, CFO, or even President of Gourmet Foods. In the extreme, she may want to resign if the corporate culture of Gourmet Foods is to reward division managers who take end-of-year actions that Taylor views
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as unethical and possibly illegal. It was precisely actions along the lines of (b), (c), and (f) that caused Betty Vinson, an accountant at WorldCom to be indicted for falsifying WorldComs books and misleading investors. 2-3 Managers believe that direct costs that are traced to a particular cost object are more accurately assigned to that cost object than are indirect allocated costs. When costs are allocated, managers are less certain whether the cost allocation base accurately measures the resources demanded by a cost object. Managers prefer to use more accurate costs in their decisions. 2-8 A unit cost is computed by dividing some amount of total costs (the numerator) by the related number of units (the denominator). In many cases, the numerator will include a fixed cost that will not change despite changes in the denominator. It is erroneous in those cases to multiply the unit cost by activity or volume change to predict changes in total costs at different activity or volume levels. 2-9 Manufacturing-sector companies purchase materials and Ashtonnents and convert them into various finished goods, for example automotive and textile companies. Merchandising-sector companies purchase and then sell tangible products without changing their basic form, for example retailing or distribution. Service-sector companies provide services or intangible products to their customers, for example, legal advice or audits. 2-18 Classification of costs, service sector.

Cost object: Each individual focus group Cost variability: With respect to the number of focus groups There may be some debate over classifications of individual items, especially with regard to cost variability. Cost Item A B C D E F G H
a

D or I D I I I D I D I

V or F V F Va F V F V Vb

Some students will note that phone call costs are variable when each call has a separate charge. It may be a fixed cost if Consumer Focus has a flat monthly charge for a line, irrespective of the amount of usage. b Gasoline costs are likely to vary with the number of focus groups. However, vehicles likely serve multiple purposes, and detailed records may be required to examine how costs vary with changes in one of the many purposes served.

2-25

Cost drivers and functions.

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1. 1. 2. 3. 4. 5. 6. 7. 2. 1. 2. 3. 4. 5. 6. 7. Function Accounting Human Resources Data Processing Research and Development Purchasing Distribution Billing Representative Cost Driver Number of journal entries made Salaries and wages of employees Number of computer transactions Number of new products being developed Number of different types of materials purchased Distance traveled to make deliveries Number of credit sales transactions Function Accounting Human Resources Data processing Research and development Purchasing Distribution Billing Representative Cost Driver Number of transactions processed Number of employees Hours of computer processing unit (CPU) Number of research scientists Number of purchase orders Number of deliveries made Number of invoices sent

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2-26 1.

Total costs and unit costs

Number of attendees 0 Variable cost per person ($9 caterer charge $5 student door fee) $4 Fixed Costs $1,600 Variable costs (number of attendees variable cost per person) 0 Total costs (fixed + variable) $1,600

100

200

300

400

500

600

$4 $1,600

$4 $1,600

$4 $1,600

$4 $1,600

$4 $1,600

$4 $1,600

400 $2,000

800 $2,400

1,200 $2,800

1,600 $3,200

2,000 $3,600

2,400 $4,000

Fixed, Variable and Total Cost of Graduation Party

5000

4000

Costs ($)

3000

Fixed costs Variable costs

2000

Total cost

1000

0 0 100 200 300 400 500 600

Number of attendees

2.
Number of attendees Total costs (fixed + variable) Costs per attendee (total costs number of attendees) 0 $1,600 100 $2,000 $20.00 200 $2,400 $12.00 300 $2,800 $9.33 400 $3,200 $ 8.00 500 $3,600 $ 7.20 600 $4,000 $ 6.67

As shown in the table above, for 100 attendees the total cost will be $2,000 and the cost per attendee will be $20. 3. As shown in the table in requirement 2, for 500 attendees the total cost will be $3,600 and the cost per attendee will be $7.20.

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4. Using the calculations shown in the table in requirement 2, we can construct the cost-perattendee graph shown below:
$25.00 $20.00 $15.00 $10.00 $5.00 $0.00 0 100 200 300 400 500 600 700 Number of Attendees Cost per Attendee ($)

As president of the student association requesting a grant for the party, you should not use the per unit calculations to make your case. The person making the grant may assume an attendance of 500 students and use a low number like $7.20 per attendee to calculate the size of your grant. Instead, you should emphasize the fixed cost of $1,600 that you will incur even if no students or very few students attend the party, and try to get a grant to cover as much of the fixed costs as possible as well as a variable portion to cover as much of the $4 variable cost to the student association for each person attending the party.

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2-29 1a.

Computing cost of goods purchased and cost of goods sold. Marvin Department Store Schedule of Cost of Goods Purchased For the Year Ended December 31, 2011 (in thousands) $155,000 7,000 162,000 $4,000 6,000

Purchases Add transportation-in Deduct: Purchase returns and allowances Purchase discounts Cost of goods purchased 1b.

10,000 $152,000

Marvin Department Store Schedule of Cost of Goods Sold For the Year Ended December 31, 2011 (in thousands) $ 27,000 152,000 179,000 34,000 $145,000

Beginning merchandise inventory 1/1/2011 Cost of goods purchased (see above) Cost of goods available for sale Ending merchandise inventory 12/31/2011 Cost of goods sold 2. Marvin Department Store Income Statement Year Ended December 31, 2011 (in thousands)

Revenues Cost of goods sold (see above) Gross margin Operating costs Marketing, distribution, and customer service costs Utilities General and administrative costs Miscellaneous costs Total operating costs Operating income

$280,000 145,000 135,000

$37,000 17,000 43,000 4,000 101,000 $ 34,000

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2-36

Income statement and schedule of cost of goods manufactured. Calendar Corporation Income Statement for the Year Ended December 31, 2011 (in millions)

Revenues Cost of goods sold Beginning finished goods, Jan. 1, 2011 Cost of goods manufactured (below) Cost of goods available for sale Ending finished goods, Dec. 31, 2011 Gross margin Marketing, distribution, and customer-service costs Operating income (loss)

$355 $ 47 228 275 11

264 91 94 $ (3)

Calendar Corporation Schedule of Cost of Goods Manufactured for the Year Ended December 31, 2011 (in millions) Direct material costs Beginning inventory, Jan. 1, 2011 Direct materials purchased Cost of direct materials available for use Ending inventory, Dec. 31, 2011 Direct materials used Direct manufacturing labor costs Indirect manufacturing costs Plant supplies used Property taxes on plant Plant utilities Indirect manufacturing labor costs Depreciationplant and equipment Miscellaneous manufacturing overhead costs Manufacturing costs incurred during 2011 Add beginning work-in-process inventory, Jan. 1, 2011 Total manufacturing costs to account for Deduct ending work-in-process inventory, Dec. 31, 2011 Cost of goods manufactured (to income statement)

$ 32 84 116 8 $108 42 4 2 9 27 6 15

63 213 18 231 3 $228

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2-37 1.

Terminology, interpretation of statements (continuation of 2-34). Direct materials used Direct manufacturing labor costs Prime costs Direct manufacturing labor costs Indirect manufacturing costs Conversion costs $108 million 42 million $150 million $ 42 million 63 million $105 million

2.

Inventoriable costs (in millions) for Year 2011 Plant utilities Indirect manufacturing labor Depreciationplant and equipment Miscellaneous manufacturing overhead Direct materials used Direct manufacturing labor Plant supplies used Property tax on plant Total inventoriable costs Period costs (in millions) for Year 2011 Marketing, distribution, and customer-service costs

9 27 6 15 108 42 4 2 $213 $ 94

3. Design costs and R&D costs may be regarded as product costs in case of contracting with a governmental agency. For example, if the Air Force negotiated to contract with Lockheed to build a new type of supersonic fighter plane, design costs and R&D costs may be included in the contract as product costs. 4. Direct materials used = $108,000,000 2,000,000 units = $54 per unit Depreciation on plant and equipment = $6,000,000 2,000,000 units = $3 per unit Direct materials unit cost would be unchanged at $54. Depreciation unit cost would be $6,000,000 3,000,000 = $2 per unit. Total direct materials costs would rise by 50% to $162,000,000 ($54 per unit 3,000,000 units). Total depreciation cost of $6,000,000 would remain unchanged. In this case, equipment depreciation is a variable cost in relation to the unit output. The amount of equipment depreciation will change in direct proportion to the number of units produced. (a) Depreciation will be $2 million (2 million $1) when 2 million units are produced. (b) Depreciation will be $3 million (3 million $1) when 3 million units are produced.

5.

6.

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3-2 1. 2. 3.

The assumptions underlying the CVP analysis outlined in Chapter 3 are Changes in the level of revenues and costs arise only because of changes in the number of product (or service) units sold. Total costs can be separated into a fixed component that does not vary with the units sold and a variable component that changes with respect to the units sold. When represented graphically, the behaviors of total revenues and total costs are linear (represented as a straight line) in relation to units sold within a relevant range and time period. The selling price, variable cost per unit, and fixed costs are known and constant.

4.

3-7 CVP certainly is simple, with its assumption of output as the only revenue and cost driver, and linear revenue and cost relationships. Whether these assumptions make it simplistic depends on the decision context. In some cases, these assumptions may be sufficiently accurate for CVP to provide useful insights. The examples in Chapter 3 (the software package context in the text and the travel agency example in the Problem for Self-Study) illustrate how CVP can provide such insights. In more complex cases, the basic ideas of simple CVP analysis can be expanded. 3-10 Examples include: Manufacturingsubstituting a robotic machine for hourly wage workers. Marketingchanging a sales force compensation plan from a percent of sales dollars to a fixed salary. Customer servicehiring a subcontractor to do customer repair visits on an annual retainer basis rather than a per-visit basis.

3-13 CVP analysis is always conducted for a specified time horizon. One extreme is a very short-time horizon. For example, some vacation cruises offer deep price discounts for people who offer to take any cruise on a days notice. One day prior to a cruise, most costs are fixed. The other extreme is several years. Here, a much higher percentage of total costs typically is variable. CVP itself is not made any less relevant when the time horizon lengthens. What happens is that many items classified as fixed in the short run may become variable costs with a longer time horizon.

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3-17

CVP computations. 1a. Sales ($68 per unit 410,000 units) Variable costs ($60 per unit 410,000 units) Contribution margin Contribution margin (from above) Fixed costs Operating income Sales (from above) Variable costs ($54 per unit 410,000 units) Contribution margin Contribution margin Fixed costs Operating income $27,880,000 24,600,000 $ 3,280,000 $3,280,000 1,640,000 $1,640,000 $27,880,000 22,140,000 $ 5,740,000 $5,740,000 5,330,000 $ 410,000

1b.

2a.

2b.

3. Operating income is expected to decrease by $1,230,000 ($1,640,000 $410,000) if Ms. Schoenens proposal is accepted. The management would consider other factors before making the final decision. It is likely that product quality would improve as a result of using state of the art equipment. Due to increased automation, probably many workers will have to be laid off. Garretts management will have to consider the impact of such an action on employee morale. In addition, the proposal increases the companys fixed costs dramatically. This will increase the companys operating leverage and risk.

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3-20 1a.

CVP exercises. [Units sold (Selling price Variable costs)] Fixed costs = Operating income [5,000,000 ($0.50 $0.30)] $900,000 = $100,000 Fixed costs Contribution margin per unit = Breakeven units $900,000 [($0.50 $0.30)] = 4,500,000 units Breakeven units Selling price = Breakeven revenues 4,500,000 units $0.50 per unit = $2,250,000 or, Selling price -Variable costs Contribution margin ratio = Selling price $0.50 - $0.30 = = 0.40 $0.50 Fixed costs Contribution margin ratio = Breakeven revenues $900,000 0.40 = $2,250,000 5,000,000 ($0.50 $0.34) $900,000 [5,000,000 (1.1) ($0.50 $0.30)] [$900,000 (1.1)] [5,000,000 (1.4) ($0.40 $0.27)] [$900,000 (0.8)] $900,000 (1.1) ($0.50 $0.30) ($900,000 + $20,000) ($0.55 $0.30) = $ (100,000) = $ 110,000 = $ 190,000 = = 4,950,000 units 3,680,000 units

1b.

2. 3. 4. 5. 6.

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3-25 1a.

Operating leverage. Let Q denote the quantity of carpets sold Breakeven point under Option 1 $500Q $350Q = $5,000 $150Q = $5,000 Q = $5,000

$150 = 34 carpets (rounded up)

1b.

Breakeven point under Option 2 $500Q $350Q (0.10 $500Q) 100Q Q

= = =

0 0 0 $5,000

2.

Operating income under Option 1 = $150Q Operating income under Option 2 = $100Q Find Q such that $150Q

$5,000 = $100Q $50Q = $5,000 Q = $5,000 $50 = 100 carpets Revenues = $500 100 carpets = $50,000 For Q = 100 carpets, operating income under both Option 1 ($150 100 $5,000) and Option 2 ($100 100) = $10,000 For Q > 100, say, 101 carpets, Option 1 gives operating income = ($150 101) Option 2 gives operating income = $100 101 So Color Rugs will prefer Option 1. For Q < 100, say, 99 carpets, Option 1 gives operating income = ($150 99) Option 2 gives operating income = $100 99 So Color Rugs will prefer Option 2. 3. Degree of operating leverage =

$5,000 = $10,150 = $10,100

$5,000 = $9,850 = $9,900

Contribution margin Operating income Contribution margin per unit Quantity of carpets sold Operating income Under Option 1, contribution margin per unit = $500 $350, so $150 100 Degree of operating leverage = = 1.5 $10,000 Under Option 2, contribution margin per unit = $500 $350 0.10 $500, so $100 100 Degree of operating leverage = = 1.0 $10,000

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4. The calculations in requirement 3 indicate that when sales are 100 units, a percentage change in sales and contribution margin will result in 1.5 times that percentage change in operating income for Option 1, but the same percentage change in operating income for Option 2. The degree of operating leverage at a given level of sales helps managers calculate the effect of fluctuations in sales on operating incomes.

3-28 1.

Sales mix, three products. SP VCU CMU Coffee $2.50 1.25 $1.25 Bagels $3.75 1.75 $2.00

The sales mix implies that each bundle consists of 4 cups of coffee and 1 bagel. Contribution margin of the bundle = 4 Breakeven point in bundles = $1.25 + 1 $2 = $5.00 + $2.00 = $7.00

Fixed costs Contribution margin per bundle

$7, 000 $7.00

1, 000 bundles

Breakeven point is: Coffee: 1,000 bundlex 4 cups per bundle = 4,000 cups Bagels: 1,000 bundles 1 bagel per bundle = 1,000 bagels Alternatively, Let S = Number of bagels sold 4S = Number of cups of coffee sold Revenues Variable costs Fixed costs = Operating income [$2.50(4S) + $3.75S] [$1.25(4S) + $1.75S] $7,000 = OI $13.75S $6.75S $7,000 = OI $7.00 S=$7,000 S = 1,000 units of the sales mix or S =1,000 bagels sold 4S=4,000 cups of coffee sold Breakeven point, therefore, is 1,000 bagels and 4,000 cups of coffee when OI = 0 Check Revenues ($2.50 4,000) + ($3.75 1,000) Variable costs ($1.25 4,000) + ($1.75 1,000) Contribution margin Fixed costs Operating income

$13,750 6,750 7,000 7,000 $ 0

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2. SP VCU CMU

Coffee $2.50 1.25 $1.25

Bagels $3.75 1.75 $2.00

The sales mix implies that each bundle consists of 4 cups of coffee and 1 bagel. Contribution margin of the bundle = 4 $1.25 + 1 $2 = $5.00 + $2.00 = $7.00

Breakeven point in bundles Fixed costs + Target operating income = Contribution margin per bundle Breakeven point is: Coffee: 5,000 bundles Bagels: 5,000 bundles

$7, 000 $28,000 $7.00

5,000 bundles

4 cups per bundle = 20,000 cups 1 bagel per bundle = 5,000 bagels

Alternatively, Let S = Number of bagels sold 4S = Number of cups of coffee sold Revenues Variable costs Fixed costs = Operating income [$2.50(4S) + $3.75S] [$1.25(4S) + $1.75S] $7,000 = OI [$2.50(4S) + $3.75S] [$1.25(4S) + $1.75S] $7,000 = 28,000 $13.75S $6.75S = 35,000 $7.00 S=$35,000 S = 5,000 units of the sales mix or S =5,000 bagels sold 4S=20,000 cups of coffee sold The target number of units to reach an operating income before tax of $28,000 is 5,000 bagels and 20,000 cups of coffee. Check Revenues ($2.50 20,000) + ($3.75 5,000) Variable costs ($1.25 20,000) + ($1.75 5,000) Contribution margin Fixed costs Operating income 3. SP VCU CMU Coffee $2.50 1.25 $1.25 Bagels $3.75 1.75 $2.00

$68,750 33,750 35,000 7,000 $28,000 Muffins $3.00 0.75 $2.25

The sales mix implies that each bundle consists of 3 cups of coffee, 2 bagels and 1 muffin
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Contribution margin of the bundle = 3 $1.25 + 2 $2 + 1 $2.25 = $3.75 + $4.00 + $2.25 = $10.00 Breakeven point in bundles = Breakeven point is: Coffee: 700 bundles Bagels: 700 bundles Muffins: 700 bundles

Fixed costs Contribution margin per bundle

$7, 000 $10.00

700 bundles

3 cups per bundle = 2,100 cups 2 bagels per bundle = 1,400 bagels 1 muffin per bundle = 700 muffins

Alternatively, Let S = Number of muffins sold 2S = Number of bagels sold 3S = Number of cups of coffee sold Revenues Variable costs Fixed costs = Operating income [$2.50(3S) + $3.75(2S) +3.00S] [$1.25(3S) + $1.75(2S) + $0.75S] $7,000 = OI $18.00S $8S $7,000 = OI $10.00 S=$7,000 S = 700 units of the sales mix or S =700 muffins 2S=1,400 bagels 3S=2,100 cups of coffee Breakeven point, therefore, is 2,100 cups of coffee 1,400 bagels, and 700 muffins when OI = 0 Check Revenues ($2.50 2,100) + ($3.75 1,400) +($3.00 700) Variable costs ($1.25 2,100) + ($1.75 1,400) +($0.75 700) Contribution margin Fixed costs Operating income

$12,600 5,600 7,000 7,000 $ 0

Bobbie should definitely add muffins to her product mix because muffins have the highest contribution margin ($2.25) of all three products. This lowers Bobbies overall breakeven point. If the sales mix ratio above can be attained, the result is a lower breakeven revenue ($12,600) of the options presented in the problem.

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3-36 1.

CVP analysis, income taxes. Revenues Variable costs Fixed costs = Let X = Net income for 2011
20,000($25.00) 20,000($13.75) $135,000 = $500,000 $275,000 $135,000 =
X 1 0.40 X

Target net income 1 Tax rate

0.60 $300,000 $165,000 $81,000 = X X = $54,000

Alternatively, Operating income = Revenues Variable costs Fixed costs

= $500,000 $275,000 $135,000 = $90,000

Income taxes = 0.40 $90,000 = $36,000 Net income = Operating income Income taxes = $90,000 $36,000 = $54,000 2. Let Q = Number of units to break even
$25.00Q $13.75Q $135,000 = 0 Q = $135,000 $11.25 = 12,000 units

3.

Let X = Net income for 2012

22,000($25.00) 22,000($13.75) ($135,000 + $11,250) $550,000 $302,500 $146,250 $101,250 = = =
X 1 0.40 X

0.60 X

0.60 X = $60,750

4.

Let Q = Number of units to break even with new fixed costs of $146,250
$25.00Q $13.75Q $146,250 Q = $146,250 $11.25 Breakeven revenues = 13,000 $25.00 = 0 = 13,000 units = $325,000

5.

Let S = Required sales units to equal 2011 net income

$25.00S $13.75S $146,250 = $11.25S = $236,250 S = 21,000 units Revenues = 21,000 units
$54,000 0.60

$25 = $525,000

6.

Let A = Amount spent for advertising in 2012

$550,000 $302,500 ($135,000 + A) =
$60,000 0.60 $550,000 $302,500 $135,000 A = $100,000 $550,000 $537,500 = A

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A = $12,500

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3-45 Multi-product CVP and decision making. 1. Faucet filter: Selling price Variable cost per unit Contribution margin per unit Pitcher-cum-filter: Selling price Variable cost per unit Contribution margin per unit

$80 20 $60

$90 25 $65

Each bundle contains 2 faucet models and 3 pitcher models. So contribution margin of a bundle = 2 $60 + 3 $65 = $315
Breakeven Fixed costs point in = Contribution margin per bundle bundles $945,000 $315 3,000 bundles

Breakeven point in units of faucet models and pitcher models is: Faucet models: 3,000 bundles 2 units per bundle = 6,000 units Pitcher models: 3,000 bundles 3 units per bundle = 9,000 units Total number of units to breakeven 15,000 units Breakeven point in dollars for faucet models and pitcher models is: Faucet models: 6,000 units $80 per unit = $ 480,000 Pitcher models: 9,000 units $90 per unit = 810,000 Breakeven revenues $1,290,000

Alternatively, weighted average contribution margin per unit = Breakeven point = Faucet filter: $945,000 15,000 units $63

(2 $60) + (3 $65) = $63 5

2 15,000 units = 6,000 units 5 3 Pitcher-cum-filter: 15,000 units 9,000 units 5 Breakeven point in dollars Faucet filter: 6,000 units $80 per unit = $480,000 Pitcher-cum-filter: 9,000 units $90 per unit = $810,000
2. Faucet filter: Selling price Variable cost per unit Contribution margin per unit

$80 15 $65

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Pitcher-cum-filter: Selling price Variable cost per unit Contribution margin per unit

$90 16 $74

Each bundle contains 2 faucet models and 3 pitcher models. So contribution margin of a bundle = 2 $65 + 3 $74 = $352
Breakeven Fixed costs point in = Contribution margin per bundle bundles $945,000 $181, 400 $352 3, 200 bundles

Breakeven point in units of faucet models and pitcher models is: Faucet models: 3,200 bundles 2 units per bundle = 6,400 units Pitcher models: 3,200 bundles 3 units per bundle = 9,600 units Total number of units to breakeven 16,000 units Breakeven point in dollars for faucet models and pitcher models is: Faucet models: 6,400 bundles $80 per unit = $ 512,000 Pitcher models: 9,600 bundles $90 per unit = 864,000 Breakeven revenues $1,376,000

Alternatively, weighted average contribution margin per unit = Breakeven point = Faucet filter: $945,000 + $181,400 $70.40 16, 000 units

(2 $65) + (3 $74) = $70.40 5

2 16,000 units = 6,400 units 5 3 Pitcher-cum-filter: 16, 000 units 9, 600 units 5 Breakeven point in dollars: Faucet filter: 6,400 units $80 per unit = $512,000 Pitcher-cum-filter: 9,600 units $90 per unit = $864,000
3. Let x be the number of bundles for Pure Water Products to be indifferent between the old and new production equipment. Operating income using old equipment = $315 x $945,000 Operating income using new equipment = $352 x $945,000 $181,400 At point of indifference: $315 x $945,000 = $352 x $1,126,400 $352 x $315 x = $1,126,400 $945,000 $37 x = $181,400 x = $181,400 $37 = 4,902.7 bundles = 4,903 bundles (rounded)
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Faucet models = 4,903 bundles 2 units per bundle = 9,806 units Pitcher models = 4,903 bundles 3 units per bundle = 14,709 units Total number of units 24,515 units Let x be the number of bundles,
When total sales are less than 24,515 units (4,903 bundles), $315x $945,000 > $352x $1,126,400, so Pure Water Products is better off with the old equipment.

When total sales are greater than 24,515 units (4,903 bundles), $352x $1,126,400 > $315x $945,000, so Pure Water Products is better off buying the new equipment.

At total sales of 30,000 units (6,000 bundles), Pure Water Products should buy the new production equipment. Check $352 6,000 $1,126,400 = $985,600 is greater than $315 6,000 $945,000 = $945,000. 3-47 1. Gross margin and contribution margin. Ticket sales ($24 525 attendees) Variable cost of dinner ($12a 525 attendees) Variable invitations and paperwork ($1b 525) Contribution margin Fixed cost of dinner Fixed cost of invitations and paperwork Operating profit (loss)
a b

$12,600 $6,300 525 9,000 1,975 6,825 5,775 10,975 $ (5,200)

$6,300/525 attendees = $12/attendee $525/525 attendees = $1/attendee $25,200 $12,600 1,050 9,000 1,975 13,650 11,550 10,975 $ 575

2.

Ticket sales ($24 1,050 attendees) Variable cost of dinner ($12 1,050 attendees) Variable invitations and paperwork ($1 1,050) Contribution margin Fixed cost of dinner Fixed cost of invitations and paperwork Operating profit (loss)

10-3 A linear cost function is a cost function where, within the relevant range, the graph of total costs versus the level of a single activity related to that cost is a straight line. An example of a linear cost function is a cost function for use of a videoconferencing line where the terms are a fixed charge of $10,000 per year plus a $2 per minute charge for line use. A nonlinear cost function is a cost function where, within the relevant range, the graph of total costs versus the level of a single activity related to that cost is not a straight line. Examples include economies of scale in advertising where an agency can double the number of advertisements for less than twice the costs, step-cost functions, and learning-curve-based costs.
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10-4 No. High correlation merely indicates that the two variables move together in the data examined. It is essential also to consider economic plausibility before making inferences about cause and effect. Without any economic plausibility for a relationship, it is less likely that a high level of correlation observed in one set of data will be similarly found in other sets of data. 10-12 Frequently encountered problems when collecting cost data on variables included in a cost function are 1. The time period used to measure the dependent variable is not properly matched with the time period used to measure the cost driver(s). 2. Fixed costs are allocated as if they are variable. 3. Data are either not available for all observations or are not uniformly reliable. 4. Extreme values of observations occur. 5. A homogeneous relationship between the individual cost items in the dependent variable cost pool and the cost driver(s) does not exist. 6. The relationship between the cost and the cost driver is not stationary. 7. Inflation has occurred in a dependent variable, a cost driver, or both. 10-19 Matching graphs with descriptions of cost and revenue behavior. a. b. c. d. e. f. (1) (6) (9) (2) (8) (10)

A step-cost function.

It is data plotted on a scatter diagram, showing a linear variable cost function with constant variance of residuals. The constant variance of residuals implies that there is a uniform dispersion of the data points about the regression line.

g. h.

(3) (8)

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10-24 Estimating a cost function, high-low method. 1. See Solution Exhibit 10-24. There is a positive relationship between the number of service reports (a cost driver) and the customer-service department costs. This relationship is economically plausible. 2. Number of Customer-Service Service Reports Department Costs Highest observation of cost driver 455 $21,500 Lowest observation of cost driver 115 13,000 Difference 340 $ 8,500 Customer-service department costs = a + b (number of service reports) Slope coefficient (b) Constant (a)
$8,500 = $25 per service report 340 = $21,500 ($25 455) = $10,125 = $13,000 ($25 115) = $10,125

Customer-service department costs = $10,125 + $25 (number of service reports)

3. Other possible cost drivers of customer-service department costs are: a. Number of products replaced with a new product (and the dollar value of the new products charged to the customer-service department). b. Number of products repaired and the time and cost of repairs.

SOLUTION EXHIBIT 10-24 Plot of Number of Service Reports versus Customer-Service Dept. Costs for Capitol Products

10-26 Cost-volume-profit and regression analysis.

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1a.

Total manufacturing costs Number of bicycle frames $1,056,000 = = $33 per frame 32,000 This cost is higher than the $32.50 per frame that Ryan has quoted.
Average cost of manufacturing =

1b. Goldstein cannot take the average manufacturing cost in 2012 of $33 per frame and multiply it by 35,000 bicycle frames to determine the total cost of manufacturing 35,000 bicycle frames. The reason is that some of the $1,056,000 (or equivalently the $33 cost per frame) are fixed costs and some are variable costs. Without distinguishing fixed from variable costs, Goldstein cannot determine the cost of manufacturing 35,000 frames. For example, if all costs are fixed, the manufacturing costs of 35,000 frames will continue to be $1,056,000. If, however, all costs are variable, the cost of manufacturing 35,000 frames would be $33 35,000 = $1,155,000. If some costs are fixed and some are variable, the cost of manufacturing 35,000 frames will be somewhere between $1,056,000 and $1,155,000. Some students could argue that another reason for not being able to determine the cost of manufacturing 35,000 bicycle frames is that not all costs are output unit-level costs. If some costs are, for example, batch-level costs, more information would be needed on the number of batches in which the 35,000 bicycle frames would be produced, in order to determine the cost of manufacturing 35,000 bicycle frames. 2.
Expected cost to make = $435,000 + $19 35,000 35,000 bicycle frames = $435,000 + $665,000 = $1,100,000

Purchasing bicycle frames from Ryan will cost $32.50 35,000 = $1,137,500. Hence, it will cost Goldstein $1,137,500 $1,100,000 = $37,500 more to purchase the frames from Ryan rather than manufacture them in-house. 3. Goldstein would need to consider several factors before being confident that the equation in requirement 2 accurately predicts the cost of manufacturing bicycle frames. a. Is the relationship between total manufacturing costs and quantity of bicycle frames economically plausible? For example, is the quantity of bicycles made the only cost driver or are there other cost-drivers (for example batch-level costs of setups, production-orders or material handling) that affect manufacturing costs? b. How good is the goodness of fit? That is, how well does the estimated line fit the data? c. Is the relationship between the number of bicycle frames produced and total manufacturing costs linear? d. Does the slope of the regression line indicate that a strong relationship exists between manufacturing costs and the number of bicycle frames produced? e. Are there any data problems such as, for example, errors in measuring costs, trends in prices of materials, labor or overheads that might affect variable or fixed costs over time, extreme values of observations, or a nonstationary relationship over time between total manufacturing costs and the quantity of bicycles produced? f. How is inflation expected to affect costs? g.Will Ryan supply high-quality bicycle frames on time? 10-29 Learning curve, cumulative average-time learning model.
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The direct manufacturing labor-hours (DMLH) required to produce the first 2, 4, and 8 units given the assumption of a cumulative average-time learning curve of 85%, is as follows: 85% Learning Curve Cumulative Number of Units (X) (1) 1 2 4 8 Cumulative Average Time per Unit (y): Labor Hours (2) 6,000 5,100 = (6,000 0.85) 4,335 = (5,100 0.85) 3,685 = (4,335 0.85) Cumulative Total Time: Labor-Hours (3) = (1) (2) 6,000 10,200 17,340 29,480

Alternatively, to compute the values in column (2) we could use the formula y = aXb where a = 6,000, X = 2, 4, or 8, and b = 0.234465, which gives when X = 2, y = 6,000 2 0.234465 = 5,100 when X = 4, y = 6,000 4 0.234465 = 4,335 when X = 8, y = 6,000 8 0.234465 = 3,685 Variable Costs of Producing 2 Units 4 Units 8 Units $320,000 $ 640,000 $1,280,000 306,000 204,000 $830,000 520,200 346,800 $1,507,000 884,400 589,600 $2,754,000

Direct materials $160,000 2; 4; 8 Direct manufacturing labor $30 10,200; 17,340; 29,480 Variable manufacturing overhead $20 10,200; 17,340; 29,480 Total variable costs

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10-30

Learning curve, incremental unit-time learning model.

1. The direct manufacturing labor-hours (DMLH) required to produce the first 2, 3, and 4 units, given the assumption of an incremental unit-time learning curve of 85%, is as follows: 85% Learning Curve Individual Unit Time for Xth Unit (y): Labor Hours (2) 6,000 5,100 = (6,000 0.85) 4,637 4,335 = (5,100 0.85)

Cumulative Number of Units (X) (1) 1 2 3 4

Cumulative Total Time: Labor-Hours (3) 6,000 11,100 15,737 20,072

Values in column (2) are calculated using the formula y = aXb where a = 6,000, X = 2, 3, or 4, and b = 0.234465, which gives when X = 2, y = 6,000 2 0.234465 = 5,100 when X = 3, y = 6,000 3 0.234465 = 4,637 when X = 4, y = 6,000 4 0.234465 = 4,335 Variable Costs of Producing 2 Units 3 Units 4 Units $320,000 $ 480,000 $ 640,000 333,000 222,000 $875,000 472,110 314,740 $1,266,850 602,160 401,440 $1,643,600

Direct materials $160,000 2; 3; 4 Direct manufacturing labor $30 11,100; 15,737; 20,072 Variable manufacturing overhead $20 11,100; 15,737; 20,072 Total variable costs 2.

Incremental unit-time learning model (from requirement 1) Cumulative average-time learning model (from Exercise 10-29) Difference

Variable Costs of Producing 2 Units 4 Units $875,000 $1,643,600 830,000 1,507,000 $ 45,000 $ 136,600

Total variable costs for manufacturing 2 and 4 units are lower under the cumulative average-time learning curve relative to the incremental unit-time learning curve. Direct manufacturing labor-hours required to make additional units decline more slowly in the incremental unit-time learning curve relative to the cumulative average-time learning curve when the same 85% factor is used for both curves. The reason is that, in the incremental unit-time learning curve, as the number of units double only the last unit produced has a cost of 85% of the initial cost. In the cumulative average-time learning model, doubling the number of units causes the average cost of all the units produced (not just the last unit) to be 85% of the initial cost.

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10-38 Regression; choosing among models. (chapter appendix) 1. Solution Exhibit 10-38A presents the regression output for (a) setup costs and number of setups and (b) setup costs and number of setup-hours. SOLUTION EXHIBIT 10-38A Regression Output for (a) Setup Costs and Number of Setups and (b) Setup Costs and Number of Setup-Hours a.
SUMMARY OUTPUT Regression Statistics Multiple R 0.686023489 R Square 0.470628228 Adjusted R Square 0.395003689 Standard Error 51385.93104 Observations 9 ANOVA df Regression Residual Total 1 7 8 SS MS F Significance F 16432501924 16432501924 6.223221 0.04131511 18483597365 2640513909 34916099289

Intercept X Variable 1

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% 12889.92611 61364.96556 0.210053505 0.839609 -132215.1596 157995.0118 -132215.1596 157995.0118 426.7711823 171.0753629 2.494638474 0.041315 22.24223047 831.3001341 22.24223047 831.3001341

b.
SUMMARY OUTPUT Regression Statistics Multiple R 0.92242169 R Square 0.850861774 Adjusted R Square 0.829556313 Standard Error 27274.59603 Observations 9 ANOVA df Regression Residual Total 1 7 8 SS MS F Significance F 29708774168 29708774168 39.93632322 0.000396651 5207325121 743903588.7 34916099289

Intercept X Variable 1

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% 6573.417913 25908.17948 0.253719792 0.807002921 -54689.69157 67836.5274 -54689.69157 67836.5274 56.27403095 8.904796227 6.319519224 0.000396651 35.21753384 77.33052805 35.21753384 77.33052805

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2. Solution Exhibit 10-38B presents the plots and regression lines for (a) number of setups versus setup costs and (b) number of setup hours versus setup costs. SOLUTION EXHIBIT 10-38B Plots and Regression Lines for (a) Number of Setups versus Setup Costs and (b) Number of SetupHours versus Setup Costs

Tilbert Toys Setup Costs and Number of Setups

$250,000

$200,000

Setup Costs

$150,000

$100,000
$50,000 $-

100

200

300

400

500

600

Number of Setups

Tilbert Toys Setup Costs and Number of Setup Hours

$250,000 $200,000

$150,000 $100,000
$50,000 $-

1,000

2,000

3,000

4,000

5,000

Setup Hours

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3. Economic plausibility Number of Setups A positive relationship between setup costs and the number of setups is economically plausible. Number of Setup Hours A positive relationship between setup costs and the number of setup-hours is also economically plausible, especially since setup time is not uniform, and the longer it takes to setup, the greater the setup costs, such as costs of setup labor and setup equipment. r2 = 85% Standard error of regression =$27,275 Excellent goodness of fit.

Goodness of fit

r2 = 47% Standard error of regression =$51,386 Reasonable goodness of fit.

Significance of Independent Variables

The t-value of 2.49 is significant at the The t-value of 6.32 is highly 0.05 level. significant at the 0.05 level. In fact, the p-value of 0.0004 (< 0.01) indicates that the coefficient is significant at the 0.01 level. Based on a plot of the data, the linearity assumption holds, but the constant variance assumption may be violated. The Durbin-Watson statistic of 1.65 suggests the residuals are independent. The normality of residuals assumption appears to hold. However, inferences drawn from only 9 observations are not reliable. Based on a plot of the data, the assumptions of linearity, constant variance, independence of residuals (Durbin-Watson = 1.50), and normality of residuals hold. However, inferences drawn from only 9 observations are not reliable.

Specification analysis of estimation assumptions

4. The regression model using number of setup-hours should be used to estimate set up costs because number of setup-hours is a more economically plausible cost driver of setup costs (compared to number of setups). The setup time is different for different products and the longer it takes to setup, the greater the setup costs such as costs of setup-labor and setup equipment. The regression of number of setup-hours and setup costs also has a better fit, a substantially significant independent variable, and better satisfies the assumptions of the estimation technique.

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10-39 Multiple regression (continuation of 10-38). 1. Solution Exhibit 10-39 presents the regression output for setup costs using both number of setups and number of setup-hours as independent variables (cost drivers). SOLUTION EXHIBIT 10-39 Regression Output for Multiple Regression for Setup Costs Using Both Number of Setups and Number of Setup-Hours as Independent Variables (Cost Drivers)
SUMMARY OUTPUT Regression Statistics Multiple R 0.924938047 R Square 0.855510391 Adjusted R Square 0.807347188 Standard Error 28997.16516 Observations 9 ANOVA df Regression Residual Total 2 6 8 SS MS F Significance F 29871085766 14935542883 17.76274 0.003016545 5045013522 840835587.1 34916099289 Upper 95.0% 82468.37339 385.0763718 84.32101912

Intercept Number of Setups Setup Hours

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% -2807.097769 34850.24247 -0.080547439 0.938421 -88082.56893 82468.37339 -88082.56893 58.61773979 133.416589 0.439358705 0.675783 -267.8408923 385.0763718 -267.8408923 52.30623518 13.08375044 3.997801352 0.007137 20.29145124 84.32101912 20.29145124

2. Economic plausibility

A positive relationship between setup costs and each of the independent variables (number of setups and number of setup-hours) is economically plausible. r2 = 86%, Adjusted r2 = 81% Standard error of regression =$28,997 Excellent goodness of fit. The t-value of 0.44 for number of setups is not significant at the 0.05 level. The t-value of 4.00 for number of setup-hours is significant at the 0.05 level. Moreover, the p-value of 0.007 (< 0.01) indicates that the coefficient is significant at the 0.01 level. Assuming linearity, constant variance, and normality of residuals, the Durbin-Watson statistic of 1.38 suggests the residuals are independent. However, we must be cautious when drawing inferences from only 9 observations.

Goodness of fit

Significance of Independent Variables

Specification analysis of estimation assumptions

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3. Multicollinearity is an issue that can arise with multiple regression but not simple regression analysis. Multicollinearity means that the independent variables are highly correlated. The correlation feature in Excels Data Analysis reveals a coefficient of correlation of 0.69 between number of setups and number of setup-hours. This is very close to the threshold of 0.70 that is usually taken as a sign of multicollinearity problems. As evidence, note the substantial drop in the t-value for setup hours from 6.32 to 4.00, despite a fairly small change in the estimated coefficient (from $56.27 to $52.31). 4. The simple regression model using the number of setup-hours as the independent variable achieves a comparable r2 to the multiple regression model. However, the multiple regression model includes an insignificant independent variable, number of setups. Adding this variable does not improve Williams ability to better estimate setup costs and introduces multicollinearity issues. Bebe should use the simple regression model with number of setup-hours as the independent variable to estimate costs.