Вы находитесь на странице: 1из 100

��#ࡱ#�################>###��

#############E###�###########�#######����####�###�###�###�###�###�###�###�###�###�#
##�###�###�###�###�###�###�###�###�###�###�###�###�###�###�###�###�###�###�###�###�
###�###�###�###�###�###�###�###�###�###�###�###�###�###�###�###�###�###�###�###�###
�###�###�###�###}###�###^###�###`###�###b###�###k###�### ##� ##}!##�!
##���������������������������������������������������������������������������������
���������������������������������������������������������������������������������#[
� ###�#�###############g#0###bjbj���##################
###�o1#ΐ##ΐ##�######�###############
%V######��##########��##########��##################�#####B#######B###�"######�"###
###��######��######��##�###########����####I�######I�######I�##@###��##l###��##4�##
I�######��##�###)h##p###�h######�i######�i######�i######��##6###ʾ######ࡱ##
###��######��######��######��######��######��######��##$###7�##�###��##�###��##Q###
################��#######�######################X�##<1##��#######�#######�######��#
#############�"######�"######�i##############�i##�###3�##.###[3######[3######[3####
###�##,###�"##�u##�i######��######�i######��##############[3#######################
################################�######��##############[3######[3##R###��##p###E�##
@-
##################################################################��######�i######�
���####0�&V�#########I�######1�##,A##h�##############��######a�##<###��######��##&
###o�######]/##�###o�##<###��######################################################
########################o�##############��######��##�###�##j
##T�##p###[3######��##�###��##M
##################################�######�######�######��######��##################
#####################2##T###################################�######�######�######��
#######�#######�#######�#######�##############����####����####����############����#
###����####����####����####����####����####����####����####����####����####����####
����####����####����####o�######�######�######�######�######�######�###############
###############################################�######�######�######B###
##K!##:#########

###################################################################################
###################################################################################
###################################################################################
###################################################################################
###################################################################################
########TABLE OF CONTENTS Chapter #1#Management Accounting: An Overview# 1-1
� 1-19###2#Management Accounting and the Business Environment# 2-1
� 2-5###3#Understanding of Financial S tatements# 3-1 � 3-
10###4#Financial S tatements Analysis � I# 4-1 � 4-9###5#Financial S tatements
Analysis � II# 5-1 � 5-38###6#Cash Flow Analysis# 6-1 � 6-
18###7#Gross Profit Valuation Analysis and Earnings Per S hare Determination# 7-1
� 7-7###8#Cost Concepts and Classifications# 8-1 � 8-
17###9#Cost Behavior: Analysis and Use# 9-1 � 9-30###10#S ystems Design:
Job-Order Costing and Process Costing# 10-1 � 10-16###11#S ystems Design:
Activity-Based Costing and Management# 11-1 � 11-15###12#Variable Costing#
12-1 � 12-21###13#Cost-Volume-Profit Relationships# 13-1 � 13-
37###14#Responsibility Accounting and Transfer Pricing# 14-1 � 14-
26###15#Functional and Activity-Based Budgeting#15-1 � 15-22###16#S tandard
Costs and Operating Performance Measures#16-1 � 16-17###17#Application of
Quantitative Techniques in Planning, Control and Decision Making - I# 17-1 �
17-2###18#Application of Quantitative Techniques in Planning, Control and
Decision Making � II# 18-1 � 18-7###19#Relevant Costs for Decision Making#
19-1 � 19-33###20#Capital Budgeting Decisions# 20-1 � 20-
16###21#Decentralized Operations and S egment Reporting # 21-1 � 21-
4###22#Business Planning# 22-1 � 22-6###23#S trategic Cost Management;
Balanced S corecard # 23-1 � 23-4###24#Advanced Analysis and Appraisal of
Performance: Financial and Nonfinancial # 24-1 � 24-12###25#Managing
Productivity and Marketing Effectiveness# 25-1 � 25-19###26#Executive
Performance Measures and Compensation #26-1 � 26-3###27#Managing Accounting
in a Changing Environment#27-1 � 27-22##CHAPTER 1MANAGEMENT ACCOUNTING:
AN OVERVIEW I. QuestionsUse of the word �need� in the quoted passage is
pejorative. It implies an unlimited level of demand for information. However,
rational managers apply a cost-benefit criterion to information and will only want
accounting information if its benefits exceed its costs. Accounting information
provides benefits by improving decision making and controlling behavior in
organizations. In most organizations, accounting information is very prevalent
which implies that its benefits exceed its costs. Hence, successful managers will
find it in their self-interest to learn how to use accounting information in these
organizations.Clearly, this statement is incurred in those firms where accounting
information has very limited usefulness (e.g., if the accounting information is
often wrong or is not produced in a timely fashion). In these organizations,
managers do not find the accounting information to have benefits in excess of its
costs, will not use it, do not need to know how to use it, and definitely do not
need it.2. a. Historical costs are of limited use in making planning decisions
in a rapidly changing environment. W ith changing products, processes and prices,
the historical costs are inadequate approximations of the opportunity costs of
using resources. Historical costs may, however, be useful for control
purposes, as they provide information about the activities of managers and can be
used as performance measures to evaluate managers. b. The purpose of
accounting systems is to provide information for planning purposes and control.
Although historical costs are not generally appropriate for planning purposes,
additional measures are costly to make. An accounting system should include
additional measures if the benefits of improved decision making are greater than
the costs of the additional information.3. Finance and economics textbooks
traditionally state that the goal of a profit organization is to maximize
shareholder wealth. Managers are frequently presumed to act in the best interest
of the shareholder, although recent finance literature recognizes that appropriate
incentives are necessary to align manager interests with shareholder interests.
The goal, however, are not very clear as to how this is achieved. Most finance
textbooks focus on financing decisions and not on the use of assets and dealing
with customers. Marketing�s goal of satisfying customers recognizes that
customers are the source of revenues for the organization, and therefore the means
through which shareholder value is increased. However, customer satisfaction is
only valuable insofar as it creates shareholder wealth. The further goal of
marketing is to ensure that customer satisfaction is maximized without compromising
the organization�s profitability.4. Yes. Planning is really much more vital than
control; that is, superior control is fruitless if faulty plans are being
implemented. However, planning and control are so intertwined that it seems
artificial to draw rigid lines of separation between them.5. Yes. The
controller has line authority over the personnel in his own department but is a
staff executive with respect to the other departments.6. Line authority is
exerted downward over subordinates. S taff authority is the authority to advise but
not command others; it is exercised laterally or upward. Functional authority is
the right to command action laterally and downward with regard to a specific
function or specialty.7. Cost accounting is the controller�s primary means of
implementing the 7-point concept of modern controllership. Cost accounting is
intertwined with all seven duties to some extent, but its major focus is on the
first three.8. Bettina Company ##President############VP, Production##VP,
Finance##VP, S ales###################Controller##Treasurer############Assistant
Controller##Assistant Treasurer#############################S pecial S tudies
Manager##CostAccountingManager##Tax Manager##Internal AuditManager##General
AccountingManager##S ystem &EDP Manager################################Cost S ystems
Analyst##Budget &S tandard Cost Analyst##Performance
Analyst#########################################Cost Clerk##Payroll Clerk##Accounts
ReceivableClerk##Accounts PayableClerk##Billing Clerk##General LedgerBookkeeper##9.
Management accountants contribute to strategic decisions by providing
information about the sources of competitive advantage and by helping managers
identify and build a company�s resources and capabilities.10. In most
organizations, management accountants perform multiple roles: problem solving
(comparative analyses for decision making), scorekeeping (accumulating data and
reporting reliable results), and attention directing (helping managers properly
focus their attention).11. Three guidelines that help management accountants
increase their value to managers are (a) employ a cost-benefit approach, (b)
recognize behavioral as well as technical considerations, and (c) identify
different costs for different purposes.12. Management accounting is an
integral part of the controller�s function in an organization. In most
organizations, the controller reports to the chief financial officer, who is a key
member of the top management team.13. Management accountants have ethical
responsibilities that are related to competence, confidentiality, integrity, and
objectivity.14. By reporting and interpreting relevant data, the controller
exerts a force or influence that impels management toward making better-informed
decisions. The controller of one company described the job as �a business advisor
to�help the team develop strategy and focus the team all the way through
recommendations and implementation.�15. Financial Accounting##Audience:#External:
shareholders, creditors, tax authorities##Purpose:#Report on past performance to
external parties; basis of contracts with owners and lenders##Timeliness:#Delayed;
historical##Restrictions:#Regulated; rules driven by generally accepted accounting
principles and government authorities##Type of Information:#Financial measurements
only##Nature of Information:#Objective, auditable, reliable, consistent,
precise##S cope:#Highly aggregate; report on entire organization##Managerial
Accounting##Audience:#Internal: W orkers, managers, executives##Purpose:#Inform
internal decisions made by employees and managers; feedback and control on
operating performance##Timeliness:#Current, future oriented##Restrictions:#No
regulations; systems and information determined by management to meet strategic and
operational needs##Type of Information:#Financial, plus operational and physical
measurements on processes, technologies, suppliers customers, and
competitors##Nature of Information:#More subjective and judgmental; valid,
relevant, accurate##S cope:#Disaggregate; inform local decisions and actions##16.
The competitive environment has changed dramatically. Companies encountered
severe competition from overseas companies that offered high-quality products at
low prices. Activity-based costing systems are introduced in many manufacturing
and service organizations to overcome the inability of traditional cost systems to
accurately assign overhead costs. Activity-based management is a viable approach
for managers to make decisions based on ABC information. There has been
improvement of operational control systems such that information is more current
and provided more frequently. The nature of work has changed from controlling to
informing. Firms are concerned about continuous improvement, employee empowerment
and total quality. Nonfinancial information
has become a critical feedback measure. Finally, the focus of many firms is on
measuring and managing activities.17. As measurements are made on operations
and, especially, on individuals and groups, the behavior of the individuals and
groups are affected. People will react to the measurements being made by focusing
on the variables or behavior being measured. In addition, if managers attempt to
introduce or redesign cost and performance measurement systems, people familiar
with the previous system will resist. Management accountants must understand and
anticipate the reactions of individuals to information and measurements. The
design and introduction of new measurements and systems must be accompanied with an
analysis of the likely reactions to the innovations.II. ExercisesExercise 1a.
(1) Problem solvingb. (3) Attention-directingc. (1) Problem solvingd.
(2) S corekeepingExercise 2a. (4) Marketingb. (3) Productionc.
(6) Customer serviced. (5) DistributionExercise 3a. (4)
Marketingb. (3) Productionc. (5) Distributiond. (4) Marketinge.
(5) Distributionf. (3) Productiong. (1) Research and development
h. (2) DesignIII. Problems Problem 1 (Problem S olving, S corekeeping, and
Attention Directing)Because the accountant�s duties are often not sharply defined,
some of these answers might be challenged:S corekeepingAttention directing
S corekeepingProblem solvingAttention directingAttention directingProblem solving
S corekeeping (depending on the extent of the report) or attention gettingThis
question is intentionally vague. The give-and-take of the budgetary process
usually encompasses all three functions, but it emphasizes scorekeeping the least.
The main function is attention directing, but problem solving is also involved.
Problem solvingProblem 2 (Management Accounting Information S ystem)1. Inputs: b,
g, i, m2. Processes: a, d, f, j3. Outputs: e, k, n4. S ystem objectives:
c, h, lProblem 3 (Role of Management Accountants)Planning. The management
accountant gains an understanding of the impact on the organization of planned
transactions (i.e., analyzing strengths and weaknesses) and economic events, both
strategic and tactical, and sets obtainable goals for the organization. The
development of budgets is an example of planning.Controlling. The management
accountant ensures the integrity of financial information, monitors performance
against budgets and goals, and provides information internally for decision making.
Comparing actual performance against budgeted performance and taking corrective
action where necessary is an example of controlling. Internal auditing is another
example.Evaluating Performance. The management accountant judges and analyzes the
implication of various past and expected events, and then chooses the optimum
course of action. The management accountant also translates data and communicates
the conclusions. Graphical analysis (such as trend, bar charts, or regression) and
reports comparing actual costs with budgeted costs are examples of evaluating
performance.Ensuring Accountability of Resources. The management accountant
implements a reporting system closely aligned to organizational goals that
contribute to the measurement of the effective use of resources and safeguarding of
assets. Internal reporting such as comparison of actual to budget is an example of
accountability.External Reporting. The management accountant prepares reports in
accordance with generally accepted accounting principles and then disseminates this
information to shareholders, creditors, and regulatory tax agencies. An annual
report or a credit application are examples of external reporting.Problem 4 (Line
Versus S taff)Jamie Reyes is staff. S he is in a support role � she prepares reports
and helps explain and interpret them. Her role is to help the line managers more
effectively carry out their responsibilities.S tephen S antos is a line manager. He
has direct responsibility for producing a garden hose. Clearly, one of the basic
objectives for the existence of a manufacturing firm is to make a product. Thus,
S tephen has direct responsibility for a basic objective and therefore holds a line
position.Problem 5 (Professional Ethics and End-of-Year Games)Requirement 1The
possible motivations for the snack foods division wanting to play end-of-year games
include:(a) Management incentives. Yummy 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 Yummy 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 Yummy 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.Requirement 2The
�S tandards of Ethical Conduct�� require management accountants to:Refrain from
either actively or passively subverting the attainment of the organization�s
legitimate and ethical objectives, andCommunicate unfavorable as well as favorable
information and professional judgment or opinions.S everal of the �end-of-year
games� clearly are in conflict with these requirements and should be viewed as
unacceptable by Tan:(a) The fiscal year-end should be closed on midnight of
December 31. �Extending� the close falsely reports next year�s sales as this
year�s sales.(b) Altering shipping dates is falsification of the accounting
reports.(c) 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 games� occur in many organizations and may fall into the �gray�
to �acceptable� area. However, much depends on the circumstances surrounding each
one:(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, it
is clearly unethical. If, however, the carrier receives no extra consideration and
willingly agrees to accept the assignment, the transaction appears ethical. Each
of the (a), (d), (e) and (g) �end-of-year games� may well disadvantage Yummy 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 Yummy 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.
Requirement 3If Tan 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,HOswever, Tan should discuss her concerns with the Corporate
Controller of Yummy Foods. Tan 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 Yummy Foods. In the extreme,
she may want to resign if the corporate culture of Yummy Foods is to reward
division managers who play �end-of-year games� that Tan views as unethical and
possibly illegal.Problem 6James Torres has come up with a scheme that involves a
combination of data falsification and smoothing! Not only has he made up the
revenue numbers, but also he has had the gall to defer some of them to the next
period. Making up such numbers is clearly illegal. S moothing, in this example is
also illegal because the numbers are fictitious.Problem 7Clearly the vice-president
will lose his or her job if you turn him or her in. Given that this is a major
violation of the code of ethics and a violation patent law, the vice-president
could go to jail. Your best course of action is to check your information and if
the vice-president is definitely involved, go immediately to the VP�s superior (who
is probably a senior VP or the company president). The organization�s attorneys
will take over from there.Problem 8One option is to do nothing and ignore what you
saw, however, this may violate your own code of ethics and your ethical
responsibilities under the organization�s code of ethics. Given that you want to
do something, it is probably best to start by talking to employees in your
organization whose job it is to deal with ethical issues. If no such employees
exist or are available, you might start by using a decision model. This model
incorporated the following steps:1. Determine the Facts � W hat, W ho, W here, How2.
Define the Ethical Issue3. Identify Major Principles, Rule, Values4.
S pecify the Alternatives.5. Compare Values and Alternatives, S ee if Clear
Decision6. Assess
the Consequences.7. Make Your Decision.IV. CasesCase 1 (Financial vs.
Managerial Accounting)Requirement (a)Other forward looking information desired in
addition to the income statement information are1. Disclosure of the components
of financial performance, i.e., nature and source of revenues, various activities,
transactions, and other relevant events affecting the company.2. Nature and
function of the components of income and expensesRequirement (b)No. GAAP does not
allow capitalization of employee training and advertising costs even if management
feels that they increase the value of the company�s brand name. The reasons are
uncertainty of the future benefits that may be derived therefrom and difficulty and
reliability of their measurement.Requirement (c)Detailed information that managers
would likely request are analysis of the significant increases in1. S ales 2.
Cost of sales3. Payroll4. S tock and option based compensation5.
Advertising and promotion.Requirement (d)Nonmonetary measures:1. Change in
number and profile of customers2. S hare in the market3. W ho, what and how many
are the competitors4. Product lines offered by the entity vs. Product lines of
competitors5. S ales promotion and advertising activities Requirement (e)1.
Competitors2. Employees3. Prospective creditorsCase 2 (You get what you
measure!)Requirement (a)Increase in sales to new customers to salesToo much
emphasis on this ratio may lead the sales manager to spend more time developing
business with new customers and disregard the needs of existing customers. It is
therefore possible to lose the business of several key accounts.Requirement (b)
Decrease in cost of goods sold to salesThis performance measure could create the
following problems:1. Purchasing goods with poor quality at lower cost and
selling them for the same price.2. Indiscriminately increasing selling price to
widen the profit margin without regard to competitor�s current prices.3. If the
entity is manufacturing its own goods, managers could try to economize on costs,
i.e., buying poorer quality of materials, employing unskilled workers, etc. thereby
causing deterioration of the quality of the finished products.In all of the above
situations, customer patronage could eventually be adversely affected. Requirement
(c)Decrease in selling and administrative expense to salesCost-cutting is generally
advisable for as long as the quality of goods and services are not compromised.
Likewise, certain cost-saving measures could demotivate sales people and other
employees and could lead to counter-productive activities.Case 3 (The Roles of
Managers and Management Accountants)1. Managerial accounting, Financial
accounting2. Planning3. Directing and motivating4. Feedback5.
Decentralization6. Line7. S taff8. Controller9. Budgets10.
Performance report11. Chief Financial Officer12. Precision; Nonmonetary
dataCase 4 (Ethics in Business)If cashiers routinely short-changed customers
whenever the opportunity presented itself, most of us would be careful to count our
change before leaving the counter. Imagine what effect this would have on the line
at your favorite fast-food restaurant. How would you like to wait in line while
each and every customer laboriously counts out his or her change? Additionally, if
you can�t trust the cashiers to give honest change, can you trust the cooks to take
the time to follow health precautions such as washing their hands? If you can�t
trust anyone at the restaurant would you even want to eat out?Generally, when we
buy goods and services in the free market, we assume we are buying from people who
have a certain level of ethical standards. If we could not trust people to
maintain those standards, we would be reluctant to buy. The net result of
widespread dishonesty would be a shrunken economy with a lower growth rate and
fewer goods and services for sale at a lower overall level of quality.Case 5
(Ethics and the Manager)Requirement 1Failure to report the obsolete nature of the
inventory would violate the S tandards of Ethical Conduct as follows:Competence
Perform duties in accordance with relevant technical standards.Prepare complete
reports using reliable information.By failing to write down the value of the
obsolete inventory, Perez would not be preparing a complete report using reliable
information. In addition, generally accepted accounting principles (GAAP) require
the write-down of obsolete inventory.IntegrityAvoid conflicts of interest.Refrain
from activities that prejudice the ability to perform duties ethically.Refrain from
subverting the legitimate goals of the organization.Refrain from discrediting the
profession.Members of the management team, of which Perez is a part, are
responsible for both operations and recording the results of operations. S ince the
team will benefit from a bonus, increasing earnings by ignoring the obsolete
inventory is clearly a conflict of interest. Perez would also be concealing
unfavorable information and subverting the goals of the organization. Furthermore,
such behavior is a discredit to the profession.ObjectivityCommunicate information
fairly and objectively.Disclose all relevant information.Hiding the obsolete
inventory impairs the objectivity and relevance of financial statements.Requirement
2As discussed above, the ethical course of action would be for Perez to insist on
writing down the obsolete inventory. This would not, however, be an easy thing to
do. Apart from adversely affecting her own compensation, the ethical action may
anger her colleagues and make her very unpopular. Taking the ethical action would
require considerable courage and self-assurance.Case 6 (Preparing an Organization
Chart)Requirement 1S ee the organization chart on page 17.Requirement 2Line
positions would include the university president, academic vice-president, the
deans of the four colleges, and the dean of the law school. In addition, the
department heads (as well as the faculty) would be in line positions. The reason
is that their positions are directly related to the basic purpose of the
university, which is education. (Line positions are shaded on the organization
chart.)All other positions on the organization chart are staff positions. The
reason is that these positions are indirectly related to the educational process,
and exist only to provide service or support to the line positions.Requirement 3All
positions would have need for accounting information of some type. For example,
the manager of central purchasing would need to know the level of current
inventories and budgeted allowances in various areas before doing any purchasing;
the vice president for admissions and records would need to know the status of
scholarship funds as students are admitted to the university; the dean of the
business college would need to know his/her budget allowances in various areas, as
well as information on cost per student credit hour; and so forth.Case 7 (Ethics in
Business)Requirement 1No, S antos did not act in an ethical manner. In complying
with the president�s instructions to omit liabilities from the company�s financial
statements he was in direct violation of the IMA�s S tandards of Ethical Conduct for
Management Accountants. He violated both the �Integrity� and �Objectivity�
guidelines on this code of ethical conduct. The fact that the president ordered
the omission of the liabilities is immaterial.Requirement 2No, S antos� actions
can�t be justified. In dealing with similar situations, the S ecurities and
Exchange Commission (S EC) has consistently ruled that ��corporate officers�cannot
escape culpability by asserting that they acted as �good soldiers� and cannot rely
upon the fact that the violative conduct may have been condoned or ordered by their
corporate superiors.� (Quoted from: Gerald H. Lander, Michael T. Cronin, and Alan
Reinstein, �In Defense of the Management Accountant,� Management Accounting, May,
1990, p. 55) Thus, S antos not only acted unethically, but he could be held legally
liable if insolvency occurs and litigation is brought against the company by
creditors or others. It is important that students understand this point early in
the course, since it is widely assumed that �good soldiers� are justified by the
fact that they are just following orders. In the case at hand, S antos should have
resigned rather than become a party to the fraudulent misrepresentation of the
company�s financial statements.
##
Case 8 (Ethics in Business)Requirement 1Andres Romero has an ethical responsibility
to take some action in the matter of PhilChem, Inc. and the dumping of toxic
wastes. The S tandards of Ethical Conduct for Management Accountants specifies that
management accountants should not condone the commission of acts by their
organization that violate the standards of ethical conduct. The specific standards
that apply are as follows.� Competence. Management accountants have a
responsibility to perform their professional duties in accordance with relevant
laws and regulations.� Confidentiality. Management accountants must refrain from
disclosing confidential information unless legally obligated to do so. However,
Andres Romero may have a legal responsibility to take some action.� Integrity.
Management accountants have a responsibility to:- refrain from either actively
or passively subverting the attainment of the organization�s legitimate and ethical
objectives.- communicate favorable as well as unfavorable information and
professional judgments or opinions.� Objectivity. Management accountants must
fully disclose all relevant information that could reasonably be expected to
influence an intended user�s understanding of the reports, comments, and
recommendations.Requirement 2The S tandards of Ethical Conduct for Management
Accountants indicates that the first alternative being considered by Andres Romero,
seeking the advice of his boss, is appropriate. To resolve an ethical conflict,
the first step is to discuss the problem with the immediate superior, unless it
appears that this individual is involved in the conflict. In this case, it does
not appear that Romero�s boss is involved.Communication of confidential information
to anyone outside the company is inappropriate unless there is a legal obligation
to do so, in which case Romero should contact the proper authorities.Contacting a
member of the Board of Directors would be an inappropriate action at this time.
Romero should report the conflict to successively higher levels within the
organization and turn only to the Board of Directors if the problem is not resolved
at lower levels.Requirement 3Andres Romero should follow the established policies
of the organization bearing on the resolution of such conflict. If these policies
do not resolve the ethical conflict, Romero should report the problem to
successively higher levels of management up to the Board of Directors until it is
satisfactorily resolved. There is no requirement for Romero to inform his
immediate superior of this action because the superior is involved in the conflict.
If the conflict is not resolved after exhausting all courses of internal review,
Romero may have no other recourse than to resign from the organization and submit
an informative memorandum to an appropriate member of the organization. (CMA
Unofficial S olution, adapted)V. Multiple Choice Questions
D#D#B#D#A#B##D#D#B#C#C#B##D#D#A#D#D#A##B#A#A#B#B#C##D#A#B#D#C#D##A#A#C#B#B#C##B#D#B
#C#A#C##D#A#D#B#B#C##D#D#B#A#C#A##A#D#C#A#D#B##CHAPTER 2MANAGEMENT ACCOUNTING AND
THE BUS INES S ENVIRONMENTI. Questions1. Managerial accounting information often
brings to the attention of managers important issues that need their managerial
experience and skills. In many cases, managerial-accounting information will not
answer the question or solve the problem, but rather make management aware that the
issue or problem exists. In this sense, managerial accounting sometimes is said to
serve an attention-directing role.2. Non-value-added costs are the costs of
activities that can be eliminated with no deterioration of product quality,
performance, or perceived value.3. Managers rely on many information systems in
addition to managerial-accounting information. Examples of other information
systems include economic analysis and forecasting, marketing research, legal
research and analysis, and technical information provided by engineers and
production specialists.4. Becoming the low-cost producer in an industry
requires a clear understanding by management of the costs incurred in its
production process. Reports and analysis of these costs are a primary function of
managerial accounting.5. S ome activities in the value chain of a manufacturer
of cotton shirts are as follows:(a) Growing and harvesting cotton(b) Transporting
raw materials(c) Designing shirts(d) W eaving cotton material(e)
Manufacturing shirts(f) Transporting shirts to retailers(g) Advertising cotton
shirtsS ome activities in the value chain of an airline are as follows:(a) Making
reservations and ticketing(b) Designing the route network(c) S cheduling(d)
Purchasing aircraft(e) Maintaining aircraft(f) Running airport operations,
including handling baggage(g) S erving food and beverages in flight(h) Flying
passengers and cargo6. S trategic cost management is the process of understanding
and managing, to the organization�s advantage, the cost relationships among the
activities in an organization�s value chain.7. If customers who provide a company
with the most profits are attracted, satisfied, and retained, profits will increase
as a result.8. A value chain is a sequence of business functions whose objective
is to provide a product to a customer or provide an intermediate good or service in
a larger value chain. These business functions include R&D, design, production,
marketing, distribution, and customer service. An organization can become more
effective by focusing on whether each link in the chain adds value from the
customer�s perspective and furthers the organization�s objectives.9. Cost:
Organizations are under continuous pressure to reduce the cost of the
products or services they sell to their customers. Quality: Customers are
expecting higher levels of quality and are less tolerant of low quality than in the
past. Time: Time has many components: the time taken to develop and bring new
products to market; the speed at which an organization responds to customer
requests; and the reliability with which promised delivery dates are met.
Organizations are under pressure to complete activities faster and to meet promised
delivery dates more reliably than in the past in order to increase customer
satisfaction. Innovation: There is now heightened recognition that a continuing
flow of innovative products or services is a prerequisite for the ongoing success
of most organizations.10. Managers make planning decisions and control
decisions. Planning decisions include deciding on organization goals, predicting
results under various alternative ways of achieving those goals, and then deciding
how to attain the desired goals. Control decisions include taking actions to
implement the planning decisions and deciding on performance evaluation and
feedback that will help future decision making.11. Four themes for managers to
attain success are customer focus, value-chain and supply-chain analysis, key
success factors, and continuous improvement and benchmarking.12. Companies add
value through R&D; design of products, services, or processes; production;
marketing; distribution; and customer service. Managers in all business functions
of the value chain are customers of management accounting information.13. This
phrase means that people will direct their attention to work primarily on those
tasks that management monitors and measures. Employees may not pay as much
attention (or no attention) to tasks that are not measured. Often management will
reward people based on how well they perform relative to a specific measure. As an
example, in a manufacturing organization, if people are measured and rewarded based
on the number of outputs per hour, regardless of quality, employees will focus
their attention on producing as many units of output as possible. A negative
consequence is that the quality of output may suffer.14. S ome of these new
measures are quality, speed to market, cycle time, flexibility, complexity and
productivity.15. Customer satisfaction is often thought to be a qualitative
measure of performance as one cannot directly observe �satisfaction.� However,
using attitude surveys and psychological measurements, customer satisfaction can be
measured in quantitative terms. For instance, people who design surveys often
employ attitude scales that ask questions in which customers respond on a 1 to 5
scale. These values can be summed and averaged to determine satisfaction scores.
16. S takeholders#Contribution#Requirements##Employees#Effort, skills,
information#Rewards, interesting jobs, economic security, proper
treatment##Partners#Goods, services, information#Financial rewards commensurate
with the risk taken##Owners#Capital#Financial rewards##Community#Allows the
organization to operate and does not oppose its operation#Conformance to laws, good
corporate citizenship and, perhaps, leadership##17. Competitive benchmarking is
an organization�s search for, and implementation of, the best way to do something
as practiced in other organizations. Continuous improvement is the relentless
search to (1) document, understand, and improve the activities that the
organization undertakes to meet its customers� requirement, (2) eliminate
processing activities that do not add product features that customers value, and
(3) improve the performance of activities that increase customer value or
satisfaction.18. A value-added activity is an activity that, if eliminated, would
reduce the product�s service to the customer in the long run. An activity that
cannot be classified as value-added is a nonvalue-added activity:a. Value-added
b. Nonvalue-addedc. Nonvalue-addedd. Value-addede. Nonvalue-addedf.
Nonvalue-addedg. Value-addedh. Value-addedi. Nonvalue-addedj. Value-
added19. Just-in-time means making a good or service
only when the customer, internal or external, requires it. Just-in-time requires
a product layout with a continuous flow (no delays) once production starts. It
means that setup costs must be reduced substantially to eliminate the need to
produce in batches, and it means that processing systems must be reliable. Just-
in-time production is based on the elimination of all nonvalue-added activities to
reduce cost and time. It is an approach to improvement that is continuous and
involves employee empowerment and involvement.20. Managerial accounting is
concerned with providing information to managers for use within the organization.
Financial accounting is con#cerned with providing information to stockholders,
creditors, and others outside of the organization.21. A strategy is a game plan
that enables a company to attract customers by distinguishing itself from
competitors. The focal point of a company�s strategy should be its target
customers.II. Multiple Choice Questions
B#A#B#####A#B#C#####D#C#C#####A#D######D#A######A#A######C#B######B#C######D#B#####
#B#A######CHAPTER 3UNDERS TANDING FINANCIAL S TATEMENTS I. Questions1. A financial
statement is a means of communicating information about an enterprise in financial
(i.e., peso) terms. It represents information that the accountant believes is a
true and fair representation of the financial activity of the enterprise.2. Every
financial statement relates to time in one way or another. A statement of
financial position, or balance sheet, represent a �picture� of the enterprise at a
point in time (e.g., the end of a month or year). An income statement and a
statement of cash flows, on the other hand, cover activity that took place over a
period of time (e.g., a month or year).3. a. Creditors are interested in
financial statements to assist them in evaluating the ability of a business to
repay its debts. No one wants to extend credit to a company that is unable to meet
its obligations as they come due. b. Potential investors use financial
statements in selecting among alternative investment opportunities. They are
interested in investing in companies in which the value of their investment will
increase as a result of future profitable operations. c. Labor unions are
interested in financial statements because the financial position of a company and
its profits are important factors in the company�s ability to pay higher wages and
to employ more people.4. Business transactions affect a company�s financial
position, and as a result they change the statement of financial position or
balance sheet. The other financial statements � the income statement and the
statement of cash flows � are detailed expansions of certain aspects of the
statement of financial position and help explain how the company�s position changed
over time.5. The cost principle indicates that many assets are included in the
financial records, and therefore, in the statement of financial position, at their
original cost to the reporting enterprise. This principle affects accounting for
assets in several ways, one of which is that the amount of most assets is not
adjusted periodically for changes in the market value of the assets. Instead, cost
is retained as the basic method of accounting, regardless of changes in the market
value of those assets.6. The going concern assumption states that in the
absence of evidence to the contrary (i.e., bankruptcy proceedings), an enterprise
is expected to continue to operate in the foreseeable future. This means, for
example, that it will continue to use the assets it has in its financial statements
for the purpose for which they were acquired.7. The three categories and the
information included in each are: Operating activities � Cash provided by and
used in revenue and expense transactions. Investing activities � Cash provided by
and used as a result of investments in assets, such as machinery, equipment, land,
and buildings. Financial activities � Cash provided by and used in debt and
equity financing, such as borrowing and repaying loans, and investments from and
dividends paid to the enterprise�s owners.8. Adequate disclosure refers to the
requirement that financial statements, including accompanying notes, must include
information necessary for reasonably informed users of financial statements to
understand the company�s financial activities. This requirement is often met, in
part, by the addition of notes to the financial statements. Financial statement
notes include both quantitative and qualitative information that is not included in
the body of the financial statements.9. A strong income statement is one that has
significantly more pesos of revenue than expenses, resulting in net income that is
a relatively high percentage of the revenue figure. A trend of relatively high
income numbers over time signals a particularly strong income situation.10. A
strong statement of cash flows is one that shows significant amounts of cash
generated from operating activities. This means that the enterprise is generating
cash from its ongoing activities and is not required to rely on continuous debt and
equity financing, or the sale of its major assets.11. The purpose of
classifications in financial statements is to develop useful subtotals, which help
users analyze the statements. The most commonly used classifications are: In a
balance sheet: current assets, plant and equipment, other assets, current
liabilities, long-term liabilities and equity. In a multiple-step income
statement: revenue, cost of goods sold, operating expenses, and nonoperating
items. The operating expense section often includes subclassifications for selling
expenses and for general and administrative expenses. In a statement of cash flows:
operating activities, investing activities, and financing activities.12. In
classified financial statements, similar items are grouped together to produce
subtotals which may assist users in their analyses. Comparative financial
statements show financial statements for two or more time periods in side-by-side
columns. Consolidated statements include not only the financial statement amounts
for the company itself but also for any subsidiary companies that it owns. The
financial statements of large corporations often possess all three of these
characteristics.13. In a multiple-step income statement, different categories
of expenses are deducted from revenue in a series of steps, thus resulting in
various subtotals, such as gross profit and operating income. In a single-step
income statement, all expenses are combined and deducted from total revenue in a
single step. Both formats result in the same amount of net income.II. Matching
Type 1.1. d#3. a#5. e#7. f#9. c##2. g#4. j#6. h#8. b#10. i## 2.1. d#3.
i#5. m#7. h#9. f#11. b#13. e##2. a#4. g#6. c#8. n#10. k#12. j#14. l##
3.a. F#c. F#e. I#g. F#I. I#k. F##b. I#d. I#f. F#h. F#j. F#l. I##
III. ProblemsProblem 1 (Preparing a Balance S heet � A S econd Problem)Requirement
(a)S M FarmsBalance S heetS eptember 30, 2005#####Assets#Liabilities and Equity##Cash
P 16,710#Liabilities:##Accounts receivable 22,365# Notes payable
P530,000 ##Land 550,000# Accounts payable 77,095##Barns and
sheds 78,300# Property taxes payable 9,135##Citrus trees 76,650# W ages
payable 1,820##Livestock 120,780# Total liabilities
P618,050##Irrigation system 20,125#Equity:##Farm machinery 42,970#
S hare capital 250,000##Fences & gates 33,570# Retained earnings*
93,420##Total P961,470#Total P961,470##* Total assets, P961,470,
minus total liabilities, P618,050, less share capital, P250,000.Requirement (b)The
loss of an asset, Barns and S heds, from a typhoon would cause a decrease in total
assets. W hen total assets are decreased, the balance sheet total of liabilities
and equity must also decrease. S ince there is no change in liabilities as a result
of the destruction of an asset, the decrease on the right-hand side of the balance
sheet must be in the retained earnings account. The amount of the decrease in
Barns and S heds, in the equity, and in both balance sheet totals, is P23,800.
Problem 2 (Preparing a Balance S heet and Cash Flow S tatement; Effects of Business
Transactions)Requirement (a)The Tasty BakeryBalance S heetAugust 1,
2005#####Assets#Liabilities and Equity##Cash P
6,940#Liabilities:##Accounts receivable 11,260# Notes payable P 74,900
##S upplies 7,000# Accounts payable 16,200##Land 67,000#
S alaries payable 8,900##Building 84,000# Total liabilities
P100,000##Equipment and fixtures 44,500#Equity:### S hare capital
80,000### Retained earnings 40,700##Total P220,700#Total
P220,700##Requirement (b)The Tasty BakeryBalance S heetAugust 3,
2005#####Assets#Liabilities and Equity##Cash P
14,490#Liabilities:##Accounts receivable 11,260# Notes payable P 74,900
##S upplies 8,250# Accounts payable 7,200##Land 67,000#
S alaries payable 8,900##Building 84,000# Total liabilities
P 91,000##Equipment and fixtures 51,700#Equity:### S hare capital
105,000### Retained earnings 40,700##Total P236,700#Total
P236,700##The Tasty BakeryS tatement of Cash FlowsFor the Period August 1 - 3,
2005######Cash flows from operating activities:#### Cash payment of accounts
payable#P(16,200)### Cash purchase of supplies# (1,250)### Cash used in
operating activities##P(17,450)######Cash flows from investing activities:####
None########Cash flows from financing activities:####S ale of share
capital##P25,000######Increase in cash##P 7,550##Cash balance, August 1, 2005##
6,940##Cash balance, August 3, 2005##P14,490##Requirement (c)The Tasty Bakery is in
a stronger financial position on August 3 than it was on August 1.On August 1, the
highly liquid assets (cash and accounts receivable) total only P18,200, but the
company
has P25,100 in debts due in the near future (accounts payable plus salaries
payable).On August 3, after additional infusion of cash from the sale of stock, the
liquid assets total P25,750, and debts due in the near future amount to P16,100.
Note to Instructor: The analysis of financial position strength in requirement (c)
is based solely upon the balance sheets at August 1 and August 3. Hopefully,
students will raise many legitimate issues regarding necessity of information about
operations, rate at which cash flows into the business, etc. In this problem, the
improvement in financial position results solely from the sale of share capital.
Problem 3 (Preparing Financial S tatements; Effects of Business Transactions)
Requirement (a)The First Malt S hopBalance S heetS eptember 30,
2005#####Assets#Liabilities and Equity##Cash P
7,400#Liabilities:##Accounts receivable 1,250# Notes payable* P 70,000
##S upplies 3,440# Accounts payable 8,500##Land 55,000#
Total liabilities P 78,500##Building 45,500#Equity:### S hare capital
50,000##Furniture & fixtures 20,000# Retained earnings 4,090##Total
P132,590#Total P132,590##* Total assets, P132,590, less
equity, P54,090, less accounts payable, P8,500, equals notes payable.Requirement
(b)The First Malt S hopBalance S heetOctober 6, 2005#####Assets#Liabilities and
Equity##Cash P 29,400#Liabilities:##Accounts receivable 1,250#
Notes payable P 70,000 ##S upplies 4,440# Accounts payable
18,000##Land 55,000# Total liabilities P 88,000##Building
45,500#Equity:### S hare capital 80,000##Furniture & fixtures 38,000#
Retained earnings 5,590##Total P173,590#Total
P173,590##The First Malt S hopIncome S tatement For the Period October 1-6,
2005######Revenues##P 5,500##Expenses## (4,000)##Net income##P 1,500####The First
Malt S hopS tatement of Cash FlowsFor the Period October 1-6, 2005######Cash flows
from operating activities:#### Cash received from revenues#P5,500### Cash
paid for expenses#(4,000)### Cash paid for accounts payable#(8,500)### Cash paid
for supplies# (1,000)### Cash used in operating
activities##P(8,000)######Cash flows from investing activities:####
None########Cash flows from financing activities:####Cash received from sale
of share capital##P30,000######Increase in cash##P 22,000##Cash balance, October 1,
2005## 7,400##Cash balance, October 6, 2005##P29,400##Requirement (c)The First
Malt S hop is in a stronger financial position on October 6 than on S eptember 30.
On S eptember 30, the company had highly liquid assets (cash and accounts
receivable) of P8,650, which barely exceeded the P8,500 in liabilities (accounts
payable) due in the near future. On October 6, after the additional investment of
cash by shareholders, the company�s cash alone exceeded its short-term obligations.
Problem 4 (Preparing a Balance S heet; Discussion of Accounting Principles)
Requirement (1)Fil-Cinema S criptsBalance S heetNovember 30,
2005#####Assets#Liabilities and Equity##Cash P 3,940#Liabilities:##Notes
receivable 2,200# Notes payable P 73,500 ##Accounts receivable 2,450#
Accounts payable 32,700##Land 39,000# Total liabilities
P106,200##Building 54,320#Equity:### S hare capital 5,000##Office
furniture* 12,825# Retained earnings 3,535##Total
P114,735#Total P114,735#####* P8,850 + P6,500 � P2,525.###
Requirement (2)(1) The cash in Cruz�s personal savings account is not an asset
of the business entity Fil-Cinema S cripts and should not appear in the balance
sheet of the business. The money on deposit in the business bank account (P3,400)
and in the company safe (P540) constitute cash owned by the business. Thus, the
cash owned by the business at November 30 totals P3,940.(2)The years-old IOU does
not qualify as a business asset for two reasons. First, it does not belong to the
business entity. S econd, it appears to be uncollectible. A receivable that cannot
be collected is not viewed as an asset, as it represents no future economic
benefit.(3) The total amount to be included in �Office furniture� for the rug is
P9,400, the total cost, regardless of whether this amount was paid in cash.
Consequently, �Office furniture� should be increased by P6,500. The P6,500
liability arising from the purchase of the rug came into existence prior to the
balance sheet date and must be added to the �Notes payable� amount.(4) The computer
is no longer owned by Hollywood S cripts and therefore cannot be included in the
assets. To do so would cause an overstatement of both assets and equity. The
�Office furniture� amount must be reduced by P2,525.(5) The P22,400 described as
�Other assets� is not an asset, because there is no valid legal claim or any
reasonable expectation of recovering the income taxes paid. Also, the payment of
income taxes by Cruz was not a business transaction by Fil-Cinema S cripts. If a
refund were obtained from the government, it would come to Cruz personally, not to
the business entity.(6) The proper valuation for the land is its historical cost of
P39,000, the amount established by the transaction in which the land was purchased.
Although the land may have a current fair value in excess of its cost, the offer by
the friend to buy the land if Cruz would move the building appears to be mere
conversation rather than solid, verifiable evidence of the fair value of the land.
The �cost principle,� although less than perfect, produces far more reliable
financial statements than would result if owners could �pull figures out of the
air� in recording asset values.(7) The accounts payable should be limited to the
debts of the business, P32,700, and should not include Cruz�s personal liabilities.
IV. Multiple Choice QuestionsD#B#21. B #31. B####D#C#22. C#32.
D####D#D#23. A#33. D####B#A#24. B#34. D####A#D#25. A#35.
C####B# A#26. D#36. A####D#17. A#27. B#37. A####C#18. B#28. B#38.
C####B#19. C#29. D#####C#20. C#30. C#####CHAPTER 4FINANCIAL S TATEMENTS
ANALYS IS - II. Questions1. The objective of financial statements analysis is to
determine the extent of a firm�s success in attaining its financial goals, namely:
To earn maximum profitTo maintain solvencyTo attain stability2. S ome of the
indications of satisfactory short-term solvency or working capital position of a
business firm are:Favorable credit positionS atisfactory proportion of cash to the
requirements of the current volumeAbility to pay current debts in the regular
course of businessAbility to extend more credit to customersAbility to replenish
inventory promptly3. These tests are:Improvement in the financial positionW ell-
balanced financial structure between borrowed funds and equityEffective employment
of borrowed funds and equityAbility to declare satisfactory amount of dividends to
shareholdersAbility to withstand adverse business conditionsAbility to engage in
research and development in an attempt to provide new products or improve old
products, methods or processes4. S ome indicators of managerial efficiency are:
Ability to earn a reasonable return on its investment of borrowed funds and equity
Ability to control operating costs within reasonable limitsNo overinvestment in
fixed assets, receivables and inventories5. The techniques used in Financial
S tatement Analysis are:I. Vertical analysis which shows the relationships of
the items in the same year: also referred to as �static measure.�a. Financial
ratiosb. Common-size statementsII. Horizontal analysis which shows the
changes or tendencies of an item for 2 or more years; also referred to as �dynamic
measure.�a. Comparative statements - showing changes in absolute amount and
percentagesb. Trend percentagesIII. Use of special reports or statementsa.
S tatements of Changes in Financial Positionb. Gross Profit / Net Income
Variation Analysis6. Refer to page 133 of the textbook.7. Horizontal
analysis involves the comparison of items on financial statements between years.
Analysis of comparative financial statements or the increase/decrease method of
analysis and trend percentages are the two techniques that may be applied under
horizontal analysis. Vertical analysis involves the study of items on a single
statement for a single year, such as the analysis of an income statement for some
given year. Common-size statement and financial ratios are techniques used in
vertical analysis.8. Trends can indicate whether a situation is improving,
remaining the same or deteriorating. They can also give insight to the probable
future course of events in a firm.9. Trend percentages represent the
expression of several years� financial data in percentage form in terms of a base
year.10. Refer to page 133 of the textbook.11. Observation of trends is
useful primarily in determining whether a situation is improving, worsening, or
remaining constant. By comparing current data with similar data of prior periods
we gain insight into the direction in which future results are likely to move.
S ome other standards of comparison include comparison with other similar
companies, comparison with industry standards, and comparison with previous years�
information. By comparing analytical data for one company with some independent
yardstick, the analyst hopes to determine how the position of the company in
question compares with some standard of performance.12. Trend percentages are
used to show the increase or decrease in a financial statement amount over a period
of years by comparing the amount in each year with the base-year amount. A
component percentage is the percentage relationship between some financial amount
and a total of which it is a part. Measuring the change in sales over a period of
several years would call for use of trend percentages. The sales in the base year
are assigned a weight of 100%. The percentage for
each later year is computed by dividing that year�s sales by the sales in the base
year.13. Expenses (including the cost of goods sold) have been increasing at an
even faster rate than net sales. Thus Premiere is apparently having difficulty in
effectively controlling its expenses.14. A corporate net income of P1 million
would be unreasonably low for a large corporation, with, say, P100 million in
sales, P50 million in assets, and P40 million in equity. A return of only P1
million for a company of this size would suggest that the owners could do much
better by investing in insured bank savings accounts or in government bonds which
would be virtually risk-free and would pay a higher return.On the other hand, a
profit of P1 million would be unreasonably high for a corporation which had sales
of only P5 million, assets of, say, P3 million, and equity of perhaps one-half
million pesos. In other words, the net income of a corporation must be judged in
relation to the scale of operations and the amount invested.II. True or False
True#True#False#True#True##False#True#False#False #True##III. ProblemsProblem 1
(Percentage Changes)a. Accounts receivable decreased 16% (P24,000 decrease
( P150,000 = 16% decrease).b. Marketable securities decreased 100% (P250,000
decrease ( P250,000 = 100% decrease).c. A percentage change cannot be calculated
because retained earnings showed a negative amount (a deficit) in the base year and
a positive amount in the following year.d. A percentage change cannot be
calculated because of the zero amount of notes receivable in 2005, the base year.e.
Notes payable increased 7 �% (P60,000 increase ( P800,000 = 7 �% increase).f.
Cash increased 3% (P2,400 increase ( P80,000 = 3% increase).g. S ales
increased 10% (P90,000 increase ( P900,000 = 10% increase).Problem 2 (Computing and
Interpreting Rates of Change)Requirement (a)Computation of percentage changes:1.
Net sales increased 10% (P200,000 increase ( P2,000,000 = 10% increase).2.
Total expenses increased 11% (P198,000 increase ( P1,800,000 = 11% increase).
Requirement (b)1. Total expenses grew faster than net sales. Net income cannot
also have grown faster than net sales, or the sum of the parts would exceed the
size of the whole.2. Net income must represent a smaller percentage of net sales
in 2006 than it did in 2005. Again, the reason is that the expenses have grown at
a faster rate than net sales. Thus, total expenses represent a larger percentage
of total sales in 2006 than in 2005, and net income must represent a smaller
percentage.Problem 3 (Financial S tatement Analysis using Comparative S tatements or
Increase-Decrease Method)Requirement 1XYZ Corporation######Balance S heet######As of
December 31#########Change#####Peso #%###2005#2006####Assets######Cash and
equivalents#14,000#16,000#2,000#14.29%##Receivables#28,800#55,600#26,800#93.06%##In
ventories#54,000#85,600#31,600#58.52%##Prepayments and others# 4,800#
7,400#2,600#54.17%## Total current
assets#101,600#164,600#63,000#62.01%##Property, plant & equipment - net of dep.#
30,200# 73,400#43,200#143.05%##Total
assets#131,800#238,000#106,200#80.58%########Liabilities and Equity#####Notes
payable to banks#10,000#54,000#44,000#440.00%##Accounts
payable#31,600#55,400#23,800#73.32%##Accrued
liabilities#4,200#6,800#2,600#61.90%##Income taxes payable# 5,800#
7,000#1,200#20.69%## Total current
liabilities#51,600#123,200#71,600#138.76%##S hare capital
#44,600#44,600#0#0.00%##Retained earnings# 35,600# 70,200#34,600#97.19%## Total
equity# 80,200#114,800#34,600#43.14%##Total liabilities and
equity#131,800#238,000#106,200#80.58%########XYZ Corporation######Income
S tatement######Years ended December 31######(P thousands)#########Change#####Peso #
%###2005#2006####Net sales#266,400#424,000#157,600#59.16%##Cost of goods
sold#191,400#314,600#123,200#64.37%## Gross profit#
75,000#109,400#34,400#45.87%##S elling, general and administrative expenses#
35,500# 58,400#22,900#64.51%##Income before income
taxes#39,500#51,000#11,500#29.11%##Income taxes# 12,300# 16,400#4,100#33.33%##
Net income # 27,200# 34,600#7,400#27.21%##Requirement 2S hort-term financial
position #####1. Current Assets#increased by 62.01%#while#Current
Liabilities#increased by 138.76%## ( Unfavorable##2. Quick
Assets#increased by 62.40%#while#Current Liabilities#increased by 138.76%##
( Unfavorable##3. Net S ales#increased by 59.16%#while#Accounts
Receivable#increased by 93.06%## ( Unfavorable##4. Cost
of Goods S old#increased by 64.37%#while#Inventories#increased by 58.52%##
( Favorable##Leverage######5. Total Assets#increased by
80.58%#while#Total Liabilities#increased by 138.76%## (
Unfavorable##6. Total Liabilities#increased by 138.76%#while#Total
Equity#increased by 43.14%## ( Unfavorable##Profitability
######7. Net S ales#increased by 59.16%#while#Cost of Goods
S old#increased by 64.37%## ( Unfavorable########8. Net
S ales#increased by 59.16%#while#S elling, General & Administrative Expenses#
increased by 64.51%## ( Unfavorable##9. Net
S ales#increased by 59.16%#while#Net Income#increased by 27.21%##
( Unfavorable##10. Net Income#increased by 27.21%#while#Total
Assets#increased by 80.58%## ( Unfavorable##Problem 4 (Trend
Percentages)Requirement (1)The trend percentages are:#Year 5#Year 4#Year 3#Year
2#Year 1##S ales #125.0#120.0#110.0#105.0#100.0#########Cash
#80.0#90.0#105.0#110.0#100.0##Accounts receivable
#140.0#124.0#108.0#104.0#100.0##Inventory
#112.0#110.0#102.0#108.0#100.0##Total current assets
#118.8#113.1#104.1#106.9#100.0#########Current liabilities
#130.0#106.0#108.0#110.0#100.0##Requirement (2)S ales:#The sales are
increasing at a steady rate, with a particularly strong gain in Year
4.#####Assets:#Cash declined from Year 3 through Year 5. This may have been due to
the growth in both inventories and accounts receivable. In particular, the accounts
receivable grew far faster than sales in Year 5. The decline in cash may reflect
delays in collecting receivables. This is a matter for management to investigate
further.###########Liabilities:#The current liabilities jumped up in Year 5. This
was probably due to the buildup in accounts receivable in that the company doesn�t
have the cash needed to pay bills as they come due.##Problem 5 (Use of Trend
Percentages)a. 1. An unfavorable tendency could be observed in Receivables in
relation to Net S ales from 2003 � 2005 because receivables had been increasing at a
much faster rate than Net S ales. This could indicate inefficiency in the
collection of receivables or simply poor company credit policy. The situation
however, improved in 2006 and 2007 when sales started to move up at a faster rate
than accounts receivable. This would indicate improvement in the credit and
collection policy or more cash sales were being generated. 2. Unfavorable
tendency in inventory persisted from 2003 to 2007 because it had been going up at a
much faster rate than Net S ales. If this continues, the company will end up with
over-investment in inventory because the buying rate is faster than the selling
price. 3. Favorable tendencies could be noted in Fixed Assets in relation
to Net S ales because inspite of the minimal additions to fixed assets made by the
company from 2003 through 2007, sales had been increasing at a very encouraging
rate. 4. Net Income had likewise been increasing at a much faster rate than net
sales. This is favorable because this would indicate that the company had been
successfully controlling the increases in Cost of S ales and Operating Expenses.b.
Review computations of the Trend Percentages. It will be noted that the
Trend Percentages in Total Noncurrent Liabilities and Equity from 2005 to 2007 were
interchanged. Correction should be made first before interpretation is done.
1. The upward tendency in current assets had been accompanied by an upward
trend in current liabilities. It could be noted that current assets had been
moving up at a much faster rate than current liabilities. This is favorable
because the margin of safety of the short-term creditors is widened. 2.
Favorable tendencies could also be observed in noncurrent assets which had
been increasing and which increases had been accompanied by downward trend in
noncurrent liabilities. This would mean better security on the part of creditors
and stronger financial position. 3. There is an unfavorable tendency in Net
S ales in relation to non-current assets. S ales had not been increasing at the same
rate as the increases in fixed assets. This could indicate that more investments
are made in noncurrent assets without considering whether or not they could sell
the additional units of product they are producing.c. The unfavorable trend in net
income could be attributed to the following tendencies:Higher rates of increases in
cost of sales as compared to sales.Higher rates of increases in selling, general
and administrative expenses in relation to net sales.Higher rates of increases in
other financial expenses than the rates of increases in net salesIV. Multiple
Choice QuestionsD#A, C,
D######A#B*######A#D######B#######D#######C#######C#######A#######D#######C#######
* (P400,000 � P160,000) ( P160,000 = 150%CHAPTER 5FINANCIAL S TATEMENTS
ANALYS IS - III. QuestionsBy looking at trends, an analyst hopes to get some idea
of whether a situation is improving, remaining the same, or deteriorating. S uch
analyses can provide insight into what is likely to happen in the future. Rather
than looking at trends, an analyst may compare one company to another or to
industry averages using common-size financial statements.Ratios highlight
relationships, movements, and trends that are very difficult to perceive looking at
the raw underlying data standing alone. Also, ratios make financial data
easier to grasp by putting the data into perspective. As to the limitation in the
use of ratios, refer to page 129.Price-earnings ratios are determined by how
investors see a firm�s future prospects. Current reported earnings are generally
considered to be useful only so far as they can assist investors in judging what
will happen in the future. For this reason, two firms might have the same current
earnings, but one might have a much higher price-earnings ratio if investors view
it to have superior future prospects. In some cases, firms with very small current
earnings enjoy very high price-earnings ratios. This is simply because investors
view these firms as having very favorable prospects for earnings in future years.
By definition, a stock with current earnings of P4 and a price-earnings ratio of 20
would be selling for P80 per share.A manager�s financing responsibilities relate to
the acquisition of assets for use in his or her company. The acquisition of assets
can be financed in a number of ways, including through issue of ordinary shares,
through issue of preference shares, through issue of long-term debt, through
leasing, etc. A manager�s operating responsibilities relate to how these assets
are used once they have been acquired. The return on total assets ratio is
designed to measure how well a manager is discharging his or her operating
responsibilities. It does this by looking at a company�s income before any
consideration is given as to how the income will be distributed among capital
resources, i.e., before interest deductions.Financial leverage, as the term is used
in business practice, means obtaining funds from investment sources that require a
fixed annual rate of return, in the hope of enhancing the well-being of the
ordinary shareholders. If the assets in which these funds are invested earn at a
rate greater that the return required by the suppliers of the funds, then leverage
is positive in the sense that the excess accrues to the benefit of the ordinary
shareholders. If the return on assets is less than the return required by the
suppliers of the funds, then leverage is negative in the sense that part of the
earnings from the assets provided by the ordinary shareholders will have to go to
make up the deficiency.How a shareholder would feel would depend in large part on
the stability of the firm and its industry. If the firm is in an industry that
experiences wide fluctuations in earnings, then shareholders might be very pleased
that no interest-paying debt exists in the firm�s capital structure. In hard
times, interest payments might be very difficult to meet, or earnings might be so
poor that negative leverage would result.No, the stock is not necessarily
overpriced. Book value represents the cumulative effects on the balance sheet of
past activities evaluated using historical prices. The market value of the stock
reflects investors� beliefs about the company�s future earning prospects. For most
companies market value exceeds book value because investors anticipate future
growth in earnings.A company in a rapidly growing technological industry probably
would have many opportunities to invest its earnings at a high rate of return;
thus, one would expect it to have a low dividend payout ratio.It is more difficult
to obtain positive financial leverage from preference shares than from long-term
debt due to the fact that interest on long-term debt is tax deductible, whereas
dividends paid on preference shares are not tax deductible.The current ratio would
probably be highest during January, when both current assets and current
liabilities are at a minimum. During peak operating periods, current liabilities
generally include short-term borrowings that are used to temporarily finance
inventories and receivables. As the peak periods end, these short-term borrowings
are paid off, thereby enhancing the current ratio. A 2-to-1 current ratio might not
be adequate for several reasons. First, the composition of the current assets may
be heavily weighted toward slow-turning inventory, or the inventory may consist of
large amounts of obsolete goods. S econd, the receivables may be large and of
doubtful collectibility, or the receivables may be turning very slowly due to poor
collection procedures.12. Expenses (including the cost of goods sold) have been
increasing at an even faster rate than net sales. Thus S unday is apparently having
difficulty in effectively controlling its expenses.13. If the company�s
earnings are very low, they may become almost insignificant in relation to stock
price. W hile this means that the p/e ratio becomes very high, it does not
necessarily mean that investors are optimistic. In fact, they may be valuing the
company at its liquidation value rather than a value based upon expected future
earnings.14. From the viewpoint of the company�s shareholders, this situation
represents a favorable use of leverage. It is probable that little interest, if
any, is paid for the use of funds supplied by current creditors, and only 11%
interest is being paid to long-term bondholders. Together these two sources supply
40% of the total assets. S ince the firm earns an average return of 16% on all
assets, the amount by which the return on 40% of the assets exceeds the fixed-
interest requirements on liabilities will accrue to the residual equity holders �
the ordinary shareholders � raising the return on equity.15. The length of
operating cycle of the two companies cannot be determined from the fact the one
company�s current ratio is higher. The operating cycle depends on the
relationships between receivables and sales, and between inventories and cost of
goods sold. The company with the higher current ratio might have either small
amounts of receivables and inventories, or large sales and cost of sales, either of
which would tend to produce a relatively short operating cycle.16. The investor
is calculating the rate of return by dividing the dividend by the purchase price of
the investment (P5 ( P50 = 10%). A more meaningful figure for rate of return on
investment is determined by relating dividends to current market price, since the
investor at the present time is faced with the alternative of selling the stock for
P100 and investing the proceeds elsewhere or keeping the investment. A decision to
retain the stock constitutes, in effect, a decision to continue to invest P100 in
it, at a return of 5%. It is true that in a historical sense the investor is
earning 10% on the original investment, but this is interesting history rather than
useful decision-making information.17. A corporate net income of P1 million
would be unreasonably low for a large corporation, with, say, P100 million in
sales, P50 million in assets, and P40 million in equity. A return of only P1
million for a company of this size would suggest that the owners could do much
better by investing in insured bank savings accounts or in government bonds which
would be virtually risk-free and would pay a higher return.On the other hand, a
profit of P1 million would be unreasonably high for a corporation which had sales
of only P5 million, assets of, say, P3 million, and equity of perhaps one-half
million pesos. In other words, the net income of a corporation must be judged in
relation to the scale of operations and the amount invested.II. True or False
True#True#True#True#False ##True#False #True#True#False ########III. Problems
Problem 1 (Common S ize Income S tatements) Common size income statements for
2005 and 2006:#2006#2005##S ales #100%#100%##Cost of goods sold # 66
# 67 ##Gross profit #34%#33%##Operating expenses # 28 #
29 ##Net income # 6%# 4%## The changes from 2005 to 2006 are all
favorable. S ales increased and the gross profit per peso of sales also increased.
These two factors led to a substantial increase in gross profit. Although
operating expenses increased in peso amount, the operating expenses per peso of
sales decreased from 29 cents to 28 cents. The combination of these three
favorable factors caused net income to rise from 4 cents to 6 cents out of each
peso of sales. Problem 2 (Measures of Liquidity) Requirement (a)Current
assets: Cash P 47,600 Marketable securities 175,040 Accounts
receivable 230,540 Inventory 179,600 Unexpired insurance 4,500
Total current assets P637,280Current liabilities: Notes payable P
70,000 Accounts payable 125,430 S alaries payable 7,570 Income taxes
payable 14,600 Unearned revenue 10,000 Total current
liabilities P227,600Requirement (b)The current ratio is 2.8 to 1. It is computed
by dividing the current assets of P637,280 by the current liabilities of P227,600.
The amount of working capital is P409,680, computed by subtracting the current
liabilities of P227,600 from the current assets of P637,280.The company appears to
be in a strong position as to short-run debt-paying ability. It has almost three
pesos of current assets for each peso of current liabilities. Even if some losses
should be sustained in the sale of the merchandise on hand or in the collection of
the accounts receivable, it appears probable that the company would still be able
to pay its debts as they fall due in the near future. Of course, additional
information, such as the credit terms on the accounts receivable, would be helpful
in a careful evaluation of the company�s current position. Problem 3 (Common-S ize
Income S tatement) Requirement 1#2006#2005##S ales #100.0#%#100.0#%##Less cost
of goods sold #�63.2##�60.0###Gross margin #�36.8##�40.0###S elling expenses
#18.0##17.5###Administrative expenses #�13.6##�14.6###Total expenses
#�31.6##�32.1###Net operating income #5.2##7.9###Interest expense
#��1.4##��1.0###Net income before taxes #��3.8#%#��6.9#%## Requirement
2 The company�s major problem
seems to be the increase in cost of goods sold, which increased from 60.0% of
sales in 2005 to 63.2% of sales in 2006. This suggests that the company is not
passing the increases in costs of its products on to its customers. As a result,
cost of goods sold as a percentage of sales has increased and gross margin has
decreased. S elling expenses and interest expense have both increased slightly
during the year, which suggests that costs generally are going up in the company.
The only exception is the administrative expenses, which have decreased from 14.6%
of sales in 2005 to 13.6% of sales in 2006. This probably is a result of the
company�s efforts to reduce administrative expenses during the year. Problem 4
(Comparing Operating Results with Average Performance in the Industry) Requirement
(a)#Ms. Freeze,Inc.#Industry Average##S ales (net)#100%#100%##Cost of goods sold#
49# 57##Gross profit on sales#51%#43%##Operating expenses:#### S elling#21%#16%##
General and administrative# 17# 20##Total operating expenses# 38%#
36%##Operating income#13%#7%##Income taxes# 6# 3##Net income# 7%# 4%##
Requirement (b) Ms. Freeze�s operating results are significantly better
than the average performance within the industry. As a percentage of sales
revenue, Ms. Freeze�s operating income and net income after nearly twice the
average for the industry. As a percentage of total assets, Ms. Freeze�s profits
amount to an impressive 23% as compared to 14% for the industry. The key to Ms.
Freeze�s success seems to be its ability to earn a relatively high rate of gross
profit. Ms. Freeze�s exceptional gross profit rate (51%) probably results from a
combination of factors, such as an ability to command a premium price for the
company�s products and production efficiencies which lead to lower manufacturing
costs. As a percentage of sales, Ms. Freeze�s selling expenses are five points
higher than the industry average (21% compared to 16%). However, these higher
expenses may explain Ms. Freeze�s ability to command a premium price for its
products. S ince the company�s gross profit rate exceeds the industry average by 8
percentage points, the higher-than-average selling costs may be part of a
successful marketing strategy. The company�s general and administrative expenses
are significantly lower than the industry average, which indicates that Ms.
Freeze�s management is able to control expenses effectively. Problem 5 (Common-
S ize S tatements)Requirement 1The income statement in common-size form would be:
# 2006# 2005##S ales #100.0%#100.0%##Less cost of goods sold
# 65.0# 60.0##Gross margin #35.0#40.0##Less operating expenses #
26.3# 30.4##Net operating income #8.7#9.6##Less interest expense # 1.2#
1.6##Net income before taxes #7.5#8.0##Less income taxes (30%) # 2.3#
2.4##Net income # 5.3%# 5.6%## The balance sheet in common-size form
would be:#2006#2005##Current assets:####Cash #2.0%#5.1%##Accounts receivable,
net #15.0#10.1##Inventory #30.1#15.2##Prepaid expenses # 1.0# 1.3## Total
current assets #48.1#31.6##Plant and equipment # 51.9# 68.4##Total assets
#100.0%#100.0%######Liabilities:#### Current liabilities
#25.1%#12.7%## Bonds payable, 12% # 20.1# 25.3## Total
liabilities # 45.1# 38.0##Equity:####Preference shares, 8%, P10 par
#15.0#19.0##Ordinary shares, P5 par #10.0#12.7##Retained earnings # 29.8#
30.4## Total equity # 54.9# 62.0##Total liabilities and equity
#100.0%#100.0%##Note: Columns do not total down in all cases due to rounding
differences. Requirement 2 The company�s cost of goods sold has increased
from 60 percent of sales in 2005 to 65 percent of sales in 2006. This appears to
be the major reason the company�s profits showed so little increase between the two
years. S ome benefits were realized from the company�s cost-cutting efforts, as
evidenced by the fact that operating expenses were only 26.3 percent of sales in
2006 as compared to 30.4 percent in 2005. Unfortunately, this reduction in
operating expenses was not enough to offset the increase in cost of goods sold. As
a result, the company�s net income declined from 5.6 percent of sales in 2005 to
5.3 percent of sales in 2006. Problem 6 (S olvency of Alabang S upermarket)
Requirement (a)#(Pesos in Millions)##Current assets:### Cash#P 74.8##
Receivables#152.7## Merchandise inventories#1,191.8## Prepaid expenses#
95.5## Total current assets#P1,514.8#####Quick assets:### Cash#P
74.8## Receivables# 152.7## Total quick assets#P 227.5#####
Requirement (b)(1) Current ratio:### Current assets (Req.
a)#P1,514.8## Current liabilities#P1,939.0## Current
ratio (P1,514.8 ( P1,939.0)#0.8 to 1#####(2) Quick ratio:### Quick assets
(Req. a)#P 227.5## Current liabilities#P1,939.0## Quick
ratio (P227.5 ( P1,939.0)#0.1 to 1#####(3) W orking capital:###
Current assets (Req. a)#P1,514.8## Less: Current
liabilities#P1,939.0## W orking capital#P(424.2)## Requirement (c)
No. It is difficult to draw conclusions from the above ratios. Alabang
S upermarket�s current ratio and quick ratio are well below �safe� levels, according
to traditional rules of thumb. On the other hand, some large companies with steady
ash flows are able to operate successfully with current ratios lower than Alabang
S upermarket�s. Requirement (d) Due to characteristics of the industry,
supermarkets tend to have smaller amounts of current assets and quick assets than
other types of merchandising companies. An inventory of food has a short shelf
life. Therefore, the inventory of a supermarket usually represents only a few
weeks� sales. Other merchandising companies may stock inventories representing
several months� sales. Also, supermarkets sell primarily for cash. Thus, they
have relatively few receivables. Although supermarkets may generate large amounts
of cash, it is not profitable for them to hold assets in this form. Therefore,
they are likely to reinvest their cash flows in business operations as quickly as
possible. Requirement (e) In evaluating Alabang S upermarket�s liquidity, it
would be useful to review the company�s financial position in prior years,
statements of cash flows, and the financial ratios of other supermarket chains.
One might also ascertain the company�s credit rating from an agency such as Dun &
Bradstreet.Note to Instructor: Prior to the year in which the data for this
problem was collected, Alabang S upermarket had reported a negative retained
earnings balance in its balance sheet for several consecutive periods. The fact
that Alabang S upermarket has only recently removed the deficit from its financial
statements is also worrisome. Problem 7 (Balance S heet Measures of Liquidity and
Credit Risk) Requirement (a)(1) Quick assets:### Cash#P 47,524##
Marketable securities (short-term)#55,926## Accounts receivable#
23,553## Total quick assets #P127,003#################(2)
Current assets:### Cash#P 47,524## Marketable securities
(short-term)#55,926## Accounts receivable#23,553##
Inventories#32,210## Prepaid expenses# 5,736##
Total current assets#P164,949#####(3) Current liabilities:### Notes
payable to banks (due within one year)#P 20,000## Accounts payable#5,912##
Dividends payable#1,424## Accrued liabilities (short-
term)#21,532## Income taxes payable# 6,438## Total
current liabilities#P 55,306##### Requirement (b)(1) Quick ratio:###
Quick assets (Req. a)#P127,003## Current liabilities (Req. a)#P
55,306## Quick ratio (P127,003 ( P55,306)#2.3 to 1#####(2)
Current ratio:### Current assets (Req. a)#P164,949## Current
liabilities (Req. a)#P 55,306## Current ratio (P164,949
( P55,306)#3.0 to 1#####(3) W orking capital:### Current assets (Req.
a)#P164,949## Less: Current liabilities (Req. a)# 55,306##
W orking capital#P109,643#####(4) Debt ratio:### Total liabilities
(given)#P 81,630## Total assets (given)#P353,816## Debt ratio
(P81,630 ( P353,816)#23.1%## Requirement (c)(1) From the viewpoint of short-
term creditors, Bonbon S weets� appear highly liquid. Its quick and current ratios
are well above normal rules of thumb, and the company�s cash and marketable
securities alone are almost twice its current liabilities.(2) Long-term
creditors also have little to worry about. Not only is the company highly liquid,
but creditors� claims amount to only 23.1% of total assets. If Bonbon S weets� were
to go out of business and liquidate its assets, it would have to raise only 23
cents from every peso of assets for creditors to emerge intact.(3) From the
viewpoint of shareholders, Bonbon S weets� appears overly liquid. Current assets
generally do not generate high rates of return. Thus, the company�s relatively
large holdings of current assets dilutes its return on total assets. This should
be of concern to shareholders. If Bonbon S weets is unable to invest its highly
liquid assets more productively in its business, shareholders probably would like
to see the money distributed as dividends. Problem 8 (S elected Financial
Measures for S hort-term Creditors) Requirement 1Current assets (P80,000 + P460,000
+ P750,000 + P10,000) #P1,300,000##Current liabilities (P1,300,000 � 2.5) #�
���520,000##W orking capital

#P#################################################################################
###################################################################################
############################################################## �#7#8#0#,#0#0#0#####
# #R#e#q#u#i#r#e#m#e#n#t# #2####### #R#e#q#u#i#r#e#m#e#n#t# #3### #a#.#
#W #o#r#k#i#n#g# #c#a#p#i#t#a#l# #w#o#u#l#d# #n#o#t# #b#e# #a#f#f#e#c#t#e#d#:#
##C#u#r#r#e#n#t# #a#s#s#e#t#s# #(#P#1#,#3#0#0#,#0#0#0# ## #P#1#0#0#,#0#0#0#)#
###P#1#,#2#0#0#,#0#0#0#####C#u#r#r#e#n#t# #l#i#a#b#i#l#i#t#i#e#s#
#(#P#5#2#0#,#0#0#0# ## #P#1#0#0#,#0#0#0#)# ###�#
#�#�#�#4#2#0#,#0#0#0#####W #o#r#k#i#n#g# #c#a#p#i#t#a#l# ###P# # #
#7#8#0#,#0#0#0###### #b#.# #T#h#e# #c#u#r#r#e#n#t# #r#a#t#i#o# #w#o#u#ld rise:#
Problem 9 (S elected Financial Ratios)1. Gross margin percentage:# 2.
Current ratio:####3. Acid-test ratio:#4. Accounts receivable turnover:
# 5. Inventory turnover:###6. Debt-to-equity ratio:# 7. Times
interest earned:#8. Book value per share:# * P100,000 total par value � P5 par
value per share = 20,000 sharesProblem 10 (S elected Financial Ratios for Ordinary
S hareholders)1. Earnings per share:#2. Dividend payout ratio:####3. Dividend
yield ratio:#### 4. Price-earnings ratio:####Problem 11 (S elected Financial
Ratios for Ordinary S hareholders)1. Return on total assets:# 2. Return on
ordinary shareholders� equity:######## 3. Financial leverage was positive,
since the rate of return to the ordinary shareholders (13.8%) was greater than the
rate of return on total assets (10.5%). This positive leverage is traceable in
part to the company�s current liabilities, which may carry no interest cost, and to
the bonds payable, which have an after-tax interest cost of only�7%.
10% interest rate � (1 � 0.30) = 7% after-tax cost.Problem 12 (S elected
Financial Measures for S hort-Term Creditors)Requirement (1)#Current assets
#(P80,000 + P460,000 + P750,000 + P10,000) #P1,300,000###Current liabilities
(P1,300,000 � 2.5) #����520,000###W orking capital

#P#################################################################################
############################################################################
�#7#8#0#,#0#0#0######R#e#q#u#i#r#e#m#e#n#t# #(#2#)###################
#R#e#q#u#i#r#e#m#e#n#t# #(#3#)###a#.# #W #o#r#k#i#n#g# #c#a#p#i#t#a#l#
#w#o#u#l#d# #n#o#t# #b#e# #a#f#f#e#c#t#e#d# #b#y# #a# #P#1#0#0#,#0#0#0#
#p#a#y#m#e#n#t# #o#n# #a#c#c#o#u#n#t#s# #p#a#y#a#b#l#e#:###C#u#r#r#e#n#t#
#a#s#s#e#t#s# #(#P#1#,#3#0#0#,#0#0#0# ## #P#1#0#0#,#0#0#0#)#
###P#1#,#2#0#0#,#0#0#0#####C#u#r#r#e#n#t# #l#i#a#b#i#l#i#t#i#e#s#
#(#P#5#2#0#,#0#0#0# ## #P#1#0#0#,#0#0#0#)#
###�#�#�#�#4#2#0#,#0#0#0#####W #o#r#k#i#n#g# #c#a#p#i#t#a#l# ###P##
�#7#8#0#,#0#0#0###### # #b#.# #T#h#e# #c#u#r#r#e#n#t# #r#a#t#i#o# #w#o#u#l#d#
#i#n#c#r#e#a#s#e# #i#f# #t#h#e# #c#o#m#p#a#n#y# #m#a#k#e#s# #a# #P#1#0#0#,#0#0#0#
#p#a#y#m#e#n#t# #o#n# #a#c#c#o#u#n#t#s# #p#a#y#a#b#l#e#:######## ######
#P#r#o#b#l#e#m# #1#3# #(#E#f#f#e#c#t#s# #o#f# #T#r#a#n#s#a#c#t#i#o#n#s# #o#n#
#V#a#r#i#o#u#s# #F#i#n#a#n#c#i#a#l# #R#a#t#i#o#s#)###
#1#.###D#e#c#r#e#a#s#e###S #a#l#e# #o#f# #i#n#v#e#n#t#o#r#y# #a#t# #a#
#p#r#o#f#i#t# #w#i#l#l# #b#e# #r#e#f#l#ected in an increase in retained earnings,
which is part of shareholders� equity. An increase in shareholders� equity will
result in a decrease in the ratio of assets provided by creditors as compared to
assets provided by owners.###### 2.#No effect#Purchasing land for cash has no
effect on earnings or on the number of ordinary shares outstanding. One asset is
exchanged for another.###### 3.#Increase#A sale of inventory on account will
increase the quick assets (cash, accounts receivable, marketable securities) but
have no effect on the current liabilities. For this reason, the acid-test ratio
will increase.###### 4.#No effect#Payments on account reduce cash and accounts
payable by equal amounts; thus, the net amount of working capital is not
affected.###### 5.#Decrease#W hen a customer pays a bill, the accounts receivable
balance is reduced. This increases the accounts receivable turnover, which in turn
decreases the average collection period.###### 6.#Decrease#Declaring a cash
dividend will increase current liabilities, but have no effect on current assets.
Therefore, the current ratio will decrease.###### 7.#Increase#Payment of a
previously declared cash dividend will reduce both current assets and current
liabilities by the same amount. An equal reduction in both current assets and
current liabilities will always result in an increase in the current ratio, so long
as the current assets exceed the current liabilities.######8.#No effect#Book value
per share is not affected by the current market price of the company�s
stock.################## 9.#Decrease#The dividend yield ratio is obtained by
dividing the dividend per share by the market price per share. If the dividend per
share remains unchanged and the market price goes up, then the yield will
decrease.###### 10.#Increase#S elling property for a profit would increase net
income and therefore the return on total assets would increase.######
11.#Increase#A write-off of inventory will reduce the inventory balance,
thereby increasing the turnover in relation to a given level of cost of goods
sold.###### 12.#Increase#S ince the company�s assets earn at a rate that is higher
than the rate paid on the bonds, leverage is positive, increasing the return to the
ordinary shareholders.###### 13.#No effect#Changes in the market price of a stock
have no direct effect on the dividends paid or on the earnings per share and
therefore have no effect on this ratio.###### 14.#Decrease#A decrease in net
income would mean less income available to cover interest payments. Therefore, the
times-interest-earned ratio would decrease.###### 15.#No effect#W rite-off of an
uncollectible account against the Allowance for Bad Debts will have no effect on
total current assets. For this reason, the current ratio will remain
unchanged.###### 16.#Decrease#A purchase of inventory on account will increase
current liabilities, but will not increase the quick assets (cash, accounts
receivable, marketable securities). Therefore, the ratio of quick assets to current
liabilities will decrease.###### 17.#Increase#The price-earnings ratio is
obtained by dividing the market price per share by the earnings per share. If the
earnings per share remains unchanged, and the market price goes up, then the price-
earnings ratio will increase.###### 18.#Decrease#Payments to creditors will reduce
the total liabilities of a company, thereby decreasing the ratio of total debt to
total equity.##Problem 14 (Interpretation of Financial Ratios)a. The market price
is going down. The dividends paid per share over the three-year period are
unchanged, but the dividend yield is going up. Therefore, the market price per
share of stock must be decreasing.b. The earnings per share is increasing.
Again, the dividends paid per share have remained constant. However, the dividend
payout ratio is decreasing. In order for the dividend payout ratio to be
decreasing, the earnings per share must be increasing.c. The price-earnings ratio
is going down. If the market price of the stock is going down [see part (a) above],
and the earnings per share are going up [see part (b) above], then the price-
earnings ratio must be decreasing.d. In Year 1, leverage was negative because
in that year the return on total assets exceeded the return on ordinary equity. In
Year 2 and in Year 3, leverage was positive because in those years the return on
ordinary equity exceeded the return on total assets employed.e. It is becoming
more difficult for the company to pay its bills as they come due. Although the
current ratio has improved over the three years, the acid-test ratio is down. Also
note that the accounts receivable and inventory are both turning more slowly,
indicating that an increasing portion of the current assets is being made up of
those items, from which bills cannot be paid.f. Customers are paying their bills
more slowly in Year 3 than in Year 1. This is evidenced by the decline in accounts
receivable turnover.g. Accounts receivable is increasing. This is evidenced both
by a slowdown in turnover and in an increase in total sales.h. The level of
inventory undoubtedly is increasing. Notice that the inventory turnover is
decreasing. Even if sales (and cost of goods sold) just remained constant, this
would be evidence of a larger average inventory on hand. However, sales are not
constant but rather are increasing. W ith sales increasing (and undoubtedly cost of
goods sold also increasing), the average level of inventory must be increasing as
well in order to service the larger volume of sales.IV. CasesCase 1 (Common-S ize
S tatements and Financial Ratios for Creditors)Requirement 1##This Year#Last
Year##a.#Current assets #P2,060,000#P1,470,000###Current liabilities #�
1,100,000#�� ��600,000###W orking capital #P ��960,000#P ��870,000#######b.#Current
assets (a) #P2,060,000#P1,470,000###Current liabilities (b)
#P1,100,000#P600,000###Current ratio (a) � (b) #1.87 to 1#2.45 to
1#######c.#Quick assets (a) #P740,000#P650,000###Current liabilities (b)
#P1,100,000#P600,000###Acid-test ratio (a) � (b) #0.67 to 1#1.08 to
1#######d.#S ales on account (a) #P7,000,000#P6,000,000###Average receivables
(b) #P525,000#P375,000###Turnover of receivables (a) � (b) #13.3 times#16.0
times########Average age of receivables:#365 � turnover #27.4 days#22.8
days#######e.#Cost of goods sold (a) #P5,400,000#P4,800,000###Average
inventory (b) #P1,050,000#P760,000###Inventory turnover (a) � (b) #5.1
times#6.3 times########Turnover in days: 365 � turnover #71.6 days#57.9
days##f.#Total liabilities (a) #P1,850,000#P1,350,000###Equity (b)
#P2,150,000#P1,950,000###Debt-to-equity ratio (a) � (b) #0.86 to 1#0.69 to
1#######g.#Net income before interest and taxes (a) #P630,000#P490,000###Interest
expense (b) #P90,000#P90,000###Times interest earned (a) � (b) #7.0 times#5.4
times##Requirement 2a.#METRO BUILDING S UPPLY###Common-S ize Balance
S heets#######This Year#Last Year###Current assets:####### Cash #2.3#%#6.1#%###
Marketable securities #0.0##1.5#### Accounts receivable, net
#16.3##12.1#### Inventory #32.5##24.2#### Prepaid expenses
#���0.5##���0.6####Total current assets #51.5##44.5####Plant and equipment,
net #�48.5##�55.5####Total
assets #100.0#%#100.0#%##########Liabilities:####### Current liabilities
#27.5#%#18.2#%### Bonds payable, 12% #�18.8##�22.7####Total liabilities
#�46.3##�40.9####Equity:####### Preference shares, P50 par, 8%
#5.0##6.1#### Ordinary shares, P10 par #12.5##15.2#### Retained
earnings #�36.3##�37.9####Total equity #�53.8##�59.1####Total liabilities and
equity #100.0#%#100.0#%##Note: Columns do not total down in all cases due to
rounding.b.#METRO BUILDING S UPPLY###Common-S ize Income S tatements#######This
Year#Last Year###S ales #100.0#%#100.0#%###Less cost of goods sold
#�77.1##�80.0####Gross margin #22.9##20.0####Less operating expenses
#�13.9##�11.8####Net operating income #9.0##8.2####Less interest expense
#��1.3##��1.5####Net income before taxes #��7.7##��6.7####Less income taxes
#��3.1##��2.7####Net income #��4.6#%#��4.0#%##Requirement 3The following
points can be made from the analytical work in parts (1) and (2) above:The company
has improved its profit margin from last year. This is attributable to an increase
in gross margin, which is offset somewhat by an increase in operating expenses. In
both years the company�s net income as a percentage of sales equals or exceeds the
industry average of 4%.Although the company�s working capital has increased, its
current position actually has deteriorated significantly since last year. Both the
current ratio and the acid-test ratio are well below the industry average, and both
are trending downward. (This shows the importance of not just looking at the
working capital in assessing the financial strength of a company.) Given the
present trend, it soon will be impossible for the company to pay its bills as they
come due.The drain on the cash account seems to be a result mostly of a large
buildup in accounts receivable and inventory. This is evident both from the
common-size balance sheet and from the financial ratios. Notice that the average
age of the receivables has increased by 5 days since last year, and that it is now
9 days over the industry average. Many of the company�s customers are not taking
their discounts, since the average collection period is 27 days and collection
terms are 2/10, n/30. This suggests financial weakness on the part of these
customers, or sales to customers who are poor credit risks. Perhaps the company
has been too aggressive in expanding its sales.The inventory turned only 5 times
this year as compared to over 6 times last year. It takes three weeks longer for
the company to turn its inventory than the average for the industry (71 days as
compared to 50 days for the industry). This suggests that inventory stocks are
higher than they need to be.In the authors� opinion, the loan should be approved on
the condition that the company take immediate steps to get its accounts receivable
and inventory back under control. This would mean more rigorous checks of
creditworthiness before sales are made and perhaps paring out of slow paying
customers. It would also mean a sharp reduction of inventory levels to a more
manageable size. If these steps are taken, it appears that sufficient funds could
be generated to repay the loan in a reasonable period of time.Case 2 (Financial
Ratios for Ordinary S hareholders)Requirement 1#a.##This Year#Last Year####Net
income #P324,000#P240,000####Less preference dividends #� ��16,000#�
��16,000####Net income remaining for ordinary (a) #P308,000#P224,000####Average
number of ordinary shares (b) #50,000#50,000####Earnings per share (a) � (b)
#P6.16#P4.48#########b.#Ordinary dividend per share (a)*
#P2.16#P1.20####Market price per share (b) #P45.00#P36.00####Dividend
yield ratio (a) � (b) #4.8%#3.33%####*P108,000 � 50,000 shares = P2.16;# P60,000
� 50,000 shares = P1.20###c.#Ordinary dividend per share (a)
#P2.16#P1.20####Earnings per share (b) #P6.16#P4.48####Dividend payout
ratio (a) � (b) #35.1%#26.8%#########d.#Market price per share (a)
#P45.00#P36.00####Earnings per share (b) #P6.16#P4.48####Price-earnings
ratio (a) � (b) #7.3#8.0##Investors regard Metro Building S upply less favorably
than other firms in the industry. This is evidenced by the fact that they are
willing to pay only 7.3 times current earnings for a share of the company�s stock,
as compared to 9 times current earnings for the average of all stocks in the
industry. If investors were willing to pay 9 times current earnings for Metro
Building S upply�s stock, then it would be selling for about P55 per share (9 �
P6.16), rather than for only P45 per share.
e.##This Year#Last Year###Equity #P2,150,000#P1,950,000###Less preference shares
#� ���200,000#� ���200,000###Ordinary equity (a)
#P1,950,000#P1,750,000########Number of ordinary shares (b)
#50,000#50,000###Book value per share (a) � (b) #P39.00#P35.00##A market
price in excess of book value does not mean that the price of a stock is too high.
Market value is an indication of investors� perceptions of future earnings and/or
dividends, whereas book value is a result of already completed transactions and is
geared to the past.# ###R#e#q#u#i#r#e#m#e#n#t# #2#####a#.#####T#h#i#s#
#Y#e#a#r###L#a#s#t# #Y#e#a#r#########N#e#t# #i#n#c#o#m#e# ###P##
�#3#2#4#,#0#0#0###P## �#2#4#0#,#0#0#0#########A#d#d# #a#f#t#e#r#-#t#a#x# #c#o#s#t#
#o#f# #i#n#t#e#r#e#s#t# #p#a#i#d#:############# #[#P#9#0#,#0#0#0# #�# #(#1# ##
#0#.#4#0#)#]# ###�#�#�# #�#�#�#5#4#,#0#0#0###�#
#�#�#�#�#�#5#4#,#0#0#0#########T#o#t#a#l# #(#a#)# ###P# #
#�#3#7#8#,#0#0#0###P## �#2#9#4#,#0#0#0#####################A#v#e#r#a#g#e#
#t#o#t#a#l# #a#s#s#e#t#s# #(#b#)#
###P#3#,#6#5#0#,#0#0#0###P#3#,#0#0#0#,#0#0#0#########R#e#t#u#r#n# #o#n#
#t#o#t#a#l# #a#s#s#e#t#s# #(#a#)# #�# #(#b#)# ###1#0#.#4#%###9#.#8#%#####
###b#.#####T#h#i#s# #Y#e#a#r###L#a#s#t# #Y#e#a#r#########N#e#t# #i#n#c#o#m#e#
###P## �#3#2#4#,#0#0#0###P## �#2#4#0#,#0#0#0#########L#e#s#s#
#p#r#e#f#e#r#e#n#c#e# #d#i#v#i#d#e#n#d#s# ###�# #�#�#�#�#�#1#6#,#0#0#0###�#
#�#�#�#�#�#1#6#,#0#0#0#########N#e#t# #i#n#c#o#m#e# #r#e#m#a#i#n#i#n#g# #f#o#r#
#o#r#d#i#n#a#r#y# ## #s#h#a#r#e#h#o#l#d#e#r#s# #(#a#)# ###P##
�#3#0#8#,#0#0#0###P## �#2#2#4#,#0#0#0#####################A#v#e#r#a#g#e#
#t#o#t#a#l# #e#q#u#i#t#y#*#
###P#2#,#0#5#0#,#0#0#0###P#1#,#8#6#8#,#0#0#0#########L#e#s#s# #a#v#e#r#a#g#e#
#p#r#e#f#e#r#e#n#c#e# #s#h#a#r#e#s# ###�# #�#�#�#2#0#0#,#0#0#0###�#
#�#�#�#2#0#0#,#0#0#0#########A#v#e#r#a#g#e# #o#r#d#i#n#a#r#y# #e#q#u#i#t#y# #(#b#)#

###P#1#,#8#5#0#,#0#0#0###P#1#,#6#6#8#,#0#0#0#########*#1#/#2#(#P#2#,#1#5#0#,#0#0#0#
#+# #P#1#,#9#5#0#,#0#0#0#)#;# #1#/#2#(#P#1#,#9#5#0#,#0#0#0# #+#
#P#1#,#7#8#6#,#0#0#0#)#.#################R#e#t#u#r#n# on ordinary equity (a) � (b)
#16.6%#13.4%##c. Financial leverage is positive in both years, since the
return on ordinary equity is greater than the return on total assets. This
positive financial leverage is due to three factors: the preference shares, which
has a dividend of only 8%; the bonds, which have an after-tax interest cost of only
7.2% [12% interest rate � (1 � 0.40) = 7.2%]; and the accounts payable, which may
bear no interest cost.Requirement 3W e would recommend keeping the stock. The
stock�s downside risk seems small, since it is selling for only 7.3 times current
earnings as compared to 9 times earnings for the average firm in the industry. In
addition, its earnings are strong and trending upward, and its return on ordinary
equity (16.6%) is extremely good. Its return on total assets (10.4%) compares
favorably with that of the industry.The risk, of course, is whether the company can
get its cash problem under control. Conceivably, the cash problem could worsen,
leading to an eventual reduction in profits through inability to operate, a
reduction in dividends, and a precipitous drop in the market price of the company�s
stock. This does not seem likely, however, since the company can easily control
its cash problem through more careful management of accounts receivable and
inventory. If this problem is brought under control, the price of the stock could
rise sharply over the next few years, making it an excellent investment.Case 3
(Comprehensive Ratio Analysis)Requirement 1###This# #Y#e#a#r###L#a#s#t#
#Y#e#a#r#######a#.###N#e#t# #i#n#c#o#m#e# ###P## �#2#8#0#,#0#0#0###P##
�#1#6#8#,#0#0#0#########A#d#d# #a#f#t#e#r#-#t#a#x# #c#o#s#t# #o#f#
#i#n#t#e#r#e#s#t#:############# #P#1#2#0#,#0#0#0# #�# #(#1# ## #0#.#3#0#)#
###8#4#,#0#0#0########### #P#1#0#0#,#0#0#0# #�# #(#1# ## #0#.#3#0#)#
### # #�#�#�#�#�#�#�#�#�#�#�#�#�#�#�###�#
#�#�#�#�#�#7#0#,#0#0#0#########T#o#t#a#l# #(#a#)# ###P## �#3#6#4#,#0#0#0###P##
�#2#3#8#,#0#0#0#####################A#v#e#r#a#g#e# #t#o#t#a#l# #a#s#s#e#t#s#
#(#b#)# ###P#5#,#3#3#0#,#0#0#0###P#4#,#6#4#0#,#0#0#0#########R#e#t#u#r#n# #o#n#
#t#o#t#a#l# #a#s#s#e#t#s# #(#a#)# #�# #(#b#)# ###6#.#8#%###5#.#1#
%###############################b#.###N#e#t# #i#n#c#o#m#e# ###P##
�#2#8#0#,#0#0#0###P## �#1#6#8#,#0#0#0#########L#e#s#s# #p#r#e#f#e#r#e#n#c#e#
#d#i#v#i#d#e#n#d#s# ###�# #�#�#�#�#�#4#8#,#0#0#0###�#
#�#�#�#�#�#4#8#,#0#0#0#########N#e#t# #i#n#c#o#m#e# #r#e#m#a#i#n#i#n#g# #f#o#r#
#o#r#d#i#n#a#r#y# #(#a#)# ###P## �#2#3#2#,#0#0#0###P##
�#1#2#0#,#0#0#0#####################A#v#e#rage total equity
#P3,120,000#P3,028,000####Less average preference shares # ����600,000#
����600,000####Average ordinary equity (b)
#P2,520,000#P2,428,000##########Return on ordinary equity (a) � (b)
#9.2%#4.9%###c.#Leverage is positive for this year, since the return on
ordinary equity (9.2%) is greater than the return on total assets (6.8%). For last
year, leverage is negative since the return on the ordinary equity (4.9%) is less
than the return on total assets (5.1%).##Requirement 2###This Year#Las#t#
#Y#e#a#r#######a#.###N#e#t# #i#n#c#o#m#e# #r#e#m#a#i#n#i#n#g# #f#o#r#
#o#r#d#i#n#a#r#y# #(#a#)# ###P## �#2#3#2#,#0#0#0###P#
#�#1#2#0#,#0#0#0#########A#v#e#r#a#g#e# #n#u#m#b#e#r# #o#f# #o#r#d#i#n#a#r#y#
#s#h#a#r#e#s# #(#b#)# ###5#0#,#0#0#0###5#0#,#0#0#0#########E#a#r#n#i#n#g#s#
#p#e#r# #s#h#a#r#e# #(#a#)# #�# #(#b#)#
###P#4#.#6#4###P#2#.#4#0###################b#.###O#r#d#i#n#a#r#y#
#d#i#v#i#d#e#n#d# #p#e#r# #s#h#a#r#e# #(#a#)#
###P#1#.#4#4###P#0#.#7#2#########M#a#r#k#e#t# #p#r#i#c#e# #p#e#r# #s#h#a#r#e#
(b) #P36.00#P20.00####Dividend yield ratio (a) � (b)
#4.0%#3.6%#########c.#Ordinary dividend per share (a)#P1.44#P0.72####Earnings
per share (b) #P4.64#P2.40####Dividend payout ratio (a) � (b)
#31.0%#30.0%#########d.#Market price per share (a)
#P36.00#P20.00####Earnings per share (b) #P4.64#P2.40####Price-earnings
ratio (a) � (b) #7.8#8.3##Notice from the data given in the problem that the
average P/E ratio for companies in Helix�s industry is 10. S ince Helix Company
presently has a P/E ratio of only 7.8, investors appear to regard it less well than
they do other companies in the industry. That is, investors are willing to pay
only 7.8 times current earnings for a share of Helix Company�s stock, as compared
to 10 times current earnings for a share of stock for the average company in the
industry.#######e.#Equity #P3,200,000#P3,040,000####Less preference shares
#� ���600,000#� ���600,000####Ordinary equity (a)
#P2,600,000#P2,440,000##########Number of ordinary shares (b)
#50,000#50,000####Book value per share (a) � (b) #P52.00#P48.80##Note
that the book value of Helix Company�s stock is greater than the market value for
both years. This does not necessarily indicate that the stock is selling at a
bargain price. Market value is an indication of investors� perceptions of future
earnings and/or dividends, whereas book value is a result of already completed
transactions and is geared to the past.#f.#Gross margin (a)
#P1,050,000#P860,000####S ales (b) #P5,250,000#P4,160,000####Gross margin
percentage (a) � (b) #20.0%#20.7%##Requirement 3###This Year#Last
Year###a.#Current assets #P2,600,000#P1,980,000####Current liabilities #�
1,300,000#� ���920,000####W orking capital #P1,300,000#P1,060,000#########b.#Current
assets (a) #P2,600,000#P1,980,000####Current liabilities (b)
#P1,300,000#P920,000####Current ratio (a) � (b) #2.0 to 1#2.15 to
1#########c.#Quick assets (a) #P1,220,000#P1,120,000####Current liabilities (b)
#P1,300,000#P920,000####Acid-test ratio (a) � (b) #0.94 to 1#1.22 to
1#########d.#S ales on account (a) #P5,250,000#P4,160,000####Average receivables
(b) #P750,000#P560,000####Accounts receivable turnover (a) � (b) #7.0
times#7.4 times####Average age of receivables,# 365 � turnover #52 days#49
days###e.#Cost of goods sold (a) #P4,200,000#P3,300,000####Average inventory (b)
#P1,050,000#P720,000####Inventory turnover (a) � (b) #4.0 times#4.6
times####Number of days to turn inventory, 365 days � turnover (rounded) #91
days#79 days#########f.#Total liabilities (a) #P2,500,000#P1,920,000####Equity
(b) #P3,200,000#P3,040,000####Debt-to-equity ratio (a) � (b) #0.78 to 1#0.63 to
1#########g.#Net income before interest and taxes (a)
#P520,000#P340,000####Interest expense (b) #P120,000#P100,000####Times
interest earned (a) � (b) #4.3 times#3.4 times##Requirement 4As stated by Meri
Ramos, both net income and sales are up from last year. The return on total assets
has improved from 5.1% last year to 6.8% this year, and the return on ordinary
equity is up to 9.2% from 4.9% the year before. But this appears to be the only
bright spot in the company�s operating picture. Virtually all other ratios are
below the industry average, and, more important, they are trending downward. The
deterioration in the gross margin percentage, while not large, is worrisome. S ales
and inventories have increased substantially, which should ordinarily result in an
improvement in the gross margin percentage as fixed costs are spread over more
units. However, the gross margin percentage has declined.Notice particularly that
the average age of receivables has lengthened to 52 days�about three weeks over the
industry average�and that the inventory turnover is 50% longer than the industry
average. One wonders if the increase in sales was obtained at least in part by
extending credit to high-risk customers. Also notice that the debt-to-equity ratio
is rising rapidly. If the P1,000,000 loan is granted, the ratio will rise further
to 1.09 to 1.In the author�s opinion, what the company needs is more equity�not
more debt. Therefore, the loan should not be approved. The company should be
encouraged to make another issue of ordinary stock in order to provide a broader
equity base on which to
operate.Case 4 (S tatement Reconstruction Using Ratios)Bulacan CompanyIncome
S tatementFor the Year Ended December 31, 2005S ales
P140,800Less: Cost of S ales (4) 84,480Gross Profit
P 56,320Less: Expenses 46,320
Net Income (1) P 10,000Bulacan CompanyBalance S heet December
31, 2005A s s e t s Current Assets:Cash P 27,720Accounts
Receivable (5) 28,160Merchandise Inventory (3)
21,120Total Current Assets (2) P 77,000Fixed
Assets (8) 55,000Total Assets
P132,000Liabilities and EquityCurrent Liabilities:Accounts Payable (2)
P 44,000Equity:S hare Capital (issued 20,000 shares) (6)
P40,000 Retained Earnings 48,000 88,000Total
Liabilities and Equity P132,000S upporting Computations:# (1)
Earnings Per S hare = #
P0.50 = X (Net Income)
= P10,000 (2) Current Assets Pxx
1.75 Current Liabilities xx 1
W orking Capital P33,000 0.75
Current Liabilities = P33,000 ( 0.75
= P44,000# (3) Current Ratio
= # 1.27 =
X (Current Assets) = P77,000#
Quick Ratio = # 1.27
= X (Current
Assets) = P55,880 Current Assets
P77,000 Quick Assets 55,800 Inventory P21,120#
(4) Inventory turnover = #
4 = X (Cost of S ales)
= P84,480# (5) Average age of outstanding =
Accounts Receivable#
= 73 days (Average age of
receivables)#
= 5#
= 5 X
(Receivables) = P28,160 Another Method:#
= 73 days = P28,160 Accounts
receivable (6) Earnings for the year as a percentage of S hare Capital
= 25%#
S hare Capital = P40,000# (7) Current
Fixed Current Liabilities + Assets
Assets = Equity
P77,000 + 0.625X = P44,000 + X 0.375X
= P33,000 X =
P88,000 Equity (8) Fixed Assets to Equity#
= 0.625#
= 0.625 X (Fixed Assets) =
P55,000 Case 5 (Ethics and the Manager) Requirement 1The loan officer
stipulated that the current ratio prior to obtaining the loan must be higher than
2.0, the acid-test ratio must be higher than 1.0, and the interest on the loan must
be no more than four times net operating income. These ratios are computed below:##
#### The company would fail to qualify for the loan because both its
current ratio and its acid-test ratio are too low.Requirement 2 By reclassifying
the P45 thousand net book value of the old machine as inventory, the current ratio
would improve, but there would be no effect on the acid-test ratio. This happens
because inventory is considered to be a current asset but is not included in the
numerator when computing the acid-test ratio.# Even if this
tactic had succeeded in qualifying the company for the loan, we strongly advise
against it. Inventories are assets the company has acquired for the sole purpose
of selling them to outsiders in the normal course of business. Used production
equipment is not considered to be inventory�even if there is a clear intention to
sell it in the near future. S ince the loan officer would not expect used equipment
to be included in inventories, doing so would be intentionally misleading.
Nevertheless, the old equipment is an asset that could be turned into cash.
If this were done, the company would immediately qualify for the loan since the P45
thousand in cash would be included in the numerator in both the current ratio and
in the acid-test ratio.###### However, other options may be available. After
all, the old machine is being used to relieve bottlenecks in the plastic injection
molding process and it would be desirable to keep this standby capacity. W e would
advise Rome to fully and honestly explain the situation to the loan officer. The
loan officer might insist that the machine be sold before any loan is approved, but
he might instead grant a waiver of the current ratio and acid-test ratio
requirements on the basis that they could be satisfied by selling the old machine.
Or he may approve the loan on the condition that the equipment is pledged as
collateral. In that case, Rome would only have to sell the machine if he would
otherwise be unable to pay back the loan.Case 6 (Financial Ratios for Ordinary
S hareholders) [pesos in thousands] Requirement (1) Calculation of the gross
margin percentage:# Requirement (2) Calculation of the earnings per
share:# Requirement (3) Calculation of the price-earnings ratio:#
Requirement (4) Calculation of the dividend payout ratio:#
Requirement (5) Calculation of the dividend yield ratio:# Requirement
(6) Calculation of the return on total assets:#Requirement (7)
Calculation of the return on ordinary shareholders� equity:#Beginning
balance, shareholders� equity (a) #P39,610###Ending balance, shareholders� equity
(b) #�41,080###Average shareholders� equity [(a) + (b)]/2 #40,345###Average
preference shares#���1,000###Average ordinary shareholders� equity #P39,345###
Requirement (8) Calculation of the book value per share:#Case 7 (Financial
Ratios for S hort-Term Creditors)Requirement (1) Calculation of working
capital:#Requirement (2) Calculation of the current ratio:######
Requirement (3) # Calculation of the acid-test ratio:Requirement (4)
Calculation of accounts receivable turnover:##Requirement (5)
Calculation of the average collection period:##Requirement (6)
Calculation of inventory turnover:#Requirement (7) Calculation of the
average sale period:#Case 8 (Financial Ratios for Long-Term Creditors)Requirement
(1) Calculation of the times interest earned ratio:######Requirement (2)
Calculation of the debt-to-equity ratio:#V. Multiple Choice Questions
A#C#B#C#41.

C###C#A#D#D####D#C#A#C####B#B#C#A####A#D#A#A####D#B#C#C####C#A#D#A####D#C#A#A####A#
A#D#C####B#C#A#C####CHAPTER 6CAS H FLOW ANALYS IS I. QuestionsPurposes of the
S tatement of Cash Flowsa. To predict future cash flowsb. To evaluate
management decisionsc. To determine the ability to pay dividends to shareholders
and interest and principal to creditorsd. To show the relationship of net income to
changes in the business�s cash.2. Comparative balance sheets present the
financial position of the enterprise at two points in time. The income statement
for the period between the two balance sheets describes how the income-producing
activities affected the financial position. Because cash flows from operating
activities may differ substantially from net income, and because numerous other
financing and investing activities have an impact on financial position, the
statement of cash flows is necessary. The statement emphasizes changes in the cash
balances that result from changes in assets, liabilities and equity accounts caused
by operating, investing and financing activities.3. The most important source of
cash for many successful companies is from operating activities. A large positive
operating cash flow is a good sign because it means funds have been internally
generated with no fixed obligations or commitment to return such to anybody.4.
It is possible for cash to decrease during a year when income is high because
cash may be used not only for operating activities but also for investing and
financing activities.5. Transactions involving accounts payable are not considered
to be financing activities because such transactions are used to obtain goods and
services rather than to obtain cash. Furthermore, purchases of goods and services
relate to a company�s day-to-day operating activities.6. The loss is added back
to net income to avoid double counting since the entire proceeds from the sale (net
book value minus loss on sale) will appear as a cash inflow from investing
activities.7. Three categories of transactions that may result in increases in
cash area. Operating activitiesb. Investing activities (e.g., sale of investments
or other assets).c. Financing activities (e.g., borrowing or sale of shares).
These activities are sources of cash when cash is increased as a result of
the particular activity.8. Three categories of transactions that may result in
decreases in cash area. Operating activitiesb. Investing activities (e.g.,
purchase of investments or other assets).c. Financing activities (e.g.,
repayment of debt or retirement of shares). These activities are uses of cash
when cash is decreased as a result of the particular activity.9. Noncash
transactions do not provide or consume cash even though they may result in
significant changes in financial position. Examples are the issuance of share
capital for plant assets and the conversion of debt or preference shares into
ordinary shares. S uch transactions are not presented in the body of the statement
of cash flows but rather disclosed in a separate schedule as financing or investing
activities.10. W hile net loss is usually associated with a decrease in cash, it
may be a source of cash if noncash expenses are greater than the amount of the net
loss. For example, if a net loss of P100,000 included amortization and
depreciation of P125,000 and no noncash revenues existed, cash provided by
operating activities would be P25,000, computed as follows:Net loss
P(100,000)Add: Expenses not requiring cash � depreciation and amortization
125,000Net cash provided by operating activities P 25,00011. The change
in cash is the difference between cash at the beginning and end of the accounting
period. The net amount of cash provided by or used in operating, investing and
financing activities must equal this change in cash. For example, if cash
increased by P150,000 during the
year, total sources from operating, investing, and financing activities must
exceed total uses by P150,000. Also, if cash decreased by P25,000 during the year,
total uses of cash must exceed total sources by P25,000.12.(a) The use of cash
does not occur until the cash dividend is actually paid in the next period. The
declaration of the dividend does affect financial position, however, and should be
disclosed as a noncash financing activity in a separate schedule accompanying the
statement of cash flows. (b) Because the dividend was declared and paid in
the same accounting period, it appears in the statement of cash flows as a cash
decrease in the financing activities category.13. Disagree. The refunding of
10% debt by the 8% debt represents a significant financing activity, even though
the net impact of the exchange on the balance sheet or on the amount of cash is not
material. The issuance of 8% bonds and the retirement of 10% bonds should be
reported as noncash financing transactions in a schedule accompanying the statement
of cash flows.14. The net income figure includes P150,000 as an expense. Only
P112,500 of this amount resulted in a decrease in cash, because P37,500 represents
an increase in the deferred income tax liability account. In determining cash
provided by operating activities, the amount of income tax paid is P112,500 (direct
method). Alternatively, under the indirect method, P37,500 must be added to net
income to determine cash flows from operating activities.15. The loss is
omitted when listing expenses requiring cash payment (direct approach) or added
back to net income (indirect approach) in determining cash provided by operating
activities. This eliminates the impact of the transaction from cash provided by
operating activities. Then, the proceeds from the sale are included as a source of
cash in the investing activities category of the statement of cash flows. Any tax
effects of the transaction are included in the tax expense figure and remain a part
of cash flows from operating activities.16. (1) Operating activities:
Transactions that affect current assets, current liabilities, or net income. (2)
Investing activities: Transactions that involve the acquisition or disposition of
noncurrent assets. (3) Financing activities: Transactions (other than the
payment of interest) involving borrowing from creditors, and any transactions
(involving the owners of a company.17. Interest is included as an operating
activity since it is part of net income. Financing activities are narrowly defined
to include only the principal amount borrowed or repaid.18.S ince the entire
proceeds from a sale of an asset (including any gain) appear as a cash inflow from
investing activities, the gain must be deducted from net income to avoid double
counting.19. The direct method reconstructs the income statement on a cash
basis by restating revenues and expenses in terms of cash inflows and outflows. The
indirect method starts with net income and adjusts it to a cash basis to determine
the cash provided by operating activities.20. An increase in the Accounts
Receivable account must be deducted from net income under the indirect method
because this is an increase in a noncash asset.21. A decrease in the Accounts
Payable account must be added to cost of goods sold under the direct method. The
cost of goods sold is increased by the amount of the decrease in accounts payable.
Because the cost of goods sold is increased, the net cash flow provided by
operating activities is decreased. The effect of a decrease in a liability is a
decrease in cash.22. A sale of equipment for cash would be classified as an
investing activity. Any transaction involving the acquisition or disposition of
noncurrent assets is classified as an investing activity.II. ExercisesExercise
1 Net income ##P84,000##Adjustments to convert net income to a cash
basis:####Depreciation charges for the year #P50,000###Increase in accounts
receivable #(60,000)###Increase in inventory #(77,000)###Decrease in prepaid
expenses #2,000###Increase in accounts payable #30,000###Decrease in accrued
liabilities #(4,000)###Increase in deferred income taxes #���6,000#(53,000)##Net
cash provided by operating activities ##P31,000###E#x#e#r#c#i#s#e# #2##
#S #a#l#e#s# ### #P#1#,#0#0#0#,#0#0#0#######A#d#j#u#s#t#m#e#n#t#s# #t#o# #a#
#c#a#s#h# #b#a#s#i#s#:#########L#e#s#s# #i#n#c#r#e#a#s#e# #i#n# #a#c#c#o#u#n#t#s#
#r#e#c#e#i#v#a#b#l#e# ### ## #
#6#0#,#0#0#0###P#9#4#0#,#0#0#0#############C#o#s#t# #o#f# #g#o#o#d#s#
#s#o#l#d# ### # #5#8#0#,#0#0#0#######A#d#j#u#s#t#m#e#n#t#s# #t#o# #a#
#c#a#s#h# #b#a#s#i#s#:#########P#l#u#s# #i#n#c#r#e#a#s#e# #i#n# #i#n#v#e#n#t#o#r#y#
### #+## #7#7#,#0#0#0#######L#e#s#s# #i#n#c#r#e#a#s#e# #i#n#
#a#c#c#o#u#n#t#s# #p#a#y#a#b#l#e# ### ## #
#3#0#,#0#0#0###6#2#7#,#0#0#0#############S #e#l#l#i#n#g# #a#n#d#
#a#d#m#i#n#i#s#t#r#a#t#i#v#e# #e#x#p#e#n#s#e#s# ### #
#3#0#0#,#0#0#0#######A#d#j#u#s#t#m#e#n#t#s# #t#o# #a# #c#a#s#h#
#b#a#s#i#s#:#########L#e#s#s# #d#e#c#r#e#a#s#e# #i#n# #p#r#e#p#a#i#d#
#e#x#p#e#n#s#e#s# ### ## # #2#,#0#0#0#######P#l#u#s# #d#e#c#r#e#a#s#e# #i#n#
#a#c#c#r#u#e#d# #l#i#a#b#i#l#i#t#i#e#s# ### #+## #4#,#0#0#0#######L#e#s#s#
#d#e#p#r#e#c#i#a#t#i#o#n# #c#h#a#r#g#e#s# ### ## #
#5#0#,#0#0#0###2#5#2#,#0#0#0#############I#n#c#o#m#e# #t#a#x#e#s# ###
# #3#6#,#0#0#0#######A#d#j#u#s#t#m#e#n#t#s# #t#o# #a# #c#a#s#h#
#b#a#s#i#s#:#########L#e#s#s# #i#n#c#r#e#a#s#e# #i#n# #d#e#f#e#r#r#e#d#
#i#n#c#o#m#e# #t#a#x#e#s# ### ## #
#6#,#0#0#0###�#�#�#3#0#,#0#0#0#############N#e#t# #c#a#s#h# #p#r#o#v#i#d#e#d#
#b#y# #o#p#e#r#a#t#i#n#g# #a#c#t#i#v#i#t#i#e#s# #####P## 3#1#,#0#0#0######N#o#t#e#
#t#h#a#t# #t#h#e# #P#3#1#,#0#0#0# #a#g#r#e#e#s# #w#i#t#h# #t#h#e# #c#a#s#h#
#p#r#o#v#i#d#e#d# #b#y# #o#p#e#r#a#t#i#n#g# #a#c#t#i#vities figure under the
indirect method in the previous exercise.Exercise 3Item#Amount#Add#Deduct##Accounts
Receivable #P70,000#decrease#X###Accrued Interest Receivable
#P6,000#increase##X##Inventory #P110,000#increase##X##Prepaid Expenses
#P3,000#decrease#X###Accounts Payable #P40,000#decrease##X##Accrued
Liabilities #P9,000#increase#X###Deferred Income Taxes Liability
#P15,000#increase#X###S ale of equipment #P8,000#gain##X##S ale of long-term
investments #P12,000#loss#X###Exercise 4Requirement (1) #Net income
##P75###Adjustments to convert net income to a cash basis:#####Depreciation
charges #P40####Decrease in accounts receivable #10####Increase in inventory
#(30)####Decrease in prepaid expenses #5####Increase in accounts payable
#20####Decrease in accrued liabilities #(10)####Increase in taxes payable
#10####Increase in deferred taxes #5####Loss on sale of long-term
investments #5####Gain on sale of land #(40)#�15###Net cash provided by
operating activities ##P90##Requirement (2) #S wan
Company######S #t#a#t#e#m#e#n#t# #o#f# #C#a#s#h# #F#l#o#w#s#
#######O#p#e#r#a#t#i#n#g# #a#c#t#i#v#i#t#i#e#s#:###########N#e#t# #c#a#s#h#
#p#r#o#v#i#d#e#d# #b#y# #o#p#e#r#a#t#i#n#g# #a#c#t#i#v#i#t#i#e#s# #(#s#e#e#
#a#b#o#v#e#)# #####P## 9#0#################I#n#v#e#s#t#i#n#g#
#a#c#t#i#v#i#t#i#e#s#:###########P#r#o#c#e#e#d#s# #f#r#o#m# #s#a#l#e# #o#f#
#l#o#n#g#-#t#e#r#m# #i#n#v#e#s#t#m#e#n#t#s# ###P## 4#5#########P#r#o#c#e#e#d#s#
#f#r#o#m# #s#a#l#e# #o#f# #l#a#n#d# ###7#0#########A#d#d#i#t#i#o#n#s# #t#o#
#l#o#n#g#-#t#erm investments #(20)####Additions to plant & equipment
#(150)####Net cash used for investing activities ##(55)########Financing
activities:#####Decrease in bonds payable #(20)####Increase in ordinary shares
#40####Cash dividends #�(35)####Net cash used by financing activities
##�(15)########Net increase in cash (net cash flow) ##20###Cash balance,
beginning ##�100###Cash balance, ending ##P120##W hile not a requirement, a
worksheet may be helpful.#Change##S ource or Use?##Cash Flow Effect##Adjust-
ments##Adjusted Effect##Classification##Assets (except cash and cash
equivalents)##Current assets:#############Accounts receivable
#�10##S ource##+10####+10##Operating##Inventory
#+30##Use##�30####�30##Operating##Prepaid expenses
#�5##S ource##+5####+5##Operating##Noncurrent assets:#############Long-term
investments #�30##S ource##+30##�50##�20##Investing##Plant and equipment
#+150##Use##�150####�150##Investing##Land
#�30##S ource##+30##�30##0##Investing####Liabilities, Contra assets, and
S hareholders� Equity##Contra assets:#############Accumulated depreciation
#+40##S ource##+40####+40##Operating##Current
liabilities:#############Accounts payable
#+20##S ource##+20####+20##Operating##Accrued liabilities
#�10##Use##�10####�10##Operating##Taxes payable
#+10##S ource##+10####+10##Operating##Noncurrent
liabilities:#############Bonds payable
#�20##Use##�20####�20##Financing##Deferred income taxes
#+5##S ource##+5####+5##Operating##S hareholders� equity:#############Ordinary
shares #+40##S ource##+40####+40##Financing##Retained earnings:#############Net
income #+75##S ource##+75####+75##Operating##Dividends
#�35##Use##�35####�35##Financing####Additional entries##Proceeds from sale of
investments #######+45##+45##Investing##Loss on sale of investments
#######+5##+5##Operating##Proceeds from sale of land
#######+70##+70##Investing##Gain on sale of land
#####�����#########################################################################
###################################################################################
###################### # 4#0###### # 4#0#####O#p#e#r#a#t#i#n#g#####T#o#t#a#l#
###########+#2#0###### # # 0###### +#2#0########## #E#x#e#r#c#i#s#e# #5##
#S #a#l#e#s# ###P#6#0#0#######A#d#j#u#s#t#m#e#n#t#s# #t#o# #a# #c#a#s#h#
#b#a#s#i#s#:#########D#e#c#r#e#a#s#e# #i#n# #a#c#c#o#u#n#t#s# #r#e#c#e#i#v#a#b#l#e#
###�#+#1#0###P#6#1#0#####C#o#s#t# #o#f# #g#o#o#d#s# #s#o#l#d#
###2#5#0#######A#d#j#u#s#t#m#e#n#t#s# #t#o# #a# #c#a#s#h#
#b#a#s#i#s#:#########I#n#c#r#e#a#s#e# #i#n# #i#n#v#e#n#t#o#r#y#
###+#3#0#######I#n#c#r#e#a#s#e#
#i#n# #accounts payable #��20#260##S elling and administrative expenses
#280###Adjustments to a cash basis:####Decrease in prepaid expenses
#�5###Decrease in accrued liabilities #+10###Depreciation charges
#��40#245##Income taxes #30###Adjustments to a cash basis:####Increase in
taxes payable #�10###Increase in deferred taxes #���5#���15##Net cash
provided by operating activities

##P################################################################################
####################################################### 9#0#####E#x#e#r#c#i#s#e#
#6###R#e#q#u#i#r#e#m#e#n#t#s# #(#1#)# #a#n#d# #(#2#)#####S #t#e#p#h#e#n#i#e#
#C#o#m#p#a#n#y#######S #t#a#t#e#m#e#n#t# #o#f# #C#a#s#h# #F#l#o#w#s#######F#o#r#
#t#h#e# #Y#e#a#r# #E#n#d#e#d# #D#e#c#e#m#b#e#r# #3#1#,#
#2#0#0#8#############O#p#e#r#a#t#i#n#g# #a#c#t#i#v#i#t#i#e#s#:#########N#e#t#
#i#n#c#o#m#e# #####P## 5#6#####A#d#j#u#s#t#m#e#n#t#s# #t#o# #c#o#n#v#e#r#t#
#n#e#t# #i#n#c#o#m#e# #t#o# #c#a#s#h# #b#a#s#i#s#:#########D#e#p#r#e#c#i#a#t#i#o#n#
#c#h#a#r#g#e#s# ###2#5#######I#ncrease in accounts receivable #(80)###Decrease
in inventory #35###Increase in prepaid expenses #(2)###Increase in accounts
payable #75###Decrease in accrued liabilities #(10)###Gain on sale of
investments #(5)###Loss on sale of equipment #2###Increase in deferred income
taxes #����8#��48##Net cash provided by operating activities
##�104######Investing activities:####Proceeds from sale of long-term
investments #12###Proceeds from sale of equipment #18###Additions to plant and
equipment #(110)###Net cash used for investing activities ##(80)######Financing
activities:####Increase in bonds payable #25###Decrease in ordinary shares
#(40)###Cash dividends #�(16)###Net cash used for financing activities
##�(31)######Net decrease in cash ##(7)##Cash balance, January 1, 2008
##���11##Cash balance, December 31, 2008

##P################################################################################
###################################################################################
######################################## # 4######W #h#i#l#e# #n#o#t# #a#
#r#e#q#u#i#r#e#m#e#n#t#,# #a# #w#o#r#k#s#h#e#e#t# #m#a#y# #b#e# #h#e#l#p#f#u#l#.##
###C#h#a#n#g#e#####S #o#u#r#c#e# #o#r# #U#s#e#?#####C#a#s#h# #F#l#o#w#
#E#f#f#e#c#t#####A#d#j#u#s#t#-#m#e#n#t#s#####A#d#j#u#s#t#e#d#
#E#f#f#e#c#t#####C#l#a#s#s#i#-#f#i#c#a#t#i#o#n#####A#s#s#e#t#s# #(#e#x#c#e#p#t#
#c#a#s#h# #a#n#d# #c#a#s#h# #e#q#u#i#v#a#l#e#n#t#s#)#####C#u#r#r#e#n#t#
#a#s#s#e#t#s#:###########################A#c#c#o#u#n#t#s# #r#e#c#e#i#v#a#b#l#e#
###+#8#0#####U#s#e###### 8#0#####�80##Operating##Inventory
#�35##S ource##+35####+35##Operating##Prepaid expenses
#+2##Use##�2####�2##Operating##Noncurrent assets:#############Plant and
equipment #+80##Use##�80##�30##�110##Investing##Long-term investments
#�7##S ource##+7##�7##0##Investing###############Liabilities, Contra assets,
and S hareholders� Equity##Contra assets:#############Accumulated depreciation
#+15##S ource##+15##+10##+25##Operating##Current
liabilities:#############Accounts payable
#+75##S ource##+75####+75##Operating##Accrued liabilities
#�10##Use##�10####�10##Operating##Noncurrent liabilities:#############Bonds
payable #+25##S ource##+25####+25##Financing##Deferred income taxes
#+8##S ource##+8####+8##Operating##S hareholders� equity:#############Ordinary
shares #�40##Use##�40####�40##Financing##Retained earnings:#############Net
income #+56##S ource##+56####+56##Operating##Dividends
#�16##Use##�16####�16##Financing###############Additional entries##Proceeds
from sale of equipment #######+18##+18##Investing##Loss on sale of equip#m#e#n#t#
###############+#2#####+#2#####O#p#e#r#a#t#i#n#g#####P#r#o#c#e#e#d#s#
#f#r#o#m# #s#a#l#e# #o#f# #l#o#n#g#-#t#e#r#m# #i#n#v#e#s#t#m#e#n#t#s#
###############+#1#2#####+#1#2#####I#n#v#e#s#t#i#n#g#####G#a#i#n# #o#n#
#s#a#l#e# #o#f# #l#o#n#g#-#t#e#r#m# #i#n#v#e#s#t#m#e#n#t#s#
###########�#�#�#�#�###### # 5###### # #
5#####O#p#e#r#a#t#i#n#g###############################T#o#t#a#l# ############ #
7###### # 0###### # # 7###########I#I#.# #P#r#o#b#l#e#m#s###P#r#o#b#l#e#m# #1# ##
#T#r#a#n#s#a#c#t#i#o#n#Operating#Investing#Financing#S ource#Use##S hort-term
investment securities were purchased #X####X##Equipment was purchased ##X###
X##Accounts payable increased #X###X###Deferred taxes decreased #X####X##Long-term
bonds were issued ###X#X###Ordinary shares were sold ###X#X###Interest was paid to
long-term creditors #X####X##A long-term mortgage was entirely paid off ###X##
X##A cash dividend was declared and paid ###X##X##Inventories decreased
#X###X###Accounts receivable increased #X####X##Depreciation charges
totaled P200,000 for the year #X###X###Problem 2 (Analysis of Cash Flow
Transactions)Requirement (a)The eight items should be presented in the statement of
cash flows as follows:1. Net income is the basis for the calculation of cash
flows from operating activities by starting with that number and adjusting for
noncash revenue and expense transactions (indirect method) or by computing by the
direct method the positive cash flows from revenues, less the negative cash flows
from expenses. The cash flows from the transaction giving rise to the
extraordinary loss is reclassified as an investing activity.2. The acquisition of
intangibles is a negative cash flow from investing activities. The amortization is
a noncash expense in determining cash flows from operating activities.3. The
payment of a cash dividend is a negative cash flow that is presented in the
financing activities section of the statement.4. The purchase of treasury
share is a negative cash flow in the financing activities section of the statement.
5. The depreciation expense recognized during the year is a noncash expense in
determining cash flows from operating activities.6. The conversion of convertible
bonds into ordinary shares is a noncash financing activity that requires disclosure
in a separate schedule.7. The changes in plant asset accounts � land,
equipment, and building � represent activities whose cash flow effects are
presented in the investing activities section of the statement.8. The increase
in working capital also represents the change in cash because all other current
assets and current liabilities remained constant. The net of all cash flows from
operating, investing and financing activities must reconcile with the change in
cash in the statement of cash flows.Requirement (b)1. Net cash provided by
operating activities Net income P145,000 Noncash expense
adjustments: Depreciation expense 46,250
Amortization expense 6,000 Reclassification of extraordinary loss
15,000 P212,2502. Net cash used in investing
activities Purchase of intangible assets P (34,000) Purchase of land
(130,000) Purchase of equipment (60,000) Purchase of
building (100,000) S ale of land 165,000
P(159,000)3. Net cash used in financing activities Purchase of
treasury shares P(31,000) Payment of dividends (12,500)
P(43,500)Computations: Depreciation expense Change in
accumulated depreciation account P35,000 Accumulated depreciation on
fully depreciated assets disposed 11,250
P46,250 Purchase of land Change in land account P (50,000)
Cost of land sold in condemnation proceedings 180,000
P130,000Problem 3 (Cash Flow from Operating Activities)Cash received from
customers: Total revenues P185,000 Less: Note receivable (15,000)
P170,000Cash disbursed for expenses: Total expenses (P173,000 + P4,200)
P177,200 Less: Income taxes deferred (1,260)
Depreciation (25,000) Amortization (7,000)
(143,940)Net cash provided by operating activities P 26,060 Problem 4
(Cash Flow from Operating Activities)Cash received from customers (1)
P5,237,000Cash paid for expenses: Cost of goods sold P3,150,000
S elling 246,000 S alaries and wages (2) 394,400 Interest (3)
65,200 Miscellaneous operating 5,000 Incomes taxes (4) 335,000
4,195,600Net cash provided by operating activities P1,041,400Computations:
1. Revenue from sales P5,432,000 Less: Note receivable (120,000)
Land (75,000) P5,237,000 2.
S alaries and wages expense P 400,000 Less: Increase in accrued salaries
and wages (P45,600 � P40,000) (5,600)
P 394,400 3. Interest expense P 72,000 Less: Discount
amortization (6,800) P 65,2004. Income
tax expense P 445,000 Less: Deferred portion (110,000)
P 335,000Problem 5 (S tatement of Cash Flows Preparation � Indirect)Green
Tea CompanyS tatement of Cash FlowsFor the Year Ended December 31, 2005Cash flows
from operating activities ####Net income*#P8,500###Adjustments to reconcile net
income to net cash flows provided by operating
activities:####Depreciation#1,000###Amortization of intangibles#1,000###Increase in
current assets# (6,000)###Increase in current liabilities# 3,000### Net cash
provided by operating activities##P7,500######Cash flows from financing
activities####Dividends paid#(1,500)###Retirement of long-term
liabilities#(1,000)### Net cash used in financing activities## (2,500)##Net
increase in cash##P 5,000##Cash, January 1, 2005## 10,000##Cash, December 31,
2005##P15,000##Problem 6 (Cash Flow S tatement Preparation � Direct)Requirement (a)
Hundred Acre CompanyS tatement of Cash FlowsFor the Year Ended December 31, 2005Cash
flows from operating activities ####Cash received from customers#P74,000###Cash
paid for expense# 67,000### Net cash provided by operating
activities##P7,000##Cash flow from investing activities####S ale of
equipment#9,500### S ale of investments#15,000### Acquisition of equipment#
(53,000)### Net cash used in investing activities##(28,500)##Cash flows from
financing activities####S ale of ordinary shares#40,000###Payment of cash dividends#
(8,500)### Net cash used
in financing activities## 31,500##Net increase in cash##P10,000##Cash, January 1,
2005## 20,000##Cash, December 31, 2005##P30,000##Reconciliation of net income to
net cash provided by operating activities:####Net income#P15,000###Adjustments to
reconcile net income to net cash provided by operating activities:####Depreciation
expense#24,500*###Amortization expense#1,000###Increase in accounts
receivable#(33,000)###Decrease in accrued expenses# (500)###Net cash provided
by operating activities#P 7,000###Computations:Cash received from customers:
Revenues P107,000 Deduct: Increase in accounts receivable
(P78,000 � P45,000) 33,000 P
74,000Cash paid for expenses: Expenses P 92,000 Add: Decrease in
accrued expenses (P7,500 � P7,000) 500 Deduct: Depreciation expense
(P33,600 � P27,100 + P18,000) (24,500)
Amortization (1,000) P 67,000Cash from sale
of equipment: Cost P 27,500 Deduct: Accumulated
depreciation (18,000) Cash received on sale at book value P 9,500Cash
paid to acquire equipment: Increase in property, plant and equipment
(P118,100 � P92,600) P 25,500 Cost of machinery sold 27,500
P 53,000Cash received on sale of shares: Increase in ordinary
shares amount (P100,000 � P75,000) P 25,000 Increase in additional
paid-in capital account (P55,000 � P40,000) 15,000
P 40,000Cash dividends: Increase in retained earnings (P21,000 �
P14,500) P 6,500 Net income (P107,000 � P92,000) (15,000)
P 8,500Requirement (b)The reconciliation of net income to net
cash provided by or used in operating activities is required to be disclosed in
order to show more clearly the relationship and emphasize the differences between
the two. Users of financial statements are often not as aware of the accrual
concepts, which determine net income, as are preparers of those statements. The
reconciliation of net income to net cash flows from operating activities clearly
demonstrates that the two are different and details those events and transactions
that account for the difference.Problem 7 (Interpretation of Cash Flow S tatement)
Requirement (a)The two companies are similar in the following respects: 1.
Overall size.2. Industry in which they operate.3. Current ratio (2.4 to
1).4. Overall peso amounts of cash provided and used:#Range, 2002-2005###Cash
Provided#Cash Used##Ebony Company#P125,000 � P168,000#P115,000 � P170,000##Ivory
Company#P135,000 � P160,000#P125,000 � P165,000## 5. Net increase in working
capital is identical for each year, 2002 � 2005.Requirement (b)The two companies
are dissimilar in the makeup of the sources of cash, as indicated in the following
analysis:#S ources of Cash in
Percentages###2002#2003#2004#2005###Ebony#Ivory#Ebony#Ivory#Ebony#Ivory#Ebony#Ivory
##Cash provided:########## Operations #80#37#77#21#70#(38)#76#7## Long-term
debt#8#56#--#10#--#44#9#--## S hare capital#--#--#16#52#--#63#--#56## Asset
disposition# 12# 7# 7# 17# 30# 31# 15#
37###100#100#100#100#100#100#100#100##Ebony Company has relied much more heavily on
operations to provide cash and to a very limited extent on debt and equity
financing and asset disposition. On the other hand, Ivory Company has not been
able to provide cash from operations and has been required to rely on the
alternatives of debt and equity financing and asset disposition.Requirement (c)
Ebony Company is in a considerably stronger position (as determined by the data
given) and thus should be considered the better investment and credit risk. The
following points are significant:1. Ebony Company has provided 70%-80% of its cash
via operating activities, supplementing with other means to maintain a current
ratio at the industry average. Ebony has not had to rely consistently on any
alternative source of funding.2. Ivory Company has apparently been forced to
rely continuously on debt financing except in 2005, perhaps because of the
inability to obtain such financing. The year 2004 is particularly weak for Ivory,
with operations resulting in a P60,000 reduction in cash. The ability of Ivory to
sustain its present financial position (i.e., current ratio, etc.) is questionable
in light of its history.III. Multiple Choice QuestionsD#D#C#B##C#B#B#A##D#D#A#D##
CHAPTER 7GROS S PROFIT VARIATION ANALYS IS AND EARNINGS PER S HARE DETERMINATIONI.
Problems Problem I The Dawn Mining CompanyGross Profit Variation Analysis
For 2006Increase in S ales:Quantity Factor [(24,000) x P8] P(192,000)Price
Factor (105,000 x P3) 315,000 Quantity/Price Factor [(24,000) x P3]
(72,000) P 51,000Less: Increase (decrease) in Cost of S ales:Quantity
Factor [(24,000) x P9] P(216,000)Cost Factor [105,000 x (P.50)]
(52,500)Quantity/Cost Factor [(24,000) x (P.50)] 12,000
(256,500)Increase in Gross Profit P 307,500 Problem II
S elling Price Factor S ales in 2006 P210,000Less: S ales in 2006
at 2005 prices (P210,000 ( 105%) 200,000Favorable
P 10,000Cost FactorCost of S ales in 2006 P164,000
Less: Cost of S ales in 2006 at 2005 costs 176,000Favorable
P(12,000)Quantity Factor Increase in S alesS ales in 2006 at 2005
prices P200,000Less: S ales in 2005 150,000Favorable
P 50,000Less: Increase in Cost of S alesCost of S ales in 2006 at 2005
costs(P132,000 x 133-1/3%) P176,000Less: Cost of S ales in 2005
132,000Unfavorable P 44,000Net favorable quantity factor
6,000*Increase in Gross Profit P 28,000* This
may also be obtained using the following presentation:Quantity Factor:S ales in 2006
at 2005 prices P200,000Less: S ales in 2005
150,000Increase in S ales P 50,000Multiplied by: Ave. Gross
Profit rate in 2005 12%Net favorable variance P
6,000 Problem IIIRequirement A:Tony CorporationS tatement Accounting for Gross
Profit VariationFor 2006Increase (Decrease) in S ales accounted for as follows:Price
Factor S ales this year P210,210Less: S ales this year at last year�s
prices 269,500Favorable (Unfavorable) P(59,290)Quantity
FactorS ales this year at last year�s prices (P210,210 ( 78%) P269,500
Less: S ales last year 192,500Favorable (Unfavorable)
P 77,000Net Increase (decrease) in sales P 17,710Increase (decrease)
in Cost of S ales accounted for as follows:Cost FactorCost of S ales this year
P 165,400Less: Cost of S ales this year at last year�s costs
161,700(Favorable) Unfavorable P 3,700Quantity Factor Cost of
S ales this year at last year�s costs (115,500 x 140%) P 161,700Less: Cost of
S ales last year 115,500(Favorable) Unfavorable P 46,200
Net increase (decrease) in Cost of S ales P 49,900Net increase (decrease)
in Gross Profit P (32,190)Gross Profit, this year P 44,810
Gross Profit, last year 77,000Increase (Decrease) in Gross Profit
P(32,190)Requirement B:(1) Change in Quantity = P 77,000
= 40% increase P192,500(2) Change in
Unit Costs = P 3,700 = 2.38% increase
P161,700 Problem IV Quantity Factor1.
Decrease in S ales due to decrease in the numberof customers [(1,000) x 18 MCF
x P2.50)] P(45,000) 2. Increase in S ales due to increase in
consumptionrate per customer (26,000 x 2 MCF x P2.50) 130,000Net
Increase P 85,000Price Factor3. Decrease in S ales due to the
decrease in rate per MCF [P(.05) x 520,000] (26,000)Increase
in operating revenues P 59,000S upporting Computations:Average Consumption:
(a) 2006 = 520,000 ( 26,000 = 20 MCF/customer 2005 = 486,000 ( 27,000 = 18
MCF/customer Increase in Consumption per customer
2 MCF/customer (b) 27,000 - 26,000 = 1,000 decrease in number of customers(c)
Price 2006 P2.45 2005 2.50
Decrease in rate or price per MCF sold P(.05)
Problem VXYZ CorporationGross Profit Variation AnalysisFor 2006Price Factor
S ales in 2006 P 1,750Less: S ales in 2006 at 2005 pricesA
(25 x P10) P 250B (75 x P20) 1,500 1,750
Increase (decrease) in gross profit P - Cost
Factor: Cost of sales in 2006 P 875Less: Cost of sales in 2006 at
2005 costs:A (25 X P5) P 125B (75 x P10) 750
875Increase (decrease) in gross profit P -
Quantity Factor: Increase (decrease) in total quantityMultiplied by: Average gross
profitper unit in 2005 (P750 ( 100) P 7.50 Increase (decrease) in gross
profit P - S ales Mix Factor: Average
gross profit per unit in 2006 at 2005 prices P8.75 *Less: Average
gross profit per unit in 2005 7.50Increase (decrease) P1.25
Multiplied by: Total quantity in 2006 100Increase (decrease) in
gross profit P125.00Increase in Gross Profit P125.00*
S ales in 2006 at 2005 prices P1,750Less: Cost of sales in 2006
at 2005 prices 875Gross profit in 2006 at 2005 prices
P 875Average Gross Profit on 2006 at 2005 prices:P875
= P8.75 100 (volume in 2006) Problem VI (Computation of W eighted
Average Number of Ordinary S hares)#Number of S hares####Date#Unadjusted#Adjustment
for 25% stock dividend#As Adjusted#Multiplier#W eighted
S hares##1/1/2006#16,000#4,000#20,000#12/12#20,000##2/15/2006#3,200#800#4,000#10.5/1
2#3,500##4/1/2006#(3,000)#(750)#(3,750)#9/12#(2,812)##6/1/2006#1,400#350#1,750#7/12
#1,020##9/1/2006#6,400#1,600#8,000#4/12#2,667##12/1/2006# 6,000#(6,000)#
- #-# - ##Total#30,000# - #30,000##24,375##
Problem VII (Computation of Basic EPS and Diluted EPS ) # 1. Basic EPS
= = P0.90# 2. Diluted EPS
= #
= = P0.82 (rounded off)Problem
VIII Requirements (1) and
(2)Explanation Earnings ( S hares = Per
S hareBasic earnings and shares P122,000a ( 33,333b
= P3.66 BasicS tock option share increment
293cTentative DEPS 1 amounts P122,000 (
33,626 = P3.63 DEPS 110% bond interest expense savingse 13,300d
Increment in shares 4,400d
Tentative DEPS 2 amounts P135,300 ( 38,026 = P3.56
DEPS 27.5% preference dividend savingse 28,500dIncrement in shares
9,310d
P163,800 ( 47,336 = P3.46 DEPS 35.8% bonds
21,924 6,264Diluted earnings and shares
P185,724 ( 53,600 = P3.465 DilutedaP122,000 = P150,500
(net income) - P28,500 (preference dividends)bW eighted average shares: 25,000
x 1.20 = 30,000 x 7/12 = 17,500
32,000 x 1.20 = 38,400 x 4/12 = 12,800
38,400 - 2,000 = 36,400 x 1/12 = 3,033
W eighted average shares 33,333cIncrement
due to stock options:Issued
4,000###Reacquired Increment in shares
293dImpact on diluted earnings per share and ranking:
Impact Ranking###
10% bonds: P3.02 5#####5.8% bonds: P3.50 3#7.5% preference:
P3.06 2eDilutive effect on diluted earnings per share: 10% bonds:
P3.02 impact < P3.63 (DEPS 1), therefore dilutive 7.5% preference: P3.06
impact < P3.56 (DEPS 2), therefore dilutive 5.8% bonds: P3.50 impact >
P3.46 (DEPS 3), therefore exclude from EPS Requirement 3Fuego Company would report
basic earnings per share of P3.66 and diluted earnings per share of P3.46 on its
2005 income statement.II. Multiple Choice Questions
B#A#A#A#A#C##B#B#A#D#B#A##C#B#D *#C#C#B##D#B#C#A#D###* S upporting computation for
no. 11:# Diluted EPS for 12/31/2006 =# = or
P6.18CHAPTER 8COS T CONCEPTS AND CLAS S IFICATIONS I. Questions1. The phrase
�different costs for different purposes� refers to the fact that the word �cost�
can have different meanings depending on the context in which it is used. Cost
data that are classified and recorded in a particular way for one purpose may be
inappropriate for another use.2. Fixed costs remain constant in total across
changes in activity, whereas variable costs change in proportion to the level of
activity.3. Examples of direct costs of the food and beverage department in a hotel
include the money spent on the food and beverages served, the wages of table
service personnel, and the costs of entertainment in the dining room and lounge.
Examples of indirect costs of the food and beverage department include allocations
of the costs of advertising for the entire hotel, of the costs of the grounds and
maintenance department, and of the hotel general manager�s salary.4. The cost of
idle time is treated as manufacturing overhead because it is a normal cost of the
manufacturing operation that should be spread out among all of the manufactured
products. The alternative to this treatment would be to charge the cost of idle
time to a particular job that happens to be in process when the idle time occurs.
Idle time often results from a random event, such as a power outage. Charging the
cost of the idle time resulting from such a random event to only the job that
happened to be in process at the time would overstate the cost of that job.5.
a. Uncontrollable cost b. Controllable cost c. Uncontrollable
cost6. Product costs are costs that are associated with manufactured goods
until the time period during which the products are sold, when the product costs
become expenses. Period costs are expensed during the time period in which they
are incurred.7. The most important difference between a manufacturing firm and a
service industry firm, with regard to the classification of costs, is that the
goods produced by a manufacturing firm are inventoried, whereas the services
produced by a service industry firm are consumed as they are produced. Thus, the
costs incurred in manufacturing products are treated as product costs until the
period during which the goods are sold. Most of the costs incurred in a service
industry firm to produce services are operating expenses that are treated as period
costs.8. Product costs are also called inventoriable costs because they are
assigned to manufactured goods that are inventoried until a later period, when the
products are sold. The product costs remain in the finished goods inventory
account until the time period when the goods are sold.9. A sunk cost is a cost
that was incurred in the past and cannot be altered by any current or future
decision. A differential cost is the difference in a cost item under two decision
alternatives.10. a. Direct cost b. Direct cost c. Indirect cost d.
Indirect cost11. The two properties of a relevant cost are:1. it differs
between the decision options2. it will be incurred in the future12. The
three types of product costs are:1. direct materials � the materials used in
manufacturing the product, which become a physical part of the finished product.2.
direct labor � the labor used in manufacturing the product.3. factory
overhead � the indirect costs for materials, labor, and facilities used to support
the manufacturing process, but not used directly in manufacturing the product.13.
The three types of manufacturing inventories are:1. materials inventory �
the store of materials used in the manufacturing process or in providing the
service.2. work in process inventory � accounts for all costs put into the
manufacturing of products that are started but not complete at the financial
statement date.3. finished goods inventory � the cost of goods that are ready for
sale.14. Direct materials include the materials in the product and a reasonable
allowance for scrap and defective units, while indirect materials are materials
used in manufacturing that are not physically part of the finished product.15.
The income statement of a manufacturing company differs from the income
statement of a merchandising company in the cost of goods sold section. A
merchandising company sells finished goods that it has purchased from a supplier.
These goods are listed as �purchases� in the cost of goods sold section. S ince a
manufacturing company produces its goods rather than buying them from a supplier,
it lists �cost of goods manufactured� in place of �purchases.� Also, the
manufacturing company identifies its inventory in this section as Finished Goods
inventory, rather than as Merchandise Inventory.16. Yes, costs such as salaries
and depreciation can end up as part of assets on the balance sheet if these are
manufacturing costs. Manufacturing costs are inventoried until the associated
finished goods are sold. Thus, if some units are still in inventory, such costs may
be part of either W ork in Process inventory or Finished Goods inventory at the end
of a period.17. No. A variable cost is a cost that varies, in total, in direct
proportion to changes in the level of activity. A variable cost is constant per
unit of product. A fixed cost is fixed in total, but the average cost per unit
changes with the level of activity.18. Manufacturing overhead is an indirect
cost since these costs cannot be easily and conveniently traced to particular units
of products.19. Direct labor cost (34 hours ( P15 per hour)
#P510##Manufacturing overhead cost (6 hours ( P15 per hour)# 90##Total
wages earned #P600##20. Direct labor cost (45 hours ( P14 per hour)
#P630##Manufacturing overhead cost (5 hours ( P7 per hour) # 35##Total
wages earned #P665##II. ExercisesExercise 1 (S chedule of Cost of Goods
Manufactured and S old; Income S tatement)Requirement 1Amazing Aluminum Company
S chedule of Cost of Goods ManufacturedFor the Year Ended December 31, 2005Direct
material:#### Raw-material inventory, January 1 #P 60,000### Add:
Purchases of raw material # 250,000### Raw material available for use
#P310,000###Deduct: Raw-material inventory, December 31 # 70,000###Raw
material used ##P240,000##Direct labor ##400,000##Manufacturing
overhead:####Indirect material #P 10,000###Indirect labor
#25,000###Depreciation on plant and equipment #100,000###Utilities
#25,000###Other # 30,000###Total manufacturing overhead ##
190,000##Total manufacturing costs ##P830,000##Add: W ork-in-process inventory,
January 1 ## 120,000##S ubtotal ##P950,000##Deduct: W ork-in-process
inventory, December 1 ## 115,000##Cost of goods manufactured ##P835,000##
Requirement 2Amazing Aluminum CompanyS chedule of Cost of Goods S oldFor the Year
Ended December 31, 2005Finished goods inventory, January 1 #P150,000##Add: Cost of
goods manufactured # 835,000##Cost of goods available for sale
#P985,000##Deduct: Finished goods inventory, December 31 # 165,000##Cost
of goods sold #P820,000##Requirement 3Amazing Aluminum CompanyIncome S tatement
For the Year Ended December 31, 2005S ales revenue #P1,105,000##Less: Cost of
goods sold # 820,000##Gross margin #P 285,000##S elling and administrative
expenses # 110,000##Income before taxes #P 175,000##Income tax expense
# 70,000##Net income #P 105,000## Exercise 2 Cost
Item#Fixed (F)Variable (V)#Period (P)Product (R)##Transportation-in costs on
materials purchased#V#R##Assembly-line workers� wages#V#R##Property taxes on work
in process inventories#V#R##S alaries of top executives in the company#F#P##Overtime
premium for assembly workers#V#R##S ales commissions#V#P##S ales personnel office
rental#F#P##Production supervisory salaries#F#R##Controller�s office supplies#F#P##
Cost Item#Fixed (F)Variable (V)#Period (P)Product (R)##Executive office heat and
air conditioning#F#P##Executive office security personnel#F#P##S upplies used in
assembly work#V#R##Factory heat and air conditioning#F#R##Power
to operate factory equipment#V#R##Depreciation on furniture for sales
staff#F#P##Varnish used for finishing product#V#R##Marketing personnel health
insurance#F#P##Packaging materials for finished product#V#R##S alary of the quality
control manager who checks work on the assembly line#F#R##Assembly-line workers�
dental insurance#F#R##Exercise 3 (Cost Classifications; Manufacturer)1. a, d,
g, i2. a, d, g, j3. b, f4. b, d, g, k5. a, d, g, k6. a, d,
g, j7. b, c, f8. b, d, g, k9. b, c and d*, e and f and g*, k* * The
building is used for several purposes.10. b, c, f11. b, c, h12. b, c, f13. b, c,
e14. b, c and d�, e and f and g�, k� � The building that the furnace heats is
used for several purposes.15. b, d, g, kExercise 4 (Economic Characteristics of
Costs)1. marginal cost2. sunk cost3. average cost4. opportunity cost5.
differential cost6. out-of-pocket costExercise 5 (Cost Classifications;
Hotel)1. a, c, e, k2. b, d, e, k3. d, e, i4. d, e, i5. a, d, e, k6.
a, d, e, k7. d, e, k8. b, d�, e, k � Unless the dishwasher has been
used improperly.9. h10. a, d, e*, j* The hotel general manager may have some
control over the total space allocated to the kitchen.11. i12. j13. a, c, e14.
e, kExercise 6Pickup Truck Output#####3,000 trucks#6,000 trucks#9,000
trucks##Variable production costs#P 29,640,000#P 59,280,000#P
88,920,000##Fixed production costs#39,200,000#39,200,000#39,200,000##Variable
selling costs#4,500,000#9,000,000#13,500,000##Fixed selling
costs#13,660,000#13,660,000#13,660,000##Total costs#P
87,000,000#P121,140,000#P155,280,000#######S elling price per
truck#46,000#40,100#35,900#######Unit cost#29,000#20,190#17,253#######Profit per
truck#17,000#19,910#18,647##Exercise 7(see next page)Exercise 81. The wages of
employees who build the sailboats: direct labor cost.2. The cost of advertising
in the local newspapers: marketing and selling cost.3. The cost of an aluminum
mast installed in a sailboat: direct materials cost.4. The wages of the
assembly shop�s supervisor: manufacturing overhead cost.5. Rent on the boathouse: a
combination of manufacturing overhead, administrative, and marketing and selling
cost. The rent would most likely be prorated on the basis of the amount of space
occupied by manufacturing, administrative, and marketing operations.6. The wages of
the company�s bookkeeper: administrative cost.7. S ales commissions paid to the
company�s salespeople: marketing and selling cost.8. Depreciation on power tools:
manufacturing overhead cost.
Exercise 7###Period#Product Cost#####Variable Cost#Fixed Cost#(S elling and
Administrative) Cost#Direct Materials#Direct Labor#Manufacturing Overhead#S unk
Cost#Opportunity Cost##1. W ood used in a table (P200 per table)#X###X######2.
Labor cost to assemble a table (P80 per table)#X####X#####3. S alary of
the factory supervisor (P76,000 per year)##X####X####4. Cost of electricity to
produce tables (P4 per machine-hour)#X#####X####5. Depreciation of machines used
to produce tables (P20,000 per year)##X####X#X*###6. S alary of the company
president (P200,000 per year)##X#X#######7. Advertising expense (P500,000 per
year)##X#X#######8. Commissions paid to salespersons (P60 per table
sold)#X##X#######9. Rental income forgone on factory
space########X1############* This is a sunk cost because the outlay for the
equipment was made in a previous period.1 This is an opportunity cost because it
represents the potential benefit that is lost or sacrificed as a result of using
the factory space to produce tables. Opportunity cost is a special category of
cost that is not ordinarily recorded in an organization�s accounting books. To
avoid possible confusion with other costs, we will not attempt to classify this
cost in any other way except as an opportunity cost.
Exercise 9###Direct#Indirect###Cost#Cost Object#Cost#Cost##1.#The salary of
the head chef#The hotel�s restaurant#X###2.#The salary of the head chef#A
particular restaurant customer##X##3.#Room cleaning supplies#A particular hotel
guest##X##4.#Flowers for the reception desk#A particular hotel guest##X##5.#The
wages of the doorman#A particular hotel guest##X##6.#Room cleaning supplies#The
housecleaning department#X###7.#Fire insurance on the hotel building#The hotel�s
gym##X##8.#Towels used in the gym#The hotel�s gym#X### Note: The room
cleaning supplies would most likely be considered an indirect cost of a particular
hotel guest because it would not be practical to keep track of exactly how much of
each cleaning supply was used in the guest�s room.III. Problems Problem 1The
relevant costs for this decision are the differential costs. These are:
Opportunity cost or lost wages (take home) [P1,500 x 70% x
12 months] P12,600 Tuition 2,200 Books and supplies
300 Total differential costs P15,100 Room
and board, clothing, car, and incidentals are not relevant because these are
presumed to be the same whether or not Francis goes to school. The possibility of
part-time work, summer jobs, or scholarship assistance could be considered as
reductions to the cost of school. If students are familiar with the time value of
money, then they should recognize that the analysis calls for a comparison of the
present value of the differential after-tax cash inflows with the present value of
differential costs of getting the education (including the opportunity costs of
lost income). Problem 2 Requirement (a)Only the differential outlay costs
need be considered. The travel and other variable expenses of P22 per hour would
be the relevant costs. Any amount received in excess would be a differential,
positive return to Pat. Requirement (b)The opportunity cost of the hours given up
would be considered in this situation. Unless Pat receives more than the P100
normal consulting rate, the contract would not be beneficial. Requirement (c)In
this situation Pat would have to consider the present value of the contract and
compare that to the present value of the existing consulting business. The final
rate may be more or less than the normal P100 rate depending on the outcome of
Pat�s analysis.Problem 3 Utilities for the bakery 2,100 Paper used in
packaging product 90 S alaries and wages in the bakery 19,500 Cookie
ingredients 35,000 Bakery labor and fringe benefits 1,300 Bakery equipment
maintenance 800 Depreciation of bakery plant and equipment 2,000 Uniforms
400 Insurance for the bakery 900 Boxes, bags, and cups used in the
bakery 1,100 Bakery overtime premiums 2,600 Bakery idle time 500
Total product costs in pesos 66,290Problem 4 Administrative costs 1,000
Rent for administration offices 17,200 Advertising 1,900 Office
manager�s salary 13,000 Total period costs in pesos 33,100Problem 5
Requirement (a)S unk costs not shown could include lost book value on traded assets,
depreciation estimates for new investment, and interest costs on capital needed
during facilities construction.Requirement (b)The client might be used to
differential cost as a decision tool, and believes (correctly) that use of
differential analyses has several advantages --- it is quicker, requires less data,
and tends to give a better focus to the decision. The banker might suspect the
client of hiding some material data in order to make the proposal more acceptable
to the financing agency.Problem 6Requirement (1)EH CorporationS chedule of Cost of
Goods ManufacturedFor the Year Ended December 31Direct materials:#### Raw
materials, inventory, January 1#P 45,000### Add: Purchases of raw materials#
375,000### Raw materials available for use#420,000### Deduct: Raw materials
inventory, December 31# 30,000### Raw materials used in production##P
390,000##Direct labor##75,000##Manufacturing overhead:#### Utilities,
factory#18,000### Depreciation, factory#81,000### Insurance, factory#20,000###
S upplies, factory#7,500### Indirect labor#150,000### Maintenance,
factory# 43,500###Total manufacturing overhead cost## 320,000##Total
manufacturing cost##785,000##Add: W ork in process inventory, January 1##
90,000####875,000##Deduct: W ork in process inventory, December 31##
50,000##Cost of goods manufactured##P825,000##Requirement (2)The cost of goods sold
would be computed as follows:Finished goods inventory, January 1##P130,000##Add:
Cost of goods manufactured## 825,000##Goods available for sale##955,000##Deduct:
Finished goods inventory, December 31## 105,000##Cost of goods sold##P850,000##
Requirement (3)EH CorporationIncome S tatementFor the Year Ended December
31######S ales##P1,250,000##Cost of goods sold (above)## 850,000##Gross
margin##400,000##S elling and administrative expenses:#### S elling expenses#P
70,000### Administrative expenses# 135,000# 205,000##Net operating
income##P 195,000######
Problem 7 Note to the Instructor: S ome of the answers below are debatable.##Cost
Item#Variable or Fixed##S elling Cost##Adminis-trative Cost##Manufacturing (Product)
Cost######################Direct##Indirect##1.##Depreciation, executive jet
#F####X######2.##Costs of shipping finished goods to customers
#V##X########3.##W ood used in manufacturing furniture#V######X####4.##S ales
manager�s salary #F##X########5.##Electricity used in manufacturing furniture
#V########X##6.##S ecretary to the company president #F####X######7.##Aerosol
attachment placed on a spray can produced by the company #V######X####8.##Billing
costs #V## X*########9.##Packing supplies for shipping products overseas
#V##X########10.##S and used in manufacturing concrete
#V######X####11.##S upervisor�s salary, factory
#F#########X#####1#2#.#####E#x#e#c#u#t#i#v#e# #l#i#f#e# #i#n#s#u#r#a#n#c#e#
###F#########X#############1#3#.#####S #a#l#e#s# #c#o#m#m#i#s#s#i#o#n#s#
###V#####X#################1#4#.#####F#r#i#n#g#e# #b#e#n#e#f#i#t#s#,#
#a#s#s#e#m#b#l#y# #l#i#n#e# #w#o#r#k#e#r#s# ###V##############
#X#*#*#########1#5#.#####A#d#v#e#r#t#i#s#i#n#g# #c#o#s#t#s#
###F#####X#################1#6#.#####P#r#o#p#e#r#t#y# #t#a#x#e#s# #o#n#
#f#i#n#i#s#h#e#d# #g#o#o#d#s# #w#a#r#e#h#o#u#s#e#s#
###F#####X#################1#7#.#####L#u#b#r#i#c#a#n#t#s for production
equipment #V########X##�*Could be an administrative cost.**Could be an indirect
cost.
Problem 8Requirement (1)######Period#######Product Cost#(S elling
and#####Variable#Fixed#Direct#Direct#Mfg.#Admin.)#Opportunity#S unk##Name of the
Cost#Cost#Cost#Materials#Labor#Overhead#Cost#Cost#Cost##Ling�s present salary of
P400,000 per month #######X###Rent on the garage, P15,000 per month
##X###X#####Rent of production equipment, P50,000 per month
##X###X#####Materials for producing flyswatters, at P30.00 each
#X##X#######Labor cost of producing flyswatters, at P50.00 each
#X###X######Rent of room for a sales office, P7,500 per month
##X####X####Answering device attachment, P2,000 per month
##X####X####Interest lost on savings account, P100,000 per year # ####
##X###Advertising cost, P40,000 per month # #X####X####S ales commission, at P10.00
per flyswatter #X#####X## ##Legal and filing fees, P60,000 ########X##
Requirement (2)The P60,000 legal and filing fees are not a differential cost. These
legal and filing fees have already been paid and are a sunk cost. Thus, the cost
will not differ depending on whether Ling decides to produce flyswatters or to stay
with the consulting firm. All other costs listed above are differential costs since
they will be incurred only if Ling leaves the consulting firm and produces the
flyswatters.Problem 9Requirement (1) Ms. Rio�s first action was to direct that
discretionary expenditures be delayed until the first of the new year. Providing
that these �discretionary expenditures� can be delayed without hampering
operations, this is a good business decision. By delaying expenditures, the company
can keep its cash a bit longer and thereby earn a bit more interest. There is
nothing unethical about such an action. The second action was to ask that the order
for the parts be cancelled. S ince the clerk�s order was a mistake, there is nothing
unethical about this action either. The third action was to ask the accounting
department to delay recognition of the delivery until the bill is paid in January.
This action is dubious. Asking the accounting department to ignore transactions
strikes at the heart of the integrity of the accounting system. If the accounting
system cannot be trusted, it is very difficult to run a business or obtain funds
from outsiders. However, in Ms. Rio�s defense, the purchase of the raw materials
really shouldn�t be recorded as an expense. He has been placed in an extremely
awkward position because the company�s accounting policy is flawed.Requirement (2)
The company�s accounting policy with respect to raw materials is incorrect.
Raw materials should be recorded as an asset when delivered rather than as an
expense. If the correct accounting policy were followed, there would be no reason
for Ms. Rio to ask the accounting department to delay recognition of the delivery
of the raw materials. This flawed accounting policy creates incentives for managers
to delay deliveries of raw materials until after the end of the fiscal year. This
could lead to raw materials shortages and poor relations with suppliers who would
like to record their sales before the end of the year. The company�s �manage-
by-the-numbers� approach does not foster ethical behavior�particularly when
managers are told to �do anything so long as you hit the target profits for the
year.� S uch �no excuses� pressure from the top too often leads to unethical
behavior when managers have difficulty meeting target profits.IV. Multiple
Choice QuestionsB#C#D#A#C##D#D#D �#A *#B##B#C#B �#B#B##A#C#A �#B#A **##C#A#C
�#C#A##D#C#C#C#B##* Controllable costs are those costs that can be influenced
by a specified manager within a given time period.** The answer assumes absorption
costing method is used. � S upporting Computations14. P60 + P10 + P18 + P4 =
P92 16. P60 + P10 + P18 + P32 = P12015. P32 + P16 = P48 17. P4 + P16 =
P20CHAPTER 9COS T BEHAVIOR: ANALYS IS AND US EI. Questions1.a. Variable cost: A
variable cost is one that remains constant on a per unit basis, but which changes
in total in direct relationship to changes in volume. b. Fixed cost: A fixed
cost is one that remains constant in total amount, but which changes, if expressed
on a per unit basis, inversely with changes in volume. c. Mixed cost: A
mixed cost is a cost that contains both variable and fixed cost elements.2. a.
Unit fixed costs will decrease as volume increases. b. Unit variable
costs will remain constant as volume increases. c. Total fixed costs will remain
constant as volume increases. d. Total variable costs will increase as volume
increases.3. a. Cost behavior: Cost behavior can be defined as the way in
which costs change or respond to changes in some underlying activity, such as sales
volume, production volume, or orders processed. b. Relevant range: The relevant
range can be defined as that range of activity within which assumptions relative to
variable and fixed cost behavior are valid.4. Although the accountant recognizes
that many costs are not linear in relationship to volume at some points, he
concentrates on their behavior within narrow bands of activity known as the
relevant range. The relevant range can be defined as that range of activity within
which assumptions as relative to variable and fixed cost behavior are valid.
Generally, within this range an assumption of strict linearity can be used with
insignificant loss of accuracy.5. The high-low method, the scattergraph method,
and the least-squares regression method are used to analyze mixed costs. The
least-squares regression method is generally considered to be most accurate, since
it derives the fixed and variable elements of a mixed cost by means of statistical
analysis. The scattergraph method derives these elements by visual inspection
only, and the high-low method utilizes only two points in doing a cost analysis,
making it the least accurate of the three methods.6. The fixed cost element is
represented by the point where the regression line intersects the vertical axis on
the graph. The variable cost per unit is represented by the slope of the line.7.
The two assumptions are:1. A linear cost function usually approximates
cost behavior within the relevant range of the cost driver.2. Changes in the
total costs of a cost object are traceable to variations or changes in a single
cost driver.8. No. High correlation merely implies that the two variables move
together in the data examined. W ithout economic plausibility for a relationship,
it is less likely that a high level of correlation observed in one set of data will
be found similarly in another set of data.9. Refer to page 312 of the textbook.
10. The relevant range is the range of the cost driver in which a specific
relationship between cost and cost driver is valid. This concept enables the use
of linear cost functions when examining CVP relationships as long as the volume
levels are within that relevant range.11. 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.12. Cost estimation is the
process of developing a well-defined relationship between a cost object and its
cost driver for the purpose of predicting the cost. The cost predictions are used
in each of the management functions: S trategic Management: Cost estimation is
used to predict costs of alternative activities, predict financial impacts of
alternative strategic choices, and to predict the costs of alternative
implementation strategies. Planning and Decision Making: Cost estimation is
used to predict costs so that management can determine the desirability of
alternative options and to budget expenditures, profits, and cash flows.
Management and Operational Control: Cost estimation is used to develop cost
standards, as a basis for evaluating performance. Product and S ervice Costing:
Cost estimation is used to allocate costs to products and services or to charge
users for jointly incurred costs.13. The five methods of cost estimation are:
a. Account Classification. Advantages: simplicity and ease of use.
Disadvantages: subjectivity of method and some costs are a mix of both variable
and fixed.b. Visual fit. The visual fit method is easy to use, and requires
only that the data is graphed. Disadvantages are that the scale of the graph may
limit ability to estimate costs accurately and in both graphical and tabular form,
significant perceptual errors are common.c. High-Low. Because of the precision
in the development of the equation, it provides a more consistent estimate than the
visual fit and is not difficult to use. Disadvantages: uses only two selected
data points and is, therefore, subjective.d. W ork Measurement. The advantage is
accurate estimates through detailed study of the different operations in the
product process, but like regression, it is more complex.e.Regression.
Quantitative, objective measures of the precision and accuracy and reliability of
the model are the advantages of this model; disadvantages are its complexity: the
effort, expense, and expertise necessary to utilize this method.14.
Implementation problems with cost estimation include:a. cost estimates
outside of the relevant range may not be reliable.b. sufficient and reliable data
may not be available.c. cost drivers may not be matched to dependent variables
properly in each observation.d. the length of the time period for each
observation may be too long, so that the underlying relationship between the cost
driver and the variable to be estimated is difficult to isolate from the numerous
variables and events occurring in that period of time; alternatively the period may
be too short, so that the data is likely to be affected by accounting errors in
which transactions are not properly posted in the period in which they occurred.e.
dependent variables and cost drivers may be affected by trend or seasonality.
f. when extreme observations (outliers) are used the reliability of the results
will be diminished.g. when there is a shift in the data, as, for example, a new
product is introduced or when there is a work stoppage, the data will be unreliable
for future estimates.15. The dependent variable is the cost object of interest
in the cost estimation. An important issue in selecting a dependent variable is
the level of aggregation in the variable. For example, the company, plant, or
department may all be possible levels of data for the cost
object. The choice of aggregation level depends on the objectives for the cost
estimation, data availability, reliability, and cost/benefit considerations. If a
key objective is accuracy, then a detailed level of analysis is often preferred.
The detail cost estimates can then be aggregated if desired.16. Nonlinear cost
relationships are cost relationships that are not adequately explained by a single
linear relationship for the cost driver(s). In accounting data, a common type of
nonlinear relationship is trend and seasonality. For a trend example, if sales
increase by 8% each year, the plot of the data for sales with not be linear with
the driver, the number of years. S imilarly, sales which fluctuate according to a
seasonal pattern will have a nonlinear behavior. A different type of nonlinearity
is where the cost driver and the dependent variable have an inherently nonlinear
relationship. For example, payroll costs as a dependent variable estimated by
hours worked and wage rates is nonlinear, since the relationship is multiplicative
and therefore not the additive linear model assumed in regression analysis.17.
The advantages of using regression analysis include that it:a. provides an
estimation model with best fit (least squared error) to the datab. provides
measures of goodness of fit and of the reliability of the model which can be used
to assess the usefulness of the specific model, in contrast to the other estimation
methods which provide no means of self-evaluationc. can incorporate multiple
independent variablesd. can be adapted to handle non-linear relationships in the
data, including trends, shifts and other discontinuities, seasonality, etc.e.
results in a model that is unique for a given set of data18. High
correlation exists when the changes in two variables occur together. It is a
measure of the degree of association between the two variables. Because
correlation is determined from a sample of values, there is no assurance that it
measures or describes a cause and effect relationship between the variables.19.
An activity base is a measure of whatever causes the incurrence of a variable
cost. Examples of activity bases include units produced, units sold, letters typed,
beds in a hospital, meals served in a cafe, service calls made, etc.20. (a)
Variable cost: A variable cost remains constant on a per unit basis, but
increases or decreases in total in direct relation to changes in activity. (b)
Mixed cost: A mixed cost is a cost that contains both variable and fixed cost
elements. (c) S tep-variable cost: A step-variable cost is a cost that is
incurred in large chunks, and which increases or decreases only in response to
fairly wide changes in activity.#21. The linear assumption is reasonably valid
providing that the cost formula is used only within the relevant range.22. A
discretionary fixed cost has a fairly short planning horizon�usually a year. S uch
costs arise from annual decisions by management to spend on certain fixed cost
items, such as advertising, research, and management development. A committed fixed
cost has a long planning horizon�generally many years. S uch costs relate to a
company�s investment in facilities, equipment, and basic organization. Once such
costs have been incurred, they are �locked in� for many years.23. a.
Committed d. Committed b. Discretionary e. Committed c.
Discretionary f. Discretionary24. The high-low method uses only two
points to determine a cost formula. These two points are likely to be less than
typical since they represent extremes of activity.25. The term �least-squares
regression� means that the sum of the squares of the deviations from the plotted
points on a graph to the regression line is smaller than could be obtained from any
other line that could be fitted to the data.26. Ordinary single least-squares
regression analysis is used when a variable cost is a function of only a single
factor. If a cost is a function of more than one factor, multiple regression
analysis should be used to analyze the behavior of the cost.II. Exercises Exercise
1 (Cost Classification)1. b2. f3. e4. i5. e6. h7. l8. a9. j10.
k11. c or d12. gExercise 2 (Cost Estimation; High-Low Method)Requirement
(1)Cost equation using square fee as the cost driver: Variable costs:# Fixed costs:
P4,700 = Fixed Cost + P1.134 x 4,050 Fixed Cost =
P107 Equation One: Total Cost = P107 + P1.134 x square feetThere are
two choices for the High-Low points when using openings for the cost driver. At 11
openings there is a cost of P2,800 and at 10 openings there is a cost of P2,875.
Cost equation using 11 openings as the cost driver: Variable costs:# Fixed costs:
P4,700 = Fixed Cost + P237.50 x 19 Fixed Cost = P187.50
Equation Two: Total Cost = P187.50 + P237.50 x openingsCost equation
using 10 openings as the cost driver: Variable costs:# Fixed costs:
P4,700 = Fixed Cost + P202.78 x 19 Fixed Cost = P847.18
Equation Three: Total Cost = P847.18 + P202.78 x openingsPredicted
total cost for a 3,200 square foot house with 14 openings using equation one:
P107 + P1.134 x 3,200 = P3,735.80Predicted total cost for a 3,200 square
foot house with 14 openings using equation two: P187.50 + P237.50 x 14 =
P3,512.50Predicted total cost for a 3,200 square foot house with 14 openings using
equation three: P847.18 + P202.78 x 14 = P3,686.10 There is no simple
method to determine which prediction is best when using the High-Low method. In
contrast, regression provides quantitative measures (R-squared, standard error, t-
values,�) to help asses which regression equation is best.Predicted cost for a
2,400 square foot house with 8 openings, using equation one:P107 + P1.134 x
2,400 = P2,828.60W e cannot predict with equation 2 or equation 3 since 8 openings
are outside the relevant range, the range for which the high-low equation was
developed.Requirement 2Figure 9-A shows that the relationship between costs and
square feet is relatively linear without outliers, while Figure 9-B shows a similar
result for the relationship between costs and number of openings. From this
perspective, both variables are good cost drivers.Figure 9-A#Figure 9-B#Exercise 3
(Cost Estimation; Account Classification)Requirement 1Fixed Costs: Rent
P10,250 Depreciation 400 Insurance 750 Advertising 650
Utilities 1,250 Mr. Black�s salary 18,500Total P31,800
Variable Costs: W ages P17,800 CD Expense 66,750 S hopping
Bags 180Total P84,730 Variable Costs Per Unit = P84,730 / 8,900
= P95.20 Cost Function Equation: y =
P31,800 + P95.20 x (CD�s sold)Requirement 2New S ales = 8,900 x 1.25
= 11,125 units = round to 11,130Total Costs
= P31,800 + P95.20 x (11,130) = P137,760Per Unit Total
Costs = P137,760 / 11,130 = P123.80Add P1 profit per
disc: P123.80 + P10 = P133.80Requirement 3Adjusted New S ales = 8,900 x
11.50 = 10,240 unitsRevenue = P133.80 x (10,240)
= P137,010Total Cost = P31,800 + P95.20 x (10,240)
= P129,280Cost Per Disc = P129,280 / 10,240 = P126.30Profit Per Disk =
P133.80 � P126.30 = P7.50 Exercise 4 (Cost
Estimation Using Graphs; S ervice)Requirement 1#Requirement 2There seems to be a
positive linear relationship for the data between P2,500 and P4,000 of advertising
expense. Llanes� analysis is correct within this relevant range but not outside of
it. Notice that the relationship between advertising expense and sales changes at
P4,000 of expense.Exercise 5 (Fixed and Variable Cost Behavior)Requirement (1)
##Cups of Coffee S erved# in a W eek####1,800#1,900#2,000###Fixed cost
#P11,000#P11,000#P11,000###Variable cost #� �4,680#� �4,940#��
5,200###Total cost #P15,680#P15,940#P16,200###Cost per cup of coffee served *
#P8.71#P8.39#P8.10## * Total cost � cups of coffee served in a week
Requirement (2) The average cost of a cup of coffee declines as the number
of cups of coffee served increases because the fixed cost is spread over more cups
of coffee.Exercise 6 (S cattergraph Analysis)Requirement (1) The completed
scattergraph is presented below:# EMBED MS Graph.Chart.8 \s ###
Requirement (2) (S tudents� answers will vary considerably due to the
inherent imprecision and subjectivity of the quick-and-dirty scattergraph method of
estimating variable and fixed costs.) The approximate monthly fixed cost
is P6,000�the point where the straight line intersects the cost axis. The
variable cost per unit processed can be estimated as follows using the 8,000-unit
level of activity, which falls on the straight line:Total cost at the 8,000-unit
level of activity #P14,000##Less fixed costs #� ��6,000##Variable costs at the
8,000-unit level of activity

#P#################################################################################
####################### 8#,#0#0#0###### # # #P#8#,#0#0#0# #�# #8#,#0#0#0#
#u#n#i#t#s# #=# #P#1# #p#e#r# #u#n#i#t#.### # #O#b#s#e#r#v#e# #f#r#o#m#
#t#h#e# #s#c#a#t#t#e#r#g#r#a#p#h# #t#h#a#t# #i#f# #t#h#e# #c#o#m#p#a#n#y# #u#s#e#d#
#t#h#e# #h#i#g#h#-#l#o#w# #m#e#t#h#o#d# #t#o# #d#e#t#e#r#m#i#n#e# #t#h#e#
#s#l#o#p#e# #o#f# #t#h#e# #l#i#n#e#,# #t#h#e# #l#i#n#e# #w#o#u#l#d# #b#e# #t#o#o#
#s#t#e#e#p#.# #T#h#i#s# #w#o#u#l#d# #r#e#s#u#l#t# #i#n#
#u#n#d#e#r#e#s#t#i#m#a#t#i#n#g# #t#h#e# #f#i#x#e#d# #c#o#s#t# #a#n#d#
#o#v#e#r#e#s#t#i#m#ating the variable cost per unit.Exercise 7 (High-Low Method)
Requirement (1) #Month#Occupancy-Days#Electrical Costs###High activity level
(August) #3,608#P8,111###Low activity level (October) #��186#�1,712###Change
#3,422#P6,399## Variable cost = Change in cost � Change in activity
= P6,399 � 3,422 occupancy-days = P1.87 per occupancy-day#Total
cost (August) #P8,111###Variable cost element #(P1.87 per occupancy-day � 3,608
occupancy-days) #� 6,747###Fixed cost element #P1,364##Requirement (2)
Electrical costs may reflect seasonal factors other than just the variation
in occupancy days. For example, common areas such as the reception area must be
lighted for longer periods during the winter. This will result in seasonal effects
on the fixed electrical costs. Additionally, fixed costs will be
affected by how many days are in a month. In other words, costs like the costs of
lighting common areas are variable with respect to the number of days in the month,
but are fixed with respect to how many rooms are occupied during the month. Other,
less systematic, factors may also affect electrical costs such as the frugality of
individual guests. S ome guests will turn off lights when they leave a room. Others
will not.Exercise 8 (Least-S quares Regression)The least-squares regression
estimates of fixed and variable costs can be computed using any of a variety of
statistical and mathematical software packages or even by hand.Month#Rental
Returns#Car W ash Costs##January #2,310#P10,113##February
#2,453#P12,691##March #2,641#P10,905##April #2,874#P12,949##May
#3,540#P15,334##June #4,861#P21,455##July #5,432#P21,270##August
#5,268#P19,930##S eptember #4,628#P21,860##October #3,720#P18,383##November
#2,106#P 9,830##December
#2,495#P11,081######Intercept#P2,296###S lope#P3.74###RS Q#0.92###The intercept
provides the estimate of the fixed cost element, P2,296 per month, and the slope
provides the estimate of the variable cost element, P3.74 per rental return.
Expressed as an equation, the relation between car wash costs and rental returns is
Y = P2,296 + P3.74Xwhere X is the number of rental returns.Note that the R2 is
0.92, which is quite high, and indicates a strong linear relationship between car
wash costs and rental returns.W hile not a requirement of the exercise, it is always
a good to plot the data on a scattergraph. The scattergraph can help spot
nonlinearities or other problems with the data. In this case, the regression line
(shown below) is a reasonably good approximation to the relationship between car
wash costs and rental returns.# EMBED Excel.Chart.8 \s ###III. ProblemsProblem 1
Requirement (a)#Miles Driven#Total Annual Cost*## High level of activity
#120,000#P13,920## Low level of activity # 80,000# 10,880##
Difference # 40,000#P 3,040###### * 120,000 miles x P0.116 =
P13,920. 80,000 miles x P0.136 = P10,880. Variable cost per
mile:# Change in cost, P3,040 Change in
activity, 40,000 Fixed cost per year: Total cost at
120,000 miles P13,920 Less variable cost element:
120,000 x P0.076 9,120 Fixed cost per year P
4,800Requirement (b) Y = P4,800 + P0.076X Requirement (c) Fixed cost
P 4,800 Variable cost: 100,000 miles x P0.076 7,600
Total annual cost P12,400Problem 2 Requirement 1 Cost of
goods sold Variable S hipping expense Mixed Advertising
expense Fixed S alaries and commissions Mixed
Insurance expense Fixed Depreciation expense Fixed
Requirement 2 Analysis of the mixed expenses:#Units #S hipping Expense#S alaries
and Comm. Expense##High level of activity #4,500#P56,000#P143,000##Low level of
activity #3,000# 44,000# 107,000## Difference #1,500#P12,000#P 36,000###
Variable cost element: Change in cost Change in activity
## S hipping expense:## S alaries and comm. expense: Fixed
cost element:#S hipping Expense#S alaries and Comm. Expense##Cost at high level of
activity #P56,000#P143,000##Less variable cost element:#### 4,500 units x P8
#36,000### 4,500 units x P24 # # 108,000##Fixed cost
element #P20,000#P 35,000## The cost elements are:
S hipping expense: P20,000 per month plus P8 per unit or Y = P20,000 + P8X.
S alaries and comm. expense: P35,000 per month plus P24 per unit or Y =
P35,000 + P24X.Requirement 3 LILY COMPANY Income S tatementFor the Month Ended June
30S ales in units 4,500S ales revenues P630,000Less
variable expenses: Cost of goods sold (@P56) P252,000 S hipping
expense (@P8) 36,000 S alaries and commission expense (@P24)
108,000 396,000Contribution margin
234,000Less fixed expense: S hipping expense 20,000 Advertising
70,000 S alaries and commissions 35,000 Insurance
9,000 Depreciation 42,000 176,000Net income
P 58,000Problem 3Requirement 1Year#Number of Leagues (X)#Total Cost (Y)#XY#
X2##2004# 5#P13,000#P 65,000#25##2005# 2# 7,000# 14,000# 4##2006# 4#
10,500# 42,000#16##2007# 6# 14,000# 84,000#36##2008# 3# 10,000#
30,000# 9###20#P54,500#P235,000#90### n ((XY) - ((X) ((Y)
n ((X2) - ((X)2# 5 (235,000) - (20)
(54,500) 5 (90) - (20)2 = 1,700#
((Y) - b((X) n#
(54,500) - 1,700 (20) 5 =
P4,100 Therefore, the variable cost per league is P1,700 and the fixed
cost is P4,100 per year.Requirement 2 Y = P4,100 + P1,700X
Requirement 3The expected value total would be: Fixed cost P 4,100
Variable cost (7 leagues x P1,700) 11,900 Total cost
P16,000The problem with using the cost formula from (2) to derive this total
cost figure is that an activity level of 7 sections lies outside the relevant range
from which the cost formula was derived. [The relevant range is represented by a
solid line on the graph in requirement 4 below.]Although an activity figure may lie
outside the relevant range, managers will often use the cost formula anyway to
compute expected total cost as we have done above. The reason is that the cost
formula frequently is the only basis that the manager has to go on. Using the cost
formula as the starting point should not present a problem so long as the manager
is alert for any unusual problems that the higher activity level might bring about.
Requirement 4#Problem 4 (Regression Analysis, S ervice Company)Requirement 1Figure
9-C plots the relationship between labor-hours and overhead costs and shows the
regression line.y = P48,271 + P3.93 XEconomic plausibility. Labor-hours
appears to be an economically plausible driver of overhead cost for a catering
company. Overhead costs such as scheduling, hiring and training of workers, and
managing the workforce are largely incurred to support labor.Goodness of fit. The
vertical differences between actual and predicted costs are extremely small,
indicating a very good fit. The good fit indicates a strong relationship between
the labor-hour cost driver and overhead costs.S lope of regression line. The
regression line has a reasonably steep slope from left to right. The positive
slope indicates that, on average, overhead costs increase as labor-hours increase.
Requirement 2The regression analysis indicates that, within the relevant range of
2,500 to 7,500 labor-hours, the variable cost per person for a cocktail party
equals: Food and beverages P15.00 Labor (0.5 hrs. x P10 per hour)
5.00 Variable overhead (0.5 hrs. x P3.93 per labor-hour) 1.97 Total
variable cost per person P21.97Requirement 3To earn a positive contribution
margin, the minimum bid for a 200-person cocktail party would be any amount greater
than P4,394. This amount is calculated by multiplying the variable cost per person
of P21.97 by the 200 people. At a price above the variable costs of P4,394, Bobby
Gonzales will be earning a contribution margin toward coverage of his fixed costs.
Of course, Bobby Gonzales will consider other factors in developing his bid
including (a) an analysis of the competition � vigorous competition will limit
Gonzales� ability to obtain a higher price (b) a determination of whether or not
his bid will set a precedent for lower prices � overall, the prices Bobby Gonzales
charges should generate enough contribution to cover fixed costs and earn a
reasonable profit, and (c) a judgment of how representative past historical data
(used in the regression analysis) is about future costs.Figure 9-CRegression Line
of Labor-Hours on Overhead Costs for Bobby Gonzales� Catering Company ##Problem 5
(Linear Cost Approximation)Requirement 1########### The linear cost function
is plotted in Figure 9-D. No, the constant component of the cost function does
not represent the fixed overhead cost of the ABS Group. The relevant range of
professional labor-hours is from 3,000 to 8,000. The constant component provides
the best available starting point for a straight line that approximates how a cost
behaves within the 3,000 to 8,000 relevant range. Requirement 2 A comparison
at various levels of professional labor-hours follows. The linear cost function is
based on formula of P228,000 per month plus P43.00 per professional labor-hours.
Total overhead cost behavior:#Month 1#Month 2#Month 3#Month 4#Month 5#Month
6##Actual total overhead costs#P340,000#P400,000#P435,000#P477,000#P529,000#
P587,000##Linear approximation# 357,000# 400,000# 443,000# 486,000# 529,000#
572,000##Actual minus linear approximation#P(17,000)#P 0#P (8,000)#P
(9,000)#P 0#P15,000##Professional labor-
hours#3,000#4,000#5,000#6,000#7,000#8,000## The data are shown in Figure 9-D.
The linear cost function overstates costs by P8,000 at the 5,000-hour level and
understates costs by P15,000 at the 8,000-hour level. Requirement 3#Based on
Actual#Based on Linear Cost Function##Contribution before deducting incremental
overhead#P38,000#P38,000##Incremental overhead# 35,000# 43,000##Contribution
after incremental overhead#P 3,000#P (5,000)## The total contribution margin
actually forgone is P3,000. Figure 9-D Linear Cost Function Plot of Professional
Labor-Hours on Total Overhead Costs for ABS Consulting Group## Problem 6 (Cost
Behavior) The variable cost per hour can be computed as follows:P20,000 / 5,000
hours = P4 per hour Therefore, the missing amounts are as follows:#Hours of
Operating Time###5,000#6,000#7,000#8,000##Total costs:###### Variable costs
(@ P4 per hour)#P 20,000#P 24,000#P 28,000#P 32,000## Fixed
costs# 168,000# 168,000# 168,000# 168,000##Total costs#P 188,000#P
192,000#P 196,000#P 200,000###########################Hours of Operating
Time###5,000#6,000#7,000#8,000##Cost per hour:###### Variable cost #P 4.00#P
4.00#P 4.00#P 4.00## Fixed cost# 33.60# 28.00# 24.00#
21.00##Total cost per hour#P 37.60#P 32.00#P 28.00#P 25.00##
Observe that the total variable costs increase in proportion to the number of
hours of operating time, but that these costs remain constant at P4 if expressed on
a per hour basis. In contrast, the total fixed costs do not change with changes in
the level of activity. They remain constant at P168,000 within the relevant range.
W ith increases in activity, however, the fixed cost per hour decreases, dropping
from P33.60 per hour when the boats are operated 5,000 hours a period to only
P21.00 per hour when the boats are operated 8,000 hours a period. Because of this
troublesome aspect of fixed costs, they are most easily (and most safely) dealt
with on a total basis, rather than on a unit basis, in cost analysis work.Problem 7
(High-Low Method) Requirement (1) The first step in the high-low method is to
identify the periods of the lowest and highest activity. Those periods are
November (1,100 patients admitted) and June (1,900 patients admitted). The second
step is to compute the variable cost per unit using those two data points:
Month#Number of Patients Admitted#Admitting Department Costs##High activity level
(June)#1,900#P15,200##Low activity level (November)#1,100# 12,800##Change#800#P
2,400######## The third step is to compute the fixed cost element by
deducting the variable cost element from the total cost at either the high or low
activity. In the computation below, the high point of activity is used: Fixed
cost element = Total cost � Variable cost element = P15,200 �
(P3 per patient admitted x 1,900 patients admitted) =
P9,500 Requirement (2) The cost formula is Y = P9,500 + P3X.Problem 8
(S cattergraph Analysis; S election of an Activity Base) Requirement (1) The
completed scattergraph for the number of units produced as the activity base is
presented below:# EMBED MS Graph.Chart.8 \s ### Requirement (2) The
completed scattergraph for the number of workdays as the activity base is presented
below:## EMBED MS Graph.Chart.8 \s ### The number of workdays should be
used as the activity base rather than the number of units produced. There are
several reasons for this. First, the scattergraphs reveal that there is a much
stronger relationship (i.e., higher correlation) between janitorial costs and
number of workdays than between janitorial costs and number of units produced.
S econd, from the description of the janitorial costs, one would expect that
variations in those costs have little to do with the number of units produced. Two
janitors each work an eight-hour shift�apparently irrespective of the number of
units produced or how busy the company is. Variations in the janitorial labor costs
apparently occur because of the number of workdays in the month and the number of
days the janitors call in sick. Third, for planning purposes, the company is likely
to be able to predict the number of working days in the month with much greater
accuracy than the number of units that will be produced. Note that the
scattergraph in part (1) seems to suggest that the janitorial labor costs are
variable with respect to the number of units produced. This is false. Janitorial
labor costs do vary, but the number of units produced isn�t the cause of the
variation. However, since the number of units produced tends to go up and down with
the number of workdays and since the janitorial labor costs are driven by the
number of workdays, it appears on the scattergraph that the number of units drives
the janitorial labor costs to some extent. Analysts must be careful not to fall
into this trap of using the wrong measure of activity as the activity base just
because it appears there is some relationship between cost and the measure of
activity. Careful thought and analysis should go into the selection of the activity
base.IV. Multiple Choice QuestionsA#C *#C#D#B##D#C
*#D#B#D##B#C#C#A#C##A#A#A#B###B#D#D#A###B#C#B#D###C#D#D#B###D#B#B#C###C#C#A#B###A#C
#D#D### * S upporting Computations:11. (10,000 x 2) � (P3,000 x 2) � P5,000 =
P9,00012. [(P20 + P3 + P6) x 2,000 units] + (P10 x 1,000 units) = P68,000CHAPTER
10S YS TEMS DES IGN: JOB-ORDER COS TING AND PROCES S COS TINGI. QuestionsJob-order
costing is used in those manufacturing situations where there are many different
products produced each period. Each product or job is different from all others
and requires separate costing. Process costing is used in those manufacturing
situations where a single, homogeneous product, such as cement, bricks, or
gasoline, is produced for long periods at a time.The job cost sheet is used in
accumulating all costs assignable to a particular job. These costs would include
direct materials cost traceable to the job, and manufacturing overhead cost
allocable to the job. W hen a job is completed, the job cost sheet is used to
compute the cost per completed unit. The job cost sheet is then used as a control
document for: (1) determining how many units have been sold and determining the
cost of these units; and (2) determining how many units are still in inventory at
the end of a period and determining the cost of these units on the balance sheet.
Many production costs cannot be traced directly to a particular product or job, but
rather are incurred as a result of overall production activities. Therefore, in
order to be assigned to products, such costs must be allocated to the products in
some manner. Examples of such costs would include utilities, maintenance on
machines, and depreciation of the factory building. These costs are indirect
production costs.A firm will not know its actual manufacturing overhead costs until
after a period is over. Thus, if actual costs were used to cost products, it would
be necessary either (1) to wait until the period was over to add overhead costs to
jobs, or (2) to simply add overhead cost to jobs as the overhead cost was incurred
day by day. If the manager waits until after the period is over to add overhead
cost to jobs, then cost data will not be available during the period. If the
manager simply adds overhead cost to jobs as the overhead cost is incurred, then
unit costs may fluctuate from month to month. This is because overhead cost tends
to be incurred somewhat evenly from month to month (due to the presence of fixed
costs), whereas production activity often fluctuates. For these reasons, most
firms use predetermined overhead rates, based on estimates of overhead cost and
production activity, to apply overhead cost to jobs.An allocation base should act
as a cost driver in the incurrence of the overhead cost; that is, the base should
cause the overhead cost. If the allocation base does not really cause the
overhead, then costs will be incorrectly attributed to products and jobs and their
costs will be distorted.A process costing system is appropriate in those situations
where a homogeneous product is produced on a continuous basis.In a process costing
system, costs are accumulated by department.First, the activity performed in a
department must be performed uniformly on all units moving through it. S econd, the
output of the department must be homogeneous.The reason cost accumulation is
simpler is that costs only need to be identified by department - not by separate
job. Usually there will be only a few departments in a company, whereas there can
be hundreds or even thousands of jobs in a job-order costing system.A quantity
schedule shows the physical flow of units through a department during a period. It
serves several purposes. First, it provides the manager with information relative
to activity in his or her department and also
shows the manager the stage of completion of any in-process units. S econd, it
serves as an essential guide in computing the equivalent units and in preparing the
other parts of the production report.By definition, manufacturing overhead consists
of costs that cannot be practically traced to products or jobs. Therefore, if these
costs are to be assigned to products or jobs, they must be allocated rather than
traced.Assigning manufacturing overhead costs to jobs does not ensure a profit. The
units produced may not be sold and if they are sold, they may not be sold at prices
sufficient to cover all costs. It is a myth that assigning costs to products or
jobs ensures that those costs will be recovered. Costs are recovered only by
selling to customers�not by allocating costs.13. (a) Job-order costing and
process costing have the same basic purposes�to assign materials, labor, and
overhead cost to products and to provide a mechanism for computing unit product
costs. (b) Both systems use the same basic manufacturing accounts. (c)
Costs flow through the accounts in basically the same way in both systems.14.
The company will want to distinguish between the costs of the metals used to
make the medallions, but the medals are otherwise identical and go through the same
production processes. Thus, operation costing is ideally suited for the company�s
needs.II. ExercisesExercise 1 (Process Costing and Job Order Costing)a. Job-
order costing f. Process costingb. Process costing
g. Process costingc. Process costing *
h. Job-order costingd. Job-order costing
i. Job-order costinge. Job-order costing j.
Job-order costing* S ome of the listed companies might use either a
process costing or a job-order costing system, depending on how operations are
carried out and how homogeneous the final product is. For example, a plywood
manufacturer might use job-order costing if plywoods are constructed of different
woods or come in markedly different sizes.Exercise 2 (Applying Overhead with
Various Bases)Requirement 1Predetermined overhead rates:Company X:#Company Y:#
Company Z:#Requirement 2Actual overhead costs incurred P420,000Overhead
cost applied to W ork in Process: 58,000* actual hours � P7.20 per hour
� 417,600Underapplied overhead cost
P########################################################### # 2#,#4#0#0###*#
#7#,#0#0#0# #h#o#u#r#s# #+# #3#0#,#0#0#0# #h#o#u#r#s# #+# #2#1#,#0#0#0# #h#o#u#r#s#
#=# #5#8#,#0#0#0# #h#o#u#r#s###E#x#e#r#c#i#s#e# #3# #(#D#e#p#a#r#t#m#e#n#t#a#l#
#O#v#e#r#h#e#a#d# #R#a#t#e#s#)###R#e#q#u#i#r#e#m#e#n#t# #1###M#i#l#l#i#n#g#
#D#e#p#a#r#t#m#e#n#t#:##########A#s#s#e#m#b#l#y# #D#e#p#a#r#t#m#e#n#t#:#########
#R#e#q#u#i#r#e#m#e#n#t# #2####O#v#e#r#h#e#a#d# #A#p#p#l#i#e#d#####M#i#l#l#i#n#g#
#D#e#p#a#r#t#m#e#n#t#:# #9#0# #M#H#s# #�# #P#8#.#5#0# #p#e#r# #M#H###P765##Assembly
Department: P160 � 125%# �200##Total overhead cost applied#P965##Requirement 3Yes;
if some jobs required a large amount of machine time and little labor cost, they
would be charged substantially less overhead cost if a plantwide rate based on
direct labor cost were being used. It appears, for example, that this would be true
of job 123 which required considerable machine time to complete, but required only
a small amount of labor cost.Exercise 4 (Process Costing Journal Entries)W ork in
Process�Mixing #330,000###Raw Materials Inventory ##330,000######W ork in
Process�Mixing #260,000###W ork in Process�Baking #120,000###W ages Payable
##380,000######W ork in Process�Mixing #190,000###W ork in Process�Baking
#90,000###Manufacturing Overhead ##280,000######W ork in Process�Baking
#760,000###W ork in Process�Mixing ##760,000######Finished Goods
#980,000###W ork in Process�Baking ##980,000##Exercise 5 (Quantity S chedule,
Equivalent Units, and Cost per Equivalent Unit � W eighted Average Method)
Requirement 1W eighted-Average Method#Quantity S chedule##Gallons to be accounted
for:###W ork in process, May 1 (materials 80% complete, labor and overhead 75%
complete) #80,000##S tarted into production #760,000##Total gallons accounted
for #840,000####Equivalent Units ####Materials#Labor#Overhead##Gallons accounted
for as follows:######Transferred to the next department
#790,000#790,000#790,000#790,000##W ork in process, May 31 (materials 60%
complete, labor and overhead 20% complete)
#�50,000#�30,000#�10,000##�#1#0#,#0#0#0#####T#o#t#a#l# #g#a#l#l#o#n#s#
#a#c#c#o#u#n#t#e#d# #f#o#r#
###8#4#0#,#0#0#0###8#2#0#,#0#0#0###8#0#0#,#0#0#0###8#0#0#,#0#0#0#####
#R#e#q#u#i#r#e#m#e#n#t# #2#####T#o#t#a#l#
#C#o#s#t#s###M#a#t#e#r#i#a#l#s###L#a#b#o#r###O#v#e#r#h#e#a#d###W #h#o#l#e#
#U#n#i#t#####C#o#s#t# #t#o# #b#e# #a#c#c#o#u#n#t#e#d# #f#o#r#:###############
#W #o#r#k# #i#n# #p#r#o#c#e#s#s#,# #M#a#y# #1# ###P# # #�#1#4#6#,#6#0#0###P#
#�#6#8#,#6#0#0###P## 3#0#,#0#0#0###P# #�#4#8#,#0#0#0####### #C#o#s#t# #a#d#d#e#d#
#d#u#r#i#n#g# the month #� 1,869,200#� 907,200#� 370,000#� 592,000###Total cost to
be accounted for (a) #P2,015,800#P975,800#P400,000#P640,000###Equivalent units
(b) #�#820,000#800,000#800,000###Cost per equivalent unit (a) � (b) ##P1.19#+
P0.50#+ P0.80#= P2.49##Exercise 6 (Quantity S chedule, Equivalent Units,
and Cost per Equivalent Unit � FIFO Method)Requirement 1FIFO Method#Quantity
S chedule##Gallons to be accounted for:###W ork in process, May 1 (materials 80%
complete, labor and overhead 75% complete) #80,000##S tarted into production
#760,000##Total gallons accounted for #840,000####Equivalent Units
####Materials#Labor#Overhead##Gallons accounted for as follows:######Transferred to
the next department:###### From the beginning inventory
#80,000#16,000*#20,000*#20,000*## S tarted and completed this month**
#710,000#710,000�#710,000�#710,000�##W ork in process, May 31 (materials 60%
complete, labor and overhead 20% complete)
#�50,000#�30,000#�10,000#�10,000##Total gallons accounted for
#840,000#756,000#740,000#740,000##* W ork required to complete the beginning
inventory.** 760,000 gallons started � 50,000 gallons in ending work in
process = 710,000 gallons started and completed.Requirement 2#Total
Costs#Materials#Labor#Overhead#W hole Unit##Cost to be accounted for:####### W ork
in process, May 31 #P �146,600###### Cost added during the month (a)
#� 1,869,200#P907,200#� P370,000#� P592,000###Total cost to be accounted for
#P2,015,800######Equivalent units (b) ##756,000#740,000#740,000###Cost
per equivalent unit (a) � (b) ##P1.20#+ P0.50#+ P0.80#= P2.50##
Exercise 7Requirement (1)The direct materials and direct labor costs listed in the
exercise would have been recorded on four different documents: the materials
requisition form for Job KC123, the time ticket for Kristine, the time ticket for
Clarisse, and the job cost sheet for Job KC123.Requirement (2)The costs for Job
KC123 would have been recorded as follows: Materials requisition form:
##Quantity#Unit Cost#Total Cost###Blanks#40#P80.00#P3,200###Nibs#960#P6.00#�
5,760######P8,960## Time ticket for Kristine#S tarted#Ended#Time
#Completed#Rate#Amount#Job Number###9:00 AM#12:15 PM#3.25#P120.00#P390.00#KC123##
Time ticket for Clarisse#S tarted#Ended#Time #Completed#Rate#Amount#Job
Number###2:15 PM#4:30 PM#2.25#P140.00#P315.00#KC123## Job Cost S heet for Job
KC123#Direct materials #P8,960.00###Direct labor:#### Kristine #390.00###
Clarisse #�� �315.00####P9,665.00##Exercise 8 The predetermined
overhead rate is computed as follows:Estimated total manufacturing overhead
#P586,000###� Estimated total direct labor hours (DLHs) #���40,000#DLHs##=
Predetermined overhead rate #���P14.65#per DLH##Exercise 9 W eighted-Average
Method#Materials#Labor#Overhead#Total##W ork in process, May 1 #P
�14,550#P23,620#P118,100###Cost added during May #� ��88,350#�
14,330#���71,650###Total cost (a) #P102,900#P37,950#P189,750#########Equivalent
units of #production (b) #1,200#1,100#1,100###Cost per equivalent unit #(a) �
(b) #P85.75#P34.50#P172.50#P292.75##Exercise 10 FIFO Method
#Materials#Conversion##To complete beginning work in process:####Materials: 400
units x (100% � 75%) #100###Conversion: 400 units x (100% � 25%) ##300##Units
started and completed during the period (42,600 units started � 500 units in ending
inventory) #42,100#42,100##Ending work in process####Materials: 500 units x 80%
complete #����400###Conversion: 500 units x 30% complete ##����150##Equivalent
units of production #42,600#42,550##III. ProblemsProblem 1Requirement 1
a.#Raw Materials Inventory #210,000####Accounts Payable ##210,000#######b.#W ork
in Process #178,000####Manufacturing Overhead #12,000####Raw Materials Inventory
##190,000#######c.#W ork in Process #90,000####Manufacturing Overhead
#110,000####S alaries and W ages Payable ##200,000#######d.#Manufacturing
Overhead #40,000####Accumulated Depreciation ##40,000#######e.#Manufacturing
Overhead #70,000####Accounts Payable ##70,000#######f.#W ork in Process
#240,000####Manufacturing Overhead ##240,000###30,000 MH x P8 per MH =
P240,000.#########g.#Finished Goods #520,000####W ork in Process
##520,000#######h.#Cost of Goods S old #480,000####Finished Goods
##480,000########Accounts Receivable #600,000####S ales
##600,000###P480,000 � 1.25 = P600,000####Requirement 2Manufacturing
Overhead#W ork in Process##(b) 12,000# 240,000 (f)#Bal. 42,000#
510,000 (g)##(c) 110,000##(b) 178,000###(d) 40,000##(c)
90,000###(e) 70,000##(f) 240,000#### 8,000#Bal. 30,000####(Overapplied
overhead)####Problem 2Requirement 1The costing problem does, indeed, lie with
manufacturing overhead cost, as suggested. S ince manufacturing overhead is mostly
fixed, the cost per unit increases as the level of production decreases. The
problem can be solved by use of predetermined overhead rates, which should be based
on expected activity for the entire year. Many students will
use units of product in computing the predetermined overhead rate, as follows:
#Estimated manufacturing overhead cost, P840,000 Estimated units to
be produced, 200,000The predetermined overhead rate could also be set on the
basis of either direct labor cost or direct materials cost. The computations are:
##Estimated manufacturing overhead cost, P840,000Estimated direct labor cost,
P240,000##Estimated manufacturing overhead cost, P840,000Estimated direct
materials cost, P600,000 Requirement 2Using a predetermined
overhead rate, the unit costs would be:#Quarter###First#S econd#Third#Fourth##Direct
materials #P240,000#P120,000#P 60,000#P180,000##Direct labor
#96,000#48,000#24,000#72,000##Manufacturing overhead:######Applied at P4.20
per units; 350% of direct labor cost, or 140% of direct materials cost # 336,000#
168,000# 84,000# 252,000## Total cost
#P672,000#P336,000#P168,000#P504,000##Number of units produced #
80,000#40,000#20,000#60,000##Estimated cost per unit #P8.40#P8.40#P8.40#P8.40##
Problem 3 W eighted-Average Method#QuantityS chedule####Pounds to be accounted
for:##### W ork in process, May 1 (all materials, 55% labor and
overhead added last month) #30,000#### S tarted into production during
May #480,000#### Total pounds #510,000###########Equivalent
Units####Materials#Labor & Overhead##Pounds accounted for as follows:#####
Transferred to Department 2 #490,000*#490,000#490,000## W ork in process,
May 31 (all materials, 90% labor and overhead added this
month) # 20,000# 20,000# 18,000## Total pounds
#510,000#510,000#508,000## * 30,000 + 480,000 - 20,000 = 490,000.Problem
4 (W eighted-Average Method; Interpreting a Production Report)Requirement 1W eighted-
Average MethodThe equivalent units for the month would be:#Quantity#Equivalent
Units###S chedule#Materials#Conversion##Units accounted for as follows:#####
Transferred to next department #190,000#190,000#190,000## W ork in
process, April 30 (75% materials, 60% conversion cost added this
month) # 40,000# 30,000# 24,000## Total units and equivalent units
of production #230,000#220,000#214,000##Requirement 2#Total
Cost#Materials#Conversion#W hole Unit##W ork in process, April 1 #P 98,000#P
67,800#P 30,200###Cost added during the month # 827,000# 579,000#
248,000### Total cost (a) #P925,000#P646,800#P278,200#########Equivalent units
of production (b) #�#220,000#214,000###Cost per EU (a) ( (b) #�#P2.94#+
P1.30#= P4.24##Requirement 3 Total units transferred 190,000 Less
units in the beginning inventory 30,000 Units started and completed
during April 160,000Requirement 4No, the manager should not be rewarded
for good cost control. The reason for the Mixing Department�s low unit cost for
April is traceable to the fact that costs of the prior month have been averaged in
with April�s costs in computing the lower, P2.94 per unit figure. This is a major
criticism of the weighted-average method in that the figures computed for product
costing purposes can�t be used to evaluate cost control or measure performance for
the current period.Problem 5 (Preparation of Production Report from Analysis of
W ork in Process T-account � W eighted-Average Method)Requirement 1 W eighted-
Average MethodQuantity S chedule and Equivalent Units #QuantityS chedule####Pounds
to be accounted for:##### W ork in process, May 1 (materials all complete,
labor and overhead 4/5 complete) #35,000#### S tarted into production
#280,000####Total pounds to be accounted for #315,000###########Equivalent
Units (EU)####Materials#Labor & Overhead##Pounds accounted for as follows:#####
Transferred to Blending* #270,000#270,000#270,000## W ork in process,
May 31 (materials all complete, labor and overhead 2/3
complete) # 45,000# 45,000# 30,000##Total pounds accounted for
#315,000#315,000#300,000## * 35,000 + 280,000 � 45,000 = 270,000.Cost per
Equivalent Unit#Total #Materials#Labor & Overhead#W hole Unit##Cost to be accounted
for:###### W ork in process, May 1 #P 63,700#P 43,400#P 20,300###Cost added
during the month # 587,300# 397,600# 189,700###Total cost to be accounted
for (a) #P651,000#P441,000#P210,000#########Equivalent units (b)
##315,000#300,000###Cost per equivalent unit (a) ( (b) ##P1.40#+
P0.70#= P2.10## Cost Reconciliation#Total#Equivalent Units
(EU)###Cost#Materials#Conversion##Cost accounted for as follows:##### Transferred
to Blending:##### 270,000 pounds x P2.10 per pound #
P567,000#270,000#270,000## W ork in process, May 31:##### Materials, at
P1.40 per EU #63,000#45,000### Labor and overhead, at P0.70
per EU # 21,000##30,000## Total work in process, May 31 #
84,000####Total costs accounted for #P651,000####Requirement 2In computing unit
costs, the weighted-average method mixes costs of the prior period with current
period costs. Thus, under the weighted-average method, unit costs are influenced to
some extent by what happened in a prior period. This problem becomes particularly
significant when attempting to measure performance in the current period. Good (or
bad) cost control in the current period might be concealed to some degree by the
costs that have been brought forward in the beginning inventory. IV. Multiple
Choice QuestionsD#D#A#A##D#A#D#D##D#C#B#A##C#C#D#C##D#B#C#D##CHAPTER 11S YS TEMS
DES IGN: ACTIVITY-BAS ED COS TING AND MANAGEMENTI. QuestionsThe three levels
available are: Level 1, in which a company uses a plantwide overhead rate; Level
2, in which a company uses departmental overhead rates; and Level 3, in which a
company uses activity-based costing.New approaches to costing are needed because
events of the last few decades have made drastic changes in many organizations.
Automation has greatly decreased the amount of direct labor required to manufacture
products; product diversity has increased in that companies are manufacturing a
wider range of products and these products differ substantially in volume, lot
size, and complexity of design; and total overhead cost has increased to the point
in some companies that a correlation no longer exists between it and direct labor.
The departmental approach to assigning overhead cost to products relies solely on
volume as an assignment base. W here diversity exists between products (that is,
where products differ in terms of number of units produced, lot size, or complexity
of production), volume alone is not adequate for overhead costing. Overhead
costing based on volume will systematically overcost high-volume products and
undercost low-volume products.Process value analysis (PVA) is a systematic approach
to gaining an understanding of the steps associated with a product or service. It
identifies all resource-consuming activities involved in the production process and
labels these activities as being either value-added or non-value-added. Thus, it
is the beginning point in designing an activity-based costing system since
management must know what activities are involved with each product before activity
centers can be designated and cost drivers established. Also, PVA helps management
to eliminate any non-value-added activities and thereby streamline operations and
minimize costs.The four general levels of activities are:1.Unit-level activities,
which are performed each time a unit is produced.2. Batch-level activities, which
are performed each time a batch of goods is handled or processed.3. Product-
level activities, which are performed as needed to support specific products.4.
Facility-level activities, which simply sustain a facility�s general
manufacturing process.First, activity-based costing increases the number of cost
pools used to accumulate overhead costs. S econd, it changes the base used to
assign overhead costs to products. And third, it changes a manager�s perception of
many overhead costs in that costs that were formerly thought to be indirect (such
as depreciation or machine setup) are identified with specific activities and
thereby are recognized as being traceable to individual products.The two chief
limitations are: First, the portion of overhead costs that relate to facility-level
activities are still usually allocated to products on some arbitrary basis, such as
machine-hours or direct labor-hours. Critics of activity-based costing argue that
facility-level activities account for the bulk of all overhead costs in some
companies. S econd, high measurement costs are involved in operating an activity-
based costing system. That is, the system requires the tracking of large amounts
of detail and the completion of many separate computations in order to determine
the cost of a unit or product.Yes, activity-based costing can be used in service
organizations. It has been successfully implemented, for example, in railroads,
hospitals, banks and data service companies.A resource driver is a measure of the
quality of resources consumed by an activity.An activity driver is a measure of
frequency and intensity of demands placed on activities by cost objects.Two-stage
allocation is a procedure that first assigns a firm�s resource costs, namely
factory overhead cost, to cost pools, and then to cost objects.Two major advantages
of ABM are:a. ABM measures the effectiveness of the key business processes and
activities, and identifies how they can be improved to reduce costs and improve the
customer value.b. ABM improves the management focus by allocating resources to key
value-added activities, key customers, key products, and continuous improvement
methods to maintain the firm�s competitive advantage.W hen direct labor is used as
an allocation base for overhead, it is implicitly assumed that overhead cost is
directly proportional to direct labor. W hen cost systems
were originally developed in the 1800s, this assumption may have been reasonably
accurate. However, direct labor has declined in importance over the years while
overhead has been increasing. This suggests that there is no longer a direct link
between the level of direct labor and overhead. Indeed, when a company automates,
direct labor is replaced by machines; a decrease in direct labor is accompanied by
an increase in overhead. This violates the assumption that overhead cost is
directly proportional to direct labor. Overhead cost appears to be driven by
factors such as product diversity and complexity as well as by volume, for which
direct labor has served as a convenient measure.Employees may resist activity-based
costing because it changes the �rules of the game.� ABC changes some of the key
measures, such as product costs, used in making decisions and may affect how
individuals are evaluated. W ithout top management support, employees may have
little interest in making these changes. In addition, if top managers continue to
make decisions based on the numbers generated by the traditional costing system,
subordinates will quickly conclude that the activity-based costing system can be
ignored.Unit-level activities are performed for each unit that is produced. Batch-
level activities are performed for each batch regardless of how many units are in
the batch. Product-level activities must be carried out to support a product
regardless of how many batches are run or units produced. Customer-level activities
must be carried out to support customers regardless of what products or services
they buy. Organization-sustaining activities are carried out regardless of the
company�s precise product mix or mix of customers.Organization-sustaining costs,
customer-level costs, and the costs of idle capacity should not be assigned to
products. These costs represent resources that are not consumed by the products.II.
True or False True #False#False #True ##True#True#False#True ##III.
ExercisesExercise 1Activity#Activity Classification#Examples of Traceable
Costs#Examples of Cost Drivers##Materials are moved from the receiving dock to
product flow lines by a material-handling crew#Batch-level#Labor cost; depreciation
of equipment; space cost#Number of receipts; pounds handled##Direct labor workers
assemble various products#Unit-level#Direct labor cost; indirect labor cost; labor
benefits#Direct labor-hours##Ongoing training is provided to all employees in the
company#Facility-level*#S pace cost; training costs; administration costs#Hours of
training time; number trained##A product is designed by a specialized design
team#Product-level#S pace cost; supplies used; depreciation of design
equipment#Hours of design time; number of engineering change orders##Equipment
setups are performed on a regular basis#Batch-level#Labor cost; supplies used;
depreciation of equipment#Number of setups; hours or setup time##Numerical control
(NC) machines are used to cut and shape materials#Unit-level#Power; supplies used;
maintenance; depreciation#Machine-hours; number of units##*Personnel administration
and training costs might be traceable in part to the facility-level and in part to
other activity centers at the unit-level, product-level, and batch-level.Exercise 2
plantwide overhead rate#Batch-level##volume#Product-level##two stage, stage,
stage#Facility-level##Process value analysis#high-volume, low-volume, low-
volume##Unit-level#activity centers##Exercise 3a.#Various individuals manage the
parts inventories.#Product-level##b.#A clerk in the factory issues purchase orders
for a job.#Batch-level##c.#The personnel department trains new production
workers.#Organization-sustaining ##d.#The factory�s general manager meets with
other department heads such as marketing to coordinate plans.#Organization-
sustaining ##e.#Direct labor workers assemble products.#Unit-level##f.#Engineers
design new products.#Product-level##g.#The materials storekeeper issues raw
materials to be used in jobs.#Batch-level##h.#The maintenance department performs
periodic preventative maintenance on general-use equipment.#Organization-sustaining
## Note: S ome of these classifications are debatable and may depend
on the specific circumstances found in particular companies.Exercise 4S ales (P1,650
per standard model glider � 10 standard model gliders + P2,300 per custom designed
glider � 2 custom designed gliders) ##P21,100##Costs:####Direct materials (P462 per
standard model glider � 10 standard model gliders + P576 per custom #designed
glider � 2 custom designed gliders) #P5,772###Direct labor (P19 per direct labor-
hour � 28.5 direct labor-hours per standard model glider � 10 standard model
gliders + P19 per direct labor-hour � 32 direct labor-hours per custom designed
glider � 2 custom designed gliders) #6,631###S upporting manufacturing (P18 per
direct labor-hour � 28.5 direct labor-hours per standard model glider � 10 standard
model gliders + P18 per direct labor-hour � 32 direct labor-hours per custom
designed glider � 2 custom designed gliders) #6,282###Order processing (P192 per
order � 3 orders) #576###Custom designing (P261 per custom design � 2 custom
designs) #522###Customer service (P426 per customer � #1 customer)
#���426#�20,209##Customer margin ##P����891##Exercise 5Requirement 1
The predetermined overhead rate is computed as follows:#The unit product
costs under the company�s traditional costing system are computed as follows:
#S pecial#Regular##Direct materials #P60.00#P45.00##Direct labor
#9.60#7.20##Manufacturing overhead (0.8 DLH � P5.80 per DLH;#0.6 DLH � P5.80
per DLH) #���4.64#���3.48##Unit product cost #P74.24#P55.68##Requirement 2
The activity rates are computed as follows:
#(a)#######Estimated#(b)####Overhead#Total#(a) � (b)##Activities#Cost#Expected
Activity#Activity Rate##S upporting direct labor #P150,000#50,000#DLHs#P3#per
DLH##Batch setups #P60,000#250#setups#P240#per setup##S afety testing
#P80,000#100#tests#P800#per test## Manufacturing overhead is assigned
to the two products as follows: S pecial Product:#Activity Cost
Pool#(a)#Activity Rate#(b)#Activity #(a) � (b)#ABC Cost###S upporting direct labor
#P3#per DLH#8,000#DLHs#P24,000###Batch setups #P240#per
setup#200#setups#48,000###S afety testing #P800#per test#80#tests#���64,000###Total
#####P136,000## Regular Product:#Activity Cost Pool#(a)#Activity
Rate#(b)#Activity #(a) � (b)#ABC Cost###S upporting direct labor #P3#per
DLH#42,000#DLHs#P126,000###Batch setups #P240#per setup#50#setups#12,000###S afety
testing #P800#per test#20#tests#���16,000###Total #####P154,000##
Activity-based costing unit product costs are computed as follows:
#S pecial#Regular##Direct materials #P60.00#P45.00##Direct labor
#9.60#7.20##Manufacturing overhead (P136,000 � 10,000 units; P154,000 �
70,000 units) #�13.60#���2.20##Unit product cost #P83.20#P54.40##IV.
Problems Problem 1Cost S ystems#Pool Rate#Cost Driver Consumption#Cost
Assignment##Traditional cost system#350%#P10,000#P35,000##ABC
system#####Labor#10%#P10,000#P 1,000##Machining#P25/hour#800
hours#20,000##S etup#P10/hour#100 hours#1,000##Production order#P100/order#12
orders#1,200##Material handling#P20/requisition#5 requisitions#100##Parts
administration#P40/part#18 parts# 720#####P24,020##Problem 2Requirement 1
Total overhead = P200,000 + P32,000 + P100,000 + P120,000
= P452,000 Overhead rate = P452,000 / 50,000 direct labor hours
= P9.04 per direct labor hourOverhead assigned to proposed job =
P9.04 x 1,000 direct labor hours =
P9,040Total cost of proposed job: Direct materials P 6,000 Direct labor
10,000 Overhead applied 9,040 Total cost P25,040
Company�s bid = Full manufacturing cost x 120% = P25,040 x 120%
= P30,048 Requirement 2Maintenance : P200,000 / 20,000
= P10 per machine hourMaterials handling: P32,000 / 1,600 =
P20 per moveS etups: P100,000 / 2,500 = P40 per
setupInspection: P120,000 / 4,000 = P30 per inspectionOverhead
assigned to proposed job: Maintenance (P10 x 500) P5,000 Material handling
(P20 x 12) 240 S etups (P40 x 2) 80 Inspection (P30 x 10) 300
Total overhead assigned to job P5,620 Total cost of proposed
project: Direct materials P 6,000 Direct labor 10,000 Overhead
applied 5,620 Total cost P21,620Company�s bid = Full
manufacturing cost x 120% = P21,620 x 120% = P25,944
The bid price of P25,944 was determined as follows: Direct materials P6,000
Direct labor 10,000 Overhead assigned: Maintenance
(P10 x 500) P5,000 Material handling (P20 x 12) 240 S etups (P40
x 2) 80 Inspections (P30 x 10) 300 Total overhead
assigned to job 5,620 Total cost P21,620 Markup
120% Bid price P25,944 Problem 3 (Activity-Based Costing)
Requirement 1The first-stage allocation of costs to the activity cost pools appears
below:#Activity Cost Pools###Assembling Units#Processing Orders#S upporting
Customers#Other#Total##Manufacturing
overhead#P250,000#P175,000#P25,000#P50,000#P500,000##S elling and administrative
overhead# 30,000# 135,000# 75,000# 60,000# 300,000##Total
cost#P280,000#P310,000#P100,000#P110,000#P800,000##Requirement 2The activity rates
for the cost pools are:#(a)Total Cost#(b)Total Activity #(a) ( (b)Activity
Rate##Assembling units#P280,000# 1,000 units# P280 per unit##Processing
orders#P310,000# 250 orders# P1,240 per order##S upporting
customers#P100,000# 100 customers# P1,000 per customer##Requirement 3
The overhead cost attributable to Lucky S ale would be computed as follows:Activity
Cost Pools#(a)Activity Rate#(b)Activity #(a) x (b)ABC Cost##Assembling units#
P280 per unit# 80 units#P22,400##Processing orders# P1,240 per
order# 4 orders#P4,960##S upporting customers# P1,000 per
customer# 1 customer#P1,000##Requirement 4The customer margin can be computed
as follows:S ales (P595 per unit x 80 units)##P47,600##Costs:#### Direct materials
(P180 per unit x 80 units)#P14,400### Direct labor (P50 per unit x 80
units)#4,000### Unit-related overhead (above)#22,400### Order-related overhead
(above)#4,960### Customer-related overhead (above)# 1,000# 46,760##Customer
margin##P 840##Problem 4 (Activity-Based Costing as an Alternative to
Traditional Product Costing)Requirement 1 a. W hen direct labor-hours are
used to apply overhead cost to products, the company�s predetermined overhead rate
would be:##b.##Model#####HY5#AS 2####Direct materials #P35.00#P25.00####Direct
labor: #P20 per hour � 0.2 DLH, 0.4 DLH #4.00#8.00####Manufacturing overhead:
#P74 per hour � 0.2 DLH, 0.4 DLH #�14.80#�29.60####Total unit product cost
#P53.80#P62.60##Requirement 2 a. Predetermined overhead rates for
the activity cost pools:#Activity Cost Pool#(a)#Estimated#Total
Cost#(b)#Estimated#Total Activity#(a) � (b)#Activity Rate###Machine setups
#P180,000#250#setups#P720#per setup###S pecial milling
#P300,000#1,000#MHs#P300#per MH###General factory
#P1,000,000#20,000#DLHs#P50#per DLH## The overhead applied to
each product can be determined as follows: Model HY5#Activity Cost
Pool#(a)#Predetermined #Overhead Rate#(b)#Activity #(a) � (b)#Overhead
Applied###Machine setups #P720#per setup#150#setups#P108,000###S pecial milling
#P300#per MH#1,000#MHs#300,000###General factory #P50#per
DLH#4,000#DLHs#�200,000###Total manufacturing overhead cost (a)
#####P608,000###Number of units produced (b) #####20,000###Overhead cost
per unit (a) � (b) #####P30.40## Model AS 2#Activity Cost
Pool#(a)#Predetermined #Overhead Rate#(b)#Activity #(a) � (b)#Overhead
Applied###Machine setups #P720#per setup#100#setups#P�72,000###S pecial milling
#P300#per MH#0#MHs#0###General factory #P50#per
DLH#16,000#DLHs#�800,000###Total manufacturing overhead cost (a)
#####P872,000###Number of units produced (b) #####40,000###Overhead cost
per unit (a) � (b) #####P21.80## b. The unit product cost of each
model under activity-based costing would be computed as follows:
##Model####HY5#AS 2###Direct materials #P35.00#P25.00###Direct labor (P20 per
DLH � 0.2 DLH; P20 per DLH � 04.DLH) #4.00#8.00###Manufacturing overhead
(above) #�30.40#�21.80###Total unit product cost #P69.40#P54.80##
Comparing these unit cost figures with the unit costs in Part 1(b), we find
that the unit product cost for Model HY5 has increased from P53.80 to P69.40, and
the unit product cost for Model AS 2 has decreased from P62.60 to P54.80.Requirement
3 It is especially important to note that, even under activity-based
costing, 68% of the company�s overhead costs continue to be applied to products on
the basis of direct labor-hours:Machine setups (number of s#e#t#u#p#s#)# ###P##
�#1#8#0#,#0#0#0###1#2###%#####S #p#e#c#i#a#l# #m#i#l#l#i#n#g# #(#m#a#c#h#i#n#e#-
#h#o#u#r#s#)# ###3#0#0#,#0#0#0###2#0#######G#e#n#e#r#a#l# #f#a#c#t#o#r#y#
#(#d#i#r#e#c#t# #l#a#b#o#r#-#h#o#u#r#s#)#
###�#1#,#0#0#0#,#0#0#0###�#6#8#######T#o#t#a#l# #o#v#e#r#h#e#a#d# #c#o#s#t#
###P#1#,#4#8#0#,#0#0#0###1#0#0###%###### # #T#h#u#s#,# #t#h#e#
#s#h#i#f#t# #i#n# #o#v#e#r#h#e#a#d# #c#o#s#t# #f#r#o#m# #t#h#e# #h#i#g#h#-
#v#o#l#u#m#e# #p#r#o#d#u#c#t# #(#M#o#d#e#l# #A#S #2#)# #t#o# #t#h#e# #l#o#w#-
#v#o#lume product (Model HY5) occurred as a result of reassigning only 32% of the
company�s overhead costs. The increase in unit product cost for Model HY5
can be explained as follows: First, where possible, overhead costs have been traced
to the products rather than being lumped together and spread uniformly over
production. Therefore, the special milling costs, which are traceable to Model HY5,
have all been assigned to Model HY5 and none assigned to Model AS 2 under the
activity-based costing approach. It is common in industry to have some products
that require special handling or special milling of some type. This is especially
true in modern factories that produce a variety of products. Activity-based costing
provides a vehicle for assigning these costs to the appropriate products.
S econd, the costs associated with the batch-level activity (machine setups)
have also been assigned to the specific products to which they relate. These costs
have been assigned according to the number of setups completed for each product.
However, since a batch-level activity is involved, another factor affecting unit
costs comes into play. That factor is batch size. S ome products are produced in
large batches and some are produced in small batches. The smaller the batch, the
higher the cost per unit of the batch activity. In the case at hand, the data can
be analyzed as shown below.#Model HY5:#####Cost to complete one setup [see 2(a)]
#P720#(a)###Number of units processed per setup #(20,000 units � 150 setups)
#133.33#(b)###S etup cost per unit (a) � (b) #P5.40#########Model
AS 2:#####Cost to complete one setup (above) #P720#(a)###Number of units
processed per setup #(40,000 units � 100 setups) #400#(b)###S etup cost per
unit (a) � (b) #P1.80### Thus, the cost per unit for setups is three
times as great for Model HY5, the low-volume product, as it is for Model AS 2, the
high-volume product. S uch differences in cost are obscured when direct labor-hours
(or any other volume measure) is used as the basis for applying overhead cost to
products. In sum, overhead cost has shifted from the high-volume product to
the low-volume product as a result of more appropriately assigning some costs to
the products on the basis of the activities involved, rather than on the basis of
direct labor-hours.V. Multiple Choice Questions
A#B#D####D#D#A####C#C#B####B#A#A####A#C#B####D#D#D####A#D#B####B#C#C####D#B#A####C#
A#C####CHAPTER 12VARIABLE COS TINGI. Questions1. The variable costing technique does
not consider fixed costs as unimportant or irrelevant, but it maintains that the
distinction between behaviors of different costs is crucial for certain decisions.
2. The central issue in variable costing is what is the proper timing for
release of fixed manufacturing overhead as expense: at the time of incurrence, or
at the time the finished units to which the fixed overhead relates are sold.3.
Direct costing would be more accurately called variable or marginal costing
because in substance it is the inventory costing method which applies only variable
production costs to product; fixed factory overhead is not assigned to product.4.
Marketing and administrative costs are treated as period costs under both
variable costing and absorption costing methods of product costing.5. Under
absorption costing, as a company manufactures units of product, the fixed
manufacturing overhead costs of the period are added to the units, along with
direct materials, direct labor, and variable manufacturing overhead. If some of
these units are not sold by the end of the period, then they are carried into the
next period as inventory. The fixed manufacturing overhead cost attached to the
units in ending inventory follow the units into the next period as part of their
inventory cost. W hen the units carried over as inventory are finally sold, the
fixed manufacturing overhead cost that has been carried over with the units is
included as part of that period�s cost of goods sold.6. Many accountants and
managers believe absorption costing does a better job of matching costs with
revenues than variable costing. They argue that all manufacturing costs must be
assigned to products to properly match the costs of producing units of product with
the revenues from the units when they are sold. They believe that the fixed costs
of depreciation, taxes, insurance, supervisory salaries, and so on, are just as
essential to manufacturing products as are the variable costs.7. If fixed
manufacturing overhead cost is released from inventory, then inventory levels must
have decreased and therefore production must have been less than sales.8. Under
absorption costing it is possible to increase net operating income without
increasing sales by increasing the level of production. If production exceeds
sales, units of product are added to inventory. These units carry a portion of the
current period�s fixed manufacturing overhead costs into the inventory account,
thereby reducing the current period�s reported expenses and causing net operating
income to rise.9. Generally speaking, variable costing cannot be used externally
for financial reporting purposes nor can it be used for tax purposes.10. If
production exceeds sales, absorption costing will show higher net operating income
than variable costing. The reason is that inventories will increase and therefore
part of the fixed manufacturing overhead cost of the current period will be
deferred in inventory to the next period under absorption costing. By contrast,
all of the fixed manufacturing overhead cost of the current period will be charged
immediately against revenues as a period cost under variable costing.11.
Absorption and variable costing differ in how they handle fixed manufacturing
overhead. Under absorption costing, fixed manufacturing overhead is treated as a
product cost and hence is an asset until products are sold. Under variable costing,
fixed manufacturing overhead is treated as a period cost and is expensed on the
current period�s income statement.12. Advocates of variable costing argue that
fixed manufacturing costs are not really the cost of any particular unit of
product. If a unit is made or not, the total fixed manufacturing costs will be
exactly the same. Therefore, how can one say that these costs are part of the costs
of the products? These costs are incurred to have the capacity to make products
during a particular period and should be charged against that period as
period costs according to the matching principle.II. ExercisesExercise 1 (Variable
and Absorption Costing Unit Product Costs and Income S tatements)Requirement 1a.
The unit product cost under absorption costing would be:Direct materials
#P18##Direct labor #7##Variable manufacturing overhead #� ��2##Total
variable manufacturing costs #27##Fixed manufacturing overhead (P160,000 � 20,000
units) #� ��8##Unit product cost #P35## b. The absorption
costing income statement:S ales (16,000 units � P50 per unit) ##P800,000###Less
cost of goods sold:##### Beginning inventory #P���������0#### Add cost of
goods manufactured # (20,000 units � P35 per unit) #�700,000#### Goods
available for sale #700,000#### Less ending inventory (4,000 units
� P35 per unit) #�140,000#�560,000###Gross margin ##240,000###Less selling and
administrative expenses ##�190,000#*##Net operating income ##P�50,000###
*(16,000 units � P5 per unit) + P110,000 = P190,000.Requirement 2 a.
The unit product cost under variable costing would be:Direct materials
#P18##Direct labor #7##Variable manufacturing overhead #� ��2##Unit
product cost #P27## b. The variable costing income statement:S ales
(16,000 units � P50 per unit) ###P800,000##Less variable expenses:##### Variable
cost of goods sold:##### Beginning inventory #P���������0####
Add variable manufacturing costs # (20,000 units � P27 per unit)
#�540,000#### Goods available for sale #540,000####
Less ending inventory # (4,000 units � P27 per unit)
#�108,000#### Variable cost of goods sold #432,000#*### Variable
selling expense # (16,000 units � P5 per unit)
#���80,000##�512,000##Contribution margin ###288,000##Less fixed
expenses:##### Fixed manufacturing overhead #160,000#### Fixed selling and
administrative #�110,000##�270,000##Net operating income ###P�18,000##* The
variable cost of goods sold could be computed more simply as: 16,000 units � P27
per unit = P432,000.Exercise 2 (Variable and Absorption Costing Unit Product Costs)
Requirement 1S ales (40,000 units � P33.75 per unit) ##P1,350,000##Less variable
expenses:#### Variable cost of goods sold # (40,000 units � P16 per
unit*) #P640,000### Variable selling and administrative expenses #
(40,000 units � P3 per unit) #�120,000#���760,000##Contribution margin
##590,000##Less fixed expenses:#### Fixed manufacturing overhead #250,000###
Fixed selling and administrative expenses #�300,000#����550,000##Net
operating income ##P����40,000##*#Direct materials #P10###Direct labor
#4###Variable manufacturing overhead #���2###Total variable
manufacturing cost #P16## Requirement 2 The difference in net
operating income can be explained by the P50,000 in fixed manufacturing overhead
deferred in inventory under the absorption costing method:Variable costing net
operating income #P40,000##Add: Fixed manufacturing overhead cost deferred in
inventory under absorption costing: 10,000 units � P5 per unit in fixed
manufacturing overhead cost #�50,000##Absorption costing net operating income
#P90,000##Exercise 3 (Variable Costing Unit Product Cost and Income
S tatement; Break-even)Requirement 1Under variable costing, only the variable
manufacturing costs are included in# #p#r#o#d#u#c#t# #c#o#s#t#s#.###D#i#r#e#c#t#
#m#a#t#e#r#i#a#l#s# ###P## 6#0#0#####D#i#r#e#c#t# #l#a#b#o#r#
###3#0#0#####V#a#r#i#a#b#l#e# #m#a#n#u#f#a#c#t#u#r#i#n#g# #o#v#e#r#h#e#a#d#
###�# #�#�#1#0#0#####U#n#i#t# #p#r#o#d#u#c#t# #c#o#s#t#
###P#1#,#0#0#0######N#o#t#e# #t#h#a#t# #s#e#l#l#i#n#g# #a#n#d#
#a#d#m#i#n#i#s#t#r#a#t#i#v#e# #e#x#p#e#n#s#e#s# #a#r#e# #n#o#t# #t#r#e#a#t#e#d#
#a#s# #p#r#o#d#u#c#t# #c#o#s#t#s#;# #t#h#a#t# #i#s#,# #t#h#e#y# #a#r#e# #n#o#t#
#i#n#c#l#u#d#e#d# #i#n# #t#h#e# #c#o#s#t#s# #that are inventoried. These expenses
are always treated as period costs and are charged against the current period�s
revenue.Requirement 2 The variable costing income statement appears below:S ales
##P18,000,000##Less variable expenses:#### Variable cost of goods
sold:#### Beginning inventory #P������������0### Add variable
manufacturing costs # (10,000 units � P1,000 per unit) #�10,000,000###
Goods available for sale #10,000,000### Less ending inventory
(1,000 units � P1,000 per unit) #����1,000,000### Variable cost of
goods sold* #9,000,000### Variable selling and administrative (9,000 units �
P200 per unit) #����1,800,000#�10,800,000##Contribution margin ##7,200,000##Less
fixed expenses:####Fixed manufacturing overhead #3,000,000###Fixed selling and
administrative #����4,500,000#����7,500,000##Net operating loss
##P��(300,000)##* The variable cost of goods sold could be computed more
simply as: 9,000 units sold � P1,000 per unit = P9,000,000.Requirement 3The break-
even point in units so#l#d# #c#a#n# #b#e# #c#o#m#p#u#t#e#d# #u#s#i#n#g# #t#h#e#
#c#o#n#t#r#i#b#u#t#i#o#n# #m#a#r#g#i#n# #p#e#r# #u#n#i#t# #a#s# #f#o#l#l#o#w#s#:#
#S #e#l#l#i#n#g# #p#r#i#c#e# #p#e#r# #u#n#i#t# ###P#2#,#0#0#0#####V#a#r#i#a#b#l#e#
#c#o#s#t# #p#e#r# #u#n#i#t# ###�# #1#,#2#0#0#####C#o#n#t#r#i#b#u#t#i#o#n#
#m#a#r#g#i#n# #p#e#r# #u#n#i#t# ###P## 8#0#0########E#x#e#r#c#i#s#e# #4#
#(#A#b#s#o#r#p#t#i#o#n# #C#o#s#t#i#n#g# #U#n#i#t# #P#r#o#d#u#c#t# #C#o#s#t# #a#n#d#
#I#n#c#o#m#e# #S #t#a#t#e#m#e#n#t#)###R#e#q#u#i#r#e#m#e#n#t# #1### #
#U#n#d#e#r# #a#b#s#o#r#p#t#i#o#n# #c#o#s#t#i#n#g#,# #a#l#l#
#m#a#n#u#f#a#c#t#u#r#i#n#g# #c#o#s#t#s# #(#v#a#r#i#a#b#l#e# #a#n#d# #f#i#x#e#d#)#
#a#r#e# #i#n#c#l#u#d#e#d# #i#n# #p#r#o#d#u#c#t# #c#o#s#t#s#.###D#i#r#e#c#t#
#m#a#t#e#r#i#a#l#s# ###P## 6#0#0#####D#i#r#e#c#t# #l#a#b#o#r#
###3#0#0#####V#a#r#i#a#b#l#e# #m#a#n#u#f#a#c#t#u#r#i#n#g# #o#v#e#r#h#e#a#d#
###1#0#0#####F#i#x#e#d# #m#a#n#u#f#a#c#t#u#r#i#n#g# #o#v#e#r#h#e#a#d#
###(#P#3#,#0#0#0#,#0#0#0# #�# #1#0#,#0#0#0# #u#n#i#t#s#)# ###�#�#�#3#00##Unit
product cost #P1,300##Requirement 2 The absorption costing income
statement appears below:S ales (9,000 units � P2,000 per unit)
##P18,000,000##Cost of goods sold:####Beginning inventory
#P������������0###Add cost of goods manufactured #(10,000 units � P1,300 per
unit) #�13,000,000###Goods available for sale #13,000,000###Less ending inventory
#(1,000 units � P1,300 per unit) #����1,300,000#�11,700,000##Gross margin
##6,300,000##S elling and administrative expenses:####Variable selling and
administrative (9,000 units � P200 per unit) #1,800,000###Fixed selling and
administrative #����4,500,000#����6,300,000##Net operating income ##P�
�����������0## Note: The company apparently has exactly zero net operating
income even though its sales are below the break-even point computed in Exercise 3.
This occurs because P300,000 of fixed manufacturing overhead has been deferred in
inventory and does not appear on the income statement prepared using absorption
costing.Exercise 5 (Variable Costing Income S tatement; Explanation of Difference in
Net Operating Income)Requirement 1 2,000 units � P60 per unit fixed
manufacturing overhead = P120,000Requirement 2 The variable costing income
statement appears below:S ales ##P4,000,000##Variable expenses:####Variable cost of
goods sold:####Beginning inventory

#P������������0####################################################################
###################################################################################
################################A#d#d# #v#a#r#i#a#b#l#e#
#m#a#n#u#f#a#c#t#u#r#i#n#g# #c#o#s#t#s###(#1#0#,#0#0#0# #u#n#i#t#s# � #�# #P#3#1#0#
#p#e#r# #u#n#i#t#)# ###�#3#,#1#0#0#,#0#0#0#######G#o#o#d#s# #a#v#a#i#l#a#b#l#e#
#f#o#r# #s#a#l#e# ###3#,#1#0#0#,#0#0#0#######L#e#s#s# #e#n#d#i#n#g#
#i#n#v#e#n#t#o#r#y# ###(#2#,#0#0#0# #u#n#i#t#s# #�# #P#3#1#0# #p#e#r# #u#n#i#t#)#
###�#�#�#�#6#2#0#,#0#0#0#######V#a#r#i#a#b#l#e# #c#o#s#t# #o#f# #g#o#o#d#s#
#s#o#l#d#*# ###2#,#4#8#0#,#0#0#0#######V#a#r#i#a#b#l#e# #s#e#l#l#i#n#g# #a#n#d#
#a#d#m#i#n#i#s#t#rative #(8,000 units � P20 per unit)
#����160,000#�2,640,000##Contribution margin ##1,360,000##Fixed
expenses:####Fixed manufacturing overhead #600,000###Fixed selling and
administrative #����400,000#�1,000,000##Net operating income ##P��360,000##
*#The variable cost of goods sold could be computed more simply as: 8,000 units
sold � P310 per unit = P2,480,000.## The difference in net operating
income between variable and absorption costing can be explained by the deferral of
fixed manufacturing overhead cost in inventory that has taken place under the
absorption costing approach. Note from part (1) that P120,000 of fixed
manufacturing overhead cost has been deferred in inventory to the next period.
Thus, net operating income under the absorption costing approach is P120,000 higher
than it is under variable costing.Exercise 6 (Evaluating Absorption and Variable
Costing as Alternative Costing Methods)Requirement 1 a. By assumption, the
unit selling price, unit variable costs, and total fixed costs are constant from
year to year. Consequently, variable costing net operating income will vary with
sales. If sales increase, variable costing net operating income will increase. If
sales decrease, variable costing net operating income will decrease. If sales are
constant, variable costing net operating income will be constant. Because variable
costing net operating income was P16,847 each year, unit sales must have been the
same in each year. The same is not true of absorption costing net
operating income. S ales and absorption costing net operating income do not
necessarily move in the same direction because changes in inventories also affect
absorption costing net operating income. b. W hen variable costing net
operating income exceeds absorption costing net operating income, sales exceeds
production. Inventories shrink and fixed manufacturing overhead costs are released
from inventories. In contrast, when variable costing net operating income is less
than absorption costing net operating income, production exceeds sales. Inventories
grow and fixed manufacturing overhead costs are deferred in inventories. The year-
by-year effects are shown below.##Year 1#Year 2#Year 3####Variable costing NOI =
Absorption costing NOI#Variable costing NOI < Absorption costing NOI#Variable
costing NOI > Absorption costing NOI####Production = S ales#Production >
S ales#Production < S ales####Inventories remain the same#Inventories
grow#Inventories shrink##Requirement 2 a. As discussed in part (1 a)
above, unit sales and variable costing net operating income move in the same
direction when unit selling prices and the cost structure are constant. Because
variable costing net operating income declined, unit sales must have also declined.
This is true even though the absorption costing net operating income increased. How
can that be? By manipulating production (and inventories) it may be possible to
maintain or increase the level of absorption costing net operating income even
though unit sales decline. However, eventually inventories will grow to be so large
that they cannot be ignored. b. As stated in part (1 b) above, when
variable costing net operating income is less than absorption costing net operating
income, production exceeds sales. Inventories grow and fixed manufacturing overhead
costs are deferred in inventories. The year-by-year effects are shown below.##Year
1#Year 2#Year 3####Variable costing NOI = Absorption costing NOI#Variable costing
NOI < Absorption costing NOI#Variable costing NOI < Absorption costing
NOI####Production = S ales#Production > S ales#Production > S ales####Inventories
remain the same#Inventories grow#Inventories grow###Requirement 3
Variable costing appears to provide a much better picture of economic reality
than absorption costing in the examples above. In the first case, absorption
costing net operating income fluctuates wildly even though unit sales are the same
each year and unit selling prices, unit variable costs, and total fixed costs
remain the same. In the second case, absorption costing net operating income
increases from year to year even though unit sales decline. Absorption costing is
much more subject to manipulation than variable costing. S imply by changing
production levels (and thereby deferring or releasing costs from inventory)
absorption costing net operating income can be manipulated upward or downward.Note:
This exercise is based on the following data:Common data:Annual fixed manufacturing
costs #P153,153##Contribution margin per unit #P35,000##Annual fixed S GA costs
#P180,000##Part 1:#Year 1#Year 2#Year 3##Beginning inventory
#1#1#2##Production #10#11#9##S ales #10#10#10##Ending
#1#2#1#######Variable costing net operating income
#P16,847#P16,847#P16,847#######Fixed manufacturing overhead in beginning
inventory* #P15,315#P15,315#P27,846##Fixed manufacturing overhead in ending
inventory #P15,315#P27,846#P17,017##Absorption costing net operating income
#P16,847#P29,378#P6,018##* Fixed manufacturing overhead in beginning
inventory is assumed in both parts 1 and 2 for Year 1. A FIFO inventory flow
assumption is used.Part 2:#Year 1#Year 2#Year 3##Beginning inventory
#1#1#4##Production #10#12#20##S ales #10#9#8##Ending
#1#4#16#######Variable costing net operating income (loss)
#P16,847#(P18,153)#(P53,153)#######Fixed manufacturing overhead in beginning
inventory* #P15,315#P15,315#P51,051##Fixed manufacturing overhead in ending
inventory #P15,315#P51,051#P122,522##Absorption costing net operating income
#P16,847#P17,583#P18,318##* Fixed manufacturing overhead in beginning
inventory is assumed in both parts 1 and 2 for Year 1. A FIFO inventory flow
assumption is used.III. ProblemsProblem 1Requirement 1: Variable Costing Method
Romero Parts, Inc.Income S tatement - ManufacturingFor the Year Ended December 31,
2005 S ales P20,700,000 Less: Variable Cost of S ales
Inventory, Jan. 1 P1,155,000 Current Production 7,700,000
Total Available for S ale P8,855,000 Inventory, Dec. 31
805,000 8,050,000 Contribution Margin P12,650,000 Less Fixed
Costs and Expenses 6,000,000 Net Income P 6,650,000
Requirement 2: Absorption Costing MethodRomero Parts, Inc.Income S tatement -
ManufacturingFor the Year Ending December 31, 2006 S ales P26,100,000 Less
Cost of goods sold: Inventory, Jan. 1 P 1,380,000
Current Production 16,100,000 Total Available for S ale
P17,480,000 Inventory, Dec. 31 747,500 Cost
of S ales - S tandard P16,732,500 Favorable Capacity Variance
900,000 15,832,500 Income from Manufacturing P10,267,500
Requirement 3: Variable Costing MethodRomero Parts, Inc.Income S tatement -
ManufacturingFor the Year Ending December 31, 2006 S ales P26,100,000
Less Variable Cost of S ales: Inventory, Jan. 1 P
805,000 Production 9,800,000 Total Available for S ale
P10,605,000 Inventory, Dec. 31 455,000
10,150,000 Contribution Margin - Manufacturing P15,950,000 Less Fixed Cost
5,400,000 Income from Manufacturing P10,550,000Reconciliation
Net Income, absorption costing P10,267,500 Add Fixed Factory
Overhead Inventory, 1/1 575,000 Total P10,842,500 Less
Fixed Factory Overhead Inventory, 12/31 292,500 Net Income, direct
costing P10,550,000Problem 2Requirement 1Honey CompanyIncome S tatement -
Direct Costing For the Year Ended December 31, 2005 S ales P280,000
Less Variable Cost of S ales: Finished Goods Inventory, 1/1 P
4,000 Current Production 120,000 Total Available for S ale
P124,000 Finished Goods Inventory, 12/31 12,000
Variable Cost of S ale - S tandard P112,000 Unfavorable Variance
5,000 117,000 Contribution Margin - Manufacturing P163,000 Less
Variable Marketing Expenses 28,000 Contribution Margin - Final
P135,000 Less Fixed Costs and Expenses: Fixed Factory Overhead
P 54,000 Fixed Marketing and Administrative Expenses
20,000 74,000 Net Income P 61,000 Requirement 2Honey
CompanyIncome S tatement - Absorption Costing For the Year Ended December 31, 2005
S ales P280,000 Less: Cost of S ales Finished goods
inventory, Jan. 1 (1,000 x P5.50) P 5,500 Current production
costs Variable (30,000 x P4.00) P120,000
Fixed (30,000 x P1.50) 45,000 165,000
P170,500 Less: Finished goods inventory, Dec. 31 (3,000
x P5.50) 16,500 Cost of S ales - at S tandard P154,000
Add (Deduct) Variance Unfavorable variable manufacturing
costs variances 5,000 Underapplied fixed
factory overhead (6,000 x P1.50) 9,000
Cost of S ales - Actual P168,000 Gross Profit P112,000 Less:
S elling and administrative expenses Variable 28,000
Fixed 20,000 P 48,000 Net Income
P 64,000 Problem 3 (Variable Costing Income S tatement; Reconciliation)
Requirement 1The unit product cost under the variable costing approach would be
computed as follows:Direct materials #P#########################
8#####D#i#r#e#c#t# #l#a#b#o#r# ###1#0#####V#a#r#i#a#b#l#e#
#m#a#n#u#f#a#c#t#u#r#i#n#g# #o#v#e#r#h#e#a#d# ###�# #�#�#2#####U#n#i#t#
#p#r#o#d#u#c#t# #c#o#s#t# ###P#2#0######W #i#t#h# #t#h#i#s# #f#i#g#u#r#e#,#
#t#h#e# #v#a#r#i#a#b#l#e# #c#o#s#t#i#n#g# #i#n#c#o#m#e# #s#t#a#t#e#m#e#n#t#s#
#c#a#n# #b#e# #p#r#e#p#a#r#e#d#:#####Y#e#a#r# #1###Y#e#a#r# #2#####S #a#l#e#s#
###P#1#,#0#0#0#,#0#0#0###P#1#,#5#0#0#,#0#0#0#####L#e#s#s# #v#a#r#i#a#b#l#e#
#e#x#p#e#n#s#e#s#:######### #V#a#r#i#a#b#l#e# #c#o#s#t# #o#f# #g#o#o#ds sold @
P20 per unit #400,000#600,000## Variable selling and administrative
@ P3 per unit #������60,000#������90,000##Total variable expenses
#����460,000#����690,000##Contribution margin
#����540,000#����810,000##Less fixed expenses:#### Fixed manufacturing
overhead #350,000#350,000## Fixed selling and administrative
#����250,000#����250,000##Total fixed expenses #����600,000#����600,000##Net
operating income (loss) #P���(60,000)#P��210,000##Requirement 2Variable costing net
operating income (loss) #P���(60,000)#P���210,000##Add: Fixed manufacturing
overhead cost deferred in inventory under absorption costing (5,000 units � P14 per
unit) #70,000###Deduct: Fixed manufacturing overhead cost released from inventory
under absorption costing (5,000 units � P14 per unit) #
���������������#�����(70,000)##Absorption costing net operating income
#P����10,000#P���140,000##Problem 4 (Prepare and Interpret S tatements;
Changes in Both S ales and Production; JIT)Requirement 1#Year 1#Year 2#Year 3##S ales
#P1,000,000#P�800,000#P1,000,000##Less variable expenses:##### Variable
cost of goods sold @ P4 per unit
#200,000#160,000#200,000##Variable selling and administrative
@ P2 per unit #����100,000# �����80,000#���100,000##Total variable
expenses #����300,000# ���240,000#���300,000##Contribution margin
#����700,000# ���560,000#���700,000##Less fixed expenses:#####Fixed
manufacturing overhead #600,000#600,000#600,000##Fixed selling and administrative
#������70,000#� ����70,000#������70,000##Total fixed expenses#
###�#�#�#�#6#7#0#,#0#0#0###�#
#�#�#6#7#0#,#0#0#0###�#�#�#�#6#7#0#,#0#0#0#####N#e#t# #o#p#e#r#a#t#i#n#g#
#i#n#c#o#m#e# #(#l#o#s#s#)#
###P#�#�#�#�#3#0#,#0#0#0###P#(#1#1#0#,#0#0#0#)###P#�#�#�#�#3#0#,#0#0#0#####
#R#e#q#u#i#r#e#m#e#n#t# #2###a#.####Y#e#a#r# #1###Y#e#a#r# #2###Y#e#a#r#
#3#####V#a#r#i#a#b#l#e# #m#a#n#u#f#a#c#t#u#r#i#n#g# #c#o#s#t# ###P## 4###P##
4###P## 4#####F#i#x#e#d# #m#a#n#u#f#a#c#t#u#r#i#n#g# #c#o#s#t#:###########
#P#6#0#0#,#0#0#0# #�# #5#0#,#0#0#0# #u#n#i#t#s# ###1#2#########
#P#6#0#0#,000 � 60,000 units ##10### P600,000 � 40,000 units #� ����#�
����#� 15##Unit product cost #P16#P14#P19##b.Variable costing net operating income
(loss) #P30,000#P(110,000)#P�30,000##Add (Deduct): Fixed
manufacturing overhead cost deferred in inventory from Year 2 to Year 3 under
absorption costing (20,000 units � P10 per unit) ##200,000#(200,000)##Add:
Fixed manufacturing overhead cost deferred in inventory from Year 3 to the future
under absorption costing (10,000 units � P15 per unit) # �����������#
�������������# �150,000##Absorption costing net operating income (loss)
#P30,000#P��90,000#P(20,000)##Requirement 3Production went up sharply in Year
2 thereby reducing the unit product cost, as shown in (2a). This reduction in
cost, combined with the large amount of fixed manufacturing overhead cost deferred
in inventory for the year, more than offset the loss of revenue. The net result is
that the company�s net operating income rose even though sales were down.
Requirement 4The fixed manufacturing overhead cost deferred in inventory from Year
2 was charged against Year 3 operations, as shown in the reconciliation in (2b).
This added charge against Year 3 operations was offset somewhat by the fact that
part of Year 3�s fixed manufacturing overhead costs was deferred in inventory to
future years [again see (2b)]. Overall, the added costs charged against Year 3 were
greater than the costs deferred to future years, so the company reported less
income for the year even though the same number of units was sold as in Year 1.
Requirement 5a. S everal things would have been different if the company had been
using JIT inventory methods. First, in each year production would have been geared
to sales so that little or no inventory of finished goods would have been built up
in either Year 2 or Year 3. S econd, unit product costs probably would have been the
same in all three years, since these costs would have been established on the basis
of expected sales (50,000 units) for each year. Third, since only 40,000 units
were sold in Year 2, the company would have produced only that number of units and
therefore would have had some underapplied overhead cost for the year. (S ee the
discussion on underapplied overhead in the following paragraph.)b. If JIT had
been in use, the net operating income under absorption costing would have been the
same as under variable costing in all three years. The reason is that with
production geared to sales, there would have been no ending inventory on hand, and
therefore there would have been no fixed manufacturing overhead costs deferred in
inventory to other years. Assuming that the company expected to sell 50,000 units
in each year and that unit product costs were set on the basis of that level of
expected activity, the income statements under absorption costing would have
appeared as follows:#Year 1#Year 2#Year 3##S ales
#P1,000,000#P�800,000#P1,000,000##Less cost of goods sold:#####Cost of goods
manufactured @ P16 per unit #800,000#640,000#* 800,000##Add underapplied
overhead # ���������������#��� 120,000#** ���������������##Cost of goods sold
#����800,000#��� 760,000#����800,000##Gross margin #200,000#
40,000#200,000##S elling and administrative expenses #� ��170,000#
���150,000#����170,000##Net operating income (loss)
#P����30,000#P(110,000)#P����30,000##* 40,000 units � P16 per unit =
P640,000.** 10,000 units not produced � P12 per unit fixed manufacturing overhead
cost = P120,000 fixed manufacturing overhead cost not applied to products.
Problem 5 (Contrasting Variable and Absorption Costing) Requirement 1 (a) Under
absorption costing, all manufacturing costs, variable and fixed, are included in
unit product costs:#Year 1#Year 2##Direct materials#P11#P11##Direct
labor#6#6##Variable manufacturing overhead#3#3##Fixed manufacturing overhead####
(P120,000 ( 10,000 units)#12### (P120,000 ( 6,000 units)#
#20##Unit product cost#P32#P40## Requirement 1 (b) The absorption costing
income statements follow:#Year 1#Year 2##S ales (8,000 units x P50 per
unit)##P400,000##P400,000##Cost of goods sold:###### Beginning inventory#P
0##P 64,000###Add cost of goods manufactured (10,000 units x P32 per unit; 6,000
units x P40 per unit)# 320,000##240,000###Goods available for
sale#320,000##304,000###Less ending inventory###### (2,000 units x P32 per unit;
0 units x P40 per unit)# 64,000# 256,000# 0# 304,000##Gross
margin##144,000##96,000##S elling and administrative expenses (8,000 units x P4 per
unit + P70,000)## 102,000# # 102,000##Net operating income##P 42,000##P
(6,000)## Requirement 2 (a) Under variable costing, only the variable
manufacturing costs are included in unit product costs:#Year 1#Year 2##Direct
materials#P11#P11##Direct labor#6#6##Variable manufacturing overhead# 3#
3##Unit product cost#P20#P20## Requirement 2 (b) The variable costing income
statements follow. Notice that the variable cost of goods sold is computed in a
simpler, more direct manner than in the examples provided earlier. On a variable
costing income statement, this simple approach or the more complex approach
illustrated earlier is acceptable for computing the cost of goods sold.#Year 1#Year
2##S ales (8,000 units x P50 per unit)##P400,000##P400,000##Variable expenses:######
Variable cost of goods sold (8,000 units x P20 per unit)
#P160,000##P160,000###Variable selling and administrative (8,000 units x P4 per
unit)# 32,000# 192,000# 32,000# 192,000##Contribution
margin##208,000##208,000##Fixed expenses:###### Fixed manufacturing
overhead#120,000##120,000###Fixed selling and administrative expenses# 70,000#
190,000# 70,000# 190,000##Net operating income##P 18,000##P 18,000##
Requirement 3 The reconciliation of the variable and absorption costing
net operating incomes follows:#Year 1#Year 2##Variable costing net operating
income#P18,000#P18,000##Add fixed manufacturing overhead costs deferred in
inventory under absorption costing (2,000 units x P12 per unit)#24,000###Deduct
fixed manufacturing overhead costs released from inventory under absorption costing
(2,000 units x P12 per unit)# #(24,000)##Absorption costing net operating
income #P42,000#P(6,000)##Problem 6 (Variable Costing Income S tatement;
Reconciliation) Requirement 1 #S ales (40,000 units � P33.75 per unit)
##P1,350,000###Variable expenses:#####Variable cost of goods sold #(40,000
units � P16 per unit*) #P640,000####Variable selling and administrative expenses
#(40,000 units � P3 per unit) #�120,000#���760,000###Contribution margin
##590,000#############Fixed expenses:#####Fixed manufacturing overhead
#250,000####Fixed selling and administrative expenses
#�300,000#����550,000###Net operating income ##P����40,000##*#Direct
materials #P10###Direct labor #4###Variable manufacturing overhead
#���2###Total variable manufacturing cost #P16## Requirement 2
The difference in net operating income can be explained by the P50,000 in
fixed manufacturing overhead deferred in inventory under the absorption costing
method:Variable costing net operating income #P40,000##Add: Fixed manufacturing
overhead cost deferred in inventory under absorption costing: 10,000 units � P5 per
unit in fixed manufacturing overhead cost #�50,000##Absorption costing net
operating income #P90,000##IV. Multiple Choice Questions
D#B##B#A##B#C##B#D##B#B##C#A##A#C##B#C##A#B##A#C##CHAPTER 13COS T-VOLUME-PROFIT
RELATIONS HIPS I. Questions1. The total �contribution margin� is the excess of
total revenue over total variable costs. The unit contribution margin is the
excess of the unit price over the unit variable costs.2. Total contribution
margin: S elling price - manufacturing variable costs expensed -
nonmanufacturing variable costs expensed = Total contribution margin. Gross
margin: S elling price - variable manufacturing costs expensed - fixed
manufacturing costs expensed = Gross margin.3. A company operating at �break-even�
is probably not covering costs which are not recorded in the accounting records.
An example of such a cost is the opportunity cost of owner-invested capital. In
some small businesses, owner-managers may not take a salary as large as the
opportunity cost of forgone alternative employment. Hence, the opportunity cost of
owner labor may be excluded.4. In the short-run, without considering asset
replacement, net operating cash flows would be expected to exceed net income,
because the latter includes depreciation expense, while the former does not. Thus,
the cash basis break-even would be lower than the accrual break-even if asset
replacement is ignored. However, if asset replacement costs are taken into
account, (i.e., on a �cradle to grave� basis), the long-run net cash flows equal
long-run accrual net income, and the long-run break-even points are the same.5.
Both unit price and unit variable costs are expressed on a per product basis,
as:( = (P1 - V1) X1 + (P2 - V2) X2 + ( + (Pn - Vn) Xn - F, for
all products 1 to n where:( = operating profit,P = average unit
selling price,V = average unit variable cost,X = quantity of units,F
= total fixed costs for the period.6. If the relative proportions of
products (i.e., the product �mix�) is not held constant, products may be
substituted for each other. Thus, there may be almost an infinite number of ways
to achieve a target operating profit. As shown from the multiple product profit
equation, there are several unknowns for one equation:( = (P1 - V1) X1 + (P2
- V2) X2 + ( + (Pn - Vn) Xn - F, for all products 1 to n.7. A constant
product mix is assumed to simplify the analysis. Otherwise, there may be no unique
solution.8. Operating leverage measures the impact on net operating income of a
given percentage change in sales. The degree of operating leverage at a given
level of sales is computed by dividing the contribution margin at that level of
sales by the net operating income.9. Three approaches to break-even analysis
are (a) the equation method, (b)
the contribution margin method, and (c) the graphical method. In the equation
method, the equation is: S ales = Variable expenses + Fixed expenses + Profits,
where profits are zero at the break-even point. The equation is solved to
determine the break-even point in units or peso sales.10. The margin of safety is
the excess of budgeted (or actual) sales over the break-even volume of sales. It
states the amount by which sales can drop before losses begin to be incurred.11.
The sales mix is the relative proportions in which a company�s products are
sold. The usual assumption in cost-volume-profit analysis is that the sales mix
will not change.12. A higher break-even point and a lower net operating income
could result if the sales mix shifted from high contribution margin products to low
contribution margin products. S uch a shift would cause the average contribution
margin ratio in the company to decline, resulting in less total contribution margin
for a given amount of sales. Thus, net operating income would decline. W ith a
lower contribution margin ratio, the break-even point would be higher since it
would require more sales to cover the same amount of fixed costs.13. The
contribution margin (CM) ratio is the ratio of the total contribution margin to
total sales revenue. It can be used in a variety of ways. For example, the change
in total contribution margin from a given change in total sales revenue can be
estimated by multiplying the change in total sales revenue by the CM ratio. If
fixed costs do not change, then a peso increase in contribution margin will result
in a peso increase in net operating income. The CM ratio can also be used in break-
even analysis. Therefore, knowledge of a product�s CM ratio is extremely helpful in
forecasting contribution margin and net operating income.14. Incremental
analysis focuses on the changes in revenues and costs that will result from a
particular action.15. All other things equal, Company B, with its higher fixed
costs and lower variable costs, will have a higher contribution margin ratio than
Company A. Therefore, it will tend to realize a larger increase in contribution
margin and in profits when sales increase.16. (a) If the selling price decreased,
then the total revenue line would rise less steeply, and the break-even point would
occur at a higher unit volume. (b) If the fixed cost increased, then both the fixed
cost line and the total cost line would shift upward and the break-even point would
occur at a higher unit volume. (c) If the variable cost increased, then the total
cost line would rise more steeply and the break-even point would occur at a higher
unit volume.II. ExercisesExercise 1 (Using a Contribution Format Income
S tatement)Requirement 1#Total#Per Unit##S ales (30,000 units � 1.15 = 34,500 units)
#P172,500#P5.00##Less variable expenses #� 103,500# �3.00##Contribution
margin #69,000#P2.00##Less fixed expenses #� ��50,000###Net operating income

#P#################################################################################
###################################################################################
##################################################################
1#9#,#0#0#0################R#e#q#u#i#r#e#m#e#n#t# #2###S #a#l#e#s# #(#3#0#,#0#0#0#
#u#n#i#t#s# #�# #1#.#2#0# #=# #3#6#,#0#0#0# #u#n#i#t#s#)#
###P#1#6#2#,#0#0#0###P#4#.#5#0#####L#e#s#s# #v#a#r#i#a#b#l#e#
#e#x#p#e#n#s#e#s# ###�# #1#0#8#,#0#0#0###�# #3#.#0#0#####C#o#n#t#r#i#b#u#t#i#o#n#
#m#a#r#g#i#n# ###5#4#,#0#0#0###P#1#.#5#0#####L#e#s#s# #f#i#x#e#d#
#e#x#p#e#n#s#e#s# ###�#�#�# #5#0#,#0#0#0#######N#e#t# #o#p#e#r#a#t#i#n#g#
#i#n#c#o#m#e# ###P# ## 4#,#0#0#0###############R#e#q#u#i#r#e#m#e#n#t# #3##
#S #a#l#e#s# #(#3#0#,#0#0#0# #u#n#i#t#s# #�# #0#.#9#5# #=# #2#8#,#5#0#0#
#u#n#i#t#s#)# ###P#1#5#6#,#7#5#0###P#5#.#5#0#####L#e#s#s# #v#a#r#i#a#b#l#e#
#e#x#p#e#n#s#e#s# ###�# #�#�#8#5#,#5#0#0###�# #3#.#0#0#####C#o#n#t#r#i#b#u#t#i#o#n#
#m#a#r#g#i#n# ###7#1#,#2#5#0###P#2#.#5#0#####L#e#s#s# #f#i#x#e#d#
#e#x#p#e#n#s#e#s# #(#P#5#0#,#0#0#0# #+# #P#1#0#,#0#0#0#)# ###�#
#�#�#6#0#,#0#0#0#######N#e#t# #o#p#e#r#a#t#i#n#g# #i#n#c#o#m#e# ###P##
1#1#,#2#5#0###############R#e#q#u#i#r#e#m#e#n#t# #4###S #a#l#e#s# #(#3#0#,#0#0#0#
#u#n#i#t#s# #�# #0#.#9#0# #=# #2#7#,#0#0#0# #u#n#i#t#s#)#
###P#1#5#1#,#2#0#0###P#5#.#6#0#####L#e#s#s# #v#a#r#i#a#b#l#e#
#e#x#p#e#n#s#e#s# ###�# #�#�#8#6#,#4#0#0###�# #3#.#2#0#####C#o#n#t#r#i#b#u#t#i#o#n#
#m#a#r#g#i#n# ###6#4#,#8#0#0###P#2#.#4#0#####L#e#s#s# #f#i#x#e#d#
#e#x#p#e#n#s#e#s# ###�# #�#�#5#0#,#0#0#0#######N#e#t# #o#p#e#r#a#t#i#n#g#
#i#n#c#o#m#e# ###P## 1#4#,#8#0#0########E#x#e#r#c#i#s#e# #2# #(#B#r#e#a#k#-
#e#v#e#n# #A#n#a#l#y#s#i#s# #a#n#d# #C#V#P# #G#r#a#p#h#i#n#g#)##
#R#e#q#u#i#r#e#m#e#n#t# #1## The contribution margin per person would be:Price per
ticket ##P30##Less variable expenses:####Dinner #P7###Favors and program
#� 3#� 10##Contribution margin per person ##P20## The fixed expenses
of the Extravaganza total P8,000; therefore, the break-even point would be computed
as follows:S ales #=#Variable expenses + Fixed expense + Profits######P30Q#=#P10Q +
P8,000 + P0##P20Q#=#P8,000##Q#=#P8,000 � P20 per person##Q#=#400 persons; or, at
P30 per person, P12,000## Alternative solution:#
or, at P30 per person, P12,000. Requirement 2Variable cost per
person (P7 + P3) #P10##Fixed cost per person (P8,000 � 250 persons) #�
32##Ticket price per person to break even #P42## Requirement 3 Cost-volume-
profit graph:## EMBED MS Graph.Chart.8 \s ### Exercise 3 (Break-even and Target
Profit Analysis)Requirement 1S ales#=#Variable expenses + Fixed expenses +
Profits##P900Q#=#P630Q + P1,350,000 + P0##P270Q#=#P1,350,000##Q#=#P1,350,000 � P270
per lantern##Q#=#5,000 lanterns, or at P900 per lantern, P4,500,000 in sales##
Alternative solution:# or at P900 per lantern,
P4,500,000 in salesRequirement 2An increase in the variable expenses as a
percentage of the selling price would result in a higher break-even point. The
reason is that if variable expenses increase as a percentage of sales, then the
contribution margin will decrease as a percentage of sales. A lower CM ratio would
mean that more lanterns would have to be sold to generate enough contribution
margin to cover the fixed costs.Requirement 3#Present: #8,000 Lanterns #Proposed:
#10,000 Lanterns*###Total#Per Unit#Total#Per Unit##S ales
#P7,200,000#P900#P8,100,000#P810#**##Less variable expenses#� 5,040,000#
�630#� 6,300,000#� 630###Contribution margin # 2,160,000#P270#1,800,000#P180#
##Less fixed expenses #� 1,350,000##� 1,350,000####Net operating income

#P#################################################################################
###################################################################################
#### 8#1#0#,#0#0#0#####P## 4#5#0#,#0#0#0######### # ##*# #8#,#0#0#0#
#l#a#n#t#e#r#n#s# #�# #1#.#2#5# #=# #1#0#,#0#0#0# #l#a#n#t#e#r#n#s##*#*#
#P#9#0#0# #p#e#r# #l#a#n#t#e#r#n# #�# #0#.#9# #=# #P#8#1#0# #p#e#r#
#l#a#n#t#e#r#n### # #A#s# #s#h#o#w#n# #a#b#o#v#e#,# #a# #2#5#%#
#i#n#c#r#e#a#s#e# #i#n# #v#o#l#u#m#e# #i#s# #n#o#t# #e#n#o#u#g#h# #t#o#
#o#f#f#s#e#t# #a# #1#0#%# #r#e#d#u#c#t#i#o#n# #i#n# #t#h#e# #s#e#l#l#i#n#g#
#p#r#i#c#e#;# #t#h#u#s#,# #n#e#t# #o#p#e#r#a#t#i#n#g# #i#n#c#o#m#e#
#d#e#c#r#e#a#s#e#s#.#Requirement 4S ales#=#Variable expenses + Fixed expenses +
Profits##P810Q#=#P630Q + P1,350,000 + P720,000##P180Q#=#P2,070,000##Q#=#P2,070,000
� P180 per lantern##Q#=#11,500 lanterns## Alternative solution:#
Exercise 4 (Operating Leverage)Requirement 1S ales (30,000 doors)
#P18,000,000#P600##Less variable expenses #�12,600,000#� 420##Contribution
margin #5,400,000#P180##Less fixed expenses #� ��4,500,000###Net
operating income #P����900,000####Requirement 2a. S ales of 37,500 doors
represents an increase of 7,500 doors, or 25%, over present sales of 30,000 doors.
S ince the degree of operating leverage is 6, net operating income should increase
by 6 times as much, or by 150% (6 � 25%).b. Expected total peso net operating
income for the next year is:Present net operating income #P 900,000##Expected
increase in net operating income next year (150% � P900,000) #�
1,350,000##Total expected net operating income #P2,250,000##Exercise 5
(Multiproduct Break-even Analysis)Requirement 1#Model E700#Model J1500#Total
Company###Amount#%#Amount#%#Amount#%###S ales
#P700,000#100#P300,000#100#P1,000,000#100###Less variable expenses #�
280,000#�40#� ��90,000#�30#�� ��370,000#�37###Contribution margin
#P420,000#�60#P210,000#�70#630,000#�63#*##Less fixed expenses #####��
��598,500####Net operating income #####P ����31,500#### * 630,000 �
P1,000,000 = 63%.Requirement 2 The break-even point for the company as a
whole would be: #######Requirement 3The additional contribution margin from the
additional sales can be computed as follows:P50,000 � 63% CM ratio = P31,500
Assuming no change in fixed expenses, all of this additional contribution margin
should drop to the bottom line as increased net operating income.This answer
assumes no change in selling prices, variable costs per unit, fixed expenses, or
sales mix.Exercise 6 (Break-even Analysis; Target Profit; Margin of S afety)
Requirement 1S ales#=#Variable expenses + Fixed expenses + Profits##P40Q#=#P28Q +
P150,000 + P0##P12Q#=#P150,000##Q#=#P150,000 � P12 per unit##Q#=#12,500 units, or
at P40 per unit, P500,000##Alternatively:# or, at P40 per unit,
P500,000.Requirement 2The contribution margin at the break-even point is P150,000
since at that point it must equal the fixed expenses.Requirement 3#
#Total#Unit##S ales (14,000 units � P40 per unit) #P560,000#P40##Less variable
expenses #(14,000 units � P28 per unit) #� 392,000#� 28##Contribution margin
#(14,000 units � P12 per unit) #168,000#P12##Less fixed expenses #�
1#5#0#,#0#0#0#######N#e#t# #o#p#e#r#a#t#i#n#g#
#i#n#c#o#m#e# ###P## 1#8#,#0#0#0########R#e#q#u#i#r#e#m#e#n#t# #4##
#M#a#r#g#i#n# #o#f# #s#a#f#e#t#y# #i#n# #p#e#s#o# #t#e#r#m#s#:###M#a#r#g#i#n# #o#f#
#s#a#f#e#t#y# #i#n# #p#e#s#o#s# #=# #T#o#t#a#l# #s#a#l#e#s# # ##
#B#r#e#a#k#-#e#v#e#n# #s#a#l#e#s### # # # # # # #=#
#P#6#0#0#,#0#0#0# ## #P#5#0#0#,#0#0#0# #=# #P#1#0#0#,#0#0#0# ###
#M#a#r#g#i#n# #o#f# #s#a#f#e#t#y# #i#n# #p#e#r#c#e#n#t#a#g#e# #t#e#r#m#s#:#
######### ##R#e#q#u#i#r#e#m#e#n#t# #5###T#h#e# #C#M# #r#a#t#i#o# #i#s# #3#0#%#.##
#E#x#p#e#c#t#e#d# #t#o#t#a#l# #c#o#n#t#r#i#b#u#t#i#o#n# #m#a#r#g#i#n#:#
#P#6#8#0#,#0#0#0# #�# #3#0#%# ###P#2#0#4#,#0#0#0#####P#r#e#s#e#n#t# #t#o#t#a#l#
#c#o#n#t#r#i#b#u#t#i#o#n# #m#a#r#g#i#n#:# #P#6#0#0#,#0#0#0# #�# #3#0#%# ###�#
#1#8#0#,#0#0#0#####I#n#c#r#e#a#s#e#d# #c#o#n#t#r#i#b#u#t#i#o#n# #m#a#r#g#i#n#
###P## 2#4#,#0#0#0##### # ##A#l#t#e#r#n#a#t#i#v#e# #s#o#l#u#t#i#o#n#:##
#P#8#0#,#0#0#0# #i#n#c#r#e#m#e#n#t#a#l# #s#a#l#e#s# #�# #3#0#%# #C#M# #r#a#t#i#o#
#= P24,000S ince in this case the company�s fixed expenses will not change, monthly
net operating income will increase by the amount of the increased contribution
margin, P24,000. Exercise 7 (Changes in Variable Costs, Fixed Costs, S elling
Price, and Volume)Requirement (1)The following table shows the effect of the
proposed change in monthly advertising budget:###S ales
W ith######Additional#####Current#Advertising#####S ales#Budget#Difference###S ales
#P225,000#P240,000#P15,000###Variable expenses
#�135,000#�144,000#���9,000###Contribution margin
#90,000#96,000#6,000###Fixed expenses #��75,000#� �83,000#���8,000###Net
operating income #P�15,000#P�13,000#P(2,000)## Assuming that there are no
other important factors to be considered, the increase in the advertising budget
should not be approved since it would lead to a decrease in net operating income of
P2,000. Alternative S olution 1#Expected total contribution
margin:#P240,000 � 40% CM ratio #P96,000###Present total contribution
margin:#P225,000 � 40% CM ratio #�90,000###Incremental contribution margin
#6,000###Change in fixed expenses:#Less incremental advertising expense
#���8,000###Change in net operating income #P(2,000)## Alternative
S olution 2#Incremental contribution margin:# P15,000 � 40% CM ratio
#P�6,000###Less incremental advertising expense #���8,000###Change in net
operating income #P(2,000)##Requirement (2) The P3 increase in variable
costs will cause the unit contribution margin to decrease from P30 to P27 with the
following impact on net operating income:#Expected total contribution margin with
the higher-quality components:#3,450 units � P27 per unit #P93,150###Present total
contribution margin:#3,000 units � P30 per unit #� 90,000###Change in total
contribution margin #P �3,150## Assuming no change in fixed costs and all
other factors remain the same, the higher-quality components should be used.
Exercise 8 (Compute the Margin of S afety)Requirement (1) To compute
the margin of safety, we must first compute the break-even unit sales.#S ales#=
Variable expenses + Fixed expenses + Profits###P25Q#= P15Q + P8,500 + P0###P10Q#=
P8,500###Q#= P8,500 � P10 per unit###Q#= 850 units###S ales (at the budgeted volume
of 1,000 units) #P25,000###Break-even sales (at 850 units) # �21,250###Margin
of safety (in pesos) #P �3,750##Requirement (2) The margin of safety as
a percentage of sales is as follows:#Margin of safety (in pesos) #P3,750###� S ales
#P25,000###Margin of safety as a percentage of sales #15.0%## Exercise 9
(Compute and Use the Degree of Operating Leverage)Requirement (1) The
company�s degree of operating leverage would be computed as follows:#Contribution
margin #P36,000###� Net operating income #P12,000###Degree of operating
leverage #3.0##Requirement (2) A 10% increase in sales should result in
a 30% increase in net operating income, computed as follows:#Degree of operating
leverage #3.0###� Percent increase in sales #�10%###Estimated percent increase
in net operating income #�30%##Requirement (3) The new income statement
reflecting the change in sales would be:##Amount#Percent of S ales###S ales
#P132,000#100%###Variable expenses #�� 92,400#�70%###Contribution margin
#39,600#�30%###Fixed expenses #�� 24,000####Net operating income #P�15,600###
#Net operating income reflecting change in sales #P15,600###Original net
operating income #P12,000###Percent change in net operating income #30%##
Exercise 10 (Compute the Break-Even Point for a Multiproduct Company)
Requirement (1) The overall contribution margin ratio can be computed as
follows:#Requirement (2) The overall break-even point in sales pesos can
be computed as follows:#Requirement (3) To construct the required income
statement, we must first determine the relative sales mix for the two products:
##Ping#Pong#Total###Original peso sales #P100,000#P50,000#P150,000###Percent of
total #67%#33%#100%###S ales at break-even
#P75,000#P37,500#P112,500##########Ping#Pong#Total###S ales
#P75,000#P37,500#P112,500###Variable expenses*
#�18,750#���3,750#��22,500###Contribution margin
#P56,250#P33,750#90,000###Fixed expenses ###��90,000###Net operating income
###P��������0##*Ping variable expenses: (P75,000/P100,000) � P25,000 =
P18,750 Pong variable expenses: (P37,500/P50,000) � P5,000 = P3,750 Exercise 11
(Break-Even and Target Profit Analysis)Requirement (1) Variable expenses:
P60 � (100% � 40%) = P36.Requirement (2)#a.#S elling price #P60#100%####Variable
expenses #� 36#�60%####Contribution margin #P24#�40%## Let Q =
Break-even point in units.S ales#=#Variable expenses + Fixed expenses +
Profits##P60Q#=#P36Q + P360,000 + P0##P24Q#=#P360,000##Q#=#P360,000 � P24 per
unit##Q#=#15,000 units## In sales pesos: 15,000 units � P60 per
unit = P900,000 Alternative solution:Let X#=#Break-even point in
sales pesos.##X#=#0.60X + P360,000 + P0##0.40X#=#P360,000##X#=#P360,000 �
0.40##X#=#P900,000## In units: P900,000 � P60 per unit = 15,000
units #b.#P60Q#=#P36Q + P360,000 + P90,000####P24Q#=#P450,000####Q#=#P450,000 � P24
per unit####Q#=#18,750 units## In sales pesos: 18,750 units � P60
per unit = P1,125,000 Alternative solution:X#=#0.60X + P360,000 +
P90,000##0.40X#=#P450,000##X#=#P450,000 � 0.40##X#=#P1,125,000## In
units: P1,125,000 � P60 per unit = 18,750 units c. The company�s new
cost/revenue relationships will be:S elling price #P60#100%##Variable expenses
(P36 � P3) #�33#�55%##Contribution margin #P27#�45%##P60Q#=#P33Q + P360,000 +
P0##P27Q#=#P360,000##Q#=#P360,000 � P27 per unit##Q#=#13,333 units (rounded).##
In sales pesos: 13,333 units � P60 per unit = P800,000 (rounded)
Alternative solution:X#=#0.55X + P360,000 +
P0##0.45X#=#P360,000##X#=#P360,000 � 0.45##X#=#P800,000## In units:
P800,000 � P60 per unit = 13,333 units (rounded)Requirement (3)#a.
In sales pesos: 15,000 units � P60 per unit = P900,000
Alternative solution:# In units: P900,000 � P60 per
unit = 15,000 units#b. In sales pesos: 18,750 units � P60 per unit =
P1,125,000 Alternative solution:# In units:
P1,125,000 � P60 per unit = 18,750 units#c. In sales pesos: 13,333
units � P60 per unit = P800,000 (rounded) Alternative solution:#
In units: P800,000 � P60 per unit = 13,333 (rounded) Exercise 12
(Operating Leverage)Requirement (1)#S ales (30,000 doors)
#P1,800,000#P60###Variable expenses #�1,260,000#�42###Contribution margin
#540,000#P18###Fixed expenses #����450,000####Net operating income
#P����90,000########Requirement (2) a. S ales of 37,500 doors
represents an increase of 7,500 doors, or 25%, over present sales of 30,000 doors.
S ince the degree of operating leverage is 6, net operating income should increase
by 6 times as much, or by 150% (6 � 25%). b. Expected total peso net
operating income for the next year is:Present net operating income

#P#################################################################################
###################################################################################
#################### 9#0#,#0#0#0#####E#x#p#e#c#t#e#d# #i#n#c#r#e#a#s#e# #i#n#
#n#e#t# #o#p#e#r#a#t#i#n#g# #i#n#c#o#m#e# #n#e#x#t# #y#e#a#r# #(#1#5#0#%# #�#
#P#9#0#,#0#0#0#)# ###�#1#3#5#,#0#0#0#####T#o#t#a#l# #e#x#p#e#c#t#e#d# #n#e#t#
#o#p#e#r#a#t#i#n#g# #i#n#c#o#m#e# ###P#2#2#5#,#0#0#0######I#I#I#.#
#P#r#o#b#l#e#m#s### #P#r#o#b#l#e#m# #1# #(#C#V#P#
#R#e#l#a#t#i#o#n#s#h#i#p#s#)###R#e#q#u#i#r#e#m#e#n#t# #1############
#R#e#q#u#i#r#e#m#e#n#t# #2###S #a#l#e#s###=###V#a#r#i#a#b#l#e#
#e#x#p#e#n#s#e#s# #+# #F#i#x#e#d# #expenses + Profits##P60Q#=#P45Q + P240,000 +
P0##P15Q#=#P240,000##Q#=#P240,000 � P15 per unit##Q#=#16,000 units, or at P60 per
unit, P960,000##Alternative solution:X#=#0.75X + P240,000 + P0##0.25X #=#P240,000
##X#=#P240,000 � 0.25##X#=#P960,000; or at P60 per unit, 16,000 units##Requirement
3 Increase in sales P400,000 Multiply by the CM ratio x
25% Expected increase in contribution margin P100,000S ince the fixed
expenses are not expected to change, net operating income will increase by the
entire P100,000 increase in contribution margin computed above.Requirement 4
S ales#=#Variable expenses + Fixed expenses + Profits##P60Q#=#P45Q + P240,000 +
P90,000##P15Q#=#P330,000##Q#=#P330,000 � P15 per unit##Q#=#22,000 units##
Contribution margin method:#Requirement 5Margin of safety in pesos = Total
sales � Break-even sales =
P1,200,000 � P960,000 = P240,000 #Requirement 6##a. b.
Expected increase in sales 8% Degree of operating leverage
x 5 Expected increase in net operating income 40%c.
If sales increase by 8%, then 21,600 units (20,000 x 1.08 = 21,600) will be
sold next year. The new income statement will be as follows:#Total#Per
Unit#Percent of S ales##S ales (21,600
units) #P1,296,000#P60#100%##Less variable expenses # 972,000# 45#
75%##Contribution margin #324,000#P15# 25%##Less fixed expenses #
240,000####Net operating income #P 84,000#### Thus, the P84,000 expected
net operating income for next year represents a 40% increase over the P60,000 net
operating income earned during the current year:# Note from the income
statement above that the increase in sales from 20,000 to 21,600 units has resulted
in increases in both total sales and total variable expenses. It is a common error
to overlook the increase in variable expense when preparing a projected income
statement. Requirement 7a. A 20% increase in sales would result in 24,000 units
being sold next year: 20,000 units x 1.20 = 24,000 units.#Total#Per Unit#Percent
of S ales##S ales (24,000 units) #P1,440,000#P60#100%##Less variable expenses
# 1,152,000# 48*# 80%##Contribution margin #288,000#P12# 20%##Less
fixed expenses # 210,000�####Net operating income #P 78,000#########
* P45 + P3 = P48; P48 ( P60 = 80%. � P240,000 � P30,000 = P210,000.
Note that the change in per unit variable expenses results in a change in
both the per unit contribution margin and the CM ratio.#b. #c. Yes, based on
these data the changes should be made. The changes will increase the company�s net
operating income from the present P60,000 to P78,000 per year. Although the
changes will also result in a higher break-even point (17,500 units as compared to
the present 16,000 units), the company�s margin of safety will actually be wider
than before: Margin of safety in pesos = Total sales � Break-
even sales = P1,440,000 � P1,050,000 = P390,000 As shown in
requirement (5) above, the company�s present margin of safety is only P240,000.
Thus, several benefits will result from the proposed changes.Problem 2 (Basics of
CVP Analysis; Cost S tructure)Requirement 1 The CM ratio is 30%.#Total#Per
Unit#Percentage##S ales (13,500 units) #P270,000#P20#100#%##Less variable
expenses #� 189,000#� 14#�70###Contribution margin

#P#################################################################################
###################################################################################
###################################################################################
######## 8#1#,#0#0#0###P## 6###�#3#0###%######### # #T#h#e# #b#r#e#a#k#-
#e#v#e#n# #p#o#i#n#t# #i#s#:###S #a#l#e#s###=###V#a#r#i#a#b#l#e# #e#x#p#e#n#s#e#s#
#+# #F#i#x#e#d# #e#x#p#e#n#s#e#s# #+# #P#r#o#f#i#t#s#####P#2#0#Q###=###P#1#4#Q# #+#
#P#9#0#,#0#0#0# #+# #P#0#####P# #
#6#Q###=###P#9#0#,#0#0#0#####Q###=###P#9#0#,#0#0#0# #�# #P#6# #p#e#r#
#u#n#i#t#####Q###=###1#5#,#0#0#0# #u#n#i#t#s###### # # #1#5#,#0#0#0#
#u#n#i#t#s# #�# #P#2#0# #p#e#r# #u#n#i#t# #=# #P#3#0#0#,#0#0#0# #i#n# #s#a#l#e#s###
### # #A#l#t#ernative solution:## Requirement 2Incremental contribution
margin:###P70,000 increased sales � 30% CM ratio #P21,000##Less increased
fixed costs:###Increased advertising cost #� ��8,000##Increase in monthly net
operating income #P13,000## S ince the company presently has a loss of
P9,000 per month, if the changes are adopted, the loss will turn into a profit of
P4,000 per month.Requirement 3S ales (27,000 units � P18 per unit*)
#P486,000##Less variable expenses #(27,000 units � P14 per unit)
#�378,000##Contribution margin #108,000##Less fixed expenses (P90,000 +
P35,000) #�125,000##Net operating loss #P(17,000)## *P20 � (P20 �
0.10) = P18Requirement 4S ales#=#Variable expenses + Fixed expenses + Profits##P
��20Q#=#P14.60Q* + P90,000 + P4,500##P5.40Q#=#P94,500##Q#=#P94,500 � P5.40 per
unit##Q#=#17,500 units## * P14.00 + P0.60 = P14.60. Alternative
solution:# ** P6.00 � P0.60 = P5.40.Requirement 5a.
The new CM ratio would be:#Per Unit#Percentage##S ales#P20#100#%##Less
variable expenses #���7#�35# ##Contribution margin #P13#�65#%##
The new break-even point would be:# #b. Comparative income statements
follow:#Not Automated#Automated###Total#Per Unit#%#Total#Per Unit#%##S ales (20,000
units) #P400,000#P20#100#P400,000#P20#100##Less variable expenses #� 280,000#�
14#�70#� 140,000#� ��7#�35##Contribution margin #120,000#P
�6#�30#260,000#P13#�65##Less fixed expenses #� ��90,000### �208,000####Net
operating income #P################################ 3#0#,#0#0#0#######P##
5#2#,#0#0#0##########c#.# #W #h#e#t#h#e#r# #o#r# #n#o#t# #o#n#e# #w#o#u#l#d#
#r#e#c#o#m#m#e#n#d# #t#h#a#t# #t#h#e# #c#o#m#p#a#n#y# #a#u#t#o#m#a#t#e# #i#t#s#
#o#p#e#r#a#t#i#o#n#s# #d#e#p#e#n#d#s# #o#n# #h#o#w# #m#u#c#h# #r#i#s#k# #h#e# #o#r#
#s#h#e# #i#s# #w#i#l#l#i#n#g# #t#o# #t#a#k#e#,# #a#n#d# #d#e#p#e#n#d#s#
#h#e#a#v#i#l#y# #o#n# #p#r#o#s#p#e#c#t#s# #f#o#r# #f#u#t#u#r#e# #s#a#l#e#s#.# #
#T#h#e# #p#r#o#p#o#s#e#d# #c#h#a#n#g#e#s# #w#o#u#l#d# #i#n#c#r#e#a#s#e# #t#h#e#
#c#o#m#p#a#n#y#�s fixed costs and its break-even point. However, the changes would
also increase the company�s CM ratio (from 30% to 65%). The higher CM ratio means
that once the break-even point is reached, profits will increase more rapidly than
at present. If 20,000 units are sold next month, for example, the higher CM ratio
will generate P22,000 more in profits than if no changes are made. The greatest
risk of automating is that future sales may drop back down to present levels (only
13,500 units per month), and as a result, losses will be even larger than at
present due to the company�s greater fixed costs. (Note the problem states that
sales are erratic from month to month.) In sum, the proposed changes will help the
company if sales continue to trend upward in future months; the changes will hurt
the company if sales drop back down to or near present levels. Note to the
Instructor: Although it is not asked for in the problem, if time permits you may
want to compute the point of indifference between the two alternatives in terms of
units sold; i.e., the point where profits will be the same under either
alternative. At this point, total revenue will be the same; hence, we include only
costs in our equation:Let Q#=#Point of indifference in units sold##P14Q +
P90,000#=#P7Q + P208,000##P7Q#=#P118,000##Q#=#P118,000 � P7 per unit##Q#=#16,857
units (rounded)## If more than 16,857 units are sold, the proposed plan will yield
the greatest profit; if less than 16,857 units are sold, the present plan will
yield the greatest profit (or the least loss). Problem 3 (S ales Mix; Multiproduct
Break-even Analysis) Requirement 1
#Products####S inks#Mirrors#Vanities#Total##Percentage of total sales
#32%###40%###28%###100%####S ales #P160,000#100#%#P200,000#100#
%#P140,000#100#%#P500,000#100#%##Less variable expenses #�
��48,000#�30##�160,000#�80##�� �77,000#�55##� 285,000#�57###Contribution margin
#P112,000#�70#%#P�40,000#�20#%#P�63,000#�45#%#215,000#�43#%*##Less fixed
expenses ##########� 223,600####Net operating income (loss) ##########P
(�8,600)####* P215,000 � P500,000 = 43%.Requirement 2Break-even sales:#Requirement
3 Memo to the president:Although the company met its sales budget of P500,000
for the month, the mix of products sold changed substantially from that budgeted.
This is the reason the budgeted net operating income was not met, and the reason
the break-even sales were greater than budgeted. The company�s sales mix was
planned at 48% S inks, 20% Mirrors, and 32% Vanities. The actual sales mix was 32%
S inks, 40% Mirrors, and 28% Vanities.As shown by these data, sales shifted away
from S inks, which provides our greatest contribution per peso of sales, and shifted
strongly toward Mirrors, which provides our least contribution per peso of sales.
Consequently, although the company met its budgeted level of sales, these sales
provided considerably less contribution margin than we had planned, with a
resulting decrease in net operating income. Notice from the attached statements
that the company�s overall CM ratio was only 43%, as compared to a planned CM ratio
of 52%. This also explains why the break-even point was higher than planned. W ith
less average contribution margin per peso of sales, a greater level of sales had to
be achieved to provide sufficient contribution margin to cover fixed costs.Problem
4 (Basic CVP Analysis)Requirement 1The CM ratio is 60%:S elling price #P150##100#
%##Less variable expenses #� �60##�40###Contribution margin #P�90##�60#
%##Requirement 2# Requirement 3 P450,000 increased sales � 60% CM ratio =
P270,000 increased contribution margin. S ince fixed costs will not change, net
operating income should also increase by P270,000. Requirement 4##a.
b. 6 � 15% = 90% increase in net operating income. Requirement 5#Last Year:
#28,000 units#Proposed: #42,000 units*###Total#Per Unit#Total#Per Unit##S ales
#P4,200,000#P150.00#P5,670,000#P135.00#**##Less variable expenses #
�1,680,000#� ��60.00#� 2,520,000#���60.00###Contribution margin
#2,520,000#P#######
9#0#.#0#0###3#,#1#5#0#,#0#0#0###P#�#7#5#.#0#0#######L#e#s#s# #f#i#x#e#d#
#e#x#p#e#n#s#e#s# ### #�#1#,#8#0#0#,#0#0#0#####�# #2#,#5#0#0#,#0#0#0#########N#e#t#
#o#p#e#r#a#t#i#n#g# #i#n#c#o#m#e# ###P## 7#2#0#,#0#0#0#####P##
6#5#0#,#0#0#0##########*# #2#8#,#0#0#0# #u#n#i#t#s# #�# #1#.#5# #=#
#4#2#,#0#0#0# #u#n#i#t#s##*#*# # #P#1#5#0# #p#e#r# #u#n#i#t# #�# #0#.#9#0# #=#
#P#1#3#5#.#0#0# #p#e#r# #u#n#i#t###N#o#,# #t#h#e# #c#h#a#n#g#e#s# #s#h#o#u#l#d#
#n#o#t# #b#e# #m#a#d#e#.###R#e#q#u#i#r#e#m#e#n#t# #6###Expected total contribution
margin: #28,000 units � 200% � P70 per unit* #P3,920,000##Present total
contribution margin: #28,000 units � P90 per unit #�2,520,000##Incremental
contribution margin, and the amount by which advertising can be increased with net
operating income remaining unchanged #P1,400,000##* P150 � (P60 + P20) = P70
Problem 5 (Break-Even and Target Profit Analysis)Requirement
1 The contribution margin per patch would be:S elling price ##P30##Less
variable expenses:####Purchase cost of# #t#h#e# #p#a#t#c#h#e#s#
###P#1#5#######C#o#m#m#i#s#s#i#o#n#s# #t#o# #t#h#e# #s#t#u#d#e#n#t#
#s#a#l#e#s#p#e#r#s#o#n#s# ###�#�#�#6###�# #2#1#####C#o#n#t#r#i#b#u#t#i#o#n#
#m#a#r#g#i#n# #####P## 9###### #S #i#n#c#e# #t#h#e#r#e# #a#r#e# #n#o#
#f#i#x#e#d# #c#o#s#t#s#,# #t#h#e# #n#u#m#b#e#r# #o#f# #u#n#i#t# #s#a#l#e#s#
#n#e#e#d#e#d# #t#o# #y#i#e#l#d# #t#h#e# #d#e#s#i#r#e#d# #P#7#,#2#0#0# #i#n#
#p#r#o#f#i#t#s# #c#a#n# #b#e# #o#b#t#a#i#n#e#d# #b#y# #d#i#v#i#d#i#n#g# #t#h#e#
#t#a#r#g#e#t# #p#r#o#f#i#t# #b#y# #t#h#e unit contribution margin:#######
Requirement 2 S ince an order has been placed, there is now a
�fixed� cost associated with the purchase price of the patches (i.e., the patches
can�t be returned). For example, an order of 200 patches requires a �fixed� cost
(investment) of P3,000 (200 patches � P15 per patch = P3,000). The variable costs
drop to only P6 per patch, and the new contribution margin per patch becomes:
S elling price #P30##Less variable expenses (commissions only)
#���6##Contribution margin #P24## S ince the �fixed� cost of
P3,000 must be recovered before Ms. Morales shows any profit, the break-even
computation would be:# 125 patches x P30 per patch = P3,750 in
total salesIf a quantity other than 200 patches were ordered, the answer would
change accordingly.Problem 6 Requirement 1: Break-even chart#Requirement 2:
Profit-volume graph# Problem 7 (S ales Mix; Break-Even Analysis; Margin of S afety)
Requirement (1) #a.##Hun##Yun##Total#####Pesos#%##P #%##Euros#%####S ales
#P80,000#100##P48,000#100##P128,000#100####Variable expenses #�
48,000#�60##�� �9,600#�20##����57,600#�45####Contribution margin
#P32,000#�40##P38,400#�80##70,400#�55####Fixed expenses
#######����66,000#####Net operating income #######P� �4,400###b. Break-
even sales = Fixed expenses � CM ratio = P66,000 � 0.55 =
P120,000# #Requirement (2)a.##Hun##Yun ##HY143##Total####Pesos#%##Pesos#%##Pesos#
%##Pesos#%###S ales
#P80,000#100##P48,000#100##P32,000#100##P160,000#100###Variable expenses
#� 48,000#�60##���9,600#�20##� 2,4000#�75##����81,600#�51###Contribution
margin #P32,000#�40##P38,400#�80##P �8,000#�25##78,400#�49###Fixed expenses
##########����66,000####Net operating income ##########P��12,400###b.
Break-even sales = Fixed expenses � CM ratio = P66,000 �
0.49 = P134,700 (rounded)# #Requirement (3)The reason for the increase in the
break-even point can be traced to the decrease in the company�s average
contribution margin ratio when the third product is added. Note from the income
statements above that this ratio drops from 55% to 49% with the addition of the
third product. This product, called HY143, has a CM ratio of only 25%, which causes
the average contribution margin ratio to fall.This problem shows the somewhat
tenuous nature of break-even analysis when more than one product is involved. The
manager must be very careful of his or her assumptions regarding sales mix when
making decisions such as adding or deleting products.It should be pointed out to
the president that even though the break-even point is higher with the addition of
the third product, the company�s margin of safety is also greater. Notice that the
margin of safety increases from P8,000 to P25,300 or from 6.25% to 15.81%. Thus,
the addition of the new product shifts the company much further from its break-even
point, even though the break-even point is higher.
Problem 8 (Break-Even Analysis with S tep Fixed Costs)Requirement (1) The
total annual fixed cost of the Pediatric W ard can be computed as follows:#Annual
#Patient-Days#Aides#Nurses#S upervising Nurses#Total #Personnel#Other Fixed
Cost#Total Fixed Cost####@ P360,000#@ P580,000#@ P760,000######10,000-
12,000#P2,520,000#P8,700,000#P2,280,000#P13,500,000#P27,400,000#P40,900,000###12,00
1-
13,750#P2,880,000#P8,700,000#P2,280,000#P13,860,000#P27,400,000#P41,260,000###13,75
1-
16,500#P3,240,000#P9,280,000#P3,040,000#P15,560,000#P27,400,000#P42,960,000###16,50
1-
18,250#P3,600,000#P9,280,000#P3,040,000#P15,920,000#P27,400,000#P43,320,000###18,25
1-
20,750#P3,600,000#P9,860,000#P3,800,000#P17,260,000#P27,400,000#P44,660,000###20,75
1-23,000#P3,960,000#P10,440,000#P3,800,000#P18,200,000#P27,400,000#P45,600,000##
Requirement (2) The �break-even� can be computed for each range of activity
by dividing the total fixed cost for that range of activity by the contribution
margin per patient-day, which is P3,000 (=P4,800 revenue
##########################################################" #P#1#,#8#0#0#
#v#a#r#i#a#b#l#e# #c#o#s#t#)#.#####A#n#n#u#a#l# ###P#a#t#i#e#n#t#-
#D#a#y#s###(#a#)###T#o#t#a#l# #F#i#x#e#d#
#C#o#s#t###(#b#)###C#o#n#t#r#i#b#u#t#i#o#n# #M#a#r#g#i#n#### B#r#e#a#k#-#E#v#e#n##
##(#a#)# #�# #(#b#)###W #i#t#h#i#n# #R#e#l#e#v#a#n#t# #R#a#n#g#e#?
#######1#0#,#0#0#0#-
#1#2#,#0#0#0###P#4#0#,#9#0#0#,#0#0#0###P#3#,#0#0#0###1#3#,#6#3#3###N#o#######1#2#,#
0#0#1#-
#1#3#,#7#5#0###P#4#1#,#2#6#0#,#0#0#0###P#3#,#0#0#0###1#3#,#7#5#3###N#o#######1#3#,#
7#5#1#-#1#6#,#5#0#0###P#4#2#,#9#6#0#,#0#0#0##P3,000#14,320#Yes###16,501-
18,250#P43,320,000#P3,000#14,440#No###18,251-
20,750#P44,660,000#P3,000#14,887#No###20,751-23,000#P45,600,000#P3,000#15,200#No##
W hile a �break-even� can be computed for each range of activity (i.e.,
relevant range), all but one of these break-evens is bogus. For example, within the
range of 10,000 to 12,000 patient-days, the computed break-even is 13,633 (rounded)
patient-days. However, this level of activity is outside this relevant range. To
serve 13,633 patient-days, the fixed costs would have to be increased from
P40,900,000 to P41,260,000 by adding one more aide. The only �break-even� that
occurs within its own relevant range is 14,320. This is the only legitimate break-
even.Requirement (3) The level of activity required to earn a profit of
P7,200,000 can be computed as follows:#Annual #Patient-Days#Total Fixed Cost#Target
Profit#(a)#Total Fixed Cost + Target Profit#(b)#Contribution Margin#Activity to
Attain Target Profit#(a) � (b)#W ithin Relevant Range?###10,000-
12,000#P40,900,000#P7,200,000#P48,100,000#P3,000#16,033#No###12,001-
13,750#P41,260,000#P7,200,000#P48,460,000#P3,000#16,153#No###13,751-
16,500#P42,960,000#P7,200,000#P50,160,000#P3,000#16,720#No###16,501-
18,250#P43,320,000#P7,200,000#P50,520,000#P3,000#16,840#Yes###18,251-
20,750#P44,660,000#P7,200,000#P51,860,000#P3,000#17,287#No###20,751-
23,000#P45,600,000#P7,200,000#P52,800,000#P3,000#17,600#No## In this
case, the only solution that is within the appropriate relevant range is 16,840
patient-days.
IV. Multiple Choice Questions
B#B#B#D#A#A##B#D#A#D#D#B##B#B#A#D#C#C##C#A#C#C#B#B##C#D#D#D#C#A##CHAPTER 14
RES PONS IBILITY ACCOUNTING AND TRANS FER PRICINGI. Questions1. Cost centers are
evaluated by means of performance reports. Profit centers are evaluated by means
of contribution income statements (including cost center performance reports), in
terms of meeting sales and cost objectives. Investment centers are evaluated by
means of the rate of return which they are able to generate on invested assets.2.
Overall profitability can be improved (1) by increasing sales, (2) by
reducing expenses, or (3) by reducing assets.3. ROI may lead to dysfunctional
decisions in that divisional managers may reject otherwise profitable investment
opportunities simply because they would reduce the division�s overall ROI figure.
The residual income approach overcomes this problem by establishing a minimum rate
of return which the company wants to earn on its operating assets, thereby
motivating the manager to accept all investment opportunities promising a return in
excess of this minimum figure.4. A cost center manager has control over cost,
but not revenue or investment funds. A profit center manager, by contrast, has
control over both cost and revenue. An investment center manager has control over
cost and revenue and investment funds.The term transfer price means the price
charged for a transfer of goods or services between units of the same organization,
such as two departments or divisions. Transfer prices are needed for performance
evaluation purposes.The use of market price for transfer purposes will create the
actual conditions under which the transferring and receiving units would be
operating if they were completely separate, autonomous companies. It is generally
felt that the creation of such conditions provides managerial incentive, and leads
to greater overall efficiency in operations.Negotiated transfer prices should be
used (1) when the volume involved is large enough to justify quantity discounts,
(2) when selling and/or administrative expenses are less on intracompany sales, (3)
when idle capacity exists, and (4) when no clear-cut market price exists (such as a
sister division being the only supplier of a good or service).S uboptimization can
result if transfer prices are set in a way that benefits a particular division, but
works to the disadvantage of the company as a whole. An example would be a
transfer between divisions when no transfers should be made (e.g., where a better
overall contribution margin could be generated by selling at an intermediate stage,
rather than transferring to the next division). S uboptimization can also result if
transfer pricing is so inflexible that one division buys from the outside when
there is substantial idle capacity to produce the item internally. If divisional
managers are given full autonomy in setting, accepting, and rejecting transfer
prices, then either of these situations can be created, through selfishness, desire
to �look good�, pettiness, or bickering.II. ExercisesExercise 1 (Evaluation of
a Profit Center) No. Although Department 3 does not cover all of the cost
allocated to it. It contributes P21,000 to the total operations over and above its
direct costs. W ithout Department 3, the company would earn P21,000 less as
compared with the original over-all income of P47,000.#Department
####1#2#4#Total##Revenue#P132,000#P168,000#P98,000#P398,000##Direct cost of
department# 82,000# 108,000# 61,000# 251,000##Contribution of the department#P
50,000#P 60,000#P37,000#P147,000##Allocated cost#### 121,000##Net income####P
26,000## W ith the discontinuance of Department 3, the revenue and direct cost of
the department are eliminated, but there is no reduction in the total allocated
cost.Exercise 2 (Evaluation of an Investment Center)Requirement 1#ROI#RI##Operating
assets#P400,000#P400,000##Operating income#P100,000#P100,000##ROI (P100,000
( P400,000)#25%###Minimum required income (16% x P400,000)##P64,000##RI
(P100,000 - P64,000)##P36,000##Requirement 2The manager of the Cling Division would
not accept this project under the ROI approach since the division is already
earning 25%. Accepting this project would reduce the present divisional
performance, as shown below:#Present#New Project#Overall##Operating
assets#P400,000#P60,000#P460,000##Operating
income#P100,000#P12,000*#P112,000##ROI#25%#20%#24.35%#######* P60,000 x 20% =
P12,000####Under the RI approach, on the other hand, the manager would accept this
project since the new project provides a higher return than the minimum required
rate of return (20 percent vs. 16 percent). The new project would increase the
overall divisional residual income, as shown below:#Present#New
Project#Overall##Operating assets#P400,000#P60,000#P460,000##Operating
income#P100,000#P12,000#P112,000##Minimum required return at 16%# 64,000#
9,600*# 73,600##RI#P 36,000#P 2,400 #P 38,400#######* P60,000 x 16% =
P9,600####Exercise 3 (ROI, Comparison of Three Divisions)Requirement 1#Division
X#Division Y#Division Z##ROI:####P10,000P40,000#P12,600P70,000#P 28,800P180,000##
Requirement 2Division X would reject this investment opportunity since the addition
would lower the present divisional ROI. Divisions Y and Z would accept it because
they would look better in terms of their divisional ROI.Exercise 4 (ROI, RI,
Comparisons of Two Divisions) Requirement 1 # Division A
: Division B :Requirement 2#Division A#Division B##Average
operating assets (a) #P3,000,000#P10,000,000##Net operating income #P
630,000#P 1,800,000##Minimum required return on average operating assets - 16% x
(a) # 480,000# 1,600,000##Residual income #P 150,000#P 200,000##
Requirement 3No, Division B is simply larger than Division A and for this reason
one would expect that it would have a greater amount of residual income. As stated
in the text, residual income can�t be used to compare the performance of divisions
of different sizes. Larger divisions will almost always look better, not
necessarily because of better management but because of the larger peso figures
involved. In fact, in the case above, Division B does not appear to be as well
managed as Division A. Note from Part (2) that Division B has only an 18 percent
ROI as compared to 21 percent for Division A.Exercise 5 (Evaluation of a Cost
Center)(1) Controllable Costs by supervisor of Department 10 are as follows:
a. S upplies, Department 10 b. Repairs and Maintenance, Department 10
c. Labor Cost, Department 10(2) Direct Costs of Department 10 are a.
S alary, supervisor of Department 10 b. S upplies, Department 10 c.
Repairs and Maintenance, Department 10 d. Labor Cost, Department 10(3)
Costs allocated to Factory Department are: a. Factory, heat and light b.
Depreciation, factory c. Factory insurance d. S alary of factory
superintendent(4) Costs which do not pertain to factory operations are:a. S ales
salaries and commissions b. General office salariesExercise 6 (Evaluating
New Investments Using Return on Investment (ROI) and Residual Income)Requirement 1
Computation of ROIDivision A: #Division B: #Division C: #Requirement 2#Division
A#Division B#Division C##Average operating assets
#P1,500,000#P5,000,000#P2,000,000�##Required rate of return #� ������15%#�
������18%#� ������12%�##Required operating income #P��225,000#P ��900,000#P
��240,000�##Actual operating income #P��300,000#P ��900,000#P ��180,000�##Required
operating income (above) #�� �225,000#� ��900,000#� ���240,000�##Residual
income #P ���75,000#P �����������0#P���(60,000)##Requirement 3a. and
b.#Division A#Division B#Division C##Return on investment (ROI)
#20%#18%#9%##Therefore, if the division is presented with an investment
opportunity yielding 17%, it probably would #Reject#Reject#Accept##Minimum
required return for computing residual income #15%#18%#12%##Therefore, if the
division is presented with an investment opportunity yielding 17%, it probably
would #Accept#Reject#Accept## If performance is being measured by ROI, both
Division A and Division B probably would reject the 17% investment opportunity.
The reason is that these companies are presently earning a return greater than 17%;
thus, the new investment would reduce the overall rate of return and place the
divisional managers in a less favorable light. Division C probably would accept
the 17% investment opportunity, since its acceptance would increase the Division�s
overall rate of return.If performance is being measured by residual income, both
Division A and Division C probably would accept the 17% investment opportunity.
The 17% rate of return promised by the new investment is greater than their
required rates of return of 15% and 12%, respectively, and would therefore add to
the total amount of their residual income. Division B would reject the
opportunity, since the 17% return on the new investment is less than B�s 18%
required rate of return.Exercise 7 (Transfer Pricing from Viewpoint of the Entire
Company)Requirement 1#Division A##Division B##Total Company###S ales
#P3,500,000#1#P2,400,000#2#P5,200,000#3##Less expenses:########Added by the
division #2,600,000##1,200,000##3,800,000###Transfer price paid #�
������������##����700,000## �������������###Total expenses #�
2,600,000##�1,900,000##� 3,800,000###Net operating income #P
��900,000##P��500,000##P1,400,000###1#20,000 units � P175 per unit =
P3,500,000.###2#4,000 units � P600 per unit = P2,400,000.###3#Division A outside
sales (16,000 units � P175 per unit) #P2,800,000###Division B outside sales
(4,000 units � P600 per unit) #� 2,400,000###Total outside sales
#P5,200,000##Observe that the P700,000 in intracompany sales has been
eliminated.Requirement
2Division A should transfer the 1,000 additional units to Division B. Note that
Division B�s processing adds P425 to each unit�s selling price (B�s P600 selling
price, less A�s P175 selling price = P425 increase), but it adds only P300 in cost.
Therefore, each tube transferred to Division B ultimately yields P125 more in
contribution margin (P425 � P300 = P125) to the company than can be obtained from
selling to outside customers. Thus, the company as a whole will be better off if
Division A transfers the 1,000 additional tubes to Division B.Exercise 8 (Transfer
Pricing S ituations)Requirement 1The lowest acceptable transfer price from the
perspective of the selling division is given by the following formula:#.There is no
idle capacity, so each of the 20,000 units transferred from Division X to Division
Y reduces sales to outsiders by one unit. The contribution margin per unit on
outside sales is P20 (= P50 � P30).#####The buying division, Division Y, can
purchase a similar unit from an outside supplier for P47. Therefore, Division Y
would be unwilling to pay more than P47 per unit. Transfer price ( Cost of buying
from outside supplier = P47The requirements of the two divisions are incompatible
and no transfer will take place.Requirement 2In this case, Division X has enough
idle capacity to satisfy Division Y�s demand. Therefore, there are no lost sales
and the lowest acceptable price as far as the selling division is concerned is the
variable cost of P20 per unit.#The buying division, Division Y, can purchase a
similar unit from an outside supplier for P34. Therefore, Division Y would be
unwilling to pay more than P34 per unit. Transfer price ( Cost of buying from
outside supplier = P34In this case, the requirements of the two divisions are
compatible and a transfer will hopefully take place at a transfer price within the
range:P20 ( Transfer price ( P34Exercise 9 (Transfer Pricing: Decision Making)
Requirement 1Division A�s purchase decision from the overall firm perspective:
Purchase costs from outside 10,000 x P150 = P1,500,000Less: S avings of
Divisions B�s variable costs 10,000 x P140 = 1,400,000Net Cost (Benefit)
for A to buy outside P 100,000Assuming Division B has no outside sales,
Division A should buy inside from Division B for the benefit of the entire firm.
Requirement 2As above, but in addition, if Division A buys outside, Division B
saves an additional P200,000.Purchase costs from outside 10,000 x P150 =
P1,500,000Less: S avings in variable costs 10,000 x P140 = 1,400,000Less:
S avings of B material assignment 200,000Net Cost (Benefit) for A to
buy outside P (100,000)The additional savings in Division B means that now
Division A should buy outside.Requirement 3Assuming the outside price drops from
P150 to P130:Purchase costs from outside 10,000 x P130 = P1,300,000Less:
S avings in variable costs 10,000 x P140 = 1,400,000Net Cost (Benefit)
for A to buy outside P (100,000)Division A should buy outside.Exercise
10 (Compute the Return on Investment (ROI))Requirement (1)#Requirement (2)#
Requirement (3) ROI = Margin x Turnover = 30% x 0.5 =
15%Exercise 11 (Residual Income)Average operating assets (a) #P2,200,000##Net
operating income #P400,000##Minimum required return: 16% � (a)
#�352,000##Residual income #P�48,000##III. Problems Problem 1
(Evaluation of Profit Centers)Requirement (a)Jadlow Manufacturing CorporationIncome
S tatementFor the Year Ended December 31, 2005#Total#Product S #Product
T##S ales#P5,100,000#P2,700,000#P2,400,000##Less: Variable Costs# 3,330,000#
1,890,000# 1,440,000##Contribution Margin#P1,770,000#P 810,000#P
960,000##Less: Controllable fixed expenses# 501,000# 66,000#
435,000##Contribution to the recovery of non-controllable fixed expenses#
P1,269,000#P 744,000#P 525,000##Requirement (b)The complaint of the manager of
Product T is justified on the ground that his product line shows a positive
contribution margin and therefore, contributes to the recovery of non-controllable
fixed expenses. This observation is, of course, made under the assumption that the
preceding year�s figures (which are not given) were less favorable than the current
year. Problem 2 (Evaluation of Profit Centers)Requirement 1
#Product###A#B#C##Incremental sales#P71,000#P46,000#P117,000##Less: Incremental
costs# 42,000# 15,000# 96,000## Net income#P29,000#P31,000#P
21,000#######Product B seems to offer the best profit potential.Requirement 2
The sunk costs are: Depreciation of equipment P 6,400
Operating cost of the equipment 4,600 Total
P11,000Requirement 3 Opportunity cost of selling Product B is From
Product A P29,000 From Product C 21,000 Total
P50,000 Problem 3 (Evaluation of Performance)Ranjie Tool Company
Performance ReportFor the Year 2005Budgeted Labor Hours#4,000#####Actual Labor
Hours #4,200######Cost-Volume Formula#Actual 4,200 Hours #Budget Based on 4,200
Hours#Variance U (F)##Variable Overhead Costs:###### Utilities#P0.80 per hour#P
3,600#P 3,360#P240## S upplies# 1.80#7,400#7,560#(160)## Indirect labor# 1.20
# 5,300# 5,040# 260##
Total#P3.80#P16,300#P15,960#P340##Fixed Overhead Costs:###### Utilities##P
1,600#P 1,600#-## S upplies##2,200#2,200#-## Depreciation##6,000#6,000#-##
Indirect labor##5,400#5,400#-## Insurance## 1,200# 1,200# -
## Total##P16,400#P16,400# - ##Total Factory Overhead
Costs#P32,700#P32,360#P340## Problem 4 (Evaluation of Performance)Requirement 1
Performance Report for the Production Manager#Actual Cost #Flexible Budget
Cost#Variance (U) or (F)##Controllable costs:##### Direct
material#P24,000#P20,000#P4,000 (U)## Direct labor#48,000#50,000#2,000 (F)##
S upplies#4,000#6,000#2,000 (F)## Maintenance# 3,000# 4,000# 1,000
(F)##Total#P79,000#P80,000#P1,000 (F)##The cost of raw materials rose
significantly, possibly because of (1) deficient machinery due to the cutback in
maintenance expenditures and/or (2) to the lower labor cost, possibly due to the
use of less-skilled workers. S upplies decreased, indicating possible inadequacies
for next period�s production run.Requirement 2Performance Report for the Vice
President#Actual Cost #Flexible Budget Cost#Variance (U) or (F)##Controllable
costs:##### Marketing division#P104,000#P102,000# P2,000 (U)## Production
division#79,000#80,000#1,000 (F)## Personnel division#72,000#76,000#4,000 (F)##
Other costs# 68,800# 70,000# 1,200 (F)##Total#P323,800#P328,000#P4,200
(F)##The marketing division is behind its cost allotment. The personnel division
came in somewhat under its budgeted costs. Perhaps there has been a cutback in
hiring, indicating possible reduction in future production.Problem 5 (Target S ales
Price; Return on Investment)Requirement 1 Return on investment = Operating
income / Investment 20% = X / P800,000 Target Operating Income =
P160,000Target revenues, calculated as follows: Fixed overhead
P200,000 Variable costs 1,500,000 x P300 450,000 Desired
operating income 160,000 Revenues P810,000The selling price per
units is P540 = P810,000 / 1,500Requirement 2Data are in thousands.
Units#1,500#2,000#1,000##Revenues#P810#P1,080#P540#######Variable
costs#450#600#300##Fixed costs# 200# 200#200##Total
costs#650#800#500#######Operating income#P160#P280#P 40##Return on
investment#20%#35%#5%###= P160 / P800#= P280 / P800#= P40 / P800##Note how the
change in income follows the change in revenues, as predicted by operating
leverage. Operating leverage multiplied times the percentage change in sales gives
the percentage change in income. Thus, the greater the operating leverage ratio,
the larger the effect on income and ROI of a given percentage change in sales.
This exercise provides an opportunity to review the relationship between volume and
profit. S ee the illustration below: Operating leverage =
contribution margin / operating income =
(P810 � P450) / P160 = 2.25 % change in income = operating leverage
x % change in revenues = 2.25 x 33.33% =
75%% change in income If volume goes to 2,000 units: (P280 � P160) / P160 = 75%
If volume goes to 1,000 units: (P160 � P40) / P160 = 75%% change in ROI
If volume goes to 2,000 units: (35% - 20%) / 20% = 75% If volume goes to
1,000 units: (20% - 5%) / 20% = 75%Problem 6 (Contrasting Return on Investment
(ROI) and Residual Income)Requirement 1ROI computations:##### Pasig:#
Quezon:Requirement 2#Pasig#Quezon##Average operating assets (a)
#P3,000,000#P10,000,000##Net operating income #P
��630,000#P########################################################################
###################################################################################
##########################################################
1#,#8#0#0#,#0#0#0#####M#i#n#i#m#u#m# #r#e#q#u#i#r#e#d# #r#e#t#u#r#n# #o#n#
#a#v#e#r#a#g#e# #o#p#e#r#a#t#i#n#g# #a#s#s#e#t#s## 1#6#%# #�# #(#a#)# ###�#
#�#�#4#8#0#,#0#0#0###P# # #1#,#6#0#0#,#0#0#0#####R#e#s#i#d#u#a#l# #i#n#c#o#m#e#
###P#�#�#1#5#0#,#0#0#0###P#�# #�#�#�#2#0#0#,#0#0#0#####
#R#e#q#u#i#r#e#m#e#n#t# #3###N#o#,# #t#h#e# #Q#u#e#z#o#n# #D#i#v#i#s#i#o#n# #i#s#
#s#i#m#p#l#y# #l#a#r#g#e#r# #t#h#a#n# #t#h#e# #P#a#s#i#g# #D#i#v#i#s#i#o#n# #a#n#d#
#f#o#r# #t#h#i#s# #r#e#a#s#o#n# #o#n#e# #w#o#u#l#d# #e#xpect that it would have a
greater amount of residual income. Residual income can�t be used to compare the
performance of divisions of different sizes. Larger divisions will almost always
look better, not necessarily because of better management but because of the larger
peso figures involved. In fact, in the case above, Quezon does not appear to be as
well
managed as Pasig. Note from Part (1) that Quezon has only an 18% ROI as compared
to 21% for Pasig.Problem 7 (Transfer Pricing)Requirement 1#S ince the Valve Division
has idle capacity, it does not have to give up any outside sales to take on the
Pump Division�s business. Applying the formula for the lowest acceptable transfer
price from the viewpoint of the selling division, we get:#The Pump Division would
be unwilling to pay more than P29, the price it is currently paying an outside
supplier for its valves. Therefore, the transfer price must fall within the range:
P16 ( Transfer price ( P29Requirement 2S ince the Valve Division is selling all
of the valves that it can produce on the outside market, it would have to give up
some of these outside sales to take on the Pump Division�s business. Thus, the
Valve Division has an opportunity cost, which is the total contribution margin on
lost sales:#S ince the Pump Division can purchase valves from an outside supplier at
only P29 per unit, no transfers will be made between the two divisions.Requirement
3Applying the formula for the lowest acceptable price from the viewpoint of the
selling division, we get:# In this case, the transfer price must fall within the
range:P27 ( Transfer price ( P29 Problem 8 (Transfer Pricing) To produce
the 20,000 special valves, the Valve Division will have to give up sales of 30,000
regular valves to outside customers. Applying the formula for the lowest
acceptable price from the viewpoint of the selling division, we get:#Problem 9
(Effects of Changes in S ales, Expenses, and Assets in ROI)#1.#2.3. ROI =
Margin x Turnover = 10% x 2.5 = 25%Problem 10 (Transfer
Pricing Basics) Requirement (1) a. The lowest acceptable transfer
price from the perspective of the selling division, the Electrical Division, is
given by the following formula:# Because there is enough idle
capacity to fill the entire order from the Motor Division, there are no lost
outside sales. And because the variable cost per unit is P21, the lowest acceptable
transfer price as far as the selling division is concerned is also P21.#
b. The Motor Division can buy a similar transformer from an outside
supplier for P38. Therefore, the Motor Division would be unwilling to pay more than
P38 per transformer. Transfer price: Cost from buying from outside
supplier = P38 c. Combining the requirements of both the selling
division and the buying division, the acceptable range of transfer prices in this
situation is:P21 : Transfer price : P38 Assuming that the managers
understand their own businesses and that they are cooperative, they should be able
to agree on a transfer price within this range and the transfer should take place.
d. From the standpoint of the entire company, the transfer should
take place. The cost of the transformers transferred is only P21 and the company
saves the P38 cost of the transformers purchased from the outside supplier.
Requirement (2) a. Each of the 10,000 units transferred to the
Motor Division must displace a sale to an outsider at a price of P40. Therefore,
the selling division would demand a transfer price of at least P40. This can also
be computed using the formula for the lowest acceptable transfer price as follows:#
b. As before, the Motor Division would be unwilling to pay more than
P38 per transformer. c. The requirements of the selling and buying
divisions in this instance are incompatible. The selling division must have a price
of at least P40 whereas the buying division will not pay more than P38. An
agreement to transfer the transformers is extremely unlikely. d. From
the standpoint of the entire company, the transfer should not take place. By
transferring a transformer internally, the company gives up revenue of P40 and
saves P38, for a loss of P2.Problem 11 (Transfer Pricing with an Outside Market)
Requirement (1)# The lowest acceptable transfer price from the
perspective of the selling division is given by the following formula: The
Tuner Division has no idle capacity, so transfers from the Tuner Division to the
Assembly Division would cut directly into normal sales of tuners to outsiders. The
costs are the same whether a tuner is transferred internally or sold to outsiders,
so the only relevant cost is the lost revenue of P200 per tuner that could be sold
to outsiders. This is confirmed below:# Therefore, the Tuner Division will
refuse to transfer at a price less than P200 per tuner. The Assembly
Division can buy tuners from an outside supplier for P200, less a 10% quantity
discount of P20, or P180 per tuner. Therefore, the Division would be unwilling to
pay more than P180 per tuner. Transfer price : Cost of buying from outside supplier
= P180 The requirements of the two divisions are incompatible. The
Assembly Division won�t pay more than P180 and the Tuner Division will not accept
less than P200. Thus, there can be no mutually agreeable transfer price and no
transfer will take place. Requirement (2) The price being paid to the
outside supplier, net of the quantity discount, is only P180. If the Tuner Division
meets this price, then profits in the Tuner Division and in the company as a whole
will drop by P600,000 per year:Lost revenue per tuner #P200##Outside supplier�s
price #P180##Loss in contribution margin per tuner #P20##Number of tuners per
year #� 30,000##Total loss in profits #P600,000## Profits in the Assembly
Division will remain unchanged, since it will be paying the same price internally
as it is now paying externally. Requirement (3)# The Tuner Division has
idle capacity, so transfers from the Tuner Division to the Assembly Division do not
cut into normal sales of tuners to outsiders. In this case, the minimum price as
far as the Assembly Division is concerned is the variable cost per tuner of P11.
This is confirmed in the following calculation: The Assembly Division can buy
tuners from an outside supplier for P180 each and would be unwilling to pay more
than that in an internal transfer. If the managers understand their own businesses
and are cooperative, they should agree to a transfer and should settle on a
transfer price within the range:P110 : Transfer price : P180 Requirement (4)
Yes, P160 is a bona fide outside price. Even though P160 is less than the
Tuner Division�s P170 �full cost� per unit, it is within the range given in Part 3
and therefore will provide some contribution to the Tuner Division. If the
Tuner Division does not meet the P160 price, it will lose P1,500,000 in potential
profits:Price per tuner #P160##Variable costs #�110##Contribution margin per
tuner #P�50## 30,000 tuners � P50 per tuner = P1,500,000 potential
increased profits This P1,500,000 in potential profits applies to the Tuner
Division and to the company as a whole. Requirement (5) No, the Assembly
Division should probably be free to go outside and get the best price it can. Even
though this would result in lower profits for the company as a whole, the buying
division should probably not be forced to purchase inside if better prices are
available outside. Requirement (6) The Tuner Division will have an
increase in profits:S elling price #P200##Variable costs #�110##Contribution
margin per tuner #P�90## 30,000 tuners � P90 per tuner =
P2,700,000 increased profits The Assembly Division will have a decrease in
profits:Inside purchase price #P200##Outside purchase price #�160##Increased cost
per tuner #P�40## 30,000 tuners � P40 per tuner = P1,200,000
decreased profits The company as a whole will have an increase in profits:
Increased contribution margin in the Tuner Division #P�90##Decreased contribution
margin in the Assembly Division #��40##Increased contribution margin per tuner
#P�50## 30,000 tuners � P50 per tuner = P1,500,000 increased
profits S o long as the selling division has idle capacity and the
transfer price is greater than the selling division�s variable costs, profits in
the company as a whole will increase if internal transfers are made. However, there
is a question of fairness as to how these profits should be split between the
selling and buying divisions. The inflexibility of management in this situation
damages the profits of the Assembly Division and greatly enhances the profits of
the Tuner Division.Problem 12 (Transfer Pricing; Divisional Performance)
Requirement (1) The Electronics Division is presently operating at
capacity; therefore, any sales of the KK8 circuit board to the Clock Division will
require that the Electronics Division give up an equal number of sales to outside
customers. Using the transfer pricing formula, we get a minimum transfer price of:#
Thus, the Electronics Division should not supply the circuit board to
the Clock Division for P90 each. The Electronics Division must give up revenues of
P125.00 on each circuit board that it sells internally. S ince management
performance in the Electronics Division is measured by ROI and dollar profits,
selling the circuit boards to the Clock Division for P9 would adversely affect
these performance measurements. Requirement (2) The key is to realize
that the P100 in fixed overhead and administrative costs contained in the Clock
Division�s P697.50 cost per timing device is not relevant. There is no indication
that winning this contract would actually affect any of the fixed costs. If these
costs would be incurred regardless of whether or not the Clock Division gets the
oven timing device contract, they should be ignored when determining the effects of
the contract on the company�s profits. Another key is that the variable cost of the
Electronics Division is not relevant either. W hether
the circuit boards are used in the timing devices or sold to outsiders, the
production costs of the circuit boards would be the same. The only difference
between the two alternatives is the revenue on outside sales that is given up when
the circuit boards are transferred within the company. S elling price of the timing
devices ##P700.00##Less:####The cost of the circuit boards used in the timing
devices (i.e. the lost revenue from sale of circuit boards to outsiders)
#P125.00###Variable costs of the Clock Division excluding the circuit board
(P300.00 + P207.50) #�507.50#�632.50##Net positive effect on the company�s
profit ##P�67.50## Therefore, the company as a whole would be better off
by P67.50 for each timing device that is sold to the oven manufacturer.
Requirement (3) As shown in part (1) above, the Electronics Division
would insist on a transfer price of at least P125.00 for the circuit board. W ould
the Clock Division make any money at this price? Again, the fixed costs are not
relevant in this decision since they would not be affected. Once this is realized,
it is evident that the Clock Division would be ahead by P67.50 per timing device if
it accepts the P125.00 transfer price.S elling price of the timing devices
##P700.00##Less:####Purchased parts (from outside vendors) #P300.00###Circuit
board KK8 (assumed transfer price) #125.00###Other variable costs
#�207.50#�632.50##Clock Division contribution margin ##P�67.50## In
fact, since the contribution margin is P62.50, any transfer price within the range
of P125.00 to P192.50 (= P125.00 + P67.50) will improve the profits of both
divisions. S o yes, the managers should be able to agree on a transfer price.
Requirement (4) It is in the best interests of the company and of the
divisions to come to an agreement concerning the transfer price. As demonstrated in
part (3) above, any transfer price within the range P125.00 to P192.50 would
improve the profits of both divisions. W hat happens if the two managers do not come
to an agreement? In this case, top management knows that there should be a
transfer and could step in and force a transfer at some price within the acceptable
range. However, such an action, if done on a frequent basis, would undermine the
autonomy of the managers and turn decentralization into a sham. Our advice
to top management would be to ask the two managers to meet to discuss the transfer
pricing decision. Top management should not dictate a course of action or what is
to happen in the meeting, but should carefully observe what happens in the meeting.
If there is no agreement, it is important to know why. There are at least three
possible reasons. First, the managers may have better information than the top
managers and refuse to transfer for very good reasons. S econd, the managers may be
uncooperative and unwilling to deal with each other even if it results in lower
profits for the company and for themselves. Third, the managers may not be able to
correctly analyze the situation and may not understand what is actually in their
own best interests. For example, the manager of the Clock Division may believe that
the fixed overhead and administrative cost of P100 per timing device really does
have to be covered in order to avoid a loss. If the refusal to come to an
agreement is the result of uncooperative attitudes or an inability to correctly
analyze the situation, top management can take some positive steps that are
completely consistent with decentralization. If the problem is uncooperative
attitudes, there are many training companies that would be happy to put on a short
course in team building for the company. If the problem is that the managers are
unable to correctly analyze the alternatives, they can be sent to executive
training courses that emphasize economics and managerial accounting.IV.
Multiple Choice Questions
C#E#C#B##D#D#B#D##A#C#A#D##A#C#D#D##C#B#B#C##A#C#A#D##D#B#A#B##A#A#B#D##C#B#D#B##A#
A#A#D##CHAPTER 15FUNCTIONAL AND ACTIVITY-BAS ED BUDGETING I.Questions1. No. Planning
and control are different, although related, concepts. Planning involves developing
objectives and formulating steps to achieve those objectives. Control, by contrast,
involves the means by which management ensures that the objectives set down at the
planning stage are attained.2. Budgets have a dual purpose, for planning and
for following up the implementation of the plan. The great benefits from budgeting
lie in the quick investigation of deviations and in the subsequent corrective
action. Budgets should not be prepared in the first place if they are ignored,
buried in files, or improperly interpreted.3. Two major features of a budgetary
program are (1) the accounting techniques which developed it and (2) the human
factors which administer it. The human factors are far more important. The
success of a budgetary system depends upon its acceptance by the company members
who are affected by the budget. W ithout a thoroughly educated and cooperative
management group at all levels of responsibility, budgets are a drain on the funds
of the business and are a hindrance instead of help to efficient operations.4.
Manufacturing overhead costs are budgeted at normal operating capacity, and
the costs are applied to the products using a predetermined rate. The
predetermined rate is computed by dividing a factor that can be identified with
both the products and the overhead into the overhead budgeted at the normal
operating capacity. Budgets may also be used in costing products in a standard
cost accounting system.5. The production division operates to produce the
products that are sold. Production and sales must be coordinated. Products must
be manufactured so that they will be available to meet sales delivery dates.
Activity of the production division will depend upon the sales that can be made.
Also, the sales division is limited by the capabilities of the production
department in manufacturing products. S uccessful operations depend upon a
coordination of sales and production.6. Labor hour required for production can be
translated into labor pesos by multiplying the number of hours budgeted by the
appropriate labor rates. The rates to be used will depend upon the rates
established for job classifications and the policy with respect to premium pay for
overtime or shift differences.7. A long-range plan for the acquisition of plant
assets is broken down and entered in the current budget as the plan unfolds. The
portion of the plan which is to be executed in the next year is included in the
budget for that year.8. A budget period is not limited to any particular unit of
time. At a minimum, a budget should cover at least one operating cycle. For
example, a budget should not cover a period when purchasing activity is high and
omit the period when sales volume and cash collection are relatively high. The
budget period should encompass the entire cycle extending from the purchasing
operation to the subsequent sale of the products and the realization of the sales
in cash. Ordinarily, a budget of operations is prepared for a year which in turn
is divided into quarters and months. Long-term budgets, such as budgets for
projects or capital investments, may extend five to ten years or more into the
future.9. A rolling budget or a progressive budget or sometimes called continuous
budget, is a budget which is prepared throughout the year. As one month elapses, a
budget is prepared for one more month in the future. At any one time for example,
the company will have a budget for one year into the future, when July of one year
is over, a budget for the following July will be added at the other end of the
budget. This process of adding a new month as a month expires is continuous.10.
Variances that are revealed by a comparison of actual results with a budget
are investigated if it appears that an investigation is warranted. The
investigation may show that stricter control measures are needed or that some
weaknesses in the operation should be corrected. It may also reveal that the
budget plan should be revised. The comparison is one step in the control and
direction of business operations.11. A comparison of actual results with a
budget can contribute information that can be applied in the preparation of better
budgets in the future. S ubsequent investigation of variances provides management
with a better knowledge of operations. This knowledge can be applied in the
preparation of more realistic budgets for subsequent fiscal periods.12. A
self-imposed budget is one in which persons with responsibility over cost control
prepare their own budgets, i.e., the budget is not imposed from above. The major
advantages are: (1) the views and judgments of persons from all levels of an
organization are represented in the final budget document; (2) budget estimates
generally are more accurate and reliable, since they are prepared by those who are
closest to the problems; (3) managers generally are more motivated to meet budgets
which they have participated in setting; (4) self-imposed budgets reduce the amount
of upward �blaming� resulting from inability to meet budget goals. One caution
must be exercised in the use of self-imposed budgets. The budgets prepared by
lower-level managers should be carefully reviewed to prevent too much slack.13.
No, although this is clearly one of the purposes of the cash budget. The
principal purpose is to provide information on probable cash needs during the
budget period, so that bank loans and other sources of financing can be anticipated
and arranged well in advance of the actual time of need.14.Zero-based budgeting
requires that managers start at zero levels every year and justify all costs as if
all programs were being proposed for the first time. In traditional budgeting, by
contrast,
budget data are usually generated on an incremental basis, with last year�s budget
being the starting point.15. A budget is a detailed quantitative plan for the
acquisition and use of financial and other resources over a given time period.
Budgetary control involves the use of budgets to control the actual activities of a
firm.16. 1. Budgets communicate management�s plans throughout the
organization. 2. Budgets force managers to think about and plan for the
future. 3. The budgeting process provides a means of allocating resources to
those parts of the organization where they can be used most effectively. 4.
The budgeting process can uncover potential bottlenecks before they occur.
5. Budgets coordinate the activities of the entire organization by
integrating the plans of its various parts. Budgeting helps to ensure that everyone
in the organization is pulling in the same direction. 6. Budgets define goals and
objectives that can serve as benchmarks for evaluating subsequent performance.17.
A master budget represents a summary of all of management�s plans and goals
for the future, and outlines the way in which these plans are to be accomplished.
The master budget is composed of a number of smaller, specific budgets encompassing
sales, production, raw materials, direct labor, manufacturing overhead, selling and
administrative expenses, and inventories. The master budget generally also contains
a budgeted income statement, budgeted balance sheet, and cash budget.18. The
flow of budgeting information moves in two directions�upward and downward. The
initial flow should be from the bottom of the organization upward. Each person
having responsibility over revenues or costs should prepare the budget data against
which his or her subsequent performance will be measured. As the budget data are
communicated upward, higher-level managers should review the budgets for
consistency with the overall goals of the organization and the plans of other units
in the organization. Any issues should be resolved in discussions between the
individuals who prepared the budgets and their managers. All levels of an
organization should participate in the budgeting process�not just top management or
the accounting department. Generally, the lower levels will be more familiar with
detailed, day-to-day operating data, and for this reason will have primary
responsibility for developing the specifics in the budget. Top levels of management
should have a better perspective concerning the company�s strategy.19. Budgeting
can assist a company forecast its workforce staffing needs through direct labor and
other budgets. By careful planning through the budget process, a company can often
smooth out its activities and avoid erratic hiring and laying off employees.II.
Matching TypeC#A##H#B##E#J##F#D##I#G##III. Exercises Exercises 1
(S chedule# #o#f# #E#x#p#e#c#t#e#d# #C#a#s#h# #C#o#l#l#e#c#t#i#o#n#s#)###
#R#e#q#u#i#r#e#m#e#n#t# #1##
###J#u#l#y###A#u#g#u#s#t###S #e#p#t#e#m#b#e#r###T#o#t#a#l#####M#a#y#
#s#a#l#e#s#:#############P#4#3#0#,#0#0#0# #�# #1#0#%# ###P##
4#3#,#0#0#0#######P#�#�# #�#�#4#3#,#0#0#0#####J#u#n#e#
#s#a#l#e#s#:#############P#5#4#0#,#0#0#0# #�# #7#0#%#,# #1#0#%#
###3#7#8#,#0#0#0###P#5#4#,#0#0#0#####4#3#2#,#0#0#0#####J#u#l#y#
#s#a#l#e#s#:#############P#6#0#0#,#0#0#0# #�# #2#0#%#,# ## #7#0#%#,# #1#0#%#
###1#2#0#,#0#0#0###4#2#0#,#0#0#0###P##
6#0#,#0#0#0###6#0#0#,#0#0#0#####A#u#g#u#s#t#
#s#a#l#e#s#:#############P#9#0#0#,#0#0#0# #�# #2#0#%#,# #7#0#%#
#####1#8#0#,#0#0#0###6#3#0#,#0#0#0###8#1#0#,#0#0#0#####S #e#p#t#e#m#b#e#r#
#s#a#l#e#s#:#############P#5#0#0#,#0#0#0# #�# #2#0#%# ###�#�#�#�#�#�# #
#�#�#�#�#�#�#�###�#�# # #�#�#�#�#�#�#�#�#�#�#�###�# #1#0#0#,#0#0#0###
#�#�#�#�#1#0#0#,#0#0#0#####T#o#t#a#l# #c#a#s#h# #c#o#l#l#e#c#t#i#o#n#s#

###P#5#4#1#,#0#0#0###P#6#5#4#,#0#0#0###P#7#9#0#,#0#0#0###P#1#,#9#8#5#,#0#0#0######
#N#o#t#i#c#e# #t#hat even though sales peak in August, cash collections peak
in S eptember. This occurs because the bulk of the company�s customers pay in the
month following sale. The lag in collections that this creates is even more
pronounced in some companies. Indeed, it is not unusual for a company to have the
least cash available in the months when sales are greatest.Requirement 2
Accounts receivable at S eptember 30:From August sales: P900,000 � 10%
#P###########################################################
9#0#,#0#0#0#####F#r#o#m# #S #e#p#t#e#m#b#e#r# #s#a#l#e#s#:# #P#5#0#0#,#0#0#0# #�#
#(#7#0#%# #+# #1#0#%#)# ###�# #4#0#0#,#0#0#0#####T#o#t#a#l# #a#c#c#o#u#n#t#s#
#r#e#c#e#i#v#a#b#l#e# ###P#4#9#0#,#0#0#0########### #E#x#e#r#c#i#s#e# #2#
#(#P#r#o#d#u#c#t#i#o#n# #B#u#d#g#e#t#)##
###J#u#l#y###A#u#g#u#s#t###S #e#p#t#e#m#b#e#r###Q#u#a#r#t#e#r#####B#u#d#g#e#t#e#d#
#s#a#l#e#s# #i#n# #u#n#i#t#s#
###3#0#,#0#0#0###4#5#,#0#0#0###6#0#,#0#0#0###1#3#5#,#0#0#0#####A#d#d#
#d#e#s#i#r#e#d# #e#n#d#i#n#g# #i#n#v#e#n#t#o#r#y*
#�4,500#�6,000#�5,000#���5,000##Total needs
#34,500#51,000#65,000#140,000##Less beginning inventory
#�3,000#�4,500#�6,000#���3,000##Required production
#31,500#46,500#59,000#137,000##* 10% of the following month�s sales
Exercise 3 (Materials Purchase Budget)#Quarter � Year 2#Year
3###First#S econd#Third#Fourth#First##Required production of calculators
#60,000#90,000#150,000#100,000#80,000##Number of chips per calculator

#������############################################################################
3###�#�#�#�#�#�## 3###�#�#�#�#�#�## 3###�#�#�#�#�#�## 3###�#�#�#�#�#�##
3#####T#o#t#a#l# #p#r#o#d#u#c#t#i#o#n# #n#e#e#d#s## c#h#i#p#s#

###1#8#0#,#0#0#0###2#7#0#,#0#0#0###4#5#0#,#0#0#0###3#0#0#,#0#0#0###2#4#0#,#0#0#0###
#####Y#e#a#r#
#2#######F#i#r#s#t###S #e#c#o#n#d###T#h#i#r#d###F#o#u#r#t#h###Y#e#a#r#####P#r#o#d#u#
c#t#i#o#n# #n#e#e#d#s## c#h#i#p#s#

###1#8#0#,#0#0#0###2#7#0#,#0#0#0###4#5#0#,#0#0#0###3#0#0#,#0#0#0###1#,#2#0#0#,#0#0#
0#####A#d#d# #d#e#s#i#r#e#d# #e#n#d#i#n#g# #i#n#v#e#n#t#o#r#y## c#h#i#p#s# ##
���54,000#� ��90,000#� ��60,000# ���48,000#� �����48,000##Total needs�chips
#234,000# 360,000# 510,000# 348,000#1,248,000##Less beginning inventory�chips
# ���36,000# ���54,000#� ��90,000# ���60,000#� �����36,000##Required
purchases�chips # �198,000# �306,000#� 420,000# �288,000#� 1,212,000##Cost of
purchases at P2 per chip #P396,000#P612,000#P840,000#P576,000#P2,424,000##
Exercise 4 (Direct Labor Budget)Requirement 1Assuming that the direct labor
workforce is adjusted each quarter, the direct labor budget would be:#1st
Quarter#2nd Quarter#3rd Quarter#4th Quarter#Year##Units to be produced # 5,000 #
4,400 # 4,500 # 4,900 # 18,800 ##Direct labor time per unit (hours) #� 0.40
#� 0.40 #� 0.40 #� 0.40 #� 0.40 ##Total direct labor hours needed
# 2,000 # 1,760 # 1,800 # 1,960 # 7,520 ##Direct labor cost per hour #�
P11.00 #� P11.00 #� P11.00 #� P11.00 #� P11.00 ##Total direct labor cost #P
22,000 #P 19,360 #P 19,800 #P 21,560 #P 82,720 ##Requirement 2Assuming that the
direct labor workforce is not adjusted each quarter and that overtime wages are
paid, the direct labor budget would be:#1st Quarter#2nd Quarter#3rd Quarter#4th
Quarter#Year##Units to be produced # 5,000 # 4,400 # 4,500 # 4,900 # 18,800
##Direct labor time per unit (hours) #� 0.40 #� 0.40 #� 0.40 #� 0.40 #� 0.40
##Total direct labor hours needed # 2,000 # 1,760 # 1,800 # 1,960 # 7,520
##Regular hours paid # 1,800 # 1,800 # 1,800 # 1,800 # 7,200 ##Overtime hours
paid # 200 # - �# - �# 160 # 360 ##W ages for regular hours
#(@ P11.00 per hour) # P19,800 # P19,800 # P19,800 # P19,800 # P79,200
##Overtime wages#(@ P11.00 per hour � 1.5) # 3,300 # - �# -
�# 2,640 # 5,940 ##Total direct labor cost #P23,100 #P19,800 #P19,800
#P22,440 #P85,140 ## Exercise 5 (Manufacturing Overhead Budget) Requirement
1Kiko CorporationManufacturing Overhead Budget##########1stQuarter#2nd Quarter#3rd
Quarter#4th Quarter#Year##Budgeted direct labor-hours # 5,000 # 4,800 # 5,200 #
5,400 # 20,400 ##Variable overhead rate #x P1.75 #x P1.75 #x P1.75 #x P1.75
#x P1.75 ##Variable manufacturing overhead #P 8,750 #P 8,400 #P 9,100 #P
9,450 #P 35,700 ##Fixed manufacturing overhead # 35,000 # 35,000 # 35,000 #
35,000 # 140,000 ##Total manufacturing overhead # 43,750 # 43,400 # 44,100
# 44,450 # 175,700 ##Less depreciation # 15,000 # 15,000 # 15,000 # 15,000
# 60,000 ##Cash disbursements for manufacturing overhead#P28,750 #P28,400
#P29,100 #P29,450 #P115,700 ## Requirement 2Total budgeted manufacturing
overhead for the year (a) #P175,700 ##Total budgeted direct labor-hours for the
year (b) # 20,400 ##Predetermined overhead rate for the year (a) � (b) #P
8.61## Exercise 6 (S elling and Administrative Budget)Helene CompanyS elling and
Administrative Expense Budget##########1st Quarter#2nd Quarter#3rd Quarter#4th
Quarter#Year##Budgeted unit sales # 12,000 # 14,000 # 11,000 # 10,000 # 47,000
##Variable selling and administrative expense per unit #x P2.75 #x P2.75 #x
P2.75 #x P2.75 #x P2.75 ##Variable expense #P33,000 #P 38,500 #P 30,250 #P
27,500 #P129,250 ##Fixed selling and administrative expenses:#######Advertising
# 12,000 # 12,000 # 12,000 # 12,000 # 48,000 ##Executive salaries #
40,000 # 40,000 # 40,000 # 40,000 # 160,000 ##Insurance ## 6,000 ## 6,000 #
12,000 ##Property taxes ### 6,000 ## 6,000 ##Depreciation # 16,000 # 16,000 #
16,000 # 16,000 # 64,000 ##Total fixed selling and administrative expenses
# 68,000 # 74,000 # 74,000 # 74,000 # 290,000 ##Total selling and
administrative expenses # 101,000 # 112,500 # 104,250 # 101,500 # 419,250 ##Less
depreciation # 16,000 # 16,000 # 16,000 # 16,000 # 64,000 ##Cash
disbursements for selling and administrative expenses ##P 85,000 #P 96,500 #P
88,250 #P 85,500 #P355,250 ## Exercise 7 (Cash Budget Analysis)#Quarter (000
omitted)####1##2##3##4##Year###Cash
balance, beginning
#P#################################################################################
################################
9###*###P#�#�#�#5#####P#�#�#�#5#####P#�#�#�#5#####P#�#�#�#9#######A#d#d#
#c#o#l#l#e#c#t#i#o#n#s# #f#r#o#m# #c#u#s#t#o#m#e#r#s#
###�#7#6#####�#�#9#0#####�#1#2#5###*###�#1#0#0#####�#3#9#1###*#####T#o#t#a#l#
#c#a#s#h# #a#v#a#i#l#a#b#l#e#
###�#8#5###*###�#�#9#5#####�#1#3#0#####�#1#0#5#####�#4#0#0#######L#e#s#s#
#d#i#s#b#u#r#s#e#m#e#n#t#s#:#########################P#u#r#c#h#a#s#e# #o#f#
#i#n#v#e#n#t#o#r#y#
###4#0###*###5#8###*###3#6#####3#2###*###1#6#6#######O#p#e#r#a#t#i#n#g#
#e#x#p#e#n#s#e#s# ###3#6#####4#2##*#54#*#48##180#*##Equipment purchases
#10#*#8#*#8#*#10##36#*##Dividends
#���2#*#����2#*#�����2#*#����2#*#����8###Total disbursements
#�88##�110#*#�100##��92##�390###Excess (deficiency) of cash available over
disbursements

#��(3)#*#�(15)##��30#*#��13##���10###########################Financing:############
Borrowings #8##20#*#�## �##28###Repayments (including interest)
#���0##����0##��(25)## ���(7)#*#��(32)###Total financing
#���8##���20##��(25)## ���(7)##� ���(4)###Cash balance, ending
#P�5##P���5##P���5##P��#6#####P#�#�#�#6######## # #*#G#i#v#e#n#.###I#V#.#
#P#r#o#b#l#e#m#s### #P#r#o#b#l#e#m# #1# #(#S #c#h#e#d#u#l#e# #o#f#
#E#x#p#e#c#t#e#d# #C#a#s#h# #C#o#l#l#e#c#t#i#o#n#s# #a#n#d#
#D#i#s#b#u#r#s#e#m#e#n#t#s#)### #R#e#q#u#i#r#e#m#e#n#t# #1##
###S #e#p#t#e#m#b#e#r# #c#a#s#h# #s#a#l#e#s# ###P##
7#,#4#0#0#######S #e#p#t#e#m#b#e#r# #c#o#l#l#e#c#t#i#o#n#s# #o#n#
#a#c#c#o#u#n#t#:#########J#u#l#y# #s#a#l#e#s#:# #P#2#0#,#0#0#0# #�# #1#8#%#
###3#,#6#0#0#######A#u#g#u#s#t# #s#a#l#e#s#:# #P#3#0#,#0#0#0# #�# #7#0#%#
#21,000###S eptember sales: P40,000 � 10% #� ��4,000###Total cash collections
#P36,000###### Requirement 2#Payments to suppliers:####August purchases
(accounts payable) #P16,000###S eptember purchases: P25,000 � 20% #�
��5,000###Total cash payments #P21,000## Requirement 3#COOKIE PRODUCTS #Cash
Budget#For the Month of S eptember###Cash balance, S eptember 1

###P###############################################################################
####################################################################
9#,#0#0#0#######A#d#d# #c#a#s#h#
#r#e#c#e#i#p#t#s#:#############C#o#l#l#e#c#t#i#o#n#s# #f#r#o#m# #c#u#s#t#o#m#e#r#s#
#######�# #3#6#,#0#0#0#######T#o#t#a#l# #c#a#s#h# #a#v#a#i#l#a#b#l#e#
#b#e#f#o#r#e# #c#u#r#r#e#n#t# #f#i#n#a#n#c#i#n#g#
#######4#5#,#0#0#0#######L#e#s#s#
#d#i#s#b#u#r#s#e#m#e#n#t#s#:#############P#a#y#m#e#n#t#s# #t#o# #s#u#p#p#l#i#e#r#s#
#f#o#r# #i#n#v#e#n#t#o#r#y# ###P#2#1#,#0#0#0###########S #e#l#l#i#n#g# #a#n#d#
#a#d#m#i#n#i#s#t#r#a#t#i#v#e# #e#x#p#e#n#s#e#s#
###9#,#0#0#0###*#########E#q#uipment purchases #18,000#####Dividends paid
#��� 3,000#####Total disbursements ###� 51,000###Excess (deficiency) of cash
available over disbursements ### �(6,000)###Financing:######Borrowings
###11,000###Repayments ###0###Interest ###� ��������0###Total financing
### 11,000###Cash balance, S eptember 30

###P###############################################################################
###################################################################################
######################################### 5#,#0#0#0###### #*# #P#1#3#,#0#0#0# ##
#P#4#,#0#0#0# #=# #P#9#,#0#0#0#.### #P#r#o#b#l#e#m# #2# #(#P#r#o#d#u#c#t#i#o#n#
#a#n#d# #P#u#r#c#h#a#s#e#s# #B#u#d#g#e#t#)### #R#e#q#u#i#r#e#m#e#n#t# #1# ###
# #P#r#o#d#u#c#t#i#o#n# #b#u#d#g#e#t#:#
#####J#u#l#y###A#u#g#u#s#t###S #e#p#t#e#m#b#e#r###O#c#t#o#b#e#r#######B#u#d#g#e#t#e#
d# #s#a#l#e#s# #(#u#n#i#t#s#)#
###4#0#,#0#0#0###5#0#,#0#0#0###7#0#,#0#0#0###3#5#,#0#0#0#######A#d#d#
#d#e#s#i#r#e#d# #e#n#d#i#n#g# #i#n#v#e#n#t#o#r#y#
###2#0#,#0#0#0###2#6#,#0#0#0###15,500#11,000###Total needs
#60,000#76,000#85,500#46,000###Less beginning inventory
#17,000#20,000#26,000#15,500###Required production
#43,000#56,000#59,500#30,500## Requirement 2 During July
and August the company is building inventories in anticipation of peak sales in
S eptember. Therefore, production exceeds sales during these months. In S eptember
and October inventories are being reduced in anticipation of a decrease in sales
during the last months of the year. Therefore, production is less than sales
during these months to cut back on inventory levels. Requirement 3
Raw materials purchases budget:#July#August#S eptember##Third
Quarter##Required production (units) #43,000#56,000#59,500##158,500##Material
P214 needed per unit #� 3 lbs.#� 3 lbs.#� 3 lbs.##� 3 lbs.##Production needs
(lbs.) #129,000#168,000#178,500##475,500##Add desired ending inventory (lbs.)
#�84,000#�89,250#�45,750#*#�45,750##Total Material P214 needs
#213,000#257,250#224,250##521,250##Less beginning inventory (lbs.)
#�64,500#�84,000#�89,250##�64,500##Material P214 purchases (lbs.)
#148,500#173,250#135,000##456,750##*#30,500 units (October production) � 3
lbs. per unit= 91,500 lbs.; 91,500 lbs. � 0.5 = 45,750 lbs.## As shown in
requirement (1), production is greatest in S eptember. However, as shown in the raw
material purchases budget, the purchases of materials is greatest a month earlier
because materials must be on hand to support the heavy production scheduled for
S eptember. Problem 3 (Cash Budget; Income S tatement; #B#a#l#a#n#c#e# #S #h#e#e#t#)#
## #R#e#q#u#i#r#e#m#e#n#t# #1### # #S #c#h#e#d#u#l#e# #o#f# #c#a#s#h#
#r#e#c#e#i#p#t#s#:###C#a#s#h# #s#a#l#e#s## J#u#n#e# ###P##
6#0#,#0#0#0#####C#o#l#l#e#c#t#i#o#n#s# #o#n# #a#c#c#o#u#n#t#s#
#r#e#c#e#i#v#a#b#l#e#:#######M#a#y# #3#1# #b#a#l#a#n#c#e#
###7#2#,#0#0#0#####J#u#n#e# #(#5#0#%# #�# #1#9#0#,#0#0#0#)# ###�#
#�#�#9#5#,#0#0#0#####T#o#t#a#l# #c#a#s#h# #r#e#c#e#i#p#t#s#
###P#2#2#7#,#0#0#0###########S #c#h#e#d#u#l#e# #o#f# #c#a#s#h#
#p#a#y#m#e#n#t#s# #f#o#r# #p#u#r#c#h#a#s#e#s#:#############M#a#y# #3#1#
#a#c#c#o#u#n#t#s# #p#a#y#a#b#l#e# #b#a#l#a#n#c#e# ###P##
9#0#,#0#0#0#####J#u#n#e# #p#u#r#c#h#a#s#e#s# #(#4#0#%# #�# #2#0#0#,#0#0#0#)# ###�#
#�#�#8#0#,#0#0#0#####T#o#t#a#l# #c#a#s#h# #p#a#y#m#e#n#t#s# ###P#1#7#0#,#0#0#0######
#P#I#C#T#U#R#E# #T#H#I#S #,# #I#N#C#.#####C#a#s#h# #B#u#d#g#e#t#####F#o#r# #t#h#e#
#M#o#n#t#h# #o#f# #J#u#n#e#########C#a#s#h# #b#a#l#a#n#c#e#,# #b#e#g#i#n#n#i#n#g#
###P#�#�#�#8#,#0#0#0#�#####A#d#d# #r#e#c#e#i#p#t#s# #f#r#o#m#
#c#u#s#t#o#m#e#r#s# #(#a#b#ove) #�227,000�##Total cash available
#�235,000�##Less disbursements:###Purchase of inventory (above)
#170,000�##Operating expenses #51,000�##Purchases of equipment
#����9,000�##Total cash disbursements #�230,000�##Excess of receipts over
disbursements #����5,000�##Financing:###Borrowings�note
#18,000�##Repayments�note #(15,000)##Interest #�����(500)##Total
financing #����2,500�##Cash balance, ending #P���7,500�## Requirement 2
#PICTURE THIS , INC.#Budgeted Income S tatement#For the Month of June###S ales
###P#2#5#0#,#0#0#0#######C#o#s#t# #o#f# #g#o#o#d#s#
#s#o#l#d#:###########B#e#g#i#n#n#i#n#g# #i#n#v#e#n#t#o#r#y##### P#
#3#0#,#0#0#0#########A#d#d# #p#u#r#c#h#a#s#e#s#
###�#2#0#0#,#0#0#0#########G#o#o#d#s# #a#v#a#i#l#a#b#l#e# #f#o#r# #s#a#l#e#
###2#3#0#,#0#0#0#########E#n#d#i#n#g# #i#n#v#e#n#t#o#r#y#
###�#�#�#4#0#,#0#0#0#########C#o#s#t# #o#f# #g#o#o#d#s# #s#o#l#d#
#####�#1#9#0#,#0#0#0#######G#r#o#s#s# #m#a#r#g#i#n#
#####6#0#,#0#0#0#######O#p#e#r#a#t#i#n#g# #e#x#p#e#n#s#e#s# #(#P#5#1#,#0#0#0#
#+# #P#2#,#0#0#0) ##���53,000###Net operating income ##7,000###Interest expense
##� ������500###Net income ##P���6,500## Requirement 3#PICTURE THIS ,
INC.#Budgeted Balance S heet#June 30###Assets####Cash #P���7,500###Accounts
receivable (50% � 190,000) #95,000###Inventory #40,000###Buildings and
equipment, net of depreciation #(P500,000 + P9,000 � P2,000) #� 507,000###Total
assets #P649,500#######Liabilities and Equity####Accounts payable (60% �
200,000) #P120,000###Note payable #18,000###S hare capital
#420,000###Retained earnings (P85,000 + P6,500) #� ��91,500###Total
liabilities and equity #P649,500## Problem 4 (S ales, Production and Materials
Purchases Budget)Requirement 1Nikko Manufacturing CompanyS ales BudgetFor the year
ending December 31, 2005#Units#Amount##First quarter#16,000#P 480,000##S econd
quarter#20,000#600,000##Third quarter#22,000#660,000##Fourth quarter#22,000#
660,000## Total#80,000#P2,400,000##Requirement 2Nikko Manufacturing Company
S tatement of Production RequiredFor 2005#Q u a r t e
r####1st#2nd#3rd#4th#Total##Units to be
sold#16,000#20,000#22,000#22,000#80,000##Add: Desired ending inventory (20%)#
4,000# 4,400# 4,400# 5,000# 5,000## Total units
required#20,000#24,400#26,400#27,000#85,000##Less: Beginning inventory# 3,000#
4,000# 4,400# 4,400# 3,000##Units to be
produced#17,000#20,400#22,000#22,600#82,000##Requirement 3Nikko Manufacturing
CompanyS tatement of Raw Materials Purchase RequirementsFor 2005#Q u a r t e
r####1st#2nd#3rd#4th#Total##Units required for
production#51,000#61,200#66,000#67,800#246,000##Add: Desired ending inventory
#12,240#13,200#13,560#15,000# 15,000## Total units
#63,240#74,400#79,560#82,800#261,000##Less: Beginning
inventory#12,500#12,240#13,200#13,560# 12,500##Raw Materials to be
Purchased#50,740#62,160#66,360#69,240#248,500## Problem 5 (S chedule of Expected
Cash Collections; Cash Budget) Requirement 1 S chedule of
expected cash collections:##Month#####April#May#June#Quarter###From accounts
receivable #P141,000#P���7,200##P148,200###From April sales:#######20% � 200,000
#40,000###40,000###75% � 200,000 ##150,000##150,000###4% � 200,000
###P���8,000#8,000##########From May sales:#######20% � 300,000
##60,000##60,000###75% � 300,000 ###225,000#225,000###From June
sales:#######20% � 250,000 #� ������������#� ������������#� ��50,000#�
��50,000###Total cash collections #P181,000#P217,200#P283,000#P681,200##
Requirement 2 Cash budget:##Month#####April#May#June#Quarter###Cash
balance, beginning #P�26,000�#P�27,000#P�20,200�#P�26,000�###Add
receipts:#######Collections from
customers #�181,000�#�217,200#�283,000�#�681,200�###Total available
#�207,000�#�244,200#�303,200�#�707,200�###Less
disbursements:#######Merchandise purchases
#108,000�#120,000#180,000�#408,000�###Payroll
#9,000�#9,000#8,000�#26,000�###Lease payments
#15,000�#15,000#15,000�#45,000�###Advertising
#70,000�#80,000#60,000�#210,000�###Equipment purchases
#����8,000�#����������#�����������#����8,000�###Total disbursements
#�210,000�#�224,000#�263,000�#�697,000�###Excess (deficiency) of receipts
over disbursements
#��(3,000)#���20,200#���40,200�#���10,200�###Financing:#######Borrowings
#30,000�#�#�#30,000�###Repayments #�#�#(30,000)#(30,000)###Interest
#�����������#����������#���(1,200)#���(1,200)###Total financing
#��30,000�#����������#�(31,200)#���(1,200)###Cash balance,
ending#P�27,000�#P�20,200#P���9,000�#P���9,000�## Requirement 3If the
company needs a minimum cash balance of P20,000 to start each month, the loan
cannot be repaid in full by June 30. If the loan is repaid in full, the cash
balance will drop to only P9,000 on June 30, as shown above. S ome portion of the
loan balance will have to be carried over to July, at which time the cash inflow
should be sufficient to complete repayment. Problem 6 (Flexible Budget)S ummer
Machine CompanyFlexible Overhead BudgetDepartment 1
#Capacity###100%#90%#80%#70%#60%##Machine Hours# 200,000# 180,000#
160,000# 140,000# 120,000##Variable
Overhead#P1,300,000#P1,170,000#P1,040,000#P 910,000#P 780,000##Fixed Overhead#
300,000# 300,000# 300,000# 300,000# 300,000##
Total#P1,600,000#P1,470,000#P1,340,000#P1,210,000#P1,080,000##
Manufacturing Overhead rate per machine hour P8.00S ummer Machine Company
Flexible Overhead BudgetDepartment 2#Capacity###100%#90%#80%#70%#60%##Direct Labor
Hours # 200,000# 180,000# 160,000# 140,000# 120,000##Machine
Hours# 400,000# 360,000# 320,000# 280,000# 240,000##Variable
Overhead#P1,400,000#P1,260,000#P1,120,000#P 980,000#P 840,000##Fixed Overhead#
500,000# 500,000# 500,000# 500,000# 500,000##
Total#P1,900,000#P1,760,000#P1,620,000#P1,480,000#P1,340,000##
Manufacturing Overhead rate per machine hour P4.75 Problem 7 (Cash Budget
with S upporting S chedules) 1.#Collections on
sales:#July#August#S ept.#Quarter###Cash sales

#P#################################################################################
###################################################################################
# 8#,#0#0#0###P#1#4#,#0#0#0###P#1#0#,#0#0#0###P## 3#2#,#0#0#0#######C#r#e#d#i#t#
#s#a#l#e#s#:###############M#a#y#:# #P#3#0#,#0#0#0# #�# #8#0#%# #�# #2#0#%#
###4#,#8#0#0#######4#,#8#0#0#######J#u#n#e#:# #P#3#6#,#0#0#0# #�# #8#0#%# #�#
#7#0#%#,# #2#0#%# ###2#0#,#1#6#0###5#,#7#6#0#####2#5#,#9#2#0#######J#u#l#y#:#
#P#4#0#,#0#0#0# #�# #8#0#%# #�# #1#0#%#,# #7#0#%#,# #2#0#%#
###3#,#2#0#0###2#2#,#4#0#0###6#,#4#0#0###3#2#,#0#0#0#######A#u#g#.#:#
#P#7#0#,#0#0#0# #�# #8#0#%# #�# #1#0#%#,# #7#0#%#
#####5#,#6#0#0###3#9,200#44,800###S ept.: P50,000 � 80% � 10%
#�����������#�����������#���4,000#�����4,000###Total cash collections
#P36,160#P47,760#P59,600#P143,520##2. a. Merchandise purchases budget:
#July#August#S ept.#Oct.##Budgeted cost of goods sold
#P24,000#P42,000#P30,000#P27,000##Add desired ending inventory*
#�31,500#�22,500#�20,250###Total needs #55,500#64,500#50,250###Less
beginning inventory #�18,000#�31,500#�22,500###Required inventory purchases
#P37,500#P33,000#P27,750### *75% of the next month�s budgeted
cost of goods sold. b. S chedule of expected cash disbursements for
merchandise purchases:#July#August#S ept.#Quarter##Accounts payable, June 30
#P11,700###P11,700##July purchases #18,750#P18,750##37,500##August purchases
##16,500#P16,500#33,000##S eptember purchases
#�����������#�����������#�13,875#�13,875##Total cash disbursements
#P30,450#P35,250#P30,375#P96,075## 3.#Ju Products, Inc.#Cash Budget#For the
Quarter Ended S eptember 30####July#August#S ept.#Quarter###Cash balance, beginning
#P################ 8#,#0#0#0###P## 8#,#4#1#0###P##
8#,#0#2#0###P#�#�#�#8#,#0#0#0#######A#d#d# #c#o#l#l#e#c#t#i#o#n#s# #f#r#o#m#
#s#a#l#e#s#

###�#3#6#,#1#6#0###�#4#7#,#7#6#0###�#5#9#,#6#0#0###�#1#4#3#,#5#2#0#######T#o#t#a#l#
#c#a#s#h# #a#v#a#i#l#a#b#l#e#

###�#4#4#,#1#6#0###�#5#6#,#1#7#0###�#6#7#,#6#2#0###�#1#5#1#,#5#2#0#######L#e#s#s#
#d#i#s#b#u#r#s#e#m#e#n#t#s#:###############F#o#r# #i#n#v#e#n#t#o#r#y#
#p#u#r#c#h#a#s#e#s#
###3#0#,#4#5#0###3#5#,#2#5#0###3#0#,#3#7#5###9#6#,#0#7#5#######F#o#r#
#s#e#l#l#i#n#g# #e#x#p#e#n#s#e#s# #7,200#11,700#8,500#27,400###For administrative
expenses #3,600#5,200#4,100#12,900###For land #4,500#0#0#4,500###For
dividends #��������0#���������0#���1,000#����1,000###Total disbursements
#�45,750#�52,150#�43,975#�141,875###Excess (deficiency) of cash available
over disbursements
#�(1,590)#���4,020#�23,645#����9,645###Financing:#######Borrowings
#10,000#4,000##14,000###Repayment #0#0#(14,000)#(14,000)###Interest
#���������0#���������0#����(380)#������(380)###Total financing
#�10,000#���4,000#(14,380)#����#�#�#(#3#8#0#)#######C#a#s#h#
#b#a#l#a#n#c#e#,# #e#n#d#i#n#g# ###P## 8#,#4#1#0###P## 8#,#0#2#0###P##
9#,#2#6#5###P#�#�#�#9#,#2#6#5######*###P#1#0#,#0#0#0# #�# #1#%# #�# #3#
#=###P#3#0#0#######P#4#,#0#0#0# #�# #1#%# #�# #2#
#=###�#�#�#8#0#########P#3#8#0########V#.# #M#u#l#t#i#p#l#e# #C#h#o#i#c#e#
#Q#u#e#s#t#i#o#n#s##
#B###C###C#####B###B###C#####C###C###D#####E###B###C#####C###D###C#####C###C###C###
##D###A###D#####C###B###A#####A###E###C#####D###B###D#######S #u#p#p#o#r#t#i#n#g#
#c#o#m#p#u#t#a#t#i#o#ns:Questions 16 to 20:#January#February##Cost of
sales#P1,400,000#P1,640,000##Add: Desired Minimum Inventory# 492,000#
456,000## Total#1,892,000#2,096,000##Less: Beginning Inventory
(1,400,000 x 0.3) (17)# 420,000# 492,000## Gross Purchases
(16)# 1,472,000# 1,604,000## Less: Cash discount#
14,720# 16,040## Net cost of purchases#P1,457,280#P1,587,960######
Payments of Purchases#### 60% - month of purchase#P874,368#P
952,776## 40% - following month## 582,912##
T o t a l# (18)#P1,535,688##(19)#Gross #February Cash Discount#Net##Current
month�s sales (with discount) 35%#P595,000#P11,900#P583,100##Current month�s sales
(without discount) 15%#255,000#0#255,000#######Previous month�s sales (with
discount) 4.5%#67,500#1,350#66,150##Previous month�s sales (without discount)
40.5%# 607,500# #
607,500###P1,525,000#P13,250#P1,511,750##(20)Total Collections in February
P1,511,750 Add: Cash sales 350,000 T o t a l P1,861,750
(21)Estimated cash receipts Collections from customers P1,350,000
Proceeds from issuance of common stock 500,000 Proceeds from
short-term borrowing 100,000 Total P1,950,000 Less:
Estimated cash disbursements For cost and expenses P1,200,000
For income taxes 90,000 Purchase of fixed asset 400,000
Payment on short-term borrowings 50,000
Total 1,740,000 Cash balance, Dec. 31 P 210,000(22)Net income
P120,000 Add: Depreciation 65,000 W orking capital
provided from operations P185,000 Add: Increase in income taxes
payable P 80,000 Increase in provision for doubtful
accounts receivable 45,000 125,000 T o t a l
P310,000 Less: Increase in accounts receivable P 35,000
Decrease in accounts payable 25,000 60,000 Increase in cash
P250,000(23)Cash Receipts for February 2005 From
February sales (60% x 110,000) P 66,000 From January sales
38,000 T o t a l P104,000(24)Pro-forma Income
S tatement, February 2005 S ales P110,000 Cost of
sales (75%) 82,500 Gross profit P 27,500
Less: Operating expenses 16,500 Depreciation
5,000 Bad debts 2,200 23,700 Net
operating income P 3,800(25)Accounts Payable on February 28, 2005 will be
the unpaid purchases in February - (75% x P120,000) = P90,000. Questions 26 to
29:Net sales P2,000,000Less: Cost of sales
Finished goods inventory, Jan. 1 P 350,000Add: Cost of goods
manufactured (S ch. I) 1,350,000 * Total available for sale
P1,700,000Less: Finished goods inventory, Dec. 31 400,000
1,300,000 (26)Gross Profit P 700,000Less: Operating and financial
expenses S elling P 300,000 Administrative 180,000
Finance 20,000 500,000Net income before taxes
P 200,000* Determined by working back from net income to sales.
S chedule I Raw materials used Raw materials inventory, Jan. 1 P
250,000 Add: Purchases 491,000 (29) Total
available 741,000 Less: Raw materials inventory, Dec. 31
300,000 Raw materials used P 441,000 Direct labor
588,000 Manufacturing overhead 441,000 (28) Total
Manufacturing Cost P1,470,000 (27) Add: W ork-in-process inventory, Jan. 1
200,000 Total P1,670,000 Less: W ork-in-process inventory, Dec. 31
320,000 Cost of goods manufactured P1,350,000 (30)Variable
factory overhead# P3.125 Fixed factory overhead#
5.000# Total factory overhead P8.125
CHAPTER 16S TANDARD COS TS AND OPERATING PERFORMANCE MEAS URES I. Questions1.
S tandard costs are superior to past data for comparison with actual costs
because they ask the question �Is present performance better than the past?�.2.
No. Cost control and cost reduction are not the same, but cost reduction
does affect the standards which are used as basis for cost control. Cost reduction
means finding ways to achieve a given result through improved design, better
methods, new layouts and so forth. Cost reduction results in setting new
standards. On the other hand, cost control is a process of maintaining performance
at or as new existing standards as is possible.3. Managerial judgment is the
basis for deciding whether a given
variance is large enough to warrant investigation. For some items, a small amount
of variance may spark scrutiny. For some items, 5%, 10% or 25% variances from
standard may call for follow-up. Management may also derive the standard deviation
based on past cost data.4. The techniques for overhead control differ becauseThe
size of individual overhead costs usually does not justify elaborate individual
control systems;The behavior of individual overhead item is either impossible or
difficult to trace to specific lots or operations; and Various overhead items are
the responsibility of different people.5. In the year-to-year planning of fixed
costs, managers must consider:the projected maximum and minimum levels of activity,
prices of cost factors, andchanges in facilities and organization.6. Four
criteria for selecting a volume base are:Cause of cost variability.Adequacy of
control over the base.Independence of activity unit.Ease of understanding.7. Non-
volume factors which cause costs to vary are:Changes in plant and equipment.Changes
in products made, materials used, or methods of manufacturing.Changes in prices
paid for cost factors.Changes in managerial policy toward costs.Lag between cost
incurrence and measurement of volume.8. A budget is usually expressed in terms of
total pesos, whereas a standard is expressed on a per unit basis. A standard might
be viewed as the budgeted cost for one unit.9. Under management by exception,
managers focus their attention on operating results that deviate from expectations.
It is assumed that results that meet expectations do not require investigation.10.
S eparating an overall variance into a price variance and a quantity variance
provides more information. Moreover, prices and quantities are usually the
responsibilities of different managers.11. The materials price variance is
usually the responsibility of the purchasing manager. The materials quantity
variance is usually the responsibility of the production managers and supervisors.
The labor efficiency variance generally is also the responsibility of the
production managers and supervisors.12. If used as punitive tools, standards can
breed resentment in an organization and undermine morale. S tandards must never be
used as an excuse to conduct witch-hunts, or as a means of finding someone to blame
for problems.13. S everal factors other than the contractual rate paid to workers
can cause a labor rate variance. For example, skilled workers with high hourly
rates of pay can be given duties that require little skill and that call for low
hourly rates of pay, resulting in an unfavorable rate variance. Or unskilled or
untrained workers can be assigned to tasks that should be filled by more skilled
workers with higher rates of pay, resulting in a favorable rate variance.
Unfavorable rate variances can also arise from overtime work at premium rates.14.
Poor quality materials can unfavorably affect the labor efficiency variance.
If the materials create production problems, a result could be excessive labor time
and therefore an unfavorable labor efficiency variance. Poor quality materials
would not ordinarily affect the labor rate variance.15. If labor is a fixed cost
and standards are tight, then the only way to generate favorable labor efficiency
variances is for every workstation to produce at capacity. However, the output of
the entire system is limited by the capacity of the bottleneck. If workstations
before the bottleneck in the production process produce at capacity, the bottleneck
will be unable to process all of the work in process. In general, if every
workstation is attempting to produce at capacity, then work in process inventory
will build up in front of the workstations with the least capacity.16. A quantity
standard indicates how much of an input should be used to make a unit of output. A
price standard indicates how much the input should cost.17.Chronic inability to
meet a standard is likely to be demoralizing and may result in decreased
productivity.18. A variance is the difference between what was planned or expected
and what was actually accomplished. A standard cost system has at least two types
of variances. A price variance focuses on the difference between the standard price
and the actual price of an input. A quantity variance is concerned with the
difference between the standard quantity of the input allowed for the actual output
and the actual amount of the input used.II. Matching Type
E#C#A#J#I##G#H#D#B#F##III. Exercises Exercise 1 (S etting S tandards; Preparing
a S tandard Cost Card) Requirement 1#Cost per 2 kilogram container
#P6,000.00###Less: 2% cash discount # ���120.00###Net cost #P5,880.00###Add
freight cost per 2 kilogram container #(P1,000 � 10 containers) #
���100.00###Total cost per 2 kilogram container (a) #P5,980.00###Number of grams
per container #(2 kilograms � 1000 grams per kilogram) (b) # ����2,000###S tandard
cost per gram purchased (a) � (b) #P������2.99## Requirement 2#Beta ML12
required per capsule as per bill of materials #6.00#grams###Add allowance for
material rejected as unsuitable #(6 grams � 0.96 = 6.25 grams; 6.25 grams � 6.00
grams = 0.25 grams) #0.25#grams###Total #6.25#grams###Add allowance for
rejected capsules #(6.25 grams � 25 capsules) #0.25#grams###S tandard quantity of
Beta ML12 per salable capsule #6.50#grams## Requirement 3#Item#S tandard
Quantity per Capsule#S tandard Price per Gram#S tandard Cost per Capsule###Beta
ML12#6.50 grams#P2.99#P19.435## Exercise 2 (Material Variances) Requirement
1#Number of chopping blocks #4,000###Number of board feet per chopping block
#� ����2.5###S tandard board feet allowed #10,000###S tandard cost per board
foot #‫נ‬P1.80###Total standard cost #P18,000#######Actual cost incurred
#P18,700###S tandard cost above #� 18,000###Total variance�unfavorable
#P ����700## Requirement 2#Actual Quantity of Inputs, at #Actual
Price#Actual Quantity of Inputs, at #S tandard Price#S tandard Quantity Allowed for
Output, at S tandard Price###(AQ � AP)#(AQ � S P)#(S Q � S P)###P18,700#11,000 board
feet � P1.80 per board foot#10,000 board feet � P1.80 per board foot####= P19,800#=
P18,000### Alternatively: Materials Price Variance = AQ (AP �
S P) 11,000 board feet (P1.70 per board foot* � P1.80 per board foot)
= P1,100 F * P18,700 � 11,000 board
feet = P1.70 per board foot. Materials Quantity Variance = S P (AQ �
S Q) P1.80 per board foot (11,000 board feet � 10,000 board feet) =
P1,800 U Exercise 3 (Labor and Variable Overhead Variances) Requirement
1#Number of units manufactured #20,000�###S tandard labor time per unit #
##################################################################################‫נ‬
###################################################################################
.#0#� #############################################################################
#4#*#######T#o#t#a#l# #s#t#a#n#d#a#r#d# #h#o#u#r#s# #o#f# #l#a#b#o#r# #t#i#m#e#
#a#l#l#o#w#e#d# ###8#,#0#0#0#�#######S #t#a#n#d#a#r#d# #d#i#r#e#c#t# #l#a#b#o#r#
#r#a#t#e# #p#e#r# #h#o#u#r# ###�#�## �#�#�#P#6#�#######T#o#t#a#l#
#s#t#a#n#d#a#r#d# #d#i#r#e#c#t# #l#a#b#o#r# #c#o#s#t#
###P#4#8#,#0#0#0#�#######*#2#4# #m#i#n#u#t#e#s# #�# #6#0# #m#i#n#u#t#e#s#
#p#e#r# #h#o#u#r# #=# #0#.#4# #h#o#u#r#################A#c#t#u#a#l# #d#i#r#e#c#t#
#l#a#b#o#r# #c#o#s#t# ###P#4#9#,#3#0#0#�#######S #t#a#n#d#a#r#d# #d#i#r#e#c#t#
#l#a#b#o#r# #c#o#s#t# ###�# #4#8#,#0#0#0#�#######T#o#t#a#l# #v#a#r#i#a#n#c#e##
u#n#f#a#v#o#r#a#b#l#e# ###P## 1#,#3#0#0#�####### # #R#e#q#u#i#r#e#m#e#n#t#
#2#####A#c#t#u#a#l# #H#o#u#r#s# #o#f# #I#n#p#u#t#,# #a#t# ###t#h#e# #A#c#t#u#a#l#
#R#a#t#e###A#c#t#u#a#l# #H#o#u#r# #o#f# #I#n#p#u#t#,# #a#t# ###S #t#a#n#d#a#r#d#
#R#a#t#e###S #t#a#n#d#a#r#d# #H#o#u#r#s# #A#l#l#o#w#e#d# #f#o#r# #O#u#t#p#u#t#,#
#a#t# #t#h#e# #S #t#a#n#d#a#r#d# #R#a#t#e#######(#A#H# #�# #A#R#)###(#A#H# #�#
#S #R#)###(#S #H# #�# #S #R#)###P49,300#8,500 hours � P6 per hour #8,000 hours* � P6
per hour ####= P51,000#= P48,000### *20,000 units � 0.4 hour per unit =
8,000 hours Alternative S olution: Labor Rate Variance = AH (AR
� S R) 8,500 hours (P5.80 per hour* � P6.00 per hour) = P1,700 F
*P49,300 � 8,500 hours = P5.80 per hour Labor Efficiency
Variance = S R (AH � S H) P6 per hour (8,500 hours � 8,000 hours) =
P3,000 U Requirement 3#Actual Hours of Input, at #the Actual Rate#Actual Hour of
Input, at #S tandard Rate#S tandard Hours Allowed for Output, at the S tandard
Rate###(AH � AR)#(AH � S R)#(S H � S R)###P39,100#8,500 hours � P4 per hour#8,000
hours � P4 per hour ####= P34,000#= P32,000### Alternative S olution:
Variable Overhead S pending Variance = AH (AR � S R) 8,500 hours
(P4.60 per hour* � P4.00 per hour) = P5,100 U *P39,100 � 8,500
hours = P4.60 per hour Variable Overhead Efficiency Variance = S R (AH
� S H) P4 per hour (8,500 hours � 8,000 hours) = P2,000 U Exercise 4
(W orking Backwards

Оценить