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# REVIEW PROBLEM 1: COST TERMS

Many new cost terms have been introduced in this chapter. It will take you some time to learn what each term means
and how to properly classify costs in an organization. Consider the following example: Chippen Corporation
manufactures furniture, including tables. Selected costs are given below:
1. The tables are made of wood that costs \$100 per table. Wood is Direct Material DM so product cost and
not period cost, DM is variable because each table uses wood.
2. The tables are assembled by workers, at a wage cost of \$40 per table. Workers are Direct Labor, DL, so
product cost and DL is variable because each additional table needs additional workers.
3. Workers making the tables are supervised by a factory supervisor who is paid \$38,000 per year. Supervisor
is Indirect Labor, which ends up in Manufacturing Overhead (MOH), Indirect cost, product cost and is a
fixed cost.
4. Electrical costs are \$2 per machine-hour. Four machine-hours are required to produce a table. Electricity,
unless it’s traced directly to the table is an indirect cost, so ends up in Manufacturing Overhead (MOH),
product cost and is a variable cost.
5. The depreciation on the machines used to make the tables totals \$10,000 per year. The machines have no
resale value and do not wear out through use. Depreciation is MOH and is fixed and is a sunk cost.
6. The salary of the president of the company is \$100,000 per year. Selling and Administration, period cost,
Fixed.
7. The company spends \$250,000 per year to advertise its products.Selling and Administration, period cost,
Fixed.
8. Salespersons are paid a commission of \$30 for each table sold. Selling and Administration, period cost,
Variable per table sold.
9. Instead of producing the tables, the company could rent its factory space for \$50,000 per year. Opportunity
cost
Required:
Classify these costs according to the various cost terms used in the chapter. Carefully study the classification of
each cost. If you don’t understand why a particular cost is classified the way it is, reread the section of the chapter
discussing the particular cost term. The terms variable cost and fixed cost refer to how costs behave with respect to
the number of tables produced in a year.
Solution to Review Problem 1
Foundational I5
Martinez Company’s relevant range of production is 7,500 units to 12,500 units. When it produces and sells 10,000
units, its unit costs are as follows:

Required:

1. For financial accounting purposes, what is the total amount of product costs incurred to make
10,000 units? Product costs = (DM + DL + VMOH)*Units + F MOH
(6+3.50+1.50)*10000 + (4*1000) = \$150000
2. For financial accounting purposes, what is the total amount of period costs incurred to sell
10,000 units? Fixed Selling + Fixed admin expense + Sales commissions + Variable admin
expense. 3+2+1+0.50=\$6.50 * 10000 = \$65000
3. If 8,000 units are sold, what is the variable cost per unit sold? DM + DL + VMOH + Sales
commission + VAdm. 6+3.50+1.50 + 1 + .5 = \$12.50
4. If 12,500 units are sold, what is the variable cost per unit sold? Same \$12.50
5. If 8,000 units are sold, what is the total amount of variable costs related to the units sold?
8000 units * 12.50 = \$100000
6. If 12,500 units are sold, what is the total amount of variable costs related to the units sold?
2500 * 12.5 = \$156250
7. If 8,000 units are produced, what is the average fixed manufacturing cost per unit produced?
40000/8000= \$5
8. If 12,500 units are produced, what is the average fixed manufacturing cost per unit produced?
40000/12.5 = \$3.20
9. If 8,000 units are produced, what is the total amount of fixed manufacturing cost incurred to
support this level of production? 40000 not 4 * 8000. It’s at 10000 units that F MOH is \$4 per
unit.
10. If 12,500 units are produced, what is the total amount of fixed manufacturing cost incurred to
support this level of production? 40000 not 4 * 12500. It’s at 10000 units that F MOH is \$4
per unit.
11. If 8,000 units are produced, what is the total amount of manufacturing overhead cost incurred
to support this level of production? What is this total amount expressed on a per unit basis?
Total MOH = VMOH + FMOH (8000*1.5) + 40000 = 52000 or 6.50 per unit
12. If 12,500 units are produced, what is the total amount of manufacturing overhead cost
incurred to support this level of production? What is this total amount expressed on a per unit
basis? (12500*1.5) + 40000 = 58750 or 4.70 per unit
13. If the selling price is \$22 per unit, what is the contribution margin per unit sold?
Price – Variable costs = Contribution Margin 22 – (11 + 1.50) = 9.50
14. If 11,000 units are produced, what are the total amounts of direct and indirect manufacturing
costs incurred to support this level of production? (11000*11) + 40000 = 161000
15. What total incremental cost will Martinez incur if it increases production from 10,000 to
10,001 units? \$11.

## EXERCISE 1–1 Classifying Manufacturing Costs [LO1]

Your Boat, Inc., assembles custom sailboats from components supplied by various manufacturers. The company is very small and
its assembly shop and retail sales store are housed in a Gig Harbor, Washington, boathouse. Below are listed some of the costs
that are incurred at the company.
Required:
For each cost, indicate whether it would most likely be classified as direct labor, direct materials, manufacturing overhead, selling, or
1. The wages of employees who build the sailboats. Direct labor
2. The cost of advertising in the local newspapers. Selling and administration
3. The cost of an aluminum mast installed in a sailboat. Direct materials
4. The wages of the assembly shop's supervisor. Manufacturing overhead
5. Rent on the boathouse. Manufacturing overhead for the production, Selling and administration for the office work
6. The wages of the company's bookkeeper. Administration
3. Sales commissions paid to the company's salespeople.Selling and administration
8. Depreciation on power tools.Manufacturing overhead

## EXERCISE 1–2 Classification of Costs as Product or Period Costs [LO2]

Suppose that you have been given a summer job at Fairwings Avionics, a company that manufactures sophisticated radar sets for
commercial aircraft. The company, which is privately owned, has approached a bank for a loan to help finance its tremendous
growth. The bank requires financial statements before approving such a loan.
Required:
Classify each cost listed below as either a product cost or a period cost for purposes of preparing the financial statements for the
bank.
1. The cost of the memory chips used in a radar set. Product
2. Factory heating costs.Product
3. Factory equipment maintenance costs.Product
4. Training costs for new administrative employees.Period
5. The cost of the solder that is used in assembling the radar sets. Product
6. The travel costs of the company's salespersons.Period
7. Wages and salaries of factory security personnel. Product
8. The cost of air-conditioning executive offices.Period
9. Wages and salaries in the department that handles billing customers. Period
10. Depreciation on the equipment in the fitness room used by factory workers. Product
11. Telephone expenses incurred by factory management. Product
12. The costs of shipping completed radar sets to customers. Period
13. The wages of the workers who assemble the radar sets. Product
14. The president's salary. Period

## 15. Health insurance premiums for factory personnel. Product

Product Period
Cost Cost
1. The cost of the memory chips used in a radar set.......................
X
2. Factory heating costs...................................................................
X
3. Factory equipment maintenance costs.......................................
X
4. Training costs for new administrative employees.......................
X
5. The cost of the solder that is used in assembling the radar
sets.......................................................................................... X
6. The travel costs of the company’s salespersons..........................
X
7. Wages and salaries of factory security personnel.......................
X
8. The cost of air-conditioning
executive offices...................................................................... X
9. Wages and salaries in the department that handles billing
customers................................................................................ X
10. Depreciation on the equipment in the fitness room used by
factory workers........................................................................ X
11. Telephone expenses incurred by factory management...............
X
12. The costs of shipping completed radar sets to customers...........
X
13. The wages of the workers who assemble the radar sets.............
X
14. The president’s salary..................................................................
X
15. Health insurance premiums for factory personnel......................
X
EXERCISE 1–3 Fixed and Variable Cost Behavior [LO3]

Koffee Express operates a number of espresso coffee stands in busy suburban malls. The fixed weekly expense of a coffee stand is
\$1,100 and the variable cost per cup of coffee served is \$0.26.

Required:

1. Fill in the following table with your estimates of total costs and average cost per cup of coffee at the indicated levels of
activity for a coffee stand. Round off the cost of a cup of coffee to the nearest tenth of a cent.
2. Does the average cost per cup of coffee served increase, decrease, or remain the same as the number of cups of coffee
served in a week increases? Explain.
3. Cups of Coffee Served
in a Week

Fixed cost

Variable cost

Total cost

## \$1,568 \$1,594 \$1,620

Average cost per cup served*

## \$0.871 \$0.839 \$0.810

* Total cost ÷ cups of coffee served in a week

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.

Required:

## 1. Prepare a traditional income statement.

2. Prepare a contribution format income statement.

no MOH)
3.

Redhawk, Inc.

## Sales (\$15 per unit × 10,000 units).............................................................................. \$150,000

*Cost of goods sold
(\$12,000 + \$90,000 – \$22,000)............................................................................... 80,000

## Gross margin............................................................................................................... 70,000

Selling expenses
((\$2 per unit × 10,000 units) + \$20,000)............................................................. \$40,000
((\$1 per unit × 10,000 units) + \$15,000).............................................................  25,000  65,000

## Net operating income.................................................................................................. \$   5,000

* Beg inv + purchases – End Inv = COGS

## 2. Contribution format income statement

4.

Redhawk, Inc.
Contribution Format Income Statement

Sales \$150,000

Variable expenses:
Cost of goods sold
(\$12,000 + \$90,000 – \$22,000).......................................................................... \$80,000

## Selling expenses (\$2 per unit × 10,000 units).......................................................... 20,000

(\$1 per unit × 10,000 units)................................................................................  10,000  110,000

Fixed expenses:

## Net operating income.................................................................................................. \$   5,000

EXERCISE 1–6 Identifying Direct and Indirect Costs [LO6]

## The Empire Hotel is a four-star hotel located in downtown Seattle.

Required:

For each of the following costs incurred at the Empire Hotel, indicate whether it would most likely be a direct cost or an indirect cost
of the specified cost object by placing an X in the appropriate column.

## Exercise 1-6 (15 minutes)

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.
PROBLEM 1–15A Identifying Cost Behavior Patterns [LO3]

A number of graphs displaying cost behavior patterns are shown on the next page. The vertical axis on each graph represents total
cost and the horizontal axis represents the level of activity (volume).

Required:

1. For each of the following situations, identify the graph that illustrates the cost behavior pattern involved. Any graph may be
used more than once.

a. Electricity bill—a flat fixed charge, plus a variable cost after a certain number of kilowatt-hours are used.

## b. City water bill, which is computed as follows:

c. Depreciation of equipment, where the amount is computed by the straight-line method. When the
depreciation rate was established, it was anticipated that the obsolescence factor would be
greater than the wear and tear factor.

d. Rent on a factory building donated by the city, where the agreement calls for a fixed fee payment
unless 200,000 labor-hours or more are worked, in which case no rent need be paid.
e. Cost of raw materials, where the cost starts at \$7.50 per unit and then decreases by 5 cents per
unit for each of the first 100 units purchased, after which it remains constant at \$2.50 per unit.

f. Salaries of maintenance workers, where one maintenance worker is needed for every 1,000
hours of machine-hours or less (that is, 0 to 1,000 hours requires one maintenance worker, 1,001
to 2,000 hours requires two maintenance workers, etc.).

## g. Cost of raw material used.

h. Rent on a factory building donated by the county, where the agreement calls for rent of \$100,000
less \$1 for each direct labor-hour worked in excess of 200,000 hours, but a minimum rental
payment of \$20,000 must be paid. 100000 at 0 hours, 10000 hours \$90 000, 20000 hours \$80000
to a minimum of \$20000

i. Use of a machine under a lease, where a minimum charge of \$1,000 is paid for up to 400 hours
of machine time. After 400 hours of machine time, an additional charge of \$2 per hour is paid up
to a maximum charge of \$2,000 per period.

## j. Cost of raw material used.

k. Rent on a factory building donated by the county, where the agreement calls for rent of \$100,000
less \$1 for each direct labor-hour worked in excess of 200,000 hours, but a minimum rental
payment of \$20,000 must be paid.

l. Use of a machine under a lease, where a minimum charge of \$1,000 is paid for up to 400 hours
of machine time. After 400 hours of machine time, an additional charge of \$2 per hour is paid up
to a maximum charge of \$2,000 per period.

a. 6

b. 11

c. 1

d. 4

e. 2

f. 10

g. 3

h. 7

i. 9
Notes: b. flat then step by step higher
e. a curved line shows a slower progression than a straight line
h. start high at 0 volumes and 0 hours
a.
PROBLEM 1–16A Variable and Fixed Costs; Subtleties of Direct and Indirect Costs [LO3, LO6]

The Central Area Well-Baby Clinic provides a variety of health services to newborn babies and their parents. The clinic is organized
into a number of departments, one of which is the Immunization Center. A number of costs of the clinic and the Immunization Center
are listed on the following page.

## a. The salary of the head nurse in the Immunization Center.

b. Costs of incidental supplies consumed in the Immunization Center, such as paper towels.

## d. The cost of disposable syringes used in the Immunization Center.

e. The salary of the Central Area Well-Baby Clinic's Information Systems manager.

f. The costs of mailing letters soliciting donations to the Central Area Well-Baby Clinic.

## g. The wages of nurses who work in the Immunization Center.

h. The cost of medical malpractice insurance for the Central Area Well-Baby Clinic.

## i. Depreciation on the fixtures and equipment in the Immunization Center.

Required:

For each cost listed above, indicate whether it is a direct or indirect cost of the Immunization Center, whether it is a direct
or indirect cost of immunizing particular patients, and whether it is variable or fixed with respect to the number of

## Problem 1-16A (20 minutes)

V
Direct or Indirect
Cost of the Direct or Indirect
Immunization Cost of Particular
Center Patients
Item Description Direct Indirect Direct Indirect
a. The salary of the head nurse in the Immunization
Center......................................................................... X X
b. Costs of incidental supplies consumed in the
Immunization Center, such as paper towels.............. X X
c. The cost of lighting and heating the Immunization
Center......................................................................... X X
d. The cost of disposable syringes used in the
Immunization Center.................................................. X X
e. The salary of the Central Area Well-Baby Clinic’s
Information Systems manager................................... X X
f. The costs of mailing letters soliciting donations to
the Central Area Well-Baby Clinic.............................. X X
g. The wages of nurses who work in the Immunization
Center*....................................................................... X X
h. The cost of medical malpractice insurance for the
Central Area Well-Baby Clinic..................................... X X
i. Depreciation on the fixtures and equipment in the
Immunization Center.................................................. X X
j. * The wages of the nurses could be variable and a direct cost of serving particular
patients.

## 1. Depreciation, executive jet.

2. Costs of shipping finished goods to customers.
3. Wood used in manufacturing furniture.
4. Sales manager's salary.
5. Electricity used in manufacturing furniture.
6. Secretary to the company president.
7. Aerosol attachment placed on a spray can produced by the company.
8. Billing costs.
9. Packing supplies for shipping products overseas.
10. Sand used in manufacturing concrete.
11. Supervisor's salary, factory.
12. Executive life insurance.
13. Sales commissions.
14. Fringe benefits, assembly-line workers.
16. Property taxes on finished goods warehouses.
17. Lubricants for production equipment.

Required:
Prepare an answer sheet with column headings as shown below. For each cost item, indicate whether it would be variable or fixed
with respect to the number of units produced and sold; and then whether it would be a selling cost, an administrative cost, or a
manufacturing cost. If it is a manufacturing cost, indicate whether it would typically be treated as a direct or indirect cost with respect
to units of product. Three sample answers are provided for illustration.

Go to solution file.

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