# Mona Loa Malaysian Manufacturing cost per bag... \$6.00 \$5.00 Add markup at 30% Selling price per bag... \$7.80 \$6.50

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1 Case a. The predetermined overhead rate would be computed as follows: Expected manufacturing overhead cost \$3,000,000 = Estimated direct labour-hours 50,000 DLHs =\$60 per DLH b. The unit product cost per 300 gram bag, using the company s present costing system, would be: Mona Loa Malaysian Direct materials (given)... \$4.20 \$3.20 Direct labour (given) Manufacturing overhead: DLH \$60 per DLH Total unit product cost... \$6.00 \$5.00 c. The selling price per bag of each coffee would be: Mona Loa Malaysian Manufacturing cost per bag... \$6.00 \$5.00 Add markup at 30% Selling price per bag... \$7.80 \$ a. Overhead rates by activity centre: (a) Estimated Overhead Costs (b) Expected Activity (a) (b) Predetermined Overhead Rate Activity Centre Purchasing... \$513,000 1,710 orders \$300 per order Material handling... \$720,000 1,800 setups \$400 per setup Quality control... \$144, batches \$240 per batch Roasting... \$961,000 96,100 hours \$10 per hour Blending... \$402,000 33,500 hours \$12 per hour Packaging... \$260,000 26,000 hours \$10 per hour Case 8-24 (continued) Before we can determine the amount of overhead cost to assign to the products we must first determine the activity for each of the products in the six activity centres. The necessary computations follow: Number of purchase orders: Mona Loa: 30,000 kgs 6,000 kgs per order = 5 orders Malaysian: 600 kgs 150 kgs per order = 4 orders Number of batches: Mona Loa: 100,000 bags 10,000 bags per batch = 10 batches Malaysian: 2,000 bags 500 bags per batch = 4 batches Number of setups: Mona Loa: 10 batches 3 setups per batch = 30 setups Malaysian: 4 batches 3 setups per batch = 12 setups Roasting hours: Mona Loa: 1 hour (30,000 kgs 30 kgs) = 1,000 hours Malaysian: 1 hour (600 kgs 30 kgs) = 20 hours Blending hours: Mona Loa: 0.5 hour (30,000 kgs 30 kgs) = 500 hours Malaysian: 0.5 hour (600 kgs 30 kgs) = 10 hours Packaging hours: Mona Loa: 0.1 hour (30,000 kgs 30 kgs) = 100 hours Malaysian: 0.1 hour (600 kgs 30 kgs) = 2 hours 1 2

2 Case 8-24 (continued) Using the activity figures, manufacturing overhead costs can be assigned to the two products as follows: Expected Activity Mona Loa Malaysian Expected Activity Amount Amount Purchasing, at \$300 per order... 5 orders \$ 1,500 4 orders \$1,200 Material handling, at \$400 per setup setups 12, setups 4,800 Quality control, at \$240 per batch batches 2,400 4 batches 960 Roasting, at \$10 per roasting hour... 1,000 hours 10, hours 200 Blending, at \$12 per blending hour hours 6, hours 120 Packaging, at \$10 per packaging hour hours 1,000 2 hours 20 Total overhead cost... \$32,900 \$7,300 Case 8-24 (continued) 3. MEMO TO THE PRESIDENT: Analysis of CBI s data shows that several activities other than direct labour drive the company s manufacturing overhead costs. These activities include purchase orders issued, number of setups for material processing, and number of batches processed. The company s present costing system, which relies on direct labour time as the sole basis for assigning overhead cost to products, significantly undercosts low-volume products, such as the Malaysian coffee, and significantly overcosts high-volume products, such as our Mona Loa coffee. An implication of the activity-based costing analysis is that our lowvolume products may not be covering the costs of the manufacturing resources they use. For example, Malaysian coffee is currently priced at \$6.50 per bag, but this price is significantly below its activity-based cost of \$7.15 per bag. Under our present costing and pricing system, our high-volume products, such as our Mona Loa coffee, may be subsidizing our low-volume products. Some adjustments in prices may be required. However, before taking such an action, an action analysis report (discussed in Appendix 8A) should be prepared. b. According to the activity-based costing system, the manufacturing overhead cost per bag is: Mona Loa Malaysian Total overhead cost assigned (above) (a)... \$32,900 \$7,300 Number of bags manufactured (b) ,000 2,000 Cost per bag (a) (b)... \$0.33 \$3.65 c. The unit product costs according to the activity-based costing system are: Mona Loa Malaysian Direct materials (given)... \$4.20 \$3.20 Direct labour (given) Manufacturing overhead Total unit product cost... \$4.83 \$

3 Case 8-24 (continued) ALTERNATIVE SOLUTION: Most students will compute the manufacturing overhead cost per bag of the two coffees as shown above. However, the per bag cost can also be computed as shown below. This alternative approach provides additional insight into the data and facilitates emphasis of some points made in the chapter. Mona Loa Malaysian Per Bag ( Per Bag ( Total 100,000) Total 2,000) Purchasing... \$ 1,500 \$0.015 \$1,200 \$0.600 Material handling... 12, , Quality control... 2, Roasting... 10, Blending... 6, Packaging... 1, Total... \$32,900 \$0.329 \$7,300 \$3.650 Note particularly how batch size impacts unit cost data. For example, the cost to the company to process a purchase order is \$300, regardless of how many kilograms of coffee are contained in the order. Six thousand kilograms of the Mona Loa coffee are purchased per order (with five orders per year), and just 150 kilograms of the Malaysian coffee are purchased per order (with four orders per year). Thus, the purchase order cost per bag for the Mona Loa coffee is just 1.5 cents, whereas the purchase order cost per bag for the Malaysian coffee is 40 times as much, or 60 cents. As stated in the text, this is one reason why unit costs of low-volume products, such as the Malaysian coffee, increase so dramatically when activity-based costing is used. Case The total direct labour-hours worked for the year would be: B-10: 60,000 units 1 DLH per unit... 60,000 C-20: 10,000 units 1.5 DLH per unit... 15,000 Total DLHs... 75,000 The predetermined overhead rate for the year would therefore be: Manufacturing overhead cost \$3,600,000 = Direct labour-hours 75,000 DLHs 2. The unit product costs would be: =\$48 per DLH B-10 C-20 Direct materials (given)... \$ 60 \$ 90 Direct labour (given) Manufacturing overhead: \$48 per DLH 1 DLH per unit, 1.5 DLH per unit Total unit product cost... \$120 \$ This part of the case is open-ended, but students should provide data such as given below. Overhead rates for the activities are: (a) Estimated Overhead Costs (a) (b) Predetermined Overhead Rate (b) Activity Expected Activity Machine setups... \$416,000 3,200 setups \$130 per setup Quality control... \$720,000 18,000 inspections \$40 per inspection Purchase orders... \$180,000 2,400 orders \$75 per order Soldering... \$900, ,000 joints \$2.25 per joint Shipments... \$264,000 1,200 shipments \$220 per shipment Machine related... \$1,120, ,000 MHs \$8 per MH 5 6

4 Case 8-25 (continued) Overhead cost assigned to each product: B-10 C-20 Expected Expected Activity Amount Activity Amount Machine setups, at \$130 per setup... 2,000 \$ 260,000 1,200 \$ 156,000 Quality inspections, at \$40 per inspection... 8, ,000 10, ,000 Purchase orders, at \$75 per order... 1, , ,000 Soldering, at \$2.25 per joint , , , ,000 Shipments, at \$220 per shipment , ,000 Machine related, at \$8 per MH... 60, ,000 80, ,000 Total overhead cost (a)... \$1,632,000 \$1,968,000 Number of units produced (b)... 60,000 10,000 Overhead cost per unit (a) (b)... \$27.20 \$ The unit product cost of each product under activity-based costing is given below. For comparison, the costs computed in Part 2 above are also provided. Activity-Based Costing Direct Labour- Hour Base B-10 C-20 B-10 C-20 Direct materials... \$60.00 \$ \$ \$ Direct labour Manufacturing overhead Total unit product cost... \$99.20 \$ \$ \$ Case 8-25 (continued) As shown by the above analysis, unit product costs may have been distorted as a result of using direct labour-hours as the base for assigning overhead costs to products. These distorted costs may have had a major impact on management s pricing policies and on management s perception of the margin being realized on each product. According to the activity-based costing approach, Model C-20 is being sold at a loss: Activity-Based Costing Direct Labour- Hour Base B-10 C-20 B-10 C-20 Selling price per unit*... \$ \$ \$ \$ Less unit product cost (above) Gross margin (loss)... \$ \$(54.80) \$ \$ *Total sales the number of units sold. 4. It is not surprising that the C-20 sells itself since the company is selling it at an apparent loss of \$ This probably explains why Borst Company couldn t meet Hammer Products price. In addition, Hammer Products distorted unit costs explains why Borst Company is able to undercut Hammer s price on the B-10 units. Hammer s management thinks that the B-10 costs \$120 per unit to manufacture, whereas it costs just \$99.20 according to the more accurate activity-based costing approach. 5. Students may suggest many possible strategies there is no single right answer. Two possible strategies are: (a) raise the selling price of the C-20 enough to provide a satisfactory margin; and (b) discontinue the C-20 and focus all available resources on the B-10. The price of the B-10 might even be decreased to increase the volume of sales, if the company has adequate capacity to do so. Before taking any action, an action analysis report should be prepared as discussed in Appendix 8A. 7 8

5 Problem Problem (continued) 1. a. Actual Quantity of Inputs, at Actual Price Actual Quantity of Inputs, at Standard Price Standard Quantity Allowed for Output, at Standard Price (AQ AP) (AQ SP) (SQ SP) 21,120 metres \$3.35 per metre 21,120 metres \$3.60 per metre 19,200 metres* \$3.60 per metre = \$70,752 = \$76,032 = \$69, a. Actual Hours of Input, at the Actual Rate Actual Hours of Input, at the Standard Rate Standard Hours Allowed for Output, at the Standard Rate (AH AR) (AH SR) (SH SR) 6,720 hours* \$4.85 per hour 6,720 hours \$4.50 per hour 7,680 hours** \$4.50 per hour = \$32,592 = \$30,240 = \$34,560 Price Variance, Quantity Variance, \$5,280 F \$6,912 U Rate Variance, Efficiency Variance, \$2,352 U \$4,320 F Total Variance, \$1,632 U Total Variance, \$1,968 F *4,800 units 4.0 metres per unit = 19,200 metres Alternatively: Materials Price Variance = AQ (AP SP) 21,120 metres (\$3.35 per metre \$3.60 per metre) = \$5,280 F Materials Quantity Variance = SP (AQ SQ) \$3.60 per metre (21,120 metres 19,200 metres) = \$6,912 U b. Raw Materials (21,120 \$3.60 per metre)... 76,032 Materials Price Variance (21,120 \$0.25 per metre F)... 5,280 Accounts Payable (21,120 \$3.35 per metre)... 70,752 Work in Process (19,200 \$3.60 per metre)... 69,120 Materials Quantity Variance (1,920 metres \$3.60 per metre)... 6,912 Raw Materials (21,120 \$3.60 per metre)... 76,032 *4,800 units 1.4 hours per unit = 6,720 hours **4,800 units 1.6 hours per unit = 7,680 hours Alternatively: Labour Rate Variance = AH (AR SR) 6,720 hours (\$4.85 per hour \$4.50 per hour) = \$2,352 U Labour Efficiency Variance = SR (AH SH) \$4.50 per hour (6,720 hours 7,680 hours) = \$4,320 F b. Work in Process (7,680 \$4.50 per hour)... 34,560 Labour Rate Variance (6,720 \$0.35 per hour U)... 2,352 Labour Efficiency Variance (960 hours \$4.50 per hour)... 4,320 Wages Payable (6,720 \$4.85 per hour)... 32,

6 Problem (continued) 3. Actual Hours of Input, at the Actual Rate Actual Hours of Input, at the Standard Rate Standard Hours Allowed for Output, at the Standard Rate (AH AR) (AH SR) (SH SR) 6,720 hours \$2.15 per hour 6,720 hours \$1.80 per hour 7,680 hours \$1.80 per hour = \$14,448 = \$12,096 = \$13,824 Spending Variance, Efficiency Variance, \$2,352 U \$1,728 F Total Variance, \$624 U Alternatively: Variable Overhead Spending Variance = AH (AR SR) 6,720 hours (\$2.15 per hour \$1.80 per hour) = \$2,352 U Variable Overhead Efficiency Variance = SR (AH SH) \$1.80 per hour (6,720 hours 7,680 hours) = \$1,728 F causes include: Materials variances: Favourable price variance: Fortunate buy, inaccurate standards, inferior quality materials, unusual discount due to quantity purchased, drop in market price. Unfavourable quantity variance: Carelessness, poorly adjusted machines, unskilled workers, inferior quality materials, inaccurate standards. Labour variances: Unfavourable rate variance: Use of highly skilled workers, change in wage rates, inaccurate standards, overtime. Favourable efficiency variance: Use of highly skilled workers, high quality materials, new equipment, inaccurate standards. Variable overhead variances: Unfavourable spending variance: Increase in costs, inaccurate standards, waste, theft, spillage, purchases in uneconomical lots. Favourable efficiency variance: Same as for labour efficiency variance. 4. No. This total variance is made up of several quite large individual variances, some of which may warrant investigation. A summary of variances is given below: Materials: Price variance... \$5,280 F Quantity variance... 6,912 U \$1,632 U Labour: Rate variance... 2,352 U Efficiency variance... 4,320 F 1,968 F Variable overhead: Spending variance... 2,352 U Efficiency variance... 1,728 F 624 U Net unfavourable variance... \$ 288 U 5. The variances have many possible causes. Some of the more likely 11 12

7 Problem Problem (continued) 1. a. Actual Quantity of Inputs, at Actual Price Actual Quantity of Inputs, at Standard Price Standard Quantity Allowed for Output, at Standard Price (AQ AP) (AQ SP) (SQ SP) 25,000 kilograms \$2.95 per kilogram 25,000 kilograms \$2.50 per kilogram = \$73,750 = \$62,500 = \$50,000 20,000 kilograms* \$2.50 per kilogram b. Actual Hours of Input, at the Actual Rate Actual Hours of Input, at the Standard Rate Standard Hours Allowed for Output, at the Standard Rate (AH AR) (AH SR) (SH SR) 3,600 hours \$8.70 per hour 3,600 hours \$9.00 per hour 3,000 hours* \$9.00 per hour = \$31,320 = \$32,400 = \$27,000 Price Variance, \$11,250 U 19,800 kilograms \$2.50 per kilogram = \$49,500 Quantity Variance, \$500 F *5,000 ingots 4.0 kilograms per ingot = 20,000 kilograms Alternatively: Materials Price Variance = AQ (AP SP) 25,000 kilograms (\$2.95 per kilogram \$2.50 per kilogram) = \$11,250 U Materials Quantity Variance = SP (AQ SQ) \$2.50 per kilogram (19,800 kilograms 20,000 kilograms) = \$500 F Rate Variance, Efficiency Variance, \$1,080 F \$5,400 U Total Variance, \$4,320 U *5,000 ingots 0.6 hour per ingot = 3,000 hours Alternatively: Labour Rate Variance = AH (AR SR) 3,600 hours (\$8.70 per hour \$9.00 per hour) = \$1,080 F Labour Efficiency Variance = SR (AH SH) \$9.00 per hour (3,600 hours 3,000 hours) = \$5,400 U 13 14

8 Problem (continued) c. Actual Hours of Input, at the Actual Rate Actual Hours of Input, at the Standard Rate Standard Hours Allowed for Output, at the Standard Rate (AH AR) (AH SR) (SH SR) \$4,320 1,800 hours \$2.00 per hour 1,500 hours* \$2.00 per hour = \$3,600 = \$3,000 Spending Variance, Efficiency Variance, \$720 U \$600 U Total Variance, \$1,320 U *5,000 ingots 0.3 hours per ingot = 1,500 hours Alternatively: Variable Overhead Spending Variance = AH (AR SR) 1,800 hours (\$2.40 per hour* \$2.00 per hour) = \$720 U *\$4,320 1,800 hours = \$2.40 per hour Variable Overhead Efficiency Variance = SR (AH SH) \$2.00 per hour (1,800 hours 1,500 hours) = \$600 U 2. Summary of variances: Material price variance... \$11,250 U Material quantity variance F Labour rate variance... 1,080 F Labour efficiency variance... 5,400 U Variable overhead spending variance U Variable overhead efficiency variance U Net variance... \$16,390 U The net unfavourable variance of \$16,390 for the month caused the plant s variable cost of goods sold to increase from the budgeted level of \$80,000 to \$96,390: Budgeted cost of goods sold at \$16 per ingot... \$80,000 Add the net unfavourable variance (as above)... 16,390 Actual cost of goods sold... \$96,390 This \$16,390 net unfavourable variance also accounts for the difference between the budgeted net operating income and the actual net loss for the month. Budgeted net operating income... \$15,000 Deduct the net unfavourable variance added to cost of goods sold for the month... 16,390 Net operating loss... \$(1,390) 3. The two most significant variances are the materials price variance and the labour efficiency variance. Possible causes of the variances include: Materials Price Variance: Outdated standards, uneconomical quantity purchased, higher quality materials, high-cost method of transport. Labour Efficiency Variance: Poorly trained workers, poor quality materials, faulty equipment, work interruptions, inaccurate standards, insufficient demand

13 Problem 3-19 (continued) 2. PACIFIC MANUFACTURING COMPANY Schedule of Cost of Goods Manufactured Direct materials: Raw materials inventory, beginning... \$ 21,000 Add purchases of raw materials ,000 Total raw materials available ,000 Deduct raw materials inventory, ending... 16,000 Raw materials used in production... \$138,000 Direct labour... 80,000 Manufacturing overhead applied to work in process ,000 Total manufacturing cost ,000 Add: Work in process, beginning... 44, ,000 Deduct: Work in process, ending... 40,000 Cost of goods manufactured... \$342, Cost of goods sold: Finished good inventory, beginning... \$ 68,000 Add: Cost of goods manufactured ,000 Goods available for sale ,000 Deduct: Finished goods inventory, ending... 60,000 Cost of goods sold... \$350,000 Under- or overapplied overhead may either be (1) closed directly to the Cost of Goods Sold account, or (2) allocated between Work in Process, Finished Goods, and Cost of Goods Sold in proportion to the overhead applied during the year in the ending balance of each of these accounts. Problem 3-19 (continued) 4. Direct materials... \$ 3,200 Direct labour... 4,200 Overhead applied (150% 4,200)... 6,300 Total manufacturing cost... \$13,700 \$13, % = \$19,180 price to customer. 5. The amount of overhead cost in Work in Process would be: \$8,000 direct labour cost 150% =\$12,000 The amount of direct materials cost in Work in Process would be: Total ending work in process... \$40,000 Deduct: Direct labour... \$ 8,000 Manufacturing overhead... 12,000 20,000 Direct materials... \$20,000 The completed schedule of costs in Work in Process would be: Direct materials... \$20,000 Direct labour... 8,000 Manufacturing overhead... 12,000 Work in process inventory... \$40,

14 Exercise 4-10 Weighted-Average Method 1. For the sake of brevity, only the portion of the quantity schedule from which the equivalent units are computed is shown below. Quantity Equivalent Units (EU) Schedule Materials Conversion Units accounted for as follows: Transferred to the next process , , ,000 Work in process, June 30 (materials 50% complete, conversion 25% complete)... 40,000 20,000 10,000 Total units accounted for , , ,000 Exercise 4-11 Weighted-Average Method Total Equivalent Units (EU) Cost Materials Conversion Cost accounted for as follows: Transferred to the next process: 300,000 units at \$2.12 each... \$636, , ,000 Work in process, June 30: Materials, at \$1.38 per EU... 27,600 20,000 Conversion, at \$0.74 per EU... 7,400 10,000 Total work in process... 35,000 Total cost accounted for... \$671, Total Cost Materials Conversion Cost to be accounted for: Work in process, June 1... \$ 71,500 \$ 56,600 \$ 14,900 Cost added by the department , , ,500 Total cost to be accounted for (a)... \$671,000 \$441,600 \$229,400 Equivalent units (b) , ,000 Cost per equivalent unit (a) (b)... \$ \$0.74 = 27 McGraw-Hill Ryerson, 2004 Solutions Manual, Chapter 4 28

15 Exercise 4-12 FIFO Method 1. Quantity Schedule Units to be accounted for: Work in process, June 1 (materials 75% complete, conversion cost 40% complete)... 60,000 Started into production ,000 Total units to be accounted for ,000 Equivalent Units (EU) Materials Conversion Units accounted for as follows: Transferred to the next process: From the beginning inventory... 60,000 15,000 * 36,000 * Started and completed this month** , , ,000 Work in process, June 30 (materials 50% complete, conversion 25% complete)... 40,000 20,000 10,000 Total units accounted for , , ,000 * Work needed to complete the units in the beginning inventory; 60,000 25% = 15,000; 60,000 60% = 36,000. ** 280,000 units started 40,000 units in ending inventory = 240,000 started and completed. Exercise 4-13 FIFO Method Total Equivalent Units (EU) Cost Materials Conversion Cost accounted for as follows: Transferred to the next process: From the beginning inventory: Cost in the beginning inventory... \$ 71,500 Cost to complete these units: Materials, at \$1.40 per EU... 21,000 15,000 Conversion, at \$0.75 per EU... 27,000 36,000 Total cost from beginning inventory.. 119,500 Units started and completed this month: 240,000 units \$2.15 per unit , , ,000 Total cost transferred to the next process ,500 Work in process, June 30: Materials, at \$1.40 per EU... 28,000 20,000 Conversion, at \$0.75 per EU... 7,500 10,000 Total work in process, June ,500 Total cost accounted for... \$671, Materials Conversion Whole Unit Cost added by the department (a)... \$385,000 \$214,500 Equivalent units (b) , ,000 Cost per equivalent unit (a) (b)... \$ \$0.75 = \$2.15 McGraw-Hill Ryerson, 2004 Solutions Manual, Chapter 4 29 McGraw-Hill Ryerson, 2004 Solutions Manual, Chapter 4 30

16 Problem 4-15 Weighted-Average Method Quantity Schedule and Equivalent Units Quantity Schedule Units to be accounted for: Work in process, June 1 (materials 5 /7 complete, conversion 3 /7 complete)... 70,000 Started into production ,000 Total units accounted for ,000 Equivalent Units (EU) Materials Conversion Units accounted for as follows: Transferred to the next department , , ,000 Work in process, June 30 (materials 3 /4 complete, conversion 5 /8 complete)... 80,000 60,000 50,000 Total units accounted for , , ,000 Problem 4-15 (continued) Costs per Equivalent Unit Total Materials Conversion Whole Unit Costs to be accounted for: Work in process, June 1... \$ 55,400 \$ 37,400 \$ 18,000 Cost added during the month , , ,000 Total cost to be accounted for (a)... \$728,400 \$428,400 \$300,000 Equivalent units (b) , ,000 Cost per equivalent unit (a) (b)... \$ \$0.60 = \$1.44 McGraw-Hill Ryerson, 2004 Solutions Manual, Chapter 4 32 McGraw-Hill Ryerson, 2004 Solutions Manual, Chapter 4 31

17 Problem 4-15 (continued) Cost Reconciliation Equivalent Units (EU) Costs Materials Conversion Cost accounted for as follows: Transferred to the next department: 450,000 units \$1.44 per unit... \$648, , ,000 Work in process, June 30: Materials, at \$0.84 per EU... 50,400 60,000 Conversion, at \$0.60 per EU... 30,000 50,000 Total work in process, June ,400 Total cost accounted for... \$728,400 Problem 4-16 FIFO Method Quantity Schedule and Equivalent Units Quantity Schedule Units to be accounted for: Work in process, June 1 (materials 5 /7 complete, conversion 3 /7 complete)... 70,000 Started into production ,000 Total units to be accounted for ,000 Equivalent Units (EU) Materials Conversion Units accounted for as follows: Transferred to the next department: From the beginning inventory*... 70,000 20,000 40,000 Started and completed this month , , ,000 Work in process, June 30 (materials 3 /4 complete, conversion 5 /8 complete)... 80,000 60,000 50,000 Total units accounted for , , ,000 * Work needed to complete the units in the beginning inventory. (1 5 /7) 70,000 = 20,000; (1 3 /7) 70,000 = 40, ,000 units started 80,000 units in ending work in process = 380,000 units started and completed

18 Problem 4-16 (continued) Costs per Equivalent Unit Total Cost Materials Conversion Whole Unit Cost to be accounted for: Work in process, June 1... \$ 55,400 Cost added during the month (a) ,000 \$391,000 \$282,000 Total cost to be accounted for... \$728,400 Equivalent units (b) , ,000 Cost per equivalent unit (a) (b)... \$ \$0.60 = \$ Problem 4-16 (continued) Cost Reconciliation Total Equivalent Units (EU) Cost Materials Conversion Cost accounted for as follows: Transferred to next department: From the beginning inventory: Cost in the beginning inventory... \$ 55,400 Cost to complete these units: Materials, at \$0.85 per EU... 17,000 20,000 Conversion, at \$0.60 per EU... 24,000 40,000 Total cost from beginning inventory... 96,400 Units started and completed this month: 380,000 units \$1.45 per unit , , ,000 Total cost transferred to next department ,400 Work in process, June 30: Materials, at \$0.85 per EU... 51,000 60,000 Conversion, at \$0.60 per EU... 30,000 50,000 Total work in process, June ,000 Total cost accounted for... \$728,400 36

21 4. Proponents of variable costing appeal to the cost avoidance criterion as a necessary condition for asset recognition. The incurrence of fixed manufacturing costs this period will not allow the firm to avoid or eliminate them next period, so fixed manufacturing costs should not be recognized as assets. It is also pointed out that use of absorption costing can lead to manipulation of the net income figure by managing levels of production and inventory. Proponents of absorption costing argue that the finished goods should bear a fair share of all the costs that were incurred to bring the goods to saleable condition, and that all costs should be properly included in inventory. Under Canadian generally accepted accounting principles, either absorption costing or variable costing is acceptable, provided the selected method is used consistently. However, it is argued that in the long run, variable costing can be misleading for purposes of long-run costing and pricing. CGA-Adapted Problem Selling price per unit... \$40 Less variable expenses per unit* Contribution margin per unit... \$16 *\$ \$ \$ \$1.70 = \$24.00 Increased unit sales (80,000 25%)... 20,000 Contribution margin per unit... \$16 Incremental contribution margin... \$320,000 Less added fixed selling expense ,000 Incremental net operating income... \$170,000 Yes, the increase in fixed selling expense would be justified. 2. Variable production cost per unit (\$24.00 \$1.70)... \$22.30 Import duties, etc. (\$14,000 20,000 units) Shipping cost per unit Break-even price per unit... \$ If the plant operates at 25% of normal levels, then only 5,000 units will be produced and sold during the three-month period: 80,000 units per year 3/12 = 20,000 units. 20,000 units 25% = 5,000 units produced and sold. Given this information, the simplest approach to the solution is: Contribution margin lost if the plant is closed (5,000 units \$16 per unit*)... \$(80,000) Fixed costs that can be avoided if the plant is closed: Fixed manufacturing overhead cost (\$400,000 3/12 = \$100,000; \$100,000 40%)... \$40,000 Fixed selling cost (\$360,000 3/12 = \$90,000; \$90,000 1/3)... 30,000 70,000 Net disadvantage of closing the plant... \$(10,000) *\$40.00 (\$ \$ \$ \$1.70) = \$

23 Problem (continued) Having determined the costs that can be avoided if the Kensington product line is dropped, we can now make the following computation: Sales revenue lost if the Kensington line is dropped ,000 Less costs that can be avoided (see above) ,800 Decrease in overall company net operating income if the Kensington line is dropped... 36,200 Thus, the Kensington line should not be dropped unless the company can find more profitable uses for the resources consumed by the Kensington line. 2. To determine the minimum acceptable sales level, we must first classify the avoidable costs into variable and fixed costs as follows: Variable Fixed Direct materials... 32,000 Direct labour ,000 Fringe benefits (30% of labour)... 60,000 Variable manufacturing overhead... 30,000 Royalties (5% of sales)... 24,000 Product-line managers salaries... 8,000 Sales commissions (10% of sales)... 48,000 Fringe benefits (30% of salaries and commissions)... 14,400 2,400 Shipping... 10,000 Advertising... 15,000 Total cost ,400 25,400 The Kensington product line should be retained as long as its contribution margin covers its avoidable fixed costs. Break-even analysis can be used to find the sales volume where the contribution margin just equals the avoidable fixed costs. Problem (continued) The contribution margin ratio is computed as follows: Contribution margin CM ratio = Sales 480, ,400 = = 12.83% (rounded) 480,000 And the break-even sales volume can be found using the break-even formula: Fixed expenses Break- even point = CM ratio 25,400 = = 198,000 (rounded) Therefore, as long as the sales revenue from the Kensington product line exceeds 198,000, it is covering its own avoidable fixed costs and is contributing toward covering the common fixed costs and toward the profits of the entire company

24 Problem A product should be processed further so long as the incremental revenue from the further processing exceeds the incremental costs. The incremental revenue from further processing of the honey is: Selling price of a container of honey drop candies... \$4.40 Selling price of 345 grams of honey (\$ ) Incremental revenue per container... \$2.12 The incremental variable costs are: Decorative container... \$0.40 Other ingredients Direct labour Variable manufacturing overhead Commissions (5% \$4.40) Incremental variable cost per container... \$1.17 Therefore, the incremental contribution margin is \$0.95 per container (\$2.12 \$1.17). The cost of purchasing the honeycombs is not relevant because those costs are incurred regardless of whether the honey is sold outright or processed further into candies. 2. The only avoidable fixed costs of the honey drop candies are the master candy maker s salary and the fixed portion of the salesperson s compensation. Therefore, the number of containers of the candy that must be sold each month to justify continued processing of the honey into candies is determined as follows: Master candy maker s salary... \$3,700 Salesperson s fixed compensation... 2,000 Avoidable fixed costs... \$5,700 Avoidable fixed costs \$5,700 = =6,000 containers Incremental CM per container \$0.95 per container Problem (continued) If the company can sell more than 6,000 containers of the candies each month, then profits will be higher than if the honey were simply sold outright. If the company cannot sell at least 6,000 containers of the candies each month, then profits will be higher if the company discontinues making honey drop candies. To verify this, we show below the total contribution to profits of sales of 5,000, 6,000, and 7,000 containers of candies, contrasted to sales of equivalent amounts of honey. For example, instead of selling 2,070 kilograms of honey, this same amount of honey can be processed into 6,000 containers of candy. Sales of candies: Containers sold per month... 5,000 6,000 7,000 Sales \$4.40 per container... \$22,000 \$26,400 \$30,800 Less incremental variable \$1.17 per container... 5,850 7,020 8,190 Incremental contribution margin... 16,150 19,380 22,610 Less avoidable fixed costs... 5,700 5,700 5,700 Total contribution to profits... \$10,450 \$13,680 \$16,910 Sales of equivalent amount of honey: Kilograms sold per month*... 1,725 2,070 2,415 Sales \$6.60 per kilogram... \$11,385 \$13,662 \$15,939 * 5,000 containers 345 grams per container = 1,725,000 grams 6,000 containers 345 grams per container = 2,070,000 grams 7,000 containers 345 grams per container = 2,415,000 grams If there is a choice between selling 1,725 kilograms of honey or selling 5,000 containers of candies, profits would be higher selling the honey outright (\$11,385 versus \$10,450). The company should be largely indifferent between selling 2,070 kilograms of honey or 6,000 containers of candy. In either case, the contribution to profits would be nearly \$13,700. On the other hand, if faced with a choice of selling 2,415 kilograms of honey or 7,000 containers of candies, profits would be higher processing the honey into candies (\$16,910 versus \$15,939)

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