management accounting

SIXTH EDITION

ACCOUNTING MANAGERIAL TOOLS FOR BUSINESS DECISION MAKING

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Jerry J. Weygandt PhD, CPA University of Wisconsin—Madison

Madison, Wisconsin

Paul D. Kimmel PhD, CPA University of Wisconsin—Milwaukee

Milwaukee, Wisconsin

Donald E. Kieso PhD, CPA Northern Illinois University

DeKalb, Illinois

John Wiley & Sons, Inc.

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our adopters in a professional

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Enid, Merlynn, and Donna

Vice President & Executive Publisher George Hoffman Associate Publisher Christopher DeJohn Senior Acquisitions Editor Michael McDonald Operations Manager Yana Mermel Senior Content Editor Brian Kamins Senior Content Editor Ed Brislin Development Editor Terry Ann Tatro Project Manager Aaron Riccio Content Manager Dorothy Sinclair Senior Production Editor Valerie Vargas Associate Director of Marketing Amy Scholz Marketing Manager Karolina Zarychta Honsa Lead Product Designer Allison Morris Product Designer Greg Chaput Interactive Product Designer Daniela DiMaggio Design Director Harry Nolan Senior Designer Maureen Eide Designer Kristine Carney Production Management Services Ingrao Associates Senior Illustration Editor Anna Melhorn Senior Photo Editor Mary Ann Price Senior Editorial Assistant Jacqueline Kepping Senior Marketing Assistant Courtney Luzzi Cover Design Maureen Eide Cover Photo Robert Zaleski/Aurora Photos

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Jerry J. Weygandt, PhD, CPA; Paul D. Kimmel, PhD, CPA; and Donald E. Kieso, PhD, CPA Managerial Accounting, Sixth Edition

ISBN-13 978-1-118-09689-5

Printed in the United States of America

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From the Authors

Dear Student,

Why This Course? Remember your biology course in high school? Did you have one of those “invisible man” models (or maybe something more high-tech than that) that gave you the opportunity to look “inside” the human body? This accounting course offers something similar: To understand a business, you have to understand the financial insides of a business organization. A managerial accounting course will help you understand the essential financial components of businesses. Whether you are looking at a large multinational company like Microsoft or Starbucks or a single- owner software consulting business or coffee shop, knowing the fundamentals of managerial accounting will help you understand what is happening. As an employee, a manager, an investor, a business owner, or a director of your own personal finances—any of which roles you will have at some point in your life—you will make better decisions for having taken this course.

Why This Book? Hundreds of thousands of students have used this textbook. Your instructor has chosen it for you because of its trusted reputation. The authors have worked hard to keep the book fresh, timely, and accurate.

This textbook contains features to help you learn best, whatever your learning style. To understand what your learning style is, spend about 10 minutes to take the learning style quiz at the book’s companion website. Then, look at page xi for how you can apply an understanding of your learning style to this course. When you know more about your own learning style, browse through pages xii–xiii. These pages describe the main features you will find in this textbook and explain their purpose.

How To Succeed? We’ve asked many students and many instructors whether there is a secret for success in this course. The nearly unanimous answer turns out to be not much of a secret: “Do the homework.” This is one course where doing is learning, and the more time you spend on the homework assignments—using the various tools that this textbook provides—the more likely you are to learn the essential concepts, techniques, and methods of accounting. Besides the textbook itself, the textbook companion website offers various support resources.

Good luck in this course. We hope you enjoy the experience and that you put to good use throughout a lifetime of success the knowledge you obtain in this course. We are sure you will not be disappointed.

Jerry J. Weygandt Paul D. Kimmel Donald E. Kieso

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“Whether you are looking at a large multinational company like Microsoft or Starbucks or a single-owner software consulting business or coffee shop, knowing the fundamentals of managerial accounting will help you understand what is happening.”

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Your Team for Success in Accounting

Wiley Accounting is your partner in accounting education. We want to be the first publisher you think of when it comes to quality content, reliable technology, innovative resources, professional training, and unparalleled support for your accounting classroom.

Your Wiley Accounting Team for Success is comprised of three distinctive advantages that you won’t find with any other publisher:

• Author Commitment • Wiley Faculty Network • WileyPLUS

Author Commitment: A Proven Author Team of Inspired Teachers

The Team for Success authors bring years of industry and academic experience to the development of each textbook that relates accounting concepts to real-world

experiences. This cohesive team brings continuity of writing style, pedagogy, and problem material to each course from Principles to Intermediate so you and your students can seamlessly progress from introductory through advanced courses in accounting.

The authors understand the mindset and time limitations of today’s students. They demonstrate an intangible ability to effectively deliver complex information so it is clear and understandable while staying one step ahead of emerging global trends in business.

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Wiley Faculty Network: A Team of Educators Dedicated to Your Professional Development

The Wiley Faculty Network (WFN) is a global group of seasoned accounting professionals who share best practices in teaching with their peers. Our Virtual Guest

Lecture Series provides the opportunity you need for professional development in an online environment that is relevant, convenient, and collaborative. The quality of these seminars and workshops meets the strictest standards, so we are proud to be able to offer valuable CPE credits to attendees.

With 24 faculty mentors in accounting, it’s easy to find help with your most challenging curriculum questions—just ask our experts!

WileyPLUS: An Experienced Team of Support Professionals

The WileyPLUS Account Managers understand the time constraints of busy

instructors who want to provide the best resources available to their students with minimal headaches and planning time. They know how intimidating new software can be, so they are sure to make the transition easy and painless.

Account Managers act as your personal contact and expert resource for training, course set-up, and shortcuts throughout the WileyPLUS experience.

Your success as an educator directly correlates to student success, and that’s our goal. The Wiley Accounting Team for Success truly strives for YOUR success! Partner with us today!

www.wileyteamforsuccess.com

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Author Commitment Collaboration. Innovation. Experience.

After decades of success as authors of textbooks like this one, Jerry Weygandt, Paul Kimmel, and Don Kieso understand that teaching accounting goes beyond simply presenting data. The authors are truly effective because they know that teaching is about telling compelling stories in ways that make each concept come to life.

TTeeaacchheerr // AAuutthhoorr // PPrrooffeessssiioonnaall Through their textbooks, supplements, online learning tools, and classrooms, these authors have developed a comprehensive pedagogy that engages students in learning and faculty with teaching.

These authors collaborate throughout the entire process. The end result is a true collaboration where each author brings his individual experience and talent to the development of every paragraph, page, and chapter, thus creating a truly well-rounded, thorough view on any given accounting topic.

MMaannyy WWaayyss iinn OOnnee DDiirreeccttiioonn Our Team for Success has developed a teaching system that addresses every learning style. Each year brings new insights, feedback, ideas, and improvements on how to deliver the material to every student with a passion for the subject in a format that gives them the best chance to succeed.

The key to the team’s approach is in understanding that, just as there are many different ways to learn, there are also many different ways to teach.

IInn TThheeiirr OOwwnn WWoorrddss Visit the Wiley Team for Success website to hear from the authors first-hand as they discuss their teaching styles, collaboration, and the future of accounting.

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Jerry Weygandt Jerry J. Weygandt, PhD, CPA, is Arthur Andersen Alumni Emeritus Professor of Accounting at the University of Wisconsin— Madison. He holds a Ph.D. in accounting from the University of Illinois. Articles by Professor Weygandt have appeared in the Accounting Review, Journal of Accounting Research, Accounting Horizons, Journal of Accountancy, and other academic and professional journals. These articles have examined such financial reporting issues as accounting for price-level adjustments, pensions, convertible securities, stock option contracts, and interim reports. Professor Weygandt is author of other accounting and financial reporting books and is a member of the American Accounting Association, the American Institute of Certified Public Accountants, and the Wisconsin Society of Certified Public Accountants. He has served on numerous committees of the American Accounting Association and as a member of the editorial board of the Accounting Review; he also has served as President and Secretary-Treasurer of the American Accounting Association. In addition, he has been actively involved with the American Institute of Certified Public Accountants and has been a member of the Accounting Standards Executive Committee (AcSEC) of that organization. He has served on the FASB task force that examined the reporting issues related to accounting for income taxes and served as a trustee of the Financial Accounting Foundation. Professor Weygandt has received the Chancellor’s Award for Excellence in Teaching and the Beta Gamma Sigma Dean’s Teaching Award. He is on the board of directors of M & I Bank of Southern Wisconsin. He is the recipient of the Wisconsin Institute of CPA’s Outstanding Educator’s Award and the Lifetime Achievement Award. In 2001 he received the American Accounting Association’s Outstanding Educator Award.

Paul Kimmel Paul D. Kimmel, PhD, CPA, received his bachelor’s degree from the University of Minnesota and his doctorate in accounting from the University of Wisconsin. He is an Associate Professor at the University of Wisconsin—Milwaukee, and has public accounting experience with Deloitte & Touche (Minneapolis). He was the recipient of the UWM School of Business Advisory Council Teaching Award, the Reggie Taite Excellence in Teaching Award and a three-time winner of the Outstanding Teaching Assistant Award at the University of Wisconsin. He is also a recipient of the Elijah Watts Sells Award for Honorary Distinction for his results on the CPA exam. He is a member of the American Accounting Association and the Institute of Management Accountants and has published articles in Accounting Review, Accounting Horizons, Advances in Management Accounting, Managerial Finance, Issues in Accounting Education, Journal of Accounting Education, as well as other journals. His research interests include accounting for financial instruments and innovation in accounting education. He has published papers and given numerous talks on incorporating critical thinking into accounting education, and helped prepare a catalog of critical thinking resources for the Federated Schools of Accountancy.

Don Kieso Donald E. Kieso, PhD, CPA, received his bachelor’s degree from Aurora University and his doctorate in accounting from the University of Illinois. He has served as chairman of the Department of Accountancy and is currently the KPMG Emeritus Professor of Accountancy at Northern Illinois University. He has public accounting experience with Price Waterhouse & Co. (San Francisco and Chicago) and Arthur Andersen & Co. (Chicago) and research experience with the Research Division of the American Institute of Certified Public Accountants (New York). He has done post doctorate work as a Visiting Scholar at the University of California at Berkeley and is a recipient of NIU’s Teaching Excellence Award and four Golden Apple Teaching Awards. Professor Kieso is the author of other accounting and business books and is a member of the American Accounting Association, the American Institute of Certified Public Accountants, and the Illinois CPA Society. He has served as a member of the Board of Directors of the Illinois CPA Society, then AACSB’s Accounting Accreditation Committees, the State of Illinois Comptroller’s Commission, as Secretary-Treasurer of the Federation of Schools of Accountancy, and as Secretary-Treasurer of the American Accounting Association. Professor Kieso is currently serving on the Board of Trustees and Executive Committee of Aurora University, as a member of the Board of Directors of Kishwaukee Community Hospital, and as Treasurer and Director of Valley West Community Hospital. From 1989 to 1993 he served as a charter member of the national Accounting Education Change Commission. He is the recipient of the Outstanding Accounting Educator Award from the Illinois CPA Society, the FSA’s Joseph A. Silvoso Award of Merit, the NIU Foundation’s Humanitarian Award for Service to Higher Education, a Distinguished Service Award from the Illinois CPA Society, and in 2003 an honorary doctorate from Aurora University.

Author Commitment

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WileyPLUS WileyPLUS is an innovative, research-based, online environment for effective teaching and learning.

What do STUDENTS receive with WileyPLUS? WileyPLUS increases confidence through an innovative design that allows greater engagement, which leads to improved learning outcomes.

Design The WileyPLUS design integrates relevant resources, including the entire digital textbook, in an easy-to-navigate framework that helps students study more effectively and ensures student engagement. Innovative features, such as calendars and visual progress tracking, as well as a variety of self-evaluation tools, are all designed to improve time-management and increase student confidence.

Engagement WileyPLUS organizes the textbook content into smaller, more man- ageable learning units with demonstrable study objectives and out- comes. Related media, examples, and sample practice items are integrated within each section to reinforce the study objectives. Throughout each study session, students can assess progress and gain immediate feedback on strengths and weaknesses in order to ensure they are spending their time most effectively.

Outcomes Throughout each study session, WileyPLUS provides precise report- ing of strengths and weaknesses, as well as individualized quizzes. As a result, students can be confident they are spending their time on the right things. With WileyPLUS, students always know the exact outcome of their efforts.

With increased confidence, motivation is sustained so students stay on task longer, leading to success.

for Students

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for Instructors

What do INSTRUCTORS receive with WileyPLUS? Support and Insight into Student Progress

WileyPLUS provides reliable, customizable resources that reinforce course goals inside and outside of the classroom, as well as visibility into individual student progress. Pre-created materials and activities help instructors optimize their time.

For class preparation and classroom use: • Interactive Tutorials • Problem Walkthrough Videos • Managerial Accounting Videos

For assignments and testing: • Gradable Reading Assignment Questions

(embedded with online text) • Question Assignments: all end-of-chapter problems

coded algorithmically with hints, links to text

For course planning: WileyPLUS comes with a pre-created Course Plan designed by a subject matter expert uniquely for this course. Simple drag-and-drop tools make it easy to assign the course plan as-is or modify it to reflect your course syllabus.

For progress monitoring: WileyPLUS provides instant access to reports on trends in class performance, student use of course materials, and progress toward learning objectives, helping inform decisions and drive classroom discussions.

Experience WileyPLUS for effective teaching and learning at www.wileyplus.com.

Powered by proven technology and built on a foundation of cognitive research, WileyPLUS has enriched the education of millions of students in numerous countries around the world.

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The Place Where Faculty Connect ... The Wiley Faculty Network is a global community of faculty connected by a passion for teaching and a drive to learn and share. Connect with the Wiley Faculty Network to collaborate with your colleagues, find a mentor, attend virtual and live events, and view a wealth of resources all designed to help you grow as an educator. Embrace the art of teaching—great things happen where faculty connect!

Discover innovative ideas and gain knowledge you can use.

• Training • Virtual Guest Lectures • Live Events

Explore your resources and development opportunities.

• Teaching Resources • Archived Guest Lectures • Recorded Presentations • Professional Development Modules

Connect with colleagues— your greatest resource.

• Find a Mentor • Interest Groups • Blog

Find out more at

www.WHEREFACULTYCONNECT.com

The Wiley Faculty Network

Virtual Guest Lectures Connect with recognized leaders across disciplines and collaborate with your peers on timely topics and discipline specific issues, many of which offer CPE credit.

Live and Virtual Events These invitation-only, discipline-specific events are organized through a close partnership between the WFN, Wiley, and the academic community near the event location.

Technology Training Discover a wealth of topic- and technology-specific training presented by subject matter experts, authors, and faculty where and when you need it.

Teaching Resources Propel your teaching and student learning to the next level with quality peer-reviewed case studies, testimonials, classroom tools, and checklists.

Connect with Colleagues Achieve goals and tackle challenges more easily by enlisting the help of your peers. Connecting with colleagues through the WFN can help you improve your teaching experience.

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What TYPE of learner are you? Understanding each of these basic learning styles enables the authors to engage students’ minds and

motivate them to do their best work, ultimately improving the experience for both students and faculty. V

IS U

A L

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IT IN

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• Pay close attention to charts, drawings, and handouts your instructors use.

• Underline. • Use different colors. • Use symbols, flow charts,

graphs, different arrangements on the page, white spaces.

Convert your lecture notes into “page pictures.” Therefore: • Use the “Intake” strategies. • Reconstruct images in

different ways. • Redraw pages from

memory. • Replace words with symbols

and initials. • Look at your pages.

The Navigator/Feature Story/Preview

Infographics/Illustrations Accounting Equation Analyses Highlighted words Questions/Exercises/Problems Real-World Focus Decision-Making at Current

Designs Managerial Analysis Problem

• Recall your “page pictures.” • Draw diagrams where

appropriate. • Practice turning your visuals

back into words.

• Attend lectures and tutorials. • Discuss topics with students

and instructors. • Explain new ideas to

other people. • Use a tape recorder. • Leave spaces in your lecture

notes for later recall. • Describe overheads, pictures,

and visuals to somebody who was not in class.

You may take poor notes because you prefer to listen. Therefore: • Expand your notes by talking

with others and with information from your textbook.

• Tape-record summarized notes and listen.

• Read summarized notes out loud.

• Explain your notes to another “aural” person.

Preview Insight Boxes DO IT!/Action Plan Summary of Learning Objectives Glossary Self-Test Questions Questions/Exercises/Problems Real-World Focus Decision-Making at Current

Designs Managerial Analysis Problem Decision-Making Across the

Organization Communication Activity Ethics Case

• Talk with the instructor. • Spend time in quiet places

recalling the ideas. • Practice writing answers

to old exam questions. • Say your answers out loud.

• Use lists and headings. • Use dictionaries, glossaries,

and definitions. • Read handouts, textbooks,

and supplementary library readings.

• Use lecture notes.

• Write out words again and again.

• Reread notes silently. • Rewrite ideas and principles

into other words. • Turn charts, diagrams,

and other illustrations into statements.

The Navigator/Feature Story/Study

Objectives/Preview DO IT!/Action Plan Summary of Learning

Objectives Glossary/Self-Test Questions Questions/Exercises/Problems Writing Problems Real-World Focus Decision-Making at Current

Designs Considering Your Costs and

Benefits Managerial Analysis Problem Decision-Making Across the

Organization Communication Activity

• Write exam answers. • Practice with multiple-choice

questions. • Write paragraphs, beginnings,

and endings. • Write your lists in

outline form. • Arrange your words into

hierarchies and points.

• Use all your senses. • Go to labs, take field trips. • Listen to real-life examples. • Pay attention to applications. • Use hands-on approaches. • Use trial-and-error methods.

You may take poor notes because topics do not seem concrete or relevant. Therefore: • Put examples in

your summaries. • Use case studies and

applications to help with principles and abstract concepts.

• Talk about your notes with another “kinesthetic” person.

• Use pictures and photographs that illustrate an idea.

The Navigator/Feature Story/Preview Infographics/Illustrations DO IT!/Action Plan Summary of Learning Objectives Self-Test Questions Questions/Exercises/Problems Real-World Focus Decision-Making at Current

Designs Managerial Analysis Problem Decision-Making Across the

Organization Ethics Case Considering Your Costs and

Benefits

• Write practice answers. • Role-play the exam situation.

Intake: To take in the information To make a study package

Text features that may help you the most

Output: To do well on exams

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Integrated Company Coverage Beginning in Chapter 1, we introduce Current Designs, a kayak-making company based in Winona, Minnesota. We then follow-up with a new decision-making problem in every chapter based on this real-world company. Each problem presents realistic managerial accounting situa- tions that students must analyze to determine the best course of action. In addition, many of these end-of-chapter activities also have an accompanying video.

People, Planet, and Profit Today’s companies are evaluating not just their profitability but also their corporate social responsibility. In this edition, we have profiled some of these companies, such as Starbucks, to highlight their sustainable business practices. We also have added a new Broadening Your Perspective prob- lem, “Considering People, Planet, and Profit,” which requires students to assess and determine how best to balance a company’s profitability with its corporate social responsibility.

New Feature Stories Students will be more willing to commit time and energy to a topic when they believe it is relevant to their future careers. There is no better way to demonstrate relevance than to ground discussions in the real world. To that end, we have written new Feature Stories about such companies as Starbucks, Amazon.com, and Zappos.com.

Managerial Accounting Video Series Through the use of real-world, cutting-edge companies, these videos engage students with a dynamic overview of managerial accounting topics and motivate them through the detailed tools, examples, and discussions presented in their textbook, WileyPLUS course, and classroom lectures.

Continued Focus on Decision-Making In the Sixth Edition, we continue to demonstrate how invaluable management accounting infor- mation is to business decision-making. New to this edition is another new Broadening Your Perspective problem, “Considering Your Costs and Benefits,” which presents a realistic situation in which students must weigh the pros and cons of two alternatives.

What’s New?

Features of the Sixth Edition

The Sixth Edition expands our emphasis on student learning and improves upon a teach- ing and learning package that instructors and students have rated the highest in cus- tomer satisfaction.

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This edition was also subject to an overall, comprehensive revision to ensure that it is technically accurate, relevant, and up-to-date. We have continued and enhanced many of the features of the Fifth Edition of Managerial Accounting, including the following:

Real-World Emphasis One of the goals of the managerial accounting course is to orient students to the application of accounting principles and techniques in practice. Accordingly, we have continued our practice of using numerous examples from real companies throughout the textbook. The names of these real companies are highlighted in red.

Also, throughout the chapters, IInnssiigghhtt and AAccccoouunnttiinngg AAccrroossss tthhee OOrrggaanniizzaattiioonn boxes show how people, often in non-accounting functions, in actual companies make decisions using accounting information. Guideline Answers to the critical thinking questions are provided at the end of each chapter. Finally, examples, exercises, and problems that focus on accounting situations faced by sseerrvviiccee ccoommppaanniieess are identified by the icon shown here.

Decision Toolkit The DDeecciissiioonn TToooollkkiittss highlight the important analytical tools inte- grated throughout the textbook, designed to assist students in evaluation and using the information at hand. A UUssiinngg tthhee DDeecciissiioonn TToooollkkiitt exercise, just before the chapter summary, asks students to use the decision tools presented in the chapter and takes them through the problem-solving steps.

Exercises Brief exercises ask students to apply their newly acquired knowledge. The exer- cises include an Action Plan, which reviews the necessary steps to complete the exercise, as well as a Solution so students can have immediate feedback. A CCoommpprreehheennssiivvee problem at the end of each chapter allows students a final check of their understanding before they do their homework. RReevviieeww problems are part of the end-of-chapter homework material.

Marginal Notes HHeellppffuull HHiinnttss in the margin further clarify concepts being discussed. EEtthhiiccss NNootteess point out ethical points related to the nearby text discussion. AAlltteerrnnaattiivvee TTeerrmmiinnoollooggyy lets students know about interchangeable words and phrases.

Comprehensive Homework Material Each chapter concludes with revised Self-Test Questions, Questions, Brief Exercises, Review, Exercises, and Problems. An icon, shown here, identifies Exercises and Problems that can be solved using EExxcceell tteemmppllaatteess at the book’s companion website. The WWaatteerrwwaayyss CCoonnttiinnuuiinngg PPrroobblleemm uses the business activities of a fictional company, to help students apply managerial accounting topics to a realistic entrepreneurial situation.

Broadening Your Perspective Section We have revised and updated the BBrrooaaddeenniinngg YYoouurr PPeerrssppeeccttiivvee section at the end of each chapter. Elements in this section include the following:

• Decision-Making at Current Designs • Ethics Case • Decision-Making Across the Organization • All About You • Managerial Analysis • Considering People, Planet, and Profit • Real-World Focus • Considering Your Costs and Benefits • Communication Activity

These assignments are designed to help develop students’ decision-making and critical-thinking skills.

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Enhanced Features of the Sixth Edition

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Chapter 1 Managerial Accounting • New Feature Story, on history and operations

of Current Designs (kayak-making company). • First section, Managerial Accounting Basics,

rewritten to discuss managerial accounting activities within context of Current Designs’ kayak-making business.

• New Management Insight, “Why Manufacturing Matters for U.S. Workers,” about importance of U.S. factory jobs.

• Revised section, Managerial Accounting Today, now includes Focus on the Value Chain section (discussing value chain, JIT, TQM, TOC, ERP, ABC), Balanced Scorecard section, and new Corporate Social Responsibility section.

• Deleted chapter appendix (Accounting Cycle for a Manufacturing Company).

Chapter 2 Job Order Costing • New Feature Story, on Lynn Tilton, founder and

CEO of Patriarch Partners, the largest, woman- owned U.S. business.

• In the Accumulating Manufacturing Costs section, included the individual T-accounts in the margin, next to where discussed in the text. Also, provided additional explanations for Raw Materials Cost, Factory Labor Costs, and Manufacturing Overhead Costs, to increase student understanding.

• Added more detail (such as totals of T-accounts) within illustrations of job cost sheets, so students can better understand assignment of costs.

Chapter 3 Process Costing • Changed example of company in Process

Cost Flow section to roller blade/skateboard wheel manufacturer instead of can opener manufacturer, to increase student appeal.

• New People, Planet, and Profit Insight, about costs/benefits of remanufactured goods.

Chapter 4 Activity-Based Costing • New Feature Story (and accompanying video)

on why Precor (fitness equipment) switched from traditional costing to activity-based costing.

• Changed example company, in Example of ABC versus Traditional Costing section, to

producing abdominal trainers instead of car-antitheft devices, to tie in with Precor.

• Rewrote definition/explanation of value-added and non–value-added activities, as well as of activity levels, to ensure student understanding of these concepts.

• Simplified the ABC costing example for the service company illustration, to avoid needless detail and potential student confusion.

• New Management Insight, summarizing a recent survey of ABC practices by companies worldwide.

• New Real-World Focus BYP problem, on use of ABC in the financial services industry.

Chapter 5 Cost-Volume-Profit • New Feature Story, on how Jeff Bezos started and

expanded Amazon.com’s operations. • New People, Planet, and Profit Insight, on hydro-

ponic farming/vertical farming. • Added material on use of scatter plots in High-Low

Method section, as well as provided supplement on regression analysis on book’s companion website.

• Added more detailed explanations and illustrations to Contribution Margin per Unit, Contribution Margin Ratio, and Break-Even Analysis sections, to ensure student understanding.

• New Real-World Focus BYP problem, on how Barnes and Noble’s current structure left it ill- prepared for an e-book environment.

Chapter 6 Cost-Volume-Profit Analysis: Additional Issues

• New Feature Story, still about Intel, but now explaining why the computer chip giant experi- ences huge swings in its earnings.

• Provided more step-by-step explanations and illustrations in the Basic Computations section, so students will improve their understanding of why and how to compute break-even points, target net income, and margin of safety.

• New Service Company Insight, about why Warren Buffett acquired Burlington Northern Railroad.

• New Real-World Focus BYP problem, on Smart Balance’s employment and cost structure.

• New Considering People, Planet, and Profit BYP problem, about whether companies should incorporate environmental costs into their decision-making process.

Content Changes by Chapter

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Chapter 7 Incremental Analysis • New Service Company Insight, about the relevant

revenues and costs of Amazon.com’s Prime free shipping program.

• Expanded sunk cost discussion and illustrations, to improve student understanding.

• New material on how behavioral decision-making can affect whether or not to replace equipment.

• Expanded discussion of elimination of an unprof- itable segment to include fixed cost analysis.

• New Considering Your Costs and Benefits BYP problem, about whether or not to drop out of college due to financial considerations.

Chapter 8 Pricing • New Feature Story (and accompanying video) on

origins and operating principles of Zappos.com. • New Management Insight, about how com-

petition affected online subscription prices. • Rewrote Cost-Plus Pricing section, adding more

explanations and illustrations to increase student understanding.

• New Considering Your Costs and Benefits BYP problem, about difference between “low-cost” and “low-price” suppliers as well as implications of full-cost accounting for corporate social responsibility.

Chapter 9 Budgetary Planning • Added more detailed explanation to the

Budgeting and Human Behavior section about participative budgeting.

• Added marginal T-accounts to Production Budget and Direct Materials Budget sections, to illustrate flow of costs.

• New Service Company Insight, on the impli- cations of budgetary optimism as it pertains to governments.

• New Management Insight, on the potential costs and benefits of a company stockpiling raw materials.

• Added a second Comprehensive DO IT! problem on budgeted income statement and balance sheet.

• New Considering Your Costs and Benefits BYP problem about whether student loans should be considered as a source of income.

Chapter 10 Budgetary Control and Responsibility Accounting

• New Service Company Insight, about NBCUniversal’s response to Fox wanting to reduce its licensing fee for the TV show “House.”

• Added graph to the solution for the DO IT! on flexible budgets, to increase student understanding.

• Moved Management by Exception to within Performance Evaluation discussion, now included in Responsibility Accounting section, for better flow of chapter topics.

• New Considering Your Costs and Benefits BYP problem, addressing the decision of whether or not to purchase a home.

Chapter 11 Standard Costs and Balanced Scorecard • New Feature Story (and accompanying video) on

Starbucks’ origins and vision. • New case study example on producing caffeinated

energy drink (replaces weed-killer manufacturer), to increase student appeal.

• New material and illustrations added, to enhance explanation of the components of variances as well as how to compute them.

• New People, Planet, and Profit Insight, highlighting Starbucks’ 10th annual Global Responsibility Report and the company’s commitment to corporate social responsibility.

• Reformatted the illustration of the objectives within the four perspectives of a balanced score- card, to increase student understanding.

• New Real-World Focus BYP problem referencing the Wall Street Journal article, “In Risky Move, GM to Run Plants Around Clock.”

• New Considering Your Costs and Benefits BYP problem, addressing the extent to which financial measures should influence medical care.

Chapter 12 Planning for Capital Investments • New Feature Story, on how timing can affect

capital investments by the cruise-line industry. • New Management Insight, about whether

Verizon’s investment in its 4G wireless service will pay off and whether there is too much plant capacity for manufacturing big-screen TVs.

• New Considering Your Costs and Benefits BYP problem, about calculating the NPVs of solar panels.

Chapter 13 Statement of Cash Flows • New Anatomy of a Fraud, about Parmalat’s

multiple frauds. • New Appendix 13C, Statement of Cash Flows—

T-Account Approach.

Chapter 14 Financial Statement Analysis • New Anatomy of a Fraud, on using Benford’s Law

statistical law to detect fraud. • New Investor Insight, “How to Manage the

Current Ratio,” about its limitations.

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For Instructors In addition to the support instructors receive from WileyPLUS and the Wiley Faculty Network, we offer the following useful supplements.

Book’s Companion Website. On this website, www.wiley.com/college/weygandt, instructors will find the Solutions Manual, Test Bank, Instructor’s Manual, Computerized Test Bank, and other resources.

Instructor’s Resource CD. The Instructor’s Resource CD (IRCD) contains all the instructor supplements. The IRCD gives instructors the flexibility to access and prepare instructional materials based on their individual needs.

Solutions Manual. The Solutions Manual contains detailed solutions to all questions, brief exercises, exercises, and problems in the textbook, as well as suggested answers to the questions and cases. The estimated time to complete exercises, problems, and cases is provided.

Solution Transparencies. The solution transparencies feature detailed solutions to brief exercises, exercises, problems, and Broadening Your Perspective activities. Transparencies can be easily ordered from the book’s companion website.

Instructor’s Manual. Included in each chapter are lecture outlines with teaching tips, chapter reviews, illustrations, and review quizzes.

Teaching Transparencies. The teaching transparencies are 4-color acetate images of the illustrations found in the Instructor’s Manual. Transparencies can be easily ordered from the book’s companion website.

Test Bank and Computerized Test Bank. The test bank and computerized test bank allow instructors to tailor examinations according to study objectives and learning out- comes, including AACSB, AICPA, and IMA professional stan- dards. Achievement tests, comprehensive examinations, and a final exam are included.

PowerPoint™. The new PowerPoint™ presentations contain a combination of key concepts, images, and problems from the textbook.

WebCT and Desire2Learn. WebCT and Desire2Learn offer an integrated set of course management tools that enable instructors to easily design, develop, and manage Web-based and Web-enhanced courses.

For Students Book’s Companion Website. On this website, students will find:

• Exercises: Set B and Challenge Exercises • Problems: Set C • Self-Tests and Additional Self-Tests • Cases for Managerial Decision-Making • A complete Glossary of all the key terms used in the

text

Student Study Guide. Each chapter of the Study Guide contains a chapter review, chapter outline, and a glossary of key terms. Demonstration problems, multiple- choice, true/false, matching, and other exercises are also included.

Working Papers. The working papers are printed templates that can help students correctly format their textbook accounting solutions. Working paper templates are available for all end-of-chapter brief exercises, exercises, problems, and cases.

Excel Working Papers. The Excel Working Papers are Excel templates that students can use to correctly format their textbook accounting solutions.

Excel Primer: Using Excel in Accounting. The online Excel primer and accompanying Excel templates allow students to complete select end-of-chapter exercises and problems identified by a spreadsheet icon in the margin of the textbook.

Managerial Accounting Video Series. Through the examples of real-world, cutting-edge companies, these videos engage students with a dynamic overview of man- agerial accounting topics and motivate them through the detailed tools, examples, and discussions presented in their textbook, WileyPLUS course, and classroom lectures.

Mobile Applications. Quizzing and reviewing content is available for download on iTunes.

Teaching and Learning Supplementary Material

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Acknowledgments

Managerial Accounting has benefited greatly from the input of focus group participants, manuscript reviewers, those who have sent comments by letter or e-mail, ancillary authors, and proofers. We greatly appreciate the constructive suggestions and innovative ideas of reviewers and the creativity and accuracy of the ancillary authors and checkers.

Sixth Edition Dawn Addington Central New Mexico Community College Bruce Bradford Fairfield University Leroy Bugger Edison State College Lisa Capozzoli College of DuPage Renee Castrigano Cleveland State University Gayle Chaky Dutchess Community College Toni Clegg Delta College Cheryl Copeland California State University, Fresno Larry DeGaetano Montclair State University Ron Dustin Fresno City College Barbara Eide University of Wisconsin—La Crosse Janet Farler Pima Community College Bambi Hora University of Central Oklahoma Don Kovacic California State University, San Marcos Richard Larkin Jason Lee SUNY Plattsburgh

Harold Little Western Kentucky University Lois Mahoney Eastern Michigan University Florence McGovern Bergen Community College Mary Michel Manhattan College Earl Mitchell Santa Ana College

Michael Newman University of Houston Judy Peterson Monmouth College Robert Rambo Roger Williams University Luther Ross Central Piedmont Community College Susan Sadowski Shippensburg University/UMUC Richard Sarkisian Camden County College Karl Schindl University of Wisconsin—Manitowoc Debbie Seifert Illinois State University Valerie Simmons University of Southern Mississippi Mike Skaff College of the Sequoias Patrick Stegman College of Lake County Karen Tabak Maryville University Diane Tanner University of North Florida Joan Van Hise Fairfield University Sheila Viel University of Wisconsin—Milwaukee

Prior Edition Eric Blazer Millersville University Rita Kingery Cook University of Delaware Cheryl Copeland California State University, Fresno Robin D’Agati Palm Beach Community College Rafik Elias University of California, Los Angeles Annette Fisher Glendale Community College

Michael Haselkorn Bentley University M.A. Maggie Houston Wright State University Mehmet Kocakulah University of Southern Indiana Wikil Kwak University of Nebraska, Omaha James Lukawitz University of Memphis Barbara Lamberton University of Hartford D. Jordan Lowe Arizona State University Sue Marcum American University Florence McGovern Bergen Community College Matthew Muller Adirondack Community College Joseph Nicassio Westmoreland County Community College Margaret O’Reilly-Allen Rider University Sandra Pelfrey Oakland University Karl Putnam University of Texas—El Paso Luther Ross Central Piedmont Community College Nancy Sill Modesto Junior College Howard Switkay Community College of Philadelphia Ron Vogel College of Eastern Utah

WileyPLUS Developers and Reviewers Carole Brandt-Fink Laura McNally Melanie Yon

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Ancillary Authors, Contributors, Proofers, and Accuracy Checkers Jack Borke University of Wisconsin, Platteville

LuAnn Bean Florida Institute of Technology

Jim Emig Villanova University

Larry Falcetto Emporia State University

Coby Harmon University of California, Santa Barbara

Benjamin Huegel St. Mary’s University Doug Kieso Aurora University

Jill Misuraca University of Tampa

Patricia Mounce University of Central Arkansas

Barbara Muller Arizona State University

John Plouffe California State University—Los Angeles

Rex Schildhouse San Diego Community College

Teresa Speck St. Mary’s University

Lynn Stallworth Appalachian State University

Ellen Sweatt Georgia Perimeter College

Diane Tanner University of North Florida

Joan Van Hise Fairfield University

Doris Warmflash SUNY, Westchester Community College

Dick Wasson Southwestern College

We thank Benjamin Huegel and Teresa Speck of St. Mary’s University for their extensive efforts in the preparation of the homework materials related to Current Designs. We also appre- ciate the considerable support provided to us by the following people at Current Designs: Mike Cichanowski, Jim Brown, Diane Buswell, and Jake Greseth. We also benefited from the assistance and suggestions provided to us by Joan Van Hise in the preparation of materials related to sustainability.

We appreciate the exemplary support and commitment given to us by senior acquisitions editor Michael McDonald, marketing manager Karolina Zarychta Honsa, operations manager Yana Mermel, senior content editor Brian Kamins, senior content editor Ed Brislin, development editor Terry Ann Tatro, lead product designer Allie Morris, product designer Greg Chaput, vice president of higher education production and manufacturing Ann Berlin, designers Maureen

Eide and Kristine Carney, illustration editor Anna Melhorn, photo editor Mary Ann Price, permissions editor Joan Naples, project editor Suzanne Ingrao of Ingrao Associates, indexer Steve Ingle, Denise Showers at Aptara, Cyndy Taylor, and project manager Angel Chavez at Integra. All of these profes- sionals provided innumerable services that helped the text- book take shape.

Finally, our thanks to Amy Scholz, Susan Elbe, George Hoffman, Tim Stookesberry, Joe Heider, and Steve Smith for their support and leadership in Wiley’s College Division. We will appreciate suggestions and comments from users—instructors and students alike. You can send your thoughts and ideas about the textbook to us via email at: [email protected].

Jerry J. Weygandt Paul D. Kimmel Donald E. Kieso Madison, Wisconsin Milwaukee, Wisconsin DeKalb, Illinois

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Brief Contents Cost Concepts for Decision-Makers 1 Managerial Accounting 2 2 Job Order Costing 48 3 Process Costing 94 4 Activity-Based Costing 144

Decision-Making Concepts 5 Cost-Volume-Profit 196 6 Cost-Volume-Profit Analysis: Additional Issues 236 7 Incremental Analysis 292 8 Pricing 332

Planning and Control Concepts 9 Budgetary Planning 382 10 Budgetary Control and Responsibility

Accounting 434 11 Standard Costs and Balanced Scorecard 494 12 Planning for Capital Investments 546

Performance Evaluation Concepts 13 Statement of Cash Flows 586 14 Financial Statement Analysis 650

APPENDICES A Time Value of Money A-1 B Standards of Ethical Conduct for Management

Accountants B-1

Cases for Managerial Decision-Making CA-1

(The full text of these cases is available online at www.wiley.com/college/weygandt.)

COMPANY INDEX I-1

SUBJECT INDEX I-3

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Contents Chapter 1

Managerial Accounting 2 Just Add Water . . . and Paddle 2 Managerial Accounting Basics 4

Comparing Managerial and Financial Accounting 4 Management Functions 4 Organizational Structure 6 Business Ethics 7

Managerial Cost Concepts 9 Manufacturing Costs 9 Product versus Period Costs 11

Manufacturing Costs in Financial Statements 12 Income Statement 12 Cost of Goods Manufactured 13 Cost of Goods Manufactured Schedule 14 Balance Sheet 15 Cost Concepts—A Review 16 Product Costing for Service Industries 18

Managerial Accounting Today 19 Focus on the Value Chain 19 Balanced Scorecard 20 Corporate Social Responsibility 21

Chapter 2

Job Order Costing 48 She Succeeds Where Others Have Failed 48 Cost Accounting Systems 50

Job Order Cost System 50 Process Cost System 50

Job Order Cost Flow 51 Accumulating Manufacturing Costs 52 Assigning Manufacturing Costs to Work

in Process 54 Manufacturing Overhead Costs 58 Assigning Costs to Finished Goods 62 Assigning Costs to Cost of Goods Sold 63 Summary of Job Order Cost Flows 64 Job Order Costing for Service Companies 65 Advantages and Disadvantages of Job Order

Costing 67 Reporting Job Cost Data 68

Under- or Overapplied Manufacturing Overhead 69

Chapter 3

Process Costing 94 Ben & Jerry’s Tracks Its Mix-Ups 94 The Nature of Process Cost Systems 96

Uses of Process Cost Systems 96 Process Costing for Service Companies 97

Similarities and Differences Between Job Order Cost and Process Cost Systems 97

Process Cost Flow 99 Assigning Manufacturing Costs—Journal

Entries 99 Equivalent Units 102

Weighted-Average Method 102 Refinements on the Weighted-Average

Method 103 Production Cost Report 105

Compute the Physical Unit Flow (Step 1) 106 Compute the Equivalent Units of Production

(Step 2) 107 Compute Unit Production Costs (Step 3) 107 Prepare a Cost Reconciliation Schedule

(Step 4) 108 Preparing the Production Cost Report 109 Costing Systems—Final Comments 111

APPENDIX 3A FIFO Method 115 Equivalent Units Under FIFO 115 Comprehensive Example 116 FIFO and Weighted-Average 120

Chapter 4

Activity-Based Costing 144 Precor Is on Your Side 144 Traditional Costing and Activity-Based Costing 146

Traditional Costing Systems 146 The Need for a New Approach 146 Activity-Based Costing 147

Example of ABC versus Traditional Costing 149 Identify and Classify Activities and Allocate

Overhead to Cost Pools (Step 1) 150 Identify Cost Drivers (Step 2) 150 Compute Activity-Based Overhead Rates

(Step 3) 150 Assign Overhead Costs to Products

(Step 4) 151 Comparing Units Costs 152

Activity-Based Costing: A Closer Look 155 Benefits of ABC 155 Limitations of ABC 155 When to Use ABC 156 Value-Added versus Non–Value-Added

Activities 157 Classification of Activity Levels 159

Activity-Based Costing in Service Industries 161

Traditional Costing Example 162 Activity-Based Costing Example 162

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APPENDIX 4A: Just-in-Time Processing 166 Objective of JIT Processing 167 Elements of JIT Processing 168 Benefits of JIT Processing 168

Chapter 5

Cost-Volume-Profit 196 Don’t Worry—Just Get Big 196 Cost Behavior Analysis 198

Variable Costs 198 Fixed Costs 199 Relevant Range 200 Mixed Costs 201 Importance of Identifying Variable and

Fixed Costs 205 Cost-Volume-Profit Analysis 206

Basic Components 206 CVP Income Statement 206 Break-Even Analysis 209 Target Net Income 213 Margin of Safety 215

Chapter 6

Cost-Volume-Profit Analysis: Additional Issues 236 Rapid Replay 236 Cost-Volume-Profit (CVP) Review 238

Basic Concepts 238 Basic Computations 239 CVP and Changes in the Business Environment 241

Sales Mix 244 Break-Even Sales in Units 244 Break-Even Sales in Dollars 246 Determining Sales Mix with Limited Resources 248

Cost Structure and Operating Leverage 251 Effect on Contribution Margin Ratio 252 Effect on Break-Even Point 252 Effect on Margin of Safety Ratio 252 Operating Leverage 252

APPENDIX 6A: Absorption Costing versus Variable Costing 256

Example: Comparing Absorption Costing with Variable Costing 256

An Extended Example 258 Decision-Making Concerns 262 Potential Advantages of Variable Costing 264

Chapter 7

Incremental Analysis 292 Make It or Buy It? 292 Management’s Decision-Making Process 294

Incremental Analysis Approach 294 How Incremental Analysis Works 295

Types of Incremental Analysis 296 Accept an Order at a Special Price 296 Make or Buy 298 Sell or Process Further 301 Repair, Retain, or Replace Equipment 304 Eliminate an Unprofitable Segment or Product 305

Other Considerations in Decision-Making 308 Qualitative Factors 308 Relationship of Incremental Analysis and

Activity-Based Costing 308

Chapter 8

Pricing 332 They’ve Got Your Size—and Color 332 Pricing Goods for External Sales 334

Target Costing 335 Cost-Plus Pricing 337 Variable-Cost Pricing 339

Pricing Services 341 Transfer Pricing for Internal Sales 345

Negotiated Transfer Prices 346 Cost-Based Transfer Prices 349 Market-Based Transfer Prices 350 Effect of Outsourcing on Transfer Pricing 351

Transfers Between Divisions in Different Countries 351 APPENDIX 8A: Other Cost Approaches to Pricing 355

Absorption-Cost Pricing 355 Variable-Cost Pricing 357

Chapter 9

Budgetary Planning 382 Was This the Next Amazon.com? Not Quite 382 Budgeting Basics 384

Budgeting and Accounting 384 The Benefits of Budgeting 384 Essentials of Effective Budgeting 384 Length of the Budget Period 385 The Budgeting Process 385 Budgeting and Human Behavior 386 Budgeting and Long-Range Planning 387 The Master Budget 387

Preparing the Operating Budgets 389 Sales Budget 389 Production Budget 390 Direct Materials Budget 392 Direct Labor Budget 395 Manufacturing Overhead Budget 395 Selling and Administrative Expense Budget 396 Budgeted Income Statement 396

Preparing the Financial Budgets 399 Cash Budget 399 Budgeted Balance Sheet 402

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Budgeting in Nonmanufacturing Companies 404 Merchandisers 404 Service Companies 405 Not-for-Profit Organizations 405

Chapter 10

Budgetary Control and Responsibility Accounting 434 Turning Trash Into Treasure 434 Budgetary Control 436 Static Budget Reports 437

Examples 437 Uses and Limitations 438

Flexible Budgets 438 Why Flexible Budgets? 439 Developing the Flexible Budget 440 Flexible Budget—A Case Study 442 Flexible Budget Reports 445

Responsibility Accounting 447 Controllable versus Noncontrollable Revenues

and Costs 449 Principles of Performance Evaluation 449 Responsibility Reporting System 451

Types of Responsibility Centers 454 Responsibility Accounting for Cost Centers 455 Responsibility Accounting for Profit Centers 455 Responsibility Accounting for Investment

Centers 458 APPENDIX 10A: Residual Income—Another Performance Measurement 465

Residual Income Compared to ROI 466 Residual Income Weakness 466

Chapter 11

Standard Costs and Balanced Scorecard 494 80,000 Different Caffeinated Combinations 494 The Need for Standards 496

Distinguishing Between Standards and Budgets 496

Why Standard Costs? 496 Setting Standard Costs 496

Ideal versus Normal Standards 497 A Case Study 498

Analyzing and Reporting Variances from Standards 502

Direct Materials Variances 503 Direct Labor Variances 506 Manufacturing Overhead Variances 508 Reporting Variances 511 Statement Presentation of Variances 512

Balanced Scorecard 512

APPENDIX 11A: Standard Cost Accounting System 518

Journal Entries 518 Ledger Accounts 520

APPENDIX 11B: A Closer Look at Overhead Variances 521

Overhead Controllable Variance 521 Overhead Volume Variance 522

Chapter 12

Planning for Capital Investments 546 Floating Hotels 546 The Capital Budgeting Evaluation Process 548

Cash Flow Information 548 Illustrative Data 549

Cash Payback 550 Net Present Value Method 551

Equal Annual Cash Flows 552 Unequal Annual Cash Flows 553 Choosing a Discount Rate 554 Simplifying Assumptions 555 Comprehensive Example 556

Additional Considerations 557 Intangible Benefits 557 Profitability Index for Mutually Exclusive

Projects 559 Risk Analysis 560 Post-Audit of Investment Projects 561

Other Capital Budgeting Techniques 561 Internal Rate of Return Method 562 Comparing Discounted Cash Flow

Methods 564 Annual Rate of Return Method 564

Chapter 13

Statement of Cash Flows 586 “Got Cash?” 586 Statement of Cash Flows: Usefulness and Format 588

Usefulness of the Statement of Cash Flows 588 Classification of Cash Flows 588 Significant Noncash Activities 590 Format of the Statement of Cash Flows 590 Preparing the Statement of Cash Flows 592 Indirect and Direct Methods 592

Preparing the Statement of Cash Flows—Indirect Method 593

Step 1: Operating Activities 594 Summary of Conversion to Net Cash Provided by

Operating Activities—Indirect Method 598 Step 2: Investing and Financing Activities 600 Step 3: Net Change in Cash 601

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Using Cash Flows to Evaluate a Company 604

Free Cash Flow 604 APPENDIX 13A: Using a Worksheet to Prepare the Statement of Cash Flows—Indirect Method 608

Preparing the Worksheet 609 APPENDIX 13B Statement of Cash Flows—Direct Method 615

Step 1: Operating Activities 616 Step 2: Investing and Financing

Activities 620 Step 3: Net Change in Cash 621

APPENDIX 13C: Statement of Cash Flows— T-Account Approach 624

Chapter 14

Financial Statement Analysis 650 It Pays to Be Patient 650 Basics of Financial Statement

Analysis 652 Need for Comparative Analysis 652 Tools of Analysis 652

Horizontal Analysis 653 Balance Sheet 654 Income Statement 655 Retained Earnings Statement 655

Vertical Analysis 657 Balance Sheet 657 Income Statement 657

Ratio Analysis 659 Liquidity Ratios 660 Profitability Ratios 664 Solvency Ratios 668 Summary of Ratios 669

Earning Power and Irregular Items 671 Discontinued Operations 672 Extraordinary Items 673 Changes in Accounting Principle 675 Comprehensive Income 675

Quality of Earnings 676 Alternative Accounting Methods 676 Pro Forma Income 676 Improper Recognition 677

Appendix A

Time Value of Money A-1 Nature of Interest A-1

Simple Interest A-1 Compound Interest A-2

Future Value Concepts A-2 Future Value of a Single

Amount A-2 Future Value of an Annuity A-4

Present Value Concepts A-7 Present Value Variables A-7 Present Value of a Single Amount A-7 Present Value of an Annuity A-9 Time Periods and Discounting A-11 Computing the Present Value of a Long-Term

Note or Bond A-11 Computing the Present Values in a Capital

Budgeting Decision A-14 Using Financial Calculators A-16

Present Value of a Single Sum A-16 Present Value of an Annuity A-17 Useful Applications of the Financial

Calculator A-18

Appendix B

Standards of Ethical Conduct for Management Accountants B-1 IMA Statement of Ethical Professional Practice B-1

Principles B-1 Standards B-1 Resolution of Ethical Conflict B-2

Cases for Management Decision- Making CA-1 (The full text of these cases is available online at www.wiley.com/college/weygandt ).

Photo Credits PC-1 Company Index I-1 Subject Index I-3

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Feature Story

✔ The Navigator

Learning Objectives After studying this chapter, you should be able to:

1 Explain the distinguishing features of managerial accounting.

2 Identify the three broad functions of management.

3 Defi ne the three classes of manufacturing costs.

4 Distinguish between product and period costs.

5 Explain the difference between a merchandising and a

manufacturing income statement.

6 Indicate how cost of goods manufactured is determined.

7 Explain the difference between a merchandising and a

manufacturing balance sheet.

8 Identify trends in managerial accounting.

✔ The Navigator

Chapter 1

Managerial Accounting

Just Add Water … and Paddle Mike Cichanowski grew up on the

Mississippi River in Winona, Minnesota.

At a young age, he learned to paddle

a canoe so he could explore the river.

Before long, Mike began crafting his

own canoes from bent wood and

fi berglass in his dad’s garage. Then,

when his canoe-making shop outgrew

the garage, he moved it into an old

warehouse. When that was going to be

torn down, Mike came to a critical

juncture in his life. He took out a bank

loan and built his own small shop, giving

birth to the company Wenonah Canoe.

Wenonah Canoe soon became known

as a pioneer in developing techniques

to get the most out of new materials

such as plastics, composites, and

carbon fi bers—maximizing strength

while minimizing weight.

In the 1990s, as kayaking became

popular, Mike made another critical

decision when he acquired Current

Designs, a premier Canadian kayak

manufacturer. This venture allowed

Wenonah to branch out with new

product lines while providing Current

Designs with much-needed capacity

expansion as well as manufacturing

expertise. Mike moved Current

Designs’ headquarters to Minnesota

and made a big (and potentially

risky) investment in a new production

facility. Today, the company’s 90

employees produce and sell about

2

DO IT!

DO IT!

Learning Objectives give you a framework for learning the specifi c concepts covered in the chapter.

The Navigator is designed to prompt you to use the learning aids in the chapter and to help you set priorities as you study.

Scan Learning Objectives

Read Feature Story

Scan Preview

Read Text and answer p. 8 p. 12 p. 15 p. 21

Work Using the Decision Toolkit p. 22

Review Summary of Learning Objectives

Work Comprehensive p. 25

Answer Self-Test Questions

Complete Assignments

Go to WileyPLUS for practice and tutorials

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12,000 canoes and kayaks per year, across the country and

around the world.

Mike will tell you that business success

is “a three-legged stool.” The fi rst leg

is the knowledge and commitment

to make a great product. Wenonah’s

canoes and Current Designs’ kayaks

are widely regarded as among the

very best. The second leg is the ability

to sell your product. Mike’s company

started off making great canoes, but

it took a little longer to fi gure out

how to sell them. The third leg is not

something that most of you would

immediately associate with entrepreneurial success. It is what

goes on behind the scenes—accounting. Good accounting

information is absolutely critical to the countless decisions,

big and small, that ensure the survival and growth of the

company.

Bottom line: No matter how good

your product is, and no matter how

many units you sell, if you don’t have

a fi rm grip on your numbers, you are

up a creek without a paddle.

Watch the What Is Managerial

Accounting? video in WileyPLUS for

an introduction to managerial

accounting and the topics presented

in this course.

Source: www.wenonah.com.

✔ The Navigator

3

The Feature Story helps you picture how the chapter topic relates to the real world of business and accounting.

This chapter focuses on issues illustrated in the Feature Story about Current Designs and its parent company Wenonah Canoe. To succeed, the company needs to determine and control the costs of material, labor, and overhead, and understand the relationship between costs and profi ts. Managers often make decisions that determine their company’s fate—and their own. Managers are evaluated on the results of their decisions. Managerial accounting provides tools for assisting management in making decisions and for evaluating the effectiveness of those decisions.

The content and organization of this chapter are as follows.

Preview of Chapter 1

• Comparing managerial and fi nancial accounting

• Management functions • Organizational structure • Business ethics

Managerial Accounting Basics

• Manufacturing costs • Product vs. period costs

Managerial Cost Concepts

• Income statement • Cost of goods

manufactured • Balance sheet • Cost concepts—A review • Product costing for

service industries

Manufacturing Costs in Financial Statements

• Focus on the value chain

• Balanced scorecard • Corporate social

responsibility

Managerial Accounting Today

✔ The Navigator

The Preview describes the purpose of the chapter and outlines the major topics and subtopics you will fi nd in it.

MANAGERIAL ACCOUNTING

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4 1 Managerial Accounting

Managerial accounting provides economic and fi nancial information for man- agers and other internal users. The skills that you will learn in this course will be vital to your future success in business. You don’t believe us? Let’s look at some examples of some of the crucial activities of employees at Current Designs, and where those activities are addressed in this textbook.

In order to know whether it is making a profi t, Current Designs needs accu- rate information about the cost of each kayak (Chapters 2, 3, and 4). And to stay profi table, Current Designs must adjust the number of kayaks it produces in light of changes in economic conditions and consumer tastes. It then needs to under- stand how changes in the number of kayaks it produces impact its production costs and profi tability (Chapters 5 and 6). Further, Current Designs’ managers must often consider alternative courses of action. For example, should the company accept a special order from a customer, produce a particular kayak component internally or outsource it, or continue or discontinue a particular product line (Chapter 7)? Finally, one of the most important, and most diffi cult, decisions is what price to charge for the kayaks (Chapter 8).

In order to plan for the future, Current Designs prepares budgets (Chapter 9), and it then compares its budgeted numbers with its actual results to evaluate per- formance and identify areas that need to change (Chapters 10 and 11). Finally, it sometimes needs to make substantial investment decisions, such as the building of a new plant or the purchase of new equipment (Chapter 12).

Someday, you are going to face decisions just like these. You may end up in sales, marketing, management, production, or fi nance. You may work for a com- pany that provides medical care, produces software, or serves up mouth-watering meals. No matter what your position is, and no matter what your product, the skills you acquire in this class will increase your chances of business success. Put another way, in business you can either guess, or you can make an informed deci- sion. As the CEO of Microsoft once noted: “If you’re supposed to be making money in business and supposed to be satisfying customers and building market share, there are numbers that characterize those things. And if somebody can’t speak to me quantitatively about it, then I’m nervous.” This course gives you the skills you need to quantify information so you can make informed business decisions.

Comparing Managerial and Financial Accounting

There are both similarities and differences between managerial and fi nancial ac- counting. First, each fi eld of accounting deals with the economic events of a busi- ness. For example, determining the unit cost of manufacturing a product is part of managerial accounting. Reporting the total cost of goods manufactured and sold is part of fi nancial accounting. In addition, both managerial and fi nancial accounting require that a company’s economic events be quantifi ed and com- municated to interested parties. Illustration 1-1 summarizes the principal differ- ences between fi nancial accounting and managerial accounting.

Management Functions

Managers’ activities and responsibilities can be classifi ed into three broad functions:

1. Planning.

2. Directing.

3. Controlling.

Managerial Accounting Basics

Essential terms and concepts are printed in blue where they fi rst appear and are defi ned in the end-of-chapter Glossary.

Explain the distinguishing features of managerial accounting.

1LEARNING OBJECTIVE

Identify the three broad functions of management.

2LEARNING OBJECTIVE

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Managerial Accounting Basics 5

In performing these functions, managers make decisions that have a signifi cant impact on the organization.

Planning requires managers to look ahead and to establish objectives. These objectives are often diverse: maximizing short-term profi ts and market share, maintaining a commitment to environmental protection, and contributing to so- cial programs. For example, Hewlett-Packard, in an attempt to gain a stronger foothold in the computer industry, has greatly reduced its prices to compete with Dell. A key objective of management is to add value to the business under its control. Value is usually measured by the trading price of the company’s stock and by the potential selling price of the company.

Directing involves coordinating a company’s diverse activities and human resources to produce a smooth-running operation. This function relates to imple- menting planned objectives and providing necessary incentives to motivate em- ployees. For example, manufacturers such as Campbell Soup Company, General Motors, and Dell must coordinate purchasing, manufacturing, warehousing, and selling. Service corporations such as American Airlines, Federal Express, and AT&T must coordinate scheduling, sales, service, and acquisitions of equipment and supplies. Directing also involves selecting executives, appointing managers and supervisors, and hiring and training employees.

The third management function, controlling, is the process of keeping the company’s activities on track. In controlling operations, managers determine whether planned goals are being met. When there are deviations from targeted objectives, managers must decide what changes are needed to get back on track. Scandals at companies like Enron, Lucent, and Xerox attest to the fact that com- panies must have adequate controls to ensure that the company develops and distributes accurate information.

How do managers achieve control? A smart manager in a very small opera- tion can make personal observations, ask good questions, and know how to eval- uate the answers. But using this approach in a larger organization would result in chaos. Imagine the president of Current Designs attempting to determine whether the company is meeting its planned objectives, without some record of what has happened and what is expected to occur. Thus, large businesses typically use a formal system of evaluation. These systems include such features as budgets,

External users: stockholders, creditors, and regulators.

Financial statements. Quarterly and annually.

General-purpose.

Pertains to business as a whole. Highly aggregated (condensed). Limited to double-entry accounting and cost data. Generally accepted accounting principles.

Audited by CPA.

Primary Users of Reports

Types and Frequency of Reports

Purpose of Reports

Content of Reports

Verification Process

Feature Financial Accounting

Internal users: officers and managers.

Internal reports. As frequently as needed.

Special-purpose for specific decisions.

Pertains to subunits of the business. Very detailed. Extends beyond double-entry accounting to any relevant data. Standard is relevance to decisions.

No independent audits.

Managerial Accounting

Illustration 1-1 Differences between fi nancial and managerial accounting

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6 1 Managerial Accounting

What are some of the steps that this company has taken in order to ensure that production meets demand? (See page 47.)?

responsibility centers, and performance evaluation reports—all of which are fea- tures of managerial accounting.

Decision-making is not a separate management function. Rather, it is the outcome of the exercise of good judgment in planning, directing, and controlling.

Organizational Structure

Most companies prepare organization charts to show the interrelationships of activities and the delegation of authority and responsibility within the company. Illustration 1-2 shows a typical organization chart.

Stockholders own the corporation, but they manage it indirectly through a board of directors they elect. The board formulates the operating policies for the company or organization. The board also selects offi cers, such as a president and one or more vice presidents, to execute policy and to perform daily manage- ment functions.

The chief executive offi cer (CEO) has overall responsibility for managing the business. As the organization chart on page 7 shows, the CEO delegates re- sponsibilities to other offi cers.

Responsibilities within the company are frequently classifi ed as either line or staff positions. Employees with line positions are directly involved in the company’s primary revenue-generating operating activities. Examples of line po- sitions include the vice president of operations, vice president of marketing, plant managers, supervisors, and production personnel. Employees with staff posi- tions are involved in activities that support the efforts of the line employees. In a company like General Electric or Facebook, employees in fi nance, legal, and human

Even the Best Have to Get Better

Louis Vuitton is a French manufacturer of high-end handbags, wallets, and suitcases. Its repu- tation for quality and style allows it to charge extremely high prices–for example, $700 for a tote bag. But often in the past, when demand was hot, supply was nonexistent–shelves were empty, and would-be buyers left empty-handed.

Luxury-goods manufacturers used to consider stockouts to be a good thing, but recently Louis Vuitton changed its attitude. The company adopted “lean” processes used by car manu- facturers and electronics companies to speed up production of “hot” products. Work is done by fl exible teams, with jobs organized based on how long a task takes. By reducing wasted time and eliminating bottlenecks, what used to take 20 to 30 workers eight days to do now takes 6 to 12 workers one day. Also, production employees who used to specialize on a single task on a single product are now multiskilled. This allows them to quickly switch products to meet demand.

To make sure that the factory is making the right products, within a week of a product launch, Louis Vuitton stores around the world feed sales information to the headquarters in France, and production is adjusted accordingly. Finally, the new production processes have also improved quality. Returns of some products are down by two-thirds, which makes quite a dif- ference to the bottom line when the products are pricey.

Source: Christina Passariello, “Louis Vuitton Tries Modern Methods on Factory Lines,” Wall Street Journal (October 9, 2006).

MANAGEMENT INSIGHT

Insight boxes illustrate interesting situations in real companies and show how managers make decisions using accounting information. Guideline answers to the critical thinking questions appear on the last page of the chapter.

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Managerial Accounting Basics 7

resources have staff positions. While activities of staff employees are vital to the company, these employees are nonetheless there to serve the line employees who engage in the company’s primary operations.

The chief fi nancial offi cer (CFO) is responsible for all of the accounting and fi nance issues the company faces. The CFO is supported by the controller and the treasurer. The controller’s responsibilities include (1) maintaining the accounting records, (2) maintaining an adequate system of internal control, and (3) preparing fi nancial statements, tax returns, and internal reports. The trea- surer has custody of the corporation’s funds and is responsible for maintaining the company’s cash position.

Also serving the CFO is the internal audit staff. The staff’s responsibilities in- clude reviewing the reliability and integrity of fi nancial information provided by the controller and treasurer. Staff members also ensure that internal control systems are functioning properly to safeguard corporate assets. In addition, they investigate compliance with policies and regulations, and in many companies they determine whether resources are being used in the most economical and effi cient fashion.

The vice president of operations oversees employees with line positions. For example, the company might have multiple plant managers, each of whom would report to the vice president of operations. Each plant would also have depart- ment managers, such as fabricating, painting, and shipping, each of whom would report to the plant manager.

Business Ethics

All employees within an organization are expected to act ethically in their busi- ness activities. Given the importance of ethical behavior to corporations and their owners (stockholders), an increasing number of organizations provide codes of business ethics for their employees.

Vice President Human

Resources

Vice President Operations

Vice President Finance/Chief

Financial Officer

Vice President Marketing

General Counsel/ Secretary

Treasurer Controller

Board of Directors

Stockholders

Chief Executive Officer and President

Illustration 1-2 Corporation’s organization chart

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8 1 Managerial Accounting

CREATING PROPER INCENTIVES Companies like Amazon.com, IBM, and Nike use complex systems to monitor, control, and evaluate the actions of managers. Unfortunately, these systems and controls sometimes unwittingly create incentives for managers to take un- ethical actions. For example, because the budget is also used as an evaluation tool, some managers try to “game’’ the budgeting process by underestimating their division’s predicted performance so that it will be easier to meet their performance targets. On the other hand, if the budget is set at unattainable levels, managers sometimes take unethical actions to meet the targets in order to receive higher compensation or, in some cases, to keep their jobs.

For example, at one time, airline manufacturer Boeing was plagued by a se- ries of scandals including charges of over-billing, corporate espionage, and illegal confl icts of interest. Some long-time employees of Boeing blame the decline in ethics on a change in the corporate culture that took place after Boeing merged with McDonnell Douglas. They suggest that evaluation systems implemented after the merger to evaluate employee performance gave employees the impression that they needed to succeed no matter what actions were required to do so.

As another example, manufacturing companies need to establish production goals for their processes. Again, if controls are not effective and realistic, problems develop. To illustrate, Schering-Plough, a pharmaceutical manufacturer, found that employees were so concerned with meeting production quantity standards that they failed to monitor the quality of the product, and as a result the dosages were often wrong.

CODE OF ETHICAL STANDARDS In response to corporate scandals, the U.S. Congress enacted the Sarbanes-Oxley Act (SOX) to help prevent lapses in internal control. One result of SOX was to clarify top management’s responsibility for the company’s fi nancial statements. CEOs and CFOs must now certify that fi nancial statements give a fair presenta- tion of the company’s operating results and its fi nancial condition. In addition, top managers must certify that the company maintains an adequate system of internal controls to safeguard the company’s assets and ensure accurate fi nancial reports.

Another result of SOX is that companies now pay more attention to the com- position of the board of directors. In particular, the audit committee of the board of directors must be comprised entirely of independent members (that is, non- employees) and must contain at least one fi nancial expert. Finally, the law sub- stantially increases the penalties for misconduct.

To provide guidance for managerial accountants, the Institute of Manage- ment Accountants (IMA) has developed a code of ethical standards, entitled IMA Statement of Ethical Professional Practice. Management accountants should not commit acts in violation of these standards. Nor should they condone such acts by others within their organizations. We include the IMA code of ethical stan- dards in Appendix B at the end of the textbook. Throughout the textbook, we will address various ethical issues managers face.

Managerial Accounting Concepts

> DO IT!

Indicate whether the following statements are true or false.

1. Managerial accountants have a single role within an organization, collecting and reporting costs to management.

2. Financial accounting reports are general-purpose and intended for external users.

DO IT! exercises ask you to put newly acquired knowledge to work. They outline the Action Plan necessary to complete the exercise, and they show a Solution.

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Managerial Cost Concepts 9

3. Managerial accounting reports are special-purpose and issued as frequently as needed.

4. Managers’ activities and responsibilities can be classifi ed into three broad functions: cost accounting, budgeting, and internal control.

5. As a result of the Sarbanes-Oxley Act, managerial accounting reports must now comply with generally accepted accounting principles (GAAP).

6. Top managers must certify that a company maintains an adequate system of internal controls.

Solution Action Plan ✔ Understand that mana-

gerial accounting is a fi eld of accounting that provides economic and fi nancial information for managers and other internal users.

✔ Understand that fi nancial accounting provides information for external users.

✔ Analyze which users require which different types of information.

1. False. Managerial accountants determine product costs. In addition, managerial accountants are now held responsible for evaluating how well the company is employ- ing its resources. As a result, when the company makes critical strategic decisions, managerial accountants serve as team members alongside personnel from production, marketing, and engineering.

2. True.

3. True.

4. False. Managers’ activities are classifi ed into three broad functions: planning, directing, and controlling. Planning requires managers to look ahead to establish objectives. Directing involves coordinating a company’s diverse activities and human resources to produce a smooth-running operation. Controlling keeps the company’s activities on track.

5. False. SOX clarifi es top management’s responsibility for the company’s fi nancial statements. In addition, top managers must certify that the company maintains an adequate system of internal control to safeguard the company’s assets and ensure accurate fi nancial reports.

6. True.

Related exercise material: BE1-1, BE1-2, BE1-3, E1-1, and 1-1.DO IT!

✔ The Navigator

In order for managers at a company like Current Designs to plan, direct, and control operations effectively, they need good information. One very important type of in- formation is related to costs. Managers should ask questions such as the following.

1. What costs are involved in making a product or providing a service?

2. If we decrease production volume, will costs decrease?

3. What impact will automation have on total costs?

4. How can we best control costs?

To answer these questions, managers need reliable and relevant cost information. We now explain and illustrate the various cost categories that companies use.

Manufacturing Costs

Manufacturing consists of activities and processes that convert raw materials into fi nished goods. Contrast this type of operation with merchandising, which sells merchandise in the form in which it is purchased. Manufacturing costs are classifi ed as direct materials, direct labor, and manufacturing overhead.

Managerial Cost Concepts

Defi ne the three classes of manufacturing costs.

3LEARNING OBJECTIVE

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10 1 Managerial Accounting

DIRECT MATERIALS To obtain the materials that will be converted into the fi nished product, the man- ufacturer purchases raw materials. Raw materials are the basic materials and parts used in the manufacturing process.

Raw materials that can be physically and directly associated with the fi n- ished product during the manufacturing process are direct materials. Exam- ples include fl our in the baking of bread, syrup in the bottling of soft drinks, and steel in the making of automobiles. A primary direct material of many Current Designs’ kayaks is polyethylene powder. Some of its high-performance kayaks use Kevlar®.

Some raw materials cannot be easily associated with the fi nished product. These are called indirect materials. Indirect materials have one of two charac- teristics: (1) They do not physically become part of the fi nished product (such as lubricants used by Current Designs in its equipment and polishing compounds used for the fi nishing touches on kayaks). Or, (2) they are impractical to trace to the fi nished product because their physical association with the fi nished product is too small in terms of cost (such as cotter pins and lock washers). Companies account for indirect materials as part of manufacturing overhead.

DIRECT LABOR The work of factory employees that can be physically and directly associated with converting raw materials into fi nished goods is direct labor. Bottlers at Coca-Cola, bakers at Sara Lee, and equipment operators at Current Designs are employees whose activities are usually classifi ed as direct labor. Indirect labor refers to the work of employees that has no physical association with the fi nished product, or for which it is impractical to trace costs to the goods produced. Examples include wages of factory maintenance people, factory time-keepers, and factory supervisors. Like indirect materials, companies classify indirect labor as manufacturing overhead.

MANUFACTURING OVERHEAD Manufacturing overhead consists of costs that are indirectly associated with the manufacture of the fi nished product. Overhead costs also include manufac- turing costs that cannot be classifi ed as direct materials or direct labor. Manu- facturing overhead includes indirect materials, indirect labor, depreciation on factory buildings and machines, and insurance, taxes, and maintenance on factory facilities.

One study of manufactured goods found the following magnitudes of the three different product costs as a percentage of the total product cost: direct materials 54%, direct labor 13%, and manufacturing overhead 33%. Note that the direct labor component is the smallest. This component of product cost is dropping substantially because of automation. Companies are working hard to increase productivity by decreasing labor. In some companies, direct labor has become as little as 5% of the total cost.

Allocating direct materials and direct labor costs to specifi c products is fairly straightforward. Good recordkeeping can tell a company how much plastic it used in making each type of gear, or how many hours of factory labor it took to assemble a part. But allocating overhead costs to specifi c products presents prob- lems. How much of the purchasing agent’s salary is attributable to the hundreds of different products made in the same plant? What about the grease that keeps the machines humming, or the computers that make sure paychecks come out on time? Boiled down to its simplest form, the question becomes: Which products cause the incurrence of which costs? In subsequent chapters, we show various methods of allocating overhead to products.

Direct Materials

Direct Labor

Alternative Terminology notes present synonymous terms used in practice.

Manufacturing Overhead

Alternative Terminology Some companies use terms such as factory overhead, indirect manufacturing costs, and burden instead of manufacturing overhead.

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? In what ways does the shift to automated factories change the amount and composition of product costs? (See page 47.)

Managerial Cost Concepts 11

Product Versus Period Costs

Each of the manufacturing cost components—direct materials, direct labor, and manufacturing overhead—are product costs. As the term suggests, product costs are costs that are a necessary and integral part of producing the fi nished product. Companies record product costs, when incurred, as inventory. These costs do not become expenses until the company sells the fi nished goods inventory. At that point, the company records the expense as cost of goods sold.

Period costs are costs that are matched with the revenue of a specifi c time period rather than included as part of the cost of a salable product. These are non- manufacturing costs. Period costs include selling and administrative expenses. In order to determine net income, companies deduct these costs from revenues in the period in which they are incurred.

Illustration 1-3 summarizes these relationships and cost terms. Our main concern in this chapter is with product costs.

Why Manufacturing Matters for U.S. Workers

Prior to 2010, U.S. manufacturing employment fell at an average rate of 0.1% per year for 60 years. At the same time, U.S. factory output increased by an average rate of 3.4%. As manu- facturers relied more heavily on automation, the number of people they needed declined. However, factory jobs are important because the average wage of a factory worker is $22, twice the average wage of employees in the service sector. Fortunately, manufacturing jobs in the United States increased by 1.2% in 2010, and they are forecast to continue to increase through at least 2015. Why? Because companies like Whirlpool, Caterpillar, and Dow are building huge new plants in the United States to replace old, ineffi cient U.S. facilities. For many products that are ultimately sold in the United States, it makes more sense to produce them domestically and save on the shipping costs. In addition, these effi cient new plants, combined with an experienced workforce, will make it possible to compete with manufacturers in other countries, thereby increasing export potential.

Source: Bob Tita, “Whirlpool to Invest in Tennessee Plant,” Wall Street Journal Online (September 1, 2010); and James R. Hagerty, “U.S. Factories Buck Decline,” Wall Street Journal Online (January 19, 2011).

MANAGEMENT INSIGHT

Alternative Terminology Product costs are also called inventoriable costs.

Direct Materials

Direct Labor

Manufacturing Overhead • Indirect materials • Indirect labor • Other indirect costs

Manufacturing Costs

All Costs

Product Costs Period Costs

Selling Expenses

Administrative Expenses

Nonmanufacturing Costs

Illustration 1-3 Product versus period costs

Distinguish between product and period costs.

4LEARNING OBJECTIVE

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12 1 Managerial Accounting

Managerial Cost Concepts

> DO IT!

A bicycle company has these costs: tires, salaries of employees who put tires on the wheels, factory building depreciation, lubricants, spokes, salary of factory manager, handlebars, and salaries of factory maintenance employees. Classify each cost as direct materials, direct labor, or overhead.

✔ The Navigator

The fi nancial statements of a manufacturer are very similar to those of a mer- chandiser. For example, you will fi nd many of the same sections and same ac- counts in the fi nancial statements of Procter & Gamble that you fi nd in the fi nan- cial statements of Dick’s Sporting Goods. The principal differences between their fi nancial statements occur in two places: the cost of goods sold section in the income statement and the current assets section in the balance sheet.

Income Statement

Under a periodic inventory system, the income statements of a merchandiser and a manufacturer differ in the cost of goods sold section. Merchandisers compute cost of goods sold by adding the beginning merchandise inventory to the cost of goods purchased and subtracting the ending merchandise inventory. Manufac- turers compute cost of goods sold by adding the beginning fi nished goods inven- tory to the cost of goods manufactured and subtracting the ending fi nished goods inventory. Illustration 1-4 shows these different methods.

A number of accounts are involved in determining the cost of goods manu- factured. To eliminate excessive detail, income statements typically show only the total cost of goods manufactured. A separate statement, called a Cost of Goods Manufactured Schedule, presents the details. (See the discussion on pages 13–14 and Illustration 1-7.)

Illustration 1-5 shows the different presentations of the cost of goods sold sections for merchandising and manufacturing companies. The other sections of an income statement are similar for merchandisers and manufacturers.

Manufacturing Costs in Financial Statements

Explain the difference between a merchandis- ing and a manufacturing income statement.

5LEARNING OBJECTIVE

Tires, spokes, and handlebars are direct materials. Salaries of employees who put tires on the wheels are direct labor. All of the other costs are manufacturing overhead.

Solution

Related exercise material: BE1-4, BE1-5, BE1-6, BE1-7, E1-2, E1-3, E1-4, E1-5, E1-6, E1-7, and 1-2.DO IT!

Action Plan ✔ Classify as direct

materials any raw materials that can be physically and directly associated with the fi nished product.

✔ Classify as direct labor the work of factory employees that can be physically and directly associated with the fi nished product.

✔ Classify as manufac- turing overhead any costs that are indirectly associated with the fi nished product.

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Manufacturing Costs in Financial Statements 13

Cost of Goods Manufactured

An example may help show how companies determine the cost of goods manu- factured. Assume that on January 1, Current Designs has a number of kayaks in various stages of production. In total, these partially completed units are called beginning work in process inventory. The costs the company assigns to begin- ning work in process inventory are based on the manufacturing costs incurred in the prior period.

Current Designs fi rst incurs manufacturing costs in the current year to com- plete the work that was in process on January 1. It then incurs manufacturing costs for production of new orders. The sum of the direct materials costs, direct labor costs, and manufacturing overhead incurred in the current year is the total manufacturing costs for the current period.

We now have two cost amounts: (1) the cost of the beginning work in process and (2) the total manufacturing costs for the current period. The sum of these costs is the total cost of work in process for the year.

At the end of the year, Current Designs may have some kayaks that are only partially completed. The costs of these units become the cost of the ending work in process inventory. To fi nd the cost of goods manufactured, we subtract this cost from the total cost of work in process. Illustration 1-6 (page 14) shows the formula for determining the cost of goods manufactured.

Helpful Hint We assume a periodic inventory system in this illustration.

Helpful Hints clarify concepts being discussed.

Beginning Merchandise

Inventory

Ending Finished Goods

Inventory

–

+ –

Cost of Goods

Purchased + =

=

Cost of Goods Sold

Beginning Finished Goods

Inventory

Cost of Goods

Manufactured

Ending Merchandise

Inventory

Manufacturer

Merchandiser Illustration 1-4 Cost of goods sold components

Illustration 1-5 Cost of goods sold sections of merchandising and manufacturing income statements

Merchandising Company Manufacturing Company Income Statement (partial) Income Statement (partial) For the Year Ended December 31, 2014 For the Year Ended December 31, 2014

Cost of goods sold Cost of goods sold Merchandise inventory, Jan. 1 $ 70,000 Finished goods inventory, Jan. 1 $ 90,000 Cost of goods purchased 650,000 Cost of goods manufactured (see Illustration 1-7) 370,000

Cost of goods available for sale 720,000 Cost of goods available for sale 460,000 Less: Merchandise inventory, Less: Finished goods inventory, Dec. 31 400,000 Dec. 31 80,000

Cost of goods sold $ 320,000 Cost of goods sold $ 380,000

Indicate how cost of goods manufactured is determined.

6LEARNING OBJECTIVE

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14 1 Managerial Accounting

Cost of Goods Manufactured Schedule

The cost of goods manufactured schedule reports cost elements used in calcu- lating cost of goods manufactured. Illustration 1-7 shows the schedule for Current Designs (using assumed data). The schedule presents detailed data for direct materials and for manufacturing overhead.

Review Illustration 1-6 and then examine the cost of goods manufactured schedule in Illustration 1-7. You should be able to distinguish between “Total manufacturing costs” and “Cost of goods manufactured.” The difference is the effect of the change in work in process during the period.

Illustration 1-6 Cost of goods manufactured formula

Beginning Total Total Cost of Work in Process 1 Manufacturing 5 Work in Process Inventory Costs

Total Cost of Ending Cost of Goods Work in Process 2 Work in Process 5 Manufactured Inventory

Illustration 1-7 Cost of goods manufactured schedule

Current Designs Cost of Goods Manufactured Schedule For the Year Ended December 31, 2014

Work in process, January 1 $ 18,400 Direct materials Raw materials inventory, January 1 $ 16,700 Raw materials purchases 152,500

Total raw materials available for use 169,200 Less: Raw materials inventory, December 31 22,800

Direct materials used $146,400 Direct labor 175,600 Manufacturing overhead Indirect labor 14,300 Factory repairs 12,600 Factory utilities 10,100 Factory depreciation 9,440 Factory insurance 8,360

Total manufacturing overhead 54,800

Total manufacturing costs 376,800

Total cost of work in process 395,200 Less: Work in process, December 31 25,200

Cost of goods manufactured $370,000

Often, numbers or categories in the fi nancial statements are highlighted in red type to draw your attention to key information.

Each chapter presents useful information about how decision-makers analyze and solve busi- ness problems. Decision Toolkits summarize the key features of a decision tool and review why and how to use it.

DECISION TOOLKIT DECISION CHECKPOINTS INFO NEEDED FOR DECISION TOOL TO USE FOR DECISION HOW TO EVALUATE RESULTS

Is the company maintaining control over the costs of production?

Cost of goods manufactured schedule

Compare the cost of goods manufactured to revenue expected from product sales.

Cost of material, labor, and overhead

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Manufacturing Costs in Financial Statements 15

Illustration 1-8 Inventory accounts for a manufacturer

Finished Goods Inventory

Work in Process Inventory

Raw Materials Inventory

Shows the cost of completed goods on hand. Shows the cost applicable to

units that have been started into production but are only partially completed.

Shows the cost of raw materials on hand.

Cost of Goods Manufactured

Action Plan ✔ Start with beginning

work in process as the fi rst item in the cost of goods manufactured schedule.

✔ Sum direct materials used, direct labor, and manufacturing overhead to determine total manufacturing costs.

✔ Sum beginning work in process and total manufacturing costs to determine total cost of work in process.

✔ Cost of goods manu- factured is the total cost of work in process less ending work in process.

> DO IT!

The following information is available for Keystone Company.

March 1 March 31

Raw materials inventory $12,000 $10,000 Work in process inventory 2,500 4,000 Materials purchased in March $ 90,000 Direct labor in March 75,000 Manufacturing overhead in March 220,000

Prepare the cost of goods manufactured schedule for the month of March.

Solution

✔ The Navigator

Related exercise material: BE1-8, BE1-10, BE1-11, E1-8, E1-9, E1-10, E1-11, E1-12, E1-13, E1-14, E1-15, E1-16, E1-17, and 1-3.DO IT!

Keystone Company Cost of Goods Manufactured Schedule

For the Month Ended March 31

Work in process, March 1 $ 2,500 Direct materials Raw materials, March 1 $ 12,000 Raw material purchases 90,000

Total raw materials available for use 102,000 Less: Raw materials, March 31 10,000

Direct materials used $ 92,000 Direct labor 75,000 Manufacturing overhead 220,000

Total manufacturing costs 387,000

Total cost of work in process 389,500 Less: Work in process, March 31 4,000

Cost of goods manufactured $385,500

Balance Sheet

The balance sheet for a merchandising company shows just one category of inventory. In contrast, the balance sheet for a manufacturer may have three inventory accounts, as shown in Illustration 1-8. Explain the difference

between a merchandising and a manufacturing balance sheet.

7LEARNING OBJECTIVE

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16 1 Managerial Accounting

Finished Goods Inventory is to a manufacturer what Merchandise Inventory is to a merchandiser. Each of these classifi cations represents the goods that the com- pany has available for sale.

The current assets sections presented in Illustration 1-9 contrast the presenta- tions of inventories for merchandising and manufacturing companies. Manufac- turing companies generally list their inventories in the order of their liquidity—the order in which they are expected to be realized in cash. Thus, fi nished goods inventory comes fi rst. The remainder of the balance sheet is similar for the two types of companies.

Illustration 1-9 Current assets sections of merchandising and manufacturing balance sheets

Merchandising Company Manufacturing Company Balance Sheet Balance Sheet December 31, 2014 December 31, 2014

Current assets Current assets Cash $100,000 Cash $180,000 Receivables (net) 210,000 Receivables (net) 210,000 Merchandise inventory 400,000 Inventories Prepaid expenses 22,000 Finished goods $80,000

Total current assets $732,000 Work in process 25,200 Raw materials 22,800 128,000

Prepaid expenses 18,000

Total current assets $536,000

Each step in the accounting cycle for a merchandiser applies to a manufacturer. For example, prior to preparing fi nancial statements, manufacturers make adjust- ing entries. The adjusting entries are essentially the same as those of a merchan- diser. The closing entries are also similar for manufacturers and merchandisers.

DECISION TOOLKIT DECISION CHECKPOINTS INFO NEEDED FOR DECISION TOOL TO USE FOR DECISION HOW TO EVALUATE RESULTS

What is the composition of a manufacturing company’s inventory?

Balance sheet Determine whether there are suffi cient fi nished goods, raw materials, and work in process inventories to meet forecasted demand.

Amount of raw materials, work in process, and fi nished goods inventories

Cost Concepts—A Review

You have learned a number of cost concepts in this chapter. Because many of these concepts are new, we provide here an extended example for review. Sup- pose you started your own snowboard factory, Terrain Park Boards. Think that’s impossible? Burton Snowboards was started by Jake Burton Carpenter, when he was only 23 years old. Jake initially experimented with 100 different prototype designs before settling on a fi nal design. Then Jake, along with two relatives and a friend, started making 50 boards per day in Londonderry, Vermont. Unfortu- nately, while they made a lot of boards in their fi rst year, they were only able to sell 300 of them. To get by during those early years, Jake taught tennis and tended bar to pay the bills.

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Manufacturing Costs in Financial Statements 17

Here are some of the costs that your snowboard factory would incur.

1. The materials cost of each snowboard (wood cores, fi berglass, resins, metal screw holes, metal edges, and ink) is $30.

2. The labor costs (for example, to trim and shape each board using jig saws and band saws) are $40.

3. Depreciation on the factory building and equipment (for example, presses, grinding machines, and lacquer machines) used to make the snowboards is $25,000 per year.

4. Property taxes on the factory building (where the snowboards are made) are $6,000 per year.

5. Advertising costs (mostly online and catalogue) are $60,000 per year.

6. Sales commissions related to snowboard sales are $20 per snowboard.

7. Salaries for factory maintenance employees are $45,000 per year.

8. The salary of the plant manager is $70,000.

9. The cost of shipping is $8 per snowboard.

Illustration 1-10 shows how Terrain Park Boards would assign these manufactur- ing and selling costs to the various categories.

Remember that total manufacturing costs are the sum of the product costs—direct materials, direct labor, and manufacturing overhead. If Terrain Park Boards produces 10,000 snowboards the fi rst year, the total manufacturing costs would be $846,000 as shown in Illustration 1-11 (page 18).

Illustration 1-10 Assignment of costs to cost categories

Product Costs

Direct Direct Manufacturing Period Cost Item Materials Labor Overhead Costs

1. Material cost ($30 per board) X

2. Labor costs ($40 per board) X

3. Depreciation on factory equipment ($25,000 per year) X

4. Property taxes on factory building ($6,000 per year) X

5. Advertising costs ($60,000 per year) X

6. Sales commissions ($20 per board) X

7. Maintenance salaries (factory facilities) ($45,000 per year) X

8. Salary of plant manager ($70,000 per year) X

9. Cost of shipping boards ($8 per board) X

Terrain Park Boards

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18 1 Managerial Accounting

Illustration 1-11 Computation of total manufacturing costs

Cost Number and Item Manufacturing Cost

1. Material cost ($30 3 10,000) $300,000 2. Labor cost ($40 3 10,000) 400,000 3. Depreciation on factory equipment 25,000 4. Property taxes on factory building 6,000 7. Maintenance salaries (factory facilities) 45,000 8. Salary of plant manager 70,000

Total manufacturing costs $846,000

Knowing the total manufacturing costs, Terrain Park Boards can compute the manufacturing cost per unit. Assuming 10,000 units, the cost to produce one snowboard is $84.60 ($846,000 4 10,000 units).

In subsequent chapters, we will use extensively the cost concepts discussed in this chapter. So study Illustration 1-10 carefully. If you do not understand any of these classifi cations, go back and reread the appropriate section in this chapter.

Product Costing for Service Industries

Much of the U.S. economy has shifted toward an emphasis on services. Today, more than 50% of U.S. workers are employed by service companies. Airlines, marketing agencies, cable companies, and governmental agencies are just a few examples of service companies. How do service companies differ from manufac- turing companies? One difference is that services are consumed immediately. For example, when a restaurant produces a meal, that meal is not put in inventory, but it is instead consumed immediately. An airline uses special equipment to provide its product, but again, the output of that equipment is consumed imme- diately by the customer in the form of a fl ight. And a marketing agency performs services for its clients that are immediately consumed by the customer in the form of a marketing plan. For a manufacturing company, like Boeing, it often has a long lead time before its airplane is used or consumed by the customer.

This chapter’s examples used manufacturing companies because accounting for the manufacturing environment requires the use of the broadest range of accounts. That is, the accounts used by service companies represent a subset of those used by manufacturers because service com- panies are not producing inventory. Neither the restaurant, the airline, or the marketing agency discussed above produces an inventoriable product. However, just like a manufacturer, each needs to keep track of the costs of its services in order to know whether it is generating a profi t. A success- ful restaurateur needs to know the cost of each offering on the menu, an

airline needs to know the cost of fl ight service to each destination, and a marketing agency needs to know the cost to develop a marketing plan. Thus, the techniques shown in this chapter, to accumulate manufacturing costs to determine manufac- turing inventory, are equally useful for determining the costs of providing services.

For example, let’s consider the costs that Hewlett-Packard (HP) might incur on a consulting engagement. A signifi cant portion of its costs would be salaries of con- sulting personnel. It might also incur travel costs, materials, software costs, and depreciation charges on equipment used by the employees to provide the consult- ing service. In the same way that it needs to keep track of the cost of manufacturing its computers and printers, HP needs to know what its costs are on each consult- ing job. It could prepare a cost of services provided schedule similar to the cost of goods manufactured schedule in Illustration 1-7 (page 14). The structure would be essentially the same as the cost of goods manufactured schedule, but section head- ings would be refl ective of the costs of the particular service organization.

Ethics Notes help sensitize you to some of the ethical issues in accounting.

Do telecommunications com- panies have an obligation to provide service to remote or low-user areas for a fee that may be less than the cost of the service?

Ethics Note

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? What are some of the line items that would appear in the cost of services provided schedule of an airline? (See page 47.)

Managerial Accounting Today 19

Many of the examples we present in subsequent chapters will be based on service companies. To highlight the relevance of the techniques used in this course for ser- vice companies, we have placed a service company icon next to those items in the text and end-of-chapter materials that relate to nonmanufacturing companies.

Low Fares but Decent Profi ts

During 2008, when other airlines were cutting fl ight service due to the recession, Allegiant Airlines increased capacity by 21%. Sounds crazy, doesn’t it? But it must know something, be- cause while the other airlines were losing money, it was generating profi ts. Consider also that its average one-way fare is only $83. So how does it make money? As a low-budget airline, it focuses on controlling costs. It purchases used planes for $4 million each rather than new planes for $40 million. It fl ies out of small towns, so wages are low and competition is nonex- istent. It only fl ies a route if its 150-passenger planes are nearly full (it averages about 90% of capacity). If a route isn’t fi lling up, it quits fl ying it as often or cancels it altogether. It adjusts its prices weekly. The bottom line is that it knows its costs to the penny. Knowing what your costs are might not be glamorous, but it sure beats losing money.

Source: Susan Carey, “For Allegiant, Getaways Mean Profi ts,” Wall Street Journal Online (February 18, 2009).

SERVICE COMPANY INSIGHT

The business environment never stands still. Regulations are always changing, global competition continues to intensify, and technology is a source of constant upheaval. In this rapidly changing world, managerial accounting must continue to innovate in order to provide managers with the information they need.

Focus on the Value Chain

The value chain refers to all business processes associated with providing a prod- uct or service. Illustration 1-12 depicts the value chain for a manufacturer. Many of the most signifi cant business innovations in recent years have resulted either directly, or indirectly, from a focus on the value chain. For example, so-called lean manufacturing, originally pioneered by Japanese automobile manufacturer Toyota but now widely practiced, reviews all business processes in an effort to increase productivity and eliminate waste, all while continually trying to improve quality.

Managerial Accounting Today

Speedy Delivery

ProductionResearch & development and product

design

Acquisition of raw materials

Sales and marketing

Delivery Customer relations and subsequent

services

Unlimited Warranty

Illustration 1-12 A manufacturer’s value chain

Identify trends in managerial accounting.

8LEARNING OBJECTIVE

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20 1 Managerial Accounting

Just-in-time (JIT) inventory methods, which have signifi cantly lowered in- ventory levels and costs for many companies, are one innovation that resulted from the focus on the value chain. Under the JIT inventory method, goods are manufactured or purchased just in time for sale. For example, Dell can deliver a computer within 48 hours of a customer’s custom order. However, JIT also necessitates increased emphasis on product quality. Because JIT companies do not have excess inventory on hand, they cannot afford to stop production because of defects or machine breakdowns. If they have to stop production, deliveries will be delayed and customers will be unhappy. For example, a recent design fl aw in an Intel computer chip was estimated to cost the company $1 billion in repairs and reduced revenue. As a consequence, many companies now focus on total quality management (TQM) to reduce defects in fi nished products, with the goal of zero defects. The TQM philosophy has been employed by some of the most successful businesses to improve all aspects of the value chain.

Another innovation, the theory of constraints, involves identifi cation of “bottlenecks”—constraints within the value chain that limit a company’s profi tability. Once a major constraint has been identifi ed and eliminated, the company moves on to fi x the next most signifi cant constraint. General Motors found that by eliminating bottlenecks, it improved its use of overtime labor while meeting customer demand. An application of the theory of constraints is presented in Chapter 6.

Technology has played a big role in the focus on the value chain and the implementation of lean manufacturing. For example, enterprise resource plan- ning (ERP) systems, such as those provided by SAP, provide a comprehensive, centralized, integrated source of information to manage all major business processes—from purchasing, to manufacturing, to sales, to human resources. ERP systems have, in some large companies, replaced as many as 200 individual software packages. In addition, the focus on improving effi ciency in the value chain has also resulted in adoption of automated manufacturing processes. Many companies now use computer-integrated manufacturing. These systems often reduce the reliance on manual labor by using robotic equipment. This increases overhead costs as a percentage of total product costs.

As overhead costs increased because of factory automation, the accuracy of overhead cost allocation to specifi c products became more important. Managerial accounting devised an approach, called activity-based costing (ABC), which allocates overhead based on each product’s use of particular activities in making the product. In addition to providing more accurate product costing, ABC also can contribute to increased effi ciency in the value chain. For example, suppose one of a company’s overhead pools is allocated based on the number of setups that each product requires. If a particular product’s cost is high because it is allocated a lot of overhead due to a high number of setups, management will be motivated to try to reduce the number of setups and thus reduce its overhead allocation. ABC is discussed further in Chapter 4.

Balanced Scorecard

As companies implement various business practice innovations, managers some- times focus too enthusiastically on the latest innovation, to the detriment of other areas of the business. For example, by focusing on total quality manage- ment, companies sometimes lose sight of cost/benefi t considerations. Similarly, in focusing on reducing inventory levels through just-in-time inventory meth- ods, companies sometimes lose sales due to inventory shortages. The balanced scorecard corrects for this limited perspective: This approach uses both fi nancial and nonfi nancial measures to evaluate all aspects of a company’s operations in an integrated fashion. The performance measures are linked in a cause-and-effect fashion to ensure that they all tie to the company’s overall objectives. For example,

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Managerial Accounting Today 21

to increase return on assets, the company could try to increase sales. To increase sales, the company could try to increase customer satisfaction. To increase cus- tomer satisfaction, the company could try to reduce product defects. Finally, to reduce product defects, the company could increase employee training. The bal- anced scorecard, which is discussed further in Chapter 11, is now used by many companies, including Hilton Hotels, Wal-Mart Stores, Inc., and HP.

Corporate Social Responsibility

The balanced scorecard attempts to take a broader, more inclusive view of corpo- rate profi tability measures. Many companies, however, have begun to evaluate not just corporate profi tability but also corporate social responsibility. In addition to profi tability, corporate social responsibility considers a company’s efforts to employ sustainable business practices with regard to its employees and the envi- ronment. This is sometimes referred to as the triple bottom line because it evalu- ates a company’s performance with regard to people, planet, and profi t. Make no mistake, these companies are still striving to maximize profi ts—in a competi- tive world, they won’t survive long if they don’t. In fact, you might recognize a few of the names on the Forbes.com list of the 100 most sustainable companies in the world. Ever hear of General Electric, adidas, Toyota, Coca-Cola, or Starbucks? These companies have learned that with a long-term, sustainable approach, they can maximize profi ts while also acting in the best interest of their employees, their communities, and the environment. At various points within this textbook, we will discuss situations where real companies use the very skills that you are learning to evaluate decisions from a sustainable perspective.

Trends in Managerial Accounting

Action Plan ✔ Develop a forward-

looking view, in order to advise and provide information to vari- ous members of the organization.

✔ Understand current business trends and issues.

> DO IT!

1. e 2. a 3. d 4. b 5. c

Match the descriptions that follow with the corresponding terms.

Descriptions: Terms:

✔ The Navigator

Related exercise material: E1-18 and 1-4.DO IT!

1. ______ All activities associated with providing a product or service.

2. ______ A method of allocating overhead based on each product’s use of activities in making the product.

3. ______ Systems implemented to reduce defects in fi nished products with the goal of achieving zero defects.

4. ______ A performance-measurement ap- proach that uses both fi nancial and nonfi - nancial measures, tied to company objec- tives, to evaluate a company’s operations in an integrated fashion.

5. ______ Inventory system in which goods are manufactured or purchased just as they are needed for use.

a. Activity-based costing

b. Balanced scorecard

c. Just-in-time (JIT) inventory

d. Total quality management (TQM)

e. Value chain

Solution

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22 1 Managerial Accounting

Giant Bike Co. Ltd. produces many different models of bicycles. Assume that the market has responded enthusiastically to a new model, the Jaguar. As a result, the company has established a separate manufacturing facility to produce these bicycles. The company produces 1,000 bicycles per month. Giant’s monthly manufacturing costs and other data are as follows.

1. Rent on manufacturing equipment (lease cost) $2,000/month 2. Insurance on manufacturing building $750/month 3. Raw materials (frames, tires, etc.) $80/bicycle 4. Utility costs for manufacturing facility $1,000/month 5. Supplies for administrative offi ce $800/month 6. Wages for assembly line workers in manufacturing facility $30/bicycle 7. Depreciation on offi ce equipment $650/month

USING THE DECISION TOOLKIT

Instructions (a) Prepare an answer sheet with the following column headings.

Product Costs Cost Direct Direct Manufacturing Period Item Materials Labor Overhead Costs

Enter each cost item on your answer sheet, placing an “X” mark under the appropriate headings. (b) Compute total manufacturing costs for the month.

Solution (a) Product Costs Direct Direct Manufacturing Period Cost Item Materials Labor Overhead Costs 1. Rent on manufacturing equipment ($2,000/month) X 2. Insurance on manufacturing building ($750/month) X 3. Raw materials ($80/bicycle) X 4. Manufacturing utilities ($1,000/month) X 5. Offi ce supplies ($800/month) X 6. Wages for assembly workers ($30/bicycle) X 7. Depreciation on offi ce equipment ($650/month) X 8. Miscellaneous manufacturing materials ($1.20/bicycle) X

8. Miscellaneous manufacturing materials (lubricants, solders, etc.) $1.20/bicycle 9. Property taxes on manufacturing building $2,400/year 10. Manufacturing supervisor’s salary $3,000/month 11. Advertising for bicycles $30,000/year 12. Sales commissions $10/bicycle 13. Depreciation on manufacturing building $1,500/month

Using the Decision Toolkit exercises ask you to use business information and the decision tools presented in the chapter. We encourage you to think through the questions related to the decision before you study the Solution.

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Summary of Learning Objectives 23

The Summary of Learning Objectives reiterates the main points related to the Learning Objectives. It provides you with an opportunity to review what you have learned.

1 Explain the distinguishing features of managerial ac- counting. The primary users of managerial accounting reports are internal users, who are offi cers, depart- ment heads, managers, and supervisors in the company. Managerial accounting issues internal reports as fre- quently as the need arises. The purpose of these re- ports is to provide special-purpose information for a particular user for a specifi c decision. The content of managerial accounting reports pertains to subunits of the business, may be very detailed, and may extend be- yond the double-entry accounting system. The report- ing standard is relevance to the decision being made. No independent audits are required in managerial accounting.

2 Identify the three broad functions of management. The three functions are planning, directing, and con- trolling. Planning requires management to look ahead and to establish objectives. Directing involves coordi- nating the diverse activities and human resources of a

company to produce a smooth-running operation. Con- trolling is the process of keeping the activities on track.

3 Defi ne the three classes of manufacturing costs. Manu- facturing costs are typically classifi ed as either (1) direct materials, (2) direct labor, or (3) manufacturing over- head. Raw materials that can be physically and directly associated with the fi nished product during the manu- facturing process are called direct materials. The work of factory employees that can be physically and directly associated with converting raw materials into fi nished goods is considered direct labor. Manufacturing over- head consists of costs that are indirectly associated with the manufacture of the fi nished product.

4 Distinguish between product and period costs. Product costs are costs that are a necessary and integral part of producing the fi nished product. Product costs are also called inventoriable costs. Under the expense recogni- tion principle, these costs do not become expenses until

✔ The NavigatorSUMMARY OF LEARNING OBJECTIVES

✔ The Navigator

9. Property taxes on manufac- turing building ($2,400/year) X 10. Manufacturing supervisor’s salary ($3,000/month) X 11. Advertising cost ($30,000/year) X 12. Sales commissions ($10/bicycle) X 13. Depreciation on manufacturing building ($1,500/month) X

(b) Cost Item Manufacturing Cost Rent on manufacturing equipment $ 2,000 Insurance on manufacturing building 750 Raw materials ($80 3 1,000) 80,000 Manufacturing utilities 1,000 Labor ($30 3 1,000) 30,000 Miscellaneous materials ($1.20 3 1,000) 1,200 Property taxes on manufacturing building ($2,400 4 12) 200 Manufacturing supervisor’s salary 3,000 Depreciation on manufacturing building 1,500 Total manufacturing costs $119,650

Product Costs Direct Direct Manufacturing Period Cost Item Materials Labor Overhead Costs

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24 1 Managerial Accounting

the company sells the fi nished goods inventory. Period costs are costs that are identifi ed with a specifi c time period rather than with a salable product. These costs relate to nonmanufacturing costs and therefore are not inventoriable costs.

5 Explain the difference between a merchandising and a manufacturing income statement. The difference be- tween a merchandising and a manufacturing income statement is in the cost of goods sold section. A manu- facturing cost of goods sold section shows beginning and ending fi nished goods inventories and the cost of goods manufactured.

6 Indicate how cost of goods manufactured is deter- mined. Companies add the cost of the beginning work in process to the total manufacturing costs for the cur- rent year to arrive at the total cost of work in process for the year. They then subtract the ending work in process from the total cost of work in process to arrive at the cost of goods manufactured.

7 Explain the difference between a merchandising and a manufacturing balance sheet. The difference between a merchandising and a manufacturing balance sheet is in the current assets section. The current assets section of a manufacturing company’s balance sheet presents three inventory accounts: fi nished goods inventory, work in process inventory, and raw materials inventory.

8 Identify trends in managerial accounting. Managerial accounting has experienced many changes in recent years. Improved practices include a focus on manag- ing the value chain through techniques such as just- in-time inventory, total quality management, activity- based costing, and theory of constraints. The balanced scorecard is now used by many companies in order to attain a more comprehensive view of the company’s operations. Finally, companies are now evaluating their performance with regard to their corporate social responsibility.

Activity-based costing (ABC) A method of allocating overhead based on each product’s use of activities in making the product. (p. 20).

Balanced scorecard A performance-measurement ap- proach that uses both fi nancial and nonfi nancial measures, tied to company objectives, to evaluate a company’s operations in an integrated fashion. (p. 20).

Board of directors The group of offi cials elected by the stockholders of a corporation to formulate operat- ing policies, select offi cers, and otherwise manage the company. (p. 6).

Chief executive offi cer (CEO) Corporate offi cer who has overall responsibility for managing the busi- ness and delegates responsibilities to other corporate offi cers. (p. 6).

Chief fi nancial offi cer (CFO) Corporate offi cer who is responsible for all of the accounting and fi nance issues of the company. (p. 7).

Controller Financial offi cer responsible for a company’s accounting records, system of internal control, and preparation of fi nancial statements, tax returns, and internal reports. (p. 7).

Corporate social responsibility The efforts of a company to employ sustainable business practices with regard to its employees and the environment. (p. 21).

Cost of goods manufactured Total cost of work in process less the cost of the ending work in process in- ventory. (p. 13).

GLOSSARY

The Decision Toolkit—A Summary reviews the contexts and techniques useful for decision-making that were covered in the chapter.

DECISION TOOLKIT A SUMMARY HOW TO EVALUATE RESULTS

Compare the cost of goods manufactured to revenue expected from product sales.

What is the composition of a manufacturing company’s inventory?

Amount of raw materials, work in process, and fi nished goods inventories

Determine whether there are suffi cient fi nished goods, raw materials, and work in process inventories to meet forecasted demand.

DECISION CHECKPOINTS INFO NEEDED FOR DECISION

Is the company maintaining control over the costs of production?

Cost of goods manufactured schedule

Cost of material, labor, and overhead

TOOL TO USE FOR DECISION

Balance sheet

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Comprehensive DO IT! 25

Direct labor The work of factory employees that can be physically and directly associated with converting raw materials into fi nished goods. (p. 10).

Direct materials Raw materials that can be physically and directly associated with manufacturing the fi n- ished product. (p. 10).

Enterprise resource planning (ERP) system Software that provides a comprehensive, centralized, integrated source of information used to manage all major busi- ness processes. (p. 20).

Indirect labor Work of factory employees that has no physical association with the fi nished product, or for which it is impractical to trace the costs to the goods produced. (p. 10).

Indirect materials Raw materials that do not physically become part of the fi nished product or for which it is impractical to trace to the fi nished product because their physical association with the fi nished product is too small. (p. 10).

Just-in-time (JIT) inventory Inventory system in which goods are manufactured or purchased just in time for sale. (p. 20).

Line positions Jobs that are directly involved in a com- pany’s primary revenue-generating operating activities. (p. 6).

Managerial accounting A fi eld of accounting that pro- vides economic and fi nancial information for managers and other internal users. (p. 4).

Manufacturing overhead Manufacturing costs that are indirectly associated with the manufacture of the fi n- ished product. (p. 10).

Period costs Costs that are matched with the revenue of a specifi c time period and charged to expense as in- curred. (p. 11).

Product costs Costs that are a necessary and integral part of producing the fi nished product. (p. 11).

Sarbanes-Oxley Act (SOX) Law passed by Congress intended to reduce unethical corporate behavior. (p. 8).

Staff positions Jobs that support the efforts of line employees. (p. 6).

Theory of constraints A specifi c approach used to iden- tify and manage constraints in order to achieve the company’s goals. (p. 20).

Total cost of work in process Cost of the beginning work in process plus total manufacturing costs for the current period. (p. 13).

Total manufacturing costs The sum of direct materi- als, direct labor, and manufacturing overhead incurred in the current period. (p. 13).

Total quality management (TQM) Systems imple- mented to reduce defects in fi nished products with the goal of achieving zero defects. (p. 20).

Treasurer Financial offi cer responsible for custody of a company’s funds and for maintaining its cash position. (p. 7).

Triple bottom line The evaluation of a company’s social responsibility performance with regard to people, planet, and profi t. (p. 21).

Value chain All activities that a business processes with providing a product or service. (p. 19).

> DO IT!

Superior Company has the following cost and expense data for the year ending December 31, 2014.

Raw materials, 1/1/14 $ 30,000 Insurance, factory $ 14,000 Raw materials, 12/31/14 20,000 Property taxes, factory building 6,000 Raw materials purchases 205,000 Sales revenue 1,500,000 Indirect materials 15,000 Delivery expenses 100,000 Work in process, 1/1/14 80,000 Sales commissions 150,000 Work in process, 12/31/14 50,000 Indirect labor 90,000 Finished goods, 1/1/14 110,000 Factory machinery rent 40,000 Finished goods, 12/31/14 120,000 Factory utilities 65,000 Direct labor 350,000 Depreciation, factory building 24,000 Factory manager’s salary 35,000 Administrative expenses 300,000

Instructions (a) Prepare a cost of goods manufactured schedule for Superior Company for 2014.

(b) Prepare an income statement for Superior Company for 2014.

Comprehensive

Comprehensive DO IT! exercises are a fi nal review before you begin homework. An Action Plan that appears in the margin gives you tips about how to approach the problem, and the Solution provided demonstrates both the form and content of complete answers.

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26 1 Managerial Accounting

(c) Assume that Superior Company’s accounting records show the balances of the follow- ing current asset accounts: Cash $17,000, Accounts Receivable (net) $120,000, Prepaid Expenses $13,000, and Short-Term Investments $26,000. Prepare the current assets section of the balance sheet for Superior Company as of December 31, 2014.

Solution to Comprehensive Action Plan ✔ Start with beginning

work in process as the fi rst item in the cost of goods manufactured schedule.

✔ Sum direct materials used, direct labor, and total manufacturing overhead to determine total manufacturing costs.

✔ Sum beginning work in process and total manufacturing costs to determine total cost of work in process.

✔ Cost of goods manu- factured is the total cost of work in process less ending work in process.

✔ In the cost of goods sold section of the income statement, show beginning and ending fi nished goods inventory and cost of goods manufactured.

✔ In the balance sheet, list manufacturing inventories in the order of their expected realization in cash, with fi nished goods fi rst.

(a) Superior Company Cost of Goods Manufactured Schedule For the Year Ended December 31, 2014

Work in process, 1/1 $ 80,000 Direct materials Raw materials inventory, 1/1 $ 30,000 Raw materials purchases 205,000

Total raw materials available for use 235,000 Less: Raw materials inventory, 12/31 20,000 Direct materials used $215,000 Direct labor 350,000 Manufacturing overhead Indirect labor 90,000 Factory utilities 65,000 Factory machinery rent 40,000 Factory manager’s salary 35,000 Depreciation, factory building 24,000 Indirect materials 15,000 Insurance, factory 14,000 Property taxes, factory building 6,000

Total manufacturing overhead 289,000

Total manufacturing costs 854,000

Total cost of work in process 934,000 Less: Work in process, 12/31 50,000

Cost of goods manufactured $ 884,000

(b) Superior Company Income Statement For the Year Ended December 31, 2014

Sales revenue $1,500,000 Cost of goods sold Finished goods inventory, January 1 $110,000 Cost of goods manufactured 884,000

Cost of goods available for sale 994,000 Less: Finished goods inventory, December 31 120,000

Cost of goods sold 874,000

Gross profi t 626,000 Operating expenses Administrative expenses 300,000 Sales commissions 150,000 Delivery expenses 100,000

Total operating expenses 550,000

Net income $ 76,000

DO IT!

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Self-Test Questions 27

(c) Superior Company Balance Sheet (partial) December 31, 2014

Current assets Cash $ 17,000 Short-term investments 26,000 Accounts receivable (net) 120,000 Inventories Finished goods $120,000 Work in process 50,000 Raw materials 20,000 190,000

Prepaid expenses 13,000

Total current assets $366,000

✔ The Navigator

Answers are at the end of the chapter. 1. Managerial accounting:

(a) is governed by generally accepted accounting principles.

(b) places emphasis on special-purpose information. (c) pertains to the entity as a whole and is highly

aggregated. (d) is limited to cost data.

2. The management of an organization performs several broad functions. They are: (a) planning, directing, and selling. (b) planning, directing, and controlling. (c) planning, manufacturing, and controlling. (d) directing, manufacturing, and controlling.

3. After passage of the Sarbanes-Oxley Act: (a) reports prepared by managerial accountants must

by audited by CPAs. (b) CEOs and CFOs must certify that fi nancial state-

ments give a fair presentation of the company’s operating results.

(c) the audit committee, rather than top manage- ment, is responsible for the company’s fi nancial statements.

(d) reports prepared by managerial accountants must comply with generally accepted accounting prin- ciples (GAAP).

4. Direct materials are a:

Product Manufacturing Period Cost Overhead Cost

(a) Yes Yes No (b) Yes No No (c) Yes Yes Yes (d) No No No

5. Which of the following costs would a computer man- ufacturer include in manufacturing overhead? (a) The cost of the disk drives. (b) The wages earned by computer assemblers. (c) The cost of the memory chips. (d) Depreciation on testing equipment.

6. Which of the following is not an element of manufac- turing overhead? (a) Sales manager’s salary. (b) Plant manager’s salary. (c) Factory repairman’s wages. (d) Product inspector’s salary.

7. Indirect labor is a: (a) nonmanufacturing cost. (b) raw material cost. (c) product cost. (d) period cost.

SELF-TEST QUESTIONS

(LO 1)

(LO 2)

(LO 2)

(LO 3)

(LO 3)

(LO 4)

(LO 3)

Self-Test, Brief Exercises, Exercises, Problem Set A, and many more resources are available for practice in WileyPLUS.

This would be a good time to return to the Preface at the beginning of the textbook (or look at it for the fi rst time if you skipped it before) to read about the various types of homework materials that appear at the ends of

chapters. Knowing the purpose of different assignments will help you appreciate what each contributes to your accounting skills and competencies.

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28 1 Managerial Accounting

8. Which of the following costs are classifi ed as a period cost? (a) Wages paid to a factory custodian. (b) Wages paid to a production department super visor. (c) Wages paid to a cost accounting department

supervisor. (d) Wages paid to an assembly worker.

9. For the year, Redder Company has cost of goods manufactured of $600,000, beginning fi nished goods inventory of $200,000, and ending fi nished goods in- ventory of $250,000. The cost of goods sold is: (a) $450,000. (b) $500,000. (c) $550,000. (d) $600,000.

10. Cost of goods available for sale is a step in the calcula- tion of cost of goods sold of: (a) a merchandising company but not a manufactur-

ing company. (b) a manufacturing company but not a merchandis-

ing company. (c) a merchandising company and a manufacturing

company. (d) neither a manufacturing company nor a mer-

chandising company. 11. A cost of goods manufactured schedule shows begin-

ning and ending inventories for: (a) raw materials and work in process only. (b) work in process only. (c) raw materials only. (d) raw materials, work in process, and fi nished goods.

12. The formula to determine the cost of goods manufac- tured is: (a) Beginning raw materials inventory 1 Total manu-

facturing costs 2 Ending work in process inventory.

(b) Beginning work in process inventory 1 Total manufacturing costs 2 Ending fi nished goods inventory.

(c) Beginning fi nished good inventory 1 Total manu- facturing costs 2 Ending fi nished goods inventory.

(d) Beginning work in process inventory 1 Total manufacturing costs 2 Ending work in process inventory.

13. A manufacturer may report three inventories on its balance sheet: (1) raw materials, (2) work in process, and (3) fi nished goods. Indicate in what sequence these inventories generally appear on a balance sheet. (a) (1), (2), (3) (b) (2), (3), (1) (c) (3), (1), (2) (d) (3), (2), (1)

14. Which of the following managerial accounting tech- niques attempts to allocate manufacturing overhead in a more meaningful fashion? (a) Just-in-time inventory. (b) Total quality management. (c) Balanced scorecard. (d) Activity-based costing.

15. Corporate social responsibility refers to: (a) the practice by management of reviewing all busi-

ness processes in an effort to increase productiv- ity and eliminate waste.

(b) an approach used to allocate overhead based on each product’s use of activities.

(c) the attempt by management to identify and elimi- nate constraints within the value chain.

(d) efforts by companies to employ sustainable busi- ness practices with regard to employees and the environment.

Go to the book’s companion website, www.wiley.com/college/weygandt, for additional Self-Test Questions.

✔ The Navigator

(LO 5)

(LO 4)

(LO 5)

(LO 6)

(LO 6)

(LO 8)

(LO 7)

(LO 8)

1. (a) “Managerial accounting is a fi eld of accounting that provides economic information for all inter- ested parties.” Do you agree? Explain.

(b) Joe Delong believes that managerial accounting serves only manufacturing fi rms. Is Joe correct? Explain.

2. Distinguish between managerial and fi nancial ac- counting as to (a) primary users of reports, (b) types and frequency of reports, and (c) purpose of reports.

3. How do the content of reports and the verifi cation of reports differ between managerial and fi nancial accounting?

4. In what ways can the budgeting process create incen- tives for unethical behavior?

5. Linda Olsen is studying for the next accounting mid- term examination. Summarize for Linda what she should know about management functions.

6. “Decision-making is management’s most important function.” Do you agree? Why or why not?

7. Explain the primary difference between line posi- tions and staff positions, and give examples of each.

8. What new rules were enacted under the Sarbanes- Oxley Act to address unethical accounting practices?

9. Tony Andres is studying for his next accounting exam- ination. Explain to Tony what he should know about the differences between the income statements for a manufacturing and for a merchandising company.

10. Jerry Lang is unclear as to the difference between the balance sheets of a merchandising company and a man- ufacturing company. Explain the difference to Jerry.

11. How are manufacturing costs classifi ed? 12. Mel Finney claims that the distinction between direct

and indirect materials is based entirely on physical association with the product. Is Mel correct? Why?

QUESTIONS

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Brief Exercises 29

13. Tina Burke is confused about the differences between a product cost and a period cost. Explain the differ- ences to Tina.

14. Identify the differences in the cost of goods sold sec- tion of an income statement between a merchandis- ing company and a manufacturing company.

15. The determination of the cost of goods manufactured involves the following factors: (A) beginning work in process inventory, (B) total manufacturing costs, and (C) ending work in process inventory. Identify the meaning of x in the following formulas:

(a) A 1 B 5 x (b) A 1 B 2 C 5 x 16. Sealy Company has beginning raw materials inventory

$12,000, ending raw materials inventory $15,000, and raw materials purchases $170,000. What is the cost of direct materials used?

17. Tate Inc. has beginning work in process $26,000, di- rect materials used $240,000, direct labor $220,000, total manufacturing overhead $180,000, and ending work in process $32,000. What are the total manufac- turing costs?

18. Using the data in Question 17, what are (a) the to- tal cost of work in process and (b) the cost of goods manufactured?

19. In what order should manufacturing inventories be listed in a balance sheet?

20. How does the output of manufacturing operations differ from that of service operations?

21. Discuss whether the product costing techniques dis- cussed in this chapter apply equally well to manufac- turers and service companies.

22. What is the value chain? Describe, in sequence, the main components of a manufacturer’s value chain.

23. What is an enterprise resource planning (ERP) sys- tem? What are its primary benefi ts?

24. Why is product quality important for companies that implement a just-in-time inventory system?

25. Explain what is meant by “balanced” in the balanced scorecard approach.

26. What is activity-based costing, and what are its potential benefi ts?

BRIEF EXERCISES

BE1-1 Complete the following comparison table between managerial and fi nancial accounting.

Financial Accounting Managerial Accounting

Primary users of reports Types of reports Frequency of reports Purpose of reports Content of reports Verifi cation process

BE1-2 The Sarbanes-Oxley Act (SOX) has important implications for the fi nancial com- munity. Explain two implications of SOX.

BE1-3 Listed below are the three functions of the management of an organization. 1. Planning 2. Directing 3. Controlling

Identify which of the following statements best describes each of the above functions. (a) ______ requires management to look ahead and to establish objectives. A key objective

of management is to add value to the business. (b) ______ involves coordinating the diverse activities and human resources of a company

to produce a smooth-running operation. This function relates to the implementation of planned objectives.

(c) ______ is the process of keeping the activities on track. Management must deter- mine whether goals are being met and what changes are necessary when there are deviations.

BE1-4 Determine whether each of the following costs should be classifi ed as direct ma- terials (DM), direct labor (DL), or manufacturing overhead (MO). (a) ______ Frames and tires used in manufacturing bicycles. (b) ______ Wages paid to production workers. (c) ______ Insurance on factory equipment and machinery. (d) ______ Depreciation on factory equipment.

Distinguish between managerial and fi nancial accounting.

(LO 1), C

Identify important regulatory changes.

(LO 2), C Identify the three management functions.

(LO 2), C

Classify manufacturing costs.

(LO 3), C

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30 1 Managerial Accounting

BE1-5 Indicate whether each of the following costs of an automobile manufacturer would be classifi ed as direct materials, direct labor, or manufacturing overhead. (a) ______ Windshield. (e) ______ Factory machinery lubricants. (b) ______ Engine. (f) ______ Tires. (c) ______ Wages of assembly line worker. (g) ______ Steering wheel. (d) ______ Depreciation of factory machinery. (h) ______ Salary of painting supervisor.

BE1-6 Identify whether each of the following costs should be classifi ed as product costs or period costs. (a) ______ Manufacturing overhead. (d) ______ Advertising expenses. (b) ______ Selling expenses. (e) ______ Direct labor. (c) ______ Administrative expenses. (f) ______ Direct material.

BE1-7 Presented below are Dieker Company’s monthly manufacturing cost data related to its personal computer products. (a) Utilities for manufacturing equipment $116,000 (b) Raw material (CPU, chips, etc.) $ 85,000 (c) Depreciation on manufacturing building $880,000 (d) Wages for production workers $191,000

Enter each cost item in the following table, placing an “X” under the appropriate headings.

Product Costs

Direct Direct Factory Materials Labor Overhead

(a) (b) (c) (d)

BE1-8 Francum Company has the following data: direct labor $209,000, direct materials used $180,000, total manufacturing overhead $208,000, and beginning work in process $25,000. Compute (a) total manufacturing costs and (b) total cost of work in process.

BE1-9 In alphabetical order below are current asset items for Ruiz Company’s balance sheet at December 31, 2014. Prepare the current assets section (including a complete heading).

Accounts receivable $200,000 Cash 62,000 Finished goods 91,000 Prepaid expenses 38,000 Raw materials 73,000 Work in process 87,000

BE1-10 Presented below are incomplete manufacturing cost data. Determine the missing amounts for three different situations.

Direct Direct Total Materials Labor Factory Manufacturing Used Used Overhead Costs

(1) $40,000 $61,000 $ 50,000 ? (2) ? $75,000 $140,000 $296,000 (3) $55,000 ? $111,000 $310,000

BE1-11 Use the same data from BE1–10 above and the data below. Determine the missing amounts.

Total Work Work Cost of Manufacturing in Process in Process Goods Costs (1/1) (12/31) Manufactured

(1) ? $120,000 $82,000 ? (2) $296,000 ? $98,000 $321,000 (3) $310,000 $463,000 ? $715,000

Classify manufacturing costs.

(LO 3), C

Identify product and period costs.

(LO 4), C

Classify manufacturing costs.

(LO 3), C

Compute total manufacturing costs and total cost of work in process.

(LO 6), AP

Prepare current assets section.

(LO 7), AP

Determine missing amounts in computing total manufac- turing costs.

(LO 6), AP

Determine missing amounts in computing cost of goods manufactured.

(LO 6), AP

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DO IT! Review 31

> DO IT! REVIEW

Indicate whether the following statements are true or false.

1. Managerial accountants explain and report manufacturing and nonmanufacturing costs, determine cost behaviors, and perform cost-volume-profi t analysis, but are not involved in the budget process.

2. Financial accounting reports pertain to subunits of the business and are very detailed. 3. Managerial accounting reports must follow GAAP and are audited by CPAs. 4. Managers’ activities and responsibilities can be classifi ed into three broad functions:

planning, directing, and controlling. 5. As a result of the Sarbanes-Oxley Act (SOX), top managers must certify that the com-

pany maintains an adequate system of internal control. 6. Management accountants follow a code of ethics developed by the Institute of

Management Accountants.

A music company has these costs:

Advertising Paper inserts for CD cases Blank CDs CD plastic cases Depreciation of CD image Salaries of sales representatives burner Salaries of factory maintenance employees Salary of factory manager Salaries of employees who burn music onto CDs Factory supplies used

Classify each cost as a period or a product cost. Within the product cost category, indicate if the cost is part of direct materials (DM), direct labor (DL), or manufacturing overhead (MO).

The following information is available for Fishel Company.

April 1 April 30

Raw materials inventory $10,000 $14,000 Work in process inventory 5,000 3,500

Materials purchased in April $ 98,000 Direct labor in April 80,000 Manufacturing overhead in April 180,000

Prepare the cost of goods manufactured schedule for the month of April.

Match the descriptions that follow with the corresponding terms. Descriptions:

1. ______ Inventory system in which goods are manufactured or purchased just as they are needed for sale.

2. ______ A method of allocating overhead based on each product’s use of activities in making the product.

3. ______ Systems that are especially important to fi rms adopting just-in-time inventory methods.

4. ______ One part of the value chain for a manufacturing company. 5. ______ The U.S. economy is trending toward this. 6. ______ A performance-measurement approach that uses both fi nancial and nonfi nan-

cial measures, tied to company objectives, to evaluate a company’s operations in an integrated fashion.

Terms:

(a) Activity-based costing (b) Balanced scorecard (c) Total quality management (TQM) (d) Research and development, and product design (e) Service industries (f) Just-in-time (JIT) inventory

DO IT! 1-1

DO IT! 1-2

DO IT! 1-3

DO IT! 1-4

Identify managerial accounting concepts.

(LO 1, 2), C

✔ The Navigator

Identify managerial cost concepts.

(LO 3, 4), C

Prepare cost of goods manufactured schedule.

(LO 6), AP

Identify trends in managerial accounting.

(LO 8), C

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32 1 Managerial Accounting

EXERCISES

E1-1 Richard Larkin has prepared the following list of statements about managerial accounting and fi nancial accounting.

1. Financial accounting focuses on providing information to internal users. 2. Analyzing cost-volume-profi t relationships is part of managerial accounting. 3. Preparation of budgets is part of fi nancial accounting. 4. Managerial accounting applies only to merchandising and manufacturing companies. 5. Both managerial accounting and fi nancial accounting deal with many of the same

economic events. 6. Managerial accounting reports are prepared only quarterly and annually. 7. Financial accounting reports are general-purpose reports. 8. Managerial accounting reports pertain to subunits of the business. 9. Managerial accounting reports must comply with generally accepted accounting

principles. 10. Although managerial accountants are expected to behave ethically, there is no code of

ethical standards for managerial accountants.

Instructions Identify each statement as true or false. If false, indicate how to correct the statement.

E1-2 Presented below is a list of costs and expenses usually incurred by Barnum Corpora- tion, a manufacturer of furniture, in its factory.

1. Salaries for assembly line inspectors. 2. Insurance on factory machines. 3. Property taxes on the factory building. 4. Factory repairs. 5. Upholstery used in manufacturing furniture. 6. Wages paid to assembly line workers. 7. Factory machinery depreciation. 8. Glue, nails, paint, and other small parts used in production. 9. Factory supervisors’ salaries. 10. Wood used in manufacturing furniture.

Instructions Classify the above items into the following categories: (a) direct materials, (b) direct labor, and (c) manufacturing overhead.

E1-3 Ryan Corporation incurred the following costs while manufacturing its product.

Materials used in product $100,000 Advertising expense $45,000 Depreciation on plant 60,000 Property taxes on plant 14,000 Property taxes on store 7,500 Delivery expense 21,000 Labor costs of assembly-line workers 110,000 Sales commissions 35,000 Factory supplies used 13,000 Salaries paid to sales clerks 50,000

Instructions (a) Identify each of the above costs as direct materials, direct labor, manufacturing over-

head, or period costs. (b) Explain the basic difference in accounting for product costs and period costs.

E1-4 Knight Company reports the following costs and expenses in May.

Factory utilities $ 15,500 Direct labor $69,100 Depreciation on factory Sales salaries 46,400 equipment 12,650 Property taxes on factory Depreciation on delivery trucks 3,800 building 2,500 Indirect factory labor 48,900 Repairs to offi ce equipment 1,300 Indirect materials 80,800 Factory repairs 2,000 Direct materials used 137,600 Advertising 15,000 Factory manager’s salary 8,000 Offi ce supplies used 2,640

Identify distinguishing features of managerial accounting.

(LO 1), C

Classify costs into three classes of manufacturing costs.

(LO 3), C

Determine the total amount of various types of costs.

(LO 3, 4), AP

Identify types of cost and explain their accounting.

(LO 3, 4), C

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Exercises 33

Instructions From the information, determine the total amount of: (a) Manufacturing overhead. (b) Product costs. (c) Period costs.

E1-5 Ikerd Company is a manufacturer of personal computers. Various costs and expenses associated with its operations are as follows.

1. Property taxes on the factory building. 2. Production superintendents’ salaries. 3. Memory boards and chips used in assembling computers. 4. Depreciation on the factory equipment. 5. Salaries for assembly-line quality control inspectors. 6. Sales commissions paid to sell personal computers. 7. Electrical components used in assembling computers. 8. Wages of workers assembling personal computers. 9. Soldering materials used on factory assembly lines. 10. Salaries for the night security guards for the factory building.

The company intends to classify these costs and expenses into the following categories: (a) direct materials, (b) direct labor, (c) manufacturing overhead, and (d) period costs.

Instructions List the items (1) through (10). For each item, indicate the cost category to which it belongs.

E1-6 The administrators of Crawford County’s Memorial Hospital are interested in identi- fying the various costs and expenses that are incurred in producing a patient’s X-ray. A list of such costs and expenses is presented below.

1. Salaries for the X-ray machine technicians. 2. Wages for the hospital janitorial personnel. 3. Film costs for the X-ray machines. 4. Property taxes on the hospital building. 5. Salary of the X-ray technicians’ supervisor. 6. Electricity costs for the X-ray department. 7. Maintenance and repairs on the X-ray machines. 8. X-ray department supplies. 9. Depreciation on the X-ray department equipment. 10. Depreciation on the hospital building.

The administrators want these costs and expenses classifi ed as: (a) direct materials, (b) direct labor, or (c) service overhead.

Instructions List the items (1) through (10). For each item, indicate the cost category to which the item belongs.

E1-7 Kwik Delivery Service reports the following costs and expenses in June 2014.

Indirect materials $ 5,400 Drivers’ salaries $16,000 Depreciation on delivery equipment 11,200 Advertising 3,600 Dispatcher’s salary 5,000 Delivery equipment repairs 300 Property taxes on offi ce building 870 Offi ce supplies 650 CEO’s salary 12,000 Offi ce utilities 990 Gas and oil for delivery trucks 2,200 Repairs on offi ce equipment 180

Instructions Determine the total amount of (a) delivery service (product) costs and (b) period costs.

E1-8 Lopez Corporation incurred the following costs while manufacturing its product.

Materials used in product $120,000 Advertising expense $45,000 Depreciation on plant 60,000 Property taxes on plant 14,000 Property taxes on store 7,500 Delivery expense 21,000 Labor costs of assembly-line Sales commissions 35,000 workers 110,000 Salaries paid to sales Factory supplies used 23,000 clerks 50,000

Homework materials related to service companies are indicated by this icon.

Classify various costs into different cost categories.

(LO 3, 4), C

Classify various costs into different cost categories.

(LO 3), C

Classify various costs into different cost categories.

(LO 4), AP

Compute cost of goods manufactured and sold.

(LO 5, 6), AP

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34 1 Managerial Accounting

Work in process inventory was $12,000 at January 1 and $15,500 at December 31. Finished goods inventory was $60,000 at January 1 and $45,600 at December 31.

Instructions (a) Compute cost of goods manufactured. (b) Compute cost of goods sold.

E1-9 An incomplete cost of goods manufactured schedule is presented below.

Molina Company Cost of Goods Manufactured Schedule For the Year Ended December 31, 2014

Work in process (1/1) $210,000 Direct materials Raw materials inventory (1/1) $ ? Add: Raw materials purchases 158,000

Total raw materials available for use ? Less: Raw materials inventory (12/31) 22,500

Direct materials used $190,000 Direct labor ? Manufacturing overhead Indirect labor 18,000 Factory depreciation 36,000 Factory utilities 68,000

Total overhead 122,000

Total manufacturing costs ?

Total cost of work in process ? Less: Work in process (12/31) 81,000

Cost of goods manufactured $530,000

Instructions Complete the cost of goods manufactured schedule for Molina Company.

E1-10 Manufacturing cost data for Copa Company are presented below.

Case A Case B Case C

Direct materials used $ (a) $68,400 $130,000 Direct labor 57,000 86,000 (g) Manufacturing overhead 46,500 81,600 102,000 Total manufacturing costs 195,650 (d) 253,700 Work in process 1/1/14 (b) 16,500 (h) Total cost of work in process 221,500 (e) 337,000 Work in process 12/31/14 (c) 11,000 70,000 Cost of goods manufactured 185,275 (f) (i)

Instructions Indicate the missing amount for each letter (a) through (i).

E1-11 Incomplete manufacturing cost data for Colaw Company for 2014 are presented as follows for four different situations.

Total Cost of Direct Direct Manufac- Manufac- Work in Work in Goods Materials Labor turing turing Process Process Manufac- Used Used Overhead Costs 1/1 12/31 tured

(1) $127,000 $140,000 $ 87,000 $ (a) $33,000 $ (b) $360,000 (2) (c) 200,000 132,000 450,000 (d) 40,000 470,000 (3) 80,000 100,000 (e) 255,000 60,000 80,000 (f) (4) 70,000 (g) 75,000 288,000 45,000 (h) 270,000

Determine missing amounts in cost of goods manufactured schedule.

(LO 6), AP

Determine the missing amount of different cost items.

(LO 6), AN

Determine the missing amount of different cost items, and prepare a condensed cost of goods manufactured schedule.

(LO 6), AN

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Exercises 35

Instructions (a) Indicate the missing amount for each letter. (b) Prepare a condensed cost of goods manufactured schedule for situation (1) for the

year ended December 31, 2014.

E1-12 Cepeda Corporation has the following cost records for June 2014.

Indirect factory labor $ 4,500 Factory utilities $ 400 Direct materials used 20,000 Depreciation, factory equipment 1,400 Work in process, 6/1/14 3,000 Direct labor 40,000 Work in process, 6/30/14 3,800 Maintenance, factory equipment 1,800 Finished goods, 6/1/14 5,000 Indirect materials 2,200 Finished goods, 6/30/14 7,500 Factory manager’s salary 3,000

Instructions (a) Prepare a cost of goods manufactured schedule for June 2014. (b) Prepare an income statement through gross profi t for June 2014 assuming sales rev-

enue is $92,100.

E1-13 Joyce Tombert, the bookkeeper for Marks Consulting, a political consulting fi rm, has recently completed a managerial accounting course at her local college. One of the topics covered in the course was the cost of goods manufactured schedule. Joyce won- dered if such a schedule could be prepared for her fi rm. She realized that, as a service- oriented company, it would have no work in process inventory to consider.

Listed below are the costs her fi rm incurred for the month ended August 31, 2014.

Supplies used on consulting contracts $ 1,200 Supplies used in the administrative offi ces 1,500 Depreciation on equipment used for contract work 900 Depreciation used on administrative offi ce equipment 1,050 Salaries of professionals working on contracts 15,600 Salaries of administrative offi ce personnel 7,700 Janitorial services for professional offi ces 400 Janitorial services for administrative offi ces 500 Insurance on contract operations 800 Insurance on administrative operations 900 Utilities for contract operations 1,400 Utilities for administrative offi ces 1,300

Instructions (a) Prepare a schedule of cost of contract services provided (similar to a cost of goods

manufactured schedule) for the month. (b) For those costs not included in (a), explain how they would be classifi ed and reported

in the fi nancial statements.

E1-14 The following information is available for Aikman Company.

January 1, 2014 2014 December 31, 2014

Raw materials inventory $21,000 $30,000 Work in process inventory 13,500 17,200 Finished goods inventory 27,000 21,000 Materials purchased $150,000 Direct labor 220,000 Manufacturing overhead 180,000 Sales revenue 910,000

Instructions (a) Compute cost of goods manufactured. (b) Prepare an income statement through gross profi t. (c) Show the presentation of the ending inventories on the December 31, 2014, balance sheet. (d) How would the income statement and balance sheet of a merchandising company be

different from Aikman’s fi nancial statements?

Classify various costs into different categories and prepare cost of services provided schedule.

(LO 4, 5, 6), AN

Prepare a cost of goods manufactured schedule and a partial income statement.

(LO 5, 6, 7), AP

Prepare a cost of goods manufactured schedule and a partial income statement.

(LO 5, 6), AP

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36 1 Managerial Accounting

E1-15 Chambers Company produces blankets. From its accounting records, it prepares the following schedule and fi nancial statements on a yearly basis. (a) Cost of goods manufactured schedule. (b) Income statement. (c) Balance sheet.

The following items are found in its ledger and accompanying data.

1. Direct labor 2. Raw materials inventory, 1/1 3. Work in process inventory, 12/31 4. Finished goods inventory, 1/1 5. Indirect labor 6. Depreciation on factory machinery 7. Work in process, 1/1 8. Finished goods inventory, 12/31 9. Factory maintenance salaries 10. Cost of goods manufactured 11. Depreciation on delivery equipment 12. Cost of goods available for sale 13. Direct materials used 14. Heat and electricity for factory 15. Repairs to roof of factory building 16. Cost of raw materials purchases

Instructions List the items (1)–(16). For each item, indicate by using the appropriate letter or letters, the schedule and/or fi nancial statement(s) in which the item will appear.

E1-16 An analysis of the accounts of Roberts Company reveals the following manufactur- ing cost data for the month ended June 30, 2014.

Inventories Beginning Ending

Raw materials $9,000 $13,100 Work in process 5,000 7,000 Finished goods 9,000 8,000

Costs incurred: raw materials purchases $54,000, direct labor $47,000, manufacturing overhead $19,900. The specifi c overhead costs were: indirect labor $5,500, factory insur- ance $4,000, machinery depreciation $4,000, machinery repairs $1,800, factory utilities $3,100, miscellaneous factory costs $1,500. Assume that all raw materials used were direct materials.

Instructions (a) Prepare the cost of goods manufactured schedule for the month ended June 30, 2014. (b) Show the presentation of the ending inventories on the June 30, 2014, balance sheet.

E1-17 Buhler Motor Company manufactures automobiles. During September 2014, the company purchased 5,000 head lamps at a cost of $10 per lamp. Buhler withdrew 4,650 lamps from the warehouse during the month. Fifty of these lamps were used to replace the head lamps in autos used by traveling sales staff. The remaining 4,600 lamps were put in autos manufactured during the month.

Of the autos put into production during September 2014, 90% were completed and transferred to the company’s storage lot. Of the cars completed during the month, 70% were sold by September 30.

Instructions (a) Determine the cost of head lamps that would appear in each of the following accounts

at September 30, 2014: Raw Materials, Work in Process, Finished Goods, Cost of Goods Sold, and Selling Expenses.

(b) Write a short memo to the chief accountant, indicating whether and where each of the accounts in (a) would appear on the income statement or on the balance sheet at September 30, 2014.

Indicate in which schedule or fi nancial statement(s) different cost items will appear.

(LO 5, 6, 7), C

Prepare a cost of goods manufactured schedule, and present the ending inventories on the balance sheet.

(LO 6, 7), AP

Determine the amount of cost to appear in various accounts, and indicate in which fi nancial statements these accounts would appear.

(LO 5, 6, 7), AP

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Problems: Set A 37

E1-18 The following is a list of terms related to managerial accounting practices.

1. Activity-based costing. 2. Just-in-time inventory. 3. Balanced scorecard. 4. Value chain.

Instructions Match each of the terms with the statement below that best describes the term. (a) ______ A performance-measurement technique that attempts to consider and evaluate all

aspects of performance using fi nancial and nonfi nancial measures in an integrated fashion. (b) ______ The group of activities associated with providing a product or service. (c) ______ An approach used to reduce the cost associated with handling and holding

inventory by reducing the amount of inventory on hand. (d) ______ A method used to allocate overhead to products based on each product’s use of

the activities that cause the incurrence of the overhead cost.

Identify various managerial accounting practices.

(LO 8), C

Visit the book’s companion website, at www.wiley.com/college/weygandt, and choose the Student Companion site to access Exercise Set B and Challenge Exercises.

EXERCISES: SET B AND CHALLENGE EXERCISES

PROBLEMS: SET A

P1-1A Lott Company specializes in manufacturing a unique model of bicycle helmet. The model is well accepted by consumers, and the company has enough orders to keep the factory production at 10,000 helmets per month (80% of its full capacity). Lott’s monthly manufacturing cost and other expense data are as follows.

Rent on factory equipment $ 9,000 Insurance on factory building 1,500 Raw materials (plastics, polystyrene, etc.) 75,000 Utility costs for factory 900 Supplies for general offi ce 300 Wages for assembly line workers 53,000 Depreciation on offi ce equipment 800 Miscellaneous materials (glue, thread, etc.) 1,100 Factory manager’s salary 5,700 Property taxes on factory building 400 Advertising for helmets 14,000 Sales commissions 10,000 Depreciation on factory building 1,500

Instructions (a) Prepare an answer sheet with the following column headings.

Product Costs

Cost Direct Direct Manufacturing Period Item Materials Labor Overhead Costs

Enter each cost item on your answer sheet, placing the dollar amount under the appropriate headings. Total the dollar amounts in each of the columns.

(b) Compute the cost to produce one helmet.

P1-2A Bell Company, a manufacturer of audio systems, started its production in October 2014. For the preceding 3 years, Bell had been a retailer of audio systems. After a thorough survey of audio system markets, Bell decided to turn its retail store into an audio equipment factory.

Classify manufacturing costs into different categories and compute the unit cost.

(LO 3, 4), AP

Classify manufacturing costs into different categories and compute the unit cost.

(LO 3, 4), AP

(a) DM $75,000 DL $53,000 MO $20,100 PC $25,100

Marginal check fi gures for parts of some problems, in most chapters, provide key numbers to confi rm that you are on the right track in your computations.

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38 1 Managerial Accounting

Raw materials cost for an audio system will total $74 per unit. Workers on the produc- tion lines are on average paid $12 per hour. An audio system usually takes 5 hours to com- plete. In addition, the rent on the equipment used to assemble audio systems amounts to $4,900 per month. Indirect materials cost $5 per system. A supervisor was hired to oversee production; her monthly salary is $3,000.

Factory janitorial costs are $1,300 monthly. Advertising costs for the audio system will be $9,500 per month. The factory building depreciation expense is $7,800 per year. Property taxes on the factory building will be $9,000 per year.

Instructions (a) Prepare an answer sheet with the following column headings.

Product Costs

Cost Direct Direct Manufacturing Period Item Materials Labor Overhead Costs

Assuming that Bell manufactures, on average, 1,500 audio systems per month, enter each cost item on your answer sheet, placing the dollar amount per month under the appropriate headings. Total the dollar amounts in each of the columns.

(b) Compute the cost to produce one audio system.

P1-3A Incomplete manufacturing costs, expenses, and selling data for two different cases are as follows.

Case

1 2

Direct materials used $ 9,600 $ (g) Direct labor 5,000 8,000 Manufacturing overhead 8,000 4,000 Total manufacturing costs (a) 16,000 Beginning work in process inventory 1,000 (h) Ending work in process inventory (b) 3,000 Sales revenue 24,500 (i) Sales discounts 2,500 1,400 Cost of goods manufactured 17,000 22,000 Beginning fi nished goods inventory (c) 3,300 Goods available for sale 20,000 (j) Cost of goods sold (d) (k) Ending fi nished goods inventory 3,400 2,500 Gross profi t (e) 7,000 Operating expenses 2,500 (l) Net income (f) 5,000

Instructions (a) Indicate the missing amount for each letter. (b) Prepare a condensed cost of goods manufactured schedule for Case 1. (c) Prepare an income statement and the current assets section of the balance sheet for

Case 1. Assume that in Case 1 the other items in the current assets section are as follows: Cash $4,000, Receivables (net) $15,000, Raw Materials $600, and Prepaid Expenses $400.

P1-4A The following data were taken from the records of Clarkson Company for the fi scal year ended June 30, 2014.

Raw Materials Factory Insurance $ 4,600 Inventory 7/1/13 $ 48,000 Factory Machinery Raw Materials Depreciation 16,000 Inventory 6/30/14 39,600 Factory Utilities 27,600 Finished Goods Offi ce Utilities Expense 8,650 Inventory 7/1/13 96,000 Sales Revenue 534,000 Finished Goods Sales Discounts 4,200 Inventory 6/30/14 75,900 Plant Manager’s Salary 58,000

(a) DM $111,000 DL $ 90,000 MO $ 18,100 PC $ 9,500

(b) Ending WIP $ 6,600 (c) Current assets $30,000

Indicate the missing amount of different cost items, and prepare a condensed cost of goods manufactured schedule, an income statement, and a partial balance sheet.

(LO 5, 6, 7), AN

Prepare a cost of goods manufactured schedule, a partial income statement, and a partial balance sheet.

(LO 5, 6, 7), AP

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Problems: Set B 39

Work in Process Factory Property Taxes $ 9,600 Inventory 7/1/13 $ 19,800 Factory Repairs 1,400 Work in Process Raw Materials Purchases 96,400 Inventory 6/30/14 18,600 Cash 32,000 Direct Labor 139,250 Indirect Labor 24,460 Accounts Receivable 27,000

Instructions (a) Prepare a cost of goods manufactured schedule. (Assume all raw materials used were

direct materials.) (b) Prepare an income statement through gross profi t. (c) Prepare the current assets section of the balance sheet at June 30, 2014.

P1-5A Phillips Company is a manufacturer of computers. Its controller resigned in October 2014. An inexperienced assistant accountant has prepared the following income statement for the month of October 2014.

Phillips Company Income Statement

For the Month Ended October 31, 2014

Sales revenue $780,000 Less: Operating expenses Raw materials purchases $264,000 Direct labor cost 190,000 Advertising expense 90,000 Selling and administrative salaries 75,000 Rent on factory facilities 60,000 Depreciation on sales equipment 45,000 Depreciation on factory equipment 31,000 Indirect labor cost 28,000 Utilities expense 12,000 Insurance expense 8,000 803,000

Net loss $ (23,000)

Prior to October 2014, the company had been profi table every month. The company’s president is concerned about the accuracy of the income statement. As her friend, you have been asked to review the income statement and make necessary corrections. After examin- ing other manufacturing cost data, you have acquired additional information as follows. 1. Inventory balances at the beginning and end of October were:

October 1 October 31

Raw materials $18,000 $29,000 Work in process 16,000 14,000 Finished goods 30,000 45,000

2. Only 75% of the utilities expense and 60% of the insurance expense apply to factory opera- tions. The remaining amounts should be charged to selling and administrative activities.

Instructions (a) Prepare a schedule of cost of goods manufactured for October 2014. (b) Prepare a correct income statement for October 2014.

(a) CGM $386,910

(b) Gross profi t $122,790 (c) Current assets $193,100

(a) CGM $577,800 (b) NI $ 1,000

Prepare a cost of goods manufactured schedule and a correct income statement.

(LO 5, 6), AN

PROBLEMS: SET B

P1-1B Agler Company specializes in manufacturing motorcycle helmets. The company has enough orders to keep the factory production at 1,000 motorcycle helmets per month. Agler’s monthly manufacturing cost and other expense data are shown on the next page.

Classify manufacturing costs into different categories and compute the unit cost.

(LO 3, 4), AP

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40 1 Managerial Accounting

Maintenance costs on factory building $ 1,500 Factory manager’s salary 5,500 Advertising for helmets 8,000 Sales commissions 4,000 Depreciation on factory building 700 Rent on factory equipment 6,000 Insurance on factory building 3,000 Raw materials (plastic, polystyrene, etc.) 25,000 Utility costs for factory 800 Supplies for general offi ce 200 Wages for assembly line workers 54,000 Depreciation on offi ce equipment 500 Miscellaneous materials (glue, thread, etc.) 2,000

Instructions (a) Prepare an answer sheet with the following column headings.

Product Costs

Cost Direct Direct Manufacturing Period Item Materials Labor Overhead Costs

Enter each cost item on your answer sheet, placing the dollar amount under the ap- propriate headings. Total the dollar amounts in each of the columns.

(b) Compute the cost to produce one motorcycle helmet.

P1-2B Elliott Company, a manufacturer of tennis rackets, started production in November 2013. For the preceding 5 years, Elliott had been a retailer of sports equipment. After a thorough survey of tennis racket markets, Elliott decided to turn its retail store into a tennis racket factory.

Raw materials cost for a tennis racket will total $23 per racket. Workers on the pro- duction lines are paid on average $15 per hour. A racket usually takes 2 hours to complete. In addition, the rent on the equipment used to produce rackets amounts to $1,300 per month. Indirect materials cost $3 per racket. A supervisor was hired to oversee produc- tion; her monthly salary is $3,500.

Janitorial costs are $1,400 monthly. Advertising costs for the rackets will be $8,000 per month. The factory building depreciation expense is $8,400 per year. Property taxes on the factory building will be $9,600 per year.

Instructions (a) Prepare an answer sheet with the following column headings.

Product Costs

Cost Direct Direct Manufacturing Period Item Materials Labor Overhead Costs

Assuming that Elliott manufactures, on average, 2,500 tennis rackets per month, enter each cost item on your answer sheet, placing the dollar amount per month under the appropriate headings. Total the dollar amounts in each of the columns.

(b) Compute the cost to produce one racket.

P1-3B Incomplete manufacturing costs, expenses, and selling data for two different cases are as follows.

Case

A B

Direct materials used $ 6,300 $ (g) Direct labor 3,000 4,000 Manufacturing overhead 6,000 5,000 Total manufacturing costs (a) 16,000 Beginning work in process inventory 1,000 (h) Ending work in process inventory (b) 2,000 Sales revenue 22,500 (i) Sales discounts 1,500 1,200 Cost of goods manufactured 15,800 20,000

Classify manufacturing costs into different categories and compute the unit cost.

(LO 3, 4), AP

Indicate the missing amount of different cost items, and prepare a condensed cost of goods manufactured schedule, an income statement, and a partial balance sheet.

(LO 5, 6, 7), AN

(a) DM $25,000 DL $54,000 MO $19,500 PC $12,700

(a) DM $57,500 DL $75,000 MO $15,200 PC $ 8,000

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Problems: Set B 41

Beginning fi nished goods inventory $ (c) $ 5,000 Goods available for sale 18,300 (j) Cost of goods sold (d) (k) Ending fi nished goods inventory 1,200 2,500 Gross profi t (e) 6,000 Operating expenses 2,700 (l) Net income (f) 2,200

Instructions (a) Indicate the missing amount for each letter. (b) Prepare a condensed cost of goods manufactured schedule for Case A. (c) Prepare an income statement and the current assets section of the balance sheet for

Case A. Assume that in Case A the other items in the current assets section are as follows: Cash $3,000, Receivables (net) $10,000, Raw Materials $700, and Prepaid Expenses $200.

P1-4B The following data were taken from the records of Moxie Company for the year ended December 31, 2014.

Raw Materials Factory Insurance $ 7,400 Inventory 1/1/14 $ 47,000 Factory Machinery Raw Materials Depreciation 7,700 Inventory 12/31/14 44,200 Factory Utilities 12,900 Finished Goods Offi ce Utilities Expense 8,600 Inventory 1/1/14 85,000 Sales Revenue 465,000 Finished Goods Sales Discounts 2,500 Inventory 12/31/14 57,800 Plant Manager’s Salary 60,000 Work in Process Factory Property Taxes 6,100 Inventory 1/1/14 9,500 Factory Repairs 800 Work in Process Raw Materials Purchases 62,500 Inventory 12/31/14 8,000 Cash 18,000 Direct Labor 145,100 Indirect Labor 18,100 Accounts Receivable 27,000

Instructions (a) Prepare a cost of goods manufactured schedule. (Assume all raw materials used were

direct materials.) (b) Prepare an income statement through gross profi t. (c) Prepare the current assets section of the balance sheet at December 31.

P1-5B Ortiz Company is a manufacturer of toys. Its controller resigned in August 2014. An inexperienced assistant accountant has prepared the following income statement for the month of August 2014.

Ortiz Company Income Statement

For the Month Ended August 31, 2014

Sales revenue $675,000 Less: Operating expenses Raw materials purchases $220,000 Direct labor cost 160,000 Advertising expense 75,000 Selling and administrative salaries 70,000 Rent on factory facilities 60,000 Depreciation on sales equipment 50,000 Depreciation on factory equipment 35,000 Indirect labor cost 20,000 Utilities expense 10,000 Insurance expense 5,000 705,000

Net loss $ (30,000)

(c) Current assets $15,600 (b) Beg. WIP $1,000

Prepare a cost of goods manufactured schedule and a correct income statement.

(LO 5, 6), AN

(a) CGM $324,900

(b) Gross profi t $110,400 (c) Current assets $155,000

Prepare a cost of goods manufactured schedule, a partial income statement, and a partial balance sheet.

(LO 5, 6, 7), AP

Case

A B

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42 1 Managerial Accounting

Prior to August 2014, the company had been profi table every month. The company’s president is concerned about the accuracy of the income statement. As her friend, you have been asked to review the income statement and make necessary corrections. After examin- ing other manufacturing cost data, you have acquired additional information as follows. 1. Inventory balances at the beginning and end of August were:

August 1 August 31

Raw materials $19,500 $35,000 Work in process 25,000 21,000 Finished goods 40,000 52,000

2. Only 60% of the utilities expense and 70% of the insurance expense apply to factory operations; the remaining amounts should be charged to selling and administrative activities.

Instructions (a) Prepare a cost of goods manufactured schedule for August 2014. (b) Prepare a correct income statement for August 2014.

(a) CGM $493,000 (b) NL $ (6,500)

Visit the book’s companion website, at www.wiley.com/college/weygandt, and choose the Student Companion site to access Problem Set C.

PROBLEMS: SET C

(Note: The Waterways Problem begins in Chapter 1 and continues in the remaining chap- ters. You can also fi nd this problem at the book’s Student Companion site.)

WCP1 Waterways Corporation is a private corporation formed for the purpose of provid- ing the products and the services needed to irrigate farms, parks, commercial projects, and private lawns. It has a centrally located factory in a U.S. city that manufactures the products it markets to retail outlets across the nation. It also maintains a division that provides installation and warranty servicing in six metropolitan areas.

The mission of Waterways is to manufacture quality parts that can be used for ef- fective irrigation projects that also conserve water. By that effort, the company hopes to satisfy its customers, provide rapid and responsible service, and serve the community and the employees who represent them in each community.

The company has been growing rapidly, so management is considering new ideas to help the company continue its growth and maintain the high quality of its products.

Waterways was founded by Will Winkman, who is the company president and chief executive offi cer (CEO). Working with him from the company’s inception is Will’s brother, Ben, whose sprinkler designs and ideas about the installation of proper systems have been a major basis of the company’s success. Ben is the vice president who oversees all aspects of design and production in the company.

The factory itself is managed by Todd Senter who hires his line managers to supervise the factory employees. The factory makes all of the parts for the irrigation systems. The purchasing department is managed by Hector Hines.

The installation and training division is overseen by vice president Henry Writer, who supervises the managers of the six local installation operations. Each of these local managers hires his or her own local service people. These service employees are trained by the home offi ce under Henry Writer’s direction because of the uniqueness of the company’s products.

There is a small human resources department under the direction of Sally Fenton, a vice president who handles the employee paperwork, though hiring is actually performed by the separate departments. Sam Totter is the vice president who heads the sales and marketing area; he oversees 10 well-trained salespeople.

The accounting and fi nance division of the company is run by Abe Headman, who is the chief fi nancial offi cer (CFO) and a company vice president. He is a member of the Institute of Management Accountants and holds a certifi cate in management accounting.

WATERWAYS CONTINUING PROBLEM

The Waterways Problem starts in this chapter and continues in every chapter. You will fi nd the complete problem for each chapter at the book’s companion website.

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Broadening Your Perspective 43

He has a small staff of certifi ed public accountants, including a controller and a treasurer, and a staff of accounting input operators who maintain the fi nancial records.

A partial list of Waterways’ accounts and their balances for the month of November follows.

Accounts Receivable $ 275,000 Advertising Expenses 54,000 Cash 260,000 Depreciation—Factory Equipment 16,800 Depreciation—Offi ce Equipment 2,400 Direct Labor 42,000 Factory Supplies Used 16,800 Factory Utilities 10,200 Finished Goods Inventory, November 30 68,800 Finished Goods Inventory, October 31 72,550 Indirect Labor 48,000 Offi ce Supplies Expense 1,600 Other Administrative Expenses 72,000 Prepaid Expenses 41,250 Raw Materials Inventory, November 30 52,700 Raw Materials Inventory, October 31 38,000 Raw Materials Purchases 184,500 Rent—Factory Equipment 47,000 Repairs—Factory Equipment 4,500 Salaries 325,000 Sales Revenue 1,350,000 Sales Commissions 40,500 Work in Process Inventory, October 31 52,700 Work in Process Inventory, November 30 42,000

Instructions (a) Based on the information given, construct an organizational chart of Waterways

Corporation. (b) A list of accounts and their values are given above. From this information, prepare

a cost of goods manufactured schedule, an income statement, and a partial balance sheet for Waterways Corporation for the month of November.

Management Decision-Making

Broadening Your PERSPECTIVE

Each chapter contains an exercise based on Current Designs, the company that was featured at the be- ginning of this chapter. We are excited to present managerial accounting situations that are based on the operations of a real company. However, to protect the proprietary nature of this information, the amounts in these exercises are realistic but not necessarily the actual data that would be found in Current Designs’ accounting records. We sincerely appreciate the cooperation of the people at Current Designs, particularly Mike Cichanowski, Jim Brown, Diane Buswell, and Jake Greseth, who made these exercises possible.

Decision-Making at Current Designs

BYP1-1 Mike Cichanowski founded Wenonah Canoe and later purchased Current Designs, a com- pany that designs and manufactures kayaks. The kayak-manufacturing facility is located just a few minutes from the canoe company’s headquarters in Winona, Minnesota.

Current Designs makes kayaks using two different processes. (See www.cdkayak.com/ craftsmanship/index.php for the details of each method.) The rotational molding process uses high

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44 1 Managerial Accounting

temperature to melt polyethylene powder in a closed rotating metal mold to produce a complete kayak hull and deck in a single piece. These kayaks are less labor-intensive and less expensive for the company to produce and sell.

Its other kayaks use the vacuum-bagged composite lamination process (which we will refer to as the composite process). Layers of fi berglass or Kevlar® are carefully placed by hand in a mold and are bonded with resin. Then, a high-pressure vacuum is used to eliminate any excess resin that would otherwise add weight and reduce strength of the fi nished kayak. These kayaks require a great deal of skilled labor as each boat is individually fi nished. The exquisite fi nish of the vacuum- bagged composite kayaks gave rise to Current Designs’ tag line, “A work of art, made for life.”

Current Designs has the following managers:

Mike Cichanowski, CEO Diane Buswell, Controller Deb Welch, Purchasing Manager Bill Johnson, Sales Manager Dave Thill, Kayak Plant Manager Rick Thrune, Production Manager for Composite Kayaks

Instructions (a) What are the primary information needs of each manager? (b) Name one special-purpose management accounting report that could be designed for each

manager. Include the name of the report, the information it would contain, and how frequently it should be issued.

(c) When Diane Buswell, controller for Current Designs, reviewed the accounting records for a recent period, she noted the following items. Classify each item as a product cost or a period cost. If an item is a product cost, note if it is a direct materials, direct labor, or manufacturing overhead item.

Product Costs

Payee Purpose Direct Direct Manufacturing Period

Materials Labor Overhead Costs

Winona Agency Property insurance for the manufacturing plant

Bill Johnson Payroll check—payment to sales (sales manager) manager

Xcel Energy Electricity for manufacturing plant

Winona Printing Price lists for salespeople

Jim Kaiser (sales Sales commissions representative)

Dave Thill Payroll check—payment to (plant manager) plant manager

Dana Schultz Payroll check—payment to (kayak assembler) kayak assembler

Composite One Bagging fi lm used when kayaks are assembled; it is discarded after use

Fastenal Shop supplies—brooms, paper towels, etc.

Ravago Polyethylene powder which is the main ingredient for the rotational molded kayaks

Winona County Property taxes on manufacturing plant

North American Kevlar® fabric for composite kayaks Composites

Waste Trash disposal for the company Management offi ce building

None Journal entry to record depreciation of manufacturing equipment

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Broadening Your Perspective 45

Decision-Making Across the Organization

BYP1-2 Wendall Company specializes in producing fashion outfi ts. On July 31, 2014, a tornado touched down at its factory and general offi ce. The inventories in the warehouse and the factory were completely destroyed as was the general offi ce nearby. Next morning, through a careful search of the disaster site, however, Bill Francis, the company’s controller, and Elizabeth Walton, the cost accountant, were able to recover a small part of manufacturing cost data for the current month.

“What a horrible experience,” sighed Bill “And the worst part is that we may not have enough records to use in fi ling an insurance claim.”

“It was terrible,” replied Elizabeth. “However, I managed to recover some of the manufactur- ing cost data that I was working on yesterday afternoon. The data indicate that our direct labor cost in July totaled $250,000 and that we had purchased $365,000 of raw materials. Also, I recall that the amount of raw materials used for July was $350,000. But I’m not sure this information will help. The rest of our records are blown away.”

“Well, not exactly,” said Bill. “I was working on the year-to-date income statement when the tornado warning was announced. My recollection is that our sales in July were $1,240,000 and our gross profi t ratio has been 40% of sales. Also, I can remember that our cost of goods available for sale was $770,000 for July.”

“Maybe we can work something out from this information!” exclaimed Elizabeth. “My experi- ence tells me that our manufacturing overhead is usually 60% of direct labor.”

“Hey, look what I just found,” cried Elizabeth. “It’s a copy of this June’s balance sheet, and it shows that our inventories as of June 30 are Finished goods $38,000, Work in process $25,000, and Raw materials $19,000.”

“Super,” yelled Bill. “Let’s go work something out.” In order to fi le an insurance claim, Wendall Company must determine the amount of its inven-

tories as of July 31, 2014, the date of the tornado touchdown.

Instructions With the class divided into groups, determine the amount of cost in the Raw Materials, Work in Process, and Finished Goods inventory accounts as of the date of the tornado touchdown.

Managerial Analysis

BYP1-3 Tenrack is a fairly large manufacturing company located in the southern United States. The company manufactures tennis rackets, tennis balls, tennis clothing, and tennis shoes, all bear- ing the company’s distinctive logo, a large green question mark on a white fl ocked tennis ball. The company’s sales have been increasing over the past 10 years.

The tennis racket division has recently implemented several advanced manufacturing tech- niques. Robot arms hold the tennis rackets in place while glue dries, and machine vision systems check for defects. The engineering and design team uses computerized drafting and testing of new products. The following managers work in the tennis racket division:

Jason Dennis, Sales Manager (supervises all sales representatives) Peggy Groneman, Technical Specialist (supervises computer programmers) Dave Marley, Cost Accounting Manager (supervises cost accountants) Kevin Carson, Production Supervisor (supervises all manufacturing employees) Sally Renner, Engineer (supervises all new-product design teams)

Instructions (a) What are the primary information needs of each manager? (b) Which, if any, fi nancial accounting report(s) is each likely to use? (c) Name one special-purpose management accounting report that could be designed for each

manager. Include the name of the report, the information it would contain, and how frequently it should be issued.

Real-World Focus

BYP1-4 Anchor Glass Container Corporation, the third largest manufacturer of glass containers in the United States, supplies beverage and food producers and consumer products manufacturers nationwide. Parent company Consumers Packaging Inc. (Toronto Stock Exchange: CGC) is a lead- ing international designer and manufacturer of glass containers.

The management discussion on page 46 appeared in a recent annual report of Anchor Glass.

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Instructions What factors affect the costs of products sold at Anchor Glass Container Corporation?

BYP1-5 The Institute of Management Accountants (IMA) is an organization dedicated to excel- lence in the practice of management accounting and fi nancial management.

Address: www.imanet.org, or go to www.wiley.com/college/weygandt

Instructions At the IMA’s home page, locate the answers to the following questions. (a) How many members does the IMA have, and what are their job titles? (b) What are some of the benefi ts of joining the IMA as a student? (c) Use the chapter locator function to locate the IMA chapter nearest you, and fi nd the name of

the chapter president.

46 1 Managerial Accounting

Critical Thinking

Communication Activity

BYP1-6 Refer to P1–5A and add the following requirement. Prepare a letter to the president of the company, Shelly Phillips, describing the changes you

made. Explain clearly why net income is different after the changes. Keep the following points in mind as you compose your letter.

1. This is a letter to the president of a company, who is your friend. The style should be generally formal, but you may relax some requirements. For example, you may call the president by her fi rst name.

2. Executives are very busy. Your letter should tell the president your main results fi rst (for ex- ample, the amount of net income).

3. You should include brief explanations so that the president can understand the changes you made in the calculations.

Ethics Case

BYP1-7 Steve Morgan, controller for Newton Industries, was reviewing production cost reports for the year. One amount in these reports continued to bother him—advertising. During the year, the company had instituted an expensive advertising campaign to sell some of its slower-moving products. It was still too early to tell whether the advertising campaign was successful.

There had been much internal debate as how to report advertising cost. The vice president of fi nance argued that advertising costs should be reported as a cost of production, just like direct materials and direct labor. He therefore recommended that this cost be identifi ed as manufacturing overhead and reported as part of inventory costs until sold. Others disagreed. Morgan believed that this cost should be reported as an expense of the current period, so as not to overstate net income. Others argued that it should be reported as prepaid advertising and reported as a current asset.

The president fi nally had to decide the issue. He argued that these costs should be reported as inventory. His arguments were practical ones. He noted that the company was experiencing fi nan- cial diffi culty and expensing this amount in the current period might jeopardize a planned bond offering. Also, by reporting the advertising costs as inventory rather than as prepaid advertising, less attention would be directed to it by the fi nancial community.

Anchor Glass Container Corporation Management Discussion

Cost of Products Sold Cost of products sold as a percentage of net sales was 89.3% in the current year compared to 87.6% in the prior year. The increase in cost of products sold as a percentage of net sales principally refl ected the impact of operational problems during the second quarter of the current year at a major furnace at one of the Company’s plants, higher downtime, and costs and expenses associated with an increased number of scheduled capital improvement projects, increases in labor, and certain other manufacturing costs (with no corresponding selling price increases in the current year). Reduced fi xed costs from the closing of the Streator, Illinois, plant in June of the current year and productivity and effi ciency gains partially offset these cost increases.

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Instructions (a) Who are the stakeholders in this situation? (b) What are the ethical issues involved in this situation? (c) What would you do if you were Steve Morgan?

All About You

BYP1-8 The primary purpose of managerial accounting is to provide information useful for man- agement decisions. Many of the managerial accounting techniques that you learn in this course will be useful for decisions you make in your everyday life.

Instructions For each of the following managerial accounting techniques, read the defi nition provided and then provide an example of a personal situation that would benefi t from use of this technique. (a) Break-even point (page 207). (b) Budget (page 384). (c) Balanced scorecard (page 513). (d) Capital budgeting (page 547).

Considering Your Costs and Benefi ts

BYP1-9 As noted in this chapter, because of global competition, companies have become increas- ingly focused on reducing costs. To reduce costs and remain competitive, many companies are turning to outsourcing. Outsourcing means hiring an outside supplier to provide elements of a product or service rather than producing them internally.

Suppose you are the managing partner in a CPA fi rm with 30 full-time staff. Larger fi rms in your community have begun to outsource basic tax-return preparation work to India. Should you outsource your basic tax-return work to India as well? You estimate that you would have to lay off six staff members if you outsource the work. The basic arguments for and against are as follows.

YES: The wages paid to Indian accountants are very low relative to U.S. wages. You will not be able to compete unless you outsource. NO: Tax-return data is highly sensitive. Many customers will be upset to learn that their data is being emailed around the world.

Instructions Write a response indicating your position regarding this situation. Provide support for your view.

Broadening Your Perspective 47

p. 6 Even the Best Have to Get Better Q: What are some of the steps that this company has taken in order to ensure that production meets demand? A: The company has organized fl exible teams, with jobs arranged by the amount of time a task takes. Employees now are multiskilled, so they can switch between tasks and products. Also, the stores now provide sales data more quickly to the manufactur- ing facility, so that production levels can be changed more quickly in response to demand. p. 11 Why Manufacturing Matters for U.S. Workers Q: In what ways does the shift to auto- mated factories change the amount and composition of product costs? A: As factories become more automated, they become more effi cient, increasing output and decreasing cost per unit. The composition of those costs also switches: Factory labor costs decline, and factory overhead costs (e.g., depreciation and maintenance on equipment) increase. p. 19 Low Fares but Decent Profi ts Q: What are some of the line items that would appear in the cost of services provided schedule of an airline? A: Some of the line items that would appear in the cost of services provided schedule of an airline would be fuel, fl ight crew salaries, maintenance wages, depreciation on equipment, airport gate fees, and food-service costs.

Answers to Self-Test Questions

1. b 2. b 3. b 4. b 5. d 6. a 7. c 8. c 9. c ($200,000 1 $600,000 2 $250,000) 10. c 11. a 12. d 13. d 14. d 15. d

Answers to Chapter Questions

Answers to Insight and Accounting Across the Organization Questions

✔ Remember to go back to The Navigator box on the chapter opening page and check off your completed work.

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Learning Objectives After studying this chapter, you should be able to:

1 Explain the characteristics and purposes of cost

accounting.

2 Describe the fl ow of costs in a job order cost system.

3 Explain the nature and importance of a job cost sheet.

4 Indicate how the predetermined overhead rate is

determined and used.

5 Prepare entries for jobs completed and sold.

6 Distinguish between under- and overapplied

manufacturing overhead.

Feature Story

Scan Learning Objectives

Read Feature Story

Read Preview

Read Text and answer p. 54 p. 62 p. 65 p. 70

Work Using the Decision Toolkit p. 70

Review Summary of Learning Objectives

Work Comprehensive p. 73

Answer Self-Test Questions

Complete Assignments

Go to WileyPLUS for practice and tutorials

✔ The Navigator

✔ The Navigator

Job Order Costing

She Succeeds Where Others Have Failed The fi nancial press is fond of highlight-

ing the fact that, sporting stilettos and

leather skirts, Lynn Tilton does not

dress like your typical manufacturing

executive. Much more important,

however, is the fact that her business

success is also far from typical. In

fact, as the full or partial owner of

74 companies with revenues of more

than $8 billion, Tilton is one of the

wealthiest female entrepreneurs in the

United States. Her company, Patriarch

Partners, is sometimes referred to as

the largest woman-owned business in

America.

Her path to success is an inspiring tale

of determination. Tilton started on

Wall Street as a single mother, working

15-hour days as she put herself

through business school. During years

of employment at numerous fi nancial

institutions, she developed a knack

for analyzing balance sheets and

interpreting complex fi nancial infor-

mation. Eventually, Tilton started her

own company, Patriarch Partners, and

invested in the debt of a number of

distressed companies. She quickly

fi gured out that the only way she

was going to make money on those

investments was to take control of

the companies and try to make them

profi table. Thus, seemingly almost by

accident, she became the CEO of

dozens of failing manufacturing

companies. Amazingly, she was able to

make these companies profi table

when others had given up on them.

DO IT!

DO IT!

48

Chapter 2

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As a result of this initial success, Tilton made corporate

turn-arounds the focus of her company. Once a business

is acquired, she installs a new

management team, improves

productivity, and identifi es new

products for the company to

produce. For example, she turned

a failed paper mill into a producer

of alternative fuels, and saved a

helicopter company by identifying

new customers. When others

were fl eeing the auto industry,

she dove in and bought a

number of auto-parts companies.

While she is a tough negotiator, Tilton also has the respect

of her workers. Duane Ludgon, a union negotiator says,

“Workers really take to Lynn. She’s just human and honest

with people. I don’t say that about many CEOs.” In fact,

Tilton is a crusader for U.S. manufacturing. She says, “The

key to America’s future is manufacturing. We simply have to

become a country that can make

things again.”

Not all of her investments are

immediate successes. Her invest-

ment in a fi re-truck manufacturer,

American LaFrance, was slow to

turn a profi t. But everyone involved

fi gured it was only a matter of time

before her persistent approach

made this fi re-truck maker another

business that she saved before it went up in smoke.

Watch the Making a Hollywood Movie video in WileyPLUS

to learn more about job order costing in the real world.

Source: Robert Frank, “Tilton Flaunts Her Style at Patriarch,” Wall Street Journal Online (January 8, 2011).

✔ The Navigator

49

The Feature Story about Patriarch Partners describes the approach Lynn Tilton uses to turn around a failing company. Accurate costing is critical to this process. For example, in order to submit accurate bids on new jobs and to know whether it profi ted from past jobs, the company needs a good costing system. This chapter illustrates how these costs are assigned to specifi c jobs, such as the manufacture of individual fi re trucks at one of Tilton’s companies, American LaFrance. We begin the discussion in this chapter with an overview of the fl ow of costs in a job order cost accounting system. We then use a case study to explain and illustrate the documents, entries, and accounts in this type of cost accounting system.

The content and organization of Chapter 2 are as follows.

Preview of Chapter 2

• Job order cost system • Process cost system

Cost Accounting Systems

• Accumulating costs • Assigning costs to work in process • Assigning costs to fi nished goods • Assigning costs to cost of goods

sold • Summary of job order cost fl ows • Job order costing for service

companies • Advantages and disadvantages

Job Order Cost Flow

• Cost of goods manufactured schedule

• Income statement presentation • Under- or overapplied manufac-

turing overhead

Reporting Job Cost Data

✔ The Navigator

JOB ORDER COSTING

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50 2 Job Order Costing

Cost accounting involves measuring, recording, and reporting product costs. Companies determine both the total cost and the unit cost of each product. The accuracy of the product cost information is critical to the success of the company. Companies use this information to determine which products to produce, what price to charge, and the amounts to produce. Accurate product cost information is also vital for effective evaluation of employee performance.

A cost accounting system consists of accounts for the various manufacturing costs. These accounts are fully integrated into the general ledger of a company. An important feature of a cost accounting system is the use of a perpetual inven- tory system. Such a system provides immediate, up-to-date information on the cost of a product.

There are two basic types of cost accounting systems: (1) a job order cost system and (2) a process cost system. Although cost accounting systems differ widely from company to company, most involve one of these two traditional product costing systems.

Job Order Cost System

Under a job order cost system, the company assigns costs to each job or to each batch of goods. An example of a job is the manufacture of a mainframe computer by IBM, the production of a movie by Disney, or the making of a fi re truck by American LaFrance. An example of a batch is the printing of 225 wedding invita- tions by a local print shop, or the printing of a weekly issue of Fortune magazine by a high-tech printer such as Quad Graphics.

An important feature of job order costing is that each job or batch has its own distinguishing characteristics. For example, each house is custom built, each consulting engagement by a CPA fi rm is unique, and each printing job is different. The objective is to compute the cost per job. At each point in manu- facturing a product or providing a service, the company can identify the job and its associated costs. A job order cost system measures costs for each completed job, rather than for set time periods. Illustration 2-1 shows the recording of costs in a job order cost system.

Cost Accounting Systems

Job Order Cost System Two Jobs: Wedding Invitations and Menus

Each job has distinguishing characteristics and related costs.

Typesetting

Vellum stock, pure white225 Invitations

Job # 9501 Job # 9502

225 Envelopes

Black ink

Typesetting Yellow stock

Colored ink

50 CopiesLamination

Illustration 2-1 Job order cost system

Process Cost System

A company uses a process cost system when it manufactures a large volume of similar products. Production is continuous. Examples of a process cost system are the manufacture of cereal by Kellogg, the refi ning of petroleum by ExxonMobil, and the production of ice cream by Ben & Jerry’s. Process costing accumulates

Explain the characteristics and purposes of cost accounting.

1LEARNING OBJECTIVE

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Job Order Cost Flow 51

product-related costs for a period of time (such as a week or a month) instead of assigning costs to specifi c products or job orders. In process costing, companies assign the costs to departments or processes for the specifi ed period of time. Illustration 2-2 shows examples of the use of a process cost system. We will discuss the process cost system further in Chapter 3.

Can a company use both types of cost systems? Yes. For example, General Motors uses process cost accounting for its standard model cars, such as Malibus and Corvettes, and job order cost accounting for a custom-made limousine for the President of the United States.

The objective of both cost accounting systems is to provide unit cost infor- mation for product pricing, cost control, inventory valuation, and fi nancial state- ment presentation.

The fl ow of costs (direct materials, direct labor, and manufacturing overhead) in job order cost accounting parallels the physical fl ow of the materials as they are converted into fi nished goods. As shown in Illustration 2-3 (page 52), companies fi rst accumulate manufacturing costs in the form of raw materials, factory labor,

Job Order Cost Flow

Process Cost System DVD Production

Similar products are produced over a specified time period.

Oil is pumped.1. 2. 3.Benzene is removed.

The benzene is made into pellets…

4. … from which DVDs are produced.

Illustration 2-2 Process cost system

Describe the fl ow of costs in a job order cost system.

2LEARNING OBJECTIVE

Jobs Won, Money Lost

Many companies suffer from poor cost accounting. As a result, they sometimes make products they should not be selling at all, or they buy product components that they could more profi t- ably make themselves. Also, inaccurate cost data leads companies to misallocate capital and frustrates efforts by plant managers to improve effi ciency.

For example, consider the case of a diversifi ed company in the business of rebuilding diesel locomotives. The managers thought they were making money, but a consulting fi rm found that the company had seriously underestimated costs. The company bailed out of the busi- ness, and not a moment too soon. Says the consultant who advised the company, “The more contracts it won, the more money it lost.” Given that situation, a company cannot stay in business very long!

MANAGEMENT INSIGHT

What type of costs do you think the company had been underestimating? (See page 92.)?

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52 2 Job Order Costing

Manufacturing Costs

Assigned to Completed Sold

Work in Process Inventory

Finished Goods Inventory Cost of Goods Sold

Manufacturing Overhead

Raw Materials

Factory Labor

Illustration 2-3 Flow of costs in job order costing

Illustration 2-3 provides a basic overview of the fl ow of costs in a manufactur- ing setting. A more detailed presentation of the fl ow of costs is summarized near the end of this chapter in Illustration 2-15. There are two major steps in the fl ow of costs: (1) accumulating the manufacturing costs incurred, and (2) assigning the accumulated costs to the work done. The following discussion shows that the company accumulates manufacturing costs incurred by debits to Raw Materials Inventory, Factory Labor, and Manufacturing Overhead. When the company in- curs these costs, it does not attempt to associate the costs with specifi c jobs. The company makes additional entries to assign manufacturing costs incurred. In the remainder of this chapter, we will use a case study to explain how a job order cost system operates.

Accumulating Manufacturing Costs

To illustrate a job order cost system, we will use the January transactions of Wallace Company, which makes custom electronic sensors for corporate safety applica- tions (such as fi re and carbon monoxide) and security applications (such as theft and corporate espionage).

RAW MATERIALS COSTS When Wallace receives the raw materials it has purchased, it debits the cost of the materials to Raw Materials Inventory. The company would debit this account for the invoice cost of the raw materials and freight costs chargeable to the purchaser. It would credit the account for purchase discounts taken and purchase returns and allowances. Wallace makes no effort at this point to associate the cost of ma- terials with specifi c jobs or orders.

To illustrate, assume that Wallace purchases 2,000 lithium batteries (Stock No. AA2746) at $5 per unit ($10,000) and 800 electronic modules (Stock No. AA2850) at $40 per unit ($32,000) for a total cost of $42,000 ($10,000 1 $32,000). The entry to record this purchase on January 4 is:

or manufacturing overhead. They then assign manufacturing costs to the Work in Process Inventory account. When a job is completed, the company transfers the cost of the job to Finished Goods Inventory. Later when the goods are sold, the company transfers their cost to Cost of Goods Sold.

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Job Order Cost Flow 53

(1)1

Jan. 4 Raw Materials Inventory 42,000 Accounts Payable 42,000 (Purchase of raw materials

on account)

At this point, Raw Materials Inventory has a balance of $42,000, as shown in the T-account in the margin. As we will explain later in the chapter, the company sub- sequently assigns direct raw materials inventory to work in process and indirect raw materials inventory to manufacturing overhead.

FACTORY LABOR COSTS Some of a company’s employees are involved in the manufacturing process, while others are not. As discussed in Chapter 1, wages and salaries of nonmanufacturing employees are expensed as period costs (e.g., Salaries and Wages Expense). Costs related to manufacturing employees are accumulated in Factory Labor to ensure their treatment as product costs. Factory labor consists of three costs: (1) gross earnings of factory workers, (2) employer payroll taxes on these earnings, and (3) fringe benefi ts (such as sick pay, pensions, and vacation pay) incurred by the em- ployer. Companies debit labor costs to Factory Labor as they incur those costs.

To illustrate, assume that Wallace incurs $32,000 of factory labor costs. Of that amount, $27,000 relates to wages payable and $5,000 relates to payroll taxes payable in February. The entry to record factory labor for the month is:

(2) Jan. 31 Factory Labor 32,000 Factory Wages Payable 27,000 Employer Payroll Taxes Payable 5,000 (To record factory labor costs)

At this point, Factory Labor has a balance of $32,000, as shown in the T-account in the margin. The company subsequently assigns direct factory labor to work in process and indirect factory labor to manufacturing overhead.

MANUFACTURING OVERHEAD COSTS A company has many types of overhead costs. If these overhead costs, such as property taxes, depreciation, insurance, and repairs, relate to overhead costs of a nonmanufacturing facility, such as an offi ce building, then these costs are expensed as period costs (e.g., Property Tax Expense, Depreciation Expense, Insurance Expense, and Repairs Expense). If the costs relate to the manufacturing process, then they are accumulated in Manufacturing Overhead, to ensure their treatment as product costs.

Using assumed data, the summary entry for manufacturing overhead in Wallace Company is:

(3) Jan. 31 Manufacturing Overhead 13,800 Utilities Payable 4,800 Prepaid Insurance 2,000 Accounts Payable (for repairs) 2,600 Accumulated Depreciation 3,000 Property Taxes Payable 1,400 (To record overhead costs)

1The numbers placed above the entries for Wallace Company are used for reference purposes in the summary provided in Illustration 2-15.

Raw Materials Inventory

42,000

Factory Labor

32,000

Manufacturing Overhead

13,800

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54 2 Job Order Costing

At this point, Manufacturing Overhead has a balance of $13,800, as shown in the T-account in the margin. The company subsequently assigns manufacturing overhead to work in process.

Assigning Manufacturing Costs to Work in Process

Assigning manufacturing costs to work in process results in the following entries.

1. Debits made to Work in Process Inventory.

2. Credits made to Raw Materials Inventory, Factory Labor, and Manufacturing Overhead.

An essential accounting record in assigning costs to jobs is a job cost sheet, as shown in Illustration 2-4. A job cost sheet is a form used to record the costs chargeable to a specifi c job and to determine the total and unit costs of the com- pleted job.

Companies keep a separate job cost sheet for each job. The job cost sheets constitute the subsidiary ledger for the Work in Process Inventory account. A subsidiary ledger consists of individual records for each individual item—in this case, each job. The Work in Process account is referred to as a control account because it summarizes the detailed data regarding specifi c jobs contained in the job cost sheets. Each entry to Work in Process Inventory must be accompanied by a corresponding posting to one or more job cost sheets.

Manufacturing Costs

Action Plan ✔ In accumulating

manufacturing costs, debit at least one of three accounts: Raw Materials Inventory, Factory Labor, and Manufacturing Overhead.

✔ Manufacturing over- head costs may be recognized daily. Or manufacturing overhead may be recorded periodically through a summary entry.

> DO IT!

(a) Raw Materials Inventory 4,200 Accounts Payable 4,200 (Purchases of raw materials on account)

(b) Factory Labor 18,000 Factory Wages Payable 15,000 Employer Payroll Taxes Payable 3,000 (To record factory labor costs)

(c) Manufacturing Overhead 7,500 Utilities Payable 2,200 Prepaid Insurance 1,800 Accumulated Depreciation 3,500 (To record overhead costs)

During the current month, Ringling Company incurs the following manufacturing costs:

(a) Raw material purchases of $4,200 on account.

(b) Incurs factory labor of $18,000. Of that amount, $15,000 relates to wages payable and $3,000 relates to payroll taxes payable.

(c) Factory utilities of $2,200 are payable, prepaid factory insurance of $1,800 has ex- pired, and depreciation on the factory building is $3,500.

Prepare journal entries for each type of manufacturing cost.

Solution

✔ The Navigator

Related exercise material: BE2-1, BE2-2, E2-1, E2-7, E2-8, E2-11, and 2-1.DO IT!

Explain the nature and importance of a job cost sheet.

3LEARNING OBJECTIVE

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Job Order Cost Flow 55

RAW MATERIALS COSTS Companies assign raw materials costs to jobs when their materials store- room issues the materials in response to requests. Requests for issuing raw materials are made on a prenumbered materials requisition slip. The materials issued may be used directly on a job, or they may be considered indirect materials. As Illustration 2-5 shows, the requisition should indicate the quantity and type of materials withdrawn and the account to be charged. The company will charge direct materials to Work in Process Inventory, and indirect materials to Manufac- turing Overhead.

Helpful Hint In today’s electronic environment, companies typically maintain job cost sheets as computer fi les.

Helpful Hint Approvals are an impor- tant part of a materials requisition slip because they help to establish individual accountability over inventory.

Helpful Hint Note the specifi c job to be charged.

Date

Cost of completed job Direct materials Direct labor Manufacturing overhead Total cost Unit cost (total dollars ÷ quantity)

Job Cost Sheet

Job No. Item For

Quantity Date Requested Date Completed

Direct Materials

Direct Labor

Manufacturing Overhead

$

$ $

Illustration 2-4 Job cost sheet

Quantity

Wallace Company Materials Requisition Slip

Deliver to: Charge to:

Req. No. Date:

Assembly Department Work in Process–Job No. 101

R247 1/6/14

Description Stock No. Cost per Unit Total

200 Lithium batteries AA2746 $5.00 $1,000

Requested by

Approved by

Received by

Costed by

Illustration 2-5 Materials requisition slip

The internal control principle of documentation includes prenumbering to enhance accountability.

Ethics Note

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56 2 Job Order Costing

Raw Materials Inventory

42,000 30,000

Work in Process Inventory

24,000

Manufacturing Overhead

13,800 6,000

Illustration 2-6 shows the posting of requisition slip R247 to Job No. 101 and other assumed postings to the job cost sheets for materials. The requisition slips provide

Helpful Hint Companies post to control accounts monthly, and post to job cost sheets daily.

Helpful Hint Prove the $24,000 direct materials charge to Work in Process Inventory by totaling the charges by jobs:

101 $12,000 102 7,000 103 5,000

$24,000

1/31

GENERAL LEDGER

1/6 1/12 1/26

Work in Process Inventory

24,000

$24,000 assigned to

SUBSIDIARY LEDGER Job Cost Sheets

Job No. 101 Quantity 1,000 Units

Date Direct

Materials Direct Labor

Manufacturing Overhead

1,000 7,000 4,000

1/10 1/17

Job No. 102 Quantity 1,500 Units

Date Direct

Materials Direct Labor

Manufacturing Overhead

3,800 3,200

1/27

Job No. 103 Quantity 2,000 Units

Date Direct

Materials Direct Labor

Manufacturing Overhead

5,000

7,000

12,000

5,000

Source documents for posting to job cost sheets and Work in Process Inventory: Materials requisition slips

specific jobs

Illustration 2-6 Job cost sheets–direct materials

The company may use any of the inventory costing methods (FIFO, LIFO, or average-cost) in costing the requisitions to the individual job cost sheets.

Periodically, the company journalizes the requisitions. For example, if Wallace uses $24,000 of direct materials and $6,000 of indirect materials in January, the entry is:

(4) Jan. 31 Work in Process Inventory 24,000 Manufacturing Overhead 6,000 Raw Materials Inventory 30,000 (To assign materials to jobs and

overhead)

This entry reduces Raw Materials Inventory by $30,000, increases Work in Pro- cess Inventory by $24,000, and increases Manufacturing Overhead by $6,000, as shown below.

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Job Order Cost Flow 57

the basis for total direct materials costs of $12,000 for Job No. 101, $7,000 for Job No. 102, and $5,000 for Job No. 103. After the company has completed all postings, the sum of the direct materials columns of the job cost sheets (the subsidiary ac- count amounts of $12,000, $7,000, and $5,000) should equal the direct materials debited to Work in Process Inventory (the control account amount of $24,000).

FACTORY LABOR COSTS Companies assign factory labor costs to jobs on the basis of time tickets prepared when the work is performed. The time ticket indicates the employ- ee, the hours worked, the account and job to be charged, and the total labor cost. Many companies accumulate these data through the use of bar coding and scan- ning devices. When they start and end work, employees scan bar codes on their identifi cation badges and bar codes associated with each job they work on. When direct labor is involved, the time ticket must indicate the job number, as shown in Illustration 2-7 (page 58). The employee’s supervisor should approve all time tickets.

The time tickets are later sent to the payroll department, which applies the employee’s hourly wage rate and computes the total labor cost. Finally, the company journalizes the time tickets. It debits the account Work in Process Inventory for

The Cost of an iPhone? Just Tear One Apart

All companies need to know what it costs to make their own products—but a lot of companies would also like to know the cost of their competitors’ products as well. That’s where iSuppli steps in. For a price, iSuppli will tear apart sophisticated electronic devices to tell you what it would cost to replicate. In the case of smart-phones, which often have more than 1,000 tiny components, that is no small feat. As shown in the chart below, components of many smart-phones cost about $170. Assembly is only about another $6.50. The difference between what you pay and the “cost” is not all profi t. Consider the additional nonproduction costs of research, design, marketing, patent fees, and selling costs.

MANAGEMENT INSIGHT

What type of costs are marketing and selling costs, and how are they treated for accounting purposes? (See page 92.)?

Source: “The Business of Dissecting Electronics: The Lowdown on Teardowns,” The Economist.com (January 21, 2010).

Sum of the Parts Cost of componentsa, 2009

Palm Apple Toshiba Motorola Pre iPhoneb TG01 Droid

Integrated $ 83.96 $ 91.38 $ 68.39 $ 60.83 circuits Display/ 38.80 34.65 35.30 35.25 touchscreen Mechanicalc 19.63 17.80 21.88 20.23 Camera 7.50 9.35 12.80 14.25 Battery 4.25 5.07 4.71 4.25 Other 16.51 11.82 30.60 44.30

Total $170.65 $170.07 $173.68 $179.11

a Latest data available b 3GS 16GB c Includes electromechanical Source: iSuppli.

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58 2 Job Order Costing

Wallace Company Time Ticket

Employee Charge to:

Date: Employee No.

Job No. John Nash

Work in Process

Time Hourly Rate

Total Cost

0800 1200 4

Approved by Costed by

Start Stop Total Hours

10.00 40.00

1/6/14 124 101

Illustration 2-7 Time ticket

Factory Labor

32,000 32,000

Work in Process Inventory

24,000 28,000

Manufacturing Overhead

13,800 6,000 4,000

Let’s assume that the labor costs chargeable to Wallace’s three jobs are $15,000, $9,000, and $4,000. Illustration 2-8 shows the Work in Process Inventory and job cost sheets after posting. As in the case of direct materials, the postings to the direct labor columns of the job cost sheets should equal the posting of direct labor to Work in Process Inventory.

Manufacturing Overhead Costs

Companies charge the actual costs of direct materials and direct labor to specifi c jobs. In contrast, manufacturing overhead relates to production operations as a whole. As a result, overhead costs cannot be assigned to specifi c jobs on the basis

Indicate how the prede- termined overhead rate is determined and used.

4LEARNING OBJECTIVE

direct labor and debits Manufacturing Overhead for indirect labor. For example, if the $32,000 total factory labor cost consists of $28,000 of direct labor and $4,000 of indirect labor, the entry is:

(5) Jan. 31 Work in Process Inventory 28,000 Manufacturing Overhead 4,000 Factory Labor 32,000 (To assign labor to jobs and

overhead)

As a result of this entry, Factory Labor is reduced by $32,000 so it has a zero bal- ance, and labor costs are assigned to the appropriate manufacturing accounts. The entry increases Work in Process Inventory by $28,000 and increases Manu- facturing Overhead by $4,000, as shown below.

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Job Order Cost Flow 59

of actual costs incurred. Instead, companies assign manufacturing overhead to work in process and to specifi c jobs on an estimated basis through the use of a predetermined overhead rate.

The predetermined overhead rate is based on the relationship between es- timated annual overhead costs and expected annual operating activity, expressed in terms of a common activity base. The company may state the activity in terms of direct labor costs, direct labor hours, machine hours, or any other measure that will provide an equitable basis for applying overhead costs to jobs. Com- panies establish the predetermined overhead rate at the beginning of the year. Small companies often use a single, company-wide predetermined overhead rate. Large companies often use rates that vary from department to department. The formula for a predetermined overhead rate is as follows.

Helpful Hint Prove the $28,000 direct labor charge to Work in Process Inventory by totaling the charges by jobs:

101 $15,000 102 9,000 103 4,000

$28,000

1/31 1/31

GENERAL LEDGER

1/6 1/10 1/12 1/26 1/31

Work in Process Inventory

24,000 28,000

$28,000 assigned to

specific jobs

SUBSIDIARY LEDGER Job Cost Sheets

Job No. 101 Quantity 1,000 Units

Date Direct

Materials Direct Labor

Manufacturing Overhead

1,000

7,000 4,000

12,000 15,000

1/10 1/15 1/17 1/22

Job No. 102 Quantity 1,500 Units

Date Direct

Materials Direct Labor

Manufacturing Overhead

3,800

3,200

1/27 1/29

Job No. 103 Quantity 2,000 Units

Date Direct

Materials Direct Labor

Manufacturing Overhead

5,000Source documents for posting to job cost sheets and Work in Process Inventory: Time tickets

9,000

6,000

4,000

5,000

4,000

7,000 9,000

5,000 4,000

Illustration 2-8 Job cost sheets–direct labor

Illustration 2-9 Formula for predetermined overhead rate

Estimated Annual Expected Annual Predetermined Overhead Costs

4 Operating Activity

5 Overhead Rate

Overhead relates to production operations as a whole. To know what “the whole” is, the logical thing is to wait until the end of the year’s operations. At that time, the company knows all of its costs for the period. As a practical matter, though, managers cannot wait until the end of the year. To price products effec- tively as they are completed, managers need information about product costs of specifi c jobs completed during the year. Using a predetermined overhead rate enables a cost to be determined for the job immediately. Illustration 2-10 (page 60) indicates how manufacturing overhead is assigned to work in process.

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60 2 Job Order Costing

Actual Activity

Base Used

is assigned

to Job 1 Job 2 Job 3

Work in Process

Predetermined Overhead

Rate ×

Illustration 2-10 Using predetermined overhead rates

The overhead that Wallace applies to each job will be 80% of the direct labor cost of the job for the month. Illustration 2-11 shows the Work in Process Inventory account and the job cost sheets after posting. Note that the debit of $22,400 to

Manufacturing Overhead

13,800 22,400 6,000 4,000

Work in Process Inventory

24,000 28,000 22,400

Wallace uses direct labor cost as the activity base. Assuming that the company expects annual overhead costs to be $280,000 and direct labor costs for the year to be $350,000, the overhead rate is 80%, computed as follows.

$280,000 4 $350,000 5 80%

This means that for every dollar of direct labor, Wallace will assign 80 cents of manufacturing overhead to a job. The use of a predetermined overhead rate enables the company to determine the approximate total cost of each job when it completes the job.

Historically, companies used direct labor costs or direct labor hours as the activity base. The reason was the relatively high correlation between direct labor and manufacturing overhead. Today more companies are using machine hours as the activity base, due to increased reliance on automation in manufac- turing operations. Or, as mentioned in Chapter 1 (and discussed more fully in Chapter 4), many companies now use activity-based costing to more accurately allocate overhead costs based on the activities that give rise to the costs.

A company may use more than one activity base. For example, if a job is manu- factured in more than one factory department, each department may have its own overhead rate. In the Feature Story, American LaFrance might use two bases in assigning overhead to fi re-truck jobs: direct materials dollars for indirect materials, and direct labor hours for such costs as insurance and supervisors’ salaries.

Wallace Company applies manufacturing overhead to work in process when it assigns direct labor costs. It also applies manufacturing overhead to specifi c jobs at the same time. For January, Wallace applied overhead of $22,400 in re- sponse to its assignment of $28,000 of direct labor costs (direct labor cost of $28,000 3 80%). The following entry records this application.

(6) Jan. 31 Work in Process Inventory 22,400 Manufacturing Overhead 22,400 (To assign overhead to jobs)

This entry reduces the balance in Manufacturing Overhead and increases Work in Process Inventory by $22,400, as shown below.

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Job Order Cost Flow 61

Work in Process Inventory equals the sum of the overhead applied to jobs: Job 101 $12,000 1 Job 102 $7,200 1 Job 103 $3,200.

At the end of each month, the balance in Work in Process Inventory should equal the sum of the costs shown on the job cost sheets of unfi nished jobs. Illustration 2-12 presents proof of the agreement of the control and subsidiary accounts in Wallace. (It assumes that all jobs are still in process.)

1/31 1/31 1/31

GENERAL LEDGER

1/6 1/10 1/12 1/26 1/31

Work in Process Inventory

24,000 28,000 22,400

SUBSIDIARY LEDGER Job Cost Sheets

Job No. 101 Quantity 1,000 Units

Date Direct

Materials Direct Labor

Manufacturing Overhead

Total

1/10 1/15 1/17 1/22

Job No. 102 Quantity 1,500 Units

3,800

3,200

1/27 1/29

Job No. 103 Quantity 2,000 Units

5,000

4,000

5,000

4,000

7,200

4,800

12,000 39,000

23,200

9,000

6,000

15,000

1,000

7,000 4,000

12,000

7,2009,0007,000

12,2003,2004,0005,000

3,200

4,000

3,200

Source documents for posting to job cost sheets: Predetermined overhead rate (80% of direct labor cost)

Date Direct

Materials Direct Labor

Manufacturing Overhead

Total

Date Direct

Materials Direct Labor

Manufacturing Overhead

Total

$22,400 assigned to

specific jobs

Illustration 2-11 Job cost sheets–manufacturing overhead applied

Illustration 2-12 Proof of job cost sheets to work in process inventory

Work in Process Inventory Job Cost Sheets

Jan. 31 24,000 No. 101 $ 39,000 31 28,000 102 23,200 31 22,400 103 12,200

74,400 $74,400

DECISION TOOLKIT DECISION CHECKPOINTS INFO NEEDED FOR DECISION TOOL TO USE FOR DECISION HOW TO EVALUATE RESULTS

What is the cost of a job? Job cost sheet Compare costs to those of previous periods and to those of competitors to ensure that costs are in line. Compare costs to expected selling price or service fees charged to determine overall profi tability.

Cost of material, labor, and overhead assigned to a specifi c job

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62 2 Job Order Costing

Work in Process

Action Plan ✔ Recognize that Work

in Process Inventory is the control account for all unfi nished job cost sheets.

✔ Debit Work in Process Inventory for the materials, labor, and overhead charged to the job cost sheets.

✔ Credit the accounts that were debited when the manufac- turing costs were accumulated.

> DO IT!

The three summary entries are:

Work in Process Inventory ($6,000 1 $3,600) 9,600 Raw Materials Inventory 9,600 (To assign materials to jobs)

Work in Process Inventory ($4,000 1 $2,000) 6,000 Factory Labor 6,000 (To assign labor to jobs)

Work in Process Inventory ($5,000 1 $2,500) 7,500 Manufacturing Overhead 7,500 (To assign overhead to jobs)

Danielle Company is working on two job orders. The job cost sheets show the following:

Direct materials—Job 120 $6,000; Job 121 $3,600 Direct labor—Job 120 $4,000; Job 121 $2,000 Manufacturing overhead—Job 120 $5,000; Job 121 $2,500

Prepare the three summary entries to record the assignment of costs to Work in Process from the data on the job cost sheets.

Solution

✔ The Navigator

Related exercise material: BE2-3, BE2-4, BE2-7, E2-2, E2-7, E2-8, and 2-2.DO IT!

Finished Goods Inventory is a control account. It controls individual fi n- ished goods records in a fi nished goods subsidiary ledger. The company posts directly from completed job cost sheets to the receipts columns. Illustration 2-14 shows the fi nished goods inventory record for Job No. 101.

Work in Process Inventory

24,000 39,000 28,000 22,400

Finished Goods Inventory

39,000

Assigning Costs to Finished Goods

When a job is completed, Wallace summarizes the costs and completes the lower portion of the applicable job cost sheet. For example, if we assume that Wallace completes Job No. 101, a batch of electronic sensors, on January 31, the job cost sheet appears as shown in Illustration 2-13.

When a job is fi nished, Wallace makes an entry to transfer its total cost to fi nished goods inventory. The entry is as follows.

(7) Jan. 31 Finished Goods Inventory 39,000 Work in Process Inventory 39,000 (To record completion of

Job No. 101)

This entry increases Finished Goods Inventory and reduces Work in Process Inventory by $39,000, as shown in the T-accounts below.

Prepare entries for jobs completed and sold.

5LEARNING OBJECTIVE

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Job Order Cost Flow 63

Date

Cost of completed job Direct materials Direct labor Manufacturing overhead Total cost Unit cost ($39,000 ÷ 1,000)

Job Cost Sheet

Job No. Item For

Quantity Date Requested Date Completed

Direct Materials

Direct Labor

Manufacturing Overhead

$

$ $

101 Electronic Sensors Tanner Company

1,000 February 5 January 31

1/6 1/10 1/12 1/26 1/31

$ 1,000

7,000 4,000

$12,000

$ 9,000

6,000

$15,000

$ 7,200

4,800

$12,000

12,000 15,000 12,000 39,000 39.00

Illustration 2-13 Completed job cost sheet

Illustration 2-14 Finished goods record

1

2

3

4

5

6

7

A P18 fx

C E IB D F HG J

Finished Goods.xls Formulas Data Review ViewPage LayoutInsertHome

Receipts

Date 1/31 1/31

Item: Electronic Sensors Job No: 101

Balance

Units 1,000

Cost $39

Total $39,000

– 0 –

Total

$39,000

Total $39,000

Issues

Units

1,000

Cost

$39

Units 1,000

Cost $39

Assigning Costs to Cost of Goods Sold

Companies recognize cost of goods sold when each sale occurs. To illustrate the entries a company makes when it sells a completed job, assume that on January 31 Wallace sells on account Job 101. The job cost $39,000, and it sold for $50,000. The entries to record the sale and recognize cost of goods sold are:

(8) Jan. 31 Accounts Receivable 50,000 Sales Revenue 50,000 (To record sale of Job No. 101)

31 Cost of Goods Sold 39,000 Finished Goods Inventory 39,000 (To record cost of Job No. 101)

As Illustration 2-14 shows, Wallace records, in the issues section of the fi nished goods record, the units sold, the cost per unit, and the total cost of goods sold for each job sold.

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64 2 Job Order Costing

Summary of Job Order Cost Flows

Illustration 2-15 shows a completed fl owchart for a job order cost accounting system. All postings are keyed to entries 1–8 in the example presented in the pre- vious pages for Wallace Company.

The cost fl ows in the diagram can be categorized as one of four types:

• Accumulation. The company fi rst accumulates costs by (1) purchasing raw materials, (2) incurring labor costs, and (3) incurring manufacturing over- head costs.

• Assignment to jobs. Once the company has incurred manufacturing costs, it must assign them to specifi c jobs. For example, as it uses raw materials on specifi c jobs (4), it assigns them to work in process, or treats them as manufacturing overhead if the raw materials cannot be associated with a specifi c job. Similarly, it either assigns factory labor (5) to work in process, or treats it as manufacturing overhead if the factory labor cannot be asso- ciated with a specifi c job. Finally it assigns manufacturing overhead (6) to work in process using a predetermined overhead rate. This deserves empha- sis: Do not assign overhead using actual overhead costs, but instead use a predetermined rate.

• Completed jobs. As jobs are completed (7), the company transfers the cost of the completed job out of work in process inventory into fi nished goods inventory.

• When goods are sold. As specifi c items are sold (8), the company transfers their cost out of fi nished goods inventory into cost of goods sold.

42,000

Raw Materials Inventory

(4)

Manufacturing Overhead

Factory Labor

(1) 30,000

32,000 (5)(2) 32,000

(6) 22,40013,800(3)

6,000(4)

4,000(5)

24,000

Work in Process Inventory

(7)(4) 39,000

28,000(5)

22,400(6)

39,000

Finished Goods Inventory

(8)(7) 39,000

39,000

Cost of Goods Sold

(8)

Flow of Costs

6

Accumulation Assignment

1. Purchase raw materials 2. Incur factory labor 3. Incur manufacturing overhead

4. Raw materials are used 5. Factory labor is used 6. Overhead is applied 7. Completed goods are recognized 8. Cost of goods sold is recognized

Key to entries:

7 8

5

4

Bal. 12,000

Bal. 1,400

Bal. 35,400

Illustration 2-15 Flow of costs in a job order cost system

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Job Order Cost Flow 65

Illustration 2-16 Flow of documents in a job order cost system

Flow of Documents Source Documents

Job Cost Sheet

Labor Time Tickets

Materials Requisition Slips

Predetermined Overhead Rate

The job cost sheet summarizes the cost of jobs completed and not completed at the end of the accounting period. Jobs completed are transferred to finished goods to await sale.

Job Order Costing for Service Companies

Our extended job order costing example focuses on a manufacturer so that you see the fl ow of costs through the inventory accounts. It is important to understand, however, that job order costing is also commonly used by service

Completion and Sale of Jobs

Action Plan ✔ Debit Finished Goods

Inventory for the cost of completed jobs.

✔ Debit Cost of Goods Sold for the cost of jobs sold.

> DO IT!

During the current month, Onyx Corporation completed Job 109 and Job 112. Job 109 cost $19,000 and Job 112 cost $27,000. Job 112 was sold on account for $42,000. Journalize the entries for the completion of the two jobs and the sale of Job 112.

Solution

Finished Goods Inventory 46,000 Work in Process Inventory 46,000 (To record completion of Job 109, costing $19,000 and Job 112,

costing $27,000)

Accounts Receivable 42,000 Sales Revenue 42,000 (To record sale of Job 112)

Cost of Goods Sold 27,000 Finished Goods Inventory 27,000 (To record cost of goods sold for Job 112)

✔ The Navigator

Related exercise material: BE2-8, E2-2, E2-3, E2-4, E2-6, E2-7, E2-10, and 2-3.DO IT!

Illustration 2-16 summarizes the fl ow of documents in a job order cost system.

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66 2 Job Order Costing

companies. While service companies do not have inventory, the techniques of job order costing are still quite useful in many service-industry environments. Consider, for example, the Mayo Clinic (health care), PriceWaterhouseCoopers (accounting), and Goldman Sachs (investment banking). These companies need to keep track of the cost of jobs performed for specifi c customers to evaluate the profi tability of medical treatments, audits, or investment banking engagements.

Many service organizations bill their customers using cost-plus contracts (discussed more fully in Chapter 8). Cost-plus contracts mean that the customer’s bill is the sum of the costs incurred on the job, plus a profi t amount that is cal- culated as a percentage of the costs incurred. In order to minimize confl ict with customers and reduce potential contract disputes, service companies that use cost-plus contracts must maintain accurate and up-to-date costing records. Up- to-date cost records enable a service company to immediately notify a customer of cost overruns due to customer requests for changes to the original plan or unexpected complications. Timely recordkeeping allows the contractor and cus- tomer to consider alternatives before it is too late.

A service company that uses a job order cost system does not have inventory accounts. It does, however, use an account similar to Work in Process Inven- tory, referred to here as Service Contracts in Process, to record job costs prior to completion. To illustrate the journal entries for a service company under a job order cost system, consider the following transactions for Frugal Interiors, an interior design company. The entry to record the assignment of $9,000 of supplies to projects ($7,000 direct and $2,000 indirect) is:

Service Contracts in Process 7,000 Operating Overhead 2,000 Supplies 9,000 (To assign supplies to projects)

The entry to record the assignment of service salaries and wages of $100,000 ($84,000 direct and $16,000 indirect) is:

Service Contracts in Process 84,000 Operating Overhead 16,000 Service Salaries and Wages 100,000 (To assign personnel costs to projects)

Frugal Interiors applies operating overhead at a rate of 50% of direct labor costs. The entry to record the application of overhead ($84,000 3 50%) based on the direct labor costs is:

Service Contracts in Process 42,000 Operating Overhead 42,000 (To assign operating overhead to projects)

Finally, upon completion, the job cost sheet of a design project for Sampson Cor- poration shows a total cost of $34,000. The entry to record completion of this project is:

Cost of Completed Service Contracts 34,000 Service Contracts in Process 34,000 (To record completion of Sampson project)

Job cost sheets for a service company keep track of materials, labor, and over- head used on a particular job similar to a manufacturer. A number of exercises at the end of this chapter apply job order costing to service companies.

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Job Order Cost Flow 67

Advantages and Disadvantages of Job Order Costing

An advantage of job order costing is it is more precise in assignment of costs to projects than process costing. For example, assume that a construction company, Juan Company, builds 10 custom homes a year at a total cost of $2,000,000. One way to determine the cost of the homes is to divide the total construction cost incurred during the year by the number of homes produced during the year. For Juan Company, an average cost of $200,000 ($2,000,000 4 10) is computed. If the homes are nearly identical, then this approach is adequate for purposes of determining profi t per home. But if the homes vary in terms of size, style, and material types, using the average cost of $200,000 to determine profi t per home is inappropriate. Instead, Juan Company should use a job order cost system to determine the specifi c cost incurred to build each home and the amount of profi t made on each. Thus, job order costing provides more useful information for de- termining the profi tability of particular projects and for estimating costs when preparing bids on future jobs.

One disadvantage of job order costing is that it requires a signifi cant amount of data entry. For Juan Company, it is much easier to simply keep track of total costs incurred during the year than it is to keep track of the costs incurred on each job (home built). Recording this information is time-consuming, and if the data is not entered accurately, then the product costs are not accurate. In recent years, technological advances, such as bar-coding devices for both labor costs and materials, have increased the accuracy and reduced the effort needed to re- cord costs on specifi c jobs. These innovations expand the opportunities to apply job order costing in a wider variety of business settings, thus improving manage- ment’s ability to control costs and make better informed decisions.

A common problem of all costing systems is how to allocate overhead to the fi nished product. Overhead often represents more than 50% of a product’s cost, and this cost is often diffi cult to allocate meaningfully to the product. How, for example, is the salary of a project manager allocated to the various homes, which may differ in size, style, and materials used, that she oversees? The accuracy of

Sales Are Nice, but Service Revenue Pays the Bills

Jet engines are one of the many products made by the industrial operations division of General Electric (GE). At prices as high as $30 million per engine, you can bet that GE does its best to keep track of costs. It might surprise you that GE doesn’t make much profi t on the sale of each engine. So why does it bother making them? Service revenue–during one recent year, about 75% of the division’s revenues came from servicing its own products. One estimate is that the $13 billion in aircraft engines sold during a recent three-year period will generate about $90 billion in service revenue over the 30-year life of the engines. Because of the high product costs, both the engines themselves and the subsequent service are most likely accounted for using job order costing. Accurate service cost records are important because GE needs to gen- erate high profi t margins on its service jobs to make up for the low margins on the original sale. It also needs good cost records for its service jobs in order to control its costs. Otherwise, a competitor, such as Pratt and Whitney, might submit lower bids for service contracts and take lucrative service jobs away from GE.

Source: Paul Glader, “GE’s Focus on Services Faces Test,” Wall Street Journal Online (March 3, 2009).

SERVICE COMPANY INSIGHT

Explain why GE would use job order costing to keep track of the cost of repairing a malfunctioning engine for a major airline. (See page 92.)?

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68 2 Job Order Costing

the job order cost system is largely dependent on the accuracy of the overhead allocation process. Even if the company does a good job of keeping track of the specifi c amounts of materials and labor used on each job, if the overhead costs are not allocated to individual jobs in a meaningful way, the product costing in- formation is not useful. This issue will be addressed in more detail in Chapter 4.

Helpful Hint Companies usually prepare monthly fi nancial state- ments for management use only.

Illustration 2-17 Cost of goods manufactured schedule

Wallace Company Cost of Goods Manufactured Schedule For the Month Ending January 31, 2014

Work in process, January 1 $ 202 Direct materials used $ 24,000 Direct labor 28,000 Manufacturing overhead applied 22,400

Total manufacturing costs 74,400

Total cost of work in process 74,400 Less: Work in process, January 31 35,400

Cost of goods manufactured $39,000

Illustration 2-18 Partial income statement Wallace Company

Income Statement (partial) For the Month Ending January 31, 2014

Sales revenue $50,000 Cost of goods sold Finished goods inventory, January 1 $ 202 Cost of goods manufactured (see Illustration 2-17) 39,000

Cost of goods available for sale 39,000 Less: Finished goods inventory, January 31 202

Cost of goods sold 39,000

Gross profi t $11,000

Note that the cost of goods manufactured ($39,000) agrees with the amount transferred from Work in Process Inventory to Finished Goods Inventory in jour- nal entry No. 7 in Illustration 2-15 (page 64).

The income statement and balance sheet are the same as those illustrated in Chapter 1. For example, Illustration 2-18 shows the partial income statement for Wallace for the month of January.

At the end of a period, companies prepare fi nancial statements that present ag- gregate data on all jobs manufactured and sold. The cost of goods manufactured schedule in job order costing is the same as in Chapter 1 with one exception: The schedule shows manufacturing overhead applied, rather than actual over- head costs. The company adds this amount to direct materials and direct labor to determine total manufacturing costs.

Companies prepare the cost of goods manufactured schedule directly from the Work in Process Inventory account. Illustration 2-17 shows a condensed schedule for Wallace Company for January.

Reporting Job Cost Data

Distinguish between under- and overapplied manufacturing overhead.

6LEARNING OBJECTIVE

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Reporting Job Cost Data 69

Under- or Overapplied Manufacturing Overhead

When Manufacturing Overhead has a debit balance, overhead is said to be un- derapplied. Underapplied overhead means that the overhead assigned to work in process is less than the overhead incurred. Conversely, when manufacturing overhead has a credit balance, overhead is overapplied. Overapplied overhead means that the overhead assigned to work in process is greater than the overhead incurred. Illustration 2-19 shows these concepts.

Manufacturing Overhead

Actual (Costs incurred)

Applied (Costs assigned)

If actual is greater than applied, manufacturing overhead is underapplied.

If actual is less than applied, manufacturing overhead is overapplied.

Manufacturing Overhead

Illustration 2-19 Under- and overapplied overhead

DECISION TOOLKIT DECISION CHECKPOINTS INFO NEEDED FOR DECISION TOOL TO USE FOR DECISION HOW TO EVALUATE RESULTS

Has the company over- or underapplied overhead for the period?

Manufacturing Overhead account

If the account balance is a credit, overhead applied exceeded actual overhead costs. If the account balance is a debit, overhead applied was less than actual overhead costs.

Actual overhead costs and overhead applied

YEAR-END BALANCE At the end of the year, all manufacturing overhead transactions are complete. There is no further opportunity for offsetting events to occur. At this point, Wallace eliminates any balance in Manufacturing Overhead by an adjusting en- try. It considers under- or overapplied overhead to be an adjustment to cost of goods sold. Thus, Wallace debits underapplied overhead to Cost of Goods Sold. It credits overapplied overhead to Cost of Goods Sold.

To illustrate, assume that Wallace has a $2,500 credit balance in Manufac- turing Overhead at December 31. The adjusting entry for the overapplied over- head is:

Dec. 31 Manufacturing Overhead 2,500 Cost of Goods Sold 2,500 (To transfer overapplied overhead to cost of goods sold)

After Wallace posts this entry, Manufacturing Overhead has a zero balance. In preparing an income statement for the year, Wallace reports cost of goods sold after adjusting it for either under- or overapplied overhead.

Conceptually, some argue, under- or overapplied overhead at the end of the year should be allocated among ending work in process, fi nished goods, and cost of goods sold. The discussion of this possible allocation approach is left to more advanced courses.

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70 2 Job Order Costing

Applied Manufacturing Overhead

Action Plan ✔ Calculate the amount

of overhead applied by multiplying the pre- determined overhead rate by actual activity.

✔ If actual manufactur- ing overhead is greater than applied, manu- facturing overhead is underapplied.

✔ If actual manufacturing overhead is less than applied, manufacturing overhead is overapplied.

> DO IT!

For Karr Company, the predetermined overhead rate is 140% of direct labor cost. During the month, Karr incurred $90,000 of factory labor costs, of which $80,000 is direct labor and $10,000 is indirect labor. Actual overhead incurred was $119,000.

Compute the amount of manufacturing overhead applied during the month. Determine the amount of under- or overapplied manufacturing overhead.

Solution

✔ The Navigator

Manufacturing overhead applied 5 (140% 3 $80,000) 5 $112,000 Underapplied manufacturing overhead 5 ($119,000 2 $112,000) 5 $7,000

Related exercise material: BE2-10, E2-5, E2-12, E2-13, and 2-4.DO IT!

Martinez Building Products Company is one of the largest manufacturers and marketers of unique, custom-made residential garage doors in the United States. It also is a major supplier of industrial and commercial doors, grills, and counter shutters for the new-construction, repair, and remodel markets. Martinez has developed plans for continued expansion of a network of service operations that sell, install, and service manufactured fi replaces, garage doors, and related products.

Martinez uses a job order cost system and applies overhead to production on the basis of direct labor cost. In computing a predetermined overhead rate for the year 2014, the company estimated manufacturing overhead to be $24 million and direct labor costs to be $20 million. In addition, it developed the following information.

Actual Costs Incurred During 2014 Direct materials used $30,000,000 Direct labor cost incurred 21,000,000 Insurance, factory 500,000 Indirect labor 7,500,000 Factory maintenance 1,000,000 Rent on factory building 11,000,000 Depreciation on factory equipment 2,000,000

Instructions Answer each of the following. (a) Why is Martinez Building Products Company using a job order cost system? (b) On what basis does Martinez allocate its manufacturing overhead? Compute the predetermined overhead rate for 2014. (c) Compute the amount of the under- or overapplied overhead for 2014. (d) Martinez had balances in the beginning and ending work in process and fi nished goods accounts as follows.

1/1/14 12/31/14 Work in process $ 5,000,000 $ 4,000,000 Finished goods 13,000,000 11,000,000

USING THE DECISION TOOLKIT

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Summary of Learning Objectives 71

1 Explain the characteristics and purposes of cost ac- counting. Cost accounting involves the procedures for measuring, recording, and reporting product costs. From the data accumulated, companies determine the total cost and the unit cost of each product. The two basic types of cost accounting systems are job order cost and process cost.

2 Describe the fl ow of costs in a job order cost system. In job order costing, companies fi rst accumulate manufac- turing costs in three accounts: Raw Materials Inventory,

Factory Labor, and Manufacturing Overhead. They then assign the accumulated costs to Work in Process Inventory and eventually to Finished Goods Inventory and Cost of Goods Sold.

3 Explain the nature and importance of a job cost sheet. A job cost sheet is a form used to record the costs chargeable to a specifi c job and to determine the total and unit costs of the completed job. Job cost sheets constitute the subsidiary ledger for the Work in Process Inventory control account.

SUMMARY OF LEARNING OBJECTIVES ✔ The Navigator

✔ The Navigator

Determine the (1) cost of goods manufactured and (2) cost of goods sold for Martinez during 2014. Assume that any under- or overapplied overhead should be included in the cost of goods sold.

(e) During 2014, Job G408 was started and completed. Its cost sheet showed a total cost of $100,000, and the company prices its product at 50% above its cost. What is the price to the customer if the company follows this pricing strategy?

Solution (a) The company is using a job order cost system because it custom-makes garage doors. Each job has its own distinguishing

characteristics. For example, each garage door would be different, and therefore a different cost per garage door can be assigned.

(b) The company allocates its overhead on the basis of direct labor cost. The predetermined overhead rate is 120%, computed as follows.

$24,000,000 4 20,000,000 5 120%

(c) Actual manufacturing overhead $22,000,000 Applied overhead cost ($21,000,000 3 120%) 25,200,000 Overapplied overhead $ 3,200,000

(d) (1) Work in process, 1/1/14 $ 5,000,000 Direct materials used $30,000,000 Direct labor 21,000,000 Manufacturing overhead applied 25,200,000 Total manufacturing costs 76,200,000 Total cost of work in process 81,200,000 Less: Work in process, 12/31/14 4,000,000 Cost of goods manufactured $77,200,000 (2) Finished goods inventory, 1/1/14 $13,000,000 Cost of goods manufactured (see above) 77,200,000 Cost of goods available for sale 90,200,000 Finished goods inventory, 12/31/14 11,000,000 Cost of goods sold (unadjusted) 79,200,000 Less: Overapplied overhead 3,200,000 Cost of goods sold $76,000,000

(e) G408 cost $ 100,000 Markup percentage 3 50% Profi t $ 50,000

Price to customer: $150,000 ($100,000 1 $50,000)

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72 2 Job Order Costing

4 Indicate how the predetermined overhead rate is de- termined and used. The predetermined overhead rate is based on the relationship between estimated annual over- head costs and expected annual operating activity. This is expressed in terms of a common activity base, such as direct labor cost. Companies use this rate to assign over- head costs to work in process and to specifi c jobs.

5 Prepare entries for jobs completed and sold. When jobs are completed, companies debit the cost to Finished Goods Inventory and credit it to Work in Process Inven-

tory. When a job is sold, the entries are (a) debit Cash or Accounts Receivable and credit Sales Revenue for the selling price; and (b) debit Cost of Goods Sold and credit Finished Goods Inventory for the cost of the goods.

6 Distinguish between under- and overapplied manufac- turing overhead. Underapplied manufacturing overhead indicates that the overhead assigned to work in process is less than the overhead incurred. Overapplied over- head indicates that the overhead assigned to work in process is greater than the overhead incurred.

DECISION TOOLKIT A SUMMARY HOW TO EVALUATE RESULTS

Compare costs to those of previous periods and to those of competitors to ensure that costs are in line. Compare costs to expected selling price or service fees charged to determine overall profi tability.

Manufacturing Overhead account

Has the company over- or underapplied overhead for the period?

Actual overhead costs and overhead applied

If the account balance is a credit, overhead applied exceeded actual overhead costs. If the account balance is a debit, overhead applied was less than actual overhead costs.

DECISION CHECKPOINTS INFO NEEDED FOR DECISION

What is the cost of a job? Job cost sheet Cost of material, labor, and overhead assigned to a specifi c job

TOOL TO USE FOR DECISION

Cost accounting An area of accounting that involves measuring, recording, and reporting product costs. (p. 50).

Cost accounting system Manufacturing-cost accounts that are fully integrated into the general ledger of a company. (p. 50).

Job cost sheet A form used to record the costs charge- able to a specifi c job and to determine the total and unit costs of the completed job. (p. 54).

Job order cost system A cost accounting system in which costs are assigned to each job or batch. (p. 50).

Materials requisition slip A document authorizing the issuance of raw materials from the storeroom to production. (p. 55).

Overapplied overhead A situation in which overhead assigned to work in process is greater than the over- head incurred. (p. 69).

Predetermined overhead rate A rate based on the re- lationship between estimated annual overhead costs and expected annual operating activity, expressed in terms of a common activity base. (p. 59).

Process cost system A cost accounting system used when a company manufactures a large volume of simi- lar products. (p. 50).

Time ticket A document that indicates the employee, the hours worked, the account and job to be charged, and the total labor cost. (p. 57).

Underapplied overhead A situation in which overhead assigned to work in process is less than the overhead incurred. (p. 69).

GLOSSARY

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Comprehensive DO IT! 73

> DO IT!

Cardella Company applies overhead on the basis of direct labor costs. The company estimates annual overhead costs will be $760,000, and annual direct labor costs will be $950,000. During February, Cardella works on two jobs: A16 and B17. Summary data concerning these jobs are as follows.

Manufacturing Costs Incurred

Purchased $54,000 of raw materials on account. Factory labor $76,000, plus $4,000 employer payroll taxes. Manufacturing overhead exclusive of indirect materials and indirect labor $59,800.

Assignment of Costs

Direct materials: Job A16 $27,000, Job B17 $21,000 Indirect materials: $3,000 Direct labor: Job A16 $52,000, Job B17 $26,000 Indirect labor: $2,000

The company completed Job A16 and sold it on account for $150,000. Job B17 was only partially completed.

Instructions (a) Compute the predetermined overhead rate.

(b) Journalize the February transactions in the sequence followed in the chapter.

(c) What was the amount of under- or overapplied manufacturing overhead?

Solution to Comprehensive

Comprehensive

(a) Estimated annual 4

Expected annual 5

Predetermined overhead costs operating activity overhead rate $760,000 4 $950,000 5 80%

(b) 1. Feb. 28 Raw Materials Inventory 54,000 Accounts Payable 54,000 (Purchase of raw materials on account)

2. 28 Factory Labor 80,000 Factory Wages Payable 76,000 Employer Payroll Taxes Payable 4,000 (To record factory labor costs)

3. 28 Manufacturing Overhead 59,800 Accounts Payable, Accumulated Depreciation, and Prepaid Insurance 59,800 (To record overhead costs)

4. 28 Work in Process Inventory 48,000 Manufacturing Overhead 3,000 Raw Materials Inventory 51,000 (To assign raw materials to production)

5. 28 Work in Process Inventory 78,000 Manufacturing Overhead 2,000 Factory Labor 80,000 (To assign factory labor to production)

DO IT!

Action Plan ✔ Predetermined over-

head rate 5 Estimated annual overhead cost 4 Expected annual operating activity.

✔ In accumulating costs, debit three accounts: Raw Materials Inven- tory, Factory Labor, and Manufacturing Overhead.

✔ When Work in Process Inventory is debited, credit one of the three accounts listed above.

✔ Debit Finished Goods Inventory for the cost of completed jobs. Debit Cost of Goods Sold for the cost of jobs sold.

✔ Overhead is underap- plied when Manufac- turing Overhead has a debit balance.

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74 2 Job Order Costing

Self-Test, Brief Exercises, Exercises, Problem Set A, and many more resources are available for practice in WileyPLUS.

6. 28 Work in Process Inventory 62,400 Manufacturing Overhead 62,400 (To assign overhead to jobs—

80% 3 $78,000)

7. 28 Finished Goods Inventory 120,600 Work in Process Inventory 120,600 (To record completion of Job A16: direct

materials $27,000, direct labor $52,000, and manufacturing overhead $41,600)

8. 28 Accounts Receivable 150,000 Sales Revenue 150,000 (To record sale of Job A16)

28 Cost of Goods Sold 120,600 Finished Goods Inventory 120,600 (To record cost of sale for Job A16)

(c) Manufacturing Overhead has a debit balance of $2,400 as shown below.

Manufacturing Overhead

(3) 59,800 (6) 62,400 (4) 3,000 (5) 2,000

Bal. 2,400

Thus, manufacturing overhead is underapplied for the month.

✔ The Navigator

Answers are at the end of the chapter. 1. Cost accounting involves the measuring, recording,

and reporting of: (a) product costs. (b) future costs. (c) manufacturing processes. (d) managerial accounting decisions.

2. A company is more likely to use a job order cost system if: (a) it manufactures a large volume of similar products. (b) its production is continuous. (c) it manufactures products with unique charac-

teristics. (d) it uses a periodic inventory system.

3. In accumulating raw materials costs, companies debit the cost of raw materials purchased in a per- petual system to:

(a) Raw Materials Purchases. (b) Raw Materials Inventory. (c) Purchases. (d) Work in Process.

4. When incurred, factory labor costs are debited to: (a) Work in Process. (b) Factory Wages Expense. (c) Factory Labor. (d) Factory Wages Payable.

5. The fl ow of costs in job order costing: (a) begins with work in process inventory and ends

with fi nished goods inventory. (b) begins as soon as a sale occurs. (c) parallels the physical fl ow of materials as they are

converted into fi nished goods. (d) is necessary to prepare the cost of goods manu-

factured schedule.

SELF-TEST QUESTIONS

(LO 1)

(LO 1)

(LO 2)

(LO 2)

(LO 2)

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Questions 75

6. Raw materials are assigned to a job when: (a) the job is sold. (b) the materials are purchased. (c) the materials are received from the vendor. (d) the materials are issued by the materials storeroom.

7. The source documents for assigning costs to job cost sheets are: (a) invoices, time tickets, and the predetermined

overhead rate. (b) materials requisition slips, time tickets, and the

actual overhead costs. (c) materials requisition slips, payroll register, and

the predetermined overhead rate. (d) materials requisition slips, time tickets, and the

predetermined overhead rate. 8. In recording the issuance of raw materials in a job

order cost system, it would be incorrect to: (a) debit Work in Process Inventory. (b) debit Finished Goods Inventory. (c) debit Manufacturing Overhead. (d) credit Raw Materials Inventory.

9. The entry when direct factory labor is assigned to jobs is a debit to: (a) Work in Process Inventory and a credit to Factory

Labor. (b) Manufacturing Overhead and a credit to Factory

Labor. (c) Factory Labor and a credit to Manufacturing

Overhead. (d) Factory Labor and a credit to Work in Process

Inventory. 10. The formula for computing the predetermined manu-

facturing overhead rate is estimated annual overhead costs divided by an expected annual operating activity, expressed as: (a) direct labor cost. (c) machine hours. (b) direct labor hours. (d) Any of the above.

11. In Crawford Company, the predetermined overhead rate is 80% of direct labor cost. During the month, Crawford incurs $210,000 of factory labor costs, of which $180,000 is direct labor and $30,000 is indirect labor. Actual over- head incurred was $200,000. The amount of overhead debited to Work in Process Inventory should be: (a) $200,000. (c) $168,000. (b) $144,000. (d) $160,000.

12. Mynex Company completes Job No. 26 at a cost of $4,500 and later sells it for $7,000 cash. A correct entry is:

(a) debit Finished Goods Inventory $7,000 and credit Work in Process Inventory $7,000.

(b) debit Cost of Goods Sold $7,000 and credit Finished Goods Inventory $7,000.

(c) debit Finished Goods Inventory $4,500 and credit Work in Process Inventory $4,500.

(d) debit Accounts Receivable $7,000 and credit Sales Revenue $7,000.

13. At the end of an accounting period, a company using a job order cost system calculates the cost of goods manufactured: (a) from the job cost sheet. (b) from the Work in Process Inventory account. (c) by adding direct materials used, direct labor

incurred, and manufacturing overhead incurred. (d) from the Cost of Goods Sold account.

14. Which of the following statements is true? (a) Job order costing requires less data entry than

process costing. (b) Allocation of overhead is easier under job order

costing than process costing. (c) Job order costing provides more precise costing

for custom jobs than process costing. (d) The use of job order costing has declined because

more companies have adopted automated ac- counting systems.

15. At end of the year, a company has a $1,200 debit bal- ance in Manufacturing Overhead. The company: (a) makes an adjusting entry by debiting Manufac-

turing Overhead Applied for $1,200 and crediting Manufacturing Overhead for $1,200.

(b) makes an adjusting entry by debiting Manufac- turing Overhead Expense for $1,200 and credit- ing Manufacturing Overhead for $1,200.

(c) makes an adjusting entry by debiting Cost of Goods Sold for $1,200 and crediting Manufactur- ing Overhead for $1,200.

(d) makes no adjusting entry because differences be- tween actual overhead and the amount applied are a normal part of job order costing and will average out over the next year.

16. Manufacturing overhead is underapplied if: (a) actual overhead is less than applied. (b) actual overhead is greater than applied. (c) the predetermined rate equals the actual rate. (d) actual overhead equals applied overhead.

(LO 3)

(LO 3)

(LO 3)

(LO 3)

(LO 5)

(LO 5)

(LO 6)

(LO 4)

(LO 4)

(LO 5)

(LO 6)

Go to the book’s companion website, www.wiley.com/college/weygandt, for additional Self-Test Questions.

1. (a) Mary Barett is not sure about the difference between cost accounting and a cost accounting system. Explain the difference to Mary.

(b) What is an important feature of a cost accounting system?

2. (a) Distinguish between the two types of cost account- ing systems.

(b) Can a company use both types of cost accounting systems?

3. What type of industry is likely to use a job order cost system? Give some examples.

4. What type of industry is likely to use a process cost system? Give some examples.

QUESTIONS

✔ The Navigator

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76 2 Job Order Costing

Prepare entries for service salaries and wages and operating overhead.

(LO 5), AP

5. Your roommate asks your help in understanding the major steps in the fl ow of costs in a job order cost system. Identify the steps for your roommate.

6. There are three inventory control accounts in a job order system. Identify the control accounts and their subsidiary ledgers.

7. What source documents are used in accumulating direct labor costs?

8. “Entries to Manufacturing Overhead normally are only made daily.” Do you agree? Explain.

9. Stan Kaiser is confused about the source documents used in assigning materials and labor costs. Identify the documents and give the entry for each document.

10. What is the purpose of a job cost sheet? 11. Indicate the source documents that are used in charg-

ing costs to specifi c jobs. 12. Explain the purpose and use of a “materials requisi-

tion slip” as used in a job order cost system.

13. Sam Bowden believes actual manufacturing overhead should be charged to jobs. Do you agree? Why or why not?

14. What elements are involved in computing a predeter- mined overhead rate?

15. How can the agreement of Work in Process Inventory and job cost sheets be verifi ed?

16. Jane Neff believes that the cost of goods manufac- tured schedule in job order cost accounting is the same as shown in Chapter 1. Is Jane correct? Explain.

17. Matt Litkee is confused about under- and overapplied manufacturing overhead. Defi ne the terms for Matt, and indicate the balance in the manufacturing over- head account applicable to each term.

18. “At the end of the year, under- or overapplied overhead is closed to Income Summary.” Is this correct? If not, indicate the customary treatment of this amount.

BRIEF EXERCISES

BE2-1 Knox Company begins operations on January 1. Because all work is done to cus- tomer specifi cations, the company decides to use a job order cost system. Prepare a fl ow- chart of a typical job order system with arrows showing the fl ow of costs. Identify the eight transactions.

BE2-2 During January, its fi rst month of operations, Knox Company accumulated the fol- lowing manufacturing costs: raw materials $4,000 on account, factory labor $6,000 of which $5,200 relates to factory wages payable and $800 relates to payroll taxes payable, and utili- ties payable $2,000. Prepare separate journal entries for each type of manufacturing cost.

BE2-3 In January, Knox Company requisitions raw materials for production as follows: Job 1 $900, Job 2 $1,400, Job 3 $700, and general factory use $600. Prepare a summary journal entry to record raw materials used.

BE2-4 Factory labor data for Knox Company is given in BE2-2. During January, time tick- ets show that the factory labor of $6,000 was used as follows: Job 1 $2,200, Job 2 $1,600, Job 3 $1,400, and general factory use $800. Prepare a summary journal entry to record factory labor used.

BE2-5 Data pertaining to job cost sheets for Knox Company are given in BE2-3 and BE2-4. Prepare the job cost sheets for each of the three jobs. (Note: You may omit the column for Manufacturing Overhead.)

BE2-6 Marquis Company estimates that annual manufacturing overhead costs will be $900,000. Estimated annual operating activity bases are direct labor cost $500,000, direct labor hours 50,000, and machine hours 100,000. Compute the predetermined overhead rate for each activity base.

BE2-7 During the fi rst quarter, Roland Company incurs the following direct labor costs: January $40,000, February $30,000, and March $50,000. For each month, prepare the entry to assign overhead to production using a predetermined rate of 80% of direct labor cost.

BE2-8 In March, Stinson Company completes Jobs 10 and 11. Job 10 cost $20,000 and Job 11 $30,000. On March 31, Job 10 is sold to the customer for $35,000 in cash. Journal- ize the entries for the completion of the two jobs and the sale of Job 10.

BE2-9 Preprah Engineering Contractors incurred service salaries and wages of $32,000 ($24,000 direct and $8,000 indirect) on an engineering project. The company applies over- head at a rate of 25% of direct labor. Record the entries to assign service salaries and wages and to apply overhead.

BE2-10 At December 31, balances in Manufacturing Overhead are Shimeca Company— debit $1,200, Garcia Company—credit $900. Prepare the adjusting entry for each com- pany at December 31, assuming the adjustment is made to cost of goods sold.

Prepare a fl owchart of a job order cost accounting system, and identify transactions.

(LO 2), C

Prepare entries in accumulating manufacturing costs.

(LO 2), AP

Prepare entry for the assignment of raw materials costs.

(LO 3), AP Prepare entry for the assignment of factory labor costs.

(LO 3), AP

Prepare job cost sheets.

(LO 3), AP

Compute predetermined overhead rates.

(LO 4), AP

Assign manufacturing overhead to production.

(LO 4), AP

Prepare entries for completion and sale of completed jobs.

(LO 5), AP

Prepare adjusting entries for under- and overapplied overhead.

(LO 6), C

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Exercises 77

> DO IT! REVIEW

During the current month, Tomlin Company incurs the following manufactur- ing costs.

(a) Purchased raw materials of $16,000 on account. (b) Incurred factory labor of $40,000. Of that amount, $31,000 relates to wages payable

and $9,000 relates to payroll taxes payable. (c) Factory utilities of $3,100 are payable, prepaid factory property taxes of $2,400 have

expired, and depreciation on the factory building is $9,500.

Prepare journal entries for each type of manufacturing cost. (Use a summary entry to record manufacturing overhead.)

Milner Company is working on two job orders. The job cost sheets show the following.

Job 201 Job 202

Direct materials $7,200 $9,000 Direct labor 4,000 8,000 Manufacturing overhead 5,200 9,800

Prepare the three summary entries to record the assignment of costs to Work in Process from the data on the job cost sheets.

During the current month, Reyes Corporation completed Job 310 and Job 312. Job 310 cost $60,000 and Job 312 cost $50,000. Job 312 was sold on account for $90,000. Journalize the entries for the completion of the two jobs and the sale of Job 312.

For Eckstein Company, the predetermined overhead rate is 130% of direct labor cost. During the month, Eckstein incurred $100,000 of factory labor costs, of which $85,000 is direct labor and $15,000 is indirect labor. Actual overhead incurred was $115,000. Compute the amount of manufacturing overhead applied during the month. Determine the amount of under- or overapplied manufacturing overhead.

DO IT! 2-1

DO IT! 2-2

DO IT! 2-3

DO IT! 2-4

✔ The Navigator

Prepare journal entries for manufacturing costs.

(LO 2), AP

Assign costs to work in process.

(LO 3, 4), AP

Prepare entries for completion and sale of jobs.

(LO 5), AP

Apply manufacturing over- head and determine under- or overapplication.

(LO 6), AN

EXERCISES

E2-1 The gross earnings of the factory workers for Vargas Company during the month of January are $66,000. The employer’s payroll taxes for the factory payroll are $8,000. The fringe benefi ts to be paid by the employer on this payroll are $6,000. Of the total accumulated cost of factory labor, 85% is related to direct labor and 15% is attributable to indirect labor.

Instructions (a) Prepare the entry to record the factory labor costs for the month of January. (b) Prepare the entry to assign factory labor to production.

E2-2 Stine Company uses a job order cost system. On May 1, the company has a balance in Work in Process Inventory of $3,500 and two jobs in process: Job No. 429 $2,000, and Job No. 430 $1,500. During May, a summary of source documents reveals the following.

Materials Labor Job Number Requisition Slips Time Tickets

429 $2,500 $1,900 430 3,500 3,000 431 4,400 $10,400 7,600 $12,500

General use 800 1,200

$11,200 $13,700

Prepare entries for factory labor.

(LO 2, 3), AP

Prepare journal entries for manufacturing costs.

(LO 2, 3, 4, 5), AP

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78 2 Job Order Costing

Stine Company applies manufacturing overhead to jobs at an overhead rate of 60% of direct labor cost. Job No. 429 is completed during the month.

Instructions (a) Prepare summary journal entries to record (i) the requisition slips, (ii) the time tickets,

(iii) the assignment of manufacturing overhead to jobs, and (iv) the completion of Job No. 429.

(b) Post the entries to Work in Process Inventory, and prove the agreement of the control account with the job cost sheets. (Use a T-account.)

E2-3 A job order cost sheet for Lowry Company is shown below.

Instructions (a) On the basis of the foregoing data, answer the following questions. (1) What was the balance in Work in Process Inventory on January 1 if this was the

only unfi nished job? (2) If manufacturing overhead is applied on the basis of direct labor cost, what over-

head rate was used in each year? (b) Prepare summary entries at January 31 to record the current year’s transactions per-

taining to Job No. 92.

E2-4 Manufacturing cost data for Orlando Company, which uses a job order cost system, are presented below.

Case A Case B Case C

Direct materials used $ (a) $ 83,000 $ 63,150 Direct labor 50,000 140,000 (h) Manufacturing overhead applied 42,500 (d) (i) Total manufacturing costs 145,650 (e) 213,000 Work in process 1/1/14 (b) 15,500 18,000 Total cost of work in process 201,500 (f) (j) Work in process 12/31/14 (c) 11,800 (k) Cost of goods manufactured 192,300 (g) 222,000

Instructions Indicate the missing amount for each letter. Assume that in all cases manufacturing over- head is applied on the basis of direct labor cost and the rate is the same.

E2-5 Duggan Company applies manufacturing overhead to jobs on the basis of machine hours used. Overhead costs are expected to total $325,000 for the year, and machine usage is estimated at 125,000 hours.

For the year, $342,000 of overhead costs are incurred and 130,000 hours are used.

Job No. 92 For 2,000 Units

Direct Direct Manufacturing Date Materials Labor Overhead

Beg. bal. Jan. 1 5,000 6,000 5,100 8 6,000 12 8,000 6,400 25 2,000 27 4,000 3,200

13,000 18,000 14,700

Cost of completed job: Direct materials $13,000 Direct labor 18,000 Manufacturing overhead 14,700

Total cost $45,700

Unit cost ($45,700 4 2,000) $22.85

Analyze a job cost sheet and prepare entries for manufacturing costs.

(LO 2, 3, 4, 5), AP

Analyze costs of manufac- turing and determine missing amounts.

(LO 2, 6), AN

Compute the manufacturing overhead rate and under- or overapplied overhead.

(LO 4, 6), AN

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Exercises 79

Instructions (a) Compute the manufacturing overhead rate for the year. (b) What is the amount of under- or overapplied overhead at December 31? (c) Prepare the adjusting entry to assign the under- or overapplied overhead for the year

to cost of goods sold.

E2-6 A job cost sheet of Sandoval Company is given below.

Job Cost Sheet

JOB NO. 469 Quantity 2,500

ITEM White Lion Cages Date Requested 7/2

FOR Todd Company Date Completed 7/31

Direct Direct Manufacturing Date Materials Labor Overhead

7/10 700 12 900 15 440 550 22 380 475 24 1,600 27 1,500 31 540 675

Cost of completed job: Direct materials Direct labor

Manufacturing overhead

Total cost

Unit cost

Instructions (a) Answer the following questions. (1) What are the source documents for direct materials, direct labor, and manufac-

turing overhead costs assigned to this job? (2) What is the predetermined manufacturing overhead rate? (3) What are the total cost and the unit cost of the completed job? (Round unit cost

to nearest cent.) (b) Prepare the entry to record the completion of the job.

E2-7 Torre Corporation incurred the following transactions.

1. Purchased raw materials on account $46,300. 2. Raw materials of $36,000 were requisitioned to the factory. An analysis of the materials

requisition slips indicated that $6,800 was classifi ed as indirect materials. 3. Factory labor costs incurred were $55,900, of which $51,000 pertained to factory wages

payable and $4,900 pertained to employer payroll taxes payable. 4. Time tickets indicated that $50,000 was direct labor and $5,900 was indirect labor. 5. Manufacturing overhead costs incurred on account were $80,500. 6. Depreciation on the company’s offi ce building was $8,100. 7. Manufacturing overhead was applied at the rate of 150% of direct labor cost. 8. Goods costing $88,000 were completed and transferred to fi nished goods. 9. Finished goods costing $75,000 to manufacture were sold on account for $103,000.

Instructions Journalize the transactions. (Omit explanations.)

E2-8 Enos Printing Corp. uses a job order cost system. The following data summarize the operations related to the fi rst quarter’s production.

1. Materials purchased on account $192,000, and factory wages incurred $87,300. 2. Materials requisitioned and factory labor used by job:

Analyze job cost sheet and prepare entry for completed job.

(LO 2, 3, 4, 5), AP

Prepare entries for manufacturing and nonmanufacturing costs.

(LO 2, 3, 4, 5), AP

Prepare entries for manufacturing and nonmanufacturing costs.

(LO 2, 3, 4, 5), AP

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80 2 Job Order Costing

Job Number Materials Factory Labor

A20 $ 35,240 $18,000 A21 42,920 22,000 A22 36,100 15,000 A23 39,270 25,000 General factory use 4,470 7,300

$158,000 $87,300

3. Manufacturing overhead costs incurred on account $49,500. 4. Depreciation on factory equipment $14,550. 5. Depreciation on the company’s offi ce building was $14,300. 6. Manufacturing overhead rate is 90% of direct labor cost. 7. Jobs completed during the quarter: A20, A21, and A23.

Instructions Prepare entries to record the operations summarized above. (Prepare a schedule showing the individual cost elements and total cost for each job in item 7.)

E2-9 At May 31, 2014, the accounts of Mantle Company show the following.

1. May 1 inventories—fi nished goods $12,600, work in process $14,700, and raw materials $8,200.

2. May 31 inventories—fi nished goods $9,500, work in process $17,900, and raw materials $7,100.

3. Debit postings to work in process were direct materials $62,400, direct labor $50,000, and manufacturing overhead applied $40,000.

4. Sales revenue totaled $210,000.

Instructions (a) Prepare a condensed cost of goods manufactured schedule. (b) Prepare an income statement for May through gross profi t. (c) Indicate the balance sheet presentation of the manufacturing inventories at May 31,

2014.

E2-10 Tierney Company begins operations on April 1. Information from job cost sheets shows the following.

Manufacturing Costs Assigned

Job Month Number April May June Completed

10 $5,200 $4,400 May 11 4,100 3,900 $2,000 June 12 1,200 April 13 4,700 4,500 June 14 5,900 3,600 Not complete

Job 12 was completed in April. Job 10 was completed in May. Jobs 11 and 13 were completed in June. Each job was sold for 25% above its cost in the month following completion.

Instructions (a) What is the balance in Work in Process Inventory at the end of each month? (b) What is the balance in Finished Goods Inventory at the end of each month? (c) What is the gross profi t for May, June, and July?

E2-11 Shown below are the job cost related accounts for the law fi rm of Jack, Bob, and Will and their manufacturing equivalents:

Law Firm Accounts Manufacturing Firm Accounts

Supplies Raw Materials Salaries and Wages Payable Factory Wages Payable Operating Overhead Manufacturing Overhead Service Contracts in Process Work in Process Cost of Completed Service Contracts Cost of Goods Sold

Prepare entries for costs of services provided.

(LO 2, 4, 5), AP

Compute work in process and fi nished goods from job cost sheets.

(LO 3, 5), AP

Prepare a cost of goods manufactured schedule and partial fi nancial statements.

(LO 2, 5), AP

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Problems: Set A 81

Cost data for the month of March follow.

1. Purchased supplies on account $1,500. 2. Issued supplies $1,200 (60% direct and 40% indirect). 3. Assigned labor costs based on time cards for the month which indicated labor costs of

$60,000 (80% direct and 20% indirect). 4. Operating overhead costs incurred for cash totaled $40,000. 5. Operating overhead is applied at a rate of 90% of direct attorney cost. 6. Work completed totaled $75,000.

Instructions (a) Journalize the transactions for March. (Omit explanations.) (b) Determine the balance of the Service Contracts in Process account. (Use a T-account.)

E2-12 Don Lieberman and Associates, a CPA fi rm, uses job order costing to capture the costs of its audit jobs. There were no audit jobs in process at the beginning of November. Listed below are data concerning the three audit jobs conducted during November.

Lynn Brian Mike

Direct materials $600 $400 $200 Auditor labor costs $5,400 $6,600 $3,375 Auditor hours 72 88 45

Overhead costs are applied to jobs on the basis of auditor hours, and the predetermined overhead rate is $50 per auditor hour. The Lynn job is the only incomplete job at the end of November. Actual overhead for the month was $11,000.

Instructions (a) Determine the cost of each job. (b) Indicate the balance of the Service Contracts in Process account at the end of November. (c) Calculate the ending balance of the Operating Overhead account for November.

E2-13 Pure Decorating uses a job order cost system to collect the costs of its interior deco- rating business. Each client’s consultation is treated as a separate job. Overhead is applied to each job based on the number of decorator hours incurred. Listed below are data for the current year.

Estimated overhead $920,000 Actual overhead $942,800 Estimated decorator hours 40,000 Actual decorator hours 40,500

The company uses Operating Overhead in place of Manufacturing Overhead.

Instructions (a) Compute the predetermined overhead rate. (b) Prepare the entry to apply the overhead for the year. (c) Determine whether the overhead was under- or overapplied and by how much.

Determine predetermined overhead rate, apply overhead and determine whether balance under- or overapplied.

(LO 4, 6), AP

Determine cost of jobs and ending balance in work in process and overhead accounts.

(LO 3, 4, 6), AP

Visit the book’s companion website, at www.wiley.com/college/weygandt, and choose the Student Companion site to access Exercise Set B and Challenge Exercises.

EXERCISES: SET B AND CHALLENGE EXERCISES

P2-1A Degelman Company uses a job order cost system and applies overhead to produc- tion on the basis of direct labor costs. On January 1, 2014, Job No. 50 was the only job in process. The costs incurred prior to January 1 on this job were as follows: direct materials

Prepare entries in a job order cost system and job cost sheets.

(LO 2, 3, 4, 5, 6), AP

PROBLEMS: SET A

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82 2 Job Order Costing

$20,000, direct labor $12,000, and manufacturing overhead $16,000. As of January 1, Job No. 49 had been completed at a cost of $90,000 and was part of fi nished goods inventory. There was a $15,000 balance in the Raw Materials Inventory account.

During the month of January, Degelman Company began production on Jobs 51 and 52, and completed Jobs 50 and 51. Jobs 49 and 50 were also sold on account during the month for $122,000 and $158,000, respectively. The following additional events occurred during the month.

1. Purchased additional raw materials of $90,000 on account. 2. Incurred factory labor costs of $70,000. Of this amount $16,000 related to employer

payroll taxes. 3. Incurred manufacturing overhead costs as follows: indirect materials $17,000; indirect

labor $20,000; depreciation expense on equipment $19,000; and various other manu- facturing overhead costs on account $16,000.

4. Assigned direct materials and direct labor to jobs as follows.

Job No. Direct Materials Direct Labor

50 $10,000 $ 5,000 51 39,000 25,000 52 30,000 20,000

Instructions (a) Calculate the predetermined overhead rate for 2014, assuming Degelman Company

estimates total manufacturing overhead costs of $980,000, direct labor costs of $700,000, and direct labor hours of 20,000 for the year.

(b) Open job cost sheets for Jobs 50, 51, and 52. Enter the January 1 balances on the job cost sheet for Job No. 50.

(c) Prepare the journal entries to record the purchase of raw materials, the factory labor costs incurred, and the manufacturing overhead costs incurred during the month of January.

(d) Prepare the journal entries to record the assignment of direct materials, direct labor, and manufacturing overhead costs to production. In assigning manufacturing over- head costs, use the overhead rate calculated in (a). Post all costs to the job cost sheets as necessary.

(e) Total the job cost sheets for any job(s) completed during the month. Prepare the jour- nal entry (or entries) to record the completion of any job(s) during the month.

(f) Prepare the journal entry (or entries) to record the sale of any job(s) during the month.

(g) What is the balance in the Finished Goods Inventory account at the end of the month? What does this balance consist of?

(h) What is the amount of over- or underapplied overhead?

P2-2A For the year ended December 31, 2014, the job cost sheets of Cinta Company contained the following data.

Job Direct Direct Manufacturing Total Number Explanation Materials Labor Overhead Costs

7640 Balance 1/1 $25,000 $24,000 $28,800 $ 77,800 Current year’s costs 30,000 36,000 43,200 109,200 7641 Balance 1/1 11,000 18,000 21,600 50,600 Current year’s costs 43,000 48,000 57,600 148,600 7642 Current year’s costs 58,000 55,000 66,000 179,000

Other data:

1. Raw materials inventory totaled $15,000 on January 1. During the year, $140,000 of raw materials were purchased on account.

2. Finished goods on January 1 consisted of Job No. 7638 for $87,000 and Job No. 7639 for $92,000.

3. Job No. 7640 and Job No. 7641 were completed during the year. 4. Job Nos. 7638, 7639, and 7641 were sold on account for $530,000.

Prepare entries in a job order cost system and partial income statement.

(LO 2, 3, 4, 5, 6), AN

(e) Job 50, $70,000 Job 51, $99,000

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Problems: Set A 83

5. Manufacturing overhead incurred on account totaled $120,000. 6. Other manufacturing overhead consisted of indirect materials $14,000, indirect labor

$18,000, and depreciation on factory machinery $8,000.

Instructions (a) Prove the agreement of Work in Process Inventory with job cost sheets pertaining to

unfi nished work. (Hint: Use a single T-account for Work in Process Inventory.) Cal- culate each of the following, then post each to the T-account: (1) beginning balance, (2) direct materials, (3) direct labor, (4) manufacturing overhead, and (5) completed jobs.

(b) Prepare the adjusting entry for manufacturing overhead, assuming the balance is allocated entirely to Cost of Goods Sold.

(c) Determine the gross profi t to be reported for 2014.

P2-3A Stellar Inc. is a construction company specializing in custom patios. The patios are constructed of concrete, brick, fi berglass, and lumber, depending upon customer preference. On June 1, 2014, the general ledger for Stellar Inc. contains the following data.

Raw Materials Inventory $4,200 Manufacturing Overhead Applied $32,640 Work in Process Inventory $5,540 Manufacturing Overhead Incurred $31,650

Subsidiary data for Work in Process Inventory on June 1 are as follows.

Job Cost Sheets

Customer Job

Cost Element Gannon Rosenthal Linton

Direct materials $ 600 $ 800 $ 900 Direct labor 320 540 580 Manufacturing overhead 400 675 725

$1,320 $2,015 $2,205

During June, raw materials purchased on account were $4,900, and all wages were paid. Additional overhead costs consisted of depreciation on equipment $700 and miscel- laneous costs of $400 incurred on account.

A summary of materials requisition slips and time tickets for June shows the following.

Customer Job Materials Requisition Slips Time Tickets

Gannon $ 800 $ 450 Koss 2,000 800 Rosenthal 500 360 Linton 1,300 1,200 Gannon 300 390

4,900 3,200 General use 1,500 1,200

$6,400 $4,400

Overhead was charged to jobs at the same rate of $1.25 per dollar of direct labor cost. The patios for customers Gannon, Rosenthal, and Linton were completed during June and sold for a total of $18,900. Each customer paid in full.

Instructions (a) Journalize the June transactions: (i) for purchase of raw materials, factory labor

costs incurred, and manufacturing overhead costs incurred; (ii) assignment of direct materials, labor, and overhead to production; and (iii) completion of jobs and sale of goods.

(b) Post the entries to Work in Process Inventory. (c) Reconcile the balance in Work in Process Inventory with the costs of unfi nished jobs. (d) Prepare a cost of goods manufactured schedule for June.

(a) $179,000; Job 7642: $179,000

(b) Amount 5 $6,800

(c) $158,600

Prepare entries in a job order cost system and cost of goods manufactured schedule.

(LO 2, 3, 4, 5), AP

(d) Cost of goods manufactured $13,840

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84 2 Job Order Costing

(a) 80%, $12, $7.50 (b) $356,000, $368,000,

$193,500 (c) $3,000, $(8,000), $1,000

Compute predetermined over- head rates, apply overhead, and calculate under- or overapplied overhead.

(LO 4, 6), AP

Analyze manufacturing accounts and determine missing amounts.

(LO 2, 3, 4, 5, 6), AN

P2-4A Agassi Company uses a job order cost system in each of its three manufacturing departments. Manufacturing overhead is applied to jobs on the basis of direct labor cost in Department D, direct labor hours in Department E, and machine hours in Department K.

In establishing the predetermined overhead rates for 2014, the following estimates were made for the year.

Department

D E K

Manufacturing overhead $1,200,000 $1,500,000 $900,000 Direct labor costs $1,500,000 $1,250,000 $450,000 Direct labor hours 100,000 125,000 40,000 Machine hours 400,000 500,000 120,000

During January, the job cost sheets showed the following costs and production data.

Department

D E K

Direct materials used $140,000 $126,000 $78,000 Direct labor costs $120,000 $110,000 $37,500 Manufacturing overhead incurred $ 99,000 $124,000 $79,000 Direct labor hours 8,000 11,000 3,500 Machine hours 34,000 45,000 10,400

Instructions (a) Compute the predetermined overhead rate for each department. (b) Compute the total manufacturing costs assigned to jobs in January in each department. (c) Compute the under- or overapplied overhead for each department at January 31.

P2-5A Rodman Corporation’s fi scal year ends on November 30. The following accounts are found in its job order cost accounting system for the fi rst month of the new fi scal year.

Raw Materials Inventory

Dec. 1 Beginning balance (a) Dec. 31 Requisitions 16,850 31 Purchases 19,225

Dec. 31 Ending balance 7,975

Work in Process Inventory

Dec. 1 Beginning balance (b) Dec. 31 Jobs completed (f) 31 Direct materials (c) 31 Direct labor 8,800 31 Overhead (d)

Dec. 31 Ending balance (e)

Finished Goods Inventory

Dec. 1 Beginning balance (g) Dec. 31 Cost of goods sold (i) 31 Completed jobs (h)

Dec. 31 Ending balance (j)

Factory Labor

Dec. 31 Factory wages 12,025 Dec. 31 Wages assigned (k)

Manufacturing Overhead

Dec. 31 Indirect materials 1,900 Dec. 31 Overhead applied (m) 31 Indirect labor (l) 31 Other overhead 1,245

Other data:

1. On December 1, two jobs were in process: Job No. 154 and Job No. 155. These jobs had combined direct materials costs of $9,750 and direct labor costs of $15,000. Overhead was applied at a rate that was 75% of direct labor cost.

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Problems: Set B 85

2. During December, Job Nos. 156, 157, and 158 were started. On December 31, Job No. 158 was unfi nished. This job had charges for direct materials $3,800 and direct labor $4,800, plus manufacturing overhead. All jobs, except for Job No. 158, were com- pleted in December.

3. On December 1, Job No. 153 was in the fi nished goods warehouse. It had a total cost of $5,000. On December 31, Job No. 157 was the only job fi nished that was not sold. It had a cost of $4,000.

4. Manufacturing overhead was $230 overapplied in December.

Instructions List the letters (a) through (m) and indicate the amount pertaining to each letter.

(c) $14,950 (f) $54,150 (i) $55,150

P2-1B Pedriani Company uses a job order cost system and applies overhead to produc- tion on the basis of direct labor hours. On January 1, 2014, Job No. 25 was the only job in process. The costs incurred prior to January 1 on this job were as follows: direct ma- terials $10,000; direct labor $6,000; and manufacturing overhead $9,000. Job No. 23 had been completed at a cost of $42,000 and was part of fi nished goods inventory. There was a $5,000 balance in the Raw Materials Inventory account.

During the month of January, the company began production on Jobs 26 and 27, and completed Jobs 25 and 26. Jobs 23 and 25 were sold on account during the month for $63,000 and $74,000, respectively. The following additional events occurred during the month.

1. Purchased additional raw materials of $45,000 on account. 2. Incurred factory labor costs of $33,500. Of this amount, $7,500 related to employer

payroll taxes. 3. Incurred manufacturing overhead costs as follows: indirect materials $10,000; indirect

labor $9,500; depreciation expense on equipment $12,000; and various other manufac- turing overhead costs on account $11,000.

4. Assigned direct materials and direct labor to jobs as follows.

Job No. Direct Materials Direct Labor

25 $ 5,000 $ 3,000 26 17,000 12,000 27 13,000 9,000

5. The company uses direct labor hours as the activity base to assign overhead. Direct labor hours incurred on each job were as follows: Job No. 25, 200; Job No. 26, 800; and Job No. 27, 600.

Instructions (a) Calculate the predetermined overhead rate for the year 2014, assuming Pedriani Com-

pany estimates total manufacturing overhead costs of $440,000, direct labor costs of $300,000, and direct labor hours of 20,000 for the year.

(b) Open job cost sheets for Jobs 25, 26, and 27. Enter the January 1 balances on the job cost sheet for Job No. 25.

(c) Prepare the journal entries to record the purchase of raw materials, the factory labor costs incurred, and the manufacturing overhead costs incurred during the month of January.

(d) Prepare the journal entries to record the assignment of direct materials, direct labor, and manufacturing overhead costs to production. In assigning manufacturing overhead costs, use the overhead rate calculated in (a). Post all costs to the job cost sheets as necessary.

(e) Total the job cost sheets for any job(s) completed during the month. Prepare the jour- nal entry (or entries) to record the completion of any job(s) during the month.

(f) Prepare the journal entry (or entries) to record the sale of any job(s) during the month. (g) What is the balance in the Work in Process Inventory account at the end of the month?

What does this balance consist of? (h) What is the amount of over- or underapplied overhead?

Prepare entries in a job order cost system and job cost sheets.

(LO 2, 3, 4, 5, 6), AP

PROBLEMS: SET B

(e) Job 25, $37,400 Job 26, $46,600

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86 2 Job Order Costing

P2-2B For the year ended December 31, 2014, the job cost sheets of Dosey Company con- tained the following data.

Job Direct Direct Manufacturing Total Number Explanation Materials Labor Overhead Costs

7650 Balance 1/1 $18,000 $20,000 $25,000 $ 63,000 Current year’s costs 32,000 36,000 45,000 113,000

7651 Balance 1/1 12,000 16,000 20,000 48,000 Current year’s costs 30,000 40,000 50,000 120,000

7652 Current year’s costs 35,000 68,000 85,000 188,000

Other data:

1. Raw materials inventory totaled $20,000 on January 1. During the year, $100,000 of raw materials were purchased on account.

2. Finished goods on January 1 consisted of Job No. 7648 for $93,000 and Job No. 7649 for $62,000.

3. Job No. 7650 and Job No. 7651 were completed during the year. 4. Job Nos. 7648, 7649, and 7650 were sold on account for $490,000. 5. Manufacturing overhead incurred on account totaled $135,000. 6. Other manufacturing overhead consisted of indirect materials $12,000, indirect labor

$16,000, and depreciation on factory machinery $19,500.

Instructions (a) Prove the agreement of Work in Process Inventory with job cost sheets pertaining to

unfi nished work. (Hint: Use a single T-account for Work in Process Inventory.) Calcu- late each of the following, then post each to the T-account: (1) beginning balance, (2) direct materials, (3) direct labor, (4) manufacturing overhead, and (5) completed jobs.

(b) Prepare the adjusting entry for manufacturing overhead, assuming the balance is allocated entirely to cost of goods sold.

(c) Determine the gross profi t to be reported for 2014.

P2-3B Robert Perez is a contractor specializing in custom-built jacuzzis. On May 1, 2014, his ledger contains the following data.

Raw Materials Inventory $30,000 Work in Process Inventory 12,200 Manufacturing Overhead 2,500 (dr.)

The Manufacturing Overhead account has debit totals of $12,500 and credit totals of $10,000. Subsidiary data for Work in Process Inventory on May 1 include:

Job Cost Sheets

Job Manufacturing by Customer Direct Materials Direct Labor Overhead

Stiner $2,500 $2,000 $1,400 Alton 2,000 1,200 840 Herman 900 800 560

$5,400 $4,000 $2,800

During May, the following costs were incurred: raw materials purchased on account $4,000, labor paid $7,000, and manufacturing overhead paid $1,400.

A summary of materials requisition slips and time tickets for the month of May reveals the following.

Job by Customer Materials Requisition Slips Time Tickets

Stiner $ 500 $ 400 Alton 600 1,000 Herman 2,300 1,300 Smith 1,900 2,300

5,300 5,000 General use 1,500 2,000

$6,800 $7,000

(a) (1) $111,000 (4) $180,000 Unfi nished job 7652, $188,000

(b) Amount 5 $2,500

(c) $156,500

Prepare entries in a job order cost system and partial income statement.

(LO 2, 3, 4, 5, 6), AN

Prepare entries in a job order cost system and cost of goods manufactured schedule.

(LO 2, 3, 4, 5), AP

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Problems: Set B 87

(d) Cost of goods manufactured $20,190

(a) 120%, $16, $6 (b) $197,600, $177,000,

$190,000 (c) $2,400 $4,000, $(3,500)

Compute predetermined overhead rates, apply overhead, and calculate under- or overapplied overhead.

(LO 4, 6), AP

Analyze manufacturing accounts and determine missing amounts.

(LO 2, 3, 4, 5, 6), AN

Overhead was charged to jobs on the basis of $0.70 per dollar of direct labor cost. The jacuzzis for customers Stiner, Alton, and Herman were completed during May. The three jacuzzis were sold for a total of $36,000.

Instructions (a) Prepare journal entries for the May transactions: (i) for purchase of raw materials, fac-

tory labor costs incurred, and manufacturing overhead costs incurred; (ii) assignment of raw materials, labor, and overhead to production; and (iii) completion of jobs and sale of goods.

(b) Post the entries to Work in Process Inventory. (c) Reconcile the balance in Work in Process Inventory with the costs of unfi nished

jobs. (d) Prepare a cost of goods manufactured schedule for May.

P2-4B Net Play Company uses a job order cost system in each of its three manufacturing departments. Manufacturing overhead is applied to jobs on the basis of direct labor cost in Department A, direct labor hours in Department B, and machine hours in Department C.

In establishing the predetermined overhead rates for 2014, the following estimates were made for the year.

Department

A B C

Manufacturing overhead $720,000 $640,000 $900,000 Direct labor cost $600,000 $100,000 $600,000 Direct labor hours 50,000 40,000 40,000 Machine hours 100,000 120,000 150,000

During January, the job cost sheets showed the following costs and production data.

Department

A B C

Direct materials used $92,000 $86,000 $64,000 Direct labor cost $48,000 $35,000 $50,400 Manufacturing overhead incurred $60,000 $60,000 $72,100 Direct labor hours 4,000 3,500 4,200 Machine hours 8,000 10,500 12,600

Instructions (a) Compute the predetermined overhead rate for each department. (b) Compute the total manufacturing costs assigned to jobs in January in each department. (c) Compute the under- or overapplied overhead for each department at January 31.

P2-5B Bell Company’s fi scal year ends on June 30. The following accounts are found in its job order cost accounting system for the fi rst month of the new fi scal year.

Raw Materials Inventory

July 1 Beginning balance 19,000 July 31 Requisitions (a) 31 Purchases 90,400

July 31 Ending balance (b)

Work in Process Inventory

July 1 Beginning balance (c) July 31 Jobs completed (f) 31 Direct materials 80,000 31 Direct labor (d) 31 Overhead (e)

July 31 Ending balance (g)

Finished Goods Inventory

July 1 Beginning balance (h) July 31 Cost of goods sold (j) 31 Completed jobs (i)

July 31 Ending balance (k)

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88 2 Job Order Costing

Factory Labor

July 31 Factory wages (l) July 31 Wages assigned (m)

Manufacturing Overhead

July 31 Indirect materials 8,900 July 31 Overhead applied 117,000 31 Indirect labor 16,000 31 Other overhead (n)

Other data:

1. On July 1, two jobs were in process: Job No. 4085 and Job No. 4086, with costs of $19,000 and $8,200, respectively.

2. During July, Job Nos. 4087, 4088, and 4089 were started. On July 31, only Job No. 4089 was unfi nished. This job had charges for direct materials $2,000 and direct labor $1,500, plus manufacturing overhead. Manufacturing overhead was applied at the rate of 130% of direct labor cost.

3. On July 1, Job No. 4084, costing $145,000, was in the fi nished goods warehouse. On July 31, Job No. 4088, costing $138,000, was in fi nished goods.

4. Overhead was $3,000 underapplied in July.

Instructions List the letters (a) through (n) and indicate the amount pertaining to each letter. Show computations.

(d) $ 90,000 (f) $308,750 (l) $106,000

Visit the book’s companion website, at www.wiley.com/college/weygandt, and choose the Student Companion site to access Problem Set C.

PROBLEMS: SET C

(Note: This is a continuation of the Waterways Problem from Chapter 1.)

WCP2 Waterways has two major public-park projects to provide with comprehensive irrigation in one of its service locations this month. Job J57 and Job K52 involve 15 acres of landscaped terrain which will require special-order sprinkler heads to meet the speci- fi cations of the project. This problem asks you to help Waterways use a job order cost system to account for production of these parts.

Go to the book’s companion website, at www.wiley.com/college/weygandt, to fi nd the completion of this problem.

WATERWAYS CONTINUING PROBLEM

Management Decision-Making

Decision-Making at Current Designs

Broadening Your PERSPECTIVE

BYP2-1 Huegel Hollow Resort has ordered 20 rotomolded kayaks from Current Designs. Each kayak will be formed in the rotomolded oven, cooled, and then the excess plastic trimmed away. Then, the hatches, seat, ropes, and bungees will be attached to the kayak.

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Dave Thill, the kayak plant manager, knows that manufacturing each kayak requires 54 pounds of polyethylene powder and a fi nishing kit (rope, seat, hardware, etc.). The polyethylene powder used in these kayaks costs $1.50 per pound, and the fi nishing kits cost $170 each. Each kayak will use two kinds of labor: 2 hours of more-skilled type I labor from people who run the oven and trim the plastic, and 3 hours of less-skilled type II labor from people who attach the hatches and seat and other hardware. The type I employees are paid $15 per hour, and the type II employees are paid $12 per hour. For purposes of this problem, assume that overhead is allocated to all jobs at a rate of 150% of direct labor costs.

Instructions Determine the total cost of the Huegel Hollow order and the cost of each individual kayak in the order. Identify costs as direct materials, direct labor, or manufacturing overhead.

Decision-Making Across the Organization

BYP2-2 Khan Products Company uses a job order cost system. For a number of months, there has been an ongoing rift between the sales department and the production department concerning a special-order product, TC-1. TC-1 is a seasonal product that is manufactured in batches of 1,000 units. TC-1 is sold at cost plus a markup of 40% of cost.

The sales department is unhappy because fl uctuating unit production costs signifi cantly affect selling prices. Sales personnel complain that this has caused excessive customer complaints and the loss of considerable orders for TC-1.

The production department maintains that each job order must be fully costed on the basis of the costs incurred during the period in which the goods are produced. Production personnel maintain that the only real solution to the problem is for the sales department to increase sales in the slack periods.

Andrea Parley, president of the company, asks you as the company accountant to collect quar- terly data for the past year on TC-1. From the cost accounting system, you accumulate the follow- ing production quantity and cost data.

Quarter

Costs 1 2 3 4

Direct materials $100,000 $220,000 $ 80,000 $200,000 Direct labor 60,000 132,000 48,000 120,000 Manufacturing overhead 105,000 153,000 97,000 125,000

Total $265,000 $505,000 $225,000 $445,000

Production in batches 5 11 4 10

Unit cost (per batch) $ 53,000 $ 45,909 $ 56,250 $ 44,500

Instructions With the class divided into groups, answer the following questions. (a) What manufacturing cost element is responsible for the fl uctuating unit costs? Why? (b) What is your recommended solution to the problem of fl uctuating unit cost? (c) Restate the quarterly data on the basis of your recommended solution.

Managerial Analysis

BYP2-3 In the course of routine checking of all journal entries prior to preparing year-end reports, Betty Eller discovered several strange entries. She recalled that the president’s son Joe had come in to help out during an especially busy time and that he had recorded some journal entries. She was relieved that there were only a few of his entries, and even more relieved that he had included rather lengthy explanations. The entries Joe made were:

1.

Work in Process Inventory 25,000 Cash 25,000

(This is for materials put into process. I don’t fi nd the record that we paid for these, so I’m crediting Cash because I know we’ll have to pay for them sooner or later.)

Broadening Your Perspective 89

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2.

Manufacturing Overhead 12,000 Cash 12,000

(This is for bonuses paid to salespeople. I know they’re part of overhead, and I can’t fi nd an account called “Non-Factory Overhead” or “Other Overhead” so I’m putting it in Manufacturing Overhead. I have the check stubs, so I know we paid these.)

3.

Wages Expense 120,000 Cash 120,000

(This is for the factory workers’ wages. I have a note that payroll taxes are $18,000. I still think that’s part of wages expense and that we’ll have to pay it all in cash sooner or later, so I credited Cash for the wages and the taxes.)

4.

Work in Process Inventory 3,000 Raw Materials Inventory 3,000

(This is for the glue used in the factory. I know we used this to make the products, even though we didn’t use very much on any one of the products. I got it out of inventory, so I credited an inventory account.)

Instructions (a) How should Joe have recorded each of the four events? (b) If the entry was not corrected, which fi nancial statements (income statement or balance sheet)

would be affected? What balances would be overstated or understated?

Real-World Focus

BYP 2-4 Founded in 1970, Parlex Corporation is a world leader in the design and manufacture of fl exible interconnect products. Utilizing proprietary and patented technologies, Parlex produces custom fl exible interconnects including fl exible circuits, polymer thick fi lm, laminated cables, and value-added assemblies for sophisticated electronics used in automotive, telecommunications, computer, diversifi ed electronics, and aerospace applications. In addition to manufacturing sites in Methuen, Massachusetts; Salem, New Hampshire; Cranston, Rhode Island; San Jose, California; Shanghai, China; Isle of Wight, UK; and Empalme, Mexico, Parlex has logistic support centers and strategic alliances throughout North America, Asia, and Europe.

The following information was provided in the company’s annual report.

90 2 Job Order Costing

Parlex Company Notes to the Financial Statements

The Company’s products are manufactured on a job order basis to customers’ specifi cations. Customers submit requests for quotations on each job, and the Company prepares bids based on its own cost estimates. The Company attempts to refl ect the impact of changing costs when establishing prices. However, during the past several years, the market conditions for fl exible circuits and the resulting price sensitivity haven’t always allowed this to transpire. Although still not satisfactory, the Company was able to reduce the cost of products sold as a percentage of sales to 85% this year versus 87% that was experienced in the two immediately preceding years. Management continues to focus on improving operational effi ciency and further reduc- ing costs.

Instructions (a) Parlex management discusses the job order cost system employed by their company. What are

several advantages of using the job order approach to costing? (b) Contrast the products produced in a job order environment, like Parlex, to those produced

when process cost systems are used.

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BYP2-5 The Institute of Management Accountants sponsors a certifi cation for management accountants, allowing them to obtain the title of Certifi ed Management Accountant.

Address: www.imanet.org, or go to www.wiley.com/college/weygandt

Steps 1. Go to the site shown above. 2. Choose CMA Certifi cation, and then, Earning & Maintaining Your Credential.

Instructions (a) What is the experience qualifi cation requirement? (b) How many hours of continuing education are required, and what types of courses qualify?

Broadening Your Perspective 91

Critical Thinking

Communication Activity

BYP2-6 You are the management accountant for Williams Company. Your company does custom carpentry work and uses a job order cost system. Williams sends detailed job cost sheets to its customers, along with an invoice. The job cost sheets show the date materials were used, the dollar cost of materials, and the hours and cost of labor. A predetermined overhead application rate is used, and the total overhead applied is also listed.

Nancy Kopay is a customer who recently had custom cabinets installed. Along with her check in payment for the work done, she included a letter. She thanked the company for including the detailed cost information but questioned why overhead was estimated. She stated that she would be interested in knowing exactly what costs were included in overhead, and she thought that other customers would, too.

Instructions Prepare a letter to Ms. Kopay (address: 123 Cedar Lane, Altoona, KS 66651) and tell her why you did not send her information on exact costs of overhead included in her job. Respond to her sug- gestion that you provide this information.

Ethics Case

BYP2-7 LRF Printing provides printing services to many different corporate clients. Although LRF bids most jobs, some jobs, particularly new ones, are negotiated on a “cost-plus” basis. Cost-plus means that the buyer is willing to pay the actual cost plus a return (profi t) on these costs to LRF.

Alice Reiley, controller for LRF, has recently returned from a meeting where LRF’s president stated that he wanted her to fi nd a way to charge more costs to any project that was on a cost- plus basis. The president noted that the company needed more profi ts to meet its stated goals this period. By charging more costs to the cost-plus projects and therefore fewer costs to the jobs that were bid, the company should be able to increase its profi t for the current year.

Alice knew why the president wanted to take this action. Rumors were that he was looking for a new position and if the company reported strong profi ts, the president’s opportunities would be enhanced. Alice also recognized that she could probably increase the cost of certain jobs by chang- ing the basis used to allocate manufacturing overhead.

Instructions (a) Who are the stakeholders in this situation? (b) What are the ethical issues in this situation? (c) What would you do if you were Alice Reiley?

All About You

BYP2-8 Many of you will work for a small business. Some of you will even own your own business. In order to operate a small business, you will need a good understanding of managerial accounting, as well as many other skills. Much information is available to assist people who are interested in starting a new business. A great place to start is the website provided by the Small Business Admin- istration, which is an agency of the federal government whose purpose is to support small business.

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Instructions Go to www.sba.gov and in the Small Business Planner, Plan Your Business link, review the ma- terial under “Get Ready.” Answer the following questions. (a) What are some of the characteristics required of a small business owner? (b) What are the top 10 reasons given for business failure?

Considering Your Costs and Benefi ts

BYP2-9 After graduating, you might decide to start a small business. As discussed in this chapter, owners of any business need to know how to calculate the cost of their products. In fact, many small businesses fail because they don’t accurately calculate their product costs, so they don’t know if they are making a profi t or losing money—until it’s too late.

Suppose that you decide to start a landscape business. You use an old pickup truck that you’ve fully paid for. You store the truck and other equipment in your parents’ barn, and you store trees and shrubs on their land. Your parents will not charge you for the use of these facilities for the fi rst two years, but beginning in the third year they will charge a reasonable rent. Your mother helps you by answering phone calls and providing customers with information. She doesn’t charge you for this service, but she plans on doing it for only your fi rst two years in business. In pricing your services, should you include charges for the truck, the barn, the land, and your mother’s services when calculating your product cost? The basic arguments for and against are as follows.

YES: If you don’t include charges for these costs, your costs are understated and your profi t- ability is overstated. NO: At this point, you are not actually incurring costs related to these activities; therefore, you shouldn’t record charges.

Instructions Write a response indicating your position regarding this situation. Provide support for your view.

92 2 Job Order Costing

Answers to Chapter Questions

Answers to Insight and Accounting Across the Organization Questions

p. 51 Jobs Won, Money Lost Q: What type of costs do you think the company had been underes- timating? A: It is most likely that the company failed to estimate and track overhead. In a highly diversifi ed company, overhead associated with the diesel locomotive jobs may have been “lost” in the total overhead pool for the entire company. p. 57 The Cost of an iPhone? Just Tear One Apart Q: What type of costs are marketing and sell- ing costs, and how are they treated for accounting purposes? A: Product costs include materials, labor, and overhead. Costs not related to production, such as marketing and selling costs, are period costs which are expensed in the period that they are incurred. p. 67 Sales Are Nice, but Service Revenue Pays the Bills Q: Explain why GE would use job order costing to keep track of the cost of repairing a malfunctioning engine for a major airline. A: GE operates in a competitive environment. Other companies offer competing bids to win service contracts on GE’s airplane engines. GE needs to know what it costs to repair engines, so that it can present competitive bids while still generating a reasonable profi t.

Answers to Self-Test Questions

1. a 2. c 3. b 4. c 5. c 6. d 7. d 8. b 9. a 10. d 11. b ($180,000 3 80%) 12. c 13. b 14. c 15. c 16. b

✔ Remember to go back to The Navigator box on the chapter opening page and check off your completed work.

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Learning Objectives After studying this chapter, you should be able to:

1 Understand who uses process cost systems.

2 Explain the similarities and differences between job order

cost and process cost systems.

3 Explain the fl ow of costs in a process cost system.

4 Make the journal entries to assign manufacturing costs in a

process cost system.

5 Compute equivalent units.

6 Explain the four steps necessary to prepare a production

cost report.

7 Prepare a production cost report.

Feature Story

✔ The Navigator

✔ The Navigator

Chapter 3 Process Costing

Ben & Jerry’s Tracks Its Mix-Ups Ben & Jerry’s Homemade, Inc., based

in Waterbury, Vermont, started its fi rst

ice cream shop in a former gas station

in 1978.

Making ice cream is a process—a

movement of product from a mixing

department to a prepping department

to a pint department. The mixing

department is where the ice cream

is created. In the prep area, the

production process adds extras such

as cherries and dark chocolate to make

plain ice cream into “Cherry Garcia,”

Ben & Jerry’s most popular fl avor, or

fudge-covered waffl e cone pieces

and a swirl of caramel for “Stephen

Colbert’s Americone Dream.” The pint

department is where the ice cream is

actually put into containers. As the

product is processed from one depart-

ment to the next, the appropriate

materials, labor, and overhead are

added to determine its cost.

“The incoming ingredients from the

shipping and receiving departments

are stored in certain locations, either

in a freezer or dry warehouse,” says

Beecher Eurich, staff accountant.

“As ingredients get added, so do the

costs associated with them.” How

much ice cream is produced? Running

plants around the clock, the company

produces 18 million gallons a year.

Scan Learning Objectives

Read Feature Story

Read Preview

Read Text and answer p. 98 p. 101 p. 105 p. 110

Work Using the Decision Toolkit p. 112

Review Summary of Learning Objectives

Work Comprehensive p. 122

Answer Self-Test Questions

Complete Assignments

Go to WileyPLUS for practice and tutorials

DO IT!

DO IT!

94

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With the company’s process cost system, Eurich can tell you

how much a certain batch of ice cream costs to make—its

materials, labor, and

overhead in each of the

production departments.

She generates reports for

the production department

heads but makes sure not to

overdo it. “You can get

bogged down in numbers,”

says Eurich. “If you’re

generating a report that no one can use, then that’s a waste

of time.”

It’s more likely, though, that

Ben & Jerry’s production people

want to know how effi cient they

are. Why? Many own stock in

the company.

Watch the Jones Soda video in

WileyPLUS to learn more about

process costing in the real world.

✔ The Navigator

The cost accounting system used by companies such as Ben & Jerry’s is process cost accounting. In contrast to job order cost accounting, which focuses on the individual job, process cost accounting focuses on the processes involved in mass-producing products that are identical or very similar in nature. The primary objective of this chapter is to explain and illustrate process costing.

The content and organization of this chapter are as follows.

Preview of Chapter 3

• Uses • Service companies • Similarities and differences • Process cost fl ow • Assigning manufacturing costs

Nature of Process Cost Systems

• Weighted-average method • Refi nements

Equivalent Units

• Physical units • Equivalent units of production • Unit production costs • Cost reconciliation schedule • Production cost report • Costing systems—Final

comments

Production Cost Report

✔ The Navigator

95

PROCESS COSTING

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96 3 Process Costing

Uses of Process Cost Systems

Companies use process cost systems to apply costs to similar products that are mass-produced in a continuous fashion. Ben & Jerry’s uses a process cost sys- tem: Production of the ice cream, once it begins, continues until the ice cream emerges, and the processing is the same for the entire run—with precisely the same amount of materials, labor, and overhead. Each fi nished pint of ice cream is indistinguishable from another.

A company such as USX uses process costing in the manufacturing of steel. Kellogg and General Mills use process costing for cereal production; Exxon- Mobil uses process costing for its oil refi ning. Sherwin Williams uses process costing for its paint products. At a bottling company like Coca-Cola, the manu- facturing process begins with the blending of ingredients. Next, automated ma- chinery moves the bottles into position and fi lls them. The production process then caps, packages, and forwards the bottles to the fi nished goods warehouse. Illustration 3-1 shows this process.

The Nature of Process Cost Systems

Manufacturing Processes

Blending Filling Packaging

CO LA

Illustration 3-1 Manufacturing processes

For Coca-Cola, as well as the other companies just mentioned, once production begins, it continues until the fi nished product emerges, and each unit of fi nished product is like every other unit.

In comparison, a job order cost system assigns costs to a specifi c job. Examples are the construction of a customized home, the making of a motion picture, or the manufacturing of a specialized machine. Illustration 3-2 provides examples of com- panies that primarily use either a process cost system or a job order cost system.

Process Cost System Company Product

Job Order Cost System Company Product

Soft drinks Advertising

Oil Motion pictures

Computer chips Ice rinks

Coca-Cola, PepsiCo

ExxonMobil, Royal Dutch Shell

Intel, Advanced Micro Devices

Dow Chemical, DuPont

Chemicals

Young & Rubicam, J. Walter Thompson

Walt Disney, Warner Brothers

Center Ice Consultants, Ice Pro

Kaiser, Mayo Clinic

Patient health care

CO LA

CO LA

Illustration 3-2 Process cost and job order cost companies and products

Understand who uses process cost systems.

1LEARNING OBJECTIVE

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The Nature of Process Cost Systems 97

Process Costing for Service Companies

Frequently, when we think of service companies, we think of specifi c, nonroutine tasks, such as rebuilding an automobile engine, providing consulting services on a business acquisition, or working on a major lawsuit. However, many service companies specialize in performing repetitive, routine aspects of a particular business. For example, auto-care vendors such as Jiffy Lube focus on the routine aspects of car care. H&R Block focuses on the routine aspects of basic tax prac- tice, and many large law fi rms focus on routine legal services, such as uncompli- cated divorces. Service companies that provide specifi c, nonroutine services will probably benefi t from using a job order cost system. Those that perform routine, repetitive services will probably be better off with a process cost system.

Similarities and Differences Between Job Order Cost and Process Cost Systems

In a job order cost system, companies assign costs to each job. In a process cost system, companies track costs through a series of connected manufacturing processes or departments, rather than by individual jobs. Thus, companies use process cost systems when they produce a large volume of uniform or relatively homogeneous products. Illustration 3-3 shows the basic fl ow of costs in these two systems.

The following analysis highlights the basic similarities and differences between these two systems.

Finished Goods Inventory

Cost of Goods Sold

Job Order Cost Flow

Direct Materials Direct Labor Manufacturing

Overhead

Work in Process Inventory

Job No. 101 Job No. 102 Job No. 103

Finished Goods Inventory

Cost of Goods Sold

Process Cost Flow

Direct Materials Direct Labor Manufacturing

Overhead

Work in Process —

Department A

Work in Process —

Department B

Illustration 3-3 Job order cost and process cost fl ow

SIMILARITIES Job order cost and process cost systems are similar in three ways:

1. The manufacturing cost elements. Both costing systems track three man- ufacturing cost elements—direct materials, direct labor, and manufacturing overhead.

2. The accumulation of the costs of materials, labor, and overhead. Both cost- ing systems debit raw materials to Raw Materials Inventory, factory labor to Factory Labor, and manufacturing overhead costs to Manufacturing Overhead.

3. The fl ow of costs. As noted above, both systems accumulate all manufacturing costs by debits to Raw Materials Inventory, Factory Labor, and Manufacturing

Explain the similarities and differences between job order cost and process cost systems.

2LEARNING OBJECTIVE

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98 3 Process Costing

Overhead. Both systems then assign these costs to the same accounts—Work in Process, Finished Goods Inventory, and Cost of Goods Sold. The methods of assigning costs, however, differ signifi cantly. These differences are explained and illustrated later in the chapter.

DIFFERENCES The differences between a job order cost and a process cost system are as follows.

1. The number of work in process accounts used. A job order cost system uses only one work in process account. A process cost system uses multiple work in process accounts.

2. Documents used to track costs. A job order cost system charges costs to individual jobs and summarizes them in a job cost sheet. A process cost system summarizes costs in a production cost report for each department.

3. The point at which costs are totaled. A job order cost system totals costs when the job is completed. A process cost system totals costs at the end of a period of time.

4. Unit cost computations. In a job order cost system, the unit cost is the total cost per job divided by the units produced. In a process cost system, the unit cost is total manufacturing costs for the period divided by the units produced during the period.

Illustration 3-4 summarizes the major differences between a job order cost and a process cost system.

Multiple work in process accounts

Each period

Production cost reports

Total manufacturing costs ÷ Equivalent units produced during the period

Process Cost System

One work in process account

Job cost sheets

Each job

Cost of each job ÷ Units produced for the job

Job Order Cost SystemFeature

Work in process accounts

Documents used

Determination of total manufacturing costs

Unit-cost computations

Illustration 3-4 Job order versus process cost systems

Compare Job Order and Process Cost Systems

Action Plan ✔ Use job order costing

in situations where unit costs are high, unit volume is low, and products are unique.

✔ Use process costing when there is a large volume of relatively homogeneous products.

> DO IT!

1. false. 2. true. 3. false. 4. false.

Indicate whether each of the following statements is true or false.

1. A law fi rm is likely to use process costing for major lawsuits.

2. A manufacturer of paintballs is likely to use process costing.

3. Both job order and process costing determine product costs at the end of a period of time, rather than when a product is completed.

4. Process costing does not keep track of manufacturing overhead.

Solution

✔ The Navigator

Related exercise material: E3-1 and 3-1.DO IT!

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The Nature of Process Cost Systems 99

Process Cost Flow

Illustration 3-5 shows the fl ow of costs in the process cost system for Tyler Com- pany. Tyler Company manufactures roller blade and skateboard wheels that it sells to manufacturers and retail outlets. Manufacturing consists of two processes: machining and assembly. The Machining Department shapes, hones, and drills the raw materials. The Assembly Department assembles and packages the parts.

Raw Materials Factory Labor Manufacturing Overhead

Manufacturing Costs

Work in Process— Machining Department

Costs transferred out to

Finished Goods Inventory

Cost of goods sold

Cost of Goods Sold

Work in Process— Assembly Department

Cost of completed work

Assigned to

Illustration 3-5 Flow of costs in process cost system

As the fl ow of costs indicates, the company can add materials, labor, and manufacturing overhead in both the Machining and Assembly departments. When it fi nishes its work, the Machining Department transfers the partially com- pleted units to the Assembly Department. The Assembly Department fi nishes the goods and then transfers them to the fi nished goods inventory. Upon sale, Tyler removes the goods from the fi nished goods inventory. Within each department, a similar set of activities is performed on each unit processed.

Assigning Manufacturing Costs—Journal Entries

As indicated, the accumulation of the costs of materials, labor, and manufactur- ing overhead is the same in a process cost system as in a job order cost system. That is, both systems follow these procedures:

• Companies debit all raw materials to Raw Materials Inventory at the time of purchase.

• They debit all factory labor to Factory Labor as the labor costs are incurred.

• They debit overhead costs to Manufacturing Overhead as these costs are incurred.

However, the assignment of the three manufacturing cost elements to Work in Process in a process cost system is different from a job order cost system. Here we’ll look at how companies assign these manufacturing cost elements in a pro- cess cost system.

MATERIALS COSTS All raw materials issued for production are a materials cost to the producing depart- ment. A process cost system may use materials requisition slips, but it generally requires fewer requisitions than in a job order cost system, because the materials are used for processes rather than for specifi c jobs and therefore typically are for larger quantities.

At the beginning of the fi rst process, a company usually adds most of the ma- terials needed for production. However, other materials may be added at various points. For example, in the manufacture of Hershey candy bars, the chocolate and other ingredients are added at the beginning of the fi rst process, and the wrappers and cartons are added at the end of the packaging process. Tyler Com- pany adds materials at the beginning of each process. Tyler makes the following entry to record the materials used.

Materials

Explain the fl ow of costs in a process cost system.

3LEARNING OBJECTIVE

Make the journal entries to assign manufacturing costs in a process cost system.

4LEARNING OBJECTIVE

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100 3 Process Costing

Work in Process—Machining XXXX Work in Process—Assembly XXXX Raw Materials Inventory XXXX (To record materials used)

Work in Process—Machining XXXX Work in Process—Assembly XXXX Factory Labor XXXX (To assign factory labor to production)

Work in Process—Machining XXXX Work in Process—Assembly XXXX Manufacturing Overhead XXXX (To assign overhead to production)

Ice cream maker Ben & Jerry’s adds materials in three departments: milk and fl avoring in the mixing department, extras such as cherries and dark chocolate in the prepping department, and cardboard containers in the pinting (packaging) department.

FACTORY LABOR COSTS In a process cost system, as in a job order cost system, companies may use time tick- ets to determine the cost of labor assignable to production departments. Since they assign labor costs to a process rather than a job, they can obtain, from the payroll register or departmental payroll summaries, the labor cost chargeable to a process.

Labor costs for the Machining Department will include the wages of employees who shape, hone, and drill the raw materials. The entry to assign these costs for Tyler Company is:

MANUFACTURING OVERHEAD COSTS The objective in assigning overhead in a process cost system is to allocate the overhead costs to the production departments on an objective and equitable basis. That basis is the activity that “drives” or causes the costs. A primary driver of overhead costs in continuous manufacturing operations is machine time used, not direct labor. Thus, companies widely use machine hours in allocating man- ufacturing overhead costs using predetermined overhead rates. Tyler’s entry to allocate overhead to the two processes is:

What is the result if a company uses the wrong “cost driver” to assign manufacturing overhead? (See page 143.)?

Choosing a Cost Driver

In one of its automated cost centers, Caterpillar feeds work into the cost center, where robotic machines process it and transfer the fi nished job to the next cost center without human intervention. One person tends all of the machines and spends more time maintaining machines than operating them. In such cases, overhead rates based on direct labor hours may be misleading. Surprisingly, some companies continue to assign manufacturing overhead on the basis of direct labor despite the fact that there is no cause-and-effect relationship between labor and overhead.

MANAGEMENT INSIGHT

Factory Labor

Manufacturing Overhead

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The Nature of Process Cost Systems 101

TRANSFER TO NEXT DEPARTMENT At the end of the month, Tyler needs an entry to record the cost of the goods transferred out of the Machining Department. In this case, the transfer is to the Assembly Department, and Tyler makes the following entry.

Work in Process—Assembly XXXXX Work in Process—Machining XXXXX (To record transfer of units to the Assembly

Department)

Finished Goods Inventory XXXXX Work in Process—Assembly XXXXX (To record transfer of units to fi nished goods)

Cost of Goods Sold XXXXX Finished Goods Inventory XXXXX (To record cost of units sold)

TRANSFER TO FINISHED GOODS When the Assembly Department completes the units, it transfers them to the fi n- ished goods warehouse. The entry for this transfer is as follows.

TRANSFER TO COST OF GOODS SOLD When Tyler sells the fi nished goods, it records the cost of goods sold as follows.

Manufacturing Costs in Process Costing

> DO IT!

Ruth Company manufactures ZEBO through two processes: blending and bottling. In June, raw materials used were Blending $18,000 and Bottling $4,000. Factory labor costs were Blending $12,000 and Bottling $5,000. Manufacturing overhead costs were Blending $6,000 and Bottling $2,500. The company transfers units completed at a cost of $19,000 in the Blending Department to the Bottling Department. The Bottling Department transfers units completed at a cost of $11,000 to Finished Goods. Journalize the assignment of these costs to the two processes and the transfer of units as appropriate.

Solution

The entries are: Work in Process—Blending 18,000 Work in Process—Bottling 4,000 Raw Materials Inventory 22,000 (To record materials used)

Work in Process—Blending 12,000 Work in Process—Bottling 5,000 Factory Labor 17,000 (To assign factory labor to production)

Work in Process—Blending 6,000 Work in Process—Bottling 2,500 Manufacturing Overhead 8,500 (To assign overhead to production)

Action Plan ✔ In process cost

accounting, keep separate work in process accounts for each process.

✔ When the costs are assigned to produc- tion, debit the sepa- rate work in process accounts.

✔ Transfer cost of com- pleted units to the next process or to Finished Goods.

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102 3 Process Costing

Suppose you have a work-study job in the offi ce of your college’s president, and she asks you to compute the cost of instruction per full-time equivalent student at your college. The college’s vice president for fi nance provides the following information.

Equivalent Units

Illustration 3-6 Information for full-time student example

Costs: Total cost of instruction $9,000,000

Student population: Full-time students 900 Part-time students 1,000

Part-time students take 60% of the classes of a full-time student during the year. To compute the number of full-time equivalent students per year, you would make the following computation.

Illustration 3-7 Full-time equivalent unit computation

Full-Time Equivalent Units Full-Time Equivalent Students

1 of Part-Time Students

5 Students

900 1 (60% 3 1,000) 5 1,500

The cost of instruction per full-time equivalent student is therefore the total cost of instruction ($9,000,000) divided by the number of full-time equivalent students (1,500), which is $6,000 ($9,000,000 4 1,500).

A process cost system uses the same idea, called equivalent units of produc- tion. Equivalent units of production measure the work done during the period, expressed in fully completed units. Companies use this measure to determine the cost per unit of completed product.

Weighted-Average Method

The formula to compute equivalent units of production is as follows.

Work in Process—Bottling 19,000 Work in Process—Blending 19,000 (To record transfer of units to the Bottling

Department)

Finished Goods Inventory 11,000 Work in Process—Bottling 11,000 (To record transfer of units to fi nished goods)

Related exercise material: BE3-1, BE3-2, BE3-3, E3-2, E3-4, and DO IT! 3-2.

✔ The Navigator

Equivalent Units of

Units Completed and 1 Ending Work in 5

Equivalent Units of

Transferred Out

Process Production

Illustration 3-8 Equivalent units of production formula

Compute equivalent units.

5LEARNING OBJECTIVE

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Equivalent Units 103

To better understand this concept of equivalent units, consider the following two separate examples.

Example 1. In a specifi c period, the entire output of Sullivan Company’s Blend- ing Department consists of ending work in process of 4,000 units which are 60% complete as to materials, labor, and overhead. The equivalent units of produc- tion for the Blending Department are therefore 2,400 units (4,000 3 60%). Example 2. The output of Kori Company’s Packaging Department during the period consists of 10,000 units completed and transferred out, and 5,000 units in ending work in process which are 70% completed. The equivalent units of production are therefore 13,500 [10,000 1 (5,000 3 70%)].

This method of computing equivalent units is referred to as the weighted-average method. It considers the degree of completion (weighting) of the units completed and transferred out and the ending work in process.

Refi nements on the Weighted-Average Method

Kellogg Company has produced Eggo® Waffl es since 1970. Three departments produce these waffl es: Mixing, Baking, and Freezing/Packaging. The Mixing Department combines dry ingredients, including fl our, salt, and baking powder, with liquid ingredients, including eggs and vegetable oil, to make waffl e batter. Illustration 3-9 provides information related to the Mixing Department at the end of June.

Illustration 3-9 Information for Mixing Department

Mixing Department

Percentage Complete Physical Units Materials Conversion Costs

Work in process, June 1 100,000 100% 70% Started into production 800,000

Total units 900,000

Units transferred out 700,000 Work in process, June 30 200,000 100% 60%

Total units 900,000

Illustration 3-9 indicates that the beginning work in process is 100% com- plete as to materials cost and 70% complete as to conversion costs. Conversion costs are the sum of labor costs and overhead costs. In other words, Kellogg adds both the dry and liquid ingredients (materials) at the beginning of the waffl e-making process, and the conversion costs (labor and over- head) related to the mixing of these ingredients are incurred uniformly and are 70% complete. The ending work in process is 100% complete as to materials cost and 60% complete as to conversion costs.

We then use the Mixing Department information to determine equiva- lent units. In computing equivalent units, the beginning work in pro- cess is not part of the equivalent-units-of-production formula. The units transferred out to the Baking Department are fully complete as to both materials and conversion costs. The ending work in process is fully complete as to materials, but only 60% complete as to conversion costs. We therefore need to make two equivalent unit computations: one

Helpful Hint When are separate unit cost computations needed for materials and conversion costs? Answer: Whenever the two types of costs do not occur in the process at the same time.

An unethical manager might use incorrect completion per- centages when determining equivalent units. This results in either raising or lowering costs. Since completion percentages are somewhat subjective, this form of income manipulation can be diffi cult to detect.

Ethics Note

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104 3 Process Costing

Illustration 3-10 Computation of equivalent units—Mixing Department

Mixing Department

Equivalent Units

Materials Conversion Costs

Units transferred out 700,000 700,000 Work in process, June 30 200,000 3 100% 200,000 200,000 3 60% 120,000

Total equivalent units 900,000 820,000

We can refi ne the earlier formula used to compute equivalent units of produc- tion (Illustration 3-8, page 102) to show the computations for materials and for conversion costs, as follows.

Units Completed and Equivalent Units of Equivalent Units of Transferred Out— 1 Ending Work in 5 Production— Materials Process—Materials Materials

Units Completed and

Equivalent Units of Equivalent Units of

Transferred Out—

1

Ending Work in 5 Production—

Conversion Costs

Process—Conversion Conversion Costs

Costs

Illustration 3-11 Refi ned equivalent units of production formula

for materials, and the other for conversion costs. Illustration 3-10 shows these computations.

Haven’t I Seen That Before?

For a variety of reasons, many companies, including Caterpillar, General Electric, and Eastman Kodak, are making a big push to remanufacture goods that have been thrown away. Items getting a second chance include cell phones, computers, home appliances, car parts, vacuum cleaners, and medical equipment. Businesses have fi gured out that profi t margins on remanu- factured goods are signifi cantly higher than on new goods. As commodity prices such as copper and steel increase, reusing parts makes more sense. Also, as more local governments initiate laws requiring that electronics and appliances be recycled rather than thrown away, the cost of remanufacturing declines because the gathering of used goods becomes far more effi cient. Besides benefi tting the manufacturer, remanufacturing provides goods at a much lower price to consumers, reduces waste going to landfi lls, saves energy, reuses scarce resources, and reduces emissions. For example, it was estimated that a remanufactured car starter results in about 50% less carbon dioxide emissions than making a new one.

Source: James R. Hagerty and Paul Glader, “From Trash Heap to Store Shelf,” Wall Street Journal Online (January 24, 2011).

PEOPLE, PLANET, AND PROFIT INSIGHT

In what ways might the relative composition (materials, labor, and overhead) of a remanufactured product’s cost differ from that of a newly made product? (See page 143.)?

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Production Cost Report 105

Equivalent Units

Action Plan ✔ To measure the work

done during the period, expressed in fully completed units, compute equivalent units of production.

✔ Use the appropriate formula: Units com- pleted and transferred out 1 Equivalent units of ending work in process 5 Equivalent units of production.

> DO IT!

The fabricating department has the following production and cost data for the current month.

Beginning Units Ending Work in Process Transferred Out Work in Process

–0– 15,000 10,000

Materials are entered at the beginning of the process. The ending work in process units are 30% complete as to conversion costs. Compute the equivalent units of production for (a) materials and (b) conversion costs.

Solution

(a) Since materials are entered at the beginning of the process, the equivalent units of ending work in process are 10,000. Thus, 15,000 units 1 10,000 units 5 25,000 equivalent units of production for materials.

(b) Since ending work in process is only 30% complete as to conversion costs, the equiv- alent units of ending work in process are 3,000 (30% 3 10,000 units). Thus, 15,000 units 1 3,000 units 5 18,000 equivalent units of production for conversion costs.

✔ The Navigator

Related exercise material: BE3-5, BE3-10, E3-5, E3-6, E3-8, E3-9, E3-10, E3-11, E3-13, E3-14, E3-15, and 3-3.DO IT!

Production Cost Report Production Cost ReportProduction Cost Report

WIP WIPBaking Department

Freezing/Packaging Department

Finished Goods

Raw Materials Factory Labor

Manufacturing Overhead

Mixing Department

Illustration 3-12 Flow of costs in making Eggo® Waffl es

As mentioned earlier, companies prepare a production cost report for each de- partment. A production cost report is the key document that management uses to understand the activities in a department; it shows the production quantity and cost data related to that department. For example, in producing Eggo® Waffl es, Kellogg Company uses three production cost reports: Mixing, Baking, and Freezing/Packaging. Illustration 3-12 shows the fl ow of costs to make an Eggo® Waffl e and the related production cost reports for each department.

Production Cost Report

Explain the four steps necessary to prepare a production cost report.

6LEARNING OBJECTIVE

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106 3 Process Costing

In order to complete a production cost report, the company must perform four steps, which, as a whole, make up the process cost system.

1. Compute the physical unit fl ow.

2. Compute the equivalent units of production.

3. Compute unit production costs.

4. Prepare a cost reconciliation schedule.

Illustration 3-13 shows assumed data for the Mixing Department at Kellogg Company for the month of June. We will use this information to complete a pro- duction cost report for the Mixing Department.

Illustration 3-13 Unit and cost data—Mixing Department

Mixing Department

Units Work in process, June 1 100,000 Direct materials: 100% complete Conversion costs: 70% complete Units started into production during June 800,000 Units completed and transferred out to Baking Department 700,000 Work in process, June 30 200,000 Direct materials: 100% complete Conversion costs: 60% complete

Costs Work in process, June 1 Direct materials: 100% complete $ 50,000 Conversion costs: 70% complete 35,000

Cost of work in process, June 1 $ 85,000

Costs incurred during production in June Direct materials $400,000 Conversion costs 170,000

Costs incurred in June $570,000

Compute the Physical Unit Flow (Step 1)

Physical units are the actual units to be accounted for during a period, irrespec- tive of any work performed. To keep track of these units, add the units started (or transferred) into production during the period to the units in process at the beginning of the period. This amount is referred to as the total units to be accounted for.

The total units then are accounted for by the output of the period. The output consists of units transferred out during the period and any units in process at the end of the period. This amount is referred to as the total units accounted for. Illustration 3-14 shows the fl ow of physical units for Kellogg’s Mixing Depart- ment for the month of June.

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Production Cost Report 107

Illustration 3-14 Physical unit fl ow—Mixing Department

Mixing Department

Physical Units

Units to be accounted for Work in process, June 1 100,000 Started (transferred) into production 800,000

Total units 900,000

Units accounted for Completed and transferred out 700,000 Work in process, June 30 200,000

Total units 900,000

The records indicate that the Mixing Department must account for 900,000 units. Of this sum, 700,000 units were transferred to the Baking Department and 200,000 units were still in process.

Compute the Equivalent Units of Production (Step 2)

Once the physical fl ow of the units is established, Kellogg must measure the Mixing Department’s productivity in terms of equivalent units of production. The Mixing Department adds materials at the beginning of the process, and it incurs conver- sion costs uniformly during the process. Thus, we need two computations of equivalent units: one for materials and one for conversion costs. The equivalent unit computation is as follows.

Helpful Hint Materials are not always added at the beginning of the process. For example, materials are sometimes added uniformly during the process.

Helpful Hint Remember that we ignore the beginning work in process in this computation.

Illustration 3-15 Computation of equivalent units—Mixing Department

Equivalent Units

Materials Conversion Costs

Units transferred out 700,000 700,000 Work in process, June 30 200,000 3 100% 200,000 200,000 3 60% 120,000

Total equivalent units 900,000 820,000

Illustration 3-16 Total materials cost computation

Work in process, June 1 Direct materials cost $ 50,000 Costs added to production during June Direct materials cost 400,000

Total materials cost $450,000

Compute Unit Production Costs (Step 3)

Armed with the knowledge of the equivalent units of production, we can now compute the unit production costs. Unit production costs are costs expressed in terms of equivalent units of production. When equivalent units of production are different for materials and conversion costs, we compute three unit costs: (1) materials, (2) conversion, and (3) total manufacturing.

The computation of total materials cost related to Eggo® Waffl es is as follows.

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108 3 Process Costing

The computation of unit materials cost is as follows.

Illustration 3-17 Unit materials cost computation

Total Materials Equivalent Units Unit Materials Cost

4 of Materials

5 Cost

$450,000 4 900,000 5 $0.50

Illustration 3-19 Unit conversion cost computation

Total Conversion Equivalent Units of Unit Conversion Costs

4 Conversion Costs

5 Cost

$205,000 4 820,000 5 $0.25

Illustration 3-20 Total manufacturing cost per unit

Unit Materials Unit Conversion Total Manufacturing Cost

1 Cost

5 Cost per Unit

$0.50 1 $0.25 5 $0.75

Illustration 3-18 shows the computation of total conversion costs.

Illustration 3-18 Total conversion costs computation

Work in process, June 1 Conversion costs $ 35,000 Costs added to production during June Conversion costs 170,000

Total conversion costs $205,000

Illustration 3-21 Costs charged to Mixing Department

Costs to be accounted for Work in process, June 1 $ 85,000 Started into production 570,000

Total costs $655,000

The computation of unit conversion cost is as follows.

Total manufacturing cost per unit is therefore computed as shown in Illustra- tion 3-20.

Prepare a Cost Reconciliation Schedule (Step 4)

We are now ready to determine the cost of goods transferred out of the Mixing Department to the Baking Department and the costs in ending work in process. Kellogg charged total costs of $655,000 to the Mixing Department in June, calcu- lated as follows.

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Production Cost Report 109

The company then prepares a cost reconciliation schedule to assign these costs to (a) units transferred out to the Baking Department and (b) ending work in process.

Illustration 3-22 Cost reconciliation schedule— Mixing Department

Mixing Department Cost Reconciliation Schedule

Costs accounted for Transferred out (700,000 3 $0.75) $ 525,000 Work in process, June 30 Materials (200,000 3 $0.50) $100,000 Conversion costs (120,000 3 $0.25) 30,000 130,000

Total costs $655,000

DECISION TOOLKIT DECISION CHECKPOINTS INFO NEEDED FOR DECISION TOOL TO USE FOR DECISION HOW TO EVALUATE RESULTS

What is the cost of a product? Production cost report Compare costs to previous periods, to competitors, and to expected selling price to evaluate overall profi tability.

Cost of materials, labor, and overhead assigned to processes used to make the product

Kellogg uses the total manufacturing cost per unit, $0.75, in costing the units completed and transferred to the Baking Department. In contrast, the unit cost of materials and the unit cost of conversion are needed in costing units in pro- cess. The cost reconciliation schedule shows that the total costs accounted for (Illustration 3-22) equal the total costs to be accounted for (Illustration 3-21).

Preparing the Production Cost Report

At this point, Kellogg is ready to prepare the production cost report for the Mixing Department. As indicated earlier, this report is an internal document for manage- ment that shows production quantity and cost data for a production department.

There are four steps in preparing a production cost report:

1. Compute the physical unit fl ow.

2. Compute the equivalent units of production.

3. Compute unit production costs.

4. Prepare a cost reconciliation schedule.

Illustration 3-23 (page 110) shows the production cost report for the Mixing Department. The report identifi es the four steps.

Production cost reports provide a basis for evaluating the productivity of a department. In addition, managers can use the cost data to assess whether unit costs and total costs are reasonable. By comparing the quantity and cost data with predetermined goals, top management can also judge whether current per- formance is meeting planned objectives.

Prepare a production cost report.

7LEARNING OBJECTIVE

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110 3 Process Costing

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A P18 fx

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Formulas Data Review ViewPage LayoutInsertHome

Mixing Department.xls

(200,000 � 60%)

$655,000

$0.75

$85,000 570,000

$655,000

$525,000

130,000 $655,000

100,000 800,000 900,000

700,000 200,000 900,000

(a) (b)

700,000 200,000 900,000

$450,000 900,000

$0.50

700,000 120,000 820,000

$205,000 820,000

$0.25

$100,000 30,000

QUANTITIES Units to be accounted for Work in process, June 1 Started into produc�on Total units Units accounted for Transferred out Work in process, June 30 Total units COSTS

Unit costs

Total cost Equivalent units Unit costs [(a) � (b)] Costs to be accounted for Work in process, June 1 Started into produc�on Total costs Cost Reconcilia�on Schedule Costs accounted for Transferred out (700,000 � $0.75) Work in process, June 30 Materials (200,000 � $0.50) Conversion costs (120,000 � $0.25) Total costs

Mixing Department Produc�on Cost Report

For the Month Ended June 30, 2014

Equivalent Units

Physical Units

Materials Conversion

Costs

Step 1 Step 2

Step 3

Step 4

Materials Conversion

Costs Total

Illustration 3-23 Production cost report

Cost Reconciliation Schedule

> DO IT!

In March, Rodayo Manufacturing had the following unit production costs: materials $6 and conversion costs $9. On March 1, it had zero work in process. During March, Rodayo transferred out 12,000 units. As of March 31, 800 units that were 25% complete as to con- version costs and 100% complete as to materials were in ending work in process. Assign the costs to the units transferred out and in process.

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Production Cost Report 111

Costing Systems—Final Comments

Companies often use a combination of a process cost and a job order cost system. Called operations costing, this hybrid system is similar to process costing in its assumption that standardized methods are used to manufacture the product. At the same time, the product may have some customized, individual features that require the use of a job order cost system.

Consider, for example, the automobile manufacturer Ford Motor Company. Each vehicle at a given plant goes through the same assembly line, but Ford uses different materials (such as seat coverings, paint, and tinted glass) for different vehicles. Similarly, Kellogg’s Pop-Tarts® toaster pastries go through numerous standardized processes—mixing, fi lling, baking, frosting, and packaging. The pastry dough, though, comes in different fl avors—plain, chocolate, and graham— and fi llings include Smucker’s® real fruit, chocolate fudge, vanilla creme, brown sugar cinnamon, and s’mores.

A cost-benefi t trade-off occurs as a company decides which costing system to use. A job order cost system, for example, provides detailed information related to the cost of the product. Because each job has its own distinguishing character- istics, the system can provide an accurate cost per job. This information is useful in controlling costs and pricing products. However, the cost of implementing a job order cost system is often expensive because of the accounting costs involved.

On the other hand, for a company like Intel, which makes computer chips, is there a benefi t in knowing whether the cost of the one-hundredth chip produced is different from the one-thousandth chip produced? Probably not. An average cost of the product will suffi ce for control and pricing purposes.

In summary, when deciding to use one of these systems, or a combination system, a company must weigh the costs of implementing the system against the benefi ts from the additional information provided.

✔ The Navigator

Related exercise material: BE3-4, BE3-6, BE3-7, BE3-8, BE3-9, BE3-10, E3-5, E3-6, E3-8, E3-9, E3-10, E3-11, E3-14, E3-15, and 3-4.

The assignment of costs is as follows.

Costs accounted for Transferred out (12,000 3 $15) $180,000 Work in process, March 31 Materials (800 3 $6) $4,800 Conversion costs (200a 3 $9) 1,800 6,600

Total costs $186,600 a800 3 25%

Solution

DO IT!

Action Plan ✔ Assign the total

manufacturing cost of $15 per unit to the 12,000 units transferred out.

✔ Assign the materials cost and conversion costs based on equiva- lent units of produc- tion to units in ending work in process.

DECISION TOOLKIT DECISION CHECKPOINTS INFO NEEDED FOR DECISION TOOL TO USE FOR DECISION HOW TO EVALUATE RESULTS

What costing method should be used?

Cost of accounting system; benefi ts of additional information

The benefi ts of providing the additional information should exceed the costs of the accounting system needed to develop the information.

Type of product or service produced

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112 3 Process Costing

Essence Company manufactures a high-end after-shave lotion, called Eternity, in 10-ounce plastic bottles. Because the market for after-shave lotion is highly competitive, the company is very concerned about keeping its costs under control. Eternity is manufactured through three processes: mixing, fi lling, and corking. Materials are added at the beginning of the process, and labor and overhead are incurred uniformly throughout each process. The company uses a weighted-average method to cost its product. A partially completed production cost report for the month of May for the Mixing Department is shown below.

USING THE DECISION TOOLKIT

Essence Company Mixing Department

Production Cost Report For the Month Ended May 31, 2014

Equivalent Units Physical Conversion Quantities Units Materials Costs Units to be accounted for Step 1 Step 2

Work in process, May 1 1,000 Started into production 2,000 Total units 3,000 Units accounted for Transferred out 2,200 ? ? Work in process, May 31 800 ? ? Total units 3,000 ? ?

Conversion Costs Materials Costs Total Unit costs Step 3

Total cost (a) ? ? ?

Equivalent units (b) ? ?

Unit costs [(a) 4 (b)] ? ? ? Costs to be accounted for Work in process, May 1 $ 56,300 Started into production 119,320 Total costs $175,620

Cost Reconciliation Schedule Step 4 Costs accounted for Transferred out ? Work in process, May 31 Materials ? Conversion costs ? ? Total costs ?

Additional information: Work in process, May 1, 1000 units Materials cost, 1,000 units (100% complete) $49,100 Conversion costs, 1,000 units (70% complete) 7,200 $ 56,300 Materials cost for May, 2,000 units $100,000 Work in process, May 31, 800 units, 100% complete as to materials and 50% complete as to conversion costs.

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Using the Decision Toolkit 113

Instructions (a) Prepare a production cost report for the Mixing Department for the month of May. (b) Prepare the journal entry to record the transfer of goods from the Mixing Department to the

Filling Department. (c) Explain why Essence Company is using a process cost system to account for its costs.

Solution (a) A completed production cost report for the Mixing Department is shown below.

Computations to support the amounts reported follow the report.

Essence Company Mixing Department

Production Cost Report For the Month Ended May 31, 2014

Equivalent Units Physical Conversion Quantities Units Materials Costs Units to be accounted for Step 1 Step 2

Work in process, May 1 1,000 Started into production 2,000 Total units 3,000 Units accounted for Transferred out 2,200 2,200 2,200 Work in process, May 31 800 800 400 Total units 3,000 3,000 2,600

Costs Conversion Unit costs Step 3 Materials Costs Total Total cost* (a) $149,100 $26,520 $175,620

Equivalent units (b) 3,000 2,600

Unit costs [(a) 4 (b)] $49.70 $10.20 $59.90 Costs to be accounted for Work in process, May 1 $ 56,300 Started into production 119,320 Total costs $175,620

*Additional computations to support production cost report data: Materials cost—$49,100 1 $100,000 Conversion costs—$7,200 1 $19,320 ($119,320 2 $100,000)

Cost Reconciliation Schedule Step 4 Costs accounted for Transferred out (2,200 3 $59.90) $131,780 Work in process, May 31 Materials (800 3 $49.70) $39,760 Conversion costs (400 3 $10.20) 4,080 43,840

Total costs $175,620

(800 3 50%)

Action Plan ✔ Compute the physical

unit fl ow—that is, the total units to be accounted for.

✔ Compute the equivalent units of production.

✔ Compute the unit production costs, expressed in terms of equivalent units of production.

✔ Prepare a cost rec- onciliation schedule, which shows that the total costs accounted for equal the total costs to be accounted for.

✔ The Navigator

(b) Work in Process—Filling 131,780 Work in Process—Mixing 131,780 (c) Companies use process cost systems to apply costs to similar products that are mass-produced in a continuous fashion.

Essence Company uses a process cost system because production of the after-shave lotion, once it begins, continues until the after-shave lotion emerges. The processing is the same for the entire run—with precisely the same amount of materials, labor, and overhead. Each bottle of Eternity after-shave lotion is indistinguishable from another.

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114 3 Process Costing

1 Understand who uses process cost systems. Compa- nies that mass-produce similar products in a continu- ous fashion use process cost systems. Once production begins, it continues until the fi nished product emerges. Each unit of fi nished product is indistinguishable from every other unit.

2 Explain the similarities and differences between job order cost and process cost systems. Job order cost sys- tems are similar to process cost systems in three ways: (1) Both systems track the same cost elements—direct materials, direct labor, and manufacturing overhead. (2) Both accumulate costs in the same accounts—Raw Materials Inventory, Factory Labor, and Manufactur- ing Overhead. (3) Both assign accumulated costs to the same accounts—Work in Process, Finished Goods Inventory, and Cost of Goods Sold. However, the method of assigning costs differs signifi cantly.

There are four main differences between the two cost systems: (1) A process cost system uses separate accounts for each department or manufacturing pro- cess, rather than only one work in process account used in a job order cost system. (2) A process cost system summarizes costs in a production cost report for each department. A job order cost system charges costs to individual jobs and summarizes them in a job cost sheet. (3) Costs are totaled at the end of a time period in a process cost system, but at the completion of a job in a job order cost system. (4) A process cost system calculates unit cost as: Total manufacturing costs for the period 4 Units produced during the period. A job order cost system calculates unit cost as: Total cost per job 4 Units produced.

3 Explain the fl ow of costs in a process cost system. A process cost system assigns manufacturing costs for raw materials, labor, and overhead to work in process accounts for various departments or manufacturing processes. It transfers the costs of partially completed units from one department to another as those units move through the manufacturing process. The sys- tem transfers the costs of completed work to Finished

Goods Inventory. Finally, when inventory is sold, the system transfers the costs to Cost of Goods Sold.

4 Make the journal entries to assign manufacturing costs in a process cost system. Entries to assign the costs of raw materials, labor, and overhead consist of a credit to Raw Materials Inventory, Factory Labor, and Manu- facturing Overhead, and a debit to Work in Process for each department. Entries to record the cost of goods transferred to another department are a credit to Work in Process for the department whose work is fi nished and a debit to the department to which the goods are transferred. The entry to record units completed and transferred to the warehouse is a credit to Work in Process for the department whose work is fi nished and a debit to Finished Goods Inventory. The entry to record the sale of goods is a credit to Finished Goods Inventory and a debit to Cost of Goods Sold.

5 Compute equivalent units. Equivalent units of produc- tion measure work done during a period, expressed in fully completed units. Companies use this measure to determine the cost per unit of completed product. Equivalent units are the sum of units completed and transferred out plus equivalent units of ending work in process.

6 Explain the four steps necessary to prepare a production cost report. The four steps to complete a production cost report are: (1) Compute the physical unit fl ow— that is, the total units to be accounted for. (2) Compute the equivalent units of production. (3) Compute the unit production costs, expressed in terms of equivalent units of production. (4) Prepare a cost reconciliation schedule, which shows that the total costs accounted for equal the total costs to be accounted for.

7 Prepare a production cost report. The production cost report contains both quantity and cost data for a pro- duction department. There are four sections in the report: (1) number of physical units, (2) equivalent units determination, (3) unit costs, and (4) cost recon- ciliation schedule.

SUMMARY OF LEARNING OBJECTIVES ✔ The Navigator

DECISION TOOLKIT A SUMMARY HOW TO EVALUATE RESULTS

Compare costs to previous periods, to competitors, and to expected selling price to evaluate overall profi tability.

Cost of accounting system; benefi ts of additional information

Which costing method should be used?

Type of product or service produced

The benefi ts of providing the additional information should exceed the costs of the accounting system needed to develop the information.

DECISION CHECKPOINTS INFO NEEDED FOR DECISION

What is the cost of a product? Production cost reportCosts of materials, labor, and overhead assigned to processes used to make the product

TOOL TO USE FOR DECISION

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Appendix 3A: FIFO Method 115

APPENDIX 3A FIFO METHOD

In this chapter, we demonstrated the weighted-average method of computing equivalent units. Some companies use a different method, referred to as the fi rst- in, fi rst-out (FIFO) method, to compute equivalent units. The purpose of this appendix is to illustrate how companies use the FIFO method to prepare a pro- duction cost report.

Equivalent Units Under FIFO

Under the FIFO method, companies compute equivalent units on a fi rst-in, fi rst-out basis. Some companies favor the FIFO method because the FIFO cost assumption usually corresponds to the actual physical fl ow of the goods. Under the FIFO method, companies therefore assume that the beginning work in process is completed before new work is started.

Using the FIFO method, equivalent units are the sum of the work performed to:

1. Finish the units of beginning work in process inventory.

2. Complete the units started into production during the period (referred to as the units started and completed).

3. Start, but only partially complete, the units in ending work in process inventory.

Normally, in a process cost system, some units will always be in process at both the beginning and end of the period.

ILLUSTRATION Illustration 3A-1 shows the physical fl ow of units for the Assembly Department of Shutters Inc. In addition, it indicates the degree of completion of the work in process accounts in regard to conversion costs.

Assembly Department

Physical Units

Units to be accounted for Work in process, June 1 (40% complete) 500 Started (transferred) into production 8,000

Total units 8,500

Units accounted for Completed and transferred out 8,100 Work in process, June 30 (75% complete) 400

Total units 8,500

Illustration 3A-1 Physical unit fl ow—Assembly Department

In Illustration 3A-1, the units completed and transferred out (8,100) plus the units in ending work in process (400) equal the total units to be accounted for (8,500). Using FIFO, we then compute equivalent units as follows.

1. The 500 units of beginning work in process were 40% complete. Thus, 300 equiv- alent units (60% 3 500 units) were required to complete the beginning inventory.

2. The units started and completed during the current month are the units trans- ferred out minus the units in beginning work in process. For the Assembly Department, units started and completed are 7,600 (8,100 2 500).

3. The 400 units of ending work in process were 75% complete. Thus, equivalent units were 300 (75% 3 400).

Compute equivalent units using the FIFO method.

8LEARNING OBJECTIVE

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116 3 Process Costing

Equivalent units for the Assembly Department are 8,200, computed as follows.

Assembly Department

Work Added Equivalent Production Data Physical Units This Period Units

Work in process, June 1 500 60% 300 Started and completed 7,600 100% 7,600 Work in process, June 30 400 75% 300

Total 8,500 8,200

Illustration 3A-2 Computation of equivalent units—FIFO method

Illustration 3A-3 Unit and cost data—Mixing Department

Mixing Department

Units Work in process, June 1 100,000 Direct materials: 100% complete Conversion costs: 70% complete Units started into production during June 800,000 Units completed and transferred out to Baking Department 700,000 Work in process, June 30 200,000 Direct materials: 100% complete Conversion costs: 60% complete

Costs Work in process, June 1 Direct materials: 100% complete $ 50,000 Conversion costs: 70% complete 35,000

Cost of work in process, June 1 $ 85,000

Costs incurred during production in June Direct materials $400,000 Conversion costs 170,000

Costs incurred in June $570,000

COMPUTE THE PHYSICAL UNIT FLOW (STEP 1) Illustration 3A-4 (page 117) shows the physical fl ow of units for Kellogg for the month of June for the Mixing Department.

Under the FIFO method, companies often expand the physical units sched- ule, as shown in Illustration 3A-5 (page 117) to explain the transferred-out section. As a result, this section reports the beginning work in process and the units started and completed. These two items further explain the completed and transferred- out section.

Comprehensive Example

To provide a complete illustration of the FIFO method, we will use the data for the Mixing Department at Kellogg Company for the month of June, as shown in Illustration 3A-3.

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Appendix 3A: FIFO Method 117

Illustration 3A-4 Physical unit fl ow—Mixing Department

Mixing Department

Physical Units

Units to be accounted for Work in process, June 1 100,000 Started (transferred) into production 800,000

Total units 900,000

Units accounted for Completed and transferred out 700,000 Work in process, June 30 200,000

Total units 900,000

Illustration 3A-5 Physical unit fl ow (FIFO)— Mixing Department

Mixing Department

Physical Units

Units to be accounted for Work in process, June 1 100,000 Started (transferred) into production 800,000

Total units 900,000

Units accounted for Completed and transferred out Work in process, June 1 100,000 Started and completed 600,000

700,000 Work in process, June 30 200,000

Total units 900,000

The records indicate that the Mixing Department must account for 900,000 units. Of this sum, 700,000 units were transferred to the Baking Department and 200,000 units were still in process.

COMPUTE EQUIVALENT UNITS OF PRODUCTION (STEP 2) As with the method presented in the chapter, once they determine the physical fl ow of the units, companies need to determine equivalent units of production. The Mixing Department adds materials at the beginning of the process, and it incurs conversion costs uniformly during the process. Thus, Kellogg must make two computations of equivalent units: one for materials and one for conversion costs.

EQUIVALENT UNITS FOR MATERIALS Since Kellogg adds materials at the be- ginning of the process, no additional materials costs are required to complete the beginning work in process. In addition, 100% of the materials costs has been in- curred on the ending work in process. Thus, the computation of equivalent units for materials is as follows.

Helpful Hint Materials are not always added at the beginning of the process. For example, companies sometimes add materials uniformly during the process.

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118 3 Process Costing

Illustration 3A-6 Computation of equivalent units—materials

Mixing Department—Materials

Materials Added Equivalent Production Data Physical Units This Period Units

Work in process, June 1 100,000 –0– –0– Started and fi nished 600,000 100% 600,000 Work in process, June 30 200,000 100% 200,000

Total 900,000 800,000

Illustration 3A-7 Computation of equivalent units—conversion costs

Mixing Department—Conversion Costs

Work Added Equivalent Production Data Physical Units This Period Units

Work in process, June 1 100,000 30% 30,000 Started and fi nished 600,000 100% 600,000 Work in process, June 30 200,000 60% 120,000

Total 900,000 750,000

EQUIVALENT UNITS FOR CONVERSION COSTS The 100,000 units of begin- ning work in process were 70% complete in terms of conversion costs. Thus, the Mixing Department required 30,000 equivalent units (30% 3 100,000 units) of conversion costs to complete the beginning inventory. In addition, the 200,000 units of ending work in process were 60% complete in terms of conversion costs. Thus, the equivalent units for conversion costs is 750,000, computed as follows.

COMPUTE UNIT PRODUCTION COSTS (STEP 3) Armed with the knowledge of the equivalent units of production, Kellogg can now compute the unit production costs. Unit production costs are costs expressed in terms of equivalent units of production. When equivalent units of production are different for materials and conversion costs, companies compute three unit costs: (1) materials, (2) conversion, and (3) total manufacturing.

Under the FIFO method, the unit costs of production are based entirely on the production costs incurred during the month. Thus, the costs in the beginning work in process are not relevant, because they were incurred on work done in the preceding month. As Illustration 3A-3 (page 116) indicated, the costs incurred during production in June were:

Illustration 3A-8 Costs incurred during production in June

Direct materials $400,000 Conversion costs 170,000

Total costs $570,000

Illustration 3A-9 shows the computation of unit materials cost, unit conver- sion costs, and total unit cost related to Eggo® Waffl es.

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Appendix 3A: FIFO Method 119

Illustration 3A-10 Costs charged to Mixing Department

Costs to be accounted for Work in process, June 1 $ 85,000 Started into production 570,000

Total costs $655,000

As shown, the unit costs are $0.50 for materials, $0.227 for conversion costs, and $0.727 for total manufacturing costs.

PREPARE A COST RECONCILIATION SCHEDULE (STEP 4) Kellogg is now ready to determine the cost of goods transferred out of the Mixing De- partment to the Baking Department and the costs in ending work in process. The total costs charged to the Mixing Department in June are $655,000, calculated as follows.

Illustration 3A-9 Unit cost formulas and computations—Mixing Department

(1) Total Materials Equivalent Units Unit Materials Cost

4 of Materials

5 Cost

$400,000 4 800,000 5 $0.50

(2) Total Conversion Equivalent Units of Unit Conversion Costs

4 Conversion Costs

5 Cost

$170,000 4 750,000 5 $0.227 (rounded)*

(3) Unit Materials Unit Conversion Total Manufacturing Cost

1 Cost

5 Cost per Unit

$0.50 1 $0.227 5 $0.727

*For homework problems, round unit costs to three decimal places.

Kellogg next prepares a cost reconciliation to assign these costs to (1) units trans- ferred out to the Baking Department and (2) ending work in process. Under the FIFO method, the fi rst goods to be completed during the period are the units in beginning work in process. Thus, the cost of the beginning work in process is always assigned to the goods transferred to the next department (or fi nished goods, if processing is complete). Under the FIFO method, ending work in process also will be assigned only the production costs incurred in the current period. Illustration 3A-11 shows a cost reconciliation schedule for the Mixing Department.

Illustration 3A-11 Cost reconciliation reportMixing Department

Cost Reconciliation Schedule

Costs accounted for Transferred out Work in process, June 1 $ 85,000 Costs to complete beginning work in process Conversion costs (30,000 3 $0.227) 6,810

Total costs 91,810 Units started and completed (600,000 3 $0.727) 435,950*

Total costs transferred out 527,760 Work in process, June 30 Materials (200,000 3 $0.50) $100,000 Conversion costs (120,000 3 $0.227) 27,240 127,240

Total costs $655,000

*Any rounding errors should be adjusted in the “Units started and completed’’ calculation.

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120 3 Process Costing

As you can see, the total costs accounted for ($655,000 from Illustration 3A-11) equal the total costs to be accounted for ($655,000 from Illustration 3A-10).

PREPARING THE PRODUCTION COST REPORT At this point, Kellogg is ready to prepare the production cost report for the Mixing Department. This report is an internal document for management that shows production quantity and cost data for a production department.

As discussed on page 109 there are four steps in preparing a production cost report:

1. Compute the physical unit fl ow.

2. Compute the equivalent units of production.

3. Compute unit production costs.

4. Prepare a cost reconciliation schedule.

Illustration 3A-12 shows the production cost report for the Mixing Depart- ment, with the four steps identifi ed in the report.

As indicated in the chapter, production cost reports provide a basis for evalu- ating the productivity of a department. In addition, managers can use the cost data to assess whether unit costs and total costs are reasonable. By comparing the quantity and cost data with predetermined goals, top management can also judge whether current performance is meeting planned objectives.

FIFO and Weighted-Average

The weighted-average method of computing equivalent units has one major advantage: It is simple to understand and apply. In cases where prices do not fl uctuate signifi cantly from period to period, the weighted-average method will be very similar to the FIFO method. In addition, companies that have been using just-in-time procedures effectively for inventory control purposes will have mini- mal inventory balances, and therefore differences between the weighted- average and the FIFO methods will not be material.

Conceptually, the FIFO method is superior to the weighted-average method because it measures current performance using only costs incurred in the cur- rent period. Managers are, therefore, not held responsible for costs from prior periods over which they may not have had control. In addition, the FIFO method provides current cost information, which the company can use to establish more accurate pricing strategies for goods manufactured and sold in the cur- rent period.

Helpful Hint What are the two self- checks in the report? Answer: (1) Total physical units accounted for must equal the total units to be accounted for. (2) Total costs accounted for must equal the total costs to be accounted for.

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Appendix 3A: FIFO Method 121

Illustration 3A-12 Production cost report—FIFO method

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Formulas Data Review ViewPage LayoutInsertHome

Mixing Department Produc�on Cost Report

For the Month Ended June 30, 2014 Equivalent Units

Physical Units

Materials Conversion

Costs

Materials Conversion

Costs

Step 1 Step 2

Step 3

Step 4

100,000 800,000 900,000

100,000 600,000 200,000 900,000

(a) (b)

30,000 600,000 120,000 750,000

$170,000 750,000

$0.227

$100,000 27,240

$570,000

$0.727

$85,000 570,000

$655,000

$85,000

6,810 91,810

435,950 527,760

127,240 $655,000

QUANTITIES Units to be accounted for Work in process (WIP), June 1 Started into produc�on Total units Units accounted for Completed and transferred out Work in process, June 1 Started and completed Work in process, June 30 Total units COSTS

Unit costs

Costs in June (excluding beginning WIP) Equivalent units Unit costs [(a) � (b)] Costs to be accounted for Work in process, June 1 Started into produc�on Total costs Cost Reconcilia�on Schedule Costs accounted for Transferred out Work in process, June 1 Costs to complete beginning work in process Conversion costs (30,000 � $0.227) Total costs Units started and completed (600,000 � $0.727)* Total costs transferred out Work in process, June 30 Materials (200,000 � $0.50) Conversions costs (120,000 � $0.227) Total costs *Any rounding errors should be adjusted in the “Units started and completed”

0 600,000 200,000 800,000

$400,000 800,000

$0.50

Total

Mixing Department.xls

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122 3 Process Costing

8 Compute equivalent units using the FIFO method. Equivalent units under the FIFO method are the sum of the work performed to: (1) Finish the units of beginning work in process inventory, if any; (2) complete the units

started into production during the period; and (3) start, but only partially complete, the units in ending work in process inventory.

SUMMARY OF LEARNING OBJECTIVE FOR APPENDIX 3A ✔ The Navigator

> DO IT!

Karlene Industries produces plastic ice cube trays in two processes: heating and stamping. All materials are added at the beginning of the Heating Department process. Karlene uses the weighted-average method to compute equivalent units.

On November 1, the Heating Department had in process 1,000 trays that were 70% complete. During November, it started into production 12,000 trays. On November 30, 2014, 2,000 trays that were 60% complete were in process.

The following cost information for the Heating Department was also available.

Work in process, November 1: Costs incurred in November: Materials $ 640 Material $3,000 Conversion costs 360 Labor 2,300 Cost of work in process, Nov. 1 $1,000 Overhead 4,050

Instructions (a) Prepare a production cost report for the Heating Department for the month of

November 2014, using the weighted-average method.

(b) Journalize the transfer of costs to the Stamping Department.

Comprehensive

GLOSSARY

Conversion costs The sum of labor costs and overhead costs. (p. 103).

Cost reconciliation schedule A schedule that shows that the total costs accounted for equal the total costs to be accounted for. (p. 109).

Equivalent units of production A measure of the work done during the period, expressed in fully completed units. (p. 102).

Operations costing A combination of a process cost and a job order cost system, in which products are manu- factured primarily by standardized methods, with some customization. (p. 111).

Physical units Actual units to be accounted for during a period, irrespective of any work performed. (p. 106).

Process cost system An accounting system used to apply costs to similar products that are mass-produced in a continuous fashion. (p. 96).

Production cost report An internal report for manage- ment that shows both production quantity and cost data for a production department. (p. 105).

Total units (costs) accounted for The sum of the units (costs) transferred out during the period plus the units (costs) in process at the end of the period. (p. 106).

Total units (costs) to be accounted for The sum of the units (costs) started (or transferred) into production during the period plus the units (costs) in process at the beginning of the period. (p. 106).

Unit production costs Costs expressed in terms of equivalent units of production. (p. 107).

Weighted-average method Method of computing equivalent units of production which considers the degree of completion (weighting) of the units completed and transferred out and the ending work in process. (p. 103).

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Comprehensive DO IT! 123

(a) Karlene Industries Heating Department Production Cost Report For the Month Ended November 30, 2014

Equivalent Units

Physical Conversion Units Materials Costs Quantities Step 1 Step 2

Units to be accounted for Work in process, November 1 1,000 Started into production 12,000

Total units 13,000

Units accounted for Transferred out 11,000 11,000 11,000 Work in process, November 30 2,000 2,000 1,200

Total units 13,000 13,000 12,200

Costs Conversion Unit costs Step 3 Materials Costs Total

Total cost (a) $ 3,640* $ 6,710** $10,350

Equivalent units (b) 13,000 12,200

Unit costs [(a) 4 (b)] $0.28 $0.55 $0.83

Costs to be accounted for Work in process, November 1 $ 1,000 Started into production 9,350

Total costs $10,350

*$640 1 $3,000 **$360 1 $2,300 1 $4,050

Cost Reconciliation Schedule Step 4

Costs accounted for Transferred out (11,000 3 $0.83) $ 9,130 Work in process, November 30 Materials (2,000 3 $0.28) $560 Conversion costs (1,200 3 $0.55) 660 1,220

Total costs $10,350

(b) Work in Process—Stamping 9,130 Work in Process—Heating 9,130 (To record transfer of units to the Stamping Department)

DO IT! Solution to Comprehensive

Action Plan ✔ Compute the physical

unit fl ow—that is, the total units to be accounted for.

✔ Compute the equivalent units of production.

✔ Compute the unit production costs, expressed in terms of equivalent units of production.

✔ Prepare a cost rec- onciliation schedule, which shows that the total costs accounted for equal the total costs to be accounted for.

✔ The Navigator

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124

Note: All asterisked Questions, Exercises, and Problems relate to material in the appendix to the chapter.

Answers are at the end of the chapter. 1. Which of the following items is not characteristic of a

process cost system? (a) Once production begins, it continues until the

fi nished product emerges. (b) The products produced are heterogeneous in

nature. (c) The focus is on continually producing homoge-

neous products. (d) When the fi nished product emerges, all units

have precisely the same amount of materials, labor, and overhead.

2. Indicate which of the following statements is not correct. (a) Both a job order and a process cost system track

the same three manufacturing cost elements— direct materials, direct labor, and manufacturing overhead.

(b) A job order cost system uses only one work in process account, whereas a process cost system uses multiple work in process accounts.

(c) Manufacturing costs are accumulated the same way in a job order and in a process cost system.

(d) Manufacturing costs are assigned the same way in a job order and in a process cost system.

3. In a process cost system, the fl ow of costs is: (a) work in process, cost of goods sold, fi nished goods. (b) fi nished goods, work in process, cost of goods sold. (c) fi nished goods, cost of goods sold, work in process. (d) work in process, fi nished goods, cost of goods sold.

4. In making journal entries to assign raw materials costs, a company using process costing: (a) debits Finished Goods Inventory. (b) often debits two or more work in process

accounts. (c) generally credits two or more work in process

accounts. (d) credits Finished Goods Inventory.

5. In a process cost system, manufacturing overhead: (a) is assigned to fi nished goods at the end of each

accounting period. (b) is assigned to a work in process account for each

job as the job is completed. (c) is assigned to a work in process account for each

production department on the basis of a prede- termined overhead rate.

(d) is assigned to a work in process account for each production department as overhead costs are incurred.

6. Conversion costs are the sum of: (a) fi xed and variable overhead costs. (b) labor costs and overhead costs. (c) direct material costs and overhead costs. (d) direct labor and indirect labor costs.

7. The Mixing Department’s output during the period consists of 20,000 units completed and transferred out, and 5,000 units in ending work in process 60% complete as to materials and conversion costs. Begin- ning inventory is 1,000 units, 40% complete as to materials and conversion costs. The equivalent units of production are: (a) 22,600. (c) 24,000. (b) 23,000. (d) 25,000.

8. In RYZ Company, there are zero units in beginning work in process, 7,000 units started into production, and 500 units in ending work in process 20% com- pleted. The physical units to be accounted for are: (a) 7,000. (c) 7,500. (b) 7,360. (d) 7,340.

9. Mora Company has 2,000 units in beginning work in process, 20% complete as to conversion costs, 23,000 units transferred out to fi nished goods, and 3,000 units in ending work in process 331

3 % complete as to

conversion costs. The beginning and ending inventory is fully com-

plete as to materials costs. Equivalent units for ma- terials and conversion costs are, respectively: (a) 22,000, 24,000. (c) 26,000, 24,000. (b) 24,000, 26,000. (d) 26,000, 26,000.

10. Fortner Company has no beginning work in process; 9,000 units are transferred out and 3,000 units in ending work in process are one-third fi nished as to conversion costs and fully complete as to materials cost. If total materials cost is $60,000, the unit ma- terials cost is: (a) $5.00. (b) $5.45 rounded. (c) $6.00. (d) No correct answer is given.

11. Largo Company has unit costs of $10 for materials and $30 for conversion costs. If there are 2,500 units in ending work in process, 40% complete as to con- version costs, and fully complete as to materials cost, the total cost assignable to the ending work in pro- cess inventory is: (a) $45,000. (c) $75,000. (b) $55,000. (d) $100,000.

12. A production cost report: (a) is an external report. (b) shows both the production quantity and cost

data related to a department. (c) shows equivalent units of production but not

physical units. (d) contains six sections.

13. In a production cost report, units to be accounted for are calculated as: (a) Units started into production 1 Units in ending

work in process.

SELF-TEST QUESTIONS

(LO 2)

(LO 1)

(LO 3)

(LO 4)

(LO 4)

(LO 5)

(LO 6)

(LO 6)

(LO 6)

(LO 6)

(LO 7)

(LO 7)

(LO 5)

Self-Test, Brief Exercises, Exercises, Problem Set A, and many more resources are available for practice in WileyPLUS.

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Questions 125

(b) Units started into production 2 Units in begin- ning work in process.

(c) Units transferred out 1 Units in beginning work in process.

(d) Units started into production 1 Units in begin- ning work in process.

*14. Hollins Company uses the FIFO method to compute equivalent units. It has 2,000 units in beginning work in process, 20% complete as to conversion costs, 25,000 units started and completed, and 3,000 units in ending work in process, 30% complete as to con- version costs. All units are 100% complete as to ma- terials. Equivalent units for materials and conversion costs are, respectively: (a) 28,000 and 26,600. (b) 28,000 and 27,500. (c) 27,000 and 26,200. (d) 27,000 and 29,600.

*15. KLM Company uses the FIFO method to compute equivalent units. It has no beginning work in process; 9,000 units are started and completed and 3,000 units in ending work in process are one-third completed. All material is added at the beginning of the process. If total materials cost is $60,000, the unit materials cost is: (a) $5.00. (b) $6.00. (c) $6.67 (rounded). (d) No correct answer given.

*16. Toney Company uses the FIFO method to compute equivalent units. It has unit costs of $10 for materials and $30 for conversion costs. If there are 2,500 units in ending work in process, 100% complete as to materials and 40% complete as to conversion costs, the total cost assignable to the ending work in process inventory is: (a) $45,000. (c) $75,000. (b) $55,000. (d) $100,000.

Go to the book’s companion website, www.wiley.com/college/weygandt, for additional Self-Test Questions.

✔ The Navigator

(LO 8)

(LO 3)

1. Identify which costing system—job order or process cost—the following companies would primarily use: (a) Quaker Oats, (b) Jif Peanut Butter, (c) Gulf Craft (luxury yachts), and (d) Warner Bros. Motion Pictures.

2. Contrast the primary focus of job order cost account- ing and of process cost accounting.

3. What are the similarities between a job order and a process cost system?

4. Your roommate is confused about the features of process cost accounting. Identify and explain the dis- tinctive features for your roommate.

5. Sam Bowyer believes there are no signifi cant differences in the fl ow of costs between job order cost accounting and process cost accounting. Is Bowyer correct? Explain.

6. (a) What source documents are used in assigning (1) materials and (2) labor to production in a process cost system?

(b) What criterion and basis are commonly used in allocating overhead to processes?

7. At Ely Company, overhead is assigned to production departments at the rate of $5 per machine hour. In July, machine hours were 3,000 in the Machining Department and 2,400 in the Assembly Department. Prepare the entry to assign overhead to production.

8. Mark Haley is uncertain about the steps used to pre- pare a production cost report. State the procedures that are required in the sequence in which they are performed.

9. John Harbeck is confused about computing physi- cal units. Explain to John how physical units to be accounted for and physical units accounted for are determined.

10. What is meant by the term “equivalent units of production”?

11. How are equivalent units of production computed? 12. Coats Company had zero units of beginning work in

process. During the period, 9,000 units were com- pleted, and there were 600 units of ending work in process. What were the units started into production?

13. Sanchez Co. has zero units of beginning work in pro- cess. During the period, 12,000 units were completed, and there were 500 units of ending work in process one- fi fth complete as to conversion cost and 100% complete as to materials cost. What were the equivalent units of production for (a) materials and (b) conversion costs?

14. Hindi Co. started 3,000 units during the period. Its beginning inventory is 500 units one-fourth complete as to conversion costs and 100% complete as to ma- terials costs. Its ending inventory is 300 units one-fi fth complete as to conversion costs and 100% complete as to materials costs. How many units were trans- ferred out this period?

15. Clauss Company transfers out 14,000 units and has 2,000 units of ending work in process that are 25% complete. Materials are entered at the beginning of the process and there is no beginning work in process. Assuming unit materials costs of $3 and unit conversion costs of $5, what are the costs to be assigned to units (a) transferred out and (b) in ending work in process?

16. (a) Ann Quinn believes the production cost report is an external report for stockholders. Is Ann correct? Explain.

(b) Identify the sections in a production cost report. 17. What purposes are served by a production cost report? 18. At Trent Company, there are 800 units of ending work

in process that are 100% complete as to materials and 40% complete as to conversion costs. If the unit cost of materials is $3 and the total costs assigned to the 800 units is $6,000, what is the per unit conversion cost?

QUESTIONS

(LO 8)

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126 3 Process Costing

19. What is the difference between operations costing and a process cost system?

20. How does a company decide whether to use a job order or a process cost system?

*21. Soria Co. started and completed 2,000 units for the pe- riod. Its beginning inventory is 800 units 25% complete and its ending inventory is 400 units 20% complete. Soria uses the FIFO method to compute equivalent units. How many units were transferred out this period?

*22. Reyes Company transfers out 12,000 units and has 2,000 units of ending work in process that are 25% com- plete. Materials are entered at the beginning of the pro- cess and there is no beginning work in process. Reyes uses the FIFO method to compute equivalent units. Assuming unit materials costs of $3 and unit conver- sion costs of $7, what are the costs to be assigned to units (a) transferred out and (b) in ending work in process?

BRIEF EXERCISES

BE3-1 Weber Company purchases $45,000 of raw materials on account, and it incurs $60,000 of factory labor costs. Journalize the two transactions on March 31 assuming the labor costs are not paid until April.

BE3-2 Data for Weber Company are given in BE3-1. Supporting records show that (a) the Assembly Department used $24,000 of raw materials and $35,000 of the factory labor, and (b) the Finishing Department used the remainder. Journalize the assignment of the costs to the processing departments on March 31.

BE3-3 Factory labor data for Weber Company are given in BE3-2. Manufacturing overhead is assigned to departments on the basis of 200% of labor costs. Journalize the assignment of overhead to the Assembly and Finishing Departments.

BE3-4 Goode Company has the following production data for selected months.

Ending Work in Process

Beginning Units % Complete as to Month Work in Process Transferred Out Units Conversion Cost

January –0– 35,000 10,000 40% March –0– 40,000 8,000 75 July –0– 45,000 16,000 25

Compute equivalent units of production for materials and conversion costs, assuming materials are entered at the beginning of the process.

BE3-5 In Lopez Company, total material costs are $36,000, and total conversion costs are $54,000. Equivalent units of production are materials 10,000 and conversion costs 12,000. Compute the unit costs for materials, conversion costs, and total manufacturing costs.

BE3-6 Trek Company has the following production data for April: units transferred out 40,000, and ending work in process 5,000 units that are 100% complete for materials and 40% com- plete for conversion costs. If unit materials cost is $4 and unit conversion cost is $7, determine the costs to be assigned to the units transferred out and the units in ending work in process.

BE3-7 Production costs chargeable to the Finishing Department in June in Cascio Com- pany are materials $16,000, labor $29,500, overhead $18,000. Equivalent units of production are materials 20,000 and conversion costs 19,000. Compute the unit costs for materials and conversion costs.

BE3-8 Data for Cascio Company are given in BE3-7. Production records indicate that 18,000 units were transferred out, and 2,000 units in ending work in process were 50% complete as to conversion cost and 100% complete as to materials. Prepare a cost reconciliation schedule.

BE3-9 The Smelting Department of Mathews Company has the following production and cost data for November.

Production: Beginning work in process 2,000 units that are 100% complete as to materials and 20% complete as to conversion costs; units transferred out 8,000 units; and ending work in process 7,000 units that are 100% complete as to materials and 40% complete as to conversion costs.

Journalize entries for accumulating costs.

(LO 4), AP Journalize the assignment of materials and labor costs.

(LO 4), AP

Journalize the assignment of overhead costs.

(LO 4), AP Compute equivalent units of production.

(LO 5), AP

Compute unit costs of production.

(LO 6), AP Assign costs to units transferred out and in process.

(LO 6), AP Compute unit costs.

(LO 6), AP

Prepare cost reconciliation schedule.

(LO 6), AP Compute equivalent units of production.

(LO 5), AP

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DO IT! Review 127

Compute the equivalent units of production for (a) materials and (b) conversion costs for the month of November.

*BE3-10 Sanderson Company has the following production data for March: no beginning work in process, units started and completed 30,000, and ending work in process 5,000 units that are 100% complete for materials and 40% complete for conversion costs. Sand- erson uses the FIFO method to compute equivalent units. If unit materials cost is $6 and unit conversion cost is $12, determine the costs to be assigned to the units transferred out and the units in ending work in process. The total costs to be assigned are $594,000.

*BE3-11 Using the data in BE3-10, prepare the cost section of the production cost report for Sanderson Company.

*BE3-12 Production costs chargeable to the Finishing Department in May at Kim Com- pany are materials $8,000, labor $20,000, overhead $18,000, and transferred-in costs $67,000. Equivalent units of production are materials 20,000 and conversion costs 19,000. Kim uses the FIFO method to compute equivalent units. Compute the unit costs for ma- terials and conversion costs. Transferred-in costs are considered materials costs.

Assign costs to units transferred out and in process.

(LO 8), AP

Prepare a partial production cost report.

(LO 7, 8), AP

Compute unit costs.

(LO 8), AP

> DO IT! REVIEW

Indicate whether each of the following statements is true or false.

1. Many hospitals use job order costing for small, routine medical procedures. 2. A manufacturer of computer fl ash drives would use a job order cost system. 3. A process cost system uses multiple work in process accounts. 4. A process cost system keeps track of costs on job cost sheets.

Kopa Company manufactures CH-21 through two processes: Mixing and Packaging. In July, the following costs were incurred.

Mixing Packaging

Raw materials used $10,000 $28,000 Factory labor costs 8,000 36,000 Manufacturing overhead costs 12,000 54,000

Units completed at a cost of $21,000 in the Mixing Department are transferred to the Packaging Department. Units completed at a cost of $106,000 in the Packaging Depart- ment are transferred to Finished Goods. Journalize the assignment of these costs to the two processes and the transfer of units as appropriate.

The assembly department has the following production data for the current month.

Beginning Units Ending Work in Process Transferred Out Work in Process

–0– 20,000 12,000

Materials are entered at the beginning of the process. The ending work in process units are 70% complete as to conversion costs. Compute the equivalent units of production for (a) materials and (b) conversion costs.

In March, Kelly Company had the following unit production costs: materials $10 and conversion costs $8. On March 1, it had zero work in process. During March, Kelly transferred out 22,000 units. As of March 31, 4,000 units that were 40% complete as to conversion costs and 100% complete as to materials were in ending work in process.

(a) Compute the total units to be accounted for. (b) Compute the equivalent units of production. (c) Prepare a cost reconciliation schedule, including the costs of materials transferred

out and the costs of materials in process.

DO IT! 3-1 Compare job order and process cost systems.

(LO 1, 2), C

DO IT! 3-2

DO IT! 3-3

DO IT! 3-4

Assign and journalize manufacturing costs.

(LO 4), AP

Compute equivalent units.

(LO 5), AP

Prepare cost reconciliation schedule.

(LO 6, 7), AP

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128 3 Process Costing

EXERCISES

E3-1 Robert Mallory has prepared the following list of statements about process cost accounting.

1. Process cost systems are used to apply costs to similar products that are mass- produced in a continuous fashion.

2. A process cost system is used when each fi nished unit is indistinguishable from another. 3. Companies that produce soft drinks, motion pictures, and computer chips would all

use process cost accounting. 4. In a process cost system, costs are tracked by individual jobs. 5. Job order costing and process costing track different manufacturing cost elements. 6. Both job order costing and process costing account for direct materials, direct labor,

and manufacturing overhead. 7. Costs fl ow through the accounts in the same basic way for both job order costing and

process costing. 8. In a process cost system, only one work in process account is used. 9. In a process cost system, costs are summarized in a job cost sheet. 10. In a process cost system, the unit cost is total manufacturing costs for the period

divided by the equivalent units produced during the period.

Instructions Identify each statement as true or false. If false, indicate how to correct the statement.

E3-2 Harrelson Company manufactures pizza sauce through two production depart- ments: Cooking and Canning. In each process, materials and conversion costs are incurred evenly throughout the process. For the month of April, the work in process accounts show the following debits.

Cooking Canning

Beginning work in process $ –0– $ 4,000 Materials 21,000 9,000 Labor 8,500 7,000 Overhead 31,500 25,800 Costs transferred in 53,000

Instructions Journalize the April transactions.

E3-3 The ledger of Custer Company has the following work in process account.

Work in Process—Painting

5/1 Balance 3,590 5/31 Transferred out ? 5/31 Materials 5,160 5/31 Labor 2,740 5/31 Overhead 1,380

5/31 Balance ?

Production records show that there were 400 units in the beginning inventory, 30% complete, 1,400 units started, and 1,500 units transferred out. The beginning work in process had materials cost of $2,040 and conversion costs of $1,550. The units in ending inventory were 40% complete. Materials are entered at the beginning of the painting process.

Instructions (a) How many units are in process at May 31? (b) What is the unit materials cost for May? (c) What is the unit conversion cost for May? (d) What is the total cost of units transferred out in May? (e) What is the cost of the May 31 inventory?

E3-4 Schrager Company has two production departments: Cutting and Assembly. July 1 inventories are Raw Materials $4,200, Work in Process—Cutting $2,900, Work in Process—

Understand process cost accounting.

(LO 1, 2), C

Journalize transactions.

(LO 4), AP

Answer questions on costs and production.

(LO 3, 5, 6), AP

Journalize transactions for two processes.

(LO 4), AP

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Exercises 129

Assembly $10,600, and Finished Goods $31,000. During July, the following transactions occurred.

1. Purchased $62,500 of raw materials on account. 2. Incurred $60,000 of factory labor. (Credit Wages Payable.) 3. Incurred $70,000 of manufacturing overhead; $40,000 was paid and the remainder is

unpaid. 4. Requisitioned materials for Cutting $15,700 and Assembly $8,900. 5. Used factory labor for Cutting $33,000 and Assembly $27,000. 6. Applied overhead at the rate of $18 per machine hour. Machine hours were Cutting

1,680 and Assembly 1,720. 7. Transferred goods costing $67,600 from the Cutting Department to the Assembly

Department. 8. Transferred goods costing $134,900 from Assembly to Finished Goods. 9. Sold goods costing $150,000 for $200,000 on account.

Instructions Journalize the transactions. (Omit explanations.)

E3-5 In Wayne Company, materials are entered at the beginning of each process. Work in process inventories, with the percentage of work done on conversion costs, and produc- tion data for its Sterilizing Department in selected months during 2014 are as follows.

Beginning Ending Work in Process Work in Process

Conversion Units Conversion Month Units Cost% Transferred Out Units Cost%

January –0– — 9,000 2,000 60 March –0– — 12,000 3,000 30 May –0– — 16,000 7,000 80 July –0– — 10,000 1,500 40

Instructions (a) Compute the physical units for January and May. (b) Compute the equivalent units of production for (1) materials and (2) conversion costs

for each month.

E3-6 The Cutting Department of Cassel Company has the following production and cost data for July.

Production Costs

1. Transferred out 12,000 units. Beginning work in process $ –0– 2. Started 3,000 units that are 60% Materials 45,000 complete as to conversion Labor 16,200 costs and 100% complete as Manufacturing overhead 18,300 to materials at July 31.

Materials are entered at the beginning of the process. Conversion costs are incurred uni- formly during the process.

Instructions (a) Determine the equivalent units of production for (1) materials and (2) conversion costs. (b) Compute unit costs and prepare a cost reconciliation schedule.

E3-7 The Sanding Department of Richards Furniture Company has the following production and manufacturing cost data for March 2014, the fi rst month of operation.

Production: 9,000 units fi nished and transferred out; 3,000 units started that are 100% complete as to materials and 20% complete as to conversion costs.

Manufacturing costs: Materials $33,000; labor $24,000; overhead $36,000.

Instructions Prepare a production cost report.

E3-8 The Blending Department of Luongo Company has the following cost and produc- tion data for the month of April.

Compute physical units and equivalent units of production.

(LO 5, 6), AP

Determine equivalent units, unit costs, and assignment of costs.

(LO 5, 6), AP

Prepare a production cost report.

(LO 5, 6, 7), AP

Determine equivalent units, unit costs, and assignment of costs.

(LO 5, 6), AP

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130 3 Process Costing

Costs: Work in process, April 1 Direct materials: 100% complete $100,000 Conversion costs: 20% complete 70,000

Cost of work in process, April 1 $170,000

Costs incurred during production in April Direct materials $ 800,000 Conversion costs 365,000

Costs incurred in April $1,165,000

Units transferred out totaled 17,000. Ending work in process was 1,000 units that are 100% complete as to materials and 40% complete as to conversion costs.

Instructions (a) Compute the equivalent units of production for (1) materials and (2) conversion costs

for the month of April. (b) Compute the unit costs for the month. (c) Determine the costs to be assigned to the units transferred out and in ending work in

process.

E3-9 Kostrivas Company has gathered the following information.

Units in beginning work in process –0– Units started into production 40,000 Units in ending work in process 6,000 Percent complete in ending work in process: Conversion costs 40% Materials 100% Costs incurred: Direct materials $72,000 Direct labor $81,000 Overhead $101,000

Instructions (a) Compute equivalent units of production for materials and for conversion costs. (b) Determine the unit costs of production. (c) Show the assignment of costs to units transferred out and in process.

E3-10 Overton Company has gathered the following information.

Units in beginning work in process 20,000 Units started into production 164,000 Units in ending work in process 24,000 Percent complete in ending work in process: Conversion costs 60% Materials 100% Costs incurred: Direct materials $101,200 Direct labor $164,800 Overhead $184,000

Instructions (a) Compute equivalent units of production for materials and for conversion costs. (b) Determine the unit costs of production. (c) Show the assignment of costs to units transferred out and in process.

E3-11 The Polishing Department of Harbin Company has the following production and manufacturing cost data for September. Materials are entered at the beginning of the process.

Production: Beginning inventory 1,600 units that are 100% complete as to materials and 30% complete as to conversion costs; units started during the period are 38,400; ending inventory of 5,000 units 10% complete as to conversion costs.

Determine equivalent units, unit costs, and assignment of costs.

(LO 5, 6), AP

Determine equivalent units, unit costs, and assignment of costs.

(LO 5, 6), AP

Compute equivalent units, unit costs, and costs assigned.

(LO 5, 6), AP

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Exercises 131

Manufacturing costs: Beginning inventory costs, comprised of $20,000 of materials and $43,180 of conversion costs; materials costs added in Polishing during the month, $177,200; labor and overhead applied in Polishing during the month, $125,680 and $257,140, respectively.

Instructions (a) Compute the equivalent units of production for materials and conversion costs for the

month of September. (b) Compute the unit costs for materials and conversion costs for the month. (c) Determine the costs to be assigned to the units transferred out and in process.

E3-12 David Skaros has recently been promoted to production manager, and so he has just started to receive various managerial reports. One of the reports he has received is the production cost report that you prepared. It showed that his department had 2,000 equivalent units in ending inventory. His department has had a history of not keeping enough inventory on hand to meet demand. He has come to you, very angry, and wants to know why you credited him with only 2,000 units when he knows he had at least twice that many on hand.

Instructions Explain to him why his production cost report showed only 2,000 equivalent

units in ending inventory. Write an informal memo. Be kind and explain very clearly why he is mistaken.

E3-13 The Welding Department of Thorpe Company has the following production and manufacturing cost data for February 2014. All materials are added at the beginning of the process.

Manufacturing Costs Production Data

Beginning work in process Beginning work in process 15,000 units Materials $18,000 1/10 complete Conversion costs 14,175 $ 32,175 Units transferred out 49,000 Materials 180,000 Units started 45,000 Labor 52,380 Ending work in process 11,000 units Overhead 61,445 1/5 complete

Instructions Prepare a production cost report for the Welding Department for the month of February.

E3-14 Remington Shipping, Inc. is contemplating the use of process costing to track the costs of its operations. The operation consists of three segments (departments): receiving, shipping, and delivery. Containers are received at Remington’s docks and sorted according to the ship they will be carried on. The containers are loaded onto a ship, which carries them to the appropriate port of destination. The containers are then off-loaded and deliv- ered to the receiving company.

Remington Shipping wants to begin using process costing in the shipping depart- ment. Direct materials represent the fuel costs to run the ship, and “Containers in transit” represents work in process. Listed below is information about the shipping department’s fi rst month’s activity.

Containers in transit, April 1 0 Containers loaded 1,200 Containers in transit, April 30 350, 40% of direct materials and 20% of conversion costs

Instructions (a) Determine the physical fl ow of containers for the month. (b) Calculate the equivalent units for direct materials and conversion costs.

E3-15 Royale Mortgage Company uses a process cost system to accumulate costs in its loan application department. When an application is completed, it is forwarded to the loan department for fi nal processing. The following processing and cost data pertain to September.

Explain the production cost report.

(LO 7), S

Prepare a production cost report.

(LO 5, 6, 7), AP

Compute physical units and equivalent units of production.

(LO 5, 6), AP

Determine equivalent units, unit costs, and assignment of costs.

(LO 5, 6), AP

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132 3 Process Costing

1. Applications in process on Beginning WIP: September 1, 100 Direct materials $ 1,000 2. Applications started in Conversion costs 3,960 September, 900 September costs: 3. Completed applications during Direct materials $ 4,500 September, 800 Direct labor 12,000 4. Applications still in process at Overhead 9,340 September 30 were 100%

complete as to materials (forms) and 60% complete as to conversion costs.

Materials are the forms used in the application process, and these costs are incurred at the beginning of the process. Conversion costs are incurred uniformly during the process.

Instructions (a) Determine the equivalent units of service (production) for materials and conversion

costs. (b) Compute the unit costs and prepare a cost reconciliation schedule.

*E3-16 Using the data in E3-15, assume Royale Mortgage Company uses the FIFO method. Also assume that the applications in process on September 1 were 100% complete as to materials (forms) and 40% complete as to conversion costs.

Instructions (a) Determine the equivalent units of service (production) for materials and conversion

costs. (b) Compute the unit costs and prepare a cost reconciliation schedule.

*E3-17 The Cutting Department of Keigi Company has the following production and cost data for August.

Production Costs

1. Started and completed 8,000 units. Beginning work in process $ –0– 2. Started 2,000 units that are 40% Materials 45,000 completed at August 31. Labor 14,700 Manufacturing overhead 16,100

Materials are entered at the beginning of the process. Conversion costs are incurred uniformly during the process. Keigi Company uses the FIFO method to compute equiv- alent units.

Instructions (a) Determine the equivalent units of production for (1) materials and (2) conversion

costs. (b) Compute unit costs and show the assignment of manufacturing costs to units trans-

ferred out and in work in process.

*E3-18 The Smelting Department of Polzin Company has the following production and cost data for September.

Production: Beginning work in process 2,000 units that are 100% complete as to ma- terials and 20% complete as to conversion costs; units started and fi nished 9,000 units; and ending work in process 1,000 units that are 100% complete as to materials and 40% complete as to conversion costs.

Manufacturing costs: Work in process, September 1, $15,200; materials added $60,000; labor and overhead $132,000.

Polzin uses the FIFO method to compute equivalent units.

Instructions (a) Compute the equivalent units of production for (1) materials and (2) conversion costs

for the month of September. (b) Compute the unit costs for the month. (c) Determine the costs to be assigned to the units transferred out and in process.

Compute equivalent units, unit costs, and costs assigned.

(LO 6, 8), AP

Determine equivalent units, unit costs, and assignment of costs.

(LO 6, 8), AP

Compute equivalent units, unit costs, and costs assigned.

(LO 6, 8), AP

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Problems: Set A 133

*E3-19 The ledger of Hannon Company has the following work in process account.

Work in Process—Painting

3/1 Balance 3,680 3/31 Transferred out ? 3/31 Materials 6,600 3/31 Labor 2,500 3/31 Overhead 1,150

3/31 Balance ?

Production records show that there were 800 units in the beginning inventory, 30% com- plete, 1,200 units started, and 1,500 units transferred out. The units in ending inventory were 40% complete. Materials are entered at the beginning of the painting process. Han- non uses the FIFO method to compute equivalent units.

Instructions Answer the following questions. (a) How many units are in process at March 31? (b) What is the unit materials cost for March? (c) What is the unit conversion cost for March? (d) What is the total cost of units started in February and completed in March? (e) What is the total cost of units started and fi nished in March? (f) What is the cost of the March 31 inventory?

*E3-20 The Welding Department of Majestic Company has the following production and manufacturing cost data for February 2014. All materials are added at the beginning of the process. Majestic uses the FIFO method to compute equivalent units.

Manufacturing Costs Production Data

Beginning work in process $ 32,175 Beginning work in process 15,000 units, Costs transferred in 135,000 10% complete Materials 57,000 Units transferred out 54,000 Labor 35,100 Units transferred in 64,000 Overhead 68,400 Ending work in process 25,000, 20% complete

Instructions Prepare a production cost report for the Welding Department for the month of February. Transferred-in costs are considered materials costs.

Answer questions on costs and production.

(LO 6, 8), AP

Prepare a production cost report for a second process.

(LO 8), AP

Visit the book’s companion website, at www.wiley.com/college/weygandt, and choose the Student Companion site to access Exercise Set B and Challenge Exercises.

EXERCISES: SET B AND CHALLENGE EXERCISES

P3-1A Conwell Company manufactures its product, Vitadrink, through two manufactur- ing processes: Mixing and Packaging. All materials are entered at the beginning of each process. On October 1, 2014, inventories consisted of Raw Materials $26,000, Work in Process—Mixing $0, Work in Process—Packaging $250,000, and Finished Goods $289,000. The beginning inventory for Packaging consisted of 10,000 units that were 50% complete as to conversion costs and fully complete as to materials. During October, 50,000 units were started into production in the Mixing Department and the following transactions were completed.

1. Purchased $300,000 of raw materials on account. 2. Issued raw materials for production: Mixing $210,000 and Packaging $45,000.

Journalize transactions.

(LO 3, 4), AP

PROBLEMS: SET A

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134 3 Process Costing

3. Incurred labor costs of $258,900. 4. Used factory labor: Mixing $182,500 and Packaging $76,400. 5. Incurred $810,000 of manufacturing overhead on account. 6. Applied manufacturing overhead on the basis of $24 per machine hour. Machine hours

were 28,000 in Mixing and 6,000 in Packaging. 7. Transferred 45,000 units from Mixing to Packaging at a cost of $979,000. 8. Transferred 53,000 units from Packaging to Finished Goods at a cost of $1,315,000. 9. Sold goods costing $1,604,000 for $2,500,000 on account.

Instructions Journalize the October transactions.

P3-2A Rosenthal Company manufactures bowling balls through two processes: Molding and Packaging. In the Molding Department, the urethane, rubber, plastics, and other materials are molded into bowling balls. In the Packaging Department, the balls are placed in cartons and sent to the fi nished goods warehouse. All materials are entered at the beginning of each process. Labor and manufacturing overhead are incurred uniformly throughout each process. Production and cost data for the Molding Department during June 2014 are presented below.

Production Data June

Beginning work in process units –0– Units started into production 22,000 Ending work in process units 2,000 Percent complete—ending inventory 40%

Cost Data

Materials $198,000 Labor 53,600 Overhead 112,800

Total $364,400

Instructions (a) Prepare a schedule showing physical units of production. (b) Determine the equivalent units of production for materials and conversion costs. (c) Compute the unit costs of production. (d) Determine the costs to be assigned to the units transferred out and in process for June. (e) Prepare a production cost report for the Molding Department for the month of

June.

P3-3A Seagren Industries Inc. manufactures in separate processes furniture for homes. In each process, materials are entered at the beginning, and conversion costs are incurred uniformly. Production and cost data for the fi rst process in making two products in two different manufacturing plants are as follows.

Cutting Department

Plant 1 Plant 2 Production Data—July T12-Tables C10-Chairs

Work in process units, July 1 –0– –0– Units started into production 19,000 16,000 Work in process units, July 31 3,000 500 Work in process percent complete 60 80

Cost Data—July

Work in process, July 1 $ –0– $ –0– Materials 380,000 288,000 Labor 234,200 110,000 Overhead 104,000 96,700

Total $718,200 $494,700

(c) Materials $9.00 CC $8.00 (d) Transferred

out $340,000 WIP $ 24,400

Complete four steps necessary to prepare a production cost report.

(LO 5, 6, 7), AP

Complete four steps necessary to prepare a production cost report.

(LO 5, 6, 7), AP

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Problems: Set A 135

Instructions (a) For each plant: (1) Compute the physical units of production. (2) Compute equivalent units of production for materials and for conversion costs. (3) Determine the unit costs of production. (4) Show the assignment of costs to units transferred out and in process. (b) Prepare the production cost report for Plant 1 for July 2014.

P3-4A Rivera Company has several processing departments. Costs charged to the Assem- bly Department for November 2014 totaled $2,280,000 as follows.

Work in process, November 1 Materials $79,000 Conversion costs 48,150 $ 127,150

Materials added 1,589,000 Labor 225,920 Overhead 337,930

Production records show that 35,000 units were in beginning work in process 30% com- plete as to conversion costs, 660,000 units were started into production, and 25,000 units were in ending work in process 40% complete as to conversion costs. Materials are entered at the beginning of each process.

Instructions (a) Determine the equivalent units of production and the unit production costs for the

Assembly Department. (b) Determine the assignment of costs to goods transferred out and in process. (c) Prepare a production cost report for the Assembly Department.

P3-5A Morse Company manufactures basketballs. Materials are added at the beginning of the production process and conversion costs are incurred uniformly. Production and cost data for the month of July 2014 are as follows.

Percent Production Data—Basketballs Units Complete

Work in process units, July 1 500 60% Units started into production 1,250 Work in process units, July 31 600 40%

Cost Data—Basketballs

Work in process, July 1 Materials $750 Conversion costs 600 $1,350 Direct materials 2,400 Direct labor 1,580 Manufacturing overhead 1,295

Instructions (a) Calculate the following. (1) The equivalent units of production for materials and conversion costs. (2) The unit costs of production for materials and conversion costs. (3) The assignment of costs to units transferred out and in process at the end of the

accounting period. (b) Prepare a production cost report for the month of July for the basketballs.

P3-6A Hamilton Processing Company uses a weighted-average process cost system and manufactures a single product—a premium rug shampoo and cleaner. The manufactur- ing activity for the month of October has just been completed. A partially completed pro- duction cost report for the month of October for the Mixing and Cooking Department is shown on the next page.

Instructions (a) Prepare a schedule that shows how the equivalent units were computed so that you

can complete the “Quantities: Units accounted for” equivalent units section shown in the production cost report, and compute October unit costs.

(b) Complete the “Cost Reconciliation Schedule” part of the production cost report below.

(a) (3) T12: Materials $20 CC $19

(4) T12: Transferred out $624,000 WIP $ 94,200

(b) Transferred out $2,211,000 WIP $ 69,000

Assign costs and prepare production cost report.

(LO 5, 6, 7), AP

Determine equivalent units and unit costs and assign costs.

(LO 5, 6, 7), AP

(a) (2) Materials $1.80 (3) Transferred

out $4,945 WIP $1,680

Compute equivalent units and complete production cost report.

(LO 5, 7), AP

(a) Materials $1.60 (b) Transferred

out $282,000 WIP $ 63,000

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136 3 Process Costing

Hamilton Processing Company Mixing and Cooking Department

Production Cost Report For the Month Ended October 31

Equivalent Units

Physical Conversion Quantities Units Materials Costs

Units to be accounted for Work in process, October 1 (all materials, 70% conversion costs) 20,000 Started into production 150,000

Total units 170,000

Units accounted for Transferred out 120,000 ? ? Work in process, October 31 (60% materials, 40% conversion costs) 50,000 ? ?

Total units accounted for 170,000 ? ?

Costs

Unit costs Conversion Materials Costs Total

Total cost $240,000 $105,000 $345,000

Equivalent units ? ?

Unit costs $ ? 1 $ ? 5 $ ?

Costs to be accounted for Work in process, October 1 $ 30,000 Started into production 315,000

Total costs $345,000

Cost Reconciliation Schedule

Costs accounted for Transferred out $ ? Work in process, October 31 Materials $ ? Conversion costs ? ?

Total costs $ ?

*P3-7A Rondeli Company manufactures bicycles and tricycles. For both products, ma- terials are added at the beginning of the production process, and conversion costs are incurred uniformly. Rondeli Company uses the FIFO method to compute equivalent units. Production and cost data for the month of March are as follows.

Percent Production Data—Bicycles Units Complete

Work in process units, March 1 200 80% Units started into production 1,250 Work in process units, March 31 300 40%

Percent Cost Data—Bicycles Units Complete

Work in process, March 1 $19,280 Direct materials 50,000 Direct labor 25,500 Manufacturing overhead 30,000

Determine equivalent units and unit costs and assign costs for processes; prepare production cost report.

(LO 8), AP

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Problems: Set B 137

Percent Production Data—Tricycles Units Complete

Work in process units, March 1 100 75% Units started into production 800 Work in process units, March 31 60 25%

Cost Data—Tricycles

Work in process, March 1 $ 6,125 Direct materials 30,400 Direct labor 15,100 Manufacturing overhead 20,000

Instructions (a) Calculate the following for both the bicycles and the tricycles. (1) The equivalent units of production for materials and conversion costs. (2) The unit costs of production for materials and conversion costs. (3) The assignment of costs to units transferred out and in process at the end of the

accounting period. (b) Prepare a production cost report for the month of March for the bicycles only.

(a) Bicycles: (1) Materials 1,250 (2) Materials $40 (3) Transferred

out $106,780 WIP $ 18,000

P3-1B Wilbury Company manufactures a nutrient, Everlife, through two manufactur- ing processes: Blending and Packaging. All materials are entered at the beginning of each process. On August 1, 2014, inventories consisted of Raw Materials $5,000, Work in Process—Blending $0, Work in Process—Packaging $3,945, and Finished Goods $7,500. The beginning inventory for Packaging consisted of 500 units, two-fi fths com- plete as to conversion costs and fully complete as to materials. During August, 9,000 units were started into production in Blending, and the following transactions were completed.

1. Purchased $25,000 of raw materials on account. 2. Issued raw materials for production: Blending $18,930 and Packaging $9,140. 3. Incurred labor costs of $25,770. 4. Used factory labor: Blending $15,320 and Packaging $10,450. 5. Incurred $36,500 of manufacturing overhead on account. 6. Applied manufacturing overhead at the rate of $28 per machine hour. Machine hours

were Blending 900 and Packaging 300. 7. Transferred 8,200 units from Blending to Packaging at a cost of $44,940. 8. Transferred 8,600 units from Packaging to Finished Goods at a cost of $67,490. 9. Sold goods costing $62,000 for $90,000 on account.

Instructions Journalize the August transactions.

P3-2B Steiner Corporation manufactures water skis through two processes: Molding and Packaging. In the Molding Department, fi berglass is heated and shaped into the form of a ski. In the Packaging Department, the skis are placed in cartons and sent to the fi nished goods warehouse. Materials are entered at the beginning of both processes. Labor and manufacturing overhead are incurred uniformly throughout each process. Production and cost data for the Molding Department for January 2014 are presented below.

Production Data January

Beginning work in process units –0– Units started into production 50,000 Ending work in process units 2,500 Percent complete—ending inventory 40%

Journalize transactions.

(LO 3, 4), AP

PROBLEMS: SET B

Complete four steps necessary to prepare a production cost report.

(LO 5, 6, 7), AP

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138 3 Process Costing

Cost Data January

Materials $510,000 Labor 92,500 Overhead 150,000

Total $752,500

Instructions (a) Compute the physical units of production. (b) Determine the equivalent units of production for materials and conversion costs. (c) Compute the unit costs of production. (d) Determine the costs to be assigned to the units transferred out and in process. (e) Prepare a production cost report for the Molding Department for the month of

January.

P3-3B Borman Corporation manufactures in separate processes refrigerators and freezers for homes. In each process, materials are entered at the beginning and conversion costs are incurred uniformly. Production and cost data for the fi rst process in making two prod- ucts in two different manufacturing plants are as follows.

Stamping Department

Plant A Plant B Production Data—June R12 Refrigerators F24 Freezers

Work in process units, June 1 –0– –0– Units started into production 20,000 20,000 Work in process units, June 30 4,000 2,500 Work in process percent complete 75 60

Cost Data—June

Work in process, June 1 $ –0– $ –0– Materials 840,000 720,000 Labor 245,000 259,000 Overhead 420,000 292,000

Total $1,505,000 $1,271,000

Instructions (a) For each plant: (1) Compute the physical units of production. (2) Compute equivalent units of production for materials and for conversion costs. (3) Determine the unit costs of production. (4) Show the assignment of costs to units transferred out and in process. (b) Prepare the production cost report for Plant A for June 2014.

P3-4B Luxman Company has several processing departments. Costs charged to the Assembly Department for October 2014 totaled $1,298,400 as follows.

Work in process, October 1 Materials $29,000 Conversion costs 16,500 $ 45,500

Materials added 1,006,000 Labor 138,900 Overhead 108,000

Production records show that 25,000 units were in beginning work in process 40% com- plete as to conversion cost, 435,000 units were started into production, and 35,000 units were in ending work in process 40% complete as to conversion costs. Materials are entered at the beginning of each process.

Instructions (a) Determine the equivalent units of production and the unit production costs for the

Assembly Department. (b) Determine the assignment of costs to goods transferred out and in process. (c) Prepare a production cost report for the Assembly Department.

Assign costs and prepare production cost report.

(LO 5, 6, 7), AP

Complete four steps necessary to prepare a production cost report.

(LO 5, 6, 7), AP

(c) Materials $10.20 CC $5

(d) Transferred out $722,000 WIP $ 30,500

(a) (3) R12: Materials $42 CC $35

(4) R12: Transferred out $1,232,000 WIP $ 273,000

(b) Transferred out $1,211,250 WIP $ 87,150

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Problems: Set B 139

P3-5B Swinn Company manufactures bicycles. Materials are added at the beginning of the production process, and conversion costs are incurred uniformly. Production and cost data for the month of May are as follows.

Percent Production Data—Bicycles Units Complete

Work in process units, May 1 500 80% Units started in production 2,000 Work in process units, May 31 800 40%

Cost Data—Bicycles

Work in process, May 1 Materials $15,000 Conversion costs 18,000 $33,000 Direct materials 50,000 Direct labor 19,020 Manufacturing overhead 33,680

Instructions (a) Calculate the following. (1) The equivalent units of production for materials and conversion. (2) The unit costs of production for materials and conversion costs. (3) The assignment of costs to units transferred out and in process at the end of the

accounting period. (b) Prepare a production cost report for the month of May for the bicycles.

P3-6B Venuchi Cleaner Company uses a weighted-average process cost system and manu- factures a single product—an all-purpose liquid cleaner. The manufacturing activity for the month of March has just been completed. A partially completed production cost report for the month of March for the mixing and blending department is shown below.

Venuchi Cleaner Company Mixing and Blending Department

Production Cost Report For the Month Ended March 31

Equivalent Units

Physical Conversion Quantities Units Materials Costs

Units to be accounted for Work in process, March 1 10,000 Started into production 76,000

Total units 86,000

Units accounted for Transferred out 66,000 ? ? Work in process, March 31 (60% materials, 20% conversion costs) 20,000 ? ?

Total units 86,000 ? ?

Costs Conversion Unit costs Materials Costs Total

Total cost $156,000 $98,000 $254,000

Equivalent units ? ?

Unit costs $ ? 1 $ ? 5 $ ?

Costs to be accounted for Work in process, March 1 $ 8,700 Started into production 245,300

Total costs $254,000

Determine equivalent units and unit costs and assign costs.

(LO 5, 6, 7), AP

Compute equivalent units and complete production cost report.

(LO 5, 7), AP

(2) Materials $26 CC $35

(3) Transferred out $103,700 WIP $ 32,000

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140 3 Process Costing

Percent Production Data—Basketballs Units Complete

Work in process units, August 1 500 60% Units started into production 2,000 Work in process units, August 31 600 50%

Cost Data—Basketballs

Work in process, August 1 $1,125 Direct materials 1,600 Direct labor 1,280 Manufacturing overhead 1,000

Percent Production Data—Soccer Balls Units Complete

Work in process units, August 1 200 80% Units started into production 2,000 Work in process units, August 31 150 70%

Cost Data—Soccer Balls

Work in process, August 1 $ 450 Direct materials 2,800 Direct labor 1,000 Manufacturing overhead 1,394

Instructions (a) Calculate the following for both the basketballs and the soccer balls. (1) The equivalent units of production for materials and conversion costs. (2) The unit costs of production for materials and conversion costs. (3) The assignment of costs to units transferred out and in process at the end of the

accounting period. (b) Prepare a production cost report for the month of August for the basketballs only.

Cost Reconciliation Schedule

Costs accounted for Transferred out $ ? Work in process, March 31 Materials ? Conversion costs $ ? ?

Total costs $ ?

Instructions (a) Prepare a schedule that shows how the equivalent units were computed so that you

can complete the “Quantities: Units accounted for” equivalent units section shown in the production cost report above, and compute March unit costs.

(b) Complete the “Cost Reconciliation Schedule” part of the production cost report above.

*P3-7B Holiday Company manufactures basketballs and soccer balls. For both products, materials are added at the beginning of the production process and conversion costs are incurred uniformly. Holiday uses the FIFO method to compute equivalent units. Produc- tion and cost data for the month of August are shown below.

Determine equivalent units and unit costs and assign costs for processes; prepare production cost report.

(LO 8), AP

(a) Basketballs: (1) Materials 2,000 (2) Materials $.80 (3) Transferred out $4,165

WIP $840

Conversion Materials Costs Total

Visit the book’s companion website, at www.wiley.com/college/weygandt, and choose the Student Companion site to access Problem Set C.

PROBLEMS: SET C

(Note: This is a continuation of the Waterways Problem from Chapters 1–2.)

WCP3 Because most of the parts for its irrigation systems are standard, Waterways han- dles the majority of its manufacturing as a process cost system. There are multiple process departments. Three of these departments are the Molding, Cutting, and Welding depart- ments. All items eventually end up in the Packaging department which prepares items for sale in kits or individually. This problem asks you to help Waterways calculate equivalent units and prepare a production cost report.

Go to the book’s companion website, at www.wiley.com/college/weygandt, to see the completion of this problem.

WATERWAYS CONTINUING PROBLEM

(a) Materials $2.00 (b) Transferred out $224,400

WIP $ 29,600

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Broadening Your Perspective 141

Management Decision-Making

Decision-Making at Current Designs

BYP3-1 Building a kayak using the composite method is a very labor-intensive process. In the fabrication department, the kayaks go through several steps as employees carefully place layers of Kevlar® in a mold and then use resin to fuse together the layers. The excess resin is removed with a vacuum process, and the upper shell and lower shell are removed from the molds and assembled. The seat, hatch, and other components are added in the fi nishing department.

At the beginning of April, Current Designs had 30 kayaks in process in the fabrication depart- ment. Rick Thrune, the production manager, estimated that about 80% of the material costs had been added to these boats, which were about 50% complete with respect to the conversion costs. The cost of this inventory had been calculated to be $8,400 in materials and $9,000 in conversion costs.

During April, 72 boats were started. At the end of the month, the 35 kayaks in the ending inven- tory had 20% of the materials and 40% of the conversion costs already added to them.

A review of the accounting records for April showed that materials with a cost of $17,500 had been requisitioned by this department and that the conversion costs for the month were $39,600.

Instructions Complete a production cost report for April 2014 for the fabrication department using the weighted- average method.

Decision-Making Across the Organization

BYP3-2 Florida Beach Company manufactures suntan lotion, called Surtan, in 11-ounce plastic bot- tles. Surtan is sold in a competitive market. As a result, management is very cost-conscious. Surtan is manufactured through two processes: mixing and fi lling. Materials are entered at the beginning of each process, and labor and manufacturing overhead occur uniformly throughout each process. Unit costs are based on the cost per gallon of Surtan using the weighted-average costing approach.

On June 30, 2014, Mary Ritzman, the chief accountant for the past 20 years, opted to take early retirement. Her replacement, Joe Benili, had extensive accounting experience with motels in the area but only limited contact with manufacturing accounting. During July, Joe correctly accumu- lated the following production quantity and cost data for the Mixing Department.

Production quantities: Work in process, July 1, 8,000 gallons 75% complete; started into produc- tion 100,000 gallons; work in process, July 31, 5,000 gallons 20% complete. Materials are added at the beginning of the process.

Production costs: Beginning work in process $88,000, comprised of $21,000 of materials costs and $67,000 of conversion costs; incurred in July: materials $573,000, conversion costs $765,000.

Joe then prepared a production cost report on the basis of physical units started into produc- tion. His report showed a production cost of $14.26 per gallon of Surtan. The management of Florida Beach was surprised at the high unit cost. The president comes to you, as Mary’s top assistant, to review Joe’s report and prepare a correct report if necessary.

Instructions With the class divided into groups, answer the following questions. (a) Show how Joe arrived at the unit cost of $14.26 per gallon of Surtan. (b) What error(s) did Joe make in preparing his production cost report? (c) Prepare a correct production cost report for July.

Managerial Analysis

BYP3-3 Harris Furniture Company manufactures living room furniture through two departments: Framing and Upholstering. Materials are entered at the beginning of each process. For May, the following cost data are obtained from the two work in process accounts.

Broadening Your PERSPECTIVE

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Framing Upholstering

Work in process, May 1 $ –0– $ ? Materials 450,000 ? Conversion costs 261,000 330,000 Costs transferred in –0– 600,000 Costs transferred out 600,000 ? Work in process, May 31 111,000 ?

Instructions Answer the following questions. (a) If 3,000 sofas were started into production on May 1 and 2,500 sofas were transferred to

Upholstering, what was the unit cost of materials for May in the Framing Department? (b) Using the data in (a) above, what was the per unit conversion cost of the sofas transferred to

Upholstering? (c) Continuing the assumptions in (a) above, what is the percentage of completion of the units in

process at May 31 in the Framing Department?

Real-World Focus

BYP3-4 Paintball is now played around the world. The process of making paintballs is actually quite similar to the process used to make certain medical pills. In fact, paintballs were previously often made at the same factories that made pharmaceuticals.

Address: http://video.google.com/videoplay?docid56864066340713942400, or go to www.wiley. com/college/weygandt

Instructions View that video at the site listed above and then answer the following questions. (a) Describe in sequence the primary steps used to manufacture paintballs. (b) Explain the costs incurred by the company that would fall into each of the following categories:

materials, labor, and overhead. Of these categories, which do you think would be the greatest cost in making paintballs?

(c) Discuss whether a paintball manufacturer would use job order costing or process costing.

142 3 Process Costing

Critical Thinking

Communication Activity

BYP3-5 Diane Barone was a good friend of yours in high school and is from your home town. While you chose to major in accounting when you both went away to college, she majored in mar- keting and management. You have recently been promoted to accounting manager for the Snack Foods Division of Melton Enterprises, and your friend was promoted to regional sales manager for the same division of Melton. Diane recently telephoned you. She explained that she was familiar with job cost sheets, which had been used by the Special Projects division where she had formerly worked. She was, however, very uncomfortable with the production cost reports prepared by your division. She emailed you a list of her particular questions:

1. Since Melton occasionally prepares snack foods for special orders in the Snack Foods Division, why don’t we track costs of the orders separately?

2. What is an equivalent unit? 3. Why am I getting four production cost reports? Isn’t there one Work in Process account?

Instructions Prepare a memo to Diane. Answer her questions, and include any additional information you think would be helpful. You may write informally, but do use proper grammar and punctuation.

Ethics Case

BYP3-6 R. B. Dillman Company manufactures a high-tech component that passes through two production processing departments, Molding and Assembly. Department managers are partially compensated on the basis of units of products completed and transferred out relative to units of

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product put into production. This was intended as encouragement to be effi cient and to minimize waste.

Jan Wooten is the department head in the Molding Department, and Tony Ferneti is her qual- ity control inspector. During the month of June, Jan had three new employees who were not yet technically skilled. As a result, many of the units produced in June had minor molding defects. In order to maintain the department’s normal high rate of completion, Jan told Tony to pass through inspection and on to the Assembly Department all units that had defects nondetectable to the human eye. “Company and industry tolerances on this product are too high anyway,” says Jan. “Less than 2% of the units we produce are subjected in the market to the stress tolerance we’ve designed into them. The odds of those 2% being any of this month’s units are even less. Anyway, we’re saving the company money.”

Instructions (a) Who are the potential stakeholders involved in this situation? (b) What alternatives does Tony have in this situation? What might the company do to prevent this

situation from occurring?

Considering People, Planet, and Profi t

BYP3-7 In a recent year, an oil refinery in Texas City, Texas, on the Houston Ship Channel exploded. The explosion killed 14 people and sent a plume of smoke hundreds of feet into the air. The blast started as a fi re in the section of the plant that increased the octane of the gasoline that was produced at the refi nery. The Houston Ship Channel is the main waterway that allows com- merce to fl ow from the Gulf of Mexico into Houston.

The Texas Commission on Environmental Quality expressed concern about the release of nitrogen oxides, benzene, and other known carcinogens as a result of the blast. Neighbors of the plant complained that the plant had been emitting carcinogens for years and that the regulators had ignored their complaints about emissions and unsafe working conditions.

Instructions Answer the following questions. (a) Outline the costs that the company now faces as a result of the accident. (b) How could the company have reduced the costs associated with the accident?

Broadening Your Perspective 143

Answers to Chapter Questions

Answers to Insight and Accounting Across the Organization Questions

p. 100 Choosing a Cost Driver Q: What is the result if a company uses the wrong “cost driver” to assign manufacturing overhead? A: Incorrect assignment of manufacturing overhead will result in some products receiving too much overhead and others receiving too little. p. 104 Haven’t I Seen That Before? Q: In what ways might the relative composition (materials, labor, and overhead) of a remanufactured product’s cost differ from that of a newly made product? A: We would expect that the materials costs would be substantially reduced since the bulk of the physical product is being reused. The labor component might increase, and the level of automa- tion might decrease, since remanufacturing a product requires identifi cation and replacement of malfunctioning components. This process might not be as easily automated as the production of a new product.

Answers to Self-Test Questions

1. b 2. d 3. d 4. b 5. c 6. b 7. b [20,000 1 (5,000 3 60%)] 8. a (7,000 1 0) 9. c (23,000 1 3,000), [23,000 1 (3,000 3 3313%)] 10. a [$60,000 4 (9,000 1 3,000)] 11. b [($10 3 2,500) 1 ($30 3 2,500 3 40%)] 12. b 13. d *14. b [25,000 1 (3,000 3 100%)]; [(2,000 3 80%) 1 25,000 1 (3,000 3 30%)] *15. a [$60,000 4 (9,000 1 3,000)] *16. b [($10 3 2,500) 1 ($30 3 2,500 3 40%)]

✔ Remember to go back to The Navigator box on the chapter opening page and check off your completed work.

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Feature Story

✔ The Navigator

Learning Objectives After studying this chapter, you should be able to:

1 Recognize the difference between traditional costing and activity-based costing.

2 Identify the steps in the development of an activity-based costing system.

3 Know how companies identify the activity cost pools used in activity-based costing.

4 Know how companies identify and use cost drivers in activity-based costing.

5 Understand the benefi ts and limitations of activity-based costing.

6 Differentiate between value-added and non–value-added activities.

7 Understand the value of using activity levels in activity-based costing.

8 Apply activity-based costing to service industries.

✔ The Navigator

Chapter 4

Activity-Based Costing

Precor Is on Your Side Do you feel like the whole world is

conspiring against your efforts to get

in shape? Is it humanly possible to

resist the constant barrage of adver-

tisements and fast-food servers who

pleasantly encourage us to “supersize”

it? Lest we think that we have no allies

in our battle against the bulge,

consider Precor.

Ever since it made the fi rst ergonomi-

cally sound rowing machine in 1980,

Precor’s sole mission has been to

provide exercise equipment. It makes

elliptical trainers, exercise bikes,

rowing machines, treadmills, multi-

station strength systems, and many

other forms of equipment designed

to erase the cumulative effects of a

fast-food nation. Its equipment is

widely used in Hilton hotels, Gold’s

Gym franchises, and even in Madonna’s

Hard Candy fi tness center in Moscow.

Building high-quality fi tness equipment

requires sizable investments by Precor

in buildings and machinery. For

example, Precor recently moved its

facilities from Valencia, California, to

Greensboro, North Carolina. In order

to reduce costs and minimize environ-

mental impact, the company installed

low-fl ow water fi xtures, high-effi ciency

heating and cooling systems, and

state-of-the-art lighting in its $26

million, 230,000-square-foot facility.

As a result of these efforts, Precor’s

new facility received a Leadership in

Energy and Effi cient Design (LEED) CI

Gold Certifi cation.

144

Scan Learning Objectives

Read Feature Story

Read Preview

Read Text and answer p. 149 p. 153 p. 158 p. 161

Work Using the Decision Toolkit p. 164

Review Summary of Learning Objectives

Work Comprehensive p. 169

Answer Self-Test Questions

Complete Assignments

Go to WileyPLUS for practice and tutorials

DO IT!

DO IT!

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Because of its huge investments in property, plant, and

equipment, overhead costs represent a large percentage of

the cost of Precor’s exercise equipment. The

combination of high overhead costs and a

wide variety of products means that it is

important that Precor allocates its overhead

accurately to its various products. Without

accurate cost information, Precor would not

know whether its elliptical trainers and

recumbent bicycles are making money,

whether its AMT 100i adaptive motion

trainer is priced high enough to cover its

costs, or if its 240i Stretchtrainer is losing

money. To increase the accuracy of its costs,

Precor uses a method of overhead allocation

that focuses on identifying the types of activities that cause

the company to incur costs. It then assigns more overhead

to those products that rely most heavily

on cost-incurring activities. By doing this,

the allocation of overhead is less arbitrary

than traditional overhead allocation methods.

In short, before it can help us burn off the

pounds, Precor needs to understand what

drives its overhead costs.

Watch the Precor video in WileyPLUS to

learn more about activity-based costing

in the real world.

Source: www.precor.com.

✔ The Navigator

As indicated in the Feature Story about Precor, the traditional costing systems described in earlier chapters are not the best answer for every company. Because Precor suspected that the traditional system was masking signifi cant differences in its real cost structure, it sought a new method of assigning costs. Similar searches by other companies for ways to improve operations and gather more accurate data for decision-making have resulted in the development of powerful new management tools, including activity- based costing (ABC). The primary objective of this chapter is to explain and illustrate this concept.

The content and organization of this chapter are as follows.

Preview of Chapter 4

ACTIVITY-BASED COSTING

• Traditional costing • Need for a new

approach • Activity-based costing

Traditional Costing and ABC

• Identify activities and allocate to cost pools

• Identify cost drivers • Compute overhead

rates • Assign overhead costs

to products • Compare unit costs

Example of ABC versus Traditional Costing

• Benefi ts • Limitations • When to use ABC • Value-added versus

non–value-added activities

• Classifi cation of activity levels

ABC: A Closer Look • Traditional costing

example • ABC example

ABC in Service Industries

✔ The Navigator

145

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146 4 Activity-Based Costing

Traditional Costing Systems

It is probably impossible to determine the exact cost of a product or service. However, in order to achieve improved management decisions, companies strive to provide decision-makers with the most accurate cost estimates they can. The most accurate estimate of product cost occurs when the costs are traceable di- rectly to the product produced or the service provided. Direct material and direct labor costs are the easiest to trace directly to the product through the use of mate- rial requisition forms and payroll time sheets. Overhead costs, on the other hand, are an indirect or common cost that generally cannot be easily or directly traced to individual products or services. Instead, companies use estimates to assign overhead costs to products and services.

Often the most diffi cult part of computing accurate unit costs is determining the proper amount of overhead cost to assign to each product, service, or job. In our coverage of job order costing in Chapter 2 and of process costing in Chapter 3, we used a single or plantwide overhead rate throughout the year for the entire factory operation. That rate was called the predetermined overhead rate. For job order costing, we assumed that direct labor cost was the relevant activity base for assigning all overhead costs to jobs. For process costing, we assumed that machine hours was the relevant activity base for assigning all overhead to the process or department.

The use of direct labor as the activity base made sense when overhead cost allocation systems were fi rst developed. At that time, direct labor made up a large portion of total manufacturing cost. Therefore, it was widely accepted that there was a high correlation between direct labor and the incurrence of overhead cost. As a result, direct labor became the most popular basis for allocating overhead.

Even in today’s increasingly automated environment, direct labor is some- times the appropriate basis for assigning overhead cost to products. It is appro- priate to use direct labor when (a) direct labor constitutes a signifi cant part of total product cost, and (b) a high correlation exists between direct labor and changes in the amount of overhead costs. Illustration 4-1 displays a simplifi ed (one-stage) traditional costing system relying on direct labor to assign overhead.

The Need for a New Approach

In recent years, manufacturers and service providers have experienced tremen- dous change. Advances in computerized systems, technological innovation, global competition, and automation have changed the manufacturing environment dras- tically. As a result, the amount of direct labor used in many industries has greatly decreased, and total overhead costs resulting from depreciation on expensive equipment and machinery, utilities, repairs, and maintenance have signifi cantly increased. When there is not a correlation between direct labor and overhead, it is inappropriate to use plantwide predetermined overhead rates based on direct labor. Companies that use overhead rates based on direct labor when this correla- tion does not exist experience signifi cant product-cost distortions.

To avoid such distortions, many companies now use machine hours as the basis on which to allocate overhead in an automated manufacturing environ- ment. But even machine hours may not suffi ce as the only plantwide basis for allocating all overhead. If the manufacturing process is complex, then only mul- tiple allocation bases can result in more accurate product-cost computations. In such situations, managers need to consider an overhead cost allocation method that uses multiple bases. That method is activity-based costing.

Traditional Costing and Activity-Based Costing

Illustration 4-1 Traditional one-stage costing system

Products

Over- head Costs

Direct Labor Hours or Dollars

Recognize the difference between traditional costing and activity- based costing.

1LEARNING OBJECTIVE

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Traditional Costing and Activity-Based Costing 147

Activity-Based Costing

Broadly, activity-based costing (ABC) is an approach for allocating overhead costs. More specifi cally, ABC allocates overhead to multiple activity cost pools, and it then assigns the activity cost pools to products and services by means of cost drivers. To understand this more clearly, we need to apply some new meanings to the rather common-sounding words that make up the defi nition: In activity-based costing, an activity is any event, action, transaction, or work sequence that incurs costs when producing a product or providing a service. An activity cost pool is the overhead cost attributed to a distinct type of activity (e.g., ordering materials or setting up machines). A cost driver is any factor or activity that has a direct cause-effect rela- tionship with the resources consumed. The reasoning behind ABC cost allocation is simple: Products consume activities, and activities consume resources.

These defi nitions of terms will become clearer as we look more closely at how ABC works. ABC allocates overhead in a two-stage process. The fi rst stage allocates overhead costs to activity cost pools. (Traditional costing systems, in contrast, allocate these costs to departments or to jobs.) Examples of overhead cost pools are ordering materials, setting up machines, assembling products, and inspecting products.

The second stage assigns the overhead allocated to the activity cost pools to products, using cost drivers. The cost drivers measure the number of individual activities undertaken or performed to produce products or provide services. Examples are number of purchase orders, number of setups, labor hours, and number of inspections. Illustration 4-2 shows examples of activities, and possible

Ab Bench Ab Coaster

Products

Cost Drivers

Activity Cost Pools

Overhead Costs

Number of Purchase Orders

Amount of Square Footage

Number of Machine Hours

Number of Employees

Supervising $Machining $

S T O R E R O O M

Storing $Purchasing $

Illustration 4-2 Activities and related cost drivers

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148 4 Activity-Based Costing

cost drivers to measure them, for a company that manufactures two types of abdominal exercise equipment—Ab Benches and Ab Coasters.

In the fi rst step (as shown at the top of Illustration 4-2 on page 147), the com- pany allocates overhead costs to activity cost pools. In this simplifi ed example, the company has identifi ed four activity cost pools: purchasing, storing, machin- ing, and supervising. After the costs are allocated to the activity cost pools, the company uses cost drivers to determine the costs to assign to the individual prod- ucts based on each product’s use of each activity. For example, if Ab Benches require more activity by the purchasing department, as measured by the number of required purchase orders, then more of the overhead costs from the purchas- ing pool are allocated to the Ab Benches.

The more complex a product’s manufacturing operation, the more activities and cost drivers it is likely to have. If there is little or no correlation between changes in the cost driver and consumption of the overhead cost, inaccurate product costs are inevitable.

Illustration 4-3 shows the design of a more complex activity-based costing system with seven activity cost pools for Lift Jack Company. Lift Jack Company manufactures two automotive jacks—an automobile scissors jack and a truck hydraulic jack.

Inspecting and

Testing Cost Pool

Number of

Tests

Painting Cost Pool

Number of

Parts

Assembling Cost Pool

Number of

Parts

Setting Up

Machines Cost Pool

Number of

Setups

Machining Cost Pool

Machine Hours

Ordering and

Receiving Materials

Cost Pool

Number of

Purchase Orders

Supervising Cost Pool

Direct Labor Hours

Activity Cost Pools

Cost Drivers

Products

Overhead Costs

Illustration 4-3 ABC system design—Lift Jack Company

The Lift Jack Company illustration contains seven activity cost pools. In some companies, the number of activities can be substantial. For example, Clark-Hurth (a division of Clark Equipment Company), a manufacturer of axles and transmis- sions, identifi ed over 170 activities. Compumotor (a division of Parker Hannifi n) identifi ed over 80 activities in just the procurement function of its Material Control Department.

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Example of ABC versus Traditional Costing 149

In this section, we present a simple case example that compares activity-based costing with traditional costing. It illustrates how ABC eliminates the distortion that can occur in traditional overhead cost allocation. As you study this example, you should understand that ABC does not replace an existing job order or process cost system. What ABC does is to segregate overhead into various cost pools in an effort to provide more accurate cost information. As a result, ABC supplements— rather than replaces—these cost systems.

Assume that Atlas Company produces two products—the Ab Bench and the Ab Coaster abdominal trainers. The Ab Bench is a high-volume item totaling 25,000 units annually. The Ab Coaster is a low-volume item totaling only 5,000 units per year. The direct materials cost per unit is $40 for the Ab Bench and $30 for the Ab Coaster. The direct labor cost is $12 per unit for each product. Each product requires one hour of direct labor for completion. Therefore, total annual direct labor hours are 30,000 (25,000 1 5,000). Expected annual manufacturing over- head costs are $900,000. Thus, the predetermined overhead rate under traditional costing, using direct labor hours, is $30 ($900,000 4 30,000) per direct labor hour. Since both products require one direct labor hour per unit, both products are allocated overhead costs of $30 per unit under traditional costing.

Let’s now calculate unit costs under ABC. Activity-based costing involves the following four steps.

1. Identify and classify the activities involved in the manufacture of specifi c products, and allocate overhead to cost pools.

2. Identify the cost driver that has a strong correlation to the costs accumu- lated in the cost pool.

3. Compute the activity-based overhead rate for each cost driver.

4. Assign overhead costs to products, using the overhead rates determined for each cost pool (cost per driver).

Example of ABC versus Traditional Costing

Costing Systems

Action Plan ✔ Understand that a

traditional costing system allocates over- head on the basis of a single predetermined overhead rate.

✔ Understand that an ABC system allocates overhead to identifi ed activity cost pools, and then assigns costs to products using related cost drivers that measure the resources consumed.

> DO IT!

1. false. 2. true. 3. true. 4. false. 5. true.

Indicate whether the following statements are true or false.

1. A traditional costing system allocates overhead by means of multiple overhead rates.

2. Activity-based costing allocates overhead costs in a two-stage process.

3. Direct material and direct labor costs are easier to trace to products than overhead.

4. As manufacturing processes have become more automated, more companies have chosen to allocate overhead on the basis of direct labor costs.

5. In activity-based costing, an activity is any event, action, transaction, or work sequence that incurs cost when producing a product.

Solution

✔ The Navigator

Related exercise material: BE4-1, BE4-2, E4-1, and 4-1.DO IT!

Identify the steps in the development of an activity-based costing system.

2LEARNING OBJECTIVE

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150 4 Activity-Based Costing

Identify and Classify Activities and Allocate Overhead to Cost Pools (Step 1)

Activity-based costing starts with an analysis of the activities performed to manu- facture a product or provide a service. This analysis should identify all resource- consuming activities. It requires documenting every activity undertaken to accomplish a task. Atlas Company identifi ed three activity cost pools: setting up machines, machining, and inspecting.

Next, the system assigns overhead costs directly to the appropriate activity cost pool. For example, all overhead costs directly associated with Atlas Com- pany’s machine setups (such as salaries, supplies, and depreciation) would be assigned to the machine setup cost pool. Illustration 4-4 shows the three cost pools, along with the estimated overhead allocated to each cost pool.

Illustration 4-4 Activity cost pools and estimated overhead

Activity Cost Pools Estimated Overhead

Setting up machines $300,000 Machining 500,000 Inspecting 100,000

Total $ 900,000

Identify Cost Drivers (Step 2)

After costs are allocated to the activity cost pools, the company must identify the cost drivers for each cost pool. The cost driver must accurately measure the actual consumption of the activity by the various products. To achieve accurate costing, a high degree of correlation must exist between the cost driver and the actual consumption of the overhead costs in the cost pool.

Illustration 4-5 shows the cost drivers identifi ed by Atlas and their total ex- pected use per activity cost pool.

Illustration 4-5 Cost drivers and their expected use

Expected Use of Cost Drivers Activity Cost Pools Cost Drivers per Activity

Setting up machines Number of setups 1,500 setups Machining Machine hours 50,000 machine hours Inspecting Number of inspections 2,000 inspections

Availability and ease of obtaining data relating to the cost driver is an impor- tant factor that must be considered in its selection.

Compute Activity-Based Overhead Rates (Step 3)

Next, the company computes an activity-based overhead rate per cost driver by dividing the estimated overhead per activity by the number of cost drivers expected to be used per activity. Illustration 4-6 shows the formula for this computation.

Illustration 4-6 Formula for computing activity- based overhead rate

Estimated Overhead per Activity 5

Activity-Based Expected Use of Cost Drivers per Activity Overhead Rate

Know how companies identify and use cost drivers in activity-based costing.

4LEARNING OBJECTIVE

Know how companies identify the activity cost pools used in activity- based costing.

3LEARNING OBJECTIVE

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Example of ABC versus Traditional Costing 151

Atlas Company computes its activity-based overhead rates by using the esti- mated overhead per activity cost pool, shown in Illustration 4-4, and the expected use of cost drivers per activity, shown in Illustration 4-5. These computations are presented in Illustration 4-7.

Illustration 4-7 Computation of activity-based overhead rates

Expected Use Estimated 4 of Cost Drivers 5 Activity-Based Activity Cost Pools Overhead per Activity Overhead Rates

Setting up machines $300,000 1,500 setups $200 per setup Machining 500,000 50,000 machine hours $10 per machine hour Inspecting 100,000 2,000 inspections $50 per inspection

Total $900,000

Illustration 4-8 Expected use of cost drivers per product

Expected Use

Expected Use of Cost Drivers

Activity Cost of Cost Drivers per Product

Pools Cost Drivers per Activity Ab Bench Ab Coaster

Setting up Number of machines setups 1,500 setups 500 1,000 Machining Machine hours 50,000 machine hours 30,000 20,000 Inspecting Number of inspections 2,000 inspections 500 1,500

Assign Overhead Costs to Products (Step 4)

In assigning overhead costs, it is necessary to know the expected use of cost driv- ers for each product. Because of its low volume, the Ab Coaster requires more setups and inspections than the Ab Bench. Illustration 4-8 shows the expected use of cost drivers per product for each of Atlas’s products.

To assign overhead costs to each product, Atlas multiplies the activity-based overhead rates per cost driver (Illustration 4-7) by the number of cost drivers expected to be used per product (Illustration 4-8). Illustration 4-9 shows the over- head cost assigned to each product.

Illustration 4-9 Assignment of activity cost pools to products

1

2

3

4

5

6

7

8

9

10

11

A P18 fx

C E I KB D F HG J L

Atlas Company.xlsAtlas Company.xls Formulas Data Review ViewPage LayoutInsertHome

Ac�vity Cost Pools 3 5 3 5

Expected Use of Cost Drivers

per Product

Ac�vity-Based Overhead

Rates Cost

Assigned

Expected Use of Cost Drivers

per Product

Ac�vity-Based Overhead

Rates Cost

Assigned Se�ng up machines Machining Inspec�ng Total costs assigned [(a)] Units produced [(b)] Overhead cost per unit [(a)4(b)]

500 30,000

500

$200 $10 $50

$100,000 300,000

25,000

$425,000

25,000

$17

1,000 20,000

1,500

$200 $10 $50

$200,000 200,000

75,000

$475,000

5,000

$95

Ab Bench Atlas Company

Ab Coaster

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152 4 Activity-Based Costing

Under ABC, the overhead cost per unit is $17 for the Ab Bench and $95 for the Ab Coaster. When compared to the $30 per unit overhead charge under tradi- tional costing, ABC shifts costs from the high-volume product (Ab Bench) to the low-volume product (Ab Coaster). This shift occurs because low-volume prod- ucts often require more special handling, such as machine setups and inspec- tions. This is true for Atlas Company. Thus, the low-volume product frequently is responsible for more overhead costs per unit than is a high-volume product.1

Assigning overhead using ABC will usually increase the cost per unit for low- volume products as compared to a traditional overhead allocation. Therefore, traditional cost drivers such as direct labor hours are usually not appropriate for assigning overhead costs to low-volume products.

Comparing Unit Costs

Illustration 4-10 shows the unit cost for each product under traditional costing.

1Robin Cooper and Robert S. Kaplan, “How Cost Accounting Distorts Product Costs,” Management Accounting 69, No. 10 (April 1988), pp. 20–27.

A comparison of unit manufacturing costs under traditional costing and ABC shows the following signifi cant differences.

Illustration 4-10 Computation of unit costs— traditional costing

Products

Manufacturing Costs Ab Bench Ab Coaster

Direct materials $ 40 $30 Direct labor 12 12 Overhead 30* 30*

Total unit cost $82 $72

*Predetermined overhead rate 3 Direct labor hours 5 $30 3 1 hr. 5 $30

Illustration 4-11 Comparison of unit product costs

Ab Bench Ab Coaster

Traditional Traditional Manufacturing Costs Costing ABC Costing ABC

Direct materials $40 $40 $30 $ 30 Direct labor 12 12 12 12 Overhead 30 17* 30 95*

Total cost per unit $82 $69 $72 $137

Overstated Understated $13 $65

*Overhead per Illustration 4-9

The comparison shows that unit costs under traditional costing are signifi - cantly distorted. The cost of producing the Ab Bench is overstated by $13 per unit ($82 2 $69), and the cost of producing the Ab Coaster is understated by $65 per unit ($137 2 $72). These differences are attributable entirely to how Atlas Com- pany assigns manufacturing overhead. A likely consequence of the differences in assigning overhead is that Atlas has been overpricing the Ab Bench and possibly losing market share to competitors. It also has been sacrifi cing profi tability by underpricing the Ab Coaster.

Activity-based costing was pioneered in the United States: John Deere Company coined the term about 25 years ago. Numerous well-known U.S. companies,

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? Why do airlines charge even higher rates for heavier bags, bags that are odd shapes (e.g., ski bags), and bags with hazardous materials in them? (see page 193.)

Example of ABC versus Traditional Costing 153

including IBM, AT&T, Hewlett-Packard, Procter & Gamble, Tektronix, Hughes Aircraft, Caterpillar, and American Express, have adopted ABC. Its use outside the United States, however, is limited. The cost of implementation may discour- age some foreign companies.

In Japan, activity-based costing is less widely used. Companies prefer volume measures such as direct labor hours to assign overhead cost to products. Japanese managers are convinced that reducing direct labor is essential to continuous cost reduction. Using direct labor as the basis for overhead allocation forces Japanese companies to watch direct labor more closely.

Apply ABC

> DO IT!

Casey Company has fi ve activity cost pools and two products. It expects to produce 200,000 units of its automobile scissors jack and 80,000 units of its truck hydraulic jack. Having identifi ed its activity cost pools and the cost drivers for each cost pool, Casey Company accumulated the following data relative to those activity cost pools and cost drivers.

Expected Use of Annual Overhead Data Cost Drivers per Product

Estimated Expected Use of Cost Scissors Hydraulic Activity Cost Pools Cost Drivers Overhead Drivers per Activity Jacks Jacks

Ordering and receiving Purchase orders $ 200,000 2,500 orders 1,000 1,500 Machine setup Setups 600,000 1,200 setups 500 700 Machining Machine hours 2,000,000 800,000 hours 300,000 500,000 Assembling Parts 1,800,000 3,000,000 parts 1,800,000 1,200,000 Inspecting and testing Tests 700,000 35,000 tests 20,000 15,000

$5,300,000

Traveling Light

Have you fl own on an airplane since baggage fees have been implemented? Did the fee make you so mad that you swore that the next time you fl ew, you would pack fewer clothes so you could use a carry-on bag instead? That is exactly how the airlines hoped that you would react. Baggage handling is extremely labor-intensive. All that tagging, sorting, loading on carts, loading in planes, unloading, and sorting again add up to about $9 per bag. They also have equipment costs: sorters, carts, conveyors, tractors, and storage facilities. That’s about another $4 of equipment-related overhead per bag. Finally, there is additional fuel cost of a 40-pound item—about $2 in fuel for a 3-hour fl ight. These costs add up to $15 ($9 1 $4 1 $2). Since air- lines have implemented their baggage fees, fewer customers are checking bags. Not only does this save the airlines money, it also increases the amount of space available for hauling cargo. An airline can charge at least $80 for hauling a small parcel for same-day delivery service.

Source: Scott McCartney, “What It Costs an Airline to Fly Your Luggage,” Wall Street Journal Online (November 25, 2008).

SERVICE COMPANY INSIGHT

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154 4 Activity-Based Costing

Using the above data, do the following.

(a) Prepare a schedule showing the computations of the activity-based overhead rates per cost driver.

(b) Prepare a schedule assigning each activity’s overhead cost to the two products.

(c) Compute the overhead cost per unit for each product.

(d) Comment on the comparative overhead cost per unit.

Solution

(a) Computations of activity-based overhead rates per cost driver:

Estimated Expected Use of Cost Activity-Based Activity Cost Pools Overhead 4 Drivers per Activity 5 Overhead Rates

Ordering and receiving $ 200,000 2,500 purchase orders $80 per order Machine setup 600,000 1,200 setups $500 per setup Machining 2,000,000 800,000 machine hours $2.50 per machine hour Assembling 1,800,000 3,000,000 parts $0.60 per part Inspecting and testing 700,000 35,000 tests $20 per test

$5,300,000

(b) Assignment of each activity’s overhead cost to products using ABC:

Scissors Jacks Hydraulic Jacks

Expected Activity- Expected Activity- Use of Based Use of Based Activity Cost Cost Drivers Overhead Cost Cost Drivers Overhead Cost Pools per Product 3 Rates 5 Assigned per Product 3 Rates 5 Assigned

Ordering and receiving 1,000 $80 $ 80,000 1,500 $80 $ 120,000 Machine setup 500 $500 250,000 700 $500 350,000 Machining 300,000 $2.50 750,000 500,000 $2.50 1,250,000 Assembling 1,800,000 $0.60 1,080,000 1,200,000 $0.60 720,000 Inspecting and testing 20,000 $20 400,000 15,000 $20 300,000 Total assigned costs $2,560,000 $2,740,000

(c) Computation of overhead cost per unit:

Scissors Jack Hydraulic Jack

Total costs assigned $2,560,000 $2,740,000

Total units produced 200,000 80,000

Overhead cost per unit $12.80 $34.25

(d) These data show that the total overhead assigned to 80,000 hydraulic jacks exceeds the overhead assigned to 200,000 scissors jacks. The overhead cost per hydraulic jack is $34.25, but it is only $12.80 per scissors jack.

✔ The Navigator

Related exercise material: BE4-5, BE4-6, BE4-7, E4-1, E4-2, E4-3, E4-4, E4-5, E4-6, E4-11, and 4-2.

DO IT!

Action Plan ✔ Determine the activity-

based overhead rate by dividing the estimated overhead per activity by the expected use of cost drivers per activity.

✔ Assign the overhead of each activity cost pool to the individual products by multiplying the expected use of cost driver per product times the activity-based overhead rate.

✔ Determine overhead cost per unit by dividing the overhead assigned to each product by the number of units of that product.

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Activity-Based Costing: A Closer Look 155

As the use of activity-based costing has grown, both its practical benefi ts and its limitations have become apparent.

Benefi ts of ABC

The primary benefi t of ABC is more accurate product costing. Here’s why:

1. ABC leads to more cost pools being used to assign overhead costs to prod- ucts. Instead of one plantwide pool (or even departmental pools) and a single cost driver, companies use numerous activity cost pools with more relevant cost drivers. Costs are assigned more directly on the basis of the cost drivers used to produce each product.

2. ABC leads to enhanced control over overhead costs. Under ABC, com- panies can trace many overhead costs directly to activities—allowing some indirect costs to be identifi ed as direct costs. Thus, managers have become more aware of their responsibility to control the activities that generate those costs.

3. ABC leads to better management decisions. More accurate product costing should contribute to setting selling prices that can help achieve desired prod- uct profi tability levels. In addition, more accurate cost data could be helpful in deciding whether to make or buy a product part or component, and some- times even whether to eliminate a product.

Activity-based costing does not change the amount of overhead costs. What it does do is allocate those overhead costs in a more accurate manner. Further- more, if the scorekeeping is more realistic and more accurate, managers should be able to better understand cost behavior and overall profi tability.

Limitations of ABC

Although ABC systems often provide better product cost data than traditional volume-based systems, there are limitations:

1. ABC can be expensive to use. The increased cost of identifying multiple activities and applying numerous cost drivers discourages many companies from using ABC. Activity-based costing systems are more complex than tra- ditional costing systems—sometimes signifi cantly more complex. So com- panies must ask, is the cost of implementation greater than the benefi t of greater accuracy? Sometimes it may be. For some companies, there may be no need to consider ABC at all because their existing system is suffi cient. If the costs of ABC outweigh the benefi ts, then the company should not imple- ment ABC.

2. Some arbitrary allocations continue. Even though more overhead costs can be assigned directly to products through ABC’s multiple activity cost pools, certain overhead costs remain to be allocated by means of some arbitrary volume-based cost driver such as labor or machine hours.

Activity-Based Costing: A Closer Look

Understand the benefi ts and limitations of activity-based costing.

5LEARNING OBJECTIVE

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156 4 Activity-Based Costing

When to Use ABC

How does a company know when to use ABC? The presence of one or more of the following factors would point to its possible use:

1. Product lines differ greatly in volume and manufacturing complexity.

2. Product lines are numerous and diverse, and they require differing degrees of support services.

3. Overhead costs constitute a signifi cant portion of total costs.

4. The manufacturing process or the number of products has changed signifi cantly—for example, from labor-intensive to capital-intensive due to automation.

5. Production or marketing managers are ignoring data provided by the existing system and are instead using “bootleg” costing data or other alternative data when pricing or making other product decisions.

The redesign and installation of a product costing system is a signifi cant decision that requires considerable cost and a major effort to accomplish. There- fore, fi nancial managers need to be very cautious and deliberate when initiating changes in costing systems. A key factor in implementing a successful ABC system is the support of top management.

Using ABC to Aid in Employee Evaluation

Although most publicized ABC applications are in manufacturing companies or large service fi rms, very small service businesses can apply it also. Mahany Welding Supply, a small family- run welding service business in Rochester, New York, used ABC to determine the cost of servic- ing customers and to identify feasible cost-reduction opportunities.

Application of ABC at Mahany Welding’s operations provided information about the fi ve employees who were involved in different activities of revenue generation—i.e., delivery of supplies (rural versus city), welding services, repairs, telephone sales, fi eld or door-to-door sales, repeat business sales, and cold-call sales. Managers applied activity cost pools to the fi ve revenue-producing employees using relevant cost drivers. ABC revealed annual net income (loss) by employee as follows.

Employee #1 $65,431 Employee #4 $(10,957) Employee #2 $35,154 Employee #5 $(46,180) Employee #3 $13,731

This comparative information was an eye-opener to the owner of Mahany Welding—who was Employee #5!

Source: Michael Krupnicki and Thomas Tyson, “Using ABC to Determine the Cost of Servicing Customers,” Management Accounting (December 31, 1997), pp. 40–46.

SERVICE COMPANY INSIGHT

What positive implications does application of ABC have for the employees of this company? (See page 194.)?

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Activity-Based Costing: A Closer Look 157

Value-Added versus Non–Value-Added Activities

Some companies that have experienced the benefi ts of activity-based costing have applied it to a broader range of management activities. Activity-based manage- ment (ABM) extends the use of ABC from product costing to a comprehensive management tool that focuses on reducing costs and improving processes and decision-making. A refi nement of activity-based costing used in ABM is the clas- sifi cation of activities as either value-added or non–value-added.

Value-added activities are those activities of a company’s operations that increase the perceived worth of a product or service to customers. Examples for the manufacture of Precor exercise equipment include engineering design, machining, assembly, and painting. Examples of value-added activities in a service company include performing surgery at a hospital, providing legal research at a law fi rm, or delivering packages by a freight company.

Non–value-added activities are those activities that, if eliminated, would not hinder the company’s operations or reduce the perceived worth of its product or service. These activities simply add cost to, or increase the time spent on, a product or service without increasing its perceived value. One example is inventory storage. If a company eliminated the need to store inventory (for example, through just-in-time inventory processes), it would not hinder its opera- tions or reduce the worth of its product, but it would decrease its product costs. Other examples include moving materials, work in process, or fi nished goods from one location to another in the plant during the production process; waiting for manufacturing equipment to become available; inspecting goods; and fi xing defective goods under warranty.

Companies often use activity fl owcharts to help identify the ABC activities. Illustration 4-12 (page 158) shows an activity fl owchart. The top part of this fl ow- chart identifi es activities as value-added or non–value-added. The value-added activities are highlighted in red. Two rows in the lower part of the fl owchart show the number of days spent on each activity. The fi rst row shows the number of days spent on each activity under the current manufacturing process. The second row shows the number of days expected to be spent on each activity under man- agement’s proposed reengineered manufacturing process.

The proposed changes would reduce time spent on non–value-added activities by 17 days. This 17-day improvement would be due entirely to moving inventory more quickly through the non–value-added processes—that is, by reducing inventory time in moving, storage, and waiting. The appendix at the end of this

Differentiate between value-added and non– value-added activities.

6LEARNING OBJECTIVE

DECISION TOOLKIT DECISION CHECKPOINTS INFO NEEDED FOR DECISION TOOL TO USE FOR DECISION HOW TO EVALUATE RESULTS

When should we use ABC? A detailed and accurate cost accounting system; cooperation between accountants and operating managers

Compare the results under both costing systems. If managers are better able to understand and control their operations using ABC, and the costs are not prohibitive, use of ABC would be benefi cial.

Knowledge of the products or product lines, the manufac- turing process, and overhead costs

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158 4 Activity-Based Costing

Illustration 4-12 Flowchart showing value- added and non–value-added activities

Heartland Company Activity Flowchart

Activities NVA NVA NVA NVA VA NVA NVA VA NVA NVA NVA VA

Current Days 1 12 2.5 1.5 2 1 0.2 6 2 0.3 0.5 14 1

Total Current Average Time 5 44 days Proposed Days 1 4 1.5 1.5 2 1 0.2 2 2 0.3 0.5 10 1

Total Proposed Average Time 5 27 days

Proposed reduction in non–value-added time 5 17 days VA 5 Value-added NVA 5 Non–value-added

Receive and Inspect Materials

Move and Store

Materials

Move Materials to Production

and Wait

Set Up Machines

Machining:

Drill Lathe Inspect

Move and Wait

Assembly Inspect

and Test

Move to

Storage

Store Finished Goods

Package and Ship

chapter discusses a just-in-time inventory system, which some companies use to eliminate non–value-added activities related to inventory.

Not all activities labeled non–value-added are totally wasteful, nor can they be totally eliminated. For example, although inspection time is a non–value- added activity from a customer’s perspective, few companies would eliminate their quality control functions. Similarly, moving and waiting time is non–value- added, but it would be impossible to completely eliminate. Nevertheless, when managers recognize the non–value-added characteristic of these activities, they are motivated to minimize them as much as possible. Attention to such matters is part of the growing practice of activity-based management, which helps manag- ers concentrate on continuous improvement of operations and activities.

Value-Added Activities Action Plan ✔ Recognize that

value-added activities increase the worth of a product or service to customers.

✔ Understand that non– value-added activities simply add cost to or increase the time spent on a product or service without increasing its market value.

> DO IT!

1. NVA. 2. NVA. 3. NVA. 4. VA. 5. VA. 6. NVA.

Classify each of the following activities within a water-ski manufacturer as value-added (VA) or non–value-added (NVA).

1. Inspecting completed skis.

2. Storing raw materials.

3. Machine setups.

4. Installing bindings on skis.

5. Packaging skis for shipment.

6. Reworking defective skis.

Solution

✔ The Navigator

Related exercise material: BE4-8, BE4-9, E4-13, E4-14, E4-15, E4-16, and 4-3.DO IT!

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Activity-Based Costing: A Closer Look 159

Classifi cation of Activity Levels

As mentioned earlier, traditional costing systems are volume-driven—driven by unit-based cost drivers such as direct labor or machine hours. Some activity costs are strictly variable and are caused by the production or acquisition of a single unit of product or the performance of a single unit of service. However, the rec- ognition that other activity costs are not driven by unit-based cost drivers has led to the development of a classifi cation of ABC activities consisting of four levels, as follows.

1. Unit-level activities are performed for each unit of production. For example, the assembly of cell phones is a unit-level activity because the amount of assembly the company performs increases with each additional cell phone assembled.

2. Batch-level activities are performed every time a company produces another batch of a product. For example, suppose that to start processing a new batch of ice cream, an ice cream producer needs to set up its machines. The amount of time spent setting up machines increases with the number of batches pro- duced, not with the number of units produced.

3. Product-level activities are performed every time a company produces a new type of product. For example, before a pharmaceutical company can produce and sell a new type of medicine, it must undergo very substantial product tests to ensure the product is effective and safe. The amount of time spent on test- ing activities increases with the number of products the company produces.

DECISION TOOLKIT DECISION CHECKPOINTS INFO NEEDED FOR DECISION TOOL TO USE FOR DECISION HOW TO EVALUATE RESULTS

How can activity-based management help managers?

Activity fl owchart The fl owchart should motivate managers to minimize non–value-added activities. Managers should better understand the relationship between activities and the resources they consume.

Activities classifi ed as value- added and non–value-added

What are the benefi ts of reducing setup time? (See page 194.)

?

What Does NASCAR Have to Do with Breakfast Cereal?

Often the best way to improve a process is to learn from observing a different process. Production- line technicians from giant food producer General Mills were fl own to North Carolina to observe fi rsthand how race-car pit crews operate. In a NASCAR race, the value-added activity is driving toward the fi nish line; any time spent in the pit is non–value-added. Every split second saved in the pit increases the chances of winning. From what the General Mills’ techni- cians learned at the car race, as well as other efforts, they were able to reduce setup time from 5 hours to just 20 minutes.

MANAGEMENT INSIGHT

Understand the value of using activity levels in activity-based costing.

7LEARNING OBJECTIVE

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160 4 Activity-Based Costing

4. Facility-level activities are required to support or sustain an entire produc- tion process. Consider, for example, a hospital. The hospital building must be insured and heated, and the property taxes must be paid, no matter how many patients the hospital treats. These costs do not vary as a function of the number of units, batches, or products.

Companies may achieve greater accuracy in overhead cost allocation by recognizing these four different levels of activities and, from them, developing specifi c activity cost pools and their related cost drivers. Illustration 4-13 graphi- cally displays this four-level activity hierarchy, along with the types of activities and examples of cost drivers for those activities at each level.

Types of Activities Examples of Cost DriversFour Levels

Equipment setups Purchase ordering Inspection

Material handling

Number of setups or setup time Number of purchase orders Number of inspections or inspection time Number of material moves

Machine-related Drilling, cutting, milling, trimming, pressing

Labor-related Assembling, painting, sanding, sewing

Machine hours

Direct labor hours or cost

Batch-Level Activities

Unit-Level Activities

CUTTING EDGE APPAREL COMPANY

There. This baby should keep the building cool.

Facility-Level Activities

Plant management salaries Plant depreciation Property taxes Utilities

Number of employees managed Square footage Square footage Square footage

Product design Engineering changes

Number of product designs Number of changes

Product-Level Activities

Illustration 4-13 Hierarchy of activity levels

This classifi cation provides managers a structured way of thinking about the relationships between activities and the resources they consume. In contrast, tra- ditional volume-based costing recognizes only unit-level costs. Failure to recog- nize this classifi cation of activities is one of the reasons that volume-based cost allocation causes distortions in product costing.

As indicated earlier, allocating all overhead costs by unit-based cost drivers can send false signals to managers: Dividing batch-, product-, or facility-level costs by the number of units produced gives the mistaken impression that these costs vary with the number of units. The resources consumed by batch-, product-, and facility-level supporting activities do not vary at the unit level, nor can man- agers control them at the unit level. The number of activities performed at the

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Activity-Based Costing in Service Industries 161

batch level goes up as the number of batches rises—not as the number of units within the batches changes. Similarly, the number of product-level activities per- formed depends on the number of different products—not on how many units or batches are produced. Furthermore, facility-sustaining activity costs are not dependent upon the number of products, batches, or units produced. Companies can control batch-, product-, and facility-level costs only by modifying batch-, product-, and facility-level activities.

Classify Activity Levels

Action Plan ✔ You should use: unit-

level activities for each unit of product; batch-level activities for each batch of product; product-level activities for an entire product line; and facility-level activities for across the entire range of products.

> DO IT!

(a) product-level. (b) batch-level. (c) product-level. (d) facility-level. (e) batch-level. (f) unit-level. (g) unit-level. (h) facility-level.

Morgan Toy Company manufactures six primary product lines of toys in its Morganville plant. As a result of an activity analysis, the accounting department has identifi ed eight activity cost pools. Each of the toy products is produced in large batches, with the whole plant devoted to one product at a time. Classify each of the following activities as either unit-level, batch-level, product-level, or facility-level: (a) engineering design, (b) machine setup, (c) toy design, (d) interviews of prospective employees, (e) inspections after each setup, (f) polishing parts, (g) assembling parts, (h) health and safety.

Solution

✔ The Navigator

Related exercise material: BE4-10, BE4-11, BE4-12, E4-17, E4-18, and 4-4.DO IT!

Although initially developed and implemented by manufacturers, activity-based costing has been widely adopted in service industries as well. ABC is used by airlines, railroads, hotels, hospitals, banks, insurance companies, telephone com- panies, and fi nancial services fi rms. The overall objective of ABC in service fi rms is no different than it is in a manufacturing company. That objective is to identify the key activities that generate costs and to keep track of how many of those activities are performed for each service provided (by job, service, contract, or customer).

The general approach to identifying activities, activity cost pools, and cost drivers is the same for service companies and for manufacturers. Also, the label- ing of activities as value-added and non–value-added, and the attempt to reduce or eliminate non–value-added activities as much as possible, is just as valid in service industries as in manufacturing operations. What sometimes makes implementation of activity-based costing diffi cult in service industries is that, compared to manufacturers, a larger proportion of overhead costs are company-wide costs that cannot be directly traced to specifi c services provided by the company.

To illustrate the application of activity-based costing to a service company, contrasted to traditional costing, we use a public accounting fi rm. This illustra- tion is equally applicable to a law fi rm, consulting fi rm, architect, or any service fi rm that performs numerous services for a client as part of a job.

Activity-Based Costing in Service Industries

Apply activity-based cost- ing to service industries.

8LEARNING OBJECTIVE

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162 4 Activity-Based Costing

Illustration 4-14 Condensed annual budget of a service fi rm under traditional costing

Check and Doublecheck, CPAs Annual Budget

Revenue $4,000,000 Direct labor $1,200,000 Overhead (expected) 600,000

Total costs 1,800,000

Operating income $2,200,000

Estimated overhead 5 Predetermined overhead rate

Direct labor cost

$600,000 5 50%

$1,200,000

Illustration 4-15 Overhead applied under traditional costing system

Check and Doublecheck, CPAs Plano Molding Company Audit

Revenue $260,000 Less: Direct professional labor $140,000 Applied overhead (50% 3 $140,000) 70,000 210,000

Operating income $ 50,000

Direct labor is the professional service performed. Under traditional costing, direct labor is the basis for overhead application to each job. As shown in Illustration 4-14, the predetermined overhead rate of 50% is calculated by divid- ing the total estimated overhead costs by the total direct labor cost. To determine the operating income earned on any job, Check and Doublecheck applies over- head at the rate of 50% of actual direct professional labor costs incurred. For example, assume that Check and Doublecheck records $140,000 of actual direct professional labor cost during its audit of Plano Molding Company, which was billed an audit fee of $260,000. Under traditional costing, using 50% as the rate for applying overhead to the job, Check and Doublecheck would compute applied overhead and operating income related to the Plano Molding Company audit, as shown in Illustration 4-15.

This example, under traditional costing, uses only one direct cost item and one overhead application rate.

Activity-Based Costing Example

Under activity-based costing, Check and Doublecheck distributes its estimated annual overhead costs of $600,000 to three activity cost pools. The fi rm computes activity-based overhead rates per cost driver by dividing each activity overhead cost pool by the expected number of cost drivers used per activity. Illustration 4-16 shows an annual overhead budget using an ABC system.

Traditional Costing Example

Assume that the public accounting fi rm of Check and Doublecheck prepares the condensed annual budget shown in Illustration 4-14. The fi rm engages in a number of services, including audit, tax, and computer consulting.

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Activity-Based Costing in Service Industries 163

Illustration 4-16 Condensed annual budget of a service fi rm under activity- based costing

Check and Doublecheck, CPAs Annual Overhead Budget

Expected Use of Activity-Based Estimated Cost Drivers Overhead Activity Cost Pools Cost Drivers Overhead 4 per Activity 5 Rates

Administration Number of partner-hours $335,000 3,350 $100 per partner-hour Customer development Revenue billed 160,000 $4,000,000 $0.04 per $1 of revenue Recruiting and training Direct professional hours 105,000 30,000 $3.50 per hour

$600,000

The assignment of the individual overhead activity rates to the actual number of activities used in the performance of the Plano Molding Company audit results in total overhead assigned of $57,200, as shown in Illustration 4-17.

Illustration 4-17 Assigning overhead in a service company

1

2

3

4

5

6

7

8

9

10

A P18 fx

C EB D

Check and Doublecheck CPA.xlsCheck and Doublecheck CPA.xls Formulas Data Review ViewPage LayoutInsertHome

Administra�on Customer development Recrui�ng and training

Check and Doublecheck, CPAs Plano Molding Company Audit

Cost DriversAc�vity Cost Pools

Actual Use of Drivers

Ac�vity- Based

Overhead Rates

Cost Assigned

Number of partner-hours Revenue billed Direct professional hours

335 $260,000

3,800

$33,500 10,400 13,300

$57,200

$100.00 $0.04 $3.50

Under activity-based costing, Check and Doublecheck assigns overhead costs of $57,200 to the Plano Molding Company audit, as compared to $70,000 under traditional costing. Illustration 4-18 compares total costs and operating margins under the two costing systems.

Illustration 4-18 Comparison of traditional costing with ABC in a service company

Check and Doublecheck, CPAS Plano Molding Company Audit

Traditional Costing ABC

Revenue $260,000 $260,000 Expenses Direct professional labor $140,000 $140,000 Applied overhead 70,000 57,200

Total expenses 210,000 197,200

Operating income $ 50,000 $ 62,800

Profi t margin 19.2% 24.2%

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164 4 Activity-Based Costing

The comparison shows that the assignment of overhead costs under tradi- tional costing is distorted. The total cost assigned to performing the audit of Plano Molding Company is greater under traditional costing by $12,800, and the profi t margin is signifi cantly lower. Traditional costing understates the profi tabil- ity of the audit.

ABC Evaluated

Surveys of companies often show ABC usage of approximately 50%. Yet, in recent years, articles about ABC have expressed mixed opinions regarding its usefulness. To evaluate ABC practices and user satisfaction with ABC, a survey was conducted of 348 companies worldwide. Some of the interesting fi ndings included: ABC methods are widely used across the entire value chain, rather than being primarily used to allocate production-specifi c costs; only 25% of non-ABC companies think they are accurately tracing the costs of activities, while 70% of ABC companies think their company does this well; and respondents felt that ABC provides greater support for fi nancial, operational, and strategic decisions. More than 87% of respondents said that their ideal costing system would include some form of ABC. Since this signifi cantly exceeds the 50% of the respondents actually using it, ABC usage may well increase in the future.

Source: William Stratton, Denis Desroches, Raef Lawson, and Toby Hatch, “Activity-Based Costing: Is It Still Relevant?” Management Accounting Quarterly (Spring, 2009), pp. 31–39.

MANAGEMENT INSIGHT

What might explain why so many companies say that ideally they would use ABC, but they haven’t adopted it yet? (See page 194.)?

As mentioned in the Feature Story, Precor manufactures a line of high-end exercise equipment of commercial quality. Assume that the chief accountant has proposed changing from a traditional costing system to an activity-based costing system. The fi nancial vice president is not convinced, so she requests that the next large order for equipment be costed under both systems for purposes of comparison and analysis. An order from Slim-Way Salons, Inc., for 150 low-impact treadmills is received and is identifi ed as the order to be subjected to dual costing. The following cost data relate to the Slim-Way order.

USING THE DECISION TOOLKIT

Data relevant to both costing systems Direct materials $55,500 Direct labor hours 820 Direct labor rate per hour $ 18.00

Data relevant to the traditional costing system Predetermined overhead rate is 300% of direct labor cost.

Data relevant to the activity-based costing system Expected Use of Activity-Based Cost Drivers Activity Cost Pools Cost Drivers Overhead Rate for Treadmill Order Engineering design Engineering hours $30 per hour 330 Machine setup Setups $200 per setup 22 Machining Machine hours $25 per hour 732 Assembly Number of subassemblies $8 per subassembly 1,500 Packaging and shipping Packaging/shipping hours $15 per hour 152 Building occupancy Machine hours $6 per hour 732

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Summary of Learning Objectives 165

✔ The Navigator

Instructions Compute the total cost of the Slim-Way Salons, Inc. order under (a) the traditional costing system and (b) the activity-based costing system. (c) As a result of this comparison, which costing system is Precor likely to adopt? Why?

Solution

(a) Traditional costing system: Direct materials $ 55,500 Direct labor (820 3 $18) 14,760 Overhead assigned ($14,760 3 300%) 44,280 Total costs assigned to Slim-Way order $114,540

Number of low-impact treadmills 150

Cost per unit $ 763.60

(b) Activity-based costing system: Direct materials $ 55,500 Direct labor (820 3 $18) 14,760 Overhead activities costs: Engineering design (330 hours @ $30) $ 9,900 Machine setup (22 setups @ $200) 4,400 Machining (732 machine hours @ $25) 18,300 Assembly (1,500 subassemblies @ $8) 12,000 Packaging and shipping (152 hours @ $15) 2,280 Building occupancy (732 hours @ $6) 4,392 51,272 Total costs assigned to Slim-Way order $121,532

Number of low-impact treadmills 150

Cost per unit $ 810.21

(c) Precor will likely adopt ABC because of the difference in the cost per unit (which ABC found to be higher). More importantly, ABC provides greater insight into the sources and causes of the cost per unit. Managers are given greater insight into which activities to control in order to reduce costs. ABC will provide better product costing and greater profi tability for the company.

1 Recognize the difference between traditional costing and activity-based costing. A traditional costing system allocates overhead to products on the basis of prede- termined plantwide or departmentwide rates such as direct labor or machine hours. An ABC system allocates overhead to identifi ed activity cost pools, and then as- signs costs to products using related cost drivers that measure the activities (resources) consumed.

2 Identify the steps in the development of an activity- based costing system. The development of an activity- based costing system involves four steps: (1) Identify and classify the major activities involved in the manu- facture of specifi c products, and allocate manufactur- ing overhead costs to the appropriate cost pools. (2) Identify the cost driver that has a strong correlation to the costs accumulated in the cost pool. (3) Compute the

overhead rate per cost driver. (4) Assign manufacturing overhead costs for each cost pool to products or services using the overhead rates.

3 Know how companies identify the activity cost pools used in activity-based costing. To identify activity cost pools, a company must perform an analysis of each op- eration or process, documenting and timing every task, action, or transaction.

4 Know how companies identify and use cost drivers in activity-based costing. Cost drivers identifi ed for as- signing activity cost pools must (a) accurately measure the actual consumption of the activity by the various products and (b) have related data easily available.

5 Understand the benefi ts and limitations of activity- based costing. Features of ABC that make it a more

SUMMARY OF LEARNING OBJECTIVES ✔ The Navigator

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166 4 Activity-Based Costing

accurate product costing system include: (1) the in- creased number of cost pools used to assign overhead, (2) the enhanced control over overhead costs, and (3) the better management decisions it makes possible. The limitations of ABC are: (1) the higher analysis and measurement costs that accompany multiple activity centers and cost drivers, and (2) the necessity still to allocate some costs arbitrarily.

6 Differentiate between value-added and non–value- added activities. Value-added activities are essential to operations of the business and often increase the worth of a product or service. Non–value-added are non- essential activities that simply add cost to or increase the time spent on a product or service without increas- ing its market value. Awareness of these classifi cations encourages managers to reduce or eliminate the time spent on non–value-added activities.

7 Understand the value of using activity levels in activity- based costing. Activities may be classifi ed as unit-level, batch-level, product-level, and facility-level. Companies control overhead costs at unit-, batch-, product-, and facility-levels by modifying unit-, batch-, product-, and facility-level activities, respectively. Failure to recognize this classifi cation of levels can result in distorted product costing.

8 Apply activity-based costing to service industries. The overall objective of using ABC in service industries is no different than for manufacturing industries—that is, improved costing of services provided (by job, service, contract, or customer). The general approach to cost- ing is the same: analyze operations, identify activities, accumulate overhead costs by activity cost pools, and identify and use cost drivers to assign the cost pools to the services.

DECISION TOOLKIT A SUMMARY HOW TO EVALUATE RESULTS

Compare the results under both costing systems. If managers are better able to understand and control their operations using ABC, and the costs are not prohibitive, the use of ABC would be benefi cial.

Activity fl owchartHow can activity-based management help managers?

Activities classifi ed as value- added and non–value-added

The fl owchart should motivate managers to minimize non–value-added activities. Managers should better understand the relationship between activities and the resources they consume.

DECISION CHECKPOINTS INFO NEEDED FOR DECISION

When should we use ABC? A detailed and accurate cost accounting system; cooperation between accountants and operating managers

Knowledge of the products or product lines, the manufac- turing process, and overhead costs

TOOL TO USE FOR DECISION

Traditionally, continuous process manufacturing has been based on a just-in- case philosophy: Inventories of raw materials are maintained just in case some items are of poor quality or a key supplier is shut down by a strike. Similarly, subassembly parts are manufactured and stored just in case they are needed later in the manufacturing process. Finished goods are completed and stored just in case unexpected and rush customer orders are received. This philosophy often results in a “push approach,” in which raw materials and subassembly parts are pushed through each process. Traditional processing often results in the buildup of extensive manufacturing inventories.

APPENDIX 4A JUST-IN-TIME PROCESSING

Explain just-in-time (JIT) processing.

9LEARNING OBJECTIVE

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Appendix 4A: Just-in-Time Processing 167

Objective of JIT Processing

A primary objective of JIT is to eliminate all manufacturing inventories. Invento- ries have an adverse effect on net income because they tie up funds and storage space that could be put to more productive uses. JIT strives to eliminate inven- tories by using a “pull approach” in manufacturing. This approach begins with the customer placing an order with the company, which starts the process of pulling the product through the manufacturing process. A computer at the fi nal workstation sends a signal to the preceding workstation. This signal indicates the exact materials (parts and subassemblies) needed to complete the production of a specifi ed product for a specifi ed time period, such as an eight-hour shift. The next-preceding process, in turn, sends its signal to other processes back up the line. The goal is a smooth continuous fl ow in the manufacturing process, with no buildup of inventories at any point.

Primarily in response to foreign competition, many U.S. fi rms have switched to just-in-time (JIT) processing. JIT manufacturing is dedicated to having the right amount of materials, parts, or products just as they are needed. JIT fi rst hit the United States in the early 1980s when automobile companies adopted it to compete with foreign automakers. Many companies, including Dell, Caterpillar, and Harley-Davidson, now successfully use JIT. Under JIT processing, companies receive raw materials just in time for use in production, they complete subas- sembly parts just in time for use in fi nished goods, and they complete fi nished goods just in time to be sold. Illustration 4A-1 shows the sequence of activities in just-in-time processing.

Receive Sales Order

Ship Goods to Customer

Order Raw Materials Rub

ber

Co.

Shoe

Lace s

Manufacture Goods

Ben Ben

“100 pairs of sneakers...

got it.”

“Send rubber & shoe laces directly

to the factory.”

Illustration 4A-1 Just-in-time processing

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168 4 Activity-Based Costing

9 Explain just-in-time (JIT) processing. JIT is a processing system dedicated to having on hand the right materials and products just at the time they are needed, thereby reducing the amount of inventory and the time inventory

is held. One of the principal accounting effects is that one account, Raw and In-Process Inventory, replaces both the raw materials and work-in-process inventory accounts.

SUMMARY OF LEARNING OBJECTIVE FOR APPENDIX 4A ✔ The Navigator

Elements of JIT Processing

There are three important elements in JIT processing:

1. Dependable suppliers. Suppliers must be willing to deliver on short notice exact quantities of raw materials according to precise quality specifi cations (even including multiple deliveries within the same day). Suppliers must also be willing to deliver the raw materials at specifi ed workstations rather than at a central receiving department. This type of purchasing requires constant and direct communication. Such communication is facilitated by an online computer linkage between the company and its suppliers.

2. A multiskilled work force. Under JIT, machines are often strategically grouped into work cells or workstations. Much of the work is automated. As a result, one worker may operate and maintain several different types of machines.

3. A total quality control system. The company must establish total quality con- trol throughout the manufacturing operations. Total quality control means no defects. Since the pull approach signals only required quantities, any defects at any workstation will shut down operations at subsequent workstations. To- tal quality control requires continuous monitoring by both line employees and supervisors at each workstation.

Benefi ts of JIT Processing

The major benefi ts of implementing JIT processing are:

1. Signifi cant reduction or elimination of manufacturing inventories.

2. Enhanced product quality.

3. Reduction or elimination of rework costs and inventory storage costs.

4. Production cost savings from the improved fl ow of goods through the processes.

The effects in many cases have been dramatic. For example, after using JIT for two years, a major division of Hewlett-Packard found that work in process in- ventories (in dollars) were down 82%, scrap/rework costs were down 30%, space utilization improved by 40%, and labor effi ciency improved 50%. As indicated, JIT not only reduces inventory but also enables a manufacturer to produce a better product faster and with less waste.

One of the major accounting benefi ts of JIT is the elimination of separate raw materials and work in process inventory accounts. These accounts are replaced by one account, Raw and In-Process Inventory. All materials and con- version costs are charged to this account. The reduction (or elimination) of in-process inventories results in a simpler computation of equivalent units of production.

Helpful Hint Without its emphasis on quality control, JIT would be impractical or even impossible. In JIT, quality is engineered into the production process.

Helpful Hint Buyer leverage is important in fi nding dependable sup- pliers. Companies like GM and GE have more success than smaller companies.

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> DO IT!

Spreadwell Paint Company manufactures two high-quality base paints: an oil-based paint and a latex paint. Both are housepaints and are manufactured in neutral white color only. Spreadwell sells the white base paints to franchised retail paint and decorating stores where pigments are added to tint (color) the paint as the customer desires. The oil-based paint is made with organic solvents (petroleum products) such as mineral spirits or tur- pentine. The latex paint is made with water; synthetic resin particles are suspended in the water, and dry and harden when exposed to the air.

Spreadwell uses the same processing equipment to produce both paints in differ- ent production runs. Between batches, the vats and other processing equipment must be washed and cleaned.

After analyzing the company’s entire operations, Spreadwell’s accountants and pro- duction managers have identifi ed activity cost pools and accumulated annual budgeted overhead costs by pool as follows.

Estimated Activity Cost Pools Overhead

Purchasing $ 240,000 Processing (weighing and mixing, grinding, thinning and drying, straining) 1,400,000 Packaging (quarts, gallons, and 5-gallons) 580,000 Testing 240,000 Storage and inventory control 180,000 Washing and cleaning equipment 560,000

Total annual budgeted overhead $3,200,000

Comprehensive

Comprehensive DO IT! 169

Activity Any event, action, transaction, or work sequence that incurs cost when producing a product or provid- ing a service. (p. 147).

Activity-based costing (ABC) An overhead cost-alloca- tion system that allocates overhead to multiple activity cost pools and assigns the activity cost pools to products or services by means of cost drivers that represent the activities used. (p. 147).

Activity-based management (ABM) Extends ABC from product costing to a comprehensive management tool that focuses on reducing costs and improving processes and decision-making. (p. 157).

Activity cost pool The overhead cost attributed to a dis- tinct type of activity or related activities. (p. 147).

Batch-level activities Activities performed for each batch of products rather than for each unit. (p. 159).

Cost driver Any factor or activity that has a direct cause– effect relationship with the resources consumed. In ABC, cost drivers are used to assign activity cost pools to products or services. (p. 147).

Facility-level activities Activities required to support or sustain an entire production process. (p. 160).

Just-in-time (JIT) processing A processing system dedi- cated to having the right amount of materials, parts, or products arrive as they are needed, thereby reducing the amount of inventory. (p. 167).

Non–value-added activity An activity that, if elimi- nated, would not hinder the company’s operations or reduce the perceived worth of its product or service. (p. 157).

Product-level activities Activities performed in sup- port of an entire product line, but not always per- formed every time a new unit or batch of products is produced. (p. 159).

Unit-level activities Activities performed for each unit of production. (p. 159).

Value-added activity An activity that increases the perceived worth of a product or service to a customer. (p. 157).

GLOSSARY

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170 4 Activity-Based Costing

Following further analysis, activity cost drivers were identifi ed and their expected use by product and activity were scheduled as follows.

Expected Cost Expected Use of

Activity Cost Drivers per Drivers per Product

Pools Cost Drivers Activity Oil-Based Latex

Purchasing Purchase orders 1,500 orders 800 700 Processing Gallons processed 1,000,000 gallons 400,000 600,000 Packaging Containers fi lled 400,000 containers 180,000 220,000 Testing Number of tests 4,000 tests 2,100 1,900 Storing Avg. gals. on hand 18,000 gallons 10,400 7,600 Washing Number of batches 800 batches 350 450

Spreadwell has budgeted 400,000 gallons of oil-based paint and 600,000 gallons of latex paint for processing during the year.

Instructions (a) Prepare a schedule showing the computations of the activity-based overhead rates.

(b) Prepare a schedule assigning each activity’s overhead cost pool to each product.

(c) Compute the overhead cost per unit for each product.

Solution to Comprehensive

(a) Computations of activity-based overhead rates:

Activity Cost Estimated Expected Use of Activity-Based Pools Overhead

4 Cost Drivers

5 Overhead Rates

Purchasing $ 240,000 1,500 orders $160 per order Processing 1,400,000 1,000,000 gallons $1.40 per gallon Packaging 580,000 400,000 containers $1.45 per container Testing 240,000 4,000 tests $60 per test Storing 180,000 18,000 gallons $10 per gallon Washing 560,000 800 batches $700 per batch

$3,200,000

(b) Assignment of activity cost pools to products:

Oil-Based Paint Latex Paint

Activity Expected Expected Cost Use of Overhead Cost Use of Overhead Cost Pools Drivers Rates Assigned Drivers Rates Assigned

Purchasing 800 $160 $ 128,000 700 $160 $ 112,000 Processing 400,000 $1.40 560,000 600,000 $1.40 840,000 Packaging 180,000 $1.45 261,000 220,000 $1.45 319,000 Testing 2,100 $60 126,000 1,900 $60 114,000 Storing 10,400 $10 104,000 7,600 $10 76,000 Washing 350 $700 245,000 450 $700 315,000

Total overhead assigned $1,424,000 $1,776,000

(c) Computation of overhead cost assigned per unit:

Oil-Based Paint Latex Paint

Total overhead cost assigned $1,424,000 $1,776,000

Total gallons produced 400,000 600,000

Overhead cost per gallon $3.56 $2.96

DO IT!

✔ The Navigator

Action Plan ✔ Identify the major

activities that pertain to the manufacture of specifi c products and allocate manufac- turing overhead costs to activity cost pools.

✔ Identify the cost drivers that accurately measure each activity’s contribution to the fi nished product.

✔ Compute the activity- based overhead rates.

✔ Assign manufacturing overhead costs for each activity cost pool to products, using the activity-based over- head rates.

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Self-Test, Brief Exercises, Exercises, Problem Set A, and many more resources are available for practice in WileyPLUS.

Self-Test Questions 171

Answers are at the end of the chapter. 1. Activity-based costing (ABC):

(a) can be used only in a process cost system. (b) focuses on units of production. (c) focuses on activities performed to produce a

product. (d) uses only a single basis of allocation.

2. Activity-based costing: (a) is the initial phase of converting to a just-in-time

operating environment. (b) can be used only in a job order costing system. (c) is a two-stage overhead cost allocation system

that identifi es activity cost pools and cost drivers. (d) uses direct labor as its primary cost driver.

3. Any activity that causes resources to be consumed is called a: (a) just-in-time activity. (b) facility-level activity. (c) cost driver. (d) non–value-added activity.

4. The fi rst step in the development of an activity-based costing system is: (a) identify and classify activities and allocate over-

head to cost pools. (b) assign overhead costs to products. (c) identify cost drivers. (d) compute overhead rates.

5. Which of the following would be the best cost driver for the assembling cost pool? (a) Number of product lines. (b) Number of parts. (c) Number of orders. (d) Amount of square footage.

6. The overhead rate for Machine Setups is $100 per setup. Products A and B have 80 and 60 setups, re- spectively. The overhead assigned to each product is: (a) Product A $8,000, Product B $8,000. (b) Product A $8,000, Product B $6,000. (c) Product A $6,000, Product B $6,000. (d) Product A $6,000, Product B $8,000.

7. Donna Crawford Co. has identifi ed an activity cost pool to which it has allocated estimated overhead of $1,920,000. It has determined the expected use of cost drivers for that activity to be 160,000 inspections. Widgets require 40,000 inspections, Gadgets 30,000 inspections, and Targets 90,000 inspections. The over- head assigned to each product is: (a) Widgets $40,000, Gadgets $30,000, Targets $90,000. (b) Widgets $640,000, Gadgets $640,000, Targets

$640,000.

(c) Widgets $360,000, Gadgets $480,000, Targets $1,080,000.

(d) Widgets $480,000, Gadgets $360,000, Targets $1,080,000.

8. A frequently cited limitation of activity-based costing is: (a) ABC results in more cost pools being used to as-

sign overhead costs to products. (b) certain overhead costs remain to be allocated by

means of some arbitrary volume-based cost driv- er such as labor or machine hours.

(c) ABC leads to poorer management decisions. (d) ABC results in less control over overhead costs.

9. A company should consider using ABC if: (a) overhead costs constitute a small portion of total

product costs. (b) it has only a few product lines that require similar

degrees of support services. (c) direct labor constitutes a signifi cant part of the to-

tal product cost and a high correlation exists be- tween direct labor and changes in overhead costs.

(d) its product lines differ greatly in volume and man- ufacturing complexity.

10. An activity that adds costs to the product but does not increase its perceived market value is a: (a) value-added activity. (b) cost driver. (c) cost/benefi t activity. (d) non–value-added activity.

11. The following activity is value-added: (a) Storage of raw materials. (b) Moving parts from machine to machine. (c) Shaping a piece of metal on a lathe. (d) All of the above.

12. A relevant facility-level cost driver for heating costs is: (a) machine hours. (c) fl oor space. (b) direct material. (d) direct labor cost.

*13. Under just-in-time processing: (a) raw materials are received just in time for use in

production. (b) subassembly parts are completed just in time for

use in assembling fi nished goods. (c) fi nished goods are completed just in time to be sold. (d) All of the above.

*14. The primary objective of just-in-time processing is to: (a) accumulate overhead in activity cost pools. (b) eliminate or reduce all manufacturing inventories. (c) identify relevant activity cost drivers. (d) identify value-added activities.

SELF-TEST QUESTIONS

Note: All asterisked Questions, Exercises, and Problems relate to material in the appendix to the chapter.

(LO 1)

(LO 1)

(LO 4)

(LO 4)

(LO 4)

(LO 2)

(LO 1, 4)

Go to the book’s companion website, www.wiley.com/college/weygandt, for additional Self-Test Questions.

✔ The Navigator

(LO 5)

(LO 5)

(LO 6)

(LO 6)

(LO 7)

(LO 9)

(LO 9)

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172 4 Activity-Based Costing

1. Under what conditions is direct labor a valid basis for allocating overhead?

2. What has happened in recent industrial history to reduce the usefulness of direct labor as the primary basis for allocating overhead to products?

3. In an automated manufacturing environment, what basis of overhead allocation is frequently more relevant than direct labor hours?

4. What is generally true about overhead allocation to high-volume products versus low-volume products under a traditional costing system?

5. What are the principal differences between activity- based costing (ABC) and traditional product costing?

6. What is the formula for computing activity-based overhead rates?

7. What steps are involved in developing an activity- based costing system?

8. Explain the preparation and use of a value-added/ non–value-added activity fl owchart in an ABC system.

9. What is an activity cost pool? 10. What is a cost driver?

11. What makes a cost driver accurate and appropriate? 12. What is the formula for assigning activity cost pools

to products? 13. What are the benefi ts of activity-based costing? 14. What are the limitations of activity-based costing? 15. Under what conditions is ABC generally the superior

overhead costing system? 16. What refi nement has been made to enhance the ef-

fi ciency and effectiveness of ABC for use in managing costs?

17. Of what benefi t is classifying activities as value-added and non–value-added?

18. In what ways is the application of ABC to service in- dustries the same as its application to manufacturing companies?

19. What is the relevance of the classifi cation of levels of activity to ABC?

*20. (a) Describe the philosophy and approach of just-in- time processing.

(b) Identify the major elements of JIT processing.

QUESTIONS

BRIEF EXERCISES

BE4-1 Warner Inc. sells a high-speed retrieval system for mining information. It provides the following information for the year.

Budgeted Actual

Overhead cost $1,000,000 $950,000 Machine hours 50,000 45,000 Direct labor hours 100,000 92,000

Overhead is applied on the basis of direct labor hours. (a) Compute the predetermined overhead rate. (b) Determine the amount of overhead applied for the year. (c) Explain how an activity-based costing system might differ in terms of computing a predetermined overhead rate.

BE4-2 Finney Inc. has conducted an analysis of overhead costs related to one of its prod- uct lines using a traditional costing system (volume-based) and an activity-based costing system. Here are its results.

Traditional Costing ABC

Sales revenue $600,000 $600,000

Overhead costs: Product RX3 $ 34,000 $ 50,000 Product Y12 36,000 20,000

$ 70,000 $ 70,000

Explain how a difference in the overhead costs between the two systems may have occurred.

BE4-3 Storrer Co. identifi es the following activities that pertain to manufacturing over- head: materials handling, machine setups, factory machine maintenance, factory supervi- sion, and quality control. For each activity, identify an appropriate cost driver.

Identify differences between costing systems.

(LO 1), AP

Identify differences between costing systems.

(LO 1), AP

Identify cost drivers.

(LO 4), AP

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Brief Exercises 173

Identify cost drivers.

(LO 4), AP

Compute activity-based overhead rates.

(LO 4), AP

Compute activity-based overhead rates.

(LO 4), AP

Compute activity-based overhead rates.

(LO 4), AP

BE4-4 Mason Company manufactures four products in a single production facility. The company uses activity-based costing. The following activities have been identifi ed through the company’s activity analysis: (a) inventory control, (b) machine setups, (c) employee training, (d) quality inspections, (e) material ordering, (f) drilling operations, and (g) building maintenance.

For each activity, name a cost driver that might be used to assign overhead costs to products.

BE4-5 Mordica Company identifi es three activities in its manufacturing process: machine setups, machining, and inspections. Estimated annual overhead cost for each activity is $150,000, $325,000, and $87,500, respectively. The cost driver for each activity and the expected annual usage are: number of setups 2,500, machine hours 25,000, and number of inspections 1,750. Compute the overhead rate for each activity.

BE4-6 Weisman, Inc. uses activity-based costing as the basis for information to set prices for its six lines of seasonal coats. Compute the activity-based overhead rates using the fol- lowing budgeted data for each of the activity cost pools.

Estimated Expected Use of Activity Cost Pools Overhead Cost Drivers per Activity

Designing $ 450,000 10,000 designer hours Sizing and cutting 4,000,000 160,000 machine hours Stitching and trimming 1,440,000 80,000 labor hours Wrapping and packing 336,000 32,000 fi nished units

BE4-7 Hollins, Inc., a manufacturer of computer chips, employs activity-based cost- ing. The budgeted data for each of the activity cost pools is provided below for the year 2014.

Estimated Expected Use of Activity Cost Pools Overhead Cost Drivers per Activity

Ordering and receiving $ 90,000 12,000 orders Etching 480,000 60,000 machine hours Soldering 1,760,000 440,000 labor hours

For 2014, the company had 11,000 orders and used 50,000 machine hours, and labor hours totaled 500,000. What is the total overhead applied?

BE4-8 Rich Novelty Company identifi ed the following activities in its production and support operations. Classify each of these activities as either value-added or non–value- added. (a) Machine setup. (d) Moving work in process. (b) Design engineering. (e) Inspecting and testing. (c) Storing inventory. (f) Painting and packing.

BE4-9 Mendle and Kiner is an architectural fi rm that is contemplating the installation of activity-based costing. The following activities are performed daily by staff architects. Classify these activities as value-added or non–value-added: (a) designing and drafting, 2.5 hours; (b) staff meetings, 1 hour; (c) on-site supervision, 2 hours; (d) lunch, 1 hour; (e) consultation with client on specifi cations, 1.5 hours; (f) entertaining a prospective client for dinner, 2 hours.

BE4-10 Kwik Pix is a large digital processing center that serves 130 outlets in grocery stores, service stations, camera and photo shops, and drug stores in 16 nearby towns. Kwik Pix operates 24 hours a day, 6 days a week. Classify each of the following activity costs of Kwik Pix as either unit-level, batch-level, product-level, or facility-level. (a) Color printing materials. (b) Photocopy paper. (c) Depreciation of machinery. (d) Setups for enlargements. (e) Supervisor’s salary. (f) Ordering materials. (g) Pickup and delivery.

Classify activities as value- or non–value-added.

(LO 6), AN

Classify service company activities as value- or non–value-added.

(LO 6, 8), AN

Classify activities according to level.

(LO 7, 8), AN

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174 4 Activity-Based Costing

(h) Commission to dealers. (i) Insurance on building. (j) Loading developing machines.

BE4-11 Trammell, Inc. operates 20 injection molding machines in the production of tool boxes of four different sizes, named the Apprentice, the Handyman, the Journeyman, and the Professional. Classify each of the following costs as unit-level, batch-level, product- level, or facility-level. (a) First-shift supervisor’s salary. (b) Powdered raw plastic. (c) Dies for casting plastic components. (d) Depreciation on injection molding machines. (e) Changing dies on machines. (f) Moving components to assembly department. (g) Engineering design. (h) Employee health and medical insurance coverage.

BE4-12 Spin Cycle Company uses three activity pools to apply overhead to its products. Each activity has a cost driver used to allocate the overhead costs to the product. The activities and related overhead costs are as follows: product design $40,000; machining $300,000; and material handling $100,000. The cost drivers and expected use are as follows.

Expected Use of Cost Drivers Activities Cost Drivers per Activity

Product design Number of product changes 10 Machining Machine hours 150,000 Material handling Number of setups 100

(a) Compute the predetermined overhead rate for each activity. (b) Classify each of these activities as unit-level, batch-level, product-level, or facility-level.

Classify activities according to level.

(LO 7), AP

Compute rates and activity levels.

(LO 4, 7), AP

> DO IT! REVIEW

Indicate whether the following statements are true or false.

(a) The reasoning behind ABC cost allocation is that products consume activities and activities consume resources.

(b) Activity-based costing is an approach for allocating direct labor to products. (c) In today’s increasingly automated environment, direct labor is never an appropriate

basis for allocating costs to products. (d) A cost driver is any factor or activity that has a direct cause-effect relationship with

resources consumed. (e) Activity-based costing segregates overhead into various cost pools in an effort to pro-

vide more accurate cost information.

Flynn Industries has three activity cost pools and two products. It expects to produce 3,000 units of Product BC113 and 1,500 of Product AD908. Having identifi ed its activity cost pools and the cost drivers for each pool, Flynn accumulated the following data relative to those activity cost pools and cost drivers.

DO IT! 4-2

DO IT! 4-1

Compute activity-based overhead rates and assign overhead using ABC.

(LO 4), AP

Identify characteristics of traditional and ABC costing systems.

(LO 1, 2), K

Expected Use of Annual Overhead Data Cost Drivers per Product

Estimated Expected Use of Cost Product Product Activity Cost Pool Cost Drivers Overhead Drivers per Activity BC113 AD908

Machine setup Setups $ 16,000 40 25 15 Machining Machine hours 110,000 5,000 1,000 4,000 Packing Orders 30,000 500 150 350

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Exercises 175

Using the above data, do the following:

(a) Prepare a schedule showing the computations of the activity-based overhead rates per cost driver.

(b) Prepare a schedule assigning each activity’s overhead cost to the two products. (c) Compute the overhead cost per unit for each product. (Round to nearest cent.) (d) Comment on the comparative overhead cost per product.

Classify each of the following activities within a tax-preparation business as value-added (VA) or non–value-added (NVA).

(a) Advertising. (b) Completing tax returns. (c) Billing clients. (d) Answering client questions. (e) Accompanying clients to audit proceedings.

Adamson Company manufactures four lines of garden tools. As a result of an activity analysis, the accounting department has identifi ed eight activity cost pools. Each of the product lines is produced in large batches, with the whole plant devoted to one product at a time. Classify each of the following activities or costs as either unit-level, batch level, product-level, or facility-level.

(a) Machining parts. (e) Assembling parts. (b) Product design. (f) Purchasing raw materials. (c) Plant maintenance. (g) Property taxes. (d) Machine setup. (h) Painting.

DO IT! 4-4

DO IT! 4-3

Classify activities according to level.

(LO 7), C

Classify activities as value- or non–value-added.

(LO 6, 8), AP

✔ The Navigator

EXERCISES

E4-1 Wilkins Inc. has two types of handbags: standard and custom. The controller has decided to use a plantwide overhead rate based on direct labor costs. The president has heard of activity-based costing and wants to see how the results would differ if this system were used. Two activity cost pools were developed: machining and machine setup. Pre- sented below is information related to the company’s operations.

Standard Custom

Direct labor costs $50,000 $100,000 Machine hours 1,000 1,000 Setup hours 100 400

Total estimated overhead costs are $270,000. Overhead cost allocated to the machining ac- tivity cost pool is $170,000, and $100,000 is allocated to the machine setup activity cost pool.

Instructions (a) Compute the overhead rate using the traditional (plantwide) approach. (b) Compute the overhead rates using the activity-based costing approach. (c) Determine the difference in allocation between the two approaches.

E4-2 Ayala Inc. has conducted the following analysis related to its product lines, using a traditional costing system (volume-based) and an activity-based costing system. Both the traditional and the activity-based costing systems include direct materials and direct labor costs.

Total Costs

Products Sales Revenue Traditional ABC

Product 540X $180,000 $55,000 $50,000 Product 137Y 160,000 50,000 35,000 Product 249S 70,000 15,000 35,000

Assign overhead using traditional costing and ABC.

(LO 1, 4), AP

Explain difference between traditional and activity-based costing.

(LO 1), AP

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176 4 Activity-Based Costing

Instructions (a) For each product line, compute operating income using the traditional costing system. (b) For each product line, compute operating income using the activity-based costing system. (c) Using the following formula, compute the percentage difference in operating income

for each of the product lines of Ayala: [Operating Income (ABC) 2 Operating Income (traditional cost)] 4 Operating Income (traditional cost). (Round the percentage to two decimals.)

(d) Provide a rationale as to why the costs for Product 540X are approximately the same using either the traditional or activity-based costing system.

E4-3 American Fabrics has budgeted overhead costs of $990,000. It has allocated over- head on a plantwide basis to its two products (wool and cotton) using direct labor hours which are estimated to be 450,000 for the current year. The company has decided to ex- periment with activity-based costing and has created two activity cost pools and related activity cost drivers. These two cost pools are: cutting (cost driver is machine hours) and design (cost driver is number of setups). Overhead allocated to the cutting cost pool is $360,000 and $630,000 is allocated to the design cost pool. Additional information related to these pools is as follows.

Wool Cotton Total

Machine hours 100,000 100,000 200,000 Number of setups 1,000 500 1,500

Instructions (a) Determine the amount of overhead allocated to the wool product line and the cotton

product line using activity-based costing. (b) What amount of overhead would be allocated to the wool and cotton product lines

using the traditional approach, assuming direct labor hours were incurred evenly between the wool and cotton? How does this compare with the amount allocated using ABC in part (a)?

E4-4 Altex Inc. manufactures two products: car wheels and truck wheels. To determine the amount of overhead to assign to each product line, the controller, Robert Hermann, has developed the following information.

Car Truck

Estimated wheels produced 40,000 10,000 Direct labor hours per wheel 1 3

Total estimated overhead costs for the two product lines are $770,000.

Instructions (a) Compute the overhead cost assigned to the car wheels and truck wheels, assuming

that direct labor hours is used to allocate overhead costs. (b) Hermann is not satisfi ed with the traditional method of allocating overhead because

he believes that most of the overhead costs relate to the truck wheel product line be- cause of its complexity. He therefore develops the following three activity cost pools and related cost drivers to better understand these costs.

Expected Use of Estimated Overhead Activity Cost Pools Cost Drivers Costs

Setting up machines 1,000 setups $220,000 Assembling 70,000 labor hours 280,000 Inspection 1,200 inspections 270,000

Compute the activity-based overhead rates for these three cost pools.

(c) Compute the cost that is assigned to the car wheels and truck wheels product lines using an activity-based costing system, given the following information.

Expected Use of Cost Drivers per Product

Car Truck

Number of setups 200 800 Direct labor hours 40,000 30,000 Number of inspections 100 1,100

(d) What do you believe Hermann should do?

Assign overhead using traditional costing and ABC.

(LO 1, 4), AN

Assign overhead using traditional costing and ABC.

(LO 1, 4), AN

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Exercises 177

E4-5 Shady Lady sells window coverings (shades, blinds, and awnings) to both commer- cial and residential customers. The following information relates to its budgeted opera- tions for the current year. Commercial Residential

Revenues $300,000 $480,000 Direct material costs $ 30,000 $ 50,000 Direct labor costs 100,000 300,000 Overhead costs 85,000 215,000 150,000 500,000

Operating income (loss) $ 85,000 ($ 20,000)

The controller, Peggy Kingman, is concerned about the residential product line. She cannot understand why this line is not more profi table given that the installations of window coverings are less complex for residential customers. In addition, the residential client base resides in close proximity to the company offi ce, so travel costs are not as expensive on a per client visit for residential customers. As a result, she has decided to take a closer look at the overhead costs assigned to the two product lines to determine whether a more accurate product costing model can be developed. Here are the three activity cost pools and related information she developed:

Activity Cost Pools Estimated Overhead Cost Drivers

Scheduling and travel $105,000 Hours of travel Setup time 70,000 Number of setups Supervision 60,000 Direct labor cost

Expected Use of Cost Drivers per Product

Commercial Residential

Scheduling and travel 1,000 500 Setup time 450 250

Instructions (a) Compute the activity-based overhead rates for each of the three cost pools, and deter-

mine the overhead cost assigned to each product line. (b) Compute the operating income for each product line, using the activity-based over-

head rates. (c) What do you believe Peggy Kingman should do?

E4-6 Perdon Corporation manufactures safes—large mobile safes, and large walk-in sta- tionary bank safes. As part of its annual budgeting process, Perdon is analyzing the profi t- ability of its two products. Part of this analysis involves estimating the amount of overhead to be allocated to each product line. The information shown below relates to overhead.

Mobile Walk-In Safes Safes

Units planned for production 200 50 Material moves per product line 300 200 Purchase orders per product line 450 350 Direct labor hours per product line 800 1,700

Instructions (a) The total estimated manufacturing overhead was $260,000. Under traditional costing

(which assigns overhead on the basis of direct labor hours), what amount of manufac- turing overhead costs are assigned to:

(1) One mobile safe? (2) One walk-in safe? (b) The total estimated manufacturing overhead of $260,000 was comprised of $160,000

for material handling costs and $100,000 for purchasing activity costs. Under activity- based costing (ABC):

(1) What amount of material handling costs are assigned to: (a) One mobile safe? (b) One walk-in safe? (2) What amount of purchasing activity costs are assigned to: (a) One mobile safe? (b) One walk-in safe?

Assign overhead using traditional costing and ABC.

(LO 1, 4), AP

Assign overhead using traditional costing and ABC.

(LO 1, 4), AN

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178 4 Activity-Based Costing

(c) Compare the amount of overhead allocated to one mobile safe and to one walk-in safe under the traditional costing approach versus under ABC.

E4-7 Quik Prints Company is a small printing and copying fi rm with three high-speed off- set printing presses, fi ve copiers (two color and three black-and-white), one collator, one cutting and folding machine, and one fax machine. To improve its pricing practices, owner- manager Terry Morton is installing activity-based accounting. Additionally, Terry employs fi ve employees: two printers/designers, one receptionist/bookkeeper, one salesperson/ copy-machine operator, and one janitor/delivery clerk. Terry can operate any of the machines and, in addition to managing the entire operation, he performs the training, designing, selling, and marketing functions.

Instructions As Quik Prints’ independent accountant who prepares tax forms and quarterly fi nancial statements, you have been asked to identify the activities that would be used to accumu- late overhead costs for assignment to jobs and customers. Using your knowledge of a small printing and copying fi rm (and some imagination), identify at least 12 activity cost pools as the start of an activity-based costing system for Quik Prints Company.

E4-8 Santana Corporation manufactures snowmobiles in its Blue Mountain, Wisconsin, plant. The following costs are budgeted for the fi rst quarter’s operations.

Machine setup, indirect materials $ 4,000 Inspections 16,000 Tests 4,000 Insurance, plant 110,000 Engineering design 140,000 Depreciation, machinery 520,000 Machine setup, indirect labor 20,000 Property taxes 29,000 Oil, heating 19,000 Electricity, plant lighting 21,000 Engineering prototypes 60,000 Depreciation, plant 210,000 Electricity, machinery 36,000 Machine maintenance wages 19,000

Instructions Classify the above costs of Santana Corporation into activity cost pools using the following: engineering, machinery, machine setup, quality control, factory utilities, maintenance. Next, identify a cost driver that may be used to assign each cost pool to each line of snowmobiles.

E4-9 Danny Baden’s Verde Vineyards in Oakville, California, produces three varieties of wine: Merlot, Viognier, and Pinot Noir. His winemaster, Russel Hansen, has identifi ed the following activities as cost pools for accumulating overhead and assigning it to products.

1. Culling and replanting. Dead or overcrowded vines are culled, and new vines are planted or relocated. (Separate vineyards by variety.)

2. Tying. The posts and wires are reset, and vines are tied to the wires for the dormant season.

3. Trimming. At the end of the harvest, the vines are cut and trimmed back in prepara- tion for the next season.

4. Spraying. The vines are sprayed with chemicals for protection against insects and fungi. 5. Harvesting. The grapes are hand-picked, placed in carts, and transported to the crushers. 6. Stemming and crushing. Cartfuls of bunches of grapes of each variety are separately

loaded into machines which remove stems and gently crush the grapes. 7. Pressing and fi ltering. The crushed grapes are transferred to presses which mechani-

cally remove the juices and fi lter out bulk and impurities. 8. Fermentation. The grape juice, by variety, is fermented in either stainless-steel tanks

or oak barrels. 9. Aging. The wines are aged in either stainless-steel tanks or oak barrels for one to three

years depending on variety. 10. Bottling and corking. Bottles are machine-fi lled and corked.

Identify activity cost pools and cost drivers.

(LO 3, 4), AN

Identify activity cost pools.

(LO 3), AP

Identify activity cost drivers.

(LO 4), AN

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Exercises 179

11. Labeling and boxing. Each bottle is labeled, as is each nine-bottle case, with the name of the vintner, vintage, and variety.

12. Storing. Packaged and boxed bottles are stored awaiting shipment. 13. Shipping. The wine is shipped to distributors and private retailers. 14. Heating and air-conditioning of plant and offi ces. 15. Maintenance of buildings and equipment. Printing, repairs, replacements, and general

maintenance are performed in the off-season.

Instructions For each of Verde’s 15 activity cost pools, identify a probable cost driver that might be used to assign overhead costs to its three wine varieties.

E4-10 Wilmington, Inc. manufactures fi ve models of kitchen appliances at its Mesa plant. The company is installing activity-based costing and has identifi ed the following activities performed at its Mesa plant.

1. Designing new models. 2. Purchasing raw materials and parts. 3. Storing and managing inventory. 4. Receiving and inspecting raw materials and parts. 5. Interviewing and hiring new personnel. 6. Machine forming sheet steel into appliance parts. 7. Manually assembling parts into appliances. 8. Training all employees of the company. 9. Insuring all tangible fi xed assets. 10. Supervising production. 11. Maintaining and repairing machinery and equipment. 12. Painting and packaging fi nished appliances.

Having analyzed its Mesa plant operations for purposes of installing activity-based cost- ing, Wilmington, Inc. identifi ed its activity cost centers. It now needs to identify relevant activity cost drivers in order to assign overhead costs to its products.

Instructions Using the activities listed above, identify for each activity one or more cost drivers that might be used to assign overhead to Wilmington’s fi ve products.

E4-11 Major Instrument, Inc. manufactures two products: missile range instruments and space pressure gauges. During April, 50 range instruments and 300 pressure gauges were produced, and overhead costs of $94,500 were estimated. An analysis of estimated over- head costs reveals the following activities.

Activities Cost Drivers Total Cost

1. Materials handling Number of requisitions $40,000 2. Machine setups Number of setups 27,500 3. Quality inspections Number of inspections 27,000

$94,500

The cost driver volume for each product was as follows.

Cost Drivers Instruments Gauges Total

Number of requisitions 400 600 1,000 Number of setups 200 300 500 Number of inspections 200 400 600

Instructions (a) Determine the overhead rate for each activity. (b) Assign the manufacturing overhead costs for April to the two products using activity-

based costing. (c) Write a memorandum to the president of Major Instrument explaining the

benefi ts of activity-based costing.

E4-12 Kragan Clothing Company manufactures its own designed and labeled sports attire and sells its products through catalog sales and retail outlets. While Kragan has for years used activity-based costing in its manufacturing activities, it has always used traditional

Identify activity cost drivers.

(LO 4), AN

Compute overhead rates and assign overhead using ABC.

(LO 4, 5), AP

Assign overhead using traditional costing and ABC.

(LO 1, 4, 6), AP

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180 4 Activity-Based Costing

costing in assigning its selling costs to its product lines. Selling costs have traditionally been assigned to Kragan’s product lines at a rate of 70% of direct material costs. Its di- rect material costs for the month of March for Kragan’s “high-intensity” line of attire are $400,000. The company has decided to extend activity-based costing to its selling costs. Data relating to the “high-intensity” line of products for the month of March are as follows.

Number of Cost Overhead Drivers Used Activity Cost Pools Cost Drivers Rate per Activity

Sales commissions Dollar sales $0.05 per dollar sales $900,000 Advertising—TV/Radio Minutes $300 per minute 250 Advertising—Newspaper Column inches $10 per column inch 2,000 Catalogs Catalogs mailed $2.50 per catalog 60,000 Cost of catalog sales Catalog orders $1 per catalog order 9,000 Credit and collection Dollar sales $0.03 per dollar sales $900,000

Instructions (a) Compute the selling costs to be assigned to the “high-intensity” line of attire for the

month of March (1) using the traditional product costing system (direct material cost is the cost driver), and (2) using activity-based costing.

(b) By what amount does the traditional product costing system undercost or overcost the “high-intensity” product line?

E4-13 Healthy Products, Inc., uses a traditional product costing system to assign over- head costs uniformly to all products. To meet Food and Drug Administration require- ments and to assure its customers of safe, sanitary, and nutritious food, Healthy engages in a high level of quality control. Healthy assigns its quality-control overhead costs to all products at a rate of 17% of direct labor costs. Its direct labor cost for the month of June for its low-calorie dessert line is $65,000. In response to repeated requests from its fi nan- cial vice president, Healthy’s management agrees to adopt activity-based costing. Data relating to the low-calorie dessert line for the month of June are as follows.

Number of Cost Overhead Drivers Used Activity Cost Pools Cost Drivers Rate per Activity

Inspections of material received Number of pounds $0.80 per pound 6,000 pounds In-process inspections Number of servings $0.33 per serving 10,000 servings FDA certifi cation Customer orders $12.00 per order 420 orders

Instructions (a) Compute the quality-control overhead cost to be assigned to the low-calorie dessert

product line for the month of June (1) using the traditional product costing system (direct labor cost is the cost driver), and (2) using activity-based costing.

(b) By what amount does the traditional product costing system undercost or overcost the low-calorie dessert line?

(c) Classify each of the activities as value-added or non–value-added.

E4-14 Lasso and Markowitz is a law fi rm that is initiating an activity-based costing system. Sam Lasso, the senior partner and strong supporter of ABC, has prepared the following list of activities performed by a typical attorney in a day at the fi rm.

Activities Hours

Writing contracts and letters 1.5 Attending staff meetings 0.5 Taking depositions 1.0 Doing research 1.0 Traveling to/from court 1.0 Contemplating legal strategy 1.0 Eating lunch 1.0 Litigating a case in court 2.5 Entertaining a prospective client 1.5

Assign overhead using traditional costing and ABC; classify activities as value- or non–value-added.

(LO 1, 4, 6), AP

Classify service company activities as value-added or non–value-added.

(LO 6), AN

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Visit the book’s companion website, at www.wiley.com/college/weygandt, and choose the Student Companion site to access Exercise Set B and Challenge Exercises.

EXERCISES: SET B AND CHALLENGE EXERCISES

PROBLEMS: SET A

P4-1A FireOut, Inc. manufactures steel cylinders and nozzles for two models of fi re extinguishers: (1) a home fi re extinguisher and (2) a commercial fi re extinguisher. The home model is a high-volume (54,000 units), half-gallon cylinder that holds 2 1/2 pounds of multi-purpose dry chemical at 480 PSI. The commercial model is a low-volume (10,200 units), two-gallon cylinder that holds 10 pounds of multi-purpose dry chemical at 390 PSI. Both products require 1.5 hours of direct labor for completion. Therefore, total annual direct labor hours are 96,300 or [1.5 hrs. 3 (54,000 1 10,200)]. Expected annual manufacturing overhead is $1,557,480. Thus, the predetermined overhead rate is $16.17 or ($1,557,480 4 96,300) per direct labor hour. The direct materials cost per unit is $18.50 for the home model and $26.50 for the commercial model. The direct labor cost is $19 per unit for both the home and the commercial models.

The company’s managers identifi ed six activity cost pools and related cost drivers and accumulated overhead by cost pool as follows.

Assign overhead using traditional costing and ABC; compute unit costs; classify activities as value- or non– value-added.

(LO 1, 4, 6), AP

Problems: Set A 181

Instructions Classify each of the activities listed by Sam Lasso as value-added or non–value-added, and defend your classifi cation. How much was value-added time and how much was non– value-added?

E4-15 Having itemized its costs for the fi rst quarter of next year’s budget, Santana Cor- poration desires to install an activity-based costing system. First, it identifi ed the activity cost pools in which to accumulate factory overhead. Second, it identifi ed the relevant cost drivers. (This was done in E4-8.)

Instructions Using the activity cost pools identifi ed in E4-8, classify each of those cost pools as either unit-level, batch-level, product-level, or facility-level.

E4-16 William Mendel & Sons, Inc. is a small manufacturing company in La Jolla that uses activity-based costing. Mendel & Sons accumulates overhead in the following activity cost pools.

1. Hiring personnel. 2. Managing parts inventory. 3. Purchasing. 4. Testing prototypes. 5. Designing products. 6. Setting up equipment. 7. Training employees. 8. Inspecting machined parts. 9. Machining. 10. Assembling.

Instructions For each activity cost pool, indicate whether the activity cost pool would be unit-level, batch-level, product-level, or facility-level.

Classify activities by level.

(LO 7), AN

Classify activities by level.

(LO 7), AN

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182 4 Activity-Based Costing

Instructions (a) Under traditional product costing, compute the total unit cost of each product.

Prepare a simple comparative schedule of the individual costs by product (similar to Illustration 4-10 on page 152).

(b) Under ABC, prepare a schedule showing the computations of the activity-based over- head rates (per cost driver).

(c) Prepare a schedule assigning each activity’s overhead cost pool to each product based on the use of cost drivers. (Include a computation of overhead cost per unit, rounding to the nearest cent.)

(d) Compute the total cost per unit for each product under ABC. (e) Classify each of the activities as a value-added activity or a non–value-added activity. (f) Comment on (1) the comparative overhead cost per unit for the two products under

ABC, and (2) the comparative total costs per unit under traditional costing and ABC.

P4-2A Schultz Electronics manufactures two large-screen television models: the Royale which sells for $1,600, and a new model, the Majestic, which sells for $1,300. The pro- duction cost computed per unit under traditional costing for each model in 2014 was as follows.

Traditional Costing Royale Majestic

Direct materials $ 700 $420 Direct labor ($20 per hour) 120 100 Manufacturing overhead ($38 per DLH) 228 190

Total per unit cost $1,048 $710

In 2014, Schultz manufactured 25,000 units of the Royale and 10,000 units of the Majestic. The overhead rate of $38 per direct labor hour was determined by dividing total expected manufacturing overhead of $7,600,000 by the total direct labor hours (200,000) for the two models.

Under traditional costing, the gross profi t on the models was Royale $552 or ($1,600 2 $1,048), and Majestic $590 or ($1,300 2 $710). Because of this difference, management is considering phasing out the Royale model and increasing the produc- tion of the Majestic model.

Before fi nalizing its decision, management asks Schultz’s controller to prepare an analysis using activity-based costing (ABC). The controller accumulates the following information about overhead for the year ended December 31, 2014.

Activity- Expected Based Estimated Use of Overhead Activities Cost Drivers Overhead Cost Drivers Rate

Purchasing Number of orders $1,200,000 40,000 $30/order Machine setups Number of setups 900,000 18,000 $50/setup Machining Machine hours 4,800,000 120,000 $40/hour Quality control Number of inspections 700,000 28,000 $25/inspection

Expected Expected Use

Use of of Drivers by

Estimated Cost Product

Activity Cost Pools Cost Drivers Overhead Drivers Home Commercial

Receiving Pounds $ 70,350 335,000 215,000 120,000 Forming Machine hours 150,500 35,000 27,000 8,000 Assembling Number of parts 412,300 217,000 165,000 52,000 Testing Number of tests 51,000 25,500 15,500 10,000 Painting Gallons 52,580 5,258 3,680 1,578 Packing and shipping Pounds 820,750 335,000 215,000 120,000

$1,557,480

(a) Unit cost—H.M. $61.76

(c) Cost assigned—H.M. $1,069,300

(d) Cost/unit—H.M. $57.30

Assign overhead to products using ABC and evaluate decision.

(LO 4), AP

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Problems: Set A 183

The cost drivers used for each product were:

Cost Drivers Royale Majestic Total

Purchase orders 17,000 23,000 40,000 Machine setups 5,000 13,000 18,000 Machine hours 75,000 45,000 120,000 Inspections 11,000 17,000 28,000

Instructions (a) Assign the total 2014 manufacturing overhead costs to the two products using activity-

based costing (ABC) and determine the overhead cost per unit. (b) What was the cost per unit and gross profi t of each model using ABC costing? (c) Are management’s future plans for the two models sound? Explain.

P4-3A Thakin Stairs Co. designs and builds factory-made premium wooden stairways for homes. The manufactured stairway components (spindles, risers, hangers, hand rails) permit installation of stairways of varying lengths and widths. All are of white oak wood. Budgeted manufacturing overhead costs for the year 2014 are as follows.

Overhead Cost Pools Amount

Purchasing $ 69,000 Handling materials 82,000 Production (cutting, milling, fi nishing) 210,000 Setting up machines 95,000 Inspecting 90,000 Inventory control (raw materials and fi nished goods) 126,000 Utilities 180,000

Total budgeted overhead costs $852,000

For the last 4 years, Thakin Stairs Co. has been charging overhead to products on the basis of machine hours. For the year 2014, 100,000 machine hours are budgeted.

Jeremy Nolan, owner-manager of Thakin Stairs Co., recently directed his accountant, Bill Seagren, to implement the activity-based costing system that he has repeatedly pro- posed. At Jeremy Nolan’s request, Bill and the production foreman identify the following cost drivers and their usage for the previously budgeted overhead cost pools.

Expected Use of Activity Cost Pools Cost Drivers Cost Drivers

Purchasing Number of orders 600 Handling materials Number of moves 8,000 Production (cutting, milling, fi nishing) Direct labor hours 100,000 Setting up machines Number of setups 1,250 Inspecting Number of inspections 6,000 Inventory control (raw materials and fi nished goods) Number of components 168,000 Utilities Square feet occupied 90,000

Steve Hannon, sales manager, has received an order for 250 stairways from Com- munity Builders, Inc., a large housing development contractor. At Steve’s request, Bill prepares cost estimates for producing components for 250 stairways so Steve can submit a contract price per stairway to Community Builders. He accumulates the following data for the production of 250 stairways.

Direct materials $103,600 Direct labor $112,000 Machine hours 14,500 Direct labor hours 5,000 Number of purchase orders 60 Number of material moves 800 Number of machine setups 100 Number of inspections 450 Number of components 16,000 Number of square feet occupied 8,000

(a) Royale $4,035,000

(b) Cost/unit—Royale $981.40

Assign overhead costs using traditional costing and ABC; compare results.

(LO 1, 4), AN

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184 4 Activity-Based Costing

Instructions (a) Compute the predetermined overhead rate using traditional costing with machine

hours as the basis. (b) What is the manufacturing cost per stairway under traditional costing? (Round to the

nearest cent.) (c) What is the manufacturing cost per stairway under the proposed activity-based cost-

ing? (Round to the nearest cent. Prepare all of the necessary schedules.) (d) Which of the two costing systems is preferable in pricing decisions and why?

P4-4A Benton Corporation produces two grades of wine from grapes that it buys from California growers. It produces and sells roughly 3,000,000 liters per year of a low-cost, high-volume product called CoolDay. It sells this in 600,000 5-liter jugs. Benton also pro- duces and sells roughly 300,000 liters per year of a low-volume, high-cost product called LiteMist. LiteMist is sold in 1-liter bottles. Based on recent data, the CoolDay product has not been as profi table as LiteMist. Management is considering dropping the inexpensive CoolDay line so it can focus more attention on the LiteMist product. The LiteMist product already demands considerably more attention than the CoolDay line.

Jack Eller, president and founder of Benton, is skeptical about this idea. He points out that for many decades the company produced only the CoolDay line and that it was always quite profi table. It wasn’t until the company started producing the more compli- cated LiteMist wine that the profi tability of CoolDay declined. Prior to the introduction of LiteMist, the company had simple equipment, simple growing and production procedures, and virtually no need for quality control. Because LiteMist is bottled in 1-liter bottles, it requires considerably more time and effort, both to bottle and to label and box than does CoolDay. The company must bottle and handle 5 times as many bottles of LiteMist to sell the same quantity as CoolDay. CoolDay requires 1 month of aging; LiteMist requires 1 year. CoolDay requires cleaning and inspection of equipment every 10,000 liters; LiteMist requires such maintenance every 600 liters.

Jack has asked the accounting department to prepare an analysis of the cost per liter using the traditional costing approach and using activity-based costing. The following information was collected.

CoolDay LiteMist

Direct materials per liter $0.40 $1.20 Direct labor cost per liter $0.50 $0.90 Direct labor hours per liter 0.05 0.09 Total direct labor hours 150,000 27,000

(b) Cost/stairway $1,356.56

(c) Cost/stairway $1,134.20

Assign overhead costs using traditional costing and ABC; compare results.

(LO 1, 4), AN

Expected Expected Use

Use of of Cost Drivers

Estimated Cost Per Product

Activity Cost Pools Cost Drivers Overhead Drivers CoolDay LiteMist

Grape processing Cart of grapes $ 145,860 6,600 6,000 600 Aging Total months 396,000 6,600,000 3,000,000 3,600,000 Bottling and Number of corking bottles 270,000 900,000 600,000 300,000 Labeling and Number of boxing bottles 189,000 900,000 600,000 300,000 Maintain and Number of inspect equipment inspections 240,800 800 350 450

$1,241,660

Instructions Answer each of the following questions. (Round all calculations to three decimal places.)

(a) Under traditional product costing using direct labor hours, compute the total manu- facturing cost per liter of both products.

(a) Cost/liter—C.D. $1.251

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Problems: Set B 185

(b) Under ABC, prepare a schedule showing the computation of the activity-based over- head rates (per cost driver).

(c) Prepare a schedule assigning each activity’s overhead cost pool to each product, based on the use of cost drivers. Include a computation of overhead cost per liter.

(d) Compute the total manufacturing cost per liter for both products under ABC. (e) Write a memo to Jack Eller discussing the implications of your analysis for

the company’s plans. In this memo, provide a brief description of ABC as well as an explanation of how the traditional approach can result in distortions.

P4-5A Polk and Stoneman is a public accounting fi rm that offers two primary services, auditing and tax-return preparation. A controversy has developed between the partners of the two service lines as to who is contributing the greater amount to the bottom line. The area of contention is the assignment of overhead. The tax partners argue for assign- ing overhead on the basis of 40% of direct labor dollars, while the audit partners argue for implementing activity-based costing. The partners agree to use next year’s budgeted data for purposes of analysis and comparison. The following overhead data are collected to develop the comparison.

Assign overhead costs to services using traditional costing and ABC; compute overhead rates and unit costs; compare results.

(LO 1, 4, 6, 8), AN

Expected Expected Use

Use of of Cost Drivers

Estimated Cost Per Service

Activity Cost Pools Cost Drivers Overhead Drivers Audit Tax

Employee training Direct labor dollars $216,000 $1,800,000 $1,050,000 $750,000 Typing and Number of reports/ secretarial forms 76,200 2,500 800 1,700 Computing Number of minutes 204,000 60,000 25,000 35,000 Facility rental Number of employees 142,500 40 22 18 Travel Per expense reports 81,300 Direct 56,000 25,300

$720,000

Instructions (a) Using traditional product costing as proposed by the tax partners, compute the total

overhead cost assigned to both services (audit and tax) of Polk and Stoneman. (b) (1) Using activity-based costing, prepare a schedule showing the computations of the

activity-based overhead rates (per cost driver). (2) Prepare a schedule assigning each activity’s overhead cost pool to each service

based on the use of the cost drivers. (c) Comment on the comparative overhead cost for the two services under both

traditional costing and ABC.

(b) (2) Cost assigned—Tax $350,241

(c) Difference—Audit $50,241

PROBLEMS: SET B

P4-1B VideoPlus, Inc. manufactures two types of DVD players, a deluxe model and a standard model. The deluxe model is a multi-format progressive-scan DVD player with networking capability, Dolby digital, and DTS decoder. The standard model’s primary fea- ture is progressive-scan. Annual production is 50,000 units for the deluxe and 20,000 units for the standard.

Both products require 2 hours of direct labor for completion. Therefore, total annual direct labor hours are 140,000 [2 hrs. 3 (20,000 1 50,000)]. Expected annual manufactur- ing overhead is $1,050,000. Thus, the predetermined overhead rate is $7.50 ($1,050,000 4 140,000) per direct labor hour. The direct materials cost per unit is $42 for the deluxe model and $11 for the standard model. The direct labor cost is $18 per unit for both the deluxe and the standard models.

The company’s managers identifi ed six activity cost pools and related cost drivers and accumulated overhead by cost pool as follows.

Assign overhead using traditional costing and ABC; compute unit costs; classify activities as value- or non– value-added.

(LO 1, 4, 6), AP

(c) Cost/liter—C.D. $.241

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186 4 Activity-Based Costing

Instructions (a) Under traditional product costing, compute the total unit cost of both products.

Prepare a simple comparative schedule of the individual costs by product (similar to Illustration 4-10 on page 152).

(b) Under ABC, prepare a schedule showing the computations of the activity-based over- head rates (per cost driver).

(c) Prepare a schedule assigning each activity’s overhead cost pool to each product based on the use of cost drivers. (Include a computation of overhead cost per unit, rounding to the nearest cent.)

(d) Compute the total cost per unit for each product under ABC. (e) Classify each of the activities as a value-added activity or a non–value-added activity. (f) Comment on (1) the comparative overhead cost per unit for the two products under

ABC, and (2) the comparative total costs per unit under traditional costing and ABC.

P4-2B Kinnard Electronics manufactures two home theater systems: the Elite which sells for $1,400, and a new model, the Preferred, which sells for $1,100. The produc- tion cost computed per unit under traditional costing for each model in 2014 was as follows.

Traditional Costing Elite Preferred

Direct materials $600 $320 Direct labor ($20 per hour) 100 80 Manufacturing overhead ($35 per DLH) 175 140

Total per unit cost $875 $540

In 2014, Kinnard manufactured 20,000 units of the Elite and 10,000 units of the Pre- ferred. The overhead rate of $35 per direct labor hour was determined by dividing total expected manufacturing overhead of $4,900,000 by the total direct labor hours (140,000) for the two models.

Under traditional costing, the gross profi t on the models was Elite $525 ($1,400 2 $875), and Preferred $560 ($1,100 2 $540). Because of this difference, management is considering phasing out the Elite model and increasing the production of the Preferred model.

Before fi nalizing its decision, management asks Kinnard’s controller to prepare an analysis using activity-based costing (ABC). The controller accumulates the following in- formation about overhead for the year ended December 31, 2014.

Expected

Use of Expected Use of

Estimated Cost Drivers by Product

Activity Cost Pool Cost Driver Overhead Drivers Standard Deluxe

Purchasing Orders $ 126,000 400 100 300 Receiving Pounds 30,000 20,000 4,000 16,000 Assembling Number of parts 444,000 74,000 20,000 54,000 Testing Number of tests 115,000 23,000 10,000 13,000 Finishing Units 140,000 70,000 20,000 50,000 Packing and shipping Pounds 195,000 80,000 18,000 62,000

$1,050,000

(a) Unit cost—Standard $44

(c) Cost assigned—Standard $291,375

(d) Cost/unit—Standard $43.57

Expected Activity- Use of Based Estimated Cost Overhead Activity Cost Driver Overhead Drivers Rate

Purchasing Number of orders $ 775,000 25,000 $31 Machine setups Number of setups 580,000 20,000 29 Machining Machine hours 3,100,000 100,000 31 Quality control Number of inspections 445,000 5,000 89

Assign overhead to products using ABC and evaluate decision.

(L0 4), AP

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Problems: Set B 187

The cost drivers used for each product were:

Cost Driver Elite Preferred Total

Purchase orders 11,250 13,750 25,000 Machine setups 11,000 9,000 20,000 Machine hours 40,000 60,000 100,000 Inspections 2,750 2,250 5,000

Instructions (a) Assign the total 2014 manufacturing overhead costs to the two products using activity-

based costing (ABC) and determine the overhead cost per unit. (b) What was the cost per unit and gross profi t of each model using ABC costing? (c) Are management’s future plans for the two models sound? Explain.

P4-3B Luxury Furniture designs and builds factory-made, premium, wood armoires for homes. All are of white oak. Its budgeted manufacturing overhead costs for the year 2014 are as follows.

Overhead Cost Pools Amount

Purchasing $ 45,000 Handling materials 50,000 Production (cutting, milling, fi nishing) 130,000 Setting up machines 85,000 Inspecting 60,000 Inventory control (raw materials and fi nished goods) 80,000 Utilities 100,000

Total budgeted overhead costs $550,000

For the last 4 years, Luxury Furniture has been charging overhead to products on the basis of materials cost. For the year 2014, materials cost of $500,000 were budgeted.

Jim Brigham, owner-manager of Luxury Furniture, recently directed his accountant, Bob Borke, to implement the activity-based costing system that he has repeatedly pro- posed. At Jim Brigham’s request, Bob and the production foreman identify the following cost drivers and their usage for the previously budgeted overhead cost pools.

Expected Use of Overhead Cost Pools Activity Cost Drivers Cost Drivers

Purchasing Number of orders 500 Handling materials Number of moves 5,000 Production (cutting, milling, fi nishing) Direct labor hours 65,000 Setting up machines Number of setups 1,000 Inspecting Number of inspections 4,000 Inventory control (raw materials and fi nished goods) Number of components 40,000 Utilities Square feet occupied 50,000

Debbie Steiner, sales manager, has received an order for 12 luxury armoires from Thom’s Interior Design. At Debbie’s request, Bob prepares cost estimates for producing 12 armoires so Debbie can submit a contract price per armoire to Thom’s. He accumulates the following data for the production of 12 armoires.

Direct materials $5,200 Direct labor $3,500 Direct labor hours 200 Number of purchase orders 3 Number of material moves 32 Number of machine setups 4 Number of inspections 20 Number of components 640 Number of square feet occupied 320

(a) Elite $2,152,500

(b) Cost/unit—Elite $807.63

Assign overhead costs using traditional costing and ABC; compare results.

(L0 1, 4), AN

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188 4 Activity-Based Costing

Instructions (a) Compute the predetermined overhead rate using traditional costing with materials

cost as the basis. (b) What is the manufacturing cost per armoire under traditional costing? (c) What is the manufacturing cost per armoire under the proposed activity-based cost-

ing? (Prepare all of the necessary schedules.) (d) Which of the two costing systems is preferable in pricing decisions and why?

P4-4B Merando Corporation produces two grades of wine from grapes that it buys from California growers. It produces and sells roughly 600,000 gallon jugs per year of a low- cost, high-volume product called Valley Fresh. Merando also produces and sells roughly 200,000 gallons per year of a low-volume, high-cost product called Merando Valley. Merando Valley is sold in 1-liter bottles. Based on recent data, the Valley Fresh product has not been as profi table as Merando Valley. Management is considering dropping the inexpensive Valley Fresh line so it can focus more attention on the Merando Valley product. The Merando Valley product already demands considerably more attention than the Valley Fresh line.

Frankie Merando, president and founder of Merando, is skeptical about this idea. He points out that for many decades the company produced only the Valley Fresh line, and that it was always quite profi table. It wasn’t until the company started producing the more complicated Merando Valley wine that the profi tability of Valley Fresh declined. Prior to the introduction of Merando Valley, the company had simple equipment, simple growing and production procedures, and virtually no need for quality control. Because Merando Valley is bottled in 1-liter bottles, it requires considerably more time and effort, both to bottle and to label and box, than does Valley Fresh. The company must bottle and handle 4 times as many bottles of Merando Valley to sell the same quantity as Valley Fresh, since there are approximately 4 liters in a gallon. Valley Fresh requires 1 month of aging; Merando Valley requires 1 year. Valley Fresh requires cleaning and inspection of equip- ment every 2,500 gallons; Merando Valley requires such maintenance every 250 gallons.

Frankie has asked the accounting department to prepare an analysis of the cost per gallon using the traditional costing approach and using activity-based costing. The follow- ing information was collected.

(b) Cost/armoire $1,201.67 (c) Cost/armoire $1,020.83

Assign overhead costs using traditional costing and ABC; compare results.

(L0 1, 4), AN

Instructions Answer each of the following questions. (Round all calculations to three decimal places.)

(a) Under traditional product costing using direct labor hours, compute the total manu- facturing cost per gallon of both products.

Valley Fresh Merando Valley

Direct materials per gallon $1.35 $3.60 Direct labor cost per gallon $0.75 $1.50 Direct labor hours per gallon 0.05 0.10 Total direct labor hours 30,000 20,000

Expected Expected Use

Use of of Cost Drivers

Estimated Cost per Product

Activity Cost Pool Cost Driver Overhead Drivers Valley Fresh Merando Valley

Grape processing Cart of grapes $ 146,000 8,000 6,000 2,000 Aging Total months 420,000 3,000,000 600,000 2,400,000 Bottling and Number of corking bottles 210,000 1,400,000 600,000 800,000 Labeling and Number of boxing bottles 140,000 1,400,000 600,000 800,000 Maintain and Number of inspect equipment inspections 234,000 1,040 240 800

$1,150,000

(a) Cost/gallon—V.F. $3.25

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Waterways Continuing Problem 189

(b) Under ABC, prepare a schedule showing the computation of the activity-based over- head rates (per cost driver).

(c) Prepare a schedule assigning each activity’s overhead cost pool to each product, based on the use of cost drivers. Include a computation of overhead cost per gallon.

(d) Compute the total manufacturing cost per gallon for both products under ABC. (e) Write a memo to Frankie Merando discussing the implications of your analy-

sis for the company’s plans. In this memo, provide a brief description of ABC as well as an explanation of how the traditional approach can result in distortions.

P4-5B Smith and Jones is a law fi rm that serves both individuals and corporations. A controversy has developed between the partners of the two service lines as to who is con- tributing the greater amount to the bottom line. The area of contention is the assignment of overhead. The individual partners argue for assigning overhead on the basis of 30% of direct labor dollars, while the corporate partners argue for implementing activity-based costing. The partners agree to use next year’s budgeted data for purposes of analysis and comparison. The following overhead data are collected to develop the comparison.

(c) Cost/gallon—V.F. $0.663

Expected Expected Use

Use of of Cost Drivers

Estimated Cost per Service

Activity Cost Pool Cost Driver Overhead Drivers Corporate Individual

Employee training Direct labor dollars $120,000 $1,600,000 $900,000 $700,000 Typing and Number of reports/ secretarial forms 60,000 2,000 500 1,500 Computing Number of minutes 130,000 40,000 17,000 23,000 Facility rental Number of employees 100,000 25 14 11 Travel Per expense reports 70,000 Direct 48,000 22,000

$480,000

Instructions (a) Using traditional product costing, compute the total overhead cost assigned to both

services (individual and corporate) of Smith and Jones. (b) (1) Using activity-based costing, prepare a schedule showing the computations of the

activity-based overhead rates (per cost driver). (2) Prepare a schedule assigning each activity’s overhead cost pool to each service

based on the use of the cost drivers. (c) Comment on the comparative overhead for the two service lines under both

traditional costing and ABC. (c) Difference—Corporate

$28,250

(b) (2) Cost assigned— Individual $238,250

Assign overhead costs to services using traditional costing and ABC; compute overhead rates and unit costs; compare results.

(L0 1, 4, 6, 8), AN

Visit the book’s companion website, at www.wiley.com/college/weygandt, and choose the Student Companion site to access Problem Set C.

PROBLEMS: SET C

(Note: This is a continuation of the Waterways Problem from Chapters 1–3.)

WCP4 Waterways looked into ABC as a method of costing because of the variety of items it produces and the many different activities in which it is involved. This problem asks you to help Waterways use an activity-based costing system to account for its production activities.

Go to the book’s companion website, at www.wiley.com/college/weygandt, to fi nd the completion of this problem.

WATERWAYS CONTINUING PROBLEM

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190 4 Activity-Based Costing

Broadening Your PERSPECTIVE

BYP4-1 As you learned in the previous chapters, Current Designs has two main product lines— composite kayaks, which are handmade and very labor-intensive, and rotomolded kayaks, which require less labor but employ more expensive equipment. Current Designs’ controller, Diane Buswell, is now evaluating several different methods of assigning overhead to these products. It is important to ensure that costs are appropriately assigned to the company’s products. At the same time, the system that is used must not be so complex that its costs are greater than its benefi ts.

Diane has decided to use the following activities and costs to evaluate the methods of assigning overhead.

Activity Cost

Designing new models $121,100 Creating and testing prototypes 152,000 Creating molds for kayaks 188,500 Operating oven for the rotomolded kayaks 40,000 Operating the vacuum line for the composite kayaks 28,000 Supervising production employees 180,000 Curing time (the time that is needed for the chemical processes to fi nish before the next step in the production process; many of these costs are related to the space required in the building) 190,400

Total $900,000

As Diane examines the data, she decides that the cost of operating the oven for the rotomolded kayaks and the cost of operating the vacuum line for the composite kayaks can be directly assigned to each of these product lines and do not need to be allocated with the other costs.

Instructions For purposes of this analysis, assume that Current Designs uses $234,000 in direct labor costs to produce 1,000 composite kayaks and $286,000 in direct labor costs to produce 4,000 rotomolded kayaks each year. (a) One method of allocating overhead would allocate the common costs to each product line by

using an allocation basis such as the number of employees in working on each type of kayak or the amount of factory space used for the production of each type of kayak. Diane knows that about 50% of the area of the plant and 50% of the employees work on the composite kayaks, and the remaining space and other employees work on the rotomolded kayaks. Using this information, and remembering that the cost of operating the oven and vacuum line have been directly assigned, determine the total amount to be assigned to the composite kayak line and the rotomolded kayak line, and the amount to be assigned to each of the units in each line.

(b) Another method of allocating overhead is to use direct labor dollars as an allocation basis. Remembering that the costs of the oven and the vacuum line have been assigned directly to the product lines, allocate the remaining costs using direct labor dollars as the allocation basis. Then, determine the amount of overhead that should be assigned to each unit of each product line using this method.

(c) Activity-based costing requires a cost driver for each cost pool. Use the following information to assign the costs to the product lines using the activity-based costing approach.

Management Decision-Making

Decision-Making at Current Designs

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Broadening Your Perspective 191

Driver Amount Driver Amount for Composite for Rotomolded Activity Cost Driver Kayaks Kayaks

Designing new models Number of models 3 1 Creating and testing prototypes Number of prototypes 6 2 Creating molds for kayaks Number of molds 12 1 Supervising production employees Number of employees 12 12 Curing time Number of days of curing time 15,000 2,000

What amount of overhead should be assigned to each composite kayak using this method? What amount of overhead should be assigned to each rotomolded kayak using this method?

(d) Which of the three methods do you think Current Designs should use? Why?

Decision-Making Across the Organization

BYP4-2 East Valley Hospital is a primary medical care facility and trauma center that serves 11 small, rural midwestern communities within a 40-mile radius. The hospital offers all the medical/ surgical services of a typical small hospital. It has a staff of 18 full-time doctors and 20 part-time visiting specialists. East Valley has a payroll of 150 employees consisting of technicians, nurses, therapists, managers, directors, administrators, dieticians, secretaries, data processors, and janitors.

Instructions With the class divided into groups, discuss and answer the following. (a) Using your (limited, moderate, or in-depth) knowledge of a hospital’s operations, identify as

many activities as you can that would serve as the basis for implementing an activity-based costing system.

(b) For each of the activities listed in (a), identify a cost driver that would serve as a valid measure of the resources consumed by the activity.

Managerial Analysis

BYP4-3 Ideal Manufacturing Company of Sycamore, Illinois, has supported a research and de- velopment (R&D) department that has for many years been the sole contributor to the company’s new farm machinery products. The R&D activity is an overhead cost center that provides services only to in-house manufacturing departments (four different product lines), all of which produce agricultural/farm/ranch-related machinery products.

The department has never sold its services outside, but because of its long history of success, larger manufacturers of agricultural products have approached Ideal to hire its R&D department for special projects. Because the costs of operating the R&D department have been spiraling uncontrollably, Ideal’s management is considering entertaining these outside approaches to absorb the increasing costs. But, (1) management doesn’t have any cost basis for charging R&D services to outsiders, and (2) it needs to gain control of its R&D costs. Management decides to implement an activity-based costing system in order to determine the charges for both outsiders and the in-house users of the department’s services.

R&D activities fall into four pools with the following annual costs.

Market analysis $1,050,000 Product design 2,350,000 Product development 3,600,000 Prototype testing 1,400,000

Activity analysis determines that the appropriate cost drivers and their usage for the four activities are:

Total Activities Cost Drivers Estimated Drivers

Market analysis Hours of analysis 15,000 hours Product design Number of designs 2,500 designs Product development Number of products 90 products Prototype testing Number of tests 500 tests

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Instructions (a) Compute the activity-based overhead rate for each activity cost pool. (b) How much cost would be charged to an in-house manufacturing department that consumed

1,800 hours of market analysis time, was provided 280 designs relating to 10 products, and requested 92 engineering tests?

(c) How much cost would serve as the basis for pricing an R&D bid with an outside company on a contract that would consume 800 hours of analysis time, require 178 designs relating to 3 products, and result in 70 engineering tests?

(d) What is the benefi t to Ideal Manufacturing of applying activity-based costing to its R&D activity for both in-house and outside charging purposes?

Real-World Focus

BYP4-4 An article in Cost Management, by Kocakulah, Bartlett, and Albin entitled “ABC for Calcu- lating Mortgage Loan Servicing Expenses” (July/August 2009, p. 36), discusses a use of ABC in the fi nancial services industry.

Instructions Read the article and answer the following questions. (a) What are some of the benefi ts of ABC that relate to the fi nancial services industry? (b) What are three things that the company’s original costing method did not take into account? (c) What were some of the cost drivers used by the company in the ABC approach?

BYP4-5 Activity-based costing methods are constantly being improved upon, and many websites discuss suggestions for improvement. The article in this activity outlines an alternative perspective on activity-based costing.

Address: http://hbswk.hbs.edu/item/4587.html, or go to www.wiley.com/college/weygandt

Instructions Read the article provided at the site and answer the following questions. (a) What concerns do the authors say are raised by “real-world use” of ABC? According to the

authors, what benefi ts have companies enjoyed from the use of ABC? (b) What method do the authors suggest for estimating practical capacity? How important is it to

be precise in this estimate? (c) Describe the steps that are taken after practical capacity has been estimated. (d) What is one of the primary benefi ts obtained by management in the report entitled “ABC, the

Time-Driven Way”? What is an example of how this worked for a real company?

192 4 Activity-Based Costing

Critical Thinking

Ethics Case

BYP4-6 Curtis Rich, the cost accountant for Hi-Power Mower Company, recently installed activity- based costing at Hi-Power’s St. Louis lawn tractor (riding mower) plant where three models—the 8-horsepower Bladerunner, the 12-horsepower Quickcut, and the 18-horsepower Supercut—are manufactured. Curtis’s new product costs for these three models show that the company’s tradi- tional costing system had been signifi cantly undercosting the 18-horsepower Supercut. This was due primarily to the lower sales volume of the Supercut compared to the Bladerunner and the Quickcut.

Before completing his analysis and reporting these results to management, Curtis is ap- proached by his friend Ed Gray, who is the production manager for the 18-horsepower Supercut model. Ed has heard from one of Curtis’s staff about the new product costs and is upset and worried for his job because the new costs show the Supercut to be losing, rather than making, money.

At fi rst, Ed condemns the new cost system, whereupon Curtis explains the practice of activity- based costing and why it is more accurate than the company’s present system. Even more worried

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now, Ed begs Curtis, “Massage the fi gures just enough to save the line from being discontinued. You don’t want me to lose my job, do you? Anyway, nobody will know.”

Curtis holds fi rm but agrees to recompute all his calculations for accuracy before submitting his costs to management.

Instructions (a) Who are the stakeholders in this situation? (b) What, if any, are the ethical considerations in this situation? (c) What are Curtis’s ethical obligations to the company? To his friend?

All About You

BYP4-7 There are many resources available on the Web to assist people in time management. Some of these resources are designed specifi cally for college students.

Instructions Go to http://www.dartmouth.edu/~acskills/videos/video_tm.html (or do an Internet search of Dartmouth’s time-management video). Watch the video and then answer the following questions. (a) What are the main tools of time management for students, and what is each used for? (b) At what time of day are students most inclined to waste time? What time of day is the best for

studying complex topics? (c) How can employing time-management practices be a “liberating” experience? (d) Why is goal-setting important? What are the characteristics of good goals, and what steps

should you take to help you develop your goals?

Considering Your Costs and Benefi ts

BYP4-8 As discussed in the chapter, the principles underlying activity-based costing have evolved into the broader approach known as activity-based management. One of the common practices of activity-based management is to identify all business activities, classify each activity as either a value-added or a non–value-added activity, and then try to reduce or eliminate the time spent on non–value-added activities. Consider the implications of applying this same approach to your everyday life, at work and at school. How do you spend your time each day? How much of your day is spent on activities that help you accomplish your objectives, and how much of your day is spent on activities that do not add value?

Many “self-help” books and websites offer suggestions on how to improve your time manage- ment. Should you minimize the “non–value-added” hours in your life by adopting the methods sug- gested by these sources? The basic arguments for and against are as follows.

YES: There are a limited number of hours in a day. You should try to maximize your chances of achieving your goals by eliminating the time that you waste. NO: Life is about more than working yourself to death. Being an effi ciency expert doesn’t guar- antee that you will be happy. Schedules and daily planners are too constraining.

Instructions Write a response indicating your position regarding this situation. Provide support for your view.

Broadening Your Perspective 193

Answers to Chapter Questions

Answers to Insight and Accounting Across the Organization Questions

p. 153 Traveling Light Q: Why do airlines charge even higher rates for heavier bags, bags that are odd shapes (e.g., ski bags), and bags with hazardous materials in them? A: Each of these fac- tors increases the costs to the airlines. Heavier baggage is more diffi cult to handle, thus increas- ing labor costs. It also uses up more fuel. Bags that are odd shapes complicate handling both for

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humans and machines. In addition, odd shapes take up more space in the cargo area. Finally, hazardous materials require special handling and storage procedures. All of these factors should be considered by an airline when it decides how much to charge for special baggage. p. 156 Using ABC to Aid in Employee Evaluation Q: What positive implications does applica- tion of ABC have for the employees of this company? A: ABC will make these employees more aware of which activities cost the company more money. They will be motivated to reduce their use of these activities in order to improve their individual performance. p. 159 What Does NASCAR Have to Do with Breakfast Cereal? Q: What are the benefi ts of reducing setup time? A: Setup time is a non–value-added activity. Customers are not willing to pay extra for more setup time. By reducing the time spent on setups, the company can reduce non–value-added costs. Also, by reducing setup time, the company can switch from producing one product to producing a different product more quickly. This enables it to respond to customers’ demands more quickly, thus avoiding stockouts. p. 164 ABC Evaluated Q: What might explain why so many companies say that ideally they would use ABC, but they haven’t adopted it yet? A: As noted in the chapter, implementation of an ABC system can be very expensive. It may be diffi cult to justify an expenditure for a system that allocates overhead costs more accurately. The benefi ts of more accurate costing may not be as obvious as some of the other things a company might spend its money on, such as a machine that produces goods more effi ciently.

Answers to Self-Test Questions

1. c 2. c 3. c 4. a 5. b 6. b ($100 3 80), ($100 3 60) 7. d [($1,920,000/160,000) 3 40,000], [($1,920,000/160,000) 3 30,000)], [($1,920,000/160,000) 3 90,000)] 8. b 9. d 10. d 11. c 12. c *13. d *14. b

194 4 Activity-Based Costing

✔ Remember to go back to The Navigator box on the chapter opening page and check off your completed work.

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Learning Objectives After studying this chapter, you should be able to:

1 Distinguish between variable and fi xed costs.

2 Explain the signifi cance of the relevant range.

3 Explain the concept of mixed costs.

4 List the fi ve components of cost-volume-profi t analysis.

5 Indicate what contribution margin is and how it can be

expressed.

6 Identify the three ways to determine the break-even point.

7 Give the formulas for determining sales required to earn

target net income.

8 Defi ne margin of safety, and give the formulas for

computing it.

✔ The Navigator

✔ The Navigator

Chapter 5 Cost-Volume-Profi t

Don’t Worry— Just Get Big It wasn’t that Jeff Bezos didn’t have a

good job. He was a vice president at a

Wall Street fi rm. But, he quit his job,

moved to Seattle, and started an

online retailer, which he named

Amazon.com. Like any good entrepre-

neur, Jeff strove to keep his initial

investment small. Operations were run

out of his garage. And, to avoid the

need for a warehouse, he took orders

for books and had them shipped from

other distributors’ warehouses. One

board member recalls how excited the

board was whenever an order came in

from a customer in a state that

Amazon had never serviced before.

By its fourth month, Amazon was

selling 100 books a day. In its fi rst full

year, it had $15.7 million in sales. The

next year, sales increased eightfold.

Two years later, sales were $1.6 billion.

Although its sales growth was

impressive, Amazon’s ability to lose

money was equally amazing. One

analyst nicknamed it Amazon.bomb,

while another, predicting its demise,

called it Amazon.toast. Why was it

losing money? The company used

every available dollar to reinvest in

itself. It built massive warehouses

and bought increasingly sophisticated

(and expensive) computer systems to

improve its distribution system. This

desire to grow as fast as possible was

196

Scan Learning Objectives

Read Feature Story

Scan Preview

Read Text and answer p. 202 p. 205 p. 213 p. 216

Work Using the Decision Toolkit p. 216

Review Summary of Learning Objectives

Work Comprehensive p. 218

Answer Self-Test Questions

Complete Assignments

Go to WileyPLUS for practice and tutorials

DO IT!

DO IT!

Feature Story

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captured in a T-shirt slogan at its company picnic, which read

“Eat another hot dog, get big fast.” This buying binge was

increasing the company’s fi xed

costs at a rate that exceeded its

sales growth. Skeptics were

predicting that Amazon would

soon run out of cash. It didn’t.

In the fourth quarter of 2010

(only 15 years after its world

headquarters were located

in a garage), Amazon reported

quarterly revenues of $12.95

billion and quarterly income of

$416 million. But, even as it

announced record profi ts, its

share price fell by 9%. Why? Because although the company

was predicting that its sales revenue in the next quarter would

increase by at least 28%, it predicted that its operating profi t

would fall by at least 2% and perhaps by as much as 34%.

The company made no apologies. It explained that it was in

the process of expanding from 39 distribution centers to 52.

As Amazon’s fi nance chief

noted, “You’re not as produc-

tive on those assets for some

time. I’m very pleased with the

investments we’re making and

we’ve shown over our history

that we’ve been able to make

great returns on the capital we

invest in.” In other words, eat

another hot dog.

Watch the Southwest Airlines

video in WileyPLUS to learn

more about cost-volume-profi t

analysis in the real world.

Source: Christine Frey and John Cook, “How Amazon.com Survived, Thrived

and Turned a Profi t,” Seattle Post (January 28, 2008); and Stu Woo, “Sticker

Shock Over Amazon Growth,” Wall Street Journal Online (January 28, 2011).

✔ The Navigator

As the Feature Story indicates, to manage any size business you must understand how costs respond to changes in sales volume and the effect of costs and revenues on profi ts. A prerequisite to understanding cost-volume-profi t (CVP) relationships is knowledge of how costs behave. In this chapter, we fi rst explain the considerations involved in cost behavior analysis. Then, we discuss and illustrate CVP analysis.

The content and organization of Chapter 5 are as follows.

Preview of Chapter 5

• Variable costs • Fixed costs • Relevant range • Mixed costs • Identifying variable and

fi xed costs

Cost Behavior Analysis

• Basic components • CVP income statement • Break-even analysis • Target net income • Margin of safety

Cost-Volume-Profi t Analysis

✔ The Navigator

197

COST-VOLUME-PROFIT

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198 5 Cost-Volume-Profi t

Cost behavior analysis is the study of how specifi c costs respond to changes in the level of business activity. As you might expect, some costs change, and others remain the same. For example, for an airline company such as Southwest or United, the longer the fl ight, the higher the fuel costs. On the other hand, Massachusetts General Hospital’s costs to staff the emergency room on any given night are rel- atively constant regardless of the number of patients treated. A knowledge of cost behavior helps management plan operations and decide between alternative courses of action. Cost behavior analysis applies to all types of entities.

The starting point in cost behavior analysis is measuring the key business activi- ties. Activity levels may be expressed in terms of sales dollars (in a retail company), miles driven (in a trucking company), room occupancy (in a hotel), or dance classes taught (by a dance studio). Many companies use more than one measurement base. A manufacturer, for example, may use direct labor hours or units of output for man- ufacturing costs, and sales revenue or units sold for selling expenses.

For an activity level to be useful in cost behavior analysis, changes in the level or volume of activity should be correlated with changes in costs. The activity level selected is referred to as the activity (or volume) index. The activity index identifi es the activity that causes changes in the behavior of costs. With an appro- priate activity index, companies can classify the behavior of costs in response to changes in activity levels into three categories: variable, fi xed, or mixed.

Variable Costs

Variable costs are costs that vary in total directly and proportionately with changes in the activity level. If the level increases 10%, total variable costs will increase 10%. If the level of activity decreases by 25%, variable costs will decrease 25%. Examples of variable costs include direct materials and direct labor for a manufacturer; cost of goods sold, sales commissions, and freight-out for a merchandiser; and gasoline in airline and trucking companies. A variable cost may also be defi ned as a cost that remains the same per unit at every level of activity.

To illustrate the behavior of a variable cost, assume that Damon Company manufactures tablet computers that contain a $10 camera. The activity index is the number of tablet computers produced. As Damon manufactures each tablet, the total cost of cameras used increases by $10. As part (a) of Illustration 5-1

Cost Behavior Analysis

Helpful Hint True or false: Variable costs per unit change directly and proportionately with changes in activity. Answer: False. Per unit costs remain constant at all levels of activity.

0 2 4 6 8 10 0

20

40

60

80

$100

0 2 4 6 8 10 0

5

10

15

20

$25

Tablet Computers Produced (in 000)Tablet Computers Produced (in 000)

C o st

( 00

0)

C o st

( pe

r un

it )

(b)

(Cameras)

(a)

(Cameras) Total Variable Costs Variable Costs per Unit

Illustration 5-1 Behavior of total and unit variable costs

Distinguish between variable and fi xed costs.

1LEARNING OBJECTIVE

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Cost Behavior Analysis 199

shows, total cost of the cameras will be $20,000 if Damon produces 2,000 tablets, and $100,000 when it produces 10,000 tablets. We also can see that a variable cost remains the same per unit as the level of activity changes. As part (b) of Illustration 5-1 shows, the unit cost of $10 for the cameras is the same whether Damon produces 2,000 or 10,000 tablets.

Companies that rely heavily on labor to manufacture a product, such as Nike or Reebok, or to provide a service, such as Hilton or Marriott, are likely to have many variable costs. In contrast, companies that use a high proportion of ma- chinery and equipment in producing revenue, such as AT&T or Duke Energy Co., may have few variable costs.

Fixed Costs

Fixed costs are costs that remain the same in total regardless of changes in the activity level. Examples include property taxes, insurance, rent, supervisory salaries, and depreciation on buildings and equipment. Because total fi xed costs remain constant as activity changes, it follows that fi xed costs per unit vary inversely with activity: As volume increases, unit cost declines, and vice versa.

To illustrate the behavior of fi xed costs, assume that Damon Company leases its productive facilities at a cost of $10,000 per month. Total fi xed costs of the facilities will remain constant at every level of activity, as part (a) of Illustration 5-2 shows. But, on a per unit basis, the cost of rent will decline as activity increases, as part (b) of Illustration 5-2 shows. At 2,000 units, the unit cost per tablet computer is $5 ($10,000 4 2,000). When Damon produces 10,000 tablets, the unit cost of the rent is only $1 per tablet ($10,000 4 10,000).

Illustration 5-2 Behavior of total and unit fi xed costs

0 2 4 6 8 10 0

5

10

15

20

$25

0 2 4 6 8 10 0

1

2

3

4

$5

Tablet Computers Produced (in 000)Tablet Computers Produced (in 000)

C o st

( 00

0)

C o st

( pe

r un

it )

(b)

(Rent Expense)

(a)

(Rent Expense) Total Fixed Costs Fixed Costs per Unit

The trend for many manufacturers is to have more fi xed costs and fewer vari- able costs. This trend is the result of increased use of automation and less use of employee labor. As a result, depreciation and lease charges (fi xed costs) increase, whereas direct labor costs (variable costs) decrease.

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200 5 Cost-Volume-Profi t

What are some of the variable and fi xed costs that are impacted by hydroponic farming? (See page 234.)?

PEOPLE, PLANET, AND PROFIT INSIGHT Gardens in the Sky

Because of population increases, the United Nations’ Food and Agriculture Organization estimates that food production will need to increase by 70% by 2050. Also, by 2050, roughly 70% of people will live in cities, which means more food needs to be hauled further to get it to the consumer. To address the lack of farmable land and reduce the cost of transporting produce, some have suggested building “vertical farming” skyscrapers in cities. This sounds great, but do the numbers work? Some variable costs would be reduced. For example, the use of pesticides, herbicides, fuel costs for shipping, and water would all drop. Soil erosion would be a non-issue since plants would be grown hydroponically (in a solution of water and minerals), and land requirements would be reduced because of vertical structures. But, other costs would be higher. First, there is the cost of the building. Also, any multistory building would require artifi cial lighting for plants on lower fl oors.

Until these cost challenges can be overcome, it appears that these skyscrapers will not break even. On the other hand, rooftop greenhouses on existing city structures already appear fi nan- cially viable. For example, a 15,000 square-foot rooftop greenhouse in Brooklyn already pro- duces roughly 30 tons of vegetables per year for local residents.

Source: “Vertical Farming: Does It Really Stack Up?” The Economist (December 9, 2010).

Relevant Range

In Illustration 5-1 part (a) (page 198), a straight line is drawn throughout the entire range of the activity index for total variable costs. In essence, the assumption is that the costs are linear. If a relationship is linear (that is, straight-line), then changes in the activity index will result in a direct, proportional change in the variable cost. For example, if the activity level doubles, the cost doubles.

It is now necessary to ask: Is the straight-line relationship realistic? Does the linear assumption produce useful data for CVP analysis?

In most business situations, a straight-line relationship does not exist for variable costs throughout the entire range of possible activity. At abnormally low levels of activity, it may be impossible to be cost-effi cient. Small-scale operations may not allow the company to obtain quantity discounts for raw materials or to use specialized labor. In contrast, at abnormally high levels of activity, labor costs may increase sharply because of overtime pay. Also, at high activity levels, ma- terials costs may jump signifi cantly because of excess spoilage caused by worker fatigue.

As a result, in the real world, the relationship between the behavior of a vari- able cost and changes in the activity level is often curvilinear, as shown in part (a) of Illustration 5-3. In the curved sections of the line, a change in the activity index will not result in a direct, proportional change in the variable cost. That is, a doubling of the activity index will not result in an exact doubling of the variable cost. The variable cost may more than double, or it may be less than double.

Total fi xed costs also do not have a straight-line relationship over the entire range of activity. Some fi xed costs will not change. But it is possible for man- agement to change other fi xed costs. For example, in some instances, salaried employees (fi xed) are replaced with freelance workers (variable). Illustration 5-3, part (b), shows an example of the behavior of total fi xed costs through all potential levels of activity.

Helpful Hint Fixed costs that may be changeable include research, such as new product development, and management training programs.

Explain the signifi cance of the relevant range.

2LEARNING OBJECTIVE

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Cost Behavior Analysis 201

Illustration 5-3 Nonlinear behavior of variable and fi xed costs

0 20 40 60 80 100

C o st

( $ )

C o st

( $ )

0 20 40 60 80 100 Activity Level (%)Activity Level (%)

(b)

Nonlinear

(a)

Curvilinear Total Variable Costs Total Fixed Costs

For most companies, operating at almost zero or at 100% capacity is the ex- ception rather than the rule. Instead, companies often operate over a somewhat narrower range, such as 40–80% of capacity. The range over which a company expects to operate during a year is called the relevant range of the activity index. Within the relevant range, as both diagrams in Illustration 5-4 show, a straight- line relationship generally exists for both variable and fi xed costs.

Alternative Terminology The relevant range is also called the normal or practical range.

Illustration 5-4 Linear behavior within relevant range

0 20 40 60 80 100 0 20 40 60 80 100 Activity Level (%)Activity Level (%)

(b) Total Fixed Costs

(a) Total Variable Costs

Relevant Range

Relevant Range

C o st

( $ )

C o st

( $ )

As you can see, although the linear (straight-line) relationship may not be completely realistic, the linear assumption produces useful data for CVP analysis as long as the level of activity remains within the relevant range.

Mixed Costs

Mixed costs are costs that contain both a variable element and a fi xed element. Mixed costs, therefore, change in total but not proportionately with changes in the activity level.

The rental of a U-Haul truck is a good example of a mixed cost. Assume that local rental terms for a 17-foot truck, including insurance, are $50 per day plus 50 cents per mile. When determining the cost of a one-day rental, the per day charge is a fi xed cost (with respect to miles driven), whereas the mileage charge is a variable cost. The graphic presentation of the rental cost for a one-day rental is as follows.

Explain the concept of mixed costs.

3LEARNING OBJECTIVE

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202 5 Cost-Volume-Profi t

Illustration 5-5 Behavior of a mixed cost

0 50 100 150 200 250

$200

Miles 300

Fixed-Cost Element

Variable-Cost Element

Total-Cost Line

150

100

50

0 C

o st

⎫ ⎪ ⎪ ⎪ ⎪ ⎪ ⎪ ⎪ ⎬ ⎪ ⎪ ⎪ ⎪ ⎪ ⎪ ⎪ ⎭ ⎫ ⎪ ⎬ ⎪ ⎭

In this case, the fi xed-cost element is the cost of having the service available. The variable-cost element is the cost of actually using the service. Another example of a mixed cost is utility costs (electric, telephone, and so on), where there is a fl at service fee plus a usage charge.

For purposes of CVP analysis, mixed costs must be classifi ed into their fi xed and variable elements. How does management make the classifi cation? One possibility is to determine the variable and fi xed components each time a mixed cost is incurred. But because of time and cost constraints, this approach is rarely followed. Instead, the usual approach is to collect data on the behavior of the mixed costs at various levels of activity. Analysts then identify the fi xed- and variable-cost components. Companies use various types of analysis. One type of analysis, called the high-low method, is discussed next. Other methods, such as the scatter diagram method and least squares regression analysis, are more appropriately explained in cost accounting courses.

Types of Costs

Action Plan ✔ Recall that a variable

cost varies in total directly and propor- tionately with each change in activity level.

✔ Recall that a fi xed cost remains the same in total with each change in activity level.

✔ Recall that a mixed cost changes in total but not proportionately with each change in activity level.

> DO IT!

Helena Company reports the following total costs at two levels of production.

10,000 Units 20,000 Units

Direct materials $20,000 $40,000 Maintenance 8,000 10,000 Direct labor 17,000 34,000 Indirect materials 1,000 2,000 Depreciation 4,000 4,000 Utilities 3,000 5,000 Rent 6,000 6,000

Classify each cost as variable, fi xed, or mixed.

Solution

✔ The Navigator

Direct materials, direct labor, and indirect materials are variable costs. Depreciation and rent are fi xed costs. Maintenance and utilities are mixed costs.

Related exercise material: BE5-1, BE5-2, E5-1, E5-2, E5-4, and 5-1.DO IT!

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Cost Behavior Analysis 203

HIGH-LOW METHOD The high-low method uses the total costs incurred at the high and low levels of activity to classify mixed costs into fi xed and variable components. The difference in costs between the high and low levels represents variable costs, since only the variable-cost element can change as activity levels change.

The steps in computing fi xed and variable costs under this method are as follows.

1. Determine variable cost per unit from the following formula.

Illustration 5-6 Formula for variable cost per unit using high-low method

Change in High minus Low Variable Cost Total Costs

4 Activity Level

5 per Unit

To illustrate, assume that Metro Transit Company has the following mainte- nance costs and mileage data for its fl eet of buses over a 6-month period.

Illustration 5-7 Assumed maintenance costs and mileage data

Miles Total Miles Total Month Driven Cost Month Driven Cost

January 20,000 $30,000 April 50,000 $63,000 February 40,000 48,000 May 30,000 42,000 March 35,000 49,000 June 43,000 61,000

The high and low levels of activity are 50,000 miles in April and 20,000 miles in January. The maintenance costs at these two levels are $63,000 and $30,000, re- spectively. The difference in maintenance costs is $33,000 ($63,000 2 $30,000), and the difference in miles is 30,000 (50,000 2 20,000). Therefore, for Metro Transit, variable cost per unit is $1.10, computed as follows.

$33,000 4 30,000 5 $1.10

2. Determine the fi xed costs by subtracting the total variable costs at either the high or the low activity level from the total cost at that activity level.

For Metro Transit, the computations are shown in Illustration 5-8.

Formulas Data Review ViewPage LayoutInsert

1

2

3

4

5

6

7

8

9

10

A P18 fx

CB D

Total cost Less:

Total fixed costs

Metro Transit

Variable costs 50,000 � $1.10 20,000 � $1.10

$63,000

55,000

$ 8,000

$30,000

22,000 $ 8,000

Ac�vity Level High Low

Home

METRO TRANSIT.xls Illustration 5-8 High-low method computation of fi xed costs

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204 5 Cost-Volume-Profi t

Maintenance costs are therefore $8,000 per month of fi xed costs plus $1.10 per mile of variable costs. This is represented by the following formula:

Maintenance costs 5 $8,000 1 ($1.10 3 Miles driven)

For example, at 45,000 miles, estimated maintenance costs would be $8,000 fi xed and $49,500 variable ($1.10 3 45,000) for a total of $57,500.

The graph in Illustration 5-9 plots the 6-month data for Metro Transit Com- pany. The red line drawn in the graph connects the high and low data points, and therefore represents the equation that we just solved using the high-low method. The red, “high-low” line intersects the y-axis at $8,000 (the fi xed-cost level), and it rises by $1.10 per unit (the variable cost per unit). Note that a completely dif- ferent line would result if we chose any two of the other data points. That is, by choosing any two other data points, we would end up with a different estimate of fi xed costs and a different variable cost per unit. Thus, from this scatter plot, we can see that while the high-low method is simple, the result is rather arbitrary. A better approach, which uses information from all the data points to estimate fi xed and variable costs, is called regression analysis. A discussion of regression analysis is provided in a supplement on the book’s companion website.

20,000

30,000

40,000

50,000

60,000

$70,000

10,000

0 20,000 40,000 60,000 Miles Driven

C o st

Illustration 5-9 Scatter plot for Metro Transit Company

Skilled Labor Is Truly Essential

The recession that started in 2008 had devastating implications for employment. But one surprise was that for some manufacturers, the number of jobs lost was actually lower than in previous recessions. One of the main explanations for this was that between 2000 and 2008, many facto- ries adopted lean manufacturing practices. This meant that production relied less on large num- bers of low-skilled workers, and more on machines and a few highly skilled workers. As a result of this approach, a single employee was supporting far more dollars in sales. Thus, it would require a larger decline in sales before an employee would need to be laid-off in order to con- tinue to break even. Also, because the employees are highly skilled, employers are reluctant to lose them. Instead of lay-offs, many manufacturers have resorted to cutting employees hours.

Source: Timothy Aeppel and Justin Lahart, “Lean Factories Find It Hard to Cut Jobs Even in a Slump,” Wall Street Journal Online (March 9, 2009).

MANAGEMENT INSIGHT

Would you characterize labor costs as being a fi xed cost, a variable cost, or something else in this situation? (See page 234.)?

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Cost Behavior Analysis 205

Importance of Identifying Variable and Fixed Costs

Why is it important to segregate costs into variable and fi xed elements? The answer may become apparent if we look at the following four business decisions.

1. If American Airlines is to make a profi t when it reduces all domestic fares by 30%, what reduction in costs or increase in passengers will be required? Answer: To make a profi t when it cuts domestic fares by 30%, American Air- lines will have to increase the number of passengers or cut its variable costs for those fl ights. Its fi xed costs will not change.

2. If Ford Motor Company meets workers’ demands for higher wages, what increase in sales revenue will be needed to maintain current profi t levels? Answer: Higher wages at Ford Motor Company will increase the variable costs of manufacturing automobiles. To maintain present profi t levels, Ford will have to cut other variable costs or increase the price of its automobiles.

3. If United States Steel Corp.’s program to modernize plant facilities through signifi cant equipment purchases reduces the work force by 50%, what will be the effect on the cost of producing one ton of steel?

Answer: The modernizing of plant facilities at United States Steel Corp. changes the proportion of fi xed and variable costs of producing one ton of steel. Fixed costs increase because of higher depreciation charges, whereas variable costs decrease due to the reduction in the number of steelworkers.

4. What happens if Kellogg’s increases its advertising expenses but cannot increase prices because of competitive pressure?

Answer: Sales volume must be increased to cover the increase in fi xed adver- tising costs.

High-Low Method

Action Plan ✔ Determine the highest

and lowest levels of activity.

✔ Compute variable cost per unit as: Change in total costs 4 (High 2 low activity level) 5 Variable cost per unit.

✔ Compute fi xed cost as: Total cost 2 (Variable cost per unit 3 Units produced) 5 Fixed cost.

> DO IT!

Byrnes Company accumulates the following data concerning a mixed cost, using units produced as the activity level.

Units Produced Total Cost

March 9,800 $14,740 April 8,500 13,250 May 7,000 11,100 June 7,600 12,000 July 8,100 12,460

(a) Compute the variable- and fi xed-cost elements using the high-low method. (b) Estimate the total cost if the company produces 6,000 units.

Solution

(a) Variable cost: ($14,740 2 $11,100) 4 (9,800 2 7,000) 5 $1.30 per unit Fixed cost: $14,740 2 $12,740 ($1.30 3 9,800 units) 5 $2,000 or $11,100 2 $9,100 ($1.30 3 7,000) 5 $2,000 (b) Total cost to produce 6,000 units: $2,000 1 $7,800 ($1.30 3 6,000) 5 $9,800

✔ The Navigator

Related exercise material: BE5-3, BE5-4, BE5-5, E5-3, E5-5, E5-6, and 5-2. DO IT!

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206 5 Cost-Volume-Profi t

Cost-volume-profi t (CVP) analysis is the study of the effects of changes in costs and volume on a company’s profi ts. CVP analysis is important in profi t planning. It also is a critical factor in such management decisions as setting selling prices, determining product mix, and maximizing use of production facilities.

Basic Components

CVP analysis considers the interrelationships among the components shown in Illustration 5-10.

Cost-Volume-Profi t Analysis

Volume or level of activity

Unit selling prices

Variable costs per unit

Total fixed costs

Sales mix

C o st

( pe

r un

it )

Units

Raw mat

erial s,

varia ble la

bor,

etc. C o st

Units

$

Utilit ies, t

axes ,

depr eciat

ion,

etc.

$

$Sales

Illustration 5-10 Components of CVP analysis

Illustration 5-11 Assumed selling and cost data for Vargo Video

Unit selling price of camcorder $500 Unit variable costs $300 Total monthly fi xed costs $200,000 Units sold 1,600

The CVP income statement for Vargo Video therefore would be reported as follows.

List the fi ve components of cost-volume-profi t analysis.

4LEARNING OBJECTIVE

The following assumptions underlie each CVP analysis.

1. The behavior of both costs and revenues is linear throughout the relevant range of the activity index.

2. Costs can be classifi ed accurately as either variable or fi xed.

3. Changes in activity are the only factors that affect costs.

4. All units produced are sold.

5. When more than one type of product is sold, the sales mix will remain con- stant. That is, the percentage that each product represents of total sales will stay the same. Sales mix complicates CVP analysis because different products will have different cost relationships. In this chapter, we assume a single product. (In Chapter 6, we relax this assumption.)

When these assumptions are not valid, the CVP analysis may be inaccurate.

CVP Income Statement

Because CVP is so important for decision-making, management often wants this information reported in a cost-volume-profi t (CVP) income statement format for internal use. The CVP income statement classifi es costs as variable or fi xed and computes a contribution margin. Contribution margin (CM) is the amount of revenue remaining after deducting variable costs. It is often stated both as a total amount and on a per unit basis.

We will use Vargo Video Company to illustrate a CVP income statement. Vargo Video produces a high-defi nition digital camcorder with 153 optical zoom and a wide-screen, high-resolution LCD monitor. Relevant data for the camcorders sold by this company in June 2014 are as follows.

Indicate what contribution margin is and how it can be expressed.

5LEARNING OBJECTIVE

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Cost-Volume-Profi t Analysis 207

Vargo Video Company CVP Income Statement

For the Month Ended June 30, 2014

Total

Sales (1,600 camcorders) $ 800,000 Variable costs 480,000

Contribution margin 320,000 Fixed costs 200,000

Net income $120,000

Illustration 5-12 CVP income statement, with net income

Vargo Video Company CVP Income Statement

For the Month Ended June 30, 2014

Total Per Unit

Sales (1,000 camcorders) $ 500,000 $ 500 Variable costs 300,000 300

Contribution margin 200,000 $200 Fixed costs 200,000

Net income $ –0–

Illustration 5-14 CVP income statement, with zero net income

A traditional income statement and a CVP income statement both report the same net income of $120,000. However a traditional income statement does not classify costs as variable or fi xed, and therefore it does not report a contribu- tion margin. In addition, sometimes per unit amounts and percentage of sales amounts are shown on a CVP income statement to facilitate CVP analysis. Home- work assignments specify which columns to present.

In the applications of CVP analysis that follow, we assume that the term “cost” includes all costs and expenses related to production and sale of the prod- uct. That is, cost includes manufacturing costs plus selling and administrative expenses.

CONTRIBUTION MARGIN PER UNIT Illustration 5-14 shows Vargo Video’s CVP income statement at the point where net income equals zero. It shows a contribution margin of $200,000, and a con- tribution margin per unit of $200 ($500 2 $300). The formula for contribution margin per unit and the computation for Vargo Video are:

Illustration 5-13 Formula for contribution margin per unit

Unit Selling Unit Variable Contribution Margin Price

2 Costs

5 per Unit

$500 2 $300 5 $200

Contribution margin per unit indicates that for every camcorder sold, the selling price exceeds the variable costs by $200. Vargo generates $200 per unit sold to cover fi xed costs and contribute to net income. Because Vargo Video has fi xed costs of $200,000, it must sell 1,000 camcorders ($200,000 4 $200) to cover its fi xed costs. At the point where total contribution margin exactly equals fi xed costs, Vargo will report net income of zero. At this point, referred to as the break- even point, total costs (variable plus fi xed) exactly equal total revenue.

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208 5 Cost-Volume-Profi t

It follows that for every camcorder sold above the break-even point of 1,000 units, net income increases by the amount of the contribution margin per unit, $200. For example, assume that Vargo sold one more camcorder, for a total of 1,001 camcorders sold. In this case, Vargo reports net income of $200, as shown in Illustration 5-15.

Illustration 5-15 CVP income statement, with net income and per unit data

Vargo Video Company CVP Income Statement

For the Month Ended June 30, 2014

Total Per Unit

Sales (1,001 camcorders) $500,500 $ 500 Variable costs 300,300 300

Contribution margin 200,200 $200 Fixed costs 200,000

Net income $ 200

Illustration 5-16 CVP income statement, with net income and percent of sales data

Vargo Video Company CVP Income Statement

For the Month Ended June 30, 2014

Total Percent of Sales

Sales (1,001 camcorders) $500,500 100% Variable costs 300,300 60

Contribution margin 200,200 40% Fixed costs 200,000

Net income $ 200

CONTRIBUTION MARGIN RATIO Some managers prefer to use a contribution margin ratio in CVP analysis. The contribution margin ratio is the contribution margin expressed as a percentage of sales, as shown in Illustration 5-16.

Alternatively, the contribution margin ratio is the contribution margin per unit divided by the unit selling price. For Vargo Video, the ratio is as follows.

Illustration 5-17 Formula for contribution margin ratio

Contribution Margin Unit Selling Contribution Margin per Unit

4 Price

5 Ratio

$200 4 $500 5 40%

The contribution margin ratio of 40% means that Vargo generates 40 cents of contribution margin with each dollar of sales. That is, $0.40 of each sales dollar (40% 3 $1) is available to apply to fi xed costs and to contribute to net income.

This expression of contribution margin is very helpful in determining the effect of changes in sales on net income. For example, if Vargo’s sales increase $100,000, net income will increase $40,000 (40% 3 $100,000). Thus, by using the contribu- tion margin ratio, managers can quickly determine increases in net income from any change in sales.

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Cost-Volume-Profi t Analysis 209

We can also see this effect through a CVP income statement. Assume that Vargo Video’s current sales are $500,000 and it wants to know the effect of a $100,000 (200-unit) increase in sales. Vargo prepares a comparative CVP income statement analysis as follows. Illustration 5-18

Comparative CVP income statements

Vargo Video Company CVP Income Statements

For the Month Ended June 30, 2014

No Change With Change

Percent of Percent of Total Per Unit Sales Total Per Unit Sales

Sales $500,000 $ 500 100% $600,000 $ 500 100% Variable costs 300,000 300 60 360,000 300 60

Contribution margin 200,000 $200 40% 240,000 $200 40% Fixed costs 200,000 200,000

Net income $ –0– $ 40,000

The $40,000 increase in net income can be calculated on either a contribu- tion margin per unit basis (200 units 3 $200 per unit) or using the contribution margin ratio times the increase in sales dollars (40% 3 $100,000). Note that the contribution margin per unit and contribution margin as a percentage of sales remain unchanged by the increase in sales.

Study these CVP income statements carefully. The concepts presented in these statements are used extensively in this and later chapters.

DECISION TOOLKIT INFO NEEDED FOR DECISION TOOL TO USE FOR DECISION HOW TO EVALUATE RESULTS

Every unit sold will increase income by the contribution margin.

Every dollar of sales will increase income by the contribution margin ratio.

Contribution Unit Unit margin 5 selling 2 variable per unit price cost

Contribution Contribution Unit margin 5 margin 4 selling ratio per unit price

Selling price per unit and variable cost per unit

Contribution margin per unit and unit selling price

DECISION CHECKPOINTS

What was the contribution toward fi xed costs and income from each unit sold?

What was the increase in income as a result of an increase in sales?

Break-Even Analysis

A key relationship in CVP analysis is the level of activity at which total revenues equal total costs (both fi xed and variable)—the break-even point. At this volume of sales, the company will realize no income but will suffer no loss. The process of fi nd- ing the break-even point is called break-even analysis. Knowledge of the break-even point is useful to management when it decides whether to introduce new product lines, change sales prices on established products, or enter new market areas.

The break-even point can be:

1. Computed from a mathematical equation.

2. Computed by using contribution margin.

3. Derived from a cost-volume-profi t (CVP) graph.

The break-even point can be expressed either in sales units or sales dollars.

Identify the three ways to determine the break- even point.

6LEARNING OBJECTIVE

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210 5 Cost-Volume-Profi t

MATHEMATICAL EQUATION The fi rst line of Illustration 5-19 shows a common equation used for CVP analysis. When net income is set to zero, this equation can be used to calculate the break- even point.

As shown in Illustration 5-14 (page 207), net income equals zero when the contri- bution margin (sales minus variable costs) is equal to fi xed costs.

To refl ect this, Illustration 5-20 rewrites the equation with contribution margin (sales minus variable costs) on the left side, and fi xed costs and net income on the right. We can compute the break-even point in units by using unit selling prices and unit variable costs. The computation for Vargo Video is:

Thus, Vargo Video must sell 1,000 units to break even. To fi nd the amount of sales dollars required to break even, we multiply the

units sold at the break-even point times the selling price per unit, as shown below.

1,000 3 $500 5 $500,000 (break-even sales dollars)

CONTRIBUTION MARGIN TECHNIQUE Many managers employ the contribution margin to compute the break-even point.

CONTRIBUTION MARGIN IN UNITS The fi nal step in Illustration 5-20 divides fi xed costs by the contribution margin per unit (highlighted in red). Thus, rather than walk through all of the steps of the equation approach, we can simply employ this formula shown in Illustration 5-21.

Illustration 5-20 Computation of break-even point in units

Required 2

Variable 2

Fixed 5

Net Sales Costs Costs Income

$500Q 2 $300Q 2 $200,000 5 $0

$500Q 2 $300Q 5 $200,000 1 $0

$200Q 5 $200,000

Q 5 $200,000

5 Fixed Costs

$200 Contribution Margin per Unit

Q 5 1,000 units

where

Q 5 sales volume in units $500 5 selling price $300 5 variable costs per unit $200,000 5 total fi xed costs

Illustration 5-19 Basic CVP equation Required Variable Fixed Net

Sales 2

Costs 2

Costs 5

Income

$500Q 2 $300Q 2 $200,000 5 $0

Illustration 5-21 Formula for break-even point in units using contribution margin per unit

Fixed Contribution Break-Even Costs

4 Margin per Unit

5 Point in Units

$200,000 4 $200 5 1,000 units

Why does this formula work? The contribution margin per unit is the net amount by which each sale exceeds the variable costs per unit. Every sale generates this

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Cost-Volume-Profi t Analysis 211

much money to pay off fi xed costs. Consequently, if we divide fi xed costs by the contribution margin per unit, we know how many units we need to sell to break even.

CONTRIBUTION MARGIN RATIO As we will see in the next chapter, when a company has numerous products, it is not practical to determine the contribu- tion margin per unit for each product. In this case, using the contribution margin ratio is very useful for determining the break-even point in total dollars (rather than units). Recall that the contribution margin ratio is the amount of contribution margin that is generated from each dollar of sales. Therefore, to determine the sales dollars needed to cover fi xed costs, we divide fi xed costs by the contribution margin ratio, as shown in Illustration 5-22.

Illustration 5-22 Formula for break-even point in dollars using contribution margin ratio

Fixed Contribution Break-Even Costs

4 Margin Ratio

5 Point in Dollars

$200,000 4 40% 5 $500,000

To apply this formula to Vargo, consider that its 40% contribution margin ratio means that for every dollar sold, it generates 40 cents of contribution margin. The question is, how many dollars of sales does Vargo need in order to generate total contribution margin of $200,000 to pay off fi xed costs? We divide the fi xed costs of $200,000 by the 40 cents of contribution margin generated by each dollar of sales to arrive at $500,000 ($200,000 4 40%). To prove this result, if we generate 40 cents of contribution margin for each dollar of sales, then the total contribution margin generated by $500,000 in sales is $200,000 ($500,000 3 40%).

Charter Flights Offer a Good Deal

The Internet is wringing ineffi ciencies out of nearly every industry. While commercial air- craft spend roughly 4,000 hours a year in the air, chartered aircraft are fl own only 500 hours annually. That means that they are sitting on the ground—not making any money—about 90% of the time. One company, FlightServe, saw a business opportunity in that fact. For about the same cost as a fi rst-class ticket, FlightServe decided to match up executives with charter fl ights in small “private jets.” The executive would get a more comfortable ride and could avoid the hassle of big airports. FlightServe noted that the average charter jet has eight seats. When all eight seats were full, the company would have an 80% profi t margin. It would break even at an average of 3.3 full seats per fl ight.

Source: “Jet Set Go,” The Economist (March 18, 2000), p. 68.

SERVICE COMPANY INSIGHT

How did FlightServe determine that it would break even with 3.3 seats full per fl ight? (See page 234.)

GRAPHIC PRESENTATION An effective way to fi nd the break-even point is to prepare a break-even graph. Because this graph also shows costs, volume, and profi ts, it is referred to as a cost-volume-profi t (CVP) graph.

As the CVP graph in Illustration 5-23 (page 212) shows, sales volume is re- corded along the horizontal axis. This axis should extend to the maximum level of expected sales. Both total revenues (sales) and total costs (fi xed plus variable) are recorded on the vertical axis.

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212 5 Cost-Volume-Profi t

The construction of the graph, using the data for Vargo Video, is as follows.

1. Plot the sales line, starting at the zero activity level. For every camcorder sold, total revenue increases by $500. For example, at 200 units, sales are $100,000. At the upper level of activity (1,800 units), sales are $900,000. The revenue line is assumed to be linear through the full range of activity.

2. Plot the total fi xed costs using a horizontal line. For the camcorders, this line is plotted at $200,000. The fi xed costs are the same at every level of activity.

3. Plot the total-cost line. This starts at the fi xed-cost line at zero activity. It increases by the variable costs at each level of activity. For each camcorder, variable costs are $300. Thus, at 200 units, total variable costs are $60,000, and the total cost is $260,000. At 1,800 units, total variable costs are $540,000, and total cost is $740,000. On the graph, the amount of the variable costs can be derived from the difference between the total-cost and fi xed-cost lines at each level of activity.

4. Determine the break-even point from the intersection of the total-cost line and the sales line. The break-even point in dollars is found by drawing a horizontal line from the break-even point to the vertical axis. The break-even point in units is found by drawing a vertical line from the break-even point to the hori- zontal axis. For the camcorders, the break-even point is $500,000 of sales, or 1,000 units. At this sales level, Vargo Video will cover costs but make no profi t.

The CVP graph also shows both the net income and net loss areas. Thus, the amount of income or loss at each level of sales can be derived from the sales and total-cost lines.

A CVP graph is useful because the effects of a change in any element in the CVP analysis can be quickly seen. For example, a 10% increase in selling price will change the location of the sales line. Likewise, the effects on total costs of wage increases can be quickly observed.

200 600 1,000 1,400 1,600

$900

Units of Sales 1,800

Fixed Costs

Variable Costs

Sales Line

700

600

400

D o lla

rs (

00 0)

⎫ ⎪ ⎪ ⎪ ⎪ ⎪ ⎪ ⎪ ⎬ ⎪ ⎪ ⎪ ⎪ ⎪ ⎪ ⎪ ⎭

⎫ ⎪ ⎪ ⎬ ⎪ ⎪ ⎭

Total-Cost Line

Fixed-Cost Line

Loss Area

Profit Area

800

500

300

100

200

Break-even point in dollars

Break-even point in units

400 800 1,200

Illustration 5-23 CVP graph

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Cost-Volume-Profi t Analysis 213

DECISION TOOLKIT INFO NEEDED FOR DECISION TOOL TO USE FOR DECISION HOW TO EVALUATE RESULTS

Below the break-even point, the company is unprofi table.

Break-even point analysis In units:

Break-even Fixed costs

point 5

Unit contribution margin In dollars:

Break-even Fixed costs

point 5

Contribution margin ratio

Unit selling price, unit variable cost, and total fi xed costs

DECISION CHECKPOINTS

At what amount of sales does a company cover its costs?

Illustration 5-24 Formula for required sales to meet target net income

Required Variable Fixed Target Net Sales

2 Costs

2 Costs

5 Income

Recall that once the break-even point has been reached so that fi xed costs are covered, each additional unit sold increases net income by the amount of the contribution margin per unit. We can rewrite the equation with contribution margin (sales minus variable costs) on the left-hand side, and fi xed costs and net income on the right. Assuming that target net income is $120,000 for Vargo Video, the computation of required sales in units is as follows.

Target Net Income

Rather than simply “breaking even,” management usually sets an income objec- tive often called target net income. It indicates the sales necessary to achieve a specifi ed level of income. Companies determine the sales necessary to achieve target net income by using one of the three approaches discussed earlier.

MATHEMATICAL EQUATION We know that at the break-even point no profi t or loss results for the company. By adding an amount for target net income to the same basic equation, we obtain the following formula for determining required sales.

Give the formulas for determining sales required to earn target net income.

7LEARNING OBJECTIVE

Break-Even Analysis

Action Plan ✔ Apply the formula:

Sales 5 Variable costs 1 Fixed costs 1 Net income.

✔ Apply the formula: Fixed costs 4 Contribution margin per unit 5 Break-even point in units.

> DO IT!

Lombardi Company has a unit selling price of $400, variable costs per unit of $240, and fi xed costs of $180,000. Compute the break-even point in units using (a) a mathematical equation and (b) contribution margin per unit.

Solution

(a) The equation is $400Q 2 $240Q 2 $180,000 5 $0; ($400Q 2 $240Q) 5 $180,000. The break-even point in units is 1,125. (b) The contribution margin per unit is $160 ($400 2 $240). The formula therefore is $180,000 4 $160, and the break-even point in units is 1,125.

✔ The Navigator

Related exercise material: BE5-6, BE5-7, BE5-8, BE5-9, E5-8, E5-9, E5-10, E5-11, E5-12, E5-13, and 5-3.DO IT!

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214 5 Cost-Volume-Profi t

Vargo must sell 1,600 units to achieve target net income of $120,000. The sales dollars required to achieve the target net income is found by multiplying the units sold by the unit selling price [(1,600 3 $500) 5 $800,000].

CONTRIBUTION MARGIN TECHNIQUE As in the case of break-even sales, we can compute in either units or dollars the sales required to meet target net income. The formula to compute required sales in units for Vargo Video using the contribution margin per unit can be seen in the fi nal step of the equation approach in Illustration 5-25 (shown in red). We simply divide the sum of fi xed costs and target net income by the contribution margin per unit. Illustration 5-26 shows this for Vargo.

To achieve its desired target net income of $120,000, Vargo must sell 1,600 camcorders.

The formula to compute the required sales in dollars for Vargo Video using the contribution margin ratio is shown below.

To achieve its desired target net income of $120,000, Vargo must generate sales of $800,000.

GRAPHIC PRESENTATION We also can use the CVP graph in Illustration 5-23 (on page 212) to fi nd the sales required to meet target net income. In the profi t area of the graph, the distance between the sales line and the total-cost line at any point equals net income. We can fi nd required sales by analyzing the differences between the two lines until the desired net income is found.

Illustration 5-25 Computation of required sales Required Variable Fixed Target Net

Sales 2

Costs 2

Costs 5

Income

$500Q 2 $300Q 2 $200,000 5 $120,000

$500Q 2 $300Q 5 $200,000 1 $120,000

$200Q 5 $200,000 1 $120,000

Q 5

$200,000 1 $120,000 5

Fixed Costs 1 Net Target Income

$200 Contribution Margin per Unit

Q 5 1,600

where Q 5 sales volume $500 5 selling price $300 5 variable costs per unit $200,000 5 total fi xed costs $120,000 5 target net income

Illustration 5-26 Formula for required sales in units using contribution margin per unit

Fixed Costs 1 Contribution Required Sales Target Net Income

4 Margin per Unit

5 in Units

($200,000 1 $120,000) 4 $200 5 1,600 units

_

_

Illustration 5-27 Formula for required sales in dollars using contribution margin ratio

Fixed Costs 1 Contribution Required Sales Target Net Income

4 Margin Ratio

5 in Dollars

($200,000 1 $120,000) 4 40% 5 $800,000

_

_

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Cost-Volume-Profi t Analysis 215

For example, suppose Vargo Video sells 1,400 camcorders. Illustration 5-23 shows that a vertical line drawn at 1,400 units intersects the sales line at $700,000 and the total cost line at $620,000. The difference between the two amounts rep- resents the net income (profi t) of $80,000.

Margin of Safety

Margin of safety is the difference between actual or expected sales and sales at the break-even point. It measures the “cushion” that a particular level of sales provides. It tells us how far sales could fall before the company begins operating at a loss. The margin of safety is expressed in dollars or as a ratio.

The formula for stating the margin of safety in dollars is actual (or expected) sales minus break-even sales. Assuming that actual (expected) sales for Vargo Video are $750,000, the computation is:

Illustration 5-28 Formula for margin of safety in dollars

Actual (Expected) Break-Even Margin of Safety Sales

2 Sales

5 in Dollars

$750,000 2 $500,000 5 $250,000

Vargo’s margin of safety is $250,000. Its sales could fall $250,000 before it oper- ates at a loss.

The margin of safety ratio is the margin of safety in dollars divided by actual (or expected) sales. The formula and computation for determining the margin of safety ratio are:

Illustration 5-29 Formula for margin of safety ratio

Margin of Safety Actual (Expected) Margin of Safety in Dollars

4 Sales

5 Ratio

$250,000 4 $750,000 5 33%

This means that the company’s sales could fall by 33% before it would be operat- ing at a loss.

The higher the dollars or the percentage, the greater the margin of safety. Management continuously evaluates the adequacy of the margin of safety in terms of such factors as the vulnerability of the product to competitive pres- sures and to downturns in the economy.

How a Rolling Stones’ Tour Makes Money

Computation of break-even and margin of safety is important for service companies. Consider how the promoter for the Rolling Stones’ tour used the break-even point and margin of safety. For example, one outdoor show should bring 70,000 individuals for a gross of $2.45 million. The promoter guarantees $1.2 million to the Rolling Stones. In addition, 20% of gross goes to the stadium in which the performance is staged. Add another $400,000 for other expenses such as ticket takers, parking attendants, advertising, and so on. The promoter also shares in sales of T-shirts and memorabilia for which the promoter will net over $7 million during the tour. From a successful Rolling Stones’ tour, the promoter could make $35 million!

SERVICE COMPANY INSIGHT

What amount of sales dollars are required for the promoter to break even? (See page 234.)

Defi ne margin of safety, and give the formulas for computing it.

6LEARNING OBJECTIVE

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216 5 Cost-Volume-Profi t

Break-Even, Margin of Safety, Target Net Income

Action Plan ✔ Apply the formula for

the break-even point in dollars.

✔ Apply the formulas for the margin of safety in dollars and the margin of safety ratio.

✔ Apply the formula for the required sales in dollars.

> DO IT!

(a) Contribution margin ratio 5 [($56 2 $42) 4 $56] 5 25% Break-even sales in dollars 5 $320,000 4 25% 5 $1,280,000

(b) Margin of safety 5 $1,382,400 2 $1,280,000 5 $102,400 Margin of safety ratio 5 $102,400 4 $1,382,400 5 7.4%

(c) Required sales in dollars 5 ($320,000 1 $410,000) 4 25% 5 $2,920,000

Zootsuit Inc. makes travel bags that sell for $56 each. For the coming year, management expects fi xed costs to total $320,000 and variable costs to be $42 per unit. Compute the following: (a) break-even point in dollars using the contribution margin (CM) ratio; (b) the margin of safety and margin of safety ratio assuming actual sales are $1,382,400; and (c) the sales dollars required to earn net income of $410,000.

Solution

✔ The Navigator

Related exercise material: BE5-10, BE5-11, BE5-12, E5-14, E5-15, E5-16, and 5-4. DO IT!

B.T. Hernandez Company, maker of high-quality fl ashlights, has experienced steady growth over the last 6 years. However, increased competition has led Mr. Hernandez, the president, to believe that an aggressive campaign is needed next year to maintain the company’s present growth. The company’s accountant has presented Mr. Hernandez with the following data for the current year, 2013, for use in preparing next year’s advertising campaign.

Cost Schedules Variable costs Direct labor per fl ashlight $ 8.00 Direct materials 4.00 Variable overhead 3.00 Variable cost per fl ashlight $15.00 Fixed costs Manufacturing $ 25,000 Selling 40,000 Administrative 70,000 Total fi xed costs $135,000

Selling price per fl ashlight $25.00 Sales, 2013 (20,000 fl ashlights) $500,000

Mr. Hernandez has set the sales target for the year 2014 at a level of $550,000 (22,000 fl ashlights).

Instructions (Ignore any income tax considerations.) (a) What is the operating income for 2013? (b) What is the contribution margin per unit for 2013? (c) What is the break-even point in units for 2013?

USING THE DECISION TOOLKIT

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Summary of Learning Objectives 217

1 Distinguish between variable and fi xed costs. Variable costs are costs that vary in total directly and propor- tionately with changes in the activity index. Fixed costs are costs that remain the same in total regardless of changes in the activity index.

2 Explain the signifi cance of the relevant range. The rel- evant range is the range of activity in which a company expects to operate during a year. It is important in CVP analysis because the behavior of costs is assumed to be linear throughout the relevant range.

3 Explain the concept of mixed costs. Mixed costs in- crease in total but not proportionately with changes in the activity level. For purposes of CVP analysis, mixed costs must be classifi ed into their fi xed and variable elements. One method that management may use to classify these costs is the high-low method.

4 List the fi ve components of cost-volume-profi t analysis. The fi ve components of CVP analysis are (a) volume or level of activity, (b) unit selling prices, (c) variable costs per unit, (d) total fi xed costs, and (e) sales mix.

5 Indicate what contribution margin is and how it can be expressed. Contribution margin is the amount of revenue remaining after deducting variable costs. It is

identifi ed in a CVP income statement, which classifi es costs as variable or fi xed. It can be expressed as a total amount, as a per unit amount, or as a ratio.

6 Identify the three ways to determine the break-even point. The break-even point can be (a) computed from a mathematical equation, (b) computed by using a con- tribution margin technique, and (c) derived from a CVP graph.

7 Give the formulas for determining sales required to earn target net income. The general formula for re- quired sales is: Required sales 2 Variable costs 2 Fixed costs 5 Target net income. Two other formulas are Required sales in units 5 (Fixed costs 1 Target net in- come) 4 Contribution margin per unit, and Required sales in dollars 5 (Fixed costs 1 Target net income) 4 Contribution margin ratio.

8 Defi ne margin of safety, and give the formulas for computing it. Margin of safety is the difference be- tween actual or expected sales and sales at the break- even point. The formulas for margin of safety are Actual (expected) sales 2 Break-even sales 5 Margin of safety in dollars; Margin of safety in dollars 4 Actual (expected) sales 5 Margin of safety ratio.

SUMMARY OF LEARNING OBJECTIVES ✔ The Navigator

✔ The Navigator

Solution (a) Sales $500,000 Less: Variable costs (20,000 fl ashlights 3 $15) 300,000 Fixed costs 135,000 Operating income $ 65,000 (b) Selling price per fl ashlight $25 Variable cost per fl ashlight 15 Contribution margin per unit $10 (c) Fixed costs 4 Contribution margin per unit 5 Break-even point in units $135,000 4 $10 5 13,500 units (d) Fixed costs 4 Contribution margin ratio 5 Break-even point in dollars $145,000* 4 40%** 5 $362,500 *Fixed costs (from 2013) $135,000 Additional advertising expense 10,000 Fixed costs (2014) $145,000

**Contribution margin ratio 5 Contribution margin per unit 4 Unit selling price 40% 5 $10 4 $25

(e) Required sales 5 (Fixed costs 1 Target net income) 4 Contribution margin ratio $525,000 5 ($145,000 1 $65,000) 4 40%

(d) Mr. Hernandez believes that to attain the sales target in the year 2014, the company must incur an additional selling expense of $10,000 for advertising in 2014, with all other costs remaining constant. What will be the break-even point in sales dollars for 2014 if the company spends the additional $10,000?

(e) If the company spends the additional $10,000 for advertising in 2014, what is the sales level in dollars required to equal 2013 operating income?

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218 5 Cost-Volume-Profi t

DECISION TOOLKIT A SUMMARY INFO NEEDED FOR DECISION TOOL TO USE FOR DECISION HOW TO EVALUATE RESULTS

Every unit sold will increase income by the contribution margin.

Every dollar of sales will increase income by the contribution margin ratio

Below the break-even point, the company is unprofi table.

Contribution Unit Unit margin 5 selling 2 variable per unit price cost

Contribution Contribution Unit margin 5 margin 4 selling ratio per unit price

Break-even point analysis In units:

Break-even Fixed costs

point 5

Unit contribution margin In dollars:

Break-even Fixed costs

point 5

Contribution margin ratio

Selling price per unit and variable cost per unit

Contribution margin per unit and unit selling price

Unit selling price, unit variable cost, and total fi xed costs

DECISION CHECKPOINTS

What was the contribution toward fi xed costs and in- come from each unit sold?

What was the increase in income as a result of an increase in sales?

At what amount of sales does a company cover its costs?

Activity index The activity that causes changes in the behavior of costs. (p. 198).

Break-even point The level of activity at which total revenues equal total costs. (p. 207).

Contribution margin (CM) The amount of revenue remaining after deducting variable costs. (p. 206).

Contribution margin per unit The amount of revenue remaining per unit after deducting variable costs; cal- culated as unit selling price minus unit variable cost. (p. 207).

Contribution margin ratio The percentage of each dol- lar of sales that is available to apply to fi xed costs and contribute to net income; calculated as contribution margin per unit divided by unit selling price. (p. 208).

Cost behavior analysis The study of how specifi c costs re- spond to changes in the level of business activity. (p. 198).

Cost-volume-profi t (CVP) analysis The study of the effects of changes in costs and volume on a company’s profi ts. (p. 206).

Cost-volume-profi t (CVP) graph A graph showing the re- lationship between costs, volume, and profi ts. (p. 211).

Cost-volume-profi t (CVP) income statement A state- ment for internal use that classifi es costs as fi xed or variable and reports contribution margin in the body of the statement. (p. 206).

Fixed costs Costs that remain the same in total regard- less of changes in the activity level. (p. 199).

High-low method A mathematical method that uses the total costs incurred at the high and low levels of activity to classify mixed costs into fi xed and variable compo- nents. (p. 203).

Margin of safety The difference between actual or ex- pected sales and sales at the break-even point. (p. 215).

Mixed costs Costs that contain both a variable- and a fi xed-cost element and change in total but not propor- tionately with changes in the activity level. (p. 201).

Relevant range The range of the activity index over which the company expects to operate during the year. (p. 201).

Target net income The income objective set by manage- ment. (p. 213).

Variable costs Costs that vary in total directly and pro- portionately with changes in the activity level. (p. 198).

GLOSSARY

> DO IT!

Mabo Company makes calculators that sell for $20 each. For the coming year, manage- ment expects fi xed costs to total $220,000 and variable costs to be $9 per unit.

Instructions (a) Compute break-even point in units using the mathematical equation.

(b) Compute break-even point in dollars using the contribution margin (CM) ratio.

Comprehensive

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Self-Test Questions 219

(c) Compute the margin of safety percentage assuming actual sales are $500,000.

(d) Compute the sales required in dollars to earn net income of $165,000.

Solution to Comprehensive Action Plan ✔ Know the formulas.

✔ Recognize that variable costs change with sales volume; fi xed costs do not.

✔ Avoid computational errors.

(a) Sales 2 Variable costs 2 Fixed costs 5 Net income $20Q 2 $9Q 2 $220,000 5 $0 $11Q 5 $220,000 Q 5 20,000 units

(b) Contribution margin per unit 5 Unit selling price 2 Unit variable costs $11 5 $20 2 $9 Contribution margin ratio 5 Contribution margin per unit 4 Unit selling price 55% 5 $11 4 $20 Break-even point in dollars 5 Fixed costs 4 Contribution margin ratio 5 $220,000 4 55% 5 $400,000

(c) Margin of safety 5 Actual sales 2 Break-even sales

Actual sales

5 $500,000 2 $400,000

$500,000 5 20%

(d) Required sales 2 Variable costs 2 Fixed costs 5 Net income $20Q 2 $9Q 2 $220,000 5 $165,000 $11Q 5 $385,000 Q 5 35,000 units 35,000 units 3 $20 5 $700,000 required sales

✔ The Navigator

Self-Test, Brief Exercises, Exercises, Problem Set A, and many more resources are available for practice in WileyPLUS.

Answers are at the end of the chapter. 1. Variable costs are costs that:

(a) vary in total directly and proportionately with changes in the activity level.

(b) remain the same per unit at every activity level. (c) Neither of the above. (d) Both (a) and (b) above.

2. The relevant range is: (a) the range of activity in which variable costs will

be curvilinear. (b) the range of activity in which fi xed costs will be

curvilinear. (c) the range over which the company expects to

operate during a year. (d) usually from zero to 100% of operating capacity.

3. Mixed costs consist of a: (a) variable-cost element and a fi xed-cost element. (b) fi xed-cost element and a controllable-cost element. (c) relevant-cost element and a controllable-cost

element. (d) variable-cost element and a relevant-cost element.

4. Your phone service provider offers a plan that is clas- sifi ed as a mixed cost. The cost per month for 1,000 minutes is $50. If you use 2,000 minutes this month, your cost will be: (a) $50. (c) more than $100. (b) $100. (d) between $50 and $100.

5. Kendra Corporation’s total utility costs during the past year were $1,200 during its highest month and $600 during its lowest month. These costs

SELF-TEST QUESTIONS

(LO 1)

(LO 2)

(LO 3)

(LO 3)

(LO 3)

DO IT!

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220 5 Cost-Volume-Profi t

corresponded with 10,000 units of production dur- ing the high month and 2,000 units during the low month. What are the fi xed and variable components of its utility costs using the high-low method?

(a) $0.075 variable and $450 fi xed. (b) $0.120 variable and $0 fi xed. (c) $0.300 variable and $0 fi xed. (d) $0.060 variable and $600 fi xed.

6. Which of the following is not involved in CVP analysis? (a) Sales mix. (b) Unit selling prices. (c) Fixed costs per unit. (d) Volume or level of activity.

7. When comparing a traditional income statement to a CVP income statement: (a) net income will always be greater on the tradi-

tional statement. (b) net income will always be less on the traditional

statement. (c) net income will always be identical on both. (d) net income will be greater or less depending on

the sales volume. 8. Contribution margin:

(a) is revenue remaining after deducting variable costs. (b) may be expressed as contribution margin per unit. (c) is selling price less cost of goods sold. (d) Both (a) and (b) above.

9. Cournot Company sells 100,000 wrenches for $12 a unit. Fixed costs are $300,000, and net income is $200,000. What should be reported as variable ex- penses in the CVP income statement?

(a) $700,000. (c) $500,000. (b) $900,000. (d) $1,000,000.

10. Gossen Company is planning to sell 200,000 pliers for $4 per unit. The contribution margin ratio is 25%. If Gossen will break even at this level of sales, what are the fi xed costs? (a) $100,000. (c) $200,000. (b) $160,000. (d) $300,000.

11. Brownstone Company’s contribution margin ratio is 30%. If Brownstone’s sales revenue is $100 greater than its break-even sales in dollars, its net income: (a) will be $100. (b) will be $70. (c) will be $30. (d) cannot be determined without knowing fi xed costs.

12. The mathematical equation for computing required sales to obtain target net income is: Required sales 5 (a) Variable costs 1 Target net income. (b) Variable costs 1 Fixed costs 1 Target net income. (c) Fixed costs 1 Target net income. (d) No correct answer is given.

13. Margin of safety is computed as: (a) Actual sales 2 Break-even sales. (b) Contribution margin 2 Fixed costs. (c) Break-even sales 2 Variable costs. (d) Actual sales 2 Contribution margin.

14. Marshall Company had actual sales of $600,000 when break-even sales were $420,000. What is the margin of safety ratio? (a) 25%. (c) 331⁄3%. (b) 30%. (d) 45%.

Go to the book’s companion website, www.wiley.com/college/weygandt, for additional Self-Test Questions.

✔ The Navigator

(LO 5)

(LO 4)

(LO 5)

(LO 5)

(LO 6)

(LO 6)

(LO 7)

(LO 8)

(LO 8)

1. (a) What is cost behavior analysis? (b) Why is cost behavior analysis important to man-

agement? 2. (a) Scott Winter asks your help in understanding the

term “activity index.” Explain the meaning and importance of this term for Scott.

(b) State the two ways that variable costs may be defi ned.

3. Contrast the effects of changes in the activity level on total fi xed costs and on unit fi xed costs.

4. J. P. Alexander claims that the relevant range concept is important only for variable costs.

(a) Explain the relevant range concept. (b) Do you agree with J. P.’s claim? Explain. 5. “The relevant range is indispensable in cost behavior

analysis.” Is this true? Why or why not? 6. Adam Antal is confused. He does not understand why

rent on his apartment is a fi xed cost and rent on a Hertz rental truck is a mixed cost. Explain the differ- ence to Adam.

7. How should mixed costs be classifi ed in CVP analy- sis? What approach is used to effect the appropriate classifi cation?

8. At the high and low levels of activity during the month, direct labor hours are 90,000 and 40,000, respectively. The related costs are $165,000 and $100,000. What are the fi xed and variable costs at any level of activity?

9. “Cost-volume-profi t (CVP) analysis is based entirely on unit costs.” Do you agree? Explain.

10. Faye Dunn defi nes contribution margin as the amount of profi t available to cover operating expenses. Is there any truth in this defi nition? Discuss.

11. Marshall Company’s GWhiz calculator sells for $40. Variable costs per unit are estimated to be $26. What are the contribution margin per unit and the contri- bution margin ratio?

12. “Break-even analysis is of limited use to management because a company cannot survive by just breaking even.” Do you agree? Explain.

QUESTIONS

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Brief Exercises 221

13. Total fi xed costs are $26,000 for Daz Inc. It has a con- tribution margin per unit of $15, and a contribution margin ratio of 25%. Compute the break-even sales in dollars.

14. Peggy Turnbull asks your help in constructing a CVP graph. Explain to Peggy (a) how the break-even point is plotted, and (b) how the level of activity and dollar sales at the break-even point are determined.

15. Defi ne the term “margin of safety.” If Revere Com- pany expects to sell 1,250 units of its product at $12

per unit, and break-even sales for the product are $13,200, what is the margin of safety ratio?

16. Huang Company’s break-even sales are $500,000. As- suming fi xed costs are $180,000, what sales volume is needed to achieve a target net income of $90,000?

17. The traditional income statement for Pace Company shows sales $900,000, cost of goods sold $600,000, and operating expenses $200,000. Assuming all costs and expenses are 70% variable and 30% fi xed, prepare a CVP income statement through contribution margin.

BRIEF EXERCISES

BE5-1 Monthly production costs in Pesavento Company for two levels of production are as follows.

Cost 2,000 Units 4,000 Units

Indirect labor $10,000 $20,000 Supervisory salaries 5,000 5,000 Maintenance 4,000 7,000

Indicate which costs are variable, fi xed, and mixed, and give the reason for each answer.

BE5-2 For Lodes Company, the relevant range of production is 40–80% of capacity. At 40% of capacity, a variable cost is $4,000 and a fi xed cost is $6,000. Diagram the behavior of each cost within the relevant range assuming the behavior is linear.

BE5-3 For Hunt Company, a mixed cost is $15,000 plus $18 per direct labor hour. Dia- gram the behavior of the cost using increments of 500 hours up to 2,500 hours on the horizontal axis and increments of $15,000 up to $60,000 on the vertical axis.

BE5-4 Bruno Company accumulates the following data concerning a mixed cost, using miles as the activity level.

Miles Total Miles Total Driven Cost Driven Cost

January 8,000 $14,150 March 8,500 $15,000 February 7,500 13,500 April 8,200 14,490

Compute the variable- and fi xed-cost elements using the high-low method.

BE5-5 Stiever Corp. has collected the following data concerning its maintenance costs for the past 6 months.

Units Produced Total Cost

July 18,000 $32,000 August 32,000 48,000 September 36,000 55,000 October 22,000 38,000 November 40,000 66,100 December 38,000 62,000

Compute the variable- and fi xed-cost elements using the high-low method.

BE5-6 Determine the missing amounts.

Unit Selling Unit Variable Contribution Contribution Price Costs Margin per Unit Margin Ratio

1. $640 $352 (a) (b) 2. $300 (c) $93 (d) 3. (e) (f) $325 25%

BE5-7 Radial Inc. had sales of $2,400,000 for the fi rst quarter of 2014. In making the sales, the company incurred the costs and expenses shown on page 222.

Classify costs as variable, fi xed, or mixed.

(LO 1, 3), C

Determine variable- and fi xed-cost elements using the high-low method.

(LO 3), AP

Determine variable- and fi xed-cost elements using the high-low method.

(LO 3), AP

Determine missing amounts for contribution margin.

(LO 5), AN

Diagram the behavior of a mixed cost.

(LO 3), AN

Diagram the behavior of costs within the relevant range.

(LO 2), AN

Prepare CVP income statement.

(LO 5), AP

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222 5 Cost-Volume-Profi t

Variable Fixed

Cost of goods sold $920,000 $440,000 Selling expenses 70,000 45,000 Administrative expenses 86,000 98,000

Prepare a CVP income statement for the quarter ended March 31, 2014.

BE5-8 Rice Company has a unit selling price of $520, variable costs per unit of $286, and fi xed costs of $163,800. Compute the break-even point in units using (a) the mathematical equation and (b) contribution margin per unit.

BE5-9 Acorn Corp. had total variable costs of $180,000, total fi xed costs of $170,000, and total revenues of $300,000. Compute the required sales in dollars to break even.

BE5-10 For Flynn Company, variable costs are 70% of sales, and fi xed costs are $195,000. Management’s net income goal is $75,000. Compute the required sales in dollars needed to achieve management’s target net income of $75,000. (Use the contribution margin approach.)

BE5-11 For Stevens Company, actual sales are $1,000,000 and break-even sales are $840,000. Compute (a) the margin of safety in dollars and (b) the margin of safety ratio.

BE5-12 Deines Corporation has fi xed costs of $480,000. It has a unit selling price of $6, unit variable costs of $4.40, and a target net income of $1,500,000. Compute the required sales in units to achieve its target net income.

Compute the break-even point.

(LO 6), AP

Compute the break-even point.

(LO 6), AP Compute sales for target net income.

(LO 7), AP

Compute the margin of safety and the margin of safety ratio.

(LO 8), AP Compute the required sales in units for target net income.

(LO 7), AP

> DO IT! REVIEW

Helena Company reports the following total costs at two levels of production.

5,000 Units 10,000 Units

Indirect labor $ 3,000 $ 6,000 Property taxes 7,000 7,000 Direct labor 28,000 56,000 Direct materials 22,000 44,000 Depreciation 4,000 4,000 Utilities 5,000 7,000 Maintenance 9,000 11,000

Classify each cost as variable, fi xed, or mixed.

Westerville Company accumulates the following data concerning a mixed cost, using units produced as the activity level.

Units Produced Total Cost

March 10,000 $18,000 April 9,000 16,650 May 10,500 18,580 June 8,800 16,200 July 9,500 17,100

(a) Compute the variable- and fi xed-cost elements using the high-low method. (b) Estimate the total cost if the company produces 9,200 units.

Larissa Company has a unit selling price of $250, variable costs per unit of $170, and fi xed costs of $140,000. Compute the break-even point in units using (a) the mathematical equation and (b) contribution margin per unit.

Presto Company makes radios that sell for $30 each. For the coming year, management expects fi xed costs to total $220,000 and variable costs to be $18 per unit.

(a) Compute the break-even point in dollars using the contribution margin (CM) ratio. (b) Compute the margin of safety ratio assuming actual sales are $800,000. (c) Compute the sales dollars required to earn net income of $140,000.

DO IT! 5-1

DO IT! 5-2

DO IT! 5-3

DO IT! 5-4

Classify types of costs.

(LO 1, 3), C

Compute costs using high- low method and estimate total cost.

(LO 3), AP

Compute break-even point in units.

(LO 6), AP

✔ The Navigator

Compute break-even point, margin of safety ratio, and sales for target net income.

(LO 6, 7, 8), AP

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Exercises 223

EXERCISES

E5-1 Turgro Company manufactures a single product. Annual production costs incurred in the manufacturing process are shown below for two levels of production.

Costs Incurred

Production in Units 5,000 10,000

Total Cost/ Total Cost/ Production Costs Cost Unit Cost Unit

Direct materials $8,000 $1.60 $16,000 $1.60 Direct labor 9,500 1.90 19,000 1.90 Utilities 2,000 0.40 3,500 0.35 Rent 4,000 0.80 4,000 0.40 Maintenance 800 0.16 1,100 0.11 Supervisory salaries 1,000 0.20 1,000 0.10

Instructions (a) Defi ne the terms variable costs, fi xed costs, and mixed costs. (b) Classify each cost above as either variable, fi xed, or mixed.

E5-2 Shingle Enterprises is considering manufacturing a new product. It projects the cost of direct materials and rent for a range of output as shown below.

Output Rent Direct in Units Expense Materials

1,000 $ 5,000 $ 4,000 2,000 5,000 7,200 3,000 8,000 9,000 4,000 8,000 12,000 5,000 8,000 15,000 6,000 8,000 18,000 7,000 8,000 21,000 8,000 8,000 24,000 9,000 10,000 29,300 10,000 10,000 35,000 11,000 10,000 44,000

Instructions (a) Diagram the behavior of each cost for output ranging from 1,000 to 11,000 units. (b) Determine the relevant range of activity for this product. (c) Calculate the variable costs per unit within the relevant range. (d) Indicate the fi xed cost within the relevant range.

E5-3 The controller of Furgee Industries has collected the following monthly expense data for use in analyzing the cost behavior of maintenance costs.

Total Total Month Maintenance Costs Machine Hours

January $2,500 300 February 3,000 350 March 3,600 500 April 4,500 690 May 3,200 400 June 4,900 700

Instructions (a) Determine the fi xed- and variable-cost components using the high-low method. (b) Prepare a graph showing the behavior of maintenance costs, and identify the fi xed-

and variable-cost elements. Use 100-hour increments and $1,000 cost increments.

E5-4 Family Furniture Corporation incurred the following costs.

1. Wood used in the production of furniture. 2. Fuel used in delivery trucks.

Defi ne and classify variable, fi xed, and mixed costs.

(LO 1, 3), C

Diagram cost behavior, determine relevant range, and classify costs.

(LO 1, 2), C

Determine fi xed and variable costs using the high-low method and prepare graph.

(LO 1, 3), AN

Classify variable, fi xed, and mixed costs.

(LO 1, 3), C

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224 5 Cost-Volume-Profi t

3. Straight-line depreciation on factory building. 4. Screws used in the production of furniture. 5. Sales staff salaries. 6. Sales commissions. 7. Property taxes. 8. Insurance on buildings. 9. Hourly wages of furniture craftsmen. 10. Salaries of factory supervisors. 11. Utilities expense. 12. Telephone bill.

Instructions Identify the costs above as variable, fi xed, or mixed.

E5-5 The controller of Dousmann Industries has collected the following monthly expense data for use in analyzing the cost behavior of maintenance costs.

Total Total Month Maintenance Costs Machine Hours

January $2,750 3,500 February 3,000 4,000 March 3,600 6,000 April 4,500 7,900 May 3,200 5,000 June 5,000 8,000

Instructions (a) Determine the fi xed- and variable-cost components using the high-low method. (b) Prepare a graph showing the behavior of maintenance costs, and identify the fi xed-

and variable-cost elements. Use 2,000-hour increments and $1,000 cost increments.

E5-6 PCB Corporation manufactures a single product. Monthly production costs incurred in the manufacturing process are shown below for the production of 3,000 units. The utili- ties and maintenance costs are mixed costs. The fi xed portions of these costs are $300 and $200, respectively.

Production in Units 3,000

Production Costs

Direct materials $ 7,500 Direct labor 18,000 Utilities 2,100 Property taxes 1,000 Indirect labor 4,500 Supervisory salaries 1,900 Maintenance 1,100 Depreciation 2,400

Instructions (a) Identify the above costs as variable, fi xed, or mixed. (b) Calculate the expected costs when production is 5,000 units.

E5-7 Jim Taylor wants Taylor Company to use CVP analysis to study the effects of changes in costs and volume on the company. Taylor has heard that certain assumptions must be valid in order for CVP analysis to be useful.

Instructions Prepare a memo to Jim Taylor concerning the assumptions that underlie CVP analysis.

E5-8 All That Blooms provides environmentally friendly lawn services for homeowners. Its operating costs are as follows.

Depreciation $1,400 per month Advertising $200 per month Insurance $2,000 per month

Determine fi xed and variable costs using the high-low method and prepare graph.

(LO 1, 3), AP

Determine fi xed, variable, and mixed costs.

(LO 1, 3), AP

Explain assumptions underlying CVP analysis.

(LO 4), K

Compute break-even point in units and dollars.

(LO 5, 6), AP

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Exercises 225

Weed and feed materials $12 per lawn Direct labor $10 per lawn Fuel $2 per lawn

All That Blooms charges $60 per treatment for the average single-family lawn.

Instructions Determine the company’s break-even point in (a) number of lawns serviced per month and (b) dollars.

E5-9 The Green Acres Inn is trying to determine its break-even point. The inn has 50 rooms that it rents at $60 a night. Operating costs are as follows.

Salaries $6,200 per month Utilities $1,100 per month Depreciation $1,000 per month Maintenance $100 per month Maid service $11 per room Other costs $28 per room

Instructions Determine the inn’s break-even point in (a) number of rented rooms per month and (b) dollars.

E5-10 In the month of March, Style Salon services 560 clients at an average price of $120. During the month, fi xed costs were $21,024 and variable costs were 60% of sales.

Instructions (a) Determine the contribution margin in dollars, per unit, and as a ratio. (b) Using the contribution margin technique, compute the break-even point in dollars and

in units.

E5-11 Kare Kars provides shuttle service between four hotels near a medical center and an international airport. Kare Kars uses two 10-passenger vans to offer 12 round trips per day. A recent month’s activity in the form of a cost-volume-profi t income statement is shown below.

Fare revenues (1,440 fares) $36,000 Variable costs Fuel $ 5,040 Tolls and parking 3,100 Maintenance 860 9,000

Contribution margin 27,000 Fixed costs Salaries 12,700 Depreciation 1,300 Insurance 1,000 15,000

Net income $12,000

Instructions (a) Calculate the break-even point in (1) dollars and (2) number of fares. (b) Without calculations, determine the contribution margin at the break-even point.

E5-12 In 2013, Manhoff Company had a break-even point of $350,000 based on a selling price of $5 per unit and fi xed costs of $112,000. In 2014, the selling price and the variable costs per unit did not change, but the break-even point increased to $420,000.

Instructions (a) Compute the variable costs per unit and the contribution margin ratio for 2013. (b) Compute the increase in fi xed costs for 2014.

E5-13 Cannes Company has the following information available for September 2014.

Unit selling price of video game consoles $ 400 Unit variable costs $ 275 Total fi xed costs $52,000 Units sold 600

Compute break-even point.

(LO 5, 6), AP

Compute contribution margin and break-even point.

(LO 5, 6), AP

Compute break-even point.

(LO 5, 6), AP

Compute variable costs per unit, contribution margin ratio, and increase in fi xed costs.

(LO 5, 6), AP

Prepare CVP income statements.

(LO 5, 6), AP

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226 5 Cost-Volume-Profi t

Instructions (a) Compute the contribution margin per unit. (b) Prepare a CVP income statement that shows both total and per unit amounts. (c) Compute Cannes’ break-even point in units. (d) Prepare a CVP income statement for the break-even point that shows both total and

per unit amounts.

E5-14 Naylor Company had $210,000 of net income in 2013 when the selling price per unit was $150, the variable costs per unit were $90, and the fi xed costs were $570,000. Management expects per unit data and total fi xed costs to remain the same in 2014. The president of Naylor Company is under pressure from stockholders to increase net income by $52,000 in 2014.

Instructions (a) Compute the number of units sold in 2013. (b) Compute the number of units that would have to be sold in 2014 to reach the stock-

holders’ desired profi t level. (c) Assume that Naylor Company sells the same number of units in 2014 as it did in 2013.

What would the selling price have to be in order to reach the stockholders’ desired profi t level?

E5-15 Cottonwood Company reports the following operating results for the month of August: sales $400,000 (units 5,000); variable costs $210,000; and fi xed costs $90,000. Man- agement is considering the following independent courses of action to increase net income.

1. Increase selling price by 10% with no change in total variable costs or units sold. 2. Reduce variable costs to 45% of sales.

Instructions Compute the net income to be earned under each alternative. Which course of action will produce the highest net income?

E5-16 Glacial Company estimates that variable costs will be 62.5% of sales, and fi xed costs will total $600,000. The selling price of the product is $4.

Instructions (a) Prepare a CVP graph, assuming maximum sales of $3,200,000. (Note: Use $400,000

increments for sales and costs and 100,000 increments for units.) (b) Compute the break-even point in (1) units and (2) dollars. (c) Compute the margin of safety in (1) dollars and (2) as a ratio, assuming actual sales

are $2 million.

E5-17 Oak Bucket Co., a manufacturer of wood buckets, had the following data for 2013:

Sales 2,600 units Sales price $40 per unit Variable costs $16 per unit Fixed costs $19,500

Instructions (a) What is the contribution margin ratio? (b) What is the break-even point in dollars? (c) What is the margin of safety in dollars and as a ratio? (d) If the company wishes to increase its total dollar contribution margin by 30% in 2014,

by how much will it need to increase its sales if all other factors remain constant? (CGA adapted)

Determine contribution margin ratio, break-even point in dollars, and margin of safety.

(LO 5, 6, 7, 8), AP

Prepare a CVP graph and compute break-even point and margin of safety.

(LO 6, 8), AP

Compute net income under different alternatives.

(LO 7), AP

Compute various components to derive target net income under different assumptions.

(LO 6, 7), AP

Visit the book’s companion website, at www.wiley.com/college/weygandt, and choose the Student Companion site to access Exercise Set B and Challenge Exercises.

EXERCISES: SET B AND CHALLENGE EXERCISES

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Problems: Set A 227

P5-1A Telly Savalas owns the Bonita Barber Shop. He employs four barbers and pays each a base rate of $1,000 per month. One of the barbers serves as the manager and receives an extra $500 per month. In addition to the base rate, each barber also receives a commis- sion of $4.50 per haircut.

Other costs are as follows.

Advertising $200 per month Rent $1,100 per month Barber supplies $0.30 per haircut Utilities $175 per month plus $0.20 per haircut Magazines $25 per month

Telly currently charges $10 per haircut.

Instructions (a) Determine the variable costs per haircut and the total monthly fi xed costs. (b) Compute the break-even point in units and dollars. (c) Prepare a CVP graph, assuming a maximum of 1,800 haircuts in a month. Use incre-

ments of 300 haircuts on the horizontal axis and $3,000 on the vertical axis. (d) Determine net income, assuming 1,700 haircuts are given in a month.

P5-2A Jorge Company bottles and distributes B-Lite, a diet soft drink. The beverage is sold for 50 cents per 16-ounce bottle to retailers, who charge customers 75 cents per bottle. For the year 2014, management estimates the following revenues and costs.

Sales $1,800,000 Selling expenses—variable $70,000 Direct materials 430,000 Selling expenses—fi xed 65,000 Direct labor 360,000 Administrative expenses— Manufacturing overhead— variable 20,000 variable 380,000 Administrative expenses— Manufacturing overhead— fi xed 60,000 fi xed 280,000

Instructions (a) Prepare a CVP income statement for 2014 based on management’s estimates. (Show

column for total amounts only.) (b) Compute the break-even point in (1) units and (2) dollars. (c) Compute the contribution margin ratio and the margin of safety ratio. (Round to nearest

full percent.) (d) Determine the sales dollars required to earn net income of $180,000.

P5-3A Dousmann Corp.’s sales slumped badly in 2014. For the fi rst time in its history, it operated at a loss. The company’s income statement showed the following results from selling 500,000 units of product: sales $2,500,000; total costs and expenses $2,600,000; and net loss $100,000. Costs and expenses consisted of the amounts shown below.

Total Variable Fixed

Cost of goods sold $2,140,000 $1,540,000 $600,000 Selling expenses 250,000 92,000 158,000 Administrative expenses 210,000 68,000 142,000

$2,600,000 $1,700,000 $900,000

Management is considering the following independent alternatives for 2015.

1. Increase unit selling price 20% with no change in costs, expenses, and sales volume. 2. Change the compensation of salespersons from fi xed annual salaries totaling $150,000

to total salaries of $60,000 plus a 5% commission on sales.

Instructions (a) Compute the break-even point in dollars for 2014. (b) Compute the break-even point in dollars under each of the alternative courses of action.

(Round all ratios to nearest full percent.) Which course of action do you recommend?

Determine variable and fi xed costs, compute break-even point, prepare a CVP graph, and determine net income.

(LO 1, 3, 5, 6), AN

PROBLEMS: SET A

(a) VC $5

(b) (1) 2,700,000 units (c) CM ratio 30%

(b) Alternative 1 $2,093,023

Prepare a CVP income state- ment, compute break-even point, contribution margin ratio, margin of safety ratio, and sales for target net income.

(LO 5, 6, 7, 8), AN

Compute break-even point under alternative courses of action.

(LO 5, 6), E

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228 5 Cost-Volume-Profi t

P5-4A Mary Willis is the advertising manager for Bargain Shoe Store. She is currently working on a major promotional campaign. Her ideas include the installation of a new lighting system and increased display space that will add $24,000 in fi xed costs to the $270,000 currently spent. In addition, Mary is proposing that a 5% price decrease ($40 to $38) will produce a 20% increase in sales volume (20,000 to 24,000). Variable costs will re- main at $24 per pair of shoes. Management is impressed with Mary’s ideas but concerned about the effects that these changes will have on the break-even point and the margin of safety.

Instructions (a) Compute the current break-even point in units, and compare it to the break-even point

in units if Mary’s ideas are used. (b) Compute the margin of safety ratio for current operations and after Mary’s changes

are introduced. (Round to nearest full percent.) (c) Prepare a CVP income statement for current operations and after Mary’s changes are

introduced. (Show column for total amounts only.) Would you make the changes suggested?

P5-5A Mozena Corporation has collected the following information after its fi rst year of sales. Sales were $1,500,000 on 100,000 units; selling expenses $250,000 (40% variable and 60% fi xed); direct materials $511,000; direct labor $290,000; administrative expenses $270,000 (20% variable and 80% fi xed); manufacturing overhead $350,000 (70% variable and 30% fi xed). Top management has asked you to do a CVP analysis so that it can make plans for the coming year. It has projected that unit sales will increase by 10% next year.

Instructions (a) Compute (1) the contribution margin for the current year and the projected year, and

(2) the fi xed costs for the current year. (Assume that fi xed costs will remain the same in the projected year.)

(b) Compute the break-even point in units and sales dollars for the current year. (c) The company has a target net income of $200,000. What is the required sales in dollars

for the company to meet its target? (d) If the company meets its target net income number, by what percentage could its sales

fall before it is operating at a loss? That is, what is its margin of safety ratio?

P5-6A Kaiser Industries carries no inventories. Its product is manufactured only when a customer’s order is received. It is then shipped immediately after it is made. For its fi s- cal year ended October 31, 2014, Kaiser’s break-even point was $1.3 million. On sales of $1.2 million, its income statement showed a gross profi t of $180,000, direct materials cost of $400,000, and direct labor costs of $500,000. The contribution margin was $180,000, and variable manufacturing overhead was $50,000.

Instructions (a) Calculate the following: (1) Variable selling and administrative expenses. (2) Fixed manufacturing overhead. (3) Fixed selling and administrative expenses. (b) Ignoring your answer to part (a), assume that fi xed manufacturing overhead was

$100,000 and the fi xed selling and administrative expenses were $80,000. The market- ing vice president feels that if the company increased its advertising, sales could be increased by 25%. What is the maximum increased advertising cost the company can incur and still report the same income as before the advertising expenditure?

(CGA adapted)

(b) Current margin of safety ratio 16%

(b) 157,000 units

(a) (2) $70,000

Determine contribution margin ratio, break-even point, and margin of safety.

(LO 1, 5, 7, 8), E

Compute break-even point and margin of safety ratio, and prepare a CVP income statement before and after changes in business environment.

(LO 5, 6, 8), E

Compute contribution margin, fi xed costs, break- even point, sales for target net income, and margin of safety ratio.

(LO 5, 6, 7, 8), AN

P5-1B The Sasoon Barber Shop employs four barbers. One barber, who also serves as the manager, is paid a salary of $3,000 per month. The other barbers are paid $1,500 per month. In addition, each barber is paid a commission of $3 per haircut. Other monthly costs are store rent $700 plus 60 cents per haircut, depreciation on equipment $400, barber supplies 40 cents per haircut, utilities $300, and advertising $100. The price of a haircut is $10.

PROBLEMS: SET B

Determine variable and fi xed costs, compute break-even point, prepare a CVP graph, and determine net income.

(LO 1, 3, 5, 6), AN

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Problems: Set B 229

Instructions (a) Determine the variable costs per haircut and the total monthly fi xed costs. (b) Compute the break-even point in units and dollars. (c) Prepare a CVP graph, assuming a maximum of 1,800 haircuts in a month. Use incre-

ments of 300 haircuts on the horizontal axis and $3,000 increments on the vertical axis. (d) Determine the net income, assuming 1,800 haircuts are given in a month.

P5-2B All Frute Company bottles and distributes Frute Ade, a fruit drink. The beverage is sold for 50 cents per 16-ounce bottle to retailers, who charge customers 70 cents per bottle. For the year 2014, management estimates the following revenues and costs.

Sales $2,500,000 Selling expenses—variable $ 80,000 Direct materials 360,000 Selling expenses—fi xed 250,000 Direct labor 450,000 Administrative expenses— Manufacturing overhead— variable 40,000 variable 270,000 Administrative expenses— Manufacturing overhead— fi xed 150,000 fi xed 380,000

Instructions (a) Prepare a CVP income statement for 2014 based on management’s estimates. (Show

column for total amounts only.) (b) Compute the break-even point in (1) units and (2) dollars. (c) Compute the contribution margin ratio and the margin of safety ratio. (d) Determine the sales dollars required to earn net income of $624,000.

P5-3B Olgivie Company had a bad year in 2013. For the fi rst time in its history, it oper- ated at a loss. The company’s income statement showed the following results from selling 60,000 units of product: sales $1,800,000; total costs and expenses $2,010,000; and net loss $210,000. Costs and expenses consisted of the amounts shown below.

Total Variable Fixed

Cost of goods sold $1,350,000 $ 930,000 $420,000 Selling expenses 480,000 125,000 355,000 Administrative expenses 180,000 115,000 65,000

$2,010,000 $1,170,000 $840,000

Management is considering the following independent alternatives for 2014.

1. Increase unit selling price 25% with no change in costs, expenses, and sales volume. 2. Change the compensation of salespersons from fi xed annual salaries totaling $200,000

to total salaries of $20,000 plus a 5% commission on net sales. 3. Purchase new high-tech factory machinery that will change the proportion between

variable and fi xed cost of goods sold to 50:50.

Instructions (a) Compute the break-even point in dollars for 2013. (b) Compute the break-even point in dollars under each of the alternative courses of action.

(Round all ratios to nearest full percent.) Which course of action do you recommend?

P5-4B Alma Ortiz is the advertising manager for CostLess Shoe Store. She is currently working on a major promotional campaign. Her ideas include the installation of a new lighting system and increased display space that will add $18,000 in fi xed costs to the $216,000 currently spent. In addition, Alma is proposing that a 10% price decrease (from $30 to $27) will produce an increase in sales volume from 20,000 to 24,000 units. Variable costs will remain at $12 per pair of shoes. Management is impressed with Alma’s ideas but concerned about the effects that these changes will have on the break-even point and the margin of safety.

Instructions (a) Compute the current break-even point in units, and compare it to the break-even point

in units if Alma’s ideas are used. (b) Compute the margin of safety ratio for current operations and after Alma’s changes

are introduced. (Round to nearest full percent.) (c) Prepare a CVP income statement for current operations and after Alma’s changes are in-

troduced. (Show column for total amounts only.) Would you make the changes suggested?

(a) VC $4

(b) (1) 3,000,000 units (c) CM ratio 52%

(b) Alternative 1, $1,750,000

Prepare a CVP income state- ment, compute break-even point, contribution margin ratio, margin of safety ratio, and sales for target net income.

(LO 5, 6, 7, 8), AN

Compute break-even point under alternative courses of action.

(LO 5, 6), E

Compute break-even point and margin of safety ratio, and prepare a CVP income statement before and after changes in business environment.

(LO 5, 6, 8), E

(b) Current margin of safety ratio 40%

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230 5 Cost-Volume-Profi t

P5-5B Isaac Corporation has collected the following information after its fi rst year of sales. Sales were $1,800,000 on 100,000 units; selling expenses $400,000 (30% variable and 70% fi xed); direct materials $456,000; direct labor $250,000; administrative expenses $484,000 (50% variable and 50% fi xed); manufacturing overhead $480,000 (40% variable and 60% fi xed). Top management has asked you to do a CVP analysis so that it can make plans for the coming year. It has projected that unit sales will increase by 20% next year.

Instructions (a) Compute (1) the contribution margin for the current year and the projected year, and

(2) the fi xed costs for the current year. (Assume that fi xed costs will remain the same in the projected year.)

(b) Compute the break-even point in units and sales dollars. (c) The company has a target net income of $213,000.What is the required sales in dollars

for the company to meet its target? (d) If the company meets its target net income number, by what percentage could its sales

fall before it is operating at a loss? That is, what is its margin of safety ratio? (e) The company is considering a purchase of equipment that would reduce its direct labor

costs by $100,000 and would change its manufacturing overhead costs to 10% variable and 90% fi xed (assume total manufacturing overhead cost is $480,000, as above). It is also considering switching to a pure commission basis for its sales staff. This would change selling expenses to 80% variable and 20% fi xed (assume total selling expense is $400,000, as above). Compute (1) the contribution margin and (2) the contribution margin ratio, and recompute (3) the break-even point in sales dollars. Comment on the effect each of management’s proposed changes has on the break-even point.

P5-6B Mega Electronix carries no inventories. Its product is manufactured only when a customer’s order is received. It is then shipped immediately after it is made. For its fi scal year ended October 31, 2014, Mega’s break-even point was $2.4 million. On sales of $2 million, its income statement showed a gross profi t of $400,000, direct materials cost of $600,000, and direct labor costs of $700,000. The contribution margin was $150,000, and variable manufacturing overhead was $200,000.

Instructions (a) Calculate the following: 1. Variable selling and administrative expenses. 2. Fixed manufacturing overhead. 3. Fixed selling and administrative expenses. (b) Ignoring your answer to part (a), assume that fi xed manufacturing overhead was

$100,000 and the fi xed selling and administrative expenses were $80,000. The market- ing vice president feels that if the company increased its advertising, sales could be increased by 15%. What is the maximum increased advertising cost the company can incur and still report the same income as before the advertising expenditure?

(CGA adapted)

(b) 150,000 units

Determine contribution margin ratio, break-even point, and margin of safety.

(LO 1, 5, 7, 8), E

(a) 2. $100,000

Compute break-even point and margin of safety ratio, and prepare a CVP income statement before and after changes in business environment.

(LO 5, 6, 7, 8), AN

Visit the book’s companion website, at www.wiley.com/college/weygandt, and choose the Student Companion site to access Problem Set C.

PROBLEMS: SET C

(Note: This is a continuation of the Waterways Problem from Chapters 1–4.)

WCP5 The Vice President for Sales and Marketing at Waterways Corporation is plan- ning for production needs to meet sales demand in the coming year. He is also trying to determine how the company’s profi ts might be increased in the coming year. This problem asks you to use cost-volume-profi t concepts to help Waterways understand contribution margins of some of its products and to decide whether to mass-produce certain products.

Go to the book’s companion website, www.wiley.com/college/weygandt, to fi nd the remainder of this problem.

WATERWAYS CONTINUING PROBLEM

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Broadening Your Perspective 231

Management Decision-Making

Decision-Making at Current Designs

BYP5-1 Bill Johnson, sales manager, and Diane Buswell, controller, at Current Designs are beginning to analyze the cost considerations for one of the composite models of the kayak division. They have provided the following production and operational costs necessary to produce one composite kayak.

Kevlar® $250 per kayak Resin and supplies $100 per kayak Finishing kit (seat, rudder, ropes, etc.) $170 per kayak Labor $420 per kayak Selling and administrative expenses—variable $400 per kayak Selling and administrative expenses—fi xed $119,700 per year Manufacturing overhead—fi xed $240,000 per year

Bill and Diane have asked you to provide a cost-volume-profi t analysis, to help them fi nalize the budget projections for the upcoming year. Bill has informed you that the selling price of the com- posite kayak will be $2,000.

Instructions (a) Calculate variable costs per unit. (b) Determine the contribution margin per unit. (c) Using the contribution margin per unit, determine the break-even point in units for this product

line. (d) Assume that Current Designs plans to earn $270,600 on this product line. Using the contribu-

tion margin per unit, calculate the number of units that need to be sold to achieve this goal. (e) Based on the most recent sales forecast, Current Designs plans to sell 1,000 units of this model.

Using your results from part (c), calculate the margin of safety and the margin of safety ratio.

Decision-Making Across the Organization

BYP5-2 Creative Ideas Company has decided to introduce a new product. The new product can be manufactured by either a capital-intensive method or a labor-intensive method. The manufactur- ing method will not affect the quality of the product. The estimated manufacturing costs by the two methods are as follows.

Capital- Labor- Intensive Intensive

Direct materials $5 per unit $5.50 per unit Direct labor $6 per unit $8.00 per unit Variable overhead $3 per unit $4.50 per unit Fixed manufacturing costs $2,524,000 $1,550,000

Creative Ideas’ market research department has recommended an introductory unit sales price of $32. The incremental selling expenses are estimated to be $502,000 annually plus $2 for each unit sold, regardless of manufacturing method.

Instructions With the class divided into groups, answer the following. (a) Calculate the estimated break-even point in annual unit sales of the new product if Creative

Ideas Company uses the: (1) Capital-intensive manufacturing method. (2) Labor-intensive manufacturing method. (b) Determine the annual unit sales volume at which Creative Ideas Company would be indifferent

between the two manufacturing methods. (c) Explain the circumstance under which Creative Ideas should employ each of the two manufac-

turing methods. (CMA adapted)

Broadening Your PERSPECTIVE

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Managerial Analysis

BYP5-3 The condensed income statement for the Peri and Paul partnership for 2014 is as follows.

Peri and Paul Company Income Statement

For the Year Ended December 31, 2014

Sales (240,000 units) $1,200,000 Cost of goods sold 800,000

Gross profi t 400,000 Operating expenses Selling $280,000 Administrative 150,000 430,000

Net loss ($30,000)

A cost behavior analysis indicates that 75% of the cost of goods sold are variable, 42% of the selling expenses are variable, and 40% of the administrative expenses are variable.

Instructions (Round to nearest unit, dollar, and percentage, where necessary. Use the CVP income statement format in computing profi ts.) (a) Compute the break-even point in total sales dollars and in units for 2014. (b) Peri has proposed a plan to get the partnership “out of the red” and improve its profi tability.

She feels that the quality of the product could be substantially improved by spending $0.25 more per unit on better raw materials. The selling price per unit could be increased to only $5.25 because of competitive pressures. Peri estimates that sales volume will increase by 25%. What effect would Peri’s plan have on the profi ts and the break-even point in dollars of the partnership? (Round the contribution margin ratio to two decimal places.)

(c) Paul was a marketing major in college. He believes that sales volume can be increased only by intensive advertising and promotional campaigns. He therefore proposed the following plan as an alternative to Peri’s: (1) Increase variable selling expenses to $0.59 per unit, (2) lower the selling price per unit by $0.25, and (3) increase fi xed selling expenses by $40,000. Paul quoted an old marketing research report that said that sales volume would increase by 60% if these changes were made. What effect would Paul’s plan have on the profi ts and the break-even point in dollars of the partnership?

(d) Which plan should be accepted? Explain your answer.

Real-World Focus

BYP5-4 The Coca-Cola Company hardly needs an introduction. A line taken from the cover of a recent annual report says it all: If you measured time in servings of Coca-Cola, “a billion Coca- Cola’s ago was yesterday morning.” On average, every U.S. citizen drinks 363 8-ounce servings of Coca-Cola products each year. Coca-Cola’s primary line of business is the making and selling of syrup to bottlers. These bottlers then sell the fi nished bottles and cans of Coca-Cola to the consumer.

In the annual report of Coca-Cola, the information shown below was provided.

232 5 Cost-Volume-Profi t

The Coca-Cola Company Management Discussion

Our gross margin declined to 61 percent this year from 62 percent in the prior year, primarily due to costs for materials such as sweeteners and packaging.

The increases [in selling expenses] in the last two years were primarily due to higher market- ing expenditures in support of our Company’s volume growth.

We measure our sales volume in two ways: (1) gallon shipments of concentrates and syrups and (2) unit cases of fi nished product (bottles and cans of Coke sold by bottlers).

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Instructions Answer the following questions. (a) Are sweeteners and packaging a variable cost or a fi xed cost? What is the impact on the con-

tribution margin of an increase in the per unit cost of sweeteners or packaging? What are the implications for profi tability?

(b) In your opinion, are marketing expenditures a fi xed cost, variable cost, or mixed cost to The Coca-Cola Company? Give justifi cation for your answer.

(c) Which of the two measures cited for measuring volume represents the activity index as defi ned in this chapter? Why might Coca-Cola use two different measures?

BYP5-5 The May 21, 2010, edition of the Wall Street Journal includes an article by Jeffrey Trachtenberg entitled “E-Books Rewrite Bookselling.”

Instructions Read the article and answer the following questions. (a) What aspect of Barnes and Noble’s current structure puts it at risk if electronic books become

a signifi cant portion of book sales? (b) What was Barnes and Noble’s primary competitive advantage in a “paper book” world? How

has this advantage been eliminated by e-books? (c) What event do the authors say might eventually be viewed as the big turning point for e-books? (d) What amount does Barnes and Noble earn on a $25 hardcover book? How much would it likely

earn on an e-book version of the same title? What implications does this have for Barnes and Noble versus its competitors?

(e) What two mistakes does the author suggest that Barnes and Noble made that left it ill-prepared for an e-book environment?

Broadening Your Perspective 233

Critical Thinking

Communication Activity

BYP5-6 Your roommate asks for your help on the following questions about CVP analysis formulas. (a) How can the mathematical equation for break-even sales show both sales units and sales dollars? (b) How do the formulas differ for contribution margin per unit and contribution margin ratio? (c) How can contribution margin be used to determine break-even sales in units and in dollars?

Instructions Write a memo to your roommate stating the relevant formulas and answering each question.

Ethics Case

BYP5-7 Scott Bestor is an accountant for Westfi eld Company. Early this year, Scott made a highly favorable projection of sales and profi ts over the next 3 years for Westfi eld’s hot-selling computer PLEX. As a result of the projections Scott presented to senior management, the company decided to expand production in this area. This decision led to dislocations of some plant personnel who were reassigned to one of the company’s newer plants in another state. However, no one was fi red, and in fact the company expanded its work force slightly.

Unfortunately, Scott rechecked his computations on the projections a few months later and found that he had made an error that would have reduced his projections substantially. Luckily, sales of PLEX have exceeded projections so far, and management is satisfi ed with its decision. Scott, however, is not sure what to do. Should he confess his honest mistake and jeopardize his possible promotion? He suspects that no one will catch the error because sales of PLEX have exceeded his projections, and it appears that profi ts will materialize close to his projections.

Instructions (a) Who are the stakeholders in this situation? (b) Identify the ethical issues involved in this situation. (c) What are the possible alternative actions for Scott? What would you do in Scott’s position?

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All About You

BYP5-8 Cost-volume-profi t analysis can also be used in making personal fi nancial decisions. For example, the purchase of a new car is one of your biggest personal expenditures. It is important that you carefully analyze your options.

Suppose that you are considering the purchase of a hybrid vehicle. Let’s assume the following facts: The hybrid will initially cost an additional $4,500 above the cost of a traditional vehicle. The hybrid will get 40 miles per gallon of gas, and the traditional car will get 30 miles per gallon. Also, assume that the cost of gas is $3.60 per gallon.

Instructions Using the facts above, answer the following questions. (a) What is the variable gasoline cost of going one mile in the hybrid car? What is the variable cost

of going one mile in the traditional car? (b) Using the information in part (a), if “miles” is your unit of measure, what is the “contribution

margin” of the hybrid vehicle relative to the traditional vehicle? That is, express the variable cost savings on a per-mile basis.

(c) How many miles would you have to drive in order to break even on your investment in the hybrid car?

(d) What other factors might you want to consider?

234 5 Cost-Volume-Profi t

Answers to Chapter Questions

Answers to Insight and Accounting Across the Organization Questions

p. 200 Gardens in the Sky Q: What are some of the variable and fi xed costs that are impacted by hydroponic farming? A: Compared to traditional methods, hydroponic farming would reduce the use of pesticides, herbicides, fuel, and water. Soil erosion would be eliminated, and land require- ments would drop. But, fi xed costs related to constructing greenhouses, suitable vertical planters, as well as investments in artifi cial lighting could be high. p. 204 Skilled Labor Is Truly Essential Q: Would you characterize labor costs as being a fi xed cost, a variable cost, or something else in this situation? A: Because these labor costs are essentially unchanged for most levels of production, they are primarily fi xed. However, it could be described as being a “step function.” If production gets too far outside the normal range, workers’ hours will change. If production goes too low, hours are cut, and if it goes too high, overtime hours are needed. p. 211 Charter Flights Offer a Good Deal Q: How did FlightServe determine that it would break even with 3.3 seats full per fl ight? A: FlightServe determined its break-even point with the following formula: Fixed costs 4 Contribution margin per seat occupied 5 Break-even point in seats. p. 215 How a Rolling Stones’ Tour Makes Money Q: What amount of sales dollars are required for the promoter to break even? A: Fixed costs 5 $1,200,000 1 $400,000 5 $1,600,000

Contribution margin ratio 5 80% Break-even sales 5 $1,600,000 4 .80 5 $2,000,000

Answers to Self-Test Questions

1. d 2. c 3. a 4. d 5. a [($1,200 2 $600) 4 (10,000 2 2,000)] 6. c 7. c 8. d 9. a [(100,000 3 $12) 2 $300,000 2 $200,000] 10. c (200,000 3 $4 3 25%) 11. c ($100 3 30%) 12. b 13. a 14. b [($600,000 2 $420,000) 4 $600,000]

✔ Remember to go back to The Navigator box on the chapter opening page and check off your completed work.

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Learning Objectives After studying this chapter, you should be able to:

1 Describe the essential features of a cost-volume-profi t

income statement.

2 Apply basic CVP concepts.

3 Explain the term sales mix and its effects on break-even sales.

4 Determine sales mix when a company has limited resources.

5 Understand how operating leverage affects profi tability.

Scan Learning Objectives

Read Feature Story

Scan Preview

Read Text and answer p. 239 p. 243 p. 248 p. 250 p. 265

Work Using the Decision Toolkit p. 254

Review Summary of Learning Objectives

Work Comprehensive p. 266

Answer Self-Test Questions

Complete Assignments

Go to WileyPLUS for practice and tutorials

✔ The Navigator

✔ The Navigator

Chapter 6

Cost-Volume-Profi t Analysis: Additional Issues

Rapid Replay Intel doesn’t do things half-way. If you

own a PC, then there is a roughly 85%

chance that the microprocessor chip

that runs your machine was made by

Intel. In fact, for as long as most

people can remember, Intel has had at

least an 85% share of the market for

PC computer chips. That doesn’t

mean, however, that life is easy for

Intel. Its earnings swings, like every-

thing else about the company, are

major league. Consider these two Wall

Street Journal headlines: “Intel’s Net

Plunges as Demand Dries Up” and

then, only slightly more than a year

later, “Intel Earnings Set High Bar.”

If Intel is so dominant in the computer

chip market, why does it experience

such huge swings in its earnings?

First, to produce computer chips,

Intel must continually make huge

investments in sophisticated equipment.

Now, consider what you learned in

the previous chapter. The higher a

company’s fi xed costs, the more units

it must sell to break even. In this

chapter, you will learn that if a

company has high fi xed costs as a

percentage of total costs, then its

earnings will be very susceptible to

economic swings.

Another way of saying this is that

when the economy gets the sniffl es,

DO IT!

DO IT!

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Intel gets the fl u. A drop in Intel’s sales results in a dispropor-

tionately large drop in its profi ts. For example, during a recent

quarter when Intel’s sales fell

23%, its profi ts fell 90%. On the

other hand, the minute the

economy turns upward, Intel’s

profi ts do a sharp about-face.

After the recent downturn,

Intel’s sales jumped 44%. While

this was a nice bump in sales,

consider what happened to its

net income. Its net income

increased by almost 10 times as

much—nearly 400%.

Is there anything that Intel can do to tame this roller coaster

ride? It can try to change its cost structure by reducing its

reliance on fi xed costs. But to do this, it would have to rely

more heavily on outside suppliers rather than producing its

own chips. Intel is probably

reluctant to make this change

because it would lose some of

its control over product

quality.

Watch the Whole Foods

video in WileyPLUS to learn

more about the use of