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Accountancy Two Homework

California State University Sacramento

Spring 2005 Accountancy Two

Professor Jim Mackey

Ch. 1-2 Things to Know

The role of audited financial statements for investment

Hard and soft data

The relationship of GAAP and the audit function

Different costs for different purposes

Stewardship function

Cost of Goods Sold

Cost of Goods Manufactured

Product costs

Period costs

Direct Material

Direct Labor

Manufacturing Overhead

Raw Materials inventories

Work In Process inventories

Finished Goods inventories

Economic Value

Ch3 Things to Know

Relevant range

Variable & fixed costs

Cost object or cost objective

Contribution Margin, per unit & ratio

Breakeven

Contribution Margin Statement

Level of sales needed to make a certain profit target

How many units do we need to make & sell

Pricing, changes in variable costs, changes in fixed costs

Ch4 Things to Know

The importance and uses of cash budgets

Conditions creating the need for cash budgets

Calculate cash collection patterns

Calculate production, purchases and payments

Reasons for keeping inventories

Adjustments for noncash flow expenses

How are cash budgets used for determining credit lines.\?

Balance equation

Solvency

Why do companies budget?

Things to Know Accy 2

Things to Know Accy 2 ch.5

Scientific Management planning

Job costing vs Process Costing

Absorption costing

Job costing calculations

Machine intensive, Labor intensive

MWSRQC production activity cycle

Predetermined Overhead rates POR calculation

Why do companies use PORs?

Chapter 6

Management by Exception

Flexible budgets

Cost Standards

All variable variances

Practical vs Theoretical cost standards

Product standard cost cards

ch. 7

Terms and examples of application: Sunk costs, mutually exclusive actions, incremental cash flows (relevant for this decision), Opportunity costs, and externalities

Special Order decisions

Make versus Buy decisions

CHAPTER TWO SOLUTIONS

P6. KO2: Contribution margin and profit analysis. Mark Fox operates the Magic Touch cleaning service specializing in commercial office buildings. Last year, his company made 25,000 office visits at $60 per visit. His variable costs were $30 per visit and fixed costs totaled $450,000. Mark is working on next year's budget and estimates his variable costs will increase $2 per unit and fixed costs will rise by $50,000.

Respond to the following directive and questions.

a. Create an income statement for last year in the contribution margin format.

(continued)

b. If Mark wishes to earn the same profit as last year what will he have to charge per visit?

c. Mark desires to maintain his current per visit price. How many visits will his company have to make to earn the same profit as last year?

Note: The spreadsheet's goal-seeking function was used for Parts b and c. When solving for volume, a “roundup” function is needed.

P7. KO3: Building a profit equation. Your regional Internal Revenue Service estimates it can collect $1,000 on average from each audit it conducts. Variable costs are $250 per audit, and fixed costs are $15,000 per month. The IRS is not expected to make a profit from audit collections, but it is expected to cover its costs.

Respond to the following directives.

a. Write the profit equation in a format solving for profit, but do not solve the equation.

(continued)

b. Write the profit equation solving for the number of audits required.

c. Write the profit equation solving for the audit collections it must make per month.

20 audits per month x $1,000 per audit = $20,000 per month

or:

CM ratio = CMU ÷ Sales price = $750 ÷ $1,000 = 75%

P8. KO3: CVP analysis using the profit equation. The Flavor Burst Gum Company has the following information regarding its costs of operations:

Using this information, determine the following:

a. Break-even revenues

b. Break-even volume

c. Sales revenues to achieve target profit

d. Sales volume to achieve target profit

I 2. KO3, 4, and Chapter 2: CVP, quality, and value. Clark manufacturing makes a line of plush toys sold widely throughout the world at novelty stores and through mail-order catalogs. The design team has developed a new product called the “Doggie Plush.” It is a large life-sized, stuffed Collie dog designed to “love and hug.” Sales are projected to be 50,000 units at $45 each. Direct materials are budgeted at $15 per toy, direct labor is $10, and variable overhead is $5. Quality inspection costs are an additional $3 per dog. Fixed production costs are estimated at $200,000. Marketing has a budget of $150,000.

Answer the following questions.

a. What is Doggie Plush's projected profit?

b. What is its break-even volume?

c. If sales exceed the original projection by 10%, what is the extra profit?

D Volume = +10% = +5,000 toys:

D Contribution margin = CMU x D Volume

= $12 per toy x +5,000 toys

= +$60,000

d. By using a lower quality cloth, material costs can be reduced $2 per dog. How will this change the profit projection?

D Variable cost = ($2): D CMU = +$2:

D Contribution margin = D CMU x Volume

= +$2 per toy x 50,000 toys

= +$100,000

(continued)

e. Not conducting quality control inspections can save $3 per dog and $20,000 per year. Using the original cloth, how will this change the profit projection?

D Contribution margin = D CMU x Volume

= +$3 per toy x 50,000 toys

= +$150,000

D Profit = +$150,000 + $20,000 Fixed cost saved = +$170,000

f. How will the changes in Parts d and e affect the company's valAue?

Profits this year will increase $270,000 assuming customers will still buy 50,000 dogs given the lower quality. This is a big assumption! If customers perceive Clark Manufacturing makes bad quality products, sales of other products now and in the future may suffer. Even if quality is restored sometime in the future, customers may be very slow to return.

Homework for Chapter 4 Accountancy 2

5. What is a cash budget, and why is it important?

6. What conditions create a need for cash budgeting?

12. What is a credit collection pattern and why is it important for budgeting?

15. Why do merchandisers and manufacturers keep finished goods inventories?

18. When preparing a cash budget and its schedules, why should we ignore financial accounting costs like depreciation, amortization, and income tax expense?

21. What is a line-of-credit, and why is it important?

P6. KO3: Cash collections for a service firm. Northern Gas and Electric serves 100,000 residential customers and 15,000 commercial customers. Projected revenues for next year are shown below. All bills are sent on the first day of the month (so they are for the previous month's use). Residential customers pay 60% of their bills within the month and 35% of their bills in the following month (5% are uncollectable). Commercial customers pay 50% in the month of billing and 40% in the following month (10% are uncollectable). Uncollectable accounts are sold to a private collection agency in the third month following the billing for 15% of the account balance.

Create the following schedules. a. Create a cash collections schedule from residential customers by month for the second quarter. (Do not include uncollectable accounts sold to the collection agency.)

b. Create a cash collections schedule from commercial customers by month for the second quarter. (Do not include uncollectable accounts sold to the collection agency.)

c. Create a cash collections schedule from sales of uncollectable accounts by month for the second quarter.

P9. KO4: Production quota and direct materials purchases. Jan's Leather Shop makes leather purses. In order to ship purses to retailers as soon as they place orders, Jan maintains ending monthly inventories equal to 50% of the next month's projected sales. She budgets $10 in direct materials per purse. Each month's direct materials beginning inventory should be 25% of the materials needed for the production quota because she can receive deliveries weekly. All bills, including payroll, for each week are paid in the following week. Projected sales volumes are:

Respond to the following directives.

a. Calculate the production quotas for July and August and show the totals for the two months.

Formulas used:

Sales forecast given

Beginning inventory 50% of this month's sales

Ending inventory 50% of next month's sales

a.

b. Determine how much will be paid for materials purchases in August.

Formulas used:

DM needed for quota This month's PQ x DM cost

Beginning DM inventory This month's DM$ x 25%

Desired ending DM inventory This month's DM x 25%

  P11. KO4: Budgeting operating expenses. Financial Aids Finders, Inc. (FAF) is a for-profit service firm specializing in helping college students obtain scholarships and loans by searching computer databases and the Internet. It projects 1,000 students will apply for financial aids in January, 500 in February, and 2,000 in March. Computer search time averages $5 per student. Preparing the forms for each student averages $10, and application fees for specific scholarships and loans averages $25 per student. FAF spends $12,000 a month on salaries, another $1,000 a month on building-related costs (property taxes, utilities, insurance, etc.), and $500 in monthly operating costs. Building and equipment depreciation expense is $2,500 per month. All costs are paid in the month incurred.

Budget the monthly cash outflows for operating expenses, with totals, during the first quarter of the year.

Sales volume Jan Feb Mar Totals

Student clients 1,000 500 2,000 3,500

Expenses Variable Fixed

Computer search time $ 5

Preparing forms 10

Application fees 25

Salaries $12,000

Building costs 1,000

Operating costs 500

Operating expenses budget Jan Feb Mar Totals

Variable cost expenses

Computer search time $ 5,000 $ 2,500 $10,000 $ 17,500

Preparing forms 10,000 5,000 20,000 35,000

Application fees 25,000 12,500 50,000 87,500

Total variable cost expenses $40,000 $20,000 $80,000 $140,000

Fixed cost expenses

Salaries $12,000 $12,000 $12,000 $ 36,000

Building costs 1,000 1,000 1,000 3,000

Operating costs 500 500 500 1,500

Total fixed cost expenses $13,500 $13,500 $13,500 $ 40,500

Cash-out for operating expenses $53,500 $33,500 $93,500 $180,500

  CHAPTER FIVE

P6. KO3: POR and billing rates for a service firm. Olive Tree Garage specializes in repairing European sports cars. Next year's budget includes $25,000 for building-related costs, $30,000 for bookkeeping, and $25,000 for other miscellaneous costs. Materials are charged to each job at cost. Direct labor, including benefits, is budgeted at $25 per hour. 10,000 direct labor hours should be billable to repair customers. Alfredo, Olive Tree's owner, wishes to earn a profit of $120,000 before taxes.

Respond to the following directives and question.

a. Calculate the predetermined overhead for the year using direct labor time as the cost driver.

b. What is the hourly rate Alfredo needs to charge customers in order to earn his target profit?

c. Why does it make sense to use direct labor hours as the cost driver for overhead and profit?

The ultimate reason for allocating overhead to products is to recover its cost through sales prices. Similarly, the only way Alfredo can receive his profit is through the rates (sales prices) he charges car repair customers. Charging overhead and profit to customers based on the number of (direct labor) hours required to repair their cars seems reasonable (from a customer's perspective), simple, and efficient.

P11. KO5: Job costing for a hospital. Scot City Trauma Center is a branch of the city hospital system. Located on the south side of town, it handles only emergency treatments. Maria broke her leg in two places during a small earthquake. The Trauma Center 's billing system uses the following activities and costs. Treatment time overhead is allocated based on the total nurse's and doctor's time treating a patient.

Calculate Maria's bill.

P15. KO5, 6 (Appendix): Departmental PORs in a prison. The state prison makes license plates in two departments: the Metal Shop and the Finishing Shop. The Metal Shop stamps license plates from sheet metal and is machine intensive, using machine hours to set its capacity. The Finishing Shop hand-paints the license plates and is labor intensive, using labor hours to set its capacity. Budgeted information for the prison, and actual resources used on Job 201 include:

Respond to the following directives.

a. Using total direct labor hours, determine the average cost of a license plate (i.e., calculate the plant-wide total overhead rate for allocating combined Metal Shop and Finishing Shop overhead to jobs).

b. Using the plantwide POR, calculate the cost of Job 201.

C. Calculate the PORs for each production department using their capacity measures as cost drivers.

  d. Using the departmental PORs, calculate Job 201's cost.

P11. KO4: Materials and labor variances for a distributor. The Cajun Hot Sauce Company is a distributor providing retailers with the ultimate experience in heated food additives. For one of its sauces, Cajun's standards budgets $1.25 per gallon to purchase the sauce from a bayou farmer. It pours the sauce into bottles provided by retailers so each bottle appears to be a unique product of each retailer. Then, the bottles are placed in cardboard cases for shipment. Each case of bottles should require 5 gallons of sauce. It should take ½ hour to pour and place the bottles in each case. The budgeted wage rate is $12 per hour. Last month Cajun produced 15,000 cases of sauce using 75,500 gallons. (It purchased 62,000 gallons for $71,300). 7,400 hours of labor were required, costing $88,800.

Calculate the following variances.

a. Sauce price variance.

b. Labor rate variance.

c. Sauce usage variance.

d. Labor efficiency variance.

•  Variable cost spending (price or rate) variance formula:

•   

•  Variable cost usage (efficiency) variance formula:

P12. KO4: Materials and labor variances for a city. During the summer, the city's purchasing agent ordered 600 gallons of liquid industrial cleaner at $18 per gallon for use in the city parks. She saved $2 a gallon (based on the budget) by purchasing this large quantity. The Parks and Recreation Department expects to use ½ gallon for each park cleaning, and department personnel did 800 cleanings. 430 gallons were used. 10 hours are budgeted for each park cleaning, and 7,600 hours actually were worked. The city's budget allows for a $20 per hour wage rate (including benefits), but Parks and Recreation Department workers were actually paid $22 per hour.

Calculate the following variances.

a. Material price variance.

b. Material use variance.

c. Labor rate variance

d. Labor efficiency variance.

Variable cost spending (price or rate) variance formula:

Variable cost usage (efficiency) variance formula:

P13. KO4: Materials, labor, and overhead variances for a tailor. Cobb's Hill is a new women's tailor shop located in the recently renovated downtown area of Whitewater , Canada . While many clothes are purchased from high quality manufacturers and sold off the racks, Cobb's Hill is primarily known for its custom tailored suits. Standards for a woman's suit are:

Of the 5.5 seamstress hours budgeted per suit, 2 hours is allowed for sewing. Variable overhead is allocated based on sewing machine time. In Canada , fixed overhead is not required to be included in a product's cost for financial reporting. Thus, Cobb's Hill does not include a fixed overhead allocation in the suit's standard cost. Annual fixed overhead is budgeted at $100,000. Actual fixed overhead was $95,000.

Other actual information includes 330 yards of cloth purchased and used at $20 per yard. While some cloth always is left over when making a suit, it is not usable on other suits and is scrapped. For the 150 suits made, 800 seamstress hours were worked at a total cost of $9,200. Included in the 800 hours was 320 hours of sewing machine time. Actual variable overhead cost was $1,568.

Calculate the following cost variances.

a. Total variance from target profit due to materials.

b. Total variance from target profit due to direct labor.

c. Total variance from target profit due to variable overhead.

d. Direct materials price variance.

e. Labor rate variance.

f. Variable overhead spending variance.

g. Direct materials usage variance.

h. Labor usage variance.

i. Variable overhead usage variance.

j. Fixed overhead spending variance.

Total variances from target profit:

(continued)

Variable cost spending (price or rate) variance formula:

Variable cost usage (efficiency) variance formula:

j. Fixed overhead spending variance:

$100,000 budgeted fixed overhead cost - $95,000 actual cost = $5,000 F

CHAPTER 7

P2. LO2. Incremental CVP to determine special sale price. Captain Pete is considering offering whale-watching trips to supplement his fishing income with weekend charters. Pete's daughter and first mate, Silvia, is examining the estimated costs for one day of operations. Captain Pete, with the help of his accountant, has put together the following cost information from last year's operations.

Respond to the following directives and questions.

a. Using these costs, what is the breakeven ticket price if 40 people take the whale-watching cruise?

Total costs $1,600/40 passengers = $40 per passenger.

(continued)

b. Captain Pete's daughter believes the ticket price is too high. In college, she learned that only relevant costs should be included in incremental pricing decisions. Remove the nonrelevant costs and recalculate the breakeven ticket price for 40 people.

The information contains two nonrelevant cost items. The fixed overhead and the depreciation are not relevant to this decision since they are already accounted for through the fishing operations. The remaining incremental costs total $700 / 40 passengers = $17.50 per passenger.

c. If whale watchers are willing to pay $25 for an afternoon cruise, what is the minimum number of passengers necessary to break even.

$700 / $25 per passenger = 28 passengers

d. By how much will Captain Pete increase his annual profits for each excursion that carries 40 passengers for a ticket price of $30 cash?

$30 ´ 40 passengers = $1,200. $1,200 – $700 = $500

P3. LO2: Incremental CVP to determine special sales price. The Coopers Guild manufactures high quality handmade wooden buckets with a retail sale price of $25 per unit. The Guild's costs per unit based on annual sales of 100,000 units are: direct materials - $6, direct labor - $7, variable overhead - $2, and fixed overhead - $5. The Guild has just received a special order of 10,000 units which is within the current capacity of production. Selling cost per unit for the special order will be $2 per unit.

Respond to the following questions and directives.

a. What is the incremental breakeven cost per unit?

Breakeven price per unit:

Direct materials $ 6

Direct labor 7

Variable overhead 2

Selling cost 2

$ 17

b. The profit margin on sales is $5. What selling price per unit on the special order will be acceptable if the Guild wishes to maintain per unit profitability?

Currently, $25 sale price less $20 = $5 per unit. Minimum necessary $17 + $5 = $22 per unit.

c. Describe any externalities that might lead the company to not accept the minimum price from part b.

If there is no difference in profitability the company may reject the order to keep current customers happy. These customers may not react favorably to the knowledge that despite circumstances others receive a better price break from the company.

d. What would the special order sales price be if the company desires to make $45,000 profit on the special order?

$45,000 / 10,000 units = $4.50 per unit. $17 cost + $4.50 = $21.50 per unit.

P14. LO5: Make-or-buy decisions. The Microtool Company manufactures 15,000 units of a part needed in a subassembly of its main product line. The following cost data was assembled relating to the part.

Zip Systems is a local supplier of similar parts and offers to supply the part for $23 per unit. Microtool estimates that if the company purchases the part, fixed overhead will be reduced by $90,000.

Answer the following questions.

a. Given the information above should Microtool accept the offer?

No. The company now produces the part for $25 per unit (total costs $375,000/ 15,000 units). Total costs if purchased would be $27 per unit. $23 per unit from Zip Systems + $4 per unit of unavoidable fixed costs [(Total fixed costs $150,000 – avoidable fixed costs $90,000) / 15,000 units]

b. What is the most that Microtool would be willing to pay per unit?

Since it now costs $25 per unit to product the part internally and they can not avoid $4 per unit of fixed costs ($60,000 / 15,000 units), the most they would pay is $21 per unit.

c. If Microtool could avoid all the fixed costs by purchasing from Zip Systems, how much would profitability increase?

($25 - $23 = $2 per unit ) ´ 15,000 units = $30,000 increase in profitability.

CHAPTER 8

  P7. KO4: Segmented income statements and product line profitability. Custom Castings has two operating divisions, Decorative Castings and Commercial Castings. Last year's information on each division's direct costs and revenues includes:

The company also had common fixed costs: $110,000 in depreciation, $30,000 in heat and light, and $160,000 in administrative costs.

Answer the following questions.

a. What is the contribution margin for Decorative Castings?

b. What is the product line margin for Decorative Castings?

c. What is the contribution margin for Commercial Castings?

d. What is the product line margin for Commercial Castings?

e. What is the net income for the company?

P8. KO4: Product line profitability for a distributor. Security Concepts sells and installs two product lines in the commercial security market. The Reporter is designed to passively watch and notify security and police in an emergency. The Terminator contains active deterrents and restraints. Each line has its own advertising, technical support and supervisors. Building and administrative costs are allocated using relative sales revenues. Last year's information includes:

Answer the following questions.

a. What are the CMU, CM ratio, and contribution margin for the Reporter?

b. What is the product line margin for the Reporter?

c. What are the CMU, CM ratio, and contribution margin for the Terminator?

d. What is the product line margin for the Terminator?

e. What is the net income for Security Concepts?

P9. KO4: Segmented income statements and performance evaluation for a CPA firm. Buck and Buck, CPAs, employs CPAs for its tax division and CMAs for its management consulting practice. Both services are supported by research personnel and administrative personnel who trace their time directly to each job. Computer equipment and on-line search fees are controllable direct fixed costs. Each service line has its own supervision. Insurance, office costs, and administrative expenses are allocated. Information about each service line includes:

Respond to the following directive and question.

a. Prepare a segmented income statement for Buck and Buck, identifying the controllable segment margins for each service line.

Solution is on next page.

b. Why do you think Buck and Buck does not include a “per unit” column in each segment?

Each consulting and tax engagement probably is unique, much like jobs in a manufacturer's job shop. Therefore, each client has unique needs, costs, and revenues. Reporting a “per unit” column would require averaging the total revenues and costs for each segment over the client volume. Because each job is unique, Buck and Buck management probably does not believe average “per unit” information is meaningful.

P10. KO5: Return on investment and residual income. Grimaldi General Contractors has two divisions, Commercial Construction and Apartment Construction. The company uses a cost of capital of 10%. Information about each division and the company includes:

Respond to the following directives.

a. Calculate the ROI and RI for Commercial Construction.

Segment margin = Sales - Variable costs - Fixed costs

$500,000 = $4,000,000 - $1,500,000 - $2,000,000

Residual Income = Investment x (ROI - Cost of Capital)

$300,000 = $2,000,000 x (25% - 10%)

b. Calculate the ROI and RI for Apartment Construction.

Segment margin = Sales - Variable costs - Fixed costs

$1,000,000 = $6,000,000 - $2,500,000 - $2,500,000

Residual Income = Investment x (ROI - Cost of Capital)

$651,000 = $3,500,000 x (28.6% - 10%)

c. Calculate the ROI and RI for the Company.

Net income = Sales - Variable costs - Segment fixed costs - Common fixed costs

$1,000,000 = $10,000,000 - $4,000,000 - $4,500,000 - $500,000

Residual Income = Investment x (ROI - Cost of Capital)

$402,000 = $6,000,000 x (16.7% - 10%)

P11. KO5: ROI and residual income for a retailer. Tiny Tot Toys has three departments within its retail store: Micro Tots, Tiny Tots, and Toddlers. Each is considered to be an investment center. The company has asked you to evaluate the performance of the divisions using ROI and RI. The company wants a 12% return on investment from each department. Round percentage calculations to one decimal place.

(continued)

Respond to the following directives and question.

a. Calculate the ROI and RI for Micro Tots.

Segment margin = Sales - Variable costs - Fixed costs

$50,000 = $800,000 - $600,000 - $150,000

Residual Income = Investment x (ROI - Cost of Capital)

$14,100 = $300,000 x (16.7% - 12%)

b. Calculate the ROI and RI for Tiny Tots.

Segment margin = Sales - Variable costs - Fixed costs

$200,000 = $1,800,000 - $1,200,000 - $400,000

Residual Income = Investment x (ROI - Cost of Capital)

$80,000 = $1,000,000 x (20% - 12%)

c. Calculate the ROI and RI for Toddlers.

Segment margin = Sales - Variable expenses - fixed expenses

$50,000 = $1,400,000 - $1,200,000 - $150,000

Residual Income = Investment x (ROI - Cost of Capital)

($34,300) = $700,000 x (7.1% - 12%)

d. Should the Toddler department be closed and the space used to expand Micro Tots and Tiny Tots?

YES: It is returning only 7.1%, but the minimum acceptable rate of return is 12%.

NO: We don't know if having Toddler toys increases the sales in the other departments. While expanding other departments into this space should increase revenues, costs will also increase. There is no guarantee that the same profit margins and ROIs can be maintained with the new larger space.

P12. KO5: Profit margin and asset turnover ratios. Idaho 's state agencies are treated as investment centers and evaluated with ROI. To create “revenues” for each agency, transfer prices are determined annually based on agency budgets and required rates of return. Water Resources Maintenance (WRM) provides electric motor and electric pump maintenance to the water purification plants throughout the state. Each service also is treated as an investment center.

Using the following information, calculate the profit margin, asset turnover ratio, and ROI for each service and for WRM.

Things to Know for Chapter 9 & 10

Chapter 9 Understand traditional volume-based cost allocations and activity-based costs.

Characteristics of providing goods and services that increase or decrease the need for ABC to improve product line costing.

Calculate cost driver rates.

Calculate product costs using ABC and traditional volume-based cost drivers.

Calculate a cost-plus price using ABC and traditional volume-based cost drivers.

Chapter 10. How does ABC support value chain management.

Define a value chain, strategic partnering, core competency, and customer profitability analysis.

How is ABC used in a differentiation strategy.

Calculate strategic partnering savings.

Calculate the VPI, order filling and delivery ratios..

Chapter Nine

P3. KO2, 3: Comparing traditional and ABC cost allocations in a law firm. Legal Hounds has 3 support activities: investigation, legal research, and courtroom support. Historically, these activities have been considered as overhead and allocated based on trial attorney courtroom hours. Legal Hounds wants to make these activities billable directly to each client because clients use different amounts of each support activity. Your CPA firm has been retained to investigate whether activity-based costing can provide more accurate charges for billing Legal Hounds' clients. As a CMA, you are assigned management consulting clients. Legal Hounds budget information for next year includes:

(continued)

Respond to the following directives and questions.

a. Determine the rate Legal Hounds has been using to bill these support activities.

Overhead resource costs total $1,200,000. Dividing this by 6,000 courtroom hours creates a $200 per courtroom hour POR.

b. Why is this allocation method similar to how manufacturers historically have allocated production overhead using direct labor hours?

Trial attorney time (courtroom hours) is traced directly and billed to each client. This is just like a manufacturer directly tracing labor to a job. Because direct labor is assigned to each job, using it as the overhead cost driver provides a way to allocate overhead to each job. Calculating an average support activity cost per courtroom hour similarly allows these costs to be allocated to each client.

c. Calculate the ABC cost driver rates for each activity.

d. Why can Legal Hounds be thought of as a manufacturer?

Manufacturers transform inputs into outputs. Legal Hounds' “product” is a specific legal service for a client. In providing legal services, it takes resources (inputs) and uses (transforms) them to make its product. Because each client requires a unique legal service, a client is similar to a manufacturer's job. Legal Hounds is a “system,” and all systems transform inputs into outputs. Therefore, all systems, including Legal Hounds, are basically manufacturing processes.

e. As a manufacturer, do Legal Hounds' production characteristics justify ABC?

Investigation, legal research, and courtroom support currently are treated as overhead. Indirect production costs are not traced directly to each job-client. These are significant costs of the legal firm. Referring to Exhibit 9-4, Legal Hounds produces multiple products (serves many clients with unique needs). Each product (client) uses different overhead activities (support services), and/or uses the same activities but in different amounts.

P8. KO4: Allocating batch-level costs. Briteglow Paints is a commercial wholesaler that makes specialty paints for painting companies. It purchases paint from manufacturers and mixes it to order. Each order incurs three batch-level costs: materials ordering, quality control, and setups. These costs are included in overhead, which is allocated using machine time (10,000 machine hours are budgeted for the year). Budget information for these costs includes:

The Funtime job is for 100 gallons. It will require 3 machine hours of run time, 2 material orders, 6 inspections, and 4 setups.

Respond to the following directives and question.

a. Determine the total overhead POR based on machine time, the overhead allocated to this batch, and the average overhead cost per gallon.

b. Calculate the cost driver rates for each batch-level cost.

c. What is the batch-level cost for the Funtime job, and the average batch-level cost per gallon?

P11. KO5: ABC-based billing rates for a law firm. Refer to the information in problem 3. Legal Hounds has been engaged by a disgruntled college student to sue the university over a computer use fee for a course that did not involve any computer usage. This case required 50 hours of investigation time, 30 hours of legal research time, and 20 hours of in-court trial time. Legal Hounds billing rate for trial lawyers is $500 per hour. A 50% markup on total client cost is added to the client's bill for general company overhead and profit. The student eventually won the case. The judge ordered the university to pay all legal costs. The university argued a traditional overhead allocation method should be used based on in-court trial time. You have been retained as an expert witness by Legal Hounds to present the ABC-based cost of this case.

Calculate Legal Hounds bill to the university using its traditional overhead allocation method and the ABC method. (Traditional = $21,000, and ABC = $22,500.)

a. Billing using a traditional allocation method based on trial lawyer time

b. Billing using ABC

Chapter Ten

P2. KO1 and 2: Strategic partnering and ABC analysis. The Chocolate Store makes a mixture of boxed and specialty chocolates. Sales have grown dramatically, but so have costs. On a trip to France , one of the partners, Cherrie Lau, visited several chocolate factories. While there, she discussed her business with several owners. One of them, Jean Pierre, made an interesting offer. His factory has excess capacity and since sales to the Chocolate Store will not affect his domestic sales, he can offer her a $5.20 special price on 1-pound blocks, packaged and delivered to the Chocolate Store's plant.

Desperate to keep the business, a memorandum is sent out to all managers for suggestions to reduce costs. A young engineer suggests a new service being offered by UPS, heated liquid trucking. UPS will pick up the melted chocolate mix and deliver to the Chocolate Company in a ready-to-pour form. Unfortunately, this service costs $1.60 a pound which increases, not decreases, High Quality's production costs. Is all lost?

It appear the French factory is using an incremental pricing policy (see Chapter 7) on this special order in order to use some of its surplus capacity.

P2 (continued).

High Quality can maintain its $0.50 per pound profit and reduce the price to $0.20 below the French bid! (Total cost to the Chocolate Store is $5.20 French purchase price + $2.60 in normal processing costs = $7.80 per pound ).

•  The idea: An activity is not a core competency if it can be eliminated!

•  High Quality Chocolate Company: Since the last three activities have been eliminated, the first two (mix and melt) must be its core competencies.

•  Chocolate Store: Since its first three activities have been eliminated, the last three (pour, store, and pack) must be its core competencies.

(See the value chains on the next two pages.)

P4. KO2: Vendor performance index. Malcolm Ridgeway, management accountant at Bell Computers, is concerned about the company's traditional methods of evaluating supplier relationships. “To achieve world-class status, we must build and maintain long-term partnerships with a small group of vendors offering the best overall value.”

Melissa Alexander, the purchasing agent responds, “Nortec supplies us with circuit boards at $20.00 per board. It continues to be our lowest cost supplier. I've managed to beat my purchasing budget every year by using Nortec, resulting in favorable purchase variances.”

“That's true,” replies Malcolm. “But I've been doing an ABC analysis and discovered Nortec's purchase price is only part of the costs caused by its circuit boards. Remember when we had to reject all those boards last month? We had to place a rush order with Quality Technologies costing $80.00 a board.”

“Yes, I remember. Manufacturing loved them! What nonvalue-adding costs have we been experiencing with these suppliers?”

Malcolm provides the following nonvalue-adding costs for each supplier from last month:

Respond to the following directives and question.

a. Calculate Nortec's VPI.

Purchase cost = $20 per board x 100 boards = $2,000

b. What is Quality Technologies' VPI?

Purchase cost = $80 per board x 20 boards = $1,600

c. Use the VPI's to compare the average cost per board for Nortec and Quality Technologies.

P5. KO2: Merchandiser's vendor performance measures. Best Values is a regional retail chain of men's clothing stores located in the northeastern United States . Men's shirts are purchased from 3 manufacturers: Woodsman Apparel, Sharp Dressers, and Casualwear. Information on last month's delivery performance includes:

Woodsman Apparel delivered one day early three times and one day late twice. Sharp Dressers delivered five days late once and four days late once. Casualwear delivered three days late once and two days late once.

Respond to the following directives.

a. Calculate on-time delivery and complete order filling ratios for each supplier.

b. Graph the delivery distributions for late and early deliveries.

c. Comment on the quality of each supplier's delivery performance and rank each one from best to worst.

• We believe on-time delivery and complete order filling ratios are equally important because they affect a firm's ability to provide its product or service in a timely manner to its customers. Not achieving this customer objective can result in lost sales now and in the future.

• However, missing customer delivery dates can be minimized by maintaining raw materials, work-in-process, and finished goods inventories. The amount of each inventory, and the costs to maintain it, depend on how early or late supplier deliveries are. Therefore, graphing days early/late may be the most important of the three ABM measures.

• Ranking suppliers from best to worst (a subjective evaluation):

P9. KO3: Snake chart for Sunnyside's bus system. Sunnyside is a unique city in many ways. Because of the vast expanses of land required by the major entertainment companies for their amusement parks, using the bus system to get to work can be difficult and time consuming. Assume the city has just received a matching grant from the federal government for modernization and upgrades to its bus system. To prioritize its improvement projects, Sunnyside conducted a customer survey with the following results:

Based on the above information, prepare a snake chart comparing customer importance ratings and the bus service performance ratings. Comment on each attribute's priority for the improvement projects.

Priorities:

1. New buses rated 9 in importance, but only 5 in performance.

2. Waiting time rated 7 in importance, but only 2 in performance.

Not critical:

• Weekend service is the most important factor to bus riders (10 rating). However, the city is doing an excellent job (9 rating). Therefore, other higher priorities exist.

• Number of routes is fairly important (6 rating), and the city is doing very well in providing service to all areas (8 rating).

• Bus fare is rated the lowest in importance (3) and the city is doing OK (performance rating = 7).

P3. KO2: Classifying quality costs. Maria's Import Company is a purveyor of custom Mexican and South American pottery for discriminating customers.

Classify each of the following quality activities according to the quality costs each creates.

P4. KO2: Classifying quality costs and recommending changes. Lormis Enterprises is a software development company. Believing its overall costs of quality can be reduced by increasing expenditures in certain key COQ categories, a 2nd generation ABC system was created, with the following costs accumulated for the year:

Respond to the following directive and question.

(continued)

a. Determine the total dollars being spent on each costs-of-quality category.

b. Comment on the effectiveness of Lormis's current quality efforts. On which COQ category should the company concentrate its efforts? Why?

• The company is currently spending the least amount on prevention activities.

• In order to reduce its overall quality costs, the company should concentrate its efforts on prevention because these activities reduce or eliminate poor quality and their associated costs in appraisal, internal failures, and external failures.

• As its first goal, Lormis should eliminate external failures, which may require a short-run increase in appraisal costs.

*Instructor's note: Expect some debate over classifications. For example, some may believe internal failure costs include only rejects and rework (thus, scrap is an appraisal cost). And some may have experiences with internal audit departments conducting “quality audits” to identify prevention improvements. We believe the classification criterion is asking “why” a cost was incurred. For example, retesting rework is an internal failure cost (not an appraisal cost simply because it involves inspection). If Lormis did not have rework (an internal failure cost), it would not have to be retested.

P5. KO2: Prepare a COQ report.

Using the budgeted and actual quality costs for the Baere Manufacturing, prepare a COQ report.

(continued)

Instructor's note: Expect some debate over classifications. For example, some may believe internal failure costs include only rejects and rework (thus, scrap is an appraisal cost). We believe the classification criterion is asking “why” a cost was incurred. For example, retesting rework is an internal failure cost (not an appraisal cost simply because it involves inspection). If Baere did not have rework (an internal failure cost), it would not have to be retested.

P6. KO3: Identifying value-adding and nonvalue-adding activities. The Madison Company produces lawnmower handles for several large manufacturers. The controller has just returned from an IMA conference on continuous improvement, and asks you to classify the following activities as value adding or nonvalue adding.

Indicate and justify your classifications.

P7. KO3: Identifying value-adding and nonvalue-adding activities. The Tailor Shop makes fine dress pants for men and women by taking orders over the Internet and shipping the finished garments to its customers. An internal value chain analysis lists the following activities in making a custom pair of pants.

Classify the activities as value adding or nonvalue adding. Justify your classifications.

Chapter 12

P3. KO1: Identifying and eliminating a constraint. Marie and Jean mail product samples from their home to customers requesting them from the merchandiser. The merchandiser receives the requests and sends them with big boxes of product samples to Marie and Jean. Jean types mailing labels (at a rate of 50 per hour). Marie opens the big sample boxes and picks the particular samples each customer wants, placing them in a little box to be mailed to the customer. This takes about 10 minutes per customer request. Jean then inspects each box, seals it, and places the mailing label on it. She can complete each customer box in about 5 minutes.

How can Marie and Jean increase their throughput by using TOC's five continuous improvement steps?

P4. KO2: Preparing tax forms at a CPA firm. 1040 O.K. specializes in tax return preparation for individuals, sole proprietors, and partnerships. It charges $250 for an individual return, which incurs $10 in materials and $100 in preparation time. $500 is charged for sole proprietor returns, which cost $20 in materials and $300 in labor. Partnership returns are billed at $1,000, costing $50 in materials and $600 in preparation labor. April 15th is fast approaching, and the firm has more work than time. The real constraint is with the partner's time in reviewing the returns. She needs 2 hours for an individual return, 5 hours for a sole proprietorship, and 10 hours for a partnership return.

(continued)

Respond to the following question and directives.

a. In which order should the returns be completed using a traditional contribution margin approach?

b. Calculate the contribution margin per return using TOC. Set the priorities for completing returns based on throughput.

P5. KO2: Scheduling priorities with TOC. Town and Country Nursery mixes two types of a fertilizer-weed control for home gardening. Both the Mountain Mix and the Valley Mix are sold in 50 lb. plastic containers. Mountain Mix is 75% BFG and 25% Weed Death. Valley Mix is half BFG and half Weed Death. The person who does the mixing can prepare Mountain Mix in 3 minutes and Valley Mix in 5 minutes. However, he has been called to jury duty and does not have enough time to fill all pending orders. Information about each product includes:

Determine which product should be mixed first.