Product Cost. Direct Material s. Vari able Cost. Fixed Cost

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Ambrose Morris Burns
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1 Problem Vari able Fixed Direct Material s Product Direct Labour Mfg. Overh ead Period (sellin g and admin) Opport unity Name of the Staci's current salary, $3,800 per month... X X Building rent, $500 per month... X X Clay and glaze, $2 per pot... X X Wages of production workers, $8 per pot... X X Advertising, $600 per month... X X Sales commission, $4 per pot... X X Rent of production equipment, $300 per month... X X Legal and filing fees, $ X X X Rent of sales office, $250 per month... X X Phone for taking orders, $40 per month... X X Recording device added to phone X X Interest lost on savings account, $1,200 per year... X X Sunk 2. The $500 cost of incorporating the business is not a differential cost. Even though the cost was incurred to start the business, it is a sunk cost. Whether Staci produces pottery or stays in her present job, she will have incurred this cost. 1

2 Case No distinction has been made between period expenses and product costs on the income statement filed by the company s accountant. Product costs (e.g., direct materials, direct labour, and manufacturing overhead) should be assigned to inventory accounts and flow through to the income statement as cost of goods sold only when finished products are sold. Since there were ending inventories, some of the product costs should appear on the balance sheet as assets rather than on the income statement as expenses. 2. Solar Technology, Inc. Schedule of of Goods Manufactured For the Quarter Ended March 31 Direct materials: Raw materials inventory, beginning... $ 0 Add: Purchases of raw materials ,000 Raw materials available for use ,000 Deduct: Raw materials inventory, ending... 10,000 Raw materials used in production... $350,000 Direct labour... 70,000 Manufacturing overhead: Maintenance, production... 43,000 Indirect labour ,000 Cleaning supplies, production... 7,000 Rental cost, facilities (80% x $75,000)... 60,000 Insurance, production... 8,000 Utilities (90% x $80,000)... 72,000 Depreciation, production equipment ,000 Total overhead costs ,000 Total manufacturing costs ,000 Add: Work in process inventory, beginning ,000 Deduct: Work in process inventory, ending... 50,000 of goods manufactured... $780,000 2

3 Case 2-31 (continued) 3. Before an income statement can be prepared, the cost of the 8,000 batteries in the ending finished goods inventory must be determined. Altogether, the company produced 40,000 batteries during the quarter; thus, the production cost per battery would be: of goods manufactured Batteries produced during the quarter = $780,000 =$19.50 per unit 40,000 units Since 8,000 batteries (40,000 x 32,000 = 8,000) were in the finished goods inventory at the end of the quarter, the total cost of this inventory would be: 8,000 units x $19.50 per unit = $156,000. With this figure and other data from the case, the company s income statement for the quarter can be prepared as follows: Solar Technology, Inc. Income Statement For the Quarter Ended March 31 Sales (32,000 batteries)... $960,000 Less cost of goods sold: Finished goods inventory, beginning... $ 0 Add: of goods manufactured ,000 Goods available for sale ,000 Deduct: Finished goods inventory, ending.. 156, ,000 Gross margin ,000 Less operating expenses: Selling and administrative salaries ,000 Advertising... 90,000 Rental cost, facilities (20% x $75,000)... 15,000 Depreciation, office equipment... 27,000 Utilities (10% x $80,000)... 8,000 Travel, salespersons... 40, ,000 Net operating income... $ 46,000 3

4 Case 2-31 (continued) 4. No, the insurance company probably does not owe Solar Technology $226,000. The key question is how cost was defined in the insurance contract. It is most likely that the insurance contract limits reimbursement for losses to those costs that would normally be considered product costs in other words, direct materials, direct labour, and manufacturing overhead. The $226,000 figure is overstated since it includes elements of selling and administrative expenses as well as all of the product costs. The $226,000 figure also does not recognize that some costs incurred during the period are in the ending Raw Materials and Work in Process inventory accounts, as explained in part (1) above. The insurance company s liability is probably just $156,000, which is the amount of cost associated with the ending Finished Goods inventory as shown in part (3) above. 4

5 Problem a. 3 c. 11 e. 4 g. 2 i. 9 b. 6 d. 1 f. 10 h Without a knowledge of the underlying cost behaviour patterns, it would be difficult if not impossible for a manager to properly analyze the firm s cost structure. The reason is that all costs don t behave in the same way. One cost might move in one direction as a result of a particular action, and another cost might move in an opposite direction. Unless the behaviour pattern of each cost is clearly understood, the impact of a firm s activities on its costs will not be known until after the activity has occurred. 5

6 Problem The CM ratio is 30%. Total Per Unit Percent of Sales Sales (19,500 units)...$585,000 $ % Less variable expenses , Contribution margin...$175,500 $ % The break-even point is: Sales = Variable expenses + Fixed expenses + Profits $30.00Q = $21.00Q + $180,000 + $0 $9.00Q = $180,000 Q = $180,000 $9.00 per unit Q = 20,000 units 20,000 units x $30.00 per unit = $600,000 in sales. Alternative solution: Break-even point in unit sales Fixed expenses = Unit contribution margin = $180,000 =20,000 units $9.00 per unit Break-even point expenses =Fixed in sales dollars CM ratio = $180,000 = $600,000 in sales Incremental contribution margin: $80,000 increased sales x 0.30 CM ratio... $24,000 Less increased advertising cost... 16,000 Increase in monthly operating income... $ 8,000 Since the company is now showing a loss of $4,500 per month, if the changes are adopted, the loss will turn into a profit of $3,500 each month ($8,000 less $4,500 = $3,500). 6

7 Problem 6-19 (continued) 3. Sales (39,000 $27.00 per unit*)... $1,053,000 Less variable expenses (39,000 $21.00 per unit) ,000 Contribution margin ,000 Less fixed expenses ($180,000 + $60,000) ,000 Operating loss... $ (6,000) *$30.00 ($30.00 x 0.10) = $ Sales = Variable expenses + Fixed expenses + Profits $30.00Q = $21.75Q* + $180,000 + $9,750 $8.25Q = $189,750 Q = $189,750 $8.25 per unit Q = 23,000 units *$ $0.75 = $21.75 Alternative solution: Unit sales to attain Fixed expenses + Target profit = target profit CM per unit **$30.00 $21.75 = $ a. The new CM ratio would be: $180,000 + $9,750 = =23,000 units $8.25 per unit** Per Unit Percent of Sales Sales... $ % Less variable expenses Contribution margin... $ % 7

8 Problem 6-19 (continued) The new break-even point would be: Break-even point in unit sales Fixed expenses = Unit contribution margin $180,000 + $72,000 = =21,000 units $12.00 per unit Break-even point expenses =Fixed in sales dollars CM ratio $180,000 + $72,000 = =$630, b. Comparative income statements follow: Not Automated Per Unit % Total Automated Per Unit % Total Sales (26,000 units)... $780,000 $ % $780,000 $ % Less variable expenses , , Contribution margin ,000 $ % 312,000 $ % Less fixed expenses , ,000 Operating income... $ 54,000 $ 60,000 c. Whether or not the company should automate its operations depends on how much risk the company is willing to take and on prospects for future sales. The proposed changes would increase the company s fixed costs and its break-even point. However, the changes would also increase the company s CM ratio (from 0.30 to 0.40). The higher CM ratio means that once the break-even point is reached, profits will increase more rapidly than at present. If 26,000 units are sold next month, for example, the higher CM ratio will generate $6,000 more in profits than if no changes are made. 8

9 Problem 6-19 (continued) The greatest risk of automating is that future sales may drop back down to present levels (only 19,500 units per month), and as a result, losses will be even larger than at present due to the company s greater fixed costs. (Note the problem states that sales are erratic from month to month.) In summary, the proposed changes will help the company if sales continue to trend upward in future months; the changes will hurt the company if sales drop back down to or near present levels. Note to the Instructor: Although it is not asked for in the problem, if time permits you may want to compute the point of indifference between the two alternatives in terms of units sold; i.e., the point where profits will be the same under either alternative. At this point, total revenue will be the same; hence, we include only costs in our equation: Let Q = Point of indifference in units sold $21.00Q + $180,000 = $18.00Q + $252,000 $3.00Q = $72,000 Q = $72,000 $3.00 per unit Q = 24,000 units If more than 24,000 units are sold in a month, the proposed plan will yield the greater profits; if less than 24,000 units are sold in a month, the present plan will yield the greater profits (or the least loss). 9

ASSIGNMENT MEMORANDUM. QUESTION 1 Suggested solution [25]

ASSIGNMENT MEMORANDUM. QUESTION 1 Suggested solution [25] Page 1 of 10 PLEASE NOTE: = 1 mark ½ = half a mark ASSIGNMENT MEMORANDUM SUBJECT : NAGEMENT ACCOUNTING () ASSIGNMENT : 1 ST SEMESTER 2012 QUESTION 1 Suggested solution [25] 1. The CM ratio is 30%. Total