chapter 08 - answer

MANAGEMENT ACCOUNTING - Solutions Manual

CHAPTER 8

COST CONCEPTS AND CLASSIFICATIONS

I. Questions

1. The phrase “different costs for different purposes” refers to the fact that the word “cost” can have different meanings depending on the context in which it is used. Cost data that are classified and recorded in a particular way for one purpose may be inappropriate for another use.

2. Fixed costs remain constant in total across changes in activity, whereas variable costs change in proportion to the level of activity.

3. Examples of direct costs of the food and beverage department in a hotel include the money spent on the food and beverages served, the wages of table service personnel, and the costs of entertainment in the dining room and lounge. Examples of indirect costs of the food and beverage department include allocations of the costs of advertising for the entire hotel, of the costs of the grounds and maintenance department, and of the hotel general manager’s salary.

4. The cost of idle time is treated as manufacturing overhead because it is a normal cost of the manufacturing operation that should be spread out among all of the manufactured products. The alternative to this treatment would be to charge the cost of idle time to a particular job that happens to be in process when the idle time occurs. Idle time often results from a random event, such as a power outage. Charging the cost of the idle time resulting from such a random event to only the job that happened to be in process at the time would overstate the cost of that job.

5. a. Uncontrollable costb. Controllable costc. Uncontrollable cost

6. Product costs are costs that are associated with manufactured goods until the time period during which the products are sold, when the product

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Chapter 8 Cost Concepts and Classifications

costs become expenses. Period costs are expensed during the time period in which they are incurred.

7. The most important difference between a manufacturing firm and a service industry firm, with regard to the classification of costs, is that the goods produced by a manufacturing firm are inventoried, whereas the services produced by a service industry firm are consumed as they are produced. Thus, the costs incurred in manufacturing products are treated as product costs until the period during which the goods are sold. Most of the costs incurred in a service industry firm to produce services are operating expenses that are treated as period costs.

8. Product costs are also called inventoriable costs because they are assigned to manufactured goods that are inventoried until a later period, when the products are sold. The product costs remain in the finished goods inventory account until the time period when the goods are sold.

9. A sunk cost is a cost that was incurred in the past and cannot be altered by any current or future decision. A differential cost is the difference in a cost item under two decision alternatives.

10. a. Direct costb. Direct costc. Indirect costd. Indirect cost

11. The two properties of a relevant cost are:

1. it differs between the decision options2. it will be incurred in the future

12. The three types of product costs are:

1. direct materials – the materials used in manufacturing the product, which become a physical part of the finished product.

2. direct labor – the labor used in manufacturing the product.3. factory overhead – the indirect costs for materials, labor, and

facilities used to support the manufacturing process, but not used directly in manufacturing the product.

13. The three types of manufacturing inventories are:

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Cost Concepts and Classifications Chapter 8

1. materials inventory – the store of materials used in the manufacturing process or in providing the service.

2. work in process inventory – accounts for all costs put into the manufacturing of products that are started but not complete at the financial statement date.

3. finished goods inventory – the cost of goods that are ready for sale.

14. Direct materials include the materials in the product and a reasonable allowance for scrap and defective units, while indirect materials are materials used in manufacturing that are not physically part of the finished product.

15. The income statement of a manufacturing company differs from the income statement of a merchandising company in the cost of goods sold section. A merchandising company sells finished goods that it has purchased from a supplier. These goods are listed as “purchases” in the cost of goods sold section. Since a manufacturing company produces its goods rather than buying them from a supplier, it lists “cost of goods manufactured” in place of “purchases.” Also, the manufacturing company identifies its inventory in this section as Finished Goods inventory, rather than as Merchandise Inventory.

16. Yes, costs such as salaries and depreciation can end up as part of assets on the balance sheet if these are manufacturing costs. Manufacturing costs are inventoried until the associated finished goods are sold. Thus, if some units are still in inventory, such costs may be part of either Work in Process inventory or Finished Goods inventory at the end of a period.

17. No. A variable cost is a cost that varies, in total, in direct proportion to changes in the level of activity. A variable cost is constant per unit of product. A fixed cost is fixed in total, but the average cost per unit changes with the level of activity.

18. Manufacturing overhead is an indirect cost since these costs cannot be easily and conveniently traced to particular units of products.

19.Direct labor cost (34 hours P15 per hour)........................ P510

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Manufacturing overhead cost (6 hours P15 per hour)....... 90Total wages earned.............................................................. P600

20.Direct labor cost (45 hours P14 per hour)....................... P630Manufacturing overhead cost (5 hours P7 per hour)....... 35Total wages earned............................. P665

II. Exercises

Exercise 1 (Schedule of Cost of Goods Manufactured and Sold; Income Statement)

Requirement 1

Amazing Aluminum CompanySchedule of Cost of Goods ManufacturedFor the Year Ended December 31, 2005

Direct material:Raw-material inventory, January 1........................ P 60,000Add: Purchases of raw material............................ 250,000Raw material available for use.............................. P310,000Deduct: Raw-material inventory, December 31 70,000

Raw material used P240,000

Direct labor................................................................. 400,000

Manufacturing overhead:Indirect material P 10,000

Indirect labor 25,000

Depreciation on plant and equipment 100,000

Utilities............................................................................................................................................

25,000

Other............................................................................................................................................

30,000

Total manufacturing overhead 190,000

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Total manufacturing costs............................................ P830,000Add: Work-in-process inventory, January 1................ 120,000Subtotal.......................................................................

.............................................................................P950,000

Deduct: Work-in-process inventory, December 1........ 115,000Cost of goods manufactured........................................ P835,000

Requirement 2

Amazing Aluminum CompanySchedule of Cost of Goods Sold

For the Year Ended December 31, 2005

Finished goods inventory, January 1............................................... P150,000Add: Cost of goods manufactured.................................................. 835,000Cost of goods available for sale...................................................... P985,000Deduct: Finished goods inventory, December 31........................... 165,000Cost of goods sold.......................................................................... P820,000

Requirement 3

Amazing Aluminum CompanyIncome Statement

For the Year Ended December 31, 2005

Sales revenue.................................................................................. P1,105,000Less: Cost of goods sold................................................................ 820,000Gross margin.................................................................................. P 285,000Selling and administrative expenses................................................ 110,000Income before taxes........................................................................ P 175,000Income tax expense........................................................................ 70,000Net income ................................................................................... P 105,000

Exercise 2

Cost ItemFixed (F)

Variable (V)Period (P)Product (R)

a. Transportation-in costs on materials purchased V R

b. Assembly-line workers’ wages V Rc. Property taxes on work in process

inventories V R

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d. Salaries of top executives in the company

F P

e. Overtime premium for assembly workers V Rf. Sales commissions V Pg. Sales personnel office rental F Ph. Production supervisory salaries F Ri. Controller’s office supplies F P

Cost ItemFixed (F)

Variable (V)Period (P)Product (R)

j. Executive office heat and air conditioning

F P

k. Executive office security personnel F Pl. Supplies used in assembly work V Rm. Factory heat and air conditioning F Rn. Power to operate factory equipment V Ro. Depreciation on furniture for sales staff F Pp. Varnish used for finishing product V Rq. Marketing personnel health insurance F Pr. Packaging materials for finished product V Rs. Salary of the quality control manager

who checks work on the assembly line F Rt. Assembly-line workers’ dental insurance F R

Exercise 3 (Cost Classifications; Manufacturer)

1. a, d, g, i2. a, d, g, j3. b, f4. b, d, g, k5. a, d, g, k6. a, d, g, j7. b, c, f8. b, d, g, k9. b, c and d*, e and f and g*, k*

* The building is used for several purposes.10. b, c, f11. b, c, h12. b, c, f

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13. b, c, e14. b, c and d†, e and f and g†, k†

† The building that the furnace heats is used for several purposes.15. b, d, g, k

Exercise 4 (Economic Characteristics of Costs)

1. marginal cost2. sunk cost3. average cost4. opportunity cost5. differential cost6. out-of-pocket cost

Exercise 5 (Cost Classifications; Hotel)

1. a, c, e, k2. b, d, e, k3. d, e, i4. d, e, i5. a, d, e, k6. a, d, e, k7. d, e, k8. b, d†, e, k

† Unless the dishwasher has been used improperly.9. h10. a, d, e*, j

* The hotel general manager may have some control over the total space allocated to the kitchen.

11. i12. j13. a, c, e14. e, k

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Exercise 6

Pickup Truck Output

3,000 trucks 6,000 trucks 9,000 trucksVariable production costs P 29,640,000 P 59,280,000 P 88,920,000Fixed production costs 39,200,000 39,200,000 39,200,000Variable selling costs 4,500,000 9,000,000 13,500,000Fixed selling costs 13,660,000 13,660,000 13,660,000Total costs P 87,000,000 P121,140,000 P155,280,000

Selling price per truck 46,000 40,100 35,900

Unit cost 29,000 20,190 17,253

Profit per truck 17,000 19,910 18,647

Exercise 7

(see next page)

Exercise 8

1. The wages of employees who build the sailboats: direct labor cost.2. The cost of advertising in the local newspapers: marketing and selling

cost.3. The cost of an aluminum mast installed in a sailboat: direct materials

cost.4. The wages of the assembly shop’s supervisor: manufacturing overhead

cost.5. Rent on the boathouse: a combination of manufacturing overhead,

administrative, and marketing and selling cost. The rent would most likely be prorated on the basis of the amount of space occupied by

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manufacturing, administrative, and marketing operations.6. The wages of the company’s bookkeeper: administrative cost.7. Sales commissions paid to the company’s salespeople: marketing and

selling cost.8. Depreciation on power tools: manufacturing overhead cost.

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Exercise 7

Period Product CostVariable

CostFixed Cost (Selling and

Administrative) CostDirect

MaterialsDirect Labor

Manufacturing Overhead

Sunk Cost Opportunity Cost

1. Wood used in a table (P200 per table) X X

2. Labor cost to assemble a table (P80 per table) X X

3. Salary of the factory supervisor (P76,000 per year)

X X

4. Cost of electricity to produce tables (P4 per machine-hour)

X X

5. Depreciation of machines used to produce tables (P20,000 per year)

X X X*

6. Salary of the company president (P200,000 per year)

X X

7. Advertising expense (P500,000 per year) X X

8. Commissions paid to salespersons (P60 per table sold)

X X

9. Rental income forgone on factory space X1

* This is a sunk cost because the outlay for the equipment was made in a previous period.1 This is an opportunity cost because it represents the potential benefit that is lost or sacrificed as a result of using the factory space to produce tables. Opportunity

cost is a special category of cost that is not ordinarily recorded in an organization’s accounting books. To avoid possible confusion with other costs, we will not attempt to classify this cost in any other way except as an opportunity cost.

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Exercise 9

Direct

Indirect

Cost Cost Object Cost Cost1. The salary of the head chef The hotel’s restaurant X2. The salary of the head chef A particular restaurant

customerX

3. Room cleaning supplies A particular hotel guest X4. Flowers for the reception

deskA particular hotel guest X

5. The wages of the doorman A particular hotel guest X6. Room cleaning supplies The housecleaning

departmentX

7. Fire insurance on the hotel building

The hotel’s gym X

8. Towels used in the gym The hotel’s gym X

Note: The room cleaning supplies would most likely be considered an indirect cost of a particular hotel guest because it would not be practical to keep track of exactly how much of each cleaning supply was used in the guest’s room.

III. Problems

Problem 1

The relevant costs for this decision are the differential costs. These are:

Opportunity cost or lost wages (take home)[P1,500 x 70% x 12 months]....... P12,600

Tuition.................................................. 2,200Books and supplies................................ 300

Total differential costs..................... P15,100

Room and board, clothing, car, and incidentals are not relevant because these are presumed to be the same whether or not Francis goes to school. The possibility of part-time work, summer jobs, or scholarship assistance could be considered as reductions to the cost of school. If students are familiar with the time value of money, then they should recognize that the analysis calls for a comparison of the present value of the differential after-tax cash

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inflows with the present value of differential costs of getting the education (including the opportunity costs of lost income).Problem 2

Requirement (a)

Only the differential outlay costs need be considered. The travel and other variable expenses of P22 per hour would be the relevant costs. Any amount received in excess would be a differential, positive return to Pat.

Requirement (b)

The opportunity cost of the hours given up would be considered in this situation. Unless Pat receives more than the P100 normal consulting rate, the contract would not be beneficial.

Requirement (c)

In this situation Pat would have to consider the present value of the contract and compare that to the present value of the existing consulting business. The final rate may be more or less than the normal P100 rate depending on the outcome of Pat’s analysis.

Problem 3

Utilities for the bakery 2,100Paper used in packaging product 90Salaries and wages in the bakery 19,500Cookie ingredients 35,000Bakery labor and fringe benefits 1,300Bakery equipment maintenance 800Depreciation of bakery plant and equipment 2,000Uniforms 400Insurance for the bakery 900Boxes, bags, and cups used in the bakery 1,100Bakery overtime premiums 2,600Bakery idle time 500Total product costs in pesos 66,290

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Problem 4

Administrative costs 1,000Rent for administration offices 17,200Advertising 1,900Office manager’s salary 13,000Total period costs in pesos 33,100

Problem 5

Requirement (a)

Sunk costs not shown could include lost book value on traded assets, depreciation estimates for new investment, and interest costs on capital needed during facilities construction.

Requirement (b)

The client might be used to differential cost as a decision tool, and believes (correctly) that use of differential analyses has several advantages --- it is quicker, requires less data, and tends to give a better focus to the decision. The banker might suspect the client of hiding some material data in order to make the proposal more acceptable to the financing agency.

Problem 6

Requirement (1)

EH CorporationSchedule of Cost of Goods Manufactured

For the Year Ended December 31

Direct materials:Raw materials, inventory, January 1 P 45,000Add: Purchases of raw materials 375,000Raw materials available for use 420,000Deduct: Raw materials inventory,

December 31 30,000Raw materials used in production P 390,000

Direct labor 75,000

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Manufacturing overhead:Utilities, factory 18,000Depreciation, factory 81,000Insurance, factory 20,000Supplies, factory 7,500Indirect labor 150,000Maintenance, factory 43,500

Total manufacturing overhead cost 320,000Total manufacturing cost 785,000Add: Work in process inventory, January 1 90,000

875,000Deduct: Work in process inventory,

December 31 50,000Cost of goods manufactured P825,000

Requirement (2)

The cost of goods sold would be computed as follows:

Finished goods inventory, January 1 P130,000Add: Cost of goods manufactured 825,000Goods available for sale 955,000Deduct: Finished goods inventory, December 31 105,000Cost of goods sold P850,000

Requirement (3)

EH CorporationIncome Statement

For the Year Ended December 31

Sales P1,250,000Cost of goods sold (above) 850,000Gross margin 400,000Selling and administrative expenses:

Selling expenses P 70,000Administrative expenses 135,000 205,000

Net operating income P 195,000

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Problem 7

Note to the Instructor: Some of the answers below are debatable.

Cost ItemVariable or

FixedSelling Cost

Adminis-trative Cost

Manufacturing (Product) Cost

Direct Indirect1. Depreciation, executive jet......................................................................... F X2. Costs of shipping finished goods to customers........................................... V X3. Wood used in manufacturing furniture....................................................... V X4. Sales manager’s salary............................................................................... F X5. Electricity used in manufacturing furniture................................................ V X6. Secretary to the company president............................................................ F X7. Aerosol attachment placed on a spray can produced by the company.......... V X8. Billing costs.............................................................................................. V X*9. Packing supplies for shipping products overseas........................................ V X

10. Sand used in manufacturing concrete......................................................... V X11. Supervisor’s salary, factory........................................................................ F X12. Executive life insurance............................................................................. F X13. Sales commissions.................................................................................... V X14. Fringe benefits, assembly line workers...................................................... V X**15. Advertising costs....................................................................................... F X16. Property taxes on finished goods warehouses............................................. F X17. Lubricants for production equipment......................................................... V X

*Could be an administrative cost.**Could be an indirect cost.

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Cost Concepts and Classifications Chapter 8Problem 8

Requirement (1)

Period

Product Cost(Selling

andVariable Fixed Direct Direct Mfg. Admin.) Opportunity Sunk

Name of the Cost Cost Cost Materials Labor Overhead Cost Cost CostLing’s present salary of P400,000 per

month....................................................................... XRent on the garage, P15,000 per month......................... X XRent of production equipment, P50,000 per

month....................................................................... X XMaterials for producing flyswatters, at

P30.00 each..............................................................X XLabor cost of producing flyswatters, at

P50.00 each..............................................................X XRent of room for a sales office, P7,500 per

month....................................................................... X XAnswering device attachment, P2,000 per

month....................................................................... X XInterest lost on savings account, P100,000

per year..................................................................... XAdvertising cost, P40,000 per month............................. X XSales commission, at P10.00 per flyswatter...................X X Legal and filing fees, P60,000....................................... X

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Requirement (2)

The P60,000 legal and filing fees are not a differential cost. These legal and filing fees have already been paid and are a sunk cost. Thus, the cost will not differ depending on whether Ling decides to produce flyswatters or to stay with the consulting firm. All other costs listed above are differential costs since they will be incurred only if Ling leaves the consulting firm and produces the flyswatters.

Problem 9

Requirement (1)

Ms. Rio’s first action was to direct that discretionary expenditures be delayed until the first of the new year. Providing that these “discretionary expenditures” can be delayed without hampering operations, this is a good business decision. By delaying expenditures, the company can keep its cash a bit longer and thereby earn a bit more interest. There is nothing unethical about such an action. The second action was to ask that the order for the parts be cancelled. Since the clerk’s order was a mistake, there is nothing unethical about this action either.

The third action was to ask the accounting department to delay recognition of the delivery until the bill is paid in January. This action is dubious. Asking the accounting department to ignore transactions strikes at the heart of the integrity of the accounting system. If the accounting system cannot be trusted, it is very difficult to run a business or obtain funds from outsiders. However, in Ms. Rio’s defense, the purchase of the raw materials really shouldn’t be recorded as an expense. He has been placed in an extremely awkward position because the company’s accounting policy is flawed.

Requirement (2)

The company’s accounting policy with respect to raw materials is incorrect. Raw materials should be recorded as an asset when delivered rather than as an expense. If the correct accounting policy were followed, there would be no reason for Ms. Rio to ask the accounting department to delay recognition of the delivery of the raw materials. This flawed accounting policy creates incentives for managers to delay deliveries of raw materials until after the end of the fiscal year. This could lead to raw materials shortages and poor relations with suppliers who would like to record their sales before the end

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of the year.

The company’s “manage-by-the-numbers” approach does not foster ethical behavior—particularly when managers are told to “do anything so long as you hit the target profits for the year.” Such “no excuses” pressure from the top too often leads to unethical behavior when managers have difficulty meeting target profits.

IV. Multiple Choice Questions

1. B 7. C 13. D 19. A 25. C2. D 8. D 14. D † 20. A * 26. B3. B 9. C 15. B † 21. B 27. B4. A 10. C 16. A † 22. B 28. A **5. C 11. A 17. C † 23. C 29. A6. D 12. C 18. C 24. C 30. B

* Controllable costs are those costs that can be influenced by a specified manager within a given time period.

** The answer assumes absorption costing method is used.† Supporting Computations

14. P60 + P10 + P18 + P4 = P92 16. P60 + P10 + P18 + P32 = P12015. P32 + P16 = P48 17. P4 + P16 = P20

chapter 08 - answer

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