COMPLETE
SOLUTION MANUAL FOR MANAGERIAL ACCOUNTING 15TH EDITION BY GARRISON
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Chapter
2
Managerial Accounting and Cost Concepts
Solutions to Questions
2–1 What are the three major
elements of product costs in a manufacturing company?
2–2 Define the following: (a)
direct materials, (b) indirect materials, (c) direct labor, (d)
indirect
labor, and (e) manufacturing overhead.
2–3 Explain the difference
between a product cost and a period cost.
2–4 Distinguish between ( a )
a variable cost, ( b ) a fixed cost, and ( c ) a mixed cost.
2–5 What effect does an increase
in volume have on—
a. Unit
fixed costs?
b. Unit
variable costs?
c. Total
fixed costs?
d. Total
variable costs?
2–6 Define the following terms:
( a ) cost behavior and ( b ) relevant range.
2–7 What is meant by an activity base when dealing with variable costs? Give several examples
of activity bases.
2–8 Managers often assume a
strictly linear relationship between cost and volume. How can
this practice be defended in light of the fact that many costs are
curvilinear?
2–9 Distinguish between
discretionary fixed costs and committed fixed costs.
2–10 Does the concept of the
relevant range apply to fixed costs? Explain.
2–11 What is the major
disadvantage of the high-low method?
2–12 Give the general formula for
a mixed cost. Which term represents the variable cost? The
fixed cost?
2–13 What is meant by the term least-squares regression?
2–14 What is the difference
between a contribution format income statement and a traditional
format income statement?
2–15 What is the contribution
margin?
2–16 Define the following terms:
differential cost, opportunity cost, and sunk cost.
2–17 Only variable costs can be
differential costs. Do you agree? Explain.
Multiple-choice questions are provided on the text website.
Applying Excel
Available with McGraw-Hill’s Connect® Accounting.
The Excel worksheet form that appears on the n ext page is to be
used to recreate Exhibit 2–9 on
page 44. Download the workbook containing this form from the
Online Learning Center at www.
mhhe.com/garrison15e .
On the website you will
also receive instructions about how to use this
worksheet form.
LO2–6
Required:
1. For financial accounting purposes, what is the total
amount of product costs incurred to make
10,000 units?
2. For financial accounting purposes, what is the total
amount of period costs incurred to sell
10,000 units?
3. If 8,000 units are sold, what is the variable cost per
unit sold?
4. If 12,500 units are sold, what is the variable cost per
unit sold?
5. If 8,000 units are sold, what is the total amount of
variable costs related to the units sold?
6. If 12,500 units are sold, what is the total amount of
variable costs related to the units sold?
7. If 8,000 units are produced, what is the average fixed
manufacturing cost per unit
produced?
8. If 12,500 units are produced, what is the average fixed
manufacturing cost per unit
produced?
9. If 8,000 units are produced, what is the total amount of
fixed manufacturing cost incurred to
support this level of production?
10. If 12,500 units are produced, what is the total amount of
fixed manufacturing cost incurred to
support this level of production?
11. If 8,000 units are produced, what is the total amount of
manufacturing overhead cost
incurred to support this level of production? What is this
total amount expressed on a per
unit basis?
12. If 12,500 units are produced, what is the total amount of
manufacturing overhead cost
incurred to support this level of production? What is this
total amount expressed on a per
unit basis?
13. If the selling price is $22 per unit, what is the
contribution margin per unit sold?
14. If 11,000 units are produced, what are the total amounts
of direct and indirect manufacturing
costs incurred to support this level of production?
15. What total incremental cost will
Martinez incur if it increases production from 10,000 to
All applicable exercises are available with
McGraw-Hill’s Connect® Accounting.
EXERCISE 2–1
Identifying Direct and Indirect Costs [ LO2–1]
Northwest Hospital is a full-service hospital that provides
everything from major surgery and
emergency room care to outpatient clinics.
Required:
For each cost incurred at Northwest Hospital, indicate whether it
would most likely be a direct cost
or an indirect cost of the specified cost object by placing an X in the appropriate column
Chapter 2
Cost Cost Object
Direct
Cost
Indirect
Cost
Ex. Catered food served to patients A
particular patient X
1. The wages of pediatric nurses The
pediatric department
2. Prescription drugs A particular
patient
3. Heating the hospital The pediatric
department
4. The salary of the head of pediatrics
The pediatric department
5. The salary of the head of pediatrics A
particular pediatric patient
6. Hospital chaplain’s salary A
particular patient
7. Lab tests by outside contractor A
particular patient
8. Lab tests by outside contractor A
particular department
EXERCISE 2–2
Classifying Manufacturing Costs [LO2–2]
The PC Works assembles custom computers from components supplied
by various manufacturers.
The company is very small and its assembly shop and retail sales
store are housed in a single facility
in a Redmond, Washington, industrial park. Listed below are some
of the costs that are incurred
at the company.
Required:
For each cost, indicate whether it would most likely be classified
as direct labor, direct materials,
manufacturing overhead, selling, or an administrative cost.
1. The cost of a hard drive installed in a computer.
2. The cost of advertising in the Puget Sound Computer User newspaper.
3. The wages of employees who assemble computers
from components.
4. Sales commissions paid to the company’s
salespeople.
5. The wages of the assembly shop’s supervisor.
6. The wages of the company’s accountant.
7. Depreciation on equipment used to test
assembled computers before release to customers.
8. Rent on the facility in the industrial park.
EXERCISE 2–3 Classification of Costs as Product or
Period Cost
Suppose that you have been given a summer job as
an intern at Issac Aircams, a company that manufactures
sophisticated spy cameras for remote-controlled
military reconnaissance aircraft. The
company, which is privately owned, has approached
a bank for a loan to help it finance its growth.
The bank requires financial statements before
approving such a loan. You have been asked to help
prepare the financial statements and were given
the following list of costs:
1. Depreciation on salespersons’ cars.
2. Rent on equipment used in the factory.
3. Lubricants used for machine maintenance.
4. Salaries of personnel who work in the finished
goods warehouse.
5. Soap and paper towels used by factory workers
at the end of a shift.
6. Factory supervisors’ salaries.
7. Heat, water, and power consumed in the
factory.
8. Materials used for boxing products for
shipment overseas. (Units are not normally boxed.)
9. Advertising costs.
10. Workers’ compensation insurance for factory
employees.
11. Depreciation on chairs and tables in the
factory lunchroom.
12. The wages of the receptionist in the
administrative offices.
13. Cost of leasing the corporate jet used by the
company’s executives.
14. The cost of renting rooms at a Florida resort
for the annual sales conference.
15. The cost of packaging the company’s product.
Required:
Classify the above costs as either product costs or period costs for the purpose of preparing the
financial statements for the bank.
EXERCISE 2–4
Fixed and Variable Cost Behavior
Espresso Express operates a number of espresso coffee stands in
busy suburban malls. The fixed
weekly
expense of a coffee stand is $1,200 and the variable cost per cup of coffee
served is $0.22
Managerial
Accounting and Cost Concepts 55
Required:
1. Fill in the following table with your estimates of total costs
and cost per cup of coffee at the
indicated levels of activity for a coffee stand. Round off the
cost of a cup of coffee to the nearest
tenth of a cent.
Cups of Coffee Served in a Week
2,000 2,100 2,200
Fixed cost . . . . . . . . . . . . . . . . . . . . . . . . . . . ?
? ?
Variable cost . . . . . . . . . . . . . . . . . . . . . . . . . ?
? ?
Total cost . . . . . . . . . . . . . . . . . . . . . . . . . . . .
? ? ?
Average cost per cup of coffee served . . . . . ? ? ?
2. Does the average cost per cup of coffee served increase,
decrease, or remain the same as the
number of cups of coffee served in a week increases? Explain.
EXERCISE 2–5
High-Low Method
The Cheyenne Hotel in Big Sky, Montana, has accumulated records of
the total electrical costs
of the hotel and the number of occupancy-days over the last year.
An occupancy-day represents a
room rented out for one day. The hotel’s business is highly
seasonal, with peaks occurring during
the ski season and in the summer.
Month Occupancy-Days Electrical Costs
January . . . . . . . . 1,736 $4,127
February . . . . . . . 1,904 $4,207
March . . . . . . . . . 2,356 $5,083
April . . . . . . . . . . 960 $2,857
May . . . . . . . . . . . 360 $1,871
June . . . . . . . . . . 744 $2,696
July . . . . . . . . . . . 2,108 $4,670
August . . . . . . . . 2,406 $5,148
September . . . . . 840 $2,691
October . . . . . . . 124 $1,588
November . . . . . . 720 $2,454
December . . . . . . 1,364 $3,529
Required:
1. Using the high-low method, estimate the fixed cost of
electricity per month and the variable
cost of electricity per occupancy-day. Round off the fixed cost to
the nearest whole dollar and
the variable cost to the nearest whole cent.
2. What other factors other than occupancy-days are likely to
affect the variation in electrical
costs from month to month?
EXERCISE 2–6
Traditional and Contribution Format Income Statements
Cherokee Inc. is a merchandiser that provided the
following information:
Amount
Number of units sold
. . . . . . . . . . . . . . . . . . . . . . . . 20,000
Selling price per
unit . . . . . . . . . . . . . . . . . . . . . . . . $30
Variable selling
expense per unit . . . . . . . . . . . . . . . $4
Variable
administrative expense per unit . . . . . . . . . $2
Total fixed selling
expense . . . . . . . . . . . . . . . . . . . $40,000
Total fixed
administrative expense . . . . . . . . . . . . . $30,000
Beginning
merchandise inventory . . . . . . . . . . . . . . $24,000
Ending merchandise
inventory . . . . . . . . . . . . . . . . $44,000
Merchandise
purchases . . . . . . . . . . . . . . . . . . . . . $180,000
Chapter 2
Required:
1. Prepare a traditional income statement.
2. Prepare a contribution format income
statement.
EXERCISE 2–7
Differential, Opportunity, and Sunk Costs
Northwest Hospital is a full-service hospital
that provides everything from major surgery and
emergency room care to outpatient clinics. The
hospital’s Radiology Department is considering
replacing an old inefficient X-ray machine with a
state-of-the-art digital X-ray machine. The
new machine would provide higher quality X-rays
in less time and at a lower cost per X-ray. It
would also require less power and would use a
color laser printer to produce easily readable X-ray
images. Instead of investing the funds in the new
X-ray machine, the Laboratory Department is
lobbying the hospital’s management to buy a new
DNA analyzer.
Required:
For each of the items below, indicate by placing
an X in the appropriate column whether it should
be considered a differential cost, an opportunity
cost, or a sunk cost in the decision to replace the
old X-ray machine with a new machine. If none of
the categories apply for a particular item, leave
all columns blank.
Item
Differential
Cost
Opportunity
Cost
Sunk
Cost
Ex. Cost of X-ray
film used in the old machine X
1. Cost of the old
X-ray machine . . . . . . . . . . . . . . . . . . . . . .
2. The salary of the
head of the Radiology Department . . . .
3. The salary of the
head of the Pediatrics Department . . . .
4. Cost of the new
color laser printer . . . . . . . . . . . . . . . . . .
5. Rent on the space
occupied by Radiology . . . . . . . . . . .
6. The cost of
maintaining the old machine . . . . . . . . . . . . .
7. Benefits from a
new DNA analyzer . . . . . . . . . . . . . . . . . .
8. Cost of
electricity to run the X-ray machines . . . . . . . . . .
EXERCISE 2–8
Cost Behavior; High-Low Method
Hoi Chong Transport, Ltd., operates a fleet of delivery trucks in
Singapore. The company has
determined that if a truck is driven 105,000 kilometers during a
year, the average operating cost
is 11.4 cents per kilometer. If a truck is driven only 70,000
kilometers during a year, the average
operating cost increases to 13.4 cents per kilometer.
Required:
1. Using the high-low method, estimate the variable and fixed cost
elements of the annual cost of
the truck operation.
2. Express the variable and fixed costs in the form Y 5 a 1 bX.
3. If a truck were driven 80,000 kilometers during a year, what
total cost would you expect to be
incurred?
EXERCISE 2–9
Cost Terminology for Manufacturers
Arden Company reported the following costs and
expenses for the most recent month:
Direct materials . .
. . . . . . . . . . . . . . . . . . . . $80,000
Direct labor . . . .
. . . . . . . . . . . . . . . . . . . . . $42,000
Manufacturing
overhead . . . . . . . . . . . . . . . $19,000
Selling expenses . .
. . . . . . . . . . . . . . . . . . . $22,000
Administrative
expenses . . . . . . . . . . . . . . . $35,000
Required:
1. What is the total amount of product costs?
2. What is the total amount of period costs?
3. What is the total amount of conversion costs?
4. What is the total amount of prime costs?
EXERCISE
2–10 Cost Behavior; Contribution Format Income Statement
Harris Company manufactures and sells a single
product. A partially completed schedule of the
company’s total and per unit costs over the
relevant range of 30,000 to 50,000 units produced and
sold annually is given
below:
Managerial Accounting and Cost Concepts 57
Units Produced and
Sold
30,000 40,000 50,000
Total costs:
Variable costs . . .
. . $180,000 ? ?
Fixed costs . . . .
. . . 300,000 ? ?
Total costs . . . .
. . . . . . $480,000 ? ?
Cost per unit:
Variable cost . . .
. . . ? ? ?
Fixed cost . . . . .
. . . ? ? ?
Total cost per unit
. . . . ? ? ?
Required:
1. Complete the schedule of the company’s total
and unit costs above.
2. Assume that the company produces and sells
45,000 units during the year at a selling price of
$16 per unit. Prepare a contribution format
income statement for the year.
EXERCISE
2–11 High-Low Method; Scattergraph Analysis
The following data relating to units shipped and
total shipping expense have been assembled by
Archer Company, a wholesaler of large, custom-built
air-conditioning units for commercial buildings:
Month
Units
Shipped
Total Shipping
Expense
January . . . . . .
. . . 3 $1,800
February . . . . . .
. . 6 $2,300
March . . . . . . .
. . . 4 $1,700
April . . . . . . .
. . . . 5 $2,000
May . . . . . . . .
. . . . 7 $2,300
June . . . . . . . .
. . . . 8 $2,700
July . . . . . . . .
. . . . 2 $1,200
Required:
1. Prepare a scattergraph using the data given
above. Plot cost on the vertical axis and activity
on the horizontal axis. Is there an approximately
linear relationship between shipping expense
and the number of units shipped?
2. Using the high-low method, estimate the cost
formula for shipping expense. Draw a straight
line through the high and low data points shown
in the scattergraph that you prepared in
requirement 1. Make sure your line intersects the
Y axis.
3. Comment on the accuracy of your high-low
estimates assuming a least-squares regression
analysis estimated the total fixed costs to be
$910.71 per month and the variable cost to be
$217.86 per unit. How would the straight line
that you drew in requirement 2 differ from a
straight line that minimizes the sum of the
squared errors?
4. What factors, other than the number of units
shipped, are likely to affect the company’s shipping
expense? Explain.
EXERCISE
2–12 Cost Classification
Wollogong Group Ltd. of New South Wales,
Australia, acquired its factory building about 10 years
ago. For several years, the company has rented
out a small annex attached to the rear of the building.
The company has received a rental income of
$30,000 per year on this space. The renter’s
lease will expire soon, and rather than renewing
the lease, the company has decided to use the
space itself to manufacture a new product.
Direct materials cost for the new product will
total $80 per unit. To have a place to store
finished units of product, the company will rent
a small warehouse nearby. The rental cost will
be $500 per month. In addition, the company must
rent equipment for use in producing the new
product; the rental cost will be $4,000 per
month. Workers will be hired to manufacture the new
product, with direct labor cost amounting to $60
per unit. The space in the annex will continue to
be depreciated on a straight-line basis, as in
prior years. This depreciation is $8,000 per year.
Advertising costs for the new product will total
$50,000 per year. A supervisor will be hired to
oversee production; her salary will be $1,500 per
month. Electricity for operating machines will be
$1.20 per unit. Costs of
shipping the new product to customers will be $9 per unit
Chapter 2
To provide funds to purchase materials, meet
payrolls, and so forth, the company will have to
liquidate some temporary investments. These
investments are presently yielding a return of about
$3,000 per year.
Required:
Prepare an answer sheet with the following column
headings:
Period
Name (Selling and
of the Variable
Fixed Direct Direct Manufacturing Administrative) Opportunity Sunk
Cost Cost Cost
Materials Labor Overhead Cost Cost Cost
Product Cost
List the different costs associated with the new
product decision down the extreme left column
(under Name of the Cost). Then place an X under each heading that helps to describe the type
of cost involved. There may be X’ s under several column headings for a single cost. (For example,
a cost may be a fixed cost, a period cost, and a
sunk cost; you would place an X under each of these
column headings opposite the cost.)
EXERCISE
2–13 Traditional and Contribution Format Income Statements
The Alpine House, Inc., is a large retailer of
snow skis. The company assembled the information
shown below for the quarter ended March 31:
Amount
Total sales revenue
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $150,000
Selling price per
pair of skis . . . . . . . . . . . . . . . . . . . . . . . $750
Variable selling
expense per pair of skis . . . . . . . . . . . . . $50
Variable administrative
expense per pair of skis . . . . . . . $10
Total fixed selling
expense . . . . . . . . . . . . . . . . . . . . . . . . $20,000
Total fixed
administrative expense . . . . . . . . . . . . . . . . . . $20,000
Beginning
merchandise inventory . . . . . . . . . . . . . . . . . . $30,000
Ending merchandise
inventory . . . . . . . . . . . . . . . . . . . . . $40,000
Merchandise
purchases . . . . . . . . . . . . . . . . . . . . . . . . . . $100,000
Required:
1. Prepare a traditional income statement for the
quarter ended March 31.
2. Prepare a contribution format income statement
for the quarter ended March 31.
3. What was the contribution toward fixed
expenses and profits for each pair of skis sold during
the quarter? (State this figure in a single
dollar amount per pair of skis.)
EXERCISE
2–14 High-Low Method; Predicting Cost
The Lakeshore Hotel’s guest-days of occupancy and
custodial supplies expense over the last seven
months were:
Month
Guest-Days
of Occupancy
Custodial
Supplies Expense
March . . . . . . .
. . . . . . . . . . . . . . 4,000 $7,500
April . . . . . . .
. . . . . . . . . . . . . . . . 6,500 $8,250
May . . . . . . . .
. . . . . . . . . . . . . . . 8,000 $10,500
June . . . . . . . .
. . . . . . . . . . . . . . . 10,500 $12,000
July . . . . . . . .
. . . . . . . . . . . . . . . 12,000 $13,500
August . . . . . . .
. . . . . . . . . . . . . . 9,000 $10,750
September . . . . .
. . . . . . . . . . . . . 7,500 $9,750
Guest-days is a measure of the overall activity
at the hotel. For example, a guest who stays at
the hotel for three days is counted as three
guest-days.
Required:
1. Using the high-low method, estimate a cost
formula for custodial supplies expense.
2. Using the cost formula you derived above, what
amount of custodial supplies expense would
you expect to be incurred at an occupancy level
of 11,000 guest-days?
3. Prepare a scattergraph using the data given
above. Plot custodial supplies expense on the vertical
axis and the number of
guest-days occupied on the horizontal axis. Draw a straight line
Managerial Accounting and Cost Concepts 59
through the two data points that correspond to
the high and low levels of activity. Make sure
your line intersects the Y -axis.
4. Comment on the accuracy of your high-low
estimates assuming a least-squares regression
analysis estimated the total fixed costs to be
$3,973.10 per month and the variable cost to be
$0.77 per guest-day. How would the straight line
that you drew in requirement 3 differ from a
straight line that minimizes the sum of the
squared errors?
5. Using the least-squares regression estimates
given in requirement 4, what custodial supplies
expense would you expect to be incurred at an
occupancy level of 11,000 guest-days?
EXERCISE
2–15 Classification of Costs as Variable or Fixed and as Product or Period
Below are listed various costs that are found in
organizations.
1. Hamburger buns in a Wendy’s outlet.
2. Advertising by a dental office.
3. Apples processed and canned by Del Monte.
4. Shipping canned apples from a Del Monte plant
to customers.
5. Insurance on a Bausch & Lomb factory
producing contact lenses.
6. Insurance on IBM’s corporate headquarters.
7. Salary of a supervisor overseeing production
of printers at Hewlett-Packard.
8. Commissions paid to automobile salespersons.
9. Depreciation of factory lunchroom facilities
at a General Electric plant.
10. Steering wheels installed in BMWs.
Required:
Classify each cost as being either variable or
fixed with respect to the number of units produced
and sold. Also classify each cost as either a
selling and administrative cost or a product cost. Prepare
your answer sheet as shown below. Place an X in the appropriate columns to show the proper
classification of each cost.
Cost Item
Period
(Selling and
Administrative)
Cost
Variable Fixed
Product
Cost
Cost Behavior
Problems
All applicable problems are available with
McGraw-Hill’s Connect® Accounting.
PROBLEM 2–16
Cost Behavior; High-Low Method; Contribution Format Income Statement
Morrisey & Brown, Ltd., of Sydney is a merchandising company
that is the sole distributor of a
product that is increasing in popularity among Australian
consumers. The company’s income statements
for the three most recent months follow:
Morrisey & Brown, Ltd.
Income Statements
For the Three Months Ended September 30
July August September
Sales in units . . . . . . . . . . . . . . . . . . . . . . . . . .
4,000 4,500 5,000
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . $400,000 $450,000 $500,000
Cost of goods sold . . . . . . . . . . . . . . . . . . . . . .
240,000 270,000 300,000
Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . .
160,000 180,000 200,000
Selling and administrative expenses:
Advertising expense . . . . . . . . . . . . . . . . . . . 21,000
21,000 21,000
Shipping expense . . . . . . . . . . . . . . . . . . . . . 34,000
36,000 38,000
Salaries and commissions . . . . . . . . . . . . . . 78,000 84,000
90,000
Insurance expense . . . . . . . . . . . . . . . . . . . . 6,000
6,000 6,000
Depreciation expense . . . . . . . . . . . . . . . . . . 15,000
15,000 15,000
Total selling and administrative expenses 154,000 162,000 170,000
Net operating income . . . . . . . . . . . . . . . . . . . . $
6,000 $ 18,000 $ 30,000
Chapter
2
Required:
1. Identify each of the company’s expenses (including cost of
goods sold) as either variable,
fixed, or mixed.
2. Using the high-low method, separate each mixed expense into
variable and fixed elements.
State the cost formula for each mixed expense.
3. Redo the company’s income statement at the 5,000-unit level of
activity using the contribution
format.
PROBLEM 2–17
High-Low Method; Predicting Cost
Sawaya Co., Ltd., of Japan is a manufacturing
company whose total factory overhead costs fluctuate
considerably from year to year according to
increases and decreases in the number of direct
labor-hours worked in the factory. Total factory
overhead costs at high and low levels of activity for
recent years are given below:
Level of Activity
Low High
Direct labor-hours .
. . . . . . . . . . . . . . . 50,000 75,000
Total factory
overhead costs . . . . . . . . $14,250,000 $17,625,000
The factory overhead costs above consist of
indirect materials, rent, and maintenance. The company
has analyzed these costs at the 50,000-hour level
of activity as follows:
Indirect materials
(variable) . . . . . . . . . . . . . . . . . . . . . . . $ 5,000,000
Rent (fixed) . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,000,000
Maintenance (mixed)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,250,000
Total factory
overhead costs . . . . . . . . . . . . . . . . . . . . . . $14,250,000
To have data available for planning, the company
wants to break down the maintenance cost into
its variable and fixed cost elements.
Required:
1. Estimate how much of the $17,625,000 factory
overhead cost at the high level of activity consists
of maintenance cost. (Hint: To do this, it may be helpful to first determine how much of
the $17,625,000 consists of indirect materials
and rent. Think about the behavior of variable
and fixed costs!)
2. Using the high-low method, estimate a cost
formula for maintenance.
3. What total factory overhead costs would you
expect the company to incur at an operating level
of 70,000 direct labor-hours?
PROBLEM 2–18
Variable and Fixed Costs; Subtleties of Direct and Indirect Costs
Madison Seniors Care Center is a nonprofit
organization that provides a variety of health services
to the elderly. The center is organized into a
number of departments, one of which is the Meals-On-
Wheels program that delivers hot meals to seniors
in their homes on a daily basis. Below are listed
a number of costs of the center and the
Meals-On-Wheels program.
example The cost of
groceries used in meal preparation.
a. The cost of
leasing the Meals-On-Wheels van.
b. The cost of
incidental supplies such as salt, pepper, napkins, and so on.
c. The cost of
gasoline consumed by the Meals-On-Wheels van.
d. The rent on
the facility that houses Madison Seniors Care Center, including the
Meals-On-Wheels program.
e. The salary
of the part-time manager of the Meals-On-Wheels program.
f. Depreciation
on the kitchen equipment used in the Meals-On-Wheels program.
g. The hourly
wages of the caregiver who drives the van and delivers the meals.
h. The costs
of complying with health safety regulations in the kitchen.
i. The costs
of mailing letters soliciting donations to the Meals-On-Wheels program.
Required:
For each cost listed above, indicate whether it
is a direct or indirect cost of the Meals-On-Wheels
program, whether it is a
direct or indirect cost of particular seniors served by the program, and
Managerial Accounting and Cost Concepts 61
whether it is variable or fixed with respect to
the number of seniors served. Use the form below for
your answer.
Direct or Indirect
Cost of the Mealson-
Wheels Program
Direct or Indirect
Cost of Particular
Seniors Served
by the Meals-on-
Wheels Program
Variable or Fixed
with Respect to the
Number of Seniors
Served by the
Mealson-
Wheels Program
Item Description
Direct Indirect Direct Indirect Variable Fixed
Example The cost of
groceries
used in meal
preparation . . . X
X X
PROBLEM 2–19
Contribution Format versus Traditional Income Statement
Marwick’s Pianos, Inc., purchases pianos from a
large manufacturer and sells them at the retail
level. The pianos cost, on the average, $2,450
each from the manufacturer. Marwick’s Pianos, Inc.,
sells the pianos to its customers at an average
price of $3,125 each. The selling and administrative
costs that the company incurs in a typical month
are presented below:
Costs Cost Formula
Selling:
Advertising . . . .
. . . . . . . . . . . . . . . . . . . $700 per month
Sales salaries and
commissions . . . . . . $950 per month, plus 8% of sales
Delivery of pianos
to customers . . . . . . $30 per piano sold
Utilities . . . . .
. . . . . . . . . . . . . . . . . . . . . $350 per month
Depreciation of
sales facilities . . . . . . . . $800 per month
Administrative:
Executive salaries .
. . . . . . . . . . . . . . . . $2,500 per month
Insurance . . . . .
. . . . . . . . . . . . . . . . . . . $400 per month
Clerical . . . . . .
. . . . . . . . . . . . . . . . . . . . $1,000 per month, plus $20 per piano
sold
Depreciation of
office equipment . . . . . . $300 per month
During August, Marwick’s Pianos, Inc., sold and
delivered 40 pianos.
Required:
1. Prepare an income statement for Marwick’s
Pianos, Inc., for August. Use the traditional format,
with costs organized by function.
2. Redo (1) above, this time using the
contribution format, with costs organized by behavior.
Show costs and revenues on both a total and a per
unit basis down through contribution
margin.
3. Refer to the income statement you prepared in
(2) above. Why might it be misleading to show
the fixed costs on a per unit basis?
PROBLEM 2–20
High-Low Method; Predicting Cost
Nova Company’s total overhead cost at various
levels of activity are presented below:
Month
Machine-
Hours
Total
Overhead
Cost
April . . . . . . .
. . . . . . 70,000 $198,000
May . . . . . . . .
. . . . . . 60,000 $174,000
June . . . . . . . .
. . . . . . 80,000 $222,000
July . . . . . . . .
. . . . . . 90,000 $246,000
Chapter 2
Assume that the total overhead cost above
consists of utilities, supervisory salaries, and maintenance.
The breakdown of these costs at the 60,000
machine-hour level of activity is:
Utilities (variable)
. . . . . . . . . . . $ 48,000
Supervisory salaries
(fi xed) . . . 21,000
Maintenance (mixed)
. . . . . . . . 105,000
Total overhead cost
. . . . . . . . . $174,000
Nova Company’s management wants to break down the
maintenance cost into its variable and
fixed cost elements.
Required:
1. Estimate how much of the $246,000 of overhead
cost in July was maintenance cost. (Hint: to
do this, it may be helpful to first determine how
much of the $246,000 consisted of utilities
and supervisory salaries. Think about the
behavior of variable and fixed costs!)
2. Using the high-low method, estimate a cost
formula for maintenance.
3. Express the company’s total overhead
cost in the linear equation form Y 5 a 1 bX.
4. What total overhead
cost would you expect to be incurred at an activity level of 75,000
machine-hours?
PROBLEM 2–21
Cost Classification
Listed below are costs found in various
organizations.
1. Property taxes, factory.
2. Boxes used for packaging detergent produced by
the company.
3. Salespersons’ commissions.
4. Supervisor’s salary, factory.
5. Depreciation, executive autos.
6. Wages of workers assembling computers.
7. Insurance, finished goods warehouses.
8. Lubricants for production equipment.
9. Advertising costs.
10. Microchips used in producing calculators.
11. Shipping costs on merchandise sold.
12. Magazine subscriptions, factory lunchroom.
13. Thread in a garment factory.
14. Billing costs.
15. Executive life insurance.
16. Ink used in textbook production.
17. Fringe benefits, assembly-line workers.
18. Yarn used in sweater production.
19. Wages of receptionist, executive offices.
Required:
Prepare an answer sheet with column headings as
shown below. For each cost item, indicate
whether it would be variable or fixed with
respect to the number of units produced and sold;
and then whether it would be a selling cost, an
administrative cost, or a manufacturing cost.
If it is a manufacturing cost, indicate whether
it would typically be treated as a direct cost
or an indirect cost with respect to units of
product. Three sample answers are provided for
illustration.
Variable Selling
Administrative
Cost Item or Fixed
Cost Cost Direct Indirect
Direct labor . . . .
. . . . . . . . . . . V X
Executive salaries .
. . . . . . . . . F X
Factory rent . . . .
. . . . . . . . . . . F X
PROBLEM 2–22
High-Low and Scattergraph Analysis
Pleasant View Hospital of British Columbia has
just hired a new chief administrator who is anxious
to employ sound management and planning
techniques in the business affairs of the hospital.
Accordingly, she has directed her assistant to
summarize the cost structure of the various departments
so that data will be available for planning
purposes.
The assistant is unsure how to classify the
utilities costs in the Radiology Department
because these costs do not exhibit either
strictly variable or fixed cost behavior. Utilities costs are
very high in the department due to a CAT scanner
that draws a large amount of power and is kept
running at all times. The scanner can’t be turned
off due to the long warm-up period required for
its use. When the scanner is used to scan a
patient, it consumes an additional burst of power. The
assistant has accumulated the following data on
utilities costs and use of the scanner since the
first of the year.
Month
Number
of Scans
Utilities
Cost
January . . . . . .
. . . . . . . . . . . . . 60 $2,200
February . . . . . .
. . . . . . . . . . . . 70 $2,600
March . . . . . . .
. . . . . . . . . . . . . 90 $2,900
April . . . . . . .
. . . . . . . . . . . . . . 120 $3,300
May . . . . . . . .
. . . . . . . . . . . . . . 100 $3,000
June . . . . . . . .
. . . . . . . . . . . . . 130 $3,600
July . . . . . . . .
. . . . . . . . . . . . . . 150 $4,000
August . . . . . . .
. . . . . . . . . . . . 140 $3,600
September . . . . .
. . . . . . . . . . . 110 $3,100
October . . . . . .
. . . . . . . . . . . . 80 $2,500
The chief administrator has informed her
assistant that the utilities cost is probably a mixed
cost that will have to be broken down into its
variable and fixed cost elements by use of a scattergraph.
The assistant feels, however, that if an analysis
of this type is necessary, then the high-low
method should be used, since it is easier and
quicker. The controller has suggested that there may
be a better approach.
Required:
1. Using the high-low method, estimate a cost
formula for utilities. Express the formula in the
form Y 5 a 1 bX. (The
variable rate should be stated in terms of cost per scan.)
2. Prepare a scattergraph by plotting the number
of scans and utility cost on a graph. Draw a
straight line though the two data points that
correspond to the high and low levels of activity.
Make sure your line intersects the Y -axis.
3. Comment on the accuracy of your high-low
estimates assuming a least-squares regression
analysis estimated the total fixed costs to be
$1,170.90 per month and the variable cost to be
$18.18 per scan. How would the straight line that
you drew in requirement 2 differ from a
straight line that minimizes the sum of the
squared errors?
PROBLEM 2–23
High-Low Method; Contribution Format Income Statement
Milden Company has an exclusive franchise to
purchase a product from the manufacturer and
distribute it on the retail level. As an aid in
planning, the company has decided to start using a
contribution format income statement. To have
data to prepare such a statement, the company has
analyzed its expenses and has developed the
following cost formulas:
Cost Cost Formula
Cost of good sold .
. . . . . . . . . . . $35 per unit sold
Advertising expense
. . . . . . . . . . $210,000 per quarter
Sales commissions .
. . . . . . . . . . 6% of sales
Shipping expense . .
. . . . . . . . . . ?
Administrative
salaries . . . . . . . . $145,000 per quarter
Insurance expense .
. . . . . . . . . . $9,000 per quarter
Depreciation expense
. . . . . . . . . $76,000 per quarter
Chapter 2
Management has concluded that shipping expense is
a mixed cost, containing both variable and
fixed cost elements. Units sold and the related
shipping expense over the last eight quarters follow:
Quarter Units Sold
Shipping
Expense
Year 1:
First . . . . . . .
. . . . . . . . . . . . . . . 10,000 $119,000
Second . . . . . . .
. . . . . . . . . . . . 16,000 $175,000
Third . . . . . . .
. . . . . . . . . . . . . . 18,000 $190,000
Fourth . . . . . . .
. . . . . . . . . . . . . 15,000 $164,000
Year 2:
First . . . . . . .
. . . . . . . . . . . . . . . 11,000 $130,000
Second . . . . . . .
. . . . . . . . . . . . 17,000 $185,000
Third . . . . . . .
. . . . . . . . . . . . . . 20,000 $210,000
Fourth . . . . . . .
. . . . . . . . . . . . . 13,000 $147,000
Milden Company’s president would like a cost
formula derived for shipping expense so that a
budgeted contribution format income statement can
be prepared for the next quarter.
Required:
1. Using the high-low method, estimate a cost
formula for shipping expense.
2. In the first quarter of Year 3, the company
plans to sell 12,000 units at a selling price of $100
per unit. Prepare a contribution format income
statement for the quarter.
PROBLEM 2–24
Ethics and the Manager
M. K. Gallant is president of Kranbrack
Corporation, a company whose stock is traded on a national
exchange. In a meeting with investment analysts
at the beginning of the year, Gallant had predicted
that the company’s earnings would grow by 20%
this year. Unfortunately, sales have been less than
expected for the year, and Gallant concluded
within two weeks of the end of the fiscal year that it
would be impossible to ultimately report an
increase in earnings as large as predicted unless some
drastic action was taken. Accordingly, Gallant
has ordered that wherever possible, expenditures
should be postponed to the new year—including canceling
or postponing orders with suppliers,
delaying planned maintenance and training, and
cutting back on end-of-year advertising and travel.
Additionally, Gallant ordered the company’s
controller to carefully scrutinize all costs that are currently
classified as period costs and reclassify as many
as possible as product costs. The company
is expected to have substantial inventories at
the end of the year.
Required:
1. Why would reclassifying period costs as
product costs increase this period’s reported earnings?
2. Do you believe Gallant’s actions are ethical?
Why or why not?
PROBLEM 2–25
Cost Classification and Cost Behavior
The Dorilane Company specializes in producing a
set of wood patio furniture consisting of a table
and four chairs. The set enjoys great popularity,
and the company has ample orders to keep production
going at its full capacity of 2,000 sets per
year. Annual cost data at full capacity follow:
Direct labor . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $118,000
Advertising . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . $50,000
Factory supervision
. . . . . . . . . . . . . . . . . . . . . . . . . . $40,000
Property taxes,
factory building . . . . . . . . . . . . . . . . $3,500
Sales commissions .
. . . . . . . . . . . . . . . . . . . . . . . . . $80,000
Insurance, factory .
. . . . . . . . . . . . . . . . . . . . . . . . . . $2,500
Depreciation,
administrative offi ce equipment . . . . . $4,000
Lease cost, factory
equipment . . . . . . . . . . . . . . . . . $12,000
Indirect materials,
factory . . . . . . . . . . . . . . . . . . . . . $6,000
Depreciation,
factory building . . . . . . . . . . . . . . . . . $10,000
Administrative offi
ce supplies (billing) . . . . . . . . . . . . $3,000
Administrative offi
ce salaries . . . . . . . . . . . . . . . . . . $60,000
Direct materials
used (wood, bolts, etc.) . . . . . . . . . $94,000
Utilities, factory .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . $20,000
Required:
1. Prepare an answer sheet with the column
headings shown below. Enter each cost item on your
answer sheet, placing the dollar amount under the
appropriate headings. As examples, this has
been done already for the first two items in the
list above. Note that each cost item is classified
in two ways: first, as variable or fixed with
respect to the number of units produced and sold;
and second, as a selling and administrative cost
or a product cost. (If the item is a product cost,
it should also be classified as either direct or
indirect as shown.)
Cost Behavior
Product Cost
Period
(Selling or
Administrative)
Cost Item Variable
Fixed Cost Direct Indirect*
Direct labor . . . .
. . . . . . $118,000 $118,000
Advertising . . . .
. . . . . . $50,000 $50,000
*To units of product.
2. Total the dollar amounts in each of the
columns in (1) above. Compute the average product
cost of one patio set.
3. Assume that production drops to only 1,000
sets annually. Would you expect the average product
cost per set to increase, decrease, or remain
unchanged? Explain. No computations are necessary.
4. Refer to the original data. The president’s
brother-in-law has considered making himself a
patio set and has priced the necessary materials
at a building supply store. The brother-in-law
has asked the president if he could purchase a
patio set from the Dorilane Company “at cost,”
and the president agreed to let him do so.
a. Would you expect any disagreement between the
two men over the price the brotherin-
law should pay? Explain. What price does the
president probably have in mind? The
brother-in-law?
b. Because the company is operating at full
capacity, what cost term used in the chapter
might be justification for the president to
charge the full, regular price to the brother-inlaw
and still be selling “at cost”?
Cases
All applicable cases are available with
McGraw-Hill’s Connect® Accounting
.
CASE 2–26
Mixed Cost Analysis and the Relevant Range
The Ramon Company is a manufacturer that is
interested in developing a cost formula to estimate
the fixed and variable components of its monthly
manufacturing overhead costs. The company
wishes to use machine-hours as its measure of
activity and has gathered the data below for this
year and last year:
Last Year This Year
Month
Machine-
Hours
Overhead
Costs
Machine-
Hours
Overhead
Costs
January . . . . . .
. . . . . . . . . . . . . 21,000 $84,000 21,000 $86,000
February . . . . . .
. . . . . . . . . . . . . 25,000 $99,000 24,000 $93,000
March . . . . . . .
. . . . . . . . . . . . 22,000 $89,500 23,000 $93,000
April . . . . . . .
. . . . . . . . . . . . . . 23,000 $90,000 22,000 $87,000
May . . . . . . . .
. . . . . . . . . . . . . . 20,500 $81,500 20,000 $80,000
June . . . . . . . .
. . . . . . . . . . . . . 19,000 $75,500 18,000 $76,500
July . . . . . . . .
. . . . . . . . . . . . . . . . 14,000 $70,500 12,000 $67,500
August . . . . . . .
. . . . . . . . . . . . 10,000 $64,500 13,000 $71,000
September . . . . .
. . . . . . . . . . . 12,000 $69,000 15,000 $73,500
October . . . . . .
. . . . . . . . . . . . . 17,000 $75,000 17,000 $72,500
November . . . . . .
. . . . . . . . . . . 16,000 $71,500 15,000 $71,000
December . . . . . .
. . . . . . . . . . . 19,000 $78,000 18,000 $75,000
Chapter 2
The company leases all of its manufacturing
equipment. The lease arrangement calls for a flat
monthly fee up to 19,500 machine-hours. If the
machine-hours used exceeds 19,500, then the fee
becomes strictly variable with respect to the
total number of machine-hours consumed during the
month. Lease expense is a major element of
overhead cost.
Required:
1. Using the high-low method, estimate a
manufacturing overhead cost formula.
2. Prepare a scattergraph using all of the data
for the two-year period. Fit a straight line or lines
to the plotted points using a ruler. Describe the
cost behavior pattern revealed by your scattergraph
plot.
3. Assume a least-squares regression analysis
using all of the given data points estimated the
total fixed costs to be $40,102 and the variable
costs to be $2.13 per machine-hour. Do you
have any concerns about the accuracy of the
high-low estimates that you have computed or the
least-squares regression estimates that have been
provided?
4. Assume that the company consumes 22,500
machine-hours during a month. Using the highlow
method, estimate the total overhead cost that
would be incurred at this level of activity. Be
sure to consider only the data points contained
in the relevant range of activity when performing
your computations.
5. Comment on the accuracy of your high-low
estimates assuming a least-squares regression
analysis using only the data points in the
relevant range of activity estimated the total fixed
costs to be $10,090 and the variable costs to be
$3.53 per machine-hour.
CASE 2–27 Scattergraph
Analysis; Selection of an Activity Base
Angora Wraps of Pendleton, Oregon, makes fine
sweaters out of pure angora wool. The business is
seasonal, with the largest demand during the
fall, the winter, and Christmas holidays. The company
must increase production each summer to meet
estimated demand.
The company has been analyzing its costs to
determine which costs are fixed and variable
for planning purposes. Below are data for the
company’s activity and direct labor costs over the
last year.
Month
Thousands of
Units Produced
Number of
Paid Days
Direct Labor
Cost
January . . . . . .
. . . . . . . . . . . . . 98 20 $14,162
February . . . . . .
. . . . . . . . . . . . 76 20 $12,994
March . . . . . . .
. . . . . . . . . . . . . 75 21 $15,184
April . . . . . . .
. . . . . . . . . . . . . . . 80 22 $15,038
May . . . . . . . .
. . . . . . . . . . . . . . 85 22 $15,768
June . . . . . . . .
. . . . . . . . . . . . . . 102 21 $15,330
July . . . . . . . .
. . . . . . . . . . . . . . 52 19 $13,724
August . . . . . . .
. . . . . . . . . . . . . 136 21 $14,162
September . . . . .
. . . . . . . . . . . . 138 22 $15,476
October . . . . . .
. . . . . . . . . . . . . 132 23 $15,476
November . . . . . .
. . . . . . . . . . . 86 18 $12,972
December . . . . . .
. . . . . . . . . . . 56 21 $14,074
The number of workdays varies from month to month
due to the number of weekdays, holidays,
and days of vacation in the month. The paid days
include paid vacations (in July) and paid
holidays (in November and December). The number
of units produced in a month varies depending
on demand and the number of workdays in the
month.
The company has eight workers who are classified
as direct labor.
Required:
1. Plot the direct labor cost and units produced
on a scattergraph. (Place cost on the vertical axis
and units produced on the horizontal axis.)
2. Plot the direct labor cost and number of paid
days on a scattergraph. (Place cost on the vertical
axis and the number of paid days on the
horizontal axis.)
3. Which measure of activity—number of units
produced or paid days—should be used as the
activity base for explaining
direct labor cost? Explain .
Appendix
2A: Least-Squares Regression Computations
The least-squares regression method for estimating a linear
relationship is based o n the
equation for a straight line:
Y 5 a 1 bX
As explained in the chapter, least-squares regression selects the
values for the intercept
a and
the slope b that minimize the sum of the squared errors. The following
formulas,
which are derived in statistics and calculus texts, accomplish
that objective:
b 5
n(SXY ) 2 (SX )(SY )
_________ __ _______
n(
SX 2
) 2 ( SX ) 2
a 5
(SY )
2 b(SX )
______n _ _____
where:
X 5 The level of activity
(independent variable)
Y 5 The total mixed cost
(dependent variable)
a 5 The total fixed cost (the
vertical intercept of the line)
b 5 The variable cost per unit
of activity (the slope of the line)
n 5 Number of observations
S 5 Sum across all n observations
Manually performing the calculations required by the formulas is tedious
at best.
Fortunately, Microsoft®
Excel can be used to estimate the intercept
(fixed cost) and
slope (variable cost per unit) that minimize the sum of the
squared errors. Excel also
provides a statistic called the R 2 , which is a measure of “goodness of fit.” The R 2 tells
us the percentage of the variation in the dependent variable
(cost) that is explained by
variation in the independent variable (activity). The R 2
varies from 0% to 100%, and the
higher the percentage, the better. You should always plot the data
in a scattergraph, but
it is particularly important to check the data visually when the R 2
is low. A quick look at
the scattergraph can reveal that there is little relation between
the cost and the activity or
that the relation is something other than a simple straight line.
In such cases, additional
analysis would be required.
To illustrate how Excel can be used to prepare a scattergraph plot
and to calculate the
intercept a, the slope b, and the R 2 , we will use the Brentline
Hospital data for patientdays
and maintenance costs on page 39 (which is recreated in Exhibit
2A–1 ). 1
To prepare a scattergraph plot, begin by highlighting the data in
cells B4 through
C10. From the Charts group within the Insert tab, select the
“Scatter” subgroup and then
click on the choice that has no lines connecting the data points.
This should produce a
scattergraph plot similar to the one shown in Exhibit 2A–2 .
Notice that the number of
patient-days is plotted on the X -axis and the maintenance
costs are plotted on the Y -axis. 2
The data is approximately linear, so it makes sense to proceed
with estimating a regression
equation that minimizes the sum of the squared errors.
LO2–8
Analyze
a mixed cost using a
scattergraph
plot and the leastsquares
regression
method.
1 The authors wish to thank
Don Schwartz, Professor of Accounting at National University, for providing
suggestions that were instrumental in creating this appendix.
2 To insert labels for the X-axis and Y-axis, go to the Layout tab
in Excel. Then, within the Labels
group,
select Axis Titles.
To determine the intercept a, the slope b, and
the R 2 , begin by right clicking on
any
data point in the scattergraph plot and selecting “Add Trendline.”
This should produce
the screen that is shown in Exhibit 2A–3 . Notice that under
“Trend/Regression Type”
you should select “Linear.” Similarly, under “Trendline Name” you
should select “Automatic.”
Next to the word “Backward” you should input the lowest value for
the independent
variable, which in this example is 5000 patient-days. Taking this
particular step
instructs Excel to extend your fitted line until it intersects the
Y -axis. Finally, you should
check the two boxes at the bottom of Exhibit 2A–3 that say
“Display Equation on chart”
and “Display R-squared value on chart.”
Once you have established these settings, then click “Close.” As
shown in Exhibit 2A–4 ,
this will automatically insert a line within the scattergraph plot
that minimizes the sum
of the squared errors. It will also cause the estimated
least-squares regression equation
and R 2 to be inserted into your
scattergraph plot. Instead of depicting the results
using the form Y 5 a 1 bX, Excel
uses an equivalent form of the equation depicted
as Y 5 bX 1 a. In
other words, Excel reverses the two terms shown to the right of the
equals sign. So, in Exhibit 2A–4 , Excel shows a least-squares
regression equation of
y 5 0.7589 x 1 3,430.9. The slope b in
this equation of $0.7589 represents the estimated
variable maintenance cost per patient-day. The intercept a in
this equation of $3,430.90
(or approximately $3,431) represents the estimated fixed monthly
maintenance cost.
Note that the R 2 is approximately 0.90, which
is quite good and indicates that 90% of the
variation in maintenance costs is explained by the variation in
patient-days.
E X H I B
I T 2 A – 2
A Scattergraph Plot for
Brentline Hospital
All applicable exercises and problems are
available with McGraw-Hill’s
Connect® Accounting.
EXERCISE
2A–1 Least-Squares Regression
Bargain Rental Car offers rental cars in an
off-airport location near a major tourist destination
in California. Management would like to better
understand the behavior of the company’s
costs. One of those costs is
the cost of washing cars. The company operates its own car wash
Chapter 2
facility in which each rental car that is
returned is thoroughly cleaned before being released
for rental to another customer. Management
believes that the costs of operating the car wash
should be related to the number of rental
returns. Accordingly, the following data have been
compiled:
Month
Rental
Returns
Car Wash
Costs
January . . . . . .
. . . . . . . . . . . . 2,380 $10,825
February . . . . . .
. . . . . . . . . . . 2,421 $11,865
March . . . . . . .
. . . . . . . . . . . . 2,586 $11,332
April . . . . . . .
. . . . . . . . . . . . . 2,725 $12,422
May . . . . . . . .
. . . . . . . . . . . . . 2,968 $13,850
June . . . . . . . .
. . . . . . . . . . . . 3,281 $14,419
July . . . . . . . .
. . . . . . . . . . . . . 3,353 $14,935
August . . . . . . .
. . . . . . . . . . . 3,489 $15,738
September . . . . .
. . . . . . . . . . 3,057 $13,563
October . . . . . .
. . . . . . . . . . . 2,876 $11,889
November . . . . . .
. . . . . . . . . . 2,735 $12,683
December . . . . . .
. . . . . . . . . . 2,983 $13,796
Required:
1. Prepare a scattergraph plot. (Place car wash
costs on the vertical axis and rental returns on the
horizontal axis.)
2. Using least-squares regression, estimate the
fixed cost and variable cost elements of monthly
car wash costs. The fixed cost element should be
estimated to the nearest dollar and the variable
cost element to the nearest cent.
EXERCISE
2A–2 Least-Squares Regression
George Caloz & Frères, located in Grenchen,
Switzerland, makes prestige high-end custom
watches in small lots. One of the company’s
products, a platinum diving watch, goes through an
etching process. The company has observed etching
costs as follows over the last six weeks:
Week Units Total
Etching Cost
1 . . . . . . . . .
. . 4 $ 18
2 . . . . . . . . .
. . 3 17
3 . . . . . . . . .
. . 8 25
4 . . . . . . . . .
. . 6 20
5 . . . . . . . . .
. . 7 24
6 . . . . . . . . .
. . 2 16
30 $120
For planning purposes, management would like to
know the amount of variable etching cost
per unit and the total fixed etching cost per
week.
Required:
1. Prepare a scattergraph plot. (Place etching
costs on the vertical axis and units on the horizontal
axis.)
2. Using the least-squares regression method,
estimate the variable and fixed elements of etching
cost. Express these estimates in the form Y 5 a 1 bX.
3. If the company processes five units next week,
what would be the expected total etching cost?
PROBLEM 2A–3 Least-Squares Regression;
Scattergraph; Comparison of Activity Bases [LO2–4, LO2–8]
The Hard Rock Mining Company is developing cost
formulas for management planning and
decision-making purposes. The company’s cost
analyst has concluded that utilities cost is a mixed
cost, and he is attempting to find a base with
which the cost might be closely correlated. The controller
has suggested that tons
mined might be a good base to use in developing a cost formula. The
production superintendent disagrees; she thinks
that direct labor-hours would be a better base. The
cost analyst has decided to try both bases and
has assembled the following information:
Quarter
Tons
Mined
Direct
Labor-Hours
Utilities
Cost
Year 1:
First . . . . . . .
. . . . . . . . . . . 15,000 5,000 $50,000
Second . . . . . . .
. . . . . . . . 11,000 3,000 $45,000
Third . . . . . . .
. . . . . . . . . 21,000 4,000 $60,000
Fourth . . . . . . .
. . . . . . . . . 12,000 6,000 $75,000
Year 2:
First . . . . . . .
. . . . . . . . . . . 18,000 10,000 $100,000
Second . . . . . . .
. . . . . . . . 25,000 9,000 $105,000
Third . . . . . . .
. . . . . . . . . 30,000 8,000 $85,000
Fourth . . . . . . .
. . . . . . . . 28,000 11,000 $120,000
Required:
1. Using tons mined as the independent variable,
prepare a scattergraph that plots tons mined on
the horizontal axis and utilities cost on the
vertical axis. Determine a cost formula for utilities
cost using least-squares regression. Express this
cost formula in the form Y 5 a 1 bX.
2. Using direct labor-hours as the independent
variable, prepare a scattergraph that plots direct
labor-hours on the horizontal axis and utilities
cost on the vertical axis. Determine a cost formula
for utilities cost using least-squares
regression. Express this cost formula in the form Y 5 a 1 bX.
3. Would you recommend that the company use tons
mined or direct labor-hours as a base for
planning utilities cost?
PROBLEM 2A–4
Least-Squares Regression Method; Scattergraph; Cost Behavior
Professor John Morton has just been appointed
chairperson of the Finance Department at Westland
University. In reviewing the department’s cost
records, Professor Morton has found the following
total cost associated with Finance 101 over the
last several terms:
Term
Number of
Sections Offered
Total Cost
Fall, last year . .
. . . . . . . . . 4 $10,000
Winter, last year .
. . . . . . . . 6 $14,000
Summer, last year .
. . . . . . 2 $7,000
Fall, this year . .
. . . . . . . . . 5 $13,000
Winter, this year .
. . . . . . . . 3 $9,500
Professor Morton knows that there are some
variable costs, such as amounts paid to graduate
assistants, associated with the course. He would
like to have the variable and fixed costs separated
for planning purposes.
Required:
1. Prepare a scattergraph plot. (Place total cost
on the vertical axis and number of sections
offered on the horizontal axis.)
2. Using the least-squares regression method,
estimate the variable cost per section and the
total fixed cost per term for Finance 101.
Express these estimates in the linear equation form
Y 5 a 1 bX.
3. Assume that because of the small number of
sections offered during the Winter Term this
year, Professor Morton will have to offer eight
sections of Finance 101 during the Fall Term.
Compute the expected total cost for Finance 101.
Can you see any problem with using the cost
formula from (2) above to derive this total cost
figure? Explain.
CASE 2A–5
Analysis of Mixed Costs in a Pricing Decision
Maria Chavez owns a catering company that serves food and
beverages at parties and business
functions. Chavez’s business is seasonal, with a heavy schedule
during the summer months and
holidays
and a lighter schedule at other times.
One
of the major events Chavez’s customers request is a cocktail party. She offers
a standard
cocktail
party and has estimated the cost per guest as follows:
Food
and beverages . . . . . . . . . . . . . . . $15.00
Labor
(0.5 hrs. @ $10.00/hr.) . . . . . . . . . 5.00
Overhead
(0.5 hrs. @ $13.98/hr.) . . . . . . 6.99
Total
cost per guest . . . . . . . . . . . . . . . . $26.99
The
standard cocktail party lasts three hours and Chavez hires one worker for every
six guests,
so
that works out to one-half hour of labor per guest. These workers are hired
only as needed and
are
paid only for the hours they actually work.
When
bidding on cocktail parties, Chavez adds a 15% markup to yield a price of about
$31
per guest. She is confident about her estimates of the costs of food and
beverages and
labor
but is not as comfortable with the estimate of overhead cost. The $13.98
overhead cost
per
labor-hour was determined by dividing total overhead expenses for the last 12
months
by
total labor-hours for the same period. Monthly data concerning overhead costs
and laborhours
follow:
Labor-
Overhead
Month
Hours Expenses
January
. . . . . . 2,500 $ 55,000
February
. . . . . 2,800 59,000
March
. . . . . . . . 3,000 60,000
April
. . . . . . . . . 4,200 64,000
May
. . . . . . . . . 4,500 67,000
June
. . . . . . . . 5,500 71,000
July
. . . . . . . . . 6,500 74,000
August
. . . . . . . 7,500 77,000
September
. . . . 7,000 75,000
October
. . . . . . 4,500 68,000
November
. . . . 3,100 62,000
December
. . . . 6,500 73,000
Total
. . . . . . . . . 57,600 $805,000
Chavez
has received a request to bid on a 180-guest fund-raising cocktail party to be
given
next month by an important local charity. (The party would last the usual three
hours.)
She
would like to win this contract because the guest list for this charity event
includes many
prominent
individuals that she would like to land as future clients. Maria is confident
that
these
potential customers would be favorably impressed by her company’s services at
the
charity
event.
Required:
1.
Prepare a scattergraph plot that puts labor-hours on the X
-axis and overhead expenses on the
Y
-axis. What insights are revealed by
your scattergraph?
2.
Use the least-squares regression method to estimate the fixed and variable
components of
overhead
expenses. Express these estimates in the form Y 5 a 1 bX.
3.
Estimate the contribution to profit of a standard 180-guest cocktail party if
Chavez charges
her
usual price of $31 per guest. (In other words, by how much would her overall
profit
increase?)
4.
How low could Chavez bid for the charity event in terms of a price per guest
and still not lose
money
on the event itself?
5.
The individual who is organizing the charity’s fund-raising event has indicated
that he has
already
received a bid under $30 from another catering company. Do you think Chavez
should
bid
below her normal $31 per guest price for the charity event? Why or why not?
(CMA, adapted
just-in-time (JIT) systems, such support to suppliers is vital. In
a JIT system, parts
are delivered from suppliers just in time and in just the correct
quantity to fill customer
orders. There are no parts stockpiles. If a defective part is
received from a supplier, the
part cannot be used and the order for the ultimate customer cannot
be filled on time.
Hence, every part received from a supplier must be free of
defects. Consequently, companies
that use JIT often require that their suppliers use sophisticated
quality control
programs such as statistical process control and that their
suppliers certify that they will
deliver parts and materials that are free of defects.
Appraisal Costs
Any defective parts and products should be caught as early as
possible in the production
process. Appraisal costs , which are sometimes called inspection costs, are
incurred to
identify defective products before the products are shipped to
customers. Unfortunately,
performing appraisal activities doesn’t keep defects from
happening again, and most
managers now realize that maintaining an army of inspectors is a
costly (and ineffective)
approach to quality control. Therefore, employees are increasingly
being asked to be
responsible for their own quality control. This approach, along
with designing products
to be easy to manufacture properly, allows quality to be built
into products rather than
relying on inspection to get the defects out.
Internal Failure Costs
Failure costs are incurred when a product fails to conform to its
design specifications.
Failure costs can be either internal or external. Internal failure costs result
from identifying
defects
before they are shipped to cus
All applicable exercises and problems are available
with McGraw-Hill’s Connect®
Accounting.
EXERCISE
2B–1 Cost of Quality Terms
A number of terms relating to the cost of quality
and quality management are listed below:
Appraisal costs Quality circles
Quality cost report Prevention costs
Quality of conformance External failure costs
Internal failure costs Quality costs
Required:
Choose the term or terms that most appropriately
complete the following statements. The terms
can be used more than once and a blank can hold
more than one word.
1. A product that has a high rate of defects is
said to have a low .
2. All of the costs associated with preventing
and dealing with defects once they occur are
known as .
3. In many companies, small groups of employees,
known as ,
meet on a regular basis to discuss ways to
improve quality.
4. A company incurs and in an
effort to keep defects from occurring.
5. A company incurs and
because defects have occurred.
6. Of the four groups of costs associated with
quality of conformance,
are generally the most damaging to a company.
7. Inspection, testing, and other costs incurred
to keep defective products from being shipped to
customers are known as .
8. are incurred in an effort to eliminate poor
product design,
defective manufacturing practices, and the providing
of substandard service.
9. The costs relating to defects, rejected
products, and downtime caused by quality problems are
known as .
10. When a product that is defective in some way
is delivered to a customer,
are incurred.
11. Over time a company’s total quality costs
should decrease if it redistributes its quality costs by
placing its greatest emphasis on and .
12. One way to ensure that management is aware of
the costs associated with quality is to summarize
such costs on a .
EXERCISE
2B–2 Classification of Quality Costs
A number of activities that are a part of a
company’s quality control system are listed below:
a. Product testing.
b. Product recalls.
c. Rework labor and overhead.
d. Quality circles.
e. Downtime caused by defects.
f. Cost of field servicing.
g. Inspection of goods.
h. Quality engineering.
i. Warranty repairs.
j. Statistical process
control
Net cost of scrap.
l. Depreciation of test equipment.
m. Returns and allowances arising from poor
quality.
n. Disposal of defective products.
o. Technical support to suppliers.
p. Systems development.
q. Warranty replacements.
r. Field testing at customer site.
s. Product design.
Required:
1. Classify the costs associated with each of
these activities into one of the following categories:
prevention cost, appraisal cost, internal failure
cost, or external failure cost.
2. Which of the four types of costs in (1) above
are incurred in an effort to keep poor quality
of conformance from occurring? Which of the four
types of costs in (1) above are incurred
because poor quality of conformance has occurred?
PROBLEM 2B–3
Analyzing a Quality Cost Report
Mercury, Inc., produces cell phones at its plant in Texas. In
recent years, the company’s market
share has been eroded by stiff competition from overseas. Price
and product quality are the two key
areas in which companies compete in this market.
A year ago, the company’s cell phones had been ranked low in
product quality in a consumer
survey. Shocked by this result, Jorge Gomez, Mercury’s president,
initiated a crash effort
to improve product quality. Gomez set up a task force to implement
a formal quality improvement
program. Included on this task force were representatives from the
Engineering, Marketing, Customer
Service, Production, and Accounting departments. The broad
representation was needed
because Gomez believed that this was a companywide program and
that all employees should
share the responsibility for its success.
After the first meeting of the task force, Holly Elsoe, manager of
the Marketing Department,
asked John Tran, production manager, what he thought of the
proposed program. Tran replied,
“I have reservations. Quality is too abstract to be attaching
costs to it and then to be holding you
and me responsible for cost improvements. I like to work with
goals that I can see and count! I’m
nervous about having my annual bonus based on a decrease in
quality costs; there are too many
variables that we have no control over.”
Mercury’s quality improvement program has now been in operation
for one year. The company’s
most recent quality cost report is shown below.
Mercury, Inc.
Quality Cost Report
(in thousands)
Last Year This Year
Prevention costs:
Machine maintenance . . . . . . . . . . .
$ 70 $ 120
Training suppliers . . . . . . . . . . .
. . . . . . . 0 10
Quality circles . . . . . . . . . . . . .
. . . . . . . . 0 20
Total prevention costs . . . . . . . . .
. . . . . . . 70 150
Appraisal costs:
Incoming inspection . . . . . . . . . . .
. . . . 20 40
Final testing . . . . . . . . . . . . . .
. . . . . . . . 80 90
Total appraisal costs . . . . . . . . . .
. . . . . . 100 130
Internal failure costs:
Rework . . . . . . . . . . . . . . . . .
. . . . . . . . 50 130
Scrap . . . . . . . . . . . . . . . . . .
. . . . . . . . . 40 70
Total internal failure costs . . . . . .
. . . . . . . 90 200
External failure costs:
Warranty repairs . . . . . . . . . . . .
. . . . . . 90 30
Customer returns . . . . . . . . . . . .
. . . . 320 80
Total external failure costs . . . . . .
. . . . . 410 110
Total quality cost . . . . . . . . . . .
. . . . . $ 670 $ 590
Total production cost . . . . . . . . . . . . $4,200 $4,800
As they were reviewing the report, Elsoe asked Tran what he now
thought of the quality
improvement program. Tran replied. “I’m relieved that the new
quality improvement program
hasn’t hurt our bonuses, but the program has increased the
workload in the Production Department.
It is true that customer returns are way down, but the cell phones
that were returned by customers
to retail outlets were rarely sent back to us for rework.”
Required:
1. Expand the company’s quality cost report by showing the costs
in both years as percentages of
both total production cost and total quality cost. Carry all
computations to one decimal place.
By analyzing the report, determine if Mercury, Inc.’s quality
improvement program has been
successful. List specific evidence to support your answer.
2. Do you expect the improvement program as it progresses to
continue to increase the workload
in the Production Department?
3. Jorge Gomez believed that the quality improvement program was
essential and that Mercury,
Inc., could no longer afford to ignore the importance of product
quality. Discuss how Mercury,
Inc., could measure the cost of not implementing the quality improvement program.
(CMA, adapted)
PROBLEM 2B–4
Quality Cost
In response to intensive foreign competition, the
management of Florex Company has attempted
over the past year to improve the quality of its
products. A statistical process control system has
been installed and other steps have been taken to
decrease the amount of warranty and other field
costs, which have been trending upward over the
past several years. Costs relating to quality and
quality control over the last two years are given
below:
Costs (in thousands)
Last Year This Year
Inspection . . . . .
. . . . . . . . . . . . . . . . $750 $900
Quality engineering
. . . . . . . . . . . . . . $420 $570
Depreciation of test
equipment . . . . $210 $240
Rework labor . . . .
. . . . . . . . . . . . . . . $1,050 $1,500
Statistical process
control . . . . . . . . $0 $180
Cost of fi eld
servicing . . . . . . . . . . . . $1,200 $900
Supplies used in
testing . . . . . . . . . . $30 $60
Systems development
. . . . . . . . . . . $480 $750
Warranty repairs . .
. . . . . . . . . . . . . . $3,600 $1,050
Net cost of scrap .
. . . . . . . . . . . . . . $630 $1,125
Product testing . .
. . . . . . . . . . . . . . . $810 $1,200
Product recalls . .
. . . . . . . . . . . . . . . $2,100 $750
Disposal of
defective products . . . . . $720 $975
Sales have been flat over the past few years, at
$75,000,000 per year. A great deal of money has
been spent in the effort to upgrade quality, and
management is anxious to see whether or not the
effort has been effective.
Required:
1. Prepare a quality cost report that contains
data for both this year and last year. Carry percentage
computations to two decimal places.
2. Prepare a bar graph showing the distribution
of the various quality costs by category.
3. Prepare a written evaluation to accompany the
reports you have prepared in (1) and (2) above.
This evaluation should discuss the distribution
of quality costs in the company, changes in this
distribution that you see taking place, the
reasons for changes in costs in the various categories,
and any other information
that would be of value to management
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