Solution manual cost accounting 14e by carter ch22

Examples of opportunities and temptations for unethical behavior in the capital budgeting area include: a pressure applied to the cost/managerial accountant by superiors or associates to

CHAPTER 22DISCUSSION QUESTIONS

22-1

Q22-1 Effective planning and control of capital

expenditures are important because:

(a) financial risk is increased by long-term

commitments;

(b) the magnitude of capital expenditures is

substantial and the penalties for unwise

decisions are usually severe;

(c) decisions made in this area provide the

supporting structure for operating

activi-ties of the firm.

Q22-2 Examples of opportunities and temptations

for unethical behavior in the capital budgeting

area include:

(a) pressure applied to the cost/managerial

accountant by superiors or associates to

circumvent the capital expenditure

approval process, in order to get a pet

project approved;

(b) pressure to write off or devalue assets

below their true value in order to justify

replacement;

(c) exaggerating the expected economic

bene-fits of a pet project in order to increase the

likelihood of getting it approved

Q22-3 The cost/managerial accountant has an

obli-gation to the company to make sure that the

company’s legitimate policies and procedures

are not circumvented and to make sure that

the data used in the evaluation of capital

expenditure proposals are as reliable and

realistic as possible If an ethical violation

occurs, the cost/managerial accountant

should first discuss the perceived problem

with his or her immediate supervisor (in order

to clarify the significance of the problem and

identify possible courses of action) and then

with the individual or individuals involved If

the individual involved is the accountant’s

immediate supervisor, the cost/managerial

accountant should consult the next higher

level of management If the problem cannot

be resolved through discussion, the

cost/managerial accountant is obligated to

provide a full disclosure of all the details to the

executives responsible for evaluating and

approving capital expenditures.

Q22-4 The economic life of a project is the period

during which it produces earnings It need not, and probably will not, be equal to the physical life of the related asset(s) Its length depends primarily upon the obsolescence of the product or manufacturing process involved or the nature of the product itself Managers usually find it quite difficult to esti- mate economic life because it depends upon future events over which they may have little

or no control.

Q22-5 Cash outflows that might be expected for a

capital expenditure include:

(a) purchase price of one or more assets (or

a down payment if property is purchased

(d) computer software development cost if a computer aided design, computer aided manufacturing, or fully computer inte- grated manufacturing system is being purchased;

(e) increased annual maintenance and/or power costs resulting from more compli- cated or technologically advanced machin- ery or equipment;

(f) lease payments, if some or all of the assets being acquired in the project are leased;

(g) working capital requirements (inventory, cash on hand, receivables, payables, etc.) may increase as a result of increased business generated by the capital project.

Q22-6 Cash inflows that might be expected from a

capital expenditure include:

(a) revenues from additional business ated by the project;

gener-(b) cost savings created by the capital diture that result in a reduction of cash outflows (e.g., maintenance savings,

expen-ments resulting from reduced setup

times, etc.);

(c) retention of market share that might have

been lost if the capital expenditure were

not made (particularly in the case of

advanced technologies that improve

product quality, reduce costs, provide

manufacturing flexibility, etc that can

pro-vide a competitive advantage to the firm

with the technology);

(d) salvage from the sale of the property at

the end of the economic life of the capital

project.

Q22-7 Some nonquantifiable benefits from investing

in advanced manufacturing technologies,

such as CIM, FMS, and robotics, include:

(a) improved product quality (ability to meet

closer production tolerances and at the

same time reduce the variability in

pro-duction output);

(b) decreased machine setup and shorter

manufacturing cycle times (which provide

the company with the ability to adjust

out-put quantity and variety quickly to meet

rapidly changing customer demands).

Q22-8 Tax depreciation is quite likely to differ from

book depreciation because the cost recovery

period used for tax purposes is usually

shorter than the economic life of the asset

used for financial accounting purposes Also,

an accelerated method of depreciation is

typ-ically used for tax purposes, whereas the

straight-line method is more often used for

book purposes.

Q22-9 Book depreciation should not be considered

in estimating the future cash flows from a

proj-ect because book depreciation has no effproj-ect

on the amount or timing of cash flows.

Q22-10 Tax depreciation should be considered in

esti-mating the future cash flows from a project

because tax depreciation reduces taxable

income and, therefore, tax liability Tax

depreci-ation results in a tax savings, i.e., a reduction

of cash flows is affected by the tax depreciation method and the recovery period used.

Q22-11 Financial accounting data are not entirely

suitable for use in evaluating capital ture proposals because:

expendi-(a) Financial accounting uses the accrual basis Capital expenditure decisions gen- erally rely on estimates of cash flows, rather than revenues and expenses determined on the accrual basis.

(b) Financial accounting is designed to measure periodic earnings Capital expenditure evaluation is concerned with the life of a given project, which seldom corresponds to usual accounting periods (c) Financial accounting measures the results of operations of a company or a segment of a company Although this entity sometimes corresponds with a cap- ital expenditure project, it is usually com- posed of many intermingled capital expenditure projects.

(d) Financial accounting capitalizes tures if the expenditure is deemed to have

expendi-a future vexpendi-alue or benefit to the compexpendi-any Capitalization is an attempt to match expenditures with revenues generated by those expenditures When future value or benefit cannot be reliably measured, financial accounting treats the expendi- ture as a period expense rather than as

an asset acquisition.

Q22-12 Benefits of following up project results include:

(a) comparison of actual with projected results to ensure that a project is meeting expected performance, or taking correc- tive action or terminating a project that is not achieving expected performance; (b) evaluation of accuracy of projections from different departments;

(c) improvement of future capital estimates; (d) motivation of personnel arising from knowledge that follow-up will occur.

EXERCISES E22-1

Initial cash outflow (cost of asset) $500,000

E22-2

Initial cash outflow (cost of machine) $150,000

Estimated 6% Annual Price-level

Total price-level adjusted net pretax cash

Total price-level adjusted

Excess of net pretax cash inflows over

E22-4

Total price-level adjusted net pretax cash

Total price-level adjusted

Excess of net pretax cash inflows over

(1) (2) (3) (4) (5)

After-tax cash inflow from salvage at end of economic life:

Adjusted Estimated

Cost of new machine $18,000

Tax

(1) Cost to purchase valve stem from outside supplier

Incremental cost of manufacturing valve stem:

Variable factory overhead (($1.70 – $.80) per unit ×

Tax

P22-5 (Continued)

Adjusted Estimate of

Adjusted

P22-7 (Concluded)

Adjusted Lost Periodic

Some of the factors that affect the decision of whether or not to delay the ment in new cleaning equipment are given below Each factor can have two sides (i.e., delay versus no delay) depending upon the circumstances involved.

invest-(a) Unemployment, inflation rate, and business conditions in general.

Business outlook improving—do not delay.

Business outlook deteriorating—delay.

All of these factors affect the climate for business and should be ered.

consid-(b) Difficulty associated with acquisition and installation of equipment and training of operators.

Great difficulty—do not delay.

Little difficulty—delay.

The greater the lead time involved, the sooner the equipment should be acquired so that it is ready when needed.

(c) Extent of operating efficiency improvements.

Great—do not delay.

Little—delay.

The greater the efficiency, the less it should be delayed because costs will

be saved even though volume does not increase.

(d) Inflation rate in cost of equipment.

Cost of equipment not expected to increase drastically—delay.

Cost of equipment expected to increase drastically—do not delay.

Company wants to minimize its initial cost outlay.

(e) Dependability of present equipment and likelihood of breakdowns.

Dependability is good—delay.

Dependability is not good—do not delay.

Company could defer, or have to go ahead with investment due to condition

of present equipment.

Good—delay.

No chance—do not delay.

If there is a chance that technological advances will develop in the design of the equipment, the company might want to take advantage of the new design.

(g) Ability to obtain market advantage by providing better quality service at same or lower price.

Good—do not delay.

Poor/neutral—delay.

Better service means more customers or justifies higher rates.

Company wants to maintain competitive advantage or meet competition.

exist-ing customers.

Good—better quality of decision; could defer switch longer.

Low—less reliable criteria for decision.

The better a company is able to predict new business, the more certain It can

be of its decision and, possibly, the longer it can wait to make a change C22-2

Knight is probably correct in her assessment that the proposed capital ment framework grants too much freedom to the divisions Neoglobe’s long-run performance depends on its capital investments While divisions must have some responsibility for capital investments for the proposed organization struc- ture to be effective, corporate management must maintain adequate control to direct the future course of the firm Under the proposed framework, division management controls a substantial portion of the capital budget, and in some years, few funds would be available for investment by corporate management The present proposal would reduce corporate management’s ability to diminish

invest-a product line, invest-and it invest-also would impinvest-air minvest-aninvest-agement’s invest-ability to hinvest-ave invest-adequinvest-ate funds available for investment in new businesses.

Capital investment procedures should involve both division and corporate managements in such a way that division management still should be able to influence the future direction of the firm Such procedures might include classi- fication of capital projects into groups, some of which could be approved by divi- sion management without corporate management study.

An alternative to the Neoglobe capital investment program might have the lowing features:

fol-(a) All proposed investment projects would be classified according to their nature—replacement, cost savings, expansion.

(b) Replacement and cost savings projects could be adopted by division agement alone, without approval of corporate management, provided an individual project did not exceed a specified dollar limit and the total of such projects did not exceed another specified dollar limit The dollar limits would reflect the nature and size of each division’s operations.

man-(c) All expansion projects, or other projects that exceed the dollar limit, would

be submitted to corporate management for evaluation and approval.

The process of planning for and evaluating long-term commitments of resources

is normally referred to as capital expenditure planning, evaluating, and control,

or capital budgeting The capital budget is distinct in that it focuses on the term effect of resources committed Its primary objectives are to provide man- agement with (1) a formal process to chart its future course, (2) a means of ranking and selecting among alternative resource commitments to maximize return on investment, and (3) a program for ongoing evaluation of extant resource commitments.

long-Any significant resource commitment is viewed as a project Hence, the ital budget is composed of projects, some of which are in process and some of which are proposed Each project affects significant periods of time in the ongo- ing life of a company A project often involves the evaluation of alternatives and the purchase of such assets as property, plant, and equipment It should also consider, however, any proposal or program that requires a significant resource commitment over an extended period, such as the development of new products, opening new markets, and the design and development of major computer pro- grams.

cap-Once resources have been committed to a particular project, the project requires ongoing evaluation; i.e., are the project’s objectives being met? If not, it needs to be evaluated in terms of whether the project should be retained as is, modified if possible, or abandoned.

McAngus can make significant use of capital expenditure planning, ing, and control At the division level, projects will need to be defined in terms of those elements of the plant, or operation of the division, over which the manager has control On the basis of the facts given, the division manager has authority

evaluat-to operate his or her plant essentially as if it were an independent company Hence, anything affecting operations, which has required or will require signifi- cant resource commitment over a significant period of time, should form an inte- gral part of that division’s capital budget At the top management level, the president may view each division as a project, particularly for evaluation pur- poses The other described activities of top management (investigating and eval- uating such things as new markets, etc.) are projects in the capital budgeting sense These and other new proposals may be defined, analyzed, and evaluated using a variety of available techniques.

C22-4

con-sidered a violation of the Standards of Ethical Conduct Arnett discarded the sonable projections and estimates after being questioned and pressured by Earle, and used figures that have only a remote chance of occurring By doing this, Arnett violated the standard of objectivity (which requires that the manage- ment accountant communicate information fairly and objectively and disclose fully relevant information that could reasonably be expected to influence an

rea-intended user’s understanding of the report presented) By altering the analysis, Arnett also violated the standard of integrity (which requires that the manage- ment accountant (1) refrain from engaging in an activity that would prejudice his

or her ability to carry out the required duties ethically, and (2) communicate vorable as well as favorable information, professional judgments, and opinions) Arnett also violated the standard of competence (which requires that the man- agement accountant prepare complete and clear reports and recommendations after appropriate analysis of relevant and reliable information).

of Ethical Conduct as a result of pressuring a subordinate to prepare a proposal with data that were false and misleading Earle has violated the standards of competence (failed to perform professional duties in accordance with techni- cal standards; and failed to prepare complete and clear reports and reliable information), integrity (engaged in an activity that would prejudice his or her abil- ity to carry out required duties ethically, actively or passively subverted the attainment of the organization’s legitimate and ethical objectives, failed to com- municate unfavorable as well as favorable information and professional judg- ments or opinions, and supported activity that would discredit the profession), and objectivity (failed to communicate information fairly and objectively and did not disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the report presented).

because of a predetermined, misleading outcome include:

(a) the quality of the base data,

(b) the quality of the assumptions used,

(c) the probability of the projection occurring, and

(d) the credibility of the people submitting the projection.

expen-(c) requiring all capital expenditure proposals be reviewed by senior operating management, which includes the controller, before the proposals are sub- mitted for approval, and

(d) requiring the internal audit staff to review all capital expenditure proposals

or contracting with external auditors to review the proposal if the tion does not have sufficient personnel.