Solution manual introduction to management accounting 14e by horngren ch02

Labor cost is a fixed-cost resource, and cleaning supplies is a variable cost... Labor cost is a fixed-cost resource, and cleaning supplies is a variable cost.. 2-4 Fixed costs, by defin

CHAPTER 2 COVERAGE OF LEARNING OBJECTIVES

LEARNING OBJECTIVE

FUNDA- MENTAL ASSIGN- MENT MATERIAL

CRITICAL THINKING EXERCISES AND EXERCISES PROBLEMS

CASES, NIKE 10K, EXCEL, COLLAB.,

& INTERNET EXERCISES LO1: Explain how cost

drivers affect cost behavior

A1, B1 24, 25, 27 41, 43, 45, 48 60

LO2: Show how changes in

cost-driver levels affect

variable and fixed costs

A1, B1, A2, A3, B2, B3

24, 25, 28, 29 41, 44, 45, 46,

48, 51, 52, 55

60, 61, 65

LO3: Calculate break-even

sales volume in total dollars

and total units

A2, A3, B2, B3

34, 35, 36 42, 44, 46, 47,

49, 51, 53,

60, 61, 65, 66

LO4: Create a

cost-volume-profit graph and

understand the assumptions

behind it

30, 31, 32, 33 41

LO5: Calculate sales

volume in total dollars and

total units to reach a target

profit

A2, A3, B2, B3

30, 31, 36, 42, 44, 46, 47,

49, 51,

61

LO6: Differentiate between

contribution margin and

gross margin

53

LO7: Explain the effects of

sales mix on profits

CHAPTER 2 INTRODUCTION TO COST BEHAVIOR AND COST-VOLUME

RELATIONSHIPS 2-A1 (20-25 Min.)

1 The cost driver for both resources is square feet cleaned Labor cost is a fixed-cost resource, and cleaning supplies is a variable cost Costs for cleaning between 4 and 8 times a month are:

Labor Cost

Cleaning Supplies Cost Total cost

Cost per Square Foot

** Cleaning supplies cost per square feet cleaned = $5,000 ÷ 100,000 = $0.05

*** $0.05 per square foot x 125,000

The predicted total cost to clean the plant during the next quarter is the sum of the total costs for monthly cleanings of 5, 6, and 8 times This is

$30,250 + $31,500 + $34,000 = $95,750

Cleaning Costs at Boeing Plant

125,000 (5)

150,000 (6)

175,000 (7)

200,000 (8)

Square Feet (Times Cleaned)

Boeing Outside Company

cost driver if Boeing cleans the plant with its own employees If Boeing expects average “times cleaned” to be 6 or more, it would save by cleaning with its own employees

2-A2 (20-25 min.)

Sales = Fixed expenses + Variable expenses + Net income

Fixed costs + Net income

Contribution margin per unit =

$.20

0) ($5,000

= 25,000 units

In dollars

Fixed costs + Net income

= ($5,000 0) = $25,000

2 The quick way: (36,000 - 25,000) x $.20 = $2,200

Compare income statements:

the slope of the total cost line would have a kink upward,

beginning at the break-even point

2-A3 (20-30 min.)

The following format is only one of many ways to present a solution This situation is really a demonstration of "sensitivity analysis," whereby a basic solution is tested to see how much it is affected by changes in critical factors Much discussion can ensue, particularly about the final three changes

The basic contribution margin per revenue mile is $1.50 -

$1.30 = $.20

2-B1 (20-25 Min.)

1 The cost driver for both resources is square feet cleaned Labor cost is a fixed-cost resource, and cleaning supplies is a variable cost Costs for cleaning between 35 and 50 times are:

Times

Cleaned

Square Feet Cleaned

Labor Cost

Cleaning Supplies Cost

Total cost

Cost per Square Foot

** The cost of cleaning supplies per square feet cleaned = $8,400 ÷ 140,000 =

$0.06 per square foot Cleaning supplies cost = $0.06 x 140,000 = $8,400

The predicted total cost to clean during the November and

December is the sum of the total costs for monthly cleanings of 45 and 50 times This is

$28,800 + $30,000 = $58,800

2 If Outback hires the outside cleaning company, all its cleaning costs will be variable at a rate of $0.17 per square foot cleaned The predicted cost to clean a total of 45 + 50 = 95 times is 95 x 4,000 x

$0.17 = $64,600 Thus Outback will not save by hiring the outside cleaning company

To determine whether outsourcing is a good decision on a

permanent basis Outback needs to know the expected demand for the cost driver over an extended time frame As the following table

Cleaning Costs at Outback

driver levels are high If average demand for cleaning is expected to

be more than about 164,000 ÷ 4,000 = 41 times a month, Outback should continue to do its own cleaning Outback should also

consider such factors as quality and cost control when an outside cleaning company is used

(1)

Times

Cleaned

(2) Square Feet Cleaned

(3) Outback Total Cleaning Cost *

Outside Cleaning Cost

* From requirement 1., total cost is the fixed cost of $18,000 +

variable costs of $.06 x square feet cleaned

= 25%

$7,500 ÷ 25% = $30,000

$7,000) ($33,000

= $40 - ($30 - $6) = $16;

New fixed expenses: $80,000 x 110% = $88,000;

$16

$20,000) ($88,000

=

$16

$108,000

= 6,750 units

2-2 Two rules of thumb to use are:

a Total fixed costs remain unchanged regardless of changes

in cost-driver activity level

b The per-unit variable cost remains unchanged regardless

2-4 Fixed costs, by definition, do not vary in total as volume

changes within the relevant range and during the time period

specified (a month, year, etc.) However, when the cost-driver level

is outside the relevant range (either less than or greater than the limits) management must decide whether to decrease or increase the capacity of the resource, expressed in cost-driver units In the long run, all costs are subject to change For example, the costs of

occupancy such as a long-term non-cancellable lease cannot be

changed for the term of the lease, but at the end of the lease

management can change this cost In a few cases, fixed costs may be changed by entities outside the company rather than by internal management – an example is the fixed, base charge for some utilities that is set by utility commissions

2-5 Yes Fixed costs per unit change as the volume of activity

changes Therefore, for fixed cost per unit to be meaningful, you must identify an appropriate volume level In contrast, total fixed costs are independent of volume level

2-6 No Cost behavior is much more complex than a simple

dichotomy into fixed or variable For example, some costs are not linear, and some have more than one cost driver Division of costs into fixed and variable categories is a useful simplification, but it is not a complete description of cost behavior in most situations

2-7 No The relevant range pertains to both variable and fixed costs Outside a relevant range, some variable costs, such as fuel consumed, may behave differently per unit of activity volume

2-8 The major simplifying assumption is that we can classify costs

as either variable or fixed with respect to a single measure of the volume of output activity

2-9 The same cost may be regarded as variable in one decision situation and fixed in a second decision situation For example, fuel costs are fixed with respect to the addition of one more passenger on

a bus because the added passenger has almost no effect on total fuel costs In contrast, total fuel costs are variable in relation to the

decision of whether to add one more mile to a city bus route

2-10 No Contribution margin is the excess of sales over all variable costs, not fixed costs It may be expressed as a total, as a ratio, as a

percentage, or per unit

2-11 A "break-even analysis" does not describe the real value of a CVP analysis, which shows profit at any volume of activity within the relevant range The break-even point is often only incidental in studies of cost-volume relationships It predicts how managers’ decisions will affect sales, costs, and net income It is an important part of a company’s planning process

2-12 No break-even points can vary greatly within an industry For example, Rolls Royce has a much lower break-even volume than does Honda (or Ford, Toyota, and other high-volume auto

2-16 An increase in demand for a company’s products will drive almost all other cost-driver levels higher This will cause cost drivers

to exceed capacity or the upper end of the relevant range for its

fixed-cost resources Since fixed-cost resources must be purchased in

“chunks” of capacity, the proportional increase in cost may exceed the proportional increase in the use of the related cost-driver Thus cost per cost-driver unit may increase

2-17 Operating leverage is a firm's ratio of fixed to variable costs

A highly leveraged company has relatively high fixed costs and low variable costs Such a firm is risky because small changes in volume lead to large changes in net income

2-18 No In retailing, the contribution margin is likely to be smaller than the gross margin For instance, sales commissions are

deducted in computing the contribution margin but not the gross margin In manufacturing companies the opposite is likely to be true because there are many fixed manufacturing costs deducted in computing gross margin

2-19 No CVP relationships pertain to both profit-seeking and

nonprofit organizations In particular, managers of nonprofit

organizations must deal with tradeoffs between variable and fixed costs To many government department managers, lump-sum

budget appropriations are regarded as the available revenues

2-20 Contribution margin could be lower because the proportion of sales of the product bearing the higher unit contribution margin declines

2-21

Target income before

income taxes = Target after - tax net income

1 - tax rate

2-22

Change in

net income = Change in volume in units x Contribution margin per unit x (1 - tax rate)

2-23 No The individual is confused Definitions of variable and

fixed cost behavior are based on total cost behavior, not unit cost

variable as a function of the number of advertisements Note that because the number of advertisements may not vary with the level of sales, advertising cost may be fixed with respect to the cost driver

“level of sales.” Salaries of marketing personnel are a fixed cost Travel costs and entertainment costs can be either variable or fixed depending on the policy of management The key question is

whether it is necessary to incur additional travel and entertainment costs to generate added sales

2-25 The key to determining cost behavior is to ask, “If there is a change in the level of the cost driver, will the total cost of the

resource change immediately?” If the answer is yes, the resource cost is variable If the answer is no, the resource cost is fixed Using

2-26 Suggested value chain functions are listed below

 Marketing

2-27 (5 –10 min.)

Situation Best Cost Driver Justification

time, the best cost driver is number of setups Data is both plausible, reliable, and easy to maintain

of mechanics’ time Simply using number of setups as in situation 1 will not capture the diversity associated with this activity

warehouse for about the same time (that is inventory turnover is about the same for all products), and that products are stacked, the volume occupied by products is the best cost driver

4 Cubic Feet Weeks If some types of product are stored for more

time than others, the volume occupied must be multiplied by a time dimension For example, if product A occupies 100 cubic feet for an

average of 2 weeks and product B occupies only 40 cubic feet but for an average of 10 weeks, product B should receive twice as much allocation of warehouse occupancy costs

Using the graph above, the estimated breakeven point in total units

sold is about 65,000 (actual breakeven volume is 68,800) The

estimated net loss for 50,000 units sold is about $200,000 ($1,500,000

- $1,700,000) Actual net loss is $500,000 - $688,000 = $188,000

2-32 (20–25 min.)

Square

Feet

Labor Cost

Labor Cost per Square Foot

Supplies Cost

Supplies Cost per Square Foot

* At 100,000 square feet on the second graph, the total supplies cost is $5,000

so the slope of the line is $0.05

Labor Cost per Square Foot

Variable-Cost per Unit Behavior

Total Labor Cost *

Supplies Cost Per Square Foot

Total Supplies Cost

Total Labor Cost

2 Daily revenue per patient = $60,000,000 ÷ 50,000 = $1,200 This may

appear high, but it includes the room charge plus additional charges for drugs, x-rays, and so forth

a 400 x 365 = 146,000 rooms per year

146,000 x $50 = $7,300,000

b 50% of $7,300,000 = $3,650,000

sales - variable expenses - fixed expenses = zero net income

2-38 (10 min.)

.2 - 1

$864

$.30N = $18,000 +

8

440 , 1

$

$.30N = $18,000 +

8

440 , 1

$

$.30N = $18,000 + $1,800

N = $19,800 ÷ $.30 = 66,000 units

2-40 (30-40 min.)

1 The cost of labor and depreciation is fixed at $18,000 per month Cleaning supplies cost varies in proportion to the number of times the store is cleaned The cost per cleaning is $10,200 ÷ 60 = $170

Cleaning Supplies

Cost

$170 per Cleaning

Total cost

Cost per Cleaning

The total cost of cleaning for the next quarter is:

Cleaning Costs at Kroger

3

Costs of Kroger Cleaning Store

Outside Cleaning Cost

Cleaning Supplies Cost

Total cost

2-42 (15-20 min.)

1 Microsoft: ($39,788 - $6,200) ÷ $39,788 = 84 or 84%

Procter & Gamble: ($68,222 - $33,125) ÷ $68,222) = 51 or 51%

There is very little variable cost for each unit of software sold by Microsoft, while the variable cost of the soap, cosmetics, foods, and other products of Procter & Gamble is substantial

2 Microsoft: $10,000,000 x 84 = $8,400,000

Procter & Gamble: $10,000,000 x 51 = $5,100,000

3 By assuming that changes in sales volume do not move the

volume outside the relevant range, we know that the total

contribution margin generated by any added sales will be added to the operating income Thus, we can simply multiply the

contribution margin percentage by the changes in sales to get the change in operating income

The main assumptions we make when we assume that the sales

volume remains in the relevant range are that total fixed costs do not change and unit variable cost remain unchanged This generally means that such predictions will apply only to small changes in

volume – changes that do not cause either the addition or reduction

of capacity

2-43 (15-20 min.)

Film Refreshments Total

Some labor might be exclusively devoted to refreshments

Labor might be allocated, but such a discussion is not the

major point of this chapter

Film Refreshments Total

producer, whereas ordinarily the theater owner bears a great deal of the risk The owner is assured of a specified income;

2-44 (15 min.)

1 Let X = amount of additional fixed costs for advertising

(1,100,000 x £13) +£300,000 -.30(1,100,000 x £13) - (£7,000,000 + X) = 0 £14,300,000 + £300,000 - £4,290,000 - £7,000,000 - X = 0

2-45 (40-50 min.)

activity and the resources used This information can now be used for cost control purposes Knowing the rates gallons per hour operated and parts moved per hour can help operating managers predict costs These rates are good measures of productivity in the receiving department

2 When the activity level increases, the use of resources will increase Thus, the output measures or cost driver levels will

increase – that is, total hours and total gallons Normally,

productivity rates such as gallons per hour and parts moved per hour will not change significantly unless there is action taken to improve efficiency or factors act to decrease efficiency

An equation can be derived to predict total cost using the above concept

Total Cost = Variable Cost of Fuel + Fixed Cost of Equipment

= (Number of Parts Received x hours/part x gallons/hour x Price/gallon) + $45,000

The total cost of receiving 40,000 parts is

(40,000 parts x 1hour/20 parts x 4 gallons/hour x

$4.00/gallon) + $45,000 = $77,000