Solution manual cost and managerial accounting by barfield 3rd financial management

Total fixed costs can be dichotomized into two groups, committed and discretionary.. The committed fixed costs are ones that are less susceptible to cost control efforts, at least during

Financial ManagementQuestions

1 The cost control system is an integral part of the cost

management system The cost control system provides

information for planning purposes and, subsequently, for

evaluation of actual performance

2 Without first establishing performance targets and benchmarks,

control systems cannot function The purpose of establishing control systems is to guide the organization toward its

established objectives Accordingly, the control cycle must begin with the establishment of plans that define where the organization is headed and what its managers want to

accomplish

3 Cost control for any specific event is exerted before, during,

and after the event Cost control is exerted before the event

to determine the expected cost and to provide a plan to

achieve the expected cost During an event, control is

exerted to maintain the cost being incurred at the planned level After an event, actual performance is compared to planned performance and explanations of differences are

developed By understanding why differences exist, managers can take actions to minimize future differences between the actual and planned amounts

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Financial Management

4 Factors potentially causing a cost to change include:

(1) changes in activity level;

5 General price-level changes are reflected economy-wide

Prices for all goods and services rise at comparable rates Specific price-level changes affect only certain industries, parts or commodities General and specific price-level

changes are similar in that their effects are similar-prices

or goods and services rise or fall They differ in that

general price-level changes are caused by macroeconomic

factors such as the supply of money and the rate of inflation.Specific price-level changes are caused by specific events such as the Gulf War, weather, or interruption of the

distribution channel

6 By cooperating with members of the supply chain, an

organization creates an opportunity for interorganizational cost management In sharing information, suppliers can inform customers about alternatives that would lower the suppliers’ costs and result in reduced prices to the customers

Additionally, opportunities for outsourcing activities may be identified for circumstances in which a supplier firm can provide a service, commodity, or part at a lower cost than thecustomer firm

7 This statement is not true Single-source contracts have

the potential to provide two advantages The first is based purchasing High-volume purchasing should command a lower price Secondly, single-source purchasing offers

volume-greater opportunities for sharing information between supplierand customer firms to identify ways to jointly reduce costs and increase profits However, only if these two

opportunities are actively pursued will cost benefits be

realized Further, for commodity goods, single-source

purchasing may offer no advantages because the purchase price

is determined strictly by the market

8 Cost avoidance means not spending money for unneeded goods or

services; cost reduction refers to using fewer goods or

services to lower expenditures The former often means findingalternatives to avoid using the goods or services whereas the latter usually means using fewer of the same goods or

services

9 Temporaries are used to avoid paying extra full-time personnel

for work that is only needed to meet peak loads Temporary workers can be “fired” after the need for their contribution abates Use of temporaries also avoids paying all of the fringe benefit costs associated with full-time employees and can provide the special expertise that is not available from full-time employees

However, use of temporaries creates new problems For example, temporaries have no loyalty to the company because they know they have only temporary positions Further,

temporary employees may demand much higher pay than permanent workers to compensate for the absence of fringe benefits and the security of a permanent position Use of temporary

workers may also cause problems of job or task continuity because of worker turnover

10 Total fixed costs can be dichotomized into two groups,

committed and discretionary The committed fixed costs are ones that are less susceptible to cost control efforts, at least during the short run These costs consist of costs associated with basic plant assets and organizational

infrastructure Discretionary fixed costs are more

susceptible to short-run cost control efforts Discretionary fixed costs are incurred as a result of managerial judgment Examples of such costs are research and development and

advertising

Costs considered as committed by one firm may be considered discretionary by other firms For example, a firm that competes on the basis of products containing the latest functionality and technology would consider research and

development to be committed A firm that competes on the basis of price might consider research and development to be discretionary

11 No all discretionary costs are not fixed; some can be

variable For example, a firm may decide to spend one cent of each sales dollar on advertising This is an example of a discretionary variable cost

Financial Management

12 Heavy investment in automated technology affects a firm’s cost

structure The main effect is an increase in committed fixed costs A negative consequence is that, as the proportion of committed fixed costs to total costs rises, fewer and fewer costs are avoidable as sales fall The result can be

substantial operating losses in economic downturns Such losses can threaten the ability of the firm to remain solvent and survive Even so, as an industry becomes more and more competitive, firms will make increased investment in automatedtechnology to control operating costs and quality The

challenge for such an industry then becomes finding ways to maintain sales volume during economic slumps

13 Issues to be considered when setting discretionary cost

14 Committed fixed costs are incurred based on long-term

considerations and are simply not controllable in the short term Discretionary fixed costs can be increased or decreased

to manage income and cash flow The budgeted amounts for discretionary fixed costs are therefore much more likely to bedetermined by short-run objectives Even so, some

discretionary fixed costs (e.g., maintenance, research and development) are incurred for long-term benefit and will be less correlated with short-term objectives such as profit and cash flow

15 Many types of discretionary costs do not have outputs for

which there is a precisely explainable and predictable

technical relationship with inputs When an output measure is devised, it is normally available only in nonmonetary,

surrogate terms

For some discretionary costs such as research and development, output may result, if at all, only after making inputs for a period of indefinite duration Thus, even when outputs occur, it is difficult to relate them to a particular period's input

16 A surrogate measure of output is an indirect or substitute

measure The results of discretionary cost activities are often not susceptible to direct financial measurement so

nonmonetary surrogate measures are used

17 Efficiency is a measure of the degree to which the actual

yield ratio (actual output ÷ actual input) conforms to the desired yield ratio (planned output ÷ planned input)

Effectiveness is a measure of the degree to which a goal or objective is achieved

Measuring the efficiency of a discretionary cost requiresboth a measure of input and a measure of output Efficiency further requires a predictable cause-and-effect relationship between input and output Input costs are readily measured However, as explained in the answer to Question 15, outputs are not normally readily available When they are readily available or when surrogates can be identified, there is stilloften a lack of confidence about the strength of the cause-and-effect relationship between input and output for most discretionary costs

To measure effectiveness of a discretionary activity, an output measure, either monetary or nonmonetary, must be

available or devised Sometimes a surrogate measure for output

of an activity can be agreed on Effectiveness of a

discretionary cost can then be measured by comparing actual output to planned output (i.e., actual output ÷ planned

output)

18 Management performance is evaluated by how efficiently and

effectively the company's goals are achieved Efficiency

measures the relationship between inputs and outputs

Effectiveness compares outputs to objectives Objectives are short-run targets set to achieve long-run goals Thus, there

is a linkage starting with inputs and ending with goal

achievement to measure the efficiency and effectiveness with which managers have performed

19 Engineered costs, unlike most discretionary costs, bear a

constant and observable relationship to changes in an

activity However, some discretionary costs can, under the appropriate conditions, be treated as if they were engineered costs for the purpose of control If output measures can be identified, then yield ratios (output ÷ input) can be devised

to evaluate control of discretionary costs

20 Quality control inspection cost is sometimes susceptible to

treatment as an engineered cost Other examples of activitiesthat could be engineered include maintenance tasks, machine setups, and employee training activities

Financial Management

21 Variance analysis can be used to evaluate cost control of

engineered costs in a manner similar to that used in standard costing For a given engineered cost, the difference between the flexible budget amount and actual cost is determined This amount is the total variance This total amount can be divided into a price and efficiency variance The price

variance captures the amount of the total variance due to paying more or less than the budgeted amount per unit of

input The efficiency variance is the amount of the total variance that is due to using a total input quantity that is above or below the budgeted input quantity

22 Budget-to-actual comparisons are necessary to control the

level of spending on discretionary fixed costs Only by such comparisons will total expenditures on such costs be

controlled However, budget-to-actual comparisons should not

be the only control measure Additional analysis should

determine whether the budgeted activities were at the expectedlevel

23 A planning budget is fixed at a given level of output volume

Often, the actual output level will not conform to this

planned level of output Accordingly, costs and revenues willdiffer from the budgeted level because of volume differences

In evaluating the performance of managers who have no control over volume, it is desirable to have a budget that is based on the actual volume level Accordingly, a flexible budget is used to evaluate the success of such managers and it

is compiled at the actual level of activity

24 Activity-based budgeting is an improvement over traditional

budgeting in that costs are organized by activities that are necessary for the organization to achieve its objectives This approach makes more transparent to managers what

consequences would result if particular costs were cut It also serves to highlight the cost of activities that aren’t necessary to achieving organizational objectives

25 Firms hold cash balances to liquidate planned transactions as

they occur, to cover cash consequences of unexpected events, and for speculative purposes

Some firms must carry relatively larger cash balances than other firms because either the cash required to maintain the liquidity of the operating cycle is less predictable, or the ability to obtain cash from financing sources is more constrained

26 Program budgeting is typically used in governmental agencies

or for special initiatives in private firms The process of program budgeting begins with a specification of the

objectives to be achieved from the initiative or “program.” Then, alternatives to achieving the objectives are identified.Finally, costs are budgeted for the activities that are

selected to generate the desired objectives The process of azero-base budget begins with no assumptions based on prior years’ data Each activity and dollar must be justified based

on their contribution to organizational goals A traditional budget has as its starting point a sales projection and cost data from prior periods Past relationships between costs andactivities are used as the basis to extrapolate and budget thelevel of future costs

27 Program budgeting requires the use of detailed surrogate

measures which necessitates answering several questions:

• What results should be measured?

• What results are significant enough to develop output

measures?

• Can cause be established between programs and results? and,

• Does the program affect the target population?

Determining answers to these questions can be very difficult Because many “programs” involve expenditures on discretionary activities, it is difficult to map inputs into outputs Although the costs of the inputs can be reasonably determined, the value of the outputs may be difficult to

establish and the extent to which objectives have been

achieved can be difficult to measure

28 Among the problems associated with zero-base budgeting are

• Its cost Zero-base budgeting is much more expensive than traditional budgeting because of the added time involved

• The requirement that all activities necessary to the achievement of an objective be specified This requirementimplies that the benefits of discretionary activities can

be measured For some activities, measurement of outputs can be very difficult

• That it requires a total commitment from all personnel An organization must have the right culture to obtain this commitment

Financial Management Exercises

30 a Cost reduction-because quantity of work fluctuates,

part-time employees provide services for peak caseload part-times without full-time cost

b Annual salary full-time clerical staff ($28,500 × 1.20) =

$34,200; if 1,600 hours or less, part-time salary = $20X;

if over 1,600 hours, part-time salary = $20X + $2,000For 1,600 or fewer hours, point of indifference:

$20X = $34,200

X = $34,200 ÷ 20

X = 1,710 hoursFor more than 1,600 hours:

$20X + $2,000 = $34,200

$20X = $32,200

X = 1,610 hoursThus, the point of indifference occurs at 1,610 hours, the level that triggers the payment of the bonus

31 a Cost understanding

b Cost reduction

c Cost avoidance for the cost of call-forwarding; the

increase in costs for staff shows a recognition of clientneed and services to be provided

d Cost avoidance

e Cost reduction

f Cost avoidance of what would have been an increase in

costs with the installation of the new telephones; also shows cost understanding since she knew why the cost would increase

32 a Classification Cost

report preparation and printing

(the amount is discretionary only if R&D is to be conducted internally)

b Building flood insurance, charitable contributions, corporate advertising, executive training, employee

continuing education, internal audit salaries, marketing research, preventive maintenance, quality control

inspection, research and development salaries, research and development supplies, secretarial pool salaries

Financial Management

Charitable Improvement in social Very difficult to contrib welfare measure

cause & effect Employee Increase in productivity, Difficult to education quality capture all costs and benefits

Internal # of internal controls No single measure audit improved will capture all

benefits of

internal auditing

Market # of new products identified Doesn’t capture research the value of the product ideas

Prev maint Reduction in number of Age of machines

role in # of breakdowns than

maintenance does

Q control Reduction in # of de- Other factors

fective items returned such as careless

moving productsmay cause defects

R & D Number of discoveries, These outputs are salaries inventions, improvements, so heterogeneous

add-itive

R & D Expenditures per dollar of Doesn’t capture supplies R&D salary benefits of expenditure

Secr pool Number of documents Does not

quality of work

33 a C Committed costs are often associated with capital

investment

b D Amounts can be set by managerial judgment

c C Committed costs often can not be reduced in the short

run by managers

d D Hence, the term “discretionary”

e C These are examples of costs that are associated with

capital investment

f D Because the cause/effect association is often not well

understood for discretionary costs

g D Only discretionary costs can be reduced in the short run without impairing a firm’s long-term viability

h C Committed costs are associated with capacity and

capital investment

i D Because the yield on discretionary costs is not

precisely known

j D Discretionary activities tend to be service activities

rather than costs associated with the basic

infrastructure

34 a Extent to which ABC has been implemented in the firm;

dollars of cost savings generated by ABC prescriptions

b Number of patient hours of treatment on the machine

c Change in employee retention rate, absenteeism rate

d Improvement in employee satisfaction, measures capturing

improvement in flow of people

e Customers generated from Yellow Page advertising

f Labor time savings, reduction in collection cycle,

35 a Dollar volume of wagers

b Direct labor cost per drink served

c Average number of nights per customer served

d Percentage of guests served from out-of-state

e Total number of convention customers served

f Develop a customer evaluation form to measure quality

based on a five-point scale; use average rating for measure

g Percent of revenue from slot machines relative to total

revenues generated

36 a Goal 300 new students

Actual achievement 330 new studentsGoal exceeded by 30 new students; consequently, the department was very effective in meeting its goal

b Yield goal: ($400,000 ÷ 300) = 1 student for each $1,333

expended

Actual efficiency ($468,600 ÷ 330) = 1 student for each

$1,420 expended Accordingly, the department was very operationally inefficient in pursuing its objectives

b 170 hours × 12 inspections per hour = 2,040 inspections

per workerCost for full-time workers = $5,000 × 4 = $20,000Part-time work ((1,030 - (170 × 4)) × $18= 6,300Total cost of this arrangement $26,300Total expected cost of existing arrangement:

1,030 × $18 18,540Disadvantage of full-time arrangement $ 7,760

standard or expected price This created a $9,000 favorable price variance The combination of the $3,000 unfavorable volume variance and the $9,000 favorable price variance

results in a $6,000 favorable total variance, and not a $4,200total variance as stated by the company president

Cost Category 1995 Cost Index Expected Actual

Wage and fringes $160,000 1.13 $180,800 $125,000Supplies 50,000 1.13 56,500 85,000Depreciation 36,000 1.13 40,680 58,000Utilities 4,800 1.13 5,424 6,600 Totals $283,404 $274,600

b The pattern of change in costs reflects both effects of

inflation and effects of changes made by management Thelarge decline in wage and fringe benefits cost is due mostly to the decline in headcount The number of employees was reduced from eight to five Although the individual effects of inflation and technology changes cannot be disentangled using the information given, the increase in expenditures for supplies, depreciation and utilities has dramatically exceeded the rate of

inflation It is likely that the major differences between figures in the 2000 expected column and the 2000 actual column are due to the increased use of technology

Financial Management

Variance = actual cost - flexible budget = $450,000 - ($400 × 1,050) = $30,000 UFixed cost analysis:

| Total Fixed Cost Variance = $10,000 U |

This method of evaluation would encourage the personnel

workers to hire lower quality workers Low-quality workers would generate more turnover than high-quality workers, thus the volume of business rises; and hiring low-quality workers requires the Personnel office to incur lower search costs thanwould be incurred to hire only high-quality workers

44 No solution provided

45 a In his humorous communication, Mr Stanley Bing’s

strategy is to raise the level of awareness and cost consciousness of employees regarding cost understanding and cost avoidance in the travel and entertainment

category His remarks display his keen insight and experience concerning how some employees may take liberties with company funds

b Mr Bing was subtly advising employees that the prudence

and reasonableness of their use of company funds in the travel and entertainment category was about to be

monitored and scrutinized much more carefully than in thepast The use (or abuse) of these funds had apparently become more significant recently and greater attention totheir management and control had become necessary The clever, lighthearted approach reflects Mr Bing’s desire

to enlist cooperation without offending

46 a The proposed maintenance work order system would provide

written documentation for all man hours and materials used in the maintenance department This system would improve cost control by giving operating management (userdepartments) the opportunity to review specific

maintenance charges for time and materials on each maintenance job charged to their department The individual job cost records will provide the basis for feedback to the maintenance department on the quality andefficiency of work performed

By providing an estimate for each job prior to starting the job, the user department will have an opportunity to cancel unneeded work or work that appears

to be too expensive The maintenance department will be able to compare the estimates with estimates on similar jobs and with the actual costs once the job is completed

in order to evaluate personnel performance In addition,the estimating should improve scheduling of priority jobsand improve cost control as the estimating procedure is refined

The maintenance work order system will provide a basis for improved allocation of costs to user

departments If the work order system is effective and abuyer/seller relationship is developed between the user department and the maintenance department, the user department will insist on an efficient preventive maintenance program in order to minimize breakdown maintenance, spoilage, and lost production time

b The documentation provided by the work order system

should provide maintenance department management with statistics to support its request for additional people

If the maintenance department can develop a meaningful cost/benefit relationship showing a payback on additionalpersonnel through reduced overtime, less downtime waitingfor repairs, improved preventive maintenance, etc.,

rational management would authorize the addition of the required manpower

(CMA adapted)

47 An approach should be used that allows for planned reductions

in costs without adversely affecting the quality of products

or services delivered to customers By delineating all

activities and associated costs necessary to deliver high quality products and services to the clients of the Medical Products Division, managers can identify opportunities for cost reductions The objective would be to eliminate

activities that are not instrumental to serving customers and find more efficient ways to execute required functions