Ch02 Managerial accounting aiou mba mcom 8508

CHAPTER 2
DISCUSSION QUESTIONS
2-1
Q2-1. (a) Cost is the current monetary value of
economic resources given up or to be
given up in obtaining goods and services.
Economic resources may be given up by
transferring cash or other property,
issuing capital stock, performing services,
or incurring liabilities.
Costs are classified as unexpired or
expired. Unexpired costs are assets and
apply to the production of future rev-
enues. Examples of unexpired costs are
inventories, prepaid expenses, plant and
equipment, and investments. Expired
costs, which most costs become eventu-
ally, are those that are not applicable to
the production of future revenues and are
deducted from current revenues or
charged against retained earnings.
Expense in its broadest sense includes
all expired costs; i.e., costs which do not
have any potential future economic benefit.
A more precise definition limits the use of
the term “expense” to the expired costs
arising from using or consuming goods and
services in the process of obtaining rev-
enues; e.g., cost of goods sold and market-
ing and administrative expenses.
(b) (1) Cost of goods sold is an expired cost
and may be referred to as an expense in
the broad sense of the term. On the
income statement, it is most often identi-
fied as a cost. Inventory held for sale
which is destroyed by an abnormal
casualty should be classified as a loss.
(2) Uncollectible accounts expense is usu-
ally classified as an expense. However,
some authorities believe that it is more
desirable to classify uncollectible accounts
as a direct reduction of sales revenue (an
offset to revenue). An uncollectible account
which was not provided for in the annual
adjustment, such as bankruptcy of a major
debtor, may be classified as a loss.
(3) Depreciation expense for plant machin-
ery is a component of factory overhead
and represents the reclassification of a
portion of the machinery cost to product
cost (inventory). When the product is sold,
the depreciation becomes a part of the
cost of goods sold which is an expense.
Depreciation of plant machinery during an
unplanned and unproductive period of idle-
ness, such as during a strike, should be
classified as a loss. The term “expense”
should preferably be avoided when making
reference to production costs.
(4) Organization costs are those costs
that benefit the firm for its entire period of
existence and are most appropriately
classified as a noncurrent asset. When
there is initial evidence that a firm’s life is
limited, the organization costs should be
allocated over the firm’s life as an
expense or should be amortized as a loss
when a going concern foresees termina-
tion. In practice, however, organization
costs are often written off in the early
years of a firm’s existence.
(5) Spoiled goods resulting from normal
manufacturing processing should be
treated as a cost of the product manufac-
tured. When the product is sold, the cost
becomes an expense. Spoiled goods
resulting from an abnormal occurrence
should be classified as a loss.
Q2-2. Cost objects are units for which an arrange-
ment is made to accumulate and measure
cost. They are important because of the need
for multiple dimensions of data (e.g., by prod-
uct, contract, or department) to accomplish
the various purposes of cost accounting,
including cost finding, planning, and control.
Q2-3. (a) To classify costs as direct or indirect, the
cost accountant must first know the
answers to the questions “Directly traced
to what?” and “Indirectly identified with
what?” Otherwise, there is no way to
assess the direct or indirect nature of a
cost. It is the choice of a cost object that
answers those two questions.
(b) For example, the cost of a department
manager’s salary cannot be classified as
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direct or indirect without selecting the
cost object first. If the cost object is a
product unit produced in the manager’s
department, then the salary is indirect. If
the cost object is the department, the
salary is direct.
Q2-4. (a) The product unit, batch, or lot is the cost
object. (Be careful about the lack of
clarity of the term “the product” when it is
not known whether it is intended to mean
(a) a single unit, batch, or lot of a product,
as opposed to (b) any large number of
identical units. It could easily be taken to
mean, say, product #321, as opposed to
some other item in the company’s catalog,
and that could suggest the grand total of all
identical pieces of #321 produced during
the entire product life cycle. The signifi-
cance of this distinction is that some costs,
such as product design, prototyping, and
initial worker training, are direct costs with
respect to the total of all units ever pro-
duced, but are indirect with respect to a
single unit, batch, or lot.)
(b) A disaggregation of overhead would be
useful for any study of how to better man-
age costs, or of what causes costs to be
incurred. Relatively few of the costs
incurred in a factory are caused by the
routine production of one more unit of one
product.
(c) (1) A batch of identical units.
(2) The sum of all identical units ever
produced.
(3) An activity or process carried out in
production.
(4) A group or “cell” of machines and
workers within a department.
(5) A department in which production
occurs.
(6) A plant or other production facility.
(7) A strategic goal of the firm (e.g.,
improved quality).
Q2-5. A cost system is a combination of procedures
and records designed to provide the various
types of information required in the conduct of
the enterprise; including cost finding, plan-
ning, and control.
Q2-6. A good information system requires the
establishment of (a) long-range objectives; (b)
an organization plan showing delegated
responsibilities in detail; (c) detailed plans for
future operations, both long- and short-term;
and (d) procedures for implementing and con-
trolling these plans.
Q2-7. A chart of accounts is necessary to classify
accounting data, so that the data may be uni-
formly recorded in journals and posted to the
ledger accounts.
Q2-8. Advantages of the electronic data processing
system for record keeping are: speed, larger
storage, single entry of multiple transactions,
automatic control features, and flexibility in
report formats.
Q2-9. The following perceived weaknesses were
mentioned in the text:
(a) Traditional measures attempt to serve
many purposes, and as a result they are
not universally regarded as serving any
one purpose ideally.
(b) Traditional measures are affected by
accounting choices that are not always
relevant to the purpose at hand; exam-
ples of these choices are cost flow
assumptions and arbitrary fixed cost allo-
cations.
(c) Traditional measures are calculated by
systems that are usually slow to respond
to changing conditions.
(d) Traditional measures of plant utilization
can seem to encourage overutilization of
capacity.
(e) Traditional measures of efficiency are
often reported too late, are too aggregat-
ed, and are easy to misinterpret.
Q2-10. Nonfinancial performance measures are
based on simple counts or other physical data
rather than allocated accounting data, they
are unconnected to the general financial
accounting system, and they are chosen to
reflect one specific aspect of performance.
Q2-11. Four examples of nonfinancial performance
measures given in the text, and the aspects of
performance they might be used to monitor,
are
(a) scrap weight as a percentage of total
shipped weight; to monitor efficiency of a
process, particularly efficiency of material
usage
(b) processing time as a percentage of total
time; to monitor cycle efficiency or
inventory velocity
(c) distance moved by a unit while inside the
plant; to monitor simplification of a process
(d) suggestions per year per employee; to
monitor employee involvement
2-2 Chapter 2

Q2-12. The challenge posed by the increased inter-
est in nonfinancial performance measures is
to define the cost accountant’s role broadly
enough to include more measures that are
not preceded by dollar signs and that are not
tied to the financial accounting system.
Q2-13. Costs are most commonly classified based on
their relationship to
(a) the product (a single batch, lot, or unit of
the good or service);
(b) the volume of activity;
(c) the manufacturing departments, process-
es, cost centers, or other subdivisions;
(d) the accounting period;
(e) a proposed decision, action, or evaluation.
Q2-14. Indirect materials are those materials needed
for the completion of the product but whose
consumption is either so small or so complex
that their treatment as direct materials would
not be feasible. For example, nails used to
make the product are indirect materials.
Q2-15. Indirect labor, in contrast to direct labor, is
labor expended that does not affect the con-
struction or the composition of the finished
product. For example, the labor of custodians
is indirect labor.
Q2-16. (a) A service department is one that is not
directly engaged in production, but
renders a particular type of service for the
benefit of other departments. Examples
of service departments are receiving,
storerooms, maintenance, timekeeping,
payroll, and cafeteria.
(b) Producing departments classify their
share of service department expenses as
indirect overhead expenses.
Q2-17. (a) Capital expenditures are intended to
benefit more than one accounting period.
The expenditures should therefore be
recorded by a charge to an asset account
for allocation to the periods benefited.
Revenue expenditures benefit the
operations of the current period only.
They should be recorded by charges to
the appropriate expense accounts.
(b) If a capital expenditure is improperly clas-
sified as an expense, assets, retained
earnings, and income for the period will
be understated. In future periods, income
will be overstated by any amount that
would have been amortized had the
expenditure been properly capitalized.
Assets and retained earnings will be
understated on future balance sheets by
successively smaller amounts until the
error has been fully counterbalanced.
If a revenue expenditure is improperly
capitalized, assets, retained earnings,
and income for the period will be over-
stated. Income will be understated in sub-
sequent periods as the improperly
capitalized item is charged to the opera-
tions of those periods. Assets and
retained earnings will continue to be over-
stated in subsequent balance sheets by
successively smaller amounts until the
improperly capitalized item has been
completely written off.
(c) The basic criterion for classifying outlays
as revenue or capital expenditures is the
period of benefit. The amount of detail
necessary to maintain subsidiary records,
the materiality of the expenditures, and
the consistency with which various
expenditures recur from period to period
are other criteria generally considered in
establishing a capitalization policy.
Firms frequently establish an arbitrary
amount below which all expenditures are
expensed, irrespective of their period of
benefit. The level at which this amount is
set is determined by its materiality in rela-
tion to the size of the firm. The objective of
such a policy is to avoid the expense of
maintaining excessively detailed sub-
sidiary records. Expenditures for items that
fall below the set amount but are material
in the aggregate should be capitalized, if
total expenditures for these items vary sig-
nificantly from period to period. A capital-
ization policy that reasonably applies these
criteria, although it disregards the period of
benefit and is therefore lacking in theoreti-
cal justification, will not significantly mis-
state periodic income.
Q2-18. Appendix In a typical balanced scorecard,
the names of the four perspectives are growth
and learning, internal business process, cus-
tomer, and financial.
Q2-19. Appendix A balanced scorecard’s growth and
learning perspective is a report on three kinds
of intangible resources: human capital, infor-
mation, and the alignment of incentives.
Q2-20. Appendix The internal business process per-
spective of a balanced scorecard reports on
the organization’s most important work, the
work in which the organization must excel in
order to be successful.
Chapter 2 2-3

Q2-21. Appendix Performance measures found in
the financial perspective of most organiza-
tions’ balanced scorecards are likely to
include the amount or the growth rate of net
income, or of operating income, or of return
on investment. For a new, start-up organiza-
tion, the most important financial measures
may be net sales and gross margin. For an
organization whose products and technology
face obsolescence, the key financial measure
may be cash flow.
Q2-22. Appendix The predictions reflected in a bal-
anced scorecard follow this sequence through
the four perspectives: growth and learning,
internal business process, customer, and
financial.
Q2-23. Appendix When the desired result is success
in the financial perspective, the other three
perspectives of a balanced scorecard report
what management believes are necessary
conditions. The other three perspectives do
not list sufficient conditions for financial suc-
cess. Sufficient conditions would constitute a
guarantee. A necessary condition, in contrast,
is an essential prerequisite.
2-4 Chapter 2

EXERCISES
E2-1 (1) $6 + $3 = $9 prime cost
(2) $3 + $1 = $4 variable conversion cost
(3) $6 + $3 + $1 = $10 variable manufacturing cost
(4) $1,000 fixed + ($10 × 500) = $6,000
E2-2 (1) $10 + $15 + $6 = $31 conversion cost
(2) $32 + $10 = $42 prime cost
(3) $32 + $10 + $15 + $3 = $60 variable cost
(4) (($32 + $10 +$15 + $6 + $4) × 12,000)
+ ($3 × 8,000) = $804,000 + $24,000
= $828,000 total cost incurred with 12,000
units produced and 8,000 units sold
E2-3
First Method:
Sales ($19,950,000 × 85%) ................................ $16,957,500
Less: Variable costs ($11,571,000 × 85%) ...... $9,835,350
Fixed costs............................................. 7,623,000 17,458,350
Operating loss.................................................... $ (500,850)
Second Method:
1st Step: Variable costs $11, 571, 000 = .58 variable cost ratio
20A sales $19,950,000
2nd Step:
Sales ($19,950,000 × 85%)................................ $16,957,500
Less: Variable costs ($16,957,500 × .58) ........ $ 9,835,350
Fixed costs............................................. 7,623,000 17,458,350
Operating loss.................................................... $ (500,850)
E2-4
1. d
2. b
3. b
4. a
5. f
6. e
7. c
8. f
Chapter 2 2-5

E2-5 The cost of direct labor per computer is $100,000, calculated as follows:
Total manufacturing cost .............................. $600,000 (given)
Less prime cost.............................................. 300,000 (given)
Equals overhead cost.................................... $300,000
Conversion cost ............................................. $400,000 (given)
Less overhead cost........................................ 300,000 (calculated above)
Equals direct labor......................................... $100,000
E2-6 The amount of factory overhead cost per blade is $300, calculated as follows:
Less conversion cost .................................... 400 (given)
Equals direct material cost ........................... $ 600
Direct labor cost = 1/6 of direct material cost
= 1/6 × $600 = $100
Conversion cost ............................................. $ 400 (given)
Less direct labor cost.................................... 100 (calculated above)
Equals overhead cost.................................... $ 300
E2-7 The direct labor cost per system is $200, calculated as follows:
Total manufacturing costs ............................ $1,000 (given)
Less prime cost.............................................. 800 (given)
Equals overhead cost.................................... $ 200
Conversion cost ............................................. $ 400 (given)
Less overhead cost........................................ 200 (calculated above)
Equals direct labor cost ................................ $ 200
2-6 Chapter 2

E2-8 The amount of factory overhead cost per machine is $1,500, calculated as
follows:
Less conversion cost .................................... 2,000 (given)
Equals direct material cost ........................... $1,000
Direct labor cost = 1/2 of direct material cost
= 1/2 × $1,000 = $500
Conversion cost ............................................. $2,000 (given)
Less direct labor cost.................................... 500 (calculated above)
Equals overhead cost.................................... $1,500
E2-9
(1) The relevant cost objects are:
(a) An item of merchandise.
(b) The use of a bank credit card.
(2) It implies that cash-paying customers are paying a part of the cost of the banks’
fees for processing credit card transactions, because these fees are paid by the
merchant who then recovers them in the form of slightly higher prices for all
merchandise.
(3) The competitive implications are that the prices paid by cash customers are too
high to be competitive with the prices charged by merchants who deal only in
cash, and the prices paid by customers using bank credit cards are too low to
reflect all the costs of a credit sale.
(4) The reason for not reducing all prices and charging extra for the use of a credit
card is because of the psychological effect of an extra charge. To customers, it
sounds like a penalty, as if the merchant wants to discourage the use of bank
credit cards. A discount for cash customers has a positive connotation, even if
prices marked on merchandise are higher to begin with. Raising all prices and
offering a cash discount yields the same net revenue as leaving prices alone and
charging extra for using a bank credit card, but the former method feels better to
the customer than the latter.
Chapter 2 2-7

E2-10
(1) The relevant cost objects are:
(a) A repair.
(b) A pickup and delivery.
(2) JTRS’s repair prices include an allocation of the cost of picking up and deliver-
ing tractors, in addition to the cost of the repairs, administrative costs, market-
ing costs, and profit. Competitors’ repair prices reflect only the cost of the
repairs, administrative and marketing costs, and profit. Competitors should be
able to price their repair services lower, because they do not have to reflect
pickup and delivery costs in repair prices.
E2-11
(1) Direct labor...................................................................................... $ 2
Variable factory overhead.............................................................. 5
Fixed factory overhead .................................................................. 4
Conversion cost.............................................................................. $11
(2) Direct material (lumber) ................................................................. $12
Direct labor...................................................................................... 2
Prime cost ....................................................................................... $14
Direct labor...................................................................................... 2
Variable manufacturing cost ......................................................... $19
Direct labor...................................................................................... 2
Variable marketing.......................................................................... 1
Total variable cost .......................................................................... $20
2-8 Chapter 2

E2-11 (Concluded)
(5) Total cost = total variable manufacturing cost
+ total variable marketing cost
+ total fixed cost
= 2,000 × ($12 + $2 + $5)
+ 1,900 × $1
+ 2,000* × ($4 + $3)
= $38,000 + $1,900 + $14,000
= $53,900
*The volume used here to calculate total fixed cost is the 2,000-unit volume level
that was used originally to calculate the amounts of fixed costs per unit, as
stated in the data given in the exercise.The 2,000-unit level of production stated
in requirement (5) is not the reason that 2,000 is used here to calculate total fixed
cost.
(6) The data indicate the bookcases are made of lumber, and some examples of the
indirect materials used in making wooden bookcases would be glue, sandpaper,
and nails.
(7) An estimate of costs referred to in the answer to requirement (6) would be
included in the variable factory overhead of $5 per unit.
E2-12 Factory overhead = 1/3 × prime cost, so:
Total
manufacturing = prime cost + factory overhead
cost
= prime cost + (1/3 × prime cost)
= 4/3 × prime cost;
multiplying both sides by 3/4 gives:
Total
3/4 × manufacturing = 3/4 × 4/3 × prime cost
cost
3/4 × $20,000 = 1 × prime cost
$15,000 = prime cost.
Prime cost......................................................................... $15,000
Less direct material cost................................................. 12,000 (given)
Direct labor cost............................................................... $ 3,000
Chapter 2 2-9

E2-13 APPENDIX
1. GL (This is a measure of information systems.)
2. GL
3. C
4. IBP
5. F
6. IBP
7. F
8. F
9. IBP (This measure and the next one are measures of innovation, which is part
of the internal business process perspective.)
10. IBP
11. C
12. GL
13. GL
2-10 Chapter 2

CASES
C2-1
(1) The percentage profit margin will be 82.5%, calculated as follows:
Revenues ($2 × 4) ..................................... $8.00
Cost of juice ($.20 × 4) ............................. $.80
Cost of one delivery ................................. .60 1.40
Profit........................................................... $6.60
Percentage profit margin = $6.60 profit divided by $8 revenue = 82.5%.
(2) The percentage profit margin will be 60%, calculated as follows:
Revenues ($2 × 1) ..................................... $2.00
Cost of juice ($.20 × 1) ............................. $.20
Cost of one delivery ................................. .60 .80
Profit........................................................... $1.20
Percentage profit margin = $1.20 profit divided by $2 revenue = 60%.
(3) The manager is treating the menu item as the cost object, for example, one
glass of orange juice.
(4) The refinement of the definition of cost object that would result in the planned
profit margin is the use of two different kinds of cost object, the item and the
delivery, which can be priced separately at $.80 and $2.40, respectively.
Chapter 2 2-11

C2-1 (Concluded)
(5) For an order consisting of four glasses of orange juice, the profit margin will be
75%, calculated as follows:
Revenues: ($.80 × 4) ........................... $3.20
+ ($2.40 × 1) ......................... 2.40
$5.60
Cost of juice ($.20 × 4) ............................. $.80
Cost of one delivery ................................. .60 1.40
Profit........................................................... $4.20
Percentage profit margin = $4.20 profit divided by $5.60 revenue = 75%.
For an order consisting of one glass of orange juice, the profit margin will also
be 75%, calculated as follows:
Revenues: ($.80 × 1) ........................... $ .80
+ ($2.40 × 1) ......................... 2.40
$3.20
Cost of juice .............................................. $.20
Cost of one delivery ................................. .60 .80
Profit........................................................... $2.40
Percentage profit margin = $2.40 profit divided by $3.20 revenue = 75%.
(6) The food service manager’s plan allocates the delivery costs over an arbitrarily
selected number of items (two). This plan would result in higher-than-planned
profit margin percentages on room service orders that contain more than two
items, as demonstrated in the answer to requirement (1). Prices on these orders
would be higher than those of a competitor who traces costs more carefully to
cost objects and sets prices accordingly. The plan would also result in lower-
than-planned profit margins on room service orders containing only one item,
as demonstrated in the answer to requirement (2). Prices on these orders would
be lower than what is needed to achieve the target profitability.
2-12 Chapter 2

C2-2
(1) The cost objects for which some amount of cost is identified in the case, and the
amount of cost identified for each, are:
(a) A new product variation, Zeggo (which means all units of Zeggo ever to be
produced), $250,000.
(b) A batch of Zeggo, $1,000.
(c) A unit of Zeggo, $5 + $10 = $15. (Notice the $10 indirect cost amount includes
all indirect production costs, so it must include the $1 amount stated in the
problem, along with an allocation or averaging of the $1,000-per-batch setup
costs, a share of the $250,000 cost amount, and a share of any other indirect
manufacturing costs. It would be double-counting to add the $1 and arrive
at a total of $16 per unit.)
(2) The other items mentioned in the case that could serve as cost objects, and a
purpose each one could serve, are:
(a) CCN Company, which is the relevant cost object when external financial
statements are prepared.
(b) The assembly line on which Zeggo and other products are to be produced.
This cost object would be relevant in a decision on whether to discontinue
production of all the products produced on the particular line, or a decision
to shut down the line and shift its production to other lines due to a reduc-
tion in customer orders.
(3) The total cost expected to result from producing the first batch of 300 units of
Zeggo is:
Cost accounted for as direct cost of a unit...... $ 5
Cost treated as indirect by the CCN system .... 1
$ 6
× 300 units
$1,800
Add: setup cost ................................................... 1,000
Total cost.............................................................. $2,800
(4) The cost expected to result from producing one more unit of Zeggo is
$5 + $1 = $6.
(5) For the first batch of 300 units, the CCN cost accounting system will report a
cost of:
($5 direct cost + $10 indirect cost allocation) × 300 units = $15 × 300 = $4,500
Chapter 2 2-13

C2-2 (Concluded)
(6) For the one additional unit, the CCN cost accounting system will report a cost of
$5 + $10 = $15
(7) The additional costs allocated by the CCN accounting system are of two types:
(a) Costs caused by activities other than the production of product units. Two
examples of these activities are mentioned in the problem: setting up the
assembly line and perfecting new product variations. Other activities would
include maintaining the assembly line and the department, ordering and
inspecting raw materials, training newly hired workers, maintaining a cost
accounting system, and expediting rush orders. (These are related to total
volume in the long run; therefore, most accounting systems classify them as
variable overhead, but they are unrelated to the production of a single unit
or batch of product.)
(b) Fixed costs that are incurred regardless of whether activities are carried out,
such as plant depreciation, insurance, and property taxes. These are the
costs of having capacity, not of using it.
2-14 Chapter 2

Ch02 Managerial accounting aiou mba mcom 8508

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