Exam (elaborations) SOLUTIONS MANUAL for Cost Accounting 14th by William K. Carter Cost Accounting, ISBN: 9780759338098

Exam (elaborations) SOLUTIONS MANUAL for Cost Accounting 14th by William K. Carter Cost Accounting, ISBN: 8098 CHAPTER 1 DISCUSSION QUESTIONS 1-1 Q1-1. Planning is the development of a consistent set of actions, resources, and measurements by which the achievement of objectives can be assessed. Planning takes into account the interactions between the organization and its environment in whatever is to be done. Control is the process by which managers assure that resources are obtained and used in an efficient and effective manner to carry out the plan and accomplish the organization’s objectives. Control implies that performance measurements are reviewed to determine if corrective action is required. Planning and control are interrelated. Control is carried out within the established planning framework and serves to evaluate conformance to the plan so that organizational objectives are achieved. Q1-2. Short-range plans usually deal with a period of a quarter or a year, while long-range plans usually cover three to five years. Short-range plans are detailed enough to permit preparation of a complete set of financial statements as of a future date, while long-range plans culminate in a very summarized set of expected results or a few quantified objectives, such as financial ratios. Q1-3. Long-range plans contain quantitative results, while strategic plans are the least quantifiable of all plans. Long-range plans usually extend three to five years into the future, while strategic plans may contemplate shorter or much longer periods. Long-range plans covering a three-to-five-year period would be prepared every three to five years, or might be systematically updated each year to maintain a complete plan, while strategic plans are formulated at irregular intervals by an essentially unsystematic process. Q1-4. Accountability is identical with responsibility accounting. Accountability deals with the discharge of an individual’s responsibility to achieve assigned objectives within the costs and expenses allowed for the performance and agreed to by the individual. Q1-5. The controller does not control, but aids the control task of the managerial levels by issuing reports pointing out deviations from the predetermined course of action. Q1-6. The cost department keeps detailed records of materials, labor, factory overhead, and marketing and administrative expenses; analyzes these costs; issues control reports; prepares cost studies for planning and decision making; and coordinates cost and budget data with other departments. Q1-7. For product research and design, the manufacturing departments need estimates of materials, labor, and machine process costs; for measuring and efficiency of scheduling, producing, and inspecting products, the departments need to know the costs incurred. The personnel department supplies employees’ wage rates. The treasury department needs accounting, budgeting, and related reports in scheduling cash requirements. The marketing department needs cost information in setting prices. The public relations department needs information on prices, wages, profits, and dividends in order to inform the public. The legal department needs cost information for keeping many affairs of the company in conformity with the law. Q1-8. Modern techniques in communications give the controller and staff the means to transmit information in the form of results, analyses, and forecasts in a way never before possible. Profit opportunities or control actions have been delayed or missed entirely because timely information that might have improved the cost and profit position of the company was poorly communicated. Q1-9. The budget is an essential cost planning tool because it (a) supplies information and serves as a standard of performance for cost control by the supervisors responsible for cost; (b) provides an easy method for anticipating profits at an anticipated sales level; (c) helps in forecasting sales, costs, expenses, and profits for a period of one year or more in advance. Q1-10. These standards will not necessarily be able to prevent management fraud, but they do give internal accountants some guidance on how to proceed if they encounter a questionable practice. Q1-11. CASB standards: (a) enunciate a principle or principles to be followed; (b) establish practices to be applied; (c) specify criteria to be employed in selecting from alternative principles and practices in estimating, accumulating, and reporting contract costs. The standards are backed by the full force and effect of the law. 1-2 Chapter 1 EXERCISES E1-1 The exercise requires two examples of the inseparability of planning and control. Three are listed here, and the third one gives two illustrations: The most obvious example of the inseparability of planning and control is found in the definition of control: management’s systematic effort to achieve objectives by comparing performance to plans and taking appropriate action to correct important differences. The definition shows that the specific results of planning are an essential input to the control phenomenon; there cannot be any such thing as a control effort without reference to some set of plans. A second example of the inseparability of planning and control results from the fact that they are simultaneous. In practice, the implementation of the first steps of a plan, and any control action needed in those steps, are begun before all parts of planning are complete. Early results and the early findings of control activity can then be used in finalizing later parts of the same plan. An example is that a single annual budget is usually not completely finalized before customer orders begin to be received for that year, and consideration of the number of these actual customer orders may point to trends that need to be considered in finalizing the budget. Even actual financial results of the early weeks and months of the year can provide a basis for better establishing the budget for the later portion of the year. The most elegant example of the inseparability of planning and control results from the fact that both planning and control are complex human activities, and almost all complex human activities are planned activities and also controlled activities. In other words, planning can be so complex that the planning effort is itself controlled (and planned), and control can be so complex that control activities are themselves planned (and controlled). Two illustrations of this are provided as follows: (1) A case in which planning is itself planned and controlled is when a complicated budget (plan) is to be prepared.To facilitate the creation of the budget, a detailed weekly schedule (another plan) is first agreed upon, showing which steps in the preparation of the budget are to be carried out during each week. Because it is desired that the creation of the budget not be allowed to fall far behind schedule, the responsible manager will exercise control by making comparisons between (a) the actual progress made on the budget each week and (b) the schedule.The manager will also take some corrective action if the difference between the schedule and the actual progress is considered important. (2) A case in which control is itself planned is when a manager decides what kinds of control reports will be used to compare actual results with plans in each future period of business operations. That decision, any efforts made to acquire a supply of preprinted report forms to be filled in each period, and any changes in the design of the cost accounting system to capture and compile the needed information about actual results represent evidence that the future control activity is being planned. Chapter 1 1-3 E1-2 (1) B (2) A (3) C (4) A (5) C (6) B—although the time frame involved in this kind of plan may be extremely long, there is nothing strategic about this kind of plan or decision. In fact, the plan and obligation to pay off the bonds when they come due is so routine that management would not consciously approach it as a decision. E1-3 (1) Paragraph (b) comes closest to describing the kind of control used in managing a business, although it is described in a nonbusiness setting. There is a plan formulated in advance, there is a measure of actual results, there is a decision maker who compares actual results with plans, there is a selection of a corrective action to bring results closer in line with the plan, and there is a foreshadowing of repeated periodic control activities (the remaining quizzes). The fact that the measures of planning and actual performance are nonfinancial measures is not the governing consideration. Much planned and actual information used in controlling a business is non-financial, including some cost accounting information such as the number of units produced, the percentage of units that were defective, and the percentage of available machine time that was utilized. (2) Paragraph (a) is a perfect example of an engineering control, rather than the kind of control managers use in business. The simple device described, which is found in any home bathroom, is the kind of control device designed to monitor a physical condition, and so it is analogous to a thermostat or any of a variety of devices called “industrial controls.” Of course, devices of this kind are used in manufacturing and other businesses, but they do not possess the essential attributes of control in the sense used in business and in cost accounting. The device achieves a continuous monitoring of the results, rather than a periodic comparison of results with plans.There is no human decision maker who selects a corrective action to be taken. A human decision maker is probably the salient attribute of control in managing a business that is missing in paragraph (a). 1-4 Chapter 1 E1-3 (Concluded) Paragraph (c) could be interpreted as an example of planning, but it lacks some essential ingredients of control (even though the word “control” is used in its last sentence). There is no periodic comparison of actual results with plans and no provision for modifying the treatment based on periodic results. For example, the contract requires five treatments each year, even if no weeds are visible. The actions taken are entirely preemptive. Paragraph (d) refers to the concept of control that applies to police work and military science. It consists of being able to physically determine each event that occurs in some location and being able to prevent certain events from occurring. The potential use of coercive force, which is very clear in paragraph (d), is always present in achieving this kind of control. In paragraph (d), there is no indication that results were periodically compared with plans. A rule that says “Obtain the objective at any cost” is sometimes associated with these activities. Chapter 1 1-5 CASES C1-1 (1) Yes, Williams has an ethical responsibility to take action. The IMA’s Standards of Ethical Conduct states that management accountants “shall not commit acts contrary to these standards nor shall they condone the commission of such acts by others within their organizations.” (2) (The requirement does not ask which standards have been violated, but, rather, which ones apply to Williams’ situation.) Management accountants have a responsibility to: Competence: Perform their professional duties in accordance with relevant laws, regulations, and technical standards. (Dumping toxic wastes in a residential landfill is generally a violation of law.) Confidentiality: Refrain from disclosing confidential information acquired in the course of their work except when authorized, unless legally obligated to do so (Williams may be legally obligated to take action and make certain disclosures.) Integrity: Refrain from either actively or passively subverting the attainment of the organization’s legitimate and ethical objectives. (Williams’ avoidance of the issue would passively subvert attainment of ethical objectives.) Communicate unfavorable as well as favorable information and professional judgments or opinions. (Williams is obligated to report his unfavorable findings to appropriate persons.) Refrain from engaging in or supporting any activity that would discredit the profession. (Williams’ silence would provide support to the dumping activity and, thus, could discredit the profession.) Objectivity: Disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations presented. (Williams should disclose his findings to the appropriate persons.) (3) Alternative (a), to seek the advice of his immediate superior, is appropriate. This is the first step he is required to take, unless the superior is involved. Alternative (b), communication of confidential information to persons outside the company, such as the local newspaper, is inappropriate unless there is a legal obligation to do so. If required by law, Williams should contact the proper authorities. Alternative (c), contacting a member of the board of directors, would be inappropriate at this time.Williams should report the problem to successively higher levels within the company and turn to the board of directors only if the problem is not resolved at lower levels. 1-6 Chapter 1 C1-1 (Concluded) (4) Williams should follow the company’s established policies for resolving such issues, if such policies exist. If the issue is not resolved through existing policies, he should report the problem to successively higher levels within the company until it is resolved. (Williams is not required to report this action to his superior if his superior appears to be involved in the conflict. He is not to disclose the matter to persons outside the organization, unless required by law.) During these steps, Williams may clarify relevant concepts by confidential discussion with an objective advisor to obtain an understanding of possible courses of action. If the conflict is not resolved after exhausting all these courses of action, Williams may have no other recourse than to resign and submit an informative memorandum to an appropriate representative of the organization. Consultation with one’s personal attorney is also appropriate. C1-2 (1) (The requirement does not ask which standards have been violated, but, rather, which ones apply to the CFO’s behavior.) Management accountants have a responsibility to: Competence: Perform their professional duties in accordance with relevant laws, regulations, and technical standards. (The CFO has asked Deerling to account for information in a way that is not in accordance with generally accepted accounting principles.) Prepare complete and clear reports and recommendations after appropriate analyses of relevant and reliable information. (The CFO’s restrictions on disclosure will result in incomplete reports.) Confidentiality: Refrain from using or appearing to use confidential information acquired in the course of their work for unethical or illegal advantage, either personally or through third parties. (The CFO is attempting to use confidential information to protect the job security and bonuses of top management.) Integrity: Avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict. (The CFO has failed to avoid a conflict of interest and has not informed the stockholders of the conflict.) Refuse any gift, favor, or hospitality that would influence or would appear to influence their actions. (The CFO’s bonus appears to be an influence on his actions.) Refrain from either actively or passively subverting the attainment of the organization’s legitimate and ethical objectives. (The CFO has subverted the attainment of the organization’s legitimate objective, profit for stockholders, by pursuing, instead, the job security and bonuses of top management.) Communicate unfavorable as well as favorable information and professional judgments or opinions. (The CFO is attempting to restrict disclosure of information about the acquisition.) Chapter 1 1-7 C1-2 (Continued) Refrain from engaging in or supporting any activity that would discredit the profession. (The CFO’s actions could discredit the profession.) Objectivity: Communicate information fairly and objectively. (The CFO is attempting to unfairly control the information reported, resulting in a report that is not objective.) Disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations presented. (The CFO is attempting to restrict disclosure of relevant information.) (2) (The requirement does not ask which standards have been violated, but, rather, which ones apply to Deerling’s situation.) Management accountants have a responsibility to: Competence: Perform their professional duties in accordance with relevant laws, regulations, and technical standards. (Deerling is being asked to violate generally accepted accounting principles.) Prepare complete and clear reports and recommendations after appropriate analyses of relevant and reliable information. (Deerling is being asked to prepare an incomplete report.) Confidentiality: Refrain from using or appearing to use confidential information acquired in the course of their work for unethical or illegal advantage either personally or through third parties. (Deerling must not use the confidential information about the possible takeover to his own advantage or to that of the person( s) mounting the takeover attempt.) Integrity: Refuse any gift, favor, or hospitality that would influence or would appear to influence their actions. (The last sentence of the case suggests that Deerling is considered a member of the top management group, so he may be eligible for a bonus.) Refrain from either actively or passively subverting the attainment of the organization’s legitimate and ethical objectives. (Deerling is being asked to subvert the attainment of the organization’s legitimate objective, profit for stockholders, by pursuing instead the job security and bonuses of top management.) Communicate unfavorable as well as favorable information and professional judgments or opinions. (Deerling is being asked to restrict disclosure of information about the acquisition.) Refrain from engaging in or supporting any activity that would discredit the profession. (Deerling is being asked to take actions that could discredit the profession.) Objectivity: Communicate information fairly and objectively. (Deerling is being asked to prepare a report that is not objective.) Disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations presented. (Deerling is being asked to restrict disclosure of relevant information.) 1-8 Chapter 1 C1-2 (Concluded) (3) If the company has established policies for dealing with such issues, Deerling should first follow these policies. If such policies do not exist, or if they are unsuccessful in resolving the problem, Deerling should present the problem to the chairman of the board. Deerling’s immediate superior is involved, so he need not be informed of this action. If the matter remains unresolved, Deerling should report to the audit committee, the board of directors, and finally the majority owners. During these steps, Deerling may clarify relevant concepts by confidential discussion with an objective advisor to obtain an understanding of possible courses of action. If the conflict is not resolved after exhausting all these courses of action, Deerling may have no other recourse than to resign and submit an informative memorandum to an appropriate representative of the organization. Consultation with one’s personal attorney is also appropriate. (4) The primary responsibility the company must fulfill before taking defensive actions is its fiduciary responsibility to stockholders. Other responsibilities include the effects that the takeover and defensive actions would have on creditors, bondholders, employees, customers, and the community. The company also has a responsibility to inform its external auditors and legal counsel to avoid putting them in a compromising position. C1-3 (1) (The requirement does not ask which standards have been violated, but, rather, which ones apply to Dixon’s behavior.) Management accountants have a responsibility to: Competence: Maintain an appropriate level of professional competence by ongoing development of their knowledge and skills. (By systematically rejecting all minority applicants, Dixon is jeopardizing the level of competence among the staff.) Perform their professional duties in accordance with relevant laws, regulations, and technical standards. (Equal opportunity in employment is required by law.) Integrity: Avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict. (Dixon’s prejudice is in conflict with the company’s legal obligation to provide equal opportunity employment, and with the company’s need for the most competent staff regardless of race.) Refrain from either actively or passively subverting the attainment of the organization’s legitimate and ethical objectives. (The company’s objective of equal opportunity employment is being subverted by Dixon’s prejudice.) Chapter 1 1-9 C1-3 (Concluded) Refrain from engaging in or supporting any activity that would discredit the profession. (Such persistent, systematic discrimination in hiring could discredit the profession.) (2) (The requirement does not ask which standards have been violated, but rather, which ones apply to Foxworth’s situation.) Because management accountants may not condone the commission of unethical acts by others within their organizations, all of the responsibilities listed in the solution to requirement (1) also apply to Foxworth’s situation. In addition, the following apply: Management accountants have a responsibility to: Confidentiality: Refrain from disclosing confidential information acquired in the course of their work except when authorized, unless legally obligated to do so. (Foxworth’s suspicions about Dixon’s behavior should not be disclosed inappropriately. See requirement (3)). Objectivity: Communicate information fairly and objectively. (Foxworth is obligated to make objective hiring recommendations to Dixon, in spite of his belief that Dixon will be prejudiced in acting on them.) (3) Alternative (a), discussion with the director of personnel, who is one of Dixon’s peers, is inappropriate at this time. If, however, Foxworth believes the director of personnel is an objective party, Foxworth may discuss the matter with the director, confidentially, to clarify the relevant concepts and to obtain an understanding of possible courses of action. Alternative (b), informal discussion with a group of MAD senior management accountants, is inappropriate. Alternative (c), private discussion with the CFO, Dixon’s superior, is appropriate. Because Foxworth has already approached his immediate superior, Dixon, who is involved in the conflict, it is not necessary for Foxworth to inform him of this action. (4) Foxworth should follow the company’s established policies for dealing with this type of conflict, if such policies exist. If policies do not exist, or if they are unsuccessful in resolving the conflict, Foxworth should discuss the issue with the CFO. If the matter remains unresolved, discussions with successively higher levels of management, including the audit committee and the board of directors, should follow. During these steps, Foxworth may discuss the matter confidentially with an objective advisor to clarify the relevant concepts and to obtain an understanding of possible courses of action. If the matter remains unresolved after exhausting all of these steps, Foxworth may have no recourse other than to resign and submit an informative memorandum to an appropriate representative of the company. Consultation with one’s personal attorney is also appropriate. 1-10 Chapter 1 C1-4 (1) (The requirement does not ask for a list of responsibilities Rodriquez has violated, merely which of the fifteen responsibilities apply to his situation.) Management accountants have a responsibility to: Competence: Perform their professional duties in accordance with relevant laws, regulations, and technical standards. (The figures Rodriquez is being asked to prepare might amount to fraud in the loan application.) Prepare complete and clear reports and recommendations after appropriate analyses of relevant and reliable information. (The reliability of the information is in doubt, and the fact that certain sales figures are or are not sufficient to justify the bank loan are not relevant to preparation of the budget.) Integrity: Refrain from either actively or passively subverting the attainment of the organization’s legitimate and ethical objectives. (There is a push to subvert legitimate objectives to the immediate need for a bank loan.) Recognize and communicate professional limitations or other constraints that would preclude responsible judgment or successful performance of an activity. (Rodriquez has not expressed to Czeisla the conflict between his desire to be a team player and his ethical responsibilities.) Communicate unfavorable as well as favorable information and professional judgments or opinions. (Rodriquez is being asked to report information that reflects so favorably on the company that it may not be justifiable.) Refrain from engaging in or supporting any activity that would discredit the profession. (Preparing a deliberately misleading budget as part of a loan application could amount to obtaining money by fraud.) Objectivity: Communicate information fairly and objectively. (Rodriquez feels pressured to abandon his objectivity in preparing the budget.) Disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations presented. (A comparison of the new targeted sales figure with the actual sales of the corresponding periods of past years would be likely to influence the bank’s understanding of just how large an increase in sales is being portrayed.) (2) Rodriquez could have clearly stated his concerns to Czeisla at each stage of the budget’s creation and revision. He could have consulted with the marketing manager and production manager at every stage, rather than only upon receiving the initial budget data. He could present the budget, or a summary of it, in a comparative form to highlight the differences between each quarter’s budget and the actual results of the corresponding quarter of the preceding year, and he could even calculate the percentage increase being budgeted and compare it with actual percentage increases that were achieved annually in the past. He could have consulted with his staff superior at the headquarters of Northwestern (the parent company)—Czeisla is his line superior, according to the second sentence of the case. Chapter 1 1-11 C1-4 (Concluded) (3) In addition to his ethical responsibilities to CD, Rodriquez has ethical responsibilities to: (a) The banks (b) The management accounting profession C1-5 (1) (The requirement does not ask for a list of responsibilities Jones has violated, merely which of the fifteen responsibilities apply to his situation.) Management accountants have a responsibility to: Confidentiality: Refrain from disclosing confidential information acquired in the course of their work except when authorized, unless legally obligated to do so. (If Jones accepts the consulting engagement with Crimson, it is likely she will be asked to disclose confidential SMI information about the desired computer system.) Refrain from using or appearing to use confidential information acquired in the course of their work for unethical or illegal advantage either personally or through third parties. (The size of the consulting fee suggests Crimson is seeking to buy confidential information to help win the job.) Integrity: Avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict (The consulting job would constitute an apparent conflict of interest, and probably an actual one, because Jones has been named to the SMI committee that will evaluate and rank all the proposals, including Crimson’s proposal, which she would have helped to write.) Refrain from engaging in any activity that would prejudice their ability to carry out their duties ethically. (The consulting job with Crimson would prejudice Jones’ ability to evaluate and rank the proposals for SMI, because one of the proposals would be Jones’ own work.) Refuse any gift, favor, or hospitality that would influence or would appear to influence their actions. (Regardless of whether the size of the consulting fee is construed as being a gift or favor, it is likely that other gifts, favors, or hospitality will be extended to Jones by Crimson during the course of the consulting engagement.) Refrain from either actively or passively subverting the attainment of the organization’s legitimate and ethical objectives. (SMI’s legitimate objective of obtaining the best computer system at the best price would be subverted to Jones’ personal need for money, as a result of Jones’ disclosing crucial information for Crimson to include in its proposal, especially if Crimson might not deliver a system with the crucial attributes.) 1-12 Chapter 1 C1-5 (Concluded) Recognize and communicate professional limitations or other constraints that would preclude responsible judgment or successful performance of an activity. (Accepting the consulting job would preclude responsible judgment in evaluating and ranking the proposals for SMI; on the other hand, ethical limitations of Jones’ employment at SMI would preclude successful performance of the consulting engagement for Crimson, especially if Crimson does expect her to reveal crucial information to help win the job—her ethical duty to SMI would prevent her from delivering what Crimson is paying for.) Refrain from engaging in or supporting any activity that would discredit the profession. (Selling confidential SMI information to a vendor would be a discreditable act.) Objectivity: Communicate information fairly and objectively. (Jones would be unlikely to communicate objective evaluations of proposals if she had helped write one of them.) Disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations presented. (Jones’ role in writing the Crimson proposal would be relevant information in SMI’s use of her evaluations of proposals.) (2) Jones might have disclosed, either orally or on her personal vita sheet or job application, the extent of her involvement on the SMI task force and the committee. (3) Jones could have first investigated all her career opportunities with firms that presented no potential conflict of interest of this kind, but for the sake of the argument, it is reasonable to assume she did exactly that before applying for a position at Crimson. Knowing that Crimson is a supplier of computer systems, Jones might have revised her personal vita sheet and the wording of her application for this one job interview to lessen the chances of Crimson’s being tempted to pursue an unethical plan. (Of course, her involvement in SMI’s upcoming purchase might have become known to Crimson anyway, or it might have been known to Crimson from other sources before her interview or even before her application for the position.) (4) In addition to her ethical responsibilities to SMI (and her financial responsibility to the hospital that provides treatment for her child), Jones has ethical responsibilities to: (a) her family (b) the management accounting profession (c) Crimson Chapter 1 1-13 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 revenues. Examples of unexpired costs are inventories, prepaid expenses, plant and equipment, and investments. Expired costs, which most costs become eventually, 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 revenues; e.g., cost of goods sold and marketing 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 identified 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 usually 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 machinery 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 idleness, 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 termination. 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 manufactured. 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 arrangement is made to accumulate and measure cost. They are important because of the need for multiple dimensions of data (e.g., by product, 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 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 significance 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 produced, 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 manage 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, planning, 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 controlling these plans. Q2-7. A chart of accounts is necessary to classify accounting data, so that the data may be uniformly 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; examples of these choices are cost flow assumptions and arbitrary fixed cost allocations. (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 aggregated, 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 interest 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, processes, 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 construction 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 classified 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 overstated. Income will be understated in subsequent periods as the improperly capitalized item is charged to the operations of those periods. Assets and retained earnings will continue to be overstated 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 relation to the size of the firm. The objective of such a policy is to avoid the expense of maintaining excessively detailed subsidiary 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 significantly from period to period. A capitalization policy that reasonably applies these criteria, although it disregards the period of benefit and is therefore lacking in theoretical justification, will not significantly misstate periodic income. Q2-18. Appendix In a typical balanced scorecard, the names of the four perspectives are growth and learning, internal business process, customer, and financial. Q2-19. Appendix A balanced scorecard’s growth and learning perspective is a report on three kinds of intangible resources: human capital, information, and the alignment of incentives. Q2-20. Appendix The internal business process perspective 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 organizations’ 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 organization, 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 balanced 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 success. 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: Total manufacturing cost .............................. $1,000 (given) 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: Total manufacturing cost .............................. $3,000 (given) 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 delivering tractors, in addition to the cost of the repairs, administrative costs, marketing 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 (3) Direct material (lumber) ................................................................. $12 Direct labor...................................................................................... 2 Variable factory overhead.............................................................. 5 Variable manufacturing cost ......................................................... $19 (4) Direct material (lumber) ................................................................. $12 Direct labor...................................................................................... 2 Variable factory overhead.............................................................. 5 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 lowerthan- 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 reduction 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 CHAPTER 3 DISCUSSION QUESTIONS 3-1 Q3-1. The total dollar amount of a fixed cost is constant at different levels of activity within the relevant range, but fixed cost per unit of activity varies. In contrast, the total amount of a variable cost varies at different levels of activity, but the variable cost per unit remains constant within the relevant range. A semivariable cost contains both fixed and variable elements. Consequently, both total semivariable cost and semivariable cost per unit vary with changes in activity. Q3-2. The relevant range is the range of activity over which a fixed cost remains constant in total or a variable cost remains constant per unit of activity. The underlying assumptions about the relationship of the activity and the incurrence of cost change outside the relevant range of activity. Consequently, the amount of fixed cost or the variable cost rate must be recomputed for activity above or below the relevant range. Q3-3. The fixed and variable components of a semivariable cost should be segregated in order to plan, analyze, control, measure, and evaluate costs at different levels of activity. Separation of the fixed and variable components of semivariable cost is necessary to: (a) compute predetermined factory overhead rates and analyze variances; (b) prepare flexible budgets and analyze variances; (c) analyze direct cost and the contribution margin; (d) determine the break-even point and analyze the effect of volume on cost and profit; (e) compute differential cost and make comparative cost analyses; (f) maximize short-run profits and minimize short-run costs; (g) budget capital expenditures; (h) analyze marketing profitability by territories, products, and customers. Q3-4. The obvious advantage to using managerial judgement to separate fixed and variable costs is expediency, i.e., it requires less time and is, therefore, less costly than the use of any of the three computational methods. The disadvantage is that the use of managerial judgment to separate fixed and variable costs often results in unreliable estimates of cost. Cost behavior is not always readily apparent from casual observation. As a consequence, managers often err in determining whether a cost is fixed or variable and frequently ignore the possibility that some costs are semivariable. Q3-5. The three computational methods available for separating the fixed and variable components of semivariable costs are: (1) the high and low points method; (2) the statistical scattergraph method; and (3) the method of least squares. Q3-6. The high and low points method has the advantage of being simple to compute, but it has the disadvantage of using only two data points in the computation, thereby resulting in a significant potential for bias and inaccuracy in cost estimates. The scattergraph has the advantage of using all of the available data, but it has the disadvantage of determining the fixed and variable components on the basis of a line drawn by visual inspection through a plot of the data, thereby resulting in bias and inaccuracy in cost estimates. The method of least squares has the advantage of accurately describing a line through all the available data, thereby resulting in unbiased estimates of the fixed and variable elements of cost, but it has the increased disadvantage of computational complexity. Q3-7. The $200 in the equation, referred to as the y intercept, is an estimate of the fixed portion of indirect supplies cost. The $4 in the equation, referred to as the slope of the regression equation, is an estimate of the variable cost associated with a unit change in machine hours. These estimates may not be perfectly accurate because they were derived from a sample of data that may not be entirely representative of the universe population, and because activities not included in the regression equation may have some influence on the cost being predicted. Q3-8. The coefficient of correlation, denoted r, is a measure of the extent to which two variables are related linearly. It is a measure of the covariation of the dependent and independent variables, and its sign indicates whether the independent variable has a positive or negative relationship to the dependent variable. The coefficient of determination is the square of the coefficient of correlation and is denoted r 2. The coefficient of determination is a more easily interpreted measure of the covariation than is the coefficient of correla