Chapter 08 - Answer

MANAGEMENT ACCOUNTING - Solutions Manual

CHAPTER 8 COST CONCEPTS AND CLASSIFICATIONS I.

Questions 1. The phrase “different costs for different purposes” refers to the fact that the word “cost” can have different meanings depending on the context in which it is used. Cost data that are classified and recorded in a particular way for one purpose may be inappropriate for another use. 2. Fixed costs remain constant in total across changes in activity, whereas variable costs change in proportion to the level of activity. 3. Examples of direct costs of the food and beverage department in a hotel include the money spent on the food and beverages served, the wages of table service personnel, and the costs of entertainment in the dining room and lounge. Examples of indirect costs of the food and beverage department include allocations of the costs of advertising for the entire hotel, of the costs of the grounds and maintenance department, and of the hotel general manager’s salary. 4. The cost of idle time is treated as manufacturing overhead because it is a normal cost of the manufacturing operation that should be spread out among all of the manufactured products. The alternative to this treatment would be to charge the cost of idle time to a particular job that happens to be in process when the idle time occurs. Idle time often results from a random event, such as a power outage. Charging the cost of the idle time resulting from such a random event to only the job that happened to be in process at the time would overstate the cost of that job. 5. a. Uncontrollable cost b. Controllable cost c. Uncontrollable cost 6. Product costs are costs that are associated with manufactured goods until the time period during which the products are sold, when the product costs become expenses. Period costs are expensed during the time period in which they are incurred. 8-1

Chapter 8 Cost Concepts and Classifications

7. The most important difference between a manufacturing firm and a service industry firm, with regard to the classification of costs, is that the goods produced by a manufacturing firm are inventoried, whereas the services produced by a service industry firm are consumed as they are produced. Thus, the costs incurred in manufacturing products are treated as product costs until the period during which the goods are sold. Most of the costs incurred in a service industry firm to produce services are operating expenses that are treated as period costs. 8. Product costs are also called inventoriable costs because they are assigned to manufactured goods that are inventoried until a later period, when the products are sold. The product costs remain in the finished goods inventory account until the time period when the goods are sold. 9. A sunk cost is a cost that was incurred in the past and cannot be altered by any current or future decision. A differential cost is the difference in a cost item under two decision alternatives. 10. a. b. c. d.

Direct cost Direct cost Indirect cost Indirect cost

11. The two properties of a relevant cost are: 1. it differs between the decision options 2. it will be incurred in the future 12. The three types of product costs are: 1. direct materials – the materials used in manufacturing the product, which become a physical part of the finished product. 2. direct labor – the labor used in manufacturing the product. 3. factory overhead – the indirect costs for materials, labor, and facilities used to support the manufacturing process, but not used directly in manufacturing the product. 13. The three types of manufacturing inventories are: 1. materials inventory – the store of materials used in the manufacturing process or in providing the service.

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Cost Concepts and Classifications Chapter 8

2. work in process inventory – accounts for all costs put into the manufacturing of products that are started but not complete at the financial statement date. 3. finished goods inventory – the cost of goods that are ready for sale. 14. Direct materials include the materials in the product and a reasonable allowance for scrap and defective units, while indirect materials are materials used in manufacturing that are not physically part of the finished product. 15. The income statement of a manufacturing company differs from the income statement of a merchandising company in the cost of goods sold section. A merchandising company sells finished goods that it has purchased from a supplier. These goods are listed as “purchases” in the cost of goods sold section. Since a manufacturing company produces its goods rather than buying them from a supplier, it lists “cost of goods manufactured” in place of “purchases.” Also, the manufacturing company identifies its inventory in this section as Finished Goods inventory, rather than as Merchandise Inventory. 16. Yes, costs such as salaries and depreciation can end up as part of assets on the balance sheet if these are manufacturing costs. Manufacturing costs are inventoried until the associated finished goods are sold. Thus, if some units are still in inventory, such costs may be part of either Work in Process inventory or Finished Goods inventory at the end of a period. 17. No. A variable cost is a cost that varies, in total, in direct proportion to changes in the level of activity. A variable cost is constant per unit of product. A fixed cost is fixed in total, but the average cost per unit changes with the level of activity. 18. Manufacturing overhead is an indirect cost since these costs cannot be easily and conveniently traced to particular units of products.

19.

Direct labor cost (34 hours  P15 per hour)........................... Manufacturing overhead cost (6 hours  P15 per hour)......... Total wages earned.................................................................

20. 8-3

P510 90 P600


Direct labor cost (45 hours  P14 per hour)......................... Manufacturing overhead cost (5 hours  P7 per hour)......... Total wages earned...............................

P630 35 P665

II. Exercises Exercise 1 (Schedule of Cost of Goods Manufactured and Sold; Income Statement) Requirement 1 Amazing Aluminum Company Schedule of Cost of Goods Manufactured For the Year Ended December 31, 2005 Direct material: Raw-material inventory, January 1.......................... Add: Purchases of raw material.............................. Raw material available for use................................. Deduct: Raw-material inventory, December 31

P 60,000 250,000 P310,000 70,000

Raw material used

P240,000

Direct labor..................................................................... Manufacturing overhead: Indirect material

400,000 P 10,000

Indirect labor

25,000

Depreciation on plant and equipment Utilities ........................................................................... ........................................................................... Other ........................................................................... ........................................................................... Total manufacturing overhead Total manufacturing costs............................................... Add: Work-in-process inventory, January 1.................. Subtotal........................................................................... .................................................................................. Deduct: Work-in-process inventory, December 1.......... Cost of goods manufactured........................................... 8-4

100,000 25,000 30,000 190,000 P830,000 120,000 P950,000 115,000 P835,000


Requirement 2 Amazing Aluminum Company Schedule of Cost of Goods Sold For the Year Ended December 31, 2005 Finished goods inventory, January 1................................................... Add: Cost of goods manufactured..................................................... Cost of goods available for sale.......................................................... Deduct: Finished goods inventory, December 31.............................. Cost of goods sold...............................................................................

P150,000 835,000 P985,000 165,000 P820,000

Requirement 3 Amazing Aluminum Company Income Statement For the Year Ended December 31, 2005 Sales revenue....................................................................................... Less: Cost of goods sold..................................................................... Gross margin....................................................................................... Selling and administrative expenses................................................... Income before taxes............................................................................. Income tax expense............................................................................. Net income ........................................................................................

P1,105,000 820,000 P 285,000 110,000 P 175,000 70,000 P 105,000

Exercise 2

a. b. c. d. e. f. g. h. i.

Cost Item Transportation-in costs on materials purchased Assembly-line workers’ wages Property taxes on work in process inventories Salaries of top executives in the company Overtime premium for assembly workers Sales commissions Sales personnel office rental Production supervisory salaries Controller’s office supplies

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Fixed (F) Variable (V)

Period (P) Product (R)

V V

R R

V F V V F F F Fixed (F)

R P R P P R P Period (P)


j. k. l. m. n. o. p. q. r. s. t.

Cost Item Executive office heat and air conditioning Executive office security personnel Supplies used in assembly work Factory heat and air conditioning Power to operate factory equipment Depreciation on furniture for sales staff Varnish used for finishing product Marketing personnel health insurance Packaging materials for finished product Salary of the quality control manager who checks work on the assembly line Assembly-line workers’ dental insurance

Variable (V) F F V F V F V F V

Product (R) P P R R R P R P R

F F

R R

Exercise 3 (Cost Classifications; Manufacturer) 1. 2. 3. 4. 5. 6. 7. 8. 9.

a, d, g, i a, d, g, j b, f b, d, g, k a, d, g, k a, d, g, j b, c, f b, d, g, k b, c and d*, e and f and g*, k* * The building is used for several purposes.

10. 11. 12. 13. 14.

b, c, f b, c, h b, c, f b, c, e b, c and d†, e and f and g†, k† †

The building that the furnace heats is used for several purposes.

15. b, d, g, k Exercise 4 (Economic Characteristics of Costs) 1. marginal cost 2. sunk cost 8-6


3. 4. 5. 6.

average cost opportunity cost differential cost out-of-pocket cost

Exercise 5 (Cost Classifications; Hotel) 1. 2. 3. 4. 5. 6. 7. 8.

a, c, e, k b, d, e, k d, e, i d, e, i a, d, e, k a, d, e, k d, e, k b, d†, e, k †

Unless the dishwasher has been used improperly.

9. h 10. a, d, e*, j * The hotel general manager may have some control over the total space allocated to the kitchen.

11. 12. 13. 14.

i j a, c, e e, k

Exercise 6 Pickup Truck Output Variable production costs Fixed production costs

3,000 trucks P 29,640,000 39,200,000 8-7

6,000 trucks P 59,280,000 39,200,000

9,000 trucks P 88,920,000 39,200,000

Chapter 8 Cost Concepts and Classifications Variable selling costs Fixed selling costs Total costs

4,500,000 13,660,000 P 87,000,000

9,000,000 13,660,000 P121,140,000

13,500,000 13,660,000 P155,280,000

Selling price per truck

46,000

40,100

35,900

Unit cost

29,000

20,190

17,253

Profit per truck

17,000

19,910

18,647

Exercise 7 (see next page) Exercise 8 1. The wages of employees who build the sailboats: direct labor cost. 2. The cost of advertising in the local newspapers: marketing and selling cost. 3. The cost of an aluminum mast installed in a sailboat: direct materials cost. 4. The wages of the assembly shop’s supervisor: manufacturing overhead cost. 5. Rent on the boathouse: a combination of manufacturing overhead, administrative, and marketing and selling cost. The rent would most likely be prorated on the basis of the amount of space occupied by manufacturing, administrative, and marketing operations. 6. The wages of the company’s bookkeeper: administrative cost. 7. Sales commissions paid to the company’s salespeople: marketing and selling cost. 8. Depreciation on power tools: manufacturing overhead cost.

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Exercise 7 Variable Cost 1. 2. 3. 4. 5. 6. 7. 8. 9. * 1

Wood used in a table (P200 per table) Labor cost to assemble a table (P80 per table) Salary of the factory supervisor (P76,000 per year) Cost of electricity to produce tables (P4 per machine-hour) Depreciation of machines used to produce tables (P20,000 per year) Salary of the company president (P200,000 per year) Advertising expense (P500,000 per year) Commissions paid to salespersons (P60 per table sold) Rental income forgone on factory space

Fixed Cost

Period (Selling and Administrative) Cost

X

Product Cost Direct Manufacturing Labor Overhead

Sunk Cost

Opportunity Cost

X

X

X X

X

X

X X

X

Direct Materials

X

X

X

X

X

X*

X X1

This is a sunk cost because the outlay for the equipment was made in a previous period. This is an opportunity cost because it represents the potential benefit that is lost or sacrificed as a result of using the factory space to produce tables. Opportunity cost is a special category of cost that is not ordinarily recorded in an organization’s accounting books. To avoid possible confusion with other costs, we will not attempt to classify this cost in any other way except as an opportunity cost.

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Exercise 9

1. 2.

Cost The salary of the head chef The salary of the head chef

3. 4. 5. 6.

Room cleaning supplies Flowers for the reception desk The wages of the doorman Room cleaning supplies

7.

Fire insurance on the hotel building Towels used in the gym

8.

Cost Object The hotel’s restaurant A particular restaurant customer A particular hotel guest A particular hotel guest A particular hotel guest The housecleaning department The hotel’s gym

Direc t Cost X

The hotel’s gym

Indirec t Cost X

X

X X X X

X

Note: The room cleaning supplies would most likely be considered an indirect cost of a particular hotel guest because it would not be practical to keep track of exactly how much of each cleaning supply was used in the guest’s room. III. Problems Problem 1 The relevant costs for this decision are the differential costs. These are: Opportunity cost or lost wages (take home) [P1,500 x 70% x 12 months]........ P12,600 Tuition..................................................... 2,200 Books and supplies.................................. 300 Total differential costs....................... P15,100 Room and board, clothing, car, and incidentals are not relevant because these are presumed to be the same whether or not Francis goes to school. The possibility of part-time work, summer jobs, or scholarship assistance could be considered as reductions to the cost of school. If students are familiar with the time value of money, then they should recognize that the analysis calls for a comparison of the present value of the differential after-tax cash inflows with the present value of differential costs of getting the education (including the opportunity costs of lost income). Problem 2 Requirement (a) 8-10


Only the differential outlay costs need be considered. The travel and other variable expenses of P22 per hour would be the relevant costs. Any amount received in excess would be a differential, positive return to Pat. Requirement (b) The opportunity cost of the hours given up would be considered in this situation. Unless Pat receives more than the P100 normal consulting rate, the contract would not be beneficial. Requirement (c) In this situation Pat would have to consider the present value of the contract and compare that to the present value of the existing consulting business. The final rate may be more or less than the normal P100 rate depending on the outcome of Pat’s analysis. Problem 3 Utilities for the bakery Paper used in packaging product Salaries and wages in the bakery Cookie ingredients Bakery labor and fringe benefits Bakery equipment maintenance Depreciation of bakery plant and equipment Uniforms Insurance for the bakery Boxes, bags, and cups used in the bakery Bakery overtime premiums Bakery idle time Total product costs in pesos

2,100 90 19,500 35,000 1,300 800 2,000 400 900 1,100 2,600 500 66,290

Problem 4 Administrative costs Rent for administration offices Advertising Office manager’s salary 8-11

1,000 17,200 1,900 13,000


Total period costs in pesos

33,100

Problem 5 Requirement (a) Sunk costs not shown could include lost book value on traded assets, depreciation estimates for new investment, and interest costs on capital needed during facilities construction. Requirement (b) The client might be used to differential cost as a decision tool, and believes (correctly) that use of differential analyses has several advantages --- it is quicker, requires less data, and tends to give a better focus to the decision. The banker might suspect the client of hiding some material data in order to make the proposal more acceptable to the financing agency. Problem 6 Requirement (1) EH Corporation Schedule of Cost of Goods Manufactured For the Year Ended December 31 Direct materials: Raw materials, inventory, January 1 Add: Purchases of raw materials Raw materials available for use Deduct: Raw materials inventory, December 31 Raw materials used in production Direct labor Manufacturing overhead: Utilities, factory Depreciation, factory Insurance, factory Supplies, factory Indirect labor Maintenance, factory Total manufacturing overhead cost Total manufacturing cost 8-12

P 45,000 375,000 420,000 30,000 P 390,000 75,000 18,000 81,000 20,000 7,500 150,000 43,500 320,000 785,000


Add: Work in process inventory, January 1

90,000 875,000

Deduct: Work in process inventory, December 31 Cost of goods manufactured

50,000 P825,000

Requirement (2) The cost of goods sold would be computed as follows: Finished goods inventory, January 1 Add: Cost of goods manufactured Goods available for sale Deduct: Finished goods inventory, December 31 Cost of goods sold

P130,000 825,000 955,000 105,000 P850,000

Requirement (3) EH Corporation Income Statement For the Year Ended December 31 Sales Cost of goods sold (above) Gross margin Selling and administrative expenses: Selling expenses Administrative expenses Net operating income

P1,250,000 850,000 400,000 P 70,000 135,000 P

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205,000 195,000


Problem 7 Note to the Instructor: Some of the answers below are debatable.

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17.

Variable or Cost Item Fixed Depreciation, executive jet............................................................................ F Costs of shipping finished goods to customers.............................................. V Wood used in manufacturing furniture.......................................................... V Sales manager’s salary.................................................................................. F Electricity used in manufacturing furniture................................................... V Secretary to the company president............................................................... F Aerosol attachment placed on a spray can produced by the company............ V Billing costs.................................................................................................. V Packing supplies for shipping products overseas........................................... V Sand used in manufacturing concrete............................................................ V Supervisor’s salary, factory........................................................................... F Executive life insurance................................................................................ F Sales commissions........................................................................................ V Fringe benefits, assembly line workers.......................................................... V Advertising costs........................................................................................... F Property taxes on finished goods warehouses................................................ F Lubricants for production equipment............................................................ V

*Could be an administrative cost. **Could be an indirect cost.

Selling Cost

Administrative Cost X

Manufacturing (Product) Cost Direct Indirect

X X X X X X X* X X X X X X** X X X


Problem 8 Requirement (1)

Variable Cost

Name of the Cost Ling’s present salary of P400,000 per month........................................................................... Rent on the garage, P15,000 per month........................... Rent of production equipment, P50,000 per month........................................................................... Materials for producing flyswatters, at P30.00 each................................................................. X Labor cost of producing flyswatters, at P50.00 each................................................................. X Rent of room for a sales office, P7,500 per month........................................................................... Answering device attachment, P2,000 per month........................................................................... Interest lost on savings account, P100,000 per year........................................................................ Advertising cost, P40,000 per month............................... Sales commission, at P10.00 per flyswatter..................... X Legal and filing fees, P60,000.........................................

Fixed Cost

Direct Materials

Product Cost Direct Mfg. Labor Overhead

Period (Selling and Admin.) Cost

Opportunity Cost

Sunk Cost

X X

X

X

X X X

X

X

X

X

X

X X

X X

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Requirement (2) The P60,000 legal and filing fees are not a differential cost. These legal and filing fees have already been paid and are a sunk cost. Thus, the cost will not differ depending on whether Ling decides to produce flyswatters or to stay with the consulting firm. All other costs listed above are differential costs since they will be incurred only if Ling leaves the consulting firm and produces the flyswatters. Problem 9 Requirement (1) Ms. Rio’s first action was to direct that discretionary expenditures be delayed until the first of the new year. Providing that these “discretionary expenditures” can be delayed without hampering operations, this is a good business decision. By delaying expenditures, the company can keep its cash a bit longer and thereby earn a bit more interest. There is nothing unethical about such an action. The second action was to ask that the order for the parts be cancelled. Since the clerk’s order was a mistake, there is nothing unethical about this action either. The third action was to ask the accounting department to delay recognition of the delivery until the bill is paid in January. This action is dubious. Asking the accounting department to ignore transactions strikes at the heart of the integrity of the accounting system. If the accounting system cannot be trusted, it is very difficult to run a business or obtain funds from outsiders. However, in Ms. Rio’s defense, the purchase of the raw materials really shouldn’t be recorded as an expense. He has been placed in an extremely awkward position because the company’s accounting policy is flawed. Requirement (2) The company’s accounting policy with respect to raw materials is incorrect. Raw materials should be recorded as an asset when delivered rather than as an expense. If the correct accounting policy were followed, there would be no reason for Ms. Rio to ask the accounting department to delay recognition of the delivery of the raw materials. This flawed accounting policy creates incentives for managers to delay deliveries of raw materials until after the end of the fiscal year. This could lead to raw materials shortages and poor relations with suppliers who would like to record their sales before the end of the year. 8-16


The company’s “manage-by-the-numbers” approach does not foster ethical behavior—particularly when managers are told to “do anything so long as you hit the target profits for the year.” Such “no excuses” pressure from the top too often leads to unethical behavior when managers have difficulty meeting target profits. IV. Multiple Choice Questions 1. 2. 3. 4. 5. 6.

B D B A C D

7. 8. 9. 10. 11. 12.

C D C C A C

13. D 14. D † 15. B † 16. A † 17. C † 18. C

*

19. 20. 21. 22. 23. 24.

A A* B B C C

25. 26. 27. 28. 29. 30.

C B B A ** A B

Controllable costs are those costs that can be influenced by a specified manager within a given time period. ** The answer assumes absorption costing method is used. † Supporting Computations 14. P60 + P10 + P18 + P4 = P92 16. P60 + P10 + P18 + P32 = P120 15. P32 + P16 = P48 17. P4 + P16 = P20

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Chapter 08 - Answer

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