Accounting for Decision Making Study Set 5

Business

Quiz 11 :

Criticisms of Absorption Cost Systems: Inaccurate Product Costs

Quiz 11 :

Criticisms of Absorption Cost Systems: Inaccurate Product Costs

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Houston Milling is a subcontractor to Pratt Whitney, which makes jet engines. Houston Milling makes two different fuel pump housings for two Pratt Whitney jet engines: the A11 housing and the D43. These pump housings are received from Pratt Whitney, which buys them from an outside (independent) foundry and ships them to Houston for precision machining. Houston performs two machining operations on the housings. These are performed in two separate machining departments (Department 1 and Department 2). Both housings, A11 and D43, require machining in both Departments 1 and 2. Before the parts are machined, the machines must first be set up, which includes cleaning the machine, checking the tools in the machine, adjusting the tolerances, and then finally machining some trial parts. Houston's current accounting system tracks the number of setups and direct labor hours used by each part. Table 1 summarizes the indirect costs of producing A11 and D43. (The direct costs such as direct labor and materials are ignored to simplify the computations.) Setup and machine hours in the two departments are pooled into two cost pools: setup and machining. Table 1 allocates the costs in these two pools to the two products. Under this accounting system, A11 has indirect costs of $8,600 and D43 has indirect costs of $6,400. Management believes that the current accounting system is not producing accurate costs for the two products because the two cost pools are too aggregated. They decide to disaggregate the data and use four cost pools. They collect some additional data, which are summarized in Table 2. Required : a. Calculate revised cost allocations based on the disaggregated data in Table 2. Number of setups is used to allocate the indirect cost of setups in both Departments 1 and 2 and direct labor hours are used to allocate the machining costs in Departments 1 and 2. b. Prepare a short memo describing the pros and cons of the revised allocated indirect costs in part (a) compared to those in Table 1. c. After completing the analysis in parts (a) and (b), some additional data are collected from a special study of setup hours and machine hours in the two departments. These data are presented in Table 3. In particular, setup hours and machine hours are collected in the two departments. Management now believes that setup hours and machine hours more accurately reflect the true cause-and-effect relations of setup costs and machining costs in Departments 1 and 2 than number of setups and direct labor hours, respectively. Based on the data presented in Table 3, calculate revised cost allocations for A11 and D43. Setup costs in Departments 1 and 2 are to be allocated based on setup hours, and machining costs in Departments 1 and 2 are to be allocated based on machine hours. d. Compare the total product costs for A11 and D43 in Table 1 and parts (a) and (c). What conclusions can you draw? img
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Cost of Goods sold:
It represents the cost attributable to the production of goods which are sold by the enterprise. It includes direct material cost, direct labor cost which incurred for production excluding indirect cost.
Absorption Costing:
It is a method used in the cost accounting system, under which all the expenses which are related to the production or manufacturing of a product are entered or taken into consideration. Under this method, all the expenses relating to the manufacturing are absorbed by the units that are being produced by the company at that point in time.a.In the present case, the information regarding the two parts of the company's manufacturing product with their respective direct and indirect costs and the basis of allocation are provided.
Prepare a table showing the revised cost allocations with the help of MS-Excel as follows:
img The result of the above calculations is as follows:
img Therefore the cost allocations comes out to be $3,000, $2,000, $8,000 and $2,000 respectively.
b.By doing the revised calculation regarding the cost allocations of various departments under the two main items of the company, the management has arrived at a strong position for the actual calculation of cost per department and the revenue generated from the said two departments item wise.
The entire process of re-calculation of cost allocation is time consuming and also requires expert knowledge from framing the bases for such computation.
By adopting or doing the re-calculation, the management and the company are in a string position because the accurate information regarding the cost consumption and revenue by each and every department with their respective items is available with the company. The management can switch the investment accordingly for generating more and more revenue.
c.
Prepare a table showing the allocation as per machine hours with the help of MS-Excel which is as follows:
img The result of the above calculations is as follows:
img Therefore the Revised allocation cost on the basis of machine hours comes out to be $3,000, $8,000, $2,000 and $2,000 respectively.
d.The calculation of allocation costs in both the table has been done on the basis of available information and data. The calculation done in table 1 shows the simplicity and accuracy of calculation can lead the management towards accurate and important financial results and in very much less time.
But in the other table, there is involvement of some complexity, due to which the management will not be able to generate accurate results.

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P 11-15: Toby Manufacturing Toby Manufacturing produces three different products in the same plant and uses a job order costing system to estimate product costs. A flexible budget is used to forecast overhead costs. Total budgeted fixed factory overhead is $450,000 and variable overhead is 120 percent of direct labor dollars. Projected volumes, selling prices, and direct costs for the three products for the next calendar year are as follows: img Upon closer analysis of the overhead account, warehousing costs are determined to be a major fraction of overhead. The manufacturing process requires six operations. Between operations, intermediate products are moved and warehoused until the next production stage. Each product requires 10 days of processing time to complete all six operations. But the products have different total cycle times because of different waiting times between operations. Cycle time is the total time from when the product is started in production until it is completed and shipped. Product AAA has the shortest cycle time (20 days) because the large volume allows more accurate forecasts and more continuous scheduling of production. Product BBB has a total cycle time of 40 days; product CCC has a total cycle time of 50 days. Products BBB and CCC have longer warehousing times of work in process because of more frequent scheduling changes and supplier delays. Half of what is currently treated as fixed overhead cost is involved in the warehousing function. Required : a. Prepare a pro forma income statement by product line for the year based on full absorption costing. Product costs should include overhead assigned on direct labor cost. b. Prepare a revised pro forma income statement by product line using activity-based costing. c. Comment on the differences.
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Job Order Costing:
It is the system used by the companies for the assignment of all the manufacturing costs incurred during production to a single product or to the group of products.
Overhead Costs:
These are the expenses incurred by the company and are shown in the income statement and also they are not direct expenses of the company. Overhead costs are the indirect expenses of the company.
Overhead Rate:
When all the overhead costs incurred by the company are summed up and divided by the appropriate allocation measure, the overhead rate is obtained. It can be calculated for both of the budgeted costs as well as the actual costs.
Absorption Costing:
It is a method used in the cost accounting system, under which all the expenses which are related to the production or manufacturing of a product are entered or taken into consideration. Under this method, all the expenses relating to the manufacturing are absorbed by the units that are being produced by the company at that point in time.Income statement:
All companies in order to calculate net profit or net loss prepare income statement. The income statement is one of the important financial statements. It is prepared by deducting all revenue expenses from total revenue receipt during that period for which statement is prepared.a.In the present case, the information regarding the sale price, costs incurred by the company on its three major products are provided. Before preparing the income statement for the company, first calculate the overhead rate with the help of MS-Excel as follows:
img The result of the above calculation is as follows:
img So the overhead rate comes out to be $501.4 per direct labor.
Now, prepare the Income Statement for the company as follows:
img The result of the above calculations is as follows:
img Therefore the Income of the company comes out to be $126,348 for the company.
b.Prepare the Income Statement of the company with the activity based costing method as follows:
img The result of the above calculation is as follows:
img Therefore the net Income of the company comes out to be $126,374.
Working Note:
Compute the Warehousing Cost per unit and Non-Warehousing Fixed Costs with the help of the following table which is as follows:
img The result of the above calculation is as follows:
img Therefore the Fixed Overhead Rate for Non-Warehousing Fixed Costs comes out to be 190.7$ and the Warehousing Costs per Unit for the three products comes out to be $11.84, $35.53 and $47.37 respectively.
c.
There is not much difference in the Net Income of the company by using either of the methods. It comes out to be the same almost. The difference arises on account of individual product evaluation.
In part an above, the least income was generated by CCC and after the assignment of warehousing costs and fixed costs as per activity based costing method then also the product CCC tends to lose more money and is occurring losses for the company.
Therefore the detailed analysis regarding such allocation and the negative results should be made by the management of the company in this regard.

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Milan Pasta At its Lyle Avenue plant, Milan Pasta produces two types of pasta: spaghetti and fettuccine. The two pastas are produced on the same machines, with different settings and slightly different raw materials. The fettuccine, being a wider noodle and more susceptible to curling edges, requires more inspection time. The total daily cost of inspection is $500. Here are daily production data for the two products: img Required: a. Calculate the inspection cost per pound of pasta using traditional absorption costing with number of machine hours as the allocation base. b. Calculate the inspection cost per pound of pasta using activity-based costing. Assume inspection time is the cost driver. c. Analyze why inspection costs differ between the methods used in parts (a) and (b).
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Absorption Costing
It is a method used in the cost accounting system, under which all the expenses which are related to the production or manufacturing of a product are entered or taken into consideration. Under this method, all the expenses relating to the manufacturing are absorbed by the units that are being produced by the company at that point in time.Activity Based Costing
It a practice used under the cost accounting system. Under this method, all the expenses or overheads incurred by the company for the manufacturing of the products are charged against all the activities which are being undertaken for the manufacturing. The charge is calculated by taking into consideration the burden of resources each activity has consumed.Inspection Cost
It refers to the cost incurred by the companies for inspecting the production process and all the related activities during the production process. In the present case, the information regarding the items manufactured by the company with their respective quantity produced and the time taken for each item is provided.
a.Compute the inspection cost per pound using the mentioned method with the help of MS-Excel as follows:
img The result of the above calculation is as follows:
img Therefore the Inspection Cost for both the items comes to be $0.05 and $0.1 per pound respectively. The cost of Fettuccine is double than that of the Spaghetti because it consumes more time than that.
b.Compute the Inspection cost by using the activity based costing method as follows:
img The result of the above calculation is as follows:
img Therefore the Inspection cost of the two items comes out to be $0.0208 and $0.1875 respectively.
c.In the calculations done above, there is a huge difference in the inspection cost under both the methods. The reason behind such a difference is the inspection being kept on the time that the inspector takes for completing the task.
On another hand, the inspection is taken on a converted mode i.e. they are being changed from the indirect cost to the direct one because of the inspection being carried out on the inspectors.

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GAMMA produces over a hundred different types of residential water faucets at its Delta, Florida, plant. This plant uses activity-based costing to calculate product costs. The following table summarizes the plant's overhead for the year and the cost drivers used for each activity center: img One faucet model GAMMA manufactures is Explorer. Its total product cost is as follows: img Required: Calculate the product cost per unit of the Explorer faucet using absorption costing where plant overhead is assigned to products using direct labor dollars.
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Sanchez Gadgets purchases innovative home kitchen gadgets from around the world (such as a kitchen torch, a pasta maker, and an automatic salad spinner) and sells them to specialty cooking retail stores. Sanchez has a marketing department that locates and purchases the innovative gadgets and prepares price lists and catalogs for Sanchez's direct selling force. Sanchez's salespeople are assigned geographic sales territories and are responsible for all the specialty kitchen stores in their geographic territories. Management at Sanchez is concerned that with more than 450 different items available, it is currently carrying too many different SKUs (SKUs are "stock keeping units"). Management is currently looking for a methodology to eliminate unprofitable SKUs. To focus on developing that methodology, assume that Sanchez has just four SKUs: SKU1, SKU2, SKU3, and SKU4. The following data summarize the current sales, selling prices, and cost (purchase price plus freight) for each SKU: img Sanchez purchases items for sale and inventories them. The cost of inventorying each item (including the opportunity cost of financing the item) is 20 percent of the annual cost of the item. So if 100 units of a gadget are sold each year, and the cost of the item is $4, Sanchez's inventory holding cost is $80 (20% × 100 × $4). The annual cost of the marketing department is $135,000. This amount consists of the salaries and fringe benefits of the employees who purchase the products and prepare the catalogs and price lists. Management determines that marketing department costs vary with the number of SKUs. The annual cost of the direct sales force is $350,000. This amount consists of the salaries, fringe benefits, and travel expenses of the salespeople who call on the retail specialty kitchen stores to sell Sanchez gadgets. After extensive conversations with the salespeople, management believes that the salespeople spend their time in proportion to the sales volume of the gadgets. In other words, if a particular gadget accounts for 10 percent of Sanchez's total revenue, then the sales force spends about 10 percent of its time selling that item. Required : a. Design a reporting methodology that identifies possible SKUs that Sanchez should consider dropping from its product mix. Using your methodology, compute the profitability of each of the four SKUs. b. Based on your analysis in part (a), which SKUs should Sanchez drop? Which ones should Sanchez retain? c. Discuss the critical assumptions underlying your analysis in part (a).
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SnapOn makes snap-together button fasteners (a male top and female bottom) for designer clothes. Each top and bottom consists of several metal parts that, when attached to the garment, allow the shirt, jacket, or pants to be closed without the use of a zipper. The top of each button consists of a shiny or painted metal surface, usually embossed with the designer's logo or design. Fashion design houses contract with manufacturers to produce their fashion lines. The fashion house specifies the particular SnapOn fasteners the manufacturer will use. The manufacturer then purchases the top and bottom sections of the fasteners and leases SnapOn attaching machines to attach the fasteners to the garments. Because each fastener is designed specifically for a particular designer, SnapOn attaching machines must be tailored to each fastener so that the fastener can be attached to the garment without scratching or marring the snap, and the machine can operate reliably without jamming. Each machine is specialized to a particular fastener by the tooling in the machines, which have tight tolerances for the particular fastener shape, size, and finish. This tooling is the materials handling device that moves the various components of the tops and bottoms through the machine and positions them in the correct location so that the machine can then compress the metal parts and fabric together. SnapOn has achieved a good reputation among top design houses for producing high-quality, unique fasteners and a line of attaching machines that do not jam and do not mar the fastener. SnapOn has a staff of service technicians who maintain the attaching equipment 24/7. If a machine malfunctions, SnapOn guarantees that it will repair it within 24 hours, anywhere in North America. This service is very important to SnapOn's customers because fashion designers operate on short cycle times. Once they design their spring, summer, fall, or winter lines and show them to the buyers, the designers have eight weeks to produce and deliver the lines. Keeping their designs secret until they are released keeps other fashion houses and knock-off producers from copying their designs. The top fashion designers are willing to pay premium prices for high-quality fasteners that can be attached using highly reliable equipment. SnapOn has two product lines (fasteners and attaching machines) and produces both lines in the same plant. Separate managers are responsible for the two product lines. Each manager receives 50 percent of his/her bonus based on reported net income of his/her product line, and 50 percent of his/ her bonus based on SnapOn's total net income. All manufacturing overhead of $59.615 million is applied to all products (attaching machines and fasteners) using direct labor dollars. All selling and service costs of $47.210 million are allocated to fasteners and attaching machines based on revenue dollars generated by each product line. The following table summarizes the operations of SnapOn (in millions) for the most recent fiscal year. img Required : a. Prepare income statements for SnapOn's two lines of business (fasteners and attaching machines) that include manufacturing overhead and selling and service expenses allocated to each business line using the methodology described previously. Assume there are no beginning or ending inventories of either attaching machines or fasteners. b. Senior management is concerned that its current costing methodology of allocating manufacturing overhead based on direct labor dollars is too simplistic and is not producing unit manufacturing costs that accurately reflect the true consumption of indirect manufacturing overheads. Since manufacturing overhead is about 50 percent of total manufacturing cost (direct labor, direct materials, and manufacturing overhead), small errors in cost allocations could materially affect the calculated unit manufacturing costs. Some foreign competitors are entering SnapOn's traditional fashion markets and are offering fasteners at prices below SnapOn's unit manufacturing costs. Garment manufacturers who use these foreign fasteners have to lease attaching machines from other U.S. manufacturers because the foreign fastener-makers do not provide their own attaching machines. SnapOn will not allow non-SnapOn fasteners to be used in SnapOn attaching equipment. Senior management organizes a task force to study SnapOn's manufacturing overhead and selling and service costs and asks the task force to devise a better methodology for tracing these costs to individual products and the two lines of business. After three months of analysis, the task force presents the following breakdown of last year's manufacturing overhead amount: img
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Friendly Grocer has three departments in its store: beverages, dairy and meats, and canned and packaged foods. Each department is headed by a departmental manager. Operating results for the last month (in thousands) are given in the table. img The direct costs consist of the cost of goods sold. Indirect costs consist of selling, general, and administrative (SG A) costs and are allocated to each department at the rate of 20 percent of costs of goods sold. Based on the preceding report, beverages had operating income of $10,000, dairy and meats had operating income of $75,200, and canned and packaged foods lost $12,400. Senior management is concerned that the allocation of costs might be distorting the relative profitability of the three departments. Further analysis of the SG A account yields the following breakdown: img Shelf space costs consist of store occupancy costs such as depreciation on the building and fixtures, utilities, store maintenance, property taxes, and insurance. Beverages make up 25 percent of the shelf space, dairy and meats make up 35 percent of the space, and canned and packaged goods make up 40 percent of the shelf space. Handling costs consist of the labor required to stock the shelves and remove outdated products. The beverage suppliers (Coca-Cola, Pepsi, etc.) provide the labor to shelve their products (i.e., the beverage delivery people stock their products on the shelf). Dairy and meats' labor costs for stocking are three-quarters of the handling costs; canned and package foods' labor and handling costs are one-quarter of the total. Coupon costs consist of the labor costs to process the redeemed coupons. Dairy and meats do not have any coupons. Twenty percent of the coupons redeemed are for beverages and 80 percent are for packaged and canned foods. Shrinkage consists of the cost of products spoiled, broken, and stolen. Shrinkage by product category comes to img The remaining indirect costs are allocated based on cost of goods sold. Required : a. Apply an activity-based costing system and recalculate the operating income of the three departments. b. Based on the statement you prepared in part (a), write a short memo to management discussing the revised operating income of the three departments and which statement (yours or the one in the question) management should use.
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ABC and Volume Changes Required: a. What differentiates unit-level costs, batch-level costs, product-line costs, and capacity-sustaining costs? Give examples. b. "One advantage of an activity-based cost system is that it prevents unit costs from rising when volumes fall and unit costs from falling as volumes rise." True or false? Discuss why.
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Wedig Diagnostics manufactures two laser photometers that are used in preparing DNA tests. The U.S. model is designed for use in the United States, and the EU model is designed to meet the specifications in most of the European Union. Both models are manufactured in the United States. The EU models are shipped to Wedig's wholly owned European subsidiary, which sells them. All units manufactured are sold. The following table summarizes the selling prices, direct materials and labor, and number of units sold. img The EU units are sold in U.S. dollars. Wedig has total manufacturing overhead of $39 million annually. This overhead is allocated to both U.S. and EU models using total direct labor dollars. Wedig transfers its EU model to its European subsidiary at full cost (direct materials and labor plus allocated overhead). Assume that Wedig pays U.S. taxes only on the profits it makes on sales in the United States, and the Wedig EU subsidiary pays taxes only on the profits it makes on sales in the EU. The U.S. income tax rate is 30 percent, and the Wedig European subsidiary has a tax rate of 15 percent. Wedig hires a consulting firm to perform an ABC analysis of its overhead costing methodology. This analysis reveals that the $39 million of overhead consists of three cost pools: batch-related costs ($12 million), parts-related costs ($9 million), and direct labor-related costs ($18 million). Each model is produced in batches, and batch-related costs consist of engineering, quality control, and machining costs that vary with the number of batches produced. The U.S. model is produced in 45 batches each year, and the EU model is produced in 55 batches a year. The U.S. and EU models differ in terms of the number of different parts in each unit. The U.S. model has 40 different part numbers, and the EU model has 80 different part numbers. Parts-related costs consist of the costs of operating the purchasing department (excluding the costs of the parts purchased), inspecting the parts upon arrival, inventorying the parts, and managing the parts inventory. Parts-related costs vary with the number of part numbers in each product. Finally, the direct labor-related costs consist of human resources, accounting, and other overhead costs that vary with the amount of direct labor in each model. Required : a. Calculate the unit manufacturing cost of the U.S. and EU models using total direct labor dollars to allocate the $39 million of manufacturing overhead. b. Calculate the unit manufacturing cost of the U.S. and EU models using the ABC analysis to allocate the $39 million of manufacturing overhead. c. Prepare income statements (including income tax expense) for Wedig and its European subsidiary using the unit manufacturing costs calculated in part (a) (overhead is allocated using total direct labor dollars). d. Prepare income statements (including income tax expense) for Wedig and its European subsidiary using the unit manufacturing costs calculated in part (b) (overhead is allocated using the ABC analysis). e. Discuss the advantages and disadvantages of using direct labor versus ABC to allocate the $39 million of overhead.
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Rextera produces a line of skin care products. It has two product lines: Young Skin and Moisturizer. Young Skin is a patented, heavily promoted, and proprietary cream that removes wrinkles and "makes you look ten years younger." Moisturizer is a cream that moisturizes the skin. Rextera sells its two products lines only through its website. Its strategy is to drive consumers to its website via articles in fashion and health magazines, other web sites, and blogs about Young Skin. Although many customers initially are drawn to Rextera's site because of these Young Skin stories, only a small fraction of Rextera website visitors buy Young Skin (due to its high price). The following data summarize the operating data on the two product lines. img Variable cost consists of both variable manufacturing cost and variable selling and distribution (shipping) cost. Young Skin and Moisturizer are produced in separate factories, each with its own separable fixed manufacturing overhead. Both product lines share the same common marketing costs (primarily the cost of maintaining the website and advertising the website via articles placed in fashion and health magazines, other websites, and blogs). Product-line profits are not used in calculating any Rextera manager bonus or compensation. Rextera only sells its products in the United States. Required : a. Prepare a report showing product-line profits for Young Skin and Moisturizer after allocating the common fixed marketing costs of $1,000,000, using total revenue on each of the two product lines. b. Rextera management worries that using revenues to allocate the common fixed marketing costs as in part (a) is distorting the relative profits of the two product lines. They believe a more accurate way to allocate these costs is to analyze how customers utilize the Rextera website. After analyzing the various Web pages downloaded by website visitors after coming to the Rextera home page, the following Web views were generated by visitors to the Rexera website during the last six months: img Prepare a report showing product line profits for Young Skin and Moisturizers after allocating the common fixed marketing costs using Web page views as the allocation base. c. Which of the two reports prepared in parts (a) and (b) best captures the profitability of Young Skin and Moisturizer?
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Astin Car Stereos manufactures and distributes four different car stereos. The accompanying table summarizes the unit sales, selling prices, and manufacturing costs of each stereo. img Selling and distribution (S D) expenses are $1,270,000. They are treated as a period cost and written off to the income statement. To assess the relative profitability of each product, S D expenses are allocated to each product based on sales revenue. Upon further investigation of the S D expenses, half are shown to be for marketing and advertising. Each product has its own advertising and marketing budget, administered by one of four marketing managers. Z7, the premier product, is advertised heavily. Forty percent of the marketing and advertising budget goes toward Z7, 30 percent to B300, 20 percent to B200, and 10 percent to A90. The remaining S D expenses consist of distribution and administration costs (25 percent) and selling costs (25 percent). The distribution and administration department is responsible for arranging shipping and for billing the customers. (Customers pay transportation charges directly to the common carrier.) It also handles federal licensing of the car radios. Upon analysis, each product line places equal demands on the distribution and administration department, and each consumes about the same resources as the others. Selling costs consist primarily of commissions paid to independent salespeople. The commissions are based on gross margin (sales revenue less manufacturing cost). Required : a. Allocate all S D expenses based only on sales revenue. Identify the most and least profitable products. b. Allocate all S D expenses based only on the advertising and marketing budget. Identify the most and least profitable products. c. Allocate all S D expenses. Use the advertising and marketing budget for advertising and marketing costs, the demand for these resources by product for distribution and administration costs, and commissions for selling costs. Identify the most and least profitable products. d. Discuss the managerial implications of the various schemes. Why do the different schemes result in different product-line profits? Which product is really the most profitable? The least profitable?
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Routers Inc. manufactures and sells two types of high-speed, secure wireless routers: a home router and a commercial router. Routers Inc. purchases components (printed circuit boards, antennas, power supplies, plastic cases), assembles complete units and tests and boxes them in its plant. The following table summarizes operations for the last fiscal year. img In other words, management budgeted and produced 12,000 home routers last year and budgeted and produced 5,000 commercial routers. Each direct labor minute cost the firm $0.40, and manufacturing overhead last year amounted to $426,000. Routers Inc. employs a traditional absorption costing system to allocate manufacturing overhead to products using direct labor minutes as the allocation base. Required: a. What was the manufacturing overhead rate Routers Inc. calculated last year assuming that actual and budgeted overheads and volumes were identical? (In other words, budgeted volume and actual volumes were the same, and budgeted and actual manufacturing overheads were the same.) b. Compute the total unit manufacturing costs of the home and commercial routers for last year. c. Some senior managers at Routers Inc. questioned using direct labor minutes to allocate the $426,000 of manufacturing overhead arguing (i) it is too coarse and (ii) a more nuanced (sophisticated) approach was required. An extensive study of the manufacturing overheads revealed that the annual manufacturing overhead of $426,000 consists of two components: batch-related costs of $308,000 and product-line related costs of $118,000. Each time a batch is produced, components must be ordered in advance, inspected and stocked when received, and moved to the assembly department before production commences. Then, the assembly line must be prepared for the batch, and a few routers produced and tested to insure the assembly process is performing properly. During the year, 40 batches of home routers were assembled (each with 300 home routers per batch) and 100 batches of commercial routers were assembled (each with 50 commercial routers per batch). The product-line related costs of $118,000 consist of engineering and technician expenses devoted to revising the technical specifications of the components used in the two product lines to comply with the various government agencies regulating wireless devices. Each product line consumes half of the product- line related costs of $118,000. Given the data revealed in the cost study (discussed earlier), compute the manufacturing overhead that should be assigned to the home router and the commercial router. d. The people conducting the manufacturing overhead cost study argue that using the new manufacturing overhead allocations will increase the accuracy of the cost of producing home routers and commercial routers, and hence should be adopted. You are hired as a consultant to the chief financial officer (CFO). Write a brief memo recommending how the CFO should proceed. Should the CFO stay with the existing absorption costing system, switch to the new system, or gather additional information (and what information should be gathered)?
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DVDS manufactures and sells DVD players in two countries. It manufactures two models-Basic and Custom-in the same plant. The Basic DVD has fewer options and provides lower-quality output than the Custom DVD. The basic model is sold only in a developing country and the custom model is sold only in a developed country. DVDS pays income taxes to the country where the final sale of the DVD player takes place. The following table summarizes DVDS operations. img Besides direct materials and direct labor, manufacturing overhead amounts to $2 million and is currently assigned to products based on direct labor dollars. Manufacturing overhead is a fixed cost (does not vary with the number of units produced). Required : a. Calculate the unit manufacturing costs of the Basic and Custom DVD models using traditional absorption costing. Manufacturing overhead is allocated based on direct labor dollars. b. DVDS hires a consulting firm to analyze its costing methods. After performing an extensive review, the consultants determine that the vast majority of the $2 million of overhead varies with the number of different parts in the two DVD models. The number of parts drives purchasing department activities. More engineering time is spent on the more complex Custom DVD models. More accounting depreciation of assembly and testing equipment is incurred producing the Custom DVD model than the Basic DVD model. The Basic DVD has 140 different parts and the Custom DVD model has 160 different parts. Calculate the unit manufacturing costs of the Basic and Custom DVD models using activitybased costing. c. Should DVDS change its costing methodology from its traditional absorption costing to ABC? Explain why it should or should not.
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The Maui Seminar Your boss, the vice president of corporate accounting, has just returned from a two-week seminar in Maui on activity-based cost accounting. He says he wants to completely overhaul the company's existing absorption-based accounting system. "Activity-based costing is the wave of the future and will allow us to make better product-line decisions and therefore be more competitive in the marketplace," he asserts. He wants you to start implementation immediately, but he would like your comments before you begin. How do you respond?
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SPP (Secure Payment Processing) is the dominant technology firm that provides end-to-end secure Internet transaction processing. SPP offers its e-tailers the best security of their customer personal information in the industry. Its clients include many large and smaller e-tailers selling online products. When an online consumer purchases a product on an SPP client website, the storage of the customer's credit card information and processing the transaction is done by SPP-all of which is invisible to the e-tailer's customer. SPP uses its proprietary encryption software to store the customer's account information on its own servers, not on the e-tailer's server. SPP is organized into two groups: Set-up Group and Transaction Processing Group. After acquiring a new client or after an existing client revises it Web portal, SPP assigns a team of its software engineers in the Set-up Group to customize SPP's software that links the e-tailer's website to SPP's servers. These SPP software engineers also run diagnostics to ensure the e-tailer's website is secure and is optimized to SPP's software. SPP charges e-tailer's a set-up charge of $12,000 for its Set-up Group's software engineers to customize the SPP software, optimize the client's site, and test the client's firewalls. Then, the e-tailer is charged a fee of $0.13 per transaction processed each time a customer makes a purchase on the e-tailer's website. The following table summarizes SPP operations for the last 12 months: img Required : a. SPP calculates the cost of processing a transaction as the ratio of total operating cost divided by the number of transactions processed. Compute the cost of processing a single transaction. b. The newly hired CFO of SPP worries that the current method of calculating the cost of processing a transaction [as described in part (a)] is too simplistic. After some further analysis, the CFO determines that 39 software engineers (with an average cost of $139,000) work exclusively on new client set-ups. In addition to the wages and benefits of $139,000 per software engineer, the Set-up Group has additional costs of $8,408,143 (occupancy costs, travel, administration, equipment, software licenses, etc.). Both the Set-up Group's wages and additional costs are included in the Total operating costs of $28,696,143. Based on the preceding information, compute the cost of processing a transaction and the cost of a client set-up. c. Should SPP compute the cost of processing a transaction using the method described in part (a) or the method you used in part (b)? Explain.
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Goodstone Tires designs, manufactures, and sells automotive tires through three profit centers (divisions): Passenger Vehicles, Industrial Vehicles, and Racing. The Racing Division develops stateof- the-art high-performance racing tires for NASCAR, grand prix, and Indy cars. Racing, while a small part of Goodstone's total revenues and profits, provides much external visibility and a proving ground for Goodstone's future generation of passenger and industrial tires. Racing's motto is "What's winning today is on tomorrow's cars and trucks." The following table summarizes the revenues and variable and fixed expenses (in millions of dollars) of the three divisions: img Each division operates as a decentralized organization with its own manufacturing, distribution, marketing, administrative, and sales organizations. Corporate headquarter costs of $1,400 million are allocated to the three divisions based on divisional sales. Required: a. Prepare a report detailing divisional performance based on net income after allocating corporate overhead using divisional sales as the allocation base. b. Discuss the pros and cons of the report you prepared in part (a). c. Upon further reflection, the chief financial officer (CFO) believes that allocating corporate overhead using divisional revenues is too simplistic. Corporate overhead consists of the following: img All research and development for the divisions is conducted at the corporate R D lab. The lab's total spending of $420 million is spent on projects directed specifically at one of the three divisions. As a percentage of total R D spending, Racing has 50 percent, Passenger 30 percent, and Industrial 20 percent. Corporate image advertising amounts to $330 million. While the content of the ads varies, each ad contains images of Goodstone's Racing, Passenger, and Industrial products. The general corporate directive, based on market research, is that each print or television corporate image ad should, on average, contain 60 percent of the images or messages drawn from Racing, 30 percent drawn from Passenger, and 10 percent drawn from Industrial. Corporate borrows to finance the operations (current assets and fixed assets) of the three divisions. No division seeks long-term external financing. Of the total current and fixed assets financed externally by the corporate office, 30 percent are in Racing, 50 percent are in Passenger, and 20 percent are in Industrial. Finally, "Corporate Office" of $280 million consists of the CEO, CFO, chief legal counsel, chief information officer, chief human resource officer, and their staffs. The CFO polled each of the senior officers in the Corporate Office asking them how much of their time and their staff's time was devoted to each of the three divisions. Based on the data, the CFO decided that Corporate Office expenses should be allocated to the three divisions as follows: 40 percent to Racing, 45 percent to Passenger, and 15 percent to Industrial. Based on the preceding information, prepare a revised divisional performance report that satisfies the CFO's request for a less simplistic, more accurate allocation of corporate overhead. d. Discuss the pros and cons of the performance report prepared in part (c). e. The corporate strategy of using the Racing Division both as a way to promote Goodstone's Passenger and Industrial products and also as a way to develop and perfect the next generation of tires was tested when an external consulting firm was hired to estimate the impact on Passenger and Industrial sales from having the Racing Division. Using both longitudinal and cross-sectional data from Goodstone and the tire industry, the consultant concluded that at the current scale of the Racing Division, Racing increases Passenger and Industrial revenues by 10 percent and 5 percent, respectively. Moreover, the consultant concluded that the benefits from corporate image advertising and centralized R D permeate the entire organization and enhance recruiting and retaining personnel. For example, the R D lab can attract better engineers and scientists to work on Passenger and Industrial projects because they also work on state-of-the-art racing projects. Corporate R D projects, while directed specifically at a particular division, provide significant spill-over effects for the other divisions. Lab equipment purchased for Passenger or Industrial projects often is used later on racing projects. And research findings generated on Racing projects almost always have implications for Passenger and Industrial products. In fact, when choosing among R D projects, the head of the lab selects projects that have maximum corporatewide benefits. Based on the findings of the external consultants, prepare another divisional performance report for the three operating divisions. f. Discuss the pros and cons of the report developed in part (e).
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Kay Enterprises is a small, family-owned and managed business. It has a patented production process for manufacturing a digital switch used in large telephone switches. It manufactures two models in its plant in Atlanta, Georgia. The U.S. model is sold to U.S.-based telephone companies, and the European switch is transferred to Kay's wholly owned subsidiary in Ireland, where it is sold to European telephone companies. U.S. switches are sold only in the United States, and European switches can be sold only in Europe. One brother, Lloyd Kay, manages the U.S. company, and his brother, Colin Kay, manages the Irish firm. The two switches share the same proprietary production process but have different design specifications to match the different telephone systems. All switches manufactured are sold; Kay does not have any work-in-process or finished goods inventories. Because of the patented nature of the production process, Kay faces very little competition for its switches either in the United States or Europe. This allows the firm to set a relatively high price above its costs. The following table summarizes the annual number of U.S. and European switches produced and the costs of manufacturing each switch. All manufacturing overhead of $24 million is a fixed cost that does not vary with the number of switches produced. Overhead is allocated to units produced based on direct labor dollars. img Because Kay operates in two countries, it must calculate and report income by country. Assume that the United States has a 35 percent income tax rate on U.S.-derived income. Profits of firms in Ireland are taxed at 10 percent to encourage foreign investment. In recent years, the U.S. and Irish tax authorities have scrutinized Kay's full-cost transfer pricing policy. The tax authorities become suspicious if a different transfer price is used for taxes than for other purposes. Kay transfers the European switches at full accounting cost (direct labor, direct material, and allocated overhead). Required : a. Prepare separate income statements for each country for Kay Enterprises for the current operating year using direct labor dollars to allocate manufacturing overhead to the switches. b. Kay is considering switching to activity-based costing for allocating overhead to the two models of switches. Upon analysis of the production process, it is determined that most of the $24 million of manufacturing overhead varies with the number of batches produced. The equipment is set up between batches; raw materials are ordered and inspected on a batch basis. The quality control department checks five units per batch. Packing and shipping costs vary with the number of batches. After conducting this analysis, Kay decides to switch to ABC for allocating manufacturing costs. European switches are produced in batch sizes of 20,000, and U.S. switches are produced in batch sizes of 30,000. Prepare separate income statements for each country for Kay Enterprises for the current operating year using ABC to allocate manufacturing overhead to the switches. c. Which set of income statements [those in part (a) or (b)] should Kay Enterprises use?
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Joe Bell, president and chief executive officer of Dyna Golf, has called a meeting of the executive committee of his board of directors. He is concerned about the price competition and declining sales of his golf wedge line of business. Bell summarizes the current situation by saying, As you know, we set target prices to maintain a gross margin on sales of 35 percent. On some products, such as our drivers, we have been able to achieve the target price. We have been able to achieve higher prices on our putters than a target 35 percent gross margin would dictate. But our wedges are a totally different story. img img img img img img img Required:What advice would you offer Joe Bell??
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LifeCam Medical produces various titanium orthopedic bone plates for trauma injuries. It has three different product lines (TS1, IFO, and Xpan) and uses activity-based costing to compute the cost of the three product lines. The ABC system employs three indirect cost pools. One pool is based on the grams of titanium in each product. Another pool is based on the number of machine milling minutes used to produce each product. And the third cost pool is allocated based on the amount of direct labor dollars in each product. The following table summarizes the operating data and the computation of ABC product costs: img The three cost pools in the ABC system have three ABC rates that were computed by taking all the costs in the cost pool divided by the total cost driver in the pool (i.e., total grams of titanium). So, for example, the cost pool based on grams of titanium per unit has an ABC rate of $17.00 per gram of titanium. Product TS1 has 40 grams of titanium per unit, so each unit of TS1 is allocated $680 (40 × $17). TS1 is charged for the milling cost pool at $72 per milling minute. Since each unit of TS1 requires 12 milling minutes, TS1's milling cost is $864 (12 × $72). All factory overheads not included in the gram and milling ABC cost pools are assigned to products at the rate of $2.53 per direct labor dollar. TS1 has $48 direct labor dollars, so its cost includes $121.44 of other overheads ($48 × $2.53). The current ABC system has been under development and refinement for the last three years. The CFO is tired of all the bickering over how many cost pools to use, what are the right cost drivers, and which costs should be included in the cost pools. She decides to eliminate the ABC system and return to the simpler system where all factory costs are allocated to the three products using a single factorywide allocation base of direct labor dollars. Compute the unit manufacturing cost of the three products using a single overhead rate where the allocation base is direct labor dollars.
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