G1: Relevant Cost Analysis in a Variety of Situations
Barker Company has a single product called a Zet. The company normally produces and sells 80,000 Zets each year at a selling price of $40 per unit. The company's unit costs at this leel of actiity are gien !elo"# irect materials irect la!or (aria!le manufacturing oerhead *i+ed manufacturing oerhead total(aria!le selling e+penses *i+ed selling e+penses Total cost per unit.
$ %.&0 0.00 ).80 &.00 $400,000 .0 4,&0 $/0,000 total$//.&0
1 num!er of 2uestions relating to the production and sale of Zets are gien !elo". 3ach 2uestion is independent. Required:
. 1ssume that Barker Company has sufficient capacity to produce 00,000 Zets each year "ithout any increase in fi+ed manufacturing oerhead costs. The company could increase sales !y )& a!oe the present 80,000 units each year if it "ere "illing to increase the fi+ed f i+ed selling e+penses !y $&0,000. 5ould 5ould the increased fi+ed f i+ed selling e+penses !e 6ustified7 ). 1ssume again that Barker Company Company has sufficient capacity to produce 00,000 Zets Zets each year. The company has an opportunity to sell )0,000 units in an oerseas market. mport duties, foreign permits, and other special costs associated "ith "ith the order "ould total total $4,000. The only only selling costs that "ould !e associated "ith the order "ould !e $.&0 per unit shipping cost. Compute the per unit !reak9een price on this order. /. :ne of the materials used in the production of Zets is o!tained from a foreign supplier. supplier. Ciil unrest in the supplier's country has caused a cutoff in material shipments that is e+pected to last for three months. Barker Company has enough material on hand to operate at )& of normal leels for the three9month period. 1s an alternatie, the company could close the plant do"n entirely for the three months. Closing the plant "ould reduce fi+ed manufacturing oerhead costs !y 40 during the three9month three9month period and the fi+ed fi+ed selling e+penses "ould "ould continue at t"o9 t"o9 thirds of their normal leel. 5hat "ould !e the impact on profits of closing the plant for the three9month period7 4. The company has &00 Zets on hand that "ere produced last month month and hae small !lemishes. ue to the !lemishes, it "ill !e impossi!le to sell these units at the normal price. f the company "ishes to sell them through regular distri!ution channels, "hat unit cost figure is releant for setting a minimum selling price7 3+plain. &. 1n outside outside manufacturer has offered to produce Zets and ship them directly to Barker's customers. f Barker Company accepts this offer, the facilities that it uses to produce Zets "ould !e idle; ho"eer, fi+ed manufacturing oerhead oerhead costs "ould continue at /0.
G2: Ethics and the Manager; Shut o!n or Continue "#erations
=arin Braun had 6ust !een appointed ice president of the >reat Basin ?egion of the *inancial
reat Basin ?egion consists of three check processing centers in 3astern dahoAocatello, daho *alls, and 1shton. rior to his promotion to ice president, =r. Braun had !een manager of a check processing center in ndiana. mmediately upon assuming his ne" position, =r. Braun re2uested a complete financial report for the 6ust9ended fiscal year from the region's controller, ance 5hiting. =r. Braun specified that the financial report should follo" the standardi@ed format re2uired !y corporate head2uarters for all regional performance reports. That report appears !elo"# $inancial %erfor&ance Great 'asin Region Chec( %rocessing Centers %ocatello *daho $alls Ashton
)otal
?eenues :perating e+penses# irect la!or (aria!le oerhead 32uipment depreciation *acility e+penses ocal administratie e+pensesD ?egional administratie e+pensesD Corporate administratie e+pensesD Total operating e+pense Eet operating income
$)0,000,000
$,000,000
$8,000,000
$&,000,000
),)00,000 400,000 ),00,000 ),000,000 4&0,000
4,400,000 &0,000 00,000 00,000 &0,000
4,00,000 0,000 800,000 &00,000 80,000
/,00,000 %0,000 00,000 %00,000 )0,000
400,000
40,000
0,000
00,000
,00,000 %,&0,000 $ 8&0,000
&0,000 ,00,000 $ /00,000
40,000 ,40,000 $ 80,000
400,000 &,/0,000 $ /0,000-
Docal administratie e+penses are the administratie e+penses incurred at the check processing centers. D?egional administratie e+penses are allocated to the check processing centers !ased on reenues. DCorporate administratie e+penses represent a standard 8 charge against reenues. Fpon seeing this report. =r. Braun summoned ance 5hiting for an e+planation. Braun: 5hat's the story on 1shton7 t didn't hae a loss the preious year, did it7 Whiting: Eo, the 1shton facility has had a nice profit eery year since it "as opened si+ years ago. But 1shton lost a !ig contract this year. Braun: 5hy7 Whiting: :ne of our national competitors entered the local market and !id ery aggressiely on the contract. 5e couldn't afford to meet the !id. 1shtonGs costs99particularly their facility 2
e+penses99are 6ust too high. 5hen 1shton lost the contract, "e had to lay off a lot of employees, !ut "e could not reduce the fi+ed costs of the 1shton facility. Braun: 5hy is 1shton's facility e+pense so high7 t9s a smaller facility than either ocatello or daho *alls and yet its facility e+pense is higher. Whiting: The pro!lem is that "e are a!le to rent suita!le facilities ery cheaply at ocatello and daho *alls. Eo such facilities "ere aaila!le at 1shton, so "e had them !uilt. Fnfortunately, there "ere !ig cost oerruns. The contractor "e hired "as ine+perienced at this kind of "ork and in fact "ent !ankrupt !efore the pro6ect "as completed. 1fter hiring another contractor to finish the "ork, "e "ere "ay oer !udget. The large depreciation charges on the facility didn't matter at first !ecause "e didnGt hae much competition at the time and could charge premium prices. Braun: 5ell, "e can't do that anymore. The 1shton facility "ill o!iously hae to !e shut do"n. ts !usiness can !e shifted to the other t"o check processing centers in the region. Whiting: "ould adise against that. The $%00,000 in depreciation charges at the 1shton facility are misleading. That facility should last indefinitely "ith proper maintenance. 1nd it has no resale alue; there is no other commercial actiity around 1shton. Braun: 5hat a!out the other costs at 1shton7 Whiting: t "e shifted 1shton's !usiness oer to the other t"o processing centers in the region, "e "ouldnGt sae anything on direct la!or or aria!le oerhead costs. 5e might sae $0,000 or so in local administratie e+penses, !ut "e "ould not sae any regional administratie e+pense. 1nd corporate head2uarters "ould still charge us 8 of our reenues as corporate administratie e+penses. n addition "e "ould hae to rent more space in ocatello and daho *alls to handle the "ork transferred from 1shton# that "ould pro!a!ly cost us at least $400,000 a year. 1nd don't forget that it "ill cost us something to moe the e2uipment from 1shton to ocatello and daho *alls. 1nd the moe "ill disrupt serice to customers. Braun: understand all of that, !ut a money9losing processing center on my performance report is completely unaccepta!le. Whiting: 1nd if you do shut do"n 1shton. Hou are going to thro" some loyal employees out of "ork. Braun: That's unfortunate, !ut "e hae to face hard !usiness realities. Whiting: 1nd you "ould hae to "rite off the inestment in the facilities at 1shton. Braun: can e+plain a "rite9off to corporate head2uarters; hiring an ine+perienced contractor to !uild the 1shton facility "as my predecessor's mistake. But they'll hae my head at head2uarters if sho" operating losses eery year at one of my processing centers. 1shton has to go. 1t the ne+t corporate !oard meeting, am going to recommend that the 1shton facility !e closed. ?e2uired# . *rom the standpoint of the company as a "hole, should the 1shton processing center !e shut do"n and its "ork redistri!uted to the other processing centers in the region7 3+plain. ). o you think =arin Braun's decision to shut do"n the 1shton facility is ethical7 3+plain. /. 5hat influence should the depreciation on the facilities at 1shton hae on prices charged !y 1shton for its serices7
3
G+: Relevant Costs; %ricing
Ienco ncorporated's only product is a com!ination fertili@er9"eed killer called *ertikil. *ertikil is sold nation"ide through normal marketing channels to retail nurseries and garden stores. Taylor Eursery plans to sell a similar fertili@er "eed killer compound through its regional nursery chain under its o"n priate la!el. Taylor does not hae manufacturing facilities of its o"n, so it has asked Ienco and seeral other companies- to su!mit a !id for manufacturing and deliering a )&,000 pound order of the priate !rand compound to Taylor. 5hile the chemical composition of the Taylor compound differs from that of *ertikil, the manufacturing processes are ery similar. The Taylor compound "ould !e produced in .000 pound lots. 3ach lot "ould re2uire /0 direct la!or9hours and the follo"ing chemicals# Chemicals
Juantity in ounds
C59/ IK9 =Z98 B39
400 /00 )00 00
The first three chemicals C59/, IK9, and =Z98- are all used in the production of *ertikil. B39 "as used in another compound that Ienco discontinued seeral months ago. The supply of B39 that Ienco had on hand "hen the other compound "as discontinued "as not discarded. Ienco could sell its supply of B39 at the preailing market price less $0.0 per pound selling and handling e+penses. Ienco also has on hand a chemical called CE9&, "hich "as manufactured for use in another product that is no longer produced. CE9&, "hich cannot !e used in *ertikil, can !e su!stituted for C59/ on a one9for9one !asis "ithout affecting the 2uality of the Talor compound. The CE9& in inentory has a salage alue of $&00. nentory and cost data for the chemicals that can !e used to produce the Taylor compound are as sho"n !elo"# ?o" =aterial C59/ IK9 =Z98 B39 CE9&
ounds in nentory
1ctual riceLound 5hen urchased $0.80 0.&& .40 0.0 0.&
)),000 &,000 8,000 4,000 &,&00
Current =arket riceLound $0.%0 0.0 .0 0.&
The current direct la!or rate is $4 per hour. The predetermined oerhead rate is !ased on direct la!or9hours M-. The predetermined oerhead rate for the current year, !ased on a t"o9 shift capacity of 400,000 total M "ith no oertime, is as follo"s# (aria!le manufacturing oerhead *i+ed manufacturing oerhead Com!ined rate
$ 4.&0 per M .&0 per M $).00 per M
Ienco's production manager reports that the present e2uipment and facilities are ade2uate to manufacture the Taylor compound. Therefore, the order "ould hae no effect on total fi+ed 4
manufacturing oerhead costs. Mo"eer, Ienco is "ithin 400 hours of its t"o9shift capacity this month. 1ny additional hours !eyond 400 hours must !e done in oertime. f need !e, the Taylor compound could !e produced on regular time !y shifting a portion of *ertikil production to oertime. Ienco's rate for oertime hours is .& times the regular pay rate, or $) per hour. There is no allo"ance for any oertime premium in the predetermined oerhead rate. Required:
. Ienco, has decided to su!mit a !id for a )&,000 pound order of Taylor Eursery's ne" compound. The order must !e deliered !y the end of the current month. Taylor Eursery has indicated that this is a one9time order that "ill not !e repeated. Calculate the lo"est price that Ienco could !id for the order "ithout reducing its net operating income. ). ?efer to the original data. 1ssume that Taylor Eursery plans to place regular orders for )&,000 pound lots of the ne" compound during the coming year. Ienco e+pects the demand for *ertikil to remain strong. Therefore, the recurring orders from Taylor Eursery "ould put Ienco oer its t"o9 shift capacity. Mo"eer, production could !e scheduled so that 0 of each Taylor Eursery order could !e completed during regular hours. 1s another option, some *ertikil production could !e shifted temporarily to oertime so that the Taylor Eursery orders could !e produced on regular time. Current market prices are the !est aaila!le estimates of future market prices. Ienco's standard markup policy for ne" products is 40 of the full manufacturing cost, including fi+ed manufacturing oerhead. Calculate the price that Ienco "ould 2uote Taylor Eursery for each )&,000 pound lot of the ne" compound, assuming that it is to !e treated as a ne" product and this pricing policy is follo"ed.
5
G,: Ma(e or 'uy; -tili.ation of a Constrained Resource
$&4.00 $44.&0 4.&0 /.& &.40
.&& $ 8.4&
=anagement !eliees /.000 K
$&.00 $.&0 )).&0 &.& .&0
).)& $ ).&
The mountain !ike frames could !e produced "ith e+isting e2uipment and personnel. =anufacturing oerhead is allocated to products on the !asis of direct la!or9hours. =ost of the manufacturing oerhead consists of fi+ed common costs such as rent on the factory !uilding, !ut some of it is aria!le. The aria!le manufacturing oerhead has !een estimated at $l.0& per K
drum and $0.0 per mountain !ike frame. The aria!le manufacturing oerhead cost "ould not !e incurred on drums ac2uired from the outside supplier.
. >ien the margins of the t"o products as indicated in the reports su!mitted !y the accounting department, does it make any sense to een consider producing the mountain !ike frames7 3+plain. ). Compute the contri!ution margin per unit for# a. urchased K
G/: Sell or %rocess $urther ecision 7
=id"est =ills has a plant that can mill "heat grain into a cracked "heat cereal and then further mill the cracked "heat into flour. The company can sell all the cracked "heat cereal that it can produce at a selling price of $4%0 per ton. n the past, the company has sold only part of its cracked "heat as cereal and has retained the rest for further milling into flour. The flour has !een selling for $00 per ton, !ut recently the price has !ecome unsta!le and has dropped to $)& per ton. The costs and reenues associated "ith a ton of flour follo"# er Ton of *lour
$/%0 )0 0
40 $ )0
The sales manager argues that since the present $)& per ton price for the flour results in a $& per ton loss, the milling of flour should not !e resumed until the price per ton rises a!oe $/0. The company assigns manufacturing oerhead cost to the t"o products on the !asis of milling hours. The same amount of time is re2uired to mill either a ton of cracked "heat or a ton of flour. (irtually all manufacturing oerhead costs are fi+ed. =aterials and la!or costs are aria!le. The company can sell all of the cracked "heat and flour it can produce at the current market prices. Required:
. o you agree "ith the sales manager that the company should discontinue milling flour and use the entire milling capacity to mill cracked "heat if the price of flour remains at $)& per ton7
8
). 5hat is the lo"est price that the company should accept for a ton of flour7 1gain support your ans"er "ith computations and e+planations.
9
G0: %lant Closing ecision
=o!ile reenille Coer lant, "hich makes seat coers. =iriam ?estin is the plant manager at the >reenille Coer lant !ut also seres as the regional production manager for the company. Mer !udget as the regional manager is charged to the >reenille Coer lant. ?estin has 6ust heard that =o!ile reenille Coer lant for $) million. ?estin "as astonished at the lo" outside !id !ecause the !udget for the >reenille Coer lant's operating costs for the coming year "as set at $)4./ million. f this !id is accepted, the >reenille Coer lant "ill !e closed do"n. The !udget for the >reenille Coer lant's operating costs for the conning year is presented !elo". 1dditional facts regarding the plant's operations are as follo"s# a. ue to the >reenille Coer lant's commitment to use high92uality fa!rics in all of its products, the urchasing epartment "as instructed to place !lanket purchase orders "ith ma6or suppliers to ensure the receipt of sufficient materials for the coming year. f these orders are canceled as a conse2uence of the plant closing, termination charges "ould amount to )& of the cost of direct materials. !. 1ppro+imately /&0 employees "ill lose their 6o!s if the plant is closed. This includes all of the direct la!orers and superisors, management and staff, and the plum!ers, electricians, and other skilled "orkers classified as indirect plant "orkers. reenille Coer lant's !ase pay of $).&0 per hour, "hich is the highest in the area. 1 clause in >reenille Coer's contract "ith the union may help some employees# the company must proide employment assistance and 6o! training to its former employees for ) months after a plant closing. The estimated cost to administer this serice "ould !e $0.8 million. c. reenille Coer lant is open or not. d. ?estin and her regional staff "ould not !e affected !y the closing of the >reenille Coer lant. They "ould still !e responsi!le for running three other area plants. e. f the >reenille Coer lant "ere closed, the company "ould reali@e a!out $) million salage alue for the e2uipment in the plant. f the plant remains open, there are no plans to make any significant inestments in ne" e2uipment or !uildings. The old e2uipment is ade2uate for the 6o! and should last indefinitely. Greenville Cover %lant Annual 'udget for "#erating Costs =aterials a!or# irect
$ 8,000,000 $,00,000 400,000 ,%00,000 10
%,000,000
:erhead# epreciationAe2uipment epreciationA!uilding ension e+pense lant manager and staff Corporate e+penses Total !udgeted costs
,/00,000 ),00,000 ,00,000 00,000 ,00,000
,/00,000 $)4,/00,000
D*i+ed corporate e+penses allocated to plants and other operating units !ased on total !udgeted "age and salary costs. Required:
. 5ithout regard to costs, identify the adantages to =o!ile reenille Coer lant. ). =o!ile reenille Coer lant. =anagement has asked you to identify# a. The annual !udgeted costs that are releant to the decision regarding closing the plant sho" the dollar amounts-. !. The annual !udgeted costs that are not releant to the decision regarding closing the plant and e+plain "hy they are not releant again sho" the dollar amounts-. c. 1ny nonrecurring costs that "ould arise due to the closing of the plant and e+plain ho" they "ould affect the decision again sho" any dollar amounts-. /. ooking at the data you hae prepared in )- a!oe, should the plant !e closed7
11
G Activity'ased Costing and the $le3i4le 'udget A##roach
The =unchkin Theater is a nonprofit organi@ation deoted 0 staging theater productions of plays for children in Toronto, Canada. The theater has a ery small full9time professional administratie staff. Through a special arrangement "ith the actors' union, actors and directors rehearse "ithout pay and are paid only for actual performances. uring )00, The =unchkin Theater had fie different productionsAeach of "hich "as performed ) times. The costs of )00's operations "ere as follo"s# )he Munch(in )heater Cost Re#ort $or the 5ear Ended +1 ece&4er 2660
Eum!er of productions Eum!er of performances of each production Total num!er of performances
& ) 0
1ctual costs incurred# 1ctors and directors' "ages
$44000 ),000 0,800 4/,000 4&,000 0,&00 /,000 4/,)00
Total actual cost incurred
$//,&00
rants from donors and ticket sales "ere also correspondingly higher.- ata concerning )00's operations appear !elo"#
12
)he Munch(in )heater Cost Re#ort $or the 5ear Ended +1 ece&4er 266
Eum!er of productions Eum!er of performances of each production Total num!er of performances
4 4
1ctual costs incurred# 1ctors and directors' "ages
$48,000 )8,00 ),/00 /%,/00 4%,00 0,%&0 ),000 4,&0 $/4),400
3en though many of the costs a!oe may !e considered direct costs rather than oerhead, The fle+i!le !udget approach coered in the chapter can !e used to ealuate ho" "ell these costs are controlled. The principles are the same "hether a cost is a direct cost or is oerhead. Required:
. Fse the actual results from )00 to estimate the cost formulas for the fle+i!le !udget for the =unchkin Theater. Oeep in mind that the theater has t"o measures of actiityAthe num!er of productions and the num!er of performances. ). repare a performance report for )00 using the fle+i!le !udget approach and !oth measures of actiity. 1ssume inflation "as insignificant. Eote# To ealuate administratie e+penses, first determine the fle+i!le !udget amounts for the three elements of administratie e+penses. Then compare the total of the three elements to the actual administratie e+pense of $4,&0./. f you "ere on the !oard of directors of the theater, "ould you !e pleased "ith ho" "ell costs "ere controlled during )007 5hy or "hy not7 4. The cost formulas proide figures for the aerage cost per production and aerage cost per performance. Mo" accurate do you think these figures "ould !e for predicting the cost of a ne" production or of an additional performance of a particular production7
13
G7 Ethics and the Manager; A4sor#tion Costing *nco&e State&ents
=ichael ee "as hired as chief e+ecutie officer C3:- in late Eoem!er !y the !oard of directors of Munter 3lectronics, a company that produces a state9of9the9art ( drie for personal computers. The preious C3: had !een fired !y the !oard due to a series of 2uestiona!le !usiness practices including prematurely recording reenues on products that had not yet !een shipped to customers. =ichael felt that his first priority on the 6o! "as to restore employee moraleA"hich had suffered during the preious C3:'s reign. Me "as particularly an+ious to !uild a sense of trust !et"een himself and the company's employees Mis second priority "as to prepare the !udget for the coming year, "hich the !oard of directors "anted to reie" in their ecem!er & meeting. 1fter hammering out the details in meetings "ith key managers, =ichael "as a!le to put together a !udget that he felt the company could realistically meet during the coming year. That !udget appears !elo"# 'asic 'udget ata
Fnits in !eginning inentory Fnits produced Fnits sold Fnits in ending inentory (aria!le costs per unit# irect materials irect la!or (aria!le manufacturing oerhead (aria!le selling and administratie Total aria!le cost per unit
0 )00,000 )00,000 0 $ &0 40 )0 0 $)0
*i+ed costs# *i+ed manufacturing oerhead *i+ed selling and administratie Total fi+ed costs
$ 8,400,000 /,00,000 $),000,000
8unter Electronics 'udgeted *nco&e State&ent 9a4sor#tion ðod
oods aaila!le for sale ess ending inentory >ross margin
$40,000,000 $
0
/0,400,000 /0,400,000 0
),000,000 /,00,000
Eet operating income
/0,400,000 %,00,000
&,00,000 $ 4,000,000
14
5hile the !oard of directors did not oppose the !udget, they made it clear that the !udget "as not as am!itious as they had hoped. The most influential mem!er of the !oard stated that Nmanagers should hae to really stretch to meet profit goals.N 1fter some discussion, the !oard decided to set a profit goal of $4,800,000 for the coming year. To proide strong incenties and a "in9"in situation, the !oard agreed to pay out !onuses to top managers of $)00,000 if this profit goal "as eentually met. =ichael's share of the !onus pool "ould !e $&0,000. The !onus "ould he all9or9nothing. f actual net operating income turned out to !e $4,800,000 or more, the !onus "ould !e paid. :ther"ise, no !onus "ould !e allo"ed. Required:
. 1ssuming that the company does not !uild up its inentory i.e. production e2uals sales- and its selling price and cost structure remain the same, ho" many units of the ( drie "ould hae to !e sold to meet the target net operating income of $4,800,0007 ). (erify your ans"er to - a!oe !y constructing a reised !udget and !udgeted a!sorption costing income statement that yields a net operating income of $4,800,000. /. Fnfortunately, !y :cto!er of the ne+t year it had !ecome clear that the company "ould not !e a!le to make the $4,800.000 target profit. n fact, it looked like the company "ould "ind up the year as originally planned, "ith sales of )00,000 units, no ending inentories, and a profit of $4,000,000.
15
