Chapter 08 - Answer

MANAGEMENT ACCOUNTING (VOLUME I) - 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. 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 Indirect labor

400,000 P 10,000 25,000

Depreciation on plant and equipment

100,000

Utilities

25,000

Other .............................................................. ..............................................................

30,000

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Chapter 8 Cost Concepts and Classifications

Total manufacturing overhead

190,000

Total manufacturing costs.................................. Add: Work-in-process inventory, January 1...... Subtotal............................................................. .................................................................... Deduct: Work-in-process inventory, December 1.................................................. Cost of goods manufactured...............................

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 Cost Item a. Transportation-in costs on materials purchased b. Assembly-line workers’ wages 8-4

Fixed (F) Variable (V)

Period (P) Product (R)

V V

R R

Cost Concepts and Classifications Chapter 8

c. Property taxes on work in process inventories d. Salaries of top executives in the company e. Overtime premium for assembly workers f. Sales commissions g. Sales personnel office rental h. Production supervisory salaries i. Controller’s office supplies j. Executive office heat and air conditioning k. Executive office security personnel l. Supplies used in assembly work m. Factory heat and air conditioning n. Power to operate factory equipment o. Depreciation on furniture for sales staff p. Varnish used for finishing product q. Marketing personnel health insurance r. Packaging materials for finished product s. Salary of the quality control manager who checks work on the assembly line t. Assembly-line workers’ dental insurance

V F V V F F F F F V F V F V F V

R P R P P R P 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. 8-5

Chapter 8 Cost Concepts and Classifications

15. b, d, g, k Exercise 4 (Economic Characteristics of Costs) 1. 2. 3. 4. 5. 6.

marginal cost sunk cost 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

3,000 trucks P 29,640,000 8-6

6,000 trucks P 59,280,000

9,000 trucks P 88,920,000

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

39,200,000 4,500,000 13,660,000 P 87,000,000

39,200,000 9,000,000 13,660,000 P121,140,000

39,200,000 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

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) 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) 8-7

Chapter 8 Cost Concepts and Classifications

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 Total period costs in pesos Problem 5 Requirement (a) 8-8

1,000 17,200 1,900 13,000 33,100

Cost Concepts and Classifications Chapter 8

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. 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. 14. 15. 16. 17. 18.

D D† B† A† C† 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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