Ch 4 Flashcards
Rodder, Inc. manufactures a component in a router assembly. The selling price and unit cost data for the component are as follows:
Selling price $15 Direct materials cost 3 Direct labor cost 3 Variable overhead cost 3 Fixed manufacturing overhead cost 3 Fixed selling and administration cost 1 The company received a special one-time order for 1,000 components. Rodder has an alternative use for production capacity for the 1,000 components that would produce a contribution margin of $5,000. What amount is the lowest unit price Rodder should accept for the component?
A.
$9 (17%)
B.
$12 (15%)
C.
$14 (60%)
D.
$24
C
Things to remember:
The special order type of question typically involves an order at a lower than usual price or gross margin. If there is a competing choice, the lowest acceptable price is the unit variable cost, any incremental fixed cost, and the opportunity cost of forgoing the alternative use of production capacity.
Remember that total fixed costs are generally constant and would not increase due to a SO.
However, if there is an alternative choice, the lowest acceptable price is the unit variable cost, the incremental fixed cost (if any), and the opportunity cost of forgoing the alternative use of production capacity. The normal variable cost is $9 per unit ($3 direct material + $3 direct labor + $3 variable overhead). The opportunity cost of the alternative use is $5 per unit ($5,000 contribution margin / 1,000 components). Therefore, the lowest price that Rodder should accept is $14 per unit (variable unit cost of $9 + contribution margin per unit of $5).
A company is reviewing its financial forecast. The selling price of the company’s product is $22.50, the per unit contribution margin is $12.50, and total fixed costs are $175,000. How many units of the product must be sold to generate $50,000 of profit?
A.
14,000 (4%)
B.
17,500 (1%)
C.
18,000 (76%)
D.
22,500
C
Use Breakeven unit formula
(Fc+profit)/cm=be unit
Del Co. has fixed costs of $100,000 and breakeven sales of $800,000. What is its projected profit at $1,200,000 sales?
A.
$50,000 (60%)
B.
$150,000 (22%)
C.
$200,000 (11%)
D.
$250,000
A
Before using the sales dollar formula presented in the above image, identify the key inputs. Remember:
Variable cost (VC) ratio plus contribution margin (CM) ratio always equals 100%.
Breakeven variable cost is $700,000 ($800,000 sales = VC + $100,000 fixed cost).
Variable cost ratio is 87.5% ($700,000 / $800,000).
Contribution margin ratio is 12.5%, or 0.125 (100% − 87.5%).
Profit is $50,000 for $1,200,000 sales, calculated as follows:
Sales dollars=Fixed cost+Desired profitContribution margin ratio
$1,200,000=$100,000+X0.125
$150,000=$100,000+X
X=$50,000
(Choice B) The amount of $150,000 is sales of $1,200,000 multiplied by the contribution margin ratio of 12.5%.
(Choice C) The amount of $200,000 is breakeven sales of $800,000 multiplied by 12.5% contribution margin, plus $100,000 fixed cost.
(Choice D) The amount of $250,000 is sales of $1,200,000 multiplied by 0.125 plus $100,000 fixed cost instead of minus $100,000.
Things to remember:
Cost-volume-profit (CVP) analysis focuses on the relationship between cost (variable and fixed), volume of sales, and profit. CVP analysis can also be used for breakeven analysis by setting the desired profit equal to $0.
Echo Company uses a normalized job costing system and applies factory overhead on the basis of machine hours. Echo’s yearly profit plan disclosed anticipated factory overhead of $4,800,000 if 200,000 machine hours are worked. By year end, actual factory overhead charges and machine hours worked amounted to $4,730,000 and 215,000, respectively. What amount correctly states the factory overhead applied to Echo’s actual year-end overhead?
A.
$70,000 overapplied. (25%)
B.
$360,000 overapplied. (15%)
C.
$430,000 overapplied. (40%)
D.
$430,000 underapplied.
C
Manufacturing overhead (OH) consists of multiple indirect costs (eg, property tax, supervisor’s salary). Each of these costs has a different cost driver. This makes it almost impossible to accurately determine and allocate OH directly to each job during production.
As a result, a predetermined overhead rate is used to apply OH costs during production. At the end of the production period, applied OH is compared to actual OH, which is now known. When actual OH is greater than applied OH, the variance is underapplied, and vice versa. Variances are generally closed to cost of goods sold, unless significant, in which case the variance is prorated to the appropriate accounts.
In this scenario, Echo Company’s predetermined OH rate was $24 per machine hour ($4,800,000 / 200,000 hours). Total applied OH was $5,160,000 ($24 per hour × 215,000 estimated machine hours). Total actual OH was given as $4,730,000. OH was overapplied by $430,000 ($5,160,000 − $4,730,000) primarily due to the excess number of machine hours incurred.
Things to remember: Manufacturing overhead (OH) consists of multiple indirect costs and cannot be directly traced to specific jobs. A predetermined OH rate is used to apply OH to each job based on estimated costs and hours. At the end of the production period, applied OH is compared to actual OH to determine the OH variance, which is typically closed to cost of goods sold. When actual OH is greater than applied OH, the variance is underapplied, and vice versa.
Spring Co. had two divisions, A and B. Division A created Product X, which could be sold on the outside market for $25 and used variable costs of $15. Division B could take Product X and apply additional variable costs of $40 to create Product Y, which could be sold for $100. Division B received a special order for a large amount of Product Y. If Division A were operating at full capacity, which of the following prices should Division A charge Division B for the Product X needed to fill the special order?
A.
$15 (28%)
B.
$20 (9%)
C.
$25 (43%)
D.
$40
C
Transfer pricing is the amount charged by one related entity to another for the sale of goods/services. For example, the price charged by an automobile manufacturer’s battery division (ie, Division A) to its final assembly division (ie, Division B) would be called the transfer price.
Internal transfer pricing is used to simplify the recording process for acquiring goods/services by eliminating the need for invoices, bills of lading, and other documents that would be required for an external purchase from an independent vendor.
Given no excess capacity, Division A would earn less profit if it set the transfer price to Division B lower than its outside market price. In other words, Division A’s opportunity cost (ie, the value given up by not selling the battery to the outside market) is $25. Therefore, Division A should charge Division B no less than $25.
If Division A had excess capacity, then the lowest transfer price would be the variable cost of $15 incurred by Division A, assuming no profit was desired for the division. The transfer price would cover all variable costs with a contribution margin of $0.
Things to remember:
Transfer pricing is the amount charged by one related entity to another for the sale of goods/services. The transferring (ie, selling) division would earn less than the normal profit if the transfer price did not at least equal the opportunity cost of selling to an external, independent purchaser.
Clay Co. has considerable excess manufacturing capacity. A special order job cost sheet includes the following applied manufacturing overhead costs:
Fixed costs $21,000
Variable costs 33,000
The fixed costs include a normal $3,700 allocation for in-house design costs, although no in-house design will be done. Instead, the job will require the use of external designers costing $7,750. What is the total amount to be included in the calculation to determine the minimum acceptable price for the job?
A.
$36,700 (2%)
B.
$40,750 (32%)
C.
$54,000 (6%)
D.
$58,050
B
The special order type of question typically involves an order at a price lower than usual, sometimes reducing regular sales. If the production facility is not at full capacity, then the minimum special order price would be all special order variable costs and any incremental fixed costs. Since fixed cost (eg, insurance) remains constant despite production volume changes, only incremental fixed cost is considered for a special order (ie, $7,750).
The existing fixed cost of $3,700 is not eliminated but reallocated to other orders, so it does not offset the incremental fixed costs of $7,750. Since Clay Co. has excess manufacturing capacity, the total amount to be included in the calculation of the special order price is $40,750 ($33,000 variable costs + $7,750 incremental fixed cost).
(Choice A) If only the $3,700 fixed cost were considered, the special order price would be $36,700 ($33,000 + $3,700).
(Choice C) If total fixed cost of $21,000 were allocated to the special order, the price would be $54,000 ($33,000 + $21,000). Remember, only the incremental fixed cost is considered.
(Choice D) An amount of $58,050 was computed as follows: $33,000 + $21,000 + $7,750 − $3,700. Only the special order variable costs and the incremental fixed cost of $7,750 are included in the price.
Things to remember:
Special orders typically involve an order at a price lower than usual. If the production facility is not at full capacity, then the minimum acceptable price is the incremental cost (ie, all special order variable costs plus incremental fixed costs).
Mat Co. estimated its material handling costs at two activity levels as follows:
Kilos handled Cost
80,000 $160,000
60,000 $132,000
What is Mat’s estimated cost for handling 75,000 kilos?
A.
$150,000 (6%)
B.
$153,000 (52%)
C.
$157,500 (37%)
D.
$165,000
Choice B (Correct): If the cost of handling 80,000 kilos is $160,000 versus a cost of $132,000 for handling 60,000 kilos, the cost of handling the additional 20,000 kilos is the difference of $28,000, which is $28,000/20,000 or $1.40 per kilo, which is the variable cost of handling each kilo. The variable cost of handling 60,000 kilos would then be 60,000 x $1.40 or $84,000, indicating that the fixed cost is $132,000 - $84,000 or $48,000. The variable cost of handling 75,000 kilos would be 75,000 x $1.40 or $105,000. With fixed costs of $48,000, the total cost of handling 75,000 kilos would be $153,000.An alternative explanation: The cost of handling the additional 20,000 kilos (80,000 kilos - 60,000 kilos = 20,000 kilos) is $160,000 - $132,000 = $28,000. As fixed costs in total do not change with the quantity produced, all of this change must be variable cost. As 20,000 more units were produced to get that additional $28,000 in cost, the variable cost per unit is $28,000 / 20,000 kilos = $1.40/kilo. To determine the total fixed costs, use the variable cost per unit to find out the total variable cost at either production level where total costs are known and then subtract total variable cost from that total cost to calculate total fixed cost. At the 80,000 kilo level, variable costs are $1.40 / unit x 80,000 units = $112,000; $160,000 - $112,000 = $48,000. At the 60,000 kilo level, variable costs are $1.40 / unit x 60,000 units = $84,000; $132,000 - $84,000 = $48,000. Total production costs at the 75,000 unit level = $48,000 + (75,000 units x $1.40) = $153,000
Brewster Co. has the following financial information:
Fixed costs $20,000
Variable costs 60%
Sales price $50
What amount of sales is required for Brewster to achieve a 15% return on sales?
A.
$33,333 (9%)
B.
$50,000 (21%)
C.
$80,000 (59%)
D.
$133,333
C
To determine a desired level of profit, set the unknown profit equal to a percentage of sales. In this scenario, unknown profit equals 15% of sales. Remember that the variable cost (VC) ratio plus the contribution margin (CM) ratio must add up to 100% of sales. Therefore, if the VC percentage is 60%, the CM percentage must be 40%. Brewster Co. needs $80,000 in sales to achieve a 15% return, calculated as follows:
Sales dollars=Fixed cost+Desired profitContribution margin ratio
X=$20,000+.15X.40
.40X=$20,000+.15X
X=$80,000
Things to remember:
Cost-volume-profit (CVP) analysis focuses on the relationship between revenue (ie, sales price), cost (ie, variable and fixed), volume of sales, and profit. The formula can be modified to calculate either the number of units that must be sold or the amount of revenue needed (ie, sales dollars) to achieve the desired profit. To determine a desired level of profit, define the unknown profit equal to a percentage of sales and solve.
Based on the following data, what is the net income for the company?
Sales $1,000,000 Net purchases of raw materials 600,000 Cost of goods manufactured 800,000 Marketing and administrative expenses 250,000 Indirect manufacturing costs 500,000
Beginning inventory Ending inventory
Work in process $500,000 $400,000
Finished goods 100,000 400,000
A.
$150,000 (14%)
B.
$250,000 (63%)
C.
$350,000 (12%)
D.
$500,000
B
The calculation of cost of goods sold (COGS) in a manufacturing company is more complicated than the equivalent computation for a merchandising company. Changes in raw materials, work in process, and finished goods must be analyzed to determine COGS.
Once COGS is calculated, the remaining part of the income statement (I/S) is the same as a nonmanufacturing I/S. In this scenario, because cost of goods manufactured is already provided, most of the additional steps to calculate COGS are unnecessary. Therefore, the information related to raw materials and work in process inventories is not needed.
Net income is calculated as follows:
Sales $1,000,000
Less cost of goods sold:
Beginning finished goods inventory $100,000
+ Cost of goods manufactured 800,000
− Ending finished goods inventory (400,000) 500,000
Gross profit 500,000
Less marketing and administrative expenses (250,000)
Net income $ 250,000
Things to remember:
Determining cost of goods sold (COGS) involves identifying changes in raw materials, work in process, and finished goods inventories. The income statement format is as follows: Sales − COGS = Gross profit − Marketing and administrative expenses = Net income.
A company produces and sells two products. The first product accounts for 75% of sales, and the second product accounts for the remaining 25%. The first product has a selling price of $10 per unit, variable costs of $6 per unit, and allocated fixed costs of $100,000. The second product has a selling price of $25 per unit, variable costs of $13 per unit, and allocated fixed costs of $212,000. At the breakeven point, what number of units of the first product will have been sold?
A.
52,000 (7%)
B.
39,000 (25%)
C.
25,000 (55%)
D.
14,625
B
Cost-volume-profit (CVP) analysis is an algebraic planning tool that focuses on the relationship between revenue (ie, sales price), cost (variable and fixed), volume (ie, production changes), and profit. CVP analysis is also referred to as breakeven analysis since setting the desired profit equal to $0 will allow computation of breakeven units or breakeven sales dollars.
To compute the breakeven point for two products, set up the equation such that there is a relationship between the two products. Sales per unit less variable cost per unit equals contribution margin per unit. Weight each contribution margin (CM) by the given percentages:
First product: [($10−$6) ×75%]= $3 weighted CM
Second product: [($25−$13)×25%]= $3 weighted CM
Total fixed cost is $312,000 ($100,000 + $212,000). Define the unknown units of total product as x. Since the contribution margins have already been weighted 75% and 25%, solve for x and then determine the number of units for the first and second products using their relative percentages:
X= Fixed cost+desired profitFirst product CM+second product CM= $312,000+$0$3+$3
X = 52,000 total units
First = 52,000 × 75% = 39,000
Second = 52,000 × 25% = 13,000
Things to remember:
Cost-volume-profit (CVP) analysis focuses on the relationship between revenue (ie, sales price), cost (variable and fixed), volume (ie, production changes), and profit. CVP analysis can be used for breakeven analysis by setting the desired profit equal to $0. If the CVP analysis includes multiple products, each product’s contribution margin must be weighted.
Green Co. produces only Product Z. As part of the annual budgeting, Green is considering whether to produce a new product. Green’s CFO obtained information from various departments within the company. The plant manager expected the following costs would be incurred in producing the new product:
Direct materials $1 per unit
Direct labor $100 per hour
Fixed cost $55,000
The marketing manager decided to spend $2 per unit for the first 5,000 items sold with no additional costs after that. The marketing manager confirmed that the current market price for the new product was $4,000 per 1,000 units. The plant manager told the CFO that the employees would be able to produce 500 units per hour. Approximately how many units would Green have to sell to break even?
A.
19,643 (20%)
B.
23,214 (44%)
C.
54,167 (18%)
D.
68,750
B
Remember:
Total, not per-unit, fixed cost is used in the formula.
Because none of the answer choices are 5,000 units or below, marketing cost will be a constant $10,000, so it is treated as a fixed cost.
Desired profit is $0 for breakeven
Variable cost consists of direct material and direct labor
Per-unit material cost is given as $1.00
Per-unit labor cost is $0.20 ($100 per hour divided by 500 units per hour).
Unit contribution margin is sales less variable cost
Total fixed cost $55,000 + $10,000 $65,000
Desired profit $0
Unit price 4,000 units / $1,000 $4.00
Unit variable cost $1.00 + $0.20 $1.20
Unit contribution margin $4.00 − $1.20 $2.80
In this scenario, Green Co.’s breakeven in units is 23,214, calculated as follows:
$65,000+0/$2.80=23,214 units
Things to remember:
The cost-volume-profit (CVP) formula for units [(fixed cost + desired profit) / contribution margin per unit] focuses on the relationship between cost, volume, and profit. It helps management establish a sales price or sales volume for a given level of desired profit. CVP analysis can be used for breakeven analysis by setting the desired profit equal to $0.
Mien Co. is budgeting sales of 53,000 units of product Nous for October. The manufacture of one unit of Nous requires four kilos of chemical Loire. During October, Mien plans to reduce the inventory of Loire by 50,000 kilos and increase the finished goods inventory of Nous by 6,000 units. There is no Nous work-in-process inventory. How many kilos of Loire is Mien budgeting to purchase in October?
A.
138,000 (6%)
B.
162,000 (18%)
C.
186,000 (64%)
D.
238,000
Choice C (Correct): With budgeted sales of 53,000 units and an intent to increased finished goods inventory by 6,000 units, Mien will have to produce 59,000 units during the period. Since each unit requires 4 kilos of Loire, the production will require 236,000 kilos. A reduction of 50,000 kilos during the period indicates that 50,000 of the 236,000 will come from inventory and the remaining 186,000 kilos will need to be purchased.
Match Co. manufactures a product with the following costs per unit, based on a maximum plant capacity of 400,000 units per year:
Direct materials $60 Direct labor 10 Variable overhead 40 Fixed overhead 30 Total $140 Match has a ready market for all 400,000 units at a selling price of $200 each. Selling costs in this market consist of $10 per unit shipping and a fixed licensing fee of $50,000 per year. Reno Co. wishes to buy 5,000 of these units on a special order. There would be no shipping costs on this special order. What is the lowest price per unit at which Match should be willing to sell the 5,000 units to Reno?
A.
$110 (22%)
B.
$140 (20%)
C.
$190 (47%)
D.
$200
C
Since Match Co. is operating at full capacity, they would have to reject regular customers to accept the special order. In this case, the lowest special order price they would accept is the normal selling price (ie, price charged to regular customers) of $200 per unit, less the $10 shipping charge that would not be incurred on the special order, or $190. This is the foregone profit amount.
Things to remember:
The special order type of question typically involves an order at a lower-than-usual price, sometimes reducing regular sales. If the production facility is not at full capacity, the lowest acceptable selling price would have to cover all special order variable costs and any incremental fixed costs related to the special order. If the facility is at full capacity, the analysis would need to consider the lost net profit from turning away regular customers.
At the start of its fiscal year, a company anticipated producing 300,000 units throughout the year. The annual budgeted manufacturing overhead was $150,000 for variable costs and $600,000 for fixed costs. In April, when there was a beginning inventory for finished goods of 5,000 units, the company showed an income of $40,000 using absorption costing. That same month, ending inventory for finished goods was 7,000 units. What amount would the company recognize as income for April using variable costing?
A.
$35,000 (13%)
B.
$36,000 (57%)
C.
$44,000 (23%)
D.
$45,000
B
With production of 300,000 units and FOH of $600,000, fixed overhead is $2 ($600,000 / 300,000) per unit. Under A/C, an increase in inventory of 2,000 (7,000 – 5,000) units indicates that $4,000 (2,000 × $2) of FOH was allocated to EI. As shown in the image below, COGS decreases when EI increases, making income under A/C $4,000 higher than under variable. Given that income was $40,000 using A/C, income under V/C will be $40,000 – $4,000 or $36,000.
↓CGS=beg Inc + production - EI↑
Things to remember:
Absorption costing includes fixed overhead (FOH) as inventory cost whereas variable costing excludes FOH from inventory cost and expenses it as incurred. Because the two methods treat FOH differently, ending inventory (EI), cost of goods sold, and operating income are generally different as well. The difference is the FOH per unit multiplied by the change in EI units.
Mason Company uses a job order cost system and applies manufacturing overhead to jobs using a predetermined overhead rate based on direct labor dollars. The rate for the current year is 200 percent of direct labor dollars. This rate was calculated last December and will be used throughout the current year. Mason had one job, No. 150, in process on August 1 with raw materials costs of $2,000 and direct labor costs of $3,000. During August, raw materials and direct labor added to jobs were as follows:
No. 150 No. 151 No. 152
Raw materials $ - $4,000 $1,000
Direct labor 1,500 5,000 2,500
Actual manufacturing overhead for the month of August was $20,000. During the month, Mason completed Job Nos. 150 and 151. For August, manufacturing overhead was
A.
Overapplied by $4,000 (14%)
B.
Underapplied by $7,000 (19%)
C.
Underapplied by $2,000 (53%)
D.
Underapplied by $1,000
Choice C (Correct) and Choices A, B, D (Incorrect): Manufacturing overhead is applied on the basis of direct-labor dollars. Total direct-labor costs are $9,000 ($1,500 + $5,000 + $2,500). Since the rate for manufacturing overhead is 200% of direct-labor dollars, the applied manufacturing overhead will be $18,000. Actual manufacturing overhead is $20,000, so manufacturing overhead has been underapplied by $2,000 ($20,000 - $18,000).
Lynn Manufacturing Co. prepares income statements using both standard absorption and standard variable costing methods. For year 2, unit standard costs were unchanged from year 1. In year 2, the only beginning and ending inventories were finished goods of 5,000 units. How would Lynn’s ratios using absorption costing compare with those using variable costing?
A.
Same current ratio, same return on stockholders’ equity. (25%)
B.
Same current ratio, smaller return on stockholders’ equity. (15%)
C.
Greater current ratio, same return on stockholders’ equity. (33%)
D.
Greater current ratio, smaller return on stockholders’ equity.
Choice D (Correct) and Choices A, B, C (Incorrect): Under absorption costing, inventory would include an allocation of fixed manufacturing overhead while, under variable costing, inventory would include no fixed costs. As a result, inventory, current assets, and total assets would all be higher under absorption costing than under variable costing. With higher total assets, stockholders’ equity would be higher as well. Since current assets are greater under absorption costing, the current ratio would be greater than under variable costing. With beginning and ending inventory remaining unchanged at 5,000 units, profit would be the same under variable and absorption costing. Since absorption costing would have a higher stockholders’ equity amount, the return on stockholders’ equity would be lower for absorption than for variable costing.
Black Co.’s breakeven point was $780,000. Variable expenses averaged 60% of sales, and the margin of safety was $130,000. What was Black’s contribution margin?
A.
$364,000 (51%)
B.
$546,000 (24%)
C.
$910,000 (16%)
D.
$1,300,000
A
The margin of safety is the excess of actual sales over the breakeven volume of sales. It defines the amount by which sales can drop before losses begin to be incurred. Because the breakeven in this scenario is $780,000 and the margin of safety is $130,000, actual sales must be $910,000.
Because the variable expenses are 60% of sales, the contribution margin ratio must be 40%. Remember, the sum of the two ratios must equal 100%. When sales are $910,000, the contribution margin (CM) is $364,000 ($910,000 × 40%).
Amount Percent of sales Sales $910,000 100% − Variable costs 546,000 60% = Contribution margin 364,000 40% (Choice B) An amount of $546,000 is the total variable cost, not the CM.
(Choice C) An amount of $910,000 is the actual sales, not the CM.
(Choice D) An amount of $1,300,000 is the breakeven point in sales of $780,000 divided by the variable cost percent of 60%.
Things to remember:
The sum of the variable cost percent of sales and the contribution margin percent must equal 100%. Actual sales can be determined by adding the breakeven sales volume and the margin of safety (ie, the excess of actual sales over the breakeven).
The following is selected information from the records of Ray, Inc.:
Purchases of raw materials $6,000 Raw materials, beginning 500 Raw materials, ending 800 Work-in-process, beginning 0 Work-in-process, ending 0 Cost of goods sold 12,000 Finished goods, beginning 1,200 Finished goods, ending 1,400 What is the total amount of conversion costs?
A.
$5,500 (15%)
B.
$5,900 (12%)
C.
$6,100 (30%)
D.
$6,500
Manufacturing costs are often called product costs since they are matched to the product and not expensed until the product is sold (ie, they are instead classified on the balance sheet as inventory). There are three types of product costs: direct material, direct labor, and manufacturing overhead.
For cost analysis purposes, direct labor and manufacturing costs are combined into conversion costs. This is because the conversion of material to the final product is completed through human labor or machine labor (ie, overhead), or a combination of the two.
To solve for conversion costs, first determine cost of goods manufactured (COGM) for finished goods (F/G), then deduct direct material. The amount left is the sum of direct labor and manufacturing overhead, or conversion costs.
- Solve raw material used = 5700
- Find cogm by using finished goods (beg fgood+cogm=av-end fgoods=cogs)
- plug in cogm (beg wip+raw material used+DL+Mfg overhead=x-ending wip=cogm)
Things to remember:
Conversion cost is the combination of direct labor and overhead. Conversion costs focus on converting raw material to the finished product. The total cost of goods manufactured (COGM) is direct materials plus direct labor plus overhead. In other words, COGM is direct material plus conversion costs.
