Ch 6 Flashcards
The New Wave Co. is considering a new method for allocating overhead to its two products, regular and premium coffee beans. Currently New Wave is using the traditional method to allocate overhead, in which the cost driver is direct labor costs. However, it is interested in using two different drivers: machine hours (MH) for separating and roasting beans, and pounds of coffee for packing and shipping. Machine hours for the current month are 700 hours, direct labor cost per pound of coffee is $1.25, and direct materials cost per pound of coffee is $1.50. There are 1,000 pounds of coffee packed and shipped for the current month. The following data are also available:
Regular Premium
Overhead for the current month $5,000.00
Cost pool for separating and roasting beans $3,500.00 150 MH 550 MH
Cost pool for packing and shipping $1,500.00 500 pounds 500 pounds
What is the total cost per pound for the premium coffee using the new activity-based costing method?
A.
$5.00 (7%)
B.
$5.75 (20%)
C.
$7.75 (30%)
D.
$9.75
D
To determine the total cost of a product, both direct and indirect costs must be allocated. Direct costs consist of materials and labor and are allocated based on the number of pounds of coffee. Indirect cost (overhead) is allocated using the activity-based costing (ABC) method.
The ABC method first allocates overhead cost to activities (ie, inspections) based on a cost driver (ie, number of inspection hours). These pooled costs are then allocated to cost objects (usually the end product) based on an activity usage ratio.
Usage ratios are unique to each cost pool. For example, the $3,500 cost pool “separating and roasting beans” uses the number of machine hours (MH) as a cost driver. Regular coffee requires 150 MH out of a total of 700 MH, so it is allocated $750 in cost [(150 MH / 700 MH) × $3,500]. Premium coffee requires 550 MH, so it is allocated $2,750 in cost [(550 MH / 700 MH) × $3,500].
The ABC method provides a more accurate allocation of cost so that management clearly sees the “true cost” of manufacturing premium ($9.75) versus regular ($5.75) coffee. Production and pricing decisions are then based on this cost information.
The total cost per pound for each type of coffee is calculated as follows:
Regular Premium Total
150 MH 550 MH
500 lbs. 500 lbs.
Direct material ($1.50/lb.) $750 $750 $1,500
Direct labor ($1.25/lb.) 625 625 1,250
Overhead (indirect):
Separating and roasting (700 total MH) 750 2,750 $3,500
Packing and shipping (1,000 total lbs.) 750 750 1,500
Total cost $2,875 $4,875 $7,750
Total lbs. ÷ 500 ÷ 500 n/a
Cost/lbs. $5.75 $9.75 n/a
(Choice A) $5.00 is the overhead cost ($5,000) per pound for the 1,000 total pounds of coffee.
(Choice B) $5.75 is the cost per pound of regular coffee, not premium coffee.
(Choice C) $7.75 is the total cost per pound if materials, labor, and overhead are all allocated using only pounds instead of using ABC costing for overhead [($1,500 + $1,250 + $5,000) / 1,000].
Things to remember:
Activity-based costing (ABC) allocates indirect manufacturing overhead cost to manufacturing activities (ie, cost pools) based on what drives the cost of that activity (ie, cost drivers). These pooled costs are then allocated to cost objects (usually the end product) based on a usage ratio.
A vendor offered Wyatt Co. $25,000 compensation for losses resulting from faulty raw materials. Alternately, a lawyer offered to represent Wyatt in a lawsuit against the vendor for a $12,000 retainer and 50% of any award over $35,000. Possible court awards with their associated probabilities are:
Award Probability
$75,000 0.6
0 0.4
Compared to accepting the vendor’s offer, the expected value for Wyatt to litigate the matter to verdict provides a
A.
$4,000 loss (42%)
B.
$18,200 gain (27%)
C.
$21,000 gain (23%)
D.
$38,000 gain
Choice A (Correct) and Choices B, C, D (Incorrect): The expected value for Wyatt to litigate the matter takes into account the probabilities of possible outcomes. There is a 60% probability of Wyatt receiving an award of $75,000, of which $12,000 will be paid as retainer and $20,000 will be paid as the lawyer’s share of awards ([$75,000 - $35,000] x 50%). In this case, there is 60% probability of net awards to Wyatt of $43,000 ($75,000 - $12,000 - $20,000). There is a 40% probability that Wyatt will win no award and will still pay $12,000 as retainer. The expected value of both probabilities is determined by the sum of potential winnings multiplied by respective likelihoods and is $21,000 ([$43,000 x 60%] + [$-12,000 x 40%]). This is a $4,000 loss because $21,000 is $4,000 less than the vendor’s offer of $25,000.
Rolling Wheels purchases bicycle components in the month prior to assembling them into bicycles. Assembly is scheduled one month prior to budgeted sales. Rolling pays 75% of component costs in the month of purchase and 25% of the costs in the following month. Component costs included in budgeted cost of sales are:
April May June July August
$5,000 $6,000 $7,000 $8,000 $8,000
What is Rolling’s budgeted cash payments for components in May?
A.
$5,750 (71%)
B.
$6,750 (14%)
C.
$7,750 (13%)
D.
$8,000
C
Rolling Wheels purchases components (ie, material) one month prior to assembly, and assembly takes place one month prior to budgeted sales. Therefore, components are purchased two months prior to anticipated sales. Therefore, April purchases are for June sales, and May purchases are for July sales.
Purchases are generally made on credit with payment terms that may span more than one month. April purchases (for June production) are paid 75% in April and 25% in May. May purchases (for July production) are paid 75% in May and 25% in June.
Under frost-free conditions, Cal Cultivators expects its strawberry crop to have a $60,000 market value. An unprotected crop subject to frost has an expected market value of $40,000. If Cal protects the strawberries against frost, then the market value of the crop is still expected to be $60,000 under frost-free conditions and $90,000 if there is a frost. What must be the probability of a frost for Cal to be indifferent to spending $10,000 for frost protection?
A.
.167 (17%)
B.
.200 (26%)
C.
.250 (24%)
D.
.333
Choice B (Correct): To turn a probability distribution into a single expected value, one multiplies each of the possible outcomes by its likelihood and sum the amounts. In this rather improbable situation, there are only two possible outcomes: frost and no frost. Since the inventory will have the same value under frost free conditions regardless of whether or not Cal spends $10,000 for frost protection, it is irrelevant. If there is frost, the crop will be worth only $40,000 if the $10,000 is not paid and $90,000 if it is. In order for Cal to be indifferent, the probability of frost, y, must be equal to a percentage such that $40,000 y = $90,000 y - $10,000. Solving the equation algebraically, if $40,000 y = $90,000 - $10,000, then $10,000 = $50,000 y, and y = $10,000/$50,000 or 20% (.200).
Expand explanation :
90,000 expected FMV-40,000 underlying FMV=50,000 expected payout
Then it’s just about probability, since a rational individual would only pay for coverage commensurate with the expected risk of a payout. Generally you’d multiply the expected payout by the chance of a payout to determine the most you should be willing to pay for insurance. In this case the probability is the unknown.
50,000x=10,000
x=0.2
Roger Co. implemented activity-based costing in the current year. To select the appropriate driver for Cost Pool A, Roger performed regression analyses for two independent variables, Driver 1 and Driver 2, using monthly operating data. The monthly levels of Cost Pool A were the dependent variables in both regressions. Output results from the regression analyses were as follows:
Driver 1 Driver 2 R squared 0.46 0.80 Intercept $551.00 $970.00 X variable (slope) $ 0.55 $ 0.33 At the budgeted production level for next month, the levels of Driver 1 and Driver 2 are expected to be 5,880 and 7,000, respectively. Based on this information, what is the budgeted amount for Cost Pool A for next month?
A.
$2,624 (8%)
B.
$3,280 (60%)
C.
$3,464 (22%)
D.
$3,785
B
Driver 2 is selected for the regression analysis since its R2 of 0.80 is closer to 1 than Driver 1’s R2 of 0.46 (ie, Driver 2 is a better predictor of cost).
Y = a + bX Y = $970 + ($0.33 × 7,000) Y = $3,280 Things to remember: The activity-based costing (ABC) method allocates overhead cost to cost pools using multiple cost drivers, and then to cost objects. Regression analysis can be used in conjunction with the ABC method to identify which, among various independent variables (ie, cost driver), is the best predictor (ie, cost driver) of the dependent variable (ie, activity cost) by comparing the coefficient of determination (R2) in each potential regression equation.
JacKue Co. plans to produce 200,000 pairs of roller skates during January of next year. Planned production for February is 250,000 pairs. Sales are forecasted at 180,000 pairs for January and 240,000 pairs for February. Each pair of roller skates has eight wheels. JacKue’s policy is to maintain 10% of the next month’s production in inventory at the end of a month. How many wheels should JacKue purchase during January?
A.
195,000 (3%)
B.
205,000 (7%)
C.
1,560,000 (20%)
D.
1,640,000
Units purchased = Units used in production + Units in ending inventory − Units in beginning inventory
To assist management in strategic planning, companies often use a master budget to help establish financial and production goals. The master budget consists of many smaller budgets, including a production budget. The production budget is further broken down for direct material, direct labor, and overhead requirements.
Determining purchases of material (eg, wheels) includes consideration of:
Units to be used in production for the given time period
Desired ending inventory (EI) because this increases current inventory needs
Beginning inventory (BI) because it reduces current period inventory purchase requirements
EI is generally some percentage of the next period’s projected production needs (eg, January’s EI is 10% of February’s production). One month’s EI becomes the next month’s BI.
In this scenario, 1,640,000 wheels should be budgeted for purchase in January, calculated as follows:
Budgeted production (wheels) 200,000 skates × 8 wheels 1,600,000
Plus: desired ending inventory 250,000 skates × 8 wheels × 10% 200,000
Total production (wheels) 1,800,000
Less: beginning inventory 200,000 skates × 8 wheels × 10% (160,000)
Wheels to be purchased 1,640,000
Things to remember:
The material budget determines the number of units to be purchased for the current period. Projected material purchases is production needs plus ending inventory less beginning inventory.
Sago Co. uses regression analysis to develop a model for predicting overhead costs. Two different cost drivers are under consideration as the independent variable. Relevant data were run on a computer using one of the standard regression programs, with the following results:
Machine hours (Driver 1) Direct material weight (Driver 2) R squared 0.7 0.5 Y-intercept 2,500 4,600 Slope (B) 5.0 2.6 To predict overhead costs, which regression equation should be used?
A.
Y = 2,500 + 5.0X (80%)
B.
Y = 2,500 + 0.7X (13%)
C.
Y = 4,600 + 2.6X (1%)
D.
Y = 4,600 + 0.5X
In this case, the relationship between overhead and machine hours (R2 = 0.70) is stronger than that between overhead and direct materials (R2 = 0.50). Therefore, the equation will be based upon the hour information. Total costs (Y) will equal fixed costs (the y intercept of $2,500) plus variable costs ($5.00 per machine-hour times machine-hours [X]). The best regression formula is Y = $2,500 + 5.0X.
Things to remember:
Regression analysis is a statistical technique used to quantify the relationship between one dependent variable and one or more independent variables. The coefficient of correlation (R2) indicates the strength of the relationship between the dependent and independent variables.
When production volume is expected to decrease within a relevant range, what effect would be anticipated with respect to each of the following costs?
Fixed cost Variable cost
A.
Decrease per unit Decrease in total
(14%)
B.
Increase in total No change per unit
(15%)
C.
Increase per unit Increase in total
(16%)
D.
No change in total No change per unit
D.
Things to remember:
Over the relevant range, total fixed cost (FC) and variable cost (VC) per unit do not change regardless of changes in production. Total VC changes in conjunction with production changes while FC per unit varies inversely with production changes.
Johnson Co. is preparing its master budget for the first quarter of next year. Budgeted sales and production for one of the company’s products are as follows:
January February March
Sales (units) 10,000 12,000 15,000
Production (units) 12,000 11,000 16,000
Each unit of this product requires four pounds of raw materials. Johnson’s policy is to have sufficient raw materials on hand at the end of each month for 40 percent of the following month’s production requirements. The January 1 raw materials inventory is expected to conform with this policy. How many pounds of raw materials should Johnson budget to purchase for January?
A.
11,600 (10%)
B.
46,400 (61%)
C.
48,000 (8%)
D.
65,600
B
To assist management in strategic planning, companies often use a master budget to help establish financial and production goals. The master budget consists of many smaller budgets, including the production budget. The production budget is divided among direct material, direct labor, and overhead requirements.
When determining purchases of material, management must consider:
Units to be used in production for the given period
Desired ending inventory (EI), which increases current inventory needs
Beginning inventory (BI), which reduces current inventory requirements
EI is generally some percentage of the next period’s projected production needs (eg, January’s EI is 40% of February’s production). This ensures that there is always material on hand for the first few days of the next month. EI rolls over and becomes the next month’s BI.
In this scenario, 46,400 pounds of raw materials should be budgeted for purchase in January:
Budgeted production (lbs) 12,000 × 4 lbs. 48,000
Plus: desired ending inventory 11,000 × 4 lbs. × .40 17,600
Total requirement (lbs.) 65,600
Less: beginning inventory 12,000 × 4 lbs. × .40 (19,200)
Pounds to be purchased 46,400
Things to remember:
The material budget determines the number of units to be purchased for the current period. Projected material purchases equals production needs plus ending inventory less beginning inventory
Crisper, Inc. plans to sell 80,000 bags of potato chips in June, and each of these bags requires five potatoes. Pertinent data includes:
Bags of potato chips Potatoes
Actual June 1 inventory 15,000 bags 27,000 potatoes
Desired June 30 inventory 18,000 bags 23,000 potatoes
What number of units of raw material should Crisper plan to purchase?
A.
381,000 (3%)
B.
389,000 (15%)
C.
411,000 (72%)
D.
419,000
C
The information can also be combined and calculated in one step, as follows:
Budgeted purchases of potatoes
Budgeted production 80,000 bags × 5 potatoes/bag 400,000 potatoes
Plus: desired ending inventory (18,000 × 5 potatoes/bag) + 23,000 potatoes 113,000 potatoes
Less: beginning inventory (15,000 × 5 potatoes/bag) + 27,000 potatoes (102,000) potatoes
Potatoes to be purchased 411,000 potatoes
Things to remember:
When calculating a purchase budget for production requirements, it may be necessary to estimate both the final product (eg, bags of potato chips) and the raw material required (eg, potatoes). The formula is: Units purchased = Units required for production + Units in ending inventory − Units in beginning inventory.
A Year 5 cash budget is being prepared for the purchase of Toyi, a merchandise item. Budgeted data are:
Cost of goods sold: Year 5 $300,000 Accounts payable: 1/1/Year 5 20,000 Inventory: 1/1/Year 5 30,000 Inventory: 12/31/Year 5 42,000 Purchases will be made in twelve equal monthly amounts and paid for in the following month. What is the Year 5 budgeted cash payment for purchases of Toyi?
A.
$286,000 (7%)
B.
$300,000 (3%)
C.
$306,000 (67%)
D.
$312,000
c
Inventory purchases are a component of the cash budget. To determine budgeted cash payments related to inventory purchases, follow these steps:
Calculate annual purchases ($312,000)
Purchases=Desired ending inventory+COGS−Beginning inventory
Determine the monthly amount of purchases ($26,000)
Calculate cash payments, remembering that purchases are paid for 1 month after purchase, so only 11 months will be paid (December will be the ending A/P balance).
Inventory purchases:
Desired ending inventory $ 42,000
Plus: COGS (ie, inventory that was sold) 300,000
Total inventory required for the year 342,000
Less: Beginning inventory (ie, already on hand) 30,000
Inventory to be purchased in Year 5 $312,000
Inventory purchases per month (divide by 12) $ 26,000
Cash payments:
Beginning accounts payable $ 20,000
Plus: Monthly inventory payments for 11 months at $26,000 286,000
Budgeted cash payments $306,000
(Choice A) An amount of $286,000 is the monthly inventory payment (assuming 11 months of payments).
(Choice B) COGS, not inventory payments, is $300,000.
(Choice D) An amount of $312,000 is the inventory that needs to be purchased for Year 5.
Things to remember:
The cash budget is one of the master budget components. One of the more significant amounts on the cash budget is payments for inventory purchases. Purchases are desired ending inventory plus COGS less beginning inventory. Cash payments may have a time lag (eg, payment ocurring one month after a purchase).
In the past, four direct labor hours were required to produce each unit of product Y. Material costs were $200 per unit, the direct labor rate was $20 per hour, and factory overhead was three times direct labor cost. In budgeting for next year, management is planning to outsource some manufacturing activities and to further automate others. Management estimates these plans will reduce labor hours by 25%, increase the factory overhead rate to 3.6 times direct labor costs, and increase material costs by $30 per unit. Management plans to manufacture 10,000 units. What amount should management budget for cost of goods manufactured?
A.
$4,820,000 (5%)
B.
$5,060,000 (85%)
C.
$5,200,000 (6%)
D.
$6,500,000
Choice B (Correct) and Choices A, C, D (Incorrect): The cost of goods manufactured for each unit will consist of direct materials of $230 (the original $200 plus the $30 increase), direct labor of $60 (4 hours per unit x $20 per hour was $80 per unit, reduced by 25% or $20 to $60), and manufacturing overhead of $216 ($60 x 3.6) for a total of $506 per unit. Based on 10,000 units, cost of goods manufactured is $5,060,000.
As part of a benchmarking process, a company’s costs of quality for the current month have been identified as follows:
Employee training $20,000 Product recalls 8,000 Scrap 4,500 Quality inspectors 48,000 Preventative maintenance 19,500 Supplier education expense 17,500 Materials inspection expense 60,000 Processing product returns 2,500 What amount is the company's prevention cost for the current month?
A.
$39,500 (8%)
B.
$57,000 (27%)
C.
$165,000 (61%)
D.
$175,500
B
Cost of quality states that preventing failures is less expensive than addressing failures after they occur. Under this philosophy, businesses generally save significant sums of money, improve their reputation for quality products, and entice more customers, driving revenues higher.
There are four categories of quality cost: prevention, detection/appraisal, internal failure, and external failure. In this case, prevention costs of $57,000 focus on stopping a defect from occurring (generally prior to production) and include items such as employee training ($20,000), preventive maintenance ($19,500), and supplier education ($17,500) (Choice A).
(Choice C) An amount of $165,000 incorrectly includes $108,000 of detection costs (eg, $48,000 quality inspectors and $60,000 material inspection cost). Detection costs are designed to prevent failures via inspections that identify unacceptable materials either before or during the manufacturing process.
(Choice D) An amount of $175,500 includes $108,000 of detection costs and $10,500 of external failure costs. External failure costs occur after the product has reached the customer and include $8,000 of product recalls and $2,500 in processing of product returns.
Internal failures identify quality issues during and after production, but before shipping the product to the customer. They include items such as $4,500 scrap are detected prior to shipping the product to the customer.
Things to remember:
Cost of quality is a philosophy designed to save businesses significant sums of money by focusing on the prevention and detection of quality issues rather than on correcting internal and external quality failures. Preventive costs include items such as employee and supplier training and preventative maintenance.
Macaw College allocates support department costs to its individual colleges using the step method. Information for July is as follows:
Maintenance
Power
Costs incurred
$79,200
$43,200
Services percentages provided to:
Maintenance
–
10
Power
20
–
School of Business
30
20
School of Humanities
50
70
Total
100
100
What is the amount of July support department costs allocated to the College of Business?
A.
$32,400 (26%)
B.
$36,880 (58%)
C.
$38,340 (9%)
D.
$39,300
Choice B (Correct): Under the step method, costs are allocated from one service department to operating departments and other service departments. Costs are not allocated to a department once costs are allocated from that service department. A percentage of use by a service department with costs already allocated is ignored; new ratios are derived using the relationships between the departments still accepting costs. This scenario (modeled after one from the AICPA) does not establish clearly which service department’s costs are allocated first. The maintenance department (M) costs must be allocated first because if one assumes the power department (P) costs are allocated first, the answer ($39,960) does not appear as one of the options. In the table below, B and H represent the Schools of Business and Humanities, respectively.
Allocating P costs first
P $
M ratio
M $
B ratio
B $
H ratio
H $
Costs (in 1,000s)
$43.2
$ 79.20
P ratio/allocation [1+2+7=10]
(43.2)
1/10
4.32
2/10
8.64
7/10
30.24
Subtotal
–0–
$83.52
$ 8.64
$30.24
M ratio/allocation [3+5=8]
(83.52)
3/8
31.32
5/8
52.20
Totals (not an answer option)
–0–
–0–
$39.96
$82.44
Allocating M costs first
M $
P ratio
P $
B ratio
B $
H ratio
H $
Costs (in 1,000s)
$79.2
$ 43.20
M ratio/allocation [2+3+5=10]
(79.2)
2/10
15.84
3/10
23.76
5/10
39.60
Subtotal
–0–
$59.04
$23.76
$39.60
P ratio/allocation [2+7=9]
(59.04)
2/9
13.12
7/9
45.92
Totals
–0–
–0–
$36.88
$85.52
The step method allocates all the first service department costs to production departments and all remaining service departments before allocating the second service department costs.
Smith Legal Services has offered to represent a plaintiff in a lawsuit for a retainer of $20,000 plus 40% of any award over $20,000. Smith expects to incur out-of-pocket expenditures of $15,000 in litigating the suit. Possible court awards with their associated probabilities are:
Award Probability
$100,000 0.7
$0 0.3
What is the expected value to Smith of the lawsuit?
A.
$25,900 (15%)
B.
$27,400 (37%)
C.
$33,000 (36%)
D.
$37,000
B
Managers use probability theory to develop the most logical single estimate from a range of possibilities. A probability distribution lists the possible outcomes related to a single action and the likelihood of each possible outcome. Attorney out-of-pocket expenses are not part of the weighting calculation, but they are considered in the expected value of the lawsuit.
In this scenario, each of the two possible outcomes is multiplied by its likelihood (or probability), and the weighted amounts are summed into a single weighted value. If there is an award, the retainer is deducted from the amount prior to weighting. If there is no award, the retainer is still due, but it would be paid out of pocket by the client and is therefore not part of the weighted award calculation.
Award Retainer Award subject to fee Probability Weighted Value $100,000 (20,000) $80,000 0.7 $56,000 0 (20,000) 0 0.3 0 $56,000 Smith is entitled to 40% of any award over $20,000, or $22,400 ($56,000 × 0.40). Remember that $56,000 represents the excess over the $20,000 retainer. Therefore, the expected value of the lawsuit is:
Retainer $20,000 Plus 40% fee 22,400 Less out-of-pocket expenses (15,000) Expected value of lawsuit $27,400 Things to remember: Probability theory can be used to develop the most logical single estimate from a range of possibilities. Possible outcomes are multiplied by their likelihood and the amounts are summed into a single weighted value for the award.
Last year a consulting company that solves computer network problems instituted a total quality management (TQM) program and produced the following summary cost-of-quality report:
Year 1 Year 2 Change
Prevention costs $ 200,000 $ 300,000 +50%
Appraisal costs 210,000 315,000 +50%
Internal failure costs 190,000 114,000 −40%
External failure costs 1,200,000 621,000 −48%
Total quality costs $1,800,000 $1,350,000 −25%
Which of the following statements regarding the report is most likely correct?
A.
An increase in inspection costs was solely responsible for the decrease in quality costs. (7%)
B.
An increase in conformance costs resulted in a decrease in nonconformance costs. (85%)
C.
The increase in conformance costs indicated that the TQM program was not working. (2%)
D.
In the long run, increased conformance costs would cause total quality costs to increase.
B
Cost of quality is a philosophy stating that product failures have an underlying cause, the cost of quality can be measured, and prevention and appraisal costs are less expensive than failure. There are four classifications of quality cost: prevention, detection/appraisal, internal failure, and external failure.
Prevention and detection/appraisal costs are frequently grouped together and called conformance costs. Likewise, internal and external failure costs are grouped together and called nonconformance costs. This grouping scheme allows for more financial analysis of quality cost spending.
In this scenario, if the quality program is successful, two trends should occur:
There is a shift from nonconformance to conformance costs year by year.
Total quality cost decreases each year.
In the second year, the company experienced an increase in conformance costs, and a significant reduction in nonconformance (ie, failure) costs, indicating that the program was working successfully (Choices C and D):
Year 1 Year 2 Change
Conformance costs $ 410,000 $ 615,000 $ 205,000
Nonconformance costs 1,390,000 735,000 (655,000)
Total quality costs $1,800,000 $1,350,000 ($450,000)
Conformance costs increased by $205,000, and nonconformance costs fell by $655,000, for a net reduction in quality cost of $450,000, or 25%. Note that although inspection costs are included in detection costs, there is no indication that they were solely responsible for the decrease in total quality costs (Choice A).
Things to remember:
Cost of quality is a philosophy stating that product failures have an underlying cause, the cost of quality can be measured, and prevention is less expensive than failure. Successful quality cost programs have two trends: a shift from nonconformance to conformance cost year by year and a decrease in total quality cost each year.
A company is conducting a risk analysis on a project. One task has a risk probability estimated to be 0.15. The task has a budget of $35,000. If the risk occurs, it will cost $6,000 to correct the problem caused by the risk event. What is the expected monetary value of the risk event?
A.
$900 (54%)
B.
$4,350 (8%)
C.
$5,250 (24%)
D.
$6,150
Choice A (Correct) and Choices B, C, D (Incorrect): The expected monetary value of the risk event is equal to its probability of 15% multiplied by its expected $6,000 cost of correction ($6,000 x 15% = $900).
Benigni Custom Appliques has two operating departments: Design and Production. Benigni allocates service department costs using the step-down method, allocating the Administration department’s costs first, then the Building & Maintenance department’s costs, and Sales department’s costs last. The Administration department’s costs are allocated to other departments based on the number of employees. The Building & Maintenance department’s costs are allocated to other departments based on the square footage of the space the departments occupy. The Sales department’s costs are allocated to other departments based on the revenue the departments will earn from that month’s sales orders. Benigni rounds allocated service department costs to the nearest whole dollar. Benigni’s September details are as follows.
Department
No. of
Employees
Square
Footage
Sales
Orders
Pre-allocation
Costs
Administration
5
750
$ 32,500
Building & Maintenance
2
150
25,500
Sales
9
450
46,000
Design
2
350
$ 33,000
11,000
Production
52
900
197,000
88,200
Total
70
2,600
$230,000
$203,200
Using the step-down method of allocating service department costs, what is allocated to the Design department from the Building & Maintenance department for September?
A.
$3,643 (17%)
B.
$3,786 (23%)
C.
$5,250 (23%)
D.
$5,456
TESTLET 51 # 5 Choice D (Correct): The step-down method of cost allocation is a means of allocating all service department costs to operating departments. The method allocates 100% of each service department's costs in turn to all other departments (including other service departments) that have not had their costs allocated. Once a service department's costs are allocated, nothing is allocated “back” to it. For instance, the second service department will not allocate anything to the first service department even if the second department provides services to the first department. Also, a service department does not allocate costs to itself. An allocation ratio denominator is derived for each allocating department based on the departments still accepting costs. The allocation ratio numerator is the accepting department's share of the basis for allocation.
In this instance, the Administration department’s costs are allocated first, based on the number of employees. The denominator is the sum of the employees in four departments, 2 + 9 + 2 + 52 = 65. As the Building & Maintenance (B&M) department has two employees, 2/65 x $32,500 = $1,000 of Administration department costs are allocated to the B&M department. Thus, the B&M department’s costs to be allocated are $25,500 + $1,000 = $26,500.
The B&M department’s costs are allocated second, based on square footage. The B&M department does not allocate costs to the Administration department. The denominator is the sum of the square footage occupied by three departments, 450 + 350 + 900 = 1,700. As the Design department occupies 350 square feet, 350/1,700 x $26,500 = $5,456 of B&M department costs are allocated to the Design department.
Note that some of the information regarding the Sales department is not needed to answer this question; exam questions often include extraneous information
