(Solution Manual) Management and Cost Accounting

Bhimani, Horngren, Datar, Rajan, 7

Business

Solution Manual

7th Edition

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Solution Manual for Management and Cost Accounting, The downloadable file consists of 440 pages, and the total size of the file is 4.9 MB. Purchase now only for highly discounted price.

Author(s): Bhimani, Horngren, Datar, Rajan

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Solutions Manual Management and Cost Accounting Seventh edition Alnoor Bhimani Charles Horngren Srikant Datar Madhav Rajan Hien Do 5 © Pearson Education Limited 2019 PART I MANAGEMENT AND COST ACCOUNTING FUNDAMENTALS 6 © Pearson Education Limited 2019 CHAPTER 1 The manager and management accounting Teaching tips and points to stress Modern management accounting While the accounting system pr ovides information (e.g. product costs and downtime) for management decisions, cost management refers to active use of t his information to plan and control costs. Cost management requires managers to actively se ek ways to reduce costs. Much cost management occurs well before the accounting system recogn ises costs. (The product design stage often offers more cost management opportunities th an controlling manufacturing operations.) Cost management is integrated throughout the text. To reinforce the value-chain concept, ask a student to illustra te activities/costs in each function in the context of his/her work experience. Students are often confused about the difference between R&D an d Design. The distinctions are not always clear-cut but R&D is basic research and idea generat ion, whereas design turns those ideas into reality. Design encompasses development of prototype p r o d u c t s a n d t h e manufacturing process by which the products are produced. Elements of management control Planning and control are distinct activities but they go hand i n hand. To maximise the benefits from planning (e.g. budgeting), the manager should use that pla n as a benchmark for controlling (i.e. assessing the effectiveness and efficiency of implementat ion). Conversely, it is difficult to control activities without a plan or budget. To help students understand how accounting numbers can affect e mployees’ behaviour and hence firm’s performance, ask questions, such as if a materials procurement officer’s annual bonus depends on the difference between budgeted price and actu al price paid, how will the officer behave? The officer may be tempted to purchase cheap, p erhaps low-quality materials that may not be delivered on a reliable, timely basis; he or sh e may refuse to order materials for rush orders if there will be an extra delivery charge, etc. Although it is difficult to quantify the costs and benefits of accounting systems, a decision about the system will be made. The question is whether costs and bene fits are considered implicitly (as part of a ‘gut feeling’) or explicitly, where effects of di fferent estimates can be examined. Additionally, it is always essent ial to consider the context in which management operates. Product cost information permeates all three functions. In the scorekeeping function, accountants accumulate product cost information for both external and inter nal reporting. Product cost information can help identify cost management opportunities (i. e. attention directing) and it is used in make-or-buy decisions, where managers compare the cost of making the product or component with the cost of buying it from an external supplier (i.e. problem solving). Bhimani et al., Management and Cost Accounting , 7e, Instructor’s Manual 7 © Pearson Education Limited 2019 Costs, benefits and context The ‘best’ information system depends on both technical and hum an aspects of the specific situation. This is a major difference between financial account ing, where firms generally need to comply with external reporting requirements where they exist, a nd management accounting, where choices are based on an explicit or implicit cost–benefit analysis. Management accounting students must do more than memorising rules. They mu st evaluate the situation and context, decide which technique or information system is most a ppropriate and implement it. A key challenge in management accounting One major challenge faced by acco untants relates to digitalisat ion. This is the process by which firms become digital businesses and the use of digital technolo gies changes the business model and provides new revenue and value-producing possibilities. Dig italisation is about enterprises not just having to become digitised but being digital. Some emerging technologies which management accountants should understand are: artificial intelligence (AI) and robotics , blockchain, big data and analytics, and the cloud. Solutions to review questions 1.1 The five broad purposes are: Purpose 1 : Formulating overall strate gies and long-range plans. Purpose 2 : Resource allocation decisions such as product and customer em phasis and pricing. Purpose 3 : Cost planning and cost control of operations and activities. Purpose 4 : Performance measurement and evaluation of people. Purpose 5 : Meeting external regulatory an d legal reporting requirements where they exist. 1.2 Management accounting measures and reports financial as well as other types of information that may be useful to managers in fulfilling the go als of the organisation. Financial accounting focuses on external reporting that is guided by generally accepted accounting principles. 1.3 The business functions in the value chain are: • Research and development – the generation of, and experimentati on with, ideas related to new products, services or processes. • Design of products, services and processes – the detailed plann ing and engineering of products, services or processes. • Production – the coordination and assembly of resources to prod uce a product or deliver a service. Bhimani et al., Management and Cost Accounting , 7e, Instructor’s Manual 8 © Pearson Education Limited 2019 • Marketing – the process by which individuals or groups (a) lear n about and value the attributes of products or se rvices and (b) purchase those p roducts or services. • Distribution – the mechanism by which products or services are delivered to a customer. • Customer service – the support activities provided to the custo mers. 1.4 Cost management refers to actions that managers undertake to satisfy customers while continuously reducing and controlling costs. 1.5 A successful accountant requires general business skills (such as understanding the strategy of an organisation) and people skills (such as motivat ing other team members) as well as technical skills (such as computer knowledge). 1.6 Yes. Drucker is advocating that accountants do more than scorek eeping, which is often interpreted as being a ‘bobby on the beat’ or a ‘ watchdog’. It is also essential that accountants emphasise their atten tion-directing and problem-sol ving functions. 1.7 The new accountant could reply in one or more of several ways: a. Demonstrate to the plant manager how he or she could make bette r decisions, if the plant accountant was viewed as a resource rather than a dead we ight. In a related way, the plant accountant could show how the plant manager’s time and resources could be saved by viewing the new plant accountant as a team member. b. Demonstrate to the plant manager a good knowledge of technical aspects at the plant. This approach may involve doing background reading. It c ertainly will involve spending much time on the plant floor speaking to plant personnel. c. Show the plant manager’s examples of the new plant accountant’s past successes in working with line managers in other plants. Examples could incl ude • assistance in preparing the budget, • assistance in analysing problem situations and • assistance in submitting ca pital budget requests. d. Seek assistance from the corpora te accountant to highlight to t he plant manager the importance of many tasks undertaken by the new plant accountant . This approach is a last resort but may be necessary in some cases. 1.8 A customer-driven management accountant function would a. approach its customers (such as managers in different parts of the value chain) to determine how it can facilitate those managers in making better decisions and b. solicit regular and systematic feedback from those customers ab out its performance. Bhimani et al., Management and Cost Accounting , 7e, Instructor’s Manual 9 © Pearson Education Limited 2019 1.9 Yes, management accountants have customers just as companies ha ve customers who purchase their products or services. Management accountants pro vide information and advice to many line and staff people in the organisation and to various external parties. It is essential that they provide information and advice that l ine and staff customers and external parties view as timely and relevant. 1.10 Five themes that affect the way managers operate and have promp ted developments in management accounting are the following: • Customer satisfaction is priority one • Key success factors (cost, quality, time and innovative product s, and services) • Total value-chain analysis • Continuous improvement • Dual external/internal focus. Solutions to exercises 1.13 Value chain and classification of costs, computer company. (15 min) Cost item Value-chain business function a Production b Distribution c Design d Research and development e Customer service f Design (or research and development) g Marketing h Production 1.14 Value chain and classification of costs, pharmaceutical company . (15 min) Cost item Value-chain business function a Design b Marketing c Customer service d Research and development e Marketing f Production g Marketing h Distribution Bhimani et al., Management and Cost Accounting , 7e, Instructor’s Manual 10 © Pearson Education Limited 2019 1.15 Uses of feedback. (10 min) Item Use of feedback a 2 b 6 c 4 d 3 e 5 f 1 1.16 Scorekeeping, attention directing and problem solving. (15 min) Because the accountant's duties are often not sharply defined, some of these answers might be challenged. Activity Function a Scorekeeping b Attention directing c Scorekeeping d Problem solving e Attention directing f Attention directing g Problem solving h Scorekeeping, depending on the extent of the report i This question is intentionally vague. The give-and-take of the budgetary process usually encompasses all three functions but it emphasis es scorekeeping the least. The main function is attention directin g but problem solving is also involved. j Problem solving 1.17 Scorekeeping, attention directing and problem solving. (15 min) The accountant’s duties are often not sharply defined, so some of these answers might be challenged. Activity Function a Attention directing b Problem solving c Scorekeeping Bhimani et al., Management and Cost Accounting , 7e, Instructor’s Manual 11 © Pearson Education Limited 2019 Activity Function d Scorekeeping e Scorekeeping f Attention directing g Problem solving h Scorekeeping i Problem solving j Attention directing 1.18 Changes in management and change s in management accounting. (15 min) Change in management accounting Key theme in newly evolving management approach a Total value-chain analysis b Key success factors (quality) or total value-chain analysis c Dual external/internal focus d Continuous improvement e Customer satisfaction is priority one 1.19 Planning and control, feedback. (15–20 min) 1. Planning is choosing goals, predicting re sults under various ways of ach ieving those goals and then deciding how to attain the desired goals. One of the goals of the European Starting News (ESN) is t o increase operating income. I ncreasing revenues is potentially one way to achieve this if the increase in reven ues exceeds any associated increase in costs. ESN expects daily circulation to increase from 250,000 per day in April to 400,000 per day in May. This budgeted circulation gain is expected to increase newspap er revenues from €5,250,000 in April to a budgeted €6,200,000 in May. Control covers both the actions that implement the planning decision an d the performance evaluation of the personnel and operations. At ESN, t h e p r i c e drop would be announced to its sales force and probably to customers . Requirement 2 illustrates a performance report for May 2003. 2. Actual results Budgeted amounts Variance Newspapers sold 13,600,000 12,400,000 1,200,000 fav Price per paper €0.50 €0.50 €0.00 fav Newspaper revenue €6,800,000 €6,200,000 €600,000 fav Bhimani et al., Management and Cost Accounting , 7e, Instructor’s Manual 12 © Pearson Education Limited 2019 3. Based on the €600,000 favourable variance for circulation reven ue, Saunier might take the following actions: a. Change predictions. ESN underestimated the daily circulation ga in by 40,000 copies per day. It might examine the procedures it uses to esti mate the response of circulation to price changes. b. Change operations. ESN might now change its advertising rates t o reflect that circulation in May is 76% above that of April. This gives adver tisers a much larger audience they can reach with each advertisement in the E SN. 1.20 Professional ethics and reporting divisional performance. (10–15 min) 1. Devallois’s ethical responsibilities are well summarised in Eth ical Guidelines. Areas of ethical responsibility include • competence, • confidentiality, • integrity and • objectivity. The key area related to Devallois’s current dilemma is integrit y. Devallois should refuse to book the €200,000 of sales until the goods are shippe d. Both financial accounting and management accounting principles maintain that t h e s a l e s a r e not complete until the title is transferred to the buyer. 2. Devallois should refuse to follow Clément’s orders. If Clément persists, the incident should be reported to the corporate accountant. Support for lin e management should be wholehearted but it should not require unethical conduct. 1.21 Responsibility for analysis of performance. (20–30 min) This problem raises plenty of thought-provoking questions. Unfo rtunately, there are no pat answers. The generalisations about these relationships are difficult to formulate. 1. Apparently, the accountant’s performance-analysis staff have no t won the confidence or respect of Hedby and other line officers. Hedby r egards these accountants as interlopers who are unqualified for their analyt ical tasks on two counts: (a) the task is Hedby’s not the accountants’ and (b) He dby understands his own problems best. It is unlikely that the accountant’s perform ance-analysis staff have maintained a day-to-day relationship with line personnel i n Division C. 2. Nedregotten should point out that her performance-analysis staf f are doing the work in order to enable Hedby to better concentrate on his other wor k. The detached analyses by her staff should help Hedby better understand and i m prove his own performance. Bhimani et al., Management and Cost Accounting , 7e, Instructor’s Manual 13 © Pearson Education Limited 2019 Furthermore, Nedgrotten should point out that Hedby would need his own divisional accounting staff in order to prepare the necessary analysis of performance, if Hedby’s group did not support him. More uniform reporting formats and p rocedures and more objective appraisals could potentially occur if the performance -analysis staff remain as part of the corporate accountant’s group. 3. Two approaches within the existing organisation reporting relat i o n s h i p s a r e t h e following: a. Placing higher priority on having her performance-analysis staf f view the division personnel as important customers and actively seeking out ways to increase customer satisfaction. b. Encouraging greater use of teams in which division personnel an d corporate control personnel are members. H opefully, mutual respect will i ncrease by this close interaction. A more extreme approach would be to change the organisation’s r eporting relationships and staff assignments. For example, each division manager could have his or her own performance-analysis staff member as part of the p l a n t accountant’s group. 1.23 Planning and control decisions: Internet company. (30 min) 1. Planning decisions at WebNews.co.uk focus on organisational goals, predicting results under various alternative ways of achieving those goals and then deciding on how to attain the desired goals. For example, WebNe ws.co.uk could have the objective of revenue growth to gain critical mas s or it could have the objective of increasing operating income. Many Internet com panies in their formative years make revenue growth (and subscriber growth) the ir primary goal. Control focuses on (a) deciding on and taking actions that implement th e planning decisions and (b) deciding on performance evaluation a nd the related feedback that will help future decision making. 2. Planning decisions a. Decision to raise monthly subscription fee. c. Decision to upgrade content of online services. e. Decision to decrease monthly subscription fee. Control decisions b. Decision to inform existing subscribers about the rate of incre ase – an implementation part of control decisions. d. Demotion of VP of Marketing – performance evaluation and feedba ck aspect of control decisions. Bhimani et al., Management and Cost Accounting , 7e, Instructor’s Manual 14 © Pearson Education Limited 2019 1.24 Problem solving, scorekeeping and attention directing: Internet company. (30 min) 1. Problem solving – comparative analysis for decision making. Scorekeeping – accumulating data and reporting reliable results to all levels of management. Attention directing – helping managers to properly focus their attention. 2. a. and e Decisions to change subscription fee. Problem solving – report outlining expected revenues from subscribers and advertising with different monthly fee amounts. Scorekeeping – report with monthly subscribers and their revenues in prior months. Attention directing – report showing the change in the number of subscribers of Internet companies at the time they change their monthly fees. b. Decision in June 2005 to inform existing subscribers about rate increase in July. Problem solving – report showing the cost of different ways of informing subscribers of the rate increase. Scorekeeping – report showing how many subscribers immediately paid the new subscription fee when past fee increases occurred. Attention directing – report showing the number of subscribers to the service that have not logged on for two months or more. c. Decision to upgrade the content of online services. Problem solving – report showing the expected cost of alternative ways to upgrade content. Scorekeeping – labour cost tracking of software developers who work on content. Attention directing – report on cost overruns relative to budget for ongoing content upgrades. d. Demotion of VP of Marketing Problem solving – budgeted cost of marketing department with alternative management teams. Scorekeeping – report showing breakdown of subscribers into renewals and new subscribers. Attention directing – report highlighting subscriber growth and rates of competing Internet news services. 15 © Pearson Education Limited 2019 CHAPTER 2 An introduction to cost terms and purposes Teaching tips and points to stress Costs in general Cost assignment is a general term for attaching either direct o r indirect costs to cost objects. The distinction between direct and i ndirect costs is important beca use direct costs are directly traced to the cost object, whereas indi rect costs are often pooled and then allocated to the cost object with less precision. Management, therefore, has more confidence in the accuracy of direct costs. The text uses the term ‘cost tracing’ to refer specifically to assigning direct costs to cost objects. Cost allocation is reserved for assigning indirect costs to cos t objects. Cost objects include (1) activities or processes; (2) outputs o f processes, such as products, services and projects; (3) parts of the organisation (e.g. depa rtments or programmes) and (4) customers. Information on costs associated with these cost obje cts facilitates decisions such as (1) which manufacturing process is most economical, (2) what pr ice should be charged for the service, (3) which department uses its resources most efficient ly and (4) which customers contribute most to the company’s profits. There is more to cost accounting than product costing. Direct costs and indirect costs Students have trouble with the distinctions between direct/indi rect costs and cost tracing/cost allocation. Familiar examples can help. Public accounting firms directly trace direct professional labour costs to each audit engagement (through time sheets). In c o n t r a s t , r e n t o n t h e f i r m ’s office and depreciation on its c omputers cannot be traced to in dividual engagements. These are indirect costs that must be allo cated to the different engageme nts. Allocation of indirect costs is a difficult but important topic that is covered in more detail in later chapters. Example: Is photocopying a direct or an indirect cost with resp ect to department cost objects? In the past, it was difficult to keep track of the amount of copyi ng done by different departments. Moreover, there was generally le ss copying. Photocopying was ty pically considered an indirect cost because it was often an immaterial amount and hard to trac e. Today, businesses are making more photocopies than ever before. Counters inserted into copie rs (copy keys) easily keep track of the number of copies made by each user. Because copying cost s are now higher and easier to trace, they are more often directly traced. (An additional bene fit of the counters is that they may induce employees to make fewer copies because the number of cop ies is now more observable.) Cost drivers and cost management Cost management occurs when managers actively strive to reduce costs. Two major avenues for cost management are focusing on value-added activities (and eli minating non-value-added activities such as stock handling) and reducing consumption of cost drivers in value-added activities. Reduced consumption of cost drivers reduces costs o nly if managers actively squeeze costs down. As more managers do their own word processing, typi ng by secretaries declines. But unless management reduces the number of secretaries in resp onse to the reduced workload, secretarial costs will not reduce. Bhimani et al., Management and Cost Accounting , 7e, Instructor’s Manual 16 © Pearson Education Limited 2019 Two types of cost behaviour pattern: variable costs and fixed costs The distinction between variable costs (VCs) and fixed costs (F Cs) is necessary to address basic questions such as how much manufacturing costs change if the le vel of output increases by 5%. For example, many fast-food restaurants guarantee workers only an hour or two of work per shift. If sales are less than exp ected, workers can be dismisse d for the shift after their guaranteed hour (or two). In this case, direct-labour cost varies directly with output (sales). In contrast, many government workers are salaried and cannot be dismissed ex cept under extreme circumstances. Here, direct-labour costs for a government depar tment are relatively fixed. Students are often confused about when VCs are variable and whe n FCs are fixed. Variable costs vary in total and FCs are fixed in total. However, VCs pe r unit are consistent and FCs per unit decline as more units are produced. Total costs and unit costs Students often treat ‘unitised’ fixed costs as if they were var iable costs, forgetting that fixed costs are fixed in total. They attempt to calculate total costs by multiplying the cost per unit by the number of units. Because of this misleading nature of uniti sed fixed costs, it is better to base projections and comparisons on total costs. When estimating tot al costs, students should consider variable costs as an amount per unit and fixed costs a s a lump sum total amount. Financial statements and cost terminology The basic concepts of assigning costs to cost objects (and usin g this information for planning and control) apply to service, merchandising and manufacturing companies. Students find it easier to grasp the basic concepts by starting with service com panies, which are the simplest as they have no stocks. Merchandisers add the complications of pur chases and stocks. The final step is manufacturers, which are more difficult due to the comp lexities of cost of good manufactured (CGM) and the three types of stock. Solutions to review questions 2.1 A cost object is anything for which a separate measurement of c osts is desired. Examples include a product, a service, a project, a customer, a brand category, an activity, a department and a programme. 2.2 Costs are not direct or indirect in isolation. A cost object (s uch as a product, service or project) must be specified. • Direct costs of a cost object are those costs that are related to the particular cost object and that can be traced to it in an economically feasible (cost-effective) way. • I n d i r e c t c o s t s o f a c o s t o b j e c t a r e t h o s e c o s t s t h a t a r e r e l a t e d to the particular cost object but cannot be traced to it in an economically feasible ( cost-effective) way. Bhimani et al., Management and Cost Accounting , 7e, Instructor’s Manual 17 © Pearson Education Limited 2019 Assume that the cost object is a Macintosh computer product. Ap ple assembles multiple products in each of its plants. The computer screen is a direct cost of the Macintosh. In contrast, the salary of the security guard at the plant where t he Macintosh is assembled would be an indirect cost of the Macintosh. 2.3 Consider a supervisor’s salary in a maintenance department of a telephone company. If the cost object is the department, the salary is a direct cost. If the cost object is a telephone call by a customer, the salary is an indirect cost. 2.4 Factors affecting the classifica tion of a cost as direct or ind irect include 1. the materiality of the cost in question, 2. available information-gathering technology, 3. design of operations and 4. contractual arrangements. 2.5 A cost driver is any factor that affects total costs. Examples include: Business function Example of cost driver Research and development Number of research projects Design Number of products in design Production Number of units produced Marketing Number of advertisements run Distribution Number of items distributed Customer service Number of service calls 2.6 The relevant range is the range of the cost driver in which a s pecific relationship between cost and driver is valid. This concept enables the use of linear cost functions when examining cost–volume–profit (CVP) relationships as long a s the volume levels are within that relevant range. 2.7 A unit cost is calculated by dividing some total cost (the nume rator) by some number of units (the denominator). In many cases, the numerator will incl ude a fixed cost that will not change despite changes in the number of units to be assembl ed. It is erroneous in those cases to multiply the unit cost by volume changes to pred ict changes in total costs at different volume levels. 2.8 Descriptions of the three sectors are: • Service-sector companies provide services or intangible product s to their customers – for example, legal advice or an audit. These companies do not h ave any stock of intangible products at the end of an accounting period. • Merchandising-sector companies provide tangible products they h ave previously purchased in the same basic form from suppliers. Merchandise pu rchased from suppliers but not sold at the end of an accounting period is he ld as stock. Bhimani et al., Management and Cost Accounting , 7e, Instructor’s Manual 18 © Pearson Education Limited 2019 • Manufacturing-sector companies provide tangible products that h ave been converted to a different form from the pr oducts purchased from suppliers. At the end of an accounting period, stock of a manufacturer can include direct m aterials, work in progress and finished goods. Thus, manufacturing and merchandising companies have stock whil e service companies do not. Manufacturing companies have direct materials, work in progress and finished goods stock, whereas merchandising companies have only goods pu rchased for resale stock (merchandise stock). 2.9 The three major categories of the stockable costs of a manufact ured product are: 1. direct materials costs, 2. direct manufacturing labour costs and 3. indirect manufacturing costs. 2.10 Direct materials costs are the acquisition costs of all materials that eventually beco me part of the cost object (say, units finished or in progress) an d that can be traced to that cost object in an economically feasible way. Acquisition costs of direct materials include freight-in (inward delivery) charges, sales taxes and c ustoms duties. Direct manufacturing labour costs include the compensation of all manufacturing labour that is specifically identified with the cost object (say, units fin ished or in progress) and that can be traced to the cost object in an economically feasible wa y. Examples include wages and fringe benefits paid to machine operators and assembl y-line workers. Indirect manufacturing costs are all manufacturing costs considered to be part of the cost object (say, units finished or in progress) but that canno t be individually traced to that cost object in an economically feasible way. Examples incl ude power supplies, indirect materials, indirect m anufacturing labour, plant rent, plant insurance, property taxes on plants, plant depreciation and the compensation of pla nt managers. Prime costs are all direct manufacturing costs. In the two-part classificat ion of manufacturing costs, prime costs would comprise direct material s costs. In the three- part classification, prime costs would comprise direct material s costs and direct manufacturing labour costs. Conversion costs are all manufacturing costs other than direct materials costs. Solutions to exercises 2.11 Total costs and unit costs. (10 min) 1. Total cost, €40,000. Unit cost per person, €40,000 ÷ 500 = €80.00. 2. Total cost, €40,000. Unit cost per person, €40,000 ÷ 2000 = €20.00. 3. The main lesson of this problem is to alert the student early i n the course to the desirability of thinking in terms of total costs rather than un it costs wherever feasible. Changes in the number of cost driver units will affec t total variable costs but not total fixed costs. In our example, it would be perilous to use either the Bhimani et al., Management and Cost Accounting , 7e, Instructor’s Manual 19 © Pearson Education Limited 2019 €80.00 or the €20.00 unit cost to predict the total cost becaus e the total costs are not affected by the attendance. Instead, the student associatio n should use the €40,000 total cost. Obviously, if the musical group agreed to w ork for, say €40.00 per person, such a unit variable cost could be used to predict the total cost. 2.13 Total costs and unit costs. (10 min) 1. Unit cost = Total costs ÷ Number of units. Total costs ( €) Number of units Unit cost ( €) a. 60,000 200 300 b. 60,000 250 240 c. 60,000 300 200 2. The unit-cost figures per passenger calculated in requirement 1 should play no role in predicting the total air-flight costs to be paid next month. Weltferien pays SaxonAir on a per round-trip flight basis but not on a per pass enger basis. Hence, the cost driver for next month is the number of round-trip flights and n ot the number of passengers. 2.14 Classification of costs, service sector. (15–20 min) Cost object : Each individual focus group. Cost variability : With respect to changes in the number of focus groups. There may be some debate over classifications of individual ite ms. Debate is more likely as regards cost variability. Cost item D or I V or F A D V B I F C I Va D I F E D V F I F G D V H I Vb aSome students will note that phone call costs are variable when e a c h c a l l h a s a separate charge. It may be a fixed cost if Presta-Serviços has a flat monthly charge for a line, irrespective of the amount of usage. bPetrol costs are likely to vary with the number of focus groups . However, vehicles likely serve multiple purposes and detailed records may be required to examine how costs vary with changes in one of the many purposes served. Bhimani et al., Management and Cost Accounting , 7e, Instructor’s Manual 20 © Pearson Education Limited 2019 2.15 Classification of costs, merchandising sector. (15–20 min) Cost object : Film section of store. Cost variability : With respect to changes in the number of films sold, assumpti ons may be made over classifications of individual items. This is mainl y in relation to cost variability. Whether DVDs and videos cost the same is another m atter. Cost item D or I V or F A I F B I V C D V D D F E I F F I V G I F H D V 2.16 Cost drivers and the value chain. (15 [AQ1] min) 1. Business function area Representative cost driver A Research and development Number of research scientists B Design of products/processes Hours of CAD work C Production Number of machine assembly hours D Marketing Number of sales personnel E Distribution Weight of cars shipped F Customer service Number of calls recalled for defective parts Bhimani et al., Management and Cost Accounting , 7e, Instructor’s Manual 21 © Pearson Education Limited 2019 2. Business function area Representative cost driver A Research and development  Hours of design and testing work  Number of new models in development B Design of products/processes  Number of focus groups on alternative models and designs  Hours of engineering and retooling C Production  Number of units coming off assembly line  Number of models manufactured D Marketing  Number of promotion packages mailed  Number of sales E Distribution  Number of cars shipped overseas  Number of cars delivered to showrooms F Customer service  Number of cars recalled  Number of personnel on free customer phone lines 2.17 Calculating cost of goods manufactured and cost of goods sold. (20–25 min) Schedule of cost of goods manufactured for the year ended 31 December 2018 (in €million) €m €m Direct materials used 13.05 Direct manufacturing labour costs 15.10 Indirect manufacturin g costs: Property tax on plant building 0.45 Plant utilities 2.56 Depreciation of plant buildin g 1.35 Depreciation of plant equipment 1.65 Plant repairs and maintenance 2.40 Indirect manufacturin g labou rcosts 3.45 Indirect materials used 1.65 Miscellaneous plant overhead 0.60 14.10 Manufacturin g costs incurred durin g2018 32.25 Add opening work in progress stock, 1 January 2018 3.00 Total manufacturing costs to account for 35.25 Deduct closin g work in pro gress stock, 31 Decembe r2018 3.90 Cost of goods manufactured 31.35 Bhimani et al., Management and Cost Accounting , 7e, Instructor’s Manual 22 © Pearson Education Limited 2019 Schedule of cost of goods sold for the year ended 31 December 2018 (in €million) €m Opening finished goods, 1 January 2018 4.05 Cost of goods manufactured (above ) 31.35 Cost of goods available fo rsale 35.40 Closin g finished goods , 31 December 2018 5.10 Cost of goods sold 30.30 2.18 Income statement and schedule of cost of goods manufactured. (25–30 min) Howell Ltd Income Statement for the Year Ended 31 December 2018 (in £millions) £m £m Revenues Cost of goods sold: Opening finished goods, 1 January 2018 70 950 Cost of goods manufactured (below ) 645 Cost of goods available for sale 715 Closing finished goods, 31 December 2018 55 660 Gross mar gin 290 Marketing, distribution and customer-service costs 240 Operating income 50 Howell Ltd Schedule of cost of goods manufactured for the year ended 31 December 2018 (in £millions) £ £ Direct materials costs: Opening stock, 1 January 2018 15 Purchases of direct materials 325 Cost of direct materials available for use 340 Closin g stock, 31 Decembe r2018 20 Direct materials used 320 Direct manufacturing labour costs 100 Indirect manufacturin g costs: Indirect manufacturing labour 60 Plant supplies used 10 Plant utilities 30 Depreciation – plant, buildin gand equipment 80 Plant supervisory salaries 5 Miscellaneous plant overhead 35 220 Manufacturing costs incurred during 2018 640 Add opening work in progress stock, 1 January 2018 10 Total manufacturin g costs to account for 650 Deduct closing work in progress, 31 December 2018 5 Cost of goods manufactured £645Bhimani et al., Management and Cost Accounting , 7e, Instructor’s Manual 23 © Pearson Education Limited 2019 2.19 Interpretation of statements. (20–25 min) 1. The schedule in 2.18 can become a schedule of cost of goods man ufactured and sold simply by including the opening and closing finished goods stock figures in the supporting schedule, rather than directly in the body of the in come statement. Note that the term cost of goods manufactured refers to the cost of goods brought to completion (finished) during the accounting period, whether the y were started before or during the current accounting period. Some of the man ufacturing costs incurred are held back as costs of the closing work in progress ; similarly, the costs of the opening work in progress stock become a part of the cost of goods manufactured for the following year. 2. The sales manager’s salary would be charged as a marketing cost as incurred by both manufacturing and merchandising companies. It is basically an operating cost that appears below the gross margin line on an income statement . In contrast, an assembler’s wages would be assigned to the products worked on. Thus, the wages cost would be charged to work in progress and would not be expe nsed until the product is transferred from finished goods stock to cost of goo ds sold as the product is sold. 3. The direct–indirect distinction can be resolved only with respe ct to a particular cost object. For example, in defence contracting, the cost object ma y be defined as a contract. Then, a plant supervisor’s salary may be charged dire ctly and wholly to that single contract. 4. Direct materials used = £320,000,000 ÷ 1,000,000 units = £320 per unit. Depreciation = £80,000,000 ÷ 1,000,000 units = £80 per unit. 5. Direct materials unit cost would be unchanged at £320. Deprecia tion unit cost would be £80,000,000 ÷ 1,200,000 = £66.67 per unit. Total direct materials costs would rise by 20% to £384,000,000, whereas total depreciation w ould be unaffected at £80,000,000. 6. Unit costs are averages and they must be interpreted with cauti on. The £320 direct materials unit cost is valid for predicting total costs because direct materials is a variable cost; total direct materials costs indeed change as ou tput levels change. However, fixed costs like deprec iation must be interpreted quit e differently from variable costs. A common error in cost analysis is to regard al l unit costs as one – as if all the total costs to which t hey are related are variable c osts. Changes in output levels (the denominator) will affect total variable costs but n o t t o t a l f i x ed co s t s . Graphs of the two costs may clarify this point; it is safer to think in terms of total costs than in terms of unit costs. Bhimani et al., Management and Cost Accounting , 7e, Instructor’s Manual 24 © Pearson Education Limited 2019 2.20 Finding unknown balances. (20–25 min) Let G = given, I = inferred. Step 1: Use gross margin formula Case 1 Case 2 Revenues £32,000G £31,800G Cost of goods sold A 20,700I 20,000G Gross margin 11,300G C 11,800I Step 2: Use schedule of cost of goods manufactured formula Case 1 Case 2 Direct materials used £8,000G £2,000G Direct manufacturing labour costs 3,000G 5,000G Indirect manufacturing costs 7,000G D 6,500I Manufacturing costs incurred 18,000I 23,500I Add opening work in progress, 1 January 0G 800G Total manufacturing costs to account for 18,000I 24,300I Deduct closing work in progress, 31 December 0G 3,000G Cost of goods manufactured 18,000I 21,300I Step 3: Use cost of goods sold formula Case 1 Case 2 Opening finished goods stock, 1 January £4,000G £4,000G Cost of goods manufactured 18,000I 21,300I Cost of goods available for sale 22,000I 25,300I Closing finished goods stock, 31 December B 1,300I 5,300G Cost of goods sold 20,700I 20,000G For case 1, do steps 1, 2 and 3 in order. For case 2, do steps 1, 3 and then 2. 2.21 Fire loss, computing stock costs. (30–40 min) 1. Cost of goods sold (or COGS) = Revenue × ( 1 – gross margin percentage based on sales) = 10(1-0.2) = 8 <=> Cost of goods available for sales – Closing finished goods stock = COGS <=> 9 – Closing finished goods stock = 8 <=> Finished goods stock (as at 26th Feb) = 1 Bhimani et al., Management and Cost Accounting , 7e, Instructor’s Manual 25 © Pearson Education Limited 2019 2. Indirect manufacturing costs = 40% of conversion cost => DL cost = 60% of conversion cost => conversion cost = 3.6/0.6 = 6 => Indirect manufacturing costs = 6 × 40% = 2.4 Manufacturing costs = DM cost + DL cost + Indirect manufacturing costs = 2.28 + 3.6 +2.4 = 8.28 Cost of goods manufactured = Cost of goods available for sales – Opening finished goods stock = 9 – 0.6 = 8.4 Work-in-progress stock (26 February) = Work-in-progress stock( 1st Jan) + Manufacturing costs – Cost of goods manufactured = 0.68 + 8.28 – 8.4 = 0.56 3. Prime cost = DM cost + DL cost <=> 5.88 = DM cost + 3.6 ó DM cost = 2.28 D M c o s t = DM ( 1st Jan) + DM purchased – DM (26th Feb) <=> 2.28 = 0.32 + 3.2 - DM (26th Feb) <=> DM (26th Feb) = 1.24 2.22 Comprehensive problem on unit costs, product costs. (30 min) 1. If 2 kg of direct materials are used to make each unit of finis hed product, 100,000 units × 2 kg or 200,000 kg were used at €l0.70 per kg of direct materi als (€140,000 ÷ 200,000 kg). Therefore, the closing stock of direct materials is 2000 kg × €0.70 = €1,400. 2. Manufacturing costs for 100,000 units Variable Fixed Total Direct materials costs €140,000 € €140,000 Direct manufacturing labour costs 30,000 – 30,000 Plant energy costs 5,000 – 5,000 Indirect manufacturing labour costs 10,000 16,000 26,000Other indirect manufacturing costs 8,000 24,000 32,000 Cost of goods manufactured €193,000 €40,000 €233,000 Average unit manufacturing cost: = €233,000 ÷ 100,000 units = €2.33 per unit Finished goods stock in units: = €20,970 (given) €2.33 per unit = 9000 units Bhimani et al., Management and Cost Accounting , 7e, Instructor’s Manual 26 © Pearson Education Limited 2019 3. Units sold in 2018 = Opening stock + Production − Closing stock = 0 + 100,000 − 9000 = 91,000 units Selling price per unit in 2018 = €436,800 ÷ 91,000 = €4.80 per unit 4. Revenues (91,000 units sold × €4.80) Cost of units sold: Opening finished goods, 1 January 2018 € €436,800 0 Cost of goods manufactured 233,000 Cost of goods available for sale 233,000 Closing finished goods, 31 December 2018 20,970 212,030 Gross margin 224,770 Operating costs: Marketing, distribution and customer-service costs 162,850 Administrative costs 50,000 212,850 Operating income € 11,920 Note: Although not required, the full set of unit variable cost s are: Direct materials costs €1.40 Direct manufacturing labour costs 0.30 Plant energy costs 0.05 per unit manufactured Indirect manufacturing labour costs 0.10 Other direct manufacturing costs 0.08 Marketing, distribution and customer-service costs 1.35 per u nit sold 2.25 Revenue and cost recording and classifications, ethics. (25–30 min) 1. Concerns include: a. Total payments made by Aran Swea ters do not ‘appear’ to be adeq uately described. Elements of ‘total compensation’ appear to be: • €12 million payment to O’Neil in Achill Island, • €4.8 million payment to O’Neil subsidiary in Switzerland and • Assistance with life insurance plans for ‘O’Neil executives at rates much more favourable than those a vailable in Achill Island’. One possible motivation for restricting the payment in Achill I sland to €12 million is to avoid showing higher profits in Achill Island. A second motivation could be that the Swiss subsidiary is siphoning off revenues to O’Neil senior executives that should be paid to O’Neil. This could arise if t he O’Neil Swiss subsidiary is ‘owned’ by the senior executives of O’Neil rather than being a 100% subsidiary of O’Neil. Bhimani et al., Management and Cost Accounting , 7e, Instructor’s Manual 27 © Pearson Education Limited 2019 The assistance with the insurance plans is in the grey area. If O’Neil is willing to accept a lower price in return for Aran Sweaters assisting w ith the insurance plans, it may be a judicious economic decision by Aran Sweaters . Aran Sweaters is not hurt economically in this scenario. The concern is whether Aran Sweaters is assisting the senior executives to divert ‘de facto ’ payments to themselves. b. Product design costs of Aran Sweaters include €4.8 million for ‘own product design’. It is stated that the director of product design views it ‘as an “off- statement” item that historically he has neither responsibility for nor any say about’ and that ‘to his knowledge, O’Neil uses only Aran Sweate rs designs with either zero or minimal changes’. It may be that the €4.8 millio n payment is a hidden payment made to avoid Achill Island taxation. However, t he result is incorrect classification of product design costs at Aran Sweate rs. c. O’Neil receives from Aran Sweaters the margin between €16.8 mil lion (€12 million + €4.8 million) and the €3 million payment for wool, that is €13 .8 million. Note that Aran Sweaters can assist O’Neil to meet the 25% ratio of ‘domestic labour costs to total costs’. Charging €6.00 million for wool a nd receiving €19.8 million for sweaters will result in the same €1 3.8 million margin but will mean O’Neil will not meet the 25% test as total costs will now be €13 million instead of €10 million. Aran Sweaters has to ensure it takes an arm’s length in its approach to supply contracts and purchase contracts or else it may be accused by the Achill Island government of assisting O’Neil to avoid local taxes. Note : Some students will ask whether O’Neil should be able to class ify labour fringe benefits as a domestic labour cost. This is not Sheridan’s doma in given that she is controller of Aran Sweaters. Her concern with the Achill Island tax rebate is whether Aran Sweaters is being ‘pressur ed’ to adjust its billing amount s to facilitate O’Neil to have a ratio of ‘domestic labour costs to total costs’ exceedin g 25%. If you want to discuss this issue, point out that labour-fringe benefits are t ypically an integral part of labour costs. Hence, if they can be traced, O’Neil is justified i n including them in domestic labour costs. 2. There are a variety of ethical issues relating primarily to com petence and integrity that Sheridan faces: a. Is Aran Sweaters assisting O’Neil to avoid income taxes in Achi ll Island either: • by funnelling €4.8 million to a Swiss company rather than to O’ Neil in Achill Island or • by understating both the €3 million wool supply cost and the €1 6.8 total revenue amount? b. Is Aran Sweaters assisting senior executives of O’Neil to enric h themselves at the expense of the shareholders of O’Neil? c. Are the accounting records of Aran Sweaters properly reflecting the underlying activities? Bhimani et al., Management and Cost Accounting , 7e, Instructor’s Manual 28 © Pearson Education Limited 2019 3. Steps Sheridan could take include: a. Seeking further information on why the €4.8 million payment is being made to the Swiss subsidiary. This should be done first internally and then by speaking to O’Neil executives. b. Ensure product design costs at Aran Sweaters reflect actual pro duct design work. The so-called ‘off-statement’ items should be eliminated if no adequate explanation can be given for them. c. Ensure Aran Sweaters personnel follow any company guidelines ab out supply relations or customer relations. There is nothing inherently wr ong with assisting O’Neil negotiate a better insurance package for its executives. The concern is whether developing a ‘too cosy’ relationship will lead to more questionable practices being overlooked.