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# Accounting for Decision Making 8th Edition Test Bank

TEST BANK AND SOLUTIONS

1-1: Accounting and Control

The controller of a small private college is complaining about the amount of work she is required to do at the beginning of each month. The president of the university requires the controller to submit a monthly report by the fifth day of the following month. The monthly report contains pages of financial data from operations. The controller was heard saying, “Why does the president need all this information? He probably doesn’t read half of the report. He’s an old English professor and probably doesn’t know the difference between a cost and a revenue.”

Required:

a. What is the probable role of the monthly report?

b. What is the controller’s responsibility with respect to a president who doesn’t know much accounting?

2-1: Fixed, Variable, and Average Costs

Midstate University is trying to decide whether to allow 100 more students into the university. Tuition is $5000 per year. The controller has determined the following schedule of costs to educate students:

Number of Students Total Costs

4000 $30,000,000

4100 30,300,000

4200 30,600,000

4300 30,900,000

The current enrollment is 4200 students. The president of the university has calculated the cost per student in the following manner: $30,600,000/4200 students = $7286 per student. The president was wondering why the university should accept more students if the tuition is only $5000.

Required:

a. What is wrong with the president’s calculation?

b. What are the fixed and variable costs of operating the university?

2-2: The Elements of Cost Volume Profit

The M Company’s variable costs are 75% of the sales price per unit and their fixed costs are $240,000. If the company earned $60,000 in selling 150,000 units, what was the sales price per unit?

2-3: Opportunity Costs

The First Church has been asked to operate a homeless shelter in part of the church. To operate a homeless shelter the church would have to hire a full time employee for $1,200/month to manage the shelter. In addition, the church would have to purchase $400 of supplies/month for the people using the shelter. The space that would be used by the shelter is rented for wedding parties. The church averages about 5 wedding parties a month that pay rent of $200 per party. Utilities are normally $1,000 per month. With the homeless shelter, the utilities will increase to $1,300 per month.

What is the opportunity cost to the church of operating a homeless shelter in the church?

2-4: Fixed and Variable Costs

The university athletic department has been asked to host a professional basketball game at the campus sports center. The athletic director must estimate the opportunity cost of holding the event at the sports center. The only other event scheduled for the sports center that evening is a fencing match that would not have generated any additional costs or revenues. The fencing match can be held at the local high school, but the rental cost of the high school gym would be $200. The athletic director estimates that the professional basketball game will require 20 hours of labor to prepare the building. Clean-up depends on the number of spectators. The athletic director estimates the time of clean-up to be equal to 2 minutes per spectator. The labor would be hired especially for the basketball game and would cost $8 per hour. Utilities will be $500 greater if the basketball game is held at the sports center. All other costs would be covered by the professional basketball team.

Required:

a. What is the variable cost of having one more spectator?

b. What is the opportunity cost of allowing the professional basketball team to use the sports center if 10,000 spectators are expected?

c. What is the opportunity cost of allowing the professional basketball team to use the sports center if 12,000 spectators are expected?

2-5: Opportunity Cost of Attracting Industry

The Itagi Computer Company From Japan is looking to build a factory for making DVD burners in the United States. The company is concerned about the safety and well-being of its employees and wants to locate in a community with good schools. The company also wants the factory to be profitable and is looking for subsidies from potential communities. Encouraging new business to create jobs for citizens is important for communities, especially communities with high unemployment.

Wellville has not been very well since the shoe factory left town. The city officials have been working on a deal with Itagi to get the company to locate in Wellville. Itagi officials have identified a 20 acre undeveloped site. The city has tentatively agreed to buy the site for $50,000 for Itagi and not require any payment of property taxes on the factory by Itagi for the first five years of operation. The property tax deal will save Itagi $3,000,000 in taxes over the five years. This deal was leaked to the local newspaper. The headlines the next day were: “Wellville Gives Away $3,000,000+ to Japanese Company”.

Required:

a. Do the headlines accurately describe the deal with Itagi?

b. What are the relevant costs and benefits to the citizens of Wellville of making this deal?

2-6: Cost, Volume, Profit Analysis

With the possibility of the US Congress relaxing restrictions on cutting old growth, a local lumber company is considering an expansion of its facilities. The company believes it can sell lumber for $0.18/board foot. A board foot is a measure of lumber. The tax rate for the company is 30 percent. The company has the following two opportunities:

• Build Factory A with annual fixed costs of $20 million and variable costs of $0.10/board foot. This factory has an annual capacity of 500 million board feet.

• Build Factory B with annual fixed costs of $10 million and variable costs of $0.12/board foot. This factory has an annual capacity of 300 million board feet.

Required:

a. What is the break-even point in board feet for Factory A?

b. If the company wants to generate an after tax profit of $2 million with Factory B, how many board feet would the company have to process and sell?

c. If demand for lumber is uncertain, which factory is riskier?

d. At what level of board feet would the after-tax profit of the two factories be the same?

2-7: Cost, Volume, Profit Analysis

Leslie Mittelberg is considering the wholesaling of a leather handbag from Kenya. She must travel to Kenya to check on quality and transportation. The trip will cost $3000. The cost of the handbag is $10 and shipping to the United States can occur through the postal system for $2 per handbag or through a freight company which will ship a container that can hold up to a 1000 handbags at a cost of $1000. The freight company will charge $1000 even if less than 1000 handbags are shipped. Leslie will try to sell the handbags to retailers for $20. Assume there are no other costs and benefits.

Required:

a. What is the break-even point if shipping is through the postal system?

b. How many units must be sold if Leslie uses the freight company and she wants to have a profit of $1000?

c. At what output level would the two shipping methods yield the same profit?

d. Suppose a large discount store asks to buy an additional 1000 handbags beyond normal sales. Which shipping method should be used and what is the minimum sales price Leslie should consider in selling those 1000 handbags?

2-8: Multiple Product Cost Volume Profit

A company sells three products as shown below:

Product X Product Y Product Z Total

Units 60,000 140,000 50,000 250,000

Sales $90,000 $150,000 $60,000 $300,000

Variable Costs $63,000 $93,000 $19,000 $175,000

Contribution Margin $125,000

Fixed Costs $100,000

Required:

a. How many units of each product need to be sold to breakeven?

b. How many units must of each product must be sold if the company wants to have a profit of $50,000?

2-9: Make Buy

A company has needs 10,000 units of a component used in producing one of its products. The latest internal accounting reports show that the per unit manufacturing cost to be $150.00. The manufacturing cost per component broken down into type of costs is as follows: Variable manufacturing costs = $110.00 and fixed manufacturing overhead = $40. The company recently received an offer from another manufacturer to produce the component for $144.00. If they buy the component on the outside 40% of the fixed overhead can be avoided.

Required:

a. If the company decides to have the component made by the outside supplier at $144.00, what is the impact on income?

b. What price would make the company indifferent between making the component internally and having the outside supplier make it?

2-10: Cost, Volume, Profit Analysis

Kalifo Company manufactures a line of electric garden tools that are sold in general hardware stores. The company’s controller, Sylvia Harlow, has just received the sales forecast for the coming year for Kalifo’s three products: weeders, hedge clippers, and leaf blowers. Kalifo has experienced considerable variations in sales volumes and variable costs over the past two years, and Harlow believes the forecast should be carefully evaluated from a cost-volume-profit viewpoint. The preliminary budget information for 1996 is presented below.

Weeders

Hedge Clippers Leaf Blowers

Unit sales 50,000 50,000 100,000

Unit selling price $28.00 $36.00 $48.00

Variable manufacturing cost per unit 13.00 12.00 25.00

Variable selling cost per unit 5.00 4.00 6.00

For 1996, Kalifo’s fixed factory overhead is budgeted at $2 million, and the company’s fixed selling and administrative expenses are forecast to be $600,000. Kalifo has a tax rate of 40 percent.

Required:

a. Determine Kalifo Co.’s budgeted net income for 1996.

b. Assuming that the sales mix remains as budgeted, determine how many units of each product Kalifo must sell in order to break even in 1996.

c. Determine the total dollar sales Kalifo must sell in 1996 in order to earn an after-tax net income of $450,000.

d. After preparing the original estimates, Kalifo determines that its variable manufacturing cost of leaf blowers will increase 20 percent and the variable selling cost of hedge clippers can be expected to increase $1 per unit. However, Kalifo has decided not to change the selling price of either product. In addition, Kalifo learns that its leaf blower is perceived as the best value on the market, and it can expect to sell three times as many leaf blowers as any other product. Under these circumstances, determine how many units of each product Kalifo will have to sell to break even in 1996.

e. Explain the limitations of cost-volume-profit analysis that Sylvia Harlow should consider when evaluating Kalifo’s 1996 budget.

Source: CMA adapted.

SOLUTIONS

1-1: Solution to Accounting and Control (15 minutes)

a. There are two possible roles for the monthly report: facilitating planning decisions and control. Monthly reports provide more timely information than annual reports. With monthly reports the president can identify problem areas more quickly and make corrective actions. The president may also use the monthly reports to evaluate the work of his managers. The monthly reports provide information about how managers are performing.

b. If the president of the university is unfamiliar with accounting numbers, the controller must adapt the monthly report to make it more comprehensible. The controller may even want to highlight areas in the report that might need attention.

2-1: Solution to Fixed, Variable, and Average Costs (15 minutes)

a. The president of the university has calculated the average cost of each student. If the decision is to add more students, the president should be looking at the marginal cost of another student. The marginal cost can be approximated by the variable cost as long as the university is below capacity.

b. The cost of adding 100 students is $300,000. Therefore, the variable cost per unit is $300,000/100, or $3,000/student. The total variable cost of 4,000 students is (4,000 students)($3,000/student) or $12,000,000. The remaining cost at 4,000 students is $30,000,000 – $12,000,000 or $18,000,000, which is equal to the fixed costs.

2-2: Solution Cost Volume Profit (5 minutes)

Total Contribution Margin = Total Fixed Cost + Profit

$300,000 = $240,000 + $60,000

$300,000/150,000 units = $2.00 Contribution per unit

If variable costs are 75% of Sales Price, then Contribution Margin is 25%,

So, Sales Price = $8.00 ($2.00/.25)

2-3: Solution to Opportunity Costs (10 minutes)

The monthly opportunity cost of operating a homeless shelter is:

Full-time employee $1,200

Supplies 400

Use of space (forgone revenue: (5 parties)($200/party) 1,000

Increase in utilities $1,300 – $1,000 300

Total $2,900

2-4: Solution to Fixed and Variable Costs (15 minutes)

a. The variable cost of one more spectator is the cost of clean-up:

(2 minutes/60 minutes/hour)($8/hour) = $0.2667

b. The opportunity cost with 10,000 spectators is:

Cost of relocating the fencing match $ 200

Cost of labor for preparation (20 hours)($8/hour) 160

Cost of additional utilities 500

Cost of clean-up (10,000)($0.2667) 2,667

Total $3,527

c. The opportunity cost with 12,000 spectators is:

Cost of relocating the fencing match $ 200

Cost of labor for preparation (20 hours)($8/hour) 160

Cost of additional utilities 500

Cost of clean-up (12,000)($0.2667) 3,200

Total $4,060

2-5: Solution to Opportunity Cost of Attracting Industry (15 minutes)

a. The headlines are not an accurate portrayal of the deal with Itagi. The analysis should consider the alternative of not having Itagi come to town. Compared to the alternative, Wellville is only paying $50,000 to buy the land and losing the property taxes on 20 acres of undeveloped land, which is probably quite small.

b. The opportunity benefits to the town of Wellville include increased jobs and increased property taxes after the first five years. The opportunity costs include increased congestion and the cost of increased city services. The problems associated with becoming a larger community should also be considered.

2-6: Solution to Cost, Volume, Profit Analysis (20 minutes)

a. Break-even point of Factory A = $20,000,000/($0.18 – $0.10) = 250,000,000 board-feet

b. To achieve an after-tax profit of $2,000,000:

[$10,000,000 + ($2,000,000/(1 – .3))]/($0.18 – $0.12) = 14,285,717 board-feet

c. Factory A has higher fixed costs, but lower variable costs per unit because of its larger capacity. If the demand for lumber is lower than expected, Factory A will have a more difficult time recovering its fixed costs. The break-even point for factory B is lower than the break-even point for factory A. Therefore, Factory A is the riskier investment.

d. The after-tax profits of the two factories will be the same when:

(1 – .3)[($0.18 – $0.10)(Quantity) – $20,000,000]

= (1 – .3)[($0.18 – $0.12)(Quantity) – $10,000,000]

Quantity = 500 million board feet

2-7: Solution to Cost, Volume, Profit Analysis (20 minutes)

a. Through the postal system, the variable cost per unit is $10 + $2 or $12. Therefore, the break-even point is:

$3,000/($20 – $12) = 375 handbags

b. The fixed costs through the freight company are $3,000 + $1,000 or $4,000 if fewer than 1,000 bags are purchased. The variable cost is only the $10 purchase cost. To make a profit of $1,000, Leslie must buy and sell:

($4,000 + $1,000)/($20 – $10) = 500 handbags

c. The two methods would yield the same profit for the following quantity of handbags:

($20 – $12)(Quantity) – $3,000 = ($20 – $10)(Quantity) – $4,000

Quantity = 500 handbags

d. The 1,000 handbags will be most cheaply transported by container. Leslie’s trip expenses of $3,000 will occur anyway, so they are not relevant for pricing the special order. The incremental cost of the additional 1,000 handbags is the cost of the container ($1,000) and the purchase cost of the handbags ($10/handbag)(1,000 handbags) or a total of $11,000. If the special order has no other effect on long term sales, then Leslie should accept a sales price above the $11,000 incremental cost.

2-8: Solution to Multiple Product Cost Volume Profit (10 minutes)

a. Weighted Contribution Margin per Unit = $125,000/250,000) = $0.50

$100,000 fixed costs/$0.50 weighted Contribution Margin per unit

= 200,000 units in total to breakeven

X = 60,000/250,000 = 24% of total

.24* 200,000 = 48,000 units

Y = 140,000/250,000 = 56% of total

.56 * 200,000 = 112,000 units

Z = 50,000/250,000 = 20% of total

.20* 200,000 = 40,000 units

b. Weighted Contribution Margin per Unit = $125,000/250,000) = $0.50

($100,000 fixed costs + $50,000 target profit) /$0.50 weighted Contribution Margin per unit

= 300,000 units in total to earn $50,000

X = 60,000/250,000 = 24% of total

.24* 300,000 = 72,000 units

Y = 140,000/250,000 = 56% of total

.56 *300,000 = 168,000 units

Z = 50,000/250,000 = 20% of total

.20* 200,000 = 60,000 units

2-9: Solution to Make-Buy (10 minutes)

a. $18,000 ($18.00 per unit more costly to buy on the outside * 10,000 units)

Make Buy

Variable Manufacturing Costs $110.00 $0.0

Fixed Manufacturing Cost avoided $16.00* $0.0

Purchase Price $0.0 $144.00

Total $126.00 $144.00

*The $16.00 is the opportunity cost. The company losses the opportunity to save on fixed costs if they make internally.

b. $126.00

Make Buy

Variable Manufacturing Costs $110.00 $0.0

Fixed Manufacturing Cost avoided $16.00 $0.0

Purchase Price $0.0 $144.00

Total $126.00 $126.00

2-10: Solution to Cost, Volume, Profit Analysis (CMA adapted) (45 minutes)

a.

Kalifo Company

Budgeted Net Income for 1996

Hedge Leaf

Weeders Clippers Blowers Total

Unit selling price $ 28.00 $ 36.00 $ 48.00

Variable manufacturing

cost $ 13.00 $ 12.00 $ 25.00

Variable selling cost 5.00 4.00 6.00

Total variable costs $ 18.00 $ 16.00 $ 31.00

Contribution margin $ 10.00 $ 20.00 $ 17.00

Unit sales 50,000 50,000 100,000

Total Contribution $500,000 $1,000,000 $1,700,000 $3,200,000

Fixed factory overhead 2,000,000

Fixed selling and

administrative expense 600,000

Total fixed costs 2,600,000

Income before taxes 600,000

Income taxes @ 40% 240,000

Budgeted net income $ 360,000

b.

Unit Sales Proportional

Contribution Proportion Contribution

Weeders $10.00 .25 $ 2.50

Hedge Clippers 20.00 .25 5.00

Leaf Blowers 17.00 .50 8.50

Proportional contribution margin/bundle $16.00

Total unit sales to breakeven = Total fixed costsProportional contribution

=

= 162,500 units

Sales Total Product

Proportion Unit Sales Line Sales

Weeders .25 162,500 40,625

Hedge Clippers .25 162,500 40,625

Leaf Blowers .50 162,500 81,250

c.

Selling Sales Proportional

Price Proportion Selling Price

Weeders $28.00 .25 $ 7.00

Hedge Clippers 36.00 .25 9.00

Leaf Blowers 48.00 .50 24.00

Proportional selling price $40.00

Contribution margin rate = Proportional contributionProportional selling price

= $16$40

= 40 percent

Total dollar sales =

=

=

= $8,375,000

d.

Unit Sales Proportional

Contribution Proportion Contribution

Weeders $10.00 .20 $ 2.00

Hedge Clippers1 19.00 .20 3.80

Leaf Blowers2 12.00 .60 7.20

Total proportional contribution

margin $13.00

Total unit sales to breakeven = Total fixed costsTotal proportional contribution

=

= 200,000 units

Sales Total Product

Proportion Unit Sales Line Sales

Weeders .20 200,000 40,000

Hedge Clippers .20 200,000 40,000

Leaf Blowers .60 200,000 120,000

1 Variable selling costs increase; thus the unit contribution decreases to $19 [$36 – ($12 + 4 + 1)].

2 The variable manufacturing cost increase 20 percent; thus, the unit contribution decreases to $12 [$48 – (1.2 × 25) – 6].

e. Sylvia Harlow should consider the following limitations when using cost-volume-profit analysis to evaluate Kalifo Company’s 1996 budget. This type of analysis assumes that:

• all costs are either fixed or variable or can be broken down into fixed and variable components.

• all costs are linear in the relevant range, i.e., variable costs change in total with a change in activity and fixed costs remain the same at all levels of output and sales in the relevant range.

• sales prices will not change and sales demand is unlimited at the unit selling prices.

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