Cost Accounting - Planning and Control - 6th Edition - MATZ - USRY
Cost Accounting - Planning and Control - 6th Edition - MATZ - USRY
Cost Accounting - Planning and Control - 6th Edition - MATZ - USRY
ACCOUNT
planning and control
It should
wUn
care unu
i'ehpet.^
and professional
library. It will
number
COST
ACCOUNTING
planning and control
Sixth
Edition
MILTON
F.
Oklahoma
State University
Published by
A85
PELHAM MANOR,
N.Y.
Copyright
1976
The
be reproduced or transmitted
ISBN: 0-538-01850-X
Library of Congress Catalog Card Number: 74-84264
12345678K32 109876
Printed in the United States of America
PREFACE
iV
Parts
whole by
and
II
first
management's
tasl<s
for
is
businesses and nonprofit organizations. Part IV considers the other two cost
elements, materials and labor, each from both the planning and cost control
budgeting. Long- and
phases. Part V is the heart of the planning function
short-range budgets as well as the flexible budget are discussed. Part VI treats
not only standard costs basic to the control of costs and profits but also gross
profit analysis and direct costing with its contribution margin. The final section, Part VII, covers the entire spectrum of cost and profit analysis, culminating in a chapter on linear programming for planning and decision making.
The concepts and techniques presented in this textbook are mainly in the
context of manufacturing business organizations. However, it is important to
note their wide, virtually universal applicability to many dimensions of organizations including: (1) small business organizations of all types; (2) nonmanufacturing businesses such as wholesale and retail stores and such service
organizations as banks, insurance companies, hotels, and motels; and (3) nonprofit institutions such as churches, fraternal and charitable organizations,
hospitals, libraries, public school systems, colleges and universities, and last,
but not least, local, county, state, and federal governmental units and agencies. Indeed, any organization charged with the responsibility of efficient use
of resources could
and should
utilize
niques.
Like many other disciplines, cost accounting has in recent years been influenced by significant advances made in the development of quantitative
modernized
management techniques and decision models. Topics retained
where appropriate
from earlier editions include such mature techniques as
economic buying quantity, the method of least squares for regression analysis,
differential cost analysis, the discounted cash flow method, as well as the ap-
plication of the
modern techniques
of
Reform Act of 1974, productivity and performance standards, zero-base budgeting, probabilistic budgets, modern marketing concepts and terminology, new transfer pricing theory, and shadow prices.
These mathematical and decision-making models together with a comtheory, the Pension
theoretical
and
PREFACE
practical aspects of cost accounting
Chapter 27
Profit
Planning
progressive levels
in
dent-learning benefit.
Three separately printed practice cases are available: a job order cost case,
a process cost case, and a standard cost analysis case. Each case acquaints
students with basic procedural characteristics without involving them In time-
consuming
details.
manual
that has been carefully prepared to Improve the effective use of the textbook,
to reduce the time the Instructor must spend in checking problems, and to
help the instructor plan his class periods more efficiently. The major portion of
manual Is devoted to detailed solutions of the end-of-chapter materials.
Wherever computations, supporting entries, schedules, or analyses are of a
detailed or involved nature, the computations are given In full. Instructors are
this
(AAA), the Financial Executive Institute (FEI), the Canadian Institute of Charnumerous other publication sources. Materials
PREFACE
Vi
who
to
dents of the Wharton School of the University of Pennsylvania and of Oklahoma State University who class-tested the new exercises, problems, and cases
and made suggestions for improvements. The cooperation and valuable assistance of Professors John H. McMichael of the University of Pennsylvania, G. M.
F. di Roccaferrera of Syracuse University, and Edward B. Deakin of The University of Texas at Austin are greatly appreciated.
Finally, we wish to express our heartfelt appreciation to our wives Trean
Benfer Matz and Dona White Usry for their patience, understanding, and assistance in typing, editing, and proofreading the many pages for this Edition.
ADOLPH MATZ
MILTON
F.
USRY
CONTENTS
PART
COST ACCOUNTING
Chapter
The Nature
Organizing, 6
Scope
The Organization
Accounting
Framework
for
Planning
Activities, 8
Participation in Planning
The Controller's
of Cost Accounting,
10
Cost Accounting, 11
Governmental and
Chart, 6
The
of
fluencing
Private
Organizations
Cost Accounting
Principles
In-
and
Practices, 12
and
Control, 9
Chapter 2
of Cost
er,
22
partments, 16
Sources
Accounting Data, 17
Information System, 18
in
Annual Reports, 19
24
Accounting
Fulfilling
Management's
Needs for Planning and Control Information,
Cost
26
Planning and Control Models, 26
Cost-and-Profit Analysis, 28
Chapter 3
of
Cost Data, 43
45
Classifications of Costs,
46
VII
CONTENTS
VII
PART
II
Chapter 4
By
Processing
Means
Journal
the
of
71
Chapter 5
Chapter 6
Process Costing
and
Characteristics
Procedures
Process
of
Costing, 120
The Cost
of
Chapter 7
Increase
rials,
Unit Cost
Due
to Addition of Mate-
147
Increase
in
Change in
Materials, 148
Units and
Unit Cost
Due
Difficulties
in
Products, 181
Joint Costs and Separable Costs,
182
of
dustry,
Allocation
in
the
Petroleum
In-
195
Chapter 9
in
Joint
III
Chapter 8
PART
in
Encountered
Difficulties
to Addition of
Methods
Opening Work
188
197
188
Variance Analysis
Predetermined, 212
224
OverOverhead
Factory Overhead
Factory Overhead
Factory
Applied,
or
228
233
Actual,
Un-
Graphic
235
Presentation
of
Factory
Overhead,
CONTENTS
IX
Chapter 10
248
of Departmentalization,
Departmental Overhead in
and Service Departments, 251
Producing
of Departmental Factory
Overhead Rates,
Spending and
Idle
268
255
Overhead
Departmental
Establishing
Use
267
Departmentalized,
263
254
Overhead Distribution,
250
Direct
for
262
249
Method
Algebraic
Rates,
Overhead Departmentalization
in
Nonmanufac-
256
Illustration for Establishing
Departmental Over-
stitutions
Chapter 11
Responsibility Accounting
Accounting, 289
ed,
Responsibility Reporting,
Fundamentals
299
Responsibility-Reporting Systems
Illustrat-
301
Responsibility-Performance
of
Reports, 300
PART
IV
Chapter 12
Procedures
for
Materials
Procurement
and
Use, 318
Cost
Summary
333
Period,
Chapter 13
End
Management, 352
340
Carrying
and
Ordering
Chapter 14
of Materials
of a
Costs
Calculations,
367
Measurement and
Incentive
Wage
Plans,
Labor Cost
Wage
404
414
CONTENTS
Accounting for Labor-Related Costs
Chapter 15
436
Overtime Earnings,
Costs,
Wage
Plans,
439
Human Resource
PART V
447
Summary
of Labor-Related Costs,
453
Accounting, 440
Chapter 16
Profit Planning,
471
476
Chapter 17
477
Human
Behavior
499
Systems
for Planning
Probabilistic Budgets,
516
Human
Behavior, 516
508
Businesses
and
Nonprofit
Organizations,
509
Chapter 18
The
Correlation Analysis
The
537
Flexible Budget,
Capacity and
Volume
(Activity),
539
Flexible
Budget
of a Service
Flexible
Flexible Marketing
Expense, 546
561
Data
Department, 560
CONTENTS
PART
XI
VI
Chapter 19
Comparison
of
Standards
Purposes
of
Setting Standards,
580
601
Chapter 20
Standard
Accounting
Cost
Procedures
for
Labor, 624
Cost
Standard
626
624
Broad Applicability
Accounting
Procedures
of
for
Chapter 21
Causes
Gross
Gross
of
Changes, 659
Profit
Profit Analysis,
Uses
Chapter 22
The Nature
of Absorption Costing,
Uses
External
Uses
PART
Chapter 23
of
of Direct Costing,
Profit Analysis,
667
of
Costing, 687
Adjustment
nal Reporting,
681
691
685
Profitability Analysis
Gross
VII
Scope
of Direct Costing,
of
Comparison
678
680
Direct Costing, 681
Internal
Analysis,
Facets of
Volume
667
600
Marketing
Profitability Analysis,
713
Problem
in
Profitability Analysis,
Marketing
723
Cost
and
CONTENTS
xii
Chapter 24
Sources
of
755
Dynamic
An
Effect
of
Changes
The
747
Costs
Fixed
in
on
Point,
Changes
750
in
Profit
Chapter 25
Differential
Graphic
Presentation
the
Cost-VolumeProducts,
Use
of Probability Estimates,
764
Programming
804
Long-Run
Implications
of
Differential
Cost
805
sions,
806
806
Differential
Differential
Chapter 26
of
The
Differential
Analysis,
763
753
802
dies,
Rela-
758
Linear
Graph, 757
Graph, 751
The Unit
Profit Charting,
Facil-
808
ities,
805
Chapter 27
Profit
Methods
Product Pricing Methods, 889
Chapter 28
A
Linear
A
Technique, 911
Simplex Method A
Graphic
Method
Technique, 914
Linear
Programming
Shadow
Linear
Programming
Linear
Prices,
928
929
Programming Techniques
Observations, 932
General
CHAPTER
CONCEPT OF MANAGEMENT
AND FUNCTION OF
THE CONTROLLER
enterprise
is
f^cturing, finance^3Jii-aCQiuiling.
suggests
thaTmanagement
The
whose
activities
an
under the~term" conirolT^ Tlanning referrioTiF^construcnonof
operaof
phases
all
cover
to
enough
operating program, comprehensive
be given to the
tions and detailed enough so that specific attention may
p-
SanrnnglTana^Temains
basically
The
even though participation at all management levels is needed.
management team.
trol phase reaches through all the levels of the
con-
Management needs
as analytical cost
and
PARTI
profit data to
manage an
enterprise.
This informa-
needed to assist in: (1) setting the company's profit goal by execumanagement, (2) establishing departmental targets which direct
middle and operating management toward the achievement of the final
goal, (3) measuring and controlling departmental and functional activities
with the aid of budgets and standards, and (4) analyzing and deciding on
adjustments and improvements to keep the entire organization moving
forward in balance toward established profit and other company objectives.
tion
is
tive
A comprehensive explanation of the concept "management" poses innumerable difficulties. Invariably it leads to descriptive phrases such as
"making
which
it
tries to
In this sense,
and processes. To be
its
of
it
Management
eff'orts
work and
sets certain
of the people
it
successful,
management
experience
objectives.
sensitizing
The budget
QrLe_Jdnd_^fjilanj_jiQon^^
is
not
only the most important plan of an enterprise, but also the basic link of
cost accounting with
management.
The
phase of
m anagement,
has_heen termed
CH.
units of input
effectively,
an
inte-
No
single function
all
S
(^
estahli sh-
,jneDl.gfcompany objectiv es. An objective is a target, an end result. Corporate planning includes such areas of investigation as the nature of the
company's business, its objectives and major poUcies, the timing of major
steps in the plan, and other factors related to long-range plans.
When
many
businessmen reply, "To realize a profit." However, in the last few years,
some businessmen have tended more frequently to soft-pedal profit
maximization and to emphasize the modern corporation's growing fist
of social obligations.
firm
making inadequate
profits will
not only not survive but will perhaps become a social or economic disaster
to the very society it is expected to support. Social rejpptr^ihiU tv is a fai rweather concept; manage ment cannot begin \n t^ink ^" ter ms of philan -
company and
its
company
will
be able to
make
formance
'See
criteria
"The Executive As
economic,
Organizational objec!ives~and]per-
sophisticated.
No.
3,
pp. 62-68.
PART
managemen t
to co mpare
prime importance
in the
is
required to keep
it
Conwithin
The
all
and if
Diagram-
manner
illustrated
Setting
Objectives
and Making
Policy
Decisions
BOARD OF DIRECTORS
PRESIDENT
MARKETING
or
or
EXECUTIVE COMMITTEE
MANAGER
Leading to
New
MFG.
ENG.
FIN.
Issues:
Reports
Decisions
in
'
or Tactical
"
Modifications
--
Graphs
and/or
Charts
Mo^M^ijiS
i-
Control Circuit
)o-^^^o^
U^ro\
-^
S^ck
Management
Levels.
CH.
management
or,
company. Because the president cannot attend to every aspect of the control program, he must delegate authority and assign responsibilities to the middle and operating
echelons of management. The delegation of authority and the assignment of responsibility are fundamental requirements if management's
plans are to succeed and control is to be exercised.
in the final analysis, with the president of the
Authority
is
sibiHtyT ItTs
Delegation of authority
tional structure.
By means of
area of operations.
is
However, he
will
an organiza-
mean
a permanent
from obligations.
obhgatio n.
It arises
is _responsibili tv.
ThQ__e^erie_Qfj;espon-
relationship due to the fact that the superior has the authority to require
specified
work or
from another person. A s this other person ac perform the work, he creates his own responsibility.
services
cepts the_obligation to
ndividu al.
Responsibility
is
is
In addition to
accountabihty
an important function of budgetary control and standard cost accountIt makes possible the comparison of actual performance with predetermined plans and the measurement
in terms of quantity, quality,
time, or cost
of the extent to which objectives were reached.
is
ing.
Accountability
and the
is
basically
.ability.
at all.
PART
ORGANIZING
\s essentially the^est ablishm ent of ^heframework within
required
a_cjivities areJo_be_p erformed^ nda designation of who
wliich
st^ould^^O-them. Without proper organization a person cannot fuliction
.Organizing
as a manager.
of
various interdependent parts and units into one whole. Considered in this
sense, organizing requires: (1) bringing the many functional units of an
enterprise into a well-conceived structure
responsibility to certain individuals.
and
These organizational
work together
for the
many
persons in-
to arrive at
and
efforts include
known
fundamentaT'actTvrties
work.
After organizational units have been created, management must assign
the work to be done within each unit. Appropriate division and distribution of
work among
vital to the
the employees
combined
Of still
greater importance
authority, responsibility,
plans,
sibilities,
management position
The
and accountability.
management evaluate
the effectiveness of
must pinpoint successes or failures in terms of specific responand must establish the conditions that will lead to corrective
action.
An
and
organization chart
cost reports
which
is
essential to the
CH.
STOCKHOLDERS
BOARD OF DIRECTORS
WORKS MANAGER
PRODUCTION
PLANNING
VICE-PRESIDENT
RESEARCH AND
DEVELOPMENT
VICE-PRESIDENT
MANUFACTURING
VICE-PRESIDENT
MARKETING
DIRECTOR
WORKS MANAGER
INDUSTRIAL RELATIONS
PLANT ENGINEERING
-i
OPERATING
STANDARDS
GENERAL
ACCOUNTING
EMPLOYMENT
V-
COST
ACCOUNTING
INTERNAL
AUDITING
SERVICE
DEPARTMENTS
NTS
OPERATIONAL DEPARTMENTS
GENERAL
OFFICE
iiiii
MANAGEMENT
MAINTENANCE
Organization Chart
Based on Line-Staff Concept
development of a
implementing management plans. The coordinated
system will lead to an
company's organization with the cost and budgetary
"responsibility accounting."
approach to accounting and reporting called
(See Chapter 11.)
form illustrated at
Generally, an organization chart is shown m the
chart is based on the hnethe top of this page. This type of organization
company's
concept that is particularly useful when a
stafif
concept, a
decisions
iunstional-teamwork
concept of management, appears on page 8. The
balance onjh^iruly
concept2 is structured to place proper emphasis_and
can be
businesnuncHShs
These
enterprise.
im5orti:ntTunction's'^of any
The
ns.
p
ht
io
mt
rre
a
hum
and
n
grouped around resqurces^_jroc esses,
of
husbanding
and
the acquisition, disposal,
resources function involves
a wide variety of resources
ical.
tangible
and
intangible,
human and
phys-
5,
pp. 67-79.
PART
STOCKHOLDERS
BOARD OF DIRECTORS
DIRECTOR OF
SECRETARY AND
DIRECTOR OF
LEGAL SERVICES
CORPORATE PLj^NNING
& CONTROL
CHIEF EXECUTIVE
DIRECTOR OF
RESOURCES
MANAGER OF
MANAGER
POLICY
DIRECTIVES
DATA PROCESSING
CENTER
DIRECTOR OF
DIRECTOR OF
PROCESS
ACTIVITIES
HUMAN
INTERRELATIONS
ASSISTANT
DIRECTOR OF:
ASSISTANT
DIRECTOR OF:
- MANPOWER
- FINANCE
ASSETS
-INTANGIBLE ASSETS
MARKETING
ASSISTANT
DIRECTOR
OF:
- PHYSICAL
ASSISTANT
DIRECTOR
OF PLANNING
ASSISTANT
DIRECTOR OF
MANAGERIAL
CONTROL
Organization Chart
Based on Functional-Teamwork Concept
and bilHng. The human interrelations function directs the company's effort toward the behavior of people inside and outside the
company.
keting,
company
effective use
of
is
capital
invested in the
.-
CH.
The effectiveness of the control of costs depends upon proper communication through control and action reports from the accounting funcmanagement. Accounting and cost control
reports are directed to three levels of management: executive, middle,
and operating. Each managerial level requires data for deciding and solving varied and difficult problems, and data assembled for one purpose
may not be usable for another purpose. For example, figures collected
and assembled for measuring and reporting to operating management the
past use of materials, labor, machines, and money are often irrelevant
for future price and output decisions made by executive management.
Inasmuch as classifying and reporting data are essential to the proper
discharge of the accounting function, the controller must devise an information system into which past, present, and future data are marshalled
to fit the multitude of problems confronting company management. The
accountant's means of classifying costs and expenses, called the chart of
accounts (Chapter 4), must be closely associated with management's own
fundamental classification, the organization chart, .^oa^ P
4 ^ " ^ 7
tion to the various levels of
>
IN
The controller, a member of the management team, assists management in both planning and control. In planning he assembles, classifies,
and presents the economic and financial data concerning men, money,
materials, machines, and methods into a coordinated plan or plans for
management's considerations and decisions. The data are based on (1)
the company's own historical, experienced, or past costs and revenues
modified by management's own evaluation of the future and (2) other
economic forecast information originating outside the company. To co ordinate the interna4-^nd--eJrteHmlJjifc)rmation_ and to chartJbf-^Banage
ment a course of expected trendjeyelsconstitutes the con troller'sjrigst
formidable contributio n to plann ing.
In recent years the controller and his staff have
centers of
many
large corporations.
permit them to extract diverse data from computer storage and to suggest
to executive
management
alternative plans
in certain
is
of management where
andjwhgQobs
"'i*-
10
PART
CH.
11
Cost control,
to be effective, depends upon proper cost planning for each activity,
function, and condition. Via the cost accounting media, management is
informed frequently of those operating functions that fail to contribute
their share to the total profit or that perform inefficiently, thereby leading
to profit erosion.
end of the
fiscal
period,
cost accounting deals with past costs for the purpose of profit determination
At
accounting procedure
is
and transferred
to cost of
goods sold as
More
specifically, cost
accounting
is
1.
'
2.
that
involve
choice
alternative
courses
((lecisimLinaking).
3.
if possible,
is
generally
considered
This
is
size, in
on
many
made
activities.
and techniques
fields
its
In other cases
to their
of endeavor.
it is
own
special
non-
12
PART
in the cost accoun ting pracfollowed by contractors in the pricing, administration, and settlement of covered negotiated federal government contracts in excess of
tices
first
The
CASB
Originally, these
from
alternative principles
and practices
in estimating, accumulating,
and
and techniques.
in the
to determine federal
CH.
13
Likewise, any
is
and
profit planning.
DISCUSSION QUESTIONS
1.
(b)
panies.
2.
(a)
Why?
What
(a)
What
company?
meant by
is
(b) Is "responsibility
"responsibility accounting"?
accounting" identical with the concept of "account-
ability"?
4.
5.
What does
6.
7.
8.
reassignment of responsibility
mean?
In what manner does the controller exercise control over the activities of
other members of management?
latest
social responsibilities of
developments in the
field
of
aware.
9.
personnel.
State
Why?
its
10.
11.
When
an organization or business outgrows direct supervision and management by its owner, authority must be delegated to subordinate managers,
and some form of accountability on their part must be provided. Discuss.
12.
The
cited as the
most
14
13.
PART
As a member of
(b)
An
An
organization chart.
opinion regarding certain duties that apparently have not been suf-
ficiently delegated.
more
satis-
indi-
14.
(b)
What
different if he
up ?
15.
interested in an improved organization, created a Control Division with a controller as its chief executive.
As one of his first steps the controller prepared the organization chart shown
below and invited staff" members to comment on the chart with respect to
(a) organization; (b) possible
improvements;
(c)
new
chart.
CONTROLLER
SECRETARY
TO CONTROLLER
ACCOUNTS PAYABLE
BOOKKEEPER
PRODUCTION
RECORDS AND
MATERIALS
CONTROL
ACCOUNTING
16.
Name
FIXED
CREDITS AND
OFFICE
ASSETS
ACCOUNTING
COLLECTIONS
SERVICES
SUPERVISOR
HEAD OF
STENOGRAPHIC
DEPARTMENT
cost accounting
17.
BOOKKEEPER
Explain the
activities
CHAPTER 2
the duties
and
responsibilities
activities.
parties concerned.
is
picture^^ as ajQart^nf
come
statement.
Any company,
and the
in-
department, will and must prepare these two financial statements at the
end of the
fiscal year.
possible the
planned
vs.
actual
Such
to be of
company's
profit goal.
is
nonm anufjactuiing
activities.
To
15
16
PARTI
management
in
It
must, in addition,
and other decision-making data to executives, superintendents, department heads, and foremen which assist in
The need for the
controlling and in improving costs and operations.
prompt issuance of reports and statements must alert the accountant to
modern developments and techniques in the field of communications.
Information transmittal problems have too often been overlooked or
neglected. Cost control needs or profit opportunities have been delayed
or missed because of poor communications. The analysis of costs and the
issue significant control reports
past, present,
come
and
future.
is
working
When
is
is
concerned with
the future.
TO OTHER DEPARTMENTS
tendents and engineers, design, plan, and control products to their finished
stage.
In research and design, cost estimates are needed for each type of
in-
can be reached in accepting or rejecting a design. Likewise, the scheduling, producing, and inspecting of jobs and products by
the manufacturing departments are measured for efficiency in terms of
telligent decision
interviews, screens,
It
and
selects
employees
and
satisfied
U^
CH. 2
The
tion, relies
financial
17
administra-
its
at a competitive
The
taining
good
relations
and employees.
in general,
Points of friction
are most hkelv to _be pric es, wages, pro fits^^aiid^viden ds.
department
is
often called
on
The
affairs
The
and
practices.
of the
company
cost
many
accounting function.
statistics
18
PARTI
INFORMATION SYSTEM
With the aid of the supervisors
in
ia.
order that he
system.
To
It is_aJsoJiis-j:es;2onsibility
m n i=f4-t4M:a^ghoiit
t
in the
the,
in the use of
enterprise
planning and^control
immeaDepending
is
Executive management
decisions, middle
is
management with
of achievements.
The middle
and reports
manageraeiiL-_engaged,ia-lactiGa4-plauniiig
requires data
on internal events
relating to
Vr\c^yrsCA^---^Si^
vA^oua^
kjs^Lqj-^^ vo-^ucAtarVj
nruAtAlsL.
rvW)^
and
Iojl yvvsT'
S\xr(\TC\^'^^S
results of
CH. 2
19
external users receive their information in the annual report, which in-
cludes the balance sheet, the income statement, and the statement of
amount of
detail, for
management and
all
it
is
many
impossible to include
needs.
The
all
the data
many
total
FINANCIAL STATEMENTS
The reporting function
is
IN
ANNUAL REPORTS
here with two historicaland the income statement
initially illustrated
Not
illustrated here
is
is
the statement of
is
The
of^ osf^f
ana~administraliYe_xpenses.
made
available to executive
management, not
to external users.
They are
March
Principles Board,
1971, p. 372.
AFB
in Financial
.-^
^0 >V^
Ansi^
cv-
-v^
'^
'\->
PART
!>
INC.
Income Statement
"t-Q
\iSy^>cS
NoXw':
ar\aKw^^
31,
19
Vo
mar*
T'.
-:^
.iv^->
Gross
on
profit
1)
sales
$580,000
533,750
3)
$24,750,000
100.0
21,285,000
86.0
$ 3,465,000
14.0
1,113,750
4.5
$ 2,351,250
9.5
49,500
0.2
$ 2,400,750
1,064,250
9.7
4.3
$ 1,336,500
5.4
Interest
$167,000
12,000
assets
$179,000
129,500
Net addition
Net income before estimated income tax
Less estimated income tax
Net income
after estimated
income tax
The cost of goods sold section of the income statement of The Seabright
Manufacturing Company or of any other manufacturing business can be
divided into five distinct parts
Q any
Q
manner
V\S
wo 61
_,-,.,
n^ ^^
overheadXr
ZS^
CH. 2
-~-3A^
INC.
December
SI, 572,400
S8,420,000
42,000
31, 19
8,378,000
$9,950,400
1,270,600
S 8,679,800
7,346,400
Direct labor
I
Factory overhead:
I
51,329,300
972,000
489,000
112,000
69,200
44,300
50,000
68,300
403,000
145,800
33,200
178,600
21,200
Indirect labor
Salaries
Payroll taxes
Power
Heat
Light
Factory supplies
factory building
Depreciation
Depreciation
machinery
Repairs and maintenance
Patent amortization
Tools and dies used
Insurance on building and machinery
3,915,900
Add work
in
$19,942,100
<ti>.J
1,
19
2,338,000
$22,280,100
1,303,200
finished
$20,976,900
(4,430,000 units)
1,
19
210,000 units)
966,100
40,000 units)
$21,943,000
658,000
(4,500,000 units)
$21,285,000
^?
IS
so
>V
Vjvj.iu^
,-jAi
-fWX
tion^^Tn
^-\2^
"^
manner:
,
urS^ J^<jv-V
br
a-
osji
^_^r.^\^^ ^
S^
UV^ W^
i^
-^
Wiv^JJ2^fi^
Work
D and
in
.j
if.
(3-
. (4
^''
>
<
v>^
<,^J3i -
dX>
W^U
r-HW
^^^
clJU
,,-
-tt/^T^
\
fi^
''
f^^
^..
-<-C
a^uJct^T
hJ> f^n ^
ojh.
^^),
tU^I^^
$3,915,900 '^^'^
rvc^+o
iov^-V --H^ o,^
^Vpii^
Finished goods inventories, beginning and ending.
uj'^V
u..rt cv. vuTT^vv.
tcO^V rvu.5f -y^ 1^ u><t ^i^
.^
71,1(X) \ v^
k
S\^\^ 7^^
'V-,
costs
JrxjOi^vd-
$3,987,000
^^t
Lu
-H
Ii
l<5<'^-
A^
t>?^+
^^
Vv^VA*-^
PARTI
iaa.
INC.
Schedule 2
Marketing Expenses
For Year Ended December 31,
Sales salaries
19
and commissions
$330,500
43,000
Travel expenses
Payroll taxes
Advertising
Telephone and telegraph
Entertainment
Donations and dues
Depreciation
furniture and fixtures.
Stationery and office supplies
Postage
16,850
125,000
11,800
21,000
4,000
7,500
13,500
6,850
Total
$580,000
INC.
Administrative Expenses
31,
19
and executives
general
employees
officers
office
Travel expenses
Payroll taxes
Depreciation
furniture and fixtures
Stationery and office supplies
Telephone and telegraph
Postage
Subscriptions, dues, and association activities
Legal and accounting fees
2-3
\YVi
J
Donations
..
{si ^\A-^>^
v^if
xS-^^<\^} ^p^J<
iuxX
T^^
v^vyx
t)U oYc
^^^^^ ,V^^1
The vario usjcosts incurr ed are g rouped according to the function serv ed
by_theiiijricun;ence^manu!ac^
The
operating.
statement
is
mar keting,
administrative,
and n onincome
earning process
is
'^^^vrx
'^
W\
C\c}
COST REPORTS; ANALYSIS FOR PLANNING AND CONTROL
CH. 2
23
INC.
Balance Sheet
December
31, 19
Assets
Current assets:
S 2,320,000
Cash
Marketable securities
Accounts receivable (net)
820,000
^2,661,000
v,;j^231l,806.
220,000
$ 9,252,800
Land
289,000
S 3,406,100
Buildings
12,529,000
515,935,100
Less accumulated depreciation
8,118,(X)0
7,817,100
8,106,100
SI 7,358,900
Total assets
Liabilities
Current
liabilities:
Accounts payable
Accrued payroll, taxes, interest,
Estimated income taxes
Due on long-term debt
Total current
1 90,700
200,000
$ 2,426,500
liabilities
2,677,500
Long-term debt
Total
990,800
1,045,000
etc
$ 5,104,000
liabilities
Stockholders' Equity
Common
$ 4,258,000
7,996,900
stock
Retained earnings
12,254,900
1.
2.
3.
4.
5.
On
liabilities
$17,358,900
"'V^
these ratios
would be computed
as
shown on page
24.
24
1.
r-,.r^^^f
Current
Dofi^
Ratio =
Current Assets
7^
Current
^.,.
Liabilities
$9,252,800
^^' ^,' ^^
$2,426,500
PART
, ,
3. 81,
==='
2.
^^
^ ^<IV"^^^^v>^
^^
$5,801,000
^ ,
A -J -r * D *
= 2J9,
Acid-Test
Ratio =
^^^^^^
3.
VS^S
ft^ftAs^-.
(a)
is
(b)
in current
Net Income
(after estimated
income
tax)
9.7%, -^^ P
LP
554^750^)tax)
5.4%,
( $24 750000 )-
^^
M.^V^
4.
TW^
,\
= 14%
)r\Xx<.(Ais
^/L"^/
'1
/
fi?r
ro iyuid%^
Chapter
5.
21.
(after estimated
income
Ca^ital_Emploiieditotal_assets)
tax)
_
~
$1,336,500
$17,358,900
_
~
^^
^-^
This ratio reveals the percentage earned on the assets employed in the
business. It should not be confused with the net income to sales ratio of
No. 3 above. The numerator may be more generally described as "profit."
The rate of return on capital employed is presented in detail in Chapter 27.
CH. 2
COST OF
MATERIALS
held
25
in
PURCHASED
requisitioned to
WORK
pay for
IN
PROCESS
Direct Materials
or allocate
Direct Labor
OTHER MANUFACTURING
COSTS:
Direct Labor
Factory Overhead:
Indirect
Labor
COST OF
Indirect Materials
Heat
GOODS COMPLETED
Light
Power
Insurance
Depreciation
move
to
As
first
asset,
the next.
Cost accounting does not discard the principles and procedures studied
Cost accounting consists of a system which is
concerned with a more adequate, detailed, and precise recording and
in financial accounting.
26
productive processes.
its
PARTI
purposes the
determination of a unit cost figure to be utilized in assigning costs to inventories included in the balance sheet and in the income statement.
illustrative
4,500,000 units were sold and that 4,430,000 units were manufactured,
_
~
_
~
140,000
_
~
$21,285,000
_
~"
520,976,900
_
~
$966,100
_
~
$658,000
Units Manufactured
Goods Inventory
4,430,000
210,000
4,500,000
all
COST ACCOUNTING
FULFILLING
its
(i.e.,
for planning
and control.
MANAGEMENT'S
progress of the enterprise, cost accounting must concern itself with the
details of the progress
units
and
centers.
of view with
its
The
efforts
and
effect
of the enter-
related categories
and
evaluate the past, are also useful in planning the future of the enterprise.
CH. 2
27
As explained
directions,
alternatives.
setting long-
who
are
made
is
also the-undaiiiiital
managements control.
is
1 1
is
This
it
at
in
costs
efficiencies.
financial statements
dard costs bring to management not only the information regarding the
profits already made, but also information as to what happened to the
profits that
made an
its
Break-Even Analysis
assist
management
levels in
Check on Planning.
information via analytical tools that express more vividly and forcefully
The return-on-
management
and convenient
basis.
To
on a very pragmatic
it is first
necessary
the present
it
JuTidamentally_considered variable_jcosts.
aad
For
28
variable costs.
mathematical and
PARTI
statistical
in Dollars
'
r-r-,
Variable Costs
Sales
in
Variable costs
$19,898,750
2,500,000
24,750,000
Fixed costs
Sales dollar
volume
The break-even
by this method
sales dollar
to break even;
sales dollar
i.e.,
checked by making
to
make
this
52,500,000
.804
volume
^,, .^y
'
indicates the
statement
$12,755,102
10,255,102
$ 2,500,000
Profit or (loss)
The answers
level
to
2,500,000
management the
it is profitable to operate. The above illustraabove $12,755,102 sales is needed if the company
of operations at which
j. .
'
.196
Volume
524,750,000 Sales
The break-even
52,500,000
make
a profit.
-:-
COST-AND-PROFIT ANALYSIS
Break-even techniques provide but one example of the ever-widening
apphcation of cost-and-profit analysis and an understanding of the behavior of costs in the use of making rational decisions. Decisions involving cost-profit-price-volume
levels
offer
still
another example of
CH.
meaningful analysis.
factors
The
multiplicity of causes
and
29
of these four
effects
is
collect
These mechanical inmodels to project future materials requirements based on orderly planning and control procedures, the use of
time-adjusted cash flow projections for capital expenditures, and the
technique of linear programming for profit maximization or cost minimixation are examples of an ever-growing number of decision-aiding models
that have become part and parcel of the information system available to
management for the execution of its planning and control responsibilities.
variety of sources for a variety of end-products.
DISCUSSION QUESTIONS
1.
2.
3.
What
4.
The
5.
6.
distinct parts.
income statement
is
Enumerate.
some
annual
company's
results.
7.
8.
An
in dollars.
(AICPA
9.
adapted)
work in process inventory has increased during the period, (a) cost
of goods sold will be greater than cost of goods manufactured; (b) cost of
goods manufactured will be greater than cost of goods sold (c) manufacturing costs for the period will be greater than cost of goods manufactured;
or (d) manufacturing costs for the period will be less than cost of goods
manufactured. Which of the above is correct?
(AICPA adapted)
If the
10.
The gross
(AICPA
adapted)
30
11,
PART!
because
(AICPA
12.
adapted)
The president of the New Haven Products Co., Inc. requests your advice
with respect to the following situation
The company's chief accountant has been telling the president each year
that "the business has just about been breaking even." This statement has
been puzzling to the president because inventories, receivables, and payables
have not varied much since the company was organized over ten years ago.
In fact, cash has been increasing constantly. The president thinks that the
business has been making money and that the chief accountant is wrong.
Furthermore, no sale of assets, no refinancing of indebtedness, nor any
change in the corporate structure, such as a sale of stock, has taken place
in these years.
Required: (1)
An
cash.
(2)
(3)
illustrate the
explanation given in
(1).
of
the president.
(AICPA
adapted)
EXERCISES
1.
Inc.
150%
Raw
materials
in process
Work
Finished goods
$ 7,000
9,600
15,000
Sept.
30
$ 7,400
13,000
17,500
Other data
Marketing expenses
General and administrative expenses
Sales for the
$ 14,100
22,900
182,000
month
manu-
Income Statement; Profit Percentage. The Cherokee Manufacturing Company submits the following information on December 31, 19
2.
CH.
31
Factory overhead
Administrative expenses
$ 1 7,650
Required: (1) An income statement for the year ended December 31, 19
(2) The percentage of net income to sales, before income taxes.
3. Statement of Cost of Goods Sold. The accountant of the Sonnenberg Corporation has submitted the following summary to the executive management:
Raw materials
Work in process
$36,000
1 5,000
3,400
2,600
12,000
Fuel
Factory repair parts
Finished goods
Raw
materials purchases
Fuel purchases
Direct labor
Miscellaneous factory overhead
Repairs to factory (including purchase of parts)
Depreciation of plant
Superintendence
Transportation out
Purchases discounts lost
Indirect factory labor
$58,000
5,200
83,100
2,300
4,200
2,700
2,200
1,100
800
2,000
Raw materials
Work in process
Fuel
Factory repair parts
Finished goods
Total
161,600
$230,600
Total costs
Inventories at September 30, 19
$ 69,000
$40,000
12,000
2,000
2,800
14,000
70,800
$159,800
Required: The management returns the summary with the request for a
statement showing cost of goods sold in proper form.
32
4.
PARTI
Company:
Inventories
Finished goods
in process
Direct materials
Work
Ending
Beginning
$95,000
80,000
95,000
$1 10,000
70,000
90,000
$684,000
584,000
1 67,000
193,000
Factory overhead
Direct materials used
all
beginning and
(AICPA
5.
adapted)
Cost of Goods Sold Statement; Unit Cost. The records of the Rein Corporashow the following information as of March 31, 19B:
tion
$440,000
290,000
46,000
4,260
4,700
5,800
29,000
41,200
34,300
42,500
31,500
Repairs to machinery
Miscellaneous factory overhead
Work in process inventory, April 1, 19A
Finished goods inventory, April 1, 19A
Work in process inventory, March 31, 19B
Finished goods inventory, March 31, 19B
The company
March
31,
overhead.
6.
Income Statement; Cost and Profit Ratios. The records of the Algarve ReCompany show the following information for the three months ended
frigerator
March
31,
19:
$1,946,700
Materials purchased
Inventories, January
1,
19
Materials
Finished goods (100 refrigerators)
Direct labor
(all
fixed)
268,000
43,000
2,125,800
764,000
516,000
461,000
6,634,000
CH. 2
March
Inventories,
31, 19
33
Materials
Finished goods (200 refrigerators), costed at $395 each.
No unfinished work on hand.
Required: (1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
An
167,000
Unit Cost; Inventory Valuation; Cost of Goods Sold. The cost department of
the Swartz Corporation made the following data and costs available for the
year 19
7.
Inventories:
Raw
materials
Work
in process....
Finished goods
Jan. 1
Dec. 31
S34,200
$49,300
81,500
42,350
48,600
Depreciation
Dec. 31
Raw
materials purchased
$364,000
Direct labor
162,500
Indirect labor
83,400
Freight-in
21,350
Interest earned
6,300
1:
8,600
Purchases discounts
47,900
5,200
all
from current
year's production.
Sold during
19
December
The total value of the finished goods inventory, December 31.
The cost of goods sold.
The gross profit total and the gross profit per unit.
(3)
(4)
8.
Income Statement.
31.
Rate of Return on Capital Employed. During the past year a company had a
income after taxes of $40,000. Sales were $200,000, and total capital employed was $400,000.
9.
net
34
PARTI
Operating Data Analysis. The 19B annual report of the Columbia Gas
contains the following statistics regarding operating revenues:
10.
Company
(MCF)
Revenue
An
Required:
19A
19B
Increase
{Decrease)
27,000
486,000
$1,215,000
26,000
520,000
$1,274,000
34,000
$59,000
(1,000)
number of customers,
(MCF)
(c)
average
sold.
(AICPA
adapted)
PROBLEMS
Statement of Cost of Goods Sold. The records of the Levitz Manufacturing
for the six months ended June 30, 19B provided the following data:
2-1.
Company
Inventories
Rawmaterials
Work
$41,600
$117,000
320
30,400
113,500
Factory supplies
in process
Finished goods
Other Data:
$101,000
6,900
3,200
Direct labor
Indirect labor
Power and
light
Heat
1,750
600
Fire insurance
11, 200
Superintendence
machinery
Depreciation
$ 3,800
factory building ...
Depreciation
1 1 00
1,645
Tool expenses
3,100
Factory supplies purchased
314,000
Raw materials purchased
1,900
Compensation insurance
,
2-2.
quantities
Material
Material
Material
A
B
Purchase
Quantities
Quantities
Price
Purchased
on Hand, June 30
$.35
.30
.60
35,000
10,000
8,000
4,000
6,000
5,000
Direct labor
Indirect labor
Supervision
salaries
Paid
Accrued
$18,000
2,625
3,000
18,200
$750
175
-01,800
CH, 2
Overhead consisted
of:
Factory
Marketing and
Overhead
Adtn. Expenses
Supplies
$1,400
900
Depreciation
1,000
Utilities
1,740
Insurance
560
-0-
Delivery expenses
At
35
800
400
350
310
280
2,460
the end of the three months, finished goods inventories contained 1,500
38,500 units were sold at an average sales price of $2.25 per unit.
units.
Required: (1)
An income
statement.
(2)
(3)
sales.
sales.
^2-3/ Income Statement. McCaflFerty Products, Inc. produces a household appTiance that sells for $90, The basic patent is held by the inventor who is paid a
royalty
$5 on each un it_sold. The royalty is considered a marketi ng expens e.
The data taken from the books and other records of the
are shown below:
ber 31, 19
Jan.
Dec. 31
materials
Work
in process
Finished goods
$3,420 S
^,159
.^4,584
-^ales.....V.?.^r'.f:>.V
-^aw
^, 30 ^qxM
^,002 vSales salaries
^,518 )J<oyalties paid
1
materials purchased
477
M^irect labor
62,522
indirect labor
5,026
factory equipment.
$ 5,000
28,000
21,500
387,000 freight-out....:
90,563 i-lvliscellaneous marketing expenses.
M^reight-in
^depreciation
Dec. 31
Inventories:
Raw
company on Decem-
2,135
17,908
..
-Office salaries
"^Ba^i debts
1,380
24,790
280
expense
8,700
H^nterest earned
130
^_^urchases discounts.
840
There were 120 finished units in the inventory of finished goods on January 1
and 179 in the inventory on December 31. All units held on January 1 were sold
during the year. Rent is to be apportioned 80% to manufacturing, 10% to
marketing, and 10% to administration.
Required: (1) An income statement for the year ended December 31, 19
supported by a schedule of cost of goods sold.
(2) Figures to prove the cost of the inventory of finished goods on
ber 31, 19.
2-4.
Decem-
Analysis
-r^^^ 3:^"
1,860
5ol(
36
Company,
Inc.
had prepared a
trial
PARTI
extracted:
Debits
$40,700
4,070
9,800
48,000
Work
Credits
6,000
96,000
37,500
3,200
1,000
650
For the month of October, the following transactions and other data have
been made available:
Purchased materials and supplies
Paid factory overhead
Paid marketing expenses
Paid administrative expenses
$ 24,800
20,
00
25,050
19,700
Requisitions for:
Direct materials
Indirect materials
29,800
3,950
Depreciation:
Building,
to manufacturing, 15% to
marketing, and 10% to administrative expenses)
5% (75%
Office equipment,
144,900
75,000
21,800
Payroll
18,600
4,400
Cash
,300
16,900
27,450
Required: (1) The cost of goods sold section of the income statement in
Any over- or underabsorbed factory overhead is deferred until the end
of the fiscal period.
detail.
(2)
(3)
::
CH. 2
37
$12,000,000
Sales
Direct materials
Direct labor
Factory overhead
Gross profit
Commercial expenses
Marketing expenses
9,150,000
$ 2,850,000
$1,350,000
1,000,000
Administrative expenses
Net income
2,350,000
$
500,000
The board discussed the ratio of net income to sales and decided that for the
year 19B an increase of at least 25% of the present profit was desirable. While
the sales volume is expected to increase about 20%, all costs and expenses point
to considerable advances in costs; e.g., direct materials up 8%; direct labor up
10%; factory overhead up 3%; marketing expenses up 4%; and administrative
expenses up 2%. The 3% increase of factory overhead applies to the variable
overhead only. Fixed factory overhead is considered to remain at the present
level of $1,250,000. Volume will not cause an increase in marketing and administrative expenses. Ignore income tax.
all
How
previous year?
2-6. Price Determination.
product which
is
5,
$100,000
Inventory, January 1, 19
Production costs for an output of 22,000 units:
Direct materials
Direct labor
Factory overhead
Total
Inventory,
December
31,
19
(2,000 units)
(all
fixed)
taxes)
$13,500
30,500
35,200
$79,200
8,220
70,980
$ 29,020
10,000
$ 19,020
38
PART
its
price
(2) A critical evaluation of the two pricing methods. Could acceptable accounting procedures be utilized to arrive at a third price for the order? Explain
this third method and indicate which of the three methods is preferable in this
instance.
2-7. Ratio
Assets
31, 19
Liabilities
Cash
Receivables
Inventories
Plant and equipment
750,000
3,508,000
2,217,000
1,353,000
and Capital
$7,828,000
$7,828,000
$6,491,000
4,676,000
Gross profit
Marketing and administrative expenses
$1,815,000
804,000
taxes.
The
The
The
19
Sales
acid-test ratio.
net operating
rate of return
$1,494,000
368,000
4,387,000
1,579,000
income as a percentage of
on capital employed.
sales.
CH. 2
(5)
39
in dollars if
80%
Analysis.
$ 23,400
2,180
44,400
38,200
44,500
60,000
3,550
15,000
125,000
Land
Buildings
Buildings
Accumulated Depreciation
Machinery
Accumulated Depreciation
Machinery
Office Furniture and Fixtures
Accumulated Depreciation
Office Furniture and Fixtures
Notes Payable
Accounts Payable
Accrued Wages Payable
Accrued Interest on Mortgage
Mortgage on Plant
66,000
500
50,000
40,000
5,000
500
75,000
100,000
130,830
360,000
6,000
50,000
100,000
3,500
90,000
Raw
Materials Purchased
Direct Labor
Patterns and Drawings Expenses
Miscellaneous Factory Overhead
Freight and Postage on Sales
Miscellaneous Marketing Expenses
Miscellaneous Administrative Expenses
2,500
6,000
5,000
$845,330
Total
is
$845,330
also available
3%
on buildings
administration)
(80%
to factory,
5%
on
office furniture
to administration)
,000
35,000
25,000
Interest Earned
Interest Paid
Discounts on Sales
5,000
2,600
Capital Stock
165,000
20%
to
to factory)
and
fixtures
(100%
40
Required: (1)
ber 30, 19B:
(2)
An income
(3)
PART
Current
ratio.
Net income
(d)
(e)
2-9.
Cash
Accounts Receivable
$ 5,000
10,000
4,000
2,000
6,000
Materials
Work in Process
Finished Goods
Prepaid Expenses
Fixed Assets (net)
500
30,000
17,500
Current Liabilities
During the year 19B the retained earnings account increased 50% as a result
of the year's business. No dividends were paid during the year. Balances of
accounts receivable, prepaid expenses, current liabilities, and capital stock
were the same on December 31, 19B as they had been on December 31, 19A.
Inventories were reduced by exactly 50%, except for the finished goods inventory
which was reduced by 33i;^%. Fixed assets (net) were reduced by depreciation
to administrative expenses.
of $4,000, charged "^i to factory overhead and
Sales of $60,000 were made on account of finished goods costing $38,000. Direct
labor cost was $9,000. Factory overhead was applied at a rate of 100% of direct
labor cost, leaving $2,000 unapplied that was closed into the cost of goods sold
account. Total marketing and administrative expenses amounted to 10% and
15%, respectively, of the gross sales.
Required: (1)
An
(AICPA
goods
adapted)
CHAPTER 3
in
facts,
competently
and
to be
computed under
ferent people.
make
is
in cost
is
computations
Costs
may have
Cost accounting
is
valid
a wide
by
dif-
itself.
needs.
become
generally familiar.
It is
its
meaning.
The Committee on
is
a foregojng^measured in
Report of the Committee on Cost Concepts and Standards, The Accounting Review, Vol.
XXVII, No.
2, p. 176.
41
42
PARTI
is
AlCPA
3 considers
expense to be:
the decrease in net assets as a result of the use of economic services in the
creation of revenues or of the imposition of taxes by governmental units. Expense is measured by the amount of the decrease in assets or the increase in
liabilities related to the production and delivery of goods and the rendering of
services. ... In its broadest sense expense includes all expired costs which are
deductible from revenues. In income statements, distinctions are often made
between various types of expired costs by captions or titles including such
terms as cost, expense, or loss; e.g., cost of goods or services sold, operating
expenses, marketing arid adijiinistrative exi)enses, and loss on s^ale of property. ^
.
v>A
o^t<-w\
\W3
:5Sujy\^^T
is
is
means, at one time, the amount paid for something; at another time, the
market value of the item given in exchange for the item receivedY The
term "expense" refers to the sacrifice, the renouncing aspect of the revenue
Tx-+vi<VN5<<<ttevCair
VxoViL'i^
MM^
xt-
V.
'
'^
"^'^
.
that are
transaction.
When
is
used specifically,
it
u/v
services
differential,
many
objectives.
show, ap-
point but will be found at the appropriate place within the textbook.
Many
2Robert T. Sprouse and Maurice Moonitz, A Tentative Set of Broad Accounting Principles for
Business Enterprises, AICPA Accounting Research Study No. 3 (New York: American Institute
of Certified Public Accountants, 1962), p. 25.
^Ibid., p. 49.
CH.
serve.
in
its
costs.
a fundamental
It is
axiom
must
that a cost
is
it
to
not serve
43
same
all
collection, presentation,
2.
3.
4.
5.
profit,
data
for
analytical
processes
for
decision
making
Planning Profit by
the future
Means
of Budgets.
deals with
Cost accounting
and other
is
costs of producing
Management
concerned with the ultimate profit arising from these costs and planned
revenues or
sales.
Budgeting
determined
Some
first in
sales.
other costs
The
If the
for
all
levels
and
of definite
fines
tional structure and, following these lines of authority, allows the assign-
44
Not only
under
their control-
made
sibility
becomes
and
PARTI
profits are
profit responsibility.
manager's controllable
costs.
Of
should be someone's responsibility. This responsibihty phase often becomes lost in a maze of cost classifications as shown later in the chapter.
The reporting and measuring phase has already been touched upon.
It is
and succcess
which he
is
responsible, the
and expenses provide the cornerstone for cost control proceof actual or experienced costs and expenses with
comparison
dures. A
These exceptions
these standards reveals an out-of-line performance.
form the basis for an investigation into the reasons, resulting hopefully in
mined
costs
The
measuring of an annual or periodic profit for the entire enterprise involves the matching of expired costs with revenues on some consistent
,-^basis. This matching process requires distin.guishingbetween_jhQxknin
-4-
and long-run costs? The longer the period, the gr eateFtHe accurac y of th e
matching process. A company's annual reports reflect the" results of separating the costs applicable to the units sold from the costs applicable to
U-
'
I"
'
'*'
.
^^^
L.\^
^^
per^
o~f turv<t
units sold!
V(a)
matching processes -^
To match
Associa-
CH. 3
(b)
45
To match manufacturing
and
match
to
all
costing).
(c)
To match
on a long-run
give the
when
same
result
but yield a
Different circumstances
may
methods.
The
estab-
combined knowledge of
the
costs
and
their
volume.
In the planning
and
sales
all
Making.
make
more
years.
tactical
in-
To implement
may have
to be determined
countant.
Changes in
ponent part, replacing equipment, substituting materials, accepting or
rejecting a price or an order
each situation calls for new expected
actual costs and a new set of revenues related to these specific situations.
134-135.
46
PARTI
about the future and (2) cost control should be designed to monitor the
accomplishments of plans.
mean that data about the past are unimportant nor that they should be neglected, because past data may aid
in future decision making. Past performance must be reported to internal
This ranking does not
in the past.
management
information system.
CLASSIFICATIONS OF COSTS
Cost
classifications are
are useful to
2.
3.
4.
5.
6.
7.
aims de-
The process of
all
and
classifying costs
manufacturing
c Qsts
according to the three main elements of cost: materia ls, labor, andjjactory
;a
^ab";^ overhead.
Total cost
may
be considered
as^U cjQsts_.or^ductionsJrpm
,tA
Manufacturing
^cQS^'y'
^[462^
jLrw^-^
^^
^^^
^^^ ^^ ^^^
cost, often
^'^^^
named "productioJi^ost"
or "factory co st,"
represents
(^xrrY\fyW^^v/hi\e
Work
in Process.
'
CH. 3
fall
47
Some
Direct Labor
Other indirect
Costs
Indirect
Indirect Lal>or
Materials
Includes:
Includes:
Includes:
Factory supplies
Supervision
Lubricants
Superintendence
Rent
Insurance
fire
and liability
Taxes
Inspection
Salaries of
Depreciation
factory clerks
Defective work
Maintenance and
Experimental work
repairs
Power
Light
Heat
Miscellaneous
factory overhead
Snnall tools
Marketing Expenses
Commerical
Expenses
Includes:
Includes:
Administrative and
Sales salaries
Commissions
Administrative Expenses
Manufacturing Cost
to
salesmen
office salaries
Advertising
Rent
Samples
Auditing expenses
Entertainment
Legal expenses
Doubtful accounts
Travel expenses
Rent
Telephone and telegraph
Stationery and printing
Postage
Freight-and cartage-out
expenses
Miscellaneous marketing
expenses
48
'--
PARTI
and
tures
(2)
revenue expenditures.
(1) capital
Ajcapital expenditur e
expendi-
^ intended
to
asset
is
The
r
L_.
is
many
in
The
application
depends
initial classification
pany's operations.
is
com-
often in-
The
number of detailed records and under-
the
lying documents required are also factors that determine the distinction
between these two basic classes of costs. Whatever classification is decided
upon can and does affect the computed unit costs and reported profit
figures of a fiscal period.
-^
Some
costs
management.
Direct materials and direct labor are generally listed
costs.
among
the variable
examined with regard to items of a variable and fixed nature. It is impossible to budget and control these costs successfully without regard to
tendency to be fixed or variable; the division is a necessary prerequisite to successful budgeting and intelligent cost planning and analysis.
their
show
(2)
(3)
comparatively
CH. 3
The following
VARIABLE FACTORY
49
50
SEMIVARIABLE
PARTI
CH. 3
it
woulcLbe
futile
la treat-it^as
51
a direct
iiaterials
Indirect labor
may
work or other
service
work not
factory
is
is
fall
into
s'ervice-dpartments
A producing
r More
specifically,
upon any
machine_opeiLa-
may be
charged to the product because they have contributed directly to its production, such as the machining, forming, upholstering, or assembling
departments.
In
many
cost centers.
different types of
machines perform
For example, in
the manufacture of cotton yarn and cloth, the producing department
"Carding" can be broken up into the cost centers: opening cotton bales,
picking, carding, drawing, and slubbing. g.w ^<)^ ^ SX^A'T cvJtA^^ ?royy\^<^<p
A service department is one that is not directly engaged in pr oductio n
''
but renders a particular type of service for the benefit of other departments.
In
some
The
must be absorbed in the cost of the product by means of the factory overhead rate. Some service departments common to many industrial concerns
are receiving, inspection, storerooms, maintenance, timekeeping, payroll,
cost accounting, budgeting, data processing, general office, cafeteria,
plant protection.
and
ft^xL 52
x<;
\:roA
r-^<
Departmentalization J for
^^AjyjoL^
l^!^
For product
o*^^^\^^ departments
^J?24
y?
Ac-
is
often
made
primarily for
rant_ppf^J^j2^[>jij^Hj>v^
K^Ln\^^a^
'
and Responsibility
Costing
,x'
fVa-A^
PART
^^
.
Product
counting.
^^_y_-^
fJ^
W^^
may
may
and
achieve a sense of
should be
made to
commitment on
feel that
A departmental
he
is
in
order to
he helped to develop.
management
rests
m the controllability.
reported upon. All costs sliQuki_be_QntraULb k at sorn e_iYeI_pfman- agement over some time frame no cost can remain in a noncontroUable
;
category-
The comparison of
it is
In the preceding
The word
and
product or job.
^s
is
building
indirect
may be
it
is
is
re-
,v
CH. 3
53
y.
Departmentalization of a factory
" ^^
is
J tJZS
of even greater importance in con^T^^
\
A_
fo the product
on the
is
charg ed
heads are made responsible and accountable for the actual controllable
operating
them.
-j^
\
management
in
Cost responsibility
is
assigned to
in line with
in attaining
provides the data required for the preparation and operation of a budget
V r>^.
.
many companies
'^
In
costs.
'^'^
manufacturing, market-
and administration
have been coordinated into a well-thought-out
budget program, the budget becomes the written expression of management's plan for the future. The budget program enlists all members of
management in the task of creating a workable and acceptable plan of
action, welds the plan into a homogeneous unit, communicates to all
managerial levels differences between planned activity and actual performance, and points out unfavorable conditions which need corrective
ing,
actions.
in
No
which budgeting
is
affairs
of a company
will
and
internal
54
PARTI
Standard Costs.
and factory overhead. They are established by using information accumulated from past experience and data secured from research studies. The
established standard costs for materials, labor, and factory overhead
form the foundation for the budget. Since standard costs are an invaluable
aid in the process nfsgttingjTriceyitjs^ssgntial to setiMl^gi9^^^^^^ CQsts
at reali stic levels.
standard states the cost under given conditions which are held con-
and measure
fluctuations.
The measurement of
It
should be
mere comparative
level.
ances provides
plete,
to be
vari-
com-
"7
mated
costs
of action
is
adopted.
and out-of-pocket
which attempt to
envision and evaluate future conditions in the light of the current situation.
When management
opportunity costs.
If
expansion of operating
facilities is
contemplated, the
Should a project be abandoned or capital costs never fully recovered through revenues, the com^pany's management will face a cost situation that is termed a sunk cost.
The measure of a sunk cost is the difference between book value at any
time and the disposal value of the facili ties.
While these isolated illustrations stress the managerial aspect of
relevant costs are future costs to be incurred.
accounting,
it
must be
CH. 3
rise
55
units into
first
step in distinguishing a
DISCUSSION QUESTIONS
1.
2.
is
(d)
head or
classifications of costs.
materials.
Select the
answer which
(AICPA
3.
adapted)
Which of the following is the best example of a variable cost? (a) property
taxes; (b) the corporate president's salary; (c) the controller's salary; (d)
interest charges; or (e) material in a unit of product?
(NAA
adapted)
4.
5.
The
division of costs between inventory charges and profit and loss charges
not uniform throughout industries.
(a) Name two broad classifications of costs that find different treatments.
(b) Give reasons for the existence of these differences.
is
6.
(AICPA
7.
(a)
(b)
What
What
is
a service department?
are
some
Name
a few.
characteristics of a service
adapted)
department in connection
56
8.
PARTI
The board of
Required: (1) An explanation of the meanings of the terms (a) "cost," (b)
"expense," and (c) "loss" as used for financial reporting in conformity with
generally accepted accounting principles. The explanation should indicate distinguishing characteristics of the terms, their similarities and interrelationships.
(2) A classification of each of the following items as a cost, expense, loss, or
other category with an explanation of how the classification of each item may
change: (a) cost of goods sold; (b) bad debts expense; (c) depreciation expense
for plant machinery; (d) organization costs; (e) spoiled goods.
(3) The terms "period cost" and "product cost" are sometimes used to
describe certain items in financial statements. Define these terms and distinguish
between them. -To what types of items does each apply?
(AICPA adapted)
EXERCISES
Exercises 1 through 4 inclusive deal with definitions and cost classifications.
1.
What
What
(1)
(2)
How
(3)
head
is
is
will increases in
(4)
Why
costs?
2. Classify the following costs as fixed, variable, or semivariable.
reasons for your classification of the semivariable costs.
(a)
Depreciation
straight-line
method
Factory insurance
3.
and power
Indirect labor
Rent
(f)
Explain the
(i)
Superintendence
(j)
Washroom
supplies
costs be classified ?
Cutting tools
(b) Depreciation of factory
Inspector's salary
(a)
(f)
(c)
Earnings of machinist
(d)
Foreman's wages
Maintenance parts for factory
equipment
(e)
4. Classify the
(b)
(c)
Ailerons on an airplane.
(f)
(g)
shell.
perfume bottle.
Sanding material in furniture making.
Bags in flour mills.
Ingots used by a foundry for making castings.
(d) 1-oz.
(e)
Wages of
(a)
(i)
(j)
CH. 3
57
(h) Seats to
(i)
(j)
Inventories
Raw
materials
in process
Finished goods
Work
Oct. 1
Oct. 31
$15,000
17,300
11,300
$19,200
19,425
9.400
(b)
(c)
Required: The
gross profit in the
set at (1)
$300;
(2)
the
same
total
selling price
is
(3) $350.
Cost of Goods Manufactured and Sold. Guy M. Cooper, Inc. incurred direct
labor costs of $205,000 and factory overhead costs of $173,000 during 19B.
During the year direct materials purchased totaled $198,000. Inventories were
counted and costed as follows:
7.
Dec. 31,
Dec. 31,
19B
19A
$39,700
74,350
22,400
$32,850
72,180
24,320
8%
5%
8%
9%
58
PART
is
Required: (1) The sales price per unit that will produce the same ratio of
gross profit, assuming no change in the rate of factory overhead in relation to
direct labor costs.
The
(2)
June, 19
(AICPA
adapted)
Loss Calculation. The Walker Products Company, Inc., a small manufacturing company, produces a highly flammable cleaning fluid. On May 31,
19F the company had a fire which completely destroyed the processing building
and the work in process inventory; some of the equipment was saved.
9. Fire
After the
fire
The
inventories
on January
1,
19F consisted
of:
Raw materials
Work in process
Finished goods
Supplies
Total
5,000
50,000
70,000
2,000
1
$137,000
review of the accounts showed that the sales and gross profit for the
were:
last
five years
19A
19B
19C
1
9D
19E
Sales
Gross Profit
$300,000
320,000
330,000
250,000
280,000
$ 86,200
102,400
108,900
62,500
84,000
The sales for the first five months of 19F were $150,000; raw materials
purchases were $50,000; freight on purchases was $5,000; direct labor for the
five months was $40,000. For the past five years, factory overhead was 50% of
direct labor cost.
Required:
The value of
the
work
by
fire.
(AICPA
adapted)
PROBLEMS
Calculations. The Meredith Equipment Company manufactures machines to customers' specifications. Two requests for bids have been received,
each calling for the delivery of one machine with the following shop and cost
C^A) Bid
specifications
Bid No.
Parts to be purchased
Materials: bar, strip, and sheet metal
Pig metal for castings
Bid No. 2
$275
$450
65
28
40
95
6 hrs.
CHAPTER 4
vital for
a part of the
total integrated,
com-
solutions.
Periodically,
form of control reports to show the individual manager, department head, supervisor, or foreman the success or failure of the objective
and the cost of his accomplishment. These cost reports should motivate
responsible people to corrective action and new decisions. The accumulation of accounting data requires many forms, methods, and systems due
to the varying types and sizes of businesses. A successful system is tailored
to give the blend of sophistication and simplicity that is most efficient
and economical for a specific organization. In recognition of these facts,
in the
the chapter
1
3.
4.
The
5.
2.
60
is
factory ledger
CH. 4
61
is
which
and
The organization
charts
on pages 7 and
responsibility relationships
partment heads,
de-
1.
2.
Incurring expenditures for materials, labor, and other costs which the
accountant must segregate and report to those in charge.
the
method of
know
collecting hours
related to operations.
of action.
management.
The
if significant,
are of interest to
made
so that
2.
Provide a
3.
4.
me ans
of c ostingjnventori es.
materials,_and-niachines.
62
5.
Aid
6.
II
in establishing sellijig^prices.
It is
all
PART
may
provide
much
vital
It is
value.
minimum
systems requirements.
certain record-keeping
For
and reporting requirements, as does the Federal Insurance Contributions
Act, the 1974 Pension Reform Act, the Securities and Exchange Commission, the Federal Power Commission for public utilities, and various other
governmental regulatory agencies and taxing authorities at local, state,
and federal levels. Also, stockholders, creditors, labor unions, and others
may impose requirements on the information system. These many legal
or contractual requirements must be met, but in meeting them the system
should be designed in a cost-conscious manner. Beyond these external
requirements, any additional sophistication in the system should be
-justified solely on the basis of its value to management.
example, the Internal
It
cost,
their mcurrence.
^<^
{^,-^
,>,
(,^'^^^fT
Qcc^.^T^
should be observed
1.
Accounts should be arranged and designated to give maximum information with the least need for supplementary analysis consistent with a
reasonable degree of econ omy in performing the accounting function.
f-^i
CH.
2.
titles
should
63
variations to
management's
attention.
classified
further so as to identify
Discussion of this
subsequent chapters.
chart of accounts
assets, liabilities,
and
is
capital,
Assignment of codes
is
in
Today's modern
classification
A typical
data.
(100-299)
Assets (100-199)
Current Assets (100-129)
101
102
103
104
106
Buildings
Factory
Machinery
Accumulated Depreciation
and Structures
135
Machinery and Equipment
135.1 Accumulated Depreciation
and Equipment
Factory
143
Automobiles
143.1 Accumulated Depreciation
Automobiles
146
Office Furniture and Fixtures
146.1 Accumulated Depreciation
and Fixtures
Office
133.1
Cash in Bank
Cash on Hand
Petty Gash
Marketable Secunties
Customers' Notes Receivable
106.1 Notes Receivable Discounted
109
Customers' Accounts Receivable
109.1 Allowance for Doubtful Accounts
115
Materials
115.1 Inventory Adjustments
116
Work in Process
117
Finished Goods
120
Prepaid Taxes
121
Prepaid Insurance
122
Other Prepaid Items
132
133
Sini(ing
*l
Furnitule"
Privileges
Buildings
Structures
iCi^'Ao
Funds (190-199)
''
^^'^
^O
c.vi^ _^
I
Liabilities
220
222
224
Capital (250-279)
Capital Stock
250
250.1
Treasury Stock
255
260
(Continued)
Earnings Retained
in
Business
64
PART
II
Sales
301.1 Sales Returns
301.2 Sales Allowances
379
Variance
Factory Overhead Efficiency
Variance
Factory Overhead Overapplied or
390
Development Expenses
378
Underapplied
Equipment
461
462
463
480
481
482
Depreciation
Structures
Buildings and
Rent of Equipment
Repairs and Maintenance of Machinery
and Equipment
Repairs and Maintenance
Repairs and Maintenance
Repairs and Maintenance
of Buildings
of Roads
of
^TraasfiQiLalion Facilities
486 ^Amortization
of
Patents
503
504
507
515
Salaries
Salaries
Salaries
Sales Supervision
Salesmen
Clerical Help
Salesmen's Commissions
Freight Out
522
530
534
536
538
546
548
560
562
565
567
568
580
Payroll
(300-899)
Taxes
Supplies
Fuel
Light and
Power
Telephone and Telegraph
Postage
Travel Expenses
Depreciation
Automobiles
Rent of Equipment
Advertising
Display Materials
of Buildings
600
620
622
630
634
636
638
646
648
660
Overtime Premium
Payroll
Taxes
Supplies
Fuel
Light and Power
Telephone and Telegraph
Postage
Travel Expenses
Furniture and
Depreciation Buildings and
Depreciation
Fixtures
661
Structures
Equipment
662
670
680
Rent
691
Donations
Bad Debts Expense
693
of
,'-_
'
Q/ct^
--
Every company designs an accounting system that will meet its own
Since a knowledge of costs is of key importance to management, the system should make pertinent cost information available to
particular needs.
To
transaction must
first
Facilities
SoLilC
U).
CH.
DATE
Journal Voucher
Evidencing Purchase
of Materials
on Account
65
h
^
15
9M
S^iV
PART
II
built.
knowledge of the
nature of the costing techniques. Since cost ac counts are an expan sionof
general accounts, they should, as a basic accounting procedure^ be related
tie-in
of cost accounts
^JO^-IV^
Sirvvs.. (s>r\
OcA O^SL
.
GENERAL ACCOUNTS
'
A^ 4.^ A^^,
COST ACCOUNTS-
TV^
(a
a^
ACCOUNTS PAYABLE
Materials
Payroll
Expenses:
Water
Electricity
Payroll taxes
etc.
PREPAID EXPENSES
Insurance
Expired
Taxes
etc.
ACCUMULATED DEPRECIATION
V
Relationship between General Accounts and Cost Accounts
Accounts describing manufacturing operations are: Materials^_PayWork in Process. Finish ed Goods, and
Cost of Goods Sold. Each fiscal period these accounts recognize and
measure the flow of costs
from the acquisition of materials, through
illustrate,
and
the factory overhead account controls indirect labor, supplies, rent, in-
CH. 4
lists
67
records
/^ -Materials
Factory Overhead
\
Materials cards
perpetuaiJnyentory
Expense ledger or departmental
expense analysis sheets
j^*^ ''^'' costing
/^^^ ^^^^
process costing
\Production reports
Finished Goods ledger cards
Plant ledger
Work
worK
in
Process
rrocess
Finished
Goods
The
is
used when
it is
desir-
in cost accounting
made
in the
terials
and
is
is
The
debiting
Ma-
column
posted at the end of the period. The individual items purchased are also
The
in the materials
tions of the
including
^^ n
^
^ ^
-^fj
y
H-^1
\^Ufl^
XY\ a^c>
68
^^^
II
MATERIALS
Relumed
Invantory
10
PurchMd
Vendor
Indirect
Matenals
6,000
Direct
^l 'S60C0
Matenals
Vh
FINISHED
INCOME SUMMARY
POOPS
By means of a predetermined
it is
"^
-V
(>^Sl
^\^\., etMofLvV
\x^
if^(Virvax
head.
The
applied,
is
Cost of
discussed in Chapter
all
it
9.
The
and apphed
total cost of
is
closed to
Income
the transactions
Labor:
slips, etc.
etc.
Factory
vouchers prepared to set up depreciation or prepaid expenses;
Overhead:
vendors' invoices, utility bills, etc.
^"R-
CH.%
(3JiAv^
69
is
many
some
accounts,
it is
practical to
do some accounting at th e
fact ory.
The
^h
invoices prepared,
factory, Cash,
Ac-
counts Receivable, Sales, and related accounts will appear in the factory
ledger.
office,
at the general
At one factory it may be advantageous to meet payrolls locally, thereby requiring a bank account and payroll accounts. In another factory, the
payroll summary might be sent to the general office which would prepare
the payroll checks or envelopes and mail or deliver them to the factory.
The liability for payroll taxes and income taxes withheld from eniployees_is
either kept injhe general ledger or transferred from the fa ctory ledger to the
gener al ledg er. For efficient managemenTand co"ntroI^ one firm may keep
detailed equipment accounts in the factory books, while another
Illustrative
Company
Problem.
may keep
as the basis for the illustration (page 68), the following entries
is_kepLa^he
from the
general^office,
with
its
deductions
is
office^^nd
goods account
is
.a.
'^ (sort
. ..
PART
FACTORY OFFICE
GENERAL OFFICE
Entries for the purchase of the materials:
Subsidiary
Dr.
Factory Ledger
Accounts Payable
Cr.
Record
25,000
Materials
and
Work
NO ENTRY
Factory
Control
in Process.
Materials
0/u
25,000
indirect materials:
NO ENTRY
Cr.
General Ledger.
25,000
Dr.
25,000
Jvr,\
31,000
31,000
Overhead
6,000
.Q-V-^V.'^.'-.mT'
Indirect Materials.
Materials.
6,000
6,000
Accounts Payable
Factory Ledger
General Ledger.
2,000
2,000
2,000
Materials
2,000
.
TWXS
C\C (-K
Entries to prepare the payroll at the factory and to set up payroll liability and pay employees
at the main office: (Employees payroll deductions, coasist ofl5'7rJ^or federal income taxe s
and 6%for FIC.4 taxes. The tax liabilities are transferred to the g eneraToffce.)
'
Factory Ledger
24,490
Accrued Payroll
Cash
PayableV-.l'i
24,490
.'
Factory Ledger
Federal Income
Tax Payable
FICA Tax Payable
6,510
.,
.'^5
'^
State
able
2,852
Tax
,000
24,490
4,650
1,860
V 3lk-)
4,650
1,860
6,510
ai>
Factory Ledger
FICA Tax Payable
Federal
Unemploy.
Payable
.x.3' "^^
t-rrr>, ovdpcV
?-t7
II
..
X^jA
CH. 4
5'o\<^
71
FACTORY OFFICE
GENERAL OFFICE
Entries to charge factory overhead to work in process base J on 6,000 direct labor hours worked
at a factory overhead rate of $2.20 per hour:
Subsidiary
Record
Cr.
Dr.
Work
NO ENTRY
.,
in Process.
Dr.
Factory Overhead
Control
r\J
Cr.
13,200
..
13,20Q
Entries to charge expense accounts in the factory office with credits in the general office books
for writing off prepaid insurance and accruing depreciation: (Prepaid expenses and accumulated depreciation accounts are kept in the general office ledgers.)
Factory Ledger
Prepaid Insurance
Factory
Overhead
Control
Expired Insurance.
Depreciation
General Ledger
1,198
516
682
Accumulated Depreciation.
in
1,198
516
682
1,198
NO ENTRY
62,180
62,180
Entries to transfer the cost of the goods sold to the general office boofis when notice is received
that shipments were made to customers: 'JivxAjL'^^ '^Wc'TAjj-vCX^ Is^^^A'''-- ^
-WXC^
General Ledger
52,300
52,300
Finished
Goods.
52,300
52,300
In the general office a second entry is necessary for the sales transaction. Entry assuming the
above shipment was sold for $88,000:
Accounts Receivable
no entry
88,000
88,000
Sales
is
shown forjac
from transaction documents, must be available for all ledger accounts for which subsidiary records are maintained; e.g., materials and
directly
finished goods.
make
pertinent
'
to
is
Any
to personnel respon-
Every purchase transaction require s a pu rchase requisition, a purchase order, verification of receipt of the order,
sible for various functions.
V^Ka..
72
PART
II
cerned, and
all
kinds
from
can be processed
city.
illustrate basic
information
flow through a typical computer accounting system and the functional parts
of a computer.
CH. 4
to...
&.
OPERATION
73
produce updated
master files and finished
results which are
to
Data
data processing
recorded into
is
punched
cards...
By a card punch:
machines or systems
which calculate,
rearrange, do table
look-up, and process
current data with master
data and historical data
stored on magnetic
tapes, disks, or
cores...
Original
Documents
Automatically from radio,
telephone, telegraph, and
digitalized recordings
instruments:
Punched
Cards
Automatically as documents
are typed:
An
74
Storage.
The computer
PART
stores information
filing
cabinet in
many
cases instantaneously
on
tiny
magnetized spots or cores in code form, and the data are processed
computer with the infor-
mation
it
seeks.
From
its
speed of
light.
Control Unit.
Y"
pletes all further actions required in connection with the transaction, along
DATA
INSTRUCTIONS
MEMORY STORAGE
DATA AND
INSTRUCTIONS
OUTPUT UNIT
INPUT UNIT
CONTROL
UNIT
ARITHMETIC
AND LOGIC
UNIT
REPORTS
AND SUMMARIES
CH.
with
summary
reports of
all
way most
75
useful
L to management.
Large businesses have converted their basic data accumulation prosome sort. Ledgers are now replaced by
account data. Ledgers in the form of punched cards, for example, offer a
high degree of economy and flexibihty; i.e., posting can be accomplished
simply by merging accounts payable cards into a master
file
(arranged
documents are withdrawn from the file, machine sorted into account
number sequence, and then listed by a printer to produce the accounts
payable distribution summary. Furthermore, these same cards can be
machine sorted into categories of purchases and expenses. Summaries
can be prepared for each class of expenditure or for each department
manager responsible for cost control.
Electronic
Successful
lines
communicate
policies
76
PART
II
r
(^_
PI
through departments, branches, and operating divisions; and data generated in one phase of operations flows into another phase. Or for inter nal
control it may be necessary for different individuals or departments to
report
'
effort often required to locate errors in order to bring control totals into
agreement.
its
The
electronic
Control Ratios.
Cost control
totals
and
creative effort.
more
is
basically a process of
may
be totals
total
For management purposes, as control totals are obtained each day, week, month, and quarter,
these totals are compared with previous time periods, with budgets, and
with standards. From control totals other ratios meaningful to management are possible, such as inventory turnover, sales per dollar of variable
cost, sales per dollar of assets, earnings per dollar of sales, and each cost
etc.
Mathematical models are now used by management as a tool to describe and help control operations. For example,
models or simulations make it possible to test out various inventory control policies and forecasting techniques based on past experience and to
select the method that best meets management objectives. By using the
computer, it is possible to simulate a complete operating budget and
manipulate product mix, price, cost factors, and the marketing program.
Mathematical Models,
By studying
it
is
possible to
CH. 4
&.
OPERATION
77
The
linear
and
its
DISCUSSION QUESTIONS
1
How may
2.
is
4.
and
controlling.
Explain.
The journal voucher control system is said to be one of the most effective
means of internal control when designed to fit a specific enterprise and
properly administered.
(a) Explain how the voucher can be a means of internal control.
(b) How does a voucher serve as a connecting link between general accounting and cost accounting?
78
5.
PART
II
If a factory
it is
How
office?
(c)
What entry would be made on the factory books when goods are shipped
directly to a
customer?
factory.
What
(e)
entry would be
entry would be
made on
it
6.
(a)
7.
(a)
What
(b)
8.
(d)
EXERCISES
1.
Raw
materials ....
Finished goods
on September
Work in
Work in
Work in
$40,000
25,000
process
process
process
materials
labor
factory overhead
$15,000
18,000
1 3,500
During the month of September the cost of materials purchased was $100,000,
was $90,000, and factory overhead applicable to production was 75% of the direct labor cost. The September 30 inventories were:
Raw
materials ....
Finished goods
$30,000
47,000
Work
Work
Work
materials
labor
process factory overhead
in process
in process
in
Overhead costs
in process,
Required: (1)
ending inventory
The
rate of factory
accounts
schedule of
$150,000
400,000
300,000
120,000
Materials used
Direct labor
Work
$12,000
20,000
15,000
cost.
The
CH.
On
Accounts
October
Dr.
1,
79
the trial
Cr.
$ 25,800
47,740
44,880
85,400
78,700
237,240
Materials
Work in Process
Finished Goods
Plant and Machinery
Accounts Payable
Accrued Payroll
Accumulated Depreciation
Plant
Allowance for Doubtful Accounts
&
$ 54,270
6,600
11 5,210
2,825
80,000
Machinery
Capital Stock
Retained Earnings
260,855
$519,760
$519,760
"
(indirect)
(c)
(f)
(g)
(h)
(i)
(j)
65,000
3,500
(e)
$ 40,000
month
(direct)
(indirect)
900
80,000
9,500
75,000
12,000
8,500
300,000
135,000
?
14,200
75,000
205,000
285,000
production.
Requisitions for indirect factory materials and supplies amounted to $2,000.
(d) The total payroll for the month was $35,000 including salesmen's salaries of
$5,000 and office salaries of $5,000. Labor time tickets show that $20,000 of
the payroll was direct labor. Income taxes were withheld at the rate of 10%
of wages earned, and employees' FICA taxes of $1,440 were deducted. The
payroll due the employees was paid during the month.
(e) The employer's payroll taxes consist of $1,440 FICA, 1.4% state unemployment insurance, and .5% federal unemployment insurance tax. Two hundred
(c)
80
salaries
PART
and $180 to
II
office
salaries.
(f)
(g)
(h)
(i)
(j)
Required: (1) Record in T accounts the transactions for October using one
in process account.
(2) Close the income statement accounts to Income Summary. Close underapplied factory overhead to Cost of Goods Sold.
work
5.
Sept.
1.
3.
5.
6.
8.
Bayside
Purchased raw materials from Ramel & Ruble Assembling Company, $5,000.
Terms: 2/10, n/30.
Recorded payroll for the week, $1,900. Payroll was distributed as follows:
Marketing
Administrative
.
13.
15.
transactions
Purchased grease, oil, and cleaning compound for factory use from Deaton
Supply Company, $400. Terms 1/10, n/30.
Purchased an electric motor from Lee Electrical Manufacturing Company
listed at $3,400. Freight charges amounted to $225 and testing and installation charges were $175. Terms of sale were: one half down plus freight and
installation charges with a cash discount of 1% on the list price; balance due
in two equal monthly installments with a 2% discount on the first installment if paid by October 1.
Paid Terrell Service Company for repairs to factory machinery, $125.
1 1
Company completed
400
300
Federal Income
Tax Withheld
FICA
$180
60
$72
24
45
18
Tax
purchased
10%
is
for
Factory Ledger Entries. The Henderson Company uses a general ledger and
a factory ledger. The following transactions took place:
6.
Nov.
2.
4.
8.
14.
14.
/lO, n/60.
Factory payroll of $2,000 for the week was made up at the home office;
$1,730 in cash was sent to the factory. FICA tax was $90, and income tax
was $180 ($1,880 direct labor; $120 factory repair).
Depreciation of $200 for factory equipment was recorded. (Assets and accumulated depreciation accounts are kept on the general office books.)
A job was completed in the factory with $960 direct labor and $450 of rnaterials being previously charged to the job. Factory overhead is to be applied
at an overhead rate of 66%% of direct labor.
81
15.
home
16.
CH. 4
Nov.
office
Required: Journal entries on the factory books and the general office books.
7.
Emco
Plastic
Company
has
its
general office in
at the
home
office
Accounts
Finished
Cr.
$ 3,500
Materials
Work in Process
7,800
6,400
Goods
General Ledger
$17,700
$17,700
Total
$17,700
(a)
Total payroll for November was $30,000. The home office prepared the payroll and the checks and also deducted 6% for PICA tax and 10% for federal
income tax. The liability for employer payroll taxes is kept on the home
office books. The state unemployment insurance tax rate is 2.1%; the federal
unemployment insurance tax rate is .5%. The Evansville payroll consisted of:
$3,000, office salaries;
$13,000, direct labor.
210%
$6,000,
labor;
indirect
(d)
Factory overhead
(e)
Materials costing $275 were defective and were returned to the supplier.
(f)
Payments made
(g)
(h)
(i)
is
applied at a rate of
to vendors
and
on account, $21,500.
is
$60,000.
office
Stillwater,
Accounts
Materials
in Process
Finished Goods
Total
Cr.
$ 19,500
Work
Dr.
68,250
23,000
540,000
120,000
$536,400
36,000
198,350
Factory Machinery
$770,750
$770,750
82
PART
II
(b)
The
factory payroll for $45,000 direct labor and $9,000 indirect labor was
mailed to the home office. The home office payroll was $15,000 for sales
salaries and $21,000 for office salaries.
Employee payroll deductions were
recorded at the home office at these rates:
of gross earnings for PICA tax;
18% of gross earnings for federal income tax.
6%
(c) Indirect
(d)
State un-
(e)
(all
Production orders
(g)
$60,000
15,000
4,500
Accounts payable totaling $142,500, including the accrued payroll, were paid,
an annual rate of 10% of the original cost was recorded on
(h) Depreciation at
(k)
(1)
(i)
(j)
goods.
(m) At the end of September the factory overhead accounts are closed, and any
over- or underapplied balance is closed to the cost of goods sold account.
Draw up the two factory overhead accounts; post applicable transactions
therein and determine the over- or underapplied amount.
Required: Journal entries to record the above transactions on the general
books and on the factory books.
office
PROBLEMS
Cost Accounting Cycle; Cost of Goods Sold and Income Statements.
Baker Co., a manufacturer, had these beginning and ending inventories at the
end of its current year
4-1.
Raw
materials
Work in process
Pinished goods
Beginning
Ending
$22,000
40,000
25,000
$30,000
48,000
18,000
Raw
materials purchased
Indirect materials and supplies purchased
Direct labor cost
Indirect factory labor
Property taxes and depreciation on factory building
Property taxes and depreciation on salesroom and office (shared
a 50%-50% basis)
*Assume no
$300,000
50,000
120,000*
60,000*
20,000
on
15,000
CH.
and
20%
to office).
$ 50,000
40,000
120%
of direct labor
?
Salesmen's salaries
40,000*
24,000*
730,000
Office salaries
Sales on account
*Assume no
goods
is
sold.
A cost of goods
(3)
An
4-2.
83
(Credit
sold statement.
(AICPA
income statement.
adapted)
place at the
Sept.
1.
1.
3.
5.
Federal
is
Gross
Earnings
Income Tax
PICA
Withheld
Tax
$3,200
$320
140
$192
84
72
in-
direct labor)
Marketing
1,400
1,200
Office
120
5.
Employer's payroll taxes on weekly payroll FICA tax, 6% state unemployment tax, 2.7%; federal unemployment, .5%. Charge factory payroll taxes
to factory overhead.
8.
9.
10.
1 1
for freight
on a machine bought
12.
Federal
Factory
(25%
Gross
Earnings
Income Tax
FICA
Withheld
Tax
$3,280
1,350
$328
$196.80
81.00
72.00
is
Marketing
Office
12.
1,200
135
120
14.
2/10, n/30.
&
Company,
$1,560.
Terms:
: :
84
Sept. 16.
Bought tools for factory use from Tower Machinery Company for cash, $60.
Charge factory overhead.
17.
PART
II
Paid Brown Garage Company for service and repair of trucks, $800. Of this
amount, charge 60% to the factory and the balance to marketing.
of the Ayres Advertising Agency.
18.
Paid the
18.
bill
net 30 days.
1
9.
(20%
Factory
Gross
Earnings
Income Tax
FICA
Withheld
Tax
$3,250
1,320
1,190
$325
132
119
$195.00
79.20
71.40
is
Marketing
Office
19.
21.
damaged condition on
22.
in
Company
for cash,
$3,000.
23. Paid
Haines
Apex Service
factory overhead.
24. Paid
Company
14 invoice.
Charge
Company
Agency $960
premium.
Factory
(20%
Gross
Earnings
Income Tax
FICA
Withheld
Tax
$3,300
$330
1,330
1,200
133
120
$198.00
79.80
72.00
is
Marketing
Office
26.
26.
Company
for Sept.
18 invoice less
damaged
materials returned.
30. Paid Central Telephone Company bill,
to office).
to marketing, and
60%
30%
30.
The beginning raw materials inventory was $2,000; the ending inventory
$2,200. Transfer the difference to
transactions.
30.
is
70%
of
$420
330
210
350
430
1 80
and accrual of
CH. 4
Sept. 30.
Work in Process
Work in Process
is
as follows:
to Finished
Goods.
Opening inventory,
Cost of goods sold
Opening inventory. Finished Goods
Sales on account
30.
85
$31,927
3,500
32,085
3,875
61,320
4-3. Factory
The
(a)
and
filled in
$13,500
the storeroom:
$12,300
4,000
$16,300
$14,200
A transfer voucher from the general office showed the following expenses to
be recorded:
Insurance on factory building and equipment
(prepaid account on general books)
Heat, light, and power
(f)
$250
325
75
240
100
Factory overhead
labor cost.
(g)
Work
(h)
Goods
is
$990
125% of
direct
4-4. Factory
: ::
86
On
January
Pottstown
$24,000
15,000
10,000
$25,000
13,500
9,000
Materials
in Process
Finished Goods
Work
General Ledger
$47,500
$47,500
Total
(a)
II
The following
PART
$49,000
$47,500
$49,000
Materials purchases
$49,000
month
Trenton
Pottstown
$29,000
$26,000
35,000
6,000
32,000
4,000
Direct
Indirect
(c)
(d)
Payments to vendors
(e)
(less
2%
discount)
400
550
30,000
25,000
15,000
3,500
1,400
2,900
$2,800
2,300
Office salaries
(Deduct
6%
books.)
(f)
Workers are paid, and employer's payroll taxes are recorded. The state unemployment insurance rate is 2%, the federal unemployment insurance rate is
,5%, and employer PICA tax is 6%.
$15,000
(g)
(h)
(i)
to
80%
$17,000
accounts.
(j)
$65,000
Finished goods amounting to $114,000 were shipped to customers
from the Trenton plant and $49,000 from the Pottstown plant. (A gross profit
of 25% of the sales price is made on these shipments.)
4-5. Factory
Cash
Accounts Receivable
Materials
in Process
Finished Goods
Work
Machinery
$20,000
25,000
10,000
4,500
9,500
30,000
Accounts Payable
Accrued Payroll
Capital Stock
Retained Earnings
Factory Ledger
General Ledger
$15,500
2,250
60,000
21,250
24,000
24,000
CH.
87
(b)
(c)
indirect labor,
(e)
Gross payrolls totaling $75,750 were paid (10% of wages paid was withheld for
income taxes, and $4,545 for PICA taxes). Debit Accrued Payroll for total
gross wages of $75,750. Credit Accounts Payable for employee earnings after
deductions; then record the cash payment to employees.
Materials were consumed as follows: direct materials, $82,500; indirect materials, $8,300.
Pactory overhead applied to production was 76% of the direct labor cost.
finished and placed in stock cost $188,000.
(g)
(h) All but $12,000 of the finished goods were sold, terms 2/10, n/60. The markup
was 30% above production cost.
(f)
Work
(j)
amount of $104,000.
Required: (1) Set up trial balances of the general ledger
ledger as of January 1, 19B.
Open general ledger and factory ledger accounts from the January 1
balances and record the balances.
(3) Post the January transactions directly into the ledger accounts without
journal entries. Open new accounts whenever necessary.
(4) Prepare trial balances of the general ledger and the factory ledger as of
(2)
trial
CASE
will:
Give managers uniform, timely, and accurate reports on business acMonthly divisional reports should be uniform and available by
tivity.
88
II
Provide
Company-wide
PART
in
each division.
4.
Mr. Mace
No
division now has more than five major product groups. The maximum
cost centers Mr. Mace foresees within any product group is six, including operating and nonoperating groups. He views general divisional costs
Altogether, Mr. Mace estimates
as a nonrevenue producing product group.
that about 44 natural expense accounts plus about 12 specific variance accounts
number of
would be adequate.
Mr. Mace is planning to implement the new chart of accounts in an environment that at present includes manual records systems and one division which
Mr. Mace expects that in the near future most acis using an EDP system.
counting and reporting for all units will be automated. Therefore, the chart of
accounts should facilitate the processing of transactions manually or by machine. Eff'orts should be made, he believes, to restrict the length of the code
for economy in processing and convenience in use.
Required: (1) Design a chart of accounts coding system that will meet
Mr. Mace's requirements. Your answer should begin with a digital layout of
the coding system. You should explain the coding method you have chosen
and the reason for the size of your code elements. Explain your code as it
would apply to asset and expense accounts.
(2) Use your chart of accounts coding system to illustrate the code needed
for the following data:
(a) In the
(b)
(NAA
adapted)
CHAPTER 5
JOB ORDER
COSTING
An
and
services.
To
decisions based
continuously necessary to
make
(1) cost
accounting in th e
sense of cost determination and measurement, (2) cost planning and con-
through budgets and sta ndards, and (3) cost an alysis for_decisipnmaking pur^^es.
The^ost finding or cost determination phase for the manufacturing
function is discussed in this and subsequent chapters. Costing involves
systems and procedures which lead to accounting entries and summary
reports designed to enable management to control the cost of materials,
labor, and factory overhead. The previous chapter presented an overall
view of the flow of costs and expenses, generally known as the manufacturing cost accounting cycle. The greater part of this chapter is devoted
trol
ween
cost systems
it
Befor e
90
must be made as
How
method
is
to
An
<^w<\^
on a standard
cost_i>asis.
IfLthe
II
PART
costs.
f'S^SLrX'TYs
^^>Vcc
Tn2^ i^>^T
iL
actual quantities
^j^^j^ ^j^g
P^V^y
-I''jlot
AM:V7*'- <jA5
all
advance of
to collect
<
actual costs.
j
may
(historical) cost
dis-
well as to
printers.
its
own
cost.
A variation of the job order cost method is that of costing or ders bv lo ts.
size
and
is
For example,
divided into
style shoe.
The
lots,
each
in the
lot
shoe manufac-
Chapters
'
CH.
91
This method
'
used when units are not separately distinguishable from one another
also exist:
1.
process:
;|,>-.>i
ccxr^
Y?va
method
process cost
"^"^
u-^ls
Sfi^ftv^oIIiV^JV^ S^WaSL-
it is
and many
others.
Becaij^e
A process
tation
product costing.
(x}}<
o^^Kac^
vvIaQ Via
AlX^cJ '^
WxA^ ^
car built according to the customer's specifications uses job order costing
to collect the cost per railway car.
^c**^^^
'^'\
and repetitive stamping machines. The cost of these stampings is accumulated by the process cost method.
Both the job order and process costing procedures can also be used for
service organizations. For example, an automobile repair shop uses order
costing to accumulate the costs associated with work performed on each
^^
automobile.
An
<\r\
Q^^"
<iaiSr\
process.
is
f"
ieii<-AMS^ tJ^**
"
is
i^
is
are
P<-^c'ai<:;\
<j2oJ^
pC-l^x^l^c^^^^si
2.
-r-
.>
airline or a hospital
"^
r^
""^
'
4^^
'
costing to accumulate costs per passenger mile or per patient day, respectively.
sizes
manufacturing
activity;
counting.
in
The accumulation of
is
costs poses a
to be stated.
figure^^s
-i.
'
'^'^if^
considered unsatisfactory from a control point of view, a cost uniLmust Cc-5 ^bJB*
be found that most adequately conforms both to the type of prodjict_and ti(J^
The cost unit used is by no means uniform.
>_
While coal
feet,
is
oil
by the
barrel,
shirts,
or
dozen or a gross.
n^c*?
\
^^
~ ^^^^1^^
ex I'^i^Oiy
'\AA i\
U\AJI
92
it is
PART
II
nor too small. If the-unit is- too large, significant cost trends _inayj2ass
unnoticed due to averaging of costs. If the unit is too small, it mayjiece.ssitate detailedjmd expensive clerical work. After the cost unit has been
established, data can belnarshaled to determine unit costs
and
to assign
inventory costs.
be placed in stock
is
recorded on a
summary
sheet called
is
3.
Job order
designed to collect
to a specific
job.
Several jobs or orders may be going through a factory at the same time.
Each cost sheet is given a job number which is placed on each materials
requisition and labor time ticket used in connection with the job. These
forms used for materials and labor, numbered for the job to which they
apply, are totaled daily or weekly and entered on the cost sheets. The cost
sheet eventually becomes a summary of all the costs, including factory
overhead, involved in completing a job. The cost sheets are subsidia ry
work
in
Jobs performed on the basis of customer specifications allow the computation of a profit or loss on each order. If jobs constitute production of
a specific quantity for inventory, job order costing permits computation
of a unit cost for inventory costing purposes.
The discussion that follows deals with job order cost accumulation
many
Company
this
pre-
chapter for
titled.
Materials.
<x.
Tiy)2ii^
CH.
93
1.
Purchase of materials
2.
in greater detail in
Chapters 12 and
13.
little
used
^^^^-^^
amo unt
Tli
^^^'
is
Materials
for
When
'^
'f^^
,>
^
recorded as
25,000
Accounts Payable
25,000
An
2,000
u>uxl .\^.
'2,000
,s
p^.^^J^
on the _a ppropria te
^^r^i^(Ji^S^]
materials ledger^rds.
work
When
a job
is
started, the
ma-
on the basis of
employees.
to the storekeeper
who
assem--^
ci3S>rMfi^
^^
count.
and a
Work
in Process
recorded as follows
Work
in Process
Materials
A copy
31,000
31,000
94
When
PART
II
materials originally requisitioned for a job are not used and are
Materials
is
Work
debited and
in
Process
is
The
credited.
return to
Ma-
ii^rt Aa. overhead control account and to departmental expense analysis sheets
which constitute a subsidiary ledger for tjie departments using the supplies.
y;i\bA'o^
or-^
Supplies issued might also be charged to marketing or administrative
^/u
s^t^^'^^expense accounts.
>(vj^\^y^
^^, ~Y
^
^^ ^^"^^^
^
^f^
V^L "W^ Factory Overhead Control
\H ^^Xx\A
r'^ct^Nv.-
^''-^'^^
<X
\o^^
'
It is
Debit
6,000
6,000
Credit
6,000
Indirect Materials
Materials
Subsidiary
^^^^>-^
is
made when
indirect
account&^ ch a s
is
The effect of
shown below.
all
MATERIALS
Mar.
Inventory
Purchase
86,000
^>
CH.
95
STAGE 2:
MATERIALS USED
STAGE 1
MATERIALS PURCHASED
Journal Entry:
Work in Process
Journal Entry:
500
Materials
.500
Accounts Payable.
400
General Ledger:
General Ledger:
WORK
MATERIALS
MATERIALS
500
500
400
IN
500
Balance
Received
500
500
Issued
Balance
500
400
Date
100
[A
Dept.
3/24
To compute
PROCESS
400
Subsidiary Records:
Subsidiary Record:
Received
400
Materials
Req.
No.
Cost
495
400
Used
on a labor time
most
factories the
Time tickets f6r the various jobs worked on each day are sorted,
priced, and summarized; at regular intervals, usually at the end of the
payroll period, the labor time and labor cost for each job are entered in
the space provided on the job order cost sheets. Po&ljiig to the cost shegjLs
constitutes the distribution of the direct t^bor payroll.
summary of
time ticket data facilitates journalzing, general ledger posting, and prepa-
To
made only
for federal
to deductions
1_'
96
PART
II
premium
However,
it
for
are subject to other deductions such as state income taxes, city earnings
taxes, pension
^^
'h'toX ^"V
?iCDi> C'^
r^T
Fund
illustrate the
bonds, union
policies, savings
contributions.
month: $12,000
of direct labor and $1,800 of indirect labor on the 15th; and $15,000 of
direct labor and $2,200 of indirect labor on the 31st. Assuming an average
of 10 percent for income taxes withheld, the journal entry would show:
payrolls during the
15th
Payroll.
Federal Income Tax
Payable
31st
Payroll
Federal
13,800
FICA Tax
Payable^.
Accrued Payroll ....
1,380
Payable
828
FICA Tax
To
1,720
1,032
14,448
Payable.
Accrued Payroll ....
1,592
17,200
Income Tax
to record the
payment
Accrued Payroll
Cash
1,592
11,592
to the workers
14,448
14,448
month-end summary
Record
_L\
WorkinProcess.U^.y^:^..^t^h^l..
Factory Overhead Control
Indirect
Payroll
Debit
Credit
2"^0
4,000
Labor
4,000
31,000
The above example was simplified for illustrative purposes. The entries
on a weekly basis, so that labor cost remains current
on the job order cost sheets made available to operating management.
The details supporting the $27,000 Work in Process debit should be found
are usually recorded
I
'F^
I
V-
r
(
'For convenience in computations, a rate of 6 percent for FICA (OASI and Medicare) on
annual wages up to SI 5,000 paid each employee is used in the illustrations and problems of
this textbook. Similarly, a maximum state unemployment tax of 2.7 percent and a federal unemployment tax of .5 percent on annual wages up to $4,200 are used.
^Payroll is the labor cost clearing account -keptirLlheLiecords as^a converLiencending.analysis
of the labor time tickets and distribution of the labor cost to the proper accowiHT"
^The employees' share of the FICA tax is withheld at the time the employees are paid. At the
same time or a later time the employer's share is recorded. For convenience, the FICA tax
liability of both the employer and the employees is commonly recorded in one account, FICA
Tax Payable.
^-tVJt
'^^
V,VvOuQ
Ol~ ^ l^f-
UC^nvow^.jurT)
Ooi^
~L^
^^^ ^'A
'
V ^^^P
\^
CH.
WS
R^
V^
t>Wi^
ty>-^
"V^^
W^^
97 <\^^^^
The employer's payroll taxes are commonly recorded at the end of each
month or sooner if necessary. Assuming the FICA tax to be 6 percent,
the state unemployment tax to be 2.7 percent, the federal unemployment
tax to be
.5
percent,
direct
Record
Factory Overhead Control
Payroll Taxes
FICA Tax Payable
Debit
Credit
2,852
2,852
1,860
837
State
Indirect labor
r1
is
155
and
<
-"r-
fv
entered in the factory overhead control account and on the departmental "^^ .^
expense analysis sheets in the same manner as indirect materials. The <?^
payroll account and employer payroll taxes accounts may also include ^X^ \.\o
L- costs
On
cost.
page 98
Stage
is
summary of
the financial accounting phase for payments to the workers each payroll
period.
Stage 3 shows the cost accounting phase resulting from the labor
"^^<'-
measured in a straightforward and reasonably exact manner. The remaining cost element, factory overhead, presents a more involved problem.
If a planing mill contracts to make fifty cabinet assemblies for an apartment complex, the materials used and the labor expended can be entered
on the requisitions and time tickets. But how much depreciation of the
factory should be charged to the fifty cabinet assemblies; how much depreciation of saws, planers, and sanders;
machines
light, heat,
how much
cutting tools, idle time, night watchman's salary, janitor's wages, plant
taxes,
some of
cutting tools
is it
vary
often not
contributing
rent, insurance,
oil,
is
known
how
such as
the expenses
\oy^^pyM\^~
JUr^c^
n/i
cUqo
the cost of materials and labor used on a given order can generally be
much
JLpp'V
until the
when
it is
the actual
end of the
Jifiw,
completed ^th
amount of
fiscal_period ?
these
y.
^^^-'^^^j
iv^J
98^
PART
II
'^
STAGE
STAGE1: PAYROLL
COMPUTED WITH
DEDUCTIONS
as +K.
DISTRIBUTED
Tax Payable
PICA Tax
Payable
Accrued Payroll
31st
Payroll
1,380
Work
Accrued
13,800
Federal Income
/M<j;l>-
Journal Entries
15th
15th
^-1
STAGE 3: PAYROLL
COSTS
PAYROLL
Journal Entries
Journal Entries
Payroll
2:
PAID
Process
in
27,000
11,592
Cash
11,592
Factory Overhead
Control
4,000
Labor
(Ind.
828
11,592
4,000)
31,000
Payroll
31st
31st
Accrued
17,200
Payroll
Federal Income
Tax Payable
FICA Tax
Payable
Accrued Payroll
Factory Overhead
Control
(Payroll Taxes,
Payroll
1,720
14,448
Cash
2,852
2,852)
14,448
FICA Tax
Payable
1
.
,860
,032
Pay
14,448
837
Pay
155
Subsidiary Records
Employees'
earnings
Genera/ Ledger
re-
WORK
IN
PROCESS
27,000
FACTORY OVERHEAD
CONTROL
4,000
2,852
Subsidiary Records:
Hours
Amount
27,000
31st
DEPARTMENTAL
EXPENSE ANALYSIS
SHEETS^
Amount
Classification
Labor
FICA Tax
Indirect
State
Unemp.
Tax
Federal
837
Unemp.
Tax
155
a separate cost sheet for every job. Entries m the direct labor section of
during the period total $27,000 as show/n by the work in process account.
2 There is an analysis sheet for each departmenlor-COSl center.
There
4,000
1,860
is
all
jobs worked on
overhead
is
presented in Chapters
9, 10,
and
18, a brief
explanation of the
CH. 5
procedure
is
99
In
between two
relationship as the
is
Work
in Process
13,200
$2.20)
13,200
It is
common
practice, as in the
13,200
13,200
and actual
it
keeps applied_asts
Some companies do
factory overhead applied account and post the credit directly to Factory
Overhead Control:
Work
in Process
Factory Overhead Control
13,200
13,200
This entry eliminates the transfer of apphed expenses to actual expenses. -4.W'> ''^'^
Actual Factory Overhead. While job order cost sheets receive factory
overhead on the basis of a predetermined factory overhead rate, actual
factory overhead (consisting of indirect materials, indirect labor, payroll
taxes, invoices received for
oil/KjtP
U)
cleft
J-
Jk
i/
f^
PART
100
II
Subsidiary
Record
Factory Overhead Control
Depreciation
Accumulated Depreciation
Factory Overhead Control
Expired Insurance
Prepaid Insurance
Debit
Credit
682
Machinery
682
682
516
516
516
For the Shamrock Manufacturing Company, $6,000 of indirect materials were requisitioned from storerooms, $4,000 of indirect labor was
used, and payroll taxes on factory labor totaled $2,852. Other factory
expenses comprised of depreciation ($682) and insurance ($516) were
prorated through month-end adjusting entries totaling $1,198. The factory overhead control account would reflect these facts as shown below.
Indirect Materials
Indirect Labor
Payroll Taxes
Depreciation
Expired Insurance
6,000
4,000
2,852
Mar. 31
Overhead Applied
to
Work
13,200
in
Process
682
516
74,050
The balance of $850 remaining in the factory overhead control account indicates that actual expenses exceeded the overhead applied to the
job orders; stated differently, overhead was underapplied. Further explanations and analyses of this balance are made in Chapters 9 through 1 1
The above control account was debited with all actual factory overhead
items and credited with the factory overhead applied amount. lapiactice,
the details of the actuaHactory overhead jt ems arg^recorde d in a j ubsidiary ledger called departmental expense analysis -sheets or
head
Jactory
ov er-
analysjs_ sheets.
is
illustrated
a month's operations.
CH.
101
STAGE
1:
General Ledger:
General Ledger:
WORK IN PROCESS
13,200
14,050
FACTORY
OVERHEAD APPLIED
MATERIALS
Indirect
13,200
Materials
6,000
PAYROLL
Indirect
Labor 4,000
Payroll
NOTE; The
application of over-
jobs
head to the
five
done merely
pose of
is
illustrating a typi-
cal factory
tion as
it
cost sheets.
OTHER COSTS
1,198
Subsidiary Record:
Subsidiary Record:
COST SHEETS
Depr.
$682
Insurance
Taxes
$2,852
$516
Indirect
Indirect
Labor
Materials
$4,000
$6,000
PART
102
In
factories
departmentalized
with
operations,
separate
work
II
in
pleted.
When
88,000
88,000
Sales
to Finished
52,300
Goods
52,300
amount of materials,
labor,
DISCUSSION QUESTIONS
said to consist of three different phases.
1.
Cost accounting
2.
Name
3.
What
4.
What
is
5.
What
is
meant by a
6.
What
is
five
is
Name
them.
subsidiary record or ledger supports each of the control accounts mentioned in answering Question 2?
cost sheet?
CH. 5
9^
kFOR:
QUANTITY:
12'
MATERIALS COSTS
103
)OB
ORDER
NO.
978
DATE ORDERED;
3/10/-
DATE STARTED:
3/1 V-
DATE WANTED:
3/22/-
DATE COMPLETED:
3/20/-
104
PART
II
CH.
105
and cases
tax, .5%;
EXERCISES
Classify these industries with
1. Cost Accumulation Procedure Determination.
respect to the type of cost accumulation procedure generally used
job order
costing or process costing.
(a)
Meat
(k)
Pianos
(b)
Sugar
(1)
Linoleum
(c)
Steel
(m) Leather
(n)
(e)
Paper boxes
(o)
(f)
Wood
(p)
furniture
Nylon
Baby foods
Locomotives
machines and equipment
Luggage
(g)
(h)
(q) Office
Coke
(r)
(i)
Cooking
(j)
Caskets
utensils
(s)
(t)
Paint
Tires and tubes
Job Order Cost Sheet. Eddystone Machine Works, Inc. collected its cost
data by the job order cost accumulation procedure. For Job No. 642, the following data are available
2.
Direct Labor
Direct Materials
9/14 Issued
$1,200
9 /20 Issued
9/22 Issued
620
480
Factory overhead
Required: (1)
(2)
The
is
Week
Week
$4.80 /hr
5.25 /hr
selling price
markup of 40% of
cost.
Raw
@
@
Company provided
Inventory, January
Purchases
(all
on
1,
19B
$10,000
30,000
19B
Labor:
$ 3,000
25,000
from materials)
Depreciation
Other factory overhead costs
(all
1 ,500
3,500
1 ,000
14,500
the
PART
106
Work
Job #1
in Process:
1,
19B..
Job #2
Job #3
II
Total
$1,000
$1,000
Direct materials
Direct labor
Job #1
$6,000
8,000
8,000
$5,000
7,000
7,000
1 5,000
20,000
20,000
Job #2 (started
Job #3 (started
finished
in
in January, 19B)
is
in the
Finished Goods:
Inventory, January
$ -0-
9B
Required: Journal entries, with detail for the respective job orders
factory overhead subsidiary records, to record these transactions
and
(b)
4.
Materials
in process
in process
in process
Finished goods
three
work
$2,800
$3,400
$1,800
1,600
1,280
1,500
1,200
900
720
$5,680
$6,100
$3,420
Labor
Factory overhead
3,2(X)
15,000
Materials
Total
the fol-
$14,000
8,000
4,000
materials
labor
factory overhead
Work
Work
Work
The
Company had
pertains to
March
operations
Of
this
Materials returned to the storeroom from the factory, $600, of which $200
were for indirect materials, the balance from Job No. 622.
Payroll, after deducting 6% for PICA tax and 12% for federal income tax,
was $31,160. The payroll amount due the employees was paid during March.
CH. 5
(f)
107
Of
the payroll, direct labor represented 55%; indirect labor, 20%; sales sala15%; and administrative salaries, 10%. The direct labor cost was distributed: $6,420 to Job No. 621; $8,160 to Job No. 622, and $6,320 to Job
No. 623.
ries,
(g)
An
(h)
(i)
(j)
(k)
(1)
9.2%
employer's
is
6% FICA
tax,
Jobs No. 621 and No. 622 were completed and transferred to the finished
goods warehouse.
Both Jobs No. 621 and No. 622 were shipped and billed at a gross profit of
40% of the cost of goods sold.
Cash collections from accounts receivable during March were $65,450.
Required: (1) Job order cost sheets to post beginning inventory data.
(3)
A schedule
of inventories on
March
March
31.
Job Costing and Journal Entries for the Cost Accounting Cycle of a MuniciThe Intragovernmental Service Fund of Reading Township manufactures: (1) street and traffic signs for the Sanitation and Street Funds and (2)
historical markers, information signs, and danger signs for the General Fund
and Utility Fund. Each job is charged to these funds at prime costs (materials
and labor) plus applied job overhead of 10% of prime costs. On November 1
there were no jobs-in-process inventories.
During November these trans5.
pality.
actions occurred:
(a)
(b)
(c)
Jobs for
Sanitation and Street
Fund
General Fund
Utility
is
called
Job Overhead
Materials
Labor
$5,000
3,000
$7,500
4,500
2,000
Fund
1,000
(d)
From the payroll in (c), these deductions were made: FICA tax, $700;
ployee's federal income tax withheld, $1,600; union dues, $100; and
ployees' group insurance, $100.
(e)
Recorded the employer's payroll taxes for November. The city has achieved
a merit rating that enables it to pay only 1.5% for state unemployment tax.
(f)
and
Due from
Fund).
billed to the
emem-
108
PART
II
(g)
(h) Paid
amount owed
to the Special
Revenue Fund.
Collected $10,000 from the Sanitation and Street Fund; $5,000 from the
General Fund; and $3,000 from the Utility Fund.
(i)
PROBLEMS
Job Order Cost Sheet. Tedyuscung Manufacturing Company produces
machines made to customer specifications. The following data pertain
to Job Order No. 1106:
5-1.
special
Date
Date
started: 11/
/IP-
Week Ending
Materials used, Dept. 1
Direct labor rate, Dept. 1
Labor hours used, Dept. 1
Direct labor rate, Dept. 2
Labor hours used, Dept. 2
Machine hours, Dept. 2
Applied factory overhead, Dept. 1
Applied factory overhead, Dept. 2.
4/19
finished: 11/18
11 111
Week Ending
$2,400
$4.10 per hour
$1,300
$4.10 per hour
600
400
300
200
25%
11 118
at a rate of
Required:
make an adequate
profit
margin on
order ?
5-2. Job Orders; Factory Overhead Subsidiary Ledger; Cost of Goods Manufactured Statement. At the beginning of September certain ledger accounts in
the books and records of the Mayfair Products Company, Inc. had these
balances:
Credit
Debit
Work
in Process
Materials.
?
Accrued Payroll
.
}~.
$ 1,010
3,690
r.
is
436
320
450
240
$ 1,010
Total
"V^d-or^
/H
r>)
.^3 3^^
f5J-
L)"?"
CH.
Certain columnar
September show:
r Accounts payable
ajy.
?^ '^ Purchase discounts
:iiry\oSX^,
Materials
lost
^-'vpH;'. h'.
Accrued payroll
Income taxes withheld
.
109
.ir;s!viftJi
0Wi";i*(
9-5-
<^4'-.
$13,820
108
5,300
4,352
478
(credit)
(debit)
(debit)
(debit)
''^^"^
(credit)/
^Vf
HT'^O
For production
For repairs and maintenance
^ For factory supplies
$ 4,270
250
600
The labor
distribution sheet
shows
t.
$ 6,000
Factory overhead
^ Foreman's
salary
800
1 80
600
Total
The
1,580
$ 7,580
month
consist of:
Direct materials
Direct labor (1,910 hours)
Factory overhead applied
$ 4,030
5,730
3,056
Total
JT/i
^h
^D
^^^^^"^
1
$12,816
foreman's
Salary
Mndirect Labor
"^/Tactory Supplies
Factory
^-Depreciation
800
430
600
600
Factory Insurance
Rent
Equipment
1,137
Factory
200
20
Total.
.'.'.
.
r.
Required: (1)
of September.
(2)
i\\.:F.vJ.
..^
150
160
150
^.f!.
560
720
384
$1,664
month
month of September.
110
PART
II
Job Order Cost Accumulation and Accounting for Factory Overhead. The
Clementon Manufacturing Company builds construction machinery to customer specifications. On December 31, the following inventories appeared on
"
^
VJoAa^^c9-5
the company's balance sheet:
n5-3.
'
V& ^ '^
(^
'
'
"
'^
$32,300
Work
55,
1 1
14,800
^^
Job No.
Materials
Labor
Factory Overhead
Total
LP4422
$14,800
7,200
$12,300
5,600
$10,455
4,760
$37,555
17,560
$22,000
$17,900
$15,215
$55,115
OK5000
The finished goods inventory consisted of one job: Job No. DU3750. Thg
company has always applied factory overhead on a rate based on direct labor
cQst.
V/J
r^ -
o-j)
Vh
year at
In January two new orders were started: No. MA4440 and No. HA5001.
For these two orders and the other work in process, the following costs were
t>L ViDur-
Materials Cost
LP 4422
$2,300
OK
MA
5000
4440
HA
5001
5,300
11,200
9,280
Vc,0i^
$1,980
4,500
5,980
5,400
-1%-^^
'U^
^^'^''/In'"-
^'^^
-'
Z-^"^
month were:
"
Power
Depreciation
Insurance
C
(
400
1,600
Repairs
Taxes
$3,200
350
900
Jobs LP4422 and OK5000 were completed and billed at $75,000 and $52,000.
Jobs MA4440 and HA5001 were still in process on January 31.
Required: (1) The overhead rate used for the application of overhead to the
jobs in process on December 31.
(2) The new overhead rate based on estimated direct labor hours.
(3) The journal entry to apply factory overhead to all jobs worked on during
CAv^r t^ "b +U. S^b- Ifici
January (in total, not individual jobs). 4- r.ct .ivS o - ^-k^ i^^
(4) The amount of over- or underapplied factory overhead for January.
(5) The total cost and the gross profit on Jobs LP4422 and OK5000.
(6) The amount of the work in process inventory on January 31.
-
^^
VUt<
CH.
111
5-4. Journal
Company:
(a)
month as follows: to
$25,250; supplies issued to the factory, $1,300.
(c)
fill
requisitions
on job orders,
(Freight
is
(f)
Scrap materials received in the storeroom were set up at a value of $175, and
credit was given to Factory Overhead Control for that amount. A separate
general ledger account, Scrap Materials, is used.)
(g) Materials
orders, $1,090;
(i)
(j)
balance of payroll,
(k) Depreciation for the
(1)
Property taxes accrued during the month, $750; insurance expired with a credit
to the prepaid account, $850.
(m) Factory overhead is charged to production at a rate of $ 1 .40 per direct labor
hour. Records show 19,200 direct labor hours used during the month.
out the over- or underapplied factory overhead to Cost of Goods Sold.
Cost of goods completed during the month, $81,750.
(p) Goods costing $75,500 were sold on account during the month at a sales price
(n) Close
(o)
of $90,000.
Indicate the
Ledger accounts for Work in Process, Factory Overhead Control, Maand Finished Goods. The November 1 balances were: Work in Process,
$9,750; Materials, $6,180; Finished Goods, $5,660.
(3) What is the effect of closing over- or underapplied overhead to Cost of
Goods Sold?
(2)
terials,
Ledger Accounts Covering Cost Accounting Cycle and Job Cost AccumulaThe following is information regarding the operations for March of the
Goodfield Products Company:
5-5.
tion.
Raw
Materials
Work in Process
Finished Goods
$ 65,000
292,621
78,830
March
Over- or Underapplied
Factory Overhead
$12,300
(cr.)
112
The work
in
process account
Job No.
Item
204
205
206
80,000 Balloons
5,000 Life Rafts
10,000 Life Belts
is
PART
II
Direct
Materials
Direct
Factory
Labor
Overhead
Total
$ 15,230
$ 21,430
$ 13,800
$ 50,460
40,450
60,875
55,240
43,860
22,370
19,366
118,060
124,101
$116,555
$120,530
$ 55,536
$292,621
(b)
(c)
calls for
4,000
life
jackets.
March:
Job No.
Amount
Hours
204
205
206
207
$13,422
14,630
14,075
12,948
6,711
6,500
7,230
5,820
federal
(f)
Raw
materials issued
Job
Job
Job
Job
(g)
No.
No.
No.
No.
204
205
206
207
$ 9,480
11,320
10,490
16,640 (excluding special purchases of $5,800 which are
also issued at this time)
factory building
2,840
1,260
Light
(h)
Factory overhead
(i)
Shipped and
is
billed
....
Indirect supplies
$1,810
3,390
2,240
1,910
at a contract price
of $97,500.
in the over- or
account.
General and Subsidiary Ledger Accounts Covering Cost Cycle Using Job
Order Cost Accumulation. The Leyden Company makes two types of storage
batteries: Dependable Senior and Dependable Junior. General and subsidiary
ledger balances as of May 1 were
5-6.
CH.
113
Credit
Debit
$ 35,000
Cash.
Accounts Receivable
?s'nnn
Raw Materials
Work in Process
\^c^
Finished Goods
Factory Equipment
Accumulated Depreciation
Accounts Payable
Capital Stock
Retained Earnings.
-yCl^m
:f^'"^^
zu,uuu
Factory Equipment
4,000
46,000
80,000
25,000
Raw materials
Fluid
$17,500
12,000
5,500
Total
$35,000
Cases
Zinc
Work
Dependable Senior.
Dependable Junior
$15,000
10,000
$25,000
Total
Dependable Junior
Job Order #85
for Stock
Dependable Senior
Job Order #84
for Stock
in process inventory
Materials
Labor
Factory overhead
Total
The
$155,000
$155,000
^^^^j
$5,000
2,500
$4,000
1,250
750
$8,750
$6,250
1,500
only.
figures in the subsidiary ledgers are expressed in dollars
the batteries,
The
SIO'OOO
5,000
5,000
Cases
Zinc
Fluid
$20,000
18,000
3,000
20,000
10,000
4,000
Payroll
Factory overhead
Marketing expenses
Administrative expenses
Financial expenses
$75,000
(b)
Summary
of materials requisitions
Cases
Zinc
Fluid
(c)
Total
$21,000
16,000
8,000
$11,000
8,000
5,000
$10,000
8,000
3,000
$45,000
$24,000
$21,000
Payroll analysis
Direct labor:
$7,000
7,500
$14,500
3,500
Indirect labor
$18,000
(d)
The overhead
rate
is
50%
114
(e)
Job #84
(f)
Summary
II
finished.
is
of sales on account:
Sales Price
Cost Price
Dependable Senior
Dependable Junior
$ 80,000
$ 45,000
22,000
8,000
Total
$102,000
$ 53,000
Summary
(g)
PART
of cash transactions:
Received on account
Paid creditors and other
Required: (1)
the above data.
$11 8,000
105,000
liabilities
The posting of
all
is
$1,250.
transferrring
(3) The checking of the control account balances with the balances of the
related subsidiary ledger balances.
(4)
A trial
balance.
CASES
A. Job Order Costing; General and Factory Ledger. On December 31, 19 A,
after closing, the ledgers of the Palmer-Travis Company contained these accounts and balances:
Cash
Accounts Receivable...
Materials*
Work in Process*
Finished Goods*
Machinery
Accounts Payable
$47,000
50,000
22,000
7,500
32,500
35,300
$ 59,375
Capital Stock
100,000
34,925
62,000
62,000
Retained Earnings
Factory Ledger
General Ledger*
Materials inventory:
AB -
2,000 units
4,000 units
$10,000
12,000
$5.00
3.00
$22,000
Total
Finished goods inventory:
Item
Item
XY-
1,000 units
2,000 units
@
@
$12,500
20,000
$12.50
10.00
$32,500
Total
Work
in process inventory:
Direct materials:
500 units of A
200 units of B
@
@
$5.00
3.00
$2,500
$
600
Direct labor:
2,000
1,000
1.000
400
$5,500
$2,000
CH.
115
completed:
During January, 19B, these transactions were
(a)
amounting to $17,520.
$110,000 was
unemployment
units
10,000
basis as follows: Material
(d) Materials were issued on a fifo
(charged to Job No. 02)
(charged to Job No. 101); Material B, 12,000 units
103).
(charged to Job
Material A, 1,000 units, and Material B, 2,500 units
Indirect materials
order.)
consecutive
in
taken
be
to
(Note: Transactions
amounting to $7,520 were issued.
No
(e)
(f)
(i)
(j)
collected
on
amounted
to
month
Marketing and administrative expenses paid during the
amountmg to $10,800 was paid and
$15 000 Miscellaneous factory overhead
machinery was $2,000.
transferred to the factory. Depreciation on
to $85,000.
Payments on account, other than payrolls paid, amounted
closed to the cost of goods
Over- or underapplied factory overhead is to be
sold account.
overhead incurred.
of January
balances of the general ledger and the factory ledger as
ledgers.
subsidiary
with
31, 19B, reconciling control accounts
goods sold for January, 19B.
(6) A statement of cost of
(5) Trial
'
^u, f^r
on a piecework basis, paymg only tor
the
Although
inspection.
be acceptable upon
,
its
direct labor
116
PART
II
or only a portion of the materials may have been issued. Any direct labor costs
incurred for these lots will be restricted to the labor for units already completed
and accepted by inspection but not transferred to finished goods.
On
September
30, 19
$133,700
the plant)
$ 20,000
Liabilities
100,000
40,000
Capital Stock
Retained Earnings
53,200
18,900
12,400
8,000
4,000
Materials
Direct Labor
Factory Overhead
Marketing Expenses
Administrative Expenses
70,200
Sales
$230,200
Total
$230,200
Of the completed lots for September, one lot of 100 units is in the storeroom;
and the remaining lots were sold to the National Mail Order Company under a
contract which called for the purchaser to pay a price equal to cost (including
a reasonable allowance for normal overhead) plus a markup equal to 30% of
cost. This contract accounted for all of the company's sales in September. Since
the Pepper Products Company has no cost accounting system, the National
Mail Order Company cost accountant made an analysis of the Pepper Products
Company's records and developed these figures pertinent to the contract:
Unit Cost
$60
30
Factory overhead
18
Basis of Calculation
Cost to company of
all
components
Mail Order
(a) Entries both on the books of the home office and on the books of the
plant to change the company's accounts to reflect the use of a job-lot accounting
system as desired by the management. (Assume that no inventories were on
and that the company closes its books on August
hand on September 1, 19
31, the end of its fiscal year.)
is
CH.
117
Required:
list
Costing formulas and ratios prepared a long time ago are still being
used by estimators even though prices for materials have increased, overhead is higher, and new machinery has been installed.
(b)
(c)
(d)
(e)
Determining departmental
never be determined.
is
efficiency
is
not
possible.
Required:
tions
and
remedy the
situation.
the standardized nature of the product. It is now believed that the old system
is no longer satisfactory because a knowledge of the profitability of each job lot
is needed.
In order to produce these small lots, skilled workers in several of the departments have been assigned to work on the special orders; in some instances,
even special locations for this type of work have been established. However, in
some phases of the production processes the special threads are processed in the
same way and by the same workers and facilities as the present, regular line.
and
118
PART
II
He
two
(^
shifts;
shift.)
Designing Cost Accumulation Procedures. You are asked by a client to adhim as to a satisfactory system of factory costs. You find that his factory
divided into two main divisions:
(a) Machine Shop. This division makes steel molds used in the manufacture
of plastic articles. These molds require careful precision work; and
vise
is
^^
\jD^:
You
(a)
-7^
/-^
^v'.-f-
(b)
Production
(c)
Raw
in
both divisions
is
^t
%,
cost records. ^
'^
1-
Cost"
o^
'^'
materials are kept in one place, but no record has been kept of
withdrawals.
(e)
Labor is paid at hourly rates, and a time clock at the factory entrance is
used for determining the hours worked in any day.
Employees have been preparing satisfactory time tickets showing the
hours worked on each job and, in the case of the Plastics Division, the
number of units produced; but this record has never been balanced
against the wages paid nor the record of production.
(f)
Spoilage
(g)
(d)
is
one building.
(h)
why you
(CICA adapted)
CHAPTER 6
PROCESS COSTING
It is
important to understand that, except for some modifications, the accumulation of materials costs, labor costs,
also applies
to process costing.
petroleum,
textiles, steel,
is
also used
by firms manu-
facturing items such as rivets, screws, bolts, and small electrical parts.
third type of industry using process costing
methods
is
the assembly-type
and household
electric appliances
costing methods.
_c r>ndit;ions_of
mass jtroductioajnetiiodsiln
fact,
their
119
120
custom machinery
company
will use
will use
PART
II
order to accumu-
Ia-onliast^he
is
piocfiss.
work
computation of costs
on unit costs.
department
originating
The cost reports of departments other than the
are also reviewed with emphasis on the costing of closing work in process
inventories and the recalculation of preceding department unit costs due
mental unit
in process, (4)
to lost units.
is
total
3.
4.
2.
is
com-
pl eted 'unit s.
5.
Total cost charged to a department is divided by total computed production of the department to determine an average cost for a specific period.
to jhe^ost of satis- J
computed and added
A cost for lost or spoiled units
~~~
"
~~ is
'~
factory iriTits~CDTnpietgd:
*^-V
.
6.
^^
-fj^
'
CH.
PROCESS COSTING
121
Costs of completed units of a department are transferred to the next processing department in order to arrive eventually at the total costs of the
finished products during a period.
are designed to
1.
2.
3.
Transfer costs from one department to the next and to finished goods.
4.
still
in process.
"
'
COSTING BY DEPARTMENTS
The nature of manufacturing operations in firms using process or job
is usually such that work on a product takes place in
several departments. I n either^^st^m d^pf^rtmf^!r^t?^li7at ion ^of material s,
towards the completion of the product. For example, after the Mixing
Department has completed the starting phase of work on the product,
^Oth units ,and.COStS are transfprrpH frrmwvjlf rmniifnrninr| ^w|ppa^rtmeiT t^to anoth er.
used to charge each department for the materials, labor, and factory
its
to obtain departmental
unit
is
The breakdown of
costing departmental
work
and unit
computation of
in process inventories
still
in process which,
costs
by departments.
and for
control purposes.
Departmental total and unit costs are determined by the use of the
cost of production report which is described and illustrated in detail in
later sections of this chapter.
Most of the
system
122
PART
II
PRODUCT FLOW
A
and
selective
are
all
same
WORK
IN
PROCESS
MIXING DEPARTMENT
PROCESS COSTING
CH. 6
As
123
subsequent to the
first
may
be added in processes
ones.
mov es
the H p<;irpH
upon
some of
lastly to
Department
Smoking Department and
finally to Finished Goods; some
the Packaging Department, and
Finished Goods.
WORK IN PROCESS
BUTCHER ING DEPARTMENT
Materials
WORK IN PROCESS
PACKAGING DEPARTMENT
Labor
Factory
Overhead
FINISHED
GOODS
WORK IN PROCESS
SMOKING DEPARTMENT
Labor
Factory
Overhead
WORK
IN
PROCESS
GRINDING DEPARTMENT
Labor
Factory
Overhead
Transfer of costs from the Butchering Department involves consideration of joint cost allocation
and
is
8.
by appropriate journal
entries.
The
and charged
details involved in a
process cost system are usually fewer than those of a job order system
124
PART
II
charged to"departmenls T5TlTgr than to jobs, and THe number of departments usmg materials Is usually less than the number of jobs a firm might
handle at a given time. Frequently materials are issued only to the processoriginating department; subsequent departments add labor and factory
If materials are
overhead.
needed
in a
department o therjhan
,1.^
&^^
^^i?c^
th&^first.
r,ppr^\\nn
b^
^^^''^
i.e.,
adding purchases to
or prorations.
Formtilas^ specify
Work
in Process
Materials
The
Mixing Department
24,500
24,500
cost figures for the above entry as well as those for labor
T<^W
is
in the cost
and
of production
126.
-VW-
made
^y^
^ W>W<
^^ r>a\^
'
Jl
lifN
-\-
^W^ f*-^
'
to departments through
Work
Work
Work
in
Mixing Department
Refining Department
Process Finishing Department
Process
(.^^.>^
in Process
in
Summary
29,140
37,310
32,400
16,600
4,550
120,000
'
CKU6
'""'"' ;i
"
is
preferably accumulated in
ments
procedure that
and
service depart-
is
bility
The
recommend
the use oi
feasible
is
stable
from or^
period to period, for factory overhead will then remain about the same
when
is
also be justi-/
total cost.
I
<-
to the next.
Production
not stable,
stable.
'
<\j
is
a significant cost.
'Y^^t-^ ^^
arwY of o/^
^<^tucJi^ oa
'*^^^^^'
factory overhead
is
/^^
"^
J-f^^^
r^ ^cZS:%'i"
"fe', /^> -^f^^
1.
2.
is
rates should
especially
fixed factory
overhead
is
significant,
''
r)^,<V~
jLi*
-~4-
it
normal or uniform
^ production,
mined
rate
highly
recommended
^J^^ <^
f-^
work
must be accumulated
in a factory over-
The use of a
is:
xxxxx
Machinery
xxxxx
xxxxx
xxxxx
which
S ervice dfipaxtmenLgx10).
penses are kept in like manner and distributed later o n to producing d eall
pa rtmeffts:
At
These
department
totals,
^^ ^
^
^-^
"^
^-*^^
126
PART
II
labor hours),
Work
Work
Work
is:
Mixing Department
Refining Department
Process Finishing Department
in Process
28,200
32,800
19,800
in Process
in
80,800
The
to a departme nt.
is
all
cojts chargeable
at the
goods storeroom.
It is customary to divide the cost section of the report into two parts:
ope showing c osts fo r which the department is accountable includi ng
de j^artmental a nd cumulative total and unit costs, the other showing the
di sposition of these cos ts:
A quantity schedule showing the total number of units for which a department
is
made of
these units
is
Information in
work
in process inventory,
to be trans-
E ither
in the cost of
production report
itself
o r in the sup20xting
labor operation
is
shown
components are
PROCESS COSTING
CH. 6
127
labor,
item
/'^
r"-'-^^
-I'h*;'^
Uyy^Jf C^-Jt
c,r
pi'(iuc.ic>
(fer-v
)S ''^-(AM^
^ ^j
one product
if
^^y^
tif
ished product
is
is
^j^i^aJtu^^ia
the
expense
J,
\^r
Q^
.
wo rk
in process
usually
t o_determj ne its
made by a foreman
or
is
stage ot
comp letion.
an amount
sufficient to
must be restated
This analysis
is
on
complete them.
and transferred
in terms of
completed
To
units, units
JuJi^^
i^
'^^
Tor
still
units,
|^
assign
This equivalent production figure represents the number of units for which
sufficient materials, labor,
^0^
which is 4,000
units for materials costs but less than 4,000 for labor and overhead costs.
The figure for partially completedunit s in proce ss is addedjo units actu ally
completed to arrive at the equivalent pro duction figure for the period.
in process
period.
5-J^^
analysia-.slieets.
J
'
KflJ^A^.
<[^^
ViO-AJL
Cw5 ^^"^fi-'s
Wcj
VWi vwo^^
VNt^jL
,
WXf e^iuJ
\a)XV
128
d't YV-tN-xtV,
PART
II
19
Quantity Schedule:
50,000
45,000
4,000
1.000
^(i<^^
Labor
Q^-
. j>cv
i<>S-1i
rs-.t
.
c<ra}.VvL. \sij:iL.
\ ...'..
-ir^
Factory overhead ).
Total cost to be accounted for
Total
Unit
Cost
Cost
524,500
29,140
28,200
$81,840
$1.72
$77,400
$ 2,000
1,240
1.200
4.440
$81,840
1/1
.50
.62
OoM
SI .72)
50,000
Additional Computations;
Equivalent production
Materials
45,000
+ 4,000 =
Materials
$24,500
$.50
$.62
$.60
49,000 units
j^^^ = 47,000
units
49,000
$29,140
Labor
47,000
Factory overhead
$28,200
47,000
llflj
o\i^
"/h
^^
'^'^
'/^
?^
^"^
is
still
this discussion
in process
have
factory overhead, for only one half, or 50 percent, of the labor and factory
Cx)Tvvv'
iA^
overhead needed to complete the units has been used. In terms of equivajgj^^ production, labor and factory overhead in process are sufficient to
complete 2,000 units.
QSir
unit costs are accumulated into a completed unit cost for the period.
The
report for the Mixing Department shows a materials cost of $24,500, labor
CH. 6
PROCESS COSTING
cost of $29,140,
$24,500
is
129
sufficient to
out of the department as well as the work in process for which enough
materials are in process to complete 4,000 units). The unit materials cost is,
therefore, $.50
( ^S.'ooo )-
number of units
$29,140 and the
similar computation
and
actually
is
made
to determine the
units
in process are
a total
factory overhead.
is
When
month of
labor of $.62 Cliioo ) is computed. The unit cost for factory overhead is
$60 CI7S ). The departmental unit cost is $1.72, computed by adding
Department" shows a total departmental cost of $81,840. The lower part of the report shows the disposition of this cost. The 45,000 units transferred to the next department
have a cost of $77,400 (45,000 units multiplied by the completed departmental unit cost of $1.72). The balance of the cost to be accounted
$4,440 ($81,840
The inventory
$77,400),
figure
parts:
for,
Contin uous operating and p r ocessing lea ds to the possibihty of waste, seepage, shrinkage, and other ia^tors which cause loss o r
- spoilage of production un its. Management is interested not only in the
Lgst^JInits.
'
L- but also
in a
figures, the
results.
and
lost units
PART
130
reconciliations
is
The
i.e.,
yields are
as follows:
Percent Yield
los t.
computed
and
11
yield figure
is
^^^
Various
ties in closely
Frequently quality control data are used to compute production costs since
the use of incorrect quantities
would
units over
>
Refining Department.
Department resulted
costs.
shown on
from that of the Mixing Department in several respects.
Several additional calculations are made for which space has been provided
on the report. Ih_addit ional in formation deals wjth (1) m^t^ fg^eived
The
page 131,
fro
differs
(2)
for the
RefinmgDepartment snows
that 45,000
These units were accounted for as follows 40,000 units sent to the Finishing Department, 3,000
units
still
in process,
lost.
PROCESS COSTING
CH. 6
131
Quantity Schedule:
Units received from preceding department
Units transferred to next department
Units still in process ( i^ labor and factory overhead).
Units lost in process
^
.
Labor
Factory overhead
Total cost added
Adjustment for
lost units
45,000
40,000
PART
132
II
Refining Department
Work in Process
Work in Process Mixing Department
77,400
77,400
The work
in process
costs received
Losfm Departments Subsequent to the Fir_st. jhQ Mixing Department's unit cost was $1 .72 when 45,000 units were transferred to the Refin-
I^^^
TKslx
L^r ^f (
)
o,v
ing Department.
during processing in the Refining Department, the $1.72 unit cost figure
has to be adjusted as it no longer applies. The total cost of the units trans-
^cAmAjP
"^
juas
^
yUnits
t^
AjyUr C^y
lost
^^ygjjjg
2^xi
increase of $.08 in the cost per unit due to the loss of 2,000 units
in the Refining
Department.
The lost unit cost can be computed by either of two methods Method
No. 1 determines a new unit cost for work done in the preceding depart\\ojM.
ment and subtracts the preceding department's old unit cost figure from
"7^ Wo-^
^he adjusted unit cost figure. The difference between the two figures is the
(J>^ ^^^"^ additional cost due to lost units.
The new adjusted unit cost for work
:
'sot-
^^
is
*^^i5o^'^ good units, 43,000 (45,000 - 2,000), into the cost transferred in, $77,400.
The old unit cost figure of $1.72 is subtracted from the revised unit cost of
$1.80
LorT
lOt.
''/^^
(o."^ J^y
^^ ^"^^
allocates
^^^^ ^Q
^l^g
is
(a
is
$.08,
^^'
y^^
^>.U_
tost
-}J>CiO
c^
-f-^
i^^^
If'-lHrp
^^.
i>Ur
i^^o^
i^
CH.
PROCESS COSTING
133
units.
for
work done
preceding depart-
in the
ment, the departmental unit cost, and the adjustment for lost units are
totaled to obtain the cumulative unit cost for
work done up
The
to the
end of
Units are jost through evaporation, shrink age, poor yields, or spoile d
work.
losses
In
many
is
and machine
error.
spreads
it
Therefore, a
show the
common method
human
OTimits
lost
some other
or
lost, as
should
c ijr-
bZZone
-fksrf /i
- 1-*^
^^>^ >t
f'^-^^'^
"^
is
,-/-
made
in the
we re never put
in proces s.
"^
f"^
^li
'^
''
^f'^^^
is
No
is
charged to units
'
"
.jT^f "n^
o/y^
On
On
Increase
+$
320
Work in process
On page 131
On page 134
Decrease
inventory
$7,110
6,790
320
^va^tI
sW M5O0O
.
.,
^^ 31
itr
Iksl
Mi
W^^"^
Aa-v- T"
Refining Department
t^r^^jiP t*V>MxUx^
I
\,
So '^t Ac<s
,X
usr
*vo
Quantity Schedule:
45.000
45,000
Total
Unit
Cost
Cost
S 77,400
SI. 72
% 37,3,0
32,800
S .87
S 70,110
S1.63
S147,510
S3. 35
month
(45,000)
.m\
i".
h".
PP.-?.
Hojf-o..<^m.
.p<>r?M<y
Labor (3,000
'
(S3. 35
S140,720
5.1675)
S
S.87)
3'
J6
5,160
870
760
S.76)
6,790
5147,510
Additional Compltations
3,000
40.000
-i-
^^^^j^
43,000 units
Unit costs:
Labor =
S37.3IO
added to
* 40.000 units
532,800
^,
5.76
43,000
53.35
S3. 35 to
53.5175
computed: 5147,510
make
is
I
Transferred to next department (40,000 units X S3. 35)*
Transferred to a lost units expense account (40,000 units
Total
is
5134,020
6,700
5140,720
X 53.351^5134,000. To avoid decimal discrepancy, the cost transcomputed: 5147,510 - [56,790 (closing inventory) + 56,700] = 5134,020.
*40,000 units
ferred
$.1675)
CH.
PROCESS COSTING
Furthermore,
part
is
if
one part of
135
this loss is
is
treated as discussed
OJj^^\^c^(j^ (a[^vu>-w.^
The
cost
U^PS sa^
of production
report on page 131 shows total cost to be accounted for by the Refining
to be $147,510.
be included.
it is
and factory overhead added by the department are costed separately to arrive at total work in process. In the case
of the Refining Department, no materials were added to the units received;
thus, the closing inventory shows no materials in process. However, labor
and factory overhead costs were incurred. The work in process analysis
stated that labor and factory overhead used on the units in process were
sufficient to complete 1,000 units. The cost of labor in process is $910
(1,000 X $.91) and factory overhead in process is $800(1, 000 X $.80). The
Materials
(if
any), labor,
is
$7,1 10 ($5,400
$910
$800).
accounts for the total cost of $147,5 10 charged to the Refining Department.
figures
slwuld bs^
_^n
136
PART
II
40,000
35,000
4,000
1,000
month
(40,000)
40,000
Total
Unit
Cost
Cost
$140.400
$3.51
S 32,400
Labor
19,800
.90
.55
S 52,200
$1 .45
$192,600
$5.05
Factory overhead
Total cost added
Adjustment for
lost units
.09
$176,750
$ 14,400
S.09)!
900
550
15,850
$192,600
Additional Comput.ations:
Equivalent production
36,000 units
Unit costs:
Labor =
S32^
Factory overhead
s.90
Adjustment for
Method No.
519^
$.55
36,000
36,000
lost units:
I
^ 140,400
$3.60-
^3 ^q
$3.51
=$.09
per unit
^|^
=$.09
per unit
39,000
Method No. 2 =
1,000 units
title
X$3.5l =
$3,510
to this department
expense analysis
fining
Department follows
The entry
140,4(X)
140,400
goods storeroom
is
CH. 6
PROCESS COSTING
137
138
^
1.
What
2.
3.
4.
7.
8.
DISCUSSION QUESTIONS
is
Gasoline
b.
Sewing machines
Chocolate syrup
Textbooks
d.
5.
II
firm has a choice of using either a job order or process cost system.
Discuss the relative merits of each.
c.
6.
PART
e.
f.
g.
h.
Dacron yam
Cigarettes
Space capsules
Men's suits
Compare
If so,
how would
they be handled?
Would
cost of production
10.
What
What
is
used?
1 1
Separate cost of production reports are prepared for each production department. Why is this method used in preference to one report for the
entire firm?
12.
13.
What
its effect
on computed
unit costs.
be used?
15.
What
16.
department?
Select the answer which best completes the following statement. The type
of spoilage that should not affect the recorded cost of inventories is (a) abnormal spoilage, (b) normal spoilage, (c) seasonal spoilage, or (d) standard
spoilage.
(AICPA
adapted)
CH. 6
PROCESS COSTING
139
EXERCISES
In solving these exercises round off all amounts, except unit costs, to the
nearest dollar. Carry unit costs to five decimal places unless stated otherwise.
were:
$140,000
148,000
103,000
Materials
Labor
Factory overhead
The inventory of
electric irons,
Required: The cost of the finished goods inventory, assuming finished units
to be costed
on the
\2.JTotal and Per Unit Manufacturing Costs. In October the Aero Company put
mto process $50,000 of raw materials. The Milling Department used 12,000
labor hours at a cost of $30,000, and the Machining Department used 9,200 labor
hours at a cost of $2.25 per hour. Factory overhead is applied at a rate of $3 per
labor hour in the Milling Department and $4 per labor hour in the Machining Department. October 1 inventories were: materials, $16,000; materials in process,
$6,000; labor in process, $6,500; factory overhead in process, $7,200; and
finished goods, $12,400.
October 31 inventories were: materials, $18,000;
materials in process, $5,000; labor in process, $6,000; factory overhead in
process, $7,000; and finished goods, $14,000. The company produced 25,000
units of product during the month.
Required:
(1)
The
for the
October
production.
3.
Quantity Schedule.
in kilograms (kg.):
Raw
materials
Work in process
Finished goods
Opening
Final
400,000 kg.
100,000 kg.
100,000 kg.
500,000 kg.
150,000 kg.
110,000 kg.
Additional data
Raw
materials purchased
Finished goods sold
1,600,000 kg.
1,240,000 kg.
work
in process,
and
finished goods.
Cost of Production Report; No Inventories; Three Departments. The HaddonCompany manufactures a rayon product which is processed in three departments known respectively as: Spinning, Twisting, and Winding. There were
4.
field
140
PART
II
Spinning
Twisting
Winding
$3,200
2,800
$2,250
4,200
$3,100
2,900
Required:
and
5.
at the
in
each department
Cost of Production Report. For December the Production Control DepartInc. reported these production data for Department 2
55,000
39,500
10,500
Department
Required:
6.
liters
liters
1.
Department 2
liters
$1 .80
$27,520
1 5,480
Cost of Production Report. Melograno, Inc. uses a process cost system. The
Department 2 for the month of April were:
costs of
$20,000
$21,816
7,776
4,104
Materials
Labor
Factory overhead
$33,696
Units received
Units transferred out
Units still in process
40%
1,000
the
work
were
Required:
The
in process
30%
Department
2 for April.
PROCESS COSTING
CH. 6
141
7.
The following
is
summary of
Department 1
Department 2
November:
Materials
Labor
$72,000
3,267
$ 8,400
$1 5,600
54,292
26,255
Reports from the Production Control Department showed that 600 units
were started in process, with no inventories at the beginning or end of the month.
In Department 2, 10 units were spoiled, of which 4 units were spoiled because
of defective materials. The good units, 590, were transferred to finished goods
inventory. The company's practice is to distribute all normal spoilage costs
among the units remaining in process and completed on the basis of actual
number of units, regardless of stage of completion. Units spoiled because of
defective materials (considered abnormal spoilage) are classified and costed as
completed units; their costs are transferred to a lost unit expense account.
Required: A cost of production report for Departments
computations to two significant decimal places.
*.
and
2.
Carry
all
8.
Packaging.
fiscal year,
June 30, 19
is
(a)
No
(b) Fabrication
(c)
(d)
(e)
at
number of equivalent
labor in
(3)
June 30, 19
all
The
units of
raw materials
in all inven-
(AICPA
adapted)
PROBLEMS
In solving these problems round off all amounts, except unit costs, to the
nearest dollar. Carry unit costs to five decimal places unless stated otherwise.
v6-l) Cost of Production Report; Three Departments. The cost data of the
Batalha Manufacturing Company for August are given on the next page.
142
PART
II
Factory
Department
Mixing
Materials
Labor
Overhead
$18,000
$11,880
11,520
$5,940
Refining
Finishing
No
8,640
8,580
1,440
beginning inventory.
in
all
- +.<(
,\
-"^^^
o..<....^
^-^ ^\s^
-,aaj-
in
Required:
31, 19
$35,000
$3.50)
$8,600
5,160
4,760
3,270
A
B
Factory overhead:
Department A
Department B
Department C
Deduct
6,450
4,760
1,635
all
12/31
(1,000 units in
materials,
560
50%
Gross
$34,635
3,750
1,000
5,310
profit
Commercial expenses:
Marketing costs
Administrative costs
Net
loss
PROCESS COSTING
CH. 6
143
Cost of Production Report; Three Departments; Lost Units in All DepartThe Globe Products Company makes a single product in three producing departments. Cost and production data for September are:
6-3.
ments.
Dept.
Dept.
Dept.
No. 1001
No. 1002
No. 1003
$12,250
14,570
14,100
$18,655
16,400
$8,100
100,000
90,000
8,000
90,000
80,000
6,000
80,000
70,000
8,000
Cost data
Materials
Labor
Factory overhead
19,800
Production data:
Units started or received from preceding dept..
Units completed and transferred or shipped
Units in process 9/30
Stage of completion of closing inventory
Materials
factory overhead
Labor
100%
50%
33M%
25%
6-4.
144
PART
II
The
reports in
planning and controlling its operations. Department A's budget for January was
for the production of 1,000 units of equivalent production, a normal month's
volume.
The following performance report was prepared for January by the company's accountant:
Variable costs:
Budget
Actual
Variance
Direct materials
Direct labor
Indirect labor
$20,000
10,000
$23,100
10,500
1,650
1,790
210
320
220
330
$3,100 (unfavorable)
500 (unfavorable)
140 (unfavorable)
10 (unfavorable)
10 (unfavorable)
$32,180
$35,940
Power
Supplies
Total
$3,760
Fixed costs:
Rent
400
400
1,000
1,000
500
100
500
100
$ 2,000
$ 2,000
$34,180
$37,940
Supervision
Depreciation
Other
Total
Grand
total
$3,760
Direct materials are introduced at various stages of the process. All conversion costs are incurred uniformly throughout the process. Because production
fluctuates from month to month, the fixed overhead is applied at the rate of
$2 per equivalent unit as to conversion costs.
Actual variable costs are applied monthly as incurred.
There was no opening inventory at January 1. Of the 1,100 new units started
during January, 900 were completed and shipped. There was no finished goods
inventory at January 31. Units in process at January 31 were estimated to be
75% complete as to direct materials and 80% complete as to conversion costs.
There was no shrinkage, spoilage, or waste of materials during January.
January
31.
schedule computing the cost of goods shipped and the cost of the
January 31 at actual cost.
Specific conclusions, if any, to
(4) Comments on the performance report.
be drawn from the report.
(AICPA adapted)
(3)
work
in process inventory at
CH. 6
PROCESS COSTING
145
to October, the
X
Y
month of operation
first
purchased
Material
100,000 kilograms ?:?.
purchased
80,000 units .'r i-. A. UvuJT.
Part
purchased
1 50,000 units
.O. c^ P. ^r.'X
Part
cuno
l*f.l^'tT?.
$25,000
1 6,000
1 5,000
1
Direct labor
,072
45,415
24,905
Factory overhead
Unit Quantity
67,000
5,000
3,000
,^
5,800
5,000
6,000
8,000
7,500
Required: A cost of production report showing total costs, equivalent production, unit cost, cost of goods finished, and work in process inventories.
(AlCPA adapted)
CASES
A. Accounting for Lost Units. The Household Aids Company assembles clip
clothespins in three sections; a process cost system is used by the company.
Under normal operating conditions, each section has a spoilage rate of 2%.
However, spoilage can go as high as
and is usually discovered when a faulty
pin enters process or on final completion by a section.
5%
The spring mechanism is the only material which can be saved from a spoiled
The production foreman assigns a man once or twice a week to remove
the springs from spoiled units. The salvaged springs are placed in bins at the
assembly tables in Section No. 1 to be used again. No accounting entry is made
unit.
rately.
Required:
What should
be recommended?
-,
^.j.
PART
146
II
Year
Tons
Produced
Cost
per Ton
170,000
180,000
175,000
110,000
S14.65
19A
19B
19C
19D
14.85
15.06
19.88
Production Costs
Per Ton
Amounts
19D
19C
Tons produced
Direct labor
Indirect labor
Supplies and other production
expenses
Depletion
Salaries (superintendents, plant
clerks,
watchmen,
Depreciation
Other fixed expenses
Total
etc.)
19D
19C
110,000
175,000
401,500
286,000
$2.70
$3.65
1.98
2.60
708.750
262,500
479,600
165,000
4.05
1.50
4.36
217,000
227,500
400,750
233,200
247,500
374,000
1.24
1.30
2.29
2.12
2.25
3.40
$2,635,500
$2,186,800
$15.06
$19.88
472,500
346,500
1.50
Indirect labor, supplies, and other production expenses are considered variable costs. There are no semivariable costs. Depletion is computed at SI. 50 per
ton mined, and depreciation on machinery and equipment is computed on a
straight-line basis. Due to an extended strike in 19D, much less of the fibrous
mineral was mined than during the three preceding years in which production
was considered normal. The management explained that the rise in 19D unit
labor costs was caused by general increases of from 33% to 40% in hourly wage
rates. The increase in the unit cost of supplies and other production expenses
is accounted for by an increase in prices of about 10%. All increases took place
at the beginning of the year.
Required: (1)
Is
on December
31,
19D,
at $19.88 per ton acceptable for financial statement purposes? Discuss fully.
(2) Assuming that the closing inventory of $19.88 per ton is not acceptable
(AICPA
adapted)
CHAPTER
PROCESS COSTING
(Concluded)
In numerous industries
process in the
first
all
on
units
and costs
in process
1.
The additional materials merely increase the unit cost since these materials
become a part of the product manufactured and do not increase the
number of final units. For example, in a finishing plant of a textile company, the material added is often a bleach; in a wire company, a plating
mixture; in an automobile assembly plant, additional parts. These materials are
teristics,
2.
qualities, charac-
or completeness.
increase the
is
page 136)
terials
on
is
used to
total
6,
148
as parts of
PART
II
an automobile,
Assume
the
and charged to the Finishing Department. Assume further that the materials in work in process are sufficient to complete 2,000 of the 4,000 units;
that is, units are 50 percent complete as to materials cost. The effect of the
additional materials cost is shown in the cost report on page 149.
The only differences in the cost report on page 149 and the cost report
on page 136 are the $17,020 materials cost charged to the department and
the $.46 materials unit cost (^JtS)- The additional materials cost is also
reflected in the total cost to be accounted for, in the cost of units transferred
to Finished
Goods, and
in the closing
work
in process inventory.
unit cost,
The
greater
number of
com-
transferred
To
UNIT COST
IN
units are
first
25 percent complete as to labor and factory overhead. Therefore, equivalent production is 46,000 units for materials and 45,000 for labor and
factory overhead.
{^^)
cost of $.37
(Ig)
for labor,
CH.
PROCESS COSTING
149
(Concluded)
19
Quantity Schedule:
Units received from preceding department
40.000
35,000
4,000
1,000
month
(40,000)
Total
Unit
Cost
Cost
$140,400
S3. 51
S 17,020
32,400
19,800
.46
.90
.55
S 69,220
SI .91
S209,620
$5.51
Labor
Factory overhead
Total cost added
Adjustment for lost units
40,000
.09
Work
closing inventorv:
in process
5192,850
S5.51)
S 14,400
S3 60)
.
920
900
550
S.55)
16.770
S209,620
Additional Computations:
Equivalent production:
Materials
1:^
+
^ 2 =
35,000
37,000 units
+ ^^^ =
36,000 units
Unit costs:
Materials
^-H^
Labor
S.46
37,000
= ^l^OO ^
Factory overhead
Adjustment for
Method No.
^^
36,000
= ^^||^ =
$-55
lost units:
1
^ S140,400 ^
S3. 60
^3 50
$3.51
=$.09perunit
39,000
Method No.
1,000 units
S3. 51
S3, 510
^"onoo
=5-09
per unit
These computations do not differ from those already discussed. PecuHar to this situation is the adjustment of the preceding department's
Department as cost transfrom the preceding department must now be allocated over a
greater number of units, thereby reducing the unit cost of work done in
unit cost. Total cost charged to the Finishing
ferred in
150
PART
II
19
Quantity Schedule:
Units received from preceding department
Additional units put into process
40,000
8,000
48,000
44,000
4,000
48,000
month
(40,000)
jotal
Unit
Cost
Cost
5140,400
$3.51
S 17,020
32,400
19,800
.37
.72
.44
$ 69,220
$1 .53
5209,620
54.455
Labor
Factory overhead
Total cost added
Adjusted unit cost of units transferred
in
2.925
Work
in process
closing inventory:
5196,020
54.455)
S 11,700
S2.925)
740
720
440
S.44)
13.600
5209,620
Additional Computations:
Equivalent production:
Materials
+ ^^^
44,000
46,000 units
+ ^^^
45,000 units
Unit costs:
Materials
= SJI:^ =
5.37
Labor =
SJM22 =
Factory
^ overhead
Adjustment for additional
S14M00 ^
s.72
45,000
46,000
MM2P
=5.44
45,000
units:
52.925
48,000
cost of $3.51
(^^).
( ^^ts'.ooo )-
CH.
PROCESS COSTING
(Concluded)
151
to departmental unit costs to arrive at the cumulative unit cost to the end
units occur,
first
department; that
it is
is,
costs.
is
the cost
is
However,
if
effect
of losing 2,000
and
in this
OPENING WORK
IN
in the
above
PROCESS INVENTORIES
1.
Average
new
2.
costing.
Opening inventory
the
costs are
added
period.
new
computed.
When
cess
is
quite simple.
The February
show
to
month of February.
Refining
CH.
PROCESS COSTING
(Concluded)
153
(all
19
materials
4,000
40,000
44,000
38,000
1,000
3,000
2,000
44,000
Total
Unit
Cost
Cost
opening inventory:
Work
in process
Materials
$ 2,000
Labor
L240
Factory overhead
Cost added during period:
Materials
,200
19,840
24,180
22,580
Labor
Factory overhead
Total cost to be accounted for
.52
.62
^8
$1.72
$71 ,040
Work
in process
closing inventory:
Labor (3,000
$1
$65,360
72)
$ 1,720
SI. 72)
1,560
1,240
1.160
S.52)
S.62)
Vi
Vi
S.58)
5.680
$71,040
Additional Computations:
Equivalent production:
3,000
42,000 units
1,000
Materials
38,000
1,000
+ (% X
3,000)
41,000 units
Unit costs:
Materials
$2,000
= 52L840 ^
$19,840
5 52
42,000
Labor =
SI, 240
$24,180
= Irl:^ =
$.62
41,000
Factory overhead
$1,200
$22,580 = 123J80 ^
5 53
41,000
to the closing
work
in process.
is
disposed of as follows
The work
is
$65,360
of
on hand; $1,560
154
process.
The
in the
work
PART
II
in process inven-
is
obtained by
multiplying the 1,000 completed units by $1.72, the cost of one completed
The
unit.
cost transfer entry for the 38,000 units transferred to the next
department
is
Refining Department
Mixing Department
Work in Process
Work in Process
Refining Department.
65,360
65,360
classified as cost
first
work
in process inventory
When
the closing
is
work in
came
from
costs
tory which
now
It is this
added
and these
by
equivalent production figures to secure average unit cost figures, the opening
work
split into
1.
2.
must be
two parts
That part of the opening inventory that consists of work which was
done in preceding departments.
That part of the opening inventory which represents costs added by the
department itself.
An
comcosts added by
to be added to
puted.
is
represents
is
then
CH. 7
PROCESS COSTING
155
(Concluded)
Quantity Schedule:
3,000
3,U0U
'^'n^^
4,000
1
Work
^ 1,000
.000
Total
Unit
Cost
Cost
^,400
$1 .80
l-^^
"5.360
$1-726
$ 70.760
(41,000)
Total
^1,VW
910
Labor
*'""
Factory overhead
34,050
30,018
^Labl?.'!^.'!"""'^
Factory overhead
Total cost added
.920
-^^^
$136,538
3.500
lost units
Adjustment for
.731
-^^^
$ 65,778
$126,000
$3.500)
Adjustedcostfromprecedingdepartmcnt [4,000
Labor (4,000 X Vi X $.920)
Factory overhead (4,000 X '/z X $.81 )
X ($1.726 +
,,
$.043)]
c-
-,
nn^
7,076
1.840
'0,538
'.^^2
$136,538
Additional Computations:
Unit cost from preceding department
-jfr^ =$1,726
Equivalent production:
1^^
38,000 units
Unit costs:
Labor
$910
Factory overhead
Adjustment for
$34,050
^^
$.920
$30,018
?||^
$800
$.811
lost units:
Method No.l
=S70J6p ^51.769
$1,769
-$1,726 =$.043
40,000
Method No. 2 =
1,000 units
$1,726
$1,726
lo^
"
^'^^^
156
PART
the opening
work
II
com-
lost in process.
which is
cost from the preceding department is entered in the current month's cost
opening inventory. It is added to the $65,360
report as work in process
of cost transferred during the month to the Refining Department from
the Mixing Department. The average unit cost for work done in the
preceding department is computed next by dividing total cost received
in process inventory
The 41,000
$65,360) by 41,000
opening work
and 38,000 units received during the month. The
average unit cost for work done in the preceding department is $1,726
This is a weighted average since it considers all units and costs
( ^Ii'.ooo )received from the preceding department.
It is not the average of the
two unit costs, $1.80 and $1.72. Such an average would be inaccurate
since there are more units with a unit cost of $1.72 (38,000 units) than with
a unit cost of $1.80 (3,000 units). Instead, the total cost is divided by the
units.
in process inventory
total units.
are
Departmental unit costs for labor ($.920) and factory overhead ($.811)
computed as explained in discussing the cost report of the Mixing
Department.
labor put in process during the month, $34,050; and the total
added to
of these two
is
(36,000
The departmental
unit cost
is
the
The lost unit cost adjustment figure of $.043 is computed on the assumpcoming from units in process at
the beginning or
is
$.043 ($1,769
$1,726).
The
lost unit
lost
by
adjustment
the preceding
department's average unit cost, $1,726, for a total cost of $1,726 (1,000
$1,726) which must be absorbed by remaining
good
units.
The
lost
CH. 7
PROCESS COSTING
157
(Concluded)
Quantity Schedule:
Units in process at beginning ('/i labor and factory overhead).
Units received from preceding department
4,000
36,000
Work in process
opening inventory ( 4,000)
Transferred in during this period
(36,000)
Total
(40,000)
Work
in process
opening inventory:
Labor.
Factory overhead
Costs added during period:
Labor
Factory overhead
$ 14,400
158
PART
II
CH.
PROCESS COSTING
Department
is
shown on page
Goods
Finished
Work
Process
in
^SS
(Concluded)
157.
The entry
is:
182,160
Finishing Department
iz,ibu
on page
158.
ditional
new
work
in process.
Under
the
first-in, first-out
beginning
costing method, the cost of completing units in process at the
cost of
of
the
is computed first, followed by the computation
of the period
in the cost of
methods of costing do
in general,
The
two
manufacturing operations
more or less uniform from period to period. Each firm will select that
and which,
costing method which can be applied easily and conveniently
guidance.
management's
for
figures
at the same time, offers reliable
Mixing Department. The cost of production report of the Mixing
Department for the month of February, page 160, uses the fifo method and
which
should be compared with the cost of production report on page 153
process
in
are
units
illustrates the average costing method. Four thousand
which are 100 percent complete as to maoverhead.
terials and 50 percent complete as to labor and factory
differences
following
the
but
same,
The cost report form remains the
costs to be
determining
exist in the methods of computing unit costs and of
transferred
1.
Opening work
down
into
its
component
and
is
not broken
160
PART
44,000
44,000
Total
Cost
II
CH.
PROCESS COSTING
2.
(Concluded)
161
in order to
Under
fifo costing,
completing opening work in process units and to arrive at the cost of units
started
and
and
Materials added
during February cost $19,840, sufficient to complete an equivalent production of 38,000 units (34,000 of the 38,000 units transferred were started
and
is
$.522 (^Mm)-
Labor cost for February is $24,180. The labor unit cost is computed
number of units that could have been completed
from this total labor cost. The labor cost was sufficient to complete:
after determining the
(1)
34,000 units started and completed this period; (3) 1,000 units still on
hand; and (4) 2/3 or 2,000 units of the 3,000 units still in work in process.
(2)
$.620
( ^39;ooo )-
of $.579
C^39;ooo ).
is
is
$1,721,
4,000)
and
1,000
2,000
39,000],
is
total cost to
be accounted for
is
$71,040.
In average costing, the cost of the units transferred to the next depart-
the
number of units
transferred by the
fifo costing.
made
first
The
completed cost pertaining to units in the opening work in process is computed separately from the cost of the units started, finished, and transferred
during the period.
To determine
work
in process, the
162
PART
II
160).
The balance of
and
is
computed
as
is
shown on
in
work
in process at
illustrated
on page
163.
38,000 total units received into the total cost received of $65,355 ($6,838
$58,517). This procedure seems to cancel out all the apparent advan-
CPA
method,
it
this cost
is
is
The entry
Refining Department
Work in Process
Mixing Department
Work in Process
is
as
fifo
to transfer
65,355
65,355
The balance of the report is consistent with the fifo method of costing.
The opening work in process inventory, valued at $7,1 10, is shown in total
and is not broken down into its component parts. Labor and factory overhead costs needed to complete the opening in-process units are added to this
figure to determine the
The $.920
$34,050 and factory overhead of $30,018, respectively. The equivalent pro(1) 2,000 units of opening in-
ventory completed
(3) 2,000
2,000
(2)
3,000)
2,000
37,000.
The labor
cost
added
to the
opening work in process was $1,840 (2,000 X $.920) and factory overhead
added was $1,622 (2,000 X $.811). These two amounts are added to the
of $7,110 to give a total cost of $10,572. This
the completed cost of the 3,000 units in opening work in process trans-
opening work
is
in process cost
CH.
PROCESS COSTING
(Concluded)
163
Quantity Schedule:
Units in process at beginning C/j labor and factory overhead)
Units received from preceding department
3,000
38,000
41,000
36,000
4,000
1,000
41,000
Total
Work
in process
opening inventory
7,1
10
$ 65,355
Labor
Factory overhead
Total cost added
Adjustment for lost units
Total cost to be accounted for
Unit
Cost
Cost
$ 34,050
30,018
$ 64,068
$136,533
164
The departmental
unit cost
is
PART
II
$1,731.
during February, computation of the cumulative cost to the end of operations in the Refining Department requires an adjustment of $.046 for lost
units.
is
of $1,720 ($1,766
$1,720
units or
new
must be
$.046). It
is
identified as either
The
fifo
identification
is
needed to
determine which unit cost should be adjusted. In either case it means that
because units were lost, total costs incurred must be spread over a smaller
is
3,000 units
came from
The entry
is
Finishing Department
Refining Department
Work in Process
Work in Process
inventory which
computed
is
Finishing Department.
126,007
126,007
is
the closing
in the conventional
To make this
work
manner.
on page 165.
The entry
Finished
Work
the
is
Goods
in Process
in process
Finishing Department
82,
reproduced
is
66
182,166
ences between the two costing methods discussed, this report should be
compared with the cost of production report on page 158 in which average
costing
is
used.
method
is
either
It
CH.
PROCESS COSTING
185
(Concluded)
Quantity Schedule
4,000
36,000
36,000
3,000
40,000
1,000
Work
40,000
Total
Unit
Cost
Cost
S 15,850
opening inventory
in process
Cost from preceding department:
Transferred in during the month (36,000)
$126,007
3.500
$33,140
.921
$ 52,570
1.461
-100
$194,427
5.061
Labor
Total cost added
Adjustment for
.540
19,430
Factory overhead
lost units
From
$.540)
5,850
2,763
1,620
$ 20,233
current production:
Work
in process
$182,166
161,933
closing inventory:
($3.50
Labor (3,000X1
$.10)]
X$.92i)
Factory overhead (3,000X
3
'
10,800
921
540
$.540)
12,261
$194,427
Labor and
Additional Computations:
Factory
Overhead
Equivalciu production:
Transferred out
Less opening inventory
(all
36,000
4,000
units)
32,000
3,000
LOOO
36,000 units
Adjustment for
Method No.
= ^||^ =
Factory Overhead
$.921
= ^j|^ =
$-540
lost units:
1
$126^007
36,000
Method No. 2
53^^
$3.60
$3.50
$.10
^''^
1,000
1,000 units
X $3.50
$ 3 500
==
$3,500
ZSQQQ
*32,000
166
PART
CH.
PROCESS COSTING
(Concluded)
167
of one or the other method depends entirely upon the opinion of a company's
management regarding
determination procedures.
The
The
fifo
method
separate figure.
work
retains opening
added to this total cost. The sum of these two cost totals is the
which
these units are transferred to the next department. Units
figure at
started and finished during the period have their own unit cost which is
usually different from the completed unit cost of units in process at the
units are
beginning of the period. Unfortunately, the true costs are averaged out in
the next department, resulting in a loss of
fifo
much
method.
as to whether they
The disadvantage of
fifo
costing
is
that
is
if
cost computations.
DIFFICULTIES ENCOUNTERED
ACCOUNTING PROCEDURES
IN
PROCESS COST
quantities and their stages of completion present problems. Every computation is influenced by these figures.
Since the data generally come to the cost department from an operating
foreman often working under circumstances that make a precise count
difficult, a certain amount of doubtful counts and unreliable estimates are
bound to exist. Yet, the data submitted form the basis for the determination of inventory costs.
168
2.
PART
II
3.
department which,
tory costs, the cost of units transferred, and the completed unit cost.
Another consideration involves the possibility of treating cost attributable
to avoidable loss as an expense of the current period.
4.
many
ing overhead to process is used. Management must decide whether economy and low operational cost are compatible with increased information
based on additional cost computations and procedures.
should be noted that some companies use both job order and process
costing procedures for various purposes in different departments. This is
It
particularly true
when
is
required.
and
analysis.
DISCUSSION QUESTIONS
1.
when
materials are
added
2.
3.
4.
When
CH.
PROCESS COSTING
(Concluded)
169
7.
Why do firms use the first-in, first-out method of computing unit costs?
How is opening work in process accounted for when fifo costing is used?
Why must the completion stage of opening work in process be known?
How are equivalent production figures computed when fifo costing is used?
8.
5.
6.
9.
certain factory transferred out 8,800 completed units during its second
period of operation. The period was begun with 400 units 75% completed
and ended with 800 units 50% completed. What was the equivalent production for the period? Assume the fifo costing method is used.
In another factory, the equivalent production (using the fifo costing method)
units during a period which saw 500 units 60% complete on hand
at the start and 600 units 75% complete at the end of the period. How many
was 7,000
units
were completed ?
10.
What
11.
are
fifo
difficulties
costing
method?
frequently encountered in a
13.
(AICPA
adapted)
EXERCISES
In solving exercises round off all amounts, except unit costs, to the nearest
Carry unit costs to five decimal places unless stated otherwise.
dollar.
1.
Ending Inventory
Beginning Inventory
Units
Factory
Factory
2,000
1,200
Complete
Materials
Labor and
Overhead
100
100
80
90
in process statis-
Units
1,200
2,000
% Complete
Materials
Labor and
Overhead
100
100
90
80
Required: The equivalent production figures for the two factories using (a)
the average method and (b) the fifo method.
Product
Product
Product
Product
100,000
71,840
4,160
24,000
kilograms
kilograms
kilograms
kilograms
170
PART
II
is
is
is
at a
^ was
3^ was J4 completed;
in process inventory.
Required: (1) The equivalent production figures for each of the materials.
The equivalent production figures for labor and factory overhead.
(2)
Computation of Equivalent Production. (1) Compute the equivalent production figures for costing from the following data, using the fifo method.
3.
(a) Started in
(b) Started in process 50,000 units; completed and transferred 36,000 units;
completed and on hand 6,000 units; in process end of period, 8,000 units,
in process
(d)
in process
40,000 units; transferred 36,000 units; closing inventory, 10,000 units, one
half completed, and 10,000 units, three fourths completed.
(e)
(2) Compute the equivalent production figures for costing, using the average
cost method, for parts (d) and (e) above.
the
are available
all
materials,
50%
all
materials,
60%
CH.
PROCESS COSTING
171
(Concluded)
20,000
32,000
$30,000
Materials
Labor
Factory overhead
Required:
6.
Department
3 for
$25,000
March.
Cost of Production Report with Average Method. The Shawnee Supply Comsingle product on a continuous plan in three departments.
pany manufactures a
On November
the
work
in process inventory in
Department 2 was
$ 1 3, 1 30
Department 2
Labor Department 2
Factory overhead Department 2
None
Materials
$
$
500
50
5,000
Units in process
November were
Labor
$14,200
Factory overhead
$ 3,450
Required:
A November
method
2,
using
172
Required:
PART
II
inventories.
necessary.
PROBLEMS
In solving these problems round off all amounts, except unit costs, to the nearCarry unit costs to Jive decimal places unless stated otherwise.
est dollar.
Cost of Production Report with Materials Added. Sanderson, Inc. manufactures Product L in two departments, No. 1 and No. 2. Materials are added in
each department increasing the number of units manufactured.
summary of the cost information for the company's first month of operations (January) is as follows:
7-1.
Materials
Department
No. 1
Department
No. 2
$ 90,000
$ 67,500
39,000
7,800
41,400
20,700
$136,800
$129,600
Labor
Factory overhead
Total
The production foreman reports that 300,000 units were put into production
Department 1. Of this quantity, 75,000, a normal number, were lost in production; and 180,000 were completed and transferred to Department 2. For
the balance in process at the end of the month, all materials had been added, but
only one third of the labor and factory overhead had been appUed.
In Department 2, 45,000 units were purchased outside and added to the units
received from Department 1; 195,000 units were completed and transferred to
finished goods inventory. The remainder were in process at the end of the month
with all materials added, but only 40% complete for labor and factory overhead.
in
Required:
7-2.
Company produces
Mixing
preceding department
Materials costs
Cost
Labor
costs
Factory overhead
Number
of units in process
Blending
$10,620
in
$3,300
750
375
1,500 liters
1,550
430
1,800 liters
CH.
PROCESS COSTING
173
(Concluded)
complete (all materials had been added, but only one half of the labor and factory overhead had been applied); 600 liters were lost.
In the Blending Department 9,000 liters were completed and transferred to
finished stock; 2,700 liters were still in process on which 40% of the labor and
overhead had been applied; 300 liters were lost.
The departmental reports showed the following costs for March
Materials
Labor
Factory overhead
Mixing
Blending
$52,500
11,680
7,535
$16,090
4,610
Required: A cost of production report for the month of March, using the
average costing method.
Company
Department
Production
Opening inventory
Stage of completion*
Started in process
Received from prior department
Finished and transferred
Finished and on hand
Closing inventory
Stage of completion*
174
PART
II
and recorded
$82,600
Invoice cost
Freight in
3,444
$96,044
Production
$84,868
1 ,940
8,636
Factory supplies
Total cost of materials used
$95,444
Payroll:
Direct labor
Supervision
Indirect labor
$56,760
5,800
Equipment maintenance.
6,048
1,360
Total payroll
$69,968
^^=^=
Heat
Payroll taxes
Rent of building
480
2,800
2,400
3,224
4,000
8,000
Power
Tools
Equipment depreciation
Total factory overhead
$20,904
all
168 units,
all
materials,
Spoiled: 128 units, all materials, ^4 labor and overhead; these spoiled units have no
salvage value. The material and labor cost spent on these spoiled units is
added to the factory overhead.
20%
of the building
is
tions to
(4)
inventory.
Report
Fifo Method. Jersey-Schell, Inc. uses three
departments to produce a hair spray. The Finishing Department is the third
and last step before the product is transferred to storage vats for bottling or
wholesale distribution.
All materials needed to give the hair spray its final composition are added at
the beginning of the process in the Finishing Department. Any lost units occur
The company
for the Finishing
Department
method
for
Production data:
In process, October 1
(Labor and factory overhead, ^^ complete)
Transferred in from preceding department
Finished and transferred to storage
In process, October 31
(Labor and factory overhead, Vi complete)
10,000 gals.
40,000 gals.
35,000 gals.
10,000 gals.
CH.
PROCESS COSTING
175
(Concluded)
Additional data:
October
Inventory work in process
Cost from preceding department
Cost from this department:
Materials
$ 38,000
21,500
39,000
42,000
Labor
Factory overhead
work
Total inventory
in process,
October
$140,500
Cost added
in this
$140,000
department:
$ 70,000
Materials
Labor
162,500
130,000
Factory overhead
Total cost added
$362,500
Required:
A cost
$643,000
(AICPA
adapted)
7-6.
are:
June
Inventory
L 19
176
PART
II
(1)
Department.
(6)
A schedule showing the computation of unit costs for the Finished Goods
Department.
(7)
Finished
Goods
Department.
(AICPA
adapted)
Firm Using Fifo Method of Treating Initial Work in Process Inventory. The
cost of production report appearing below shows production and cost data for
the Finishing Department of the Powlenko Processing Company. The company
uses the fifo costing method in its process cost system. All production and cost
data have been placed in the cost of production report.
7-7.
Finishing
Department
Quantity Schedule:
10,000
40,000
50,000
35,000
5,000
10,000
50,000
Materials
$ 38,000
$21,500
39,000
42,000
(all)
Labor (Ya)
Overhead (M)
102,500
SI 40,500
Total
SI 40,000
Materials
Labor
Overhead
Total departmental cost this month
S362,500
Total cost
S643,000
The
work
in process inventory.
(AICPA
adapted)
CH.
PROCESS COSTING
177
(Concluded)
Computation of Fifo and Average Costing Methods. The King Process ComNo. 1 and No. 2.
pany manufactures one product through two processes
For each unit of Process No. 1 output, 2 units of Raw Material X are put in at
the start of processing. For each unit of Process No. 2 output, 3 cans of Raw
Material Y are put in at the end of processing. Two pounds of Process No. 1
output are placed in at the start of Process No. 2 for each unit of finished goods
7-8.
started.
(a)
(f)
Process No. 1
Inventory data:
Initial
Final
Process No. 2
Initial Final
Units
200
300
200
Fraction complete,
conversion costs
1/2
1/3
1/2
300
2/3
Costs:
$560
Materials
Conversion costs
Prior department costs
Required:
108
390
2,200
(AICPA
March.
adapted)
Cost of Production Report for Firm Using Average Costing Method; Units
Lost at End of a Process. Ward, Inc. manufactures a single product that passes
through two departments: Extruding and Finishing-Packing. The product is
shipped at the end of the day in which it is packed. The production in the
Extruding and Finishing-Packing Departments does not increase the number
of units started.
The cost and production data for the month of October are as follows:
7-9.
Finishing-
Extruding
Production Data
October production
Units
Units
Units
Units
Packing
Department
statistics:
in process, 10/1
10/31
started or received from preceding department.
completed and transferred or shipped
in process,
Department
10,000
8,000
20,000
22,000
29,000
6,000
22,000
44,000
178
10/1
10/31
PART
10/1
II
10/31
70%
50%
Labor
50
50
40
40
Factory overhead
0%
30
30
0%
35
35
Cost Data
Work
in process,
October
$60,200
$ 5,900
Labor
1,900
Factory overhead
1,400
1,500
2,000
20,100
10,700
8,680
4,400
7,720
11,830
Labor
Factory overhead
In the Extruding Department materials are added at various stages throughout the process.
In the Finishing-Packing Department the materials added consist only of
packing supplies. These materials are added at the midpoint of the process when
the packing operation begins. Cost studies have disclosed that one half of the
labor and overhead costs apply to the finishing operation and one half to the
packing operation. All lost units occur at the end of the finishing operation
when the product is inspected. All of the work in process in this department at
October 1 and 31 was in the finishing operation stage of the manufacturing
process. The company uses the average costing method.
Required: (1) Units lost, if any, for each department during October.
(2) The equivalent production for the calculation of unit costs for each
department for October.
cost of production report for both departments for October. The re(3)
port should disclose the departmental total cost and cost per unit (for materials,
labor, and overhead) of the units (a) transferred to the Finishing-Packing Department and (b) shipped. Carry unit costs to three decimal places.
(AICPA
adapted)
Method of Accounting for Initial Work in Process Inventory. Englehard, Inc. produces a chemical agent for commercial use. The company accounts for production in two cost centers: (1) Cooking and (2) Mix-Pack. In
the first cost center liquid substances are combined in large cookers and boiled,
which causes a normal decrease in volume from evaporation. After cooking,
the chemical is transferred to Mix-Pack, the second cost center. It then has an
equal quantity of alcohol added before being mixed and bottled in one-liter
containers.
7-10. Fife
Materials are added at the beginning of production in each cost center, and
labor is added equally during production in each cost center. The process is
"in control" as lone as the yield ratio for the Cooking Department is not less
than 78%.
The
at
fifo
method
is
of units transferred.
CH.
PROCESS COSTING
(Concluded)
is
179
Cooking
Department
Cost Information
Work
in process,
month of October:
Mix- Pack
Department
October:
Materials
990
Labor
Overhead
120
60
48
100
80
Month
426
of October:
Materials
39,600
10,050
8,040
Labor
Overhead
15,276
16,000
12,800
Inventory and production records show that the Cooking Department had
1,000 liters 40% processed on October 1 and 800 liters 50% processed on October 31; the Mix-Pack Department had 600 liters 50% processed on October 1
and 1,000 liters 30% processed on October 31.
Production reports for October show that the Cooking Department started
50,000 liters into production and completed and transferred 40,200 liters to MixPack, and Mix-Pack completed and transferred 80,000 one-liter containers of
the finished product to the distribution warehouse.
Required: (1)
quantity report for the
centers which accounts for both actual units
(AICPA
adapted)
Product
CHOA.
Inventories,
and production data for the month of October are shown below.
Sept.
Raw
Raw
materials
materials cost
Work in process inventories:
All materials, 40%, complete as to labor
100,000
$100,000
30
Oct. 31
lbs.
80,000
lbs.
and
overhead
Cost
20,000 units
$ 84,000
overhead
Finished goods inventory
40,000 units
$448,000
Cost
Purchases of raw materials
Transferred to production
Production ratio: 2 lbs:l unit of
Completed during the month
Materials and units are costed on the
Direct labor
Factory overhead
440,000
460,000
lbs.
lbs.
CHOA
220,000 units
fifo
method
$1,198,800
421,800
30,000 units
24,000 units
$1.10 per
lb.
180
Required:
overhead.
(1)
PART
II
(AICPA
adapted)
7-12. Fifo Method of Treating Initial Work in Process Inventory ; Units Lost at
End of Process. In the process of verifying the pricing of the company's inventory
of work in process and finished goods recorded on the company's books, the
auditor finds
Finished goods inventory, 1 10,000 units
in process inventory, 90,000 units,
Work
50%
completed
$504,900
330,480
The company follows the practice of pricing the above inventories at the
lower of cost or market on a first-in, first-out method. Materials are added to the
production line at the start of the process, and overhead is applied to the product
at the rate of 75% based on direct labor dollars. The auditor also learns that the
market value of the finished goods inventory and the work in process inventory
is greater than the amounts shown above, with the exception of the defective
units in the ending inventory of finished goods, the market value of which
amounts to $1.00 per unit. The difference between the market value and the
assigned cost is expensed.
A review
Amounts
19 80%
19
1,
completed.
Units
Materials
Labor
100,000
500,000
$100,000
$160,000
550,000
997,500
Amounts
Units
Units completed in 19
Good
Materials
Labor
500,000
10,000
units
Defective units
December
31, 19
i.e.,
units are
found to be defective
or equivalent production.
(b)
(c)
production.
Costing of inventories of finished goods, defective units, and work in
process.
if
(AICPA
adapted)
CHAPTER 8
Sk
%!i|
BY-PRODUCTS AND
JOINT PRODUCTS COSTING
Many
and often
and /or
joint products.
is
that
it
furnishes
profit potentials
maximum
DIFFICULTIES
IN
JOINT PRODUCTS
difficult to cost
off"
stage.
The ^total
mu st
be borne byjthe
181
182
^5<
Oi^
^b
>\
,.^
selling prices
and zinc
V^^^
there
is
II
6^5^s-
PART
However,
and the
Common
among
prodjjctSujor
^^V^
P^ ^
s^a" y.o^'^
^"^
is
common
in
accordance with
However, the result of such a division is of limited use to management for decision making.
Because of the indivisibility of joint costs, cost allocation and apportiona
ment procedures used for establishing the unit cost of a product are far
from perfect. The costing of joint products and by-products highlights the
problem of assigning costs to products whose origin, use of equipment,
share of raw materials, share of labor costs, and share of other facilities
p- cannot truly be determined. Whatever methods of allocation are employed,
provided there are no beginii^Q iQi^i profit or loss figure is not affected
)\wt
'-^
*'^'^'
-V~T >" However, joint costs are ordinarily allocated to the products on some
acceptable basis to determine product costs needed for inventory carrying
'^
by-products, for these costs are recombined in the final income statement.
'
cost-causing characteristic.
costs.
^'^
\
<^^ (^^
su^yy-JL
ferent
For this reason there is an effect on periodic income because difamounts may be allocated to inventories of the numerous joint or
In additiijii^-pipduc t costs
^^y
>t)\ycJ"
iiC^aDt
*JO<NT
Joint costs are costs incurred prior to the point at which separately
,
identifiable products
is
is
oil,
crude
used to
fire
tar,
and
the coke
ovens as well as the boilers in the power plant. The coke ovens are the
split-off point for cost assignments. The cost of each product consists of
CH. 8
183
184
necessitates
PART
II
a reasonably
complete knowledge of the technological factors underlying their manufacture, for the origin of by-products is not always the same. By-products
arising from the cleansing of the main product, such as gas and tar from
coke manufacture, generally have a residual value. In some cases, the byproduct is leftover scrap or waste such as sawdust in lumber mills. In
may
may arise from preparing raw materials before they are used
manufacture of the main product. The separation of cotton seed
process but
in the
shells
\v
>
v\^ ve ntQuy r,r><;ting, some independent value rna y be assigried__to th^Jby1 >> product.
(Methods 1, 2, and 3 explained below are examples of
"XZategory 1.) (2) Some-poilion of the joint cojts_ is allocated to^JJieJ^y-
"^Jl.
'^^
j)
- SoXa-
.Method
rjLc
{jo^
4^
i^-
rvv""
.
OC
a.
b.
VftP^
>(\3a
Method
Re venues from
this
4).
s uj^se-
on the inco me
c-
d.
Other income,
Additional sales revenue.
^ deduction from the cost of goods sold of the main product.
A deduction from total production costs of the main product.
Met hod 2
K>-\^
1.
(see
statenifinLas:
V^eJO-
tvjL
'
-jj
rgjj
by-products
S pecific costs are jiaL^llocat^d tn the hy-
fall
>
\.
methods used
several accepted
Vv^wx
Method
3.
Th e replacement
Method
4.
The accounting
steps
cost
metho d.
are:
Method
1.
presentation.
Method
income statement
CH. 8
185
$20,000
$2)
@ $1.50)
$18,000
3.000
Net
15.000
$ 5.000
2,000
$ 3,000
1,500
$ 4,500
In
this
case
the
$1,500 would be shown below the revenue from the main product, making
All other figures, except the resuhant
tW
^
By-Product Revenue as a Deduction from the Cost of Goods Sold. In this
from
the
would
be
deducted
A^-cc^
by-products
from
case the $1,500 income
*
$15,000 cost of goods sold figure, thereby reducing the cost and increasing ^oMctc^
^^ C(r^
the gross profit figure. The net profit remains at $4,500.
\j
In this case
By-Product Revenue Peducted from Produ^ioiuCosts.
from
the $18,000,
is
deducted
sales
from'by-product
the $I:7500T^evenue
uUU.-Hus
qSI&c^
|U
follows
Sales (main product, 10,000 units
@ $2)
$20,000
$18,000
1,500
$16,500
2,750
$1.375)
Net production costs (12,000 units
Ending inventory (2,000 units @ $1.375)
$ 6,250
2,000
Net
$ 4,250
The above
all
(or
13,750
Gross profit
Marketing and administrative expenses
illustrations require
no complicated journal
is
credited to
is
In
entries.
debited to Cash
Income from
Sales of By-
Product.
Witli
^e
In fact,
it is
Me thod
is
some ofthe
main pr oduct
is
_^
INI.
This shortcoming
is
somewhat removed
in the last
technique
Method
-+v^
\s
Method
2.
some
cost to
It
\Xx)i-frS^
y^,^
All
Journal entries in
Method
revenue from accounts such as Payroll for the additional work required and
perhaps charges for factory overhead. Marketing and administrative expenses might also be allocated to the by-product on some predetermined
Some
W
-.
oF purchasing._Ilain
product, however, receive credit forfurnishing such materials. The cost asI
is
V^market.
This method
is
particularly
industry.
1.
Coke oven and blast furnace gas are credited respectively to cost of coke
and cost of pig iron at computed value based on cost of fuel oil yielding
equivalent heat units.
3.
Tar and pitch used as fuel are credited respectively to cost of coke at
computed value based on cost of fuel oil yielding equivalent heat units.
4.
steel at
market cost
CH.
5.
187
Method
4.
The market
valiie (revers.aLcost)~mlhpd
Method
1.
basically similar
is
Hqwever^Jt^educesJhe
:^
U^^-'^
^'^" '^J^^
by-product is_separatedjVo^^
charg^^7'^''-p^tly tn thp-Ry-proHn cf Any proceedsjrom subsequent_s ales
of the by-product are cr edited toJligJiy^progu cTaccou nt. The^ balance in
heaBlncurred
^ Ot^'t
gy ^"^
after the
and by-product
costs
may
^^^V
MAIN
BY-
PRODUCT
PRODUCT
ITEM
m^;t
$ 50,000
Materials
^^S
70,000
40,000
Labor
Factory overhead
Total production costs (40,000 units).
.4^>Market value (5,000 units $2).-;iUW) .P.Ot^-^S S,'Jj3^'^Estimated gross profit consisting, of:
^
(20% of selling price, assumed)
V<>
Marketing and adm. exp. (5% of
^
^^
^U ^st
^t
Vy ifrMif'-)<0-^
<J '^T'^
fc^ $10,000
mlCi- t^d t^ ^^
f^oSA.^
$160,000
fWS
$2,000
V,ut
^
i_^(^
2,500
,/^
q c^~,
1,200
300
Factory overhead
to^^nlETogu^ --"
cost of
2.500
,
5,000
^
$5,000"^
VU
1$
$ 7,300
.t::
units
Unit cost
5,000
40,000
$3,875
Joint Products,"
bw _^^
1.46
NACA
Bulletin,
vUWA'
^v^^ ^4
2.300
number of
fWj
$155,000
main product
T'^tli7r:7rrrr^
Total
'
^^
.--CP^
$1,000
Materials
Add back
^VOji^t^A
split-off:
Labor
Net
fcA' oT
/)<,/
^^YroLtVf
S 7,500
r,
^00
selling price)
^u>^
a>^/:^l -^V^
\su)j^''^
fxJIi
vuT e^rS
^td-
'
?5^^^
dx^^
C{cJr
'
t;(
188
PART
is
II
pro-
towa r d the recognition of a_byproduct cost prior to its split-off fromt he main prod uct. It is also the
nearest approach to methods employed m joint product costing.
portional to
its
sales value,
jt js a step
pro cess or
more than
a nominal
W^ value
yty^\r.'S
cXjo^^(/j^'>'
'
common processing
mon raw material.
products are
split-off or to the
results in the
production of such
oils.
all
sum
for
all
products
andn ot
is
co^^t
i<^
inriirre d in a tQ tajjidivi.'^ible
^Financial Planning and Control in the Meat Industry, prepared by Price Waterhouse & Co. in
cooperation with the Accounting Committee, American Meat Institute, Chicago, 111., 1967.
CH. 8
189
and separate,
in-
as direct materials and direct labor, but also of those indirect factory overhead costs such as plant and machinery depreciation and service faciUties
necessary to produce the products. ThejndjrecLcQg ts are general y {^pplig d
to the product on the basis of Jhe est[matedJ^tory_^erh^^
the ^^sumptlqn that iherejs a functional j'elationship between the bas is
The joint
chosen and the^cosjLap4ilicabte-4o-4h_products or spgrnents
production costs require allocation or assignment to the individual products, and these methods are discussed below. HmveYCf; while aJlnration -^(^
is possible and even desirable, "t he conceptso f joint and separable co sts ^-^'jcvU^'
cufacrossthe ^oncepts of direct and indirect co sts. lU^notjlwaYsrealji^ed ^ ovy^ or
l
\<>
m ay^in
o_segrnents
real ity,
"
be-lomt?^3
2.
3.
4.
and manufacturing
vwt
So
V^^^.^
costs incurred
relative
up
market values of
The quantitative or physical unit method based on some physical measurement unit such as weight, linear measure, or volume.
The average unit cost method.
The weighted average method based on predetermined standards or index
of production.
great popularity
is
man i-
festatipji_ofih-rnsts incnrrfd-ilt!^roduction.
T he conte ntlnn
because more^cjast-wjis
expended_to_prQduce
it.
it
is
way
jq
that
^f
to prorate joint
cosTTTs on the basis of the respective market values of the items produced.
The method
is
really a
or sales value of each unit (quantity sold times the unit sales price).
The
<
^y^ J(m'>S
made by
^X)
4.VV
190
PART
II
it is
more
may have
in their
Nevertheless, this condition does not destroy the usefulness of the sales
Joint
Products
costs
is
made
in the following
manner:
CH. 8
191
assumptions
listed
To
illustrate the
procedure, the
Ultimate
Units
Market Value
Product
Produced
Per Unit
20,000
15,000
10,000
15,000
S0.50
5.00
4.50
8.00
D
To
Processing Costs
After Split-Off
$ 2,000
10,000
10,000
28,000
it
is
necessary to use a
The following
Ulti-
mate
Market
Product
A
B
Value
per
Unit
duced
$0.50
5.00
4.50
8.00
20,000
15,000
10,000
15,000
Units
Ultimate
Pro-
Market
Value
;
10,000
75,000
45,000
120,000
Processing HypoCosts
thetical
Market
After
Value*
Split-Off
$ 2,000
10,000
10,000
28,000
8,000
65,000
35,000
92,000
60%
192
PART
II
units
Sales dollars
52,000
18,000
12,000
8,000
14,000
$217,000
$9,000
$60,000
$36,000
$1 12,000
$120,000
50,000
$4,800
2,000
$39,000
10,000
$21,000
10,000
$55,200
28,000
Total
Less ending inventory
$1 70,000
$6,800
680
$49,000
9,795
$3 ,000
6,192
$83,200
22,211
$147,789
$6,120
$39,205
$24,808
$ 77,656
Gross
profit
$69,211
$2,880
$20,795
$11,192
$34,344
Gross
profit
32%
32%
34%
31%
30%
Sales
percentage........
5,544
used to
(1)
T he
gross profit from saTesv alue to ffn^T he total cost, and (3) reduce t otal co st
costs' share
Total
$250,000
$10,000
$75,000
$45,000
$120,000
80,000
3,200
24.000
14,400
38,400
Total costs
$170,000
$6,800
$51,000
$30,600
$81,600
50,000
2,000
10,000
10,000
28,000
$120,000
$ 4,800
$41,000
$20,600
$ 53,600
Observe that
if sales
measurable by the basic measurement unit. If this is not possible, the joint
units must be converted to a denominator common to all units produced.
For instance, in the manufacture of coke, products such as coke, coal tar,
benzol,
in diff'erent units.
The
CH. 8
193
\}oi>
194
PART
II
Using figures from the previous example, weight factors assigned to the
four products might be as follows:
Product
Product
Product
Product
The
cost allocation
Product
would
points
12 points
C 13.5 points
D 15 points
B
CH. 8
195
any joint and by-product inventories are assigned costs for income tax
purposes, the tax director must study the proposed costing program and
inform the producer whether it will be allowed. It is a genuine problem
for the tax director to decide whether or not a cost policy conforms closely
enough to the accepted standards of the industry, or whether or not the
alleged cost of a joint product or a by-product
is
market values. So much depends upon the judgment of the tax director
that one might justifiably claim that in joint product and by-product costing disputes, the tax director
decisions
may
is
Of course,
by the same vague, general statute; and thus they, too, must rely almost
entirely upon their own independent discretion and practically make
the law.
Clearly, tax laws have not solved the
and by-products
that
if
itsimpligatign thatthejnarto-A^akie--method
manifestly inaccurate and illogical,
it
can and
is
desirab le
will
is
be changed
with
unfair or
if
industry
procedures.
PETROLEUM INDUSTRY
IN
THE
whether he
produced by
oil
and natural gas. Traditionally, ac looke4 u pon gas as a by-pro d uct; a nd_no
serious eflfort^was made to separate gas eosts4iomJiitaUjQint_costs. With
the dramatic increase in natural gas demand, coupled with long-distance
pipe lines, natural gas has emerged as a full joint product.
In recent years the problem of allocating joint costs between crude
oil and natural gas has been intensified due to the Federal Power Commission's role in attempting to estabhsh just and reasonable prices for
natural gas. A landmark court decision required the FPC to consider gas
these costs relate to both crude oil
counting
196
comparison
witli
PART
II
is
i_.e.,
spHttin g
oint costs for the purpose of s e tting a s^Uing price fo r o ne of the product s,
based on_actual_osts. Despite the best efforts of accountants and economists, the basic
at
problem remains.
2.
3.
in order to arrive
The
The
The
BTU
Thermal Units)
method
(British
relative cost
allocation
method
types of costs:
(1)
This ratio takes into account the value of the reserves remaining
ground
test year.
V
\
by the company
in the
tions the
new
hearings.
BTU
The
BTU
The
rationale of the
method
is
that the
consumer
is
interested in
CH. 8
on
oil,
or coal.
The
and oil.
method has been
197
all
the prod-
The
BTU
value of all the joint products produced. Only a part of the products resulting from crude
oil
Gasoline
is
valuable
because of its form. Various modifications of the basic BTU formula have
been suggested to give proper weighting to energy form.
Relative Cost Method. Under this method which has been accepted
by the Federal Power Commission, producti on costs from joint product
lease^.are allocatedjo^the^l and gas produced_on the basi s_ofthexelationship between costs act]jallyJllcurredJn_p^
the same productsTrom
single product leases (i.e., leases fr om which only oil or oriI y~"gas ig
produced).
method has considerable appeal where the company has sufficomputing representative single product
r"~~
costs.
In addition, the company should be large enough to assume an
averaging of economic and geological lease characteristics. Of cour se,
TTiTs
expenditu res
this methQd^_doS_jiol4iix^44-4^of^-atioatioji^^
total_costs
'
"
amount of
ble.
It is
198
PART
II
are considered in determining the price that a packer is willing to pay for
livestock. Sales realization values are also considered when deciding to sell
hams or other
them
further.
Joint costs are often incurred for products that are either interchange-
r~
all.
to
programming).
Forjrofitjgi Lanni n^^jiTdjerhaps as
h s_onlvj|eliabi-jnasiirp of profitthe
^ould_considei
conlnbatjon margin a product
management
a bihty,
^
mal:.es-t r> jnint r nr. t nftpr r ¶lTTenrindi\H dual_c
are deduct^dJVom
sales. The contribution margin allows management to predict the amount
that a segment or product line will add or subtract from company profits.
^
r.
This margin
is
;;;^
"^
^r
It
"Net
profit
determined
-VyJ-
h(
!i^^^^
IV_
categories.
j.
'^^^'^^^
re-
^'"/iVb
^ business.
is
re-
arguments
^u
uct lines
''^.
is
is
^^"^
Of
and prod-
i<nterpretation
caused
separable costs.
CH. 8
199
DISCUSSION QUESTIONS
1.
(a)
ducing department.
(AICPA adapted)
2.
sale of
statement ?
3.
4.
5.
6.
7.
income statement
Name four methods for apportioning total production costs to joint products.
Why is the market value method for joint cost allocation so often used by
industry?
8.
What
is
Does
the Internal
definite allocation
method
Explain.
10.
11.
(AICPA
adapted)
12.
13.
Select the
Select the
(AICPA
adapted)
(NAA
adapted)
200
PART
II
EXERCISES
In solving these exercises, round off all amounts, except unit costs, to the nearCarry unit costs to five decimal places unless stated otherwise.
est dollar.
The manufacturing
costs of the
to the
Materials
Labor
Factory overhead
These costs were sufficient to produce 150,000 kilograms of Ole and 20,000
kilograms of the by-product.
Required: Entries for the by-product
without assigning
have been added.
(a) Stored,
(b)
it
any
when
cost,
and
it is
later sold.
No
additional costs
Not
further processed but stored and priced, using market price to secure
value and reducing the cost of the main product by the amount allocated
to the by-product.
its
(c)
it.
to
it,
C^ Reversal
for the
month of
July are:
Main Product
Sales
Required:
-r-^
".
,f
An income
f^--^.
By-Product
$12,000
$7,000
2,200
1,800
12,000
1,500
1,100
reversal cost
for By-Product
11 ir;j;+.
By-Product
$150,000
75,000
23,000
expenses
-fl/X^CC
by-products.
profit for
By-Product B
cw
3.
wood
CH. 8
201
Actual data:
(a) 2,000,000 MBTU's of steam were distributed from the boiler during
the period at a cost of $0,250 per MBTU.
(b) 60,000 tons of paper were sold at a selling price of $75 per ton. Costs
for the period were
Materials
$2,700,000
264,000
876,000
Labor
Factory overhead
(c)
The
Additional materials
$12,000
7,000
6,500
Labor
Factory overhead
Required: An income statement for the month for paper using the market
value (reversal cost) method for costing the paper and tall oil. Include a credit
to the cost of paper for steam.
Cost Allocation for By-Products and Joint Products. The cost accountant of
the Reinhart Processing Company, Inc. prepared the income statement reproduced below on the assumptions that Mirex is the main product and Vitex is the
by-product, and that by-product revenue be treated as other income
4.
Inc.
$442,000
$5.20)
Mirex
Mirex
$221,400
101,700
finishing
$323,100
Less inventory of finished Mirex**
17,950
305,150
$136,850
113,000
$ 23,850
$ 40,800
$.85)
$11,440
1,456
$ 9,984
Net income
9,000
8,984
Inventory
$323,100
90,000
of finished Mirex:
5,000
$17,950
21,816
$ 45,666
7,000
$1,456
202
PART
II
as follows:
Factory
Department
Cleaning
Labor
Overhead
Mixing
Grinding
Packing
$50
20
20
80
$30
60
48
72
Finishing
15
10
6.
CH. 8
203
by the average unit cost method to either the Insulating or Twisting Departments. In these latter two departments, the costs are charged to the individual
products by the market value method, with the costs before separation in the
Twisting Department being credited with the value of the by-product less its
marketing costs, normal profit of 10%, and additional costs before it can be sold.
Data
for
Department
Forming room
Market
Units
Value
Produced
Labor
$10,000
$5,000
$5,000
2,000
1,000
500
500
250
500
500
250
2,000
5,000
4,000
,000
5,000
4,000
1 ,000
500
250
Insulating products
Furnace
Factory
Overhead
Materials
filters
Air conditioners
Twisting
Yarn
Electrical
Waste materials
25,000 spindles
10,000 (from Forming)
200 filters
200 filters
15,000(from Forming)
3 .00 10,000 bobbins
2 00 5,000 bobbins
$50.00
25.00
.00
1,500 lbs.
Cost Allocation
Weighted Average Method. The product engineering staff
of the Bockhorst Company prepared the following analysis of relative weights
for cost elements in the manufacture of joint products A, B, and C in Depart-
7.
ment
10:
Product
1-1/6
1-1/6
Factory
Overhead
to
products
size;
that
and B are
the
is
in
total twice as
twice their
heavy and
bulk.
Department 10
Materials
in the
month of March:
Factory overhead
$220,000
190,000
1 70,000
$580,000
Labor
(Based on an
NAA article)
204
PART
II
(Market
Value at the Split-Off Point for Joint Cost Allocation. Miller Manufor $.80 a gallon. At the end of processing in
Department 1, Zeon splits off into Products A, B, and C. Product A is sold at
the split-off point with no further processing; Products B and C require further
processing before they can be sold; Product B is processed in Department 2;
and Product C is processed in Department 3. The following data is a summary
of costs and other related data for the year ended June 30, 19B:
facturing
Department
Cost of Zeon .]%9,
.
?y.^. .(^Aoi^S.
^hdc^ ^A
Direct labor
Factory overhead
$96,000
14,000
10,000
$45,000
21,000
$65,000
49,000
Product
B
Gallons sold
Gallons on hand
at
20,000
10,000
$30,000
{2x
'U)
\i2ind at
r
{
\MK .0**.'
'
Required:
units
(1)
(2)
(3)
(4)
The
The
The
$96,000
45,000
15,000
$141,750
30,000
Product
total
year.
cost of Product
ended June
A ending inventory.
(AICPA
adapted)
PROBLEMS
In solving these problems, round ojf all amounts, except unit costs, to the
nearest dollar. Carry unit costs to five decimal places unless stated otherwise.
8-1.
25%
manu-
known
is
P 50%,
L 20%,
A 30%,
12%
CH. 8
205
The data show the cost of direct labor per ton of ingredients handled and the
percentage of departmental factory expense to the direct labor:
Direct Labor
Dept.
No.
1
2
3
Manufacturing Department
Mixing
Furnace
per Ton
$35.00
17.50
24.00
80.00
Percentage of
Departmental
Factory Expense
to Direct Labor
70%
280
110
40
Materials P, L, and
are put in process in the Mixing Department. General
factory expenses that cannot be charged to any one department amount to 50%
of the departmental direct labor cost for each department.
In Department 2 there is a yield of only 80% of Isplastic from the tonnage
of the ingredients mixed. The other 20% is treated in Department 5, two thirds
of this 20% being recovered as the by-product, Notplastic, and the other third
being entirely waste.
A net profit of $50 per ton is made on the sale of Notplastic after all expenses
of every kind are charged against it. This profit is credited to the main product.
No charge is made against Notplastic for the raw materials from which it is
recovered.
Required:
The
profit
on every ton of
Isplastic sold.
(CICA adapted)
Clay mined
Machine-made brick
Handmade brick and
Kilns
tile
tons
9-inch brick molded
9-inch brick molded
Machine-made brick set
Machine-made brick drawn of which
20,000 are broken
300,000 Handmade brick set
285,000 Handmade brick drawn of which
10,000 are broken
8,000
850,000
350,000
800,000
620,000
206
PART
II
Clay mining
Machine-made brick
Handmade
brick
Payroll
$2,404.00
800.00
522.00
$1,200.00
1 ,300.00
2,040.00
1,660.00
325.00
455.00
1,850.75
Kilns
485.00
165.00
Power house
General plant expenses
Depletion and depreciation must be provided as follows: Clay lands estito contain 2,000,000 tons; cost $60,000. Depreciation: Power Plant,
$100; Kilns, $250; Machine Molding, $175; Hand Molding, $75.
A reserve for extraordinary kiln repairs is to be provided, at $.30 per 1,000
brick set in kilns, which is charged to Kiln Burning.
The power is used at the clay mines and at the Machine-made Brick Plant
and is distributed in proportion to the horsepower ratings of the motors used,
viz.
Clay Mines, 30 hp. Brick Plant, 50 hp.
The general plant expense is absorbed by the production departments in
proportion to the direct labor cost in each.
mated
two
^\S^
Management Processing
Decision.
The
t^verock Company's joint cost of producing 1,000 units of Product A, 500 units
of Product B, and 500 units of Product C is $100,000. The unit sales values of the
$200;
$20; Product B
three products at the split-oflf point are Product A
$160. Ending inventories include 100 units of Product A, 300 units
Product C
of Product B, and 200 units of Product C.
Required: (1) The amount of joint cost that would be included in the ending
inventory of the three products (a) on the basis of their relative sales value and
(b) on the basis of physical units.
(2) The relative merits of each of these two bases of joint cost allocation
(a) for financial statement purposes and (b) for decisions about the desirability
of selling joint products at the split-oflf point or processing them further.
(AICPA
adapted)
8-4. Joint
result.
Material is started in Process 1, and the three products emerge from this first
process. Colossal is processed further in Process 2; Formidable is processed
further in Process 3; Petite is sold without further processing.
Process 2
Process 3
=
=
=
=
512,000
8,000
4,000
300
in process inventories.
CH. 8
207
Produced
September
End
Quantity
Sold
Sales Price
of September
Price
Colossal
5,000
3,000
4,000
2,000
$6.00
1.00
S6.00
Formidable
Petite
1,000
900
.50
.55
.90
Required: (1) The costs assigned to the Petite inventory and the costs transfrom Process 1 to Petite units during the period.
ferred
costs transferred
(AICPA
adapted)
processes.
The company considers the income from Bypo, after allowing $.05 per pound
for estimated selling and delivery costs, to be a reduction of the cost of the two
principal products. The company assigns Department 101 costs to the two
principal products in proportion to their net sales value at point of separation,
computed by deducting
from the
March 31
Inventories:
Quantity
(Pounds)
Department 101
Department 201
Department 301
Finished stock
Finished stock
Finished stock
XO
MO
Bypo
Cost
April 30
Quantity
{Pounds)
....
800
200
300
$17,160
2,340
7,260
1,200
18,550
....
1,000
360
80
700
208
PART
II
Department 101
Department 201
Department 301
The
Materials Used
Costs:
$134,090
$87,418
31,950
61,880
Sales Prices:
XO
MO
Required:
in effect
(AICPA
8-6. Joint
adapted)
Company manu-
(a) In Department 1 the raw materials amanic acid and bonyl hydroxide
are used to produce Amanyl, Bonanyl, and Am-Salt. Amanyl is sold to others
who use it as a raw material in the manufacture of stimulants. Bonanyl is not
salable without further processing. Although Am-Salt is a commercial product
for which there is a ready market, Amaco Chemical Company does not sell this
product, preferring to submit it to further processing.
production.
In its financial statements Amaco Chemical Company states inventory at
the lower of cost (on the first-in, first-out basis) or market. Unit costs of the
items most recently produced must therefore be computed. Costs allocated to
Demanyl are computed so that after allowing for packaging and selling costs of
$.04 per pound, no profit or loss will be recognized on sales of this product.
follow:
Certain data for October, 19
Raw
Materials:
Amanic
acid
Bonyl hydroxide
Colb
Pounds
Used
Total
Cost
6,300
9,100
5,600
$5,670
6,370
2,240
..
CH. 8
209
Cost
Department 1
Department 2
Department 3
$33,600
3,306
22,400
Products:
Inventories,
Pounds
Amanyl
Bonanyl.
Am-Salt..
Bonanyl-X.
Colbanyl
.
Demanyl
Pounds
210
PART
II
B. Theory of Joint Product Cost Allocation Methods; Product Mix and Gross
Profit Analysis. Kimel, Inc. manufactures two plate glass sizes that are produced
simultaneously in the same manufacturing process. Since the small sheets of
plate glass are cut from large sheets with flaws, the joint costs are allocated
equally to each good sheet, large and small, produced. The difference in after
split-off costs for large and small sheets is considerable.
Last year the company decided to increase its efforts to sell the large sheets
because they produced a larger gross profit than the small sheets. Accordingly,
the amount of the fixed advertising budget devoted to large sheets was increased;
and the amount devoted to small sheets was decreased. However, no changes
in sales prices were made.
By midyear the Production Scheduling Department had increased the
monthly production of large sheets in order to stay above the minimum inventory
However, it also had cut back the monthly production of small sheets
level.
because the inventory ceiling had been reached.
At the end of last year the net result of the change in product mix was a
decrease of $11 2,000 in gross profit. Although sales of large sheets had increased
34,500 units, sales of small sheets had decreased 40,200 units.
Fixed costs
(c)
Prime costs
(2)
The propriety of
financial statements
on the basis
of:
(3) In the development of weights for allocating joint costs to joint products,
advantages in reducing the relative sales value of each joint product by its after
split-off costs.
(4)
explaining
why
it
Inc. in deciding to
change
its
product mix,
last year.
(AICPA
adapted)
CHAPTER 9
further in this
This chapter
will:
available for applying factory overhead, (2) describe methods and pro-
cedures for classifying and accumulating actual factory overhead, (3) show
computations for over- or underapplied factory overhead, and then (4)
analyze the total variance into the spending and idle capacity variances.
will:
(1)
head, (2) explain the creation and use of separate departmental overhead
rates, and (3) discuss departmentalization in nonmanufacturing businesses
and nonprofit
institutions
1 1
example, and
(3)
its
cost as an
responsibility accounting
service
departments.
Factorj overhe ad
indirect labor,
and
is
all
nor charged directly to specific jobs or products. The assignment of factory overhead to departments and, ultimately, to specific
identified with
211
212
is
PART
III
of all production costs other than direct materials and direct labor.
Other terms used for factory overhead are factory burden, manufacturing
expenses, manufacturing overhead, factory expenses, and indirect
sists
manufacturing cost.
Factory overhead possesses two characteristics that require specific
recognition and consideration if products are to be charged with a fair
share of these expenses. These^charj^cterist ics deal with the pnrt'H'^^*
r elationship
of factorv overhead to
(1) the
product
itself
and
(2) th-A^okime
an
No
materials requisition or
overhead
is
as
much
as factory
Yet factory
overhead to
some more or
less arbitrary
to the units
produced.
^ V^
would
an inequitable
situation.
CH.
213
$22,000-
$20,000-
fe
o
u
$10,000
(UNITS,
4,000
3,000
2,000
1,000
VOLUME
ETC.)
Volume
For example, costing problems would result if actual costs incurred for
and maintenance were charged directly to a job or product. What
work should be charged with the expense of these repairs? Should work
repairs
is
month when
repairs are
again unreasonable.
because of wear and tear over a much longer period than one month and
are made to permit continuous operations in any month. Furthermore,
overhead costs need to be assigned to production promptly, and ineffiTherefore, factory overhead is usually
ciencies need to be identified.
charged to work done on an estimated
'
basis.
esti-
/i^
'^'^
careful studies.
^-^
/fi
>F^
^'^^
~'-9
^-
^^
ay\ \v^<a^f\t^
"^^""^^
mates can cause certain difficulties because underlying data are the result P^*^
of opinions and judgments. Consequently, estimates must be the <^^t-ovf^^
come of
used on a job are determined from materials requisitions and time cards
u^^
yj.,^.^viijy>P
214
PART
III
and are entered on job order cost sheets. Overhead costs have been predetermined from cost data to arrive at the total amount of overhead estimated for the activity level to be used in computing the rate. This total
^
H ^^
cost is then related to estimated direct labor hours, machine hours, direct
xd- Ujai3Qi- dollars, or some other base for the same activity level, ultimately to be
^vsT ~-VW
expressed in a rate. For example, overhead applicable to a job may be
'"'^
calculated by multiplying actual direct labor hours incurred on the job
for JiAtU.
|3y the predetermined rate. The amount of overhead is then entered on the
^
->*-
"^^^^^^
/
J0J3
2,<\^.
is
known
at the
is
completed.
Process Costing. With a process cost system, unit costs are computed
total weekly or monthly costs of each process by the output of
by dividing
Factors to
Be Considered
in Selection of
overhead rates used differ not only from company to company but also
from department to department within the same company. The type,
significance, and use of factory overhead items must be considered when
deciding upon applicable rates. At least five main factors influence the
selection of overhead rates
Base t o be us ed
II.
Iriclusion
ongxclusion
of fixe d
^overhea d
d.
Units of production
Materials cost
Direct labor cost
Direct labor hours
e.
Machine hours
a.
b.
c.
IV.
II.
AclMJy-LeUaJie_used
a.
Absorption costing
b.
Direct costing
Use
a.
b.
a.
Normal capacity
c.
Departmental rates
Cost center rates
b.
d.
Operational rates
V.
Use
activities
CH.
215
Base
the
head
is
If,
A
and
When two
effort.
or
same
the
differs
factory overhead:
(1) units
of production,
labor cost, (4) direct labor hours, and (5) machine hours.
Units of Production Basis.
and most
direct
The
Estimated
Factory-Overhead
^
= Overhead
,
is
.^
per Unit
If estimated
company
computed
\
\
as
'^X'^Mi
i
C/.
..
intends to produce
i)
juJ'-v-"
- 250,000
units) as
its
^T
j^
'^^.
250,000 units during the next period, each completed unit would be charged
with $1 .20 ($300,000
V-vCa
iLfAcA/.-^
\m(j^
An ^-^A
>^J"
^^ -^'^^^
order with 1,000 completed units would be charged with $1,200 (1,000
(My^^
X $1.20) of factory overhead.
units
The
is
satisfact onLjwiieiL a
'
An example
is
illustrated
-nf
Yrl --^^^^
a,
miA^
,
,^-,4}\,^i
<>
),
i^tc^i,G2_
iXJ'<VNb
V^^I^
bo+W ^ViL^
i,^<^^^^-c>^^^
216
IbO
i^^-'
^
PLANNING AND CONTROL OF FACTORY OVERHEAD
Products manufactured
If the
5 lbs.
00,000
III
20,000
1
PART
5,000
20,000
2 lbs.
30,000
20,000
lb.
$2
$2
$2
$200,000 $60,000 $40,000
$10
$4
$2
number of points
compensate for differences. For example, a company manuL, S, M, and F computes an overhead rate per product
Products
facturing
to each unit to
as follows
Estimated
Products Quantities
(,
S^
CH.
217
This method has only limited use because in most cases no logical
relationship exists between the direct materials cost of a product
its
and
"
production. One product might be made from
To overcome
two overhead
this unfairness,
rates
than
share..
its
might be calculated
-r,
^
one
The
overhead
is
the most
-^.
-V-r
Esumated Direc^
Labor TTC ost
If estimated factory
100 percent
is
overhead
100
wideW
i>^
A job
100).
C^)J^
fM-jl
\'"^
Wj^/3
ixiyc B\^
^1^^'^^
U>^
f^Ai
(HmS X
Qy
y^f^i^v^is
o^
is
vvSiA'j
'o->'3^A(J
^
.
_____
^rt, <Kmc3[
would be
^\-
it is
^^
^^
factured.
WtK-
Ulor
\%:)tx.
.l-
_*.
<
v^V
is
-^-.
jo bs
ClMt
k"
-4-
^^ ^
'
Any
must take
this
The
it
wdva^J
Va^^
t^,
is
overhead.
The
oy
when
(1)
head
exists
parable.
is
and
readily available.
direct. relationship
(2) the rates
The weekly
is
between
di rect
It s
use
is
information
^^^^^
particularly favore d
G^^^
work
are
com-
As long
as
economy
SS
\\sc
p^^
'^or
ji^
sinJl'v-w^^
d3
information remains a main prerequisite, the direct labor cost basis can be k^hjx
accepted as the best and quickest of the available methods for applying
t^^
I
overhead.
^^
vvu)Dl
o- Wss ^/\4
v^
v^oji^ ^c^
4|^^^
-He..
'
>
PLANNING AND CONTROL OF FACTORY OVERHEAD
218
On
PART
III
two reasons:
to for
'
'
Total direct labor cost represents the sum of high- and low-wage production workers. By applying overhead on the basis of direct labor cost, a
job or product is charged with more overhead when a high-rate operator
performs work instead of a low-rate worker. Such a method can lead to
when numerous
\jksi yov.
jV.^
0^^^
w
is
-c^l^
A) ^-Wv-
basis,
,--~1r
r.
If estimated factory
overhead
is
designed to over-
is
asj'ollows:
on
direct labor
hours would be $1.50 per hour of direct labor ($300,000 -^ 200,000 hours).
A job that required 400 direct labor hours would be charged with $600
(400 hours
L cosV
The use of
Job
or product.
must be organized
method
Lxrvy-iovi^
The use of
the direct
relationship b_elwen^4iieLlabor
first -a-direct
o ^ouc5^^
VcS
inaccurate costing.
i;udt^v5
^^
This disadvantage
is
J^
Vl
^/m
lX^
-^^A^
^va1\^'
^/h
"^ ^ ^'^"^
P^^^W >^A
^<^^'^
%^ JL^l^
(P>V.
\ ..
^/aJ
Q5* V^^vfiJ
S^^
U "^
CH.
If factory
overhead
is
will
Work
-^
219
is
$1 per
ma-
$l)for factory
overhead.
Shopmen, foremen, or
timekeepers will have to collect machine hour data needed to charge over-
-"
,_
and
efficiently into
if
a cost system
is
to receive meaningful
is
Activity Level to
depends on the
is of utmost importance
and accurate costs and if management
Be Used.
The
the lower the J&xed portion of the overhead rate, because fixed overheadjvlH
be spread over a
gifeater
number of
The
variable portion of the rate will tend to remain constant at various activity
levels.
rate
i.e.,
Other capacity
actual capacity.
Chapter
18.
enough
A rate
based_.oii~QOtnnal
and
cap ac-
<^^ results in a
'
in
of certain
more
normal capacity rate concept assumes that the rate should not be rz^'w-^'^
changed because existing plant facilities are used to a greater or lesser msu-t t^ aa-^s/
AJoId or product sh ould not cost more Jo_4iciiduceJn _any o ne v^\)j^4xr>^
accounting period just because production was lower and fixed charges
degree.
units.
Mys
i^-
it
,,
- -+W-iL5pM-.
220
-+
In
mo stjnstances,
the-use. of. a
normal
'^/f/
III
differ
when
head,
is
further analyzed,
reveals
it
much
management information
useful
E>^ected_jiliiaLipuity.
The use of
1
V,
'^
yv
'^
xticXjL
AwM
i*Ji?
)c^4j^
figures.
is
Vr
.(^YN
and production
normal capacity
level.
The
overhead
and acceptable even though the expenses are not representative of normal
Loperations.(^ \\Sb
<^^
^i^A^-rv^^
^uM^
both
activity levels.
Assume
-\a\)v!L
-|\a\X>^v<^'^^
^1
/
'1
^V\
^ ^^r^ J
Normal
Expected
Capacity
Actual Capacity
Fixed expenses
Variable expenses:
1 50,000 hours
X $.50
120,000 hours X .50
$120,000
$120,000
$ 195,000
$ 180,000
150,000
120,000
$1.30
$1.50
$ -80
$1.00
75,000
60,000
^'^-
V.^-'^
v -"
"^
v>
The
difference in the
CH.
221
Since fixed
rate.
must be assumed that management anticipated a volume of business requiring such an amount of fixed
costs. It is executive management's task to reach that level of operation
which will assure a profitable and competitive position.
Inclusion or Exclusion
it
Under
levels,
all
overhead
rates.
sometimes used,
method of
Fixed^ expenses
management purposes.
overheadjsj^ncluded
Under
in
is
th is
in overheadj;ates.
tr eated
as perjod
meaning that they are charged off in total each period as are marketing and adminjstrative-fiipenses. TliyLare_jLQt includedjn^eit]^
in
process or^^nis hed goods inventories.
Absorption and direct costmg are the result of two entirely different
cost concepts with respect to product cost, period cost, gross income, and
net income. The two methods result in different inventory costs and difcosts
Direct costing
is
may be
used
Of
the five
main
outlined at the beginning of this section, two have not been discussed;
namely, the use of a single rate or several rates and the use of separate rates
for service activities. These
in the next
two chapters.
Calculating a factory
is
Th e
first st eD_ in
Un
calculatin g
and then estimate or budget each individual expense^^t the_estimated activi ty level in or der-te arrive-at the total est imated._overhead.
The list on page 222 shows the estimated factory overhead for Proctor
Products, Inc. for a normal capacity activity level estimated at 200,000
selected
222
PROCTOR PRODUCTS,
PART
III
INC.
Amount
Expenses
Supervisors and foremen
Indirect labor
$ 70,000
75,000
9,000
23,000
12,000
20,000
6,000
Overtime premium
Supplies
power
Fuel
Water
PICA
1,000
18,000
5,000
3,000
2,000
15,000
12,000
4,000
5,000
13,000
4,000
3,000
taxes
Unemployment taxes
Workmen's compensation
Hospitalization insurance
Pensions
Vacations and holidays
Group insurance
Depreciation
building
equipment
Depreciation
Taxes (property)
Insurance
(fire)
specific
and the
state of technology.
expense
may remain
Once
$300,000
facilities, prices,
managerial policy,
Should
tion level. Increased production causes a decrease in fixed expense per unit.
Knowledge of the
cost
is
effect
of the behavior of
all
costs
is
knowledge
An
of segregating
partly fixed
level
all
change
expenses are
as production increases.
Some
difficulty
Furthermore, costs
production
levels.
may
Such expenses
in the
CH. 9
PROCTOR PRODUCTS,
223
INC.
Fixed
Expenses
$ 70,000
$ 70,000
$66,000
9,000
Indirect labor
Overtime premium
4,000
Supplies
75,000
9,000
9,000
19,000
23,000
3,000
9,000
12,000
2,000
18,000
20,000
1,000
5,000
6,000
500
500
1,000
taxes! !!!!!!
3,000
15,000
18,000
Unemployment taxes
Workmen's compensation
1,500
3,500
5,000
500
2,500
3,000
Hospitalization insurance
500
1,500
2,000
Pensions
2,000
13,000
15,000
2,000
10,000
12,000
1,000
3,000
4,000
Depreciation
5,000
power
Fuel
Water..!!
FICA
building
Depreciation equipment
Taxes (property)
4,000
Insurance
3,000
(fire)
5,000
3,000
3,000
4,000
3.000
^
$125,000
$175,000
$300.000
expected to increase 10 percent, it is possible to determine the corresponding increase in total expense as well as the increase in
detailed
individual expenses such as supplies, power, indirect labor, etc.
when production
is
Chapter 18.
illustration and discussion of such procedures are presented in
Total expenses as illustrated on page 222 amount to $300,000; in the
illustration above, they are classified as either fixed or variable.
overhead
selected base and the factory overhead have been estimated, the
used and
is
base
hours
rates can be computed. Assuming the direct labor
(normal
direct labor hours for the coming year are estimated to be 200,000
capacity level), the factory overhead rate at this selected activity level
would be
Estimated Expenses
Factory Overhead Rate
$3 00,000 _ .^^-f,Pf^,
= ^00;500 " ^'^
Hour
224
down
into
its
fixed
PART
III
and variable
components:
$125,000 Estimated Fixed
O verhead
^ "^"^
'^
I'^'f
.
Factory n""i,^^
Overhead d^
Rate
This rate
applied are
is
first
Hour
Amounts
reports.
amount of overhead
Factory overhead
is
applied as soon as the necessary data, in this case direct labor hours, have
as actual
rate.
Accumulation of Actual Factory Overhead for Control. Factory overhead includes numerous items which can be classified in many different
ways. Every firm because of its own manufacturing peculiarities will devise its own particular accounts and methods of classifying them. However,
regardless of these possible variations, expenses are usually summarized in
a factory overhead control account kept in the general ledger.
this general ledger
recognize
is
under
^
I
in use.
Kmj
\^
Q;y\ <^^^^^
(XdTuO' ^-\
it
as such, particularly
Details of
many
when
forms, and
it
may
be
difficult to
and
jhg accumulation of
Due
many
C'V^<i^^^f"
fe "^
to the
CH.
it
is
almost impossible to
set
up an all-purpose system
225
for accumulating
factory overhead.
The
^.
clx6v-yit
S^"^"^
Steps in Accounting for Actual Factory Overhead. In small or mediumin
a
sized businesses factory overhead accounts have usually been kept
prosubsidiary ledger. Punched cards, tapes, or magnetic disks in data
of accounts used
prise a partial
list
Supervisors and
Foremen
Labor
Overtime Premium
Indirect
Supplies
Repairs and Maintenance
Electric
Power
Fuel
Water
Group Insurance
FICA
Taxes
Depreciation
Building
Equipment
Depreciation
Unemployment Taxes
Workmen's Compensation Taxes (Property)
Hospitalization Insurance
Insurance (Fire)
Pensions
as discussed in the
next chapter.
The
1.
2.
3.
Some overhead
paid for during the month; others are the result of current journal entries
at
for supplies and indirect labor used; still others are adjustments made
- the end of a fiscal period. The principal source documents used for recording overhead in the journals are: (1) purchase vouchers, (2) materials
requisitions, (3) labor job time tickets, and (4) general journal vouchers.
"tb
t
226
PART
III
Underlying source documents provide a record of the overhead information which must be analyzed and accumulated in proper accounts.
To obtain accurate and useful information, each transaction must be
its
inception.
Purchase Vouchers.
vouchers are those charged off in tot al eaclLpeiiod. These transactions are
supported by vendors' invoices which are analyzed and classified in ac-
specific
account charged
is
in-
all
charges for
Labor Job Time Tickets. Labor job time tickets are used for indirect
Foremen, timekeepers, or the workmen themselves enter pertinent
data on the time ticket so that proper factory overhead accounts can be
labor.
charged.
is
to be charged.
making
fqr^
used for
fire
is
amjinncipally used
to
accumuand /or
journal.
The format
for the
outsiders
Trans-
and/or cash payments journal. Items are journalized from prepared vouchers based on the original source documents (as discussed in
register
CH.
Chapter
The entry
4).
is
made
227
Overhead Control.
General Journal.
in the general
To avoid
many
Factory Journal.
when
posting process
cost accounts are kept in a separate ledger rather than in the general
ledger.
In such instances,
all
accounts are entered in the factory journal using factory journal vouchers.
To avoid
The
factory journal
and
reciprocal accounts
is
was described
in
Chapter
4.
'^
t"";'
duplication
Use of
these
The general
General Ledger.
items
is
the
same
reflect certain
factory ledger
Factory Ledger.
ledger.
It is
ac-
is
operations are removed from the general ledger and placed in a separate
factory ledger as was described in Chapter
4.
when accounts
it is
is
its
subsidiary ledger
When
all
made
is
its
the
same
as that
between the
subsidiary ledger.
account from the various journals, the debit side represents total actual
factory overhead incurred during the period.
T he
The
illustration
on page 228 indicates that actual factory overhead for the period was
228
Dec. 31
Dec.
292,000
31 (190,000
PART
III
285,000
$1.50)
/
TOTAL ACTUAL OVERHEAD
OVERHEAD APPLIED
DURING PERIOD
credits as
come
available.
factory overhead, as
illustration
5.
is
is
used for
CH. 9
for
229
is:
285,000
Work
in Process
Factory Overhead Applied
zD,uuu
work in process
head charged to jobs or departments. The debit to the
ledger or
general
the
into
applied
control account brings total overhead
factory cost accounts are kept there. The factory
overoverhead applied account is subsequently closed out to the factory
head control account by the entry
if
285,000
285,UUU
practice to use a factory overhead applied account beHowkeeps applied costs and actual costs in separate accounts.
post
but
Applied
do not use Factory Overhead
common
It is
cause
it
ever,
some companies
Overhead Control.
expenses
Debits to the factory overhead control account are for actual
adjustments
credit
be
course,
of
may,
incurred during the period. There
(e.g., the return of supto actual factory overhead in the control account
Such credits would reduce total actual factory
plies to the storeroom).
'
overhead.
is
There is usually a debit or a credit balance. A_debit baiancejndicredit bala nce me an s ^hat
cates that overhead has been undej;apBli_ed; a
balances
overhead has been overapplied. These over- or underapplied
information
much
of
source
the
analyzed carefuITyTbr they are
equal.
^T^ij^Tbe
and
needed by management for judging the efficiency of the operations
^the use of available capacity during a particular perio.d.. Vr^"^ ^'f^'
^^ ^^
2.
,or
computed
underapplied jkctory-QSierbead
I^o
to volume or
due
variance
a
capacity variance
to
Idle
activity
-i
\
^
0\
W^^^230
2^0
*^
/>^''
\)^r-\'v.V3i^
"^i
The
head
PART
analysis can be
made
in the following
Ul
\AS^^'
'!)
$292,000.
750
$ 1 25,000
$291,250.
166,250
$.875)
,250
$285,000-
$285,000)
$7,000
NX:?*
vr>
made
in
{2-3)
Overhead
Spending
Variance
Variance
Capacity
Variance
(I)
(7)
(2)
(i)
U-3)
Actual
Factory
Budget Allowance
{Based on
Applied
Factory
Total
"VCmuvn^O
Overhead
Capacity Utilized)
Overhead
blcc^^AiJl-
$292,000
VC aOcVJ
>^A'-^-VV;&
IOdot)
^uVjo^
r_
VC
O^-^
\r\VJ^^
Variable
$125,000
166,250*
Total
$291,250
Fixed
$7,000
$750
Debitor
Debitor
$6,250***
Debit or
*190,000 direct labor hours X variable overhead rate of S.875 per direct labor hour.
**190,000 direct labor hours X total overhead rate of SI. 50 per direct labor hour.
0\MkS^**^'[ooV. Idle hours of 10,000 X fixed overhead rate of S.625 per direct labor hour.
Spending Variance.
a.if^lM^
'^^'^'^.^
$285,000**
Idle
worked.
also be
computed
as follows
5292,000
125,000
Spending variance
C70a<*
^
If actual
unfavorable
$.875)..
$167,000
166,250
S
less t han
750
its
.. .
CH.
PROCTOR PRODUCTS,
Comparison of
INC.
= 95%
Sa
oV /v\Yo^
rr^JL
Variable
231
Lc'7\i
Or^^'O^^
Budgeted
Actual
$ 71,700
8,550
22,050
11,550
19,100
5,750
975
17,250
4,825
2,875
$ 72,550
8,700
1,925
1,935
14,350
11,500
3,850
14,550
11,300
3,820
$196,250
$197,000
$ 70,000
5,000
13,000
$ 70,000
5,000
13,000
4,000
3,000
4,000
3,000
$95,000
$ 95,000
$291,250
$292,000
of Normal)
Under
Over
Indirect labor
Overtime premium
Supplies
power
Fuel
Water
FICA
taxes
Unemployment taxes
Workmen's compensation.
Hospitalization insurance
Pensions
Vacations and holidays.
Group insurance
Total
Fixed Overhead:
Supervisors and foremen
Depreciation
Depreciation
buildings
equipment
Taxes (property)
Insurance
(fire)
Total
Total overhead
Spending variance
850
150
670
22,720
10,200
19,650
5,300
1,000
17,450
4,925
2,900
unfavorable
1,350
550
450
25
200
100
25
10
200
200
30
$
2,780
2,030
^
^rt^Co^^
2,780
750
GPL
2,030
Chapter
18.
the level
Basically, the budget figures represent the budget for
of activity attained
(e.g.,
\-\\sr J)
'-'
or $71,700.
/ 190,0Q0
'
t,
i^
budgeted
Certain of the expenses that are itemized above exceed the
figures; others are below. Each differencejnust-beL-anaJb^zedjJl^^
must bejnitiated
for the' difference must be determined; and discussion
with tTieindividuarresponsible for
its
-^
OijO
O^H^'^
^^f^^^H^
'J\MUt
^ ^^(.^t,
TTVoP
vM/^K
- \)(y^ u^'^
incurrence.
OCatU.
\jJ
\jp
n^
232
PART
III
and
eflficient
The
However,
direct labor
is
is
only 190,000 hours; capacity not used, 10,000 direct labor hours.
capacity attained was 95 percent (190,000
-=-
The
200,000) of normal.
TheSL5Q
.pacXfc
)c^o^cia^
part of total
)Qr*Y\cA\x^ ^-^VsL
^J[-
Uw-er
^^f^^^*^ because
o^oOv>()l
J:>^
VX^\J
O'^ZT
-WM
m anufacturin gcost.
j(jlg
The
The $6,250
^)^X/^
^
direct labor
-VKaV
capacity variance
is
computed
as follows:
$291,250
285,000
utilized)
unfavorable
6,250
k^W^VAr
10,000 idle hours by the $.625 fixed expense rate or by multiplying total
j^jj-Vnca-^
-."zyT^^
\ml
'f\^\^^^
^(^
~Xc>
ft^ ct^
<, - "buT
^^'"'^
^<:?Acik,
-^
^JKx.
Because of
V\3r
Ux5
agement, inasmuch as
\x bdSiS
or
- 95%).
^^
in detail.
t otal
1"^
^^
is
is
its
impor-
presented
Althoug h
"
'
CH.
^Current
Internal
233
req^uire inclusiQiiJji_Ln-
Where
the
amount involved
is
made
is
treat
is
both
CFor
j,
/''
'
Sold or
'^
'^^''yv'
"^
'
''^
7,000
1^0
7,000
or
Income Summary
Factory Overhead Control
7,000
7,000
figure
is
made
idle capacity
regarding
its
show
until the
|c,
is
..
h-^xrn^
(i\)ajyi^
^.^t
^^'^^^'-^^ ^
aS$e^^^^-
oy er- o r
d^esjiotjiecessarily-jneaiiJhat_the overhead
lar ge
Q, S
'
'^<--^^^^(x.
underappHed overhead figure
rate was wrong.
As ment ioned, use of a n^mal overhead ratp isjTiir- r'\Mi1' Vml
posely designed to show_the^xtentio_vvii^
not f '^ '^'^ ^'^
Likewise, when an overhead rate based on expected actual condi- a A^iivml)
ijsed.
tions is used, seasonal variations may lead to large over- or underabsorbed aiix^
PLANNING AND CONTROL OF FACTORY OVERHEAD
234
PART
PROCTOR PRODUCTS,
INC.
Income Statement For 19
$1,600,000
Sales
Less: Cost of goods sold at normal
$1,195,000
Gross
7,000
1,202,000
$
profit
Administrative expenses
150,000
100,000
Net income
398,000
250,000
$
148,000
400,000
500,000
285,000
at
k-
.\.^.
^^^-K^.
...
.AjU-.
.\ir\
'JC.X.
normal
PROCTOR PRODUCTS,
Factory Overhead For
Overtime premium
Supplies
Repairs and maintenance
Electric
power
Fuel
Water
PICA
taxes
Unemployment taxes
Workmen's compensation
Hospitalization insurance
Pensions
Vacations and holidays
Group insurance
Depreciation
buildings
Depreciation
equipment
Taxes (property)
Insurance
(fire)
$1,185,000
20,000
$1,165,000
30,000
$1,195,000
7,000
Schedule B-1
>!^. .^?^?7v^?-)
$1,202,000
INC.
19
$ 70,000
72,550
8,700
22,720
10,200
19,650
5,300
1,000
17,450
4,925
2,900
1,935
14,550
11 ,300
3,820
5,000
13,000
4,000
3,(X)0
$292,000
7,000
$285,000
III
CH. 9
overhead which
will tend to
even
itself
out during a
235
The
full year.
best
way
ties
is
ESTIMATING
FACTORY
OVERHEAD
CAPACITY UTILIZED
ACCOUNTING FOR
FACTORY
OVERHEAD
^- X
ACTUAL ACTIVITY
(eg.
Direct Labor
Hours, etc)
IN PROCESS
FACTORY OVERHEAD
WORK
FACTORY OVERHEAD CONTROL
FINISHED
Goods Completed
Applied (Rate x
Actual Capacity
GOODS
Completed
with Factory
Goods
Overhead
Based on
Translerred
OVER-/UN0ERAPPLIED FACTORY
OVERHEAD
(Actual-Applied)
BUDGET ALLOWANCE OF
FACTORY OVERHEAD
SPENDING VARIANCE
Overhead
Minus Budget Allowance
o( Factory Overhead tor
(Actual Factory
Capacity Utilized)
v^oci^
oOLi/s^~7fc>0
xx
(Budget Allowance
Utilized
OOa^s-V^^
Actual Activity)
xx
Uudg Allowance
Budget
xx
SPENDING VARIANCE
(Favorable/Unfavorable)
(Favorable/Unfavorable)
IDLE CAPACITY
VARIANCE
(Favorable/Unfavorable)
1^
rou,w.^-c-v-.
UcV-
o^
8-3-
+U
^\^<'-2-''
.-A-
/Or
r>
/-.I
yi
AAii
j^
44
s^
236
^
1
PART
DISCUSSION QUESTIONS
Factory overhead constitutes a much larger proportion of total manufacturing costs today than in the past. This trend is expected to continue. Why?
2.
Why
3.
What
4.
State
5.
6.
will a
month
to
month?
predetermined factory overhead rates be used? Indiand inaccuracies of charging actual overhead to jobs
system?
Explain.
8.
(b)
(c)
(d)
9.
relate to
in
Why
10.
Name
11.
If a
What
factors
must be
(AICPA
12.
How
select the
adapted)
The difference over a period of time between actual factory overhead and
applied factory overhead will usually be minimal when the predetermined
overhead rate is based on (1) normal capacity; (2) designed capacity;
(3) direct labor hours; or (4) direct machine hours.
(b)
_^
CH. 9
237
(e)
which
(AICPA
13.
The
14.
If large
factory overhead control account has a credit balance at the end of the
period. Was overhead over- or underapplied ?
month
after
unit costs
15.
adapted)
more
accurate.
Comment.
What
why
how
are
they computed ?
16.
fluctuation.
If not,
17.
18.
what
alternative
is
possible?
(a) If over- or
(AICPA
adapted)
238
PART
III
Underapplied factory overhead costs are (1) fixed factory costs not
allocated to units produced; (2) factory overhead costs not allocated to
units produced; (3) excess variable factory overhead costs; (4) costs that
cannot be controlled; (5) none of the above.
(b)
(NAA
adapted)
(AICPA
adapted)
EXERCISES
Required: (1) Classification of the following
1. Classification of Expenses.
expenses as either (a) indirect labor, (b) indirect materials or supplies, or (c)
other factory overhead.
(2) Classification
(a)
Building repairs
Coal
(c) Depreciation
(d) Fuel oil
(b)
(j)
Power
(k)
Rent
(1)
Freight-in
Shop
supplies
(e)
(n)
(f)
(p) Superintendent
(q) Storekeepers' salaries
3.
Required: The factory overhead rate that may be used in applying factory
overhead to production on each of the following bases
(a)
Materials cost
(c)
(d)
Machine hours
CH.
: :
239
(b)
(c)
(d)
(e)
(f)
Expected
Average
Normal
Practical
Actual
Sales
Capacity
Capacity
Capacity levels
80%
85%
90%o
27,200
28,900
30,600
34,000
Factory overhead:
Fixed factory overhead
Variable factory overhead
$102,000
136,000
$102,000
144,500
$102,000
153,000
$102,000
170,000
Total
$238,000
$246,500
$255,000
$272,000
100%
Required: (1) Factory overhead rates for each of the four capacity
calculations to two decimal places only.)
levels.
(Make
(2) The amount of over- or underabsorbed factory overhead for the other
three levels if actual hours worked and actual factory overhead incurred were
identical with the estimated hours and the estimated overhead of the expected
actual capacity level.
6.
CPA firm
(a)
(b)
volume
fol-
240
(c)
About 60% of
the manufacturing
is
PART
III
quarter of
first
the year.
(d)
plant, the wage rates range from $2.25 to $5.75 an hour. Howeach of the eight individual departments, the spread between the
high and low wage rate is less than 5%.
ever, within
(e)
all
from
30%
to
80%
of conversion cost.
Required:
letter to the president of Minelli, Inc. explaining whether
cost system should use:
(a)
(b)
A method
its
depart-
(AICPA
adapted)
7. Entries for Factory Overhead. Whirl, Inc. assembles and sells electric mixers.
All parts are purchased and labor is paid on the basis of $22 per mixer assembled.
The cost of the parts per mixer totals $20. As the company handles only this one
product, the unit cost basis for applying factory overhead is used. Estimated
factory overhead for the coming period, based on a production of 40,000 mixers,
is as follows
Indirect materials
Indirect labor
$22,000
24,000
10,000
10,000
14,000
During the period, 39,000 mixers were assembled and actual factory overhead was $82,300. These units were completed but not yet transferred to the
finished goods storeroom.
Required: (1) Journal entries to record the above information.
(2)
The amount of
8. Entries
Farro Company:
Estimated factory overhead
$16,750
$18,250
17,500
CH.
241
Required: (1) The entry or entries to close out the two factory overhead
balances and to set up the over- or underapplied factory overhead account.
(2) The spending and idle capacity variances. Explain why they are favorable
or unfavorable.
Variance Analysis.
estimated as follows
9.
Company
has been
$15,000
45,000
20,000
75%
Spending and
10. Level of Activity; Variance Analysis. The Conley Company estimates its
normal factory overhead to be $10,000 per month. During the past four months,
$9,000
8,500
March
$ 9,500
10,500
April
$ 72,000
216,000
in June,
$15,400.
Required: (1) The total factory overhead rate per unit and the variable
factory overhead rate per unit.
(2) The factory overhead variances, in total and in detail.
Analysis.
company's budgeted fixed overhead costs are $50,000
plus a variable rate of $4 per direct labor hour. The total factory
overhead rate is $6. Actual factory overhead in January is $115,000 and 18,000
direct labor hours were reported.
VllJVariance
per
month
'^
U^^~f^^
or- ^JO^xieZt^ J^
iU>r~)r^
qT^ZT'^P
.
242
PART
III
Job
301
CH.
243
shipped out, and the customers were billed in the amounts of $18,000 and
$42,000 respectively.
Required: General journal entries to summarize the transactions for June.
Over- or underapplied factory overhead is not closed out until the end of the
year.
9-2.
McDonald,
Inc.
1,
19
Cash
S 20,000
Notes Receivable
Accounts Receivable
Allowance for Doubtful Accounts
10,000
28,000
$
Materials
Work in Process
Finished Goods
Prepaid Insurance on Machinery
500
8,500
75,000
25,000
10,000
2,000
900
Capital Stock
100,000
31,300
Retained Earnings
$172,000
Total
2,800
5,000
10,000
5,000
1
month of
July, 19
$172,000
were:
(b)
Shop
(c)
supplies purchased
on account, $5,000.
(d) Paid
federal
(e)
(f)
(g)
(h)
(i)
(j)
$6,000.
(1)
Sales
on account, $50,000.
244
PART
III
9-3.
Materials used
Direct labor
Indirect materials used in plant
Indirect plant labor
Supervisors' salaries, plant
Labor fringe costs, plant
Depreciation of plant
Depreciation of factory machinery
Taxes on plant
Marketing and administrative expenses
Insurance on plant
Miscellaneous factory overhead
Power and light for plant
Advertising
$10,000
15,000
3,000
4,000
3,000
1,500
,000
3,000
1
300
3,500
200
1,500
500
1
,500
During the month the company worked on four orders, three of which were
completed. Costs and other pertinent data in connection with these orders are:
Job 501
Job 502
Materials cost
Direct labor hours
$2,000
4,000
$3,500
Machine hours
1,900
$6,000
Job 503
Job 504
The company has not set up a predetermined rate for applying factory overhead. It intends to wait until the end of each month to charge actual overhead
incurred during the month to jobs worked on during that month. Labor pay
rates vary considerably among the various labor skills employed in the plant.
There is also a wide variation in the proportionate use made of labor skills on
each job order.
Required: (1) The cost of each job using as the basis for charging factory
overhead: (a) direct labor cost, (b) direct labor hours, (c) machine hours.
(2)
that
9-4. Factory
Required: (1) The factory overhead rate based on (a) labor cost, (b) labor
hours, and (c) materials cost.
(1)
CH.
245
rate
$2 per hour. Budgeted overhead for 3,000 hours per month is $8,000 and at
7,000 hours is $12,000. Actual factory overhead for the month is $9,000, and
actual volume is 5,000 hours.
IS
(3)
(4)
(5)
Spending variance.
^^r6^^udgeted Overhead and Variance Analysis. In June the idle capacity variance of Carr Processing, Inc. was zero, and the spending variance showed
a debit of $6,000. In July the idle capacity variance was a debit of $8,000, but
the spending variance was zero. In June, actual overhead expense was $70,000
for an output of 8,000 tons. July's expense was $56,000, and output was 6,000
tons. In August output was 9,000 tons, and actual overhead expense was $71,000.
Required: (1) Factory overhead budgeted (estimated) for 9,000 tons.
(2)
(3)
9-7.
Normal capacity
August.
Variance Analysis.
in
May
is
rate.
May
75% of normal)
Factory Overhead
(Actual Activity
Expense
Superintendence
Depreciation
Taxes
Rent
Power
Maintenance labor...
Insurance
Idle labor
Supplies
Indirect labor
Payroll taxes
Total
(3)
Estimated
Factory Overhead
at
75% of Normal
100
415
375
200
300
75
150
50
75
90
300
75
$2,360
$2,105
415
375
200
300
100
200
50
100
120
400
Actual
Factory Overhead
Required: (1)
(2)
Estimated
Factory Overhead
at 100%, {Normal)
415
375
200
300
95
115
50
90
95
270
95
$2,100
246
PART
III
S 32,500
21,000
130,000
106,000
5,050
1 8,500
29,050
8,700
7,500
4,000
3,000
14,100
6,500
8,250
7,500
9,900
18,000
11 5,200
Direct labor
Raw materials purchased
Raw materials returned to suppliers
Supervision
Indirect labor
Heat, light, and power
Depreciation
factory buildings
Property taxes
Insurance on factory buildings
Additional data:
(a) Physical
(b)
Work
in process
Finished goods
(c)
show
Direct Labor
S 9,000
S 8,000
10,000
20,000
=
=
2,000 hrs.)
5,000 hrs.)
Required: (1) The cost assigned to the ending work in process and finished
goods inventories, including factory overhead.
(2) A schedule of the total actual factory overhead for the month.
(3) An analysis of the over- or underapplied factory overhead, assuming that
the predetermined factory overhead rate was based on the following data:
Variable factory overhead
Fixed factory overhead
Direct labor hours
(4)
overhead
is
$70,875
$42,525
31 ,500
CHAPTER 10
DEPARTMENTALIZATION
OF FACTORY OVERHEAD
FOR PRODUCT COSTING
AND COST CONTROL
the establishment
and
and products,
and
The departmentalization of
unit
and
is
so necessary
is
costs in
nonmanufacturing busi-
248
PART
III
charged.
and
More
more accurate
of overhead costs.
is
with factory overhead for work done in that department, using the department's predetermined
rate.
is
during the
until the
computing overhead
all
costs
for pricing
purposes involves
rates
In addition to
its
direct
utilities,
methods
is
etc.
The
important in deter-
costs.
still
CH. 10
249
For example:
classified as either
250
activities constituting a
department.
PART
III
Division
is
the emphasis
the cost system puts on cost control and the development of overhead
the
If the
emphasis
is
when
machines are
and overhead
overhead control and in applicadifferent types of
of providing the service, (3) importance of the service, and (4) assignment of supervisory responsibility. Establishing a separate department
for every service function is rarely done even in large companies. When
(2) cost
relatively
CH. 10
251
as follows
1.
2.
Labor
3.
Indirect materials
4.
5.
Equipment depreciation
and overtime
fringe benefits
is
In the discussion
its
do not
alter the
manufacture.
It is
important to realize
Inasmuch
is
automatically
overhead.
as overhead
is
allocated to
all
Incorrectly
Identified
as Indirect Labor
$6,000
$5,000
$5,000
1,000
$6,000
1,000
$6,000
$7,000
Identified
Direct labor
Factory overhead:
Indirect labor
Other overhead
Total factory overhead
Factory Overhead
^$^00^
$6,000
100%
$W0
$5,000
140%
252
PART
III
all
Labor Fringe
Benefits.
Labor
FICA
taxes, state
cedure
is
become
Distinguishing incorrectly
between direct and indirect materials (the latter being part of overhead)
has the same adverse effects on product costing as failure to make proper
facturing operation, direct materials are those which are changed in form
etc.,
and become an
end
end product.
There are two basic methods of accounting for the cost of supplies:
as a direct departmental charge or (2) as a charge to inventories.
(1)
An
way
ment
is
easy,
(I) the
efficient,
(2) the
Charge
to Inventories.
When
it is
is
required or
not practical or
an inventory account
In such
at the time
when suppHes
are issued.
When an
inventory account
by one of two
it is
is
used, consumption
amount
is
may be
determined
by
CH. 10
month
253
inventory at the end of each month, (2) adding purto the cost of the beginning inventory, and (3) sub-
month-end from
Requisitions
it is
With
and maintenance
by
to devise effective means
respect to repairs
and
(2)
As
a rule, the
maintenance superintendent.
is
all
supervised by a
actual mainte-
its
costs
and
trollable cost
fixtures, etc.
Some
on departmental cost
controlling, depreciation
is
vehicles,
firms
and the cost is charged directly to departments. The recommended method is to compute depreciation by departments based on the
the assets;
254
When no
records.
on detailed
is
is
PART
III
fixed asset
not specifically
plant expense.
therefore, be prorated to
of
To
is
difficult
footage
is
its fair
many cases is
Square
DISTRIBUTION
BASIS
__
Square
Square
Square
Square
Factory rent
Depreciation
buildings
Building repairs
Heat
Superintendence
Telephone and telegraph
footage
footage
footage
footage
Number of employees
Number of employees or
number of telephones
Department
Light
Kilowatt-hours
Freight-in
Materials used
Power
Horsepower-hours
payroll
After the distribution bases have been selected, a survey of the factory
must be made
its
breakdown by depart-
machinery
horsepowerand
by departments, and estimates of kilowatt-hours (kwh)
hours (hph) to be used are items listed in the survey.
CH. 10
255
department be
partments
may
first
charged with
its
direct overhead.
Service de-
Most of
found in service
departments. The number and types of service departments in a company
depend on its operations and the degree of expense control desired. Service departments used for illustrative purposes are: (1) materials handling,
(2) inspection, (3) utilities, and (4) general plant services.
discussed for producing departments will naturally also be
Materials Handling.
cranes, trucks, fork
by
this function,
lifts,
Since
many departments
are served
same as those
charged to any department and include wages and labor fringe costs of
crane and truck operators; supplies, such as batteries, gasoline, etc.;
Inspection.
manner
a special
To accumulate
lished for the
is
This
may
be estab-
Power and
consumed
operating manufacturing
fuel are
facilities
for
such as machines
256
PART
III
However, a
possible.
A common
Charge
all
power and
department; then
Charge specific departments with power or fuel cost if separate meters are
provided, and charge the remaining power and fuel costs to a separate
utilities department or to general plant; this remainder is then allocated
to benefiting departments.
Allocation of
departments
is
based on special
of machines,
etc.
above come under the category "general plant" because they cannot be
identified directly with any specific producing or service department.
Therefore, a separate general plant cost center or department is estabhshed
to accumulate
Such a department
is
Salaries of
usually
manage-
ment personnel
directly
to general plant
and use
when
they
is
usually applied
on the
or hours when one factory overhead rate is used for the entire plant, since
this procedure is considered most convenient and acceptable. The use of
department rates requires a distinct consideration of each producing
diff"erent
it is
bases for
possible to
use a direct labor hour rate for one department and a machine hour rate
CH. 10
for another.
and
257
must eventually
find
its
way
Overhead
from past records or from new or revised estimates prepared by the budget
or cost department in consultation with the department head.
factory expenses, such as heat, power, water, rent,
etc.,
General
must
first
be
decision.
to either
The
ducing departments.
ployees,
on number of em-
hours, or
costs of producing
and
service
same manner
in the
the year.
ments,
When
it is
all
in the
producing depart-
producing departments:
Cutting, Planing,
Handhng, Inspection,
Materials
The
Utilities,
Its
purpose
will
be
"
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258
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PART
III
CH. 10
PROCTOR PRODUCTS,
INC.
259
1
1
260
PART
III
CH. 10
261
i.e.,
25 percent of $5,000
= $1,250
an
departments
Certain rules are followed for the transfer of service department over-
partments.
all
service
directly to
department overhead
may
first
2), service
be charged to
In
some com-
much
clerical
When
should be transferred on the basis of the use made of the respective services
by all benefiting departments, both producing and service, the usual procedure is to transfer expenses of service departments in the order of the
amount of
by the departments; i.e., expenses of the department rendering the greatest amount of service are transferred first.
When
service rendered
by a department cannot be determined accurately, it is possible to distribute first the expenses of the service department
which has the largest total overhead. This rule assumes that the department
service rendered
with the largest amount of expense rendered the greatest amount of service.
service or the
the
made
to
it.
262
PART
III
on the basis of the estimated cost of marequisitioned per Schedule A; i.e., 45 percent of $28,300 == $12,735
of this department
terials
to the Cutting
is
distributed
Department.
basis,
costs based
represents 20 percent of
is
Plant
is
distributed
employee.
method can be
illus-
trated as follows
$36,900 General Plant Costs
150 Employees
Then $246
$7,380.
department costs distributed to the producing departments, the departmental factory overhead rates can be calculated. In Exhours,
hibit 2, three different bases are used: direct labor hours, machine
With
and
all service
The proration of
service
Department
other.
other and therefore before receiving any expense proration from the
CH. 10
263
followed.!
Department
Producing
Producing
Service
Service
A
B
Y
Z
Departmental Overhead
Before Distribution of
Service Departments
$ 6,000
8,000
3,630
2,000
S19,630
Services Provided
264
PART
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4)
III
CH. 10
265
412
411
Date
Explanation
For
i--cutting
413
421
433
March,
451
453
i9--
Summary
departments,
reproduced above.
is
partially
column represents a
head that will be charged to the department. For example, the column
coded 411 represents supervisors and foremen, 412 represents indirect
labor, and so forth. Entries to departmental expense analysis sheets are
A
facihtated by combining department numbers and expense codes.
code such as 1412 indicates that Department No. 1 (Cutting) is charged
with indirect labor (Code 412). Similar combinations are used for other
departments. The chart of accounts establishes the codes.
The subsidiary ledger must also include a sheet for each indirect factory
control account.
2.
3.
end of the
fiscal
End
of Fiscal Period.
The
steps
and procedures
period are
4.
Distribute actual service department costs on the basis of the end-of(See Schedule B and Exhibit 4 on the follow-
ing pages.)
5.
Compare
266
1
'^
OS
a.
O o
H <
O o
PART
III
CH. 10
PROCTOR PRODUCTS,
Factory
Survey December
INC.
31,
19
267
1
1
268
Using the
PART
III
figures pro-
following entry
4), the
can be made:
Factory Overhead
Cutting Department
Factory Overhead
Planing Department
Factory Overhead
Assembly Department
Factory Overhead
Upholstery Department
Factory Overhead Control
82,592
56,712
69,730
82,966
292,000
A comparison of actual and applied overhead of each producing department as well as of the total overhead of the company results in the following
over- or underappHed factory overhead
Total
Cutting
Planing
Assembly
Upholstery
$7.000
$(1,428)
$2,312
$2,710
$3,406
sum of
9.
factory overhead
However,
this
would seem
$7,000 figure
is
the composite
and a $6,250 unfavorable idle capacity variance. The $1.50 overhead rate
used there and based on 200,000 direct labor hours is not applicable for the
departmentalized illustration. New rates with different bases have been
However, it should be possible to analyze each departmental
created.
over- or underapplied figure and determine a departmental spending and
idle capacity variance. What is particularly needed is the amount of overhead budgeted for the level of operation attained (capacity utilized) which,
in turn, requires a knowledge of the fixed and variable overhead in each
producing department. To develop the budget allowance, the estimates
shown in the summaries of the departmental factory overhead (Exhibit 1)
and the distribution of service department costs (Exhibit 2) are examined.
The summary of the departmental factory overhead indicates the fixed and
variable departmental costs at the bottom line of the estimates. The service
department costs distributed to the producing department as shown in the
is
on the next
CH. 10
269
OVERHEAD RATES
Producirtff
Departments
Cuttinj^
Planing
Assembly
Upholstery
$17.100
$17.900
$ 16,100
$18,300
$23,400
40,716
$18,800
22,183
$ 18,900
38,242
$20,300
48,059
$64,116
$40,983
$ 57,142
$68,359
40,608
Machine hours
48,140
1
8,400
$122,000
$0.42
1.58
$0.98
2.22
3%
$0.38
47%
1.42
$2.0
$3.20
60%
$1.80
Fixed overhead
Variable overhead:
42,010 direct labor hours
17,000 machine hours
utilized;
Planing
Assembly
00
$17,900
$ 16,100
$1.58...
7,
X
X
47'';
$ .42
1
$18,300
37,740
.
52,499
62,764
$83,476
i.e.,
Upholstery
66,376
$2.22
*Based on capacity
Cutting
$55,640
$ 68,599
$81,064
actual activity.
270
PART
III
annual data after the books have been closed. However, the middle- and
operating-management levels require cost control information currently
once a month. With ever greater emphasis placed upon the control
of costs by the responsible supervisory personnel, a procedure must be
found which communicates to all levels of management the control information in a manner that permits the charging and discharging of responat least
sibility
is
OVERHEAD DEPARTMENTALIZATION IN
NONMANUFACTURING BUSINESS ACTIVITIES
AND NONPROFIT INSTITUTIONS
AND ORGANIZATIONS
The responsible control of departmental expenses is equally essential in
The following have or should have
divided their large complex entities into administrative and supervisory
departments, sections, or service units for cost planning and control:
other than manufacturing activities.
savings
(banks,
Financial
institutions
and loan associations, and brokerage
houses)
Insurance companies
Educational institutions (public school
systems, colleges, and universities)
organizations (hotels, motels,
hospitals, and nursing homes)
Federal, state, and municipal governments
(and their agencies)
Service
many
headings:
rate.
activities.
size
and
(1) direct
The
to different
costs again
CH. 10
such as
light, heat,
appropriate bases.
to create a
work
and
air
271
are ascertained,
it is
possible
facilitated
departments.
This
quite detailed departmentalization might include actuarial, premium collection, group insurance, policyholders' service, registrar, medical, legal,
etc. While some costs are unique to the individual group, most are identical
office
department.
hospitals
in creating a costing or
management
will assist
X rays,
laboratory examinations,
filling
services
of prescrip-
tions, etc.).
It is
number of people
in a vast
better
known
to the public.
Common
projects, police
street
and
fire
departments, city hospitals, sewage disposal plants, trash and garbage col-
lection, etc.
on a
made to measure
on some unit of measurement
paving and cleaning (per mile), trash
and garbage
looking for
The
efficient service in
state
means additional
taxes.
will
be rendered
272
at a
efficiency.
The
federal
government with
must
particularly
make
all
PART
its
III
many
of these units
^
1.
2.
3.
DISCUSSION QUESTIONS
Why
method
improvements.
4.
overtime pre-
rates.
5.
State reasons for the use of departmental overhead rates instead of a single
6.
7.
What
8.
What
plantwide rate.
that the entire process of departmentalizing
factory overhead is an extension of methods used when a single overhead rate
Explain.
is used.
are some of the factors that must be considered in deciding the kinds
and number of departments required to control costs and establish accurate
of each.
9.
What
and
10.
What
overhead rates?
11.
What
are some of the practices with respect to the sequence used in transWhat
ferring service department overhead to producing departments?
bases should be used to transfer the overhead of the service departments
listed
below
Production control
Purchasing
Medical
Maintenance
Payroll
Accounting
Storeroom
Personnel
Utilities
Cafeteria
CH. 10
273
12.
What
13.
14.
are the important factors involved in selecting the base to be used for
applying the factory overhead of a producing department?
15.
16.
17.
Federal, state, and local governments should practice cost control via responsibihty accounting. Discuss.
EXERCISES
1.
series
specific individuals.
Factory wages
(b) Depreciation of
machinery
(c)
(e)
(f)
(g)
Entries with Overhead Subsidiary Ledger. The general ledger of the DoleJohnson Company contains a factory overhead control account supported by a
subsidiary ledger showing the details by departments. The plant is departmentalized with one service and three producing departments.
2.
The following
table
shows
Machining
Dept.
Building space (sq. ft.)
Value of machinery
Horsepower rating
Compensation insurance
10,000
$30,000
100
$1.50
(a)
Depreciation on buildings,
(b) Depreciation
3%
Assembly
4,000
$10,000
4,000
$6,000
10
$1.00
$1.50
departments:
Painting
Dept.
some
Dept.
liabilities
General
Factory
2,000
$2,000
15
$1.00
accrued as
life;
machinery
cost, $48,000.
274
PART
III
Taxes for the year ending December 3 1 are estimated to be $ 1 ,200, of which 60%
is on buildings and 40% on machinery.
(d) Fire insurance in the amount of $100,000 is carried on buildings and machinery,
and the rate is $.60 per $100 of coverage. Sixty percent of this insurance applies
to buildings. The prepaid fire insurance account shows a balance of $300 at
January 31 before adjustment.
(e) Compensation insurance is based on the following earnings of factory employees
for the month of January Machining Department, $3,000 Painting Department,
$1,200; Assembly Department, $1,600; and General Factory, $600.
(f) Power meter reading at January 31 shows 12,500 kilowatt-hours consumed.
Rate is $.03 per kilowatt-hour.
(g) Heat and light bill for the month of January is $300.
(c)
in the
Required: Journal entries with details entered in the factory overhead subsidiary ledger.
Overhead Distribution and Rates. The Bloomfield Products Company has four
producing departments: 11, 15, 21, and 25; and three service departments:
M, F, and T. The direct departmental overhead has been estimated for the proNo. 11 $100,000; No. 15
ducing departments:
$140,000; No. 21
$80,000; for the service departments:
$30,000; F
$40,000; No. 25
$60,000. Service department overhead is to be distributed to pro$50,000; T
using the following
ducing and service departments in the order of T, F, and
value of equipment
floor area; F
number of employees;
bases: T
investment. It is the company's policy that once a service department's costs
have been allocated, no costs from other service departments are to be allocated
3.
to
it.
M
M
CH. 10
275
Actual expenses
Total
$4,000
1,250
500
$3,000
1,000
$5,000
1,500
S14,000
750
S8,000
Z's expenses
Y's expenses
1,800
1,200
1,800
600
600
S6,000
X's expenses
2,000
1,000
1,200
400
$4,600
$1 5,300
$1 6,950
$8,250
$9,500
Total
S10,000
1.000
$6,000
6,000
$50,000
$50,000
Department A
Department B
Department C
Department D
20,200
10,600
10,600
$15,000
17,800
9,400
9.400
$59,200
$51,600
$1 7,800
Total
16,000 Hours
Required: (1) Assuming that the actual factory overhead incurred was
charged to a single factory overhead control account, prepare entries to record
(a) the transfer of the actual factory overhead to producing departments and (b)
the applied factory overhead of Departments A and B only.
(2)
and B
Compute
the spending
and
Departments
only.
Company
..
276
Allocation of
Fixed Overhead
of Service Departments
Maintenance
PART
Total
01
02
03
04
$15,000
$5,000
3,500
6,000
$4,000
2,500
3,000
$3,000
2,500
2,000
$3,000
2,000
1,000
Toolroom
10,500
12,000
Storeroom
II
Maintenance
{Area in
Square Feet)
Department
No. 01
No. 02
No. 03
No. 04
12,000
10,000
9,000
5,000
5,000
3,000
1,000
Maintenance.
Toolroom
Storeroom.
No
50
{Number of
Materials
Requisitions)
30,000
30,000
28,000
12,000
40
30
30
10
5
5
Required: (1)
and
is
Toolroom
{Number of
Employees)
on the
(2) Factory overhead rates for the four producing departments based on the
following predetermined labor hours, machine hours, and direct labor cost:
Department No.
01
02
03
04
Company
direct laborers for which timeOvertime premium, the amount in excess of the regular
charged as overhead to the department in which the overtime is worked.
CH. 10
(b)
(c)
277
A $.15 per hour wage increase was granted November 1. Direct labor hours
worked in November and December totaled 2,500.
The company cafeteria incurred a $1,500 loss which was distributed to producing departments on the basis of number of employees. Nine of the 120 employees work in the Fabricating Department. No loss was anticipated when
predetermined overhead rates were computed.
Algebraic Distribution of Factory Overhead. A company's two service departments serve not only the two producing departments but also one another. The
relationships between the four departments can be expressed as follows:
7.
Service
Departments
278
PART
III
9.
Service Departments
Producing Departments
General Factory
Factory
Administration Maintenance
Fabrication
Assembly
$1,950,000
3,130,000
1,650,000
$2,050,000
950,000
1,850,000
$90,000
562,500
280
88,000
437,500
31,000
12
1,750
200
72,000
70,000
Factory
Cafeteria
$82,100
65,000
56,100
$87,000
91,000
62,000
27,000
42,000
20
2,000
4,800
Round
all final
Required: (1) Assuming that Parker Manufacturing Company elects to distribute service department costs directly to the producing departments without
inter-service department cost allocation, compute the amount of Factory
Assuming
service
(AICPA
adapted)
PROBLEMS
Overhead Distribution Sheet. Montag Manufacturing
factory overhead on the following bases:
10-1.
Company
applies
Producing Depts.
Materials costs
Direct labor hours
25%
$2.50
..
CH. 10
279
At the end of the fiscal period the following accounts and their balances have
been taken from the books and records:
Work
in Process
Indirect
Materials
Direct Labor
Factory Overhead (Applied)
$46,000
29,450
23,250
17,400
3.200
4,000
2,800
Labor
Factory Office
Building Charges (including depreciation, insurance,
Powerhouse Expenses (coal, labor, etc.)
etc.)
Additional information
Producing Departments
B
.
11,780
6,000
3,500
40%
60%
Power used
750
Indirect labor
direct labor.
$13,000
17,670
$33,000
Direct materials
Direct labor.
and factory
office are
sq.
Powerhouse
ft.
750
sq.
ft.
500
sq.
ft.
Required: (1) A distribution sheet showing the distribution of factory overhead costs to producing departments and the powerhouse.
(2) The total and departmental over- or underapplied factory overhead after
the powerhouse expenses have been allocated to the producing departments.
Overhead Rates. The Hilsinger Manufacturing Company has three producing departments: A, B, and C. Departmental estimates for the coming year
10-2.
are as follows:
Direct
Direct
Labor
head
Labor
Hours
15,000
50,000
40,000
$24,000
$10,000
12,000
16,000
75,000
60,000
9,000
5,000
2,000
Total
$38,000
105,000
$159,000
16,000
Department
Department
Department
Factory
Over-
Producing Departments
A
B
Machine
Hours
Costs
Direct materials
Direct labor costs
$300
200
$200
500
125
300
company
0
$400
250
using three dif-
ferent bases.
The
280
PART
III
CH. 10
Required:
rates for the
281
individual departments.
282
PART
III
10-5. Overhead Distribution Sheet and Rate Calculation. At the end of September the factory ledger trial balance of the Wellinghoff Products Company
contained the following factory overhead items and amounts for the past three
months:
Indirect
Labor
Factory Rent
Insurance
$30,600
1
Machinery
Equipment
Compensation Insurance
Superintendent
Clerical
Help
Factory
,400
Fuel
$ 2,100
Electricity
1,600
3,600
5,130
and
3,200
1,400
5,000
3,900
21,000
12,453
No attempt had been made (a) to charge these costs directly to departments
or (b) to create departmental overhead rates. The accountant believes that departmentalization is desirable for meaningful product costing and efficient
responsibility reporting. He gathered the information shown below concerning
the three producing departments, called A, B, and C, and the two service departments, Maintenance and Repairs (other than machinery and equipment)
and General Factory.
CH. 10
283
10-6. Cost Center Rates and Variance Analysis. The cost department of the
Venus Manufacturing Co. applies factory overhead to jobs and products on the
basis of predetermined cost center overhead rates; i.e., in each of the two producing departments, two cost centers have been set up. For the coming year,
the following estimates and other data have been made available:
%
Estimated Annual
Factory Overhead
Department 10:
Center 10-1
Cost
Cost Center 10-2
Fixed
Variable
Total
514,040
26,910
523,400
43,290
537,440
70,200
Estimated Annual
Machine Hours
15,600
23,400
Estimated Annual
Direct Labor Hours
Department 20:
Cost Center 20-1
Cost Center 20-2
S 8,320
521 ,580
6,240
19,760
529,900
26,000
26,000
20,800
Required: (1) The annual normal cost center overhead rates based on the
estimated machine hours in Department 10 and the direct labor hours in De-
partment
(2)
20.
these actual
February
Cost Centers
10-1
10-2
20-1
20-2
2,250
1,650
2,000
(3) The spending and the idle capacity variances for the two producing departments. Actual factory overhead in Department 10 amounted to $9,630 and
in
Department 20
to $4,205.
(4) Analysis of the total idle capacity variance of Department 10 into the idle
capacity variances of the two cost centers. Use 1 /12 of the total annual estimated
hours as normal monthly hours.
Corporation instructs
The
284
Department
Departmental Overhead
Before Distribution of
Service Departments
Mixing
$125,000
90,000
105,000
Refining
Finishing
Powerhouse ....
The
total factory
Personnel
20
General
Factory
25%
/O
20
20
20
30
20
10
10
15
20
100%
100%
100%
Powerhouse
J-'
$407,500
III
Services Provided
25
16,000
29,500
42,000
Personnel
General Factory.
PART
service
department
(a)
The
hospital's charges
services
were as follows
Charges for
Department
Inpatient routine services
(room, board, nursing)
HI Program
Total
Beneficiaries
Charges
Total
Allowable
Costs
$1,275,000
$1,350,000
425,000
X-ray
Operating room
Laboratory
Pharmacy
Other
Total ancillary
Total
56,000
CH.
10
285
part of the provider's total allowable cost attributable to ancillary (nonroutine) services is to be apportioned in the ratio of the beneficiaries' share
of charges for ancillary services to the total charges for all patients for such
services.
(c)
Statistical
(1)
(2)
(3)
all
patients
5,000
intermediary acting on behalf of the government's Medicare profixed allowance rate of $45 per inpatient day subject to
retroactive adjustment as a reasonable cost basis for reimbursement of
covered services to the hospital under the HI program. Interim payments
based on an estimated 1,000 inpatient days per month were received during
the 12-month period subject to an adjustment for the provider's actual cost
fiscal
gram negotiated a
experience.
Explain.
(3) Providence Hospital wishes to compare its charges to HI program beneficiaries with published information on national averages for charges for hospital
Determine with computations (a) the average total hospital charge for
an HI inpatient and (b) the average charge per inpatient day for HI inpatients.
services.
(AICPA
adapted)
CASES
A. Deciding on Depreciation for Old and New Building. The Rossmoyne Manufacturing Company owned one factory building with a net depreciated cost of
$90,000. Machinery and equipment was carried at $120,000. Because of expanding business, it built a new building at a cost of $150,000 and installed $210,000
of equipment therein. During the next several years it put some new equipment
into the old building and continued to operate both plants. Depreciation has
been computed on a straight-line basis.
Recently the company shut down the old plant because of lack of orders.
The sales manager proposes that the company should no longer take depreciation on the old building and machinery. He suggests that while the old plant is
useful, it is not in use and is not wearing out. He also suggests that to take depreciation on it increases cost, overvalues inventory, and places the company in
a poor competitive position to bid for business since its costs are high.
Required:
A full discussion
of this proposal.
(AICPA
adapted)
286
8 in
II
>2
'^i
2
O
88
V) O
r<^
o "n
8:
8:
CO
OOQO
O
^ -^
<N
>n -^
PART
III
CH. 10
287
Income Determination.
engaged in manufacturing items
to fill specific orders received from its customers. While at any given time it may
have substantial inventories of work in process and finished goods, all such
amounts are assignable to firm sales orders which it has received.
The company's operations, including the administrative and sales functions,
are completely departmentalized. Its cost system is on a job order basis. Direct
materials and direct labor are identified with jobs by the use of materials issue
tickets and daily time cards. Overhead costs are accumulated for each factory
service, administrative, and marketing department. These overhead costs, including administrative and marketing expenses, are then allocated to producing departments and an overhead rate computed for each producing department. This
rate is used to apply overhead to jobs on the basis of direct labor hours. The
result is that all costs and expenses incurred during any month are charged to the
B.
work
is
Debits
Raw
Materials
Store Supplies
Work in Process
Credits
$30,000
10,000
20,000
$60,000
$60,000
$60,000
for the
The
direct, indirect,
and
producing departments as
Raw
in
month of September.
Work
General
in Process.
(AICPA
adapted)
CHAPTER 11
RESPONSIBILITY ACCOUNTING
AND RESPONSIBILITY
REPORTING
Direct materials and direct labor are generally directly identifiable with
specific products, jobs, or processes.
and depreciation,
1.
Its
utilities,
creates
two
repairs
distinct
and
profit
determination, and
2.
However,
it
mechanism encompassing
responsibility accounting
288
CH.
11
RESPONSIBILITY ACCOUNTING
prices of
its
AND REPORTING
289
The
products.
these considerations.
accurate, include all
products.
Defined.
upon
to
Kohler's
Series
No.
22, says:
"A
responsibility
may
of the unit."
Responsibility Accounting
Basic Concepts.
initiation
accounting system.
1.
Responsibility accounting
is
The
rests
3.
Each
him.
by
to permit recording of
A program to develop
must be considered a prime responsibility
management accounting
controls
290
PART
III
of top management with the accounting department providing the technical assistance.
To
and
a complete clarifica-
teamwork in
of the word.
Responsibility for Overhead Costs.
indicate,
many overhead
As
To
must be allocated so that all costs can be charged to the job or product. The allocation procedure, however, is not necessary for cost control;
that is, for responsibility accounting. If allocated charges are to be shown
on the report furnished to the supervisor, they should be limited to those
expenses for which he has assumed control and responsibility. The procedure depends a great deal upon the methods of cost accumulation and allocation employed by a firm. Certain expenses (e.g., electricity) could, when
costs
be shown on the reports for the departments served rather the control or
;
'*
Billing" or
CH.
RESPONSIBILITY ACCOUNTING
11
AND REPORTING
291
based on what
The
is
The determination of
2.
Costs of any service or maintenance department are estimated or budgeted according to their nature (supervision, supplies, electricity, etc.).
Costs are classified as fixed or variable. This classification often leads to
many service departmental costs are fixed over fairly
wide ranges of service volume.
the realization that
3.
4.
Maintenance ex-
penses like any other indirect factory cost must find their
way
into the
292
PART
Still
III
un-
is
costs,
is
in reality twofold
the
maintenance engineer or foreman controls the quantity of men and materials required to serve the various departments. As maintenance work is
done
At the source
service
level,
Control at
supervised.
is
organized and
predetermination of man-
work
itself
may reach
the executive
is
rests
needed
in a department.
management group
how much
The answer
thereto
even the original responsibility for the type and amount of maintenance
work
For at the time the factory was laid out and the machinery
maintenance program should have been planned. The size of
the maintenance department, the type or class of workers (carpenters,
plumbers, electricians, pipefitters, masons, millwrights, machinists, etc.),
and the kind of equipment and tools are greatly influenced by the early
decision. On the other hand, experience indicates that such maintenance
required.
installed, a
to
Many
of their maintenance.
all
CH.
RESPONSIBILITY ACCOUNTING
11
Preventive Maintenance.
AND REPORTING
293
is
It is
breakdowns and
minimum. Preventive maintenance
facilitates the scheduling of maintenance work and helps to obtain better
utilization of the maintenance work force and the productive equipment.
the need for emergency repairs are at a
It
damage, or serious
injuries to personnel.
minor
work automatically
so that
inspection,
The
repairs, adjustments,
tion people
made
Not only
are produc-
Responsibility for Direct Materials and Direct Labor. Basically, the best
approach to assigning responsibility for any cost element is a study of
those individuals who are in the most favored position to keep the costs
under control. The assignment of responsibility for overhead expenses to
foremen, supervisors, and department heads allows a conceivable amount
of control. It is admitted, however, that certain expenses are often troublesome; e.g., maintenance expenses. In the direct materials and direct labor
areas, the assignment of responsibility for cost incurrences falls
upon many
shoulders and often becomes very obscure and nearly impossible to identify.
Of course,
it
In the direct materials area, the variances or deviations from a predetermined norm or standard will result in (1) materials price variances, (2) materials quantity, or mix and yield variances, and /or (3) excessive defective
:
work,
rejects, or
scrap costs.
294
norm
PART
III
However, these cost elements are not the only ones subject to change
In later chapters the
for which an executive may be held responsible.
deviations from budgeted gross or net profit figures require explanation.
The changes in sales prices, in sales volume, and in sales mix are the
responsibility of the marketing department. Yet the gross profit figure
contains elements of costs as well, so that a further investigation
is
warranted.
liabilities,
some circumstances
all
e.g.,
costs in
may
employee fringe
most
situations.
be controlled at a
benefits
may
be de-
the labor
their controllability
CH.
RESPONSIBILITY ACCOUNTING
11
AND REPORTING
295
costs are
controllable.
Some
periods.
all
equipment
rental,
costs, depreciation
raw
For example, a
management
terial is
five-year contract
level.
may
commitment,
is
be negotiable only at a
variances even though the control or certain aspects of the control do not
fall
Illustrated.
The
data,
Cutting department
Planing department
Assembly department
Upholstery department
At
the
Departments
Cutting
Planing
Assembly
Upholstery
Actual Hours
{Labor or Machine)
or Labor Cost
3,046 direct labor hours
1,620 machine hours
$1 1,400 direct labor cost
4,100 direct labor hours
Actual
Consumption
for the
kwh
1,180
700
1,700
1,980
5,560
Utilities
Month
hph
19,000
10,800
7,000
8,000
Departmental
Overhead Before
Billing Out
Utilities
$3,575
3,125
2,900
3,570
44,800
5,860
296
PART
III
Floor space data remain the same as shown on page 259 of the previous
Based on the actual production and cost data, the cost department would apply the following amounts of factory overhead to the pro-
chapter.
If it is
=
=
=
=
3,046
1,620
$11,400
4,100
X $2.00 =
X $3.20 =
X 60% =
X $1.80 =
machine hours
direct labor cost
direct labor hours
56,092
$5,184
$6,840
$7,380
direct
emphasis
rests
upon
costs.
(i.e.,
many
ment head
responsible) should be
ducing departments and for the one service department: (1) total actual
departmental overhead, both fixed and variable, is compared with budgeted or predetermined departmental overhead (2) only variable or con;
overhead
is
compared with
its
budgeted or
predetermined amount.
situations.
Departments
1.
Actual departmental
overhead
Cutting
Planing
Assembly
Upholstery
Utilities
S3,575
$3,125
$2,900
$3,570
$5,860
Budget allowances:
Fixed expenses (1/12
annual fixed costs;
e.g., $17,100 ^ 12 =
$1,425
$1,425)
Variable expenses:
3,046 hours X S.5762*
1,620 hours X $1.0217*
$11,400 X 15.5^;*
4,100 hours X $.4217*
5,560 kwh X $.1544*
44,800 hph X $.0494*
1,750 sq. ft.** X $.7057*
Budget allowances...
Spending variances..
$1,333
1,755
1,655
1,767
1,731
858
2,213
1,235
$3,180
$3,109
$3,147
$3,256
$5,639
$ 221
$ 314
$(209)
$ 395
$ (22)
unfavorable favorable favorable unfavorable unfavorable
$1,525
$1,342
$1,492
ft.
and $1,235
is
1,750 sq.
ft.
CH.
or
11
RESPONSIBILITY ACCOUNTING
AND REPORTING
297
298
The
analysis
PART
as follows
is
U)
(2)
(3)
(4)
(5)
(6)
Actual
Applied
Idle Capacity
Overhead
Total
Variance
(1-3)
Spending
Overhead
Budget
Allowance
Variance
(1-2)
Variance
(2-3)
$3,575
$3,180
$3,038*
$537
unfavorable
$395
unfavorable
$142**
unfavorable
3,046
actual hours
$.9973
III
made
as follows
(1)
(2)
Actual
Budget
Allowance
Overhead
(3)
Utilities''
$5,701*
$5,639
$5,860
Cost
Charged Out
(4)
(5)
Total
Variance
Spending
Idle Capacity
Variance
Variance
(1-3)
(1-2)
(2-3)
$159
unfavorable
$221
unfavorable
favorable
(6)
$(62)
*The amount of cost charged out is based on the total predetermined cost of $65,4(X)
which was to be distributed: 20% or $13,080 based on kwh; 50% or $32,700 on hph;
and 30% or $19,620 on floor area, resulting in these charging rates: $.2044 ($13,080 -^
64,000 kwh); $.0654 ($32,700 ^ 500,000 hph); and $.9343 ($19,620 ^ 21,000 sq. ft.).
The
$5,701
1,750 sq.
ft.
is
(one month,
i.e.,
X
X
X
$.2044
$.0654
$.9343
=
=
=
$1,136
2,930
1,635
$5,701
While the responsibility for the cost incurred is, generally speaking,
producing departments, a service department's cost
variances need a great deal of additional investigation. With a service
department such as Utihties, the analysis is not so easy because
1.
2.
line losses.
differ
The pinpointing of
3.
Since any utiHty can often be either purchased from outside or manufactured inside, it could be possible that the interchangeable use of one
source with another will give rise to variances for which the cause is also
difficult to detect.
CH.
RESPONSIBILITY ACCOUNTING
11
AND REPORTING
299
many
an example. In
The
volume. For
this reason,
respon-
As a
rule, the
manager of the
service
department
is
variance between the actual cost and the cost based on the
department
is
The manager of
number of hours
the producing or
foreman, for the number of hours or service units consumed in the department. This statement indicates that a kind of dual responsibility exists
between the charges to the services received departments and the credits to
The consuming department's cost must
must examine
its
cost
on the
consumed or
sold.
RESPONSIBILITY REPORTING
is a program engulfing all operating managewhich the accounting, cost, or budget divisions provide technical
assistance in the form of daily, weekly, or monthly control reports. Responsibility reporting encompasses the reporting phase of responsibility
Responsibility accounting
ment
for
levels
two
is
clear
To inform
which he
2.
the
is
manager and
his superior
how
To
motivate the manager and his superior to generate the direct action
necessary to improve performance.
man-
ager with information relevant to his areas of interest, although not necessarily directly associated
300
formance reports.
set
PART
III
long view, information reports bearing on the progress and growth of the
business are also important.
FUNDAMENTALS OF
RESPONSIBILITY-PERFORMANCE REPORTS
Responsibility-performance reports should be based on certain funda-
2.
Reports should fit the organization chart; that is, the report should be
addressed to the individual responsible for the items covered by it and
who, in turn, will be able to control those costs under his jurisdiction.
Managers must be educated to use the results of the reporting system.
Reports should be prompt and timely.
is
available
re-
when
needed.
3.
4.
5.
The amount
level receiving
Reports to management should neither be flooded with immanagement lacks vital information
7.
8.
if
man
may
give a fore-
difficulty.
CH.
RESPONSIBILITY ACCOUNTING
11
AND REPORTING
301
may
Reports
inefficiencies.
RESPONSIBILITY-REPORTING SYSTEMS
ILLUSTRATED
The
illustrations presented
system
system
The
is
is
employed
first
The
is
the establishment
Each block
in a
com-
department,
etc.) that is
functions responsible to
easily
fits
reported
it.
Any
upon and
chart below.
on the
302
PART
III
CCHPAKY OVEMEAD
TO,
Thr Pre
vp, Narkeclnii:.
(SOOO)
-Presldetit, JUnufcturlog
$5,700
S3Z2
PROWCTIOfC &EPAKTMEKTS
Hcls. Cencrol.
SI. 180
TO:
SubsBseobly Departs
Supervlsi
(Lender)
Budget
5L90
(10)
$.lj.S0 2
St^O)
expenses for the three departments for which the Production Superintendent is held accountable.
Report B provides the Vice-President of
Manufacturing with performance figures for the five responsibility areas
within his division. Finally, the President receives a summary, Report A,
indicating overhead expenses not only for his area but also for the three
divisions (Marketing, Manufacturing, Finance) reporting to him.
in a
Exhibit
provide
all levels
of management with
all
the facts
M, Carr
1st
Executive Office
2nd
Operations Department
3rd
Cashier's Department
4th
Savings Tellers
J.
C.E.
Evans
W.T. Brown
H.B. fvlann
2ND LEVEL
EXHIBIT A
EXPENSE
ACCOUNT REPORT
304
highlighted
and brought
without too
much
PART
III
many
pages.
The num-
ber of reports issued and sent to a manager also needs constant examination.
Too many
is
and
voluminous reports; and no one has ever considered the cost of their prep-
No
and the
reporting system
and examination
is
ever perfect.
in the light of
It re-
changing times
DISCUSSION QUESTIONS
1.
2.
3.
4.
from responsibility
(NAA
accounting.
The
6.
7.
8.
9.
10.
adapted)
Emmons Company
5.
electric bill
of the
of overhead.
Why
Why
is
essential for
maximum
con-
must
On what
is
all
accounting.
method of presenting
cost data to
Discuss.
manage-
ment be based?
11.
Discuss the information which a well-designed cost report should give to the
the point of view of production and of control. Is there
any other information with which the cost figures should be amplified ? How
should such information be given?
management from
12.
department manager?
(1)
CH.
13.
11
RESPONSIBILITY ACCOUNTING
AND REPORTING
305
14.
15.
(AICPA
adapted)
answer for the following statement. The concept of "management by exception" refers to management's (1) lack of a predetermined
Of most
(b)
Of most
(c)
The most
(AICPA
18.
adapted)
listed
State which, if any, of these charges are consistent with the "responsibility
accounting" concept. Support each answer with a brief explanation.
(a) A charge for general corporation administration at 10% of division
sales.
(b)
(c)
charge for the use of the corporate computer facility. The charge is
determined by taking actual annual Computer Department costs and
allocating an amount to each user on the ratio of its use to total corporation use.
A charge for goods purchased from another division. (The charge is
based upon the competitive market price for the goods.)
(NAA adapted)
EXERCISES
Maintenance Charging Rate. A charging rate is frequently used to charge
Maintenance Department overhead to departments using its services. The charge
is determined by multiplying the number of man-hours of service provided by
the charging rate which is computed by the following formula
1.
Total Man-Hours
Worked
306
PART
III
Transfer Rates and Variance Analysis, The Haiger Company uses predeterrates to apply factory overhead. In computing
these rates, every attempt is made to transfer service department overhead to
producing departments on the most equitable bases. Budgeted overhead and
other data for the Maintenance Department and General Factory are
2.
Monthly
General Factory
$7,500
$30,000
Variable overhead
Normal
Maintenance Dept.
fixed overhead
level
rate.
$4.50
15,000 maintenance
hours per month
of activity
Spending and
November
departments using
results
$27,000
Maintenance overhead
General factory overhead
Maintenance labor hours
Producing department employees
$55,000
16,000
1,100
Rate and Variance Analysis. The LeClerc Company operates its own
power-generating plant. Power cost is distributed to the producing departments
by charging the fixed cost according to the standby capacity provided and the
variable cost on the basis of a predetermined rate multiplied by actual consumption. The rated standby capacity of the three departments A, B, and C is 50,000,
37,500, and 12,500 kwh respectively per month.
The following information relative to the producing departments and the
power plant for the months of January through May is available
3. Billing
Consumption
Dept.
January
February
March
April
May
45,000
55,000
47,500
53,800
44,000
in
Kilowatt-Hours
Dept.
40,000
35,000
38,000
37,000
33,000
Dept.
10,000
11,000
11,000
12,500
1 3,000
Power Plant
Fixed
Variable
$10,000
10,000
10,000
10,000
10,000
5 9,800
10,000
9,900
10,900
9,500
CH.
AND REPORTING
RESPONSIBILITY ACCOUNTING
11
307
months.
five
(2)
of the
power plant
for each
months.
five
Power Plant Charging Rate. During the month of November the actual expenses of operating a power plant amounted to $9,300, of which $2,500 was considered a fixed cost.
4.
Producing
Departments
Service
Departments
Schedule of Horsepower-Hours:
10,000
8,000
20,000
1 3,000
12,000
7,000
8,000
6,000
to be allocated
Fixed costs are assigned based on
(AICPA
5. Service
adapted)
company's two
Service Center
Carpenter Shop
Electricians
The two
Monthly
Budget
Service-Hours
Actual
Available
Monthly Expense
$20,000
30,000
4,000
5,000
$19,300
23,400
Department No.
1
2
3
Estimated
Actual
Services Required
Services Used
Carpenter Shop
Electricians
1,200 hrs.
,500 hrs.
1,300 hrs.
1,800 hrs.
2,000 hrs.
1,200 hrs.
Carpenter Shop
800
1
hrs.
,600 hrs.
900
hrs.
(3)
60%
2,000 hrs.
1 ,700 hrs.
1,100 hrs.
Required: (1)
(2)
Electricians
: :
::
308
PART
III
Rates; Variance Analysis. The management of the Hollander Manufacturing Company wishes to secure greater control over service departments and
decides to create a billing rate for the Maintenance and Payroll Departments.
For the month of September the following predetermined and actual operating
and cost data have been made available:
6. Billing
Maintenance Department:
Predetermined data (beginning of the month)
Normal
level of
3,200
$5.50
$9,800
2,300
$.50
Supervision
Actual data
700
.75
.05
3,455
$19,610
16,390
Payroll Department:
in factory
and
office
1,2(X)
$12,000
office
Number
1,165
$14,375
Overhead Analysis; Report to Supervisor. For the month of April, the cost
and operating data on factory overhead for Department 10 were as shown at
7.
Required: (1)
(2)
CH.
11
RESPONSIBILITY ACCOUNTING
AND REPORTING
Budgeted
Factory Overhead
Month of April
Variable departmental overhead:
Supplies
Repairs and maintenance
Indirect labor
Power and
light
Heat
Total
Total
Total departmental overhead
Operating data:
Normal
capacity hours
Factory overhead rate per hour.
Actual hours
April
$ 2,000
309
Actual
Factory Overhead
Month of April
310
PART
II
and Service Departments Based on ReProduction in the Milstein Linoleum Company, Inc.
moves through four producing departments assisted by three service departments. Departmental overhead rates are established at the beginning of the
fiscal year to aid in costing products completed. Actual factory overhead is accumulated and monthly budget reports are sent to each department supervisor
for the purpose of responsibility accounting. On the basis of predetermined departmental expenses and after the allocation of the three service departments'
costs, the following overhead rates for the four producing departments for
product costing purposes were calculated:
11-2. Variance Analysis in Producing
sponsibility Reporting.
Producing Departments
Forming
Departmental expenses:
Variable expenses
Fixed expenses
$19,500
19,500
.
$39,000
Machine shop
Hydraulic power
General plant
Total departmental overhead
6,200
1 ,400
5,400
$52,000
$4 per
direct
labor hour
Molding
CH.
11
RESPONSIBILITY ACCOUNTING
AND REPORTING
311
(2) The spending and idle capacity variances for the Forming and Molding
Departments before service departments' costs are allocated.
(3) The amount of departmental overhead variance for which each departmental supervisor is being held responsible considering only variable costs for
all departments. Assume that the use of service department facilities was exactly
the same as the amount budgeted when the producing departments' overhead
rates were calculated.
Expenses
Service Departments
312
PART
III
Actual cost and operating data before allocation of service departments' costs
end of the budget period are:
at the
ABC
Producing Departments
Expenses
Service Departments
Repairs and
Maintenance
Utilities
$49,240
$56,220
$52,850
$42,580
$55,320
20,480
39,300
29,850
46,200
20,100
35,800
18,950
Operating data
Direct labor hours
Kilowatt hours
their
amounts used
Required: (1)
producing departments.
(2) The amount of over- or underapplied factory overhead for each of the
three producing departments, charging them with service department costs on
the basis of actual kilowatt hours or labor hours multiplied by the billing rate.
(3)
The
11-4. Billing Rate; Variance Analysis. The Croesus Corporation has three producing departments: Assembling, Painting, Finishing and Packing; and one
General Factory. Overhead is applied to the product via
service department
departmental overhead rates that include a share of the service department's
expenses. The following monthly predetermined and actual costs and production
data are available
:
Departments
Service
Producing
Assembling
Variable expenses per direct
labor hour
Fixed expenses
Normal monthly
Finishing
$.50
$.25
$.30
$1.00
$2,800
$4,000
$2,320
$6,000
2,000
1,600
2,400
$4,400
2,050
$4,100
1,500
$3,300
2,200
activity
Hours worked
Painting
$12,600
CH.
11
The
.,
RESPONSIb.LITY ACCOUNTING
AND REPORTING
313
producing depart-
(2) The factory overhead rate for each of the three producing departments
with the service department's expenses being prorated on the basis of the bilhng
11-5. Billing Rates; Estimated Factory Overhead and Variance Analysis. The
Riehle Machine Tool Co. has two producing departments, Planers and Radial
Drills, and two service departments, Maintenance and Utilities.
The Cost
Department collected the following data and information:
Producing Departments
Planers
Factory overhead
Fixed overhead
Variable overhead
Total
Maintenance hours
Kilowatt hours
Service Departments
314
PART
III
Required: (1) The billing (or charging) rate for each of the two service departments, Maintenance and Utilities.
(2) The total predetermined factory overhead for each of the two producing
departments, Planers and Radial Drills, and their departmental factory overhead
rates based on direct labor hours. Service departments' expenses are to be distributed on the basis of the billing rates calculated in (1) above.
An
(3)
two producing departments for the month of January, isolating the spending
and idle capacity variances. Service departments' expenses are to be charged on
the basis of actual hours (maintenance or kilowatt) multiplied by the billing
rate. This method treats these expenses as being wholly variable.
(4)
head
in each of the
two
and
idle
capacity variances.
11-6.
The
Gross
I)
profit
Operating expenses:
Marketing expenses
Administrative expenses
Net
Year 19
$80,000
70,000
profit
Schedule
Amount
Unit
$600,000
384,000
$10.00
$216,000
$ 3.60
6.40
150,000
2.50
$ 66,000
$ 1.10
$102,000
162,000
120,000
$ 1.70
$384,000
$ 6.40
Direct materials
Direct labor
Factory overhead
Total
2.70
2.00
that
ments, the cost accountant has prepared an overhead distribution sheet and
calculated factory overhead rates for product costing as reproduced at the top
of the next page.
CH.
11
RESPONSIBILITY ACCOUNTING
AND REPORTING
315
Producing Departments
Dept. 10
Data
Production units
Direct labor hours
Direct labor cost
Factory overhead
Variable overhead
Fixed overhead
To marketing and
tive
administra-
expenses
$1.80
Service Departments
CHAPTER 12
MATERIALS CONTROL
PROCEDURES
AND COSTING METHODS
Effective materials
(1)
efficiency,
and
(3)
management
manage
investments in inventories.
is
essential
To succeed
in effectively
managing materials
Materials
the
Costing materials presents some important, often complex, and sometimes highly controversial questions concerning the costing of materials
is
usually presented
lem
is
management
2.
3.
4.
317
318
PART
IV
AND USE
cycle of
steps
1
applicable.
2.
The production budget provides the master plan from which details concerning materials requirements are eventually developed.
3.
4.
5.
The
results
The materials
specified types
specified time or
is
to departments.
7.
The materials
class of materials
and summary of materials used are some of the forms used for materials
control under a cost system. The purchases journal, the cash payments
journal, the general journal, and the general ledger control accounts are
also used.
The discussion
of industry,
it is,
in this section
is
flowchart on page 319 shows procedures for purchasing, receiving, recording, and paying materials;
is
i.e.,
usually
chasing agent.
CH. 12
319
PURCHASE
REQUISITION
HX
ACCTG. DEPT.
for
account number
PURCHASING DEPT.
VENDOR
Issues purchase
Returns acknowl-
order
to:
edgment copy
Ships materials
Vendor
ACCOUNTING DEPT.
Uses:
Sends invoice
Invoice
Purchase order
Receiving and
Inspection
Accounting Dept.
report(s)
for invoice
Receiving Dept. -
RECEIVING DEPT.
approval
Payment approved
and voucher
Issues receiving
Materials Ledger
Clerk
report to:
Purchasing Dept.
Own
File
copy
prepared
file
Balance to
TREASURER
for
payment
INSPECTION DEPT.
Makes distribution
to:
Own
MATERIALS LEDGER
file
Accounting Dept.
Materials
CLERK
-
MATERIALS DEPT.
Storekeeper stores
materials in
proper location
320
PART
IV
reports between the purchasing, the receiving, and the accounting depart-
ments.
many
enter-
many
is
the verification
made
in
or department head
sition,
a necessity in controlling
all
all
A requi-
purchases properly.
some types of factory equipment may be requiand ordered in the usual manner. In other cases, a department
head or other employee may telephone for service and in a matter of
minutes may have a machine repaired and back in operation. In such cases,
duplicating equipment, and
sitioned
a so-called
amounts to approval of all repair and service costs of a specific type without
knowing the actual amount charged. When the repair bill is received, the
CH. 12
amount of the
bill
321
the repairs took place and then approves the invoice for payment.
in
The purchase
minimum, or with
ordering
when
at
be re-
to buy, or with a
works
is
who may
who
needs ma-
programmed
chasing department.
need
Httle
it
may
A purchase
requisition
is
illustrated below.
is
322
The purchase
time and
As
IV
by the purchasing
official, is
place.
order, signed
PART
goods
at
may
be used but in typical practice, the order forms are prepared by the purchasing company, and the form is adapted to the particular needs of the
purchaser. As a matter of record and for accounting control, a purchase
;
order should be issued for every purchase of materials, supplies, or equipment, whether the purchase is made by mail, telephone, telegraph, or from
a salesman.
view with a
Where
a purchase
commitment
is
made by
wire or in an inter-
tions.
Where
may
and specification pages. The original and one carbon copy, the latter being
labeled "Acknowledgment Copy," are sent to the vendor. The vendor is
asked to return the carbon copy with his signature which indicates to the
purchasing agent that the order was received and will be delivered according to the specifications enumerated in the purchase order. The acknowl-
edgment copy
is
shown
in the flowchart
Other carbon
on page 319.
necessary
of any damage
in transit
and
The
to be charged,
The form
the inspection department to note either the complete approval of the shipment or the quantity rejected and reason for the rejection. If inspection
does not take place immediately after receipt of the material, the receiving
report is distributed as follows: (1) the receiving department keeps one
CH. 12
is
not
made
323
until inspection
is
com-
one copy of the receiving report, with the inspecis sent for payment to the accounting department
where it is matched with the purchase order and the vendor's invoice.
Other copies go to various departments such as materials and production
planning. The copy to the storekeeper accompanies the materials so that
he knows the quantity and the kind of materials he is receiving.
Approval and Data Processing. By the time materials reach the receiving
department via parcel post, express, truck, rail, air, or water transportation, the company usually will have received the invoice from the vendor.
This invoice is then routed to the accounting department and is filed with
the copy of the purchase order until the receiving report arrives.
the receiving report with
its
inspection report
is in,
When
meet purchase
count and credit terms, shipping instructions, and other possible conditions. Inasmuch as the purchase order and the receiving report contain the
account number that was originally placed on the purchase requisition, the
invoice clerks need no further assistance in this respect and speedy ap;
When
is
assured.
the invoice
is
receiving report, and sends these papers to another clerk for the preparation of the voucher.
Invoice approval
since
it
is
The
stamped.
dure
is
The
invoice
INVOICE APPROVAL
is
often built
verification proce-
handled by responsible
in-
examination
and
handhng of
the
The
invoice Approval
Stamp
in the cash
324
PART
IV
issuance of the check. The treasurer mails the check with the original
voucher to the vendor, files a voucher copy, and returns one voucher
copy to the accounting department for the vendor's file. Purchase transactions entered in the purchases journal
subsidiary records as
pF
shown
aff'ect
and the
CH. 12
325
purchase order the invoice clerk will make a notation of the quantity
received in place of the quantity ordered. The vendor may explain that
he is out of stock or otherwise unable to deliver specified merchandise.
In such a case an immediate ordering from other sources may be necessary.
2.
Items ordered
may
3.
The
seller
order.
may
to the invoice,
on the purchase
and add the excess
may
be returned or
the overshipment.
4.
may
to keep
damaged or
5.
defective shipments
may
When delivered prices are quoted and purchases are made on this basis,
may be expedient for a purchaser to pay transportation charges. The
it
amount paid by
freight bill
Electronic
is
the purchaser
is
Data Processing
and Issued.
The
ment), the accounts payable clerk enters the account distribution on the
The data are then directly inputted from the invoice to the computer data bank via a terminal device. The data are edited, audited, and
merged with the purchase order and the receiving order data, both of
which have been stored in the computer data bank. The common matching
criterion on all documents is the purchase order number. Quantities, dollar
values, due dates, terms, and unit prices are matched. When in agreement,
invoice.
computer
file
with a
payment.
is
EDP
system.
enter the
EDP
file
in the
system from
326
PART
IV
CHECK
FOR
PAYMENT
Integration of a Purchase Transaction for Materials
into the Accounts
Payable Phase of an
EDP
System
second program would also have been designed for the withdrawal
of the materials that would eliminate the manual postings to the materials
inventory
file.
is
raw mate-
visible costs
Controversial concepts and certain practical limitations result in variations in implementing the principles of costing for materials even
Calculating a
with
number of cost
may
although
all
commonly
acquisition costs
CH. 12
costs.
As
327
head when
it is
Purchase Discount.
major problem
in
is one
Trade discounts and
quantity discounts normally are not on the accounting records but are
if
per year, or
charge is ^^^^^^
^^-^ =
18 periods
if
18 periods
3 percent
X
=
If
2 percent
regarded as
36 percent
On
is pricing on essentially a cash basis, and the purchaser has no reasonable choice except to buy on the cash basis.
Although the nature of a purchase discount is readily understood, for
is
commonly
of the freight belongs to each of the invoice items, and what unit price
should go on the materials ledger card ? When the purchased units are not
numerous and are large in size and unit cost, computation of actual
amounts of freight may be feasible; otherwise, some logical, systematic,
and expedient procedure is necessary.
If freight charges are debited to Materials, the total
amount should be
The
relative weight of
^^^'d
328
PART
IV
used as a basis for calculating the applicable freight. If invoice item No. 4
is
added for
freight.
This procedure
all
^~ X
is
more
freight costs
inventories.
Overhead.
in
is
the net price paid the vendor plus incoming freight charges plus other acquisition costs, such as those of the purchasing department, receiving de-
procedure
is
impractical, a single
combined
a given
lot,
order, or department.
to the total
ma-
Estimated
Number
of Purchases or Estimated
Estimated Receiving
Estimated
Number
Number
Durmg
:
of Items to Be Received
Month
=;
or Budget Period
Estimated
Number
Month
r^-
Period
etc.
or Budget Period
_
~
of Transactions
xxx
xxx
xxx
xxx
xxx
CH. 12
329
the expenses incurred by the departments during the period and the
of
Goods Sold
or prorated to Cost
inventories.
from the receiving or inThe storekeeper and his assistants are responsible
materials, which means that materials and supplies
spection department.
for safeguarding the
are placed in proper bins or other storage spaces, that they are kept safely
and that
room
It is
all
good policy
to restrict admittance
windows somewhat
as a
bank
teller operates.
may
be a substantial
may
effec-
be attached
containers.
tities
issued,
show
is
right.
BIN C
STORES NO
5^5
MATERIALS REQUISITION
Deliver
To
Requested By
Charge To
ITEM
NO.
PART
534871
Finishing Department
job. No.
October 23,
Date
tXULud' IEmJum^
19-
Approved By
952
QUANTITY
QUANTITY
RECEIVED NUMBER
ISSUED
DESCRIPTION
125
1013
Carbon
$12.40
$12.40
130
1413
Carbon
10.60
10.60
85
2M
1482
Carbon
2M
4.50
9.00
PRICED BY
FILLED BY
IV
ENTERED BY
RECEIVED BY
DATE RECEIVED
McxiL
MATERIALS LEDGER
CLERK
COST
DEPARTMENT
MATERIALS
FILE
DEPARTMENT
COPY
Materials Requisition
supplies,
and
To
and
and important
and supphes.
Materials Requisition.
this
page)
is
The
on
a written order to the storekeeper to deliver materials or supand the department designated or to give the materials
someone who
It is
drawn by
and
basic
production reports, or the various expense analysis sheets for indidividual departments. All withdrawals result in debits to Work in Process
sheets,
CH. 12
331
and
in credits to Materials.
it is still
is
greatly facili-
summary.
following form
materials
^^^^P
form of
332
Bill
of Materials. The
bill
lists all
run
is
bill
is
of materials.
on the
bill
When
a job or production
a rather
terials is
cumbersome medium
is
the materials
Time
the use of a
IV
moted through
PART
As
the
of ma-
bill
cards for materials requisitions. While the storekeeper issues the materials
as stated
on the
bill
the materials ledger section and in the cost department at almost the
bill
same
computer program will
As
is
maintaining
for each
type of material a record showing quantities and prices of materials received, issued,
sheets
if in-
commonly show
minimum
quantities to carry.
ledger,
basically
the familiar debit, credit, and balance ruHng columns under the description of Received, Issued,
and Balance.
is
illustrated
below.
Reorder Point
Reorder Quantity
Description
Materials
RECEIVED
Ledger
Card
Date
Rec. Qty.
No.
Amount
ISSUED
Date Req. Qty
No.
BALANCE
Amount Quantity
Unit
Cost
Amount
CH. 12
333
is
Each
receipt
of the receipt.
Unsatisfactory goods or defective units should be detected by the
inspection department before being stored or even paid for.
The
receiving
report should show materials actually accepted, and the ledger entries are
made after all adjustments. However, goods accepted in the storeroom
may
factory
in
When
who
is
sent
of the materials ledger card showing the date, the requisition number, the
job, lot, or department number, the quantity,
in order to
move
either
from storeroom
is
to cost
to factory as direct
2.
Average cost
3.
4.
Other methods
or market price
cost, last
purchase price
334
These methods
flow of units
relate to
may
such a condition
assumptions as to flow of
method of
costs.
PART
IV
The physical
with raw materials inventory; however, the same costing methods are
work
tive
in process
is
method of costing
Method
of Costing.
The
is
lifo
costing methods,
unit.
4.
25.
Returned 100 excess units from the factory to the storeroom to be recoded
The above
transactions
Fifo Costing
Method
Feb.
would be calculated
Illustrated:
@
$6
$7
200 units
(a
$8
800 units
(a;
$6
/200 units
(o;
^200 units
$7
$8
400 units
(S,
$8
/200 units
\300 units
@
@
$7
$8
300 units
(a;
$8
4.
Received
800 units
200 units
10.
Received
11.
Issued
Beginning balance
Balance
12.
Received
20. Issued
Balance
25.
Returned to storeroom
28. Received
Balance
The
as follows
fifo
method of costing
100 units
$8
600 units
(a
$9
|400 units
\600 units
@
@
$8
$9
=
=
=
=
=
=
=
=
=
=
=
=
=
=
$4,800
1,400
1,600
$7,800
4,800
1,400
1,600
3,000
3,200
6,200
1,400
2,400
3,800
2,400
800
5,400
8,600
$3,200
5,400
$8,600
materials used should carry the actual experienced cost of the specific
from
CH. 12
335
1.
2.
materials used are drawn from the cost records in a logical and systematic manner.
The
The
fifo
method
recommended whenever
is
materials units are large, (2) materials are easily identified as belonging to
lot,
and the
more or
less at
random
is
may
How-
is
an
is
advantageous because:
1
identifiable order.
If
It is a reaUstic costing method useful to management in analyzing operating results and appraising future production.
2.
Average costs minimize the eff"ect of unusually high and unusually low
raw materials prices, thereby making possible more stable cost estimates
for future work.
3.
It is
The average costing method divides the total cost of all materials of a
by the number of units on hand to find the average price.
The cost of new invoices is added to the total in the Balance column the
particular class
336
PART
IV
added to the existing quantity and the new total cost is divided
by the new quantity to arrive at the new average price. Materials are issued
at the established average cost until a new purchase is recorded. Although
a new average price may be computed when materials are returned to venunits are
when
dors and
it
seems
sufficient to
new average
is
When
new purchase
is
made and
will
be
absorbed.
Using the data of the fifo illustration (page 334), the transactions can
this manner:
be summarized in
Illustrated:
Average
Cost
Feb.
4.
Balance
10.
Issued
Balance
12.
Received
Balance
20. Issued
Balance
25.
28.
,000 units
,200 units
200 units
Received
Balance
800 units
200 units
Beginning balance
Received
Returned to storeroom
Balance
Received
Balance
800
400
400
800
500
300
units
@
@
$6
$7
(a>
$8
$6.50
$8
=
=
units
units
units
units @i $7.25
units
100 units
400 units
600 units
1,000 units
(gj
$9
$4,800
1,400
1,600
338
Lifo Costing
tages of the lifo
1.
2.
Materials
Method
Advantages and Disadvantages.
costing method are:
consumed
and
PART
IV
The advan-
realistic
manner.
Unrealized inventory gains and losses are minimized, and reported operating profits are stabilized in industries subject to sharp materials price
fluctuations.
3.
The disadvantages of
1.
The
method
are:
unless a change
is
Service (IRS).
2.
Lifo
is
a "cost only"
lifo
cost
3.
4.
5.
if it is
greater than
The
inflation, but
it
method has
Long-range
effects as well as
are
are described
methods
exist.
Although
fifo,
some of
the other
work
in
methods
CH.
12
Month-End Average
Cost.
To
339
each month an average cost for each kind of material on hand and use
cost for
when
all issues
in process costing;
this
mentioned
is
compute
of
oil,
issue.
perienced or consumed cost but has the virtue of charging materials into
costing and that of using the last purchase price are often used, especially
for small, low-priced items.
Standard Cost.
ing the record keeping and reducing clerical or data processing costs.
In recording materials purchases, the difference between actual
standard cost
is
and
Materials are charged into production at the standard price, thereby elimi-
Standard
normal production runs at standard prices enable management to detect trouble areas and take corrective action immediately.
Materials pricing under standard costs is discussed in Chapters 19 and 20.
quantities for
The
several
eff'ort
is
methods of
to measure
to all situa-
The same
method need not be used for the entire inventory of a business. Whatever the method of costing, it should be followed consistently from period
tions;
to period.
340
PART
IV
Perhaps no materials costing method will reflect consumed materials cost with complete accuracy at all times in all situations.
The most appropriate method of costing materials will as nearly as
revenue produced.
possible:
procure-
consumed
fiscal
in
subsequent periods.
difficult
and
illustrations
indicate:
$8,600
8,300
7,800 (or $6,200, depending upon the
timing of the costing procedure)
Fifo costing
Average costing
Lifo costing
and
cost,
fifo.
made
out at highest costs and average costing will result in a figure between the
;
with
fifo
the other
two methods.
COST OF MATERIALS
INVENTORY AT THE
IN
END OF A PERIOD
When the cost basis is used in costing inventories for financial statements and income tax returns, the sum total of the materials ledger cards
must agree with the general ledger materials control account which, in
turn, is the materials inventory figure on the balance sheet. Unless a shift
from the cost basis
is
made
is
the
method used
method
to inventory.
is
the position
and
or
sales.
if
stock
generally defended
is
taken that a
full
stock
is
when
finally utilized
and
its
stated cost
CH. 12
341
an additional cost of the goods produced and sold during the period when
the decline in value occurred.
AICPA
for inventories
is
and
is
After
defining inventory
AICPA
states
The primary basis of accounting for inventories is cost, which has been
defined generally as the price paid or consideration given to acquire an asset.
As applied to inventories, cost means in principle the sum of the applicable
expenditures and charges directly or indirectly incurred in bringing an article
to its existing condition and location.'
is
way
is
pri-
market rule.
mandatory that cost be abandoned in
valuing inventory when the usefulness of goods is no longer as great as its
cost. This, then, becomes a principle of cost, or residual useful cost, which-
The
ever
AICPA
in effect says
lower:
is
A departure from the cost basis of pricing the inventory is required when the
of the goods is no longer as great as its cost. Where there is evidence
that the utility of goods, in their disposal in the ordinary course of business,
will be less than cost, whether due to physical deterioration, obsolescence,
change in price levels, or other causes, the difference should be recognized
as a loss of the current period. This is generally accomplished by stating
such goods at a lower level commonly designated as market.^
utility
The
last
whichever
in turn
is
is
it is
mid.,
p. 30.
In the
is
AICPA's
market, which
cost or
market
(New York:
1961),
342
PART
IV
that a replacement cost should be used for inventory value merely because
it is
what
it
figure.
The
real test
The
is
the usefulness
AlCPA
is
more
cannot be recovered
As used in the phrase lower of cost or market, the term market means
current replacement cost (by purchase or by reproduction, as the case may
be) except that
Market should not exceed the net realizable value (i.e., estimated selling
price in the ordinary course of business less reasonably predictable costs
of completion and disposal); and
2.
may
Accountants
be interpreted as follows
2.
3.
To
This lower figure is normally market replacement cost, except that the
amount should not exceed the expected sales price less a deduction
for costs yet to be incurred in making the sale. On the other hand, this
lower market figure should not be less than the expected amount to be
realized in the sale of the goods, reduced by a normal profit margin.
illustrate the
for $1
it
may
to each inventory
with
may
less effort.
Adjustments for Departures from the Costing Method Used. The problem of year-end inventory valuation is primarily a question of the materials
^Ibid., p. 31.
ed. (Cincinnati:
South-Western
CH. 12
&.
COSTING METHODS
343
344
On
PART
IV
$100,000
is
5,000
$95,000
lower]
The price decline may be shown as a factory overhead item in the statement of cost of goods sold or it may be deducted from the ending inven;
Whenever
or market figure
next year,
it
of the new
hand
is
fiscal
first
day
would be
intended destination of
all
raw materials
units
is
When
process
is
completed, the
Finished
Work
of materials used
effect
Goods
xxxx
xxxx
in Process
In production devoted to
provide
is
sufficient
filling
is
fill
should
Should a
incoming
The
finished
goods ledger,
is
may
in
finished
goods
similar
also
as well as consideration
consist of
If the units
move
Work
in
directly into
and credited
to
in Process.
CH. 12
345
between actual count and balances on the materials ledger cards due to
errors in transferring invoice data to the cards
sitions;
In
theft.
some
suspended periodically
is
taken.
year while a
fiscal
members of
more stock classes
make
a count of one or
will
Inventory Count.
When
actual count.
is
is
made
is
card balance
is less
may
may
section with the Balance section being increased to agree with the actual
count.
In addition to the corrections on the materials ledger cards, the
ma-
terials
would be:
Subsidiary
Record
Debit
Credit
many manufacturing
346
due
and
(5) the
time of
and broken
sale, the
in
following entry
parts,
This scrap
is
usually
At the
made:
xxxx
(or
Factory
Overhead
xxxx
Control)
in
IV
PART
The amount realized from the sale of scrap and waste can be treated
two ways with respect to the income statement:
1.
2.
credited to Factory
When
scrap
is
collected
realized
from the
would be
Cash
(or
Work
When
xxxx
the quantity
should be stored in
keeper.
xxxx
Accounts Receivable)
in Process
scrap report
is
The
transfer
and
original
is
file
procedures
1.
2.
Open a materials ledger card, filling in the quantity only. The dollar value
would not be needed. When the scrap is sold, any of the previous entries
and treatment of the income item might be made.
Record not only the quantity but also the dollar value of the scrap delivered
The value would be based on scrap prices quoted on
the market at the time of entry. The entry would be
to the storekeeper.
CH. 12
xxxx
Scrap Inventory
When
the scrap
Cash
(or
is
(or
Work
Factory
in Process or
xxxx
would be:
Accounts Receivable)
xxxx
xxxx
Scrap Inventory
Any
347
is
re-
corded and the price realized at the time of sale would be a plus or minus
adjustment in the income from sale of scrap account, the work in process
account, or the factory overhead control account, consistent with the
first
To reduce accounting
entry.
is
is
for scrap to a
actually sold.
trol
What
is
important
is
an
effective scrap
con-
sonnel. Timely scrap reports for each producing department call attention
to unexpected items
corrective action.
DEPARTMENT
Fabricating
FOR WEEK
ENDING November
PART NO. DESCRIPTION
10,
WEEKLY
SCRAP
REPORT
19--
UNITS USED
SCRAPPED
% SCRAP COST
115b
Joints
7,200
108
1.50
$7.00
115e
Fins
9,400
305
3.23
30.50
115s
Guides
15,600
520
3.33
41.40
115k
Supports
8,500
42
.50
5.30
$4,533.75
104.20
REASON
Defec tive
parts
348
the nature
IV
Spoiled Goods.
know
PART
is
units.
first
requirement
is
to
and
to ac-
cumulate spoilage costs and report them to responsible personnel for corrective action.
If spoilage
is
normal
in the
manufacturing process,
its
cost should be
head
rate,
all
The degree of
production of a period.
Charged
to Total Production.
The
manufacture
to
Production
is caused by a
During Novem-
per unit, labor cost $.50 per unit, and factory overhead was charged to
production
at a rate
of
150%
Work
Work
Work
in
Materials
Labor
Process Factory Overhead
Process
Materials
Payroll
10,000
12,500
18,750
On
into
10,000
12,500
18,750
in Process
in
work put
is
the last working day of the month, the entire day's production of
4,000 units
is
is
CH. 12
&.
COSTING METHODS
349
Subsidiary
Record
Goods
Spoiled
Work
Work
Work
Process
in Process
in Process
in
Credit
2,000
4,600
It
Debit
4,600
Materials
Labor
Factory Overhead
1,600
2,000
3,000
should be noted that the 25,000 units completed each week without
week carry a unit cost of $.40 for materials, $.50
for labor,
total, $1.65.
these units ($1,600 materials plus $2,000 labor plus $3,000 factory over-
head
is
Work
in Process to Factory
is
$4,600.
$.05
Overhead
month has a
and the
produced
$4,800),
The good
units
during the week or on the order where spoilage did occur carry a cost of
$.40 for materials, $.50 for labor, and $.75 for overhead because spoilage
is
charged to
all
production
not to the
lot or
weeks)
less the
to be divided
is
made
trans-
levels.
If
may
be charged to
350
PART
IV
in the cost of
goods sold
to a Particular
Job Order.
statement.
Charged
springs
$.60.
is
spoilage
is
tion the
first
first
hour of pro-
good
springs.
Work
Work
Work
Materials
Labor
Process Factory Overhead
6,600
5,500
7,700
in Process
in Process
in
6,600
5,500
7,700
Materials
Payroll
One thousand
Work
Work
Work
The entry
450
Goods
Materials
Process Labor
Process Factory Overhead
150
125
175
in Process
in
in
Sa.es recovery
450
^O Materia, cos.
Labor cost
$ 5,500
[
(
^^
,
$450 sales recovery
^.^r,
$125
$19,800
is
$450
sales recovery
;
=
$150
$175
S|50
$175
CH. 12
The entry
in
in
is
be:
19,350
Materials
Process Labor
Process Factory Overhead
in Process
6,450
5,375
7,525
$450 cost recovery) to the 10,000 good units that are delivered
($19,350
351
Goods would
Goods
Work
Work
Work
($1,800
COSTING METHODS
Finished
The
&.
The
is
$1,935
10,000 units).
Work.
Defective
may
product,
spoiled
it
is
work cannot
usually be
made
Although
in the pre-
To
rate.
entries are:
Subsidiary
Record
Work
Work
Work
Materials
Process Labor
Process Factory Overhead
Debit
in Process
2,500
in
1 ,500
3,000
in
Materials
Payroll
2,500
1,500
3,000
Credit
210
Work
(Dr.)
210
30
60
Work
Work
Work
The
120
Goods
7,000
Materials
Process Labor
Process Factory Overhead
in Process
in
in
2,500
1,500
3,000
is
$14.00 ($7,000
-^
500
units).
352
PART
IV
Suppose, however, that the same company received a special order for
500 units with the agreement stating that any defective work is chargeable
to the contract.
units are
assembled.
for labor,
During production, 50
and
200%
found to be improperly
is
The
Work
Work
Work
Process
in Process
in Process
in
Materials
Labor
Factory Overhead
Credit
2,500
1,500
3,000
Materials
Payroll
2,500
3,000
Work
Work
Work
in Process
Process
in Process
in
1,500
Materials
Labor
Factory Overhead
30
60
120
30
60
1 20
Materials
Payroll
Work
Work
Work
The
Process
in Process
in Process
7,210
Materials
Labor
Factory Overhead
Whenever
slight
Goods
in
the defective
is
2,530
1 ,560
3,
20
work
cost
is
rework cost
in the factory
overhead
Inventories account for a large portion of the working capital requirements of most businesses. This fact makes materials and/or inventory
management a major problem of significant importance requiring constant attention by all three management levels.
2.
At present, the problem has become even more acute due to market
conditions and the inflationary costs of materials.
3.
CH. 12
^M
1.
2.
3.
353
DISCUSSION QUESTIONS
How
is
to a great extent
4.
5.
Does
6.
In costing materials received and placed in stock, should the cost of transportation, receiving, inspecting, and storing be added to the purchase price?
State reasons.
7.
its
principal effect
on the balance
An invoice for materials shows a total of $5,400 terms 3 /lO, n /30. If the
purchaser elects to pay the invoice at the end of 30 days, what is the effective
interest cost resulting from failure to take the discount ?
;
8.
During periods of rapid increase or decrease in materials prices, which costing method might result in a more desirable figure for cost of goods manufactured and sold?
9.
10.
11
costing method.
Is it also
12. Several
chapter.
13.
lifo
in this
An
item of inventory purchased this period for $15 has been written down
current replacement cost of $10. It sells for $30 with disposal costs of
$3 and normal profit of $12. Which of the following statements is not true?
to
(a)
(b)
(c)
(d)
its
(AICPA
adapted)
354
14.
in
PART
IV
(b)
15.
Sawdust; split, broken, and short ends of boards; and shavings from
planing machines in lumber mills
(b) Off-cuts in cutting paper linings and wrappers
(c) Off-cuts and broken pieces in foil wrapping
(d) Scraps in suit and dress factories
(e) Turnings from engine lathes
(a)
17. In
Which of
is
(b)
This category of inventory is an exception, and the rule does not apply.
Costs of completing the inventory are added to costs of disposal, and
both are deducted from estimated selling price when computing realiz-
able value.
Market value cannot ordinarily be determined.
(d) Equivalent production is multiplied by the selling price.
(c)
(AICPA
19.
adapted)
A client who wishes to include as a part of the cost of raw materials all of the
cost of acquiring
(a)
The
and
The arguments favoring
principal items that
handling.
may
to
know
(b)
(AICPA
20. In order to effect
adapted)
method of
been developed.
Describe the establishment of and subsequent pricing procedures when
applied to units of product with a periodic inventory system in use.
(b) Discuss the general advantages and disadvantages claimed for the lifo
(a)
lifo is
method.
(AICPA
adapted)
CH. 12
355
EXERCISES
The Mellan Company began using a
1. Materials Costing Methods.
with these transactions:
material during May, 19
May
new raw
Received 100 units (a> $5.40 per unit; total cost, $540.00.
Received 30 units (q^ $8.00 per unit; total cost, $240.00.
15. Issued 50 units.
$9.00 per unit; total cost, $1,080.00.
22. Received 120 units
2.
8.
Required: With a perpetual inventory control system in use, state the cost
of materials consumed and the cost assigned to the inventory at the end of May
using: (a) first-in, first-out costing; (b) last-in, first-out costing; and (c) average
costing. Present computations using materials ledger cards.
9,000 kilograms are $990. Shipping weights for the respective materials are
2,900, 2,400, and 3,700 kilograms.
Required: (1) The cost per kilogram to be entered on the materials ledger
cards for A, B, and C if each dollar of invoice cost is assigned an equal portion
of the freight charge.
(2)
The
each material
each material.
Ledger Accounts for Materials Cost Flow. The Littner Company produces a
product from one basic raw material. During one week of operations, the
materials ledger card reflected the following transactions:
3.
1st
weekday
2d
3d
4th
5th
6th
"
"
lb.
"
Other costs for the week were direct labor, $4,800, and factory overhead,
$4,360; 1,700 units of product were completed, and 1,500 were sold. There was
no beginning inventory of finished goods, and no work is left in process over
the weekend.
Required: (1) Ledger accounts for Materials, Work in Process, Finished
Goods, and Cost of Goods Sold, using (a) fifo costing and (b) lifo costing. Assume a perpetual inventory system is used.
(2)
The
final
week and
356
PART
IV
Correcting Perpetual Inventory Cards. The following differences were reported in reconciling the physical inventories of materials with the materials
ledger cards. The physical inventory has been verified and is correct in each case.
4.
Materials
Physical
Inventory
Ledger
Balance
2,000 units
2,100 units
500 units
400 units
Material
Differences Reported
to record an issue
of direct materials to production. Average
cost per unit, $2.
An
purchased
1,000 gals.
1,030 gals.
900
Required: (1)
930
lbs.
Shortage due to
pound, $10.
lbs.
theft.
transaction.
(2) The procedure necessary to correct or adjust the materials ledger card for
each difference.
October
is
to be used in
@
@
@
5.
Required: The cost of materials used and the cost assigned to the October 31
inventory by each of these perpetual inventory costing methods: (a) first-in,
first-out (fifo); (b) last-in, first-out (lifo); (c) moving average, using a materials
ledger card; (d) most recent purchase price.
Physical Inventory.
company's own power plant uses coal as the principal
The coal is delivered by rail and stored in an open field close to the powerhouse from which it is fed into furnaces by conveyor belt.
6.
fuel.
CH. 12
357
were asked to decide on the proper valuation for the following situations with
these pertinent factors and simplified figures:
Situation
Cost
$100
80
50
60
$100
80
50
90
$100
80
50
40
$40
80
50
30
$100
80
50
110
is
is
The following
8.
(a)
(b)
AICPA rule.
transactions
The inventory of raw materials on the average costing basis was $4,200 and
represented a book quantity of 8,000 units. An actual count showed 7,780 units.
$150 of materials issued to Job Order No. 182 should have been charged to the
Repair Department.
Materials returned from the factory as excess on requisitions for Job Order No. 257
to $382.
(d) Materials returned to vendor amounted to $165. Freight-out on this shipment,
to be borne by the Patterson Company, was $14, paid in cash.
(e) Finished goods returned by customers: cost, $1,500; selling price, $2,100.
(f) Summary of materials requisitions totaled $4,814.50, of which $214,50 represented
supplies used.
(g) Materials purchased and placed in stockroom, $6,150, of which $500 represented
supplies. Freight-in paid, all applicable to direct materials, amounted to $70.
(h) Supplies returned to the storeroom, $150.
(i)
Scrap materials sent to the storeroom valued at selling price (debit Scrap Materials)
(c)
amounted
From
From
$190
direct materials
10
supplies
work
Spoiled
Required:
that should be
Inventory
December
December
December
31,
19A
31,
19B
31,
19C
Liters
fifo
lifo
250,000
237,500
256,500
$112,500
201,500
169,000
$112,500
105,000
if
17,500
358
PART
IV
10. Fifo-Lifo and Cash Flow. Due to rising prices for materials, the problem of
using the most appropriate inventory costing method has become very acute.
With the wide variety of methods available for accounting of inventories, it is
important to select one that will be the most beneficial for a company. To illustrate, assume that two companies are almost identical except that one uses fifo
costing and the other uses lifo costing. Both companies have a beginning inven$2 per unit. The ending inventory is 240 units, for which
tory of 200 units
the current cost per unit is $2.40. Sales during the fiscal period totaled 180
a selling price of $3.60. The income tax rate is 50% for both companies.
items
amount of
(5)
(Based on a Haskins
&
Sells Newsletter)
11. Journal Entries to Correct Defective Work. The Spurrier Products Company
manufactures, among other items, a unique nutcracker. One order from the
San Diego Specialty Company for ,000 nutcrackers showed the following costs
per unit:
1
$3.00
2.00
Materials
Labor
Factory overhead applied at rate of
125%
of labor cost.
Final inspection revealed that 120 units were improperly machined. These
units were broken down, properly machined, and reassembled. Cost of correcting the defective nutcrackers consists of $1.20 per unit labor plus overhead at
the normal rate, which includes an allowance for defective work.
Required:
the
when
(a)
(b)
Work.
Dino Fashions,
Lot No. 647, which called for 500 dresses. Style No.
Inc.,
in
producing
Materials
Labor
Factory overhead
Includes an allowance for spoiled work of
specific order.
17 per dress*
$1.
When the lot was completed, inspection rejected 20 spoiled dresses which
were sold for $30 each.
Required: (1) Entries if the loss is to be charged to Lot
(2) Entries if the loss is to be charged to all production
No. 647.
of the
fiscal period.
CH.
12
359
PROBLEMS
12-1. Analyzing a Company's Future Plant Expansion Based on Its Costing
Methods. The board of directors of the Windham Corporation is considering
the possibiHty of a plant expansion. After some research and a review of the
company's materials costing methods, the president presents the controller with
the proposition of using the lifo method instead of the present fifo method because of its apparent tax advantages.
reduction of the company's income tax
liability might provide additional capital for the planned expansion. The president requests the controller to make a further study on the proposal. The controller's analysis regarding the inventory is based on these transactions for
June, 19:
June
1.
2.
7.
11.
14.
@
%
17.
21.
24.
26.
29.
Required:
for June, 19
(2)
(1)
,
(w,
per unit.
per unit.
per unit.
per unit.
using the
12-2. Ledger Cards for Materials. Records of the Summit Company show the
following purchases and issues of materials during October:
October
1.
4.
6.
8.
14.
17.
(aj,
20. Received
(5)
(6)
The October
(3)
(4)
date
is
inventory
if
on that
Budgeted for
the
Month
CH. 12
361
12-5. Inventory Valuation. In January the materials ledger card for metal castings of a certain kind and weight showed the following data:
Issued
Received
Units
Jan.
Balance
Purchase
20. Purchase
28. Purchase
1.
10.
Cost Per
Unit
100
100
$1.00
200
.90
.88
100
.95
362
PART
IV
Under
(3) Normally, inventory amounts include the costs of Freight-In.
certain circumstances, however, these costs are excluded from the determination
of inventory cost.
(a)
(b)
practiced with
Masten Manufacturing,
Inc.
INVOICE
Materials Cost
$11,786.25
7,811.25
5,207.50
Labor Cost
Factory Overhead
Total Cost
$24,805.00
Fixed Fee
1,145.00
$25,950.00
The Air Force Cost Inspector objected to this billing, stating that the spoilage
of 5 motors and additional costs for 1 defective motor had been charged directly
to the Air Force job, whereas the procedure previously had been to spread such
costs over all the jobs.
The spoiled motors had been sold as scrap for $50 each (the original scrap
value assigned to them). The defective motor had required $30 of additional
materials and 5 labor hours to correct its defects. Men working on the contract
were paid $3 per hour and had worked a total of 7,200 hours, of which 2,630
hours had been spent on the Air Force contract. Masten Manufacturing, Inc.
uses a predetermined factory overhead rate of $2 per labor hour. Each motor
Spoiled and defective work is discovered
requires $95 of direct materials.
during final inspection after all normal labor costs have been incurred.
Required: Assuming that the company's work in process account has
tiot
(a) All
(b)
(c)
The journal
(d)
made
in con-
and
CH.
12
&.
COSTING METHODS
363
12-8. Accounting for Spoiled Work. The Galarde Manufacturing Co. produces
a variety of products, each requiring several parts. The parts are manufactured
and placed in stock for assembly as needed. The following cost sheet for Part
No. 105 indicates the present costing method.
COST SHEET
105
6-5574
Quantity finished
Date wanted
2/5/2/28/
Quantity spoiled
Date finished
2/26/-
Quantity started
Date
2,000
started
Materials:
2,000 pieces
ibor Cost:
Dept.
(all
material issued
364
(2)
pleted.
(3)
PART
The journal entries to be made at the time Job Order No. 6-5574
Assume the spoilage is to be charged to total production.
The information contained
in a
is
is
IV
com-
sent to
Product
Debit
Entry
1
Spoiled
Work
Work
Work
2
Spoiled
Goods
Process
in Process
in Process
in
Materials
Labor
Factory Overhead
Goods
Spoiled
Goods
Work
Work
Work
4
Spoiled
in
100
200
300
Materials
Labor
Process Factory Overhead
5,400
1,000
2,000
3,000
600
5,400
1,000
2,000
3,000
Process
in Process
in
Goods
Accounts Receivable
Work
Work
Work
600
600
Credit
Materials
Labor
in Process Factory Overhead
600
5,400
in Process
1,000
2,000
3,000
in Process
Required: The circumstances under which each of the above entries would
be appropriate.
(AICPA
adapted)
CHAPTER 13
QUANTITATIVE MODELS
FOR MATERIALS PLANNING
AND CONTROL
economic
Size of inventory at
some additional costs. Inventory investment varies with the type of industry and characteristics of a company;
on the average, inventory accounts for about one third of total assets,
and for many manufacturers the cost of materials represents about one
Any
inventory planning and control method should have but one goal
maximize
two ways:
(1) to
and resource
(2) to
allocations.
raw materials
into production.
is
it is
neces-
366
PART
IV
available specifications
The
division
proposal.
the proposal.
To
to
1.
Forecast
2.
3.
4.
Establish quantity
5.
6.
Using these
on hand.
and
receive delivery of
November
is
as follows
September production
October production
November production
Desired inventory, November 30
units
units
units
units
8,000 units
Total to be provided
1,600 units
2,000 units
2,000 units
5,600 units
2,400 units
planned, even the most elaborate control system will result in the wrong
level
Materials
planning deals
with
two fundamental
to buy.
Determination of
factors: (1)
the
simply,
how
or
of cost the
to
buy
CH. 13
COST OF
367
conflicting costs
368
However,
it
is
difficult, if
PART
IV
difficult to
measure, yet they are needed in computing the economic order quantity.
The
and the
receipt of materials,
ment.
when
factors,
it
may
cost
to
to
Mathematical and
sta-
maximize
profits
and minimize
costs.
tabular
Order
size in units
sizes
2,400 units
$ 1 .50
$6.00
10%
can be evaluated
CH. 13
369
$200-,
800
600
,000
,200
,400
,600
440
EOQ
ORDER QUANTITY
Graphic Determination of the Economic Order Quantity
Of
is
the
most economical
thus,
an order
may
there
may
size
200 /400 or 400 /800 with a cost to order and carry that
is
above shows the lowest point of the total cost to order and
carry curve, about $66, and the most economic order quantity of about
440 units. The ideal order size is the point when the sum of both costs is
illustration
at a minimum; i.e., the total cost curve is at its lowest. This point occurs
when the annual carrying charges equal the ordering charges; i.e., where
these
two cost
lines intersect.
370
/- J
.-.
r
i-v
=
Quar*-*"
entity
Economic Order
PART
IV
'
^^Cost
X RU X CO
CU X CC%
/2
^OQ =
is
demands and
denominator is the product of the unit price and the annual carrying
Using this formula and the data from page 368 results in:
2X2.400^
EQQ-J
^ \ $1.50X10%
28,800
.15
^R^^;^ =
V
CC as
rate.
438 units
'
specified, the
formula
derived as follows
RU
Number
EOQ
RU X CO = Annual ordering cost
EOQ
EOQ Average number of units in
CU X CC X EOQ =
RU X CO
CU X CC X EOQ ^
EOQ
RU X CO CU X CC X EOQ
2
EOQ
AC = RU X CO X EOQ-. + SiXCCXEOQ
f^=-RUXCOXEOQ-. + -f-RU X CO
CU X CC
EOQ
-RU X CO CU X2 CC
^.
^''
^'=
+
EOQ2
^''dE6Q =
^^^dEOQ
CU X CC ^ RU X CO
dAC
dEOQ
dAC
^
Q
>
EOQ2
2
EOQ2 X CU X CC = 2 X RU X CO
2X^^XCO
EOQ2 =
C U X CC
X RU X CO
EOQ
^
CU
=V^
'
X CC%
minimum
total
CH. 13
It is
following formula
hOQ =
X AB
where
Using
Example.
in dollars rather
usually employed:
is
-^
EOQ
371
this
Annual requirements
g ^
=
I
in dollars
(%
of average
earlier
illustration
$3,600
-
$6
units
^.^^
$657
$1.50)
,
,
total
costs, or
^^
/$657
438 units
second example
is
Any
jj^
when new
cost data
Of
course, only
those cost components that vary directly with order or production quantities
should be used;
i.e.,
Example:
RU =
6,000 units of material No. 60,841 used per year (500 units per month)
The
calculation
is
EOQ=JI^M20X^
^
\
of inventory
$2.50X20%o
J\ 180>0OQ
.50
= J^^5:000"=
600 units
>
ment
372
Annual
PART
IV
CH. 13
373
than the minimum, quantity price discounts and /or freight savings may
be made, enabling the purchase to be made at a lower cost per unit. However,
buying
investment in inventories.
The
EOQ
CO
if
an added return
adequate.
is
optimum
size
EOQ formula is
equally
CU the
and
variable
manu-
Assume
Illustration:
No. 841967
is
manufactured
rather than purchased, that setup costs such as labor cost of rearrang-
ing and adjusting machines (CO) are $62, and that the variable
facturing cost
{CU)
$2 per unit.
is
^^^
cost
7~.
-^^
manu-
^, ^(.m
$2 variable manufacturing cost, X
20%
= ^1,860,000
=
\
744,000
,,o^nnnr.
-.
tcA
1,364 units,
i
.4
the
optimum
size of a
production run
is
to
(2) rate
However,
just as important.
order
is
(1)
time
Unlike
the generally accepted solution to the economic order quantity, the order
if
lead time
placing an order and having materials on the factory floor ready for pro-
and the usage pattern for a given item were definitely predictFor most stock items there is a variation in either or both of these
factors which almost always causes one of three results: (1) if lead time
or usage is below expectation during an order period, the new materials
will arrive before the existing stock is consumed, thereby adding to the cost
duction
able.
of carrying inventory;
(2) if lead
time or usage
is
stockout will occur with the resultant incurrence of costs associated with
(3) if
374
PART
IV
money.
In materials
management,
an expense as well as an
and the cost to carry inventory. Since
possible, an inventory cushion or safety stock
forecasts are
problem
is
The
If the safety
if
basic
stock
is
The optimum
mal
safety stock
that quantity
is
costs.
if
an order was
processed ten times a year, two stockouts per year on the average would
occur.
If
if
and carrying
would be $115.
carrying cost $30, a total of $80. If increasing the safety stock to 80 units
reduces the stockout probability to 5 percent or once every two years, the
annual stockout cost would be $25 with carrying costs of $60, a total of $85.
Analysis of this type covering important stock items leads to smooth operations
and
effective materials
management.
Order Point Formula. Order points and /or reorder points are based on
usage during the time necessary to requisition, order, and receive delivery
of materials plus an allowance for protection against stockout.
order point
is
The
are equal to the lead time usage quantity plus the safety stock quantity.
QD =
+ QD
Inventory balance on
may
= LTQ
be expressed as:
SSQ, when:
hand
and returns
LTQ =
Lead time
SSQ =
CH. 13
375
2.
is
therefore,
no safety
provided.
Based on the same figures, a safety stock is injected into the calculation.
Both examples are solved mathematically and graphically.
First Illustration:
Assume
Monday through
and a lead time of four weeks which estabhshes an order point at 700 units
(175 units X 4 weeks). Assuming that unit cost is $.50, carrying cost 20%,
order cost $24, and annual usage 175 units per week for 52 weeks, then
the EOQ is computed at 2,090 units.
EOQ =
2X9,100X$24
436,800
$.50X20%
10
= ^4,368,000 =
2,090 units
and
(2) if
needed.
2,500.
is
is
inevitable.
Since perfect
376
Second
shown
Illustration.
in Figure
Assuming
the
units per
IV
week
1,
PART
would be 175
units
4 weeks
700 units usage during normal lead time plus 875 safety stock (175
X 5 weeks) = 1,575 order point. Assuming a beginning inventory
units
of 2,800 units and no orders outstanding, the usage, order schedule, and
inventory levels would be:
2,800 units beginning inventory
1,225 usage to order point (1,225
-4-
7 weeks)
maximum
EOQ
-^
4 weeks)
units received
EOQ
H-
Normal usage
for
units (175
unitsX4 weeks)
Safety stock
Normal usage
875
315
1,190 units
Order point
,890 units
units with
-^
210
maximum
weekly usage
no orders
would be:
=
4.3
out-
weeks)
maximum
EOQ
-f-
units received
EOQ ^
known
but variable.
3,000-
Figure 2
Rate of
WEEKS
Figure 3
Rate of
Known
but Variable
377
..
378
PART
The preceding
iV
situa-
tions tend to provide a safety stock for the extreme boundaries of usage
variability.
amount of
safety stock
supply.
statistical
Method
techniques for a
inevitable.
Illustrated.
statistical
approach:
January.
February.
March.
April.
May
June
July
August.
In
Column
3,
and
totaled.
vided by the
tracted
total
In
Column
The Column
(8
4,
3 total
the
is
Column
3 dif-
squared and
is
di-
sub-
CH.
13
379
Here the average difference of 2.75 increases the safety stock beis, on the average, greater than the forecast usage.
positive average difference would indicate that the actual usage is on
the average less than the forecast, thus reducing the safety stock figure.
Three times the standard deviation minus the average difference, ap (2.75)] of safety stock, would result in
usage
in
With a usage forecast of 260 units for a needed lead time of one month
and a safety stock of 22 units, the order point is 282 units for Material
No, 925. Of course, an additional safety stock allowance may be needed
if
desired by management.
When
it
The above
illustration uses
months
e.g.,
units of
measure as those
tions times the standard deviation times the square root of the
and from
this
is
differ-
subtracted.
As-
(2
(19.48
9.74
X 2)+
= 38.96+
= 49 96 =
.
Forecasting Usage.
itself
It is
X V^) -
(-2.75
4)
11
11
It is
barometric methods
1.
Factor
2.
Statistical
3.
Forcasting surveys
listing or
methods
380
Factor
listing
PART
IV
company and
relies
upon
the forecaster's
listing.
The
Statistical methods describe historical patterns in time series.
methods may be simple or complex, but the purpose is to reveal patterns
that have occurred in the past and project them into the future. The usual
procedure results in plotting time series data on a graph (such as total sales,
sales of specific lines or products, inventory units or dollars,
man
hours or
is
growth or decline over a period of time. Regression analysis usually employs the least-squares method (see Chapter 18) to determine economic
relationships between a dependent variable and one or more independent
variables, such as sales territory, family incomes, advertising expenditures,
to determine
consumer buying
investment intentions.
rests pri-
enough self-confidence
needs of the company.
Basically,
demand.
2.
3.
Normal
4.
5.
6.
Statistical
distribution of
demand
forecast errors.
is
made
all
inventory items.
all
size.
reached.
EOQ
are available,
practical purposes.
The formu-
remember
CH.
13
1.
2.
CONTROL
&.
381
The order point is singularly the most significant factor affecting inventory planning inasmuch as it establishes the inventory level. It determines the investment in inventories and the ability to provide satisfactory
customer service. The order point is primarily dependent on the accuracy
of the sales or usage forecast.
MATERIALS CONTROL
Materials control
is
stages of operations
Executive management
is
production schedules.
The control of
and
(2)
objective of
eflflcient
is
opera-
basic
right time with the right source to acquire the right quantity at the right
price
1.
and quahty.
efficient
and un-
interrupted operations.
2.
3.
them from
4.
Keep
loss
by
minimum
fire, theft,
inactive, surplus,
elements, and
to a
minimum by
systematic
6.
382
Control Principles.
PART
IV
Inventory
and
is
money
for
finished goods.
2.
Inventory
3.
4.
5.
is
Ordering materials
is
efficient
controls inventory.
6.
7.
ment
in
finished
terials control.
or
all
materials
Finished
Goods
Warehousing
Packing
Traffic
Shipping
Statistical Analysis
Value Analysis
New Product Planning
expended
item.
in
making
and
(2) care
and cost
and high-value
materials,
it is
necessary
CH. 13
to
make a weekly
six
may
be adequate.
method,
low and
The
(3)
On
383
(4)
(1)
risk of obsolescence
is
often
30, 60, or
class.
and may
High-value items
When
a replenishment order
is
is
for order point or order quantity can be adjusted to projected sales for
seasonal items.
maximum
level.
The two-bin system of inventory control separates each stock item into
two piles, bundles, or bins. The first bin contains enough stock to satisfy
usage which occurs between receipt of an order and the placing of the next
order; the second bin contains the normal amount used from order to
dehvery date plus the safety stock. When the first bin is empty and the
second bin is tapped, a requisition for a new supply is prepared. The second bin or reserve quantity is determined originally by estimating usage
requirements and adding a safety stock adequate to cover the time required
for replenishing the materials. For example, if monthly usage of an item is
ten dozen, a one-month safety stock is desired; and if 30 days are required
to place an order and receive delivery, the second bin or segregated reserve
should contain 20-dozen units. A purchase order must be written when
the reserve stock
is
is
Hkely to occur.
The
384
"C"
little
ABC
is
PART
IV
particularly
proportional value
records.
Re-
is
is
triggered
when a
materials
who
Selective Control
tive control, called
statistical averages.
the
"A" or high-value items would be under the tightest conand the responsibility of the most experienced personnel. 'C" items
would be under simple physical controls such as the two-bin system with
safety stocks. The plan provides impressive savings in materials costs.
The procedure for segregating materials for selective control consists of
materials item,
trol
six steps
1
month,
2.
3.
Multiply the projected price per unit by the projected unit requirement
to determine the total cost of that item during the period.
4.
in
6.
number
for each item its percentage of the total for: (a) units
of units of each item divided by total units of all items and (b) total cost
total cost of each item divided by total cost of all materials,
Compute
The
fication.
table
on a graph.
ABC
inventory classi-
CH. 13
Item
385
386
PART
IV
In
most
situations
10%
30%
60%
The following
70%
25%
5%
and low-value
Quality of personnel
Low-Value Items
Middle-Value Items
(c)
Very best
available
Average
Low
Records needed
Very complete
Simple
Not
As
Infrequent
review
Strictly
Two
One or two
guides, fre-
quent changes
quantity use
essential
used
Number
of orders
per year
Generally high
Amount
to six
As
short as
possible
Normal
Can be long
Low
Moderate
High
High
Moderate
Low
of safety
stock
Inventory turnover.
The
receiving or inspec-
copy of
safeguarding the
bins or other storage spaces to be kept there safely until required in pro-
Materials taken from the storeroom must be properly requisiAdmittance to the storeroom should be restricted to employees of
that department. These employees often work behind locked doors, issuing
materials through cage windows.
duction.
tioned.
may
be a very substan-
tial
CH. 13
not ended
when
The
387
Until
control procedures.
ing department, cost center, or process by dividing the cost of units transferred to the next department by the average inventory cost of the transferring department.
is
Turnover
rates vary
upon turnover
rate changes.
Scheduling or production
in
turnover rates
delivery
is
the key to
delivery
to
faced with the problem of surplus and obsolete inventory at one time or
Whatever the many possible reasons for such conditions may be,
some action is required to reduce or efiminate these items from inventory
and free the related capital. To accomplish a reduction, management
should first make certain that the buildup will not continue due to present
other.
Accurate
obsolete and surplus items. Obsolete inventory usually results from changing a design or dropping a product.
first
reasonable offer
is
Prompt
388
DISCUSSION QUESTIONS
1.
2.
3.
PART
IV
An
What
data
is
needed
in
and inventories?
What are some of the costs of not carrying enough inventory? How can
these costs be measured ?
What factors are used to determine the inventory level at which an order
costs
4.
5.
should be placed ?
6.
7.
In
It is
what
of materials effective ?
8.
9.
10.
What
control.
1 1
commonly used
control plans?
The control of materials must meet two opposing needs. What are they?
The principle of exception should be utilized fully for effective materials
What
Explain.
it make whether an annual requirement of 720 units
ordered weekly, monthly, quarterly, twice a year, or
difference does
is
12.
13.
14.
to controlling finished
the
(2)
(4) $50,000.
(AICPA
15.
sales office
adapted)
Daily Sales
Probabilities
Units
100
150
.2
200
250
.2
.5
.1
Total
1.0
CH. 13
389
The product
sires
16.
Leslie Company has developed an inventory model for Product A and needs
a solution for minimizing total annual inventory costs. Included in Product
A's inventory costs are the costs of holding, ordering and receiving, and
incurring stockouts. Select the answer that would best complete the following sentence: The solution for minimizing inventory costs would state
(a) at what inventory level to reorder and how many units to reorder; (b)
either at what inventory level to reorder or how many units to reorder;
(c) how many units to reorder but not at what inventory level to reorder;
(d) at what inventory level to reorder but not how many units to reorder.
(AICPA
17.
adapted)
situations.
(a)
(b) (1)
(2)
(c)
(1)
What
How
What
inventory levels?
(2)
What are the difficulties of measuring precisely the costs associated with understocking?
normal inventory,
overstocking, and understocking) in the inventory cost: (1) for external
reporting and (2) for internal decision making.
(AICPA
adapted)
EXERCISES
1. Usage Forecast and Inventory Balances. On October 5, the materials analyst
of Endicott Corp. is asked to determine the number of units of Material No.
1776 to purchase for December delivery. She has reviewed production schedules
and calculates 360 units of the material will be needed for October production,
320 units in November, and 300 units for December production. The lead time
to process an order and receive delivery on this material is two months, and a
safety stock of approximately two weeks' supply is maintained based on an
average monthly usage of 320 units. The inventory card shows an October 5
balance of 180 units with 300 units on order for October delivery and 340 units
on order for November delivery.
Required: (1)
December.
390
PART
IV
Use of EOQ Formula. Shields, Inc. has an annual usage of 100 units of
with a purchase price of $55 per unit. The following data are applicable
Item
to Item
2.
Ordering costs
Carrying cost percentage
$5 per order
1
5%
EOQ
3.
Required: (1)
(2)
is
20%
The
difference in the
of average inventory.
EOQ Formula.
4.
20 to 24 orders per year. However, the feeling is expressed that there should be
a more direct and accurate way to determine the most economical order quantity.
Required: (1) The economic order quantity and the frequency of orders,
using the EOQ formula.
(2)
Explain whether the increased accuracy through use of the formula seems
justified.
5.
Required:
run.
Cost Resulting from Inability to Use EOQ. The Electro Company manusome of its product lines from raw materials to finished units, and for
other products assembles purchased parts. For one product annual purchase of
10,000 subassembled parts at $100 each is being experienced. Per order and
6.
factures
receiving cost
is
$200,
is
25%.
CH. 13
391
This is only one of many inventory items the firm must carry, and a capital
rationing decision has been made to spend only $10,000 at a time on these subassemblies. Units must be ordered in multiples of 100.
Required: (1) Computation of the EOQ.
(2) By changing the EOQ and inventory level to the availability of capital,
the "opportunity loss" expressed as carrying cost.
7.
ABC
Plan of Control.
Manitoba
Industries, Inc.
is
Materials
considering a system of
392
PART
IV
PROBLEMS
EOQ
13-1.
Formula and Safety Stock. Robney Company sells a number of
products to many restaurants in the area. One product is a special meat cutter
with a disposable blade. Blades are sold in a package of 12 blades at $20 per
package. It has been determined that the demand for the replacement blades
The packages cost the
is at a constant rate of 2,000 packages per month.
Robney Company $10 each from the manufacturer and require a three-day
lead time from date of order to date of delivery. The ordering cost is $1.20 per
order, and the carrying cost is 10% per annum. The Robney Company uses
the economic order quantity formula.
360 days
year.)
Discuss the problems that most firms would have in attempting to apply
the EOQ formula to their inventory problems.
(5)
(NAA
adapted)
Month
Usage Forecast
January
February
475
480
490
500
510
March
April
May
It is
490
490
475
485
500
Month
Usage Forecast
520
500
490
485
June
July
August
September
Required: (1)
(2)
The
is
510
510
510
500
adequate.
is
two months.
CH. 13
393
sizes in units for different items of materials. The Cost Department has determined the unit cost, ordering cost, and carrying cost and has made the data
394
PART
IV
Materials cost of one important manufactured product is $12 per unit; sales
average 100 units per month; and one month from order date to receipt of
materials can be expected. Calculations show that variable costs of placing an
order and handling the incoming shipment total $50, and the cost of holding
units in stock is 25% of the average inventory.
(2)
(3)
two months, and the Marketing Department provides the following schedule of
forecast and actual sales for the past eight months:
Month
Forecast
May
June
July
August
September
October
November
December
make
and
failure to
99.5%
protec-
CH.
13
395
stockout
air freight in five working days at an extra cost of $52 per gross.
(complete exhaustion of the inventory) of Komtronics would stop production,
and Komtron would purchase Komtronics locally at list price rather than shut
down
(e)
(f)
The
the plant.
cost of placing
an order
is
is
$20.
Space storage cost, insurance, and taxes are approximately 16.8% of the net
delivered cost of average inventory; and Komtron expects a return of at least
on its average inventory investment. (Ignore rate of return on investment
8%
in
(3)
This is
reordering so as to guard against a stockout. Factors to be considered include
average lead-period usage and safety stock requirements.
Komtronics. Factors to
(4) A schedule computing the cost of a stockout of
be considered include the excess costs for local purchases and for rush orders.
Assume no komtronics are on order at the time the stockout occurs, and that
rush orders are one gross per order.
(AICPA adapted)
CASES
A. Improving Materials Control Procedures. A small company manufacturing
various commodities for stock, and to a lesser extent for special orders, is faced
with difficulties in its control of raw materials.
Under the present system materials are requested from the storekeeper by
production foremen according to their work needs. Materials requisitions signed
by a foreman and identifying the production or lot number to which they relate
are used. The purchasing agent, who is also office manager, orders regular stock
items upon notice of the materials ledger clerk that a particular item has reached
the reorder point. Incoming materials are checked in by the storekeeper who
prepares a daily report of materials received.
One of the major difficulties has been coordinating purchasing with accounting. In addition to the purchasing agent, the plant superintendent and some of
the foremen are free to order, especially when supplies and parts are needed
which are not regularly carried in the storeroom. As a result of purchases being
made by the superintendent and foremen, frequently no document for the order
is available when a vendor's invoice is received. When goods do not meet specifications, the person upon whose request the goods were ordered proceeds to
return the goods to the vendor; and, generally, the Accounting Department is
not notified. Sometimes a remittance in payment for a vendor's bill is made for
goods which have been returned.
Required:
cedures, and
in the
396
PART
IV
of inventory on hand.
The management is suspicious that the workers are either being very wasteful
or are pilfering substantial quantities of blades and handles. They also feel
that too much time is lost each month taking inventory and that some better
method of determining cost of materials used can be developed.
Required:
system of accounting for inventories and for the quantities
costs of materials used which will satisfy the objections of management,
explaining how the new system would eliminate the weaknesses of the present
system.
and
(CICA
adapted)
at
$432
per year.
(b)
(c)
(d)
An
(e)
$15.
CHAPTER 14
CONTROLLING AND
ACCOUNTING FOR
LABOR COSTS
and is an
important cost factor requiring constant measurement, control, and analysis. The economic advantage of increased production at lower unit costs,
along with rising wage rates and ever-increasing fringe benefits, have accelerated the trend toward greater use of automatic equipment to produce
more goods
to production
398
PART
IV
the ratio of labor costs to total costs and in changes in the labor cost ratio.
ments, product
processes.
know
lines,
their jurisdiction.
Cost control
is
Labor
as an activity.
mind
as
much
by product
lines,
number of employees
to dollar
and
achieved through
(1)
is
service enterprises.
production planning,
(2)
is
labor time and wage standards, (3) labor performance reports, and (4) appropriate payment for labor performance including wage incentive systems.
Productivity
may
and accomplishment.
effort as a yardstick.
Perhaps
performance.
iprank W. Kolmin and Michael J. Cerullo, "Measuring Productivity and Efficiency," Management Accounting, Vol. LV, No. 5, p. 32.
CH.
14
399
However, in many productivity statistics, particularly those developed by the Bureau of Labor Statistics of the U. S. Department of Labor,
the measurement takes into account only one element of input
labor.
It ignores such essential factors as capital and land, thereby assigning the
taxes).
put factor.
At
devices.
productivity.
economy
standard time for the job, expressed in minutes per piece or in units to be
The
productivity-efficiency ratio
is
em-
an entire organization.
Departmental ratios, such as the labor efficiency ratio discussed below, assist in judging the efficiency of department heads and foremen. A
labor efficiency ratio usually expresses the difference between actual hours
worked and standard hours allowed for the work performed. For example, if 4,000 hours at $5 an hour is standard and if 4,400 hours are used,
400
then there
is
110%, which
4,400
The
If the
$20,000
variance.
IV
hours by 10%107c
ratio
PART
amount of
is
$20,000, then
9Q
c^
''^
^_
variance.
The
Chapter
is
it is
sufficient to
indicate that,
$23,100
22,000
Labor
$ 1,100
$22,000
20,000
Labor
$ 2,000
Base Rate
(or
Job Rate).
The
basic
payment
for
work performed
is
office
quality personnel.
Fringe costs
such
as
etc.
PICA
at the
CH. 14
401
While these fringe costs are generally included in the factory overhead rate, they should not and cannot be overlooked in management's planning and control responsibilities, in decision-making analyses, or as a more specific example in labor-management wage or salary
arbitration sessions. Workers' demands for a lOjii per hour increase in
pay may result in far greater expenditures by the company when related
full
labor cost.
sent plans
402
LABOR COST
REPORT
PART
IV
CH. 14
403
reports.
The Daily
below
is
depend
The report shows
upon
the utmost
efficiency of
shop personnel.
actual hours, standard hours, and the percent of efficiency of each group.
404
The report
is
81%
IV
historical pattern.
but the
PART
efficiency rate
is
is
man-
The following
illustration
is
labor cost
Even with no knowledge of the situation, a reading of the illustrasuggests that Asbury, Clarke, and probably Varney are not likely to
control.
tion
be satisfactory workers in
considered minimal.
Employee
Low Performance)
CH. 14
405
as fast as prices are forced to curb their spending habits because the prices
wage-price spiral because labor costs form such a large part of total
costs. If prices are to be kept from rising, then wage increases should not
this
exceed an amount that will cause further increases in unit costs. In recent
have risen
wages, salaries, and fringes
years, employment costs
more than output or production per man-hour, leading to higher prices
to
costs.
In
some
(1)
when
increased pro-
ductivity reflected in lower prices rather than higher wages, so that every-
may
benefit
(2)
To
the entire control process begins with the design of the product
tinues as a cooperative activity until the product
Personnel Department.
is
to provide
an
efficient
The
is
and con-
sold.
is
good personnel
done by employees
but very
little
work
is
workers, and
among
all
employees.
human
If the original
vacancy
is
better jobs, that job will usually be filled by promotion; and the replacement requisition will be for the job which is finally vacant. Expansion
Authority to
hiring requires authorization by executive management.
hire results
406
in conjunction with
fill
PART
IV
individual jobs.
upon promotions
and promotional transfers to be made, the number and kind of workers
to be hired, and the dates at which new recruits will report for work.
Recruitment,
interviewing,
testing,
physical
examinations,
induction
department.
Employment
(i.e.,
the Equal
responsible for the scheduling of work, the release of job orders to the
product.
Specific
important
if
work
is
producing department, lead to cost control through the use of departmental labor budgets similar to the illustration on the next page.
2.
costs.
work of the
The employment
initial
CH. 14
tp
LABOR BUDGET
Department
Cooler Assembly
For
Prepared
Model No.
or
October, 19--
407
408
The accounting
principles, procedures,
and objectives
although considerable
PART
IV
in labor costing
may
and
COST ACCOUNTING
FINANCIAL ACCOUNTING
record
is
and the
kept of the
total
worker.
daily or weekly amount earned by
each worker is entered on the payroll
The
The
book.
is:
following entry:
Work
xxx
Payroll
xxx
xxx
in
Process
xxx
xxx
Payroll
Labor
xxx
xxx
xxx
2.
Job
is
in the plant.
Both forms are supervised, controlled, and collected by the timeAs the earnings of the employee depend mainly
upon these two forms and as the timekeeper processes them in the first
step toward final payment, the timekeeping department forms a most
keeping department.
CH. 14
409
is
first
Clock Card.
vides space for the
an
each day or
with
shift
overtime
work
in
during change of
shifts
movement
in
and
may
name and
identification
number.
Upon
and places it
where he works. Time-
the worker removes his card or disk from the rack or board
many
in the department
way
sheet,
a method of labor cost recording seems less exact than the clock card
procedure, reliance must be placed on the timekeeper or the foreman to
secure accurate records.
410
Time
Ticket
Job Ticket).
counting
terials,
sheet
In
for
S/jI//
(or
qate
ac-
EMPLOYEE'S
NAME
ma-
TIME STAFITED
the receiving
HRS.
is
in order.
accounting
In
OVERTIME HRS.
J<i/
DESCRIPTION OF
WORK
'yi/7Ujf
yO<^
OR JOB
OVERTIME EARN,
PIECE NO.
TOTAL EARNINGS
PIECES COMPLETED
3.8S
OPERATION NO.
/4
for
FOREMAN'S APPROVAL
ek)V
A^
Al
CHARGE
RGE ACCOUNT
NUMBER
/~$.4o
WORKED
iV
JOB TICKET
/Z: 00
00
PART
Job Ticket
and is comparable to the receiving sheet. The time ticket {or job ticket)
shows the specific use that has been made of the time purchased and is
comparable to the materials requisition.
When the individual time ticket is used, a new ticket must be made out
for each job worked on during the day. As this procedure leads to many
tickets per employee, some plants use a daily time report on which the
worker lists his jobs.
The best procedure for filling in the time or job tickets depends upon
many factors peculiar to shop operations. In some factories, where little
time is consumed and the work permits ready access to the forms, the
workers prepare their own time
tickets.
when changing
jobs, get a
the dispatch clerk, secure instructions at the foreman's desk, get the re-
quired tools at the tool crib, and thus shift from one job to another with
effort.
Under a wage
When
form the
all
after the
morning
shift
has clocked
in,
the time-
CH. 14
in reporting
411
Many companies
practical.
find
it
Computation of time
in
1.6
is
make
the payments.
(1)
com-
putation of the payroll and (2) distribution of the payroll to jobs, processes, and departments.
computed payroll may be recorded in a payroll journal, payor payroll sheet. The record may be a bound
book with sheets ruled for the special needs of a company; it may be a
loose-leaf book, cards, or sheets for filing; or it may be produced on
The
final
methods.
number of employees
is
not large,
all
workers
monthly.
to give
it is
If
workers
employees.
412
drawn
may
PART
Payroll checks
IV
may be
is
is
drawn
especially advantageous
is
amount required
is
payroll
general
period.
against
payroll
accounting, the payroll journal, the checks, the check register, and the
commonly prepared
in
one simultaneous
operation.
the total
summary
amount recorded
also
shows the labor hours when they are the basis for the appli-
Cost Department.
On
summary
or the time tickets, the cost department records the direct labor cost
and
may
summarized time
tickets to
compute
may
CH. 14
PERSONNEL
413
414
PART
IV
CH. 14
415
industries
support them.
Requirements of an Incentive
Wage
Plan.
To be
successful,
an incentive
Wage Plan. The primary purpose of an inwage plan is to induce a worker to produce more, to earn a higher
wage, and at the same time to reduce unit costs. The plan seeks to insure
greater output, to increase control over labor cost by insuring more uniform unit costs, and to change the basis for reward from hours served to
work accomplished. Naturally, producing more in the same period of
Purpose of an Incentive
centive
number of
units produced,
it
higher income.
416
PART
IV
CH. 14
Types of Incentive
Wage
Plans.
417
and
volve wage rates based upon various combinations of output and time.
Many wage incentive systems retain the names of industrial engineers and
efficiency
experts
who
Premium
the
Taylor Differential
adaptations are
Plan, the
still
in use.
wage
determine that
is
The
straight piecework plan, one of the simwages above the base rate for production
The production standard is computed in minutes
plans, pays
five
minutes
is
money per
piece.
If
time studies
ducing one unit, the standard rate is 12 pieces per hour. If a worker's
base pay rate is $3.72 per hour, the piece rate is $.31. A worker is generally
guaranteed a base pay rate, even if he fails to earn that amount in terms
of output. If a worker's production exceeds 12 pieces per hour, the $.31
per unit
still
appHes.
any
level
is
418
PART
IV
new and
better machines.
is
is
a variation of
It differs in
at his
less.
hourly rate
Thus
if
if
is
com-
and the standard time is 80 units per shift (or 10 units per
hour), he would be paid his hourly rate for 10 hours. In other variations
of the 100 percent bonus plan, savings are shared with the foreman and /or
the company.
A production indicator must be figured for every worker each payroll
period before earnings can be computed. Production standards in units of
output per hour are set by industrial engineers. Hours of work and units
produced are reported to the payroll department where the reported hours
worked are multiplied by the hourly production standard to determine the
standard units. The worker's hourly production is then divided by the
an 8-hour
shift
The
Worker
The
table
CH. 14
419
Group bonus
Usually,
bonus earned by the group for production in excess of a quota or stanis divided among the group members in accordance with their respec-
the
dard
base rates. Group plans reduce the amount of clerical work necessary
compute labor cost and payrolls and the amount of supervision neces-
tive
to
pressure to bear
among
Group
plans
may
also contribute to
the earning of
Group bonus
Each worker
minimum
standard.
420
Wage
Plans.
PART
The
IV
installa-
and successful operation of incentive wage plans require not only the
combined efforts of the personnel department, labor unions, factory engineers, and accountants but also the cooperation and willingness of each
worker. The discussion on wage incentives is:
tion
.based on the premise that monetary bonuses will, in fact, motivate workers
to achieve higher production rates. While this seems a reasonable assumption, the
writing of behavioral scientists and the empirical research that has been carried out
suggest that the relationship between monetary incentives and increased production
is not a simple or unambiguous one.
William F. Whyte, a behavioral scientist, notes
in a study of the effect of piecework on productivity, 'It is only in a fraction of the
jobs.
.that the piecework proves an incentive to tap the full productive capacities of
workers.'^ After describing in detail a number of case situations, he concludes, 'Management should recognize that financial incentives are both a technical engineering
and a human relations problem. '5 This suggests that management should approach
the design, evaluation, and implementation of such plans with the awareness of their
possible behavioral, as well as economic, implications.^
.
VIA
monetary bonuses
that
rates.
is
will
motivate
rewards.
standards
no
matter
how
scientifically
engineered
often
does not
The
is
is
is,
"the
time, hours, or dollars) a given percentage less than the last unit produced
it
means
If
it is
assumed that
cit.,
20
Money and
^Ibid., p. 262.
^Frank, op.
is
first
'William F. Whyte,
reduction
this
pp. 159-160.
Motivation (Harper
&
With
CH. 14
421
following table of values for an 80 percent learning curve can be computed, assuming that 10 direct labor hours are required to produce the
first
unit:
Unit
Number
Cumulative Average
Required Man-Hours per Unit
10.0
8.0 (10.0 hours
6.4 (8.0 hours
4
8
16
4.1 (5.1
32
64
3.3 (4.1
2.6 (3.3
5.1 (6.4
hours
hours
hours
hours
X 80%)
X 80%)
X 80%)
X 80%)
X 80%)
X 80%)
hours
hours
hours
hours
hours
25.6
40.8
65.6
105.6
166.4
The
is
would be 32
3.3
performed.
first
The
figures in the
To
unit.
estimate the
first
64 times, 64
2.6
At the
latter
i.e.,
100 minutes
extreme,
if
X 100% =
first
100 minutes, then the time for the second unit must equal zero
minutes
X 50% =
50 minutes
Inasmuch
as the
first
+
z
,^
= 50
By means of
must be equal
.
would mean
to zero
,
is
100
unit
(i.e.,
is
now changed
The
to a variable
is
said to meet more equitably the needs of an incentive wage system. "The
improvement phenomenon, as well as its mathematical model, the learning
''James A. Broadston, "Learning
XLIX, No. 12, pp. 15-23.
8For further discussion of learning curves, see Leonard W. Hein, The Quantitative Approach
to Managerial Decisions (Englewood Cliffs, N. J.: Prentice-Hall, Inc., 1967), pp. 90-113.
422
An
to
learn
new
yet
it
skills.
or individual
As soon
human
human
PART
IV
do work and
them to
may show
small irregularities;
activity. "^
worker has passed the learning stage and begins to produce the expected number of units (i.e., reaches the "standard" proficiency), he will begin to draw bonus pay for doing the operation in less
than standard time. Then the worker may even slow down a little and
yet perform the operation in "standard" time or better, drawing the bonus
pay but working less hard for it.
Government procurement agencies have used the learning curve
as a
When
on a contract
a bid
is
mated.
By comparing
the initial stages of production, the trend of the labor costs can be deter-
mined.
If,
is
to be
achieved, the following output and cost table with 80, 85 and 90 percent
learning curves can be predetermined
i^^
^
Cumulative
Learning Curve
Quantity
80%
85^7
90%
25
50
100
200
400
800
$61.02
48.82
39.06
31.25
25.00
20.00
$45.36
38.56
32.78
27.68
23.53
20.00
$33.22
30.47
27.43
24.69
22.22
20.00
90%
Learning Curve
The learning curve theory allows projection of the final average unit
cost at any stage of production. The learning curve also predicts manhours with accuracy and reliability, establishes manpower load, and allows production control to take advantage of reducing time per unit by
increasing lot sizes, thereby maintaining a level
work
force.
9Broadston, op.
cit., p.
NAA
Bulletin, Vol.
further
19),
15.
"Some Applications of
XLVI, No. 2, pp. 21-22.
lOWilliam H. Boren,
It
Chapter
the Learning
Curve
to
Government Contracts,"
CH. 14
423
and
finally
UNION CONTRACTS
Many
when a labor
contract
is
negotiated.
The employer
and a mutual
the agreement
is
all
interested parties.
Provisions
and premium
bonus payments under incenwage plans; and the cost department, since a contract represents the
terms and price of labor to be purchased during the life of a contract. It
is important that managers of these departments become thoroughly
familiar with provisions of the contract and that all procedures in connection with labor accounting be designed and executed in harmony with
its provisions.
Grievances leading to stoppages and strikes can be
vacations, night shifts,
rates or
tive
caused
DISCUSSION QUESTIONS
1
Define productivity.
2.
What
3.
The
4.
All wage payments are ultimately limited by and are usually based, directly
or indirectly, on the productivity of the worker. Is this statement generally
is
meant hy performance
rating']
subject of inflation has been receiving ever-increasing attention throughout the nation and the world? Why?
true?
5.
6.
The
basis for labor cost control is the provision of pertinent and timely
information to management. What kind of information is needed by executive management as compared with that needed by departmental managers?
How
424
7.
PART
IV
become a
fixed cost.
8.
9.
In controlling labor cost, is the primary objective to control labor cost per
hour of work or per unit of output?
In
efficient
labor force a
cooperative effort ?
accounting for and controlling labor costs, what is the function of:
timekeeping department, (b) the payroll department, and (c) the cost
accounting department?
10. In
(a) the
11.
What purpose
12.
If
is
served by: (a) the clock card; (b) the time ticket?
tickets,
how
is
14.
Accounting for labor has a twofold aspect: financial accounting and cost
accounting. Differentiate between the two.
What
is
employee;
15.
What
16.
Do you
17.
Wage
is
wage plan?
18.
In most incentive wage plans, does production above standard reduce the
labor cost per unit of output? Discuss.
19.
20.
suggest ?
21. State the basic concept underlying the relationship involved in the learning
curve theory.
22.
Name some
23. It
24.
is
year.
month amount to $680. Of these savings, 20% are distributed to the superThe department employs a foreman and an assistant. The
staff.
method of sharing the bonus is on a point scale basis with 100 points assigned
visory
to the
How much
bonus
is
each
CH. 14
25.
425
Have someone other than persons who prepare or distribute the payroll
obtain custody of unclaimed payroll checks.
(d) From time to time, rotate persons distributing the payroll.
(c)
(AICPA
adapted)
EXERCISES
Production Planning and Control Reports. Ferguson Fabricators, Inc., a supof bulk metals and alloys, recently negotiated to supply 3,000 sections of
aluminum air conditioning ductwork for an office building under construction.
The order requires fabricating, cutting, and assembly. Based on experience, the
foreman prepared the following daily budget:
1.
plier
Sections
Hours
Department
Scheduled
Budgeted
Fabricating
Cutting
100
100
100
50
30
25
Assembly
Hours
Department
Produced
Required
Fabricating
Cutting
112
48
30
22
81
Assembly
The second
77
day's report
showed
Sections
Hours
Department
Produced
Required
Fabricating
Cutting
120
96
96
49
30
23
Assembly
first
day's
report.
(2)
2.
426
PART
IV
Actual
Budgeted
Labor
Units
Hours
Cost
Produced
Department
Mixing
Processing
1,100
3,320
Packaging
580
740
615
800
4,312
12,700
1,744
Standard
Hours
Department
Required:
Mixing
1.5
Processing
5.0
Packaging
0.5
Standard Labor
Cost per Hour
per Unit
$4.10
4.50
4.00
100 Percent Bonus Plan. Mary Mullin, employed by the Barnegat Bay Canning Company, submitted the following labor data for the first week in June:
3.
Monday
270
210
300
240
260
Tuesday
Wednesday
Thursday
Friday
units
units
units
units
units
8
8
8
8
8
hours
hours
hours
hours
hours
rate,
The company employs 10 workers on an 8-hour shift at $5 per hour. Depreon plant equipment is $4.50 per hour, and other overhead is applied at
ciation
first
Monday
Tuesday
Wednesday
Thursday
Friday
Management
wage plan.
cost,
units
units
units
units
units
Required:
head
is
3,800
4,500
4,600
4,500
4,400
new
incentive
5. Incentive
CH. 14
427
The company has been producing 150 units per week; fixed factory overhead
was estimated to be $600 per week. The following is a schedule of the pay rates
of three workers properly classified as direct labor:
Employee
Clancy,
Luken,
Hourly Rate
$3.00
4.00
3 50
Schott, J
Customers have been calling in for additional units, but management does
not want to work more than 40 hours per week. In order to motivate its workers
to produce more, the company decided to institute an incentive wage plan. The
following schedule describes the plan formulated and started on a trial basis:
Employee
Clancy,
Luken,
Base Rate
$1.75
2.75
2.25
Schott, J
Incentive
Premium
The
first week the plan was put into operation production increased to 165
The shop superintendent studied the results and believed the plan too
costly; production had increased 10%, but labor costs had increased by approximately 23.2%. He requested permission to redesign the plan to make the labor
units.
Required: (1) The approximate dollar value of the 23.2%, labor cost increase.
An opinion, supported by figures, as to whether the shop superintendent
was correct in assuming that the incentive wage plan was too costly. Discuss
other factor(s) to be considered.
(2)
(a)
from 27 through 29
all
units
all
units
Overhead consists almost entirely of depreciation, taxes, and insurance. Consequently, it is assumed that the current overhead rate of $5.50 per labor hour
will
remain constant.
Required: (1) An analysis of the proposal showing unit conversion cost for
production of 24, 27, 30, 33, and 37 units.
(2) An opinion as to whether or not (a) management and (b) employees
would be receptive to such a plan.
7.
428
PART
IV
average output per employee is 48 good units per hour with two rejects per hour
per worker. The last efficiency report shows 50% of the operators averaged
only 40 good units an hour with three rejects, while the other 50% averaged 55
good units per hour with one reject. The piece rate is $.15 each for good units.
Repairing rejects costs $.25 each.
The job is a one-man, one-machine operation. The depreciation cost of each
machine is $1,000 a year, and the variable cost of operating one machine is $.20
an hour. Fixed factory overhead other than depreciation is $4 per machine hour.
The plant operates 2,000 hours a year, or 250 days.
Required: Assuming that product demand increases, the amount the company can afford to pay for a training program which would upgrade the 20
8.
PROBLEMS
14-1. Planning
company
Costs.
Virontrol, Inc.
is
a relatively
new
Required:
monthly labor budget for the extra shift, showing the time
required in each department, the labor cost for each department and service,
unit labor cost, and the number of employees required.
is
,
.,
CH. 14
429
Labor Activity
Hours
Actual
Expenses
8,000
$46,900
200
1,254
110
462
350
1,776
Required: (1)
labor performance report for September to be sent to the
plant manager. For control purposes, it should include total variances and
labor efficiency variances.
(2) An explanation and analysis for any difference between the labor
ciency variance and the total labor variance.
effi-
Company
Required: The weekly gross earnings of both employees, assuming that both
5 days a week and 8 hours each day and that the $3.50 base rate forms
the basis applicable to both incentive wage plans.
work
five,
for one
week shows
Hours
Monday
Tuesday.
Wednesday
Thursday.
Friday
430
PART
IV
Required: (1) Based upon the above data, show the week's earnings of the
group (excluding the leader), the labor cost per unit, the overhead cost per unit,
and the conversion cost per unit (carrying figures to three decimal places).
(2) Assuming Chianti Enterprises uses the group bonus plan, a schedule
showing daily earnings of the group (excluding the leader), unit labor cost, unit
overhead cost, and the conversion cost per unit.
14-5. Group Bonus Plan. Ten-man crews work as teams in a Processing Department. Each crew member is paid a bonus if his group exceeds the standard
production of 200 kilograms per hour.
The amount of the bonus is computed by first determining the percentage
by which the group's production exceeds the standard one half of this percentage
is then applied to a wage rate of $4.80 to determine the hourly bonus rate. Each
man in the group is paid a bonus for his group's excess production in addition
to his wages at hourly rates.
;
Week
Monday..
Tuesday.
Wednesday
Thursday.
Friday
Required:
(1)
On
for each
(2) The week's earnings for each employee, assuming that each worker
earned $4.80 per hour and that each worked the same number of hours during
the week.
14-6. Quarterly
Employees
Participating
Each Employee
Works manager
2 Production engineers
5
Shop foremen
Storeskeeper
Factory office clerks
1 50
Factory workers
1
250
200
200
100
10
20
CH. 14
431
The employees' earnings are not penalized for any month in which the actual
output falls below the monthly average of the normal quarterly production. In
such a case, the deficiency is deducted from any excess in subsequent months
before any bonus is earned by and paid to the employees.
At the end of March, cumulative actual production amounted to 270,000
units.
to the
employees
(2)
Journal entries at the end of each month on the basis of the production
March, 101,000 units.
14-7. Incentive Wage Plans. The company's union steward complained to the
Payroll Department that several union members' wages had been miscalculated
in the previous week. The schedule below indicates the wages and conditions
of the earnings of the workers involved:
Gross
Incentive
Worker
DODD
Plan
Wage
Total
Hours
Down
Units
Stan-
Time
Hours
Pro-
dard
duced
Units
Wages
Base
Rate
per
Books
432
(c)
PART
IV
66%%
Efficiency
Up
to 662/3%
Bonus
CH.
14
433
Olympia's direct labor hour input process for payroll and job-cost determination is summarized in the following flowchart:
TIME CARDS
JOB TICKETS
TIME CARDS
JOB TICKETS
PAYROLL HOUR
COMPUTER
SUMMARY
LABOR HOUR
COMPUTER
SUMMARY
Steps
and C are performed in the Timekeeping Department; Step B in
in the Payroll Audit and Control
the factory operating departments; Step
Department; Step E in the Data Preparation (Keypunch) Department; and
Step F in the Computer Operations Department.
through F
or discrepancies that
may
occur.
NOTE
in effect for
Limit the discussion of Olympia's procedures to the input process for direct
labor hours (as shown in Steps A through F in the flowchart). Do not
discuss personnel procedures for hiring, promotion, termination, and pay
rate authorization. In Step F, do not discuss equipment, computer program,
and general computer operational controls.
Control Procedures
(AICPA
adapted)
434
PART
IV
for one press should be 1,000 pieces per hour. The Alton Company has similar
presses now in operation that average 600 pieces per hour. This average is
derived from these individual outputs:
Daily Output
Worker
Alfers, L
H
R
750
750
600
500
550
450
Brown,
Green,
HoAG,
Jones,
Smith,
(in Pieces)
Total
3,600
600
accounting
a standard
a standard
foreman, a
The
alternative
(NAA
adapted)
C. Controlling Hiring Practices and Payroll Procedures. The Besco Corporation employs about fifty production workers and has these payroll procedures:
The factory foreman interviews applicants and on the basis of the interview
either hires or rejects them. When hired, the applicant prepares a W-4 form
(Employee's Withholding Exemption Certificate) and gives it to the foreman,
who writes the hourly rate of pay for the new employee in the corner of the W-4
form. He then gives the form to a payroll clerk as notice that the worker has
The foreman verbally advises the Payroll Department of rate
adjustments.
A supply of blank time cards is kept in a box near the entrance to the factory.
Each worker takes a time card on Monday morning, fills in his name, and notes
in pencil on the time card his daily arrival and departure times. At the end of the
week the worker drops the time card in a box near the factory door.
The completed time cards are taken from the box on Monday morning by a
payroll clerk. Two payroll clerks divide the time cards alphabetically, one taking
to Z section. Each
the A to L section of the payroll and the other taking the
clerk is fully responsible for his section of the payroll. He computes the gross
pay, deductions, and net pay, posts the details to the employees' earnings
Employees are autorecords, and prepares and numbers the payroll checks.
matically removed from the payroll when they fail to turn in a time card.
The payroll checks are manually signed by the chief accountant and given to
the foreman. The foreman distributes the checks to the workers in the factory
and arranges for the delivery of the checks to absent workers. The payroll bank
account is reconciled by the chief accountant who also prepares the various
quarterly and annual payroll tax reports.
been employed.
CH. 14
435
E. Labor Budget and Performance Variances. The Devon Co.'s contract with
the labor union guarantees a minimum wage of $500 per month to each direct
labor employee having at least ten years of service. One hundred employees
currently qualify. All direct labor employees are paid $5 per hour.
The direct labor budget for the current year, 19
was based on the annual
February
March
22,000
32,000
42,000
5127,000
51 10,000
5162,000
5160,000
$197,000
5210,000
$ 17,000F
January
Direct labor hours worked
Direct labor costs budgeted
Direct labor costs incurred
favorable;
Variances (F
unfavorable)
2,000F
13,000U
(2) Explanation of this direct labor budget as a basis for controlling direct
labor cost, indicating changes that might improve control over direct labor cost
and facilitate performance evaluation of direct labor employees.
(AICPA
adapted)
CHAPTER 15
ACCOUNTING FOR
LABOR-RELATED COSTS
or
mium pay
for
work on
holidays, Saturdays,
is
not involved
as
personnel,
as
office
and administrative
OVERTIME EARNINGS
The Fair Labor Standards Act of 1938, commonly referred to as the
Wages and Hours Law, estabhshed a minimum wage per hour with time
436
CH. 15
437
2.
total
4.
5.
Regular rate of pay and total extra pay for overtime worked each week
3.
(1) the
minimum
employment.
earnings are:
Regular work week.
Overtime
Overtime premium.
40 hours
5 hours
5 hours
@ $4 =
@ 4=
@ 2
Gross earnings
$160
20
10
$190
Even though these details are not required by the Wages and Hours Law,
good payroll practice to separate regular wages and overtime premium
it is
wages.
The
upon
specific
job or department, or to
contract price of a particular job, taken as a rush order with the fore-
knowledge that overtime will be necessary, may include the premium wage
factor, which should be charged to the specific job. For example, if a law-
in type
438
the overtime
work
that
happens to be
in process
IV
PART
cannot properly be
during overtime hours.
it
BONUS PAYMENTS
Bonus payments may be a
tion,
fixed
classifica-
weekly
amount to $260 and the company intends to pay him two weeks'
pay as a bonus at the end of the year, his earnings actually amount to
$270 per week with $260 paid for each week and with the additional $10
per week paid in a lump sum of $520 ($10 X 52 weeks) at the end of the
year. In order to spread the bonus cost over production throughout the
year via the predetermined factory overhead rate, the weekly entry would
earnings
be:
Subsidiary
Record
Work
in
Credit
260.00
Process
10.00
Bonus Pay
10.00
260.00
Payroll
Liability for
When
Debit
Bonus
the bonus
is
10.00
is
In theory, this and other labor-related or fringe benefit costs are additional labor costs
the
same
usually
is
and for
impractical;
and these
charged to
Work in Process
rate.
VACATION PAY
Vacation pay presents cost problems similar to those of bonus pay-
ments.
When
a shop employee
is
the total wages earned during 50 weeks of productive labor are paid over
is
CH. 15
the deferred
payment of $400
will
439
The
entry to set up the weekly labor cost including the provision for vacation
pay would be
Subsidiary
Record
Work
in Process
Factory Overhead Control
Vacation Pay
Debit
Credit
200.00
8.00
8.00
Payroll
200.00
Pay
8.00
When the vacation is taken, the liability account is debited and Cash
and the withholding accounts are credited. Similarly, accrual should be
made for employer liability pertaining to sick leave, holidays, jury duty,
military training, or other personal activities for which the employer pays
compensation.!
Pay of a
Should
it
it is
performed
become necessary
to hire
employee's return.
In
some
some
rightfully
instances, the
is
440
PART
IV
In principle,
Subsidiary
Record
Work
Debit
200.00
4.00
in Process
Factory Overhead Control
Unemployment Pay
4.00
200.00
4.00
Payroll
Liability for
Credit
Unemployment Pay
is
minimum
figure but
no
limit
new workers
plants
receive
excess of the average or standard paid for the productive output, plus the
cost of instruction,
is
rates.
total
annual
In case of unusual
second or third shift, a case can be made for treating the training cost as
development or starting load cost and deferring a portion of the cost over
a considerable period of time.
system does
is
little
to provide
any
assistance.
Human
resource accounting
economic
It
results.
CH. 15
441
consideration to
Human
human
human
resource
assets.
Many
on such investments.
without evaluating the expected payoff or the return
development
executive
A firm is apt to send its managers to a variety of
which are disprograms whose value is essentially taken on faith and
continued when profits cannot afford them.
A human resource accounting system needs
first
to identify incurred
other costs.
resource costs that are to be separated from the firm's
the asset
between
distinguish
should
used
The techniques and procedures
human
resulting
The
costs.
and expense components of human resource
as
such
categories
functional
resource assets would then be classified into
human
and
familiarization.
ther provide
making
stumbhng
quantification of human resources appears to be the first
have
companies
All
block for the creation of human resource accounting.
equipment,
of measuring sales, profits, investments in plant and
The
methods
investments in inventories,
etc.
Similarly, incurred
human
resource costs
determining the
such as training programs can be measured although
the possibility
time period for amortization may be difficuk. But beyond
how does a comof capitalizing certain incurred human resource costs,
morale,
pany set a quantitative value for such attributes as loyalty, skills,
to
difficuk
seems
it
Since
decision-making ability, intelligence, etc.?
quantify these
status to
identified.
The
justification for
is
assign asset
costs can be
based on the
benefits to
economic concept that an asset is capable of providing future
sucfuture
the
to
important
the firm. Therefore, the employee group is
as
reported
should be
cess of the company and, as such, has value that
for human resources is
assets on the balance sheet. Asset determination
for professional sports franchises where a "super-
particularly meaningful
star"
is
As
is
the case
wkh
thus, the
any other asset, the professional athlete can be sold or traded;
increasing litigation involving current player contracts.
been expounded
In spke of the difficulties, a number of proposals have
Some proposals focus
that attempt to utiUze human resource accounting.
442
PART
Management Accounting^
proposals, reviewed in a
1.
IV
These
article, are:
2.
of'''' acquiring'''
an employee
and
training.
envisions capitalizing
would require
collecting
method
among such
changes
in the
end
variables.
result variables
resources.
5.
Opportunity costs
suggest
desire.
ager includes his bid in his investment base. The division's benefit
the increased profit produced by the new employee.
6.
compares
differences in present
is
and future
human
7.
resources based
on
their contribution.
ments based on
8.
To measure an
indi-
Critical Evaluation,"
443
CH. 15
(a)
an individual
estimate of the time interval during which
and
organization,
the
to
services
render
pected to
(b)
An
is
ex-
the individual
measure of the services expected to be derived from
by a discount factor
resource's expected value is then multiplied
services.
future
expected
of
value
present
to arrive at the
The
resource accounting
At present, as theory and techniques for human
problem must turn to models
have become known and established, the
Research is required to
testing.
and methods subjected to empirical
attitude and behavior.
demonstrate both its feasibility and its effects on
using human resource acUnless empirical data from organizations
published, the attractivecounting systems are collected, analyzed, and
^
lose its glamour.
soon
ness of current theoretical arguments may
PENSION PLANS
A pension plan is an
may be sufficiently
unwritten policy with regard to pension payments
definitive to constitute a formal plan.
A pension plan is probably the most important, as well as the most
costs. A pension plan
complicated, factor associated with labor and labor
personnel relations, company financis also important in that it influences
tax considerations, and general ecoing, income determination, income
nomic conditions.
Pension Cost Factors.
The ultimate
cost of a
7.
Expense of administration
company before
Treatment of benefits to employees who leave the
reaching the pension age
Human
444
When
a pension plan
is
initiated, the
all
is
PART
who
IV
amount
are ex-
number of em-
ployees eventually to retire, (2) the average benefit, and (3) the average
period of payment.
is
$.20.
is
of months and then paid in a lump sum. In the case of pension payments,
wage is earned and the labor cost is incurred many years before the
payment is made. As a matter of principle, if an employee is paid a base
wage of $160 for a 40-hour week and if the retirement payments to be made
will amount to $.20 an hour for all the hours purchase from this employee, the pension cost incurred is $8 per week chargeable to factory
the
may
be."*
common body
of legislation practically
all
employee
4For an extensive study of accounting for pension plans, refer to: AICPA Research Study
No. 8 (1965) by E. L. Hicks; AICPA APB Opinion No. 8 (1966); FASB Interpretation No. 3,
1974.
Commerce
CH. 15
445
the Pension
Reform Act of
1974.
in
Many
plans will be
burdened with increased costs and /or funding obligations. Plans most
Hkely to be affected are those that (1) have not provided for a substantial
degree of vesting prior to retirement, (2) have not been funding past service
costs or have operated on a "pay-as-you-go" basis, and (3) have had
restrictive
criteria
and years of
as to age
participation.
1974, a vast
lation,
The presentation
New
unless an employee
fully
2.
existing plans
sulting
thirty
3.
In case the assets of a terminated plan are not sufficient to pay the insured benefits, the Pension Benefit Guaranty Corporation (PBGC)
guarantees vested benefits of terminated plans up to $750 per month
for each participant or beneficiary. To finance this insurance program,
the
PBGC
premiums
will collect a
premium from
all
the
4.
covered plans.
is
retroactive to July
1,
The annual
and 50 cents
this
Descriptions of the plan and annual financial, actuarial, and other information must be provided to participants and beneficiaries and to the
Secretaries of Labor and the Treasury.
benefits
is
his benefits
tinuance of
company
to enable the
ment age
which
will still
his rights
operations.
An
retire-
his resignation.
446
PART
IV
Act of 1974 sets minimum standards for vesting of employee benefits that
must be met by all plans subject to the participation standards. To protect
participants
arising
Benefit
and
Funding.
established
is
to
The
pay retirement
benefits to participants.
minimum
effect
of these
sufficient assets
contribute currently the normal cost of the plan for the plan year plus a
costs.
ficiency
is
establish
the excess of the total charges over the total credits to the fund-
"pay-as-you-go"
method,
Basic to
all
funding methods
is
the concept of
The present
value principle permits the value at any given point of time under a set
The
principle
is
at a different
ment
annuities, etc.
It
life
life
contingencies.
An
actuary
Administrative Problems.
member of the
actuarial profession.
all
types of quali-
employee benefit plans. For many businesses, the new and more rigid
tax requirements for eligibility, vesting, and funding means dramatically
fied
CH. 15
447
equivalent to 25 percent or
more of
staggering
its
annual
rise to
level often
may
only be a
20 percent of a company's
profit.
It
pension costs.
in such areas as
and insurance.
to the
employers to
initiate
for wages
and
make an
salaries.*^
This legislation
1,
must withhold
1936, the
1
is
ad-
Originally
Act provided
to a
to contribute
^These pages summarize the major provisions. U. S. Treasury Department Internal Revenue
Service Circular E entitled "Employer's Tax Guide" is an excellent source for a more comprehensive coverage of these regulations. A free copy of the current edition can be obtained by
writing to the nearest District Director, Internal
FICA
Revenue
Service.
change.
448
who
PART
IV
its
provisions keep
records providing:
1.
The name,
address,
and
social security
ployee.
total amount and the date of each remuneration payment and the
period of service covered by such payment.
2.
The
3.
4.
Although the
legislation
or details for securing the required information, the employer must keep
records that will enable a government agency to ascertain whether the taxes
for which the employer
is
computed and
paid.
These
records must be kept for at least four years after the date the tax becomes
due or the date the tax is paid, whichever is later. Employees are not
required to keep records, but the Act recommends that each employee keep
accurate and permanent records showing the name and address of each
employer, dates for beginning and termination of employment, wages
earned, and tax withheld during employment.
Collection
made on
deposits are
time.
Federal Unemployment
tion insurance
costs
if all
is
gram,
FUTA
ments
in the establishment
ance.
When
is strictly
a federal pro-
CH. 15
FUTA
449
maximum
state tax.^
rates
Most
rates
of 4 to 5 percent.
Records Necessitated by the FUTA. Every employer subject to unemployment taxes must keep records providing
1.
The
total
calendar year.
2.
3.
4.
his
As with
the
prescribe or
FICA
employees.
shown on
recommend forms
information.
Payment of the
tax
is
FUTA
payable quarterly.
However,
if
any accumulated tax liabihty for previous quarters) is $100 or less for the
fiscal year, only one payment is required by January 31 of the following
year. The related tax return, due January 31, is sent to the IRS regional
service center of the employer's principal place of business.
8The $4,200 base and the rates of .5 percent (federal) and 2.7 percent (state) were current at
the time of publication and are used in the illustrations and in the end-of-chapter material.
450
The various
PART
state
IV
unem-
make
contributions, the
amount of
and
he becomes
taxes to be paid,
1.
Status Report.
required to
The
make
state,
an employer
is
unemployment insurance
fund.
2.
3.
Separation Report.
When
it
becomes necessary to
lay
off"
workers,
Workmen's Compensation
Insurance.
Workmen's compensation
insur-
ance laws provide insurance benefits for workers or their survivors for
losses caused by accidents and occupational diseases suffered in the course
These are all state laws and in most states have been in
While the benefits, premium costs (usually less than
1 percent of the payroll), and various other details vary from state to state,
the total insurance cost is borne by the employer. The employer may have
the option of insuring with an approved insurance company or through a
of employment.
effect for
many
years.
In
some
may
carry
its
own
and the
financial resources
risk.
Withholding of Federal Income Tax, State Income Tax, and City Wage
and state
Tax. The employer is required to withhold federal income tax
from salary and wage payments
income and city wage tax, if applicable
to employees and to furnish information to the Internal Revenue Service
showing the amount of remuneration paid each employee and the amount
CH.
15
451
taxes from emof federal income tax withheld. The collection of income
payroll acaffect
obviously
ployees and the remittance of these taxes
to
required
counting. Before a new employee begins work, he or she is
fill
withheld showing
or receipt to each employee from whom taxes have been
taxes and
(income
withheld
taxes
of
amount
the
and
the total wages earned
form)
(W-2
statement
withholding
This
PICA) during a calendar year.
A
W-2
the
reconciliation of the quarterly returns with duplicate copies of
fourth-quarter
the
accompany
must
forms furnished employees
names of
periods of employment, the amounts
show
the
and dates of payment, and the taxes withheld each payroll date.
The state may also levy an income tax that must be withheld from
auemployees' wages. The tax withheld must be remitted to the taxing
thorities
city or municipality
may
levy a
working within its boundaries even though the employee is not a resident.
taxing
Here, too, reports and payments must not only be made to the local
employee.
authority, but information must also be supplied to the
The Pair Labor Standards Act, PICA tax, federal and state taxes for
unemployment compensation insurance, workmen's compensation laws,
and other governmental regulations require a multiplicity of forms for
personnel in a
their monthly, quarterly, and annual reports. Competent
company's payroll department are needed to comply with all regulations.
LABOR-RELATED DEDUCTIONS
other deIn addition to compulsory payroll deductions, a variety of
of the
consent
the
with
pay
take-home
the
from
ductions are withheld
employee.
Insurance.
Many companies
and
life
insurance.
It is
common
452
for the
company and
PART
IV
share being deducted from wages each payroll period or at regular in-
tervals. If the
in
advance, including
and Acci-
dent Insurance will be debited at the time that the payments are made;
when
similar cases,
employee
is
more general
maintained.
Union Dues.
Many
is
for
treasurer.
up
to
show
Employee U.
S.
Savings
Bond Deposits
is
made
debiting
Employee U.
is
S.
is
set
When
the
sufficient
Savings
to
Bond
made
to officers, salesmen,
company, might be
When
entitled Salary
CH. 15
453
payroll date, the employee's earnings are entered in the payroll journal
as usual
is
is
credited to Salary
salary
Some of
the
FICA
disability
6.0%
.5
2.0
1.0
8.0
17.5%
10.0%
4.0
3.5
1.3
1.5
20.3%
37.8%
the entries
(if
exist,
depending in part
itself.
454
A record
is
PART
IV
is
The accounting
entries
required,
therefore, are:
1.
To
2.
To
amounts
charge the total labor cost to appropriate jobs, processes, and de-
partments.
chased
1.
The
is
payroll
for the
period
month of
January, 19B.
..
.
CH. 15
455
Subsidiary
Record
Debit
Credit
Accrued Payroll
26,000.00
Payroll
Jan.
26,000.00
Payroll
50,000.00
Accrued Payroll
Federal Income Tax Withheld
PICA Tax Payable
Salary and Wage Advances
Liability for Union Dues Collected
Employee U.S. Savings Bond Deposits.
Prepaid Health and Accident Insurance.
Jan. 23
37,550.00
Payroll
40,000.00
37,550.00
Accrued Payroll
Cash
Accrued Payroll
Federal Income Tax Withheld
PICA Tax Payable
Liability for Union Dues Collected
Employee U.S. Savings Bond Deposits
Prepaid Health and Accident Insurance.
Jan. 3
37,550.00
4,800.00
3,000.00
2,200.00
1,000.00
1,200.00
250.00
31,800.00
3,700.00
2,400.00
1,000.00
900.00
200.00
Accrued Payroll
Cash
31,800.00
Payroll
24,500.00
31,800.00
Accrued Payroll
Work
in Process
24,500.00
Labor
38,500.00
6,429.50
FICA Tax
Unemployment Insurance Taxes.
Workmen's Compens. Insurance
Pension Cost
Health and Accident Insurance
Estimated Unemployment Cost
Payroll
FICA Tax
Payable
Federal
State
Unemployment Pay
{continued)
2,310.00
1,232.00
385.00
1,540.00
192.50
770.00
38,500.00
2,310.00
192.50
1,039.50
385.00
1,540.00
192.50
770.00
..
456
PART
IV
Subsidiary
Record
Jan. 31
(cont.)
Debit
21,186.00
Labor
PICA Tax
Indirect
18,000.00
1,080.00
576.00
180.00
Pension Cost
Health and Accident Insurance
Estimated Unemployment Cost
900.00
90.00
360.00
18,000.00
1,080.00
90.00
Payroll
PICA Tax
Payable
Liability for
486.00
180.00
900.00
90.00
360.00
Unemployment Pay
22,940.00
Sales Salaries
PICA Tax
Unemployment Insurance Taxes
Pension Cost
Health and Accident Insurance
20,000.00
1,200.00
640.00
1,000.00
100.00
20,000.00
1,200.00
100.00
540.00
1,000.00
100.00
Payroll
PICA Tax
Pederal
Payable
PICA Tax
Unemployment Insurance Taxes
Pension Cost
Health and Accident Insurance
13,724.00
1
2,000.00
720.00
384.00
560.00
60.00
Payroll
PICA Tax
Federal
Payable
Credit
12,000.00
720.00
60.00
324.00
560.00
60.00
The
the regulations.
Added assumptions:
Unemployment insurance: .5% federal; 2.7% state.
Workmen's compensation insurance: 1% of factory
payroll earned.
CH. 15
Added assumptions
457
{continued):
2%
liability
of each
fiscal
next period
many employers do
when
As a
period because the legal hability does not occur until the
when
sidered acceptable
may
be con-
material.
m
1.
2.
3.
DISCUSSION QUESTIONS
An employee, who is paid $4 per hour for a 40-hour week with time and
a half for overtime and double time for Sundays and holidays, works 40
hours Monday through Friday, 8 hours on Saturday, and 4 hours on Sunday.
Figure the employee's regular pay, overtime pay, overtime premium, and
total earnings for the week. How should the overtime premium wages be
accounted for?
For many years a company has paid all employees with 1 to 10 years of
one month's wages as a Christmas bonus and employees with more
than 10 years' service two months' wages. It is company policy to give 2-week
paid vacations to those with 1 to 10 years' service and 4-week paid vacations
service
to those with
4.
An
is
458
5.
PART
IV
The productive
on their own time, but the company pays the tuition charges.
should the company account for this cost?
class at night
How
6.
In recent years the concept of human resource accounting has been theorized
in
(a)
How
literature.
(b)
What
(c)
made
in favor of
human
resource accounting.
(d)
What
are
concept
7.
8.
serious
drawbacks of
this
new accounting
(AICPA
9.
adapted)
Explain.
(AICPA
10.
adapted)
(AICPA
adapted)
CH. 15
11.
459
increasing amount of fringe benefits has focused the attention of accountants on these costs. One of the principal costs is that of pension plans.
(a) Distinguish between "pay-as-you-go" and funded pension plans.
(b) The total cost of contributions that must be paid ultimately to provide
pensions for the present participants in a plan cannot be determined
precisely in advance; however, reasonably accurate estimates can be
made by the use of actuarial techniques. List the factors entering into
the determination of the ultimate cost of a funded pension plan.
The
(AICPA
12.
adapted)
a funded pension plan is adopted, its total cost to the employer for
the first year may be apportioned to past-service cost and current-service
When
cost.
(a) Distinguish
(b)
(c)
How
(AICPA
13.
adapted)
(a)
Enumerate the
employee, or both.
15.
What
is
The Glencoe Company has a straight hourly wage rate system with the
hourly rates ranging from $2.75 to $4.25 depending solely on the length of
the employee's service with the company. Sometimes, unusually high or
unusually low labor cost occurs on a job or in a department depending
upon the seniority of the workers who draw the production assignment.
The company does not wish to change its wage policy but also does not
want per-unit labor cost to depend on the seniority of workers on a parHow might the company acticular job or in a particular department.
complish both of these objectives?
Unless otherwise directed, use these rates in the exercises, problems, and
cases that follow: PICA tax, 6%; federal unemployment insurance tax, .5%;
state unemployment insurance tax, 2.7%.
EXERCISES
ledger of the Alvarez Products
direct labor, $24,000;
PICA
indirect labor, $5,500; sales salaries, $6,000; and office salaries, $4,500.
tax is applicable to 60% of the payroll in each department; unemployment
insurance rates apply to only 20%. Income taxes to be withheld are $5,350,
and there is a city payroll tax of 1% on employee gross earnings. Due to an
1.
The general
460
excellent
1%
state
PART
IV
unemployment
insurance tax.
Required: (1) The entry to record payroll
(2)
(3)
The entry
The entry
liability.
$525
325
400
Union Dues
Income Taxes
185
1,720
Employees'
PICA Tax
6%
Payroll Taxes. The following information, taken from daily time tickets,
summarizes time and piecework for the week ended April 30 for a producing
3.
department.
Employee
Busam,
Garner,
Stange,
Wolf,
Clock
No.
Job
Order
No.
90
641
91
...
92
638
93
...
Produc-
Hours
tion
Worked
Pieces
40
46
40
40
960
...
...
...
Hourly
Rate
Piece
Rate
$.24
$5.00
4.80
5.20
The company operates on a 40-hour week and pays time and a half
overtime.
(a)
(b)
(c)
(d)
is
for
as follows:
An
Garner works
all
(e)
Additional information
others
Use 10%
is 2%.
in
Required: (1)
net pay.
in the
work
directly
on
is
the foreman;
The
and
(2) Journal entries (a) to set up the accrued payroll and other liabilities, (b)
to pay the payroll, and (c) to distribute the payroll and to record the employer's
payroll taxes.
CH. 15
461
Fringe Benefits. Mary Murphy works for the Colorado Land Development
Corporation at a monthly salary of $1,380. The company contributes $368 a
year into a pension fund in her behalf and grants her a two-week paid vacation
annually. The state unemployment insurance rate is 1.3%. All labor-related
costs are considered part of Mary's salary as a sales representative.
4.
Monday through
made on January
2:
Accrued Payroll
5,000
Payroll
5,000
7 (December 29-January 3)
14 (January 5-10)
21 (January 12-17)
$7,500
7,800
7,600
6,900
28 (January 19-24)
Required: (1) The entries to record each of the payrolls met during January.
(2)
distribute
payroll,
(3)
Pension Costs. The Mathis Company employs 125 factory workers for a 40hour week and, on the average, operates 50 weeks each year. Under the provisions of a pension plan, it is estimated that 70 of the employees will be pensioned after an average of 25 years of employment. It is further estimated that,
on the average, pension payments will be $250 a month for a period of 10 years.
For the payroll period of March 15, factory labor totaled 5,000 hours.
6.
March
5 payroll.
462
PART
IV
Each day the work required for the regular company business was completed
The remainder of the day, with whatever overtime was necessary, was given
over to production under the contract. During the contract period, overtime
hours represented a substantial proportion of the total hours worked. Under
an agreement with the employees, time and a half was paid for all hours over
eight worked each day.
Job sheets recorded the actual cost of materials and direct labor, including
any overtime premium paid. Factory overhead was applied on the basis of the
labor cost so recorded, and the job sheets were adjusted each month to eliminate
any balance in the overhead variance account.
first.
(2) Incorrectness
(3)
(AICPA
adapted)
PROBLEMS
15-1. Entries for Payroll
$8,500
FICA Tax
940
90
408
For the December 1-15 payroll, which totaled $28,000, employees' FICA
deductions amounted to only $730 since some of the employees had already
earned the maximum applicable during the year. For the same period, income
taxes withheld totaled $2,372.
The company apportions employer payroll taxes as follows: 60% to Factory
Overhead, 30% to Marketing Expenses, and 10% to General Office Expenses.
The state unemployment insurance tax rate is 2%, and only $5,000 of the payroll is subject to this tax since all other employees had earned more than $4,200
by December 1. The company closed for the year on December 15 and had no
more
payroll expenses.
Required: (1) The entry to record the payroll for the period
(2)
(3)
The entry
The entry
to
December
1-15.
Decem-
ber 1-15.
(4) The entry to record payment of all taxes due governmental agencies for
the period October 1 through December 3 1
Office.
CH. 15
463
the Shipping Department and Finished Goods Stockroom are charged to marketing expenses. Payroll checks are prepared at the home office and sent to the
factory for delivery to the factory employees. Overtime premium wages are
treated as factory overhead. The liability for payroll taxes is kept on the general
office books. Factory payroll taxes are charged to factory overhead.
May
summary was
prepared
May
30,
Income
Tax With-
Payroll
Department
Casting
Forging
Machining
Assembly
Toolroom
Storeroom
Stockroom
Shipping
Total
Labor
Hours
(Earned
Hours)
Overtime
holding
Net
Premium
(10%)
Pay
240
410
560
$1,134
1,720
2,860
160
84
82
640
344
322
$118.80
180.00
292.00
64.00
32.20
33.60
40
40
140
152
1,616
$7,322
Sales Office
$1,600
General Office
A recapitulation
19
750
54
80
60
$206
$ 50
May
997.92
1,512.00
2,452.80
14.00
15.20
$752.80
$451.68
$6,323.52
$160.00
$ 96.00
$1,344.00
$ 80.00
$ 48.00
108.00
175.20
38.40
21.12
20.16
8.40
9.12
Job
$ 71.28
30, 19
537.60
295.68
282.24
117.60
127.68
672.00
Total
Weekh
CH. 15
(2)
taxes
is
The labor
465
2%.
(3) Ledger accounts for Payroll and Accrued Payroll and the entry to record
accrued wages at the end of November.
lines
entire
work
force
on Sunday,
May
29, at
200% wages
to
this order.
fill
Required: (1) Entries to record the payroll liability and labor cost for the
week in May.
The entry to record labor cost for
(3) The entry to record the labor cost
first
(2)
May
24.
15-6. Pension Plans. The DiMario Corporation adopted a pension plan for its
employees on January 1, 19E. A trial balance of the records of the plan at De-
cember
Debit
Cash
400
3,400
$1,590
1,060
Received
in
850
300
19F
$3,800
Dohler
Dec.
Feb.
Dec.
Kolman
Sept. 15,
Jones
Sept. 21,
Lehman
May
Total
$3,800
Bone
Cohan
Credit
8,
1,
8,
6,
19A
19C
19C
19D
19F
19F
Date
Terminated
Salary Paid
$17,900
14,100
3,500
8,000
3,000
5,500
April
9,
19F
in
19F
$52,000
466
The
(a)
PART
IV
The corporation
10%
of
its
in
(b)
(c)
following
on January
point.
(d)
participant shall have a vested interest of 10% of his total equity for each
full year of employment.
Forfeitures shall be distributed to the remaining
participants in proportion to their equities in the plan at the beginning of the
year. Terminated employees shall receive their vested interests at year end.
(e)
remaining participants
year.
in
Required: (1)
plan for 19F.
A schedule
to each participant.
(4)
schedule showing the allocation of the plan's 19F income on investforfeitures by terminated participants.
ments and
(AICPA
adapted)
January
CH. 15
Periods
1
Present Value of
$1 at Compound
Interest
Interest
467
468
PART
IV
(NAA
adapted)
CASES
A. Payroll Taxes. In January, 19C, the financial statements of the Grabill
Company for the year ended December 31, 19B, were examined. The company
filed the necessary payroll tax returns for the first three quarters of 19B and had
prepared drafts of the returns scheduled to be filed by January 31, 19C.
The following information was available from the general ledger, copies
and drafts of payroll tax returns, and other sources:
General Ledger:
Balance as of
31, 19
Wages
Composition of Balance
December
Account
(various expense accounts).
12
$121,800.00
PICA (6%
of
S102,000), $6,120;
tax (2.7%
of $59,000), $1,593; federal unemployment tax (.5% of $59,000),
8,458.00
state
unemployment
$450
3,122.50
$1,592.50
December PICA tax, $462.50; October through December state unemployment tax, $199; 19B federal unemployment tax, $295
956.50
Additional information:
August 19B, six laborers were hired to tear down an old warehouse building
located on the site where a new warehouse would soon be constructed. The
laborers' 19B wages totaling $1,000 were charged to the land and buildings
account. Payroll taxes were not withheld.
(a) In
(b)
on December
is
gross factory payroll of $1,200 through December 31, 19B, and the related
(c)
FICA taxes (employer and employee) were accrued on the general ledger at the
year end for a portion of the week ending January 4, 19C. Each of the employees included in this payroll earned between $4,000 and $6,000 as a Grabill
employee in 19B.
December, 19B, a contractor was paid $2,300 for making repairs to machinery
made by company employees and the amount was charged to Wages
Expense. No payroll taxes were withheld.
(d) In
usually
CH. 15
(e)
469
Totals
for Year
Three Quarters
PART
470
Casey
&
IV
I.
C urrent
for
cost (before adjustment
actuarial gains) computed under the
Normal
^4 1 50
j J4,iou
entry-age-normal method
Actuarial gains:
Investment gains (losses):
Excess of expected dividend income
over actual dividend income
Gain on sale of investments
Gains
in actuarial
assumptions for:
3,400
5,050
Mortality
Employer turnover
Reduction
in
(350)
4,050
fP'='"'
-^^
20150
tt^t^t^
14,000
$ 14,000
Normal
14,245
Funding
^^ ^^^
Amortization
Total funded
^ 28,245
II,
Fund
^^^
Assets:
$
Cash
Dividends receivable
Investment in common stocks,
(market value, $177,800)
III.
'
Actuarial
4,200
1,5/j
at
cost
$168,475
1^2,750
Liabilities:
46
Number
Number
of employees
of employees retired
Yearly earnings of employees
Actuarial liability
ci^^ nnn
3.14!),UUU
..,,.,
'^^'-t^^'^y
Retirement
5%
1951
Group
Annuity Tables
^
CHAPTER 16
at short intervals
of production.
in
advance
standard cost system combined with budgets constitutes the most logical
foundation for the achievement of these multiple tasks and goals.
PROFIT PLANNING
Sound and intelligent planning of profits, sales, and costs and expenses
is both more important and more difficult than ever before in this age of
rapid technological change and heightened recognition of the need to
consider social and political parameters. Modern profit planning encourages desirable action and recognizes the divisional and departmental
autonomy and responsibihty of managers, motivating them to strive for
471
472
PART V
planning
Profit
is
geting,
Profit planning
is
its
financial
implications expressed as both long- and short-range profit plans or budgets in the
form of
control costs.
It is
management
income
Profit planning
is
and
specific
Long-
range profit planning intends to find the most probable course of events or
range of probabilities.
It
To
and make the wisest decisions, manageLong-range planning does not ehminate
the essence of economic activity. The end result of
to the future.
for this
is
the only
way
to
is
Long-
these decisions and measuring the results of these decisions against the
Science,
VoL
5,
No.
3, p.
240.
BUDGETING:
CH. 16
473
balance sheet by
administrative expenses, and net operating income.
balances,
inventory
cash
anticipated
indicate
to
prepared
years can be
levels,
liabilities, etc.
stable level of
profit.
management needs
factors
1.
2.
sales
3.
Break-even point
4.
Sales
5.
6.
be followed to
1.
The a
priori
method
which the
in
At the
outset,
management
The a
is
posteriori
method
in
specifies
it
a given rate
seeks to realize by
of the planning
3.
which
procedures can
profit expectancy
itself.
in
comparative analysis
is
474
PART V
common
share.
environmental pollu-
their future
One
year, however,
is
For
efllicient
planning,
allowing for a three-month period at the end of the old year, twelve months
for the regular budget period
into the
These overlapping months are needed in order to allow transition from year to year and to make adjustments based on prior months'
experience. The budget period should be divided into months. It should:
third year.
1.
2.
Cover
3.
Be long enough
at least
advance
of actual needs.
4.
Some
month
or
is
2"Long-Range
Controls, Vol.
XXI, No.
1,
p. 2.
BUDGETING:
CH. 16
needed.
its
&.
EXPENSES
475
short-range plans.
advantages of:
1.
2.
stilling into
decisions.
3.
Developing throughout the organization an atmosphere of profitmindedness, encouraging an attitude of cost-consciousness and maximum
resource utilization.
4.
management organization
so that
total organization
its
basic
policies
6.
and
most
7.
Aiding
8.
more
9.
in directing capital
profitable channels.
eff"ectively.
and
pitfalls
need to be mentioned:
2.
A
all
profit
XLV, No.
6, p. 36.
Profit Planning,"
NAA
476
PART V
absolute adherence to and enthusiasm for the budget plan. Too often a
budgetary plan has failed because executive management has paid only
lip service to its
3.
execution.
feel
"hemmed-in."
ganization's objectives.
4.
Often, a
expects too
it
first be sold to the responsible people; and they, in turn, must then
be guided, trained, and educated in the fundamental steps, methods, and
purposes of a budgetary system.
must
A company's organization chart and its chart of accounts form the two
basic frameworks
on which
and
effi-
is
system
is
If a
budgetary control
to be successful,
each company
official,
is
composed of executives
in charge
of major
The
1.
Decide on general
2.
policies.
3.
Suggest revisions.
4.
5.
6.
Recommend
agement committee.
activities
It is
man-
BUDGETING:
CH. 16
477
initial
function
is
complete
to request, receive,
set
and
of budgets generally
consists of:
1.
b. Territory,
2.
3.
4.
5.
6.
7.
8.
A
A
A
income statement
showing the estimated financial position of the
end of the budget period
company
at the
SALES BUDGET
The most important single element in a budgetary control system is a
sound and accurate sales forecast. This forecast must consider past sales
and be based on market and sales analyses. The task of preparing the sales
budget is usually approached from two different angles: (1) judging and
evaluating external influences and (2) considering internal influences.
These two influences are brought together in an intelligent and workable
sales budget.
tivity,
governmental
policies, cychcal
and modes of
capacities,
living.
new products,
shift,
and changes
buying
estimates,
in
territories.
significant
part.
Forecasting Sales.
responsibility of the
478
PART V
and
known
down by
company's
profits,
company's past
and
sales
volume and
(3)
due
of sales and profits are secured from trade associations, trade publications,
Commerce
Department
background data.
industries the U, S.
is
useful as
facts assembled,
2.
The
3.
Seasonal Variations.
proved,
show
it
its
own
basis.
Experience will
Records are examined to determine the trend a product has followed during
past years. Consideration should be given to the causes of the fluctuations.
CH. 16
BUDGETING:
sales
budget
is
479
of a sales program.
Too many
is
not
one month have been excused with the optimistic statement that sales in
the following month will make up the difference. When this does not happen, the sales budget and the entire budget plan suffer.
sales
budget should
not only be placed on a monthly basis for each product but should also
be prepared by territories or
tomers.
districts
governmental agencies,
analysis of this type will often reveal that certain classes of customers or
and salesmen.
customer budget can thus become a strong means for analyzing possible
new
trade outlets.
It
drop
in sales to
Product
Sales Budget
Territory
North
East
South
West
Total
Customer
Group
January
February
PLANNING OF PROFITS, COSTS, AND SALES
480
PART V
experiences are available, coordination of the sales budget with the pro-
duction budget
is
not too
difficult.
However, production planning must realize that the best possible level
of production keeps men and machinery operating all year with a sufficient
but economic inventory on hand. If, for example, the sales budget should
indicate that in certain months factory employment would fall seriously
below a desirable level, it would be necessary to attempt to increase sales
volume or increase inventories. Should estimated sales be higher than
available capacity, the possibility of increasing plant capacity through
purchase or rental of new machinery and factory space must be considered.
If factory capacity is available,
an
efficient rate
of production should be
To
workers
is
always expensive.
When
definite
hire
StabiUzation of employment
company
policy.
is
and lay
desirable
labor relations.
end of each month are important. It is necessary to have inventories on hand which permit fulfillment of the month's
finished stock
on hand
sales requirements.
at the
At the same
PRODUCTION BUDGET
A production budget is stated in physical units and frequently is merely
the sales budget adjusted for any inventory changes (as
shown below).
Seasonal fluctuations of sales are usually leveled out in production planning in order to stabiHze employment without causing a shortage of
finished products, inefficient service to customers, or large inventories.
be detailed by months
Product X
Production Budget
For Year Ending December,
19
Year,
Planned production
February
December
8,000
6,400
9,000
7,400
7,000
4,400
120,000
4,400
14,400
4,400
16,400
6,400
11,400
1,400
124,400
4,400
10,000
10,000
10,000
120,000
January
19
CH. 16
sales
BUDGETING:
makes
this desirable in
481
broken down by work stations for comparison with actual production. The
nature of the breakdown will be determined by plant layout, type of production, and other factors.
For a company that does not manufacture a standard product but produces only on orders, plans cannot be too detailed. The problem here is to
be prepared for production when orders are received. However, if there are
standardized parts, production can often be budgeted in a manner similar
special-order
to that used by a company producing a standard product. In
work, the routing and scheduhng of work through the factory is of prime
importance to prevent delays and to utilize production facilities fully.
Coordination of the production budget with the sales budget is of
extreme importance, otherwise production may become unbalanced. The
Sales persales department may emphasize volume and overlook balance.
concentrate on selling what they think are the most profitable
products that the company has facilities to produce
overlook
lines and
and which cannot be used for other products. Such a condition may result
had been
in idle capacity with resultant losses greater than if sales effort
sonnel
may
concentrated otherwise.
No
scientific
made
so
much
When
progress in
competition
becomes keen and pressure for price cutting increases, management looks
pressing
for reduced production costs. With labor resisting decreases or
devices
for increases in wages, reduction must take the form of labor-saving
always
is
effort
Constant
scheduling.
and
routing,
and careful planning,
more
to
will
lead
that
cuts
short
and
directed toward devising new ways
efficiency
production
in
efficient production and cost savings. Any gains
will be reflected in earnings.
The production budget deals with the scheduUng of operations, the determination of volume, and the establishment of maximum and minimum
quantities of raw materials and finished goods inventories. Its summaries
and details provide the basis for preparing the budgets of materials, labor,
and factory overhead. These three elements of cost constitute the cost of
goods sold section of the income statement, and their totals are estimated
in the manufacturing budget.
MANUFACTURING BUDGET
With the forecasted
sales
volume translated
production budget, the future costs of materials, labor, and factory overhead essential to the sales and production program can be computed.
These costs, often based on standard costs, are usually summarized in a
482
PART V
never be forgotten: fixed costs are fixed in total, but variable per unit;
variable costs are variable in total, but fixed per unit.
Example
Lopez Company
Manufacturing Budget Estimates
For Year Ending December 31, 19
Production
20,000 Units
25,000 Units
$100,000
60,000
20,000
40,000
$125,000
75,000
25,000
40,000
The
factory overhead
is
($2)
($1.60)
would be prepared for each center. The budget information thus developed
becomes part of the master budget to be used as a standard or target
against which the performance of the individual department is judged and
evaluated. Detailed budgets are also prepared for direct materials and
direct labor.
2.
Establishes a
means by which
quantities of
must be on hand.
The materials budget usually deals with direct materials only. Supplies
and indirect materials are generally included in the factory overhead
budget; however, the necessary factors discussed below are also applicable
to supplies
Purchase Requirements. The production planning department determines the quantity and type of materials required for the various products
CH. 16
BUDGETING:
&.
EXPENSES
483
and
(2)
(1)
changes
in
Raw
Material
Raw
Material
A
,
Purchases
Materials available.
February
January
Beginning inventory.
...
31, 19
80,000
80,000
45,000
45,000
25,000
'
;
25,000
Ending inventory
80,000
80,000
Materials used
45,000
45,000
December
Total
80,000
80,000
50,000
600,000
130,000
680,000
80,000
80,000
50,000
600,000
record clerk quantities that should not be exceeded and below which
stocks should not drop.
When
down by
funds
will
program
laid out
484
and
PART V
who work
in
and so
in
for direct
and
who work
forth.
labor force has been with the firm for several years and
if
the production
schedule does not call for additional workers, the task of the personnel
department
is
rather easy.
It is
make
affected, giving
companies
When
due recognition to
this schedule is
skill
and
workers are to be
list
of the workers
seniority rights.
from any
many
injustice or hardship.
In
the
dollar values.
are generally
Should conditions indicate that labor rates might change, the new
rates should be used so that the financial budget reflects the most recent
used.
figures available.
is
prepared on
the basis of the chart of accounts, which properly classifies expense ac-
As
discussed previously,
2.
3.
classification alone
is
i.e.,
variable
and
fixed
It is
by
The departmental
producing depart-
falls
into
is
CH. 16
485
to submit an estimate of
on
the projected activity of his departhis departmental expenses based
ment for the budget period. Past costs are tempered by estimates about
the future. These estimates are reviewed in the light of other budgets, and
all
ment
Any
revision
is
This procedure
is
more
willingly in executing
the budget.
The
is
generally prepared
management and
individual depart-
Molding Department
Factory Overhead Budget
For July, 19
Budgeted
Indirect labor
Oil
Fuel
Tools
Heat
Power and
light
Repairs to machinery
Supervisor
Depreciation
Spoiled work
930
Actual
Over
Under
486
seasonal budget
is
highly valuable
if
PART V
basis
a comparision
(Chapter
is
flexible
budgeting
18).
Budget of the Maintenance Department. Among the expenses comin a departmental overhead budget is the item "Repairs
monly included
to machinery,"
which
is
a service department
ment
frustrating.
(see
and
the difficulty of determining their causes. Economical use of plant and
equipment is the joint responsibility of production and maintenance
personnel, such as the department supervisor who uses the equipment
and the maintenance force who repair and keep it in good condition.
unpredictability, the impossibiUty of measuring their cost in advance,
is
and budgetary control of commercial expenses which include both marketing (often referred to as seUing or distribution expenses) and administrative
expenses. These expenses may be classified by primary accounts and by
functions. Classification by primary accounts stresses the nature or the
type of expenditure, such as salaries, commissions, repairs, light and heat,
rent, telephone
promotion,
entertainment,
delivery
emphasizes departmental
and
expenses,
interest.
activities,
such as
freight-out,
Classification
selling,
insurance,
by function
advertising,
ware-
and
financing,
and
is
responsibility accounting.
manner
this
CH. 16
487
BUDGETING:
Commercial expenses:
Marketing expenses:
Advertising
^,1'?2S
Sales salaries
Store supplies
\im\
cAri,
5,4UU
6,600
3,300
$40,000
^'^'tnX
2,200
'590
J
c'\r^
6,100
"hOS^
$70,000
As expenses
counts, posted
statement.
No
further allocation
is
made
or even attempted.
At
the end of
budgeted expenses or
a period actual expenses are compared either with
with expenses of the previous month or year.
To control
Budgeting and Analyzing Commercial Expenses by Functions.
activities
commercial expenses, it is necessary to group them by functional
often
expenses,
commercial
of
or operating units. Such a classification
referred to as a departmental classification, can be
factory overhead by departments or cost centers.
compared
to collecting
departmental
classi-
fication of
chart.
tive staff.
is
used in
Direct and indirect departmental expenses also exist as
to a
directly
charged
those
factory cost procedures. Direct expenses are
488
PART V
department, such as
salaries,
tainment expenses.
and
utilities,
when shared by
Expenses such as
To
an outlay of cash or the incurrence of a liability with a function requires considerably more work than is required by the primary account method. However, the chart of accounts will normally provide the
initial
identify
breakdown of expenses.
made
is
prepared.
it
is
An
method
is
at the
requis-
more than
offset
cost control.
company's marketing
activities
can be
selling, advertising,
and
market analysis
2.
Filling
ing,
the order
involving
warehousing,
shipping,
transportation,
billing,
and
credit
and
collection
all
and
to take steps to
remedy them.
One
difficulty deals
either category, or in
marketing
costs.
lies
CH. 16
BUDGETING:
489
executive
expense under the jurisdiction and control of some
division.
or
section
the administrative expenses for his
who
estimates
previously.
Administrative expenses include the same items as outlined
often
those
are
activity
Additional expenses peculiar to the administrative
fees, franchise taxes,
Usted as corporate expenses; namely, directors'
professional services by accapital stock taxes, donations, as well as
to make these expenses the
order
countants, lawyers, and engineers. In
functions may be
responsibihty of a department head, administrative
controller, general
divided as follows: company executive, treasurer,
incur certain expenses
accounting, and general office. Each function will
of office equipment,
depreciation
to all of them, such as salaries,
common
etc.,
lists
all
employees
classified
intense utilization of
manpower
in clerical jobs
and more
where overlapping and
better control
DISCUSSION QUESTIONS
Profit planning includes a complete financial
phases and facets of the business. Discuss.
1.
between long-range
profit
all
2.
Diff"erentiate
3.
management might
Discuss the three diff"erent procedures that a company's
objectives.
profit
set
to
follow
The
'
490
PART V
in the financial resources of the firm. How does this view relate to that of
current organization theorists with respect to (a) the nature of organization
objectives and (b) the estabUshment of such objectives?
(NAA
5.
6.
adapted)
How
is
control system?
7.
8.
axiom of
fixed
and variable
identified as marketing and administraare these expenses grouped for budgetary purposes?
How
EXERCISES
1. Profit
Planning.
$1,050,000
90,000
1,600,000
Sales
31 ,000
Financial expenses
The
1.
enterprise
Required: The
above estimates,
if
amount
2.
on
this stock.
The budget
sales at $12,000,000.
Marketing
Administrative
Financial
5%
5%
1%
of sales
of sales
of sales
End of Year
$200,000
50,000
400,000
$500,000
150,000
300,000
Finished goods
Work in process
Raw
materials
Required: The projected cost of goods sold statement, showing therein the
budgeted purchases of materials and the adjustments for inventories of raw
materials,
work
in process,
and
finished goods.
CH. 16
491
District
Maine
New Hampshire
Vermont
Massachusetts
March
Jan.
Feb.
50
55
50
50
30
30
25
25
20
100
100
100
100
15
25
25
months are
Vnit
Sales
District
Maine
20,000
30,000
10,000
40,000
New Hampshire
Vermont
Massachusetts
Total
The
Total
100,000
is
$2.
Company
55%
30%
15%
January
February
March
Required: (1)
three
months
(2)
inventory
and
An
and
first
in total,
The beginning
year are:
Pennsylvania
Product A
Product B.
492
PART V
Sales Budgets by Territories and Product Lines. Javierolon Electronics Corporation has two product lines, high-speed printers and electronic typewriters.
The company's market research department prepared the following sales fore-
5.
coming year:
High-Speed
Electronic
Typewriters
Printers
The
sales force
75,000
25,000
20%
10%
$1,800
$450
New
England Area
Middle Atlantic
Southern States
1,200
3,000
1,800
4,200
2,000
Total
6,000
8,000
1,800
6.
A sales forecast showing unit sales and total sales revenue by sales
and by product
territory
Production Budget.
lines.
next
Expected
Product
Unit Sales
Ceno...
14,000
37,500
54,300
Nepo
Teno
Inventories at the beginning
are as follows
at the
Product
March 31
Ceno...
5,800
10,600
13,000
Nepo
Teno
Required:
June 30
6,200
10,500
12,200
7.
Product
Frozen soups:
Snapper
Shrimp
Pea
Condensed soups:
Tomato
Chicken noodle
1,000.000
750,000
Sales
CH. 16
BUDGETING:
levels
493
fVork in Process
Ending
Beginning
~
Units
i-
% Processed
Units
'u>
o
Beginning
r iEnding
Units
Units
15,000
8,000
20,000
20,000
5,000
20,000
75,000
30,000
60,000
20,000
Processed
Frozen soups:
5,000
3,000
4,000
80
70
75
4,000
3,000
5,000
25,000
80
60
40,000
25,000
Snapper
Shrimp
Pea
75
75
80
Condensed soups:
Tomato
Required:
75
80
10,000 kits
8,000 kits
5,000 kits
Maryland
23,000
Total
kits
35,000
25,000
20,000
kits
kits
kits
80,000 kits
The inventory of
Boxes
Material
Material
A
B
125,000
1 5,000 units
45,000 units
There are sufficient boxes on hand for both quarters; none will be purchased
during the two periods.
Material A can be bought whenever needed and in any quantity desired. The
starting inventory of 15,000 units is considered to be an ideal quantity.
Material B must be purchased in quantities of 10,000, or multiples of 10,000.
It is desired that, at the end of both the second and third quarters, a minimum
quantity of 30,000 units be on hand, or as close thereto as the standard purchase
quantity will permit.
Required: (1) Schedule of ending inventories and budgeted production of
kits for
each quarter.
494
PART V
Labor Cost Budget. The Satzger Manufacturing Company produces numerous related small parts. The Cost Department has always prepared a labor
budget in dollars only since no information regarding the number of parts manufactured is available. During the past year direct labor costs by quarters were
9.
reported as follows:
Quarters
BUDGETING:
CH. 16
Sales
on account
Cash
sales
Total sales
July, 19
495
August, 19
$1,500,000
200,000
$1,600,000
210,000
$1,700,000
220,000
$1,700,000
$1,810,000
$1,920,000
All merchandise is marked up to sell at its invoice cost plus 25%. Merchandise inventories at the beginning of each month are at 30% of that month's
projected cost of goods sold.
(2)
(AICPA
adapted)
12. Critique of Performance Report. The Kristina Company uses a fixed or forecast budget to measure its performance against the objectives set by the forecast
and to help in controlling costs. At the end of a month, management received
the report below which compares actual performance with budgeted figures:
Items of Cost
Actual
Units produced
Direct materials
Direct labor
Factory supplies
Indirect labor
73,500
75,000
$37,020
5,950
$39,000
6,000
,550
,500
710
726
2,300
Rent
2,000
2,200
2,250
355
2,000
2,200
$52,080
$54,031
350
Depreciation
Total
if
Budget
Required: Conclusions to be
any, of this type of budget.
drawn from
weaknesses,
PROBLEMS
16-1. Sales, Materials, Labor, and Inventory Budgets.
A budget department
gathered the following data concerning future sales and budget requirements:
19
Product
Units
Price
Expected Inventories
January 1, 19
20,000
50,000
30,000
$55
50
80
8,000 units
15,000 units
6,000 units
Desired Inventories
31, 19
December
10,000 units
15,000 units
6,000 units
30
40
Unit
Each
Each
Kilograms
Kilograms
Meters
B
1
5
3
2
3
496
110
50
41
$3.00
2.00
2 50
4.00
3.25
.
30
40
December
each
each
kilograms
kilograms
meters
25,000
23,000
15,000
18,000
30,000
each
each
per kilogram
per kilogram
per meter
Expected Inventories
January 1, 19
21,000
17,000
10,000
18,000
25,000
Desired Inventories
31, 19
each
each
kilograms
kilograms
meters
Product
$4.00
3.00
4.20
Overhead is applied
PART V
(in dollars).
The purchasing
agent and the cost accountant of Animations, Inc. are trying to solve the
problem of scheduling purchases in connection with a planned expansion in the
production of rocking horses. All lumber used is procured in a standard size,
of which the following amounts, which include a due allowance for waste, are
used in one complete rocking horse:
16-2. Materials Purchases, Production, and Inventory Budgets.
2 board
board
Maple 10 board
Oak
Pine
feet
feet
feet
A sales budget has been approved, and the following production schedule
has been drawn up for I9A:
Quarter
CH. 16
BUDGETING:
&.
EXPENSES
497
Purchases of 1,500 board feet lots are restricted because of limited storage
At the present time there is sufficient space to store 3,000 board feet
of all types of lumber combined. During the early part of the year it is anticipated that a new shed will be constructed to store an additional 1,200 board feet.
It is expected that the total storage space of 4,200 board feet will be available
prior to the end of the second quarter.
facilities.
1,
19A
is
as follows:
150 board
600 board
Pine
Maple 900 board
Oak
feet
feet
feet
Required: Schedule, or schedules, indicating the materials production requirements, materials purchases, and materials inventories for each type of
lumber, by quarter, expressed in board feet.
16-3. Materials Requirements and Purchases Budget. The Budget Department of
the Mifer-Jifson Manufacturing Company prepares an annual production and
materials requirement budget in which the first quarter of the year is on a
monthly basis and the balance of the year in totals by quarters. In the third
month of a quarter, detailed budgets are again prepared for the next quarter.
The company produces two products, Miff and Jiff, which require three raw
materials, XLO, YO, and ZMO, in the following quantities (kilograms)
Materials Requirement and Costs
Product
Miff
Cost
Jiff
Production schedule:
XLO
YO
ZMO
1kg.
23^ kg.
132 kg.
$2 per kg.
S1.50perkg
I
kg.
$1 per kg.
2 kg.
kg.
498
PART V
in
Units
TERRITORIES
I_
package
package
1-lb.
2-lb.
Total
The
6 Months" Total
Other
Ji
JIJi
10,000
15,000
12,000
18,000
12,000
12,000
613,000
783,000
650,000
825,000
22,000
33,000
24,000
1,396,000
1,475,000
in the light
Factory
facilities
budget.
January
February
March
April
May
June
Beginning Inventory,
January
1
Raw
Required: (1)
(4)
(5)
Type S
Quantity (bu.)
Price
Quantity (bu.)
Price
5,000
2,000
$1.30
1.40
2,000
1,000
3,000
3,000
$1.20
1.20
8,000
3,000
4,000
50
1.50
1.60
4,000
1.00
10,000
1.20
3,000
1.00
.1.25
1
.00
fifo basis.
sales forecast
(2)
2-lb. package for $.50.
(3)
and the
inventory, purchases, usage, and ending inventory for the six-month period
taken as a whole.
CHAPTER 17
BUDGETING EXPENDITURES
AND CASH, FORECAST
STATEMENTS, BUDGETING FOR
NONMANUFACTURING
BUSINESSES AND NONPROFIT
ORGANIZATIONS, PERT/COST,
HUMAN BEHAVIOR
and capable judgment. Decisions regarding current manufacturing operations can always be changed if a change is considered the
trating analysis
499
500
PART V
term commitments.
reaped over a
come
fairly
Capital expenditures, however, represent longBecause the benefits of a capital expenditure will be
extended length of time, managerial errors could be-
many
years.
requires
definite procedures
It is
is
Management
will
addition of capital assets are only significant in the current budget period.
management
budget commitments only as
the
and are
translated
their
into
implementation approaches.
Timing
is
CH. 17
501
market trends and demands and that the future cost of the program is not
at odds with forecasted economic and financial conditions.
From the
short-range viewpoint, management must be assured that experimental
efforts are being expended on programs which promise a satisfactory
margin of return on the dollars invested.
to
manage-
controller's
data.i
Defined.
Research and development
compete with other projects for available financial resources.
The value of the research and development program must be shown as
clearly as possible so that management can compare it with similar programs and with other investment opportunities. Therefore, the motivation and intent of the experimental activities must be carefully identified.
projects
Research
is
planned search or
critical investigation
aimed
at discovery
of
new knowledge with the hope that such knowledge will be useful in
developing a new product or service (hereinafter "product") or a new
process or technique (hereinafter "process") or in bringing about a
significant improvement to an existing product or process.
2.
Development
is
improvement
or use.
It
to
knowledge
new product
and
sale
testing of
is still
grams. Other planning devices are used at times, but the budget is considered
best for (1) balancing the research
(2)
coordi-
nating the program with the company's other plans and projects, and (3)
'For a comprehensive treatment of the research and development subject, examine
Raymond Villers, Research and Development: Planning and Control, a research study and
report prepared for the Financial Executives Research Foundation (New York, 1964).
Robert E. Seller, Improving the Effectiveness of Research and Development (New York:
McGraw-Hill, Inc., 1965).
^Statement of Financial Accounting Standards No. 2, "Accounting for Research and Development Costs," Financial Accounting Standards Board (Stamford, Connecticut: 1974), pp. 2-3.
PLANNING OF PROFITS, COSTS, AND SALES
502
PART V
checking certain phases ofnonfinancial planning. The budget forces management to think in advance about planned expenditures, both in total amounts
Management
and development
to submit a complete
Submission of data
The following
proposed
i^
been
has
sheet
balance
development
and
research
Cost Reduction
Phase
A^BC
Applied research.
Development....
Basic research...
Improved Products
Al AB
4% 3%
5% 12%
7% 6%
3%,
2%
4%
2%
5%
21%
8%
11%
3%
4%
1%
16%
Total by area of
inquiry
A, B, and
3J. B.
letin,
45%
C refer
4%
1%
2%
1%
10%
Total by product
lines
New Products
5%
20%
4%
13%
_1%
3%
3%
15%
25%
30%
45%
.^^
21%
XL, No.
100%
35%
to product lines.
Total
1,
pp. 79-90.
NAA
Bul-
CH. 17
The
specific
503
the necessary
man
is
reviewed monthly,
results attained.
Accounting
treat-
(1)
depreciation or amortization.
the income statement.
CASH BUDGET
A
and disbursements
It
some other
specific period.
has generally been recognized not only as an extremely useful but also
to
specifically, a
cash budget:
2.
Indicates the cash requirements needed for a plant or equipment expansion program.
3.
Points up the need for additional funds from sources such as bank
loans or sales of securities and the time factors involved. In this connection it might also exert a cautionary influence on plans for plant expansion
leading to a modification of capital expenditures decisions.
4.
5.
Assists
in
Shows
2,
op.
cit.,
pp. 1-2,
6.
or long-term
504
its
PART V
pared by months for a year with changes made at the end of each month
in order to (1) incorporate deviations
month
to replace the
month
(2)
add
or week moves closer, weekly or even daily cash receipts and disburse-
ments schedules are considered necessary for prudent and efficient cash
management.
A cash budget includes no accrual items. For instance, payroll may
be accrued at the beginning and end of each month. If at the beginning
and end of a month accrued payroll amounts to $4,800 and $3,300 respectively, and the budget shows that $18,000 in wages and salaries will
be earned by employees, the treasurer computes the monthly cash requirement for the payroll as follows
Accrued payroll
Add
at beginning
of month
$ 4,800
18,000
Amount
at
$22,800
3,300
end of month
$19,500
when
month
withheld.
low
either of
1.
2.
may
fol-
In the
first
collections
method,
all
on accounts
1.
Sales budget.
2.
3.
wages earned.
Various types of expense budgets, both manufacturing and commercial,
which indicate expenses expected to be incurred. Noncash expenses such
4.
indicates
CH.
17
505
5.
Plant and equipment budget, which details cash needed for the purchase
of new equipment or replacements.
6.
requirements for
These data sources are used in estimating cash receipts and disbursements for each budgeted time period segment.
and collections of
accounts receivable.
study
is
made of
how
customers
pay their accounts, how many take the discount offered, and how many
pay within 10 days, 30 days, and so forth. These experiences are set up in a
schedule of anticipated collections from sales. Collections during a month
will
(1) this
month's
sales,
and
(2)
accounts receivable of
From
From
this
collec-
10.8%
month's sales
78
6.3
1.2
2.1
1.2
Doubtful accounts
.2
100.0%
On
are
computed
as follows
Month
July
June
May
April
March
Credit Sales
$160,000
200,000
175,000
180,000
178,000
month of
July
506
commercial
PART V
costs, the
profit
and
loss or
income method
accruals.
The next
liabilities
is
This method
technique as
is
is
it is
cash budget
is
it
when
it
allowances for
new
Most firms
month to make
all efforts
Its
purpose
are directed.
is
to project
No new
esti-
mates are actually made; figures taken from various budgets are merely
arranged in the form of an income statement. The sales budget gives expected sales revenue; the manufacturing budget furnishes manufacturing
and cost of goods sold which, when deducted from sales, give the
Estimates from the marketing and administrative
expense budgets are subtracted from estimated gross profit to arrive at
the net operating income.
Other income and expense items are either
added or deducted to determine net income before taxes. Finally, the
provision for income taxes is deducted to determine net income after
taxes. Preparation of a forecast income statement offers management the
opportunity to judge the accuracy of the budget work and investigate
costs
CH. 17
507
480,000
540,000
180,000
90,000
December
Totals
$420,000
$ 7,200,000
$200,000
100,000
2,400,000
1,200,000
49,500
60,000
594,000
720,000
$409,500
$ 4,914,000
'i
Direct labor
80,000
90,000
Factory overhead
Fixed
Variable
49,500
54,000
inventory
February
$
19
373,500
49,500
54,000
$
'
373,500
630,000
667,500
$1,003,500
$1,041,000
(fifo)
491,400
630,000
$900,900
$ 5,544,000
667,500
664,000
614,250
614,250
$286,650
$ 4,929,750
$133,350
$ 2,270,250
$ 25,000
10,500
300,000
180,000
20,000
9,000
20,000
7,000
240,000
120,000
Gross
profit
336,000
377,000
144,000
163,000
25,000
12,000
25,000
13,500
Commercial expenses
Marketing expenses:
'
Fixed
Variable
Administrative expenses:
Fixed
Variable
20,000
8,000
65,000
67,500
$ 62,500
79,000
95,500
$ 70,850
$ 1,430,250
4,800
5,400
4,200
500
500
72,000
6,000
144,000
840,000
Other expenses
Bad
debts expense
on notes payable
Sales discount
500
Interest
9,600
Total
Other income
Interest income
10,800
8,400
16,700
$13,100
3,600
4,000
- -
Purchases discount
Other expenses
14,900
(net)
7,500
48,000
1,250
3,600
222,000
11,300
13,100
67,700
82,400
$ 63,000
41,200
31,500
33,850
41,200
$ 31,500
33,850
7,850
166,500
$ 1,263,750
631,875
631,875
is
and
various departments.
It
incorporates
all
changes
by the
508
PART V
January 1
Assets
Cash
Accounts receivable
400,000
250,000
(2,500)
January 31
S
173,000
153,400
(1,300)
19
February 28
B
>
December 31
99,300
180,100
(700)
245,675
149,500
(2,500)
Inventories:
Raw
materials
Finished goods
Plant and equipment
Less accum. depreciation
320,000
630,000
3,000,000
.
Other assets
U. S. Government bonds
320,000
667,500
3,000,000
(600,000)
(616,850)
202,500
200,650
320,000
664,000
3,000,000
320,000
614,250
3,000,000
(633,950)
198,550
(815,400)
167,100
500,000
7,500
Interest receivable
Total assets
LlABILFTIES
$4,200.000
$3,896,400
$3,827,300
770,000
231,000
32,400
77,000
32,400
134,800
136,800
1,000
75,050
120,000
960,000
AND CAPITAL
Current liabilities
Accounts payable (purchases).
Accounts payable (factory
overhead and marketing and
administrative expenses)
500
Interest payable
Income
taxes payable
Long-term debt
Capital stock
Retained earnings and surplus
reserves
Total
$4,186,125
liabilities
and capital
120,000
960,000
33,850
120,000
960,000
36,000
137,600
118,650
960,000
2,350,000
2,383,850
2,425,050
2,933,875
$4,200,000
$3,896,400
$3,827,300
$4,186,125
sheet.
favorable ratios can lower credit ratings or cause a drop in the value of the
corporation's securities.
that
it
serves as a check
budget changes.
management of organiza-
tions
is
well recognized.
CH. 17
investors
to
509
the future.
made
has been
1.
2.
that
the forecast.
3.
Forecasts
should be updated periodically and ultimately compared
with actual accomplishments.
The preparer should explain
.
significant diff"erences
do not require
porting.
NONPROFIT ORGANIZATIONS
Nonmanufacturing Businesses.
Many
pay only
lip service to these suggested steps, methods, and procedures. To an even
greater extent, nonmanufacturing businesses
and especially nonprofit
organizations
generally lack an effective planning and control mechanism. However, under the guidance of the National Retail Merchants
Association, department stores have followed merchandise budget procedures that have a long and quite successful history.
industrial concerns
still
510
retail store is
PART V
generally low
is
budgeting,
Planning,
statements.
tions,
The
of the institution.
and objectives
and mix, num-
services, personnel
The long-
one whole.
have been severely criticized by the general public, responsible for the
money via payment of taxes. While the federal government might be under more obvious attack, state, county, and municipal governments are
equally criticized not only for the lack of a satisfactory control system,
but also for the ill-conceived procedure for planning the costs and revenues
needed to govern.
The concept of a planning, programming, budgeting system, commonly referred to as PPBS, has received attention and acceptance in
governmental budgeting and accounting. PPBS might be defined as an
puts are directly relatable to the planned goals or objectives through use
CH.
17
The
of performance budgets.
511
analysis technique
is
therewith closely
its
some
measurement.
problem complicates
governmental programs should be undertaken
this
field
grams.
in a
Throughout
federal, state,
developmental stage.
The
and
in the light
The
how-
idea that
of final benefits
PPBS
to their activities
local governments,
and pro-
PPBS
is still
and innovation, an understanding of its aims and methods at many government levels, and active participation of executive and middle management.
It is difficult
to
citizens are ever more critical of services reand budget program assuring them of a
plan
ceived for money spent.
managerial approach to any government's spending plan will go a long
program.
way
same way
In the
conscious,
nonprofit
or
not-for-profit
organizations
like
cost
hospitals,
practiced.
to
fill
the needs of
programs to
these nonprofit organizations.
must
personnel,
train and improve the performance of the administrative
Personnel practices, such as
be made
512
PART V
ZERO-BASE BUDGETING
Customarily, those in charge of an established budgetary program are
required to justify only the increase sought above last year's appropriation.
with
What
little
or no examination.
Beginning
introduced
budgeting
is
in
is
Zero-base
organizations.
and expenditures.
ganization's programs
justify his entire
budget request
in detail
Each manager
is
package" that includes an analysis of cost, purpose, alternative courses of action, measures of performance, consequences
of not performing the activity, and benefits. The zero-base budgeting
approach asserts that in building the budget from zero, two types of
alternatives should be considered by managers: (1) different ways of
his control a "decision
forming the
activity.
(2) different
levels
of effort of per-
"^
is
a careful evalua-
prepared.
Therefore,
in
approach
Navy
Polaris program,
CPM's
origin
is
industrial.
Many
in planning, scheduhng,
and
activities.
Yet there
is
also
an
7For a comprehensive treatment of zero-base budgeting, see Peter A. Pyhrr, Zero-Base BudSons, Inc., 1973).
geting (New York: John Wiley
&
CH.
513
17
for
Opportunity for using PERT in the field of business administration
data,
cost
standard
tasks such as scheduling the closing of books, revising
scheduHng the time elements for the preparation of departmental budgets,
PERT
The
Whether a
System.
projects
ministration task, time is the fundamental element of any of the
longest
the
of
determination
the
is
method
The major burden of the
cited.
calculation
time duration for the completion of the entire project. This
for the longest sequence of activities.
is based on the length of time required
a given job or program must be
complete
to
tasks
All of the individual
comaccomthe network
and
visualized in a network which points out interrelationships
specified
a
prised of events and activities. An event represents
is
(tg) is
on the formula
to
+ 4tn, +
tp
expressed in time periods and often in units of one week. The three-way
activity line.
basis appears on the network with three numbers on each
to the
Referring
distribution.
Beta
the
from
The formula is derived
flowchart, the activity
D-F
has a value of
Ifto
tg
7 determined as follows
= 5;tm = 6;tp=13;
- 5+ 4(6)4^e
13
42
_^
Robert
No.
3,
L. Shultis,
"Applying
PERT
to Standard
Cost Revisions,"
NAA
Bulletin, Vol.
XLIV,
pp. 35-43.
Gordon
B. Davis,
Bulletin, Vol.
Bulletin, Vol.
an Illustration,"
5,
NAA
pp. 357-373.
514
PART V
PERT
Network
with
Time
Estimates
in
Weeks
critical
path (A-D-F-G).
The longest path through the network is known as the critical path
and is denoted on the flowchart by the line connecting A-D-F-G. All
other paths on the network are called slack paths.
Shortening of total
critical
critical
critical
path because
it
is
The
sion of
System. The PERT /Cost System is really an expanseems advisable to assign cost to time and activities,
PERT /Cost
PERT.
It
The predetermination of
cost
is
in
harmony with
the ac-
The
PERT /Cost
estimates are
activity- or project-oriented.
The
and
is
im-
portant for control purposes. In the network chart (page 515), the activities
The
dollar figures
in the white blocks represent estimated costs e.g., $30,000 for activity F-G.
;
Figures in the tinted blocks to the right of the estimates are actual costs.
Letters
tg
ta
A-C, and
A-D
A-B
Activities
A-B,
week more
CH. 17
515
Solid nodes indicate event completed; tinted dollar blocks denote actual
cost experienced;
ta= actual time for the activity.
PERT/Cost Network
and Cost
enough
it is
If excess time
with
Time
(in
Weeks)
Thousands of Dollars)
(in
on a
slack path
will
and
would be involved.
The
A-D had
Each
activity
is
is
on scheduled
tasks, with
controlling schedules
and
manage-
in planning
existing
516
PART V
PROBABILISTIC BUDGETS
The budget may be developed based on one
set
of assumptions as to
However, there
is increasing evidence of management's evaluating several sets of assumptions before finalizing the budget. The PERT-like three-level estimates,
referred to as optimistic, most likely, and pessimistic, offer one possibility
and would involve estimating each budget component assuming the three
conditions stated. Probability trees can be used in which several variables
can be considered in the analysis; e.g., number of units sold, sales price,
and variable manufacturing and marketing costs.
To each
comes but
possible out-
Further
statistical
$114,600.
The computational capability of the computer facilitates the concomplex sets of assumptions and permits the use of simulation programs, making it possible to develop more objectively determined probabiHties.9
sideration of
receiving,
is
made
a cooperative effort.
it
While
even
is
is
this discussion.
For ex-
illustrations, see:
William L. Ferrara and Jack C. Hayya, "Toward Probabilistic Profit Budgets," Manage-
LII,
No.
3,
pp. 23-28.
Belverd E. Needles, Jr., "Budgeting Techniques: Subjective to Probabilistic," Management Accounting, Vol. LIII, No. 6, pp. 39^5.
Hugh
J.
Watson, "Financial Planning and Control," Management Adviser, Vol. IX, No.
pp. 43-48.
6,
CH.
17
517
been aware of the irrational and often obstinate behavior of certain supervisors with respect to the contemplated budget program,
i^'
In
some
firms
is
with the data required for planning, coordinating, and controlling activi-
to the
behavioral function.
The
greatly
the middle
In the field of cost control, use the budget as a tool to be placed in the
foremen's hand
their heads.
To implement
may
it
practice. 13
lOChris Argyris, The Impact of Budgets on People (New York: Financial Executives Research
Foundation; formerly, ControUership Foundation, Inc., 1952).
Its
detail, see:
Behavioral Implications
Inc., 1971).
Comes
3,
518
PART V
first.
spiritual
will
it
promises, i^
DISCUSSION QUESTIONS
1.
What
differ
2.
4.
5.
6.
Name (a) some purposes of and (b) some reasons for a research and
develop-
ment program.
Name the two methods used for the preparation of a cash budget.
Managers of large or small industrial or commercial enterprises consider a
cash budget an extremely useful management tool. Why?
The forecast income statement may be viewed as the apex of budgeting. Explain this statement.
7.
8.
9.
10.
sheet
may
Discuss.
tion.
What
14/6/V/., p.
is
66.
PPBS?
CH. 17
11.
519
answer that best completes the following statement: A perforin PPBS relates a governmental unit's expenditures to
Select the
individual
(AICPA
adapted)
12.
What
13.
14. State
is
PERT
and
PERT /Cost
systems.
15.
16.
17.
Select the answer that best completes the following statement: The measure
of employee attitude toward objectives which is most relevant in participative budgeting is the level of (a) absorption; (b) appreciation; (c) arbitrari-
human
behavior are
(AICPA
18.
adapted)
The budget
it
usually
is
described in (b)
(NAA
adapted)
EXERCISES
A
treasurer gathered the following data related to the com1. Cash Budget.
pany's cash position for the next six months
$ 5,000
as well as at the
40,000
4,000
500
10,000
Other data
January February
Cash
sales
Purchases
Accounts payable
Credit sales
$15,000
12,000
11,000
65,000
$14,000
16,500
30,000
80,000
March
April
$12,000
14,000
25,000
72,000
$16,000
May
June
520
PART V
Credit sales are collected 50% in the month sales are made, 45% in the month
following, and
in the second month. Purchases and accounts payable are
paid in the month incurred.
5%
Required:
Product
Product
X @ $.30
Y @ $.20
3 kg. material
W@
$.80
Y@
$.20
Ya kg. material
1.5 man-hours of labor
$6
budget that
is
Fixed Costs
Variable Costs
Depreciation
$ 6,900
Insurance (one year prepaid)
800
Superintendence
3,000
.
Total for a
month
$10,700
2%
collectible.
4.
CH. 17
521
The budget
is
to
Sales:
(a)
(b)
Each month's sales are billed on the last day of the month.
Customers are allowed a 3% discount if payment is made within 10 days
the billing date.
(c)
after
Sixty percent of the billings are collected within the discount period; 25% are
collected by the end of the month;
are collected by the end of the second
prove uncollectible.
month; and
9%
6%
Purchases:
(b)
purchases of material and a like percentage of marand administrative expenses are paid in the month purchased
with the remainder paid in the following month.
Each month's units of ending inventory are equal to 130% of the next month's
(c)
The
(d)
keting, general,
units of sales.
is
$20.
deprecia-
is
March
April
May
June
July
August
Dollars
Units
$354,000
363,000
357,000
342,000
360,000
366,000
11,800
12,100
11,900
1 1,400
12,000
12,200
(2)
(AICPA
adapted)
Beginning
Ending
5,000
10,000
6,000
7,000
Inventories (annual)
Raw
100,000 (units)
Sales (gross)
Average
Raw
$4.00
and cost
150%
@ $.25 each
$1.00
at
16%
of gross
sales.
manufactured.
(2)
of the
inventories.)
522
The
Sales Budget
PART V
Crompton Ma-
data:
Labor, $30,000
Fixed factory overhead, $10,000
Variable factory overhead can be computed from the data given in the exercise.
Raw
December 31
$5,000
6,000
6,000
$6,000
8,000
5,000
materials
in process
Finished goods
A projected income
Required:
showing
is
in detail the
of the cost of
Planned
January 1
Work
25%
10%
Planned
of
sales.
sold.
Last
Year
Previous
Year
Best
Year
Normal
Year
Materials used
Direct labor
(1)
$30,000
$45,000
Factory overhead
(3)
60,000
50,000
90,000
67,500
$40,000
80,000
52,000
$36,000
(2)
$140,000
$202,500
$172,000
$156,000
Total
Departmental
2,500
7,500
28,000
15,000
$142,500
$210,000
$200,000
$171,000
200,000
300,000
400,000
360,000
83.3%
75%
65%
66.6%
$ 15,000
$ 15,000
$ 12,000
Output
Rate of factory
overhead (3) to
Required: (1)
72,000
48,000
$ 12,000
profit.
(2)
(3)
(The unit
the
same
and wage
remain
CH. 17
8.
523
Company
is
31,
19
Total
Sales (300,000 units)
Cost of goods sold (see Schedule 1)
Marketing expenses
Administrative expenses
Net operating
profit
$150,000
75,000
524
on the statement.
50%
fixed,
and
all
PART V
administrative
PERT
Network.
budget department prepared the following time estimates
for a contemplated project with 36 days as the target date:
9.
Event
Activity
"m.
CH.
17
525
work
illustrated
right, has
at
the
been developed.
All paths from the start point, Event 1, to the finish point, Event 6, represent activities or processes that must be completed before the entire project
(the building) will be completed. The numbers above the line segments represent expected completion times for the activities. The expected time is based
upon the commonly used three-estimate method, 1-4-1. For example, the threeestimate method gives an estimated time of 4.2 to complete Activity 1-2.
(AICPA
PERT /Cost
adapted)
Company
526
PART V
PROBLEMS
17-1.
year on
Management
sales.
believes the
Sales in 19A were:
19A
sales pattern
This information
is
January
February
March
May
June
July
August
September
October
November
December
On December
generally
31,
made
as follows
During month of
sale
(c)
360,000
420,000
600,000
540,000
480,000
400,000
350,000
550,000
500,000
400,000
600,000
800,000
$6,000,000
Total
(b)
available
April
is
60%
30%
9%
1%
The purchase cost of goods averages 60% of the selling price on December 3 1
the cost of the inventory on hand is $840,000 of which $30,000 is obsolete.
Arrangements have been made to sell the obsolete inventory in January at half
;
(d)
amount
to
10%
of sales.
CH. 17
as follows
During Month
Following
Incurred
Month
55%
70%
45%
30%
Fixed expenses
Variable expenses
(e)
527
Annual property taxes amount to $50,000 and are paid in equal installments on
December 31 and March 31 The property taxes are in addition to the expenses
.
in (d) above.
(f)
(g)
anticipated that cash dividends of $20,000 will be paid each quarter on the
15th day of the third month of the quarter.
It is
During the winter, unusual advertising costs will be incurred that require cash
payments of $10,000 in February and $15,000 in March. These advertising
costs are in addition to the expenses in (d) above.
(h)
(i)
(j)
(k)
Equipment replacements are paid for at the rate of $3,000 per month. The
equipment has an average estimated life of six years.
federal
in
March.
On December 31, 19A, the company had a bank loan with an unpaid balance
of $280,000. The loan requires a principal payment of $20,000 on the last day
of each month plus interest at Vi% per month on the unpaid balance at the
first of the month. The entire balance is due on March 31, 19B.
On December
31, 19 A, the
Required:
cash forecast statement by months for the first three months of
19B, showing the cash on hand (or deficiency of cash) at the end of each month.
Present all computations and supporting schedules in good form.
(AICPA
adapted)
17-2. Estimated Operating Statement; Cash Receipts and Disbursements Statement; Estimated Balance Sheet. About three weeks before the end of each year
the Budget Department of the Tonkens Company prepares an operating budget
for the coming year. The budget for the year 19B showed the following figures:
Depreciation
buildings
Depreciation
machinery and equipment
Direct labor
General and administrative expenses
Factory insurance expense
Interest expense
Direct materials purchases
Provision for bad debts
Sales
Marketing expenses
5,625
23,750
1
21 ,875
36,875
12,000
9,000
123,750
9,750
462,500
71,500
528
The
trial
balance of the
company
as of
December
31,
19A
PART V
is:
Trial Balance
December 31, 19A
Cash
in
Bank
Accounts Receivable
Allowance for Uncollectible Accounts
Land
Buildings
Machinery
Accumulated Depreciation
Machinery and Equipment
Accumulated Depreciation
Equipment
Accounts Payable
Notes Payable
Accrued Payroll
30,000.00
120,000.00
and
65,000.00
70,000.00
162,500.00
3,750.00
250,000.00
94,125.00
420,000.00
Capital Stock
Retained Earnings
Sales
22,500.00
195,000.00
1,875.00
1,250.00
50,000.00
187,500.00
Prepaid Insurance
Prepaid Interest
Buildings
10,000.00
145,000.00
323,330.00
67,800.00
8,300.00
7,820.00
$1,117,875.00 $1,117,875.00
35%
It is
$ 8,750
10,500
Accounts payable on December 31, 19B are estimated at $77,500 and the
accrued payroll will be $2,190. A cash dividend of $15,000 will be paid during
the budget year.
Required: (1)
(2)
(3)
An
An
December
31, 19B.
December
31, 19B.
CH. 17
529
is
available
(a) Sales
(b)
The inventory of
goods inventory
(c)
finished
at the
The inventory of raw materials on October 1 was 22,800 pounds. At the end of
each month the raw materials inventory is to be maintained at not less than 40%
of production requirements for the following month. Materials are purchased
as needed in quantities of 25,000 pounds per shipment. Raw materials purchases
of each month are paid in the next succeeding month on terms of net 30 days.
last
(e)
All factory overhead and marketing and administrative expenses are paid on the
10th of the month following the month in which incurred. Marketing expenses
are 10% of gross sales. Administrative expenses, which include depreciation of
$500 per month on office furniture and fixtures, total $33,000 per month.
(f)
The standard
Materials
Vi pound
$ .50
Labor
40
Total
.20
.10
$1.20
is
expected to be $10,000.
is
granted, prepare
(b)
come
in-
taxes.
cash budget for the month of November, showing the opening bal(c)
ance, receipts (itemized by dates of collection), disbursements, and balance at
the end of the month.
(AICPA
adapted)
530
PART V
records:
Mining properties
Accumulated depletion (one year)
Equipment
Accumulated depreciation (one year)
$ 60,000
3,000
150,000
10,000
300,000
184,000
60,000
Sales
From market
studies
(a)
The
(b)
When
(c)
The SI 84,000 production costs include direct labor of $1 10,000 of which $10,000
was due to labor inefficiencies experienced in the early stages of operation.
and gravel
Beginning next year, the union contract calls for a 6% increase in hourly rates.
Other production costs except depreciation, depletion, and direct labor will
increase
(d)
(e)
5%
New
(f)
Show compu-
Required:
forecast income statement for the coming year.
tations to support the figures in the income statement.
(AICPA
adapted)
Production
ratio
(10%)
(b) Production
(c)
is
to current sales.
is
(d) Inventories of
work
in process
is
Production and sales data and the manufacturing cost of goods sold
two preceding periods are:
Period
Units
Beginning inventory
Production
21,000
22,000
20,000
3.3,000
Sales
2,000
3,000
Ending inventory
,000
2.000
31,000
30,000
for the
Amount
532
PART V
time and costs. Analysis of the contract showed the following tasks with
mates of cost and time:
Time Estimates
Weeks)
esti-
Cost Estimates
CH.
17
Inventories
(fifo
533
system)
Beginning Inventories
Raw Materials
Lumber (board
Legs
Units
22,000
feet)
Work
None
in process :
at
Modern
style
Unit Cost
40,000
2,000
2,000
.25
2.00
1.25
Beginning Inventories
Tables
style
Units
.25
2.00
1.25
Finished goods
Spanish
1,500
1,600
(sets)
Ending Inventories
Unit Cost
Units
Unit Cost
500
500
Ending Inventories
Units
$12.75
12.20
12.50
1,000
Unit Cost
$14.25
13.50
1,500
500
500
13.75
The factory overhead includes ten supervisors, each earning $800 per month, and
building, supplies, and utility expenses of $30,000 a month. Total factory overhead
is equally distributed to the three departments and also shared equally by the tables
produced. The factory overhead rate in each department is $1 per table.
Marketing expenses: $25,000 per month.
Administrative expenses: $20,000 per month.
Income tax
rate
30%
style: Spanish, 8
Labor cost
is
feet.
Lumber
all
board
cost
is
and
workers.
(b)
(c)
(d)
first
quarter ending
March
31, 19
prepare:
(in units).
A
A
A
A
534
Type of
Total
Patients
Patient
Expected
Average Number of
Days
in
Regular
Hospital
PART V
Medicare
Private
Semiprivate
Medical
2,100
17
10%
60%
Surgical
2,400
10
15
15
75
Ward
30%
10
Type of
Operation
show
that operations
on
inpatients
CH. 17
Basis of allocations:
salaries
Maintenance of plant
square feet
Operation of plant
535
salaries
8^ ^ to operating room
Administration
All others
(a) Projected
City
City B
All other
cities
Unincorporated areas.
Federal government
State government
.
Total
536
PART V
CASE
Analysis of Budgeted Performance. Mr. George Johnson was hired on July 1,
19A, as assistant general manager of the Botel Division of Staple, Inc. It was
understood that he would be elevated to general manager of the division on
January 1, 19C, when the then current general manager retired; and this was
duly done. In addition to becoming acquainted with the division and his new
duties, George was specifically charged with the responsibility for development
of the 198 and 19C budgets. As general manager in 19C, he was obviously
responsible for the 19D budget.
Staple, Inc. is a highly decentralized multiproduct company. Each division
is quite autonomous. The corporate staff approves division-prepared operating
budgets but seldom makes major changes in them. The corporate staff actively
participates in decisions requiring capital investment (for expansion or replacement) and makes the final decisions. The division management is responsible
for implementing the capital program. The major method used by Staple, Inc.
to measure division performance is "contribution return on division net investment." The budgets presented below were approved by the corporate staff.
Revision of the 19D budget is not considered necessary even though 19C actual
departed from the approved 19C budget.
Actual
19A
19B
19C
19C
19D
SI, 000
$1,500
$1,800
$2,000
$2,400
Accounts
Sales
Employee
programmed
600
75
450
50
30
36
40
120
48
30
50
35
55
25
40
40
60
45
70
120
80
160
100
160
110
200
200
140
140
250
50
20
375
500
100
fixed costs
training
Maintenance
Less division committed fixed costs:
Depreciation
Rent
Total
600
830
871
$1,080
$1,223
400
670
929
920
$1,177
100
150
180
200
400
Division investment
Accounts receivable
Inventory
Fixed assets
Less accounts payable and wages payable
Net investment
Contribution return on net investment
200
1,590
(150 )
300
270
2,800
(350 )
2,565
(225 )
3,380
(300 )
240
480
4,000
(360)
$1,740
$2,790
$2,900
$3,680
$4,360
23%
24%
32%
25%
27%
(3)
CHAPTER 18
be estimated within close limits, the fixed budget seems satisfactory. The
term "fixed" budget is actually misleading, since it is also subject to
revision.
volume
attained.
are compared.
and
It
is
few cases.
If business conditions
537
538
the less
penses,
it
some of which
The reason
PART V
Insurance, taxes, registration, and garaging are fixed costs which remain
same whether the car is operated 1,000 or 20,000 miles. The costs of
and repairs are variable costs and depend largely upon the
miles driven. Obsolescence and depreciation result in a combined type of
semivariable cost which fluctuates to some degree but does not vary directly with the usage of the car. The cost of operating the automobile per
mile depends on the number of miles driven. Mileage constitutes the basis
for judging the activity of the automobile. If the owner prepares an estimate of total costs and compares his actual expenses with the budget at
the
tell
how
within the allowed limits without accounting for the mileage factor.
flexible
budget
some norm
norm should be
expenditures. To recog-
is
known beforehand
is
static.
erroneous,
It is
if
not
is
dynamic,
futile, to
expect a
Each
series, in turn,
has a formula
chine hours.
rate, as
well as the subsequent application of the rate to the level of activity actually
making possible a
The
flexible
budget
assists in evalu-
on
profits
to the con-
has been applied to the entire budget so that production as well as marketing and administrative budgets are prepared on a flexible budget basis.
FLEXIBLE BUDGET,
CH. 18
539
fixed
and
1.
An
2.
flexible
means
business
3.
the
It is
many
the organized
individuals
fixed
and
flexible budgets.
Canacitv
cons titutes
whom management
personnel to
terials, labor,
sales, costs,
and expenses.
Ma-
must be brought
into
harmony with
In discussing the
^o'^vr
540
PART V
sales
budget
sales the
activity)
Is
the
than the amount of sales the company can safely expect to achieve in a
given market during a given period?
upon
decisions
made
Answers
to these questions
depend
CAPACITY LEVELS
The following capacity
p*
Theoretical Capacity.
The
It is
its
It is
if
rated capacity.
is its
achieved
company can
raw materials
must
also
be considered.
influences
or-ders.
Expected Actual Capacity. The use of expected actual capacity for each
period
is
It is feasible
ket
and
makes
style
Normal Capacity.
Firms
may modify
enough to
cyclical variations.
plant capacity and sales volume constitutes one of the important problems
of business management.
FLEXIBLE BUDGET,
CH. 18
541
Use
ofliliese
UiFperiod.
provided nr^rm^l r^pa ntv^nd normal expenses prevail durinf
overheaTwHl result
deviation from normal capacity and /or normal
overhead chapters. It is
in variances as already discussed in the factory
may be compared with
results
actual
the ease and speed with which the
inestimable value in
of
that make the flexible budget
Any
budgeted figures
The
effect
is
rate
per direct labor hour. At higher capacity levels the
is
overhead.
Normal
Practical
Theoretical
Capacity
Capacity
Capacity
75%
85%
100%
7,500 hrs.
8,500 hrs.
10,000 hrs.
$12,000
$12,000
Variable
Total
6,000
6,800
$18,000
$18,800
$1.60
.80
.80
$2.40
$2.21
542
budget system,
PART V
product standard costs, and (3) operating plans. However, other capacity
assumptions are sometimes used due to existing circumstances.
Factors Involved in Determining
Normal Capacity.
In determining the
normal capacity of a plant, both its physical capacity and average sales
expectancy must be considered; neither plant capacity nor sales potential
alone
is sufficient.
As
level
It
should also be
noted that machinery bought for future use and outmoded machinery
Working overtime
2.
Introducing an additional
3.
4.
5.
On
shift
the other hand, the department with excess facilities might have to
reduce them
tween
idle
and excess
capacity.
ducti on becausg_oLa
distinction
FLEXIBLE BUDGET,
CH. 18
543
Unbalanced machinery
it
must be sychronized.
An.y_gxpense^isinjrom
2.
3.
4.
5.
Scheduling production
6.
7.
Measurement of
8.
9.
The normal capacity level fulfills both long- and short-term purposes.
The long-term utilization of the normal capacity level relates the marketing
phase and therewith the pricing policy of the business to the production
phase over a long period of time, leveling out fluctuations that are of short
duration and of comparatively minor significance. The short-term utilization relates to the use
made by management of
the
normal capacity
level
its
causes.
analysis
Fixed Expenses.
increases or decreases.
the
and
same
(3) semivariable.
in total as activity
These and many_other e xpenses not inherently fixed acthrough the dictates of manageme nt poficy.
544
Yet, just as
management
and amount.
PART V
and change a
its
classification
really
The amounts of
fixed ex-
penses remain valid only on the assumption that the underlying conditions remain unchanged. In the long run, all expenses a j^ ypHahlp Some
fixed expenses, however, can be
Variable Expenses.
variable expense
may
there-
is
and maintenance of
measure of activity
such as direct labor hours
or dollars, or machine hours
must be selected as an independent variable for use in estimating the variable expense (the dependent variable)
labor, receiving, storing, rework, perishable tools,
machinery and
tools.
is
thus determined.
For instance,
it is
assumed that
if
prices of
Semivariable Expenses.
and
j^^ariable
fi"^^d
1.
The need
volume.
CH. 18
FLEXIBLE BUDGET,
545
When such
Production factors are divisible into infinitely small units.
movements appear as a series
costs are charted against their volume, their
situation is quite
of steps rather than as a continuous straight line. This
from a two-shift
noticeable in moving from a one-shift to a two-shift or
steps in the cost
definite
in
result
moves
Such
operation.
to a three-shift
be added at one
must
etc.,
clerks,
fine because a complete set of foremen,
point.
of the expense
a corresponding increase in the variable portion
is
dependent variable).
$1,000
RELEVANT RANGE-
UJ
(0
2
0.
X
m
$800 -
<
E
<
>
$400-
Line
UJ
$0
~r~
20
10
40
30
60
50
70
80
90
100
is
This linearity
is
is
indiscriminately from zero to 100 percent.
range,
relevant
negligible as long as activity remains within a reasonably
^NAiQA
No.
546
PART V
activity over
activity.
is
at
may
line
and
and the
(activity)
fixed expense
under consideration.
analytical.
simply zero.
is
is
The
historical
ing statistical methods: (1) high and low points method, (2) statistical
method of
least squares,
least
used
in
expense.
High and Low Points Method. This technique can best be explained
by using an example. To establish the fixed and variable elements of machine repair costs for a producing department, actual expenses incurred
during two different periods are listed on page 547. Periods (data points)
selected are the high and low periods as to activity level from the array of
historical data being analyzed. These periods are usually, but not necessarily, also the highest and lowest figures for the expense being analyzed.
CH. 18
FLEXIBLE BUDGET,
547
Producing Department
Activity Level
Dir ect Labor Hours
Expenses
High
6,840 hours
100%
$2,776
Low
2,736 hours
Difference
4,104 hours
40%
60%
$1,026
Variable rate
$1,026
^ 4,104
1,750
Total expense
Variable expense ($.25 per direct labor hour)
High
Low
$2,776
$1 ,750
1,710
684
$1^066
$1,066
Fixed element
same
having the highest or lowest activity levels are not the
being analyzed, the activity
as those having the highest or lowest expense
These two periods are
selection.
level should govern in making the
If the periods
two
select
conditions.
difference between the activity levels selected is 4,104
rate is determined by
hours with a cost variation of $1,026. The variable
per
by the 4,104 hours, arriving at a variable costing rate
The 60 percent
dividing $1,026
direct labor
hour of
$.25.
The
is
found by
are used.
The same answer is obtained when low activity hours and cost
exWith variable and fixed elements established, it is easy to calculate
factor in the conpense totals for various levels of activity, an important
of the budget
determination
the
in
struction of the flexible budget and
total
expense and
its
fixed
and variable
budget allowance
elements, but it also permits the quick calculation of any
the total expense
within the relevant range of activity i.e., for 4,000 hours,
;
The
$2,066.
is that it
calculations are simple, but the method's disadvantage
assumes that
cost behavior based on only two data points and
determines
548
PART V
$3,066
$2,776
._
$2,250
.vf
$2,066
UJ
a.
"^
$1,750
Fixed and
(0
oc
VARIABLE ELEMENT
$1,500
Variable
UJ
oc
z
z
u
<
^
Elements
in
$1,066
Machine
$750 -
Repairs
FIXED
ELEMENT
$0
1
,000
3,000
2,000
4,000
5,000
7,000 8,000
6,000
6,840
2,736
points,
on a
straight line
Because the high and low points method uses only two data
points.
it
may
Statistical Scattergraph
Method.
is
method various
the
on a vertical line
y-axis; and measurement figures (direct
graph method.
In this
or percentage
plotted
along
X-axis.
statistical
of capacity) are
horizontal
Hne
the
statistical scatter-
electricity
expense
when
in the statistical
CH. 18
FLEXIBLE BUDGET,
549
$800-
$700Dec.
Jan.
Feb. Mar.
<o
2
a.
X
$600-
_^Apr., Noy
UJ
t
u
^
$500-
UJ
$400-
Oct.
Sept. June
July & Aug.
Une^--^-^^
Line A~t VARIABLE ELEMENT
$440-
May
$0-
10,000
30,000
20,000
50,000
40,000
60,000
when 43,000
were worked.
The
x-axis
November
shows the
direct
labor hours, and the y-axis shows the electricity expense. In the scatter-
graph. Line
trend
is
shown by
The
G eneral ly,
therp should be
This Line
The
shows
The increase for
computed as follows
triangle
electricity expense,
Average Monthly
Expense
$440
Fixed
Element
and B
$440
$570
formed by Lines
all activity
$130
_
~
35,000 Hours
Hour
Hour
is
550
now
It is
PART V
Line B
a perfect
cause
it is
is
range.
sion line."
The method of
least
squares (sometimes
best
fit
sum of
the
the
on the regression
it
line is a
from the
minimum.
The following steps are required to arrive at the desired answer using
method of least squares. (Data from page 548 are used for this illustra-
tion.)
1.
2.
First, determine the average direct labor hours and electricity expense.
Total direct labor hours are 420,000 which, when divided by 12, result
in an average of 35,000 hours per month.
Total expense is $6,840, or
an average of $570 per month ($6,840 ^ 12).
computed
Column
in (1)
Column 2
Column 3
Direct
Month
January
February....
March
April
May
June
July
August
September...
October
November...
December...
34,000
30,000
34,000
39,000
42,000
32,000
26,000
26,000
31,000
35,000
43,000
48.000
from
Average of
35,000
lus.
Columns
Column 4
to 4 below.
Column 5
Column 6
Column 2 X
Column 4
Difference
Difference
Labor
Hours
in
Elec-
from Average
tricity
of $570
Column 2
Expense
Electricity Exp.
Squared
S640
620
620
590
500
530
500
500
530
550
580
680
1,000
5,000
1,000
4,000
7,000
3,000
9,000
9,000
4,000
8,000
13,000
70
50
50
20
70
40
70
70
40
20
1,000,000
25,000,000
1,000,000
16,000,000
49,000,000
9,000,000
81,000,000
81,000,000
16,000,000
+
+
10
110
64,000,000
169,000,000
+
+
+
-
512,000,000
3.
Two
multiplications must be
and entered
multiplied by differences
are squared
in
in
+
+
+
+
70,000
250,000
50,000
80,000
490,000
120,000
630,000
630,000
160,000
+
+
80,000
1,430,000
2,270,000
made:
FLEXIBLE BUDGET,
CH. 18
4.
It is
now
possible to
Column
?
7^A
Columns
5.
2,270,000
= gionnnnnn =
512,000,000
551
..
..^
,^^ t^.
-0044 Or 44% or $.44 per 100 Direct
.
Labor Hours
Where: y
=
=
+ bx
$570 Average Electricity Expense
2 270 000
= ^-0044 Variable Rate of Electricity
<ionr>nnnn
5
1 2,000,000
Expense per Direct Labor Hour
a
^=^
$570
$570
$154
=
=
=
=
+
a+
Thus:
$570
$154
per
Month
The above answer differs somewhat from the figure determined by the
method because visual inspection does not offer so accurate
scattergraph
an answer as
this
injects a higher
Many
accountants
Method of Least Squares for Multiple Independent Variables. Typibehavior is shown as dependent on a single measure of volume
on some other independent variable (e.g., the behavior of the dependent
cally, cost
or
In the
method of
analysis), only
sion analysis
one independent variable was considered. Multiple regresa further application and expansion of the method of
is
variable.
552
PART V
independent variable.
in the
equation y
independent variables as
are concerned.
If the cost
accounts
is
may
be possible.
Application of the
statistical scatter-
electricity
Perfect correlation
is
When
perfect.
as a
number
0, there is
As
pendent variable
1,
known
independent variable
(x) increases;
fine
the correlation
is
2For a comprehensive treatment, see Chapter 17, "Regression and Correlation: Multivariate
Analysis," Charles T. Clark and Lawrence L. Schkade, Statistical Analysis for Administrative
Decisions (Cincinnati: South-Western Publishing Co., 1974).
FLEXIBLE BUDGET,
CH. 18
553
(y) decreases as the independent variable (x) increases; and the regression
would slope downward to the right.
The coefficient of determination, known as the number "r^," is found
by squaring the coefficient of correlation. The coefficient of determination
is
cause
it
coefficient
The
(r)
be-
larger the
1.
in the independent variable but that the fluctuations are related to the
related not solely to direct labor hours but to other factors as well, such
correlation.
The
illustrative data,
of correlation
below.
(r)
and the
554
nv;xy
ni:x2
PART V
(vx) (vy)
(Sx)2
n>::y2
(Sy)2
2,900,040,000
182,544,000,000
2,872,800,000
176,400,000,000
.49666
47,275,200
46 ,785,600
j
3,008,102,400,000,000
(6,144,000,000) (489,600)
54,846,170
27.240,000
27,240,000
27,240,000
r2
.24667
two
attributes
flexible budget.
which would
FLEXIBLE BUDGET,
CH. 18
nSxy
n2x2
555
(2x) (2y)
n2y2
(Sx)2
(2y)2
3,362,640,000
182,544,000,000
3,301,200,000
176,400,000,000
(62,426,400
61,779,600
)
61,440.000
(6,144,000,000)
(646,800)
61,440,000
3,973,939,200.000,000
61,440,000
6-3;039jF8
-^M''
Analytical Approach.
^'
-m^
staff
This approach
all
most
efficient
method
to
do
the job,
and
expenses, for close scrutiny of every expense item will frequently reveal
known
or questioned.
when future
556
PART V
and
is
6.
7.
Company
1.
2.
3.
4.
5.
8.
9.
10.
The
profit structure.
major role
in all
subsequent
chapters deahng with profit planning, cost control, and decision making.
It
not intended to convey the idea that the factory overhead budget on a
flexible basis
Any
some
activities
decreases.
When
The
more or
flexible
less direct
throughout
budget concept.
reflected
must be
amount and
this
problem.
been determined, budget allowances for any level within a relevant range
of activity can be computed without difficulty. Illustrated on page 557 is
a budget allowances schedule for normal capacity that becomes the basis
for preparing a flexible budget for the
Machining Department.
In the flexible budget on page 558, the factory overhead rate declines
steadily as production
moves
it
in-
line,
definite level
However, it must be
must be agreed upon and used for setting
of activity.
CH. 18
FLEXIBLE BUDGET,
557
production.
spending and
Costs and base selected and the resulting rate will lead to
idle capacity variances that
more meaningful
In any case, the effective use of cost data for planning, conand decision-making purposes requires reasonably accurate knowl-
procedures.
trol,
its
its
fixed
means
that
all
The
factory over-
?V
^^
^Od.
558
Cl-3V^J)^ f
,\
rA
TV^
.
vjt^
ufe.
/far
A-"^^J' A^^
ArV(<.
r.
Cr.K2
tW^
f\wv\ -
'^^Vs'>r; ^ I0<^
VJM-
cc^
<^^>^ tO
^'^\aD
^C
V^J ^^,.
PART V
^^Z3ql, IV
Operating Level
av>^ AVjl
"^
^^
CH. 18
FLEXIBLE BUDGET,
559
THROUGH ELECTRONIC
DATA PROCESSING AND STEP CHARTS
FLEXIBLE BUDGETING
The determination of
mental expense
is
the fixed
in
each depart-
calculations,
calculator.
this
Whenever
etc.,
560
PART V
Producing Departments
Only
CH. 18
FLEXIBLE BUDGET,
561
562
PART V
FLEXIBLE BUDGET,
CH. 18
6.
Why
is it
fixed,
563
and semi-
variable?
7.
Why
and
8.
9.
its
its
What methods
Select the
(a)
(b)
(c)
The above equation was probably found through the use of the mathematical technique known as (1) linear programming; (2) multiple regression analysis; (3) the method of least squares (simple regression analysis); (4) dynamic programming; (5) none of these.
The relationship shown above is (1) parabolic; (2) curvilinear; (3)
linear; (4) probabilistic; (5) none of these.
The "y" in the above equation is an estimate of (1) total variable costs;
(NAA
adapted)
10.
11.
12.
The
13.
Can service departments' expenses also be set up using flexible budget procedures? What makes the situation difficult? How are the expenses allocated to producing departments ?
14.
Select the
(a) Flexible
may
dards
be adjusted at will;
upon;
(b) If a
(c)
564
(d)
PART V
(e)
Of
would be
activities.
(f)
(g)
(1) theoretical
(h)
incurred.
(i)
The effect of changes in volume on semivariable costs may be approximated by means of a statistical technique employing (1) linear programming; (2) calculation of expected value; (3) the method of least squares
(4)
(j)
matrix algebra.
(AICPA
adapted)
EXERCISES
(
Capacity
Department
80%
(in percentages)
48,000
$96,000
is
90%
100%
110%
54,000
$108,000
60,000
$120,000
66,000
$132,000
levels
of
activity.
:.
CH. 18
FLEXIBLE BUDGET,
565
The variable factory overhead rate for the same three capacity levels.
The amount of unabsorbed fixed overhead if the company operates at
80% of capacity, yet applies a rate based on the 100% capacity level.
(2)
(3)
Required: (1) The variable budget allowance per 100 direct labor hours.
(2) The fixed budget allowance for this expense.
3.
Electricity
Direct
Month
Cost
Labor Hours
November
December
$1,548
1,667
1,405
1,534
1,600
1,600
297
350
January
February
March
April
May
241
280
274
266
285
1,613
1,635
June
301
Required: (1) The amount of fixed overhead and the variable cost ratio
using (a) the high and low points method, (b) a scattergraph with trend line
fitted by inspection, and (c) the method of least squares.
(2) The coefficient of correlation (r) and the coefficient of determination
(r2).
Guest Days
January
February
March
April
May
June
July
August
September
October
November
December
Year
total
1,000
1,500
2,500
3,000
2,500
4,500
6,500
6,000
5,500
3,000
2,500
3,500
42,000
Electricity Cost
400
500
500
700
600
800
1,000
900
900
700
600
800
$8,400
(1) The fixed and variable elements of electricity costs by (a) the
least squares, (b) the high and low points method, and (c) a scatter-
Required:
method of
line fitted
by inspection.
Compute
Power
CH. 18
FLEXIBLE BUDGET,
567
.
.
568
PART V
Qj Flexible Budget. The Ontario Corporation operates its producing departments under a flexible budget with monthly allowances established for 20%
intervals. Capacity is based on direct labor hours with 2,500 direct labor hours
.representing 100% normal capacity.
In the month of October the Shelving Department operated at the 87% level.
The exhibit shows budget allowances at the 80% and 100% levels.
-
For October,
19
80%
Percentage of Capacity
Direct labor hours
2,500
$4,000
$5,000
Indirect labor
Clerical salaries
Factory supplies
Depreciation
Taxes
Insurance
Maintenance
Power
Total indirect expenses
Required: (1)
(2)
100%
2,000
500
500
1,350
1,500
700
430
500
250
200
380
360
750
500
500
250
200
400
400
$4,670
$5,000
$2,335
$2.00
2%
of total
Materials costs are $7 per unit with spoilage averaging
materials costs. Labor costs are $2.25 per hour with 15 hours required to produce 10 units.
fixed nature.
Other expenses which generally were considered wholly variable yet seem to
possess a fixed component are
Expenses
At 30,000 Units
of Production
At 80,000 Units
of Production
$12,500
9,600
3,000
8,000
2,500
6,000
2,500
$20,000
$44,100
$79,600
Supervision
Indirect labor
Payroll taxes
Heat,
light,
and power
Indirect materials
Maintenance of machinery
15,600
7,500
1 8,000
5,000
9,000
4,500
FLEXIBLE BUDGET,
CH. 18
569
Total production has never exceeded 100,000 units in any one year.
Required: (1)
(2)
the 30,000
PROBLEMS
The Cost Department of the Elco Electric
attempts to establish a flexible budget to assist in the control of
marketing expenses each month. An examination of individual expenses shows:
18-1. Statistical Correlation Analysis.
Company
Item
Fixed Portion
Salesmen's salaries
$1,200
2,000
Salesmen
Salesmen
retainers
commissions
none
none
4%
none
Advertising
Travel expenses
Variable Portion
on
sales values
none
5,000
?
Month
their fixed
Calls
Made
January
February
410
420
March
380
460
430
450
390
470
480
490
440
460
April
May
June
July
August
September
October
November
December
split
Statistical
Orders Received
Travel Expenses
$53,000
65,000
48,000
73,000
62,000
67,000
60,000
76,000
82,000
62,000
64,000
80,000
$3,000
3,200
2,800
3,400
3,100
3,200
2,900
3,300
3,500
3,400
3,200
3,400
(Based on an
article in the
NAA
Bulletin)
18-2. Flexible Budget; Overhead Rate. The controller of the Mexicali Corporation decided to prepare a flexible factory overhead budget ranging from 80% to
110% of capacity for the next year with 50,000 hours as the 100% level. The
570
PART V
data used in the construction of this budget were based on either past experiences, shop supervisors' figures, or management's decisions. For expenses of a
semivariable nature, it was necessary to determine the fixed amount and the
variable rate via the high and low points method. The direct labor rate was
$2.50 per hour. Additional data are:
Factory overhead data available:
Annual
fixed expenses:
Depreciation
Insurance
Property taxes
Supervisory staff
payroll
taxes
and
fringe benefits)
Variable expenses:
Shop
supplies
Indirect labor (excluding inspection)
Payroll taxes
Fringe benefits
Semivariable expenses:
(Figures constitute previous six years' experience)
FLEXIBLE BUDGET,
CH. 18
571
Variable Expenses
Indirect labor
Indirect materials
/3
/4 of materials cost
$.10 per direct labor
1
Heat
hour
Light
Power
5%
Miscellaneous
Apportioned
Fixed Expenses
Superintendent
$2,000
/5
1,500
/3
600
/3
Rent
Insurance
to
Each Department
Required: (1)
(2)
demand drops
to
600
company should
follow
if
units.
Cost Variability Analysis. The Cleves Chemical Coma small firm which manufactures cleaning fluid. Its management realizes
that, as a small company, it must strive constantly to control and reduce costs
in order to meet the competition by both large and small chemical firms. The
president is interested in a budget system which the company can use effectively
during the coming year, 19F, to help achieve some degree of control over costs.
The Accounting Department provided the following information:
18-4. Flexible Budget;
pany
is
of product
(thousands)
Liters
sold
five
572
PART V
No budgets had ever been used by the company because it was felt that
budgeting was not feasible for such a small company where most of the operations were directly under the president and two assistants. Prior to his resignation, the former chief accountant had devised a standard labor cost for 19D at
$.10909 per liter for the entire process. An examination of the figures indicates
that they are quite adequate except for an expected rise of about 10% in wage
rates since 19D. Materials costs are expected to rise by 4% for the coming year
over 19E prices. The average cost of the mix of materials was $.25 per liter of
fluid. Materials usage seldom varies; the differences in materials costs over the
years represent changes in the cost of materials.
Required: A flexible budget in income statement form for the year 19F. The
statements should cover a range from 1,250,000 to 2,250,000 liters, with increments of 250,000 liters. Use the high and low points method in segregating the
fixed and variable elements of any semivariable expenses.
Income Statement
9A
$4,000,000
Sales
Direct materials
Direct labor
Variable factory overhead
Fixed factory overhead
Administrative expenses:
Variable
Fixed
Net operating
2,040,000
$1,960,000
$240,000
360,000
$600,000
$320,000
480,000
800,000
1,400,000
$
profit
560,000
year 19B:
A 20%
variable.
At
the end of the year 19B, the actual results were as follows:
Sales
Direct materials
Direct labor
Variable factory overhead
Fixed factory overhead
Variable marketing expenses
Fixed marketing expenses
Variable administrative expenses
Fixed administrative expenses
$4,600,000
940,000
700,000
270,000
410,000
276,000
364,000
380,000
510,000
CH. 18
FLEXIBLE BUDGET,
Required: (1)
573
actual results.
(2) A budget report which would adequately portray and appraise the
performance of those individuals charged with the responsibility of providing
satisfactory earnings and effective cost control.
Sales prices did not change.
This report should make use of flexible budget procedures.
18-6. Budget Planning and Performance Comparison. The Melcher Co. produces
farm equipment at several plants. The business is seasonal and cyclical in
nature. The company has attempted to use budgeting for planning and controlling activities, but the variable nature of the business has caused some
company officials to be skeptical of its usefulness. The accountant for the
Adrian Plant has been using a system she calls "flexible budgeting" to help her
in direct labor
hours
10,000 hours
$9 per unit
$6 per unit
@ $1.50)
Labor cost (2 hours @ $3)
Materials cost (6
lbs,
$ 6,650
600
750
Repairs
Total variable factory overhead
$ 8,000
3,000
$ 6,250
3,250
Supervision
$14,250
4,000
6,000
Hours worked
8,400
3,800
Units produced
Costs incurred:
Materials (24,000
Direct labor
Indirect labor
Indirect materials
Repairs
Depreciation
Supervision
lbs.)
Total
Required: (1)
$36,000
25,200
6,000
600
1,800
3,250
3,000
$75,850
574
PART V
Can
the Melcher
flexible
activities
of
Co.? Explain.
(NAA
adapted)
Department.
Controllable Costs
Employees' salaries
Indirect wages
Indirect materials
Other costs
Fixed Amount
Per Month
FLEXIBLE BUDGET,
CH. 18
575
Employees' salaries
Indirect wages
20,500
2,850
7,510
Indirect materials
Other costs
$40,160
Total
What
Department
activity base
A?
Explain
is
utilized as a
how
(b) The high and low points method was utilized in developing this flexible
budget. Using indirect wage costs as an example, illustrate how this method
would be applied in determining the fixed and variable components of indirect
wage costs for Department A. Assume that the high and low values for indirect wages are $19,400 at 20,000 direct machine ho'urs and $20,100 at 30,000
direct machine hours.
(c)
how
budgeting costs when the annual sales plan and production budget
are completed (about May 5, 19A, or shortly thereafter).
(1) In
(2)
(3) In
(AICPA
adapted)
CASES
Jim Thomas was appointed budget
A. Setting Up a Budgetary Program.
He had no
officer of the Washington Laundry Equipment Company in 19
previous budgeting background, and the president asked him to set up a bud-
was
worked
eff"ectively.
The president
it
Jim requested the Accounting Department to supply him with weekly budshowing the budgeted amount of each expense for the week (computed by dividing the annual budgeted amount by 52), actual expenses incurred
during the week, and the variance for each expense. He also informed all
supervisors that any continued excess of actual expenses over budgeted amounts
get reports
Actual
Sales
Depreciation
Salespersons' travel
Telephone and telegraph.
Office supplies
Department was
as follows:
576
PART V
Jim was highly disturbed over the unfavorable expense variances and told
the sales manager that continued unfavorable variances would be sufficient
cause for his dismissal. The sales manager then discussed the situation with
the president, stating that "either the new budget officer leaves or I'm quitting."
Required: (I) Are the expenses for the Sales Department "unfavorable?"
B. Cost Behavior and the Flexible Budget. The Clark Company has a contract
with a labor union guaranteeing a minimum wage of $500 per month to each
direct labor employee with at least twelve years of service.
At present, 100
employees qualify for this coverage. All direct labor employees are paid $5
per hour.
The
direct labor
budget for 19
for the
first
Variance
((/
three
months of
19
are:
January
February
March
22,000
$127,000
32,000
$162,000
160,000
SI 97,000
10,000
42,000
210,000
unfavorable;
F favorable)
17,0O0F
2,000F
3,000 1/
The factory manager was perplexed by the results that showed favorable
variances when production was low and unfavorable variances when production
was high, because he believed that his control over labor costs was consistently
good.
Required: (1) Explanation and illustration of variances, using amounts and
diagrams as necessary.
(2) Explanation of this direct labor flexible budget as a basis for controlling
direct labor cost, indicating changes that might be made to improve control
over direct labor cost and to facilitate performance evaluation of direct labor
employees.
(AICPA
adapted)
CHAPTER 19
STANDARD COSTING:
SETTING STANDARDS AND
ANALYZING VARIANCES
industrial
many
engineering
having
management since
method of uniting accounting and
planning operations, motivating emusefully served
years ago as a
aid
in
is
created.
Because
both aim
at the
577
578
PART
VI
Building budgets without the use of standard cost figures can never lead
The
been
fair
estimates
with the greatest care and with the cooperation of those in-
set
volved.
only
are
the budget
is
in a vulnerable position
be measured.
is
and
results are to
added as a refinement.
With the use of standard costs, a budget becomes a summary of standards for all items of revenue and costs. When actual costs are superseded
by standard costs, the preparation of budgets for any volume and mixture
of products is more reliably and speedily accomplished.
The principal difference between budgets and standard costs lies in
itself;
The budget,
their scope.
is
post which keeps the business on a charted course. Standards, on the other
hand, do not
what costs are expected to be, but rather what they will be
A budget emphasizes the volume of
business and the cost level which should be maintained if the firm is to
operate as desired. Standards stress the level to which costs should be reif
tell
duced.
If costs
reach this
be increased.
mmponents
a standard and a
norm and whatever is considered normal can
standard
is
like
if
a score of 72
is
cost.
generally
capacity to be used.
time.
change
is
They
in this
chapter and
in
Ma^tmR^s
and /or
CH. 19
579
and current. A
and actual pe rnumber agaijis t which
The expected
2.
overhead over the firm's economic or seasonal cycle. Advoproblem by treating fixed costs as period
costs to be written off at the end of the current fiscal period.
fixed factory
3.
The
ideal or
Establishing budgets.
2.
3.
4.
5.
inventories.
6.
Forming the
setting
selling prices.
These
dard
six
costs.
The
knowledge of expected
costs.
become
cost-
productive operations.
580
PART
VI
can be prepared
in
grated and
tie in
costs.
and variances.
signing costs to
ventories.
raw
file
materials,
work
asin-
greatly
enhanced by the
The standard
cost system
may
However,
it
is
more
I
1
often used
in process cost
of setting standards for a continuous flow of like units than for unique
)
job
orders.
SETTING STANDARDS
The
on the reliability,
and
accuracy,
acceptance of the standards. Extreme care must be taken
to be sure that all factors have been considered in the establishment of
standards. In certain cases, averages of past experience taken from the
accounting records of previous periods are used as standards. However,
the most effective standards are set by the industrial engineering department on the basis of a careful study of all products and operations and
genuine participation by those individuals whose performance is to be
measured by the standards.
success of a standard cost system depends
Time
set after
more or
less intensive
study of past
perform various
made of
is
Above
C:of managers
and workers.
CH. 19
581
illus-
how
cost card
Date of Standard
582
PART
VI
Prices will
market price of any of the principal raw materials or parts takes place.
Price standards permit (1) checking the performance of the purchasing
department and (2) measuring the effect of price increases or decreases on
the company's profits.
if
past
records are not considered a reliable basis on which to predict future costs,
may be
quantity standards
set
Lstandard quantity
is
The determination
been passed.
The
is
computed by comparing
the actual
The standard
quantity allowe d
to produce__one unit
(t he
Illustration.
parlances
Standard unit price of Item Code 5-489 of
the standard cost card (page 581)
$2.50
Purchased
5,000 pieces
Requisitioned
3,550 pieces
$2.47
duction
*
Code 5-489
CH. 19
price variance
Pieces
Materials purchase
price variance
computed as follows
is
= Amount
Unit Cost
5,000
5,000
$2.47 actual
2.50 standard
$12,350
12,500
5,000
$(.03 )
(150) Credit or
The $150
credit
is
favorable
As an
puixh4s^e_ricevariance_an be
when they
rather than
583
m atepal
and
are purchased
^rp
\^e.(\
is
lY\'^IiL-iJii'
is
The $125
debit
is
as follows:
3,550
3,500
$2.50 standard
"
2.50
50
2.50 standard
cjUctvJrTi;\)(Ar.
mQ^O ^cSp
= Amount
Unit Cost
^"^"^"^^
computed
$8,875
8,750
125 Debit or
^^^^^ unfavorable
The
50-pieces figure
is
the physical
amount
variance.
1.
2.
An
rate
many
is
based on
To assure fairness in
all
factors involved.
When
a rate
is
revised or
Any
difference
rise to
labor rate
584
standards
is
PART
VI
by industrial engineers using time and motion studies. Standards are set
in accordance with scientific methods and accepted practices. They are
based on actual performance of a worker or group of workers possessing
average skill and using average effort while performing manual operations
or working on machines operating under normal conditions. Time factors
for acceptable levels of fatigue, personal needs, and delays beyond the
control of the worker are studied and included in the standard. Such allowances are an integral part of the labor standard.
Establishment of time standards requires a detailed study of manufacturing operations.
and
(3)
(1) are
knows
understood by
patterns, or parts.
styles,
direct
labor cost in most plants, time required for setting up machines, waiting,
At the end of any agreed upon reporting period (day, week, or month)
worked are compared with standard hours allowed to arrive
a labor efficiency (or time) variance. The standard hows allowed figuvQ
actual hours
at
found by multiplying the direct labor hours established or predetermined to produce one unit (the standard labor hours per unit) times the
actual number of units produced during the period for which the variances
are being computed. The units produced are the equivalent units of pro-
is
rr~)r
<aAj2_
,
The labor
rate variance
is
computed
A(|/^- A^i^
Time
as follows:
Rate
Amount
1,880
1,880
$6.50 actual
6.00 standard
$12,220
11,280
Labor
1,880
$ .50
rate variance
940
Debitor
unfavorable
is
unfavorable.
CH. 19
The labor
efficiency variance
is
computed
Time
Actual hours worked
Standard hours worked
Labor
The
Rate
1,880
1,590
$6
$6
290
^^^^^
$6
$1,740
Debitor
is
hours allowed.
!o.:%?
^f.O. .>c
is
Tpt'A
Ji>f
JoJ".
9,540
..".'.
$ 2,680
Debit or
unfavorable
^(.jiO-j^ X/^\jj^
$2,680 Debit or
^^^"^^ unfavorable
ment should consider the learning curve phenomenon (see Chapter 14).
The learning curve may well be at least in part an explanation of the labor
efficiency variance associated with
new
to them.
be recalled
is
amount
up
The maximum
limit of a range
set
"z:
$ 1 2,220
that are
-^ ^ o
9,540
"
So
unfavorable
.)MP.X
.
HN
$1 1,280
"
recapitulation of the
Mr^
Amount
standard
efficiency variance
in excess of standard
as follows
585
\vC^
OoywO^i^
586
PART
VI
^
FACTORY OVERHEAD BEHAVIOR PER UNIT OF PRODUCT
Production volume (units)
CH. 19
may
also be used;
Chapter
9).
direct
e.g.,
However^-difect
587
labor h ours
i^_the
standard costing.
illustrate the
$8,000
$4,000
At
the
100%
Hour
^^2^ =
$4,000
^
~
$3,200
Overhead Rate
$4,000
Department
Monthly
Overhead Rate
per Standard Direct
Labor Hour
Flexible Budget
Capacity (expressed as a
percentage of normal
Standard production
Direct labor hours
80%
100%
i20%n
800
1,000
1,200
-^
3,200
4,000
4,800
"
$1,600
$2,000
,200
$2,400
1 ,440
160
800
600
200
960
720
240
$3,840
$4,800
$5,760
$1,200
$1,200
$1,200
700
250
250
400
400
700
250
250
400
400
700
250
250
400
400
$3,200
$3,200
$3,200
$8,000
$8,960
r^,j^
Supplies
Repairs
Power and
light
960
640
480
n;
J^^.
u'']
L j
-f
^ "^
c/
'^^7
Per Direct
Labor Hour
$ .50
.30
.20
.15
.05
$1.20
Power and
light
Maintenance
Total fixed factory over-
head
Total factory overhead
^=
$7,040
==
$3,200 per
month
588
PART VI
Joh<; or proj-gsses a re
cha rged with costs applicable to them on the ba sJ^_Qj[^ tandar d hours
alTowed multiplied by the standard factory overhead ra te. The standard
^^
M
^^amC
'
J>
YVflJr
/V
V<\r"
Illustration.
3 are as
follows
Actual overhead
Standard hours allowed for actual production
Actual hours used
Overall factory overhead variance
units produced X 4 standard
labor hours per unit of production.
*850
$7,384
3,400 hours*
3,475 hours
$584
Department
direct
$7,384
6,800
584 Debit or
unfavorable
2.
3.
The two variances are: (1) controllable variance and (2) volume variance. The controllable variance is fhp differgnre
between actual expenses in curred and the budget allow ance based on
standaj d hours allowed fo r]work_perfofttt&d. The volume"variance repreTwo-Variance Method.
penses charged to
overhead
rate).
work
in process (standard
hours allowed
standard
CH. 19
(1)
?D>^
$7,384
$ 1 .20 variable
UUu
j,
$3,200
also be
4,080
cW'-^ ^^
/
x
-2-
$ 104 Debit or
^^^^^=^ unfavorable
$4,184
4,080
Controllable variance
\>
>T, u*^..
<^^^-^6^,^te.
and can
"^W^i
^r
7^
"^V
as follows
,4
5"Gj?-^Ju_^
7,280
computed
Ia^
al-
overhead rate)
Controllable variance
The
iVs
on standard hours
allowed:
Fixed expenses budgeted
Variable expenses (3,400 standard hours
lowed
589
nTWii
\s
Vov^
VW^
v
Co-wnowVc
104 Debit or
<^
'."?
^^^^^^ unfavorable
The
controllable variance
is
man-
ager to the extent that he can indeed exercise control over the costs to
relate.
-^^^^
$7,280
6,800
Volume variance
480 Debit or
^^^"^^^
unfavorable
This variance consists of fixed expenses only and can also be computed
as follows
4,000
3,400
tuJC
600
ciently
-v^/^DtLM)
eflfi-
i)
$480 Debit or
unfavorable
$.80*)
^""^^^
V^isilfl-Vl
and
is
Three-Variance Method.
ance, (2) idle
variance
is
are:
(1)
variance.
The
spending variT-h
spendin g
>^
590
PART
VI
variance
is
The
10.
worked
efficiency
multiplied by
the standard overhead rate and the standard hours allowed times the
standard overhead
(1)
rate.
Spending Variance:
Actual factory overhead
Budget allowance based on actual hours worked
Fixed expenses budgeted
Variable expenses (3,475 actual hours X $1.20
variable overhead rate)
$7,384
$3,200
4,170
Spending variance
7,370
$
14 Debit or
unfavorable
and can
also
Spending variance
14 Debit or
unfavorable
is
manager
who
is
favorable budget allowance which reduces his variance from $104 to $14.
>joU ^^^
j^ifi}
lo.
^M'^S'^
\JCi^
(2) Idle
t!<-;ok/
5^'^
UsY
-.r^
Capacity Variance:
$7,370
6,950
WslYM^^^^
,tVL^C
^-
420 Debit or
unfavorable
This variance consists of nxed expenses only and can also be computed as follows: 4,000 hours - 3,475 hours = 525 hours X $.80 (fixed
expense rate)
An
$420.
idle capacity
amount of overhead
that
is
^
.
CH.
19
591
$6,950
6,800
Efficiency variance
hours
^^
The
75 hours
150 Debit or
^=^= unfavorable
$2
3,475 hours
3,400
$150.
because actual hours used are more or less than standard hours
allowed. Causes for this variance are inefficiencies, inexperienced labor,
results
etc.
This
mdance an dits
factory^^^oyerheaj[^_when^abo^
applying factory overhead if marh[rip
;
>
hou rs are_the
Y\n^^r<i
basis^Jgr
b asis^lhe varia.nce
g re the
(1)
spending variance,
and
(4) idle
capacity variance. Actually, these four variances merely add to the three-
variance
method an
its
fixed
and
variable components.
(1)
Spending Variance:
Actual factory overhead
Budget allowance based on actual hours worked
$7,384
7,370
Spending variance
14 Debit or
$
^^=^=^ unfavorable
is
method.
(2)
$7,370
7,280
$
'
90 Debit or
unfavorable
This variance recognizes the difference between the 3,475 actual hours
work performed.
The sum of
'Hml VvxS>i
(3)
^/>CrjLfli>'
VCS.
rvS
^O
Vo
-\oS-'f^
CH. 19
5^?=^
v^r,^-t^
overhead rate
allowed
rv^oVib^ f i>62 ^
X
'
59
$2,780
overhead
$.80 fixed
Yh '* fk^^^
U){\s
y\\jf
.^^^^\ji
$.80 fixed
^\^il
1^-^
i'
1,12Q
$.80)
60 Debit or
unfavorable
"^^"^^^^
The
and the
shown
below, are split-offs of the $480 unfavorable volume variance of the twovariance method which was computed by multiplying the 600 hours not
utilized
Jodicates how
Th e fixed ^^'f^nsx^^rian ce
foreman hag_emp1oyedjvaj1abl^
rate.
e ffectively or ineffectively a
_capaily.
(4) Idle
Capacity Variance:
This variance
is
$3,200
2,780
$.80)
"^^
^-^^"^'tS
420 Debit or
unfavorable
i.e.,
the differ-
It in -
the month.
The question might arise as to which factory overhead variance analymethod is most frequently used in industry. Although all methods
are commonly used, the two-variance method seems to be favored. It
should be noted that at times the methods are intermingled, are given different titles, and involve additional analyses. A summary of the three
methods described in this chapter is given on page 592.
sis
MIX
AND
YIELD VARIANCES
yield play
tests.
Comparative costs
594
PART
VI
Mix
Variance.
calculated.
it
difficult at
may be
offset
favor-
by an unfavorable yield
may
is
differences in yield
In
when
total cost
of melted metal
is
is
yield
is
results in a cost of
CH. 19
when 96 pounds of
595
is
processed
and a small percentage is completely lost. On the average it takes approximately 102.5 pounds of sucrose in raw sugar form to produce 100
pounds of sucrose in finished sugars.
In the canning industry it is customary to estimate the expected yield
purchased or delivered to the plant. Should
from predetermined percentages, cost and profit
of the grade will differ. The diff'erence may be due to a shift of the raw
materials into a different grade which has a lower selling value.
of grades per ton of
fruit
Since the final product cost contains not only materials but also labor
is
when
the
The
actual quantities resulting from the processes are multiplied by the stan-
all
may have
It
is
due to the
a significant effect
Problem Involving Mix and Yield Variances. The illustraproblem presented shows the calculation of mix and yield variances
in connection with manufacturing chewing gum. It should be noted that
actual output is placed into finished goods inventory at the total standard
Illustrative
tive
gum
uses a
$.25 per
Ib.^
596
PART
VI
Gum
Sugar
Inventory
in
162,000
30,000
32,000
10,000 lbs.
12,000 lbs.
1 5,000 lbs.
base
Corn syrup
Ending
Purchases
January
Beginning
lbs.
$.24
lbs.
.42
lbs.
(n
15,000 lbs.
4,000 lbs.
11 ,000 lbs.
To
convert 1,200
is
The standard
cost per
$.30
12
Materials
Labor
-10
Factory overhead
$.52 per
lb.
Materials
Quantity
Actual
Standard
Price
Price
Gum
lbs.
$.24
$.25
Corn syrup.
lbs.
.42
lbs.
.11
.40
.10
base.. 162,000
30,000
32,000
Sugar
Unit Price
Variance
Price
Variance
$(.01)
.02
$(1,620)
600
320
.01
price variance
(700 ) Credit or
favorable
Gum
base
Corn syrup
Sugar
(157,000
( 38,000
( 36,000
lbs.
lbs.
(5
$.25)
$.40)
lbs.
$. 10)
231,000
lbs.
$39,250
15,200
3,600
$58,050
lbs.
$57,750
$.25*)
or
lbs.)
$57,750
$.30*]
Weighted average
cost
57,750
$
computed on page
595.
300 Debit or
unfavorable
.,
CH. 19
597
$57,750
$60,000
or
lbs.
(240,000
$60,000
$.25)
60,000
$ (2,250 ) Credit or
favorable
583.
Gum
base:
Unit
Unit
157,000
lbs.
Cost
= Amount
$.25
$39,250
25
40,000
160,000 lbs.*
(750) Credit or
favorable
1,200 lbs.
160,000 lbs.
Corn syrup
Unit
Unit
Cost
= Amount
38,000
lbs.
$.40
$15,200
40,000
lbs.
.40
16,000
(800) Credit or
favorable
The
240,000
lbs.
cf the formula
"
40,000
^"
..
lbs.
Sugar
Unit
Unit
36,000
lbs.
Cost
= Amount
$.10
$3,600
.10
4,000
40,000 lbs.*
(400) Credit or
favorable
The
240,000
formula
lbs.
40,000
^^ j^^'
sugar portion of
lbs.
(1,950) Credit or
favorable
598
The
PART
VI
$15,200+ $3,600),
$60,000 (200,000
lbs.
yield
===
$(1,950) Credit or
favorable
Total
(Lbs.)
(Lbs.)
base.
157,000
-|^
Corn syrup
38,000
Gum
Sugar
The
lbs.
-^
-^
36,000
231,000
lbs.
(Lbs.)
Standard
Formula
(Lbs.)
231,000
154,000
231,000
38,500
231,000
following manner:
Variation
(Lbs.)
3,000
38,500
231,000
'
in the
Actual
Quantity
Using
Standard Actual
Formula Quantity
Actual
Quantity
S.25
(500)
.40
(2,500)
.10
S750
(200)
(250)
$300
lbs.
lbs.
(5/6ths of
231,000
Labor Variances:
lbs.)
lbs.
of chewing
Labor
Labor
rate variance
efficiency variance
as follows
$23,104
22,800
is
304 Debit or
unfavorable
^^'^^
$22,800
X
23,100
(300) Credit or
^^^^^"^^ favorable
$
CH.
19
Labor
$23, 100
24,000
efficiency variance
The labor
599
(900) Credit or
'^^'^^^ favorable
rate variance
is
computed
as
shown on page
on page 585,
is
The
computed
584.
as follows
Time
Actual hours worked
Standard hours allowed
Labor
efficiency variance
The labor
is
200)
$ (1,200) Credit or
=^^=^=
favorable
an unfavorable
$900).
or, as in this
$300
$22,800
24,000
$ 6
^^^^
= Amount
Rate
output
3,800
4,000
150 hours
is
Yield Variance)
$22,000
$12,000
7,600
Spending variance
19,600
$ 2,400 Debit or
unfavorable
$19,600
19,000
600 Debit or
unfavorable
^^^^^^^^^^
Actual hours
Overhead
$19,000
efficiency variance
Overhead
yield variance
at-
Three- Variance
efficiency variance of
19,250
$
(250) Credit or
^^^^^^ favorable
$19,250
20,000
$
(750) Credit or
^"^^'^^ favorable
600
PART
VI
The spending and idle capacity variances are computed in the same
manner as discussed on page 590. The overhead efficiency variance and
the overhead yield variance, when combined, equal the efficiency variance discussed earlier in this chapter on page 591. The overhead yield
variance measures that portion of the total overhead variances resulting
from a favorable
4,000 hours
150
$5
$750).
$22,000
$2)
$12,000
7,700
19,700
===
$ 2,300 Debit or
Controllable variance
unfavorable
$19,700
450 Debit or
$
^==^=^= unfavorable
Overhead
19,250
$19,250
20,000
$ (750) Credit or
^^^"^"^^^
yield variance
favorable
variance, $2,400,
$2
vari-
3,850 hours)
The
idle capacity
overhead
able, the
ance
is
the
same
consisting of $300 variable cost (3,850 standard hours allowed for ex-
pected output
and $450
The journal
4,000)
$2,
$3.
CH. 19
601
management
formed of the
With
their aid,
management
is
in-
supervisory personnel.
Supervisors
who
made
quantity, yield,
and scrap) or as
show up
and
efficiency).
Materials and labor variances can be computed for each materials item,
variable
and
fixed
overhead expenses
in
each department.
were not
their fault.
itself
and
its
employees against
make
^ff
DISCUSSION QUESTIONS
602
PART
VI
3.
Is a Standard cost system equally applicable to job order costing and process
costing?
4.
The problem of
6.
What
determines the
final
decision?
Does a standard cost system increase or decrease the amount of accounting and clerical effort and expense required to prepare cost reports and
financial statements?
What
computed
and factory
overhead ?
7.
8.
How
differ
variance ?
9.
Yield
is
theoretically possible.
10.
11.
The
12.
(a)
The product
(1) direct cost; (2) fixed cost; (3) joint cost; (4)
(b)
(c)
is
expected cost.
is
(e)
CH. 19
(f)
603
$100; (2) $55; (3) $105; (4) $50, and the materials quantity vari(1) $100; (2) $55; (3) $105; (4) $50.
company has set its normal capacity at 24,000 hours for the current
(g)
year. Fixed overhead was budgeted for $18,000 while variable overhead
was budgeted for $24,000. Actual hours worked for the current year
were 22,000. The idle capacity variance for the current year is (1)
is
(1)
ance
is
(AICPA
adapted)
EXERCISES
Wherever variances are required
in
^ve
$20,000
Total
604
PART
VI
Factory Overhead Variance Analysis. The accountant for the McGee Company prepared the following flexible monthly factory overhead budget:
4.
10,400
9,600
8,800
8,000 (normal capacity)
7,200
at
$21,600
20,400
19,200
18,000
16,800
In August the actual factory overhead was $21,200. The company operated
of normal capacity. Standard hours allowed for actual production
125%
were 10,200.
Required: An analysis of factory overhead by (a) the two-variance
(b) the three-variance method.
method
and
Flexible Budget
Glenmore
Company
CH. 19
605
for performing
(1
packet of chemicals
$.50)
$6 per direct labor hour)
direct labor hour)*
$ .50
1
test
$3.50
.00
2.00
tests
S'OtJo tisTs
,
"
_>
SOooO
QXlon^^.^
3V
73
"? -?
"U
Krt
incurred
$ 2,600
5,100
9,200
Total
$16,900
$16,900
^
^-,
^- ^
$3.52 average cost per
blood
test
Fund of the
materials used.
Based on normal highway repair of 30,000 cubic yards per month, the
standards are:
Materials ($5 per cubic yard)
Labor
(Vz
hour
$5.00
at $2)
1.00
Overhead
Fixed ($1 per direct labor dollar)
.00*
.00
$8.00
The
$168,300
33,150
66,000
h^i) -r
L^
606
PART
VI
8. iFactory
$13,200
$90,230
$8,000
$2 per direct labor hour
Variable overhead
40,000
40,300
39,500
5,500 standard direct
labor hours
Direct materials
Direct labor
Factory overhead
24
kilograms (kg.)
6 hours
6 hours
(;
(&
$3.00 per kg
3.25 per hour
.75 per hour
$72.00
19.50
4.50
$96.00
The
factory overhead
80%
Hours
90%
flexible
budget:
100%,
110%
36,000
40,500
45,000
49,500
Variable expenses
Fixed expenses
$18,000
11,250
$20,250
11,250
$22,500
11,250
$24,750
11,250
$29,250
$31,500
$33,750
$36,000
(direct labor)
Other data:
Opening inventory, work
Closing inventory, work
Required:
cost,
and
(c)
in process,
in process,
50%
50%
converted.
converted.
variance analysis of (a) the direct materials, (b) the direct labor
the factory overhead (two-variance method).
CH. 19
10.
Variance Analyses
607
The Brad-
production costs.
The standard
Lumber, 100
feet
$15.00
10.00
Factory overhead:
Fixed (30% of direct labor)
Variable (60% of direct labor)
$3.00
6.00
The following
flexible
is
in effect
Budgeted Overhead
$10,800
10,200
9,600
9,000
8,400
5,200
4,800
4,400
4,000 (normal capacity)
3,600
The
9.00
$34.00
@
@
feet
$120 per 1,000 feet)
$2.60 per hour)
Direct labor (4}i hours
Factory overhead ($10,560 ^ 1,200 units)
as follows
$13.20
1 1
.05
8.80
$33.05
(AICPA
adapted)
$1.50 per lb
40 lbs. of materials
$2 per hour
20 hours of direct labor
Factory overhead (40% variable)
$ 60
Total cost
$130
40
30
On
still
in
September
work
when
in process;
608
is
PART
VI
month of September:
Materials purchased:
Pounds
Amount
8,000
8,000
4,000
$12,000
12,000
5,600
lbs.
Factory overhead was applied on the basis of allowed standard hours. Actual
factory overhead incurred was $13,140. Standard normal capacity was estimated at 400 kartz per month.
Required: (1)
quantity schedule.
(2) An equivalent production schedule.
(3) Variance analysis of (a) direct materials, (b) direct labor, and
overhead using the two-variance method.
(c)
(AICPA
factory
adapted)
12. Price, Mix, and Yield Variances. The Zorba Manufacturing Company uses
a standard cost system. The standard cost card for one of its products shows
the following materials standards:
Material
Kilograms
(kg.)
610
PART
VI
runs of 1,200 quarts each. The standard product mix for making 1,200 quarts of
Datrex
is
^i
C"
Material
Actual Price
$.26 per quart
3,400 quarts
2,900 quarts
1,300 quarts
T
Required: The materials
December production run.
price, mix,
and
PROBLEMS
Wherever variances are required
in
Specifications
and Standards
plywood
$256 per
Mechanism
Department
Screws, rivets, and glue:
Used in Department 2
Used in Department 3
in
9.20 each
34
10
Department 1
Department 2
Department 3
Factory Overhead
1.100 hour
$2.40
2.20
100%
150%
.250 hour
1.60
75%
.085 hour
Actual Performance
sq.
ft.
CH. 19
ply panels
hardware
mechanisms
sets
screws, etc.
611
612
PART
VI
Factory Overhead:
Compounding
Filling
and packing
Required: (1) A standard cost sheet for one gross bottles of this product,
arranging the data under the five subheadings listed above. Calculations should
be made to the nearest cent per gross.
(2) The company expected to produce 1,000 gross of Lanosof Lotion in its
first week of production, but actually produced only 850 gross.
Its direct labor cost of filling and packing was: 825 hours
$1,467.75. Prepare an analysis
of the labor variance from standard.
(AICPA
adapted)
Company
product.
Total standard cost per unit including overhead on a direct labor hour
basis, $23.55.
March:
of month, none
Completed during month, 8,000 units
In process
first
In process end of month, 1,000 units, which are one-half complete as to labor
and overhead and have had all of Material P issued for them and sufficient
Material Q for one half of them.
Direct labor was $88,440, which was at a rate of $1.32 per hour.
Materials issued to production
94,000 kilograms of
42,600 units of Q
Required:
and an
(AICPA
adapted)
Raw
Standard Cost
Materials
Scrap iron
Pig iron
Coke
Flux
$56.00
67.20
70.00
20.00
per
per
per
per
ton
CH. 19
Raw
613
materials are loaded into the cupola in 500-lb. "charges" consisting of:
Materials
Quantities
Scrap iron
Pig iron
Coke
Flux
A "charge"
is
The standard
425
20
45
lbs.
10
lbs.
500
lbs.
lbs.
lbs.
yield of
During the month, 600 charges were melted and yielded the standard amount
of good castings. The following amounts of raw materials were requisitioned
and used during the month:
Raw
Materials
Quantities
Scrap iron
Pig iron
256,800
12,600
26,400
6,000
Coke
Flux
lbs.
lbs.
lbs.
lbs.
Actual Cost
$ 7,704.00
315.00
1,056.00
60.00
The standard labor rate was $2.50 per hour, and 3,200 hours should have
been worked based on the production for this month. Actual direct labor cost
was $7,824 for an actual average labor rate of $2.40 per hour.
Total annual factory overhead including fixed overhead is $200,000 to be
applied on the basis of estimated 40,000 direct labor hours. The variable overhead rate is $2.60 per direct labor hour. Actual overhead during January was
$15,800.
Required: (1) Materials price and quantity variances for each material.
pound of
@
@
$ 35
$215
Normal
Raw
capacity per
materials used
110
70
month
statistics are:
24,000 units
14,500 lbs.
$ 8,000
23,000
1 5,000
7,200
614
PART
VI
from standard
(AICPA
adapted)
Glyoxide
Florimene
Data on standard
costs:
3 lbs.
(q:
5 hrs. (S
$1 per lb.
$2 per hr.
lbs.
6 hrs.
month
per
Normal
activity per
month. 5,750
Direct labor
1,200 units
1,000 units
3,100
materials
Raw
$26,520
$20,700
lbs.
lbs.
$1.15 per
7,400 hrs.
S2.55perhr.
4,700
lb.
$25,234
$26,400
$16,170
$20,930
Required: Select the correct answer for each of the following statements.
Support each answer with computations that are clearly labeled.
(a)
The
(1)
(2)
(3)
(4)
(5)
(b)
(2)
(3)
(4)
(5)
both products
in
September are:
The labor
(1)
(c)
both products
in
September are:
Florimene,
Florimene,
Florimene,
Florimene,
none of the above.
The labor
both products
in
September are
CH. 19
(d)
615
(AICPA
adapted)
19-7. Variance Analyses; Unit Manufacturing Cost. Bronson Company manufactures a fuel addhive with a stable selling price of $40 per drum. Since the
company lost a government contract, it has been producing and selling 80,000
drums per month (50% of normal capacity). For the coming fiscal year, man-
of Miracle
Mix
$16
empty drum
"$17
Direct labor
hour
$5
$6
Factory overhead
(b)
Miracle Mix:
500,000 gallons purchased
Empty drums:
94,000 purchased
Direct labor:
$414,100
Factory overhead:
Depreciation of building and machinery (fixed)
Supervision and indirect labor (semivariable)
Other factory overhead (variable)
$210,000
460,000
98,000
$768,000
Other factory overhead was the only actual factory overhead cost that
varied from the overhead budget allowance for the September, 19
level of actual production; other actual factory overhead was $98,000,
and the budgeted amount was $90,000.
(d)
in-
linear.
(e)
616
September, 19
(f)
is
PART
VI
considered
tion of 140,000 drums per month, using these cost categories: materials, direct
labor, fixed factory overhead, and variable factory overhead.
(AICPA
adapted)
The
Sharpstown Company
19B, due to a fire.
The
trial
lost
most of
its
Inventories:
Raw
65,900
General Ledger
$119,900
$119,900
All payments
Credit
$ 54,000
Materials
Finished Goods
Work in Process
$119,900
office.
copy of the January 19B standard cost variance report was found showing
the following data:
Favorable
Unfavorable
price variance
quantity variance
rate variance
Direct labor
efficiency variance
Factory overhead spending variance
capacity variance
efficiency variance
Raw
$2,000
materials
480
3,000
1
,250
,000
3,000
idle
1,000
The executive to whom the variance report had been sent noted beside the
spending variance "Budget Allowance for January, $26,000" and wrote on the
top of the report "January Production, 25,000 units."
The following additional
facts are
made
available
Standard costs are revised annually at the beginning of each fiscal year. The
figures in the trial balance reflect 19B standards.
(b) The actual direct labor costs for January 19B were $33,000 based on 12,000
actual hours worked. This information as well as the fact that actual hours or
production represent 80*^ of normal hours or production was obtained from
(a)
(c)
(d)
The
Raw
ary
1,
No
at
Janu-
CH. 19
(e)
Overhead
(f)
is
(g) All
Required: (1)
617
in
19-9. Standard Costs for Lots; Variance Analysis of Cost Elements. Vincenti
stores.
Shirts, Inc. manufactures short- and long-sleeve men's shirts for large
Vincenti produces a single quality shirt in lots to each customer's order and
attaches the store's label to each. The standard costs for a dozen long-sleeve
shirts are
24 meters
3 hours
3 hours
Direct materials
Direct labor
Factory overhead
@ $ .55
@ $2.50
@ $2.25
$13.20
7.50
6.75
%HA5
shirts.
Units in Lot
Lot
000 dozen
30
31
1,650
1,200
32
"
"
Materials Used
Hours Worked
24,100 meters
"
40,440
"
28,750
3,000 hours
"
5,130
"
2,870
available
(c)
Overhead
is
Factory overhead
totaling $25,500
(d)
(e)
A total of $324,000 was budgeted for factory overhead for the year 19, based
on estimated production at the plant's normal capacity of 48,000 dozen shirts
per year. Overhead is 40% fixed and 60% variable at this level of production.
There was no work in process at October 1. During October Lots 30 and 31
were completed all materials were issued for Lot 32, and it was 80% completed
;
as to labor.
618
PART
VI
19-10. Materials Price, Quantity, Mix, and Yield Variance Analysis. Sudsall
Corporation manufactures a laundry detergent that requires three major
A, B, and C.
components
Material
Material
Material
50 kilograms
"
50
"
25
@
@
@
"
1.00
125 kilograms
$ 40.00
35.00
25.00
$100.00
Work
month of November
in process inventory,
November
3,000 kg.
4,800 kilograms
"
5,400
"
2,500
@
@
@
.99
Output:
Finished product
in process inventory,
Work
9,900 kg.
3,200 kg.
November 30
Required: All materials variances, including the total quantity variance analyzed as to mix and yield components, for November.
Ingredients
Quantities
Unit
Mix
{Pounds)
Cost
Cost
Cocoa beans
800
Milk
Sugar
3,700
$.45
.50
500
.25
Total batch
5,000
360
1,850
125
$2,335
Cocoa beans
Milk
Sugar
225,000
lbs.
,400,000
lbs.
250,000
lbs.
1,875,000
lbs.
@
@
@
$.425 per
.533 per
.240 per
lb.
$ 95,625
lb.
746,200
60,000
lb.
$901,825
CH. 19
619
19-12. Materials, Mix and Yield, Labor, and Overhead Variances. The Brandon
Cement Manufacturing Company uses a standard cost system for its production
of cement. Cement is produced by mixing two major raw material components,
A (lime) and B (clay), with water and by adding a third raw material component
C, quantitatively insignificant.
Materials standards and cost for the production of 100 tons output are:
Components
Material
Material
Material
Tons
Cost
Percent of
Input Quantity
$43.00
35.00
25.00
50%
40%
10%
$2,365
1,540
100%
$4,180
55
44
_n_
Input
110
Output
100
The monthly
Amount
275
=
=
4,180
Variable Overhead
Fixed Overhead
Plant manager
Supervisors
Indirect labor
$ 2,000
1 ,800
2,220
production
850
300
480
500
450
Indirect supplies
facilities.
Total
810
2,040
2,200
2,000
1,200
3,775
$8,250
$12,375
To convert 1 10 tons of raw materials into 100 tons of finished cement requires
500 direct labor hours at $2.50 per direct labor hour or $12.50 per ton. Factory
overhead is applied on a direct labor hour basis.
Actual data for the month of April
15,800 hrs.
$1 1,075
$ 8,490
Materials Purchased
Materials Requisitioned
Price
Material
Materials
Material
No
inventories of
month of April
Quantity
per Ton
Quantity
2,000 tons
1,200 tons
500 tons
$44
37
24
1,870 tons
1,100 tons
440 tons
existed.
time of purchase.
Required: (1) Materials price, mix, and yield variances.
(2)
(3)
and
yield variances.
CHAPTER 20
STANDARD COSTING:
ACCUMULATING, REPORTING,
AND EVALUATING COSTS
AND VARIANCES
It
permits
work
in process
Some
systems employ
The
Partial Plan.
work
in process
(materials,
account
is
debited for the actual cost of materials, labor, and factory overhead and
620
CH. 20
The
Partial Plan
WORK
IN
Actual
cost
PROCESS
WORK
IN
PROCESS
621
622
3.
when
in
and
PART
VI
Calculate variances
(2).
At
method
results in
This
is
is dif-
of purchase.
Illustrations.
chased are illustrated below. The data used for these methods are identical
with that used in the previous chapter
Standard unit price as per standard cost card
Purchased
Requisitioned
Standard quantity allowed for actual production
Method
1.
$2.50
5,000 pieces
3,550 pieces
3,500 pieces
12,500
Accounts Payable
Materials Purchase Price Variance
12,350
150
is
Work
in Process
Materials Quantity Variance
Materials
Method
2.
8,750
125
8,875
is
12,350
Materials
Accounts Payable
No
variance
journal entry
Work
$2.47
Materials
When
(q}
is
computed.
12,350
issued, the
is
in Process
Materials Quantity Variance
Materials
Materials Price Usage Variance
8,750.00
125.00
8,768.50
106.50
CH. 20
Computations for
Pieces
Unit Cost
3,550
3,550
$2.47 actual
2.50 standard
3,550
$(.03 )
Pieces
method
Amount
$8,768.50
8,875.00
$
Unit Cost
(106.50) Credit or
~ favorable
Amount
3,550
3,500
$2.50 standard
2.50 standard
$8,875.00
8,750.00
50
$2.50 standard
In this
623
on
issued
not
cost used
is
As no other
is
correct.
cost
is
available
and no other
would depend upon the type of inventory costing method employed, such
as fifo,
lifo,
The
or average costing.
$.03 less than the standard price; the quantity variance because 50 pieces
were used
be
in excess of the
first
entry in
Materials
Method
When
would
12,500
Accounts Payable
Materials Purchase Price Variance
Work
1,
12,350
1 50
are
made
in Process
8,750
125
8,875
This entry recognizes the 50 pieces used beyond the standard quantity.
Materials Purchase Price Variance
Materials Price Usage Variance
106.50
106.50
This entry transfers $106.50 from the purchase price variance account
to the materials price usage variance account.
Any
balance remaining in
the materials purchase price variance account at the end of the accounting
period
is
cost.
sheet
would show:
$3,625.00
43.50
$3,581.50
624
PART
VI
tickets,
i.e.:
is
made
1 ,880 hours
$6.50 per hour
1,590 hours
$6 per hour
to set
up the
12,220
Accrued Payroll
To
12,220
journal entry
Work
and
to set
is:
in Process
9,540
940
1,740
Payroll
12,220
is
is
applied overhead cost, but also against a budget prepared at the beginning
of the
fiscal
company
expects to operate during the period as well as against actual and standard
activity allowed for actual production.
illustrate the
journal entries:
Labor
Hours
Total
Overhead
Rate
Overhead
per Hour
4,000
S8,000
$ 2.00
Direct
Normal
capacity
$3,200
4,800
.
3,475
3,400
$7,384
80
1.20
CH. 20
2.
When
overhead
is
applied to
7,384
7,384
work
in process:
Work
in Process
Factory Overhead Control
6,800
6,800
3.
625
it is
subsequently transferred
The
Controllable Variance
104
Volume Variance
480
584
2.
When
overhead
Work
in Process
is
applied to
7,384
7,384
work
in process:
Efficiency Variance
6,800
150
6,950
The
as follows
Spending Variance
Idle Capacity Variance
Factory Overhead Control
14
420
434
As an alternative, Entry 2 may be recorded as a debit to Work in Proand as a credit to Factory Overhead Control for $6,800. The balance
Factory Overhead Control of $584 would then be closed as follows:
cess
in
Spending Variance
Efficiency Variance
Idle Capacity Variance
Factory Overhead Control
14
50
420
1
584
7,384
7,384
626
2.
When
Work
overhead
in
is
work
applied to
in
VI
process:
Process
6,800
PART
90
60
6,950
The factory overhead control account now has a debit balance of $434,
which can be analyzed as spending and idle capacity variances and closed
as follows:
Spending Variance
14
420
As an
alternative, Entry 2
may be
recorded as a debit to
Work
in Pro-
cess
in
434
and
as a credit to Factory
Spending Variance
14
90
60
420
584
of the
work
last
in process
Work
The
Goods
(at
is
as follows:
xxxx
standard cost)
standard cost)
xxxx
in Process (at
finished
will
show
standard costs of the units remain the same during a period unless severe
cost changes occur.
When
Goods
standard cost)
standard cost)
(at
(at
is:
xxxx
mix and
yield variances
computed
in the
To record
materials purchases:
Materials
Accounts Payable
Materials Purchase Price Variance
55,700
55,000
700
CH. 20
2.
To charge
Work in
Process
Materials Mix Variance
Materials
3.
To
627
57,750
300
58,050
Finished Goods
Materials Yield Variance
Work in Process
60,000
2,250
57,750
To
set
up payroll
liability:
Payroll
23,104
Accrued Payroll
2.
To transfer payroll
Work in Process
23,104
to
work
in process
and
to isolate variances:
23,100
304
300
Payroll
3.
To
23,104
Finished
Goods
24,000
Work
900
in Process
23,100
To
22,000
22,000
to products:
19,250
To
set
19,250
Controllable Variance
2,300
To
450
2,750
Finished
Goods
20,000
Work
It
750
in Process
19,250
Work
in Process
is
production (yield) that should be attained from the input into the system
and not for the standard for the amount of actual production (output).
628
The
resulting difference
PART
When
is
V!
is
re-
Finished
Work
Goods
in
yield variance
is
104,000
$.52).
100,100
3,900
comprised of:
$2,250 favorable
"
900
750
lbs.
192:500
lbs.
,^,
^
= ^Q3.89or
7,500
lbs.
j,,;3QQ^,^^
is
"
3.89 percent.
, ^_
XlOO = 3.89%
,^^
ances occur?"
And,
if
is
"What
corrective
management
"Why
to carry out
an
The
if
extent of
some
Of
course, there
is
be of
To
and reported as
no
substitute for
and remedial
CH. 20
629
outside the limits of its control. Internal factors such as costly rush orders
necessitated by sudden changes in production plans requiring materials
at special prices
fault
may
result
may
If the
who
prepared the purchase requisition which informed the purchasing department concerning the quality of materials to be purchased. If the purchasing department varied from the purchase requisition specifications, the
may
fault
lie
Or perhaps the
when they were
faulty materials
received.
Other
Labor
if
usually based
too, a
rate.
scheduling of
Labor
work assignments.
efficiency variances
may
in
be observed in
factories.
and
Then,
The spending or
controllable variance
actual cost
is
generally ascribed to
Differences between
may
be caused by
figure, in turn,
is
etc.
with regard to the utilization of plant capacity and the setting of the
rate's volume base rests with the planning group.
However, changes within the range of fixed costs occur due to changes
in depreciation rates, increase in insurance premiums, increases in salaries
of top-level managers, etc. The managerial significance and use of the
spending and idle capacity variances are discussed in more detail in
Chapter 9, pages 229-233. Responsibility for overhead efficiency variances (both the fixed and variable components) is generally attributed to
the department manager.
predetermined overhead
No
significant variance,
630
PART
VI
Perhaps stan-
more than
offset by a
low cost materials of poor quality) or
necessary activities such as maintenance of equipment are being neglected,
causing lower expenditures and a favorable variance. Of course, manis
is
terms of explaining the origin, the responsibility, and the cause of the
variance.
a decision
cost variances
and
be established so that
if
considered acceptable;
if
A
costs
decision to investigate
and deviations
it
can be
is
it
is
reasonable.
(variances) therefrom.
formances.
What
is
needed
now
is
pered by estimated changes in the future, usually furnish reliable bases for
estimating expected costs and calculating control limits that serve to
indicate
good
as well as
The question
is
"By
CH. 20
631
at this time.
may
be judged
signifi-
The
example
in the above
cost classification, maintenance expenses, is used
from the basic
as a fixed cost which assumes that no deviation
amount
is
the variance
Illustration II.
Assume
established.
and
is
$.05(2,700)
($14,000
$3,135.
The
$10,000) variance.
order to
Control and investigation limits should be established in
highlighted
is
variance
each
that
present cost and variance information so
variance is above the upper
in a manner indicating whether or not the
control limit.
control limit, within the control limit, or below the lower
to accept
Such information enables the responsible manager or supervisor
of costs
control
the
for
tool
valuable
the deviations from the standard as a
to
averse
more
being
their
in his department and lessens the dangers of
concerned
A manager, unduly
risk than upper-level managers prefer.
may perform in a manner that
variances,
small
even
for
about the penalty
profitable operations.
DISPOSITION OF VARIANCES
be disposed of in either of the following ways: (1) they
may be closed to Income Summary or (2) they may be treated as adjustments to Cost of Goods Sold and to inventories.
Variances
may
632
PART
VI
The determination of an
The use of a factory overhead rate as
many companies indicates that management has accepted this
is
practiced in
almost impossible.
it
workable.
To
which they arise might distort the net income figure reveals
a misunderstanding of standard costs. The treatment of variances dematerials, labor, or factory overpends upon: (1) type of variance
the period in
head, (2) size of variance, (3) experience with standard costs, (4) cause of
variance (e.g., incorrect standards), and (5) timing of the variance, (e.g.,
The
1.
Any
fluctuations).
summarized
as follows
They should not be dethem in the inventory accounts. This would include quantity variances on materials and labor as well as idle time
(capacity) and efficiency variances on overhead.
should be written
off"
ferred by capitalizing
2.
An
would
bring the work in process and finished goods inventories up to, but not
in excess of, current market values. The rest of the price (spending and
rate) variance amounts should be written off", as they represent excess
costs. In this way, the inventory accounts themselves will be valued at
standard cost while the inventories on the balance sheet will, as a whole,
be shown at reasonable values through the use of the inventory reserve
In addition, losses caused by excessive costs and inefficiencies
be shown in the operating statement for the period in which they
account.
will
occur. 1
and
Method
finished
month
or year
is
to consider
them
as profit or
loss
items.
Variances, in
effect,
tween the actual and standard costs of operations for the month or year.
iW. Wesley Miller, "Standard Costs and Their Relation
Vol. XXVII, No. 15, p. 692.
to Cost Control,"
NA{C)A
Bulletin,
CH. 20
633
Income Statement
see Schedule
31, 19
^^2,000
^^'^^^
$28,000
Debit
Balances
$
.200
^00
720
Labor
^'^00
$ 3,720
^'^^^
$24,280
i'^iin
O'*^"^
s nnn
i6,y}w
profit (adjusted)
Less: Marketing expenses
Administrative expenses
Gross
Net operating
$ ^'^80
profit
Schedule
^^^'nnn
'^'Q^"
Materials used
^In
aaX
lO'OW
Direct labor
z\j,wu
Factory overhead
$46,000
^^'^^^
^^2 nnn
^'^^^
$^4,000
method
is
de-
summary account by
Income Summary
^'
Labor
Efficiency Variance
"J:
'jrJJ
''"^"^
may
^^.p.
^"JJ
Volume Variance
The
variances)
Controllable Variance
As an
'^"
to
Income Summary.
634
Accountants
who
PART
VI
No
variance
treated as an in-
is
all
This viewpoint
summary account
at the
on hand and shown on the balance sheet as part of the cost of the
20%
account.
This method would increase the materials account and lower the cost
of goods sold, increasing the net operating profit from $6,280 to $6,520.
be:
Income Summary
3,480
240
Materials
Materials Purchase Price Variance
Labor
1,200
600
720
Efficiency Variance
Controllable Variance
Volume Variance
,200
considered ac-
is
Second Method:
No. 43
if
of inventories that
flect
In such cases descriptive language should be used which will express this
relationship, as, for instance,
first-in,
it
is
CH. 20
635
must
is
treat
made
Also,
Using the previous figures and other data, the following computations
and prorations would be made when variances are distributed to inventories and Cost of Goods Sold
CONTROLLING COSTS AND PROFITS
636
PART
Income Statement
Gross
31, 19
see Schedule
$52,000
25,800
profit (actual)
$26,200
$12,000
6,000
Administrative expenses
Net operating
profit
8,000
$ 8,200
Schedule
31,
19
Standard
Materials available
Materials purchase price variance
Less materials inventory (ending)
Materials purchase price variance
$20,000
Materials used
Materials purchase price variance
Direct labor
Efficiency variance
$1 6,000
Factory overhead
Variance
Actual
$21,200
$1,200
4,000
4,240
240
10,000
20,000
Controllable variance
Volume variance
$46,000
16,000
$30,000
6,000
$24,000
VI
CH. 20
REVISION OF
637
STANDARD COSTS
details.
Events, rather
and changes
among
special requirements,
and changes
rate adjustments,
Ex-
changes have already been incorporated in the standard costs being used
in order to reflect the
new
conditions.
New
and
too,
may
If
new labor
Other overhead
costs,
change.
over
is
comparatively easy.
When
up or down"
off"ers
arbitrarily.
changes
1.
If the
new standard
new standard cost and carry the contra side of the adjusting
entry to cost of sales by way of the variance accounts. In effect, this
procedure assumes that the standard costs used to cost goods in the
inventory have been incorrect and that restatement of inventory cost
to the
accounts.
2.
standard costs represent conditions which are expected to precoming period but which have not affected costs in the
past period, ending inventories are costed at the old standards. It
appears to be common practice to adjust the detailed inventory
records to new standard costs.
In order to maintain the control relationship which the inventory
accounts have over subsidiary records, the same adjustment is entered
in the inventory control accounts; and the contra entry is carried to
an inventory valuation account. Thus, the net effect is to state the
inventory in the closing balance sheet at old standard costs. In the
If the
vail in the
638
is
PART
VI
when the goods to which the reserve relates move out of inventories.
By use of this technique, the detailed records can be adjusted to new
standards before the beginning of the year while at the same time the
net charge to cost of sales in the new period is for old standard cost
since the latter cost
was correct
is
This powerful working tool for planning and control can be used in other
aspects of business organizations (as discussed in Chapter 23, "Marketing
many
opportunities to
mental agencies,
etc., in
harmony with
and
ning of work, including staffing needs, and the planning and control of
routine operating activities.
^
1.
DISCUSSION QUESTIONS
Some
them only
2.
The
3.
4.
Diff'erences between actual costs and standard costs are found in the variance
accounts of which a great number are discussed in the chapter. What considerations might determine the number of variance accounts?
5.
is
considered
3"How Standard
p. 64.
NA(C)A Standard
CH. 20
6.
639
The determination of periodic net income depends greatly upon the cost
assigned to raw materials, work in process, and finished goods inventories.
8.
9.
and,
ations.
(a)
(b)
What
(c)
(2)
(3)
(AICPA
10.
sheet.
adapted)
Which of
fiscal year, the Graham Company had several subfrom standard variable manufacturing costs. The
one for which there is the strongest justification for allocation between
inventories and cost of goods sold is the one attributable to (1) additional costs of raw material acquired under a speculative purchase
contract; (2) a breakdown of equipment; (3) overestimates of production activity for the period, resulting from failure to predict an unusual
decline in the market for the company's product; (4) increased labor
rates won by the union as a result of a strike during the year.
Standard costing will produce the same financial statement results as
stantial variances
(c)
actual or conventional costing when standard cost variances are distributed to (1) cost of goods sold; (2) an income or expense account;
(3) cost of goods sold and inventory; (4) a balance sheet account.
NAA
adapted)
indicate
(AICPA and
EXERCISES
1.
possibility of
90%
CH. 20
641
Dye
(1,000 pints
Work
$1 per yd.)
$2,000
500
$.50)
ma-
terials issued)
2,875
$4 each)
2,000
all
materials added
@
@
5,000 yds.
$1.10 per yd.
2,500 pints
$.49
5,600 yards
2,700 pints
$1.90 per hour
1,550 hours
$1,700
3,100 sweatshirts
$8 on account
Dyes purchased
Cotton cloth to factory
Dyes issued
to factory
Direct labor payroll
Actual factory overhead
Sales
Transferred completed
Work
in Process to Finished
Goods.
Required: General journal entries to record the January transactions, accounting for work in process at standard cost and recognizing variances in the
proper accounts. Use the two-variance method in computing materials, labor,
and factory overhead variances; recognize the materials price variance at the
time of purchase. Use separate inventory and variance accounts for each raw
material. Close all variances into Cost of Goods Sold.
4. Materials Variance Analysis and Journal Entries. Toronto Plastics Corporation produces kitchen utensils. The company uses a standard cost system for
controlling manufacturing costs. One of its finished products is a small salad
Rexo
Zyco
Total
@$1
$150
500
300
@ $2
100 lbs. @ $3
250
Durel
lbs.
$950
During the current cost period, the completed job orders included ten jobs
of 1,000 salad bowls each.
Cost data relative to materials for these ten jobs were:
Material
Rexo
Zyco
"
Durel
Purchased
l,8001bs.
l,000 1bs.
2,000 lbs.
1 ,200 lbs.
@ $1.10
@ $1.80
@ $2.00
@ $3.20
Consumed
@
@
@
1,400 lbs.
$1.10
1,000 lbs. (^ $1.80
$2.00
1,600 lbs.
850 lbs.
$3.20
642
PART
VI
Required: (1) The amount of variations from standard, both price and
quantity, for each item of raw material under each of the following assumptions: (a) price variations are computed on materials purchased and (b) price
variations are computed on materials issued to production, using the fifo
costing method.
(2)
General journal entries for the purchase and issue of materials under
(1).
Factory Overhead Variance Analysis; Journal Entries. The following overhead data of the Ponca Company are presented for analysis of the variances
from standard:
5.
20,000
$ 8,000
Variable
15,000
Actual Results:
Direct labor hours
18,700
Overhead
Fixed
Variable
$ 8,060
14,100
Materials (300
lbs.
of materials
$3)
900
165
1
50
$1,215
During the period direct materials were purchased in the following quantities,
market prices, in economical lot sizes:
at the prevailing
7,300
7,000
8,000
lbs.
@;$2.90
lbs.
@
@
lbs.
$3.10
$3.00
CH. 20
643
At the completion of the period the production and cost records showed the
following results:
(a)
2,000 hours
1,200 hours
@ $2.20
@ $2.15
@ $2.40
850 hours
700 hours @$1.90
(b)
(c)
Materials requisitioned and used in the production process were tallied and
found to represent 17,870 lbs.
There was no work in process inventory at the beginning or end of the account-
(d)
ing period.
(e)
(f)
The
sales
manager
at
(h)
7. Price,
antiseptic
10 lbs. of
10 lbs. of
30 lbs. of
20 lbs. of
50 lbs. of
hexachlorophene
para-chlor-meta-xylenol
bentonite (aj $.08 per lb.
kaolin
$.10 per lb.
talc
$.05 per lb.
The
is
lb.
lbs.
lbs.
lbs.
lbs.
lbs.
of
of
of
of
of
hexachlorophene
para-chlor-meta-xylenol
bentonite
kaolin
talc
Required: (1) Calculation of all materials variances (price, mix, and yield).
Journal entries for (a) purchase, (b) usage, (c) completion of materials,
and (d) disposition of variances, assuming all completed units were sold.
(2)
644
PART
VI
19:
Raw
materials inventory at
December
31, 19
December
$ 65,000
31, 19
87,000
130,500
104,400
Direct materials
Direct labor
Applied factory overhead
348,000
739,500
591,600
Direct
Direct
Direct
Direct
10,000
15,000
20,000
5,000
690,000
There were no beginning inventories and no ending work in process invenFactory overhead is applied at 80% of standard direct labor.
tory.
to finished
9.
1,
19
Materials
Finished goods
and
costs.
Quantity
Standard Cost
6,000 units
4,000 units
$12,000
84,000
Actual and standard quantities and costs for the month are summarized
as follows
Costs
Quantities
Actual
Materials purchases (units)
Materials requisitions (units)
Direct labor (hours)
Factory overhead
actual
100,000
95,000
46,800
Standard
94,000
47,000
Actual
Standard
$193,500
$200,000
164,970
143,800
164,500
CH. 20
is
645
based on
hour
During the month the company planned 24,000 units, yet only 23,500 units
were produced and placed into finished goods inventory. There was no work in
process at the beginning or the end of the period. 21,000 units were sold for
$35 per unit. Marketing and administrative expenses amounted to $185,000.
cost card for the product.
statement for the month. Variances for materials, labor, and
factory overhead are closed out into Cost of Goods Sold. Use the two-variance
method for factory overhead.
Required: (1)
(2)
An income
Month
of November
Budget
Actual
$120,000
80,000
$120,000
88,388
Gross profit
Marketing and administrative expenses
Net operating profit
$ 40,000
$ 31,612
The standard
$ 15,000
is
3,612
$4.40
10
1-^0
2.
$8.00
as follows
28,000
25,000
$ 6,000
Variable expenses
Fixed expenses
9,000
$15,000
2%
Assume
646
11.
Inc.
VI
Sumner Products,
PART
flexible
9,938
4,000
11,180
4,500
12,422
80%
90%
100%
110%
$ 6,510
S 6,510
$ 6,510
S 7,100
5,750
3,490
1,680
110
675
5,750
3,490
5,750
3,490
1,680
110
5,750
3,510
1,680
110
675
352
675
352
5,000
13,664
5,500
Factory overhead:
Fixed:
Superintendence
Indirect labor
Manufacturing supplies
Maintenance
Heat, power, and light
Depreciation
Insurance
1,680
352
110
675
352
S18,567
S18,567
$18,567
S19,177
S 1,928
S 2,169
S 2,410
$ 2,651
1,720
1,935
2,150
2,365
628
61
707
68
785
76
864
84
$4,337
S 4,879
$5,421
$5,964
$22,904
$23,446
$23,988
$25,141
Variable
Indirect labor
Manufacturing supplies
Maintenance
Heat, power, and light
Maintenance
Heat, power, and light
Depreciation
Insurance
Total factory overhead
$ 6,605
7,512
5,450
2,3
195
675
352
$23,106
Required: (1) Overhead variances using (a) the three- variance and (b) the
two-variance methods.
(2) An itemized budget report for the spending variance, including actual
factory overhead, budgeted factory overhead, and variances.
Company buys
CH. 20
$36,000
$45)
$ 4,000
10,560
8,800
4,800
Gross
Cost per
profit for
set:
20 workers.
28,160
$ 7,840
August
$28,160
-^
800
sets
= $35.20
costs
per set
(no inventory)
@ $45
sets
$43
3,360 hours
Actual production
Actual sales
647
sets
sets
$ 3.05
$8,800
$4,680
set.
Overhead
is
PROBLEMS
Wherever variances are required
in
indicate
peared as follows
Raw
620.00
3,100.00
$3,720.00
$3,720.00
$3,720.00
The company
which
all
Direct Materials: One raw material is used in the manufacturing process; 20 kg.
should be used for each unit of finished product and should cost $.60 per kg.
5,000
CH. 20
649
Standard costs were based on 256,000 direct labor hours with a production
of 1,600 units. The standards are as follows:
$2)
Materials (100 lbs.
$2.25)
Direct labor (160 hrs.
Factory overhead (160 direct labor hours
A summary
is
$200
360
160
$1)
$.40.)
$720
of the transactions for the year ended December 31, 19, shows
the following:
$396,000
595,020
248,640
177,600 lbs.
Factory overhead
Materials issued to production
Units processed:
Units completed
Units one-half complete
Units one-fourth complete
,500
1
50
30
Required: (1) Ledger accounts with the above transactions recorded therein.
for materials. No adjust(2) Entries to adjust Finished Goods to actual cost
ment is needed for labor and factory overhead. No other accounts should be
used.
(AICPA
Work
in
adapted)
unit
M. The manufacturing of
Labor
Overhead
Operation
Materials
M-10
20%
20%
40%
80
35
45
40
20
M-11
M-12
100%
Total
100%
100%
costs
650
PART
VI
Work
M
Amount
Materials
all
$ .50
2.00
1
1
hour
1.25
.60
.90
$5.25
Amoun t
Materials purchases:
Item M-a
12,000 units
$ .55 per unit
Item M-b
12,000 units (a $2.10 per unit
Payroll for all operations:
Direct labor
$1.2625 per i^ hour
3,100 hours
Indirect labor
Factory overhead, other than indirect labor
Marketing, administrative, and general expenses
$ 6,600
25,200
15,655
1,500
1 5,000
31 ,600
Other facts:
(1)
An income
(AICPA
adapted)
20-4. Standard Costing in the Accounts; Variance Disposition. Tolbert ManuCompany uses a standard cost system in accounting for the cost of
production of its only product, Product A. The standards for the production of
facturing
A are
: :
CH. 20
651
Direct materials: 10 feet of Item 1 at $.75 per foot; and 3 feet of Item 2 at $1 per
foot
Direct labor: 4 hours at $3.50 per hour
Factory overhead: applied at 150% of standard direct labor costs
1,
Required: (1) The total debits to the raw materials account for the purchase
of Item 1, for the year ended June 30, 19B.
(2)
The
work
in process
(AICPA
adapted)
Raw materials
Direct labor
Factory overhead (applied on
10 kilograms
$.70 per kg.
1 hr.
$2 per hr.
the basis of $2 per direct labor hour)
$ 7
2
2
Total
$11
Additional information
(a) The following data were
month of December
extracted
Budgeted production
Units sold
Sales
Sales discounts
Materials price usage variance
Debit
for the
Credit
3,000
1,500
$30,000
$
500
1,500
660
250
120
300
652
PART
VI
Raw
None
materials
in process
Work
1,200 units
900 units
Finished goods
The work in process inventory was 100% complete as to materials and 50%
as to direct labor and factory overhead. The corporation's policy is to allocate
variances over the cost of goods sold and ending inventories; i.e., work in
process and finished goods.
Required: (1)
lost to the
(2)
and
December, 19
shown
Amounts
and
separately.
(3) A schedule computing the actual cost of materials, labor, and factory
overhead included in the work in process inventory and in the finished goods
inventory at December 31,1 9
(AICPA adapted)
product, Mudexin, and uses a standard cost accounting system. The process
requires preparation and blending of three materials in large batches with a
variation from the standard mixture sometimes necessary to maintain quality.
The following information is available for the Blending Department.
The standard
costs
Quantity
Unit
Price
Total Cost
$ .14
$35
.09
18
.08
Materials
Dextrose
Other ingredients
250 pounds
200 pounds
50 pounds
500 pounds
Mucilloid
$ 57
Labor:
Blending
30
10 hours
$3.00
10 hours
10 hours
$1.00
$10
.30
Factory overhead:
Variable
Fixed
Total standard cost per 500-pound
batch
13
$100
During October 410 batches of 500 pounds each of the finished compound
were completed and transferred to the Packaging Department.
CH. 20
: :
653
prices.
During the month of October the following materials were purchased and
put into production
Pounds
Mucilloid
Dextrose
Other ingredients
Totals
14,400
85,800
19,800
Unit
Price
Total Cost
$ .17
.11
$19,448
9,438
.07
220,000
1,386
$30,272
Wages paid
for 4,212 hours of direct labor at $3.25 per hour were $13,689.
Actual factory overhead costs for the month totaled $5,519.
The standards were established for a normal production volume of 200,000
pounds (400 batches) of Mudexin per month. At this level of production variable factory overhead was budgeted at $4,000; and fixed factory overhead was
budgeted at $1,200.
(Note:
No
(AICPA
adapted)
Direct materials
M, 2 pounds
$1 .50 per pound
Direct labor (1.5 hours per unit)
$ 3.00
6.00
Factory overhead
Variable
Fixed
$1.50
1.10
2.60
$1 1.60
654
materials:
(pounds)
Work in process:
All materials, yi processed
All materials, }i processed
50,000
20,000
VI
Units
January
Raw
PART
December 31
60,000
10,000
1
5,000
2,000
During 19
250,000 pounds of
were purchased at an average cost of
$1,485 per pound; and 240,000 pounds were transferred to work in process
inventory. Direct labor costs amounted to $656,880 at an average labor cost
of $4.08.
,
Variable
$181,500
Fixed
14,000
(AICPA
adapted)
Goods
to
Direct materials
Direct labor
-,
$ 60,000
Factory overhead
$75,000
7,500
15,000
Total
$97,500
$120,000
No raw
20,000
40,000
December
31, 19
All purchases discounts were earned on the purchase of raw materials. The
company has included a scrap allowance in the cost standards; the scrap sold
cannot be traced to any particular operation or department.
cost
and
market.
at actual cost.
(2),
finished
CH. 20
655
Sales
Direct materials
Direct labor
Factory overhead
$600,000
Total
Variances
Direct materials
Direct labor
$ 25,400
25,500
(16,500)
$ 34,400
Total
Gross
634,400
$265,600
profit
Marketing expenses:
$ 28,000
Sales salaries
Sales commissions
72,000
18,000
7,000
Shipping expenses
Other marketing expenses
$125,000
50,000
Total
175,000
$ 90,600
8,000
9,000
17,000
$107,600
goods inventory was composed of 1,000 units with a cost of $180 each. The
current market price for the product is $250. The company, however, has an
old contract to sell 200 units at $175 each. The normal gross profit rate is
33H% of cost. The shipping expenses for the old contract will be $5 per unit;
of the sale.
the sales commission is
8%
(AICPA
adapted)
Material
Materials
Material C
Direct labor
Direct labor
Direct labor
Direct labor
Total
Cutting
Shaping
Assembling
Boxing
$10.00
5.00
2.00
8.00
4.00
2 00
1.00
.
$32.00
$4.00
2.00
1
00
$10.00
5.00
2.00
12.00
6.00
3 00
.50
1.50
$7.50
$39.50
Unit Cost
CH. 20
its
657
problem with
(NAA
adapted)
B. Variance Analysis; Variance Control Responsibility. The Carberg Corporation manufactures and sells a single product. The company uses a standard
cost system, and the standard cost per unit of product is as follows:
$ 2.00
6.40
3.00
1-45
$2)
Material (one pound plastic
$4)
Direct labor (1.6 hours
Variable factory overhead cost per unit
Fixed factory overhead cost per unit
$12.85
The factory overhead cost per unit was calculated from the following annual
overhead cost budget for a 60,000 unit volume
Variable factory overhead cost
$120,000
30,000
30,000
$4)
Indirect labor (30,000 hours
$.50)
60,000 gallons
Supplies (Oil
Allocated variable service department costs
$180,000
Supervision
Depreciation
45,000
15,000
$ 87,000
$267,000
@
@
@
U^^O
$68,035
Total
classification.
its responsibilities so that the Purchasing Deresponsible for the price at which materials and supplies are purchased, while the Manufacturing Department is responsible for the quantities
(2)
partment
is
658
PART
VI
of materials used. Does this division of responsibilities solve the conflict between price and quantity variances? Explain.
(3) Prepare a report which details the factory overhead budget variance.
The report, which will be given to the Manufacturing Department manager,
should display only that part of the variance that is the manager's responsibility
and should highlight the information in ways that would be useful to that manager in evaluating departmental performance and in considering corrective
action.
(4) Assume that the department manager performs the timekeeping function
that, at various times, an analysis of factory overhead and direct labor
and
shown
variances has
resolve this
problem?
(NAA
adapted)
effect.
Debit
Credit
$25,000
$ 9,000
30,000
7,500
2,000
75,000
Standards were set at the beginning of the year and have remained unchanged. All inventories are priced at standard cost.
Required: (1) Conclusions to be drawn from each of the six variances shown
Mafco Corporation's trial balance.
in the
(2) The amount of fixed factory overhead cost to be included in product cost
depends on whether or not the allocation is based on (a) ideal (or theoretical)
capacity, (b) practical capacity, (c) normal capacity, or (d) expected annual
capacity. Describe each of these allocation bases and give a theoretical argument
for each.
statement.
(b) Allocating the net variance
among
(AICPA
adapted)
CHAPTER 21
CONVENTIONAL
GROSS PROFIT ANALYSIS
and analysis
and factory
overhead, which constitute the major portion of the cost of goods sold
section of the income statement. Subtracting the cost of goods sold figure
from sales results in the gross profit. Any deviation from the predetermined standard cost is normally shown as an increase or decrease in the
The standard
gross profit.
profit figure
is
Not only do
is
itself
profit is
following
1
Changes
2.
Changes
in
3.
Changes
in cost elements
volume sold
659
660
three causes
changes
in
PART
volume sold
VI
may
volume
1.
Changes
in
2.
Changes
in types of
Volume
refers to the
number of
mix
is
It
should be
and
costs of
the previous year, or any year selected as the basis for the comparison,
serve as the basis for the computation of the variances.
When
standard
Illustration
I.
This
first illustration
The
Silcon Manufacturing
Company
Sales (net)
Gross
profit
on
sales
profit
figures.
19A
19 B
Changes
$120,000
$140,000
+$20,000
100,000
110,000
$ 20,000
$ 30,000
10,000
Additional data taken from various records indicate that the sales and
the cost of goods sold figures can be broken
page 661.
down
as
::
CH.
21
661
19B Sales
Quantity
Product
Product
Product
X =
Y =
Z =
Unit Price
10,000 units
4,000 units
20,000 units
@
@
@
$6.60
3.50
$ 66,000
14,000
3.00
60,000
Total sales
Unit Price
$140,000
Total
$4.00
3.50
2.80
$ 40,000
Total cost
$110,000
14,000
56,000
The illustration indicates that, in comparison with the year 19A, sales
19B increased $20,000 and costs increased $10,000, resulting in an increase in gross profit of $10,000. What caused this increase?
The method shown below follows a procedure similar to the one employed in connection with the computation of standard cost variances.
Sales and costs of 19A are accepted as the basis (or standard) for all
in
comparisons.
third step to
compute a
First Step.
sales
mix and a
final sales
volume variance.
sales
volume variances
$140,000
X =
Y =
Z =
10,000 units
4,000 units
20,000 units
X
X
X
$5.00
4.00
2.60
=
=
=
$50,000
16,000
52,000
118,000
$ 22,000
$1 18,000
120,000
$
2,000
$110,000
X =
Y =
Z =
10,000 units
4,000 units
20,000 units
X
X
X
$4.00
3.50
2.175
=
=
=
$40,000
14,000
43,500
97,500
$ 12,500
$ 97,500
100,000
2,500
662
PART
VI
At this point the above analysis shows the following results which
might explain the reason for the $10,000 increase in gross profit:
Favorable sales price variance
$22,000
Net
500
$22,500
12,500
$10,000
Computation of the
Third Step.
sales
final sales
volume
variances
The $.5714
Number of
^ $20,000 ^
Units Soldi 9A
^ ^^^^
35,000
is
all units
number of
units sold in
gross profit
The
can
final sales
volume variances
now be made:
19B
19B
sales at
sales at
19A
19A
$1 18,000
prices
costs
97,500
$ 20,500
Difference
19B
sales at
19A average
19,427
gross profit
19B
sales at
$ 19,427
profit
$120,000
1 00,000
20,000
Difference
Unfavorable
1,073
final sales
volume variance
573
1,073
500
573
CH.
21
The
Column
Product
663
in the following
Column 2
Column 3
manner:
Column 4
664
Statement
Product
PART
VI
CH.
21
duct
price
cost,
Product
is
665
is
is
and
most
the
is
the
unit.
Statement 3 indicates that the average gross profit would have been
$2.41 per unit if the sales price and cost per unit had been according to the
budget. Changes in sales prices, sales volume, sales mix, and costs resulted
in a gross profit of only $1.93 per unit.
Had
profit
prices, costs,
What caused
this decrease
Statement
i.e.,
First Step.
10,425 units
Computation of
$2.50
sales price
$26,062.50.
and
sales
volume variances
Actual sales
Actual sales at budgeted prices
$142,233
138,226
$138,226
142,000
Budgeted
sales
Second Step.
4,007
3,774
Computation of cost
price
actual
Cost of goods sold
Budgeted costs of actual goods sold
$122,123
$1 13,093
Third Step.
Computation of the
sales
13,093
9,030
115,750
2,657
final sales
volume
variances
$3,774
2,657
$1,117
666
As
PART
VI
$138,226.00
11 3,093.00
Difference
$ 25,133.00
Budgeted gross
(10,425
profit of actual
goods sold
$2.50)
26,062.50
final sales
Check: Unfavorable
Unfavorable
volume variance
sales
mix variance
volume variance
$ 26,062.50
$142,000
11
5,750
26,250.00
$
187.50
929.50
187.50
final sales
929.50
1,1
17.00
Again, the sales mix variance can be viewed in the following manner;
CH.
21
Recapitulation:
667
Gains
$4,007
Total
Less
$4,007
Net decrease
in gross profit
Losses
$ 9,030.00
929.50
187.50
$10,147.00
4,007.00
$ 6,140.00
Using the figures from the income statements of Vitt Manufacturing, Inc., an analysis by products can be made
to the individual product lines.
in the
^^^^^^^^^^
^^^^^^^^^m
MANUFACTURING, INC.
Analysis By Product
^ll"!*
^H^
-hhbi
668
PART
VI
outline the remedies that should be taken to correct the situation, i In Illustration II the gain
more than
As
is
To
be further analyzed into variances for materials, labor, and factory over-
head as explained
^M
1.
Why
What
3.
5.
DISCUSSION QUESTIONS
2.
4.
in the
is
figure be
analyzed?
how
6.
How
7.
What
final sales
standard ?
8.
The gross
9.
What important
information
is
duct basis ?
10.
Whose
task
is it
is
met?
EXERCISES
How much
must be added
to the cost
5%?
Gap Between
CH.
21
100 articles
120 articles
@
@
$3
$4
669
= $300
= 480
$180 difference (increase)
Method
this result:
X
X
$4
$1
=
=
$ 80
100
$180
tried
this result
2:
X
X
$3
$1
=
=
$ 60
120
$180
3.
Distributing
Company
19
are:
Product
Actual sales
Actual cost of goods sold.
Budgeted sales
Budgeted cost of goods sold
60,000
60,000
50,000
50,000
units
units
units
units
X
X
X
X
Product
$1 .00
.80
1
.25
1.00
20,000
20,000
35,000
35,000
units
units
units
units
X
X
X
X
Total
$2.00
1.85
2.50
2.00
$100,000
85,000
150,000
120,000
The computations of
Required: (1)
(b) sales
volume;
(c)
Gross Profit Analysis. Bates Brothers Clothiers handles two lines of men's
The Bostonian and The Varsity. For the years 19A and 19B, Sam
Bates, the store owner and manager, realized a gross profit of $159,300 and
$159,570, respectively. He was puzzled because the dollar sales volume and
number of suits sold was higher for 19B than for 19A yet the gross profit had
remained about the same.
The firm's accounting records provided the following detailed information:
4.
suits
670
PART
VI
19B
19
330,000
300,000
$13,860,000
$12,000,000
$ 1,400,000
nurses,
&
other supplies
7,500,000
1,500,000
1,500,000
$11,900,000
$10,000,000
$ 1,960,000
$ 2,000,000
2,013,000
1,800,000
Gross
profit
Administrative expenses
1,000,000
9,000,000
(53,000)
200,000
6.
Company
Net
sales
Gross profit
General expenses
Net operating
profit (loss)
19A
19B
$482,961
434,665
$679,241
503,645
$48,296
$175,596
89,533
76,258
$(27,962 )
$ 86,063
the end of
much
When
was the
case.
Required:
gross profit.
An
CH.
7.
21
671
Gross Profit Analysis. The 19A income statement of the Royer Corporation
showed
Sales (90,500 units)
$760,200
452,500
Gross
$307,700
profit
For 19B the management forecasts a sales volume of 100,000 units at a sales
For this range of activity, variable costs are estimated to
be $4.80 per unit. No fixed costs are included in the cost of goods sold.
price of $8.20 per unit.
Required: An analysis of the variation in gross profit between the two years
indicating the effects of changes in sales prices, sales volume, and unit costs.
(AICPA
adapted)
PROBLEMS
The Chapeau Company manufactures both men's
The traditional selling price for men's hats has been $8 per
hat, whereas women's hats have sold for $7. The president was very pleased
with the performance of his company in 19A which, summarized, was as follows:
21-1. Gross Profit Analysis.
and women's
hats.
$325,000
200,000
Gross
$125,000
profit
(38%)
that 38% gross profit was satisfactory; and, since the 43,000
hats sold was an increase of 8,000 over the previous year, he felt that the company
was enjoying a healthy growth.
The sales manager happily informed the president that expected sales for
19B were 45,000 hats. Based on this estimate, the controller submitted the
following budget for 19B to the president:
Sales
Men's hats
Women's
hats
Total
Units
Amount
Cost
Gross Profit
30,000
15,000
$240,000
105,000
$ 32,000
84,000
$108,000
21,000
45,000
$345,000
$216,000
$129,000
were as follows:
Sales
Units
Men's hats
Women's
hats
Total
The
Amount
25,000
20,000
45,000
president, furious with the results and the apparently erroneous forehis staff for a conference and demanded an explanation. The
sales manager was quick to defend his position, pointing out that his department
cast,
summoned
672
PART
VI
sales quota of 45,000 hats and therefore was not to blame. He accused
the controller of allowing costs to get out of hand.
The controller, reaHzing he was not entirely to blame, explained that he was
not responsible for forecasting price changes when such changes are brought
about by competition. He also pointed out that a substantial portion of the
error was due to the sales manager's inability to maintain sales of the more
profitable men's hat line at the level estimated.
In order to settle the dispute, the president asked the controller to prepare
a complete analysis of the $39,000 variance from budgeted gross profit, along
with suggestions to correct the situation.
met the
Required:
Profit
Analysis.
19A
Net
sales
$ 840,000
945,000
19B
CH.
21
673
year.
The volume is apportioned between the three grades based upon the
prior year's product mix, again adjusted for planned changes due to company
programs for the coming year.
Given below are the company's budgeted income statement for 19
and
the results of operations for 19
19
Sales units
Grade 2
Grade 3
Total
1,000 rolls
1,000 rolls
2,000 rolls
4,000 rolls
$1,000
$2,000
$3,000
$6,000
700
1,600
2,300
4,600
700
$1,400
400
Sales dollars
(000 omitted)
Variable expenses
Contribution margin
300
Traceable fixed
expenses
200
200
Traceable margin
100
400
200
300
700
700
Marketing and
administrative
expenses
Net operating
250
profit
19
Sales units
450
Grade 2
Grade 3
Total
1,000 rolls
2,100 rolls
3,900 rolls
$810
560
$2,000
$3,000
$5,810
1,610
2,320
4,490
$250
680
$1,320
rolls
Sales dollars
(000 omitted)
Variable expenses
Contribution margin
Traceable fixed
expenses
Traceable margin
210
$
390
220
40
170
315
$
365
745
$
575
Marketing and
administrative
expenses
Net operating
275
profit
300
Required: (1) The profit impact of the final sales volume variance for 19
using budgeted contribution margins.
(2) The portion of the variance,
condition of the carpet industry.
if
(NAA
adapted)
674
PART
VI
21-5. Estimated Gross Profit. Kelco Co. produces one principal product. The
income from sales of this product for the year 19A is expected to be $200,000.
will
be as follows:
Materials used
Direct labor
540,000
60,000
20,000
30,000
Fixed overhead
Variable overhead
The company realizes that it faces rising costs and in December is attempting to plan its operations for the year 19B. It is believed that if the product is
not redesigned, the following changes in operations will result: materials prices
will average 5% higher; rates for direct labor will average 10% higher; variable
overhead will vary in proportion to direct labor costs if sales price is increased
to produce the same rate of gross profit as the 19A rate, there will be a 10%
decrease in the number of units sold in 19B.
;
manager,
it is
if
the
same
product
if
the product
(AICPA
is
re-
adapted)
CASES
The senior
A. Gross Profit Analysis of Time-Sharing Computer Programs.
systems analyst of Sweetenall, Inc., Bob Canedy, developed in his spare time
three unique packages of computer programs: Package 1, Inventory Control;
Package 2, Sales Analysis; Package 3, Report Preparation. After realizing their
marketability, he struck out on his own, forming Data-Pack Co., a computer
time-sharing service bureau. He rented an adequate computer and leased some
data communication lines and terminals, then placed his packages on-line.
Once operational, he planned to sell the use of his packages to industrial customers by the system-connect-hour; i.e., total time elapsing while customer's
terminal is directly connected to the central computer.
In the process of establishing profitable selling prices, Bob decided to project
his costs for the first year. Using processing information provided by the computer salesman, Bob allocated total costs to the packages as follows
CH.
676
PART
VI
Bob was pleased that his new firm had exceeded planned profits by $4,250.
However, it was evident that changes in demand for the packages and changes
in costs and selling prices had made this "gain" only coincidental.
B. Comparative Income Statement and Profit Analysis. The Navasota Manufacturing Company wishes an analysis of the comparative income statements
for 19A and 19B shown below:
Gross
sales
Net
sales
19B
19A
$12,000,000
1,500,000
$8,750,000
500,000
$10,500,000
$8,250,000
$ 4,000,000
$2, 1 00,000
800,000
4,800,000
400,000
1,200,000
300,000
2,700,000
1 50,000
1,200,000
$11,200,000
2,200,000
$6,450,000
1,000,000
$13,400,000
6,000,000
$7,450,000
2,200,000
$ 7,400,000
$5,250,000
$ 3,100,000
400,000
$3,000,000
250,000
$ 2,700,000
$2,750,000
Raw
materials (special)
Materials (other)
Direct labor
Indirect factory overhead
Depreciation
Add
Gross
profit
Net operating
profit
single
sale in a
com-
petitive market.
The management knows that wages have risen in its industry and in its plant
by an overall average of about 50^ from 19A to 19B. Special raw materials
used in the manufacturing process increased approximately 509c and other
costs have risen in varying degrees. However, unit selling prices did not increase
in proportion to the costs. Although the number of units sold increased 20%
from 250,000 in 19A to 300,000 in 19B, the company did not expect the profit
for 19B to be as favorable as the statements indicate because of the adverse
conditions stated. However, the operating departments claimed large savings
due to technological manufacturing improvements and the shifting of supervisors and personnel.
The management is faced with the necessity of making important decisions
with respect to the payment of dividends, the adjustment of executives' compenAhhough the income statement
sation, and a program of plant expansion.
indicates a favorable profit before taxes, the company's cash position is not
strong. The management, being at a loss to understand the apparent contradictions presented by the increased costs and the results shown by the statements,
..
CH.
21
677
19B
Beginning finished goods inventory
Special
19A
man
hours
19B
Gross weight
Scrap recovered
100,000
200,000
400,000
2,845,000
19A
units
units
units
hours
Net Tons
2,000
50,000
100,000
300,000
2,400,000
units
units
units
hours
Amount
500
$2,600,000
500,000
1,500
$2,100,000
2,300
300
$4,450,000
450,000
2,000
$4,000,000
and net
profits as
An
An
analysis
profits.
CHAPTER 22
The factory overhead chapters presented the use of the factory overhead rate for product costing and pricing. The method combined all
factory overhead costs, fixed and variable, into a composite rate. At the
time the rate is constructed, a capacity, volume, or activity level must be
decided upon so that all costs and expenses can be expected to be recovered over a certain period of time.
known
and
as
direct
labor costs and a share of both fixed and variable factory overhead to
units of production.
At
month
^wJien
T
ox>Ji/-
1>^
tAv^a^^\^ J
Ci>>r-
oSi^i^
^vw;d
overhead and
costs.
Fixed costs
upon
head
oO-c
'i
is
f^ >^
i~f
The
management
to place
^v )^^is^^y
still
in-
DIRECT COSTING
CH. 22
679
In Standard cost accounting a dual factory overhead rate, one for variable cost
is still
on the
If
it
'
V^^
^^^^if^
^y\'^
the fixed costs included in the periodic cost of goods sold would vary di-
ij
and proportionately with sales volume. In the above cases, the fixed / Mif
overhead in its long-run, normal capacity concept behaves like the unit
^^^^i^^YVfi/
"^^
a^^lu
variable cost. However, if variances are expensed each period, fluctuaJ
tions in the unit product cost occur.
The unit p roduct cost will als o ^\Vc-3 6&s1j
fluctuate in cases in which the capacity le vel used to calculate the facto ry 'oo^
Wjloverheadraie IS ditlerent trom one^p eriod to the ne xt J^ggause^he fixed (X ooj-\'-Ui2part of tTie^'ate will be higher when a lower capa city level is used _and ^siy/is^ 'vM-SL
rectly
^,
is
use d.
r^Mi
'
rj-
overhead rate also causes even wider unit product cost fluctuations be"^cause fixed factory overhead is then allocated to production based on the ^'^-^
<J
Information accumulated in
NAA
-{^o^
and inventory
is
on
(\&^
\l.
V^
v^JJLic*aA
^)^ ^j)
.
^Mt-^^^
^sarWJJ
i>'^
\mJ^
Long-rangejTormal_^r_standard vnlum^
r;
v,
2.
'^^^^^
'
The
-H^
Mm'
4^^
'
NAA
680
the
NAA
VI
The
PART
is
unsatisfactory in
cost concept
long-range in nature.
is
They want
to
is
Business-
Direct costing charges the products with only those costs that vary
directly with
plus variable factory overhead expenses are used to assign costs to inventories
..^ost of
labor,
the product.
surance, and factory and property taxes that are a function of time rather
office
and
sales
staff',
Also ex-
as well as those
etc.,
interest
moves
in
decision making,
and
can be presented as
Hbid., p. 73.
in cost control.
illustrated
on page
CH. 22
DIRECT COSTING
COSTING OF
INVENTORY
681
682
Item
Per Unit
Total
Percentage
of Sales
$70
_42
$700,000
420,000
100
60
$280,000
175,000
40
$105,000
15
Contribution margin
Less fixed costs
$28
The
variable costs
VI
25
(sales
revenue
PART
In such situations,
is
it
assumed
that the change or shift of a small segment within the total volume does
not require major changes in capacity, which means in fixed costs. Generally, total period costs are subtracted from the contribution margin figure
to arrive at net operating income. Period costs that are specific or relevant
to a product, a product fine, or
isolated
and attached
management
further in
a firm has
little difficulty
How
from
it,
aff'ect
situations.
pricing
and
"marginal income,"
sales revenues.
The
best
optimum
price
is
that
is
the
optimum volume.
DIRECT COSTING
CH. 22
The
price at
which
this
is
the
683
optimum
price.
inefficiencies
by
what extent?
might be regulated through supply and demand, but to
which
demand
on
influence
Management, it is contended, has little or no
and,
supply;
certainly regulate
rests with the consumer. However, it can
management's
the stimulation of demand is not always beyond
indeed,
influence.
whether each
In multiproduct pricing, management needs to know
contribute
still
product can be priced competitively in the industry and
and profit.
to the contribution margin for fixed cost recovery
sufficiently
The^ seful
pa rt of a unit cost
is
'
mn s
s ti
of
A long-run
its failures.
Installation of a direct
Direct Costing for Managerial Decision Making.
segregation of fixed
costing system requires a study of cost trends and a
and variable
costs.
The
identification
and
classification
of costs as either
cumulation and
proposed actions conof contemplated changes in production levels or
or special procerning new markets, plant expansion or contraction,
that a study of
motional activities. Of course, it is important to recognize
accomplished
behavior which identifies fixed and variable costs can be
cost
NAA
its
findings
on
this
Companies
major
field
684
PART
VI
The marginal income (contribution margin) figure, which resuhs from the
step in matching costs and revenues in the direct costing income statement, is reported to be a particularly useful figure to management because it
can be readily projected to measure increments in net income which accompany increments in sales. The theory underlying this observed usefulness of
the marginal income figure in decision making rests upon the fact that, within
a limited volume range, period costs tend to remain constant in total when
volume changes occur. Under such conditions, only the direct costs are
first
The tendency of net income to fluctuate directly with sales volume was reported to be an important practical advantage possessed by the direct costing
approach to income determination because it enables management to trace
changes in sales to their consequence in net income. Another advantage attributed to the direct costing income statement was that management has a
better understanding of the impact that period costs have on profits when such
costs are brought together in a single group.
The
direct costing
procedure
is
income statement
and
sales figures
re-
is
ing
figure for
work performed.
management which
originally authorized
The
The
Gen-
DIRECT COSTING
CH. 22
685
<^
fixed expenses, since all fixed costs are charged against revenue instead of to
the product;
i.e.,
to inventories.
management group
by organizational
fines
priate responsibility.
last
month
makes
it
Performance
Accounting
now each
its
own
basis of
standard.
direct
state-
costs to inventories.
To keep
and
For
and
fixed ex-
this reason,
it is
one
and one
Also, instead of one overhead contwo have to be used Factory Overhead Control
Variable
Expenses and Factory Overhead Control
Fixed Expenses.
When
variable expenses are charged to work in process using an overhead rate,
the credit is to an applied overhead account now labeled Variable Factory
Overhead Applied. Differences between actual and applied variable overhead constitute (1) controllable or (2) the spending and variable efficiency
variances when a standard cost system is used and a spending variance
for the fixed portion of the expense.
trol account,
when standard costing is not used. Because fixed expenses are not charged
to work in process, they are excluded from the predetermined overhead
rate. The total fixed expenses accumulated in the account Factory Overhead Control
Fixed Expenses are charged directly to Income Summary.
Operating Profits.
to illustrate
compare the
costing on gross
profit,
and
686
factory overhead
unit at
VI
units a year.
labor, $2.25
is
PART
total of $6.
Fixed
is
normal capacity.
The
is
plying overhead.
$5,000 per month, or $60,000 a year; and variable marketing and administrative expenses are S3,400, $3,600, $4,000,
first,
that actual
Units
Units
Units
Units
in
Second
Third
Fourth
Month
Month
Month
21,000
18,000
3,000
3,000
19,000
21,000
1,000
20,000
16,500
4,500
beginning inventory
produced
17,500
17,500
sold
in
First
Month
ending inventory
1,000
$10
factory overhead
Absorption
is
Costing.
In
to inventory.
r
)
V^ko^, Vl
^^ ^"f V
P^^"^"
First
Second
Third
Fourth
Month
Month
Month
Month
Sales
$175,000
$180,000
$210,000
$165,000
Direct materials
Direct labor
Variable factory overhead
Fixed factory overhead
$ 52,500
$ 63,000
$ 57,000
$ 60,000
39,375
13,125
21,875
47,250
15,750
26,250
42,750
14,250
23,750
45,000
15,000
25,000
$126,875
$152,250
$137,750
21,750
$145,000
7,250
$126,875
$152,250
21,750
$159,500
7,250
$152,250
32,625
$126,875
$130,500
$152,250
$119,625
$130,000
$129,250
$153,500
$119,625
$ 45,000
8,400
$ 50,750
$ 56,500
8,600
9,000
$ 45,375
8,00
$ 36,600
$ 42,150
$ 47,500
$ 37,375
Ending inventory
^^-v.
_.
^p^ Y
^Y^
cli\
ovJjiJ
19"^
3,125
(1,250 )
1,250
CH. 22
DIRECT COSTING
687
is
Illustration 11
Direct Costing. In direct costing fixed factory overhead
excluded from the unit cost and from the costs assigned to inventory.
Sales
^C Direct materials
W^ Direct labor
I
1^
First
Second
Third
Fourth
Month
Month
Month
Month
$175,000
$180,000
$210,000
$165,000
$52,500
$63,000
$57,000
$60,000
39,375
13,125
47,250
15,750
42,750
14,250
45,000
1 5,000
$105,000
$126,000
$114,000
18,000
$120,000
6,000
$ 1 26,000
$ 1 32,000
$ 1 26,000
18,000
6,000
27,000
j-^cvAa'.
^ Variable cost of goods available for
AiM^Ending inventory
i
=
,%X,
i.
sale
$ 1 05,000
$105,000
$108,000
$126,000
$ 99,000
$ 70,000
$ 72,000
$ 84,000
$ 66,000
3,400
3,600
4,000
3,000
Contribution margin
$ 66,600
$ 68,400
$ 80,000
$ 63,000
$ 25,000
$ 25,000
$ 25,000
5,000
5,000
5,000
$ 25,000
5,000
$ 30,000
$ 30,000
$ 30,000
$ 36,600
^= ==
expenses
A>^
$ 38,400
$ 50,000
$ 30,000
$33,000
illustrations
show
u<h>>a\ ^<>^
Hii?c*)
^^
ascjiAou.
m-
^Hc^f
costing and direct costing: (1) gross profit vs. gross contribution margin, ^tr^ fU^^
^'^ ^'^
(2) costs assigned to inventory, and (3) net operating income.
Gross Profit
vs.
of fixed expenses from inventories and cost of goods sold causes the gross
profit to vary considerably
is
The
It is
argued
UinJ
688
benefits.
it is
PART
VI
and bonuses are in most cases not based on gross profit but
on net income. This net income will be the same in each method when no
inventories exist or when no change in total cost assigned to inventory
occurs from the beginning to the end of the period. Although the two
illustrations were on a monthly basis, they could just as well have been
quarterly or annual. The shorter period is chosen to indicate more forcefully the effects of each method.
As explained previously, managers favor direct costing because sales
figures guide cost figures. Variable cost of goods sold varies directly with
sales volume. The influence of production on profit is eliminated. The
idea of "selling overhead to inventories" might sound plausible and appear pleasing at first; but when the prior month's inventories become this
nionth's opening inventories, the apparent advantages cancel out. The
results of the second month with absorption costing offer a good example
selling prices
^JJVc^^
^<^
-qJ.5C>1^Y
\Lo^
^
>vJdiiA.
;c
I
I
p^ L
i^-the
io
,.j,j-
resulting
Illustration
effect
from production
fluctuations.
The
illustrations
First
Second
Third
Fourth
Month
Month
Month
Month
$ -0-0-
$21,750
18,000
$7,250
6,000
$32,625
27,000
$ -0-
$ 3,750
$1,250
$ 5,625
Absorption costing
Direct costing
Differences
Differences are caused by the elimination of fixed manufacturing exIn absorption costing, these
^^'^\'^overhead
/^
"^
^>f^
w\csj-a^,^
\aOv^ia>^'^
rate.
offsetting effect
L^}^JC^ii)/
CovXr^^
is
Institute
The
AICPA.
Its
is
Ac-
"Inventory
'^^yc
^^^
a)?iv.iir^
for inventories
j^
V'^*
^^^
N^-V cAl^^
is
^,3^;^^ 5^
^a-
Qjf(s,^S^K^
Pfl^^siU^
^A
I-
^''^^^
DIRECT COSTING
CH. 22
The
for inventories
is
cost,
689
means
in principle the
sum of the
and location."
As
applied to inventories,
an
condition
all
ponents of direct costing might, however, argue that while the exclusion
of all overhead is not acceptable, by inference the exclusion of some is
acceptable. This argument might sound true, but it does not seem to have
any bearing on the Institute's acceptance of direct costing since in an
earlier discussion of cost the Bulletin states that
AICPA
recognizes as
There
is
Standards Board (an independent private sector body, which in 1973 began its work of promulgating accounting standards) will take a position
on
AICPA.
Research studies conducted by the National Association of Accountants and the Financial Executives Research Foundation indicate that an
ever-increasing
price setting,
agement
and management
services divisions of
control.
CPA
it
It
direct
auditors of these firms adjust the year-end figures for income tax returns
i,
'
is given to
V^- +"1^^
any particular method of inventory costing so long as the method used is ^y\dsif^
'^vi?Sor-P'>^ UJoiUJ rjzymcL-^ m Z. X h(^'i<iKac,Ij^ ^HX-D, Mr)o,v\ ctUq S oj- p'to/-^ "t
690
in
The
PART
VI
the case of merchandise produced to be "(1) the cost of raw materials and
consumed
in
(2)
expenditures for direct labor, and (3) indirect expenses incident to and
necessary for the production of the particular article, including in such
indirect production
penses."
direct costing
costs
1973
the
SEC
is
its
is
its
In filing reports
with the SEC, a firm that uses direct costing must adjust
to
among
its
inventories
Net Operating Income. The difference in net operating income between absorption costing and direct costing is attributable to the fixed
cost charged to inventory as illustrated below. The data are from Illustrations
and
II
687.
Absorption Costing:
Net operating income for the month
Direct Costing:
First
Second
Third
Fourth
Month
Month
Month
Month
$36,600
$42,150
$47,500
$37,375
Illustration I
Illustration II
36,600
Difference..^
A^^
+v
33,000
$(2,500)
$ 4,375
$ -0-
$21,750
$(14,500)
$25,375
-0-
18,000
(12,000)
21.000
$ -0-
$ 3,750
$(2,500)
$ 4,375
-Y(^
'>*
50,000
$ 3,750
I
Absorption Costing:
Inventory change (ending less beginning
Illustration
5o"YML
\v>
38,400
$ -0-
i\-r
^-^
Illustration II
Direct Costing:
less
beginning
fixed
however,
Alsg^anv over- or underapplied fij^d_ia ctory ov erhead deferred on the balance shee^jathe^han being currently exEcnged
operating income.
DIRECT COSTING
CH. 22
691
income.
n
i
)
)
/
1^
mventory
Ithas been observed that the amount of fixed cost charged to
costing
inventory
the
by
but
produced
is affected not only by the quantities
beauthors
The
a fact which is largely overlooked.
method employed
\^^^^
costing in relation to
ating income under absorption costing and direct
fifo, lifo, and
costing,
average
four methods of inventory costing
standard costing.
They show
and
methods; however,
considered by the usual generalizaresults are more complex than those
tions which therefore do not apply.
As long
as the
AICPA,
the IRS,
net
identical with
previously noted, net operating income differences are
caused by the inclusion or
the differences in costs assigned to inventory
exclusion of fixed expenses.
Company practice indicates that comparatively simple procedures are
As
According
employed to determine the amount of periodic adjustment.
at the end
that
company reports
to the NAA Research Report No. 37, one
by actual production to
of each year period manufacturing costs are divided
on hand. Another comcreate a costing rate which is applied to the units
of direct labor and
dollar
pany expresses period expenses as a rate per
The dollar amount of direct labor
direct expenses at normal volume.
multiplied by the
and direct expenses in the year-end inventory is then
of the closing
foregoing rate to arrive at the period expense component
inventory.
4Yuji
Ijiri.
692
PART
VI
A third company allocates all manufacturing overhead to production departments with the result that period manufacturing cost is collected in seven
major pools corresponding to the company's major product lines. However,
the period costs are not allocated to individual products within product lines.
At the end of each month, period cost is transferred from inventory to cost of
sales on the basis of the relative amounts of direct cost in production and
Since the amount of period cost associated with the several product
sales.
lines varies widely, it is thought desirable to make the segregation by product
lines for external reporting purposes.
DISCUSSION QUESTIONS
1
and
and
direct costing.
2.
3.
How
4.
5.
direct costing.
Why does the direct costing theorist state that fixed manufacturing costs
are not to be included in inventories?
6.
Why
7.
Has
8.
10.
used ?
the Internal Revenue Service approved direct costing for tax purposes ?
Explain.
(AICPA
9.
is
adapted)
Why
figures
11.
speaker remarked recently that even though direct costing has attractive
merits, there are certain items that should be considered before converting
the present system. What hidden dangers are present in direct costing?
12.
costing?
NAA
CH. 22
DIRECT COSTING
693
(1) Sales
(2) Sales
(3)
(AICPA
13.
A basic cost
adapted)
added to inventory
Reporting under the direct costing concept is accomplished by (1) including only direct costs in the income statement; (2) matching variable
costs against revenues and treating fixed costs as period costs; (3)
treating all costs as period costs; (4) eliminating the work in process
inventory account.
(c)
(d)
When a firm uses direct costing, (1) the cost of a unit of product changes
because of changes in number of units manufactured; (2) profits fluctuate with sales; (3) an idle capacity variation is calculated by a direct
costing system; (4) product costs include variable administrative costs;
(5) none of the above.
(e)
(f)
(g)
Under the direct costing concept, unit product cost would most likely
be increased by (1) a decrease in the remaining useful life of factory
machinery depreciated on the units-of-production method; (2) a decrease in the number of units produced; (3) an increase in the remaining
useful life of factory machinery depreciated on the sum-of-the-years'
-digits method; (4) an increase in the commission paid to salesmen for
each unit sold.
Absorption costing differs from direct costing in the (1) fact that standard costs can be used with absorption costing but not with direct
costing; (2) kinds of activities for which each can be used to report;
(3) amount of costs assigned to individual units of product; (4) amount
of fixed costs that will be incurred.
(AICPA and
NAA adapted)
::
694
PART
VI
EXERCISES
Absorption Costing vs. Direct Costing. As part of its in1. Inventory Costs
vestigation regarding the possible adoption of direct costing, the management
of the Garcia Company asks the controller what effect the adoption of such
procedures would have on inventories. In developing the answer to this question, the following figures, representing operations for the past year, are used:
Units produced
50,000, of which
$200,000
260,000
Direct materials
Direct labor
Factory overhead
Variable expenses
Fixed expenses
150,000
75,000
Required: (1) The cost to be assigned the 15,000 units in inventory using
absorption costing.
(2) The cost to be assigned the 15,000 units in inventory using direct costing.
:^^^
Vos
Materials
Direct labor
^^
$ 60,000
60,000
Factory overhead
120,000
96,000
Variable costs
Fixed costs
Required: (1)
(2)
3.
April
process inventories.
Required: Comparative income statements for April and May using (a) the
absorption costing method and (b) the direct costing method.
Direct Costing Statements; Gross Profit Analysis. The Duro-Auto Seat Cover
Corporation manufactures one style of automobile seat covers for mail order
4.
houses.
DIRECT COSTING
CH. 22
695
January
Sales (at $10 per unit)
$5.000
February
March
$2,000
$20,000
$ 6,500
$5,000
$2,500
5,000
$7,500
6,500
$1 1 ,500
Ending inventory
$5,000
2,500
$2,500
$1,000
$10,000
Gross
$2,500
$1,000
$10,000
Beginning inventory
Cost of goods manufactured in month
profit
5,000
1,500
Supplementary information
$10
Units manufactured per month 1,000
Standard cost per unit at normal volume
Sales price per unit
$5
$3,000
2,000
Variable
Fixed
may be more
helpful for
system presently in use.
Required: (1) Income statements for each of the three months on the direct
standard cost basis.
(2)
each month.
$90,000
60,000
30,000
50,000
Direct labor
Direct materials
Variable factory overhead
Fixed factory overhead
Assume
(a)
the following:
'-
is
v-
''
is
.
(b) $120,000 direct labor is used in determining the factory overhead rate. At that
level the fixed cost is estimated to be $50,000 and the variable cost $40,000.
(c)
is
closed to Cost of
Goods Sold
at
696
PART
VI
6.
Manufacturing costs:
Variable costs per kilogram of production: $4
Fixed factory overhead $160,000 (normal capacity: 80,000 kilograms)
:
is
used.
under the
(a)
absorption costing
An
two concepts.
Direct Costing Statements; Analysis of Profit Differences. The Travis Manufacturing Company's Cost Department prepares quarterly income statements
based on absorption costing. For the last two quarters of last year and the first
quarter of this year, the following income statements were sent to management:
7.
Income Statements
3rd quarter
4th quarter
1st quarter
$1,600,000
$1,600,000
$1,600,000
$1,200,000
$1,200,000
$1,200,000
250,000
100,000
250,000
250,000
250,000
Total costs
$1,550,000
$1,700,000
$1,400,000
$ (100,000 )
Other
cost, sales,
(loss)
50,000
(c)
Normal
(d)
(e)
sales
demand
Third
Fourth
First
40,000 units
50% of sales price
100,000 units per quarter
100,000 units per quarter
Production
Sales
Quarters
80%
80%
80%
200,000
are:
(b)
(a)
(50,000 )
of normal
of normal
of normal
80%
50%
10%
of normal
of normal
of normal
Required: (1) Income statements for the three quarters based on direct
costing procedures.
DIRECT COSTING
CH. 22
(2)
An
697
quarter.
Profit Differences.
Flexible Budget
Product
100,000
Sales
volume
200,000
150,000
Units
Units
Units
$800,000
$1,200,000
$1,600,000
$300,000
200,000
450,000
200,000
600,000
200,000
$500,000
650,000
800,000
$200,000
160,000
300,000
160,000
400,000
160,000
$360,000
460,000
560,000
$ (60,000 )
90,000
240,000
Manufacturing costs
Variable
Fixed
Total manufacturing costs
(loss)
will
first six
Units
Production completed
20,000
60,000
All fixed costs are budgeted and incurred uniformly throughout the year,
all costs incurred coincide with the budget.
Over- and underapplied fixed manufacturing costs are deferred on the ballance sheet until the end of the year.
and
Required: (1) The amount of fixed manufacturing costs applied to production during the first six months under absorption costing.
(2) In income statement format (including ending inventory), (a) the net
operating income (loss) for the first six months under absorption costing; (b) the
net operating income (loss) for the first six months under direct costing.
(3) Computations explaining the difference in net operating income (loss).
(AICPA
adapted)
PROBLEMS
22-1.
Income Statements
Absorption Costing vs. Direct Costing. The conof the Shriver Manufacturing Company has been encountering con-
troller
difficulties
from
diff'erences
698
PART
Results:
Jan. 1
Actual sales
Actual production
May
Aug. 31
Sept. 1
Dec. 31
60,000 units
50,000 units
50,000 units
40,000 units
40,000 units
60,000 units
fol-
50,000 units
$2.50 per unit
$50,000
25,000
volume
April 30
VI
all situations.
Required: Income statements using direct costing and absorption costing for
each of the three periods.
$1 per hour)
(a)
Year
1st
Produced
Sold
and
DIRECT COSTING
CH. 22
699
Sales
Production
Opening inventory
Unfavorable variances:
$13,500
9,200
Favorable variance:
Direct materials price variance
8,800
statements
Goods
Sold.
costing
and
(b)
direct costing.
(2)
An
(3)
The
on retained earnings
if
the
company
decides to convert to
ManuMarch
1,000
900
all
materials,
50%
100
800
$150
$10
20
$1)
$35
(10% of
sales price)
15
$50
Labor hours
in operations
completed
$ 5,000*
1 5,000
20,000
30,(X)0
Actual
$ 5,400
1 5,000
20,000
30,000
5,075 hrs.
$20,550
9,600
units.
700
PART
VI
MOLEN
OLME @
$ 8
9
$23
December
31
2,000 units,
1,000 units,
all
all
materials,
materials,
50%
50%
processed
processed
Other data
Finished goods, January 1, 1,000 units; December 31, 1,500 units
Materials put in process: 260,000 units of
Actual factory overhead: $398,700, including an increase of $15,000 in fixed
were transferred to the
overhead during the year. 66,000 units of
OLME
MOLEN
warehouse.
4 1/6
Direct labor
Factory overhead
lbs.
$1 .92
$ 8.00
@
@
$1 .80
5.40
6.00
/6 lb.
lbs.
hours
hours
$2.00 =
$19.40
Per Hour
Nonvariable with production
Variable directly with production in labor hours
Total factory overhead for
9 anticipated
$1 10,700
135,300
$246,000
$
1
.90
-10
$2.00
DIRECT COSTING
CH. 22
701
May
31, 19
Debit
Finished
Goods
Credit
$ 48,500
1 3,240
74,310
Work
in Process
Materials
Sales ($26 per unit)
Cost of Goods Sold
Direct Labor
$421,200
238,620
20,160
22,375
Factory Overhead
Materials Price Variance
Materials Quantity Variance
Direct Labor Rate Variance
Direct Labor Efficiency Variance
Factory Overhead Spending Variance
Factory Overhead Efficiency Variance
Factory Overhead Idle Capacity Variance
476
960
30
180
50
200
450
The company carries materials inventory at actual cost and records the variances when charging Work in Process.
Production plans for May called for 1 1,000 direct labor hours in 22 working
days. On this basis, a flexible budget for factory overhead for the month had
been drawn as follows
Fixed overhead (22 days @ $450 per day)*
Variable overhead (1 1,000 hours
$1.10 per hour)
$ 9,900
12,100
$22,000
total fixed costs by the number of working days in the year and
charges overhead each month on the basis of the budgeted number of working days rather than
on the basis of 1/12 of the annual amount.
May
lbs.
800
3,800
1,000
May
31,
(2)
at
19.
Journal entries to complete the general ledger record assuming that the
direct costing instead of absorption costing.
Income Statements
Absorption and Direct Costing Profit and BreakEven Analysis. Seller, Inc. has a maximum productive capacity of 210,000 units
per year. Normal capacity is regarded as 180,000 units per year. Standard
variable manufacturing costs are $11 per unit.
Fixed factory overhead is
$360,000 per year. Variable marketing expenses are $3 per unit sold, and fixed
marketing expenses are $252,000 per year. The unit sales price is $20.
22-7.
702
and
under
PART
VI
(a)
absorption costing
19
(2)
in (1).
(3)
(4)
(5)
in sales dollars.
10% on
sales.
For (3), (4), and (5), assume there are no variances from standards for manufacturing costs. (See Chapters 2 and 24 for a discussion of break-even analysis.)
(AICPA
22-8. Absorption Costing vs. Direct Costing.
adapted)
Norwood Corporation
is
con-
Unit Cost
Marsh
(2 lbs.
$1.50 per
$ 3.00
6.00
1 .00
lb.)
Labor
Variable factory overhead
Fixed factory overhead
110
$11.10
are as follows:
Units
January
Marsh
Work
50,000
(lbs.)
December 31
40,000
in process:
10,000
2/5ths processed
1 / 3d processed
20,000
Finished goods
During
19
220,000
lbs.
5,000
12,000
lbs.
were
Required: (1) Schedules for the computation of (a) equivalent units of pro(b) number
duction for materials, labor, and factory overhead for the year 19
(c) standard unit costs under direct costing and
of units sold during 19
absorption costing; (d) over- or underapplied fixed factory overhead, if any,
for
19.
DIRECT COSTING
CH. 22
(2)
703
using standard
direct costing
(AICPA
22-9. Comparative
adapted)
Advantages and Disadvantages. S. T. Shire Company uses direct costing for its
internal management purposes and absorption costing for its external reporting
purposes. Thus, at the end of each year, financial data must be converted from
direct costing to absorption costing in order to satisfy external requirements.
At the end of 19 A, the company anticipated that sales would rise 20% the
next year. Therefore, production was increased from 20,000 units to 24,000
units to meet this expected demand. However, economic conditions kept the
sales level at 20,000 units for each year.
to
I9A
19B
$30
20,000
2,000
20,000
2,000
20,000
2,000
24,000
6,000
$5,000
$4,000
$30
Standard variable costs per unit for 19A and 19B are:
Materials
$ 4.50
7.50
3.00
Labor
Variable factory overhead
Total
Annual
$15.00
fixed costs for
Production
actual) are:
$ 90,000
100,000
$190,000
The factory overhead rate under absorption costing is based upon practical
plant capacity, which is 30,000 units per year.
All variances and over- or
underabsorbed factory overhead are closed to Cost of Goods Sold. Income
taxes are to be ignored.
Required: (1) Income statements for
(b) absorption costing.
(The beginning
The advantages and disadvantages attributed to direct costing for incompany develops its internal financial data on a direct
costing basis.
(4) The arguments for and against the use of direct costing in external reporting.
(Many businesspersons believe direct costing is appropriate for
external reporting while others oppose its use for this purpose.)
(NAA
adapted)
CHAPTER 23
MARKETING COST
packaging,
etc.,
be charged, (3)
physical distribution to be
(2) price(s) to
advertising
followed.
and controlling
At the end of
each month, budget reports are issued that indicate the success or failure
of holding expenses within budgetary boundaries.
Cost control
at the
costs
departmental level
is
the im-
In marketing, which
company,
To limit mar-
emphasis ordinarily
rests
on
selling rather
than on costs.
which
704
in turn could
mean
CH. 23
705
calls for
making
and governmental
retailers, institutions,
units
radio, etc.
in order to
level.
and
(2)
(1)
to aid in achieving
marketing objectives.
In today's
2.
3.
4.
5.
6.
7.
costs
706
It is
PART
VII
research and development costs for manufacturing as well as other business enterprises should also be planned, analyzed,
and controlled.
De-
partment stores and other merchandising businesses recognized the functional cost control concept
many
years ago.
The
and reducing
same concepts
and techniques are applicable to these other nonmanufacturing costs experienced in municipal, state, and federal units and agencies and other
nonbusiness organizations where functional cost control and analysis are
not only possible but, in many instances, positively necessary. For exto extreme care in controlling
firms
is
costs
on a departmental-functional
in
line basis.
In fact, the
should be placed on a departmental budget basis with a supervisor responsible for the efficient operation
many and
com-
varied. Manufacturers
of certain products use basically the same raw materials and machinery.
However,
in
CH. 23
707
There
is
most
sales
Cause and
effect,
costs are incurred for future results, creating a time lag between cause
eff"ect.
felt
quickly and matching between elTort and result usually can be determined.
;
marketing costs.
For marketing
costs,
it is
quantities or units of activity with the cost incurred and results achieved.
Goods
if
variable,
fall
off"
end of the accounting period. Thus, marketing costs are generally charged
against the operations of the accounting period in which they are incurred
while production costs are held in inventory until the units are sold. This
practice
is
followed because
it is felt
that too
much
expenses.
expensed
In the
Marketing
uncertainty exists as to
of marketing costs,
it is
more common
to speak of
not necessary.
tie-in
it is, is
often
cedure
is
mar-
is
this pro-
historical or
employed.
accountant.
real
policies, fore-
708
The
1.
3.
4.
5.
VII
2.
PART
Departmentalization of
management
activities
so well
or functions
6.
7.
Functional Classification.
costs
is
first
It is
method of operation.
should
be a homogeneous unit whose activity can be
Each function
related to specific items of cost. A function might incur its particular pat-
its
most functions
light,
will
power, supplies,
etc.
The
manner:
1.
Selling
2.
Warehousing
Packing and shipping
3.
4.
5.
6.
Advertising
Credit and collection
General accounting (for marketing)
truck. Expenses
which can be
The charging of
may
tions
to
its
point of incurrence.
CH. 23
709
Marketing expenses have been coded in the 500 series (500-599) in the
chart of accounts illustrated in Chapter 4. However, a three-digit number
is
For
DIGITS
as follows
710
(1)
As a
solution to the
(2)
first,
how
PART
far
VII
should
statements and
opinions stress the fact that the bases used should be fair and equitable;
they should be an ideal combination of efforts expended and benefits
reaped.
advantages of
full
allocation of
raised as to the
Suggestions have
indirect expenses.
all
been made that certain expenses should be omitted from the allocation
procedure when they are not measurable in relation to the function or
activity.
many
This
is
especially true
when
is
a mere guess.
and
staffs
salaries of
collection departments;
warehousing, ad-
and
costs of asso-
is
valuable in connec-
tion with managerial decisions dealing with the possible opening or closing
line.
The
selection
Factory
overhead rates use a base which most definitely expresses the effort connected with the work of the department, such as labor hours, machine
hours, or labor dollars. A similar procedure is to divide the total cost of
each marketing function by the units of functional service (the base) to
obtain the cost per unit.
The
and
CH. 23
costs
is
greatly dependent
upon
711
Each
function must be examined with respect to that factor which most in-
FUNCTION
712
PART
VII
and
policies.
Budgets are
set
up
to anticipate the
amount of functional
ex-
penses for the coming period and to compare them with the actual ex-
The
this
flexible
billing
might take
form
Flexible Budget
Functional Unit
Expenses
50,000
400
300
Clerical salaries
Supervision
Depreciation
Depreciation
Supplies
building.
equipment
75
125
Total
Invoice Line
55,000
$
400
300
60,000
65,000
400
300
400
300
75
125
75
125
75
125
250
275
300
325
SI, 150
$1,175
$1,200
$1,225
is
will
fol-
idle
billing rate
lines represent
$1,200
^r, r,r^ r
T^
60,000 Invoice Lines
Assuming $900
portion of the rate
fixed expenses
= $02
pCT
InVOlCe LlHC
^
is
$300
made
month
at a total
of
can be
budgeting.
CH. 23
The computation of
713
is
as
follows
Actual expenses
$1,25
Budget allowance:
Fixed expenses budgeted
Variable expenses
voice lines)
$900
($.005
63,000
in-
315
$1,215'
^ $(45)
$1,260'
On
due
made
Expenses Charged-In
Applied Billing Expenses
Billing
,260
1
,250
Sundry Credits
1,250
35
45
1,250
management
,260
,260
is
this type
of variance analysis
is
presented
in report form.
profitability of territories,
cost
and
and
profits.
needed to
amount of
When
is
marketing
activities
are organized
on a
is
territorial
basis,
each
714
incurred within
its
PART
VII
and shipping
costs;
and advertising
specifically
Expenses that must be prorated to the territory are: general management, general office, general sales manager,
identified with the territory.
credit
No.
Net
sales
Gross profit
Marketing expenses:
$210,000
160,000
S 50,000
S 15,000
Selling
Warehousing
Packing and shipping
Advertising
Credit and collection
General accounting
3,600
,500
2,000
1
800
1,200
$ 24,100
5,000
Net income
S 29,100
S 20,900
No. 2
$80,000
No. 3
CH. 23
analysis meaningful.
(4)
An
made
(1)
by
ter-
ritories, (2)
by
715
size
reflects
The
analysis
would proceed
in the
territory.
minimum
dollar values or
minimum
and
much
favor
among many
routines, something
which
profits.
executives.
is
It
Selective seUing
requires changing
In order to present
regarding size
spent,
and
$100
to
$999
Less
than
$100
CUSTOMERS
TIME SPENT
BY SALESPERSONS
716
customer-volume groups
with this exception.
is
like that
An
PART
VII
analysis of customers by
or volume.
ability
price differentials.
customers
The
analysis
Though they
shown below
profits.
CH. 23
some
For
and
717
made by
the firm's
own
order
size,
by
territories,
common
actual contribution of each product line to total profits for the year.
718
PART
To
VII
These standards are used not only for the control of costs
established.
is
made by
salespersons.
Cost Control. In the allocation table on page 711, selling expenses are
assumed
to be allocated
salesperson
on the
basis of calls
made.
call
or
visit
by a
usually
is
merchandise or
each of these types of work and to compare the actual cost with the
standard cost allowed for a
call.
calls
such
activities,
call is
establish.
and to
tomer or town report providing information regarding the type of calls
made as well as the quantity, type, and dollar value of products sold. This
information
is
Profitability Analysis.
persons' activities,
ability.
Sales
it is
much
tell
sales-
profit-
High volume
The
table
made.
and
all
mar-
CH. 23
719
720
Although
sales
PART
sales
VII
man-
Even though a manuknow the production costs, the question remains: "How
company afford for marketing costs?" The problem of
much can
the
program
gets
is
intensified because
once a
The
activity.
in
competitive society.
the
Robinson-Patman Act
To make
is
CH. 23
721
of damages in certain cases; and to protect the independent merchant, the public
whom he serves, and the manufacturer who sells him his goods from exploitation by unfair competitors.
compelled or
vendor may sell to
customers
all
is
at the
serving them.
Differentials granted
Price differences
5.
2.
Discounts
Delivery service
Allowances for service
6.
Advertising appropriations
Brokerage or commissions
7.
Consignment
3.
4.
These discriminating
Many
costs.
interesting
policies
will
of marketing
continue to arise
because of the nature of these costs and the numerous variations and
apply
many marketing
As
indicated,
it is
its
the interest in
The
he must
make a
dif-
Therefore,
The complaint
is
lists
vaUd
if
2.
3.
4.
5.
The most
effective
method
is
marketing
make
722
PART
VII
The sales manager estimates (since exact records are not available) that
salespersons typically pursue the following call schedule:
Annual Number
Customer Size
{in
Carloads)
of Sales Calls
10-40
12
24
36
50
41-80
81-150
151 and up
The sales manager further estimates that each sales call costs approximately
$50-$70 regardless of customer size. After questioning, he agrees that study
would probably show that calls on large customers (more than 100 carloads)
are longer in duration than calls on smaller customers. For study and testing
purposes, it was assumed that a call on a small customer costs $60 and a call on
a large customer costs $90. The cost-sales relationship illustrated in Exhibit 1
can now be developed.
Differential Cost
Large
vs.
Small Customers
Annual Carloads per Customer
25
Sales value
Number
of sales calls
Assumed cost per call
Assumed cost of call per customer
Assumed cost of call as a percent of sales
50
100
200
500
Exhibit 1
Since the assumed differential costs are less than the 6 percent proposed
discount, it appears obvious that a discount of that magnitude is not susceptible
to cost justification. Indeed, it is possible that even a one percent discount to a
500-carload customer might be hard to justify since it is probable that more
exact costing would narrow the spread in the percentages among the various
classes.'
citation.
No.
4,
pp. 31-32.
3,
CH. 23
that
by
show
723
maximum
allowable cost savings and (2) maintain the cost data cur-
not be utilized;
to
i.e.,
add an order
it
is
to increase
its
its
due to
(The reduced cost per unit resulting from the
volume change.
volume must be spread over all units.)
In general, the Robinson-Patman Act seems to be working toward
greater equity between prices, inasmuch as pricing schedules appear to be
more carefully attuned to differences in marketing costs than they were
the
"^
greater
and
continuously to help management avoid unintentional price discriminations that might be in violation of the law.
it
is
profitable
is
fixed costs
profitable basis.
review the firm's marketing costs and to study the steps, methods, and
procedures necessary to provide more accurate information about the
profitability of territories, products,
and customers.
4,
pp. 33-40.
724
The
PART
VII
2.
Direct or functional (departmental) costs were assigned directly to funcand indirect expenses were allocated via a measurement unit, such
as kilowatt-hour, footage, number of employees, etc.
3.
tions
4.
5.
6.
7.
8.
selling prices
were
prepared.
9.
lines in
one territory
summarizes the results of the study prepared by the con1 shows the total budgeted expenses per function.
Each
total is supported by a budget showing the amount for each individual
expense of the function. Columns 2 and 3 place total expenses in a variable and fixed expense classification. Column 4 indicates the functional
unit measurement selected as being reliably applicable to that function.
Exhibit
Column
troller.
Column
and
Exhibits 2 and 3
hibit
and
illustration,
list
Columns
rate.
6, 7,
and
8 indicate
(2) the
been excluded.
a profit.
This analysis
is
is
not suf-
and
made by
illustrates
state-
Next,
Function
SS.*""
Selling
(5)
S 38,200
$ 87,300
46,000
37,500
30,000
25,500
54,000
28,800
*0.800
18,720
21,300
10,080
27,900
$368,800
$180,720
$204,780
Warehousinp
Packing nnd shipping.
Advertising
Credit and collection.
General accounting.
(S)
J.000
63,000
".000
.
Functional
Unit Costing Rates
Total
Variable Fixed
Functional Unit
Measurement Base
Quantity
U)
(5)
(8)
(7)
(6)
3%
2%
Jl,910,000
Gross sules dollar value of
product sold
375,000
Weight of units shipped
160,000
Quantity product units sold
160,000
sold
Quantity product units
7,200
Number of customers' orders
16,000
Number of times product items
appear on customers' invoices
.08
.17
.36
4.00
1.40
1.88
2.60
1.42
.20
.42
.98
3.28
Exhibit 1
DATA CONCERNING
Product
Produ ct Class
$10.00
8-00
Product 2
Product 3
$15.00
$18.00
n.^
80,000
2.25 kg.
20 OW
3.5 kg.
,',^^
3,000
^ 900
, 'oqq
,U0
1
O'^""
2,400
customers' invoices
Number of customers' orders
50,000
2.5 kg.
Exhibit 2
in Territories
Number of
Territory
Pennsylvania
New
55,000
25,000
Jersey
Customers' Orders
Product Product Product
3
2
1
Invoices
30,000
16,000
4,000
2,900
1,000
1,000
1,900
20,000
4,000
2,400
2,800
1,900
1,400
1,100
900
900
Exhibit 3
in
the
Two
Territories
Territory
Gross
,,^,
sales.
Total
Pennsylvania
$19iW0
$1,288,000
962,000
1430
000
i,4:>u,uuu
Grossprofit
Less marketing expenses:
^^
^^^
75'000
'^'YY^
63,000
Sf'''"S--;Warehousing.....
Packing and shipping
Advertising
Credit and collection
General accounting
Tnt^x
^,,.
Net income
480,00
,"^ )CC^
326,000
$622,000
468,000
^t^iAnnn
$154^0
^44^^
$31,100
50,950
^2
42O
42,420
24,050
20 580
2U,.^
70'finn
800
28
4y^zuu
....
New Jersey
15
200
13
13
600
6^^
Jt'^-
365,500
235,242
TTuTt^
$130,258
$
j>
114,500
ii.t,^v/
90,758-
$23,742
Exhibit 4
726
in
PART
VII
Product
Product 2
Product 3
$1,288,000
962,000
$550,000
440,000
5450,000
330,000
$288,000
192,000
326,000
$110,000
$120,000
$ 96,000
64,400
50,950
42,420
36,360
5,200
25,912
$27,500
$22,500
$14,400
Total
Gross
sales
Gross
profit
Warehousing
Packing and shipping
Advertising
Credit and collection
General accounting
Total
Net income
24,750
23,100
19,800
4,000
13,120
(loss)
235,242
90,758
$112,270
$(
2,270 )
5,000
12,600
10,800
7,600
9,512
1
,200
6,720
5,760
3,600
3,280
$ 78,012
$ 44,960
$ 41,988
$ 51,040
Exhibit 5
Gross
$550,000
264,000
sales
= 60%
of $8)
$286,000
$11,000
14,850
Selling
Warehousing
Packing and shipping
Credit and collection
13,750
2,600
5,680
General accounting
Contribution margin
Less fixed costs and expenses
Manufacturing costs
Marketing expenses
fixed
fixed:
$176,000
$16,500
9,900
9,350
Selling
Advertising
Credit and collection
19,800
1 ,400
7,440
General accounting
loss
47,880
$238,120
Warehousing
Packing and shipping
Net
240,390
$
(2,270)
Exhibit 6
improvement
in the profitability
of
this
product
ysis
selling
line
should be determined.
cost-
CH. 23
727
DISCUSSION QUESTIONS
1.
What
2.
On what
number of
(e)
(f)
Warehouse expenses
(d)
3.
How
5.
selling jobs or
4.
products?
6.
The
staff.
How
(a)
What adequate
(b)
7.
company with a
which are again divided into districts. The products are nationally
advertised and are sold to retail shops. Assuming 1,000 sales per day with
an average of four items to each order, what marketing cost system should
ritories,
(b)
(c)
8.
The necessary sales statistics to control sales by both territories and lines ?
The expenses of such a sales force ?
Records and statistical analyses for use in the preparation of sales budgets and profit margins?
What
income
statements?
(AICPA
9.
adapted)
10. (a)
728
11.
When and
to
what extent
PART
VII
is
2.
Explain briefly the difference between the profit and the contribution margin
in marketing cost analysis.
approach
13.
to the establishment of
EXERCISES
1.
Comparative Statement
Applied
vs.
the Eldridge Company has requested the establishment and use of volumerelated standards for marketing cost analysis to allow management to know
what the marketing costs should have been as well as what they are. With
standard costing rates set for various functional costs, charges can be made on
the basis of these rates and applied to actual sales volume.
The assistant controller presents the following data supporting the analysis:
Planned sales
Product
Product
Number
Number
Sales
of Orders
of Units
Amount
2,000
8,000
4,000
16,000
$80,000
10,000
20,000
$240,000
A
B
Total
160,000
Product B
4%
5%
of sales
of sales
$.30 per order
$.40 per unit
$.10 per unit
Product
Product
A
B
Total
Number
Number
Sales
of Orders
of Units
Amount
2,800
6,000
5,000
12,000
$100,000
120,000
8,800
17,000
$220,000
Order filling
Order handling
to
Expenses
Month
Total
Next Month
$8,700
$700
$8,000
500
12,000
2,850
4,000
12,000
2,850
4,500
for
..
CH. 23
729
Customer
Class
Dollar
Sales
Gross
Number of Number of
Profit
Sales Calls
Orders
Number of
Invoice Lines
Department
240
$180,000
$ 26,000
Retail appliance
stores
240,000
80,000
Wholesalers
300,000
71,000
$720,000
$177,000
1,000
stores
Total
120
2,100
360
580
4,600
400
300
3,300
1,000
10,000
Required:
Measure of Activity
$65,000
12,000
10,000
15,000
18,000
Salespersons' calls
Customers' orders
Dollar sales
Invoice lines
Customers' orders
3. Territorial
Costs
(When
round to
Net
sales
Salespersons' salaries
Salespersons' traveling expenses
Warehouse expenses
Delivery expenses
Supplies
Territory 1
Territory 2
Territory 3
Total
$120,000
6,000
3,650
$100,000
$180,000
9,000
5,000
$400,000
20,000
1,200
2,000
5,000
2,350
1,000
3,000
500
400
3,300
6,000
800
11,000
5,500
11,000
1,700
manufacturing
three territories.
..
730
(2) An explanation of
determining:
how
PART
management
(a)
(b)
(c)
VII
certain
in
made
of
class
customer.
4. Profitability
Litenpower Electric
distribution.
Warehousing
Packing and shipping
Advertising
Credit and collection
General accounting
fol-
and
customer order
costs were:
Activitv
Depart-
Total
Actiial
Measure of
Costs
Activity
$187,500
Salespersons' calls.
Function
Selling
Warehousing
Packing and shipping.
12,100
35,900
Advertising
II
23,800
9,300
,200
Cu.
Cu.
ft.
ft.
Media
of product
of product.
circulation
Invoice lines
Customers' orders.
Retailers
Whole-
ment
salers
Stores
75,000
390,000
390,000
4,000
115.000
18,500
10,000
160,000
160,000
75,000
2,000
5,000
60,000
4.500
$670,000
25*^
$310,000
$405,000
40%
30%
,000
15,000
250,000
250,000
Gross
profit percentage
110, etc.
CH. 23
The records
for the
Salesperson
Palmer,
731
Thompson,
J.
Weatherbil, O.
Sales
Travel
Calls
Expenses
Sales
70
100
120
S500
400
360
S7,000
4,200
3,000
Required: A monthly report comparing the standard and actual performances of the salespersons (including the performance indices) for (a) sales
calls, (b) travel expenses, (c) sales, and (d) sales revenue per call.
Amount
Expense
Advertising:
Direct-to-customer catalog
3,600
9,000
36,000
48,000
28,800
10,800
8,400
$144,600
Net
sales
Number
Number
Small-
Medium-
Order
Customers
Order
Customers
LargeOrder
Customers
$1 50,000
$220,000
$350,000
2,500
1 00,000
2,000
1 50,000
250,000
$1
Number
of customers
Relative number of miles
sales person)
Number of salespersons
1,500
traveled
per
day
$2
1,500
1,500
$3
2,000
(per
10
16
13
In the Collection Department, bookkeeping costs per order handled are about
ten cents. Each customer is mailed a statement of his account at the end of the
month, and the customers make single monthly remittances on account.
All salespersons are paid the same salary; each salesperson works with a
single class of customer.
Required:
proration of the marketing costs of Territory 1 to the three
order-size classes of customers to justify costs. Indicate the base or bases on
is
made.
732
PART
VII
PROBLEMS
23-1. Territorial Profit Contribution Report. The Shamblin Products Company
uses a "territorial profit contribution report" as an effective tool for marketing
cost analysis. The report is coordinated with the company's semiannual budget
by establishing the profit required from each sales territory to meet all branch
and head office operating expenses plus expected net income for each month.
This procedure gives the sales managers not only a sales budget in both quantity
and value but also the estimated profit required from each territory under their
supervision.
period, the
statement:
sales
$10,000,000
6,000,000
$ 4,000,000
700,000
1,500,000
300,000
$ 1,500,000
$1,000,000
300,000
Net income
The
sales forecast
2,500,000
1,300,000
200,000
territories
is
as follows:
Territories
11
$ 8,000
$ 8,000
974,000
$ 1,000,000
,000
11,000
November
December
$ 10,000
1 5,000
15,000
30,000
20,000
10,000
22,000
15,000
8,000
2,000
12,000
24,000
16,000
8,000
,462,000
1,462,000
2,924,000
1,949,000
974,000
1 ,500,000
1,500,000
3,000,000
2,000,000
1,000,000
Total
$100,000
$75,000
$80,000
$9,745,000
$10,000,000
Month
July
August
September
October
II
1 1
shown
Others
$
1
Total
sum
to
The budget of the territorial profit contribution for the three territories for
the three-month period ending September 30, 19
showed the following costs
and expenses
CH. 23
Territories
Salaries
$24,890
18,319
75
42
55
733
and
Freight
Commissions
$1,820
$6,500
4,250
6,200
\,iAe
3,845
14,815
Travel
Expenses, Etc.
790
1,185
2,340
Actual results in the three territories for the same period were;
and
Territories
Sales
Cost of
Goods Sold
Freight
Commissions
Travel
Expenses, Etc.
75
$44,250
33,465
18,865
$27,878
24,710
11,378
$2,212
2,245
3,329
$6,100
3,900
5,820
$1,437
1,420
1,940
42
55
Salaries
comparing
(Based on an
NAA article)
By
Expense
Not
Sales salaries
Not
Sales traveling
By Order-Size
Products
Classes
number
allocated
allocated
of customers in class
Number of customers
in
class
Not
Sales office
Number
allocated
of
customers
in
of
customers
in
times
number
of
times
number
of
class
Sales commissions
Credit
management
Direct
Direct
Volume of sales
Number
in dollars
class
Weight
times
number
of
units
Weight
units
Warehousing
Weight
Advertising
units
Not allocated
units
Not allocated
Volume of
Number
Bookkeeping and
billing
times
number
sales in dollars
of
Weight
of orders
Not
allocated
Not
allocated
734
PART
VII
From books, records, and other sources, the following data have been compiled
Order-Size
CH. 23
(a)
(b)
(d)
Order handUng
General and administrative expenses
SelHng expenses
(e)
Commissions
(c)
735
Number of Orders
Weight
Freight shipments
Parcel post shipments
Total
The
allocation
Freight
Parcel post
387,000 kg.
6,500 kg.
1,680
2,320
393,500 kg.
4^000
is
of Shipments
by Weight
of Shipments
Handled
98
2
42
58
%
Total
of Total
140
60
70
30
The detailed data assembled further shows that all orders under $10 and
620 orders in the $10 to $49.99 class are sent via parcel post. Shipping and
warehousing costs total $7,000.
Order-handling expenses amount to $9,000 to be allocated on a cost per
order basis with each invoice being considered a separate order.
General and administrative expenses
Marketing expenses
$17,000
24,000
27,000
Commissions
(All distributed
on the
Required: (1) Using the partially completed form below, (a) allocation of
the costs to the various groups (b) computation of the percentages as indicated,
and (c) determination of the net income (loss) of each order-size group.
Order Size
Under 810
$10 to $49.99
$50 to $99.99
$100 to $499.99
$500 and over
Budget
at Standard Cost
CH. 23
737
size classification,
and the
profit
(b)
For each unit volume classification, a schedule computing the standard cost per
unit for each order filling cost: freight, packing, and warehousing. Use the
format in item (d) above for this schedule.
A schedule
each unit-volume
classification.
(AICPA
adapted)
Store
Ashville
Burns
$353,600
183,300
Clinton
Total
120
CH. 23
739
local manager; sales orders are forwarded to the main office and filled from
a central warehouse; billing and collections are also centrally processed. Expenses are first classified by function and then allocated to each territory in the
following ways
by a
Function
Basis
Sales salaries
Actual
Equally
(AICPA
adapted)
Gross
sales
Sales returns
Tolan
$247,000
$142,000
2,000
85,000
2,100
17,000
180,000
5,500
4,000
5%
450
5%
Required: (1)
work
Darn
List any questionable sales practices by a salesperson that might be encouraged by basing commissions on gross sales.
lated.
(2) (a) Do the data reveal any evidence that the compensation plan may be
working to the detriment of the company ? (b) What other information should
the manager obtain before reaching definite conclusions about this particular
situation?
Why?
C. Commissions for Sales Force Motivation. The Parsons Company compensates its field sales force on a commission and year-end bonus basis. The commission is 20% of standard gross profit (selling price standard cost of goods
740
PART
VII
sold on a full absorption costing basis), contingent upon collection of the account. The customer's credit is approved by the Credit Department. A yearend bonus of 15% of commissions earned is paid to salespersons who equal or
exceed their annual sales target. The annual sales target is usually established
by applying approximately a 5% increase to the preceding year's sales.
(2) The features of this compensation plan that would seem to be countereffective in motivating the salespersons to accomplish the company goals of
Explain.
(NAA
adapted)
Required: (1) The positive and the negative financial- and accounting-related
factors to be considered in deciding whether to participate in this credit card
plan. Explain.
(2) If the department store does participate, the income statement accounts
and the balance sheet accounts that may change materially as the plan becomes
Explain. (Such factors as market position, sales mix, prices,
fully operative.
markup, etc., are expected to remain about the same as in the past.)
(AICPA
adapted)
CHAPTER 24
BREAK-EVEN AND
COST-VOLUME-PROFIT
ANALYSIS
The break-even
and
tables.
The
Break-even analysis
is
made with
its
efficiency as a
com-
741
742
PART
VII
analysis
most of the information required already exists; and the break-even analysis and charts become merely by-products of the current flexible budget.
The relationship between standard costs and budgets is pointed out in
the budget chapters. AntiripatpH <;ales rpvpnn? bRSfd. on market conditio ns
a nd tempered by^^pjf nt capacity is; -&F^-(kM^tinined. Existing flexible budgets are reviewed and revised to incorporate expected changes in prices and
'lo^y
r"^
Z^
becomes the basis for establishing standard costing rates for materials,
and factory overhead. Values so determined are then incorporated
(^~\S
labor,
V.
in the budget.
Where
and administrative activities and used in budget construction which becomes a summary
of standards. The data in the flexible budget can be used directly and withpossible, standards are also set for marketing
budget report
is
better understood by
in tabular
form.
management than
As standard
voluminous
and readily obtainable source of data for various types of cost reports
and analyses, they form a most valuable tool for the preparation of a
chart designed to indicate future profit possibilities.
In observing the
its
its
aff'ected
by cost-volume-profit relationships.
This procedure
is
If
such an analysis
CH. 24
743
has been made, the costs and expenses in a conventional income statement
can be restated as follows
Cost Item*
Total
Materials
Labor
Factory overhead
Marketing expenses
Administrative expenses
$1,000,000
1,400,000
400,000
1 50,000
50,000
$1 ,200,000
$4,600,000
$3,000,000
$1,600,000
60%
total, is
make
all
Each dollar of
a percentage of sales.
To
"HjL
available to cover
goal.
200,000
200,000
assumed to be $5,000,000.
Fixed
Variable
$1,000,000
1,400,000
1 ,600,000
350,000
250,000
The balance, 40
a profit and
is
60 percent
percent,
is
expressed as
toward
this
find the total sales dollars required to recover the fixed costs
The
{C jM) and is
40 percent
is
known
It is
volume
ratio.
also
(sales
variable costs) by
sales revenue.
in this
textbook
is
"con-
The
resulting $4,000,000,
that sales
is
(C/M)
volume
.40
known
which neither a
in dollars at
= $1,600^ ^
profit
is
made nor
a loss
follows
Net
sales
(60%
$4,000,000
2,400,000
of net sales)
Contribution margin
Less fixed costs
Net income
$1,600,000
1,600,000
-0-
(loss)
volume of $5,000,000 can be regarded as normal, the percompany must operate in order to break
computed as shown below.
If a sales
even
is
Normal
Sales
Volume
in Dollars
in Dollars
3^
$4,000,000
$5,000,000
D^ nx^m
1^ ^'^^ pf^^nt^g
f^'^''^
O^Urv^ i^M
U5-
^^^^^
PART
VII
at
744
The answer
indicates the
must be reached.
For
If profits
this reason, a
following formula:
in Dollars
Volume
in Dollars
in Dollars
$1,600,000
^~
$3,000,000
$5,000,000
$1,600,000
1-.60
$1,600,000
.40
An
alternative formula
is
$4,000,000
in the previous
in Dollars
formula;
i.e.:
Volume
in
Dollars
sales
(60%
of net sales)
$5,000,000
3,000,000
Contribution margin
Less fixed costs
$2,000,000
1,600,000
Net income
400,000
xDf~
"r.
A-->
\\^M t0^r(\WA'-Vi
-J
CH. 24
price of $4
also be
computed
in units.
745
With a
unit sales
(60% of
$4)
in units
is
obtained
Break-Even Sales
Volume
in
Units
$1,600,000
SI. 60
'
^^ ^^^
$4,000,000
Dollars
in
$4
^^.^^
first,
break-
sales price:
^^^ ^^^
,000,000 units
if
break -even
is first
price:
Break-Even Sales Volume
in
Units
1,000,000 Units
$4
$4,000,000
may
With
mininglix ed,aiifl
vnriahlt^ cQsts ^
and
volum e. o^.^V
7>
2.
Forecast sales
Fixed and variable costs
2.
is
constructed as follows
horizontal base line, the x-axis, is drawn and spaced into equal distances to represent the sales volume in dollars or in number of units.
the chart.
sales
and
The
is
costs in dollars.
drawn
is
Lo^
ICV-
U?fh
746
VU
c^
'^->c^<-
^O.
(,0^^
i^
\./nMvn,>^
\-U^
C(CSL
**
\y^^>r^ijt-.
PART
VII
$5,000
$4,000'
T3
(0
VARIABLE
'COST AREA
$3,000-^
$2,000$1 ,600
$1 ,000 -
FIXED
COST AREA
$3,000
750
^4?, ^r^t^/,^.-1f
SALES VOLUME
IN
$4,000
1,000
$5,000
1,250
(OOO's Omitted)
3.
drawn
the y-axis.
total cost line is drawn from the $1,600,000 fixed cost point
y-axis to the $4,600,000 cost point on the right side of the y-axis.
5.
The
on the
X-axis
6.
7.
total cost line intersects the sales line at the break-even point representing $4,000,000 sales or 1,000,000 units of sales.
The shaded area to the left of the break-even point is the loss area while
the shaded area to the right of the break-even point is the profit area.
The
and variable
That
is,
the
amount of
for
behavior are assumed and have general acceptance within the relevant
range of activity, i
iCalculus can be employed in dealing with curvilinear functions. See Travis P. Goggans,
"Break-even Analysis with Curvilinear Functions," The Accounting Review, Vol. XL, No. 4,
pp. 867-871.
CH. 24
747
and variable
costs begin
costs at a definite
above fixed
amount
costs.
is
Many
drawn
fixed
analysts
first,
and
line.
$5
$4.6
^"^
CONTRIBUTION
MARGIN
$3
VARIABLE
COST
AREA
-T
r
$3,000,000 $4,000,000 $5,000,000
1
$1,000,000 $2,000,000
20%
40%
60%
80%
100%
250,000
500,000
750,000
1,000,000
1,250,000
SALES VOLUME
IN
line
Where
and the
break-even point has been reached. The space between the sales
and the
and the
748
this
PART
VII
Should
sales, for
variable costs
costs
[$2,000,000
($1,200,000
$1,600,000)].
This solution
is
indicated by
sales line
to
situation
Col. 1
Col. 2
Col. 3
Col. 4
Col. 5
Col. 6
Profit
$4.6
$4.4
.
J.
Adm. Expenses
Marketing Expenses
'
S2 95^
$2.8
Factory Overhead
Adm. Expenses
Marketing Expenses
Factory Overhead
Break-Even Chart
^jj^ Detailed
Fixed and
Variable Costs
'Direct Labor
Direct Materials
$1,000,000
$2,000,000 $3,000,000
$4,000,000
$5,000,000
20%
40%
60%
80%
100%
250,000
500,000
750,000
1,000,000
1,250,000
SALES VOLUME
$1,000,000
IN
\.
ii
^3
^.JA^A^^
'^^^^^'^-^\<^
750^.
<-
qO/-
-h
_^
|PdX)
3tt ^
VII
-?
PART
products.
An
illustration
of such a
is
realized
shift
on
all
in sales
of a high-margin item.
vFmJ^^ L
^
$1,500,000
Sales
$900,000
400,000
Variable expenses
Fixed expenses
1,300,000
Net income
200,000
The break-even
sales
volume
in dollars
as follows:
Variable Expenses
^
_
~
in Dollars
fiscal
^.
^'
$1,500,000
= 60%
^ of
_
=
$400,000
^40
Sales
^^ ^^
^
51,iaju,uuu
.
company's
->
$1,420,000
Sales
$900,000
400,000
Variable expenses
Fixed expenses
1,300,000
Net income
120,000
in this case
is
now approximately
$1,092,000,
indicating that the decrease in sales of the high-margin item caused an un-
It illustrates
the necessity
is
pro ducts
is
that changes in
CH. 24
751
new equipment.
replaced by
may be
effects
of the shift
is
to be maintained ($1
The break-even
and
^ 25% =
sales efforts.
$4).
analysis formula
is
(C/M)
is
Total
"^
Fixed Costs
~i
r"i
Pro
+
'
fit
?^
Objective _
'
77^
management wants
profit objective
Assume
is
The
$400,000.
sales
is
.40
would lead
to a
$1,600,000
$200,000
J7{
.40
$3,500,000
;=^=i^!=^
on the
and expense
figures
sales
ment the
on the product
unit cost.
As an example,
752
$300
$210$200-
Loss
Per
Revenue
VPerUnit
Unit
I
3^,
r$ioo-
Break-Even Point
CONTRIBUTION'
MARGIN
$60-
100
'
PART
VII
CH. 24
The analyses
753
in
"What
understanding the
on
effect
when
profits
When
per unit.
must
at a different level
costs
must be judged
New
effect
may
be
Unit
comparison.
Using figures
from the example introduced on page 752, total cost of $45,000 ($15,000 +
$30,000) divided by total units (500) gives a unit cost of $90, The formula
is:
Unit Cost = '''-"""s^of"'"""'
At the 100 percent level of activity,
X in the equation is 1 Use of this formula facilitates the computation of
unit costs under conditions of fluctuating activity levels.
The formula
would be: Unit Cost = Hr^? where a = fixed costs; bi = variable expenses at normal capacity level; b2 = units of production at normal
capacity level; and x = level of activity, expressed as a percentage of
-
^normal capacity.
To
illustrate the
Using these
the
facts, the
computations below
new break-even
point,
unit cost
when operating
at
90 percent of capacity.
New Break-Even
Letting
Point
New
Profit
New
New
Profit
New
Profit
Profit
f-.
,,
rC
^ ^
$23,OOOx
- $27,000x) - $17,000
=
=
$23,000x
$17,000
.739
=
=
^
x
ScXi ^
= (sx
($50,000x
$17,000
$17,000
$23,000
100, or
74%
capacity (approximate)
754
PART
VII
(or)
Fixed Cost
Variable Cost
$27^ ^
1
$17,000
=
=
537 000, or
$17,000
74%
54%
of sales
.46
.54
Unit Cost at
New Break-Even
Unit Cost
Point
=iL+_M
boX
$17.000
$27,000 (.74)
500
$17,000
(.74)
$19,9 80
370
= $100
(approximate)
$17,000
$27,000 (.90)
^^^^^^
$17,000
$24,300
450
= $92 (approximate)
The above equations permit the development of unit costs using data
included in the budget. They further permit quick and easy computations
in connection with
Budget data
MARGIN OF SAFETY
Information developed from a break-even analysis offers additional
useful control data such as th e margin of safety, which is a selec ted_sales
..^urejess_break-eyen sales.
From
Ex pressed
is
as a percentapp of
called the
Margm
m argin
of safety
of Safety Ratio
is
<;;^le<;,
ratio
. ,
(M
/S) =
,r,x
the data
sales are
$1,000,000 ($5,000,000
$4,000,000).
pprr,pnT.and
(M /S
is
).
Break-Even Sales
$5,000,000
$4,000,000
$5,000,000
= 20%
CH. 24
755
The margin of safety indicates how much sales may decrease before
company will suffer a loss. The margin of safety is directly related to
profit. Using the same data from page 743, with a contribution margin
ratio of 40 percent and a margin of safe ty ratio of 20 percent, then
the
Profit
P = C/M
P = 40%
P = 8^
X M/S
X 20%
If the contribution
known,
is
1.
levels
2.
3.
4.
5.
may
shown
sale,
specific
and for
product
Further-
class, to distri-
profit determination.
The
Total
Costs
Profit
Montli of June
Month of May
$50,000
40,000
$40,000
36.000
$10,000
4,000
Net difference
$10,000
$4,000
$6,000
756
An
PART
VII
and an increase
covered
in sales
fixed expenses
The
in profit
its
and
100 percent.
is
is
As $6,000
$10,000
$10,000
100 percent
60 percent (the
60 percent
.40)
May
from
ratio), the
more
ratio,
as follows:
$40,000
20,000
Fixed costs
ratio
percent or,
Total costs
Variable costs ($50,000
= 40
C/M
C/M
follows: $36,000
profit or
profit.
$20,000
.40)
computed
as
is
in
$60,000
45,000
Profit
$15,000
Sales
$45,000
$24,000
20,000
.40)
44,000
$ 1,000
Difference
fixed costs
shift
may
C/M
The
(S
S, sa lSj_andFC,j2ced_costs.
X C/M) - FC
P = ($5,000,000 X .40) - $1,600,000
P = $2,000,000 - $1,600,000
P = $400,000
P =
(S
CH. 24
757
The same formula permits the computation of additional data. If, for
example, a company has fixed costs of $90,000 with sales at $300,000 and
a profit of $60,000, the
C/M
ratio is:
P =
$60,000
$60,000
$90,000
$150,000
=
=
X C/M) - FC
X C/M) ($300,000 X C/M)
(S
($300,000
^ ^
$300,000
'
$90,000
j^
50% = C/M
Or suppose
a $30,000 loss.
the
p =
C /M
758
3.
PART
VII
which crosses
line
$2
$2-
o ? 5
$1-
-$.4 Profit
-0
Margin
of Safety
w o
w E
O ;^
-$(1)
$(1)-
${1.6)-
0^
V tjVc^ ^ST
U-OrJi.
CK^O
$(2)
$(2)-
Obqs
Profit- Volume Analysis
Graph
GRAPHIC PRESENTATION OF
PROFIT-VOLUME RELATIONSHIP
A break-even chart presents a more compact
profit structure
more
company's
P/V analysis graph indicates
picture of a
management
and a 20 percent drop in prices causes a $40,000 loss. However, the 10 percent and 20 percent price increases cause profits to increase $40,000 and
The various price increases or decreases would
$80,000, respectively.
result in the
CH. 24
759
<^^~^
760
;-
)p^
^DOG
-7
-^
^S7
Lo^
<v_,/
10%
12%
in price
Increase in volume
Variable costs increase
Fixed costs increase
Decrease in volume
4%
5%
^ ^ The
of these plans
effect
is
summarized below
Plan
PD
it39bi
224,000
Units
(,
10%
12%
Increase in price
4%
5%
Composite
Changes
"7
VII
y.
PART
Plan 2:
1:
Decrease
iAyvZAV>
/
^ ifNOji^l^
Plan
u^/o
lockjy
('^
1^00
<
fJ^rmJ^
>
,t
Normal
Volume
Plan 2
76,000
200,000
$400,000
200,000
Sales
Variable costs
Contribution margin.
Fixed costs
$170,240
168,000
$200,000
160,000
$218,240
152,000
Net
proiit
2,240
$ 40,000
$ 66,240
Net
$.01
-94.4%
Return on investment*.
Break-even point
1.12%
20%
$397,895
$320,000
investment
is
$.3763
$.20
% change in profit
+65.6%
33.1%
$269,677
$200,000.
illustrates
$100,000-
Sales
Line
$50,000-
$66,240
Intersections of
(in
Profit
Thousands)
$40,000
Profit
break-even points
$2,240
$400
$(50,000)-
'^ {
$(100,000)-
$(152,000).
$(160,000)$(168,000)-
ixed Cost
Po
$(200,000)-
P /V
Profit
CH. 24
PRICE DECREASES
761
it is
often
argued that the price decrease will in most instances be offset by an increase
in volume, and, therefore, profits will not be reduced. Such an argument
Many
at first.
that price reduction does not necessarily lead to the desired increase in
If the increase in volume does occur, it is often not large enough
overcome the effect of the price reduction on total profit.
This problem of a possible price reduction's being offset by a volume
increase was studied by the U. S. Steel Corporation. The purpose of the
study was "to ascertain the increase in volume that would have to take
place to offset various decreases in steel prices by the United States Steel
volume.
to
volume on
result from
costs,
and
to offset
of increased
which would
of
% Reduction
in Price
% of Volume Increase
Required to Ofiset
Price Decrease
1%
5
*
10
15
20
of Greatest
Probable Resulting
Volume Increase
ro%
Ta^o
19.6
48.8
96.7
190.3
5.3
1
1.1
17.7
25.0
PRODUCT ANALYSIS
The discussion so far has dealt with cost-volume-profit relationships
based on total costs and total sales revenue. It is, however, much more
desirable to investigate these relationships for individual products.
down
^^^^Uvjowc^
price reductions."
effect
Break-
^^^'^
/^uci
p^
^O^JLL
or
762
are manufactured.
number of products
PART
In such instances,
to several
major
many
it is
lines.
VII
and
factory output.
However,
it
is
possible to
2.
Direct materials and direct labor costs can be based on standard costs.
3.
11
hcdl'
Vjl
\s
k\^'^
^
vv*T
itIaa
CT.
Once
termined,
will be
it
margin and
if -or
'">^
iv
J Co
C/M
and
this limitation
page 760 are used and separated into four products resulting in the detailed data
Product
shown below.
CH. 24
763
C /M
ratios af-
But the
product's
C/M
be related to
ratio
is
The product
facility utilization.
margin (C /M
sales dollars)
the
same
is
some
C/M
X
ratio
alternate use of
facihties.
P/V
The horizontal
line
OO
and
total costs.
represents sales
and
is
to
$400,000.
2.
The profit path for all products is then drawn, starting at the $(160,000)
fixed cost point in the loss area and ending at the $40,000 profit point in
the profit area. The break-even point is at the point of crossover from
the loss to the profit area.
3.
The profit path of each product is plotted next. Lstarts with the produc t
witlrt he highest
ratio
n this case, ProducF b. 1 he Ime begins at
C/M
^j
$100,000-
$100,000
$40,000
Sales
Line
$50,000-
Profit.
-$50,000
(in
Thousands)
$20,000
0-
$400
PROFIT PATH OF
EAC^i
PRODUCT
'
-$(100,000)
$(150,000)-
$(160,000)
$(200,000)-
P/V
$(200,000)
764
p^ ),
,^
'"'
Mjojc*
(_
W\P;L Vc
t.W
'^ -^
*
'
y^.
ifi pTO
402.
PART
VII
the toal fixed cost point and is drawn to the $(120,000) point in the loss
area directly below the $50,000 sales-volume point. The plotting indicates
/that $40,000 of the $160,000 fixed costs have been recovered.
The
profit path of
line for
Product
;j^7"53CviYv^^'^ \V%ales volume figure of $140,000. The $(60^000) figure shows that $60,000
additional fixed costs were recovered. The $140,000 point on the sales
-V ^
-^or c^-^
^7iine is the accumulated sales total of Products D and C ($50,000
dcji iLyoOO^
$90,000).
/jDoo: -
(^
(Y\
t>v>^c:o
Vc
f r.rs'^
6.
l^^j.^
jj^g profit path for Product B begins at the end of C's path and leads
across the sales line into the profit area to the $20,000 profit point immediately above the sales volume figure of $280,000.
Product
the profit,
The
and
management
the.
h|g her th e
^ -
VW
0+
classes of customers.
It is
XjOo
U?i
"^f^^
Jb^/-4"^
tnI
q|-
rf
-w. Uaot
way, sales
costs
and
profit
ipClh'^
>u>\A
it
V
B
'^ Tor-
S'ooD'O
C/M
Because
should be discontinued.
This reasoning
is
it is
often
felt
particularly prevalent
that
when
and
Depending on methods used to allocate
others a
costs, it is likely that certain products will show a profit
total
costs
not
But individual variable product costs and sales
variable costs to
loss.
in cost-
f^y^Q^
this
In
fixed
is
volume-profit analysis.
^;;^\"c
effort
ycA '^
('QQ_\yi^
,
p
activities,
-r>^jj^this
Cc.lL
of salespersons' selling
all
is
products.
The
determined by distributing
To
make
help
on the
fixed
of
is
on page 765.
eliminated.
all
is
Such reasoning is obviously wrong. Product A actually concompany's total profit picture. Most methods used
CH. 24
765
Sales Value
of Production
Percentage of
Total Cost*
Profit
Profit to Sales
766
VII
DISCUSSION QUESTIONS
1.
2.
How
3.
What
is
Why
4. (a)
PART
and standards
to break-even analysis?
6.
7.
The break-even
is
type of statement
is
constructed ?
What
What
commonly used
5.
differ.
show
the
same
How?
(b)
How is
8.
(a)
9.
is
break-even points:
certain specific steps involving operating economies, made 'the hard way'
by elimination of personnel and consolidation of duties, were one factor. Price
were another. Lowering the cost of distribution was the third.
increases
All three of these steps were within the control of the management. Manage."
ment recognizes the importance of lowering the break-even point
".
(a)
(b)
By comparative
illustrations,
show what
the
management of
11.
What
12.
What can
13.
How
14.
What
15.
Why
16.
is
is
17.
18.
19.
Why
is
is
this
in (a) variable
price reduction
crease.
Why
is
form?
in-
Discuss.
management?
framework
CH. 24
20.
767
showing
numbered components of
even analyses.
(Relevant Range)
(AICPA
21.
adapted)
(b).
point,
re-
spectively.
(4)
(5)
None of the
(2)
(3)
(b)
above.
vertical scale represents (1) sales volume; (2) units produced; (3)
the profit area above O and the loss area below O (4) the contribution
margin; (5) none of the above.
The
(NAA
22. Select the correct
(a)
adapted)
An accountant would typically have the following in mind when referring to the margin of safety: (1) the excess of budgeted or actual
sales revenue over the fixed costs; (2) the excess of actual sales over
budgeted sales; (3) the excess of sales revenue over the variable costs;
(4) the excess of a selected sales figure over break-even sales; (5) none
of the above.
768
PART
VII
(b)
The
(c)
by considering only
linearly
(e)
(1)
(f)
In 19A the contribution margin ratio of the Wayne Company was 30%.
In 19B fixed costs are expected to be $120,000
as in 19 A. Sales are
forecast at $550,000
a 10% increase over 19A. To increase net income by $15,000 in 19B, the contribution margin ratio must be (1)
20%;
(g)
(2)
30%;
(3)
(4)
70%.
of relationships;
(h)
40%;
(4) linearity
of relationships.
The cost-volume-profit
chart does not assume
(NAA
and
AICPA
adapted)
EXERCISES
Exercises 1-14 cover basic cost accounting procedures and mathematical
and cost-volume-profit analyses.
1.
for 19
is:
Sales
$1,400,000
560,000
800,000
40,000
Variable costs
Fixed costs
Net income
(2)
Required: (1) The break-even sales volume and a proof of the answer.
The sales volume needed for a desired net income of $150,000.
O)
2.
Jhs. Michel
Annual
Company makes
$ 3,000,000
fixed costs
(C/M)
30%
$15,000,000
CH. 24
769
The firm of Smith and Thompson, certified public accountants, has been
studying the sales requirements of the Frisco Bottling Company. In the course
of the study, the managing partner submits the following estimated data:
3.
$900,000
210,000
165,200
169,000
102,600
Sales
Direct materials
Direct labor
Fixed factory overhead
Variable factory overhead
Fixed marketing expenses
Variable marketing expenses
Fixed administrative expenses
Variable administrative expenses
71 ,000
80,000
9,500
4,150
4.
May
2,000 units per month
$4,000 per month
$2.50 per unit
$5 per unit
Plant capacity
Fixed costs
Variable costs
Selling price
(^^^rom
Variable Costs
Direct materials
Direct labor
Factory overhead
Marketing expenses
Administrative expenses
Sales
amounted
to
(b)
(4)
at
an
annual increase of fixed costs of $250,000, with the expectation of saving the
same amount in each of the direct materials and the direct labor costs. Refer
to the original data in (1). The results of this proposal with respect to (a) the
contribution margin ratio (C/M), (b) the break-even point, and (c) the profit of
the company.
Variable Costs
CH. 24
771
(4) Assume fixed costs are increased by $2,000 and variable costs by $1,000
at the $80,000 sales level.
much must sales be increased to make the same
How
$10,000 profit?
The
sales
expected drop of
15%
in
sales dollars ?
10.
safety ratio
11. Prince
sales of $250,000,
and a
amounted
profit of $80,000.
sales
sales
13.
On
facturing
Company
is
margin
ratio of the
Taro Manu-
40%.
The new
sales
volume
10%
in dollars.
40% and
decrease.
is
772
PART
VII
are available
Present
Unit price
Unit sales volume
$2.50
200,000
$350,000
120,000
30,000
Net income
Proposed
$2.25
Plus
Same
25%
unit rate
$120,000
?
Required: (1) The new net income or loss based on the sales manager's
proposal. (2) The unit sales volume required to make the original $30,000 net
income.
lowing situations:
Required
Situation
(1)
ratio
(2)
(3)
ratio
is
in dollars.
75%.
75%
is
(4)
creased by 10%.
to
(5),
(6),
and
Labor strikes for a 10% increase in
wage rates. In the present 75%
ratio, the labor cost represents 15%.
(5)
(6)
(7)
The
10%
Take
all
(8)
(9)
to (8)
and
(9)
(7).
consideration.
17. Achieving
Management's
Profit Goal.
(10)
(11)
(12)
state-
ment shows:
$80,000
Sales
Variable costs
Fixedcosts
Net
if
loss
$63,420
25.150
88,570
$ (8,570)
Presently total labor costs amount to $30,000. Management believes that (a)
an increase of productivity of labor is possible, labor costs per unit could be
CH. 24
773
Required: The
Percent Total of
Sales Volume
Variable Costs
Item
Price
$20
25
30
per Item
40%
$10
35
15
18
25
Item
is
to be replaced by Item D.
Item
Price
$20
25
28
Variable Costs
per Unit
50%
$10
30
20
15
14
19.
Profits.
plant capacity
200,000 units
$120,000
$1.35 per unit
$2.25 per unit
Fixed costs
Variable costs
Selling price
Required: (1)
cent of capacity.
The break-even
point, in dollars,
number of
units,
and per-
(2) The margin of safety ratio and the margin of safety in dollars, when
operating at normal plant capacity.
(3) The new break-even point in dollars, if the selling price is reduced to $2;
other data remain the same.
(4) Volume in dollars required to yield a profit of $30,000 if the calculation
is based on (a) the data of (1) above; (b) the data of (3) above.
(5) The break-even point in dollar sales if fixed costs are reduced by $20,000;
state in sales dollars, number of units, and percent of capacity based on data
given in (1) above only.
(6) The expected profit if budgeted sales of $450,000 are realized with costs
the same as at the beginning of the problem and when (a) the selling price per
unit is $2.25; (b) the selling price per unit is $2.
774
PART
VII
100
60
30,000
(2)
(3)
at a 900-unit volume.
Considering the contemplated changes:
(a) The new break-even number of units.
(b) The profit if the company wishes to retain the 900-unit volume.
(c) The profit if the company should experience a sales volume of 1,000
units as the sales manager predicts on the basis of the price reduction.
(b)
The new
profit if the
company did not buy the new machine and laid off no
10% and increased volume to 950 units.
is
Variable costs
Fixed costs
Units per hour
Product
Product
S12.60
9.62
2.07
S5.50
4.18
45
70
.65
(3)
profit for
each product.
(4)
(5)
profit
for each
product.
(6)
fixed costs
and
profit if
(a)
(b)
A and
A and
(Based on an
(22r^reak-Even Analysis
Hospital Operations.
its
NAA
article)
CH. 24
Costs
Direct patient supplies
Direct salaries
Patient service overhead
Administrative expenses
Total
775
Variable
Fixed
$100,000
754,625
25,000
75,000
$105,000
1 75,000
$954,625
$280,000
These costs are based on normal inpatient service days of 27,275 in the
eighty-bed hospital and on patient service revenues of $1,227,375. Deficits are
financed by contributions from the Southern Baptist Convention.
Required: (1) The contribution margin ratio (C/M).
to 1/lOOthof 1%.)
(2)
(3)
in revenue
ratio
volum e and
(M /S). (Compme
(4) Since the hospital is currently operating at its highest practicable capacity, a proposal has been made for the construction of an additional wing of
twenty beds. Fixed costs are expected to increase in about the same ratio as the
current fixed costs per bed ratio; the variable cost to sales should remain the
same. (Compute the new break-even point in revenue volume and in inpatient
service days.)
Break-Even Analysis. The Carey Company sold 100,000 units of its product
$20 per unit. Variable costs are $14 per unit (manufacturing costs of $11
and marketing costs of $3). Fixed costs are incurred uniformly throughout
19
and amount to $792,000 (manufacturing costs of $500,000 and marketing
costs of $292,000).
23.
at
and
salaries.
(AICPA
adapted)
PROBLEMS
Income Statement; Break-Even Analysis. The
has recently leased manufacturing facilities
for production of a new product. Based on studies made by the cost analyst, the
following data have been made available:
Amount
Per Unit
24-1. Selling Price; Forecast
Vantage Manufacturing
Company
Estimated costs:
Direct materials
Direct labor
Factory overhead
Administrative expenses
Total
$ 96,000
14,400
24,000
28,800
$163,200
$4.00
.60
1
00
20
$6.80
24,000 units
776
15%
is
PART
to
VII
amount
ofl%.)
(AICPA
adapted)
Brand
Trade-Name Brands
Tru-Ade Brands
Dietary Brands
Selling Price
Variable Cost
per Case
per Case
$1
1
1
50
.20
.00
$ 1 40
1 .00
.
.40
The
fixed costs of the company are $38,000 annually and do not change with
any change in product mix nor with total volume changes of less than 50%.
During 19A sales of Trade-Name Brands accounted for 50% of the company's
total sales in cases. Sales of Tru-Ade Brands were four times that of Dietary
Brands. Total sales revenue for the year was $500,000.
Required: (1) The break-even sales in dollars and units of each product
sales mix. (Show answers to
nearest $1,000.)
(2) The amount which could be spent for advertising in 19B to increase sales
of the more profitable lines so that Tru-Ade sales would account for 50% of
sales in cases; Dietary 20%; and Trade-Name 30% with the company still making a profit of one and one-half times that of 19
on the same total sales revenue.
24-3.
market position. It was also concerned about the possibility that variable
costs would increase in the next year as they had in the previous year. Total
fixed costs amounted to $1,800,000; and they, too, were expected to increase.
At the moment an average price of $42 was received for the product.
breakits
down
Direct materials
CH. 24
Sales
777
$4,200,000
$1,000,000
500,000
1.000,000
on sales
and advertising expenses
Administrative and general expenses
Gross
2,500,000
$1 ,700,000
profit
Selling
700,000
600,000
Net income
1,300,000
$
400,000
The management faces the problem of finding out what will happen
and prices of the product are changed. A 7% decrease in prices and a
if
costs
7%
in-
crease in fixed costs have been considered. An analysis of past conditions indicated that variable costs have been increasing at a rate of
each year. The
management requests the controller to off"er his ideas in the solution of this
problem. The management is interested in some knowledge regarding the percentage increase in volume necessary under each of the possible outcomes to
maintain the same profit of $400,000.
7%
Required: (1) The current break-even point and the contribution margin.
(2)
Taken
and
if:
reduced 7%.
7%.
(3)
and
off'set
(a), (b),
(c).
(4)
is
most
influential
Break-Even Analysis
Jentzen
combined
778
PART
VII
24-5. Product Mix Ratio and Break-Even Analysis. In constructing a breakeven chart, analysts have been aware of the difficulty of dealing with the product
mix in a multi-product firm. Yet, break-even analysis has been useful in making
product mix decisions. To illustrate this usefulness, a cost analyst assumed the
following situation for a company's three major products:
Product
1.
$8.00
5.00
SI
Variable costs
SIO.OO
6.00
Contribution margin
S 4.00
$3.00
$2.00
C/M ratio
to Ij 100th
Sales price
1. 00
9.00
For
(1)
Required: (1)
and
(2) below,
compute the
if
of 1%.
new
with
if
its
24-6.
Ro Company,
a manufacturer of quality
growth in its sales for the past five
years. Increased competition, however, has led Mr. Ro, the president, to believe that an aggressive advertising campaign will be necessary next year to
maintain the company's present growth.
To prepare for next year's advertising campaign, the accountant presents
Mr. Ro with the following data for the current year 19A:
handmade
Cost Schedule
Per Pipe
Variable costs
Direct labor
Direct materials
Variable factory overhead
Total variable costs
Fixed costs:
Manufacturing
Marketing
Administrative
$25
19A (20,000
units)
set the
19B
$500,000
40%
sales target at a level of $550,000, or 22,000 pipes.
(2)
13.75
$135,000
Mr. Ro has
40,000
70,000
8.00
3.25
2.50
$ 25,000
Expected
CH. 24
(3)
The
aftertax net
if
779
(5)
come,
(6)
The required
if
if
is
is
(NAA
adapted)
Baubles
Units
Amount
780
PART
VII
GiVENs Company
Operating Income Statement
For Year Ending October 31, 19
All Three Products
565,000
Product
CH. 24
781
common
each patient an average of $65 per day, had a capacity of 60 beds, operated 24
hours per day for 365 days, and had a revenue of $1,138,800.
Expenses charged by the hospital to the Pediatrics Department for the fiscal
year ending June 30, 19 A, were:
Basis of Allocation
Patient Days
( Variable)
Dietary
{Fixed)
$ 42,952
Janitorial
Laundry
Bed Capacity
$ 12,800
28,000
Pharmacy
Repairs and maintenance
47,800
33,800
5,200
and collections
Bad debts expense
Billings
Other expenses
782
PART
VII
is
shown below.
Nicoletta's Pizza Parlor
Projected Income Statement
31,
19E
Sales
$95,000
$28,500
8, 1 50
1 7,300
4,800
3,600
5,000
3,000
2,325
Rent
Accounting services
Depreciation
Depreciation
delivery equipment
pizza parlor equipment
Utilities
73,875
1,200
Income taxes
$21,125
6,338
Net income
$14,787
30%
sells
for $2.50.
Assume
that
taxes.
Required: (1) The break-even point in number of pizzas that must be sold.
The cash remaining from the 19E income-producing activities if Ms.
Calderone withdraws $4,800 for her personal use.
(3) The volume that must be reached in number of pizzas sold in order to
obtain a desired aftertax net income of $20,000.
(4) A brief explanation as to why profits have increased at a faster rate than
(2)
sales.
(5)
brief explanation as to
why
(NAA
adapted)
24-11. Linear
CH. 24
a
a
a
a
a
$80
$70
price of $60
price of $50
price of $40
selling price of
selling price of
selling
selling
selling
each,
each,
each,
each,
each,
783
sold.
sold.
sold.
sold.
sold.
The variable expenses amount to $30 per raincoat while the fixed expenses
average $40,000 per year.
Required: Assuming that the only feasible selling prices are $80, $70, $60,
or $40, diagrammatic expositions of the cost-profit-price relationship
within the demand constraint in order to indicate
$50,
(a)
The maximum
and the
price
and volume
at
which
it
will
be
achieved.
(b)
The maximum
profit possible,
at
which
it
will
be achieved.
(c)
point,
Mix and Contribution Margin Analysis. Product mix has an important effect on costs and profits. It is quite common that some products of a
multi-product company are more profitable than others. The greater profit can
arise from one or more causes, such as: customer demand, unusual skill or
know-how, special equipment, efficient layout, etc. Obviously, the greater the
quantity of higher-profits products in the product mix, the greater the total
profit.
On the other hand, less profitable, or even loss items, are sometimes
deliberately pushed for specific reasons such as diversification of product lines,
entering into a new field or outlet with the product, a leader item for introducing
more profitable products, etc. However, it is especially important to press the
more profitable items when feasible.
To consider some of the problems of product mix, the following data have
been made available. A company with a plant with 20 machines makes three
products. On a one-shift operation 24,000 units
considered 100% capacity
can be produced per day, with production going 8,000 units to Product A,
12,000 units to Product B, and 4,000 units to Product C.
Each unit sells for $1, and a profit of 10% on total sales is earned. On the
basis of these data, the operating statement, ignoring nonmanufacturing costs,
appears as follows
24-12. Product
Amount
Sales (24,000 units)
$6,100
8,200
1
,780
Contribution margin
Fixed factory overhead
Net income
in order to
Product
CH. 24
785
Established
Net Price
(Units)
(Units)
Product
Joanna
Trean
Sarah
Meredith
Sewing kit
$6.00
2.90
9.90
50,000
42,000
35,000
40,000
325,000
5 .00
3.00
To promote sales of the sewing kit, there is a 15% reduction in the established
net price for a kit purchased at the same time that a Cebula doll is purchased.
Accounting records indicate the following:
(a)
Direct
Materials
Product
Joanna
Trean
Sarah
$1.40
kit
Direct
Labor
2.69
1.00
$1.60
1.00
2.80
2.00
.60
.80
.70
Meredith
Sewing
unit
The labor rate of $4 per hour is expected to continue without change in the
next year. The plant has an effective capacity of 130,000 labor hours per year
on a single-shift basis. Present equipment can produce all of the products.
(c) Next year's total fixed costs will be $100,000. Variable overhead costs will be
equivalent to 25*^^ of direct labor cost.
(d) The company's small inventory of its products can be ignored.
(e) Assume that all nonmanufacturing costs are fixed.
(b)
(AICPA
adapted)
786
PART
VII
income.
The proposals
Plan
are as follows
lowing schedule:
Number of Books
CH. 24
787
Expected changes:
Product
Product
Plan 1
Plan 2
50%
40%
50%
25%
5%
10%
6y3%
Planl
Plan2
71^%
Advertising:
None
Plan 1
Plan 2
None
8%
of sales
7%
of sales
15%
12%
of sales
of sales
12%
12%
of sales
of sales
Plan 1
Plan 2
indicated
None
Administrative expenses:
Plan 1
Plan 2
4%
None
4%
of sales
Same
dollar
amount
of sales
as prior year
24-15. Profit- Volume Analysis when One Factory Is Shut Down and a Foreign
Subsidiary Is Opened. The Dodson Corporation's home office is located in
Trenton, New Jersey. The company leases factory buildings in Pennsylvania,
Michigan, and North Carolina. The same single product is manufactured in all
three factories. The following information is available for 19A's operations:
Total
Pennsylvania
Sales
S900,000
$200,000
Variable costs
$500,000
Fixed costs
Factory
Administration
Allocated home office expenses
Total
North Carolina
80,000
59,000
63,000
$802,000
per unit
Michigan
is
$ 98,000
$10.
Management
788
PART
VII
If the North CaroHna factory is shut down, the company can continue to
serve customers of the North Carolina factory by one of the following methods:
(a)
Expanding the Pennsylvania factory, which would increase present fixed costs by
15%. Additional shipping expense of $2 per unit will be incurred on the increased production.
(b) Entering into a long-term contract with a competitor who will serve the North
Carolina factory customers and who will pay the Dodson Corporation a commission of $1 .60 per unit.
Total
Direct materials
Direct labor
Factory overhead
Administrative expenses
who
will receive a
$193,600
90,000
80,000
30,000
Variable
100%
70
64
30
commission of
office
(AICPA
adapted)
24-16. Increase in Labor Cost and Depreciation; New Sales Price. The management of the Besser Corporation anticipates a 10% wage increase on January 1
of next year. Presently, labor comprises $12 of the per unit total variable cost.
No other cost changes are expected. The management needs assistance to
formulate a reasonable product strategy for next year.
regression analysis indicates that volume is the primary factor aff"ecting
costs.
Semivariable costs have been separated into their fixed and variable
Annual volume of
sales
$80
48
5,000 units
$51,000
CH. 24
789
Required: (1) The increase in the selling price necessary to cover the 10%
wage increase and still maintain the current profit-volume ratio.
(2) The number of units to be sold to maintain the current net income if the
sales price remains at $80 and the 10% wage increase goes into effect.
(3) The management believes that an additional $190,000 in machinery (to
be depreciated at 10% annually) will increase present capacity (5,300 units) by
30%. If all units produced can be sold at the present price and the wage increase
goes into effect, how would the estimated net income, before capacity is increased, compare with the estimated net income after capacity is increased?
Computations of estimated net income before and after the expansion.
(AICPA
adapted)
(b)
(c)
(d)
6%
5%
5%
6%
bonds are
is
issued.
issued.
bonds are issued and North Shore requires that South Bend contribute
its sales to be credited to North Shore Industries' retained earnings for
internal financing and future expansion.
of
5%
bonds are issued and North Shore requires that South Bend contribute
annually both $100,000 to be paid out as dividends to North Shore's common
stockholders and 6% of South Bend's sales to be credited to North Shore's
retained earnings for internal financing and future expansion.
(2) South Bend will have 72 salespersons. Market surveys indicate that each
salesperson must sell an average of one unit every three months if the sales price
of the computer is set at $50,000 per unit, and that none is likely to sell more
than one unit in any month. North Shore's management requests a computation of:
(b)
The probability that any salesperson will sell a computer in any month.
The average number of units that South Bend can expect to sell per
month at $50,000.
(3)
(a)
pected to
sell
also indicated that each salesperson should be exif the sales price should be set at
790
$60,000 per
unit.
Reduced
(b)
VII
sales
PART
(AICPA
adapted)
24-18. Effect of Product Mix Variation. The officers of the Bradshaw Company
reviewed the profitability of the company's four products and the potential
effect of several proposals for varying the product mix. An excerpt from the
income statement for 19
and other data follows:
Product
Sales
Total
$62,600
44,274
$10,000
4,750
$18,000
7,056
$12,600
$22,000
18,500
18,326
12,012
5,250
1,990
10,944
2,976
$ 6,314
$ 3,260
$ 7,968
1,000
1,200
1,800
2,000
Gross profit
Operating expenses
Net income before taxes
Units sold
Sales price per unit
13,968
3,500
4,220
(1,368)
2,826
$(4,194) $
(720)
$10.00
$15.00
$7.00
$11.00
$2.50
$3.00
$6.50
$6.00
$1.17
$1.25
$1.00
$1.20
Total fixed costs are not expected to fluctuate as a result of changes under
consideration.
if Product R is discontinued.
Product R is discontinued and if a consequent loss of customers causes a decrease of 200 units in sales of Product Q.
(3) The effect on net income if Product R's sale price is increased to $8 with
a decrease in the number of units sold to 1,500 with no effect on the other
(2)
The
effect
on
net
income
if
products.
R is
CHAPTER 25
DIFFERENTIAL
COST ANALYSIS
Many management
such as
1.
2.
3.
4.
5.
6.
7.
8.
Selecting
new
sales territories.
Historical costs
agement
action.
all
give
man-
Many
terms, concepts,
and
classifications
is
when a
decision has to be
made
It is
involving
792
Any added
output
is
same market
in
in a gain.
quite different.
is
If these
reduction in
its full
limit
little
The
this
VII
PART
differential cost
of added production
is
results.
same.
of a
If,
is
generally
new machine
e.g.,
is
solving
management problems
method of
analysis, a
is first
presented.
importance of distinguishing between fixed and variable costs. In breakeven analysis fixed and variable costs play an all-important part. In differential cost studies variable costs are significant, for they usually repre-
is
maximum
set at
when operating
is
computed so
CH. 25
793
overhead
If this
is
if
more
would be
5 per unit
100,000 for this unit
$100,005
Total
The
overabsorbed.
Variable cost
Total fixed costs
at
is
Total
is
$5.00
1
.25
$6.25
Present
Business
--
80,000 units)
794
PART
VII
charged with
is
The two
1.
2.
in a differential
ment
The idea
is
that the
new
is
when
Of
recovered.
only
not
is
manage-
If available capacity is
full
recovery, to profit,
desirable.
is
new
is
It
become part
perhaps a misnomer.
might find
itself
originally contemplated
units,
which
90 percent
is
( 5oo^,ooo'unita )
The
Each
is
when operations
$1.80,
and
is
are at 100
is
is
$.50
$1.40 per
On
the basis of
iJhe normal capacity used for the application of factory overhead does not necessarily represent
available practical capacity. Normal capacity represents average expected utilization whereas
practical capacity represents maximum production potential. If normal capacity is less than
practical capacity, the idle capacity variance (the unabsorbed fixed factory overhead) is smaller
with the use of normal instead of practical capacity in determining the factory overhead rate.
Consequently, normal capacity yields an idle capacity variance that understates the true unused,
yet available capacity.
..
CH. 25
795
these data
ac-
Income Statement
Sales (450,000 units
@ $5)
$2,250,000
overhead
[$335,000
$810,000
630,000
225,000
301,500
$.67)]
The
sales
1,966,500
283,500
33,500
250,000
loss
on
this order.
incurred.
@ $4.25)
$425,000
Loss on
this
$180,000
140,000
50,000
67,000
order
437,000
$
all
2,000
is
allocated
overhead
Fixed factory overhead (at present)
Fixed factory overhead (because of additional business).
$335,000
1 0,000
$345,000
$301,500
67,000
368,500
$ 23,500
796
PART
VII
would
result in
This
$57,000 minus the computed $12,000 loss on the order results in a gain of
$45,000.
Differential Cost Statement for Additional Business
Sales (100,000 units
@ $4.25)
$425,000
Gain on
this
$180,000
140,000
50,000
10,000
order
380,000
$ 45,000
$380,000
Additional Units
The
100,000
output.
flexible
budget with
its
only.
differential
The
flexible
budget
It
is
at
60
two
levels).
1.
$324,250
is
computed by:
Subtracting one level of output from the next higher level (output at
80 percent, 80,000 units minus output at 60 percent, 60,000 units = 20,000
units, the differential output).
2.
Dividing the differential cost total between these two levels by the added
number of units ( 2ocKK)'ut'its ^ $4.96, the differential cost per unit).
CH. 25
797
798
PART
VII
would have
to be
tells
worked
However, a
out.
flexible
many
finer details
budget based on
facilitates the
300 (275
Within a temperature
differential
of
ends, or cuts, pass off as vapors and are then condensed back into liquids.
The
initial
the
and
temperature
rises.
the crude and condensing the gaseous vapors to obtain the various cuts
is
commonly
with but
little
in order to
treating.
Cracking
gasoline.
tures
is
made
to yield a
is
may
be subjected to crack-
as
fraction
oil,
heavy
hydrocarbon possessing
among
these a
lower boiling point. The heaviest of the fractions resulting from primary
distillation
is
known
further processing,
oils
and
ancillary
The management of a
refinery
to
distillates
or
do with each
2Adapted from a study prepared by John L. Fox, later published in NACA Bulletin, Vol.
XXXI, No. 4, pp. 403-413, under the title, "Cost Analysis Budget to Evaluate Operating
Alternatives for Oil Refiners."
CH. 25
fraction.
At what
tional fractions be
What
What
make
refineries to
in order to
in
moment ?
be able to handle
management take
departmental
addi-
a greater volume?
Or should
799
the preparation of
term
is
They
differ
from the
flexible
budget used for control purposes in several respects. All expenses are inBudgeted expenses of service departments
The aim of
is
tial costs.
The amounts stated for each class of expense at each production level
computed on separate work sheets where the various individual expenses are separated into their fixed and variable elements. This separaare
made up
for
Solvent Extraction
Wax
and Burners
Specialties
Cracking
Canning
Solvent Dewaxing
Barrel
House
finishing op-
eration.
below
illustrate the
in
oil.
and
Current prices:
Fuel oil
Gasoline
He must
decide whether to
residual fuel.
The following
refiner has
sell it
on hand 20,000
it
800
PART
VII
Analysis Budget
Department: Cracking
Period Budgeted:
Normal Capacity
Supervisor:
Department and or
Expense Account
to
100'^,'
Shut-
Down
60',
Direct Expenses:
Allocated Expenses:
Fixed and variable
$3,000
$7,000
$8,000
$ 8,500
500
1.000
1,500
2,000
Total costs
$3,500
$8,000
$9,500
$10,500
Differential cost
60,000
60,000
$4,500
80,000
20,000
$1,500
$1,000
$4,000
$.075
$.133
$.075
$.119
$
$
$
$
80'
100'
Through-put
Total gallons
Differential gallons
00,000
20,000
.05
.105
20,000
20,000
.20
.1208
80%
of capacity
The
refiner
Potential revenue
products from cracking:
Gasoline (15,000 gallons
$.14)
Fuel oil (3,000 gallons
$.07)
$2,100
210
$2,310
1,400
$.07)
Differential revenue
loss,
per
se,
1,000
$.05)
sell
90*
oil
910
it
would be more
profit-
them
further.
price he can
pay and
still
make a
profit.
The stock
CH. 25
working
rently
90%
5%
5%
making
is
motor
finished
Available information
at full capacity.
Cylinder stock
801
it
is
oils is cur-
as follows
probably yield:
will
Bright stock
Petrolatum
Loss
no market
Filtering
Total
refiner
can analyze
his position
Revenue
and
deter-
$4,500
500
$.05)
Margin
$4,000
$4,000
10,000 gallons
-=
The
stock.
even point
a gain.
He
loss, to
pay
how much
less
would result in
profit is required to
for another purpose, then perhaps the proposed purchase should not be
consummated.
Applications: Choice of Alternate Routings. A refiner is trying to
decide whether to treat and sell the kerosene fraction or to crack it for its
gasoline content.
kerosene.
Cracking yields:
Gasoline
Residual fuel
Loss
85%
oil
5%
10%
802
PART
VII
analysis budgets):
Cracking
Treating
refiner
$1,190
35
$1,225
300
$925
Net
potential revenue
kerosene
Total revenue (10,000 gallons ^ $.08)
Less differential cost (10,000 gallons
more
800
700
100
$.01)
$225
treating
profitable alternative
is
fraction.
He
is
A refiner
an addition
would prove profitable.
The additional wax distillate stock required would be purchased on the
open market at the current rate. However, before going ahead with the
to the solvent
construction, he
first
units
who
presents the
on page 803.
It would appear from the accountant's analysis that the proposed increase in the productive capacity would not be justified under the stated
analysis illustrated
conditions.
satis-
on page 797,
If,
between two
Linear equations
levels
of
bx,
y2
Vi equals the differential cost. Using the linear equation y = a
where a = costs that do not change, b = the 100 percent capacity level of
one
level
CH. 25
803
Assumed
90%
yield
from wax
distillate:
Viscous neutral
1.5% Paraffin
8.5% Loss
(8
it
have to
will
Less cost of
Margin
wax
distillate
$4,230
96
$.47
$4,326
3,500
$.35)
826
Differential costs:
from
Potential loss
differential
and x
@ $.10)
@ $.10)
$1,000
1,000
production
2,000
$1,174
Using the
operations at
represents
y2
yi
= (a + bxj) (a
= a + bxj a
= bxg bXj
= b(x2- X,)
bxj)
bxj
flexible
80%
the
normal capacity
variable
level
costs,
$325,000
$25,000
$33,000,
at
the
levels)
Differential Cost
=
=
=
$383,000 (1.00
$383,000 (.2)
$ 76,600
.8)
804
Often
PART
VII
in the flexible
in fixed costs
or the
variable costs
that
in
is,
they
Chapter
18.
usually offers
nues, costs,
or available capacity.
The
feasible
by
trial
Whenever a differential cost analysis leads to a decision by manageit is assumed that the acceptance of an additional order at or above
ment,
products
now
is
offered.
rect decisions.
sufficient
all
old and
new
is
dis-
sup-
A previous example
units.
Any
additional business
is
it is
not
for
facilities
it
and
personnel.
If
new product or
the firm are placed in a competitive market, they might have to be marketed
at established prices; otherwise, competitors
prices.
Any
might
by cutting
by the accountant.
retaliate
CH. 25
He
is
in
805
when a
certain price
would
eflficiently
the operations
of the business, in this case the sales department, such a trend could be
discovered in time to put any needed remedial measures into
effect.
LONG-RUN IMPLICATIONS OF
DIFFERENTIAL COST ANALYSIS
Care must be taken to avoid action to maximize short-run profits if
such action is likely to be detrimental to the overall company profit objective of long-run profit maximization. Walter B. McFarland issued this
warning:
Because overall company profit objectives are usually long-run objectives,
seems advisable to consider long-run implications of decisions which are intended to maximize short-run profits. To illustrate, addition of a product for
the purpose of utilizing capacity which is currently excess may preclude more
it
profitable use of the same capacity at a later date. Likewise, at a time when
capacity is temporarily inadequate to meet sales demand, actions to maximize
short-run profits (e. g., raising profits, dropping low margin products or customers) may be inconsistent with long-run profit objectives. ^
is
typically based
on a
do
when
The
is
of possible events and the use of probability estimates to allow for risk
and uncertainty
these events.
and allowance for risk and uncertainty.) In many decisionmaking analyses a wealth of reasonably reliable historical data permit the
analysis
assignment of
example, in
(1) setting
forth probabilities of the rate of material usage and the lead time for
806
order
filling
in
computing
PART
much more
VII
may
be
irregular sales
and no
study of a
specific sales
CH. 25
and even
space,
idle labor.
807
is
inclined to
should
1
Consider the quantity and quality of the parts or the tools as well as the
know-how required, weighing such requirements for both the
short-run and long-run period.
technical
2.
Compare
the cost of
3.
Compare
to possibly
of the firm's
4.
own
more
made
facilities if
making of
the parts.
If
1.
statement that compares the company's cost of making the parts with
the price of the vendor. The statement should present the differential costs
of the part or tool as well as a share of existing fixed expenses and a
profit figure to place the total cost on a comparable basis.
2.
fol-
808
specifications
PART
VII
There are many examples of lower prices being obtained from suppliers
for larger quantities, standardization of specifications, etc., as well as
from the use of competitive bids and /or the threat of self-manufacture.
All direct and indirect costs of functions and facilities which are properly
allocable to the "buy" alternative, under the "full cost" concept, must be
considered. Cost to buy must also include the "full cost" to bring the
inproduct to the same condition and location as if self manufactured
cluding freight, handling, purchasing, incoming inspection, inventory
identified as
All direct and indirect costs of functions and facilities which are properly
allocable to self-manufacture under the "full cost" concept
must be
considered.
cost determinations not only consider present costs but also projections
future cost to
what the
make and
the cost to
possible improvements
full
consideration to
not just
operating conditions.'^
An
ences in the required capital investment and the timing of cash flows (see
Chapter
26).
SHUTDOWN OF
FACILITIES
is
also used
when a
business
is
confronted with
both manufacturing and marketing. In the short run, a firm seems to be better off" operating than not
the possibility of a
shutdown of
facilities,
fixed costs.
of the facilities
would be saved.
ment might
facility
down
Make-or-Buy Decisions,"
ment Accounting Practice, pp. 5, 7-8.
^"Criteria for
If op-
NAA
it
has
made an investment
Statement Number
5,
in the
Committee on Manage-
CH. 25
809
employees wliich would be lost in the event of a shutdown. Recruiting and training new workers would add to present costs.
Another factor is the loss of estabHshed markets. To reenter a market
later requires a reeducation of the consumers of the company's products.
training of
its
active
shutdown of
interest,
To
facilities
all costs.
Depreciation,
management regarding
orientate
accountant might again resort to the flexible budget to determine the eff'ects
of continuing operations as long as differential costs or any amount above
them can be
volume
set in
most
volume
dif-
levels.
management decision-making
Opportunity Costs.
process.
In the
made
as to
how much
profit
is
for another purpose, then perhaps the intended purchase should not be
to
in
favor of one or the other alternative in the future suggests that opportunity
costs are also a type of future costs.
Other examples
may
is
The
the sacri-
the machine.
own
business
The opportunity
is
Imputed Costs.
Imputed
is
no opportunity
If
cost.
its
use value.
Imputed costs do
not involve actual cash outlay nor are they recorded in the books. Interest
on invested
and
salaries
810
PART
VII
costs into a
costs relevant to
relevance.
total
little or no
management's deciding
significant in
is
whether or not a particular venture will at least return the cash expenditures caused by the contemplated business undertaking.
Relevant-Irrelevant Costs.
In
many
it
indi-
cates that
manner
it.
Costs must be
(1) classified in
an appro-
in
many
little
may
cost.
The question
of information
and analyze
collect
inefficient use
if
centers
of re-
Ideally,
its
antici-
CH. 25
811
its
differential cost.^
management may be forced to make a decision with less information than it would like simply because there is insufficient time to
acquire more information. In some cases information may not be available even though cost-and-time constraints would permit its collection.
Of
course,
Sunk Costs. Sunk costs are the irrecoverable costs in a given situation.
The expenditure having been made in the past, its chances for recovery are
almost nil. The meaning of a sunk cost will become particularly apparent
when a decision must be reached regarding the exchange of an old asset
for a new asset (see Chapter 26 dealing with investment analysis.) As
explained there, the undepreciated book balance of the old asset is a sunk
cost and entirely irrelevant to the decision-making process except in computing the income tax liabiUty. Sunk costs also play a part in reaching the
decision to abandon or continue operations. The essential feature of sunk
costs in making managerial decisions is that they may be irrelevant either
whole or in part. Accountants have been reluctant in excluding these
costs from their traditional mode of analysis.
in
DISCUSSION QUESTIONS
1.
Differential costs
do not correspond
to
Explain.
Differential costs have also been termed alternative costs. In what connections are such alternative costs desirable ?
3. Suggest a broad definition of the term "differential cost." What other terms
2.
4.
5.
6.
7.
8.
9.
How
analyses?
type of questions could be answered for management from the differential cost analysis illustrated in the chapter on pages 798-803 ?
When differentially-costed products are marketed, close watch must be kept
What
on
10.
Why?
Differential cost studies deal not only with alternatives that mean increased
business but also with decreased business or even shutdown conditions.
Explain.
5For further discussion and a quantitative illustration, see "American Accounting Association
Report of Committee on Managerial Decision Models," The Accounting Review, Supplement
to Vol.
XLIV,
pp. 58-64.
812
11.
PART
VII
(a)
(b)
(c)
(d)
The effect on a company's net income before income taxes of discontinuing a department with a contribution to overhead of $16,000
and allocated overhead of $32,000, of which $14,000 cannot be eliminated, would be to (1) decrease net income before income taxes by
$2,000; (2) decrease net income before income taxes by $18,000; (3)
increase net income before income taxes by $2,000; (4) increase net income before income taxes by $16,000.
(e)
Costs that do not appear in accounting records and that do not require
dollar outlays but do involve a foregone opportunity by the entity
whose costs are being measured are (1) conversion costs; (2) differential
(f)
(AICPA
adapted)
EXERCISES
1. Planning Profit and Cost Potential. Palo Alto Mills, Inc. is considering manufacturing and marketing a new type of hosiery. Market research studies point
to a sales price of $12 per dozen. Cost studies show a variable manufacturing
cost of $5.50 per dozen with a fixed manufacturing cost at $75,000 per year for
every 150,000 dozen produced; i. e., fixed factory overhead would step up in
$75,000 increments.
150,000 dozen.
Differential Cost Statement for Special Order. The Detroit sales manager
of Brolin Manufacturing, Inc. called the home office stating that she could
secure a special order involving 3,600,000 gross of Product A if it could be
sold for 121/2% off the list price.
2.
CH. 25
813
Management contacted the cost analyst who sent the following analysis to
the vice-president in charge of sales with a notation that the profit on this order
would be $167,400 ($405,000
$237,600):
Special
Forecast
19
60%
of Capacity
Rate
Amount
$ 14
.
Total
$1,512,000
$1,512,000
Standard costs
$.040
010
020
005
009
007
432,000
226,800
108,000
21 6,000
54,000
97,200
75,600
$.112
$1,209,600
$.028
Direct materials
Direct labor
Variable factory overhead
Fixed factory overhead
Variable marketing expenses
Fixed marketing expenses
Fixed administrative expenses
Volume
021
302,400
variances
Factory overhead
Marketing expenses
Administrative expenses
Profit at actual cost
(36,000)
(1 6,200)
(12,600)
$
237,600
Special Order
Added
814
PART
VII
Required: (1) The unit cost of gears for direct costing inventory purposes.
(2) The relevant unit cost to a pricing decision on an offer from a foreign
manufacturer to purchase 25,000 gears. (Domestic sales would be unaffected
by this transaction. If the offer is accepted, variable marketing costs will increase $1.50 per gear for insurance, shipping, and import duties.)
(AICPA
adapted)
Capacity Theory; Special Order Acceptance. Last year the Bradburn Company, manufacturer of a single product, operated at 80% of normal capacity.
The company bases its factory overhead rate on normal capacity and had,
therefore, a substantial amount of underapplied factory overhead for the period.
Early this year the company received an order for a substantial number of
units at 30% off the regular $7 sales price. The controller wants to accept the
order because $.80 of the total manufacturing cost of $5 per unit is fixed overhead
and because the additional units can be produced within the company's practical
4.
capacity.
(c)
Differential Cost Analysis for New Product. The Research Division of the
Maine Corporation, a chemical manufacturer, has developed a new product
named Zip. The product will be marketed through the company's regular sales
agents. However, at the main office a sales manager will have to be added at a
minimum total annual salary of $22,000. Annual advertising and promotion
5.
$25,000.
It is
work
of an accounts receivable clerk at $6,000 per annum. The Production Department has estimated that prime costs will be $.37 per unit (direct materials, $.20;
direct labor, $.17). The factory overhead rate for the plant is $.35 per unit, of
which $.10 is considered to be the variable portion. Variable marketing and
general and administrative expenses have been set at $.05 per pound of product.
income
taxes,
article)
CH. 25
815
New
Product Analysis.
will
annual basis
Sales
$500,000
385,000
30,000
10,000
The company requires an average annual rate of return of 11% (after income taxes) on the average investment in proposals. The effective income tax
rate is 46%. (Ignore the time value of money.)
Required: (1) The average annual differential costs for the first five years
(including income taxes) which must be considered in evaluating this decision.
(2) The minimum annual net income needed to meet the company's requirement for this proposal.
(3) The estimated annual residual income (after allowing for return on investment in new equipment) resulting from introduction of the new product.
(4) The estimated differential cash flow during the third year.
(AICPA
adapted)
Additional Costs
Added
Produced
Sales Values
at Split-Off
6,000
4,000
2,000
$25,000
41,000
24,000
$42,000
45,000
32,000
$9,000
7,000
8,000
Units
Product
X
Y
Z
cal
Costs
Joint costs are allocated to the products in proportion to the relative physivolume of output.
Required: (1) For units of Product Z, the unit production cost most relevant
sell, or process further, decision.
(2) The products the company should subject to additional processing in
order to maximize profits.
(AICPA adapted)
to a
816
PART
VII
Ltd., a
having demonstrated both their fertility and ability to give birth, will have
an estimated sale value of $16,000. Their calves, which will be seven-eighths
Simmentals and which are sold along with the rebred parent heifer, are expected to sell for $20,000 if heifers and $1,250 if bulls.
The probabilities of combinations of heifer and bull calves from nine
live births were obtained from the Texas-Oklahoma Simmental Cattlebreeders
Association and are as follows:
Heifers
CH. 25
817
no additional charge.
cost study
in the decision.
Required:
Company
Merriman
(AICPA
adapted)
requests assistance
is
unit.
$26,500
28,000*
6,000*
Power
300
640
Other costs
Exclusive of 14% labor fringe
benefits.
its
benefits generally
added to labor
costs.
which
(AICPA
11. Make-or-Buy Decision. Standard costs and other data for two
parts used by Griffon Electronics are presented below
Part
Direct materials
Direct labor
A4
$ .40
1.00
adapted)
component
Part B5
$ 8.00
4.00
4.70
2.00
$5.40
$14.70
6,000
8,000
2
$15.00
Factory overhead
4
$5.00
818
PART
VII
(AICPA
12.
sells
adapted)
are:
Product
Product
Product
Total
Total costs
S100,000
90,000
$190,000
210,000
5250,000
210,000
$540,000
510,000
Profit (loss)
$ 10,000
$ (20,000)
$ 40,000
$ 30,000
Sales
40%
80%
60%
Research Project; Sunk Costs. Management of the Sifri Chemreviewing a research project that was initiated with the purpose
of developing a new product. Expenditures to date on the project total $126,000.
The Research and Development Department now estimates that an additional
$24,000 will be required to produce a marketable product. Current market estimates indicate a lifetime profit potential having a present value of $40,000 for
the product, excluding Research and Development expenditures.
13. Continuing
ical
Company
is
PROBLEMS
George Jackson owns and operates
a small machine shop manufacturing (1) a standard product available from
many other similar businesses and (2) products to customer order. His accountant prepared the 19
income statement shown on page 819.
Depreciation is for machines used in the respective product lines. Power
Rent is for the building
is apportioned on the estimate of power consumed.
space that has been leased for ten years at $7,000 per year. Rent and also heat
and light are apportioned to the product lines based on amount of occupied
floor space.
All other costs are current expenses identified with the product
line causing them.
valued custom-parts customer asks Jackson to manufacture 5,000 special
25-1. Differential and Opportunity Costs.
CH. 25
819
19
Custom
Standard
Sales
Sales
Sales
$50,000
$25,000
Materials
$10,000
20,000
6,300
Labor
Depreciation
Power
Rent
Heat and
Other
700
6,000
light
600
400
Total costs
$44,000
Net income
$ 6,000
Total
820
PART
VII
These per pound standard costs were developed by using an estimated production volume of 200,000 pounds of materials as the normal volume. The Bay
Company assigns Department I costs to Materials A and B in proportion to
their net sales values at the point of separation, computed by deducting subsequent standard production costs from sales prices except that the $300,000
of common fixed factory overhead costs are allocated to the two producing departments on the basis of the space used by the departments.
The proposed Department III would be used to process Material B into
Product D. It is expected that any quantity of Product D can be sold for $30
per pound. Standard costs per pound under this proposal were developed by
using 200,000 pounds of material as the normal volume and are:
Department I
{Materials
Prior department costs
A &B)
'21
CH. 25
25-4
is
available:
completes Mansers
The Machining Department starts and substantially
in the Finishing
labor
direct
of
use
the
by
completed
is
and minor finishing
in the finis ed
Mansers
places
Department
Department. The Assembly
product.
(b)
(c)
(d) In
19 when
ment
costs were
Total
Costs
$95,000
39,400
20,600
12,000
6,000
Materials
^rttborV.-;::::::::
Indirect labor
Heat and
light
Depreciation
Property taxes and insurance
Production supplies
Costs
Allocated
to
Mansers
$24,200
12,200
7,800
3,000
1,500
i^wu
j,'^^
4,000
800
(e)
Reauired- (1)
Mansers
A schedule comparing Mansell's total annual cost oftaxes.)
(Ignore income
manufactured with their annual cost if purchased.
taxes, if Mansers are (a)
income
ignoring
(2) The annual net cash outflow,
to the solution to (1) above,
regard
(Without
purchased.
(b)
and
manufactured
if manufactured and if purassume that the total annual cost of Mansers
if
chasedis
(3) The working
$60,000.)
deciding whether
capital requirements to be considered in
^^^^p^
^^^^^^^^
822
PART
VII
Make-or-Buy Decision.
Vernom Corporation, a manufacturer of a
highly successful line of summer lotions and insect repellents, has decided to
diversify in order to stabilize sales throughout the year.
natural area for the
company to consider is the production of winter lotions and creams to prevent
25-5.
Direct labor
Direct materials
Total factory overhead
Total
empty
tubes.
(Explain.)
(4) The answer to (3) if the company has the option of manufacturing and
purchasing the empty tubes at the same time. Assume that 100,000 boxes are
to be manufactured and the remainder purchased. (Show calculations.)
(5)
the
The nonquantifiable
(NAA
adapted)
CH. 25
823
product
Annual Purchases
Unit Cost
(in Units)
5,000-7,499
7,500-19,999
20,000-34,999
35,000-99,999
100,000-250,000
$2.00
1.95
1.80
1.65
1.35
Alternatives are available for using the space previously used to manufacture Product P. Some may be used in combination. All can be implemented
by June 30, 19A. Should no action be taken, the Richmond Plant is expected
to operate profitably, and factory overhead is not expected to differ materially
from past years when Product P was manufactured. The alternatives are to:
will
an annual rental of $12,100 with a lease requirement that the equipment be removed at a nominal cost and that
leasehold improvements costing $38,000 be installed. (Annual indirect
costs are expected to increase by $3,500 as a result of the sublease and
are to be borne by the Virginia Manufacturing Company.)
(c)
Required:
A schedule
analyzing the best utilization of the following alterna30, 19E (ignore income taxes and the time
ended June
value of money)
(a)
sell
824
(b)
(c)
PART
VII
as
as
needed.
(d)
Manufacture Product
on one assembly
line;
purchase Product
needed.
columns
a, b, c,
(AICPA
adapted)
the SouthernTex Cottonseed Mills, Inc. has requested its cost analysis
section to assist in the development of information to be used for managerial
decisions. The company's plant has the capacity to process 20,000 tons of cottonseed per year with the following yield per ton of cottonseed
ment of
CH. 25
825
compound.
The corporation has sold the compound for the past 30 months. Demand has
been irregular and there is no sales trend. During this period sales per month
have been
Units Sold per
Month
Number of Months
4,000
5,000
6,000
6
15
(b)
Contribution margin
if sales
made
(c)
(2) The cost of the primary ingredient used to manufacture the compound is
$12 per unit of compound. It is estimated that there is a 60% chance that
the primary ingredient supplier's plant may be shut down by a strike for an
indefinite period.
A substitute ingredient is available at $18 per unit of
compound, but the corporation must contract immediately to purchase the substitute or it will be unavailable when needed. A firm purchase contract for either
the primary or the substitute ingredient must now be made with one of the
suppliers for production next month. If an order were placed for the primary
ingredient and a strike should occur, the corporation would be released from
the contract and management would purchase the compound from the competitor. Assume that 5,000 units are to be manufactured, and all sales orders
are to be filled.
(a)
if
is
(b)
(c)
(d)
Why?
(AICPA
adapted)
826
PART
VII
and
clear weather
clear.
(3) Assuming the probability exists that it would be unprofitable to begin
shipping 10,000 liters per day by rail on either the fourth or fifth consecutive
foggy day, a schedule of the probable weighted three-day contribution (including fixed conversion costs) that should be expected from rail and air shipments if (a) rail shipments were started on the third consecutive foggy day and
the probability that the next two days will be foggy is .25; (b) the probability
that the next day will be foggy and Day 5 will be clear is .25; and (c) the probability that the next two days will be clear is .50. The company returns immediately to air shipments on the first clear day.
(4)
based.
ability.
(AICPA
adapted)
25-10. Probability Analysis. Vendo, Inc. operates the concession stands at the
Tecumseh College football stadium. Tecumseh College has had successful
football teams for many years; as a result, the stadium is virtually always filled.
The college is located in an area with almost no rainfall during its football
season. From time to time, Vendo has found that its supply of hot dogs is inreview of Vendo's
adequate while at other times the supply has been a surplus.
sales records for the past ten seasons reveals the following frequency of hot
dogs sold:
CH. 25
827
Vendo, Inc.
Hot Dog
(Frequency of Sales)
Number of
Games
Hot Dogs
10,000
20,000
30,000
40,000
10
20
\5
5Q
Total
Hot dogs sell for $.50 each at a cost of $.30 each to Vendo.
are donated to a local orphanage.
The
(NAA
adapted)
Ski Shop
Restaurant
24,000
Lodge
828
(b) Ski
(c)
For the
vary in
VII
room occupancy.
in direct
(d)
PART
ski
proportion to
room occupancy.
The
ski shop, restaurant, and lodge are located in the same building.
Depreciation on the building is charged to the lodge. The ski shop and
restaurant are charged with depreciation on equipment only. The full cost
of the restaurant equipment became fully depreciated on March 15, 19D;
but the equipment has a remaining useful life of three years. The equipment can be sold for SI, 200 but will be worthless in three years. All depreciation is computed by the straight-line method. The undepreciated cost
of the building, ski shop, and lodge equipment equals its present disposable
value.
(e)
Insurance premiums are for annual coverage for public liability and fire
insurance on the building and equipment and are the same whether or
not facilities are in use. All building insurance is charged to the lodge.
(f)
Salaries are the minimum necessary to keep each facility open and are for
the ski season only, except for the lodge security guard who is paid S5,400
per year.
Two alternatives are being considered by Ms. Wedekind for the future
operation of the ski lodge:
(a)
To
close the restaurant during the ski season because "it does not have
to cover its out-of-pocket costs."
If the restaurant were
closed during the ski season, lodge occupancy would drop to 80% of
capacity. The restaurant space would be used as a lounge for lodge guests.
enough revenue
(b)
To keep
the lodge open from March 15 to November 15. The ski shop
into a gift shop if the lodge should be operated during
this period with conversion costs of $1,000 in March and $1,000 in November each year. Revenues from the gift shop would be the same per room
occupied as revenues from the ski shop; variable costs would be in the same
ratio to revenues and all other costs would be the same for the gift shop as
for the ski shop. The occupancy rate of the lodge at a room rate of $7 per
day is estimated at 50% during the period from March 15 to November 15
whether or not the restaurant is operated.
would be converted
Required: (Ignore income taxes and use 30 days per month for computational
purposes.)
projected income statement for the ski shop and lodge from Novem(1)
ber 15, 19D to March 15, 19E, assuming the restaurant is closed during this
period and all facilities are closed during the remainder of the year.
(2)
Assuming
period of
November
15 to
March
(a)
An
(b)
4-month
analysis which indicates the projected contribution or loss of operating the gift shop and lodge during the eight-month period from
March 15 to November 15. Assume that the restaurant will be closed
during this eight-month period.
rate that should be charged to allow the lodge to
break even during the eight months from March 15 to November 15,
assuming the gift shop and restaurant are not operated during this period.
(AICPA
adapted)
CHAPTER 26
CAPITAL EXPENDITURE
PLANNING, EVALUATING,
AND CONTROL
segment of the capital expenditure process. In the final analysis, the firm
must earn a reasonable return on invested funds to satisfy the profit objec-
Yet evaluation
tive.
is
is
the
and
is
substantial
risk, (2) the magnitude of expendiand the penalties for unwise decisions are usually severe,
made
and
(1)
planning,
(3) control.
and requesting
830
PART
VII
roles
relative
to
policies
and programs
management
Ideally, executive
objectives.
sets
formulate specific
activities
when approved,
are executed by
is
autho-
An
program.
The framework
is
A company
illustrative
expeditious review.
Searching.
when the
tives
capital investment
program
and
all
reasonable alterna-
of each proposal have been brought into the analysis for evaluating
and screening.
Ideas should
come from
all
bounds of
their technical
knowledge and
ability, their
This incentive
is
strong
when
The
coming period
It
presents
for
Some
is
a genuine feeling
there
is
which approval
is
sought,
prepared.
is
management with
AND CONTROL
CAPITAL EXPENDITURE PLANNING, EVALUATING,
CH. 26
831
development.
832
2.
PART
project
VII
is
designed.
3.
The
pled with a profound understanding of the risk and danger existing in over-
The mechanics of
is
vari-
the relation-
and control
can be
classified as
(1)
equipment-replacement expenditures,
(2)
expansion
of new products.
like-for-like
Book
decision except for the treatment of income tax liability related to fixed
asset transactions.
CH. 26
capital investments.
comparison
833
is
The added
of cash inflow.
profit
is
first
life
much
category.
The
is
on projects
in this category
is
New
Products,
strategic
make
that
is,
invest-
a decision.
A proposal
may
For example, a
firm may consider a proposal to replace a job printing press, whose maintenance cost has become excessive, with a new press that will off"er an
expanded productive capacity. Also, certain expenditures may be required
because of tactical or legal requirements rather than purely economic
reasons. For example, a manufacturer may be forced into the production
of a
less profitable
may be
regulations may
involve
classification.
installed for
necessitate
criteria,
fit
Some
projects
may
compound
an interaction term.i
IH. Martin Weingartner, "Capital Budgeting of Interrelated Projects: Survey and Synthesis,"
Science, Vol. XII, No. 7, p. 492.
Management
834
and
PART
VII
their
current usage: (1) the payback (or payout) period method, (2) the average
annual return on investment method, (3) the present value method, and
(4) the
(DCF) method.
The circum-
stances and needs of the situation determine the most appropriate tech-
niques to be used. A company may use more than one technique (e.g.,
payback period and DCF) in evaluating each project; however, the same
method or methods should be used uniformly for every project throughout
the firm. Confusion could arise if Division A used the discounted cash
flow method while Division B used the average annual return on investment method. These evaluation techniques, if thoroughly understood by
the analysts
must
still
who
exercise
management
but
management
in
terms of the
value to management.
Moreover, inaccurate raw data used in the calculations or lack of uniform procedures may yield harmful and misleading
conclusions.
evaluation methods
assumed The Shields Company is
operating at the limit of the capacity of one of its producing units. Maintenance costs of the existing unit have become excessive. A new unit can be
listed
illustrating the
is
is
basis of the
kind. 2
in,
new
asset for
However,
if
any gain or
is
loss resulting
from a replacement
in
new
sale.
It is
The company's
capital (discussed
investors
demand
cost of capital
is
estimated to be 10 percent.
Cost of
money
in a firm.
2If the book value of the old asset is not zero, then the cash invested (net of the trade-in allowance) will be less than the adjusted depreciable basis of the new asset by the amount of the
old asset's book value.
CH. 26
835
836
management
is
PART
VII
illustrated as follows
Flow
Cq^/'
Payback Years
Year
Total
Needed
Required
$22,000
18,000
21,000
20,000
1.0
1.0
1.0
1.0
17,000
$22,000
18,000
21,000
20,000
1,796
2
3
Investment
.1
$82,796
If the
is
4.1
if
-^
for ex-
$22,000
3.8 years.
This method
is
The previous methods fail to account for the time value of money.
The next two techniques, the present value and the discounted cash flow
methods, consider
nomic
this
life.
To
illustrate, if
+ 20% of $500).
at
use of money
20 percent, $600
The $600
will
is
not the
has a value.
be received
if
PV =
is
or
(1
i.e., its
i)'^
+
?
(1
or S(I
i)""
when
i)-^
present value.^
CH. 26
837
Net
Profit After
Taxes
-H
Economic
Net
Original Investment
Life
$153,000
Less depreciation*
Net
74,496
economic
<r7o cf)4
'
H-
$82,796
S 78,504
life
$9,8134- $82,796
= 11.85%
:==
8 years
*The depreciable
basis.
Profit After
Taxes
-f-
Economic
Average Investment
Life
Original investment
$82,796
life
(salvage value)
8,300
$91,096
'-
$45,548 =$9,813
8 years
$ 91 096
Average investment
-h
$45,548
$45,548
21.547o
'
Two
Present value tables have been devised to facilitate application of present value theory.
The
table
to three
decimal places and shows today's value, or the present value, of each dollar
to be received or paid in the future for various rates of interest
and periods
838
of time.5
By multiplying
PART
from the
VII
table
times an expected future cash flow, the present value of the cash flow
is
easily determined.
to the Shields
Company
at the
it
all
proposals at a constant rate; and, preferably, the rate should be the cost of
capital.
Management can
teristics peculiar to
each specific
an allowance for risk and other characproposal in the raw data or in the net
interject
An
effect
of inflation
may
be
added as well.
The computation follows (data from aftertax cash flow schedule):
Net
Year
Cash (Outflow)
Present Value of $1
Present Value
or Inflow
10%
of Flow
CH. 26
A project's useful
life is
know
the
minimum
839
In project evaluation,
necessary
life
and earn a desired rate of return on the investThe present value payback calculation focuses on this question
and is computed as follows, using the "net present value of flow" figures
shown on page 838.
the original investment
ment.
Year
840
PART
VII
CH. 26
841
842
PART
VII
Advantages
1.
Simple to compute.
2.
May
3.
Permits a
its
company
each investment.
4.
The reciprocal of the payback period may be used under certain conditions
as a rough approximation of the rate of return calculated by the discounted cash flow method. The approximation exists when the project's
life is long (approximately double or more) as compared to the length of
the payback period and when the annual savings and /or cash inflow are
relatively uniform in amount. In the example, the reciprocal is 24 percent
(1 -^ 4.1) and compares to the discounted cash flow computation (page
840) of 18 percent. The lack of uniformity of annual cash flow in this
example accounts in large part for the roughness of the approximation.
Also, the project's life is only 8 years, compared to a payback period of
If the project's life were longer, the approximation would
4.1 years.
be closer.
5.
It is
a widely used, rough-and-ready method that is certainly an improverule of thumb, or intuitive method.
Ignores the time value of money. For the Shields Company, the payback
period is 4.1 years. Assume that the "Net Increase in Aftertax Cash Inflow" had been: Year 1, $55,000; Year 2, $12,000; Year 3, $10,000;
Year
4,
5,
$2,960.
Cash Flow
Year
1
2
3
4
5
Payback Years
Total
Needed
Required
$55,000
12,000
10,000
$55,000
12,000
10,000
5,500
1.0
1.0
1.0
1.0
296
.1
5,500
2,960
$82,796
Investment
Total payback period in years
4.
In both cases the payback period is 4.1 years; however, in the latter
computation $33,000 more ($55,000 - $22,000) was received in the first
Thus, the latter situation is more desirable from an investment
year.
standpoint because money has a time value; that is, a dollar is worth
more
the earlier
it is
received.
::
..
CH. 26
::
843
2.
life
of the project.
Disadvantages
1.
Ignores the time value of money as did the payback method. Two projects
might have the same average return yet vary considerably in the pattern
of flow of cash. In such a case, the recognition of the time value of money
Inapplicable
if
is
made
project.
Advantages
1.
2.
life
of the project.
Disadvantages
1
2.
3.
used. However, a
well-informed management should already be aware of its cost of capital
that should represent the benchmark for discount rate purposes.
844
In the Shields
Company,
PART
VII
the computation
is:
M
Net
,
D
^
Present x/
Value IIndex
.
Required Investment
$24,290
.^,
.2934
$82,796
This index simplifies finding the optimum solution for competing projects
when the total budget for capital outlays is fixed arbitrarily, because one
is able to rank by percentages rather than absolute dollars.
4.
May
be misleading
may
life
it
Advantages
1.
2.
3.
The percentage
figure
life
of the project.
value method.
4.
The percentage
uniform ranking of
projects.
Disadvantages:
1.
2.
Too
difficult to
Implies that earnings are reinvested at the rate earned by the investment,
whereas the present value method implies earnings are reinvested at the
rate of discount.
It is
cut-oflf
project
assumption
whose estimated
For example,
if
the
if
minimum
when
is
desirability
the answer
one alternative
there
more reasonable.
is
very near
is
is
little
is
latter
in
is
obviously
computing the
rate of
in evaluating
best
any project;
at a higher cost
of
obtaining the data, may be necessary to add confidence when the evaluation is close to a cut-off' point or when two or more project alternatives
yield about the same "best" answer.
CH. 26
In
many
845
from altermaking
is
not justified.
The following
topics related to
alter-
natives having unequal lives, purchase versus leasing, cost of capital, sen-
sitivity analysis,
Alternatives
when
An
economic
compared. To illustrate, a firm may be faced with the problem
of acquiring equipment for a manufacturing operation. Two alternatives
are available: Equipment A, expected to last 18 years, and Equipment B,
expected to last 5 years. There are two ways to deal with this problem:
expenditure evaluation arises
lives are
1.
2.
lease
arrangement
may be
available as an
should be
The
of return on
purchasing.
rate
Cost of Capital.
and
demand
money
in a
may
from a particular financing effort to provide funds for a specific project. Such use of the concept
connotes the marginal cost of capital point of view and implies finkage of
the financing and investment decisions. This view has been challenged as
a useful concept for allocating capital; the funds available for one or all
control,
846
projects are
more
PART
VII
more than
source.
This weighted average considers the joint costs and the desired
relative proportions of
follows
Funds
Source
Bonds
Preferred stock
may
be computed as
CH. 26
35
37
36
38
847
40
39
DCF
To illustrate, assume
on the
DCF
rate of return
rate of return at
was 26 percent.
An
from $.34 to $.41 per gallon could also be computed assuming the primary
raw material would cost $.29 and $.27, if these are reasonable possibilities.
The graph shown above presents this illustration in visual form, assuming that a plant having a capacity of five million gallons per year and
an economic life of ten years will require a $600,000 investment. Annual
sales volume is also assumed to be five miUion gallons. The DCF rate of
return can be read for the various combinations of Product
and
Raw
Material
costs.
X selling prices
at the expected
impact of a range of
possibilities.
The
848
PART
VII
risk
and uncertainty
in order to indicate
will
how
likely
it
sumptions and
range plans, the annual budget, break-even and cost-volume-profit analysis, differential cost analysis,
and
programming.
linear
considered
may
To
assist
set
management
more
level project
is
basically
is
Determine the net present value of the net cash flows for three
risk
different
assumptions:
a. Most probable series of events.
b. A reasonably pessimistic series of events.
c. A reasonably optimistic series of events.
2.
Weigh
the three net present values, using the best information available
may
For example:
Optimistic assumptions
838).
be used to represent
CH. 26
Probability of
Selling Price
Occurrence
849
30%
$.39
30
.38
.37
40
100%
Raw
Material
Cost
$.29
.28
.27
Probability of
Occurrence
20%
70
10
100%
any of the three Product X selling prices. Other selling prices and Raw
Material Z costs are assumed to have a zero probability of occurrence.
The resulting nine possible outcomes for these assumptions and their
related probabilities are summarized below:
il)
Product
(2)
850
to
PART
VII
tive probabilities
various rates.
possibilities,
DCF Rate
Cumulative
of
Return
Thus, there
Probability
36%
.03
31
.27(.03
26
.58(.03+.21
+ .03 +
.06
+.04)
21
.92
16
1.00
is
+ .21 +
-f .21
.03)
be at
least 31 percent,
a .58 probability
Computer Usage for Evaluation Analysis. The ever-increasing installation of electronic data processing equipment offers the analyst an opportunity to expand the investment evaluation analysis beyond a mere handful
of manual computations. The computer permits the creation of numerous
models that simulate various possibilities and probabilities of expected
results.
The main purpose of the simulation process is to improve the
quality of management's decisions by offering new and more reliable information and guidance. Whenever the key factors in a business problem
are susceptible to various patterns of variations, the use of models and
simulation will be especially helpful. It should be understood that even
the most sophisticated and computerized analytical methods do not relieve
any management of the all-important task of making the final decision.
in process
and
(2)
When
a project or a series of
and procedures
must be set in motion to permit the control and review of all project elements (costs, time, quality, and quantity) until completion. Control respon-
needs to be clearly designated, recognizing the necessity of assistance from and coordination with many individuals and groups including
sibility
results.
CH. 26
to responsible authorities
on time
851
in order
vehicles.
network scheme to show the interrelationcomplete the average to largeships of the multiple activities required to
of a single large machine,
scale project. Any project, be it the installation
construction of a new faca complex of machinery and equipment, or the
can
building, will involve many diverse tasks. Some of them
(see
Chapter
tory or office
be done simuhaneously
others
of PERT
risk
to expedite
The
desire
difficult estimates.
is
an
inefficient use
commensurate
of administrative
resources.
administrative costs,
are management's unwillingness to incur additional
of investments, aptypes
certain
of
difficulty of quantifying the results
Value
uniformity,
mation should determine the extent of any follow-up. For
a centraldesignate
should
efficiency, and independent review, management
followthe
of
ized group to prescribe procedures and audit the performance
device and
up activity. The assembled data should be utilized as a control
Out-of-line results
be reported to the controlling levels of management.
management by
the
corrective action in harmony with
should then trigger
exception principle.
852
3.
Differentiate between
4.
5.
life
and physical
life
of a project.
Modern
How
7.
economic
important?
How
this
6.
VII
DISCUSSION QUESTIONS
2.
1.
PART
can
concept be stated?
Discuss the differences in the computations of the present value and the dis-
methods:
a.
b.
c.
d.
9.
10.
11.
After a capital expenditure has been made, what should the company's
analysts do in the matter of reporting the results of these decisions?
12.
purchase of one of two machines to replace an old machine, the management of Ashworth Company should consider as
relevant (1) historical costs associated with the old machine; (2) future
costs that will be classified as variable rather then fixed; (3) future costs
that will be different under the two alternatives; (4) future costs that
will be classified as fixed rather than variable.
(b)
may
(c)
The method of
money
(4)
(d)
is
payback.
A company
value analysis; (3) payback analysis; (4) Program Evaluation and Review Technique with Cost (PERT /Cost).
CH. 26
(e)
853
(AICPA
adapted)
EXERCISES
Investment Analysis. The Weinman Company is considering a capital investfor which the initial outlay is $20,000. Net annual cash receipts, after
taxes, are predicted to be $4,000 for ten years. Straight-line depreciation is to be
used, with an estimated salvage value of zero.
1.
ment
(4)
(5)
854
PART
VII
(b)
New
equipment:
(c)
(d)
Old Equipment
Direct labor
Supplies
Maintenance
Supervision
Power
Depreciation
new equipment:
New Equipment
$30,000
14,000
8,000
6,000
4,000
5,000
$12,000
11,500
6,000
6,000
7,000
10,000 [($26,000
$4,000)
(e)
Assume
3]
50%.
Investment Analysis. For a certain project for the city of Toledo, the following
data have been made available:
4.
Original investment
Estimated life of project
Average annual cash savings
$93,510
15 years
$20,000
$2,000,000
Sales
250,000
Gross profit
Operating expenses:
Fixed expenses
Variable expenses
1,650,000
1,400,000
$
66,000
200,000
350,000
266,000
84,000
42,000
Net income
42,000
CH. 26
855
(3)
(4)
10% on
its
(6)
(7)
(5)
Study.
proposed addition to the Hidden Valley Colorado ski
requires an investment of $1,300,000, and it is estimated that net
income after taxes over the life of the project will total $600,000. The ski resort
manager, Ms. Maura Shelton, has prepared these estimates:
7. Feasibility
lift facilities
5 years
straight-line
Revenue
Expenses: Depreciation
Other (cash)
Income before
Income
taxes
taxes
J.
500
2,
7^'^^fl/
$1,000
$2,000
$2,500
$2,000
$8,000
660
$1,010
$ (160) $
(40%)
260
750
260
400
.40
260$
1,400
1,300
5,700
$1,660
$2,010
$1,660
$7,000
(10 ) $
340
490
340
$1,000
136
196
136
468
196
136
400
294
204
600
68
$ (160) $
(10) $
272
$
after taxes
260
(68)*
Net taxes
=($160+ $10)
1,750
Net income
260
1,400
(68)
856
PART
Vil
(2)
(3)
(4)
(5)
article in
at
8%.
Managerial Planning)
at a rate of
50%.
Required: (1) In terms of net present value, the cost for one machine (a)
the use of the Model
machine and (b) when using the Model
when continuing
machine.
to
make
(2)
Does the
Purchase vs. Leasing. Sangaman's is considering two alternatives for providing additional warehousing space for its department stores. The purchase
price of this facility is assumed to be $330,000 with an economic life of ten
years. The estimated salvage value at the end of the economic life is zero, and
the straight-line depreciation method is to be used. The irrevocable lease provides that Sangaman's pays an annual rent of $50,000 for ten years, payable at
the beginning of each year.
Maintenance costs, insurance, etc., are covered in a separate contract with
the lessor whether the asset is purchased or leased. Assume that an income
tax rate of 50% is to be paid at the end of each year and that the taxing authorities will permit taxation of the lease-rental agreement as a lease.
9.
Required: The discounted cash flow rate of return of the aftertax cash
savings of purchasing rather than leasing.
(Based on an
article in
in Present
money
Management Accounting)
Value Calculations.
It
is
CH. 26
857
payback or the
average annual return on investment method. Present-value techniques, however, are often presented with an assumption of certainty, which is not entirely applicable to real-world situations.
The administrator of Portland Municipal Hospital is considering the purchase of new operating-room equipment at a cost of $7,500. The surgical stafiF
has furnished the following estimates of useful life and cost savings. Each
useful life estimate is independent of each cost savings estimate.
Years of
Estimated
Useful Life
858
At the end of
the
first
5,000 hrs.
,500 units
11
equipment
Installation cost
Relocation, alteration,
Variable costs
$90,000
6,000
6,000
$20,000
Tooling
Depreciation
Other expenses
VII
Machine hours
Output
New
PART
1,000
5,
00
6,000
rate
is
50%.
Required: (1) For the proposal, the (a) payback period, (b) average annual
return on the original investment, and (c) return by the discounted cash flow
method.
(2) For the actual results at the end of the first year, assuming these results
represent expectations for the life of the project, the (a) payback period, (b)
average annual return on the original investment, and (c) return by the discounted cash flow method.
(Based on an
article in
Management Accounting)
PROBLEMS
Equipment Replacement Study. The Sureseal Gasket & Mfg. Company,
is currently producing wire ring gaskets by hand labor with a minor
amount of machinery, is contemplating the purchase of an automatic machine
which will cut down the amount of labor needed in the process. The process
entails the cutting of the wire by hand, the welding of the gasket by machine,
and subsequently the deburring, sanding, and forming of the gaskets by hand.
The materials costs under both methods would be $3,000. Maintenance and
repairs for the old process cost $70, and the expected cost applicable to the new
machine is $200. Tools and supplies under the old process amounted to $3,250,
while the new machine would require only $1,000. These figures represent an26-1.
which
nual costs.
The company works on a two shift, forty-hour week, fifty weeks of the year,
a premium of $.1 an hour for the second shift. The welding of the
gaskets is done by one man on each shift; the first shift man receives $5.25 per
hour under the old process. The new machine would require only one man on
each shift also. He would receive $5.00 per hour for the first shift.
After the gaskets are welded, they have to be deburred, sanded, and formed.
Under the old method, this required three men on each shift; the first shift
received $4.50 per hour.
The new machine would automatically debur the
gaskets; therefore, under the new method only two men would be needed on each
shift to form and sand the gaskets. They would receive $4.50 per hour.
Electricity under the old method was charged at $.02 per kilowatt hour, and
the old machines consumed 2 kilowatt hours per hour of operation. The new
machine would consume 8 kilowatt hours of electricity per hour of operation
and pays
CH. 26
859
The old machinery has a trade-in value and a book value of $3,000 at the
present time. The salvage value for depreciation purposes is $3,000 for both
the old and new machines. The new machine would cost $63,000 less trade-in,
and have a useful life of 15 years. The estimated cash value of the new machine
at the end of 15 years will be negligible.
Required: An equipment replacement study, indicating the net cash savings
per year based on a 50% tax rate, the payback period, and the rate of return
based on the discounted cash flow method.
860
PART
VII
projects have been proposed by different department heads. The Cost Analysis
Section has prepared the following data concerning the projects:
Capital outlay
Net cash savings in cost
(per year)
Project #1
$15,000
4,000 during the next
5 years;
Project #2
Net increase
in
cash income
(per year)
Project #3
Project #4
$25,000
4,000 during the next
20 years
Capital outlay
Net cash savings in cost
(per year)
$20,000
3,000 during the next
Capital outlay
Net increase in cash income
$35,000
10,000 the first 2 years;
5,000 the next 8 years;
4,000 the next 10 years
(per year)
5 years
5,000 during the second
5 years
Required: (1) The aftertax payback period for each project. Depreciation
and the tax rate is 45%. The economic life of
the projects is indicated by the number of years of expected returns.
is
(2)
The
rates of return expected for the project using the discounted cash
flow method.
(3)
26-4.
The
New
project(s)
R&D
CH. 26
Sales
861
19A
19B
$1,000,000
$1 ,600,000
$800,000
750,000
$350,000
72,500
50,000
150,000
X $4)....
Depreciation
400,000
77,500
50,000
450,000
19C
12,500
50,000
300,000
Total expenses
977,500
$1,212,500
$622,500
22,500
9,000
387,500
155,000
$177,500
71,000
Net income
13,500
232,500
$106,500
Required: (1)
The
on average investment
for the
project.
accepted
(NAA
adapted)
862
PART
VII
good
Operating costs
Foundry fixed overhead
General plant overhead (fixed)
Depreciation on new plant
$822,000
Total costs
Cost of purchasing
$800,000
$ 22,000
to the
Project
Project
Project
Original investment
SI 00,000
S 1 00.000
S 1 00,000
Life of investment
25 years
25 years
25 years
5350,000
14,000
4,000
5350,000
14,000
4,000
5350,000
14,000
4,000
$25
PROJECT A
$24,000
w PROJECTS15B
Q
PROJECT C
$5
$0
CH. 26
863
Required: (1)
(2)
(3)
(4)
26-7. Purchase vs. Leasing. Madisons, Inc. has decided to acquire a new machine either by an outright cash purchase at $25,000 or by a leasing alternative
of $6,000 per year for the life of the machine. Other relevant information is:
$25,000
5 years
$3,000
$500
Additional information:
(a)
tax rate
straight-line
method
of depreciation.
(b)
(c)
Assume
agreement as a
lease.
The company's
cost of capital
is
10%.
Required: (1) The present value of the purchase price of the new machine.
Under the purchase alternative, the present value of the estimated
salvage value.
(2)
(3) Under the purchase alternative, the annual tax reduction (cash inflow)
related to depreciation.
(4)
maintenance.
(AICPA
adapted)
Purchase.
economic life
the economic
life is
zero.
Straight-line depreciation
is
used.
Leasing: The annual rental of the facility is $80,000 for three years, payable
at the beginning of each year
Thereafter,
a three-year commitment.
year-to-year lease renewals at the option of the lessee are available at the
rate of $60,000 per year payable at the beginning of each year.
864
PART
VII
income tax rate is 50% and is paid at the end of each year. Assume the
taxing authorities will permit taxation of the lease-rental agreement as a
lease.
Required: (1)
tween aftertax cash savings of purchasing rather than leasing assuming that
(a) the use of the facility is terminated at the end of three years; (b) the facility
is leased three years, at which time the purchase option is exercised; (c) the
facility is leased for the entire ten years.
(2)
facility.
(Based on an
article in
Management Accounting)
Equipment
Feasibility
Annual
Probability
Requirements
of Occurrence
2,000
3,000
5,000
.2
.6
.2
Required: (1) The net present value for each of the three activity levels for
Machines A and B using a discount rate of 6%.
(2) The weighted net present value for each machine. (Ignore income tax
considerations.)
(Based on an
article in
Management
Services)
26-10. New Product Analysis Considering Risk and Uncertainty; Net Present
Value. Vernon Enterprises designs and manufactures toys. Past experience
indicates that the product life cycle of a toy is three years. Promotional advertising produces large sales in the early years, but there is a substantial sales
decline in the final year of a toy's life.
Consumer demand for new toys placed on the market tends to fall into
three classes. About 30% of the new toys sell well above expectations; 60%
sell as anticipated; and 10% have poor consumer acceptance.
CH. 26
Above average ..
Average
Below average.
30%
10
..
Year
$1,200,000
700,000
200,000
60
sales projections
Estimated Sales
Chance of
Occurring
865
were
in
Year 2
Year 3
$2,500,000
1,700,000
900,000
$600,000
400,000
150,000
Variable costs are estimated at 30% of the selling price. Special machinery
at a cost of $860,000 and will be installed in an unused
portion of the factory which Vernon has unsuccessfully been trying to rent for
several years at $50,000 per year and which has no prospects for future utilization. Fixed costs (excluding depreciation) of a cash-flow nature are estimated at
$50,000 per year on the new toy. The new machinery is to be depreciated by the
sum-of-the-years-digits method with an estimated salvage value of $110,000
and will be sold at the end of the third year. Advertising and promotional expenses will total $100,000 in the first year, $150,000 in the second year, and
$50,000 in the third year. These expenses will be deducted as incurred for income tax reporting.
The management of Vernon Enterprises believes that federal and state income taxes will total 60% in the foreseeable future.
must be purchased
Required: (1)
schedule of the
(a)
new
above average
A schedule of the new toy's probable net income for each year of its
assuming that the probable sales computed in (1) are $900,000 in the first
year, $1,800,000 in the second year, and $410,000 in the third year.
(3) A schedule of net cash flows from the new toy's sales for each of the
years involved and from disposition of the machinery purchased.
[Use the
(2)
life,
sales
data given in
(2).]
(AICPA
(3),
adapted)
866
Variable costs
Fixed costs (excluding depreciation)
PART
Old Machinery
New Machinery
$50,000
11,000
$15,000
18,500
VII
required by the
is
50%.
Assume, for income tax purposes, that the sum-of-the-years-digits depreciation method is used for the old and new machinery with a 10% provision for
residual value. Any gain or loss on the disposal of the old machinery will serve
to adjust the depreciable basis of the
Required: (1)
decision as to whether or not New Brunswick should replace the existing machinery now.
(2) The net present value, the net present value index, and the rate of return on the investment by the discounted cash flow method.
The following
$
300,000
100,000
600,000
800,000
PEP
#12)
$1,800,000 Total
(b)
The corporation
6%
projects.
(c)
Under PEP #12, a cash investment of $75,000 will be made one year before
operations begin. The investment will be depreciated by the sum-of-the-yearsdigits method over a three-year period and is expected to have a salvage value
of $15,000. Additional financial data for PEP #12 follow:
Time Period
Revenue
Variable Costs
0-1
1-2
2-3
$80,000
95,000
60,000
$35,000
41,000
25,000
Maintenance,
Property Taxes,
and Insurance
$ 8,000
11,000
12,000
CH. 26
(d)
capital structure of
Bonds
at
5%
Rowekamp
Corporation follows:
interest
4% cumulative preferred
Common
stock and
Amount
Percentage
$ 3,500,000
1,750,000
10%
29,750,000
$35,000,000
(e)
Current
Market Price
Preferred stock.
Common stock.
$120
50
85
100%
867
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869
CHAPTER 27
PROFIT PERFORMANCE
MEASUREMENTS,
INTRACOMPANY
TRANSFER PRICING,
PRODUCT PRICING METHODS
The establishment of a
profit goal
lower management
mous
and
divisions of a
profit
levels,
and
company
of decentralized, autono-
company-wide
management
in
performance
The
appraising
Appraising
first, followed by the subject of intrawhich plays a significant role in divisional and
departmental result measurement. Finally, the chapter deals with different
product pricing methods with which management may establish product
prices needed to cover costs and return a profit.
profit
company
is
discussed
transfer pricing
870
CH. 27
rate.
871
In equation
P^Q*^'"*"
% OF
PROFIT TO SALES
SALES
I
X =
RATE OF RETURN
ON CAPITAL
EMPLOYED
^ALbb
ti/^Ai-ii-T-Ai
^tini r\\/c:r\ ti
lOkirwica RATETURNOVER
- CAPITAL-EMPLOYED
CAPITAL EMPLOYED
->
were cancelled out in the two fractions, the end result would
However, the shortened formula does not express the
of
the
concept which deals with two independent variables
real objective
profit on sales and turnover of capital employed. Using the full formula
If sales
still
be the same.
gives
i.e.,
which committed
assets are employed in the operations. The return on capital is an internal
measure of operating management. It is not a guide for shareholders or
investors who measure profitability or earning power by relating profits to
of costs.
The turnover
equity capital.
The elements
and whose
result will
respond
margin
improved
can be caused by an
turnover rate with no change in sales prices indicates that the capital employed is worked harder; that is, more sales are coming out of the same
Changes
in the profit
An
investment.
Complete
percentage of profit to
and capital-employed
are portrayed more vividly in the chart on page 872.
turnover rate
Executive management of
sales
many companies
profitability.
872
COST OF
GOODS SOLD
MARKETING
EXPENSES
SALES
minus
t
TOTAL
COSTS
ADMINISTRATIVE
EXPENSES
ACCOUNTS
RECEIVABLE
NOTES
CURRENT
RECEIVABLE
ASSETS
INVENTORIES
PREPAID
EXPENSES
FIXED
ASSETS
MACHINERY AND
EQUIPMENT
PROFIT
PART
VII
CH. 27
fair
In such cases
in the analysis.
873
it
total
of this chapter.
employed
figures used in
computing the
rate.
Which
profit
should be used?
The income statement generally reports several profits such as (1) net
operating income or profit, which includes cost of goods sold and marketing and administrative expenses but excludes nonoperating income
and expenses; (2) net income or net profit before taxes, which would include the nonoperating income and expense items, and (3) the net income
or net profit after taxes, representing the amount that is transferred to
retained earnings. Using net operating income or profit means that only
transactions of an operating nature should be considered.
figure
is
This profit
company.
The use of
The
net
It
The
sales figure
commonly used
is
net sales
gross
"investment"
is
its
common
use in connec-
worth or equity
capital)
is
the entire asset side must be considered, and the term "capital employed"
seems to express this element best. However, beyond the term itself, the
phrase "capital employed" raises pertinent questions regarding each asset
item included.
874
Current Assets.
The
PART
VII
three
Ordinarily, cash
Cash.
the
is
amount shown on
However, if cash should include funds set aside for a future expansion or development program,
these amounts should be deducted from cash or from whatever account
was charged. Funds, such as pension, welfare, or tax funds, should be
excluded. Yet, even these items are challenged. Some companies believe
is
that if such items are treated uniformly in relation to total cash or assets,
any change of the balance sheet figure is not warranted. On the other
hand, certain managers do not accept the stated cash figure but consider
or one related to cost of
a predetermined percentage based on cost
goods sold, or an amount equal to say one half of the annual operating
expenses
Receivables.
At
assets.
all
this point
one
may
receivables allowances.
in excess of actual
age, or
lifo,
The
give rise to
some
differences
when
How such
is
compared
differences should
any should be made for comparative purif an allowance account is used for
lower of cost or market adjustments, the question arises as to whether or
be adjusted or what allowance
poses
is
difficult to state.
if
Again,
Some companies'
role.
costing basis.
CH. 27
Fixed Assets.
875
(1)
original cost
(original
book
value),
i.e.,
book value), and (3) estimated replacement value or price level changes.
The arguments for the first two bases are summarized below.
net
Original Cost.
argue that:
1.
abandoned
2.
basis.
Gross assets of one plant can be compared better with those of another
plant where depreciation practices, or the age of the assets,
may
be
diflFerent.
3.
from
use.
who
2.
assets,
at net
An
which
it is
is
made.
year.
They further
assert that
some equalization of
facility values
876
of the
new
VII
diflferent divisions
PART
built at relatively
on the
This
subject.
is
on
and, of course,
profits, sales,
It suffices
and
profits
and the
current assets might be measured in current dollar values while the fixed
assets
and
behind.
at least parts of
it,
should
Many
ac-
fiscal
period
if
possible.
the end-of-year balance sheet figures, but rather an average figure, might
and
their
is,
The
it
return
on
capital
Under such
of substance.
:
;
CH. 27
Some
877
show a higher
company. This approach might create a psychological dilemma, for it would be difficult to
obtain additional effort from the unit supervisory staff when a unit shows
objectives or desired returns higher than those of the
a return which
it still
is
company
average. Furthermore,
does not eliminate the endless arguments against any basis used for
cost allocations.
The
measured
is
the allocation
who
individual
is
profitability,
products in
it is
efficiency,
fold:
(2) general
culties.
This
is
to segments
might follow
this pattern
Cash: gross sales billed cost of goods sold in ratio to total product cost
a standard percentage of sales or cost of goods sold; manufacturing cost
;
less
product
878
PART
VII
or actual volume. General or service facilities costs, such as the powerhouse, hospital, machine shop, and plant laboratory, will already have
been prorated to products so that the allocation of the investment in
these facilities can follow cost. The powerhouse, for instance, producing
steam, electricity, and water will be prorated on the basis of pounds of
steam used, kilowatts of electricity taken, and gallons of water consumed
by each product.
income
capital
is
a matter of relating
management.
to total assets.
may
Assume
than absolute
profits.
be accepted.
employed are
Sound
planning and successful operation must point toward the optimum combination of these three factors. As stated earlier, the combination will
necessarily vary depending upon the characteristics of the product. The
heavy industry with products tailor-made to customers' specifications
will have different profit margins and turnover ratios compared to the
mass production industries of highly competitive consumer goods. In
multiproduct companies the three basic factors cannot be uniform due to
Graphs as Operating Guides.
Profits, sales,
and
capital
among
products.
However, in order to judge in concrete though ffexible terms the performance of segments or products in their relationship to a desired overall
return on capital employed, a special type of graph can be of immeasurable
assistance. The graph on page 879 shows possible combinations of percentage of profit to sales and capital-employed turnover rate which yield a
20 percent return.
It
ffexibility in
appraising profit
factors.
CH. 27
~~i
-10
-7.5
-0+ +2.5 +
-2.5
% OF
7.5
basic curve.
If
on the
22.5+25 +
15 +17.5 + 20 +
27.5 + 30
PROFIT TO SALES
20%
+10+12.5 +
Graph
(Based on a
879
of
Rate
Rate of Return on Capital Employed)
left,
company
as a whole.
segment whose ratios appear to the right of the basic curve produces a
return in excess of that expected for the entire company.
pretation applies
when
the
company's
total return
is
The same
inter-
plotted.
Employed
1.
rate of return
on
capital
profit possible
on
3.
Serve as a yardstick in measuring management's efficiency and effectiveness in managing the company as a whole and its major divisions or
departments.
Tie together the
control,
and the
many phases
profit goal.
4.
5.
6.
Aid
in detecting
880
PART
VII
employed
1.
ratio are
Lack of agreement on the right or optimum rate of return might discourage managers whose opinion is that the rate is set at an unfair level.
2.
Proper allocation requires certain data regarding sales, costs, and assets.
The accounting and cost system might not give such needed details.
3.
4.
to ratios
5.
to
make
on
capital
result in a fixation
Budgeting
is
Among
most companies.
casting
is still
difficult
Assum-
ing that an acceptable sales budget has been established and production,
Management's
as well as the immediate returns for each division, plant, or product, in-
fluence
capital
employed
offers a
most
When
considering long-
PRICING METHODS
PROFIT PERFORMANCE, TRANSFER PRICING,
CH. 27
881
is
to: (1)
each factor;
(3)
and (4)
upon income and asset accounts.
The effect of planned programs on assets,
employed is shown below.
for each;
of
its eff'ect
profit,
and return on
capital
Improvement
Effect of Planned Programs for Profit
Assets:
Future
Curtail-
ment
$100,000- $ 400,000
500,000
Inventory
Asset
Change
by Cost
Change
by Volume Reduction
Present
Other current
220,000
200,000
assets
Fixed assets
300,000
Total assets.
$1,000,000
Profit:
Sales billed
Manufacturing
770,000
77.0% $140,000+
130,000
13.0
900,000
90.0% $150,000
100,000
10.0%
costs
380,000
$80,000+
$1,200,000 100.0%
822,000
68.5%
138,000
11.5
960,000
80.0%
240,000
20.0%
Marketing and
administrative
expenses ....
Net operating
profit
10,000+
50,000+ $90,000+
Return on capital
employed:
% of profit to
sales
10.0%
Capital-employed turn
over rate
1.0
(times)
20.0%
1.2
Return on
capital
em-
ployed (%)...
24.0%
10.0%^
882
PART
VII
Whether
is
mesh
and segments but also shows the extent to which profitable coordination
exists. A company's interlocking efforts are never more effectively demonstrated than by this rate.
Return-on-capital-employed information provides an executive with a
brief yet
ment which
figure for
definitely
which he
is
line.
The product
responsible.
in every
receives a state-
results in the
one
engineer's opportunities
if
they contain
There is danger in undue fixameasure of performance whether for the entire company
or for its individual divisions. The result may be emphasis on improving
the components of the one measure (e.g., return on capital employed) to
Multiple Performance Measurements.
tion
on a
single
both in the
compared
Profits are
compared
to the budget.
iprank J. Tanzola, "Performance Rating for Divisional Control," Financial Executive, Vol.
XLIII, No. 3, pp. 20-24.
CH. 27
Here,
measures are employed
Cash and capital management
receivables.
and
management of inventory
phasis is on effective
883
the
em-
are that:
4.
ThTsyrrtasllexibility
shifting of
as to timely, needed
management
emphasis.
enough
example concludes that it is not
effectively
must be
statistics. The results
nrerdy to tabulate performance
good performance
and
taken,
must be
"ommunicated, corrective action
and support of
interest
the
The system must also have
Company management
in this
muTbe
rewarded.
management.
division and corporate
or multiproduct
WeTv decrnLized multiplant
semiautonof the enterprise as a
TatLer is expected to run his portion
or
AS long as his'umt, segment,
omous"
A
Pro^^^^^Z:^
iness
A.r^i
frorone u
The fir^shed
o a
or
transterrea
services are generally
J^.^on common
to integrated corporations.
-
or subsid
of one or more divs.ons
or semifinished product
divisions^
other
more
or
the raw material of one
Iri s fr quenUy becomes
conceivably
might
are centralized and
Be ides some'service functions
When transfers of goods or services
delwih a number of profit centers.
center becomes a portion
the revenue of one profit
are made a portion of
made
influences
Tr,
tv.f>
"o^thfcIl^uirtfolVthe
nature of the formula.
ts
^^^^^^^^^
884
The
is
PART
one reason
and
steel
VII
coal mine and sell some of its output on the open market but use the remainder in its own steel mills. The coal's transfer price can control
whether the Mining Division shows a large, small, or zero profit.
may
External factors
company with an
may keep
the
transfer price high for materials sent to the domestic facility in order to
retain profits abroad.
inventory tax
may keep
tax
its
bill.
Years ago transfer pricing played only a minor role, chiefly as part of
a cost accounting system for the purpose of cost control. Today the technique of transfer pricing has expanded into a complex set of procedures in
The
management
objectives
makes
extremely
it
difficult
for a
management
basically
makes
makes
all
This centralized
is
is
mea-
usually
discussed in
11 ("Responsibility
may
Service charges
costs,
costs.
value.
monthly or annual
profit
is
sharing percentages.
The value of
114,
mana-
calculating profit-
No.
3,
pp. 37-38.
CH. 27
abilities
fundamental
criteria: (1)
885
must
management to
transfer prices
allow central
manner conducive
division's
autonomy
and
selling
as a whole,
and
as a profit center.^
company
sound approach.
As
a practical matter,
it
In the last analysis, the profit center manager's interest must remain
Product
interest.
to Division
from the
of the Division
If the
is
assumed not
to change).
facilities
intracompany transfer
is
made
to Division Y.
still
remains
the task of establishing a just transfer price for both divisions for divisional
performance measurement.
Therefore, a transfer pricing system must be designed that can be
judged
in
terms of
its
making that is in the best interest of the total firm, for efficient divisional autonomy as well as for its ease of application, and for
meeting of legal and external reporting requirements. No one method of
for decision
The
it is
8,
III,
No.
1,
Autonomy,"
886
is
VII
widely used in
cost figure
direct, or differential.
that described
Cost-based pricing
The
PART
'Billing'
or 'Sold-Hour' Rate
Differential cost
is
is
The
measure production
may
transferred.
problem.
this
efficiency
field
may
alleviate
utility in the
effi-
The market-based
transfer price
is
making
and performance measurement. Divisional operaon a competitive basis with the same price charged for external
and internal customers. Some companies apply a discount to the market
The
price, reflecting economics resulting from intracompany trading.
method reflects product profitability and division management performance, aids in future planning, and is generally required by foreign
it
tions are
tariff"
laws.
The most
serious
drawback
to this
method
is
is
Unfortunately, a market
Also, the
CH. 27
made by
887
Con-
is
It is
comprised of cost plus a markup that is meant to provide a return on investment in divisional assets. Much less frequently used, this transfer price may
be applied in lieu of the hard-to-establish market price.'*
The negotiated
transfer price
It is felt
is
used in
of their units.
serious
management
is
An
The
company
interests
with neither the buying nor selling units having any control over the final
decision. The method's disadvantages far outweigh any kind of advantage.
can defeat the most important purpose of decentralizing profit responsibility (namely, making divisional personnel profit conscious) and severely
It
hampers the
managers.
(selling) divisions
may
differ in the
is
to
Diversity
888
may
cordingly,
ducing division
1.
VII
price that
profit.
In such circumstances, a
transfer pricing
its
PART
approach
in
company may
find
it
which the
price in
2.
3.
Variable costs of the producing division are transferred to the purchasing division, together with an equitable portion of fixed costs.
Total of the divisional profits will be greater than for the company as a
whole, and the profit assigned to the producing division would be eliminated in preparing company-wide financial statements.
Under
profit
Of
tions.
consuming division
is
aware of the
be achieved only
if
and
reliable. ^
it
performs. 6
B. Troxel,
"On
Transfer Pricing,"
Management
Controls, Vol.
XX,
^The transfer pricing methods employed in the meat industry can be studied in the brochure
Financial Planning and Control in the Meat Industry, prepared by Price Waterhouse & Co. in
cooperation with the Accounting Committee, American Meat Institute (Chicago, Illinois,
1967), pp. 142-143.
7For further study, the nature and scope of several major transfer pricing models categorized
as to (1) the economic theory of the firm, (2) mathematical programming approaches, and (3)
other analytical approaches are covered in A. Rashed Abdel-khalik and Edward J. Lusk,
"Transfer Pricing
A Synthesis," The Accounting Review, Vol. XLIX, No. 1, pp. 8-23.
CH. 27
METHODS
PROFIT PERFORMANCE. TRANSFER PRICING. PRICING
889
is
is
neither a one-person
judgment is
ment and marketing managers with mileposts
tical
to be used as guides
when
its final
most
determination can
Price setting
is
that field of
company
is
the sole
over
may
differ.
order to
selling prices, the costs incurred in
more within
its
control.
may
price discrimination.
Even
if
selling price,
it
890
PART
VII
cost to meet changing needs resulting from fluctuating sales volume, sales
The accountant's
must be computed
management
assistance to
in
such
25).
in the highly
important
field
of
and
may
all
methods
Methods Used
maximization
relating
(3)
conver-
sion cost pricing, (4) contribution margin and the differential cost ap-
(5)
Maximization
Relating
The
aim and purpose of most business enterprises is to obtain a price that conamount to its profit. Economic theorists describe this
as profit maximization. The profit return on each unit sold is not so important as the total return realized from all units sold. The price that yields
the largest profit at a certain volume is the price to be charged to a
tributes the largest
consumer.
$300,000 for
all
ranges of output.
The most
$14 per unit with a contribution margin of $560,000 and with a net
after deducting fixed costs.
come of $260,000
Selling
is
in-
METHODS
PROFIT PERFORMANCE, TRANSFER PRICING, PRICING
CH. 27
891
maximization
Profit
is
all
previous presuppositions.
Percentage Markup
on Cost
_
~
Sales
Volume
Sales
Capital
^
T^talArii^^iarC^s
= 80%
x20%
^
$ 5,000,000
Total Annual
Costs
$5,000,000
j^ QQQ
on Cost
(80%
(^ ^
Markup ^
Percentage
$20,000,000
_
"
Volume
Employed
Total Annual
Costs
$5,000,000)
$4,000,000*
$9,000,000
in the
amount of
Total Costs
+ (%
Sales
Price
=
1
_ (%
NAA
above method
direct effect
on
itself,
that a change in selling price, by
the latter
the investment in inventory since
would have no
is
is
stated at cost.
much
simpler
- form.
8"ReturnonCapkal Employed
No. 35,
p. 44.
Assume
as a
Guide
that a single-product
to Managerial Decisions,"
company
NAA
total
Research Report
892
PART
VII
Total Costs
+ {%
Desired Return
Sales
Price
$210,000
^
+(20^ X
Volume
$200,000)
in
50,000 units
Units
$250,000
50,000 units
$250,000
210,000
$5)
Net Income
$200,000 capital employed
$5
==
$ 40,000
$ 40,000
207^
formula
are,
illustrations
increase,
prices,
more cash
reverse effect.
employed, standard
re-
and
which product
is
the following
Items of Cost
Direct materials
Direct labor
Product
$3
4
2
1_
Selling price
$9
JO
Gross
profit
Product
$6
Factory overhead
Total manufacturing costs
$9
_10
S
CH. 27
The
cost
breakdown
Factory overhead
893
is,
likewise,
it
and
difficulties
this
The
fixed
ter
customers, territories,
etc.
its
The
latter
product
The
differential cost
of an order
is
duce the additional units, plus additional fixed costs (if any) at the new
production level. If the cost of the additional units is accepted as a basis
for pricing them, any price over and above total differential cost would be
acceptable. This procedure
is,
units.
To base
all
selling prices
shift to
related factors.
mitted to
on
sales
of
and a reasonable
If cost estimates
are prepared on the basis of the standard costs for materials, labor, and
and
be aided considerably.
detail.
As a
894
set
Any
by the estimate.
PART
VII
should come to light for quick action through the accounting information
system.
The use of standard costs for pricing purposes divides itself into two
broad categories: (1) the use of standard costs for setting catalog prices
and (2) the use of standard costs for bid prices on individual orders.
The National Association of Accountants in one of its bulletins stated
that "companies can be divided into four groups with respect to the type
of cost figures which they supply to pricing executives. These groups are
composed
1.
of:
2.
Companies
3.
4.
Companies which adjust their standard costs to reflect actual costs which are
anticipated during the period for which the prices are to be in eff"ect."9
Where standard
on
However, while some materials parts or
labor operations might be identical with those used for another product,
ponents in order to
set
a profitable price.
2.
3.
14,
XXX, No.
its
fixed
pp. 165-166.
NAA
CH. 27
4.
and
6.
895
Profit consisting of
a.
b.
two
and other
office
personnel
parts:
^o
Manufacturing cost:
Materials:
Invoice cost
Freight
$1,000
10
60
$1,070
Producing:
Direct labor
Overhead
variable
fixed
730
500
1,100
2,330
$3,447
47
$200
Materials
& shipping
Packing
Direct labor
50
Overhead
40
Selling cost
290
233
523
500
93
Development cost
General administrative cost at
4%
of producing cost
Total cost
$4,563
Profit:
Interest
on invested capital
Invested capital
5% for normal annual interest
16,200 normal hours = $.19 per hr.
Interest on 852 hours for the job
5% provision for stockholders' risk
$61,156
3,058
$
62
162
1
324
$4,887
Date
Estimated
By
$4,887
5,500
Established ceiling
None
Competitive price
Quoted
By
Date
5,500
Ji
lOA. E. Grover,
11, p. 486.
No.
"Problems Involved
in Pricing
Postwar Products,"
NAA
Bulletin, Vol.
XXVII,
896
The
inclusion of interest
PART
VII
($3,058
16,200 hours).
is
$4,887)
is
is
authorities
looked upon as
It is difficult
and acceptable.
Many
to state
always desirable
this
is
ruled out.
If
in the
price
illustration the
and $887 below the price estimated to cover all costs and minimum
With the aid of the estimating cost sheet, possible concessions can
profit.
be determined
"(1)
interest
on invested
may
capital
(2)
The $162
(3)
(4)
The S233
(5)
may
be eliminated.
be eliminated.
cost
may be
job
conceded.
may
may
be eliminated.
be taken out.
These concessions
selling price.
11/6/V/., p.
491.
If the
total $887, or
company
is
CH. 27
897
DISCUSSION QUESTIONS
confusing, for it has been
of financial measureused indiscriminately to describe two different types
ment. Discuss.
What items are generally included in the term "capital employed" ?
I
'
2.
How
3.
is
the return
'
(NAA
adapted)
when setting
two major objectives that management may have in mind
employed.
capital
divisional
on
return
the
measuring
up a system for
accountants have argued that
6 In measuring the return on capital, some
assets without any deducgross
capital employed should be measured by
State
'
off^er
An
7
'
sideration.
Name some
8.
Name and
9.
intracompany transfer
Explain the dual transfer pricing approach in
pricing.
10
II
What methods
and
12.
13.
14
is
truly an art."
the computation
are available that might assist and perniit
cost-accounting-wise?
price
sales
of
a
determination
company
in
be designed primarily
one another, the transfer pricing system should
autonomy of
of managerial performance.
(c)
return on capital
With other variables remaining constant, the rate of
will increase with a decrease in
company
merchandising
a
of
employed
(1) sales; (2)
ment
in inventory.
(AICPA
adapted)
898
PART
VII
EXERCISES
1.
Return on Capital Employed. During the past year the Lorraine Waterworks
a net income after taxes of $40,000. Net sales were $200,000, and
Company had
total capital
Required: (1)
(2)
(3)
2.
On December
rate.
31, 19
a company's balance
sheet showed:
Assets
Cash
Accounts receivable
Liabilities
Accounts payable
Long-term loan
Inventory
Plant and machinery
$100,000
125,000
175,000
550,000
Total assets
$950,000
Total
.,
$ 70,000
280,000
500,000
100,000
Capital stock
Retained earnings
down
and Capital
liabilities
the
same
and
set
capital.
of machines.
$950,000
break-
Product
$10.00
4.00
2.00
$7.00
$16.00
$19.00
Selling price
$20.00
$24.00
Gross profit
Marketing and administrative expenses
4.00
.00
$ 5.00
1 .00
Net income
$ 3.00
$ 4.00
Materials
Labor
(2 hrs. for
Factory overhead
Total
8 .00
4.00
Estimated sales
Product
Product
Required:
The
15,000 units
20,000 units
B
rate of return
on
Return on Capital Employed; Minimum Price. The Aster Corporation manufactures a highly specialized alloy used in missile skins. Rising materials costs
led the company to adopt the lifo method for inventory costing. In 19A the
company produced 702,000 kilograms of alloy. New government contracts and
other new business should increase volume by about 30%. In spite of increased
costs the management felt that it could reduce the sales price from $12.30 per
kilogram in 19A to $1 1.40 in 19B and still maintain the same rate of return on
3.
capital employed.
CH. 27
Data
Sales
19A
IVo
$8,450
7,370
$8,550
^^^^
8^0
'""
UOOO
1,000
^'^JJJ
6,650
/,4UU
Accounts
receivable-.:
Inventories
Plant and other fbced assets
7,93
^^
899
'.^.r.
two
years.
(2)
The minimum
Investment
...
IdesToumein-doilars::;.....
Net income after taxes
Aftertax cash inflows
Product
Product
Product
Product
$ 500,000
2,000,000
300,000
600,000
5,000000
3,000000
45,000
60,000
175,000
200,000
60,000
75,000
200,000
1,800,000
36,000
60,000
turnover rate;
Required- (1) For all four products, the (a) capital-employed
rate.
return-on-capital-employed
(c)
and
(b) percentage of profit to sales;
of time required for
is further interested in the length
outlay. Compute
cash
original
the
repay
to
investment
cash produced by the
products based on the data given above.
the payback period for each of the four
(2)
The management
(Based on an
article in
Management
Services)
COST AND PROFIT ANALYSIS
900
PART
VII
19
Sales
$1,200,000
Factory overhead:
Fixed
Variable
$200,000
300,000
$100,000
150,000
250,000
Gross
750,000
profit
$150,000
50,000
Net income
450,000
200,000
$
250,000
Additional data:
100,000
$600,000
500,000
200,000
200,000
50%
tion facilities.
Division Transfer Pricing. The Wallach Iron Mill produces high-grade pig
iron in its single blast furnace in Bedford, Pennsylvania.
Coal from nearby
mines is converted into coke in company-owned ovens and 80% of the coke
produced is used in the blast furnace. The management of the mill is experimenting with divisional profit reporting and control and has established the
blast furnace as well as the coke producing activity as profit centers. Coke used
by the blast furnace is charged to that profit center at $6 a ton which approximates the current market price less costs of marketing (including substantial
freight costs). The remaining 20% of the coke produced at a normal annual
volume output of 80,000 tons is sold to other mills in the area at $7.50 a ton.
Cost of coal and other variable costs of coke production amount to $4.50 a
ton. Fixed costs of the coke division amount to $40,000 a year.
The blast furnace manager has found a reliable, independent coke producer
who has offered to sell him coke at a fixed delivered price of $5 a ton on a longterm contract. The manager of Wallach Iron Mill's coke division claims it cannot match that price and maintain profitable operations.
6.
S5.60
1.50
.40
902
PART
VII
agreed to allow the firm the full bid price for direct materials, direct labor, and
variable overhead on the four capsule components already completed and
delivered. These costs were to be adjusted to reflect the company's learning
curve for labor time by allowing 1 25% of the bid hours in determining the direct
labor and the factory overhead, variable and fixed. The fixed overhead rate was
to be increased to $3.50 an hour to compensate for idle plant capacity resulting
from the termination. In addition, the customary margin percentage based on
total bid price was to be allowed plus a $10,000 penalty.
Required: The amount the Comp-Bell
renegotiation settlement.
Company
PROBLEMS
Rate of Return on Capital Employed Using Various Proposals.
Safe-for-Kids Toy Company manufactures two specialty children's toys marthe following
keted under the trade names of Springy and Leapy. During 19
costs, revenues, and capital employed by the company in the production of
these two items were:
27-1. Profit and
Leapy
Springy
Sales price per unit
Sales in units
.50
280,000
unit
.20
.50
.15
.05
100,000
30,000
10%
of sales
.95
150,000
$
.30
.75
.20
.10
30,000
15,000
20%
$148,000
of sales
$91,500
capital
Required: (1) The net income before taxes and the return on capital em-
in total for 19
capital
employed for
CH. 27
903
Employed. The
Measuring Operating Performance via Return on Capital
manufacturmg
is composed of three autonomous
Corporation
Tramber
T
types of heavy
different
three
manufacture
plants
three
The
plants X Y and Z.
made by mdependent
machinery Operating decisions are decentralized and are
staff is in
managers who report to a central executive staff. The executive
27-2
plant
(19B) performance of the three plants.
the process of evaluating the past year's
showed an upward trend, so the presisales
Y's
19A,
of
months
During the last
Now the president
in Plant Y.
dent invested additional capital during 19A
off and if addipaid
has
Y
Plant
in
investment
increased
the
wants to know if
Z which has had the least amount of
tional investments should be made in Plant
three plants during 19A and 19B was:
sales. The capital employed in the
Plant
19B
X
Y
$35,119
78,125
9,361
I9A
$23,421
20,115
5,742
the following
At the executive committee meeting the controller presents
relation of the three plants to
the
show
which
statements
income
comparative
each other and to the base year:
904
PART
VII
Neal Corporation
Statement of Working Capital Deficit
December 31, 19A
Current
$198,625
liabilities
Cash
Accounts
5,973
70,952
90,200
$
receivable, net
Inventory
Working
167,125
$ 31,500
capital deficit
Neal Corporation
Income Statement
31,
19A
$751,150
451,000
Gross profit
Marketing and general expenses, including $22,980 depreciation
$300, 1 50
149,920
$1 50,230
Net income
$75,115
75,115
Additional data:
Assets other than current assets consist of land, building, and equipment
with a book value of $350,000 on December 31, 19 A.
The return-on-capitai-employed
income
ratio after
tax.
assets after
Within
income
this relevant
Fixed
Costs
Total
Variable Costs
per Unit
$4 90
range of
taxes):
$125,750
1.10
$125,750
$6.00
The income tax rate is expected to be 50%. Past experience indicates that
current assets vary in direct proportion to sales. Management feels that in 19B
the market will support a sales price of $8.40 at a sales volume of 100,000 units.
(AICPA
adapted)
CH. 27
905
Cash
15%
$7,500,000.
this
Sales
Present
Proposed
100%
150%
$10,000
Factory overhead
Fixed
Variable
$2,000
4,000
$2,500
5,750
$6,000
$8,250
$1,500
500
Total
$15,000
$2,000
...
750
Total cost
Net income
Required {Ignore income taxes): (1) The new unit selling price for the
proposed new production level if the:
(a) Original earnings ratio on total capital employed should be retained.
(Compute the answer to 1/lOOth of 1%.)
(b) Desired ratio for the return on capital employed is 17%. (Use the long
form of the formula on page 891.)
(2) Two new income statements for the 150% output based on (a) the answer
to (1) (a) above and (b) the answer to (1) (b) above.
(3) The following ratios for both income statements: (a) percentage of
profit to sales; (b) capital-employed turnover rate; and (c) return on capital
employed.
A. R. Oma, Inc. manufactures men's cologne. The
manufacturing process is basically a series of mixing operations with the addiThe finished product is
tion of certain aromatic and coloring ingredients.
packaged in a company-produced glass bottle and is packed in cases containing
27-5. Transfer Pricing.
six bottles.
906
PART
VII
A. R. Oma feels that the sale of its product is heavily influenced by the appearance of the bottle and has therefore devoted considerable managerial eff'ort
to the production process.
This has resulted in the development of certain
unique bottle production processes in which management takes considerable
pride.
The two areas (i.e., cologne production and bottle manufacture) have
evolved over the years in an almost independent manner; in fact, a rivalry has
developed between management personnel as to "which division is the most
important" to the company. This attitude is probably intensified because the
bottle manufacturing plant was purchased intact ten years ago, and no real
interchange of management personnel or ideas (except at the top corporate
level) has taken place.
Since the acquisition, all bottle production has been used by the cologne
manufacturing plant. Each area is considered a separate profit center and
evaluated as such. As the new corporate controller, you are responsible for the
definition of a proper transfer price to use in crediting the bottle production
profit center and in debiting the cologne profit center.
At your request, the Bottle Division general manager asks other bottle
manufacturers to quote a price for the three possible levels demanded by the
Cologne Division. These competitive prices are:
Sales Volume
(In Equivalent
Total
Sales
Sales
Price
Cases)*
Revenue
Per Case
2,000,000
4,000,000
6,000,000
$ 4,000,000
$2.00
7,000,000
10,000,000
1.75
1.67
*An
it
can produce
Sales Volume
(In Equivalent
Total
Cost
Cases)
Cost
Per Case
2,000,000
4,000,000
6,000,000
$3,200,000
5,200,000
7,200,000
$1.60
1.30
1.20
Total
Cost
Cases)
Cost
Per Case
2,000,000
4,000,000
6,000,000
$16,400,000
32,400,000
48,400,000
$8.20
8.10
8.07
CH. 27
Sales Volume
Total
Sales
Sales
Price
Revenue
Per Case
$25,000,000
45,600,000
63,900,000
$12.50
{In Equivalent
Cases)
2,000,000
4,000,000
6,000,000
907
11.40
10.65
Required: (1) The profit for (a) the Bottle Division, (b) the Cologne Diviand (c) the company. A. R. Oma, Inc. has used market-based transfer
prices in the past. Use current market prices and costs, and assume a volume
of 6,000,000 cases.
sion,
(2)
An
(c)
is the most
Cologne Division, and
volume for
the company.
profitable
(3) Assuming that A. R. Oma, Inc. uses the profit-center concept for divisional operation, (a) define a profit center, (b) discuss the conditions that
should exist for the establishment of a profit center, and (c) indicate whether
the two divisions should be organized as profit centers.
(NAA
adapted)
$22.50
5.00
14.00
8.00
$49.50
Total
Gunnco
uses return-on-investment
is
and dollar
profits in
measuring division
if
(NAA
adapted)
CH. 27
909
Required: (1)
schedule of the expected differential profit for each of the
seUing prices proposed for the new product. Include the expected sales levels
in units (weighted according to the sales manager's estimated probabilities),
the expected total monetary sales, the expected variable costs, and the expected
differential profit.
(2) The company's (a) current rate of return on investment in the Home
Appliances Division and (b) the anticipated rates of return under the alternative suggestions made by (7) Green and (2) Gold.
(3) The net present value of the investment opportunities of financing
Black, White, and Gray. Determine if the discounted cash flows expected from
(a) Black, (b) White, and (c) Gray would be more or less than the amounts of
Benjamin Industries' investment in loans to each of the three dealers.
(AICPA
adapted)
Direct materials
Direct labor
$ 5,000
Overhead
8,000
2,000
20%
$15,000
3,000
Plus
$18,000
Selling price
The overhead figure was determined by estimating total overhead costs for
the year and allocating them at 25% of direct labor.
If a customer rejects the price and business is slack, Ed Berg, Sr. is often
willing to reduce the markup to as little as
over estimated costs. Thus,
average markup for the year is estimated at 15%.
Ed Berg, Jr. has just completed a pricing course and believes the company
could use some of the modern techniques he has learned. The course emphasized
the contribution margin approach to pricing, and Ed Berg, Jr. feels such an
approach would be helpful in determining the selling prices of their custom-made
pleasure boats.
Total overhead (including marketing and administrative expenses for the
year) has been estimated at $150,000, of which $90,000 is fixed and the remainder is variable in direct proportion to direct labor.
5%
The
pitfalls, if
(NAA
adapted)
CHAPTER 28
LINEAR PROGRAMMING
FOR PLANNING
Increasingly,
as they seek to
heart
personnel,
materials,
facilities,
and
time.
management because
made of available
it
resources.
It is
a valuable aid
in decision
making.
910
CH. 28
911
capacity to standard and deluxe models and (2) the number of units of
each model in order to maximize the total contribution margin.
solve this linear programming problem, the symbol X is assigned to
number of standard models and Y to the number of deluxe models.
The contribution margin from making X standard models and Y deluxe
models then is 3X + 4Y dollars. The contribution margin per unit is the
To
the
The
on machine capacity
restrictions
number of
units.
manner
To
is
2X
written:
5Y ^
120
expressed
4X
information
2Y ^80
Standard model
Deluxe model
In
summary,
the relevant
Grinding
Polishing
Contribution
Time
Time
Margin
4 hours
2 hours
80 hours
$3
2 hours
hours
120 hours
5
Plant capacity
Two
is
Grinding.
A vailahle
Polishing.
120
80
Hours Required
Per Model
Standard
Deluxe
Maximum
Number of Models
Standard
120
60
Deluxe
120
^4 = 20
24
The lowest number in each of the two columns at the extreme right
measures the impact of the hours limitations. At best, the company can
produce 20 standard models with a contribution margin of $60 (20 X $3)
or 24 deluxe models at a contribution margin of $96 (24
a better solution ?
$4).
Is there
912
To determine production
+ $4Y when
PART
VII
levels in
margin of $3X
2X
4X
+ 5Y
+ 2Y
^120
^ 80
is
technique
70 i
20-1
Polishing Constraint, 4X + 2Y
-^^^M^
(^""O.
80 Hours
Grinding Constraint, 2X + 5Y
<
120 Hours
X (STANDARD MODELS)
The
when they
are sketched
graph
When X =
Y ^
When Y =
X ^
X ^
on the
::
CH. 28
AND
DECISION MAKING
913
solutions, is bounded
solution space, representing the area of feasible
graph. Any combination of
the corner points a, b, c, and d on the
The
by
falls
is
a feasible
(CM): $3X
$4Y.
computed
computed
in the
as follows
2X
4X
To
+
+
5Y =
2Y =
Y, multiply the
120
80
equation by two and subtract
first
4X
lOY =
-4X - 2Y = -
b
c
at
8Y =
160
Y =
20
2X
Trying values
240
80
=
2X =
X =
5(20)
120
20
10
+
4 (10) +
2 (10)
5 (20)
2 (20)
=
=
914
PART
VII
method'^
is
which many
derived.
working tools from which the simplex method was developed, requiring
mathematical formulation in describing the problem.
Contribution Margin Maximization.
earlier in
this
standard
and deluxe
which
require
different
operating times
Standard model
Deluxe model
The
two models
is
first
With
in the
form of inequalities.
Initial Steps.
1.
2X
4X
in
this
2.
Y must
of constraint equations,
5Y ^
2Y ^
is:
120
80
0;
Y^
0) for
problem.
The
CM
3.
set
+
+
inequalities used
iThis presentation is adapted from G. M. F. di Roccaferrera, Introduction to Linear Programming Processes (Cincinnati: South-Western Publishing Company, 1967).
CH. 28
AND
DECISION MAKING
915
2X+
4X +
and the
objective equation
Maximize:
in
5Y
2Y
+
+
Si
S2
=
=
120
4Y
80
becomes
CM
= 3X
OSi
+ OS2
fictitious
products Si and
S2 are zero.
4.
At
first
matrix, or
916
The
PART
VII
column receives different entries at each iteration, representing the contribution margin per unit of the variables in the solution.
The variable column receives different notations at each iteration, by
objective
replacement.
no production
For
is
In the
first
total
matrix, a
marked
in the variable
in the objective
column. As the
itera-
The
equations in the
first
of the constraint
it
tion mix.
carries values
computed by
Multiply the values of the quantity column and those columns to the right
of the quantity column by the corresponding value, by rows, of the
objective column.
2.
3.
Add
Subtract the values in the objective row from the results in Step 2.
For this operation, the objective row is assumed to have a zero value in
the quantity column. The contribution margin entered in the cell lying
in the quantity column and in the index row is zero, a condition valid
only for the first tableau where a situation of no production is considered.
In the subsequent matrices, it will be a positive value, denoting the total
contribution margin represented by the particular matrix.
Index row
CH. 28
917
simplex method.
positive ratio
computed
Step
2.
in
918
5.
PART
VII
Compute the amounts in all other rows. In this problem new values
must be determined for the S2 row only, by the following procedure:
(OldSnRow
Y
(the
Column
(when n = 2)
80
New Y Row
Key)
(Second Tableau)
\
\
I
Values of
Sn Row
(when n = 2)
= New
CH. 28
variables, appearing in
the
same meaning
919
as 0.4
model
model
indicates the
amount
(above)
1
is
computed by
these steps
and
2.
4.
which
the column from the second tableau
in the index row
value
absolute
highest
the
with
is
is
0.4, 3.2,
and -1.4.
determined
which is
replaced by
Select the key row, S^, the row to be
for the
-y- 0.4 = 60
row:
24
for
as follows: from the second tableau,
ratio and comes
positive
smaller
the
-is
=
10
Since
10.
3.2
2 row: 32
X.
from the S2 row, S2 should be replaced by
located in the crossing
value
the
Select the key number, 3.2, which is
(second) tableau.
preceding
the
of
row
of the key column and the key
cell
Compute
3.2
0.3125
920
5.
Old
Compute
Y Row
(Second Tableau)
24
the
amounts
Old
Minus
Y Row
(the
Key)
Column
New X Row
(Third Tableau)
PART
VII
Y row are:
Values
of
New
YRow
CH. 28
921
three constraints
1.
2.
No more
than 12 gallons of
stated as:
At
3.
XS
least 10 gallons
summary form,
12 gallons
10 gallons
follows:
the problem can be written as
c = 8X +
Minimize:
Subject to:
15Y
X + Y = 40 gallons
X S 12 gallons
Y 6 10 gallons
X is cheaper, as mtrch of it as
then Y should be used to obtatn
should be used, i.e., 12 gallons;
Thus Y should be 40 - 12 - 28^
total quantity of 40 gallons.
The optimum
possible
can be used.
YS
In
solution
is
obvious. Since
the desired
mgred.ents each
especially if there are many
In inore realistic problems,
procedur
stmple
not be so obvious.
havTng constraints' a solution may
the
complex
matter how
generate an optimal solution no
is
needed to
probler^
The
steps
toward a solution
in the cost
min.m.zatton problem
maxtmtzatton case
in the contribution margin
a e similar to those taken
at the first and
arrtve
in order to
where slack variables were introduced
a zero contribution mar^^tv
feasible solution which gave
the slack
illustration, in addition to
In the minimization problem
vanabe^s
variable known as an amfiaal
variables a different type of
de.
computattona
as
only
value
n'duced. Artificial variables are of
treated.
be
to
of restrictions or constraints
vices- thev allow two types
type. Artificial variables
greater-than-or-equal-to
Te equalUy ype and the
when equality or greater-than-orare
are
eaual-to types of constraints
^ ,v
three
problem with two mgredients and
Thlrefore, in this minimization
variable
artificial
an
A., is introduced as
conltrJnts, a third ingredient.
which leads to the new equality:
in the first constraint,
X+Y+
Ai = 40
gallons
expensive item;
be thought of as a very
This new ingredient. A., must
gallons cost $39,960. This
gallon, making the 40
for example, $999 per
922
high cost
wise;
it
is
Such an answer
is
PART
VII
undesirable cost-
optimum
solution.
variable, Si,
is
form an equation: X + Si = 12 gallons. Si represents the difference between 12 gallons of X and the actual number of gallons of X in
added
to
to
if Y should be 18
8 = 10 gallons). However, if Y
S2 = 10 or S2 = 10. This is
would be
gallons, then S2
appears in the
first
8 gallons (18
solution as 0, then
10
gallons of an ingredient
is
not pos-
to
it,
such as
2,
is
Thus,
S2
A2 = 10
is
assigned
gallons.
introduction of the
slack
and two
The new
artificial variable,
artificial,
would be
cost equation
C= 8X+
For minimizing
15Y
The
resulting expression
first
must be multiplied by
is
C = - 8X - 15Y +
OS2
- MAi -
OSi
- MA2
X + Y + Ai =
X + Si=
Y-
S2+ A2=
40
12
10
CH. 28
^^^
923
924
PART
VII
CH. 28
Index row
Steps 1 and 2
925
926
PART
VII
CH. 28
The row
A
X
to be replaced
row 18/1 =
18
is
replaced
row
927
928
PART
VII
Step 3
-516-0
_
-
15
15
= -516
(-8) =
- (-15) =
=
- (-M) = M-15
=
7
_(_M)=
No
except the
minimum
The optimum
cost figure
which
is
+ 28
gals,
A@
of B @
40
gals,
of mixture
12 gals, of
$ 8 per gal.
$15 per
gal.
=
=
=
$ 96
420
$516 (the lowest cost combination)
X + Y = 40
X ^ 12
Y ^ 10
The
by the
gallons
gallons
gallons
line ab.
Any combination
is
a feasible
of Ingredients
is
= (X =
= (X =
0,
A and
28 gallons of Ingredient
CH. 28
929
12
20
30
40
(GALLONS OF INGREDIENT A)
Graph Depicting Feasible Solutions
SHADOW
PRICES
The determination of
the
optimum mix
This effect
is
to
set
of the solution
if
of constraints.
a constraint
It is
is
use-
relaxed.
(if
minimization problem)
re-
maximum
sulting
on the
acquire one
To
more
sets a
shadow
Programming Shadow
930
PART
VII
If the
The index row of the third (optimal solution) simplex tableau shows
shadow prices. The coefficients under the Sj (grinding) and S2 (polishing) slack variable columns give the trade-off in terms of product mix
as the constraints are increased and decreased. Thus, one more hour of
grinding time will increase the contribution margin by $.625, computed
as follows: as one more grinding hour is made available, .25 units of Y
the
margin (.125
If additional
$3
of
X (standard
$4
$1)
$.375
$.625).
would
result;
and
as
much
as $.625
more than
which
would occur. Thus, overtime hours
might be considered. These observations assume that the selling price
per unit remains unchanged. The $.4375 has the same meaning for each
hour of polishing time.
The range of hours over which the shadow prices of $.625 and $.4375
for grinding and pohshing hours are valid can be found as follows
cost of grinding time could be incurred before reaching a point at
Step
1.
For the lower limit of the range, divide each unit in the solution mix
by the coefficients under the slack variable columns; i.e., the Si and S2
columns. The smallest positive number that results in a column is the
Product
-Si
5*2
Units
Grinding
Polishing
(1)
(2)
(3)
Si
Grinding
(1)^(2)
S2
Polishing
(1)^(3)
CH. 28
maximum
increase
80;
is
931
and smce
is
160;
is
200
pohshmg
240 hours (160, plus the original constraint of 80
is
hours).
or decreases
limits occur for a constraint because increases
The
In
summary,
_,.
the lower
shadow price.
and upper constraint limits
beyond
Lower
Upper
Limit
Limit
40
^o
^^
200
Grinding hours
Polishing hours
im
cedure
is
the same.
When there
there
is
is
a zero
shadow
no defined upper
cause there
There
is
is
already
above example),
more
no defined lower
limit
cause there
constraint
is
is
already
more of
this constraint
to
linear
problems.
3See Harvey
M. Wagner,
(Englewood
Cliffs,
NJ: Prentice-
932
PART
VII
GENERAL OBSERVATIONS
The maximization and minimization studies, together with the exercises and problems presented in this chapter, are reaUstic examples of the
types of problems management faces. By maximizing certain managerial
objectives such as contribution margin and utilization of available labor
hours or factory capacities or by minimizing functions such as costs,
weight, materials mix, or time, management's goal can be determined
quantitatively,
and hopefully,
satisfied.
To
it
is
Restrictions
appear
in the
variables.
techniques.
DISCUSSION QUESTIONS
1
2.
scientific
method of solving
CH. 28
3.
this
AND
DECISION MAKING
933
questions
(a)
(b)
The
triangles
formed by
(d)
c,
and d
is
called the
Why?
b, c,
c, d,
Why?
line c-10
linec-20?
4.
5.
Examine
the
first
of a tableau.
6.
What
is
7.
What
is
8.
9.
in
which a
20 pounds of
and
for Products
934
14,000; and Painting, 10,000.
the three products:
Product
Beko
Seko
Weko
Selling
Variable
Price
per Unit
Cost
per Unit
$5.25
5.00
4.50
$4.45
is
PART
VII
available
on
CH. 28
935
assumes
Product Mix Contribution Margin. The illustration on page 912
the
that
and
$3 and
stable
was
models
deluxe
and
standard
that the market for
Increased demand for
$4 per unit was maintainable for at least the near future.
the price well above the
the deluxe model suggests the desirability of raising
margin.
level that produced the original $4 contribution
2.
to
but maintain
maximum
profits.
Gamma
D and
ingredients in
is 16 000 gallons of
D
6,000 gallons of K. The only company producmg
these ingredients in the
produce
nor
deliver
neither
will
and
and k is on
the gallons of Alpha and
foreseeable future. The company wishes to know
of raw materials in order
stock
present
its
with
produce
should
Gamma that it
strike
to
maximize
its
total profit.
(2)
of
(3)
A graph to
produce
determine the product mix that the company should
to
(AICPA
adapted)
Graphic Method.
Contribution Margin Maximization
in two departments. Fabricating
Telo,
and
Nelo
products,
two
pany produces
operated 1^0 ^^urs per week
be
can
machines
and Hnishing. The fabricating
Each unit of Nelo requires
week.
per
hours
150
machines
finishing
and the
requires three times as
but
Telo,
as
time
only one half as much fabricating
requires two hours of work in
Telo
of
unit
Each
Telo.
as
time
finishing
much
and on each
The contribution margin on each unit of Nelo is $8,
4.
each process.
unit of Telo, $6.
Neeley
Com-
(2)
- Simplex Method.
The
first
tableau of
simplex method.
Required: (1) The second tableau of the
solution has been reached.
optimum
an
whether
to
(2) An explanation as
936
PART
VII
CH. 28
937
b2 Each
each unit of Product
X2
Prices.
The
contributes $875.
entire
pressed as:
CM
Maximize:
8/IOX1+ 5/IOX2 ^
5/10X1+ 1X2
^
Xi, X2
^
Subject to:
Required: (1)
tion margin.
(2)
The
linear
= 960Xi+ 875X2
programming tableaus
1.0
.9
0.0
to
The shadow
prices
^
and upper constraint range
their lower
and
(Based on an
article in
i-
limits.
Product
Material
Product
Product
1.5
'.'.'..'.'.'...
32
14
15
^7
Cost of
Material
Raw
$3 per ton
$4 per ton
The shadow
prices
and
their lower
limits.
The
For
For
tensile strength
2A
A sells for
4-
A+
flexibility
g ^ j-H
3B
1.5J
(2)
T^ shadow
938
PART
VII
PROBLEMS
Required: The quantity of each type belt to be produced to maximize conmethod and (b) the simplex method.
Maximizing Capacity
Simplex Method.
to
in order
28-3.
balsa each.
The labor requirements for the models are
in kit
7
6
7
5
3
Model
940
PART
VII
28-6. Product
compound,
Compound
Processing step 1
Processing step 2
Processing step 3
is
33-1 /3
$4 per barrel; of
maximum
Compound N,
total contribution
tion per
(3)
Compound N
50
66-2 /3
100
(2)
33-1 /3
compound and
The shadow
prices
and
their lower
limits.
Simplex
Costs; Admission Policies; Cost Minimization
Method. Due to the budget squeeze, Victoria University is faced with the problem of minimizing scholarship expenditures subject to these past traditions and
new agreements
28-7. Scholarship
Out of
tion,
a class of 1,700 freshmen, the University, for reasons of diversificaadmits no more than 800 students who are children of its alumni.
The University will admit at least 250 minority-group students. (To encourage universities to admit more minority-group students, the federal
government supports the schools with $800 in aid for each minority-group
student admitted.
Required: The students to be admitted and the total cost to Victoria Unisimplex method.
28-8. Materials
minimum
require-
ments of the two vitamins, using the graphic method and the simplex method.
(2) The shadow prices and their lower and upper constraint range limits.
INDEX
framework
trolling
for
planning and
management
con-
activities,
8;
resource, 440; labor proce408; payroll, 412; responsibility, and departmentalization, 52; responsibility, def., 299;
standard cost, def., 578, 621-623,
human
dures,
illus.,
679
Accounting
Accounting
Accounting
overhead
control totals, 76
data, 18
records, flow of factory
through, illus., 101; summary of purchase transactions of
materials, services, and equipment
wlth,/7/us., 324
Accounting system, /7/us., 73
Accounts, chart of, 62-64
Accounts payable computer file, 325
Accounts payable register, 65, 226
Accounts receivable, allocation, 877
Accrued payroll, 96, 454
Acid-test ratio, 23, 24
Acquisition costs, 326; applied, 328
221;
264,
departmental factory
overhead, ///us., 265
Actual expenses, 224, 229
Actual factory overhead, 99, 224;
charging costs to departments, 125;
comparison of budgeted factory
overhead with, 230, 231; departmentalized, 263; standard cost accounting procedures, 624; steps in
accounting for, 225
Adjusting entries, factory overhead
costs involving, 99, 100
Adjustment, for lost units, 149; for
materials purchase price variance,
direct
tion,
896
on
performance measurements,
870-883;
risk,
in
296
Actual
629
in-
874
Authority, de/., 5; delegation of, 5; establishing lines of, 43
Authority for Expenditure, 831
B
Balance sheet, 19; illus., 23
Bank, responsibility reporting, 302
Banks, budgeting and planning for,
510
Base rate (job rate), 400, 417
Basic standard (cost), 579
Behavioral variables approach, 442
"Billing" rate, 290
Bonus payments, 438
Bonus plan, 418, 419
Break-even analysis, 27, 741; alternate break-even chart, 747; and
cost-volume- profit analysis, 714-
break-even
constructing a
contribution margin
745;
743; determining break-even
point, 742; dynamic profit charting,
755; effect of changes in fixed costs
on break-even point, 750; for decision making, 751; margin of safety,
754; sources of data for, 742; unit
profit
unit
753;
cost formulas,
graph, 751
Break-even chart, 741; alternate, 747;
constructing a, 745; illus., 746; with
detailed fixed and variable costs,
749; with fixed costs superimposed
on variable costs, 747; with a reduc765;
chart,
ratio,
Break-even
calculating
changes
in
costs
556,
expenses, 561; identifies controllable costs, 289; indirect labor included in factory overhead, 483;
production,
manufacturing, 481;
318, 480; research and development, 500; sales, 477-479, 504;
standard costs as foundation for, 54
Budget allowances, 269, 557, 592
Budget building and human behavior,
516
Budget committee, 476
Budget
prerequisites of a, 476
Budget plans, fixed, 537; objectives of
budgetary control, 539
Budgetary control, 3, 539, 559
Budgeted factory overhead, 230, 231
Budgeted income statement, 664
Budgeting, advantages of, 475; expenditures and cash, 499; flexible,
559; for nonmanufacturing businesses and nonprofit organizations,
509; governmental; 510; limitations,
475; zero-base, 512
Budgets, analysis, 799, 800, 803;
and/or standards, 4; comparison of,
and standards, 577; cost analysis,
799; preparing and operating, 53;
probabilistic, 516; short-range, 474
By-product revenue, 184-186
Byproducts, and
ing, 181-198
joint
products cost-
941
INDEX
942
540
framework, 830
Capital expenditures budget, 499, 803
Capital investments, 830, 832, 833,
835
Cash, allocation of, 877; budgeting
expenditures and, 499; valuation
problems relating to, 874
Cash budget, 327, 483, 503, 504
Cash
flow,
differential aftertax,
835;
form, 840
of a service depart-
Committed
Completed
chart.
747;
weighted.
352;
629
Controllership. cluster, ///us., 10
Controlling costs, via responsibility
accounting, 43
Conventional costing. 221, 678
Conventional gross profit analysis,
659-668
Conversion cost,de/., 50
Corner points, 913
Correlation, de/., 552
Cost, behavior, 27, 543, 551, 556; concepts, 41. 42. 679, 809; cost analysis
on, 886
Cost accounting, fulfilling management's need for planning and control information, 26; reasons for, 11,
25; governmental and private organizations, 12; information system
60, 61, 68; nature of, 10; scope, 11
standard, 679; sources of data, 17
three basic phases, 89
Cost Accounting Standards Board
(CASB) regulations, 439
Cost accounts, relationship between
general accounts and, illus.. 66
Cost of accumulation procedures, job
order or process, 90, 92; process
costing. 119; job order. 92
Cost centers, 51, 248, 256, 301
Cost data, 43, 45, 64, 894
Cost department, 15. 16. 406. 412
Cost information system, 53, 65, 249
Cost minimization, 923-929
Cost of Goods Sold, closing over- or
underapplied overhead to. 233; distributing variances to, 631. 633,
634; percentage of cost elements
in, 635
Cost of goods sold statement, 234
Cost of production report, 67, 120.
126-131,
340, 341
Cost-price variance, 661, 665
of,
illus.,
illus.,
53;
441;
joint
pension, 446; planning and budgeting, 471-489; prime, 680; relevantirrelevant, 810;
semivariable, 49;
short-run vs. long-run, 44; standard,
27, 54, 578, 893; sunk, 811; to make
vs. costs to buy, 807; variable, 48,
49,680, 792; unit. 91. 128
Costing, absorption, 678; average,
151, 334; by departments, 121; byproducts, 184-188; departmentalization for product, 52, 53; direct,
678, 680-682, 685; fifo, 151, 334; job
order, 89, 92, 213; joint products,
181-198; labor, 123, 124, 397-423.
406-413, 453, 436-457; lifo, 336; inventory, 680, 681; orders by lots, 90;
other materials costing methods,
338; process, 119, 120, 214; scrap,
spoiled goods, and defective work,
345; selecting method, 150; standard, 577-601.620-638
45
Department,
coding
expenses
by,
Departmental
Departmental
Departmental
Departmental
Departmental
activities,
486
budget, 52
capacity, 542
charges, 52, 252, 254
cost of production
re-
port, 126
401
Departmental
expense
analysis
268
Departmental flexible budgets, 799
Departmental labor budget, 407
Departmental overhead, 251, 266, 296
Departmental overhead rates, 256,
257. 260, 267; predetermined, 125,
247-249: proration of expenses,
259-262
Departmentalization, concept, 248;
for product costing and responsibility accounting, 52; of administrative
expenses, 489; product analysis
INDEX
943
lection of service,
250
approach to
pricing,
893
Differential cost statement, 793, 796
Differential cost studies, 792, 802,
293
252
Direct labor hours, as base for selecting overhead rates, 214, 218
Direct materials, 47; def., 50; entries
for. 626; responsibility for. 293
Direct materials budget. 482
Discounted cash flow method. 839;
Employment practices
406
having unequal lives in evaluating capital expenditures,
845;
equipment-replacement expenditures, 832;
purchase of, 324
Estimated cost statement, 894
Estimated fixed and variable over-
Equipment,
head
(federal),
alternatives
rates, ///us.,
269
542
48;
equipment-replacement.
for. 831
indirect departmental
charges, 52; both fixed and variable
(included in overhead rates), 221;
channeling into separate accounts,
685; classified by function, 486;
classified by primary accounts. 486;
classifying as fixed or variable (to
474
Factory
Factory
Factory
Factory
264; actual
departmentalized, 263; actual, incurred, 101 adjusting entries, 99, 100; allocation,
90, 877; analysis, 100, 229; applied.
99. 228; base to be used in selecting rates, 214, 215; calculation of
departmental rates, illus., 260;
changing rates. 235; channeling
into separate accounts.
685;
illus.,
characteristics,
freight-in to, 328; comparison of actual and budgeted, 230, 231; com-
of,
235; illustration for establishing departmental rates, 257; indirect departmental charges, 254; originating documents for. 68; over- or
underapplied, 267; planned, applied, and actual with variance analysis, 211-235; predetermined rate,
see Predetermined factory overhead rate; process costing procedures for, 123; proration of service
departments', to benefiting departments, 255; rate, see Factory overhead rate; semivariable, 49, 50;
standard cost accounting procedures, 624; standard rate, 586; summary of variance analysis methods,
illus., 592; treating spoilage as, 348,
349; underapplied, 100; variances,
232, 599, 600, 629
Factory overhead analysis sheets. 100
Factory overhead applied account.
99. 229. 267
Factory overhead budget, 482-484
Factory overhead control account, 66,
227; recording expenses in, 229;
with
monthly adjusting entries,
illus.. 100
Factory overhead rate. 221, 223, 586;
departmental, 267; dual, 679; estimating activity level and expenses,
221; monthly comparison of, 295;
on the flexible budget, 556; spoilage spread via, 348; use of predetermined, 213
Factory overhead subsidiary ledger,
227, 231
Factory overhead variances, 595, 599
Fair Labor Standards Act of 1938, 436
Feasible area, on graph, 912
Federal income tax, 450
Federal Insurance Contributions Act
(FICA). 62, 96, 447
FICA
681,836
journal, 227
ledger, 69, 70, 227
departmentalization, 51
Economic order
order system, 384; def., 367; formula, 369. 371, 373; general observations, 380; graphic determination
of, 369; ///us., 369; tabulate determination of, 368
Efficiency ratio. 418
alyzing, illus., 235; factors for selecting rates. 214-224; fixed. 49.
543, 629; flow of, through accounting records, ///us., 101; mechanics
of applying, 228; overapplied and
underapplied, 100. 229; predetermined departmental rate for, 221,
Financial
Accounting
Standards
Board (FASB), 12, 198,689
Discounts, 327
Disposition, of departmental costs,
129; of over- or underapplied overhead. 232; of variances. 631
Distribution expenses, 47
Divisions, dual transfer pricing approach for, 887; multiple perfor-
mental rates, 256; establishing standard costs, 54; estimated. 98; estimated, departmental, illus., 258;
estimating, accounting for. and an-
212;
charging
count
trol
of,
Finished goods, account. 122, 344; allocation of, 877; entries for, 70, 344,
351, 626-628; inventories, 21
Finished goods ledger, 344
Finished goods ledger card, 626
Fixed assets, allocation of, 877; valuation methods favored, 875
Fixed budget, 537
Fixed costs, analyzing, 27; characteristics, 49; departmental, 291; effect of changes in, on break-even
point, 748; in manufacturing budget, 482; see also Fixed expenses
Fixed efficiency variance, 591, 626
Fixed expenses, 543; classifying, 221;
committed, 294, 544; included in
overhead rates, 221; marketing
costs as. 710; programmed, 294
Fixed factory overhead, 49. 629
Fixed-variable cost relationship to
volume.
///us.,
213
742;
departmental,
799;
monthly, illus., 587; of a service department, 560; preparing a, 556;
ysis,
INDEX
944
to,
710
payment
tax,
General
of,
accounts,
449
relationship
illus.,
be-
66
charges,
52,
work-
451;
888
Inventories, AlCPA's position on pricing, 688; distributing variances to,
634; effects of direct costing on,
685; opening work in process, 126,
151, 154; percentage of cost elements in, 635; production planning,
480; valuation problems for, 874
Inventory, costs assigned to, 91, 688;
control of obsolete and surplus,
387; cost of materials in, at end of
difference
period,
340;
(procedures), 124; general observations
for planning, 380; order point formula, 374; perpetual, 93; physical,
344
ledger account, 69
ledger control, 324
materials
program-
Gross
664
control
382;
plans, 439
Guaranteed retirement benefits, 445
H
High and low points method, 546
Historical cost allocation vs. differen-
resource accounting,
def.,
440
324
when
used, 120
Job order costing, 67. 89. 92; predetermined overhead costs, 213
Job ticket, 95, 408,410, 412
Jobs completed, 100, 101
Joint cost allocation, 195
Joint costing, 124, 196, 197
Joint costs, actual, 192; and separable costs, 182; contribution margin
and. 198; methods of allocating.
189-194; prorating. 190
Joint processing costs. 168
Joint product cost analysis, 197
Joint products, 181; and fallacy of
total cost analysis. 765; def.. 188
Journal voucher. 65
Journal voucher control system, 64
420
Income statement,
19, 20;
by product
(lifo)
method
of cost-
ing, 336
Learning curve, computations for a
typical 80 percent, illus.. 421; labor
efficiency variance and the, 585;
output and cost table for 80%, 85%,
and 90%, ///us., 422
Learning curve theory, 420
Ledgers, 75
Legal department, 17
Lifo costing, 336, 338
Linear cost and sales behavior. 746
Linear equations for differential cost
studies, 802
Linear programming, cost minimization, 920; for differential cost studies, 804; for planning and decision
making, 910-932; graphic method,
911-913; problem, 910; shadow
prices, 929; simplex method, 914general observa928; techniques
tions,
932
132
material, 346
98;
484
mathematical
principles,
Human
control,
382;
models used, 76;
two levels of, 381
rates.
Last-in first-out
methods,
Labor
ments
inspection, 255
Insurance, employees',
departments.
Inventory
expenses, 47
summary. 412;
233;
to,
631, 632
380
Four-variance method, 591, 592, 625
Freight-in, 327
Fringe costs (fringes), 400
Full costing, 221, 678
Functional activity, controlling, 711
Functional costs, selection of bases
tial
overhead
closing variances
254
FUTA
underapplied
for.
397-423; distribution
M
Maintenance, preventive, 293; repairs
and, 253
Maintenance department budget, 486
Make-or-buy decisions, differential
cost studies for, 806
Management, by exception principle,
10, 288; concept of, and function of
controller, 1-13; cost accounting
fulfilling needs of. 26; cost accounting information system and, 60, 61;
responsibility reporting, 299
Manpower performance report, 403
Manufacturing, costing by departments, 121
Manufacturing budget, 481
Manufacturing concern, flow of responsibility reporting in a,
302; organization chart for a,
illus.,
illus.,
301
25
Manufacturing departments, 16, 51
Manufacturing overhead, 50
Manufacturing requirements, 366
Margin of safety ratio (M/S), 754
Marginal cost, ^792
Marginal income ratio, 743
Market, inventory value at, 340. 341;
lower of cost or, limited by concepts. 343
945
INDEX
activity,
544
turing and, 706; functional classifications, 708; scope, 705; see also
Marketing expenses
Marketing department, 17
Marketing expenses, 47; analysis by
Performance
383
Mix and yield variances, 593, 595,
626-628
Month-end average cost, 339
Multiple performance measurements,
882
as variable costs,
27; budget for, 488; bonus payments as, 438; budgeting, 486;
charging of, on basis of a costing
rate, 709; coding of, 709; on income
statement, 20, 22
territories,
713;
forecasting
usage,
chase
317;
tities,
dures,
123;
procurement
profit
performance, 870-883
PERT (Program
16, 405,
484
Evaluation and
Re-
PERT/Cost system,
for
planning and
of
materials
for
plan-
ning, 512
Physical
control
sales,
quantity
table
367,
368;
order quantity vs.,
calculations,
showing
372
Organization chart, 43, 476; based on
functional-teamwork concept, illus.,
based on line-staff concept,
8;
illus., 7; del., 6; for labor cost control, ///us.,
413
Organizing, de/., 6
Other income, by-product revenue as,
185; cash discounts and, 327; income from sale of scrap shows as,
346
Out-of-pocket costs, 810
Output, 72
Output system (a printer), 73
overhead
Overall
(or
net) factory
variance, 588, 589, 591, 592
Overhead, see Factory overhead and
factory
overhead
Predetermined
programming,
budgeting
system
475,
profit, 43,
881;
681,
responsibilities
of
in
storeroom, 386
446
Present value method, 442, 836, 843
Present value payback, 839
Present value tables, 837, 868, 869
Preventive maintenance, 293
Price, best or optimum, 682; summary
of changes of profit, 759; volume
889-896;
product,
683; standard costs
Prime costs,
47, 50,
multiproduct,
for,
893
680
illustrated,
806
rate
procedures,
department, 406,411,413
Payroll
Payroll journal, 227,411
Payroll report, 411
Pension costs, 252, 400, 446
Pension plan, 96, 443, 444-446
580
Process costing, 67, 119; characteristics and procedures, 120, 121, 123,
125; costing by departments, 121;
cost of production report, 126; difficulties encountered, 167; factory
overhead costs, 125; labor and materials costs, 124; overhead, 214;
product flow, 122
Producing departments, 51, 249, 251,
297, 413; overhead rates, 251, 257
Product, analysis, 667, 761, 717; costs
in relation to, 50; idle facilities part
of cost,
INDEX
946
215
Production budget, 318, 480
Production costs, 46, 438
Production planning department, 406,
413
Productivity, de/., 398
Productivity-efficiency ratio, 399
Profit, cost data used to measure, 45;
effect of price changes on, 759;
erosion of, 11; measuring annual or
periodic, 44; planning, 43, 471; realizing a, 3; revenue from sales of byproducts, 184, 185
Profit-analysis (P/V) graph, 757; illus..
758
performance
870-883
Profit
measurements,
Program
Programmed
Reviews
Programming,
linear,
910-932
penses
joint
costs,
190;
of
ex-
departmentalization of
overhead, 259-262; of service departments' overhead to materials
handling and
utilities,
of
255;
variances, 635
Public relations department, 17
Purchase discount, 327
in
joint costs,
performance,
403, 404;
payroll,
411;
receiving,
322;
variance analysis, 632; see also Reports
Reporting, and controlling costs, 44;
external financial, 680; financial,
680, 681; function, 18; individual
586
Rate (wage or cost) standard and
variance, 583
Ratio, contribution margin (C/M), 743;
efficiency, 418; of gross profit to
sales, 23, 24; labor efficiency, 399;
income as
measure,
474;
profit
performance
illus.,
performance,
43;
responsibility,
responsibility and, 5; re-
of,
302
ning),
Sales,
473
192
of net
329, 386
def., 299;
maximization, 3, 890
Profit path, product, on a P/V analysis
graph, 763
Profit
for,
874
873; relationship of factors influencing rate of, illus., 872; tool for
planning and decision making, 880
Return-on-capital employed concept,
870. 871,882
Revenue expenditure, 48
Risk analysis, 848
Robinson-Patman Act, 17, 720, 889
512
Scrap and waste, 345, 346
Seasonal variations, in sales forecasting, 478
SEC, position on direct costing, 690
Selective control
the ABC plan, 384
Selling expenses, 718
Selling price, adjustments of contemplated, 896; based on differential
cost, 893; based on return on capital
employed, 891; determining,
890; establishing, 45; product pricing methods, 889-896; profit maximization to determine, 890
Sell or process further, 799
Semivariable expense, 49, 50, 222,
544; cost-line of a, 545; determining
fixed and variable elements, 545,
546
Sensitivity analysis, 846, 847
Sequential product flow, 122
Service department, 51, 249, 250, 255,
260, 262, 266, 290, 298, 559, 560
Shadow prices, 929
Shortage of materials, 483
Simplex method
a
linear
programming technique, 914-928
Simplex tableau, de/^., 915
Slack paths, in a PERT network, 514
"Sold-hour rate, 290
Source documents, 65, 75, 225
Spending and idle capacity variance
analysis, 268, 269
"
Spending variance,
229,
230,
296,
589-592, 629
Spoilage reports, 349
Spoiled goods, 129, 133, 333, 348350, 582; lost units, 129, 132, 156
Standard, 578; expected actual, 579;
labor
efficiency,
584;
materials
price, 581; materials quantity, 582;
normal, 579; rate (wage or cost),
583; theoretical, 579
Standard cost, def ., 578
947
INDEX
cost, 583; materials cost, 581; measuring performance, 882; setting,
577-601
Startup costs, capitalizing, 442
State income tax, 96, 450
State unemployment insurance, 439
State unemployment tax, 252, 449
Statistical correlation analysis,
552
380
method, 548,
549
Step chart, 559, 560
Stock cards, 329
Stock ledger sheets, 332
Stockholders' equity, 23
Stockout, 373, 374, 383
Stockroom, 628
Stocks, minimum and
maximum
termining type
of, 67;
U
Underapplied factory overhead, 229
Unemployment compensation insurance, 448
Unemployment pay, entry for, 440
Unemployment taxes, 448, 449
Union contracts, 423
Union dues, 452
Unit cost, of additional units, 793; difof
determination
796;
ferential,
functional, 711; factory overhead
and, 212; increase in, due to addition of materials, 147; inventory valuation, 342, 343; on materials ledger card, 332
Unit cost formulas, 753
Unit costs, determination of, 91; dif-
transfer-
EOQ
for-
370; increase
in,
materials, 148;
129, 130, 132,
lead time, 379;
133; physical flow of, 334; spoiled,
345, 348
Units in process, 127, 147
Units of production, 214, 215
Usage, rate of, 375, 377
lost,
costs, 811
Supervision, 251
Supplies, indirect materials and factory, 252; issuance of, 94; methods
for accounting cost of, 252; physical control of, 386; purchase of,
Sunk
Utilities,
255
320, 324
625
Time, idle, 403; keeping labor, 454;
normal, 399; employees', 408; standard, 399; value of money, 836
Time
Time
studies, 580
ticket, 95. 124,
Tolerance
630
limits
226,410
(variance
control),
162
887
Transfer rate (service department),
291
Transportation charges, 325-327
Treasurer's budget, 505
Treasury department, 17
874
variable
efficiency
(four-variance
Volume
W
incentive time standards, 420
payments, 397, 442
plan, guaranteed annual, 439;
incentive, 410, 414-416, 417
Wage
Wage
Wage
allo-
Yield,
der, 594
626
Variable factory overhead, 49, 629
Variables, corner point (in linear programming), 913; method of least
squares for multiple independent,
551; statistical correlation analysis,
552
Variance, controllable (two-variance
method), 588, 592; cost price, 661,
665; cost volume, 661, 665; efficiency (three-variance method),
589; 591, 592; factory overhead
yield, 595; final sales volume, 662,
663, 666; final volume, 665; fixed efmethod),
(four-variance
ficiency
(threecapacity
idle
591-593;
variance method), 589, 590, 592;
idle capacity (four-variance method), 591-593; labor efficiency, 598,
599; labor rate, 598; labor yield,
595; materials mix, 596; 598; mate581; materials price
price,
rials
purchase
materials
usage, 583;
price, 583, 596; materials quantity,
598;
597,
yield,
materials
582;
overall (or net) factory overhead,
for