Cost Accounting

Horngren, C. T. , Datar, S. M. and Foster, G. (2003) Cost Accounting – A Managerial Emphasis, Pearson Education, Inc. , New Jersey, Eleventh Edition CHAPTER 11 DECISION MAKING AND RELEVANT INFORMATION 11-1 The five steps in the decision process outlined in Exhibit 11-1 of the text are: 1. 2. 3. 4. 5. Obtain information Make predictions about future costs Choose an alternative Implement the decision Evaluate performance to provide feedback 11-2 Relevant costs are expected future costs that differ among the alternative courses of action being considered.

Historical costs are irrelevant because they are past costs and, therefore, cannot differ among alternative future courses of action. 11-3 No. Relevant costs are defined as those expected future costs that differ among alternative courses of action being considered. Thus, future costs that do not differ among the alternatives are irrelevant to deciding which alternative to choose. 11-4 Quantitative factors are outcomes that are measured in numerical terms. Some quantitative factors are financial––that is, they can be easily expressed in monetary terms. Direct materials is an example of a quantitative financial factor.

Qualitative factors are outcomes that are difficult to measure accurately in numerical terms. An example is employee morale. 11-5 Two potential problems that should be avoided in relevant cost analysis are: 1. 2. Do not assume all variable costs are relevant and all fixed costs are irrelevant. Do not use unit-cost data directly. It can mislead decision makers because a. it may include irrelevant costs, and b. comparisons of unit costs computed at different output levels lead to erroneous conclusions 11-6 No. Some variable costs may not differ among the alternatives under consideration and, hence, will be irrelevant.

Some fixed costs may differ among the alternatives and, hence, will be relevant. 11-7 No. Some of the total unit costs to manufacture a product may be fixed costs, and, hence, will not differ between the make and buy alternatives. These fixed costs are irrelevant to the make-or-buy decision. The key comparison is between purchase costs and the costs that will be saved if the company purchases the component parts from outside plus the additional benefits of using the resources freed up in the next best alternative use (opportunity cost). 1-8 Opportunity cost is the contribution to income that is forgone (rejected) by not using a limited resource in its next-best alternative use. 11-1 11-9 No. When deciding on the quantity of inventory to buy, managers must consider both the purchase cost per unit and the opportunity cost of funds invested in the inventory. For example, the purchase cost per unit may be low when the quantity of inventory purchased is large, but the benefit of the lower cost may be more than offset by the high opportunity cost of the funds invested in acquiring and holding inventory. 1-10 No. Managers should aim to get the highest contribution margin per unit of the constraining (that is, scarce, limiting, or critical) factor. The constraining factor is what restricts or limits the production or sale of a given product (for example, availability of machine-hours). 11-11 No. For example, if the revenues that will be lost exceed the costs that will be saved, the branch or business segment should not be shut down. Shutting down will only increase the loss. Allocated costs are always irrelevant to the shutting down decision. 1-12 Cost written off as depreciation is irrelevant when it pertains to a past cost. But the purchase cost of new equipment to be acquired in the future that will then be written off as depreciation is often relevant. 11-13 No. Managers tend to favor the alternative that makes their performance look best so they focus on the measures used in the performance-evaluation model. If the performanceevaluation model does not emphasize maximizing operating income or minimizing costs, managers will most likely not choose the alternative that maximizes operating income or minimizes costs. 1-14 The three steps in solving a linear programming problem are: 1. 2. 3. Determine the objective function. Specify the constraints. Compute the optimal solution. 11-15 The text outlines two methods of determining the optimal solution to an LP problem: 1. Trial-and-error solution approach 2. Graphical solution approach Most LP applications in practice use standard software packages that rely on the simplex method to compute the optimal solution. 11-2 11-16 (20 min. ) Disposal of assets. 1. This is an unfortunate situation, yet the $80,000 costs are irrelevant regarding the decision to remachine or scrap.

The only relevant factors are the future revenues and future costs. By ignoring the accumulated costs and deciding on the basis of expected future costs, operating income will be maximized (or losses minimized). The difference in favor of remachining is $3,000: (a) Remachine Future revenues Deduct future costs Operating income Difference in favor of remachining $35,000 30,000 $ 5,000 $3,000 (b) Scrap $2,000 – $2,000 2. This, too, is an unfortunate situation. But the $100,000 original cost is irrelevant to this decision.

The difference in relevant costs in favor of rebuilding is $7,000 as follows: (a) Replace New truck Deduct current disposal price of existing truck Rebuild existing truck $102,000 10,000 – $ 92,000 $7,000 (b) Rebuild – – $85,000 $85,000 Difference in favor of rebuilding Note, here, that the current disposal price of $10,000 is relevant, but the original cost (or book value, if the truck were not brand new) is irrelevant. 11-3 11-17 (10 min. ) The careening personal computer. Considered alone, book value is irrelevant as a measure of loss when equipment is destroyed.

The measure of the loss is replacement cost or some computation of the present value of future services lost because of equipment loss or damage. In the specific case described, the following observations may be apt: 1. A fully depreciated item probably is relatively old. Chances are that the loss from this equipment is less than the loss for a partially depreciated item because the replacement cost of an old item would be far less than that for a nearly new item. 2. The loss of an old item, assuming replacement is necessary, automatically accelerates the timing of replacement.

Thus, if the old item were to be junked and replaced tomorrow, no economic loss would be evident. However, if the old item were supposed to last five more years, replacement is accelerated five years. The best practical measure of such a loss probably would be the cost of comparable used equipment that had five years of remaining useful life. The fact that the computer was fully depreciated also means the accounting reports will not be affected by the accident. If accounting reports are used to evaluate the office manager’s performance, the manager will prefer any accidents to be on fully depreciated units. 11-18 (15 min. Multiple choice. 1. (b) Special order price per unit Variable manufacturing cost per unit Contribution margin per unit Effect on operating income = $1. 50 ? 20,000 units = $30,000 increase $1,200,000 $48 9 $57 1,140,000 60,000 25,000 $ 85,000 $6. 00 4. 50 $1. 50 2. (b) Costs of purchases, 20,000 units ? $60 Total relevant costs of making: Variable manufacturing costs, $64 – $16 Fixed costs eliminated Costs saved by not making Multiply by 20,000 units, so total costs saved are $57 ? 20,000 Extra costs of purchasing outside Minimum overall savings for Reno Necessary relevant costs that would have to be saved in manufacturing Part No. 75 11-4 11-19 (30 min. ) Special order, activity-based costing (CMA, adapted). 1. Award Plus’s operating income under the alternatives of accepting/rejecting the special order are: Without OneWith OneTime Only Time Only Special Order Special Order 7,500 Units 10,000 Units Revenues Variable costs: Direct materials Direct manufacturing labor Batch manufacturing costs Fixed costs: Fixed manufacturing costs Fixed marketing costs Total costs Operating income 1 2 Difference 2,500 Units $250,000 87,500 100,000 12,500 –– –– 200,000 $ 50,000 $1,125,000 262,500 300,000 75,000 1,375,000 350,000 2 400,000 3 87,500 1 275,000 275,000 175,000 175,000 1,087,500 1,287,500 $ 37,500 $ 87,500 $300,000 ? 10,000 7,500 3 $262,500 ? 10,000 7,500 $75,000 + (25 ? $500) Alternatively, we could calculate the incremental revenue and the incremental costs of the additional 2,500 units as follows: Incremental revenue $100 ? 2,500 Incremental direct manufacturing costs Incremental direct manufacturing costs Incremental batch manufacturing costs Total incremental costs Total incremental operating income from accepting the special order $262,500 ? 2,500 7,500 300,000 ? ,500 7,500 $500 ? 25 $250,000 87,500 100,000 12,500 200,000 $ 50,000 Award Plus should accept the one-time-only special order if it has no long-term implications because accepting the order increases Award Plus’s operating income by $50,000. If, however, accepting the special order would cause the regular customers to be dissatisfied or to demand lower prices, then Award Plus will have to trade off the $50,000 gain from accepting the special order against the operating income it might lose from regular customers. 11-5 11-19 (Cont’d. ) 2. Award Plus has a capacity of 9,000 medals.

Therefore, if it accepts the special one-time order of 2,500 medals, it can sell only 6,500 medals instead of the 7,500 medals that it currently sells to existing customers. That is, by accepting the special order, Award Plus must forgo sales of 1,000 medals to its regular customers. Alternatively, Award Plus can reject the special order and continue to sell 7,500 medals to its regular customers. Award Plus’s operating income from selling 6,500 medals to regular customers and 2,500 medals under one-time special order follow: Revenues (6,500 ? $150) + (2,500 ? 100) 1 1 Direct materials (6,500 ? $35 ) + (2,500 ? $35 ) 2 2 Direct manufacturing labor (6,500 ? $40 ) +(2,500 ? $40 ) 3 Batch manufacturing costs (130 ? $500) + (25 ? $500) Fixed manufacturing costs Fixed marketing costs Total costs Operating income 1 $1,225,000 315,000 360,000 77,500 275,000 175,000 1,202,500 $ 22,500 $35 = $262,500 7,500 2 $40 = 300,000 7,500 3 Award Plus makes regular medals in batch sizes of 50. To produce 6,500 medals requires 130 (6,500 ? 50) batches. Accepting the special order will result in a decrease in operating income of $15,000 ($37,500 – $22,500).

The special order should, therefore, be rejected. A more direct approach would be to focus on the incremental effects––the benefits of accepting the special order of 2,500 units versus the costs of selling 1,000 fewer units to regular customers. Increase in operating income from the 2,500-unit special order equals $50,000 (requirement 1). The loss in operating income from selling 1,000 fewer units to regular customers equals: Lost revenue, $150 ? 1,000 Savings in direct materials costs, $35 ? 1,000 Savings in direct manufacturing labor costs, $40 ? 1,000 Savings in batch manufacturing costs, $500 ? 0 Operating income lost $(150,000) 35,000 40,000 10,000 $ (65,000) Accepting the special order will result in a decrease in operating income of $15,000 ($50,000 – $65,000). The special order should, therefore, be rejected. 3. Award Plus should not accept the special order. Increase in operating income by selling 2,500 units under the special order (requirement 1) Operating income lost from existing customers ($10 ? 7,500) Net effect on operating income of accepting special order The special order should, therefore, be rejected. $ 50,000 (75,000) $(25,000) 11-6 11-20 (30 min. ) Make versus buy, activity-based costing. . The expected manufacturing cost per unit of CMCBs in 2004 is as follows: Total Manufacturing Manufacturing Costs of CMCB Cost per Unit (1) (2) = (1) ? 10,000 $1,700,000 $170 450,000 45 120,000 12 320,000 800,000 $3,390,000 32 80 $339 Direct materials, $170 ? 10,000 Direct manufacturing labor, $45 ? 10,000 Variable batch manufacturing costs, $1,500 ? 80 Fixed manufacturing costs Avoidable fixed manufacturing costs Unavoidable fixed manufacturing costs Total manufacturing costs 2. The following table identifies the incremental costs in 2004 if Svenson (a) made CMCBs and (b) purchased CMCBs from Minton.

Total Incremental Costs Make Buy $ 3,000,000 $1,700,000 450,000 120,000 320,000 $2,590,000 $3,000,000 $410,000 Per-Unit Incremental Costs Make Buy $300 $170 45 12 32 $259 $300 $41 Incremental Items Cost of purchasing CMCBs from Minton Direct materials Direct manufacturing labor Variable batch manufacturing costs Avoidable fixed manufacturing costs Total incremental costs Difference in favor of making Note that the opportunity cost of using capacity to make CMCBs is zero since Svenson would keep this capacity idle if it purchases CMCBs from Minton.

Svenson should continue to manufacture the CMCBs internally since the incremental costs to manufacture are $259 per unit compared to the $300 per unit that Minton has quoted. Note that the unavoidable fixed manufacturing costs of $800,000 ($80 per unit) will continue to be incurred whether Svenson makes or buys CMCBs. These are not incremental costs under either the make or the buy alternative and are, hence, irrelevant. 3. Svenson should continue to make CMCBs. The simplest way to analyze this problem is to recognize that Svenson would prefer to keep any excess capacity idle rather than use it to make CB3s. Why?

Because expected incremental future revenues from CB3s, $2,000,000 are less than expected incremental future costs, $2,150,000. If Svenson keeps its capacity idle, we know from requirement 2 that it should make CMCBs rather than buy them. 11-7 11-20 (Cont’d. ) An important point to note is that, because Svenson forgoes no contribution by not being able to make and sell CB3s, the opportunity cost of using its facilities to make CMCBs is zero. It is, therefore, not forgoing any profits by using the capacity to manufacture CMCBs. If it does not manufacture CMCBs, rather than lose money on CB3s, Svenson will keep capacity idle.

A longer and more detailed approach is to use the total alternatives or opportunity cost analyses shown in Exhibit 11-7 of the chapter. Choices for Svenson Make CMCBs Buy CMCBs Buy CMCBs and Do Not and Do Not and Make Relevant Items Make CB3s Make CB3s CB3s TOTAL-ALTERNATIVES APPROACH TO MAKE-OR-BUY DECISIONS Total incremental costs of making/buying CMCBs (from requirement 2) Excess of future costs over future revenues from CB3s Total relevant costs $2,590,000 0 $2,590,000 $3,000,000 0 $3,000,000 $3,000,000 150,000 $3,150,000 Svenson will minimize manufacturing costs by making CMCBs.

OPPORTUNITY-COST APPROACH TO MAKE-OR-BUY DECISIONS Total incremental costs of making/buying CMCBs (from requirement 2) $2,590,000 $3,000,000 Opportunity cost: profit contribution forgone because capacity will not be used to make CB3s 0* 0* Total relevant costs $2,590,000 $3,000,000 $3,000,000 0 $3,000,000 *Opportunity cost is 0 because Svenson does not give up anything by not making CB3s. Svenson is best off leaving the capacity idle (rather than manufacturing and selling CB3s). 11-8 11-21 (10 min. ) Inventory decision, opportunity costs. 1. Unit cost, orders of 20,000 Unit cost, order of 240,000 (0. 5 ? $8. 00) Alternatives under consideration: (a) Buy 240,000 units at start of year. (b) Buy 20,000 units at start of each month. Average investment in inventory: (a) (240,000 ? $7. 60) ? 2 (b) ( 20,000 ? $8. 00) ? 2 Difference in average investment $8. 00 $7. 60 $912,000 80,000 $832,000 Opportunity cost of interest forgone from 240,000-unit purchase at start of year = $832,000 ? 0. 08 = $66,560 2. No. The $66,560 is an opportunity cost rather than an incremental or outlay cost. No actual transaction records the $66,560 as an entry in the accounting system. 3.

The following table presents the two alternatives: Alternative A: Alternative B: Purchase Purchase 240,000 20,000 spark plugs at spark plugs beginning of at beginning year of each month Difference (1) (2) (3 )= (1) – (2) Annual purchase-order costs (1 ? $200; 12 ? $200) Annual purchase (incremental) costs (240,000 ? $7. 60; 240,000 ? $8) Annual interest income that could be earned if investment in inventory were invested (opportunity cost) (8% ? $912,000; 8% ? $80,000) Relevant costs $ 200 1,824,000 $ 2,400 1,920,000 $ (2,200) (96,000) 72,960 $1,897,160 6,400 $1,928,800 66,560 $ (31,640)

Column (3) indicates that purchasing 240,000 spark plugs at the beginning of the year is preferred relative to purchasing 20,000 spark plugs at the beginning of each month because the lower purchase cost exceeds the opportunity cost of holding larger inventory. If other incremental benefits of holding lower inventory such as lower insurance, materials handling, storage, obsolescence, and breakage costs were considered, the costs under Alternative A would have been higher, and Alternative B may have been preferred. 11-9 11-22 (20–25 min. ) Relevant costs, contribution margin, product emphasis. 1. Cola $18. 0 13. 50 $ 4. 50 Lemonade $19. 20 15. 20 $ 4. 00 Punch $26. 40 20. 10 $ 6. 30 Natural Orange Juice $38. 40 30. 20 $ 8. 20 Selling price Deduct variable cost per case Contribution margin per case 2. The argument fails to recognize that shelf space is the constraining factor. There are only 12 feet of front shelf space to be devoted to drinks. Sexton should aim to get the highest daily contribution margin per foot of front shelf space: Natural Orange Juice $ 8. 20 ? 5 Contribution margin per case Sales (number of cases) per foot of shelf space per day Daily contribution per foot of front shelf space 3.

Cola $ 4. 50 ? 25 Lemonade $ 4. 00 ? 24 Punch $ 6. 30 ? 4 $112. 50 $96. 00 $25. 20 $41. 00 The allocation that maximizes the daily contribution from soft drink sales is: Daily Contribution per Foot of Front Shelf Space $112. 50 96. 00 41. 00 25. 20 Cola Lemonade Natural Orange Juice Punch Feet of Shelf Space 6 4 1 1 Total Contribution Margin per Day $ 675. 00 384. 00 41. 00 25. 20 $1,125. 20 The maximum of six feet of front shelf space will be devoted to Cola because it has the highest contribution margin per unit of the constraining factor.

Four feet of front shelf space will be devoted to Lemonade, which has the second highest contribution margin per unit of the constraining factor. No more shelf space can be devoted to Lemonade since each of the remaining two products, Natural Orange Juice and Punch (that have the second lowest and lowest contribution margins per unit of the constraining factor) must each be given at least one foot of front shelf space. 11-10 11-23 (10 min. ) Selection of most profitable product. Only Model 14 should be produced. The key to this problem is the relationship of manufacturing overhead to each product.

Note that it takes twice as long to produce Model 9; machine-hours for Model 9 are twice that for Model 14. Management should choose the product mix that maximizes operating income for a given production capacity (the scarce resource in this situation). In this case, Model 14 will yield a $9. 50 contribution to fixed costs per machine hour, and Model 9 will yield $9. 00: Model 9 Selling price Variable costs per unit Contribution margin per unit Relative use of machine-hours per unit of product Contribution margin per machine hour $100. 00 82. 00 $ 18. 00 ? 2 $ 9. 00 Model 14 $70. 00 60. 50 $ 9. 50 ? $ 9. 50 11-23 Excel Application Decision-Making and Relevant Information Body-Builders, Inc. Original Data Selling Price Costs Direct materials Direct manufacturing labor Variable manufacturing overhead Fixed manufacturing overhead Marketing costs (all variable) Total costs Operating Income Model 9 $100. 00 28. 00 15. 00 25. 00 10. 00 14. 00 92. 00 $8. 00 $70. 00 13. 00 25. 00 12. 50 5. 00 10. 00 65. 50 $4. 50 Product Mix Analysis Selling price Variable cost per unit Contribution margin per unit Relative use of machine-hours per unit of product Contribution margin per machine-hour Model 9 $100 82. 0 18. 00 2 $9. 00 Model 14 $70 60. 50 9. 50 1 $9. 50 11-11 11-24 (20 min. ) Which base to close, relevant-cost analysis, opportunity costs. The future outlay operating costs will be $400 million regardless of which base is closed, given the additional $100 million in costs at Everett if Alameda is closed. Further, one of the bases will permanently remain open while the other will be shut down. The only relevant revenue and cost comparisons are: a. $500 million from sale of the Alameda base. Note that the historical cost of building the Alameda base ($100 million) is irrelevant.

Note, also, that future increases in the value of the land at the Alameda base is also irrelevant. One of the bases must be kept open, so if it is decided to keep the Alameda base open, the Defense Department will not be able to sell this land at a future date. b. $60 million in savings in fixed income note if the Everett base is closed. Again, the historical cost of building the Everett base ($150 million) is irrelevant. The relevant costs and benefits analysis favors closing the Alameda base despite the objections raised by the California delegation in Congress. The net benefit equals $440 ($500 – $60) million. 11-25 (25? 0 min. ) Closing and opening stores. 1. Solution Exhibit 11-25, Column 1, presents the relevant loss in revenues and the relevant savings in costs from closing the Rhode Island store. Lopez is correct that Sanchez Corporation’s operating income would increase by $7,000 if it closes down the Rhode Island store. Closing down the Rhode Island store results in a loss of revenues of $860,000 but cost savings of $867,000 (from cost of goods sold, rent, labor, utilities, and corporate costs). Note that by closing down the Rhode Island store, Sanchez Corporation will save none of the equipment-related costs because this is a past cost.

Also note that the relevant corporate overhead costs are the actual corporate overhead costs $44,000 that Sanchez expects to save by closing the Rhode Island store. The corporate overhead of $40,000 allocated to the Rhode Island store is irrelevant to the analysis. 2. Solution Exhibit 11-25, Column 2, presents the relevant revenues and relevant costs of opening another store like the Rhode Island store. Lopez is correct that opening such a store would increase Sanchez Corporation’s operating income by $11,000.

Incremental revenues of $860,000 exceed the incremental costs of $849,000 (from higher cost of goods sold, rent, labor, utilities, and some additional corporate costs). Note that the cost of equipment written off as depreciation is relevant because it is an expected future cost that Sanchez will incur only if it opens the new store. Also note that the relevant corporate overhead costs are the $4,000 of actual corporate overhead costs that Sanchez expects to incur as a result of opening the new store. Sanchez may, in fact, allocate more than $4,000 of corporate overhead to the new store but this allocation is irrelevant to the analysis. 1-12 11-25 (Cont’d. ) The key reason that Sanchez’s operating income increases either if it closes down the Rhode Island store or if it opens another store like it is the behavior of corporate overhead costs. By closing down the Rhode Island store, Sanchez can significantly reduce corporate overhead costs presumably by reducing the corporate staff that oversees the Rhode Island operation. On the other hand, adding another store like Rhode Island does not increase actual corporate costs by much, presumably because the existing corporate staff will be able to oversee the new store as well.

SOLUTION EXHIBIT 11-25 Relevant-Revenue and Relevant-Cost Analysis of Closing Rhode Island Store and Opening Another Store Like It. Incremental (Loss in Revenues) Revenues and and Savings in (Incremental Costs) Costs from of Opening New Closing Rhode Store Like Rhode Island Store Island Store (1) (2) Revenues Cost of goods sold Lease rent Labor costs Depreciation of equipment Utilities (electricity, heating) Corporate overhead costs Total costs Effect on operating income (loss) $(860,000) 660,000 75,000 42,000 0 46,000 44,000 867,000 $ 7,000 $ 860,000 (660,000) (75,000) (42,000) (22,000) (46,000) (4,000) (849,000) $ 11,000 1-13 11-26 (20 min. ) Choosing customers. If Broadway accepts the additional business from Kelly, it would take an additional 500 machine-hours. If Broadway accepts all of Kelly’s and Taylor’s business for February, it would require 2,500 machine-hours (1,500 hours for Taylor and 1,000 hours for Kelly). Broadway has only 2,000 hours of machine capacity. It must, therefore, choose how much of the Taylor or Kelly business to accept. To maximize operating income, Broadway should maximize contribution margin per unit of the constrained resource. Fixed costs will remain unchanged at $100,000 regardless of the business Broadway chooses to accept in February, and is, therefore, irrelevant. ) The contribution margin per unit of the constrained resource for each customer in January is: Taylor Corporation $78,000 = $52 1,500 Kelly Corporation $32,000 = $64 500 Contribution margin per machine-hour Since the $80,000 of additional Kelly business in February is identical to jobs done in January, it will also have a contribution margin of $64 per machine-hour, which is greater than the contribution margin of $52 per machine-hour from Taylor.

To maximize operating income, Broadway should first allocate all the capacity needed to take the Kelly Corporation business (1,000 machine-hours) and then allocate the remaining 1,000 (2,000 – 1,000) machine-hours to Taylor. Taylor Corporation $52 ? 1,000 $52,000 Kelly Corporation $64 ? 1,000 $64,000 Total Contribution margin per machine-hour Machine-hours to be worked Contribution margin Fixed costs Operating income $116,000 100,000 $ 16,000 11-14 11-27 (30–40 min. ) Relevance of equipment costs. 1a. Statements of Cash Receipts and Disbursements Keep Year 2, 3, 4 $150,000 (110,000) (15,000)

Year 1 Receipts from operations: Revenues Deduct disbursements: Other operating costs Operation of machine Purchase of “old” machine Purchase of “new” equipment Cash inflow from sale of old equipment Net cash inflow $150,000 (110,000) ( 15,000) (20,000)* Four Years Together $600,000 (440,000) (60,000) (20,000) Buy New Machine Four Year Years Year 1 2, 3, 4 Together $150,000 (110,000) (9,000) (20,000) (24,000) 8,000 $ (5,000) $150,000 (110,000) (9,000) $600,000 (440,000) (36,000) (20,000) (24,000) 8,000 $ 88,000 $ 5,000 $ 25,000 80,000 $ 31,000 *Some students ignore this item because it is the same for each alternative. However, note that a statement for the entire year has been requested. Obviously, the $20,000 would affect Year 1 only under both the “keep” and “buy” alternatives. The difference is $8,000 for four years taken together. In particular, note that the $20,000 book value can be omitted from the comparison. Merely cross out the entire line; although the column totals are affected, the net difference is still $8,000. 11-15 11-27 (Cont’d. ) 1b.

Again, the difference is $8,000: Income Statements Keep Year 1, 2, 3, 4 Revenues Costs (excluding disposal): Other operating costs Depreciation Operating costs of machine Total costs (excluding disposal) Loss on disposal: Book value (“cost”) Proceeds (“revenue”) Loss on disposal Total costs Operating income $150,000 110,000 5,000 15,000 130,000 Four Years Together $600,000 440,000 20,000 60,000 520,000 Buy New Machine Four Years Year Together Year 1 2, 3, 4 $150,000 $150,000 110,000 6,000 9,000 125,000 110,000 6,000 9,000 125,000 $600,000 440,000 24,000 36,000 500,000 20,000* (8,000) 12,000 512,000 $ 88,000 30,000 $ 20,000 520,000 $ 80,000 20,000 (8,000) 12,000 137,000 125,000 $ 13,000 $ 25,000 *As in part (1), the $20,000 book value may be omitted from the comparison without changing the $8,000 difference. This adjustment would mean excluding the depreciation item of $5,000 per year (a cumulative effect of $20,000) under the “keep” alternative and excluding the book value item of $20,000 in the loss on disposal computation under the “buy” alternative. 1c. The $20,000 purchase cost of the old equipment, the revenues, and the other costs are irrelevant because their amounts are common to both alternatives. 2.

The net difference would be unaffected. Any number may be substituted for the original $20,000 figure without changing the final answer. Of course, the net cash outflows under both alternatives would be high. The Auto Wash manager really blundered. However, keeping the old equipment will increase the cost of the blunder to the cumulative tune of $8,000 over the next four years. 3. Book value is irrelevant in decisions about the replacement of equipment, because it is a past (historical) cost. All past costs are down the drain. Nothing can change what has already been spent or what has already happened. The $20,000 has been spent.

How it is subsequently accounted for is irrelevant. The analysis in requirement (1) clearly shows that we may completely ignore the $20,000 and still have a correct analysis. The only relevant items are those expected future items that will differ among alternatives. 11-16 11-27 (Cont’d. ) Despite the economic analysis shown here, many managers would keep the old machine rather than replace it. Why? Because, in many organizations, the income statements of part (2) would be a principal means of evaluating performance. Note that the first-year operating income would be higher under the “keep” alternative.

The conventional accrual accounting model might motivate managers toward maximizing their first-year reported operating income at the expense of long-run cumulative betterment for the organization as a whole. This criticism is often made of the accrual accounting model. That is, the action favored by the “correct” or “best” economic decision model may not be taken because the performance-evaluation model is either inconsistent with the decision model or because the focus is on only the short-run part of the performance-evaluation model. There is yet another potential conflict etween the decision model and the performance evaluation model. Replacing the machine so soon after it is purchased may reflect badly on the manager’s capabilities and performance. Why didn’t the manager search and find the new machine before buying the old machine? Replacing the old machine one day later at a loss may make the manager appear incompetent to his or her superiors. If the manager’s bosses have no knowledge of the better machine, the manager may prefer to keep the existing machine rather than alert his or her bosses about the better machine. 11-28 (30 min. Equipment upgrade versus replacement (A. Spero, adapted). 1. Solution Exhibit 11-28 presents a cost comparison of the upgrade and replacement alternatives for the three years taken together. It indicates that Pacifica Corporation should replace the production line because it is better off by $180,000 by replacing rather than upgrading. SOLUTION EXHIBIT 11-28 Comparing Upgrade and Replace Alternatives Three Years Together Upgrade Replace Difference (1) (2) (3) = (1) – (2) $2,160,000 $1,620,000 $ 540,000 (90,000) 90,000 300,000 $2,460,000 750,000 $2,280,000 (450,000) $ 180,000 Cash-operating costs, $12; $9 ? 80,000 Current disposal price One-time capital costs, written off periodically as depreciation Total relevant costs Note that sales and book value of the existing machine are the same under both alternatives and, hence, are irrelevant. 11-17 11-28 (Cont’d. ) 2a. Suppose the capital expenditure to replace the production line is $X. Using data from Solution Exhibit 11-28, the cost of replacing the production line is equal to $1,620,000 – $90,000 + $X. Using data from Solution Exhibit 11-28, the cost of upgrading the production line is equal to $2,160,000 + $300,000 = $2,460,000.

We want to find $X such that $1,620,000 – $90,000 + $X = $2,460,000 that is, $1,530,000 + $X = $2,460,000 that is, $X = $2,460,000 – $1,530,000 or $X = $ 930,000 Pacifica would prefer replacing, rather than upgrading, the existing line if the replacement cost of the new line does not exceed $930,000. Note that the $930,000 can also be obtained by adding the $180,000 calculated in requirement 1 to the replacement cost of $750,000 for the new machine assumed in requirement 1 ($750,000 + $180,000 = $930,000). 2b. Suppose the units produced and sold each year equal y.

Using data from Solution Exhibit 11-28, the cost of replacing the production line is $9y – $90,000 + $750,000, while the cost of upgrading is $12y + $300,000. We solve for the y at which the two costs are the same. $9y – $90,000 + $750,000 $9y + $660,000 $3y y = = = = $12y + $300,000 $12y + $300,000 $360,000 120,000 units For expected production and sales of less than 120,000 units over 3 years (40,000 units per year), the upgrade alternative is cheaper. When production and sales are low, the higher operating costs of upgrading are more than offset by the significant savings in capital costs when upgrading relative to replacing.

For expected production and sales exceeding 120,000 units over 3 years, the replace alternative is cheaper. For high output, the benefits of the lower operating costs of replacing, relative to upgrading, exceed the higher capital costs. 3. Operating income for the first year under the upgrade and replace alternatives are as follows: Upgrade Replace Revenues $25 ? 60,000 $1,500,000 $1,500,000 Cash-operating costs $12 ? 60,000, $9 ? 60,000 720,000 540,000 a b Depreciation 220,000 250,000 c Loss on disposal of old production line –– 270,000 Total costs 940,000 1,060,000 Operating income $ 560,000 $ 440,000 a $360,000 + $300,000) ? 3 = $220,000 $750,000 ? 3 = $250,000 c Book value – current disposal price = $360,000 – $90,000 = $270,000 b First-year operating income is higher by $120,000 under the upgrade alternative. If first year’s operating income is an important component of Azinger’s bonus, he would prefer the upgrade over the replace alternative even though the decision model (in requirement 1) prefers the replace to the upgrade alternative. This exercise illustrates the conflict between the decision model and the performance evaluation model. 11-18 11-29 (30 min. Contribution approach, relevant costs. 1. Average one-way fare per passenger Commission at 8% of $500 Net cash to Air Frisco per ticket Average number of passengers per flight Revenues per flight ($460 ? 200) Food and beverage cost per flight ($20 ? 200) Total contribution margin from passengers per flight 2. If fare is Commission at 8% of $480 Net cash per ticket Food and beverage cost per ticket Contribution margin per passenger Total contribution margin from passengers per flight ($421. 60 ? 212) All other costs are irrelevant. $ 500 40 $ 460 ? 200 $92,000 4,000 $88,000 $480. 0 38. 40 441. 60 20. 00 $421. 60 $89,379. 20 On the basis of quantitative factors alone, Air Frisco should decrease its fare to $480 because reducing the fare gives Air Frisco a higher contribution margin from passengers ($89,379. 20 versus $88,000). 3. In evaluating whether Air Frisco should charter its plane to Travel International, we compare the charter alternative to the solution in requirement 2 because requirement 2 is preferred to requirement 1. Under requirement 2, contribution from passengers Deduct fuel costs Total contribution per flight $89,379. 0 14,000. 00 $75,379. 20 Air Frisco gets $74,500 per flight from chartering the plane to Travel International. On the basis of quantitative financial factors, Air Frisco is better off not chartering the plane and, instead, lowering its own fares. Other qualitative factors that Air Frisco should consider in coming to a decision are: a. The lower risk from chartering its plane relative to the uncertainties regarding the number of passengers it might get on its scheduled flights. b. The stability of the relationship between Air Frisco and Travel International.

If this is not a long-term arrangement, Air Frisco may lose current market share and not benefit from sustained charter revenues. 11-19 11-30 (30 min. ) Relevant costs, opportunity costs. 1. Easyspread 2. 0 has a higher relevant operating income than Easyspread 1. 0. Based on this analysis, Easyspread 2. 0 should be introduced immediately: Easyspread 1. 0 $150 $ 0 0 $150 Easyspread 2. 0 $185 $25 25 $160 Relevant revenues Relevant costs: Manuals, diskettes, compact discs Total relevant costs Relevant operating income Reasons for other cost items being irrelevant are: Easyspread 1. • Manuals, diskettes—already incurred • Development costs—already incurred • Marketing and administrative—fixed costs of period Easyspread 2. 0 • Development costs—already incurred • Marketing and administration—fixed costs of period Note that total marketing and administration costs will not change whether Easyspread 2. 0 is introduced on July 1, 2003, or on October 1, 2003. 2. Other factors to be considered: a. Customer satisfaction. If 2. 0 is significantly better than 1. 0 for its customers, a customer driven organization would immediately introduce it unless other factors offset this bias towards “do what is best for the customer. b. Quality level of Easyspread 2. 0. It is critical for new software products to be fully debugged. Easyspread 2. 0 must be error-free. Consider an immediate release only if 2. 0 passes all quality tests and can be fully supported by the salesforce. c. Importance of being perceived to be a market leader. Being first in the market with a new product can give Basil Software a “first-mover advantage,” e. g. , capturing an initial large share of the market that, in itself, causes future potential customers to lean towards purchasing Easyspread 2. 0. Moreover, by introducing 2. earlier, Basil can get quick feedback from users about ways to further refine the software while its competitors are still working on their own first versions. Moreover, by locking in early customers, Basil may increase the likelihood of these customers also buying future upgrades of Easyspread 2. 0. d. Morale of developers. These are key people at Basil Software. Delaying introduction of a new product can hurt their morale, especially if a competitor then preempts Basil from being viewed as a market leader. 11-20 11-31 (20 min. ) Opportunity costs (H. Schaefer). 1.

The opportunity cost to Wolverine of producing the 2,000 units of Orangebo is the contribution margin lost on the 2,000 units of Rosebo that would have to be forgone, as computed below: Selling price Variable costs per unit: Direct materials Direct manufacturing labor Variable manufacturing overhead Variable marketing costs Contribution margin per unit Contribution margin for 2,000 units $20 $2 3 2 4 11 $ 9 $ 18,000 The opportunity cost is $18,000. Opportunity cost is the maximum contribution to operating income that is forgone (rejected) by not using a limited resource in its next-best alternative use. . Contribution margin from manufacturing 2,000 units of Orangebo and purchasing 2,000 units of Rosebo from Buckeye is $16,000, as follows: Manufacture Orangebo Selling price Variable costs per unit: Purchase costs Direct materials Direct manufacturing labor Variable manufacturing costs Variable marketing overhead Variable costs per unit Contribution margin per unit Contribution margin from selling 2,000 units of Orangebo and 2,000 units of Rosebo $15 – 2 3 2 2 9 $ 6 $12,000 Purchase Rosebo $20 14 Total 4 18 $ 2 $4,000 $16,000

As calculated in requirement 1, Wolverine’s contribution margin from continuing to manufacture 2,000 units of Rosebo is $18,000. Accepting the Miami Company and Buckeye offer will cost Wolverine $2,000 ($16,000 – $18,000). Hence, Wolverine should refuse the Miami Company and Buckeye Corporation’s offers. 3. The minimum price would be $9, the sum of the incremental costs as computed in requirement 2. This follows because, if Wolverine has surplus capacity, the opportunity cost = $0. For the short-run decision of whether to accept Orangebo’s offer, fixed costs of Wolverine are irrelevant.

Only the incremental costs need to be covered for it to be worthwhile for Wolverine to accept the Orangebo offer. 11-21 11-32 (30-40 min. ) Product mix, relevant costs (N. Melumad, adapted). 1. Selling price Variable manufacturing cost per unit Variable marketing cost per unit Total variable costs per unit Contribution margin per unit Contributi on margin per hour of the constraine d resource (the regular machine) Total contribution margin from selling only R3 or only HP6 R3: $25 ? 50,000; HP6: $30 ? 0,000 Less Lease costs of high-precision machine to produce and sell HP6 Net relevant benefit R3 $100 60 15 75 $ 25 $25 = $25 1 HP6 $150 100 35 135 $ 15 $15 = $30 0. 5 $1,250,000 ? $1,250,000 $1,500,000 300,000 $1,200,000 Even though HP6 has the higher contribution margin per unit of the constrained resource, the fact that Pendleton must incur additional costs of $300,000 to achieve this higher contribution margin means that Pendleton is better off using its entire 50,000-hour capacity on the regular machine to produce and sell 50,000 units (50,000 hours ? 1 hour per unit) of R3.

The additional contribution from selling HP6 rather than R3 is $250,000 ($1,500,000 ? $1,250,000), which is not enough to cover the additional costs of leasing the high-precision machine. Note that, because all other overhead costs are fixed and cannot be changed, they are irrelevant for the decision. 2. If capacity of the regular machines is increased by 15,000 machine-hours to 65,000 machine-hours (50,000 originally + 15,000 new), the net relevant benefit from producing R3 and HP6 is as follows: R3 Total contribution margin from selling only R3 or only HP6 R3: $25 ? 5,000; HP6: $30 ? 65,000 Less Lease costs of high-precision machine that would be incurred if HP6 is produced and sold Less Cost of increasing capacity by 15,000 hours on regular machine Net relevant benefit HP6 $1,625,000 $1,950,000 300,000 150,000 150,000 $1,475,000 $1,500,000 11-22 11-32 (Cont’d. ) Investing in the additional capacity increases Pendleton’s operating income by $250,000 ($1,500,000 calculated in requirement 2 minus $1,250,000 calculated in requirement 1), so Pendleton should add 15,000 hours to the regular machine.

With the extra capacity available to it, Pendleton should use its entire capacity to produce HP6. Using all 65,000 hours of capacity to produce HP6 rather than to produce R3 generates additional contribution margin of $325,000 ($1,950,000 ? $1,625,000) which is more than the additional cost of $300,000 to lease the highprecision machine. Pendleton should therefore produce and sell 130,000 units of HP6 (65,000 hours ? 0. 5 hours per unit of HP6) and zero units of R3. 3.

R3 Selling price Variable manufacturing costs per unit Variable marketing costs per unit Total variable costs per unit Contribution margin per unit Contributi on margin per hour of the constraine d resource (the regular machine) $100 60 15 75 $ 25 $25 = $25 1 HP6 $150 100 35 135 $ 15 S3 $120 70 15 85 $ 35 $15 $35 = $30 = $35 0 . 5 1 The first step is to compare the operating profits that Pendleton could earn if it accepted the Carter Corporation offer for 20,000 units with the operating profits Pendleton is currently earning.

S3 has the highest contribution margin per hour on the regular machine and requires no additional investment such as leasing a high-precision machine. To produce the 20,000 units of S3 requested by Carter Corporation, Pendleton would require 20,000 hours on the regular machine resulting in contribution margin of $35 ? 20,000 = $700,000. Pendleton now has 45,000 hours available on the regular machine to produce R3 or HP6. R3 Total contribution margin from selling only R3 or only HP6 R3: $25 ? 45,000; HP6: $30 ? 45,000 Less Lease osts of high-precision machine to produce and sell HP 6 Net relevant benefit HP6 $1,125,000 $1,350,000 ? 300,000 $1,125,000 $1,050,000 Pendleton should use all the 45,000 hours of available capacity to produce 45,000 units of R3. Thus, the product mix that maximizes operating income is 20,000 units of S3, 45,000 units of R3, and zero units of HP6. This optimal mix results in a contribution margin of $1,825,000 ($700,000 from S3 and $1,125,000 from R3). Relative to requirement 2, operating income increases by $325,000 ($1,825,000 minus $1,500,000 calculated in requirement 2).

Hence, Pendleton should accept the Carter Corporation business and supply 20,000 units of S3. 11-23 11-33 (35–40 min. ) Discontinuing a product line, selling more units. 1. The incremental revenue losses and incremental savings in cost by discontinuing the Tables product line follows: Difference: Incremental (Loss in Revenues) and Savings in Costs from Dropping Tables Line Revenues Direct materials and direct manufacturing labor Depreciation on equipment Marketing and distribution General administration Corporate office costs Total costs Operating income (loss) $(500,000) 300,000 0 70,000 0 0 370,000 $(130,000)

Dropping the Tables product line results in revenue losses of $500,000 and cost savings of $370,000. Hence, Grossman Corporation’s operating income will be $130,000 higher if it does not drop the Tables line. Note that, by dropping the Tables product line, Home Furnishings will save none of the depreciation on equipment, general administration costs, and corporate office costs, but it will save variable manufacturing costs and all marketing and distribution costs on the Tables product line. . Grossman’s will generate incremental operating income of $128,000 from selling 4,000 additional tables and, hence, should try to increase table sales. The calculations follow: Incremental Revenues (Costs) and Operating Income $500,000 (300,000) (42,000)* (30,000)† 0** 0** $128,000 Revenues Direct materials and direct manufacturing labor Cost of equipment written off as depreciation Marketing and distribution costs General administration costs Corporate office costs Operating income Note that the additional costs of equipment are relevant future costs for the “selling more tables decision” because they represent incremental future costs that differ between the alternatives of selling and not selling additional tables. †Current marketing and distribution costs which varies with number of shipments = $70,000 – $40,000 = $30,000. As the sales of tables double, the number of shipments will double, resulting in incremental marketing and distribution costs of (2 ? $30,000) – $30,000 = $30,000. *General administration and corporate office costs will be unaffected if Grossman decides to sell more tables. Hence, these costs are irrelevant for the decision. 11-24 11-34 (30 min. ) Discontinuing or adding another division (continuation of 11-33). 1. Solution Exhibit 11-34, Column 1, presents the relevant loss of revenues and the relevant savings in costs from closing the Northern Division. As the calculations show, Grossman’s operating income would decrease by $140,000 if it shut down the Northern Division (loss in revenues of $1,500,000 versus savings in costs of $1,360,000).

Grossman will save variable manufacturing costs, marketing and distribution costs, and division general administration costs by closing the Northern Division but equipment-related depreciation and corporate office allocations are irrelevant to the decision. Equipment-related costs are irrelevant because they are past costs (and the equipment has zero disposal price). Corporate office costs are irrelevant because Grossman will not save any actual corporate office costs by closing the Northern Division. The corporate office costs that used to be allocated to the Northern Division will be allocated to other divisions. . The manager at corporate headquarters responsible for making the decision is evaluated on Northern Division’s operating income after allocating corporate office costs. The manager will evaluate the options as follows: If the manager does not close the Northern Division in 2002, the division is expected to show an operating loss of $110,000 after allocating all corporate office costs. If the manager closes the Northern Division, the division would show an operating loss of $100,000 from the write off of equipment.

It would show no revenues and, hence, would not attract any corporate office costs. It would also not incur any manufacturing, marketing and distribution, and general administration costs. From the viewpoint of maximizing the operating income against which the manager is evaluated, the manager would prefer to shut down Northern Division (and show an operating loss of $100,000 instead of an operating loss of $110,000 by operating it). In fact, the manager might argue that even the $100,000 operating loss is more a consequence of accounting write offs rather than a “real” operating loss.

Recall from requirement 1 that the decision model favored keeping the Northern Division open. The performance evaluation model of the manager making the decision suggests that the Northern Division be closed. Hence, the performance evaluation model is inconsistent with the decision model. 3. Solution Exhibit 11-34, Column 2, presents the relevant revenues and relevant costs of opening the Southern Division (a division whose revenues and costs are expected to be identical to the revenues and costs of the Northern Division).

Grossman should open the Southern Division because it would increase operating income by $40,000 (increase in relevant revenues of $1,500,000 and increase in relevant costs of $1,460,000). The relevant costs include direct materials, direct manufacturing labor, marketing and distribution, equipment, and division general administration costs but not corporate office costs. Note, in particular, that the cost of equipment written off as depreciation is relevant because it is an expected future cost that Grossman will incur only if it opens the Southern Division.

Corporate office costs are irrelevant because actual corporate office costs will not change if Grossman opens the Southern Division. The current corporate staff will be able to oversee the Southern Division’s operations. Grossman will allocate some corporate office costs to the Southern Division but this allocation represents corporate office costs that are already currently being allocated to some other division. Because actual total corporate office costs do not change, they are irrelevant to the division. 1-25 11-34 (Cont’d. ) SOLUTION EXHIBIT 11-34 Relevant-Revenue and Relevant-Cost Analysis for Closing Northern Division and Opening Southern Division Incremental (Loss in Revenues) Revenues and and Savings in (Incremental Costs) Costs from Closing from Opening Northern Division Southern Division (1) (2) $(1,500,000) $1,500,000 825,000 0 205,000 330,000 0 1,360,000 $ (140,000) (825,000) (100,000) (205,000) (330,000) 0 (1,460,000) $ 40,000

Revenues Variable direct materials and direct manufacturing labor costs Equipment cost written off as depreciation Marketing and distribution costs Division general administration costs Corporate office costs Total costs Effect on operating income (loss) 11-35 (30–40 min. ) Make or buy, unknown level of volume (A. Atkinson). 1. Let X = 1 starter assembly. The variable costs required to manufacture 150,000X are: Direct materials Direct manufacturing labor Variable manufacturing overhead Total variable costs $200,000 150,000 100,000 $450,000 The variable costs per unit are $450,000 ? 150,000 = $3. 00 per unit. 11-26 11-35 (Cont’d. The data can be presented in both “all data” and “relevant data” formats: All Data Relevant Data Alternative Alternative Alternative Alternative 1: 2: 1: 2: Buy Make Buy Make Variable manufacturing costs $ 3X – $ 3X – Fixed general manufacturing overhead 150,000 $150,000 – – Fixed overhead, avoidable 100,000 – 100,000 – Division 2 manager’s salary 40,000 50,000 40,000 $50,000 Division 3 manager’s salary 50,000 – 50,000 – Purchase cost, if bought from Tidnish Electronics – 4X – 4X Total $340,000 $200,000 $190,000 $50,000 + $ 3X + $ 4X + $ 3X + $ 4X The number of units at which the costs of make and buy are equivalent is: All data analysis: or Relevant data analysis: $340,000 + $3X = $200,000 + $4X X = 140,000 $190,000 + $3X = $50,000 + $4X X = 140,000

Assuming cost minimization is the objective, then: • If production is expected to be less than 140,000 units, it is preferable to buy units from Tidnish. • If production is expected to exceed 140,000 units, it is preferable to manufacture internally (make) the units. • If production is expected to be 140,000 units, this is the indifference point between buying units from Tidnish and internally manufacturing (making) the units. 2. The information on the storage cost, which is avoidable if self-manufacture is discontinued, is relevant; these storage charges represent current outlays that are avoidable if self-manufacture is discontinued. Assume these $50,000 charges are represented as an opportunity cost of the make alternative.

The costs of internal manufacture that incorporate this $50,000 opportunity cost are: All data analysis: Relevant data analysis: All data analysis: Relevant data analysis: $390,000 + $3X $240,000 + $3X $390,000 + $3X X $240,000 + $3X X = = = = $200,000 + $4X 190,000 $50,000 + $4X 190,000 The number of units at which the costs of make and buy are equivalent is: If production is expected to be less than 190,000, it is preferable to buy units from Tidnish. If production is expected to exceed 190,000, it is preferable to manufacture the units internally. 11-27 11-36 (30 min. ) Make versus buy, activity-based costing, opportunity costs (N. Melumad and S. Reichelstein, adapted). 1. Relevant costs under buy alternative: Purchases, 10,000 ? $8. 0 Relevant costs under make alternative: Direct materials Direct manufacturing labor Variable manufacturing overhead Inspection, setup, materials handling Machine rent Total relevant costs under make alternative $82,000 $40,000 20,000 15,000 2,000 3,000 $80,000 The allocated fixed plant administration, taxes, and insurance will not change if Ace makes or buys the chains. Hence, these costs are irrelevant to the make-or-buy decision. The analysis indicates that Ace should not buy the chains from the outside supplier. 2. Relevant costs under the make alternative: Relevant costs (as computed in requirement 1) Relevant costs under the buy alternative: Costs of purchases (10,000 ? $8. 0) Additional fixed costs Additional contribution margin from using the space where the chains were made to upgrade the bicycles by adding mud flaps and reflector bars, 10,000 ? ($20 – $18) Total relevant costs under the buy alternative $80,000 $82,000 16,000 (20,000) $78,000 Ace should now buy the chains from an outside vendor and use its own capacity to upgrade its own bicycles. 3. In this requirement, the decision on mud flaps and reflectors is irrelevant to the analysis. Cost of manufacturing chains: Variable costs, ($4 + $2 + $1. 50 = $7. 50) ? 6,200 Batch costs, $200/batcha ? 8 batches Machine rent Cost of buying chains, $8. 20 ? 6,200 a $46,500 1,600 3,000 $51,100 $50,840 $2,000 ? 10 batches In this case, Ace should buy the chains from the outside vendor. 11-28 11-37 (60 min. Multiple choice; comprehensive problem on relevant costs. You may wish to assign only some of the parts. Per Unit Fixed Manufacturing costs: Direct materials Direct manufacturing labor Variable manufac. indirect costs Fixed manufac. indirect costs Marketing costs: Variable Fixed Total $1. 00 1. 20 0. 80 0. 50 $1. 50 0. 90 Variable $3. 50 $0. 50 $3. 00 2. 40 $5. 90 0. 90 $1. 40 1. 50 $4. 50 1. (b) $3. 50 Manufacturing Costs Variable $3. 00 Fixed 0. 50 Total $3. 50 2. (e) None of the above. Decrease in operating income is $16,800. Differential $1,440,000+ $ 91,200* 720,000 + 360,000 + 1,080,000+ 360,000 – 120,000 216,000 336,000 $ 24,000 New Old Revenues 240,000 ? $6. 0 Variable costs Manufacturing 240,000 ? $3. 00 Marketing and other 240,000 ? $1. 50 Variable product costs Contribution margin Fixed costs: Manufacturing $0. 50 ? 20,000 ? 12 mos. = Marketing and other $0. 90 ? 240,000 Fixed product costs Operating income *Incremental revenue: $5. 80 ? 24,000 Deduct price reduction $0. 20 ? 240,000 264,000 ? $5. 80 792,000 396,000 1,188,000 343,200 120,000 216,000 $ 7,200 72,000264,000 ? $3. 00 36,000264,000 ? $1. 50 108,000 16,800 –– –– –– – $ 16,800 3 $139,200 48,000 $ 91,200 3. (c) $3,500 If this order were not landed, fixed manufacturing overhead would be underallocated by $2,500, $0. 50 per unit ? 5,000 units.

Therefore, taking the order increases operating income by $1,000 plus $2,500, or $3,500. 11-29 11-37 (Cont’d. ) Another way to present the same idea follows: Revenues will increase by (5,000 ? $3. 50 = $17,500) + $1,000 Costs will increase by 5,000 ? $3. 00 Fixed overhead will not change Change in operating income $18,500 15,000 – $ 3,500 Note that this answer to (3) assumes that variable marketing costs are not influenced by this contract. These 5,000 units do not displace any regular sales. 4. (a) $4,000 less ($7,500 – $3,500) Government Contract As above $3,500 Regular Channels Sales, 5,000 ? $6. 00 Increase in costs: Variable costs only: Manufacturing, 5,000 ? $3. 0 $15,000 Marketing, 5,000 ? $1. 50 7,500 Fixed costs are not affected Change in operating income 5. (b) $4. 15 $30,000 22,500 $ 7,500 Differential costs: Variable: Manufacturing Shipping Fixed: $4,000 ? 10,000 $3. 00 0. 75 $3. 75 ? 10,000 0. 40 ? 10,000 4,000 $4. 15 ? 10,000 $41,500 $37,500 Selling price to break even is $4. 15 per unit. 6. (e) $1. 50, the variable marketing costs. The other costs are past costs, and are, therefore, irrelevant. None of these. The correct answer is $3. 55. This part always gives students trouble. The short-cut solution below is followed by a longer solution that is helpful to students. 7. (e) 11-30 11-37 (Cont’d. Short-cut solution: The highest price to be paid would be measured by those costs that could be avoided by halting production and subcontracting: Variable manufacturing costs Fixed manufacturing costs saved $60,000 ? 240,000 Marketing costs (0. 20 ? $1. 50) Total costs Longer but clearer solution: Comparative Annual Income Statement Present Difference Proposed Revenues Variable costs: Manufacturing, 240,000 ? 3. 00 Marketing and other, 240,000 ? $1. 50 Variable costs Contribution margin Fixed costs: Manufacturing Marketing and other Total fixed costs Operating income $1,440,000 720,000 360,000 1,080,000 360,000 120,000 216,000 336,000 $ 24,000 $ – +132,000 – 72,000 $1,440,000 852,000* 288,000 1,140,000 300,000 60,000 216,000 276,000 $ 24,000 $3. 00 0. 25 0. 30 $3. 55 – 60,000 $ 0 This solution is obtained by filling in the above schedule with all the known figures and working “from the bottom up” and “from the top down” to the unknown purchase figure. Maximum variable costs that can be incurred, $1,140,000 – $288,000 = maximum purchase costs, or $852,000. Divide $852,000 by 240,000 units, which yields a maximum purchase price of $3. 55. 11-31 11-38 (15 min. ) Make or buy (continuation of 11-37). The maximum price Class Company should be willing to pay is $3. 9417 per unit. Expected unit production and sales of new product must be half of the old product (1/2 ? 240,000 = 120,000) because the fixed manufacturing overhead rate for the new product is twice that of the fixed manufacturing overhead rate for the old product.

Proposed Make New Old Present Product Product Total Revenues $1,440,000 $1,080,000 $1,440,000 $2,520,000 Variable (or purchase) costs: Manufacturing 720,000 600,000 946,000* 1,546,000 Marketing and other 360,000 240,000 288,000 528,000 Total variable costs 1,080,000 840,000 1,234,000 2,074,000 Contribution margin 360,000 240,000 206,000 446,000 Fixed costs: Manufacturing 120,000 120,000 120,000 Marketing and other 216,000 60,000 216,000 276,000 Total fixed costs 336,000 180,000 216,000 396,000 Operating income $ 24,000 $ 60,000 $ (10,000) $ 50,000 *This is an example of opportunity costs, whereby subcontracting at a price well above the $3. 50 current manufacturing (absorption) cost is still desirable because the old product will be displaced in manufacturing by a new product that is more profitable.

Because the new product promises an operating income of $60,000 (ignoring the irrelevant problems of how fixed marketing costs may be newly reallocated between products), the old product can sustain up to a $10,000 loss and still help accomplish management’s overall objectives. Maximum costs that can be incurred on the old product are $1,440,000 plus the $10,000 loss, or $1,450,000. Maximum purchase cost: $1,450,000 – ($288,000 + $216,000) = $946,000. Maximum purchase cost per unit: $946,000 ? 240,000 units = $3. 9417 per unit. Alternative Computation Operating income is $9. 00 – $8. 50 = $0. 50 per unit for 120,000 new units Target operating income Maximum loss allowed on old product Maximum loss per unit allowed on old product, $10,000 ? 40,000 = Selling price of old product Allowance for loss Total costs allowed per unit Continuing costs for old product other than purchase cost: Fixed manufacturing costs––all transferred to new product Variable marketing costs Fixed marketing costs Maximum purchase cost per unit $60,000 50,000 $10,000 $0. 0417 $6. 0000 0. 0417 6. 0417 $ – 1. 20 0. 90 2. 1000 $3. 9417 11-32 11-39 (30 min. ) Appendix). 1. Optimal production plan, computer manufacturer (Chapter X = Units of printers Y = Units of desktop computers Objective: Maximize total contribution margin of $200X + $100Y Constraints: For production line 1: 6X + 4Y ? 24 For production line 2: 10X ? 0 Sales of X and Y: X – Y ? 0 Negative production impossible: X 0 ? Y ? 0 2. Solution Exhibit 11-39 presents a graphical summary of the relationships. The sales-mix constraint here is somewhat unusual. The X – Y ? 0 line is the one going upward at a 45-degree angle from the origin. The optimal corner is the point (2, 3), 2 printers and 3 computers. The corner point where the production line 1 and production line 2 constraints meet is X = 2, Y = 3 that can be calculated by solving: 6X + 4Y = 24 (1) Production line 1 constraint 10X = 20 (2) Production line 2 constraint From (2) X = 20 ? 10 = 2 Substituting for X in (1) 6 ? 2 + 4Y = 24 4Y = 24 – 12 = 12 Y = 12 ? = 3 The corner point where the production line 2 constraint and the product-mix constraint meet is X = 2, Y = 2 that can be calculated by solving: 10X = 20 (2) Production line 2 constraint X – Y = 0 (3) Product-mix constraint From (2) X = 20 ? 10 = 2 Substituting for X in (3) Y = 2 Using the trial-and-error method: Trial 1 2 3 4 Corner (X; Y) (0; 0) (2; 2) (2; 3) (0; 6) Total Contribution Margin $ 200(0) + $100(0) = $ 0 200(2) + 100(2) = 600 200(2) + 100(3) = 700 200(0) + 100(6) = 600 The optimal solution that maximizes operating income is 2 printers and 3 computers. 11-33 11-39 (Cont’d. ) SOLUTION EXHIBIT 11-39 Graphic Solution to Find Optimal Mix, Information Technology, Inc. Product Line 1 Constraint Product Y Production in Units 6 Product Line 2

Cost accounting offers benefits for manufacturing companies. A cost accounting information system offers benefits for many companies. Cost accounting is a type of accounting method concerned with the cost of goods manufactured and /or sold. Many factors are taken into consideration when cost accountants analyze business costs . The information determined by these accountants is used for inventory valuation , financial statements and decision making .

Inventory Valuation Cost accounting offers the benefit of having an accurate inventory valuation of all inventories on hand . This includes all raw products used to make goods , all work-in -process inventories and all finished goods ready for sale. Cost accountants take all costs into consideration and are able to determine the value of all of these inventories on hand . This information is useful for financial statements and for management of the company . Managers use this information to determine selling goals and production needs .

Maximum Efficiency Cost accounting is beneficial to determine the maximum efficiency production amounts . Cost accountants take all costs into consideration when calculating this amount . Manufacturing costs consist of direct labor , materials and manufacturing overhead. These costs are all calculated and added up to find a per- unit cost price for manufactured items. When the cost price is calculated, these accountants begin determining a hypothesis of production rates .

Many times cost accountants determine that if production is increased slightly, overhead costs remain the same. If this is the case, increasing production actually results in a lower per -unit cost for production , and the end result is a higher profit . Decision Making The information determined by cost accountants is used for decision making for future company needs . Short -term goals and decisions are made as well as long-term strategic decisions. The analysis of cost information is used to compare projected costs to actual costs .

This is useful for businesses when budgets are created . Often times, unforeseen costs occur with production , and they are determined in this way. Unforeseen costs are added into the future budgets at rates calculated by cost accountants . Cost accounting also helps companies establish approximate future cash flows . Short -term production goals and marketing decisions are set based on this information. Long -term production plans are also calculated.

Cost accounting is a procedure that aims to capture a companys production, to measure the input cost of each production. Cost accounting is frequently used in the company to assist the direction with determination devising. Cost comptrollers are a good as a tool for direction in budgeting and in puting up cost control which improves the net borders of the company in future. Cost comptrollers in traditional fabrication companies would normally do usage of machines that automate certain operations. Production activity is measured in machine hours.

Traditional fabrication is besides labour intensive where there are high labor costs and low operating expenses. Traditional fabrication allocates the companies ‘ indirect cost to the points produced in order of their volume, figure of units produced, direct labor hours and machine hours. The usage of machine hours implies that machine hours are cause footing of the mill operating expense, this deduction is done when merely machine hours are used to apportion the fabricating operating expense to merchandises. Cost comptrollers in traditional fabrication companies use a individual caput pool, this method of apportioning indirect costs normally consequences in the wrong cost of informations. Merchandises with high volumes have high labor costs likewise merchandises with lower volumes would normally be understated and be ignored. Traditional fabrication companies cost comptrollers are needed to assist in the managing of costs which is normally non an easy undertaking to make, but the cost comptrollers have found a manner of pull offing them.

Modern fabrication was developed to work out the complexness of running a immense concern. Modern fabrication companies make use computing machines and robotics ; they control the whole production/manufacturing procedure. Cost comptrollers would normally necessitate modern fabrication companies because they have an built-in flexibleness to supply particular studies and assist direction with determination doing sing cost activities undertaken. Modern fabrication houses are normally non forced to stay by the fiscal coverage demands. Modern fabrication companies would normally delegate costs to activities and merchandises based on how the costs and resources are consumed by the procedure or merchandise. Cost comptrollers are needed in the modern fabrication companies because it gives them a clearer image of cost of procedure and the profitableness of clients and merchandises. They are besides needed because it would assist them with budgeting techniques for the truth of fiscal prognosis and besides increasing the comprehension of the directors. Cost comptrollers are needed in the modern fabrication companies because modern fabrication houses use computing machines and robotics this helps in the quick and accurate production of fiscal programs to assist the comptrollers in wise determination devising. Productivity is truly improved in modern fabrication companies because there is a wider set of related component here, which is computing machines and robotics.

Absorption costing is no longer for modern auto manufacturer such as BMW discuss.

Your reply should include suggestions of other bing methods that are more relevant for a modern auto manufacturer and supply your accounts.

Absorption costing is absorbing all the fabrication through units produced. It absorbs all the direct labor, direct stuffs, with all the variable and fixed costs. It is By and large Accepted Accounting Principles which means it is used for external coverage.

Absorption costing because it absorbs all the cost is non suited for modern fabrication houses, because with this bing pricing is lesser extent than it appears to be in the instance. Cost is calculated to make up one’s mind how much net income you have made, and so the monetary value while be set. Because absorbs all the costs, that establishes the fact that it does non recognize the importance fixed costs. This makes it difficult to distinguish between fixed and variable costs. The variableness of net incomes besides causes confusion because the gross revenues and stock alteration. Absorption bing recognises the importance of fixed costs in production by including them in the production procedure. It is used to fix fiscal histories. When production remains changeless while gross revenues rise and autumn irregularly in figure this method will demo a less fluctuation in net net income.

Absorption costing is non suited for the modern auto makers like BMW because it is non so utile to the direction to do wise determinations, to be after and command that is it does non assist directors to develop the company ‘s mission and aims to be the decisive factor in carry throughing them and non set uping public presentation criterions, mensurating and describing existent public presentation and comparing them to take a disciplinary action as necessary. This truly shows that it is non suited fabricating companies like BMW because they need to utilize the cost information for good determination devising intents and budgeting. But instead modern fabrication houses like BMW need to utilize Activity Based Costing because is the method of bing that assigns costs to their activities based on the resources instead than merchandises or services. Other costs and resources are equally distributed to the merchandises and services they use. This method does non extinguish any costs ; it gives more information and takes into history how costs are consumed. This method is suited for BMW because BMW is involved process betterment and reduction costs.

Activity Based Costing assigns all the single activities involved in the fabrication procedure are accurately costed, that is it makes seeable waste and non value added. Therefore doing it easier to place the cost of each procedure. It uses unit cost instead entire cost. It facilitates benchmarking which means there is a standard mention against which things can be compared and assessed. It provides a better apprehension of operating expenses and it is easy understood by everyone because since companies like BMW discloses their fiscal studies to the populace they can understand why things are the manner they are. Activity Based Costing helps with future merchandise planning because for illustration all the activities associated with BMW can be accurately determined before it is launched. This can besides assist to find the monetary value and other outgos.

The minimal monetary value that should be quoted to the new purchaser is ?174, 240 ( working 4 ) . This is because this monetary value includes all the alteration work costs. MM should accept the offer made by the new purchaser because it more than the sum willing to be paid by the first purchaser. MM should besides disregard the ?2000 sedimentation made by the original purchaser because it is a historical cost that is it is a cost that has already occurred therefore doing it an irrelevant cost. I would besides advice MM to go on with alterations asked for by the new purchaser as would convey him more net income than of the original purchaser. The net incomes made would besides assist him to cover the costs he incurred when doing the alterations.

This report was originated to make a study about the cost accounting system of Beximco Pharmaceuticals Ltd. for the requirement of completion of 1st semester of Master of Business Administration (MBA) program of the Department of Accounting & Information Systems, University of Dhaka. This term paper was an attempt to acquaint the students with the real world situations so that the knowledge gained from the classroom is further strengthened.

As the classroom discussion alone cannot make a student perfect in handling the real business situation, therefore it is an opportunity for the students to know about the real life situation through this term paper.

Background of the Report

The importance of cost accounting and cost accounting information is being increased day by day. It is not only help to reduce cost but also in all kind of decision making. Without analysis of cost accounting information no manager can make effective decision. The cost accounting collects the data, analyze those data and help the managers to make better decision.

In accordance with development of new tools and techniques of cost accounting the use of cost accounting information is changing. Managers need to use the cost accounting information in different way from traditional method to evaluate the performance. Developing and accepting the JIT, TQM and other contemporary costing techniques force to manager to change the performance evaluation techniques and requires different cost accounting information unlike traditional labor based information now a day’s which become obsolete.

Primarily this report is concerned with cost accounting information by an organization in decision making as well as corporate reporting, the tools and techniques used by organizations and the implications of these in the organization. We select Beximco Pharma to examine the use of cost accounting information and cost accounting tools and techniques used by the company. We emphasize on the implication of using information and technique and examine whether Beximco Pharma use or not that particular techniques and the reason of following or not following based on our queries to respective authority of the company.

Scope of the Report:

This report is limited to the cost accounting department of the Beximco Pharma including cost accounting systems procedure and techniques. Since Beximco want to achieve top quality along with cost control it uses its cost accounting information very strongly. This report covers only the use of cost accounting information for the purpose of decision making and coporate reporting not overall performance of the Beximco Pharma.

Objective of the Report:

• to have a general idea about cost accounting information and its use in decision making.
• To have clear understanding about the cost accounting system used by Beximco Pharma. . Finding out the disclosure of cost accounting information used by the company.
• To draw a conclusion based on our understanding of Beximco Pharma.

Methodology of the Report: The details of the work plan are furnished below

The data and information for this report have been collected from both the primary and secondary sources. Among the primary sources, face to face conversation with the respective stuffs of the head office. The secondary sources of information are annual reports, websites, and study of relevant reports, documents and different manuals.

Data processing Data collected from primary and secondary sources have been processed manually and qualitative approach in general and quantitative approach in some cases has been used throughout the study. Data analysis and interpretation Qualitative approach has been adopted for data analysis and interpretation taking the processed data as the base.

Organization of the Report

This report is divided in to mainly 5 parts. The 1st part is introductory part that states the origin, background, scope, objectives, methodology of the report. The 2nd part is the literature review of the study.

This part explains the cost accounting information and its use in decision making by the managers. The next part discusses about the cost accounting system of Beximco Pharma. The 4th part finds out the contemporary methods and techniques of cost accounting used in Beximco Pharma. The last part concludes the report with some recommendation.

Limitation of the Report

There were some limitations in the preparation of the report. The source of the cost accounting system of the company was mainly based on their financial reports of different.

Though we conducted the responsible authority, they were reluctant to give us the full disclosure about their management policies. Because of such information is prepared for the management for internal use only, this was not available. Moreover, most of them were confidencial. Other limitations were our time constraint and resources to prepare an effective term paper on this topic.

Cost Accounting Information:

In a broad aspect, cost accounting refers to the measurement, analysis, and reporting financial and nonfinancial information relating to the cost of acquiring or using resources in an organization.

So cost accounting can be defined as the information obtained from cost accounting activities. For example, calculating the cost of product is a cost accounting function that answers manager’s decision making needs (such as choosing products to offer). Modern cost accounting takes the perspective that collecting cost information is a function of the management decision being made. Cost accounting information helps the manager in short-run and long-run planning and control decisions that increase value for the customers and lower the costs of products and services.

For example, managers make decisions regarding the amounts and kinds of material being used, changes in plant processes, and changes in product designs.

Cost Accounting Information in Decision Making:

For making decision by using cost accounting information cost accountant usually follow some specific models. They use different decision model for different courses of action. Management accountants work with manager by analyzing and presenting relevant data to guide decisions. For example, if any organization wants to reduce its existing manufacturing costs it must dentify the alternatives then it will analyze the alternatives by using only relevant data i. e. , which can influence the decisions. For making decision managers usually use five step decision process which is described below: Historical Costs Step-5 Step-4 Step-1 Obtain information Step-2 Step-3 Other Information Make prediction about future costs Specific prediction Choose an alternative Implement the decision Evaluate performance

Factors regarding decision making using cost accounting information: There are several factors that affect the decision making procedure of the managers.

Some important factors are discussed here: a. Relevant costs and relevant revenues: Relevant costs are expected future costs and relevant revenues are expected future revenues that differ among the alternative courses of action being considered. Both relevant costs and relevant revenues must occur in future and they differ among the alternative courses of action. Focusing on the relevant data is especially helpful when all the information needed to prepare detailed income information is unavailable.

Understanding which costs are relevant and which are irrelevant helps the decision maker concentrate on obtaining only the pertinent data and saves time.

Qualitative and quantitative relevant information: Manager defines and weighs qualitative and quantitative information.

Quantitative information are those which can be measured by the numerical number and qualitative information are those which cannot be measured by the number and off course manager will decide which one is measurable by the number and which one is not.

Relevant cost analysis generally emphasis on quantitative factors but qualitative factors also have their own importance.

One time only special orders: When factory has idle production capacity then manager must decide whether accepting or rejection special orders if special order has no long implications. Example: if any company has capacity to produce 18000 units and currently producing 16000 units. The total cost (fixed-5 and variable-5) per unit is tk. 10. If they got an order to deliver 4000 units for tk. 6 per unit they should accept it.

But if they get the order of 5000 units they should not accept it because it crosses its relevant range. To make decision about special onetime order only relevant cost should be considered. A common term in decision making is incremental cost which means additional cost for producing every additional unit is also important in this regard. d. Insourcing Vs. Outsourcing and Make Vs. Buy decision: Outsourcing or Bye decision is purchasing goods and services from outside rather than producing in inside of the organization. Whether bye or make is sometimes influenced by qualitative factors.

For example coca-cola company will never do outsourcing due to secrecy of the formula, know-how, and technology. In order to make decision if bye or make manager usually take into consideration about quality, dependability, material handling and set-up activity. And off course manager does cost benefit analysis based relevant cost information. e. Focusing on grand total: Manager will focus on grand total cost in making decision rather than unit cost. Sometimes unit cost could be misleading. If we want to make decision about make or buy, insourcing vs. utsourcing we need to consider total cost not unit cost. f. Using constrained resources: Under this condition, manager should select the product that yields the highest contribution margin per unit of the constraining or limiting resources. g. In deciding whether add or drop customer or to add or discontinue segment: Manager should focus on whether total overhead cost change in making decision about adding or dropping customer or adding or discontinuing segment. Manager should ignore allocating overhead cost. h. Replacement of equipment:

In the time of equipment replacement existing book value is irrelevant because it is a sunk cost so it should be ignored. i. Concentrate on consistency on performance evaluation: There is always a confliction between the decision model used by a manager and the performance model used to evaluate that manager. Top management must ensure that the performance evaluation model will be consistent with decision model. A common inconsistency is to tell these managers to take a multiple year view in their decision making but then to judge their performance only on the basis of current year’s operating income.

If there is no consistency between performance evaluation and performance model then control will be impossible and making decision model will be valueless.

Cost Accounting Information in Corporate Reporting:

The main purpose of cost accounting information is to help managers in decision making. Such information is provided for the internal purpose only. There are some guided rules and regulations about the information in the reports. According to IAS 1 (Presentation of Financial Statements), aragraph 117, ‘’ An entity shall disclose in the summary of significant accounting policies: (a) the measurement basis (or bases) used in preparing the financial statements, and (b) the other accounting policies used that are relevant to an understanding of the financial statements. ” It is important for an entity to inform users of the measurement basis or bases used in the financial statements (for example, historical cost, current cost, net realizable value, fair value or recoverable amount) because the basis on which an entity prepares the financial statements significantly affects users’ analysis.

When an entity uses more than one measurement basis in the financial statements, for example when particular classes of assets are revalued, it is sufficient to provide an indication of the categories of assets and liabilities to which each measurement basis is applied. According to paragraph 125 of the same IAS, “An entity shall disclose information about the assumptions it makes about the future, and other major sources of estimation uncertainty at the end of the reporting period, that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next financial year.

In respect of those assets and liabilities, the notes shall include details of: (a) their nature, and (b) their carrying amount as at the end of the reporting period. ” An entity presents the disclosures in paragraph 125 in a manner that helps users of financial statements to understand the judgements that management makes about the future and about other sources of estimation uncertainty. The nature and extent of the information provided vary according to the nature of the assumption and other circumstances.

Examples of the types of disclosures an entity makes are: (a) the nature of the assumption or other estimation uncertainty; (b) the sensitivity of carrying amounts to the methods, assumptions and estimates underlying their calculation, including the reasons for the sensitivity; (c) the expected resolution of an uncertainty and the range of reasonably possible outcomes within the next financial year in respect of the carrying amounts of the assets and liabilities affected; and (d) an explanation of changes made to past assumptions concerning those assets and liabilities, if the uncertainty remains unresolved.

Other IFRSs require the disclosure of some of the assumptions that would otherwise be required in accordance with paragraph 125. For example, IAS 37 requires disclosure, in specified circumstances, of major assumptions concerning future events affecting classes of provisions. IFRS 7 requires disclosure of significant assumptions the entity uses in estimating the fair values of financial assets and financial liabilities that are carried at fair value.

IAS 16 requires disclosure of significant assumptions that the entity uses in estimating the fair values of revalued items of property, plant and equipment. There are also some guidelines for reporting cost accounting information in IAS 2: Inventories. The objective of this Standard is to prescribe the accounting treatment for inventories. A primary issue in accounting for inventories is the amount of cost to be recognised as an asset and carried forward until the related revenues are recognised.

This Standard provides guidance on the determination of cost and its subsequent recognition as an expense, including any write-down to net realizable value. It also provides guidance on the cost formulas that are used to assign costs to inventories. Measurement of inventories Inventories shall be measured at the lower of cost and net realisable value. Cost of inventories The cost of inventories shall comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.

Costs of purchase The costs of purchase of inventories comprise the purchase price, import duties and other taxes (other than those subsequently recoverable by the entity from the taxing authorities), and transport, handling and other costs directly attributable to the acquisition of finished goods, materials and services. Trade discounts, rebates and other similar items are deducted in determining the costs of purchase. Costs of conversion

The costs of conversion of inventories include costs directly related to the units of production, such as direct labour. They also include a systematic allocation of fixed and variable production overheads that are incurred in converting materials into finished goods. Fixed production overheads are those indirect costs of production that remain relatively constant regardless of the volume of production, such as depreciation and maintenance of factory buildings and equipment, and the cost of factory management and administration.

Variable production overheads are those indirect costs of production that vary directly, or nearly directly, with the volume of production, such as indirect materials and indirect labour. The allocation of fixed production overheads to the costs of conversion is based on the normal capacity of the production facilities. Normal capacity is the production expected to be achieved on average over a number of periods or seasons under normal circumstances, taking into account the loss of capacity resulting from planned maintenance.

The actual level of production may be used if it approximates normal capacity. The amount of fixed overhead allocated to each unit of production is not increased as a consequence of low production or idle plant. Unallocated overheads are recognised as an expense in the period in which they are incurred. In periods of abnormally high production, the amount of fixed overhead allocated to each unit of production is decreased so that inventories are not measured above cost.

Variable production overheads are allocated to each unit of production on the basis of the actual use of the production facilities. A production process may result in more than one product being produced simultaneously. This is the case, for example, when joint products are produced or when there is a main product and a by-product. When the costs of conversion of each product are not separately identifiable, they are allocated between the products on a rational and consistent basis.

The allocation may be based, for example, on the relative sales value of each product either at the stage in the production process when the products become separately identifiable, or at the completion of production. Most by-products, by their nature, are immaterial. When this is the case, they are often measured at net realisable value and this value is deducted from the cost of the main product. As a result, the carrying amount of the main product is not materially different from its cost. Disclosure of Inventory in Financial Statesments The financial statements shall disclose: a) the accounting policies adopted in measuring inventories, including the cost formula used; (b) the total carrying amount of inventories and the carrying amount in classifications appropriate to the entity; (c) the carrying amount of inventories carried at fair value less costs to sell; (d) the amount of inventories recognised as an expense during the period; (e) the amount of any write-down of inventories recognised as an expense in the period in accordance with paragraph 34; (f) the amount of any reversal of any write-down that is recognised as a reduction in the amount of inventories recognised as expense in the period in accordance with paragraph 34; (g) the circumstances or events that led to the reversal of a write-down of inventories in accordance with paragraph 34; and (h) the carrying amount of inventories pledged as security for liabilities. Information about the carrying amounts held in different classifications of inventories and the extent of the changes in these assets is useful to financial statement users. Common classifications of inventories are merchandise, production supplies, materials, work in progress and finished goods. The inventories of a service provider may be described as work in progress.

The amount of inventories recognised as an expense during the period, which is often referred to as cost of sales, consists of those costs previously included in the measurement of inventory that has now been sold and unallocated production overheads and abnormal amounts of production costs of inventories. The circumstances of the entity may also warrant the inclusion of other amounts, such as distribution costs.

An overview of Beximco Pharma Beximco Pharmaceuticals Ltd. is a leading edge pharmaceutical company and is a member of the BEXIMCO Group, the largest private sector industrial conglomerate in Bangladesh. The strategic strengths of Beximco Pharma are its strong brand recognition, highly skilled work force and diversified business mix.

Beximco Pharma brands – Neoceptin R (Ranitidine), Napa (Paracetamol), Amdocal (Amlodipine), Neofloxin (Ciprofloxacin), Bexitrol F (Salmeterol Plus Fluticasone), Bextrum Gold (Multivitamin and Multi Mineral) and Atova (Atorvastatin) are among the most recognized brands in the Bangladesh Pharmaceutical industry. Beximco Pharma started its operation in 1980, manufacturing products under the licenses of Bayer AG of Germany and Upjohn Inc. of USA and now has grown to become nation’s one of the leading pharmaceutical companies, supplying 15% of country’s total medicine need. Today Beximco Pharma manufactures and markets its own `branded generics’ for almost all diseases from AIDS to cancer, from infection to asthma, from hypertension to diabetes, both nationally and internationally.

Beximco Pharma manufactures a range of dosage forms including tablets, capsules, dry syrup, powder, cream, ointment, suppositories, large volume intravenous fluids, metered dose inhalers etc. in several world-class manufacturing plants, ensuring high quality standards complying with the World Health Organization (WHO) approved current Good Manufacturing Practices (cGMP). The recipient of three times `gold’ national export trophy, Beximco Pharma is the largest exporter of pharmaceuticals from Bangladesh, spreading its presence in many developing and developed countries across the globe. Beximco Pharma is the only company in Bangladesh to receive this highest national accolade for export, for record three times. Beximco Pharma markets its brands through professional sales and marketing teams in African, Asian and European markets.

It also supplies its products to renowned hospitals and institutions in many countries, including Raffles Hospital and K K Women & Children Hospital in Singapore, MEDS and Kenyatta National Hospital (KNH) in Kenya, Jinnah Hospital, Agha Khan Hospital and Shaukat Khanum Memorial Hospital in Pakistan. Beximco Pharma is also an enlisted supplier of WHO and UNICEF. Another important business activity of Beximco Pharma is the contract manufacturing for major international brands of leading multinational companies. Beximco Pharma is acclaimed domestically and internationally for its outstanding product quality, world class manufacturing facilities, product development capabilities and outstanding service.

Beximco Pharma has a strong market focus and is anticipating continued future growth by leveraging business capabilities and developing superior product brands and markets. In particular the company is very interested in developing a strong export market in USA and Europe. To meet the future demand Beximco Pharma has invested US$ 50 million to build a new state-of-the-art manufacturing plant, confirming to USFDA and UK MHRA standards. This new plant will also offer contract-manufacturing facility to leading pharmaceutical companies, especially from Europe and US. 3. 2 Cost Accounting System of the company: The company primarily uses batch costing method in their costing system.

As a pharmaceuticals manufacturing company they need to produce huge amount of product so here batch costing is appropriate for the company. Here it is cost effective and easy to calculation. Batch costing has the several advantages over other methods in regard of the providing following information: -the analysis and the cost control at each cost generator; -the operative management of each place generator of costs, the specification of the production and of the predicted costs and their control and realization; -the correct assessment of the produced stocks; -determination of the efficiency obtained by the taken decisions. The company uses weighted average method in time of inventory valuation.

They believe that it gives more accurate and clear picture of inventory. In this method it is very hard to manipulate and easy to calculate though it has a limitation that it sometimes can’t represent inflation.

Valuation of Inventories:

Inventories are carried at the lower of cost and net realizable value as prescribed by IAS 2: Inventories. Cost is determined on weighted average cost basis. The cost of inventories comprises of expenditure incurred in the normal course of business in bringing the inventories to their present location and condition. Net realizable value is based on estimated selling price less any further costs expected to be incurred to make the sale.

Cost included for the local raw materials purchased are 1) Procurement Cost. 2) Transportation Cost 3) Bank Charge Cost included for the imported raw materials are 1) Procurement Cost 2) Bank Charge for Opening L/C 3) Insurance 4) Clearing from the Port and 5) Transportation Cost. 3. 4 Disclosure of Inventory in Financial Statements According to IAS 2: Inventories, the Company disclosed the following information regarding inventory: (a) The Company uses weighted average method in measuring the inventories. (b) The total carrying amount of inventories is tk 1,739,818,419.

Contemporary cost accounting methods and techniques used by Beximco Pharma: Beximco Pharmaceuticals Ltd is a leading company in our country. To compete with the other companies in the industry, Beximco Pharma uses several contemporary methods and techniques. Mass production of a mature product with known characteristics and a stable technology was the basis of traditional cost accounting models. Anyway, Beximco Pharma, with automation, lessened the labor content in manufacturing process while the other costs in the company are increased. Flexible manufacturing system: Flexible manufacturing systems use computer controlled production processes, ncluding CAD/CAM programmable machine tools. Because flexible manufacturing reduces setup or changeover times, companies can efficiently manufacture a wide variety of products in small batches. Though Beximco Pharma can adopt flexible manufacturing system, it merely reduces the size of the batch. Total quality management: Total Quality Management refers (TQM) to the process of continuous improvement to achieve the full customer satisfaction. Rather than waiting to inspect items at the end of the production line or striving to stay within acceptable tolerance limit, TQM’s goal is eliminating all waste. In Beximco Pharma, quality is maintained with great care.

As it is a pharmaceutical company, it is mandatory to keep up with the quality level with the other companies. As a result, they have received GMP Clearance from Therapeutic Goods Administration (TGA) of Australia and from Gulf Central Committee for Drug Registration, Executive Board of the Health Ministers’ Council for Gulf Cooperation Council (GCC) states (representing Saudi Arabia, Kuwait, Bahrain, United Arab Emirates, Qatar and Oman). The company is also in the process of obtaining approvals from several other regulatory authorities including National Health Surveillance Agency (ANVISA) of Brazil, Medicine and Healthcare Regulatory Agency of United Kingdom (UK MHRA), US FDA etc. Just in Time Concept:

The Just in Time (JIT) minimizes throughput time by emphasizing continuous improvements. JIT reduces inventories by achieving a continuous production process. In JIT system, employees keep on hand only the inventory needed to production until the next order arrives. Having fewer goods in hand not only requires less warehouse spaces and storage equipment but also reduces inventory holding cost, while realizing productivity. For implementing JIT, company must need a strong supply chain system. In Beximco Pharma, they can’t follow JIT because most of the inventory or raw materials are come from abroad so it is impossible to implement JIT in Beximco Pharma.

If they want to implement JIT their cost will be higher rather than being lower because here ordering cost is very high as raw materials are imported. Beximco use EOQ model to determine their ordering size and they have large storage facilities. Pull Rather than push system: Pull system refers to decision will come from downstream of management. The factory production line operates on a demand pull basis. A pull system can only work while manufacturing process can react to a pull system. However Beximco Pharma doesn’t follow the pull system they use push system. The authority of Beximco Pharma believes that push system is more effective than pull in the context of Bangladesh.

Because of JIT is not possible in the firm, pull system is difficult to implement because in pull system it is believed that it is better not to produce unnecessary products and do not keep inventory in hand. Activity-Based Management: The activity-based management system links resources consumption to the activities a company performs and cost the activities to product or customers. Activity-based management uses activity based costing systems to measure and control this relationship. In Beximco Pharma there is no such use activity cost driver to measure the cost of a product. The traditional system is used to determine the cost of the product.

Life Cycle Costing:

Life cycle costing tracks and determines the cost attributed to each product and service from its initial research and development to development to final marketing to customer. In Beximco Pharma, this type activities is done in mainly in the Central Product Management (CPM) Department. The activities of CPM are:

• Market research
• Selection of new product
• Design and testing of product (DTP)
• Sample store (logistics) management
• Making strategy The department deals with the controllable marketing variables, the 4p’s.

This department takes decisions in the following areas:

• Product – Size, color, shape, packaging etc.
• Price – Raw materials cost, customer ability, regulatory body’s approval etc.
• Promotion – Promotional aids include brochure, pads, folder, and plant visit by physicians, health-related people, students, and people of different student.

Other than this department, in January, 2000, the Business Research ; Development department was established.

The functions that are done by this department are:

• Outsourcing negotiated
• New product study
• New technology study
• Project feasibility study
• Commercial negotiation
• Observing the world pharmaceuticals market

With these departments, Beximco Pharma determines the Life Cycle of the products.

Target Costing: Target costing is an approach which determines what a product or service should cost based on its sales price less a target profit.

Unlike traditional costing for making up cost, it is a market driven way of examining the relationship of price and cost. In Beximco Pharma, the use of Target Costing is very common to make the target for the cost of the product. Change In performance Evaluation: The adoption of JIT, life cycle costing and other innovative techniques requires new performance evaluation techniques rather than traditional productivity measures because it is irrelevant in this context. The use of single short term profit measure may not be sufficient because it is not reliable indicator of managers’ ability. Profit may be increased by doing some activities which are not conform to companies overall organizational goal.

Goal Congruence: this performance measures should encourage manager to achieve overall organizational goal. The Beximco Pharma does not explain the measurement of the performance of the employees. In general, some marketing employees get benefited if the sales volume is high. But the total performance evaluation system depends in the decision of the management. Concluding Remarks: Beximco Pharmaceuticals Ltd. is a leading edge pharmaceutical company and is a member of the BEXIMCO Group, the largest private sector industrial conglomerate in Bangladesh. Beximco Pharma is also the largest exporter of pharmaceuticals from Bangladesh, spreading its presence in many developing and developed countries across the globe.

Recently, BPL has successfully made its footmark in the global market when it made its debut on the London Stock Exchange as the first Bangladeshi company to be listed in the world’s most prestigious bourse. This milestone event has widened the responsibility, accountability and transparency of the company beyond geographical border. The listing adds new challenges to the staffs of Accounts & Finance department who are directly responsible for financial reporting to a diverse group of stakeholders both in national and international arena. In this report, we have tried my level best to identify cost accounting techniques and procedures used by Beximco Pharma.

What and how Beximco Pharma use cost accounting information for decision making and external financial reporting along with describing the procedure and systems of using cost accounting information. In this report, we imply our acquired knowledge from cost accounting course and try to comply with the techniques procedure and systems followed by the company. Beximco believes that quality and control should be ensured and these can be ensured by using proper cost accounting information. Relevant and reliable cost information can be ensured by implementing by using effective cost accounting methods. And they do the best one fit in the context of Bangladesh.

References:

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3. Hansen, Don R. , Mowen Maryanne M. ; “Cost Management: Accounting and Control”; South-Western College Pub; 5th edition, 2005.
4. “International Financial Reporting Standard”; International Accounting Standard Board; as approved at 1 January, 2008.
5. http://www. beximco-pharma. com
6. http://britannica. com
7. http://en. wikipedia. org
8. http://www. bizmanualz. com
9. http://www. iasplus. com

Cost Accounting, 14e (Horngren/Datar/Rajan) Chapter 20 Inventory Management, Just-in-Time, and Simplified Costing Methods Objective 20. 1 1) Which of the following industries would have the highest cost of goods sold percentage relative to sales? A) computer manufacturers B) retail organizations C) drug manufacturers D) The percentage will usually depend on the success of a particular company. Answer: B Diff: 2 Terms: inventory management Objective: 1 AACSB: Reflective thinking 2) The costs of goods acquired from suppliers including incoming freight or transportation costs are: A) purchasing costs

B) ordering costs C) stockout costs D) carrying costs Answer: A Diff: 2 Terms: purchasing costs Objective: 1 AACSB: Reflective thinking 3) The costs of preparing, issuing, and paying purchase orders, plus receiving and inspecting the items included in orders is: A) purchasing costs B) ordering costs C) stockout costs D) carrying costs Answer: B Diff: 2 Terms: ordering costs Objective: 1 AACSB: Reflective thinking 4) The costs that result from theft of inventory are: A) shrinkage costs B) external failure costs C) stockout costs D) costs of quality Answer: A Diff: 2 Terms: shrinkage

Objective: 1 AACSB: Reflective thinking 5) The costs that result when a company runs out of a particular item for which there is a customer demand are: A) shrinkage costs B) shortage costs C) stockout costs D) EOQ estimation costs Answer: C Diff: 2 Terms: stockout costs Objective: 1 AACSB: Reflective thinking 6) The costs that result when features and characteristics of a product or service are NOT in conformance with the specifications are: A) inspection costs B) costs of quality C) purchasing costs D) design costs Answer: B Diff: 2 Terms: stockout costs Objective: 1 AACSB: Reflective thinking ) The costs that result when a company holds an inventory of goods for sale: A) purchasing costs B) carrying costs C) opportunity costs D) interest costs Answer: B Diff: 2 Terms: stockout costs Objective: 1 AACSB: Reflective thinking 8) Quality costs include: A) purchasing costs B) ordering costs C) stockout costs D) prevention costs Answer: D Diff: 2 Terms: quality costs Objective: 1 AACSB: Reflective thinking Answer the following questions using the information below: The following information applies to Labs Plus, which supplies microscopes to laboratories throughout the country.

Labs Plus purchases the microscopes from a manufacturer which has a reputation for very high quality in its manufacturing operation. Annual demand (weekly demand=1/52 of annual demand)20,800 units Orders per year20 Lead time in days15 days Cost of placing an order$100 9) What is the reorder point? A) 1,040 units B) 857 units C) 1,560 units D) 2,080 units Answer: B Explanation: B) 20,800/52 = 400/7 = 57. 14 daily demand ? 15 = 857. 1 Diff: 2 Terms: reorder point Objective: 1 AACSB: Analytical skills 10) Retailers generally have a high percentage of net income to revenues. Answer: FALSE

Explanation: Retailers have a low percentage of net income to revenues. Diff: 2 Terms: inventory management Objective: 1 AACSB: Analytical skills 11) Inventory management is the planning, organizing, and controlling activities that focus on the flow of materials into, through, and from the organization. Answer: TRUE Diff: 2 Terms: inventory management Objective: 1 AACSB: Analytical skills 12) Purchasing costs arise in preparing and issuing purchase orders, receiving and inspecting the items included in the orders, and matching invoices received, purchase orders, and delivery records to make payments.

Answer: FALSE Explanation: Ordering costs arise in preparing and issuing purchase orders, receiving and inspecting the items included in the orders, and matching invoices received, purchase orders, and delivery records to make payments. Diff: 2 Terms: purchasing costs Objective: 1 AACSB: Analytical skills 13) The opportunity cost of the stockout includes lost contribution margin on the sale NOT made plus any contribution margin lost on future sales due to customer ill will. Answer: TRUE Diff: 2 Terms: stockout costs

Objective: 1 AACSB: Analytical skills 14) Carrying costs arise when an organization experiences an ability to deliver its goods to its customers. Answer: FALSE Explanation: Carrying costs arise when an organization holds its goods for sale. Diff: 2 Terms: carrying costs Objective: 1 AACSB: Analytical skills 15) Shrinkage is measured by adding (a) the cost of the inventory recorded on the books in the absence of theft and other incidents just mentioned, and (b) the cost of inventory when physically counted. Answer: FALSE

Explanation: Shrinkage is measured by the difference between (a) the cost of the inventory recorded on the books in the absence of theft and other incidents just mentioned, and (b) the cost of inventory when physically counted. Diff: 2 Terms: shrinkage Objective: 1 AACSB: Analytical skills 16) Shrinkage costs result from theft by outsiders, embezzlement by employees, misclassifications, and clerical errors. Answer: TRUE Diff: 2 Terms: shrinkage Objective: 1 AACSB: Analytical skills 17) All inventory costs are available in financial accounting systems. Answer: FALSE

Explanation: Opportunity costs are rarely recorded in formal accounting systems and they are often a very significant cost component. Diff: 2 Terms: shrinkage Objective: 1 AACSB: Analytical skills 18) Sharing inventory data throughout the supply chain leads to more “rush” orders occurring. Answer: FALSE Explanation: Sharing inventory data throughout the supply chain leads to fewer “rush” orders occurring. Diff: 2 Terms: inventory management Objective: 1 AACSB: Analytical skills 19) Managing inventories to increase net income requires companies to effectively manage costs associated with goods for sale.

Required: Classify the below listed items as either Purchasing Costs, Ordering Costs, Carrying Costs, Stockout Costs, Costs of Quality, or Shrinkage Costs. ________________a. costs of obtaining purchase approvals ________________b. costs resulting from embezzlement by employees ________________c. internal failure costs ________________d. opportunity cost of the investment tied up in inventory ________________e. spoilage of stored items ________________f. costs of lost sales as a result of not having an item requested by a customer ________________g. costs of incoming freight ________________h. osts of matching invoices received to the items and the purchase orders ________________i. costs of wages for work-in-process inspections ________________j. costs that result from clerical errors Answer: a. Ordering Costs b. Shrinkage Costs c. Costs of Quality d. Carrying Costs e. Carrying Costs f. Stockout Costs g. Purchasing Costs h. Ordering Costs i. Costs of Quality j. Shrinkage Costs Diff: 2 Terms: costs associated with goods for sale Objective: 1 AACSB: Analytical skills Objective 20. 2 1) Obsolescence is an example of which cost category? A) carrying costs B) labor costs C) ordering costs

D) quality costs Answer: A Diff: 2 Terms: carrying costs Objective: 2 AACSB: Reflective thinking 2) The costs associated with storage are an example of which cost category? A) quality costs B) labor costs C) ordering costs D) carrying costs Answer: D Diff: 2 Terms: carrying costs Objective: 2 AACSB: Reflective thinking 3) Which of the following is an assumption of the economic-order-quantity decision model? A) The quantity ordered can vary at each reorder point. B) Demand ordering costs and carrying costs fluctuate. C) There will be timely labor costs. D) No stockouts occur. Answer: D Diff: 2

Terms: economic order quantity (EOQ) Objective: 2 AACSB: Reflective thinking 4) The economic order quantity ignores: A) purchasing costs B) relevant ordering costs C) stockout costs D) Both A and C are correct. Answer: D Diff: 3 Terms: economic order quantity (EOQ) Objective: 2 AACSB: Reflective thinking 5) The purchase-order lead time is the: A) difference between the times an order is placed and delivered B) difference between the products ordered and the products received C) discrepancies in purchase orders D) time required to correct errors in the products received Answer: A Diff: 2

Terms: purchase-order lead time Objective: 2 AACSB: Reflective thinking 6) Which of the following statements about the economic-order-quantity decision model is FALSE? A) It assumes purchasing costs are relevant when the cost per unit changes due to the quantity ordered. B) It assumes quality costs are irrelevant if quality is unaffected by the number of units purchased. C) It assumes stockout costs are irrelevant if no stockouts occur. D) It assumes ordering costs and carrying costs are relevant. Answer: A Diff: 3 Terms: economic order quantity (EOQ) Objective: 2 AACSB: Reflective thinking ) Relevant total costs in the economic-order-quantity decision model equal relevant ordering costs plus relevant: A) carrying costs B) stockout costs C) quality costs D) purchasing costs Answer: A Diff: 2 Terms: economic order quantity (EOQ), ordering costs, carrying costs Objective: 2 AACSB: Reflective thinking Answer the following questions using the information below: The Wood Furniture company produces a specialty wood furniture product, and has the following information available concerning its inventory items: Relevant ordering costs per purchase order$300 Relevant carrying costs per year:

Required annual return on investment10% Required other costs per year$2. 80 Annual demand is 20,000 packages per year. The purchase price per package is $32. 8) What is the economic order quantity? A) 2,000,000 units B) 1,414. 21 units C) 150,000 units D) 3,464. 00 units Answer: B Explanation: B) Unit carrying costs = ($32 ? 0. 10) + $2. 80 = $6 EOQ = The square root of [(2 ? 20,000 ? $300) / $6] = 1,414. 21 units Diff: 3 Terms: economic order quantity (EOQ) Objective: 2 AACSB: Analytical skills 9) What are the relevant total costs at the economic order quantity? A) $1,414. 21 B) $4,242. 5 C) $8,485. 28 D) $9,000. 00 Answer: C Explanation: C) Unit carrying costs = ($32 ? 0. 10) + $2. 80 = $6 EOQ = The square root of [(2 ? 20,000 ? $300) / $6] = 1,414. 21 units RTC = [pic]= $8,485. 28 Diff: 3 Terms: economic order quantity (EOQ), ordering costs, carrying costs Objective: 2 AACSB: Analytical skills 10) What are the total relevant costs, assuming the quantity ordered equals 1,000 units? A) $3,000 B) $500 C) $6,000 D) $9,000 Answer: D Explanation: D) RTC = [pic] = $9,000 Diff: 3 Terms: economic order quantity (EOQ), ordering costs, carrying costs Objective: 2

AACSB: Analytical skills 11) How many deliveries will be required at the economic order quantity? A) 1. 00 delivery B) 5. 10 deliveries C) 7. 07 deliveries D) 14. 14 deliveries Answer: D Explanation: D) 20,000 / 1,414. 21 = 14. 14 deliveries Diff: 3 Terms: economic order quantity (EOQ) Objective: 2 AACSB: Analytical skills 12) The annual relevant total costs are at a minimum when relevant: A) ordering costs are greater than the relevant carrying costs B) carrying costs are greater than the relevant ordering costs C) carrying costs are equal to relevant ordering costs

D) None of these answers is correct. Answer: C Diff: 3 Terms: economic order quantity (EOQ), ordering costs, carrying costs Objective: 2 AACSB: Reflective thinking Answer the following questions using the information below: The following information applies to Labs Plus, which supplies microscopes to laboratories throughout the country. Labs Plus purchases the microscopes from a manufacturer which has a reputation for very high quality in its manufacturing operation. Annual demand (weekly demand=1/52 of annual demand)20,800 units Orders per year20 Lead time in days15 days

Cost of placing an order$100 13) What are the annual relevant carrying costs, assuming each order was made at the economic-order-quantity amount? A) $200 B) $1,000 C) $2,000 D) $6,000 Answer: C Explanation: C) Annual carrying costs = annual ordering costs = $100 ? 20 = $2,000 Diff: 2 Terms: economic order quantity (EOQ), carrying costs Objective: 2 AACSB: Analytical skills 14) What is the economic order quantity assuming each order was made at the economic-order-quantity amount? A) 15 units B) 20 units C) 780 units D) 1,040 units Answer: D Diff: 2 Terms: economic order quantity (EOQ)

Objective: 2 AACSB: Analytical skills 15) If Brian Company has a safety stock of 320 units and the average daily demand is 20 units, how many days can be covered if the shipment from the supplier is delayed by 12 days? A) 24. 0 days B) 20. 0 days C) 16. 0 days D) 13. 4 days Answer: C Explanation: C) 320/20 = 16 days Diff: 3 Terms: safety stock, purchase-order lead time Objective: 2 AACSB: Analytical skills 16) If Jackson Collectibles, Inc. has a safety stock of 70 units and the average weekly demand is 14 units, how many days can be covered if the shipment from the supplier is delayed ?

A) 5 days B) 35. days C) 42 days D) 70 days Answer: B Explanation: B) 70/2 = 35. 0 days Diff: 3 Terms: safety stock, purchase-order lead time Objective: 2 AACSB: Analytical skills 17) The optimal safety stock level is the quantity of safety stock that minimizes the sum of the annual relevant: A) stockout costs and carrying costs B) ordering costs and carrying costs C) ordering costs and stockout costs D) ordering costs and purchasing costs Answer: A Diff: 2 Terms: economic order quantity (EOQ), safety stock, stockout costs, carrying costs Objective: 2 AACSB: Reflective thinking 8) The simplest version of the Economic Order Quantity model incorporates only ordering costs, carrying costs, and purchasing costs into the calculation. Answer: FALSE Explanation: Purchasing costs are ignored in the Economic Order Quantity. Diff: 2 Terms: economic order quantity (EOQ) Objective: 2 AACSB: Analytical skills 19) To determine the Economic Order Quantity, the relevant ordering costs are maximized and the relevant carrying costs are minimized. Answer: FALSE Explanation: We minimize both the relevant ordering costs and the relevant carrying costs. Diff: 2

Terms: economic order quantity (EOQ) Objective: 2 AACSB: Analytical skills 20) The Economic Order Quantity increases with demand and carrying costs and decreases with ordering costs. Answer: FALSE Explanation: The Economic Order Quantity increases with demand and ordering costs and decreases with carrying costs. Diff: 2 Terms: economic order quantity (EOQ) Objective: 2 AACSB: Analytical skills 21) The EOQ model is solved using calculus but the key intuition is that relevant total costs are minimized when relevant ordering costs equal relevant carrying costs.

Answer: TRUE Diff: 2 Terms: economic order quantity (EOQ) Objective: 2 AACSB: Analytical skills 22) Safety stock is used as a buffer against unexpected increases in demand, uncertainty about lead time, and unavailability of stock from suppliers. Answer: TRUE Diff: 1 Terms: safety stock Objective: 2 AACSB: Ethical reasoning 23) Due to unprecedented growth during the year, Flowers by Kelly decided to use some of its surplus cash to increase the size of several inventory order quantities that had been previously determined using an EOQ model. Required:

Identify whether increasing the size of inventory orders will increase, decrease, or have no effect on each of the following items. ________________a. Average inventory ________________b. Cost of goods sold ________________c. Number of orders per year ________________d. Total annual carrying costs ________________e. Total annual carrying and ordering costs ________________f. Total annual ordering costs Answer: a. Increase b. No effect c. Decrease d. Increase e. Depends which costs increase/decrease more f. Decrease Diff: 2 Terms: economic order quantity (EOQ) Objective: 2 AACSB: Analytical skills 4) The only product of a company has an annual demand of 4,000 units. The cost of placing an order is $20 and the cost of carrying one unit in inventory for one year is $4. Required: Determine the economic order quantity. Answer: The square root of [(2 ? 4,000 ? $20) / $4 = 200 units Diff: 1 Terms: economic order quantity (EOQ), ordering costs, carrying costs Objective: 2 AACSB: Analytical skills 25) Ralph was in the process of completing the quarterly planning for the purchasing department when a major computer malfunction lost most of his data. For direct material XXX he was able to recover the following: Average inventory level of XXX |200 | |Orders per year |40 | |Average daily demand |48 | |Working days per year |250 | |Annual ordering costs |$4,000 | |Annual carrying costs |$6,000 | Ralph purchases at the EOQ quantity level. Required: Determine the annual demand, the cost of placing an order, the annual carrying cost of one unit, and the economic order quantity.

Answer: Annual demand= 48 ? 250 = 12,000 Cost of placing an order= $4,000/40 = $100 per order Carrying cost of one unit= $6,000/200 = $30 per unit EOQ= The square root of (2 ? 12,000 ? $100)/30 = 283 units Diff: 3 Terms: economic order quantity (EOQ), ordering costs, carrying costs Objective: 2 AACSB: Analytical skills 26) Clothes, Inc. , has an average annual demand for red, medium polo shirts of 25,000 units. The cost of placing an order is $80 and the cost of carrying one unit in inventory for one year is $25. Required: a. Use the economic-order-quantity model to determine the optimal order size. . Determine the reorder point assuming a lead time of 10 days and a work year of 250 days. c. Determine the safety stock required to prevent stockouts assuming the maximum lead time is 20 days and the maximum daily demand is 125 units. Answer: a. The square root of [(2 ? 25,000 ? $80) / $25] = 400 units b. Daily demand = 25,000/250 = 100 units Reorder point = 100 units per day ? 10 days = 1,000 units c. |Maximum demand per day |125 units | |Maximum lead time |? 0 days | |Maximum lead time demand |2,500 units | |Reorder point without safety stocks |1,000 units | |Safety stock |1,500 units | Diff: 2 Terms: economic order quantity (EOQ), reorder point, safety stock Objective: 2 AACSB: Analytical skills 27) An inventory item of XYZ Manufacturing has an average daily demand of 10 units with a maximum daily demand of 12 units. The economic order quantity is 200 units. Without safety stocks, the reorder point is 50 units. Safety stocks are set at 94 units. Required: a.

Determine the reorder point with safety stocks. b. Determine the maximum inventory level. c. Determine the average lead time. d. Determine the maximum lead time. Answer: a. |Reorder point without safety stocks |50 units | |Safety stock |94 units | | Reorder point with safety stocks |144 units | b. |Economic-order quantity |200 units | |Safety stocks |94 units | |Maximum inventory level |294 units | . Average lead time = 50 units at reorder point/10 units a day = 5 days d. Reorder point with safety stocks is 144 Maximum demand is 12 Maximum lead time = 144/12 = 12 days Diff: 2 Terms: economic order quantity (EOQ), reorder point, safety stock Objective: 2 AACSB: Analytical skills 28) For supply item ABC, Andrews Company has been ordering 125 units based on the recommendation of the salesperson who calls on the company monthly. A new purchasing agent has been hired by the company who wants to start using the economic-order-quantity method and its supporting decision elements. She has gathered the following information: Annual demand in units |250 | |Days used per year |250 | |Lead time, in days |10 | |Ordering costs |$100 | |Annual unit carrying costs |$20 | Required: Determine the EOQ, average inventory, orders per year, average daily demand, reorder point, annual ordering costs, and annual carrying costs. Answer: EOQ= The square root of [(2 ? 250 ? $100) / $20] = 50 Average inventory= 50/2 = 25 Orders per year= 250/50 = 5

Average daily demand= 250/250 = 1 unit Reorder point= 10/1 = 10 units Annual ordering costs= 5 ? $100 = $500 Annual carrying costs= 25 ? $20 = $500 Diff: 2 Terms: economic order quantity (EOQ), reorder point, ordering costs, carrying costs Objective: 2 AACSB: Analytical skills 29) Discuss considerations that should be fully taken into account when developing inventory related relevant costs for use in an economic order quantity (EOQ) model. Answer: It is crucial that the costs be incremental. Consider incremental carrying costs. If they are costs that will change with the quantity of inventory held, then they are relevant.

If there are costs that would be unchanged regardless of how much inventory was in the warehouse (such as a clerical salary or material handler who was working at below full capacity), then those costs are not relevant for decision-making purposes. Relevant carrying costs are likely to be costs like shrinkage, breakage, obsolescence, and costs of hiring extra employees (or having existing employees work overtime) if higher levels of inventory will make those costs increase. Consider incremental opportunity cost of capital. If there is a decision to carry more inventory, then there will be money spent to purchase the inventory.

The opportunity cost of capital is what would the other most beneficial use of the money be if it wasn’t needed to purchase the higher level of inventory. It is calculated by multiplying the company’s required rate of return by the per unit costs and then by the number of units purchased for the inventory and incurred at the time the units are received. Stockout costs require an estimate of the lost contribution margin on sales lost because of a stockout. Ordering costs are only those that change with the numbers of orders placed. Diff: 2 Terms: economic order quantity (EOQ), ordering costs, carrying costs Objective: 2

AACSB: Reflective thinking Objective 20. 3 1) Video Images is a distributor of DVDs. Quick-Disk Mart is a local retail outlet which sells blank and recorded DVDs. Quick-Disk Mart purchases tapes from Video Images at $3. 00 per DVD. DVDs are shipped in packages of 20. Video Images pays all incoming freight, and Quick-Disk Mart does not inspect the DVDs due to Video Images reputation for high quality. Annual demand is 104,000 DVDs at a rate of 4,000 DVDs per week. Quick-Disk Mart earns 20% on its cash investments. The purchase-order lead time is two weeks. The following cost data are available: Relevant ordering costs per purchase order$90. 0 Carrying costs per package per year: Relevant insurance, materials handling, breakage, etc. , per year$ 4. 50 What is the required annual return on investment per package? A) $60. 00 B) $2. 50 C) $12. 00 D) $0. 60 Answer: C Explanation: C) 20 DVDs ? $3. 00 =$60. 00 $60. 00 ? 0. 2 = $12. 00 Diff: 3 Terms: ordering costs, carrying costs Objective: 3 AACSB: Analytical skills Answer the following questions using the information below: Digital Goods is a distributor of DVDs. DVD Mart is a local retail outlet which sells blank and recorded DVDs. DVD Mart purchases tapes from Digital Goods at $10. 0 per DVD; DVDs are shipped in packages of 25. Digital Goods pays all incoming freight, and DVD Mart does not inspect the DVDs due to Digital Goods’ reputation for high quality. Annual demand is 208,000 DVDs at a rate of 4,000 DVDs per week. DVD Mart earns 15% on its cash investments. The purchase-order lead time is one week. The following cost data are available: Relevant ordering costs per purchase order$94. 50 Carrying costs per package per year: Relevant insurance, materials handling, breakage, etc. , per year$ 3. 50 2) What is the economic order quantity? A) 384 packages B) 475 packages C) 146 packages D) 196 packages Answer: D

Explanation: D) EOQ = The square root of [(2 ? (208,000/25) ? $94. 50) / ($37. 50+ $3. 50)] EOQ = 196 packages Diff: 2 Terms: economic order quantity (EOQ) Objective: 3 AACSB: Analytical skills 3) What are the relevant total costs? A) $5,697 B) $2,829 C) $8,029 D) $2,868 Answer: C Diff: 3 Terms: economic order quantity (EOQ), ordering costs, carrying costs Objective: 3 AACSB: Analytical skills 4) How many deliveries will be made during each time period? A) 86. 7 deliveries B) 72. 0 deliveries C) 138. 0 deliveries D) 42. 1 deliveries Answer: A Explanation: A) EOQ = The square root of [(2 ? (208,000/25) ? $94. 50) / ($37. 0+ $3. 50)] EOQ = 196 packages [(208,000 / 25) / 196 = 86. 7 deliveries Diff: 3 Terms: economic order quantity (EOQ) Objective: 3 AACSB: Analytical skills Answer the following questions using the information below: Short Grass Incorporated is a distributor of golf balls. Martin’s Golf Supplies is a local retail outlet which sells golf balls. Martin’s purchases the golf balls from Short Grass Incorporated at $0. 75 per ball; the golf balls are shipped in cartons of 72. Short Grass Incorporated pays all incoming freight, and Martin’s Golf Supplies does not inspect the balls due to Short Grass’ reputation for high quality.

Annual demand is 155,520 golf balls at a rate of 2,991 balls per week. Martin’s Golf Supplies earns 12% on its cash investments. The purchase-order lead time is one week. The following cost data are available: Relevant ordering costs per purchase order$125. 00 Carrying costs per carton per year: Relevant insurance, materials handling, breakage, etc. , per year$ 0. 77 5) If Martin’s makes an order (1/12 of annual demand) once per month, what are the relevant total costs? A) $1,500 B) $652. 50 C) $2,152. 50 D) $3,000. 00 Answer: C Explanation: C) Order Quantity = Annual Demand / 12 =12,960 balls/month = 180 cartons per month

RTC = Ordering Costs + Carrying Costs Carrying Cost per carton = price ? invest rate + insurance/handling Carrying Cost per carton = ($. 75 ? 72 ? 12%) + $0. 77 = $7. 25 RTC = (12 ? $125. 00) + ((180/2) ? $7. 25) =$2,152. 50 Diff: 3 Terms: economic order quantity (EOQ), ordering costs, carrying costs Objective: 3 AACSB: Analytical skills 6) What is the economic order quantity? A) 180 cartons B) 273 cartons C) 270 cartons D) 360 cartons Answer: B Explanation: B) Annual Demand / 155,520 / 72 =2,160 cartons Carrying Cost per carton = ($. 75 ? 72 ? 12%) + $0. 77 = $7. 25 EOQ = The square root of [(2 ? (155,520/72) ? $125. 0) / ($7. 25)] EOQ = 272. 9 cartons – round to 273 Diff: 2 Terms: economic order quantity (EOQ) Objective: 3 AACSB: Analytical skills 7) Purchasing at the EOQ recommended level, how many deliveries will be made during each time period? A) 2 deliveries B) 6. 0 deliveries C) 7. 91 deliveries D) 12 deliveries Answer: C Explanation: C) Annual Demand / 155,520 / 72 =2,160 cartons Carrying Cost per carton = ($. 75 ? 72 ? 12%) + $0. 77 = $7. 25 EOQ = The square root of [(2 ? (155,520/72) ? $125. 00) / ($7. 25)] EOQ = 272. 9 cartons – round to 273 Deliveries = Annual Demand / EOQ = 7. 91 Diff: 3 Terms: economic order quantity (EOQ)

Objective: 3 AACSB: Analytical skills 8) Purchasing at the EOQ recommended level, what are the relevant total costs? A) $1,500. 00 B) $1,978. 60 C) $989. 37 D) $3,000. 00 Answer: B Explanation: B) Annual Demand / 155,520 / 72 =2,160 cartons Carrying Cost per carton = ($. 75 ? 72 ? 12%) + $0. 77 = $7. 25 EOQ = The square root of [(2 ? (155,520/72) ? $125. 00) / ($7. 25)] EOQ = 272. 9 cartons – round to 273 989. 37+989. 26 RTC = [pic] + [pic]= $1,978. 60 (Your solution might be slightly different based on rounding. ) Diff: 3 Terms: economic order quantity (EOQ), ordering costs, carrying costs Objective: 3

AACSB: Analytical skills 9) The reorder point is simplest to compute when: A) both demand and purchase-order lead times are known with certainty B) the number of units sold varies C) the safety stock amount never varies D) the relevant ordering costs and the relevant carrying costs are equal Answer: A Diff: 2 Terms: economic order quantity (EOQ), reorder point Objective: 3 AACSB: Reflective thinking 10) What are the major relevant costs in maintaining safety stock? A) carrying costs and purchasing costs B) ordering costs and purchasing costs C) ordering costs and stockout costs D) stockout costs and carrying costs

Answer: D Diff: 2 Terms: safety stock Objective: 3 AACSB: Reflective thinking 11) The annual relevant carrying costs of inventory consists of the sum of the: A) ordering costs and carrying costs B) stockout costs and carrying costs C) incremental costs plus the opportunity costs of capital D) incremental costs plus the carrying costs Answer: C Diff: 2 Terms: carrying costs Objective: 3 AACSB: Reflective thinking 12) Party Animals sells stuffed tigers. Products, Inc. , manufactures many different stuffed animals. Party Animals orders 10,400 tigers per year, 200 per week, at $10 per tiger.

The manufacturer covers all shipping costs. Party Animals earns 12% on its cash investments. The purchase-order lead time is 3 weeks. Party Animals sells 210 tigers per week. The following data are available (based on management’s estimates): Estimated ordering costs per purchase order$10 Estimated insurance, materials handling, breakage, and so on, per year$3 Actual ordering costs per order$15 What is the economic order quantity using the estimated amounts? A) 119 stuffed tigers B) 223 stuffed tigers C) 273 stuffed tigers D) 325 stuffed tigers Answer: B Explanation: B) EOQ = The square root of [(2 ? 10,400 ? 10) / ($3 + (0. 12 ? $10))] EOQ = 223 units Diff: 3 Terms: economic order quantity (EOQ) Objective: 3 AACSB: Analytical skills 13) A conflict between the EOQ model’s optimal order quantity and the order quantity the purchasing manager, evaluated on conventional accounting numbers, regards as optimal is considered a(n): A) problem for the chief financial officer to resolve B) problem for the performance evaluation system to resolve C) goal congruence D) opportunity cost Answer: B Diff: 2 Terms: economic order quantity (EOQ) Objective: 3 AACSB: Analytical skills 14) Just-in-time purchasing requires:

A) larger and less frequent purchase orders B) smaller and less frequent purchase orders C) smaller and more frequent purchase orders D) larger and more frequent purchase orders Answer: C Diff: 2 Terms: just-in-time (JIT) purchasing Objective: 3 AACSB: Analytical skills 15) Increases in the carrying cost and decreases in the ordering cost per purchase order result in: A) smaller EOQ amounts B) larger EOQ amounts C) larger relevant total costs D) smaller relevant total costs Answer: A Diff: 2 Terms: economic order quantity (EOQ), ordering costs, carrying costs Objective: 3 AACSB: Analytical skills 6) The annual relevant carrying costs of inventory consist of incremental costs plus the opportunity cost of capital. Answer: TRUE Diff: 3 Terms: carrying costs Objective: 3 AACSB: Analytical skills 17) Relevant opportunity cost of capital is the return forgone by investing capital in inventory rather than elsewhere. Answer: TRUE Diff: 2 Terms: relevant opportunity cost of capital Objective: 3 AACSB: Analytical skills 18) Video Boy has one particular product that has an annual demand of 2,000 units. Total manufacturing costs per unit total $20. Ordering costs for the product total $25 per purchase order.

Currently, the carrying costs per unit are 25% of manufacturing costs. Required: Determine the economic manufacturing order quantity. Answer: The square root of [(2 ? 2,000 ? $25) / $5] = 141. 42 units Diff: 2 Terms: economic order quantity (EOQ), ordering costs, carrying costs Objective: 3 AACSB: Analytical skills 19) The IBP Grocery orders most of its items in lot sizes of 10 units. Average annual demand per side of beef is 720 units per year. Ordering costs are $25 per order with an average purchasing price of $100. Annual inventory carrying costs are estimated to be 40% of the unit cost.

Required: a. Determine the economic order quantity. b. Determine the annual cost savings if the shop changes from an order size of 10 units to the economic order quantity. c. Since the shelf life is limited, the IBP Grocery must keep the inventory moving. Assuming a 360-day year, determine the optimal lot size under each of the following: (1) a 20-day shelf life and (2) a 10-day shelf life. Answer: a. The square root of [(2 ? 720 ? $25) / $40] = 30 units b. |Current 10-unit order: | | | | Ordering costs ($25 ? 20/10) |$1,800 | | | Carrying costs ($100 ? 0. 40 ? 10/2) |200 |$2,000 | |EOQ 30-unit order: | | | | Ordering costs ($25 ? 720/30) |600 | | | Carrying costs ($100 ? 0. 40 ? 30/2) |600 |1,200 | |Annual savings | |$ 800 | c. Average daily demand = 720 / 360 = 2 per day

Average days’ supply in EOQ = 30/2 = 15 days (1) 20-day shelf life allows for up to 40 units (20 ? 2), EOQ is acceptable. (2) 10-day shelf life allows for up to 20 units (10 ? 2), EOQ is not acceptable Diff: 3 Terms: economic order quantity (EOQ) Objective: 3 AACSB: Analytical skills 20) The executive vice president of Robotics, Inc. , is concerned because the cost of materials has not been in line with the budget for several periods, even after implementing an EOQ model. The company has the normal direct material variance computations of price and efficiency at the end of each month.

The price variance of the direct materials used is usually near expectations. The vice president does not understand how the budget differences are always larger than the material price variances. Required: What explanation can you give for the evaluation problems presented? Answer: An EOQ model does not solve all inventory related problems. The first problem is the timing of material price variance computations. They should be at the time of purchase, not at the time of usage. By changing when the variance is computed, the responsibility is placed where it should be, in purchasing, not in production.

Also, the timing of when materials are used could explain the difference between the budget variances and the material price variances. Materials may be purchased in one period and not used until another period. Also, material usage may include items purchased during several previous periods. Diff: 2 Terms: inventory management, economic order quantity (EOQ) Objective: 3 AACSB: Reflective thinking Objective 20. 4 1) Flashdrive Company sells 200 flash drives per week. Purchase-order lead time is 1-1/2 weeks and the economic-order quantity is 450 units. What is the reorder point? A) 200 units B) 300 units C) 750 units

D) 1,125 units Answer: B Explanation: B) 200 ? 1. 5= 300 units Diff: 2 Terms: economic order quantity (EOQ), reorder point Objective: 4 AACSB: Analytical skills 2) Wilson’s Deli can predict with virtual certainty the demand for its products. Wilson’s sells 30 hams per week. Purchase-order lead time is 3 weeks and the economic-order quantity is 75 hams. What is the reorder point? A) 30 hams B) 75 hams C) 90 hams D) 100 hams Answer: C Explanation: C) 30 ? 3= 90 hams Diff: 2 Terms: economic order quantity (EOQ), reorder point Objective: 4 AACSB: Analytical skills Answer the following questions using the information below:

Owen-King Company sells optical equipment. Lens Company manufactures special glass lenses. Owen-King Company orders 5,200 lenses per year, 100 per week, at $20 per lens. Lens Company covers all shipping costs. Owen-King Company earns 30% on its cash investments. The purchase-order lead time is 2. 5 weeks. Owen-King Company sells 125 lenses per week. The following data are available: Relevant ordering costs per purchase order$21. 25 Relevant insurance, materials handling, breakage, and so on, per year$ 2. 50 3) What is the economic order quantity for Owen-King Company? A) 325 lenses B) 297 lenses C) 210 lenses

D) 161 lenses Answer: D Explanation: D) EOQ = The square root of [(2 ? 5,200 ? $21. 25) / (($20 ? 30%) + $2. 50)] EOQ = 161 lenses Diff: 2 Terms: economic order quantity (EOQ) Objective: 4 AACSB: Analytical skills 4) What is the reorder point? A) 220. 5 lenses B) 312. 5 lenses C) 397. 5 lenses D) 415. 5 lenses Answer: B Explanation: B) 125 lenses ? 2. 5 weeks = 312. 5 lenses Diff: 2 Terms: reorder point Objective: 4 AACSB: Analytical skills 5) The ________ describes the flow of goods, services, and information from the initial sources of materials and services to the delivery of products to consumers.

A) customer list B) enterprise requirements plan (ERP) C) material requirements plan (MRP) D) supply chain Answer: D Diff: 2 Terms: supply chain Objective: 4 AACSB: Reflective thinking 6) When using a vendor-managed inventory system to enhance the features of supply chain management, a challenging issue is: A) problems of communication and trust B) the sharing of accurate, timely, and relevant information about sales forecasts C) potentially incompatible information systems D) all of the above Answer: D Diff: 2 Terms: supply chain Objective: 4 AACSB: Reflective thinking ) Just-in-time purchasing is guided solely by the economic order quantity. Answer: FALSE Explanation: Inventory management also includes purchasing costs, stockout costs, and quality costs. Diff: 2 Terms: just-in-time (JIT) purchasing, economic order quantity (EOQ) Objective: 4 AACSB: Analytical skills 8) Companies that implement JIT purchasing will switch their suppliers when another supplier offers a lower price. Answer: FALSE Explanation: Companies that implement JIT purchasing choose their suppliers carefully and develop long-term supplier relationships. Diff: 3 Terms: just-in-time (JIT) purchasing

Objective: 4 AACSB: Reflective thinking 9) Just-in-time purchasing describes the flow of goods, services, and information from the initial sources of materials and services to the delivery of products to consumers, regardless of whether those activities occur in the same organization or in other organizations. Answer: FALSE Explanation: Supply chain describes the flow of goods, services, and information from the initial sources of materials and services to the delivery of products to consumers, regardless of whether those activities occur in the same organization or in other organizations. Diff: 3

Terms: supply chain Objective: 4 AACSB: Reflective thinking 10) The manufacturing manager of New Technology Company is concerned about the company’s newest plant. When the plant began operations three years ago, it had the best of everything. It had modern equipment, well-trained employees, engineered work and assembly stations, and a controlled environment. During the first two years, the evaluation results were very good with almost all cost variances being favorable. However, recently, things have turned negative. In recent months, everything seems to be operating in a crisis management mode.

Although most cost variances remain favorable, the plant’s segment contribution is declining and customers are complaining about poor quality and slow delivery. Several customers have suggested that they may take their business elsewhere if things do not improve. The shop floor is in continual turmoil. In-process inventory is everywhere, production employees have difficulty finding jobs that need to be worked on, and scheduling has requested a larger computer to keep track of work in process. The vice president of sales does not know where to begin with solving the customers’ problems.

It seems that everyone is working very hard and the plant has the best facilities and trained employees in the industry. Required: What is the nature of the plant’s problems? What recommendation would you make to help improve the situation? Answer: The basic problem appears to be too much work-in-process inventory and a lack of control over the flow of this inventory. Since the plant had two good years of production, it may be that increased demands are pushing the plant near its capacity and management has lost control of how to manage a near-capacity situation.

Although the employees are well trained and skilled in what they do, that is not enough to ensure the production process runs smoothly. All activities must be organized to be efficient. A beginning recommendation is to implement a materials required planning system where each workstation controls what it produces, and pushes it to the next workstation. This can be accomplished by tighter controls over the scheduling of production units by workstation. This would be incorporated with a master production schedule, bill of materials, and timely inventory system. Diff: 2

Terms: inventory management, material requirements planning (MRP) Objective: 4 AACSB: Communication 11) What is a supply chain, and what are the benefits of a supply chain analysis? Provide an example of these benefits. Answer: The supply chain describes the flow of goods, services, and information from the initial sources of materials and services to the delivery of products to customers, regardless of whether these activities occur in the same organization or in other organizations. Utilizing supply chain analysis allows companies to coordinate their activities and reduce inventories throughout the supply chain.

An example of the benefits of supply chain analysis might be the emergence of supplier or vendor-managed inventories such as the relationship between Procter & Gamble and Walmart. Diff: 2 Terms: inventory management Objective: 4 AACSB: Reflective thinking Objective 20. 5 1) A push-through system that manufactures finished goods for inventory on the basis of demand forecasts is referred to as: A) just-in-time purchasing B) materials requirements planning C) relevant total costs D) economic order quantity Answer: B Diff: 1 Terms: material requirements planning (MRP) Objective: 5 AACSB: Reflective thinking ) A demand-pull system in which each component in a production line is produced immediately as needed by the next step in the production line is referred to as: A) just-in-time purchasing B) materials requirements planning C) relevant total costs D) economic order quantity Answer: A Diff: 1 Terms: just-in-time (JIT) purchasing Objective: 5 AACSB: Reflective thinking 3) The management accountant aids in MRP by: A) doing journal entries as requested B) preparing plant appropriation requests C) maintaining accurate records of inventory and its costs D) contacting vendors to make sure they can deliver the materials in time Answer: C

Diff: 1 Terms: material requirements planning (MRP) Objective: 5 AACSB: Reflective thinking 4) A “push-through” system, often described as a just-in-time system, emphasizes simplicity and close coordination among work centers. Answer: FALSE Explanation: The narrative describes a Materials Requirement Planning system. Diff: 2 Terms: just-in-time (JIT) production Objective: 5 AACSB: Communication 5) Costs of setting up a production run are analogous to ordering costs in the Economic Order Quantity (EOQ) model. Answer: TRUE Diff: 2 Terms: ordering costs Objective: 5 AACSB: Analytical skills ) A “demand-pull” system, often described as a materials requirement planning system, focuses first on the forecasted amount and timing of finished goods and then determines the demand for materials components and subassemblies at each of the prior stages of production. Answer: FALSE Explanation: The narrative describes a push-through system. Diff: 2 Terms: material requirements planning (MRP) Objective: 5 AACSB: Reflective thinking 7) Just-in-time (JIT) production, is a “demand-pull” manufacturing system that manufactures each component in a production line as soon as, and only when, needed by the next step in the production line.

Answer: TRUE Diff: 2 Terms: just-in-time (JIT) production Objective: 5 AACSB: Reflective thinking 8) Just-in-time systems are similar to materials requirement planning systems in that both systems are demand-pull systems. Answer: FALSE Explanation: Just-in-time systems are not similar to materials requirement planning systems in that just-in-time production is a demand-pull system and materials requirements planning is a push-through approach. Diff: 2 Terms: just-in-time (JIT) production, materials requirements planning (MRP) Objective: 5

AACSB: Analytical skills 9) Kretzinger Company makes extensive use of financial performance reports for each of its departments. Although most departments have been reporting favorable cost variances with the company’s current inventory system, management is concerned about the overall performance of the purchasing department. For example, the following information is for the purchasing of materials for a product the company has been manufacturing for several years: Purchase Year |Quantity Used |Average Inventory |Price Variance | |20X1 |40,000 |8,000 |$ 1,000 F | |20X2 |60,000 |15,000 |10,000 F | |20X3 |60,000 |20,000 |12,000 F | |20X4 |50,000 |12,500 |20,000 U | |20X5 |54,000 |18,000 |8,000 F | |20X6 |58,000 |23,200 |9,500 F |

Required: a. Compute the inventory turnover for each year. Can any conclusions be drawn for a yearly comparison of the purchase price variance and the inventory turnover? b. Identify problems likely to be caused by evaluating purchasing only on the basis of the purchase price variance. c. What recommendations will improve the evaluation process? Answer: a. |Year |Quantity used | |Average inventory |Turnover | |20X1 |40,000 |divided by |8,000 |5. | |20X2 |60,000 |divided by |15,000 |4. 0 | |20X3 |60,000 |divided by |20,000 |3. 0 | |20X4 |50,000 |divided by |12,500 |4. 0 | |20X5 |54,000 |divided by |18,000 |3. 0 | |20X6 |58,000 |divided by |23,200 |2. 5 |

Favorable purchase prices appear to be associated with decreases in inventory turnover and increases in average inventory levels. Decreases in inventory turnover are a possible signal of the buildup of excess inventory. Excess inventory will reduce return on investment of the company and the above information indicates a need for a just-in-time inventory system. b. To achieve quantity discounts and favorable materials price variances, purchasing may be ordering excess inventory, thereby increasing subsequent storage, obsolescence, and handling costs.

To obtain a low price, purchasing may be ordering from a supplier whose goods have inferior quality which may, in turn, lead to increased inspection, rework, and, perhaps, dissatisfied customers. c. It appears that two items may help improve the situation. First, consider the change to a just-in-time inventory system that would greatly improve the inventory turnover and reduce the amount of inventory carried. Second, additional measures should be used in the evaluation of the purchasing department. Either different financial measures should be used or the addition of nonfinancial measures should be implemented.

Diff: 3 Terms: inventory management, just-in-time (JIT) production Objective: 5 AACSB: Analytical skills 10) Minnesota Ore Company mines iron ore for production into various metal products. During recent years, the company has had large fluctuations in its inventories of metal ingots. Much of the volatility of the inventory levels is due to the variability of demand by the company’s largest customers, automobile manufacturers. For large orders, the company has the technology to quickly shift production from one product to another. Required:

Explain how the company can improve its inventory control system and give the advantages of whatever you recommend. Answer: The company can probably benefit from changing to a just-in-time system for inventory control. This would allow the company to be responsive to actual needs rather than finished goods inventory building. The advantages would be: 1. Lower inventory requirements; 2. Reductions in carrying and handling costs of inventories; 3. Reduction in risks of obsolete inventories; 4. Reduction in total manufacturing costs; and 5. Reductions in paperwork.

Diff: 2 Terms: inventory management, just-in-time (JIT) production Objective: 5 AACSB: Reflective thinking Objective 20. 6 1) A grouping of all the different types of equipment used to make a given product is referred to as: A) total quality management B) materials requirements planning C) manufacturing cells D) economic order quantity Answer: C Diff: 1 Terms: manufacturing cells Objective: 6 AACSB: Reflective thinking 2) The time required to get equipment, tools, and materials ready to start production is referred to as: A) setup time B) manufacturing lead time

C) pass-through time D) None of these answers is correct. Answer: A Diff: 1 Terms: lean production Objective: 6 AACSB: Reflective thinking 3) The time from when an order is received by manufacturing until it becomes a finished good is referred to as: A) work-in-process time B) manufacturing lead time C) pass-through time D) None of these answers is correct. Answer: B Diff: 1 Terms: lean production Objective: 6 AACSB: Reflective thinking 4) All of the following are potential financial benefits of just-in-time EXCEPT: A) lower investments in inventories

B) lower investments in plant space for inventories C) reducing the risk of obsolescence D) reducing manufacturing lead time Answer: C Diff: 1 Terms: just-in-time (JIT) production Objective: 6 AACSB: Analytical skills 5) A system that comprises a single database that collects data and feeds it into software applications supporting all of a company’s business activities is known as a(n): A) economic order quantity (EOQ) system B) enterprise requirements planning (ERP) system C) just-in-time (JIT) system D) material requirements planning (MRP) system Answer: B

Diff: 2 Terms: enterprise resource planning (ERP) system Objective: 6 AACSB: Use of Information Technology 6) One DISADVANTAGE of an enterprise resource planning (ERP) system is: A) the use of standard costing systems is not allowed B) these systems are not in accordance with Generally Accepted Accounting Principles (GAAP) C) the systems must often be customized to fit the strategic needs of the user D) the systems increase lead times when purchasing material from a supplier Answer: C Diff: 2 Terms: enterprise resource planning (ERP) system Objective: 6

AACSB: Reflective thinking 7) A financial benefit of a just-in-time system is that inventory carrying costs are reduced. Answer: TRUE Diff: 2 Terms: just-in-time (JIT) production, just-in-time (JIT) purchasing Objective: 6 AACSB: Reflective thinking 8) In a just-in-time system, suppliers are selected primarily on the basis of their ability to provide materials and products at the lowest possible price. Answer: FALSE Explanation: In a just-in-time system, suppliers are selected on the basis of their ability to deliver quality materials in a timely manner. Diff: 2

Terms: just-in-time (JIT) production, just-in-time (JIT) purchasing Objective: 6 AACSB: Reflective thinking 9) An Enterprise Resource Planning (ERP) System comprises a single database that collects data and feeds it into software applications supporting all of a company’s business activities. Answer: TRUE Diff: 2 Terms: enterprise resource planning (ERP) system Objective: 6 AACSB: Use of Information Technology 10) The Jarvis Corporation produces bucket loader assemblies for the tractor industry. The product has a long term life expectancy. Jarvis has a traditional manufacturing and inventory system.

Jarvis is considering the installation of a just-in-time inventory system to improve its cost structure. In doing a full study using its manufacturing engineering team as well as consulting with industry JIT experts and the main vendors and suppliers of the components Jarvis uses to manufacture the bucket loader assemblies, the following incremental cost-benefit relevant information is available for analysis: The Jarvis cost of investment capital hurdle rate is 15%. One time cost to rearrange the shop floor to create the manufacturing cell workstations is $275,000.

One time cost to retrain the existing workforce for the JIT required skills is $60,000. Anticipated defect reduction is 40%. Currently there is a cost of quality defect assessment listed as $150,000 per year. The setup time for each of the existing functions will be reduced by 67%. Currently the forecast for setup costs are $225,000 per year. Jarvis will expect to save $200,000 per year in carrying costs as a result of having a lower inventory. The suppliers will require a 15% premium over the current level of prices in order to position themselves to supply the material on a smaller and more frequent schedule.

Currently the materials purchases are $1,500,000 per year. Required: Determine whether it is in the best interest of Jarvis Corporation to install a JIT system. Answer: 1. Initial Investment = $275,000 + 60,000 = $335,000 2. Annual Savings: Defect Cost Reduction = 40% of $150,000 = $60,000 Setup Cost Reduction = 67% of $225,000 = $150,750 Carrying Cost reduction = $200,000 Total Savings = (60,000 + 150,750 + 200,000) = $410,750 3. Annual Increased Costs: Vendor Premium = 15% of $1,500,000 = $225,000 4. Net Annual Savings = (410,750 – 225,000) = $185,750 5.

Savings/Initial Investment = (185,750 / 335,000) = 55 % Since the net savings is returning 55% per year on the initial investment (which is far in excess of the companies hurdle rate of 15%), the JIT project should be implemented. Diff: 3 Terms: just-in-time (JIT) production Objective: 6 AACSB: Analytical skills 11) What are five features of a just-in-time manufacturing system? Answer: A just-in-time (JIT) system has many positive features. It organizes production in manufacturing cell groups which allow for all equipment used for a given product to be grouped together.

This reduces material handling costs and sequences the production process. A second feature of a JIT system is that workers are trained to be multiskilled. They are trained to operate various machines as well as to do light maintenance and repairs on the machines. A third feature of JIT is that it aggressively works to eliminate defects. Because there is a tight link between the steps, defects are quickly noticed in the next step and addressed before large numbers of units become backlogged. A fourth feature of a JIT system is that it reduces setup time and manufacturing lead time.

Reduced setup costs make it more practical to produce smaller batches and react faster to changes in customer demand. A fifth feature of a JIT system is the firm only uses suppliers who are capable of meeting delivery demands in a timely fashion. This also causes an increase in the quality of the goods being received by the firm. Diff: 2 Terms: just-in-time (JIT) production Objective: 6 AACSB: Reflective thinking Objective 20. 7 1) Traditional normal and standard costing systems use: A) backflush costing B) delayed costing C) post-deduct costing D) sequential tracking Answer: D Diff: 2 Terms: backflush costing

Objective: 7 AACSB: Reflective thinking 2) A costing system that omits recording some or all of the journal entries relating to the cycle from purchase of direct materials to the sale of finished goods is called: A) dependent costing B) synchronous costing C) sequential costing D) backflush costing Answer: D Diff: 2 Terms: backflush costing Objective: 7 AACSB: Reflective thinking Answer the following questions using the information below: Games R Us manufactures various games. For March, there were no beginning inventories of direct materials and no beginning or ending work in process.

Conversion costs is the only indirect manufacturing cost category currently used. Journal entries are recorded when materials are purchased and when conversion costs are allocated under backflush costing. Conversion costs ? March$ 400,000 Direct materials purchased ? March$1,070,000 Units produced ? March58,800 Units sold ? March41,800 3) Which of the following journal entries properly records the purchase of direct materials? A) Accounts Payable Control1,070,000 Inventory: Raw and In-Process Control1,070,000 B) Inventory: Raw and In-Process Control1,070,000 Accounts Payable Control1,070,000

C) Inventory: Raw and In-Process Control1,070,000 Conversion Costs1,070,000 D) Conversion Costs1,070,000 Inventory: Raw and In-Process Control1,070,000 Answer: B Diff: 3 Terms: backflush costing, trigger point Objective: 7 AACSB: Analytical skills 4) Which of the journal entries properly records conversion costs? A) Conversion Costs400,000 Various Accounts400,000 B) Various Accounts400,000 Conversion Costs400,000 C) Conversion Costs400,000 Inventory: Direct Materials400,000 D) Inventory: Direct Materials400,000 Conversion Costs400,000 Answer: A Diff: 2 Terms: backflush costing Objective: 7 AACSB: Analytical skills ) Which of the following entries properly records the cost of goods sold for the month? A) Finished Goods1,045,000 Work in Process1,045,000 B) Cost of Goods Sold1,045,000 Finished Goods1,045,000 C) Finished Goods1,045,000 Cost of Goods Sold1,045,000 D) Cost of Goods Sold1,045,000 Work in Process1,045,000 Answer: B Diff: 3 Terms: backflush costing Objective: 7 AACSB: Analytical skills Answer the following questions using the information below: Complete Digital Products manufactures digital cameras. For October, there were no beginning inventories of direct materials and no beginning or ending work in process.

Conversion costs is the only indirect manufacturing cost category currently used. Journal entries are recorded when materials are purchased and when units are sold. Conversion costs – October$ 45,200 Direct materials purchased – October$125,200 Units produced – October40,000 units Units sold – October37,500 units Selling price$10 each 6) Which of the following journal entries properly reflects the purchase of materials in a JIT environment? A) Inventory: Raw and In-Process125,200 Accounts Payable Control125,200 B) Accounts Payable Control125,200 Allocated Costs: Direct Materials125,200

C) Accounts Payable Control125,200 Materials Inventory125,200 D) Allocated Costs: Direct Materials125,200 Inventory: Raw and Material125,200 Answer: A Diff: 3 Terms: backflush costing Objective: 7 AACSB: Analytical skills 7) Which of the following journal entries would be recorded when units are sold for the month? A) Cost of Goods Sold159,750 Inventory: Raw and In-Process159,750 B) Cost of Goods Sold159,750 Inventory: Raw and In-Process117,375 Conversion Costs Allocated42,375 C) Inventory: Raw and In-Process117,375 Conversion Costs Allocated42,375 Cost of Goods Sold159,750 D) Cost of Goods Sold159,750

Inventory: Raw and In-Process114,750 Conversion Costs Allocated45,000 Answer: B Explanation: B) Direct materials ($125,200/40,000)$3. 13 Conversion costs ($45,200/40,000)1. 13 Total$4. 26 37,500 ? $4. 26= $159,750 37,500? $3. 13= $117,375 37,500 ? $1. 13= $42,375 Diff: 3 Terms: backflush costing Objective: 7 AACSB: Analytical skills 8) Which of the following entries would occur if the only trigger point is the production of finished units? A) Cost of Goods Sold159,750 Inventory: Raw and In-Process Control114,750 Conversion Costs Allocated45,000 B) Inventory: Raw and In-Process Control117,375

Conversion Costs Allocated42,375 Cost of Goods Sold159,750 C) Finished Goods170,400 Accounts Payable Control125,200 Conversion Costs Allocated45,200 D) Accounts Payable Control125,200 Conversion Costs Allocated45,200 Finished Goods170,400 Answer: C Explanation: C) 40,000 ? $4. 26= $170,400 40,000 ? $3. 13= $125,200 40,000 ? $1. 13 = $45,200 Diff: 3 Terms: backflush costing Objective: 7 AACSB: Analytical skills 9) Companies that would benefit from backflush costing include companies: A) which have fast manufacturing lead times B) whose inventories vary from period to period C) companies that require audit trails

Synopsis: Telepresence is key to offering businesses of every size and location to grow globally with low cost expansion. Telepresence offers face to face interaction between individuals, with miles and miles between their monitors. The technology of telepresence offers many avenues of expansion, growth, costs saving and , as an all in one product. Businesses of today need to step on board with the meetings and preferred “contact” of tomorrow. 1) What kinds of limitations do you see for users of telepresence? Is it really a substitute for face-to-face meetings?

Make a list of features of face-to-face meetings. Then consider a range of business situations as an employee, from initial hire, to working with a team, to understanding what your boss wants, and even a termination meeting. How would telepresence work for you in these situations? The limitations presented for users of telepresence are the eye contact, body gestures, actual feeling of the atmosphere present with the other individual(s). There is a lacking of personal warmth. I believe that it has to be the substitute for face to face meetings as the world is changing.

If it was my decision, I would not think that it is best for business, I appreciate face to face, smell, touch, and feeling. However in today’s business world, it has to be the substitute. Telepresence would work for satisfactory of the business purpose at hand, in an interview, employers can save time by logging onto their computer screen, instead of taking up time meeting, greeting, seating applicants etc. It would allow the employee the benefit of being in familiar surroundings during the stressful interview, as well as cut costs on time, gas etc.

Understanding what a boss wants can be achieved, as if your boss is out of the country, he can still be reached and seen and spoken too about the project at hand. He is always available. That is kind of the same as working with a team; you can consistently be in contact with your team members, even if your team members live on different continents. This allows for technology to stream together continuously as a whole. A termination meeting would be a lot less stressful if it happened somewhere else other than work in front of coworkers; also, I am the kind of person that is a better speaker when I am in confrontation, via phone, Skype etc.

This would benefit me as I would be persistent and persuasive, more so than I would be in person. 2) What are the business benefits of telepresence described in these videos? What is the benefit of a hologram? The benefits are the strategic communications solution, time management, creating stronger relationships with customers and clients, as well as partners and suppliers, decision making is increased, as well as studies (as you can have individuals in another country with separate data speaking and working with you at once).

Travel costs are cut, and employee time is better spent actually working on the project and/or tasks at hand. Also, there are no limitations to how far your business can grow and reach, if a computer is at hand. A hologram benefits individuals as it creates the design of the human, not an avatar but actual human. This is a benefit as it creates the more personal, believable online meeting. 3) In the past, work was organized into central buildings located in central locations (like cities) in order to facilitate face-to-face interactions.

What impacts might telepresence have on the organization of work? How could you use these tools to organize work on a global scale with actually building physical facilities in remote locations? The impact of telepresence in large and small origination is immense. Large corporations can place headquarters, units, etc in low cost areas, allowing for cost saving and centralizing of the area. Small businesses are impacted as they are able to compete and operate on a global scale, while still saving money and operating in low cost areas, or even homes.

Telepresence strengthens the ability of businesses to operate and expand globally, while decreasing costs, and space needed in the previous central buildings in skyscraper cities. 4) Why is it important that the remote locations using teleprescence have the same lighting, seating, and style? I believe it is to create a more realism meeting, distracting the viewer with separate lighting, colors, objects, areas etc, only adds to the distraction that it is a teleprescence meeting at hand.

The goal of the teleprescence product is to create transparency among users. 5) What applications of telepresence would be useful for marketing to customers? I believe there are many different aspects of telepresence that would be useful for marketing to customers. Customers could see the product in real time being used. They would be able to ask the instructor questions about the product, just as they could be using or showing the product and defects that they are finding.

It would be a product that would gain trust as customers could speak with the supplier company in real time. Also, customers could speak about what they don’t like about the product, as well as helping to design future products. It all depends on the product at hand, if it was a large scale product placing demos in remote locations would add to the products success, no matter where the customer lived. The customer would always be able to see and hear the business, and their questions would not go unanswered.

The proposed solution will be useful to agricultural enterprises because it will enhance the level of efficiency in cost control. The organization presented in the case study produces two commodities: corn and soybeans.

Additionally, the equipment used is shared between two parties. Complicating the situation further is that the ownership of the farm is distributed among several parties. Therefore the establishment of cost and profit centers is a must for correctly assessing the level of costs and earnings.

Currently the management focus is on production. However the management intent is to shift greater focus to implementing a managerial accounting system that will correctly allocate costs and assign the level of profits proportionally.

In this respect, implementation of activity based costing is the best solution inasmuch as it facilitates the identification of allocation criteria based upon which costs and profits can be assigned.

The advantage of using the managerial accounting system mentioned above is that the management can exercise its own discretion about how to allocate costs between different processes and commodities.

Unlike the financial statements prepared under the strict scrutiny of the GAAP, internal reports generated by the managerial accounting system mentioned above do not have to follow any hard and fast rules. As a result the management can customize the system to the specific characteristics of its own business.

This customizability is one of the most important features in favor of implementing an activity based costing system. The customizability enables the management not only to assign costs to different processes and commodities based upon resources consumed but also to enhance the level of process efficiency.

For example, the proposed solution for the organization in the case study enables John and Mary Farmer to allocate costs to the equipment based upon their level of usage in producing different commodities. As a result, the cost driver is this case is identified as the two commodities. The cost of production for each of the commodities is calculated accordingly.

The advantage from using this system is that the overhead is allocated in proportion to the level of resources expended in producing each commodity. This strengthens the quality of the cost structure. The result is that the management is in a much better position to measure performance and formulate strategies accordingly.

As illustrated in the case, John and Mary Farmer are going to have to collect a considerable level of information in order to implement an activity based costing system.

Therefore in conducting a cost benefit analysis of implementing the managerial accounting system, the cost of collecting the information will have to be taken into account. Additional costs will be incurred by the maintenance of the information system which will have to be supported by expensive hardware and software requirements.

These are some of the drawbacks that agricultural enterprises can run up against when implementing the proposed solution. However these drawbacks must be the weighed against the benefits of more cost-efficient strategy formulation.

Question 2

If the Farm Council Case did not use activity based costing, then it would not be in a position to correctly assess the cost of producing each commodity. As a result some costs would be overstated and some understated. This would distort profit comparisons between the two commodities. Consequently, any future investment decisions would be distorted as well.

The traditional cost allocation method would be particularly harmful in the Farm Council case because the resources being used belong to several different parties. For this reason it is particularly important for the management to use the activity based costing method in order to allocate costs based on the level of consumption.

Although the costs of implementing an advanced managerial accounting system would be high, the long term benefits of more effective strategy formulation outweigh the costs. Such would not be the case when implementing the traditional cost allocation method.

According to the traditional cost allocation method, product costs are calculated according to the number of units produced. As a result, this method does not take into account the level of resources expended in producing these units.

This cost distortion is particularly pronounced in the Farm Council Case because the same level of production for two different commodities necessitates different levels of resource consumption.

If John and Mary were to use the traditional cost allocation method, then these differences would not be taken into account and the unit costs that would be calculated would be incorrect. As a result, they would not be in a position to make decisions about which product line to invest in more.

Currently the focus at the farm was on production rather than on cost control. Therefore, the traditional cost allocation method seemed to satisfy the requirements. However there were massive pools of overhead that were being improperly assigned. These errors in the costing system would be perpetuated under the traditional cost allocation system.

The problem with the alternative solution was that the identification of resource drivers for support and production cost centers would be difficult. This would complicate the process of assigning costs.

The support cost centers in terms of equipment, shop & maintenance, and general farm would have to be defined in terms of the activities involved. Otherwise it would not be possible to assess the level of resources consumed by each of the cost centers. Therefore the unit costs for different commodities would not reflect the true expenditures and the management would be stuck with a costing system that would be misleading.

Commodities which consumed a lower level of resources would have unit costs overstated and vice versa. The reason why this would happen under the alternative solution is that the costs would be divided equally between different cost centers based on production volume. As a result, the alternative solution is not recommended.

References

Atkinson, Anthony A., et al. (2006) Management Accounting. McGraw Hill/Irwin.