ACG 2071 Midterm 2 Review Problems & Solutions

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1 ACG 2071 Midterm 2 Review Problems & Solutions 5-1. On July 1, JKL Corporation s packaging department had Work in Process inventory of 6,000 units that were 75% complete with respect to materials and 30% complete with respect to conversion costs. The cost of these units was $93,525 (made up of $60,000 transferred-in from previous departments, $26,775 in materials, and $6,750 in labor and overhead). During July, 125,000 units were transferred into the pkg department. These units had accumulated costs in previous departments of $1,218,560. The packaging department incurred costs of $756,225 for materials and $488,010 for conversion costs in July and transferred 130,000 units out of the department. The 1,000 units remaining in ending inventory are 50% complete with respect to materials and 20% complete with respect to conversion costs. a. Calculate cost per equivalent unit for transferred-in costs, material, and conversion costs. Explanation of process costing in 2 nd dept: Process Costing uses averaging to calculate average Product Cost. Cost in Beg. WIP Inv + Costs incurred this period = Total Costs this period total equiv. units completed = Average Cost of Product 1. Must deal with equivalent units 2. Must separate transferred in cost; direct materials cost; conversion cost Process Costing in 2 nd Department is hardest! Transferred in cost costs incurred in previous process/dept carried forward as part of Product Cost when it moves to next process/dept. In 2 nd or later dept, all units whether completed & transferred out of 2 nd dept or in ending WIP inventory in 2 nd dept are 100% complete w/respect to transferred in work and cost. 5 step Process Costing in 2 nd or later Dept: 1. Summarize flow of physical units 2. Compute output in terms of equivalent units 3 columns: Equiv. units complete as to TI costs Equiv. units complete as to DM costs Accounted for all units in & out of Dept Equiv. units complete as to CC costs 3. Summarize total costs to account for: (put in costs to units in step 1 & 2) 4. Calculate cost/equivalent unit (total costs total equivalent units) 5. Assign total costs to units completed and transferred out & to units in Ending WIP inventory Can now compute total costs of manufacturing one product from start to finish in 2 or more departments Cost/equivalent unit = Total Cost # of completed units + equiv.completed units left in ending WIP inventory Back to a. Calculate cost per equivalent unit for transferred-in costs, material, and conversion costs 1. Transferred in Cost = $ 60,000 Beginning 7/1 + 1,218,560 Transferred in during July $1,278, ,000 units (6,000 Beg + 125,000 Transferred In) = $9.76 cost/equivalent unit for transferred in cost 2. D.Material = $ 26,775 Beginning costs + 756,225 Costs incurred in July $783,000 Total costs 130,500 units (130,000 completed (transf.out) + 500*) * 1000 units in ending inventory x 50% complete as to materials 500 equiv. units materials = $6.00 cost/equiv. unit as to materials in 2 nd dept for July 1

2 3. Conversion Costs = $ 6,750 beginning costs + 488,010 costs incurred during July $ 494, ,200 units (130,000 + (1000 x 20% complete = 200 equiv. units = $ 3.80 cost/equiv. unit as to conversion costs b. Calculate the cost of the units transferred out of the department. Cost of units transferred out of Dept = ($ $ $3.80) x 130,000 units transferred out = $2,542,800 c. Calculate the cost of the ending inventory. Cost of ending inventory: 1000 units x $9.76 (transferred in cost) = $ 9, units x 50% x $6.00 (material) = $ 3, units x 20% x $3.80 (conversion) = $ 760 Cost of ending inventory $13, Gator Inc. uses a process costing system. The company s work-in-process inventory account at February 28 th consists of 70,000 units which are 100% complete with respect to materials and 80% complete with respect to conversion costs. If the balance in the work-in-process inventory account is $546,000 and the cost per equivalent unit for conversion costs is $6.00, what is the cost per equivalent unit for materials? WIP Inventory 70,000 units (100% M; 80% Conv) WIP Inventory $546,000 less conversion costs = Material costs Conversion cost = 70,000 units x 80% = 56,000 units complete as to Conversion Cost x $ 6 cost/equiv unit for conversion costs $336,000 conversion costs WIP inventory $546,000 less $336,000 conversion cost = $210,000 material cost $210,000 material cost 70,000 units = $3.00 cost/equivalent unit for materials 6-1 Tribune Company has collected the following data for recent months: Month Issues published Total cost May 20,500 $20,960 June 22,300 21,428 July 18,750 20,505 August 21,200 21,520 a. Using the high-low method, find variable cost per unit, total fixed costs, and the total cost equation. Variable cost/unit: Change in cost change in activity (between high and low activity) $21,428 - $20,505 = $0.26 per unit (estimated variable cost/unit) 22,300(units) - 18,750(units) Total Fixed Costs = Difference between total cost & estimated variable cost Total Cost (pick either high or low cost, here we pick low) at low activity $20,505 Less: estimated variable cost (18,750 units x $.26) ( 4,875) Total fixed costs $15,630 Total Cost Equation: Fixed Cost + (V.C./unit x activity) = $15,630 + ($0.26 x activity) b. What is the estimated cost for a month in which 22,000 issues are published? $15,630 + ($0.26 x 22,000 units) = $21,350 estimated total cost 2

3 6-2. Gator Co. had the following activity last year: Unit Sales 8,000 Unit sales price $15 Production in units 10,000 Beginning inventory units -0- Ending inventory units 2,000 Unit direct material cost $3 Unit direct labor cost $5 Unit variable S & A costs $ 0.50 Fixed overhead production costs $30,000 10,000 units = $3.00 FOH/unit Fixed S & A costs $20,000 Prepare income statement using both full costing and variable costing methods. Reconcile any difference in net income. Full Costing Sales $120,000 (8,000 x $15) Less: COGS (88,000) ($3 FMO + $8 VC x 8,000 units) Gross Profit 32,000 Less: S & A expense (24,000) ($.50 x 8,000 + $20,000) Net Income 8,000 Variable Costing Sales $120,000 Less: Variable product costs (64,000) ($8 x 8000 units) Variable S & A expenses (4,000) (.50 x 8000 units) Contribution Margin 52,000 Less: Fixed overhead product costs (30,000) Fixed S & A (20,000) Net Income $ 2,000 Reconciliation: Full costing net income $8,000 + fixed overhead in Beg Inv fixed overhead in ending inv (6,000) ($3 x 2000 units) Produced 10,000 Variable costing net income $ 2,000 Sold 8,000 In E. I. 2,000 units *Full Costing Variable Costing (Divide all costs between fixed & variable) Sales Revenue Sales Revenue Less: COGS (Full P.C.-DM,DL,MO) Less: All V.C. = Gross Margin = Contribution Margin Less: Period Costs (S,G & A) Less: All Fixed Costs = Net Income = Net Income Only difference in full costing & variable costing income statement is treatment of fixed MOH in Ending Inv. Under full costing it is a product cost. Under variable costing FMOH is treated as a period cost & deducted in period incurred. Using full costing FMOH in ending inventory is an asset on B/S and not deducted on I/S Using variable costing FMOH treated as a period cost & deducted on I/S 3

4 6-3. Donovan Dynasty produces gator call whistles which sell for $10 each. The following information is for their 1 st two years of operations. Year 1 Year 2 Sales 1,500 whistles 1,700 whistles Production 2,100 whistles 1,500 whistles Variable manufacturing cost per whistle $ 4 $ 4 Sales commission expense per whistle $ 1 $ 1 Total fixed manufacturing overhead $1,260 $1,260 Total fixed administrative expenses $500 $500 Reconcile the difference in net income using full costing and variable costing for both Year 1 and Year 2. In computing COGS, assume weighted-average inventory cost flow. (Round to 4 decimal places). Year 1 Production 2100 units Sales (1500) E.I. Yr1 600 Year 2 Production 1500 Available for Sale 2100 Sales (1700) E.I. Yr2 400 Donovan Dynasty Income Statement (Absorption Costing) Year 1 & Year 2 Year 1 Year 2 Sales revenue $15,000 $17,000 Cost of goods sold (1500 units x $4.60) (6,900) (8,111)* Gross profit 8,100 8,889 Operating expenses (2,000) (2,200) Operating income $ 6,100 $ 6,689 *Units Sold: 1700 Total cost of goods available for sale at beginning of Year 2: 600 from last year s production (beginning inventory this year) 1500 from this year s production Year 1 Cost Per Unit: $4 variable cost per unit+ ($1260 fixed costs/2100 whistles produced) = $4.6 Year 2 Cost Per Unit: $4 variable cost per unit + (1260 fixed costs/1500 whistles) = $4.84 Weighted Avg =[($4.6*600 units + $4.84*1500 units)]/2100 units total = per unit COGS for Y2: 1700 units sold * $ per unit = $8,111 Donovan Dynasty Income Statement (Variable Costing) Year 1 & Year 2 Year 1 Year 2 Sales revenue $15,000 $17,000 Variable expenses: Variable cost of goods sold 6,000 6,800 Sales commission expense 1,500 (7,500) 1,700 (8,500) Contribution margin 7,500 8,500 Fixed expenses: Fixed manufacturing overhead 1,260 1,260 Fixed administrative expenses 500 (1,760) 500 (1,760) Operating income 5,740 6,740 4

5 Year 1 Op. Income using Absorption Costing $6,100 Year 1 Op. Income using Variable Costing 5,740 Difference $ 360 Yr 1 Absorption Costing excludes 600 units in Ending Inventory x.60 FMOH/unit=$360 Year 2 Op. Income using Absorption Costing $6,689 Year 2 Op. Income using Variable Costing 6,740 Difference $ 51 Yr. 2 Absorption Costing includes 600 units x.60 FMOH/unit=$360 from Year 1 s Ending Inventory & excludes 400 units x FMOH/unit =$309 units at the end of Year 2 (weighted average of Y1 inventory and Y2 inventory) It d be incorrect to simply net these differences as 200 units x some FMOH/unit because the FMOH/unit changes across the years and that difference needs to be accounted for. Reconciliation using Method at Bottom of Problem 6-2: Year 1 Year 2 Full costing net income $6,100 $6,689 + fixed MOH in Beg. Inv fixed MOH in End. Inv = Variable costing Net Inc. $5,740 $6, Fast Connect has fixed costs of $700,000. Selling price per unit is $180 and variable cost per unit is $110. a. How many units must Fast Connect sell in order to break even? Profit Equation = SP(x) VC(x) TFC Breakeven: 0 = ($180 - $110)x - $700,000 0 = $70(x) - $700,000 $70(x) = $700,000 x (breakeven) = 10,000 units b. How many units must Fast Connect sell in order to earn a profit of $560,000? x = Profit + TFC Contribution Margin/unit (SP VC) x = $560,000 + $700,000 $70 CM/unit ( ) x = 18,000 units c. A new employee suggests that Fast Connect sponsor a company softball team as a form of advertising. The cost to sponsor the team is $3,500. How many more units must be sold to cover this cost? $3,500 = 50 units more will cover $3,500 additional costs $ 70 contribution margin/unit 7-2 Gator Company sells a single product at a price of $57 per unit. Variable costs per unit are $35 and total fixed costs are $719,400. Gator Co. is considering the purchase of a new piece of equipment that would increase the fixed costs to $1,023,700, but decrease the variable costs per unit to $28. If Gator Co. expects to sell 40,000 units next year, should they purchase this new equipment? Current: (( $57 - $35) x 40,000 ) - $719,400 = $160,600 current profit Proposed: (( $57 - $28) x 40,000) - $1,023,700 = $136,300 proposed profit Gator Co. should not buy new equipment 5

6 7-3 Ben s Bikes sells two mountain bikes for every four street bikes. The mountain bike sells for $2,000 and has variable costs of $1,250. The street bike sells for $500 and has variable costs of $200. If Ben s Bikes fixed costs total $1,620,000, how many bikes must be sold in order for the company to break even? How many of these bikes will be mountain bikes and how many will be the street bikes? Multiproduct Analysis: need weighted average contribution margin/unit Mountain Bike CM/unit = $2,000 (1,250) = $750/unit Street Bike CM/unit = $ 500 (200) = $300/unit 2 ($750) + 4 ($300) = $450 weighted average CM/unit 6 bikes total Breakeven in units = Profit + TFC = 0 + $1,620,000 = 3600 bikes Weighted Average CM/unit = $450 cm/unit Mix = 3600 total bikes x 1/3 (2/6) Mtn Bikes = 1200 Mtn Bikes x 2/3 (4/6) Street Bikes = 2400 Street Bikes 3600 total 7-4. Gator Bike Repair Shop has a monthly target operating income of $15,000. Variable expenses are 75% of sales, and monthly fixed expenses are $12,000. a. Compute the monthly margin of safety in dollars if the shop achieves its monthly income goal. Need CMR, have F.C. but not V.C.; but V.C. are 75% of Sales. So if SP = $1, then V.C. = 75 ; CM/unit= 25 Contribution margin ratio = 1 less.75 (V.C.) = 0.25 CMR Target sales in dollars = $12,000 F.C. + $15,000 target inc..25 CMR = $108,000 Breakeven in sales dollars = $12, CMR = $48,000 Margin of safety = $108,000 Target Sales Dollars less $48,000 Breakeven Sales Dollars = $60,000 MOS b. What is Gator s margin of safety expressed as a percentage of target sales? MOS $60,000 =.56 or 56% of target sales Target sales $108,000 c. What is Gator s operating leverage factor at the target level of operating income? Target Sales $108,000 x CMR x.25 CM $ 27,000 - F.C. (12,000) Operating Income $ 15,000 OLF = CM Operating income OLF = $27,000 $15,000 = 1.8 operating leverage factor at target operating income d. Assume that Gator reaches its target. By what percentage will Gator s operating income fall if sales volume declines by 9% the next year? If volume decreases by 9%, operating income will decrease by 16.2% (OLF of 1.8 x 9% decrease) = 16.2% 6

7 7-5. Gator Team Spirit makes Gator t-shirts. Co. has fixed expenses of $1,035,000 each month plus variable expenses of $33.60 per carton of t-shirts. Of the variable expenses, 70% is cost of goods sold, while the remaining 30% relates to variable operating expenses. Gator Team Spirit sells each carton of t-shirts for $ a. What is the Company s contribution margin ratio? (If necessary, round the contribution margin ratio to two decimal places). Contribution margin: SP/unit ($65) less VC/unit ($33.60) = $31.40 CM/unit CMR = $31.40 CM/unit $65 (SP/unit) =.48 (rounded) CMR b. What does their monthly sales revenue need to be to earn $300,000 in operating income? Target sales in dollars = FC + Target operating income CMR = $1,035,000 + $300, (CMR) = $2,781, Gator Corp is purchasing new more efficient manufacturing equipment. Gator s current contribution margin ratio is 60% and their current breakeven point is $360,000 sales revenue. If Gator s fixed expenses increase by $60,000 due to the new equipment, what will Gator s new breakeven point be (in Sales Revenue)? Must find current fixed expenses: Sales Rev to Breakeven = FC CMR; $360,000 = x 60%; x = $216,000 current FC New FC = $216,000 + $60,000 = $276,000 New Breakeven: FC = $276,000 = $460,000 CMR 60% 8-1. McCarthy Company sells hides and uses cost plus pricing. The hides have a variable cost per unit of $ McCarthy has annual fixed costs of $500,000. If McCarthy can sell 50,000 hides and has a markup of 40% of total cost, what price will McCarthy charge? 1.4 x ($40(VC/unit) + (500,000 (FC) 50,000 units)) = $70.00 sales price or Total cost of $40 (VC) + $10 (FC) = $50 Total Cost x 40% = $20 $50 (total cost) + $20 = $70 Sales Price 8-2. Gator Music is designing a new portable recording studio. The product development team includes staff from marketing, engineering & accounting. The team thinks they can sell the product for a price of $4,000. Mgt wants a per unit profit of 20% of selling price. a. Calculate target cost/unit Price $4,000 Desired profit at 20% (800) Target cost $3,200 b. The team estimates that fixed production costs will be $1,860,000 and variable costs to produce and sell the product will be $2,500 per unit. How many units must be produced and sold to meet the target cost per unit? $2,500 + ($1,860,000 X units) = $3,200 X = 2,657 units c. Suppose Gator Music decides that only 2,000 units can be sold at a price of $4,000 and therefore the target cost cannot be reached. They are considering dropping a feature which adds $750 of variable costs per unit. With this feature dropped, Gator Music believes it can sell 2,700 units at $3,200 per unit. Will Gator Music be able to produce the item at the new target cost or less? Show calc. to support answer. Price $3,200 Desired profit of 20% (640) Target cost $2,560 7

8 Variable cost/unit $1,750 Fixed cost/unit ($1,860,000 2,700 units) 689 Total $2,439 The revised target cost will be $2,560, and after dropping the feature, the cost/unit will only be $2,439 (with sales of 2,700 units). Therefore, Co. will be able to produce the item at less than the new target cost. So yes, they should proceed by dropping $750 feature High Strokes Inc. produces two types of rowing machines, the Deluxe and the Regular models. A recent segmented income statement is shown below. Regular Deluxe Total_ W/O Reg Difference Sales $160,000 $240,000 $400,000 $240,000 $160,000 Less: Variable Cost of goods sold 120, , ,000 (160,000) 120,000 Contribution margin 40,000 80, ,000 80,000 40,000 Less: Direct fixed costs 10,000 20,000 30,000 (20,000) 10,000 Common fixed costs* 32,800 49,200 82,000 (82,000) -0- Total fixed costs 42,800 69, , ,000 10,000 Net income (Loss) $ ( 2,800) $10,800 $ 8,000 (22,000) (30,000) *Common fixed costs allocated based on relative sales of the two models. Determine if High Strokes should drop the Regular model. Incremental Analysis Dropping Regular Model Lost sales $ ( 160,000) Cost savings: Cost of goods sold 120,000 Direct fixed costs 10,000 Total cost savings 130,000 Net loss from dropping $ (30,000) So they should not drop the Regular model 8

9 8-4 Jermaine s Bobcats makes two models of bobcats the Bill and the Buck. Each Bill sells for $8,000, has $5,000 in variable costs and takes 100 hours to make. Each Buck sells for $15,000, has $9,000 in variable costs, and takes 300 hours to make. Jermaine s Bobcats can sell all of either unit they can produce. There are only 30,000 labor hours available each month. a. How many of each model should be produced? CM of Bill is ($8000 ($5000) = $3000 CM/unit; takes 100 hours per unit CM of Buck is ($15,000 ($9,000) = $6000 CM/unit; takes 300 hour per unit Bill CM/unit of constraint = $ hrs = $30/hour Buck CM/unit of constraint = $ hrs = $20/hour With only 30,000 labor hours available: Bill can generate $900,000 ($30 x 30,000 hours) Buck can generate $600,000 ( $20 x 30,000 hours) Company should produce only Bill model since it has a higher contribution margin/hour b. Same facts except the Sales Dept. estimates that only a maximum of 200 Bills could be sold. Now how many of each model should be produced? 30,000 hrs available 100 hrs to make Bill = 300 units, but can only sell 200 units, so only produce 200 Bills 200 Bills x 100 hrs/bill = 20,000 hours That leaves 10,000 hours 300 hours to make Buck = 33 Bucks 8-5. Digital View Inc. has decided to discontinue its Basic model DVD player. They currently have a number of partially completed units on hand that have incurred $50 of costs per unit. They could complete them incurring the following additional unit costs: direct materials $10, direct labor $20, variable overhead $5, and fixed overhead $30. The fixed costs relate to depreciation on plant assets. If Digital View completes the DVD players they can be sold at $100 per unit. However, another company is willing to buy the DVD players as is for $60. What should Digital View do? Sell Process Incremental As Is Further Revenue & Costs Sales Price $ 60 $ 100_ $ 40_ Less: Prior costs (Sunk) Not Relevant, don t include Additional costs: DM DL VOH Total cost Gain per unit $ 60 $ 65 $ 5 They should process further and sell for $100 per unit. The fixed overhead costs are irrelevant because they are not avoidable and they represent sunk costs. 9

10 8-6. Fulcrum Co. is currently producing 20,000 components at a cost of $16 per unit. An outside supplier has offered to sell 20,000 units to Fulcrum Co. for $14 a unit. The production costs are shown below: Direct materials $ 2 Direct Labor 4 Variable overhead 5 Fixed overhead (40% avoidable) Production Per Unit 5 x 40% avoidable = $2 avoidable; $3 unavoidable A. Should Fulcrum make or buy the component? Incremental A. Make Buy Cost (Savings) $16 Purchase price $ 0 $14 $14 Cost Direct materials 2 0 ( 2 ) Savings Direct labor 4 0 ( 4 ) Savings Variable overhead 5 0 ( 5 ) Savings Fixed overhead 5 3 unavoid ( 2 ) avoid Savings Totals $ 16 $ 17 $ 1 They should continue to make B. For this part only, assume the space used to produce the component could be leased to another company for $40,000. What decision should now be made? Totals from above $16 $ 17 $ 1 Opportunity cost 0 ( 2) ( 2 ) Totals $ 16 $ 15 $ ( 1 ) They should now Buy. (Opportunity cost-represents benefits foregone by selecting one alternative over another. If Co. continues to make in-house, they forego $40,000 of potential rental income Jenks Industries is considering a special order from an overseas customer for 10,000 units at a price of $40.00 per unit. Jenks s product normally sells for $52.00 per unit and has variable manufacturing costs of $21.00 per unit and variable selling costs of $4.00 per unit. Fixed manufacturing costs are $500,000 and fixed selling and administrative costs are $200,000. Jenks has capacity to produce 100,000 units and is currently producing 80,000. If Jenks accepts the order, Jenks will incur special legal and accounting fees of $7,000 in connection specifically with this order. In addition, Variable selling costs will not be incurred on special order. A. What are the incremental revenues associated with the special order? $40.00 x 10,000 units = $400,000 incremental revenue B. What are the incremental costs associated with the special order? $21.00 x 10,000 = $210, ,000 = $217,000 (Note: $7,000 is extra cost, fixed costs not incremental and variable selling costs avoidable) C. What amount of additional profit or loss will be incurred if the order is accepted? Incremental Revenue (Incr. Costs) = Incremental profit $400,000 - $217,000 = $183,000 profit; so yes special order s/b accepted 10