Ma Mod4 W08

CMA Ontario
Accelerated Program
MANAGEMENT ACCOUNTING
MODULE 4
CMA Ontario January 2008

Module 4 - Management Accounting
Table of Contents
Textbook Ch*
1. Cost-Volume-Profit Analysis 3 3
2. Relevant Costs 11 14
3. Linear Programming 11 25
4. Decision Analysis under Uncertainty 3 28
5. Pricing 12 29
6. Budgeting 6 31
7. Capital Budgeting 21-22 39
8. The Lease vs. Buy decision - 50
9. Cost Variances 7-8 54
10. Revenue Variances 16 69
11. Direct and Absorption Costing 9 80
12. Transfer Pricing 23 88
13. Performance Evaluation For Profit Organizations 24 97
14. In-Class Problems 109
15. Multiple-Choice Questions 161
16. Powerpoint Slides 191
* note that this module comprises mostly of solutions to selected problems in the
textbook.
Page 2 CMA Ontario January 2008

1. Cost-Volume-Profit Analysis
Exercise 3-20
Current Situation -
Revenues $12,000,000
Variable costs 9,840,000
Contribution margin 2,160,000
Fixed costs 2,040,000
Operating Income $120,000
1. Increase in CM = $2,160,000 x 10% = $216,000

New operating income = $120,000 + 216,000 = $336,000
2. Decrease in CM = $2,160,000 x 10% = $216,000

New operating income = $120,000 - 216,000 = ($96,000)
3. Increase in fixed costs = $2,040,000 x 5% = $102,000

New operating income = $120,000 - 102,000 = $18,000
4. Decrease in fixed costs = $2,040,000 x 5% = $102,000

5. Note that if units sold increase by 8%, then total contribution

margin will also increase by 8%.
Increase in CM = $2,160,000 x 8% = $172,800

6. Decrease in CM = $2,160,000 x 8% = $172,800

New operating income = $120,000 172,800 = ($52,800)
7. Increase in CM = $2,160,000 x 10% = $216,000

Increase in fixed costs = $2,040,000 x 10% = $204,000
New operating income = $120,000 + 216,000 204,000 = $132,000
8. New variable costs = $9,840,000 x 0.95 = $9,348,000

New CM = $12,000,000 9,348,000 = $2,652,000
Increase in CM = $2,652,000 2,160,000 = $492,000
Increase in fixed costs = $2,040,000 x 5% = $102,000
New operating income = $120,000 + 492,000 102,000 = $510,000

Exercise 3-28
2. Net sales price to the publisher = $36.00 x 70% = $25.20
Contribution margin per unit

Sales price $25.20
Variable costs
Producing and marketing $4.80
Royalty: $25.20 x 15% 3.78 8.58
$16.62
Fixed costs
Production and marketing $ 600,000
Up-front payment 3,600,000
$4,200,000
a) Breakeven point = $4,200,000 / 16.62 = 252,708 copies
b) ($4,200,000 + 2,400,000) / 16.62 = 397,112 copies
3. a) Contribution margin per unit

Sales price: $36.00 x 80% $28.80
Variable costs
Royalty: $28.80 x 15% 4.32 9.12
$19.68
Breakeven point = $4,200,000 / 19.68 = 213,415 copies
b) Contribution margin per unit

Sales price: $48.00 x 70% $33.60
Variable costs
Royalty: $33.60 x 15% 5.04 9.84
$23.76
Breakeven point = $4,200,000 / 23.76 = 176,768 copies

Exercise 3-33
1. CM/unit = $54 36 = $18

Operating income = (40,000 x $18) CM (1,000 x $72) Shipping - $288,000 FC
= $360,000
2. Operating income = (40,000 x $18) CM (800 x $72) Shipping - $288,000 FC

= $374,400
3. Costs to be recovered = (500 x $72) Shipping + $288,000 FC = $324,000

Breakeven = $324,000 / $18 = 18,000
4. For example, if Susan incurred 1,500 shipments, then

Costs to be recovered = (1,500 x $72) Shipping + $288,000 FC = $396,000
Breakeven = $396,000 / $18 = 22,000
The breakeven point is not unique because there are two cost driversquantity of
picture frames and number of shipments. Various combinations of the two cost
drivers can yield zero operating income.

Problem 3-35
1a. Fixed costs

Advertising 4,800
Mailing 3,600
Administrative labour 2,400
Auditorium charge 1,200
12,000
Airfare and accommodations 3,600
Lecture fee 2,400
18,000
Contribution margin/participant = 312 30 42 = 240

Breakeven point = 18,000 / 240 = 75
1b. Breakeven point = 12,000 / 240 = 50

The breakeven point drops from 75 attendees to 50 attendeesthe 6,000 package
to Smith requires 25 attendees with a unit contribution margin of 240 to be
recouped. In the regular compensation package, Smiths expense allowance and
lecture speaking fee of 6,000 is a fixed cost to UKBS. In contrast, UKBS has no
cost item (either fixed or variable) for Smith up to its breakeven point. Beyond the
breakeven point, Smith receives 50% of the operating income from the one-day
program.
2. 2005 = (240 x 60) 12,000 = 2,400 x 50% = 1,200

2006 = (240 x 90) 12,000 = 9,600 x 50% = 4,800
2007 = (240 x 180) 12,000 = 31,200 x 50% = 15,600
3. This question raises a broad set of issues:

Smith has taken a high level of risk with a compensation plan that only pays
him the guaranteed 6,000 under the regular plan when 100 executives attend
the seminar. In both 2006 and 2007, he received less than the 6,000 figure.
Smith could comment to the Dean that if the UKBS finds the risk-sharing
program attractive in periods of low demand, it should be willing to share the
revenues in periods of high demand.
Smith could stress to UKBS how much they both have gained from the one-
day seminars. UKBS has made an operating income each year. In addition,
only some of UKBSs fixed costs are cash outflows. For example, the 1,200
charge for use of the lecture auditorium is not a cash outflow. If the
auditorium would not be otherwise used that day, UKBS may well view the
1,200 amount as quite different from the cash outlay items.
Smith could respond to the Dean that the agreement is not really a 50%/50%
profit-sharing plan. It considers only the UKBS costs. Assume Smith pays
3,600 for airfare/accommodation. Then, in 2005 he actually lost 2,400
(1,200 3,600) for giving the seminar, while in 2006 he received only
1,200 (4,800 3,600).

Problem 3-39
1. CM/unit = $36.00 25.20 = $10.80

CM ratio = $10.80 / $36.00 = 30%
Breakeven units = $432,000 / $10.80 = 40,000

Breakeven sales = $432,000 / 0.30 = $1,440,000
2. (35,000 x $10.80) Total CM - $432,000 Fixed Costs = ($54,000)
OR: at 5,000 units below the breakeven point, the loss is:
5,000 x $10.80 = ($54,000)
3. New CM/unit = $10.80 + 1.80 = $12.60

New CM Ratio = $12.60 / $36.00 = 35%
New fixed costs = $432,000 + 97,200 = $529,200
Breakeven units = $529,200 / $12.60 = 42,000

Breakeven sales = $529,200 / 0.35 = $1,512,000
4. New CM/unit = $10.80 0.36 = $10.44

New CM Ratio = $10.44 / $36.00 = 29%
Breakeven units = $432,000 / $10.44 = 41,380

Breakeven sales = $432,000 / 0.29 = $1,489,655
5. Operating income = 10,000 Pairs above breakeven x $10.44 = $104,400

Problem 3-40
1. Commission operating income equation: $10.80x - $432,000

Fixed salary plan operating income: $12.60x - $529,200
Equating the two we get: $10.80x - $432,000 = $12.60x - $529,200

x = 97,200 / $1.80 = 54,000 units
2. Commission Fixed Salary

50,000 units $10.80(50,000) - $432,000 $12.60(50,000) - $529,200
= $108,000 = $100,800
60,000 units $10.80(60,000) - $432,000 $12.60(60,000) - $529,200

= $216,000 = $226,800
The decision regarding the plans will heavily depend on the unit sales level that is
generated by the fixed salary plan. For example, as part (1) shows, at identical unit
sales levels in excess of 54,000 units, the fixed salary plan will always provide a
more profitable final result than the commission plan.
3. Commission plan: ($432,000 + 201,600) / $10.80 = 58,667 units

Fixed salary plan: ($529,200 + 201,600) / $12.60 = 58,000 units
The decision regarding the salary plan heavily depends on predictions of demand.
For instance, the salary plan offers the same operating income at 58,000 units as
the commission plan offers at 58,667 units

Problem 3-41
1. CM on first 48,000 units: 48,000 x $10.80 $518,400

CM on remaining 2,000 units -
2,000 ($21.60 23.40 1.08 Commission) (5,760)
Fixed costs (432,000)
Operating income $80,640
2. $80,640 + 5,760 = $86,400
3. The point of indifference is where the operating incomes are equal. Let X = unit
cost per pair that would produce the identical operating income of $80,640
48,000($36.00 X - $1.80) 432,000 = 80,640

48,000($34.20 X) 432,000 = 80,640
$1,641,600 48,000X = $512,640
48,000X = $1,128,960
X = $1,128,960 / 48,000 = $23.52
Therefore, any rise in purchase cost in excess of $23.52 per pair increases the
operating income benefit of signing the long-term contract.
In a short-cut solution you could take the $5,760 difference between the "ideal"
operating income (of $86,400) at the current cost per pair and the operating
income under the contract (of $80,640) and divide it by 48,000 units to get 12
cents per pair difference.

Problem 3-46
1. Sales Mix = 3 Standard : 1 Deluxe
Bundle CM = (3 x $7.20) + (1 x 14.40) = $36.00

Breakeven point = $1,440,000 / $36.00 = 40,000 bundles
=> 40,000 x 3 = 120,000 Standard + 40,000 Deluxe
2. Standard = $1,440,000 / $7.20 = 200,000

Deluxe = $1,440,000 / $14.40 = 100,000
3. (180,000 x $7.20) + (20,000 x 14.40) - $1,440,000 = $144,000
Sales Mix = 9 Standard : 1 Deluxe
Bundle CM = (9 x $7.20) + (1 x 14.40) = $79.20

Breakeven point = $1,440,000 / $79.20 = 18,182 bundles
=> 18,182 x 9 = 163,638 Standard + 18,182 Deluxe
The major lesson of this problem is that changes in sales mix change breakeven
points and operating incomes. In this example, the budgeted and actual total sales
in number of units were identical, but the proportion of products having the higher
contribution margin declined. Operating income suffered, falling from $360,000 to
$144,000. Moreover, the breakeven point rose from 160,000 to 181,820 units in
total.

Problem 3-47
1. CM/Unit = $126 54 12 = $60

CM Ratio = $60 / $126 = 0.47619
Breakeven point in units = $1,680,000 / 60 = 28,000

Breakeven point in sales = $1,680,000 / 0.47619 = $3,528,000
2. TCM before = 40,000 x $60 $2,400,000

TCM after = 50,000 x ($118.80 54 12) 2,640,000
Maximum increase in fixed costs $ 240,000
3. Operating income before = $2,400,000 1,680,000 = $720,000
Let X = selling price
CM/unit = X 54 2.40 12 = X 68.40

40,000(X 68.40) $1,680,000 - $120,000 = $720,000
40,000X $2,736,000 $1,680,000 - $120,000 = $720,000
40,000X = $5,256,000
X = $5,256,000 / 40,000 = $131.40

Problem 3-53
When solving a problem like this one, the best approach is usually to put down the
numbers you have, and then solve the unknowns. In the table below the numbers
provided are in italic. The numbers beside the solved numbers represent the order in
which they were solved.
Case 1 Case 2
Cost of goods manufactured -
Direct materials used
Direct materials inventory, January 1, 2007 $14,400 $24,000
Direct materials purchased 18,000 60,000
Direct materials inventory, December 31, 2007 (6,000) (36,000) 1
26,400 1 48,000
Direct manufacturing labour 36,000 18,000
Fixed manufacturing overhead 21,600 6 24,000
Variable manufacturing overhead 6,000 6,000 6
Total manufacturing costs 90,000 5 96,000 5
WIP January 1, 2007 0 10,800
WIP December 31, 2007 0 (10,800)
Cost of goods manufactured $90,000 4 $96,000
4
Revenues $120,000 $120,000
Cost of goods sold
Finished goods inventory, January 1, 2007 0 6,000
Cost of goods manufactured 90,000 3 96,000 3
Finished goods inventory, December 31, 2007 0 (6,000)
90,000 2 96,000 2
Gross margin 30,000 24,000
Operating expenses
Variable 15,600 7 18,000 8
Fixed 2,400 8 12,000
18,000 9 30,000 7
Operating Income $12,000 10 ($6,000)

Case 1
(7) Total Variable Costs = $120,000 Revenues - $36,000 Contribution Margin = $84,000
Variable Operating expenses = $84,000 26,400 Direct materials 36,000 Direct Labour
6,000 Variable Overhead = $15,600
(8) Breakeven point = Fixed Costs / CM Ratio
CM Ratio = $36,000 / 120,000 = 0.30
Total fixed costs = $80,000 x 0.30 = $24,000
Fixed Operating expenses = $24,000 21,600 Fixed Overhead = $2,400
Case 2
Contribution Margin = $120,000 Revenues 48,000 Direct materials 18,000 Direct Labour
6,000 Variable Overhead - 18,000 Variable Operating = $30,000
Fixed costs = $24,000 Overhead + 12,000 Operating = $36,000

CM Ratio = $30,000 / 120,000 = 0.25
Breakeven point (sales) = $36,000 / 0.25 = $144,000

2. Relevant Costs
Exercise 11-19
1. Special order revenue: 2,500 medals x $110 $275,000

Variable costs -
Direct materials and labour:
($288,750 + 330,000) / 7,500 = $82.50 x 2,500 (206,250)
Variable costs setups: 25 batches x $550 (13,750)
Special order contribution $55,000
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 $55,000.
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
$55,000 gain from accepting the special order against the operating income it
might lose from regular customers.
2. CM lost on regular sales: 1,000 medals x (165 82.50) $82,500

Less variable batch costs: 1,000 / 50 x $550 (11,000)
Opportunity cost of taking the special order $71,500
Accepting the special order will result in a decrease in operating income of

$16,500 ($71,500 55,000). The special order should therefore be rejected.
3. Special order contribution $55,000

Cost of price reduction: 7,500 x $11 82,500
Net effect on operating income of accepting the special order ($27,500)
Do not accept the special order

Exercise 11-24
Given that the plant is operating at capacity, the scarce resource is machine hours. If we
assume that model 14 uses 1 machine hour, then Model 9 uses 27.5 / 13.75 = 2 machine
hours.
Model 9 Model 14
CM/Unit: $110.00 30.80 16.50 27.50 15.40 $19.80
$77.00 14.30 27.50 13.75 11.00 $10.45
Machine hour per unit 2 1
CM per machine hour $9.90 $10.45
Only Model 14 should be produced.

Exercise 11-25
1. Lost gross margin of Saskatoon Store: $946,000 726,000 ($220,000)

Avoidable costs -
Lease rent $82,500
Labour costs 46,200
Utilities 50,600
Allocated corporate overhead 47,300 226,600
Increase in operating income if Saskatoon store is closed $6,600
Marie Lopez is correct - closing the Saskatoon store will increase the companys
operating income.
2. Gross margin of new Store: $946,000 726,000 $220,000

Avoidable costs -
Lease rent $82,500
Labour costs 46,200
Utilities 50,600
Equipment 24,200
Allocated corporate overhead 4,400 207,900
Operating income of new store $12,100
Lopez is correct that opening such a store would increase Sanchez Corporations
operating income by $12,100. Also note that the relevant corporate overhead costs
are the $4,400 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 $4,400 of
corporate overhead to the new store, but this allocation is irrelevant to the analysis.
The key reason that Sanchezs operating income increases either if it closes down
the Saskatoon store or if it opens another store like it is the behaviour of corporate
overhead costs. By closing down the Saskatoon store, Sanchez can significantly
reduce corporate overhead costs, presumably by reducing the corporate staff that
oversees the Saskatoon operation. On the other hand, adding another store like
Saskatoon does not increase actual corporate costs by much, presumably because
the existing corporate staff will be able to oversee the new store as well.

Problem 11-31
1. Hours required by special order = 100,000 / 40 = 2,500

Hours required by regular sales = 750,000 / 100 = 7,500
Regular sales lost = 0
Incremental operating income of special order

CM: 100,000 x ($3.30 2.64) $66,000
Cost of mould (22,000)
Incremental income $44,000
Accept the special order.

Regular sales lost = 1,000 hours x 100 = 100,000 bottles
Incremental operating income of special order $44,000

Less CM lost on regular sales: 100,000 x ($0.55 0.25) (30,000)
Incremental income of accepting the special order $14,000
Accept the special order only if it believes that the lost sales of 100,000 bottles
will be recovered in the future, i.e. assuming there is no impact on future regular
sales.
3. Given that the mould will have to be purchased anyways, it is not a relevant cost.
We will want to maximize production of the product that generates the highest CM
per machine hour:
Bottles Toys
CM per unit $0.30 $0.66
Machine hours per unit 0.01 0.025
CM per machine hour $30.00 $26.40
Maximize sales of bottles: make 850,000 bottles + 60,000 toys (1,500 hours x 40
toys per hour)
Incremental operating income of special order:

CM: 60,000 x ($3.30 2.64) $39,600


Regular sales lost = 1,500 hours x 100 = 150,000 bottles
Incremental operating income of special order $44,000

Less CM lost on regular sales: 150,000 x ($0.55 0.25) (45,000)
Incremental income of accepting the special order ($1,000)
Reject the special order.
5. As per #3, we would want to maximize the production of water bottles. This would
leave us with 1,000 hours to produce 40,000 toys:

CM: 40,000 x ($3.30 2.64) $26,400
6. As per #3, we would want to maximize the production of water bottles.- 950,000
bottles. This would leave us with 500 hours to produce 20,000 toys:

CM: 20,000 x ($3.30 2.64) $13,200
Incremental income $(8,800)
So MPC should refuse to make any of the plastic toys.
7. Alternative 1 - MPC makes 40,000 toys and subcontract the remaining 60,000:
Incremental income of making 40,000 toys (per # 5) $4,400

Income on the subcontracted toys: 60,000 ($3.30 3.08) 13,200
$17,600
Alternative 2 - MPC subcontracts the whole order:

Income on the subcontracted toys: 100,000 ($3.30 3.08) $22,000
MPC should subcontract the whole order.

Problem 11-35
1. CM Lost: $550,000 242,000 66,000 ($242,000)

Avoidable expenses -
Setups and materials handling $44,000
Marketing and distribution costs 66,000 110,000
Incremental income if tables are discontinued ($132,000)
They should not drop the tables line.
2. a. Sales $275,000
Direct materials: $440 / 1,100 x $275,000 $110,000
Direct labour: $88/1,100 x $275,000 22,000
Tools and fixtures 4,400 136,400
Operating income of increasing bed line $138,600
Discontinue table line since increasing the bed line will increase operating
income by $138,600 132,000 = $6,600
b. The opportunity cost of continuing the tables product line is $138,600 from
the lost sales of beds.
c. Before making a decision, Home Furnishings should consider other factors,

among them (1) whether it wants to retain its image of being a full-line
supplier and (2) whether it would lose sales of bookshelves and beds in the
long run because customers cannot get all their needs, which include tables,
satisfied by Home Furnishings. Such strategic considerations may cause
Home Furnishings to continue the tables product line.
3. Incremental CM: $550,000 242,000 66,000 $242,000

Incremental setup costs: $44,000 x 2 (88,000)
Incremental tools and fixtures (52,800)
Incremental marketing and distribution:
$38,500* x 2 (77,000)
* allocated marketing costs: $123,750 x 550,000 / 2,475,000 = $27,500

Marketing and distribution costs related to shipping
= $66,000 27,500 = $38,500

Problem 11-36
1. Kaytell:
Net price $75,240
Incremental costs
Direct materials and labour (11,440)
Variable manufacturing overhead: $4,620 x 50% (2,310)
Sales commission: $75,240 x 3% (2,257)
$59,233
Convert to Standard Model:

Net price (68,750 x .98) $67,375
Incremental costs
Direct materials and labour (6,765)
Variable manufacturing overhead: $3,630 x 50% (1,815)
$57,447
Sell as special order without modifications

Net price (assume no discount) $57,200
$55,484
2. Kaytell contribution $59,233

Next-best alternative: Standard model contribution 57,447
Change in contribution to operating income $ 1,786
Change in sales price = Change in contribution / 1 - Commission

= 1,786 / .97 1,841
Original Kaytell price 75,240
Minimum price $73,399

3. Fixed manufacturing overhead should have no influence on the selling price quoted
by Auer Company for (one-time-only) special orders:
(a) Auer Company should accept special orders whenever the company is
operating substantially below capacity, including below the breakeven
point, if incremental revenue from an order exceeds incremental cost.
Normally, this approach would mean that the order should be accepted as
long as the selling price of the order exceeds the variable manufacturing
costs. The special order will result in a positive contribution toward fixed
costs. The fixed manufacturing overhead is not considered in the pricing
because it will be incurred whether the order is accepted or not.
(b) If Auer Company is operating above its breakeven point and if a special
order will allow the company to utilize unused capacity efficiently, the
special order should be accepted as long as incremental revenue exceeds
incremental cost, or, in most cases, the selling price exceeds the variable
manufacturing costs. If the selling price exceeds the variable manufacturing
costs, the order will yield a positive contribution toward the company's fixed
costs. Fixed manufacturing overhead is not considered because it will be
incurred whether the order is accepted or not. The only time the fixed
manufacturing overhead would be relevant would be if Auer were near
capacity and additional fixed costs would have to be incurred to complete
the order. If this situation occurred, Auer's incremental costs would be
higher, and they would have to be covered by the selling price.

Problem 11-37
1. CM per passenger = $550 22 (550 x 8%) $484

Total passenger CM per flight: 200 passengers x $484 $96,800
Fuel costs (15,400)
Flight CM 81,400
Fixed costs
Lease $58,300
Ground services 7,700
Flight crew salaries 4,400 70,400
Operating income per flight $11,000
2. Passenger CM before $96,800

Passenger CM after: [$528 22 (528 x 8%)] x 212 98,317
Increase in CM and operating income $1,517
They should lower the fare.
3. Passenger CM lost (per requirement 2) $98,317

Less fuel cost (15,400)
CM lost per flight $82,917
Air Pacific gets $82,500 per flight from chartering the plane to Travel International.
On the basis of quantitative financial factors, Air Pacific is better off not chartering
the plane and instead lowering its own fares.
Other qualitative factors that Air Pacific should consider in coming to a decision
are:
The lower risk from chartering its plane relative to the uncertainties
regarding the number of passengers it might get on its scheduled flights.
Chartering to Travel International means that Air Pacific would not have a
regular schedule of flights each week. This arrangement could cause
inconvenience to some of its passengers.
The stability of the relationship between Air Pacific and Travel International.
If this is not a long-term arrangement, Air Pacific may lose current market
share and not benefit from sustained charter revenues.

Problem 11-44
1. Cost to buy: 32,000 x $19.03 $608,960
Cost to make:
Direct materials: $214,500 x 1.08 x 32/30 $247,104
Direct labour: $132,000 x 1.05 x 32/30 147,840
Plant space rental costs 92,400
Equipment leasing costs: $39,600 6,600 33,000
Manufacturing overhead:
$247,500 x 40% x 32/30 105,600 625,944
Savings in favour of buying $16,984
2. Based solely on the financial results, the 32,000 units of MTR-2000 for 2008
should be purchased from Marley. At least three other factors that Paibec
Corporation should consider before agreeing to purchase MTR-2000 from Marley
Company are the following:
The quality of the Marley component should be equal to, or better than, the
quality of the internally made component, or else the quality of the final
product might be compromised and Paibecs reputation affected.
Marleys reliability as an on-time supplier is important, since late deliveries
could hamper Paibecs production schedule and delivery dates for the final
product.
Layoffs may result if the component is outsourced to Marley. This could
impact Paibecs other employees and cause labour problems or affect the
companys position in the community. In addition, there may be termination
costs which have not been factored into the analysis.
3. Lynn Hardt would consider the request of John Porter to be unethical for the
following reasons:
Prepare complete and clear reports and recommendations after appropriate
analysis of relevant and reliable information. Adjusting cost is unethical.
Refrain from either actively or passively subverting the attainment of the
organizations legitimate and ethical objectives. Paibec has a legitimate
objective of trying to obtain the component at the lowest cost possible,
regardless of whether it is manufactured by Paibec or outsourced to Marley.
Communicate unfavourable as well as favourable information and professional
judgments or opinions. Hardt needs to communicate the proper and accurate
results of the analysis, regardless of whether or not it is favourable to Paibec.
Refrain from engaging in or supporting any activity that would discredit the
profession. Falsifying the analysis would discredit Hardt and the profession.
Communicate information fairly and objectively. Hardt needs to perform an
objective make-versus-buy analysis and communicate the results fairly.
Disclose fully all relevant information that could reasonably be expected to

influence an intended users understanding of the reports, comments, and

recommendations presented. Hardt needs to disclose fully the analysis and the
expected cost increases.
Hardt should indicate to Porter that the costs derived under the make alternative
are correct. If Porter still insists on making the changes to lower the costs of
making MTR-2000 internally, Hardt should raise the matter with Porters superior,
after informing Porter of her plans. If, after taking all these steps, there is
continued pressure to understate the costs, Hardt should consider resigning from
the company, rather than engage in unethical conduct.

3. Linear Programming
Problem 11-41
1. Let D represent the batches of Dellas Delights made and sold.

Let C represent the batches of Cathys Chocolate Chips made and sold.
The contribution margin per batch for Dellas Delights is $630 210 = $420.
The contribution margin per batch for Cathys Chocolate Chips is $402 102 =
$300.
The LP formulation for the decision is:

Maximize TCM = $420D + $300C
Subject to 36D + 18C 720 (Mixing Department constraint)
12D + 18C 360 (Baking Department constraint)
24D 384 (Dipping Department constraint)
2. See graph below.
Coordinates TCM
D=0 C = 20 $6,000
D = 15 C = 10 9,300 <- Optimum Point
D = 16 C=8 9,120
D = 16 C=0 6,720


Problem 11-42
1. Let X = Units of printers

Let Y = Units of desktop computers
Maximize TCM = $240X + $120Y

Subject to: 7.2X + 4.8Y 28.8 Production Line 1
12X 24 Production Line 2
XY0 Sales of X and Y
X 0, Y 0 Non-negative constraint
2. See graph below.
Coordinates TCM
X=2 Y=2 $720
X=2 Y=3 840 <- Optimum Point
X=0 Y=6 720

4. Decision Analysis under Uncertainty
Exercise 3-34
1. Expected demand = (100,000 x 0.05) + (200,000 x 0.10) + (300,000 x 0.30)

+ (400,000 x 0.35) + (500,000 x 0.15) + (1,000,000 x 0.05) = 380,000
Expected payment = $2,400,000 + (380,000 x $4.80) = $4,224,000
2. CM/Unit = $19.20 4.80 2.40 = $12.00

Fixed costs = $2,400,000 + 1,200,000 = $3,600,000
Breakeven = $3,600,000 / $12.00 = 300,000
Note that the probability that the demand is at least 300,000 is 85%.
Problem 3-55
1. CM/Unit = $12.00 9.60 = $2.40

Breakeven for either product: $480,000 / 2.40 = 200,000
2. Expected demand for Emerald Green Umbrellas:

(50,000 x 0.0) + (100,000 x 0.1) + (200,000 x 0.2) + (300,000 x 0.4)
+ (400,000 x 0.2) + (500,000 x 0.1) = 300,000
Expected demand for Shocking Pink Umbrellas:

(50,000 x 0.1) + (100,000 x 0.1) + (200,000 x 0.1) + (300,000 x 0.2)
+ (400,000 x 0.4) + (500,000 x 0.1) = 305,000
Choose the Shocking Pink Umbrellas since they have the highest expected demand.
3. The expected operating income from the two products would be identical. If the
choice criterion is to maximize expected operating income, the company will be
indifferent between emerald green and shocking pink umbrellas. However, assume
that management considers risk factors. Emerald green umbrellas, for example,
have a 10% chance of selling only 100,000 units, which would result in a net
operating loss of $200,000. Also, there is a 30% chance that sales of emerald green
will exceed 300,000 units. If this event happens, the operating income of emerald
green umbrellas will be higher than the operating income of shocking pink
umbrellas
The expected values are important, but the dispersion of the probability distribution
is also important. Normally, the wider the dispersion, the greater the risk.
Knowledge of the entire probability distribution helps management assess the risk
before reaching a decision.

5. Pricing
Exercise 12-16
1. Incremental operating income =

1,000 tapes x ($4.56 1.80 0.96 0.84 0.228 Sales Commission)
1,000 tapes x $0.732 = $732
2. This calculation assumes that: (a) the monthly fixed manufacturing overhead of
$150,000 and $65,000 of monthly fixed marketing costs will be unchanged by
acceptance of the 1,000 unit order, and (b) the price charged and the volumes sold
to other customers are not affected by the special order.
3. Key issues are:

Will the existing customer base demand price reductions? If this 1,000-tape
order is not independent of other sales, cutting the price from $6.00 to $4.56
can have a large negative effect on total revenues.
Is the 1,000-tape order a one-time-only order, or is there the possibility of
sales in subsequent months? The fact that the customer is not in Dill
Company's "normal marketing channels" does not necessarily mean it is a
one-time-only order. Indeed, the sale could well open a new marketing
channel. Dill Company should be reluctant to consider only short-run
variable costs for pricing long-run business.
Exercise 12-18
1. $9.60 Pyrone + $4.80 Direct Labour + $3.60 Variable OH $18.00
2. Variable costs per part 1 $18.00

CM lost on sales of Bolzene: $7.20 x 2/1.5 9.60
$27.60

Problem 12-31
1. DLH required = 1,000,000 doses / 1,000 doses per hour = 1,000 hours
Incremental costs -
Direct manufacturing labour: 1,000 hours x $19.20 $19,200
Variable overhead: 1,000 hours x $8.20 7,200
Administrative 6,000
$32,400
Minimum price per dose = $32,400 / 1,000,000 = $0.0324
2. Incremental costs per part 1 $32,400

Fixed overhead costs: 1,000 hours x $36.00 36,000
68,400
Maximum allowable return [9% / (1 - .4) = 15%] 10,260
Total bid price $78,660
Bid price per dose = $78,660 / 1,000,000 = $0.07866
3. The factors that Hall should consider before deciding whether or not to submit a
bid at the maximum allowable price include (a) whether Hall has excess capacity,
(b) whether there are available jobs for which profitability might be greater, and
(c) whether the maximum bid of $0.084 contributes toward recovering fixed costs.

6. Budgeting
Exercise 6-22
1. 480,000 yen x 960,000 units = 460,800,000,000 yen
2. Needs -
Sales 960,000
Targeted ending inventory 120,000
Less opening inventory (144,000)
Budgeted production 936,000
3. Needs -
Production: 936,000 x 2 1,872,000
Targeted ending inventory 36,000
Less opening inventory (24,000)
Budgeted purchases (units) 1,884,000
Budgeted purchases (yen): 1,884,000 x 19,200 yen 36,172,800,000
Exercise 6-23
January February March Total

Production budget -
Needs -
Sales 12,000 14,400 9,600 36,000
Targeted ending inventory 19,200 15,000 16,200 16,200
Less opening inventory (19,200) (19,200) (15,000) (19,200)
Budgeted production in units 12,000 10,200 10,800 33,000
Direct manufacturing labour budget

Direct labour hours per unit 2.0 2.0 1.5
Total direct labour hours 24,000 20,400 16,200 60,600
Total direct labour cost /hour * $14.16 $14.16 $14.16 $14.16
Total budgeted direct labour cost $339,840 $288,864 $229,392 $858,096
* $12.00 + 0.60 Pension + 0.18 Workers Compensation + 0.48 Medical Insurance

+ 0.90 Employment Insurance = $14.16

Problem 6-39
1. Lemonade D-Lemonade
Budgeted sales (lots) 1,296 648
Budgeted selling price per lot $10,800 $10,200
Budgeted sales ($) $13,996,800 $6,609,600
Needs -
Sales 1,296 648
Ending inventory 20 10
Less opening inventory (100) (50)
Budgeted production 1,216 608
3. Syrup Syrup
& Lemonade D-Lemonade Containers Packaging
4. Needs -
Production 1,216 608 1,824 1,824
Ending Inv. 30 20 100 200
Less Op. Inv. (80) (70) (200) (400)
Purchases 1,166 558 1,724 1,624
Cost/unit $1,440 $1,320 $1,200 $960
Total Purchases $1,679,040 $736,560 $2,068,800 $1,559,040
Cost of DM Used
Cost of Op Inv.* $105,600 $84,000 $228,000 $432,000
Purchases 1,679,040 736,560 2,068,800 1,559,040
Ending Inv ** (43,200) (26,400) (120,000) (192,000)
$1,741,440 $794,160 $2,176,800 $1,799,040
* Opening inventory quantity x cost of opening inventory

** Ending inventory quantity x budgeted 2008 cost
Budgeted production 1,216 608
Budgeted hours per lot 20 20
Hourly rate $30 $30
Budgeted direct labour cost $729,600 $364,800

6. Variable overhead
Budgeted production (1,216 + 608) 1,824
x Budgeted bottling time per lot 2
x Budgeted variable overhead rate $720
Budgeted variable overhead $2,626,560
Budgeted fixed overhead 1,440,000
$4,066,560
7. Direct Materials (from part 3)

Syrup Lemonade $43,200
Syrup D-Lemonade 26,400
Containers 120,000
Packaging 192,000 $381,600
Finished Goods (Schedule)

Lemonade 20 lots x $6,430 $128,600
D-Lemonade - 10 lots x $6,310 63,100 191,700
$573,300
Schedule of Finished Goods Inventory Cost/Unit

Lemonade D-Lemonade
Syrup $1,440 $1,320
Containers 1,200 1,200
Packaging 960 960
Direct labour: 20 hours x $30 600 600
Variable manufacturing overhead: 2 hours x $720 1,440 1,440
Fixed manufacturing overhead: 2 hours x $395* 790 790
$6,430 $6,310
* $1,440,000 / (1,824 lots x 2 hours per lot)
8. Beginning FG Inventory [($100 x $6,360) + (50 x $6,240)] $948,000

Cost of goods manufactured
Direct materials used (part 3 and 4) $6,511,440
Direct labour (part 5) 1,094,400
Manufacturing overhead (part 6) 4,066,560 11,672,400
Ending inventory (part 7) (191,700)
$12,428,700
9. Budgeted marketing costs - $20,606,400 x 12% $2,472,768
10. Budgeted distribution costs - $20,606,400 x 8% $1,648,512
11. Budgeted administration costs - $11,672,400 x 10% $1,167,240

12. Sales $20,606,400

Cost of goods sold 12,428,700
Gross margin 8,177,700
Operating expenses
Marketing $2,472,768
Distribution 1,648,512
Administration 1,167,240 5,288,520
Operating income $2,889,180
Problem 6-40
1. April May June

Cash Collections -
February Sales: $12,000 x 40% $4,800
March Sales: $10,800 x 60% | 40% 6,480 $4,320
April Sales: $13,800 x 60% | 40% 8,280 $5,520
May Sales: $15,000 x 60% 9,000
$11,280 $12,600 $14,520
Purchases -
COGS (40% of revenues) $5,520 $6,000 $6,720
Ending inventory
(70% of next mo. COGS) 4,200 4,704 5,040
Less opening inventory (3,864) (4,200) (4,704)
$5,856 $6,504 $7,056
February Purchases = ($12,000 x 40%) + ($10,800 x 40% x 70%)

- (12,000 x 40% x 70%) $4,464
March purchases = ($10,800 x 40%) + (13,800 x 40% x 70%)
- (10,800 x 40% x 70%) $5,160

Cash Disbursements
On Purchases
Feb Purchases: $4,464 x 25% $1,116
Mar Purchases: $5,160 x 75% | 25% 3,870 $1,290
Apr Purchases: $5,856 x 75% | 25% 4,392 $1,464
May Purchases: $6,504 x 75% 4,878
4,986 5,682 6,342
Wages and fringe benefits (30% of rev.) 4,140 4,500 5,040
Salaries and fringe benefits 320 320 320
Promotion 380 380 380
Property taxes 408
Insurance 200 200 200
Utilities 180 180 180
Income taxes: $3,840 x 40% 1,536
$11,742 $11,262 $12,870
Cash budget
Cash, beginning $ 600 $ 600 $ 1,476
Cash collections 11,280 12,600 14,520
Cash disbursements (11,742) (11,262) (12,870)
Cash before financing 138 1,938 $3,126
Borrowing (repayments) 462 (462) -
Cash, ending $ 600 $1,476 $3,126
2. Cash budgeting is important for Alpha-Tech because as sales grow so will

expenditures for input factors. Since these expenditures generally precede cash
receipts, the company must plan for possible financing to cover the gap between
payments and receipts. The cash budget shows the probable cash position at certain
points in time, allowing the company to plan for borrowing, as Alpha-Tech must do
in April.
Cash budgeting also facilitates the control of excess cash. The company may be
losing investment opportunities, if excess cash is left idle in a chequing account.
The cash budget alerts management to periods when there will be excess cash
available for investment, thus facilitating financial planning and cash control.

Problem 6-43
1. Schedule A
Budgeted Monthly Cash Receipts
Item September October November December

Total sales $48,000 $57,600 $72,000 $96,000
Credit sales 12,000 14,400 18,000 24,000
Cash sales $36,000 $43,200 $54,000 $72,000
Receipts:
Cash sales $43,200 $54,000 $72,000
Collections on accounts receivable 12,000 14,400 18,000
$55,200 $68,400 $90,000
2. Schedule B
Budgeted Monthly Cash Disbursements for Purchases
Item October November December 4th Quarter

Purchases $50,400 $67,200 $30,240 $147,840
Deduct: 2% cash discount 1,008 1,344 605 2,957
Disbursements $49,392 $65,856 $29,635 $144,883
3. Schedule C
Budgeted Monthly Cash Disbursements for Operating Costs

Salaries and wages $ 8,640 $10,800 $14,400 $33,840
Rent 2,880 3,600 4,800 11,280
Other cash operating costs 2,304 2,880 3,840 9,024
Total $13,824 $17,280 $23,040 $54,144
4. Schedule D
Budgeted Total Monthly Cash Disbursements

Purchases $49,392 $65,856 $29,635 $144,883
Cash operating costs 13,824 17,280 23,040 54,144
Light fixtures 720 480 1,200
Total $63,936 $83,616 $52,675 $200,227

5. Schedule E
Budgeted Cash Receipts and Disbursements

Receipts $55,200 $68,400 $90,000 $213,600
Disbursements 63,936 83,616 52,675 200,227
Net cash increase (decrease) -$8,736 -$15,216 $37,325 $13,373
6. Schedule F
Financing Required
Item October November December Total

Beginning cash balance $14,400 $ 9,664 $10,448 $14,400
Net cash increase (decrease) -8,736 -15,216 37,325 13,373
Cash position before
borrowing 5,664 -5,552 47,773 27,773
Minimum cash balance
required 9,600 9,600 9,600 9,600
Excess/deficiency -3,936 -15,152 38,173 18,173
Borrowing required 4,000 16,000 20,000
Interest payments 660 660
Borrowing repaid 20,000 20,000
Ending cash balance $ 9,664 $10,448 $27,113 $27,113
* (4,000 x 18% x 3/12) + (16,000 x 18% x 2/12)
7. Short-term, self-liquidating financing is best. The schedules clearly demonstrate the

mechanics of a "self-liquidating" loan. The need for such a loan arises because of
the seasonal nature of many businesses. When sales soar, the payroll and suppliers
must be paid in cash. The basic source of cash is proceeds from sales. However, the
credit extended to customers creates a lag between the sale and the collection of
cash. When the cash is collected, it in turn may be used to repay the loan. The
amount of the loan and the timing of the repayment are heavily dependent on the
credit terms that pertain to both the purchasing and selling functions of the
business. Somewhat strangely, in seasonal businesses the squeeze on cash is often
heaviest in the months of peak sales and is lightest in the months of low sales.

8. Newport Stationery Store

Budgeted Income Statement
for the quarter ending December 31
Sales $225,600
Cost of goods sold ($225,600 x 70%) - $2,957 Purchase Discounts* 154,963
Gross margin 70,637
Operating expenses
Salaries and wages 33,840
Rent 11,280
Other cash operating costs 9,024
Amortization (1,200 x 3 mo.) 3,600
57,744
Operating income 12,893
Interest expense 660
Net income before taxes $12,233
* note that the purchase discounts include those on September purchases and not those that will
be taken in January on December sales. Although the accrual method for purchase discounts
would be preferable, this company seems to be accounting for purchase discounts on the cash
basis. This is evidenced by the opening balance sheet there are no accrued purchase discounts.
9. Newport Stationery Store

Budgeted Balance Sheet
as at December 31
ASSETS
Current assets
Cash $27,113
Accounts receivable 24,000
Inventory ($36,000 Basic Inventory + 30,240 Additional Amount) 66,240
117,353
Equipment net ($120,000 3,600**) 116,400
Fixtures 1,200
117,600
$234,953
OWNERS EQUITY ($222,720 Beginning + 12,233 NIBT) $234,953
** we do not have enough information to calculate the amortization on fixtures.

7. Capital Budgeting
Exercise 21-16
1. $132,000 / 33,600 = 3.93 years
2. Initial investment ($132,000)

PV of annual cash flows: PMT = 33,600, n=10, i=12 189,847
NPV $57,847
3. PV= -132,000, PMT = 33,600, n=10, solve for i =21.96%
4. Not required as knowledge of the Accrual accounting rate of Return not required by
the CMA Competency Map.
Exercise 21-20
1. a. Payback measures the time taken to recoup, in the form of expected future cash
flows, the net investment in a project. Payback emphasizes the early recovery of
cash as a key aspect of project ranking. Some managers argue that this emphasis
on early recovery of cash is appropriate if there is a high level of uncertainty
about future cash flows. Projects with shorter paybacks give the organization
more flexibility because funds for other projects become available sooner.
Strengths
Easy to understand
One way to capture uncertainty about expected cash flows in later
years of a project (although sensitivity analysis is a more systematic way)
Weaknesses
Fails to incorporate the time value of money
Does not consider a projects cash flows after the payback period
b. Project A: $240,000 / 60,000 = 4 years
Project B: Cumulative cash flows at end of 3rd year = $192,000

Payback = 3 years + (228,000 192,000) / 90,000
= 3 years + 36,000 / 90,000
= 3.4 years

Project C: Cumulative cash flows at end of 3rd year = $252,000

Payback = 3 years + (300,000 252,000) / 96,000
= 3 years + 48,000 / 96,000
= 3.5 years
Project D: Cumulative cash flow at end of 3rd year = $252,000

Payback = 3 years
2. Project A -
Initial investment ($240,000)
PV of operating cash flows: PMT = $60,000, n=5, i=10%, PV= 227,447
NPV ($12,553)
Project B -
PV of operating cash flows:
Year 1: FV = $48,000, n=1, i=10%, PV= 43,636
Year 2: FV = $60,000, n=2, i=10%, PV= 49,587
Year 3: FV = $84,000, n=3, i=10%, PV= 63,110
Year 4: FV = $90,000, n=4, i=10%, PV= 61,471
Year 5: FV = $90,000, n=5, i=10%, PV= 55,883
NPV $45,687
Project C -
Year 1: FV = $90,000, n=1, i=10%, PV= 81,818
Year 2: FV = $90,000, n=2, i=10%, PV= 74,380
Year 3: FV = $72,000, n=3, i=10%, PV= 54,095
Year 4: FV = $96,000, n=4, i=10%, PV= 65,569
Year 5: FV = $120,000, n=5, i=10%, PV= 74,511
NPV $50,373
Project D -
Year 1: FV = $90,000, n=1, i=10%, PV= 81,818
Year 2: FV = $90,000, n=2, i=10%, PV= 74,380
Year 3: FV = $72,000, n=3, i=10%, PV= 54,095
Year 4: FV = $48,000, n=4, i=10%, PV= 32,785
Year 5: FV = $24,000, n=5, i=10%, PV= 14,902
NPV $5,980
3. Project A is discarded due to its negative NPV. Given the capital budget of
$600,000, we should accept projects B and C for an overall NPV of $96,060.

Exercise 21-22
1. a. Initial investment machine ($132,000)

working capital (9,600)
PV of savings: PMT=$30,000, n=8, i=12%, PV= 149,029
PV of salvage value: FV=$36,000, n=8, i=12%, PV= 14,540
PV of Working Capital recovery:
FV=$9,600, n=8, i=12%, PV= 3,878
$25,847
b. CF0 = -$141,600 CF1 to 7 = $30,000 CF8 = $75,600

Solve for IRR = 16.51%
Problem 21-26
1. Cafeteria operating cash outflow saved: $144,000 149,000 $5,000

Vending machine gross receipts: $96,000 x 10% 9,600
Incremental cash flows $14,600
2. Net initial investment = $77,000 5,000 = $72,000

Payback = $72,000 / 14,600 = 4.9 years
3. Net initial investment ($72,000)

PV of annual cash flows: PMT=$14,600, n=10, i=14%, PV= 76,155
PV of salvage value: FV =$6,000, n=10, i=14%, PV= 1,618
NPV $5,773
4. PV of annual cash flows = $76,155 5,773 = $70,382

Net annual cash inflows: PV = 70,380, n=10, i=14%, PMT = $13,493
10% of vending machine gross receipts: $13,493 5,000 = $8,493

Minimum vending machine gross receipts = $8,493 / 0.10 = $84,930

Problem 21-30
1. Initial investment: $54,000,000 6,000,000 ($48,000,000)

Reduction in working capital: $7,200,000 2,400,000 4,800,000
PV of annual cash flows: $5,400,000 + 1,200,000 1,800,000
PMT= $4,800,000, n=10, i=14%, PV = 25,037,355
PV of salvage value: FV=$16,800,000, n=10, i=14%, PV = 4,531,696
Recovery of reduction in working capital:
FV=$4,800,000, n=10, i=14%, PV = (1,294,770)
NPV ($14,925,719)
2. Requirement 1 only looked at cost savings to justify the investment in CIM. Burns
estimates additional cash revenues net of cash operating costs of $3.6 million a year as
a result of higher quality and faster production resulting from CIM.
The net present value of the $3.6 million annuity stream for 10 years discounted at
14% is $18,778,016. Taking these revenue benefits into account, the net present
value of the CIM investment is $3,852,297 ($18,778,016 $14,923,200). On the
basis of this financial analysis, Dynamo should invest in CIM.
3. To obtain a NPV = 0, the operating cash flows can reduce by:

PV = $14,925,719, n=10, i=14%, solve for PMT = $2,861,462
4. Initial investment: $54,000,000 6,000,000 ($48,000,000)

Reduction in working capital: $7,200,000 2,400,000 4,800,000
PV of annual cash flows:
= $5,400,000 + 1,200,000 1,800,000 + 3,600,000
PMT = $8,400,000 n=5, i=14%, PV = 28,837,880
PV of increase in salvage value: ($24,000,000 4,800,000) =
FV=19,200,000, n=5, i=14%, PV = 9,971,878
Recovery of reduction in working capital:
FV=$4,800,000, n=5, i=14%, PV = (2,492,970)
NPV ($6,883,212)

Problem 22-25
1. Purchase price of new pump ($744,000)

Salvage value of old pump 60,000
Tax shield: ($684,000 x .25 x .4) / (.25 + .16) x (1.08 / 1.16) 155,324
Salvage value of new pump: FV= $96,000, n=4, i=16%, PV= 53,020
Tax shield lost: ($53,020 x .25 x .4) / (.25 + .16) (12,932)
Annual cash savings: PMT = $150,000 x .6, n=4, i=16%, PV= 251,836
Increase in CM for additional units sold:

2009: 30 x $1,440* x .6 = $25,920 = FV, n=1, i=16%, PV= 22,345
2010/2011: 50 x $1,440 x .6 =
$43,200 = PMT, n=2, i=16%, PV = $69,346
FV = $69,346, n=1, i=16%, PV= 59,781
2012: 70 x $1,440 x .6 = $60,480 = FV, n=4, i=16%, PV= 33,403
* $4,200 - (2,940 - 180) = $1,440
Net present value ($121,223)
Do not buy the new machine as the NPV is negative.
2. Nonfinancial and qualitative factors that VacuTech should consider before making
the pump replacement decision include:
availability of any necessary financing.
probability of further technological changes for the vacuum pumps.
leasing of the new equipment.

Problem 22-28
1. 1 2 3 4
Sales $180,000 $186,000 $221,760 $81,840
Variable manufacturing costs -
Opening inventory -0- 14,400 20,280 1,680
COGM - Variable 100,800 101,400 109,200 54,000
Less ending inventory (14,400) (20,280) (1,680) -0-
86,400 95,520 127,800 55,680
Variable adm & mkt costs 21,600 22,320 27,720 11,160
100,800 117,840 155,520 66,840
Contribution margin 72,000 68,160 66,240 15,000
Taxes @ 40% 28,800 27,264 26,496 6,000
Net of tax CM 43,200 40,896 39,744 9,000
Adjust for change in inventory (14,400) (5,880) 18,600 1,680
Net operating cash flow $28,800 $35,016 $58,344 $10,680
PV of cash flow @ 16% $24,828 $26,023 $37,379 $5,898
2. Initial investment ($131,040)

Tax shield: ($131,040 x .25 x .4) / (.25 +.16) x (1.08/1.16) 29,757
Salvage value: $21,600 x PVIF16%, 4 (0.552) 11,929
Tax shield lost: ($11,929 x .25 x .4) / (.25 +.16) (2,910)
PV of annual cash flows 94,128
NPV $ 1,864

Problem 22-30
1. Annual cash flows: [300 pounds x 16 x ($420 - 120)] $1,440,000

Less technicians and maintenance: $132,000 + 60,000 (192,000)
1,248,000
x .6
After tax annual operating cash flows $748,800
Tax Shield Operating Total Cumulative

Year CCA on CCA Cash Flow Cash Flow Cash Flow
1 $540,000 $216,000 $748,800 $964,800 $964,800
2 918,000 367,200 748,800 1,116,000 2,080,800
3 642,600 257,040 748,800 1,005,840 3,086,640
4 449,820 179,928 748,800 928,728 4,015,368
Payback = 3 years + (513,360* / 928,728) = 3.55 years
* $3,600,000 3,086,640
2. Initial investment ($3,600,000)

Tax shield: (3,600,000 x .3 x .4) / (.3 + .12) x (1.06 / 1.12) 973,469
PV of annual cash flows: PMT=$748,800 n=5, i=12%, PV= 2,699,256
Net present value $72,725
3. We need the PV of annual cash flows to equal -

($2,699,256 - 72,725) = $2,626,531
Annual before tax cash flow should be:
PV = $2,626,532 / 0.6 = $4,377,553, n=5, i=12%, PMT= 1,214,376
[300 x 16 x (SP - 120)] - 192,000 = 1,214,376

4,800SP - 576,000 - 192,000 = 1,214,376
SP = $1,982,376 / 4,800 = $413.00
4. Under the assumptions given here, requirement 2 has already calculated NPV
using nominal cash flows and nominal rates of return. It has already taken
inflationary effects into consideration. Hence no new calculations are necessary.
The after-tax net present value is $72,725 as calculated in requirement 2. Some
students may question whether the assumptions specified in requirement 4 are
appropriate since despite the 2% inflation per year, the revenues and cash-
operating costs are assumed to be the same each year for the 5 years. There is no
inconsistency here. Despite the 2% increase in general price levels, the specific
revenues per ounce of gold and the specific cash-operating costs in this industry
could well be the same either because of contractual reasons or because of the
general economic conditions of supply and demand.

Problem 22-34
1. Initial investment ($1,080,000)
Tax shield: ($1,080,000 x .25 x .36) / (.25 + .12) x (1.06/1.12) 248,629
PV of salvage value: FV = $360,000, n=6, i=12%, PV= 182,387
Tax shield lost: ($182,387 x .25 x .36) / (.25 + .12) (44,364)
Lease cancellation payment: $36,000 x .64 (23,040)
Annual rental lost: PMT = $54,000 x .64, n=6, i=12%, PV= (142,090)
Market research: PMT = $360,000 x .64, n=1, i=12%, PV= (205,714)
Working Capital -
T=0 (240,000)
T = 2 FV = $240,000, n=2, i=12%, PV= (191,327)
Release: FV = $480,000, n=6, i=12%, PV= 243,183
Operating Cash Flows:

Years 1-2: PMT = $480,000 x .64, n=2, i=12%, PV= 519,184
Years 3-5: PMT = $720,000 x .64, n=3, i=12%, PV=$1,106,764
FV= $1,106,764 , n=2, i=12%, PV= 882,305
Year 6: FV= $120,000 x .64, n=6, i=12%, PV= 38,909
2. NPV as above $188,062

Add back initial investment net of tax shield: $1,080,000 248,629 831,371
Less - new investment amount (1,380,000)
Tax shield on new investment amount
($1,380,000 x .25 x .36) / (.25 + .12) x (1.06/1.12) 317,693
Revised NPV ($42,874)
The overall NPV of the project would then be $(42,874). Griffey is unhappy with
Chen's revised analysis because the NPV of the project is now negative, possibly
leading to the project being rejected. He would like to resume production in the
plant, and reemploy his friends who had been laid off earlier. There is also the
possibility that Griffey may be hired as a consultant by the new plant management
after he retires next year.
Considering the ethical issues, Andrew Chen should evaluate Eric Griffey's
directives as follows:

1. Chen should present complete and clear reports and recommendations after
appropriate analyses of relevant and reliable information. Griffey does not wish
the report to be complete or clear, and has provided some information which is
not totally reliable.
2. Chen should not disclose confidential information outside of the organization;

but it also appears that Griffey wants to refrain from disclosing information to
senior management that it should know about.
3. In evaluating Griffey's directive as it affects Chen, Chen has an obligation to

communicate unfavourable as well as favourable information and professional
judgments or opinions.
The responsibility to communicate information fairly and objectively, as well as to

disclose fully all relevant information that could reasonably be expected to influence
an intended user's understanding of the reports and recommendations presented, is
being hampered. Management will not have the full scope of information they
should have when they are presented with the analysis.
Andrew Chen should take the following steps to resolve this situation:
Chen should first investigate and see if Dudley Company has an

established policy for resolution of ethical conflicts and follow those
procedures.
If this policy does not resolve the ethical conflict, the next step would be
for Chen to discuss the situation with his supervisor, Griffey, and see if
he can obtain resolution. One possible solution may be to present a "base
case" and sensitivity analysis of the investment. Chen should make it
clear to Griffey that he has a problem and is seeking guidance.
If Chen cannot obtain a satisfactory resolution with Griffey, he could take
the situation up to the next layer of management, and inform Griffey that
he is doing this. If this is not satisfactory, Chen should progress to the
next, and subsequent, higher levels of management until the issue is
resolved (i.e., the president, Audit Committee, or Board of Directors).
Chen may want to have a confidential discussion with an objective
advisor to clarify relevant concepts and obtain an understanding of
possible courses of action.
If Chen cannot satisfactorily resolve the situation within the organization,
he may resign from the company and submit an informative memo to an
appropriate person in Dudley (i.e., the president, Audit Committee, or
Board of Directors).

Problem 22-36
1. Initial investment net ($5,280,000 120,000) ($5,160,000)

- working capital (1,200,000)
Tax shield:
($5,160,000 x 0.30 x 0.40) / (0.30 + 0.12) x (1.06/1.12) 1,395,306

$480,000 + 360,000 + 840,000 240,000 = $1,440,000
PMT = $1,440,000 x 0.60 , n=10, i=12%, PV= 4,881,793
Salvage value: FV = $1,020,000, n=10, i=12%, PV= 328,413
Tax shield lost: ($328,413 x 0.30 x 0.40) / (0.30 + 0.12) (93,832)
Recovery of working capital:

FV = $1,200,000 , n=10, i=12%, PV= 386,368
Forklift lease savings:

PMT = $96,000 x 0.60, n=2, i=12%, PV= $97,347
FV = $97,347, n=8, i=12%, PV= 39,317
2. Initial investment net ($5,280,000 120,000) ($5,160,000)

- working capital (1,200,000)
Tax shield:
($5,160,000 x 0.30 x 0.40) / (0.30 + 0.12) x (1.06/1.12) 1,395,306

$480,000 + 360,000 + 840,000 240,000 = $1,440,000
PMT = $1,440,000 x 0.60 , n=8, i=12%, PV= 4,292,041
Salvage value: FV = $120,000, n=8, i=12%, PV= 48,466
Tax shield lost: ($48,466 x 0.30 x 0.40) / (0.30 + 0.12) (13,847)
Recovery of working capital:

FV = $1,200,000 , n=8, i=12%, PV= 484,660
Net present value ($153,374)

3. Lealand Forrest should evaluate Bill Rollands directives as follows:

Forrest has a responsibility to present complete and clear reports and
recommendations after appropriate analyses of relevant and reliable
information. Rolland does not wish the report to be complete or clear.
Forrest should not disclose confidential information outside of the
organization; but it also appears that Rolland wants to refrain from
disclosing information to the Board that it should know about.
Rolland is engaging in activities that could prejudice him from carrying out
his duties ethically.
In evaluating Rollands directive as it affects Forrest, Forrest has an
obligation to communicate unfavourable as well as favourable information
and professional judgments or opinions.
The responsibility to communicate information fairly and objectively, as
well as to disclose fully all relevant information that could reasonably be
expected to influence an intended users understanding of the reports and
recommendations presented, is being hampered. The Board will not have
the full scope of information that they should have when they are presented
with the analysis.
4. Lealand Forrest should take the following steps to resolve this situation:
Forrest should first investigate and see if Instant Dinners, Inc. (IDI) has an
established policy for resolution of ethical conflicts and follow those
procedures.
If such a policy does not resolve the ethical conflict, the next step would be
for Forrest to discuss the situation with his supervisor, Rolland, and see if he
can obtain resolution. One possible solution may be to present a base case
and sensitivity analysis of the investment. Forrest should make it clear to
Rolland that he has a problem and is seeking guidance.
If Forrest cannot obtain a satisfactory resolution with Rolland, he could take
the situation up to the next layer of management, and inform Rolland that he
is taking this action. If this approach is not satisfactory, Forrest should
progress to the next, and subsequent, higher levels of management until the
issue is resolved (i.e., the president, Audit Committee, or Board of
Directors).
Since Rolland has instructed him not to discuss the situation with anyone
else at IDI, Forrest may want to have a confidential discussion with an
objective advisor to clarify relevant concepts and obtain an understanding of
possible courses of action.
If Forrest cannot satisfactorily resolve the situation within the organization,
he may resign from the company and submit an informative memo to an
appropriate person at IDI (i.e., the president, Audit Committee, or Board of
Directors).

8. THE LEASE VS. BUY DECISION
Assume that you have completed the net present value analysis of a project and have
concluded that you should be acquiring the asset. The next step is to decide how to
finance the asset:
- you can purchase the asset (in this section we will assume that the asset will be
financed through debt), or
- you can lease the asset.
The Canada Revenue Agency stipulates that lease payments are deductible as long as the
lease agreement does not contain any of the following four provisions:
there is an automatic transfer of ownership at any time,
the lessee is required to purchase the asset,
the lessee has the option of purchasing the asset at a price that is substantially
below the fair market value of the asset (a bargain purchase option), or
the lessee has the option of purchasing the asset at a price that would lead a
reasonable observer to conclude that the lessee would buy the asset.
So, if there is an expectation that the asset will revert to the lessor during or at the end of
the lease term, then the lease payments are not deductible. On the other hand, if the asset
reverts back to the lessor at the end of the lease term, then the lease payments are
deductible. In this section we are only concerned with leases whose lease payments are
deductible.
If the company chooses to lease the asset, then from a cash flow perspective, the
following occurs:
1. they do not have to pay for the asset,
2. they forgo the tax shield on the asset (i.e. they cannot deduct CCA),
3. they have to make annual lease payments (which are tax deductible).
The lease vs. buy decision is a discounted cash flow analysis that essentially discounts
the above cash flows. Because this is a financing decision, all cash flows are discounted
at the after-tax borrowing rate.
Example: assume that you wish to purchase a machine costing $600,000. You can
finance the asset through a bank loan costing you 6.5% or you can lease the machine for
eight annual lease payments of $93,500. The machine will revert back to the lessor at the
end of the lease term (which is also equal to the assets useful life). If you purchased the
asset, it would qualify as a Class 8 asset (CCA rate = 20%). Assume a tax rate of 40%.

The net advantage to leasing is as follows. Note that the analysis is done from the
perspective of leasing (i.e. the original cost of the asset is avoided and thus is positive).
Also note that all cash flows are discounted at the after-tax borrowing rate of 3.9% (6.5%
x 0.6).
Cost of machine saved $600,000
Tax shield that is lost because asset is leased: `

$600,000(0.2)(0.4) / (0.2 + 0.039) x (1.0195 /1.039) (197,068)
Present value of lease payments (recall that leases are annuity dues the
first lease payment is due on signing the lease):
First lease payment: $93,500 x 0.6 (56,100)
Next seven lease payments -
PMT = $93,500 x 0.6, n=7, i=3.9%, PV = (337,963)
Net advantage to leasing $ 8,869
The net advantage to leasing is positive, so the company should go ahead with the leasing
arrangements.

Leasing Problems with Solutions
Problem 1
The Jamey Corporation is looking to the purchase of a new dye spreading machine for its
manufacturing operations and is faced with two possibilities:
Machine A is available only on a lease basis. The annual lease payments are
$2,500 for 5 years. This machine will save the Jamey Corporation $7,000 a year
through reductions in electricity costs in each of the five years.
As an alternative, Jamey can purchase a more energy-efficient machine (Machine

B) for $15,000. This machine will save $9,000 in electricity costs. Jameys bank
has offerred to finance the machine with a $15,000 loan. The interest rate on the
loan will be 8% on the remaining balance with five annual principal payments of
$3,000.
The tax rate is 40% and the CCA rate for the machine is 30%. Both machines have a
useful life of 5 years and no salvage value. Should Jamey lease the Machine A or
purchase the more efficient Machine B?
Problem 2
Friendship Airlines proposes to lease a $10 million aircraft. The terms require six annual
lease payments of $2,000,000 million. Friendship pays tax at 40%. If it purchases the
aircraft, it would put the aircraft cost in a 25% CCA class. The aircraft will be worthless
after six years. The interest rate is 8%. Should the aircraft be purchased or leased?
Problem 3
Central College needs a new computer. It can either buy it for $250,000 or lease it from
Lessor Inc. The lease terms require Central College to make six annual payments of
$50,000. Central College, being a non-profit organization pays no tax. Lessor Inc. pays
tax at 36%. Lessor Inc. would place the computer in Class 10 (30%) with all its other
computers. The computer will have no residual value at the end of year 5. Central
Colleges borrowing rate is 8%.
(a) What is the NPV of the lease for Central College?
(b) What is the NPV for Lessor Inc.?
(c) What is the overall gain to the two parties if the lease is undertaken?

Solutions
Problem 1
Cost of machine saved $15,000

Tax shield foregone - $15,000(0.3)(0.4) / (0.3 + 0.048) * (1.024/1.048) -5,054
PV of lease payments: 1st payment: $2,500 x 0.6 -1,500
Next 4 lease payments: PMT = $1,500, n=4, i=4.8%, PV = -5,344
PV of incremental electricity costs -
PMT = $2,000 x 0.6, n=5, i=4.8%, PV= -5,224
Net advantage to leasing -$2,122
The Jamey Corporation should purchase Machine B.
Problem 2
Cost of aircraft $10,000,000

Tax shield foregone - $10,000,000(0.25)(0.4) / (0.25 + 0.048)
* (1.024/1.048) -3,278,856
PV of lease payments: 1st lease payment: $2,000,000 x 0.6 -1,200,000
Last 5 payments: PMT = $1,200,000, n=5, i = 4.8%, PV= -5,224,221
$296,923
Lease.
Problem 3
a. Cost of equipment $250,000

PV of lease payments: 1st payment -50,000
Next 5: PMT = 50,000, n=5, i=8%, PV= -199,636
$364
Lease
b. r = 8%(.64) = 5.12%
Cost of equipment -$250,000

Tax shield: $250,000(0.3)(0.36) / (0.30 + 0.0512)
* (1.0256/1.0512) 75,007
PV of lease payments: 1st payment: $50,000 x 0.64 32,000
Next 5: PMT = 50,000 x 0.64, n=5, i=5.12%, PV= 138,085
-$4,908
c. Overall loss = 364 4,908 = $4,544. Not likely to happen.

9. Cost Variances
CostVariance Formulas -
Direct materials:
price variance = Actual Quantity Purchased x (Actual Price - Standard Price)
quantity variance = Standard Price x (Actual Quantity Used
- Standard Quantity allowed for output produced)
Direct Labor and Variable Overhead:

rate variance = Actual Hours x (Actual Rate - Standard Rate)
efficiency variance = Standard Rate x (Actual Hours
- Standard Hours allowed for output produced)
Quantity/Efficiency Variance = Yield + Mix Variances
Yield Variance:
(Actual units of input used - Standard units of input allowed for actual output)
x Standard average price per unit of input
Mix Variance:
{ (Actual mix percentage - Standard mix percentage)
x Actual total units of inputs used }
x (Standard price per unit of input
- Standard average price per unit of input)
or: (Actual Mix % - Budgeted Mix %) x Actual total quantities x Budgeted price/unit
Fixed overhead budget variance = Actual FOH - Budgeted FOH

Fixed overhead volume variance = Budgeted FOH - Applied FOH

Exercise 7-16
1. Static Flexible
Budget Budget Actual Variance
Volume 3,000 2,800 2,800
Revenue $396,000 $369,600 $375,200 $5,600 F
Variable costs 264,000 246,400 275,520 29,120 U
Contribution margin 132,000 123,200 99,680 23,520 U
Fixed costs 64,800 64,800 60,000 4,800 F
Operating income $67,200 $58,400 $39,680 $18,720 U
2. Sales volume variance = $67,200 - $58,400 = $8,800 U

Flexible budget variance = 18,720 U
The unfavourable sales-volume variance arises solely because actual units

manufactured and sold were 200 fewer than the budgeted 3,000 units. The
unfavourable flexible-budget variance of $18,720 in operating income is due
primarily to the $10.40 increase in unit variable costs. This increase in unit variable
costs is only partially offset by the $2 increase in unit selling price and the $4,800
decrease in fixed costs.
Exercise 7-22
1. Per Static Flexible

Unit Budget Budget Actual Variance
Volume 700 750 750
Direct materials $38.40 $26,880 $28,800 $29,198* $ 398 U
Direct labour 108.00 75,600 81,000 86,025 5,025 U
$146.40 $102,480 $109,800 $115,223 $5,423 U
* (1,185 square meters x $24.60) + (79 square meters in inventory x 0.60)
Direct materials price variance = AQP (AP SP)

= 1,264 (24.60 24.00) = $758 U
Direct materials quantity variance = SP (AQU SQA)

= $24.00 (1,185 (750 x 1.6))
= $24.00 (1,185 1,200)
= $360 F
Direct labour rate variance = AH (AR SR)

= 2,325 (37 36)

= $2,325 U
Direct labour efficiency variance = SR (AH SHA)

= $36 (2,325 (750 x 3))
= $36 (2,325 2,250)
= $2,700 U
2. Direct Materials Price Variance ($758 U, due to actual price of $24.60 exceeding
budgeted price of $24.00)
Standard wrongly (unrealistically) set

Poor price negotiation
Purchase of higher quality wood
Materials price unexpectedly increased due to external shocks (e.g., a
natural disaster in major forest areas)
Purchased in smaller lot sizes than budgeted and did not get quantity
discounts
Change in supplier when lower-priced supplier went out of business
Direct Materials Quantity Variance ($360 F, due to actual usage of 1.58 square
metres per desk, compared to budgeted 1.6 square meters)

Increased skills of workers
Use of more automated machinery (e.g., laser cutting)
Workers did more extensive planning and scheduling for materials usage
Economies of scale in production
Direct Manufacturing Labour Price Variance ($2,325 U, due to actual rate of

$37.00 compared to budgeted $36.00)

Use of higher skill mix than budgeted
Poor negotiations with labour
Overtime may have been necessary to produce the extra 50 decks more
than budgeted
Unexpected labour shortage due to external factors
Direct Manufacturing Labour Efficiency Variance ($2,700 U, due to actual time

being 3.1 hours compared to budgeted 3.0 hours per desk)

Labour may be less efficient at higher output levels due to tiredness
Scheduler assigned less skilled workers to desk production
Machine breakdowns required more use of labour
Lower quality wood purchased requiring more labour input to finish
desks

Exercise 7-28

Volume 5,000 6,000 6,000
Direct materials $120 $ 600,000 $ 720,000 $792,000 $72,000 U
Direct labour 192 960,000 1,152,000 1,125,000 27,000 F
Fixed costs - 1,200,000 1,200,000 1,206,000 6,000 U
$312 $2,760,000 $3,072,000 $3,123,000 $51,000 U
Sales volume variance = $2,760,000 3,072,000 = $312,000 F
2. Direct materials price variance = AQP (AP SP)

= 60,000 (13.20 12.00) = $72,000 U

= $12.00 (60,000 (6,000 x 10))
= $24.00 (60,000 60,000)
= $0

= 25,000 (45 48)
= $75,000 F

= $48 (25,000 (6,000 x 4))
= $48 (25,000 24,000)
= $48,000 U

Problem 7-42

Volume 400,000 450,000 450,000
Sales $9.60 $3,840,000 $4,320,000 $4,266,000 $54,000 U
Direct materials
Cookie Mix 0.24 96,000 108,000 111,360 3,360 U
Milk Choc. 0.90 360,000 405,000 621,005 216,005 U
Almonds 0.60 240,000 270,000 285,000 15,000 U
Direct labour
Mixing 0.288 115,200 129,600 129,600 -
Baking 0.720 288,000 324,000 288,000 36,000 F
2.748 1,099,200 1,236,600 1,434,965 198,365 U
Contribution
Margin $6.852 $2,740,800 $3,083,400 $2,831,035 $252,365 U
a. Sales price variance = $54,000 U
b. Direct materials price variance = AQP (AP SP)

Cookie mix: 290,000 (0.384 0.384) = 0
Milk chocolate: 161,720 (3.84 2.88) = $155,251 U
Almonds: 29,688 (9.60 9.60) = 0
c. Direct materials quantity variance = SP (AQU SQA)

Cookie mix: $0.384 (290,000 281,250) = $3,360 U
Milk chocolate: $2.88 (161,720 140,625) = $60,754 U
Almonds: $9.60 (29,688 28,125) = $15,000 U
d. Direct labour rate variance = AH (AR SR)

Mixing: 7,500* (17.28 17.28) = 0
Baking: 13,333 (21.20 21.20) = 0
* 450,000 minutes / 60
e. Direct labour efficiency variance = SR (AH SHA)

Mixing: $17.28 (7,500 7,500) = 0
Baking: $21.60 (13,333 15,000) = $36,000 F

2. (a) Selling price variance. This may arise from a proactive decision to reduce price
to expand market share or from a reaction to a price reduction by a competitor. It
could also arise from unplanned price discounting by salespeople
(b) Material price variance. The $0.96 increase in the price per kg. of milk
chocolate could arise from uncontrollable market factors or from poor contract
negotiations by Aunt Molly's.
(c) Material efficiency variance. For all three material inputs, usage is greater than budgeted.
Possible reasons include lower quality inputs, use of lower quality workers, and the mixing and
baking equipment not being maintained in a fully operational mode.
(d) Labour price variance. The zero variance is consistent with workers being on
long-term contracts that are not renegotiated on a month-by-month basis.
(e) Labour efficiency variance. The favourable efficiency variance for baking
could be due to workers eliminating non-valued-added steps in production.

Problem 7-43

Volume 5,000 4,850 4,850
Revenues $96.00 $480,000 $465,600 $477,240 $11,640 F
Direct materials
Frames 7.92 39,600 38,412 44,698 6,286 U
Lenses 22.32 111,600 108,252 120,590 12,338 U
Direct labour 21.60 108,000 104,760 116,284 11,524 U
51.84 259,200 251,424 281,572 30,148 U
Contribution
margin $44.16 220,800 214,176 195,668 18,508 U
Fixed costs 90,000 90,000 86,718 3,282 F
Operating
Income $130,800 $124,176 $108,950 $15,226 U
a. Sales price variance = $11,640 F
b. Sales volume variance for

Revenues: $480,000 465,600 = $14,400 U (or 150 units x $96.00)
Variable manufacturing costs = 150 units x $51.84 = $7,776 F
Fixed manufacturing costs = 0
Gross margin: $14,400 U + 7,776 F = $6,624U
Flexible budget variances see schedule above
c. Direct materials price variance = AQP (AP SP)

Frames: 15,5201 ($2.882 2.643) = $3,725 U
Lenses: 33,950 ($3.552 3.72) = $5,704 F
1
4,850 frames x 3.2 grams per frame
2
$44,698 / 15,520
3
$39,600 / (5,000 frames x 3 grams per frames)

Frames: 2.64 (15,520 14,5504) = $2,561 U
Lenses: 3.72 (33,950 29,100) = $18,042 U
4
4,850 frames x 3 grams


6,547.55 x (17.76 18.006) = $1,571 F
5
$116,284 / 17.76
6
$108,000 / 5,000 units / 1.2 hours

$18.00 (6,547.5 5,820) = $13,095 U
2. Frames - possible explanations for the price variance of $3,725 U:

(a) Increase in purchase prices
(b) Purchasing frames of higher quality
(c) Standards were set incorrectly
Possible explanations for the efficiency variance of $2,561 U:
(a) Frames damaged in manufacturing
(b) Frames lost or stolen
Lenses - possible explanations for price variance of $5,704 F:

(a) Astute negotiations in purchasing
(b) Lower quality lenses purchased at lower price
Possible explanations for efficiency variance of $18,042 U:
(a) Higher materials usage due to lower quality lenses purchased at lower price
(b) Lesser trained workers hired at lower rates result in higher materials
Labour - possible explanations for the price variance of $1,571 F:

(a) Less overtime wages paid
(b) Lower skilled employees hired
Possible explanations for the efficiency variance of $13,095 U:

(a) Too much down time in the production schedule
(b) Workers and equipment operating slower
(c) Standards were not set correctly

Exercise 8-18
1. 32,000 batches x 2 hours per batch = 64,000 hours
2. Variable overhead spending variance = AH (AR SR)

= 50,400 ($16.20* - 12.00)
= $211,680 U
* $816,480 / 50,400 hours
Variable overhead efficiency variance = SR (AH SHA)

= $12.00 (50,400 (28,000 batches x 2 hours)
= $12.00 (50,400 56,000)
= $67,200 F
Total variable overhead variance = $211,680 U + 67,200 F = $144,480 U
Check:
Actual variable overhead $816,480

Applied variable overhead: 28,000 batches x 2 hours x $12 672,000
$144,480 U
3. Spending variance of $211,680 U. It is unfavourable because variable

manufacturing overhead was 35% higher than planned. A possible explanation
could be an increase in energy rates relative to the rate per standard labour-hour
assumed in the flexible budget.
Efficiency variance of $67,200 F. It is favourable because the actual number of

direct manufacturing labour-hours required was lower than the number of hours
budgeted. Labour was more efficient in producing the baguettes than management
had anticipated in the budget. This could occur because of improved morale in the
company, which could result from an increase in wages or an improvement in the
compensation scheme.

Exercise 8-19
1. Fixed overhead spending variance = Actual FOH Budgeted FOH

= $326,400 (38,400 batches x 2 hours x $4 per hour)
= $326,400 307,200
= $19,200 U
Fixed overhead volume variance = Budgeted FOH Applied FOH

= $307,200 (33,600 batches x 2 hours x $4 per hour)
= $307,200 268,800
= $38,400 U
2. Fixed overhead is underapplied by $19,200 + $38,400 = $57,600
Check:
Actual fixed overhead $326,400
Applied fixed overhead 268,800
$57,600 U
3. The production-volume variance captures the difference between the budgeted

3,840,000 baguettes and the actual 3,360,000 baguettes. The spending variance of
$19,200 unfavourable means that the actual aggregate of fixed costs ($326,400)
exceeds the budget amount ($307,200). For example, monthly leasing rates for
baguette-making machines may have increased above those in the budget for 2007.

Exercise 8-24
1. Variable overhead spending variance = AH (AR SR)

= 28,600 ($10.30* - 9.60)
= $20,020 U
* $294,580 / 28,600 hours

= $9.60 (28,600 (4,400 units x 6 hours)
= $9.60 (28,600 26,400)
= $21,120 U
Fixed overhead spending variance = Actual FOH Budgeted FOH

= $447,590 (4,000 units x 6 hours x $18)
= $447,590 432,000
= $15,590 U

= $432,000 (4,400 units x 6 hours x $18)
= $432,000 475,200
= $43,200 F
Total overhead variance = $20,020 U + $21,120 U + $15,590 U + $43,200 F

= $13,530 U
Check:
Actual total overhead ($294,580 + $447,590) $742,170

Applied total overhead: 4,400 units x 6 hours x $27.60 728,640
$13,530 U
2. Manufacturing overhead variable $294,580

Cash, Accounts Payable. $294,580
WIP 253,440
Manufacturing overhead variable 253,440
4,400 units x 6 hours x $9.60
Manufacturing overhead fixed 447,590

Cash, Accounts Payable. 447,590
WIP 475,200
Manufacturing overhead variable 475,200
4,400 units x 6 hours x $18

3. The control of variable manufacturing overhead requires the identification of the

cost drivers for such items as energy, supplies, and repairs. Control often entails
monitoring nonfinancial measures that affect each cost item, one by one. Examples
are kilowatts used, quantities of lubricants used, and repair parts and hours used.
The most convincing way to discover why overhead performance did not agree
with a budget is to investigate possible causes, line item by line item.
Individual fixed manufacturing overhead items are not usually affected very much
by day-to-day control. Instead, they are controlled periodically through planning
decisions and budgeting procedures that may sometimes have horizons covering
six months or a year (for example, management salaries) and sometimes covering
many years (for example, long-term leases and depreciation on plant and
equipment).
Exercise 8-30

1
Volume - rev 280,000 308,000 308,000
Revenues
Circulation $0.60 $168,000 $184,800 $184,800 -
Advertising 1.543 432,000 475,200 473,520 $1,680 U
2.143 600,000 660,000 658,320 $1,680 U
Volume - costs 300,000 320,000 320,000
Variable Costs
Direct mat 0.72 216,000 230,400 269,568 39,168 U
Direct labour 0.18 54,000 57,600 60,134 2,534 U
Indirect 0.24 72,000 76,800 76,723 77 F
1.14 342,000 364,800 406,425 41,625 U
Contribution
margin $1.003 258,000 295,200 251,895 43,305 U
Fixed costs 108,000 108,000 116,400 8,400 U
Operating
Income $150,000 $187,200 $135,495 $51,705 U
1
Budgeted circulation revenues of $168,000 / 0.60 = 280,000

Problem 8-31
1. Direct materials price variance = AQP (AP SP)

= 17,280,000 ($0.01561 0.01442)
= $20,736 U
1
$269,568 / 17,280,000 pages
2
$216,000 / 15,000,000 pages

= $0.0144 (17,280,000 (320,000 x 50))
= $0.0144 (17,280,000 16,000,000)
= $18,432 U

= 1,7283 ($34.80 36.004)
= $2,074 F
3
17,280,000 pages / 10,000 pages per hour
4
15,000,000 pages / 10,000 pages per hour = 1,500 hours
$54,000 budgeted direct labour cost / 1,500 hours = $36 per hour

= $36 (1,728 (320,000 x 50 / 10,000))
= $36 (1,728 1,600)
= $4,608 U
Variable overhead spending variance = AH (AR SR)

= 1,728 ($44.405 48.006)
= $6,221 F
5
$76,723 actual VOH / 1,728 actual DLH
6
$72,000 budgeted VOH / 1,500 budgeted DLH

= $48.00 (1,728 1,600)
= $6,144 U
Fixed overhead spending variance = Actual FOH Budgeted FOH

= $116,400 108,000
= $8,400 U

= $108,000 (320,000 x 50 pages / 10,000 hours per page x $727)
= $108,000 115,200
= $7,200 F

7
$108,000 budgeted FOH / 1,500 budgeted DLH
2. The unfavourable sales-volume variance for direct materials, direct labour, and
variable indirect costs is due to 20,000 extra copies of the newspaper being
produced.
The largest individual variance category is for direct materials-comprising a

$20,736 U price variance (the actual cost per page of $0.0156 exceeds the budgeted
$0.0144 per page) and a $18,432 U efficiency variance (the 1,280,000 unusable
pages x $0.0144 budgeted cost).
The direct labour price variance ($2,074 F) is due to the actual labour rate being
$34.80 per hour compared with the budgeted $36.00 per hour.
The unfavourable variable indirect costs efficiency variance of $6,144 U is due to

1,280,000 extra pages being used (the cost allocation base) over the quantity
budgeted.
The spending variance for fixed indirect costs is due to actual costs being $8,400
above the budgeted $108,000. An analysis of the line items in this budget would
help assist in determining the causes of this variance.

Problem 8-43
1. Direct materials: 7,800 units x $18 $140,400

Direct labour: 7,800 x $90 702,000
Variable manufacturing overhead: 7,800 x $36 280,800
Fixed manufacturing overhead: 7,800 x $48 374,400
$1,497,600
2. a. Direct materials price variance = AQP (AP SP)

= 25,000 (6.24 6.00)
= $6,000 U
b. Direct materials quantity variance = SP (AQU SQA)

= $6.00 (23,100 (7,800 x 3))
= $6.00 (23,100 23,400)
= $1,800 F
c. Direct labour rate variance = AH (AR SR)

= 40,100 (17.52 18.00)
= $19,248 F
d. Direct labour efficiency variance = SR (AH SHA)

= $18 (40,100 (7,800 x 5))
= $18 (40,100 39,000)
= $19,800 U
e. Actual total manufacturing overhead $720,000

Budgeted manufacturing overhead
Variable: 40,100 hours x $7.20 $288,720
Fixed: 40,000 hours x $9.60 per hour 384,000 672,720
$47,280 U
f. Variable overhead efficiency variance = SR (AH SHA)

= $7.20 (40,100 39,000)
= $7,920 U
g. FOH Budget FOH Applied

= (40,000 denominator level hours x $9.60) (7,800 units x $48)
= $384,000 374,400
= $9,600 U

10. Revenue Variances
Sales Variances
Sales Price Variance = Actual Quantity x (Actual Sales Price - Budgeted Sales Price)
Sales Volume Variance = Sales Quantity + Sales Mix Variances

(Actual Sales volume - Budgeted Sales volume)
x Budgeted Individual product contribution margin per unit
Sales Quantity Variance = Market Size + Market Share Variances

(Actual sales volume - Budgeted sales volume)
x Budgeted Average Contribution Margin per unit
Sales Mix Variance:

{ (Actual sales mix % - Budgeted sales mix %) x Actual total sales volume }
x (Budgeted individual CM per unit - Budgeted Average CM per unit)
or -(Actual Mix % - Budgeted Mix %) x Actual total sales volume x Bud CM/unit
Market Size Variance:

Budgeted market share %
x (Actual industry sales volume - Budgeted industry sales volume)
x Budgeted average CM per unit
Market Share Variance:

(Actual market share % - Budgeted market share %)
x Actual Industry Sales Volume in units
x Budgeted average CM per unit
Problem 16-30: note that when you subtract the selling price from the variable cost per
kg. for some of the items in the first table, you do not get the same CM per unit as shown.
Use the following budgeted CMs per unit:
Chocolate Chip $2.10

Oatmeal Raisin 2.40
Coconut 2.70
White Chocolate 3.10
Macadamia Nut 3.20

Problem 16-21
1, and 2.
Sales Quantity Variance:
Budgeted
Actual Sales Budgeted Sales Average
Volume Volume CM/Unit
2,5003 3,0002 2.801 1,400U2
1
Budgeted Average CM/Unit = $8,400 / 3,000 = $2.80
2
Given
3
3,000 1,400/2.80
Budgeted Sales mix: let x = budgeted sales mix of Plain

2x + 6(1-x) = 2.80
2x - 6x + 6 = 2.80
4x = 3.2
x = .8
Sales Mix Variance:
Budgeted
Actual Units Contribution
Actual Budgeted Sales Sold of All Margin per
Sales Mix Mix Glasses unit
Plain .68 .8 2,500 $2 $ 240 F
Chic .32 .2 2,500 6 960 F
$1,200 F
Sales Volume Variance:
Budgeted
Actual Sales Budgeted Sales Individual
Plain 1,700 2,400 2 $1,400 U
Chic 800 600 6 1,200 F
$ 200 U

3. Jinwa Corporation shows an unfavourable sales-quantity variance because it sold

fewer wine glasses in total than was budgeted. This unfavourable sales-quantity
variance is partially offset by a favourable sales-mix variance because the actual
mix of wine glasses sold has shifted in favour of the higher contribution margin
Chic wine glasses. The problem illustrates how failure to achieve the budgeted
market penetration can have negative effects on operating income.
Problem 16-22
Budgeted
Canada 480,000 400,000 2.60 $208,000 F
Mexico 900,000 600,000 1.60 480,000 F
US 1,620,000 1,500,000 3.20 384,000 F
3,000,000 2,500,000 $1,072,000 F
Budgeted
3,000,000 2,500,000 2.72 $1,360,000 F
Budgeted Average CM/Unit = ($2.60 x .16) + $(1.60 x .24) + ($3.20 x .60) = $2.72
Sales Mix Variance:
Budgeted
Actual Sales Budgeted Sold of All Margin per
Mix Sales Mix Glasses unit
Canada .16 .16 3,000,000 2.60 0
Mexico .30 .24 3,000,000 1.60 288,000 F
US .54 .60 3,000,000 3.20 576,000 U
$288,000 U

Problem 16-26
1. Materials Price Variance
Actual Quantity Actual Cost per Budgeted Cost per

Purchased unit unit Variance
Tolman 62,000 $0.30 $0.32 $1,240 F
Golden 155,000 0.28 0.28 0
Ribston 93,000 0.22 0.24 1,860 F
$3,100 F
Materials Quantity Variance
Budgeted Cost Actual Quantity Standard Quantity

per unit Used Allowed Variance
Tolman $0.32 62,000 45,000 $5,440 U
Golden 0.28 155,000 180,000 7,000 F
Ribston 0.24 93,000 75,000 4,320 U
310,000 300,000 $2,760 U
2. Materials Yield Variance
Budgeted
Average Cost Actual Total Standard Total Variance
per unit Quantity Used Quantity Allowed
$0.276 310,000 300,000 $2,760 U
Budgeted average cost per unit

= (45,000 x $0.32) + (180,000 x $0.28) + (75,000 x $0.24) / 300,000
= $82,800 / 300,000
= $0.276
Materials Mix Variance:
Actual Total
Actual Budgeted Quantity Budgeted
Mix % Mix % Used Cost per unit
Tolman 20% 15% 310,000 $0.32 $4,960 U
Golden 50% 60% 310,000 0.28 8,680 F
Ribston 30% 25% 310,000 0.24 3,720 U
0

3. Greenwood paid less for Tolman and Ribston apples and, so, had a favourable
direct materials price variance of $3,100. It also had an unfavourable efficiency
variance of $2,760. Greenwood would need to evaluate if these were unrelated
events or if the lower price resulted from the purchase of apples of poorer quality
that affected efficiency. The net effect in this case from a cost standpoint was
favourablethe savings in price being greater than the loss in efficiency. Of
course, if the applesauce is of poorer quality, Greenwood must also evaluate the
potential effects on current and future revenues that have not been considered in
the variances described in requirements 1 and 2.
The unfavourable efficiency variance is entirely attributable to an unfavourable

yield. The actual mix does deviate from the budgeted mix but at the budgeted prices,
the greater quantity of Tolman and Ribston apples used in the actual mix exactly
offsets the fewer Golden Delicious apples used. Again, management should evaluate
the reasons for the unfavourable yield variance. Is it due to poor quality Tolman and
Ribston apples (recall from requirement 1 that these apples were acquired at a price
lower than the standard price)? Is it due to the change in mix (recall that the mix
used is different from the budgeted mix, even though the mix variance is $0)?
Isolating the reasons can lead management to take the necessary corrective actions.

Problem 16-28
1, & 2
Actual Contribution margins
Actual
Actual Sales Sales Actual Total
Product CM/Unit Volume Mix % CM %
Palm Pro $176 11,000 10.0% $1,936,000 15.5%
Palm CE 198 44,000 40.0% 8,712,000 69.6%
Palm Kid 34 55,000 50.0% 1,870,000 14.9%
110,000 100.0% $12,518,000 100.0%
Budgeted Contribution margins
Budgeted
Budgeted Sales Sales Budgeted
Product CM/Unit Volume Mix % Total CM %
Palm Pro $202 12,500 12.5% $2,525,000 18.6%
Palm CE 176 37,500 37.5% 6,600,000 48.6%
Palm Kid 89 50,000 50.0% 4,450,000 32.8%
100,000 100.0% $13,575,000 100.0%
Budgeted average CM/unit = $13,575,000 / 100,000 = $135.75
3, & 4.
Static-Budget Variance:
Actual Budgeted
Contribution Contribution
Margin Margin Variance
Palm Pro $1,936,000 $2,525,000 $ 589,000 U
Palm CE 8,712,000 6,600,000 2,112,000 F
Palm Kid 1,870,000 4,450,000 2,580,000 U
$12,518,000 $13,575,000 $1,057,000 U

Flexible Budget Variance:
Budgeted
Actual Contribution
Contribution Margin at Actual
Margin Volumes Variance
Palm Pro $1,936,000 $2,222,000 $ 286,000 U
Palm CE 8,712,000 7,744,000 968,000 F
Palm Kid 1,870,000 4,895,000 3,025,000 U
12,518,000 14,861,000 $2,343,000 U
Budgeted
Palm Pro 11,000 12,500 $202 $ 303,000 U
Palm CE 44,000 37,500 176 1,144,000 F
Palm Kid 55,000 50,000 89 445,000 F
110,000 100,000 $1,286,000 F
Budgeted
110,000 100,000 135.75 $1,357,500 F
Sales Mix Variance:
Budgeted
Actual Sales Budgeted Sold of All Margin per
Mix Sales Mix Glasses unit
Palm Pro 10.0% 12.5% 110,000 $202 $555,500 U
Palm CE 40.0% 37.5% 110,000 176 484,000 F
Palm Kid 50.0% 50.0% 110,000 89 0
$71,500 U

5. Some factors to consider are:
The difference in actual vs. budgeted contribution was $1,057,000.

However, the contribution from the PalmCE exceeded budget by
$2,112,000 while the contributions from the PalmPro and the PalmKid
were lower than expected to an offsetting degree.
In percentage terms, the PalmCE accounted for 70% of total contribution

vs. a planned 49% contribution. However, the PalmPro accounted for 15%
vs. planned 19% and the PalmKid accounted for only 15% vs. a planned
32%.
In unit terms (rather than in contribution terms), the PalmKid accounted

for 50% of the s-ales mix as planned. However, the PalmPro accounted for
only 10% vs. a budgeted 12.5% and the PalmCE accounted for 40% vs. a
planned 37.5%.
Variance analysis for the PalmPro shows an unfavourable sales-mix

variance outweighing a favourable sales-quantity variance and producing
an unfavourable sales-volume variance of $303,000. The drop in sales-mix
share was far larger than the gain from an overall greater quantity sold.
The PalmCE gained both from an increase in share of the sales mix as well
as from the increase in the overall number of units sold. These factors
combined to a $1,144,000 favourable sales-volume variance.
The PalmKid maintained sales-mix shareas a result, the sales-mix

variance is zero. However, PalmKid sales did gain from the overall increase
in units sold.
Overall, there was a favourable total sales-volume variance. However, the

large drop in PalmKids contribution margin per unit combined with a
decrease in the number of PalmPro units sold vs. budget, led to the total
contribution margin being much lower than budgeted.
Other factors could be discussed herefor example, it seems that the PalmKid did not
achieve much success with a three digit price pointselling price was budgeted at
$154 but dropped to $107. At the same time, variable costs increased. This could have
been due to a marketing push aimed at announcing the lower price in some markets.

Problem 16-29
1. Market Size Variance
Budgeted Actual Total Budgeted Total Budgeted

Market Industry Sales Industry Sales Average
Share % Volume Volume CM/Unit Variance
.25 500,000 400,000 135.75 $3,393,750 F
Market Share Variance
Actual Total Budgeted Actual Budgeted

Industry Sales Market Market Average
Volume Share % Share % CM/Unit Variance
500,000 .25 .22 135.75 $2,036,250 U
2. The sales quantity variance is broken down into the market size and market share
variances. The market size variance tells us that had we kept our market share as
budgeted at 25%, that the sales quantity variance would be $3,393,750
favourable. However, the sales quantity variance was substantially lower than
this. It was $2,036,250 lower because we were unable to keep our market share at
25% but rather let it drop to 22%.
3. The actual market size that would have led to no market size variance is 400,000
units.

Problem 16-30
1. Sales Volume Variance
Budgeted Budgeted Sales Actual Sales

CM/Unit Volume Volume Variance
Choc Chip $2.10 45,000 57,600 $26,460 F
Oatmeal Raisin 2.40 25,000 18,000 16,800 U
Coconut 2.70 10,000 9,600 1,080 U
White Choc 3.10 5,000 13,200 25,420 F
Macadamia N 3.20 15,000 21,600 21,120 F
$55,120 F
2. Sales Quantity Variance
Budgeted
Average Budgeted Total Actual Total
CM/Unit Sales Sales Variance
2.45* 100,000 120,000 $49,000 F
* Total Budgeted CM = (45,000 x $2.10) + (25,000 x $2.40) + (10,000 x $2.70)

+ (5,000 x $3.10) + (15,000 x $3.20) = $235,000
Budgeted Average CM/unit = $245,000 / 100,000 = $2.45
3. Sales Mix Variance
Budgeted
Actual Budgeted Actual Total Contribution
Sales Mix Sales Mix Units Sold Margin per
% % unit
Choc Chip .48 .45 120,000 $2.10 $7,560 F
Oatmeal Raisin .15 .25 120,000 2.40 28,800 U
Coconut .08 .10 120,000 2.70 6,480 U
White Choc .11 .05 120,000 3.10 22,320 F
Macadamia N .18 .15 120,000 3.20 11,520 F
$6,120 F
4. The companys contribution margin was $55,120 higher than budgeted. This is
due to selling 20,000 more kilograms than budgeted and by shifting the mix from
less profitable products to more profitable products.

Problem 16-31
Market Size Variance
Budgeted Actual Total Budgeted Total Budgeted

Market Industry Sales Industry Sales Average
Share % Volume Volume CM/Unit Variance
.10 960,000 1,000,000 2.45 $9,800 U
Market Share Variance
Actual Total Budgeted Actual Budgeted

Industry Sales Market Market Average
Volume Share % Share % CM/Unit Variance
960,000 .10 .125* $2.45 $58,800 F
* actual market share = actual volume / actual market volume = 120,000 / 960,000 = 12.5%
The market size variance is unfavourable because the size of the market was smaller than
anticipated. $9,800 was lost due to this. However, because the company increased their
share of the market, $56,8000 was gained.

11. Direct and Absorption Costing
Exercise 9-16
1. Variable Costing -
April May
Sales (350 x $28,800 | 520 x $28,800) $10,080,000 $14,976,000
Variable costs (350 x $15,000 | 520 x $15,000) 5,250,000 7,800,000
Contribution margin 4,830,000 7,176,000
Fixed Costs 2,600,000 2,600,000
Operating income $2,230,000 $4,576,000
Absorption Costing -
Sales (350 x $28,800 | 520 x $28,800) $10,080,000 $14,976,000

Cost of goods sold
Opening inventory 2,400,000
Cost of goods manufactured -
Variable (500 x $12,000 | 400 x $12,000) 6,000,000 4,800,000
Fixed 2,000,000 2,000,000
8,000,000 6,800,000
Less ending inventory:
$8,000,000 / 500 x 150 units (2,400,000)
$6,800,000 / 400 x 30 units (510,000)
5,600,000 8,690,000
Gross margin 4,480,000 6,286,000
Marketing costs
Variable (350 x $3,000 | 520 x $3,000) 1,050,000 1,560,000
Fixed 600,000 600,000
1,650,000 2,160,000
Operating income $2,830,000 $4,126,000
2. Variable costing operating income $2,230,000 $4,576,000

Add fixed costs in ending inventory
$2,000,000 / 500 x 150 units 600,000
$2,000,000 / 400 x 30 units 150,000
Less fixed costs in beginning inventory (600,000)
Absorption costing operating income $2,830,000 $4,126,000

Exercise 9-22
1. Variable Costing -
Sales (25,000 x $48) $1,200,000

Variable costs (25,000 x $27.30) 682,500
Contribution margin 517,500
Fixed costs ($120,000 + 190,000) 310,000
Absorption Costing -
Sales (25,000 x $48) $1,200,000

Cost of goods sold
Beginning inventory [1,000 x ($26.10 Variable MFG Costs + 4.00 FOH)] 30,100
Cost of goods manufactured (29,000 x $30.10) 872,900
Ending inventory (5,000 x $30.10) (150,500)
752,500
Underapplied overhead -
Actual fixed manufacturing overhead $120,000
Applied fixed manufacturing overhead
29,000 units x $4.00 116,000 4,000
756,500
Gross margin 443,500
Marketing and administrative costs
Variable: 25,000 x $1.20 30,000
Fixed 190,000 220,000
2. Absorption Costing Operating Income $223,500

Add fixed costs in opening inventory: 1,000 x $4.00 4,000
Less fixed costs in ending inventory: 5,000 x $4.00 (20,000)
Variable Costing Operating Income $207,500
The operating income figures differ because the amount of fixed manufacturing
costs in the ending inventory differs from that in the beginning inventory.

3. Advantages -
The fixed costs are reported as period costs (and not allocated to inventory),
thus increasing the likelihood of better control of these costs.
Operating income is directly influenced by changes in unit sales (and not
influenced by build-up of inventory).
The impact of fixed costs on operating income is emphasized.
The income statements are in the same form as used for cost-volume-profit
analysis.
Product line, territory, etc., contribution margins are emphasized and more
readily ascertainable.
Disadvantages -
Total costs may be overlooked when considering operating problems.
Distinction between fixed and variable costs is arbitrary for many costs.
Emphasis on variable costs may cause some managers to ignore fixed costs.
A new variable-costing system may be too costly to install unless top
managers think that operating decisions will be improved collectively.

Problem 9-23
1. Standard cost per unit -

Variable costs $3.60
Fixed overhead: $7.00 per hour / 10 units per hour 0.70
$4.30
Sales (540,000 x $6) $3,240,000

Cost of goods sold
Beginning inventory (30,000 x $4.30) 129,000
Cost of goods manufactured (550,000 units x $4.30) 2,365,000
Ending inventory (40,000 x $4.30) (172,000)
2,322,000
Under applied overhead:
Budgeted and actual overhead $420,000
Applied overhead: 550,000 units x $0.70 385,000 35,000
2,357,000
Gross margin 883,000
Marketing and administrative costs
Variable: 540,000 x $1 $540,000
Fixed 120,000 660,000
2. Sales (540,000 x $6) $3,240,000

Variable costs (540,000 x ($3.60 + 1.00)) 2,484,000
Fixed costs ($420,000 + 120,000) 540,000
The difference is equal to the increase in inventory times the fixed

cost per unit: 10,000 units x $0.70 = $7,000.

3.
Actual & budget line

$420,000
$385,000 Underallocated
55,000 60,000
Machine-hours

Problem 9-35
1. Operating income is a function of both sales and production under absorption

costing, whereas it is a function only of sales under variable costing. Therefore,
inventory changes can have dramatic effects on operating income under absorption
costing. In this case, the severe decline in inventory has resulted in enormous fixed
costs from beginning inventory being charged against 2007 operations.
2. Total fixed manufacturing overhead $1,200,000

Less production volume variance 480,000
Fixed manufacturing overhead in COGS $ 720,000
Plant was operating at 720,000 / 1,200,000 = 60% of denominator level.
3. Variable costing operating income $720,000

Less fixed costs in opening inventory ($1,980,000 1,584,000) (396,000)
Add fixed costs in ending inventory ($90,000 72,000) 18,000
Absorption costing operating income $342,000
4. a. Absorption costing is more likely than variable costing to lead to inventory

buildups. Under absorption costing, operating income in a given accounting
period is increased because some fixed manufacturing overhead is accounted
for as an asset (inventory) instead of an expense (fixed cost written off
during the current period).
b. Although variable costing will counteract undesirable inventory buildups,

other measures can be used without abandoning absorption costing.
Examples include budget targets and nonfinancial measures of performance
such as maintaining specific inventory levels, inventory turnovers, delivery
schedules, and equipment maintenance schedules.

Problem 9-47
1. Sales (450,000 x $79.20) $35,640,000

Cost of goods sold
Cost of goods manufactured
Variable: 480,000 x $44.40 $21,312,000
Fixed: 480,000 x $21.601 10,368,000 31,680,000
Ending inventory: 30,000 x (44.40 + 21.60) (1,980,000)
29,700,000
Variances 360,000
30,060,000
Gross margin 5,580,000
Marketing costs -
Variable: 450,000 x $4.80 2,160,000
Fixed 1,200,000
Variances (187,200) 3,172,800
Operating income $2,407,200
1
$10,800,000 / 500,000 denominator volume
2. The ending inventory of 30,000 crankshafts absorbs $648,000 of the standard fixed
manufacturing costs. Thus, if the Mississauga Division had zero ending inventory,
the operating income would have been $1,759,200 ($2,407,200 - $648,000).
(Alternatively, if the Mississauga Division had ending inventory of 30,000 units but
used variable costing, operating income would have been $1,759,200.) The 2007
operating income increase over 2006 would have been only
($1,759,200 / $1,712,412) - 1 = 2.7% increase
Operating income under variable costing follows sales and is not affected by
inventory.
Easson may suspect Wood of "producing for inventory" because he has qualified
himself for a 30% annual bonus by having 30,000 crankshafts in inventory. A
policy of producing only to order (with zero inventories) would have resulted in
Wood's receiving a visit from the "IEC corporate consulting team."
Assuming 250 working days a year, daily production averages 1,920. Hence, the
ending inventory is approximately 15.625 days of production. Wood might argue
that it is necessary to hold this inventory to meet any variation in demand.
However, this position seems unlikely given that there has been a reduction in
demand in the last four months of 2007 (hence excess capacity now probably
exists) and the standard machining time per crankshaft is only 30 minutes. Another

argument Wood might make is that there are economies of scale in large production
runs of crankshafts. (Note that the data in the question assumes no economies of
scale.)
3. Easson should be careful in raising issues of management ethics with Wood. As the
head of IEC corporate consulting, she is in an advisory role. She might make
detailed suggestions about how IEC's costs could be reduced by holding less
inventory. However, suggestions about Wood's being unethical probably should
come from those to whom Wood reports in a line relationship.
Problem 9-48
1. Behaviours that might suggest problems for IEC with the existing bonus plan and
accounting system include:
Plant managers switching production orders at year-end to those orders that
absorb the highest amount of manufacturing overhead, irrespective of the
demand by customers of IEC.
Plant managers at one division of IEC accepting orders that they know
another plant of IEC is better suited to handle.
Plant managers deferring maintenance beyond the normal maintenance
period.
2. Possible changes include:

Change the incentive scheme so that there are not the major discontinuities at
15% and 10%.
Change the operating income measure to variable costing rather than
absorption costing.
Add other performance measures (such as inventory turnover) that explicitly
penalize "building for inventory."
Emphasize the importance of managers considering IEC total benefits and
costs of their decisions. This could be done via persuasion or by an incentive
system based on IEC operating income rather than 100% of each division's
operating income.

12. Transfer Pricing
Exercise 23-18
1. a. Mining Metals
Revenue
400,000 x $108 | $180 $43,200,000 $72,000,000
Costs: 400,000 x $72 | ($61.20 + $108) 28,800,000 67,680,000
Operating income $14,400,000 $ 4,320,000
b. Revenue
400,000 x $79.20* | $180 $31,680,000 $72,000,000
Costs: 400,000 x $72 | ($61.20 + 79.20) 28,800,000 56,160,000
Operating income $ 2,880,000 $15,840,000
* $72.00 x 1.10 = $79.20
2. Mining Metals
Market Price $144,000 $43,200
110% of Full Costs 28,800 158,400
The Mining Division manager will prefer Method A (transfer at market prices)
because this method gives $144,000 of bonus rather than $28,800 under Method B
(transfers at 110% of full costs). The Metals Division manager will prefer Method
B because this method gives $158,400 of bonus rather than $43,200 under Method
A.
3. Brian Jones, the manager of the Mining Division, will appeal to the existence of a
competitive market to price transfers at market prices. Using market prices for
transfers in these conditions leads to goal congruence. Division managers acting in
their own best interests make decisions that are also in the best interests of the
company as a whole.
Jones will further argue that setting transfer prices based on cost will cause Jones to
pay no attention to controlling costs since all costs incurred will be recovered from
the Metals Division at 110% of full costs.

Exercise 23-19
1. Using the general guideline presented in the chapter, the minimum price at which
the Airbag Division would sell airbags to the Igo Division is $132, the
incremental costs. The Airbag Division has idle capacity (it is currently working
at 80% of capacity). Hence, its opportunity cost is zerothe Airbag Division
does not forgo any external sales and, hence, does not forgo any contribution
margin from internal transfers.
2. Transferring products internally at incremental cost has the following properties.

a. Achieves goal congruenceYes.
b. Useful for evaluating subunit performanceNo, because transfer price
does not exceed full costs. By transferring at incremental costs and not
covering fixed costs, the Airbag Division will show a loss. This loss, the
result of the incremental cost-based transfer price, is not a good measure of
the economic performance of the subunit.
c. Motivating management effortYes, if based on budgeted costs (actual
costs can then be compared to budgeted costs). If, however, transfers are
based on actual costs, Airbag Division management has little incentive to
control costs.
d. Preserves subunit autonomyNo. Because it is rule-based, the Airbag
Division has no say in and, hence, no ability to set the transfer price.
3. If the two divisions were to negotiate a transfer price, the range of possible
transfer prices will be between $132 and $168 per unit. The Airbag Division has
excess capacity that it can use to supply airbags to the Igo Division. The Airbag
Division will be willing to supply the airbags only if the transfer price equals or
exceeds $132, its incremental costs of manufacturing the airbags. The Igo
Division will be willing to buy airbags from the Airbag Division only if the price
does not exceed $168 per airbag, the price at which the Igo division can buy
airbags in the market from outside suppliers. Within the price range of $132 to
$168, each division will be willing to transact with the other. The exact transfer
price between $132 and $168 will depend on the bargaining strengths of the two
divisions. The negotiated transfer price has the following properties.
a. Achieves goal congruenceYes.

b. Useful for evaluating subunit performanceYes, because the transfer price
is the result of direct negotiations between the two divisions. Of course, the
transfer prices will be affected by the bargaining strengths of the two
divisions.
c. Motivating management effortYes, because once negotiated, the transfer
price is independent of actual costs of the Airbag Division. Airbag Division
management has every incentive to manage efficiently to improve profits.

d. Preserves subunit autonomyYes, because the transfer price is based on

direct negotiations between the two divisions and is not specified by
headquarters on the basis of some rule (for example, Airbag Division
incremental costs).
4. Neither method is perfect, but negotiated transfer pricing (described in

requirement 3) has more favourable properties than the cost-based transfer pricing
(described in requirement 2). Both transfer-pricing methods achieve goal
congruence, but negotiated transfer pricing facilitates the evaluation of subunit
performance, motivates management effort, and preserves subunit autonomy,
whereas the transfer price based on incremental costs does not achieve these
objectives.

Exercise 23-21
1. a. Full Cost Transfer - Canadian Austrian

Division Division
Sales: 1,000 x $600 | 1,000 x $900 $600,000 $900,000

Full Mfg cost: 1,000 x $600 (600,000)
Transfer price: 1,000 x $600 (600,000)
Import Duty: 1,000 x $600 x 10% (60,000)
Operating income 0 240,000
Taxes @ 40% | 44% 0 105,600
Net income $ 0 $134,400
b. Transfer at $780 -
Sales: 1,000 x $780 | 1,000 x $900 $780,000 $900,000

Full Mfg cost: 1,000 x $600 600,000
Transfer price: 1,000 x $780 (780,000)
Import Duty: 1,000 x $780 x 10% (78,000)
Operating income 180,000 42,000
Taxes @ 40% | 44% 72,000 18,480
Net income $108,000 $ 23,520
2. The following calculates the net tax burden on a

transfer of one unit:
TP = $600 TP = $780
Taxes paid in Canada:
$0 x 40% | ($780 600) x 40% $ 0.00 ($72.00)
Duty paid in Austria: $600 x 10% | $780 x 10% (60.00) (78.00)
Taxes saved in Austria:
($600 + 60) x 44% | ($780 + 78) x 44% 290.40 377.52
Net tax savings $230.40 $227.52
Mornay Company will minimize import duties and income taxes by setting the
transfer price at its minimum level of $600, the full manufacturing cost.

Exercise 23-22
1. Incremental CM if units are sold in Canada:

1,000 units x ($900 720) ($180,000)
Import duties saved 60,000
Net incremental operating income if sold in Canada ($120,000)
Mornay should sell the 1,000 units in Austria.
2. Transferring Product 4A36 at the full manufacturing cost of the Canadian

Division minimizes import duties and taxes (requirement 2), but creates zero
operating income for the Canadian Division. Acting autonomously, the Canadian
Division manager would maximize division operating income by selling Product
4A36 in the Canadian market which results in $120,000* in division operating
income, rather than by transferring Product 4A36 to the Austrian division at full
manufacturing cost.
* 1,000 units x ($720 600) = $120,000
3. The minimum transfer price at which the Canadian Division manager acting
autonomously will agree to transfer Product 4A36 to the Austrian division is $720
per unit. Any transfer price less than $720 will leave the Canadian Divisions
performance worse than selling directly in the Canadian market. Since the
Canadian Division can sell as many units of Product 4A36 in the Canadian
market as it makes, there is an opportunity cost of transferring the product
internally.

Problem 23-33
1. a. Selling Price = $44.40
CM generated from external sales:

10,000 cassette decks x ($42 30) $120,000
Cost of cassette decks paid to Johnson:
10,000 x $44.40 (444,000)
Savings due to not manufacturing cassette decks internally:
10,000 x $30 300,000
CM generated from sales of head mechanisms to Johnson:
10,000 x ($21.60 14.40) 72,000
Net advantage to company or purchasing cassette decks
externally from Johnson Company $48,000
b. Selling Price = $51.60
Net advantage as per part (a) $48,000

Increase in cost paid to Johnson:
10,000 x ($51.60 44.40) (72,000)
Net disadvantage to company or purchasing cassette decks
externally from Johnson Company ($24,000)
Sather should only accept Johnsons offer if the price is $44.40.
2. The best transfer price is the maximum transfer price the Assembly Division
would be willing to pay an external supplier and is equal to the external price that
will make the advantage to the company or purchasing cassette decks externally
from Johnson Company equal to zero:
$44.40 + $48,000 / 10,000 = $49.20
Alternatively, can be calculated as follows:

Variable costs of producing a cassette deck $30.00
CM foregone on external sales when transferring a cassette deck 12.00
internally
CM foregone on head mechanism ($21.60 14.40) 7.20
$49.20

Problem 23-36
1. CM gained from external sale: 2,000 x (450 120 48 30) $504,000

Cost to company of purchasing pumps externally:
1,200* x $480 (576,000)
Cost saved by not making the 1,200 pumps internally:
1,200 x ($150 + 60 + 30) 288,000
Net benefit to company $216,000
* 4,000 capacity 3,200 internal transfers = 800 excess capacity

2,000 external sales 800 excess capacity = 1,200
2. The options facing the Engine Division manager are (a) to sell 2,000 units of the
special order engine and make 2,000 units for the Assembly Division or (b) to
make 3,200 units for the Assembly Division. The contribution margin per unit
from accepting the special order is $252 per unit. Let the transfer price be $X.
Then we want to find X such that:
$252 2,000 + ($X $240) 2,000 = ($X $240)3,200

($X $240)(3,200 2,000) = $504,000
$X - $240 = $504,000 / 1,200
$X $240 = $420
X = $660
For transfer prices below $660, the Engine Division gets more by selling 2,000
units outside and transferring 2,000 units to Assembly Division. It will not transfer
more than 2,000 units to Assembly even though the transfer price is greater than
the variable costs of manufacturing the existing engine, $240 plus the contribution
margin per unit from accepting the special order of $252 equal to $492 ($600,
say). Why? Because by transferring an additional 1,200 units (say) it will have to
give up $504,000 ($252 2,000) of contribution margin by not accepting the
special order. The Engine Division manager would be willing to transfer the
remaining 2,000 units for which it has capacity to the Assembly Division provided
the transfer price covers the Engine Divisions variable costs. So the range of
transfer price that will induce the Engine Division manager to implement the
optimal solution in requirement 1 is:
$240 TP < $660
The Assembly Division manager would be willing to buy from the Engine
Division so long as the transfer price is less than or equal to the price at which the
Assembly Division can buy the engines on the outside market
TP $480

It will not buy the engines from the Engine Division if TP > $480. The range of TP
that will result in both managers favouring the optimal actions in requirement 1 are
TPs that satisfy the respective constraints described above.
$240 TP $480 for the first 2,000 units

$480 < TP < $660 for any additional units
This transfer pricing scheme will induce both managers to transfer 2,000 units
between the Engine and Assembly Divisions but no more.
3. a. The full manufacturing costs of the engines transferred to the Assembly

Division are:
Direct materials $150

Direct manufacturing labour 60
Variable manufacturing overhead 30
Fixed manufacturing overhead*
$624,000 / 2 = $312,000 / 2,000 engines 156
$396
b. A transfer price of $396 is in the optimal range identified in requirement 2

and so will achieve the optimal actions of selling 2,000 engines under the
outside offer and transferring 2,000 engines to the Assembly Division as
identified in requirement 1. (If we also want the Assembly Division
manager to not ask for any additional engines beyond 2,000 units, the
transfer price for any additional engines would have to be set such that
$480 < TP < $660.) If the transfer price is set at $396, the Assembly
Division manager will want more engines but the Engine Division manager
will not have any incentive to transfer anything more than 2,000 units,
preferring to supply 2,000 units for the special order.
c. One advantage of full cost transfer pricing is that it is useful for the firms
long-run pricing decisions.
One disadvantage of full cost transfer pricing is that costs that are fixed for
the corporation as a whole look like variable costs from the viewpoint of
the Assembly Division manager. This is because by choosing not to have a
unit transferred from the Engine Division, the Assembly Division manager
would appear to save both the variable and fixed costs of the engine. This
could lead to suboptimal decisions.

4. a. To minimize taxes, Saskatchewan should transfer the engines at the market

price of $480. The Engine Division would pay no taxes on any income that it
would report. By setting the transfer price as high as possible, the Assembly
Division would minimize the income it would report and hence the taxes it
would pay.
b. Yes, as in part 3b, the transfer price of $480 is also within the range
identified in requirement 2 and so will achieve the outcome desired in
requirement 1 (sell 2,000 engines under the outside offer and transfer 2,000
engines to the Assembly Division).
5. Recommend that Saskatchewan use a transfer price of $480 for transferring engines
from the Engine Division to the Assembly Division. This transfer price minimizes
tax payments for the Saskatchewan Corporation as a whole and also achieves goal
congruence. That is, at a transfer price of $480 for all engines transferred from the
Engine Division to the Assembly Division, both Divisions will be content with the
following arrangement:
(a) The Engine Division will make 2,000 engines for outside customers and
2,000 engines for the Assembly Division.
(b) The Assembly Division will take 2,000 engines from the Engine Division
and 1,200 engines from the outside market.
Of course the Assembly Division manager would like to negotiate a price lower than
$480 (but greater than $240) for the 2,000 engines from the Engine Division, but
this would increase Saskatchewans tax payments.
At a transfer price of $480, it would still be alright to evaluate each divisions

performance on the basis of division operating income because the transfer price of
$480 approximates the market prices for the engines transferred from the Engine
Division to the Assembly Division. Market-based transfer prices give top
management a reasonably good picture of the contributions of the individual
divisions to overall companywide profitability.

13. Performance Evaluation For Profit Organizations
Exercise 24-16
1. The separate components highlight several features of return on investment not
revealed by a single calculation:
the importance of investment turnover as a key to income is stressed.
the importance of revenues is explicitly recognized.
the important components are expressed as ratios or percentages instead of
dollar figures. This form of expression often enhances comparability of
different divisions, businesses, and time periods.
the breakdown stresses the possibility of trading off investment turnover
for income as a percentage of revenues so as to increase the average ROI at
a given level of output.
2. A B C
Revenue $1,200,000 $600,000 $12,000,000
Income 120,000 60,000 60,000
Investment 600,000 6,000,000 6,000,000
Income as a % of revenue 10% 10% 0.5%
Investment turnover 2.0 0.1 2.0
Return on investment (ROI) 20% 1% 1%
Income and investment alone shed little light on comparative performances

because of disparities in size between Company A and the other two companies.
Thus, it is impossible to say whether Bs low return on investment in comparison
with As is attributable to its larger investment or to its lower income.
Furthermore the fact that Companies B and C have identical income and
investment may suggest that the same conditions underlie the low ROI, but this
conclusion is erroneous. B has higher margins but a lower investment turnover. C
has very small margins (1/20th of B) but turns over investment 20 times faster

Exercise 24-20
1. Operating income is a good summary measure of short-term financial performance.

By itself, however, it does not indicate whether operating income in the short run was
earned by taking actions that would lead to long-run competitive advantage. For
example, Summits divisions might be able to increase short-run operating income by
producing more product while ignoring quality or rework. Harrington, however,
would like to see division managers increase operating income without sacrificing
quality. The new performance measures take a balanced scorecard approach by
evaluating and rewarding managers on the basis of direct measures (such as rework
costs, on-time delivery performance, and sales returns). This motivates managers to
take actions that Harrington believes will increase operating income now and in the
future. The nonoperating income measures serve as surrogate measures of future
profitability.
2. The semi-annual installments and total bonus for the Charter Division are calculated
as follows:
Charter Division Bonus Calculation

For Year Ended December 31, 2007
January 1, 2007 to June 30, 2007

Profitability (0.02) ($554,400) $ 11,088
Rework (0.02 $554,400) $13,800 (2,712)
On-time delivery No bonus under 96% 0
Sales returns [(0.015 $5,040,000) $100,800] 50% (12,600)
Semi-annual installment $ (4,224)
Semi-annual bonus awarded $ 0
July 1, 2007 to December 31, 2007

Profitability (0.02) ($528,000) $10,560
Rework (0.02 $528,000) $13,200 (2,640)
On-time delivery 96% to 98% 2,400
Sales returns [(0.015 $5,280,000) $84,000] 50% (2,400)
Semi-annual installment $ 7,920

Semi-annual bonus awarded $ 7,920
Total bonus awarded for the year $ 7,920

The semi-annual installments and total bonus for the Mesa Division are calculated as
follows:
Mesa Division Bonus Calculation
For Year Ended December 31, 2007
January 1, 2007 to June 30, 2007
Profitability (0.02) ($410,400) $ 8,208
Rework (0.02 $410,400) $7,200 0*
On-time delivery Over 98% 6,000
Sales returns [(0.015 $3,420,000) $53,700] 50% (1,200)
Semi-annual bonus installment $13,008
Semi-annual bonus awarded $13,008
July 1, 2007 to December 31, 2007

Profitability (0.02) ($487,200) $ 9,744
Rework (0.02 $487,200) $9,600 0*
On-time delivery No bonusunder 96% 0
Sales returns [(0.015 $3,480,000) $51,000]
which is greater than zero, yielding
a bonus of 3,600
Semi-annual bonus installment $13,344
Semi-annual bonus awarded $13,344
Total bonus awarded for the year $26,352
* 2% Operating income > rework costs: No reduction
3. The manager of the Charter Division is likely to be frustrated by the new plan as the
division bonus is more than $24,500 less than the previous year. However the new
performance measures have begun to have the desired effectboth on-time deliveries
and sales returns improved in the second half of the year while rework costs were
relatively even. If the division continues to improve at the same rate, the Charter
bonus could approximate or exceed what it was under the old plan.
The manager of the Mesa Division should be as satisfied with the new plan as
with the old plan as the bonus is almost equivalent. However, there is no sign of
improvements in the performance measures instituted by Harrington in this division;
as a matter of fact, on-time deliveries declined considerably in the second half of the
year. Unless the manager institutes better controls, the bonus situation may not be as
favourable in the future. This could motivate the manager to improve in the future but
currently, at least, the manager has been able to maintain his bonus without showing
improvements in the areas targeted by Harrington.

Ben Harringtons revised bonus plan for the Charter Division fostered the following
improvements in the second half of the year despite an increase in sales
increase of 1.9 percent in on-time deliveries.
$600 reduction in rework costs.
$16,800 reduction in sales returns.
However, operating income as a percent of sales has decreased (11 to 10 percent)

The Mesa Divisions bonus has remained at the status quo as a result of the
following effects
increase of 2.0 percent in operating income as a percent of sales (12 to 14 percent).
decrease of 3.6 percent in on-time deliveries.
$2,400 increase in rework costs.
$2,700 decrease in sales returns.
This would suggest that there needs to be some revisions to the bonus plan.
Possible changes include:
increasing the weights put on on-time deliveries, rework costs, and sales returns in
the performance measures while decreasing the weight put on operating income.
a reward structure for rework costs that are below 2 percent of operating income
that would encourage managers to drive costs lower.
reviewing the whole year in total. The bonus plan should carry forward the negative
amounts for one six-month period into the next six-month period incorporating the
entire year when calculating a bonus.
developing benchmarks, and then giving rewards for improvements over prior
periods and encouraging continuous improvement.

Exercise 24-23
The method for computing profitability preferred by each manager follows:
Manager of Method Chosen

Mastex Residual income based on net book value
Banjo Residual income based on gross book value
Randal ROI based on either gross or net book value
The biggest weakness of ROI is the tendency to reject projects that will lower historical
ROI even though the prospective ROI exceeds the required ROI. The biggest weakness of
residual income is it favours larger divisions in ranking performance. The greater the
amount of the investment (the size of the division), the more likely that larger divisions will
be favoured assuming that income grows proportionately.
Supporting Computations:
Return on Investment Calculations

Operating Income Operating Income
Division Gross Book Value Net Book Value*
Mastex $57,000 $480,000 = 11.875% (3) $57,000 $240,000 = 23.750% (3)
Banjo $55,200 $456,000 =12.105% (2) $55,200 $228,000 = 24.211% (2)
Randal $36,960 $300,000 =12.320% (1) $36,960 $150,000 = 24.640% (1)
Residual Income Calculations

Division Operating Income 10% Gross BV Operating Income 10% Net BV*
Mastex $57,000 $48,000 = $9,000 (2) $57,000 $24,000 = $33,000 (1)
Banjo $55,200 $45,600 = $9,600 (1) $55,200 $22,800 = $32,400 (2)
Randal $36,960 $30,000 = $6,960 (3) $36,960 $15,000 = $21,960 (3)
*Net book value is one half of gross book value given that all assets were purchased ten years ago and have
ten years useful life remaining, zero terminal disposal price, and straight-line amortization.

Problem 24-28
1. ROI using historical cost measures:
Calistoga: $156,000 / $408,000 = 38.2%

Alpine Springs: $264,000 / $1,380,000 = 19.1%
Rocky Mountains: $456,000 / $1,944,000 = 23.5%
The Calistoga Division appears to be considerably more efficient than the Alpine
Springs and Rocky Mountain Divisions.
2. The gross book values (i.e., the original costs of the plants) under historical cost are
calculated as the useful life of each plant (12) the annual amortization:
Calistoga : 12 $ 84,000 = $1,008,000

Alpine Springs : 12 $120,000 = $1,440,000
Rocky Mountains : 12 $144,000 = $1,728,000
Step 1: Restate long-term assets from gross book value at historical cost to gross book
value at current cost as of the end of 2007.
Gross book value
Construction cost index in 2007
of long-term assets
Construction cost index in year of construction
at historical cost
Calistoga: $1,008,000 (170 100) = $1,713,600

Alpine Springs: $1,440,000 (170 136) = $1,800,000
Rocky Mountain: $1,728,000 (170 160) = $1,836,000
Step 2: Derive net book value of long-term assets at current cost as of the end of
2007. (Assume estimated useful life of each plant is 12 years.)
Gross book value
of long-term assets Estimated useful life remaining

at current cost Estimated total useful life
at the end of 2007
Calistoga: $1,713,600 (2 12) = $ 285,600

Alpine Springs: $1,800,000 (9 12) = $1,350,000
Rocky Mountains: $1,836,000 (11 12) = $1,683,000

Step 3: Compute current cost of total assets at the end of 2007. (Assume current assets
of each plant is expressed in 2007 dollars.)
Current assets at the end Net book value of long-term assets at
+
of 2007 (given) current cost at the end of 2007 (Step 2)
Calistoga: $240,000 + $ 285,600 = $ 525,600

Alpine Springs: $300,000 + $1,350,000 = $1,650,000
Rocky Mountains: $360,000 + $1,683,000 = $2,043,000
Step 4: Compute current-cost amortization expense in 2007 dollars.

Gross book value of long-term assets at current cost at the end of 2007 (from Step 1)
(1 12)
Calistoga: $1,713,600 (1 12) = $142,800
Alpine Springs: $1,800,000 (1 12) = $150,000
Rocky Mountains: $1,836,000 (1 12) = $153,000
Step 5: Compute 2007 operating income using 2007 current-cost amortization.

Current-cost
Historical-cost Historical-cost
amortization in
operating income amortization
2007 dollars (Step 4)
Calistoga: $156,000 ($142,800 $ 84,000) = $ 97,200

Alpine Springs: $264,000 ($150,000 $120,000) = $234,000
Rocky Mountains: $456,000 ($153,000 $144,000) = $447,000
Step 6: Compute ROI using current-cost estimates for long-term assets and
amortization.
Operating income for 2007 using 2007 current-cost amortization (Step 5)
Current cost of total assets at the end of 2007 (Step 3)
Calistoga: $ 97,200 $ 525,600 = 18.49%

Alpine Springs: $234,000 $1,650,000 = 14.18%
Rocky Mountains: $447,000 $2,043,000 = 21.88%
ROI: ROI:
Historical Cost Current Cost
Calistoga 38.24% 18.49 %
Alpine Springs 19.13 14.18
Rocky Mountains 23.46 21.88

Use of current cost results in the Rocky Mountains Division appearing to be the most
efficient. The Calistoga ROI is reduced substantially when the ten year old plant is
restated for the 70% increase in construction costs over the 1997 to 2007 period.
3. Use of current costs increases the comparability of ROI measures across divisions
operating plants built at different construction cost price levels. Use of current cost
also will increase the willingness of managers, evaluated on the basis of ROI, to move
from divisions with assets purchased many years ago to divisions with assets
purchased in recent years.

Problem 24-34
1. Revenues x Operating income = Operating income

Total Assets Revenues Total Assets
2007:
Newspapers 0.939 0.239 22.4%
Television 2.133 0.025 5.3%
Film Studios 0.635 0.121 7.7%
2006 (not required)

Newspapers 1.023 0.200 20.5%
Television 2.222 0.022 4.9%
Film Studios 0.640 0.137 8.8%
The Newspaper Division has a high ROI because of its high income margin. The
Television Division has a low ROI despite a high investment turnover because of its
very low income margin. The Film Studios Division has a low ROI despite a
reasonably high income margin because of its low investment turnover.
2. Although the proposed investment is small, relative to the total assets invested, it earns
less than the 2007 return on investment (0.224) [or the 2006 return on investment
(0.205)] (All dollar numbers in millions):
$1, 320
2007 ROI (before proposal) = = 0.224
$5, 880
$36
Investment proposal ROI = = 0.150
$240
$1, 356
2007 ROI (with proposal) = = 0.222
$6,120
Given the existing bonus plan, any proposal that reduces the ROI is unattractive.
3. Residual income for 2007 (before proposal, in millions):
Operating Imputed Division
Income Interest Charge Residual
Income
Newspapers $1,320 $705.60 (0.12 $5,880) = $ 614.40
Television $192 $432 (0.12 $3,600) = $(240)
Film Studios $240 $374.40 (0.12 $3,120) = $(134.40)

4. Residual income for proposal (in millions):

Operating Imputed Division
Income Interest Charge Residual
Income
$36 $28.80 (0.12 $240) = $7.2
Investing in the fast-speed printing press will increase the Newspaper Divisions
residual income. Hence, if Kearney is evaluated using a residual income measure,
Kearney would be much more willing to adopt the printing press proposal.
Problem 24-35
Consider each of the three proposals that Rupert Prince is considering:
1. Compensate managers on the basis of Division ROI.

The benefit of this arrangement is that managers would be motivated to put in extra
effort to increase ROI because managers rewards would increase with increases in
ROI. But compensating managers largely on the basis of ROI subjects the managers to
excessive risk, because each divisions ROI depends not only on the managers effort
but also on random factors over which the manager has no control. A manager may
put in a great deal of effort, but the divisions ROI may be low because of adverse
factors (high interest, recession) that the manager cannot control.
To compensate managers for taking on uncontrollable risk, Prince must pay them
additional amounts within the structure of the ROI-based arrangement. Thus, using
mainly performance-based incentives will cost Prince more money, on average, than
paying a flat salary. The key question is whether the benefits of motivating additional
effort justify the higher costs of performance-based rewards. The motivation for
having some salary and some performance-based bonus in compensation
arrangements is to balance the benefits of incentives against the extra costs of
imposing uncontrollable risk on the manager.
Finally, rewarding a manager only on the basis of division ROI will induce
managers to maximize the divisions ROI even if taking such actions are not in the
best interests of the company as a whole.
2. Compensate managers on the basis of companywide ROI.

Rewarding managers on the basis of companywide ROI will motivate managers to
take actions that are in the best interests of the company rather than actions that
maximize a divisions ROI.
A negative feature of this arrangement is that each division managers
compensation will now depend not only on the performance of that division manager
but also on the performance of the other division managers. For example, the
compensation of Ken Kearney, the manager of the Newspaper Division, will depend

on how well the managers of the Television and Film studios perform, even though
Kearney himself may have little influence over the performance of these divisions.
Hence compensating managers on the basis of company-wide ROI will impose extra
risk on each division manager.
3. Compensate managers using the other divisions average ROI as a benchmark.

The benefit of benchmarking or relative performance evaluation is to cancel out the
effects of common noncontrollable factors that affect a performance measure. Taking
out the effects of these factors provides better information about a managers
performance. What is critical, however, for benchmarking and relative performance
evaluation to be effective is that similar noncontrollable factors affect each division. It
is not clear that the same noncontrollable factors that affect the performance of the
Newspaper Division (cost of newsprint paper, for example) also affect the
performance of the Television and Film studios divisions. If the noncontrollable
factors are not the same, then comparing the ROI of one division to the average ROI
of the other two divisions will not provide useful information for relative performance
evaluation.
A second factor for Prince to consider is the impact that benchmarking and
relative performance evaluation will have on the incentives for the division managers
of the Newspaper, Television and Film studios Divisions to cooperate with one
another. Benchmarking one division against another means that a division manager
will look good by improving his or her own performance, or by making the
performance of the other division managers look bad.

Problem 24-37
Operating Income $2,160, 000

1. ROS = = = 12%
Sales $18, 000, 000
Operating Income $2,160, 000

ROI = = = 18%
Total Assets $12, 000, 000
Operating Income X
2. a. ROI = 20% = =
Total Assets 12, 000, 000
Hence operating income = 20% 12,000,000 = $2,400,000

Operating income = Revenue Costs
Therefore, Costs = $18,000,000 $2,400,000 = $15,600,000
Currently,
Costs = Revenues Operating income = $18,000,000 $2,160,000 = $15,840,000
Costs need to be reduced by $240,000 ($15,840,000 $15,600,000)
Operating Income $2,160,000

b. ROI = 20% = =
Total Assets X
Hence X = $2,160,000 20% = $10,800,000

PD would need to decrease total assets in 2008 by $1,200,000 ($12,000,000
$10,800,000).
3. RI = Income (Required rate of return Investment)
= $2,160,000 (0.15 $12,000,000)
= $360,000
4. PD wants RI to increase by 50% $360,000 = $180,000
That is, PD wants RI in 2008 to be $360,000 + $180,000 = $540,000
If PD cuts costs by $54,000 its operating income will increase to
$2,160,000 + $54,000 = $2,214,000
RI2008 = $540,000 = $2,214,000 (0.15 Assets)
$1,674,000 = 0.15 Assets
Assets = $1,674,000 0.15 = $11,160,000
PD would need to decrease total assets by $840,000 ($12,000,000 $11,160,000).
5. Barrington could use ROS to some degree. That way there is less focus on cutting
costs and reduction in assets and more emphasis on actual revenues and how they
translate into operating income.
Barrington may also want to consider nonfinancial measures such as customer
satisfaction and market share, quality, yield and on-time performance as well as
monitor employee satisfaction and the development of employee skills.

14. In-Class Problems
Problem 1 CVP Analysis
The following statement of income for Davann Company represents the operating results
for the fiscal year just ended. Davann had sales of 1,800 tons during the current year. The
manufacturing capacity of Davann's facilities is 3,000 tons.
Davann Company
Variable Costing Income Statement
for the Year Ended December 31, 20x5
Sales $900,000
Variable costs:
Manufacturing 315,000
Selling costs 180,000
495,000

Fixed costs:
Manufacturing 90,000
Selling 112,500
Administration 45,000
247,500
Income before income taxes 157,500

Income taxes (40%) 63,000
Net income $ 94,500
Required
a. What is the break-even volume in tons for 20x5?

b. If the sales volume is estimated to be 2,100 tons in the next year, and if prices
and costs stay at the same levels and amounts next year, what can Davann expect
aftertax net income to be?
c. Davann plans to market its product in a new territory. Davann estimates that an
advertising and promotion program costing $61,500 annually would need to be
undertaken for the next two or three years. In addition, a $25 per ton sales
commission over and above the current commission would be required for the sales
force in the new territory. How many tons would have to be sold in the new
territory to maintain Davann's current aftertax income of $94,500?
d. Davann is considering replacing a highly labor-intensive process with an automatic
machine. This would result in an increase of $58,500 annually in manufacturing

fixed costs. The variable manufacturing costs would decrease $25 per ton. What
would the new break-even volume in tons be?
e. Ignore the facts presented in Requirement (d) and now assume that Davann
estimates that the per-ton selling price would decline 10% next year. Variable costs
would increase $40 per ton, and the fixed costs would not change. What sales
volume in dollars would be required to earn an aftertax net income of $94,500 next
year?
Problem 2 CVP Analysis
Hewtex Electronics manufactures two products - tape recorders and electronic calculators
- and sells them nationally to wholesalers and retailers. The Hewtex management is very
pleased with the company's performance for the current fiscal year. Projected sales
through December 31,20x7, indicate that 70,000 tape recorders and 140,000 electronic
calculators will be sold this year. The projected earnings statement follows:
Hewtex Electronics
Projected Earnings Statement
For The Year Ended December 31, 20x7
Tape Electronic
Recorders Calculators
Total Total
Amount Per Amount Per Total
(000's) Unit (000's) Unit (000's)
Sales $1,050 $15.00 $3,150 $22 50 $4,200.00
Production costs:
Direct materials 280 4.00 630 4.50 910.00
Direct labor 140 2.00 420 3.00 560.00
Variable overhead 140 2.00 280 2.00 420.00
Fixed overhead 70 1.00 210 1.50 280.00
630 9.00 1,540 11.00 2,170.00
Gross margin $ 420 $ 6.00 $1,610 $11.50 2,030.00
Fixed selling and administrative 1,040.00

Net income before income taxes 990.00
Income taxes (55 %) 544.50
Net income $ 445.50

It shows that Hewtex will exceed its earnings goal of 9% on sales after income taxes.
The tape recorder business has been fairly stable the last few years, and the company
does not intend to change the tape recorder price. Competition among manufacturers of
electronic calculators has been increasing, however. Hewtex's calculators have been very
popular with consumers. In order to sustain this interest in their calculators and to meet
the price reductions expected from competitors, management has decided to reduce the
wholesale price of its calculator from $22.50 to $20.00 per unit effective January 1, 20x8.
At the same time, the company plans to spend an additional $57,000 on advertising
during fiscal year 20x8. As a consequence of these actions, management estimates that
80% of its total revenue will be derived from calculator sales compared to 75% in 20x7.
As in prior years, the sales mix is assumed to be the same at all volume levels.
The total fixed overhead costs will not change in 20x8, nor will the variable overhead
cost rates (applied on a direct labor hour base). However, the cost of materials and direct
labor is expected to change. The cost of solid-state electronic components will be cheaper
in 20x8. Hewtex estimates that material costs will drop 10% for the tape recorders and
20% for the calculators in 20x8. Direct labor costs for both products will increase 10% in
the coming year, however.
Required:
a. How many tape recorder and electronic calculator units did Hewtex Electronics
have to sell in 20x7 to break even?
b. What volume of sales is required if Hewtex Electronics is to earn a profit in 20x8
equal to 9% on sales after income taxes?
c. How many tape recorder and electronic calculator units will Hewtex have to sell in
20x8 to break even?

Problem 3 Relevant Costs (Special Orders)
Anchor Company manufactures several different styles of jewelry cases. Management

estimates that during the third quarter of 20x6 the company will be operating at 80% of
normal capacity. Because Anchor desires a higher utilization of plant capacity, the
company will consider a special order. Anchor has received special-order inquiries from
two companies. The first order is from JCP, Inc., which would like to market a jewelry
case similar to one of Anchor's cases. The JCP jewelry case would be marketed under
JCP's own label. JCP, Inc., has offered Anchor $5.75 per jewelry case for 20,000 cases to
be shipped by October 1, 20x6. The cost data for the Anchor jewelry case, which would
be similar to the specifications of the JCP special order, are as follows:
Regular selling price per unit $9.00
Costs per unit:

Raw materials $2.50
Direct labor 0.5 hours @ $6.00 3.00
Overhead 0.25 machine hours @ $4.00 1.00
Total costs $6.50
According to the specifications provided by JCP,Inc., the special-order case requires less
expensive raw materials. Consequently, the raw materials will cost only $2.25 per case.
Management has estimated that the remaining costs, labor time, and machine time will be
the same as for the Anchor jewelry case.
The second special order was submitted by the Krage Company for 7,500 jewelry cases
at $7.50 per case. Like the JCP cases, these jewelry cases would be marketed under the
Krage label and have to be shipped by October 1, 20x6. However, the Krage jewelry case
is different from any jewelry case in the Anchor line. The estimated per-unit costs of this
case are as follows:
Raw materials $3.25

Direct labor 0.5 hours @ $6.00 3.00
Overhead 0.5 machine hours @ $4.00 2.00
Total costs $8.25
In addition, Anchor will incur $1,500 in additional setup costs and will have to purchase
a $2,500 special device to manufacture these cases; this device will be discarded once the
special order is completed.
The Anchor manufacturing capabilities are limited to the total machine hours available.
The plant capacity under normal operations is 90,000 machine hours per year or 7,500
machine hours per month. The budgeted fixed overhead for 20x6 amounts to $216,000.
All manufacturing overhead costs are applied to production on the basis of machine hours
at $4.00 per hour.

Anchor will have the entire third quarter to work on the special orders. Management does
not expect any repeat sales to be generated from either special order. Company practice
precludes Anchor from subcontracting any portion of an order when special orders are
not expected to generate repeat sales.
Required: Should Anchor Company accept either special order? Justify your answer and
show your calculations.
Problem 4 Make/Buy
Powell Dentistry Services operates in a large metropolitan area. Currently, Powell has its
own dental laboratory to produce porcelain and gold crowns. The unit costs to produce
the crowns are as follows:
Porcelain Gold
Raw materials $ 55 $ 94
Direct labour 22 22
Variable overhead 5 5
Fixed overhead 22 22
Total $104 $143
Fixed overhead is detailed as follows:
Salary (supervisor) $24,000

Depreciation 5,000
Rent (lab facility) 26,000
Overhead is applied on the basis of direct labour hours. The rates above were computed
using 5,500 direct labour hours.
A local dental laboratory has offered to supply Powell all the crowns it needs. Its price is
$100 for porcelain crowns and $132 for gold crowns; however, the offer is conditional on
supplying both types of crowns-it will not supply just one type for the price indicated. If
the offer is accepted, the equipment used by Powell's laboratory would be scrapped (it is
old and has no market value), the lab facility would be closed and the supervisor would
be laid off. Powell uses 1,500 porcelain crowns and 1,000 gold crowns per year.
Required
1. Should Powell continue to make its own crowns or should they be purchased from
the external supplier? What is the dollar effect of purchasing?
2. Suppose that the lab facility is owned rather than rented and that the $26,000 is
depreciation rather than rent. What effect does this have on the analysis in
requirement 1?
3. Refer to the original data. Assume that the volume of crowns is 3,000 porcelain
and 2,000 gold. Should Powell make or buy the crowns? Explain the outcome.

Problem 5 Add/Drop
Sales have never been good in Department C of Staceys Department Stores, For this
reason, management is considering the elimination of the department. A summarized
income statement for the store, by departments, for the most recent month is given below:
Department
Total A B C
Sales $1,000,000 $400,000 $320,000 $180,000
Variable expenses 574,300 338,000 166,000 70,300
Contribution margin 425,700 162,000 154,000 109,700
Fixed expenses
Salaries 49,000 18,000 16,000 15,000
Utilities 6,200 2,600 2,000 1,600
Direct advertising 89,000 32,000 27,000 30,000
General advertising 1 25,000 12,500 8,000 4,500
Rent on building 2 38,000 16,000 12,000 10,000
Employment taxes 3 4,900 1,800 1,600 1,500
Depreciation of fixtures 36,000 12,000 15,000 9,000
Insurance and property taxes
On inventory and fixtures 7,900 2,300 4,000 1,600
General office expenses 54,000 18,000 18,000 18,000
Service department expenses 81,000 27,000 27,000 27,000
391,000 142,200 130,600 118,200
Net income (loss) $ 34,700 $ 19,800 $ 23,400 $ (8,500)

1
Allocated on the basis of sales dollars
2
Allocated on the basis of space occupied
3
Based on salaries paid directly in each department

The following additional information is available:

a. If department C is eliminated, the utilities bill will be reduced by $700 per month.
b. All departments are housed in the same building. The store leases the entire building
at a fixed annual rental rate.
c. One of the employees in department C is Fred Jones, who has been with the company
for many years. Mr. Jones will be transferred to another department if Department C
is eliminated. His salary is $1,000 per month. Transferring Mr. Jones to the other
department will allow that department to avoid hiring an new employee that would
have been paid $800 per month.
d. The fixtures in department C would be transferred to the other departments if
department C is eliminated. One-fourth of the insurance and property taxes in
Department C relates to the fixtures of the department.
e. The company has two service departments purchasing and warehouse.. If
Department C is eliminated, one employee in the warehouse can be discharged. This
employees salary is $800 per month. General office expenses will not change,
f. The space being occupied by department C could be subleased at a rental rate of
$48,000 per month.
g. If department C is eliminated, the company expects department As sales to increase
by 10% and department Bs sales to decrease by 5%.
Required
Do you recommend the elimination of department C. Use incremental analysis.

Problem 6 Make/Buy + Scarce Resources
Stewart Industries has been producing two bearings, components B12 and B18, for use in
production. Data regarding these two components follow:
B12 B18
Machine hours required per unit 2.5 3.0
Standard cost per unit:

Direct materials $ 2.25 $ 3.75
Direct labor 4.00 4.50
Manufacturing overhead
Variable* 2.00 2.25
Fixed** 3.75 4.50
$12.00 $15.00
* Variable manufacturing overhead is applied on the basis

of direct labor hours.
** Fixed manufacturing overhead is applied on the basis
of machine hours.
Stewart's annual requirement for these components is 8,000 units of B12 and 11,000 units
of B18. Recently, Stewart's management decided to devote additional machine time to
other product lines, with the result that only 41,000 machine hours per year can be
dedicated to the production of the bearings. An outside company has offered to sell
Stewart the annual supply of the bearings at prices of $11.25 per unit for B12 and $13.50
per unit for B18. Stewart wants to schedule the otherwise idle 41,000 machine hours to
produce bearings so that the company can minimize its costs (maximize its net benefits).
Required: Determine the combination of purchasing and manufacturing that will

maximize benefits.

Problem 7 Add/Drop
Profits have been decreasing for several years at Oceanic Airlines. In an effort to improve
the company's performance, consideration is being given to dropping several flights that
appear to be unprofitable. A typical income statement for one such flight (flight 482) is
given below (per flight):
Ticket revenue (175 seats x 40%

occupancy x $200 ticket price) $14,000 100.0%
Less variable expenses ($15 per person) 1,050 7.5
Contribution margin 12,950 92.5%
Less flight expenses:
Salaries, flight crew 1,800
Flight promotion 750
Depreciation of aircraft 1,550
Fuel for aircraft 6,800
Liability insurance 4,200
Salaries, flight assistants 500
Baggage loading and flight preparation 1,700
Overnight costs for flight crew and assistants at destination 300
Total flight expenses 17,600
Net operating loss -$4,650
The following additional information is available about flight 482:

a. Members of the flight crew are paid fixed annual salaries, whereas the flight
assistants are paid by the flight.
b. One-third of the liability insurance is a special charge assessed against flight 482
because in the opinion of the insurance company, the destination of the flight is in
a "high-risk" area. The remaining two-thirds would be unaffected by a decision to
drop flight 482.
c. The baggage loading and flight preparation expense is an allocation of ground
crews' salaries and depreciation of ground equipment. Dropping flight 482 would
have no effect on the company's total baggage loading and flight preparation
expenses.
d. If flight 482 is dropped, Oceanic Airlines has no authorization at present to
replace it with another flight.
e. Depreciation of aircraft is due entirely to obsolescence. Depreciation due to wear
and tear is negligible.
f. Dropping flight 482 would not allow Oceanic Airlines to reduce the number of
aircraft in its fleet or the number of flight crew on its payroll.
Required
Prepare an analysis showing what impact dropping flight 482 would have on the airline's
profits.

Problem 8 Special Order with a twist
Altaco, Ltd. manufactures one product in its Edmonton factory. The general manager,
Ellen Simpson, has just received a special request from a customer for 10,000 units of
this product to be produced and delivered this month. The customer has suggested a
selling price of $3.00 per unit. Simpson is unsure whether she should accept this offer.
The company normally produces and sells 50,000 units per month and capacity is at
70,000 units per month. The normal selling price is $4.00 per unit.
Simpson approached Frank Giterman, the plant accountant, with the issue. Giterman was
unable to provide a proper analysis at that time because he had a meeting to attend.
However, in quickly reviewing his files, he provided the following schedule of cost
information:
Level of Activity
(units of production per month) Average Unit Cost
40,000 $3.675
50,000 3.500
60,000 3.383
70,000 3.41
As he rushed off for his meeting, Giterman indicated that if production exceeds 62,000
units per month, an additional supervisor must be hired and costs will increase by $7,700
per month.
Required:
Note: All requirements are independent situations. Expected activity levels do not include
the 10,000 units.
1. Assume that the company already expects to be working at a level of 50,000 units
for the month. Calculate the minimum price the company could charge for this
special order without reducing its expected net income.
2. If the company expects to produce and sell 55,000 units this month, calculate the
minimum price the company could charge the customer for this special-order job
without reducing its expected net income.
3. Assume that the company expects to produce and sell 65,000 units this month.
Should the manager accept the customer's order? Support your decision with
appropriate calculations.

Problem 9 Scarce Resources
Innovate Design Inc. sells three types of heat sensitive products: Cool, Warm and Hot.
Estimated sales demand, unit selling prices and production requirements are as follows:
Cool Warm Hot

Estimated sales demand 600 500 400
Unit sales price $16 $18 $14
Production requirements per unit:
Material Y9 (in kilograms) 8 5 2
Heat sensitive paint (in litres) 6 12 18
The company has existing stocks of 300 units of Cool and 200 units of Hot, but is
adopting just-in-time inventory management and expects to reduce inventory to zero by
the end of next year.
All three products use the same direct materials. In the next year, the available supply of
materials will be restricted to 5,000 kilograms of material Y9 and 12,000 litres of heat
sensitive paint. Material Y9 costs $0.95 per kilogram and the heat sensitive paint costs
$0.50 per litre. All other costs are fixed.
Required -
Calculate the number of units of each product Innovate Design Inc. should produce next
year to maximize company profits.

Problem 10 Make/Buy
Sportway, Inc., is a wholesale distributor supplying a wide range of moderately priced

sporting equipment to large chain stores. About 60 percent of Sportway's products are
purchased from other companies, while the remainder of the products are manufactured
by Sportway. The company's Plastics Department is currently manufacturing molded
fishing tackle boxes. Sportway is able to manufacture and sell 8,000 tackle boxes
annually, making full use of its direct labour capacity at available workstations.
Following are the selling price and costs associated with Sportway's tackle boxes.
Selling price per box $86.00

Costs per box:
Molded plastic $ 8.00
Hinges, latches, handle 9.00
Direct labour ($15/hour) 18.75
Manufacturing overhead 12.50
Selling and administrative expenses 17.00 65.25
Profit per box $20.75
Because Sportway believes it could sell 12,000 tackle boxes if it had sufficient
manufacturing capacity, the company has looked into the possibility of purchasing the
tackle boxes for distribution. Maple Products, a steady supplier of quality products,
would be able to provide up to 9,000 tackle boxes per year at a price of $68 per box
delivered to Sportway's facility.
Bart Johnson, Sportway's product manager, has suggested that the company could make
better use of its Plastics Department by manufacturing skateboards. To support his
position, Bart has a market study that indicates an expanding market for skateboards and
a need for additional suppliers. He believes that Sportway could expect to sell 17,500
skateboards annually at a price of $45 per skateboard. Bart's estimate of the costs to
manufacture the skateboards follows:
Selling price per skateboard $45.00

Costs per skateboard:
Molded plastic $5.50
Wheels, hardware 7.00
Direct labor ($15/hour) 7.50
Manufacturing overhead 5.00
Selling and administrative expenses 9.00 34.00
Profit per skateboard $11.00
In the Plastics Department, Sportway uses direct labor hours as the application base for
manufacturing overhead. Included in the manufacturing overhead for the current year is
$50,000 of factory-wide, fixed manufacturing overhead that has been allocated to the
Plastics Department. For each unit of product that Sportway sells, regardless of whether
the product has been purchased or is manufactured by Sportway, an allocated $6 fixed

overhead cost per unit for distribution is included in the selling and administrative
expenses for all products. Total selling and administrative expenses for the purchased
tackle boxes would be $10 per unit.
Required
In order to maximize the company's profitability, prepare an analysis based on the data
presented that will show which product or products Sportway, Inc., should manufacture
and/or purchase. It should also show the associated financial impact. Support your answer
with appropriate calculations.
Problem 11 Relevant Costs
Fisher Manufacturing Co. produces and sells its product AA100 to well-known cosmetics
companies for $940 per ton. The marketing manager is considering the possibility of
refining AA100 further into finer perfumes before selling them to the cosmetics
companies. Product AA101 is expected to command a price of $1500 per ton, and AA102
a price of $1700 per ton. The maximum expected demand is 400 tons for AA101 and 100
tons for AA102.
The annual plant capacity of 2400 hours is fully utilized at present to manufacture 600
tons of AA100. The marketing manager proposed that Fisher sell 300 tons of AA100, 100
tons of AA101, and 75 tons of AA102 in the next year. It requires four hours of capacity
to make one ton of AA100, two hours to refine AA100 further into AA101, and four
hours to refine AA100 into AA102 instead. The plant accountant has prepared the
following cost sheet for the three products:
COSTS PER TON

AA100 AA101 AA102
Direct materials:
Chemicals and fragrance $560 $ 400 $ 470
AA100 0 800 800
Direct labor 60 30 60
Manufacturing support:
Variable 60 30 60
Fixed 120 60 120
Total manufacturing costs $800 $1,320 $1,510
Selling support:
Variable 20 30 30
Fixed 10 10 10
$830 $1,360 $1,550
Proposed sales level 300 tons 100 tons 75 tons

Maximum demand 600 tons 400 tons 100 tons

Required -
(a) Determine the production levels for the three products under the present
constraint on plant capacity that will maximize operating income.
(b) Suppose a customer is very interested in the new product AAl0l. It has offered to
sign a long-term contract for 400 tons of AA101. It is also willing to pay a higher
price if the entire plant capacity is dedicated to the production of AA101. What is
the minimum price for AA101 at which it becomes worthwhile for Fisher to
dedicate its entire capacity to the production of AA101?
(c) Suppose, instead, that the capacity can be increased temporarily by 600 hours if
the plant is operated overtime. Overtime premium payments to workers and
supervisors will increase direct labor and variable manufacturing support costs by
50% for all products. All other costs will remain unchanged. Is it worthwhile
operating the plant overtime? If the plant is operated overtime for 600 hours, what
are the optimal production levels for the three products? Show details to your
calculations.
Problem 12 CVP Analysis / Regression / Relevant Costs
The Piston Co. is a firm operating in the automotive industry. The controller had decided
to use regression analysis to predict manufacturing overhead for next year's budget.
She ran a number of regressions based on data from the company's most recent ten-year
history. Partial outputs from two of the regressions run by the controller are as follows:
First Second
Regression Regression
Dependent variable Overhead Overhead

Cost Cost
Independent variable Machine Direct

Hours Labour Hours
r2 0.72 0.94
t value 4.5 11.7
b coefficient 18.54 10.62

Required -
a) Which regression would you choose and why?
b) For inventory costing purposes, the Piston Co. used an overhead allocation rate
based on machine hours for its four main product lines. Recent gross margin
statements are as follows:
Product
A B C D
Selling price per unit $100 $115 $128 $155
Cost of goods sold:
Materials 12 16 25 30
Labor @ $16/direct labor hour 32 24 40 32
Overhead @ $20/machine hour 20 40 30 60
64 80 95 122
Gross margin per unit $ 36 $ 35 $33 $33
Using the results of the second regression run by the controller and the following
additional data, determine the number of units of each of the four product lines (at
standard mix) that the Piston Co. will need to sell in order to achieve its target of a
9% after-tax return on sales. The company's effective tax rate is 40%.
Additional data:
Fixed manufacturing overhead costs $335,000

Fixed selling costs $ 50,000
Standard product mix A:B:C:D = 3:1:2:4
(e.g., Product A accounts for 3 of every 10 company
products sold)
c) It is expected that, next year, the Piston Co.'s production capacity of 30,000
machine hours will be reached. Demand for each of the four product lines next
year is estimated as follows:
Units
A 5,000
B 1,500
C 3,500
D 7,000
Determine the optimal production strategy for the Piston Co. (i.e., how many units
of each product line should be produced and sold?). Use the data and assumptions
provided in part (b). (Ignore standard mix.)

Problem 13 Linear Programming
Iris manufacturing produces two products, X and Y. The company utilizes just-in-time
inventory techniques whereby little or no raw materials, work-in-process or finished
goods inventories are maintained. Careful planning of production schedules is required to
ensure the success of the just-in-time inventory systems.
For the month of July, the sales manager estimates that the maximum demand will be
2,500 units of product X and 2,000 units of product Y. The company's contract with its
raw materials supplier stipulates that a maximum of 32,000 kilograms of direct materials
will be delivered to Iris Manufacturing during July at a cost of $1.25 per kilogram.
Employee vacations are expected to limit direct labor to 900 hours during July at a rate of
$20.00 per hour.
Price and production data for each product are as follows:
X Y
Selling Price $30.00 per unit $32.00 per unit
Raw materials 10 kg per unit 8 kg per unit
Direct labor 12 minutes per unit 18 minutes per unit
Variable overhead $7.00 per DLH $8.50 per DLH
Required:
(a) Formulate and solve the linear programming problem required to determine the
production mix plan that will maximize the total contribution margin during the
month of July. Calculate the optimum contribution margin for July.
(b) How much of an overtime premium should Iris Manufacturing be willing to

pay per hour to increase its direct labor capacity by 50 hours in July?

Problem 14 - Uncertainty
Enrico, a renowned pastry chef employed by a four-star hotel, has decided to leave his
job at the hotel and invest $100,000 to open his own upscale pastry shop. His preliminary
investigations have uncovered the following:
i) There is a 55% chance that the market size in the area will be 600,000 pastries per
year and a 45% chance that it will be 450,000 pastries per year.
ii) The size of market share that Enrico will capture will depend on the location of his
shop. Two possibilities are available: location A, which costs $36,000 annual rent,
and location B, which costs $8,000 annual rent. It is estimated that Enrico will
capture a 30% share of the total market if he opens a shop in location A and a 21%
share of the total market if he opens a shop in location B.
The predicted market shares are based on a selling price of $2.00 per pastry. Variable
costs are estimated to be $0.80 per pastry and fixed costs, other than rent, are estimated to
be $80,000 per year at location A and $50,000 per year at location B.
Required -
a. Determine at which location Enrico should open his shop.

b. How much should Enrico be willing to pay to know with certainty the total market
size?
Problem 15 - Uncertainty
Jackson, Inc., manufactures and distributes a line of toys. The company neglected to
keep its doll house line current. As a result, sales have decreased to approximately
10,000 units per year from a previous high of 50,000 units. The doll house was recently
redesigned and is considered by company officials to be comparable to its competitors'
models. Joan Blocke, the sales manager, is not sure how many units can be sold next
year, but she is willing to place probabilities on her estimates. Blocke's estimates of the
number of units that can be sold during the next year and the related probabilities are as
follows:
Estimated
Sales in Units Probability
20,000 .10
30,000 .40
40,000 .30
50,000 .20
The units will sell for $20 each.

The entire year's sales must be manufactured in one production run. If demand is greater
than the number of units manufactured, sales will be lost. If demand is below supply, the
extra units cannot be carried over to the next season and must be discarded The disposal
costs of discarding one doll house is $2 per doll house.
Variable costs are as follows:

Manufacturing $8
Selling 2
Fixed costs are $140,000 for production volumes of 20,000 to 30,000 and $160,000 for
volumes of 40,000 and more.
The company must decide on the optimal size of the production run.
Required
1. Based on the above information, optimal size run do you recommend?

2. If the company could hire a consultant that could predict with a high degree of
accuracy what the sales in units would be, what is the most you would be willing
to pay this consultant?

Problem 16 - Budgeting
The Hurley Companys actual November and December sales and estimated sales for the
following four months as follows:
November Actual 6,700

December - Actual 9,800
January - Estimated 6,200
February 8,900
March 6,600
April 7,100
The companys inventory policy is to hold enough inventory at the end of the month to
meet 30% of next months sales requirements. Each inventory item costs $1.75. Cash
disbursement on purchases is made as follows: 40% is paid in the month of purchase and
60% is paid in the month following purchase.
Each items sells for $4.00 and cash collection patterns are as follows:
% of sales made for cash 20%
Credit sales are collected as follows -

In the month of sale 35%
In the month following sale 40%
In the second month following sale 23%
Uncollectible 2%
Required
a) Estimate the purchases (in units) for the months of January through March.
b) Estimate the cash disbursements on purchases for the months of January through
March. What is the accounts payable at the end of March?
c) Estimate the cash collections for the months of January through March. What is
the accounts receivable at the end of March?

Problem 17 - Budgeting
You are given the following information for XYZ Company.
1. Monthly Sales
November 20x1 (Actual) $100,000
December 20x1 (Actual) 150,000
January 20x2 (Forecasted) 175,000

February 20x2 160,000
March 20x2 120,000
April 20x2 100,000
2. Cash collection pattern:

30% in the month of sale
50% in the next month
18% in the month following
2% uncollected
3. Cost of goods sold = 60% of sales

Desired ending inventory = 20% of next months sales
4. Payment pattern:
40% of purchases paid in the month of purchase
60% paid next month
5. Other -
Cash in Bank, Jan 20x2 $10,000
Expected purchase of equipment in January 20x2 50,000
Dividends March 20x2 30,000
Selling and administrative expense per month, paid in month 40,000
Equipment balance as at Dec 31, 19x1 200,000
Accumulated depreciation (Straight line 10 years) 50,000
Common stock 100,000
6. The company has access to a line of credit with the bank with the
following terms:
- the interest rate is 1% per month payable on the first day of the next month,
the interest payable is calculated as 1% of the previous months outstanding
balance
- borrowings in a given month are taken out at the beginning of the month
- any repayments are made at the end of the month
7. The company wants to maintain a minimum cash balance of $10,000 at all times.

Required
a. Prepare a balance sheet as at December 31, 20x1

b. Prepare the following schedules for the first quarter of 20x2:
- Cash Collections Schedule
- Purchase Schedule
- Cash disbursement on purchases schedule
- Cash budget
c. Prepare a Statement of Income and Retained Earnings for the quarter ended
March 31, 20x2.
d. Prepare a Balance Sheet as at March 31, 20x2.
Problem 18 Linear Programming
Baxter, Inc., manufactures two industrial products, X-10, which sells for $90 a unit, and
Y-12, which sells for $85 a unit. Each product is processed through both of the
company's manufacturing departments. The limited availability of labor, material, and
equipment capacity has restricted the firm's ability to meet the demand for its products.
The production department believes that linear programming can be used to routinize the
production schedule for the two products. It has the following weekly data:
Amount Required
per Unit Weekly
X-10 Y-12
Direct material:
Supply limited to 1,800 pounds at $12 per pound 4 pounds 2 pounds
Direct labor
Department 1: Supply limited to 10 people at 40 hours 2/3 hour 1 hour
each at an hourly cost of $6
Department 2: Supply limited to 15 people at 40 hours 1.25 hours 1 hour
each at an hourly rate of $8
Machine time
Department 1: Capacity limited to 250 hours 0.5 hour 0.5 hour
Department 2: Capacity limited to 300 hours 0 hours 1 hour
Baxter's overhead costs are accumulated on a plantwide basis and are assigned to
products on the basis of the number of direct labor-hours required to manufacture the
product. This base is appropriate for overhead assignment because most of the variable
overhead costs vary as a function of labor time. The estimated overhead cost per direct
labor-hour follows:
Variable overhead cost $6

Fixed overhead cost 6
Total overhead cost per direct labor-hour $12

The production department formulated the following equations for the linear
programming statement of the problem:
A = Number of units of X-10 to be produced.

B = Number of units of Y-12 to be produced
Objective function to minimize costs: Minimize 85A + 62B
Constraints: Material 4A + 2B 1,800 pounds

Department 1 labor 2/3A + 1B 400 hours
Department 2 labor 1.254A + 1B 600 hours
Other A 0, B 0
Required
a. The formulation of the linear programming equations prepared by Baxter's

production department is incorrect. Write a brief memo to management
explaining what errors were made in its formulation.
b. Formulate and label the proper equations for the linear programming statement of
Baxter's production problem.
c. Solve the linear program.

Problem 19 Capital Budgeting
Rundle Company manufactures three different models of paper shredders including the
waste container, which serves as the base. Although each model uses a different shredder
head, the waste container is the same. The number of waste containers that Rundle will
need during the next five years is estimated as follows:
20x4 - 50,000 20x5 - 50,000 20x6 - 52,000

20x7 - 55,000 20x8 - 55,000
The equipment used to manufacture the waste container must be replaced because it has
broken and cannot be repaired. The new equipment would have a purchase price of
$945,000 with terms of 2/10, n/30; company policy is to take all purchase discounts. The
freight on the equipment would be $11,000, and installation costs would total $22,900.
The equipment would be purchased in December 20x3 and be placed into service on
January 1, 20x4. It would have a five-year economic life. This equipment is expected to
have a salvage value of $12,000 at the end of its economic life in 20x8. The new
equipment would be more efficient than the old equipment, resulting in a 25% reduction
in both direct materials and variable overhead. The savings in direct materials would
result in an additional onetime decrease in working capital requirements of $2,500 due to
a reduction in direct materials inventories. This working capital reduction would be
recognized at the time of equipment acquisition. The old equipment is fully depreciated
and is not included in the fixed overhead. The old equipment from the plant can be sold
for a salvage amount of $1,500. Rundle has no alternative use for the manufacturing
space at this time, so if the waste containers are purchased, as discussed next, the old
equipment would be left in place. Rather than replace the equipment, one of Rundle's
production managers has suggested that the waste containers be purchased. One supplier
has quoted a price of $27 per container. This price is $8 less than Rundle's current
manufacturing cost, which is as follows:


Direct labor 8
Variable overhead 6
Fixed overhead:
Supervision $2
Facilities 5
General 4 11
Total manufacturing cost per unit $35
Rundle employs a plantwide fixed overhead rate in its operations. If the waste containers
are purchased outside, the salary and benefits of one supervisor, included in the fixed
overhead at $45,000, would be eliminated. There would be no other changes in the other
cash and noncash items included in fixed overhead, except depreciation on the new
equipment. Rundle is subject to a 40% income tax rate. Management assumes that all
annual cash flows and tax payments occur at the end of the year. A 12% after-tax
discount rate is used.
Required
Rundle Company must decide whether to purchase the waste containers from an outside
supplier or to purchase the equipment to manufacture the waste containers. Calculate the
NPV of the estimated aftertax cash inflows at December 31, 20x3, and determine which
of these two options to pursue. Assume that the equipment cost is a class 8 asset - 20%.
Pilfer Limited is a manufacturer of standard and custom-designed bottling equipment.

Early in December 20x3, Lyan Company asked Pilfer to quote a price for a custom-
designed bottling machine to be delivered on April 1, 20x4. Lyan intends to make a
decision on the purchase of such a machine by January 1 so Pilfer would have the entire
first quarter of 20x4 to build the equipment.
Pilfer's standard pricing policy for custom-designed equipment is 50% markup on full
cost. Lyan's specifications for the equipment have been reviewed by Pilfer's Engineering
and Cost Accounting Departments, and they made the following estimates for raw
materials and direct labor:
Direct Materials $256,000

Direct Labour (11,000 hours at $15) 165,000
Manufacturing overhead is applied on the basis of direct labor hours. Pilfer normally
plans to run its plant with 15,000 direct labor hours per month and assigns overhead on
the basis of 180,000 direct labor hours per year. The overhead application rate for 20x4

of $9 per direct labor hour is based on the following budgeted manufacturing overhead
costs for 20x4:
Variable manufacturing overhead $ 972,000

Fixed manufacturing overhead 648,000
$1,620,000
The Pilfer production schedule calls for 12,000 direct labor hours per month during the
first quarter. If Pilfer is awarded the contract for the Lyan equipment, production of one
of its standard products will have to be reduced. This is necessary because production
levels can only be increased to 15,000 direct labor hours each month on short notice.
Furthermore, Pilfer's employees are unwilling to work overtime.
Sales of the standard product equal to the reduced production will be lost, but there will
be no permanent loss of future sales or customers. The standard product, whose
production schedule will be reduced, has a unit sales price of $12,000 and the following
cost structure:
Raw materials $2,500

Direct labour (250 hours at $15) 3,750
Overhead (250 hours at $9) 2,250
$8,500
Lyan needs the custom-designed equipment to increase its bottle-making capacity so that
it will not have to buy bottles from an outside supplier. Lyan Company requires
5,000,000 bottles annually. Its present equipment has a maximum capacity of 4,500,000
bottles with a directly traceable cash outlay of $0.15 per bottle. Thus, Lyan has had to
purchase 500,000 bottles from a supplier at $0.40 each. The new equipment would allow
Lyan to manufacture its entire annual demand for bottles at a raw material cost savings of
$0.01 for each bottle manufactured. Pilfer estimates that Lyan's annual bottle demand
will continue to be 5,000,000 bottles over the next five years, the estimated economic life
of the special-purpose equipment. Pilfer further estimates that Lyan has an after-tax cost
of capital of 15% and is subject to a 40% marginal income tax rate, the same rates as
Pilfer.
Required:
a. Pilfer Limited plans to submit a bid to Lyan Company for the manufacture of the
special-purpose bottling equipment.
1. Calculate the bid Pilfer would submit if it follows its standard pricing
policy for special-purpose equipment.
2. Calculate the minimum bid Pilfer would be willing to submit on the Lyan
equipment that would result in the same profits as planned for the first
quarter
b. What is the maximum price the Lyan company would likely pay for the machine?
In your answer, assume that the equipment will be depreciated for tax purposes as

a class 8 asset (20% d.b.) and that it will have a salvage value of $100,000 at the
end of its useful life.
DeSteur Plastics Limited (DPL) manufactures a wide range of household plastic products
for kitchens and bathrooms. The company's products are sold primarily to large retailers,
including department stores, discount chains, and grocery chains. One of DPL's products
is a line of plastic dishware that is sold prepackaged as 4-piece place settings. DPL sells
the dishes to the retailers at $8.00 per set, and has in recent years been operating at or
near the limited capacity of the equipment, which is approximately 500,000 sets per year.
The costs of producing the dishes have been determined by DPL's bookkeeper as follows:
Material $2.00 per set

Direct labour 1.60
Factor overheads:
Assignable variable .60
Allocated fixed .40
Equipment depreciation .15
Selling, delivery and administration .20
Total cost per set $4.95
The selling, delivery and administration costs are those that are identifiable with the
product, and are essentially variable.
The equipment used for the dishes is old and substantially depreciated, and will have to
be retired or replaced within the next two years. Its present book value is $130,000,
although it would probably fetch only about $15,000 scrap value (or twice that on a trade-
in). The equipment has no other uses within DPL.
A major grocery chain that is not a regular customer of DPL approaches the company in
late 20x2 and offered to buy 700,000 sets per year for at least four years to use in special
promotions commencing the following June 20x3. The additional sets would be identical
to DPL's regular line, except that the packaging would bear the grocery chain's name and
teddy bear logo. The chain proposes to buy the special sets for $5.00 per set. They would
be priced in the stores at two-thirds the price of the regular line.
Since DPL does not presently have the capacity to produce the additional sets, they
would have to buy additional dish-making capacity if the company decides to accept the
order. Rather than supplement the current capacity, DPL proposes to retire the old
equipment and to buy new equipment that has triple the capacity of the old. This would
allow for possible expansion of the regular line as well as provide the capacity for both
the regular and the special dishes.

The DPL plant manager estimates that if the new equipment is purchased, the greater
efficiency of the machine would permit a 10 percent savings in material cost and 25
percent savings in labour cost. Depreciation however, would go from $.15 per set to $.40
per set, and there would also be the added cost of the interest on the loan to buy the new
equipment. The bookkeeper has also pointed out that the fixed overhead allocation would
increase because the allocation is based partially on the cost of the equipment in use. The
estimated cost per set to produce the additional 700,000 sets is estimated as follows:
Material $1.80 per set

Direct labour 1.20
Factor overheads:
Assignable variable .50
Allocated fixed .64
Equipment depreciation .40
Selling, delivery and administration .10
Interest on loan .41
Total per set $5.05
The selling, delivery and administration cost is less per set on the special 700,000 set
order, but the cost of servicing the regular line would not change. The interest cost is 12
percent per annum on the $2,400,000 loan that would be required to purchase the new
equipment, divided by the 700,000 additional sets. The total cost of the new equipment is
$3,000,000.
Assume a weighted average cost of capital of 10%.
Required
Perform the necessary calculations to determine whether DPL should accept offer
for the 700,000 additional sets of dishes per year. Indicate what uncertainties exist and
what qualitative factors are important in this decision.
Assume a 40 percent tax rate. The new equipment is in Class 39 for CCA. The
CCA rate in Class 39 is 30 percent for 20x3, dropping to 25 percent for 20x4 and later
years. The half-year rule applies.

Mallette Manufacturing, Inc. produces washing machines, dryers, and dishwashers.

Because of increasing competition, Mallette is considering investing in an automated
manufacturing system. Since competition is most keen for dishwashers, the production
process for this line has been selected for initial evaluation. The automated system for the
dishwasher line would replace an existing system (purchased one year ago for $6
million). Although the existing system will be fully depreciated in nine years, it is
expected to last another ten years. The automated system would also have a useful life of
ten years.
The existing system is capable of producing 100,000 dishwashers per year. Sales and
production data using the existing system are provided by the Accounting Department:
Sales per year (units) 100,000

Selling price $300
Costs per unit:
Direct materials 80
Direct labor 90
Variable overhead 20
Direct fixed overhead* 40
* All cash expenses with the exception of depreciation,

which is $6 per unit. The existing equipment is being
depreciated using the straight-line method with no
salvage value considered.
The automated system will cost $34 million to purchase, plus an estimated $20 million in
software and implementation. If the automated equipment is purchased, the old
equipment can be sold for $3 million.
The automated system will require fewer parts for production and will produce with less
waste. Because of this, the direct materials cost per unit will be reduced by 25 percent.
Automation will also require fewer support activities, and, as a consequence, volume
related overhead will be reduced by $4 per unit. Direct labor is reduced by 60 percent.
Other information:
if Mallette keeps the old system, sales will drop by 20,000 units to 80,000 units
per year
the automated equipment could be sold for $4 million at the end of ten years. The
software and implementation will have zero salvage value at any time after the
implementation
the equipment of the old system would have no salvage value at the end of ten
years.

the firm's cost of capital is 12 percent.

the tax rate is 40 percent.
the CCA rate for the new system is currently 35%. It will drop to 30% in the
second year and then to 25% in years 3 and onwards.
the complete software and implementation costs are depreciated for tax purposes
over 5 years on the straight-line basis. Assume that the half-rate rule does not
apply.
the automated system will require an initial increase in working capital of
$5,000,000 followed by another increase of $2,000,000 at the end of year 5.
the automated system cost of $54,000,000 will be depreciated on a straight line
basis over 10 years
total annual fixed costs for the automated system will be $6,000,000
Required -
Do you recommend that Mallette purchase the automated system. Show detailed
calculations.

Problem 23 Process Costing (Review Problem)
Richard Chemical Company manufactures a product that requires processing in two

departments. All units from Department A are transferred to Department B. No additional
materials are added in Department B. Conversion costs are added continuously
throughout the process.
The following data pertain to the operations of Department B for the month of July:
Transferred from Department A during July: 12,000 units,

Department A costs $75,000
Conversion costs incurred during July 162,000
In process, July 1, 3,000 units, 60% complete:

Department A costs $17,300
Department B conversion costs 25,100
In process, July 31, 3,650 units, 80% complete.
Units transferred out: 11,000 units
Normal spoilage is equal to 2% of the god units transferred out. Spoilage is detected at
90% of the conversion process
Required
Calculate the cost of goods manufactured and cost of abnormal spoilage assuming that
the Richard Company uses (a) FIFO and (b) Weighted Average.

Problem 24 Cost Variances
The Lauderdale Company produces one product whose standard cost for the year 20x3
was as follows:
Direct materials (6 kg. x $9) $54.00

Direct labour (2 hours x $15) 30.00
Manufacturing overhead (2 hours x $8.90) 17.80
$101.80
The denominator level of activity is 40,000 hours and the total budgeted fixed overhead
is $212,000. The budgeted selling price of the product is $150.
At the end of 20x3, the following actual results are produced by the accounting
department:
Units produced and sold 18,000

Selling price $155
Direct labour hours 39,600
Total direct labour cost $588,060
Direct materials purchased 120,000 kg.
Direct materials opening inventory 0 kg.
Direct materials ending inventory 10,000 kg.
Average cost of direct materials purchased $9.10
Variable overhead $126,000
Fixed overhead $220,000
Required
a. Prepare a schedule showing the following: static budget, flexible budget, actual
and variance.
b. Calculate the sales volume and sales price variance.
c. Calculate the following cost variances:
i. direct materials price and quantity variance
ii. direct labour rate and efficiency variance
d. Calculate the four overhead variances and reconcile these to the over- or under-
applied overhead for the year.

Derf Company applies overhead on the basis of direct labor hours in department B. Two
direct labor hours are required for each product unit. Planned production for the period
was set at 9,000 units. Manufacturing overhead was budgeted at $135,000 for the period,
20% of this cost is fixed. The 17,200 hours worked during the period resulted in
production of 8,500 units. Variable manufacturing overhead costs incurred were
$108,500, and fixed manufacturing overhead costs were $28,000.
Required -
a. Calculate the VOH spending variance for the period.

b. Calculate the VOH efficiency variance for the period.
c. Calculate the FOH spending (budget) variance for the period.
d. Calculate the FOH production volume variance for the period.

Energy Modification Company produces a gasoline additive, Gas Gain. This product
increases engine efficiency and improves gasoline mileage by creating a more complete
burn in the combustion process. Careful controls are required during the production
process to ensure that the proper mix of input chemicals is achieved and that evaporation
is controlled. Loss of output and efficiency may result if the controls are not effective.
The standard cost of producing a 500-liter batch of Gas Gain is $135. The standard
materials mix and related standard cost of each chemical used in a 500-liter batch are as
follows:
Standard Input Standard

Quantity Price per Total
Chemical (Liters) Liter Cost
Echol 200 $.200 $ 40.00
Protex 100 .425 42.50
Benz 250 .150 37.50
CT-40 50 .300 15.00
Totals 600 $135.00
The quantities of chemicals purchased and used during the current production period are
shown in the schedule below. A total of 140 batches of Gas Gain were manufactured
during the current production period. Silly Willy, the controller of Energy Modification
Company, determines its costs and chemical usage variations at the end of each
production period.
Quantity Total Quantity

Purchased Purchase Used
Chemical (Liters) Price (Liters)
Echol 25,000 $ 5,365 26,600
Protex 13,000 6,240 12,880
Benz 40,000 5,840 37,800
CT-40 7,500 2,220 7,140
Totals 85,500 $19,665 84,420
Required
Calculate all cost variances.

Gelltite Corporation manufactures a basic line of draperies with the following standard
costs:
Direct materials (20 yards x $1.35 per yard) $27

Direct labor (4 hours x $9.00 per hour) 6
Factory overhead (applied at % of direct labor
(Ratio of variable costs to fixed costs: 2 to 1 ) 30
Total standard cost per unit of output $93
Standards are based on normal monthly production involving 2,400 direct labor hours
(600 units of output). The following information pertains to the month of July:
Direct materials purchased (18,000 yards x $1.38 per yard) $24,840

Direct materials used 9,500 yards
Direct labor (2,100 hours x $9.15 per hour) $19,215
Actual fixed factory overhead $5,836
Actual variable factory overhead 10,815
500 units of the product were actually produced in July.
Required -
a. Calculate the predetermined VOH rate per direct labor hour.

b. Calculate the budgeted FOH costs based on normal activity.
c. Calculate the direct materials price variance (isolated at time of purchase).
d. Calculate the direct materials usage variance for July.
e. Calculate the direct labor rate variance for July.
f. Calculate the direct labor efficiency variance for July.
g. Calculate the variable overhead spending variance
h. Calculate the variable overhead efficiency variance
i. Calculate the FOH production volume variance
j. Calculate the FOB budget variance
k. Calculate the over or under applied overhead and reconcile to the variances
calculated in parts (g) to (j).

Problem 28 Revenue Variances
The Siobhan Company produces and sells two product lines with the following budgeted
revenues and expenses:
X Y
Expected total industry sales (units) 76,800 136,000

Expected Siobhan Company sales (units) 7,680 34,000
Budgeted selling price per unit $160 $200
Budgeted CM/Unit $90 $125
Actual results for 20x2 included:

Actual total industry sales 100,000 145,000
Actual Siobhan Company Sales 12,000 31,900
Actual selling price (per unit) $150 $205
Required
Calculate all revenue variances.

Problem 29
Community Cable Inc. (CCI) provides cable television services to the suburban
community of Aspen View. CCI completed installation of a fibre optic network in 20x7.
With completion of the new network in mind, Jill Morley, President, had promised the
shareholders a great year. Jill just received the preliminary operating results for the fourth
quarter (see Exhibit 1). Even though the network is complete and the customer base
increased during the quarter, net income was less than expected.
Jill was concerned about the level of profitability reported during the quarter and decided
to contract with Jacques Ambrioux to provide her with the an analysis of the fourth
quarter operating results, sales variances and market competitiveness.
Required:
As Jacques Ambrioux, prepare an analysis breaking up in as much detail the variance

between the budgeted income and the actual income. Explain the reasons for each
variance.
Exhibit 1
20x7 Fourth Quarter Operating Statement
Actual Budget
Revenue1:
Regular $ 687,456 $ 668,250
Deluxe 702,576 594,000
1,390,032 1,262,250
Expenses:
Billing & collection @ $2 per customer per quarter 25,936 24,750
Program access cost - 20 basic channels @ $24 311,232 297,000
Program access cost - 5 special channels @ $18 100,368 89,100
Network maintenance & service costs 78,000 78,000
Amortization 122,000 122,000
Warranty expense 42,000 42,000
Administration 80,000 80,000
Marketing 90,000 90,000
Research and development 478,000 250,000
1,327,536 1,072,850
Income before taxes $ 62,496 $ 189,400

Note:
1. The budget is based on CCI holding a 95% market share, assuming a total market
size of 13,025 potential customers. Installation of cable lines to new subdivisions
was completed ahead of schedule increasing the market size to 14,250 potential
customers at the beginning of the quarter. The budget also assumes that 60% of
CCI's customers select the regular package and 40% select the deluxe package.
The regular cable package consists of 20 basic channels at a budgeted price of $90
per customer per quarter. The deluxe cable package features five special
entertainment channels in addition to the 20 basic channels and has a budgeted
price of $120 per customer per quarter. Prior to the fourth quarter, the CRTC
granted CCI price increases. The actual prices in the fourth quarter were $93 and
$ 126 per customer for the regular and deluxe cable packages, respectively.
Problem 30 Relevant Costs
Gardner Company has a single product called a Zet. The company normally produces and
sells 80,000 Zets each year at a selling price of $40 per unit. The company's unit costs at
this level of activity are given below:
Direct materials $ 9.50

Direct labour 10.00
Variable manutacturing overhead 2.80
Fixed manufacturing overhead 5.00 ($400,000 total)
Variable selling expenses 1.70
Fixed selling expenses 4.50 ($360,000 total)
Total cost per unit $33.50
A number of questions relating to the production and sale of Zets are given below. Each
question is independent.
Required
1. Assume that Gardner Company has sufficient capacity to produce 100,000 Zets
each year without any increase in fixed manufacturing overhead costs. The
company could increase sales by 25% above the present 80,000 units each year if
it were willing to increase the fixed selling expenses by $150,000. Would the
increased fixed expenses be justified? Use the incremental approach.
2. Assume again that Gardner Company has sufficient capacity to produce 100,000
Zets each year. The company has an opportunity to sell 20,000 units in an
overseas market. Import duties, foreign permits, and other special costs associated
with the order would total $14,000. The only selling costs that would be
associated with the order would be $1.50 per unit shipping cost. You have been
asked by the president to compute the per unit break-even price on this order.

3. One of the materials used in the production of Zets is obtained from a foreign
supplier. Civil unrest in the supplier's country has caused a cutoff in material
shipments that is expected to last for three months. Gardner Company has enough
of the material on hand to continue to operate at 25% of normal levels for the
three-month period. As an alternative, the company could close the plant down
entirely for the three months. Closing the plant would reduce fixed overhead costs
by 40% during the three-month period; the fixed selling costs would continue at
two-thirds of their normal level while the plant was closed. What would be the
dollar advantage or disadvantage of closing the plant for the three-month period?
4. The company has 500 Zets on hand that were produced last month and have small
blemishes. Due to the blemishes, it will be impossible to sell these units at the
regular price. If the company wishes to sell them through regular distribution
channels, what unit cost figure is relevant for setting a minimum selling price?
5. An outside manufacturer has offered to produce Zets for Gardner Company and to
ship them directly to Gardner's customers. If Gardner Company accepts this offer,
the facilities that it uses to produce Zets would be idle; however, fixed overhead
costs would continue at 30% of their present level. Since the outside manufacturer
would pay for all the costs of shipping, the variable selling costs would be
reduced by 60%. Compute the unit cost figure that is relevant for comparison
against whatever quoted price is received from the outside manufacturer.

Problem 31 Variable/Absorption Costing
The Loebach Corporation manufactures high quality widgets. The company uses a
standard costing system. The following data are for the year ended December 31, 20x3:
Inventory, Jan 1, 20x3 100,000 units

Inventory, Dec 31, 20x3 35,000 units
Sales 350,000 units
Selling price $35.00
Variable manufacturing costs 7.00
Variable selling costs 1.50
Fixed manufacturing overhead $1,710,000
Denominator-level direct labour hours 7,500
Standard production rate 40 units per direct labour hour
Fixed operating expenses $1,000,000
Required
Prepare income statements under variable and absorption costing for the year ended
December 31, 20x3 and reconcile the two incomes.

Problem 32 Transfer Pricing
Part A
TAA, a multidivisional telecommunications corporation, has two completely independent

profit centers considering a transfer. TAA subsidiaries operates within a decentralized
environment. TAA will not dictate transfers or impose a transfer pricing policy on the
divisions. They must be free to decide whether they should transfer, and if so, they must
negotiate a transfer price. Further, the TAA reward system must be based on the total
divisional profits reported by the profit centers.
One of TAA's divisions; Southwestern Ringer, produces telephone sets that it sells for
$30 each. The standard absorptive manufacturing cost is $24, which includes $6 per unit
in fixed overhead. The fixed overhead is allocated over its annual sales forecast of 50,000
telephone sets its maximum production capacity is 75,000, sets annually.
Another division, Northeastern Tell, can use the telephone sets in an answering machine-
telephone-radio product it markets As an alternative to buying telephone sets from
Southwestern, Northeastern can enter into a contract for the 20,000 sets needed from a
Mexican company, OLA, Inc. OLA has quoted a price of $25 per set for the same quality
telephone.
Required:
a. Determine whether a transfer should take place between Southwestern Ringer and
Northeastern Tell.
b. Should a transfer occur if Southwestern can increase sales and production
volumes to 75,000 sets annually by dropping the sales price to $27.50?

Part B
Refer to Part A. Northeastern Tell wants its name imprinted on the telephone set. Its
Mexican supplier has quoted a price of $31.00 per set. Southwestern Ringer will have to
buy a stamping machine at a net cost of $20,000. Southwestern no longer can produce at
full capacity by dropping its sales price to $27.50, so the manager has abandoned that
idea.
Required:
Determine whether there should now be a transfer. What transfer price will result in the
managers benefiting equally from the transfer?
Part C
Continuing the TAA example from the previous part, the Northeastern marketing staff
has decided against imprinting its name on the phone. However, they believe that if the
color is changed to fuchsia, 30,000 specialty phone-answering machine-radios can be
sold in the greater Toronto area. The Mexican supplier has quoted a price of $26.50 for
an order of this size due to the higher cost of fuchsin. Southwestern already produces
fuchsia-colored phones for its Vancouver market and will incur no extra costs in
changing the color.
Required:
Calculate whether this transfer should occur. If so, what transfer price will share the
differential profits equally between the two managers?
Part D
The Northeastern marketing staff has always been known for their creativity. Now they
are considering changing the color of their specialty phone product to paisley. The
Mexican supplier will not even bid on this, and no other supplier has been found.
Northeastern believes that 27,500 of these specialty phone products can be sold at $200
each in the Ottawa market. The costs to produce this product, other than the cost of the
Southwestern phone set are $183 each. Fortunately Southwestern already produces a
paisley phone for its Calgary market. While this phone's cost structure is the same as
Southwestern 's other phones it can only be sold for $200.
Required:
Determine whether a transfer is profitable for TAA. If so, suggest a transfer price that
shares TAA's differential profit 75% for Northeastern and 25% for Southwestern.

Problem 33
The Whole Company is an integrated multidivisional manufacturing firm. Two of its

divisions, Rod and Champ, are profit centres and their division managers have full
responsibility for production and sales (both internal and external). Both the Rod and
Champ division managers are evaluated by top management on the basis of total profit.
Rod Division is the exclusive producer of a special equipment component called Q-32.
Since there is no outside competition for Q-32, the Rod division manager used the results
of a market study together with statistical probability analysis to set the price at $450 per
unit of Q-32. At this price, the normal sales and production volume is 21,000 units per
year; however, production capacity is 26,000 units per year. Standard production costs
for one unit of Q-32 based on normal production volume are as follows:
Direct materials $175.00

Direct labor 75.00
Variable overhead 50.00
Fixed overhead 90.00
Total unit production costs $390.00
Champ Division produces machinery for several large customers on a contractual basis. It
has recently been approached by a potential customer to produce a specially designed
machine which would require one unit of Q-32 as its main component. The potential
customer has indicated that it would be willing to sign a long-term contract for 10,400
units of the machine per year at a maximum price of $650 per unit. Although Champ
Division has sufficient idle capacity to accommodate the production of this special
machine, the division manager is not willing to accept the contract unless he can
negotiate a reasonable transfer price with the Rod division manager for Q-32. He has
calculated that the unit costs to produce the special machine are as follows:
Direct material other than Q-32 $100.00

Direct labor 50.00
Fixed overhead 50.00
Total unit production costs before transfer of Q-32 $235.00
Required -
a) What is the maximum unit transfer price that the Champ division manager should be
willing to accept for Q-32 if he wishes to accept the contract for the special machine?
Support your answer.
b) What is the minimum unit transfer price that the Rod division manager should be
willing to accept for Q-32? Support your answer.

c) Assume that Rod Division would be able to sell its capacity of 26,000 units of Q-32
per year in the outside market if the selling price was reduced by 5%. From top
management's point of view, evaluate, considering both quantitative and qualitative
factors, whether Rod Division should lower its market price or transfer the required
units of Q-32 to Champ Division.
Problem 34
Ms. Dundee was recently promoted to the position of Executive Vice-President, Finance,
of CAM Company. Among several of her new responsibilities are (i) settling transfer
price disputes, (ii) reviewing sources, and (iii) changing the transfer price rules where
appropriate.
An immediate dispute Ms. Dundee has to settle involves two of the several divisions of
CAM Company: Engines Division and Jet Fighter Division. The Engines Division
manufactures, on a full standard manufacturing cost-plus contract basis, a special engine,
ETX, for the makers of single-engine executive jets. It has the physical capacity to
produce and sell 60 ETX engines in any given year but its actual annual capacity has
been limited to only 45 because of severe shortage of skilled labour. The standard cost of
producing one ETX engine is as follows:
Materials $ 200,000
Labour (4,000 hours) 160,000
Total manufacturing overhead 440,000
Total $ 800,000
The variable portion of the total manufacturing overhead varies directly with labour
hours. The fixed portion is based on annual fixed manufacturing overhead of $10.8
million applied on the basis of annual denominator production volume of 45 ETX
engines (or 180,000 labour hours). Annual administrative expenses of $900,000 are all
fixed. The division's only selling expenses are commissions of 2% of sales it pays to
outside sales agents. Each contract for ETX engine stipulates a selling price that
represents a mark-up of 40% over full standard manufacturing costs.
The Jet Fighter Division assembles twin-engine jet fighter planes which it sells to foreign
governments of small countries. It has been buying both the engines and the body for
these jets from outside suppliers. The manager of the Jet Fighter Division, Mr. Yankey,
has become concerned recently about the decreasing number of outside suppliers of the
engines. The outside suppliers appear to be embarking on diversification in anticipation
of reduced demand for these engines as the relations among world super powers are
expected to continue to improve. Mr. Yankey has therefore approached the manager of
the Engines Division, Mr. Maple, for a quote on 16 of these engines.
Mr. Maple feels that his division can make the necessary modifications easily to

the EXT engine to suit the needs of the Jet Fighter Division. He estimates that the
materials would be slightly different and should cost about 10% less than those used in
the EXT engine. Additional skilled labour would not be available. The present work force
would not work overtime but the necessary labour hours can be switched to work on the
new engine without any problem. Each new engine would require 3,000 labour hours.
Total manufacturing overhead, consisting of fixed and variable, would be applied at the
same rate per labour hour as on the EXT engine but in order not to lose any profit, the
mark-up on full cost would have to be at least 40%, the same as on the EXT engine.
Mr. Yankey, the manager of the Jet Fighter Division, agrees that Mr. Maple should not
lose any profit on the quote. However, he also feels that this can be accomplished if Mr.
Maple priced the new engine at its estimated variable manufacturing cost. As Mr. Yankey
sees it, the Engine Division is after all operating at only 75% of physical capacity of plant
and equipment.
Required -
(a) As an assistant to Ms. Dundee, compute the minimum price she could allow the
manager of the Engines Division to charge for each new engine his division
manufactures for the Jet Fighter Division.
(b) Does the situation in the Engines Division justify a transfer price based on
estimated variable manufacturing cost? Why or why not?
(c) What additional information would you recommend Ms. Dundee to seek before
arriving at a transfer price that will be in the overall best interest of CAM
Company? Explain.

Problem 35
Morningside Industries Limited (MIL) is a diversified corporation with separate and

distinct operating divisions. Each division is given complete autonomy in making
investment, sourcing and selling decisions and the head office intervenes only if there are
conflicts among divisions. Accordingly, each division is regarded as an investment
centre, the performance of which is evaluated on the basis of residual income. The bonus
pool for each division is 6% of divisional residual income.
Two of MIL's divisions are the Aircool and Compressor divisions. The Aircool division
manufactures and sells air conditioners. It has operated as a division of MIL for more
than 20 years during which time it has established a stable market share. The Compressor
division was formed recently through the acquisition of a small compressor
manufacturing company. It currently manufactures Model C compressors that it sells
exclusively to a large outside market. The 20x2 operating budgets for these two divisions
are presented in Exhibits 1 and 2 respectively.
The manager of the new Compressor division was not content with maintaining current
profit levels and, in an effort to find a way to increase profitability, conducted a market
research study. This study indicated the following expected sales price/volume
combinations for the Model C compressors:
Selling Price per Compressor Volume
$147 44,000
$140 55,000
$133 63,800
$130 70,400
The Aircool division manager, also searching for ways to increase divisional profits,
decided to investigate the possibility of purchasing compressors from the Compressor
division. Each air conditioner requires one Model A compressor which Aircool currently
purchases from an outside supplier at a cost of $105 per unit. Realizing that the
Compressor division currently has idle capacity, the Aircool division manager offered to
pay a transfer price of $42 per Model A compressor.
The Compressor division manager compared the costs of producing Model A

compressors versus Model C compressors. He found the following:
1. Direct labor costs per unit would be the same for both.
2. Raw material costs would be $8.00 per unit less for Model A.
3. Machine time would be 0.75 hour less (i.e., 45 minutes less) per unit for Model A.

4. The Compressor division would incur no variable selling costs for units transferred to
the Aircool division.
5. Fixed overhead and administrative expenses in 20x2 would increase by $125,130 and
$78,940 respectively for the Aircool division for handling the internal transfers.
The Compressor division manager wondered whether it would be more profitable for him
to increase his external sales volume by lowering the price of Model C compressors or to
accept the Aircool division manager's offer.
Required -
a) Assuming that the transfer price for Model A compressors would be $42 per unit,
analyze the Compressor division's options regarding internal and external sales and
determine the course of action that would optimize overall company income before
taxes and bonuses.
b) What is the minimum transfer price per unit that the Compressor division manager
would be willing to accept for Model A compressors? What is the maximum transfer
price per unit that the Aircool division manager should be willing to pay for Model A
compressors? Support your answer.

EXHIBIT 1
Aircool Division
20x2 Operating Budget
Per Unit Total
Sales volume (units) 25,000
Sales revenue $650 $16,250,000
Manufacturing costs:
Compressor (Model A) 105 2,625,000
Other direct materials 56 1,400,000
Direct labor 45 1,125,000
Variable overhead (Note 1) 72 1,800,000
Fixed overhead (Note 2) 48 1,200,000
326 8,150,000
Gross margin 324 8,100,000
Operating expenses:
Variable selling 32 800,000
Fixed selling 46 1,150,000
Fixed administrative 34 850,000
Head office expenses (Note 3) 23 575,000
135 3,375,000
Income before taxes and bonuses $189 4,725,000

Less cost of capital (15% of divisional assets) 2,385,000
Residual income $ 2,340,000
Divisional assets $15,900,000
Bonus pool (6% of residual income) $ 140,400
NOTES:
1. Variable overhead is charged at a rate of $24 per machine hour.
2. Fixed overhead is charged at a rate of $16 per machine hour based on budgeted
activity of 75,000 machine hours. Production capacity of the Aircool division is
limited to 90,000 machine hours .
3. Head office expenses are allocated to divisions on the basis of budgeted gross margin.

EXHIBIT 2
Compressor Division
20x2 Operating Budget
Per Unit Total
Sales volume (units) 55,000
Sales revenue $140 $7,700,000
Manufacturing costs:
Direct materials 18 990,000
Direct labor 12 660,000
Variable overhead (Note 1) 16 880,000
Fixed overhead (Note 2) 18 990,000
64 3,520,000
Gross margin 76 4,180,000
Operating expenses:
Variable selling 9 495,000
Fixed selling 7 385,000
Fixed administrative 8 440,000
Head office expenses (Note 3) 3 165,000
27 1,485,000
Income before taxes and bonuses $ 49 2,695,000

Less cost of capital (15% of divisional assets) 1,132,500
Residual income $1,562,500
Divisional assets $7,550,000

Bonus pool (6% of residual income) $ 93,750
NOTES:
1. Variable overhead is charged at a rate of $4 per machine hour.

2. Fixed overhead is charged at a rate of $4.50 per machine hour based on budgeted
activity of 220,000 machine hours. Production capacity of the Compressor division is
limited to 300,000 machine hours.
3. Head office expenses are allocated to divisions on the basis of budgeted gross margin.

Problem 36
Bertram Corporation manufactures a synthetic element, pixie dust. Management

expressed surprise to learn that income before taxes had dropped even though sales
volume had increased. Steps had been taken during the year to improve profitability. The
steps included raising the selling price by 12% because of a 10% increase in production
costs and instructing the selling and administrative departments to spend no more this
year than last year. Both changes were implemented at the beginning of this year.
Bertram's accounting department prepared and distributed to top management the

comparative income statements and related financial information shown below. Bertram
uses the FIFO inventory method for finished goods.
BERTRAM CORPORATION
Statements of Operating Income (in thousands)
20x1 20x2
Sales revenue $9,000 $11,200
Cost of goods sold 7,200 8,320
Manufacturing volume variance (600) 495
Adjusted cost of goods sold 6,600 8,815
Gross margin 2,400 2,385
Selling and administrative expenses 1,500 1,500
Income before taxes $ 900 $ 885
BERTRAM CORPORATION
Selected Operating and Financial Data
20x1 20x2
Sales price $10.00/kg. $11.20/kg.
Material cost $ 1.50/kg. $ 1.65/kg.
Direct labor cost $ 2.50/kg. $ 2.75/kg.
Variable overhead cost $ 1.00/kg. $ 1.10/ kg.
Fixed overhead cost $ 3.00/kg. $ 3.30/kg.
Total fixed overhead costs $3,000,000 $3,300,000
Selling and administrative (all fixed) $1,500,000 $1,500,000
Sales volume 900,000 kg. 1,000,000 kg.
Beginning inventory 300,000 kg. 600,000 kg.
Required
a. Explain verbally for management why net income decreased despite the sales
sales volume increases.

b. It has been proposed that the firm adopt variable (direct) costing for internal
purposes. Prepare the income statement for 20x1 and 20x2..
c. Present a numerical reconciliation of the difference in income before taxes using

absorption costing method as currently employed by Bertram and the variable
method as proposed for 20x1 and 20x2.
Problem 37
The Boersma Corporation has three operating divisions. The managers of these divisions
are evaluated on their divisional operating income, a figure that includes an allocation of
corporate overhead proportional to the sales of each division. The operating statement for
the first quarter of 20x0 appears below:
Division
A B C Total
Net sales (000) $2,000 $1,200 $1,600 $4,800

Cost of sales 1,050 540 640 2,230
Division overhead 250 125 160 535
Division contribution 700 535 800 2,035
Corporate overhead 400 240 320 960
Operating income $ 300 $ 295 $ 480 $1,075
The manager of Division A is unhappy that his profitability is about the same as Division
B's and much less than Division C's, even though his sales are much higher than either of
these other two divisions. The manager knows that he is carrying one line of products
with very low profitability. He was going to replace this line of business as soon as more
profitable product opportunities became available but has retained it until now, since the
line was still marginally profitable and used facilities that would otherwise be idle. The
manager now realizes, however, that the sales from this product line are attracting a fair
amount of corporate overhead because of the allocation procedure and maybe the line is
already unprofitable for him.
This low margin line of products had the following characteristics for the quarter:
Net sales (000) $800

Cost of sales 600
Escapable divisional overhead 100
Contribution $100
Thus, the product line accounted for 40% of divisional sales but less than 15% of
divisional profit.

Required:
(a) Prepare the operating statement for the Boersma Corporation for the second
quarter of 20x0 assuming that sales and operating results are identical to the first
quarter except that the manager of Division A drops the low margin product line
entirely from his product group. Is the Division A manager better off from this
action? Is the Boersma Corporation better off from this action?
(b) Suggest improvements to the Boersma Corporation's divisional reporting and
evaluation system that will improve local incentives for decision making that is in
the best interests of the firm.
Problem 38
Assume that you are managing a division that produces and sells 100,000 units every
quarter. Your production capacity is 150,000 units, but the maximum amount of
production that the market can absorb is 100,000 units per quarter.
Relevant cost data is as follows:
Selling Price $35

Variable cost per unit 20
Fixed costs per quarter $1,200,000
Net investment $10,000,000
Required -
(a) Calculate the ROI for Quarter 1.

(b) Assume that you are paid a quarterly bonus based on your abilities to maximize
ROI. Can you think of a way to increase ROI in quarter 2. Assume you intent to
resign immediately after the second quarter.
Problem 39
Assume a division with assets of $90,000, net income before taxes of $20,000 is looking
at a new investment opportunity. This new investment opportunity will increase the asset
base by $15,000 and generate net income before taxes in perpetuity of $3,000. This
amount will increase at a rate of 8% per year.
What is division management likely to do with regards to this new investment? Assume
that the corporate required ROI is 15% (also equal to its cost of capital).

Problem 40
The Shephard Company uses ROI to measure the performance of its operating divisions.
A summary of the annual reports from two divisions is shown below. The company's cost
of capital is 12%.
Division A Division B
Capital invested $2,400 $4,000

Net income $ 480 $ 720
ROI 20% 18%
Required:
(a) Which division is more profitable?

(b) At what cost of capital would both divisions be considered equally profitable?
(c) What performance measurement procedure would more clearly show the relative
profitability of the two divisions?
(d) Suppose the manager of Division A were offered a one-year project that would
increase his investment base (for that year) by $1,000 and show a profit of $150.
Would the manager accept this project if he were evaluated on his divisional
ROI? Should she accept this project?

17. Multiple Choice Questions
Week 17
Multiple Choice Questions (80 minutes)
1. Spencer Company expects to sell 60,000 units of Product B next year. Variable
production costs are $4 per unit, and variable selling costs are 10% of the selling
price. Fixed costs are $115,000 per year, and the company desires an after tax profit
of $30,000 next year. The company's tax rate is 40%. Based on this information,
the unit selling price next year should be
a) $7.00
b) $10.75
c) $7.50
d) $6.75
e) none of these
2. Operating income is shown on a cost-volume-profit chart where the

a) total variable cost line exceeds the total fixed cost line.
b) total cost line exceeds the total sales revenue line.
c) total sales revenue line exceeds the total fixed cost line.
d) total sales revenue line exceeds the total cost line.
e) total cost line intersects the total sales revenue line.
3. The following information relates to a new product that an organization plans to

introduce:
Selling price $80 per unit

Variable selling cost $5 per unit
Direct materials $25 per unit
Direct labor $10 per unit
Variable overhead $20 per unit
Fixed overhead $140,000 per year
Fixed selling expense $60,000 per year
How many units of this product must be sold each year to break even?
a) 2,500.
b) 10,000.
c) 7,000.
d) 8,000.
e) 4,444.

4. Which of the following statements is consistent with the conventional cost-volume-

profit model?
a) All costs can be divided into fixed and variable elements.
b) Costs and sales revenues are linear over a relevant range.
c) Variable costs remain constant on a unit basis.
d) All of the above.
e) b and c only.
5. Monnex Corp. sells three designs of all-weather vehicle tires: Radial, All Terrain
and Super Pro. The following represents the sales and cost information budgeted
for 1997
Radial All Terrain Super Pro
Sales price per unit $50 $100 $200
Costs per unit
Direct materials 25 50 70
Direct labour 15 15 15
Variable overhead 10 10 10
Fixed overhead* 5 5 5
55 80 100
Gross margin per unit -$5 $20 $100
* Fixed overhead per unit is based on the 1996 sales of 5,000 Radial tires,
20,000 A11 Terrain tires and 10,000 Super Pro tires.
Fixed administration costs total $150,000 in the 1997 budget. Assuming the 1996
sales mix continues, what is the breakeven volume of Radial tires?
a) Monnex Corp. cannot break even
b) 6,500 units
c) 351 units
d) 7,338 units
e) 1,049 units

The following information pertains to items 6 - 9:
Tic Toc Ltd. produces two types of clocks: a digital model and an analog model.
Budgeted sales for next year are as follows:
Digital Analog Total

Sales Volume 8,000 units 12,000 units 20,000 units
Sales Revenue $180,000 $140,000 $320,000
Total variable manufacturing costs, which are joint costs, are estimated to amount
to $ 160,000 next year and variable selling costs are estimated to amount to 5% of
sales. Budgeted fixed cost for next year are $80,000 for manufacturing overhead
and $24,000 for selling and administration. All manufacturing costs are allocated to
the two models on the basis of sales revenue. The company's effective tax rate is
30%.
6. The budgeted contribution margin percentage of sales is

a) 45% for both models
b) 59.4% for the digital model and 26.4% for the analog model
c) 25% for both models
d) 50% for both models
e) 12.5% for both models
7. Assuming the budgeted contribution margin percentage is 40% of sales for both
models, the desired total sales required to be raised by Tic Toc Ltd. to earn an after-
tax income of $70,000 is
a) $354,286
b) $453,333
c) $487,500
d) $510,000
e) $582,857
8. Assuming the budgeted dollar sales mix is maintained during the year and the
contribution margin percentage of sales is 30% for the digital model and 50% for
the analog model, how many units of each model must Tic Toc Ltd. sell during the
year to make a contribution margin of $ 164,000?
a) Digital model - 15,449 units; analog model - 10,332 units
b) Digital model - 13,667 units; analog model - 12,300 units
c) Digital model - 10,581 units; analog model - 15,871 units
d) Digital model - 9,762 units; analog model - 14,643 units
e) Digital model - 9,719 units; analog model - 16,869 units

9. Assume the budgeted dollar sales mix and the budgeted sales volume for each
model are maintained for next year. Also assume the budgeted contribution margin
is 40% of sales for both models and total fixed costs amount to $105,000 for next
year.
What is the minimum unit price for each model that should be set to earn a 7%
after-tax return on sales next year?
a) Digital model - $ 17.50/unit; analog model - $ 17.50/unit
b) Digital model - $18.46/unit; analog model - $9.57/unit
c) Digital model - $20.51/unit; analog model - $10.64/unit
d) Digital model - $22.37/unit; analog model - $11.60/unit
e) Digital model - $24.61/unit; analog model - $12.76/unit
10. When you undertake long-range cost-volume-profit analysis, step cost functions
with multiple steps may be treated as variable costs if
a) the range over which production volumes vary is wide.
b) the range over which production volumes vary is narrow.
c) the operating leverage is high.
d) the relevant range is fixed.
e) none of the above.
11. West Coast Laser (WCL) has a production capacity limit of 4,000 laser machine
hours and 1,000 image machine hours. The direct costs per hour to operate the
machines are $15 and $20, respectively. Both machines are operating at 90% of
capacity and all current production is sold at $1,500 per unit.
Each unit of output requires $250 of direct materials, 4 laser machine hours and 1
image machine hour to produce. Indirect variable overhead costs are $200 per unit,
and indirect fixed overhead costs are $225 per unit based on full capacity.
A prospective customer, Company L, has offered to buy 240 units at $1,350 per
unit. If the offer is accepted, all 240 units must be delivered by the end of the year.
WCL can lease machinery to accommodate the new customers order at a cost of
$70,000. By what amount would WCLs income change if Company Ls offer is
accepted and the machine is leased?
a) $254,000 increase.
b) $72,800 increase.
c) $106,000 decrease.
d) $90,800 increase.
e) $126,800 increase.

12. The budgeted income for RST Ltd. for next year is as follows:
Sales - 100,000 units @ $20 $2,000,000

Variable manufacturing costs $800,000
Fixed manufacturing costs 300,000
Sales commissions - $1.50 per unit 150,000
Fixed selling and administration expenses 350,000 1,600,000
Operating income $ 400,000
Assume that a regular customer has requested RST Ltd. to provide a quote for a
special order of 8,000 units. RST Ltd. has sufficient capacity to fill the order and
would be required to pay only $6,000 in sales commissions for the order. If RST
Ltd. would like the special order to make a contribution to operating income of
$28,000, the sales price per unit that should be quoted to the customer for the
special order is
a) $12.25.
b) $20.00.
c) $15.75.
d) $15.25.
e) $19.25.

The following information pertains to questions 13 - 15:
Joie Inc. produces Product X. Each unit of the product requires 0.2 hour of direct labour,
2 kilograms of material A and 1 kilogram of material B. The company has a production
capacity of 30,000 units of Product X per year, but its current production and sales are
25,000 units per year. For the current year, costs and revenues are as follows:
Price per unit of Product X $13.50

Direct labour cost per hour $15.00
Material A cost per kilogram $0.80
Material B cost per kilogram $2.40
Fixed factory overhead $50,000
Variable selling and administration costs $12,500
All other fixed expenses $37,500
13. At the current level of production, the contribution margin per unit of Product X is
a) $6.50.
b) $4.50.
c) $6.80.
d) $4.00.
e) $6.00.
14. At the current level of production, the gross margin per unit of Product X is
a) $6.00.
b) $4.50.
c) $4.83.
d) $3.00.
e) $4.00.
15. Assume that variable production costs for next year will be $8.00 per unit of
Product X and that all other costs will be the same as for the current year. If the
selling price remains at $13.50 per unit, the breakeven volume for next year would
be
a) 17,500.
b) 10,000.
c) 18,182.
d) 15,909.
e) 10,294.

16. Which of the following statements is true with regard to the profit-volume chart,
where profit represents the vertical axis and sales volume represents the horizontal
axis?
a) The slope of the profit line is affected by the products total fixed costs.
b) The slope of the profit line is not affected by the products selling price.
c) The slope of the profit line remains unchanged as the variable cost per unit
decreases, assuming the selling price and total fixed costs remain unaffected.
d) The slope of the profit line is the products contribution margin per unit.
e) None of the above.
(There is no question 17)

Questions 18 - 20 refer to the following:
The Melville Company produces a single product called a Pong. Melville has the
capacity to produce 60,000 Pongs each year. If Melville produces at capacity, the
per unit costs to produce and sell one Pong are as follows:
Direct labour 12
Variable factory overhead 8
Fixed factory overhead 9
Variable selling expense 8
Fixed selling expense 3
The regular selling price for one Pong is $80. A special order has been received by
Melville from Mowen Company to purchase 6,000 Pongs during the current year. If
this special order is accepted, the variable selling expense will be reduced by 75%.
However, Melville will have to purchase a specialized machine to engrave the
Mowen name on each Pong in the special order. This machine will cost $9,000 and
it will have no use after the special order is filled.
18. Assume that Melville can sell 54,000 units of Pong to regular customers during the
current year. At what selling price for the 6,000 special order units would Melville
be economically indifferent between accepting or rejecting the special order from
Mowen?
a) $51.50
b) $49.00
c) $37.00
d) $38.50
19. Assume Melville can sell only 50,000 units of Pong to regular customers during the
current year. If Mowen Company offers to buy the special order units at $65 per
unit, the effect of accepting the special order on Melville's net income for 1995 will
be a:
a) $60,000 increase
b) $90,000 decrease
c) $159,000 increase
d) $36,000 increase
20. Assume Melville can sell 58,000 units of Pong to regular customers during the
current year. If Mowen Company offers to buy the special order units at $70 per
unit, the effect of accepting the special order on Melville's net income for the
current year will be a:
a) $66,000 increase
b) $41,000 increase
c) $198,000 increase
d) $50,000 increase

Questions 21-22 refer to the following:
Meacham Company has traditionally made a subcomponent of its major product. Annual
production of 20,000 subcomponents resulted in the following per unit costs:
Direct materials $10.00

Direct labour 9.00
Fixed overhead 5.00
$31.50
Meacham has received an offer from an outside supplier who is willing to provide 20,000
units of this subcomponent each year at a price of $28 per subcomponent. Meacham
knows that the facilities could be rented to another company for $75,000 per year if the
subcomponent were purchased from the outside supplier
21. If Meacham decides to purchase the subcomponent from the outside supplier, how
much higher or lower will net income be than if Meacham continued to make the
subcomponent?
a) $45,000 higher
b) $70,000 higher
c) $30,000 lower
d) $70,000 lower
22. At what price per unit charged by the outside supplier would Meacham be
economically indifferent between making the subcomponent or buying it from the
outside?
a) $30.25
b) $29.25
c) $26.50
d) $31.50

23. Dunford Company produces three products with the following costs and selling
prices:
X Y Z
Selling price per unit $40 $30 $35
Variable cost per unit 24 16 20
Machine hours per unit 5 7 4
If Dunford has a limit of 30,000 machine hours but no limit on units produced, then
the three products should be produced in the order:
a) Y, Z, X
b) X, Y, Z
c) X, Z, Y
d) Z, X, Y

Week 18
The following information pertains to questions 1-3
A company manufactures two types of plastic covered steel fencing: standard and
heavy duty. Both types of fencing pass through the processes involving steel
forming and plastic bonding.
The standard type of fencing sells for $15 per roll and the heavy duty fencing sells
for $20 per roll. There is an unlimited market for the heavy duty fencing, but outlets
of the standard fencing are limited to 13,000 rolls per year. However, the factory
operations of each process are limited to 24,000 hours per year. Direct labor at $10
per hour is based on forming hours. Variable overhead is applied based on total
processing hours at $ 1 per hour. Direct materials cost $5 and $7 per roll for
standard and heavy duty fencing, respectively. Processing hours per roll are as
follows:
Forming Bonding Total

Standard 0.6 0.4 1.0
Heavy Duty 0.8 1.2 2.0
1. In determining the production mix that would maximize total contribution, which of
the following would be an appropriate constraint?
a) 0.6 standard + 0.8 heavy duty 24,000.
b) 15 standard + 20 heavy duty 13,000
c) 1.0 standard + 2.0 heavy duty 24,000
d) 1.0 standard + 2.0 heavy duty 48,000
e) 0.4 standard + 1.2 heavy duty 24,000
2. Which of the following would be an appropriate objective function in determining

the production mix that would maximize total contribution?
a) Maximize $15 standard + $20 heavy duty
b) Maximize $12 standard + $17 heavy duty
c) Maximize $3 standard + $3 heavy duty
d) Maximize $3.40 standard + $4.20 heavy duty
e) Maximize $3.60 standard + $3.80 heavy duty
3. Assume that, to maximize total contribution, the company should maximize its
production of standard fencing. How many units of heavy duty fencing can be
produced?
a) Zero
b) 5,500
c) 11,000
d) 15,666
e) 20,250

The following information pertains to questions 4 6:
Snead Company manufactures two products, Zeta and Beta, each of which passes through
two processing operations. All materials are introduced at the start of process 1. No work
in process inventories exist. Snead may produce either one product exclusively or various
combinations of both products subject to the following constraints:
Contribution
Process Process Margin
Number 1 Number 2 per Unit
Hours required to produce one unit of
Zeta 2 1 $4.00
Beta 1 3 5.25
Total capacity in hours per day 1,000 1,275
A shortage of technical labor has limited Beta production to 400 units per day. There are
no constraints on the production of Zeta other than the hour constraints in the preceding
schedule. Assume that all relationships between capacity and production are linear.
4. Given the objective to maximize total contribution margin, what is the production
constraint for process 1?
a. Zeta + Beta 1,000
b. Zeta + Beta 1,000
c. 2 Zeta + Beta 1,000
d. 2 Zeta + Beta 1,000
e. Some other answer.
5. Given the objective to maximize total contribution margin, what is the labor
constraint for production of Beta?
a. Beta 425
b. Beta 400
c. Beta 400
d. Beta 425
6. What is the objective function of the data presented? Maximum is

a. 2 Zeta + 1 Beta
b. $4.00 Zeta + $5.25 Beta
c. $400 Zeta + 3($5.25) Beta
d. 2($4.00) Zeta + 3($5.25) Beta

7. The Bergeson Company makes and sells a single product. The company reported
the following production costs for each unit of product:
Quantity Cost
Direct materials 15 kilograms $0.45 per kilogram
Direct labour 0.8 hours $12.00 per hour
Manufacturing overhead 0.8 hours ? per hour
Manufacturing overhead is applied to production on the basis of direct labour

hours. If the Finished Goods inventory on October 31 was $123,540 (6,000
units), the manufacturing overhead cost per hour was:
a) $ 4.24
b) $ 5.30
c) $17.30
d) $20.59
Questions 8-9 refer to the following
Mitchell Company had the following budgeted sales for the last half of 19x9:
Cash Sales Credit Sales

July $50,000 $150,000
August 55,000 170,000
September 45,000 130,000
October 50,000 145,000
November 60,000 200,000
December 80,000 350,000
The company is in the process of preparing a cash budget and must determine
the expected cash collections by month. To this end, the following
information has been assembled:
Collections on credit sales: 60% in month of sale 30% in month following

sale 10% in second month following sale
8. Assume that the accounts receivable balance on July 1, l9x9, was $75,000. Of this
amount, $60,000 represented uncollected June sales. Given these data, the total
cash collected during July would be:
a) $150,000
b) $235,000
c) $215,000
d) $200,000

9. What is the budgeted accounts receivable balance on December 1, l9x9?

a) $ 80,000
b) $140,000
c) $ 94,500
d) $131,300
10. Walman Company is budgeting sales of 42,000 units of product Y for March 19x3.
To make one unit of product Y, three kilograms of direct material A are required.
Actual beginning and desired ending inventories of direct material A and product Y
are as follows
March 1 March 31
Direct material A 100,000 kg 110,000 kg
Product Y 22,000 units 24,000 units
There is no work in process inventory for product Y at the beginning and end of
March. For the month of March, how many kilograms of direct material A is
Walman planning to purchase?
a) 126,000
b) 132,000
c) 136,000
d) 142,000
11. The first step in formulating next year's master budget for a manufacturing
company is to project next year's
a) capital budget to decide which production machine to buy in order to increase
productivity
b) cash budget to decide if the company needs to take out a bank loan
c) materials and labor budget to decide on next year's direct material costs and
direct labor costs
d) production budget to decide on next year's production schedule
e) sales budget to decide next year's sales volume

12. Huang Company has budgeted sales and production over the next quarter as
follows:
April May June

Sales in Units 100,000 120,000 ?
Production in Units 104,000 128,000 156,000
On April 1, the company has 20,000 units of product on hand. A minimum of 20%
of the next month's sales needs (in units) must be on hand at the end of each month.
July sales are expected to be 140,000 units. What would be the budgeted sales for
June (in units)?
a) 128,000 units.
b) 160,000 units.
c) 184,000 units.
d) 188,000 units.
13. BH Wholesalers has a sales budget for December of $800,000. Cost of merchandise
sold is expected to be 30% of sales. Sixty percent (60%) of all merchandise is paid
for in the month of purchase and the remaining 40% is paid in the following month.
The merchandise inventory balance on November 30 is $24,000 and the December
31 merchandise inventory balance is budgeted to be $30,000. The merchandise
accounts payable balance on November 30 is $102,000. The budgeted accounts
payable balance for December 31 is
a) $138,000.
b) $98,400.
c) $93,600.
d) $147,600.
e) $96,000.

The Following Data Apply to questions 14-15:
Berol Company plans to sell 200,000 units of finished product in July of 20x0 and
anticipates a growth rate in sales of 5 percent per month. The desired monthly ending
inventory in units of finished product is 80 percent of the next month's estimated sales.
There are 150,000 finished units in inventory on June 30, 20x0.
Each unit of finished product requires four pounds of direct material at a cost of $1.20 per
pound. There are 800,000 pounds of direct material in inventory on June 30, 20x0.
14. Berol Company's production requirement in units of finished product for the three-
month period ending September 30, 20x0, is
a) 712,025 units.
b) 630,500 units.
c) 664,000 units.
d) 665,720 units.
e) 862,025 units.
15. Without prejudice to your answer for question 8, assume Berol Company plans to
produce 600,000 units of finished product in the three-month period ending
September 30, 20x0, and have direct materials inventory on hand at the end of the
three-month period equal to 25 percent of the use in that period. The estimated cost
of direct material purchases for the three-month period ending September 30, 20x0,
is
a) $2,200,000.
b) $2,400,000.
c) $2,640,000.
d) $2,880,000.
e) $3,600,000.

Esplanade Company has the following historical pattern for its credit sales.
70 percent collected in month of sale

15 percent collected in the first month after sale
10 percent collected in the second month after sale
4 percent collected in the third month after sale
1 percent uncollectible
The sales on open account have been budgeted for the last six months of 20x0 as shown
below.
July $60,000
August 70,000
September 80,000
October 90,000
November 100,000
December 85,000
16. The estimated total cash collections during October 20x0 from accounts receivable
would be
a) $63,000.
b) $84,400.
c) $89,100.
d) $21,400.
e) $83,556.
17. The estimated total cash collections during the fourth calendar quarter from sales
made on open account during the fourth calendar quarter would be
a) $172,500.
b) $275,000.
c) $230,000.
d) $251,400.
e) $265,400.

Pardise Company budgets on an annual basis for its fiscal year. The following beginning
and ending inventory levels (in units) are planned for the fiscal year of July 1, 20x0,
through June 30, 20x1.
July1, 20x0 June 30, 20x1
Direct material* 40,000 50,000

Work-in-process 10,000 20,000
Finished goods 80,000 50,000
*Two (2) units of direct material are needed to produce each unit of finished product.
18. If Pardise Company plans to sell 480,000 units during the 20x0-x1 fiscal year, the
number of units it would have to manufacture during the year would be
a) 440,000 units.
b) 480,000 units.
c) 510,000 units.
d) 450,000 units.
e) 460,000 units.
19. If 500,000 complete units were to be manufactured during the 20x0-x1 fiscal year
by Pardise Company, the units of raw material needed to be purchased would be
a) 1,000,000 units.
b) 1,020,000 units.
c) 1,010,000 units.
d) 990,000 units.
e) 950,000 units.

Week 19
1. Company D is considering an investment in a new more efficient machine to replace

an existing machine to produce Product Q. Product Q is in the mature stage of its
life cycle and Company D expects to produce and sell it for only five more years.
Data pertaining to the two machines are as follows:
New Machine Existing Machine

Current cost $60,000 NA
Current disposal value $60,000 $30,000
Disposal value in five years $25,000 $10,000
Annual amortization $7,000 $4,000
Annual cash operating costs $8,000 $15,000
Other cash costs to produce Product Q $82 per unit $85 per unit
The company expects to produce and sell 2,500 units of Product Q per year for the
next five years. Its required rate of return is 12%. For tax purposes, the two
machines are considered to be in the same asset class, together with many other of
the companys assets.
Assume that neither the existing machine nor the new machine will have any
disposal value at the end of five years. Ignoring income taxes, what is the payback
period for the potential investment in the new machine?
a) 4.2 years
b) 10 years
c) 2.1 years
d) 3.8 years
e) 2.6 years
2. Ultraviolet Purifiers Ltd. purchased a patent for a new water treatment process for
$130,000. The patent has a legal life of 40 years and a terminal disposal price of nil.
Patents are Class 14 assets and the CCA is straight-line over the legal life.
Assuming the marginal tax rate is 40%, what is the effect on the company's after-
tax cash flow from the patent's CCA in the year of acquisition?
a) $650
b) $975
c) $1,300
d) $1,625

3. Garfield Inc. is considering a 10-year capital investment project with forecasted

annual cash revenues of $40,000 and forecasted annual cash operating costs of
$29,000. The initial cost of the new equipment is $23,000, and Garfield expects to
sell the equipment for $9,000 at the end of the tenth year. The equipment's CCA
rate is 20%. The project requires a working capital investment of $7,000 at its
inception and another $5,000 at the end of year 5. Assuming a 40% marginal tax
rate, the cash flow, net of income taxes, from the project for the second year is:
a) $4,116
b) $520
c) $8,256
d) $8,440
4. Which one of the following is included when calculating the cash flow in a capital
budgeting decision?
a) Depreciation on old equipment.
b) Depreciation on new equipment.
c) Net book value of old equipment.
d) Tax effect of CCA.

The following information pertains to questions 5 and 6:
LeBlanc Co. must choose between two projects, both of which require a $400,000
investment. Each project has a three-year life and yields different annual net cash flows
depending on the actions of a major competitor. Management at LeBlanc Co. has
estimated the probability of the competitor's actions and the associated net annual cash
flows for each project as follows:
Action of Project A Project B

Competitor Probability Cash Flows Cash Flows
I 20% $200,000 $500,000
II 30% $250,000 $300,000
III 50% $550,000 $200,000
5. The payback period for Project A is

a) 0.73 years
b) 1.03 years
c) 1.2 years
d) 1.6 years
e) 2.0 years
6. Assuming an after-tax cost of capital of 8%, up to how much should LeBlanc Co.
be willing to spend to know with certainty which action the major competitor will
take?
a) $193,282
b) $225,000
c) $257,700
d) $300,000
e) $644,250

Week 20
The following information pertains to questions 1-2:
Dartmouth Company uses two interchangeable raw materials, A and B, in the

manufacture of its only product, Gizbo. The standard proportions for the manufacture of
a unit of Gizbo are 2 units of A and 3 units of B. The unit standard prices of A and B are
$10 and $8, respectively. During the month of may, the company used 450 units of A and
750 units of B to produce 230 units of Gizbo.
1. The yield variance of raw materials was:

a) $450U
b) $440F
c) $450F
d) $440U
2. The mix variance of raw materials was:

a) $36.00F
b) $60.00F
c) $12.00F
d) $57.50F

The following information pertains to items 3 5:
Acme Inc. uses a standard cost system in which direct materials inventory is carried at
standard cost. The following information pertains to Acme's direct materials standards
and actual production for November:
Standard quantity of direct material per unit of output 8 kg.

Standard price per kilogram $1.80
Quantity of direct materials purchased 160,000 kg.
Actual cost of direct materials purchased $304,000
Quantity of direct materials placed into production 142,500 kg.
Units of output produced 19,000
3. The direct materials price variance for November is

a) $14,250 unfavorable
b) $15,200 unfavorable
c) $16,000 unfavorable
d) $30,400 unfavorable
e) $47,500 unfavorable
4. The direct materials efficiency (usage, quantity) variance for November is

a) $31,500 unfavorable
b) $ 14,400 unfavorable
c) $2,850 favorable
d) $17,100 favorable
e) $18,050 favorable
5. Acme's policy is to investigate only those unfavorable variances that exceed

$16,000 or 5% of standard and favorable variances that exceed $20,000 or 7% of
standard, whichever is lower. What are the upper and lower control limits for the
direct materials price variance for November?
a) Lower limit - $ 16,000 unfavorable; Upper limit - $20,000 favorable
b) Lower limit - $15,200 unfavorable; Upper limit - $20,000 favorable
c) Lower limit - $14,400 unfavorable; Upper limit - $20,000 favorable
d) Lower limit - $ 13,680 unfavorable; Upper limit - $ 19,152 favorable
e) Lower limit - $12,825 unfavorable; Upper limit - $17,955 favorable

6. A company uses an absorption-costing system with standard costs. For the year just
ended, it showed a $28,775 unfavorable production volume variance. The
unfavorable production volume variance occurred because
a) budgeted fixed production overhead was less than applied fixed production
overhead
b) budgeted fixed production overhead was less than actual fixed production
overhead
c) actual production volume was greater than denominator volume
d) actual production volume was less than denominator volume
e) both b and c above
The following information pertains to questions 7 8:
Given for Irvington Enterprises Inc.:
Budgeted industry volume in units 5,500,000

Actual industry volume in units 5,600,000
Budgeted market share percentage 16%
Actual market share percentage 15%
Budgeted average unit contribution margin $2.00
7. What is the market size variance?

a) $112,000F
b) $112,000U
c) $32,000F
d) $32,000U
8. What is the market share variance?

a) $112,000F
b) $112,000U
c) $32,000F
d) $32,000U

The following information pertains to 13 19:
Acme Beds Inc. produces two models of beds: Regular and Majestic. Budget and
actual data for 20x2 were as follows:
Budget Actual
Regular Majestic Regular Majestic
Selling price per unit $300 $800 $325 $700
Sales volume in units 4,500 5,500 7,200 4,800
Variable costs per unit $220 $590 $238 $583
Master Budget Actual

Sales revenue $5,750,000 $5,700,000
Variable costs 4,235,000 4,512,000
Contribution margin 1,515,000 1,188,000
Fixed costs 882,500 919,500
Operating income $ 632,500 $ 268,500
Market data for 20x2:

Expected total sales of beds 500,000 beds
Actual total market sales of beds 666,667 beds
9. The sales price variance is:

a) $437,500 U
b) $300,000 U
c) $50,000 U
d) $660,000 U
e) $69,000 F
10. The sales volume (activity) variance is:

a) $300,000 U
b) $250,000 F
c) $153,000 F
d) $69,000 F
e) $234,000 U
11. The sales mix variance is:

a) $303,000 F
b) $54,000 U
c) $202,000 U
d) $207,000 F
e) $234,000 U

12. The sales quantity variance is:

a) $303,000 F
b) $54,000 U
c) $202,000 U
d) $207,000 F
e) $234,000 U
13. The market share variance is

a) $303,000 F
b) $505,000 F
c) $202,000 U
d) $151,500 U
e) $132,000 U
14. The market size variance is

a) $303,000 F
b) $505,000 F
c) $202,000 U
d) $454,500 F
e) $330,000 F
15. The lower than budgeted 20x2 operating income for Acme beds was partially a
result of
a) selling less of the model with the higher contribution margin
b) decreased average contribution margin
c) increased average variable costs
d) both b and c
e) both a and b

Week 21
The following information pertains to items 1 4:
The Wye Co. Ltd. expects to produce 11,000 units of product RGW during its first
year of operations. The following standard manufacturing costs per unit were
established based on this expected production volume:

Direct labor 12
Variable overhead 11
Fixed overhead 6
Unit standard cost $42
No variable selling and administrative costs were incurred during the year. At the
end of the first year of operations, the accountant prepared income statements
utilizing actual absorption costing, normal variable (direct) costing, normal
absorption costing, standard variable (direct) costing, and standard absorption
costing. These five income statements, labelled A through E, are produced below
(in random order):
A B C D E
Sales $540,000 $540,000 $540,000 $540,000 $540,000
Cost of sales 346,500 324,000 400,500 378,000 423,000
Variances:
Direct materials - 5,000 - 5,000 -
Direct labor - 20,000 - 20,000 -
Variable overhead 15,000 15,000 15,000 15,000 -
Fixed overhead - - 10,000 10,000 -
Other costs 150,000 150,000 80,000 80,000 80,000
511,500 514,000 505,500 508,000 503,000
Operating income $ 28,500 $ 26,000 $ 34,500 $ 32,000 $ 37,000
1. Which income statement was prepared using actual absorption costing?

a) A
b) B
c) C
d) D
e) E

2. Which income statement was prepared using standard variable costing?

a) A
b) B
c) C
d) D
e) E
3. How many units of product RGW were actually sold during the year?
a) 8,357
b) 9,000
c) 9,643
d) 10,000
e) 11,000
4. How many units of product RGW were actually produced during the year?
a) 8,333
b) 9,000
c) 10,000
d) 10,667
e) 11,667
5. Mar Company has two decentralized divisions, X and Y. Division X has been
purchasing certain component parts from Division Y at $75 per unit. Because
Division Y plans to raise the price to $100 per unit, Division X desires to purchase
these parts from external suppliers for $75 per unit. The following information is
available:
Y's variable costs per unit $70

Y's annual fixed costs $15,000
Y's annual production of these parts for X 1,000 units
If Division X buys from an external supplier, the facilities Division Y uses to

manufacture these parts will be idle. Assuming Division Y's fixed costs cannot be
avoided, what is the result if Mar requires Division X to buy from Division Y at a
transfer price of $100 per unit?
a) It is suboptimal for the company as a whole because X should buy from
outside suppliers at $75 per unit.
b) It is more profitable for the company as a whole than allowing X to buy from
outside suppliers at $75 per unit.
c) It provides higher overall company operating income than a transfer price of
$75 per unit.
d) It provides lower overall company operating income than a transfer price of
$75 per unit

Questions 6-7 refer to the following:
A company has two divisions- The Hogan Division and the Jasper Division. The Hogan
Division makes and sells K7 motors which can either be sold to outside customers or to
the Jasper Division. Next month the following results are expected to occur at Hogan:
Selling price per K7 motor to outside customers $115

Unit variable production cost $ 75
Monthly capacity of K7 motors 3,500 units
Sales of K7 motors to outside customers 2,100 units
Jasper would like to buy 1,200 of these motors from Hogan next month. Hogan can
purchase these motors from an outside supplier at $110 each.
6. If Hogan sells 1,200 of the motors to Jasper next month at a price of $110 per
motor, the monthly effect on profits of the company as a whole
will be
a) $42,000 decrease
b) $42,000 increase
c) $48,000 increase
d) $48,000 decrease
e) none of these
7. Suppose sales of K7 motors to outside customers is expected to be 2,840

units next month while all other conditions remain the same. If Hogan sells 1,200
motors to Jasper next month at a price of $110 per motor, the monthly effect on
profits of the company as a whole will be
a) $42,000 decrease.
b) $42,000 increase.
c) $21,600 decrease.
d) $20,400 increase.
e) none of these
8. Last year, fixed manufacturing overhead costs were $30,000, variable production
costs were $48,000, fixed selling and administration costs were $20,000, and
variable selling administrative expenses were $9,600. There was no beginning
inventory. During the year, 3,000 units were produced and 2,400 units were sold at
a price of $40 per unit. Under variable costing, what would be the operating
income?
a) A profit of $6,000.
b) A profit of $4,000.
c) A loss of $2,000.
d) A loss of $4,400.

9. During the last year, Margot Company's total variable production costs were
$10,000, and its total fixed manufacturing overhead costs were $6,800. The
company produced 5,000 units during the year and sold 4,600 units. There were no
units in the beginning inventory. Which of the following statements is true?
a) The net income under absorption costing for the year will be $800 higher than
net income under variable costing.
b) The net income under absorption costing for the year will be $544 higher than
c) The net income under absorption costing for the year will be $544 lower than
d) The net income under absorption costing for the year will be $800 lower than
10. Under direct costing, product costs consist of

a) variable production costs.
b) variable selling costs.
c) variable and fixed production costs.
d) variable production and selling costs.
e) variable and fixed production and selling costs.

Management Accounting - Module 4
(1) CVP Analysis
CVP Analysis Exercise
Assume the following:
Selling price = $20 per unit Variable cost = $12 per unit
Fixed costs = $100,000 Current Sales Volume =
15,000 units
1. What is the breakeven point?

2. If the company desires an operating income of $50,000, how
many units must be sold?
3. Assume a tax rate of 40%, how many units must be sold if the
company desires a net income of $24,000?
CVP Analysis Exercise - contd
4. Refer to the first income statement and assume you do not have
per unit data. What sales level is required for the firm to
breakeven?
5. Refer to the original data. If sales increase by 20%, what is the
increase in operating income? What is the percentage increase in
operating income?
6. Assume the company wants to generate an operating income
equal to 20% of sales. What is the sales level required to achieve
this objective? What if the objective is to generate a net income
equal to 9% of sales?
7. The company believes that an increase in advertising expense of
$30,000 accompanied by a 5% price cut will boost sales by 40%
next year. Would you recommend they do this?
191
Jacques Maurice, 2008
Breakeven and CVP Analysis
breakeven point: the level of activity at which

total revenues equal total costs
unit sales = (fixed costs + desired NIBT) / CM

per unit
sales = (fixed costs + desired NIBT) / CM ratio
desired NIBT = desired Net Income / (1 - t)
margin of safety = current sales - breakeven sales
Multi-Product Environment
multiproduct environment: the ratio in which the products

are sold is always specified
simulate the single-product environment by:
bundling the products by their ratio and determine the

bundle CM
find the units for the bundle
unbundle into individual products
Multi-Product Example
A B C
Selling Price $150 $60 $30
Variable Cost 100 30 20
Sales Volume 2,000 6,000 10,000
Fixed Costs $256,500
1. Calculate the breakeven point in units.
2. How many units must be sold to generate an operating

income equal to 15% of sales?
192
The CVP Chart
CVP Chart: shows the relationship between

revenues, variable costs, fixed costs and net
income (loss)
volume is x-axis
$ is y-axis
the above noted lines are plotted
Major Underlying Assumptions
revenue per unit, variable costs per unit, fixed

costs are constant within the relevant range
mixed costs can be accurately separated into their
fixed and variable components
sales = production
necessary because of the allocation of fixed
costs to inventory at potentially different rates
each year
sales mix remains constant
labour, production productivity does not change
(2) Relevant Costs
193
The Special Order Pricing Decision
involves the sale of normal or customized

products at a discounted or special price
if idle capacity exists, lowest price =
variable cost of special order
+ differential fixed costs to the order/units in
special order
if idle capacity does not exist, lowest price =
above, plus
contribution forgone from normal sales that
are lost (i.e. displaced by the special order
The Special Order Pricing Decision -

contd
loss of normal customers need to be assessed

if products have short customer use life and/or repeat customers
are important, loss of normal customers may have a long-term
profitability impact
problem solving:
calculate the incremental income from the special order= CM
from special order - any differential fixed costs
if positive and does not displace regular sales, accept if it can
be contained
if positive and displaces regular sales, consider long-term
impact of lost customers
Make or Buy Decision
decision to make a fabricated part or component internally,

or to purchase it from an external supplier
qualitative factors to consider:
quality of the component
reliability of the supplier
technical capabilities of the supplier
financial strength and reputation of the supplier
availability of production capacity to manufacture the
components
194
Make or Buy Decision - contd
problem solving - compare the cost to buy with

the cost to make
cost to make =
all variable costs
any avoidable fixed costs
any opportunity costs of making the
component: alternative uses of space, lost CM
Add/Drop a Product, Service or

Department
analyze the incremental impact on profits of adding or

dropping the product, service or department
consider:
fixed cost allocations
cannibalization of existing products
alternative uses of space
problem solving: calculate the incremental income of
adding or dropping: incremental CM, avoidable fixed
costs, opportunity costs (lost CM)
The Scarce Resource Decision
involves choosing which product to produce

when there is a shortage of a resource used in
more than one product
if one resource constraint exists, then the
contribution margin per unit of constraining
factor is used to rank profitability of products
if more than one constraint, must formulate and
solve a linear programming problem
195
Scarce Resources - contd
problem solving:
calculate the contribution margin for each
product
divide by the units of scarce resource to obtain
the CM per unit of scarce resource
maximize profits by meeting demand for
products which have a higher CM/unit of
scarce resource
(3) Linear Programming
Linear Programming
used when there is more than one binding

constraint
objective function - what we want to maximize
(CM) or minimize (costs)
constraints are stated in terms of equations, i.e. -
5X + 7Y 50,000
solve by the graphical method
196
(4) Decision Analysis under Uncertainty
Uncertainty
typically involves setting up a pay-off table:
States
State 1 State 2 Expected

P=x P=1-x Payoff
Action 1
Action 2
Uncertainty Example
Jacques operates a hot dog stand on Sunday mornings in the market.

Every Friday he has to let the market management know whether or
not he will set up his stand inside or outside. If he sets up inside, the
rent is $100 for the day. If he sets up outside, the rent s $200 for the
day. Each hot dog sells for $2.00 and variable costs per hot dog are
$0.50. It is 3:00 on Friday afternoon and Jacques has one hour to
decide where the stand will be located. The Weather Networks
forecast of rain is 30% for Sunday. He estimates sales volumes to be
the following:
Rain No Rain
Inside 300 180
Outside 70 400
197
(5) Pricing
Pricing
major influences on pricing:
Customer demand
Competitors actions
Cost of the product
competitive environment: company is a price taker and will not
have much flexibility in making pricing decisions
cost based pricing:
consider fixed costs when setting long-term pricing decisions
Rationale: fixed costs are differential over the long run
beware of variable cost pricing
Target Costing
target price = the estimated price for a product that

potential customers will be willing to pay
target cost is the long-run cost of a product that when sold
enables the company to achieve targeted profits
goal: design costs out of the RD&E stage of a products life
cycle, rather than trying to reduce costs during the
manufacturing stage
once the target cost has been set, the company must
determine the target costs for each components
198
(6) Budgeting
The Master Budget
starting point: the sales forecast

cash collections schedule: collections of credit sales based
on historical cash collection patterns
inventory purchases schedule: monthly requirements =
sales (cost of goods sold)
add ending inventory requirements
less opening inventory
cash disbursement schedule - payments to suppliers based
on historical cash payment patterns
The Master Budget - contd

Cash budget -
Cash balance, beginning
Add collections
Less disbursements
= Cash Balance before financing
- Interest
Borrowings / Repayments
= Cash balance, end
proforma financial statements: income statement and balance sheet
199
(7) Capital Budgeting
Capital Budgeting
involves decisions that require an immediate

cash outlay and result in cash flows in the future
4 methods:
net present value
payback
internal rate of return
profitability index
Payback
payback: the amount of time required for an

investment to generate cash flows to recover its
initial cost
decision rule: an investment is acceptable if its
calculated payback is less than some pre-
specified number of years
200
Assessment of Payback
shortcomings:
ignores time value of money
requires an arbitrary cutoff point
ignores cash flows beyond the cut-off point
biased against long-term and new projects
advantages:
ease of use
adjusts for uncertainty of future cash flows
biased towards liquidity
Internal Rate of Return
the discount rate that makes the NPV of an

investment zero
decision rule: an investment is acceptable if the
IRR exceeds the required return; otherwise it is
rejected
Internal Rate of Return - contd
advantages:
closely related to NPV; generally leading to identical
decisions
easy to understand and communicate
disadvantages:
may result in multiple IRRs
may lead to incorrect decisions when analyzing
mutually exclusive investments
assumes cash flows are reinvested at the IRR
201
Profitability Index
the present value of an investments future cash flows divided

by its initial cost
decision rule: a project is accepted if the PI>1
advantages
closely related to NPV, generally leading to identical
decisions
easy to understand and communicate
may be useful when available investment funds are limited
disadvantage: may lead to incorrect decisions when analyzing
mutually exclusive investments
Net present value

discount all future cash flows at the companys WACC and
compare to the initial cash outflow
net present value (NPV)=
- Initial Cash Outflow + PV of future cash flows
If NPV > 0, the projects adds value and should be accepted
If NPV < 0, the project does not return the WACC and should
be rejected
working capital investments: treat as cash outflows when
investment is made, cash inflows when recovered (always assume
recovery at the end of a project)
operating cash flows are taxable, after tax value = cash flow(1 - t)
Net Present Value - contd

if the asset is subject to CCA, then it generates tax shield
Cdt 1+ 0.5k
d + k 1+ k
if the asset is eventually disposed of, some of this tax shield will
be lost because the proceeds on disposal will reduce the UCC
class:
S dt
(1+ k) n ( d + k )
working capital investments/recoveries and salvage value of

assets are not taxable/deductible
202
NPV Example 1
Assume you purchase a Class 8 asset costing $1,000,000.

a. What amount of tax shield will be available from this asset in the
first three years.
b. What is the present value of this tax shield. Assume
k=10% and t=35%.
c. Assume that at the beginning of the fourth year, the asset is sold
for $300,000. What will be the impact of this on the tax shield
calculations for this asset? Assume there are other assets left in
the class.
NPV Example 2
You invest $1,000,000 in an asset that will generate

cash flows of $200,000 per year for 10 years. The
asset is a class 8 asset (CCA rate = 20%) and the
expected salvage value if $200,000.
The asset will require an investment in working
capital of $75,000. The WACC is 12%, the tax rate
is 40%.
What is the net present value of the project?
(8) The Lease vs. Buy Decision
203
Leasing
CRA will allow a lease when the following conditions are

met:
the lessee does not automatically acquire title of the
property,
there is no bargain purchase option.
the lessee is not required to acquire the property during or
at the end of the least term.
An allowable lease means that the lease payments are
deductible for tax purposes (even though the lease may be
classified as a capital lease for accounting purposes).
Note that the capital budgeting decision to acquire the asset
has already been made. The issue is strictly one of
financing: should we buy or lease the asset.
The Net Advantage to Leasing
The net advantage to leasing (NAL) =

The cost of the asset saved (+)
The tax shield on the asset that is lost if we lease (-)
The PV of the after-tax lease payments (-)
Any other after-tax incremental cash flows ()
If the NAL >0, we should lease.
The discount rate used is the incremental borrowing rate (net
of tax)
Leasing Example
The MF Excavating Company plans to acquire a fleet of

10 dump trucks. Each truck costs $75,000. MF can
borrow $750,000 at a pretax cost of 12%. The trucks
would belong to Class 10 30%. Truck Leasing Corp.
has offered to lease the fleet of trucks to MF under a
5-year lease that calls for lease payments of $190,000.
MFs tax rate is 34%.
Should MF purchase or lease the trucks?
204
(9) Cost Variances
Static vs. Flexible Budgets
static budgets do not vary with volume

a flexible budget is a function of some measure of
volume
the static budget is re-calculated at the actual
level of volume
if there are variable costs, any comparison of
budget vs. actual must be done using the
flexible budget.
Standard Cost Systems
the standard cost card - provides the budgeted

inputs at budgeted prices required to produce
one good unit of output:
Direct materials: 3.5 kg @ $5.00 $17.50

Direct labour: 2 hours @ $14.00 28.00
Variable overhead: 2 hours @ 5.00 10.00
Fixed overhead: 2 hours @ 8.00 16.00
$71.50
205
Standard Cost Systems
all inventories are carried at standard cost:

direct materials
work-in-process
finished goods
variances between standard and actual are
written off in the period incurred against cost of
goods sold
Direct materials variances
direct materials flexible budget variance = DM

flexible budget less DM actual costs incurred
= DM Price Variance + DM Quantity Variance
DM price variance = Actual Quantity Purchased
x (Actual Price - Standard price)
the price variance measures how much more (or
less) it cost us to acquire direct materials relative
to the standard cost
Direct materials variances - contd
DM quantity variance = Standard price x (Actual Quantity

Used - Standard Quantity Allowed)
the standard quantity allowed = the actual output x the
standard input quantities allowed per unit of output
the quantity variance measures the cost incurred (or saved)
because we used more (or less) quantities of input relative
to the standard quantity allowed
206
Direct labour variances
direct labour flexible budget variance = DL

flexible budget less DL actual costs incurred
breaks out into two variances:
DL rate variance = Actual Hours x (Actual
Rate - Standard Rate)
DL efficiency variance = Standard Rate x
(Actual Hours - Standard Hours Allowed)
Variable Overhead Variances
variable overhead flexible budget variance =

VOH flexible budget less VOH actual costs
incurred
breaks out into two variances:
VOH Spending variance = Actual Hours x
(Actual Rate - Standard Rate)
VOH efficiency variance = Standard Rate x
(Actual Hours - Standard Hours Allowed)
Fixed Overhead Variances
FOH Budget Variance = FOH Budget - FOH

Actual
FOH Volume Variance = FOH Budget - FOH
Applied
if underapplied, then Unfavourable
if overapplied, then Favourable
207
(10) Revenue Variances
Sales Price Variance
The sales price variance is a flexible-budget

variance and is equal to the difference between
the actual revenues and the flexible budget
revenues
formula:
= Actual Volume x (Actual Sales Price -
Budgeted Sales Price)
Sales Volume Variance
the sales volume variance is the difference

between the static budget operating income and
the flexible budget operating income
formula:
Budgeted CM/unit x (Actual Sales Volume -
Budgeted Sales Volume)
208
Sales Volume Variance Breakdown
Sales Volume Variance
Sales Mix Variance Sales Quantity Variance
Market Share Variance Market Size Variance
Sales Volume Variance Breakdown -

contd
the sales mix variance tells us how much we gained/lost

by shifting the mix of products sold
the sales quantity variance tells us how much we
gained/lost by selling more or less quantities than
budgeted
the market size variance is how much of the sales quantity
variance is due to to a change in market size
the market share variance is how much of the sales
quantity variance is due to to a change in market share
(11) Direct and Absorption Costing
209
Absorption Costing vs. Variable Costing
Absorption Variable
Costing Costing
Direct Materials
Direct Labour
Variable manufacturing overhead
Fixed manufacturing overhead Period Cost
Absorption/Variable Costing Example
Year 1 Year 2
Production 100,000 70,000
Sales 80,000 80,000
Selling Price $100 $100

Variable Production Costs 40 40
Variable Selling Costs 10 10
Fixed Production Costs 2,975,000 2,975,000
Fixed Selling Costs $500,000 $500,000
Absorption Approach
all factory overhead (both variable and fixed) is

treated as product cost that becomes an expense
in the form of manufacturing cost of goods sold
only as sales occur
gross margin = difference between sales and cost
of goods sold
selling and administrative expenses are treated as
period expenses and deducted from gross
margin to arrive at operating income
210
Contribution Approach
all variable costs (both manufacturing and selling

and administrative) are deducted from sales to
result in contribution margin
fixed expenses are deducted from the
contribution margin to arrive at operating
income
costs are classified according to behaviour
Variable (Direct) Costing
all fixed costs are written off against income in

they year they are incurred
treated as period costs
advantages:
eliminates distortions to income and product
costs when volume changes
reduces the dysfunctional incentives to
overproduce
Variable (Direct) Costing - contd
problems
determination of what is fixed and variable is
subject to manipulation
produces misleading cost figures, i.e. ignore
fixed costs and managers will have incentives
to overconsume fixed resources
not used for financial reporting
211
(12) Transfer Pricing
Transfers from Cost Centres

transfer cost = value used in the accounting system to record required
transfers from production cost centers
transfer cost should be based on standard absorptive cost:
if transfer is at actual cost, it becomes difficult to evaluate managers
performance
in actual cost transfers, the manager of the selling division has no
incentive to control costs
absorptive cost (vs variable) is used to ensure that an adequate
markup and sales price result
use or market price as a transfer cost should be discouraged in transfers
from cost centres
Transfers from Profit Centres
policy question: should divisions be able to source externally

when internal goods are available?
operational question: at what price should transfers be made?
if transfers are required or if managers are not evaluated on
income resulting from transfers, then they should be recorded at
standard absorptive cost
this implies treating the supplying division as a cost centre
with respect to the intermediate product transferred
212
Transfers from Profit Centres - contd
when transfers are optional (at either the supplying or

purchasing divisions discretion), transfers should take
place if they create a differential profit for the
company as a whole
maximum (ceiling) transfer price is the maximum
price the purchasing division is willing to pay
maximum transfer price = external selling price less
any costs associated with the transfer
minimum (floor) transfer price is the minimum

acceptable price the selling division is willing to
accept and is equal to the price that will make the
division as well off before and after the transfer
minimum transfer price
= variable cost of making the internal transfer
+ opportunity cost of making the transfer (lost sales)
+ any incremental costs of transferring

if maximum > minimum, then a range of transfer prices exist and it can be
shown that transfers will result in a differential profit to the company
question to be resolved is where to set the transfer price:
if set at the minimum, all differential profits are allocated to the purchasing
division
if set at the maximum, all differential profits are allocated to the selling
division
any transfer price within the range will result in splitting the differential
profit between the two division
where the transfer price settles is a matter of negotiation between the
divisions
213
Transfer Pricing Example
A company has many divisions, two of which are the engine and the
Boat division. Data for these two divisions are as follows:
Engine Division Boat Division
Capacity 50,000 Production 17,000

Production 40,000 Selling Price $27,000
Selling Price $500 Variable costs* 17,000
Variable Costs $300 * Includes engine purchased
externally at a cost of $480
Fixed Costs $5M
Calculate the minimum and maximum transfer price.
Negotiated Transfer Prices

to be successful the following conditions must exist:
all market and cost information must be shared
support from top management in the form of arbitration (when
required)
limitations:
time consuming
leads to conflicts between divisions
makes the measurement of divisional profitability sensitive to the
negotiating skills of managers
requires top management time to oversee the negotiating process and
to mediate disputes
Multinational Transfer Pricing
must consider the following additional factors:

taxation: if goods are transferred to a country
which has a higher corporate tax rate, a company
has an incentive to use a high transfer price
customs duties: minimization of transfer price
income or dividend repatriation restrictions:

maximization of transfer price
214
Multinational Transfer Pricing - contd
multinational issues result in a setting of an external

transfer price that minimize the overall tax burden
while operating within the laws of the countries
concerned
these multinational issues have no bearing on the
setting of transfer prices for internal decision making
purposes
Multinational TP Example
A Canadian Company has two divisions - one

located in Canada and the other in Timbucktwo.
The Canadian division transfers products to the
Timbucktwo subsidiary. The tax treaty between
the two countries stipulates that transfers can be
between full absorption cost and 150% of full
absorption cost. The Canadian corporate tax rate
is 36%. The Timbucktwo tax rate is 25% and the
duty is 15%.
What transfer price should be set - full absorptive
cost or 150% of full absorption cost?
(13) Performance Evaluation For Profit

Organizations
215
Responsibility Centres
defined: an organizational unit that is headed by

a manager
in essence:
Inputs Outputs
Work
Resources used, Goods or Services
measured by cost
Capital
Relationship between Inputs and

Outputs
managements responsibility is to obtain the

optimum relationship between inputs and
outputs
this relationship can be causal and direct
i.e. a production department
or indirect
i.e. advertising department, R&D
Efficiency and Effectiveness
both used as a criteria for judging the performance of a

responsibility centre
both terms are almost always used in a comparative sense,
rather than in an absolute sense
efficiency: ratio of outputs to inputs, or amount of output
per unit of input (do things right)
effectiveness: the relationship between a responsibility
centres outputs and its objectives (do the right things)
216
Decentralization - Pros
greater responsiveness to customer needs

quicker decision making
increased motivation
management development and learning
sharpens the focus of managers
Decentralization - Cons
leads to dysfunctional decision making

duplication of activities
decreases loyalty towards the organization as a
whole
increases the cost of gathering information
Standard Cost Centers
can be established whenever we can define and

measure output well and can specify the amount
of inputs required to produce each unit of output
manager is not held responsible for variations in
activity levels - usually externally determined
manager is held responsible for the effectiveness
with which externally determined demands are
met and by how efficient the cost centre is
217
Standard Cost Centers - contd
efficiency is evaluated by the measured relation

between inputs and outputs
effectiveness is evaluated by whether the center
achieved the desired level of production schedule
at specified levels of quality and timeliness
decisions as to selling price of output, output
quantity, product mix, plant equipment and
technology are made externally
Discretionary Expense Centers
appropriate for units that produce outputs that are

not measurable in financial terms or,
for units where no strong relationship exists between
resources expended (inputs) and resources achieved
(outputs)
consists of accounting, legal, HR, R&D and most marketing
functions
because of the weak relationship between inputs and
outputs, we are unable to determine whether they are
operating efficiently
Discretionary Expense Centers -

contd
most common measure of performance: the budget

what is the optimal budget level?
budget is negotiated on the basis of what is needed to
achieve specific goals
deviations from budget need to be analyzed
variance is not a measure of efficiency, but rather the
difference between the budgeted input and the actual
input -> it in no way measures the value of the output
218
Revenue Centers
typical center acquires finished goods from a

manufacturing division and is responsible for
selling and distributing these goods
some notion of the cost of each product should be
included so that the center is motivated to
maximize contribution margin rather than just
sales revenues
Profit Centers
managers can make decisions about which

products to manufacture, how to produce them,
the quality level, the price and the selling and
distribution system
profit is the single best performance measure
supplemented by a variety of nonfinancial
indicators of short-term and long-term
performance
Investment Centers
profit center situation + responsibility and

authority for working capital and physical assets
performance measure based on the level of
physical assets employed is preferred ->
profitability is related to the assets used to
generate the profit
ROI and Residual Income are the most
commonly used performance measures
219
Investment Centers -
Measures of Performance Evaluation
Return on Investment
ROI = Income / Investment
= Revenue / Investment x Income / Revenue
most popular measure
asset turnover tells us how many revenue dollars
are generated by each dollar of investment
return on sales tells us how much of each dollar
of revenue goes into income
Investment Centers - Measures of

Performance Evaluation - contd
Return on Investment - Technical Limitations

actions that increase the divisional ROI can make
the corporation worse off and, actions that
decrease divisional ROI can increase the
economic wealth of the corporation
in general, any project or asset whose returns is
below the average ROI will be a candidate for
disposal or will not be recommended for
funding, since its inclusion in the investment
base lowers the divisional ROI measure

Residual Income (EVA)
an explicit cost of capital is specified for the division and applied
to the divisions investment base to obtain a capital charge for
the division
the capital charge is subtracted from net income before taxes,
remainder is called residual income
eliminates the technical limitations found in ROI
more flexible since different percentages can be applied to
investments of different risks
less convenient than ROI since it is an absolute number
220

Residual Income - contd

companies using RI will usually not simply
direct managers to maximize RI but will set
targeted level of RI, appropriate for the asset
structure and business risk of each division
few companies use it
221

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CMA Ontario

CMA Ontario January 2008

4. Decision Analysis under Uncertainty 3 28

7. Capital Budgeting 21-22 39

8. The Lease vs. Buy decision - 50

9. Cost Variances 7-8 54

10. Revenue Variances 16 69

11. Direct and Absorption Costing 9 80

12. Transfer Pricing 23 88

13. Performance Evaluation For Profit Organizations 24 97

14. In-Class Problems 109

15. Multiple-Choice Questions 161

16. Powerpoint Slides 191

Page 2 CMA Ontario January 2008

1. Increase in CM = $2,160,000 x 10% = $216,000

2. Decrease in CM = $2,160,000 x 10% = $216,000

3. Increase in fixed costs = $2,040,000 x 5% = $102,000

4. Decrease in fixed costs = $2,040,000 x 5% = $102,000

5. Note that if units sold increase by 8%, then total contribution

Increase in CM = $2,160,000 x 8% = $172,800

6. Decrease in CM = $2,160,000 x 8% = $172,800

7. Increase in CM = $2,160,000 x 10% = $216,000

8. New variable costs = $9,840,000 x 0.95 = $9,348,000

Page 3 CMA Ontario January 2008

Contribution margin per unit

a) Breakeven point = $4,200,000 / 16.62 = 252,708 copies

b) ($4,200,000 + 2,400,000) / 16.62 = 397,112 copies

3. a) Contribution margin per unit

Breakeven point = $4,200,000 / 19.68 = 213,415 copies

b) Contribution margin per unit

Breakeven point = $4,200,000 / 23.76 = 176,768 copies

Page 4 CMA Ontario January 2008

1. CM/unit = $54 36 = $18

2. Operating income = (40,000 x $18) CM (800 x $72) Shipping - $288,000 FC

3. Costs to be recovered = (500 x $72) Shipping + $288,000 FC = $324,000

4. For example, if Susan incurred 1,500 shipments, then

Page 5 CMA Ontario January 2008

1a. Fixed costs

Contribution margin/participant = 312 30 42 = 240

1b. Breakeven point = 12,000 / 240 = 50

2. 2005 = (240 x 60) 12,000 = 2,400 x 50% = 1,200

3. This question raises a broad set of issues:

Page 6 CMA Ontario January 2008

1. CM/unit = $36.00 25.20 = $10.80

Breakeven units = $432,000 / $10.80 = 40,000

2. (35,000 x $10.80) Total CM - $432,000 Fixed Costs = ($54,000)

3. New CM/unit = $10.80 + 1.80 = $12.60

Breakeven units = $529,200 / $12.60 = 42,000

4. New CM/unit = $10.80 0.36 = $10.44

Breakeven units = $432,000 / $10.44 = 41,380

5. Operating income = 10,000 Pairs above breakeven x $10.44 = $104,400

Page 7 CMA Ontario January 2008

1. Commission operating income equation: $10.80x - $432,000

Equating the two we get: $10.80x - $432,000 = $12.60x - $529,200

2. Commission Fixed Salary

60,000 units $10.80(60,000) - $432,000 $12.60(60,000) - $529,200

3. Commission plan: ($432,000 + 201,600) / $10.80 = 58,667 units

Page 8 CMA Ontario January 2008

1. CM on first 48,000 units: 48,000 x $10.80 $518,400

2. $80,640 + 5,760 = $86,400

48,000($36.00 X - $1.80) 432,000 = 80,640

Page 9 CMA Ontario January 2008

1. Sales Mix = 3 Standard : 1 Deluxe