Test Bank For Accounting for Decision Making and Control 8th Edition by Jerold Zimmerman

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Test Bank For Accounting for Decision Making and Control 8th Edition by Jerold Zimmerman

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WITH ANSWERS
Accounting for Decision Making and Control 8th Edition by Jerold Zimmerman  
Test Bank 

 

Chapter 02

The Nature of Costs

 

Multiple Choice Questions

1. Opportunity Costs:

A. must never be negative

 

B. may be found in financial statements (annual report)

 

C. reflect the benefit of the next best alternative

 

D. are pecuniary in nature

 

E. none of the above

 

2. John invested $12,000 in the stock of Hyper Cyber Eight years later, Hyper Cybers shares reached $125,000, but John held onto the shares in the belief that their price would double in the next five years. Unfortunately, Hyper Cyber did not double. Rather the market value of Johns shares today is $4,000. If the shares were sold and the proceeds invested in another investment, they would likely earn 5% per annum. Which of the following terms and values is correct?

A. $125,000 is the opportunity cost of selling the shares today

 

B. $12,000 is a sunk cost

 

C. $250,000 is the opportunity cost

 

D. $2000 is the opportunity cost

 

E. None of the above

 

3. Which of the following can be an opportunity cost?

A. Interest on cost of inventory

 

B. Cost of idle capacity

 

C. Cost of underutilized labor

 

D. The decline in an assets value

 

E. All of the above

 

4. Davos Inc. makes fiberglass ski-boards in Switzerland. Identify the correct matching of terms.

A. Fiberglass is factory overhead

 

B. Plant real estate taxes are a period cost

 

C. Depreciation on delivery trucks is a product cost

 

D. Payroll taxes for workers in the Packaging Department are direct labor

 

E. None of the above

 

5. Pamela in Bamplona makes bull-repellent scent according to a traditional Spanish recipe, which normally sells at 9 (Euros) per unit. Normal production volume is 10,000 ounces per month. Average cost is 5 per ounce, of which 2 is direct material and 1 is variable conversion cost. This product is seasonal. After July, demand for this product drops to 6,000 ounces monthly. In November, Umberto offers to buy 1,500 ounces for 6,000.

If Pamela accepts the order, she must design a special label for Umberto at a cost of 500. Each label will cost 25 cents to make and apply. Pamela should:

A. accept the order, at a gain of 625

 

B. reject the order, at a loss of 1,875

 

C. reject the order, at a loss of 2,375

 

D. accept the order, at a gain of 1,125

 

E. none of the above

 

6. Pamela in Bamplona makes bull-repellent scent according to a traditional Spanish recipe, which normally sells at 9 (Euros) per unit. Normal production volume is 10,000 ounces per month. Average cost is 5 per ounce, of which 2 is direct material and 1 is variable conversion cost. This product is seasonal. After July, demand for this product drops to 6,000 ounces monthly. In November, Umberto offers to buy 1,500 ounces for 6,000.

Now assume that the order is received in July, peak season. If Pamela accepts the order, she will turn away regular customers who order 500 ounces. Pamela should:

A. reject the order, which loses 1,875

 

B. reject the order as it is less than her cost

 

C. accept the order if Umberto raises the price higher than 6.58/ounce

 

D. accept the order if Umberto raises the price higher than 5.58/ounce

 

E. none of the above

 

7. Francois French manufactures cheese, which he normally sells at 20/kg, on which sales commission of 5% is paid. Plant capacity is 7,500 kg/month. Income tax is levied at 30%.

Fixed costs Costs per kg.
Plant depreciation 8,000 Direct materials 4
Other plant costs 15,000 Direct labor 2
Corporate salaries 10,000 Var. factory O/H 3
Advertising 3,000    

The number of kilograms to sell to break-even is:

A. 3,273

 

B. 3,600

 

C. 3,000

 

D. 2,300

 

E. none of the above

 

8. Francois French manufactures cheese, which he normally sells at 20/kg, on which sales commission of 5% is paid. Plant capacity is 7,500 kg/month. Income tax is levied at 30%.

Fixed costs Costs per kg.
Plant depreciation 8,000 Direct materials 4
Other plant costs 15,000 Direct labor 2
Corporate salaries 10,000 Var. factory O/H 3
Advertising 3,000    

If sales are 5,000 kgs, which of the following is true?

A. Total contribution margin is 50,000

 

B. Ratio of total contribution margin to net income before taxes is 3.57

 

C. Taxes payable are 4,200

 

D. Operating leverage is 42%

 

E. All of the above

 

9. Francois French manufactures cheese, which he normally sells at 20/kg, on which sales commission of 5% is paid. Plant capacity is 7,500 kg/month. Income tax is levied at 30%.

Fixed costs Costs per kg.
Plant depreciation 8,000 Direct materials 4
Other plant costs 15,000 Direct labor 2
Corporate salaries 10,000 Var. factory O/H 3
Advertising 3,000    

Francois French wants to increase after-tax profits to 35,000. Assuming sufficient demand, which strategy achieves this goal?

A. Sell 7,100 kgs at the present price

 

B. Pay the dairy 1/kg less and sell 7,500 kgs

 

C. Sell 8,000 kgs at 20.79/kg

 

D. Sell 7,500 kgs at the present price and eliminate the sales commission

 

E. None of the above

 

10. The Mojave Water Agency (MWA) sets water policy and water rates for a desert area that faces a severe water shortage. It has 200,000 customers who are charged $100 per month for the first 20,000 cubic feet (cu.ft) and 1 cent per cu.ft thereafter. The average customer bill is $200 per month. It costs the agency cent per cu.ft to monitor and bill for usage. The MWA wants to cut costs by replacing metered billing with a flat fee which would be added to each property owners real estate tax bill. Which is true?

A. The proposed policy will be more expensive to operate and will lead to decreased water usage

 

B. The proposed policy will be cheaper to operate and will lead to increased water usage

 

C. The proposed policy will be cheaper to operate and will lead to decreased water usage

 

D. The most that the MWA should pay the County Real Estate Department for handling the proposed billing process is $6,000,000

 

E. b) and d) above

 

11. Hardley sells mamburgers. He faces fixed costs of $18,000 per month and variable production and marketing costs of $2 per mamburger. Market research has developed the following demand schedule. Which price/volume combination should Yardley choose?

A. Price: $12; Quantity: 4,000

 

B. Price: $10; Quantity: 5,500

 

C. Price: $8; Quantity: 7,000

 

D. Price: $6; Quantity: 9,000

 

E. Unable to determine

 

12. Berties Burritos, a fast food enterprise, wants to understand his cost structure. He collected data, which appears below, to analyze costs using the high-low method.

Month Volume Total costs
January 5,000 $2,700
February 7,000 $3,700
March 6,000 $3,400

Which is true?

A. Estimated variable costs are 70 cents per burrito

 

B. Fixed costs cannot be estimated

 

C. Estimated fixed costs are $200

 

D. Total costs at volume of 8,000 are estimated at $4,200

 

E. c) and d) only

 

 

Essay Questions

13. Fixed, Variable, and Average Costs

Midstate University is trying to decide whether to allow 100 more students into the university. Tuition is $5,000 per year. The controller has determined the following schedule of costs to educate students:

Number of Students Total Costs
4,000 $30,000,000
4,100 30,300,000
4,200 30,600,000
4,300 30,900,000

The current enrollment is 4,200 students. The president of the university has calculated the cost per student in the following manner: $30,600,000/4,200 students = $7286 per student. The president was wondering why the university should accept more students if the tuition is only $5,000.

Required:

a. What is wrong with the presidents calculation?
b. What are the fixed and variable costs of operating the university?

 

 

 

 

14. The Elements of Cost Volume Profit

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

 

 

 

 

15. Opportunity Costs

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

 

 

 

 

16. Fixed and Variable Costs:

The university athletic department has been asked to host a professional basketball game at the campus sports center. The athletic director must estimate the opportunity cost of holding the event at the sports center. The only other event scheduled for the sports center that evening is a fencing match that would not have generated any additional costs or revenues. The fencing match can be held at the local high school, but the rental cost of the high school gym would be $200. The athletic director estimates that the professional basketball game will require 20 hours of labor to prepare the building. Clean-up depends on the number of spectators. The athletic director estimates the time of clean-up to be 2 minutes per spectator. The labor would be hired especially for the basketball game and would cost $16 per hour. Utilities will be $500 greater if the basketball game is held at the sports center. All other costs would be covered by the professional basketball team.

Required:

a. What is the variable cost of having one more spectator?
b. What is the opportunity cost of allowing the professional basketball team to use the sports center if 10,000 spectators are expected?
c. What is the opportunity cost of allowing the professional basketball team to use the sports center if 12,000 spectators are expected?

 

 

 

 

17. Opportunity Cost of Attracting Industry

The Itagi Computer Company from Japan is looking to build a factory for making Wi-Fi routers in the United States. The company is concerned about the safety and well-being of its employees and wants to locate in a community with good schools. The company also wants the factory to be profitable and is looking for subsidies from potential communities. Encouraging new business to create jobs for citizens is important for communities, especially communities with high unemployment.
Wellville has not been very well since the shoe factory left town. The city officials have been working on a deal with Itagi to get the company to locate in Wellville. Itagi officials have identified a 20 acre undeveloped site. The city has tentatively agreed to buy the site for $50,000 for Itagi and not require any payment of property taxes on the factory by Itagi for the first five years of operation. The property tax deal will save Itagi $3,000,000 in taxes over the five years. This deal was leaked to the local newspaper. The headlines the next day were: Wellville Gives Away $3,000,000 + to Japanese Company.

Required:

a. Do the headlines accurately describe the deal with Itagi?
b. What are the relevant costs and benefits to the citizens of Wellville of making this deal?

 

 

 

 

18. Cost, Volume, Profit Analysis

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

Build Factory A with annual fixed costs of $20 million and variable costs of $0.10/board foot. This factory has an annual capacity of 500 million board feet.
Build Factory B with annual fixed costs of $10 million and variable costs of $0.12/board foot. This factory has an annual capacity of 300 million board feet.

Required:

a. What is the break-even point in board feet for Factory A?
b. If the company wants to generate an after tax profit of $2 million with Factory B, how many board feet would the company have to process and sell?
c. If demand for lumber is uncertain, which factory is riskier?
d. At what level of board feet would the after-tax profit of the two factories be the same?

 

 

 

 

19. Cost, Volume, Profit Analysis

Leslie Mittelberg is considering the wholesaling of a leather handbag from Kenya. She must travel to Kenya to check on quality and transportation. The trip will cost $3,000. The cost of the handbag is $10 and shipping to the United States can occur through the postal system for $2 per handbag or through a freight company which will ship a container that can hold up to a 1,000 handbags at a cost of $1,000. The freight company will charge $1,000 even if less than 1,000 handbags are shipped. Leslie will try to sell the handbags to retailers for $20. Assume there are no other costs and benefits.

Required:

a. What is the break-even point shipping through the postal system?
b. How many units must be sold if Leslie uses the freight company and she wants to have a profit of $1,000?
c. At what output level would the two shipping methods yield the same profit?
d. Suppose a large discount store asks to buy an additional 1,000 handbags beyond normal sales. Which shipping method should be used and what is the minimum sales price Leslie should consider in selling those 1,000 handbags?

 

 

 

 

20. Multiple Product Cost Volume Profit

A company sells three products as shown below:

  Product X Product Y Product Z Total
Units 60,000 140,000 50,000 250,000
Sales $90,000 $150,000 $60,000 $300,000
Variable Costs $63,000 $93,000 $19,000 $175,000
Contribution Margin       $125,000
Fixed Costs       $100,000

These three products all always sold in fixed proportions. In other words, Product X always accounts for 24% of total sales (60,000/250,000), Product Y always accounts for 56% of total sales (140,000/250,000), and Product Z always accounts for 20% of total sales (50,000/250,000).

Required:

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

 

 

 

 

21. Make or Buy

A company needs 10,000 units of a component used in producing one of its products. The latest internal accounting reports show that the per unit manufacturing cost to be $150.00, variable manufacturing costs of $110.00 and fixed manufacturing cost of $40. The company recently received an offer from another manufacturer to produce the component for $144.00. If it buys the component on the outside 40% of the fixed manufacturing cost can be avoided.

Required:

a. If the company buys the component from the outside supplier at $144.00, what is the impact on income?
b. What price would make the company indifferent between making the component internally and having the outside supplier make it?

 

 

 

 

22. Cost, Volume, Profit Analysis

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

  Weeders Hedge Clippers Leaf
Blowers
Unit sales 50,000 50,000 100,000
Unit selling price $28.00 $36.00 $48.00
Variable manufacturing cost per unit 13.00 12.00 25.00
Variable selling cost per unit 5.00 4.00 6.00

For the next year, Easy Gos fixed factory overhead is budgeted at $2 million, and the companys fixed selling and administrative expenses are forecast to be $600,000. Easy Go has a tax rate of 40 percent.

Required:

a. Determine Easy Go Co.s budgeted net income for next year.
b. Assuming that the sales mix remains as budgeted, determine how many units of each product Easy Go must sell in order to break even next year.
c. Determine the total dollar sales Easy Go must sell next year in order to earn an after-tax net income of $450,000.
d. After preparing the original estimates, Easy Go determines that its variable manufacturing cost of leaf blowers will increase 20 percent and the variable selling cost of hedge clippers can be expected to increase $1 per unit. However, Easy Go has decided not to change the selling price of either product. In addition, Easy Go learns that its leaf blower is perceived as the best value on the market, and it can expect to sell three times as many leaf blowers as any other product. Under these circumstances, determine how many units of each product Easy Go will have to sell to break even in next year.
e. Explain the limitations of cost-volume-profit analysis that Amy Tait should consider when evaluating Easy Gos next years budget.

 

 

 

 

23. Break-even and Cost-Volume-Profit with Taxes

DisKing Company sells used DVDs on line. The projected after-tax net income for the current year is $120,000 based on a sales volume of 200,000 DVDs. DisKing has been selling the disks at $16 each. The variable costs consist of the $10 unit purchase price of the disks and a handling cost of $2 per disk. DisKings annual fixed costs are $600,000 and DisKing is subject to a 40 percent income tax rate.

Required:

a. Calculate DisKing Companys break-even point for the current year in number of DVDs.
b. Calculate the increased after-tax income for the current year if projected unit sales volume increase 10 percent.
c. Management expects that the price DisKing pays for used DVDs to increase 30 percent next year. If the unit selling price remains at $16, calculate the volume of sales in dollars that DisKing Company must achieve in the coming year to maintain the same after-tax net income as projected for the current year.

 

 

 

 

24. Cost-Volume-Profit of a Make/Buy Decision

Telly Industries is a multiproduct company that currently manufactures 30,000 units of Part MR24 each month. The facilities now being used to produce Part MR24 have a fixed monthly cost of $150,000 and a capacity to produce 84,000 units per month. If Telly were to buy Part MR24 from an outside supplier, the facilities would be idle, but its fixed costs would continue at 40 percent of its present amount. The variable production costs of Part MR24 are $11 per unit.

Required:

a. If Telly Industries continues to use 30,000 units of Part MR24 each month, it would realize a net benefit by purchasing Part MR24 from an outside supplier only if the suppliers unit price is less than how much?
b. If Telly Industries can obtain Part MR24 from an outside supplier at a unit purchase price of $12.875, what is the monthly usage at which it will be indifferent between purchasing and making Part MR24?

 

 

 

 

25. Opportunity Cost of Purchase Discounts and Lost Sales

Spring Company manufactures hard drives for computer manufacturers. At the beginning of this year Spring began shipping a much-improved hard drive, Model W899. The W899 was an immediate success and accounted for $5 million in revenues for Spring this year.
While the W899 was in the development stage, Spring planned to price it at $130. In preliminary discussions with customers about the W899 design, no resistance was detected to suggestions that the price might be $130. The $130 price was considerably higher than the estimated variable cost of $70 per unit to produce the W899, and it would provide Spring with ample profits.
Shortly before setting the price of the W899, Spring discovered that a competitor had a product very similar to the W899 and was no more than 60 days behind Springs own schedule. No information could be obtained on the competitors planned price, although it had a reputation for aggressive pricing. Worried about the competitor, and unsure of the market size, Spring lowered the price of the W899 to $100. It maintained the price although, to Springs surprise, the competitor announced a price of $130 for its product.
After reviewing the current years sales of the W899, Springs management concluded that unit sales would have been the same if the product had been marketed at the original price of $130 each. Management has predicted that next years sales of the W899 would be either 85,000 units at $100 each or 60,000 units at $130 each. Spring has decided to raise the price of the disk drive to $130 effective immediately.
Having supported the higher price from the beginning, Sharon Haley, Springs marketing director, believes that the opportunity cost of selling the W899 for $100 should be reflected in the companys internal records and reports. In support of her recommendation, Haley explained that the company has booked these types of costs on other occasions when purchase discounts not taken for early payment have been recorded.

Required:

a. Define opportunity cost and explain why opportunity costs are not usually recorded.
b. What is the current years opportunity cost?
c. Explain the impact of Spring Companys selection of the $130 selling price for the W899 on next years operating income. Support your answer with appropriate calculations.

 

 

26. Make/Buy and the Opportunity Cost of Freed Capacity

Zelean Manufacturing uses 10 units of part KJ37 each month in the production of radar equipment. The cost to manufacture one unit of KJ37 is presented in the accompanying table.

Direct materials $1,000
Materials handling (20% of direct material cost) 200
Direct labor 8,000
Manufacturing overhead  12,000
Total manufacturing cost $21,200

Materials handling represents the direct variable costs of the receiving department and is applied to direct materials and purchased components on the basis of their cost. This is a separate charge in addition to manufacturing overhead. Zeleans annual manufacturing overhead budget is one-third variable and two-third fixed. Scott Supply, one of Zeleans reliable vendors, has offered to supply part KJ37 at a unit price of $15,000. The fixed cost of producing KJ37 is the cost of a special piece of testing equipment that ensures the quality of each part manufactured. This testing equipment is under a long-term, noncancelable lease. If Zelean were to purchase part KJ37, materials handling costs would not be incurred.

Required:

a. If Zelean purchases the KJ37 units from Scott, the capacity Zelean was using to manufacture these parts would be idle. Should Zelean purchase the parts from Scott? Make explicit any key assumptions.
b. Assume Zelean Manufacturing is able to rent all idle capacity for $25,000 per month. Should Zelean purchase from Scott Supply? Make explicit any key assumptions.
c. Assume that Zelean Manufacturing does not wish to commit to a rental agreement but could use idle capacity to manufacture another product that would contribute $52,000 per month. Should Zelean manufacture KJ37? Make explicit any key assumptions.

 

 

 

 

27. Price gouging or increased opportunity cost?

After the Iraqi invasion of Kuwait in August 1990, the world price of crude oil doubled to more than $30 per barrel in anticipation of reduced supply. Immediately, the oil companies raised the retail price on refined oil products even though these products were produced from oil purchased at the earlier, lower prices. The media charged the oil companies with profiteering and price gouging, and politicians promised immediate investigations.

Required:

Critically evaluate the charge that the oil companies profited from the Iraqi invasion. What advice would you offer the oil companies?

 

 

 

 

28. Break-even analysis with multiple products

You are a new consultant with the Boston Group and have been sent to advise the executives of Penury Company. The company recently acquired product line L from an out-of-state concern and now plans to produce it, along with its old standby K, under one roof in a newly renovated facility. Management is quite proud of the acquisition, contending that the larger size and related cost savings will make the company far more profitable. The planned results of a months operations, based on managements best estimates of the maximum product demanded at todays selling prices are:

  LINE K LINE L  
  Amount Per Unit Amount Per Unit Total
Sales revenue $120,000 $1.20 $80,000 $0.80 $200,000
Variable expense 60,000 0.60 60,000 0.60 120,000
Contribution margin $60,000 $0.60 $20,000 0.20 80,000
Fixed expense          50,000
Net income         $30,000

Required:

a. Based on historical operations, K alone incurred fixed expenses of $40,000, and L alone incurred fixed expenses of $20,000. Find the break-even point in sales dollars and units for each product separately.
b. Give reasons why the fixed costs for the two products combined are expected to be less than the sum of the fixed costs of each product line operating as a separate business.
c. Assuming that for each unit of K sold, one unit of L is sold, find the break-even point in sales dollars and units for each product.

 

 

 

 

29. Average versus Variable Cost

Measer Enterprises produces energy-efficient light bulbs and operates in a highly competitive market in which the bulbs are sold for $4.50 each. Because of the nature of the production technology, the firm can produce only between 10,000 and 13,000 units per month, in fixed increments of 1,000 units. Measer has the following cost structure:

Production and Cost Data
  Units Produced
  10,000 11,000 12,000 13,000
Factory cost, variable $37,000 $40,800 $44,600 $48,400
Factory cost, fixed 9,000 9,000 9,000 9,000
Selling cost, variable 6,000 6,600 7,400 8,200
Administration, fixed 6,000 6,000 6,000 6,000
Total $58,000 $62,400 $67,000 $71,600
Average unit cost $5.80 $5.67 $5.58 $5.51

Required:

At what output level should the firm operate?

 

 

 

 

30. Break-even Analysis

The MedView brochure said, Only 45 scans per month to cover the monthly equipment rental of $18,000. The footnote at the bottom of the brochure read: *Assumes a reimbursable fee of $475 per scan.
The MedView brochure refers to a new radiology imaging system that MedView rents for $18,000 per month. A scan refers to one imaging session that is billed at $475 per scan. Each scan involves giving the patient a chemical injection and requires exposing and developing an X-ray negative.

Required:

a. What variable cost per scan is MedView assuming in calculating the 45-scans-per-month amount?
b. Is the MedView brochure really telling the whole financial picture? What is it omitting?

 

 

 

 

31. Break-even Analysis

Exotic Roses, owned by Margarita Rameriz, provides a variety of rare rose bushes to local nurseries that sell Ramerizs roses to the end consumer (landscapers and retail customers). Rameriz grows the roses from cuttings that she has specifically cultivated for their unusual characteristics (color, size, heartiness, and resistance to disease). Margaritas roses are in great demand as evidenced by the wholesale price she charges nurseries, $15 per potted plant. Exotic Roses has the following cost structure (variable costs are per potted plant):

  Fixed Costs per Year Variable Costs
Plant materials   $0.50
Pot   0.30
Labor $8,000 0.70
Utilities 9,000  
Rent 7,500  
Other costs 2,500  

Required:

a. How many potted rose plants must Exotic Roses sell each year to break even?
b. If Rameriz wants to make profits of $10,000 before taxes per year, how many potted rose plants must be sold?
c. If Rameriz wants to make profits of $10,000 after taxes per year, how many potted rose plants must be sold assuming a 35 percent income tax rate?

 

 

 

 

32. Break-even Analysis

You are evaluating ways to expand an optometry practice and its earnings capacity. Optometrists perform eye exams, prescribe corrective lenses (eyeglasses and contact lenses), and sell corrective lenses. One way to expand the practice is to hire an additional optometrist. The annual cost of the optometrist, including salary, benefits, and payroll taxes, is $63,000. You estimate that this individual can conduct two exams per hour at an average price to the patient of $45 per exam. The new optometrist will work 40-hour weeks for 48 weeks per year. However, because of scheduling conflicts, patient no-shows, training, and other downtime, the new optometrist will not be able to conduct, bill, and collect 100 percent of his or her available examination time.
From past experience, you know that each eye exam drives additional product sales. Each exam will lead to either an eyeglass sale with a net profit (revenue less cost of sales) of $90 (not including the exam fee) or a contact lens sale with net profits of $65 (not including the exam fee). On average, 60 percent of the exams lead to eyeglass sales, 20 percent lead to contact lens sales, and 20 percent of the exams lead to no further sales.
Besides the salary of the optometrist, additional costs to support the new optometrist include:

Office occupancy costs $1,200/year
Leased equipment $330/year
Office staff $23,000/year

Required:

In terms of the percentage of available time, what is the minimum level of examinations the new optometrist must perform to recover all the incremental costs of being hired?

 

Chapter 07

Cost Allocation: Theory

 

Multiple Choice Questions

1. Which is not a reason for allocating internal costs to cost objects?

A. Managers should be charged for benefits received by departments (or products) under their control

 

B. US GAAP requires allocation of factory overheads

 

C. To determine the selling price of products

 

D. To determine the amount to be reimbursed under a cost-reimbursement contract

 

E. All of the above are reasons for allocating internal costs to cost objects

 

2. You are going to dinner with three friends, one who likes steak, another wine, and the third is a vegetarian (which is assumed to be the least expensive). Which is true?

A. How the bill is shared has no effect on what and how much people choose to eat

 

B. Equal sharing of the bill ensures that people order a similar dollar amount of food

 

C. The wine-drinker will argue for equal shares, and will drink as fast (and/or as much) as possible

 

D. The vegetarian will be better off with equal shares

 

E. None of the above

 

3. A sound allocation system should:

A. be cheap and easy to administer

 

B. provide incentives for cost control

 

C. charge in proportion to amount used or benefit received

 

D. be perceived as equitable by those who are charged

 

E. be all of the above

 

4. Pluton makes particular plastics for sale to the public and the government. Basic cost data for a 100-pound drum of one particular product called Xentra appears below:

  Qty Cost
Chemical Xeta, gals 15 $25.00
Chemical Thenta, gals 35 $27.50
Base material, lbs 20 $1.00
100-lb lined drum 1 $51.83

Variable factory overheads are estimated to be $1,200,000 per month, when 1,000,000 pounds of various products are produced. The plant employs 20 chemical workers who typically work 175 hours each per month and are paid $24 per hour. Other workers are classified as indirect and are included in fixed overheads. The highly automated plant typically runs 21,000 machine hours per month. The preparation of one 100 lbs batch of Xentra needs ten minutes of direct labor and 75 minutes of machine time. Fixed manufacturing overheads total $3,500,000 per month. Forty percent of these fixed manufacturing overheads are labor-related costs and the balance are machine-related costs.

Assuming normal production levels, what is the direct materials and direct labor cost (i.e., the prime cost) per drum?

A. $1,433.33

 

B. $1,413.33

 

C. $1,313.33

 

D. $1,293.33

 

E. None of the above

 

5. Pluton makes particular plastics for sale to the public and the government. Basic cost data for a 100-pound drum of one particular product called Xentra appears below:

  Qty Cost
Chemical Xeta, gals 15 $25.00
Chemical Thenta, gals 35 $27.50
Base material, lbs 20 $1.00
100-lb lined drum 1 $51.83

Variable factory overheads are estimated to be $1,200,000 per month, when 1,000,000 pounds of various products are produced. The plant employs 20 chemical workers who typically work 175 hours each per month and are paid $24 per hour. Other workers are classified as indirect and are included in fixed overheads. The highly automated plant typically runs 21,000 machine hours per month. The preparation of one 100 lbs batch of Xentra needs ten minutes of direct labor and 75 minutes of machine time. Fixed manufacturing overheads total $3,500,000 per month. Forty percent of these fixed manufacturing overheads are labor-related costs and the balance are machine-related costs.

Assuming normal production levels, what is the conversion cost (direct labor and overhead) per drum?

A. $191.67

 

B. $287.40

 

C. $311.67

 

D. $315.67

 

E. None of the above

 

6. Pluton makes particular plastics for sale to the public and the government. Basic cost data for a 100-pound drum of one particular product called Xentra appears below:

  Qty Cost
Chemical Xeta, gals 15 $25.00
Chemical Thenta, gals 35 $27.50
Base material, lbs 20 $1.00
100-lb lined drum 1 $51.83

Variable factory overheads are estimated to be $1,200,000 per month, when 1,000,000 pounds of various products are produced. The plant employs 20 chemical workers who typically work 175 hours each per month and are paid $24 per hour. Other workers are classified as indirect and are included in fixed overheads. The highly automated plant typically runs 21,000 machine hours per month. The preparation of one 100 lbs batch of Xentra needs ten minutes of direct labor and 75 minutes of machine time. Fixed manufacturing overheads total $3,500,000 per month. Forty percent of these fixed manufacturing overheads are labor-related costs and the balance are machine-related costs.

Assuming normal production levels, what is the full cost per drum?

A. $1,725.00

 

B. $1,700.73

 

C. $1,625.00

 

D. $1,609.00

 

E. None of the above

 

7. Pluton makes particular plastics for sale to the public and the government. Basic cost data for a 100-pound drum of one particular product called Xentra appears below:

  Qty Cost
Chemical Xeta, gals 15 $25.00
Chemical Thenta, gals 35 $27.50
Base material, lbs 20 $1.00
100-lb lined drum 1 $51.83

Variable factory overheads are estimated to be $1,200,000 per month, when 1,000,000 pounds of various products are produced. The plant employs 20 chemical workers who typically work 175 hours each per month and are paid $24 per hour. Other workers are classified as indirect and are included in fixed overheads. The highly automated plant typically runs 21,000 machine hours per month. The preparation of one 100 lbs batch of Xentra needs ten minutes of direct labor and 75 minutes of machine time. Fixed manufacturing overheads total $3,500,000 per month. Forty percent of these fixed manufacturing overheads are labor-related costs and the balance are machine-related costs.

A government agency wants to purchase 200 drums of Xentra at cost plus a flat fee. Which allocation method gives the profit-maximizing result?

A. The current method of determining cost

 

B. Allocating overheads per machine hour

 

C. Allocating overheads per direct labor hour

 

D. Allocating overheads per pound

 

E. None of the above

 

8. If Pluton selects the cost allocation method indicated by your answer to Q7-7, how much will profits increase on this order compared with the present system?

A. No change

 

B. Change by $31,666.67

 

C. Change by $17,571.43

 

D. Change by $6,380.95

 

E. None of the above

 

9. Which of the following are true about cost allocation?

A. Cost allocation is a form of transfer pricing for indirect costs

 

B. Cost allocation is an internal tax on services

 

C. Cost allocation distorts choices that managers would make otherwise

 

D. Cost allocation should be imposed when marginal cost exceeds average cost of an internal resource

 

E. All of the above

 

10. King Khan Corporation (KKC) manufactures kongs and kangs, the production of which requires considerable energy. Power generation department costs amounted to $4 million this month, for a total of 50 million kilowatt hours (kwh) supplied to the plant. Analysis shows that 40% of power generation costs are fixed. This month the Kang Dept. made 5 million kangs, each using 4 kwh, and the Kang Dept. made 4 million kangs, each using 6 kwh.

If KKC uses the simplest algorithm to allocate power costs, which is not true?

A. Kong will be charged $1.6 million

 

B. Kang will be charged $2.18 million

 

C. Kangs charge will depend on Kongs usage

 

D. Since the production departments consume the vast majority of the plants power costs, it is not cost-efficient to allocate power costs to the service departments

 

E. All are true

 

11. King Khan Corporation (KKC) manufactures kongs and kangs, the production of which requires considerable energy. Power generation department costs amounted to $4 million this month, for a total of 50 million kilowatt hours (kwh) supplied to the plant. Analysis shows that 40% of power generation costs are fixed. This month the Kang Dept. made 5 million kangs, each using 4 kwh, and the Kang Dept. made 4 million kangs, each using 6 kwh.

In the following month, the power generation department costs amounted to $4.3 million for 51 million kwh. Kong Dept.s usage was the same, but the Kang Dept. increased output to 4.1 million kangs, each using the standard power allowance. If KKC employs an insulating cost allocation mechanism, and fixed costs are shared equally, which is true?

A. Kang will be charged $1.93 million

 

B. Kong will be charged $1.79 million

 

C. Kong will be charged $2.07 million

 

D. Kang will be charged $2.29 million

 

E. None of the above

 

 

Essay Questions

12. Cost Allocation and Contingency Fees

A lawyer allocates overhead costs based on his hours working with different clients. The lawyer expects to have $200,000 in overhead during the year and expects to work on clients cases 2,000 hours during the year. In addition, she wants to pay herself $50 per hour for working with clients. In other words, the lawyers billing rate is the sum of her hourly fee ($50) and a fee to recover the expected overhead spread over 2,000 hours. The lawyer, however, does not bill all of her clients based on covering overhead costs and her own salary. Some clients pay her on contingency fees. If the lawyer works with a client on a contingency fee basis, the lawyer receives half of any settlement for her client. During the year the lawyer works 1,200 hours that are billable to clients. The remaining hours are worked on a contingency basis. The lawyer wins $300,000 in settlements for his clients of which she receives half. Actual overhead was $210,000.

Required:

What does the lawyer earn during the year after expenses?

 

 

 

 

13. Fixed Costs and Allocated Costs

The maintenance departments costs are allocated to other departments based on the number of hours of maintenance use by each department. The maintenance department has fixed costs of $500,000 and variable costs of $30 per hour of maintenance provided. The variable costs include the salaries of the maintenance workers. More maintenance workers can be added if greater maintenance is demanded by the other departments without affecting the fixed costs of the maintenance department. The maintenance department expects to provide 10,000 hours of maintenance.

Required:

a. What is the application rate for the maintenance department?
b. What is the additional cost to the maintenance department of providing another hour of maintenance?
c. What problem exists if the managers of other departments can choose how much maintenance to be performed?
d. What problem exists if the other departments are allowed to go outside the organization to buy maintenance services?

 

 

 

 

14. Choosing Allocation Bases for Levying Taxes

The town of Seaside has decided to construct a new sea aquarium to attract tourists. The cost of the measure is to be paid by a special tax. Although most of the townspeople believe the sea aquarium is a good idea, there is disagreement about how the tax should be levied.

Required:

Suggest three different methods of levying the tax and the advantages and disadvantages of each.

 

 

 

 

15. Outsourcing and Overhead

Peluso Company, a manufacturer of snowmobiles, is operating at 70 percent of plant capacity. Pelusos plant manager is considering manufacturing headlights, which are now being purchased for $11 each (a price that is not expected to change in the near future). The Peluso plant has the equipment and labor force required to manufacture the headlights. The design engineer estimates that each headlight requires $4 of direct materials and $3 of direct labor. Pelusos plant overhead rate is 200 percent of direct labor dollars, and 40 percent of the overhead is fixed cost.

Required:

If Peluso Co. manufactures the headlights, how much of a gain (loss) for each headlight will result?

 

 

 

 

16. Incentive Effects of Cost Allocations

Eastern University prides itself on providing faculty and staff a competitive compensation package. One aspect of this package is a faculty and staff child tuition benefit of $4,000 per child per year for up to four years to offset the cost of a college education. The faculty or staff members child can attend any college or university, including Eastern University, and receive the tuition benefit. If a staff member has three children in college one year, the staff member receives a $12,000 tuition benefit. This money is not taxed to the individual staff or faculty member.
Eastern University pays the benefit directly to the university where the staff/faculty members child is enrolled or if the student is attending Eastern, it reduces the amount of tuition owed by the faculty/staff member. The university then charges this payment to a benefits account. This benefits account is then allocated back to the various colleges and departments based on total salaries in the college or department.

Required:

Evaluate the pros and cons of the present university accounting for tuition benefits. What changes would you recommend making?

 

 

 

 

17. Allocating Overhead versus Direct Tracing

Nixon & Ross, a law firm, is about to install a new accounting system that will allow the firm to track more of the overhead costs to individual cases. Overheads are currently allocated to individual client cases based on billable professional staff salaries. Attorneys working on client cases charge their time to billable professional staff salaries. Attorney time spent in training, law firm administrative meetings, and the like is charged to an overhead account titled unbilled staff salaries.
The following is a summary of the costs for the current year:

Billable professional staff salaries $4,000,000
Overhead   8,000,000
Total costs $12,000,000

The overhead costs were as follows:

Secretarial costs $1,500,000
Staff benefits 2,750,000
Office rent 1,250,000
Telephone and mailing costs 1,500,0

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