MANAGEMENT ACCOUNTING
CONCEPTS AND TECHNIQUES
By Dennis Caplan, University
at Albany (State University of New York)
CHAPTER
16: Fixed Manufacturing Overhead
Exercises
and Problems:
Discussion Question 16-1:
The Taos Ski and Tennis Resort has a Summer manager and a Winter manager. These managers receive a substantial portion of their income in the form of a bonus based on profitability. They constantly argue about how certain costs should be allocated across the two seasons. For example, they both wanted a new espresso bar constructed, and they convinced the owner to build it by agreeing to have the construction cost depreciated over the life of the building, and to have each year’s depreciation expense allocated between the Summer season and the Winter season for purposes of calculating each manager’s profits. This convinced the owner that the managers really believed the espresso bar would cover its costs. However, although the two managers agreed that these fixed costs should be allocated, and although they believe that the incremental revenue will more than cover the costs, including the cost to build the espresso bar, they can’t agree on how to allocate depreciation expense between the two seasons. The summer manager suggests splitting depreciation expense 50/50, since the number of visitors is about the same for each season. The Winter manager suggests splitting depreciation expense 70/30 (70% to Summer), since this roughly represents the length (in days) of each season.
The best way for the owner to resolve this dispute is to
(A) Not allocate depreciation expense at all, since the cost of the building was relevant before it was built, but is irrelevant now that it is a sunk cost.
(B) Allocate depreciation 50/50, since all else equal, this will not favor either manager.
(C) Allocate depreciation 70/30, because this method is consistent with depreciating the entire cost of the building over its useful life.
(D) Allocate the cost based on actual espresso bar revenues, since this allocates costs on an “ability to bear” basis, and recognizes the fact that guests are more likely to buy coffee when the weather is cooler, so that the Summer manager is not penalized.
Discussion Question 16-2:
The Bernalillo
Tortilla Factory manufactures a variety of packaged Mexican food products in a
large factory in
(A) Allocating fixed manufacturing overhead to production will encourage product managers to set sales prices on individual products that will help achieve the company’s overall profitability goals.
(B) Allocating fixed manufacturing overhead to production using factory square feet as the allocation base will assist management in determining the most profitable product mix.
(C) Allocating fixed manufacturing overhead to production during the year will provide product cost information that is more consistent with the company’s year-end financial statements (prepared in accordance with Generally accepted Accounting Principles) than would treating fixed manufacturing overhead as a period expense.
(D) Fixed manufacturing overhead costs are sunk in the short-run, and hence, are independent of the level of production. Therefore, there is no purpose in allocating these costs to production.
16-3: Milwood Mills makes decorative woodcut prints. Each design is run in a single batch once during the year. Milwood Mills allocates machine set-up costs using set-up hours as the allocation base. Following is budgeted information for next year for two of the company’s numerous designs: Bull and Matador and Dogs Playing Poker.
|
|
Bull |
Dogs |
|
Number of woodcuts Direct materials cost Direct labor cost Number of machine set-up hours Pounds of material Kilowatt hours |
5,000 $25,000 $14,000 120 5,000 2,000 |
15,000 $33,000 $16,000 150 10,000 3,000 |
Required:
A) What is the anticipated effect of making the 5,000 “Bull” woodcuts in two batches instead of one, holding all else constant, if machine set-up costs are variable, in a linear fashion, in the number of setups?
(A) The unit cost of “Bull” will increase, and the unit cost of “Dogs” will decrease.
(B) The unit cost of “Bull” will increase, and the unit cost of “Dogs” will remain unchanged.
(C) The unit cost of “Bull” will decrease, and the unit cost of “Dogs” will remain unchanged.
(D) The unit cost of both “Bull & Matador” and “Dogs” will remain unchanged.
B) What is the anticipated effect of making the 5,000 woodcuts of “Bull” in two batches instead of one, holding all else constant, if machine set-up costs include both fixed and variable components?
(A) The unit cost of “Bull” will increase, and the unit cost of “Dogs” will decrease.
(B) The unit cost of “Bull” will increase, and the unit cost of “Dogs” will remain unchanged.
(C) The unit cost of “Bull” will decrease, and the unit cost of “Dogs” will remain unchanged.
(D) The unit cost of both “Bull & Matador” and “Dogs” will remain unchanged.
16-4: The not-for-profit health clinic Shots-Я-Us provides various types of vaccinations and other shots, especially flu shots, to the public for free or for a nominal fee. The clinic is funded by several local governmental agencies as well as by a number of charitable organizations. Since different donors wish to fund different types of shots, the clinic determines the full cost of each type of shot, by adding overhead to the direct costs, and then provides this information to current and prospective donors.
Following are actual and budgeted costs for Shots-Я-Us for 2003:
|
|
Actual |
Budgeted |
|
Number of patient visits Number of shots administered Fixed overhead: salaries, rent for the facility, insurance, depreciation. Variable overhead: nursing staff hoursly wages, utilities, disposable supplies. Cost of hypodermics (a direct cost) Cost of medications (a direct cost) |
5,000 6,000 $94,000 $66,000 $1,000 $30,000 |
4,000 4,500 $110,000 $40,500 $750 $20,000 |
Assume the clinic allocates fixed overhead separately from variable overhead, and allocates fixed overhead using the number of shots as the allocation base. Clinic management believes that the facility could deliver as many as 7,000 shots per year. Which of the following overhead rates will result in underallocated fixed overhead for the year?
I. Actual level of activity in the denominator, and actual costs in the numerator.
II. Budgeted level of activity in the denominator, and budgeted costs in the numerator.
III. Practical capacity in the denominator, and budgeted costs in the numerator.
(A) III only
(B) II and III only
(C) II only
(D) I only
(E) neither I, II, nor III
16-5: The Carl-Carlson Corporation uses Absorption Costing, begins the year
with zero inventory, and has both fixed and variable manufacturing costs.
Relative to the benchmark in which the company produces the same number of
units that it sells, which of the following statements is true?
(A) By
producing above its sales level, the company will increase the total cost of
ending inventory on the balance sheet, and will also increase net income.
(B) By
producing above its sales level, the company will increase the total cost of
ending inventory on the balance sheet, but will not affect net income.
(C) By
producing above its sales level, the company will increase the total cost of
ending inventory on the balance sheet, but will decrease net income.
(D) None of
the above statements can be made with certainty, unless the actual costs and unit
volumes are known.
16-6: For the year 2004 (his first year of operations), Harvey Mudd sold 7,500 units at $350 per unit, and produced 10,000 units, of his sole product, a combination espresso machine and rug steamer. Factory capacity is 15,000 units. Other information for the year included the following:
|
Direct manufacturing labor Variable manufacturing overhead Direct materials Variable selling expense (a sales commission) Fixed non-manufacturing expenses Fixed manufacturing overhead |
$750,000 400,000 600,000 400,000 400,000 800,000 |
Required: On January 1,
2005,
16-7: For the year 2049, its first year of operations, Montgomery Scott Enterprises sold 7,500 units at $350 per unit, and produced 10,000 units, of its sole product, a Shuttlecraft navigational device. Other information for the year included:
|
Direct manufacturing labor Variable manufacturing overhead Direct materials Variable selling expenses Fixed administrative expenses Fixed manufacturing overhead |
$750,000 400,000 600,000 400,000 400,000 800,000 |
Required: On January 1, 2050, Scott uses a new software program, Econ-forecast, which predicts that his sales demand and cost structure will remain exactly the same in 2050 as it was in 2049. Scott doesn’t want to change his sales price, uses LIFO for financial reporting, and wants to show zero profits (i.e., wants to break even) in 2050. Is there a production level under absorption costing that will accomplish this goal? If so, what is it?
16-8: The Eureka Company began operations on January 1, 2005 with no inventory. The company makes one product, an electric lawn mower. Following is information for production and sales for 2005, and projected information for 2006:
|
|
Actual for 2005 |
Projections for 2006 |
|
Units produced Units sold Selling price per unit Direct materials per unit Direct labor per unit Variable non-manufacturing costs: Sales commission per unit |
190 100 $2,500 $190 $70 $40 |
To be determined (by you) 210 $2,600 $220 $70 $45 |
Factory capacity is 200 units per year. In 2005, total variable manufacturing overhead was $85,500; total fixed manufacturing overhead was $200,000; and total fixed non-manufacturing overhead was $30,000. There were no variable non-manufacturing costs other than the sales commissions. The total fixed costs and the per-unit variable overhead costs are expected to be the same in 2006 as in 2005. The company uses LIFO (Last-in, First-out) and Absorption Costing.
Required:
16-9: The Well-Managed Manufacturing Company is concerned about how much income it will report for the year ending December 31, 2006. It is now mid-November, and the estimated (pro forma) income statement for the year, calculated on a Variable Costing basis, is as follows:
|
Sales Variable costs: Manufacturing costs Selling and administrative costs Contribution margin Fixed costs: Manufacturing costs Selling and administrative costs Operating income |
50,000 units $200,000 100,000 $300,000 100,000 |
$750,000 300,000 $450,000 400,000 $ 50,000 |
Required:
A) What is the cost per unit of inventory, and operating income, using Absorption Costing, assuming the company has no inventory at year-end, as planned?
B) How much inventory would have to be produced for ending inventory, in order to raise income to $100,000? In other words, what would the balance in ending inventory have to be?
C) One manager believes that producing unneeded inventory to generate income is a bad idea. What do you think?
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Management
Accounting Concepts and Techniques; copyright 2006; most recent update:
November 2010
For a printer-friendly version, contact Dennis Caplan at dcaplan@uamail.albany.edu