Solution manual introduction to management accounting 14e by horngren ch05

To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER COVERAGE OF LEARNING OBJECTIVES LEARNING OBJECTIVE LO1: Discriminate between relevant and irrelevant information for making decisions LO2: Apply the decision process to make business decisions LO3: Construct absorption and contribution-margin income statements and identify their relevance for decision making LO4: Decide to accept or reject a special order using the contribution margin technique LO5: Explain why pricing decisions depend on the characteristics of the market LO6: Identify the factors that influence pricing decisions in practice LO7: Compute a target sales price by various approaches, and compare the advantages and disadvantages of these approaches LO8: Use target costing to decide whether to add a new product FUNDAMENTAL ASSIGNMENT MATERIAL CRITICAL THINKING EXERCISES AND EXERCISES 23,30,37,38 PROBLEMS 49,50,51,54,57 CASES, EXCEL, COLLAB & INTERNET EXERCISES 66 28,29,39 A1,B1 24,31,32,33, 34,35 48 A2,B2 36,40 55,56,62 A2,B2 25,42 58 26,41 47,52,53 A3 43,44 A4,B3 27,45,46 246 59,60,61 63,64 65 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER Relevant Information and Decision Making: Marketing Decisions 5-A1 (40-50 min.) INDEPENDENCE COMPANY Contribution Income Statement For the Year Ended December 31, 2006 (in thousands of dollars) Sales $1,800 Less variable expenses Direct material $400 Direct labor 330 Variable manufacturing overhead (Schedule 1) 150 Total variable manufacturing cost of goods sold $880 Variable selling expenses 60 Variable administrative expenses 23 Total variable expenses 963 Contribution margin $ 837 Less fixed expenses: Fixed manufacturing overhead (Schedule 2) $322 Selling expenses 240 Administrative expenses 121 Total fixed expenses 683 Operating income $ 154 247 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com INDEPENDENCE COMPANY Absorption Income Statement For the Year Ended December 31, 2006 (in thousands of dollars) Sales Less manufacturing cost of goods sold: Direct material Direct labor Manufacturing overhead (Schedules and 2) Total manufacturing cost of goods sold Gross margin Less: Selling expenses Administrative expenses Operating income $1,800 $400 330 472 1,202 $ 598 $300 144 444 $ 154 INDEPENDENCE COMPANY Schedules of Manufacturing Overhead For the Year Ended December 31, 2006 (in thousands of dollars) Schedule 1: Variable Costs Supplies Utilities, variable portion Indirect labor, variable portion Schedule 2: Fixed Costs Utilities, fixed portion Indirect labor, fixed portion Depreciation Property taxes Supervisory salaries Total manufacturing overhead 248 $ 20 40 90 $ 12 40 200 20 50 $150 322 $472 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Change in revenue Change in total contribution margin: Contribution margin ratio in part is $837 ÷ $1,800 = 465 Ratio times increase in revenue is 465 x $200,000 Operating income before change New operating income $200,000 $ 93,000 154,000 $247,000 This analysis is readily done by using data from the contribution income statement In contrast, the data in the absorption income statement must be analyzed and split into variable and fixed categories before the effect on operating income can be estimated 249 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 5-A2 (25-30 min.) A contribution format, which is similar to Exhibit 5-6, clarifies the analysis Units Sales Less variable expenses: Manufacturing Selling & administrative Total variable expenses Contribution margin Less fixed expenses: Manufacturing Selling & administrative Total fixed expenses Operating income Without With Special Effect of Special Order Special Order Order 2,000,000 150,000 2,150,000 Total Per Unit $10,000,000$660,000 $4.401 $10,660,000 $ 3,600,000$330,000 $ 3,930,000 800,000 37,500 253 $ 4,400,000$367,500 $ 4,767,500 $ 5,600,000$292,500 $ 5,892,500 $ 2,900,000 0.00 2,000,000 00.00 $ 4,900,000 0.00 $ 700,000 $292,500$1.95 $660,000 ÷ 150,000 = $4.40 Regular unit cost = $3,600,000 ÷ 2,000,000 = Logo Variable manufacturing costs Regular unit cost = $800,000 ÷ 2,000,000 = Less sales commissions not paid (3% of $5) 250 $1.80 40 $2.20 $ 40 (.15) $2.202 837,500 $2.45 $1.95 $ 2,900,000 2,000,000 $ 4,900,000 $ 992,500 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Regular unit cost, excluding sales commission 251 $ 25 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Operating income from selling 7.5% more units would increase by $292,500 ÷ $700,000 = 41.8% Note also that the average selling price on regular business was $5.00 The full cost, including selling and administrative expenses, was $4.65 The $4.65, plus the 40¢ per logo, less savings in commissions of 15¢ came to $4.90 The president apparently wanted $4.90 + 08($4.90) = $4.90 + 392 = $5.292 per pen Most students will probably criticize the president for being too stubborn The cost to the company was the forgoing of $292,500 of income in order to protect the company's image and general market position Whether $292,500 was a wise investment in the future is a judgment that managers are paid for rendering 5-A3 (15-20 min.) The purpose of this problem is to underscore the idea that any of a number of general formulas might be used that, properly employed, would achieve the same target selling prices Desired sales = $7,500,000 + $1,500,000 = $9,000,000 The target markup percentage would be: 100% of direct materials and direct labor costs of $4,500,000 Computation is: $9,000,000- $4,500,000 = 100% $4,500,000 50% of the full cost of jobs of $6,000,000 Computation is: $9,000,000- $6,000,000 = 50% $6,000,000 252 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com $9,000,000 - ($3,500,000 + $1,000,000 + $600,000) = 76.47% $5,100,000 $9,000,000- $7,500,000 = 20% $7,500,000 $9,000,000 - ($3,500,000 + $1,000,000 + $600,000 + $600,000) $5,700,000 $3,300,000 = = 57.9% $5,700,000 If the contractor is unable to maintain these profit percentages consistently, the desired operating income of $1,500,000 cannot be obtained 253 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 5-A4 (15-20 minutes) Revenue ($360 x 70,000) Total cost over product life Estimated contribution to profit Desired (target) contribution to profit 40% x $25,200,000 Deficiency in profit $25,200,000 16,600,000 $ 8,600,000 $10,080,000 $ 1,480,000 The product should not be released to production Previous total estimated cost Cost savings from suppliers 20 x 70 x $8,000,000 Revised total estimated cost Revised total contribution to profit: $25,200,000 - $15,480,000 Desired (target) contribution to profit Deficiency in profit $16,600,000 1,120,000 $15,480,000 $ 9,720,000 $10,080,000 $ 360,000 The product should not be released to production Previous revised total estimated cost from requirement $15,480,000 Process improvement savings: 25 x 30 x $8,000,000 $600,000 Less cost of new technology 220,000 380,000 Revised total estimated cost 15,100,000 Revised total contribution to profit: $25,200,000 - $15,100,000 $10,100,000 Desired (target) contribution to profit $10,080,000 Excess contribution to profit $ 20,000 The product should be released to production 254 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 5-B1 (40-50 min.) KINGLAND MANUFACTURING Contribution Income Statement For the Year Ended December 31, 2006 (In thousands of dollars) Sales $12,000 Less variable expenses: Direct material $4,000 Direct labor 2,000 Variable indirect manufacturing costs (Schedule 1) 960 Total variable manufacturing cost of goods sold $6,960 Variable selling expenses: Sales commissions $500 Shipping expenses 300 800 Variable clerical salaries 400 Total variable expenses 8,160 Contribution margin $ 3,840 Less fixed expenses: Manufacturing (Schedule 2) $ 582 Selling (advertising) 400 Administrative-executive salaries 100 Total fixed expenses 1,082 Operating income $ 2,758 255 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 5-55 (15-20 min.) Compare option a to option b: Extra revenue from option a: ($32 - $15) x 30 passengers = 510 Extra costs for option a: ($2.20 - $.20) x 65 mi + $400 = $530 Therefore, option b (adding a car to an existing train) is more profitable by $530 - $510 = $20 Costs that are the same for both alternatives are irrelevant These include the cost of the tour guide, cost of moving the car or car and engine to the main track (assuming both options require an additional car to be moved to the track), and depreciation This depends on the total additional revenues and costs for option b, the best of the two options: Revenues: $15 x 32 Costs: Fuel - 65 mi x $.20/mi $ 13.00 Tour guide 200.00 Moving car 40.00 Total additional cost Extra profit $480.00 253.00 $227.00 This option is definitely profitable, generating extra profit of $480 - $253 = $227 The cost of the tour guide and the cost of moving the car to the main track are relevant for this decision because they would be incurred only if the agreement with the tour agent is accepted The depreciation remains irrelevant as long as excess cars are available 301 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 5-56 (15-20 min.) Net income will be increased by 300 x (€40 - €25 - €10) = €1,500 The variable manufacturing costs per unit: €25 €180,000, €70,000, €30,000, €10; i.e., all numbers are irrelevant except €25 Selling price: €180,000 ÷ 2,000 units = €90 Total sales: 2,400 x x €90 = Less expenses: Fixed: €70,000 + €30,000 + €125,000* = Variable: 2,400 x x (€25 + €10) = 393,000 Net income *Depreciation: €500,000 ÷ = €125,000 302 €432,000 €225,000 168,000 € 39,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 5-57 (15-25 min.) Budgeted fixed manufacturing overhead per unit: $10,000,000 ÷ 2,000,000 = $5 Relevant items: Additional sales Additional manufacturing costs, 100,000 x $10 Additional selling and administrative expenses Total relevant costs Additional operating income $1,300,000 $1,000,000 20,000 $1,020,000 $ 280,000 Fixed manufacturing costs are irrelevant because their total will be the same regardless of the special order being accepted or rejected Students may raise many points, including: a Whether the president is willing to "invest" $280,000 in forgone operating income now to preserve a marketing policy or to prevent a general weakening of prices among competitors b Whether accepting the order now may lead to more profitable orders from the same customer subsequently Budgeted fixed manufacturing overhead rate would be $10,000,000 ÷ 1,000,000 = $10 However, the additional operating income in requirement would be unaffected by how fixed costs are "unitized." (Of course, the original budgeted operating income would have been different, but that is irrelevant in requirement 2.) 303 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 5-58 (20-30 min.) When this problem was used in an exam, it was well done by students who used contribution margin analysis in total dollars A number of students attempted to force a decision by means of analysis of unit costs or by break-even analysis, failing to consider the effect of sales volume on profits A number of good solutions were marred by failure to draw specific conclusions Output and pricing: Volume 50,000 60,000 70,000 80,000 90,000 CM per Total Contribution Price Unit Margin $26 11 $550,000 25 10 600,000 24 630,000 23 640,000 22 630,000 The contribution margin per unit decreases as volume increases Output of 80,000 at selling price of $23 yields the largest contribution margin However, this is in excess of present capacity Maximum at present capacity: 60,000 units output at $25 = Contribution margin of $600,000 To increase capacity: Investment Useful life Cost per year ($500,000 ÷ 10) $500,000 10 years $ 50,000 By increasing capacity to 80,000 units, which maximizes the total contribution margin, the company gains an additional $40,000 in contribution margin but incurs an additional fixed cost of $50,000 Conclusions: Do not invest in new capacity Sell at $25 Produce 60,000, the maximum capacity now available 304 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 5-59 (10-15 min.) Manufacturing cost $27.00 Gross margin, 20% x $27.00 5.40 Price $32.40 Memphis would not produce a motor because it would not be able to sell them at $32.40, assuming that market research is right about the market price of $26.00 Even with no profit margin, the cost of $27 exceeds the price of $26 Using target costing, Memphis would begin with the market price of $26.00 From this, managers would compute the largest acceptable manufacturing cost: Price $26.00 Less gross margin 4.33* Manufacturing cost $21.67 * Price = Cost + (.20 x Cost) $26.00 = 1.20 x Cost Cost = $26.00  1.20 = $21.67 Margin = $26.00 - $21.67 = $4.33 Memphis managers would have to determine if they could design the garage-door-opener motor and its production process in a way that manufacturing costs were below $21.67 Both the design specifications for the motor and the production process would need to be looked at If there is no way to reduce production costs to $21.67 or below, the product should not be produced However, target costing forces managers to examine ways to lower the production costs through product and process design Instead of taking the design and process as givens and then examining the market to see if Memphis can sell the product for a high enough price, the company’s managers will try to design a product and process that meets the constraints of the market 305 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 5-60 (35-45 min.) Direct material Setup/maintenance Processing Marketing Customer service Total existing cost Total demand in units Existing cost per unit Target cost per unit Required cost reduction RCR as a percent of market price Decision Cost per driver unit $1.60/ pound $1,015/ setup $370/ mach hr $860/order $162/sales call C-200472 C-200473 C-200474 C-200475 Number Number Number Number of units Cost of units Cost of units Cost of units Cost 2,000 $3,200 1,000 $ 1,600 4,000 $ 6,400 800 $1,280 10 10,150 4,060 12 12,180 5,075 20 7,400 12 4,440 32 11,840 12 4,440 30 25,800 10 8,600 50 43,000 16 13,760 55 8,910 35 5,670 20 3,240 28 4,536 $55,460 $24,370 $76,660 $29,091 2,000 1,400 4,000 600 $ 27.73 $23.40* $ 4.33 $ 17.41 $ 16.80 $ 0.61 $ 19.17 $ 21.00 $ $ 48.49 $ 30.00 $ 18.49 11.1% 2.2% Release to production and set kaizen cost improvement plan 0% 37.0% Redesign product and process using value engineering Release to production Abandon subject to approval * Target cost = (1 – desired contribution percentage) x market price = (1 - 40) x $39 = $23.40 306 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 5-61 (20 min.) Contribution margin = $800 - ($475 + $25) = $300 Total contribution = $300 x 44,000 mowers = $13,200,000 Total fixed costs = years x ($900,000 + $50,000) = $6,650,000 Development costs = $5,000,000 Life-cycle profit = $13,200,000 - $6,650,000 - $5,000,000 = $1,550,000 Desired profit = 10 x ($800 x 44,000) = $3,520,000 The life cycle profit is $3,520,000 - $1,550,000 = $1,970,000 short of what is desired Therefore, unless some changes can be made, Southeast will not enter the riding lawn mower market A target costing company does not quit when the first cost estimate comes in too high Managers establish a target cost and try to adjust design, production and marketing processes to meet the target cost In this case, the target cost is: Revenue Desired profit Target cost $35,200,000 3,520,000 $31,680,000 Expected costs are: Variable production costs Fixed production costs Variable selling costs Fixed selling costs Development costs Total costs $20,900,000 6,300,000 1,100,000 350,000 5,000,000 $33,650,000 If total costs can be reduced by at least $1,970,000, to $31,680,000 or less by changes in the product’s design, the production process design, or production or selling methods, this will begin to be a profitable product 307 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 5-62 (30 – 40 min.) Fixed overhead allocation rate per machine hour = €2,160,000  90,000 = €24 Variable overhead allocation rate = €40 - €24 =€ 16 St Tropez should not accept either order The company does not have adequate plant capacity to manufacture the order of 20,000 jewelry cases from Lyon Inc without subcontracting The order from Avignon Co does not yield St Tropez a positive contribution margin The calculations showing that St Tropez does not have the necessary plant capacity in the second quarter to produce the order for 20,000 jewelry cases are as follows: Annual plant capacity Monthly plant capacity Estimated monthly capacity use, x 7,500 Excess capacity per month Period involved, second quarter Total excess capacity available 90,000 machine hours 7,500 machine hours 6,000 machine hours 1,500 machine hours x months 4,500 machine hours Machine hours required to produce 20,000 jewelry cases = Number of cases x machine hours per case = 20,000 x 25 = 5,000 hours 308 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com The Lyon Inc order for 20,000 jewelry cases would require 5,000 machine hours, but only 4,500 machine hours are available in the second quarter Computations related to the order from Avignon Co are as follows: Price offered per case Variable production cost per case: Raw materials Direct labor, hours @ €60 Overhead, machine hours @ €16* Contribution margin per case Number of cases Total contribution margin Fixed costs related to the order: Setup costs Special device Loss from taking the order € 85.0 €43.0 30.0 8.0 81.0 € 4.0 x 7,500 €30,000 €15,000 20,000 35,000 € (5,000) *Fixed costs are not relevant in this case and should be omitted The Avignon Co order should be rejected because it is unprofitable in the short run with the present price and cost structure 309 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 5-63 (10 – 15 min.) Capacity is not sufficient to accept both orders, but there is enough capacity to accept either the Nordstrom or the Macy’s order There is excess capacity for 150,000 shoes, but the two orders together would require production of 90,000 + 75,000 = 165,000 shoes Nordstrom Macy’s Order Order Revenue Variable Costs: Direct Materials Direct Labor Var Factory OH Packaging Contribution margin Unit sales Total contribution margin $136.00 $130.00 49.00 49.00 22.00 22.00 14.00 14.00 3.50 2.00 $ 47.50 $ 43.00 x 75,000 x 90,000 $3,562,500 $3,870,000 Based on the analysis above, accepting the Macy’s order is the optimal decision, generating an additional contribution margin of $3,870,000 over not accepting a special order, and an additional $307,500 in contribution margin relative to the Nordstrom order Some considerations would involve cannibalization of existing sales by lower prices, and whether variable and fixed cost distinctions remain valid within the relevant range (especially as maximum capacity is achieved) 5-64 (20 – 30 min.) For the solution, see the Prentice Hall Web site, www.prenhall.com/ 310 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 5-65 (60 or more) Pricing tends to be more of an "art" rather than a "science" in small firms In large firms, students will find a wide variety of tools and techniques but will most likely get interesting answers to all the recommended questions Perhaps the most significant factor that influences the process for establishing a pricing policy is company size For many small companies, the process is simple For example, one restaurant establishes prices using a formula of three times the cost of material used in each menu item This markup is designed (hoped) to cover all the operating costs in the restaurant's value chain beyond direct material (food cost) Other important factors commonly mentioned include market conditions and the experience level of management Target costing is not often mentioned Some form of cost plus pricing is most often used When target costing is used and managers are asked to explain the target-costing process, it is often discovered that only some elements of a fully developed target costing process are used Students may discover that different pricing policies are used for different product or service families in the same firm This is particularly true for large companies that compete in many different markets 311 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 5-66 (50 – 60 min.) NOTE TO INSTRUCTOR This solution is based on the web site as it was in early 2007 Be sure to examine the current web site before assigning this problem, as the information there may have changed As of January 2007, the Web address for Colgate-Palmolive was www.colgate.com In its 2005 Annual Report, the major component of Colgate’s strategy is investing in innovative new products with growth potential The company supports this strategy by focusing on the R & D and marketing value chain functions The company that places an emphasis on rapid product development needs relevant information regarding expected revenues and costs for proposed new products In 2005, Colgate’s advertising spending was at a record high, up 12% versus the prior year, led by a double-digit increase in media This is generating healthy volume and strong market share gains worldwide According to Reuben Mark, CEO: “Colgate is entering 2006 in an excellent position after a year of strong top-line momentum that built throughout 2005 Our financial strategies are on track and the fundamentals of our business are sound We are confident that, excluding restructuring charges and accounting changes for stock-based compensation, we will generate double-digit earnings per share growth in 2006.” Colgate also needs to have reliable estimates of the impact of its advertising and promotion on sales If a company uses an ABC system as discussed in chapter 4, the impact of increased sales from new products will be estimated via increased activity levels as well as higher variable costs and capacity utilization This information is very relevant in Colgate’s planning process 312 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com The importance of Colgate’s code of conduct can be measured several ways A search of the 2005 annual report indicates that “code of conduct” is mentioned times The following references give a good feel for the code of conduct priority at Colgate From page of the annual report: First formalized in 1996, Colgate’s “Guidelines on Significant Corporate Governance Issues” are reviewed annually to ensure that they are state-of-the-art Formal charters define the duties of each Board committee and guide their execution Colgate’s Corporate Governance Guidelines and all Committee Charters are available on our web site at www.colgate.com Additionally, the Board sponsors the Company’s Code of Conduct and Business Practices Guidelines, which promote the highest ethical standards in all of the Company’s business dealings.” From page 19 of the annual report: On an ongoing basis, management focuses on a variety of key indicators to monitor business health and performance These indicators include market share, sales (including volume, pricing and foreign exchange components), gross profit margin, operating profit, net income and earnings per share; and measures to optimize the management of working capital, capital expenditures, cash flow and return on capital The monitoring of these indicators, as well as the Company’s corporate governance practices (including the Company’s Code of Conduct), are used to ensure that business health and strong internal controls are maintained 313 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com As of February 2007, the latest new product is Colgate Max Fresh Cinnamint Toothpaste This appears to be a variation of an existing product The company displays its major product groups and major market regions using a moving heading page In February 2007, nine laundry conditioners were listed The information provided is sketchy with little differentiation made between the different conditioners The site gives no guidance as to when to use a product It basically provides a list and some advertising information on selected items The site does not indicate which conditioner is best for a particular fabric There is not enough information to select the best conditioner for specific laundry situation The company’s financial strategy is to continuously improve gross margin percentage, reduce overhead (sales, general, and administrative expenses), and increase advertising The income statement and other disclosures in the annual report provide sufficient data to evaluate the effectiveness of the company’s strategy By emphasizing high-profit-margin products, and implementing numerous cost reduction programs, the gross margin percentage has remained steady from 55.1% in 2004 to 54.4% in 2005 (from the comparative consolidated statements of income) Sales, general, and administrative expenses (a good surrogate for overhead) have also remained stable at 34.2% of sales to 34.4% of sales during this same period, even with higher advertising costs Advertising costs are included in sales, general, and administrative expenses The amount of advertising costs is not given in the footnotes or the financial statement Management’s letter, however, states that “in 2005, Colgate’s advertising spending was at a record high, up 12% 314 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com versus the prior year, led by a double-digit increase in media This is generating healthy volume and strong market share gains worldwide.” These results are the primary source supporting increased R & D and advertising for rapid new product development When all components of Colgate’s strategy are taken together, the company’s overall profitability improved as measured by net profit, which has increased by 1.8% from 1,327,100,000 in 2004 to 1,351,400,000 in 2005 315 ... from predatory and discriminatory pricing Predatory pricing involves setting prices so low that they drive competitors out of the market Discriminatory pricing is charging different prices to different... Revised total estimated cost 15,100,000 Revised total contribution to profit: $25,200,000 - $15,100,000 $10,100,000 Desired (target) contribution to profit $10,080,000 Excess contribution to profit... Factory supervisors' salaries Factory methods research Long-term rent, factory Fire insurance on equipment Property taxes on equipment Depreciation on equipment Factory superintendent's salary Total