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Solutions Manual, Chapter 2
19
Chapter 2
Managerial Accounting and Cost Concepts
Solutions to Questions
2-1
Managers carry out three major
activities in an organization: planning, directing
and motivating, and controlling. Planning
involves establishing a basic strategy, selecting a
course of action, and specifying how the action
will be implemented. Directing and motivating
involves mobilizing people to carry out plans and
run routine operations. Controlling involves
ensuring that the plan is actually carried out and
is appropriately modified as circumstances
change.
2-2
The planning and control cycle involves
formulating plans, implementing plans,
measuring performance, and evaluating
differences between planned and actual
performance.
2-3
In contrast to financial accounting,
managerial accounting: (1) focuses on the needs
of managers rather than outsiders; (2)
emphasizes decisions affecting the future rather
than the financial consequences of past actions;
(3) emphasizes relevance rather than objectivity
and verifiability; (4) emphasizes timeliness
rather than precision; (5) emphasizes the
segments of an organization rather than
summary data concerning the entire
organization; (6) is not governed by GAAP; and
(7) is not mandatory.
2-4
The three major elements of product
costs in a manufacturing company are direct
materials, direct labor, and manufacturing
overhead.
2-5
a. Direct materials are an integral part of a
finished product and their costs can be
conveniently traced to it.
b. Indirect materials are generally small
items of material such as glue and nails. They
may be an integral part of a finished product but
their costs can be traced to the product only at
great cost or inconvenience.
c. Direct labor consists of labor costs that
can be easily traced to particular products.
Direct labor is also called “touch labor.”
d. Indirect labor consists of the labor costs
of janitors, supervisors, materials handlers, and
other factory workers that cannot be
conveniently traced to particular products. These
labor costs are incurred to support production,
but the workers involved do not directly work on
the product.
e. Manufacturing overhead includes all
manufacturing costs except direct materials and
direct labor. Consequently, manufacturing
overhead includes indirect materials and indirect
labor as well as other manufacturing costs.
2-6
A product cost is any cost involved in
purchasing or manufacturing goods. In the case
of manufactured goods, these costs consist of
direct materials, direct labor, and manufacturing
overhead. A period cost is a cost that is taken
directly to the income statement as an expense
in the period in which it is incurred.
2-7
The income statement of a
manufacturing company differs from the income
statement of a merchandising company in the
cost of goods sold section. A merchandising
company sells finished goods that it has
purchased from a supplier. These goods are
listed as “purchases” in the cost of goods sold
section. Because a manufacturing company
produces its goods rather than buying them
from a supplier, it lists “cost of goods
manufactured” in place of “purchases.” Also, the
manufacturing company identifies its inventory

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20
Managerial Accounting, 13th Edition
in this section as Finished Goods inventory,
rather than as Merchandise Inventory.
2-8
The schedule of cost of goods
manufactured lists the manufacturing costs that
have been incurred during the period. These
costs are organized under the three categories
of direct materials, direct labor, and
manufacturing overhead. The total costs
incurred are adjusted for any change in the
Work in Process inventory to determine the cost
of goods manufactured (i.e. finished) during the
period.

The schedule of cost of goods
manufactured ties into the income statement
through the cost of goods sold section. The cost
of goods manufactured is added to the
beginning Finished Goods inventory to determine
the goods available for sale. In effect, the cost
of goods manufactured takes the place of the
Purchases account in a merchandising firm.
2-9
A manufacturing company usually has
three inventory accounts: Raw Materials, Work
in Process, and Finished Goods. A merchandising
company may have a single inventory account—
Merchandise Inventory.
2-10 Product costs are assigned to units as
they are processed and hence are included in
inventories. The flow is from direct materials,
direct labor, and manufacturing overhead to
Work in Process inventory. As goods are
completed, their cost is removed from Work in
Process inventory and transferred to Finished
Goods inventory. As goods are sold, their cost is
removed from Finished Goods inventory and
transferred to Cost of Goods Sold. Cost of Goods
Sold is an expense on the income statement.
2-11 Yes, costs such as salaries and
depreciation can end up as part of assets on the
balance sheet if they are manufacturing costs.
Manufacturing costs are inventoried until the
associated finished goods are sold. Thus, if some
units are still in inventory, such costs may be
part of either Work in Process inventory or
Finished Goods inventory at the end of the
period.
2-12 No. A variable cost is a cost that varies,
in total, in direct proportion to changes in the
level of activity. The variable cost per unit is
constant. A fixed cost is fixed in total, but the
average cost per unit changes with the level of
activity.
2-13 A differential cost is a cost that differs
between alternatives in a decision. An
opportunity cost is the potential benefit that is
given up when one alternative is selected over
another. A sunk cost is a cost that has already
been incurred and cannot be altered by any
decision taken now or in the future.
2-14 No, differential costs can be either
variable or fixed. For example, the alternatives
might consist of purchasing one machine rather
than another to make a product. The difference
between the fixed costs of purchasing the two
machines is a differential cost.

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Solutions Manual, Chapter 2
21
Exercise 2-1 (10 minutes)
1. Directing and motivating
2. Budgets
3. Planning
4. Precision; Timeliness
5. Managerial accounting; Financial accounting
6. Managerial accounting
7 Financial accounting; Managerial accounting
8. Feedback
9. Controller
10. Performance report

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22
Managerial Accounting, 13th Edition
Exercise 2-2 (10 minutes)
1. The cost of a hard drive installed in a computer: direct materials.

2. The cost of advertising in the Puget Sound Computer User newspaper:
selling.

3. The wages of employees who assemble computers from components:
direct labor.

4. Sales commissions paid to the company’s salespeople: selling.

5. The wages of the assembly shop’s supervisor: manufacturing overhead.

6. The wages of the company’s accountant: administrative.

7. Depreciation on equipment used to test assembled computers before
release to customers: manufacturing overhead.

8. Rent on the facility in the industrial park: a combination of
manufacturing overhead, selling, and administrative. The rent would
most likely be prorated on the basis of the amount of space occupied by
manufacturing, selling, and administrative operations.
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Solutions Manual, Chapter 2
23
Exercise 2-3 (15 minutes)



Product
Cost
Period
Cost
1. Depreciation on salespersons’ cars ........................

X
2. Rent on equipment used in the factory ..................
X

3. Lubricants used for machine maintenance .............
X

4. Salaries of personnel who work in the finished
goods warehouse ..............................................

X
5. Soap and paper towels used by factory workers at
the end of a shift ...............................................
X

6. Factory supervisors’ salaries ..................................
X

7. Heat, water, and power consumed in the factory ...
X

8. Materials used for boxing products for shipment
overseas (units are not normally boxed) .............

X
9. Advertising costs ..................................................

X
10. Workers’ compensation insurance for factory
employees .........................................................
X

11. Depreciation on chairs and tables in the factory
lunchroom .........................................................
X

12. The wages of the receptionist in the administrative
offices ...............................................................

X
13. Cost of leasing the corporate jet used by the
company's executives ........................................

X
14. The cost of renting rooms at a Florida resort for
the annual sales conference ...............................

X
15. The cost of packaging the company’s product ........
X


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24
Managerial Accounting, 13th Edition
Exercise 2-4 (15 minutes)
CyberGames
Income Statement




Sales ......................................................
$1,450,000
Cost of goods sold:


Beginning merchandise inventory ..........
$ 240,000

Add: Purchases ....................................
950,000

Goods available for sale ........................
1,190,000

Deduct: Ending merchandise inventory ..
170,000 1,020,000
Gross margin ..........................................

430,000
Selling and administrative expenses:


Selling expense ....................................
210,000

Administrative expense .........................
180,000
390,000
Net operating income ..............................

$ 40,000
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Solutions Manual, Chapter 2
25
Exercise 2-5 (15 minutes)
Lompac Products
Schedule of Cost of Goods Manufactured



Direct materials:


Beginning raw materials inventory...........
$ 60,000

Add: Purchases of raw materials .............
690,000

Raw materials available for use ...............
750,000

Deduct: Ending raw materials inventory ..
45,000

Raw materials used in production ............

$ 705,000
Direct labor ..............................................

135,000
Manufacturing overhead ............................

370,000
Total manufacturing costs .........................

1,210,000
Add: Beginning work in process inventory ..

120,000


1,330,000
Deduct: Ending work in process inventory ..

130,000
Cost of goods manufactured ......................
$1,200,000

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26
Managerial Accounting, 13th Edition
Exercise 2-6 (15 minutes)
A few of these costs may generate debate. For example, some may argue
that the cost of advertising a rock concert is a variable cost because the
number of people who come to the rock concert depends on the amount
of advertising. However, one can argue that if the price is within reason,
any rock concert in New York City will be sold out and the function of
advertising is simply to let people know the event will be happening.
Moreover, while advertising may affect the number of persons who
ultimately buy tickets, the causation is in one direction. If more people buy
tickets, the advertising costs don’t go up.



Cost Behavior

Cost (Measure of Activity)
Variable Fixed
1. The cost of X-ray film used in the radiology lab at
Virginia Mason Hospital in Seattle (Number of X-rays
taken) ....................................................................
X

2. The cost of advertising a rock concert in New York
City (Number of rock concert tickets sold) ................

X
3. The cost of renting retail space for a McDonald’s
restaurant in Hong Kong (Total sales at the
restaurant) .............................................................

X
4. The electrical cost of running a roller coaster at Magic
Mountain (Number of times the roller coaster is run)
X

5. Property taxes paid by your local cinema theater
(Number of tickets sold) ..........................................
X
6. The cost of sales commissions paid to salespersons at
a Nordstrom store (Total sales at the store) .............
X

7. Property insurance on a Coca Cola bottling plant
(Number of cases of bottles produced) ....................

X
8. The costs of synthetic materials used to make a
particular model of running shoe (Number of shoes
of that model produced) .........................................
X

9. The costs of shipping Panasonic televisions to retail
stores (Number of televisions sold) ..........................
X

10. The cost of leasing an ultra-scan diagnostic machine
at the American Hospital in Paris (Number of
patients scanned with the machine) .........................

X
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Solutions Manual, Chapter 2
27
Exercise 2-7 (15 minutes)


Cost
Cost Object
Direct
Cost
Indirect
Cost
1. The wages of pediatric
nurses
The pediatric
department
X

2. Prescription drugs
A particular patient
X

3. Heating the hospital
The pediatric
department

X
4. The salary of the head
of pediatrics
The pediatric
department
X

5. The salary of the head
of pediatrics
A particular pediatric
patient

X
6. Hospital chaplain’s
salary
A particular patient

X
7. Lab tests by outside
contractor
A particular patient
X

8. Lab tests by outside
contractor
A particular department
X


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Managerial Accounting, 13th Edition
Exercise 2-8 (15 minutes)

Item
Differential
Cost
Opportunity
Cost
Sunk
Cost
1. Cost of the old X-ray machine ...


X
2. The salary of the head of the
Radiology Department ............



3. The salary of the head of the
Pediatrics Department ............



4. Cost of the new color laser
printer ...................................
X


5. Rent on the space occupied by
Radiology ..............................



6. The cost of maintaining the old
machine ................................
X


7. Benefits from a new DNA
analyzer .................................

X

8. Cost of electricity to run the X-
ray machines .........................
X



Note: The costs of the salaries of the head of the Radiology Department
and Pediatrics Department and the rent on the space occupied by
Radiology are neither differential costs, nor opportunity costs, nor sunk
costs. These costs do not differ between the alternatives and therefore are
irrelevant in the decision, but they are not sunk costs because they occur
in the future.
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Solutions Manual, Chapter 2
29
Exercise 2-9 (15 minutes)
1. Product cost; variable cost
2. Conversion cost
3. Opportunity cost
4. Prime cost
5. Sunk cost
6. Period cost; variable cost
7. Product cost; period cost; fixed cost
8. Product cost
9. Period cost
10. Fixed cost; product cost; conversion cost


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30
Managerial Accounting, 13th Edition
Exercise 2-10 (15 minutes)



Selling and



Cost Behavior
Administrative Product
Cost Item
Variable
Fixed
Cost
Cost
1. Hamburger buns at a
Wendy’s outlet ........
X




X
2. Advertising by a
dental office ............

X

X


3. Apples processed and
canned by Del
Monte .....................
X




X
4. Shipping canned
apples from a Del
Monte plant to
customers ...............
X


X


5. Insurance on a Bausch
& Lomb factory
producing contact
lenses .....................

X



X
6. Insurance on IBM’s
corporate
headquarters ..........

X

X


7. Salary of a supervisor
overseeing
production of
printers at Hewlett-
Packard ..................

X



X
8. Commissions paid to
Encyclopedia
Britannica
salespersons ...........
X


X


9. Depreciation of factory
lunchroom facilities
at a General Electric
plant ......................

X



X
10. Steering wheels
installed in BMWs ....
X




X
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Solutions Manual, Chapter 2
31
Exercise 2-11 (30 minutes)
1.
Mason Company
Schedule of Cost of Goods Manufactured

Direct materials:


Beginning raw materials inventory ..................
$ 7,000

Add: Purchases of raw materials .....................
118,000

Raw materials available for use .......................
125,000

Deduct: Ending raw materials inventory ..........
15,000

Raw materials used in production ...................
$110,000
Direct labor ......................................................

70,000
Manufacturing overhead ...................................
80,000
Total manufacturing costs .................................
260,000
Add: Beginning work in process inventory ..........
10,000

270,000
Deduct: Ending work in process inventory .........
5,000
Cost of goods manufactured .............................
$265,000

2. The cost of goods sold section of Mason Company’s income statement:

Beginning finished goods inventory ............ $ 20,000
Add: Cost of goods manufactured .............. 265,000
Goods available for sale .............................
285,000
Deduct: Ending finished goods inventory .... 35,000
Cost of goods sold ..................................... $250,000

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32
Managerial Accounting, 13th Edition
Exercise 2-12 (30 minutes)
1. a. Batteries purchased ........................................................
8,000

Batteries drawn from inventory .......................................
7,600

Batteries remaining in inventory ......................................
400

Cost per battery..............................................................
× $10

Cost in Raw Materials Inventory at April 30 ......................
$4,000



b. Batteries used in production (7,600 – 100) .......................
7,500

Motorcycles completed and transferred to Finished Goods
(90% × 7,500) ............................................................
6,750

Motorcycles still in Work in Process at April 30 .................
750

Cost per battery..............................................................
× $10

Cost in Work in Process Inventory at April 30 ...................
$7,500



c. Motorcycles completed and transferred to Finished Goods
(see above) .................................................................
6,750

Motorcycles sold during the month
(70% × 6,750) ............................................................
4,725

Motorcycles still in Finished Goods at April 30 ...................
2,025

Cost per battery..............................................................
× $10

Cost in Finished Goods Inventory at April 30 .................... $20,250



d. Motorcycles sold during the month (above) ......................
4,725

Cost per battery..............................................................
× $10

Cost in Cost of Goods Sold at April 30 .............................. $47,250



e. Batteries used in salespersons’ motorcycles ......................
100

Cost per battery..............................................................
× $10

Cost in Selling Expense at April 30 ...................................
$ 1,000

2. Raw Materials Inventory—balance sheet
Work in Process Inventory—balance sheet
Finished Goods Inventory—balance sheet
Cost of Goods Sold—income statement
Selling Expense—income statement

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Solutions Manual, Chapter 2
33
Problem 2-13 (30 minutes)
Note to the Instructor: There may be some exceptions to the answers below. The purpose of this
problem is to get the student to start thinking about cost behavior and cost purposes; try to avoid
lengthy discussions about how a particular cost is classified.



Variable or Selling Administrative
Manufacturing
(Product) Cost

Cost Item
Fixed
Cost
Cost
Direct Indirect
1. Property taxes, factory ................................
F



X
2. Boxes used for packaging detergent
produced by the company .........................
V


X

3. Salespersons’ commissions ..........................
V
X



4. Supervisor’s salary, factory ..........................
F



X
5. Depreciation, executive autos ......................
F

X


6. Wages of workers assembling computers .....
V


X

7. Insurance, finished goods warehouses .........
F
X



8. Lubricants for production equipment ............
V



X
9. Advertising costs .........................................
F
X



10. Microchips used in producing calculators ......
V


X

11. Shipping costs on merchandise sold .............
V
X



12. Magazine subscriptions, factory lunchroom ...
F



X
13. Thread in a garment factory ........................
V



X
14. Billing costs ................................................
V
X*



15. Executive life insurance ...............................
F

X



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34
Managerial Accounting, 13th Edition
Problem 2-13 (continued)


Variable or Selling Administrative
Manufacturing
(Product) Cost

Cost Item
Fixed
Cost
Cost
Direct Indirect
16. Ink used in textbook production ...................
V



X
17. Fringe benefits, assembly-line workers .........
V


X**

18. Yarn used in sweater production ..................
V


X

19. Wages of receptionist, executive offices .......
F

X



* Could be administrative cost.
** Could be indirect cost.
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Solutions Manual, Chapter 2
35
Problem 2-14 (30 minutes)



Product Cost
Period
(Selling


Name of the Cost
Variable
Cost
Fixed
Cost
Direct
Materials
Direct
Labor
Manu-
facturing
Overhead
and
Admin)
Cost
Oppor-
tunity
Cost
Sunk
Cost
Rental revenue forgone, $30,000
per year .....................................






X

Direct materials cost, $80 per unit .
X

X





Rental cost of warehouse, $500
per month .................................

X



X


Rental cost of equipment, $4,000
per month .................................

X


X



Direct labor cost, $60 per unit .......
X


X




Depreciation of the annex space,
$8,000 per year .........................

X


X


X
Advertising cost, $50,000 per year .

X



X


Supervisor's salary, $1,500 per
month .......................................

X


X



Electricity for machines, $1.20 per
unit ...........................................
X



X



Shipping cost, $9 per unit .............
X




X


Return earned on investments,
$3,000 per year .........................






X


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36
Managerial Accounting, 13th Edition
Problem 2-15 (30 minutes)


Cost Behavior
To Units of Product

Cost Item
Variable
Fixed
Direct
Indirect
1. Electricity to run production equipment ....................
X



X
2. Rent on a factory building .......................................

X


X
3. Cloth used to make drapes ......................................
X


X

4. Production superintendent’s salary ...........................

X


X
5. Wages of laborers assembling a product ..................
X


X

6. Depreciation of air purification equipment used to
make furniture .....................................................

X


X
7. Janitorial salaries ....................................................

X


X
8. Peaches used in canning fruit ..................................
X


X

9. Lubricants for production equipment ........................
X



X
10. Sugar used in soft drink production ..........................
X


X

11. Property taxes on the factory ..................................

X


X
12. Wages of workers painting a product .......................
X


X

13. Depreciation on cafeteria equipment ........................

X


X
14. Insurance on a building used in producing
helicopters ...........................................................

X


X
15. Cost of rotor blades used in producing helicopters ....
X


X


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Solutions Manual, Chapter 2
37
Problem 2-16 (45 minutes)
1.
Swift Company

Schedule of Cost of Goods Manufactured

For the Month Ended August 31

Direct materials:


Raw materials inventory, August 1................. $ 8,000

Add: Purchases of raw materials .................... 165,000

Raw materials available for use ..................... 173,000

Deduct: Raw materials inventory, August 31 .. 13,000

Raw materials used in production ..................
$160,000
Direct labor .....................................................

70,000
Manufacturing overhead ..................................
85,000
Total manufacturing costs................................

315,000
Add: Work in process inventory, August 1 ........
16,000


331,000
Deduct: Work in process inventory, August 31 ..
21,000
Cost of goods manufactured ............................
$310,000

2.
Swift Company
Income Statement
For the Month Ended August 31

Sales ..............................................................
$450,000
Cost of goods sold:


Finished goods inventory, August 1 ............... $ 40,000

Add: Cost of goods manufactured ................. 310,000

Goods available for sale ................................ 350,000

Deduct: Finished goods inventory, August 31 . 60,000 290,000
Gross margin ..................................................
160,000
Selling and administrative expenses .................
142,000
Net operating income ......................................
$ 18,000


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38
Managerial Accounting, 13th Edition
Problem 2-16 (continued)
3. In preparing the income statement for August, Sam failed to distinguish
between product costs and period costs, and he also failed to recognize
the changes in inventories between the beginning and end of the
month. Once these errors have been corrected, the financial condition
of the company looks much better and selling the company may not be
advisable.
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Solutions Manual, Chapter 2
39
Problem 2-17 (15 minutes)
1. The controller is correct that the salary cost should be classified as a
selling (marketing) cost. The duties described in the problem have
nothing to do with manufacturing a product, but rather deal with
moving finished units from the factory to distribution warehouses.
Selling costs include all costs necessary to secure customer orders and
to get the finished product into the hands of customers. Coordination of
shipments of finished units from the factory to distribution warehouses
falls in this category.

2. No, the president is not correct. The reported net operating income for
the year will differ depending on how the salary cost is classified. If the
salary cost is classified as a selling expense all of it will appear on the
income statement as a period cost. However, if the salary cost is
classified as a manufacturing (product) cost, it will be added to Work in
Process inventory along with other manufacturing costs for the period.
To the extent that goods are still in process at the end of the period,
part of the salary cost will remain with these goods in the Work in
Process inventory account. Only that portion of the salary cost that has
been assigned to finished units will leave the Work in Process inventory
account and be transferred into the Finished Goods inventory account.
In like manner, to the extent that goods are unsold at the end of the
period, part of the salary cost will remain with these goods in the
Finished Goods inventory account. Only the portion of the salary that
has been assigned to finished units that are sold during the period will
appear on the income statement as an expense (part of Cost of Goods
Sold) for the period. The remainder of the salary costs will be on the
balance sheet as part of inventories.

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40
Managerial Accounting, 13th Edition
Problem 2-18 (45 minutes)
1.
Meriwell Company
Schedule of Cost of Goods Manufactured

Direct materials:


Raw materials inventory, beginning ...........
$ 9,000

Add: Purchases of raw materials ................
125,000

Raw materials available for use ..................
134,000

Deduct: Raw materials inventory, ending ...
6,000

Raw materials used in production ..............
$128,000
Direct labor .................................................

70,000
Manufacturing overhead ..............................
105,000
Total manufacturing costs ............................
303,000
Add: Work in process inventory, beginning ...
17,000

320,000
Deduct: Work in process inventory, ending ...
30,000
Cost of goods manufactured ........................
$290,000

2.
Meriwell Company
Income Statement

Sales ..........................................................
$500,000
Cost of goods sold:


Finished goods inventory, beginning .......... $ 20,000

Add: Cost of goods manufactured ..............
290,000

Goods available for sale ............................
310,000

Deduct: Finished goods inventory, ending ..
40,000
270,000
Gross margin ...............................................

230,000
Selling and administrative expenses:


Selling expenses .......................................
80,000

Administrative expenses ............................
110,000
190,000
Net operating income ..................................
$ 40,000
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Solutions Manual, Chapter 2
41
Problem 2-18 (continued)
3. Direct materials: $128,000 ÷ 10,000 units = $12.80 per unit.
Fixed manufacturing overhead: $90,000 ÷ 10,000 units = $9.00 per
unit.

4. Direct materials:
Unit cost: $12.80 (unchanged)
Total cost: 15,000 units × $12.80 per unit = $192,000.

Fixed manufacturing overhead:
Unit cost: $90,000 ÷ 15,000 units = $6.00 per unit.
Total cost: $90,000 (unchanged)

5. Unit cost for fixed manufacturing overhead dropped from $9.00 to
$6.00, because of the increase in production between the two years.
Because fixed costs do not change in total as the activity level changes,
they will decrease on a unit basis as the activity level rises.


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42
Managerial Accounting, 13th Edition
Problem 2-19 (45 minutes)
1.

Cost Behavior
Selling or
Administrative
Product Cost
Cost Item
Variable
Fixed
Cost
Direct
Indirect
Factory labor, direct ..................
$118,000


$118,000

Advertising ................................

$50,000
$50,000


Factory supervision ....................

40,000

$40,000
Property taxes, factory building ..

3,500


3,500
Sales commissions .....................
80,000

80,000


Insurance, factory .....................

2,500


2,500
Depreciation, administrative
office equipment .....................

4,000
4,000


Lease cost, factory equipment ....

12,000


12,000
Indirect materials, factory ..........
6,000



6,000
Depreciation, factory building .....

10,000


10,000
Administrative office supplies .....
3,000

3,000


Administrative office salaries ......

60,000
60,000


Direct materials used .................
94,000


94,000

Utilities, factory .........................
20,000



20,000
Total costs ................................
$321,000 $182,000
$197,000
$212,000 $94,000

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Solutions Manual, Chapter 2
43
Problem 2-19 (continued)
2.
Direct .................................................
$212,000
Indirect ...............................................
94,000
Total ...................................................
$306,000
$306,000 ÷ 2,000 sets = $153 per set


3. The average product cost per set would increase if the production
drops. This is because the fixed costs would be spread over fewer units,
causing the average cost per unit to rise.

4. a. Yes, the president may expect a minimum price of $153, which is the
average cost to manufacture one set. He might expect a price even
higher than this to cover a portion of the administrative costs as well.
The brother-in-law probably is thinking of cost as including only
direct materials, or, at most, direct materials and direct labor. Direct
materials alone would be only $47 per set, and direct materials and
direct labor would be only $106.

b. The term is opportunity cost. The full, regular price of a set might be
appropriate here, because the company is operating at full capacity,
and this is the amount that must be given up (benefit forgone) to sell
a set to the brother-in-law.


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44
Managerial Accounting, 13th Edition
Problem 2-20 (30 minutes)
1.



Product Cost
Period
(Selling


Name of the Cost
Variable
Cost
Fixed
Cost
Direct
Materials
Direct
Labor
Manuf.
Overhead
and
Admin)
Cost
Oppor-
tunity
Cost
Sunk
Cost
Staci's current salary, $3,800
per month ...........................

X




X

Building rent, $500 per month .

X


X



Clay and glaze, $2 per pot .......
X

X





Wages of production workers,
$8 per pot ...........................
X


X




Advertising, $600 per month ...

X



X


Sales commission, $4 per pot ..
X




X


Rent of production
equipment, $300 per month .

X


X



Legal and filing fees, $500 ......

X



X

X
Rent of sales office, $250 per
month .................................

X



X


Phone for taking orders, $40
per month ...........................

X



X


Interest lost on savings
account, $1,200 per year ..

X




X


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Solutions Manual, Chapter 2
45
Problem 2-20 (continued)
2. The $500 cost of incorporating the business is not a differential cost.
Even though the cost was incurred to start the business, it is a sunk
cost. Whether Staci produces pottery or stays in her present job, she
will have incurred this cost.


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46
Managerial Accounting, 13th Edition
Problem 2-21 (60 minutes)
1.
Superior Company
Schedule of Cost of Goods Manufactured
For the Year Ended December 31
Direct materials:



Raw materials inventory, beginning (given) $ 40,000


Add: Purchases of raw materials (given) ....
290,000


Raw materials available for use .................
330,000


Deduct: Raw materials inventory, ending
(given) ..................................................
10,000


Raw materials used in production ..............
$320,000
Direct labor .................................................

93,000 *
Manufacturing overhead (given)...................
270,000
Total manufacturing costs (given) ................
683,000
Add: Work in process inventory, beginning ...
42,000 *


725,000
Deduct: Work in process inventory, ending
(given) .....................................................
35,000

Cost of goods manufactured ........................
$690,000

The cost of goods sold section of the income statement follows:

Finished goods inventory, beginning (given) .
$ 50,000
Add: Cost of goods manufactured ................
690,000 *
Goods available for sale (given) ...................
740,000
Deduct: Finished goods inventory, ending ....
80,000 *
Cost of goods sold (given) ...........................
$660,000

* These items must be computed by working backwards up through the
statements.

2. Direct materials: $320,000 ÷ 40,000 units = $8.00 per unit.
Manufacturing overhead: $270,000 ÷ 40,000 units = $6.75 per unit.

3. Direct materials: $8.00 per unit.
Manufacturing overhead: $270,000 ÷ 50,000 units = $5.40 per unit.

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Solutions Manual, Chapter 2
47
Problem 2-21 (continued)
4. The average cost per unit for manufacturing overhead dropped from
$6.75 to $5.40 because of the increase in production between the two
years. Because fixed costs do not change in total as the activity level
changes, the average cost per unit will decrease as the activity level
rises.

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48
Managerial Accounting, 13th Edition
Problem 2-22 (30 minutes)
1. A cost that is classified as a period cost will be recognized on the
income statement as an expense in the current period. A cost that is
classified as a product cost will be recognized on the income statement
as an expense (i.e., cost of goods sold) only when the associated units
of product are sold. If some units are unsold at the end of the period,
the costs of those unsold units are treated as assets. Therefore, by
reclassifying period costs as product costs, the company is able to carry
some costs forward in inventories that would have been treated as
current expenses.

2. The discussion below is divided into two parts—Gallant’s actions to
postpone expenditures and the actions to reclassify period costs as
product costs.

The decision to postpone expenditures is questionable. It is one thing to
postpone expenditures due to a cash bind; it is quite another to
postpone expenditures in order to hit a profit target. Postponing these
expenditures may have the effect of ultimately increasing future costs
and reducing future profits. If orders to the company’s suppliers are
changed, it may disrupt the suppliers’ operations. The additional costs
may be passed on to Gallant’s company and may create ill will and a
feeling of mistrust. Postponing maintenance on equipment is particularly
questionable. The result may be breakdowns, inefficient and/or unsafe
operations, and a shortened life for the machinery.

Interestingly, in a survey of 649 managers reported in Management
Accounting, only 12% stated that it is unethical to defer expenses and
thereby manipulate quarterly earnings. The proportion who felt it was
unethical increased to 24% when it involved annual earnings. Another
41% said that deferring expenses is a questionable practice when it
involved quarterly reports and 35% said this when annual reports were
involved. Finally, 47% said that it is completely ethical to manipulate
quarterly reports in this way and 41% gave the green light for annual
reports. (See William J. Bruns, Jr. and Kenneth A. Merchant, “The
Dangerous Morality of Managing Earnings,” Management Accounting,
August 1990, pp. 22-25)
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Solutions Manual, Chapter 2
49
Problem 2-22 (continued)
Gallant’s decision to reclassify period costs is not ethical—assuming that
there is no intention of disclosing in the financial reports this
reclassification. Such a reclassification would be a violation of the
principle of consistency in financial reporting and is a clear attempt to
mislead readers of the financial reports. Although some may argue that
the overall effect of Gallant’s action will be a “wash”—that is, profits
gained in this period will simply be taken from the next period—the
trend of earnings will be affected. Hopefully, the auditors would
discover any such attempt to manipulate annual earnings and would
refuse to issue an unqualified opinion due to the lack of consistency.
However, recent accounting scandals may lead to some skepticism
about how forceful auditors have been in enforcing tight accounting
standards.


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50
Managerial Accounting, 13th Edition
Problem 2-23 (20 minutes)


Direct or Indirect
Cost of the Meals-
On-Wheels
Program

Direct or Indirect
Cost of Particular
Seniors Served
by the Meals-On-
Wheels Program
Variable or Fixed
with Respect to the
Number of Seniors
Served by the
Meals-On-Wheels
Program
Item
Description
Direct
Indirect
Direct
Indirect Variable
Fixed
a. The cost of leasing the meals-on-wheels van .....
X



X


X
b. The cost of incidental supplies such as salt,
pepper, napkins, and so on ............................
X



X*

X

c. The cost of gasoline consumed by the meals-on-
wheels van....................................................
X



X

X

d. The rent on the facility that houses Madison
Seniors Care Center, including the meals-on-
wheels program ............................................

X


X*


X
e. The salary of the part-time manager of the
meals-on-wheels program ..............................
X



X


X
f. Depreciation on the kitchen equipment used in
the meals-on-wheels program ........................
X



X


X
g. The hourly wages of the caregiver who drives
the van and delivers the meals .......................
X


X


X

h. The costs of complying with health safety
regulations in the kitchen ...............................
X



X


X
i. The costs of mailing letters soliciting donations
to the meals-on-wheels program ....................
X



X


X

*These costs could be direct costs of serving particular seniors.
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51
Problem 2-24 (60 minutes)
1.
Visic Corporation
Schedule of Cost of Goods Manufactured

Direct materials:


Raw materials inventory, beginning ..................... $ 20,000

Add: Purchases of raw materials .......................... 480,000

Raw materials available for use ........................... 500,000

Deduct: Raw materials inventory, ending ............. 30,000

Raw materials used in production ........................
$470,000
Direct labor ...........................................................

90,000
Manufacturing overhead ........................................
300,000
Total manufacturing costs ......................................
860,000
Add: Work in process inventory, beginning .............
50,000

910,000
Deduct: Work in process inventory, ending .............
40,000
Cost of goods manufactured ..................................
$870,000

2. a. To compute the number of units in the finished goods inventory at
the end of the year, we must first compute the number of units sold
during the year.
Total sales
$1,300,000
=
= 26,000 units sold
Unit selling price
$50 per unit sold

Units in the finished goods inventory, beginning ...
0
Units produced during the year ............................
29,000
Units available for sale .........................................
29,000
Units sold during the year (above) ......................
26,000
Units in the finished goods inventory, ending ........
3,000

b. The average production cost per unit during the year is:

g
Cost of oods manufactured
$870,000
=
= $30 per unit
Number of units produced
29,000 units

Thus, the cost of the units in the finished goods inventory at the end
of the year is: 3,000 units × $30 per unit = $90,000.

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52
Managerial Accounting, 13th Edition
Problem 2-24 (continued)
3.
Visic Corporation
Income Statement





Sales ...........................................................

$1,300,000

Cost of goods sold:



Finished goods inventory, beginning ........... $ 0


Add: Cost of goods manufactured ..............
870,000


Goods available for sale .............................
870,000


Finished goods inventory, ending ...............
90,000
780,000

Gross margin ...............................................

520,000

Selling and administrative expenses ..............

380,000

Net operating income ...................................
$ 140,000

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53
Problem 2-25 (45 minutes)

Case 1
Case 2
Case 3
Case 4

Direct materials ...................................... $ 4,500
$ 6,000 $ 5,000 $ 3,000
Direct labor ............................................
9,000 *
3,000
7,000
4,000
Manufacturing overhead ..........................
5,000
4,000
8,000 * 9,000
Total manufacturing costs .......................
18,500
13,000 * 20,000
16,000 *
Beginning work in process inventory ........
2,500
2,000 *
3,000
4,500 *
Ending work in process inventory ............ (3,000) *
(1,000)
(4,000)
(3,000)
Cost of goods manufactured .................... $18,000
$14,000 $19,000 * $17,500






Sales ...................................................... $30,000
$21,000 $36,000 $40,000
Beginning finished goods inventory ..........
1,000
2,500
3,500 *
2,000
Cost of goods manufactured ....................
18,000
14,000
19,000 * 17,500
Goods available for sale ..........................
19,000 *
16,500 * 22,500 * 19,500 *
Ending finished goods inventory .............. (2,000) *
(1,500)
(4,000)
(3,500)
Cost of goods sold ..................................
17,000
15,000 * 18,500
16,000 *
Gross margin ..........................................
13,000
6,000 * 17,500
24,000 *
Selling and administrative expenses ......... (9,000) *
(3,500)
(12,500) * (15,000) *
Net operating income .............................. $ 4,000
$ 2,500 * $ 5,000 $ 9,000
* Missing data in the problem.


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54
Managerial Accounting, 13th Edition
Case 2-26 (60 minutes)
The following cost items are needed before a schedule of cost of goods
manufactured can be prepared:


Materials used in production:
Prime cost .................................................. $410,000
Less direct labor cost ..................................
180,000
Direct materials cost ................................... $230,000


Manufacturing overhead cost:
Direct labor cost
$180,000
=
Percentage of conversion cost
30%*
= $600,000 total conversion cost

*100% – 70% = 30%.

Conversion cost .......................................... $600,000
Less direct labor cost ..................................
180,000
Manufacturing overhead cost ....................... $420,000


Cost of goods manufactured:
Goods available for sale .............................. $810,000
Less finished goods inventory, beginning ..... 45,000
Cost of goods manufactured ........................ $765,000

The easiest way to proceed from this point is to place all known amounts
in a partially completed schedule of cost of goods manufactured and a
partially completed income statement. Then fill in the missing amounts by
analysis of the available data.
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55
Case 2-26 (continued)
Direct materials:

Raw materials inventory, beginning ....................... $ 18,000
Add: Purchases of raw materials ............................ 290,000
Raw materials available for use .............................. 308,000
Deduct: Raw materials inventory, ending ............... A
Raw materials used in production (see above) ........ 230,000
Direct labor cost ...................................................... 180,000
Manufacturing overhead cost (see above) ................. 420,000
Total manufacturing costs ........................................ 830,000
Add: Work in process inventory, beginning ............... 65,000

895,000
Deduct: Work in process inventory, ending ............... B
Cost of goods manufactured (see above) .................. $765,000

Therefore, “A” (Raw materials inventory, ending) is $78,000; and “B”
(Work in process inventory, ending) is $130,000.

Sales ...............................................................
$1,200,000
Cost of goods sold:


Finished goods inventory, beginning ............... $ 45,000

Add: Cost of goods manufactured (see above) 765,000

Goods available for sale .................................
810,000

Deduct: Finished goods inventory, ending .......
C 720,000
Gross margin ....................................................
$ 480,000

*$1,200,000 × (100% – 40%) = $720,000.

Therefore, “C” (Finished goods inventory, ending) is $90,000. The
procedure outlined above is just one way in which the solution to the
case can be approached. Some may wish to start at the bottom of the
income statement (with gross margin) and work upwards from that
point. Also, the solution can be obtained by use of T-accounts.

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Managerial Accounting, 13th Edition
Case 2-27 (60 minutes)
1. No distinction has been made between period expenses and product
costs on the income statement filed by the company’s accountant.
Product costs (e.g., direct materials, direct labor, and manufacturing
overhead) should be assigned to inventory accounts and flow through
to the income statement as cost of goods sold only when finished
products are sold. Because there were ending inventories, some of the
product costs should appear on the balance sheet as assets rather than
on the income statement as expenses.

2.
Solar Technology, Inc.
Schedule of Cost of Goods Manufactured
For the Quarter Ended March 31


Direct materials:



Raw materials inventory, beginning .............. $ 0


Add: Purchases of raw materials ...................
360,000


Raw materials available for use ....................
360,000


Deduct: Raw materials inventory, ending ...... 10,000


Raw materials used in production .................
$350,000

Direct labor ....................................................

70,000
Manufacturing overhead .................................

410,000

Total manufacturing costs...............................

830,000

Add: Work in process inventory, beginning ......

0



830,000

Deduct: Work in process inventory, ending ......

50,000

Cost of goods manufactured ...........................
$780,000
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Solutions Manual, Chapter 2
57
Case 2-27 (continued)
3. Before an income statement can be prepared, the cost of the 8,000
batteries in the ending finished goods inventory must be determined.
Altogether, the company produced 40,000 batteries during the quarter;
thus, the production cost per battery was:

Cost of goods manufactured
$780,000
=
=$19.50 per unit
Batteries produced during the quarter 40,000 units

Because 8,000 batteries (40,000 – 32,000 = 8,000) were in the finished
goods inventory at the end of the quarter, the total cost of this
inventory was:
8,000 units × $19.50 per unit = $156,000.
With this and other data from the case, the company’s income
statement for the quarter can be prepared as follows:


Solar Technology, Inc.
Income Statement
For the Quarter Ended March 31



Sales (32,000 batteries) ..............................
$960,000
Cost of goods sold:


Finished goods inventory, beginning ......... $ 0

Add: Cost of goods manufactured ........... 780,000

Goods available for sale ............................ 780,000

Deduct: Finished goods inventory, ending . 156,000 624,000
Gross margin ..............................................
336,000
Selling and administrative expenses .............
290,000
Net operating income .................................
$ 46,000

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Managerial Accounting, 13th Edition
Case 2-27 (continued)
4. No, the insurance company probably does not owe Solar Technology
$226,000. The key question is how “cost” was defined in the insurance
contract. It is most likely that the insurance contract limits
reimbursement for losses to those costs that would normally be
considered product costs—in other words, direct materials, direct labor,
and manufacturing overhead. The $226,000 is overstated because it
includes elements of selling and administrative expenses as well as
product costs. The $226,000 also does not recognize that some costs
incurred during the period are in the ending Raw Materials and Work in
Process inventory accounts, as explained in part (1) above. The
insurance company’s liability is probably just $156,000, which is the
amount of cost associated with the ending Finished Goods inventory as
shown in part (3) above.
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59
Research and Application 2-28
1. Dell succeeds because of its operational excellence customer value
proposition. Page 1 of the 10-K (under the heading Business Strategy)
lists the key tenets of Dell’s business strategy. The first three tenets
focus on operational excellence. The first tenet discusses the direct
business model, which “eliminates wholesale and retail dealers that add
unnecessary time and cost or diminish Dell’s understanding of customer
expectations.” The second tenet is Dell’s build-to-order manufacturing
process that “enables Dell to turn over inventory every four days on
average, and reduce inventory levels.” The third tenet is “Dell’s
relentless focus on reducing its costs [which] allows it to consistently
provide customers with superior value.” Also, the first bullet point on
Page 8 of the 10-K says “Dell’s success is based on its ability to
profitably offer its products at a lower price than its competitors.”

2. Dell faces numerous business risks as described in pages 7-10 of the
10-K. Students may mention other risks beyond those specifically
mentioned in the 10-K. Here are four risks faced by Dell with suggested
control activities:

 Risk: Profits may fall short if Dell’s product, customer, and
geographic mix is substantially different than anticipated. Control
activities: Maintain a budgeting program that forecasts sales by
product line, customer segment, and geographic region. While the
budget is not going to be perfectly accurate, a reasonably accurate
forecast would help Dell manage investor expectations.
 Risk: Disruptions in component availability from suppliers could
reduce Dell’s ability to meet customer orders. This is of particular
concern for Dell because its lean production practices result in
minimal inventory levels and because Dell relies on several single-
sourced suppliers. Control activities: Develop a plan with single-
sourced suppliers to ensure that they can produce the necessary
components at more than one plant location and to ensure that each
location has more than one means of delivering the parts to Dell’s
assembly facilities.

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Managerial Accounting, 13th Edition
Research and Application 2-28 (continued)
 Risk: Infrastructure failures (e.g., computer viruses, intentional
disruptions of IT systems and website outages) may threaten Dell’s
ability to book or process orders, manufacture products, or ship
products in a timely manner. Control activities: Install controls such
as physical security, data storage backup sites, firewalls and
passwords that protect technology assets.
 Risk: Losing government contracts could adversely affect the
company’s revenues. Control activities: Develop a formal review
process, supervised by legal counsel, to ensure that Dell complies
with governmental regulations.

3. Pages 34-35 of Dell’s Form 10-K contain the audit report issued by
PricewaterhouseCoopers (PWC). The audit report makes reference to
the role of the Public Company Accounting Oversight Board (PCAOB)
that was created by the Sarbanes-Oxley Act of 2002 (SOX). The audit
report also contains two opinions dealing with internal control. The first
opinion relates to management’s assessment of its internal controls. The
second opinion relates to the auditor’s assessment of the effectiveness
of Dell’s internal controls. These two opinions were required by SOX at
the time of this 10-K filing. Page 59 includes management’s report on
internal control over financial reporting. This report includes a reference
to SOX. Finally, pages 76-78 contain signed certifications from the CEO
(Kevin Rollins) and the CFO (James Schneider). SOX requires the CEO
and CFO to certify that the 10-K and its accompanying financial
statements do not contain any untrue statements and are fairly stated
in all material respects.

4. Based solely on the inventories number on the balance sheet,
students cannot determine the answer to this question. Furthermore,
given that Dell’s total amount of inventories is so small, the company
does not report the break down of its inventories between raw
materials, work-in-process, and finished goods. Nonetheless, students
should be able to readily ascertain that Dell is a manufacturer. Page 2
of the 10-K says “Dell designs, develops, manufactures, markets, sells,
and supports a wide range of products that are customized to customer
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requirements.” Page 5 states “Dell’s manufacturing process consists of
assembly,

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62
Managerial Accounting, 13th Edition
Research and Application 2-28 (continued)

software installation, functional testing, and quality control.” Page 7
states that Dell has manufacturing facilities in Austin, Texas, Eldorado
do Sul, Brazil, Nashville and Lebanon, Tennessee, Limerick, Ireland,
Penang, Malaysia, and Xiamen, China.

5. Examples of direct inventoriable costs include the component parts that
go into making Dell’s main product families, which include enterprise
systems, client systems, printing and imaging systems, software, and
peripherals. The “touch” laborers that work in each of the
aforementioned plants would also be a direct inventoriable cost.
Examples of indirect inventoriable costs include the costs to sustain the
manufacturing plants that cannot be conveniently traced to specific
products. The utility bills, insurance premiums, plant management
salaries, and equipment-related costs, etc. that are incurred to sustain
plant operations would all be indirect inventoriable costs.

The gross margin (in dollars) has steadily increased and the gross
margin as a percent of sales has remained fairly steady for two reasons.
First, the cost of goods sold consists largely of variable costs (e.g.,
direct materials and direct labor costs). As sales grow, these variable
costs increase in total, but as a percentage of sales, they remain fairly
stable over time.

Some students may ask about the fixed overhead costs that are
incurred to run the plants. Spreading fixed overhead costs over a higher
volume of sales would increase the gross margin percentage. However,
the fixed overhead costs are relatively small in relation to the dollar
value of raw materials that flows through Dell’s plants each year.

Second, pages 22-23 mention that Dell plans to reduce product costs in
four areas: manufacturing costs, warranty costs, design costs, and
overhead costs. The company says that its “general practice is to
aggressively pass on declines in costs to its customers in order to add
customer value while increasing global market share.” In other words,
rather than holding price constant when costs decline, thereby
increasing the gross margin percentage, the company lowers prices.
Using terminology that will be defined in Chapter 12, Dell grows profits
by increasing turnover while holding margin reasonably constant.
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