Variable costs and activity bases in decision making
Sales volume has been dropping at Pinnacle Publishing Company. During this time, however, the Shipping Department manager has been under severe financial constraints. The manager knows that most of the Shipping Department's effort is related to pulling inventory from the warehouse for each order and performing the paperwork. The paperwork involves preparing shipping documents for each order. Thus, the pulling and paperwork effort associated with each sales order is essentially the same, regardless of the size of the order. The Shipping Department manager has discussed the financial situation with senior management. Senior management has responded by pointing out that sales volume has been dropping, so that the amount of work in the Shipping Department should be dropping. Thus, senior management told the Shipping Department manager that costs should be decreasing in the department.
The Shipping Department manager prepared the following information:
Given this information, how would you respond to senior management?
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Survey of Accounting (Accounting I)
- Flexible budgeting, performance measurement, and ethics Montevideo Manufacturing, Inc. produces a single type of small motor. The bookkeeper who does not have an in-depth understanding of accounting principles prepared the following performance report with the help of the production manager. In a conversation with the sales manager, the production manager was overheard saying, You sales guys really messed up our May performance, and it is only because production did such a great job controlling costs that we arent in even worse shape. Required: 1. Do you agree with the production manager that the manufacturing area did a good job of controlling costs? 2. Prepare a flexible budget for Montevideo Manufacturings expenses at the following activity levels: 45,000 units, 50,000 units, and 55,000 units. 3. Prepare a revised performance report, using the most appropriate flexible budget from (2) above. 4. Now what is your response to the production managers claim? 5. Assume that you have just been hired as the new accountant. You observe that the production manager is about to receive a large bonus based on the favorable materials, labor, and factory overhead variances indicated in the flexible budget prepared by the bookkeeper. Using the IMA Statement of Ethical Professional Practice as your guide, what standards, if any, apply to your responsibilities in this matter?arrow_forwardEvaluating selling and administrative cost allocations Gordon Gecco Furniture Company has two major product lines with the following characteristics: Commercial office furniture: Few large orders, little advertising support, shipments in full truckloads, and low handling complexity Home office furniture: Many small orders, large advertising support, shipments in partial truckloads, and high handling complexity The company produced the following profitability report for management: The selling and administrative expenses are allocated to the products on the basis of relative sales dollars. Evaluate the accuracy of this report and recommend an alternative approach.arrow_forwardAssume you are the warehouse manager for Vinnies Vinyls, a multi-location business specializing in vinyl records. Vinniess operates under a cost-based transfer structure and the warehouse supplies all stores with the records. The stores can purchase records only from the warehouse, and the warehouse can only sell to Vinnies stores. The manager of the West store has some concerns relating to the stores financial performance and has asked for your help analyzing transfer costs. After calculating the operating income in dollars and the operating income percent, analyze the following financial information to determine costs that may need further investigation. (Hint: it may be helpful to perform a vertical analysis.)arrow_forward
- Suspicious Acquisition of Data, Ethical Issues Bill Lewis, manager of the Thomas Electronics Division, called a meeting with his controller, Brindon Peterson, and his marketing manager, Patty Fritz. The following is a transcript of the conversation that took place during the meeting: Bill: Brindon, the variable costing system that you developed has proved to be a big plus for our division. Our success in winning bids has increased, and as a result our revenues have increased by 25%. However, if we intend to meet this years profit targets, we are going to need something extraam I right, Patty? Patty: Absolutely. While we have been able to win more bids, we still are losing too many, particularly to our major competitor, Kilborn Electronics. If we knew more about their bidding strategy, we could be more successful at competing with them. Brindon: Would knowing their variable costs help? Patty: Certainly. It would give me their minimum price. With that knowledge, Im sure that we could find a way to beat them on several jobs, particularly on those jobs where we are at least as efficient. It would also help us to identify where we are not cost competitive. With this information, we might be able to find ways to increase our efficiency. Brindon: Well, I have good news. Ive been talking with Carl Penobscot, Kilborns assistant controller. Carl doesnt feel appreciated by Kilborn and wants to make a change. He could easily fit into our team here. Plus, Carl has been preparing for a job switch by quietly copying Kilborns accounting files and records. Hes already given me some data that reveal bids that Kilborn made on several jobs. If we can come to a satisfactory agreement with Carl, hell bring the rest of the information with him. Well easily be able to figure out Kilborns prospective bids and find ways to beat them. Besides, I could use another accountant on my staff. Bill, would you authorize my immediate hiring of Carl with a favorable compensation package? Bill: I know that you need more staff, Brindon, but is this the right thing to do? It sounds like Carl is stealing those files, and surely Kilborn considers this information confidential. I have real ethical and legal concerns about this. Why dont we meet with Laurie, our attorney, and determine any legal problems? Required: 1. Is Carls behavior ethical? What would Kilborn think? 2. Is Bill correct in supposing that there are ethical and/or legal problems involved with the hiring of Carl? (Reread the section on corporate codes of conduct in Chapter 1.) What would you do if you were Bill? Explain.arrow_forwardRizzo Goal Inc. produces and sells hockey equipment, often custom made for online orders. The company has the following performance metrics on its balanced scorecard: days from ordered to delivered, number of shipping errors, customer retention rate, and market share. A measure map illustrates that the days from ordered to delivered and the number of shipping errors are both expected to directly affect the customer retention rate, which affects market share. Additional internal analysis finds that: Every shipping error over three shipping errors per month reduces the customer retention rate by 1.5%. On average, each day above three days from ordered to delivered yields a reduction in the customer retention rate of 1%. Each day before three days from order to delivery yields an increase in the customer retention rate of 1%, on average. Rizzo Goal Inc.s current customer retention rate is 60%. The company estimates that for every 1% increase or decrease in the customer retention rate, market share changes 0.5% in the same direction. Rizzo Goal Inc.s current market share is 21.4%. Ignoring any other factors, if the company has six shipping errors this month and an average of 3.5 days from ordered to delivered, determine (a) the new customer retention rate and (b) the new market share that Rizzo Goal Inc. expects to have.arrow_forwardKimball Company has developed the following cost formulas: Materialusage:Ym=80X;r=0.95Laborusage(direct):Yl=20X;r=0.96Overheadactivity:Yo=350,000+100X;r=0.75Sellingactivity:Ys=50,000+10X;r=0.93 where X=Directlaborhours The company has a policy of producing on demand and keeps very little, if any, finished goods inventory (thus, units produced equals units sold). Each unit uses one direct labor hour for production. The president of Kimball Company has recently implemented a policy that any special orders will be accepted if they cover the costs that the orders cause. This policy was implemented because Kimballs industry is in a recession and the company is producing well below capacity (and expects to continue doing so for the coming year). The president is willing to accept orders that minimally cover their variable costs so that the company can keep its employees and avoid layoffs. Also, any orders above variable costs will increase overall profitability of the company. Required: 1. Compute the total unit variable cost. Suppose that Kimball has an opportunity to accept an order for 20,000 units at 220 per unit. Should Kimball accept the order? (The order would not displace any of Kimballs regular orders.) 2. Explain the significance of the coefficient of correlation measures for the cost formulas. Did these measures have a bearing on your answer in Requirement 1? Should they have a bearing? Why or why not? 3. Suppose that a multiple regression equation is developed for overhead costs: Y = 100,000 + 100X1 + 5,000X2 + 300X3, where X1 = direct labor hours, X2 = number of setups, and X3 = engineering hours. The coefficient of determination for the equation is 0.94. Assume that the order of 20,000 units requires 12 setups and 600 engineering hours. Given this new information, should the company accept the special order referred to in Requirement 1? Is there any other information about cost behavior that you would like to have? Explain.arrow_forward
- In 20X1, Don Blackburn, president of Price Electronics, received a report indicating that quality costs were 31% of sales. Faced with increasing pressures from imported goods. Don resolved to take measures to improve the overall quality of the companys products. After hiring a consultant in 20X1, the company began an aggressive program of total quality control. At the end of 20X5, Don requested an analysis of the progress the company had made in reducing and controlling quality costs. The accounting department assembled the following data: Required: 1. Compute the quality costs as a percentage of sales by category and in total for each year. 2. Prepare a multiple-year trend graph for quality costs, both by total costs and by category. Using the graph, assess the progress made in reducing and controlling quality costs. Does the graph provide evidence that quality has improved? Explain. 3. Using the 20X1 quality cost relationships (assume all costs are variable), calculate the quality costs that would have prevailed in 20X4. By how much did profits increase in 20X4 because of the quality improvement program? Repeat for 20X5.arrow_forwardKathy Shorts, president of Oliver Company, was concerned with the trend in sales and profitability. The company had been losing customers at an alarming rate. Furthermore, the company was barely breaking even. Investigation revealed that poor quality was at the root of the problem. At the end of 20x5, Kathy decided to begin a quality improvement program. As a first step, she identified the following costs in the accounting records as quality related: Required: 1. Prepare a quality cost report by quality cost category. 2. Calculate the relative distribution percentages for each quality cost category. Comment on the distribution. 3. Using the Taguchi loss function, an average loss per unit is computed to be 15 per unit. What are the hidden costs of external failure? How does this affect the relative distribution? 4. Shortss quality manager decided not to bother with the hidden costs. What do you think was his reasoning? Any efforts to reduce measured external failure costs will also reduce the hidden costs. Do you agree or disagree? Explain.arrow_forwardJolene Askew, manager of Feagan Company, has committed her company to a strategically sound cost reduction program. Emphasizing life-cycle cost management is a major part of this effort. Jolene is convinced that production costs can be reduced by paying more attention to the relationships between design and manufacturing. Design engineers need to know what causes manufacturing costs. She instructed her controller to develop a manufacturing cost formula for a newly proposed product. Marketing had already projected sales of 25,000 units for the new product. (The life cycle was estimated to be 18 months. The company expected to have 50 percent of the market and priced its product to achieve this goal.) The projected selling price was 20 per unit. The following cost formula was developed: Y=200,000+10X1 where X1=Machinehours(Theproductisexpectedtouseonemachinehourforeveryunitproduced.) Upon seeing the cost formula, Jolene quickly calculated the projected gross profit to be 50,000. This produced a gross profit of 2 per unit, well below the targeted gross profit of 4 per unit. Jolene then sent a memo to the Engineering Department, instructing them to search for a new design that would lower the costs of production by at least 50,000 so that the target profit could be met. Within two days, the Engineering Department proposed a new design that would reduce unit-variable cost from 10 per machine hour to 8 per machine hour (Design Z). The chief engineer, upon reviewing the design, questioned the validity of the controllers cost formula. He suggested a more careful assessment of the proposed designs effect on activities other than machining. Based on this suggestion, the following revised cost formula was developed. This cost formula reflected the cost relationships of the most recent design (Design Z). Y=140,000+8X1+5,000X2+2,000X3 where X1=MachinehoursX2=NumberofbatchesX3=Numberofengineeringchangeorders Based on scheduling and inventory considerations, the product would be produced in batches of 1,000; thus, 25 batches would be needed over the products life cycle. Furthermore, based on past experience, the product would likely generate about 20 engineering change orders. This new insight into the linkage of the product with its underlying activities led to a different design (Design W). This second design also lowered the unit-level cost by 2 per unit but decreased the number of design support requirements from 20 orders to 10 orders. Attention was also given to the setup activity, and the design engineer assigned to the product created a design that reduced setup time and lowered variable setup costs from 5,000 to 3,000 per setup. Furthermore, Design W also creates excess activity capacity for the setup activity, and resource spending for setup activity capacity can be decreased by 40,000, reducing the fixed cost component in the equation by this amount. Design W was recommended and accepted. As prototypes of the design were tested, an additional benefit emerged. Based on test results, the post-purchase costs dropped from an estimated 0.70 per unit sold to 0.40 per unit sold. Using this information, the Marketing Department revised the projected market share upward from 50 percent to 60 percent (with no price decrease). Required: 1. Calculate the expected gross profit per unit for Design Z using the controllers original cost formula. According to this outcome, does Design Z reach the targeted unit profit? Repeat, using the engineers revised cost formula. Explain why Design Z failed to meet the targeted profit. What does this say about the use of unit-based costing for life-cycle cost management? 2. Calculate the expected profit per unit using Design W. Comment on the value of activity information for life-cycle cost management. 3. The benefit of the post-purchase cost reduction of Design W was discovered in testing. What direct benefit did it create for Feagan Company (in dollars)? Reducing post-purchase costs was not a specific design objective. Should it have been? Are there any other design objectives that should have been considered?arrow_forward
- The controller for Dohini Manufacturing Company felt that the number of purchase orders alone did not explain the monthly purchasing cost. He knew that nonstandard orders (for example, one requiring an overseas supplier) took more time and effort. He collected data on the number of nonstandard orders for the past 12 months and added that information to the data on purchasing cost and total number of purchase orders. Multiple regression was run on the above data; the coefficients shown by the regression program are: Required: 1. Construct the cost formula for the purchasing activity showing the fixed cost and the variable rate. 2. If Dohini Manufacturing Company estimates that next month will have 430 total purchase orders and 45 nonstandard orders, what is the total estimated purchasing cost for that month? (Round your answer to the nearest dollar.) 3. What if Dohini Manufacturing wants to estimate purchasing cost for the coming year and expects 5,340 purchase orders and 580 nonstandard orders? What will estimated total purchasing cost be? What is the total fixed purchasing cost? Why doesnt it equal the fixed cost calculated in Requirement 2? (Round your answers to the nearest dollar.)arrow_forwardDiscuss how, as warehouse manager for Vinnies Vinyls, you view the different rate of allocated costs the warehouse is being charged compared to the West store. Describe the implications of this. What steps could you take to solve this discrepancy? What alternatives would you consider, assuming management is willing to consider making changes in the rate?arrow_forwardThe problem statement here is that in recent months, the cost accounting reports have been somewhat disturbing to management. It seems that some of the finished products are costing more than they should, even to the point of approaching their retail value. It has been noted by the accounting manager that this problem began when the company started buying ore from different parts of the world, some of which require difficult extraction methods. Explain how the company might change its accounting system to reflect the reporting problems better.arrow_forward
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