Managerial Accounting Whitecotton Solutions Chapter 3

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Chapter 3 Job-Order Costing Solutions to Questions 3-1 By definition, manufacturing overhead consists of costs that cannot be practically traced to jobs. Therefore, if these costs are to be assigned to jobs, they must be allocated rather than traced. 3-2 The first step is to estimate the total amount of the allocation base (the denominator) that will be required for next period's estimated level of production. The second step is to estimate the total fixed manufacturing overhead cost for the coming period and the variable manufacturing overhead cost per unit of the allocation base. The third step is to use the cost formula Y = a + bX to estimate the total manufacturing overhead cost (the numerator) for the coming period. The fourth step is to compute the predetermined overhead rate. 3-3 The job cost sheet is used to record all costs that are assigned to a particular job. These costs include direct materials costs traced to the job, direct labor costs traced to the job, and manufacturing overhead costs applied to the job. When a job is completed, the job cost sheet is used to compute the unit product cost. 3-4 Some production costs such as a factory manager's salary cannot be traced to a particular product or job, but rather are incurred as a result of overall production activities. In addition, some production costs such as indirect materials cannot be easily traced to jobs. If these costs are to be assigned to products, they must be allocated to the products. 3-5 If actual manufacturing overhead cost is applied to jobs, the company must wait until the end of the accounting period to apply overhead and to cost jobs. If the company computes actual overhead rates more frequently to get around this problem, the rates may fluctuate widely due to seasonal factors or variations in output. For this reason, most companies use predetermined overhead rates to apply manufacturing overhead costs to jobs. 3-6 The measure of activity used as the allocation base should drive the overhead cost; that is, the allocation base should cause the overhead cost. If the allocation base does not really cause the overhead, then costs will be incorrectly attributed to products and jobs and product costs will be distorted. 3-7 Assigning manufacturing overhead costs to jobs does not ensure a profit. The units produced may not be sold and if they are sold, they may not be sold at prices sufficient to cover all costs. It is a myth that assigning costs to products or jobs ensures that those costs will be recovered. Costs are recovered only by selling to customers—not by allocating costs. 3-8 The Manufacturing Overhead account is credited when overhead cost is applied to Work in Process. Generally, the amount of overhead applied will not be the same as the amount of actual cost incurred because the predetermined overhead rate is based on estimates. 3-9 Underapplied overhead occurs when the actual overhead cost exceeds the amount of overhead cost applied to Work in Process inventory during the period. Overapplied overhead occurs when the actual overhead cost is less than the amount of overhead cost applied to Work in Process inventory during the period. Underapplied or overapplied overhead is disposed of by either closing out the amount to Cost of Goods Sold or by allocating the amount among Cost of Goods Sold and ending inventories in proportion to the applied overhead in each account. The adjustment for underapplied overhead increases Cost of © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 1 Goods Sold (and inventories) whereas the adjustment for overapplied overhead decreases Cost of Goods Sold (and inventories). 3-10 Manufacturing overhead may be underapplied for several reasons. Control over overhead spending may be poor. Or, some of the overhead may be fixed and the actual amount of the allocation base may be less than estimated at the beginning of the period. In this situation, the amount of overhead applied to inventory will be less than the actual overhead cost incurred. 3-11 Underapplied overhead implies that not enough overhead was assigned to jobs during the period and therefore cost of goods sold was understated. Therefore, underapplied overhead is added to cost of goods sold. On the other hand, overapplied overhead is deducted from cost of goods sold. 3-12 A plantwide overhead rate is a single overhead rate used throughout a plant. In a multiple overhead rate system, each production department may have its own predetermine overhead rate and its own allocation base. Some companies use multiple overhead rates rather than plantwide rates to more appropriately allocate overhead costs among products. Multiple overhead rates should be used, for example, in situations where one department is machine intensive and another department is labor intensive. 3-13 When automated equipment replaces direct labor, overhead increases and direct labor decreases. This results in an increase in the predetermined overhead rate—particularly if it is based on direct labor. © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 2 Managerial Accounting, 15th edition The Foundational 15 1. The estimated total manufacturing overhead cost is computed as follows: Y = $10,000 + ($1.00 per DLH)(2,000 DLHs) Estimated fixed manufacturing overhead .................. Estimated variable manufacturing overhead: $1.00 per DLH × 2,000 DLHs ................................ Estimated total manufacturing overhead cost ............ $10,000 2,000 $12,000 The predetermined overhead rate is computed as follows: Estimated total manufacturing overhead (a) .... Estimated total direct labor hours (DLHs) (b) . Predetermined overhead rate (a) ÷ (b) ........... $12,000 2,000 DLHs $6.00 per DLH 2. The manufacturing overhead applied to Jobs P and Q is computed as follows: Actual direct labor hours worked (a) ............... Predetermined overhead rate per DLH (b) ....... Manufacturing overhead applied (a) × (b) ....... Job P 1,400 $6.00 $8,400 Job Q 500 $6.00 $3,000 3. The direct labor hourly wage rate can be computed by focusing on either Job P or Job Q as follows: Job P Direct labor cost (a) ....................................... $21,000 Actual direct labor hours worked (b) ............... 1,400 Direct labor hourly wage rate (a) ÷ (b) ........... $15.00 Job Q $7,500 500 $15.00 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 3 The Foundational 15 4. Job P's unit product cost and Job Q's assigned manufacturing costs are computed as follows: Total manufacturing cost assigned to Job P: Direct materials ................................ Direct labor ...................................... Manufacturing overhead applied ($6 per DLH × 1,400 DLHs) ........... Total manufacturing cost .................. $13,000 21,000 8,400 $42,400 Unit product cost for Job P: Total manufacturing cost (a) ............. Number of units in the job (b) ........... Unit product cost (a) ÷ (b)................ $42,400 20 $2,120 Total manufacturing cost assigned to Job Q: Direct materials ................................ Direct labor ...................................... Manufacturing overhead applied ($6 per DLH × 500 DLHs) .............. Total manufacturing cost .................. $ 8,000 7,500 3,000 $18,500 5. The journal entries are recorded as follows: Raw Materials ....................... 22,000 Accounts Payable .......... 22,000 Work in Process .................... 21,000 Raw Materials ............... 21,000 6. The journal entry is recorded as follows: Work in Process .................... 28,500 Wages Payable ............. 28,500 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 4 Managerial Accounting, 15th edition The Foundational 15 7. The journal entry is recorded as follows: Work in Process ..................................... 11,400 Manufacturing Overhead ...................... 11,400 8. The Schedule of Cost of Goods Manufactured is as follows: Direct materials: Raw materials inventory, beginning ............... $ 0 Add: Purchases of raw materials ................... 22,000 Total raw materials available ........................ 22,000 Deduct: Raw materials inventory, ending ....... 1,000 Raw materials used in production.................. Direct labor ...................................................... Manufacturing overhead applied to work in process inventory ........................................... Total manufacturing costs ................................. Add: Beginning work in process inventory .......... Deduct: Ending work in process inventory.......... Cost of goods manufactured ............................. $21,000 28,500 11,400 60,900 0 60,900 18,500 $42,400 9. The journal entry is recorded as follows: Finished Goods ....................................... 42,400 Work in Process ................................... 42,400 10. The completed T-account is as follows: Beg. Bal. (a) (b) (c) End. Bal. (a) (b) (c) (d) Work in Process 0 21,000 28,500 11,400 (d) 18,500 42,400 Raw material used in production = $21,000 Direct labor cost = $28,500 Manufacturing overhead applied = $11,400 Cost of goods manufactured = $42,400 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 5 The Foundational 15 11. The Schedule of Cost of Goods Sold is as follows: Finished goods inventory, beginning .................. $ 0 Add: Cost of goods manufactured ..................... 42,400 Cost of goods available for sale ......................... 42,400 Deduct: Finished goods inventory, ending .......... 0 Unadjusted cost of goods sold........................... $42,400 12. The journal entry is recorded as follows: Cost of Goods Sold ................................. 42,400 Finished Goods .................................... 42,400 13. The amount of underapplied overhead is computed as follows: Actual direct labor-hours (a) ...................... Predetermined overhead rate (b) ............... Manufacturing overhead applied (a) × (b) .. 1,900 $6.00 $11,400 Actual manufacturing overhead .................. Deduct: Manufacturing overhead applied .... Underapplied overhead .............................. $12,500 11,400 $ 1,100 14. The journal entry is recorded as follows: Cost of Goods Sold ................................. 1,100 Manufacturing Overhead ...................... 1,100 15. The income statement is as follows: Sales .............................................................. Cost of goods sold ($42,400 + $1,100) ............. Gross margin................................................... Selling and administrative expenses.................. Net operating income ...................................... $60,000 43,500 16,500 14,000 $ 2,500 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 6 Managerial Accounting, 15th edition Exercise 3-1 (10 minutes) The estimated total manufacturing overhead cost is computed as follows: Y = $94,000 + ($2.00 per DLH)(20,000 DLHs) Estimated fixed manufacturing overhead .................. Estimated variable manufacturing overhead: $2.00 per DLH × 20,000 DLHs ........................................ Estimated total manufacturing overhead cost ............ $ 94,000 40,000 $134,000 The predetermined overhead rate is computed as follows: Estimated total manufacturing overhead .......... ÷ Estimated total direct labor hours (DLHs) ...... = Predetermined overhead rate ....................... $134,000 20,000 DLHs $6.70 per DLH © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 7 Exercise 3-2 (10 minutes) Actual direct labor-hours ............................. × Predetermined overhead rate ................... = Manufacturing overhead applied............... 10,800 $23.40 $252,720 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 8 Managerial Accounting, 15th edition Exercise 3-3 (10 minutes) 1. Total direct labor-hours required for Job A-500: Direct labor cost (a) ..................................... Direct labor wage rate per hour (b) .............. Total direct labor hours (a) ÷ (b).................. $108 $12 9 Total manufacturing cost assigned to Job A-500: Direct materials ....................................................... Direct labor ............................................................. Manufacturing overhead applied ($14 per DLH × 9 DLHs) ................................................................... Total manufacturing cost .......................................... $230 108 126 $464 2. Unit product cost for Job A-500: Total manufacturing cost (a) ........................ Number of units in the job (b) ...................... Unit product cost (a) ÷ (b) ........................... $464 40 $11.60 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 9 Exercise 3-4 (15 minutes) a. Raw Materials .................... Accounts Payable .......... 80,000 b. Work in Process ................. Manufacturing Overhead..... Raw Materials ............... 62,000 9,000 c. Work in Process ................. Manufacturing Overhead..... Wages Payable ............. 101,000 11,000 d. Manufacturing Overhead..... Various Accounts .......... 175,000 80,000 71,000 112,000 175,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 10 Managerial Accounting, 15th edition Exercise 3-5 (20 minutes) Parts 1 and 2. Cash (a) (c) (d) 94,000 132,000 143,000 (b) (c) (e) Bal. Work in Process 78,000 112,000 152,000 (f) 342,000 0 (b) (c) (d) Bal. Manufacturing Overhead 11,000 (e) 152,000 20,000 143,000 (g) 22,000 0 (a) Bal. Raw Materials 94,000 (b) 5,000 89,000 (f) Bal. Finished Goods 342,000 (f) 342,000 0 (f) (g) Bal. Cost of Goods Sold 342,000 22,000 364,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 11 Exercise 3-6 (20 minutes) 1. Cost of Goods Manufactured Direct materials: Raw materials inventory, beginning............... Add: Purchases of raw materials ................... Total raw materials available ........................ Deduct: Raw materials inventory, ending ...... Raw materials used in production ................. Less indirect materials included in manufacturing overhead ......................................... Direct labor ...................................................... Manufacturing overhead applied to work in process inventory ................................................ Total manufacturing costs................................. Add: Beginning work in process inventory.......... $12,000 30,000 42,000 18,000 24,000 5,000 87,000 164,000 56,000 220,000 65,000 $155,000 Deduct: Ending work in process inventory ......... Cost of goods manufactured ............................. 2. Cost of Goods Sold Finished goods inventory, beginning .................. Add: Cost of goods manufactured ..................... Goods available for sale .................................... Deduct: Finished goods inventory, ending.......... Unadjusted cost of goods sold .......................... Add: Underapplied overhead ............................. Adjusted cost of goods sold .............................. $ 19,000 58,000 $ 35,000 155,000 190,000 42,000 148,000 4,000 $152,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 12 Managerial Accounting, 15th edition Exercise 3-7 (10 minutes) 1. Manufacturing overhead incurred (a) ......... $215,000 Actual direct labor-hours ........................... × Predetermined overhead rate ................ = Manufacturing overhead applied (b)....... 11,500 $18.20 $209,300 Manufacturing overhead underapplied (a) – (b) ................................................ $5,700 2. Because manufacturing overhead is underapplied, the cost of goods sold would increase by $5,700 and the gross margin would decrease by $5,700. © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 13 Exercise 3-8 (10 minutes) Direct material ......................... Direct labor ............................. Manufacturing overhead: $12,000 × 125%................... Total manufacturing cost.......... Unit product cost: $37,000 ÷ 1,000 units ........... $10,000 12,000 15,000 $37,000 $37 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 14 Managerial Accounting, 15th edition Exercise 3-9 (30 minutes) 1. a. Raw Materials Inventory........................... Accounts Payable .................................. 210,000 b. Work in Process ....................................... Manufacturing Overhead .......................... Raw Materials Inventory ........................ 178,000 12,000 c. Work in Process ....................................... Manufacturing Overhead .......................... Salaries and Wages Payable................... 90,000 110,000 d. Manufacturing Overhead .......................... Accumulated Depreciation ..................... 40,000 e. Manufacturing Overhead .......................... Accounts Payable .................................. 70,000 f. Work in Process ....................................... Manufacturing Overhead ....................... 30,000 MH × $8 per MH = $240,000. 240,000 g. Finished Goods ........................................ Work in Process .................................... 520,000 h. Cost of Goods Sold .................................. Finished Goods ..................................... 480,000 Accounts Receivable ................................ Sales .................................................... $480,000 × 1.25 = $600,000. 600,000 2. (b) (c) (d) (e) Manufacturing Overhead 12,000 (f) 240,000 110,000 40,000 70,000 8,000 (Overapplied overhead) Bal. (b) (c) (f) Bal. 210,000 190,000 200,000 40,000 70,000 240,000 520,000 480,000 600,000 Work in Process 42,000 (g) 520,000 178,000 90,000 240,000 30,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 15 Exercise 3-10 (10 minutes) Yes, overhead should be applied to value the Work in Process inventory at year-end. Because $6,000 of overhead was applied to Job V on the basis of $8,000 of direct labor cost, the company's predetermined overhead rate must be 75% of direct labor cost. Job W direct labor cost (a) ................................................ Predetermined overhead rate (b)....................................... Manufacturing overhead applied to Job W (a) × (b) ........... $4,000 0.75 $3,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 16 Managerial Accounting, 15th edition Exercise 3-11 (30 minutes) 1. Mason Company's schedule of cost of goods manufactured is as follows: Direct materials: Beginning raw materials inventory .................. Add: Purchases of raw materials ..................... Raw materials available for use ....................... Deduct: Ending raw materials inventory .......... Raw materials used in production ................... Direct labor ...................................................... Manufacturing overhead ................................... Total manufacturing costs ................................. Add: Beginning work in process inventory .......... $ 7,000 118,000 125,000 15,000 Deduct: Ending work in process inventory .......... Cost of goods manufactured.............................. $110,000 70,000 90,000 270,000 10,000 280,000 5,000 $275,000 2. Mason Company's schedule of cost of goods sold is as follows: Beginning finished goods inventory............. Add: Cost of goods manufactured ............... Goods available for sale ............................. Deduct: Ending finished goods inventory .... Unadjusted cost of goods sold .................... Deduct: Overapplied overhead ................... Adjusted cost of goods sold........................ 3. $ 20,000 275,000 295,000 35,000 $260,000 $10,000 $250,000 Mason Company Income Statement Sales .............................................................. $524,000 Cost of goods sold ($260,000 – $10,000) .......... 250,000 Gross margin................................................... 274,000 Selling and administrative expenses: Selling expenses ........................................... $140,000 Administrative expense ................................. 63,000 203,000 Net operating income ...................................... $ 71,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 17 Exercise 3-12 (15 minutes) 1. Actual manufacturing overhead costs ........ Manufacturing overhead cost applied: 19,400 MH × $25 per MH....................... Overapplied overhead cost ........................ 2. Direct materials: Raw materials inventory, beginning ........ Add purchases of raw materials .............. Raw materials available for use .............. Deduct raw materials inventory, ending .. Raw materials used in production ........... Less indirect materials............................ Direct labor .............................................. Manufacturing overhead cost applied to work in process ..................................... Total manufacturing costs ......................... Add: Work in process, beginning ............... Deduct: Work in process, ending ............... Cost of goods manufactured ..................... $473,000 485,000 $ 12,000 $ 20,000 400,000 420,000 30,000 390,000 15,000 $375,000 60,000 485,000 920,000 40,000 960,000 70,000 $890,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 18 Managerial Accounting, 15th edition Exercise 3-13 (30 minutes) Note to the instructor: This exercise is a good vehicle for introducing the concept of predetermined overhead rates. This exercise can also be used as a launching pad for a discussion of Appendix 3B. 1. High activity level (First quarter) ... Low activity level (Third quarter) ... Change ........................................ Units Produced 80,000 20,000 60,000 Manufacturing Overhead $300,000 180,000 $120,000 Variable cost = Change in cost ÷ Change in activity = $120,000 ÷ 60,000 units = $2.00 per unit produced Total overhead cost (First quarter) ............................. $300,000 Variable cost element ($2.00 per unit × 80,000 units) . 160,000 Fixed cost element .................................................... $140,000 These fixed and variable cost estimates can be used to estimate the total manufacturing overhead cost for the fourth quarter as follows: Y = $140,000 + ($2.00 per unit)(60,000 units) Estimated fixed manufacturing overhead .................. Estimated variable manufacturing overhead $2.00 per unit × 60,000 units ................................ Estimated total manufacturing overhead cost ............ Total manufacturing cost and unit product cost: Direct materials..................................................... Direct labor .......................................................... Manufacturing overhead ........................................ Total manufacturing costs ...................................... ÷ Number of units to be produced ......................... = Unit product cost (rounded) ............................... $140,000 120,000 $260,000 $180,000 96,000 260,000 $536,000 60,000 $8.93 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 19 Exercise 3-13 (continued) 2. The fixed portion of the manufacturing overhead cost is causing the unit product costs to fluctuate. The unit product cost increases as the level of production decreases because the fixed overhead is spread over fewer units. 3. The unit product cost can be stabilized by using a predetermined overhead rate that is based on expected activity for the entire year. The cost formula created in requirement 1 can be adapted to compute the annual predetermined overhead rate. The annual fixed manufacturing overhead is $560,000 ($140,000 per quarter × 4 quarters). The variable manufacturing overhead per unit is $2.00. The cost formula is as follows: Y = $560,000 + $2.00 per unit × 200,000 units Estimated fixed manufacturing overhead .................. Estimated variable manufacturing overhead $2.00 per unit × 200,000 units .............................. Estimated total manufacturing overhead cost ............ $560,000 400,000 $960,000 The annual predetermined overhead rate is computed as follows: Estimated total manufacturing overhead .... ÷ Estimated total units produced ............... = Predetermined overhead rate................. $960,000 200,000 $4.80 per unit Using a predetermined overhead rate of $4.80 per unit, the unit product costs would stabilize as shown below: Direct materials ................. Direct labor ....................... Manufacturing overhead: at $4.80 per unit, ........... Total cost ......................... Number of units produced . Unit product cost ............... First Quarter Second Third Fourth $240,000 $120,000 $ 60,000 $180,000 128,000 64,000 32,000 96,000 384,000 192,000 96,000 288,000 $752,000 $376,000 $188,000 $564,000 80,000 40,000 20,000 60,000 $9.40 $9.40 $9.40 $9.40 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 20 Managerial Accounting, 15th edition Exercise 3-14 (20 minutes) 1. The estimated total manufacturing overhead cost is computed as follows: Y = $650,000 + ($3.00 per MH)(100,000 MHs) Estimated fixed manufacturing overhead ................... Estimated variable manufacturing overhead: $3.00 per MH × 100,000 MHs ......................................... Estimated total manufacturing overhead cost ............ $650,000 300,000 $950,000 The predetermined overhead rate is computed as follows: Estimated total manufacturing overhead ....... ÷ Estimated total machine-hours (MHs) ........ = Predetermined overhead rate.................... $950,000 100,000 MHs $9.50 per MH 2. Total manufacturing cost assigned to Job 400: Direct materials ....................................................... Direct labor ............................................................. Manufacturing overhead applied ($9.50 per MH × 40 MHs) .................................................................... Total manufacturing cost .......................................... $ 450 210 380 $1,040 3. Computing underapplied/overapplied overhead: Actual manufacturing overhead (a) .......... $1,350,000 Actual machine-hours.............................. 146,000 × Predetermined overhead rate ............... $9.50 = Manufacturing overhead applied (b) ..... $1,387,000 Overapplied overhead (a) – (b)................ $ (37,000) The closing entry would decrease cost of goods sold by $37,000 and increase net operating income by $37,000. © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 21 Exercise 3-15 (15 minutes) 1. Cutting Department: The estimated total manufacturing overhead cost in the Cutting Department is computed as follows: Y = $264,000 + ($2.00 per MH)(48,000 MH) Estimated fixed manufacturing overhead .................. Estimated variable manufacturing overhead $2.00 per MH × 48,000 MHs ................................. Estimated total manufacturing overhead cost ............ $264,000 96,000 $360,000 The predetermined overhead rate is computed as follows: Estimated total manufacturing overhead .... ÷ Estimated total machine-hours ............... = Predetermined overhead rate................. $360,000 48,000 MHs $7.50 per MH Finishing Department: The estimated total manufacturing overhead cost in the Finishing Department is computed as follows: Y = $366,000 + ($4.00 per DLH)(30,000 DLH) Estimated fixed manufacturing overhead .................. Estimated variable manufacturing overhead $4.00 per DLH × 30,000 DLHs............................... Estimated total manufacturing overhead cost ............ $366,000 120,000 $486,000 The predetermined overhead rate is computed as follows: Estimated total manufacturing overhead .... ÷ Estimated total direct labor-hours .......... = Predetermined overhead rate................. $486,000 30,000 DLHs $16.20 per DLH © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 22 Managerial Accounting, 15th edition Exercise 3-15 (continued) 2. Total manufacturing cost assigned to Job 203: Direct materials ($500 + $310) ......................... Direct labor ($70 + $150) ................................. Cutting Department (80 MHs × $7.50 per MH) .. Finishing Department (20 DLH × $16.20 per DLH)............................................................. Total manufacturing cost .................................. $600 324 $810 220 924 $1,954 3. Yes; if some jobs require a large amount of machine time and a small amount of labor time, they would be charged substantially less overhead cost if a plantwide rate based on direct labor hours were used. It appears, for example, that this would be true of Job 203 which required considerable machine time to complete, but required a relatively small amount of labor hours. © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 23 Exercise 3-16 (15 minutes) 1. Item Item Item Item (a): (b): (c): (d): Actual manufacturing overhead costs incurred for the year. Overhead cost applied to work in process for the year. Cost of goods manufactured for the year. Cost of goods sold for the year. 2. Cost of Goods Sold .......................................... Manufacturing Overhead ............................ 70,000 70,000 3. The underapplied overhead will be allocated to the other accounts on the basis of the amount of overhead applied during the year in the ending balance of each account: Work in Process ............ Finished Goods ............. Cost of Goods Sold ....... Total cost ..................... $ 19,500 58,500 312,000 $390,000 5% 15 80 100 % Using these percentages, the journal entry would be as follows: Work in Process (5% × $70,000) ................ Finished Goods (15% × $70,000) ................ Cost of Goods Sold (80% × $70,000) .......... Manufacturing Overhead........................ 3,500 10,500 56,000 70,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 24 Managerial Accounting, 15th edition Exercise 3-17 (45 minutes) 1a. The estimated total manufacturing overhead cost is computed as follows: Y = $910,000 + ($3.00 per MH)(50,000 MHs) Estimated fixed manufacturing overhead ................... Estimated variable manufacturing overhead: $3.00 per MH × 50,000 MHs ........................................... Estimated total manufacturing overhead cost ............ $ 910,000 150,000 $1,060,000 The predetermined overhead rate is computed as follows: Estimated total manufacturing overhead ....... ÷ Estimated total machine-hours (MHs) ........ = Predetermined overhead rate.................... $1,060,000 50,000 MHs $21.20 per MH 1b. Total manufacturing cost assigned to Jobs D-70 and C-200: D-70 C-200 Direct materials ....................................................... $700,000 $550,000 Direct labor ............................................................. 360,000 400,000 Manufacturing overhead applied ($21.20 per MH × 20,000 MHs; $21.20 per MH × 30,000 MHs) ......................................................... 424,000 636,000 Total manufacturing cost .......................................... $1,484,000 $1,586,000 1c. Bid prices for Jobs D-70 and C-200: D-75 C-200 Total manufacturing cost .......................................... $1,484,000 $1,586,000 × Markup percentage (150%) .................................. 150% 150% = Bid price .............................................................. $2,226,000 $2,379,000 1d. Because the company has no beginning or ending inventories and only Jobs D-70 and C-200 were started, completed, and sold during the year, the cost of goods sold is equal to the sum of the manufacturing costs assigned to both jobs of $3,070,000 (=$1,484,000 + $1,586,000). © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 25 Exercise 3-17 (continued) 2a. Molding Department: The estimated total manufacturing overhead cost in the Molding Department is computed as follows: Y = $700,000 + ($3.00 per MH)(20,000 MH) Estimated fixed manufacturing overhead ................... Estimated variable manufacturing overhead: $3.00 per MH × 20,000 MHs ........................................... Estimated total manufacturing overhead cost ............ $700,000 60,000 $760,000 The predetermined overhead rate is computed as follows: Estimated total manufacturing overhead ....... ÷ Estimated total machine-hours ................. = Predetermined overhead rate ................... $760,000 20,000 MHs $38.00 per MH Fabrication Department: The estimated total manufacturing overhead cost in the Fabrication Department is computed as follows: Y = $210,000 + ($3.00 per MH)(30,000 MH) Estimated fixed manufacturing overhead ................... Estimated variable manufacturing overhead: $3.00 per MH × 30,000 MHs ........................................... Estimated total manufacturing overhead cost ............ $210,000 90,000 $300,000 The predetermined overhead rate is computed as follows: Estimated total manufacturing overhead ....... ÷ Estimated total direct labor-hours ............. = Predetermined overhead rate ................... $300,000 30,000 MHs $10.00 per MH © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 26 Managerial Accounting, 15th edition Exercise 3-17 (continued) 2b. Total manufacturing costs assigned to Jobs D-70 and C-200: D-70 Direct materials ............................................... $700,000 Direct labor ..................................................... 360,000 Molding Department (14,000 MHs × $38 per MH; 6,000 MHs × $38 per MH) ...................... 532,000 Fabrication Department (6,000 MH × $10 per MH; 24,000 MH × $10 per MH) ..................... 60,000 Total manufacturing cost ................................. $1,652,000 2c. Bid prices for Jobs D-70 and C-200: D-70 Total manufacturing cost .......................................... $1,652,000 × Markup percentage (150%) .................................. 150% = Bid price .............................................................. $2,478,000 2d. C-200 $550,000 400,000 228,000 240,000 $1,418,000 C-200 $1,418,000 150% $2,127,000 Because the company has no beginning or ending inventories and only Jobs D-70 and C-200 were started, completed, and sold during the year, the cost of goods sold is equal to the sum of the manufacturing costs assigned to both jobs of $3,070,000 (=$1,652,000 + $1,418,000). 3. The plantwide and departmental approaches for applying manufacturing overhead costs to products produce identical cost of goods sold figures. However, these two approaches lead to different bid prices for Jobs D70 and C-200. The bid price for Job D-70 using the departmental approach is $252,000 higher than the bid price using the plantwide approach. This is because the departmental cost pools reflect the fact that Job D-70 is an intensive user of Molding machine-hours. The overhead rate in Molding ($38) is much higher than the overhead rate in Fabrication ($10). Conversely, Job C-200 is an intensive user of the lessexpensive Fabrication machine-hours, so its departmental bid price is $252,000 lower than the plantwide bid price. © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 27 Exercise 3-17 (continued) Whether a job-order costing system has only one plantwide overhead cost pool or numerous departmental overhead cost pools does not usually have an important impact on the accuracy of the cost of goods sold reported for the company as a whole. However, it can have a huge impact on internal decisions with respect to individual jobs, such as establishing bid prices for those jobs. Job-order costing systems that rely on one plantwide overhead cost pool are commonly used to value ending inventories and cost of goods sold for external reporting purposes, but they can create costing inaccuracies for individual jobs that adversely influence internal decision making. © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 28 Managerial Accounting, 15th Edition Exercise 3-18 (30 minutes) 1. The predetermined overhead rate is computed as follows: Y = $128,000 + $0.80 per MH × 80,000 MHs Estimated fixed manufacturing overhead .................. Estimated variable manufacturing overhead $0.80 per MH × 80,000 MHs ................................. Estimated total manufacturing overhead cost ............ $128,000 64,000 $192,000 The predetermined overhead rate is computed as follows: Estimated total manufacturing overhead ........ ÷ Estimated total machine-hours .................. = Predetermined overhead rate .................... $192,000 80,000 MHs $2.40 per MH 2. The amount of overhead cost applied to Work in Process for the year would be: 75,000 machine-hours × $2.40 per machine-hour = $180,000. This amount is shown in entry (a) below: Manufacturing Overhead Maintenance 21,000 (a) Indirect materials 8,000 Indirect labor 60,000 Utilities 32,000 Insurance 7,000 Depreciation 56,000 Balance 4,000 Direct materials Direct labor Overhead (a) 180,000 Work in Process 710,000 90,000 180,000 3. Overhead is underapplied by $4,000 for the year, as shown in the Manufacturing Overhead account above. The entry to close out this balance to Cost of Goods Sold would be: Cost of Goods Sold ...................................... Manufacturing Overhead ......................... 4,000 4,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 29 Exercise 3-18 (continued) 4. When overhead is applied using a predetermined rate based on machine-hours, it is assumed that overhead cost is proportional to machine-hours. When the actual machine-hours turn out to be 75,000, the costing system assumes that the overhead will be 75,000 machine-hours × $2.40 per machine-hour, or $180,000. This is a drop of $12,000 from the initial estimated manufacturing overhead cost of $192,000. However, the actual manufacturing overhead did not drop by this much. The actual manufacturing overhead was $184,000—a drop of $8,000 from the estimate. The manufacturing overhead did not decline by the full $12,000 because of the existence of fixed costs and/or because overhead spending was not under control. These issues will be covered in more detail in later chapters. © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 30 Managerial Accounting, 15th Edition Exercise 3-19 (20 minutes) 1. Because $120,000 of studio overhead was applied to Work in Process on the basis of $75,000 of direct staff costs, the predetermined overhead rate was 160%: Studio overhead applied $120,000 = = 160% rate Direct staff costs incurred $75,000 2. The Lexington Gardens Project is the only job remaining in Work in Process at the end of the month; therefore, the entire $35,000 balance in the Work in Process account at that point must apply to it. Recognizing that the predetermined overhead rate is 160% of direct staff costs, the following computation can be made: Total cost in the Lexington Gardens Project ...... Less: Direct staff costs ................................... Studio overhead cost ($6,500 × 160%).. Costs of subcontracted work ............................ $ 6,500 10,400 $35,000 16,900 $18,100 With this information, we can now complete the job cost sheet for the Lexington Gardens Project: Costs of subcontracted work ....... Direct staff costs ........................ Studio overhead ......................... Total cost to January 31 ............. $18,100 6,500 10,400 $35,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 31 Exercise 3-20 (30 minutes) 1. a. Raw Materials ........................................ Accounts Payable .............................. 325,000 b. Work in Process ..................................... Manufacturing Overhead ........................ Raw Materials ................................... 232,000 58,000 c. Work in Process ..................................... Manufacturing Overhead ........................ Wages and Salaries Payable .............. 60,000 120,000 d. Manufacturing Overhead ........................ Accumulated Depreciation ................. 75,000 e. Manufacturing Overhead ........................ Accounts Payable .............................. 62,000 f. Work in Process ..................................... Manufacturing Overhead ................... 300,000 325,000 290,000 180,000 75,000 62,000 300,000 Predetermined = Estimated total manufacturing overhead cost overhead rate Estimated total amount of the allocation base = $4,800,000 = $20 per MH 240,000 MHs 15,000 MH × $20 per MH = $300,000 2. (b) (c) (d) (e) Manufacturing Overhead 58,000 (f) 300,000 120,000 75,000 62,000 (b) (c) (f) Work in Process 232,000 60,000 300,000 3. The cost of the completed job is $592,000 as shown in the Work in Process T-account above. The journal entry is: Finished Goods ................................. Work in Process .......................... 592,000 592,000 4. The unit product cost on the job cost sheet would be: $592,000 ÷ 16,000 units = $37 per unit © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 32 Managerial Accounting, 15th Edition Problem 3-21 (45 minutes) 1. The cost of raw materials put into production was: Raw materials inventory, 1/1................. Debits (purchases of materials) ............. Materials available for use ..................... Raw materials inventory, 12/31 ............. Materials requisitioned for production .... $ 15,000 120,000 135,000 25,000 $110,000 2. Of the $110,000 in materials requisitioned for production, $90,000 was debited to Work in Process as direct materials. Therefore, the difference of $20,000 was debited to Manufacturing Overhead as indirect materials. 3. Total factory wages accrued during the year (credits to the Factory Wages Payable account) ............................. Less direct labor cost (from Work in Process) ................... Indirect labor cost .......................................................... $180,000 150,000 $ 30,000 4. The cost of goods manufactured was $470,000—the credits to the Work in Process account. 5. The Cost of Goods Sold for the year was: Finished goods inventory, 1/1 ........................................... $ 40,000 Add: Cost of goods manufactured (from Work in Process) .. 470,000 Goods available for sale .................................................... 510,000 Finished goods inventory, 12/31 ........................................ 60,000 Cost of goods sold ............................................................ $450,000 6. The predetermined overhead rate was: Predetermined = Estimated total manufacturing overhead cost overhead rate Estimated total amount of the allocation base = $240,000 = 160% of direct labor cost $150,000 direct labor cost © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 33 Problem 3-21 (continued) 7. Manufacturing overhead was overapplied by $10,000, computed as follows: Actual manufacturing overhead cost for the year (debits) . $230,000 Applied manufacturing overhead cost (see Work in Process—this would have been the credits to the Manufacturing Overhead account) ................................ 240,000 Overapplied overhead ..................................................... $(10,000) 8. The ending balance in Work in Process is $30,000. Direct materials make up $9,200 of this balance, and manufacturing overhead makes up $12,800. The computations are: Balance, Work in Process, 12/31 .................................... $30,000 Less: Direct labor cost (given) ........................................ (8,000) Manufacturing overhead cost ($8,000 × 160%) ...... (12,800) Direct materials cost (remainder) ................................... $ 9,200 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 34 Managerial Accounting, 15th Edition Problem 3-22 (30 minutes) 1. The predetermined overhead rate was: Y = $795,000 + $1.40 per hour × 75,000 hours Estimated fixed manufacturing overhead .................. Estimated variable manufacturing overhead $1.40 per computer hour × 75,000 hours............... Estimated total manufacturing overhead cost ............ $795,000 105,000 $900,000 The predetermined overhead rate is computed as follows: Estimated total manufacturing overhead ........ ÷ Estimated total computer hours ................. = Predetermined overhead rate .................... $900,000 75,000 hours $12.00 per hour 2. Actual manufacturing overhead cost ....................... Manufacturing overhead cost applied to Work in Process during the year: 60,000 actual MHs × $12 per MH ........................................................ Underapplied overhead cost ................................... 3. Cost of Goods Sold ................................... Manufacturing Overhead ..................... 130,000 $850,000 720,000 $130,000 130,000 4. The underapplied balance would be allocated using the following percentages: Overhead applied during the year in: Work in process ................................. Finished goods................................... Cost of goods sold ............................. Total.................................................... $ 36,000 5 180,000 25 504,000 70 $720,000 100 % % % % The entry to record the allocation of the underapplied overhead would be: Work in Process (5% × $130,000)........... Finished Goods (25% × $130,000) .......... Cost of Goods Sold (70% × $130,000) .... Manufacturing Overhead ................ 6,500 32,500 91,000 130,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 35 Problem 3-22 (continued) 5. Comparing the two methods: Cost of goods sold if the underapplied overhead is closed directly to cost of goods sold ($1,400,000 + $130,000) .................................... Cost of goods sold if the underapplied overhead is allocated among the accounts ($1,400,000 + $91,000) ...................................... Difference in cost of goods sold ............................. $1,530,000 1,491,000 $ 39,000 Thus, net operating income will be $39,000 greater if the underapplied overhead is allocated rather than closed directly to cost of goods sold. © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 36 Managerial Accounting, 15th Edition Problem 3-23 (30 minutes) Schedule of cost of goods manufactured: Direct materials: Raw materials inventory, beginning*.......... Add: Purchases of raw materials* .............. Raw materials available for use ................. Deduct: Raw materials inventory, ending* . Raw materials used in production .............. Direct labor ................................................. Manufacturing overhead applied* ................. Total manufacturing costs* .......................... Add: Work in process inventory, beginning ... $ 40,000 290,000 330,000 10,000 Deduct: Work in process inventory, ending* . Cost of goods manufactured ........................ $320,000 78,000 285,000 683,000 42,000 725,000 35,000 $690,000 Schedule of cost of goods sold: Finished goods inventory, beginning* ........... Add: Cost of goods manufactured ................ Cost of goods available for sale* .................. Deduct: Finished goods inventory, ending ..... Unadjusted cost of goods sold* .................... Deduct: Overapplied overhead ..................... Adjusted cost of goods sold ......................... $ 50,000 690,000 740,000 80,000 660,000 15,000 $645,000 Income statement: Sales ......................................................... Cost of goods sold ($660,000 – $15,000) ..... Gross margin.............................................. Selling and administrative expenses: Selling expenses* .................................... Administrative expense*........................... Net operating income*................................ $915,000 645,000 270,000 $140,000 100,000 240,000 $ 30,000 * Given in the problem © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 37 Problem 3-24 (30 minutes) 1. Molding Department: The estimated total manufacturing overhead cost in the Molding Department is computed as follows: Y = $497,000 + $1.50 per MH × 70,000 MH Estimated fixed manufacturing overhead .................. Estimated variable manufacturing overhead: $1.50 per MH × 70,000 MHs ................................. Estimated total manufacturing overhead cost ............ $497,000 105,000 $602,000 The predetermined overhead rate is computed as follows: Estimated total manufacturing overhead ...... ÷ Estimated total machine-hours ................ = Predetermined overhead rate .................. $602,000 70,000 MHs $8.60 per MH Painting Department: The estimated total manufacturing overhead cost in the Painting Department is computed as follows: Y = $615,000 + $2.00 per DLH × 60,000 DLH Estimated fixed manufacturing overhead .................. Estimated variable manufacturing overhead: $2.00 per DLH × 60,000 DLHs............................... Estimated total manufacturing overhead cost ............ $615,000 120,000 $735,000 The predetermined overhead rate is computed as follows: Estimated total manufacturing overhead ...... ÷ Estimated total DLHs............................... = Predetermined overhead rate .................. $735,000 60,000 DLHs $12.25 per DLH © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 38 Managerial Accounting, 15th Edition Problem 3-24 (continued) 2. Molding Department overhead applied: 110 machine-hours × $8.60 per machine-hour Painting Department overhead applied: 84 direct labor-hours × $12.25 per DLH .......... Total overhead cost ............................................. $ 946 1,029 $1,975 3. Total cost of Job 205: Direct materials .......................... Direct labor ................................ Manufacturing overhead applied .. Total cost ................................... Molding Dept. $ 470 325 946 $1,741 Unit product cost for Job 205: Total manufacturing cost .......................... ÷ Number of units in the job ..................... = Unit product cost .................................. 4. Manufacturing overhead incurred ............ Manufacturing overhead applied: 65,000 MHs × $8.60 per MH ................ 62,000 direct labor-hours × $12.25 per direct labor-hour ............................... Underapplied (or overapplied) overhead .. Painting Dept. $ 332 588 1,029 $1,949 Total $ 802 913 1,975 $3,690 $3,690 50 units $73.80 per unit Molding Dept. $570,000 Painting Dept. $750,000 559,000 759,500 $ 11,000 $ (9,500) © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 39 Problem 3-25 (60 minutes) 1. a. Predetermined = Estimated total manufacturing overhead cost overhead rate Estimated total amount of the allocation base = $800,000 =160% $500,000 direct materials cost b. Before the underapplied or overapplied overhead can be computed, we must determine the amount of direct materials used in production for the year. Raw materials inventory, beginning ..................... Add, Purchases of raw materials .......................... Raw materials available....................................... Deduct: Raw materials inventory, ending ............. Raw materials used in production ........................ Actual manufacturing overhead costs: Indirect labor ................................................... Property taxes ................................................. Depreciation of equipment................................ Maintenance .................................................... Insurance ........................................................ Rent, building .................................................. Total actual costs ............................................... Applied manufacturing overhead costs: $450,000 × 160%............................................ Underapplied overhead ....................................... $ 20,000 510,000 530,000 80,000 $450,000 $170,000 48,000 260,000 95,000 7,000 180,000 760,000 720,000 $ 40,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 40 Managerial Accounting, 15th Edition Problem 3-25 (continued) 2. Gitano Products Schedule of Cost of Goods Manufactured Direct materials: Raw materials inventory, beginning ............... $ 20,000 Add purchases of raw materials ..................... 510,000 Total raw materials available ......................... 530,000 Deduct raw materials inventory, ending ......... 80,000 Raw materials used in production..................... $ 450,000 Direct labor..................................................... 90,000 Manufacturing overhead applied to work in process ........................................................ 720,000 Total manufacturing costs ............................... 1,260,000 Add: Work in process, beginning ...................... 150,000 1,410,000 Deduct: Work in process, ending ..................... 70,000 Cost of goods manufactured ............................ $1,340,000 3. Unadjusted cost of goods sold: Finished goods inventory, beginning .................. Add: Cost of goods manufactured ...................... Goods available for sale .................................... Deduct: Finished goods inventory, ending .......... Unadjusted cost of goods sold ........................... $ 260,000 1,340,000 1,600,000 400,000 $1,200,000 The underapplied overhead can either be closed out to Cost of Goods Sold or allocated between Work in Process, Finished Goods, and Cost of Goods Sold based on the overhead applied during the year in the ending balance in each of these accounts. 4. Direct materials ................................................... Direct labor ......................................................... Overhead applied ($8,500 × 160%) ..................... Total manufacturing cost ..................................... $ 8,500 2,700 13,600 $24,800 $24,800 × 125% = $31,000 price to the customer © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 41 Problem 3-25 (continued) 5. The amount of overhead cost in Work in Process was: $24,000 direct materials cost × 160% = $38,400 The amount of direct labor cost in Work in Process is: Total ending work in process ............... Deduct: Direct materials .................... Manufacturing overhead ........ Direct labor cost ................................. $24,000 38,400 $70,000 62,400 $ 7,600 The completed schedule of costs in Work in Process was: Direct materials .................................. Direct labor ........................................ Manufacturing overhead ..................... Work in process inventory ................... $24,000 7,600 38,400 $70,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 42 Managerial Accounting, 15th Edition Problem 3-26 (120 minutes) 1. a. Raw Materials .................................... Accounts Payable ......................... 200,000 b. Work in Process ................................. Raw Materials............................... 185,000 c. Manufacturing Overhead .................... Utilities Expense ................................ Accounts Payable ......................... 63,000 7,000 d. Work in Process ................................. Manufacturing Overhead .................... Salaries Expense................................ Salaries and Wages Payable .......... 230,000 90,000 110,000 e. Manufacturing Overhead .................... Accounts Payable ......................... 54,000 f. Advertising Expense ........................... Accounts Payable ......................... 136,000 g. Manufacturing Overhead .................... Depreciation Expense......................... Accumulated Depreciation ............. 76,000 19,000 h. Manufacturing Overhead .................... Rent Expense .................................... Accounts Payable ......................... 102,000 18,000 i. Work in Process ................................. Manufacturing Overhead ............... 390,000 200,000 185,000 70,000 430,000 54,000 136,000 95,000 120,000 390,000 Predetermined = Estimated total manufacturing overhead cost overhead rate Estimated total amount of the allocation base = $360,000 = $400 per DLH 900 DLHs 975 actual DLH × $400 per DLH = $390,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 43 Problem 3-26 (continued) j. Finished Goods .................................. Work in Process ............................ 770,000 k. Accounts Receivable ........................... Sales ............................................ Cost of Goods Sold ............................. Finished Goods ............................. 1,200,000 800,000 770,000 1,200,000 800,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 44 Managerial Accounting, 15th Edition Problem 3-26 (continued) 2. Accounts Receivable 1,200,000 (k) Bal. (a) Bal. Raw Materials 30,000 185,000 200,000 (b) 45,000 Bal. (b) (d) (i) Bal. Work in Process 21,000 (j) 770,000 185,000 230,000 390,000 56,000 Bal. (j) Bal. Finished Goods 60,000 (k) 800,000 770,000 30,000 Accumulated Depreciation (g) 95,000 Accounts Payable (a) 200,000 (c) 70,000 (e) 54,000 (f) 136,000 (h) 120,000 Salaries & Wages Payable (d) 430,000 Sales (k) Cost of Goods Sold 800,000 (k) (c) (d) (e) (g) (h) 1,200,000 Manufacturing Overhead 63,000 (i) 390,000 90,000 54,000 76,000 102,000 Bal. 5,000 (f) Advertising Expense 136,000 (c) Utilities Expense 7,000 (d) Salaries Expense 110,000 (g) Depreciation Expense 19,000 (h) Rent Expense 18,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 45 Problem 3-26 (continued) 3. Froya Fabrikker A/S Schedule of Cost of Goods Manufactured Direct materials: Raw materials inventory, beginning ........ Purchases of raw materials ..................... Materials available for use ...................... Raw materials inventory, ending ............. Materials used in production ................... Direct labor .............................................. Manufacturing overhead applied to work in process ................................................. Total manufacturing costs ......................... Add: Work in process, beginning ............... $ 30,000 200,000 230,000 45,000 390,000 805,000 21,000 826,000 56,000 $770,000 Deduct: Work in process, ending ............... Cost of goods manufactured ..................... 4. Manufacturing Overhead ........................... Cost of Goods Sold .............................. Schedule of cost of goods sold: Finished goods inventory, beginning ....... Add: Cost of goods manufactured ........... Goods available for sale ......................... Deduct finished goods inventory, ending . Unadjusted cost of goods sold ................ Deduct: Overapplied overhead................ Adjusted cost of goods sold .................... $185,000 230,000 5,000 5,000 $ 60,000 770,000 830,000 30,000 800,000 5,000 $795,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 46 Managerial Accounting, 15th Edition Problem 3-26 (continued) 5. Froya Fabrikker A/S Income Statement Sales ..................................................... Cost of goods sold .................................. Gross margin ......................................... Selling and administrative expenses: Advertising expense ............................. Utilities expense .................................. Salaries expense .................................. Depreciation expense ........................... Rent expense ...................................... Net operating income ............................. $1,200,000 795,000 405,000 $136,000 7,000 110,000 19,000 18,000 6. Direct materials ......................................................... Direct labor ............................................................... Manufacturing overhead applied (39 hours × $400 per hour) .................................... Total manufacturing cost ........................................... Add markup (60% × $32,800) ................................... Total billed price of Job 412 ....................................... 290,000 $ 115,000 $ 8,000 9,200 15,600 32,800 19,680 $52,480 $52,480 ÷ 4 units = $13,120 per unit © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 47 Problem 3-27 (60 minutes) 1. a. Raw Materials ........................................ Cash ................................................ 275,000 b. Work in Process ..................................... Manufacturing Overhead ........................ Raw Materials ................................... 220,000 60,000 c. Work in Process ..................................... Manufacturing Overhead ........................ Sales Commissions Expense ................... Salaries Expense .................................... Cash ................................................ 180,000 72,000 63,000 90,000 d. Manufacturing Overhead ........................ Rent Expense ........................................ Cash ................................................ 13,000 5,000 e. Manufacturing Overhead ........................ Cash ................................................ 57,000 f. Advertising Expense ............................... Cash ................................................ 140,000 g. Manufacturing Overhead ........................ Depreciation Expense ............................. Accumulated Depreciation ................. 88,000 12,000 h. Work in Process ..................................... Manufacturing Overhead ................... 297,000 275,000 280,000 405,000 18,000 57,000 140,000 100,000 297,000 Predetermined = Estimated total manufacturing overhead cost overhead rate Estimated total amount of the allocation base = $330,000 165% of = direct labor cost $200,000 direct labor cost $180,000 actual direct labor cost × 165% = $297,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 48 Managerial Accounting, 15th Edition Problem 3-27 (continued) i. Finished Goods ...................................... Work in Process ................................ 675,000 j. Cash...................................................... Sales ................................................ Cost of Goods Sold ................................. Finished Goods ................................. 1,250,000 2. Bal. (a) Bal. Raw Materials 25,000 (b) 280,000 275,000 20,000 Bal. (i) Bal. Finished Goods 40,000 (j) 700,000 675,000 15,000 (j) Bal. (b) (c) (h) Bal. (b) (c) (d) (e) (g) 700,000 675,000 1,250,000 700,000 Work in Process 10,000 (i) 675,000 220,000 180,000 297,000 32,000 Manufacturing Overhead 60,000 (h) 297,000 72,000 13,000 57,000 88,000 Bal. 7,000 Cost of Goods Sold 700,000 3. Manufacturing overhead is overapplied by $7,000 for the year. The entry to close this balance to Cost of Goods Sold would be: Manufacturing Overhead ..................................... Cost of Goods Sold ........................................ 7,000 7,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 49 Problem 3-27 (continued) 4. Gold Nest Company Income Statement Sales ..................................................... Cost of goods sold ($700,000 - $7,000) ............................. Gross margin.......................................... Selling and administrative expenses: Sales commissions ............................... Administrative salaries .......................... Rent expense....................................... Advertising expense ............................. Depreciation expense ........................... Net operating income ............................. $1,250,000 693,000 557,000 $63,000 90,000 5,000 140,000 12,000 310,000 $ 247,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 50 Managerial Accounting, 15th Edition Problem 3-28 (60 minutes) 1. and 2. Bal. (l) Bal. Cash 63,000 (m) 850,000 128,000 Bal. (a) Bal. Raw Materials 30,000 (b) 185,000 15,000 Bal. (b) (f) (i) Bal. Videos in Process 45,000 (j) 550,000 170,000 82,000 290,000 37,000 Bal. Studio and Equipment 730,000 (b) (c) (d) (f) (g) (n) * (e) 785,000 200,000 Bal. (k) Bal. Accounts Receivable 102,000 (l) 850,000 925,000 177,000 Bal. Bal. Prepaid Insurance 9,000 (g) 2,000 Bal. (j) Bal. Finished Goods 81,000 (k) 600,000 550,000 31,000 7,000 Accumulated Depreciation Bal. 210,000 (d) 84,000 Bal. 294,000 Studio Overhead Depreciation Expense 30,000 * (i) 290,000 (d) 21,000 72,000 63,000 110,000 5,600 Insurance Expense 9,400 Bal. 9,400 (g) 1,400 $280,000 ÷ 7,000 hours = $40 per hour; 7,250 hours × $40 per hour = $290,000 Advertising Expense 130,000 (h) Miscellaneous Expense 8,600 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 51 Problem 3-28 (continued) Administrative Salaries Expense (f) 95,000 (k) Cost of Goods Sold 600,000 (n) Bal. 590,600 9,400 Sales (k) (m) 925,000 Accounts Payable 500,000 Bal. 160,000 (a) 185,000 (c) 72,000 (e) 130,000 (h) 8,600 Bal. 55,600 Salaries & Wages Payable (m) 285,000 (f) 287,000 Bal. 2,000 Capital Stock Bal. 420,000 Retained Earnings Bal. 270,000 3. Overhead is overapplied for the year by $9,400. Entry (n) above records the closing of this overapplied overhead balance to Cost of Goods Sold. 4. Supreme Videos, Inc. Income Statement For the Year Ended December 31 Sales of videos ........................................... Cost of goods sold ($600,000 – $9,400)....... Gross margin.............................................. Selling and administrative expenses: Depreciation expense ............................... $ 21,000 Advertising expense ................................. 130,000 Administrative salaries.............................. 95,000 Insurance expense ................................... 1,400 Miscellaneous expense ............................. 8,600 Net operating income ................................. $925,000 590,600 334,400 256,000 $ 78,400 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 52 Managerial Accounting, 15th Edition Case 3-29 (45 minutes) 1. Shaving 5% off the estimated direct labor-hours in the predetermined overhead rate will result in an artificially high overhead rate. The artificially high predetermined overhead rate is likely to result in overapplied overhead for the year. The cumulative effect of overapplying the overhead throughout the year is all recognized in December when the balance in the Manufacturing Overhead account is closed out to Cost of Goods Sold. If the balance were closed out every month or every quarter, this effect would be dissipated over the course of the year. 2. This question may generate lively debate. Where should Terri Ronsin's loyalties lie? Is she working for the general manager of the division or for the corporate controller? Is there anything wrong with the "Christmas bonus"? How far should Terri go in bucking her boss on a new job? While individuals can certainly disagree about what Terri should do, some of the facts are indisputable. First, understating direct labor-hours artificially inflates the overhead rate. This has the effect of inflating the Cost of Goods Sold in all months prior to December and overstating the costs of inventories. In December, the huge adjustment for overapplied overhead provides a big boost to net operating income. Therefore, the practice results in distortions in the pattern of net operating income over the year. In addition, because all of the adjustment is taken to Cost of Goods Sold, inventories are still overstated at year-end. This means, of course, that the net operating income for the entire year is also overstated. While Terri is in an extremely difficult position, her responsibilities under the IMA's Statement of Ethical Professional Practice seem to be clear. The Credibility Standard states that management accountants have a responsibility to "disclose all relevant information that could reasonably be expected to influence an intended user's understanding of the reports, analyses or recommendations." In our opinion, Terri should discuss this situation with her immediate supervisor in the controller's office at corporate headquarters. This step may bring her into direct conflict with the general manager of the division, so it would be a very difficult decision for her to make. © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 53 Case 3-29 (continued) In the actual situation that this case is based on, the corporate controller's staff were aware of the general manager's accounting tricks, but top management of the company supported the general manager because "he comes through with the results" and could be relied on to hit the annual profit targets for his division. Personally, we would be very uncomfortable supporting a manager who will resort to deliberate distortions to achieve "results." If the manager will pull tricks in this area, what else might he be doing that is questionable or even perhaps illegal? © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 54 Managerial Accounting, 15th Edition Case 3-30 (60 minutes) 1. a. Predetermined = Estimated total manufacturing overhead cost overhead rate Estimated total amount of the allocation base = $840,000 = 140% of direct labor cost $600,000 direct labor cost b. $9,500 × 140% = $13,300 2. a. Estimated manufacturing overhead cost (a) ......... Estimated direct labor cost (b) ........................ Predetermined overhead rate (a) ÷ (b) ............... Fabricating Machining Assembly Department Department Department $350,000 $400,000 $ 90,000 $200,000 $100,000 $300,000 175% 400% 30% b. Fabricating Department: $2,800 × 175% ............................. Machining Department: $500 × 400%................................ Assembly Department: $6,200 × 30%............................... Total applied overhead ..................... $4,900 2,000 1,860 $8,760 3. The bulk of the labor cost on the Koopers job is in the Assembly Department, which incurs very little overhead cost. The department has an overhead rate of only 30% of direct labor cost as compared to much higher rates in the other two departments. Therefore, as shown above, use of departmental overhead rates results in a relatively small amount of overhead cost being charged to the job. Use of a plantwide overhead rate in effect redistributes overhead costs proportionately between the three departments (at 140% of direct labor cost) and results in a large amount of overhead cost being charged to the Koopers job, as shown in Part 1. This may explain why the company © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 55 Case 3-30 (continued) bid too high and lost the job. Too much overhead cost was assigned to the job for the kind of work being done on the job in the plant. On jobs that require a large amount of labor in the Fabricating or Machining Departments the opposite will be true, and the company will tend to charge too little overhead cost to the jobs if a plantwide overhead rate is being used. The reason is that the plantwide overhead rate (140%) is much lower than the rates would be if these departments were considered separately. 4. The company's bid was: Direct materials ........................................... Direct labor ................................................. Manufacturing overhead applied (above) ...... Total manufacturing cost ............................. Bidding rate ................................................ Total bid price ............................................. $ 4,600 9,500 13,300 $27,400 × 1.5 $41,100 If departmental overhead rates had been used, the bid would have been: Direct materials ........................................... Direct labor ................................................. Manufacturing overhead applied (above) ...... Total manufacturing cost ............................. Bidding rate ................................................ Total bid price ............................................. $ 4,600 9,500 8,760 $22,860 × 1.5 $34,290 Note that if departmental overhead rates had been used, Teledex Company would have been the low bidder on the Koopers job because the competitor underbid Teledex by only $2,000. 5. a. Actual overhead cost ....................................... Applied overhead cost ($580,000 × 140%) ....... Underapplied overhead cost............................. $864,000 812,000 $ 52,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 56 Managerial Accounting, 15th Edition Case 3-30 (continued) b. Actual overhead cost ...................... Applied overhead cost: ..................... $210,000 × 175% . $108,000 × 400% . $262,000 × 30% ... Underapplied (overapplied) overhead cost ...................... Department Fabricating Machining Assembly Total Plant $360,000 367,500 $420,000 432,000 $ (7,500) $ (12,000) $84,000 $864,000 78,600 878,100 $ 5,400 $ (14,100) © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Chapter 3 57 Appendix 3A Activity-Based Absorption Costing Exercise 3A-1 (20 minutes) 1. Activity rates are computed as follows: Activity Cost Pool Machine setups ...... Special processing .. General factory ...... (a) Estimated Overhead Cost (b) Expected Activity $72,000 400 setups $200,000 5,000 MHs $816,000 24,000 DLHs (a) ÷ (b) Activity Rate $180 per setup $40 per MH $34 per DLH © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 58 Managerial Accounting, 15th Edition Exercise 3A-1 (continued) 2. Overhead is assigned to the two products as follows: Hubs: Activity Cost Pool Machine setups ..................... Special processing ................. General factory ..................... Total..................................... Sprockets: Activity Cost Pool Machine setups ..................... Special processing ................. General factory ..................... Total..................................... (a) Activity Rate $180 per setup $40 per MH $34 per DLH (b) Activity 100 setups 5,000 MHs 8,000 DLHs (a) × (b) ABC Cost (a) Activity Rate (b) Activity (a) × (b) ABC Cost $180 per setup 300 setups $40 per MH 0 MHs $34 per DLH 16,000 DLHs $ 18,000 200,000 272,000 $490,000 $ 54,000 0 544,000 $598,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Appendix 3A 59 Exercise 3A-1 (continued) 2. Each product's unit product cost is computed as follows: Direct materials ................................... Direct labor: $15 per DLH × 0.80 DLHs per unit..... $15 per DLH × 0.40 DLHs per unit..... Overhead: $490,000 ÷ 10,000 units ................... $598,000 ÷ 40,000 units ................... Unit product cost................................. Hubs $32.00 12.00 49.00 $93.00 Sprockets $18.00 6.00 14.95 $38.95 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 60 Managerial Accounting, 15th Edition Exercise 3A-2 (45 minutes) 1. The unit product costs under the company's conventional costing system would be computed as follows: Number of units produced (a) ..................... Direct labor-hours per unit (b) ..................... Total direct labor-hours (a) × (b) ................ Total manufacturing overhead (a) ............... Total direct labor-hours (b) ......................... Predetermined overhead rate (a) ÷ (b) ........ Direct materials .......................................... Direct labor ................................................ Manufacturing overhead applied: 0.40 DLH per unit × $24.00 per DLH ......... 0.20 DLH per unit × $24.00 per DLH ......... Unit product cost ........................................ Rascon 20,000 0.40 8,000 Parcel 80,000 0.20 16,000 Total 24,000 $576,000 24,000 DLHs $24.00 per DLH Rascon $13.00 6.00 9.60 $28.60 Parcel $22.00 3.00 4.80 $29.80 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Appendix 3A 61 Exercise 3A-2 (continued) 2. The unit product costs using activity-based absorption costing can be computed as follows: Activity Cost Pool Labor related ........... Engineering design ... Estimated Overhead Cost* $288,000 $288,000 $576,000 (b) Expected Activity (a) ÷ (b) Activity Rate 24,000 direct labor-hours $12.00 per direct labor-hour 6,000 engineering-hours $48.00 per engineering-hour *The total estimated manufacturing overhead cost of $576,000 is split evenly between the two activity cost pools. Manufacturing overhead is assigned to the two products as follows: Rascon: Activity Cost Pool Labor related ......... Engineering design . Total...................... (a) Activity Rate $12 per DLH $48 per engineering-hour (b) Activity 8,000 DLHs 3,000 engineering-hours (a) × (b) ABC Cost (a) Activity Rate (b) Activity (a) × (b) ABC Cost $ 96,000 144,000 $240,000 Parcel: Activity Cost Pool Labor related ......... Engineering design . Total...................... $12 per DLH $48 per engineering-hour 16,000 DLHs 3,000 engineering-hours © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 62 Managerial Accounting, 15th Edition $192,000 144,000 $336,000 Exercise 3A-2 (continued) The unit product costs combine direct materials, direct labor, and overhead costs: Direct materials ............................................. Direct labor ................................................... Manufacturing overhead ($240,000 ÷ 20,000 units; $336,000 ÷ 80,000 units) .................. Unit product cost ........................................... Rascon Parcel 12.00 $31.00 4.20 $29.20 $13.00 6.00 $22.00 3.00 3. The unit product cost of the high-volume product, Parcel, declines under the activity-based approach, whereas the unit product cost of the lowvolume product, Rascon, increases. This occurs because half of the overhead is applied on the basis of engineering design hours instead of direct labor-hours. When the overhead was applied on the basis of direct labor-hours, most of the overhead was applied to the high-volume product. However, when the overhead is applied on the basis of engineering-hours, more of the overhead cost is shifted over to the lowvolume product. Engineering-hours is a product-level activity, so the higher the volume, the lower the unit cost and the lower the volume, the higher the unit cost. © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Appendix 3A 63 Exercise 3A-3 (45 minutes) 1. The predetermined overhead rate is computed as follows: Predetermined = $325,000 = $6.50 per DLH overhead rate 50,000 DLHs The unit product costs under the company's traditional costing system are computed as follows: Direct materials ............................................... Direct labor ..................................................... Manufacturing overhead (1.0 DLH × $6.50 per DLH; 0.8 DLH × $6.50 per DLH) .................... Unit product cost ............................................. Deluxe Standard $72.00 12.00 $53.00 9.60 6.50 $90.50 5.20 $67.80 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 64 Managerial Accounting, 15th Edition Exercise 3A-3 (continued) 2. The activity rates are computed as follows: Activity Cost Pool Supporting direct labor ... Batch setups .................. Safety testing ................ (a) Estimated (b) Overhead Total Cost Expected Activity $200,000 $75,000 $50,000 (a) ÷ (b) Activity Rate 50,000 DLHs $4 per DLH 300 setups $250 per setup 100 tests $500 per test Manufacturing overhead is assigned to the two products as follows: Deluxe Product: Activity Cost Pool Supporting direct labor .......... Batch setups ......................... Safety testing ........................ Total..................................... Standard Product: Activity Cost Pool Supporting direct labor .......... Batch setups ......................... Safety testing ........................ Total..................................... (a) Activity Rate (b) Activity (a) × (b) ABC Cost (a) Activity Rate (b) Activity (a) × (b) ABC Cost $4 per DLH 10,000 DLHs $250 per setup 200 setups $500 per test 30 tests $4 per DLH 40,000 DLHs $250 per setup 100 setups $500 per test 70 tests $ 40,000 50,000 15,000 $105,000 $160,000 25,000 35,000 $220,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Appendix 3A 65 Exercise 3A-3 (continued) Activity-based absorption costing unit product costs are computed as follows: Direct materials ................................................... Direct labor ......................................................... Manufacturing overhead ($105,000 ÷ 10,000 units; $220,000 ÷ 50,000 units) ........................ Unit product cost................................................. Deluxe $72.00 12.00 10.50 $94.50 Standard $53.00 9.60 4.40 $67.00 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 66 Managerial Accounting, 15th Edition Problem 3A-4 (60 minutes) 1. a. When direct labor-hours are used to apply overhead cost to products, the company's predetermined overhead rate would be: Predetermined = Manufacturing overhead cost overhead rate Direct labor-hours = $1,800,000 = $50 per DLH 36,000DLHs b. Direct materials .......................................... Direct labor: $10 per hour × 1.8 hours and 0.9 hours.... Manufacturing overhead: $50 per hour × 1.8 hours and 0.9 hours.... Total unit product cost ................................ Model X200 X99 $ 72 $ 50 18 9 90 45 $180 $104 2. a. Predetermined overhead rates for the activity cost pools: Activity Cost Pool (a) Estimated Total Cost (b) Estimated Total Activity Machine setups ...... $360,000 150 setups Special processing .. $180,000 12,000 MHs General factory ...... $1,260,000 36,000 DLHs (a) ÷ (b) Activity Rate $2,400 per setup $15 per MH $35 per DLH © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Appendix 3A 63 Problem 3A-4 (continued) The overhead applied to each product can be determined as follows: Model X200 Activity Cost Pool (a) Activity Rate Activity Cost Pool (a) Activity Rate Machine setups .................................... $2,400 per setup Special processing ................................ $15 per MH General factory .................................... $35 per DLH Total manufacturing overhead cost (a) .. Number of units produced (b) ............... Overhead cost per unit (a) ÷ (b) ........... (b) Activity (a) × (b) ABC Cost (b) Activity (a) × (b) ABC Cost 50 setups 12,000 MHs 9,000 DLHs $120,000 180,000 315,000 $615,000 5,000 $123.00 Model X99 Machine setups .................................... $2,400 per setup Special processing ................................ $15 per MH General factory .................................... $35 per DLH Total manufacturing overhead cost (a) .. Number of units produced (b) ............... Overhead cost per unit (a) ÷ (b) ........... 100 setups 0 MHs 27,000 DLHs © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 68 Managerial Accounting, 15th Edition $ 240,000 0 945,000 $1,185,000 30,000 $39.50 Problem 3A-4 (continued) b. The unit product cost of each model under the activity-based approach would be computed as follows: Direct materials .................................... Direct labor: $10 per DLH × 1.8 DLHs, 0.9 DLHs ..... Manufacturing overhead (above) ........... Total unit product cost .......................... Model X200 X99 $ 72.00 $50.00 18.00 9.00 123.00 39.50 $213.00 $98.50 Comparing these unit cost figures with the unit costs in Part 1(b), we find that the unit product cost for Model X200 has increased from $180 to $213, and the unit product cost for Model X99 has decreased from $104 to $98.50. 3. It is especially important to note that, even under activity-based costing, 70% of the company's overhead costs continue to be applied to products on the basis of direct labor-hours: Machine setups (number of setups) ... $ 360,000 Special processing (machine-hours) ... 180,000 General factory (direct labor-hours) ... 1,260,000 Total overhead cost .......................... $1,800,000 20 % 10 70 100 % Thus, the shift in overhead cost from the high-volume product (Model X99) to the low-volume product (Model X200) occurred as a result of reassigning only 30% of the company's overhead costs. The increase in unit product cost for Model X200 can be explained as follows: First, where possible, overhead costs have been traced to the products rather than being lumped together and spread uniformly over production. Therefore, the special processing costs, which are traceable to Model X200, have all been assigned to Model X200 and none assigned to Model X99 under the activity-based approach. It is common in industry to have some products that require special handling or special processing of some type. This is especially true in modern factories that produce a variety of products. Activity-based costing provides a vehicle for assigning these costs to the appropriate products. © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Appendix 3A 69 Problem 3A-4 (continued) Second, the costs associated with the batch-level activity (machine setups) have also been assigned to the specific products to which they relate. These costs have been assigned according to the number of setups completed for each product. However, because a batch-level activity is involved, another factor affecting unit costs comes into play. That factor is batch size. Some products are produced in large batches and some are produced in small batches. The smaller the batch, the higher the per unit cost of the batch activity. In the case at hand, the data can be analyzed as follows: Model X200: Cost to complete one setup [see 2(a)] ........................ Number of units processed per setup (5,000 units per setup ÷ 50 setups = 100 units) ....... Setup cost per unit (a) ÷ (b) ...................................... Model X99: Cost to complete one setup (above) ........................... Number of units processed per setup (30,000 units per setup ÷ 100 setups = 300 units) ... Setup cost per unit (a) ÷ (b) ...................................... $2,400 (a) 100 units (b) $24 $2,400 (a) 300 units (b) $8 Thus, the cost per unit for setups is three times as great for Model X200, the low-volume product, as it is for Model X99, the high-volume product. Such differences in cost are obscured when direct labor-hours (or any other volume measure) is used as a basis for applying overhead cost to products. In sum, overhead cost has shifted from the high-volume product to the low-volume product as a result of more appropriately assigning some costs to the products on the basis of the activities involved, rather than on the basis of direct labor-hours. © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 70 Managerial Accounting, 15th Edition Problem 3A-5 (60 minutes) 1. The company's estimated direct labor-hours can be computed as follows: Deluxe model: 5,000 units × 2 DLHs per unit..... Regular model: 40,000 units × 1 DLH per unit ... Total direct labor hours .................................... 10,000 DLHs 40,000 DLHs 50,000 DLHs Using just direct labor-hours as the base, the predetermined overhead rate would be: Estimated overhead cost $900,000 = = $18 per DLH Estimated direct labor-hours 50,000DLHs The unit product cost of each model using the company's traditional costing system would be: Direct materials ........................ Direct labor .............................. Manufacturing overhead: $18 per DLH × 2 DLHs ........... $18 per DLH × 1 DLH ............ Total unit product cost.............. Deluxe $40 14 36 $90 Regular $25 7 18 $50 2. Predetermined overhead rates are computed below: Activity Cost Pool Purchasing ................ Processing ................ Scrap/rework ............ Shipping ................... (a) Estimated Overhead Cost (b) Expected Activity $204,000 600 purchase orders $182,000 35,000 machinehours $379,000 2,000 orders $135,000 900 shipments (a) ÷ (b) Activity Rate $340 per purchase order $5.20 per machine-hour $189.50 per order $150 per shipment © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Appendix 3A 71 Problem 3A-5 (continued) 3. a. The overhead applied to each product can be determined as follows: The Deluxe Model Activity Cost Pool (a) Activity Rate (b) Activity (a) × (b) ABC Cost (a) Activity Rate (b) Activity (a) × (b) ABC Cost Purchasing ................................. $340 per Processing ................................. $5.20 per Scrap/rework ............................. $189.50 per Shipping .................................... $150 per Total overhead cost (a) .............. Number of units produced (b) ..... Overhead cost per unit (a) ÷ (b) . PO 200 POs MH 20,000 MHs order 1,000 tests shipment 250 shipments $ 68,000 104,000 189,500 37,500 $399,000 5,000 $79.80 The Regular Model Activity Cost Pool Purchasing ................................. $340 per Processing ................................. $5.20 per Scrap/rework ............................. $189.50 per Shipping .................................... $150 per Total overhead cost (a) .............. Number of units produced (b) ..... Overhead cost per unit (a) ÷ (b) . PO 400 POs MH 15,000 MHs order 1,000 orders shipment 650 shipments © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 72 Managerial Accounting, 15th Edition $136,000 78,000 189,500 97,500 $501,000 40,000 $12.53 Problem 3A-5 (continued) b. Using activity-based absorption costing, the unit product cost of each model would be: Direct materials .......................... Direct labor ................................ Manufacturing overhead (above) . Total unit product cost ................ Deluxe $ 40.00 14.00 79.80 $133.80 Regular $25.00 7.00 12.53 $44.53 4. Unit costs appear to be distorted as a result of using direct labor-hours as the base for assigning overhead cost to products. Although the deluxe model requires twice as much labor time as the regular model, it still is not being assigned enough overhead cost, as shown in the analysis in part 3(a). When the company's overhead costs are analyzed on an activities basis, it appears that the deluxe model is more expensive to manufacture than the company realizes. Note that the deluxe model accounts for a majority of the machine-hours worked, even though it accounts for only 20% of the company's direct labor-hours. Also, it requires just as many scrap/rework orders as the regular model, and scrap/rework orders are very costly to the company. When activity-based absorption costing is used and the company's transactions are analyzed by product, the overhead cost increases for the deluxe model from $36.00 per unit to $79.80 per unit. This suggests that less than half the overhead cost is being assigned to the deluxe model that ought to be assigned, and unit costs for the deluxe model are understated. If these costs are being used as a basis for pricing, then the selling price for the deluxe model may be too low. This may be the reason why profits have been steadily declining over the last several years. It may also be the reason why sales of the deluxe model have been increasing rapidly. © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Appendix 3A 73 Case 3A-6 (90 minutes) 1. a. The predetermined overhead rate would be computed as follows: Expected manufacturing overhead cost $2,200,000 = Estimated direct labor-hours 50,000 DLHs = $44 per DLH b. The unit product cost per pound, using the company's present costing system, would be: Direct materials (given) ......... Direct labor (given) ............... Manufacturing overhead: 0.02 DLH × $44 per DLH ..... Total unit product cost ........... Kenya Dark $4.50 0.24 Viet Select $2.90 0.24 0.88 $5.62 0.88 $4.02 2. a. Overhead rates for each activity cost pool: Activity Cost Pools (a) Estimated Overhead Costs (b) Expected Activity Purchasing ........... $560,000 2,000 orders Material handling .. $193,000 1,000 setups Quality control ...... $90,000 500 batches Roasting ............... $1,045,000 95,000 hours Blending ............... $192,000 32,000 hours Packaging............. $120,000 24,000 hours (a) ÷ (b) Activity Rate $280 $193 $180 $11 $6 $5 per per per per per per order setup batch hour hour hour © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 74 Managerial Accounting, 15th Edition Case 3A-6 (continued) Before we can determine the amount of overhead cost to assign to the products we must first determine the activity for each of the products in the six activity centers. The necessary computations follow: Number of purchase orders: Kenya Dark: 80,000 pounds ÷ 20,000 pounds per order = 4 orders Viet Select: 4,000 pounds ÷ 500 pounds per order = 8 orders Number of setups: Kenya Dark: 16 batches × 2 setups per batch = 32 setups Viet Select: 8 batches × 2 setups per batch = 16 setups Number of batches: Kenya Dark: 80,000 pounds ÷ 5,000 pounds per batch = 16 batches Viet Select: 4,000 pounds ÷ 500 pounds per batch = 8 batches Roasting hours: Kenya Dark: 1.5 hours × (80,000 pounds ÷ 100 pounds) = 1,200 hours Viet Select: 1.5 hours × (4,000 pounds ÷ 100 pounds) = 60 hours Blending hours: Kenya Dark: 0.5 hour × (80,000 pounds ÷ 100 pounds) = 400 hours Viet Select: 0.5 hour × (4,000 pounds ÷ 100 pounds) = 20 hours Packaging hours: Kenya Dark: 0.3 hour × (80,000 pounds ÷ 100 pounds) = 240 hours Viet Select: 0.3 hour × (4,000 pounds ÷ 100 pounds) = 12 hours © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Appendix 3A 75 Case 3A-6 (continued) The overhead applied to each product can be determined as follows: Kenya Dark Activity Cost Pool Activity Rate Expected Activity Amount Viet Select Activity Cost Pool Activity Rate Expected Activity Amount Purchasing.................. $280 per order 4 orders Material handling ........ $193 per setup 32 setups Quality control ............ $180 per batch 16 batches Roasting ..................... $11 per roasting hour 1,200 roasting hours Blending ..................... $6 per blending hour 400 blending hours Packaging ................... $5 per packaging hour 240 packaging hours Total .......................... Purchasing.................. $280 per order Material handling ........ $193 per setup Quality control ............ $180 per batch Roasting ..................... $11 per roasting hour Blending ..................... $6 per blending hour Packaging ................... $5 per packaging hour Total .......................... 8 16 8 60 20 12 orders setups batches roasting hours blending hours packaging hours © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 76 Managerial Accounting, 15th Edition $ 1,120 6,176 2,880 13,200 2,400 1,200 $26,976 $2,240 3,088 1,440 660 120 60 $7,608 Case 3A-6 (continued) b. According to the activity-based absorption costing system, the manufacturing overhead cost per pound is: Total overhead cost assigned (above) (a) ... Number of pounds manufactured (b) .......... Cost per pound (a) ÷ (b) ........................... Kenya Dark $26,976 80,000 $0.34 Viet Select $7,608 4,000 $1.90 c. The unit product costs according to the activity-based absorption costing system are: Direct materials (given) ........... Direct labor (given) ................. Manufacturing overhead .......... Total unit product cost ............. Kenya Dark $4.50 0.24 0.34 $5.08 Viet Select $2.90 0.24 1.90 $5.04 3. MEMO TO THE PRESIDENT: Analysis of JSI's data shows that several activities other than direct labor drive the company's manufacturing overhead costs. These activities include purchase orders issued, number of setups for material processing, and number of batches processed. The company's present costing system, which relies on direct labor time as the sole basis for assigning overhead cost to products, significantly undercosts low-volume products, such as the Viet Select coffee, and significantly overcosts high-volume products, such as our Kenya Dark coffee. An implication of the activity-based approach is that our low-volume products may not be covering the costs of the manufacturing resources they use. For example, Viet Select coffee is currently priced at $5.03 per pound ($4.02 plus 25% markup), but this price is below its activitybased cost of $5.04 per pound. Under our present costing and pricing system, our high-volume products, such as our Kenya Dark coffee, may be subsidizing our low-volume products. Some adjustments in prices may be required. © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Appendix 3A 77 Case 3A-6 (continued) ALTERNATIVE SOLUTION: Most students will compute the manufacturing overhead cost per pound of the two coffees as shown above. However, the per pound cost can also be computed as shown below. This alternative approach provides additional insight into the data and facilitates emphasis of some points made in the chapter. Purchasing ........... Material handling .. Quality control...... Roasting .............. Blending .............. Packaging ............ Total.................... Kenya Dark Per Pound Total (÷ 80,000) $ 1,120 6,176 2,880 13,200 2,400 1,200 $26,976 $0.014 0.077 0.036 0.165 0.030 0.015 $0.337 Viet Select Per Pound Total (÷ 4,000) $2,240 3,088 1,440 660 120 60 $7,608 $0.560 0.772 0.360 0.165 0.030 0.015 $1.902 Note particularly how batch size impacts unit cost data. For example, the cost to the company to process a purchase order is $280, regardless of how many pounds of coffee are contained in the order. Twenty thousand pounds of the Kenya Dark coffee are purchased per order (with four orders per year), and just 500 pounds of the Viet Select coffee are purchased per order (with eight orders per year). Thus, the purchase order cost per pound for the Kenya Dark coffee is just 1.4 cents, whereas the purchase order cost per pound for the Viet Select coffee is 40 times as much, or 56 cents. As stated in the text, this is one reason why unit costs of lowvolume products, such as the Viet Select coffee, increase so dramatically when activity-based costing is used. © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 78 Managerial Accounting, 15th Edition Appendix 3B The Predetermined Overhead Rate and Capacity Exercise 3B-1 (20 minutes) 1. There were no beginning or ending inventories, so all of the jobs were started, finished, and sold during the month. Therefore cost of goods sold equals the total manufacturing cost. We can verify that by computing the cost of goods sold as shown below: Manufacturing costs charged to jobs: Direct materials ........................................... Direct labor (all variable) .............................. Manufacturing overhead applied (150 hours × $82 hour) ............................. Total manufacturing cost charged to jobs ........ Add: Beginning work in process inventory ........ Deduct: Ending work in process inventory ....... Cost of goods manufactured ........................... Beginning finished goods inventory ................. Add: Cost of goods manufactured ................... Goods available for sale .................................. Deduct: Ending finished goods inventory ......... Cost of goods sold .......................................... $ 5,350 8,860 12,300 26,510 0 26,510 0 $26,510 $ 0 26,510 26,510 0 $26,510 At the end of the month, overhead was underapplied by $1,920 as shown below: Manufacturing overhead incurred ....................................... $14,220 Manufacturing overhead applied 12,300 (150 hours × $82 hour) .................................................. Overhead underapplied...................................................... $ 1,920 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Appendix 3B 79 Exercise 3B-1 (continued) Consequently, the income statement would appear as follows: Wixis Cabinets Income Statement Sales .................................................... Cost of goods sold (see above) .............. Gross margin ........................................ Cost of unused capacity ......................... Selling and administrative expenses ....... Net operating income ............................ $1,920 8,180 $43,740 26,510 17,230 10,100 $ 7,130 2. When the predetermined overhead rate is based on capacity, overhead is ordinarily underapplied because manufacturing overhead ordinarily contains significant amounts of fixed costs. Suppose, for example, that manufacturing overhead includes $10,000 of fixed costs and the capacity is 100 hours. Then the portion of the predetermined overhead rate that represents fixed costs is $10,000 divided by 100 hours or $100 per hour. Because the plant is seldom (if ever) operated beyond capacity, less than $10,000 will ordinarily be applied to jobs. In other words, $100 per hour multiplied by something less than 100 hours always yields less than $10,000. Therefore, overhead will ordinarily be underapplied. © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 80 Managerial Accounting, 15th Edition Exercise 3B-2 (30 minutes) 1. The overhead applied to Mrs. Brinksi's account would be computed as follows: 2012 2013 Estimated overhead cost (a) ............................. $310,500 $310,500 Estimated professional staff hours (b) ............... 4,500 4,600 Predetermined overhead rate (a) ÷ (b).............. $69.00 $67.50 Professional staff hours charged to Ms. Brinksi's account ......................................................... × 2.5 × 2.5 Overhead applied to Ms. Brinksi's account.......... $172.50 $168.75 2. If the actual overhead cost and the actual professional hours charged turn out to be exactly as estimated there would be no underapplied or overapplied overhead. 2012 2013 Predetermined overhead rate (see above) ......... $69.00 $67.50 Actual professional staff hours charged to clients' accounts (by assumption) ...................... × 4,500 × 4,600 Overhead applied ............................................. $310,500 $310,500 Actual overhead cost incurred (by assumption) .. 310,500 310,500 Underapplied or overapplied overhead ............... $ 0 $ 0 3. If the predetermined overhead rate is based on the professional staff hours available, the computations would be: 2012 2013 Estimated overhead cost (a) ............................... $310,500 $310,500 Professional staff hours available (b) ................... 6,000 6,000 Predetermined overhead rate (a) ÷ (b) ............... $51.75 $51.75 Professional staff hours charged to Ms. Brinksi's account .......................................................... × 2.5 × 2.5 Overhead applied to Ms. Brinksi's account ........... $129.38 $129.38 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Appendix 3B 81 Exercise 3B-2 (continued) 4. If the actual overhead cost and the actual professional staff hours charged to clients' accounts turn out to be exactly as estimated, overhead would be underapplied as shown below. 2012 2013 Predetermined overhead rate (see above) (a) ..... $51.75 $51.75 Actual professional staff hours charged to clients' accounts (by assumption) (b) ............... × 4,500 × 4,600 Overhead applied (a) × (b) ................................ $232,875 $238,050 Actual overhead cost incurred (by assumption) .... 310,500 310,500 Underapplied overhead ...................................... $ 77,625 $ 72,450 The underapplied overhead is best interpreted in this situation as the cost of idle capacity. Proponents of this method of computing predetermined overhead rates suggest that the underapplied overhead be treated as a period expense that would be disclosed separately on the income statement as Cost of Unused Capacity. © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 82 Managerial Accounting, 15th Edition Problem 3B-3 (60 minutes) 1. The overhead applied to the Verde Baja job is computed as follows: 2012 2013 Estimated studio overhead cost (a) ................. $160,000 $160,000 Estimated hours of studio service (b)............... 1,000 800 Predetermined overhead rate (a) ÷ (b)............ $160 $200 Verde Baja job's studio hours ......................... × 40 × 40 Overhead applied to the Verde Baja job .......... $6,400 $8,000 Overhead is underapplied for both years as computed below: Predetermined overhead rate (see above) (a) .. Actual hours of studio service provided (b) ...... Overhead applied (a) × (b) ............................. Actual studio cost incurred .............................. Underapplied overhead ................................... 2012 2013 $160 $200 750 500 $120,000 $100,000 160,000 160,000 $ 40,000 $ 60,000 2. If the predetermined overhead rate is based on the hours of studio service at capacity, the computations would be: Estimated studio overhead cost at capacity (a) Hours of studio service at capacity (b) ............. Predetermined overhead rate (a) ÷ (b)............ Verde Baja job's studio hours ......................... Overhead applied to the Verde Baja job .......... 2012 2013 $160,000 $160,000 1,600 1,600 $100 $100 × 40 × 40 $4,000 $4,000 Overhead is underapplied for both years under this method as well: Predetermined overhead rate (see above) (a) .. Actual hours of studio service provided (b) ...... Overhead applied (a) × (b) ............................. Actual studio cost incurred .............................. Underapplied overhead ................................... 2012 $100 750 $ 75,000 160,000 $ 85,000 2013 $100 500 $ 50,000 160,000 $110,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Appendix 3B 83 Problem 3B-3 (continued) 3. When the predetermined overhead rate is based on capacity, the underapplied overhead is interpreted as the cost of idle capacity. Indeed, proponents of this method suggest that the underapplied overhead should be treated as a period expense that would be disclosed separately on the income statement as Cost of Unused Capacity. 4. Platinum Track's fundamental problem is the competition that is drawing customers away. The competition is able to offer the latest equipment, excellent service, and attractive prices. The company must do something to counter this threat or it will ultimately face failure. Under the conventional approach in which the predetermined overhead rate is based on the estimated studio hours, the apparent cost of the Verde Baja job has increased between 2012 and 2013. That happens because the company is losing business to competitors and therefore the company's fixed overhead costs are being spread over a smaller base. This results in costs that seem to increase as the volume declines. Under this method, Platinum Track's managers may be misled into thinking that the problem is rising costs and they may be tempted to raise prices to recover their apparently increasing costs. This would almost surely accelerate the company's decline. Under the alternative approach, the overhead cost of the Verde Baja job is stable at $4,000 and lower than the costs reported under the conventional method. Under the conventional method, managers may be misled into thinking that they are actually losing money on the Verde Baja job and they might refuse such jobs in the future—another sure road to disaster. This is much less likely to happen if the lower cost of $4,000 is reported. It is true that the underapplied overhead under the alternative approach is much larger than under the conventional approach and is growing. However, if it is properly labeled as the cost of idle capacity, management is much more likely to draw the appropriate conclusion that the real problem is the loss of business (and therefore more idle capacity) rather than an increase in costs. While basing the predetermined rate on capacity rather than on estimated activity will not solve the company's basic problems, at least this method is less likely to send managers misleading signals. © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 84 Managerial Accounting, 15th Edition Case 3B-4 (120 minutes) 1. Traditional approach: Actual total manufacturing overhead cost incurred (assumed to equal the original estimate) ................. Manufacturing overhead applied (160,000 units × $25 per unit) ............................... Overhead underapplied or overapplied ....................... $4,000,000 4,000,000 $ 0 Vault Hard Drives, Inc. Income Statement: Traditional Approach Sales (150,000 units × $60 per unit) ............ Cost of goods sold: Variable manufacturing (150,000 units × $15 per unit) ............... Manufacturing overhead applied (150,000 units × $25 per unit) ............... Gross margin .............................................. Selling and administrative expenses ............. Net operating income .................................. $9,000,000 $2,250,000 3,750,000 6,000,000 3,000,000 2,700,000 $ 300,000 New approach: Vault Hard Drives, Inc. Income Statement: New Approach Sales (150,000 units × $60 per unit).................... $9,000,000 Cost of goods sold: Variable manufacturing (150,000 units × $15 per unit) ....................... $2,250,000 Manufacturing overhead applied (150,000 units × $20 per unit) ....................... 3,000,000 5,250,000 Gross margin ...................................................... 3,750,000 Cost of unused capacity [(200,000 units – 160,000 units) × $20 per unit] .......................... 800,000 Selling and administrative expenses ..................... 2,700,000 Net operating income .......................................... $ 250,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Appendix 3B 85 Case 3B-4 (continued) 2. Traditional approach: Under the traditional approach, the reported net operating income can be increased by increasing the production level which then results in overapplied overhead which is deducted from Cost of Goods Sold. Additional net operating income required to attain target net operating income ($500,000 – $300,000) (a) ... $200,000 Overhead applied per unit of output (b) ......................... $25 per unit Additional output required to attain target net operating income (a) ÷ (b) .................................................. 8,000 units Actual total manufacturing overhead cost incurred .......... $4,000,000 Manufacturing overhead applied [(160,000 units + 8,000 units) × $25 per unit] ............ 4,200,000 Overhead overapplied ................................................... $ 200,000 Vault Hard Drives, Inc. Income Statement: Traditional Approach Sales (150,000 units × $60 per unit)............... Cost of goods sold: Variable manufacturing (150,000 units × $15 per unit) .................. Manufacturing overhead applied (150,000 units × $25 per unit) .................. Less: Manufacturing overhead overapplied ... Gross margin ................................................. Selling and administrative expenses ................ Net operating income ..................................... $9,000,000 $2,250,000 3,750,000 200,000 5,800,000 3,200,000 2,700,000 $ 500,000 Note: If the overapplied manufacturing overhead were prorated between ending inventories and Cost of Goods Sold, more units would have to be produced to attain the target net profit of $500,000. In fact, it can be shown that the total production level would have to be 169,014 units rather than 168,000 units. © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 86 Managerial Accounting, 15th Edition Case 3B-4 (continued) New approach: Under the new approach, the reported net operating income can be increased by increasing the production level. This results in less of a deduction on the income statement for the Cost of Unused Capacity. Additional net operating income required to attain target net operating income ($500,000 – $250,000) (a) .......... Overhead applied per unit of output (b) .......................... Additional output required to attain target net operating income (a) ÷ (b) ......................................................... Estimated number of units produced .............................. Actual number of units to be produced ........................... $250,000 $20 per unit 12,500 units 160,000 units 172,500 units Vault Hard Drives, Inc. Income Statement: New Approach Sales (150,000 units × $60 per unit) ................... $9,000,000 Cost of goods sold: Variable manufacturing (150,000 units × $15 per unit) ...................... $2,250,000 Manufacturing overhead applied (150,000 units × $20 per unit) ...................... 3,000,000 5,250,000 Gross margin ..................................................... 3,750,000 Cost of unused capacity [(200,000 units – 172,500 units) × $20 per unit] ......................... 550,000 Selling and administrative expenses .................... 2,700,000 Net operating income ......................................... $ 500,000 © The McGraw-Hill Companies, Inc., 2015. All rights reserved. Solutions Manual, Appendix 3B 87 Case 3B-4 (continued) 3. Net operating income is more volatile under the new method than under the old method. The reason for this is that the reported profit per unit sold is higher under the new method by $5, the difference in the predetermined overhead rates. As a consequence, swings in sales in either direction will have a more dramatic impact on reported profits under the new method. 4. As the computations in part (2) above show, the "hat trick" is a bit harder to perform under the new method. Under the old method, the target net operating income can be attained by producing an additional 8,000 units. Under the new method, the production would have to be increased by 12,500 units. Again, this is a consequence of the difference in predetermined overhead rates. The drop in sales has had a more dramatic effect on net operating income under the new method as noted above in part (3). In addition, because the predetermined overhead rate is lower under the new method, producing excess inventories has less of an effect per unit on net operating income than under the traditional method and hence more excess production is required. 5. One can argue that whether the "hat trick" is unethical depends on the level of sophistication of the owners of the company and others who read the financial statements. If they understand the effects of excess production on net operating income and are not misled, it can be argued that the hat trick is not unethical. However, if that were the case, there does not seem to be any reason to use the hat trick. Why would the owners want to tie up working capital in inventories just to artificially attain a target net operating income for the period? And increasing the rate of production toward the end of the year is likely to increase overhead costs due to overtime and other costs. Building up inventories all at once is very likely to be much more expensive than increasing the rate of production uniformly throughout the year. In this case, we assumed that there would not be an increase in overhead costs due to the additional production, but that is likely not to be true. In our opinion, the hat trick is unethical unless there is a good reason for increasing production other than to artificially boost the current period's net operating income. It is certainly unethical if the purpose is to fool users of financial reports such as owners and creditors or if the purpose is to meet targets so that bonuses will be paid to top managers. © The McGraw-Hill Companies, Inc., 2015. All rights reserved. 88 Managerial Accounting, 15th Edition

Managerial Accounting Whitecotton Solutions Chapter 3

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