ACCT-241 Chapter 2: Managerial Accounting Ch2
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Bushman Case
The Bushman Company is a publicly traded corporation that produces different types of digital control systems. My name is Alan Smith and I have worked for this company for the last ten years in the controllerâs office. I was both an accounting and finance major in university. The company currently produces 300 products and does not anticipate any new products coming out over the next three years. I have previously mentioned to my superiors that it is not appropriate for our firm to use a traditional accounting system (where overhead costs are allocated across products at a rate of 400% of direct labor costs) when different products require different amounts of indirect overhead resources. For example, under the traditional system all costs associated with testing of products for quality assurance purposes are part of overhead costs and therefore allocated across products based on direct labor costs. Yet, some of our products require as much as 5 hours of testing whereas some products require less than 1 minute of testing with no connection to direct labor costs. Given that traditional costing systems result in significant cost distortions when determining products costs and given that the firm now has revenues of over $700,000,000 a year, Bushman has decided to adopt activity based costing over the next year or two.
Bushmanâs management has hired Deloitte Consulting to help us implement activity based costing. I will be acting as the liaison between our firm and Deloitte. As part of the initial implementation phase, I have asked Deloitte to derive the costs and product margins associated with two of our products, delta and vega, so that these costs and product margins could be compared with the costs and product margins under our current traditional accounting system. I picked these products since Bushman management believe they have very different demands on indirect overhead resources. Further, delta is sold in large quantities whereas vega is sold in small quantities and traditional accounting systems can cause large cost distortions in different directions for products sold in large and small quantities.
Current information from our existing system on a per unit basis is shown in Exhibit 1.
Exhibit 1
| delta | vega | |
| Direct material | $10 | $10 |
| Direct labor hours | 1 | 1 |
| Direct labor wage rate per hour | $20 | $20 |
| Sales price per unit | $160 | $170 |
My staff has identified for Deloitte five activity cost pools. Information on those cost pools and the related activity measures are provided in Exhibit 2.
Exhibit 2
| Activity cost pool | Total costs | Activity measure | Activity level |
| Equipment setups | $20,000,000 | number of setups | 50,000 |
| Purchase orders | $15,000,000 | number of purchase orders | 300,000 |
| Machining | $90,000,000 | number of machine hours | 2,000,000 |
| Testing | $13,300,000 | number of testing hours | 700,000 |
| Packaging | $24,000,000 | number of containers | 2,000,000 |
Although fixed costs are lumped in with variable costs across the five different cost pools, I am aware that machining related costs consists almost exclusively of depreciation costs. Hence, with respect to all questions asked in this case, machining costs will be treated as entirely fixed with respect to machine hours. Each machine is used in the production of multiple product lines. The resale value of machines is only affected by the passage of time and not by how much they are used in a given year.
In all questions asked in this case, the firm will assume that costs associated with equipment setups, purchase orders, testing, and packaging are variable with respect to their respective activity measures. Currently, we believe our assumptions on cost behavior patterns are quite reasonable.
All products are produced in batches, where the size of a batch differs across products. For example, if we produce 80 units of a product in batch sizes of 40, then the product will be produced in two batches. An equipment setup must be performed before producing each batch of a product. Hence, in the example above, two equipment setups would be performed. Units of product are packaged in containers and sent to distributors.
Production volumes are set equal to sales volumes since the company only produces products that they have orders for. Consequently, the firm never has a beginning or ending work in process inventory, and it does not have a beginning or ending finished goods inventory.
Further information on our two products is provided in Exhibit 3
Exhibit 3
| delta | vega | |
| annual sales and production in units | 800,000 | 12,000 |
| number of units per batch | 200 | 150 |
| number of purchase orders | 400 | 100 |
| number of machine hours per unit | 0.2 | 3 |
| total number of testing hours | 7,000 | 21,000 |
| total number of containers | 5,000 | 2,000 |
REQUIRED:
1. (20 Points) Prepare an income statement for delta and an income statement for vega using the traditional accounting system where overhead is applied at a rate of 400% of direct labor costs. (For simplicity, there are no SG&A expenses for the firm.) The income statements should be prepared on a total basis and then show the average net operating income per unit using the following template for guidance:
delta vega
Sales $$$ $$$
Direct materials $$$ $$$
Direct labor $$$ $$$
Manufacturing overhead $$$ $$$
Total Costs $$$ $$$
Net operating income $$$ $$$
Average net operating income
per unit $$$ $$$
2. (20 Points) Calculate the five activity rates under activity based costing.
3. (35 Points) Prepare an income statement for delta and an income statement for vega using activity based costing. (For simplicity, there are no SG&A expenses for the firm.) The income statements should be prepared on a total basis and then show the average net operating income per unit using the following template for guidance:
delta vega
Sales $$$ $$$
Direct materials $$$ $$$
Direct labor $$$ $$$
Equipment Setups $$$ $$$
Purchase orders $$$ $$$
Machining $$$ $$$
Testing $$$ $$$
Packaging $$$ $$$
Total Costs $$$ $$$
Net operating income $$$ $$$
Average net operating income
per unit $$$ $$$
4. (10 Points) Assume next year that the activity rates remain the same as you calculated in question (2). Assume that the demand for delta is expected to increase significantly. Consequently, the firm expects to produce more batches of delta next year than this year and the firm plans to produce in batch sizes of 500 rather than 200. Calculate what the equipment setup cost per unit of delta will be next year if it can be calculated. If it cannot be calculated, then explain in words why the equipment setup cost per unit of delta cannot be determined in the absence of more information. Excluding your quantitative analysis if any, your explanation should not be more than 1/3 page double spaced with a 12 font size. Your grade will be lowered for poor writing (e.g., grammar).
5. (15 Points) Question 5 is independent of question 4. Next year, because of an expected increase in product demand, machine hours are expected to increase from 2,000,000 to 2,500,000. The company will not need any new machinery since the current machinery is highly underutilized. Also, the number of purchase orders will increase from 300,000 to 360,000. Assume that these new levels of operations are within the firmâs relevant range. Calculate what the activity rate for the cost pool of machining would be next year if it can be calculated. Also, calculate what the activity rate for the cost pool of purchase order would be next year if it can be calculated. If one or both rates cannot be calculated, then explain in words why the calculations cannot be determined in the absence of more information. Excluding any quantitative analysis, your explanation should not be more than 1/3 page double spaced with 12 font. Your grade will be lowered for poor writing (e.g., grammar).
Integrative Exercise
Cost Behavior and Cost-Volume-Profit Analysis for Many GlacierHotel
Using the High-Low Method to Estimate Variable and FixedCosts
Located on Swiftcurrent Lake in Glacier National Park, ManyGlacier Hotel was built in 1915 by the Great Northern Railway. Inan effort to supplement its lodging revenue, the hotel decided in20X1 to begin manufacturing and selling small wooden canoesdecorated with symbols hand painted by Native Americans living nearthe park. Due to the great success of the canoes, the hotel beganmanufacturing and selling paddles as well in 20X3. Many hotelguests purchase a canoe and paddles for use in self-guided tours ofSwiftcurrent Lake. Because production of the two products began indifferent years, the canoes and paddles are produced in separateproduction facilities and employ different laborers. Each canoesells for $500, and each paddle sells for $50. A 20X3 firedestroyed the hotelâs accounting records. However, a new system putinto place before the 20X4 season provides the following aggregateddata for the hotelâs canoe and paddle manufacturing and marketingactivities:
| Manufacturing Data: | ||||||||||||||
| Year | Number of Canoes Manufactured | Total Canoe Manufacturing Costs | Year | Number of Paddles Manufactured | Total Paddle Manufacturing Costs | |||||||||
| 20X9 | 250 | $103,000 | 20X9 | 900 | $38,500 | |||||||||
| 20X8 | 275 | 128,000 | 20X8 | 1,200 | 49,000 | |||||||||
| 20X7 | 240 | 108,000 | 20X7 | 1,000 | 44,000 | |||||||||
| 20X6 | 310 | 114,000 | 20X6 | 1,100 | 45,500 | |||||||||
| 20X5 | 350 | 141,500 | 20X5 | 1,400 | 52,000 | |||||||||
| 20X4 | 400 | 140,000 | 20X4 | 1,700 | 66,500 | |||||||||
| Marketing Data: | ||||||||||||||
| Year | Number of Canoes Sold | Total Canoe Marketing Costs | Year | Number of Paddles Sold | Total Paddle Marketing Costs | |||||||||
| 20X9 | 250 | $45,000 | 20X9 | 900 | $7,500 | |||||||||
| 20X8 | 275 | 43,000 | 20X8 | 1,200 | 9,000 | |||||||||
| 20X7 | 240 | 44,000 | 20X7 | 1,000 | 8,000 | |||||||||
| 20X6 | 310 | 51,000 | 20X6 | 1,100 | 8,500 | |||||||||
| 20X5 | 350 | 62,000 | 20X5 | 1,400 | 10,000 | |||||||||
| 20X4 | 400 | 60,000 | 20X4 | 1,700 | 11,500 | |||||||||
Required:
1. High-Low Cost Estimation Method
a. Use the high-low method to estimate the per-unit variablecosts and total fixed costs for the canoe productline.
| Variable cost per unit | $ |
| Total fixed cost | $ |
b. Use the high-low method to estimate the per-unit variablecosts and total fixed costs for the paddle productline.
| Variable cost per unit | $ |
| Total fixed cost | $ |
2. Cost-Volume-Profit Analysis, Single-ProductSetting
Use CVP analysis to calculate the break-even point in units for
a. The canoe product line only (i.e.,single-product setting)
| BE units | canoes |
b. The paddle product line only (i.e.,single-product setting)
| BE units | paddles |
3. Cost-Volume-Profit Analysis,Multiple-Product Setting
The hotel's accounting system data show an average sales mix ofapproximately 300 canoes and 1,200 paddles each season.Significantly more paddles are sold relative to canoes because someinexperienced canoe guests accidentally break one or more paddles,while other guests purchase additional paddles as presents forfriends and relatives. In addition, for this multiple-product CVPanalysis, assume the existence of an additional $30,000 of commonfixed costs for a customer service hotline used for both canoe andpaddle customers. Use CVP analysis to calculate the break-evenpoint in units for both the canoe and paddle product lines combined(i.e., the multiple-product setting).
| Canoe BE units | canoes |
| Paddle BE units | paddles |
4. Cost Classification
a. Classify the manufacturing costs, marketing costs, andcustomer service hotline costs either as production costs or periodcosts.
All manufacturing costs are costs. All marketing costs andcustomer hotline costs are costs
b. For the period costs, further classify them into eitherselling expenses or general and administrative expenses.
Marketing costs are selling oriented; therefore, the marketingperiod costs would be further classified as . Customer hotlinecosts relate to the customer service section of the value chain andwould be further classified as .
5. Sensitivity Cost-Volume-Profit Analysis andProduction Versus Period Costs, Multiple- Product Setting
If both the variable and fixed production costs (refer to youranswer to Requirement 1) associated with the canoe product lineincreased by 5% (beyond the estimate from the high-low analysis),how many canoes and paddles would need to be sold in order to earna target income of $96,000? Assume the same sales mix andadditional fixed costs as in Requirement 3.
| Canoe target income units | canoes |
| Paddle target income units | paddles |
6. Margin of Safety
Calculate the hotelâs margin of safety (both in units and insales dollars) for Many Glacier Hotel, assuming the same facts asin Requirement 3, and assuming that it sells 700 canoes and 2,500paddles next year.
total MOS units above total BE units
$ MOS in sales dollars
