CHAPTER 3: COST DRIVERS AND BASIC COST CONCEPTS
CHAPTER 3: BASIC COST MANAGEMENT CONCEPTS
QUESTIONS
3-1Cost assignment refers to the general case of assigning costs
to cost pools or cost objects. When there is a direct and traceable
link between the cost and the cost pool or cost object, then the
management accountant traces that cost to the cost pool or cost
object. When there is an indirect link between the cost and the
cost pool or cost object, then the management accountant uses cost
allocation. Cost allocation uses cost drivers to assign the
cost.
3-2Direct costs can be physically identified with and/or traced
to the cost object because there is a direct causal link between
them. Indirect costs cannot be traced to each cost object. Direct
costs for a manufactured product include the materials (called
direct materials) which are part of the product and the labor
(called direct labor) which is used to assemble the product.
Indirect costs include the machinery, plant and other labor
necessary to manufacture the product, but which is not directly
traceable to the product, such as labor for inspection and
supervision.
3-3All direct costs are variable by definition since they can be
directly traced to the cost object, and thus must vary with the
cost driver.
3-4All fixed costs must be indirect, since the increase in the
cost driver or volume of output does not affect the level of fixed
cost.
3-5A cost driver is any activity that has the effect of changing
the level of total cost.
3-6Variable costs are those for which total cost changes with
each change in the cost driver. Fixed costs are the portion of
total cost which remains constant as the cost driver changes.
3-7A step-fixed cost varies with the cost driver, but in
discrete steps. Costs remain fixed over narrow ranges of the cost
driver. However, total costs increase by a constant amount at set
intervals. Examples of step-fixed costs are the costs for certain
clerical tasks, order filling, and other administrative tasks. At
specific levels of the cost driver, an additional clerk must be
added. Therefore, total costs increase by a constant amount at
these points.
3-8The relevant range is the range of the cost driver for which
total cost is approximately linear. The relevant range is used to
provide a useful range of activity for the cost driver in which it
can be assumed that variable costs will be constant per unit of the
cost driver. This is an assumption since the behavior of actual
costs is likely to be non-linear (see Exhibit 3-6) over the range
of the cost driver. The concept of the relevant range allows the
management accountant to use the concept of constant unit variable
cost for a defined range of operations, even though actual unit
variable costs change over the entire range of the cost driver.
3-9Conversion costs are the sum of direct labor and overhead
costs. Prime costs are the sum of direct materials and direct
labor.
3-10Average cost can be misleading unless the activity level
(denominator) is known. Because average cost includes a fixed cost
component, it will be different at each possible activity level.
The term average cost is meaningless if the denominator is unknown.
An increase in volume does not increase total cost by the amount of
the increase in volume multiplied by total unit cost; total cost
increases by the increase in volume multiplied by the unit variable
cost.
3-11Total variable costs increase as the cost driver
increases.Total fixed costs remain constant as the cost driver
increases.Average variable costs remain constant as the cost driver
increases.Average fixed costs decrease as the cost driver
increases.
3-12Unit cost is the additional cost that is incurred as the
cost driver increases by one unit.
3-13Product costs are costs which are capitalized as assets, or
inventoried. They are referred to as manufacturing costs in
manufacturing firms and merchandise inventory in merchandising
firms. Period costs are expensed as they are incurred because there
is no expectation that they will provide any future benefit to the
firm. Since period costs are not directly or indirectly related to
the production process, they are sometimes called non-manufacturing
costs.
3-14Cost of goods manufactured is the cost of the units produced
this period and transferred into finished good inventory. Cost of
goods sold is the cost of the units sold this period. Cost of goods
sold will differ from cost of goods manufactured because of changes
in finished goods inventory. If finished goods inventory is very
nearly the same from the beginning to the end of the period, then
cost of goods sold and cost of goods manufactured will be very
nearly the same.
3-15The types of inventory in manufacturing firms are:1.
materials inventory2. work-in-process inventory3. finished products
inventory
3-16Both accuracy and timeliness are important attributes of
cost information. Accuracy is important because effective planning
and decision making require accurate cost information. The same is
true for effective decision making.
3-17Executional cost drivers include employee empowerment,
design of the production process or work place, and management of
supplier relationships.
3-18Structural cost drivers include scale, experience,
technology, and complexity
3-19Indirect materials include items used in the production
process that are not included in the product itself; rags and small
tools, lubricant for the machines, etc.
3-20 Indirect labor includes labor that is used in the
manufacturing process but cannot be traced to each product as it is
produced; indirect labor includes supervision, inspection (by
batch, because inspection of each and every product would be a
variable cost), training, etc.
BRIEF EXERCISES
3-21 The answer depends on what you consider the cost object.
Suppose we consider the flight as the cost object, then the
variable costs should include fuel and the flight team, and any
meals or other products provided to passengers on the flight. If
the object is the individual passenger, then the list of variable
costs is shorter, since fewer costs are actually caused by the
addition of another passenger perhaps only beverages. While the
cost of the aircraft and most airline staff would be clearly fixed
costs for either type of cost object, some types of airline staff,
such as baggage handlers and gate attendants might be variable with
the flight.
3-22 We start with the cost object, which in this case could be
the item of merchandise sold. Then the variable costs are the cost
of merchandise and the selling costs for the cashiers and
restocking. For a large discount retailer, most other costs will be
driven by the number of hours open each week, and the variety of
merchandise handled. For other types of retailers (not
discounters), sales commissions might be an applicable variable
cost.
3-23 The cost object for a movie theater could be the number of
films being shown, or the number of screens. The cost of renting
the movie from the film producer is the main cost. The key driver
of revenue (not cost) is the number of ticket holders for ticket
revenue and also revenue from sales of food and beverages. Some
costs will also be driven by the number of ticket holders, such as
the cost of food and beverages. The cost of staff is likely to be a
step cost, which depends on the expected number of ticket holders
for each different day in the week, and time of day. Other
facilities costs are likely to be fixed for the number of ticket
holders, or number of films being shown.
3-24 The cost object here is more readily identified the beer
product, whether measured in individual bottles or larger
quantities. The variable costs will be significant here, including
the ingredients that go into the brewing of beer. Other costs for
the brewery are likely to be fixed for this cost object, but there
are important activity costs which will vary with, for example, the
number of customers/distributors (delivery and account management
costs), the number of different types of beer, or the complexity of
the brewing process for the brewery (a brewery that specializes in
the more expensive beers require more costly ingredients,
processing time, and different packaging).
3-25 Here it is plausible to consider the individual lesson as
the cost object. Variable costs would include that portion of the
trainers pay which is based on each lesson (the salary portion of
the trainers pay would be fixed for this cost object). Other
variable costs could include any materials that are used for each
lesson, and perhaps the travel cost to each client, if the company
reimburses the trainers for miles traveled.
3-26 $200 + $13,400 -$400 = $13,200
3-27 $2.6 + $10 = $12.6 million
3-28 $66,000 + $98,000 +($22,000 - $1,000) - $2,000 =
$183,000
3-29 $400,000 + $1,600,000 - $200,000 = $1,800,000 cost of goods
sold
3-30 Period cost includes interest, advertising, and office
expense: $4,000 + $2,500 + $14,000 = $20,500
EXERCISES
3-31 Fares and Fees in the Airline Industry (15 min)
Very much like the consumer products industry (Procter &
Gamble as an example) introduced at the start of the chapter, the
airline industry is characterized by a high degree of complexity in
pricing both fares and fees.
1. It is likely most will argue that the airline industry is a
cost leadership industry. Most passengers look for the lowest price
ticket and see very little difference between airlines in terms of
quality, reliability, or service. On the other hand, airlines would
very much like to build a brand loyalty by providing certain free
services and customer service. Whether this will work is a good
question for class discussion. One point that should arise in the
discussion is to determine whether the airline business is a
commodity business. Can a customer differentiate the different
carriers?Another issue is the airlines desire for more control over
the purchasing of tickets. Could this approach help them develop a
brand, or simply add to the complexity and frustration of the
consumer? On the other hand, some travel analysts have questioned
the impartiality of the available Web sites passengers use to
purchase tickets; arguments of this nature could drive the
development of new search engines and away from airlines that did
not participate in trusted, independent Web search sites. If the
number of Web sites increases, as some in the travel industry
expect, then it is likely to place more price pressure on the
airlines and reinforce the commodity view of the industry.
2. The complexity of fees and fares presents a challenge for the
consumer, and an opportunity for search sites such as Expedia to
assist passengers in getting the flight they want at the lowest
price. From the airlines point of view, the complexity presents an
opportunity for revenue growth (fees for various services such as
checked baggage, priority seating, etc.). Does the additional
complexity increase the operating costs of the airline?
3-31 (continued -1)
It is likely that the additional complexity in fares and fees
will affect the airlines costs for the cost of additional time and
materials in processing fee payments and in assisting customers. Of
course, the additional fees are very likely to cover these
additional costs.
Source: Jad Mouawad and Claire Cain Miller, Search for Low
Airfares Gets More Competitive, The New York Times, February 10,
2011; Gary Stoler, Fee-fi-fo-fum, Airline Charges Leave Some
Travelers Numb, USA Today, September 20, 2011, p B1.
For a contrasting view, see, Loizos Hereacleous and Jochen
Wirtz, Singapore Airlines Balancing Act, Harvard Business Review,
July-August 2010, pp. 145-149. The authors argue that Singapore
Airlines simultaneously competes on cost leadership and
differentiation. The authors further argue that this competition is
common in Asian airlines. The authors call this a dual
strategy.
3-32 Complexity of Operations and the Effect on Cost (15
min)
The observations made by the consultant show that the
manufacturer was incurring large costs in operations, distribution,
and administration due to the high level of complexity in its
products. Maintaining relationships with 10 vendors for a single
item contributed to high purchasing and stocking costs. Similarly,
most of the firms volume was made up of products with five color
combinations, with the result that manufacturing, warehousing,
shipping and selling costs were high relative to fewer color
combinations. Also, the high product variety required smaller batch
production and more frequent set-ups, which caused increased
manufacturing costs. Also, the variety of different customers,
prices, and promotional programs created increased manufacturing,
shipping and customer service costs as well as increased costs in
accounting for the customers invoices and account balances.The
solution? Reduce complexity. This was done by reducing the number
of customers; the low value customers were reviewed and some were
not continued. Also, a process of review was developed for the
introduction of new products or new variations on existing
products, to ensure the likely profitability of the new product.
Further, the complexity of equipment set-ups was reduced so that
the firm could meet the customers demands for smaller batch sizes
without increasing overall costs. The result of the program was
that overall profit margins improved. The firm had found a way to
deal with the cost consequences of its strategic initiative.Also,
the firm adopted new cost management practices that included new
non-financial measures such as set-up time and frequency, percent
of orders shipped on time, percent of orders on just-in-time, and
number of vendors for the top 20 commodity raw materials items. In
addition, the firm began to calculate and regularly review customer
profitability, by type of market and customer size.
Based on information in: Barry Berman, Products, Products
Everywhere, The Wall Street Journal, August 23, 2010, p R8;
Managing Complexity Through Performance Measurement, by Frank A. J.
Gonsalves and Robert G. Eiler, Management Accounting, August 1996,
pp 34-39.
3-33 Classification of Costs (10 min)
Parts 1 and 2:
1. Print machine setup costs: activity; product 2. Cost of
complexity; the number and variety of products: structural;
product3. Training costs for new staff: structural or executional;
product4. Ink: volume; product 5. Customer service costs: activity;
period6. Paper: volume; product 7. Redesign of the print process to
improve efficiency: executional; product8. Machine operation labor:
volume; product9. Order taking: activity; period10. Purchasing and
stocking paper and other supplies activity; product
3. The ink could have a harmful environmental impact. The
company could choose to use environmentally friendly ink, or
dispose of the harmful ink in a proper manner. All waste paper
should be properly recycled.
3-34Classification of Costs (10 min)1. period2. product and
indirect3. product and indirect4. product and direct5. period (the
answer is correct, but note that delivery of materials would be
included in inventory cost of the materials if the purchaser paid
for delivery)6. period7. product and direct8. period9. product and
indirect (could be direct if electricity is metered and measured
for each product)10. period11. period12. product and indirect13.
period14. period
3-35Classification of Costs (10 min) 1. direct and variable2.
indirect and fixed3. indirect and variable4. indirect and fixed5.
direct and variable6. indirect and fixed7. indirect and variable8.
direct and variable9. indirect and fixed10. indirect and fixed
3-36Classification of Costs (10 min)
1. direct2. indirect3. direct4. indirect5. direct6. indirect7.
indirect8. direct9. indirect10. indirect
3-37 Activity Levels and Cost Drivers (10 Min)
Cost ObjectCost Driver
1product line or customertrace to product line, or each custom
order requiring design
2product line or customertrace to product line, or each custom
order requiring testing
3product lineproduct line
4product linenumber of purchase orders
5customer ordertrace directly to customer
6customer ordertrace directly to customer
7customer ordertrace directly to customer
8customer ordertrace directly to customer
9each customertrace directly to customer
10customer ordertrace directly to customer
11 not allocatedcannot be traced to product or customer; must be
allocated using some reasonable method, for example, number of
units produced
12 not allocatedcannot be traced to product or customer; must be
allocated using some reasonable method, for example, the number of
units produced
3-38 Application of the Direct Cost Concept in the Fashion
Industry (15 min)
It is always possible, by definition, to trace direct materials
and direct labor costs to each unit produced. In some cases, as
this one, the most practical approach is to trace the materials and
labor costs directly to the batch. This is convenient both for cost
management and pricing, since the batch is often for a single
customer. This is a preview of job costing, which is the topic of
the following chapter, chapter 4.
3-39 Direct Manufacturing Labor: Fixed or Variable? (10 min)
The effect of the policy on cost is that labor expense, while
fixed in total expenditure, is in reality a variable expense. Labor
is flexible and can be moved from job to job or plant to plant as
demand dictates; that is, labor cost at the plant level fluctuates
with demand at each plant, while total labor cost at the firm stays
fixed. Thus, instead of incurring a fixed cost for labor, the
companys total labor costs are flexible and vary with demand, as
part-time labor is added when needed.
Source: Clara Asbury, In the Workplace, Jobs Morph to Suit Rapid
Pace of Change, The Wall Street Journal, March 22, 2002, p1.
3-40Average and Total Costs (15 min)
1. Total cost:$ 1,500 (fixed cost of space rental)+ 1,500
(variable cost of refreshments = $15 x 100)$ 3,000
Average cost: $3,000/100 people = $30.00 per person
2. Total cost: $ 1,500 (fixed cost of space rental)+ 3,000
(variable cost of refreshments = $15 x 200) $ 4,500
Average cost: $4,500/200 people = $22.50 per person
3. Average costs decrease as attendance increases because the
fixed cost component to total costs is now spread over 100 extra
people.
Fixed cost per person: $1,500/100 people = $15 $1,500/200 = $
7.50 Decrease in fixed cost per person $ 7.50
Average cost for 100 people$30.00 - Decrease per person in fixed
costs 7.50 Average cost for 200 people $ 22.50
3-41Cost Classification for Dance Studio (15 min)
1. While a variety of possible cost objects are possible for the
dance studio, the most reasonable choice is the studio since
managements goal is to analyze the profitability of the
studios.
2. Studios as the cost object1. a,c2. a,c3. a,c4. a,c5. a,c6.
b,c7. a,c8. a,d
Or,
Lessons as the cost object1. a,d2. b,d3. b,d4. b,d5. b,d6. b,d7.
b,d8. b,d
3-42 Relevant Range (20 min)
This exercise is intended to develop the students appreciation
of the complexities in cost determination and the importance of
considering foreign exchange effects when doing business abroad. 1.
The volume-based costs include:a. Fixed costs: administrative costs
of management in Austin and Paris and the 16 marketing and customer
service locationsb. Variable costs: the royalties paid for the
images sold, the cost of computer operations personnel, the
purchase of small servers as neededc. Step costs: purchase of
larger computer servers as needed when demand increases, facilities
costs including lease or depreciation expense, insurance,
maintenance, security, etc. 2. The relevant range is applicable for
PGI because PGIs operations centers must grow as demand increases.
This means higher variable costs due to the cost of adding small
computer servers and the cost of hiring additional staff, etc. Note
that the cost of the additional staff would be variable costs, but
the cost of adding capacity additional large servers and new
administrative staff would be a step cost, increasing unit costs.
So PGIs total costs increase in a non-linear, upward-sloping manner
over wide ranges of demand. The relevant range is used to determine
the level of unit variable cost and total fixed cost for a limited
range of activity a range in which there is no need for additional
servers or hiring costs, etc.
3-42 (continued -1)
3. The growth of the company globally means that the company
will be more exposed to the effects of foreign currency
fluctuations. For example, a falling dollar relative to the Euro
will lower the effective cost of PGIs U.S.-based services to
European customers, thereby potentially increasing demand in
Europe. Also, the translation of the European earnings in Euros to
PGIs financial statement will mean foreign currency gains, as the
Euro earnings are worth more with the falling dollar. The changes
in the currency exchange rates can potentially and perhaps
significantly affect the companys earnings in two ways: increased
sales and foreign currency exchange gains. The reverse would be
true if the dollar were to appreciate relative to the Euro. The
same currency issues apply should the companys business continue to
grow in China. In this case, the currency effect is likely to be
smaller, since the Chinese currency has not changed much relative
to the dollar in recent years.
3-43Fixed, Variable and Mixed Costs (10 min)
Department A fixed
Department B variable
Department C mixed
Department D mixed
Department E variable
3-44Fixed, Variable and Mixed Costs (10 min)
Department A mixed
Department B mixed
Department C fixed
Department D variable
Department E variable
3-45Strategy; Variable and Fixed Costs (20 min)
1. The variable costs for Zipcar would be the same as for any
car owner gasoline (customers do not pay for gas, but instead a
simple hourly rate) and upkeep. The fixed cost are the largest part
of total cost, the cost of the car, insurance, and the parking
spot, among others.2. The key challenge facing Zipcar is the
entrance of competitors such as Hertz and Enterprise car rental
agencies. Zipcar has no barrier to entry, and is vulnerable to new
competition.
A good question for class discussion: How will Zipcar be able to
compete effectively against the larger companies? Is the Zipcar
concept a commodity which can be copied and used by the other
companies, or are there some features and services that can make
Zipcar unique and differentiated? One idea would be to stress that
the company uses very small cars to achieve both convenience (in
large cities) and a green advantage (by Zipcars estimate, each car
it adds to its fleet keeps up to 20 cars off the road). Another
approach might be to emphasize its initiative in the business and
its environmental contribution over the last 10 years, ideas that
might have traction with those customers who want to make a
statement about their commitment to the environment. Since fixed
costs are a key component of total costs for the company, the
ability of the company to grow at a fast rate is critical. A larger
company, with more members and more usage of its vehicles, would be
able to more easily cover those fixed costs. As shown in Exhibit
3.11, average fixed costs fall as output increases.Another
challenge for Zipcar is the rising cost of gasoline. Because of the
short rental periods, it is not practical to have customers refuel
the car, and the flat hourly rate is appropriate and convenient.
But this also exposes Zipcar to fluctuations in gas prices which
must be covered by that fixed hourly rate.
Source: The Business of Sharing, The Economist, October 14,
2010; Adam Aston, Growth Galore, but Profits are Zip, Business
Week, September 8, 2008, p 62. Also: Mark Clothier, In The Race for
the Car-less, Can Hertz Outrun Zipcar? Bloomberg Businessweek,
April 2, 2012, pp. 23-24.
3-46Interpreting Average Cost (15 min)
This question is based on a report by Paul Raeburn, Hybrid Cars:
Less Fuel but More Costs, Business Week, April 15, 2002, p 107. See
also information on the history of gas prices from January 2000 to
the present at the U.S. Department of Energy website:
http://tonto.eia.doe.gov/oog/info/gdu/gaspump.html
CAF standards have remained at 27.5 mpg since 2002 but have been
increased by 2007 legislation which required 35 mpg by the year
2020. In May 2009, the Obama admiration pushed the 35MPG target
back to 2012, and in August 2011 legislation was passed that
required 54.5 mpg by 2025. The urgency of energy sustainability,
oil independence from non-domestic supplies, and climate change
have substantially increased the efforts to improve vehicle
efficiency and reduce vehicle emissions.
The rapid increase of gasoline prices in 2004-2011 should
enhance the interest in the issue discussed. The costs shown for
each gallon of gasoline saved look much better in 2011 than in 2002
when the article was written; in 2002 the price of gas averaged
$1.30, about 30% of the 2011 price. The cost justification for
higher fuel efficiency of the full hybrid would not pass in 2002
(cost of $1.80 per gallon when the price of gas was $1.30), but
would surely pass the test in summer 2011, with the price of gas
just short of $4.00 per gallon.
The main point of this exercise is to have the students
understand that the determination of an average cost, as in this
report, requires a specification of the level of activity, or
output, that drives costs. This is the reason the concept of
average cost is often misunderstood and misused in practice. For
example, since in this case total cost per gallon of gas depends on
both variable costs (gasoline) and fixed costs (vehicle cost), the
determination of an average cost requires an assumption of activity
level. While variable costs (the price of gasoline) are constant
per unit, for the number of gallons purchased, theaverage
per-gallon fixed costof purchasing the vehicle will depend on the
number of miles traveled. Car owners who travel relatively few
miles will have large average fixed costs in contrast to road
warriors with many miles traveled.
3-46 (continued -1)
The Business Week report does a good job in this regard by
reporting that the assumed activity was 12,000 miles per year for
12 years. This gives the reader a way to interpret the findings;
those who drive more than this amount can expect lower cost for
each gallon of gas saved from improvements in the vehicle, while
those who drive fewer miles can expect higher costs than those
reported.Instructors can start this exercise by asking the class
how average cost is determined in this case. The key idea to bring
out is that average fixed cost is determined by some pre-determined
activity level.
CAF Standards links:
http://www.nhtsa.gov/fuel-economy
3-47Interpreting Average Cost (15 min)
This question is based upon the following: Vincent Ryan,
Treasury: Bigger is Better, CFO.com, November 9, 2010; How Does
Your Finance Department Measure Up?Journal of Accountancy, January
1997, pp50-51.
The main point of this exercise, as for 3-46 above, is to help
the student understand the importance of taking activity levels
into account when interpreting average cost information.
The two articles show, as represented by the information
presented in the exercise, that average fixed costs decline with
higher levels of activity. Larger companies, with higher levels of
transaction volume, will have higher total fixed costs, but average
fixed costs should be lower due to economies of scale. Looked at
another way, if a given firm were to grow, and its volume of
transactions grew as well, then average fixed costs (or in this
case the ratio of total accounting costs to total revenue) would
have to fall. Average fixed cost would continue to fall with
increasing numbers of transactions, until the firm felt it
necessary to increase capacity in the accounting department,
thereby increasing fixed costs.
Thus, the data presented is as we would expect larger firms will
have lower average costs. We would not expect otherwise. Average
fixed costs should be lower for the larger firms.
3-48 Average Cost (15 min)
The percentage increase in total variable manufacturing cost,
averaging both labor and fuel costs, is 7.5% for Company A and 6%
for Company B. The increase is higher for Company A because it has
a higher percent of fuel costs which have risen faster than labor
costs.
Calculations: 7.5% =(.5 x 5%) + (.5 x 10%) 6% = (.8 x 5%) + (.2
x 10%)
The calculations for percentage change shown above hold
irrespective of the underlying amounts, as long as the amounts are
positive. The example below illustrates:
This example illustrates that two companies that may have the
same total variable costs, and facing the same changes in materials
or labor costs, will be affected differently if the mix of variable
costs are not the same for the two companies.
This example is sometimes called the fallacy of averages. The
take-away is that averages should be interpreted carefully, and in
particular, the management accountant should always consider the
components of cost which make up that average, as in the example
above.
3-48 (continued -1)
Here is another example. The recession in the early 1980s caused
an increase in unemployment for workers at all educational levels.
Also, in the great recession, during 2009, the unemployment rates
were higher for all educational levels than in 1983. However, the
overall unemployment rate in 2009 (10.2%) was lower than the
overall unemployment rate in 1983(10.8%). Why? The reason for this
apparently confusing result is that the group with the highest
educational attainment and lowest unemployment rates in both
recessions was a larger percentage of the total employed in 2009
relative to 1983. Since more 2009 workers were in the highly
educated group than in 1983, and this groups unemployment rate was
lower (in both periods), the effect was to bring down the overall
unemployment rate in 2009 relative to 1983.
Source: Carl Bialik, When Combined Data Reveal the Flaw of
Averages, The Wall Street Journal, December 9, 2009, p A21.
3-49 Classification of Costs; Customer Profitability Analysis
(15 min)
1. Direct (D) or Indirect(I)
1. Staff salariesD
2. Rent on office and work space used by the companyI
3. Licenses and feesI
4. Supplies; grooming supplies, and related itemsD
5. MedicationsD
6. Legal feesI*
7. Accounting services provided part-time by practicing
accountantI
8. Pet foodD
9. Utilities for office and work space; electricity and
waterI
10. Fire insurance for office and work space and its
contentsI
11. Liability insurance for the company business I
*It may be possible to trace some portions of legal fees to
specific customers, so that the cost would be direct and not
indirect
2. Pet Partner could use the information to identify costs that
are traceable to each customer (the direct costs) and determine
over a period of a month (or year) whether the direct costs traced
to the customer are less than or greater than the revenues from the
customer, that is, to determine if the customer is profitable or
not. A much more thorough means of determining customer
profitability analysis is covered in chapter 5, together with
activity-based costing.
3-50 Classification of Costs (15 min)
Parts 1 and 2Fixed(F) orVariable (V)Product (P) or Period
(PD)
1. Food costs including pizza dough, olive oil, tomato sauce,
etc.VP
2. Salaries for driversN*PD
3. Salaries for telephone operatorsN*PD
4. Salaries for cooksN*P
5. Insurance for driversFP
6. Utilities; water and electricityVP/PD (allocated to kitchen
and other space)
7. AdvertisingFPD
8. Discount coupons VPD
9. Food handling licenses, inspections, and feesFP
10. Accounting and payroll servicesFPD
11. Cooking suppliesVP
12. Cleaning suppliesVP
13. Mortgage payments FPD
14. Insurance on facilitiesFPD
*Note for Class Discussion: these costs are fixed unless Papas
manager schedules drivers, operators, and cooks so as to eliminate
slack time, in which case the cost of the drivers, operators, and
cooks could be considered variable costs
3. There are a number of possible answers. Inefficiency and
waste in the use of utilities or food products could be considered
an environmental issue. Also, cleaning supplies should be
environmentally-friendly and/or disposed of properly.
3-51 Classification of Costs (15 Min)
Parts 1 and 2Fixed(F) orProduct (P)
Variable (V)Period (PD)
1.TechniciansFP
2.PartsVP
3.Purchase of oil and tiresVP
4.SuppliesVP
5.ToolsFP
6.Rental of each locationFPD
7.AdvertisingFPD
8. UtilitiesFPD
9.Licenses and feesFPD
10.Employee training*FP
11.Security serviceFPD
12. Software for sales and reportsFPD
13. Disposal of waste oil and used tiresVPD
Employee training is considered a product cost because it is
related to direct labor of the technicians.
3. The disposal of waste oil and used tires is the critical
environmental issue for Speedy Auto Service. Both the waste oil and
used tires, which would accumulate in significant quantities for
this type of business, should be disposed of in an environmentally
appropriate manner.
PROBLEMS
3-52Executional Cost Drivers: Internet Retailer (20 min)
The example of an internet retailer such as Bikes.com is a good
example of the type of firm that must pay close attention to
executional cost drivers. The reason is that its success depends on
customer service prompt response to customer requests, and prompt
and accurate filling of customer orders. Customer loyalty is a key
success factor for a firm such as this, and loyalty comes from
superior customer service in all its dimensions. Amazon.com
introduced the successful internet retailing business model, and
has built a successful business on the basis of customer loyalty.
This is the approach Bikes.com needs to follow and this means
execution, execution, execution. The fall off in sales growth could
be an indication of problems in customer sales returns, that is
customer satisfaction and loyalty. Bikes.com can review sales
records to investigate.Specific executional steps that Bikes.com
can take include looking for possible improvements in the purchase
and stocking of merchandise and the shipping of customer orders the
upstream and downstream activities that must work smoothly to get
the orders to the customers quickly and accurately. Also, Bikes.com
should consider the work flow in the company. Can it be
streamlined? Are there non-value-adding activities that can be
eliminated? What are the bottlenecks, if any, that slow the process
of accurately filling a customers order? Also, are employees aware
of the importance of executional issues? Are the employees working
together to achieve the required speed and accuracy necessary for
the firms success? Executional cost drivers are important to
Bikes.com in two ways. First, these are the executional issues
which the firm must achieve in a superior way in order to compete
effectively in internet retailing. And second, effective attention
to the cost drivers and effective cost management can lower the
costs of operation and speed the arrival of profits.
3-53Structural Cost Drivers (25 min)Case A: A key structural
issue for Food Fare is complexity. As the menu has changed, so will
costs and service. More complexity means higher food purchasing
costs, higher operating costs, and more complex operations. This
will require new types of training for employees and perhaps
additional employees. Moreover, it will be a challenge for Food
Fare to continue to provide the speed of service that was possible
with the shorter menu. The change will require careful attention to
operations and to cost management issues for the firm to continue
to be profitable. Employee training and new uses of technology to
streamline the process of order taking and order filling are likely
to be necessary. Scale might also be an important issue in this
case how large must each restaurant become, and how many
restaurants must the chain have in order to justify the increased
purchasing and stocking costs, and the new training and technology
costs?
Case B: A key issue in this case is the speed with which Gilman
can provide customer service. The speed of service provides value
to the customer and also increases profitability. In order to
increase the speed of service, Gilman needs effective communication
and coordination among the service teams. This is probably being
accomplished now by cell phone. Gilman can research new and more
effective ways to accomplish this, perhaps using hand-held internet
access devices, iphones, or other modem-equipped devices. The
advantage of computer-based access is that computer-based tools can
be used in the scheduling and assignment of the service teams.
Additionally, the computer can be used by each service team to
quickly determine the availability of parts in the firms warehouse
or in other service vehicles, thereby allowing faster service time.
Also, the computer can be used to develop real-time analyses of
customer demand and profitability in order to better understand
which services and which types of customers are most
profitable.
3-53 (continued -1)
Is it in installation or service, Brand X or Brand Y,
residential or commercial, etc.? Scale is also an important cost
driver for Gilman. To serve the large area it now serves, there
should be a careful strategic analysis to get the right balance
between order getting costs (advertising and promotion to obtain
new customers) plus the costs of maintaining the truck fleet and
service teams versus the opportunity to provide additional services
to existing customers.
3-54Cost of Goods Manufactured and Sold (30 min)
Chapter 3 - Basic Cost Management Concepts3-20 2013 by
McGraw-Hill Education. This is proprietary material solely for
authorized instructor use. Not authorized for sale or distribution
in any manner. This document may not be copied, scanned,
duplicated, forwarded, distributed, or posted on a website, in
whole or part.3-55Cost of Goods Manufactured and Sold (30 min)
3-56Cost of Goods Manufactured and Sold (30 min)
3-57 Cost of Goods Manufactured and Sold (30 min)
3-58Cost of Good Manufactured and Income Statement (40 min)
3-58(continued -1)
Sheet1 Hamilton, IncDecember 31, 2013DataDirect Materials
Inventory, Beginning25,000Direct Materials Inventory,
Ending40,000Direct Materials Purchases555,000Direct
Labor310,000Indirect Labor70,000Finished Goods Inventory,
Beginning135,000Finished Goods Inventory, Ending75,000Utilities for
Plant38,000Indirect Mateials66,000Factory
Rent380,000Work-in-Process Inventory,
Beginning45,000Work-in-Process Inventory, Ending40,000
Hamilton, IncStatement of Cost of Goods Manufactured For The
Year EndedDecember 31, 2013Direct Materials Used Direct Materials
Inventory, Beginning$ 25,000Direct Materials Purchases 555,000Total
Direct Materials Available580,000Direct Materials Inventory,
Ending$40,000Direct Materials Used$ 540,000Direct
Labor310,000Factory OverheadIndirect Mateials$ 66,000Utilities for
Plant38,000Indirect Labor70,000Factory Rent 380,000Total Factory
Overhead 554,000Total Manufacturing Costs Incurred during
year1,404,000Work-in-Process Inventory, Beginning 45,000Total
Manufacturing Costs to Account for1,449,000Work-in-Process
Inventory, Ending 40,000Cost of Goods Manufactured$ 1,409,000
Cost of Goods SoldFinished Goods Inventory, Beginning$
135,000Cost of Goods Manufactured1,409,000Total Goods Available for
Sale1,544,000Finished Goods Inventory, Ending75,000Cost of Goods
Sold$ 1,469,000
Sheet2
Sheet3
Sheet1Problem 3-57Blazek CompanyDecember 31,
2013DataDepreciation Expense--Plant$ 33,000Direct Materials
Inventory, Beginning22,000Direct Materials Inventory,
Ending55,000Direct Materials Purchases165,000Direct
Labor--Wages115,000Indirect Labor--Wages45,000Finished Goods
Inventory, Beginning17,000Finished Goods Inventory,
Ending24,000Repairs and Maintenance11,000Factory
insurance8,000General and Administrative86,000Work-in-Process
Inventory, Beginning13,000Work-in-Process Inventory,
Ending16,000Marketing Expenses145,000Sales Revenue625,000Blazek
CompanyStatement of Cost of Goods ManufacturedFor the Year Ended
December 31, 2013Direct Materials UsedDirect Materials Inventory,
Beginning$22,000Direct Materials Purchases165,000Total Direct
Materials Available187,000Direct Materials Inventory,
Ending55,000Direct Materials Used$132,000Direct
Labor--Wages115,000Factory OverheadRepairs and
Maintenance$11,000Factory insurance8,000Depreciation
Expense--Plant33,000Indirect Labor--Wages45,000Total Factory
Overhead97,000Total Manufacturing Costs Incurred during
year344,000Work-in-Process Inventory, Beginning13,000Total
Manufacturing Costs to Account for357,000Work-in-Process Inventory,
Ending16,000Cost of Goods Manufactured$341,000Blazek CompanyIncome
StatementFor the Year EndedDecember 31, 2013Sales
Revenue$625,000Cost of Goods SoldFinished Goods Inventory,
Beginning$17,000Cost of Goods Manufactured341,000Total Goods
Available for Sale358,000Finished Goods Inventory, Ending24,000Cost
of Goods Sold334,000Gross Margin291,000Marketing
Expenses$145,000General and Administrative86,000Total Selling &
Administrative Expenses231,000Operating Income$60,000
Sheet2
Sheet3
Sheet1Problem 3-41Household Furnishings, IncDecember 31,
2004DataDepreciation Expense--Admin. Office33,000Depreciation
Expense--Plant and Equip.88,000Direct Materials Inventory,
Beginning18,000Direct Materials Inventory, Ending25,000Direct
Materials Purchases155,000Direct Labor--Wages487,000Indirect
Labor--Wages25,000Finished Goods Inventory, Beginning15,000Finished
Goods Inventory, Ending38,000Heat, Light, &
Power--Plant44,000Property Taxes--Plant34,000Supervisor's Salary
Plant66,000Supplies--Plant27,000Supplies--Administrative
Office16,000Work-in-Process Inventory,
Beginning23,000Work-in-Process Inventory, Ending9,000Sales
Representatives' Salaries145,000Sales Revenue1,500,000Household
Furnishings, Inc.Statement of Cost of Goods ManufacturedFor the
Year Ended December 31, 2013Direct Materials UsedDirect Materials
Inventory, Beginning$18,000Direct Materials Purchases155,000Total
Direct Materials Available173,000Direct Materials Inventory,
Ending25,000Direct Materials Used$148,000Direct
Labor--Wages487,000Factory OverheadHeat, Light, &
Power--Plant$44,000Supplies--Plant29,000Property
Taxes--Plant34,000Depreciation Expense--Plant and
Equip.88,000Indirect Labor--Wages25,000Supervisor's Salary
Plant66,000Total Factory Overhead286,000Total Manufacturing Costs
Incurred during year921,000Work-in-Process Inventory,
Beginning23,000Total Manufacturing Costs to Account
for944,000Work-in-Process Inventory, Ending9,000Cost of Goods
Manufactured$935,000Household Furnishings, Inc.Income StatementFor
the Year Ended December 31, 2013Sales Revenue$1,500,000Cost of
Goods SoldFinished Goods Inventory, Beginning$15,000Cost of Goods
Manufactured935,000Total Goods Available for Sale950,000Finished
Goods Inventory, Ending38,000Cost of Goods Sold912,000Gross
Margin588,000Sales Representatives'
Salaries$145,000Supplies--Administrative Office16,000Depreciation
Expense--Admin. Office33,000Total Selling & Administrative
Expenses194,000Net Income$394,000
Sheet2
Sheet3
Sheet1Problem 3-57Fair Wind YachtsDecember 31,
2013DataAdvertising Expenses$ 150,000Depreciation Expense--Admin.
Office75,000Depreciation Expense--Plant and
Equip.320,000Depreciation Expense - Delivery Trucks45,000Direct
Materials Inventory, Beginning16,000Direct Materials Inventory,
Ending18,000Direct Materials Purchases410,000Direct
Labor512,000Indirect Labor269,000Finished Goods Inventory,
Beginning55,000Finished Goods Inventory, Ending43,000Insurance on
Plant32,000Heat and Light for Plant22,000Repairs on Plant
Building36,000Supervisor's Salary
Plant98,000Supplies--Plant132,000Supplies--Administrative
Office78,000Work-in-Process Inventory,
Beginning31,000Work-in-Process Inventory, Ending39,000Sales
Representatives' Salaries325,000Sales Revenue2,885,000
Fair Wind YachtsStatement of Cost of Goods Manufactured For The
Year EndedDecember 31, 2013Direct Materials Used Direct Materials
Inventory, Beginning$ 16,000Direct Materials Purchases 410,000Total
Direct Materials Available426,000Direct Materials Inventory,
Ending18,000Direct Materials Used$ 408,000Direct
Labor512,000Factory OverheadInsurance on Plant$
32,000Supplies--Plant132,000Repairs on Plant
Building36,000Depreciation Expense--Plant and Equip.320,000Heat and
Light for Plant22,000Indirect Labor269,000Supervisor's Salary Plant
98,000Total Factory Overhead 909,000Total Manufacturing Costs
Incurred during year1,829,000Work-in-Process Inventory, Beginning
31,000Total Manufacturing Costs to Account
for1,860,000Work-in-Process Inventory, Ending 39,000Cost of Goods
Manufactured$ 1,821,000Fair Wind YachtsIncome StatementFor the Year
Ended December 31, 2013Sales Revenue$ 2,885,000Cost of Goods
SoldFinished Goods Inventory, Beginning$ 55,000Cost of Goods
Manufactured1,821,000Total Goods Available for
Sale1,876,000Finished Goods Inventory, Ending43,000
Cost of Goods Sold1,833,000Gross Margin1,052,000Advertising
Expenses$ 150,000 Sales Representatives'
Salaries325,000Supplies--Administrative Office78,000Depreciation
Expense--Admin. Office75,000Depreciation Expense - Delivery
Trucks45,000Total Selling & Administrative
Expenses673,000Operating Income$ 379,000
Sheet2
Sheet3
Sheet1Norton IndustriesStatement of Cost of Goods
ManufacturedFor the Month Ended May 31, 2013($000) omittedDirect
Materials Used Direct Materials Inventory, April 30$28 Direct
Materials Purchases510 Freight in15 Total Direct Materials
Available553 Direct Materials Inventory, May 3123Direct Materials
Used$530Direct Labor-Wages260Factory Overhead Indirect factory
labor90 Utilities108 Property taxes--Plant60 Insurance12
Depreciation50Total Factory Overhead320Total Manufacturing Cost
Incurred During Year1,110Work-in-Process Inventory, April
30150Total Manufacturing Costs to Account for1,260Work-in-Process
Inventory, May 31220Cost of Goods Manufactured$1,040
Norton IndustriesIncome StatementFor the Month Ended May 31,
2013($000) omitted
Sales RevenueERROR:#REF!Less: Sales DiscountsERROR:#REF!Net
SalesERROR:#REF!
Cost of Goods Sold: Finished Goods Inventory, April
30ERROR:#REF! Cost of Goods Manufactured1,260 Total Goods Available
for SaleERROR:#REF! Finished Goods Inventory, May 31ERROR:#REF!
Cost of Goods SoldERROR:#REF!Gross MarginERROR:#REF!
General, Selling, & Administrative Expense: Office
SalariesERROR:#REF! Sales SalariesERROR:#REF! InsuranceERROR:#REF!
UtilitiesERROR:#REF! RentERROR:#REF! DepreciationERROR:#REF!
InterestERROR:#REF!Total General, Selling, & Administrative
ExpenseERROR:#REF!
Income from operationsERROR:#REF!Other revenueERROR:#REF!Net
IncomeERROR:#REF!
Sheet2Norton IndustriesCash and Marketable securities$
54Accounts and notes receivable210Direct materials inventory
(4/30/13)28Direct materials inventory (5/31/13)23Work-in-process
inventory (4/30/13)150Work-in-process inventory
(5/31/13)220Depreciation Expense - Plant50Finished goods inventory
(4/30/13)247Finished goods inventory (5/31/13)175Property, plant,
and equipment (net)1,140Accounts, notes, and taxes payable70Bonds
Payable600Paid-in capital100Retained earnings930Sales1,488Sales
discounts20Other revenue2Purchases of direct materials510Direct
Labor260Indirect factory labor90Office salaries122Sales
salaries42Utilities135Rent9Depreciation - Administrative4Property
tax60Insurance20Depreciation54Interest expense6Freight-in for
materials purchases15
Norton IndustriesStatement of Cost of Goods ManufacturedFor the
Month Ended May 31, 2013($000) omitted
Direct Materials Used Direct Materials Inventory, April 30$ 28
Direct Materials Purchases510 Freight in15 Total Direct Materials
Available553 Direct Materials Inventory, May 3123Direct Materials
Used$ 530Direct Labor-Wages260Factory Overhead Indirect factory
labor$ 90 Utilities108 Property taxes--Plant60 Insurance12
Depreciation50Total Factory Overhead320Total Manufacturing Cost
Incurred During Month1,110Work-in-Process Inventory, April
30150Total Manufacturing Costs to Account for1,260Work-in-Process
Inventory, May 31220Cost of Goods Manufactured$ 1,040
Norton IndustriesIncome StatementFor the Month Ended May 31,
2013($000) omitted
Sales Revenue$ 1,488Less: Sales Discounts20Net Sales1,468
Cost of Goods Sold: Finished Goods Inventory, April 30$ 247 Cost
of Goods Manufactured1,040 Total Goods Available for Sale1,287
Finished Goods Inventory, May 31175
Cost of Goods Sold1,112Gross Margin$ 356
General, Selling, & Administrative Expense: Office Salaries$
122 Sales Salaries42 Insurance8 Utilities27 Rent9 Depreciation4
Interest6Total General, Selling, & Administrative
Expense218
Income from operations138Other revenue2Net Income$ 140
Sheet3