Classroom Materials ACC 232

Chapter 13 Corporations: Organization, Stock Transactions, and Dividends

Characteristics of a corporation:

1.

2.

3.

4.

5.

6.

7.

Organization costs include:

Hoover Corporation was organized early in 2009. Legal costs and other fees associated with incorporation totaled $3,500.

Organization Expenses 3,500Cash 3,500

Stockholders’ Equity

Two main sources of stockholders’ equity:

Paid-in Capital

Retained Earnings

Stockholders’ Equity Section of a Balance Sheet

Paid-in capital:

Preferred stock $ X

Paid-in capital in excess of par—preferred X

Common stock X

Paid-in capital in excess of par—common X

Paid-in capital from treasury stock X

Total paid-in capital $ X

Retained earnings X

Less: Treasury stock (X)

Total stockholders’ equity $ X

Par Value

Common Stock

The major rights usually granted to a common stockholder are:

1.

2.

3.

Preferred stock

Treasury stock

Dividends

Authorized shares

Issued shares

Outstanding shares

Cumulative preferred stock

Dividends in arrears

Dividing Dividends Between Preferred and Common

Problem 1: Belson Corporation has 10,000 common shares and 5,000 preferred shares of stock outstanding. The preferred stock has a $5 dividend rate. Two years of dividends are currently in arrears. Assume that the preferred stock is noncumulative. Belson has $155,000 to distribute in the form of dividends. The dividends to be distributed to common and preferred stockholders are calculated as follows:

Preferred CommonStockholders Stockholders

Dividends in arrears 0Regular dividend (5,000 x $5) $25,000Remainder $130,000Total dividends paid $25,000 $130,000 $155,000Dividends per share $5 $13

Assume the same information above except that the preferred stock is cumulative.

Preferred CommonStockholders Stockholders

Dividends in arrears(5,000 x $5 x 2) $50,000Regular dividend 25,000Remainder $80,000 Total dividends paid $75,000 $80,000 $155,000Dividends per share $15 $8

Problem 2: Belson Corporation has 10,000 common shares and 5,000 preferred shares of stock outstanding. The preferred stock has a $5 dividend rate. Assume that Belson has $90,000 of dividends to be paid under each of the following assumptions:

1. There is one year of dividends in arrears and the preferred stock is noncumulative.

Preferred CommonStockholders Stockholders

2. There are three years of dividends in arrears and the preferred stock is cumulative.

Preferred CommonStockholders Stockholders

New Accounts

Know the normal balance of all new accounts and where they go in the financial statements.

Financial Statement Section Normal Balance

Preferred stock

Common stock

Paid-in capital in excess of par

Treasury Stock

Paid-in capital from sale of TS

Retained earnings

Cash Dividends

Cash Dividends payable

Stock Dividends

Stock Dividends Distributable

Closing Journal Entries for Corporations

Assume that a corporation has closed its revenues and expenses into income summary. Net income is $35,000. Cash dividends of $10,000 and stock dividends of $5,000 were declared during the year.

Close the net income held in income summary to retained earnings.

Income Summary 35,000Retained Earnings 35,000

Close the temporary dividend accounts to retained earnings.

Retained Earnings 15,000Cash Dividends 10,000Stock Dividends 5,000

Issuance of Stock

Kats, Inc. issued 1,000 shares of $2 par value preferred stock at $34 per share and 3,000 shares of $1 par value common stock at $40 per share.

Cash 34,000 Preferred Stock 2,000

Paid-in Capital in Excess of Par, PS 32,000

Cash 120,000 Common Stock 3,000

Paid-in Capital in Excess of Par, CS 117,000

Note: If the shares have a stated value instead of par, the account used would be Paid-in Capital in Excess of Stated Value.

Assume that both classes of stock had no par value.

Cash 34,000Preferred Stock 34,000

Cash 120,000

Common Stock 120,000

Two months later, Kats, Inc. issued 2,000 shares of common stock, $1 par, in exchange for land with a market value of $81,500.

Land 81,500Common Stock 2,000Paid-in Capital in Excess of Par 79,500

Kats, Inc. received a statement for $25,000 from the attorney who provided services during the incorporation and start-up of the company. The attorney has accepted the company’s offer of 610 shares of $1 par common stock in exchange for the services rendered.

Legal Expense 25,000Common Stock 610Paid-in Capital in Excess of Par 24,390

Treasury Stock

Black Corporation purchases 2,000 shares of its $5 par value common stock at $15 per share.

Treasury Stock 30,000Cash 30,000

One month later, Black reissues 1,000 shares of its treasury stock at $16 per share.

Cash 16,000Treasury Stock 15,000Paid-in Capital from Sale of Treasury Stock 1,000

Six months later, Black reissues 500 shares of its treasury stock at $14 per share.

Cash 7,000Paid-in Capital from Sale of Treasury Stock 500

Treasury Stock 7,500

Note: If there is no balance in paid-in capital from treasury stock to reduce when treasury stock is reissued, then debit retained earnings.

Dividends and Splits

Monsters, Inc. has 100,000 shares of $2 par common stock outstanding.

May 1: Board of Directors declares a $5 cash dividend to be paid on June 30.

Cash Dividends ($5x100,000) 500,000 Cash Dividends Payable 500,000

June 30: Dividend is paid.

Cash Dividends Payable 500,000 Cash 500,000

December 31: Close cash dividends.

Retained Earnings 500,000 Cash Dividends 500,000

May 1: Instead, the Board of Directors declares a 10% stock dividend when themarket price of the common stock is $50 per share. Number of shares to be issued = 10% x 100,000 = 10,000 shares.

Stock Dividends ($50x10,000) 500,000 Stock Dividends Distributable($2x10,000) 20,000 Paid-in Capital in Excess of Par, Common 480,000

June 30: Common stock is distributed.

Stock Dividends Distributable 20,000 Common Stock 20,000

December 31: Close stock dividends.

Retained Earnings 500,000Stock Dividends 500,000

May 1: Instead, the Board of Directors announces a 2 for 1 split.

No journal entry is necessary if the number of outstanding shares is changed to 200,000 and the par value per share is changed to $1.

Comparison of Stock Dividend and Stock Split

On April 30, the stockholders’ equity section of Stanford Company’s balance sheet consist of common stock $240,000, paid-in capital in excess of par $60,000, and retained earnings $100,000. The company is considering two courses of action: (1) declaring a 5% stock dividend on the 80,000 $3 par value shares outstanding or (2) effecting a 3 for 1 stock split. The current market price is $10 per share.

Prepare all journal entries necessary to record the stock dividend and stock split.

Stock Dividend: Number of shares to be issued =

Stock Split:

Complete the following table showing the effects before any action, after the stock dividend, and after the stock split.

After Stock After StockBefore Dividend Split

Outstanding shares

Par value per share

Stockholders’ Equity:

Common Stock

Paid-in Capital In Excess of Par

Retained Earnings

Total Stockholders’ Equity

Journal Entries

The Gamma Corporation was organized in 2009 in the state of Texas. Its charter authorized the corporation to issue 1,000,000 shares of $1 par value common stock and an additional 25,000 shares of 4 percent, $2 par value cumulative preferred stock. The following transactions relate to the company’s stock during 2009.Feb. 1 Issued 100,000 shares of common stock for $125,000.Feb. 15 Issued 3,000 shares of common stock for legal services. The services were billed

to the company at $3,600. Mar. 15 Issued 120,000 shares of common stock in exchange for equipment that had an

appraised value of $125,000. Apr. 2 Purchased 20,000 shares of common stock to be held in treasury at $1.25/share.July 1 Issued 25,000 shares of preferred stock for $3.00 per share. Nov. 15 Reissued 10,000 shares of treasury stock at $1.35 per share.Dec. 31 The board of directors declared the regular dividend on the preferred stock and

$0.25 per share on the common stock. Preferred dividend =

Common dividend = Date Accounts Debit CreditFeb. 1

Feb. 15

Mar. 15

Apr. 2

July 1

Nov. 15

Dec. 31

Using the information of the previous page, complete a stockholders’ equity section of the balance sheet dated 12/31/09. Assume net income was $210,000 for 2009.

Stockholders’ Equity

Paid-in capital:

Preferred 4% stock, cumulative, $2 par (____________ shares authorized and_____________ shares issued)

Paid-in capital in excess of par, preferred

Common stock, $1 par (_____________ shares authorized and __________ shares issued)

Paid-in capital in excess of par, common

Paid-in capital from sale of treasury stock

Total paid-in capital

Retained Earnings

Total stockholders’ equity

Statement of Retained Earnings

The second required financial statement for a corporation can be either a statement of retained earnings or a statement of stockholders’ equity.

Gamma CorporationStatement of Retained Earnings

For the period ended December 31, 2009

Retained earnings, January 1, 2009 $__________Add: Net income __________Less dividends: Preferred Stock $ _________ Common Stock _________ _________

Retained earnings, December 31, 2009 $__________

Stockholders’ Equity Problem

The stockholders’ equity section of the Turner Corporation’s December 31, 2009, balance sheet is presented below:

STOCKHOLDERS’ EQUITY:4% Cumulative Preferred Stock, $100 par, authorized 50,000 shares, 10,000 shares issued and outstanding (A)Common Stock, $2 par, authorized 1,000,000 shares, (B) shares issued of which 25,000 are in the treasury 800,000

Paid-in Capital in Excess of Par: Preferred 20,000 Common 200,000Total Paid-in Capital (C)

Retained Earnings 1,500,000

Less: Treasury Stock (50,000)Total Stockholders’ Equity (D) 1. What is the amount represented by (A)?

2. How many shares of common stock have been issued (B)?

3. What is the total paid-in capital (C)?

4. What is total stockholders’ equity (D)?

5. What was the average selling price per share of preferred stock?

6. How many shares of common stock are outstanding?

7. What was the average selling price per share of common stock?

8. What was the average purchase price paid for the treasury stock?

9. What is the annual stated dividend on the preferred stock per share?

10. If the company paid no dividends in 2007 or 2008, what is the total dividends in arrears?

Effects of Transactions on Stockholders’ Equity (SE)

Transactions Effect (increase, decrease or no affect)

1. Issuance of capital stock.

2. Declaration of a cash dividend.

3. Payment of cash dividend.

4. Declaration of a stock dividend.

5. Distribution of a stock dividend.

6. Stock split (no journal entry).

7. Acquisition of treasury stock.

8. Reissuance of treasury stock.

Chapter 14 Bonds Payable

Bond

Bond indenture

Characteristics of bonds:

1.

2.

3.

Term bonds

Serial bonds

Convertible bonds

Callable bonds

Secured bonds

Debenture bonds

Contract rate

Market rate

Premium

Discount

Carrying amount

Present Value

Annuity

Assume that you have won a sweepstakes with a $5 million grand prize. You have to choose how to take your winnings: $500,000 per year for 10 years (an annuity) or $3 million now. If the market interest rate is 11%, which would you choose.

To calculate the present value of an annuity:

Annuity amount x Factor from the Present Value of Annuity of $1 table

i=11%, n=10 years

500,000 x 5.88923 = $2,944,615

3,000,000 > 2,944,615, so take the $3 million today

Bond Pricing

Present value concepts are used to price bonds. The bond price is equal to the sum of the present value of all future cash flows. The cash flows include the face value of the bond and the periodic interest payments.

Bond sells at a discount.A $10,000, 5-year, 11% bond is sold when interest rates are 12%. The bond pays interest semiannually.

Principal = $10,000Interest payments =$550 [($10,000 11%)/2]

Present value tables are found on pages 634-635 in your textbook.

PV of principal, i = 6%, n = 10

$10,000 0.55840....................................................................................... $5,584

PV of interest payments, i = 6%, n = 10

$550 7.36009............................................................................................ 4,048

Selling price of bond......................................................................................... $9,632

Reasonableness Check—Market interest rate > contract rate, so the bond should sell at a discount.

Bond sells at a premium.A $50,000, 8-year, 14% bond is sold when market interest rates are 13%. The bond pays interest semiannually.

Principal = $50,000Interest payments =$3,500 [($50,000 14%)/2]

PV of principal, i = 6.5%, n = 16

$50,000 0.36510....................................................................................... $18,255

PV of interest payments, i = 6.5%, n = 16

$3,500 9.76776......................................................................................... 34,187Selling price of bond......................................................................................... $52,442

Reasonableness Check—Market interest rate < contract rate, so the bond should sell at a premium.

Bond Pricing Problem

A corporation issued $100,000 of 3-year, 11% bonds on December 31, 2008. The market rate of interest was 10%, and semiannual interest payment dates are June 30 and December 31. Calculate the issue price of the bonds.

Instead, assume that the market rate of interest was 12%. Calculate the bond issue price.

New Accounts

Know the normal balance of all these accounts and where they go in the financial statements.

Financial Statement Section Normal BalanceBonds Payable

Discount on Bonds Payable

Premium on Bonds Payable

Gain on Redemption of Bonds

Loss on Redemption of Bonds

Journal Entries for Bonds Payable

Bonds Issued at Par

Bearkat Corporation issued $100,000 of 3-year, 8% bonds on December 31, 2008 at par. Semiannual interest payment dates are June 30 and December 31.

Journal entries to record the issuance of the bonds, the first two interest payments, and the payment of the principal at maturity.

12/31/08 Cash 100,000Bonds Payable 100,000

06/30/09 Interest Expense 4,000Cash (100,000 x .08 /2) 4,000

12/31/09 Interest Expense 4,000Cash 4,000

12/31/11 Bonds Payable 100,000Cash 100,000

Balance Sheet presentation at 12/31/08 and 12/31/09

Long-Term Liabilities: 12/31/08 12/31/09Bonds Payable $100,000 $100,000

Bonds Issued at a Discount

Bearkat Corporation issued $100,000 of 3-year, 8% bonds on December 31, 2008 for $94,925. The market rate of interest was 10%, and semiannual interest payment dates are June 30 and December 31. The straight-line method of amortization is used.

Journal entries to record the issuance of the bonds, the first two interest payments, and the payment of the principal at maturity.

12/31/08 Cash 94,925Discount on Bonds Payable 5,075

Bonds Payable 100,000

06/30/09 Interest Expense (4,000 + 846) 4,846Cash (100,000 x .08 /2) 4,000Discount on Bonds Payable (5,075 / 6) 846

12/31/09 Interest Expense 4,846Cash 4,000Discount on Bonds Payable 846

12/31/11 Bonds Payable 100,000Cash 100,000

Balance Sheet presentation at 12/31/08 and 12/31/09

Long-Term Liabilities: 12/31/08 12/31/09Bonds Payable $100,000 $100,000Less: Discount on Bonds Payable 5,075 3,383*Carrying amount $ 94,925 $ 96,617

* 3,383 = 5, 075 – 846 – 846

Bonds Issued at a Premium

Bearkat Corporation issued $100,000 of 3-year, 8% bonds on December 31, 2008 for $105,418. The market rate of interest was 6%, and semiannual interest payment dates are June 30 and December 31. The straight-line method of amortization is used.

Journal entries to record the issuance of the bonds, the first two interest payments, and the payment of the principal at maturity.

12/31/08 Cash 105,418Premium on Bonds Payable 5,418Bonds Payable 100,000

06/30/09 Interest Expense (4,000 – 903) 3,097Premium on Bonds Payable (5,418 / 6) 903

Cash (100,000 x .08 / 2) 4,000

12/31/09 Interest Expense 3,097Premium on Bonds Payable 903

Cash 4,000

12/31/11 Bonds Payable 100,000Cash 100,000

Balance Sheet presentation at 12/31/08 and 12/31/09

Long-Term Liabilities: 12/31/08 12/31/09Bonds Payable $100,000 $100,000Add: Premium on Bonds Payable 5,418 3,612 *Carrying amount $105,418 $103,612

* 3,612 = 5,418 – 903 – 903

Redemption of Bonds

Assume that these bonds in the last example were redeemed (paid off) on January 1, 2010 at 102 when the carrying amount was $103,612.

Journal entry

01/01/10 Bonds Payable 100,000Premium on Bonds Payable 3,612

Cash 102,000Gain on Redemption of Bonds 1,612

Bonds ProblemsThe Kelsey Corporation issued bonds with a face value of $1,000,000 for $926,390 on January 1, 2008. The bonds pay interest every six months (June 30 and December 31) at a stated rate of 10% and mature in 5 years. The market interest rate was 12%. Prepare the journal entries for the issuance of the bonds, the first two interest payments, and the payment of the bonds at maturity. Date Accounts Debit CreditJan. 1, 2008

June 30,2008

Dec. 31,2008

Jan. 1, 2013

On January 1, 2008, Santana, Inc. issued bonds with a $2,000,000 face value. The bonds mature in 5 years and have a stated interest rate of 5.5%. Interest is paid each July 1 and January 1. The effective rate of interest when the bonds were issued was 5%, and the bonds were issued for $2,043,760. Prepare the journal entries for the issuance of the bonds, the first interest payment, the accrual of interest at year end, the second interest payment, and the payment of the principal at maturity (assume the last interest payment has been journalized). Date Accounts Debit CreditJan. 1, 2008

July 1, 2008

Dec.31,2008

Jan. 1, 2009

Jan. 1, 2013

Bond Retirement Problems

The Sullivan Company retired a $400,000, 8% bond issue that had an unamortized premiumbalance of $16,000 on September 1, 2008. Prepare the journal entry if the bonds were called at 106. Date Accounts Debit CreditSept.1,2008

Flannagan, Inc. retired a $250,000 , 6% bond issue on March 1, 2008. The unamortized discount balance was $6,800 and the bonds were called at 97. Prepare the journal entry. Date Accounts Debit CreditMar.1,2008

Chapter 15: Investments and Fair Value Accounting

A company may have excess cash that is not needed for its current operations. These companies may invest in debt or equity securities.

Debt securities

Equity securities

Why do companies invest?

1.

2.

3.

4.

5.

These investments may be classified as current assets or long-term assets on the balance sheet according to management’s intent.

Investments in Stocks and Bonds

Accounting for Debt Investments

On May 31, 2010, Bellbugg Enterprises invested $60,000 in Johnsonville municipal bonds (issued at par) that pay 8% interest semiannually on June 30 and December 31 each year.The journal entry to record the purchase of the investment in the bonds is:

May 31 Investments-Johnsonville Bonds 60,000 Cash 60,000

Journal entry to record the receipt of the interest revenue on June 30:

June 30 Cash (.08x60,000/2) 2,400 Interest Revenue 2,400

Journal entry to record the receipt of the interest revenue on December 31.

Dec. 31 Cash 2,400 Interest Revenue 2,400

The next day on January 1, the bonds are sold for 97.5. The journal entry is:

Jan. 1 Cash (60,000 x .975) 58,500Loss on Bond Investment 1,500 Investment in Johnsonville Bonds 60,000

Bond Investment ProblemOn January 31, 2008, Jackson Corporation purchased $100,000, 12%, 5-year bonds from the Dillon Corporation at par. Interest will be paid semiannually on June 30 and December 31. January 1. On January 2, 2009, Jackson sold the entire bond investment at 101. Make the necessary journal entries.Date Accounts Debit CreditJan.31,2008

June 30,2008

Dec.31, 2008

Jan. 2, 2009

Investments in StocksA company may invest in the stock of another corporation. The investing company is called the investor and the company whose stock is being purchased is called the investee. The percentage of the investee’s stock being purchased determines the accounting method used.

% of outstanding stock Degree of control of owned by investor investor over investee Accounting methodLess than 20% No control Cost methodBetween 20% and 50% Significant influence Equity methodGreater than 50% Control Consolidation

Only the Cost Method journal entries will be studied.Investments: Less than 20% Ownership-Cost Method.Assume that on September 1, Jordan Corporation purchased 1,000 shares of Cumberland, Inc. as a long-term investment at $15 per share plus a brokerage fee of $60. Jordan’s purchase represents less than 20 percent of the shares of Cumberland, Inc. In addition, there are no other factors that would suggest Jordan had a significant influence over Cumberland. On October 18, Jordan received a $0.50 per share dividend. The journal entries for these events are:

Sept. 1 Investment in Cumberland, Inc. Stock 15,060Cash (1,000 shares x 15) + 60 15,060

Oct. 18 Cash (1,000 shares x .50) 500Dividend Revenue 500

Stock Investment Problem

The Larsen Corporation purchased 10,000 shares of the common stock of Green Corporation for $50,000 on October 1, 2009. Green Corporation had 100,000 shares issued and outstanding. Larsen received a dividend check from this investment in the amount of $2,500 on December 15th. On January 2, 2010, Larsen sold the investments in Green for $54,000. Prepare the necessary journal entries for the Larsen Corporation.

Date Accounts Debit CreditOct. 1, 2009

Dec. 15, 2009

Jan. 2, 2010

Valuing and Reporting Investments

For purposes of valuing and reporting investments, GAAP requires that debt and equity securities be classified as:

Trading securities

Available-for-sale securities

Reporting Trading and Available-for-Sale Investments at Fair Valueon the Balance Sheet

Portfolio ofTrading FairSecurities Cost Value Gain/(Loss)

Security A $10,000 $10,000 $ 0Security B 22,000 21,900 (100)Security C 8,000 9,500 1,500Total $40,000 $41,400 $ 1,400

Cost………………………. $40,000

UnrealizedGain/(Loss)……………… 1,400

The Trading Investments accounts remain at cost of $40,000, but they must be presented on the balance sheet at $41,400, the fair value. So a valuation account, which is added to the Trading Investments on the balance sheet, must have a balance of $1,400. Also, the unrealized gain must be recorded.

Chapter 16: Statement of Cash Flows

The statement of cash flows provides useful information about a company’s ability to:1. generate cash from operations2. maintain and expand its operating capacity3. meet its financial obligations4. pay dividends

Three main sections of a statement of cash flows:

Operating activities:Cash inflows:

From sale of goods or services (from customers)From interest received and dividends received

Cash outflows:For inventoryFor salaries and wagesFor other operating expensesFor interest and income taxes

Investing activities:Cash inflows:

From sale of property, plant, and equipmentFrom sale of investmentsFrom collection of principal on loans

Cash outflows:For purchase of property, plant, and equipmentFor purchase of investmentsFor the principal on loans to others

Financing activities:Cash inflows:

From issuance of stockFrom issuance of bonds payableFrom issuance of notes payable

Cash outflows:For purchase of treasury stockFor payment of bonds payable principalFor payment of note payable principalFor payment of dividends

Schedule of Noncash Investing and Financing Activities is used to report transactions that are investing and/or financing activities but do not bring in or use up any cash. These transactions need to be reported because they will affect cash flows in the future. Examples include:1. Purchasing fixed assets by signing a note payable2. Purchasing a building through a mortgage loan3. Exchanging stock for fixed assets4. Issuing stock to retire debt5. Converting preferred stock to common stock

Direct and Indirect Methods for Operating Activities

Direct (calculations to convert not shown on statement of cash flows)

Sales → Cash received from customers

Cost of merchandise sold → Cash paid for merchandise

Operating expenses → Cash paid for operating expenses

Interest expense → Cash paid for interest

Income tax expense → Cash paid for income taxesCash from operating activities

Indirect (calculations to convert are shown on statement of cash flows)

Net income → Cash from operating activities

For each of the following indicate where it will appear on a Statement of Cash Flows prepared using the direct method. Use the following codes:

O + = In operating section as inflow of cashO - = In operating section, as outflow of cashI + = In investing section as inflow of cashI - = In investing section as outflow of cashF + = In financing section as inflow of cashF - = In financing section as outflow of cashNC = Schedule of noncash investing/financing activities section

_____ 1. Purchase of land for cash

_____ 2. Cash received from customers

_____ 3. Sale of building for cash

_____4. Paid interest on bonds payable

_____5. Loaned cash to another party (note receivable)

_____ 6. Payment of cash dividends

_____ 7. Borrowed cash from the bank (note payable)

_____8. Issuance of common stock for cash

_____ 9. Cash paid for income taxes

____10. Sale of investment in stock

____11. Interest received from investment

____12. Purchase of investment in bonds

____13. Conversion of bonds into common stock

____14. Cash paid for inventory

____15. Purchase of treasury stock

____16. Dividends received from investment

____17. Received payment of principal on a note receivable

____18. Repaid principal on a note payable

____19. Paid cash for operating expenses ____21. Issuance of bonds payable

____20. Purchased a truck by signing a note payable ____22. Sale of treasury stock

Net Cash Flow From Operating Activities (Direct Method)

Cash Receipts

+ decreases in accounts receivableFrom customers: sales revenue

- increases in accounts receivable

From interest and dividends

Cash Payments: + increases in inventory + decreases in accts.payable

For merchandise: cost of goods sold - decreases in inventory - increases in accts.payable

+ increases in prepaid exp. + decreases in accrued liab.For operating expenses: operating expenses

(excluding depr. & amort) -decreases in prepaid exp. - increases in accrued liab.

+ decrease in interest payableFor interest: interest expense

- increase in interest payable

+ decrease in income tax payableFor income taxes income tax expense

- increase in income tax payable

Net cash flow from operating activities

Operating Activities Section – Direct Method

Listed below are selected items from the financial statements of the Andrews Company for the year ended December 31, 2008:

Income statementSales revenue $500,000Dividend revenue (all cash) 40,000Gain from sale of land 5,000Cost of goods sold 280,000Operating expenses 80,000Depreciation expense 14,000Interest expense 9,000Income tax expense 45,000

Changes in current assets and current liabilities from the balance sheetDecrease in accounts receivable $23,000Decrease in inventory 8,000Increase in prepaid expenses 2,000Increase in accounts payable (for inventory only) 11,000Decrease in accrued liabilities 3,000Increase in income taxes payable 7,000

Using the diagram on the previous page, the calculations for cash flows from operating activities are calculated below:

Cash received from customers (500,000 + 23,000) $523,000

Cash received from dividends 40,000

Cash paid for merchandise (280,000 – 8,000 – 11,000) (262,000)

Cash paid for operating expenses (80,000 + 2,000 +3,000) (85,000)

Cash paid for interest = (9,000 + 0) (9,000)

Cash paid for income taxes = 45,000 – 7,000 = $38,000 (38,000)

Net cash flow from operating activities $169,000

Cash Flows from Operating Activities

The following selected account balances are taken from a merchandising company’s records:Dec. 31, 2007 Dec. 31, 2008 For the year 2008

Merchandise inventory $15,600 $21,200Prepaid expenses 2,500 1,200Accounts payable 32,400 27,400Salaries payable 4,400 3,000Accounts receivable 42,000 36,000Interest payable 500 300Other accrued liabilities 1,000 600Sales $312,000Interest expense 2,000Cost of goods sold 165,600Depreciation and amortization expense 29,000Other operating expenses 69,000

Assume all of the accounts payable result from inventory purchases. Calculate the following:

1. cash received from customers

2. cash paid for merchandise

3. cash paid for operating expenses

4. cash paid for interest

5. net cash flow from operating activities

Schedule Reconciling Net Income with Cash

GAAP requires that a separate schedule be added to the Statement of Cash Flows using the direct method to show a reconciliation of the net income to cash provided by operating activities (also called the indirect method).

Net income Add: Noncash expenses and losses

Deduct: Noncash revenues and gains

Add: Decreases in current assets Deduct: Increases in current assets

Add: Increases in current liabilitiesDeduct: Decreases in current liabilities

Net cash flow from (or used by) operating activities

Example:

Net income 145,000Depreciation and amortization 60,000Increase in accounts receivable 90,000Increase in accounts payable 220,000 Decrease in wages payable 17,000Increase in inventory 100,000Loss on sale of investments 2,000Decrease in prepaid expenses 8,000

Calculate net cash flow from operating activities for the reconciliation schedule.

Net income $145,000Depreciation and amortization 60,000Loss on sale of investment 2,000Increase in accounts receivable (90,000)Increase in inventory (100,000)Decrease in prepaid expenses 8,000Increase in accounts payable 220,000Decrease in wages payable (17,000)

New cash flow from operating activities $228,000

Statement of Cash Flow Problem – Direct Method

Use the Bearkat, Inc. had a cash balance on January 1, 2007 of $381,000 and a cash balance on December 31, 2007 of $20,000. Net income was $254,000. Using the information below, prepare a statement of cash flows (direct method) on the next page.

The transactions affecting income or cash were:Cash paid for merchandise, $307,000 Cash paid for operating expenses, 205,000Decrease in Wages Payable was $24,000. Paid cash dividends of $88,000.Retired (paid off) long-term debt, $25,000. Depreciation expense was $151,000.Purchased Investment in ABC stock, $40,000 Increase in accounts receivable was $97,000.Cash paid for income taxes, 61,000. Dividends received, $10,000Increase in accounts payable was $2,000 Purchased warehouse for cash, $500,000. Received $35,000 for issuance of common stock. Increase in inventory was $56,000.Purchased treasury stock $7,000. Decrease in income tax payable was $3,000.Sold equipment for $42,000. Gain on sale of equipment was $5,000.Cash received from customers, 785,000

Statement of Cash FlowsFor the Year Ended December 31, 2007

(in thousands)Cash flows from operating activities:

Net cash provided by (used for) operating activities

Cash flows from investing activities:

Net cash provided by (used for) investing activities

Cash flows from financing activities:

Net cash provided by (used for) financing activities

Net increase (decrease) in cashCash balance, January 1Cash balance, December 31

Schedule Reconciling Net income with Cash Flow from Operating Activities

Statement of Cash Flows – Direct Method

Selected data from the comparative balance sheet of Summerlin, Inc. follows:

December 31Current Assets 2008 2007Cash $ 97,800 $ 48,400Accounts receivable 95,800 33,000Inventories 112,500 102,850Prepaid expenses 18,400 6,000

Current Liabilities Accounts payable(merchandise creditors) $102,000 $ 67,300Other accrued liabilities 10,500 10,000Interest payable 5,300 5,000 Income tax payable 700 2,000

Summerlin, Inc.Income Statement

For the Year Ended December 31, 2008

Sales $392,780Less: Cost of goods sold $105,400

Wages expense 30,060Depreciation expense 46,500Other operating expenses 12,410Interest expense 4,730 Income taxes 7,280Loss on sale of plant assets 7,500 213.880

Net income $178,900

Additional information:1. New plant assets costing $85,000 were purchased for cash during the year.2. Old plant assets having an original cost of $57,500 were sold for $1,500 cash.3. Bonds matured and were paid off at face value in the amount of $25,000 in cash.4. Long-term investments were purchased for $19,000 cash.5. Common stock was issued for $45,000 cash.6. A cash dividend of $50,350 was declared and paid during the year.

Instructions: Prepare a statement of cash flows using the direct method on the next page.

Summerlin, Inc.Statement of Cash Flows

For the Year Ended December 31, 2008

Cash flows from operating activities:

Net cash from (used for) operating activities

Cash flows from investing activities:

Net cash from (used for) investing activities

Cash flows from financing activities:

Net cash from (used for) financing activities

Net increase (decrease) in cash

Cash balance, January 1Cash balance, December 31

Statement of Cash Flow Problem (continued)

Schedule Reconciling Net income with Cash Flow from Operating Activities

Chapter 18: Managerial Accounting Concepts and Principles

Financial Accounting

1.

2.

3.

4.

Managerial Accounting

1.

2.

3.

4.

Cost object

Direct costs

Indirect costs

Product (manufacturing) costs

Direct materials cost

Direct labor cost

Factory overhead cost

Period (nonmanufacturing) costs

Selling expenses

Administrative expenses

Classification of Costs

ABC Marine Company produces and sells boats. Classify each cost below from the following choices.

DM direct materialsDL direct laborFOH factory overheadS selling expensesA administrative expenses

____1. Cost of metal hardware for boats

____2. Power used by sanding equipment

____3. Depreciation of sales manager’s copy machine

____4. Steering wheels

____5. Masks used by sanders in smoothing boat hulls

____6. Hourly wages of the sanders

____7. Legal department costs for the year

____8. Commissions to sales representatives

____9. Oil to lubricate factory equipment

____10. Salaries of factory maintenance workers

____11. Salary of the president of the company

____12. Depreciation on factory equipment

____13. Wood paneling for use in interior boat trim

____14. Salary of production supervisor

____15. Special advertising campaign in “Bass World”

____16. Hourly wages of the painters

Three types of inventories on the balance sheet of a manufacturer:

Materials inventory –

Work in process inventory –

Finished goods inventory -

Income statement of a manufacturer:

Cost of goods sold-

Income Statement for a Merchandising Company

Jasper Cleaning Company sells cleaning products. Its primary expense is cost of merchandise sold.

Jasper Cleaning CompanyIncome Statement

For the Month Ended June 30, 2008

Sales revenue $58,000Less: Cost of goods sold Beginning inventory $ 3,000 Purchases 29,000 Freight in 1,500 Cost of goods available for sale 33,500 Less: Ending inventory 8,000 Cost of merchandise sold 25,500 Gross profit 32,500Less: Operating expenses Selling 13,000 Administrative 10,000 Total operating expenses 23,000Operating income $ 9,500

Income Statement for a Manufacturing Company

Jasper Manufacturing Company makes cleaning supplies. Its primary expense is cost of goods sold. Cost of goods manufactured must be calculated before cost of goods sold. A schedule of cost of goods manufactured is shown below.

Jasper Manufacturing CompanySchedule of Cost of Goods Manufactured

For the Month Ended June 30, 2008

Beginning work in process inventory $ 5,000 Add: Direct materials used:

Beginning materials inventory 1,100 Purchases and freight in 20,000

Materials available for use 21,100 Less: ending materials inventory 800

Direct materials used 20,300 Direct labor 14,000 Manufacturing overhead 6,200 Total manufacturing costs incurred during period 40,500 Total manufacturing costs to account for 45,500 Less: ending work in process inventory 12,800 Cost of goods manufactured $32,700

Jasper Manufacturing CompanyIncome Statement

For the Month Ended June 30, 2008

Sales revenue $84,000 Less: Cost of goods sold

Beginning finished goods inventory 1,000 Cost of goods manufactured 32,700 Cost of goods available for sale 33,700 Less: ending finished goods inventory 1,900 Cost of goods sold 31,800

Gross profit 52,200 Less: Operating expenses

Selling expenses 11,000 Administrative expenses 14,000

Total operating expenses 25,000 Operating income $27,200

Calculations needed for a schedule of cost of goods manufactured and the calculation of cost of goods sold:

1. Direct materials used

beginning materials inventory+ materials purchased - ending materials inventory direct materials used

2. Total manufacturing costs

direct materials used (from step 1)+ direct labor+ factory overhead total manufacturing costs

3. Cost of goods manufactured

beginning work in process inventory+ total manufacturing costs (from step 2)- ending work in process inventory cost of goods manufactured

4. Costs of goods sold

beginning finished goods inventory+ cost of goods manufactured (from step 3)- ending finished goods inventory cost of goods sold

Income Statement Calculations for a Manufacturer

Work-in-Process, Jan. 1 $12,000 Factory depreciation $65,000 Work-in-Process, Dec. 31 14,000 Administrative expenses 33,000 Finished Goods, Jan. 1 15,000 Indirect materials 15,000 Finished Goods, Dec. 31 12,000 Selling expenses 19,000 Materials inventory, Jan. 1 9,000 Indirect labor 10,000 Materials inventory, Dec. 31 11,000 Direct labor 80.000 Materials purchases 70,000 Factory utilities 28,000 Sales 500,000

Using the data above for the Dillon Company, calculate

direct materials used

factory overhead

total manufacturing costs

cost of goods manufactured

cost of goods sold

gross profit

operating income

Chapter 19: Job Order Costing

Types of Costing Systems:

1. Job order costing -

2. Process costing –

Cost allocation –

Activity base (or allocation base) -

Factory Overhead

In job order costing, costs are accumulated for each job. This includes direct materials, direct labor, and factory overhead. Factory overhead has to be allocated to each job based on a predetermined rate. The activity base used can be direct labor hours, direct labor costs, or machine hours.

Before the accounting period begins:

Predetermined factory overhead rate = estimated total factory overhead costsestimated activity base

When manufacturing overhead needs to be applied to a specific job:

Applied factory overhead = predetermined factory X actual quantity of activity overhead rate base used by each job

Assume that estimated overhead costs for the period are $50,000, and the estimated activity base is 10,000 direct labor hours. On Job 71, direct labor hours worked were 350. There were 500 direct labor hours for Job 72.

Predetermined factory overhead rate = $50,000 = $5 per direct labor hour 10,000

Job Direct labor hours Factory overhead applied71 350 X $5 = $1,75072 500 X $5 = 2,500

$4,250

The actual factory overhead incurred for the period was $4,550. Jobs 71 and 72 were the only jobs worked on during the period. Was the factory overhead over or under allocated? What happens to the over or under applied overhead?

Factory Overhead 4,550 | 4,250 300

The factory overhead was under applied during the period. Factory overhead has to be closed to cost of goods sold at the end of the accounting period: The journal entry would be

Cost of goods sold 300Factory overhead 300

Factory Overhead Problem

Hardy Manufacturing, Inc. had estimated the following costs and expenses for 2008:

Direct materials used $180,000 Factory depreciation $30,000 Direct labor (15,000 hours @ $16/hr.) 240,000 Other factory overhead 60,000 Indirect material 40,000 Selling expenses 24,000 Indirect labor 50,000 Administrative expenses 10,000 During January 2008, the direct labor employees worked 1,400 hours and were paid $16/hr. a. Calculate the predetermined overhead rate if direct labor hours are used as an activity base.

b. How much overhead would be applied to Work in Process during the first month?

Journal Entries in a Job Order Cost System

Prepare the following entries for Jen Manufacturing.1. Purchased raw materials costing $20,000 on account.

2. Requisitioned $13,000 of materials into production. Of this total, $12,000 was for direct materials.

3. Actual manufacturing labor totaled $17,000. Assume labor has not yet been paid. Direct labor assigned for the period totaled $7,800, and indirect labor totaled $9,500.

4. Factory overhead costs totaling $5,000 were paid in cash.

5. $3,700 in depreciation was recorded on factory machines.

6. Overhead was applied to production using a predetermined rate of $24.50 per direct labor hour. Jen used 780 direct labor hours during the period.

7. Jobs costing $38,000 were completed.

8. Jobs costing $32,000 were sold to credit customers for $55,000.

9. Factory overhead has a debit balance of $90. Close the account.

Job Order Costing in a Manufacturing Business

Kemper, Inc. uses a job order costing system. Factory overhead is allocated using direct labor costs as an allocation base. Kemper’s estimates for factory overhead and direct labor costs for the year were $900,000 and $600,000 respectively. On January 1, the only job in production was # 12, which was carried in the accounting records at a cost of $19,000. Job 14 was the only job in production at month-end. Jobs 12 and 15 were sold during the month. Direct materials and direct labor costs incurred during January for the four jobs are listed in the chart below along with the beginning work in process balance.

Allocation of Manufacturing Costs to Jobs

Job #12 13 14 15

Beginning work in process $19,000 Direct materials 0 $20,000 $ 8,000 $12,000Direct labor 4,000 30,000 5,000 10,000

Application of overhead

Total Cost

Instructions:

1. Calculate the predetermined factory overhead rate and complete the job cost chart above for the month of January.

2. What is the balance in Work in Process Inventory on January 31?

3. What is the balance in Finished Goods Inventory on January 31?

4. What is the balance in Cost of Goods Sold on January 31?

Job Order Cost Accounting

The following information describes the job order manufacturing activities of Peak Manufacturing Company for May:

Direct materials purchased $11,000Direct labor cost 11,900Factory overhead costs incurred 9,400

The direct materials inventory account balance at April 30 was $1,200. Estimated overhead costs for the year are $90,000 and estimated labor costs are $100,000. The following costs were allocated to the five jobs worked on during May:

Job 401 402 403 404 405Balances at 4/30 Direct materials $1,700 $1,900 Direct labor 1,000 700 Applied overhead 900 630

Costs during May Direct materials 50 3,500 $2,200 $1,300 $1,400 Direct labor 1,100 4,000 3,200 2,800 800 Applied overhead Total

Job status at 5/31 Finished Finished Finished Finished In Sold Sold Unsold Unsold Process

Calculate the following:1.Calculate the predetermined factory overhead rate, allocate the overhead for May, and complete the chart.

2. April 30 WIP inventory

3. Direct materials used during May

4. Factory overhead incurred and allocated during May and the amount of over or under applied overhead at May 31

5. May 31 Materials inventory

6. May 31 Work in process inventory

7. May 31 Finished goods inventory

8. Cost of goods sold during May

Chapter 21: Cost Behavior and Cost-Volume-Profit Analysis

Cost behavior –

Variable costs –

Fixed costs –

Mixed costs –

Relevant range -

High-low method –

Breakeven point –

Contribution margin –

High-Low Method

1. Calculate the variable cost per unit:

Variable cost per unit = change in total cost or high cost – low cost change in volume of activity high units – low units

2. Calculate the total fixed costs:

Total fixed costs = total mixed costs – total variable costs

3. Equation to show the behavior of a mixed cost:

Total mixed cost = (variable cost per unit x number of units) + fixed costs

High-low problem:

The power costs of Jones Manufacturing are mixed costs. The activity that creates most of the power cost is machine usage so machine hours will be used as the activity base. Machine hours and power costs for the past six months are presented below.

Machine Power Hours Costs

April 15,000 $1,950May 17,000 2,080June 18,000 2,150July 14,000 1,900August 20,000 2,200September 19,000 2,170

1. Calculate the variable cost per unit.

2,200 – 1,900 = 300 = .05 20,000 – 14,000 6,000

2. Calculate the total fixed costs.

At high level: FC = 2,200 – (.05 * 20,000) = 2,200 – 1,000 = 1,200 OR

At low level: FC = 1,900 – (.05 * 14,000) = 1,900 – 700 = 1,200

3. The cost equation is TC = VC + FC TC = .05X + 1,200

High-Low Problem

The Slugger Company makes wooden bats. The company has used the same manufacturing procedures for years, and the prices of wood and labor have remained relatively constant. The following data are the historical mixed costs of making the bats during the last six months.

Number of BatsMonth Total Costs Produced

July $13,000 1.800August 12,500 1,600September 12,000 1,500October 11,000 1,000November 11,500 1,300December 11,700 1,200

Using the high-low method with units of production as the activity base, calculate the following:

1. Variable cost per unit

2. Fixed costs

3. Estimated total costs for next March if 2,000 bats are produced.

Cost-Volume-Profit Analysis

The Van Buren Company had the following sales and cost data based on sales of 20,000 units.

Total Per UnitSales $570,000 $28.50Variable costs 387,600 19.38Fixed costs 140,000

Contribution Margin and Contribution Margin Ratio

Contribution margin is the excess of sales revenues over variable costs. The contribution margin is used to pay the fixed costs. Once all fixed costs have been covered, any contribution margin left represents profit. The contribution margin ratio tells what percent of each sales dollar is contribution margin. The contribution margin income statement follows.

SalesLess: variable costsContribution marginLess: fixed costsOperating income

The contribution margin is calculated as sales minus variable costs.

570,000 – 387,600 = 182,400

The contribution margin ratio is the contribution margin as a percentage of sales or the contribution margin divided by sales.

182,400 = .32 or 32% 570,000

The unit contribution margin is calculated as sales price per unit minus variable costs per unit.

28.50 – 19.38 = $9.12

Break-Even Analysis

The break-even point is the level of operations at which revenues and expenses are exactly equal.Break-even sales in units = Fixed Costs

Unit Contribution Margin

Break-even sales in dollars = Fixed CostsContribution Margin Ratio

Since the break-even point is not the goal of the business, the formula can be modified to seek an amount of operating income.

Sales in units = Fixed costs + Target Profit Unit Contribution Margin

Sales in dollars = Fixed costs + Target Profit Contribution Margin Ratio

The basic break-even formula can also be modified for “what if” analysis, often called sensitivity analysis. What if the selling price is increased? What if fixed costs could be decreased?

Example using the Van Buren Company again:Total Per Unit

Sales $570,000 $28.50Variable costs 387,600 19.38Fixed costs 140,000

What is the contribution margin per unit and the contribution margin ratio?

Unit contribution margin = 28.50 – 19.38 = $9.12

Contribution margin ratio = 9.12 = .32 or 32%28.50

What is the break-even points in units?

140,000 = 15,351 units 9.12

What is the break-even points in dollars?

140,000 = $437,500 .32

What sales volume in units would be necessary to earn a target profit of $75,000?

140,000 + 75,000 = 215,000 = 23,575 units 9.12 9.12

If fixed costs are expected to increase by $10,000 and the selling price is increased to $30.00 per unit, what would be the break-even point?

150,000 = 150,000 = 14,124 units 30.00-19.38 10.62

CVP Problem

Abner Corporation makes a product that sells for $200 per unit. The variable costs to make this product are $120 per unit. Fixed costs total $500,000 for a year. Abner currently sells 7,500 units each year.

1. Calculate the number of units that Abner must sell to break even.

2. Calculate the number of units that Abner must sell to make $200,000 in profit.

3. Abner can purchase equipment that will automate its production facility. This equipment will raise Abner's fixed costs to $600,000 per year. Automation will cause the product's variable costs to drop to $100 per unit. How many units will Abner need to sell to make a $200,000 profit if the factory is automated?

4. Abner estimates that $40,000 of radio advertising could increase the company's sales by 10%. Should the company purchase the radio ads? (Use the original cost data to answer this question; do not include any changes due to factory automation.)

Sensitivity Analysis Problem

Riding Rick purchases ATV helmets in China for $30 and sells them in the United States for $70. Riding Rick has additional variable costs of $15 for each helmet and a fixed cost of $16,000 per month. Assume each of the following requirements is a separate situation.

1. Calculate Riding Rick’s breakeven point in units and dollars.

2. Rick can lease a machine to make his operation more efficient, this reducing his variable costs by $2 per unit, but increasing his fixed cost by $1,000 per month. Calculate the new breakeven in units.

3. Riding Rick believes the market will pay an additional $5 for his helmets without reducing his sales drastically. Calculate the new breakeven in units with a $5 price increase.

4. A 4-wheeler magazine has proposed an advertising program for Riding Rick that will increase fixed costs by $2,000 per month. Calculate the new breakeven in units.

Chapter 22: Budgeting

Budget

Objectives of budgeting–

1. Planning

2. Directing

3. Controlling

Static budget

Flexible budget

Master budget

Static Budget(for 7,500 units)

Sales $150,000 Variable costs: Direct material 52,500 Fuel 15,000 Total variable costs 67,500Contribution margin 82,500Fixed costs: Depreciation 16,000 Salaries 40,000 Total fixed costs 56,000Operating income $26,500

Use the static budget to prepare a flexible budget at 6,000, 7,000, and 8,000 units.

Flexible Budget

Various Levels of Output

Units 6,000 7,000 8,000

Sales $ $ $

Variable costs Direct material Fuel

Total variable costs

Contribution margin

Fixed costs Depreciation Salaries Total fixed costs

Operating income (loss)

FLEXIBLE BUDGETS

Mars Corporation incurs the following overhead costs to manufacture its product:

Indirect materials........................................$2 per unitIndirect labor...............................................$1.50 per unitSupervisory salaries....................................$84,000 per monthDepreciation of

plant and equipment..............................$58,000 per monthUtilities........................................................$3,000 per month +

$0.25 per unit

Prepare a flexible overhead cost budget for the following production levels: 6,000 units, 8,000

units, and 10,000 units.

Mars CorporationMonthly Factory Overhead Cost Budget

Units of Product

Sales Budget

Expected units to be sold x Expected unit selling price Total sales

Production Budget

Expected units to be sold+Desired units in ending finished goods inventory Total units needed- Estimated beginning finished goods inventory

Total units to be produced

Direct Materials Budget

Materials required for production+Desired ending materials inventory

Total materials needed- Estimated beginning materials inventory Total materials to be purchasedx Unit price

Total direct materials purchases\

Direct Labor Budget

Units to be producedx Hours required per unit Total hours required for productionx Hourly rate

Total direct labor cost

Cash Budget

Estimated cash receipts - Estimated cash payments

Cash increase (or decrease)+Cash balance at the beginning of month

Cash balance at the end of month- Minimum cash balance

Excess (or deficiency)

Sales Budget

The sales budget is prepared first because sales impact most elements of the master budget.

Miles Manufacturing has prepared the following sales budget for the first four months of the year:

January February March AprilSales 20,000 22,000 25,000 21,000

Miles estimates that it will begin the year with 3,000 units in inventory. The company wants to end each month with inventory equal to 25 percent of the next month’s projected sales. Prepare a production budget for January through March.

Production Budget

January February MarchExpected Sales in Units 20,000 22,000 25,000Desired Units for Ending Inventory 5,500 6,250 5,250Total Units Needed 25,500 28,250 30,250Estimated Units in Beg. Inventory 3,000 5,500 6,250Total Units to be Produced 22,500 22,750 24,000

Miles will prepare a direct materials purchases budget for January and February, using the following additional information:

1. Each unit requires two pounds of materials.2. Materials cost $0.60 per pound.3. Miles estimates that it will have 4,000 pounds of materials inventory on January 1.4. Miles’ desired ending inventory for materials is 5,000 pounds.

Direct Materials Purchases Budget

January February

Materials required for production.....................……….45,000 45,500Plus desired ending inventory..........................................5,000 5,000

Total units needed.....................................................50,000 50,500Less estimated beg. inventory..........................................4,000 5,000

Total units to be purchased.......................................46,000 45,500Unit price.................................................................... $0.60 $0.60

Total direct materials purchases...................................$27,600 $27,300

Budgeting Problem

Darrow, Inc. plans to sell 75,000 units of product X in May, and each of these units requires 5 pounds of raw material. The raw materials cost $0.50 per pound.

Finished Goods Inventory Materials InventoryExpected May 1 inventory 12,000 units 24,000 poundsDesired May 31 inventory 15,000 units 20,000 pounds

What should be the total dollar amount of materials purchased in May?

Budgeted Cash Collections

The following sales budget has been prepared for December through March:

Sales Budget

December January February MarchCash Sales $20,000 $40,000 $60,000 $ 80,000Credit Sales 40,000 60,000 80,000 100,000

Collections are expected to be 30% in the month of the sale and 70% in the month following the sale. The schedule of budgeted cash collections for January through March is shown below.

Budgeted Cash Collections

January February MarchCash Sales $ 40,000 $ 60,000 $ 80,000From current month’s credit sales 18,000 24,000 30,000From last month’s credit sales 28,000 42,000 56,000Total cash collections $ 86,000 $126,000 $166,000

Sales Budget and Budgeted Cash Collections

The following projections have been made regarding sales and collections for Kim’s Computer Company. April sales were $50,000 and May sales were $60,000.

Sales:Compared to May sales, June sales are expected to decrease by 15%.Compared to June sales, July sales are expected to increase by 10%.Compared to July sales, August sales are expected to increase by 6%.Cash sales are expected to be 20% of each month’s sales.

Collections:20% of credit sales are collected in the month of the sale.50% of credit sales are collected in the month following the sale.30% of credit sales are collected two months following the sale.

1. Prepare a sales budget for June through August for cash and credit sales.

June July August

2. Prepare a schedule of budgeted cash collections for June through August.

June July August

Budgeted Cash Payments

Budgeted Cash Payments for Purchases

Mickle Company has the following budgeted purchases:

September October November December $190,000 $217,500 $182,500 $230,000

Purchases are paid for in the following manner: 20% in the month of purchase and 80% in the month after purchase. The schedule of budgeted cash payments for October through December is shown below.

Budgeted Cash Payments for Purchases

October November December

Current month’s purchases $ 43,500 $ 36,500 $ 46.000Last month’s purchases 152,000 174,000 146,000Total cash payments $195,500 $210,500 $192,000

Budgeted Cash Payments for Operating Expenses

Mickle Company has the following operating expense budget:

October November December

Salaries expense $33,000 $33,000 $33,000Sales commissions expense 15,000 17,000 25,000Insurance expense 2,000 2,000 2,000Depreciation expense 1,500 1,500 1,500Miscellaneous expenses 800 1,000 1,700

Total operating expenses $52,300 $54,500 $63,200

All of the operating expenses are paid in the month incurred except for depreciation and insurance. The insurance is paid annually in October. The budgeted cash payments for operating expenses is shown below.

Budgeted Cash Payments for Operating Expenses October November December

Salaries expense $33,000 $33,000 $33,000Sales commissions expense 15,000 17,000 25,000Insurance expense 24,000 0 0Miscellaneous expenses 800 1,000 1,700

Total operating expenses $72,800 $51,000 $59,700

Budgeted Cash Payments for Purchases

Use the following budgeted purchases of direct materials to prepare a schedule of budgeted cash payments.

Purchases Budget

January February March April May$115,000 $96,000 $100,000 $110,000 $105,000

Purchases are paid for as follows: 10% in the month of the purchase, 50% in the month after the purchase, and 40% two months after the purchase.

Prepare a schedule of budgeted cash payments for purchases for March, April, and May.

March April May

Cash Budget

The cash budget estimates cash receipts and cash payments for a future period.

Cash receipts include cash from customers, from sale of long-term assets, from borrowing, and from owners.

Cash payments include cash paid for inventory, for operating expenses, for purchasing long-term assets, for loan repayment, and cash paid to owners.

Estimated cash receipts - Estimated cash payments

Cash increase (or decrease)+Cash balance at the beginning of month

Cash balance at the end of month- Minimum cash balance

Excess (or deficiency)

CASH BUDGETESTIMATING CASH RECEIPTS

The sales budget of Carson Industries projects the following sales for January through May:

January.................................................. $235,000February................................................ 250,000March.................................................... 270,000April...................................................... 212,000May....................................................... 220,000

Carson sells 30% of its merchandise to cash customers. Of the sales on credit, 75% are collected

in the month after the sale, and 25% are collected in the second month after the sale.

Determine the amount of cash that Carson will collect from cash sales and accounts receivable

during the months of March, April, and May.

March April May

Cash sales.................................................

Collections on

accounts receivable:

(1) From last month's

credit sales....................................

(2) From credit sales

2 months ago................................

Total cash receipts....................................

CASH BUDGETESTIMATING CASH PAYMENTS

Carson Industries estimates its manufacturing and operating costs for the months of January

through May to be the following amounts:

Manufacturing Operating

Costs Expenses

January $130,000 $80,000

February 138,000 82,000

March 149,000 85,000

April 118,000 78,500

May 119,000 79,000

Carson pays for 60% of its manufacturing costs in the month they are incurred. The remaining

manufacturing costs are paid in the following month. All operating expenses are paid in the same

month they are incurred. Of the amounts shown for manufacturing costs, $10,000 per month

represents depreciation on equipment. Operating expenses include $2,000 per month that

represents the expiration of insurance prepaid in December of last year. Carson will make a

$17,000 tax payment in April.

Determine the amount of cash that Carson will pay for these items in the months of March,

April, and May. The following shell may help you complete your calculations.

March April May

Manufacturing costs:(1) Payment on this

month’s costs...............................(2) Payment on last

month’s costs...............................

Operating expenses.....................................

Tax payments..............................................

Total cash payments....................................

Cash Budget

Carson Industries requires that a minimum cash balance of $20,000 be maintained at the end of each month. The cash balance at the beginning of February is expected to be $22,500. Using the information from the estimated cash receipts and the estimated cash payments on the two previous pages, prepare a cash budget for Carson Industries for the months of March, April, and May.

March April May

Estimated cash receipts

Estimated cash payments

Cash increase (decrease)

Cash balance, beginning of month

Cash balance, end of month

Minimum cash balance

Excess (deficiency)

Chapter 23: Performances Evaluation Using Variances from Standard Costs

Standards

Standard cost

Who sets the standards?

Ideal standards

Currently attainable standards

Cost variances

Budget performance report

Standard Costs

The following example can be used to illustrate performance measurement under standard costing. Assume a pizza company has set $5 as the standard cost of ingredients per pizza. The company anticipates selling 1,000 pizzas during the next week. The budget at the beginning of the week would be $5,000. This amount would be used for planning.

Now, assume the actual number of pizzas sold during the week was 1,200. The standard cost for ingredients to make 1,200 pizzas is $6,000. If the pizza parlor actually used $6,900 in ingredients during the week, there is a $900 variance from standard. This is an unfavorable variance since actual costs exceeded the standard cost for 1,200 pizzas.

This information would be presented on a budget performance report as follows:

Actual Cost Standard CostPizza Ingredients at Actual Volume Cost Variance

(1,200 pizzas) (Favorable)/Unfavorable $6,900 $6,000 $900 U

Management should investigate to determine whether this variance resulted from using ingredients that were more expensive than anticipated or from using more ingredients per pizza than budgeted. Note that comparing the $6,900 actual cost to the $5,000 original budget is not meaningful.

DEMONSTRATION PROBLEM — Direct Materials Variances

To demonstrate materials variances, use the following data for Martin Manufacturing during the month of November.

Standard: 5 pounds of direct materials are required per unit at $3.20 per pound

Actual: 104,000 pounds were used to produce 20,000 units; actual materials cost was$3.15 per pound

Price Variance: Emphasize that a direct materials price variance shows the difference between the actual and standard price for the actual quantity of materials used. The formula for this calculation is:

(Actual Price per Unit – Standard Price per Unit) Actual Quantity Used(AP – SP) AQ Used

Using the data from Martin Manufacturing:

($3.15 – $3.20) 104,000 = $5,200 favorable price variance

This variance is favorable because the materials cost $0.05 less per pound than standard.

Quantity Variance: Emphasize that the direct materials quantity variance shows the difference between the actual and standard quantity of materials used. This difference is measured at the standard price because the effect of the $0.05 per pound price savings was computed in the price variance. The formula to compute the quantity variance is:

(Actual Quantity Used – Standard Quantity) Standard Price per Unit(AQ Used – SQ) SP per Unit

Using the data from Martin Manufacturing:

(104,000 – 100,000) $3.20 = $12,800 unfavorable quantity variance

Note that the standard quantity is 100,000 (5 lbs. per unit 20,000 units actually produced). This variance is unfavorable because Martin used 4,000 more pounds than standard.

Total Variance: The total materials variance is the difference between the actual and standard cost of materials. It may be computed as follows:

(Actual Quantity Actual Price per Unit) – (Standard Quantity Standard Price per Unit) (AQ AP per Unit) – (SQ SP per Unit)

Using the data from Martin Manufacturing:

(104,000 pounds $3.15 per pound) – (100,000 pounds $3.20 per pound)= $327,600 – $320,000= $7,600 unfavorable total direct materials cost variance.

The total variance may also be computed as follows:

Price variance $ 5,200 favorableQuantity variance 12,800 unfavorableTotal variance $ 7,600 unfavorable

Variances can be calculated using the formulas on the previous page or using the diagram approach which will be illustrated in class and entered below.

Direct Materials Variances

Brass Works, Inc. produces brass lamps and gift products. Engineers at Brass Works have established the following direct materials standards to produce a brass candelabra:

Direct Materials Standard: 1 pound of materials at $5 per pound

During April, Brass Works used 1,050 pounds of direct materials at an actual cost of $5.40 per pound to make 1,000 candelabras.

Compute the following variances: (if positive, unfavorable; if negative, favorable)(1) materials price variance

(actual price – standard price) x actual quantity used = materials price variance($5.40 – $5.00) x 1,050 = $420 unfavorable price variance

(2) materials quantity variance

(actual quantity – standard quantity) x standard price = materials quantity variance(1,050 – 1,000) x $5 = $250 unfavorable quantity variance

(3) total materials variance = $420 U + $250 U = $670 U

Calculation of materials variances using the diagram approach:

Interpreting Materials Variances

Amount Responsibility Possible Reason(s) for Variance

Materials $420 U Purchasing Price increase from supplier.Price Variance Department Extra freight charge on a rush order.

Materials $250 U Production Waste due to machine malfunction.Quantity Variance Department Poor quality materials.

Direct Labor VariancesBrass Works, Inc. produces brass lamps and gift products. Engineers at Brass Works have established the following direct labor standards to produce a brass candelabra:

Direct Labor Standard: 2 hours at $10 per hour

During April, Brass Works used 2,380 hours of direct labor time to make 1,000 candelabras. The actual wage rate paid was $9 per hour.

Compute the following variances: (if positive, unfavorable; if negative, favorable)(1) labor rate variance

(actual rate - standard rate) x actual hours worked = labor price variance($9 – $10) x 2,380 = ($2,380) favorable rate variance

(2) labor time variance

(actual hours – standard hours) x standard rate = labor efficiency variance(2,380 – 2,000) x $10 = $3,800 unfavorable time variance

(3) total labor variance = $2,380 F + 3,800 U = $1,420 U

Calculation of labor variances using the diagram approach:

Interpreting Labor Variances

As you review the solution on TM 23-4, ask your students to identify which department of Brass Works, Inc. should be held accountable for each labor variance. Also ask them to brainstorm possible reasons for the variance. Some examples follow:

Amount Responsibility Possible Reason(s) for Variance

Labor $2,380 F Production Workers at lower wage rateRate Variance Department assigned to job (e.g., temporary

employees, less-skilled workers).

Labor $3,800 U Production Extra labor time required due to Time Variance Department poor quality materials.

Extra labor time required due to machine malfunctions.

Nonmanufacturing Businesses

Standards can be applied to nonmanufacturing businesses, provided that they use repetitive activities to produce a common product or service. For example, businesses that specialize in fast, no-appointment-needed oil changes provide a standard service comprised of repetitive activities. A standard cost to perform an oil change could be developed based on the (1) standard labor time to change a customer’s oil, (2) standard wage rate, (3) standard quantity of supplies used (motor oil, filters, etc.), and (4) standard price of supplies.

Public accounting firms are another example of businesses that rely heavily upon standards. Budgets and standards are used to measure performance on various client engagements, such as audits and tax work.

Standard Costs and Variance Analysis Problem

Jayhawk Flag manufactures college flags. Jayhawk uses a standard cost system to control manufacturing costs. The following standard unit cost information is based on the static budget volume of 7,500 flags per month.

Direct materials (12 sq.ft. @ $1.50 per sq.ft) $18.00Direct labor (0.50 hours @ $15.00 per hour) 7.50

Actual production was 7,000 flags. The actual direct material usage was 11.60 square feet per flag, at an actual cost of $1.60 per square foot. The actual direct labor usage was 3,400 hours at $15.60 per hour.

Calculate the direct materials price, quantity, and total variance.

Calculate the direct labor rate, time, and total variance.

Variance Problem

The following data apply to the Harwell Corporation for the year 2008.Direct Material for Product X

Standard quantity per unit 4 poundsStandard price per pound $11Materials price variance $900 FMaterials usage variance $3,300 F

Units produced 300 The actual quantity of material purchased and used is ______________________.

The actual price per pound is _____________. The total variance for materials is ___________________________.

Chapter 25: Differential Analysis

Managerial decision making involves choosing between alternative courses of action. Accounting assists managers in decision making by

1.

2.

3.

Differential revenue or cost

Relevant revenue or cost

Sunk cost

DIFFERENTIAL ANALYSIS

Summer Job Offers

You have been offered two different jobs for the upcoming summer. Since both are full-time positions, you must choose to work only one of the jobs.

The first job is in an office. The pay will be $320 per week. The office is located 20 miles from your home, so you estimate that you will spend $25 per week on gas. You will also have to pay $25 per week for parking. Because you are required to dress professionally, you will need to purchase some new clothes. You estimate that you will spend $350 on new clothes for this job during the summer.

The second job is at an amusement park. The pay will be $220 per week. The amusement park is also 20 miles from your home, but you can carpool with a friend. Your share of the gas will be $12.50 per week. There is no charge for parking. The amusement park will furnish you with a uniform, so you won't need to buy any special clothes.

Assuming that your summer break will allow you to work 12 weeks, which job will provide you with more money?

(Continued)

Differential revenue from alternatives:

Revenue from office job ($320 12) $3,840Revenue from amusement park job ($220 12) 2,640Differential revenue from office job $1,200

Differential cost of alternatives:

Gas—office job ($25 12) $300Parking—office job ($25 12) 300Clothes—office job 350

Total cost of office job $950Gas—amusement park job ($12.50 12) 150Differential cost of office job $800

Net advantage of office job $400

Purchase or Lease Equipment Example

Badonsky Manufacturing needs to obtain a gear-cutting machine, which can be purchased for $75,000. Badonsky estimates that repair, maintenance, insurance, and property tax expense will be $20,000 for the machine’s five-year life. At the end of the machine’s life, it will have no salvage value.

As an alternative, Badonsky can lease the machine for five years for $18,000 per year. If the machine is leased, Badonsky is required to pay only for routine maintenance on the machine, which is estimated to be $8,000 over the machine’s life. All other costs will be paid by the lessor. Prepare a differential analysis to determine whether Badonsky should purchase or lease the machine.

Differential cost of leasing:Lease payments ($18,000 5) $90,000Maintenance 8,000

$98,000Differential cost of purchasing:

Purchase price $75,000Repairs, maintenance, insurance,

and property tax 20,000$95,000

Net advantage of purchasealternative $3,000

Decision: purchase

Discontinue a Segment or Product Example

Boyle’s Home Center has two departments, A and B. The most recent year’s information for the company follows: Department A B

Sales $1,000,000 $4,000,000 Less variable expenses 300,000 1,600,000Contribution margin 700,000 2,400,000Less fixed expenses, 900,000 1,800,000 Operating income (loss) $ (200,000) $ 600,000

A study indicates that $370,000 of the fixed expenses being charged to department A will continue even if department A is dropped. Use differential analysis to determine if Product A should be dropped.

Differential sales $1,000,000Differential costs:

Variable 300,000Fixed (900,000-370,000) 530,000 830,000

Differential operating income $ 170,000

Decision: Keep Dept.A

Discontinue a Segment or Product Problem

Savoy Fashions operates three departments, Men’s, Women’s, and Children’s. Savoy allocates fixed expenses based on square footage occupied by each department. Departmental operating income for the second quarter of 2008 is as follows:

Department Men’s Women’s Children’s

Sales $105,000 $ 54,000 $100,000 Less variable expenses 60,000 30,000 90,000Contribution margin 45,000 24,000 10,000Less fixed expenses 25,000 20,000 25,000Operating income (loss) $ 20,000 $ 4,000 $ (15,000)

Assuming that the store will remain in the same building regardless of the decision, should Savoy Fashions drop the Children’s department?

Make or Buy Example

Grayson Enterprises currently manufactures part A-14, one of the component parts used to assemble the company’s main product. Specialty Parts has offered to make part A-14 for $12.50 per unit.

Grayson’s per-unit cost to make part A-14 is $14.75, as follows:

Direct materials $5.00Direct labor 6.00Variable overhead 1.75Fixed overhead 2.00

None of Grayson’s fixed overhead costs will be eliminated if the part is purchased. However, the plant space currently used to manufacture the part can be leased to another company for $30,000 per year. Assuming that Grayson needs 100,000 parts per year, should the company continue to make part A-14 or buy it?

Purchase price of A-14 ($12.50 100,000) $1,250,000Revenue from leasing excess plant space (30,000)

$1,220,000Differential cost of making part A–14:

Direct materials $5.00Direct labor 6.00Variable factory overhead 1.75

$12.75 ($12.75 100,000) 1,275,000

Cost reduction(savings) from purchasing part $ 55,000

Decision: purchase

Make or Buy Problem

For many years Diehl Company has produced a small electrical part that it uses in the production of its standard line of diesel tractors. The company’s unit product cost, based on a production level of 60,000 parts per year is as follows:

Direct materials $240,000Direct labor 165,000Variable manufacturing overhead 30,000Fixed manufacturing overhead 315,000Total cost $750,000

Total cost per unit = 750,000/60,000 = $12.50

An outside supplier has offered to supply the electrical parts to the Diehl Company for only $10 per part. The company has determined that one-third of the fixed overhead costs represent supervisory salaries and other costs that can be eliminated if the parts are purchased. The decision would have no effect on the other fixed costs of the company. Should the company buy the parts from the supplier?

What if the space being used to make the parts could be used to expand other manufacturing operations which would generate an additional contribution margin of $90,000.

Keep or Replace Example

Columbian Coffee Company presents the following data for a machine it ownsNet book value $32,000Present scrap value $12,000Estimated remaining useful life 8 yrsPredicted scrap value at end of useful life noneAnnual cash operating costs $11,000

A new machine with the same productive capacity is available as follows:Purchase price $43,000Estimated useful life 8 yrsPredicted scrap value at end of useful life noneAnnual cash operating costs $ 6,000

Should the company keep the old machine or replace it?

Savings in annual operating costs :(11,000 – 6,000) x 8 years $ 40,000

Scrap value of old machine 12,000 $52,000Purchase price of new machine 43,000Differential decrease in cost of new machine $ 9,000

Decision: Replace

Keep or Replace Problem

Natural Products, Inc. is a manufacturer of various herb and vitamin capsules. One yearago, the company purchased a new capsule press at a cost of $84,000. The press has beenvery satisfactory, but the company’s production manager has just received information on acomputer operated press that is vastly superior to the press that has been purchased. Thecomputer-operated press would slash annual operating costs by 70% as shown below:

Present Press New PressPurchase price when new $84,000 $110,000

Estimated useful life remaining 5 years 5 yearsRemaining book value $70,000 --Disposal value now 30,000 --Annual operating costs 40,000 $12,000

Process or Sell Example

Envirocare, Inc. annually produces non-toxic cleaning products A and B from a joint production process costing $195,000 per year. Each product can be sold at the split-off point or further processed before being sold:

RevenuesProduct Sell As Is Process Further Costs after Split-off A $120,000 $180,000 $52,000 B 160,000 200,000 47,000

Analyze whether the individual products should be processed beyond the split-off point.

Product A Product B

Differential revenues of processing further $60,000 $40,000Differential costs of processing further (52,000) (47,000)Differential income or (loss) from

processing further $ 8,000 $(7,000)

Decision: Product A, process further. Product B, sell as is.

Process or Sell Example

Apple Valley Orchards sells apples for $15.00 per bushel. The company has considered processing some of its apples into apple butter. Each bushel of apples will yield 2 dozen jars of apple butter which can be sold for $1.50 per jar. The additional cost to process apples into apple butter is $0.75 per jar. Determine whether Apple Valley Orchards should make the apple butter.

Accept Business at a Special Price Example

Gooding Foods makes Goody-Goody brand peanut butter. The cost to make each jar is $2.05 and consists of the following:

Direct materials $1.00Direct labor 0.25Variable overhead 0.30Fixed overhead 0.50

A grocery store chain wants to purchase a generic brand peanut butter from Gooding and is willing to pay $1.50 per jar. The generic peanut butter will be made using a different recipe, lowering the direct materials cost to $0.80 per jar. Gooding can produce this special order using excess capacity; therefore, fixed costs will not increase. Use differential analysis to determine whether Gooding should accept this special order.

Differential revenue from special order $1.50Differential cost of special order:

Direct materials $.80Direct labor .25Variable overhead .30 1.35

Differential income from acceptance of offer (per unit) $ .15

Decision: Accept

Accept Business at a Special Price Problem

Glade Company produces a single product. The cost of producing and selling a single unit ofthis product at the company’s normal activity level of 8,000 units per month is as follows:

Direct materials $2.50Direct labor 3.00Variable manufacturing overhead .50Fixed manufacturing overhead 4.25Variable selling and administrative expenses 1.50Fixed selling and administrative expenses 2.00

Total unit cost $13.75

The normal selling price is $15 per unit. The company’s capacity is 10,000 units per month. A monthly order has been received from an overseas source for 2,000 units at a price of $12 per unit. The order would not change the company’s total fixed costs. If the order is accepted, by how much will monthly operating income be increased or decreased?