Principles of Accounting, Tenth Edition - Cengage...Principles of Accounting, Tenth Edition Answers to Stop, Review, and Apply Questions Chapter 14 The Corporate Income Statement and

Principles of Accounting, Tenth Edition Answers to Stop, Review, and Apply Questions Chapter 14 The Corporate Income Statement and the Statement of Stockholders’ Equity 1-1. Quality of earnings refers to the substance of earnings and their sustainability into

future accounting periods. Gains and losses on transactions, write-downs and restructurings, and nonoperating items are components of the income statement that affect quality of earnings.

1-2. The reader of financial statements is interested in a company’s choice of accounting methods and estimates because of their effect on the company’s quality of earnings. For example, by shortening the period over which it depreciates long-term assets, a company can increase its quality of earnings.

1-3. A write-down is a reduction in the value of an asset below its carrying value on the balance sheet. A restructuring is the estimated cost of a change in a company’s operations; it usually involves the closing of facilities and layoff of personnel. Both write-downs and restructurings reduce current operating income and boost future income by shifting future costs to the current accounting period. Both appear in the operating (top) portion of a corporate income statement.

1-4. Cash flows relate to quality of earnings in that if earnings have underlying cash flows, they are considered more sustainable and of higher quality. Thus, a company with low earnings and high cash flows has higher quality earnings than a company with high earnings and low cash flows.

2-1. Accounting income and taxable income should not be treated alike because they serve different purposes. The purpose of accounting income is to give some indication (however imperfect) of a business’s financial status; the sole purpose of taxable income is to provide a basis for collecting government revenues. Income tax allocation is necessary because of differences between accounting and taxable income caused by the timing of revenues and expenses.

2-2. Deferred income taxes represent the difference between income tax expense and income tax payable. If the former is greater than the latter, a deferred income tax liability exists.

2-3. On the income statement, net of taxes means that income taxes have been allocated among the various components of the statement so that each item, such as a gain or loss, is shown at an amount that is net of any tax consequences.

3-1. A gain or loss on discontinued operations should be disclosed separately on the income statement because separating the results of continuing operations and discontinued operations enhances the usefulness of the statement. It enables users to evaluate the company’s ongoing activities and make projections about future operations.

3-2. The two major criteria for extraordinary items are that they be unusual in nature and that they occur infrequently. Extraordinary items should be disclosed separately from continuing operations on the income statement, and extraordinary gains or losses should be shown net of applicable taxes.

4-1. Earnings per share are disclosed on the income statement and usually appear immediately below the net income figure. They are broken down into income from continuing operations, income before extraordinary items, and net income. If a company reports a gain or loss from discontinued operations or extraordinary items, earnings per share figures are presented for those as well. If a company has potentially dilutive securities, diluted earnings per share must be shown.

4-2. A company has a simple capital structure when it has issued no preferred stocks, bonds, or stock options that can be converted to common stock. A company that has issued securities or stock options that can be converted to common stock has a complex capital structure.

4-3. Diluted earnings per share differ from basic earnings per share in that they take into account the effect of all potentially dilutive securities on earnings per share.

5-1. Comprehensive income consists of items from sources other than stockholders that account for the change in stockholders’ equity during an accounting period. Comprehensive income includes net income, changes in unrealized investment gains and losses, gains and losses from foreign currency translation, and other items affecting equity.

5-2. The statement of stockholders’ equity summarizes changes in the components of the stockholders’ equity section of the balance sheet that occurred during an accounting period. The stockholders’ equity section of the balance sheet lists the items of contributed capital and retained earnings on the balance sheet date.

5-3. A company has a deficit in retained earnings when its dividends and subsequent losses exceed its accumulated profits from operations.

6-1. Accounting for a stock dividend and accounting for a cash dividend differ in that in accounting for a cash dividend, dividends payable is credited, and in accounting for a stock dividend, common stock distributable and additional paid-in capital are credited for the amount of the stock dividend measured at market value.

6-2. A stock dividend is a proportional distribution of newly issued shares of stock to stockholders. A stock split divides the shares already owned by stockholders into additional shares according to a predetermined ratio. Both increase the number of shares outstanding.

6-2. A stock dividend results in a transfer of ownership interest from retained earnings to contributed capital. A stock split changes the number and par value of the common stock; it does not change the dollar amount in retained earnings or contributed capital.

7-1. When a corporation has no preferred stock, the book value per share is determined by dividing stockholders’ equity by the number of common shares outstanding.

7-2. Book value per share is based on total assets minus total liabilities. Because assets are usually recorded at historical cost, one would not expect book value per share to equal market value per share.

Chapter 15 The Statement of Cash Flows 1-1. In the statement of cash flows, cash includes both cash and cash equivalents. Cash

equivalents are short-term (ninety days or less), highly liquid investments, such as money market accounts, commercial paper, and U.S. Treasury bills.

1-2. The primary purpose of the statement of cash flows is to provide information about a company’s cash receipts and cash payments during an accounting period. A secondary purpose is to provide information about a company’s operating, investing, and financing activities during the period.

1-3. Cash flows are classified under operating, investing, and financing activities. Cash flows related to operating activities include cash receipts from customers for goods and services and from interest and dividends on investments; cash payments for wages, goods, and services; interest paid on debt; and taxes paid. Cash flows related to investing activities include cash received from the sale of long-term assets and marketable securities and the collection of loans, and cash expended for purchases of long-term assets and marketable securities and the making of loans. Cash flows related to financing activities include proceeds from issues of stock, long-term debt, and short-term borrowings; repayment of loans; the purchase of treasury stock; and payments made to owners, including cash dividends.

1-4. Significant noncash investing and financing transaction do not affect current cash flows, but they will affect cash flows in the future. They are therefore disclosed in a separate schedule on the statement of cash flows.

1-5. Analysts consider cash flows from operations an important indicator of the cash flows that underlie earnings, or the quality of earnings. Thus, a company may try to make its cash flows from operating activities look better by placing items that belong in the operating section of the statement of cash flows in the investing or financing sections.

2-1. Cash-generating efficiency is a company’s ability to generate cash from current or continuing operations.

2-2. Three ratios that measure cash-generating efficiency are cash flow yield, cash flows to sales, and cash flows to assets.

2-3. Free cash flow is the cash that remains after deducting the funds a company must commit to continue operating at its planned level.

2-4. If free cash flow is positive, it means that the company has met all its planned cash commitments and has cash available to reduce debt or to expand. A negative free cash flow means that the company will have to sell investments, borrow money, or issue stock in the short term to continue at its planned level.

3-1. The direct method adjusts each item on the income statement from an accrual basis to a cash basis. The indirect method does not require the adjustment of each item on the income statement; it lists only the adjustments necessary to convert net income to cash flows from operations.

3-2. A company can have a positive cash flow from operations despite a net loss if it has (1) large amounts of noncash expenses, such as depreciation and amortization; (2) large reductions in accounts receivable, inventories, or other prepaid assets; or (3) large increases in accounts payable, accrued liabilities, or income taxes payable. A positive cash flow occurs if the amount of any one of these items or their combined amount is greater than the net loss.

3-3. Depreciation is deducted from net income on the income statement, but it does not require a cash outlay and so does not affect cash flows in the current period. Thus, to arrive at cash flows from operating activities on the statement of cash flows, depreciation must be added back to net income.

3-4. The cash from the sale of an asset, which includes the amount of a gain, is included in the investing activities section of the statement of cash flows. The gain is also included in net income in the operating activities section. It is deducted in this section to prevent double counting.

3-5. Changes in current assets and current liabilities represent amounts by which the accrual accounting numbers for net income differ from the actual cash received or paid. Thus, adjustments are necessary to convert the accrual-based net income to cash flows from operating activities.

3-6. When the indirect method is used to determine net cash flows from operating activities, (a) an increase in accounts receivable should be subtracted from net income, (b) a decrease in inventory should be added, (c) an increase in accounts payable should be added, (d) a decrease in wages payable should be subtracted, (e) depreciation expense should be added, and (f) amortization of patents should be added.

4-1. The two major categories of assets that relate to the investing activities section of the statement of cash flows are investments and plant assets.

4-2. A building that cost $50,000, that had accumulated depreciation of $32,000, and that is sold at a loss of $5,000 would result in an increase in cash flow of $13,000 (carrying value of $18,000 less the loss of $5,000). The transaction should be shown as the sale of a building for $13,000 in the investing activities section of the statement of cash flows. If the indirect method is used, the $5,000 loss should be added to net income to determine net cash flows from operating activities.

4-3. The transaction should be disclosed on the schedule of noncash investing and financing transactions that accompanies the statement of cash flows, as follows: Issue of mortgage for buildings and land, $234,000.

5-1. The major categories of liabilities and stockholders’ equity that relate to the financing activities section of the statement of cash flows are long-term liabilities, stock issues and repurchases (treasury stock), and cash dividends.

5-2. The conversion of bonds to common stock does not involve cash and does not appear in the financing section of the statement of cash flows. It should, however, be listed in the schedule of noncash investing and financing transactions that accompanies the statement of cash flows.

Chapter 16 Investments 1-1. Investments are generally recorded on the date they are made and are valued at cost,

which includes any commissions.

1-2. Trading securities are debt or equity securities bought and help principally for the purpose of being sold in the near term. Available-for-sale securities are debt or equity securities that may be sold at any time. Held-to-maturity securities are debt securities that a company intends to hold until their maturity date.

1-3. In accounting for equity investments, the level and percentage of ownership are important because they are factors in determining how the investments should be treated.

1-4. Disclosure of investments is important because it describes how the investments are classified and the methods used to account for them.

1-5. Insider trading is the unethical and illegal practice of using inside information (information not available to the public) for personal gain.

2-1. Trading securities are valued at fair value on the balance sheet date.

2-2. Unrealized gains and losses on trading securities are the differences between the securities’ costs and current market values. They are reported on the income statement.

2-3. Unrealized gains and losses on trading securities are the differences between the securities’ costs and current market values. They are reported on the income statement.

2-3. Accounting for available-for-sale securities differs from accounting for trading securities in two ways: (1) an unrealized gain or loss is reported as a special item in the stockholders’ equity section of the balance sheet, not as a gain or loss on the income statement; (2) if a decline in the value of a security is considered permanent, it is charged as a loss on the income statement.

3-1. a. Less than 20 percent ownership constitutes a noninfluential and noncontrolling investment; the cost-adjusted-to-market method should be used. b. A 20 to 50 percent ownership constitutes an influential but noncontrolling investment; the equity method should be used. c. More than 50 percent ownership constitutes a controlling investment; consolidated financial statements should be prepared.

3-2. A parent-subsidiary relationship exists when a company (the parent) owns more than 50 percent of the voting stock of another company (the subsidiary).

3-3. Although information about American Home Products Corporation’s subsidiaries may be helpful in assessing the corporation’s performance, stockholders would be interested primarily in its consolidated financial statements because they give an overview of the entire economic entity.

3-4. Under the equity method, the parent company increases or decreases its investment in subsidiaries according to its share of their earnings and dividends. The equity method is required when the parent—in this case, Merchant Corporation—has significant influence over a subsidiary.

4-1. Eliminating entries prevent duplication of accounts in the records of a parent and its subsidiaries and reflect the financial position and operations of the consolidated entity. They are not entered in the accounting records; they appear only on the work sheets used in preparing consolidated financial statements.

4-2. Consolidated statements are valuable because they show the parent and all its subsidiaries as a single operating entity.

4-3. The practice violates the rule that all majority-owned subsidiaries must be consolidated.

4-4. Minority interest represents the holdings of owners of less than 50 percent of a subsidiary’s voting stock. Minority interest appears on the consolidated balance sheet between long-term liabilities and stockholders’ equity or as a separate item in the stockholders’ equity section.

4-5. Goodwill from consolidation arises if a parent company (Merchant, in this case) pays more for an investment in a subsidiary than the fair value of the subsidiary’s net assets. Goodwill from consolidation is shown on the balance sheet as a separate intangible asset.

4-6. To avoid double counting and overstating accounts, intercompany receivables, payables, sales, and purchases must be eliminated from consolidated financial statements. Only transactions with outside parties should be presented.

4-7. The amount of sales on the consolidated income statement is $1,400,000, or the sales of both companies minus the intercompany sales ($500,000 + $1,000,000 - $100,000).

4-8. Before consolidating the financial statements of foreign subsidiaries and their parent company, the foreign subsidiaries’ financial statements must be translated into the parent company’s currency.

5-1. Held-to-maturity securities are debt securities that management intends to hold until their maturity date. They are valued on the balance sheet at cost adjusted for the effects of interest.

5-2. Most long-term bond investments are classified as available-for-sale securities because companies generally do not expect to hold them until their maturity date.

Chapter 17 Financial Performance Measurement 1-1. Both investors and creditors use financial performance evaluation in choosing

investments that will provide a return commensurate with the risk involved. Each group, however, evaluates a different type of risk. Investors evaluate the risk that dividends and stock price will not meet the required rate of return. Creditors evaluate the risk that a debtor will default on a loan.

1-2. The degree of risk involved in making a loan or investment depends on how easy it is to predict a company’s future liquidity or profitability. In return for taking a greater risk, a creditor may demand a higher interest rate, and an investor may look for a higher return.

1-3. Three commonly used standards of comparison for evaluating financial statements are rule-of-thumb measures, a company’s past performance, and industry norms. Rule-of-thumb measures are the weakest approach because they do not take into consideration a company’s individual characteristics. Comparison of a company’s financial measures or ratios over time can be effective, but this standard must be used with care. Industry norms are useful in showing how a company compares with other companies in the same industry.

1-4. A financial analyst might compare Steelco’s ratios with those of other steel companies to determine how Steelco ranks in the industry. If Steelco has characteristics that make it different from other steel companies, this comparison would not be valid.

1-5. The major sources of information about public corporations are reports published by the company, reports filed with the SEC, business periodicals, and credit and investment advisory services. Much of this information is available on the Internet.

1-6. A corporation’s compensation committee, which is made up of independent directors appointed by the board of directors, is charged with determining how top executives will be paid. The common components of executive compensation are salary, bonuses, and stock options.

2-1. Both horizontal and trend analyses focus on a company’s performance over time. However, horizontal analysis focuses on performance from one year to the next, whereas trend analysis has a long-term perspective. Thus, an investor would want to see both types of analyses.

2-2. The statement means that net income in 1990 was set equal to 100 and that net income in 2000 and 2001 was recomputed, or indexed, in reference to net income in 1990. That is, net income in 2000 was 240 percent of net income in 1990 and increased to 260 percent of that figure in 2001.

2-3. Horizontal analysis is a year-to-year analysis of the components of various financial statements. Vertical analysis is concerned with the relationship of items within a single financial statement.

2-4. The purpose of ratio analysis is to identify meaningful relationships between components of the financial statements.

3-1. Although these two companies have the same net income, without more information, it is impossible to conclude that they are equally successful. For example, if one of them had twice as many assets as the other, its return on assets (a measure of profitability) would be only half of the other company’s.

3-2. Because Circo Company has a return on assets of 12 percent and a debt to equity ratio of .5, one would expect its return on equity to be more than 12 percent because of its ability to use financial leverage.

3-3. With a profit margin of less than 1 percent, a supermarket would have to maintain a high asset turnover to achieve a satisfactory return on assets.

3-4. The amount of net cash flows from operating activities is common to all cash flow adequacy ratios. These ratios are most closely related to the liquidity and long-term solvency ratios.

3-5. The ratios most relevant to determining the financing period are days’ sales uncollected, days’ inventory on hand, and days’ payable. The longer a company’s financing period (Days’ Sales Uncollected + Days’ Inventory on Hand – Day’s Payable), the greater its financing or interest costs will be. Thus, determining the financing period is especially important in periods of high interest rates.

3-6. To determine whether investors are equally confident about the future of Companies J and Q, one would compare the companies’ price/earnings (PE) ratios. The P/E ratio is computed by dividing a company’s market price by its earnings per share. A high P/E ratio indicates that investors have a high degree of confidence in a company’s future earnings and therefore are willing to accept a lower rate of return.

Chapter 18 The Changing Business Environment: A Manager’s Perspective 1-1. Management accounting is the process of identifying, measuring, accumulating,

analyzing, preparing, interpreting, and communicating financial and nonfinancial information used by management to plan, evaluate, and control an organization and to ensure that resources are used and accounted for appropriately. Management accounting is similar to financial accounting in that both are responsible for summarizing information and reporting it to interested parties. Moreover, both are part of an organization's management information system. For this reason, much of the information used to report to external parties can also be used internally to help managers plan, control, and make decisions. In addition, management accountants may develop information systems that are useful to financial accountants. For example, information from the inventories information system can be used to report inventory costs on the balance sheet.

1-2. The supply chain is the path that leads from the sources of materials that products are made out of to the final consumer. Products or services flow from suppliers to manufacturers to distributors to retailers to consumers in the supply chain.

1-3. a. Why? Why is this report being prepared? This question is important because it establishes the report's characteristics and is instrumental in answering the other three questions.

b. Who? For whom is the report being prepared? To whom will the report be distributed? Who will read it? The answers to these questions are important because they dictate the report's format.

c. What? What information should the report contain to satisfy the purpose decided upon in the “why” question? At this point, the presentation method is established. This question is important because it results in a report that is relevant and easy to read.

d. When? When is the report due? This question is important because information is useful only if it is timely. Since quick reports sometimes lack accuracy, a tradeoff between accuracy and urgency may be necessary.

1-4. The writer should include a clear statement of the assumptions underlying the report and the conditions under which the estimates and projections were made. This will enable the reader to assess how valid the estimates and projections are.

2-1. The value chain is a way of defining a business as a set of primary and support processes that link together to provide products and services to customers to achieve the business’s mission and objectives.

2-2. Each primary process in the value chain adds value to the final product or service of a business. Support services facilitate the primary processes but do not add value to the final product or service. The primary processes are research and development, design, supply, production, marketing, distribution, and customer service; the support services to the value chain are human resources, legal services, information systems, and management accounting.

2-3. A company needs to be good at both. However, it is more important to have a primary process as a core competency because primary processes add value to the final product, and it is on the basis of primary processes that a company distinguishes itself from its competitors.

3-1. Managers must first develop measures that reflect the quality they seek. They must then carefully monitor these measures and report the results on a regular basis.

3-2. All the management approaches described in this chapter have perfection by means of continuous improvement as their goal. By continuously trying to improve operations, all contribute to the same basic results: reduced product or service costs and throughput time, and increased product or service quality and customer satisfaction.

4-1. The balanced scorecard is “balanced” in the sense that it weighs the needs of the four perspectives of an organization to achieve the organization’s mission.

4-2. Performance measures are quantitative tools that are used to gauge an organization's performance in relation to a specific process, activity, task, or expected outcome. Examples of financial performance measures include return on investment, net income as a percentage of sales, and the costs of poor quality as a percentage of sales. Examples of nonfinancial performance measures include number of customer

complaints, number of orders shipped the same day, hours of inspection, and time to fill an order.

4-3. The balanced scorecard provides a framework for measuring and evaluating performance from a variety of viewpoints. The scorecard links the interdependent goals of all stakeholder groups to the organization's mission, performance measures, strategic plan, and resources.

5-1. Both are important. Nonfinancial data are important for measuring the performance of business processes, but ultimately these data are translated into budgets and financial reports that reflect the financial objectives of the company.

5-2. From the information provided, it appears that machines 1 and 3 may not be operating efficiently and need further analysis.

6-1. Your first step should be to discuss the situation with your immediate superior unless he or she is involved, in which case you should discuss the situation with someone at a higher level. You may have to take the matter to the board of directors or to the authorities. If you cannot resolve it, your last resort is to resign.

6-2. Integrity is the foundation on which the accounting profession is built. Without integrity, the accountant has no role on the management team. Management accountants are expected to provide impartial, accurate, and relevant information that recipients can rely on. Their integrity makes this possible.

Chapter 19 Cost Concepts and Cost Allocation 1-1. Managers use information about costs to plan (estimate operating costs and sales

volume, set prices, and prepare budgets); to perform (monitor profitability, make decisions concerning products and services, and compute the unit cost of a product or service); to evaluate (compute variances between estimated and actual costs and analyze variances, address causes, and revise future plans); and to communicate (prepare internal reports for management and external reports for stakeholders).

1-2. Different organizations have different types of costs. Service organizations need information about the costs of providing services, retail organizations need information about the costs of purchasing products for resale, and manufacturing organizations need information about the costs of manufacturing products.

2-1. Managers use different cost classifications to select and use relevant information to improve the efficiency of operations, provide quality products or services, and satisfy customer needs.

2-2. Direct costs of a product are traceable; however, indirect costs are often difficult to trace and therefore managers use a formula to assign them.

2-3. A value-adding cost increases the market value of a product or service, whereas a nonvalue-adding cost adds cost to a product or service but does not increase its market value.

2-4. Product costs are costs assigned to inventory, such as direct materials, direct labor, and overhead. Period costs are costs of resources used during the accounting period that are not assigned to products.

3-1. Because service organizations sell services and not products, they maintain no inventories for sale or resale and thus have no inventory accounts on their balance sheets. Because retail organizations purchase products ready for resale, they maintain just one inventory account on the balance sheet, the Merchandise Inventory account. Because manufacturing organizations make products for sale, they maintain three inventory accounts on the balance sheet: Materials Inventory, Work in Process Inventory, and Finished Goods Inventory.

3-2. The Work in Process Inventory account accumulates the cost information used in the statement of cost of goods manufactured.

3-3. The cost of goods sold is computed by adding the beginning balance of the Finished Goods Inventory account to the cost of goods manufactured to arrive at the total cost of finished goods available for sale and then subtracting the ending balance in Finished Goods Inventory.

4-1. The Materials Inventory account shows the balance of unused direct materials. The cost of direct materials purchased increases the balance, and the cost of direct materials used by the production decreases this account. The Work in Process Inventory account records the balance of partially completed units of the product. The costs of direct materials, direct labor, and overhead (called total manufacturing costs) are transferred to the Work in Process Inventory account and increase its balance. The cost of all units completed and moved to finished goods inventory (called the cost of goods manufactured) decreases the balance of the Work in Process Inventory account. The Finished Goods Inventory account holds the balance of costs assigned to all completed products that a manufacturing company has not yet sold. The cost of goods manufactured increases the balance, and the cost of goods sold decreases the balance.

4-2. Manufacturing cost flow is the flow of manufacturing costs (direct materials, direct labor, and overhead) through the Materials Inventory, Work in Process Inventory, and Finished Goods Inventory accounts into the Cost of Goods Sold account.

4-3. Total manufacturing costs increase the balance of the Work in Process Inventory account, whereas the cost of goods manufactured decreases the balance of the Work in Process Inventory account.

5-1. The three elements of product costs are direct materials costs, direct labor costs, and overhead costs.

5-2. Production-related costs that cannot be practically or conveniently traced directly to an end product are considered overhead costs. They include indirect materials costs and indirect labor costs.

5-3. The three elements of product cost—direct materials, direct labor, and overhead—may differ in amount depending on whether the actual, normal, or standard costing

method is used. Actual costing calculates the product unit cost by summing the actual per-unit costs of direct materials, direct labor, and overhead. Actual product cost is calculated at the end of the accounting period when actual costs are known. Normal costing combines the actual costs of direct materials and direct labor with an estimated overhead cost to determine the normal product cost per unit. Normal costing is used during the accounting period to provide estimated information about product costs for management decision making.

6-1. A cost pool is a collection of overhead costs related to a cost object (the recipient of an assigned, or allocated cost). A cost driver is an activity that causes the cost pool to increase in amount as the cost driver increases. An example of a cost object in a computer manufacturing company is a computer. A cost pool could be the dollar amount of the inspection costs. A cost driver for the inspection activity could be the number of inspections.

6-2. A predetermined overhead rate enables managers to make decisions about pricing products or services and controlling costs before some of the actual costs are known. It also allows managers to apply overhead costs to each unit produced in an equitable and timely manner.

6-3. a. Planning the overhead rate. Managers determine cost pools and cost drivers and calculate a predetermined overhead rate by dividing the cost pool of total estimated overhead costs by the total estimated cost driver level. b. Applying the overhead rate. As units of the product or service are produced, the estimated overhead costs are assigned to the product or service using the predetermined overhead rate. c. Recording actual overhead costs. The actual overhead costs are recorded as they are incurred. d. Reconciling the applied and actual overhead amounts. At the end of the accounting period, the difference between the applied and actual overhead costs is calculated and reconciled. An adjustment is made for overapplied or underapplied overhead costs, whether they are immaterial or material, to reflect the actual overhead costs on the income statement.

7-1. One overhead cost pool is used in the traditional approach to cost allocation.

7-2. Direct labor hours, direct labor costs, machine hours, or units of production are examples of cost drivers used in the traditional approach to allocating overhead.

8-1. Traditional overhead allocation uses one overall cost pool and a traditional activity base or cost driver, such as direct labor hours, direct labor costs, machine hours, or units of production. Activity-based costing creates many smaller activity pools from the single overhead cost pool used in the traditional method. Because the cost drivers associated with each of these activity cost pools are more closely associated with the causes of the costs, more accurate allocations can be made.

8-2. In the ABC approach to cost allocation, managers use as many cost pools as are needed for effective and efficient management of overhead costs.

8-3. A cost driver is used to associate an activity pool with a cost object. Because the cost driver is a measure of a production-related activity and the events and circumstances that cause that activity, it is a good basis for assigning indirect costs.

Chapter 20 Costing Systems: Job Order and Process Costing 1-1. When managers of manufacturing organizations plan, they use cost information to

budget costs, forecast product prices, and plan production volumes. Managers of service organizations use cost information to develop budgets, establish prices, set sales goals, and determine human resource needs. In both kinds of organizations, managers use cost information to determine performance expectations.

1-2. Managers use cost information to make decisions about whether to drop a product or service, add a production shift, outsource the manufacture of parts or tasks, bid on a special order or service proposal, negotiate a selling price, or add staff.

1-3. When managers evaluate results, they watch for changes in cost or quality by comparing actual and targeted total and unit costs as well as relevant price and volume information. Managers analyze such information to evaluate the organization's performance and adjust planning and decision-making strategies.

2-1. A product costing system is a set of procedures used to account for an organization's product costs and provide timely and accurate unit cost information for pricing, cost planning and control, inventory valuation, and financial statement preparation.

2-2. The main similarity between a job order costing system and a process costing system is that both provide information about product unit cost that managers can use to price products, control costs, value inventory, and prepare financial statements. The main difference is that a job order costing system traces product costs to a specific job order or batch of products and uses a single Work in Process Inventory account to summarize the costs of all jobs. This account is supported by job order cost cards. A process costing system traces the production costs to processes, departments, or work cells. A process costing system uses several Work in Process Inventory accounts—one for each process, department, or work cell.

2-3. Most companies use hybrid systems that combine features of both job order costing and process costing to meet the specific needs of the business.

3-1. The Work in Process Inventory account is used to record the manufacturing costs incurred and allocated to partially completed units of product.

3-2. At year end, actual overhead costs for the period are reconciled with the estimated overhead costs that were allocated so that when the financial statements are prepared, the cost of goods sold will reflect the actual overhead costs incurred.

3-3. The main difference is that in a service organization, costs are not associated with a physical product that can be assembled, stored, and valued. Services are rendered and cannot be held in inventory. As a result, service organizations have few or no costs for materials. The most important costs in a service organization are labor and overhead. Any material costs are incidental and referred to as supplies.

4-1. Companies that produce large amounts of similar products or liquid products or that have long, continuous production runs of identical products use a process costing system. Companies that make unique or special-order products use a job order costing system.

4-2. Unlike a job order costing system, a process costing system is not limited to one Work in Process Inventory account. Process costing uses as many Work in Process Inventory accounts as there are processes, departments, or work cells in the production process. The product unit cost in a process costing system consists of one set of costs from each process, department, or work cell through which a product passes.

5-1. Equivalent production, a key factor in the computation of product unit costs in a process costing system, is a measure of equivalent whole units produced during a period of time. Partially completed units are restated in terms of equivalent whole units. The number of equivalent units produced is equal to the sum of (a) total units started and completed during the period and (b) an amount representing the work done on partially completed units in both the beginning and the ending work in process inventories. A percentage of completion factor is applied to partially completed units to compute the number of equivalent whole units.

5-2. Actual unit data must be converted to equivalent unit data to compute true per unit direct materials costs and conversion costs. Restating partially completed units in terms of equivalent whole units allows the appropriate amount of direct materials costs and conversion costs to be applied to all products worked on during a period.

5-3. Conversion costs are the combined total of direct labor and overhead costs incurred by a production process, department, or work cell. The two costs are combined because both are often incurred uniformly throughout the making of the product or service, and so adding them together saves one unit cost computation.

6-1. a. Account for physical units. b. Account for equivalent units. c. Account for costs. d. Compute cost per equivalent unit. e. Assign costs to cost of goods manufactured and ending inventory.

6-2. The purpose of accounting for costs in a process report is to track and analyze costs for a process, department, or work cell in a process costing system.

6-3. The two important dollar amounts are cost of goods manufactured and ending inventory. The cost of manufacturing is part of the cost of goods sold on an income statement, and ending inventory can be found on the balance sheet.

6-4. One process cost report is prepared each period for every Work in Process Inventory account.

7-1. By analyzing the information from a job order or process costing system, managers can compare budgeted and actual costs. They can also track units produced and monitor labor costs to evaluate operating performance.

7-2. a. Tracking units produced per time period helps managers evaluate how efficiently an organization is operating. b. Monitoring labor cost per unit produced helps managers evaluate how well the

organization is utilizing its labor force. c. Keeping track of customer needs can help managers determine if their efforts are

focused in the right areas and can significantly enhance customer relationships. Chapter 21 Activity-Based Systems: ABM and JIT 1-1. A company generates revenue when customers see value in its products or services

and therefore buy them. As a result, companies measure customer value by looking at the revenue generated. To create value and satisfy customers’ needs, managers can work with suppliers, view their organization as a collection of value-adding activities, use resources for value-adding activities, reduce or eliminate nonvalue-adding activities, and know the total cost of creating value for a customer.

1-2. The main focus of an activity-based system is on managing activities rather than costs.

1-3. Gathering quantitative information at the activity level provides managers with flexible cost pools for assignment to different types of cost objects. For example, the costs of the selling activity can be assigned to a customer group, a sales territory, or a product line.

2-1. Activity-based management (ABM) is an approach to managing a business that involves identifying all major operating activities, determining what resources are consumed by each activity and the cause of the resource usage, and categorizing the activities as either adding value to a product or service or not adding value. ABM benefits both strategic planning and operational decision making because it provides financial and operational performance information at the activity level that is useful for making decisions about business segments, such as product lines, market segments, and customer groups. It also helps managers eliminate waste and inefficiencies and redirect resources to activities that add value to the product or service.

2-2. A supply chain focuses on external relationships, whereas a value chain focuses on internal relationships.

3-1. Customers are not willing to pay for such activities, which is why businesses try to minimize or eliminate them.

3-2. Process value analysis (PVA) is an analytical method of identifying all activities and relating them to the events that cause or drive the need for the activities and the resources consumed.

4-1. Many organizations have turned to activity-based costing because they realized that the traditional methods of using direct labor hours, direct labor costs, or machine hours as cost drivers to allocate overhead costs were not only inaccurate but also were causing poor pricing decisions.

4-2. The five steps of activity-based product costing are (1) identify each activity and classify it into one of the four categories of the cost hierarchy, (2) estimate the cost of resources for each activity, (3) identify all cost drivers and estimate the quantity of each cost driver, (4) calculate an activity cost rate, and (5) assign all costs to cost objects based on the level of activity required to make the product or provide the service.

4-3. For a company, unit-level activities are performed each time a unit of product or service is produced. Batch-level activities are performed each time a batch or production run of goods or services is made. Product-level or service-level activities are performed to support a certain line or brand of products or services. Facility-level or operations-level activities are performed to support an organization's general production process.

4-4. A bill of activities includes not only the product or service costs found on a job order cost card, but also the costs of all relevant operating activities.

5-1. The objectives of a JIT operating environment are to enhance productivity, eliminate waste, reduce costs, and improve product quality.

5-2. When an organization uses pull-through production, a customer's order triggers the purchase of materials and the scheduling of production for the required products. This approach is in sharp contrast to the push-through method, where products are manufactured and stored in anticipation of customers' orders. The pull-through approach is a fundamental characteristic of the JIT operating environment.

5-3. In the traditional manufacturing environment, inspection is a separate function. JIT incorporates inspection into the continuous production operation. Machine operators are responsible for inspecting products as they pass through the process. When the operators detect a product flaw, production is stopped until the cause of the problem is determined. Operators may even help the engineer or quality control person find a way to correct the process.

6-1. Processing time is value-adding time in the production process.

6-2. Under JIT, costs associated with inspection, moving, queue, and storage time should be reduced or eliminated because they do not add value to the product. Only costs associated with processing time are classified as either direct materials costs or conversion costs.

7-1. Backflush costing is commonly used to account for product costs in a JIT operating environment. When backflush costing is used, all product costs are first accumulated in the Cost of Goods Sold account. Then, at period end, the costs are “flushed back,” or worked backward, into the appropriate inventory accounts. This approach saves recording time because all product costs flow straight to a final destination. Then, at period end, the ending balances are transferred to the inventory accounts. Time is also saved because several accounts are eliminated and fewer transactions are recorded. ABM does not use backflush costing since it tracks costs first to activities or cost pools and then assigns those activity costs to products. Recordkeeping time is not reduced, although product costing accuracy improves.

7-2. The ending balance in the Finished Goods Inventory account is the difference between the cost of goods sold and the cost of goods completed.

8-1. Activity-based management uses activity-based costing to calculate the costs of products or services more accurately. In a just-in-time system, backflush costing is used to identify all the product or service costs of units completed in a shorter and less costly time period through the elimination of some traditional accounting steps such as materials inventory and work-in process inventory.

8-2. Yes, a business can use both of these activity-based systems.

Chapter 22 Cost Behavior Analysis 1-1. Cost behavior is the way in which costs respond to changes in volume or activity.

Total variable costs increase or decrease in direct proportion to the number of units (or services) produced. Total fixed costs remain relatively constant over the accounting period, even with changes in productive output. Some costs are mixed, exhibiting characteristics of both variable and fixed costs.

1-2. Managers use cost behavior information in most decisions, including the analysis of changes in operating income, the estimation of future revenues, and the preparation of budgets. Knowledge of cost behavior is also useful in determining the effects of decisions on operating income.

2-1. Normal capacity is the average annual level of operating capacity required to satisfy anticipated sales demand. The sales demand figure is adjusted for seasonal business factors and operating cycles. Normal capacity is a realistic measure that expresses what will be produced—not what can be produced—by an operating unit over a specific period. Theoretical capacity is the maximum productive output for a given period, assuming all of the department’s or organization’s machinery and equipment are operating at optimum speed, without interruption. Although the concept is useful for estimating maximum output capability, it bears no relationship to day-to-day operations. Practical capacity is theoretical capacity reduced by normal and anticipated work stoppages. No organization operates at theoretical, or practical capacity.

2-2. The relevant range of activity includes all the potential levels of volume within which actual operations are likely to occur and within which fixed costs remain constant in total. Once volume increases beyond the relevant range, total fixed costs also increase.

2-3. In total, fixed costs remain constant over a given period. This means that the greater the number of units produced in that period, the lower the fixed cost per unit.

2-4. A mixed cost is a cost that has both variable and fixed cost components. Part of the cost changes with volume or usage, and part of the cost is fixed over the period. An example is the cost of electricity.

3-1. Cost-volume-profit analysis is an examination of the cost behavior patterns that underlie the relationships among cost, volume of output, and profit.

3-2. C-V-P analysis is used to forecast future operations: to predict profit when sales volume is known, to determine the sales volume necessary to reach a target profit, and to budget. For cost control purposes, C-V-P relationships provide a means of measuring the performance of various departments or operating segments in an organization.

3-3. The following conditions must exist for C-V-P analysis to be accurate: The behavior of variable and fixed costs can be measured accurately. Costs and revenues have a close linear approximation. Efficiency and productivity hold steady within the relevant range of activity. Cost and price variables hold steady during the period being planned. The sales mix does not change during the period being planned. Production and sales volume are roughly equal.

4-1. The breakeven point is the point at which total revenues equal total costs; it is the point (in sales units or dollars) at which an organization begins to generate a profit. Breakeven analysis gives managers valuable information about how production levels relate to profitability.

4-2. Contribution margin is the amount that remains after variable costs are subtracted from sales. As a result, the breakeven point can be expressed as the point at which contribution margin minus total fixed costs equals zero, or the point at which contribution margin equals total fixed costs.

4-3. At zero sales, there is zero revenue; at zero sales and production, there is no variable cost, yet fixed costs still exist.

5-1. Fixed Costs + Target Profit

Target Sales Units = Contribution Margin per Unit

5-2. Service businesses can use C-V-P analysis to make decisions about the level of

volume and fees for services needed to cover operating costs, the sales mix of services required to break even (in a company providing multiple services), and the impact on profits when variable or fixed operating costs change.

5-3. Both types of organizations will use the same formula for breakeven analysis, which requires a selling price or fee, a volume of sales activity, and variable and fixed costs. For manufacturing companies, the variable costs for manufacturing, selling, and administrative activities are separated from the fixed costs for the same set of activities. For service organizations, the variable costs of labor, service overhead, and selling and administrative activities are separated from the fixed costs for the same set of activities. Because no products are manufactured in the course of providing services, service organizations have no materials costs.

Chapter 23 The Budgeting Process 1-1. A budget is a plan of action that forecasts future transactions, activities, and events in

financial or nonfinancial terms. A budget can reflect financial information based on

the availability of resources. A budget can show the activities planned to meet certain requirements or standards established during the planning process.

1-2. Long-term strategic and tactical plans usually cover a five- or ten-year period and are general in nature, describing probable product line changes, expansion of plant and facilities, machinery replacement, and changes in marketing strategies. They provide broad goals to strive for through yearly operations. Annual operating plans translate long-term strategic and tactical objectives into specific goals for the year. Annual operating plans contain instructions on how to attain the anticipated results through annual production and sales efforts.

1-3. It is management's responsibility to implement the final budget. The controller and the budget committee coordinate the master budget and the budgeting process. They are responsible for communicating the relevant components of the budget to all involved parties within the organization. The controller plays an important role in working with all the managers who are responsible for the operations on which the budget is based.

2-1. A master budget is a set of operating and financial budgets that consolidates an organization's plans into budgeted financial statements for a future period of time. Regardless of the type of organization, master budgets provide helpful information for managers to plan, perform, evaluate, and communicate about the business. Master budgets help new organizations obtain financing and help existing organizations plan future operating, investing, and financing activities.

2-2. Manufacturing, retailing, and service organizations all need a set of operating budgets to support the budgeted income statement. In all three types of organizations, the information from the operating budgets and the capital expenditures budget affects the cash budget and the budgeted balance sheet. The cash budget also provides information for the budgeted balance sheet.

2-3. The following guidelines are helpful when preparing a budget: Know the purpose of the budget. Identify the user group and its information needs. Begin the budget with a clearly stated title or heading. Identify the format for the budget, and use appropriate formulas and

calculations to derive the quantitative information. Label the budget's components, and list the unit and financial data in an

orderly manner. Know the sources of budget information. Revise the budget until all planning decisions are included.

3-1. A sales forecast is a projection of sales demand based on an analysis of external and

internal factors. External factors include the state of the local and the national economies, the state of the industry's economy, and the nature of the competition. Internal factors include historical unit sales, pricing policies, credit and collection policies, anticipated new products, and capacity constraints.

3-2. The three steps in preparing a direct materials purchases budget are: (1) calculate the total units of direct materials needed for production; (2) calculate the total units of direct materials to be purchased; and (3) calculate the total cost of direct materials purchases.

3-3. The first step in preparing a direct labor budget is to calculate the estimated total direct labor hours for the period. The second step is to calculate the total budgeted direct labor cost.

3-4. Selling and administrative activities relate to the units sold, not the units produced; thus, selling and administrative expenses are computed based on units sold.

4-1. A cash budget is related to the master budget in that it summarizes the cash flow forecasts of planned transactions in all phases of the master budget. The items in a cash budget differ from those in the master budget in terms of the timing of the receipt or payment of cash. For example, cash from a sale listed in the master budget may not be collected until the next accounting period, or a purchase of direct materials may not be paid for until the next accounting period.

4-2. The final step in the development of the master budget is to prepare the budgeted balance sheet. This budget incorporates information from all the other budgets that have been previously prepared.

4-3. A budgeted balance sheet must include the ending cash balance that appears in the cash budget.

Chapter 24 Performance Management and Evaluation 1-1. The four basic stakeholder groups included in the balanced scorecard are financial

(investors), learning and growth (employees), internal business processes, and customers.

1-2. Most businesses focus on the financial perspective.

1-3. When managers understand the causal relationships between their actions and their company's overall performance, they can evaluate their strategies in meeting performance objectives and targets, see new ways to be more effective, and contribute to the coordination of goals throughout the organization.

2-1. A performance management and evaluation system is a set of procedures that account for and report on both financial and nonfinancial performance, so that a company can identify how well it is doing, where it is going, and what improvements will make it more profitable.

2-2. Yes. Appropriate financial and nonfinancial performance measures are key to yielding the performance results managers want.

3-1. Responsibility accounting is an information system that classifies data according to areas of responsibility and reports each area's activities by including only the revenue, cost, and resource categories that the assigned manager can control.

3-2. A responsibility center is an organizational unit whose manager has been assigned the responsibility of managing a portion of the organization's resources. The activity of a responsibility center dictates the extent of a manager's responsibility. There are five types of responsibility centers: (1) cost centers, (2) discretionary cost centers, (3) revenue centers, (4) profit centers, and (5) investment centers.

3-3. Evaluation should be based on how managers perform their assigned responsibilities.

3-4. A company's organizational structure formalizes its lines of managerial authority and control. That structure is expressed visually in its organization chart. The types of reports generated at each level of the organization can be traced through the organization chart. The organization chart dictates which centers are included at each level and therefore what information is included in each report. As one moves up the organization chart, the reports change in two ways. First, the range of information increases because the manager at each higher level is responsible for more lower-level centers. Second, when information about lower-level organizations appears in upper-level reports, it becomes increasingly summarized and condensed.

4-1. Performance reports contain information about costs, revenues, and resources that are controllable by individual managers and include comparisons between actual performance and budget expectations. Such comparisons allow management to evaluate an individual’s performance with respect to responsibility center objectives and companywide objectives and to recommend changes. The content and format of a performance report depend on the nature of the responsibility center.

4-2. A flexible budget is prepared at the end of the period, when performance results are evaluated.

4-3. Although performance reports will vary in format depending on the type of responsibility center, they are similar in several ways. For example, all responsibility center reports compare a center’s actual results to its budgeted figures and focus on the differences. Frequently, comparisons are made to a flexible budget as well as to the master budget. Only the items controllable by the manager are included in the performance report. Nonfinancial measures are also examined to achieve a more balanced view of the manager's responsibilities.

5-1. Return on investment (ROI) is a composite index of many cause-and-effect relationships and interdependent financial elements. A manager can improve ROI by increasing sales, decreasing costs, or decreasing assets.

5-2. Economic value added (EVA) is similar to residual income (RI) in that both are expressed in dollars and both subtract a performance target from operating income. EVA differs from RI because it uses after-tax operating income instead of pretax operating income, and the performance target is a cost of capital percentage multiplied by the center’s total assets less current liabilities instead of desired ROI multiplied by invested assets.

6-1. Responsibility center managers are more likely to achieve their performance targets if their compensation depends on it. Performance-based pay links employee compensation to measurable business targets.

6-2. Which incentives work best depends on the facts and circumstances of each organization.

Chapter 25 Standard Costing and Variance Analysis 1-1. Standard costs are realistically predetermined costs that are developed from analyses

of both past and projected future costs and operating conditions. They are usually expressed as a cost per unit of finished product.

1-2. A variance is the difference between standard costs and actual results.

1-3. Yes, standard costing can be used by a service organization. The main difference between a service organization and a manufacturing organization is that the service organization does not have direct materials costs. Therefore, service organizations will have only direct labor and overhead variances to analyze.

2-1. Standard costing is a total unit cost concept because all components of a unit cost are stated at standard cost instead of actual cost. The Materials Inventory, Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold accounts are all stated in terms of standard costs. All inventory balances are computed using standard unit costs.

2-2. Predetermined overhead costing and standard costing share two important characteristics: (1) both produce forecasted amounts to be used in product costing, and (2) both are formulated using anticipated costs. However, unlike predetermined overhead rates, standard costing focuses on total unit cost, and the determination of standard costs is more complex than that of predetermined overhead rates. Standard costs are based on engineering estimates, forecasted demand, worker input, time and motion studies, and type and quality of direct materials. Predetermined overhead rates are based on simple projections of trends in past costs.

2-3. The following six elements are used to compute a standard unit cost: Direct materials price standard Direct materials quantity standard Direct labor time standard Direct labor rate standard Standard variable overhead rate Standard fixed overhead rate

3-1. This statement means managers constantly compare the actual costs of what did happen with the costs of what was expected to happen, try to identify the cause of the difference, and seek to correct the operating problem. A standard costing system is used to compute and track the budget versus actual cost differences—or variances—for products and services. This comparison between the standard and actual costs provides much valuable information about operations and is useful in both cost planning and cost control.

3-2. A flexible budget is a summary of anticipated costs prepared for a range of activity levels, geared to changes in the level of productive output. It is a cost control tool used in evaluating performance at the end of a period.

3-3. The two parts of the flexible budget formula are the variable costs (the variable cost per unit multiplied by the number of units produced) and the budgeted fixed costs. Added together, they will yield the expected budgeted cost for any level of output.

4-1. Each variance must be evaluated according to its specific circumstances. An unfavorable direct materials price variance means that the actual price of materials was greater than the standard price. Perhaps an uneconomical purchase was made or a higher grade of materials was purchased, or perhaps the standard price may need to be updated.

4-2. Yes. The use of cheaper direct materials could have led to excessive spoilage or usage, thus raising the quantity of direct materials used.

5-1. Direct labor variances causes and measures include the following:

Possible Causes Performance Measures for Tracking

Causes Labor Rate Variance Worker hired at a pay rate higher or lower than expected

Testing of skills at time of hiring, monitoring of wage rate; authorization policy; tracking of personnel training time

Worker performing the duties of a higher- or lower-paid position

Study of number of times wrong workers are used per supervisor; analysis of hourly or daily wage rate, variance reports

Sudden changes in overall wage rates Establishment of new standard wage rates if changes are permanent

Labor strike that causes temporary hiring of unskilled help

Monitoring of temporary help used to cover each job

Large layoffs resulting in unusual usage of the workers who remain

Review of any shifting of skilled workers to lower-skilled jobs, study of crosstraining activities

Labor Efficiency Variance Employee training Review of number of hours of training Machine breakdowns Review of percentage of unscheduled

downtime reports, monitoring of machine maintenance activities

Inferior direct materials or higher-quality materials

Analysis of quality of materials purchased versus desired quality; inquiry into quality of goods delivered

5-2. Direct labor rate and efficiency variances can be either favorable or unfavorable and are not causal. Direct labor rate variances pertain to labor wage rates while the direct labor efficiency variances pertain to labor productivity.

6-1. The efficiency variances for direct labor and variable overhead are generally based on the same quantity—that is, direct labor hours—and thus are caused by the same factors.

6-2. The fixed overhead budget variance is the difference between actual fixed overhead costs incurred and budgeted fixed overhead. The fixed overhead volume variance is the difference between budgeted fixed overhead and the fixed overhead applied to production using the standard fixed overhead rate. The fixed overhead budget variance measures the difference between the costs actually incurred and the costs that should have been incurred. The fixed overhead volume variance measures the use of existing facilities and capacity. A fixed overhead volume variance will exist whenever either more or less than normal capacity is used.

6-3. If standard hours allowed are more than normal hours, the period's fixed overhead volume variance will be favorable. Fixed overhead costs are applied on the basis of standard hours allowed. Overhead would be applied on the basis of the higher number of standard hours allowed, but the fixed overhead rate was computed using the lower number of normal hours. Thus, more fixed costs than were budgeted would be applied to products. Because the products can absorb no more than actual costs incurred, this condition would tend to lower unit cost. When expected capacity usage is exceeded, the result is a favorable fixed overhead volume variance. Fixed costs per unit decline because the fixed costs are spread over more units, which increases profitability.

7-1. Because managers have different responsibilities, evaluations of their performance should be tailored to those responsibilities.

7-2. The key to preparing a performance report based on standard costs and related variances is to follow company policies by (1) identifying those responsible for each variance, (2) determining the causes for each variance, and (3) developing a reporting format suited to the task. Performance reports should be tailored to a manager's responsibilities.

Chapter 26 Analysis for Decision Making 1-1. During the year, managers may decide to accept a special order, examine the

profitability of a segment, select the appropriate product mix given a resource constraint, outsource manufacturing or service activities, or sell a product at its split-off point rather than process it into a more refined product.

1-2. Yes, because qualitative factors such as competition, economic conditions, social issues, quality, and timeliness influence decision making.

2-1. Incremental analysis is a method of comparing alternative projects by focusing on the differences in their projected revenues and costs. Incremental analysis is also called differential analysis. Incremental analysis ignores revenues or costs that stay

the same or that do not differ among the alternative projects. Many business decisions can be made using incremental analysis. Among these decisions are outsourcing decisions, special order decisions, segment profitability decisions, sales mix decisions involving constrained resources, and sell or process-further decisions.

2-2. An opportunity cost is the benefits forfeited because another alternative was selected. Opportunity costs arise when the choice of one course of action eliminates the possibility of another course of action.

3-1. Business activities that are good candidates for outsourcing includes payroll processing, training, managing fleets of vehicles, sales and marketing, custodial services, and information management. Many of those activities involve relatively low skill levels or require highly specialized knowledge that could be better obtained from outside experts.

3-2. When deciding whether to make or buy parts in a manufacturing operation, the following factors must be considered: (1) the need for additional machinery, (2) other variable costs of making the item, and (3) incremental fixed costs. When deciding whether to purchase the same parts, the following must be considered: (1) the purchase price of the item(s), (2) the rent or net cash flow to be generated from vacated space in the factory, and (3) the salvage value of parts or machinery that are no longer needed.

3-3. One approach is to compare the special order price to the relevant costs to produce, package, and ship the order. Another approach is to prepare a special order bid price by calculating a minimum selling price for the special order. The minimum selling price is to cover the costs and a determined amount of profit.

3-4. First, calculate the contribution margin per unit for each product or service affected by the constrained resource (selling price per unit minus variable cost per unit). Second, calculate the contribution margin per unit of the constrained resource (contribution margin per unit divided by the quantity of the constrained resource required per unit).

3-5. Joint costs are ignored in the decision analysis because they are production costs common to all products and services and are incurred before the split-off point.

4-1. Capital investments are expenditures for capital facilities or other long-term projects for a company. Examples of capital facilities and projects include (1) installation of new equipment, (2) replacement of old equipment, (3) expansion of a production area through additions to an existing building, (4) purchase or construction of a new building, (5) acquisition of an existing company to be merged with present operating facilities, and (6) distribution and software systems.

4-2. Capital investment analysis, or capital budgeting includes (1) identifying the need for a capital investment, (2) analyzing courses of action to meet that need, (3) preparing reports for managers, (4) choosing the best alternative, and (5) dividing funds among competing needs.

4-3. Capital investment decisions will affect a company for many years, first as broad estimates used for planning purposes and finally, in the year of the expenditure, as specific investment analyses.

4-4. Cost savings and net cash inflows can both be used to evaluate proposed capital investments, but they are not the same. Cost savings is used when revenue from the alternatives being considered is the same or is not affected by the proposals. Net cash inflows are the difference between cash revenue generated and cash expenditures required for a proposed capital project.

4-5. Unequal cash flows must be analyzed separately for each year of a project's life, whereas equal cash flows require less detailed analysis.

4-6. The statement is valid. Carrying values are irrelevant because they represent the undepreciated portion of past or historical costs and cannot be altered by a current decision. Current or future residual values do influence cash flows involved in capital investment and are therefore relevant.

4-7. Because depreciation may be deducted in computing the amount of income taxes a company owes, the amount of depreciation associated with a capital investment project will reduce the cash outflow in each future year by the amount of the income taxes saved by the annual depreciation deduction. This is a favorable effect on annual cash flows. Capital investment analysis deals with future net cash inflows or net cost savings. Neither amount is influenced by the depreciation of old equipment.

5-1. Because an organization has many potentially profitable uses for its investment capital, management expects a reasonable return from an acquired asset during its economic life. That return is affected by the number of years that the expended capital is tied up in the investment. Cash flows from different periods have different values when measured in current dollars because of compound interest. Therefore, to treat all future income flows alike ignores the time value of money.

5-2. Present value looks back to determine value in the present, and future value looks forward to determine value at a future time. Thus, to achieve a future value of $1,000.00 a year from today, a present value of $952.38 must be invested today. Interest of 5 percent on $952.38 for one year equals $47.62, and the two amounts added together equal $1,000.00.

5-3. Table 3 is used for determining the present value of a single sum to be received in the future. Table 4 is used to determine the present value of a series of payments to be received in the future (ordinary annuity).

6-1. The net present value method takes into account the time value of money, whereas the other methods do not.

6-2. An organization may use its average cost of capital as its minimum rate of return from proposed capital investments. This amount then acts as a discount rate and as a cutoff point for evaluating capital investment proposals under the net present value method. A project with a rate of return equal to or above the cost of capital can be accepted; others are rejected.

7-1. The payback and accounting rate-of-return methods do not consider the time value of money.

7-2. The payback period method is not very accurate. The payback period is easy to compute and understand, but the disadvantages of this approach far out- weigh its advantages. First, the method does not measure profitability. Second, it ignores differences in the present values of cash flows from different periods. Finally, it emphasizes the time it takes to recover the investment rather than the long-term return on the investment. It ignores all future cash flows after the payback period is reached.

Appendix B Partnerships 1-1. A partnership is an association of two or more people to carry on as co-owners of a

business for profit. Partnerships are treated as separate entitles in account, but legally there is no economic separation between them and their owners.

1-2. The advantages of partnerships are they are easy to form, but also easy to change. They facilitate the pooling of capital resources and individual talents. They have no corporate tax burden, and they give the partners a certain amount of freedom and flexibility in operating the business. The disadvantages are that the life of a partnership is limited. One partner can bind the partnership to a contract, and the partners have unlimited personal liability for the debts of the business. It is also more difficult for a partnership to raise large amounts of capital or transfer ownership than for a corporation.

1-3. Unlimited liability means that each partner has personal responsibility for all the debts of the partnership. If the assets of one partner are not enough to pay all the debts, the creditors can seek payment from the personal assets of the other partners. The only way a partner can avoid liability is to declare personal bankruptcy.

1-4. If the partnership agreement does not describe the method of income and loss distribution, the law specifies that the partners must share income and losses equally.

1-5. In a limited partnership, a general partner usually has unlimited liability, but the liability of the other partners is limited to the amount of their investments in the business. In an ordinary partnership, each partner is liable for the debts of the partnership. A limited partnership differs from a limited liability partnership in that a limited liability partnership has no general partner, and the personal assets of all the partners are protected by law.

2-1. Noncash assets should be valued at their fair market value on the date they are transferred to the partnership.

2-2. After a partnership is formed, a partner’s capital will be equal to the net assets (assets minus liabilities) contributed by the partner to the partnership.

3-1. Three common bases for sharing income or losses in a partnership are (1) return to the partners for use of their capital (interest on partners’ capital), (2) compensation for services the partners have rendered (partners’ salaries), and (3) other income for

any special contributions individual partners may make to the partnership or for risks they may take.

3-2. Partners share income and losses in accordance with the partnership agreement. If the agreement says nothing about how income and losses will be distributed, the partners share them equally.

3-3. If the total of partners’ salaries and interest exceeds the partnership’s total net income, the negative balance or loss must be distributed according to the stated ratio in the partnership agreement or equally if the agreement does not mention a ratio.

4-1. The dissolution of a partnership is the loss of legal authority to continue a partnership and the cessation of the partnership as a separate accounting entity caused by a change in the original association of partners.

4-2. Admission of a partner, withdrawal of a partner, or death of a partner are the three actions that can cause a partnership to dissolve.

4-3. A bonus to a new partner means that part of the original partner’s capital will be transferred to the new partners’ Capital account as a bonus. A bonus to the old partners means that a new investor pays more than the actual dollar interest he or she receives in the partnership and the excess payment is treated as a bonus to the original partners.

4-4. A person can withdraw from a partnership by selling his or her interest in the business to the remaining partners or by withdrawing company assets in an amount equal to, less than, or greater than the partner’s interest.

5-1. The following are steps in a liquidation: (1) The partnership adjusts and closes it books and any existing income or losses are distributed among the partners; (2) the partnership sells its assets and pays its liabilities or distributes them to the partners; (3) any gain or loss on the sale of the assets is allocated to the partners according to their stated ratios; (4) as cash from the sale of assets becomes available, it is applied first to outside creditors, then to loans from partners, and finally to the partners’ capital balances; and (5) a partner with a negative capital balance is obligated to pay the amount of the negative balance from personal assets or the remaining partners have to absorb the deficit.

5-2. When a partnership is liquidated, (1) the assets are sold, (2) the liabilities are paid, (3) gains or losses are distributed to the partners’ Capital accounts, and (4) the cash is distributed to the partners; based on the remaining balances of their accounts.

5-3. Any remaining cash will be used to settle the partners’ Capital accounts.

5-4. The partner is required to make up the negative balance in the Capital account from his or her personal assets.

Chapter 15 The Statement of Cash FlowsChapter 16 InvestmentsChapter 17 Financial Performance MeasurementChapter 18 The Changing Business Environment: A Manager’s PerspectiveChapter 19 Cost Concepts and Cost AllocationChapter 20 Costing Systems: Job Order and Process CostingChapter 21 Activity-Based Systems: ABM and JITChapter 22 Cost Behavior AnalysisChapter 23 The Budgeting ProcessChapter 24 Performance Management and EvaluationChapter 25 Standard Costing and Variance AnalysisPossible CausesChapter 26 Analysis for Decision MakingAppendix B Partnerships