Practice Question

Question 1.1-Barton Industries

Barton Industries processes chemicals for the pharmaceutical industry. Wiley Richardson, company president, was eager to see the operating results for the just completed fiscal year as he believed that changes that were made during the year would result in increased profit on the expected sales volume of 1 million kg. At the beginning of the year, in response to a 10% increase in production costs, the sales price had been increased 12%, and the selling and administrative departments had been given strict instructions to hold expenses at the same level as the previous year. Therefore, Richardson was dismayed to learn that net income had dropped despite achieving the planned increase in sales volume. Shown below are comparative operating income statements for Barton Industries for the last two years along with budgeted operating and financial data. This year’s cost of goods sold includes an adjustment of fixed overhead costs that were under-applied. Actual results were the same as budget, except for production volume. The company uses the first-in, first-out inventory valuation method, and has an ending inventory of 450,000 kg. this year.

Comparative Operating Income Statements

($000 omitted)

Data

REQUIRED:

1. Explain why Barton Industries’ operating income decreased in the current fiscal year despite the sales price and sales volume increases.

2. Prepare an operating income statement for the current fiscal year for Barton Industries using the variable (direct) costing method.

3. Prepare a reconciliation of the difference in Barton’s operating income using the current method of absorption costing and using the variable (direct) costing method.

4. Identify two advantages and two disadvantages of using variable (direct) costing for internal reporting.

Question 1.2-Great Heart

Great Heart Clinic is a medical service institute that provides various services for its patients. The doctors working for the institute are required to fill out a note in the medical system for each patient treated. The system then generates a unique bill for each patient according to the pricing for the specific service or treatment received. Included in each patient’s bill is the applied overhead cost based on direct labor hours. The clinic created the following overhead budget for this year, but the actual overhead was $296,047.

During this year, the doctors actually charged a total of 12,190 hours as shown below.

The overhead variance is deemed material by the CEO, and he wonders why this variance happened and how to address this variance. The CEO is also considering implementing an activity-based costing (ABC) system.

REQUIRED:

1. Explain whether the clinic should use a job costing system or a process costing system.

2. Calculate the applied overhead and identify if it is over or under applied. Show your calculations.

3. Identify and explain two shortcomings of using predetermined overhead rates to apply overhead.

4. Identify and explain why there is usually a difference between the applied overhead and the actual overhead.

5. Identify and explain the appropriate accounting treatment of this under or over applied overhead amount.

6. Describe how an ABC system usually assigns overhead costs.

Question 2.1-FSL Industries

FSL Industries manufactures and sells conveyor systems to large industrial customers. When systems are sold, the contracts require FSL to provide replacement parts for the systems on fairly short notice so that their customers’ operations are not interrupted. FSL is in the process of introducing a new line of products, which would require an estimated $9 million investment in replacement parts and equipment. The CFO is investigating financing options to cover the cost of carrying the replacement parts and the new equipment investment. Two financing alternatives are presented below.

• Option 1: A commercial bank has offered FSL a loan at an interest rate of 5% with a compensating balance of 10%. The loan would have to be renegotiated each year.

• Option 2: An insurance company has offered a ten-year term loan to FSL with a fixed annual interest rate of 7%. Interest is paid semi-annually.

REQUIRED:

1. a. In order to have sufficient funds to manufacture replacement parts and purchase the new equipment, how much would FSL have to borrow if it uses Option 1? Show your calculations.

b. Calculate the first year’s interest cost of Option 1. Show your calculations.

2. a. Calculate the annual interest cost of Option 2. Show your calculations.

b. Identify and explain two advantages and two disadvantages of Option 2 as compared to Option 1.

3. Identify and explain the impact on FSL’s net working capital and balance sheet accounts if it utilizes a. Option 1, the bank loan to finance the replacement parts and new equipment. b. Option 2, the term loan to finance the replacement parts and new equipment.

4. In addition to the manufacturing cost of the replacement parts in inventory, identify three other costs FSL can expect to incur in relation to this inventory.

Question 2.2-Spreck

Spreck Technologies manufactures microchips and interfaces for several electronics manufacturers. Spreck’s reputation has been built on quality, timely delivery, and cutting edge products. The company’s business is fast-paced as its products tend to have a short life. Each product is in development for about a year followed by a year of strong demand. The products then experience reduced sales as new products and technologies become available.

Marc Elvar has recently been hired by Spreck as a member of the finance department with primary responsibility for cash budgeting and cash management. During his orientation with Spreck’s CFO, the CFO said, “The thing that fascinates me about this business is that change is its central ingredient. One of our key variables is a reliable stream of new products; in fact, it is the only way to deal with the threat of product obsolescence. Our products go through only the first two stages of the product life cycle as they rarely reach the other stages. Of course, this situation affects our cash flow. We have not been managing our cash well, so we are looking forward to having you improve our cash forecasting and management.” In addition, Elvar has been asked to analyze the company’s pricing tactics.

REQUIRED: b. Identify the four stages of the product life cycle. c. Identify and explain the characteristics of each stage of the product life cycle.

1. a. Define product life cycle.

2. Explain why pricing decisions might be different over the last three stages of the product life cycle.

3. Identify and explain two factors affecting the cash inflows and two factors affecting cash outflows at Spreck Technologies.

4. Identify and explain three actions that Elvar could take to improve Spreck Technologies’ cash management processes.