Managerial Accounting, 3E Karen W. BraunWendy M Tietz Solution Manual

Type:

Solution Manual

Resource:

Managerial Accounting

Edition:

3rd Edition

Author(s):

Karen W. Braun Wendy M. Tietz

Contents Chapter 1

Introduction to Managerial Accounting.………………………… 1-1

Chapter 2

Building Blocks of Managerial Accounting…………………….... 2-1

Chapter 3

Job Costing………………………………………………………… 3-1

Chapter 4

Activity-Based Costing, Lean Operations, and the Costs of Quality …………………………………………………... 4-1

Chapter 5

Process Costing………………………….…………………….....… 5-1

Chapter 6

Cost Behavior…………………..…………………...........................6-1

Chapter 7

Cost-Volume-Profit Analysis……………………………….……...7-1

Chapter 8

Short-Term Business Decisions.………………………………...…8-1

Chapter 9

The Master Budget …….…………………………...……………...9-1

Chapter 10

Performance Evaluation ………………………………………….10-1

Chapter 11

Standard Costs and Variances………………………..…………..11-1

Chapter 12

Capital Investment Decisions and the Time Value of Money…..12-1

Chapter 13

Statement of Cash Flows…….……………………………………13-1

Chapter 14

Financial Statement Analysis……………………………………..14-1

Chapter 15

Environmental Sustainability…………………………………….15-1

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Chapter 1 Overview Introduction to Managerial Accounting The chapter introduces managerial accounting along with the fundamental principle of the text which is the importance of using managerial accounting data in decision-making. Students are introduced to the importance of such data to decision-making by discussing the primary responsibilities of a manager: planning, directing, and controlling. To help students understand the managerial accounting focus, financial and managerial accounting are contrasted and compared. Managerial accounting has internal users relying on relevant information prepared specifically for management’s needs while financial accounting has external users using reliable and objective information in the form of financial statements.

The importance of using managerial accounting for decision-making is illustrated through the presentation of a typical organizational structure as well as the roles and skills required of management accountants. In addition to their traditional costing and reporting roles, management accountants also play an important role in planning, analyzing, and interpreting accounting data including developing budgets that influence the organization’s culture and strategy. Increasing the importance and profile of management accountants is a goal of the Institute of Management Accountants (IMA). The IMA is the professional association for management accountants which also develops standards of ethics and standards of professional conduct.

The Decision Guidelines and Summary Problems are useful examples of questions and outlines that help students summarize their learning reinforcing the objectives of the chapter. Two sets of Decision Guidelines and Summary Problems are present in this chapter. The first set of Guidelines reinforces the role of managerial accounting and the management accountant in an organization. The first set of Summary Problems reinforces the concepts introduced in the first part of the chapter. Topics include managements’ responsibilities, managerial versus financial accounting, and ethical responsibilities.

The next section of the chapter presents the implications of regulatory trends. These include the Sarbanes-Oxley Act of 2002, IFRS, and XBRL. The final section of the chapter considers the impact of certain business trends affecting companies and their managerial accounting systems. These trends include: sustainability, social responsibility and the triple bottom line; shifting toward a service economy; competing in the global marketplace; advanced information systems; lean operations; total quality management; and ISO 9001:2008. Cost-Benefit Analysis, a staple of decision making, is introduced.

The second set of Decision Guidelines illustrates some of the decisions managers need to consider in response to changes in the regulatory and business environment. An additional Summary Problem allows students to use cost-benefit analysis to determine whether a company should expand or not.

1-1 .

Learning Objectives After studying Chapter 1, your students should be able to: 1. Identify managers’ three primary responsibilities.

2. Distinguish financial accounting from managerial accounting.

3. Describe organizational structure and the roles and skills required of management accountants within the organization.

4. Describe the role of the Institute of Management Accountants (IMA) and use its ethical standards to make reasonable ethical judgments.

5. Discuss and analyze the implications of regulatory and business trends.

1-2 .

Teaching Outline 1. Identify managers’ three primary responsibilities. a. Planning b. Directing c. Controlling d. Exhibit 1-1 Managers’ Three Primary Responsibilities 2. Distinguish the differences between financial accounting and managerial accounting. a. Users b. Purpose of information provided c. Accounting product d. Required information and reporting format e. Underlying basis of the information f. Information characteristic emphasis g. Business unit h. Timing i. Verification j. Required information k. Impact of reports on employee behavior l. Exhibit 1-2 Managerial Accounting Versus Financial Accounting 3. Describe the organizational structure and the management accountant’s place within the organization. a. Board of directors b. CEO c. COO d. CFO e. Treasurer f. Controller g. Internal audit function h. Audit committee i. Exhibit 1-3 Typical Organizational Structure 4. Discuss the changing roles of management accountants. a. Use of cross-functional teams 5. Discuss the skills required of management accountants. a. Solid accounting knowledge b. Analytical skills c. Knowledge of how a business functions d. Team oriented e. Oral and written communication skills f. Exhibit 1-4 The Skills Required of Management Accountants 6. Describe the role of the Institute of Management Accountants (IMA). a. Professional association b. Certified Management Accountant (CMA) c. Average salaries 1-3 .

7. Identify the IMA’s ethical standards and how they are used to make reasonable ethical decisions. a. Competence b. Confidentiality c. Integrity d. Credibility e. Exhibit 1-5 Summary of Ethical Standards f. Exhibit 1-6 IMA Statement of Ethical Professional Practice g. Resolving ethical dilemmas h. Unethical versus illegal behavior 8. Discuss current regulatory issues. a. Sarbanes-Oxley Act of 2002 (SOX) b. Exhibit 1-7 Some Important Results of SOX c. International Financial Reporting Standards (IFRS) d. Extensible Business Reporting Language (XBRL)

9. Discuss current business trends. a. Sustainability, social responsibility, and the triple bottom line b. Shifting economy c. Global marketplace d. Advanced information systems i. Enterprise resource planning (ERP) ii. Cost benefit analysis e. Lean operations i. Just-in-time ii. Throughput time f. Total quality management (TQM) g. ISO 9001:2008

1-4 .

Key Topics This chapter is the foundation for the rest of the text. Without a good understanding of this chapter, the student will have a difficult time understanding the remaining content.

After covering managers’ three primary responsibilities, consider offering the following example: A manager may wish to expand its custodial service from only cleaning private homes to also cleaning corporate offices and plants. This goal is then developed into a budget (planning). That budget is analyzed thoroughly to determine both the price points and how to market the service (directing). After comparing the budget to the actual results, the managerial accountant determines that the expansion into the new market is somewhat slower than expected and decides to change its marketing strategy (controlling). Decision making occurs at all levels of the process. For example, if the marketing strategy works and the corporation proceeds toward meeting its goals, the managerial accountant focuses attention on which new services will be offered, how much to charge for the services, and if loyalty discounts should be given to existing customers who purchase these services (decision-making).

In teams or in partners, have students complete E1-19B Managers’ responsibilities, which should take about five minutes. Call on a student to give the answers.

At this point, the accounting student has most likely only been exposed to financial accounting. Students sometimes have a difficult time making the adjustment from financial to managerial accounting. Use Exhibit 1-2 to emphasize the differences between financial and managerial accounting. This is a great time to review the role of financial accountants in our society and then explain the role of management accountants. In doing so, be sure to also point out that their study of financial accounting focuses on external decision makers, whereas managerial accounting focuses on internal decision makers.

Here’s an example: A manager is setting the price of items in the store. In order to make this decision, the manager needs to know the cost of the items, the other organizational costs, the sales prices for other similar items, etc. Of course, these matters are of great importance to an internal management accountant.

An external accountant would not make the same decisions; instead, he/she would make decisions based on information contained in the financial statements.

In team or in partners, have students complete E1-21B Identify users of accounting information (10 minutes). Point out that most decisions impact non-accountants and stress the importance for nonaccounting majors to understand managerial accounting.

Many students love to discuss ethical issues. Sometimes students may have ethical issues presented to them in a casual way. Here is an example: A supervisor requests that you don’t record your overtime on your timesheet. This will allow the supervisor to stay within the budget, but it doesn’t properly reflect what is happening within the organization. You feel pressure from the supervisor. Ask students what ethical issues are involved in this example and what steps they would take to resolve the ethical dilemma.

Ask students how many of them were left unsupervised when they first started a new job. How accurate was their work? Would the students feel responsible for making an error if they had been properly trained?

Ask students to assume they work for a company. In this scenario, they will have heard that their company is being sold. The information is confidential, and they can’t speak about it. What would they do if their best friend wanted to buy stock?

1-5 .

You can use E1-24B Ethical dilemma (5 minutes) as a group or partner exercise.

When discussing the Sarbanes-Oxley Act, remember that many of today’s students probably don’t remember businesses before accounting scandals. Students have likely become cynical about accounting practices based on news media. Ask students to identify what would give them confidence in the accounting decisions of an organization.

Many students today are concerned about the impact businesses have on the environment as well as whether or not companies are acting in a socially responsible manner. Discuss the concept of the triple bottom line and the interrelationships between profit, people, and planet. What are the difficulties in measuring the impact a company has on people and planet? Ask students if they think that a company concerned about people and planet can be profitable? Have students share examples of companies that have “green initiatives.” Do these companies advertise that they are “green”? What are some companies that the students think are socially responsible? Have them share examples of what they think companies should be doing to be considered socially responsible. Would a business’ actions (or lack of action) in these areas affect their behavior as consumers?

In the shifting economy section, ask students if they think Apple manufactures its own headphones or if they are manufactured by an outside company. Ask them what information might be part of Apple’s decision: How much it would cost Apple to make the headphones? How much would it cost to have someone else make them? If someone else made them, could that manufacturing space be used for additional funds?

For a cost-benefit example, ask students if they think retailers should attach large alarm tags on leather coats that would signal an alarm if someone carried the coat out of the store without paying. Would these same tags be effective on candy bars? What factors make it better for the coat than the candy? Answer: The tags would not be customer friendly and the cost of the tags would not be worth the amount of candy stolen from the store (cost-benefit).

Personalize the expected value concept by comparing the cost investment in college to the expected increase in earnings the students expect to have with their education.

In the lean production section, JIT management is easily illustrated by using milk as an example. If a company bought more milk than the space allowed on a store shelf, where would it be kept? Can it be kept cold? Is it worth paying for the refrigeration? How long can it be held to keep it fresh? JIT is more economical if the store does not buy large quantities of milk, but instead buys small amounts of milk more often.

Have student complete E1-28B Lean production cost-benefit analysis (5 minutes) in teams or partners.

1-6 .

Chapter 1: Student Summary Handout 1. Managers’ three primary responsibilities a. Planning b. Directing c. Controlling d. Exhibit 1-1 Managers’ Three Primary Responsibilities 2. Differences between Financial Accounting and Managerial Accounting a. Exhibit 1-2 Managerial Accounting versus Financial Accounting 3. Organizational structure and how management accountants fit in a. Exhibit 1-3 Typical Organizational Structure b. Changing roles i.

Cross functional teams c. Skills required i.

Solid knowledge of both financial and managerial accounting ii. Analytical skills iii. Knowledge of how a business functions iv. Ability to work on a team v. Oral and written communication skills vi. Exhibit 1-4 The Skills Required of Management Accountants 4. The IMA and ethical standards a. Competence b. Confidentiality c. Integrity d. Credibility e. Exhibit 1-5 Summary of Ethical Standards f. Exhibit 1-6 IMA Statement of Ethical Professional Practice g. Resolving Ethical Dilemmas h. Unethical versus illegal behavior 5. Regulatory issues a. Sarbanes-Oxley Act of 2002 (SOX) b. Exhibit 1-7 Some Important Results of SOX c. International Financial Reporting Standards (IFRS) d. Extensible Business Reporting Language (XBRL) 6. Business trends a. Sustainability, social responsibility, and the triple bottom line b. Shifting economy c. Global marketplace d. Advanced information systems i.

Enterprise resource planning (ERP) ii. Cost benefit analysis e. Lean operations f. Total quality management (TQM) g. ISO 9001:2008

1-7 .

7. MyAccountingLab.com homework algorithmic assignments: E1-8A, E1-10A, E1-12 A, E1-14 A

1-8 .

CHAPTER 1: ASSIGNMENT GRID Assignment

S1-1 S1-2 S1-3 S1-4 S1-5 S1-6 S1-7 E1-8A E1-9A E1-10A E1-11A E1-12A E1-13A E1-14A E1-15A E1-16A E1-17A E1-18A

E1-19B E1-20B E1-21B E1-22B E1-23B

Learning Objective(s)

Topic(s)

Short Exercises Roles of managers 1 Contrast managerial and 2 financial accounting Accounting roles in the 3 organization Role of internal audit 3 function Importance of ethical 4 standards Violations of ethical 4 standards Identify current competitive 5 tools Exercises (Set A) Managers’ responsibilities 1 Define key terms 1&2 Identify users of accounting 3 information Classify roles within the 3 organization Professional organization 4 and certification Ethical dilemma 4 Classify ethical 4 responsibilities Define key terms 5 Summarize the Sarbanes5 Oxley Act Lean production cost-benefit 5 analysis Identify sustainability efforts as impacting people, planet, 5 or profit Exercises (Set B) Managers’ responsibilities 1 Define key terms 1&2 Identify users of accounting 3 information Classify roles within the 3 organization Professional organization 4 and certification 1-9 .

Estimated Time in Minutes

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Assignment

E1-24B E1-25B E1-26B E1-27B E1-28B E1-29B

P1-30A P1-31A P1-32A P1-33A P1-34A

P1-35B P1-36B P1-37B P1-38B P1-39B Decision Case A1-40 Ethical Issue A1-41 Team Project A1-42 A1-43 A1-44 A1-45

Learning Objective(s)

Topic(s)

Ethical dilemma 4 Classify ethical 4 responsibilities Define key terms 5 Summarize the Sarbanes5 Oxley Act Lean production cost-benefit 5 analysis Identify sustainability efforts as impacting people, planet, 5 or profit Problems (Set A) Management processes and 1&2 accounting information Ethical dilemmas 4 ERP cost-benefit analysis 5 E-commerce cost-benefit 5 analysis Continuation of P1-33A: 5 revised estimates Problems (Set B) Management processes and 1&2 accounting information Ethical dilemmas 4 ERB cost-benefit analysis 5 E-commerce cost-benefit 5 analysis Continuation of P1-38B: 5 revised estimates Other

Estimated Time in Minutes

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10

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5

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10 15-20

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15

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10 15-20

Medium Medium

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15

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Ethical standards

4

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Ethical dilemma Interviewing a local company about sustainability

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10

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5

60-120

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60-90

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30-60

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4

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Discussion and Analysis Application and Analysis Ethics at Enron

1-10 .

Pre-Test Questions on MyAccountingLab: S1-2, S1-3, S1-7, E1-8A, E1-15A Post-Test Questions on MyAccountingLab: E1-10A, E1-14A, P1-30A

Answer Key to Chapter 1 Quiz (Quiz on following pages.)

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2.

3.

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A C A D C

6. B 7. D 8. B 9. D 10. B

1-11 .

Name____________________________________ Date_________________ Section_______________

CHAPTER 1 TEN-MINUTE QUIZ Circle the letter of the best response.

1. Which of the following are a manager’s three primary responsibilities?

A. Planning, Directing, Controlling B. Budgeting, Planning, Controlling C. Budgeting, Directing, Controlling D. Budgeting, Planning, Directing 2. Which of the following is integrated throughout managers’ primary responsibilities?

A. Planning B. Directing C. Decision Making D. Controlling 3. Which of the following is FALSE about managerial accounting vs. financial accounting?

A. Both managerial and financial reports are prepared quarterly and annually.

B. Managerial accounting is primarily utilized by internal users, while financial accounting is primarily utilized by external users.

C. The primary information characteristic for managerial accounting is relevance, while the primary information characteristics for financial accounting are reliability and objectivity.

D. No authoritative body requires managerial accounting reports while the SEC requires financial accounting reports for publicly traded companies.

4.

Which of the following statements is TRUE? A. Managers are concerned with the external use of accounting information.

B. Managerial accounting information relies heavily on its reliability and objectivity.

C. The format of managerial accounting reports is determined by GAAP. D. Managerial accounting information must be relevant.

5.

Which of the following statements is TRUE? A. The CEO is elected by the stockholders.

B. The CFO is responsible for the company’s operations.

C. The board of directors is elected by the stockholders.

D. The internal audit department reports solely to the CFO.

6.

The individual responsible for managing all of the financial aspects of the organization is the: A. COO. B. CFO. C. CEO. D. CPA.

1-12 .

7.

Which of the following skills are required of management accountants?

A. Knowledge of both financial and managerial accounting B. Knowledge of how a business functions C. Oral and written communication skills D. All of the above

8.

All of the following are ethical principles identified in the IMA’s Statement of Ethical Professional Practice EXCEPT: A. honesty.

B. teamwork.

C. objectivity.

D. responsibility.

9.

Which of the following is used in decision making to weigh the expected costs of taking a specific action against the expected benefits of the action?

A. Cross-Functional Teams B. Enterprise Resource Planning C. Extensible Business Reporting Language (XBRL) D. Cost benefit analysis.

10.

Which of the following is NOT one of the three factors influencing a company’s triple bottom line?

A. People B. Development C. Planet D. Profit

1-13 .

Chapter 2 Overview Building Blocks of Managerial Accounting Chapter 2 begins with a discussion of the three most common business sectors: service, merchandising, and manufacturing, and describes the types of inventory held by each. The text then describes the six business activities that comprise the value chain, focusing on the importance of cross functional teams in managing and coordinating these business activities. The importance of incorporating sustainability throughout every function of the value chain is discussed. Next, the chapter introduces the concept of cost objects and describes the difference between the direct costs and indirect costs of any chosen cost object.

The first half of the chapter concludes by distinguishing between period costs (operating expenses) and inventoriable product costs. This distinction must be made because of Generally Accepted Accounting Principles (GAAP). Examples of each cost concept are illustrated for both merchandising and manufacturing companies.

The first set of Decision Guidelines reinforces the concepts from the first half of the chapter. The first set of Summary Problems allows students to review the value chain and the correct classification of costs as inventoriable product costs (DM, DL, MOH) or period costs.

The second half of the chapter illustrates the similarities and differences between the financial statements of service, merchandising and manufacturing companies. This discussion includes a detailed example illustrating the computation of Cost of Goods Manufactured for a manufacturing entity. The chapter concludes by discussing other cost concepts frequently used by managers, including controllable versus uncontrollable costs, relevant versus irrelevant costs, and fixed versus variable costs. Examples of the calculation of total costs and average costs at different volume levels are provided. All cost concepts introduced in this chapter will be revisited in later chapters of the text.

The final Decision Guidelines review the cost concepts presented in the second half of the chapter including a review of the calculation of cost of goods sold and cost of goods manufactured. The Summary Problem allows the student to practice the computations for cost of goods manufactured, average cost, and total cost.

2-1 .

Learning Objectives After studying Chapter 2, your students should be able to: 1. Distinguish among service, merchandising, and manufacturing companies.

2. Describe the value chain and its elements.

3. Distinguish between direct and indirect costs.

4. Identify the inventoriable product costs and period costs of merchandising and manufacturing firms.

5. Prepare the financial statements for service, merchandising, and manufacturing companies.

6. Describe costs that are relevant and irrelevant for decision making.

7. Classify costs as fixed or variable and calculate total and average costs at different volumes.

2-2 .

Teaching Outline 1. Distinguish among three types of companies a. Service b. Merchandising i. Retailers ii. Wholesalers c. Manufacturing i. Raw materials inventory (RM) ii. Work in process inventory (WIP) iii. Finished goods inventory (FG) iv. Exhibit 2-1 Manufacturers’ Three Types of Inventory v. Exhibit 2-2 Service, Merchandising, and Manufacturing Companies 2. Describe the value chain and its elements a. Research and development b. Design c. Production or purchases d. Marketing e. Distribution f. Customer service g. Exhibit 2-3 The Value Chain h. Coordinating activities across the value chain i. Sustainability and the value chain 3. Defining cost a. Cost objects, direct costs and indirect costs b. Exhibit 2-4 The Same Cost Can Be Direct or Indirect, Depending on the Cost Object c. Exhibit 2-5 Assigning Direct and Indirect Costs to Cost Objects 4.

Identify inventoriable product costs and period costs of merchandising and manufacturing firms a. Total costs for internal decision making b. Inventoriable product costs for external reporting c. Exhibit 2-6 Total Costs, Inventoriable Product Costs, and Period Costs d. Merchandising companies’ inventoriable product costs e. Manufacturing companies’ inventoriable product costs i. Exhibit 2-7 Summary of the Three Types of Manufacturing Costs ii. Direct materials (DM) iii. Direct labor (DL) iv. Manufacturing overhead (MOH) v. Exhibit 2-8 Components of Manufacturing f. Review inventoriable product costs versus period costs i. Exhibit 2-9 Inventoriable Product Costs and Period Costs for Service, Merchandising, and Manufacturing Companies g. Prime and conversion costs i. Exhibit 2-10 Prime and Conversion Costs h. Additional labor compensation costs

2-3 .

5. Prepare financial statements for service, merchandising and manufacturing companies a. Service companies i. Exhibit 2-11 Service Company Income Statement b. Merchandising companies i. Exhibit 2-12 Merchandiser’s Income Statement ii. Exhibit 2-13 Calculation of Cost of Goods Sold for a Merchandising Firm c. Manufacturing companies i. Exhibit 2-14 Manufacturer’s Income Statement ii. Calculating the cost of goods manufactured and cost of goods sold iii. Exhibit 2-15 Flow of Costs Through a Manufacturer’s Financial Statements iv. Exhibit 2-16 Calculation of Direct Materials Used v. Exhibit 2-17 Calculation of Cost of Goods Manufactured (CGM) vi. Exhibit 2-18 Calculation of Cost of Goods Sold d. Comparing balance sheets between the three types of organizations 6. Other cost terms a. Controllable vs uncontrollable costs b. Relevant and irrelevant costs i. Differential cost ii. Sunk cost c. Exhibit 2-19 Comparison of Relevant Information 7. Behavior of manufacturing costs a. Exhibit 2-20 Fixed Cost Behavior b. Exhibit 2-21 Variable Cost Behavior c. Exhibit 2-22 The Behavior of Manufacturing Costs d. Calculating total and average costs at different volumes

2-4 .

Key Topics Students can never review too many financial statements. The coverage of the management accountant’s role in service and merchandising companies is a great time to review the income statement. This can be done by reviewing Exhibits 2-11, 2-12, and 2-14. Discuss the differences between the income statements. Emphasize the logical flow of all three types of income statements.

Have students work in teams or with a partner and complete E2-32B Identify types of companies and their inventories (5 minutes). Call on a student to report the answers.

Discuss the value chain and its elements. Ask students to describe some of the activities that might take place in each element for a given type of entity and how sustainability might be incorporated in these activities. Explain the importance of cross functional teams in managing and coordinating the various activities across the value chain.

Students need to understand that manufacturing companies have a broad range of production activities that require tracking in three kinds of inventory: raw materials (RM), work in process (WIP), and finished goods (FG). Students should understand that all three of these inventories are assets. This is also a good time to explain to students that finished goods (FG) inventory is an inventoriable product cost with three cost components: direct materials (DM), direct labor (DL), and manufacturing overhead (MOH). Explain these three components in detail.

After discussing direct versus indirect costs, product costs (DM, DL, MOH) and period costs, prime costs and conversion costs, have students complete E2-38B Classify and calculate a manufacturer’s costs (10 minutes) in teams and report their answers.

The schedule of cost of goods manufactured summarizes the activities that take place in a manufacturing plant over the accounting period. Use Exhibit 2-15 to explain the logical flow of costs in a manufacturing environment. Point out that the first two inventories (RM and WIP) are used in the calculation of the cost of goods manufactured. The cost of goods manufactured and the third inventory (FG) are then used in the calculation of cost of goods sold for the income statement. Emphasize that the schedule of cost of goods manufactured must be prepared before the income statement as it’s needed to compute cost of goods sold for a manufacturer. Work through an example of a schedule of cost of goods manufactured and the income statement on the board. After working through an example, have students work in teams or with a partner to complete E42B Compute cost of goods manufactured and cost of goods sold (10-15 minutes). Call on a student to present the answers.

When describing the differences between fixed and variable costs, be sure to reinforce that these terms illustrate the way in which a cost behaves. If the total cost increases/decreases as a result of changes in sales/production, then it’s a variable cost (or a mixed cost). Let them know that sometimes a fixed cost will fluctuate over different time periods, but that it is not changing as a result of changes in sales/production.

Discuss the importance of being able to calculate total cost and average cost for different levels of production. After working through an example, have students work in teams to complete E2-48B Compute total and average costs (10-15 minutes). Have a team present their results to the rest of the class.

2-5 .

Suggest your students make and use flashcards for all the definitions/terminology in this chapter. In addition, some students are overwhelmed when they see a completed income statement for a manufacturer. Show them how to break it down into smaller pieces and then put it together. For instance, begin with computing gross profit. Sales – Cost of Goods Sold = Gross Profit. Then show the detail for COGS: Beginning inventory + Purchases = Cost of Goods Available for Sale – Ending inventory = COGS. (Abbreviations can help students as well: S – COGS = GP; BI + P = GAFS – EI = COGS.)

2-6 .

Chapter 2: Student Summary Handout 1. The three most common types of companies a. Service b. Merchandising i. Retailers ii. Wholesalers c. Manufacturing i. Raw materials inventory (RM) ii. Work in process inventory (WIP) iii. Finished goods inventory (FG) iv. Exhibit 2-1 Manufacturer’s Three Types of Inventory d. Exhibit 2-2 Service, Merchandising, and Manufacturing Companies 2. Value Chain a. Research and Development b. Design c. Production or Purchases d. Marketing e. Distribution f. Customer Service g. Exhibit 2-3 The Value Chain h. Coordinating activities across the value chain i. Sustainability and the value chain 3. Cost Objects a. Direct Costs b. Indirect Costs c. Exhibit 2-4 The Same Cost Can Be Direct or Indirect Depending on the Cost Object d. Exhibit 2-5 Assigning Direct and Indirect Costs to Cost Objects 4. Costs for internal decision making and external reporting a. Total costs for internal decision making b. Inventoriable product costs for external reporting i. GAAP- specified inventoriable product costs ii. Period costs (operating expenses) c. Exhibit 2-6 Total Costs, Inventoriable Product Costs, and Period Costs 5. Inventoriable Product Costs for Merchandising Companies a. Cost of the merchandise itself b. Freight-in and any import duties

2-7 .

6. Inventoriable Product Costs for Manufacturing Companies a. Exhibit 2-7 Summary of the Three Types of Manufacturing Costs b. Direct Materials (DM) c. Direct Labor (DL) d. Manufacturing Overhead (MOH) i. Indirect materials ii. Indirect labor iii. Other indirect manufacturing costs e. Exhibit 2-8 Components of Manufacturing Overhead f. Exhibit 2-10 Prime and Conversion costs g. Additional labor compensation costs 7. Exhibit 2-9 Inventoriable Product Costs and Period Costs for Service, Merchandising, and Manufacturing Companies 8. Income Statements a. Service Companies (Exhibit 2-11) b. Merchandising Companies (Exhibit 2-12) i. Exhibit 2-13 Calculation of Cost of Goods Sold for a Merchandising Firm c. Manufacturing Companies (Exhibit 2-14) i. Exhibit 2-15 Flow of Costs Through a Manufacturer’s Financial Statements ii. Calculating Cost of Goods Manufactured • Exhibit 2-16 Calculation of Direct Materials Used • Exhibit 2-17 Calculation of Cost of Goods Manufactured iii. Exhibit 2-18 Calculation of Cost of Goods Sold 9. Comparing Balance Sheets 10. Other Cost Terms a. Controllable versus uncontrollable costs b. Relevant and irrelevant costs i. Differential cost ii. Sunk cost iii. Exhibit 2-19 Comparison of Relevant Information c. Fixed and variable costs 11. Behavior of manufacturing costs a. Exhibit 2-20 Fixed Cost Behavior b. Exhibit 2-21 Variable Cost Behavior c. Exhibit 2-22 The Behavior of Manufacturing Costs d. Calculating total and average costs at different volumes MyAccountingLab.com algorithmic homework assignments: S2-8, S2-9, E2-17A, E2-24A, E2-25A, E2-26A 2-8 .

CHAPTER 2: ASSIGNMENT GRID Assignment

Topic(s)

Learning Objective(s)

S2-1

Identify type of company from balance sheets Identify types of companies & inventories Classify costs by value chain function Classify costs as direct or indirect Classify inventoriable product costs and period costs Classify a manufacturer’s costs

Classify costs incurred by a dairy processing company Determine total manufacturing overhead Compute Cost of Goods Sold for a merchandiser Prepare a retailer’s income statement Calculate direct materials used Compute Cost of Goods Manufactured Consider relevant information Classify costs as fixed or variable Identify types of companies and their inventories Classify costs along the value chain for a retailer

Estimated Time in Minutes(s)

Level of Difficulty

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Short Exercises S2-2 S2-3 S2-4 S2-5

S2-6 S2-7

S2-8 S2-9 S2-10 S2-11 S2-12 S2-13 S2-14 E2-15A

E2-16A

2-9 .

Assignment

Topic(s)

Learning Objective(s)

Estimated Time in Minutes(s)

Level of Difficulty

E2-17A

Classify costs along the value chain for a manufacturer Value chain and sustainability efforts Classify costs as direct or indirect Define cost terms Classify and calculate a manufacturer’s costs Prepare the current assets section of the balance sheet Prepare a retailer’s income statement Compute direct materials used and cost of goods manufactured Compute cost of goods manufactured and cost of goods sold Continues E2-25A: Prepare income statement Work backwards to find missing amounts Determine whether information is relevant Describe other cost terms Classify costs as fixed or variable Compute total and average costs Identify types of companies and their inventories Classify costs along the value chain for a retailer Classify costs along the value chain for a manufacturer

2&3

10

Easy

2

5

Easy

3

5

Easy

3&4 3&4

10 10

Easy Easy

5

10

Medium

5

10

Medium

5

10-15

Medium

5

10-15

Medium

5

10

Medium

5

10-15

Medium

6

5

Easy

6&7 7

5 10

Easy Medium

7

10-15

Medium

1

5

Easy

2

10

Easy

2&3

10

Easy

E2-18A E2-19A E2-20A E2-21A E2-22A

E2-23A E2-24A

E2-25A

E2-26A E2-27A E2-28A E2-29A E2-30A E2-31A E2-32B

E2-33B E2-34B

2-10 .

Assignment

Topic(s)

Learning Objective(s)

Estimated Time in Minutes(s)

Level of Difficulty

E2-35B

Value chain and sustainability efforts Classify costs as direct or indirect Define cost terms

2

5

Easy

3

5

Easy

3&4

10

Easy

3&4

10

Easy

5

10

Medium

5

10

Medium

5

10-15

Medium

5

10-15

Medium

5

10

Medium

5

10-15

Medium

6

5

Easy

6&7 7

5 10

Easy Medium

7

10-15

Medium

2&4

15

Medium

5

15-20

Difficult

5 6

15 15-20

Medium Difficult

7

15-20

Difficult

E2-36B E2-37B E2-38B E2-39B

E2-40B E2-41B

E2-42B

E2-43B E2-44B E2-45B E2-46B E2-47B E2-48B P2-49A P2-50A P2-51A P2-52A P2-53A

Classify and calculate a manufacturer’s costs Prepare the current assets section of the balance sheet Prepare a retailer’s income statement Compute direct materials used and cost of goods manufactured Compute cost of goods manufactured and cost of goods sold Continues E2-42BA: Prepare income statement Work backwards to find missing amounts Determine whether information is relevant Describe other cost terms Classify costs as fixed or variable Compute total and average costs Classify costs along the value chain Prepare income statements Fill in missing amounts Identify relevant information Calculate the total and average costs

2-11 .

Assignment

P2-54B P2-55B P2-56B P2-57B P2-58B

Topic(s)

Learning Objective(s)

Estimated Time in Minutes(s)

Level of Difficulty

15

Medium

5

15-20

Difficult

5 6

15 15-20

Medium Difficult

7

15-20

Difficult

5

15-20

Medium

All

60-90

Medium

All

30-60

Medium

3, 4, & 5

5

Medium

Problems (Group B) 2&4

Classify costs along the value chain Prepare income statements Fill in missing amounts Identify relevant information Calculate the total and average costs

Other Decision Case C2-59 Discussion and Analysis A2-60 Application and Analysis A2-61 CMA Adapted Multiple Choice Questions A2-62, A2-63, A2-64

Determine ending inventory balances

Costs in the value chain at a real company and cost objects

Pre-Test Questions on MyAccountingLab: S2-3, S2-5, S2-9, S2-10, S2-11 Post-Test Questions on MyAccountingLab: E2-17A, E2-24A, E2-25A, E2-26A

Answer Key to Chapter 2 Quiz (Quiz on following pages.)

1.

2.

3.

4.

5.

A A C D D

6. C 7. B 8. A 9. C 10. B

2-12 .

Name____________________________________ Date_________________ Section_______________

CHAPTER 2 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

A portion of a company’s income statement is shown below:

Sales Cost of Goods Sold: Beginning Inventory Purchases Cost of Goods Available for Sale Less: Ending Inventory Cost of Goods Sold Gross Profit

$350,000 $ 15,000 250,000 265,000 13,000 252,000 $ 98,000

What type of company is illustrated?

A. Merchandising Corporation B. Manufacturing Corporation C. Service Corporation D. Not-for-profit Corporation 2.

Which of the following is NOT a value chain activity?

A. Human Resources B. Customer Service C. Marketing D. Production

3.

Work in process inventory is: A. raw materials that will be used in manufacturing.

B. completed goods not yet sold.

C. goods that are in the manufacturing process but are not yet complete.

D. goods that have been shipped to customers.

4.

Which of the following is a direct cost in the production of wine for a winery?

A. Utilities B. Taxes C. Insurance D. Grapes

5.

Which of the following is a NOT a component of manufacturing overhead?

A. Depreciation on plant machinery B. Salaries of plant supervisors C. Oil and lubricants for machines D. Direct Labor 2-13

.

6.

Which of the following companies has all costs along the value chain accounted for as period costs?

A. Manufacturing Corporation B. Merchandising Corporation C. Service Corporation D. None of the above

7.

Which of the following is a period cost?

A. Direct materials B. Advertising C. Salaries of plant supervisors D. Wages of production line employees

8.

Given the following July financial information for Classic Toy Manufacturing Company, what amount of cost of goods sold would be reported by Classic Toy for the month of July?

Cost of goods manufactured Beginning finished goods inventory Ending finished goods inventory General and administrative expenses Selling expenses A. B. C. D.

$25,000 4,000 6,000 3,000 2,000

$23,000 $25,000 $26,000 $28,000

9.

Which of the following is a NOT a variable cost for a plant that manufactures iPods?

A. Plastic used to make the cases B. Employee wages for assembly C. Straight line depreciation of warehouse building D. Computer chip used in each iPod

10.

Far Fly Golf Ball Company’s manufacturing costs for September are: * Materials cost: $20,000 * Labor cost: $15,500 * Overhead: $5,500 If plant employees manufactured 50,000 golf balls during the month of September, what is the cost (rounded) per golf ball?

A. $1.22 C. $0.71 B. $0.82 D. $0.40

2-14 .

Chapter 3 Overview Job Costing

This chapter outlines the two basic costing systems: job costing and process costing. Job costing is used when relatively small quantities of unique products are manufactured. Process costing is used when large quantities of homogeneous products are manufactured.

The chapter begins by comparing and contrasting job costing and process costing. Next, the chapter explains the documents and system used to trace direct materials and direct labor to specific jobs. The text reviews how manufacturing overhead is allocated to each job using a predetermined overhead rate. Job cost information is then used to make various business decisions.

The first set of Decision Guidelines explains some of the decisions a company might need to make in designing its costing system. The Summary Problems allows the student to practice calculating the predetermined overhead rate as well as the total cost and unit cost for a specific job.

The second half of the chapter discusses the calculation of over- or underallocated manufacturing overhead as well as the proper treatment of the amount over or underallocated. The final section of the chapter illustrates all journal entries associated with a job costing system for a manufacturer. The last set of Decision Guidelines discusses the implications of over- or underallocating manufacturing overhead.

The application to a service firm as well as the proper treatment of operating expenses is also covered.

The final Summary Problem allows for practice in recording journal entries and preparing a simple income statement for a manufacturer using a job costing system. Finally, the appendix illustrates job costing at a service company (law firm).

3-1 .

Learning Objectives After studying Chapter 3, your students should be able to: 1. Distinguish between job costing and process costing.

2. Understand the flow of production and how direct materials and direct labor are traced to jobs.

3. Compute a predetermined manufacturing overhead rate and use it to allocate MOH to jobs.

4. Determine the cost of a job and use it to make business decisions.

5. Compute and dispose of overallocated or underallocated manufacturing overhead.

6. Prepare journal entries for a manufacturer’s job costing system.

7. (Appendix) Use job costing at a service firm as a basis for billing clients.

3-2 .

Teaching Outline 1. Distinguish between job costing and process costing a. Process costing b. Job costing c. Exhibit 3-1 Differences Between Job and Process Costing 2. Understand the flow of production and how direct materials and direct labor are traced to jobs a. Exhibit 3-2 Flow of Inventory Through a Manufacturing System b. Exhibit 3-3 Monthly Production Schedule c. Using a job cost record to accumulate job costs i. Exhibit 3-7 Job Cost Record ii. Tracing direct materials cost to a job • Exhibit 3-4 Bill of Materials (Partial Listing) • Exhibit 3-5 Raw Materials Record • Exhibit 3-6 Individual Raw Materials Records Sum to the Raw Materials Inventory Balance • Exhibit 3-9 Materials Requisition • Exhibit 3-10 Raw Materials Record Updated for Materials Received and Used • Exhibit 3-11 Posting Direct Materials Used to the Job Cost Record iii. Tracing direct labor cost to a job • Exhibit 3-12 Labor Time Record • Exhibit 3-13 Posting Direct Labor Used to the Job Cost Record d. Exhibit 3-8 Job Cost Records on Incomplete Jobs Sum to the WIP Inventory Balance 3. Compute a predetermined manufacturing overhead (MOH) rate and use it to allocate MOH to jobs a. Explain what allocating MOH means b. Steps to allocating MOH i. Step 1) The company estimates its total MOH costs for the coming year. ii. Step 2) The company selects an allocation base and estimates the total amount that will be used during the year. iii. Step 3) The company calculates its predetermined MOH rate using the information estimated in Steps 1 and 2. iv. Step 4) The company allocates some MOH to each individual job. c. Discuss the point in time at which MOH is allocated to jobs 4. Determine the cost of a job and use it to make business decisions a. Exhibit 3-14 Posting Manufacturing Overhead and Completing the Job Cost Record b. Reducing future job costs c. Assessing and comparing the profitability of each model d. Dealing with pricing pressure from competitors e. Allowing discounts on high volume sales f. Bidding for custom orders g. Preparing the financial statements h. Enhancing information to aid in decisions regarding sustainability issues i. Considering non-manufacturing costs 3-3 .

5. Compute and dispose of overallocated or underallocated manufacturing overhead a. Underallocated MOH b. Overallocated MOH c. Exhibit 3-15 Underallocated Versus Overallocated Manufacturing Overhead d. Adjusting Cost of Goods Sold, in most cases e. Exhibit 3-16 Correcting Cost of Goods Sold for Underallocated or Overallocated MOH 6. Prepare journal entries for a manufacturer’s job costing system a. Exhibit 3-17 Review of Journal Entry and T-account Mechanics b. Purchase of raw materials c. Use of direct materials d. Use of indirect materials e. Use of direct labor f. Use of indirect labor g. Incurring other MOH costs h. Allocating MOH to jobs i. Completion of jobs j. Sale of units k. Operating expenses l. Closing MOH m. Exhibit 3-18 Income Statement After Adjusting for Underallocated Manufacturing Overhead 7. (Appendix) Use job costing at a service firm as a basis for billing clients a. Exhibit 3-19 Assigning Costs to Client Jobs b. Direct costs are traced to the client’s job c. Indirect costs are allocated to the client’s job – predetermined indirect cost allocation rate i. Step1) Estimate the total indirect costs for the coming year. ii. Step 2) Choose an allocation base and estimate the total amount that will be used during the year. iii. Step 3) Compute the predetermined indirect cost allocation rate. iv. Step 4) Allocate indirect costs to client jobs using the predetermined rate. d. Finding the total cost of the job and adding a profit markup e. Invoicing the client using a professional billing rate i. Exhibit 3-20 Invoice to Client f. Journal entries needed in a service firm’s job costing system

3-4 .

Key Topics Make it clear to students that both a job costing system and a process costing system provide the same basic production costing information. Emphasize that the goal of either system is the same: to find the cost of manufacturing one unit of product. The difference in the two systems is the way they accumulate the costs. The first major distinction between the two systems is quantity and uniqueness of product while the second is costing. Process costing is used when large quantities of homogeneous product are produced; the total costs are divided by the quantity produced to give the average cost. Job costing is used by companies that produce smaller quantities of relatively unique products which vary in the manufacturing resources required. Direct materials (DM) and direct labor (DL) costs are traced to the product while manufacturing overhead is allocated to the product using a predetermined manufacturing overhead rate.

Have students work in teams or with a partner and complete E3-29B Identify type of costing system (5 minutes). Call on a student to report the answers.

Stress that there are three product or manufacturing costs: DM, DL, and MOH. Keep repeating this throughout the chapter presentation. All manufacturing costs flow into the WIP inventory account. MOH is allocated to jobs based on a predetermined rate using estimated data.

Students are typically confused as to why overhead needs to be allocated rather than added directly to jobs as it is used. Explain that this is a timing problem. Companies need the cost information for decision making before the actual costs are known. Use E3-40B Analyze manufacturing overhead to illustrate how the MOH rate is predetermined and then how it’s used. Help students to understand that debits to the MOH account represent actual (or incurred) MOH costs and credits to the MOH account represent allocated MOH. Draw a T-account on the board and write “actual” on the debit side and “allocated” on the credit side. Enter the MOH entries into the T-account to show students how to determine whether MOH was over- or underallocated. Emphasize that the account is temporary and how to close the account at the end of the period.

A job cost record is used to accumulate all costs related to each specific job: DM and DL used, and MOH allocated to that specific job. The job cost records for incomplete jobs sum to the total Work in Process (WIP) general ledger account. The job cost records are used to “prove” the WIP balance. The job cost records really serve as subsidiary ledgers keeping track of the specific jobs being produced by the company.

Have students work in teams to solve E3-38B Determine the cost of a job (10 minutes). Ask students to explain the differences between the recording for materials and labor.

Over- or underallocated MOH at the end of the period should, in theory, be divided among Finished Goods (FG), WIP, and Cost of Goods Sold (COGS) in proportion to their ending balances because these are the accounts in which the MOH costs lie. In reality, because most of the jobs have been sold, companies will close the MOH to COGS only. If that is not the case, or the amount of over- or underallocated MOH is material, then MOH should be closed to FG, WIP, and COGS as discussed previously.

Most of the accounts involved in a job order costing system can be characterized as cost accounts.

Relating cost accounts to expense accounts and asset accounts can help students quickly grasp the accounting flows. Use E3-43B Analyze T-accounts to illustrate the flow.

3-5 .

Illustrate job costing in a service firm by using a maid service as an example.

1. Estimate total indirect costs-office rent, insurance, etc. For example, estimate $100,000.

2. Identify a cost allocation base-for example, number of homes cleaned per year.

3. Estimate total quantity of the indirect cost allocation base-for example, 1,000 homes.

4. Compute the predetermined indirect cost allocation rate: $100,000/1,000 = $100 per property.

5. Obtain the actual quantity of the cost allocation base used by individual jobs-for example, 995 homes cleaned.

6. Allocate indirect cost to jobs-for example, if 995 homes were cleaned and the allocation rate is $100 per property, the amount allocated to overhead would be $99,500.

7. Compare actual overhead to the amount allocated to overhead to determine over- or underallocated overhead. For example, if actual indirect costs were 99,000, then $500 would be the amount of overallocated overhead.

Students are interested to know that the cost mark-up varies greatly by industry. In the chapter they learn that the cross-trainer that sells for $1,900 cost the company $1,160 to produce. However, students tend to forget that the markup of $740 is not all profit, but must cover sales commissions as well as other noninventoriable costs.

3-6 .

Chapter 3: Student Summary Handout 1. Differences between Process Costing and Job Costing (Exhibit 3-1) 2. Flow of Production • Exhibit 3-2 Flow of Inventory Through a Manufacturing System • Raw Materials • Work in Process • Finished Goods • Cost of Goods Sold 3. Using a Job Cost Record to Accumulate Job Costs • Exhibit 3-7 Job Cost Record • Tracing direct materials cost to a job - Exhibit 3-10 Raw Materials Record Updated for Materials Received and Used - Exhibit 3-11 Posting Direct Materials Used to the Job Cost Record • Tracing direct labor cost to a job - Exhibit 3-12 Labor Time Record - Exhibit 3-13 Posting Direct Labor Used to the Job Cost Record • Exhibit 3-8 Job Cost Records on Incomplete Jobs Sum to the WIP Inventory Balance 4. Compute a Predetermined Manufacturing Overhead (MOH) Rate – used to allocate MOH to jobs • Step 1) Estimate total MOH costs for the coming year • Step 2) Select an allocation base and estimate the total amount of the base that will be used during the year • Step 3) Calculate the predetermined MOH Rate: Total estimated MOH costs (from Step 1) / Total estimated amount of the allocation base (from Step 2) • Step 4) Allocate MOH to each individual job: Predetermined MOH rate (from Step 3) x Actual amount of allocation base used by the job 5. Completing the Job Cost Record and Using it to Make Business Decisions • Exhibit 3-14 Posting Manufacturing Overhead and Completing the Job Cost Record • Determining total cost and unit cost for each job • Reducing future job costs • Assessing and comparing profitability of each model • Dealing with pricing pressure from competitors • Allowing discounts on high volume sales • Bidding for custom orders • Preparing the financial statements • Enhancing information to aid in decisions regarding sustainability issues • Considering non-manufacturing costs 6. Over- or underallocated MOH • Compare actual MOH costs incurred to MOH allocated to jobs • Difference is over- or underallocated MOH • Exhibit 3-15 Underallocated Versus Overallocated Manufacturing Overhead • In most cases, adjust Cost of Goods Sold for the amount of over- or underallocation • Exhibit 3-16 Correcting Cost of Goods Sold for Underallocated or Overallocated MOH 3-7 .

7. Journal entries • Exhibit 3-17 Review of Journal Entry and T-account Mechanics • Purchase of raw materials • Use of direct materials • Use of indirect materials • Use of direct labor • Use of indirect labor • Incurring other MOH costs • Allocating MOH to jobs • Completion of jobs • Sale of units • Operating expenses • Closing MOH 8. (Appendix 3A) Service Firms using Job Costing • Exhibit 3-19 Assigning Costs to Client Jobs • Direct costs are traced to the client’s job • Indirect costs are allocated to client’s job – use predetermined indirect cost allocation rate - Step 1) Estimate total indirect costs for the coming year - Step 2) Choose an allocation base and estimate the total amount that will be used during the year - Step 3) Compute the predetermined indirect cost allocation rate (amount from Step 1 / amount from Step 2) - Step 4) Allocate indirect costs to client jobs using the predetermined rate (amount from Step 3 x actual amount of allocation based used by the job) • Invoice the client using a professional billing rate 9. MyAccountingLab.com algorithmic homework assignments: E3-13A, E3-14A, E3-17A, E3-19A, E3-24A

3-8 .

CHAPTER 3: ASSIGNMENT GRID Assignment

S3-1 S3-2 S3-3 S3-4 S3-5 S3-6 S3-7 S3-8 S3-9 S3-10 S3-11 S3-12

E3-13A E3-14A E3-15A E3-16A E3-17A

E3-18A

E3-19A

Topic(s)

Learning Objective(s)

Short Exercises Decide on product costing 1 system Determine the flow of costs 2 between inventory accounts Compute various manufacturing 3 overhead rates Continuation of S3-3: compute 3 total allocated overhead Continuation of S3-4: determine 3&5 over- or underallocation Calculate rate and analyze year3&5 end results Calculate job cost and billing 2&4 Calculate job cost and billing at 2&4 appliance repair service Ramifications of overallocating 2&5 and underallocating jobs Record purchase and use of 6 materials Record manufacturing labor 6 costs Recompute job cost at a legal 3, 4 & 7 firm Exercises (Set A) Identify type of costing system 1 Describe the flow of costs in a 2 job cost shop Understanding key document 2 terms in a job cost shop Understand the flow of costs in a 2 job cost shop Compute a predetermined 3&4 overhead rate and calculate cost of jobs based on direct labor hours Compute a predetermined 3&4 overhead rate and calculate cost of job based on direct labor costs Determine the cost of a job and 2&4 use it for pricing

3-9 .

Estimated Time in Minutes

Level of Difficulty

5

Easy

5

Easy

5

Easy

5

Easy

10

Easy

10

Easy

5 5

Easy Easy

10

Medium

10

Easy

5

Easy

10

Easy

5 10

Easy Easy

5

Easy

10

Easy

10

Easy

10

Easy

15

Medium

Assignment

E3-20A

E3-21A E3-22A E3-23A E3-24A E3-25A E3-26A E3-27A E3-28A

E3-29B E3-30B E3-31B E3-32B E3-33B

E3-34B

E3-35B E3-36B

E3-37B E3-38B E3-39B E3-40B E3-41B E3-42B

Topic(s)

Learning Objective(s)

Calculate job cost, billing, and 2, 4, & 7 profit at a furniture and sign manufacturer Understanding key terms 1, 2, 3, & 4 Determine the cost of a job 2, 3, & 4 Compare bid prices under two 3&4 different allocation bases Analyze manufacturing 3&5 overhead Record manufacturing overhead 5&6 Record journal entries 2, 3, 5, & 6 Analyze T-accounts 2, 3, 5, & 6 Job cost and bid price at a 7 consulting firm Exercises (Set B) Identify type of costing system 1 Describe the flow of costs in a 2 job cost shop Understanding key document 2 terms in a job cost shop Understand the flow of costs in a 2 job cost shop Compute a predetermined 3&4 overhead rate and calculate cost of jobs based on direct labor hours Compute a predetermined 3&4 overhead rate and calculate cost of job Determine the cost of a job and 2&4 use it for pricing Calculate job cost, billing, and 2, 4, & 7 profit at a furniture and sign manufacturer Understanding key terms 1, 2, 3, & 4 Determine the cost of a job 2, 3, & 4 Compare bid prices under two 3&4 different allocation bases Analyze manufacturing 3&5 overhead Record manufacturing overhead 5&6 Record journal entries 2, 3, 5, & 6

3-10 .

Estimated Time in Minutes

Level of Difficulty

15

Medium

10 10 15

Medium Medium Medium

15-20

Medium

25 25 20 15

Difficult Difficult Difficult Medium

5 10

Easy Easy

5

Easy

10

Easy

10

Easy

10

Easy

15

Medium

15

Medium

10 10 15

Medium Medium Medium

15-20

Medium

25 25

Difficult Difficult

Assignment

E3-43B E3-44B

P3-45A P3-46A P3-47A P3-48A P3-49A P3-50A

P3-51B P3-52B P3-53B P3-54B P3-55B P3-56B

Decision Cases C3-57 C3-58 Team Project T3-59 Discussion and Analysis A3-60 Application and Analysis A3-61 CMA Adapted Multiple Choice Questions A3-62, A3-63

Topic(s)

Learning Objective(s)

Estimated Time in Minutes

Level of Difficulty

Analyze T-accounts 2, 3, 5, & 6 Job cost and bid price at a 7 consulting firm Problems (Set A) Analyze Manufacturing 3&5 Overhead Use job costing at an advertising 3, 4, & 7 agency Use job costing at a consulting 3, 4, & 7 firm Prepare job cost record 2, 3, & 4 Determine and record job costs 2, 3, 4, & 6 Determine flow of costs through 2&6 accounts Problems (Set B) Analyze Manufacturing 3&5 Overhead Use job costing at an advertising 3, 4, & 7 agency Use job costing at a consulting 3, 4, & 7 firm Prepare job cost record 2, 3, & 4 Determine and record job costs 2, 3, 4, & 6 Determine flow of costs through 2&6 accounts Other

20 15

Difficult Medium

20

Medium

20

Medium

20

Medium

20 45 20

Medium Difficult Difficult

20

Medium

20

Medium

20

Medium

20 45 20

Medium Difficult Difficult

Issues with cost of job Issues with the manufacturing overhead rate

2, 3, & 4 2, 3, & 4

30 30

Medium Medium

Finding the cost of flight routes

2, 3, & 4

60-90

Difficult

Discussion questions

All

60

Medium

Unwrapped or How It’s Made

All 5

30-60 5

Medium Medium

3-11 .

Pre-Test Questions on MyAccountingLab: S3-1, S3-2, S3-3, S3-4, S3-5 Post-Test Questions on MyAccountingLab: E3-13A, E3-18A, P3-45A

Answer Key to Chapter 3 Quiz (Quiz on following pages.)

1.

2.

3.

4.

5.

D A B B C

6. D 7. C 8. D 9. A 10. D

3-12 .

Name____________________________________ Date_________________ Section_______________

CHAPTER 3 TEN-MINUTE QUIZ Circle the letter of the best response: 1.

Which of the following products would have its costs accumulated using a process costing system?

A. Personal computers B. Luxury yachts C. Dinner at a restaurant D. Fishing supplies

2.

Which of the following companies would use a job costing system?

A. Health care provider B. Crayon manufacturing company C. Potato chip manufacturing corporation D. Spring water bottling company

3.

Which of the following is used to document the manufacturing costs of direct materials, direct labor, and manufacturing overhead?

A. Raw materials record B. Job cost record C. WIP inventory D. Cost Assignment record

4.

When accounting for materials and labor, materials used are recorded in: A. raw materials inventory.

C. finished goods inventory.

B. work in process inventory.

D. cost of goods sold.

5.

When accounting for materials and labor, indirect labor is recorded in: A. raw materials inventory.

C. manufacturing overhead.

B. work in process inventory.

D. finished goods inventory.

6.

Smart Corporation is a manufacturer of smartphones. Assume Smart allocates manufacturing overhead based on machine hours. Additional information for Smart is as follows: • Budgeted 5 million machine hours and $50 million of manufacturing overhead costs • Actual machine hours of 6 million • Actual total manufacturing overhead costs of $48 million What is Smart’s predetermined manufacturing overhead rate?

A. B.

$8.00/machine hour $8.33/machine hour

C. D.

3-13 .

$9.60/machine hour $10.00/machine hour

7.

When selecting a manufacturing overhead allocation base, managers should select the: A. number of products produced.

B. activity based products.

C. cost driver of those manufacturing overhead costs.

D. same number used in prior years.

8.

Which is the entry to record the sale of a job costing $5,000 to produce?

A. B. C. D.

9.

5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000

Which is the journal entry to record the closing of manufacturing overhead given the following facts? * The actual manufacturing overhead is $7,100. * The estimated manufacturing overhead was $7,000. * The amount of overhead allocated is $6,900.

A. B. C. D.

10.

Finished Goods Inventory Work in Process Inventory Cost of Goods Sold Work in Process Inventory Work in Process Inventory Finished Goods Inventory Cost of Goods Sold Finished Goods Inventory

Cost of Goods Sold Manufacturing Overheard Cost of Goods Sold Manufacturing Overhead Manufacturing Overhead Cost of Goods Sold Manufacturing Overhead Cost of Goods Sold

200 200 100 100 100 100 200 200

A marketing consultant uses the job costing system and has a pre-determined overhead rate of $15 per direct labor hour. This amount is based on an estimated overhead of $30,000 and an average time of 5.0 hours per job. Job # 521 incurred direct material costs of $50 and six direct labor hours costing of $75 per hour. The total cost of job 521 is: A. B.

$155. $215.

C. D.

$565. $590.

3-14 .

Chapter 4 Overview Activity-Based Costing, Lean Operations, and the Costs of Quality The chapter begins with a discussion of cost distortion, and how it can occur from using an overly simple cost allocation system. Managers can often obtain more accurate product costs by using departmental overhead rates or Activity Based Costing (ABC) in place of a traditional plantwide overhead allocation rate. ABC allocates indirect costs based on the cost drivers and their varying levels of use for the various products. As managers understand the production cycle and obtain information about how different products use different resources, more accurate costing is used to help managers make better decisions about pricing and production, cutting costs, and routine planning and control. The chapter also addresses the use of ABC in service and merchandising companies. ABC costing systems are used when the benefits obtained by the new system outweigh the costs incurred to obtain the additional cost information.

The first half of the chapter concludes with Decision Guidelines summarizing the decisions a company might face as it refines its cost system. The first Summary Problem allows students practice using both a refined cost system and the traditional plantwide overhead rates to allocate indirect costs. The problem calls for the student to compare the results as they relate to the bidding process.

ABC costing provides the manager with more details on production and sometimes, in turn, reveals the high costs of non-value added activities, such as storing and moving inventories and producing poorquality products. Many companies have linked their ABC costing system to a lean operations philosophy which focuses on manufacturing without waste. Part of the lean philosophy is Just-in-time (JIT) inventory systems. JIT is a demand-pull system where raw materials are ordered just in time for production and finished goods are completed just in time for delivery to customers. The quick production and low inventory maintained in a JIT system require a quality product be produced in order to have the product reach the customer in a timely manner.

The chapter concludes with a discussion of the costs of quality framework including Total Quality Management (TQM) and the four costs of quality: prevention, appraisal, internal failure, and external failure costs. This framework is used to aid managers in their decision making.

The final set of Decision Guidelines highlights some of the decisions managers must make when adopting lean operations and TQM. The accompanying Summary Problem requires a completion of a Cost of Quality Report as well as a discussion of its uses and potential limitations.

4-1 .

Learning Objectives After studying Chapter 4, your students should be able to:

1. Develop and use departmental overhead rates to allocate indirect costs 2. Develop and use activity-based costing (ABC) to allocate indirect costs 3. Understand the benefits and limitations of ABC/ABM systems 4. Describe lean operations 5. Describe and use the costs of quality framework

4-2 .

Teaching Outline 1. Simple cost allocation systems can lead to cost distortion a. Cost distortion b. Exhibit 4-1 More –Refined Versus Less-Refined Cost Allocation System c. Review: Using a plantwide overhead rate to allocate indirect costs (Exhibit 4-6) 2. Develop and use departmental overhead rates to allocate indirect costs a. Conditions warranting consideration of refinement of cost allocation system i. Each department incurs different types and amounts of manufacturing overhead (MOH) ii. Each product, or job, uses the departments to a different extent iii. Exhibit 4-5 Circumstances Favoring Departmental Overhead Rates b. Four basic steps to computing and using departmental overhead rates i. Step 1) The company estimates the total MOH costs that will be incurred in each department in the coming year. These estimates are known as departmental overhead cost pools. ii. Step 2) The company selects an allocation base for each department and estimates the total amount that will be used during the year. iii. Step 3) The company calculates departmental overhead rates using the information estimated in Steps 1 and 2. iv. Step 4) The company allocates some MOH from each department to the individual jobs that use those departments. v. Exhibit 4-7 Steps to Calculating the Departmental Overhead Rates vi. Exhibit 4-10 Departmental Cost Allocation System 3. Develop and use activity-based costing (ABC) to allocate indirect costs a. Four basic steps to computing and using activity cost allocation rates i. Step 1) The company first identifies its primary activities and then estimates the total MOH costs associated with each activity. These are known as activity cost pools. ii. Step 2) The company selects an allocation base for each activity and estimates the total amount that will be used during the year. iii. Step 3) The company calculates its activity cost allocation rates using the information estimated in Steps 1 and 2. iv. Step 4) The company allocates some MOH from each activity to the individual jobs that use the activities. b. Cost distortion: comparing the three allocation systems i. Single plantwide overhead rate ii. Departmental overhead rates iii. ABC iv. Exhibit 4-19 Comparing the Three Cost Allocation Systems c. The cost hierarchy – setting up activity cost pools i. Unit-level activities ii. Batch-level activities iii. Product-level activities iv. Facility-level activities v. Exhibit 4-20 The Cost Hierarchy 4-3 .

4. Understand the benefits and limitations of ABC/Activity Based Management (ABM) systems a. Pricing and product mix decisions b. Cutting costs i. Value-added activities ii. Non-value added activities iii. Value-engineering iv. Exhibit 4-22 The Goal of Value-Engineering c. Routine planning and control decisions d. Using ABC in service and merchandising companies e. Sustainability and refined costing systems f. Passing the cost-benefit test i. Circumstances favoring ABC/ABM systems 1. The benefits of adopting ABC/ABM are higher for companies in competitive markets 2. The benefits of adopting ABC/ABM are higher when the risk of cost distortion is high 3. The costs of adopting ABC are generally lower when the company has advanced information systems and technology in place ii. Signs that the old system may be distorting costs 1. Managers don’t understand costs and profits 2. The cost system is outdated 5. Describe lean operations a. Lean thinking b. The eight wastes of traditional operations – DOWNTIME (defects, overproduction, waiting, not utilizing people to their full potential, transportation, inventory, movement, excess processing) i. Exhibit 4-23 The 8 Wastes c. Characteristics of lean operations i. Just-in-Time (JIT) inventory philosophy ii. Exhibit 4-25 Traditional System Versus JIT System iii. Value stream mapping iv. Production occurs in self-contained cells v. Employee empowerment: broad roles and the use of teams vi. 5s: Workplace organization vii. Point of use storage (POUS) viii. Continuous flow ix. Pull system x. Shorter manufacturing cycle times xi. Reduced set-up times xii. Smaller batches xiii. Emphasis on quality xiv. Supply-chain management xv. Drawbacks xvi. Lean operations in service and merchandising companies xvii. Sustainability and lean thinking

4-4 .

6. Describe and use the costs of quality framework a. Total Quality Management b. Costs of Quality i. Prevention ii. Appraisal iii. Internal failure iv. External failure v. Exhibit 4-29 Four Types of Quality Costs c. Using the costs of quality framework to aid decisions

4-5 .

Key Topics This is a great time to review the traditional method of allocating manufacturing overhead costs (using a plantwide allocation rate). The student will better understand departmental overhead rates and activitybased costing (ABC) by showing that these refined costing systems are simply natural extensions of the traditional method. All methods of cost allocation essentially use the same four basic steps, but use different cost pools and different cost allocation bases.

Create a discussion among students about cost allocation. What if two students wanted to order pizza and two other students weren’t interested? But, when the pizza is delivered, the other two students changed their minds. Is it fair to split the price among the four students? What if these students always say no when ordering the pizza but always say yes when it’s delivered? How would the price of a pizza be split if only three students were interested and one of those students only wanted one slice? Is there always a fair way to split the costs? Does splitting the costs based on the slices eaten make sense? The way to allocate indirect costs isn’t always perfect but allocating the cost among those that consume the most is ABC costing.

Explain that because competition is greater today than in the past, managers need more accurate estimates of product costs than in the past. Managers need this information to set prices and to identify the most profitable products. ABC can provide this information more accurately. Refined costing systems are also important for companies moving toward environmental sustainability because jobs and products can drive environmental overhead costs differently.

The primary difference between traditional costing and ABC systems is that ABC systems strive to use the cost driver that causes the specific cost to increase. This better allocates costs based on a cause and effect relationship. ABC does this by separately estimating the indirect costs associated with each activity and then allocating those costs based on the volume of activity that caused them. Note that the refined cost system is used when the benefits of the system outweigh the costs of obtaining the additional cost information.

Students are often confused when the focus of a cost goes from company level to the department level.

Student look for a formula to do the same thing every time and varying how the company allocates the costs may be difficult. Students need to understand that the allocation process is the same and that not all costs are broken down to their smallest component.

Use E4-36B Compute activity rates and apply to jobs to illustrate the process of computing cost allocations by activity and applying them to jobs.

It is important for companies to eliminate waste to be competitive in today’s operating environment.

Discuss the eight wastes typically found in traditional organizations using the acronym, “DOWNTIME.” Have the students provide examples of each type of waste. Ask the students what costs are incurred in maintaining large inventories. Explain how adoption of a “Just-in-Time” (JIT) inventory philosophy can aid in achieving lean operations.

In teams or as partners, have students complete E4-44B Differentiate between traditional and lean operations (10 minutes). Call on a student to give the answers.

4-6 .

Make it clear to students that the goal of total quality management (TQM) is to provide customers with superior products and services. This is accomplished by each business function in the value chain examining its own activities, improving quality, and eliminating defects and waste.

Students can better understand the benefits of TQM if they understand that the quality costs and benefits are hard to measure. Explain to the students that the biggest benefit of TQM is the reduction of unhappy customers who would never return. Unhappy customers do not appear directly in the accounting records, so TQM programs emphasize nonfinancial measures such as the number of customer complaints.

Have students complete E4-47B Classify costs and make a quality-initiative decision (15 minutes).

4-7 .

Chapter 4: Student Summary Handout 1. Develop and use Departmental Overhead (OH) rates to allocate indirect costs a. Four basic steps – Step 1) Estimate the total manufacturing overhead (MOH) costs that will be incurred in each department in the coming year: departmental overhead cost pools.

– Step 2) Select an allocation base for each department and estimate the total amount that will be used during the year.

– Step 3) Calculate departmental overhead rates using the information estimated in Steps 1 and 2: Department overhead rate = Total estimated department overhead cost pool (Step 1) / Total estimated amount of the department allocation base (Step 2) – Step 4) Allocate some MOH from each department to the individual jobs that use those departments.

MOH allocated to job = Departmental overhead rate (from Step 3) × Actual amount of departmental allocation base used by job – Exhibit 4-7 Steps to Calculating the Departmental Overhead Rates – Exhibit 4-10 Departmental Cost Allocation System 2. Develop and use Activity Based Costing (ABC) to allocate indirect costs a. Four basic steps – Step 1) Identify primary activities and then estimate the total MOH costs associated with each activity (i.e., activity cost pools).

– Step 2) Select an allocation base for each activity and estimate the total amount that will be used during the year.

– Step 3) Calculate activity cost allocation rates using the information estimated in Steps 1 and 2.

Activity cost allocation rate = Total estimated activity cost pool (Step 1) / Total estimated activity allocation base (Step 2) – Step 4) Allocate some MOH from each activity to the individual jobs that use the activities.

MOH allocated to job = Activity cost allocation rate (from Step 3) × Actual amount of activity allocation base used by job – Exhibit 4-19 Comparing the Three Cost Allocation Systems b. Cost hierarchy - setting up activity cost pools – Unit-level activities – Batch-level activities – Product-level activities – Facility-level activities – Exhibit 4-20 The Cost Hierarchy 3. Understand the benefits and limitations of ABC/Activity Based Management (ABM) systems a. Pricing and product mix decisions b. Cutting costs i. Value-added activities ii. Non-value added activities iii. Value-engineering iv. Exhibit 4-22 The Goal of Value-Engineering 4-8 .

c. d. e. f.

Routine planning and control decisions Using ABC in service and merchandising companies Sustainability and refined costing systems Passing the cost-benefit test i. Circumstances favoring ABC/ABM systems – Competitive markets – Risk of cost distortion is high – Already established advanced information systems and technology ii. Signs that the old system may be distorting costs – Managers don’t understand costs and profits – The cost system is outdated

4. Lean Operations a. Lean thinking b. The eight wastes of traditional operations – DOWNTIME (defects, overproduction, waiting, not utilizing people to their full potential, transportation, inventory, movement, excess processing) i. Exhibit 4-23 The 8 Wastes c. Characteristics of lean operations i. Just-in-Time (JIT) inventory philosophy ii. Exhibit 4-25 Traditional System Versus JIT System iii. Value stream mapping iv. Production occurs in self-contained cells v. Employee empowerment: broad roles and the use of teams vi. 5s: Workplace organization vii. Point of use storage (POUS) viii. Continuous flow ix. Pull system x. Shorter manufacturing cycle times xi. Reduced set-up times xii. Smaller batches xiii. Emphasis on quality xiv. Supply- chain management xv. Drawbacks xvi. Lean operations in service and merchandising companies xvii. Sustainability and lean thinking 5. Costs of Quality a. Total Quality Management b. Costs of Quality i. Prevention ii. Appraisal iii. Internal failure iv. External failure v. Exhibit 4-29 Four Types of Quality Costs c. Using the costs of quality framework to aid decisions 6. MyAccountingLab.com algorithmic homework assignments: S4-6, S4-9, E4-23A, E4-25A, 4-33A

4-9 .

CHAPTER 4: ASSIGNMENT GRID Assignment

S4-1 S4-2 S4-3 S4-4 S4-5 S4-6 S4-7 S4-8 S4-9 S4-10 S4-11 S4-12 S4-13 S4-14 S4-15 S4-16 S4-17 S4-18 S4-19 S4-20 S4-21

E4-22A E4-23A E4-24A

Topic(s)

Learning Objective(s)

Short Exercises Understand key terms 1, 2, 3, 4, & 5 Use departmental overhead rates to 1 allocate manufacturing overhead Compute departmental overhead rates 1 Compute activity cost allocation rates 2 Continuation of S4-4: Use ABC to 2 allocate overhead Calculate a job cost using ABC 2 Apply activity cost allocation rates 2 Classifying costs within the cost hierarchy 2 Classifying costs within the cost 2 hierarchy Determine the usefulness of refined 3 costing systems in various situations Compute and use traditional allocation 1 rate Identify clues that old system is broken 3 Compute activity cost allocation rates 2 Continuation of S4-13: Compute job 2 costs using ABC Identifying costs as value-added or 3 non-valued-added Identifying activities as value-added or 3 non-valued-added Identify lean production characteristics 4 Identifying the DOWNTIME activities 4 at a manufacturer Classifying costs of quality 5 Quality initiative decision 5 Categorize different costs of quality 5 Exercises (Set A) Compare traditional and departmental cost allocations 1 Compute activity rates and apply to 2 jobs Apply activity cost allocation rates 2

4-10 .

Estimated Time in Minutes

Level of Difficulty

10 5

Easy Easy

10 5 10

Easy Easy Easy

15

Easy

10

Easy

5 5

Easy Easy

5

Easy

10

Easy

5 5 10

Easy Easy Easy

5

Easy

5

Easy

5 5

Easy Easy

5 10

Easy Easy

5

Easy

15 10

Easy Easy

10

Easy

Assignment Topic(s)

E4-25A E4-26A E4-27A E4-28A E4-29A E4-30A E4-31A E4-32A E4-33A E4-34A

E4-35B E4-36B E4-37B E4-38B E4-39B E4-40B E4-41B E4-42B E4-43B E4-44B E4-45B E4-46B E4-47B

P4-48A P4-49A

Learning Objective(s)

Using ABC to bill clients at a service firm Compare traditional and ABC cost allocations at a pharmacy Reassess product costing using ABC Use ABC to allocate manufacturing overhead Continuation of E4-28A: Determine product profitability Work backward to determine ABC rates Differentiate between traditional and lean operations Identifying waste activities in an office Prepare a Cost of Quality report Classify costs and make a qualityinitiative decision Exercises (Set B) Compare traditional and departmental cost allocations Compute activity rates and apply to jobs Apply activity cost allocation rates Using ABC to bill clients at a service firm Compare traditional and ABC cost allocations at a pharmacy Reassess product costing using ABC Use ABC to allocate manufacturing overhead Continuation of E4-41B: Determine product profitability Work backward to determine ABC rates Differentiate between traditional and lean operations Identifying waste activities in an office Prepare a Cost of Quality report Classify costs and make a qualityinitiative decision Problems (Set A) Implementation and analysis of departmental rates Use ABC costing to compute full product costs 4-11

.

Estimated Time in Minutes

Level of Difficulty

2

15

Easy

2

20

Easy

2 2

15 15

Medium Medium

2&3

10

Easy

2

10

Medium

4 4 5

10 10 15

Easy Easy Medium

5

15

Medium

1 2

15 10

Easy Easy

2 2

10 15

Easy Easy

2

20

Easy

2 2

15 15

Medium Medium

2&3

10

Easy

2

10

Medium

4 4 5

10 10 15

Easy Easy Medium

5

15

Medium

1

30

Difficult

2

30

Medium

Assignment

P4-50A P4-51A P4-52A

P4-53B P4-54B P4-55B P4-56B P4-57B

Decision Cases A4-58 A4-59 Ethical Issue A4-60 Discussion and Analysis A4-61 Application and Analysis A4-62 A4-63 CMA Adapted Multiple Choice Question A4-64

Topic(s)

Learning Objective(s)

Comprehensive ABC Implementation Comprehensive ABC implementation Using ABC in conjunction with quality decisions Problems (Set B) Implementation and analysis of departmental rates Use ABC costing to compute full product costs Comprehensive ABC Implementation Comprehensive ABC implementation Using ABC in conjunction with quality decisions Other

2&3 2&3

Estimated Time in Minutes 30 25

2&5

20

Medium

1

30

Difficult

2 2&3 2&3

30 30 25

Medium Medium Medium

2&5

20

Medium

Comprehensive ABC Continues C4-58: Meeting target costs

2&3 2&3

30 15

Medium Medium

ABC and ethical dilemma

2&3

15

Medium

Discussion Questions

All

60

Medium

ABC in Real Companies

All 4

30-60 30-60

Medium Medium

2&3

5

Medium

Pre-Test Questions on MyAccountingLab: S4-2, S4-4, S4-5, S4-8, S4-15, S4-19

Post-Test Questions on MyAccountingLab: E4-24A, E4-33A, P4-49A

4-12 .

Level of Difficulty Medium Medium

Answer Key to Chapter 4 Quiz (Quiz on following pages.)

1.

2.

3.

4.

5.

B A B C D

6. A 7. C 8. B 9. D 10. A

4-13 .

Name____________________________________ Date_________________ Section_______________

CHAPTER 4 TEN-MINUTE QUIZ Circle the letter of the best response: 1.

Which of the following circumstances do NOT favor departmental overhead rates?

A. Each department incurs different types and amounts of manufacturing overhead.

B. All departments incur approximately equal types and amounts of manufacturing overhead.

C. Each product or job uses the departments to a different extent.

D. All of the above favor departmental overhead rates.

2.

Activity-based costing helps to: A. reduce cost distortion.

B. develop departmental overhead rates.

C. allocate direct costs.

D. develop a plantwide overhead rate.

3.

The cost to set up a machine for a specific production run is an example of which type of activity?

A. Unit-level B. Batch-level C. Product-level D. Facility-level

4.

Which of the following refers to using refined cost information to make decisions that increase profits while satisfying customers’ needs?

A. Traditional costing B. Activity-based costing C. Activity-based management D. Total quality management

5.

Place the following steps in developing an ABC system in the correct order.

1. Allocate some MOH from each activity to the individual jobs that use the activities.

2. Identify the primary activities and estimate the total MOH associated with each activity.

3. Identify the allocation base for each activity’s direct costs and estimate the total amount to be used for the year.

4. Calculate an activity cost allocation rate for each activity.

A. B. C. D.

1, 2, 3, 4 2, 1, 4, 3 2, 4, 3, 1 2, 3, 4, 1

4-14 .

6.

The activity cost allocation rate is computed by dividing: A. total estimated activity cost pool by total estimated activity allocation base .

B. total actual indirect costs of activity by estimated total estimated activity allocation base.

C. total estimated indirect costs of activity by total actual quantity of cost allocation base.

D. total actual indirect costs of activity by total actual quantity of cost allocation base.

Use the following information for questions 7 and 8.

Gale Corporation manufactures windsocks. The business recently decided to adopt an ABC accounting system. The following activities have been identified:

Activity Materials handling Machining Packaging

Cost Driver Chosen as Allocation Base Number of parts Machine hours Number of finished units

Conversion Cost Per Unit of Allocation Base $ 1.00 60.00 2.00

Each windsock requires three parts and spends five minutes in the machining department. The total cost of direct materials and direct labor is $3.50 per windsock. Gale produces 20,000 windsocks each year and sells them at 140% of cost.

7.

The total cost of producing the 20,000 windsocks is: A. $160,000.

B. $230,000.

C. $270,000.

D. $1,260,000.

8.

The selling price per windsock is: A. $13.50.

B. $18.90.

C. $16.10.

D. $88.20.

9.

The goal of total quality management (TQM) is to: A. eliminate waste from operations.

B. determine the cost driver behind each activity.

C. identify non-value added activities.

D. provide customers with superior products and services.

10.

The primary objective of lean operations is to: A. focus on creating value for the customer by eliminating waste.

B. provide customers with superior products and services.

C. make the company’s processes as efficient and effective as possible.

D. use activity-based cost information to make decisions that increase profits while satisfying customer needs.

4-15 .

Chapter 5 Overview Process Costing

Chapter 5 begins with a comparison between job order costing and process costing, before discussing in detail how a process costing system works. Process costing is generally used when a company produces large quantities of identical goods. Companies first assign manufacturing costs to each production department, and then average those costs over the units that flow through the department during the period. There are two common process costing inventory flow assumptions: the weighted-average method and the first-in, first-out (FIFO) method. This text uses the weighted-average method because it is simpler and the differences between the two methods are usually not material.

Process costing becomes more complicated when beginning and ending work in process (WIP) inventories exist. All units, whether complete or in process, are converted to equivalent units based on the amount of work performed on them by the end of the period. Equivalent units combine the partially and fully completed units into an expression of how many units are wholly completed. Once the equivalent units have been computed, the company is able to calculate the cost per equivalent unit for both direct materials and conversion costs. These average costs are then used to value the units that were completed as well as those that are still in process at the end of the period.

There are five steps used in process costing: Step 1 Summarize the flow of physical units of output.

Step 2 Compute output in terms of equivalent units.

Step 3 Summarize total costs to account for.

Step 4 Compute the cost per equivalent unit.

Step 5 Assign total costs to units completed and to units in ending Work in Process inventory.

The five steps are usually summarized in a production cost report. The first half of the chapter shows students how to use process costing in the first production process, while the second half of the chapter discusses how to use process costing in a second or later department. Journal entries are also illustrated showing the cost flow through the accounts.

Two sets of Decision Guidelines and Summary Problems reinforce the concepts presented in each half of the chapter. The first set of Decision Guidelines illustrates some key decisions that managers must make in setting up a process cost system while the second set reviews decisions that arise in a second (or later) process. The first Summary Problem enables the students to practice the calculations and journal entries required in the five steps used in process costing. The second Summary Problem is a continuation of the first problem giving the students practice in completing the five-step process costing procedure including accounting for units completed in the final production process and transferred to Finished Goods Inventory. Students also determine the cost of making one unit of product from start to finish.

5-1 .

Learning Objectives After studying Chapter 5, your students should be able to: 1. Distinguish between the flow of costs in process costing and job costing.

2. Compute equivalent units.

3. Use process costing in the first production department.

4. Prepare journal entries for a process costing system.

5. Use process costing in a second or later production department.

5-2 .

Teaching Outline 1. Contrast the two basic types of costing systems a. Job costing b. Process costing 2. Understand the building blocks of process costing a. Conversion costs b. Equivalent units c. Inventory flow assumptions 3. Illustrate process costing in the first production department a. Step 1: Summarize the flow of physical units (Exhibit 5-5) b. Step 2: Compute output in terms of equivalent units (Exhibit 5-5) c. Step 3: Summarize total costs to account for (Exhibit 5-7) d. Step 4: Compute the cost per equivalent unit (Exhibit 5-8) e. Step 5: Assign total costs to units completed and to units in ending Work in Process inventory (Exhibit 5-9) f. Compute average unit costs 4. Sustainability and process costing a. Employing lean practices b. Employing green practices 5. Prepare journal entries for a process costing system a. Raw materials requisitioned b. Direct labor used c. Allocate manufacturing overhead d. Transfer completed units 6. Illustrate process costing in a second or later production department a. Transferred in costs b. Follow steps 1-5 in part 3 above c. Step 1: Summarize the Flow of Physical Units; Step 2: Compute Output in Terms of Equivalent Units (Exhibit 5-12) d. Step 3: Summarize Total Costs to Account For; Step 4: Compute the Cost per Equivalent Unit (Exhibit 5-13) e. Step 5: Assign Total Costs to Units Completed and to Units in Ending Work in Process Inventory (Exhibit 5-14) f. Determining unit costs and gross profit 7. Summarize steps 1-5 in a production cost report a. Exhibit 5-16 Production Cost Report 8. Prepare journal entries in a second or later production department

5-3 .

Key Topics Students need to understand that the goal of both process costing and job order costing is the same: to provide product cost information to help managers make decisions. The nature of the production process determines which product costing system is used.

Students sometimes have a difficult time understanding the concept of equivalent units. Students may be able to work through all the computations, but don’t understand why. Emphasize that equivalent units are necessary because of the partially completed units in work in process at the end of a period. Equivalent units express the amount of work done during a period in terms of fully completed units. This allows accountants to be able to assign costs to complete and partially complete products.

Students get confused when using different equivalent units to compute the direct materials cost of ending inventory versus the conversion cost of ending inventory. Illustrate with examples that direct materials could be introduced at the beginning or end of the production process, yet conversion costs ( labor and manufacturing overhead) are usually incurred evenly throughout the process.

Emphasize that the first two steps in process costing deal with units only. There are no dollar amounts in the process until Step 3. Use E5-38B Summarize physical units and compute equivalent units (process costing Steps 1 and 2) (10 minutes) to illustrate. Use E5-40B Complete five-step procedure in first department (15 minutes) to illustrate the remaining steps in the process costing procedure.

In a process cost system, direct materials and conversion costs refer to the costs incurred for that particular department and not the costs of other departments. The weighted-average inventory flow assumption combines any beginning inventory units (and costs) with the current period’s units (and costs) to arrive at a weighted average cost.

The journal entries used in a process costing system are very similar to those used in a job costing system.

The basic difference is that the manufacturing costs (direct materials, direct labor, and manufacturing overhead) are assigned to processing departments, rather than jobs. There is a separate work in process account for each processing department. Work through E5-42B Record journal entries (10 minutes) to illustrate the journal entries required in a process costing system, noting the similarities and differences between process costing and job costing.

Have students work in teams or with a partner to complete E5-46B Complete five-step procedure and journalize result (20 minutes). Have different teams record a portion of the solution on the board or overhead transparency to share with the class.

5-4 .

Chapter 5: Student Summary Handout 1. Two basic types of costing systems a. Job costing b. Process costing 2. Building blocks of production costing a. Conversion costs include direct labor and manufacturing overhead b. Number of equivalent units = Number of partially complete physical units x Percentage of process completed c. Inventory flow assumptions i. Weighted-average ii. First-in, first-out (FIFO) 3. Process costing steps a. Step 1: Summarize the flow of physical units (Exhibit 5-5) b. Step 2: Compute output in terms of equivalent units (Exhibit 5-5) c. Step 3: Summarize total costs to account for (Exhibit 5-7) d. Step 4: Compute the cost per equivalent unit (Exhibit 5-8) e. Step 5: Assign total costs to units completed and to units in ending Work in Process inventory (Exhibit 5-9) f. Compute average unit costs 4. Sustainability and process costing a. Employing lean practices b. Employing green practices 5. Journal entries a. Raw materials requisitioned b. Direct labor used c. Allocate manufacturing overhead d. Transfer completed units 6. Process costing steps in a second or later department a. Transferred in units and costs b. Same five basic steps c. Step 1: Summarize the Flow of Physical Units; Step 2: Compute Output in Terms of Equivalent Units (Exhibit 5-12) d. Step 3: Summarize Total Costs to Account For; Step 4: Compute the Cost per Equivalent Unit (Exhibit 5-13) e. Step 5: Assign Total Costs to Units Completed and to Units in Ending Work in Process Inventory (Exhibit 5-14) f. Finding the average unit cost of the product and its gross profit 7. Production cost reports summarize the entire five-step process on one schedule (Exhibit 5-16)

5-5 .

8. Journal entries in a second or later production department a. Manufacturing costs incurred in the production department b. Transfer completed units to finished goods inventory 9. MyAccountingLab.com algorithmic homework assignments: S5-4, S5-5, S5-7, S5-8, S5-10, E527A, E5-31A

5-6 .

CHAPTER 5: ASSIGNMENT GRID Assignment

S5-1 S5-2 S5-3 S5-4

S5-5 S5-6 S5-7

S5-8

S5-9 S5-10 S5-11 S5-12

S5-13 S5-14 S5-15

S5-16

S5-17 S5-18

Topic(s)

Learning Objective(s)

Short Exercises Compare flow of costs 1 Flow of costs through WIP 1 inventory Recompute SeaView’s 2 equivalent units Determine the physical flow 2 of units (process costing Step 1) Compute equivalent units 2 (process costing Step 2) Compute equivalent units 2 (process costing Step 2) Summarize total costs to 3 account for (process costing Step 3) Compute the cost per 3 equivalent unit (process costing Step 4) Recompute SeaView’s cost 3 per equivalent unit Assign costs (process 3 costing Step 5) Flow of costs through Work 4 in Process Inventory Assign total costs in a second processing 5 department Find unit cost and gross profit on a final product 5 Compute cost per liter 1 Summarize physical flow and compute equivalent 2 units Continuation of S5-15: summarize total costs to account for and compute 3 cost per equivalent unit Continuation of S5-15 and 3 S5-16: assign costs Continuation of S5-17: 4 record journal entry and post to T-account 5-7 .

Estimated Time in Minutes

Level of Difficulty

5 5

Easy Easy

5

Easy

5

Easy

5

Easy

10

Medium

5

Easy

5

Easy

5

Easy

10

Medium

10

Easy

15

Medium

10 5

Medium Easy

10

Easy

10

Easy

10

Medium

10

Easy

Assignment

S5-19 S5-20

S5-21

S5-22

E5-23A E5-24A

E5-25A

E5-26A

E5-27A E5-28A E5-29A E5-30A E5-31A E5-32A E5-33A

E5-34A E5-35A

Topic(s)

Learning Objective(s)

Compute equivalent units in 2&5 second department Continuation of S5-19: compute cost per equivalent 5 unit in second department Continuation of S5-19 and 5 S5-20: assign costs in second department Continuation of S5-21: 4 record journal entry and post to T-account Exercises (Set A) Diagram flow of costs 1 Analyze flow of costs 1 through inventory Taccounts Summarize physical units 2 and compute equivalent units (process costing Steps 1 and 2) Compute equivalent units in 2&5 a second processing department Complete five-step procedure in first department 3 Continuation of E5-27A: journal entries 4 Record journal entries 4 Compute equivalent units and assign costs 2, 3, & 4 Complete five-step procedure in first department 3 Sustainability and process 3 costing Complete five-step procedure and journalize 3&4 result Compute equivalent units in two later departments 2&5 Complete five-step procedure in second 5 department

5-8 .

Estimated Time in Minutes 10

Level of Difficulty

10

Medium

10

Easy

5

Easy

10 10

Medium Easy

10

Easy

10

Medium

15

Medium

10 10

Medium Medium

20

Medium

15 10

Medium Easy

20

Medium

10

Easy

15

Medium

Medium

Assignment

E5-36B E5-37B

E5-38B

E5-39B

E5-40B E5-41B E5-42B E5-43B E5-44B E5-45B E5-46B

E5-47B E5-48B

P5-49A P5-50A P5-51A P5-52A P5-53A

Topic(s)

Learning Objective(s)

Exercises (Set B) Diagram flow of costs 1 Analyze flow of costs 1 through inventory Taccounts Summarize physical units 2 and compute equivalent units (process costing Steps 1 and 2) Compute equivalent units in 2&5 a second processing department Complete five-step procedure in first department 3 Continuation of E5-40B: journal entries 4 Record journal entries 4 Compute equivalent units and assign costs 2, 3, & 4 Complete five-step procedure in first department 3 Sustainability and process 3 costing Complete five-step procedure and journalize 3&4 result Compute equivalent units in two later departments 2&5 Complete five-step procedure in second 5 department Problems (Set A) Process costing in a single processing department 1, 2,& 3 Process costing in a first department 1, 3, & 4 Five-step process: materials added at different points 1, 2, & 3 Prepare a production cost report and journal entries 4&5 Complete five-step process in a later department 1&5

5-9 .

Estimated Time in Minutes

Level of Difficulty

10 10

Medium Easy

10

Easy

10

Medium

15

Medium

10 10

Medium Medium

20

Medium

15 10

Medium Easy

20

Medium

10

Easy

15

Medium

15

Medium

15

Medium

20

Medium

20

Difficult

25

Difficult

Assignment

P5-54B P5-55B P5-56B P5-57B P5-58B

Decision Case A5-59 Ethical Issue A5-60 Team Projects A5-61 Discussion and Analysis A5-62 Application and Analysis A5-63

Topic(s)

Learning Objective(s)

Problems (Set B) Process costing in a single processing department 1, 2,& 3 Process costing in a first department 1, 3, & 4 Five-step process: materials added at different points 1, 2, & 3 Prepare a production cost report and journal entries 4&5 Complete five-step process in a later department 1&5 Other Cost per unit and gross profit 5 Ethical dilemma regarding percentage of completion 2&5 Calculating costs for a customer order 5 All

Estimated Time in Minutes

Level of Difficulty

15

Medium

15

Medium

20

Medium

20

Difficult

25

Difficult

30

Medium

15

Medium

30

Difficult

60

Medium

30-60

Medium

Discussion Questions Process Costing in Real Companies

1, 3, &5

Pre-Test Questions on MyAccountingLab: S5-14, S5-15, S5-16, S5-17, S5-18

Post-Test Questions on MyAccountingLab: E5-25A, P5-49A, P5-50A

Answer Key to Chapter 5 Quiz (Quiz on following pages.)

1. C 2. A 3. D 4. A 5. B

6. B 7. C 8. B 9. C 10. D

5-10 .

Name____________________________________ Date_________________ Section_______________

CHAPTER 5 TEN-MINUTE QUIZ Circle the letter of the best response.

1. Which of the following would use process costing?

A. Accounting firm B. Custom furniture manufacturer C. Crayon manufacturer D. Personal computer manufacturer 2. Equivalent units are usually determined for: A. direct materials and conversion costs.

B. direct labor and conversion costs.

C. direct materials only.

D. conversion costs only.

3. Recording the transfer of the cost of items completed in the Forming Department to the Packaging Department would include a: A. credit to Work in Process Inventory-Packaging.

B. debit to Work in Process Inventory– Forming.

C. debit to Finished Goods Inventory.

D. debit to Work in Process Inventory-Packaging.

4. Conversion costs include: A. direct labor and manufacturing overhead.

B. manufacturing overhead only.

C. direct materials and direct labor.

D. direct materials and manufacturing overhead.

5. The number of equivalent units is computed as: A. the number of complete units transferred to the next process.

B. the number of partially complete physical units x percentage of process completed.

C. the number of partially complete units plus the number of units transferred to the next process.

D. beginning work in process inventory plus the units transferred in from the previous process.

6. Hay Company had 3,000 units in its beginning inventory, 2,000 units in its ending inventory, and completed and transferred out 14,000 during the month. What are the total units to account for?

A. 13,000 B. 16,000 C. 17,000 D. 19,000

5-11 .

7. Costs transferred out of the second process of a three-step production process include which of the following?

A. Costs incurred in the current process B. Costs incurred in the previous process C. Costs of the previous process combined with costs of the current process D. Costs of the current process combined with costs of the next process 8. The Shaping Department started the month with a beginning work in process inventory of $15,000. During the month, it was assigned the following costs: direct materials $120,000; direct labor, $40,000; overhead allocated at the rate of 20% of direct labor cost. Inventory with a cost of $160,000 was transferred to finished goods. What was the ending balance of work in process inventory for the department?

A. $ 8,000 B. $ 23,000 C. $168,000 D. $183,000 9. There are 10,000 units in work in process inventory for the Mixing Department at the end of the month. The units were 60% complete for conversion costs. What are the equivalent units for conversion costs using the weighted-average method?

A. 600 B. 4,000 C. 6,000 D. 10,000 10. Using the same information as in Question 9, assume that the beginning work in process inventory for the Mixing Department had $12,000 in conversion costs; and that $30,000 in conversion costs were added during the month. What is the cost per equivalent unit for conversion costs?

A. $ 3.50 B. $ 4.20 C. $ 5.00 D. $ 7.00

5-12 .

Chapter 6 Overview Cost Behavior

This chapter discusses cost behavior and the implications of managements’ understanding of that behavior. Management must understand how costs are classified, how changes in volume affect costs, and how changes in price affect volume. Costs are classified as fixed, variable, or mixed. As volume changes within the relevant range, total fixed costs remain constant; while in contrast, total variable costs change in direct proportion to changes in volume.

This chapter also presents methods that can be used to analyze mixed costs in order to break them into their fixed and variable components. These methods include the high-low method, scatter plot method, and regression analysis. Understanding whether a cost is variable or fixed is important for managers to make decisions and develop budgets based on anticipated expenses. Management needs to understand how costs behave over a relevant range in order to make optimal decisions. While absorption costing is required for external reporting and for tax purposes, variable costing is used for internal management purposes. Variable costing is often better for decision making because it more clearly shows managers the additional cost of making one more unit of product.

Two sets of Decision Guidelines and Summary Problems accompany the material in the chapter. Both sets of Decision Guidelines address some of the decisions a manager might have to make regarding cost behavior. The first set of Summary Problems gives the students practice in calculating operating costs at varying levels of volume. The second set of Summary Problems affords the student practice using the various techniques presented in the chapter to predict operating costs needed to prepare both a traditional income statement and a contribution margin income statement.

Learning Objectives After studying Chapter 6, your students should be able to: 1. Describe key characteristics and graphs of various cost behaviors.

2. Use cost equations to express and predict costs.

3. Use account analysis and scatter plots to analyze cost behavior.

4. Use the high-low method to analyze cost behavior.

5. Use regression analysis to analyze cost behavior.

6. Describe variable costing and prepare a contribution margin income statement.

6-1 .

Teaching Outline 1. Describe key characteristics and graphs of various cost behaviors a. Variable costs (See Exhibit 6-1 for graph) i. Exhibit 6-2 Key Characteristics of Variable Costs b. Fixed costs (See Exhibit 6-2 for graph) i. Committed ii. Discretionary iii. Exhibit 6-4 Key Characteristics of Fixed Costs c. Mixed costs (See Exhibit 6-5 for graph) i. Exhibit 6-6 Key Characteristics of Mixed Costs d. Relevant range e. Other cost behaviors i. Step costs (See Exhibit 6-10 for graph) ii. Curvilinear costs (See Exhibit 6-11 for graph) f. Sustainability and cost behavior 2. Analyze cost behavior to predict costs a. Use account analysis b. Scatter plot (See Exhibit 6-13 for graph) c. High-low method (See Exhibit 6-14 for graph) d. Regression analysis (See Exhibit 6-15 for Example of Output of Microsoft Excel Regression Analysis) e. Data concerns 3. Understanding the roles of variable costing and the contribution margin income statement a. Compare absorption and variable costing i. Exhibit 6-18 Comparing inventoriable product costs ii. Exhibit 6-19 Comparing period costs (operating expenses) b. Effect of costing concept on income statement format i. Exhibit 6-20 Traditional Income Statement based on Absorption Costing ii. Exhibit 6-21 Contribution Margin Income Statement using Variable Costing iii. Service and merchandising companies c. Comparing operating income: variable versus absorption costing i. When inventory levels remain constant (Exhibit 6-22) ii. When inventory levels increase (Exhibit 6-23) iii. When inventory levels decrease (Exhibit 6-24) d. Reconciling operating income between the two costing systems e. Key points to remember (Exhibit 6-27)

6-2 .

Key Topics Understanding how costs behave is crucial for students to grasp, so that they will be able to perform the necessary analysis that managers use for decision-making with respect to cost, volume, and profits.

Illustrate cost behavior as follows: Variable costs:

Per unit remains constant Total changes in direct proportion to changes in levels of activity

Fixed costs:

Total remains constant Per unit changes with changes in levels of activity

Ask students for examples of variable and fixed costs. Use the examples to emphasize the concept of the relevant range. For instance, if they suggest rent as a fixed cost, explain how that would change if they needed a bigger (presumably more expensive) apartment due to accepting a new roommate.

Expand your discussion of cost behavior to include mixed costs, step costs, and curvilinear costs.

This will lead nicely into a series of exercises (E6-53B Create a scatter plot to E6-54B High-low method through E6-55B Regression analysis) that show how to analyze cost behavior to predict costs.

It is helpful to use Excel for the scatter plot and regression analysis so that students can see how it works.

Be sure to cover the meaning and importance of the R-square in the regression analysis output.

Point out that because of outliers, sometimes the highest cost is not always correlated to the highest volume. The high-low method estimates the variable and fixed components of a mixed cost by using data points with the highest and lowest volume of activity and the associated total costs with both of these data points.

Divide the class into three teams where each one prepares one of the following exercises: • • •

E6-57B Prepare and interpret a scatter plot (15 minutes) E6-58B High-low method (15 minutes) E6-59B Regression analysis (15 minutes)

Have them share their findings with the entire class.

When introducing variable costing, it is important to highlight that the difference from traditional costing (i.e., absorption costing) is in the treatment of fixed manufacturing overhead. Absorption costing is used for external financial reporting because GAAP requires all manufacturing-related costs, whether fixed or variable, to be “absorbed” into the cost of the product resulting in all manufacturing costs being treated as inventoriable product costs. (Remind them that product costs include direct materials, direct labor, and MOH.) Variable costing treats fixed manufacturing costs as period costs, not inventoriable product costs, because those fixed costs will be incurred regardless of actual production volume during the period. So, in variable costing, only variable manufacturing costs (i.e., direct materials, direct labor, and variable manufacturing overhead) are treated as inventoriable product costs.

6-3 .

When discussing the contribution income statement it is helpful to show students how it differs from the traditional format.

Traditional (costs organized by function)

Contribution (costs organized by behavior)

Sales (COGS) Gross profit (Operating expenses) Operating income

Sales (Variable costs) Contribution margin (Fixed costs) Operating income

Have students work in teams to complete E6-66B Prepare a contribution margin income statement (25 minutes).

Use the results of this exercise to reconcile the difference in operating income between the traditional income statement that is provided in the exercise and the contribution margin income statement they just prepared. Emphasize the difference between the two relates to the treatment of fixed overhead.

• •

In absorption costing, fixed overhead is considered a product cost just as direct materials, direct labor, and variable overhead.

In variable costing, fixed overhead is considered a period cost and is expensed as such on the statement.

Note: If there was no change in ending inventory, the operating income figure would be the same for both statements.

Hint: A shortcut to reconciling the difference between the two operating incomes: change in units in ending inventory x fixed MOH cost per unit.

6-4 .

Chapter 6: Student Summary Handout 1. Describe key characteristics and graphs of various cost behaviors. a. Variable costs (See Exhibit 6-1 for graph) i. Exhibit 6-2 Key Characteristics of Variable Costs b. Fixed costs (See Exhibit 6-2 for graph) i. Committed ii. Discretionary iii. Exhibit 6-4 Key Characteristics of Fixed Costs c. Mixed costs (See Exhibit 6-5 for graph) i. Exhibit 6-6 Key Characteristics of Mixed Costs d. Relevant range e. Other cost behaviors i. Step costs (See Exhibit 6-10 for graph) ii. Curvilinear costs (See Exhibit 6-11 for graph) f. Sustainability and cost behavior 2. Analyze cost behavior to predict costs a. Use account analysis – classify each account as variable, fixed, or mixed b. Scatter plot (See Exhibit 6-13 for graph) c. High-low method (See Exhibit 6-14 for graph) – estimate variable and fixed components of a mixed cost i. Step 1: Identify the months with the highest and lowest volumes of activity ii. Step 2: Calculate variable cost per unit of activity (Change in cost/Change in volume) iii. Step 3: Choose either the high or low month and calculate fixed cost using Step 2 and the following formula: Total mixed costs = Variable cost component (variable cost per unit from Step 2 x activity level for month) + Fixed cost component iv. Step 4: Write the equation representing the costs’ behavior using the results from Steps 2 and 3 d. Regression analysis (See Exhibit 6-15 for Example of Output of Microsoft Excel Regression Analysis) 3. Understand the roles of variable costing and the contribution margin income statement a. Compare absorption and variable costing i. Absorption costing treats all costs as inventoriable product costs including fixed manufacturing overhead (MOH) ii. Variable costing treats only variable costs as inventoriable product costs with fixed MOH expensed as a period cost iii. Exhibit 6-18 Comparing inventoriable product costs iv. Exhibit 6-19 Comparing period costs (operating expenses) b. Effect of costing concept on income statement format i. Exhibit 6-20 Traditional Income Statement based on Absorption Costing ii. Exhibit 6-21 Contribution Margin Income Statement using Variable Costing c. Comparing operating income: variable versus absorption costing i. When inventory levels remain constant (Exhibit 6-22) ii. When inventory levels increase (Exhibit 6-23) iii. When inventory levels decrease (Exhibit 6-24) 6-5 .

d. Reconciling operating income between the two costing systems e. Key points to remember (Exhibit 6-27) 4. MyAccountingLab.com algorithmic homework assignments: E6-20A, E6-24A, E6-28A, E6-30A, E6-44A

6-6 .

CHAPTER 6: ASSIGNMENT GRID Assignment

S6-1 S6-2 S6-3 S6-4 S6-5 S6-6 S6-7 S6-8 S6-9 S6-10 S6-11 S6-12 S6-13 S6-14

S6-15 S6-16 S6-17

S6-18

E6-19A E6-20A E6-21A Assignment

Topic(s)

Learning Objective(s)

Short Exercises Identify cost behavior 1 Sketch cost behavior 1 graphs Compute fixed costs per 2 unit Define various costs 2 equations Predict total mixed costs 2 Predict and graph total 1&2 mixed costs Classify cost behavior 3 Prepare and analyze a 3 scatter plot Use the high-low method 4 Use the high-low method 4 Predicting costs in a health 4 care setting Critique the high-low 4 method Analyze a scatter plot 3&4 Theoretical comparison of 4&5 high-low and regression analysis Write a cost equation given 5 regression output Prepare a contribution 6 margin income statement Prepare income statements 6 using variable costing and absorption costing with no change in inventory levels Prepare income statements 6 using variable costing and absorption costing when inventory units increase Exercises (Set A) Graph specific costs 1 Identify cost behavior 1 graph Identify cost behavior 1, 2, 3, 4 & 5 terms Topic(s) Learning Objective(s) 6-7 .

Estimated Time in Minutes

Level of Difficulty

5 10

Easy Easy

5

Easy

10

Easy

5 10

Easy Easy

5 15

Easy Easy

10 10 10

Easy Easy Easy

5

Easy

10 10

Easy Medium

10

Medium

15

Medium

15-20

Medium

20

Medium

10 10

Medium Easy

5

Easy

Estimated Time in

Level of Difficulty

E6-22A E6-23A E6-24A E6-25A E6-26A E6-27A E6-28A E6-29A E6-30A E6-31A E6-32A

E6-33A

E6-34A

E6-35A E6-36A E6-37A E6-38A E6-39A E6-40A E6-41A E6-42A

Forecast costs at different volumes Prepare income statement in two formats Use the high-low method Use unit cost data to forecast total costs Sustainability and cost estimation Create a scatter plot

1&2

Minutes 15

Easy

6

20

Easy

4 2

10 20

Easy Medium

4

15

Medium

3

15

Easy

High-low method Continuation of E6-27A: regression analysis Regression analysis using Excel output Create a scatter plot for a hospital laboratory Using the high-low method to predict overhead for a hospital laboratory Using regression analysis output to predict overhead for a hospital laboratory Performing a regression analysis to predict overhead for a hospital laboratory Prepare and interpret a scatter plot High-low method Regression analysis Regression analysis using Excel output Determine cost behavior and predict operating costs Prepare a contribution margin income statement Prepare a contribution margin income statement Prepare income statements using variable costing and absorption costing with changing inventory levels

4 5

15 20

Easy Medium

5

15

Easy

3

15

Easy

4

15

Easy

5

15

Easy

5

20

Medium

3

15

Easy

4 5

15 20

Easy Medium

5 4

15 15

Easy Easy

6

25

Medium

6

30

Difficult

6

30-40

Difficult

6-8 .

Assignment

E6-43A

E6-44A

E6-45B E6-46B E6-47B E6-48B E6-49B E6-50B E6-51B E6-52B E6-53B E6-54B E6-55B E6-56B E6-57B E6-58B

E6-59B

E6-60B

E6-61B E6-62B E6-63B

Topic(s)

Learning Objective(s)

Prepare a variable costing 6 income statement given an absorption costing income statement Absorption and variable 6 costing income statements Exercises (Set B) Graph specific costs 1 Identify cost behavior 1 graph Identify cost behavior 1, 2, 3, 4 & 5 terms Forecast costs at different 1&2 volumes Prepare income statement 6 in two formats Use the high-low method 4 Use unit cost data to 2 forecast total costs Sustainability and cost 4 estimation Create a scatter plot 3 High-low method 4 Continuation of E6-54B: 5 regression analysis Regression analysis using 5 Excel output Create a scatter plot for a 3 hospital laboratory Using the high-low method 4 to predict overhead for a hospital laboratory Using regression analysis 5 output to predict overhead for a hospital laboratory Performing regression 5 analysis to predict overhead for a hospital laboratory Prepare and interpret a 3 scatter plot High-low method 4 Regression analysis 5

6-9 .

Estimated Time in Minutes 30

Level of Difficulty

30-40

Difficult

10 10

Medium Easy

5

Easy

15

Easy

20

Easy

10 20

Easy Medium

15

Medium

15 15 20

Easy Easy Medium

15

Easy

15

Easy

15

Easy

15

Easy

20

Medium

15

Easy

15 20

Easy Medium

Difficult

Assignment

E6-64B E6-65B E6-66B E6-67B E6-68B

E6-69B

E6-70B

P6-71A

P6-72A P6-73A P6-74A

P6-75A P6-76A

P6-77B

P6-78B P6-79B P6-80B

P6-81B P6-82B

Topic(s)

Learning Objective(s)

Regression analysis using 5 Excel output Determine cost behavior 4 and predict operating costs Prepare a contribution 6 margin income statement Prepare a contribution 6 margin income statement Prepare income statements 6 using variable costing and absorption costing with changing inventory levels Prepare a variable costing 6 income statement given an absorption costing income statement Absorption and variable 6 costing income statements Problems (Set A) Analyze cost behavior at a 1,2,3,4, & 5 hospital using various cost estimation methods Analyze cost behavior 1,2,3, & 4 Continuation of P6-72A: 5 regression analysis Prepare traditional and 6 contribution margin income statements Determine financial 6 statement components Absorption and variable 6 costing income statements Problems (Set B) Analyze cost behavior at a 1,2,3,4 & 5 hospital using various cost estimation methods Analyze cost behavior 1,2,3 &4 Continuation of P6-78B: 5 regression analysis Prepare traditional and 6 contribution margin income statement Determine financial 6 statement components Absorption and variable 6 costing income statements 6-10 .

Estimated Time in Minutes 15

Level of Difficulty

15

Easy

25

Medium

30

Difficult

30-40

Difficult

30

Difficult

30-40

Difficult

50-60

Difficult

40 30

Medium Medium

40

Medium

45

Difficult

45

Difficult

50-60

Difficult

40 30

Medium Medium

40

Medium

45

Difficult

45

Difficult

Easy

Assignment

Topic(s)

Learning Objective(s)

Estimated Time in Minutes

Level of Difficulty

Other Decision Cases Discussion and Analysis A6-83 Application and Analysis A6-84 Decision Cases C6-85 C6-86

Discussion Questions

All

60

Medium

Cost Behavior in Real Companies

All

30-60

Medium

6 1, 2, 3, 4 & 5

20 30-40

Medium Medium

2&6

5

Easy

Appendix Analyze cost behavior using a variety of methods

CMA Adapted Multiple Choice Questions A6-87, A6-88

Pre-Test Questions on MyAccountingLab: S6-1, S6-7, S6-10, S6-15, S6-16 Post-Test Questions on MyAccountingLab: E6-35A, E6-36A, E6-38A, E6-76A

Answer Key to Chapter 6 Quiz (Quiz on following pages.)

1.

2.

3.

4.

5.

A C D B B

6. A 7. D 8. D 9. C 10. B

6-11 .

Name____________________________________ Date_________________ Section_______________

CHAPTER 6 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

Costs that increase in total as the volume of production increases are: A. variable costs.

C. mixed costs.

B. fixed costs.

D. step costs.

2.

When graphing total variable costs, using a horizontal axis representing units of production and the vertical axis representing total costs, the line on the graph would be shown as a(n): A. horizontal line.

B. vertical line.

C. upward sloping line.

D. downward sloping line.

3.

Which of the following statements is NOT true about costs per unit within the relevant range?

A. Fixed costs decrease in proportion to increases in volume.

B. Mixed costs decrease, but not in direct proportion to increases in volume.

C. Variable costs stay constant with changes in volume.

D. Curvilinear costs stay constant with changes in volume.

4.

How would the equation for total costs be written using the following? y = total costs v = variable cost per unit of activity x = volume of activity f = total fixed costs A. B.

5.

y = xv y = xv + f

C. D.

y = xf y=f

A utility bill consisting of a monthly base, plus an added amount based on usage, is classified as a: A. fixed cost.

B. mixed cost.

C. curvilinear cost.

D. variable cost.

6-12 .

6.

A company is analyzing its mixed costs. During July, its busiest month, a company had total labor hours of 14,000 and total costs of $40,000. During February, its slowest month, the company had labor hours of 8,000 and total costs of $25,000. The company is planning for 12,000 direct labor hours next April. How many dollars should the company budget for fixed costs during April?

A. $5,000 C. $35,000 B. $6,000 D. $36,000

7.

A company is analyzing its mixed costs. During July, its busiest month, a company had total labor hours of 14,000 and total costs of $40,000. During February, its slowest month, the company had labor hours of 8,000 and total costs of $25,000. The company is planning for 12,000 direct labor hours next April. How many dollars should the company budget for total costs during April?

A. $5,000 C. $30,000 B. $6,000 D. $35,000

8.

Which of the following statements is true regarding regression analysis?

A. Regression analysis considers all of the data points for determining the line that best fits the data so is usually more accurate than the high-low method.

B. Regression analysis helps generate a statistic, called the R-square, which tells how well the line fits the data points.

C. Regression analysis helps managers implement activity based costing systems.

D. All of the above are true.

9.

The only difference between absorption costing and variable costing is: A. the treatment of fixed MOH. B. the timing with which fixed MOH is expensed.

C. both of the above are differences.

D. none of the above are differences.

10.

Which of the following is NOT true regarding an income statement organized according to the contribution margin approach?

A. The contribution margin income statement is organized by cost behavior.

B. Operating income will always be the same as operating income in a traditional income statement regardless of changes in inventory levels.

C. All fixed costs, including fixed MOH, are expensed below the contribution margin line.

D. The contribution margin is equal to sales revenue minus variable expenses.

6-13 .

Chapter 7 Overview Cost-Volume-Profit Analysis

This chapter discusses how cost-volume-profit (CVP) analysis is used in decision-making. CVP analysis expresses the relationships between costs, volume, and profit or loss. All of the decisions are based on initial CVP assumptions. These assumptions—such as assuming a change in volume is the only factor affecting costs, or assuming that managers can classify each cost or cost component as fixed or variable— help managers isolate the decision at hand.

The chapter follows the contribution margin approach introduced in the last chapter, but quickly moves into break-even computations. Total fixed costs divided by the contribution margin, referred to as the contribution margin ratio, will yield the break even point in units or in dollars. When a target profit is added to the fixed costs, the same computation yields the units or the dollar sales necessary to earn the target profit.

The Decision Guidelines in the first part of the chapter highlight some decisions that might need to be made when opening a new business. The accompanying Summary Problem gives the student practice in using CVP to calculate breakeven point as well as the sales level needed to earn a target operating income.

The same CVP formulas that are used to perform CVP analysis for a company with a single product can be used for a company with multiple products. However, these formulas will use weighted-average contribution margin of all products. So, each unit’s contribution margin is weighted by the relative number of units sold. Companies that offer many products though, don’t want to know the breakeven point in terms of units. Rather, they focus on the breakeven (or target profit volumes) in terms of sales revenue. Therefore, they need to know the weighted-average contribution margin ratio.

After managers compute break-even, they do sensitivity analysis to help answer important “what-if” business questions.

Finally, the chapter reviews common indicators of risk, including the margin of safety and operating leverage.

The final set of Decision Guidelines addresses some decisions that might need to be made in responding to changing business conditions. The last Summary Problem affords the student practice in determining a company’s margin of safety and operating leverage factor. The Summary Problem concludes with CVP analysis for multi-products.

7-1 .

Learning Objectives After studying Chapter 7, your students should be able to: 1. Calculate the unit contribution margin and the contribution margin ratio.

2. Use CVP analysis to find breakeven points and target profit volumes.

3. Perform sensitivity analysis in response to changing business conditions.

4. Find breakeven and target profit volumes for multi-product companies.

5. Determine a firm’s margin of safety and operating leverage.

7-2 .

Teaching Outline 1. Using Cost-Volume-Profit (CVP) analysis a. CVP assumptions i. A change in volume is the only factor that affects costs. ii. Managers can classify each cost (or the components of mixed costs) as either variable or fixed. These costs are linear throughout the relevant range of volume. iii. Revenues are linear throughout the relevant range of volume. iv. Inventory levels will not change. v. The sales mix of products will not change. b. Unit contribution margin c. Contribution margin ratio 2. Using CVP analysis to find breakeven points and target profit volumes. a. BE is the point where revenues = expenses and net income is zero b. The income statement approach c. The shortcut approach using the unit CM d. The shortcut approach using the CM ratio e. Formulas i. BE point in units = fixed costs / CM per unit ii. BE point in sales dollars = fixed costs / CM ratio iii. Target profit volume in units = (fixed costs + target profit) / CM per unit iv. Target profit volume in sales dollars = (fixed costs + target profit) / CM ratio 3. Graph CVP relationships a. Step 1: Choose a sale volume b. Step 2: Draw the fixed expense line c. Step 3: Draw the total expense line d. Step 4: Identify the breakeven point e. Step 5: Mark the operating income and operating loss areas f. Exhibit 7-4 Cost-Volume-Profit Graph 4. Perform sensitivity analysis: “what if” a. Changing the sales price (Exhibit 7-5) b. Changing variable costs (Exhibit 7-6) c. Changing fixed costs (Exhibit 7-7) d. Sustainability and CVP Analysis 5. Multi-product companies a. Changing the mix of products offered for sale b. Find BE in sales units c. Find BE in sales revenue d. Formulas: i. BE sales in total units = fixed costs/weighted-average CM per unit ii. BE sales in dollars = fixed costs/weighted-average CM ratio iii. Exhibit 7-8 Calculating the Weighted-Average Contribution Margin per Unit

7-3 .

6. Information technology and sensitivity analysis a. Excel b. Enterprise resource planning software 7. Indicators of risk a. Margin of safety = excess of actual or expected sales over breakeven sales i. In units ii. In sales dollars iii. As a percentage b. Operating leverage - the relative amount of fixed and variable costs that make up total costs i. Characteristics of high operating leverage firms (Exhibit 7-10) ii. Characteristics of low operating leverage firms (Exhibit 7-11) iii. Operating leverage factor = CM/operating income iv. Choosing a cost structure v. Exhibit 7-13 Using an Indifference Point to Choose the Most Profitable Cost Structure

7-4 .

Key Topics Make sure students understand cost behavior from Chapter 6. If they understand cost behavior, it makes this chapter much easier to grasp. In particular, remind students about fixed costs decreasing per unit as more is produced. A good example is the rent cost on apartment. If one student lives in the apartment, it would cost $800 per month, a fixed cost per unit/person of $800. If another student moves in, this fixed cost per student is reduced to $400 per student.

Relevant range is important to explain regarding fixed cost. A good example to illustrate this concept is the depreciation on a school building. Depreciation is a fixed cost for the number of classrooms that are available. If enrollment increased dramatically, then the school would need to purchase another building, thus increasing the fixed cost. The relevant range would be the number of students that can be served with the number of available rooms.

Have students work in teams or with a partner to calculate the contribution margin in Requirement 1 of E7-43B Find breakeven and target profit volume. Call on a student for the answer. Sometimes the contribution margin is expressed as a ratio. Illustrate how to calculate the contribution margin ratio. This can be used to compare different products within a company, to compare one year’s information to another, or it can be used to compare one company to another company.

Remind students to keep track of the labels (units, dollars, etc.) when using the breakeven formulas.

Proper attention will ensure that breakeven is accurately shown in dollars or units. Illustrate how to calculate contribution margin. Have students complete the remaining part of Requirement 1(i.e., compute contribution margin ratio) E7-43B Find breakeven and target profit volume.

Show students how to calculate the breakeven point and target profit using the contribution margin shortcut approaches. Emphasize that companies want to do more than just break even; they want to determine how much must be sold to earn a desired profit.

Have students complete Requirements 2 and 3 of E7-43B Find breakeven and target profit volume.

Students tend to understand that the target income needs to be added to the fixed costs. However, they often forget that this is no longer “breakeven”, but the sales necessary to achieve the target income.

Remind students that a company may break even (or take a loss) on some products in order to sell other products from which the company profit will be earned. When a company has more than one product, they must consider a sales mix when performing CVP analysis. Remind students that companies that sell multiple products use formulas based on the weighted-average contribution margin of all products. So, each unit’s contribution margin is weighted by the relative number of units sold. Ask students why stores that sell multiple brands “push” one brand. (Answer: The contribution margin is larger for that brand.

This is sometimes referred to as the profit margin.)

The most powerful tool of CVP analysis is sensitivity analysis. It is the “what if” technique to determine what the results will be if actual prices or costs change or if an underlying assumption changes. Have students work in teams to complete E7-44B Continuation of E7-43B: Changing costs (10 minutes).

Managers need to routinely compute sensitivity analysis and be prepared for additional changes to occur after their first decision. For example, if a manager lowers the price, the sales increase is expected to offset the larger amount of sales needed to break even (or reach desired profit). However, managers also need to be ready to make additional decisions if the competition reacts and also lowers the price of a comparable product.

7-5 .

Margin of safety can be used to determine the risk of a project. It is the excess of expected sales over breakeven sales. The higher the margin of safety, the less risk involved in the business venture. It also tells managers how far sales can drop before they are ‘in trouble’ of incurring a loss.

While CVP analysis relies on certain assumptions, the assumptions are not absolute or guaranteed.

Companies obviously want to sell more than break even. The amount above break even (or the target profit) is the margin of safety and hopefully the margin of safety insures the company will at least break even or attains its target profit.

Have students complete Requirement 1 of E7-58B Compute margin of safety and operating leverage (15 minutes).

Operating leverage refers to the relative amount of fixed and variable costs that make up the total costs of a company. The higher the fixed costs as compared to the variable costs, the higher the leverage and the higher the company’s risk if sales decrease. High operating leverage firms are characterized by higher levels of fixed costs and lower levels of variable costs, and higher contribution margin ratios. So, these firms are more likely to have higher risk and higher potential for rewards. Examples might be hotels, and cruise lines. Low operating leverage firms, such as merchandising companies, have the opposite characteristics.

Have students complete Requirement 3 of E7-58B Compute margin of safety and operating leverage.

Point out to the students that management often has some control over the structure of a company’s cost.

They may have two or more alternatives to choose from when it comes to how a certain cost is structure.

The point at which you would be indifferent between the two or more options, is the indifference point.

Have students complete Requirement 1 of E60B Calculating total costs under two different scenarios.

If time allows, have students complete Requirement 2 to determine the indifference point.

7-6 .

Chapter 7: Student Summary Handout 1. Data assumptions in CVP analysis: a. Change in volume is the only factor that affects costs b. Costs can be classified as variable or fixed c. Revenues are linear in the relevant range d. Inventory levels will not change e. Sales mix will not change 2. Calculate the unit contribution margin (CM) and the contribution margin ratio. a. Unit CM = sales price per unit –variable cost per unit b. CM ratio = CM / sales price per unit 3. Use CVP to find breakeven (BE) points and target profit volumes. a. BE is the point where revenues = expenses and net income is zero b. BE point in units = fixed costs / CM per unit c. BE point in sales dollars = fixed costs / CM ratio d. Target profit volume in units = (fixed costs + target profit) / CM per unit e. Target profit volume in sales dollars = (fixed costs + target profit) / CM ratio 4. Graph CVP relationships a. Step 1: Choose a sale volume b. Step 2: Draw the fixed expense line c. Step 3: Draw the total expense line d. Step 4: Identify the breakeven point e. Step 5: Mark the operating income and operating loss areas f. Exhibit 7-4 Cost-Volume-Profit Graph 5. Sensitivity analysis a. Changing the sales price i. Exhibit 7-5 The Effect of Changes in Sales Price on Breakeven and Target Profit Volumes b. Changing variable costs i. Exhibit 7-6 The Effect of Changes in Variable Costs on Breakeven and Target Profit Volumes c. Changing fixed costs i. Exhibit 7-7 The Effect of Changes in Fixed Costs on Breakeven and Target Profit Volumes d. Sustainability and CVP Analysis 6. Multi-product companies a. Changing the mix of products offered for sale b. Exhibit 7-8 Calculating the Weighted-Average Contribution Margin per Unit c. BE sales in total units = fixed costs/weighted-average CM per unit d. BE sales in dollars = fixed costs/weighted-average CM ratio

7-7 .

7. Information technology and sensitivity analysis a. Excel b. Enterprise resource planning software 8. Measures of Risk a. Margin of safety = excess of actual or expected sales over breakeven sales i. In units ii. In sales dollars iii. As a percentage b. Operating leverage – relative amount of fixed and variable costs that make up its total costs i. Operating leverage factor = CM/operating income ii. Exhibit 7-10 Characteristics of High Operating Leverage Firms iii. Exhibit 7-11 Characteristics of Low Operating Leverage Firms iv. Choosing a cost structure v. Exhibit 7-13 Using an Indifference Point to Choose the Most Profitable Cost Structure 9. MyAccountingLab.com algorithmic homework assignments: E7-17A, E7-19A, E7-38A, E7-39A, E7-40A.

7-8 .

CHAPTER 7: ASSIGNMENT GRID Assignment

S7-1 S7-2 S7-3 S7-4 S7-5 S7-6 S7-7 S7-8 S7-9 S7-10 S7-11 S7-12 S7-13 S7-14 S7-15 S7-16

E7-17A E7-18A E7-19A E7-20A E7-21A E7-22A E7-23A E7-24A

Assignment

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Learning Objective(s)

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Short Exercises Compute unit contribution margin and contribution margin ratio Project change in income Find breakeven Find target profit volume Prepare a CVP graph Interpret a CVP graph Changes in sales price and variable costs Changes in fixed costs Compute weighted-average contribution margin Continuation of S7-9: breakeven Compute margin of safety Compute and use operating leverage factor Compute margin of safety Compute and use operating leverage factor Calculate total costs under two different scenarios Calculate total costs under two different scenarios Exercises (Set A) Prepare contribution margin income statements Working backward to find missing information Find breakeven and target profit volume Continuation of E7-19A: Changing costs Find breakeven and target profit volume Continuation of E7-21A: Changing business conditions Compute breakeven and project income Continuation of E7-23A: Changing business conditions

Topic(s) 7-9 .

Minutes E7-25A E7-26A E7-27A E7-28A E7-29A E7-30A E7-31A E7-32A E7-33A E7-34A E7-35A E7-36A E7-37A E7-38A E7-39A E7-40A E7-41B E7-42B E7-43B E7-44B E7-45B E7-46B E7-47B E7-48B E7-49B E7-50B

Sustainability and CVP concepts 3 Prepare a CVP graph 2 Work backward to find new breakeven 2&3 point Find consequence of rising fixed costs 1&3 Extension of E7-28A: multiproduct 4 firm Find breakeven for a multiproduct 4 firm Work backward to find missing data 4 Breakeven and an advertising decision 3, 4, & 5 at a multiproduct company Work backward through margin of 5 safety Compute margin of safety and 5 operating leverage Use operating leverage factor to find 5 fixed costs Calculate total costs under two 5 different scenarios Calculate total costs under two 5 different scenarios Comprehensive CVP analysis 1, 2, 3, 4, & 5 Comprehensive CVP analysis 1, 2, 3, 4, & 5 Comprehensive CVP analysis 1, 2, 3, 4, & 5 Exercises (Set B) Prepare contribution margin income 1 statements Working backward to find missing 1&2 information Find breakeven and target profit 1&2 volume Continuation of E7-43B: Changing 3 costs Find breakeven and target profit 1&2 volume Continuation of E7-45B: Changing 3 business conditions Compute breakeven and project 1&2 income Continuation of E7-47B: Changing 3 business conditions Sustainability and CVP 3 Prepare a CVP graph 2

7-10 .

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Assignment

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E7-51B

Work backward to find new breakeven 2&3 point E7-52B Find consequence of rising fixed costs 1&3 E7-53B Extension of E7-52B: multiproduct 4 firm E7-54B Find breakeven for a multiproduct 4 firm E7-55B Work backward to find missing data 4 E7-56B Breakeven and an advertising decision 3, 4, & 5 at a multiproduct company E7-57B Work backward through margin of 5 safety E7-58B Compute margin of safety and 5 operating leverage E7-59B Use operating leverage factor to find 5 fixed costs E7-60B Calculate costs under two different 5 scenarios E7-61B Comprehensive CVP analysis 1, 2, 3, 4, & 5 E7-62B Comprehensive CVP analysis 1, 2, 3, 4, & 5 E7-63B Comprehensive CVP analysis 1, 2, 3, 4, & 5 E7-64B Comprehensive CVP analysis 1, 2, 3, 4, & 5 Problems (Set A) P7-65A Find missing data in CVP 1&2 relationships P7-66A Find breakeven and target profit and 1&2 prepare income statements P7-67A Comprehensive CVP problem 1, 2, & 5 P7-68A Compute breakeven, prepare CVP 1, 2, & 3 graph and respond to change P7-69A CVP analysis at a multi-product firm 4&5 Problems (Set B) P7-70B Find missing data in CVP 1&2 relationships P7-71B Find breakeven and target profit and 1&2 prepare income statements P7-72B Comprehensive CVP problem 1, 2, & 5 P7-73B Compute breakeven, prepare CVP 1, 2, & 3 graph and respond to change P7-74B CVP analysis at a multi-product firm 4&5 Other Decision Case Determine the feasibility of a business 2 A7-75 plan Ethical Issue Ethical dilemma with CVP analysis 2 A7-76 error 7-11 .

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1&3

Estimated Time in Minutes 60

Team Projects A7-77 Discussion and Analysis A7-78 Application and Analysis A7-79

Advertising campaign and production level decision

Discussion questions

All

45

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CVP for a product

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30-60

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Pre-Test Questions on MyAccountingLab: S7-1, S7-3, S7-4, S7-6, S7-9, S7-11, S7-12

Post-Test Questions on MyAccountingLab: P7-65A, P7-66A

Answer Key to Chapter 7 Quiz (Quiz on following pages.)

1.

2.

3.

4.

5.

A D A C D

6. D 7. A 8. B 9. A 10. C

7-12 .

Name____________________________________ Date_________________ Section_______________

CHAPTER 7 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

Which of the following is NOT an assumption of Cost-Volume-Profit analysis?

A. Inventory levels will change as production levels vary.

B. Managers can classify each cost as either variable or fixed, and mixed costs can be broken down into their variable or fixed component.

C. Revenues are linear throughout the relevant range of volume.

D. A change in volume is the only factor that affects costs.

2.

If the sales price is $20 per unit, the variable cost is $12 per unit, total fixed costs is $12,000, and 15,000 units are produced, the contribution margin per unit is: A. $20.

C. $9.

B. $12.

D. $8.

3.

If the sales price is $60 per unit, the variable cost is $10 per unit, total fixed costs is $60,000, and 12,000 units are produced, the break-even in units is: A. 1,200.

C. 240.

B. 1,000.

D. 200.

4.

If the sales price is $150 per unit, the variable cost is $90 per unit, and total fixed costs is $24,000, the contribution margin ratio is: A. 80%.

C. 40%.

B. 60%.

D. 20%.

5.

If the sales price is $150 per unit, the variable cost is $90 per unit, and total fixed costs is $24,000, the break-even in sales dollars is: A. $15,000.

C. $36,000.

B. $24,000.

D. $60,000.

6.

If the sales price is $60 per unit, the variable cost is $36 per unit, total fixed costs is $50,000, how many units need to be sold if the desired profit is $100,000?

A. 1,000 B. 2,500 C. 4,100 D. 6,250

7-13 .

Cost-Volume-Profit Graph $1,100

Dollars

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C

cost sales

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0

500 Volume of units

7.

In the cost-volume-profit graph (above), what is represented by the point marked “A”?

A. Break-even point B. Fixed expenses C. Operating income area D. Operating loss area

8.

In the cost-volume-profit graph (above), what is represented by the point marked “B”?

A. Break-even point B. Fixed expenses C. Operating income area D. Operating loss area

9.

In the cost-volume-profit graph (above), what is represented by the point marked “D”?

A. Operating loss area B. Operating income area C. Break-even point D. Fixed expenses

10.

Leverage Corporation sells two products: Regular and Supreme. Leverage sells three Regulars for every two Supremes. The Regular sells for $20 each with variable costs of $11 each, while the Supreme sells for $25 each with variable costs of $15 each. If fixed costs are $21,000, what is the breakeven point in units?

A. 1,167 of each B. 1,050 of each C. 1,340 Regulars and 894 Supremes D. 894 Regulars and 1,340 Supremes

7-14 .

Chapter 8 Overview Short-Term Business Decisions

The chapter emphasizes decision-making and discusses the managers’ decision-making process of defining goals, identifying alternative courses of action, gathering and analyzing relevant information before selecting the best alternative. As part of this discussion, relevant information is defined as having expected future data that differs among alternatives. Sunk costs are not relevant because they are costs that have been incurred in the past and cannot be changed by the current decision. There is also relevant nonfinancial (qualitative) information, such as the impact of closing a plant on the local community or the reduced control over product quality when you choose to outsource.

The chapter proceeds to discuss factors that affect managers’ short-term decisions regarding: 1. Pricing 2. Discontinuing products, departments, or stores 3. Special orders 4. Product mix 5. Selling as is or processing further, and 6. Outsourcing (make-or-buy decisions).

For each alternative, the manager must consider which costs will be eliminated, how much revenue will increase, and if additional profit or loss will be generated. The text presents the contribution margin approach that focuses on separating variable from fixed costs in the analysis. In some cases, the variable costs will be eliminated along with a portion of the fixed costs and that analysis must be understood as part of the process. In all cases, management must consider the financial impact and the nonfinancial impact of each decision.

Regular pricing decisions are made considering target profit, how much customers will pay, and if the company is a price taker or price-setter. Price-takers emphasize a target costing approach. Price-setters emphasize a cost-plus approach to pricing.

Two sets of Decision Guidelines and Summary Problems accompany the material in the text. The midchapter Decision Guidelines highlights some quantitative and qualitative factors mangers must consider in making their decisions. The first Summary Problem illustrates the differences between price-takers and price-setters. It also affords the student practice in special-order decisions. The end-of-chapter Decision Guidelines focuses on key guidelines that management can follow in making special business decisions.

The final Summary Problem allows students practice in making product mix decisions and make or buy decisions.

8-1 .

Learning Objectives After studying Chapter 8, your students should be able to: 1. Describe and identify information relevant to short-term business decisions.

2. Make special order decisions.

3. Make pricing decisions.

4. Make discontinuation decisions.

5. Make product mix decisions.

6. Make outsourcing (make or buy) decisions.

7. Make sell as is or process further decisions.

8-2 .

Teaching Outline 1. Discuss relevant information a. Expected future costs and revenues b. Differs among alternatives c. Note irrelevant information such as sunk costs d. Note relevant nonfinancial/qualitative information 2. Keys to making short-term special decisions a. Focus on relevant revenues, costs, and profits (i.e., the incremental analysis approach) b. Use a contribution margin approach that separates variable costs from fixed costs c. Sustainability 3. Making special sales order decisions a. Exhibit 8-4 Special Order Considerations b. Exhibit 8-6 Incremental Analysis of Special Sales Order c. Decision rule 4. Making pricing decisions a. Regular pricing decisions i. Stockholder expectations ii. Customer expectations iii. Exhibit 8-7 Regular Pricing Considerations iv. Price-takers versus price-setters (Exhibit 8-8) b. Target costing approach to pricing c. Cost-plus pricing 5. Making decisions about discontinuing a product, department, or store a. Does the product provide a positive contribution margin? b. Will fixed costs continue to exist, even if the product is discontinued? i. Unavoidable c. Are there any direct fixed costs that can be avoided if the product is discontinued? d. Will discontinuing the product affect sales of other products? e. What can be done with any freed capacity? f. Decision rule 6. Making product mix decisions a. Constraints b. Product mix when demand is limited c. Exhibit 8-17 Product Mix Considerations d. Decision rule

8-3 .

7. Making outsourcing (make or buy) decisions a. Exhibit 8-20 Outsourcing Considerations b. Can costs be eliminated by outsourcing? c. No incremental revenue d. Use of freed capacity e. Decision rule f. Exhibit 8-22 Using an Indifference Point to Find an Acceptable Outsourcing Price g. Opportunity cost h. Potential drawbacks 8. Making sell as is or process further decisions a. Exhibit 8-22 Sell As Is or Process Further Considerations b. Revenue “as is” c. Revenue if processed further d. Cost to process further e. Sunk costs f. Decision rule

8-4 .

Key Topics Having the class talk about planning a trip with friends mirrors a manager’s short-term business decision.

1. Define business goals – what are the friends’ goals for activities during Spring Break?

2. Identify alternative courses of action – what are the possible things to do: going somewhere, day trips, working, etc.

3. Gather and analyze relevant information and compare alternatives – cost of trip, making money vs. spending money, etc.

4. Choose the best alternative – selecting plans for Spring Break.

Students may understand that relevant information needs to make a difference in their decision, but they tend to think all important information is relevant. It may help to remind them that if the important information is the same among alternatives, it isn’t relevant.

Students need to understand that the key to managers making decisions is to focus on information that is relevant to the decision at hand. Costs that were incurred in the past are irrelevant because they do not affect the decision, which is true for all decision-making situations.

For decision-making purposes, managers find the contribution margin concept very useful. Contribution margin separates variable costs from fixed costs. Assuming there is idle capacity; only include variable costs when computing the cost of producing one more unit.

Regular pricing decisions are made considering target profit, how much customers will pay, and if the company is a price taker or price-setter. If students understand price-takers vs. price setters, they can more easily understand how prices are set. Price-takers do not have much choice in setting their prices and their choices are in cutting costs to reach their target profit or changing their target profit. When a company is a price-taker, it emphasizes a target costing approach to pricing. Price-setters do not have to worry about the competitor’s price so they can set prices by adding their desired profit to the cost to produce that product. Price-setters use a cost-plus approach to pricing.

Ask students if they know of a corner where there are at least two gas stations. What happens to the one station when the other station lowers its costs? Why is the second station a price-taker?

Have students work in teams or with a partner and complete E8-33B Pricing decisions given two scenarios (10 minutes). Call on a student to give their response.

When making a decision whether to continue or discontinue a segment of the business, the expected decrease in the segment’s relevant revenues and expenses is analyzed. If the decrease in expenses exceeds revenues, then operating income will increase if the segment is discontinued.

Have students work in teams to complete E8-35B Discontinuing a product line (15 minutes) and give their responses.

When constraints such as labor hours, machine hours, or available space are factors, decisions must be made as to which product-mix will maximize operating income. If fixed costs are unaffected by the product-mix, the product with the highest contribution margin per constraint should be allocated the maximum constraint quantity, up to the customer demand.

Have students work in teams to complete E8-36B Identify constraint, then determine product mix (10 minutes).

8-5 .

The make-or-buy decision is similar to the decision to discontinue a product. Managers must look at the costs that will be eliminated if the product is purchased and add the increased revenue from utilizing that production space (if possible) and compare it to the cost to purchase the product. Offer insight into how outsourcing occurs with services.

Have students work in teams to complete E8-40B Make-or-buy with alternative use of facilities (10 minutes). Call on a student to give their response.

Discuss sell as is or process further decisions by asking students if a company is considering selling storage boxes for under their beds, should the company assemble the boxes or not? Why? Would more students buy it assembled or not?

Have student work in teams to complete E8-42B Sell as is or process further (20 minutes). Call on a student to give their answer.

8-6 .

Chapter 8: Student Summary Handout 1. How managers make decisions (Exhibit 8-1) a. Define business goals b. Identify alternative courses of action c. Gather and analyze information: Compare alternatives d. Choose the best alternative 2. Understand relevant information a. Expected future costs and revenues g. Differences between alternatives h. Irrelevant information such as sunk costs b. Relevant nonfinancial/qualitative information 3. Short-term special decisions a. Focus on relevant revenues, costs, and profits (i.e., the incremental analysis approach) b. Use contribution margin approach separating variable costs from fixed costs c. Sustainability 4. Decisions managers must make a. Special orders i. Exhibit 8-4 Special Order Considerations ii. Exhibit 8-6 Incremental Analysis of Special Sales Order iii. Decision rule: 1. Accept special order if expected increase in revenues exceeds increase in variable and fixed costs.

2. Reject special order if expected increase in revenues is less than expected increase in variable and fixed costs. b. Pricing decisions i. Regular pricing 1. Stockholder expectations 2. Customer expectations 3. Exhibit 8-7 Regular Pricing Considerations 4. Price-takers versus price-setters (Exhibit 8-8) ii. Price-takers emphasize a target costing approach to pricing iii. Price-setters emphasize a cost-plus pricing approach c. Discontinuing a product, department, or store i. Does the product provide a positive contribution margin? ii. Will fixed costs continue to exist, even if the product is discontinued?

1. Unavoidable iii. Are there any direct fixed costs that can be avoided if the product is discontinued? iv. Will discontinuing the product affect sales of other products? v. What can be done with any freed capacity? vi. Decision rule 1. Do not discontinue if lost revenues from discontinuing exceed the cost savings from discontinuing 2. Discontinue if total cost savings exceed the lost revenues from discontinuing 8-7 .

d. Product mix i. Constraints ii. Product mix when demand is limited iii. Exhibit 8-17 Product Mix Considerations iv. Decision rule 1. Emphasize product with the highest contribution margin per unit of the constraint e. Outsourcing (make or buy) i. Exhibit 8-20 Outsourcing Considerations ii. Can costs be eliminated by outsourcing? iii. No incremental revenue iv. Use of freed capacity v. Decision rule 1. Outsource if incremental costs of making exceed incremental costs of outsourcing.

2. Do not outsource if incremental costs of making are less than the incremental costs of outsourcing. vi. Exhibit 8-22 Using an Indifference Point to Find an Acceptable Outsourcing Price vii. Opportunity cost viii. Potential drawbacks f. Sell as is or process further i. Exhibit 8-22 Sell As Is or Process Further Considerations ii. Revenue “as is” iii. Revenue if processed further iv. Cost to process further v. Sunk costs vi. Decision rule 1. Process further if extra revenue from processing further exceeds extra cost of processing further 2. Do not process further if extra revenue from processing further is less than extra cost of processing further 5. MyAccountingLab.com algorithmic homework assignments: E8-16A, E8-19A, E8-20A, E8-24A, E-8-25A, E-8-28A.

8-8 .

Chapter 8: ASSIGNMENT GRID Assignment

S8-1 S8-2 S8-3 S8-4 S8-5 S8-6 S8-7 S8-8 S8-9 S8-10 S8-11 S8-12 S8-13 S8-14

E8-15A E8-16A E8-17A E8-18A E8-19A E8-20A E8-21A E8-22A E8-23A E8-24A E8-25A Assignment

Topic(s)

Learning Objective(s)

Short Exercises Determine relevance of information 1 Special order decisions 2 Determine pricing approach and 3 target price Use target costing to analyze data 3 Decide whether to discontinue a 4 department Discontinue a department: Revised 4 information Replace a department 4 Product mix decision: Unlimited 5 demand Product mix decision: Limited 5 demand Outsourcing production decision 1&6 Relevant information for outsourcing 1&6 delivery function Outsourcing qualitative 1&6 considerations Scrap or process further decision 7 Determine most profitable final 7 product Exercises (Set A) Determine relevant and irrelevant 1 information Special order decisions given two 2 scenarios Short-term decision-making and 2 sustainability Special order decision and 2 considerations Pricing decisions given two scenarios 3 Decide whether to discontinue a 4 product line Discontinuing a product line 4 Identify constraint, then determine 5 product mix Determine product mix for retailer 5 Determine product mix for retailer— 5 two stocking scenarios Make-or-buy product component 6 Topic(s) Learning 8-9 .

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Objective(s) E8-26A E8-27A E8-28A E8-29B E8-30B E8-31B E8-32B E8-33B E8-34B E8-35B E8-36B E8-37B E8-38B E8-39B E8-40B E8-41B E8-42B P8-43A P8-44A P8-45A

P8-46A P8-47A P8-48A P8-49B P8-50B P8-51B

Make-or-buy with alternative use of facilities Determine maximum outsourcing price Sell as is or process further Exercises (Set B) Determine relevant and irrelevant information Special order decisions given two scenarios Special order decision and considerations Short-term decision-making and sustainability Pricing decisions given two scenarios Decide whether to discontinue a product line Discontinuing a product line Identify constraint, then determine product mix Determine product mix for retailer Determine product mix for retailer— two stocking scenarios Make-or-buy product component Make-or-buy with alternative use of facilities Determine maximum outsourcing price Sell as is or process further Problems (Set A) Special order decision and considerations Pricing of nursery plants Prepare and use contribution margin statements for discontinuing a line decision Product mix decision under constraint Outsourcing decision given alternative use of capacity Sell or process further decisions Problems (Set B) Special order decision and considerations Pricing of nursery plants Prepare and use contribution margin statements for discontinuing a line decision 8-10 .

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6

10

Medium

7

20

Medium

2

15

Easy

3 4

15 30

Medium Difficult

5

20

Medium

6

20

Difficult

7

20

Difficult

2

15

Easy

3 4

15 30

Medium Difficult

Medium

P8-52B P8-53B P8-54B Decision Case A8-55 Ethical Issue A8-56 Team Project) A8-57 Discussion and Analysis A8-58 Application and Analysis A8-59 CMA Adapted Multiple Choice Questions A8-60

Product mix decision under constraint Outsourcing decision given alternative use of capacity Sell or process further decisions Other

5

20

Medium

6

20

Difficult

7

20

Difficult

Outsourcing email

6

30

Difficult

Outsourcing and ethics

6

30

Medium

Relevant information to outsourcing decision

6

30

Difficult

Discussion questions

All

30-40

Medium

Outsourcing Decision at a Real Company

All

30-60

Medium

5

5

Medium

Pre-Test Questions on MyAccountingLab: S8-1, S8-2, S8-3, S8-5, S8-10, S8-13 Post-Test Questions on MyAccountingLab: P9-43A, P8-45A, P8-48A

Answer Key to Chapter 8 Quiz (Quiz on following pages.)

1.

2.

3.

4.

5.

D E D D C

6. B 7. A 8. A 9. C 10. B

Name____________________________________ Date_________________ Section_______________

CHAPTER 8 TEN-MINUTE QUIZ Circle the letter of the best response.

8-11 .

1.

Which of the following costs are irrelevant to business decisions?

A. Variable costs B. Costs that differ between alternatives C. Current costs D. Sunk costs

2.

Which of the following are keys to making short-term special decisions?

A. Relevant revenues, costs, and profits B. Use of traditional (absorption costing) income statements C. Use of a contribution margin approach D. Both A and B are keys E. Both A and C are keys

3.

Fishing Run Corporation received a special order request for 20,000 new fishing poles at a sales price of $30 each. This is a $10 reduction in the normal sales price. The variable costs per fishing pole are $20. The total fixed costs of $110,000 will not change. Which of the following is TRUE? A. Management should accept the order if the variable costs per unit and fixed costs in total will not change with the order.

B. Management should accept the order if they have excess capacity.

C. Management should consider not accepting the order if the customers will expect the price decrease as the standard price in the future.

D. All of the above are true.

4.

Fishing Run Corporation received a special order request for 20,000 new fishing poles at a sales price of $30 each. This is a $10 reduction in the normal sales price. The variable costs per fishing pole are $20. The total fixed costs of $110,000 will not change as a result of the special order.

The Corporation has enough excess capacity to fill the order without affecting current sales.

What will be the impact on operating income if the special order is accepted?

A. Decrease in operating income of $90,000 B. Decrease in operating income of $200,000 C. Increase in operating income of $90,000 D. Increase in operating income of $200,000

8-12 .

5.

A company sells a product that is relatively unique. Consequently, there is not a lot of competition for the product. The company most likely: A. is a price-taker.

B. uses a pricing approach emphasizing target costing.

C. is a price-setter.

D. sells commodities.

6.

In deciding which product to emphasize, Gadgets Inc., should focus on the product line that has the highest: A. profit per unit of product.

B. contribution margin per unit of the constraint.

C. contribution margin ratio.

D. selling price per unit of product.

7.

Signature Corporation has three product lines: silver, gold, and platinum. All three products have a positive contribution margin, but the gold line has an operating loss. Management is considering discontinuing the product. If management decides to discontinue the gold line, then which of the following was (is) true?

A. Total cost savings exceeded the lost revenues from discontinuing the line.

B. Lost revenues exceeded the cost savings from discontinuing the line.

C. Operating income will not change.

D. Not enough information is present to make that determination.

8.

Thematics Publishing produces 10,000 binders each year. Each binder has a variable cost of $17 and total fixed costs of $110,000 per year. The binders can be purchased from an outside supplier for $20 each. The production space will remain idle, but fixed costs can be reduced by 30%. The annual impact of purchasing the binders will be to: A. increase operating income by $3,000.

B. increase operating income by $47,000.

C. decrease operating income by $3,000.

D. decrease operating income by $47,000.

9. Quinn Bakery bakes gingerbread cookies and sells them by the dozen. During the holiday season, they bake 1,000 dozen cookies. They can sell the plain, undecorated cookies (“as is”) for $2.50 per dozen. If they decorate the cookies at an additional cost of $1 per dozen, each decorated dozen could be sold for $4.00. Should Quinn Bakery sell the cookies undecorated (“as is”) or should the cookies be decorated (“processed further”)?

A. B. C. D.

Quinn Bakery should sell undecorated cookies (“as is”) since operating income will be higher by $500 than if they sell them decorated (“processed further”).

Quinn Bakery should sell undecorated cookies (“as is”) since operating income will be higher by $3,500 than if they sell them decorated (“processed further”).

Quinn Bakery should decorate the cookies since operating income will be higher by $500 than if they sell them undecorated (“as is”).

Quinn Bakery should decorate the cookies since operating income will be higher by $3,500 than if they sell them undecorated (“as is”).

8-13 .

10. When deciding whether to sell as is or process a product further, managers should ignore which of the following?

A. The revenue if the product is sold as is.

B. The costs incurred in producing the product as is.

C. The cost of processing the product further.

D. The revenue if the product is processed further.

8-14 .

Chapter 9 Overview The Master Budget

This chapter presents an overview of the budgeting process and shows how various budgets relate to one another. The chapter focuses on budgets for a manufacturer; however the budgets for service and merchandising companies are also discussed. The sales budget is the foundation for all budget planning.

Once sales have been projected, management can determine the number of units that must be produced.

This information is captured on the production budget. The production budget then leads to individual budgets for direct materials, direct labor and manufacturing overhead. The sales budget also leads to the creation of an operating expense budget, which in turn leads to a budgeted income statement.

The first set of Decision Guidelines addresses some of the decisions a company would make as it sets up its budgeting process. The accompanying Summary Problem requires the student to prepare a sales budget, a production budget, and a direct materials purchases budget.

The second half of the chapter focuses on the capital expenditure budget, cash budgets, and the budgeted balance sheet. The importance of sensitivity analysis and flexible budgeting are introduced. Lastly, the chapter covers how the budgets for service and merchandising companies differ from those of a manufacturer.

The end of the chapter Decision Guidelines covers some additional decisions that might be made with respect to budgeting. The final Summary Problem allows the student practice in developing cash collections and cash disbursements budgets.

Learning Objectives After studying Chapter 9, your students should be able to: 1. Describe how and why managers use budgets 2. Prepare the operating budgets 3. Prepare the financial budgets 4.

Prepare a merchandiser’s Cost of Goods Sold, Inventory, and Purchases Budget

9-1 .

Teaching Outline 1. Discuss how and why managers use budgets a. How budgets are used and developed b. Time frame i. Strategic planning ii. Monthly budgets iii. Rolling budgets c. Those involved in developing budgets i. Participative budgeting ii. Budget slack iii. Budget committees d. Budget starting point i. Prior year actual or budget ii. Zero based budgeting e. The benefits of budgeting i. Planning ii. Coordination and communication iii. Benchmarking 2. Prepare the master budget for a manufacturing company a. Exhibit 9-4 Master Budget for a Manufacturing Company b. Operating budgets i. Sales ii. Production iii. Direct materials iv. Direct labor v. Manufacturing overhead vi. Operating expenses vii. Budgeted income statement c. Financial budgets i. Capital expenditure ii. Cash collections iii. Cash payments iv. Combined cash budget v. Budgeted balance sheet d. Sensitivity analysis and flexible budgeting e. Sustainability and budgeting 3. Budgets for Service and Merchandising Companies a. Service companies i. Operating Budgets: Sales, Operating Expenses, Budgeted Income Statement ii. Financial Budgets: Capital Expenditures, Cash Budgets and Budgeted Balance Sheet.

9-2 .

b. Merchandising Companies i. Operating Budgets: In addition to the Sales, Operating Expenses, and Budgeted Income Statement, the company would prepare a combined Cost of Goods Sold, Inventory, and Purchases Budget to project the amount of inventory that needs to be purchased. ii. Impact of credit and debit card sales on budgeting iii. Financial Budgets: Capital Expenditures, Cash Budgets and Budgeted Balance Sheet

9-3 .

Key Topics Preparing budgets can become mechanical for students. It is important to continually remind them of the purpose and benefits of budgeting. Also, because budgets are all interrelated, it is important for students to understand how one budget affects another.

Most students don’t believe that they ever prepare personal budgets because they rarely write out a budget. Yet most students at least mentally prepare a personal budget. Challenge students to think of a mental budget they’ve prepared even if it was just for a shopping trip. This process helps students relate to the business use of budgets.

Have students consider saving for a new car. In order to attain the funds needed for a down-payment, they develop a strategy (get a job, work more hours, spend less than they are currently spending). The strategy becomes more specific and plans are made using dollars and specific time frames. The students then follow their plan and, after a period of time, compare their actual savings to their planned savings.

Based on the results, a new strategy may be developed and the cycle continues.

Students can relate personally to benchmarking. Students typically set a benchmark for a grade in their accounting class. Explain how this process motivates them to study and complete the class work. The grade benchmark also is a way for them to evaluate their performance when they compare their actual grade with their benchmarked grade. Explain that the student may do this comparison a month into the semester so that he or she will have time to make proper adjustments just as companies do with their budgets.

Companies provide benchmarks to motivate employees and help managers evaluate performance. When actual results are compared to budgeted results, the difference (variance) may be due to poor estimates in the original budget, uncontrollable events, or as a result of the employees’ performance.

Stress the importance of the sales budget and how it affects all other budgets in the master budget. If the sales budget is incorrect, it will create a ripple effect on the other budgets with the master budget.

Be sure to stress the difference between sales price and cost. The sales budget deals with the projected sales price to the customer, while most of the other budgets deal with the cost to the company.

Have students work in teams or with a partner to complete E9-36B Prepare a sales budget for a retail organization (10 minutes). Call on a student to give their response.

Discussion of the cash budget is a great time to review the concept of depreciation. Students need to be reminded that depreciation is a noncash expense and is not included in the cash budget. Discuss the increased use of debit cards as a method of payment. What effect do they have on budgeting?

Have students work in teams to complete E9-48B Combined cash budget (20 minutes).

Stress the importance of sensitivity analysis and flexible budgeting to respond to changes in key assumptions that will affect the previously prepared budgets. Ask the students to identify some of those changes that might occur. Discuss how a company might need to respond to those changes.

9-4 .

Chapter 9: Student Summary Handout 1. Budgeting a. How budgets are used and developed b. Importance of participative budgeting c. Budget starting point i. Prior year actual or budget ii. Zero based budgeting d. Benefits of budgeting i. Planning ii. Coordination and communication iii. Benchmarking 2. Master budget preparation (for a manufacturer) a. Exhibit 9-4 Master Budget for a Manufacturing Company b. Operating budgets i. Sales ii. Production iii. Direct materials iv. Direct labor v. Manufacturing overhead vi. Operating expenses vii. Budgeted income statement c. Financial budgets i. Capital expenditure ii. Cash collections iii. Cash payments iv. Combined cash budget v. Budgeted balance sheet d. Sensitivity analysis and flexible budgeting e. Sustainability and budgeting 3. Budgets for service and merchandising companies a. Production, Direct materials, direct labor and manufacturing overhead budgets are not needed since inventory is not produced. b. Service companies i. Operating Budgets: Sales, Operating Expenses, Budgeted Income Statement ii. Financial Budgets: Capital Expenditures, Cash Budgets, and Budgeted Balance Sheet c. Merchandising companies: i. Operating Budgets: In addition to Sales, Operating Expenses, and Budgeted Income Statement, the company would prepare a combined Cost of Goods Sold, Inventory, and Purchases budget to project the amount of inventory that needs to be purchased ii. Financial Budgets: Capital Expenditures, Cash Budgets, and Budgeted Balance Sheet 4. MyAccountingLab.com algorithmic homework assignments: E9-16A, E9-20A, E9-26A, E9-27A, E9-28A. 9-5 .

CHAPTER 9: ASSIGNMENT GRID Assignment

S9-1 S9-2 S9-3 S9-4 S9-5 S9-6 S9-7 S9-8 S9-9 S9-10 S9-11 S9-12 S9-13 S9-14

E9-15A E9-16A E9-17A E9-18A E9-19A E9-20A E9-21A E9-22A E9-23A E9-24A E9-25A E9-26A E9-27A E9-28A E9-29A

Topic(s)

Learning Objective(s)

Short Exercises Order of preparation and 1 components of master budget Understand key terms and 1&2 definitions Prepare a sales budget 2 Production budget 2 Direct materials budget 2 Direct labor budget 2 Manufacturing overhead budget 2 Operating expenses budget 2 Budgeted income statement 2 Cash collections budget 3 Cash payments budget 3 Cash budget 3 Estimate credit card fees 4 Inventory, purchases, and cost of 4 goods sold Exercises (Set A) Budget and sustainability 1 Prepare a sales budget for a 2 retail organization Prepare a sales budget for a not2 for-profit organization Production budget 2 Direct materials budget 2 Production and direct materials 2 budgets Direct labor budget 2 Manufacturing overhead budget 2 Prepare an operating expenses 2 budget and an income statement Budgeted income statement 2 Prepare budgeted income 2 statement Cash collections budget 3 Cash payments budget 3 Combined cash budget 3 Estimate debit and credit card 4 fees

9-6 .

Estimated Time in Minutes

Level of Difficulty

5

Easy

5

Easy

5 10 10 10 10 10 10 10 10 10 5 15

Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Medium

15 10

Easy Easy

10

Easy

10 10 15

Easy Easy Medium

10 10 15

Easy Easy Easy

15 15

Easy Easy

15 20 20 10

Medium Medium Medium Easy

Assignment

E9-30A E9-31A E9-32A E9-33A E9-34A

E9-35B E9-36B E9-37B E9-38B E9-39B E9-40B E9-41B E9-42B E9-43B E9-44B E9-45B E9-46B E9-47B E9-48B E9-49B E9-50B E9-51B E9-52B E9-53B E9-54B

P9-55A P9-56A

Topic(s)

Learning Objective(s)

Estimated Time in Minutes 15

Level of Difficulty

15 10 15

Medium Medium Medium

15

Medium

Prepare summary performance 1 report Prepare a sales budget for a 2 retail organization Prepare a sales budget for a not2 for-profit organization Production budget 2 Direct materials budget 2 Production and direct materials 2 budgets Direct labor budget 2 Manufacturing overhead budget 2 Prepare an operating expenses 2 budget and an income statement Budgeted income statement 2 Prepare budgeted income 2 statement Cash collections budget 3 Cash payments budget 3 Combined cash budget 3 Estimate debit and credit card 4 fees Prepare sales and cash 2&3 collections budgets Prepared budgeted balance sheet 3 Prepare cash budget 3 Finish an incomplete cash 3 budget Prepare inventory, purchases, 4 and cost of goods sold budget Problems (Set A)

15

Easy

10

Easy

10

Easy

10 10 15

Easy Easy Medium

10 10 15

Easy Easy Easy

15 15

Easy Easy

15 20 20 10

Medium Medium Medium Easy

15

Medium

15 10 15

Medium Medium Medium

15

Medium

Comprehensive budgeting problem Prepare budgeted income statement

2&3

30

Difficult

2

15

Medium

Prepare sales and cash 2&3 collections budgets Prepare budgeted balance sheet 3 Prepare cash budget 3 Finish an incomplete cash 3 budget Prepare inventory, purchases, 4 and cost of goods sold budget Exercises (Set B)

9-7 .

Medium

Assignment

P9-57A P9-58A P9-59A P9-60A

P9-61B P9-62B P9-63B P9-64B P9-65B P9-66B

Topic(s)

Learning Objective(s)

Estimated Time in Minutes 30 30

Level of Difficulty

20

Medium

15

Medium

30

Difficult

15

Medium

30 30

Medium Difficult

20

Medium

15

Medium

1

20

Medium

2&3

30

Difficult

1&4

20

Medium

1, 2, & 3

30

Medium

All

45

Medium

All

30-60

Medium

2&3

5

Medium

Cash budgets 3 Prepare a combined cash budget 3 and a budgeted balance sheet Prepare an inventory, purchases, 4 and cost of goods sold budget Estimate debit and credit card 4 fees Problems (Set B) Comprehensive budgeting 2&3 problem Prepare budgeted income 2 statement Cash budgets 3 Prepare a combined cash budget 3 and a budgeted balance sheet Prepare an inventory, purchases, 4 and cost of goods sold budget Estimate debit and credit card 4 fees Other

Decision Cases A9-67 Suggest performance improvements A9-68 Prepare cash budget under two alternatives Ethical Issue Ethical considerations for A9-69 padded budgets Team Project Analyzing and discussing A9-70 budget concerns Discussion and Analysis A9-71 Discussion questions Application and Analysis A9-72 Budgeting for a Single Product CMA Adapted Multiple Choice Questions A9-73, A9-74

Medium Difficult

Pre-Test Questions on MyAccountingLab: S9-3, S9-4, S9-5, S9-6, S9-10, S9-12, S9-16

Post-Test Questions on MyAccountingLab: E9-17A, E9-18A, E9-19A, E9-24A, E9-30A 9-8 .

Answer Key to Chapter 9 Quiz (Quiz on following pages.)

1.

2.

3.

4.

5.

D A C B C

6. D 7. C 8. B 9. A 10. B

9-9 .

Name____________________________________ Date_________________ Section_______________

CHAPTER 9 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

Which of the following is NOT true of the budgeting process?

A. Budgeting provides feedback to management to aid in assessing how well it’s reaching its goals.

B. Budgets force managers to plan for the future.

C. Budgets force managers to consider relations among operations across the entire value chain.

D. The performance report is prepared as part of the master budget.

2.

The financial budget consists of which of the following components?

A. Budgeted balance sheet B. Operating expenses C. Sales budget D. Budgeted income statement

3.

Which of the following budgets is the comprehensive planning document for the entire organization?

A. Sales budget B. Capital expenditure budget C. Master budget D. Budgeted income statement

4.

Which type of budgeting involves the participation of many levels of management?

A. Zero-based budgeting B. Participative budgeting C. Group budgeting D. Department budgeting

5.

Green Company has budgeted sales of 23,000 units for June and 25,000 units for July. Green's policy is to maintain its finished goods inventory at 25% of the following month's sales.

Accordingly, at the end of May, Green had 5,750 units on hand. How many units must it produce in June in order to support the sales goal and maintain its policy regarding finished goods inventory?

A. 6,250 units B. 23,000 units C. 23,500 units D. 29,250 units

9-10 .

6.

Usually the first step in the budgetary process is the preparation of the: A. budgeted balance sheet.

B. budgeted income statement.

C. combined cash budget.

D. sales budget.

7.

Which of the following would appear on both the budgeted income statement and the cash budget?

A. Depreciation expense B. Capital expenditures C. Rent expense D. Equipment

8.

Which of the following budgets would NOT be prepared by a service company?

A. Operating expense budget B. Production budget C. Budgeted income statement D. Capital expenditures budget

9.

Monroe Group is preparing its cash collections budget. Budgeted sales are $150,000 in July, $175,000 in August, and $200,000 in September. Fifty percent of sales are cash sales; the remainder is on account. Sales on account are expected to be collected 30% in the month of sale, 60% in the month following the month of sale, and 10% in the second month following the month of sale. How much are anticipated cash collections during the month of September?

A. $190,000 B. $180,000 C. $130,000 D. $100,000

10.

Beginning inventory is $120,000 and ending inventory is 60% of beginning inventory. Compute cost of goods sold for the period if purchases are $400,000.

A. $ 72,000 B. $448,000 C. $520,000 D. $592,000

9-11 .

Chapter 10 Overview Performance Evaluation This chapter continues promoting quality decision-making among managerial accountants. These decisions are often based on understanding the goals of the company and the product or unit. Business units are classified into responsibility centers: revenue, cost, profit, and investment centers. As a company grows, the decision making for these centers can be decentralized. This allows top management time to plan for the future while other managers are handling the day to day decisions.

The actual performance of the various types of responsibility centers can be evaluated using performance reports. Performance reports compare actual revenues and expenses against budgeted information.

Variances for the cost centers are calculated highlighting the difference between actual and budgeted figures. Cost centers are only responsible for controlling costs so the related performance report will only include costs incurred by the center. Likewise, the performance report for revenue centers will only include the revenues generated by the center. The performance reports of profit and investment centers include both revenues and costs. The investment center is evaluated on how efficiently the company uses its assets and can be evaluated using Return on Investment (ROI), Residual Income (RI), and Economic value added (EVA). The internal sale of products between two different divisions will affect these calculations. Strategies involved in setting transfer prices include market price, negotiated price, and cost or cost-plus markup.

The first set of Decision Guidelines considers some issues regarding performance evaluation. The accompanying Summary Problem allows for practice in calculating the measures used to evaluate investment centers including ROI, sales margin, capital turnover, and RI. Flexible budgets are summarized budgets prepared for different levels of volume and are used for planning revenues and expenses at different sales volumes. Managers use the flexible budgeted amounts for the actual units sold to break down the master budget into two broad categories: volume variance and flexible budget variance. The volume variance arises when the number of units actually sold differs from the master budget units. The flexible budget variance arises when the company actually earned more or less revenue, or incurred more or less cost, than expected for the actual level of output. This variance is due to factors other than volume. The flexible budget performance report can then be used to determine master budget variances.

The balanced scorecard is an evaluation method that allows the manager to consider both financial factors and operational factors when doing a performance evaluation. The balanced scorecard is made up of four perspectives: financial perspective, customer perspective, internal business perspective, and learning and growth perspective. Each company’s balanced scorecard will be unique to its business and strategy and, because each perspective is causally linked to its purpose, most companies benefit from developing key performance indicators (KPIs) for each perspective. Sustainability-related KPIs may be integrated into the balanced scorecard.

The final set of Decision Guidelines reviews performance evaluation and the balanced scorecard. The last Summary Problem allows the student to match KPIs and company initiatives to the related balanced scorecard perspective.

10-1 .

Learning Objectives After studying Chapter 10, your students should be able to: 1. Understand decentralization and describe different types of responsibility centers.

2. Develop performance reports.

3. Calculate ROI, Sales Margin, and Capital Turnover.

4. Prepare and evaluate flexible budget performance reports.

5. Describe the balanced scorecard and identify key performance indicators (KPIs) for each perspective.

10-2 .

Teaching Outline 1. Explain decentralized operations a. Advantages of decentralization i. Frees top management’s time ii. Encourages use of expert knowledge iii. Improves customer relations iv. Provides training v. Improves motivation and retention b. Disadvantages of decentralization i. Potential duplication of costs ii. Potential problems achieving goal congruence c. Performance evaluation systems i. Clearly communicate expectations ii. Providing benchmarks iii. Motivate segment managers 2. Discuss responsibility accounting a. Four Types of Responsibility Centers (Exhibit 10-1) i. Cost ii. Revenue iii. Profit iv. Investment v. Organizational chart b. Responsibility center performance reports i. Favorable variance ii. Unfavorable variance iii. Management by exception iv. Segment margin c. Organization-wide performance reports 3. Evaluation of investment centers a. Return on Investment (ROI) i. Sales margin ii. Capital turnover b. Residual Income (RI) c. Goal congruence i. Comparing ROI and RI ii. Economic Value Added (EVA) d. Limitations of financial performance evaluation 4. Transfer pricing a. Strategies for Determining Transfer Price (Exhibit 10-9) i. Market price ii. Negotiated price iii. Cost or cost-plus a markup b. Global considerations

10-3 .

5. Flexible budget performance reports a. Flexible budget versus master budget b. Master budget variance i. Volume variance ii. Flexible budget variance c. Underlying causes of the variances 6. Describe the balanced scorecard a. Purpose i. Lag indicators ii. Lead indicators b. Perspectives (Exhibit 10-15) i. Financial perspective ii. Customer perspective iii. Internal business perspective iv. Learning and growth perspective c. Key performance indicators (KPIs) i. Performance scorecard or dashboard 7. Sustainability and performance evaluation

10-4 .

Key Topics Ask students how they break down large group projects with several requirements. In most cases, students break the project down into parts and assign the parts to individual students or small groups.

Continue the discussion by asking them why they break the large projects apart, or why they shouldn’t break the projects apart. Guide the students’ responses to illustrate the benefits and disadvantages of decentralization.

Students need to understand how decentralized companies delegate responsibility for specific decisions to each subunit, creating responsibility centers.

Have students work together to complete E10-34B Identify type of responsibility center (10 minutes).

Call on a student to give their responses.

Students sometimes have difficulty understanding the presentation of cost center or profit center performance reports. A detailed review of what each column represents and an explanation of the differences in the columns helps students understand each report. Point out that the dollar variances should add across and down but that is not the case with the % variances.

Have students work in teams or with a partner to solve E10-35B Complete and analyze a performance report (15 minutes).

Various tools are used to measure the financial performance of investment centers. For investment centers it is important to measure two factors: (1) how much income the division is generating, and (2) how effectively the division is using its assets (invested capital). Three commonly used performance measures are return on investment (ROI), residual income (RI), and economic value added (EVA). All three measures incorporate the division’s assets and its operating income. Ask the students why one division will buy products or components from another division instead of from an outside supplier. Will this impact any of these calculations? Why? Have students work in teams to complete E10-41B Comparison of ROI and Residual Income (15 minutes). Call on students to give their responses.

Ask students about their budgets at the start of the term. Did they have a set amount to spend or did they have a range? Most students have an idea about how much they spend and are capable (although not happy) of spending more if the situation arises. Students don’t think of themselves as having flexible budgets, but they do.

Flexible budgets account for volume differences, as they summarize cost and revenue information for several different volume levels within a relevant range. Students sometimes have difficulty understanding the flexible budget performance report. A detailed review of what each column represents and an explanation of the differences in the columns helps students understand the report. Be sure that students understand the difference between flexible budget and volume variances.

Have students complete E10-43B Prepare a flexible budget performance report (20 minutes).

Differentiate between the concepts of benchmarking and the balanced scorecard. Benchmarking is often a comparison of financial performance to the entity’s past experience and to competitors and industry standards. Benchmarking is largely a lagging indicator, an assessment of past results. The financial perspective is only one of the four areas of importance in the balanced scorecard; the customer 10-5 .

perspective, internal business perspective, and learning and growth perspectives are also addressed.

Students need to understand that the three non-financial perspectives focus on the future and attempt to better the company in the long run.

Students need to understand the components of the KPIs so their analysis is more than a computation.

They need to understand how to compare the ratios and look for differences between the companies (or divisions) being compared. Comparing the use of these three, what information they provide for performance measurement purposes, and how managers may be able to manipulate them is helpful.

Have students complete E10-48B Classify KPIs by balanced scorecard perspective (10 minutes). Call on students to give their responses.

10-6 .

Chapter 10: Student Summary Handout 1. Explain decentralized operations a. Advantages of decentralization i. Frees top management’s time ii. Encourages use of expert knowledge iii. Improves customer relations iv. Provides training v. Improves motivation and retention b. Disadvantages of decentralization i. Potential duplication of costs ii. Potential problems achieving goal congruence c. Performance evaluation systems i. Clearly communicate expectations ii. Providing benchmarks iii. Motivate segment managers 2. Discuss responsibility accounting a. Four Types of Responsibility Centers (Exhibit 10-1) i. Cost ii. Revenue iii. Profit iv. Investment v. Organizational chart b. Responsibility center performance reports i. Favorable variance ii. Unfavorable variance iii. Management by exception iv. Segment margin c. Organization-wide performance reports 3. Evaluation of investment centers a. Return on Investment (ROI) i. Sales margin ii. Capital turnover b. Residual Income (RI) c. Goal congruence i. Comparing ROI and RI ii. Economic Value Added (EVA) d. Limitation of financial performance evaluation 4. Transfer pricing a. Strategies for Determining Transfer Price (Exhibit 10-9) i. Market price ii. Negotiated price iii. Cost or cost-plus a markup b. Global considerations

10-7 .

5. Flexible budget performance reports a. Flexible budget versus master budget b. Master budget variance i. Volume variance ii. Flexible budget variance c. Underlying causes of the variances 6. Describe the balanced scorecard a. Purpose i. Lag indicators ii. Lead indicator b. Perspectives (Exhibit 10-15) i. Financial perspective ii. Customer perspective iii. Internal business perspective iv. Learning and growth perspective c. Key performance indicators (KPIs) i. Performance scorecard or dashboard 7. Sustainability and performance evaluation 8. MyAccountingLab.com algorithmic homework assignments: E10-16A, E10-17A, E10-18A, E10-24A, E10-25A, E10-28A

10-8 .

CHAPTER 10: ASSIGNMENT GRID Assignment

S10-1 S10-2 S10-3 S10-4 S10-5 S10-6 S10-7 S10-8 S10-9 S10-10 S10-11 S10-12 S10-13 S10-14 S10-15 E10-16A E10-17A E10-18A E10-19A E10-20A E10-21A E10-22A E10-23A E10-24A E10-25A

Assignment

Topic(s)

Learning Objective(s)

Short Exercises Identify responsibility centers 1 Identify types of responsibility 1 centers Give advice about decentralization 1 Classify types of subunits 2 Calculate performance report 2 variances Calculate ROI, capital turnover, and 3 sales margin Calculate ROI 3 Compute sales margin and capital 3 margin turnover Compute RI 3 Determine transfer price range 3 Interpret a performance report 4 Complete a master budget 4 performance report Classify KPIs by balanced scorecard 5 perspective Classify KPIs by balanced scorecard 5 perspective Use vocabulary terms 1, 2, 3, 4, & 5 Exercises (Set A) Identify centralized and decentralized 1 organizations Identify type of responsibility center 1 Complete and analyze a performance 2 report Create a performance report for a 2 revenue center Prepare a segment margin 2 performance report Compute and interpret the expanded 3 ROI equation Relationship between ROI and 3 residual income Compute ROI and residual income 3 Comparison of ROI and residual 3 income Determine transfer price range 3

Topic(s)

Learning Objective(s) 10-9

.

Estimated Time in Minutes

Level of Difficulty

5 5

Easy Easy

5 5 10

Easy Easy Easy

10

Easy

5 5

Easy Easy

5 5 10 10

Easy Easy Easy Easy

5

Easy

5

Easy

10

Easy

10

Easy

10 15

Easy Medium

10

Medium

15

Medium

20

Medium

10

Medium

15 15

Medium Medium

15

Medium

Estimated Time in

Level of Difficulty

Minutes E10-26A E10-27A E10-28A E10-29A E10-30A E10-31A E10-32A E10-33B E10-34B E10-35B E10-36B E10-37B E10-38B E10-39B E10-40B E10-41B E10-42B E10-43B E10-44B E10-45B E10-46B E10-47B E10-48B E10-49B P10-50A P10-51A P10-52A

Prepare a flexible budget performance report Complete and analyze a performance report Work backward to find missing values Differentiate between lag and lead indicators Construct balanced scorecard Classify KPIs by balanced scorecard perspective Sustainability Exercises (Set B) Identify centralized and decentralized organizations Identify type of responsibility center Complete and analyze a performance report Create a performance report for a revenue center Prepare a segment margin performance report Compute and interpret the expanded ROI equation Relationship between ROI and residual income Compute ROI and residual income Comparison of ROI and residual income Determine transfer price range Prepare a flexible budget performance report Complete and analyze a performance report Work backward to find missing values Differentiate between lag and lead indicators Construct balanced scorecard Classify KPIs by balanced scorecard perspective Sustainability Problems (Set A) Evaluate subunit performance Prepare a flexible budget for planning Prepare and interpret a performance report 10-10 .

4

20

Medium

4

20

Medium

4

15

Medium

5

10

Medium

5 5

10 10

Medium Easy

5

10

Easy

1

10

Easy

1 2

10 15

Easy Medium

2

10

Medium

2

15

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3

20

Medium

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10

Medium

3 3

15 15

Medium Medium

3 4

15 20

Medium Medium

4

20

Medium

4

15

Medium

5

10

Medium

5 5

10 10

Medium Easy

5

10

Easy

4 2

15 30

Medium Medium

2

30

Medium

Assignment

P10-53A P10-54B P10-55B P10-56B P10-57B P10-58B P10-59B

Decision Cases A10-60 A10-61 Discussion and Analysis A10-62 Application and Analysis A10-63

Topic(s)

Learning Objective(s)

Estimated Time in Minutes

Level of Difficulty

Evaluate divisional performance Problems (Set B) Collect and analyze division data from an annual report Evaluate subunit performance Prepare a flexible budget for planning Prepare and interpret a performance report Evaluate divisional performance Collect and analyze division data from an annual report Other

3

45

Difficult

5

45

Difficult

4 2

45 30

Medium Medium

2

30

Medium

3 5

45 45

Difficult Difficult

Collect and analyze divisional data Compute flexible budget and volume variances

3 2

30 30

Medium Medium

Discussion questions

All

45

Medium

Segmented financial information

2&3

30-60

Medium

Pre-Test Questions on MyAccountingLab: S10-4, S10-6, S10-10, S10-13, S10-15 Post-Test Questions on MyAccountingLab: E10-25A, E10-31A, E10-50A, P10-53A

Answer Key to Chapter 10 Quiz (Quiz on following pages.)

1.

2.

3.

4.

5.

D C B A C

6. A 7. D 8. A 9. B 10. D

10-11 .

Name____________________________________ Date_________________ Section_______________

CHAPTER 10 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

All of the following are advantages of decentralization except to: A. improve customer relations.

B. encourage use of expert knowledge.

C. increase employee motivation.

D. allow goal congruence to be achieved more easily.

2.

All of the following are responsibility centers except: A. profit centers.

B. investment centers.

C. customer centers.

D. cost centers.

3.

The difference between actual and budgeted figures are known as: A. fluctuations.

B. variances.

C. overages.

D. underages.

4.

Which of the following is a performance measure commonly used to assess the performance of investment centers?

A. Return on investment B. Profit margin C. Current ratio D. Gross income

5.

Residual income is calculated as: A. revenues less expenses B. contribution margin less minimum acceptable income C. operating income less minimum acceptable income D. sales less variable costs

10-12 .

6.

Which of the following is NOT a strategy for determining the transfer price of a product?

A. Related party discounted price B. Market price C. Cost or cost-plus a markup D. Negotiated price

7.

Employee capabilities, information system capabilities, and the company’s “climate for action” are important factors of the: A. employee perspective.

B. customer perspective.

C. internal business perspective.

D. learning and growth perspective.

8.

Assume Cucumber Company expects each division to earn an 8% target rate of return. Assume the Company’s Pickle Division had the following results: Sales Operating income Total assets

$24,500,000 1,250,000 15,500,000

The Division’s ROI is: A. 8.1%.

B. 15.8%.

C. 5.1%.

D. 8.0%.

9.

Assume Cucumber Company expects each division to earn an 8% target rate of return. Assume the Company’s Pickle Division had the following results: Sales Operating income Total assets

$24,500,000 1,250,000 15,500,000

The Division’s RI is: A. ($10,000).

B. $10,000.

C. ($710,000).

D. $710,000.

10.

Which of the following are examples of KPIs? A. Average customer satisfaction ratings B. Number of repeat customers C. Sales revenue growth D. All of the above are examples of KPIs

10-13 .

Chapter 11 Overview Standard Costs and Variances

This chapter addresses standard costing including the calculation and use of variances. The computation of standard costs is explained and illustrated including standard costs for direct materials, direct labor, and manufacturing ovexrhead. Managers set direct material and direct labor price and quantity standards that allow for unavoidable waste and spoilage. These are then used to compute the standard cost of one unit.

The use of standard costs to develop the flexible budget is explained. In addition, various variances are explained with the calculation of each illustrated. The Direct Material (DM) price variance arises; then the actual price differs from the standard price. The DM quantity variance is caused by the difference between the actual quantity used the standard quantity allowed. Direct Labor (DL) variances are broken down between the DL rate variance and the DL efficiency variance. The rate variance arises when the actual DL rate varies from the standard. The efficiency variance is caused by a difference between the actual DL hours versus the standard allowed. Variance analysis helps companies to plan and control their cost and usage of materials and labor. The first half of the chapter concludes with a presentation of the advantages and disadvantages of standard costing.

The mid-chapter Decision Guidelines section affords the students the opportunity to consider some decisions managers must make regarding standard costs and variances. The accompanying Summary Problem gives the students practice in calculating the standard DM cost and DL cost for a product. In addition, the calculation of DM and DL variances is reinforced by practicing the calculation of the respective variances.

In addition to the direct material and direct labor standards, companies also set standard manufacturing overhead rates. The second half of the chapter addresses the use of standard costs to compute Manufacturing Overhead (MOH) variances. Planning for indirect manufacturing costs focuses on efficient use of the resources, with the control function being illustrated by use of standard costing and variance analysis techniques. The calculation of those variances are broken down between variable MOH variances and fixed MOH variances. The calculation of variable overhead rate and efficiency variances are discussed and illustrated. A similar presentation is made for the calculation of fixed overhead budget and volume variances.

The last set of Decision Guidelines considers some of management’s decisions relating to overhead variances. The accompanying Summary Problem allows for practice in the calculation of both variable and fixed overhead variances.

The appendix reviews standard cost accounting systems, whereby inventory-related costs are recorded at standard cost, rather than actual cost. Standard costing saves on bookkeeping costs and also isolates price and efficiency variances as soon as they occur.

11-1 .

Learning Objectives After studying Chapter 11, your students should be able to: 1. Explain how and why standards costs are developed.

2. Compute and evaluate direct material variances.

3. Compute and evaluate direct labor variances.

4. Explain the advantages and disadvantages of using standard costs and variances.

5. Compute and evaluate variable overhead variances.

6. Compute and evaluate fixed overhead variances.

7. (Appendix) Record standard costing journal entries.

11-2 .

Teaching Outline 1. Define and explain standard costs a. Benchmark b. Types of standards c. Developing and updating standards i. Ideal (or perfection) standards ii. Practical (or attainable) standards d. Computing standard costs i. Standard cost of direct materials (DM) ii. Standard cost of direct labor (DL) iii. Standard cost of manufacturing overhead (MOH) iv. Standard cost of one unit e. Sustainability and standard costs 2. Discuss how managers use standard costs to compute DM and DL variances a. Using standard costs to develop the flexible budget b. Direct material variances i. Price variance ii. Quantity variance iii. Exhibit 11-4 DM Variances if DM Purchased Equals DM Used iv. Evaluating DM Variances v. Computing DM variances when quantity of DM purchased differs from quantity of DM used c. Direct labor variances i. DL rate variance ii. DL efficiency variance d. Exhibit 11-9 Summary of DM and DL Variance Formulas e. Advantages of using standard costs and variances i. Cost benchmarks ii. Usefulness in budgeting iii. Motivation iv. Standard cost systems simplify bookkeeping f. Disadvantages of using standard costs and variances i. Outdated or inaccurate standards ii. Lack of timeliness iii. Focus on operational performance measures and visual management iv. Lean thinking v. Increase in automation and decrease in DL vi. Unintended behavioral consequences 3. Discuss how managers use standard costs to compute MOH variances a. Variable MOH variances i. Variable overhead rate (or spending) variance ii. Variable overhead efficiency variance iii. Exhibit 11-10 Calculation of Variable Overhead Variances b. Fixed MOH variances i. Fixed overhead budget (or spending) variance ii. Fixed overhead volume variance iii. Exhibit 11-11 Calculation of Fixed Overhead Variances 11-3 .

iv. Exhibit 11-12 Favorable Fixed Overhead Volume Variance v. Exhibit 11-13 Unfavorable Fixed Overhead Volume Variance c. Standard costing systems 4. Appendix: Standard cost accounting system a. Each variance has own general ledger account b. Manufacturing costs flow c. Journal entries i. Recording raw materials purchases ii. Recording use of direct materials iii. Recording direct labor costs iv. Recording manufacturing overhead costs incurred v. Allocating overhead vi. Recording the completion of goods vii. Recording the sale and release of inventory viii. Closing manufacturing overhead ix. Closing the cost variance accounts to Cost of Goods Sold d. Standard costing income statement for management (Exhibit 11-14)

11-4 .

Key Topics Continue the discussion of budgets from chapter 10 with the students. Ask the students if they have ever saved for one item they really wanted, like an iPhone or a car. What information did they use to determine how much they needed to save? Did it take them longer to save than they anticipated? If so, did they update their budgeted goal for new information? Did the actual cost differ from the amount they thought they needed to save? The amount they saved was really the standard cost, which may have ended up differing from the actual cost. Variances from the budget can arise from, and are potentially caused by, a variety of factors.

Have students complete E11-34B Calculate standard cost per unit (10 minutes).

Tell students to pretend they are buying a car and develop a plan to earn the money. They plan on working 20 hours per week and earn $10 per hour. At the end of the month, they discover that they worked 15 hours a week and earned $12 per hour. The comparison between the expected hours per week (20) and the actual hours per week (15) is the DL efficiency variance. The difference between the money earned ($12/hour) and the budgeted money earned ($10/hour) is the DL rate variance.

Stress to students the logic of direct material and direct labor variances. Encourage them to use common sense when determining whether the variances are favorable or unfavorable. This forces the students to examine the formula and think about what occurred.

Have the students form teams and complete E11-38B Calculate and interpret direct material and direct labor variances (15 minutes). Call on two teams to report their answers.

Review fixed and variable MOH with the students. Ask them whether they think overhead costs can result in variances as did DM and DL. How do they think they would be calculated? What would make sense based on the discussion of DM and DL variances? When would a fixed overhead variance be favorable? Unfavorable?

Have students complete E11-47B Calculate and interpret overhead variances (15 minutes).

Address the keys points of standard cost accounting systems: (1) that each type of variance has its own general ledger account; (2) that standard costs, rather than actual costs, are used to record the manufacturing costs put into the inventory accounts, and that (3) at the end of the period, the variance accounts are closed to cost of goods sold to “correct” for the fact that the standard costs recorded in the accounts were different than the actual costs. Have students complete E11-48B Make journal entries in a standard costing system (15 minutes).

11-5 .

Chapter 11: Student Summary Handout 1. Define and explain standard costs a. Benchmark b. Types of standards c. Developing and updating standards i. Ideal (or perfection) standards ii. Practical (or attainable) standards d. Computing standard costs i. Standard cost of direct materials (DM) ii. Standard cost of direct labor (DL) iii. Standard cost of manufacturing overhead (MOH) iv. Standard cost of one unit e. Sustainability and standard costs 2. Discuss how managers use standard costs to compute DM and DL variances a. Using standard costs to develop the flexible budget b. Direct material variances i. Price variance (actual quantity purchased x (actual price – standard price)) ii. Quantity variance (standard price x (actual quantity used – standard quantity allowed)) iii. Exhibit 11-4 DM Variances if DM Purchased Equals DM Used iv. Evaluating DM Variances v. Computing DM variances when quantity of DM purchased differs from quantity of DM used c. Direct labor variances i. DL rate variance (actual hours x (actual rate – standard rate)) ii. DL efficiency variance (standard rate x (actual hours – standard hours allowed)) d. Exhibit 11-9 Summary of DM and DL Variance Formulas e. Advantages of using standard costs and variances i. Cost benchmarks ii. Usefulness in budgeting iii. Motivation iv. Standard cost systems simplify bookkeeping f. Disadvantages of using standard costs and variances i. Outdated or inaccurate standards ii. Lack of timeliness iii. Focus on operational performance measures and visual management iv. Lean thinking v. Increase in automation and decrease in DL vi. Unintended behavioral consequences 3. Discuss how managers use standard costs to compute MOH variances a. Variable MOH variances i. Variable overhead rate (or spending) variance (actual hours x (actual rate – standard rate)) ii. Variable overhead efficiency variance (standard rate x (actual hours – standard hours allowed)) 11-6 .

iii. Exhibit 11-10 Calculation of Variable Overhead Variances b. Fixed MOH variances i. Fixed overhead budget (or spending) variance (actual fixed overhead incurred – budgeted fixed overhead costs) ii. Fixed overhead volume variance (budgeted fixed overhead – standard fixed overhead cost allocated to production); (standard fixed overhead allocated to production = standard hours allowed x standard rate) iii. Exhibit 11-11 Calculation of Fixed Overhead Variances iv. Exhibit 11-12 Favorable Fixed Overhead Volume Variance v. Exhibit 11-13 Unfavorable Fixed Overhead Volume Variance c. Standard costing systems 4.

Appendix: Standard cost accounting system a. Each variance has own general ledger account b. Manufacturing costs flow c. Journal entries i. Recording raw materials purchases ii. Recording use of direct materials iii. Recording direct labor costs iv. Recording manufacturing overhead costs incurred v. Allocating overhead vi. Recording the completion of goods vii. Recording the sale and release of inventory viii. Closing manufacturing overhead ix. Closing the cost variance accounts to Cost of Goods Sold d. Standard costing income statement for management (Exhibit 11-14)

5. MyAccountingLab.com algorithmic homework assignments: E11-16A, E11-18A, E1119A, E11-20A, E11-23A, E11-25A

11-7 .

CHAPTER 11: ASSIGNMENT GRID Assignment

S11-1 S11-2 S11-3

S11-4

S11-5 S11-6

S11-7 S11-8 S11-9 S11-10 S11-11 S11-12 S11-13 E11-14A E11-15A E11-16A E11-17A E11-18A E11-19A E11-20A

E11-21A E11-22A

Topic(s)

Learning Objective(s)

Short Exercises Compute the standard cost of direct materials Compute the standard cost of direct labor Calculate direct material variances when the quantity purchased equals the quantity used Calculate direct material variances when the quantity purchased differs from the quantity used Calculate direct labor variance Identify advantages and disadvantages of standards costs and variance analysis Calculate variable overhead variances Calculate fixed overhead variances Calculate and interpret fixed overhead variances Calculate overhead rates Calculate and interpret overhead variances Record costing transactions Record standard costing transactions Exercises (Set A) Calculate standard cost and gross profit per unit Calculate standard cost per unit Calculate and explain direct material variances Calculate missing direct materials variables Calculate and explain direct labor variances Calculate and interpret direct material and direct labor variances Calculate the materials and labor variances Record materials and labor transactions Calculate the standard cost of a product before and after proposed 11-8

.

Estimated Time in Minutes

Level of Difficulty

1

5

Easy

1

5

Easy

2

10

Easy

2

10

Easy

3 4

5 5

Easy Easy

5

10

Medium

6 6

10 10

Medium Medium

5&6 6

10 10

Medium Medium

7 7

10 10

Easy Easy

1

15

Medium

1 2

10 10

Medium Medium

2

10

Easy

3

10

Easy

2&3

15

Medium

2&3

15

Medium

7

15

Medium

1&4

20

Medium

sustainability effort changes

Assignment

Topic(s)

Learning Objective(s)

Estimated Time in Minutes

Level of Difficulty

E11-23A

Recognize advantages and disadvantages of standard cost and variance analysis in various situations Compute and interpret overhead variances Vocabulary

4

15

Medium

5&6

20

Medium

1, 2, 3, 4, 5 & 6 2

10

Easy

15

Medium

3

15

Medium

5&6

15

Medium

7

15

Medium

7

15

Medium

7

15

Medium

7

15

Medium

1

15

Medium

1 2

10 10

Medium Medium

2

10

Easy

3

10

Easy

2&3

15

Medium

2&3

15

Medium

7

15

Medium

1&4

20

Medium

E11-24A E11-25A E11-26A E11-27A E11-28A E11-29A E11-30A E11-31A E11-32A

E11-33B E11-34B E11-35B E11-36B E11-37B E11-38B E11-39B E11-40B E11-41B

Calculate and interpret direct material variances Calculate and interpret direct labor variances Calculate and interpret overhead variances Make journal entries in a standard costing system Prepare a standard cost income statement Interpret a standard cost income statement Prepare a standard cost income statement Exercises (Set B) Calculate standard cost and gross profit per unit Calculate standard cost per unit Calculate and explain direct material variances Calculate missing direct materials variables Calculate and explain direct labor variances Calculate and interpret direct material and direct labor variances Calculate the materials and labor variances Record materials and labor transactions Calculate the standard cost of a product before and after proposed sustainability effort changes

11-9 .

Assignment

Topic(s)

Learning Objective(s)

Estimated Time in Minutes

Level of Difficulty

E11-42B

Recognize advantages and disadvantages of standard cost and variance analysis in various situations Calculate and interpret overhead variances Vocabulary

4

15

Medium

5&6

20

Medium

1, 2, 3, 4, 5 & 6 2

10

Easy

15

Medium

15

Medium

15

Medium

15

Medium

15

Medium

15

Medium

15

Medium

20

Medium

25

Medium

30

Medium

15

Medium

35

Medium

20

Medium

25

Medium

30

Medium

15

Medium

35

Medium

Estimated

Level of

E11-43B E11-44B E11-45B E11-46B E11-47B E11-48B E11-49B E11-50B E11-51B

P11-52A P11-53A P11-54A P11-55A P11-56A

P11-57B P11-58B P11-59B P11-60B P11-61B

Assignment

Calculate and interpret direct materials variances Calculate and interpret direct labor 3 variances Calculate and interpret overhead 5&6 variances Make journal entries in a standard 7 costing system Prepare a standard cost income 7 statement Interpret a standard cost income 7 statement Prepare a standard cost income 7 statement Problems (Set A) Calculate and explain direct material 1, 2, 3 & 4 and direct labor variances Comprehensive standards and 2, 3, 4, 5 & 6 variances problem Comprehensive standards and 1, 2, 3, 4, 5 & variances problem 6 Working backward through labor 3 variances Determine all variances and make 2, 3, 4, 5, 6 & journal entries 7 Problems (Set B) Calculate and explain direct material 1, 2, 3 & 4 and direct labor variances Comprehensive standards and 2, 3, 4, 5 & 6 variances problem Comprehensive standards and 1, 2, 3, 4, 5 & variances problem 6 Work backwards through labor 3 variances Determine all variances and make 2, 3, 4, 5, 6 & journal entries 7

Topic(s)

Learning 11-10 .

Objective(s)

Time in Minutes

Difficulty

Ethical dilemmas relating to standards

3

30

Medium

Evaluate standard setting approaches

3

30

Medium

Discussion questions

All

60

Medium

Analyzing Variances and Potential Causes

All

30-60

Medium

Other Ethical Issues A11-62 Team Project A11-63 Discussion and Analysis A11-64 Application and Analysis A11-65

Pre-Test Questions on MyAccountingLab: S11-3, S11-4, S11-5, S11-7, S11-8, S11-10, S11-11 Post-Test Questions on MyAccountingLab: E11-26A, E11-27A, E11-28A, P11-53A

Answer Key to Chapter 11 Quiz (Quiz on following pages.)

1.

2.

3.

4.

5.

D D A C B

6. A 7. D 8. C 9. A 10. B

11-11 .

Name____________________________________ Date_________________ Section_______________

CHAPTER 11 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

Which of the following is NOT an advantage of using standard costs and variances?

A. Use as a performance benchmark for evaluation of actual costs B. Use as a basis for components of the master budget C. Simplification of bookkeeping D. Change in behavior of managers to obtain desired variances

2.

One level of a company’s flexible budget was prepared for production of 8,000 units. Total costs were $38,000 and included direct materials, direct labor, and variable overhead at $1.50, $2.50, and $0.50 per unit respectively. What is the total cost for production of 8,500 units?

A. $ 2,000 C. $38,250 B. $38,000 D. $40,250

3.

The direct labor price variance was unfavorable and much greater than anticipated. Who would be in the best position to explain why the unfavorable variance occurred?

A. Both the production and human resource supervisors B. The production supervisor C. The purchasing manager D. Both the purchasing manager and production supervisor

4.

A manager purchased better quality materials for a slightly higher cost than anticipated.

However, as a result, there was less spoilage than normal. What is the effect on the price and quantity variances respectively?

A. Favorable, favorable B. Favorable, unfavorable C. Unfavorable, favorable D. Unfavorable, unfavorable

5.

A company uses a single raw material in its production process. The standard price for a unit of material is $2.00. During the month the company purchased and used 600 units of this material at a price of $2.25 per unit. The standard quantity required per finished product is 2 units and during the month, the company produced 310 finished units. How much was the material price variance?

A. $150 favorable B. $150 unfavorable C. $155 favorable D. $155 unfavorable

11-12 .

6.

A company uses a single raw material in its production process. The standard price for a unit of material is $2.00. During the month the company purchased and used 600 units of this material at a price of $2.25 per unit. The standard quantity required per finished product is 2 units and during the month, the company produced 310 finished units. How much was the material quantity variance?

A. $40 favorable B. $40 unfavorable C. $45 favorable D. $45 unfavorable

7.

A company produced 2,200 units of output during a production process that normally requires 2 hours of labor per unit of output. The standard labor rate is $16 per hour, but the company paid $15 per hour. Actual hours needed to complete the production process were 4,600. How much was the labor efficiency variance?

A. $3,000 favorable B. $3,000 unfavorable C. $3,200 favorable D. $3,200 unfavorable

8.

A company produced 2,200 units of output during a production process that normally requires 2 hours of labor per unit of output. The standard labor rate is $16 per hour, but the company paid $15 per hour. Actual hours needed to complete the production process were 4,600. How much was the labor rate variance?

A. $4,400 favorable B. $4,400 unfavorable C. $4,600 favorable D. $4,600 unfavorable

9.

Which of the following formulas is used to compute variable overhead rate (or spending) variance?

A. actual hours x (actual rate – standard rate) B. standard hours allowed x (actual rate – standard rate) C. actual rate x (actual hours – standard hours allowed) D. standard rate x (actual hours – standard hours allowed)

10.

Which of the following is a true statement regarding fixed overhead volume variance?

A. If production volume is less than anticipated, then fixed overhead have been underallocated and the fixed overhead volume variance is favorable.

B. If production volume is less than anticipated, then fixed overhead have been underallocated and the fixed overhead volume variance is unfavorable.

C. If production volume is greater than anticipated, then fixed overhead have been underallocated and the fixed overhead volume variance is favorable.

D. If production volume is greater than anticipated, then fixed overhead have been overallocated and the fixed overhead volume variance is unfavorable.

11-13 .

Chapter 12 Overview Capital Investment Decisions and the Time Value of Money

The chapter begins with a discussion of capital investments and the capital budgeting process. After setting the company’s goals, managers evaluate capital investment projects and decide which should be funded. Some of the strategies used in evaluating investment proposals are the payback period or the accounting rate of return (ARR). The payback period is the number of periods necessary to recover the project’s initial investment. The most optimal project is the one with the lowest payback period. The AAR measures the average annual rate of return over the asset’s life. The ARR is the average annual operating income earned from the asset divided by the initial investment in the asset. If the expected ARR exceeds the company’s required rate of return, the investment should not be rejected. The payback period method focuses on time and the ARR method focuses on the profitability of the asset over its entire life. Neither method considers the time value of money.

The first set of Decision Guidelines present some questions that must be answered when making capital budgeting decisions. The first Summary Problem gives the student practice in computing payback period and ARR. The student then must make the decision as to whether or not the investment proposal should be considered further.

There are other strategies used in decision making that take into account the time value of money. After a review of time value of money concepts, those strategies are presented. The net present value (NPV) method discounts net cash flows to their present value so they can be fairly compared to the current cash outflows (i.e., the investment’s cost). The difference between the present value of the net cash inflows and the present value of the cash outflow is the investment’s NPV. If the NPV of the investment is negative, the investment is rejected. Another evaluation method is the internal rate of return (IRR). The IRR is the rate of return where the present value of the investment’s net cash inflows equals the investment’s cost. If the internal rate of return is more than the company’s required minimum rate of return, the investment is accepted.

The company may have more than one viable investment after analyzing the investment proposals and rejecting those that do not meet the decision rules. When that occurs, the manager engages in capital rationing by using the profitability index and selecting the alternative that best meets the company’s goals. After selecting and funding the project, a post-audit is performed on the capital investment that was selected.

The final set of Decision Guidelines presents additional questions that must be answered when making capital budgeting decisions. The accompanying Summary Problem continues the earlier Summary Problem by requiring the computation of both NPV and IRR for the same asset presented earlier. The student must then make the final decision as to whether or not the capital asset should be purchased.

Three appendices conclude the chapter. Appendix 12A presents the formulas and resulting tables for both present and future values of single sums and annuities. Appendices 12B and C show how to compute problems using either a programmed calculator or Excel.

12-1 .

Learning Objectives After studying Chapter 12, your students should be able to: 1. Describe the importance of capital investments and the capital budgeting process.

2. Use the paycheck and accounting rate of return methods to make capital investment decisions.

3. Use the time value of money to compute the present and future values of single lump sums and annuities.

4. Use discounted cash flow models to make capital investment decisions.

5. Compare and contrast the four capital budgeting methods.

12-2 .

Teaching Outline 1. Define capital budgeting a. Four methods of capital budgeting analysis i. Payback period ii. Accounting rate of return (ARR) iii. Net present value (NPV) iv. Internal rate of return (IRR) b. Focus on cash flows c. Exhibit 12-1 Capital Budgeting Process 2. Payback period a. Payback with equal annual net cash inflows b. Payback with unequal net cash inflows c. Criticism of payback period method 3. Accounting rate of return (ARR) a. Investments with equal annual net cash inflows b. Investments with unequal net cash inflows 4. Discuss the time value of money a. Factors i. Principal amount 1. Single lump sum 2. Annuity ii. Number of periods iii. Interest rate 1. Simple interest 2. Compound interest b. Future values and present values i. Factors ii. Calculating future values of single sums and annuities iii. Calculating present values of single sums and annuities 5. Net present value (NPV) a. NPV with equal annual net cash inflows (annuity) b. NPV with unequal annual net cash inflows c. Capital rationing and the profitability index d. NPV of a project with residual value e. Sensitivity analysis 6. Internal rate of return (IRR) a. IRR with equal annual net cash inflows (annuity) b. IRR with unequal annual net cash inflows 7. Compare and contrast the four capital budgeting methods a. Exhibit 12-16 Capital Budgeting Methods That Ignore the Time Value of Money b. Exhibit 12-17 Capital Budgeting Methods That Incorporate the Time Value of Money 8. Sustainability and capital investments 12-3 .

Key Topics This chapter addresses the need to make long-term decisions regarding investing in capital assets.

Resources are limited and businesses want to be more efficient and profitable. Various techniques are used to evaluate long-term asset acquisitions. This is a very important and time consuming process.

Four methods of analyzing capital investments are explored: payback period, accounting rate of return (ARR), net present value (NPV), and internal rate of return (IRR). Emphasize that all of these methods, except for the ARR, use net cash inflows in the analyses to evaluate capital investments. The emphasis is on the creation of future cash inflows in capital budgeting. ARR uses accrual-based accounting income to evaluate capital investments.

Making capital budgeting decisions is not an exact science. The calculations may appear to be precise, but they are based on an uncertain future. Many unknown factors must be taken into consideration when budgeting for the acquisition of capital assets.

Ask students to recall when they loaned a friend some money. How long did it take to be repaid? Was getting the money back important to them? What if they invested money in a business? How soon would they want their money back? Use their answers as a way to illustrate the importance of the payback method to analyze investments.

Have students work together to complete E12-37B Compute payback period—equal cash inflows (10 minutes). Call on a student to give their response.

If an individual’s initial investment was returned quickly (within one year) but generated little cash in the following year, would it be a good investment? What if there was another investment that paid back the original investment in two years and provided cash back for the following two years? Would that be a better investment? What are some criticisms of the payback period method? Remind students that the payback period method selects the shortest payback provided “all else being equal”.

Some students become confused when changing from the accrual method to the cash method. The concept of subtracting noncash expenses, such as depreciation, from the net cash inflows in order to arrive at operating income can be confusing because students are subtracting something that doesn’t have cash from net “cash” inflows. You may find it helpful to remind students how to calculate income using the accrual method: Revenue – expenses = income $5,000 - $2,500 = $2,500 If depreciation was the only noncash expense, the cash flow would be: Revenue – (expenses – noncash expenses) = net cash flows.

So if depreciation is $500, the net cash inflows would be: $5,000 – ($2,500 - $500) = $5,000 - $2,000 = $3,000 Likewise, to work from net cash inflows to operating income: Net cash inflows – noncash expenses = operating income $3,000 - $500 = $2,500.

Have students work in teams to complete E12-39B ARR with unequal cash inflows (10 minutes). Call on a student to give their response.

12-4 .

What problems exist with the Payback Period and the ARR methods? They both ignore the value of money over time.

Tell students that they have just invested $10,000 in a new piece of equipment. Would they rather receive the investment money back in one month or in one year? Obviously the answer is one month. Would they rather receive $1,000 a month for one year or $12,300 in a lump sum in one year? The answer depends on the time value of money. Both options need to be converted to the same time frame in order to compare them. Therefore, both options have to be converted to the value today-present value.

Some students are confused about which table is used when computing the time value of money. They seem to understand the concept but forget how to use the formulas. Review the factors affecting the time value of money.

Discuss how NPV and IRR are discounted cash flow models, meaning that these models consider the time value of money when analyzing investment alternatives. These models use present value calculations so they allow for a better comparison of an investment’s initial cost to its expected net cash inflows than either the payback period or ARR. NPV and IRR compare that initial cost, which is in present dollars, to the expected net cash inflows discounted to present value.

Have students work together to complete E12-46B Calculate NPV—equal annual cash inflows (15 minutes). Call on a student to give their response.

Have students work in teams to complete E12-47B Calculate IRR – equal annual cash inflows (10 minutes). Call on a team to give their response.

The decision rules show students how to accept or reject a project, but what if there are multiple projects that meet the company’s investment requirements? Net present value computations help to compare multiple projects.

There are two projects: A has an IRR of 10% and B has an IRR of 7%. Which project should be selected?

All things being equal, A should be selected. If A’s project has a payback period of 5 years and B’s project has a payback period of 3 years, would the answer change? It could very possibly change.

Having a higher IRR may not meet the company’s need to have its investment returned more quickly.

12-5 .

Chapter 12: Student Summary Handout 1. Time value of money a. Factors i. Principal amount 1. Single lump sum 2. Annuity ii. Number of periods iii. Interest rate 1. Simple interest 2. Compound interest b. Future values and present values i. Factors ii. Calculating future values of single sums and annuities iii. Calculating present values of single sums and annuities 2. Four methods of capital budgeting a. Payback period i. Equal annual net cash inflows ii. Unequal net cash inflows b. Accounting rate of return (ARR) i. Equal annual net cash inflows ii. Unequal net cash inflows c. Net present value (NPV) i. Equal annual net cash inflows (annuity) ii. Unequal annual net cash inflows iii. Capital rationing and the profitability index iv. Project with residual value v. Sensitivity analysis d. Internal rate of return (IRR) i. Equal annual net cash inflows (annuity) ii. Unequal annual net cash inflows e. Capital budgeting process (Exhibit 12-1) i. Identify potential capital investments ii. Estimate future net cash inflows iii. Analyze potential investments iv. Engage in capital rationing v. Perform post audits 3. Compare and contrast the four capital budgeting methods a. Exhibit 12-16 Capital Budgeting Methods That Ignore the Time Value of Money b. Exhibit 12-17 Capital Budgeting Methods That Incorporate the Time Value of Money 4. Sustainability and Capital Investments 5. Appendices: Present Value and Future Value tables a. (If appropriate): Using technology to perform time value of money calculations 6.

MyAccountingLab.com algorithmic homework assignments: E12-18A, E12-20A, E12-28A, E12-30A, E12-35A 12-6

.

Chapter 12: ASSIGNMENT GRID Assignment

S12-1 S12-2 S12-3 S12-4 S12-5 S12-6 S12-7 S12-8 S12-9 S12-10 S12-11 S12-12 S12-13 S12-14 S12-15

E12-16A E12-17A E12-18A E12-19A E12-20A E12-21A E12-22A E12-23A E12-24A E12-25A E12-26A

Topic(s)

Learning Estimated Objective(s) Time in Minutes

Short Exercises Order the capital budgeting process Compute payback period - equal cash inflows Compute payback period -unequal cash inflows Compute ARR - equal cash inflows Compute ARR - unequal cash inflows Compute annual cash savings Find the present values of future cash flows Show how timing affects future values Compare payout options at their future values Relationship between the PV tables Compute NPV - equal net cash inflows Compute IRR - equal net cash inflows Compute NPV - unequal net cash inflows Compute IRR – unequal net cash inflows Compare the capital budgeting methods Exercises (Set A) Identify capital investments Compute payback period -equal cash inflows Compute payback period - unequal cash inflows Compute ARR with unequal cash inflows Compute and compare ARR Compare retirement savings plans Calculate the payback and NPV for a sustainable energy project Fund future cash flows Choosing a lottery payout option Solve various time value of money scenarios Calculate NPV - equal annual cash inflows 12-7

.

Level of Difficulty

1

5

Easy

2

5

Easy

2 2 2 2

5 5 5 5

Easy Easy Easy Easy

3

5

Easy

3

5

Easy

3 3

5 5

Easy Easy

4 4

10 10

Easy Easy

4

10

Easy

4 5

10 10

Easy Easy

1

5

Easy

2

10

Easy

2

10

Easy

2 2 3

10 10 10

Easy Easy Medium

2&4 3 3

10 15 15

Medium Medium Medium

3

15

Medium

4

15

Medium

Assignment

Topic(s)

E12-27A E12-28A E12-29A E12-30A E12-31A

Calculate IRR - equal cash inflows Calculate NPV - unequal cash flows Compute IRR - unequal cash flows Capital rationing decision Compute payback and ARR with residual value Continuation of E12-31A: Compute payback and ARR with no residual value Calculate NPV with and without residual value Calculate IRR with no residual value Comparing capital budgeting methods Exercises (Set B) Identify capital investments Compute payback period -equal cash inflows Compute payback period - unequal cash inflows Compute ARR with unequal cash inflows Compute and compare ARR Compare retirement savings plans Calculate the payback and NPV for a sustainable energy project Fund future cash flows Choosing a lottery payout option Solve various time value of money scenarios

E12-32A

E12-33A E12-34A E12-35A E12-36B E12-37B E12-38B E12-39B E12-40B E12-41B E12-42B E12-43B E12-44B E12-45B

E12-46B

Learning Estimated Objective(s) Time in Minutes

E12-54B E12-55B

Calculate NPV - equal annual cash inflows Calculate IRR - equal cash inflows Calculate NPV - unequal cash flows Compute IRR - unequal cash flows Capital rationing decision Compute payback and ARR with residual value Continuation of E12-51B: Compute payback and ARR with no residual value Calculate NPV with and without residual value Calculate IRR with no residual value Comparing capital budgeting methods

Assignment

Topic(s)

E12-47B E12-48B E12-49B E12-50B E12-51B E12-52B

E12-53B

12-8 .

Level of Difficulty

4 4 4 4

10 15 15 20

Medium Difficult Difficult Medium

2

10

Medium

2

10

Medium

4 4 5

10 10 15

Medium Medium Medium

1

5

Easy

2

10

Easy

2

10

Easy

2 2 3

10 10 10

Easy Easy Medium

2&4 3 3

10 15 15

Medium Medium Medium

3

15

Medium

4 4 4 4 4

15 10 15 15 20

Medium Medium Difficult Difficult Medium

2

10

Medium

2

10

Medium

4 4 5

10 10 15

Medium Medium Medium

Learning

Estimated

Level of

Objective(s)

P12-56A P12-57A P12-58A P12-59A

P12-60B P12-61B P12-62B P12-63B

Decision Cases A12-64 Discussion and Analysis A12-65 Application and Analysis A12-66

Problems (Set A) Solve various time value of money scenarios Retirement planning in two stages Evaluate an investment using all four methods Compare investments with different cash flows and residual values Problems (Set B) Solve various time value of money scenarios Retirement planning in two stages Evaluate an investment using all four methods Compare investments with different cash flows and residual values Other Apply time value of money to a personal decision

Discussion Questions Evaluating the Purchase of an Asset with Various Capital Budgeting Methods

Time in Minutes

Difficulty

3&4 3

20 30

Medium Difficult

2&4

30

Difficult

2&4

30

Difficult

3&4 3

20 30

Medium Difficult

2&4

30

Difficult

2&4

30

Difficult

3

20

Medium

All

45

Medium

All

30-60

Medium

Pre-Test Questions on MyAccountingLab: S12-2, S12-3, S12-4, S12-5, S12-12, S12-13 Post-Test Questions on MyAccountingLab: P12-56A, P12-58A

Answer Key to Chapter 12 Quiz (Quiz on following pages.)

1.

2.

3.

4.

5.

B D B A A

6. C 7. B 8. D 9. C 10. D

12-9 .

Name____________________________________ Date_________________ Section_______________

CHAPTER 12 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

Which of the following is correct?

A. All capital budgeting methods produce the same decision and their use is based on the information available.

B. Payback period ignores the cash flows after the original investment is recovered.

C. The accounting rate of return method considers the time value of money.

D. The cost of capital is the company’s desired rate of return.

2.

Which of the following capital decision methods uses accrual accounting rather than net cash flows, as a basis for calculations?

A. Payback method B. Internal Rate of Return C. Net Present Value D. Accounting Rate of Return

3.

Which of the following may be useful when comparing potential investments of different sizes?

A. Accounting Rate of Return B. Profitability index C. Future value of net cash inflows D. Payback method

4.

The internal rate of return is: A. the interest rate at which the net present value of the investment equals the cost of the investment.

B. the interest rate at which the net present value of the investment exceeds the company’s desired rate of return.

C. equal to the accounting rate of return.

D. none of the above.

5.

Which of the following capital decision methods ignores the time value of money?

A. Accounting Rate of Return B. Internal Rate of Return C. Net Present Value D. Profitability index

12-10 .

6.

Eagle Corporation is considering the purchase of a new machine. The machine cost $550,000 and will generate an annual net cash inflow of $100,000. What is the payback period?

A. 4 years and 6 months B. 5 years C. 5 years and 6 months D. 6 years and 1 month

7.

Cardinal Company purchased a new machine for $125,000. The machine will last eight years and will be depreciated using the straight-line method. The estimated residual value of the machine is zero and should generate a yearly cash inflow of $30,000. Ignoring taxes, what is the accounting rate of return?

A. 3.65% B. 11.5% C. 23% D. 24%

8.

Which of the following decision rules is a correct statement?

A. If the net present value is positive, do not invest in the capital asset.

B. If the internal rate of return is less than the required rate of return, invest in the asset.

C. Investments with longer payback periods are more desirable, all else being equal.

D. If the net present value is positive, invest in the capital asset.

9.

Which of the following is not a factor when considering the time value of money?

A. The interest rate B. The principal amount C. The payback period D. The number of periods

10.

The final step in the capital budget process is: A. to identify potential capital investments.

B. to engage in capital rationing, if necessary, to choose among alternative investments.

C. to utilize decision rules when screening out undesirable investments.

D. to perform post-audits after making capital investments.

12-11 .

Chapter 13 Overview Statement of Cash Flows

This chapter begins by reviewing the four basic financial statements and discussing why the statement of cash flows is so important. The three types of activities that generate and use cash (operating, investing, and financing activities) are then covered in detail. Included is the treatment of non-cash investing and financing transactions. The two methods of presenting operating activities, direct and indirect, are then introduced.

The first set of Decision Guidelines presents some decisions that need to be made before preparing the statement of cash flows. The accompanying Summary Problem reinforces the classification of various transactions as operating, investing, or financing activities.

The second part of the chapter fully illustrates the preparation of the statement of cash flows using both the indirect and the direct methods, emphasizing that the two methods differ only in the presentation of operating activities. The investing and financing activities are prepared the same way under both methods. A section of the chapter describes how to interpret the statement of cash flows and explains how the concept of free cash flow is computed.

The final set of Decision Guidelines provides general guidelines for preparing the statement of cash flows using either the indirect or direct method. The Summary Problem allows practice preparing the statement of cash flows using the indirect method.

Learning Objectives After studying Chapter 13, your students should be able to: 1. Classify cash flows as operating, investing or financing activities.

2. Prepare the statement of cash flows using the indirect method.

3. Prepare the statement of cash flows using the direct method.

13-1 .

Teaching Outline 1. Review four basic financial statements a. Income Statement b. Balance Sheet c. Statement of Stockholders’ Equity d. Statement of Cash Flows i. Exhibit 13-1 Basic Format of the Statement of Cash Flows ii. Cash equivalents 2. Classify cash flows a. Operating activities b. Investing activities c. Financing activities d. Exhibit 13-2 Classification of Activities on the Statement of Cash Flows 3. Non-cash investing and financing activities 4. Discuss two methods of presenting operating activities a. Direct b. Indirect 5. Prepare the statement of cash flows using the indirect method (Exhibit 13-14) a. Items needed i. Income statement for the current year ii. Comparative balance sheets iii. Miscellaneous additional information concerning investing and financing transactions b. Operating activities (reconcile accrual based net income back to a cash basis) i. Non-cash expenses ii. Non-cash revenues iii. Changes in non-cash current asset accounts 1. Exhibit 13-7 General Rule for Increases in Current Asset Accounts 2. Exhibit 13-8 General Rule for Decreases in Current Asset Accounts iv. Changes in current liability accounts 1. Exhibit 13-10 General Rule for Decreases in Current Liability Accounts 2. Exhibit 13-11 General Rule for Increases in Current Liability Accounts v. Interpreting cash flows from operating activities vi. Exhibit 13-15 Steps for Using the Indirect Method c. Investing activities (reconcile all long-term asset accounts) i. Property, plant and equipment ii. Accumulated depreciation iii. Investments d. Financing activities (reconcile all long-term liability and owner’s equity accounts) i. Long-term liabilities ii. Common stock iii. Retained earnings e. Interpreting the statement of cash flows – free cash flow 13-2 .

6. Prepare the statement of cash flows using the direct method (Exhibit 13-16) a. Operating activities i. Determine cash receipts ii. Determine cash payments b. Investing and financing activities – same regardless of method used for operating activities (see above 5c and 5d) c. Comparison of direct and indirect methods

13-3 .

Key Topics The statement of cash flows can be confusing to students because most of the material covered up to this point has been accrual based. Now they are being asked to look at the cash flow so that they can recognize inflows and outflows of cash.

Ask students what they would do if they needed cash. The answers will vary, but there are basically three ways to do this and they fall into the three classifications of cash flows on the statement. They either need to earn it (operating activities), sell something they own (investing activities), or borrow it (financing activities). This helps students see that ultimately a company must generate its cash flow from operations.

Emphasize that the disclosure of any non-cash investing and financing activities is important because these activities will affect cash flow in the upcoming years. This information is necessary when making decisions about and for the company.

Illustrate the two methods, direct and indirect, for preparing cash flows from operating activities side by side so that students can see the similarities and the differences. Students are often confused by the reconciliation of net income to net cash flows from operating activities using the indirect method. Show them step by step how each type of account (non-cash revenues and expenses, current assets, current liabilities, and gains/losses) can affect net income differently than the cash flow. Emphasizing why amounts are added or subtracted as a means to ‘adding’ the items to net income or ‘removing’ the items from net income is helpful. Be sure they understand that regardless of the method used, the net cash flow from operating activities will be exactly the same under both methods.

To help students work with the indirect method concept, show them the following grid: Begin with Net Income (Loss) ADD 1. Non-cash expenses like depreciation 2. Losses 3. Decreases in non-cash Current Assets 4. Increases in Current Liabilities

SUBTRACT 1. Gains 2. Increases in non-cash Current Assets 3. Decreases in Current Liabilities

Have students work in teams to complete E13-24B Calculate operating cash flows (indirect method) (10 minutes). Call on a student to present the solution.

Have students work in teams to complete E13-27B Compute operating cash flows using direct method (15 minutes). Call on a student to present their solution.

Point out the similarities and differences between the two methods using the results of the two exercises.

As an alternative, you might decide to calculate both methods using the same data, so that students can see the operating cash flow amounts are the same.

When illustrating the preparation of the investing and financing sections of the statement of cash flows, emphasize that these are prepared exactly the same no matter which method is used for preparing the operating activities section. Be sure students understand that both inflows and outflows of cash for each account must be presented in the investing and financing sections.

13-4 .

Chapter 13: Student Summary Handout 1. Four basic financial statements a. Income Statement b. Balance Sheet c. Statement of Stockholders’ Equity d. Statement of Cash Flows i. Exhibit 13-1 Basic Format of the Statement of Cash Flows ii. Cash equivalents 2. Classify cash flows a. Operating activities b. Investing activities c. Financing activities d. Exhibit 13-2 Classification of Activities on the Statement of Cash Flows e. Non-cash investing and financing activities 3. Prepare the statement of cash flows using the indirect method (Exhibit 13-14) a. Items needed i. Income statement for the current year ii. Comparative balance sheets iii. Miscellaneous additional information concerning the investing and financing transactions b. Operating activities (reconcile accrual based net income back to a cash basis) i. Non-cash expenses ii. Non-cash revenues iii. Changes in noncash current asset accounts 1. General rule of thumb: If a current asset account increases, then subtract the change from net income. (Exhibit 13-7) 2. General rule of thumb: If a current asset account decreases, then add the change to net income. (Exhibit 13-8) iv. Changes in current liability accounts 1. General rule of thumb: If a current liability account decreases, then subtract the change from net income. (Exhibit 13-10) 2. General rule of thumb: If a current liability account increases, then add the change to net income. (Exhibit 13-11) v. Interpreting cash flows from operating activities vi. Exhibit 13-15 Steps for Using the Indirect Method c. Investing activities (reconcile all long-term asset accounts) i. Property, plant and equipment ii. Accumulated depreciation reconciliation iii. Investments d. Financing activities (reconcile all long-term liability and owner’s equity accounts) i. Long-term liabilities ii. Common stock iii. Retained earnings e. Interpreting the statement of cash flows i. Free cash flow = Cash flow from operating activities – capital expenditures 13-5 .

4. Prepare the statement of cash flows using the direct method (Exhibit 13-16) a. Operating activities i. Determine cash receipts ii. Determine cash payments b. Investing and financing activities – same regardless of method used for operating activities (see above 3c and 3d) c. Comparison of direct and indirect methods

5. MyAccountingLab.com algorithmic homework assignments: S13-2, S13-4, E13-11A, E13-12A, E13-19A.

13-6 .

Chapter 13: ASSIGNMENT GRID Assignment

Topic(s)

Learning Objective(s)

Estimated Time in Minutes

Level of Difficulty

5 5

Easy Easy

5

Easy

5

Easy

5 5 5

Easy Easy Easy

10

Medium

5

Easy

10

Medium

10

Medium

10

Medium

15

Medium

10

Medium

10

Medium

15

Medium

15

Medium

15

Medium

10

Medium

5

Medium

Short Exercises S13-1 S13-2

S13-3 S13-4 S13-5 S13-6 S13-7 S13-8 S13-9 S13-10

E13-11A E13-12A E13-13A

E13-14A E13-15A E13-16A E13-17A E13-18A E13-19A E13-20A

Classifying cash flows 1 Identifying activities for the 1&2 statement of cash flows – indirect method Preparing the operating cash flows 2 section (indirect method) Classify cash flows as operating, 1&2 investing, or financing Calculate investing cash flows 1, 2 & 3 Calculate financing cash flows 2&3 Classify cash flows as operating, 1, 2, & 3 investing, or financing Prepare statement of cash flows 2 (indirect method) Calculate increase or decrease in 3 current assets and liabilities Prepare statement of cash flows 3 (direct method) Exercises (Set A) Prepare operating cash flows 2 section (indirect method) Prepare statement of cash flow 2 preparation (indirect method) Calculate cash flows from 2&3 operating, investing and financing activities (direct method) Calculate operating cash flows 2 (indirect method) Prepare statement of cash flows 2 (indirect method) Prepare statement of cash flows 2 (indirect method) Compute operating cash flows 3 using direct method Prepare statement of cash flows 3 (direct method) Prepare statement of cash flows 3 (direct method) Classify sustainable activities 1, 2, & 3 effect on cash flows

13-7 .

Assignment

E13-21B E13-22B E13-23B

E13-24B E13-25B E13-26B E13-27B E13-28B E13-29B E13-30B

P13-31A P13-32A P13-33A P13-34A

P13-35B P13-36B P13-37B P13-38B

Decision Case A13-39

Topic(s)

Learning Objective(s)

Exercises (Set B) Prepare operating cash flows 2 section (indirect method) Prepare statement of cash flow 2 preparation (indirect method) Calculate cash flows from 2&3 operating, investing and financing activities (direct method) Calculate operating cash flows 2 (indirect method) Prepare statement of cash flows 2 (indirect method) Prepare statement of cash flows 2 (indirect method) Compute operating cash flows 3 using direct method Prepare statement of cash flows 3 (direct method) Prepare statement of cash flows 3 (direct method) Classify sustainable activities 1, 2, & 3 effect on cash flows Problems (Set A) Prepare statement of cash flows 2 (indirect method) Prepare statement of cash flows 1&2 (indirect method) Prepare a statement of cash flows 1&3 (direct method) Prepare statements of cash flows 1, 2, & 3 (indirect and direct methods) Problems (Set B) Prepare statement of cash flows 2 (indirect method) Prepare statement of cash flows 1&2 (indirect method) Prepare a statement of cash flows 1&3 (direct method) Prepare statements of cash flows 1, 2, & 3 (indirect and direct methods) Other Use cash flow data to evaluate potential investments

13-8 .

1&2

Estimated Time in Minutes

Level of Difficulty

10

Medium

10

Medium

15

Medium

10

Medium

10

Medium

15

Medium

15

Medium

15

Medium

10

Medium

5

Medium

20

Medium

25

Difficult

30

Difficult

30

Difficult

20

Medium

25

Difficult

30

Difficult

30

Difficult

15

Medium

Assignment

Discussion and Analysis A13-40 Application and Analysis A13-41

Topic(s)

Learning Objective(s)

Estimated Time in Minutes

Level of Difficulty

Discussion questions

All

30-40

Medium

Comparing Cash Flow Statements from Companies in the Same Industry

All

30-60

Medium

Pre-Test Questions on MyAccountingLab: S13-1, S13-5, S13-8, S13-9, S13-10 Post-Test Questions on MyAccountingLab: P13-31A, P13-33A, P13-34A

Answer Key to Chapter 13 Quiz (Quiz on following pages.)

1.

2.

3.

4.

5.

D B C A B

6. A 7. D 8. B 9. C 10. C

13-9 .

Name____________________________________ Date_________________ Section_______________

CHAPTER 13 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

Which of the following statements is true regarding a statement of cash flows?

A. A statement of cash flows measures the profitability of a company using the cash basis of accounting.

B. Two different methods may be used to compute the net cash flows from operating, investing, and financing activities.

C. Non-cash investing and financing activities do not need to be disclosed.

D. The statement of cash flows reports the changes in cash and cash equivalents.

2.

Which of the following is a cash equivalent?

A. Accounts receivable B. Certificates of deposit that mature in less than three months C. Certificates of deposit that mature in one year or less D. Prepaid expenses

3.

Which of the following activities is an operating activity?

A. Payment on the principal portion of a bank loan B. Collection of cash from issuing stock C. Payment of interest on a bank loan D. Payment of cash dividends

4.

Which of the following activities would NOT be considered an investing activity?

A. Issuance of common stock B. Purchase of used equipment C. Sale of land D. Sale of a long-term investment

5.

Which of the following activities is a financing activity?

A. Purchase of land by issuing stock B. Payment of cash dividends C. Purchase of land for cash D. Purchase of inventory for cash

6.

On a statement of cash flows, the net increase in cash was $24,000. Cash provided from operations was $30,000. If the net cash outflow from investing activities was $7,000, then what was the net cash flow from financing activities?

A. A net inflow of $1,000 B. A net outflow of $1,000 C. A net inflow of $13,000 D. A net outflow of $13,000

13-10 .

7.

Using the following information for Stewart Auto, Inc., calculate the net cash flow from operating activities using the indirect method.

Net income Depreciation expense Increase in accounts receivable Decrease in inventory Increase in accounts payable Loss on sale of equipment

$150,000 10,000 4,000 5,000 8,000 7,000

The net cash provided by operating activities is: A. $142,000.

B. $144,000.

C. $160,000.

D. $176,000.

8.

Which of the following statements is correct regarding the indirect method of preparing a statement of cash flows?

A. A decrease in inventory is subtracted from net income.

B. A loss on the sale of an investment is added to net income.

C. Depreciation expense is subtracted from net income.

D. An increase in wages payable is subtracted from net income.

9.

Which of the following statements is correct regarding the direct method of preparing a statement of cash flows?

A. Depreciation expense is added as a reconciling item.

B. It is easier and less costly to prepare than the indirect method.

C. A supplementary schedule reconciling net income to the cash basis must also be provided.

D. All of the statements above are correct.

10.

Which of the following is an example of a noncash investing and financing activity that is disclosed in a supplementary schedule accompanying the statement of cash flows or in a footnote to the financial statements?

A. Selling goods on credit B. Paying the amount due a creditor C. Purchasing equipment in exchange for a long-term note D. Gain on the sale of land

13-11 .

Chapter 14 Overview Financial Statement Analysis

This chapter continues the discussion of performance evaluation and decision making. A company’s performance is often evaluated by comparing its current performance to past performance, to other companies’ performance, or to industry averages. The first half of the chapter illustrates horizontal and vertical analysis. Horizontal analysis compares the company’s financial performance over time.

Horizontal analysis, including both dollar changes and percentage changes, is explained and illustrated using a comparative income statement and balance sheet. Trend percentages are also explained and illustrated. Vertical analysis consists of computing each line of the financial statements as a percentage of a base amount. Total revenue (net sales) serves as the base amount for the income statement, while total assets is used as the base amount for the balance sheet. The use of common-size statements as a means of comparing one company with another is illustrated. The use of benchmarking and comparison to industry averages is also discussed.

The first set of Decision Guidelines summarizes how decision makers judge the financial performance of a company. The accompanying Summary Problem gives the student practice using the elements of financial statement analysis presented in the first half of the chapter – trend, horizontal, and vertical analysis.

The second half of the chapter presents several of the most commonly used financial statement ratios.

The use of ratio analysis to help make business decisions is discussed. Ratio analysis is presented using the following categories: • Ratios measuring a company’s ability to pay current liabilities (working capital, current ratio, and acid-test (quick) ratio) • Ratios measuring a company’s ability to sell inventory and collect receivables (inventory turnover, accounts receivable turnover, and days’ sales in receivables) • Ratios measuring a company’s ability to pay long-term debt (debt ratio and times-interest-earned ratio) • Ratios measuring profitability (rate of return on net sales, rate of return on total assets, rate of return on common stockholders’ equity, and earnings per share of common stock) • Ratios analyzing current or potential stock investments (price/earnings ratio, dividend yield, and book value per share of common stock).

This section is followed with a discussion of the red flags that may signal financial trouble. The chapter concludes with suggestions on how to disclose a company’s sustainability targets and achievements.

The last set of Decision Guidelines summarizes the information that ratios can provide investors, creditors, and managers. The final Summary Problem affords the student practice in the calculation of the ratios presented in the chapter. In addition, the student compares the calculated ratios for the company presented to those of its competitors.

14-1 .

Learning Objectives After studying Chapter 14, your students should be able to: 1. Perform a horizontal analysis of financial statements.

2. Perform a vertical analysis of financial statements.

3. Prepare and use common-size financial statements.

4. Compute the standard financial ratios.

14-2 .

Teaching Outline 1. Describe three common methods of analysis a. Horizontal b. Vertical c. Ratio 2. Illustrate horizontal analysis a. Compute the dollar amount of the change from the earlier period to the later period b. Divide the dollar amount of change by the earlier (base) period amount c. Comparative Financial Statements i. Exhibit 14-3 Comparative Income Statement – Horizontal Analysis ii. Exhibit 14-4 Comparative Balance Sheet – Horizontal Analysis d. Trend percentages i. Exhibit 14-5 Supermart’s Sales Trends 3. Illustrate vertical analysis a. Financial statement line items expressed as a percentage of the base amount b. Income statement: Net sales revenue is the base amount i. Exhibit 14-7 Income Statement – Vertical Analysis c. Balance sheet: Total assets is the base amount i. Exhibit 14-8 Balance Sheet – Vertical Analysis d. Common-size financial statements i. Exhibit 14-9 Common-Size Income Statement 4. Compute financial ratios a. Measuring ability to pay current liabilities i. Working Capital ii. Current Ratio iii. Acid-test Ratio (Quick Ratio) b. Measuring ability to sell inventory and collect receivables i. Inventory Turnover ii. Accounts Receivable Turnover iii. Days’-Sales-in-Receivables c. Measuring ability to pay long-term debt i. Debt Ratio ii. Times-Interest Earned ratio d. Measuring profitability i. Rate of Return on Net Sales ii. Rate of Return on Total Assets iii. Rate of Return on Common Stockholders’ Equity 1. Leverage/trading on the equity iv. Earnings per Share of Common Stock e. Analyzing stock investments i. Price/Earnings Ratio ii. Dividend Yield iii. Book Value per Share of Common Stock

14-3 .

f.

Discuss red flags in financial statement analysis i. Movement of sales, inventory, and receivables ii. Earnings problems iii. Decreased cash flow iv. Too much debt v. Inability to collect receivables vi. Buildup of inventories g. Sustainability and financial statement analysis i. Disclosure of sustainability targets and achievements in annual report or in a separate Corporate Social Responsibility (CSR) report

14-4 .

Key Topics Emphasize that horizontal analysis looks at numbers across the balance sheet and income statement over time. On the other hand, vertical analysis looks down the balance sheet and income statement, expressing the percentage of each line item as a percentage of a total (base) amount. Net sales revenue is usually used as the base amount on the income statement, while total assets is used as the base amount on the balance sheet. The percentages computed through vertical analysis could be represented through a pie chart: each line item represents a fraction of the whole pie.

Students sometimes get confused with the horizontal analysis calculations for subtracted/negative numbers (such as expenses on the income statement). Point out that the absolute value of these numbers is used to determine if there is an increase or a decrease.

Have students work in teams to complete E14-25B Horizontal analysis (10 minutes). Call on a student to give their responses.

The base year is the starting point to determine whether an account increased or decreased. While the base year is often the prior year, it does not have to be (for example, one account may be looked at over multiple years, all compared to the base year, to determine its trend).

Have students work together to complete E14-27B Perform vertical analysis (10 minutes). Call on a student to give their responses.

Show students that the gross profit percentage and net income as a percentage of sales ratios are part of the vertical analysis of the income statement.

Be sure to explain how to interpret the results of the financial ratios. Students need to not only know how to do the calculations, but also how to understand the results. Is the number a good one? Has the company improved? Which company is better? Once students have the result, what do they do with it?

Have students work together to complete E14-29B Calculate ratios (10 minutes). Call on a student to give their responses.

Start a discussion among students about how much cash a company should maintain. For example, imagine a company having $1,000,000 cash in excess of its liabilities. How much cash is too much (a high current ratio)? What if the amount of cash was not enough to pay its liabilities (a low current ratio)?

Continue the discussion and ask students about the ability to pay current liabilities in a financial emergency. If a company needed cash the same day, what could it use to pay? What information is available from the acid-test ratio that would differ from the current ratio? The assets used in the acid-test ratio exclude inventory, so having a high current ratio doesn’t translate into a high acid-test ratio if the company is holding a large dollar amount in inventory.

Analysis of turnover ratios follows the same pattern. When inventory is sold, it becomes cost of goods sold. Accounts receivable develop from credit sales. So inventory turnover = cost of goods sold/average inventory and accounts receivable turnover = net credit sales/average net accounts receivable.

Start a discussion among the students about comparing companies to industry averages. If one company has an inventory turnover of four, it sells the inventory roughly every three months. That might be good 14-5 .

for a furniture store but it is not appetizing for a grocery store which may sell its entire dollar value of inventory every three days.

If students understand the theory behind calculating the accounts receivable turnover ratio and the days’ sales in average accounts receivable ratio, they can understand that days’ sales in average accounts receivables can be calculated as 365/accounts receivable turnover ratio.

If a company normally requires its customers to pay their accounts receivables within 20 days, what can be determined from a company that has 18 average days’ sales remaining in accounts receivable? The company strongly enforces its accounts receivable collection policies.

Current ratios illustrate the company’s ability to pay its current liabilities. The debt ratio illustrates the portion of assets that are financed with liabilities. That is why liabilities are the denominator in the current ratio and the numerator in the debt ratio.

Students may not realize why it is important to know how many times interest is earned through operating income. Ask students if they have ever had a car loan. What is the biggest part of each monthly payment? For the first 65% of the payment period, most loan payments are primarily interest.

Point out to students that all of the profitability ratios have something in common; they all begin with income.

14-6 .

Chapter 14: Student Summary Handout 1. Three common methods of analysis a. Horizontal – provides a year-to-year comparison of a company’s performance in different periods i. Compute the dollar amount of the change from the earlier period to the later period ii. Divide the dollar amount of change by the earlier (base) period amount iii. Comparative Financial Statements 1. Exhibit 14-3 Comparative Income Statement – Horizontal Analysis 2. Exhibit 14-4 Comparative Balance Sheet – Horizontal Analysis iv. Trend percentage 1. Select a base year 2. Express each following year as a percentage of the base amount (i.e., any year’s dollar amount divided by the base year dollar amount) 3. Exhibit 14-5 Supermart’s Sales Trends b. Vertical – provides a means of evaluating the relative size of each line item in the financial statements allowing comparison of companies of different sizes i. Relationship (percentage) of each item to its base amount 1. The base amount is the 100% figure 2. Income Statement base amount is net sales revenue 3. Balance Sheet base amount is total assets 4. Exhibit 14-7 Income Statement – Vertical Analysis 5. Exhibit 14-8 Balance Sheet – Vertical Analysis ii. Common-size financial statements: Benchmarking 1. Exhibit 14-9 Common-Size Income Statement c. Ratios – provides a means of evaluating relationships between key components of the financial statements i. Measuring ability to pay current liabilities 1. Working Capital = Current assets – Current liabilities 2. Current Ratio = Current assets/Current liabilities 3. Acid-test (Quick) Ratio = (Cash + Short-term investments + Net current receivables)/Current liabilities ii. Measuring ability to sell inventory and collect receivables 1. Inventory Turnover = Cost of goods sold/Average inventory 2. Accounts Receivable Turnover = Net credit sales/Average net accounts receivable 3. Days’ Sales in Receivables = Average net accounts receivable/One day’s sales (where One day’s sales = Net sales/365 days) iii. Measuring ability to pay long-term debt 1. Debt Ratio = Total liabilities/Total assets 2. Times-Interest-Earned ratio = Income from operations/Interest expense iv. Measuring profitability 1. Rate of Return on Net Sales = Net income/Net sales 2. Rate of Return on Total Assets = (Net income + Interest expense)/Average total assets 3. Rate of Return on Common Stockholders’ Equity = (Net income – Preferred dividends)/Average common stockholders’ equity 14-7 .

a. Leverage/trading on the equity 4. Earnings per Share of Common Stock = (Net income – Preferred dividends)/Number of shares of common stock outstanding a. Outstanding common stock = Number of share of common stock issued – Treasury stock v. Analyzing stock investments 1. Price/Earnings (P/E) Ratio = Market price per share of common stock/Earnings per share 2. Dividend Yield on Common Stock = Dividend per share of common stock/Market price per share of common stock 3. Book Value per Share of Common Stock = (Total stockholders’ equity – Preferred equity)/Number of shares of common stock outstanding 2. Red flags in financial statement analysis a. Movement of sales, inventory, and receivables b. Earnings problems c. Decreased cash flow d. Too much debt e. Inability to collect receivables f. Buildup of inventories 3. Sustainability and financial statement analysis a. In annual report b. Separate Corporate Social Responsibility (CSR) report 4. MyAccountingLab.com algorithmic homework assignments: E14-12A, E14-13A, E14-14A, E14-18A, E14-19A, E14-22A.

14-8 .

Chapter 14: ASSIGNMENT GRID Assignment

S14-1 S14-2 S14-3 S14-4 S14-5 S14-6 S14-7 S14-8 S14-9 S14-10 S14-11

E14-12A E14-13A E14-14A E14-15A E14-16A E14-17A E14-18A E14-19A E14-20A E14-21A E14-22A E14-23A

E14-24B E14-25B E14-26B E14-27B E14-28B

Topic(s)

Learning Objective(s)

Level of Difficulty

1

5

Easy

2 2 3

5 5 10

Easy Easy Easy

4 4 4 4 4 4

5 5 5 5 5 10

Easy Easy Easy Easy Easy Easy

4

10

Easy

1 1 1 2 3

10 10 10 10 10

Easy Easy Easy Easy Easy

4 4 4 4 4 4 4

10 20 20 20 20 20 10

Easy Medium Medium Medium Medium Medium Easy

1 1 1 2 3

10 10 10 10 10

Easy Easy Easy Easy Easy

Learning Objective(s)

Estimated Time in Minutes

Level of Difficulty

Short Exercises Horizontal analysis of revenue and cost of sales Find trend percentages Vertical analysis of assets Prepare common-size income statements Find current ratio Analyze inventory and receivables Compute and interpret debt ratio Compute profitability ratios Determine earnings per share Find missing values on income statement Find missing values on balance sheet Exercises (Set A) Trend analysis of working capital Horizontal analysis Compute trend percentages Perform vertical analysis Prepare common-size income statement Calculate ratios More ratio analysis Compute profitability ratios Compute stock ratios Find missing values Calculate ratios Classify company sustainability measurements into triple bottom line components Exercises (Set B) Trend analysis of working capital Horizontal analysis Compute trend percentages Perform vertical analysis Prepare common-size income statement

Assignment Topic(s)

14-9 .

Estimated Time in Minutes

E14-29B E14-30B E14-31B E14-32B E14-33B E14-34B E14-35B

P14-36A P14-37A P14-38A P14-39A P14-40A P14-41B P14-42B P14-43B P14-44B P14-45B Decision Cases A14-46 A14-47 A14-48 Ethical Issue A14-49 Team Project A14-50 Discussion and Analysis A14-51 Application and Analysis A14-52

Calculate ratios 4 More ratio analysis 4 Compute profitability ratios 4 Compute stock ratios 4 Find missing values 4 Calculate ratios 4 Classify company sustainability 4 measurements into triple bottom line components Problems (Set A) Prepare trend analysis 1&4 Comprehensive analysis 2, 3 & 4 Effect of transactions on ratios 4 Ratio analysis over two years 4 Make an investment decision 4 Problems (Set B) Prepare trend analysis 1&4 Comprehensive analysis 2, 3, 4 Effect of transactions on ratios 4 Ratio analysis over two years 4 Make an investment decision 4 Other

10 20 20 20 20 20 10

Easy Medium Medium Medium Medium Medium Easy

20 30 30 30 30

Medium Medium Medium Difficult Difficult

20 30 30 30 30

Medium Medium Medium Difficult Difficult

Investment recommendation Effect of transactions on ratios Identify affected ratios

4 4 4

30 30 20

Medium Medium Medium

Effect of decisions on ratios

4

20

Medium

Comparison of common size financials

3

30

Medium

Discussion questions

All

30

Medium

Calculating ratios for companies within the same industry

All

30-45

Medium

Pre-Test Questions on MyAccountingLab: S14-1, S14-2, S14-3, S14-4, S14-5, S15-6, S16-7, S14-8, S14-9 Post-Test Questions on MyAccountingLab: E14-20A, E14-21A, P14-37A

14-10 .

Answer Key to Chapter 14 Quiz (Quiz on following pages.)

1.

2.

3.

4.

5.

A B D A D

6. C 7. A 8. C 9. C 10. B

14-11 .

Name____________________________________ Date_________________ Section_______________

CHAPTER 14 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

A company’s income statement reports:

Net Sales Cost of goods sold Gross profit Selling expenses Administrative expenses Net income

2013 $48,000 26,000 22,000 7,000 9,000 $6,000

2012 $50,500 27,250 23,250 7,200 9,100 $6,950

Using horizontal analysis, compute the percent change for gross profit: A. -5.38%.

C. 27.27%.

B. -5.68%.

D. 100%.

2.

A company’s income statement reports:

Net Sales Cost of goods sold Gross profit Selling expenses Administrative expenses Net income

2013 $48,000 26,000 22,000 7,000 9,000 $6,000

2012 $50,500 27,250 23,250 7,200 9,100 $6,950

For the year 2011, vertical analysis computes the net income percentage as: A. -13.7%.

C. 27.3%.

B. 12.5%.

D. 100%.

3.

A common size financial statement is a useful tool in performance evaluation because it enables the user to: A. compare one company’s performance in different periods.

B. evaluate the direction a business is taking over a longer period of time.

C. evaluate relationships between key components in the financial statements.

D. compare companies of different sizes in the same industry.

14-12 .

4.

Comparing one company against a competitor or against industry averages is called: A. benchmarking.

B. comparative analysis.

C. horizontal analysis.

D. cost benefit analysis.

5.

The following amounts were selected from ABC company’s income statements:

Net Sales

Year 4 $155,000

Year 3 $150,000

Year 2 $130,000

Year 1 $100,000

Using trend analysis and Year 1 as the base year, the trend percentage for Year 4 is: A. 35%.

C. 100%.

B. 55%.

D. 155%.

6.

The accounts receivable turnover shows the: A. proportion of assets financed with debt.

B. ability to collect receivables.

C. ability to collect cash from credit customers.

D. number of times a company sells its average level of inventory during the year.

7.

A company’s balance sheet reports:

The debt ratio is: A. 0.65.

B. 0.95.

8.

Cash Accounts Receivable Inventory Plant & Equipment Total Assets

$ 50,000 75,000 110,000 95,000 $330,000

Current Liabilities Long-term liabilities Stockholders' equity Total Liabilities & Stockholders' Equity

$105,000 110,000 115,000 $330,000

C. D.

1.19.

1.87.

Shaker Corporation was organized on January 1 of the current year with 200,000 shares of $15 par value common stock authorized with 100,000 shares issued on that date. No other changes in common stock occurred during the year. The annual preferred stock dividend is $30,000. Net income for the current year was $400,000. What was the earnings per share reported on the income statement for the current year?

A. $1.85 B. $2.00 C. $3.70 D. $4.00

14-13 .

9.

Which of the following is NOT a measure of a company’s ability to pay its current liabilities?

A. Current ratio B. Working capital C. Debt ratio D. Acid-test (quick) ratio

10.

Which of the following help measure a company’s profitability?

A. Price/earnings ratio B. Rate of return on total assets C. Times-interest-earned ratio D. Current ratio

14-14 .

Chapter 15 Overview Environmental Sustainability The chapter is devoted to the importance of environmental sustainability to today’s organizations.

Students are introduced to environmental management accounting (EMA) and how it can help support an organization’s efforts toward environmental sustainability. The business reasons for adopting environmentally sustainable practices are discussed. EMA uses two types of information for internal decision making: monetary and physical information. Illustrations of both types are given.

EMA information is used to help support a manager’s primary responsibilities of planning, directing, controlling, and decision-making. Common areas where management accountants can support an organization’s sustainability efforts include compliance, strategy development, systems and information flow, costing, investment appraisal, performance management, and reporting. The use of the triple bottom line reports on three factors: profit, people, and planet. Many organizations have expanded their tracking and reporting to include their carbon footprint and water footprint.

The areas of an organization that can impose challenges in implementing EMA include communication issues, hidden costs, aggregated accounting information, the historical orientation of accounting, and the fact that EMA is a new and evolving field. With an increased interest in sustainability and “green” practices by the general public, there will be an increased need for management accountants to assist their organizations in supporting sustainability.

The Decision Guidelines illustrate some of the business reasons for adopting sustainable business practices. The guidelines outline the types of information an EMA system collects and analyzes. The Decision Guidelines conclude with how EMA information is used and the challenges faced in implementing an EMA system.

Learning Objectives After studying Chapter 15, your students should be able to: 1. Describe why sustainability is important to today’s organizations.

2. Describe the role of management accounting in supporting sustainability.

3. Describe the challenges to implementing and using an environmental management accounting system.

15-1 .

Teaching Outline 1. Explain the importance of sustainability a. Define sustainability b. Exhibit 15-1 Business Reasons for Adopting Environmentally Sustainable Practices i. Cost reduction ii. Regulatory compliance iii. Stakeholder influence iv. Competitive strategy 2. Discuss the information used to support sustainability a. Define environmental management accounting (EMA) b. Types of information used for internal decision making i. Monetary information ii. Physical information c. Materials flow accounting 3. Uses of environmental management accounting information a. To support managers’ primary responsibilities of planning, directing, controlling, and decision-making b. Compliance c. Strategy development i. Triple bottom line: profit, people, planet d. Systems and information flow e. Costing f. Investment appraisal g. Performance management i. Balanced scorecard ii. Carbon footprint iii. Water footprint h. Reporting i. Exhibit 15-2 FPO (Organizations developing standards related to external environmental reporting) 4. Discuss the challenges to implementing environmental management accounting a. Communication issues b. Hidden costs c. Aggregated accounting information and archaic information systems d. Historical orientation of accounting e. Undeveloped field 5. Future of environmental management accounting

15-2 .

Key Topics This chapter can be used to illustrate how the various concepts and techniques learned in earlier chapters can be applied to environmental sustainability. Begin by asking the students why they think sustainability is important to today’s organizations. This is also a good time to review manager’s four primary responsibilities of planning, directing, controlling, and decision- making. Ask the students to give examples of responsibilities in each area as related to environmental sustainability.

Ask the students to identify an organization that has been in the news as a company concerned about the effect of their operations on the environment. Using that organization, have the students give examples of business reasons for the organization adopting sustainable practices. Categorize the reasons by category: cost reduction, regulatory compliance, stakeholder influence, and competitive strategy.

Introduce the concept of environmental management accounting (EMA). For the company identified above, what are some examples of monetary and physical information that the organization might use in internal decision-making? What type of information might be tracked using materials flow accounting?

Once an organization has some of that information, how can it be used? Discuss the triple bottom line including the students’ opinions as to its use. Ask the students if they can explain what the carbon footprint and water footprint are. Where do companies report the triple bottom line?

In teams or in partners, have students complete E15-20B Identify sustainability efforts as impacting people, planet, or profit (10 minutes). Call on a student to give the answers.

Ask the students what they see as the challenges to implementing EVM. Do they think that more organizations will begin using EMA and reporting environmental information?

As time allows, various exercises can be used to illustrate how the concepts and techniques learned throughout the course can be applied to environmental sustainability. The importance of the use of these concepts and techniques to make management decisions regarding sustainability should be emphasized.

Various exercises can be used to illustrate the applications of these concepts and techniques. Some suggested exercises are: E15-21B Sustainability and the value chain (5 minutes); E15-22B Sustainability and job costing (10 minutes); E15-23B Sustainability and activity-based costing (15-20 minutes); E15-24B Sustainability and process-costing (15-20 minutes); E15-26B Sustainability and CVP concepts (15-20 minutes); E15-27B Sustainability and short-term decision-making (10 minutes); E15-28B Sustainability and budgeting (15-20 minutes); E15-29B Sustainability and the balanced scorecard (10 minutes); and E15-31B Sustainability and capital investments (10 minutes).

Students can be divided up into teams to complete selected exercises from the list and then called on to share their results.

15-3 .

Chapter 15: Student Summary Handout 1. Explain the importance of sustainability a. Sustainability – ability to meet the needs of the present without compromising the ability of future generations to meet their own needs b. Exhibit 15-1 Business Reasons for Adopting Environmentally Sustainable Practices i. Cost reduction ii. Regulatory compliance iii. Stakeholder influence iv. Competitive strategy 2. Discuss the information used to support sustainability a. Define environmental management accounting (EMA) b. Types of information used for internal decision making i. Monetary information ii. Physical information c. Materials flow accounting 3. Uses of environmental management accounting information a. To support managers’ primary responsibilities of planning, directing, controlling, and decision-making b. Compliance c. Strategy development i. Triple bottom line: profit, people, planet d. Systems and information flow e. Costing f. Investment appraisal g. Performance management i. Balanced scorecard ii. Carbon footprint iii. Water footprint h. Reporting i. Exhibit 15-2 FPO (Organizations developing standards related to external environmental reporting) 4. Discuss the challenges to implementing environmental management accounting a. Communication issues b. Hidden costs c. Aggregated accounting information and archaic information systems d. Historical orientation of accounting e. Undeveloped field 5. Future of environmental management accounting 6. MyAccountingLab.com algorithmic homework assignments: E15-6A, E15-7A, P15-34A, P1535A

15-4 .

CHAPTER 15: ASSIGNMENT GRID Assignment

S15-1 S15-2 S15-3 S15-4 S15-5

E15-6A E15-7A E15-8A E15-9A E15-10A E15-11A E15-12A E15-13A E15-14A E15-15A E15-16A E15-17A E15-18A E15-19A

E15-20B

Learning Objective(s)

Topic(s)

Short Exercises Identifying reasons to pursue 1 sustainability Classifying sustainability 2 costs Distinguish between monetary and physical 2 information Identifying implementation 3 challenges Define key sustainability 1, 2, & 3 terms Exercises (Set A) Identify impact of 2 sustainability efforts Sustainability and the value 1 chain Sustainability and job 2 costing Sustainability and activity2 based costing Sustainability and process 2 costing Sustainability and cost 2 behavior Sustainability and CVP 2 concepts Sustainability and short-term 2 decision-making Sustainability and budgeting 2 Sustainability and the 2 balanced scorecard Sustainability and standard 2 costing Sustainability and capital 2 investments Sustainability and the 1&2 statement of cash flows Sustainability and external 2 financial reporting Exercises (Set B) Identify sustainability efforts as impacting people, planet, 2 or profit 15-5 .

Estimated Time in Minutes

Level of Difficulty

5

Easy

5

Easy

5

Easy

5

Easy

5

Easy

10

Easy

5

Easy

10

Easy

15-20

Medium

15-20

Medium

15-20

Medium

15-20

Medium

10

Medium

15-20

Medium

10

Easy

15-20

Medium

10

Easy

10

Easy

5

Easy

10

Easy

Assignment

E15-21B E15-22B E15-23B E15-24B E15-25B E15-26B E15-27B E15-28B E15-29B E15-30B E15-31B E15-32B E15-33B

P15-34A P15-35A

P15-36B P15-37B Discussion and Analysis A15-38 Application and Analysis A15-39 Team Project A15-40

Learning Objective(s)

Topic(s)

Sustainability and the value 1 chain Sustainability and job 2 costing Sustainability and activity2 based costing Sustainability and process 2 costing Sustainability and cost 2 behavior Sustainability and CVP 2 concepts Sustainability and short-term 2 decision-making Sustainability and budgeting 2 Sustainability and the 2 balanced scorecard Sustainability and standard 2 costing Sustainability and capital 2 investments Sustainability and the 1&2 statement of cash flows Sustainability and external 2 financial reporting Problems (Set A) Sustainability and cost 2 behavior Sustainability and capital 1&2 investments Problems (Set B) Sustainability and cost 2 behavior Sustainability and capital 1&2 investments Other

Estimated Time in Minutes

Level of Difficulty

5

Easy

10

Easy

15-20

Medium

15-20

Medium

15-20

Medium

15-20

Medium

10

Medium

15-20

Medium

10

Easy

15-20

Medium

10

Easy

10

Easy

5

Easy

20

Medium

15

Medium

20

Medium

15

Medium

Discussion questions

All

30

Medium

Corporate sustainability reports

All

30-40

Medium

Sustainability and investment choices

1&2

60

Difficult

15-6 .

Pre-Test Questions on MyAccountingLab: S15-1, S15-2, S15-3, S15-4, S15-5 Post-Test Questions on MyAccountingLab: E15-20B, E15-21B, P15-34A, P15-35A

Answer Key to Chapter 15 Quiz (Quiz on following pages.)

1.

2.

3.

4.

5.

D D C C D

6. A 7. B 8. B 9. A 10. C

15-7 .

Name____________________________________ Date_________________ Section_______________

CHAPTER 15 TEN-MINUTE QUIZ Circle the letter of the best response.

1. All of the following are business reasons for adopting environmentally sustainable practices except A. cost reduction.

B. competitive strategy.

C. stakeholder influence.

D. historical orientation of accounting.

2. The type(s) of information used for internal decision making in environmental management accounting is (are) A. monetary information.

B. physical information.

C. neither monetary and physical information.

D. both monetary and physical information.

3. The triple bottom line reports on A. process, productivity, and profit.

B. profit, planet, and productivity.

C. people, profit, and planet.

D. profit, planet, and process.

4.

Which of the following statements is FALSE? A. Environmental management accounting is used for the identification, collection, analysis, and use of both monetary information and physical information for management decision making.

B. Materials flow accounting reconciles physical inputs with physical outputs.

C. Non-monetary information is one of the two types of information used in an environmental management accounting system.

D. Physical information is one type of information used in an environmental management accounting system.

5.

The measure of the total emissions of various greenhouse gases for an organization as a whole or for its individual products or processes is A. its global sustainability report.

B. the planet factor for the organization’s triple-bottom line.

C. its water footprint.

D. its carbon footprint.

6.

The potential fifth perspective of the balanced scorecard is A. environmental performance.

B. customer satisfaction.

C. learning and growth.

D. sustainability.

15-8

.

7.

All of the following are examples of key performance indicators for the financial perspective EXCEPT? A. recycling revenues.

B. percent of employees with environmental responsibilities.

C. energy costs.

D. cost of engineering change orders.

8.

All of the following are potential challenges inherent in implementing and using an environmental accounting system EXCEPT: A. communication between various groups in the organization.

B. simplicity of information required for environmental management accounting.

C. identifying hidden environmental costs.

D. the historical orientation of accounting.

9.

The cost of treating wastewater to meet requirements of the Environmental Protection Agency is an example of A. monetary information included in an environmental management accounting system.

B. physical information included in an environmental management accounting system.

C. a cost irrelevant for inclusion in an environmental management accounting system.

D. a key performance indicator for the customer perspective.

10.

Increasing pressure from customers led Circuit Power and Light to add solar energy as a choice for how their electricity is generated. This is an example of which business reason for adopting environmentally sustainable products?

A. Competitive strategy B. Cost reduction C. Stakeholder influence D. Regulatory compliance

15-9 .

Roadmap to MyAccountingLab Resources MyAccountingLab offers an effective and easy way in which to work through the chapter content. In order to take greatest advantage of MyAccountingLab, we suggest you follow the work plan specified below: www.myaccountinglab.com 1) Study Plan 2) Chapter Resources: Multimedia Library a) Demo Docs (as available) b) Excel in Practice: Multiple examples per chapter c) Online Textbook: One file for each learning objective d) Other Extras i) Online Appendix: Check figures for Assignment Materials e) PowerPoint f) Review i) Study Guide Chapter ii) Lecture Notes iii) Learning Objectives iv) Flashcards (as available) g) Video i) MyAccountingLab video: See student resources on MAL ii) Accounting Equation h) Working Papers in Excel and PDF formats i) All exercises (A and B) ii) All problems (A and B) iii) Continuing Exercise (as available) iv) Continuing Problem (as available)

Introduction

3

Course # Managerial Accounting Sample Syllabus: Fall 2012 (10 week course) Professor

Address and telephone

Office Hours

XXX

XXX

XXX

Course Schedule Session

Date

1

Topic

Ch 1: Introduction to Managerial Accounting

Reading Assignment and Class Preparation

After Class Homework Assignment

Chapter 1: S1-2, S1-3, S1-7, E1-8A, E1-15A

E1-9A, E1-10A, E112A, E1-14A

Quiz Ch 2: Building Blocks of Managerial Accounting

Chapter 2; S2-3, S2-5, S2-9, S2-10, S2-11 Quiz

2

Ch 3: Job Costing

Chapter 3: S3-1, S3-2, S3-3, S3-4, S3-5

ES2-8, S2-15, E2-17A, E2-24A, E2-25A, E226A E3-13A, E3-14A, E317A, E3-19A, E3-25A

Quiz 3

Ch 4: Activity-Based Costing, Lean Operations and the Costs of Quality

Chapter 4: S4-2, S4-4, S4-5, S4-8, S4-15, S419

S4-6, S4-9, E4-23A, E4-25A, E4-33A

Quiz 4

Ch 5: Process Costing

Chapter 5: S5-14, S515, S5-16, S5-17, S518 Quiz

Introduction .

11

S5-4, S5-5, S5-7, S5-8, S5-10, E5-27A, E531A

5

Ch 6: Cost Behavior

Chapter 6: S6-1, S6-7, S6-10, S6-15, S6-17

E6-20A, E6-24A, E628A, E6-30A, E6-44A

Quiz Chapter 7: S7-1, S7-3, S7-4, S7-6, S7-9, S711, S7-12

Ch 7: Cost-Volume-Profit Analysis

E7-17A, E7-24A, E738A, E7-39A, E7-40A

Quiz Mid-Term 6

Ch 8: Short-Term Business Decisions

Chapter 8: S8-1, S8-2, S8-3, S8-5, S8-10, S813

E8-16A, E8-19A, E820A, E8-24A, E8-25A, E8-28A

Quiz 7

Ch 9: The Master Budget

Chapter 9: S9-3, S9-4, S9-5, S9-6, S9-10, S912

E9-16A, E-20A, E926A, E9-27A, E9-28A

Quiz 8

Ch 10: Performance Evaluation

Chapter 10: S10-1, S10-3, S10-4, S10-5, S10-7, S10-8, S10-9, S10-10, S10-13

E10-16A, E10-17A, E10-18A, E10-23A, E10-25A, E10-30A, E10-31A

Quiz Ch 11: Standard Costs and Variances

Chapter 11: S11-1, S11-2, S11-3, S11-5, S11-7, S11-8 Quiz

Introduction .

12

E11-14A, E11-16A, E11-18A, E11-24A, E11-26A, E11-27A, E11-28A

9

Ch 12: Capital Investment Decisions and the Time Value of Money

Chapter 12: S12-2, S12-3, S12-4, S12-5, S12-12, S12-13

E12-18A, E12-20A, E12-28A, E12-30A, E12-35A

Quiz Ch 13: Statement of Cash Flows

Chapter 13: S13-1, S13-5, S13-8, S13-9, S13-10

S13-2, S13-4, E1311A, E13-12A, E1319A

Quiz 10

Ch 14: Financial Statement Analysis

Chapter 14: S14-1, S14-2, S14-3, S14-4, S14-5, S14-6, S14-7, S14-8, S14-9

E14-12A, E14-13A, E14-14A, E14-18A, E14-19A, E14-22A

Quiz Ch 15: Environmental Sustainability

Chapter 15: S15-1, S15-2, S15-3, S15-4, S15-5 Quiz

Final Exam

Introduction .

13

E15-6A, E15-11A, E15-12A, E15-14A, E15-17A, E15-18A

Course # Managerial Accounting Sample Syllabus: Fall 2012 (16 week course) Professor XXX

Address and telephone

Office Hours

XXX

XXX

Course Schedule Session

Date

1

Topic

Ch 1: Introduction to Managerial Accounting

Reading Assignment and Class Preparation

After Class Homework Assignment

Chapter 1: S1-2, S1-3, S1-7, E1-8A, E1-15A

E1-9A, E1-10A, E112A, E1-14A

Quiz

2

Ch2: Building Blocks of Managerial Accounting

Chapter 2; S2-3, S2-5, S2-9, S2-10, S2-11 Quiz

3

Ch 3: Job Costing

Chapter 3: S3-1, S3-2, S3-3, S3-4, S3-5 Quiz

4

Ch 4: Activity-Based Costing, Lean Operations and the Costs of Quality

Chapter 4: S4-2, S4-4, S4-5, S4-8, S4-15, S419

ES2-8, S2-15, E217A, E2-24A, E225A, E2-26A E3-13A, E3-14A, E3-17A, E3-19A, E3-25A S4-6, S4-9, E4-23A, E4-25A, E4-33A

Quiz 5

Ch 5: Process Costing

Chapter 5: S5-14, S515, S5-16, S5-17, S518 Quiz

Introduction .

8

S5-4, S5-5, S5-7, S5-8, S5-10, E527A, E5-31A

6

Ch 6: Cost Behavior

Chapter 6: S6-1, S6-7, S6-10, S6-15, S6-17

E6-20A, E6-24A, E6-28A, E6-30A, E6-44A

Quiz 7

Ch 7: Cost-Volume-Profit Analysis

Chapter 7: S7-1, S7-3, S7-4, S7-6, S7-9, S711, S7-12

E7-17A, E7-24A, E7-38A, E7-39A, E7-40A

Quiz 8

Mid-term

9

Ch 8: Short-Term Business Decisions

Chapter 8: S8-1, S8-2, S8-3, S8-5, S8-10, S813

E8-16A, E8-19A, E8-20A, E8-24A, E8-25A, E8-28A

Quiz 10

Ch 9: The Master Budget

Chapter 9: S9-3, S9-4, S9-5, S9-6, S9-10, S912

E9-16A, E-20A, E926A, E9-27A, E928A

Quiz 11

Ch 10: Performance Evaluation

Chapter 10: S10-1, S10-3, S10-4, S10-5, S10-7, S10-8, S10-9, S10-10, S10-13

E10-16A, E10-17A, E10-18A, E10-23A, E10-25A, E10-30A, E10-31A

Quiz 12

Ch 11: Standard Costs and Variances

Chapter 11: S11-1, S11-2, S11-3, S11-5, S11-7, S11-8 Quiz

Introduction .

9

E11-14A, E11-16A, E11-18A, E11-24A, E11-26A, E11-27A, E11-28A

13

Ch 12: Capital Investment Decisions and the Time Value of Money

Chapter 12: S12-2, S12-3, S12-4, S12-5, S12-12, S12-13

E12-18A, E12-20A, E12-28A, E12-30A, E12-35A

Quiz 14

Ch 13: Statement of Cash Flows

Chapter 13: S13-1, S13-5, S13-8, S13-9, S13-10

S13-2, S13-4, E1311A, E13-12A, E1319A

Quiz Ch 14: Financial Statement Analysis

Chapter 14: S14-1, S14-2, S14-3, S14-4, S14-5, S14-6, S14-7, S14-8, S14-9

E14-12A, E14-13A, E14-14A, E14-18A, E14-19A, E14-22A

Quiz 15

Complete Chapter 14 Ch 15: Environmental Sustainability

Chapter 15: S15-1, S15-2, S15-3, S15-4, S15-5 Quiz

16

Introduction .

Final Exam

10

E15-6A, E15-11A, E15-12A, E15-14A, E15-17A, E15-18A

Tips for Taking Your Course from Traditional to Hybrid, Blended or Online

1. Don’t try to take the “entire” course online in one semester. Decide on a twosemester strategy for implementation, implementing graded online homework FIRST. By only implementing the homework portion of the online solution, you don’t overwhelm yourself with having to learn every piece of the online component in one semester, regardless of whether it is myaccountinglab.com, Course Compass, or some other solution. Additionally, this allows you the flexibility to add other graded assignments later that first semester, if you choose.

2. Define homework by chapter in your syllabi, rather than identifying specific exercises or problems. The first semester as you and your students get accustomed to the online resources, you may need to be more flexible. Further, this gets your students used to looking “online” for their assignments.

3. Schedule one day in class in a computer lab (or some class time, if you can’t get into a computer lab), to demonstrate. This allows you to gain a “captive audience” so that you can show the class some of the resources you want them to use. It also allows you to highlight some of the resources that they may find useful in their learning.

You may wish to use this time in conjunction with the VARK analysis and require students to complete the questionnaire: http://www.varklearn.com/english/page.asp?p=questionnaire Then you can also point out which online tools will help specific learning styles for the students. Also, it gives those visual and kinesthetic learners a chance to “see” the tools.

4. Use myaccountinglab.com’s static/book match problems to demonstrate in class problems or exercises. This is a good way to not only save you time in setting up in class assignments, but it also demonstrates to the student the completion ease of the myaccountinglab homework solution. You may wish to setup a “static” course that has all the book/match problems in it and use that course for demonstrating this in class.

Remember, you have 5 book match/static questions (A, B, C, D, and E) with versions A and B being in your student’s text in the end of chapter material.

5. Same as Item 4, except using only the excel spreadsheets. Have the students print out the Excel or PDF worksheets for book match/static questions before covering the material in class. Again, this establishes the online center as the “go to” place for students to glean information.

5 .

6. The first assignments I give after demonstrating the online login/registration is submitted via their online e-mail account. For this, I use the e-mail students option from the gradebook. I submit their first assignment via e-mail to try in myaccountinglab.com. This is a “bonus” points only assignment; the students are eager to try online tools (no penalty—only bonus point reward) and it gets them registered quicker in myaccountinglab.com. I suggest using something like the built-in pre-test chapter questions.

7. Have students give each other feedback. One of the problems with teaching online is that giving feedback to all of your students all the time can quickly get out of control.

The way to deal with this is to have students give the initial drafts of their papers to other students for feedback. You give a grade for the feedback based on how helpful the original author finds it. Then you only have to review papers one time, and many of the problems should be worked out before you see them. (Contributed by: Jas Bhangal, Chabot College) 8. Set up discussion forums. You might, for example, ask a critical thinking question on one of the key chapter topics. Your students will have a certain amount of time to (1) post an answer to your question, and (2) post a response or comment on the answer of another student. You can offer extra credit for the “best” response.

Or, you might ask students to answer one of the end of chapter or additional online questions/case problems within a set period of time. The first one to respond can get an extra credit point. Then the first student who “adds value” to the answer can also get an extra point.

(Contributed by: Jas Bhangal, Chabot College) 9. Set up online group competitions. Divide your online class into teams. Assign a problem or a current event situation (something regarding current economic problems, an ethical dilemma, etc…) for which students will need to conduct research, answer your questions and post an analytical response. Assign extra credit points for the first complete response; a few less for the second response, etc.

Or, ask each team to develop a scenario, list of questions and responses for an additional class project. Reward those teams who submit activities that you deem suitable for use in the course.

NOTE: This suggestion could be used in-class as well.

(Contributed by Lydia R. Botsford, DeAnza College) 6 .

10. The second semester you put the class online, you can add video, voice-overs to any PowerPoint or notes you post, etc. Have fun and get more creative with each subsequent semester.

7 .

STUDENT HANDOUT Tips on how to use the resources and online tools to get an A in this class: •

READ the chapter. Yes, I know it’s hard, but it’s an important 30 minutes to an hour spent in learning this material. When you’re reading the chapter, be sure that you spend time reviewing the Decision Guidelines. Think about the answer to each decision that must be made before you read the answer (i.e., the Guideline). Take the time to work out the answers to the Summary Problems. Be sure to check your answer with the solution presented. Go back over any part that you did not answer correctly and review that portion of the chapter again.

•

WATCH the Demo Docs. Right after reading, view the interactive multi-media demo docs for the chapter. (Found at the Chapter Resources button in myaccountinglab.com)

•

PRACTICE homework online. Sure it makes sense when your professor goes over the assignment—they’ve been doing this for a long time. There is no substitute for doing problems/exercises. That’s how you learn accounting. And the online homework assignments are algorithmic, so they are already setup for you to practice problems until you “get it”. Be sure to utilize the tools available online if you need a little help as you go.

•

STUDY in groups. Creating study groups is a great way to expand your learning. These groups will not only increase your number of resources to go to for help, but they also create a sort of accountability that will help keep you on track for success.

•

Learn WHY as well as HOW. Sure the “how” to do it is a big part of accounting, but if you can learn why you are doing a particular accounting task, it will be much easier to perform the task.

•

RELATE topics to your personal life or job. The best way to insure you understand a topic is to apply it to your life or job. The “Stop & Think” portions of the text use this same theory.

•

ASK questions. When online, use the “Ask my instructor” button to ask specific homework questions at the point you have them. Also, ask questions while in class.

Don’t assume you are the only one who doesn’t understand. Your questions help you and other students learn.

Introduction .

7