CHAPTER DISCUSSION QUESTIONS Q2-1 (a) Cost is the current monetary value of economic resources given up or to be given up in obtaining goods and services Economic resources may be given up by transferring cash or other property, issuing capital stock, performing services, or incurring liabilities Costs are classified as unexpired or expired Unexpired costs are assets and apply to the production of future revenues Examples of unexpired costs are inventories, prepaid expenses, plant and equipment, and investments Expired costs, which most costs become eventually, are those that are not applicable to the production of future revenues and are deducted from current revenues or charged against retained earnings Expense in its broadest sense includes all expired costs; i.e., costs which not have any potential future economic benefit A more precise definition limits the use of the term “expense” to the expired costs arising from using or consuming goods and services in the process of obtaining revenues; e.g., cost of goods sold and marketing and administrative expenses (b) (1) Cost of goods sold is an expired cost and may be referred to as an expense in the broad sense of the term On the income statement, it is most often identified as a cost Inventory held for sale which is destroyed by an abnormal casualty should be classified as a loss (2) Uncollectible accounts expense is usually classified as an expense However, some authorities believe that it is more desirable to classify uncollectible accounts as a direct reduction of sales revenue (an offset to revenue) An uncollectible account which was not provided for in the annual adjustment, such as bankruptcy of a major debtor, may be classified as a loss (3) Depreciation expense for plant machinery is a component of factory overhead and represents the reclassification of a portion of the machinery cost to product cost (inventory) When the product is sold, the depreciation becomes a part of the cost of goods sold which is an expense Depreciation of plant machinery during an unplanned and unproductive period of idleness, such as during a strike, should be classified as a loss The term “expense” should preferably be avoided when making reference to production costs (4) Organization costs are those costs that benefit the firm for its entire period of existence and are most appropriately classified as a noncurrent asset When there is initial evidence that a firm’s life is limited, the organization costs should be allocated over the firm’s life as an expense or should be amortized as a loss when a going concern foresees termination In practice, however, organization costs are often written off in the early years of a firm’s existence (5) Spoiled goods resulting from normal manufacturing processing should be treated as a cost of the product manufactured When the product is sold, the cost becomes an expense Spoiled goods resulting from an abnormal occurrence should be classified as a loss Q2-2 Cost objects are units for which an arrangement is made to accumulate and measure cost They are important because of the need for multiple dimensions of data (e.g., by product, contract, or department) to accomplish the various purposes of cost accounting, including cost finding, planning, and control Q2-3 (a) To classify costs as direct or indirect, the cost accountant must first know the answers to the questions “Directly traced to what?” and “Indirectly identified with what?” Otherwise, there is no way to assess the direct or indirect nature of a cost It is the choice of a cost object that answers those two questions (b) For example, the cost of a department manager’s salary cannot be classified as 2-1 2-2 direct or indirect without selecting the cost object first If the cost object is a product unit produced in the manager’s department, then the salary is indirect If the cost object is the department, the salary is direct Q2-4 (a) The product unit, batch, or lot is the cost object (Be careful about the lack of clarity of t cost $3,000 (given) 2,000 (given) $1,000 Direct labor cost = 1/2 of direct material cost = 1/2 × $1,000 = $500 Conversion cost Less direct labor cost Equals overhead cost $2,000 (given) 500 (calculated above) $1,500 E2-9 (1) The relevant cost objects are: (a) An item of merchandise (b) The use of a bank credit card (2) It implies that cash-paying customers are paying a part of the cost of the banks’ fees for processing credit card transactions, because these fees are paid by the merchant who then recovers them in the form of slightly higher prices for all merchandise (3) The competitive implications are that the prices paid by cash customers are too high to be competitive with the prices charged by merchants who deal only in cash, and the prices paid by customers using bank credit cards are too low to reflect all the costs of a credit sale (4) The reason for not reducing all prices and charging extra for the use of a credit card is because of the psychological effect of an extra charge To customers, it sounds like a penalty, as if the merchant wants to discourage the use of bank credit cards A discount for cash customers has a positive connotation, even if prices marked on merchandise are higher to begin with Raising all prices and offering a cash discount yields the same net revenue as leaving prices alone and charging extra for using a bank credit card, but the former method feels better to the customer than the latter 2-8 Chapter E2-10 (1) The relevant cost objects are: (a) A repair (b) A pickup and delivery (2) JTRS’s repair prices include an allocation of the cost of picking up and delivering tractors, in addition to the cost of the repairs, administrative costs, marketing costs, and profit Competitors’ repair prices reflect only the cost of the repairs, administrative and marketing costs, and profit Competitors should be able to price their repair services lower, because they not have to reflect pickup and delivery costs in repair prices E2-11 (1) Direct labor $ Variable factory overhead Fixed factory overhead Conversion cost $11 (2) Direct material (lumber) $12 Direct labor Prime cost $14 (3) Direct material (lumber) $12 Direct labor Variable factory overhead Variable manufacturing cost $19 (4) Direct material (lumber) $12 Direct labor Variable factory overhead Variable marketing Total variable cost $20 Chapter 2-9 E2-11 (Concluded) (5) Total cost = total variable manufacturing cost + total variable marketing cost + total fixed cost = 2,000 × ($12 + $2 + $5) + 1,900 × $1 + 2,000* × ($4 + $3) = $38,000 + $1,900 + $14,000 = $53,900 *The volume used here to calculate total fixed cost is the 2,000-unit volume level that was used originally to calculate the amounts of fixed costs per unit, as stated in the data given in the exercise The 2,000-unit level of production stated in requirement (5) is not the reason that 2,000 is used here to calculate total fixed cost (6) The data indicate the bookcases are made of lumber, and some examples of the indirect materials used in making wooden bookcases would be glue, sandpaper, and nails (7) An estimate of costs referred to in the answer to requirement (6) would be included in the variable factory overhead of $5 per unit E2-12 Factory overhead Total manufacturing cost = 1/3 × prime cost, so: = prime cost + factory overhead = prime cost + (1/3 × prime cost) = 4/3 × prime cost; multiplying both sides by 3/4 gives: Total 3/4 × manufacturing cost 3/4 × $20,000 $15,000 = 3/4 × 4/3 × prime cost = × prime cost = prime cost Prime cost Less direct material cost Direct labor cost $15,000 12,000 (given) $ 3,000 2-10 Chapter E2-13 APPENDIX 10 11 12 13 GL (This is a measure of information systems.) GL C IBP F IBP F F IBP (This measure and the next one are measures of innovation, which is part of the internal business process perspective.) IBP C GL GL Chapter 2-11 CASES C2-1 (1) The percentage profit margin will be 82.5%, calculated as follows: Revenues ($2 × 4) Cost of juice ($.20 × 4) $.80 Cost of one delivery 60 Profit $8.00 1.40 $6.60 Percentage profit margin = $6.60 profit divided by $8 revenue = 82.5% (2) The percentage profit margin will be 60%, calculated as follows: Revenues ($2 × 1) Cost of juice ($.20 × 1) $.20 Cost of one delivery 60 Profit $2.00 80 $1.20 Percentage profit margin = $1.20 profit divided by $2 revenue = 60% (3) The manager is treating the menu item as the cost object, for example, one glass of orange juice (4) The refinement of the definition of cost object that would result in the planned profit margin is the use of two different kinds of cost object, the item and the delivery, which can be priced separately at $.80 and $2.40, respectively 2-12 Chapter C2-1 (Concluded) (5) For an order consisting of four glasses of orange juice, the profit margin will be 75%, calculated as follows: Revenues: ($.80 × 4) + ($2.40 × 1) Cost of juice ($.20 × 4) Cost of one delivery Profit $3.20 2.40 $5.60 $.80 60 1.40 $4.20 Percentage profit margin = $4.20 profit divided by $5.60 revenue = 75% For an order consisting of one glass of orange juice, the profit margin will also be 75%, calculated as follows: Revenues: ($.80 × 1) + ($2.40 × 1) Cost of juice Cost of one delivery Profit $ 80 2.40 $3.20 $.20 60 80 $2.40 Percentage profit margin = $2.40 profit divided by $3.20 revenue = 75% (6) The food service manager’s plan allocates the delivery costs over an arbitrarily selected number of items (two) This plan would result in higher-than-planned profit margin percentages on room service orders that contain more than two items, as demonstrated in the answer to requirement (1) Prices on these orders would be higher than those of a competitor who traces costs more carefully to cost objects and sets prices accordingly The plan would also result in lowerthan-planned profit margins on room service orders containing only one item, as demonstrated in the answer to requirement (2) Prices on these orders would be lower than what is needed to achieve the target profitability Chapter 2-13 C2-2 (1) The cost objects for which some amount of cost is identified in the case, and the amount of cost identified for each, are: (a) A new product variation, Zeggo (which means all units of Zeggo ever to be produced), $250,000 (b) A batch of Zeggo, $1,000 (c) A unit of Zeggo, $5 + $10 = $15 (Notice the $10 indirect cost amount includes all indirect production costs, so it must include the $1 amount stated in the problem, along with an allocation or averaging of the $1,000-per-batch setup costs, a share of the $250,000 cost amount, and a share of any other indirect manufacturing costs It would be double-counting to add the $1 and arrive at a total of $16 per unit.) (2) The other items mentioned in the case that could serve as cost objects, and a purpose each one could serve, are: (a) CCN Company, which is the relevant cost object when external financial statements are prepared (b) The assembly line on which Zeggo and other products are to be produced This cost object would be relevant in a decision on whether to discontinue production of all the products produced on the particular line, or a decision to shut down the line and shift its production to other lines due to a reduction in customer orders (3) The total cost expected to result from producing the first batch of 300 units of Zeggo is: Cost accounted for as direct cost of a unit $ Cost treated as indirect by the CCN system $ × 300 units $1,800 Add: setup cost 1,000 Total cost $2,800 (4) The cost expected to result from producing one more unit of Zeggo is $5 + $1 = $6 (5) For the first batch of 300 units, the CCN cost accounting system will report a cost of: ($5 direct cost + $10 indirect cost allocation) × 300 units = $15 × 300 = $4,500 2-14 Chapter C2-2 (Concluded) (6) For the one additional unit, the CCN cost accounting system will report a cost of $5 + $10 = $15 (7) The additional costs allocated by the CCN accounting system are of two types: (a) Costs caused by activities other than the production of product units Two examples of these activities are mentioned in the problem: setting up the assembly line and perfecting new product variations Other activities would include maintaining the assembly line and the department, ordering and inspecting raw materials, training newly hired workers, maintaining a cost accounting system, and expediting rush orders (These are related to total volume in the long run; therefore, most accounting systems classify them as variable overhead, but they are unrelated to the production of a single unit or batch of product.) (b) Fixed costs that are incurred regardless of whether activities are carried out, such as plant depreciation, insurance, and property taxes These are the costs of having capacity, not of using it  ... prime cost + factory overhead = prime cost + (1/3 × prime cost) = 4/3 × prime cost; multiplying both sides by 3/4 gives: Total 3/4 × manufacturing cost 3/4 × $20,000 $15,000 = 3/4 × 4/3 × prime cost. .. t cost $3,000 (given) 2,000 (given) $1,000 Direct labor cost = 1/2 of direct material cost = 1/2 × $1,000 = $500 Conversion cost Less direct labor cost Equals overhead cost ... cost accounting system will report a cost of $5 + $10 = $15 (7) The additional costs allocated by the CCN accounting system are of two types: (a) Costs caused by activities other than the production