REGUNAYAN, MARCO PAUL C.

AC17 – Management Accounting

CBET – 01 – 602P Prof. Rowell C. Marasigan

Midterm Examination Chapters 3 & 4

Answer the following items:

Chapter 3

Item #5 - page 175 How do cost flows using activity-based costing differ from cost flows using
one plantwide rate?
Instead of using one plantwide overhead rate to allocate (or apply) overhead to products,
an ABC system uses several overhead rates to allocate overhead.
The cost information provided by ABC is generally regarded as more accurate than the
information provided by most traditional costing methods. This allows management to make
better decisions in areas such as product pricing, product line changes (adding products or
eliminating products), and product mix decisions (how much of each product to produce and
sell).

Item #19 - page 176 Describe the four categories included in the hierarchy of costs.
Some organizations group activities into four cost categories, called the Hierarchy of
Costs, to help managers form cost pools for activity-based costing purposes. The cost
hierarchy groups costs based on whether the activity is at the facility level, product or
customer level, batch level, or unit level.
Facility-level activities (or costs) are required to sustain facility operations and include
items such as building rent and management of the factory. These costs are generally incurred
over long time horizons and regardless of how many product-, batch-, or unit-level activities
occur.
Product-level activities (or customer-level activities) are required to develop, produce,
and sell specific types of products. Product development and product advertising are examples
of items in this category. These costs are incurred regardless of the number of batches run or
units produced and can be changed over a shorter time horizon than facility-level activities.
Batch-level activities are required to produce batches (or groups) of products and include
items such as machine setups and quality inspections. These costs, which are determined by the
number of batches run rather than the number of units produced, can be changed over a shorter
time horizon than product- and facility-level activities. The number of batches, rather than the
number of units in each batch, determines the costs in this category.
Unit-level activities are required to produce individual units of product and include items
such as energy to run machines, direct labor, and direct materials. These costs can fluctuate over
a short time period depending on how many units management decides to produce.

Item #22 - page 176 Describe the four categories related to the costs of quality. How might the
allocation of quality costs to these four categories help managers?
Managers are also concerned about measuring the costs associated with quality. Quality-
related costs can be organized into four categories. The first two categories—prevention and
appraisal—are costs incurred to control and improve quality. The final two categories—internal
failure and external failure—are costs incurred as a result of failing to control and improve
quality.
Prevention costs are costs incurred to prevent defects in products and services. Designing
production processes to minimize defects, providing quality training to employees, and
inspecting raw materials before they are used in production are some examples.
Appraisal costs (often called detection costs) are costs incurred to detect defective
products before they are delivered to customers. This category includes the cost of finished
goods inspections.
Internal failure costs are the costs incurred as a result of detecting defective products
before they are delivered to customers. Reworking defective products, scrapping defective
products, and machine downtime due to process problems that cause defects are all examples.
External failure costs are the costs incurred as a result of delivering defective products to
customers. Warranty repairs, warranty replacements, and product liability resulting from unsafe
defective products are some examples.

Item #54 - pages 196-197 Activity-Based Costing, Journal Entries, T-Accounts, and
Preparing an Income Statement.
This problem is an adaptation of the example presented at the end of Chapter 2 “How Is
Job Costing Used to Track Production Costs?” for Custom Furniture Company. The only
difference is that this problem uses activity-based costing to allocate overhead costs rather than
one plantwide rate. Recall that inventory beginning balances were $25,000 for raw materials
inventory, $35,000 for work-in-process inventory, and $90,000 for finished goods inventory.
Management of Custom Furniture Company would like to use activity-based costing to allocate
overhead costs totaling $1,140,000 rather than one plantwide rate based on direct labor hours.
The following estimates are for the activities and related cost drivers identified as having the
greatest impact on overhead costs.

Transactions for the month of May are shown as follows:

1. Raw materials were purchased during the month for $15,000 on account.
2. Raw materials totaling $21,000 were placed in production: $3,000 for indirect materials
(glue, screws, nails, and the like) and $18,000 for direct materials (wood planks,
hardware, etc.).
3. Timesheets from the direct labor workforce show total costs of $40,000, to be paid the
next month.
 4. Production supervisors and other indirect labor working in the factory are owed wages
totaling $27,000.
5. The following costs were incurred related to the factory: building depreciation of
$29,000, insurance of $11,000 (originally recorded as prepaid insurance), utilities of
$4,000 (to be paid the next month), and maintenance costs of $22,000 (paid
immediately).
6. Manufacturing overhead is applied to products based on the following cost driver activity
for the month:

Number of purchase orders 75

Number of machine setups 120

Machine hours 1,850

Direct labor hours 3,240

7. The following selling costs were incurred: wages of $5,000 (to be paid the next month),
building rent of $3,000 (originally recorded as prepaid rent), and advertising totaling
$10,000 (to be paid the next month).
8. The following general and administrative (G&A) costs were incurred: wages of $13,000
(to be paid the next month), equipment depreciation of $6,000, and building rent of
$7,000 (originally recorded as prepaid rent).
9. Completed goods costing $155,000 were transferred out of work-in-process inventory.
10. Sold goods for $100,000 on account and $90,000 cash.
11. The goods sold in the previous transaction had a cost of $129,000.
12. Closed the manufacturing overhead account to cost of goods sold.

Required:

a. Calculate the predetermined overhead rate for each activity.

ACTIVITY COST ESTIMATED ESTIMATED PREDETERMINED
DRIVER OVERHEAD COST DRIVER OVERHEAD RATE
COSTS ACTIVITY
Purchase order Number of $260,000 800 orders $325 per order
purchase order
Machine setup Number of 360,000 1,000 setups 360 per setup
setups
Machine Machine hours 140,000 20,000 machine 7 per machine hour
Maintenance hours
Misc. Direct labor 380,000 38,000 direct 10 per direct labor
production hours labor hours hour
activities
Total $1,140,000
 b. Prepare T-accounts for the following accounts: cash, accounts receivable, prepaid
insurance, prepaid rent, raw materials inventory, work-in-process inventory, finished
goods inventory, accumulated depreciation (building and equipment), accounts
payable, wages payable, manufacturing overhead, sales, cost of goods sold, advertising
expense (selling), rent expense (selling), wages expense (selling), depreciation expense
(G&A), rent expense (G&A), and wages expense (G&A). Enter beginning balances in
T-accounts for the inventory accounts (raw materials, work in process, and finished
goods).

Cash
(10) $90,000 (5) $22,000

Accounts Receivable
(10) $100,000

Prepaid Insurance
(5) $11,000

Prepaid Rent
(7) $3,000
(8) 7,000

Raw Materials Inventory

Beg. Balance $25,000 (2) $21,000
(1) 15,000
End. Balance $19,000

Work-In-Process Inventory
Beg. Balance $35,000 (9) $155,000
(2) 18,000
(3) 40,000
(6) 112,295
End. Balance $50,295

Finished Goods Inventory

Beg. Balance $ 90,000 (11) $129,000
(9) 155,000
End. Balance $116,000

Accumulated Depreciation - Building

(5) $29,000
 Accumulated Depreciation - Equipment
(8) $6,000

Accounts Payable
(1) $29,000
(5) 4,000
(7) 10,000

Wages Payable
(3) $40,000
(4) 27,000
(7) 5,000
(8) 13,000

Manufacturing Overhead
(2) $3,000 (11) $112,925
(4) 27,000
(5) 66,000
96,000
(12) 16,925 overapplied
112,925

Sale
(10) $190,000

Cost of Goods Sold

(11) $129,000 (12) $6,000
112,075

Advertising Expense - Selling

(7) $10,000

Rent Expense - Selling

(7) $3,000

Wages Expense - Selling

(7) $5,000

Depreciation Expense – Gen. & Admin.

(8) $6,000
 Rent Expense – Gen. & Admin.
(8) $7,000

Wages Expense – Gen. & Admin.

(8) $13,000

c. Prepare a journal entry for each of the transactions 1 through 11, and post each entry
to the T-accounts set up in requirement b. Label each entry in the T-accounts by
transaction number, and total each T-account.
PARTICULARS DEBIT CREDIT
1 Raw Materials Inventory $15,000
Accounts Payable $15,000
2 Work in process Inventory 18,000
Manufacturing Overhead 3,000
Raw Materials Inventory 21,000
3 Work in Process Inventory 40,000
Wages Payable 40,000
4 Manufacturing Overhead 27,000
Wages Payable 27,000
5 Manufacturing Overhead 66,000
Accumulated depreciation- building 29,000
Prepaid Insurance 11,000
Accounts Payable 4,000
Cash 22,000
6 Work in process Inventory 112,925
Manufacturing Overhead 112,925
7 Wages Expense- Selling 5,000
Rent expense- selling 3,000
Advertising expense- selling 10,000
Wages payable 5,000
Prepaid rent 3,000
Accounts payable 10,000
8 Wages Expense- GA 13,000
Depreciation expense-GA 6,000
Rent expense-GA 7,000
Wages payable 13,000
Accumulated Depreciation- equipment 6,000
Prepaid Rent 7,000
9 Finished Goods inventory 155,000
Work in Process Inventory 155,000
10 Cash 90,000
Accounts Receivable 100,000
Sales 190,000
 11 Cost of goods sold 129,000
Finished Goods inventory 129,000

d. Is overhead underapplied or overapplied for the month of May? Based on the balance
in the manufacturing overhead T-account prepared in requirement c, prepare a
journal entry for transaction 12.
PARTICULARS DEBIT CREDIT
12 Overapplied Manufacturing Overhead $16,925
Cost of Goods Sold $16,925

e. Prepare an income statement for the month of May. (Hint: Be sure to include the
adjustment made to cost of goods sold in requirement d.)
Custom Furniture Company
Income Statement
As of May 31, 20XX
Sales $ 190,000
Cost of goods sold before adjustment for $   129,000
overapplied overhead
Adjustment for overapplied overhead 16,925
Cost of Goods Sold 112,075
Gross Profit $ 77,925
Less: Operating Expenses:
Selling 18,000
General and Administrative 26,000
Operating Profit $ 33,925
Chapter 4

Item #2 - page 232 Describe the similarities between a process costing system and a job
costing system.
First, the product cost of both process costing and a job costing system consist of direct
materials, direct labor, and manufacturing overhead.
Second, the unit cost information of both process costing and a job costing system is
needed by management for decision-making purposes.
Lastly, the inventory accounts of both process costing and a job costing system include
raw materials inventory, work-in-process inventory, and finished goods inventory.

Item #3 - page 232 Describe the differences between a process costing system and a job
costing system.
First, the product costs in process costing are assigned to departments or processes. In
a job costing system, product costs are assigned to jobs.
Second, the unit cost information in process costing comes from the departmental
production cost report. In a job costing system, unit cost information comes from the job cost
sheet.
Lastly, process costing has Several different work-in-process inventory accounts are used
—one for each department (or process). In a job costing system, one work-in-process inventory
account is used—job cost sheets track costs assigned to each job.

Item #38 - pages 242-243 and 243-245

Ethics: Manipulating Percentage of Completion Estimates.
Computer Tech Corporation produces computer keyboards, and its fiscal year ends on
December 31. The weighted average method is used for the company’s process costing system.
As the controller of Computer Tech, you present December’s production cost report for the
Assembly department to the president of the company. The Assembly department is the last
processing department before goods are transferred to finished goods inventory. All 160,000
units completed and transferred out during the month were sold by December 31. The board of
directors at Computer Tech established a compensation incentive plan that includes a substantial
bonus for the president of the company if annual net income before taxes exceeds $2,000,000.
Preliminary figures show current year net income before taxes totaling $1,970,000, which is
short of the target by $30,000. The president approaches you and asks you to increase the
percentage of completion for the 40,000 units in ending WIP inventory to 90 percent for direct
materials and to 95 percent for direct labor and overhead. Even though you are confident in the
percentages used to prepare the production cost report, which appears as follows, the president
insists that his change is minor and will have little impact on how investors and creditors view
the company.
Required:

a. Why is the president asking you to increase the percentage of completion estimates?
The president is asking me to raise the percentage of completion estimates
because if the company's annual income before taxes exceeds $2,000,000, he will receive
a compensation incentive plan bonus for the year, but the income is only $1,970,000,
which is less than $30,000.

b. Prepare another production cost report for Computer Tech Company that includes the
president’s revisions. Indicate what impact the president’s request will have on cost of
goods sold and on net income (ignore income taxes in your calculations).

Computer Tech Company

Assembly Department Production Cost Report
For the year ended, December 31, 20XX
Units to be accounted for Physical Units
Units in Beg. WIP Inventory 50,000
 Units started during the period 150,000
Total units to be accounted for 200,000

EUP
Units accounted for Physical Units DM DL OH
Units completed and t-out 160,000 160,000 160,000 160,000
Units in End. WIP Inventory 40,000 36,000 38,000 38,000
Total units accounted for 200,000 196,000 198,000 198,000

Cost to be accounted for DM DL OH Total

Costs in Beg. WIP Inventory $80,000 $30,000 $28,000 $138,000
Costs incurred during period 210,000 85,000 72,000 367,000
Total costs to be accounted for $290,000 $105,000 $100,000 $505,000

DM DL OH Total
Total costs to be accounted for $290,000 $115,000 $100,000
Total equiv. units account for 196,000 198,000 198,000
Cost per equivalent unit 1.4796 0.5808 0.5051 2.5655

DM DL OH Total
Cost assigned to units t-out $236,736 $92,928 $80,816 $410,480
Cost assigned to end. WIP inv. 53,266 22,070 19,194 94,530
Rounding difference (10)
Total costs accounted for $505,000

The impact of the President's request for Computer Tech Company reduces the
unit cost that is transferred out and sold to customers, increasing income as the cost of
goods sold decreases. As the President told you, if you increase the percentage of
completion of ending WIP, he will receive his substantial bonus in an unethical manner,
which no company should tolerate.

c. As the controller of the company, how would you handle the president’s request? (If
necessary, review the presentation of ethics in Chapter 1 “What Is Managerial
Accounting?” for additional information.)
As the company's controller, I will not tolerate such a request, whether made by
the CEO, President, or anyone else. Overall, it is bad for the company's image if this
issue becomes known to investors or the general public, so they must address it properly.
Financial statements are used by investors to determine a company's worth, while internal
financial reports are used by management to make sound decisions. Inaccurate reports
can lead to the company making poor or incorrect decisions. I will approach the President
professionally and inform him that his request is unethical.

Ethics: Increasing Production to Boost Profits.

Pacific Siding, Inc., produces synthetic wood siding used in the construction of
residential and commercial buildings. Pacific Siding’s fiscal year ends on March 31, and the
weighted average method is used for the company’s process costing system. Financial results for
the first 11 months of the current fiscal year (through February 28) are well below expectations
of management, owners, and creditors. Halfway through the month of March, the chief executive
officer and chief financial officer asked the controller to estimate the production results for the
month of March in the form of a production cost report (the company only has one production
department). This report is shown as follows.

Armed with the preliminary production cost report for March, and knowing that the
company’s production is well below capacity, the CEO and CFO decide to produce as many
units as possible for the last half of March even though sales are not expected to increase any
time soon. The production manager is told to push his employees to get as far as possible with
production, thereby increasing the percentage of completion for ending WIP inventory.
However, since the production process takes three weeks to complete, all the units produced in
the last half of March will be in WIP inventory at the end of March.

Required:
a. Explain how the CEO and CFO expect to increase profit (net income) for the year by
boosting production at the end of March.
The CEO and CFO anticipate profits by lowering the unit cost of each sold item.
Because of the fixed overhead costs, each unit transferred out in March will have lower
unit costs, resulting in lower reported costs of goods sold. As a result, profit will be
higher.

b. Using the following assumptions, prepare a revised estimate of production results in

the form of a production cost report for the month of March.Assumptions based on the
CEO and CFO’s request to boost production
1. Units started and partially completed during the period will increase to 225,000
(from the initial estimate of 70,000). This is the projected ending WIP inventory
at March 31.
2. Percentage of completion estimates for units in ending WIP inventory will
increase to 80 percent for direct materials, 85 percent for direct labor, and 90
percent for overhead.
3. Costs incurred during the period will increase to $95,000 for direct materials,
$102,000 for direct labor, and $150,000 for overhead (most overhead costs are
fixed).
4. All units completed and transferred out during March are sold by March 31.

Pacific Siding Incorporated

Revised Production Cost Report
For the year ended, March 31, 20XX
Step 1. Summary of Physical Units and Equivalent Unit Calculations.
Units to be accounted for Physical Units
Units in Beg. WIP Inventory 250,000
Units started during the period 365,000
Total units to be accounted for 615,000

EUP
Units accounted for Physical Units DM DL OH
Units completed and t-out 390,000 390,000 390,000 390,000
Units in End. WIP Inventory 225,000 180,000 191,250 202,500
Total units accounted for 615,000 570,000 581,250 592,500

Step 2. Summary of Costs to be Accounted for

Cost to be accounted for DM DL OH Total
Costs in Beg. WIP Inventory $76,000 $90,000 $150,000 $316,000
Costs incurred during period 95,000 102,000 150,000 347,000
Total costs to be accounted for $171,000 $192,000 $300,000 $663,000

Step 3. Calculation of Cost per Equivalent Unit

DM DL OH Total
Total costs to be accounted for $171,000 $192,000 $300,000
 Total equiv. units account for 570,000 581,250 592,500
Cost per equivalent unit $0.3000 $0.3303 $0.5063 $1.1367

Step 4. Assign Costs to Units Transferred Out and Units in End. WIP Inventory.
DM DL OH Total
Cost assigned to units t-out $117,000 $128,826 $197,468 $443,294
Cost assigned to end. WIP inv. 54,000 63,174 102,532 219,706
Total costs accounted for $171,000 $192,000 $300,000 $663,000

c. Compare your new production cost report with the one prepared by the controller. How
much do you expect profit to increase as a result of increasing production during the
last half of March? (Ignore income taxes in your calculations.)
The costs assigned to units transferred out has decreased from $541,621 to
$443,294, or $98,327. Because all the units transferred out will be sold before the end of
March, profits will be $98,327 higher than originally planned.

d. Is the request made by the CEO and CFO ethical? Explain your answer.
This is not ethical. The reason for the production increase was solely to
manipulate income and distort results for the year. There is no indication that the increase
in production was to meet much larger demand.