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CH 2 solutions - Solution s for chapter 2

Management accounting (Forman Christian College)

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CHAPTER 2
AN INTRODUCTION TO COST TERMS AND PURPOSES

2.4 Factors affecting the classification of a cost as direct or indirect include

 the materiality of the cost in question
 available information-gathering technology
 design of operations

2.5 A variable cost changes in total in proportion to changes in the related level of total
activity or volume. An example is a sales commission that is a percentage of each sales revenue
dollar.
A fixed cost remains unchanged in total for a given time period, despite wide changes in
the related level of total activity or volume. An example is the leasing cost of a machine that is
unchanged for a given time period (such as a year) regardless of the number of units of product
produced on the machine.

2-6 A cost driver is a variable, such as the level of activity or volume, that causally affects
total costs over a given time span. A change in the cost driver results in a change in the level of
total costs. For example, the number of vehicles assembled is a driver of the costs of steering
wheels on a motor-vehicle assembly line.

2-7 The relevant range is the band of normal activity level or volume in which there is a
specific relationship between the level of activity or volume and the cost in question. Costs are
described as variable or fixed with respect to a particular relevant range.

2-8 A unit cost is computed by dividing some amount of total costs (the numerator) by the
related number of units (the denominator). In many cases, the numerator will include a fixed cost
that will not change despite changes in the denominator. It is erroneous in those cases to multiply
the unit cost by activity or volume change to predict changes in total costs at different activity or
volume levels.

2-9 Manufacturing-sector companies purchase materials and components and convert them
into various finished goods, for example automotive and textile companies.
Merchandising-sector companies purchase and then sell tangible products without
changing their basic form, for example retailing or distribution.
Service-sector companies provide services or intangible products to their customers, for
example, legal advice or audits.

2.10 Manufacturing companies have one or more of the following three types of inventory:
1. Direct materials inventory. Direct materials in stock and awaiting use in the
manufacturing process.
2. Work-in-process inventory. Goods partially worked on but not yet completed. Also
called work in progress.
3. Finished goods inventory. Goods completed but not yet sold.

2.11 Inventoriable costs are all costs of a product that are considered as assets in the balance
sheet when they are incurred and that become cost of goods sold when the product is sold. These

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costs are included in work-in-process and finished goods inventory (they are “inventoried”) to
accumulate the costs of creating these assets.
Period costs are all costs in the income statement other than cost of goods sold. These
costs are treated as expenses of the accounting period in which they are incurred because they are
expected not to benefit future periods (because there is not sufficient evidence to conclude that
such benefit exists). Expensing these costs immediately best matches expenses to revenues.

2-12 Direct material costs are the acquisition costs of all materials that eventually become part
of the cost object (work in process and then finished goods) and can be traced to the cost object
in an economically feasible way.
Direct manufacturing labor costs include the compensation of all manufacturing labor
that can be traced to the cost object (work in process and then finished goods) in an economically
feasible way.
Manufacturing overhead costs are all manufacturing costs that are related to the cost
object (work in process and then finished goods) but cannot be traced to that cost object in an
economically feasible way.
Prime costs are all direct manufacturing costs (direct material and direct manufacturing
labor).
Conversion costs are all manufacturing costs other than direct material costs.

2-13 Overtime premium is the wage rate paid to workers (for both direct labor and indirect
labor) in excess of their straight-time wage rates.
Idle time is a subclassification of indirect labor that represents wages paid for
unproductive time caused by lack of orders, machine breakdowns, material shortages, poor
scheduling, and the like.

2-14 A product cost is the sum of the costs assigned to a product for a specific purpose.
Purposes for computing a product cost include
 pricing and product mix decisions,
 contracting with government agencies, and
 preparing financial statements for external reporting under GAAP.

2-15 Three common features of cost accounting and cost management are
 calculating the costs of products, services, and other cost objects
 obtaining information for planning and control and performance evaluation
 analyzing the relevant information for making decisions

2-17 (15 min.) Direct, indirect, fixed, and variable costs.

Wonder Bakery manufactures two types of bread, which it sells as wholesale products to various
specialty retail bakeries. Each loaf of bread requires a three-step process. The first step is mixing.
The mixing department combines all of the necessary ingredients to create the dough and
processes it through high-speed mixers. The dough is then left to rise before baking. The second
step is baking, which is an entirely automated process. The baking department molds the dough
into its final shape and bakes each loaf of bread in a high-temperature oven. The final step is
finishing, which is an entirely manual process. The finishing department coats each loaf of bread
with a special glaze, allows the bread to cool, and then carefully packages each loaf in a specialty
carton for sale in retail bakeries.

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Required:
1. Costs involved in the process are listed next. For each cost, indicate whether it is a direct
variable, direct fixed, indirect variable, or indirect fixed cost, assuming “units of production
of each kind of bread” is the cost object.

Costs:
Yeast Mixing department manager
Flour Materials handlers in each department
Packaging materials Custodian in factory
Depreciation on ovens Night guard in factory
Depreciation on mixing machines Machinist (running the mixing machine)
Rent on factory building Machine maintenance personnel in each department
Fire insurance on factory building Maintenance supplies for factory
Factory utilities Cleaning supplies for factory
Finishing department hourly laborers

2. If the cost object were the “mixing department” rather than units of production of each kind
of bread, which preceding costs would now be direct instead of indirect costs?

SOLUTION

1. Yeast—direct, variable
Flour—direct, variable
Packaging materials—direct (or could be indirect if small and not traced to each unit), variable
Depreciation on ovens—indirect, fixed (unless “units of output” depreciation, which then
would be variable)
Depreciation on mixing machines—indirect, fixed (unless “units of output” depreciation,
which then would be variable)
Rent on factory building—indirect, fixed
Fire Insurance on factory building—indirect, fixed
Factory utilities—indirect, probably some variable and some fixed (e.g., electricity may be
variable but heating costs may be fixed)
Finishing department hourly laborers—direct, variable (or fixed if the laborers are under a
union contract)
Mixing department manager—indirect, fixed
Materials handlers—depends on how they are paid. If paid hourly and not under union
contract, then indirect, variable. If salaried or under union contract, then indirect, fixed
Custodian in factory—indirect, fixed
Night guard in factory—indirect, fixed
Machinist (running the mixing machine)—depends on how they are paid. If paid hourly and
not under union contract, then indirect, variable. If salaried or under union contract,
then indirect, fixed
Machine maintenance personnel—indirect, probably fixed, if salaried, but may be variable if
paid only for time worked and maintenance increases with increased production
Maintenance supplies—indirect, variable
Cleaning supplies—indirect, most likely fixed because the custodians probably do the same
amount of cleaning every night

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2. If the cost object is Mixing Department, then anything directly associated with the Mixing
Department will be a direct cost. This will include:
 Depreciation on mixing machines
 Mixing Department manager
 Materials handlers (of the Mixing Department)
 Machinist (running the mixing machines)
 Machine Maintenance personnel (of the Mixing Department)
 Maintenance supplies (if separately identified for the Mixing Department)

Of course the yeast and flour will also be a direct cost of the Mixing Department, but it is already
a direct cost of each kind of bread produced.

2-18 (15–20 min.) Classification of costs, service sector.

Market Focus is a marketing research firm that organizes focus groups for consumer-product
companies. Each focus group has eight individuals who are paid $60 per session to provide
comments on new products. These focus groups meet in hotels and are led by a trained,
independent marketing specialist hired by Market Focus. Each specialist is paid a fixed retainer
to conduct a minimum number of sessions and a per session fee of $2,200. A Market Focus staff
member attends each session to ensure that all the logistical aspects run smoothly.

Required: Classify each cost item (A–H) as follows:

a. Direct or indirect (D or I) costs of each individual focus group.
b. Variable or fixed (V or F) costs of how the total costs of Market Focus change as the number
of focus groups conducted changes. (If in doubt, select on the basis of whether the total costs
will change substantially if there is a large change in the number of groups conducted.)

You will have two answers (D or I; V or F) for each of the following items:

Cost Item D or I V or F

A. Payment to individuals in each focus group to provide comments on new products

B. Annual subscription of Market Focus to Consumer Reports magazine
C. Phone calls made by Market Focus staff member to confirm individuals will attend a focus
group session (Records of individual calls are not kept.)
D. Retainer paid to focus group leader to conduct 18 focus groups per year on new medical
products
E. Recruiting cost to hire marketing specialists
F. Lease payment by Market Focus for corporate office
G. Cost of tapes used to record comments made by individuals in a focus group session (These
tapes are sent to the company whose products are being tested.)
H. Gasoline costs of Market Focus staff for company-owned vehicles (Staff members submit
monthly bills with no mileage breakdowns.)
I. Costs incurred to improve the design of focus groups to make them more effective

SOLUTION

Cost object: Each individual focus group

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Cost variability: With respect to the number of focus groups

There may be some debate over classifications of individual items, especially with regard
to cost variability.

Cost Item D or I V or F
A D V
B I F
C I Va
D I F
E I V
F I F
G D V
H I Vb
I I F
a
Some students will note that phone call costs are variable when each call has a separate charge. It may be a fixed
cost if Market Focus has a flat monthly charge for a line, irrespective of the amount of usage.
b
Gasoline costs are likely to vary with the number of focus groups. However, vehicles likely serve multiple
purposes, and detailed records may be required to examine how costs vary with changes in one of the many
purposes served.

2-19 (15–20 min.) Classification of costs, merchandising sector.

Band Box Entertainment (BBE) operates a large store in Atlanta, Georgia. The store has both a
movie (DVD) section and a music (CD) section. BBE reports revenues for the movie section
separately from the music section.

Required: Classify each cost item (A–H) as follows:

a. Direct or indirect (D or I) costs of the total number of DVDs sold.

b. Variable or fixed (V or F) costs of how the total costs of the movie section change as the total
number of DVDs sold changes. (If in doubt, select on the basis of whether the total costs will
change substantially if there is a large change in the total number of DVDs sold.)
You will have two answers (D or I; V or F) for each of the following items:

Cost Item D or I V or F
A. Annual retainer paid to a video distributor
B. Cost of store manager’s salary
C. Costs of DVDs purchased for sale to customers
D. Subscription to DVD Trends magazine
E. Leasing of computer software used for financial budgeting at the BBE store
F. Cost of popcorn provided free to all customers of the BBE store
G. Cost of cleaning the store every night after closing
H. Freight-in costs of DVDs purchased by BBE

SOLUTION

Cost object: DVDs sold in movie section of store

Cost variability: With respect to changes in the number of DVDs sold

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There may be some debate over classifications of individual items, especially with regard
to cost variability.

Cost Item D or I V or F
A D F
B I F
C D V
D D F
E I F
F I V
G I F
H D V

2-20 (15–20 min.) Classification of costs, manufacturing sector.

The Kitakyushu, Japan, plant of Nissan Motor Corporation assembles two types of cars (Teanas
and Muranos). Separate assembly lines are used for each type of car.

Required: Classify each cost item (A–H) as follows:

a. Direct or indirect (D or I) costs for the total number of Teanas assembled.

b. Variable or fixed (V or F) costs depending on how total costs change as the total number of
Teanas assembled changes. (If in doubt, select on the basis of whether the total costs will
change substantially if there is a large change in the total number of Teanas assembled.)

You will have two answers (D or I; V or F) for each of the following items:

Cost Item D or I V or F
A. Cost of tires used on Teanas
B. Salary of public relations manager for Kitakyushu plant
C. Annual awards dinner for Teana suppliers
D. Cost of lubricant used on the Teana assembly line
E. Freight costs of Teana engines shipped from Yokohama to Kitakyushu
F. Electricity costs for Teana assembly line (single bill covers entire plant)
G. Wages paid to temporary assembly-line workers hired in periods of high Teana production
(paid on hourly basis)
H. Annual fire-insurance policy cost for Kitakyushu plant

SOLUTION

Cost object: Type of car assembled (Teana or Murano)

Cost variability: With respect to changes in the number of Teanas assembled
There may be some debate over classifications of individual items, especially with regard
to cost variability.

Cost Item D or I V or F
A D V
B I F
C D F

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D D V
E D V
F I V
G D V
H I F

2-21 (20 min.) Variable costs, fixed costs, total costs.

Bridget Ashton is getting ready to open a small restaurant. She is on a tight budget and must
choose between the following long-distance phone plans:

Plan A: Pay 10 cents per minute of long-distance calling.

Plan B: Pay a fixed monthly fee of $15 for up to 240 long-distance minutes and 8 cents per
minute thereafter (if she uses fewer than 240 minutes in any month, she still pays $15
for the month).
Plan C: Pay a fixed monthly fee of $22 for up to 510 long-distance minutes and 5 cents per
minute there- after (if she uses fewer than 510 minutes, she still pays $22 for the month).

Required:
1. Draw a graph of the total monthly costs of the three plans for different levels of monthly
long-distance calling.
2. Which plan should Ashton choose if she expects to make 100 minutes of long-distance calls?
240 minutes? 540 minutes?

SOLUTION

1.
Minutes/month 0 50 100 150 200 240 300 327.5 350 400 450 510 540 600 650
Plan A ($/month) 0 5 10 15 20 24 30 32.75 35 40 45 51 54 60 65
Plan B ($/month) 15 15 15 15 15 15 19.80 22 23.80 27.80 31.80 36.60 39 43.80 47.80
Plan C ($/month) 22 22 22 22 22 22 22 22 22 22 22 22 23.50 26.50 29

2. In each region, Ashton chooses the plan that has the lowest cost. From the graph (or from
calculations)*, we can see that if Ashton expects to use 0–150 minutes of long-distance each
month, she should buy Plan A; for 150–327.5 minutes, Plan B; and for more than 327.5 minutes,
Plan C. If Ashton plans to make 100 minutes of long-distance calls each month, she should
choose Plan A; for 240 minutes, choose Plan B; for 540 minutes, choose Plan C.

*Let x be the number of minutes when Plan A and Plan B have equal cost
$0.10x = $15

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x = $15 ÷ $0.10 per minute = 150 minutes.

Let y be the number of minutes when Plan B and Plan C have equal cost
$15 + $0.08 (y – 240) = $22
$0.08 (y – 240) = $22 – $15 = $7
$7
y – 240 =  87.5
$0.08
y = 87.5 + 240 = 327.5 minutes
2-22 (15–20 min.) Variable costs and fixed costs.

Beacher Motors specializes in producing one specialty vehicle. It is called Surfer and is styled to
easily fit multiple surfboards in its back area and top-mounted storage racks. Beacher has the
following manufacturing costs:

Plant management costs, $1,200,000 per year

Cost of leasing equipment, $1,800,000 per year
Workers’ wages, $700 per Surfer vehicle produced
Direct materials costs: Steel, $1,500 per Surfer; Tires, $125 per tire, each Surfer takes 5 tires (one
spare).
City license, which is charged monthly based on the number of tires used in production:
0–500 tires $ 50,000
501–1,000 tires $ 74,500
more than 1,000 tires $200,000

Beacher currently produces 110 vehicles per month.

Required:
1. What is the variable manufacturing cost per vehicle? What is the fixed manufacturing cost
per month?
2. Plot a graph for the variable manufacturing costs and a second for the fixed manufacturing
costs per month. How does the concept of relevant range relate to your graphs? Explain.
3. What is the total manufacturing cost of each vehicle if 100 vehicles are produced each
month? 225 vehicles? How do you explain the difference in the manufacturing cost per unit?

SOLUTION

1. Variable manufacturing cost per vehicle

Steel $1,500 per Surfer
Tires 625 per Surfer
Direct manufacturing labor 700 per Surfer
Total $2,825 per Surfer

Fixed manufacturing costs per month

Plant management costs ($1,200,000 ÷ 12) $ 100,000
Cost of leasing equipment ($1,800,000 ÷ 12) 150,000
City license (for 110 surfers or 550 tires) 74,500
Total fixed manufacturing costs $324,500

Fixed costs per month (1 surfer takes 5 tires)

0 to 100 surfers per month = $100,000 + $150,000 + $50,000 = $300,000
101 to 200 surfers per month = $100,000 + $150,000 + $74,500 = $324,500

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More than 200 surfers per month = $100,000 + $150,000 + $200,000 = $450,000

2.

The concept of relevant range is potentially relevant for both graphs. However, the question does
not place restrictions on the unit variable costs. The relevant range for the total fixed costs is
from 0 to 100 surfers; 101 to 200 surfers; more than 200 surfers. Within these ranges, the total
fixed costs do not change in total.

3.

Vehicles Tires Unit Variable Unit Total

Produced Produced Fixed Cost Unit Fixed Cost per Cost per
per Month per Month per Month Cost per Vehicle Vehicle Vehicle
(1) (2) = (1) × 5 (3) (4) = FC ÷ (1) (5) (6) = (4) + (5)
(a) 100 500 $300,000 $300,000 ÷ 100 = $3,000 $2,825 $5,825
(b) 225 1,125 $450,000 $450,000 ÷ 225 = $2,000 $2,825 $4,825

The unit cost for 100 vehicles produced per month is $5,825, while for 225 vehicles it is only
$4,825. This difference is caused by the fixed cost increment of $150,000 (an increase of 50%,
$150,000 ÷ $300,000 = 50%) being spread over an increment of 125 (225 – 100) vehicles (an
increase of 125%, 125 ÷ 100). The fixed cost per unit is therefore lower.

2-23 (20 min.) Variable costs, fixed costs, relevant range.

Dotball Candies manufactures jaw-breaker candies in a fully automated process. The machine
that produces candies was purchased recently and can make 4,400 per month. The machine costs
$9,500 and is depreciated using straight-line depreciation over 10 years assuming zero residual
value. Rent for the factory space and warehouse and other fixed manufacturing overhead costs
total $1,300 per month.
Dotball currently makes and sells 3,100 jaw-breakers per month. Dotball buys just
enough materials each month to make the jaw-breakers it needs to sell. Materials cost 10 cents
per jawbreaker.
Next year Dotball expects demand to increase by 100%. At this volume of materials
purchased, it will get a 10% discount on price. Rent and other fixed manufacturing overhead
costs will remain the same.

Required:

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1. What is Dotball’s current annual relevant range of output?

2. What is Dotball’s current annual fixed manufacturing cost within the relevant range? What is
the annual variable manufacturing cost?
3. What will Dotball’s relevant range of output be next year? How, if at all, will total annual
fixed and variable manufacturing costs change next year? Assume that if it needs to Dotball
could buy an identical machine at the same cost as the one it already has.

SOLUTION

1. The production capacity is 4,400 jaw breakers per month. Therefore, the current annual
relevant range of output is 0 to 4,400 jaw breakers × 12 months = 0 to 52,800 jaw breakers.

2. Current annual fixed manufacturing costs within the relevant range are $1,300 × 12 =
$15,600 for rent and other overhead costs, plus $9,500 ÷ 10 = $950 for depreciation, totaling
$16,550.
The variable costs, the materials, are 10 cents per jaw breaker, or $3,720 ($0.10 per jaw
breaker × 3,100 jaw breakers per month × 12 months) for the year.

3. If demand changes from 3,100 to 6,200 jaw breakers per month, or from 3,100 × 12 =
37,200 to 6,200 × 12 = 74,400 jaw breakers per year, Sweetum will need a second machine.
Assuming Sweetum buys a second machine identical to the first machine, it will increase
capacity from 4,400 jaw breakers per month to 8,800. The annual relevant range will be between
4,400 × 12 = 52,800 and 8,800 × 12 = 105,600 jaw breakers.
Assume the second machine costs $9,500 and is depreciated using straight-line
depreciation over 10 years and zero residual value, just like the first machine. This will add $950
of depreciation per year.
Fixed costs for next year will increase to $17,500 from $16,550 for the current year + $950
(because rent and other fixed overhead costs will remain the same at $15,600). That is, total
fixed costs for next year equal $950 (depreciation on first machine) + $950 (depreciation on
second machine) + $15,600 (rent and other fixed overhead costs).
The variable cost per jaw breaker next year will be 90% × $0.10 = $0.09. Total variable
costs equal $0.09 per jaw breaker × 74,400 jaw breakers = $6,696.
If Sweetum decides not to increase capacity and meet only that amount of demand for
which it has available capacity (4,400 jaw breakers per month or 4,400 × 12 = 52,800 jaw
breakers per year), the variable cost per unit will be the same at $0.10 per jaw breaker. Annual
total variable manufacturing costs will increase to $0.10 × 4,400 jaw breakers per month × 12
months = $5,280. Annual total fixed manufacturing costs will remain the same, $16,550.

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2-25 (10–15 min.) Cost drivers and functions.

The representative cost drivers in the right column of this table are randomized so they do not
match the list of functions in the left column.

Function Representative Cost Driver

1. Accounts payable A. Number of invoices sent

2. Recruiting B. Number of purchase orders
3. Data processing C. Number of research scientists
4. Research and development D. Hours of computer processing unit (CPU)
5. Purchasing E. Number of employees hired
6. Warehousing F. Number of payments processed
7. Billing G. Number of pallets moved

Required:
1. Match each function with its representative cost driver.
2. Give a second example of a cost driver for each function.

SOLUTION

1.
Function Representative Cost Driver
1. Accounts payable Number of payments processed
2. Recruiting Number of employees hired
3. Data processing Hours of computer processing unit (CPU)
4. Research and development Number of research scientists
5. Purchasing Number of purchase orders
6. Warehousing Number of pallets moved
7. Billing Number of invoices sent

2.
Function Representative Cost Driver
1. Accounts payable Number of supplier invoices received
2. Recruiting Number of interviews conducted
3. Data Processing Number of computer transactions
4. Research and Development Number of new products being developed
5. Purchasing Number of different types of materials purchased
6. Warehousing Distance of deliveries made
7. Billing Number of credit sales transactions

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2-28 (20–30 min.) Inventoriable costs versus period costs.

Each of the following cost items pertains to one of these companies: Star Market (a
merchandising-sector company), Maytag (a manufacturing-sector company), and Yahoo! (a
service-sector company):

a. Cost of lettuce and tomatoes on sale in Star Market’s produce department

b. Electricity used to provide lighting for assembly-line workers at a Maytag refrigerator-
assembly plant
c. Depreciation on Yahoo!’s computer equipment used to update its Website
d. Electricity used to provide lighting for Star Market’s store aisles
e. Depreciation on Maytag’s computer equipment used for quality testing of refrigerator
components during the assembly process
f. Salaries of Star Market’s marketing personnel planning local-newspaper advertising
campaigns
g. Perrier mineral water purchased by Yahoo! for consumption by its software engineers
h. Salaries of Yahoo!’s marketing personnel selling advertising
i. Depreciation on vehicles used to transport Maytag refrigerators to retail stores

Required:
1. Distinguish between manufacturing-, merchandising-, and service-sector companies.
2. Distinguish between inventoriable costs and period costs.
3. Classify each of the cost items (a–h) as an inventoriable cost or a period cost. Explain your
answers.

SOLUTION

1. Manufacturing-sector companies purchase materials and components and convert them

into different finished goods.
Merchandising-sector companies purchase and then sell tangible products without
changing their basic form.
Service-sector companies provide services or intangible products to their customers—for
example, legal advice or audits.
Only manufacturing and merchandising companies have inventories of goods for sale.

2. Inventoriable costs are all costs of a product that are regarded as an asset when they are
incurred and then become cost of goods sold when the product is sold. These costs for a
manufacturing company are included in work-in-process and finished goods inventory (they are
“inventoried”) to build up the costs of creating these assets.
Period costs are all costs in the income statement other than cost of goods sold. These
costs are treated as expenses of the period in which they are incurred because they are presumed
not to benefit future periods (or because there is not sufficient evidence to conclude that such
benefit exists). Expensing these costs immediately best matches expenses to revenues.

3. (a) Lettuce and tomatoes purchased for resale by Star market—inventoriable cost of a
merchandising company. It becomes part of cost of goods sold when the lettuce and tomatoes are
sold.

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(b) Electricity used for lighting at Maytag refrigerator assembly plant—inventoriable cost
of a manufacturing company. It is part of the manufacturing overhead that is included in the
manufacturing cost of a refrigerator finished good.
(c) Depreciation on Yahoo!’s computer equipment used to update directories of websites
—period cost of a service company. Yahoo! has no inventory of goods for sale and, hence, no
inventoriable cost.
(d) Electricity used to provide lighting for Star Market’s store aisles—period cost of a
merchandising company. It is a cost that benefits the current period, and it is not traceable to
goods purchased for resale.
(e) Depreciation on Maytag’s assembly testing equipment—inventoriable cost of a
manufacturing company. It is part of the manufacturing overhead that is included in the
manufacturing cost of a refrigerator finished good.
(f) Salaries of Star Market’s marketing personnel—period cost of a merchandising
company. It is a cost that is not traceable to goods purchased for resale. It is presumed not to
benefit future periods (or at least not to have sufficiently reliable evidence to estimate such future
benefits).
(g) Perrier mineral water consumed by Yahoo!’s software engineers—period cost of a
service company. Yahoo! has no inventory of goods for sale and, hence, no inventoriable cost.
(h) Salaries of Yahoo!’s marketing personnel—period cost of a service company. Yahoo!
has no inventory of goods for sale and, hence, no inventoriable cost.

2-29 (20 min.) Computing cost of goods purchased and cost of goods sold.

The following data are for Marvin Department Store. The account balances (in thousands) are for
2014.

Marketing, distribution, and customer-service costs $ 37,000

Merchandise inventory, January 1, 2014 27,000
Utilities 17,000
General and administrative costs 43,000
Merchandise inventory, December 31, 2014 34,000
Purchases 155,000
Miscellaneous costs 4,000
Transportation-in 7,000
Purchase returns and allowances 4,000
Purchase discounts 6,000
Revenues 280,000

Required:
1. Compute (a) the cost of goods purchased and (b) the cost of goods sold.
2. Prepare the income statement for 2014.

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SOLUTION

1a. Marvin Department Store

Schedule of Cost of Goods Purchased
For the Year Ended December 31, 2014
(in thousands)

Purchases $155,000
Add transportation-in 7,000
162,000
Deduct:
Purchase returns and allowances $4,000
Purchase discounts 6,000 10,000

Cost of goods purchased $152,000

1b. Marvin Department Store

Schedule of Cost of Goods Sold
For the Year Ended December 31, 2014
(in thousands)

Beginning merchandise inventory 1/1/2014 $ 27,000

Cost of goods purchased (see above) 152,000
Cost of goods available for sale 179,000
Ending merchandise inventory 12/31/2014 34,000
Cost of goods sold $145,000

2. Marvin Department Store

Income Statement
Year Ended December 31, 2014
(in thousands)

Revenues $280,000
Cost of goods sold (see above) 145,000
Gross margin 135,000
Operating costs
Marketing, distribution, and customer
service costs $37,000
Utilities 17,000
General and administrative costs 43,000
Miscellaneous costs 4,000
Total operating costs 101,000
Operating income $ 34,000

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2-30 (20 min.) Cost of goods purchased, cost of goods sold, and income statement.

The following data are for Montgomery Retail Outlet Stores. The account balances (in
thousands) are for 2014.

Marketing and advertising costs $ 48,000

Merchandise inventory, January 1, 2014 90,000
Shipping of merchandise to customers 4,000
Building depreciation 8,400
Purchases 520,000
General and administrative costs 64,000
Merchandise inventory, December 31, 2014 104,000
Merchandise freight-in 20,000
Purchase returns and allowances 22,000
Purchase discounts 18,000
Revenues 640,000

Required:
1. Compute (a) the cost of goods purchased and (b) the cost of goods sold.
2. Prepare the income statement for 2014.

SOLUTION

1a. Montgomery Retail Outlet Stores

Schedule of Cost of Goods Purchased
For the Year Ended December 31, 2014
(in thousands)

Purchases $520,000
Add freight—in 20,000
540,000
Deduct:
Purchase returns and allowances $22,000
Purchase discounts 18,000 40,000

Cost of goods purchased $500,000

1b. Montgomery Retail Outlet Stores

Schedule of Cost of Goods Sold
For the Year Ended December 31, 2014
(in thousands)

Beginning merchandise inventory 1/1/2014 $ 90,000

Cost of goods purchased (see above) 500,000
Cost of goods available for sale 590,000
Ending merchandise inventory 12/31/2014 104,000
Cost of goods sold $486,000

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2. Montgomery Retail Outlet Stores

Income Statement
Year Ended December 31, 2014
(in thousands)

Revenues $640,000
Cost of goods sold (see above) 486,000
Gross margin 154,000
Operating costs
Marketing and advertising costs $48,000
Building depreciation 8,400
Shipping of merchandise to customers 4,000
General and administrative costs 64,000
Total operating costs 124,400
Operating income $ 29,600

2-31 (20 min.) Flow of Inventoriable Costs.

Renka’s Heaters selected data for October 2014 are presented here (in millions):

Direct materials inventory 10/1/2014 $ 105

Direct materials purchased 365
Direct materials used 385
Total manufacturing overhead costs 450
Variable manufacturing overhead costs 265
Total manufacturing costs incurred during October 2014 1,610
Work-in-process inventory 10/1/2014 230
Cost of goods manufactured 1,660
Finished goods inventory 10/1/2014 130
Cost of goods sold 1,770

Required: Calculate the following costs:

1. Direct materials inventory 10/31/2014
2. Fixed manufacturing overhead costs for October 2014
3. Direct manufacturing labor costs for October 2014
4. Work-in-process inventory 10/31/2014
5. Cost of finished goods available for sale in October 2014
6. Finished goods inventory 10/31/2014

SOLUTION

(All numbers below are in millions).

1.
Direct materials inventory 10/1/2014 $ 105
Direct materials purchased 365
Direct materials available for production 470
Direct materials used (385)

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Direct materials inventory 10/31/2014 $ 85

2.
Total manufacturing overhead costs $ 450
Subtract: Variable manufacturing overhead costs (265)
Fixed manufacturing overhead costs for October 2014 $ 185

3.
Total manufacturing costs $ 1,610
Subtract: Direct materials used (from requirement 1) (385)
Total manufacturing overhead costs (450)
Direct manufacturing labor costs for October 2014 $ 775

4.
Work-in-process inventory 10/1/2014 $ 230
Total manufacturing costs 1,610
Work-in-process available for production 1,840
Subtract: Cost of goods manufactured (moved into FG) (1,660)
Work-in-process inventory 10/31/2014 $ 180

5.
Finished goods inventory 10/1/2014 $ 130
Cost of goods manufactured (moved from WIP) 1,660
Cost of finished goods available for sale in October 2014 $ 1,790

6.
Finished goods available for sale in October 2014
(from requirement 5) $ 1,790
Subtract: Cost of goods sold (1,770)
Finished goods inventory 10/31/2014 $ 20

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