BU 247 – Managerial Accounting

Class 1 Notes – January 9th

Comparing Managerial Accounting to Financial Accounting

- Managerial Accounting is for internal users

- Financial Accounting is just for financial information and for external users
- Managerial Accounting uses retrospective and prospective information
- Financial Accounting only looks at retrospective (past) info

Examples of non-financial information

Measures related things like:

- Customer satisfaction
- Product quality
- Process time
- Employee satisfaction

Problem 1-6

- A balance scorecard provides a system for measuring and managing all aspects of performance
- It balances traditional financial measures of success with non-financial measures of the drivers
of future financial performance
- Balance scorecard measures organizational performance across 4 perspectives (See exhibit 1-1)
o Financial perspective: What performance do we deliver to shareholders, and do we
have the resources?
 Examples: Revenue growth, operating expenses, net income (retrospective info)
o Customer perspective: Do we deliver value to our customers?
 Examples: Response time of customer deliveries, customer satisfaction
o Process perspective: Which processes do we need to excel at?
 Examples: Cycle time, Quality of output (# of defects and # of new innovations)
o Learning and growth perspectives: How can we improve critical processes?
 Employee satisfaction and training
- The 4 balance scorecard perspectives are derived from the mission, vision and strategy of the
organization
Problem 1-3 (Parts A and C)

- Why would operators need non-financial information?

o Cycle time
o Quality of outputs
o They need measures that they can influence and control factors relating to the
measures, or the output produces
o To keep track of measures of performance, and make required changes quickly to
improve processes
o Financial measures don’t provide direct measures of process effectiveness or explain the
root cause of poor financial performance

- Why would senior executives need non-financial information?

o They need to see the Learning and Growth perspective, the Process perspective, and the
Customer perspective to understand the success or failure of the business decisions and
efficiencies of the internal operations
o They want to know root causes of financial performance so they can make better
decisions for the organization in the future

Class Problem – Ellen

Ellen might find these useful:

- An income statement to itemize her expenses and track how they have changed from period to
period
- What is the customer churn rate?
- How many repeat customers are repeat versus new?
- What do customers like and don’t like about the business?
- The number of times someone call and there is no available inventory
- Is it reasonable to have 10 fridges on hand?
- Are there competitors? How do they compare?
Class 2 Notes – January 11th
Cost information is pervasive throughout decision making
- Pricing of products
- Product planning
- Budgeting (estimating)
- Performance evaluations (employees and managers to control costs)
- Contracting (outsourcing activities and components, how much it will cost)

Important Costs Terms

- Cost Object
o Anything for which a cost is to be determined
o Examples: activities, products, product lines, depots, orgs
- Direct costs
o Uniquely attributable to a single cost object
o Chair = cost object, Wood = Direct material cost
- Indirect Costs
o Can’t trace them to a single cost object
o A cost that is not classified as a direct cost
o Ex: Rent for the facility
- Variable Costs
o A cost that changes in direct proportion to changes in the activity level of some variable
o The variable is called a cost driver

Formula and Example

Total Variable Costs = variable cost per unit of the cost driver X the # of cost driver units

Cost driver = number of chairs made

Direct Material Costs = Variable costs

- Fixed Costs
o Cost associated with a fixed asset that is not wholly consumed or traceable to one unit
of product
o They don’t vary in the short run directly with a specific activity
o Depends on the amount of a resource that is acquired rather than the amount used
o Provides the capacity to produce products
o We need them so we can run smoothly
o Examples: Facility, Equipment, Machinery
o *We recognize the cost of these things as Depreciation
 - Step Variable Cost
o A cost that is fixed over a specific relevant range of activity but varies with the cost
driver in discrete steps
o Ex: If an organization buys an additional machine, their production capacity could
double
- Mixed Cost
o A cost that has both variable and fixed cost components
o Ex: If an organization pays employees a fixed salary, plus a sales commission of 5%

Are labor costs fixed or variable?

- If employees are directly involved in producing the output and the wages vary with the number
of units produced, then the labor costs are VARIABLE COSTS
- If they are paid a set wage rate or salary, regardless of the number of units produced then they
are FIXED COSTS

Cost Behavior Estimation

- We can study past costs to estimate variable and fixed costs using the equation for a line
o The High-Low method – use the highest and lowest cost data points to estimate the cost
equation
o Visual inspection method – plot the data points and visually estimate the line that best
fits

Problem 2-18 - Classifying variable and fixed costs

a) Salaries of production supervisors – Fixed

b) Steel used in automobile production – Variable
c) Salaries for custodial staff – Fixed
d) Depreciation for factory equipment – Fixed
e) Lubricants for machines – Variable
f) Electricity used to operate a specific machine – Variable
g) Hourly wages paid to production workers – Fixed
h) Rent for a factory building – Fixed
i) Glue used in furniture production – Variable
j) Maintenance for production equipment performed every month – Either

Problem 2-20 – Cost Classification

Percy’s is a small hamburger shop catering mainly to students at a nearby university. It sells hamburgers
and vegetarian burgers and is open for business from 11:00 a.m. until 11:00 p.m. Monday through
Friday. The owner, Percy Luk, employs two cooks, one server, and a part-time janitor. Because there is
no space for dining inside the shop, all orders are takeout orders. Moreover, almost all orders are for
one burger. Percy prepared the following partial list of costs incurred last month:

Classify these costs as variable or fixed with respect to the number of burgers served.
- Burger ingredients – Variable (also a direct material cost)
- Cooks’ wages – Fixed
- Server’s wages – Fixed
- Janitor’s wages – Fixed or variable (if the wages vary directly with the # of orders)
- Depreciation on cooking equipment – Fixed
- Paper supplies (wrapping, napkins, and bags) – Variable
- Rent - Fixed
- Advertisement in local newspaper – Fixed

Class problem - VICTOR HOTEL

We want to determine the cost estimation equation for a total utility costs:
Y= a+ bx
Y = estimation of total utility costs
a = fixed utility costs (intersection)
b = variable utility cost per unit of the cost driver (slope)
x = cost driver volume (# of occupancy days)

High-Low method
1. Find the highest and lowest points
2. Find the value of b (variable costs)
3. Determine the value of A (FC) by plugging in the value of B from step 2 in the equation for
either the high or low point
4. Determine the cost estimation equation

Occupancy days = X
Utility Costs = Y
- July is the high point (1300)
- January is the lowest cost driver value (700)
 HP X = 1300 Y = 7500$
LP X = 700 Y = 6260

Find B.
B = High Y – Low Y/High X – Low X
= 2.07

Find A.
7500 = a + 2.07(1300)
A = 4809

Write the equation:

Y = 4809 + 2.07x

More Cost Definitions:

Incremental cost – The cost of the next unit of activity (the cost for each additional unit of the output
produced)

Sunk Costs – Costs that result for a previous commitment that cannot be changed or recovered

Relevant Costs – Any cost that changes between alternatives when making a decision

Avoidable Costs – Costs that can be avoided by taking a specific course of action

Opportunity Costs – (not actual costs) Maximum value or gain that is foregone from the next best
alternative when another course of action is chosen

Class Problem - CARLS AUTOMOTIVE REPAIRS

Carl’s Automotive Repairs provides general repairs to automobiles. In the context of an automobile
repair business gives an example of each of the following costs:
1. Variable cost – Direct materials to repair each vehicle (parts replaced)
2. Fixed cost – Rent, equipment, general manager salary, insurance
3. Mixed cost – Cost of electricity if there is a base charge plus additional charges based on the amount
used
4. Step-variable cost – The cost of salespeople if one is added at different levels of planned sales, cost of
additional equipment to increase capacity over a particular range
5. Incremental cost – The cost of taking on an additional customer or repair job
6. Sunk cost – Depreciation on machinery or equipment
7. Relevant cost – The cost of contracting out a service such as detailing versus in house cleaning service
8. Opportunity cost – Revenue from customers lost when operating at capacity
9. Avoidable cost – Costs saved if part of the business, or all of the business is shut down
Class 3 Notes – January 16th

Cost Volume Profit Analysis

- Assumptions:
o Selling price per unit and variable costs per unit will stay constant at all levels of
production
o All costs will be classified as either Variable Costs (VC) or Fixed Costs (FC)
o Fixed costs remain constant over all levels of production
o The number of units that we produce, we are also able to sell

Basic Profit Calculation

Profit = Revenue – Total Costs
Profit = Revenue – VC – FC
Profit = (Rev per unit – VC per unit) x #units produced and sold – FC
Profit = (Cont. Margin per unit x # units sold) – FC

Break-Even point using the CVP Equation

- We can rearrange the CVP to find the breakeven point
- Set the CVP equation equal to 0

CM per unit x # units sold – FC = 0

FC – CM per unit x # units sold
# Units sold = FC/CM per unit

Why is the Break-Even important?

- We need to know the minimum number of units we need to sell to cover our costs
- The unknown number of units is typically denoted as X or Q

Variations of the CPV Equation

To calculate the # of units needed to achieve a target profit (ignoring taxes):
 # Unit sales = (FC + Target before-tax profit) / CM per unit

Introducing income taxes into the formula and calculating the # of units sold needed to achieve a given
target profit:

# Unit sales = {FC + [Target after-tax profit/ (1-tax rate)]}/CM per unit

Problem 2-26 - Break-even analysis

Breakeven analysis Klear Camera Company is planning to introduce a new video camera. The camera’s
selling price is projected to be $1,000 per unit. Variable manufacturing costs are estimated to be $500
per unit. Variable selling costs are 10% of sales dollars. The company expects the annual fixed
manufacturing costs for the new camera to be $3.5 million.

(a) Compute Klear’s contribution margin per unit and contribution margin ratio.

Contribution margin per unit = selling price per unit – VC per unit

= 1000 – 500 – (10% x 1000)

= 400

Contribution margin ratio: 400/1000 = 0.4 or 40%

So, 40% of the selling price remains after our variable costs.

(b) Determine the number of units Klear must sell to break even.

Break-even number of units = FC / CM per unit

BEUnits = 3 500 000/400

BEUnits = 8750 units

(c) Klear is considering a design modification that would reduce the variable cost of the camera
by $50 per unit. Explain whether this change will cause Klear’s breakeven point to increase or
decrease compared to the initial plan.

The reduction in the variable costs of the camera of $50 will increase the contribution margin.

VC will go down by $50 and the CM will go up by $50

Break-even number of units = FC / CM per unit

BEUnits = 3 500 000/450

BEUnits = 7778 units (rounded) So their break-even will decrease.

*When we have a decimal number of units, we always round up to ensure we sell enough units to meet
the threshold of breaking even.
Problem 2-41 – Break-even analysis and target profit, taxes
Action Delivery delivers specialty medical supplies to hospitals from its central warehouse. Maureen
Fan, the owner and manager, charges customers a delivery fee of $2.80 per kilometer. The variable
delivery costs reflect the cost of the drivers and the delivery vans. Maureen believes the total variable
cost per kilometer is $2.10. The total fixed costs at Action Delivery amount to $280,000 per year.

(a) What is the breakeven number of delivery kilometers per year?

0 = (2.8 x #kilometers) – (2.10 x #kilometers) – 280 000

280000 = 0.7 km

400 000 km = Break Even

(b) How many kilometers of delivery service must be provided each year to earn a pretax income
of $70,000?

Let X = # of kilometers needed

X = (FC + Before-tax profit) / Contribution Margin per Kilometer

X = (280000 + 70000) / (2.8 x #kilometers) – (2.10 x #kilometers)

X = 350 000 / 0.7

X = 500 000 km

(c) Action Delivery faces a tax rate of 30%. How many kilometers of delivery service must be
provided each year to earn an after-tax income of $29,400?

Required Unit Sales = ((Target after tax profit/(1-tax rate)) + Fixed Costs / Cont. Margin per unit

= (29400 / (1-0.3)) + 280000

= 322 000 / 0.7

= 460 000 kms

(d) Maureen has the opportunity to contract out deliveries to an outside supplier who would
charge Maureen a fixed fee of $180,000 per year plus $1.90 per kilometer. Under the
contracting-out alternative, the existing level of fixed costs would drop to $200,000, making
total fixed costs $380,000. At what annual number of delivery kilometers will Maureen be
indifferent between continuing doing deliveries herself or contracting out the deliveries?

First thing: At what number of kilometers is Maureen indifferent between alternatives?

Cost of in-house delivery = Cost of contracting

2.10 X + 280000 = 380000 + 1.9 X

0.2 X = 100 000

X = 500 000 kilometers

Second thing: If our expected Kms are below the indifference point, we will want to stick with the higher
variable cost option (the first one).

Problem 2-56 – Cost behavior and decisions – Parts a, c and d

Second City Airlines operates 35 scheduled round-trip flights each week between New York and
Chicago. It charges a fixed one-way fare of $200 per passenger. Second City Airlines can carry 150
passengers per one-way flight. Fuel and other flight-related costs are $5,000 per one-way flight. On-
flight meal and refreshment costs average $5 per passenger. Flight crew, ground crew, advertising,
and other administrative expenditures for the New York–to–Chicago route amount to $400,000 each
week.

(a) How many passengers must each of the 70 one-way flights have on average to break even
each week?

What are the drivers for each variable?

Variable Drivers
Revenue form passenger fees # Passengers per flights x # flights
Meals # Passengers per flight x # flights
Fuel and other flight costs # Flights
All other costs (fight and ground crews) N/A

Profit = Revenue from passengers – VC for passengers – Fuel Costs – FC

We are searching for the number of passengers to break even.

Let X be the number of passengers per flight:

0 = (200 X x 70 Flights) – (5 X x 70) – (5000 x 70) – 400 000

0 = 14000 X – 350 X – 350000 – 400000

0 = 13650X – 750000

X = 54.945

55 passengers per flight

(b) If the load factor is 60% on all flights (that is, the flights are 60% full), how many flights must
Second City Airlines operate on this route to earn a total profit of $500,000 before taxes per
week?
(c) Are fuel costs variable or fixed?
Fuel costs vary directly with the number of flights; thus, they are primarily variable costs.

But they do not vary directly with the number of passengers on each flight, so they are fixed costs once
a flight is scheduled.

(d) What is the variable cost to Second City Airlines for one additional passenger on a flight if the
passenger takes a seat that would otherwise go empty?

The incremental costs to add an additional passenger are the variable costs of 5$ for meals and
refreshments.

All other costs to operate each flight are primarily fixed and are unlikely to change with the addition of
another passenger.

The incremental profit from an additional passenger is:

= 200-5

= 195 dollars per passenger

Class 4 Notes – January 18th
What-if Analysis
- Cost-volume profit can help evaluate incremental profit impact of decisions
- Incremental profit = Incremental contribution margin – Incremental cost
Cost-Volume Profit Analysis for Multiple Products
- Many combinations of sales levels for multiple products that would allow the
organization to break-even or reach a target profit
- One approach is to assume a constant product mix and use Weighted Average
Contribution Margin

Required Total Unit Sales – (Fixed Costs + Target pre-tax profit)/

Weighted Average Contribution Margin per Unit

Or

[Fixed costs + {Target after-tax profit/(1-tax-rate}] /

Weighted Average Contribution Margin per Unit

- Weighted Average Contribution Margin per Unit

o It is the sum of the contribution margin per unit of each product multiplied by
their product mix percentage, given that the product mix percentage for each
product is:

# Units sold for a product / total # of units sold across all products

o The total product mix percentages across all products must add up to 1 (100%)

- Product mix percentages are applied to the total unit sales to obtain the required sales
of individual products
Cost-Volume Profit Assumptions
- The unit selling price and variable cost per unit remain the same over all levels of
production
- All costs are either variable or fixed
- Fixed costs remain the same over all levels of production
 - The number of units produced equals the number of units
Problem 2-31 – Multiproduct Break-Even Analysis - Florida Favorites
Part A

Part B
Part C
The break-even # of units decreased in Part B because the product mix percentage is larger for
the product with the higher contribution margin (15 and 0.7). This leads to a higher weighted
average contribution margin (WACM) overall (14.1 vs. 12.9). Thus, fewer total units will need to
be sold to break-even.

Problem 2-36 – Multiproduct Break-Even Analysis – Brant Consulting

Problem 2-44 - Multiproduct breakeven analysis, target profit, taxes - Johnson
a) How many Grippers must Johnson Company sell in order to break even?

Break-even = Fixed Costs/ CM per unit

BE = (1 000 000 + 500 000) / 6

BE = 1 500 000 / 6

BE = 250000 units of the Gripper

 b) How many Grippers must Johnson Company sell in order to earn a target profit of $300,000?

Units = (Fixed Costs + Profit) / CM per Unit

Units = (1 000 000 + 500 000 + 300 000) / 6

Units = 1 800 000 / 6

Units = 300 000

c) The Johnson Company sales manager has come up with an idea for a new product called the
Gripper Plus. The sales manager is projecting a sales mix of 300,000 units of the Gripper and
100,000 units of the Gripper Plus. The Gripper Plus has the following per-unit revenue and
costs:

Class 5 Notes – January 23rd

Make or Buy Decisions
Why should decision makers only focus on relevant costs in decision making?

- Because costs that remain the same regardless of what alternative is chosen are not useful for
the managers decisions.

Are sunk costs considered relevant costs in decision making?

- No, sunk costs are cost result from a past commitment and do not differ between alternatives.
A common decision for manufacturers is to choose what products to manufacture themselves and what
products to outsource

Example: Apple is making more of their own components

Make or Buy?

- Relevant costs to make > relevant costs to buy

o BUY IT!
- Relevant costs to make < Relevant costs to buy
o MAKE IT!

Relevant Internal Costs to Make Relevant External Costs to Buy

Typically, variable costs to produce internally Acquisition cost
Any avoidable fixed costs Any transportation/ shipping costs
Fixed costs
Anything that differs between alternatives

Problem 3-27 – Make or Buy and Relevant Cost

Part A

Assuming that Seven Oaks Data Stream will provide a service similar to the current in-house service,
under what conditions should the offer be accepted?

Irrelevant Costs
- Managers Salary of 100 000 (unavoidable)
- Staff Salaries of 1 500 000 (unavoidable)
- Server depreciation of 500 000 (sunk cost)
- Building costs of 350 000 (unavoidable)

Internal costs incurred in house Costs incurred if outsourced

Variable costs of processing 0.1 x service Variable processing costs: 0.08 x service revenues
revenues
Fixed costs: 90000 salary for the open manager Fixed costs: 250000
position
Fixed cost: 500000 data security costs

Let X = the service revenues where we are indifferent, and set the alternatives equal

In house = Outsource costs

0.1X + 90000 + 50000 = 0.08X + 250000

0.02X = 110000

X = 5 500 000

So, we should only accept the offer if the level of service revenues is at $5500000. Given this
indifference point, if we expect service revenues to be above $5500000, we will outsource.

Part B
Assumptions

- Current capacity can handle additional business

- Current sales levels are $4 000 000
- There are no other variable costs other than the data processing costs
Assume outsourcing would increase service revenues by 300000 per year, how would this
impact your decision to outsource versus keep data processing in house?

Total relevant costs of in-house processing:

(4 000 000 x 0.1) + 90 000 + 50 000 = 540 000

Total relevant costs of outsourcing:

(4 000 000 x 0.08) + 250 000 = 570 000

Profit from additional sales of 300 000:

300 000 – (0.08 x 4 000 000) = 276 000

Net cost of outsourcing:

570 000 – 276 000 = 294 000

Marginal benefit of outsourcing:

540 000 – 294 000 = 246 000
Problem 3-29 – Make or Buy – Langdon
Part A
What is the maximum price that Langdon Company should accept from the Eastern Engine for each
engine?

Irrelevant costs
- Fixed overhead of $25 (unavoidable)
 Internal costs incurred in house Costs incurred if outsourced
Variable costs: $110 direct materials cost per Variable cost: Purchase Price = $X per engine
engine
Variable costs: $80 for direct labor per engine
Variable costs: $20 overhead per engine

Total variable cost per engine = $210

*We only want to outsource is the purchase price

is lower than this

Part B
If the number of engines produced is 2000 units, then the relevant cost per unit is…
Internal costs incurred in house Costs incurred if outsourced
Total Variable Costs = $210 per engine Variable cost: Purchase Price = $X per engine
Fixed cost: 20 000 rent
Fixed cost: 50 000 for open supervisor positions
(fill the vacancy)

In house cost per engine

= 210X + ((20000 + 50000) / 2000)

= 210 per unit + 35 per unit
= 245 per unit
-----------------------------------------------
$210 is the variable costs
$35 is the fixed cost allocated per unit
$245 is the max price you are willing to pay to outsource

Problem 3-57– Make or Buy – Home Grocery

Part A

Irrelevant costs
- The unavoidable 300 000 fixed cost of the grocery delivery operation (500 000 – 200 000)

Internal costs incurred in house Costs incurred if outsourced

Fixed cost: 200 000 850 per customer
250 per customer
0.5 per item
 - 1800 customers
- X = customer
- Y = items
----------------------------------
In house
= 250X + 0.5XY + 200000
= 250 (1800) + 0.5 (1800 x 1000) + 200000
= 1 550 000

Outsource
= 850 X
= 850 (1800)
= 1 530 000

In house cost is larger than the outsourcing option, so the decision is to outsource and save
the difference of 20 000.

Part B

250X + 0.5 (X x 1000) + 200 000 = 850 X

250 X + 500 X + 200 000 = 850 X
100 X = 200 000
X = 2000 customers

So, we would need 2000 customers to be indifferent between in house and outsourcing
delivery service if each customer is ordering 1000 items.

Class 6 Notes – January 25th

Decision to drop a product or a division
- Organizations may abandon a product or a division when it is no longer profitable to
continue it, either because revenues no longer exceed relevant costs, or because
another organization has the rights at a favorable price.
- Example: Hudson’s Bay shut down Zellers in 2011-2013 due to lack of profitability. It is
now planning on re-opening some Zellers within some Hudson Bay stores.
Relevant cost analysis involves comparing the costs saved by abandoning the product or
division with revenues forgone and discontinuance costs incurred.
The analysis of which costs are avoided can be very difficult to determine since:
- Costs that are attributed to a product or division may only be avoidable in the
intermediate or long run.
- Sales of one product may affect sales of other products or divisions

Relevant Costs and Revenues – page 47 of the textbook

Internal costs avoided (gains) Lost revenue and discontinuance costs

incurred (losses)
All variable costs Lost revenue
Any avoidable fixed costs Discontinuance costs
Any other costs incurred

*Discontinuance costs – any additional costs incurred to drop a product or service

Problem 3-32 – Drop a division relevant cost – Johnny’s bar and restaurant
Part A
Think about this: What happens to the variable cost in the games division if we close it down?
- All variable costs are driven by revenues. If it is closed, no variable costs are incurred.
Therefore, we will eliminate the division’s contribution margin.
Think about this: What will happen to the 45000 fixed cost if we close the division?
- We aren’t told if the fixed costs are avoidable or unavoidable, so we will have to
examine both scenarios.

If fixed costs are avoidable If fixed costs are unavoidable

Gain or (loss) in (20 000) (20 000)
contribution margin
Gain from avoidable fixed +45 000 0
costs
Increase or (decrease) in ------------ ------------
operating income +25 000 (20 000)
Additional current income
+45 000 +45 000
Revised operating income
70 000 25000
 We will close the Games division if the fixed costs are avoidable.

Part B

If fixed costs are avoidable

Gain or (loss) in contribution margin (20 000)
Gain from avoidable fixed costs +15 000
Increase or (decrease) in operating income ------------
(5000)
Additional current income
+45 000
Revised operating income
40 000
We notice there is a decrease/loss of $5000 of the operating income, so we would keep the
Games division open, so we don’t lose money.

Part C
Think about this: If the revenues for the restaurant and bar divisions increase by 10%, what is
the impact on the variable costs?
- Variable costs are directly driven by revenues so our variable costs and overall
contribution margins will also increase by 10% in each division.

Restaurant Bar Games Total

Gain or (loss) in 14 000 12 000 (20 000) + 6000
Contribution (10% x 140000) (10% x 120000)
Margin
Gain from / / +15000 +15000
avoidable fixed No impact on FC No impact on FC ---------- ----------
costs
Increase or +14 000 +12 000 (5000) +21 000
(decrease) in
operating income
Revised operating 21 000 + 45 000 = 66 000
income *The 45 000 comes from the total division contribution

So, as long as the change is positive (in this case +21000), we should recommend the
decisions, which in this case is to close down the Games division.

Problem 3-33 – Drop a division relevant cost – Spike Transportation

Part A

Close transportation division

Gain or (loss) in contribution margin (2 970 000)
Gain from avoidable fixed costs + 2 350 000
Increase or (decrease) in operating income ------------
(620 000)
So, don’t shut down because they will lose 620 000 which will decrease income.

Part B

Restaurant Bar Games Total

Gain or (loss) in + 525 300 + 95 680 (2 970 000) (2 349 020)
 Contribution (15% x 3502000) (15% x 95680)
Margin
Gain from / / +2 350 000 +2 350 000
avoidable fixed No impact on FC No impact on FC ---------- ----------
costs
Increase or + 525 300 + 95 680 (620 000) + 980
(decrease) in
operating
income

So, the decision is to drop the division, even though the increase isn’t really that big.

Problem 3-58 – Dropping a product – Merchant Company

Part A

Impact on operating income by dropping JT484

Loss in contribution margin from JT484 (65 000)
Gain from avoidable utility costs 9 000
Gain from avoidable supervision costs 30 000
Gain from avoidable maintenance costs 7 000
Gain from avoidable administrative costs 30 000
 Total increase in operating income 11 000

Part B

Impact on operating income by dropping JT484 calculation

Increase in operating income from part A 11 000
Loss in contribution margin for JT284 (5%) (10 000) 200 000 x 5%
Loss in contribution margin for JT384 (5%) (5 000) 100 000 x 5%
Total increase/(decrease) in operating income (4000)

BU 247 – Managerial Accounting

Class 7 Notes – January 30th - The special-order decision

Costing Orders
- Order costing involves estimating the relevant costs associated with a unique (special) order.
- Only costs that will change as a result of changing from the existing product to the proposed
product should be considered.
- We also need to consider any opportunity costs of using the production capacity to fill the order
if there is no idle capacity available to fill the order.

Costs to consider…

Revenues earned from a special order Costs incurred to fill a special order
Order revenue Variable manufacturing and selling costs
Additional fixed manufacturing costs
Opportunity costs

Floor Price
The floor price is the minimum acceptable price per unit that would make the company no worse off
from a profit perspective.

Minimum acceptable price =

(Variable costs for the order + fixed costs increase for the order + opportunity cost) /
number of units in the order
*The opportunity cost is the lost gain from the next best alternative use of the production capacity.

Note: The opportunity cost may be zero if there is idle production capacity available to fill the order.

Problem 3-34 – Special-order – Centrum Manufacturing

Centrum Manufacturing makes a single product with the following attributes:

Direct labor is paid $20 per hour, and each unit of the product requires 2 labor hours. Fixed
manufacturing overhead is applied to products at the rate of $10 per direct labor hour.

Part A

Centrum Manufacturing has received an offer from a new customer to buy 20 units of a modified version
of the existing product. The modification would require an additional $15 of direct materials cost and an
additional 0.50 labor hours for each unit. Centrum Manufacturing has enough idle direct labor capacity
to fill this order without disrupting existing production and sales. What is the minimum price that
Centrum Manufacturing should accept per unit for this modified product?

First, we find the minimum price per unit for the order (here we are only looking at relevant costs):

Variable Costs:
- Direct Materials Costs = $30 + 15 per unit = $45 per unit
- Direct Labour Costs = $20 per hour

Calculate the Direct Labour Costs based on the number of hours

- $20 per hour x (2 hours + additional 0.5 hours) = 20 x 2.5 = $50 dollars per hour

Total cost per unit: 45 + 50 = $95

So, our total cost per unit is $95 dollars, which they need to produce the modified product. It is the
floor price we should accept.

Part B

Assume now that Centrum Manufacturing is operating at its direct labor hour capacity and would need
to displace some of its existing production to accept this offer to purchase 20 units of the modified
product. What is the minimum price that Centrum Manufacturing should accept per unit for this
modified product?
Think about this: Does Centrum Manufacturing have to give up anything to produce the 20 special order
units?

- The Contribution Margin that they would earn on the regular units they could produce with the
Direct Labour Hours required to produce the special-order units. This is the Opportunity Cost.

Now we are dealing with an opportunity cost:

1. Total Direct Labour Hours needed to fill this special order:

20 units x 2.5 Direct Labour Hours/per unit

= 50 hours

Number of regular units given up to fill this special order:

50 Direct Labour Hours / 2 hours per regular unit

= 25 units that we have to give up

2. Now we can find the opportunity cost we would lose out on:

Take the Contribution Margin (profit) and multiply by the number of units:

CM = $130 (price) - $70 (VC per unit)

= $60 Contribution margin
60 x 25 units = 1500 dollars

Divide by the number of units:

Price per unit = $1500 / 20 special units

= $75 per unit

Minimum price per unit required to accept the order

Total variable cost per order unit (from part A): 95
Opportunity cost per unit: 75
Incremental cost per order: 170

Problem 3-48 – Costing orders, profitability and opportunity costs – Wedmark Corporation

Wedmark Corporation’s Cupertino plant manufactures chips used in personal computers. Its
practical capacity is 2,000 chips per week, and fixed costs are $75,000 per week. The selling price is $500
per chip. Production this quarter is 1,600 chips per week. At this level of production, variable costs are
$720,000 per week.

Part A

What will the plant’s profit per week be if it operates at practical capacity?

Think about this: What is the practical capacity?

- It is the reasonable production they expect in a normal week.

Weekly profit at a practical capacity level:

Selling price = $500 per chip

1. So, we can find our Variable Costs per unit using the number of chips of 1600 and the variable
costs of 720000

720000/1600 = $450 in variable costs per chip

2. The fixed costs per week are given to us: $75000 per week

3. Profit = revenue – VC – FC

P = ((500 – 450) x 2000 chips) – 75000

*Note: The 500 – 450 gives us our contribution margin
P = 100000 – 75000
P = $25000

So, the profit, while producing at 2000 units is $25000.

Part B

Suppose that a new customer offers $480 per chip for an order of 200 chips per week for delivery
beginning this quarter. If this order is accepted, production will increase from 1,600 chips to 1,800 chips
per week. What is the estimated change in the company’s profit if it accepts the order?

Think about this: Do we have to worry about any opportunity costs?

- No because 1800 is still within their practical capacity

We can calculate the change in profit:

Current profit at 1600 units:

((500 - 450) x 1600) – 75000
= $5000

Additional costs of adding the special order

 Increase in profit from the order:

(Price – variable cost per unit) x number of chips

*This is the same calculation as part A but with a new price and number of units
= (480 – 450) x 200
= $6000

So, the change in profit is $6000 and total profit would be $11000.

Part C

Suppose that the new customer in part (b) offered $480 per chip for an order of 600 chips per week and
that Wedmark cannot schedule overtime production. Consequently, it would have to give up some of its
current sales to fill the new order for 600 chips per week. What is the estimated change in Wedmark’s
profit if it accepts this order for 600 chips per week?

Now, Wedmark faces an opportunity cost based on its current production level.

1. The company’s current idle capacity is:

2000 (practical capacity) – 1600 (regular units) = 400 units
And 600 > 400

2. Find the increase in profit from the order at 600 units:

(480 – 450) x 600 units

= $18000

3. Take away the opportunity cost from the 200 units that we are giving up:

(500 – 450) x 200 units

= $10000

4. Find the difference between the revenues:

18000 – 10000 = +8000

So, we should fill the order to increase our profit by $8000.

Problem 3-49 - Classifying variable and fixed costs – France’s Floral Shop

Frances’s Floral Shop (FFS) produces and sells a wide range of floral arrangements. Designers, who are
paid $30 per hour, produce the arrangements with the help of assistants, who are paid $18 per hour.
There are 200 designer hours available for this period; however, 180 have already been committed.
There are unlimited assistant hours available for the period. Fixed costs at FFS amount to $2,000 per
period. Fixed costs are allocated to customers at a rate of $10 per designer hour. FFS has just received a
request to produce floral arrangements for a wedding. Frances estimates that completing this order will
require $1,200 of materials, 14 designer hours, and 6 assistant hours.

Part A

What is the minimum price that FFS should charge for this order?

Find the minimum price that FFS should charge:

The special order requires 14 designer hours and there are 20 hours available. Therefore, there will be
no opportunity cost to fulfill the order.

= Direct Materials Costs + Direct Labor Costs

= 1200 + ($30 x 14 hours) + ($18 x 6 hours)
= 1200 + 420 + 108
= 1728
The minimum that FFS should charge for this order is $1728.

Part B

Suppose now that FFS has already committed to using 190 designer hours this month. If needed, a
designer can be diverted from producing arrangements that sell for $25, have total variable costs of $16,
and require 15 designer minutes, the cost of which is included in the $16 variable cost. What is the
minimum price that FFS should charge for this order?

Think about this: Do we have an opportunity cost?

Now there are only 10 designer hours available (200 – 190), so 4 hours will have to be redirected
from current production.

1. Current Contribution Margin = (25 -16) = $9 per flower arrangement

2. We use the minutes to calculate the units:

Number of units given up to the order = 60 minutes / 15 designer minutes = 4 units

3. The total Opportunity Cost (lost contribution margin) is:

= $9 contribution margin per unit x # units given up to fill the order
= $9 contribution margin per unit x ((60 minutes x 4 hours) / 15 designer minutes per unit)
= $9 x (240 /15)
= $9 cm per unit x 16 units given up
= $144

The $144 is the opportunity cost of taking this order.

4. Now, we can add it to the floor price found in part A to find the minimum they should charge
for this order.
= 1728 + 144
 = 1872

The minimum price that FFS should charge for this order is $1872.

Class 8 Notes – February 1st

Short term product mix decisions
- Organizations often face competing demands for their limited production resources
- The relevant costs concept should be applied to these decisions
- Key Objective: To maximize the contribution margin per unit of scarce resource
- Ex: CM per labour hour or CM per machine hour

Steps to solve product mix problems

1. Calculate the CM per unit of the scarce resource for each product
2. Rank the products form the highest to the lowest CM per unit of the scarce resource.
3. Determine the number of units of the product ranked #1 that can be produced (based
on the number demanded and the total scarce resources available).
4. If there are any scarce resources remaining, we can determine the # of units of the
product ranked 2nd that can be produced.
5. Repeat step 4 for each remaining product until the scarce resource is used up and/or
demand for all remaining products is met.

Problem 3-46 – Product Mix Decision – Boyd Wood

Boyd Wood Company makes a regular and a deluxe grade of wood floors. The regular grade is sold at
$16 per square yard, and the deluxe grade is sold at $25 per square yard. The variable cost of making the
regular grade is $10 per square yard. It costs an extra $5 per square yard to make the deluxe grade. It
takes 0.15 labor hours to make 1 square yard of the regular grade and 0.20 labor hours to make 1
square yard of the deluxe grade. There are 4,600 hours of labor time available for production each week.
The maximum weekly sales for the regular and the deluxe models are 30,000 and 8,000 square yards,
respectively. Fixed production costs total $60,000 per year. All selling costs are fixed.

What is the optimal production level in number of square yards for each product?

*To determine the optimal production level, we first need to find which product provides the highest
contribution margin per direct labour hour (the constrained resource)

Steps 1 and 2 Regular Deluxe

Sales price per square yard 16 25
Variable cost per square yard (10) (15)
Contribution Margin per square yard $6 $10
Direct Labor hours per square yard 0.15 0.20
CM per Direct Labour hour $40 $50 = CM / DLH
Production ranking 2 1

Production # sq yards DLHs needed #sq yards Hours used Hours

ranking order demanded to meet produced available
demand
4600
1. Deluxe 8000 (8000 x 0.2) All the 8000 1600 3000 hours
=1600 remaining
(4600-1600)
2. Regular 30000 (30000 x 0.15) 20000 3000 0 hours
= 4500 (3000/0.15) remaining
TOTAL 38000 6100 28000 46000

Problem 3-50 - Cost-volume-profit product mix special order pricing – Sunfish Valves

Sunfish Valves Company (SVC) pro- duces two valves that are used in irrigation systems. The following
exhibit provides product details:

The availability of labor hours limits (constrains) the sales of the two products. The marketing manager
provided the maximum sales for each product shown in the above table. The production manager has
advised the general manager that a new collective agreement limited the maximum labor hours to
9,025. After the general manager developed this income statement, she shared it with the production
and marketing manager. After some quick calculations, the marketing manager determined that if
production and sales of both products were each reduced by 5%, there would be exactly enough
production capacity to meet the resulting production levels of the two products. The general manager
concurred and proceeded to develop a revised production plan.

a. What is the sales level that would result in SVC breaking even if the sales mix is 25/43 standard
and 18/43 deluxe?
b. The general manager shared the planned production mix in part (a) with her son, a business
student at a local university. The son said, “This is not the optimal production plan, and I’ll show
you the best mix later.” Show that the son was correct by determining the optimal pro- duction
plan.
c. After the optimal production plan in part (b) was chosen, the marketing manager announced
that he had just received a one-time offer to purchase 2,000 units of a new product, a medium
pressure valve. The offer price per valve was $33, the variable cost per valve was $25, and it
would take 0.15 labor hours to produce each one of these valves. If the offer is accepted, SVC
must deliver all 2,000 units. The general manager was unsure whether this offer should be
accepted, but she was doubtful because the valve contribution margin was only $8, which was
less than the contribution margins of the existing products. Determine whether this offer should
be accepted. If so, what would be the revised production plan?

*See attached excel document for solution

Hint: you can click on the cells to see what calculations are being done to get certain values.

Problem 3-60 – Product Mix and Overtime Decisions - Excel Corporation

Product mix and overtime decisions Excel Corporation manufactures three products at its plant. The
plant capacity is limited to 120,000 machine hours per year on a single-shift basis. Direct material and
direct labor costs are variable. The following data are available for planning purposes:

a. Given the capacity constraint, determine the production levels for the three products that will
maximize profits.
 b. If the company authorizes overtime in order to produce more units of XL2, the direct labor cost
per unit will be higher by 50% because of the overtime premium. Materials cost and variable
overhead cost per unit will be the same for overtime production as for regular production. Is it
worthwhile operating overtime?

The new contribution margin for the overtime production of XL2 will be $1.05.

Calculation:

14 – [ 4.7 – ($3.30 x 1.5) – 3.30 ] = 1.05

14 = sales price per unit

4.7 = Direct materials cost
3.3 = Direct labor cost
1.5 = accounts for the 50% overtime premium
3.3 = Variable overhead

Because the unit contribution margin of XL2 using overtime is positive, it is worthwhile operating
overtime.

BU 247 – Managerial Accounting

Class 9 Notes – Monday February 6th - The nature of indirect costs
Cost Flows in Organizations
- Cost management systems differ in the way that they assign indirect overhead costs to
cost objects.
- To compute total product costs, management accounting systems should reflect the
flow of actual cost flows in an organization.
 - Therefore, organizations need to be able to assign the indirect overhead costs to the
outputs produced.
- Manufacturing, retail, and service organizations have different patterns of cost flows
resulting in different management accounting priorities.

Manufacturing costs are classified into 3 groups

- Direct Materials Costs (variable costs: driven by volume of production)
- Direct Labor Costs (variable costs: driven by volume of production)
- Manufacturing overhead – can include variable and fixed costs
o Materials are drawn from raw materials inventory as production begins
o The costs are moved from the raw materials account to the work in process
account
o The manufacturing operation consumes labor and overhead items, and their
costs are added to the work in process inventory.

Exhibit 4-1 form the textbook page 78

Indirect Cost Pools

- One type of Indirect Cost Pool collects the actual indirect costs incurred for the period
o Indirect Cost Incurred
- A second type of Indirect Cost Pool accumulates the indirect cost that has been applied
to production for the same
o Indirect Cost Applied (based on pre-determined indirect rates)
- At the end of the year, the two pools need to be reconciled once actual indirect costs
incurred are known.
*See page 85-86 for different cost reconciliation methods.

Steps to Find Predetermined Overhead Rates

1. Determine the cost driver that will be used to allocate the indirect costs to production
(Denominator). Examples of costs driver: number of labor hours or machine hours

2. The estimated (planned) total factory indirect costs are divided by the practical capacity
in cost driver units to compute the predetermined overhead rate (numerator).
Formula:

Predetermined indirect (overhead rate) =

Estimated (planned) total indirect cost/

Practical capacity in cost driver units

- The simplest structure in a manufacturing system is to have a single Indirect Cost Pool
for the entire manufacturing operation.
- Most organizations have multiple Indirect Cost Pools in order to more accurately cost
the resources used by the cost object.
- Example: An indirect cost pool may be used for each department or activity

Problem 4-25 – Practical capacity and machine hours – Calla Manufacturing

Calla Manufacturing Company has 40 machines in its factory. The machines run for two shifts each day.
Allowing for machine maintenance and break time for machine operators, each machine can be used for
production for an average of 6.5 hours per shift. Assuming the factory operates for an average of 22
days per month, what is Calla’s practical capacity number of machine hours per month?

Machine Hours = Cost driver for the question

Practical Capacity =
Theoretical Total Capacity Available –
Downtime Expected (equipment downtime, maintenance, breaks)

- 40 machines
- 2 shifts per day for each machine
- 6.5 hours her shift
 - 22 days per month

Practical capacity = 40 x 2 x 6.5 x 22

= 11440 machine hours per month

Problem 4-31 – Single rate versus departmental rate – Northern Wood

Northern Wood Products has two production departments: cutting and assembly. The company has been
using a plantwide cost driver rate computed by dividing plantwide overhead costs by total plantwide
direct labor hours. The estimates for overhead costs and practical capacity quantities of cost drivers for
the current year follow:

Part A

Compute the plantwide cost driver rate.

Plantwide cost driver rate:

- Combining all the overhead cost: (125000 + 35000 = 160000)

Total Manufacturing Overhead = 160000 / 8000 direct labour hours

= $20 per Direct Labor Hour

Part B

Determine departmental cost driver rates based on direct labor hours for assembly and ma- chine hours
for cutting.

Each department will have their own cost driver:

Cutting Department cost driver rate

125000 overhead / 5000 machine hours

= $25 per machine hour

Assembly Department cost driver rate

 35000 overhead / 5000 Direct Labour Hours
= $7 per direct labor hour

Part C

Provide reasons why Northern Wood might use the method in part (a) or the one in part (b).

Plantwide cost driver rate may be used if:

- All overhead costs have a cause-and-effect relationship with the same cost driver
- It is much simpler to use one Cost Driver Rate

Departmental cost driver rates may be used if :

- Each departmental overhead costs have a different cost driver that best represent the cause-
and-effect relationship
- May be more accurate than using a plant-wide cost driver rate

Problem 4-48 - Job cost, markup, and single rate versus departmental rates – Modern Metalworks

Modern Metalworks Company has two departments: milling and assembly. The company uses a job
costing system with a plant- wide cost driver rate that is computed by dividing plantwide overhead costs
by total plantwide practical capacity direct labor hours. The following cost and practical capacity
estimates are for October:

The following information pertains to job 714, which was started and completed during October:

Part A

Determine the cost of job 714.

We will need to determine the OH cost that should be applied to job 714, using the current plant-
wide cost driver rate:

Total plantwide overhead costs / Total plantwide practical capacity DL hours

= (120000+160000) / (8000+12000 direct labor hours)

 = (280000 / 20000 DL hours)

= $14 per direct labor hour

Now we can find the total cost of the job:

Total direct materials cost

= 800 + 50
= 850

Total direct labour costs

= 100 + 600
= 700

Indirect Overhead Costs:

$14 per direct labour hour x (10 + 40 direct labour hours) = 700

Total cost =
850 + 700 + 700 = 2250

Part B

Suppose that instead of using the plantwide cost driver rate, the company uses machine hours as the
cost driver for applying overhead costs in the milling department and direct labor hours as the cost driver
in the assembly department. Compute these departmental cost driver rates and determine the cost of
job 714 using these rates.

Milling cost driver rate:

$120000 / 12000 machine hours

= $10 per machine hour

Multiply by the number of Direct material hours for Milling (18 hours)
= 10 x 18
= $180

Assembly cost driver rate:

$160000 / 12000 direct labor hours

=13.333 per direct labour hour

Multiply by the number of Direct Labour hours for Assembly (40 hours)
= 13.333 x 40
= $533.33
 Total Overhead = 180 + 533.33 = 713.33

Now we add in the total direct materials and direct labour costs as in Part A, to find the total cost of
the job:

= 850 + 700 + 713.33 = 2263.33

Summary of Job Costing for Job 714

Total
Total Direct Material Cost (800+50) 850
Total Direct Labour Costs (100+600) 700
Manufacturing Overhead
Milling: 18 machine hrs. x 10 per OH rate 180
Assembly: 40 x 13.3333 per OH rate 533.33
Total OH cost: 713.33
Total cost for Job 714 2263.33

Part C

Using the costs, you computed in parts (a) and (b), determine the bid price that Modern Metalworks will
quote under each cost system if it uses a 25% markup on total manufacturing cost.

Bid price for part A Bid price for part B

Total cost of job 2250 2263.33
+ 25% markup 562.5 565.83
Bid price 2812.5 2829.17

*We can make the observation that they are quite similar in cost.

Part D

Provide reasons why Modern Metalworks might prefer the method in part (a) or the one in part (b).

The company will favour the method in Part B using department overhead cost driver rates if:

- Each department has a cause-and-effect relationship with a different cost driver. This will result
in more accurate overhead costs allocations to jobs.
 - However, the bid prices for Job 714 under each option in Part C suggest that the differences in
cost allocations are small. Therefore, the company may be inclined to use plant-wide cost driver
rate. This is a simpler method.

Class 10 Notes – Wednesday February 8th – Job Costing

Job Order Costing
- Job Order Costing accumulates the cost for specific customer orders because the orders
tend to vary from customer to customer.
- Examples: consulting work, treating a patient, auto repairs, home building
- Each job is assigned a unique job order number for collecting costs.
- When businesses have indirect costs, we have to allocate them out to each order.
 - The company collects the actual Direct Material Costs and Direct Labour used for a
specific job.
- Indirect overhead costs are allocated to each job using the approaches that we
discussed in session 9.
Steps to Job Order Costing
1. Cost Driver Rate (CDR) = Total Overhead Cost / Total Volume of the Cost Driver
2. Overhead Cost of Job = CDR x Volume of the Cost Driver used by the job
Note: If using a departmental approach, compute Cost Driver Rate for each department,
compute the Overhead cost of the job in each dept and then add all department Overhead
Costs to find that total Overhead cost of the job.
Problem 4-28 - Job cost – Pat’s Auto Shop

The following costs pertain to job 903 at Pat’s Auto Shop:

Determine the total cost for job 903.

Job 903 Quantity Rate Amount

Direct Materials
Engine Oil 14 ounces $5 $70
Lubricant 22 ounces $8 $176
Total Direct Materials $246

Direct Labour 3 hours $15 $45

Overhead costs 3 direct labour hours $8 $24
Total D-Labour Costs $69
Total cost of job $315

Problem 4-46 – Job Costing – The Jiang Company

The Jiang Company employs a job order cost system to account for its costs. There are three production
departments. Separate departmental cost driver rates are employed because the demand for support
activities for the three departments is very different. All jobs generally pass through all three production
departments. Data regarding the hourly direct labor rates, cost driver rates, and three jobs on which
work was done during April appear below. Jobs 101 and 102 were completed during April, while job 103
was not completed as of April 30. The costs charged to jobs not completed at the end of a month are
shown as work in process at the end of that month and at the beginning of the next month.
Part A

Determine the total cost of completed job 101.

Job 101 Quantity Rate Amount

Beginning Work in $27000
Progress
Department 1 (cost driver: 150% of direct material)
Direct Materials $50000
Direct Labour 600 hours $22 $13200
Overhead $50000 150% $75000
Department 2 (cost driver: $60 per machine hour)
Direct Materials $4000
Direct Labour 250 hours $18 $4500
Overhead 1500 machine hours $60 $90000
Department 3 (cost driver: $40 per direct labour hour)
Direct Materials 0
Direct Labour 1800 hours $20 $36000
Overhead 1800 hours $40 $72000

TOTAL COST 371700

Part B
Determine the total cost of completed job 102.

Job 102 Quantity Rate Amount

Beginning Work in $36000
Progress
Department 1 (cost driver: 150% of direct material)
Direct Materials $28000
Direct Labour 500 hours $22 $11000
Overhead $28000 150% $42000
Department 2 (cost driver: $60 per machine hour)
Direct Materials $7000
Direct Labour 300 hours $18 $5400
Overhead 1800 machine hours $60 $108000
Department 3 (cost driver: $40 per direct labour hour)
Direct Materials 0
Direct Labour 2100 hours $20 $42000
Overhead 2100 hours $40 $84000

TOTAL COST 363400

Part C

Determine the ending balance of work in process for job 103 as of April 30.

Job 103 Quantity Rate Amount

Beginning Work in $0
Progress
Department 1 (cost driver: 150% of direct material)
Direct Materials $68000
Direct Labour 500 hours $22 $11000
Overhead $68000 150% $102000
Department 2 (cost driver: $60 per machine hour)
Direct Materials $19000
Direct Labour 350 hours $18 $6300
Overhead 1200 machine hours $60 $72000
Department 3 (cost driver: $40 per direct labour hour)
Direct Materials 0
Direct Labour 2800 hours $20 $56000
Overhead 2800 hours $40 $112000
 TOTAL COST 446300

*The $446300 is the ending work in progress balance for April.

Problem 4-50 – Job Costing – The Gonzalez Company

The Gonzalez Company uses a job order costing system at its plant in Green Bay, Wisconsin. The plant
has a machining department and a finishing department. The company uses two cost driver rates for
allocating manufacturing overhead costs to job orders: one based on machine hours for allocating
machining department overhead costs and the other based on direct labor cost for allocating the
finishing department overhead costs. Estimates for the current year follow:

Part A

Determine the two departmental cost driver rates.

There are 2 departmental cost driver rates

Cost driver rate for the machining department:

500000 manufacturing OH Cost / 20000 machine hours

$25 per machine hours

Cost driver rate for the finishing department:

400000 manufacturing OH cost / 500000 direct labour cost

= 0.8
= 80% of direct labour costs

Part B

Last month, cost records for job 511 show the following:
 Machining Department
Direct Materials Cost $12000
Direct Labour cost $300
Overhead 80 machine hours x $25 per machine hour
calculated in Part A
= 2000
SUB-TOTAL $14300

Finishing Department
Direct Materials Cost $2000
Direct Labour cost $1200
$1200 direct labour costs x 80% calculated in
Part A
= 960
SUB-TOTAL $4160
TOTAL $18460

Part C

Explain why Gonzalez Company uses two different cost driver rates in its job costing system.

They likely believe that the manufacturing overhead costs are driven by different factors in each
manufacturing department. Overhead costs in the Machining department have a cause-and-effect
relationship with Machine hours, and those in the Finishing department have a cause-and-effect
relationship with Direct Labour costs.

BU 247 – Managerial Accounting

Class 11 Notes – Monday February 13th – Process Costing (Steps 1-3)
Due to the way content was split this week, I have consolidated all the weekly problems at
the end of the notes, for completeness.
The solutions will only have the direct answers, see the Excel File for the elaborations 

Process costing
- Process costing is used to allocate costs when output produced is identical and it is
difficult to assign costs to each unit of output.
- Ex: food production, chemical processing, textiles
- We will use the weighted average process costing approach
o Total production costs are added up and then divided by the number of units
produced to get a cost per unit.
Process costing systems use two different cost terms:
- Direct Materials Costs
- Conversion Costs – All manufacturing costs incurred that are not direct materials costs
o Examples: Direct Labor and Indirect Overhead

Something to think about: Why does process costing separate out direct materials from all
other production costs?
- Direct materials are added at specific points in time during the production process,
whereas Direct Labor and Indirect Overhead are likely to be incurred throughout the
entire production process.
Process Costing is a 5-Step Process
1. Summarize the physical flow of units and identify the % completion of ending inventory
 How many units we have in the production process and how many units in
ending inventory that are not fully completed
2. Compute the equivalent units for materials and conversion costs.
 Multiply the physical number of units by the % completion for materials and
conversion costs separately
3. Summarize the total material and conversion costs
 Record the costs incurred during the period and add these to any costs in the
opening inventory (ending inventory from previous period)

Equivalent Units
- Units are not always fully complete, so we need to account for them by multiplying the
amount by the percent completion.
o If we have 4 physical units 50% completed, then we only have 2 equivalent units

Class 12 Notes – Wednesday February 15th – Process Costing (Steps 4-5)

Process Costing
- Process Costing is used to allocate costs when:
o Output produced is identical and goes through the same production process
requirements
o The production process is continuous (or semi-continuous)
o It is difficult to assign costs to individual units of output

Review from last class

 - What are conversion costs?
o Conversion Costs include all manufacturing costs that are not material costs
o Ex: Direct Labor, Factory overhead
- What do equivalent units represent in process costing?
o Equivalent units = Physical units x Percentage (%) of Completion
o This is calculated for materials and conversion costs separately, as they often have
different completion percentages.

All Process Costing Steps

1. Summarize the physical flow of units and identify the % completion of ending
inventory
 How many units we have in the production process and how many units in
ending inventory that are not fully completed
2. Compute the equivalent units for materials and conversion costs.
 Multiply the physical number of units by the % completion for materials and
conversion costs separately
3. Summarize the total material and conversion costs
 Record the costs incurred during the period and add these to any costs in the
opening inventory (ending inventory from previous period)
4. Compute the Costs Per Equivalent Unit
 Divide the costs from step 3 by the total equivalent units from Step 2 to get
the cost per equivalent unit for materials and conversion costs
5. Assign Costs to Work Completed (and transferred out) and to Ending Work in Process
o Use the cost per equivalent unit and the equivalent unit values to assign
materials and conversion costs to ending work in process and work completed
(and transferred out) separately.
Below we have an Excel Template for completing Steps 1-5
In-Class Problems
Problem 4-33 – Cost per equivalent unit – Badger Company
*Only completed Steps 1-3 for this problem in class

Badger Company manufactures a unique machine hardware item that it sells to companies that
specialize in repairing oil drilling equipment. At the start of the most recent month, there were 100,000
units in opening inventory. During the month, 750,000 units were entered into production and 800,000
were completed. The units in ending inventory were 100% complete with respect to materials costs and
75% complete with respect to conversion costs. The accounting records show that there were $500,000
of materials costs and $25,000 of conversion costs in opening inventory and in the current month,
materials costs of $3,835,000 and conversion costs of $310,000 were added.

Compute the cost per equivalent unit for materials and conversion.

The cost per equivalent unit for materials would be $5.1 and $0.4 for conversion.

Problem 4-35 – Process Costing – Cambridge Company

Cambridge Company manufactures plastic bottles that it sells to organizations that manufacture bottled
water. During the most recent month, there was no opening inventory. During the month, 25 million
bottles were entered into production and 24 million were completed. The units in ending inventory were
100% complete with respect to materials costs and 60% complete with respect to conversion costs.
During the month, materials costs were $500,000 and conversion costs were $246,000.

Part A
What was the number of equivalent units of work done for conversion costs this month?

24 600 000 equivalent units for conversion costs.

Part B
What was the cost per equivalent unit of conversion cost this month?

$0.01 is the cost per equivalent unit of conversion costs.

Part C
What is the cost that will be allocated to units completed and transferred out?

The cost allocated to units Completed and Transferred Out is $720 000.
Part D
What is the cost that will be allocated to ending work in process?

The cost allocated to Ending Work in Process is $26000.

Problem 4-36 – Process Costing – Beek Manufacturing

Beek Manufacturing uses a process costing system to manufacture its single product. Production began
in November 2018. Production details for the month of December 2018 were as follows:

- Work in process, December 1: 1,000

- Units started in December: 9,000
- Units completed and transferred out: 7,000
- Work in process, December 31: 3,000
- Percentage completion in ending inventory
o Materials: 100%
o Conversion costs: 50%
- Costs in opening inventory
o Materials: $4,000
o Conversion: $6,000
- Costs added in December
o Materials: $10,000
o Conversion: $19,500

Part A
Compute the cost per equivalent unit for materials. $1.4

Part B
Compute the cost per equivalent unit for conversion. $3

Part C
Compute the materials cost in ending work in process. $4200

Part D
Compute the conversion cost in ending work in process. $4500

Part E
Compute the material costs transferred out. $9800

Part F
Compute the conversion cost transferred out. $21000

Problem 4-38 – Process Costing – Center City Products

Center City Products uses process costing to determine the production costs of its only product. The
factory accountant has reported the following facts for the most recent period:

- There were 4,000 units in opening work in process, and 20,000 units were started this period.
During the period, 18,000 units were completed and transferred out.
- Ending inventory was 100% complete with respect to materials costs and 20% complete with
respect to conversion costs.
- Total materials and conversion costs in opening inventory were $16,000 and $12,320,
respectively. Materials and conversion costs incurred in this period were $32,000 and $76,000,
respectively.

Part A
Compute the cost per equivalent unit for materials. $2

Part B
Compute the cost per equivalent unit for conversion. $4.6

Part C
Compute the materials cost in ending work in process. $12000

Part D
Compute the conversion cost in ending work in process. $5520

Part E
Compute the material costs transferred out. $36000

Part F
Compute the conversion cost transferred out. $82800