Test Bank Accounting For Decision Making And Control Zimmerman 9th Edition | INSTANT DOWNLOAD AFTER PURCHASED

A chair manufacturer has established the following flexible budget for the month.

Required:

a. What is the sales price per chair?
b. What is the expected profit if 1,600 chairs are made?

The Sticky Company makes a glue that is used to glue the layers of wood veneer together to make plywood. The process for making the glue has been used for many years and the customers are satisfied with the product. The Sticky Company has had very low turnover of personnel and the president and the managers have all been with the company for many years. Although the company appears very stable today, plywood prices are rising and the construction industry is beginning to switch to a cheaper product called chipboard. Chipboard uses a different glue than the glue made by the Sticky Company.

Required:

Given the present condition of Sticky Company, should the company use long-term budgets, line-item budgets, budget lapsing, flexible budgets, or zero-based budgeting?

Describe (a) the benefits of top-down budgeting and (b) the benefits of bottom-up budgeting.

Describe how budgets and budgeting systems help solve the organization problem. Give examples.

The Fancy Umbrella Company makes beach umbrellas. The production process requires 3 square meters of plastic sheeting and a metal pole. The plastic sheeting costs $0.50 per square meter and each metal pole costs $1.00. At the beginning of the month, the company has 5,000 square feet of plastic and 1,000 poles in raw materials inventory. The preferred raw material amount at the end of the month is 3,000 square feet of plastic sheeting and 600 poles. The company has 300 finished umbrellas in inventory at the beginning of the month and plans to have 200 finished umbrellas at the end of the month. Sales in the coming month are expected to be 5,000 umbrellas.

Required:

a. How many umbrellas must the company produce to meet demand and have sufficient ending inventory?
b. What is the cost of materials that must be purchased?

The Gold Bay Hotel is in the process of developing a master budget and pro-forma financial statements. The beginning balance sheet for the current fiscal year is estimated to be:

During the year the hotel expects to rent 30,000 rooms. Rooms rent for an average of $90 per night. The hotel expects to sell 40,000 meals during the year at an average price of $20 per meal. The variable cost per room rented is $30 and the variable cost per meal is $8. The fixed costs not including depreciation is expected to be $2,000,000. Depreciation is expected to be $500,000. The hotel also expects to refurbish the kitchen at a cost of $200,000, which is capitalized (included in the facility account). Interest of the note payable is expected to be $50,000 and $100,000 of the note payable will be retired during the year. The ending accounts receivable amount is expected to be $40,000 and the ending accounts payable is expected to be $30,000.

Required:

Prepare pro-forma financial statements for the end of the current year.

The Jung Corporation’s budget calls for the following production:

Each unit of production requires three pounds of direct material. The company’s policy is to begin each quarter with an inventory of direct materials equal to 30 percent of that quarter’s direct material requirements.

Required:

Compute budgeted direct materials purchases for the third quarter.

Picture Maker is a freestanding photo kiosk consumers use to download their digital photos and make prints. Shashi Sharma has a small business that leases several Picture Makers from the manufacturer for $120 per month per kiosk, and she places them in high-traffic retail locations. Customers pay $0.18 per print. (The kiosk only makes six- by eight-inch prints.) Sharma has one kiosk located in the Sanchez Drug Store, for which Sharma pays Sanchez $80 per month rent. Sharma checks each of her kiosks every few days, refilling the photographic paper and chemicals, and collects the money. Sharma hires a service company that cleans the machine, replaces any worn or defective parts, and resets the kiosk’s settings to ensure the kiosk continues to provide high-quality prints. This maintenance is performed monthly and is independent of the number of prints made during the month. The average cost of the service runs about $90 per month, but it can vary depending on the extent of repairs and parts required to maintain the equipment.
Paper and chemicals are variable costs, and maintenance, equipment lease, and store rent are fixed costs. If the kiosk is malfunctioning and the print quality deteriorates, Sanchez refunds the customer’s money and then gets his money back from Sharma when she comes by to check the paper and chemical supplies. These occasional refunds cause her variable costs per print for paper and chemicals to vary over time.
The following table reports the results from operating the kiosk at the Sanchez Drug Store last month. Budget variances are computed as the difference between actual and budgeted amounts. An unfavorable variance (U) exists when actual revenues fall short of budget or when actual expenses exceed the budget. Last month, the kiosk had a net loss of $23, which was $87 more than budgeted.

Required:

a. Prepare a schedule that shows the budget Sharma used in calculating the variances in the preceding report.
b. How many good prints were made last month at the Sanchez Drug Store kiosk?
c. Prepare a flexible budget for the Sanchez Drug Store kiosk based on a volume of 2,000 prints.

Production departments often over-estimate costs, to make it easier to stay within budget targets. Similarly, sales forecasts are often under-estimated to make them easier to beat.

Budget ratcheting occurs when next year’s targets are increased because this year’s targets were met or exceeded. This technique is dysfunctional, because it discourages people from trying hard to beat this year’s target.

The correct matrix is:

Both sectors might be improved if there were a transfer of budgeting know-how!

While the actual expenditure of $54,280 is $620 less than the master budget of $54,900, it is not appropriate to compare directly actual expenditure with master budget expenditure, because the levels of activity are different (650 in master and 630 for actual). Thus actual is properly compared only with the flexible budget, which essentially is the master budget UPDATED for actual levels of output.

Spending more than the budget allowance for fixed manufacturing overhead will create an unfavorable variance. All the other examples would, on their own, cause favorable variances

The organizational process of budgeting performs all of the important functions, including assigning decision rights, sharing knowledge, forced planning, and measuring performance. Organizations use budgets in order to accomplish these important functions within the business.

A chair manufacturer has established the following flexible budget for the month.

Required:

a. What is the sales price per chair?
b. What is the expected profit if 1,600 chairs are made?

a. The sales price per chair can be calculated by dividing the sales dollars by the number of units: $10,000/1,000 units = $10/unit
b. The variable cost per unit can be calculated by dividing the variable costs by the number of units: $5,000/1,000 units = $5/unit

The expected profit of making and selling 1,600 chairs is:

The Sticky Company makes a glue that is used to glue the layers of wood veneer together to make plywood. The process for making the glue has been used for many years and the customers are satisfied with the product. The Sticky Company has had very low turnover of personnel and the president and the managers have all been with the company for many years. Although the company appears very stable today, plywood prices are rising and the construction industry is beginning to switch to a cheaper product called chipboard. Chipboard uses a different glue than the glue made by the Sticky Company.

Required:

Given the present condition of Sticky Company, should the company use long-term budgets, line-item budgets, budget lapsing, flexible budgets, or zero-based budgeting?

If the market for the glue for plywood was viewed as a stable market, then Sticky Company is likely to use long-term budgets. The managers and employees have all been with the Sticky Company for many years, so there is no need to use line-item budgeting and not much need to transfer information. Therefore, incremental budgeting is probably better than zero-based budgeting. Budget lapsing is generally not used in a profit company. Flexible budgets are probably appropriate because the demand for the product depends on the demand for plywood, which is not controlled by the managers of Sticky Company.
If Sticky Company is facing a transition due to the conversion from plywood to chipboard, the company is likely to change its budgeting. There will be a greater focus on short-term budgets because of increased uncertainty about the long run. Line item and fixed budgets may be used more frequently because more control from central administration may be desired in an attempt to adapt to a new environment. Zero-based budgeting may be instituted to increase information flow.

Describe (a) the benefits of top-down budgeting and (b) the benefits of bottom-up budgeting.

a. Benefits of top-down budgeting include:

• Better for decision control in the sense that the variance from the budget is useful for performance measurement and compensation
• Lower influence costs and less gaming by the people being held accountable for the numbers
• The budgeted numbers are not biased by lower-level managers who are being evaluated based on these numbers (less sandbagging)
• Less time is spent generating these top-down numbers to the extent that lower-level managers spend no time on the process

b. Benefits of bottom-up budgeting include:

• More knowledge assembly of information held by lower level employees
• Participative budgeting provides more employee buy-in and perhaps better acceptance and higher morale
• Better for decision management

Describe how budgets and budgeting systems help solve the organization problem. Give examples.

The organization problem consists of partitioning decision rights and measuring and rewarding performance. Budgets help solve the organization problem by providing a measure of performance, by linking knowledge and decision rights, and by transferring specialized knowledge within the firm.
Agency problems exist in all multi-person organizations. Budgets are an important mechanism for controlling agency problems. Budgets provide a performance measure by comparing budgeted amounts to actual amounts.
Within organizations it is useful to try to link decision rights and specific knowledge. Budgets give managers the decision rights to spend resources on specific functions up to the dollar limit in the budget. Budgets partition decision rights, and by giving budgets to managers with the specialized knowledge, decision rights and knowledge are linked.
The budgeting process separates decision management from decision control via the initiation, ratification, implementation, and monitoring process. A manager does not have decision rights over all steps in the process. Through a bottom-up budgeting process, the manager’s budgeting decision rights are controlled.
Finally, budgeting does not solve all organization problems. There is the remaining problem of managers biasing their budget forecasts if these same numbers also are used for performance evaluations.

The Fancy Umbrella Company makes beach umbrellas. The production process requires 3 square meters of plastic sheeting and a metal pole. The plastic sheeting costs $0.50 per square meter and each metal pole costs $1.00. At the beginning of the month, the company has 5,000 square feet of plastic and 1,000 poles in raw materials inventory. The preferred raw material amount at the end of the month is 3,000 square feet of plastic sheeting and 600 poles. The company has 300 finished umbrellas in inventory at the beginning of the month and plans to have 200 finished umbrellas at the end of the month. Sales in the coming month are expected to be 5,000 umbrellas.

Required:

a. How many umbrellas must the company produce to meet demand and have sufficient ending inventory?
b. What is the cost of materials that must be purchased?

a. Number of umbrellas that must be produced:

b. Materials needed to produce 4,900 umbrellas:

Materials that must be purchased
= usage + ending inventory – beginning inventory:
Poles 4,900 + 600 – 1,000 = 4,500 poles
Plastic sheeting 14,700 + 3,000 – 5,000 = 12,700 square meters

Cost of material that must be purchased:

The Gold Bay Hotel is in the process of developing a master budget and pro-forma financial statements. The beginning balance sheet for the current fiscal year is estimated to be:

During the year the hotel expects to rent 30,000 rooms. Rooms rent for an average of $90 per night. The hotel expects to sell 40,000 meals during the year at an average price of $20 per meal. The variable cost per room rented is $30 and the variable cost per meal is $8. The fixed costs not including depreciation is expected to be $2,000,000. Depreciation is expected to be $500,000. The hotel also expects to refurbish the kitchen at a cost of $200,000, which is capitalized (included in the facility account). Interest of the note payable is expected to be $50,000 and $100,000 of the note payable will be retired during the year. The ending accounts receivable amount is expected to be $40,000 and the ending accounts payable is expected to be $30,000.

Required:

Prepare pro-forma financial statements for the end of the current year.

The Jung Corporation’s budget calls for the following production:

Each unit of production requires three pounds of direct material. The company’s policy is to begin each quarter with an inventory of direct materials equal to 30 percent of that quarter’s direct material requirements.

Required:

Compute budgeted direct materials purchases for the third quarter.

Picture Maker is a freestanding photo kiosk consumers use to download their digital photos and make prints. Shashi Sharma has a small business that leases several Picture Makers from the manufacturer for $120 per month per kiosk, and she places them in high-traffic retail locations. Customers pay $0.18 per print. (The kiosk only makes six- by eight-inch prints.) Sharma has one kiosk located in the Sanchez Drug Store, for which Sharma pays Sanchez $80 per month rent. Sharma checks each of her kiosks every few days, refilling the photographic paper and chemicals, and collects the money. Sharma hires a service company that cleans the machine, replaces any worn or defective parts, and resets the kiosk’s settings to ensure the kiosk continues to provide high-quality prints. This maintenance is performed monthly and is independent of the number of prints made during the month. The average cost of the service runs about $90 per month, but it can vary depending on the extent of repairs and parts required to maintain the equipment.
Paper and chemicals are variable costs, and maintenance, equipment lease, and store rent are fixed costs. If the kiosk is malfunctioning and the print quality deteriorates, Sanchez refunds the customer’s money and then gets his money back from Sharma when she comes by to check the paper and chemical supplies. These occasional refunds cause her variable costs per print for paper and chemicals to vary over time.
The following table reports the results from operating the kiosk at the Sanchez Drug Store last month. Budget variances are computed as the difference between actual and budgeted amounts. An unfavorable variance (U) exists when actual revenues fall short of budget or when actual expenses exceed the budget. Last month, the kiosk had a net loss of $23, which was $87 more than budgeted.

Required:

a. Prepare a schedule that shows the budget Sharma used in calculating the variances in the preceding report.
b. How many good prints were made last month at the Sanchez Drug Store kiosk?
c. Prepare a flexible budget for the Sanchez Drug Store kiosk based on a volume of 2,000 prints.

a. Since the budget variance = Actual – Budget, rearranging gives

Budget = Actual – Variance, or:

b. Since actual revenues were $360, and each print cost $0.18, then $360 ÷ $0.18 = 2,000.
c. The budget in part (a) reports revenues of $468. With each print generating revenues of $0.18, the budget in part (a) is based on 2,600 prints ($468 ÷ $0.18). Using the 2,600 prints amount, the budgeted cost of paper ($78), and the budgeted cost of chemicals ($26) we can calculate the budgeted variable cost of paper to be $0.03 per print ($78 ÷ 2,600) and the budgeted variable of chemicals to be $0.01 per print ($26 ÷ 2,600). The flexible budget based on 2,000 prints is:

Variable factory overheads are estimated to be $1,200,000 per month, when 1,000,000 pounds of various products are produced. The plant employs 20 chemical workers who typically work 175 hours each per month and are paid $24 per hour. Other workers are classified as indirect and are included in fixed overheads. The highly automated plant typically runs 21,000 machine hours per month. The preparation of one 100 lbs batch of Xentra needs ten minutes of direct labor and 75 minutes of machine time. Fixed manufacturing overheads total $3,500,000 per month. Forty percent of these fixed manufacturing overheads are labor-related costs and the balance are machine-related costs.

Assuming normal production levels, what is the direct materials and direct labor cost (i.e., the prime cost) per drum?

Variable factory overheads are estimated to be $1,200,000 per month, when 1,000,000 pounds of various products are produced. The plant employs 20 chemical workers who typically work 175 hours each per month and are paid $24 per hour. Other workers are classified as indirect and are included in fixed overheads. The highly automated plant typically runs 21,000 machine hours per month. The preparation of one 100 lbs batch of Xentra needs ten minutes of direct labor and 75 minutes of machine time. Fixed manufacturing overheads total $3,500,000 per month. Forty percent of these fixed manufacturing overheads are labor-related costs and the balance are machine-related costs.

Assuming normal production levels, what is the conversion cost (direct labor and overhead) per drum?

Variable factory overheads are estimated to be $1,200,000 per month, when 1,000,000 pounds of various products are produced. The plant employs 20 chemical workers who typically work 175 hours each per month and are paid $24 per hour. Other workers are classified as indirect and are included in fixed overheads. The highly automated plant typically runs 21,000 machine hours per month. The preparation of one 100 lbs batch of Xentra needs ten minutes of direct labor and 75 minutes of machine time. Fixed manufacturing overheads total $3,500,000 per month. Forty percent of these fixed manufacturing overheads are labor-related costs and the balance are machine-related costs.

Assuming normal production levels, what is the full cost per drum?

Variable factory overheads are estimated to be $1,200,000 per month, when 1,000,000 pounds of various products are produced. The plant employs 20 chemical workers who typically work 175 hours each per month and are paid $24 per hour. Other workers are classified as indirect and are included in fixed overheads. The highly automated plant typically runs 21,000 machine hours per month. The preparation of one 100 lbs batch of Xentra needs ten minutes of direct labor and 75 minutes of machine time. Fixed manufacturing overheads total $3,500,000 per month. Forty percent of these fixed manufacturing overheads are labor-related costs and the balance are machine-related costs.

A government agency wants to purchase 200 drums of Xentra at cost plus a flat fee. Which allocation method gives the profit-maximizing result?

If KKC uses the simplest algorithm to allocate power costs, which is not true?

In the following month, the power generation department costs amounted to $4.3 million for 51 million kwh. Kong Dept.’s usage was the same, but the Kang Dept. increased output to 4.1 million kangs, each using the standard power allowance. If KKC employs an insulating cost allocation mechanism, and fixed costs are shared equally, which is true?

A lawyer allocates overhead costs based on his hours working with different clients. The lawyer expects to have $200,000 in overhead during the year and expects to work on clients’ cases 2,000 hours during the year. In addition, she wants to pay herself $50 per hour for working with clients. In other words, the lawyer’s billing rate is the sum of her hourly fee ($50) and a fee to recover the expected overhead spread over 2,000 hours. The lawyer, however, does not bill all of her clients based on covering overhead costs and her own salary. Some clients pay her on contingency fees. If the lawyer works with a client on a contingency fee basis, the lawyer receives half of any settlement for her client. During the year the lawyer works 1,200 hours that are billable to clients. The remaining hours are worked on a contingency basis. The lawyer wins $300,000 in settlements for his clients of which she receives half. Actual overhead was $210,000.

Required:

What does the lawyer earn during the year after expenses?

The maintenance department’s costs are allocated to other departments based on the number of hours of maintenance use by each department. The maintenance department has fixed costs of $500,000 and variable costs of $30 per hour of maintenance provided. The variable costs include the salaries of the maintenance workers. More maintenance workers can be added if greater maintenance is demanded by the other departments without affecting the fixed costs of the maintenance department. The maintenance department expects to provide 10,000 hours of maintenance.

Required:

a. What is the application rate for the maintenance department?
b. What is the additional cost to the maintenance department of providing another hour of maintenance?
c. What problem exists if the managers of other departments can choose how much maintenance to be performed?
d. What problem exists if the other departments are allowed to go outside the organization to buy maintenance services?

The town of Seaside has decided to construct a new sea aquarium to attract tourists. The cost of the measure is to be paid by a special tax. Although most of the townspeople believe the sea aquarium is a good idea, there is disagreement about how the tax should be levied.

Required:

Suggest three different methods of levying the tax and the advantages and disadvantages of each.

Peluso Company, a manufacturer of snowmobiles, is operating at 70 percent of plant capacity. Peluso’s plant manager is considering manufacturing headlights, which are now being purchased for $11 each (a price that is not expected to change in the near future). The Peluso plant has the equipment and labor force required to manufacture the headlights. The design engineer estimates that each headlight requires $4 of direct materials and $3 of direct labor. Peluso’s plant overhead rate is 200 percent of direct labor dollars, and 40 percent of the overhead is fixed cost.

Required:

If Peluso Co. manufactures the headlights, how much of a gain (loss) for each headlight will result?

Eastern University prides itself on providing faculty and staff a competitive compensation package. One aspect of this package is a faculty and staff child tuition benefit of $4,000 per child per year for up to four years to offset the cost of a college education. The faculty or staff member’s child can attend any college or university, including Eastern University, and receive the tuition benefit. If a staff member has three children in college one year, the staff member receives a $12,000 tuition benefit. This money is not taxed to the individual staff or faculty member.
Eastern University pays the benefit directly to the university where the staff/faculty member’s child is enrolled or if the student is attending Eastern, it reduces the amount of tuition owed by the faculty/staff member. The university then charges this payment to a benefits account. This benefits account is then allocated back to the various colleges and departments based on total salaries in the college or department.

Required:

Evaluate the pros and cons of the present university accounting for tuition benefits. What changes would you recommend making?

Nixon & Ross, a law firm, is about to install a new accounting system that will allow the firm to track more of the overhead costs to individual cases. Overheads are currently allocated to individual client cases based on billable professional staff salaries. Attorneys working on client cases charge their time to “billable professional staff salaries.” Attorney time spent in training, law firm administrative meetings, and the like is charged to an overhead account titled “unbilled staff salaries.”
The following is a summary of the costs for the current year:

The overhead costs were as follows:

Under the new accounting system, the firm will be able to trace secretarial costs, staff benefits, and telephone and mailing costs to specific clients.
The following are the costs incurred on the Lawson Company case:

Required:

a. Calculate the current year’s overhead application rate under the old cost accounting system.
b. How would this application rate change if the secretarial costs, staff benefits, and telephone and mailing costs were reclassified as direct costs instead of overhead, and overhead was assigned based on direct costs (instead of staff salaries)? Direct costs are defined as billable staff salaries plus secretarial costs, staff benefits, and telephone and mailing costs.
c. Use the overhead application rates from (a) and (b) to compute the cost of the Lawson case.
d. Nixon & Ross bills clients 150 percent of the total costs of the job. What will be the total billings to the Lawson Co. if the old overhead application scheme is replaced with the new overhead scheme?
e. Steve Nixon, managing partner, has commented that replacing the old allocation system with the direct charge method of the new accounting system will result in more accurate costing and pricing of cases. Evaluate the new system.

The Independent Underwriters Insurance Co. (IUI) established a systems department two years ago to implement and operate its information technology system. IUI believed that its own system would be more cost-effective than the service bureau it had been using.
IUI’s three departments – claims, records, and finance – have different requirements with respect to hardware and other capacity-related resources and operating resources. The system was designed to recognize these differing demands. It was also designed to meet IUI’s long-term capacity. The excess capacity designed into the system is being sold to outside users until IUI needs it. The estimated resource requirements used to design and implement the system are shown in the following schedule.

IUI currently sells the equivalent of its expansion capacity to a few outside clients.
When the system became operational, management decided to redistribute total expenses of the systems department to the user departments based upon actual computer time used. The actual costs for the first quarter of the current fiscal year were distributed to the user departments as follows:

The three user departments have complained about the cost distribution since the systems department was established. The records department’s monthly costs have been as much as three times the costs experienced with the service bureau. The finance department is concerned about the costs distributed to the outside user category, because these allocated costs form the basis for the fees billed to outside clients.
James Dale, IUI’s controller, decided to review the distribution method by which the systems department’s costs have been allocated for the past two years. The additional information he gathered for his review is reported in Tables 1, 2, and 3. Dale has concluded that the method of cost distribution should be changed to reflect more directly the actual benefits received by the departments. He believes that hardware and capacity-related costs should be allocated to the user departments in proportion to their planned, long-term needs. Any difference between actual and budgeted hardware costs should remain with the systems department.
The remaining costs for software development and operations would be charged to the user departments based upon actual hours used. A predetermined hourly rate based upon the annual budget data would be used. The hourly rates proposed for the current fiscal year are as follows:

Dale plans to use first-quarter activity and cost data to illustrate his recommendations. The recommendations will be presented to the systems department and the user departments for their comments and reactions. He then expects to present his recommendations to management for approval.

Required:

a. Prepare a schedule to show how the actual first-quarter costs of the systems department will be charged to the users if James Dale’s recommended method is adopted.
b. Explain whether James Dale’s recommended system for charging costs to the user departments will

(i) Improve cost control in the systems department.
(ii) Improve planning and cost control in the user departments.
(iii) Be a more equitable basis for charging costs to user departments.

Table 1

Systems Department Costs and Activity Levels

Table 2

Historical Utilization by Users

Table 3

Utilization of Systems Department’s Services for First Quarter
(in Hours)

Kraft Foods Group used to sponsor a car in the NASCAR races. Like other major corporations that sponsor sports events, Kraft believes that the public’s awareness of its products is enhanced by sponsoring a NASCAR. For the right to have “Kraft” displayed prominently on the automobile, Kraft pays the racing team an annual fee.
Kraft is organized around a number of business units that are profit centers. Senior management at Kraft believes that since the various business units at Kraft receive the benefits of the NASCAR exposure through greater name recognition, and hence greater sales, the costs of the program should be allocated back to the business units and ultimately to all Kraft products. The cost of the NASCAR program is allocated back to the Kraft business units based on sales revenue. Suppose the allocation is 10 percent of revenues. That is, for every $1 of revenue, the business unit is allocated $0.10 of cost from the NASCAR car.
One of Kraft’s business units sells Velveeta processed cheese in cartons containing 200 32 ounce packages. The following table summarizes possible pricing levels, cartons sold at that price, and costs for the various number of cartons.

Required:

a. What price-quantity combination maximizes the profits of the Velvetta, ignoring the allocation of NASCAR?
b. If $0.10 of the NASCAR is allocated for every dollar of Velvetta revenue, what price-quantity combination of Velvetta maximizes profits after allocating NASCAR costs?
c. What price-quantity combination of Velvetta maximizes profits after allocating NASCAR costs using total costs (instead of revenues), where for every dollar of total costs, $0.20 of NASCAR costs are allocated?
d. Instead of allocating the NASCAR based on revenues, it is allocated based on profits before allocated costs. For every $1.00 of profits before allocated costs, $0.30 of NASCAR costs are allocated. Now what price-quantity combination maximizes Velvetta profits after allocating NASCAR costs?
e. Should NASCAR costs be allocated to the business units, and if so, what allocation scheme should be used (revenues, costs, or profits)?

Jim Shoe, chief executive officer of Jolsen International, a multinational textile conglomerate, has recently been evaluating the profitability of one of the company’s subsidiaries, Pride Fashions, Inc., located in Rochester, New York. The Rochester facility consists of a dress division and a casual wear division. Daneille’s Dresses produces women’s fine apparel, while the other division, Tesoro’s Casuals, produces comfortable cotton casual clothing.
Jolsen’s chief financial officer, Pete Moss, has recommended that the casual wear division be closed. The year-end financials Shoe just received show that Tesoro’s Casuals has been operating at a loss for the past year, while Daneille’s Dresses continues to show a respectable profit. Shoe is puzzled by this fact because he considers both managers to be very capable.
The Rochester site consists of a 140,000-square-foot building where Tesoro’s Casuals and Daneille’s Dresses utilize 70 percent and 30 percent of the floor space, respectively. Fixed overhead costs consist of the annual lease payment, fire insurance, security, and the common costs of the purchasing department’s staff. Fixed overhead is allocated based on percentage of floor space. Housing both divisions in this facility seemed like an ideal situation to Shoe because both divisions purchase from many of the same suppliers and have the potential to combine materials ordering to take advantage of quality discounts. Furthermore, each division is serviced by the same maintenance department. However, the two managers have been plagued by an inability to cooperate due to disagreements over the selection of suppliers as well as the quantities to purchase from common suppliers. This is of serious concern to Shoe as he turns his attention to the report in front of him.

Required:

a. Evaluate Pete Moss’s recommendation to close Tesoro’s Casuals.
b. Should the overhead costs be allocated based on floor space or some other measure? Justify your answer.

Five departments of National Training Institute, a nonprofit organization, share a rented building. Four of the departments provide services to educational agencies and have little or no competition for their services. The fifth department, Technical Training, provides educational services to the business community in a competitive market with other nonprofit and private organizations. Each department is a cost center. Revenues received by Technical Training are based on a fee for services, identified as tuition.
All five departments have dedicated space as listed in the accompanying table. Common shared space, including hallways, restrooms, meeting rooms, and dining areas, is not included in these allocations. National Training Institute rents space at $10 per square foot.

In addition to its assigned space, the technical training department offers training during off-hours using many of the areas allocated to other departments. Technical Training also uses off-site facilities for the same purpose. About 50 percent of its training activities are in off-site facilities, which have excess capacity, charge no rent, and are available only during off-hours.
John Daniels, the administration department’s business manager, proposed a rental allocation plan based on each department’s percentage of dedicated square footage plus the same percentage of the common space. The technical training department would be charged an additional amount for the space it uses during off-hours that is dedicated to other departments. This additional amount would be based on planned usage per year.
Jane Richards, director of technical training, claims this allocation method will cause her to increase the price of services. As a result, she will lose business to competition. She would rather see the allocation method use the percentage of department revenue in relation to total revenue.

Required:

Comment on Daniels’s and Richards’s proposed rent allocation plans. Make appropriate recommendations.

Encryption, Inc. (EI), sells and maintains fax encryption hardware and software. EI hardware and software are attached to both sending and receiving fax machines that encode/decode data, preventing anyone from wiretapping the phone line to receive a copy of the fax.
Two EI product groups (Federal Systems and International) manufacture and sell the hardware and software in different markets. Both are profit centers. Federal Systems contracts with federal government agencies to manufacture, install, and service EI products. Existing contracts call for revenues of $1 million per quarter for the next eight quarters.
International is currently seeking foreign buyers. Expected quarterly revenues will be $1 million, but with equal likelihood revenues can be $1.5 or $0.5 million in any given quarter.
Federal Systems and International each have their own products that differ in some ways but share a common underlying technology. Fax encryption is a new technology and offers new markets. Transferring manufacturing and marketing ideas across products and customers provides important synergies.
The variable cost of Federal Systems and International is 50 percent of revenues. The only fixed cost in EI is its Engineering Design group.
Engineering Design is EI’s R…D group. It designs new hardware and software that Federal Systems and International sell. Quarterly expenses for Engineering Design will be $0.60 million for the next two years. These expenses do not vary with revenues or production costs.
Engineering Design costs are to be included in calculating profits for the Federal Systems and International groups. Two ways of assigning the Engineering Design costs to Federal Systems and International are (1) group revenues, and (2) an even 50-50 split.

Required:

a. Prepare financial statements for Federal Systems and International illustrating the effects of the alternative ways of handling Engineering Design costs.
b. Which method of assigning Engineering Design costs do you favor? Why?

Telstar Electronics manufactures and imports a wide variety of consumer and industrial electronics, including stereos, televisions, camcorders, telephones, and VCRs. Each line of business (LOB) handles a single product group (e.g., televisions) and is organized as a profit center. The delivery of the product to the wholesaler or retailer is handled by Telstar’s distribution division, a cost center. Previously, Telstar was organized functionally, with manufacturing, marketing, and distribution as separate cost centers. Two years ago, it reorganized to the present arrangement.
Distribution assembles products from the various LOBs into larger shipments to the same geographic area to capture economies of scale. The division is also responsible for inbound shipments and storage of imported products. It has its own fleet of trucks, which handles about two-thirds of the shipments, and uses common carriers for the remainder. Currently, the costs of the distribution division are not allocated to the LOBs, but LOBs do pay the cost for any special rush shipment using an overnight or fast delivery service, such as Federal Express or UPS. For example, if a customer must have overnight delivery, the LOB ships directly without using Telstar’s distribution center and the LOB is charged for the special delivery.
The corporate controller is mulling over the issue of allocating the costs of distribution. Several allocation schemes are possible:

1. Allocate all distribution division costs based on gross sales of the LOBs.
2. Allocate all distribution division costs based on LOB profits.
3. Allocate the direct costs of each shipment (driver, fuel, truck depreciation, tolls) using the gross weight of each LOB’s product in the shipment. Then allocate the other costs of the distribution division (schedulers, management, telephones, etc.) using the total direct shipping costs assigned to each LOB.
One argument against allocating is that it will distort relative profitability. The controller says, “Because allocations are arbitrary, the resulting LOB profitabilities become arbitrary.” Another argument is that it is not fair to charge managers for costs they cannot control. LOBs cannot control shipping costs. For example, there are savings when two small separate shipments are combined into a single large shipment. LOBs will tend to avoid opening up new sales territories when other Telstar products are not being shipped to that area.

Required:

Write a memo addressing the controller’s concerns. Should Telstar begin allocating distribution costs to the LOBs? If so, which allocation scheme should it use?

Bio Labs is a genetic engineering firm manufacturing a variety of gene-spliced, agricultural-based seed products. The firm has five separate laboratories producing different product lines. Each lab is treated as a profit center and all five labs are located in the same facility. The wheat seed lab and corn seed lab manufacture two of the five product lines. These two labs are located next to each other and are of roughly equal size in terms of sales. The two departments have close interaction, often sharing equipment and lab technicians. Both use very similar technology and science and usually attend the same scientific meetings.
Recent discoveries have shown how low-power lasers can be used to significantly improve product quality. The wheat seed and corn seed managers are proposing the creation of a laser testing department to employ this new technology. Leasing the equipment and hiring the personnel cost $350,000 per year. Supplies, power, and other variable costs are $25 per testing hour. The testing department is expected to provide 2,000 testing hours per year. The wheat seed manager expects to use 700 testing hours per year of the laser testing department and the corn seed manager expects to use 800 testing hours. The remaining 500 hours of testing capacity can be used by the other three labs if the technology applies or can be left idle for future expected growth of the two departments. Initially, only wheat and corn are expected to use laser testing.
The executive committee of Bio Labs has approved the proposal but is now grappling with how to treat the costs of the laser testing department. The committee wants to charge the costs to the wheat seed and corn seed labs but is unsure of how to proceed.
At the end of the first year of operating the laser, wheat seed used 650 testing hours, corn seed used 900 hours, and 450 hours were idle.

Required:

a. Design two alternative cost allocation systems.
b. Give numerical illustrations of the charges the corn and wheat seed labs will incur in the first year of operations under your two alternatives.
c. Discuss the advantages and disadvantages of each.

Woodley Furniture is a small boutique manufacturer of high quality contemporary wood tables. They make two models: end tables and coffee tables in a variety of different woods and finishes. Current annual production of end tables is 8,000 units that sell for $250 and have variable cost of $120 each. Current annual production of coffee tables is 6,000 units that sell for $475 and have variable cost of $285 each. Woodley has fixed costs of $2.4 million. Woodley sells all the tables they produce each year.

Required:

a. Calculate total firm-wide profits and product-line profits for the end tables and coffee tables after allocating the fixed costs to the two product lines using sales revenues as the allocation base.
b. Which of the two products is the most profitable based on total profits (after allocating fixed costs)? Is Woodley making an adequate profit?
c. Woodley management decides to add a dining table to its product offerings. The plant currently has excess capacity, so no additional fixed costs are required to produce the dining tables. The new dining table will not affect the number of units sold or prices of the existing coffee and end tables. They expect to sell 4,000 dining tables at a price of $620 each, and variable cost per table is $500. Calculate total firm-wide profits and product-line profits for the end tables, coffee tables, and dining tables after allocating the fixed costs to the three product lines using sales revenues as the allocation base.
d. Analyze the profitability of the three products and firm-wide profits calculated in part (c) compared to the profitability of the two products alone and firm-wide profits in part (a).
e. Recalculate your answers to parts (a) and (c), but, instead of allocating the $2.4 million of fixed costs using sales revenues as in parts (a) and (c), allocate the $2.4 million of fixed costs using the total contribution margin of each product (total sales revenue less total variable cost).
f. Discuss the relative advantages and disadvantages of using total contribution margin to allocate the fixed costs in part (e) relative to using sales revenues to allocate the fixed costs, as in parts (a) and (c).

In a market-driven economy, selling prices are set by supply and demand, not by an arbitrary measure of one producer’s inputs.

Where there is a common resource, and billing is not proportionate to consumption or benefits received, the greedy and the first-arrivals are better off. The vegetarian is better off with individual billing. In an equal sharing of the bill, the vegetarian is subsidizing those with more expensive tastes. Billing practices for internal services must take these aspects into account.

A well-designed allocation system should display all of these characteristics.

Variable factory overheads are estimated to be $1,200,000 per month, when 1,000,000 pounds of various products are produced. The plant employs 20 chemical workers who typically work 175 hours each per month and are paid $24 per hour. Other workers are classified as indirect and are included in fixed overheads. The highly automated plant typically runs 21,000 machine hours per month. The preparation of one 100 lbs batch of Xentra needs ten minutes of direct labor and 75 minutes of machine time. Fixed manufacturing overheads total $3,500,000 per month. Forty percent of these fixed manufacturing overheads are labor-related costs and the balance are machine-related costs.

Assuming normal production levels, what is the direct materials and direct labor cost (i.e., the prime cost) per drum?

The direct materials and direct labor cost per drum: