the Problem for Self-Study included there.

Introduction 2. Read the Overview and Highlights sections in the

This Student Guide is a self-study aid to Student Guide. The Highlights refer only to the most
accompany the 13th edition of Cost Accounting: essential textbook exhibits and examples (an average
A Managerial Emphasis, by Horngren, Datar, of three per chapter), so the Student Guide can almost
Foster, Rajan and Ittner. The Student Guide has be used in a stand-alone way at this stage of your
three purposes: (1) to reinforce and clarify your study.
understanding of the textbook material, (2) to 3. Prepare your solution to the Featured Exercise in the
develop your analytical thinking skills, and (3) Student Guide and compare it to the solution
to help you review for exams effectively. I provided there.
designed the Student Guide to provide maximum 4. Answer the Review Questions and Exercises in the
benefit from your study time. Student Guide and compare your answers with those
provided at the end of the chapter.
Each Student Guide chapter has the 1 • Resist the temptation to look at the answers
following sections: before preparing your own! This approach keeps
1 • Overview is a one-paragraph description you from developing a false sense of confidence
of the textbook chapter. about your knowledge of the material.
2 • Highlights is a comprehensive summary 2 • When your answers to an exercise do not agree
of the chapter presented in an easy-to-read with the Check Figures, first try reworking the
paragraph style, with the textbook “Terms to exercise before you look at the complete
Learn” in bold type. solution.
3 • Featured Exercise covers key points in
the textbook assignment material. 5. Solve the homework problems assigned by your
4 • Review Questions and Exercises consist professor.
of completion statements, true-false and 6. Use the Student Guide to review for exams.
multiple choice questions, short exercises, Concentrate on the Featured Exercises as well as the
and an occasional crossword puzzle. They Review Questions and Exercises that you found to be
help you master the concepts in the chapter. most difficult.
Most chapters include at least five
questions/exercises from the Certified As you study cost accounting, keep in mind that there
Public Accountant (CPA) and Certified is no substitute for hard work and a desire to learn. These
Management Accountant (CMA) exams. qualities are key to your success.
5 • Answers and Solutions to Review
Questions and Exercises—located at the Acknowledgments
end of the chapter—allow you to check your
work. This section provides complete For ideas and assistance, I am indebted to the
explanations for each false statement and all textbook authors, Jim Payne of The University of Tulsa,
multiple-choice answers, and easy-to-follow and numerous students. I thank Mary Nelson for her
solutions to the exercises. expertise in preparing the camera-ready copy. I also thank
6 • Check Figures for the Review Exercises the American Institute of Certified Public Accountants
are at the end of the Student Guide. and the Institute of Certified Management Accountants
for permission to use their professional examination
questions.
How to Use the Student Guide
-John K. Harris
I recommend a six-step approach for using Preview Chapters
Chapter 1: The Accountant’s Role in the Organization
the Student Guide with the textbook: Chapter 2: An Introduction to Cost Terms and Purposes
Chapter 3: Cost-Volume-Profit Analysis
1. Study the chapter in the textbook and solve
CHAPTER
The Accountant’s Role in the Organization
1
reports financial and nonfinancial information relating to
If you have not already read the Introduction the costs of acquiring or using resources in an
(page vii), do so now. It describes the purposes organization. Cost accounting provides information for
and contents of the Student Guide and both management accounting and financial accounting.
recommends a six-step approach for using the
Student Guide with the textbook. 3. Cost management is the approaches and activities
of managers to use resources to increase value to
Overview customers and to achieve organizational goals. For
example, rearranging the production-floor layout might
Welcome to the study of cost accounting. This reduce manufacturing costs, or additional product design
introductory chapter explains the intertwining costs might be incurred in an effort to increase revenues
roles of managers and management accountants and profits.
in choosing an organization’s strategy, and in
planning and controlling its operations. Unlike 4. Strategy specifies how an organization matches its
the remainder of the textbook, this chapter has own capabilities with the opportunities in the marketplace
no “number crunching.” Its main purpose is to to accomplish its objectives. In other words, strategy
emphasize the management accountant’s role in describes how an organization will compete and the
providing information for managers. opportunities its employees should seek and pursue.
Companies follow one of two broad strategies:
Highlights
1 • Sell quality products or services at low prices. An
1. It is important to distinguish management example is Southwest Airlines.
accounting from financial accounting. 2 • Sell differentiated or unique products or services at
higher prices than charged by competitors. An example
1 • Management accounting measures, is Pfizer.
analyzes, and reports financial and
nonfinancial information that helps
managers make decisions to fulfill the goals Deciding between these strategies is a critical part of what
of an organization. Management accounting managers do. The term strategic cost management
(a) emphasizes the future, (b) aims to describes cost management that specifically focuses on
influence the behavior of managers and strategic issues.
other employees in achieving the goals of an
organization, (c) does not have to follow 5. The value chain is the sequence of business
generally accepted accounting principles functions in which customer usefulness is added to
(GAAP), and (d) is based on cost-benefit products or services. These business functions are
analysis. research and development (R&D); design of products,
2 • Financial accounting focuses on reporting services, or processes; production; marketing;
to external parties such as investors, distribution; and customer service. Managers in each of
government agencies, banks and suppliers. It these six business functions of the value chain are
measures and records business transactions customers of management accounting information. Rather
and provides financial statements—the than proceeding sequentially through the value chain,
balance sheet, income statement, statement companies can gain when various parts of the value chain
of cash flows, and statement of retained work concurrently as a team. For example, additional
earnings—that are based on GAAP. spending on R&D and product design might be more than
offset by lower costs of production and customer service.

2. Cost accounting measures, analyzes, and 6. The term supply chain describes the flow of goods,
services, and information from the initial achieving those goals, (c) deciding how to attain the
sources of materials and services to the delivery desired goals, and (d) communicating the goals and how to
of products to customers, regardless of whether attain them to the entire organization. Control comprises
those activities occur in the same organization or (a) taking actions that implement the planning decisions,
in other organizations. Cost management (b) deciding how to evaluate performance, and (c)
emphasizes integrating and coordinating providing feedback and learning to help future decision
activities across all companies in the supply making.
chain, as well as across each business function
in an individual company’s value chain, to 9. Planning and control are linked by a five-step
reduce costs. decision making process: (i) identify the problem and
uncertainties, (ii) obtain information, (iii) make predictions
7. Customers want companies to use the about the future, (iv) make decisions by choosing among
value chain and supply chain to deliver ever alternatives, and (v) implement the decision, evaluate
improving levels of performance regarding four performance and learn. Collectively, the first four steps are
key success factors: planning and the last step is control.

1 a. Cost and efficiency—Companies face 10. Budgeting is essential for planning and control. A
continuous pressure to reduce the cost of the budget is the quantitative expression of a proposed plan of
products or services they sell. Examples action by management for a specified period and is an aid
include eliminating the need for rework and to coordinating what needs to be done to implement that
outsourcing one or more business functions plan. Because the process of preparing a budget crosses
to foreign countries. business functions, it forces coordination and
2 b. Quality—Customers expect high levels of communication throughout the company, as well as with
quality. Total quality management (TQM) is the company’s suppliers and customers.
a philosophy in which management
improves operations throughout the value 11. A performance report (see Exhibit 1-4, text p. 10),
chain to deliver products and services that spurs investigation and learning. Learning is examining
exceed customer expectations. past performance (the control function) and systematically
3 c. Time—Time has many components. exploring alternative ways to make better informed
Examples include the time to develop and decisions and plans in the future. Learning can lead to
bring new products to market and the speed changes in goals, changes in the ways decision alternatives
at which an organization responds to are identified, changes in the range of information
customer requests. collected when making predictions, and sometimes
4 d. Innovation—A constant flow of changes in managers.
innovative products or services is the basis
for ongoing company success. A main 12. Three guidelines help management accountants
source of innovations is R&D. provide the most value to their companies in strategic and
operational decision making:

Management accountants help managers track a. Employ a cost-benefit approach. This approach guides
performance on the key success factors in decision making: resources should be spent if the
comparison to the performance of competitors expected benefits to the company exceed the expected
on the same factors. Tracking what is happening costs. For example, consider a budgeting system. The
in other companies serves as a benchmark and expected costs of a proposed budgeting system (such
alerts managers to the changes their own as personnel, software, and training) should be
customers are observing and evaluating. The compared with its expected benefits, which are the
goal is for a company to continuously improve collective decisions of managers that will better attain
its critical operations. the company’s goals. In particular, measurement of the
expected benefits is seldom easy.
b. Give full recognition to behavioral as well as technical
8. Management accounting facilitates considerations. A management accounting system
planning and control. Planning comprises (a) should have two simultaneous missions for providing
selecting organization goals, (b) predicting information: (i) to help managers make wise economic
results under various alternative ways of decisions by providing them with desired information
(the technical mission), and (ii) to help
motivate managers and other employees to 14. The chief financial officer (CFO), a staff
aim for goals of the organization (the management function, is the executive responsible for
behavioral mission). Management is overseeing the financial operations of an organization,
primarily a human activity that should focus which usually include controllership, treasury, risk
on how to help individuals do their jobs management, taxation, investor relations, and internal
better. audit. The controller, also a staff management function, is
c. Use different costs for different purposes. To the financial executive primarily responsible for
illustrate this guideline, consider how to management accounting and financial accounting. The
account for advertising. For the purpose of controller “controls” by exerting a force or influence that
preparing financial statements under GAAP, helps managers make better informed decisions as they
advertising is an expense in the accounting implement their strategies.
period when it is incurred. For the purpose
of determining a product’s selling price, its 15. Accountants have special obligations regarding
advertising costs, along with its other costs ethics, given that they are responsible for the integrity of
from all business functions of the value the financial information provided to internal and external
chain, should be taken into account. parties. Professional accounting organizations such as the
Institute of Management Accountants (IMA), the largest
13. Most organizations distinguish line association of management accountants in the United
management from staff management. Line States, play an important role in promoting high ethical
management (for example, production) is standards. For example, the IMA has identified four
directly responsible for attaining the goals of the standards of ethical conduct for management accountants:
organization. Staff management (for example, competence, confidentiality, integrity, and credibility.
accounting) exists to provide advice and EXHIBIT 1-7, text p. 16, provides the IMA’s guidance on
assistance to line management. Increasingly, issues relating to the four standards, and EXHIBIT 1-8,
organizations rely on teams for attaining their text p. 17, presents the IMA’s guidance on how to resolve
goals; as a result, the traditional distinction ethical conflict.
between line and staff management becomes
less clear-cut than it was in the past.
Featured Exercise

Exon Tackle Company manufactures a wide range of fishing equipment and supplies for the retail market. In the
current fiscal year, Exon incurred the costs described below. For each of these costs, indicate the applicable
business function of the value chain by putting the identifying number in the space provided.

Business Functions of the Value Chain

1. Research and development

2. Design of products, services, or processes
3. Production
4. Marketing
5. Distribution
6. Customer service

_____a. Cost of repairing reels that malfunctioned during the warranty period.
_____b. Cost of hooks used in making fishing lures.
_____c. Salary of a mechanical engineer working on the basic concept for the next generation of ultra-light
fishing rods.
_____d. Cost of overnight delivery of rods and reels to winter boat shows.
_____e. Cost of running advertisements in fishing magazines.
_____f. Cost of printing operating instructions to be packaged with a new model of trolling motor.

Solution (on next page)

Solution

a. 6 c. 1 e. 4
b. 3 d. 5 f. 3

Review Questions and Exercises

This section is designed to help determine how well you have mastered the textbook material. Try to answer all of
these questions and exercises without using your textbook or the Highlights in the Student Guide. In answering the
Review Questions and Exercises, be sure to follow Step 4 of the study approach recommended in the Introduction, p.
vii. All answers are at the end of the chapter.

_____________________________________
Completion Statements 6. The ____________________ approach helps guide
managers’ decision making.
Fill in the blank(s) to complete each statement. 7. The Institute of Management Accountants’ four
standards of ethical conduct for management
1. _______________________ (a) emphasizes accountants are ____________
the future, (b) aims to influence the behavior ____________________________________
of managers and other employees in _____________________.
achieving the goals of an organization, and
(c) does not have to follow generally True-False
accepted accounting principles (GAAP).
2. __________________________ is the Indicate whether each statement is true (T) or false (F).
approaches and activities of managers to use
resources to increase value to customers and __1. Management accounting does not have to follow
to achieve organizational goals. generally accepted accounting principles.
3. Selecting organization goals, predicting __2. Cost accounting provides information for
results under various alternative ways of management accounting but not for financial
achieving these goals, and deciding how to accounting.
attain the desired goals are aspects of __3. Control is defined as the process of setting maximum
________________. limits on expenditures.
4. A __________ is a quantitative expression of __4. Managers should proceed sequentially through the
a proposed plan of action by management value chain of business functions.
for a specified period and is an aid to __5. The term supply chain describes the flow of goods,
coordinating what needs to be done to services, and information from the initial sources
implement that plan. of materials and services to the delivery of
5. Name the six business functions in the value products to customers, regardless of whether those
chain in their sequential order: activities occur in the same organization or in
____________ other organizations.
____________________________________ __6. Learning is examining past performance (the control
_ function) and systematically exploring alternative
____________________________________ ways to make better informed decisions and plans
_ in the future.
__7. The CFO, a line management function, is an organization.
the executive responsible for overseeing c. management accounting and financial
the financial operations of an accounting.
organization. d. obtaining short-term and long-term financing.
__3. Maintaining records on traffic tickets issued by the
Multiple Choice city of Atlanta is performing what management
accounting role?
Select the best answer to each question. a. Scorekeeping
b. Attention directing
__1. Control includes: c. Problem solving
a. selecting organization goals. d. Internal auditing
b. implementing the planning decisions. __4. The Institute of Management Accountants’ Standards
c. deciding how to attain the desired of Ethical Conduct for Management Accountants
results. includes standards on:
d. preparing budgets. a. competence and responsibility.
__2. The primary responsibility of the controller b. integrity and professionalism.
is: c. objectivity and responsibility.
a. risk management. d. competence and confidentiality.
b. overseeing the financial operations of
Review Exercises

1. Define strategy. Then specify the two broad strategies that companies choose between.

________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
__a. Company X monitors the number and nature of
2. For each of the following actions by customer complaints on a customer-by-customer
companies, identify the applicable management basis.
theme. __b. Company Y reports how long it takes a new product
CF: Customer focus to be introduced to the market after the initial
KSF: Key success factors (cost and concept for the product is approved by
efficiency, quality, time, innovation) management.
VC: Value-chain and supply-chain analysis

Answers to Chapter 1 Review Questions and Exercises

Completion Statements

1. Management accounting
2. Cost management
3. planning
4. budget
5. research and development (R&D); design of products, services, or processes; production; marketing;
distribution; customer service
6. cost-benefit
7. competence, confidentiality, integrity, credibility

True-False

1. T
2. F Cost accounting provides information for both management accounting and financial accounting. Cost
accounting measures, analyzes, and reports financial and nonfinancial information relating to the cost of
acquiring and using resources in an organization.
3. F Control comprises (a) taking actions that implement the planning decisions, (b) deciding how to evaluate
performance, and (c) providing feedback and learning to help future decision making.
4. F Rather than proceeding sequentially through the value chain, companies can gain when various parts of the
value chain work concurrently as a team. For example, additional spending on R&D and product design
might be more than offset by lower costs of production and customer service.
5. T
6. T
7. F The CFO, a staff management function (not a line management function), is the executive responsible for
overseeing the financial operations of an organization, which usually include controllership, treasury, risk
management, taxation, and internal audit. Staff management exists to provide advice and assistance to line
management. Line management is directly responsible for attaining the goals of the organization.

Multiple Choice

1. b Control comprises (i) taking actions that implement the planning decisions, (ii) deciding how to evaluate
performance, and (iii) providing feedback that will help future decision making. Answers (a), (c) and (d)
are aspects of planning.
2. c The controller, a staff management function, is the financial executive primarily responsible for management
accounting and financial accounting.
3. d The IMA’s Standards of Ethical Conduct for Management Accountants has four standards: competence,
confidentiality, integrity, and credibility.

Review Exercise 1
Strategy specifies how an organization matches its own capabilities with the opportunities in the marketplace
to accomplish its objectives. In other words, strategy describes how an organization will compete and the
opportunities its employees should seek and pursue. Companies follow one of two broad strategies:
1 • Sell quality products or services at low prices. Examples are Wal-Mart and Southwest Airlines.
2 • Sell differentiated or unique products or services at higher prices than charged by competitors. Examples
are EMC and Pfizer.

Deciding between these strategies is a critical part of what managers do. Management accountants work
closely with managers in formulating strategy.

Review Exercise 2

a. CF b. KSF
CHAPTER
An Introduction to Cost Terms and Purposes
2
describes the assignment of direct costs to the
Overview particular cost object.
2 • The indirect costs of a cost object are related to the
This chapter introduces the basic terminology of particular cost object but cannot be traced to it in an
cost accounting. Communication among economically feasible way. The term cost allocation
managers and management accountants is describes the assignment of indirect costs to the
greatly facilitated by having a common particular cost object.
understanding of the meaning of cost terms and
concepts. The chapter illustrates a major theme
of the textbook: using different costs for Several factors affect the classification of a cost as direct
different purposes. The chapter also provides a or indirect: the materiality (relative importance) of the cost
framework to help you understand cost in question, available information-gathering technology,
accounting and cost management. and design of operations.

Highlights 4. Consider this question: Is the production department

manager’s salary a direct cost or an indirect cost? The
1. Accountants define cost as a resource answer: It depends on the choice of the cost object. For
sacrificed (used) or forgone to achieve a specific example, if the cost object is the production department,
objective. For example, it might cost $5,000 per the salary is a direct cost because it can be traced to the
month to rent retail space in a shopping center. cost object. But if the cost object is one of the many
To guide their decisions, managers often want to products manufactured in the production department, the
know how much a particular thing costs. This salary is an indirect cost because it can be allocated (but
“thing” is called a cost object, anything for not traced) to the cost object.
which a measurement of costs is desired. In the
following questions, the cost object is in italics: 5. Two basic types of cost-behavior patterns are found
How much does it cost to manufacture a 12- in accounting systems.
pack of diet Pepsi? Which delivery truck at the
local Pepsi bottling company is the least 1 • A variable cost changes in total in proportion to
expensive to operate? changes in the related level of total activity or volume.
A variable cost does not change on a per unit basis
2. Costing systems account for costs in two when the related level of total activity or volume
basic stages. The first stage is cost changes.
accumulation, the collection of cost data in 2 • A fixed cost remains unchanged in total for a given
some organized way by means of an accounting time period despite wide changes in the related level of
system. The second stage is cost assignment, a total activity or volume. A fixed cost increases
general term that encompasses both (a) tracing (decreases) on a per unit basis when the related level
direct costs to a cost object and (b) allocating of total activity or volume decreases (increases).
indirect costs to a cost object.

3. The key question in cost assignment is Costs are variable or fixed with respect to a specific
whether costs have a direct or an indirect activity and for a given time period. Relevant range is the
relationship to the particular cost object. band of normal activity level or volume in which there is a
specific relationship between the level of activity or
1 • The direct costs of a cost object are volume and the cost in question.
related to the particular cost object and can
be traced to it in an economically feasible 6. A cost driver is a variable, such as the level of
(cost-effective) way. The term cost tracing activity or volume, that causally affects costs over a given
time span. In other words, a cause-and-effect 3 • Service-sector companies provide services
relationship exists between a change in the level (intangible products)—for example, legal advice,
of activity or volume and a change in the level checking accounts, or audits—to their customers.
of total costs. These companies do not have an inventory of items for
sale.
1 • The cost driver of a variable cost is the
level of activity or volume whose change
causes proportionate changes in that cost. 9. For companies with inventories, generally accepted
For example, the number of trucks accounting principles distinguish inventoriable costs from
assembled is a cost driver of the cost of period costs.
steering wheels for the trucks.
2 • Costs that are fixed in the short run have 1 • Inventoriable costs are all costs of a product that are
no cost driver in the short run but may have considered as assets in the balance sheet when they are
a cost driver in the long run. For example, incurred and that become cost of goods sold only when
the equipment and staff costs of product the product is sold. For manufacturing companies, all
testing typically are fixed in the short run manufacturing costs are inventoriable costs. For
with respect to changes in the volume of merchandising companies, inventoriable costs are the
production. In the long run, however, the costs of purchasing the merchandise. Because service
company increases or decreases these costs companies have no inventories, they have no
to the levels needed to support future inventoriable costs.
production levels. 2 • Period costs are all costs in the income statement
other than cost of goods sold. Period costs are treated
as expenses of the accounting period in which they are
7. Accounting systems typically report both incurred.
total costs and unit costs (also called average
costs). A unit cost is computed by dividing some
amount of total costs by the related number of 10. Three terms are widely used in describing
units. Unit costs are regularly used in financial manufacturing costs. In the following definitions, “the cost
reports. Generally, however, managers should object” refers to “work in process and then finished
think in terms of total costs rather than unit goods.”
costs. That’s because fixed cost per unit changes
when the related level of volume changes. Unit 1 • Direct material costs are the acquisition costs of all
costs, therefore, should be interpreted with materials that eventually become part of the cost
caution if they include a fixed-cost component. object and that can be traced to that cost object in an
The Tennessee Products example, text p. 35-36, economically feasible way.
illustrates this important point. 2 • Direct manufacturing labor costs include the
compensation of all manufacturing labor that can be
8. Companies in the manufacturing, traced to the cost object in an economically feasible
merchandising, and service sectors of the way.
economy are frequently referred to in the study 3 • Indirect manufacturing costs (also called
of cost accounting. manufacturing overhead costs or factory overhead
costs) are all manufacturing costs that are related to
1 • Manufacturing-sector companies the cost object but that cannot be traced to it in an
purchase materials and components and economically feasible way. Examples include power,
convert them into various finished goods. indirect materials, indirect manufacturing labor, plant
These companies typically have one or more insurance, plant depreciation, and compensation of
of three types of inventory: direct materials plant managers.
inventory, work-in-process inventory, and
finished goods inventory.
2 • Merchandise-sector companies purchase 11. In the income statement of a manufacturing
and then sell tangible products without company, cost of goods sold is computed as follows
changing their basic form. These companies (figures assumed):
have one type of inventory: merchandise
inventory. Beginning finished $ 50,000
goods
Add cost of goods 800,000 1 • Prime costs are all direct manufacturing costs. Under
manufactured the three-part classification of manufacturing costs in
Cost of goods 850,000 paragraph 10, prime costs are equal to direct material
available for sale costs plus direct manufacturing labor costs. In cases
Deduct ending 60,000 where other direct manufacturing cost categories are
finished goods
used, they too are prime costs. For example, power
Cost of goods sold $790,000
costs could be classified as a direct cost if the power is
metered to specific areas of a plant that are dedicated
to manufacturing separate products.
The line item, cost of goods manufactured, 2 • Conversion costs are all manufacturing costs other
refers to the cost of goods brought to than direct material costs; they are incurred to convert
completion, whether they were started before or direct materials into finished goods. Under the three-
during the current accounting period. Cost of part classification of manufacturing costs, conversion
goods manufactured is often computed in a costs are equal to direct manufacturing labor costs plus
supporting schedule to the income statement as indirect manufacturing costs.
follows (figures assumed):

Beginning direct $ 60,000 13. All manufacturing labor compensation other than
materials
for direct labor, managers’ salaries, department heads’
Add purchases of 510,000
direct materials salaries, and supervisors’ salaries is usually classified as
Direct materials 570,000 indirect labor costs—a major component of manufacturing
available for use overhead. Two main categories of indirect labor in
Deduct ending 50,000 manufacturing and service companies are overtime
direct materials premium and idle time. Overtime premium is the wage
Direct materials 520,000 rate paid to workers (for both direct labor and indirect
used labor) in excess of their straight-time wage rates. Overtime
Add direct 100,000 premium is classified as overhead when the overtime is
manufacturing attributable to the heavy overall volume of work. When a
labor particular job, such as a rush order, is the sole reason for
Add 230,000
the overtime, the overtime premium is classified as a direct
manufacturing
overhead costs cost of that job. Idle time is wages paid for unproductive
Manufacturing time caused by lack of orders, machine breakdowns,
costs incurred 850,000 material shortages, poor scheduling, and the like.
during the
period 14. Some manufacturing companies classify payroll
Add beginning 120,000 fringe benefit costs of direct labor as overhead cost,
work in process whereas others classify them as direct labor cost. The latter
Total approach is preferable because these payroll fringe benefit
manufacturing 970,000 costs are a fundamental part of acquiring direct
cost to account
manufacturing labor services. To prevent disputes about
for
Deduct ending 170,000
cost items such as payroll fringe benefits, training time,
work in process overtime premium, idle time, vacations, and sick leave,
Cost of goods $800,000 contracts and laws should be as specific as feasible
manufactured regarding definitions and measurements.

15. An important theme of the textbook is using

EXHIBIT 2-9, text p. 42, shows the flow of different costs for different purposes. For example,
manufacturing costs, from Work-in-Process managers can assign different costs to a product depending
Inventory to Finished Goods Inventory to Cost on their purpose. A product cost is the sum of costs
of Goods Sold. assigned to a product for a specific purpose, such as (a)
preparing financial statements for external reporting under
12. Manufacturing costing systems use the generally accepted accounting principles (GAAP), (b)
terms prime costs and conversion costs. contracting with government agencies, or (c) pricing and
product-mix decisions. For financial statements b. Obtaining information for planning and control and
based on GAAP, a product cost includes only performance evaluation.
inventoriable costs. A product cost includes a c. Analyzing the relevant information for making
broader set of costs for reimbursement under decisions.
government contracts, or a still broader set of
costs for pricing and product-mix decisions. Chapters 3 through 12 explain these ideas, which also form
the foundation for study of various topics later in the
16. Three features of cost accounting and textbook.
cost management across a wide range of
applications are:

a. Calculating the cost of products, services, and

other cost objects.
Featured Exercises

1. Whitaker Company’s relevant range is between 8,000 units and 16,000 units. If 10,000 units are produced,
variable costs are $200,000 and fixed costs are $450,000. Assuming production increases to 15,000 units, compute
(a) total variable costs, (b) variable cost per unit, and (c) fixed cost per unit.

Solution

a. Variable cost per unit = $200,000 ÷ 10,000 = $20

Total variable costs = $20 × 15,000 = $300,000
b. Variable cost per unit = $300,000 ÷ 15,000 = $20
c. Fixed cost per unit = $450,000 ÷ 15,000 = $30
2. The following information pertains to Thorpe Company’s operations for January of the current year:

Inventories Beginnin Ending

g
Direct materials $18,000 $15,00
0
Work in process 9,000 6,000
Finished goods 27,000 36,000

Additional cost information for January: direct materials purchased $42,000, direct manufacturing labor
$30,000, manufacturing overhead $40,000.

Compute cost of goods manufactured for January.

Solution

Direct material used, $18,000 + $42,000 − $ 45,000

$15,000
Direct manufacturing labor 30,000
Manufacturing overhead 40,000
Manufacturing costs incurred during the period 115,000
Add beginning work-in-process inventory 9,000
Total manufacturing costs to account for 124,000
Deduct ending work-in-process inventory 6,000
Cost of goods manufactured $118,000
object and allocating costs to that cost object.
Review Questions and Exercises __3. A given cost item can be a direct cost of one cost
object and an indirect cost of another cost object.
(All answers are at the end of the chapter.) __4. When graphed on a per unit basis, both variable costs
and fixed costs are linear within the relevant
Completion Statements range.
__5. For a manufacturer of soft drinks, television
Fill in the blank(s) to complete each statement. advertising and depreciation on bottle-capping
machines are period costs.
1. For a given cost object, ___________ costs __6. In the income statement of a manufacturing company,
are traced to it and __________ costs are cost of goods manufactured refers to the cost of
allocated to it. goods brought to completion, whether they were
2. A ____________________ is the band of started before or during the current accounting
normal activity level or volume in which period.
there is a specific relationship between the __7. The concept of inventoriable costs is applicable to
level of activity or volume and the cost in manufacturing companies and merchandising
question. companies, but not to service companies.
3. A ________________ is a variable, such as __8. Manufacturing costs incurred during the accounting
the level of activity or volume, that causally period minus the decrease in work-in-process
affects costs over a given time span. inventory during the period is equal to cost of
4. All costs of a product that are considered as goods manufactured.
assets when they are incurred and that __9. When a manufacturing plant becomes highly
become cost of goods sold only when the automated, the traditional three-part classification
product is sold are called of manufacturing costs is not necessarily used.
__________________ costs. __10. It is preferable to classify payroll fringe benefit
5. _________________ costs are all costs in the costs of direct manufacturing labor as a
income statement other than cost of goods manufacturing overhead cost.
sold.
6. Indirect manufacturing costs are also known Multiple Choice
as
___________________________________ Select the best answer to each question. Space is provided
costs. for computations after the quantitative questions.
7. _____________________ costs are incurred
to convert direct materials into finished __1. (CMA adapted) A fixed cost that would be considered
goods. a direct cost is:
8. Different costs are assigned to products for a. a controller’s salary if the cost object is a unit of
different purposes. Three of these purposes product.
are: b. the cost of renting a warehouse to store
____________________________________ inventory if the cost object is the Purchasing
_ Department.
____________________________________ c. an order clerk’s salary if the cost object is the
_ Purchasing Department.
____________________________________ d. the cost of electricity if the cost object is the
_ Internal Audit Department.
__2. Booth Company has total fixed costs of $64,000 if
True-False 8,000 units are produced. The relevant range is
8,000 units to 16,000 units. If 10,000 units are
Indicate whether each statement is true (T) or produced, fixed costs are:
false (F). a. $80,000 in total.
b. $8 per unit.
__1. A cost object is a target level of costs to be c. $48,000 in total.
achieved. d. $6.40 per unit.
__2. Cost accumulation is a general term that __3. In general, costs that can be most reliably predicted
encompasses both tracing costs to a cost are:
a. fixed cost per unit. beginning inventories of work in process and
b. total cost per unit. finished goods are $28,000 and $45,000,
c. total variable costs. respectively; and the ending inventories of work in
d. variable cost per unit. process and finished goods are $38,000 and
__4. Oxley Company has total variable costs of $52,000, respectively. The revenues of Dumas
$120,000 if 15,000 units are produced. Company for 2008 are:
The relevant range is 10,000 units to a. $419,000.
20,000 units. If 12,000 units are b. $429,000.
produced, variable costs are: c. $434,000.
a. $10 per unit. d. $436,000.
b. $120,000 in total.
c. $8 per unit.
d. $90,000 in total.
__5. (CPA adapted) The monthly cost of renting
a manufacturing plant is:
a. a prime cost and an inventoriable cost.
b. a prime cost and a period cost. __8. Using the traditional three-part classification of
c. a conversion cost and an inventori- manufacturing costs, prime costs and conversion
able cost. costs have the common component of:
d. a conversion cost and a period cost. a. direct material costs.
__6. (CPA adapted) Anthony Company has b. direct manufacturing labor costs.
budgeted its cost of goods sold at c. variable manufacturing overhead costs.
$4,000,000, including fixed costs of d. fixed manufacturing overhead costs.
$800,000. The variable cost of goods __9. An assembly worker at a manufacturing company
sold is expected to be 75% of revenues. earns $12 per hour for straight time and $18 per
Budgeted revenues are: hour for time over 40 hours per week. In a given
a. $4,266,667. week, the assembler worked 47 hours. The
b. $4,800,000. overtime premium for the week is:
c. $5,333,333. a. $6.
d. $6,400,000. b. $42.
__7. (CPA) For 2008, the gross margin of c. $84.
Dumas Company is $96,000; the cost of d. $126.
goods manufactured is $340,000; the
Review Exercises

Check Figures for these Review Exercises are at the end of the Student Guide. Solutions are at the end of the
chapter.

1. (CMA adapted) Backus Company estimated its unit cost of producing and selling 12,000 units per month as
follows:

Direct materials used $32

Direct manufacturing labor 20
Variable manufacturing overhead 15
Fixed manufacturing overhead 6
Variable nonmanufacturing costs 3
Fixed nonmanufacturing costs 4
Total costs $80

The cost driver for manufacturing costs is units produced. The cost driver for nonmanufacturing
costs is units sold. The relevant range is 7,000 units to 14,000 units.

a. Compute fixed manufacturing overhead per unit for monthly production of 10,000 units.
b. Compute total costs (manufacturing and nonmanufacturing) for a month when 9,000 units are
produced and 8,000 units are sold.

2. Yardley Corp. incurred the following manufacturing costs in 2008:

Variable manufacturing costs:

Direct materials $ 600,000
Direct manufacturing 560,000
labor
Manufacturing overhead 40,000
Fixed manufacturing overhead 540,000
Total manufacturing costs $1,740,000

In 2008, the total unit cost at production levels of 40,000 units and 60,000 units is $37.50 and
$33.00, respectively. The relevant range is 35,000 units to 70,000 units.

Compute the number of units produced in 2008.

3. (CPA) The following information is from the records of Wiggins & Sons for 2008:

Inventories
Ending Beginning
Finished goods $95,000 $110,000
Work in process 80,000 70,000
Direct materials 95,000 90,000

Costs Incurred During the Period

Total manufacturing costs $580,000
Manufacturing overhead 160,000
Direct materials used 190,000

a. Compute direct materials purchased.

b. Compute direct manufacturing labor costs.
c. Compute cost of goods sold.
Crossword Puzzle for Chapters 1 and 2

1 2 3 4

5 6 7

11 9
12

13 10 14
15 1
6
17

18 19
20

21

21. Relevant __________

ACROSS DOWN

1. A resource sacrificed or forgone 1. Supply __________

3. Different costs for different __________ 2. Matches organization’s capabilities to opportunities in marketplace

5. The management accountant’s attention-directing __________ 3. All direct manufacturing costs are __________ costs.

7. A __________ cost increases in total as more units are produced. 4. Includes selecting organization goals

11. Cost-__________ approach 6. __________ management versus staff management

12. Chief accounting officer 8. __________ chain of business functions

13. Code of professional __________ 9. A __________ cost decreases per unit as more units are produced.

14. A planning tool 10. Planning and __________ functions

15. All costs in the income statement except cost of goods sold 15. __________ cost has three different meanings

18. __________ focus 16. Direct costs of a cost __________

20. A cost __________ is a variable that causes costs to increase or 17. Part of the value chain: __________ of products, services, or processes
decrease over a given time period. 19. $100,000/20,000 units = $5; $5 is the __________ cost
Answers and Solutions to Chapter 2 Review Questions and Exercises

Completion Statements

1. direct, indirect
2. relevant range
3. cost driver
4. inventoriable
5. Period
6. manufacturing overhead (factory overhead)
7. Conversion
8. preparing financial statements, contracting with government agencies, pricing and product-mix decisions

True-False

1. F A cost object is anything for which a measurement of costs is desired. Examples of cost objects include
products, customers, projects, and departments.
2. F The statement defines cost assignment, not cost accumulation. Cost accumulation is the collection of cost
data in some organized way by means of an accounting system.
3. T
4. F Variable cost per unit remains the same within the relevant range. Fixed cost per unit increases (decreases)—
though not in a straight line—if the related level of activity or volume decreases (increases). When
graphed on a total basis, both variable costs and fixed costs are straight lines (linear) within the relevant
range.
5. F Nonmanufacturing costs are period costs, and manufacturing costs are inventoriable costs. Television
advertising is a period cost, and depreciation on the bottle-capping machines is an inventoriable cost.
6. T
7. T
8. F When work-in-process inventory decreases during the accounting period (that is, the ending work-in-process
inventory is less than the beginning work-in-process inventory), cost of goods manufactured exceeds
manufacturing costs incurred for the period. Cost of goods manufactured, therefore, is equal to
manufacturing costs incurred during the period plus the decrease in work-in-process inventory. Exhibit 2-
8, text p. 41, shows the opposite case in which work-in-process inventory increased during the period.
9. T
10. F It is preferable to classify payroll fringe benefit costs of direct manufacturing labor as a direct
manufacturing labor cost. That’s because payroll fringe benefit costs are a fundamental aspect of
acquiring the direct manufacturing labor services.

Multiple Choice

1. c Answers (a), (b), and (d) refer to indirect costs of their respective cost objects.
2. d $64,000 ÷ 10,000 = $6.40 per unit
3. d In general, variable cost per unit and fixed costs in total can be most reliably predicted because a forecast of
the level of activity or volume is not required.
4. c $120,000 ÷ 15,000 = $8 per unit, which is also the variable cost per unit when 12,000 units are produced.
5. c Plant rent is part of manufacturing overhead costs. As a result, it is a conversion cost and an inventoriable
cost.
6. a The variable portion of budgeted cost of goods sold is $4,000,000 − $800,000 = $3,200,000. Because this
amount is 75% of revenues, budgeted revenues are $3,200,000 ÷ 0.75 = $4,266,667.

7. b Beginning finished goods $ 45,000

Cost of goods manufactured 340,000
Cost of goods available for 385,000
sale
Ending finished goods 52,000
Cost of goods sold $333,000

Revenues $ R
Cost of goods sold 333,000
Gross margin $ 96,000

R − $333,000 = $96,000
R = $96,000 + $333,000 = $429,000

Note, the beginning and ending work-in-process inventories are not explicitly included in these
computations. That’s because the cost of goods manufactured, $340,000, includes the change in
work-in-process inventory.
8. b Under the traditional three-part classification of manufacturing costs:
Prime costs = Direct material costs + Direct manufacturing labor costs
Conversion costs = Direct manufacturing labor costs + Manufacturing overhead costs
9. b Overtime premium = (47 − 40) × ($18 − $12) = 7 × $6 = $42

Review Exercise 1

a. Fixed manufacturing overhead = 12,000 × $6 = $72,000

Fixed manufacturing overhead per unit = $72,000 ÷ 10,000 = $7.20
b. Variable manufacturing costs
9,000 × ($32 + $20 + $15) $603,000
Fixed manufacturing costs, 12,000 × $6 72,000
Variable nonmanufacturing costs, 8,000 × $3 24,000
Fixed nonmanufacturing costs, 12,000 × $4 48,000
Total costs $747,000

Review Exercise 2

Variable cost per unit:

$37.50 − ($540,000 ÷ 40,000) = $37.50 − $13.50 = $24.00
or
$33.00 − ($540,000 ÷ 60,000) = $33.00 − $9.00 = $24.00
Units produced = ($600,000 + $560,000 + $40,000) ÷ $24.00
= $1,200,000 ÷ $24.00 = 50,000 units
Review Exercise 3

a. Direct material costs:

Beginning inventory $90,000
Add purchases P
Available for use ?
Deduct ending inventory 95,000
Direct materials used $190,000

$90,000 + P − $95,000 = $190,000

P = $190,000 − $90,000 + $95,000 = $195,000

b. Direct materials used $190,000

Direct manufacturing labor costs L
Manufacturing overhead costs 160,000
Manufacturing costs incurred during the $580,000
period

$190,000 + L + $160,000 = $580,000

L = $580,000 − $190,000 − $160,000 = $230,000

c. Two steps are used to obtain the answer. First, compute cost of goods manufactured:

Manufacturing costs incurred during the $580,000

period
Add beginning work in process 70,000
Manufacturing costs to account for 650,000
Deduct ending work in process 80,000
Cost of goods manufactured $570,000

Second, compute cost of goods sold:

Beginning finished goods $110,000

Add cost of goods manufactured 570,000
Cost of goods available for sale 680,000
Deduct ending finished goods 95,000
Cost of goods sold $585,000

Solution to Crossword Puzzle for Chapters 1 and 2

C O S T P U R P O S E S
H T R L
A R O L E I V A R I A B L E
I A I M N
N T N E N V
B E N E F I T I A
G I C O N T R O L L E R
Y X G U
E T H I C S B U D G E T
P E R I O D O
R B N D
O J C U S T O M E R
D R I V E R N R S
U C I O I
C T T L G
T R A N G E
2. Under CVP analysis, the income statement above
CHAPTER is reformatted to show a key line item, contribution
Cost- margin:
3 Volume-
Revenues, $100,000
Profit 2,000 × $50
Variable costs, 40,000
Analysis 2,000 × $20
Contribution 60,000
margin
Overview Fixed costs 60,000
Operating $ -0-
income
This chapter explains a planning tool called
cost-volume-profit (CVP) analysis. CVP
analysis examines the behavior of total
revenues, total costs, and operating income This format, called the contribution income statement,
(profit) as changes occur in the units sold, the is used extensively in this chapter and throughout the
selling price, the variable cost per unit, or the textbook.
fixed costs of a product. The reliability of the
results from CVP analysis depends on the 3. Contribution margin can be expressed three ways:
reasonableness of the assumptions. The in total, on a per unit basis, and as a percentage of
Appendix to the chapter gives additional insights revenues. In our example, total contribution margin is
about CVP analysis; it explains decision models $60,000. Contribution margin per unit is the difference
and uncertainty. between selling price and variable cost per unit: $50 −
$20 = $30. Contribution margin per unit is also equal to
Highlights contribution margin divided by the number of units sold:
$60,000 ÷ 2,000 = $30. Contribution margin
1. Because managers want to avoid percentage (also called contribution margin ratio) is
operating losses, they are interested in the contribution margin per unit divided by selling price: $30
breakeven point calculated using CVP analysis. ÷ $50 = 60%; it is also equal to contribution margin
The breakeven point is the quantity of output divided by revenues: $60,000 ÷ $100,000 = 60%. This
sold at which total revenues equal total costs. contribution margin percentage means that 60 cents in
There is neither a profit nor a loss at the contribution margin is gained for each $1 of revenues.
breakeven point. To illustrate, assume a
company sells 2,000 units of its only product for 4. In our example, compute the breakeven point
$50 per unit, variable cost is $20 per unit, and (BEP) in units and in revenues as follows:
fixed costs are $60,000 per month. Given these
conditions, the company is operating at the
breakeven point:

Revenues, $100,000
2,000 × $50
Deduct:
Variable 40,000
costs, 2,000
× $20
Fixed costs 60,000 1 5. The CVP analysis above is based on the
Operating $ -0- following assumptions:
income

1 a. Changes in the levels of revenues and costs arise

The breakeven point can be expressed two ways: only because of changes in the number of product (or
2,000 units and $100,000 of revenues. service) units sold (that is, the number of output units
is the only driver of revenues and costs).
2 b. Total costs can be separated into a fixed
component that does not vary with units sold managers decide how much to spend on advertising,
and a component that is variable with whether or not to reduce selling price, whether or not
respect to units sold. to expand into new markets, and which features to
3 c. When represented graphically, the add to existing products. Of course, different choices
behaviors of both total revenues and total can affect fixed costs, variable cost per unit, selling
costs are linear (straight lines) in relation to
prices, units sold, and operating income.
the units sold within a relevant range (and
time period).
4 d. Selling price, variable cost per unit, and 9. Single-number “best estimates” of input data
total fixed costs (within a relevant range and for CVP analysis are subject to varying degrees of
time period) are known and constant. uncertainty, the possibility that an actual amount
will deviate from an expected amount. One approach
to deal with uncertainty is to use sensitivity analysis
6. While the breakeven point is often of (discussed in paragraphs 10 through 12). Another
interest to managers, CVP analysis considers a approach is to compute expected values using
broader question: What amount of sales in units probability distributions (discussed in paragraph 19).
or in revenues is needed to achieve a specified
target operating income? The answer is easily
10. Sensitivity analysis is a “what if” technique
obtained by adding target operating income to
total fixed costs in the numerator of the formulas that managers use to examine how a result will
above. Assuming target operating income (TOI) change if the original predicted data are not achieved
is $15,000: or if an underlying assumption changes. In the
context of CVP analysis, sensitivity analysis
examines how operating income (or the breakeven
point) changes if the predicted data for selling price,
variable cost per unit, fixed costs, or units sold are
not achieved. The sensitivity to various possible
outcomes broadens managers’ perspectives as to
7. Because for-profit organizations are what might actually occur before they make cost
subject to income taxes, their CVP analyses commitments. Electronic spreadsheets, such as
must include this factor. For example, if a Excel, enable managers to conduct CVP-based
company earns $50,000 before income taxes and
sensitivity analyses in a systematic and efficient way.
the tax rate is 40%, then:

Operating $50,000 11. An aspect of sensitivity analysis is the

income margin of safety, the amount by which budgeted (or
Deduct 20,000 actual) revenues exceed the breakeven quantity. The
income taxes margin of safety answers the “what-if” question: If
(40%) budgeted revenues are above breakeven and drop,
Net income $30,000 how far can they fall below budget before the
breakeven point is reached?

To state a target net income figure in terms 12. CVP-based sensitivity analysis highlights the
of operating income, divide target net risks and returns that an existing cost structure holds
income by 1 − tax rate: $30,000 ÷ (1 − .40) for a company. This insight may lead managers to
= $50,000. Note, the income-tax factor does consider alternative cost structures. For example,
not change the breakeven point because no compensating a salesperson on the basis of a sales
income taxes arise if operating income is $0. commission (a variable cost) rather than a salary (a
fixed cost) decreases the company’s downside risk if
8. Managers use CVP analysis to guide demand is low but decreases its return if demand is
their decisions, many of which are strategic high. The risk-return tradeoff across alternative cost
decisions. For example, CVP analysis helps structures can be measured as operating leverage.
Operating leverage describes the effects that products remains constant as the level of total units
fixed costs have on changes in operating sold changes. The breakeven point is some number
income as changes occur in units sold and of units of each product, depending on the sales mix.
contribution margin. Companies with a high To illustrate, assume a company sells two products,
proportion of fixed costs in their cost A and B. The sales mix is 4 units of A and 3 units of
structures have high operating leverage. B. The contribution margins per unit are $80 for A
Consequently, small changes in units sold and $40 for B. Fixed costs are $308,000 per month.
cause large changes in operating income. At To compute the breakeven point:
any given level of sales:

Knowing the degree of operating leverage at

a given level of sales helps managers
calculate the effect of changes in sales on
operating income.

13. The time horizon being considered Proof of breakeven point:

for a decision affects the classification of
costs as variable or fixed. The shorter the
time horizon, the greater the proportion of
total costs that are fixed. For example,
virtually all the costs of an airline flight are
fixed one hour before takeoff. When the
time horizon is lengthened to one year and
then five years, more and more costs
become variable. This example underscores
the point that which costs are fixed in a
specific decision situation depends on the
length of the time horizon and the relevant 16. Recall from paragraph 5a that CVP analysis
range. assumes that the number of output units is the only
revenue and cost driver. By relaxing this assumption,
14. Sales mix is the quantities (or CVP analysis can be adapted to the more general
proportions) of various products (or case of multiple cost drivers but the simple formulas
services) that constitute total unit sales of a in paragraphs 4 and 6 can no longer be used.
company. If the sales mix changes and the Moreover, there is no unique breakeven point. The
overall unit sales target is still achieved, example, text pp. 76-78, has two cost drivers—the
however, the effect on the breakeven point number of software packages sold and the number of
and operating income depends on how the customers. One breakeven point is selling 26
original proportions of lower or higher packages to 8 customers. Another breakeven point is
contribution margin products have shifted. selling 27 packages to 16 customers.
Other things being equal, for any given total
quantity of units sold, the breakeven point 17. CVP analysis can be applied to service
decreases and operating income increases if organizations and nonprofit organizations. The key is
the sales mix shifts toward products with measuring their output. Unlike manufacturing and
higher contribution margins. merchandising companies that measure their output
in units of product, the measure of output differs
15. In multiple product situations, CVP from one service industry (or nonprofit organization)
analysis assumes a given sales mix of to another. For example, airlines measure output in
passenger-miles and hotels/motels use room- gross margin).
nights occupied. Government welfare
agencies measure output in number of 19. The Appendix to this chapter uses a
clients served and universities use student probability distribution to incorporate uncertainty
credit-hours. into a decision model. This approach provides
additional insights about CVP analysis. A decision
18. Contribution margin, a key concept model, a formal method for making a choice, usually
in this chapter, contrasts with gross margin includes five steps: (a) identify a choice criterion
discussed in Chapter 2. Gross margin is an such as maximize income, (b) identify the set of
important line item in the GAAP income alternative actions (choices) to be considered, (c)
statements of merchandising and identify the set of events (possible occurrences) that
manufacturing companies. Gross margin is can occur, (d) assign a probability to each event that
total revenues minus cost of goods sold, can occur, and (e) identify the set of possible
whereas contribution margin is total outcomes (the economic result of each action-event
revenues minus total variable costs (from the combination). Uncertainty is present in a decision
entire value chain). Gross margin and model because for each alternative action there are
contribution margin will be different two or more possible events, each with a probability
amounts (except in the highly unlikely case of occurrence. The correct decision is to choose the
that cost of goods sold and total variable action with the best expected value. Expected value
costs are equal). For example, a is the weighted average of the outcomes, with the
manufacturing company deducts the fixed probability of each outcome serving as the weight.
manufacturing costs that become period Although the expected value criterion helps
costs from revenues in computing gross managers make good decisions, it does not prevent
margin (but not contribution margin); it bad outcomes from occurring.
deducts sales commissions from revenues in
computing contribution margin (but not
Featured Exercise

In its budget for next month, Welker Company has revenues of $500,000, variable costs of $350,000, and fixed costs
of $135,000.

a. Compute contribution margin percentage.

b. Compute total revenues needed to break even.
c. Compute total revenues needed to achieve a target operating income of $45,000.
d. Compute total revenues needed to achieve a target net income of $48,000, assuming the income tax rate is 40%.

Solution

a. Contribution margin percentage = ($500,000 − $350,000) ÷ $500,000

= $150,000 ÷ $500,000 = 30%
Note, variable costs as a percentage of revenues = $350,000 ÷ $500,000 = 70%
b. Breakeven point = $135,000 ÷ 0.30 = $450,000
Proof of breakeven Revenues $450,000
point:
Variable costs, $450,000 × 0.70 315,000
Contribution margin 135,000
Fixed costs 135,000
Operating income $ -0-

c. Let X = Total revenues needed to achieve target operating income of $45,000

d. Two steps are used to obtain the answer. First, compute operating income when net income is $48,000:

Second, compute total revenues needed to achieve a target operating income of $80,000 (that is, a target
net income of $48,000), which is denoted by Y:
__5. Trading off fixed costs in a company’s cost structure
Review Questions and Exercises for higher variable cost per unit decreases
downside risk if demand is low and decreases
(All answers are at the end of the chapter.) return if demand is high.
__6. At any given level of sales, the degree of operating
Completion Statements leverage is equal to contribution margin divided
by operating income.
Fill in the blank(s) to complete each statement. __7. If the budget appropriation for a government social
welfare agency is reduced by 15% and the cost-
1. __________________________________ is volume relationships remain the same, the client
equal to selling price minus variable cost per service level would decrease by 15%.
unit. __8. The longer the time horizon in a decision situation,
2. The financial report that highlights the the lower the percentage of total costs that are
contribution margin as a line item is called variable.
the _______________________________. __9. Cost of goods sold in manufacturing companies is a
3. The possibility that an actual amount will variable cost.
deviate from an expected amount is called __10. (Appendix) The probability distribution for the
_______________. mutually exclusive and collectively exhaustive set
4. ________________________ is a “what if” of events in a decision model sums to 1.00.
technique that, when used in the context of __11. (Appendix) Even if a manager makes a good
CVP analysis, examines how an outcome decision, a bad outcome may still occur.
such as operating income will change if the
original predicted data are not achieved or if Multiple Choice
an underlying assumption changes.
5. The quantities (or proportions) of various Select the best answer to each question. Space is provided
products (or services) that constitute total for computations after the quantitative questions.
unit sales of a company is called the
________________. __1. (CPA) CVP analysis does not assume that:
6. _________________ describes the effects that a. selling prices remain constant.
fixed costs have on changes in operating b. there is a single revenue and cost driver.
income as changes occur in units sold and, c. total fixed costs vary inversely with the output
hence, in contribution margin. level.
7. (Appendix) In a decision model, the correct d. total costs are linear within the relevant range.
decision is to choose the action with the best __2. Given for Winn Company in 2008: revenues
______________________, which is the $530,000, manufacturing costs $220,000 (one-
weighted average of the outcomes with the half fixed), and marketing and administrative
probability of each outcome serving as the costs $270,000 (two-thirds variable). The
weight. contribution margin is:
True-False  a. $40,000.
  b. $240,000.
Indicate whether each statement is true (T) or c. $310,000.
false (F). d. $330,000.

__1. Generally, the breakeven point in revenues

can be easily determined by simply
summing all costs in the company’s
contribution income statement.
__2. At the breakeven point, total fixed costs
always equals contribution margin. __3. Using the information in question 2 and ignoring
__3. The amount by which budgeted (or actual) inventories, the gross margin for Winn Company
revenues exceed breakeven revenues is is:
called the margin of forecasting error. a. $40,000.
__4. An increase in the income tax rate increases b. $240,000.
the breakeven point. c. $310,000.
d. $330,000. unchanged, what should the selling price be
in 2009 if Thor is to earn the same operating
income of $200,000?
a. $120
b. $135
__4. (CPA) Koby Company has revenues of
c. $150
$200,000, variable costs of $150,000,
fixed costs of $60,000, and an operating d. $240
loss of $10,000. By how much would
Koby need to increase its revenues in
order to achieve a target operating
income of 10% of revenues?
a. $200,000
b. $231,000 __7. In the fiscal year just completed, Varsity Shop
c. $251,000 reports net income of $24,000 on revenues of
d. $400,000 $300,000. The variable costs as a percentage
of revenues are 70%. The income tax rate is
__5. (CPA) The following information pertains
40%. What is the amount of fixed costs?
to Nova Co.’s CVP relationships:
a. $30,000
Breakeven 1,000 b. $50,000
point in c. $66,000
units d. $170,000
Variable $500 __8. The amount of total costs probably will not vary
cost per unit significantly in decision situations in which:
Total fixed $150,000 a. the time span is quite short and the change
costs in units of output is quite large.
b. the time span is quite long and the change
in units of output is quite large.
How much will be contributed to c. the time span is quite long and the change
operating income by the 1,001st unit in units of output is quite small.
sold? d. the time span is quite short and the change
a. $650 in units of output is quite small.
b. $500 __9. (CPA) Product Cott has revenues of $200,000, a
c. $150 contribution margin of 20%, and a margin of
d. $0 safety of $80,000. What are Cott’s fixed
costs?
a. $16,000
b. $24,000
c. $80,000
d. $96,000

__6. (CPA) During 2008, Thor Lab supplied

hospitals with a comprehensive
diagnostic kit for $120. At a volume
of 80,000 kits, Thor had fixed costs __10. For a multiple-product company, a shift in
of $1,000,000 and an operating sales mix from products with high
income of $200,000. Due to an contribution-margin percentages toward
adverse legal decision, Thor’s products with low contribution-margin
liability insurance in 2009 will percentages causes the breakeven point to be:
increase by $1,200,000. Assuming a. lower.
the volume and other costs are
b. higher.
c. unchanged.
d. different but undeterminable.
__11. (Appendix, CMA) The College Honor
Society sells large pretzels at the
home football games. The following The pretzels are sold for $2.00 each, and the
information is available: cost per pretzel is $0.60. Any unsold pretzels
are discarded because they will be stale
before the next home game. If 4,000 pretzels
are on hand for a game but only 3,000 of
them are sold, the operating income is:
a. $5,600.
b. $4,200.
c. $3,600.
d. $900.
e. none of the above.
Review Exercises

Check Figures for these Review Exercises are at the end of the Student Guide. Solutions are at the end of the chapter.

1. (CMA) The income statement for Davann Co. presented below shows the operating results for the fiscal year just
ended. Davann had sales of 1,800 tons of product during that year. The manufacturing capacity of Davann’s
facilities is 3,000 tons of product.

Revenues $900,000
Variable costs:
Manufacturing $315,000
Nonmanufacturing 180,000 495,000
Contribution margin 405,000
Fixed costs:
Manufacturing 90,000
Nonmanufacturing 157,500 247,500
Operating income 157,500
Income taxes (40%) 63,000
Net income $ 94,500

a. If the sales volume is estimated to be 2,100 tons for next year, and if the selling price and cost-
behavior patterns remain the same next year, how much net income does Davann expect to earn
next year?
b. Assume Davann estimates the selling price per ton will decline 10% next year, variable cost will
increase by $40 per ton, and total fixed costs will not change. Compute how many tons must be
sold next year to earn net income of $94,500.

2. Valdosta Manufacturing Co. produces and sells two products:

T U
Selling price $25 $16
Variable costs per unit 20 13

Total fixed costs are $40,500.

Compute the breakeven point in units, assuming the sales mix is five units of U for each unit of T.
3. (CPA) Dallas Corporation wishes to market a new product at a selling price of $1.50 per unit. Fixed
costs for this product are $100,000 for less than 500,000 units of output and $150,000 for 500,000 or
more units of output. The contribution-margin percentage is 20%.

Compute how many units of this product must be sold to earn a target operating income of $100,000.

4. (Appendix, CMA) The ARC Radio Company is trying to decide whether to introduce a new product, a
wrist “radiowatch” designed for shortwave reception of the exact time as broadcast by the National
Bureau of Standards. The “radiowatch” would be priced at $60, which is exactly twice the variable cost
per unit to manufacture and sell it. The fixed costs to introduce the radiowatch are $240,000 per year.
The following probability distribution estimates the demand for the product:

Annual Demand Probability

6,000 units .20
8,000 units .20
10,000 units .20
12,000 units .20
14,000 units .10
16,000 units .10

a. Compute the expected value of demand for the radiowatch.

b. Compute the probability that the introduction of the radiowatch will not increase the company’s
operating income.

Answers and Solutions to Chapter 3 Review Questions and Exercises

Completion Statements

1. Contribution margin per unit

2. contribution income statement
3. uncertainty
4. Sensitivity analysis
5. sales mix
6. Operating leverage
7. expected value
True-False

1. F The breakeven point in revenues is computed by dividing total fixed costs by contribution-margin percentage.
The computation described in the statement gives breakeven revenues only if the company happened to be
operating at the breakeven point.
2. T
3. F The amount by which budgeted revenues exceed the breakeven quantity is called the margin of safety.
4. F The breakeven point is unaffected by income taxes because operating income at the breakeven point is $0 and,
hence, no income taxes arise.
5. T
6. T
7. F If the budget appropriation for a government social welfare agency is reduced by 15% and the cost-volume
relationships remain the same, the client service level would decrease by more than 15% because of the
existence of fixed costs. For example, the illustration, text p. 78, has a 21.4% decrease in the service level
when the budget appropriation is reduced by 15%.
8. F The longer the time horizon in a decision situation, the lower the percentage of total costs that are fixed and the
higher the percentage of total costs that are variable.
9. F Cost of goods sold in manufacturing companies includes both variable and fixed manufacturing costs.
10. T
11. T

Multiple Choice

1. c One of the assumptions in CVP analysis is that total fixed costs remain the same within the relevant range. In
other words, fixed cost per unit varies inversely with the output level within the relevant range.
2. b Contribution margin = $530,000 − $220,000(1/2 variable) − $270,000(2/3 variable)
= $530,000 − $110,000 − $180,000 = $240,000
3. c Gross margin = $530,000 − $220,000 = $310,000
4. a Let R = Revenues needed to earn a target operating income of 10% of revenues

Because current revenues are $200,000, an increase in revenues of $200,000 is needed to earn a target
operating income of 10% of revenues.
5. c Total costs at breakeven = (1,000 × $500) + $150,000 = $650,000
Selling price = $650,000 ÷ 1,000 units = $650
Contribution margin per unit = $650 − $500 = $150
6. b The selling price in 2009 to earn the same operating income of $200,000 is the selling price in 2008, $120,
increased by the amount of the higher liability insurance in 2009, $1,200,000, spread over the 80,000-unit
sales volume:
Selling price in 2009 = $120 + ($1,200,000 ÷ 80,000) = $120 + $15 = $135
7. b Three steps are used to obtain the answer. First, compute the contribution margin.
Contribution margin percentage = 100% − Variable costs percentage of 70% = 30%.
Contribution margin = $300,000 × 0.30 = $90,000. Second, compute operating income:

Third, the difference between contribution margin and operating income is fixed costs:
$90,000 − $40,000 = $50,000
8. d An example of this decision situation is deciding whether to add a passenger to an airline flight that has empty
seats and will depart in one hour. Variable cost for the passenger is negligible. Virtually all the costs in this
decision situation are fixed.
9. b Margin of safety answers the what-if question: If budgeted revenues exceed the breakeven point and drop, how
far can they fall below the budget before the breakeven point is reached?
Proof of breakeven point: $24,000 ÷ 0.20 = $120,000
10. b A shift in the sales mix from high contribution-margin percentage products toward low ones decreases the
overall contribution-margin percentage of the sales mix. This change increases the breakeven point.
11. c Operating income = 3,000($2.00) − 4,000($0.60) = $6,000 − $2,400 = $3,600

eview Exercise 1
R
a. Three steps are used to obtain the answer. First, compute selling price: $900,000 ÷ 1,800 = $500. Second,
compute variable cost per unit: $495,000 ÷ 1,800 = $275. Third, prepare a contribution income statement at
the 2,100-ton level of output:

Revenues, 2,100 × $500 $1,050,000

Variable costs, 2,100 × $275 577,500
Contribution margin 472,500
Fixed costs 247,500
Operating income 225,000
Income taxes (40%) 90,000
Net income $ 135,000

b. Let Q = Number of tons to break even next year

eview Exercise 2
R

Proof:
eview Exercise 3
R
Two steps are used to obtain the answer. First, determine if fixed costs will be $100,000 or $150,000. If
fixed costs are $100,000, the maximum operating income is attained at 499,999 units:

Revenues, 499,999 × $1.50 $749,998.50

Variable costs, 80% of revenues 599,998.80
Contribution margin, 20% of revenues 149,999.70
Fixed costs 100,000.00
Operating income $ 49,999.70
Because this operating income is below the target of $100,000, the output level needs to be greater than
499,999 units and, hence, fixed costs will be $150,000. Second, compute the required output level:

Let Q = Number of units to be sold to earn a target operating income of $100,000

eview Exercise 4
R
a. 6,000 × .20 = 1,200
8,000 × .20 = 1,600
10,000 × .20 = 2,000
12,000 × .20 = 2,400
14,000 × .10 = 1,400
16,000 × .10 = 1,600
Expected value of demand in units 10,200

b. If the number of units sold each year is equal to or less than the breakeven point, the radiowatch will
not increase the company’s operating income. At the breakeven point,

Because the company’s operating income will not increase if 8,000 units or 6,000 units are sold, the
probability of either of these events occurring is equal to the sum of their individual probabilities:
0.20 + 0.20 = 0.40.