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Chapter 8 - CHAPTER 11

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					                                         CHAPTER 8

        ABSORPTION AND VARIABLE COSTING, AND
              INVENTORY MANAGEMENT
                                   DISCUSSION QUESTIONS

1. The only difference between absorption cost-                 tory. Examples include insurance, taxes, han-
   ing and variable costing is the way in which                 dling costs, and the opportunity cost of capital
   fixed overhead costs are assigned. Under va-                 tied up in inventory.
   riable costing, fixed overhead is a period cost;
   under absorption costing, it is a product cost.          7. Stockout costs are the costs of insufficient
                                                               inventory (e.g., lost sales and interrupted pro-
2. Absorption-costing income is greater because                duction).
   some of the period’s fixed overhead is placed
   in inventory and not recognized as part of               8. Reasons for carrying inventory include the
   Cost of Goods Sold on the absorption-costing                following: (a) to balance setup and carrying
   income statement.                                           costs, (b) to satisfy customer demand, (c) to
                                                               avoid shutting down manufacturing facilities,
3. A segment is any subunit of sufficient impor-               (d) to take advantage of discounts, and (e) to
   tance to warrant production of performance                  hedge against future price increases.
   reports.
                                                            9. If carrying costs increase, that implies that
4. Contribution margin is the amount available to              fewer orders are placed. However, the com-
   cover fixed expenses and provide for profit.                pany still needs the annual demand for the
   Segment margin is the amount available to                   part. So fewer orders imply a larger number of
   cover common fixed expenses and provide for                 parts ordered. This increases carrying costs.
   profit. Contribution margin is the difference
   between revenues and variable expenses.              10.     The economic order quantity is the amount
   Segment margin is contribution margin less                   that should be ordered so as to minimize the
   direct fixed expenses.                                       sum of ordering and carrying costs.

5. No, the purchase price is not part of the fun-       11.     Safety stock is the difference between maxi-
   damental EOQ formula. However, the poten-                    mum demand and average demand, multip-
   tial for quantity discounts may be considered                lied by the lead time. By reordering whenever
   by management in deciding whether or not to                  the inventory level hits the safety stock point,
   order the EOQ amount. For example, the                       a company is ensured of always having suffi-
   company may order more than the EOQ                          cient inventory on hand to meet demand
   amount if the quantity discount is larger than
   the additional carrying cost.                        12.     JIT minimizes carrying costs by driving inven-
                                                                tories to insignificant levels. Ordering costs
6. Ordering costs are the costs of placing and                  are minimized by entering into long-term con-
   receiving an order. Examples include clerical                tracts with suppliers (or driving setup times to
   costs, documents, insurance, and unloading.                  zero).
   Carrying costs are the costs of carrying inven-




                                                      8-1
           MULTIPLE-CHOICE EXERCISES

8–1    a

8–2    d

8–3    a

8–4    e

8–5    c

8–6    b

8–7    d

8–8    a

8–9    c

8–10   d

8–11   b

8–12   d




                     8-2
                        CORNERSTONE EXERCISES

Cornerstone Exercise 8–13

1. Units ending inventory    = Units beginning inventory + Units produced – Units
                               sold
                             = 400 + 12,000 – 11,200
                             = 1,200

2. Direct materials         $ 25
   Direct labor               80
   Variable overhead          20
   Fixed overhead             30
   Unit product cost        $155

3. Value of ending inventory = 1,200 × $155 = $186,000


Cornerstone Exercise 8–14

1. Units ending inventory    = Units beginning inventory + Units produced – Units
                               sold
                             = 400 + 12,000 – 11,200
                             = 1,200

2. Direct materials         $ 25
   Direct labor               80
   Variable overhead          20
   Unit product cost        $125

3. Value of ending inventory = 1,200 × $125 = $150,000




                                        8-3
Cornerstone Exercise 8–15

1. Direct materials                         $20
   Direct labor                              14
   Variable overhead                          3
   Fixed overhead                             5
   Unit COGS                                $42
     Total COGS = $42 × 7,500 units = $315,000

2.                                      Engers Company
                           Income Statement Under Absorption Costing
                                    For the Most Recent Year
     Sales ($70 × 7,500) .....................................................................   $525,000
     Less: Cost of goods sold ..........................................................          315,000
        Gross margin ........................................................................    $210,000
     Less: Selling and administrative expenses .............................                      142,000
     Operating income .......................................................................    $ 68,000


Cornerstone Exercise 8–16

1. Direct materials                         $20
   Direct labor                              14
   Variable overhead                          3
   Unit variable COGS                       $37
     Total variable COGS = $37 × 7,500 units = $277,500

2.                                       Engers Company
                              Income Statement Under Variable Costing
                                     For the Most Recent Year
     Sales ($70 × 7,500) ...............................................                         $525,000
     Less: Variable cost of goods sold ......................                                     277,500
        Contribution margin .......................................                              $247,500
     Less fixed expense:
        Overhead .........................................................         $ 40,000
        Selling and administrative expenses ............                            142,000       182,000
     Operating income .................................................                          $ 65,500




                                                         8-4
Cornerstone Exercise 8–17

                             Fering Nurseries, Inc.
                          Segmented Income Statement
                             For the Coming Year
                                       Poinsettias     Fruit Trees      Total
Sales                                  $1,200,000     $ 3,000,000    $ 4,200,000
Variable cost of goods sold              (400,000)     (1,000,000)    (1,400,000)
Variable selling expense                  (36,000)        (90,000)      (126,000)
Contribution margin                    $ 764,000      $ 1,910,000    $ 2,674,000
Less direct fixed expenses:
   Direct fixed overhead                 (260,000)       (200,000)      (460,000)
   Direct selling and administrative     (127,000)        (78,000)      (205,000)
Segment margin                         $ 377,000      $ 1,632,000    $ 2,009,000
Less common fixed expenses:
   Common fixed overhead                                              (1,475,000)
   Common selling and administrative                                    (380,000)
Operating income                                                     $ 154,000


Cornerstone Exercise 8–18

                        Annual number of pounds used
1. Number of orders =
                         Number of pounds in an order
                        2,500
                      =
                         500
                      = 5 orders per year

2. Total ordering cost = Number of orders × Cost per order
                       = 5 orders × $4
                       = $20

3. Total carrying cost = Average number of pounds in inventory ×
                         Cost of carrying one pound in inventory
                         500
                       =      × $2
                          2
                       = $500

4. Total inventory-related cost = Total ordering cost + Total carrying cost
                                = $20 + $500
                                = $520




                                        8-5
Cornerstone Exercise 8–19

            2 × D × CO
1. EOQ =
                CC

   EOQ =     2 × 4 × $2,500/2

         = 100 pounds

                         Annual number of pounds used
2. Number of orders =
                          Number of pounds in an order
                         2,500
                       =
                          100
                       = 25 orders per year

3. Total ordering cost = Number of orders × Cost per order
                       = 25 orders × $4
                       = $100

4. Total annual carrying cost under the EOQ policy
                               = (100/2)/2
                               = $100

5. Total inventory-related cost = Total ordering cost + Total carrying cost
                                = $100 + $100
                                = $200


Cornerstone Exercise 8–20

Reorder point = Daily usage × Lead time
Reorder point = 10 × 4 days = 40


Cornerstone Exercise 8–21

1. Safety stock = (Maximum daily usage – Average daily usage) × Lead time
                = (15 – 10) × 4 days
                = 20

2. Reorder point = Maximum daily usage × Lead time
   Reorder point = 15 × 4 days = 60
   Or
   Reorder point = (Average daily usage × Lead time) + Safety stock
   Reorder point = (10 × 4 days) + 20 = 60


                                       8-6
                                     EXERCISES

Exercise 8–22

                                  $79,500
1. Unit direct materials cost =           = $5.30
                                  15,000
                              $105,000
   Unit direct labor cost =            = $7.00
                               15,000
                                    $15,900
   Unit variable overhead cost =            = $1.06
                                    15,000
                                  $51,000
   Unit fixed overhead cost =             = $3.40
                                  15,000

2. Unit direct materials cost                       $ 5.30
   Unit direct labor cost                             7.00
   Unit variable overhead cost                        1.06
   Unit fixed overhead cost                           3.40
      Absorption cost per unit                      $16.76

3. Ending inventory in units = 15,000 – 13,800 = 1,200

4. Absorption-costing ending inventory = $16.76 × 1,200 = $20,112


Exercise 8–23

1. Unit direct materials cost               $3.80
   Unit direct labor cost                    3.15
   Unit variable overhead cost               0.68
      Variable-costing cost per unit        $7.63

2. Variable-costing ending inventory = $7.63 × (30,000 – 28,900) = $8,393




                                          8-7
Exercise 8–24

1. Unit direct materials cost ( $615,000 )
                                  75,000
                                                $ 8.20


   Unit direct labor cost (           )
                            $105,000
                                                  1.40
                             75,000

   Unit variable overhead cost (            )
                                   $78,750
                                                  1.05
                                    75,000

   Unit fixed overhead cost (             )
                               $270,000
                                                  3.60
                                 75,000
      Absorption cost per unit                  $14.25


2. Unit direct materials cost ( $615,000 )
                                 75,000
                                                $ 8.20


   Unit direct labor cost (          )
                            $105,000
                                                  1.40
                             75,000

   Unit variable overhead cost (          )
                                  $78,750
                                                  1.05
                                   75,000
      Variable cost per unit                    $ 10.65

3. Absorption-costing ending inventory = $14.25 × 400 = $5,700

4. Variable-costing ending inventory = $10.65 × 400 = $4,260


Exercise 8–25

1. Unit direct materials cost                   $ 7.50
   Unit direct labor cost                         2.75
   Unit variable overhead cost                    3.90
   Unit fixed overhead cost                       4.50
      Absorption cost per unit                  $18.65

2. Unit direct materials cost                   $ 7.50
   Unit direct labor cost                         2.75
   Unit variable overhead cost                    3.90
      Variable cost per unit                    $14.15




                                        8-8
Exercise 8–25          (Concluded)

3. Absorption-costing income:
   Sales ($30 × 74,600) ..............................................   $2,238,000
   Less: Cost of goods sold ($18.65 × 74,600)........                     1,391,290
      Gross margin ...................................................                $ 846,710
   Less:
      Variable selling expense ($2 × 74,600) ..........                  $ 149,200
      Fixed selling expense .....................................           56,500
      Fixed administrative expense ........................                213,000      418,700
   Operating income .................................................                 $ 428,010

4. Variable-costing income:
   Sales ($30 × 74,600) ..............................................                $2,238,000
   Less variable costs:
      Cost of goods sold ($14.15 × 74,600) ............                  $1,055,590
      Selling expense ($2 × 74,600) .........................               149,200    1,204,790
   Contribution margin .............................................                  $1,033,210
   Less fixed costs:
      Fixed overhead ($4.50 × 80,000) .....................              $ 360,000
      Selling and administrative expenses.............                     269,500      629,500
   Operating income .................................................                 $ 403,710


Exercise 8–26

1. Direct materials                                     $ 8.00
   Direct labor                                           4.00
   Variable overhead                                      1.50
   Fixed overhead                                         4.15
      Absorption-costing unit cost                      $17.65

2. Direct materials                                     $ 8.00
   Direct labor                                           4.00
   Variable overhead                                      1.50
      Variable-costing unit cost                        $13.50

3. Ending inventory = Beginning inventory + Units produced – Units sold
                    = 0 + 20,000 – 17,200
                    = 2,800

4. Absorption-costing ending inventory = $17.65 × 2,800 = $49,420

5. Variable-costing ending inventory = $13.50 × 2,800 = $37,800




                                                       8-9
Exercise 8–27

1. Absorption-costing income:
   Sales ($32 × 17,200) .............................................   $550,400
   Less: Cost of goods sold ($17.65 × 17,200) .......                    303,580
      Gross margin ..................................................              $246,820
   Less:
      Variable selling expense ($3 × 17,200) ..........                 $ 51,600
      Selling and administrative expenses ............                    24,300     75,900
   Operating income .................................................              $170,920

2. Variable-costing income:
   Sales ($32 × 17,200) .............................................              $550,400
   Less variable costs:
      Cost of goods sold ($13.50 × 17,200) ............                 $232,200
      Selling expense ($3 × 17,200) ........................              51,600    283,800
   Contribution margin .............................................               $266,600
   Less fixed costs:
      Fixed overhead ($4.15 × 20,000) ....................              $ 83,000
      Selling and administrative expenses ............                    24,300    107,300
   Operating income .................................................              $159,300


Exercise 8–28

1. Units ending inventory             = Units beginning inventory + Units produced – Units
                                        sold
                                      = 0 + 17,000 – 14,000 = 3,000 units

2. Absorption costing:
   Direct materials                          $ 35
   Direct labor                                65
   Variable overhead                           30
   Fixed overhead                              20
   Unit product cost                         $150
   Value of ending inventory = 3,000 × $150 = $450,000

3. Variable costing:
   Direct materials                          $ 35
   Direct labor                                65
   Variable overhead                           30
   Unit product cost                         $130
   Value of ending inventory = 3,000 × $130 = $390,000




                                                   8-10
Exercise 8–28     (Concluded)

4. Sales ($200 × 14,000)                                       $2,800,000
   Less: Cost of goods sold ($150 × 14,000)                     2,100,000
   Gross margin                                                $ 700,000
   Less: Selling and administrative expenses                      200,000
   Absorption-costing operating income                         $ 500,000

5.                 B&O Cafe Variable-Costing Income Statement
     Sales ($200 × 14,000)                                     $2,800,000
     Less: Cost of goods sold ($130 × 14,000)                   1,820,000
     Contribution margin                                       $ 980,000
     Less fixed expenses:
        Fixed overhead ($20 × 17,000)         $340,000
        Fixed selling and administrative       200,000           540,000
     Variable-costing operating income                         $ 440,000


Exercise 8–29

                                   Trendy Inc.
                           Segmented Income Statement
                              For the Coming Year
                                          Sweaters       Jackets        Total
Sales                                    $ 300,000       $ 420,000    $ 720,000
Variable cost of goods sold               (180,000)       (200,000)    (380,000)
Variable selling expense                   (15,000)        (21,000)     (36,000)
Contribution margin                      $ 105,000       $ 199,000    $ 304,000
Less direct fixed expenses:
   Direct fixed overhead                   (25,000)        (40,000)     (65,000)
   Direct selling and administrative       (20,000)        (50,000)     (70,000)
Segment margin                           $ 60,000        $ 109,000    $ 169,000
Less common fixed expenses:
   Common fixed overhead                                                (45,000)
   Common selling and administrative                                    (15,000)
Operating income                                                      $ 109,000




                                        8-11
Exercise 8–30

1.                                     Consumer                Small Business
                                       Computers                Computers
     Direct materials                     $500                     $1,800
     Direct labor                          160                        290
     Variable overhead                      40                         75
     Variable selling expense               75                         70
        Total unit variable cost          $775                     $2,235
     No, the unit variable cost does not equal the unit variable product cost. The
     unit variable product cost includes direct materials, direct labor, and variable
     overhead. The unit variable cost also includes variable selling and administra-
     tive expense.

2.                              Hill Computers Inc.
                            Segmented Income Statement
                               For the Coming Year
                                      Consumer       Small Business
                                      Computers       Computers               Total
     Sales                       $ 62,400,000        $ 276,000,000       $ 338,400,000
     Variable cost of goods sold   (56,000,000)        (259,800,000)      (315,800,000)
     Variable selling expense       (6,000,000)          (8,400,000)       (14,400,000)
     Contribution margin         $     400,000       $    7,800,000      $ 8,200,000
     Less direct fixed expenses:
        Direct fixed overhead         (120,000)              (200,000)        (320,000)
     Segment margin              $     280,000       $      7,600,000    $   7,880,000
     Less common fixed expenses:
        Common fixed overhead                                                 (700,000)
        Common selling and
           administrative                                                    (3,460,000)
     Operating income                                                    $    3,720,000


Exercise 8–31

                            4,000 units
1. Orders per year =                        = 10 orders
                        400 units per order

2. Total ordering cost = $20 × 10 = $200

                                     400 + 0
3. Average amount in inventory =              = 200 units
                                         2
     Total carrying cost = $4 × 200 units = $800



                                        8-12
Exercise 8–31    (Concluded)

4. Total inventory-related cost        = Total ordering cost + Total carrying cost
                                       = $200 + $800 = $1,000


Exercise 8–32

               2 × 4,000 × $20
1. EOQ     =
                      $4

               160 ,000
           =
                  4
           = 200 units

                              Annual numberof units used
2. Number of orders =
                              Number of units in an order
                              4,000
                          =
                               200
                          = 20 orders per year

3. Total ordering cost = Number of orders × Cost per order
                       = 20 orders × $20
                       = $400

4. Total carrying cost = Average number of units in inventory × Cost of carry-
                         ing one unit in inventory
                                  200
                              =       × $4
                                   2
                              = $400

5. Total inventory-related cost        = Total ordering cost + Total carrying cost
                                       = $400 + $400
                                       = $800




                                             8-13
Exercise 8–33

1. Reorder point without safety stock = Average daily rate × Lead time
                                      = 80 × 3
                                      = 240

2. Safety stock = (Maximum daily rate – Average daily rate) × Lead time
                = (90 – 80) × 3
                = 30

3. Reorder point with safety stock = Reorder point without safety stock + Safety
                                     stock
                                   = 240 + 30
                                   = 270
   OR
   Reorder point with safety stock = Maximum daily usage × Lead time
                                   = 90 × 3
                                   = 270


Exercise 8–34

1. Reorder point without safety stock = Average daily rate × Lead time
                                      = 30 × 6
                                      = 180

2. Safety stock = (Maximum daily rate – Average daily rate) × Lead time
                = (35 – 30) × 6
                = 30

3. Reorder point with safety stock = Reorder point without safety stock + Safety
                                     stock
                                   = 180 + 30
                                   = 210
   OR
   Reorder point with safety stock = Maximum daily usage × Lead time
                                   = 35 × 6
                                   = 210




                                     8-14
                                                       PROBLEMS

Problem 8–35

1. Direct materials                                                           $2.45
   Direct labor                                                                2.10
   Variable overhead                                                           0.25
   Fixed overhead ($180,000/200,000)                                           0.90
      Total                                                                   $5.70
     Per-unit inventory cost on the balance sheet is $5.70.
     Units in ending inventory = 11,300 + 200,000 – 208,000
                               = 3,300
     Total ending inventory = $5.70 × 3,300 = $18,810

2. Absorption-costing income:
   Sales (208,000 × $9) ...................................................................            $1,872,000
   Less: Cost of goods sold (208,000 × $5.70).............................                              1,185,600
      Gross margin ........................................................................            $ 686,400
   Less: Selling and administrative expenses.............................                                 118,400
      Operating income .................................................................               $ 568,000

3. Direct materials                                                           $2.45
   Direct labor                                                                2.10
   Variable overhead                                                           0.25
      Total                                                                   $4.80
     Per-unit inventory cost under variable costing equals $4.80.
     This differs from the per-unit inventory cost in Requirement 1 because the
     balance sheet is for external use and reflects absorption costing. Variable
     costing does not include per-unit fixed overhead.

4. Variable-costing income:
   Sales ...........................................................................................   $1,872,000
   Less variable expenses:
      Variable cost of goods sold (208,000 × $4.80) ...................                                  (998,400)
      Variable selling and administrative ....................................                            (62,400)
   Contribution margin ..................................................................              $ 811,200
   Less fixed expenses:
      Fixed overhead .....................................................................               (180,000)
      Fixed selling and administrative .........................................                          (56,000)
   Operating income ......................................................................             $ 575,200




                                                               8-15
Problem 8–35               (Concluded)

5. Absorption-costing income:
   Sales (196,700 × $9) ...................................................................              $1,770,300
   Less: Cost of goods sold (196,700 × $5.70) .............................                               1,121,190
      Gross margin ........................................................................              $ 649,110
   Less: Selling and administrative expenses .............................                                  115,010
      Operating income .................................................................                 $ 534,100
    Variable-costing income:
    Sales ............................................................................................   $1,770,300
    Less variable expenses:
       Variable cost of goods sold .................................................                       (944,160)
       Variable selling and administrative .....................................                            (59,010)
    Contribution margin ...................................................................              $ 767,130
    Less fixed expenses:
       Fixed overhead .....................................................................                (180,000)
       Fixed selling and administrative .........................................                           (56,000)
    Operating income .......................................................................             $ 531,130


Problem 8–36

                       $160,500
1. Unit cost =                  = $3
                        53,500
    Absorption-costing ending inventory = 1,500 × $3 = $4,500

2. Variable-costing ending inventory:
    $3 per unit – $0.50 per unit = $2.50 per unit
    Ending inventory = 1,500 × $2.50 = $3,750

    Sales ............................................................................................    $ 454,750
    Less: Variable cost of goods sold ($2.50 × 53,500) .................                                    133,750
       Contribution margin .............................................................                  $ 321,000
    Less fixed expenses:
       Fixed overhead .....................................................................                 (27,500)
       Fixed selling and administrative .........................................                          (120,000)
    Net income ..................................................................................         $ 173,500




                                                            8-16
Problem 8–36      (Concluded)

3.                                Sugarsmooth, Inc.
                          Variable-Costing Income Statement
                                 For the Coming Year
                                Drugstores & Discount        Beauty
                                Supermarkets Stores          Shops         Total
     Sales                        $ 454,750    $ 135,000    $ 90,000     $ 679,750
     Less variable costs:
       Cost of goods sold          (133,750)     (50,000)     (25,000)    (208,750)
       Commissions                    —            —           (9,000)      (9,000)
       Return penalties               —           (1,350)       —           (1,350)
       Packing expense                —            —           (5,000)      (5,000)
     Contribution margin          $ 321,000    $ 83,650     $ 51,000     $ 455,650
     Less fixed expenses:
       Shipping                       —         (45,000)       —           (45,000)
       Additional clerk               —         (30,000)       —           (30,000)
     Segment margin               $ 321,000    $ 8,650      $ 51,000     $ 380,650
     Less common costs:
       Overhead                                                            (27,500)
       Selling and administrative                                         (120,000)
     Net income                                                          $ 233,150

4. Yes, all three customer groups are profitable. However, the discount stores
   are the least profitable, and Sugarsmooth might consider how carefully it has
   estimated the expenses associated with this customer group. Since Sugar-
   smooth does not currently sell to discount stores, it may not want to expand
   its customer base by selling to this segment.


Problem 8–37

1.                              Walker Company
                           Segmented Income Statement
                                        Blenders       Coffee Makers    Total
Sales                                   $2,200,000      $1,125,000   $3,325,000
Less: Variable cost of goods sold        2,000,000       1,075,000    3,075,000
Contribution margin                     $ 200,000       $ 50,000     $ 250,000
Less: Direct fixed expenses                 90,000          45,000      135,000
Segment margin                          $ 110,000       $     5,000  $ 115,000
Less: Common fixed expenses                                             115,000
Operating income                                                     $        0

2. If the coffee maker line is dropped, profits will decrease by $5,000, the seg-
   ment margin. If the blender line is dropped, profits will decrease by $110,000.


                                        8-17
Problem 8–37       (Concluded)

3.                                         Blenders    Coffee Makers      Total
     Sales                             $2,405,000       $1,125,000     $3,530,000
     Less: Variable cost of goods sold 2,200,000         1,075,000      3,275,000
     Contribution margin               $ 205,000        $ 50,000       $ 255,000
     Less: Direct fixed expenses           90,000           45,000        135,000
     Product margin                    $ 115,000        $    5,000     $ 120,000
     Less: Common fixed expenses                                          115,000
     Operating income                                                  $    5,000
     Profits increase by $5,000.


Problem 8–38

1. Absorption costing:
   Direct materials                $1.20
   Direct labor                     0.75
   Variable overhead                0.65
   Fixed overhead                   3.10
   Unit cost                       $5.70
     Cost of ending inventory = $5.70 × 200 = $1,140

2. Variable costing:
   Direct materials                $1.20
   Direct labor                     0.75
   Variable overhead                0.65
   Unit cost                       $2.60
     Cost of ending inventory = $2.60 × 200 = $520

3. Selling price                           $ 7.50
   Less:
   Variable cost of goods sold              (2.60)
   Commission                               (0.75)
   Contribution margin per unit            $ 4.15




                                       8-18
Problem 8–38       (Concluded)

4. Sales ($7.50 × 17,600)                                       $132,000
   Less:
      Variable cost of goods sold              $45,760
      Commissions                               13,200            58,960
      Contribution margin                                        $73,040
   Less fixed expenses:
      Fixed overhead                           $27,900
      Fixed administrative                      23,000            50,900
      Operating income                                          $ 22,140
     Variable costing should be used, since the fixed costs will not increase as
     production and sales increase.


Problem 8–39

1.                                   Scented         Musical    Regular     Total
     Sales                           $13,000        $ 19,500     $25,000   $57,500
     Less: Variable expenses           9,100          15,600      12,500    37,200
     Contribution margin             $ 3,900        $ 3,900      $12,500   $20,300
     Less: Direct fixed expenses       4,250           5,750       3,000    13,000
     Product margin                  $ (350)        $ (1,850)    $ 9,500   $ 7,300
     Less: Common fixed expenses                                             7,500
     Operating income (loss)                                               $ (200)
     Kathy should accept this proposal. The 30 percent sales increase, coupled
     with the increased advertising, reduces the loss from $1,000 to $200. Both
     scented and musical product-line profits increase. However, more must be
     done. If the scented and musical product margins remain negative, the two
     products may need to be dropped.

2. Regular
   Sales                                       $20,000
   Less: Variable expenses                      10,000
   Contribution margin                         $10,000
   Less: Fixed expenses                         10,500
   Operating income (loss)                     $ (500)
     While dropping the two lines results in a $500 loss versus the original $1,000
     loss, it is worse than the alternative offered in requirement 1. Other options
     need to be developed.




                                        8-19
Problem 8–39       (Concluded)

3. Combinations would be beneficial. Dropping the musical line (which shows
   the greatest segment loss) and keeping the scented line while increasing ad-
   vertising yields a profit (the optimal combination).
                                          Scented       Regular           Total
   Sales                                  $13,000        $22,500         $35,500
   Less: Variable expenses                   9,100        11,250          20,350
   Contribution margin                     $ 3,900       $11,250         $15,150
   Less: Direct fixed expenses               4,250         3,000           7,250
   Product margin                          $ (350)       $ 8,250         $ 7,900
   Less: Common fixed expenses                                             7,500
   Operating income                                                      $ 400


Problem 8–40

1. Ordering cost = 12 orders × $125 = $1,500

2. Carrying cost = $6 × (2,000/2) = $6,000

3. Total cost of current inventory policy = $1,500 + $6,000 = $7,500

             2 × 24,000 × $125
4. EOQ =
                     $6
         = 1,000

                           24,000
5. Ordering cost at EOQ =          × $125 = $3,000
                            1,000
                                1,000
   Carrying cost at EOQ = $6 ×        = $3,000
                                  2

6. Total cost EOQ policy = $3,000 + $3,000 = $6,000
   Savings = $7,500 – $6,000 = $1,500

7. Cost of ordering 2,000 units   = Ordering cost + Carrying cost
                                  = $1,500 + $6,000
                                  = $7,500
   Cost of ordering 1,000 units   = Increased price + Ordering cost + Carrying cost
                                  = ($0.05 × 24,000) + $3,000 + $3,000
                                  = $1,200 + $3,000 + $3,000
                                  = $7,200
   Even with the price increase, it is better to order the economic order quantity.


                                        8-20
Problem 8–41

                           14,000
1. Ordering cost = $40 ×
                            400
                   = $1,400
                                400
   Carrying cost   = $1.75* ×
                                 2
                   = $350
   *10% of purchase price or 0.10 × $17.50.
   Total cost = $1,400 + $350 = $1,750

             2 × 14,000 × $40
2. EOQ =
                   $1.75

         =   640,000
         = 800
                            14,000
   Ordering cost = $40 ×
                             800
                   = $700
                                800
   Carrying cost   = $1.75 ×
                                 2
                   = $700
   Total cost = $700 + $700 = $1,400
   Savings = $1,750 – $1,400 = $350

3. Rate of usage = 7 × 50 = 350 days
                   14,000
                 =         = 40 blocks per day
                     350
   Reorder point = Average rate of usage × Lead time
                 = 40 × 5
                 = 200
   This coincides with the current reorder policy.




                                         8-21
Problem 8–41       (Concluded)

4. The order quantity would have to be 600 instead of 800 (the EOQ). If so, the
   following inventory costs would be incurred:
                             14,000
   Ordering cost = $40 ×
                              600
                    = $933
                                600
   Carrying cost    = $1.75 ×
                                 2
                    = $525
   Total cost       = $933 + $525
                    = $1,458
   This restriction would mean an additional cost of only $58 ($1,458 – $1,400)
   over the cost of using the EOQ.

5. The most cheese that should be kept on hand given the 10-day constraint is
   400 blocks (40 × 10). Reorder would occur when inventory dropped to 200
   units.




                                      8-22
                                        CASES

Case 8–42

1.   Many legitimate reasons support the creation of inventory (e.g., the need to
     avoid stockouts and the need to ensure on-time delivery). Paul Chesser’s
     reasons, however, are based on self-interest and ignore what’s best for the
     company. Knowingly producing for inventory to obtain personal financial
     gain at the expense of the company certainly could be labeled as unethical
     behavior.

2.   Since the decision to produce for inventory was not motivated by any sound
     economic reasoning, and Ruth knows the real motive behind the decision,
     she should feel discomfort in the role she has been asked to assume. If she
     decides to appeal to higher-level management, the divisional manager can
     counter with arguments that inventory was created because he expected the
     economy to turn around and did not want to be in a position of not having
     enough goods to meet demand. Even though Ruth may have a difficult time
     proving any allegation of improper conduct, if she is convinced that the be-
     havior is truly unethical, then appeals to higher-level management with the
     prospect of ultimate resignation should be the route she takes.
     Alternatively, Ruth might decide that the use of absorption costing for inter-
     nal reporting and bonus calculation has led to this situation. She could lobby
     higher management to begin using variable costing as a way of avoiding
     these dysfunctional decisions. Ruth will have a very hard time proving uneth-
     ical behavior—at worst, Paul may be accused of having poor judgment re-
     garding future economic upturns.

3. The following standards may apply:

     Integrity. Refrain from engaging in any conduct that would prejudice carrying
     out duties ethically. (III-2)

     Credibility. Communicate information fairly and objectively. (IV-1) Disclose ful-
     ly all relevant information that could reasonably be expected to influence an
     intended user’s understanding of the reports, analyses, or recommendations.
     (IV-2)




                                          8-23
Case 8–43

1.   By discussing the amount by which his company and Piura have reduced
     costs, Mac may have violated the confidentiality standard. Specifically, Mac
     should: ―keep information confidential except when disclosure is authorized
     or legally required.‖ He may also be involved in a conflict of interest, although
     he may not have realized this until the conversation of the evening unfolded.
     Finally, he may be guilty of ―using confidential information for unethical or il-
     legal advantage.‖

2.   Mac would violate a host of standards: disclosing confidential information,
     accepting a gift or favor that would influence his actions, actively subverting
     his company’s legitimate objectives, and engaging in an activity that would
     discredit the profession. He would be well advised to refuse the offer and
     avoid any disclosure of information.




                                        8-24
    (IV-2)




                                          8-23
Case 8–43

1.   By discussing the amount by which his company and Piura have reduced
     costs, Mac may have violated the confidentiality standard. Specifically, Mac
     should: ―keep information confidential except when disclosure is authorized
     or legally required.‖ He may also be involved in a conflict of interest, although
     he may not have realized this until the conversation of the evening unfolded.
     Finally, he may be guilty of ―using confidential information for unethical or il-
     legal advantage.‖

2.   Mac would violate a host of standards: disclosing confidential information,
     accepting a gift or favor that would influence his actions, actively subvertin g
     his company’s legitimate objectives, and engaging in an activity that would
     discredit the profession. He would be well advised to refuse the offer and
     avoid any disclosure of information.




                                        8-24

				
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