6

Fundamentals of Product and Service Costing

Solutions to Review Questions

6-1.

Cost allocation is the assignment of costs in cost pools to cost objects. The cost objects
may be products, services, customers, processes, or anything for which we want to
know the cost. Product costing uses cost allocation to calculate product costs. Product
costing is an application of cost allocation where products are the cost objects.

6-2.
Cost management systems should satisfy the following criteria:
• Cost systems should have a decision focus.
• Different cost information is used for different purposes.
• Cost information for managerial purposes must meet the cost-benefit test.

6-3.
Cost flow diagrams serve two purposes. First, they help describe how a cost
management system works, just like a flow chart helps you understand how a process
works. Second, cost flow diagrams help managers identify and understand quickly the
effect of changes in the system design on reported costs.

6-4.
A job costing accounting system traces costs to individual units or to specific jobs
(typically custom products). A process costing accounting system is used when identical
units are produced through a series of uniform production steps. Operation costing is
used when goods have some common characteristics (process costing) and some
individual characteristics (job costing).

6-5.
The predetermined overhead rate is the value at which overhead is applied to one unit
of the cost allocation base. It is used in product costing to apply the overhead to the
units produced.
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Solutions Manual, Chapter 6 165
6-6.
Continuous flow processing is used when a single product is mass produced in a
continuing process. Examples would include products such as paint, gasoline, paper, or
any others that are mass produced in a continuing process.

6-7.
The basic cost flow model appears as follows:
Beginning balance + Transfers in – Transfers out = Ending balance
Beginning balance is the balance of inventory at the beginning of the period. Transfers
in represent inventory purchased or transferred in from another department (for
example, raw materials would be goods transferred in to work in process) for the period.
Transfers out are goods transferred from one department to another (for example, work
in process would be transferred out to finished goods). Ending balance represents the
amount of inventory in a department at the end of the accounting period.

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166 Fundamentals of Cost Accounting
Solutions to Critical Analysis and Discussion Questions

6-8.
Although there may be no one correct way to allocate cost, cost allocation can provide
managers with information about the costs of the resources they use. Ignoring costs that
cannot be directly assigned leads to the possibility that managers forget that it is a real
resource that is being used.

6-9.
There are three important points to consider:
1. The cost system should meet the needs of the users (the decision makers).
2. The cost system must provide the appropriate data for its intended purpose.
Different cost information is used for different purposes.
3. Cost information for managerial purposes must meet the cost-benefit test. The costs
of implementing the system should be less than the benefits derived from the system
(i.e. better decisions).

6-10.
The basic cost flow model is as follows:
Beginning balance + Transfers in – Transfers out = Ending balance
This model is used for finding one unknown or for comparing perpetual inventory system
output to a physical inventory count. An example of finding one unknown is if the
beginning balance is known (from the previous period ending balance), transfers in are
known, and ending inventory is counted physically—and we are asked to find the cost of
goods sold for the period (transfers out).

6-11.
It is sometimes difficult (and frustrating) for managers when the cost accountant says
that the cost depends on the decision being made. Many people feel that there is one
cost that is “correct.” However, as we saw in Chapter 2, costs behave in different ways
and this behavior is affected by the decision being made.

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Solutions Manual, Chapter 6 167
6-12.
Reasons to agree with approach: If the products are not contributing to company profits,
then the customers should be eliminated. This will increase overall company profits.
Reasons not to agree with approach: The reported product costs and the associated
product profits depend on the allocation of indirect costs. Under a different allocation
process, the results could be very different. In addition, many of the indirect costs are
unavoidable. If the products are eliminated, the costs will be allocated to the remaining
products.

6-13.
The way the “products” are defined will depend, at least in part, on the decision the
dean is interested in making. They may be defined as degree programs vs. non-degree
programs. They may be the different degree programs. They might be the credit hour
(although it is unlikely you would be able to get much information at this level).
You might ask about the time frame of the analysis (to determine fixed and variable
costs), the source of the data, and how to treat costs that the school does not directly
pay for but where the school consumes the resources (e.g., university buildings).
This is a very difficult analysis in a university setting because of the high proportion of
common costs and the difficulty in defining products.

6-14.
The two most important criteria in determining an allocation base are (1) causality and
(2) measurability. We would like an allocation base that “causes” costs. This is rarely
possible, but it is a good criterion to use. Second, we need to be able to measure the
allocation base at reasonable cost.

6-15.
The allocation base determines the costs assigned to the cost objects. If these costs are
used to make decisions and if they are based on inappropriate or improper allocation
bases, they could lead the manager to make bad decisions.

6-16.
There are many reasons why two companies may have different cost systems. First,
they may be in different industries. We saw in the chapter that firms in continuous
process industries have different cost systems than those in discrete manufacturing
industries.
Firms may be pursuing different strategies (cost containment versus product
differentiation) and want different information from the cost system. A third reason is that
some firms may be subject to regulations (for example, utilities) and the regulations
dictate the information needed from the cost system.
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168 Fundamentals of Cost Accounting
6-17.
A firm can have a two-stage system and use the same allocation base to allocate costs
in the second stage. There will be different costs reported if the allocation base (direct
labor, say) is used differently by the products in the second stage cost pools.

©The McGraw-Hill Companies, Inc., 2008

Solutions Manual, Chapter 6 169
Solutions to Exercises

6-18. (20 min.) Basic Cost Flow Model: Office Mart.

a. $300,000 (see item 5)
b. $1,240,000 = $1,200,000 + $40,000 (see items 2 & 3)
c. $200,000 (see item 5)
d. $1,340,000. BB + TI – TO = EB
$300,000 + $1,240,000 – X = $200,000
X = $300,000 + $1,240,000 – $200,000
X = $1,340,000

6-19. (20 min.) Basic Cost Flow Model: General Electric

a. $67 million = $16 million + $27 million + (.8 x $30 million)
b. $50.25 million = .75 x $67 million
c. BB + TI – TO = EB
0 + $67 million – $50.25 million = EB
EB = $16.75 million

6-20. (20 min.) Basic Cost Flow Model.

Based on the basic formula:

BB + TI – TO = EB
a. $51,000 + $48,000 – $57,000 = X
X = $42,000
b. $28,400 + X – $88,000 = $24,800
X = $24,800 – $28,400 + $88,000
X = $84,400
c. $67,000 + $170,000 – X = $56,000
X = $67,000 + $170,000 – $56,000
X = $181,000

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170 Fundamentals of Cost Accounting
6-21. (20 min.) Basic Cost Flow Model.
Based on the basic formula:

BB + TI – TO = EB
A. $250,000 + $260,000 – $270,000 = X
X = $240,000
B. $7,100 + X – $22,000 = $6,200
X = $6,200 – $7,100 + $22,000
X = $21,100
C. $156,000 + $280,000 – X = $128,000
X = $156,000 + $280,000 – $128,000
X = $308,000

6-22. (20 min.) Basic Cost Flow Model.

Based on the basic formula:

BB + TI – TO = EB
A. $14,000 + $12,000 – $18,000 = X
X = $8,000
B. $90,000 + X – $330,000 = $93,000
X = $93,000 – $90,000 + $330,000
X = $333,000
C. $65,000 + $230,000 – X = $30,000
X = $65,000 + $230,000 – $30,000
X = $265,000

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Solutions Manual, Chapter 6 171
6-23. (10 min.) Basic Product Costing: Enviro Corporation.

Materials............................................ $595,000
Labor................................................. 51,000
Manufacturing overhead.................... 204,000
Total cost...................................... $850,000
÷ Gallons produced ........................... ÷ 1,700,000
= Cost per gallon ............................... $0.50

6-24. (10 min.) Basic Product Costing: Big City Bank.

Labor.................................................. $ 17,000
Manufacturing overhead..................... 67,000
Total .............................................. $ 84,000
÷ Checks processed........................... ÷ 1,400,000
= Cost per check ................................ $0.06

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172 Fundamentals of Cost Accounting
6-25. (20 min.) Basic Cost Flow Model: Kim and Smith Refiners

a. b.
Work-in-
Process,
Total Sold March 31
Production:
Gallons ......................................... 180,000 160,000 20,000
Percentage complete................... 100% 80%
Equivalent gallons ....................... 176,000 160,000 16,000
Costs:
Materials ...................................... $ 94,000
Labor .......................................... 24,200
Manufacturing overhead .............. 49,000
Total cost incurred ....................... $167,200
Cost per equivalent barrel............... $0.95a
Cost assigned to product ................ $167,200 $152,000b $15,200c
a $0.95= $167,200 ÷ 176,000 equivalent units.
b $152,000 = 160,000 equivalent units x $0.95.
c $15,200 = 16,000 equivalent units x $0.95.

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Solutions Manual, Chapter 6 173
6-26. (20 min.) Basic Cost Flow Model—Ethical Issues: Old Tyme Soda
a. and b.

a. b.
Work-in-
Process,
Total Sold November 30
Production:
Barrels.............................................. 10,000 8,800 1,200
Percentage complete ...................... 100% 30%
Equivalent barrels............................ 9,160 8,800 360
Costs:
Materials.......................................... $18,072
Manufacturing overhead.................. 20,400
Total cost incurred........................... $38,472
Cost per equivalent barrel .................. $4.20a
Cost assigned to product.................... $38,472 $36,960b $1,512c
a $4.20 = $38,472 ÷ 9,160 equivalent units.
b $36,960 = 8,800 equivalent units x $4.20.
c $1,512 = 360 equivalent units x $4.20.

c. (1) The change in the estimate will cause more cost to be assigned to work-in-
process inventory and less to finished goods. As the finished goods are sold, cost of
goods will be lower and income higher.
(2) Unless the production supervisor’s estimates are incorrect, the controller should
not change the estimates. He or she has an ethical (and legal) obligation to ensure
that the estimates reflect fairly the results of operations.

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174 Fundamentals of Cost Accounting
6-27. (15 min.) Process Costing: Van Goe.
a. and b.

a. b.
Transferred Work-in-
to Finished Process,
Total Goods January 31
Production:
Gallons ......................................... 100,000 80,000 20,000
Percentage complete................... 100% 80%
Equivalent gallons ....................... 96,000 80,000 16,000
Costs:
Materials ...................................... $219,200
Conversion costs ......................... 280,000
Total cost incurred ....................... $499,200
Cost per equivalent barrel............... $5.20a
Cost assigned to product ................ $499,200 $416,000b $83,200c
a $5.20= $499,200 ÷ 96,000 equivalent units.
b $416,000 = 80,000 equivalent units x $5.20.
c $83,200 = 16,000 equivalent units x $5.20.

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Solutions Manual, Chapter 6 175
6-28. (15 min.) Process Costing: Opech, Inc.
a. and b.

a. b.
Work-in-
Process,
Total Shipped May 31
Production:
Barrels (millions).......................... 200 180 20
Percentage complete................... 100% 70%
Equivalent barrels (millions)......... 194 180 14
Costs:
Materials (millions)....................... $2,500
Conversion costs (millions).......... 3,320
Total cost incurred (millions)........ $5,820
Cost per equivalent barrel............... $30a
Cost assigned to product ................ $5,820 $5,400b $420c
a $30 = $5,820 ÷ 194 equivalent units.
b $5,400 = 180 equivalent units x $30.
c $420 = 14 equivalent units x $30.

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176 Fundamentals of Cost Accounting
6-29. (15 min.) Process Costing: Oholics, Ltd.
a. and b.

a. b.
Work-in-
Process,
Total Sold April 30
Production:
Pounds ........................................ 40,000 38,000 2,000
Percentage complete................... 100% 60%
Equivalent pounds ....................... 39,200 38,000 1,200
Costs:
Materials ...................................... $44,000
Conversion costs ......................... 54,000
Total cost incurred ....................... $98,000
Cost per equivalent pound.............. $2.50a
Cost assigned to product ................ $98,000 $95,000b $3,000c
a $2.50= $98,000 ÷ 39,200 equivalent units.
b $95,000 = 38,000 equivalent units x $2.50.
c $3,000 = 1,200 equivalent units x $2.50.

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Solutions Manual, Chapter 6 177
6-30. (15 Minutes) Predetermined Overhead Rates: Tiger Furnishings
Predetermined overhead rate = $34.82 per direct labor hour.

Basic Dominator Total

Units produced ...................... 1,000 250 1,250
Machine-hours....................... 4,000 2,000 6,000
Direct labor-hours.................. 3,000 2,000 5,000
Direct materials ..................... $10,000 $3,750 $13,750
Direct labor............................ 64,500 35,500 100,000
Manufacturing overhead........ 174,100
Total Costs ............................ $287,850
Burden Rate: .........................
Total overhead .................. $174,100
÷ Direct labor-hours............ ÷ 5,000 = $34.82

6-31. (15 Minutes) Predetermined Overhead Rates: Tiger Furnishings

Predetermined overhead rate = 174.1% of direct labor cost.

Basic Dominator Total

Units produced ...................... 1,000 250 1,250
Machine-hours....................... 4,000 2,000 6,000
Direct labor-hours.................. 3,000 2,000 5,000
Direct materials ..................... $10,000 $3,750 $13,750
Direct labor............................ 64,500 35,500 100,000
Manufacturing overhead........ 174,100
Total Costs ............................ $287,850
Burden Rate: .........................
Total overhead .................. $174,100
÷ Direct labor cost .............. ÷ $100,000 =174.1%

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178 Fundamentals of Cost Accounting
6-32. (15 Minutes) Predetermined Overhead Rates: Tiger Furnishings
Predetermined overhead rate = $29.0167 per machine-hour (rounded).

Basic Dominator Total

Units produced .................. 1,000 250 1,250
Machine-hours................... 4,000 2,000 6,000
Direct labor-hours.............. 3,000 2,000 5,000
Direct materials ................. $10,000 $3,750 $13,750
Direct labor........................ 64,500 35,500 100,000
Manufacturing Overhead... 174,100
Total Costs ........................ $287,850
Burden Rate: .....................
Total overhead .............. $174,100
÷ Machine-hours............. ÷ 6,000 =$29.0167

6-33. (20 Minutes) Cost Flow Diagram: Tiger Furnishings

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Solutions Manual, Chapter 6 179
6-34. (30 Minutes) Operation Costing: Howrey-David, Inc.
The unit costs are:
Fatboy:............ $3,700
Screamer: ....... $4,700
Fatboy Screamer Total
Number of units ......................... 1,000 2,000 3,000
Materials cost per unit ............... $2,000 $3,000
Costs ......................................... $2,000,000 $6,000,000 $ 8,000,000
Operation costs:
Direct Labor.......................... $ 3,000,000
Indirect materials .................. 800,000
Other overhead .................... 1,300,000
Total operation cost......... $ 5,100,000

Cost per unit in plant ................. ($5,100,000 ÷ 3,000 units) = $1,700 per unit.

Operation cost
(@ $1,700 per unit) ................... $1,700,000a $3,400,000b $5,100,000
Material cost.............................. 2,000,000 6,000,000
Total cost................................... $3,700,000 $9,400,000
Number of units ......................... 1,000 2,000
Unit cost .................................... $3,700 $4,700

a $1,700,000 = 1,000 units x $1,700 per unit.

b $3,400,000 = 2,000 units x $1,700 per unit.

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180 Fundamentals of Cost Accounting
6-35. (30 Minutes) Operation Costing: Organic Grounds.
The unit costs are:
Star: ................
$8.96
Bucks: .............
$10.96
Star Bucks Total
Number of units ......................... 10,000 40,000 50,000
Materials cost per unit ............... $5.00 $7.00
Costs ......................................... $50,000 $280,000 $ 330,000
Operation costs:
Direct Labor.......................... $ 60,000
Indirect materials .................. 17,000
Other overhead .................... 121,000
Total operation cost......... $198,000

Cost per unit in plant ................. ($198,000 ÷ 50,000 units) = $3.96 per pound.

Operation cost
(@ $3.96 per unit) ..................... $39,600a $158,400b $198,000
Material cost.............................. 50,000 280,000
Total cost................................... $89,600 $438,400
Number of units ......................... 10,000 40,000
Unit cost .................................... $8.96 $10.96

a $39,600 = 10,000 units x $3.96 per unit.

b $158,400 = 40,000 units x $3.96 per unit.

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Solutions Manual, Chapter 6 181
Solutions to Problems

6-36. (30 Minutes) Product Costing: Tiger Furnishings

The unit costs are: Basic: $186.79 and Dominator: $404.22

Basic Dominator Total

Direct materials ............................................................ $10,000 $3,750 $13,750
Direct labor...................................................................64,500 35,500 100,000
Manufacturing overhead
a
(@174.1% of Direct labor cost) .................................. 112,295 61,806 174,100b
$186,795 $101,056 $287,850b
Total costs....................................................................
Units produced ............................................................. 1,000 250
Unit cost .......................................................................
$186.795 $404.22
a 174.1% = $174,100 ÷ $100,000.
b Adjusted for rounding error.

6-37. (30 Minutes) Product Costing: Tiger Furnishings

The unit costs are: Basic: $190.57 and Dominator: $389.13

Basic Dominator Total

Direct materials ......................................................
$ 10,000 $3,750 $13,750
Direct labor.............................................................64,500 35,500 100,000
Manufacturing overhead
a
(@29.0167 per machine-hour) ............................ 116,067b 58,033c 174,100
Total costs..............................................................
$ 190,567 $97,283 $287,850
Units produced ....................................................... 1,000 250
Unit cost .................................................................
$ 190.57 $389.13
a $29.0167 per machine-hour = $174,100 ÷ 6,000 machine-hours.
b $116,067 = 4,000 machine-hours x $29.0167 per machine-hour.
c $58,033 = 2,000 machine-hours x $29.0167 per machine-hour.

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182 Fundamentals of Cost Accounting
6-38. (30 Minutes) Product Costing—Ethical Issues: Tiger Furnishings
a. The unit costs are different because the two products use the machine hours and
direct labor costs in different proportions. The Basic model is more machine
intensive (it uses relatively more machine hours than labor compared to the
Dominator model). This means that when the company moves to machine hours to
allocate costs, the Basic model will be assigned more overhead costs resulting in
higher reported product costs.
b. Without knowing more about the production process at Tiger Furnishings, it is not
possible to say which of these is better. Because you get different results, it may pay
to use a two stage system to split overhead between that which is driven more by
machine hours and that driven more by direct labor.
c. The allocation base should be chosen on the basis of how overhead is related to
cost. Income is the result of this decision and not the basis for the decision.

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Solutions Manual, Chapter 6 183
6-39. (30 Minutes) Two-Stage Allocation and Product Costing: Mets Products
a. The overhead rates are $9 per machine hour and 30% of direct-materials cost.

Machine-Hour Materials
Account Related Related
Utilities …………………………. ................. $ 4,000
Supplies .................................................... $2,800
Machine depreciation and maintenance ... 8,800
Purchasing and storing materials ............. 3,200
Miscellaneous............................................ 3,400 __________________________
Total overhead ........................................ $ 16,200 $ 6,000
÷ Total machine hours ............................... ÷ 1,800 hours
÷ Total materials cost ................................ ÷ $20,000
Overhead rate ........................................... $9 / hour 30%

b.
Baseball
Caps T-shirts Total
Machine hours used...........................................
1,000 800 1,800

Direct materials costs …………………. $12,000 $8,000 $20,000

Direct labor costs ……………………… 4,000 2,400 6,400
Manufacturing overhead costs ……….
a
Machine-hour related overhead ...................... 9,000 7,200 16,200
b
Materials-related overhead ............................. 3,600 2,400 6,000
Total cost ...........................................................
$28,600 $20,000 $48,600
Units produced ……………………….. 10,000 5,000 15,000
Cost per unit.......................................................
$2.86 $4.00

a
$9,000 = 1,000 machine hours x $9 per machine hour;
$7,200 = 800 machine hours x $9 per machine hour.
b
$3,600 = $12,000 materials cost x 30%;
$2,400 = $8,000 materials cost x 30%.

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184 Fundamentals of Cost Accounting
6-40. (30 Minutes) Two-Stage Allocation and Product Costing: Owl-eye
Radiologists
a. The overhead rates are $46 per equipment hour and $50 per direct labor hour.

Equipment- Direct-Labor
Account Hour Related Hour Related
Utilities …………………………. .................... $ 4,800
Supplies ....................................................... $12,600
Indirect labor and supervision ...................... 20,400
Equipment depreciation and maintenance ... 8,400
Miscellaneous............................................... 3,360 __________________________
Total overhead ........................................... $ 16,560 $ 33,000
÷ Total equipment hours ............................... ÷ 360 hours
÷ Total labor hours........................................ ÷ 660 hours
Overhead rate .............................................. $46 per hour $50 per hour

b.
Hospital Other
Patients Patients Total
Equipment hours used .......................................240 120 360
Direct labor-hours...............................................480 180 660

Direct labor costs ……………………… $38,400 $10,800 $49,200

Overhead costs ……….
a
Equipment-hour related overhead .................. 11,040 5,520 16,560
b
Direct labor-hours related overhead ............... 24,000 9,000 33,000
Total cost ...........................................................
$73,440 $25,320 $98,760
Patients ………………………………….. 640 860 1,500
Cost per patient..................................................
$114.75 $29.44

a
$11,040 = 240 equipment hours x $46 per equipment hour;
$5,520 = 120 equipment hours x $46 per equipment hour.
b
$24,000 = 480 direct labor-hours x $50 per direct labor-hour;
$9,000 = 180 direct labor-hours x $50 per direct labor-hour.

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Solutions Manual, Chapter 6 185
6-41. (40 Minutes) Operation Costing: Vermont Instruments
The unit costs are:
Fin-X: ....... $23
Sci-X: ....... $28
Fin-X Sci-X Total
Number of units ......................... 10,000 40,000 50,000
Parts cost per unit ..................... $20 $25
Costs ......................................... $200,000 $1,000,000 $ 1,200,000
Operation costs:
Direct Labor.......................... 62,000
Parts..................................... 17,500
Overhead ............................. 70,500
Total operation cost......... $ 150,000

Cost per unit in plant ................. ($150,000 ÷ 50,000 units) = $3 per unit.

Operation cost (@ $3 per unit) .. $ 30,000a $ 120,000b $150,000

Material cost.............................. 200,000 1,000,000
Total cost................................... $ 230,000 $1,120,000
Number of units ......................... 10,000 40,000
Unit cost .................................... $23 $28

a $30,000 = 10,000 units x $3 per unit.

b $120,000 = 40,000 units x $3 per unit.

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186 Fundamentals of Cost Accounting
6-42. (45 Minutes) Accounts Analysis, Two-Stage Allocation, and Product
Costing: Tiger Furnishings
a. Cost Flow Diagram

Overhead

First Stage

Direct Labor Cost

Machine-Related
Related
Overhead
Overhead

Machine Hours Direct Labor Cost

Second Stage

Basic Dominator

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Solutions Manual, Chapter 6 187
6-42 (continued)
b.
Basic $188.00
Dominator $400.00
Basic Dominator Total
Units Produced........................................... 1,000 250 1,250
Machine hours............................................ 4,000 2,000 6,000
Direct labor hours....................................... 3,000 2,000 5,000

Direct materials .......................................... $10,000 $3,750 $ 13,750

Direct labor................................................. 64,500 35,500 100,000

Machine-hour Direct labor

Manufacturing Overhead related cost related
Utilities................................................... $1,800 $0 $1,800
Supplies ................................................ 0 5,000 5,000
Training ................................................. 0 10,000 10,000
Supervision ........................................... 0 25,800 25,800
Machine depreciation ............................ 32,000 0 32,000
Plant depreciation.................................. 14,200 0 14,200
Miscellaneous ....................................... 0 85,300 85,300
Total ................................................. $48,000 $126,100 174,100
Total Costs ................................................. $287,850
Burden Rates
Machine hour rate ................................. ($48,000 ÷ 6,000 hours =) $8.00
Direct labor cost rate ............................. ($126,100 ÷ $100,000) = 126.1%

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188 Fundamentals of Cost Accounting
6-42 (continued)

Product Costing
Direct material ......................................... $ 10,000 $ 3,750 $ 13,750
Direct labor.............................................. 64,500 35,500 100,000
Overhead
Machine-related (@$8 per machine-hour)...... 32,000a 16,000b 48,000
Labor-related (@126.1% direct labor cost) 81,335c 44,766 d 126,100
Total overhead ....................................... $113,335 $60,766 $174,100
Total cost.................................................... $187,835 $100,016 $287,850
÷ Units produced ........................................ ÷ 1,000 ÷ 250 1,250
= Unit cost ................................................. = $188 = $400
a $32,000 = 4,000 machine-hours x $8 per machine-hour.
b $16,000 = 2,000 machine-hours x $8 per machine-hour.
c $81,335 = $64,500 x 126.1% direct labor cost.
d $44,766 = $35,500 x 126.1% direct labor cost

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Solutions Manual, Chapter 6 189
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190 Fundamentals of Cost Accounting