MANAGEMENT ACCOUNTING - Solutions Manual

CHAPTER 7

COST CONCEPTS AND CLASSIFICATIONS

I. Questions

1. The phrase “different costs for different purposes” refers to the fact that
the word “cost” can have different meanings depending on the context in
which it is used. Cost data that are classified and recorded in a particular
way for one purpose may be inappropriate for another use.

2. Fixed costs remain constant in total across changes in activity, whereas

variable costs change in proportion to the level of activity.

3. Examples of direct costs of the food and beverage department in a hotel

include the money spent on the food and beverages served, the wages of
table service personnel, and the costs of entertainment in the dining
room and lounge. Examples of indirect costs of the food and beverage
department include allocations of the costs of advertising for the entire
hotel, of the costs of the grounds and maintenance department, and of
the hotel general manager’s salary.

4. The cost of idle time is treated as manufacturing overhead because it is a

normal cost of the manufacturing operation that should be spread out
among all of the manufactured products. The alternative to this
treatment would be to charge the cost of idle time to a particular job that
happens to be in process when the idle time occurs. Idle time often
results from a random event, such as a power outage. Charging the cost
of the idle time resulting from such a random event to only the job that
happened to be in process at the time would overstate the cost of that
job.

5. a. Uncontrollable cost
b. Controllable cost
c. Uncontrollable cost

6. Product costs are costs that are associated with manufactured goods until
the time period during which the products are sold, when the product

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costs become expenses. Period costs are expensed during the time
period in which they are incurred.

7. The most important difference between a manufacturing firm and a

service industry firm, with regard to the classification of costs, is that the
goods produced by a manufacturing firm are inventoried, whereas the
services produced by a service industry firm are consumed as they are
produced. Thus, the costs incurred in manufacturing products are treated
as product costs until the period during which the goods are sold. Most
of the costs incurred in a service industry firm to produce services are
operating expenses that are treated as period costs.

8. Product costs are also called inventoriable costs because they are
assigned to manufactured goods that are inventoried until a later period,
when the products are sold. The product costs remain in the finished
goods inventory account until the time period when the goods are sold.

9. A sunk cost is a cost that was incurred in the past and cannot be altered
by any current or future decision. A differential cost is the difference in
a cost item under two decision alternatives.

10. a. Direct cost

b. Direct cost
c. Indirect cost
d. Indirect cost

11. The two properties of a relevant cost are:

1. it differs between the decision options
2. it will be incurred in the future

12. The three types of product costs are:

1. direct materials – the materials used in manufacturing the product,
which become a physical part of the finished product.
2. direct labor – the labor used in manufacturing the product.
3. factory overhead – the indirect costs for materials, labor, and
facilities used to support the manufacturing process, but not used
directly in manufacturing the product.

13. The three types of manufacturing inventories are:

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1. materials inventory – the store of materials used in the

manufacturing process or in providing the service.
2. work in process inventory – accounts for all costs put into the
manufacturing of products that are started but not complete at the
financial statement date.
3. finished goods inventory – the cost of goods that are ready for sale.

14. Direct materials include the materials in the product and a reasonable
allowance for scrap and defective units, while indirect materials are
materials used in manufacturing that are not physically part of the
finished product.

15. The income statement of a manufacturing company differs from the

income statement of a merchandising company in the cost of goods sold
section. A merchandising company sells finished goods that it has
purchased from a supplier. These goods are listed as “purchases” in the
cost of goods sold section. Since a manufacturing company produces its
goods rather than buying them from a supplier, it lists “cost of goods
manufactured” in place of “purchases.” Also, the manufacturing
company identifies its inventory in this section as Finished Goods
inventory, rather than as Merchandise Inventory.

16. Yes, costs such as salaries and depreciation can end up as part of assets
on the balance sheet if these are manufacturing costs. Manufacturing
costs are inventoried until the associated finished goods are sold. Thus,
if some units are still in inventory, such costs may be part of either Work
in Process inventory or Finished Goods inventory at the end of a period.

17. No. A variable cost is a cost that varies, in total, in direct proportion to
changes in the level of activity. A variable cost is constant per unit of
product. A fixed cost is fixed in total, but the average cost per unit
changes with the level of activity.

18. Manufacturing overhead is an indirect cost since these costs cannot be

easily and conveniently traced to particular units of products.

19.
Direct labor cost (34 hours  P15 per hour).......................... P510

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Manufacturing overhead cost (6 hours  P15 per hour)........ 90

Total wages earned................................................................ P600

20.
Direct labor cost (45 hours  P14 per hour)......................... P630
Manufacturing overhead cost (5 hours  P7 per hour)......... 35
Total wages earned.............................. P665

II. Exercises

Exercise 1 (Schedule of Cost of Goods Manufactured and Sold; Income

Statement)

Requirement 1

Amazing Aluminum Company

Schedule of Cost of Goods Manufactured
For the Year Ended December 31, 2005

Direct material:
Raw-material inventory, January 1......................... P 60,000
Add: Purchases of raw material.............................. 250,000
Raw material available for use................................ P310,000
Deduct: Raw-material inventory, December 31 70,000

Raw material used P240,000

Direct labor..................................................................... 400,000

Manufacturing overhead:
Indirect material P 10,000

Indirect labor 25,000

Depreciation on plant and equipment 100,000

Utilities 25,000
...........................................................................
...........................................................................
Other 30,000
...........................................................................
...........................................................................
Total manufacturing overhead 190,000

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 Cost Concepts and Classifications Chapter 8

Total manufacturing costs.............................................. P830,000

Add: Work-in-process inventory, January 1................. 120,000
Subtotal........................................................................... P950,000
..................................................................................
Deduct: Work-in-process inventory, December 1........ 115,000
Cost of goods manufactured........................................... P835,000

Requirement 2

Amazing Aluminum Company

Schedule of Cost of Goods Sold
For the Year Ended December 31, 2005

Finished goods inventory, January 1.................................................. P150,000

Add: Cost of goods manufactured..................................................... 835,000
Cost of goods available for sale......................................................... P985,000
Deduct: Finished goods inventory, December 31............................. 165,000
Cost of goods sold............................................................................... P820,000

Requirement 3

Amazing Aluminum Company

Income Statement
For the Year Ended December 31, 2005

Sales revenue...................................................................................... P1,105,000

Less: Cost of goods sold.................................................................... 820,000
Gross margin....................................................................................... P 285,000
Selling and administrative expenses.................................................. 110,000
Income before taxes............................................................................ P 175,000
Income tax expense............................................................................. 70,000
Net income ........................................................................................ P 105,000

Exercise 2

Fixed (F) Period (P)

Cost Item Variable (V) Product (R)
a. Transportation-in costs on materials
purchased V R
b. Assembly-line workers’ wages V R
c. Property taxes on work in process
inventories V R

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d. Salaries of top executives in the F P

company
e. Overtime premium for assembly workers V R
f. Sales commissions V P
g. Sales personnel office rental F P
h. Production supervisory salaries F R
i. Controller’s office supplies F P
Fixed (F) Period (P)
Cost Item Variable (V) Product (R)
j. Executive office heat and air F P
conditioning
k. Executive office security personnel F P
l. Supplies used in assembly work V R
m. Factory heat and air conditioning F R
n. Power to operate factory equipment V R
o. Depreciation on furniture for sales staff F P
p. Varnish used for finishing product V R
q. Marketing personnel health insurance F P
r. Packaging materials for finished product V R
s. Salary of the quality control manager
who checks work on the assembly line F R
t. Assembly-line workers’ dental insurance F R

Exercise 3 (Cost Classifications; Manufacturer)

1. a, d, g, i
2. a, d, g, j
3. b, f
4. b, d, g, k
5. a, d, g, k
6. a, d, g, j
7. b, c, f
8. b, d, g, k
9. b, c and d*, e and f and g*, k*
* The building is used for several purposes.
10. b, c, f
11. b, c, h
12. b, c, f

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 Cost Concepts and Classifications Chapter 8

13. b, c, e
14. b, c and d†, e and f and g†, k†
†
The building that the furnace heats is used for several purposes.
15. b, d, g, k

Exercise 4 (Economic Characteristics of Costs)

1. marginal cost
2. sunk cost
3. average cost
4. opportunity cost
5. differential cost
6. out-of-pocket cost

Exercise 5 (Cost Classifications; Hotel)

1. a, c, e, k
2. b, d, e, k
3. d, e, i
4. d, e, i
5. a, d, e, k
6. a, d, e, k
7. d, e, k
8. b, d†, e, k
†
Unless the dishwasher has been used improperly.
9. h
10. a, d, e*, j
* The hotel general manager may have some control over the total space
allocated to the kitchen.
11. i
12. j
13. a, c, e
14. e, k

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Exercise 6

Pickup Truck Output

3,000 trucks 6,000 trucks 9,000 trucks

Variable production costs P 29,640,000 P 59,280,000 P 88,920,000
Fixed production costs 39,200,000 39,200,000 39,200,000
Variable selling costs 4,500,000 9,000,000 13,500,000
Fixed selling costs 13,660,000 13,660,000 13,660,000
Total costs P 87,000,000 P121,140,000 P155,280,000

Selling price per truck 46,000 40,100 35,900

Unit cost 29,000 20,190 17,253

Profit per truck 17,000 19,910 18,647

Exercise 7

(see next page)

Exercise 8

1. The wages of employees who build the sailboats: direct labor cost.
2. The cost of advertising in the local newspapers: marketing and selling
cost.
3. The cost of an aluminum mast installed in a sailboat: direct materials
cost.
4. The wages of the assembly shop’s supervisor: manufacturing overhead
cost.
5. Rent on the boathouse: a combination of manufacturing overhead,
administrative, and marketing and selling cost. The rent would most
likely be prorated on the basis of the amount of space occupied by

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manufacturing, administrative, and marketing operations.

6. The wages of the company’s bookkeeper: administrative cost.
7. Sales commissions paid to the company’s salespeople: marketing and
selling cost.
8. Depreciation on power tools: manufacturing overhead cost.

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Exercise 7

Period Product Cost

Variable Fixed Cost (Selling and Direct Direct Manufacturing Sunk Cost Opportunity
Cost Administrative) Cost Materials Labor Overhead Cost
1. Wood used in a table (P200
X X
per table)
2. Labor cost to assemble a
X X
table (P80 per table)
3. Salary of the factory
supervisor (P76,000 per X X
year)
4. Cost of electricity to
produce tables (P4 per X X
machine-hour)
5. Depreciation of machines
used to produce tables X X X*
(P20,000 per year)
6. Salary of the company
president (P200,000 per X X
year)
7. Advertising expense
X X
(P500,000 per year)
8. Commissions paid to
salespersons (P60 per table X X
sold)
9. Rental income forgone on
X1
factory space
*
This is a sunk cost because the outlay for the equipment was made in a previous period.
1
This is an opportunity cost because it represents the potential benefit that is lost or sacrificed as a result of using the factory space to produce tables. Opportunity
cost is a special category of cost that is not ordinarily recorded in an organization’s accounting books. To avoid possible confusion with other costs, we will not
attempt to classify this cost in any other way except as an opportunity cost.

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Exercise 9

Direc Indirec
t t
Cost Cost Object Cost Cost
1. The salary of the head chef The hotel’s restaurant X
2. The salary of the head chef A particular restaurant X
customer
3. Room cleaning supplies A particular hotel guest X
4. Flowers for the reception A particular hotel guest X
desk
5. The wages of the doorman A particular hotel guest X
6. Room cleaning supplies The housecleaning X
department
7. Fire insurance on the hotel The hotel’s gym X
building
8. Towels used in the gym The hotel’s gym X

Note: The room cleaning supplies would most likely be considered an

indirect cost of a particular hotel guest because it would not be practical to
keep track of exactly how much of each cleaning supply was used in the
guest’s room.

III. Problems

Problem 1

The relevant costs for this decision are the differential costs. These are:

Opportunity cost or lost wages (take home)

[P1,500 x 70% x 12 months]........ P12,600
Tuition.................................................... 2,200
Books and supplies................................. 300
Total differential costs...................... P15,100

Room and board, clothing, car, and incidentals are not relevant because these
are presumed to be the same whether or not Francis goes to school. The
possibility of part-time work, summer jobs, or scholarship assistance could
be considered as reductions to the cost of school. If students are familiar
with the time value of money, then they should recognize that the analysis
calls for a comparison of the present value of the differential after-tax cash

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Chapter 8 Cost Concepts and Classifications

inflows with the present value of differential costs of getting the education
(including the opportunity costs of lost income).
Problem 2

Requirement (a)

Only the differential outlay costs need be considered. The travel and other
variable expenses of P22 per hour would be the relevant costs. Any amount
received in excess would be a differential, positive return to Pat.

Requirement (b)

The opportunity cost of the hours given up would be considered in this

situation. Unless Pat receives more than the P100 normal consulting rate,
the contract would not be beneficial.

Requirement (c)

In this situation Pat would have to consider the present value of the contract
and compare that to the present value of the existing consulting business.
The final rate may be more or less than the normal P100 rate depending on
the outcome of Pat’s analysis.

Problem 3

Utilities for the bakery 2,100

Paper used in packaging product 90
Salaries and wages in the bakery 19,500
Cookie ingredients 35,000
Bakery labor and fringe benefits 1,300
Bakery equipment maintenance 800
Depreciation of bakery plant and equipment 2,000
Uniforms 400
Insurance for the bakery 900
Boxes, bags, and cups used in the bakery 1,100
Bakery overtime premiums 2,600
Bakery idle time 500
Total product costs in pesos 66,290

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Problem 4

Administrative costs 1,000

Rent for administration offices 17,200
Advertising 1,900
Office manager’s salary 13,000
Total period costs in pesos 33,100

Problem 5

Requirement (a)

Sunk costs not shown could include lost book value on traded assets,
depreciation estimates for new investment, and interest costs on capital
needed during facilities construction.

Requirement (b)

The client might be used to differential cost as a decision tool, and believes
(correctly) that use of differential analyses has several advantages --- it is
quicker, requires less data, and tends to give a better focus to the decision.
The banker might suspect the client of hiding some material data in order to
make the proposal more acceptable to the financing agency.

Problem 6

Requirement (1)

EH Corporation
Schedule of Cost of Goods Manufactured
For the Year Ended December 31

Direct materials:
Raw materials, inventory, January 1 P 45,000
Add: Purchases of raw materials 375,000
Raw materials available for use 420,000
Deduct: Raw materials inventory,
December 31 30,000
Raw materials used in production P 390,000
Direct labor 75,000

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Manufacturing overhead:
Utilities, factory 18,000
Depreciation, factory 81,000
Insurance, factory 20,000
Supplies, factory 7,500
Indirect labor 150,000
Maintenance, factory 43,500
Total manufacturing overhead cost 320,000
Total manufacturing cost 785,000
Add: Work in process inventory, January 1 90,000
875,000
Deduct: Work in process inventory,
December 31 50,000
Cost of goods manufactured P825,000

Requirement (2)

The cost of goods sold would be computed as follows:

Finished goods inventory, January 1 P130,000

Add: Cost of goods manufactured 825,000
Goods available for sale 955,000
Deduct: Finished goods inventory, December 31 105,000
Cost of goods sold P850,000

Requirement (3)

EH Corporation
Income Statement
For the Year Ended December 31

Sales P1,250,000
Cost of goods sold (above) 850,000
Gross margin 400,000
Selling and administrative expenses:
Selling expenses P 70,000
Administrative expenses 135,000 205,000
Net operating income P 195,000

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Problem 7

Note to the Instructor: Some of the answers below are debatable.

Adminis- Manufacturing
Variable or Selling trative (Product) Cost
Cost Item Fixed Cost Cost Direct Indirect
1. Depreciation, executive jet........................................................................... F X
2. Costs of shipping finished goods to customers............................................ V X
3. Wood used in manufacturing furniture......................................................... V X
4. Sales manager’s salary................................................................................. F X
5. Electricity used in manufacturing furniture.................................................. V X
6. Secretary to the company president.............................................................. F X
7. Aerosol attachment placed on a spray can produced by the company.......... V X
8. Billing costs................................................................................................. V X*
9. Packing supplies for shipping products overseas.......................................... V X
10. Sand used in manufacturing concrete........................................................... V X
11. Supervisor’s salary, factory.......................................................................... F X
12. Executive life insurance............................................................................... F X
13. Sales commissions....................................................................................... V X
14. Fringe benefits, assembly line workers........................................................ V   X**
15. Advertising costs.......................................................................................... F X
16. Property taxes on finished goods warehouses.............................................. F X
17. Lubricants for production equipment........................................................... V X
 *Could be an administrative cost.
**Could be an indirect cost.

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 Cost Concepts and Classifications Chapter 8
Problem 8
Requirement (1)
Period
(Selling
Product Cost and
Variable Fixed Direct Direct Mfg. Admin.) Opportunity Sunk
Name of the Cost Cost Cost Materials Labor Overhead Cost Cost Cost
Ling’s present salary of P400,000 per
month.......................................................................... X
Rent on the garage, P15,000 per month........................... X X
Rent of production equipment, P50,000 per
month.......................................................................... X X
Materials for producing flyswatters, at
P30.00 each.................................................................
X X
Labor cost of producing flyswatters, at
P50.00 each.................................................................
X X
Rent of room for a sales office, P7,500 per
month.......................................................................... X X
Answering device attachment, P2,000 per
month.......................................................................... X X
Interest lost on savings account, P100,000
per year........................................................................ X
Advertising cost, P40,000 per month.............................. X X
Sales commission, at P10.00 per flyswatter.................... X X
Legal and filing fees, P60,000......................................... X

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Requirement (2)

The P60,000 legal and filing fees are not a differential cost. These legal and
filing fees have already been paid and are a sunk cost. Thus, the cost will not
differ depending on whether Ling decides to produce flyswatters or to stay
with the consulting firm. All other costs listed above are differential costs
since they will be incurred only if Ling leaves the consulting firm and
produces the flyswatters.

Problem 9

Requirement (1)

Ms. Rio’s first action was to direct that discretionary expenditures be

delayed until the first of the new year. Providing that these “discretionary
expenditures” can be delayed without hampering operations, this is a good
business decision. By delaying expenditures, the company can keep its cash
a bit longer and thereby earn a bit more interest. There is nothing unethical
about such an action. The second action was to ask that the order for the
parts be cancelled. Since the clerk’s order was a mistake, there is nothing
unethical about this action either.

The third action was to ask the accounting department to delay recognition
of the delivery until the bill is paid in January. This action is dubious.
Asking the accounting department to ignore transactions strikes at the heart
of the integrity of the accounting system. If the accounting system cannot be
trusted, it is very difficult to run a business or obtain funds from outsiders.
However, in Ms. Rio’s defense, the purchase of the raw materials really
shouldn’t be recorded as an expense. He has been placed in an extremely
awkward position because the company’s accounting policy is flawed.

Requirement (2)

The company’s accounting policy with respect to raw materials is incorrect.

Raw materials should be recorded as an asset when delivered rather than as
an expense. If the correct accounting policy were followed, there would be
no reason for Ms. Rio to ask the accounting department to delay recognition
of the delivery of the raw materials. This flawed accounting policy creates
incentives for managers to delay deliveries of raw materials until after the
end of the fiscal year. This could lead to raw materials shortages and poor
relations with suppliers who would like to record their sales before the end

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of the year.

The company’s “manage-by-the-numbers” approach does not foster ethical

behavior—particularly when managers are told to “do anything so long as
you hit the target profits for the year.” Such “no excuses” pressure from the
top too often leads to unethical behavior when managers have difficulty
meeting target profits.

IV. Multiple Choice Questions

1. B 7. C 13. D 19. A 25. C

2. D 8. D 14. D† 20. A* 26. B
3. B 9. C 15. B† 21. B 27. B
4. A 10. C 16. A† 22. B 28. A **
5. C 11. A 17. C† 23. C 29. A
6. D 12. C 18. C 24. C 30. B

* Controllable costs are those costs that can be influenced by a specified

manager within a given time period.
** The answer assumes absorption costing method is used.
†
Supporting Computations
14. P60 + P10 + P18 + P4 = P92 16. P60 + P10 + P18 + P32 = P120
15. P32 + P16 = P48 17. P4 + P16 = P20