Management and Cost Accounting Bhimani Solutions 5th Edition

CVP chp8
8.18
CVP, movie production. (10 min)

1
Fixed costs = 5,000,000 (production cost)

Unit variable cost = 0.20 per 1 revenue (marketing fee)
Unit contribution margin = 0.80 per 1 revenue
Break even point in revenues =
Fixed costs
Unit contribution margin per 1 revenue
a
5, 000, 000
0.80
=
= 6,250,000
b
2
8.19
Espasso receives 62.5% of box-office receipts. Box-office receipts of

10,000,000 translate to 6,250,000 in revenues to Espasso.
Revenues, 0.625 300,000,000
187,500,000
Variable costs, 0.20 187,500,000

Contribution margin
Fixed costs
Operating income
37,500,000
150,000,000
5,000,000
145,000,000
CVP, cost structure differences, movie production. (20 min)

1
a
Contract A
Fixed costs for Contract A:
Production costs
21,000,000
Fixed salary
15,000,000
Total fixed costs
36,000,000
Unit variable cost = 0.25 per 1 revenue marketing fee
Box-office receipts of 76,800,000 translate to 48,000,000 in revenues to Espasso.

b
Contract B
Fixed costs for Contract B:
Production costs
21,000,000
Fixed salary
3,000,000
Total fixed costs
24,000,000
Unit variable cost = 0.25 per 1 revenue fee to Artes e Media
0.15 per 1 revenue residual to director/actors
0.40 per 1 revenue
24,000,000
Breakeven points in revenues =
0.60
= 40,000,000
Box-office receipts of 64,000,000 translate to 40,000,000 in revenues to Espasso.
Bhimani, Horngren, Datar and Rajan, Management and Cost Accounting, 5th Edition, Instructors Manual
Difference in breakeven points

Contract A has a higher fixed cost and a lower variable cost per sales euro. In
contrast, Contract B has a lower fixed cost and a higher variable cost per sales euro.
In Contract B, there is risk sharing between Espasso and Vieira, Moura and Rebello
that lowers the breakeven point, but results in Espasso receiving less operating
income if Tornado 2 is a mega-success.
2
Revenues, 0.625 300,000,000

Variable costs, 0.40 187,500,000
Contribution margin
Fixed costs
Operating income
187,500,000
75,000,000
112,500,000
24,000,000
88,500,000
Tornado 2 has a higher breakeven point than Tornado due to having a higher level
of fixed costs and a lower unit contribution margin.
8.24
CVP, shoe stores. (2030 min)

1
a
In number of pairs:
Fixed costs
360,000
40,000 pairs
Contribution margin per pair
9.00
b
In revenues:
Fixed costs
360,000
1, 200,000
Contribution margin % per pound sterling 100% 70%
2
Revenues, 30 35,000
1,050,000
Variable costs, 21 35,000
735,000
Contribution margin
315,000
Fixed costs
360,000
Operating income (loss)
(45,000)
An alternative approach is that 35,000 units is 5,000 units below the breakeven
point and the unit contribution margin is 9.00:
9.00 5,000 = 45,000 below the breakeven point.
3
Fixed costs: 360,000 + 81,000 = 441,000

Contribution margin per pair = 10.50
a
Breakeven point in units =
441,000
= 42,000 pairs
9.00
2
Pearson Education Limited 2012
b
4
Breakeven point in revenues = 30 42,000 = 1,260,000
Fixed costs = 360,000

Contribution margin per pair = 8.70
a
b
Breakeven point in units =
360,000
= 41,380 pairs
8.70
Breakeven point in revenues = 30 41,380 = 1,241,400
3
Breakeven point = 40,000 pairs

Store manager receives commission on 10,000 pairs
Cost of commission = 0.30 10,000 = 3,000
Revenues, 30 50,000
1,500,000
Variable costs
Cost of shoes
975,000
Salespeople commission
75,000
Manager commission
3,000
1,053,000
Contribution margin
447,000
Fixed costs
360,000
Operating income
87,000
An alternative approach is 10,000 units 8.70 = 87,000

8.25
CVP, shoe stores. (2025 min)

1
Because the unit sales level at the point of indifference would be the same for each
plan, the revenue would be equal. Therefore, the unit sales level sought would be
that which produces the same total costs for each plan.
Let Q=unit sales level
a
19.50Q + 360,000 + 81,000=21.00Q + 360,000

81,000=1.50Q
Q=54,000 units
2
Commission plan
Sales in units
Salary plan
50,000
60,000
50,000
60,000
1,500,000
1,800,000
1,500,000
1,800,000
1,050,000
1,260,000
975,000
1,170,000
Contribution margin
450,000
540,000
525,000
630,000
Fixed costs
360,000
360,000
441,000
441,000
90,000
180,000
84,000
189,000
Revenues @ 30.00
Variable costs @ 21.00
and 19.50
Operating income ()
The decision regarding the plans will depend heavily on the unit sales level that is
generated by the fixed salary plan. For example, as the answer to requirement (1)
shows, at identical unit sales levels in excess of 54,000 units, the fixed salary plan
will always provide a more profitable final result than the commission plan.
4
Let TQ = Target number of units

a
30.00TQ 19.50TQ 441,000 = 168,000

10.50TQ = 609,000
TQ = 609,000 10.50
TQ = 58,000 units
30.00TQ 21.00TQ 360,000 = 168,000

9.00TQ = 528,000
TQ = 528,000 9.00
TQ = 58,667 units (rounded)
The decision regarding the salary plan depends heavily on predictions of demand. For
instance, the salary plan offers the same operating income at 58,000 units as the
commission plan offers at 58,667 units.
Cost estimation chpt 9
9.15
Linear cost approximation. (25 min)

1
Difference in cost
Slope coefficient (b) = Difference in labour hours
529,000 400,000
=
Constant (a)
7, 000 4, 000
= 43.00
= 529,000 43.00 (7,000)

= 228,000
Cost function
= 228,000 + 43.00 (professional labour-hours)
The linear cost function is plotted in Solution Exhibit 9.15.

No, the constant component of the cost function does not represent the fixed
overhead cost of Marre-Quise. The relevant range of professional labour-hours is
from 3,000 to 8,000. The constant component provides the best available starting
point for a straight line that approximates how a cost behaves within the 3,000
8,000 relevant range.
2
A comparison at various levels of professional labour-hours is as follows. The linear

cost function is based on the formula of 228,000 per month plus 43.00 per
professional labour-hour.
Total overhead cost behaviour:
Month 1
Month 2
Month 3
Month 4
5
Month 5
Month 6
Actual total overhead costs
Linear approximation
Actual minus linear
approximation
Professional labour-hours
340,000
357,000
400,000
400,000
435,000
443,000
477,000
486,000
529,000
529,000
587,000
572,000
(17,000)
(8,000)
(9,000)
5,000
00007,000
00008,000
3,000
0004,000
5,000 00006,000
The data are shown in Solution Exhibit 9.15. The linear cost function overstates
costs by 8,000 at the 5,000-hour level and understates costs by 15,000 at the
8,000-hour level.
6
Based on
Based on linear
Actual
Contribution before deducting incremental overhead
Incremental overhead
Contribution after incremental overhead
Cost function
38,000
38,000
35,000
43,000
3,000
(5,000)
Solution Exhibit 9.15

Linear-cost function plot of professional labour-hours on total overhead costs for Marre-Quise
consultants.
9.16
Regression analysis, service company. (25 min)

1a Solution Exhibit 9.16 plots the relationship between labour-hours and overhead
costs and shows the regression line.
y = 48,271 + 3.93X
b
Economic plausibility. Labour-hours appears to be an economically plausible driver

of overhead costs for a catering company. Overhead costs such as scheduling, hiring
and training of workers and managing the workforce are largely incurred to support
labour.
Goodness of fit. The vertical differences between actual and predicted costs are
extremely small, indicating a very good fit. The good fit indicates a strong
relationship between the labour-hour cost driver and overhead costs.
Slope of the regression line. The regression line has a reasonably steep slope from
left to right. The positive slope indicates that, on average, overhead costs increase as
labour-hours increase.
7
The regression analysis indicates that, within the relevant range of 2,5007,500
labour-hours, the variable cost per person for a cocktail party equals:
Food and beverages
Labour (0.5 hours 10 per hour)
5.00
Variable overhead (0.5 hours 3.93 per labour-hour)
1.97
Total variable cost per person
15.00
21.97
To earn a positive contribution margin, the minimum bid for a 200-person cocktail
party would be any amount greater than 4,394. This amount is calculated by
multiplying the variable cost per person (21.97) by the total number of people
(200). At a price above the variable costs of 4,394, Hans Mehrlich will be earning
a contribution margin towards coverage of his fixed costs.
Of course, Hans Mehrlich will consider other factors in developing his bid,
including (a) an analysis of the competition vigorous competition will limit
Mehrlichs ability to obtain a higher price; (b) a determination of whether or not his
bid will set a precedent for lower prices overall, the prices Hans Mehrlich charges
should generate enough contribution to cover fixed costs and earn a reasonable
profit and (c) a judgement of how representative past historical data (used in the
regression analysis) is about future costs.

Regression line of labour-hours on overhead costs for Hans Mehrlichs catering company.
8
9.19
Evaluating alternative simple regression models, not for profit. (3040 min)
1a Solution Exhibit 9.19A plots the relationship between number of academic
programmes and overhead costs.
b Solution Exhibit 9.19B plots the relationship between number of enrolled students
and overhead costs.
2
Solution Exhibit 9.19C compares the two simple regression models estimated by
Raphal. Both regression models appear to perform well when estimating overhead
costs. Cost function 1 using number of academic programmes as the independent
variable appears to perform slightly better than cost function 2 which uses number
of enrolled students as the independent variable. Cost function 1 has a high r2 and
goodness of fit, a high t-value indicating a significant relationship between the
number of academic programmes and overhead costs and meets all the specification
assumptions for ordinary least squares regression. Cost function 2 has a lower r2
than cost function 1 and exhibits positive autocorrelation among the residuals as
indicated by a low DurbinWatson statistic.
The analysis indicates that overhead costs are related to the number of academic
programmes and the number of enrolled students. If Ecole Suprieure des Mines
(ESM) has pressures to reduce and control overhead costs, it may need to look hard
at closing down some of its academic programmes and reducing its intake of
students. Reducing enrolled students may cut down on overhead costs, but it also
cuts down on revenues (tuition payments), hurts the reputation of the school and
reduces its alumni base, which is a future source of funds. For these reasons, ESM
may prefer to downsize its academic programmes, particularly those programmes
that attract few students. Of course, ESM should continue to reduce costs by
improving the efficiency of the delivery of its programmes.
Solution Exhibit 9.19A

Plot of number of academic programmes versus overhead costs (in thousands).
Solution Exhibit 9.19B

9
Plot of number of enrolled students versus overhead costs (in thousands).
10
Solution Exhibit 9.19C

Comparison of alternative cost functions for overhead costs estimated with simple regression for
Ecole Suprieure des Mines.
Criterion
Cost function 1:
number of
academic programmes as
independent variable
Cost function 2:
number of
enrolled students as
independent variable
Economic plausibility
A positive relationship between

overhead costs and number of
academic programmes is
economically plausible at Ecole
Suprieure des Mines.
A positive relationship
between overhead costs and
number of enrolled students is
economically plausible at
Ecole Suprieure des Mines.
Goodness of fit
r2 = 0.72
r2 = 0.55
Good goodness of fit, but not
as good as for number of
academic programmes.
Excellent goodness of fit.
Significance of
t-value of 5.08 is significant.
independent variable(s)
t-value of 3.53 is significant.
Specification analysis
of estimation
assumptions
Plot of the data indicates that

assumptions of linearity,
constant variance and
normality of residuals hold, but
inferences drawn from only 12
observations are not reliable;
the DurbinWatson statistic =
0.77 indicates that
independence of residuals
does not hold.
Plot of the data indicates that

assumptions of linearity,
constant variance,
independence of residuals and
normality of residuals hold, but
inferences drawn from only 12
observations are not reliable;
DurbinWatson statistic = 1.81
indicates that independence of
residuals holds.
19.20 Solution given in book
Relevant costs and LP

10.11
Relevant costs, contribution margin and product emphasis. (2025 min)

1
Cola
Selling price per case
Deduct variable costs per case
Contribution margin per case
Lemonade
Punch
Natural
orange
juice
108.00
115.20
158.40
230.40
81.00
91.20
120.60
181.20
27.00
24.00
37.80
49.20
11
The argument fails to recognise that shelf space is the constraining factor. There are
only 12 metres of front shelf space to be devoted to drinks. Consuelo should aim to
get the highest daily contribution margin per metre of front shelf space:
Cola
Contribution margin per case
Sales (number of cases) per metre
of shelf space per day
Daily contribution per metre
of front shelf space
Lemonade
Natural
orange
juice
Punch
27.00
24.00
37.80
49.20
25
24
675.00
576.00
151.20
246.00
The allocation that maximises the daily contribution from soft drink sales is:
Metres of
shelf space
Daily contribution
per metre of
front shelf space
Cola
Lemonade
Natural orange juice
Punch
Total contribution
margin per day
675.00
4,050.00
576.00
151.20
246.00
2,304.00
151.20
246.00
6,751.20
The maximum of 6 metres of front shelf space will be devoted to Cola because it
has the highest contribution margin per unit of the constraining factor. Four metres
of front shelf space will be devoted to Lemonade, which has the second highest
contribution margin per unit of the constraining factor. No more shelf space can be
devoted to Lemonade, since each of the remaining two products, Natural orange
juice and Punch (that have the second lowest and lowest contribution margins per
unit of the constraining factor), must be given at least one metre of front shelf space.
10.12
Customer profitability, choosing customers. (2025 min)

1
Jours-Daim should not drop the Fourbe-Riz business as the following analysis
shows:
Loss in revenues from dropping Fourbe-Riz
(80,000)
Savings in costs:
Variable costs
Fixed costs 20% 100,000
Total savings in costs
Effect on operating income
48,000
20,000
68,000
(12,000)
Jours-Daim would be worse off by 12,000 if it drops the Fourbe-Riz business.
12
If Jours-Daim accepts the additional business from Fourbe-Riz, it would take an

additional 500 hours of machine time. If Jours-Daim accepts all of Fourbe-Rizs and
Harpes--Gonds business for February, it would require 2,500 hours of machine
time (1,500 hours for Harpes--Gonds and 1,000 hours for Fourbe-Riz). Jours-Daim
has only 2,000 hours of machine capacity. It must, therefore, choose how much of
the Harpes--Gonds or Fourbe-Riz business to accept. If Jours-Daim accepts any
additional business from Fourbe-Riz, it must forgo some of Harpes--Gondss
business.
To maximise operating income, Jours-Daim should maximise contribution margin
per unit of the constrained resource. (Fixed costs will remain unchanged at
100,000 whatever business Jours-Daim chooses to accept in February, and are
therefore irrelevant.) The contribution margin per unit of the constrained resource
for each customer in January is:
Harpes--Gonds
Revenues
Variable costs
Contribution margin
Fourbe-Riz
120,000
42,000
78,000
78,000
Contribution margin per machine-hour
= 52
1,500
80,000
48,000
32,000
32,000
= 64
500
Since the 80,000 of additional Fourbe-Riz business in February is identical to jobs

done in January, it will also have a contribution margin of 64 per machine-hour,
which is greater than the contribution margin of 52 per machine-hour from
Harpes--Gonds. To maximise operating income, Jours-Daim should first allocate
all the capacity needed to take the Fourbe-Riz business (1,000 machine-hours) and
then allocate the remaining 1,000 (2,000 1,000) machine-hours to Harpes-Gonds. Jours-Daims operating income in February would then be 16,000 as
shown below, greater than the 10,000 operating income in January.
Harpes--Gonds
Contribution margin per machine-hour
Machine-hours to be worked
Contribution margin
Fixed costs
Operating income
52
1,000
52,000
Fourbe-Riz
64
1,000
64,000
Total
116,000
100,000
16,000
Alternatively, we could present Jours-Daims operating income by taking two-thirds

(1,000 1,500 machine-hours) of Harpes--Gondss January revenues and variable
costs and doubling (1,000 500 machine-hours) Fourbe-Rizs January revenues and
variable costs.
13
Harpes--Gonds Fourbe-Riz
Revenues
Variable costs
Contribution margin
Fixed costs
Operating income
80,000
28,000
52,000
160,000
96,000
64,000
Total
240,000
124,000
116,000
100,000
16,000
The problem indicated that Jours-Daim could choose to accept as much of the
Harpes--Gonds and Fourbe-Riz business for February as it wants. However, some
students may raise the question that Jours-Daim should think more strategically
before deciding what to do. For example, how would Harpes--Gonds react to
Jours-Daims inability to satisfy its needs? Will Fourbe-Riz continue to give JoursDaim 160,000 of business each month or is the additional 80,000 of business in
February a special order? For example, if Fourbe-Rizs additional work in February
is only a special order and Jours-Daim wants to maintain a long-term relationship
with Harpes--Gonds, it may in fact prefer to turn down the additional Fourbe-Riz
business. It may feel that the additional 6,000 in operating income in February is
not worth jeopardising its long-term relationship with Harpes--Gonds. Other
students may raise the possibility of Jours-Daim accepting all the Harpes--Gonds
and Fourbe-Riz business for February if it can subcontract some of it to another
reliable, high-quality printer.
10.13
Relevance of equipment costs. (3040 min)

1a Statements of cash receipts and disbursements
Keep
Year 1
Years
24
Buy new machine

Four
years
together
Year 1
Years
24
Four years
together
Receipts from operations:

Sales
150,000
150,000
600,000
150,000
150,000
600,000
Other operating costs
(110,000)
Operation of machine
(15,000)
(110,000)
(440,000)
iiiii(110,000)
iiiii(110,000)
(440,000)
(15,000)
iiiii i(60,000)
iiiii (9,000)
iiiiiiii (9,000)
(36,000)
iiiii(20,000)
iiiii (20,000)
(20,000)
iiiii (24,000)
(24,000)
Deduct disbursements:
Purchase of old
machine
(20,000)*
Purchase of new
equipment
Cash
inflow
from sale of old
equipment
Net cash inflow
5,000
25,000
80,000
8,000
8,000
(5,000)
88,000
31,000
*Some students ignore this item because it is the same for each alternative. However, note that a statement for
the entire year has been requested. Obviously, the 20,000 would affect Year 1 only under both the keep and
buy alternatives.
14
The difference is 8,000 for four years taken together. In particular, note that the
20,000 book value can be omitted from the comparison. Merely cross out the entire
line; although the column totals are affected, the net difference is still 8,000.
Note the motivational factors here. A manager may be reluctant to replace simply
because the large loss on disposal severely harms profitability in Year 1. Nevertheless,
the cumulative cash flow effects are beneficial to the company as a whole (assuming a
world of no income taxes and no interest).
1b Again, the difference is 8,000:
Income statements
Keep
Buy new machine

Four
Sales
Years
years
14
together
Four years
together
Years
Year 1
24
150,000
600,000
150,000
150,000
600,000
110,000
440,000
110,000
110,000
440,000
24,000
Costs (excluding disposal):

Other operating costs
Depreciation
Operating costs of machine
Total costs (excluding disposal)
5,000
20,000
6,000
6,000
15,000
60,000
9,000
9,000
36,000
130,000
20,000
125,000
125,000
500,000
Loss on disposal:
Book value (cost)
20,000
Proceeds (revenue)
(8,000)
20,000*
(8,000)
Loss on disposal
12,000
12,000
Total costs
130,000
520,000
137,000
125,000
512,000
Operating income
20,000
80,000
13,000
25,000
88,000
* As in requirement (1a), the 20,000 book value may be omitted from the comparison without changing the 8,000
difference. This adjustment would mean excluding the depreciation item of 5,000 per year (a cumulative effect of
20,000) under the keep alternative and excluding the book value item of 20,000 in the loss on disposal
calculation under the buy alternative.
1c The 20,000 purchase cost of the old equipment, the sales and the other costs are
irrelevant because their amounts are common to both alternatives.
2
The net difference would be unaffected. Any number may be substituted for the
original 20,000 figure without changing the final answer. Of course, the net cash
outflows under both alternatives would be high. The Car Wash manager really
blundered. However, keeping the old equipment will increase the cost of the
blunder to the cumulative tune of 8,000 over the next 4 years.
Book value is irrelevant in decisions about the replacement of equipment, because it

is a past (historical) cost. All past costs are down the drain. Nothing can change
what has already been spent or what has already happened. The 20,000 has been
spent. How it is subsequently accounted for is irrelevant. The analysis in
requirement (1) clearly shows that we may completely ignore the 20,000 and still
have a correct analysis. The only relevant items are those expected future items that
will differ among alternatives.
Despite the economic analysis shown here, many managers would keep the old machine
rather than replace it. Why? Because, in many organisations, the income statements of
requirement (2) would be a principal means of evaluating performance. Note that the
15
first-year operating income would be higher under the keep alternative. The
conventional accrual accounting model might motivate managers towards maximising
their first-year reported operating income at the expense of long-run cumulative
betterment for the organisation as a whole. This criticism is often made of the accrual
accounting model. That is, the action favoured by the correct or best economic
decision model may not be taken, either because the performanceevaluation model is
inconsistent with the decision model or because the focus is only on the short-run part
of the performanceevaluation model.
10.15
Optimal production plan, computer manufacturer. (30 min)

1
Let X = Units of printers,

and Y = Units of desktop computers.
Objective: Maximise total contribution margin of 200X + 100Y

Constraints:
For production line 1:
For production line 2:
Sales of X and Y:
Negative production impossible:
6X + 4Y
10X
X
X
Y
<
24
<
20
<
>
>
Solution Exhibit 10.15 presents a graphical summary of the relationships. The salesmix constraint here is somewhat unusual. The X Y < 0 line is the one going
upward at 45 angle from the origin. Using the trial-and-error method:
Trial
Corner (X; Y)
Total contribution margin
(0; 0)
200 (0)
100 (0)
(2; 2)
200 (2)
100 (2)
600
(2; 3)
200 (2)
100 (3)
700
(0; 6)
200 (0)
100 (6)
600
The optimal solution that maximises operating income is two printers and three
computers.
16

Graphic solution to find optimal mix, Fiordi-Ligio Srl.
10.16
Optimal sales mix for a retailer, sensitivity analysis. (3040 min)

1
Let G
floor space of grocery products carried.
floor space of dairy products carried.
The LP formula of the decision is:

Maximise:
10G
3D
Subject to:
10G
3D
10G
3D
<
4,000
>
1,000
>
1800
Vier-und-Zwanzig may wish to maintain its reputation as a full-service food store

carrying both grocery and dairy products. Customers may not be attracted if Vierund-Zwanzig carries only the product line with the highest unit contribution
margins. (Marketing and economics courses examine this issue under the label of
interdependencies in the demand for products.)
Solution Exhibit 10.16 presents the graphic solution. The optimal solution is 3,200
square metres of grocery products and 800 square metres of dairy products.
17
The trial-and-error solution approach is:

Trial
Corner (G; D)
1
2
3
(1,000; 800)
(1,000; 3,000)
(3,200; 800)
TCM = 10G + 3D
10 (1,000) + 3 (800) = 12,400*
10 (1,000) + 3 (3,000) = 19,000*
10 (3,200) + 3 (800) = 34,400*
* Optimal solution is G = 3,200 and D = 800.

4
The optimal mix determined in requirement (3) will not change if the contribution
margins per square metre change to grocery products, 8 and dairy products, 5. To
avoid cluttering the graphic solution in Solution Exhibit 10.16, we demonstrate this
using the trial-and-error solution approach.
Trial
Corner (G; D)
TCM = 8G + 5D
1
2
3
(1,000; 800)
(1,000; 3,000)
(3,200; 800)
8 (1,000) + 5 (800) = 12,000*

8 (1,000) + 5 (3,000) = 23,000*
8 (3,200) + 5 (800) = 29,600*
* Optimal solution is still G = 3,200 and D = 800.

The student can also verify, by drawing lines parallel to the line through G = 500 and D
= 800 (the equal contribution line for 4,000) that the furthest point, where the equal
contribution line intersects the feasible region, is the point G = 3,200 and D = 800.
Graphic solution to find optimal mix, Vier-und-Zwanzig.
18
ABC chpt 11
11.13
Activity-based costing, product cost cross-subsidisation. (3040 min)
The idea for Exercise 11.13 came from ABC Minicase: Let them Eat Cake, in Cost Management Update
(Issue No. 31).
1
Budgeted MOH
rate in 2011
210,800
200,000 units
= 1.054 per 1 Kg unit of cake
Raisin cake
Unit direct manufacturing cost

Direct materials
Direct manufacturing labour
Unit indirect manufacturing cost
Manufacturing overhead
(1.054 1, 1)
Unit total manufacturing cost
2
Unit direct manufacturing cost
Direct materials
Unit indirect manufacturing cost
Mixing (0.04 5, 8)
Cooking (0.14 2, 3)
Cooling (0.2 3, 5)
Creaming/icing (0.25 0, 3)
Packaging (0.08 3, 7)
Unit total manufacturing cost
0.600
0.140
1.054
Layered carrot cake
0.740
1.054
1.794
Raisin cake
0.600
0.140
0.200
0.280
0.060
0.000
0.240
0.740
0.780
1.520
19
0.900
0.200
1.054
1.100
1.054
2.154
Layered carrot cake
0.900
0.200
0.320
0.420
0.100
0.750
0.560
1.100
2.150
3.250
The unit product costs in requirements 1 and 2 differ only in the assignment of indirect costs to
individual products. The assumed usage of indirect-cost areas under each costing system is:
Existing system
Layered
Raisin cake
carrot cake
Mixing
Cooking
Cooling
Creaming/icing
Packaging
50%
50
50
50
50
50%
50
50
50
50
ABC system
Layered
Raisin cake
carrot cake
38.5%
40.0
37.5
0.0
30.0
61.5%
60.0
62.5
100.0
70.0
The ABC system recognises the substantial difference in usage of individual activity areas between
raisin cake and layered carrot cake. The existing costing system erroneously assumes equal usage of
activity areas by 1 kg of raisin cake and 1 kg of layered carrot cake.
4
Uses of activity-based cost numbers include:

a
Pricing decisions. Starkuchen can use the ABC data to decide preliminary prices for
negotiating with its customers. Raisin cake is currently overcosted while layered carrot cake is
undercosted. Actual production of layered carrot cake is 100% more than budgeted. One
explanation could be the underpricing of layered carrot cake.
Product emphasis. Starkuchen has more accurate product margins with ABC. Starkuchen can
use this information for deciding which products to push (especially if there are production
constraints).
Product design. ABC provides a road map on how a change in product design can reduce
costs. The percentage breakdown of total indirect costs for each product is:
Raisin cake
Mixing
Cooking
Cooling
Creaming/icing
Packaging
25.6% (0.20/0.78)
35.9
7.7
0.0
30.8
100.0%
Layered carrot cake

14.9% (0.32/2.15)
19.5
4.7
34.9
26.0
100.0%
Starkuchen can reduce the cost of either cake by reducing its usage of each activity area. For
example, Starkuchen can reduce raisin cakes cost by sizably reducing its cooking time or
packaging time. Similarly, a sizeable reduction in creaming/icing will have a marked
reduction on layered carrot cake costs.
d
Process improvements. Improvements in how activity areas are configured will cause a
reduction in the costs of products that use those activity areas.
20
11.16
Cost planning and flexible budgeting. ABC provides a more refined model to forecast
costs of Starkuchen and to explain why actual costs differ from budgeted costs.
Activity-based job-costing system. (40 min)

1
Solution Exhibit 11.16 presents costing overviews of the previous job-costing system and the
refined activity-based job-costing system.
Direct manufacturing costs:

Direct materials
Indirect manufacturing costs:
Materials handling, DKr 8 50
Machining, DKr 68 12
Assembly, DKr 75 15
Inspection, DKr 104 4
Total manufacturing costs
DKr 3,000
DKr 400
816
1,125
416
2,757
DKr 5,757
Total manufacturing costs = DKr 5,757 50 = DKr 287,850.
A direct cost is a cost that is related to the particular cost object and that can be traced to it in an
economically feasible way. Henriksen may differ from its competitor in several ways.
a
Henriksen uses a more automated production approach with the result that manufacturing
labour provides support to the machines.
Henriksen uses a less sophisticated information tracking system for manufacturing labour than
its competitors.
Manufacturing labour costs are included in the individual indirect manufacturing (overhead) cost
pools.
4
The refined activity-based costing system can provide information to:

a
Product designers the indirect-cost rates in each of the four indirect-cost areas can guide
decisions about how much (say) machine-hours to use versus assembly-line-hours when
designing packaging machines.
Manufacturing personnel decisions about productivity and cost management can focus on
ways to reduce the indirect-cost rates (such as decisions on how to make more efficient use of
machines).
Marketing personnel the ABC approach can help guide pricing decisions and negotiations
with potential customers on ways to manufacture a lower-cost packaging machine.
21

Job Costing Systems for Henriksen
11.17
Activity-based job costing. (15 min)

1
An overview of the product-costing system is:
22
Direct manufacturing costs:

Direct materials
Direct manufacturing labour,
20 7,500; 500
Direct manufacturing costs
Indirect manufacturing costs:
Materials handling,
0.25 100,000; 3,500
Cutting,
2.50 100,000; 3,500
Assembly,
25.00 7,500; 500
Indirect manufacturing costs
Total manufacturing costs
600,000
25,000
150,000
750,000
10,000
35,000
25,000
875
250,000
8,750
187,500
462,500
1,212,500
12,500
22,125
57,125
Unit costs
Executive chair: 1,212,500 5,000 = 242.50
Chairman chair: 57,125 100 = 571.25
2
Executive chair
Upstream costs
Manufacturing costs
Downstream costs
Total costs
11.19
60.00
242.50
110.00
412.50
Chairman chair
146.00
571.25
236.00
953.25
Question from the Association of Chartered Certified Accountants, Pilot Paper 2.4, Financial
Management and Control. (45 min)
a
General
Activity-based costing (ABC) focuses the mindset of the organisation from processes to activities
and in this way, provides a framework to enable management to manage costs by altering
activities undertaken. Traditional methods of product costing were often volume related (e.g.
hours of labour used), but this did not develop with the growth in activities that had no relation to
volume or in multiproduct businesses.
There are general conditions under which ABC is most likely to operate and are:
where there is a requirement to apportion costs (e.g. in a multiproduct business);

23
where there are significant overheads to apportion and
where the availability of sophisticated information retrieval systems allows management to

track product costs as they pass through a production system.
24
Multiproduct businesses
The main issue is that there has to be at least two products in the business, otherwise there are no
costs to apportion between products. For a single product company, all costs of the business are
identifiable with the product and product probability is directly related to the profitability of the
business as a whole.
Other advantages of ABC in multiproduct business relate to the accurate valuation of stock and
facilitating the effective management of stock levels with multiple products. Allied to this is that
there is reduced cross-subsidisation of products: with costs accurately identified with products, it
becomes easier for management to discern which products are profitable against those that are not.
The significance of overheads and the ABC method of charging costs
Since ABC is a cost apportionment system, it is principally beneficial when there is a high
proportion of overhead costs if a business incurs only direct costs, there is no issue for ABC to
resolve.
ABC is based on the premise that it is activities that lead to costs being incurred and that costs
should, therefore, be apportioned on the basis of those activities. Cost drivers are then chosen that
reflect the events that create costs when the activities are undertaken. These costs are then
collected into cost pools where there are common cost drivers. Finally, products are allocated costs
on the basis of the activities they use.
Information systems
A basic requirement for any cost allocation system is information availability. This is particularly
so for ABC systems that rely heavily on activity information.
In addition, ABC requires the monitoring of activities that have not involved monitoring
previously. This raises issues of information capture and it is in new technology that answers to
this are most likely to be found.
b
ABC can enable the exclusion of non-controllable costs, focusing only on those costs that are
traceable to manager decisions, thereby providing a more fair outcome than absorption costing.
ABC is often claimed to rest on a more accurate information base than absorption costing and
hence, the impact of management decisions is potentially more easily seen under ABC than it is
under traditional volume-related absorption methods.
Also, ABC absorbs costs into products in a wider variety of ways than traditional absorption
methods that rely mostly on labour and/or machine-hours. In extending the range of absorption
bases, ABC is able to more closely track costs to the causes of the costs, which then links to
management decisions.
NB 11.19 for info that could assist with any written parts.
11.18 solution given in the book
CIA chpt 13
13.12
Comparison of approaches to capital budgeting. (2225 min)

1
Payback period = 220,000 50,000 = 4.4 years
The table for the present value of annuities (Appendix B, Table 4) shows
10 periods at 16% = 4.833
Net present value = 50,000 (4.833) 220,000
= 241,650 220,000 = 21,650
25
Internal rate of return (IRR):

220,000 = Present value of annuity of 50,000 at X% for 10 years or what factor (F) in
the table of present values of an annuity (Appendix B, Table 4) will satisfy the
following equation.
220,000 = 50,000F
220,000
F=
50,000 = 4.400
On the 10-year line in the table for the present value of annuities (Appendix B, Table 4), find the
column closest to 4.400; 4.400 is between a rate of return of 18% and 20%.
26
Interpolation is necessary:
Present-value factors
4.494
4.494
4.400
4.192
0.302
0.094
18%
IRR rate
20%
Difference
Internal rate of return
= 18% +
= 18% + (0.311) (2%) = 18.62%
Accounting rate of return based on net initial investment:

Net initial investment
= 220,000
Estimated useful life
= 10 years
Annual straight-line depreciation
= 220,000 10 = 22,000
ARR =
50, 000 22, 000
=
220, 000
28, 000
= 220, 000 = 12.73%
Note how the accrual accounting rate of return, whichever way calculated, can produce results that
differ markedly from the internal rate of return.
13.13
Special order, relevant costs, capital budgeting. (30 min)

1
Relevant cash inflow from accepting the special order

Relevant cash flows
Per car
(1)
Incremental revenues (cash inflows)
Incremental costs (cash outflows)
Neon paint
Boxes
Total incremental costs
Net incremental benefit
Total
(2) = (1) 100,000
50
5,000,000
6
3
8
17
33
600,000
300,000
800,000
1,700,000
3,300,000
Notes
a
The costs of plastic cars are irrelevant because these cars have already been purchased and so
entail no incremental cash flow.
VAT depreciation is irrelevant because it is a past cost.
Allocated plant manager's salary is irrelevant because it will not change whether or not the special
order is accepted.
27
Variable marketing costs are not deducted because they will not be incurred on the special order.
Fixed marketing costs are irrelevant because they will not change whether or not the special order
is accepted.
If it must offer the same 50 price to its other customers, Euro-Jouets will lose cash flow of 9
130,000 = 1,170,000 per year for 4 years from its existing customers.
Note that whatever incremental costs Euro-Jouets incurs on sales to its existing customers is
irrelevant. These costs would continue to be incurred whether Euro-Jouets prices the cars at 50 or
59. You can verify that Euro-Jouets generates positive contribution margin at a price of 50 and so
should continue to sell to its existing customers.
From Appendix B, Table 4, the present value of a stream of 1,170,000 payments for 4 years
discounted at 16% is 1,170,000 2.798 = 3,273,660.
The net relevant benefit of accepting the special order is 3,300,000 3,273,660 = 26,340.
Therefore, Euro-Jouets should accept the special order.
2
Let the Euro discount from the current 59 price offered to existing customers be X.
Then
X (130,000) (2.798)=3,300,000
3, 300, 000
X= (130, 000)(2.798) =9.0724
At a price of 49.9276 (59 9.0724) per car to its existing customers, Euro-Jouets would just be
indifferent between accepting and rejecting Mille-Fontaines special order.
13.15
Net present value, internal rate of return, sensitivity analysis. (2030 min)
1a The table for the present value of annuities (Appendix B, Table 4) shows
16 periods at 14% = 3.889
Net present value
= 40,000 (3.889) 120,000

= 155,560 120,000 = 35,560
b Internal rate of return:

120,000
120,000
Present value of annuity of 40,000 at X% for 6 years or what

factor (F) in the table of present values of an annuity (Appendix
B, Table 4) will satisfy the following equation.
40,000F
120, 000
40, 000 = 3.0
On the 6-year line in the table for the present value of annuities (Appendix B, Table 4), find the
column closest to 3.0; 3.0 is between a rate of return of 24% and 26%.
28
Interpolation is necessary:
Present-value factors
3.020
3.020
3.000
2.885
0.135
0.020
24%
IRR rate
26%
Difference
= 24% +
= 24% + (0.148) (2%) = 24.30%
Let the minimum annual cash savings be X.

X (3.889)
Then we want
120,000
120, 000
3.889
X
=
=
30,856
Carmelo, SA, would want annual cash savings of at least 30,856 for the net present value of the
investment to equal zero. This amount of cash savings would justify the investment in financial
terms.
13.16
When the manager is uncertain about future cash flows, the manager would want to do sensitivity
analysis, a form of which is described in requirement 2. Calculating the minimum cash flows
necessary to make the project desirable gives the manager a feel for whether the investment is
worthwhile or not. If the manager were quite certain about the future cash-operating cost savings,
the approaches in requirement 1 would be preferred.
DCF, accounting
(2030 min)
rate
of
return,
working
capital,
evaluation
of
performance.
1a Summary of cash inflows and outflows (in thousands) is:

8
Present value of annuity of savings in cash-operating costs

(25,000 per year for 8 years at 14%): 25,000 4.639
Present value of 30,000 terminal disposal price of machine at
end of year 8: 30,000 0.351
Present value of 8,000 recovery of working capital at
end of year 8: 8,000 0.351
115,975
10,530
2,808
Gross present value

Deduct net initial investment
Special-purpose machine, initial investment
Additional working capital investment
Net present value
129,313
110,000
8,000
1b Use a trial and error approach. First, try a 16% discount rate:
25,000 4.344
108,600
(30,000 + 8,000) 0.305
11,590
Gross present value

Net present value
120,190
(118,000)
2,190
29
118,000
11,313
Second, try an 18% discount rate:

25,000 4.078
101,950
(30,000 + 8,000) 0.266
10,108
Gross present value

Net present value
112,058
(118,000)
(5,942)
By interpolation:
16%
2,190
(2%)
2,190 5, 942
= 16% + (.269) (2%) = 16.54%

2
The accounting rate of return based on net initial investment:

= 110,000 + 8,000
= 118,000

Annual depreciation
(110,000 30,000) 8 years
= 10,000
25, 000 10, 000
Accounting rate of return

3
118, 000
= 12.71%
If your decision is based on the DCF model, the purchase would be made because the net present
value is positive and the 16.54% internal rate of return exceeds the 14% required rate of return.
However, you may believe that your performance may actually be measured using accrual
accounting. This approach would show a 12.71% return on the initial investment, which is below
the required rate. Your reluctance to make a buy decision would be quite natural unless you are
assured of reasonable consistency between the decision model and the performance evaluation
method.
30
13.17
Sporting contract, net present value, payback. (30 min)

1a Summary of cash inflows and outflows (in millions) is as follows:
Cash outflows
Year 1 (start)
Year 1 (end)
Year 2 (end)
Year 3 (end)
Year 4 (end)
Year
0: Year 1 (start)
1: Year 1 (end)
2: Year 2 (end)
3: Year 3 (end)
4: Year 4 (end)
NKr 3.000
5.500
6.200
7.300
7.900
PV
discount
factor
1.000
0.893
0.797
0.712
0.636
Cash
outflows
NKr 3.000
5.500
6.200
7.300
7.900
Cash inflows
Net cash inflows
NKr 0
5.600
8.300
9.100
9.700
NKr (3.000)
0.100
2.100
1.800
1.800
PV of cash
outflows
NKr 3.0000
4.9115
4.9414
5.1976
5.0244
NKr23.0749
Cash
inflows
NKr 0
5.600
8.300
9.100
9.700
PV of cash
inflows
NKr 0
5.0008
6.6151
6.4792
6.1692
NKr24.2643
The net present value of the Monteiro contract is NKr1.1894 (NKr24.2643 NKr23.0749) million.
An alternative approach to determine the NPV of the Monteiro contract is as follows:
Total
Present
present
value
value
of NKr 1
discounted at
12%
(in millions)
End of year
Sketch of relevant cash flows
Year 1 (start)
1.
Initial signing bonus
NKr(3.0000)
2.
Recurring operating cash flows
Year 1 (end) Year 2 (end) Year 3 (end) Year 4 (end)
1.000NKr(3.0)
0.0893
NKr0.1
1.6737
1.2816
1.1448
Net present value
0.636NKr1.8
NKr 1.1894
31
1b Payback period:
Net cash
inflows
Cumulative net
cash inflows
0: Year 1 (start)
1: Year 1 (end)
NKr0.100
NKr0.100
2.900
2: Year 2 (end)
2.100
2.200
0.800
3: Year 3 (end)
1.800
4.000
4: Year 4 (end)
1.800
5.800
Year
Payback period = 2 years +

2
13.20
Cash investment yet

to be recovered
at end of year
NKr 0.800
NKr1.800
NKr3.000
= 2.44 years
Other factors Aspelund might consider include:

a
Uncertainty over the predicted cash inflows for 2012 to 2015. A key factor here is the possible
risk of injury to Monteiro or a diminishing of his soccer ability.
Increase in number of championships Aalesund Fotballklubb wins.
Increase in community pride that accompanies a championship team.
Aspelund's own personal prestige of being president of a championship club.
The effect the signing would have on Aalesund Fotballklubbs ability to sign other players.
Equipment replacement, relevant costs, sensitivity analysis. (3040 min)

1
The first step is to analyse all relevant operating cash flows and align them with the appropriate
alternative. This analysis is as follows:
Moulding
machine
(1)
Sales (irrelevant)
Costs:
Direct materials
Direct manufacturing labour*
Variable overhead*
Fixed overhead (irrelevant)
Marketing and administrative
costs
(irrelevant)
Total relevant operating cash
outflows
Automatic
machine
(2)
Increment
(3)
10,000
20,000
15,000
9,000
10,000
7,500
1,000
10,000
7,500
45,000
26,500
18,500
*Because the automatic machine produces twice as many units per hour, the direct
manufacturing labour cost with the automatic machine would be 10,000; variable overhead,
being 75% of direct manufacturing labour cost, would be 7,500.
Solution Exhibit 13.20 indicates that the automatic machine has a 9,423 net present-value advantage
over the moulding machine.
32
Note: The book value of the old machine is irrelevant and thus is completely ignored. In the light of
subsequent events, nobody will deny that the original 50,000 investment could have been avoided,
with a little luck or foresight. But nothing can be done to alter the past. The question is whether the
company will nevertheless be better off buying the new machine. Management would have been much
happier if the 50,000 had never been spent in the first place, but the original mistake should not be
compounded by keeping the old machine.
33
Net present-value analysis of purchasing new automatic machine.

Presentvalue
Total
discount
present
factor
value
at 18%
End of year
A.
3
4
Automatic machine
(44,000)
1.000
(44,000)
Current disposal price

of old equipment
5,0001.000
5,000
Recurring operating
cash costs
Present value of net
cash outflows
B.
(71,285)2.690
(26,500)
(26,500) (26,500) (26,500)
(110,285)
Moulding machine
Terminal disposal price
of old equipment
4 years hence
1,342 0.516 2,600
Recurring operating
cash costs
(121,050) 2.690
Present value of net

cash outflows
(119,708)
Difference in favour of
replacement (A B)
(45,000) (45,000) (45,000) (45,000)
9,423
An alternative analysis of cash inflows and outflows (in thousands) is:

Presentvalue
Total
discount
present
factor
value
at 18%
End of year
Initial machine investment
(44,000)
Current disposal price of

old machine
5,000
(39,000) 1.000(39,000)
3
4
Recurring operating
cash savings
49,765
2.69018,500
Difference in terminal
disposal prices of machines
(1,342)
0.516 (2,600)
Net present value
9,423
34
18,500 18,500 18,500
Note the cash outflow of 2,600 from the difference in terminal disposal prices of machines. The
relevant cash flow equals the difference in terminal disposal prices of the two machines. If the toy
manufacturer continues to use the old machine, it will receive 2,600 on disposal of its machine at the
end of year 4. If it switches to the new machine, it will receive 0 on disposal at the end of year 4.
Hence, by investing in the new machine instead of continuing with the old one, the toy manufacturer
forgoes 2,600 in terminal disposal price. Hence, 2,600 appears as a cash outflow in year 4 in the
sketch of relevant cash flows.
2
The uniform payback formula can be used because the operating savings are uniform:
Payback period= Uniform increase in annual cash inflow
P=
44,000 5,000
= 2.1 years
18,500
The 5,000 current disposal price of the moulding machine is deducted from the 44,000 cost of
the automatic machine to determine the net initial investment in the automatic machine.
3
This is an example of sensitivity analysis:

Note that the net initial investment and the difference in terminal disposal prices of machines are
unaffected and hence, are included in the equation at the present values that we calculated earlier.
The present value of an annuity of 1 received at the end of each year for 4 years is 2.690.
2.690X=40,342
X=14,997
If the annual savings fall by 3,503, from the estimated 18,500 to 14,997, the point of
indifference will be reached. (Rounding errors may affect the calculation slightly.)
Because the annual operating savings are equal, an alternative way to get the same answer is to
divide the net present value of 9,423 by 2.690 (see Table 4 of Appendix B), obtaining 3,503;
3,503 is the amount of the annual difference in savings that will eliminate the 9,423 of net
present value.
35
13.21
Capital budgeting, computer-integrated manufacturing (CIM), sensitivity.

(25 min.)
1
The net present-value analysis of the CIM proposal is as follows. We consider the differences in
cash flows if the machine is replaced. All values in millions.
Relevant
cash
flows
Presentvalue
discount
factors at
14%
Total
present
value
Initial investment in CIM today
(45)
2a
Current disposal price of old production line
2b
Current recovery of working capital (6 2)
Recurring operating cash savings
4a
Higher terminal disposal price of machines
4b
Reduced recovery of working capital
4* each year for 10 years

(14 0) in year 10
(2 6) in year 10
1.000
(45.000)
1.000
5.000
1.000
4.000
5.216
20.864
14
0.270
3.780
(4)
0.270
Net present value of CIM investment
(1.080)
(12.436)
* Recurring operating cash flows are as follows:

Cost of maintaining software programs and CIM equipment
(1.5)
Reduction in lease payments due to reduced floor-space requirements
1.0
Fewer product defects and reduced reworking
4.5
Annual recurring operating cash flows
4.0
On the basis of this formal financial analysis, Dinamica should not invest in CIM it has a
negative net present value of (12.436) million.
2
Requirement 1 only looked at cost savings to justify the investment in CIM. Manuel estimates
additional cash revenues net of cash operating costs of 3 million a year as a result of higher
quality and faster production resulting from CIM.
From Appendix B, Table 4, the net present value of the 3 million annuity stream for 10 years
discounted at 14% is 3 5.216 = 15.648. Taking these revenue benefits into account, the net
present value of the CIM investment is 3.212 (15.648 12.436) million. On the basis of this
financial analysis, Dinamica should invest in CIM.
Let the annual cash flow from additional revenues be X. Then we want the present value of this
cash flow stream to overcome the negative NPV of (12.436) calculated in requirement 1. Hence,
X (5.216) = 12.436
X = 2.384 million
An annuity stream of 2.384 million for 10 years discounted at 14% gives an NPV of 2.384
5.216 = 12.436 (rounded).
36
4
Relevant
Present-value
Total
cash
discount
present
flows
factors at 14%
(45)
1.000
value
Initial investment in CIM today
(45.000)
2a
Current disposal price of old production line
1.000
5.000
2b
Current recovery of working capital (6 2)
1.000
4.000
3a
Recurring operating cash savings 4
3b
Recurring cash flows from additional revenues of

3 each year for 5 years
3.433
13.732
4a
Higher terminal disposal price of machines

(20 4) in year 5
4b
Reduced recovery of working capital (2 6) in

year 5
3.433
10.299
16
0.519
8.304
(4)
0.519
(5.741)
each year for 5 years
Net present value of CIM investment
(2.076)
The use of too short a time horizon such as 5 years biases against the adoption of CIM projects.
Before finally deciding against CIM in this case, Manuel should consider other factors, including:
a
Sensitivity to different estimates of recurring cash savings or revenue gains.
Accuracy of the costs of implementing and maintaining CIM.
Benefits of greater flexibility that results from CIM and the opportunity to train workers for
the manufacturing environment of the future.
Potential obsolescence of the CIM equipment. Dinamica should consider how difficult the
CIM equipment would be to modify if there is a major change in CIM technology.
Alternative approaches to achieve the major benefits of CIM such as changes in process or
implementation of just-in-time systems.
Strategic factors. CIM may be the best approach to remain competitive against other low-cost
producers in the future.
TP chpt 18
18.13
Transfer-pricing dispute. (20 min)

1
The company as a whole will not benefit if Division C buys on the outside market.
Purchase costs from outsider, 1,000 units 135
135,000
Deduct: Savings in variable costs by reducing

Division A output, 1,000 units 120
120,000
Net cost (benefit) to company as a whole by

buying from outside
15,000
The company will benefit if C purchases from the outside supplier:
37

Deduct: Savings in variable costs,
1,000 units 120
Savings due to As equipment
and facilities being assigned
to other operations
buying from outside
135,000
120,000
18,000
138,000
(3,000)
The company will benefit if C purchases from the outside supplier:

Deduct: Savings in variable costs by reducing
Division A output, 1,000 units 120
buying from outside
38
115,000
120,000
(5,000)
The three requirements are summarised below (in thousands):

(1)
Total purchase costs from outsider

Total relevant costs if purchased from Division A
Total incremental (outlay) costs if purchased
from A
Total opportunity costs if purchased from A
Total relevant costs if purchased from A
Operating income advantage (disadvantage) to
company as a whole by buying from A
(2)
(3)
135
135
115
120
120
120
18
138
120
120
15
(3)
(5)
Goal congruence would be achieved if the transfer price is set equal to the total relevant costs of
purchasing from Division A.
18.14
Transfer-pricing problem. (5 min)

The company as a whole would benefit in this situation if C purchased from outside suppliers. The
15,000 disadvantage to the company as a whole by purchasing from the outside supplier would be
more than offset by the 30,000 contribution margin of As sale of 1,000 units to other customers.
Purchase costs from outside supplier, 1,000 units 135
Deduct variable cost savings, 1,000 units 120
Net cost to company as a whole by buying from outside
135,000
120,000
15,000
As sales to other customers, 1,000 units 155
155,000
Deduct:
Variable manufacturing costs, 120 1,000 units
120,000
Variable marketing costs, 5 1,000 units

Variable costs
Contribution margin from A selling to other customers
18.17
Effect of
(30 min)
alternative
transfer-pricing
methods
1
Internal transfers at
market prices
(Method A)
5,000
125,000
30,000
on
divisional
Internal transfers at
110% of
full costs
(Method B)
Mining Division
Revenues:
90 400,000 units; 66a
400,000 units
36,000,000
26,400,000
20,800,000
20,800,000
3,200,000
3,200,000
Division operating income
12,000,000
2,400,000
Metals Division
Revenues:
150 400,000 units
60,000,000
60,000,000
Deduct:
Division variable costs:
52b 400,000 units
Division fixed costs:
8c 400,000 units
operating
39
profit.
Deduct:
Transferred-in costs:
36,000,000
26,400,000
90 400,000 units; 66
400,000 units
Division variable costs:
36d 400,000 units
14,400,000
14,400,000
Division fixed costs:

15e 400,000 units
6,000,000
6,000,000
3,600,000
13,200,000
Division operating income

a
b
66 = 60 110%.
Variable cost per unit in Mining Division = Direct materials + Direct manufacturing labour + 75% of Manufacturing
overhead = 12 + 16 + 75% 32 = 52.
Fixed cost per unit = 25% of Manufacturing overhead = 25% 32 = 8.
Variable cost per unit in Metals Division = Direct materials + Direct manufacturing labour + 40% of Manufacturing
overhead = 6 + 20 + 40% 25 = 36
e
Fixed cost per unit in Metals Division = 60% of Manufacturing overhead = 60% 25 = 15
Bonus paid to division managers at 1% of divisional operating income will be as follows:
Mining Division managers bonus

(1% 12,000,000; 1% 2,400,000)
Metals Division managers bonus
(1% 3,600,000; 1% 13,200,000)
Method A
(Internal transfers
at market prices)
Method B
(Internal transfers at
110%
of full costs)
120,000
24,000
36,000
132,000
40
The Mining Division manager will prefer Method A (transfer at market prices) because this
method gives 120,000 of bonus rather than 24,000 under Method B (transfers at 110% of full
costs). The Metals Division manager will prefer Method B because this method gives 132,000 of
bonus rather than 36,000 under Method A.
3
Arturo Tuzn, the manager of the Mining Division will appeal to the existence of a competitive
market to price transfers at market prices. Using market prices for transfers in these conditions
leads to goal congruence. Division managers acting in their own best interests make decisions that
are also in the best interests of the company as a whole.
Tuzn will further argue that setting transfer prices based on cost will cause him to pay no
attention to controlling costs since all costs incurred will be recovered from the Metals Division at
110% of full costs.
41

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CVP chp8

CVP, movie production. (10 min)

Fixed costs = 5,000,000 (production cost)

Break even point in revenues =

Espasso receives 62.5% of box-office receipts. Box-office receipts of

Revenues, 0.625 300,000,000

Variable costs, 0.20 187,500,000

CVP, cost structure differences, movie production. (20 min)

Box-office receipts of 76,800,000 translate to 48,000,000 in revenues to Espasso.

Breakeven points in revenues =

Box-office receipts of 64,000,000 translate to 40,000,000 in revenues to Espasso.

Difference in breakeven points

Revenues, 0.625 300,000,000

CVP, shoe stores. (2030 min)

Variable costs, 21 35,000

Operating income (loss)

Fixed costs: 360,000 + 81,000 = 441,000

Breakeven point in units =

Breakeven point in revenues = 30 42,000 = 1,260,000

Fixed costs = 360,000

Breakeven point in units =

Breakeven point in revenues = 30 41,380 = 1,241,400

Breakeven point = 40,000 pairs

An alternative approach is 10,000 units 8.70 = 87,000

CVP, shoe stores. (2025 min)

19.50Q + 360,000 + 81,000=21.00Q + 360,000

Let TQ = Target number of units

30.00TQ 19.50TQ 441,000 = 168,000

30.00TQ 21.00TQ 360,000 = 168,000

Cost estimation chpt 9

Linear cost approximation. (25 min)

= 529,000 43.00 (7,000)

= 228,000 + 43.00 (professional labour-hours)

The linear cost function is plotted in Solution Exhibit 9.15.

A comparison at various levels of professional labour-hours is as follows. The linear

Solution Exhibit 9.15

Regression analysis, service company. (25 min)

Economic plausibility. Labour-hours appears to be an economically plausible driver

Variable overhead (0.5 hours 3.93 per labour-hour)

Total variable cost per person

Solution Exhibit 9.16

Solution Exhibit 9.19A

Solution Exhibit 9.19B

Plot of number of enrolled students versus overhead costs (in thousands).

Solution Exhibit 9.19C

A positive relationship between

Excellent goodness of fit.

t-value of 3.53 is significant.

Plot of the data indicates that

Plot of the data indicates that

19.20 Solution given in book

Relevant costs and LP

Relevant costs, contribution margin and product emphasis. (2025 min)

Customer profitability, choosing customers. (2025 min)

Jours-Daim would be worse off by 12,000 if it drops the Fourbe-Riz business.

If Jours-Daim accepts the additional business from Fourbe-Riz, it would take an

Contribution margin per machine-hour

Since the 80,000 of additional Fourbe-Riz business in February is identical to jobs

Alternatively, we could present Jours-Daims operating income by taking two-thirds

Relevance of equipment costs. (3040 min)

Buy new machine

Receipts from operations:

Other operating costs