III.

Problems with Solutions

Standard costing

You have recently graduated from a university and have accepted a

position with Villar Company, the manufacturer of a popular consumer
product. During your first week on the job, the vice president has been
favorably impressed with your work. She has been so impressed, in fact,
that yesterday she called you into her office and asked you to attend
the executive committee meeting this morning for the purpose of leading
a discussion on the variances reported for last period. Anxious to
favorably impress the executive committee, you took the variances and
supporting data home last night to study.

On your way to work this morning, the papers were laying on the seat of
your new, red convertible. As you were crossing a bridge on the highway,
a sudden gust of wind caught the papers and blew them over the edge of
the bridge and into the stream below. You managed to retrieve only one
page, which contains the following information:

Standard Cost Summary

Direct materials, 6 pounds at P3 P18.00
Direct labor, 0.8 hours at P5 4.00
Variable overhead, 0.8 hours at P3 2.40
Fixed overhead, 0.8 hours at P7 5.60
P30.00

Total V A R I A N C E S R E P O R T E
Standard D
Cost Price Spending Quantity Volume
or or or
Rate Budget Efficiency
Direct P405,000 P6,900 P9,000 U
materials F
Direct 4,850 7,000 U
labor 90,000 U
Variable P1,300 F ?@
overhead 54,000
Fixed 500 P14,000U
overhead 126,000 F
Applied to Work in process during the period
@ Figure obliterated.

You recall that manufacturing overhead cost is applied to production

on the basis of direct labor-hours and that all of the materials
purchased during the period were used in production. Since the
company uses JIT to control work flows, work in process inventories
are insignificant and can be ignored.

It is now 8:30 A.M. The executive committee meeting starts in just

one hour; you realize that to avoid looking like a bungling fool you
must somehow generate the necessary “backup” data for the variances
before the meeting begins. Without backup data it will be impossible
to lead the discussion or answer any questions.

1. How many pounds of direct materials were purchased and used in the
production of 22,500 units?

SQ allowed (22,500 x 6) 135,000

Unfavorable usage variance 3,000
Actual quantity of materials 138,000
2. What was the actual cost per pound of material?

Actual quantity purchased and used at standard price (138,000 x

3) 414,000
Favorable price variance 6,900
Actual Quantity @ Actual Price 407,100
Actual Price (407,100 ÷ 138,000) P2.95

3. How many actual direct labor hours were worked during the period?

SH @ SR 90,000
Efficiency Variance 7,000
AH @ SR 97,000
Actual hours (97,000 ÷ 5) 19,400

4. What is the total fixed manufacturing overhead cost in the company’s

flexible budget?

Applied Fixed OH 126,000

Underapplied fixed overhead 14,000
Budgeted fixed overhead 140,000

5. What were the denominator hours for last period?

Denominator or Budgeted Hours: (140,000 ÷ 7) = 20,000

Franklin Glass Works’ production budget for the year ended November 30,
2001 was based on 200,000 units. Each unit requires two standard hours
of labor for completion. Total overhead was budgeted at P900,000 for the
year, and the fixed overhead rate was estimated to be P3.00 per unit.
Both fixed and variable overhead are assigned to the product based on
direct labor hours. The actual data for the year ended November 30, 2001
are presented below.

Actual production in units 198,000

Actual direct labor hours 440,000
Actual variable overhead P 352,000
Actual fixed overhead P 575,000

Franklin’s variable overhead efficiency variance for the year ended

November 30, 2001 is

Ans. P33,000 unfavorable

Lucky Company sets the following standards for 2003:

Direct labor cost (2 DLH @ P4.50) P 9.00

Manufacturing overhead (2 DLH @ P7.50) 15.00
Lucky Company plans to produce its only product equally each month. The
annual budget for
overhead costs are:
Fixed overhead P150,000
Variable overhead 300,000
Normal activity in direct labor hours 60,000

In March, Lucky Company produced 2,450 units with actual direct labor
hours used of 5,050.
Actual overhead costs for the month amounted to P37,245 (Fixed overhead
is as budgeted.)

The amount of overhead volume variance for Lucky Company is

Answer: P250 unfavorable

Capital Budgeting

Bilt-Rite Co. has the opportunity to introduce a new product. Bilt-

Rite expects the product to sell for $60 and to have per-unit variable
costs of $40 and annual cash fixed costs of $3,000,000. Expected
annual sales volume is 250,000 units. The equipment needed to bring
out the new product costs $5,000,000, has a four-year life and no
salvage value, and would be depreciated on a straight-line basis.
Bilt-Rite's cost of capital is 10% and its income tax rate is 40%.

a. Find the increase in annual after-tax cash flows for this

opportunity.

b. Find the payback period on this project.

c. Find the NPV for this project.

SOLUTION:

a. Increase in annual cash flows: $1,700,000

Income before taxes, 250,000 x ($60 - $40)

- $3,000,000 - $5,000,000/4 $ 750,000
Income tax (300,000)
----------
Net income $ 450,000
Plus depreciation 1,250,000
----------
Net cash flow $1,700,000
==========

b. Payback period: 2.94 years ($5,000,000/$1,700,000)

c. NPV: $389,000 [($1,700,000 x 3.170) - $5,000,000]

Panama Insurance Company’s management is considering an advertising

program that would require an initial expenditure of P165,500 and bring
in additional sales over the next five years. The cost of advertising
is immediately recognized as expense. The projected additional sales
revenue in Year 1 is P75,000, with associated expenses of P25,000. The
additional sales revenue and expenses from the advertising program are
projected to increase by 10 percent each year. Panama Insurance Company’s
tax rate is 40 percent. The present value of 1 at 10 percent, end of
each period:

Periods Present value Factory

1 0.90909
2 0.82645
3 0.75131
4 0.68301
5 0.62092
The net present value of the advertising program would be

Answer: P37,064

The management of Arleen Corporation is considering the purchase of a

new machine costing P400,000. The company’s desired rate of return is
10%. The present value of P1 at compound interest of 10% for 1 through
5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively, and the
present value of annuity of 1 for 5 periods at 10 percent is 3.79. In
addition to the foregoing information, use the following data in
determining the acceptability in this situation:

Year Income from Operations Net Cash Flow

1 P100,000 P180,000
2 40,000 120,000
3 20,000 100,000
4 10,000 90,000
5 10,000 90,000

1. The average rate of return for this investment is:

Average Annual net income:

(100,000 + 40,000 + 20,000 + 10,000 + 10,000) ÷ 5 =
36,000
Divide by average investment (400,000 ÷ 2) 200,000
Accounting rate of return 18%
Accounting rate of return or unadjusted rate of return computes the
profitability of the project in term of accrual profit. Net profit
under accrual method considers depreciation, a substantial amount
that understates the average profit. This understatement of amount
that is used in the computation necessarily requires that preferably,
average investment should be used, instead of the initial investment,
in the determination of accounting rate of return.

2. The net present value for this investment is:

Cash Flow PV Factor PV of annual net cash

flows:
180,000 0.909 163,620
120,000 0.826 99,120
100,000 0.751 75,100
90,000 0.683 61,470
90,000 0.621 55,890
Total 455,200
Amount of 400,000
investment
Net Present 55,200
Value

3. The present value index for this investment is:

Present Value Index (Profitability Index)

Present Value of ATCF ÷ Net Investment(455,200 ÷ 400,000) = 1.14
The present value index computes net present value in terms of P1
investment. Therefore, the index of 1.14 means the net present value
per P1 of investment is P0.14. This concept makes the present value
index better than the net present value technique because the index
indicates which one is the most profitable on a per P1 investment.

4. The cash payback period for this investment is:

Cash Inflow Unrecovered

Investment
Period 0 (400,000)
Outflows
Period 1 180,000 (220,000)
Period 2 120,000 (100,000)
 Period 3 100,000 Zero

The total outflows are fully recovered by the end of period 3.

The analyst should be careful in computing the payback period when
the project has uneven cash inflows. The common error in handling
uneven cash flows is using the average cash flows instead of reducing
the unrecovered outflows

Financial Statement Analysis

Milward Corporation’s books disclosed the following information for

the year ended December 31, 2007:
Net credit sales P1,500,000
Net cash sales 240,000
Accounts receivable at beginning of year 200,000
Accounts receivable at end of year 400,000
Milward’s accounts receivable turnover is

Answer: 5.00 times

During 2007, Tarlac Company purchased P960,000 of inventory. The

cost of goods sold for 2007 was P900,000, and the ending inventory
at December 31, 2007 was P180,000. What was the inventory turnover
for 2007?

Answer 6.0

Selected information from the accounting records of Petals Company is

as follows:
Net sales for 2007 P900,000
Cost of goods sold for 2007 600,000
Inventory at December 31, 2006 180,000
Inventory at December 31, 2007 156,000
Petals’ inventory turnover for 2007 is

Answer: 3.57 times

The current assets of Mayon Enterprise consists of cash, accounts

receivable, and inventory. The following information is available:
Credit sales 75% of total sales
Inventory turnover 5 times
Working capital P1,120,000
Current ratio 2.00 to 1
Quick ratio 1.25 to 1
Average Collection period 42 days
Working days 360
The estimated inventory amount is:

Answer: 840,000

Selected information from the accounting records of the Blackwood Co.

is as follows:
Net A/R at December 31, 2006 P 900,000
Net A/R at December 31, 2007 P1,000,000
Accounts receivable turnover 5 to 1
Inventories at December 31, 2006 P1,100,000
Inventories at December 31, 2007 P1,200,000
Inventory turnover 4 to 1
What was the gross margin for 2007?

Answer: P150,000