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MA1 2012-2013

MANAGEMENT ACCOUNTING

MODULE 10

PART 1 Slides 8 – 23: Cost-plus pricing Naylor Company is considering the introduction of a new product. Management has gathered the following information: Number of units to be produced and sold each year: Unit product costs: Direct materials Direct labour Variable overhead Fixed overhead Variable SG&A expenses Fixed SG&A Estimated investment required by the company Desired return on investment (ROI) Required • •

12,500 $12 9 4 5

$30

$2/unit $35,000 $500,000 18%

Compute the markup the company will have to use to achieve the desired ROI Compute the target selling price per unit.

Solution Absorption costing approach

Variable costing approach

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MA1_mod10_handout1.docx

MA1 2012-2013

MANAGEMENT ACCOUNTING

MODULE 10

PART 2 Slides 26 – 28: Target costing Naylor Company is considering the introduction of a new product. Based on market research it has been decided that there will be a demand for the product if it is priced at $40 per unit. Management has gathered the following additional information: Number of units to be produced and sold each year Estimated investment required by the company Desired return on investment (ROI)

12,500 $500,000 18%

Required •

Compute the total and per unit target cost for the year.

Solution

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MA1_mod10_handout1.docx

MA1 2012-2013

MANAGEMENT ACCOUNTING

MODULE 10

PART 2 Slides 30 – 35: Time and material pricing Solution 1. Time rate to be used: Mechanics’ wages and fringe benefits ($900,000 ÷ 50,000 hours) Other repair costs ($450,000 ÷ 50,000 hours) Desired profit per hour of plumber time Total charging rate per hour for service

$18 9 8 $35

Ma terial loading charge: Ordering, handling, and storage cost Desired profit on parts Material loading charge 2. Time charge: 12 hours × $35 per hour Material charge: Invoice cost of parts Material loading charge (80% × $100) Billed cost of the job

40% of material invoice cost 40% of material invoice cost 80% of material invoice cost $ 420 $100 80

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180 $600

MA1_mod10_handout1.docx

MA1 2012-2013

MANAGEMENT ACCOUNTING

MODULE 10

PART 4 Slides 50 – 53: Past CGA exam question Joseph Cramden, an inventor, has discovered a new material for camping tents that provides better protection from the elements than any other tents on the market. Joseph has come to you to help him launch his new venture. He provides you with the following projections for his first year of operations. Direct labour hours for yea r Cost of goods sold Selling and administrative expenses

90,000 $ 8,100,000 $ 4,260,000

For each tent, he will use 10 metres of the special material at a price of $15 per metre and will required three hours of direct labour to assemble. 25% of the overhead is variable and the remainder is fixed. The variable overhead cost per tent is $18 and the variable selling cost is $12 per unit sold. Overhead is allocated on the basis of direct labour hours. (Assume that all tents produced are sold.) Joseph thinks that he will need an investment of $2,000,000 to carry inventories and accounts receivable and to purchase the necessary equipment. He believes that he can get a price that yields a 30% return on Investment (ROI). Required a.

Compute a standard cost card for one tent.

b.

Assume that Joseph uses absorption costing.

c.

i)

Compute the markup percentage that Joseph needs on the tents in order to achieve a 30% ROI.

ii)

Based on your answer to part i), prepare a price quotation sheet for a single tent.

iii)

Assume that Joseph will sell all the tents he produces. Prepare an income statement for the first year of activity.

Assume that Joseph uses the variable costing approach. i)

Compute the markup percentage that Joseph needs on the tents in order to achieve a 30% ROI.

ii)

Based on your answer to part i), prepare a price quotation sheet for a single tent.

iii)

Assume that Joseph will sell all the tents he produces. Prepare an income statement for the first year of activity.

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MA1_mod10_handout1.docx

MA1 2012-2013

MANAGEMENT ACCOUNTING

PART 4 Slides 50 – 53: Past CGA exam question Solution (continued) a) Standard Standard quantity/hours price/rate Direct materials 10 metres/tent $ 15 per metre Direct labour 3 hours/tent $ 16 per hour Overhead (25% variable, 75% fixed) Variable Fixed

MODULE 10

Standard Cost $ 150 48 3

3 hours/tent $ 6 per DL hour 3 hours/tent $18 per DL hour

Total standard cost per tent

$18 2

54 $ 270

1

Calculations

Number of tents produced: 90,000 / 3 hours per tent = 30,000 tents 1

COGS =

DM DL VOH FOH 8,100,000/30,000 = $270 per tent

2

variable costs are 25% (total overhead) total overhead (18/.25) fixed overhead is 75% of the total $72

3

Per tent:

DM DL VOH FOH

= = = =

150 ? 18 54 270

= 18 = 72 = 54

(variable costs) 25% x 72 = 18 and 75% x 72 = 54

Solving for DL = $48 per tent

(b)(i) Markup % = desired return + selling and admin expenses Volume*(unit cost to manufacture)

(b)(ii) Direct materials Direct labour VOH FOH Total costs to manufacture Add: 60% markup Target selling price

= 30%(2,000,000) + 4,260,000 30,000*(270) = 60%

$ 150 48 18 54 270 162 $ 432

(b)(iii) Sales (30,000 x 432) $ 12,960,000 COGS (30,000 x 270) 8,100,000 Gross profit 4,860,000 Selling and administrative expenses 4,260,000 Net income $ 600,000

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MA1_mod10_handout1.docx

MA1 2012-2013

MANAGEMENT ACCOUNTING

MODULE 10

PART 4 Slides 50 – 53: Past CGA exam question Solution (continued) (c)(i) Markup % = = desired return + fixed costs volume ( unit variable costs) = 30% (2,000,000) + 5,520,000 * 30,000 (150 + 48 + 18 + 12) = .8947368 = 89.47368%

* FOH = 75% (72) x 30,000 FSE = 4,260,000 - 30,000(12) Total fixed costs

(c)(ii) Direct materials Direct labour VOH VSE

$ 150 48 18 12

Total variable costs Add: 89.47368% markup Target selling price

228 204 $ 432

= =

1,620,000 3,900,000 5,520,000

(c)(iii) Sales (30,000 x 432) $ 12,960,000 Variable costs (30,000 x 228) 6,840,000 Contribution margin 6,120,000 Fixed expenses Manufacturing 1,620,000 Selling and administrative 3,900,000 5,520,000 Net income $ 600,000

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MA1_mod10_handout1.docx

MA1 2012-2013

MANAGEMENT ACCOUNTING

MODULE 10

PART 5 Slides 55 – 58: Past CGA exam question Carrier Fabrication Company (CFC) manufactures and sells only one product, a special front-mounting bicycle rack for large vehicles. CFC entered into a one-time contract to produce an additional 1,000 racks for the local public transit authority, at a price of “cost plus 20%.” The company has a plant with a capacity of 9,000 units per year, but normal capacity utilization for production of this product is 4,000 units per year. The costs to produce those 4,000 units are as follows. Cost Materials Labour Supplies and other variable indirect costs Fixed indirect costs (allocated based on normal capacity) Variable marketing Administrative (all fixed)

Total $ 192,000 304,000 128,000 176,000 32,000 64,000

After completing half of the order, the company billed the authority for $134,400. Shortly thereafter, the transit authority’s purchasing agent called the president of CFC to dispute the invoice. The purchasing agent stated that the invoice should have been for $93,600. Required a.

Calculate the components of the “full-cost” unit price charged to the transit authority, as determined by CFC.

b.

Calculate the components of the “differential cost” unit price that should have been charged, as determined by the transit authority purchasing agent.

c.

What price per unit would you recommend? Explain your rationale. (Note: You need not limit yourself to the costs selected by the company or by the agent.)

Solution a.

The company used “full cost” per unit and charged the transit authority on that basis. The per-unit cost is as follows: Cost Materials Labour Supplies and other variable indirect costs Fixed indirect costs Variable marketing Administrative Total

Total $ 192,000 304,000 128,000 176,000 32,000 64,000

Per Unit $ 48.00 76.00 32.00 44.00 8.00 16.00 $ 224.00

Per-unit price billed to the authority is $224.00 × 120% = $268.80 Proof: $268.80 × 500 = $134,400

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MA1_mod10_handout1.docx

MA1 2012-2013

MANAGEMENT ACCOUNTING

MODULE 10

PART 5 Slides 55 – 58: Past CGA exam question Solution (continued) b.

The transit authority agent looked at the differential costs and considered only those costs as the cost basis. The per-unit price as determined by the transit authority purchasing agent would be: Price per unit = $93,600/500 = $187.20 “Cost” after removing 20% markup = $156.00 Let X = cost before markup X + .20X = 187.20 1.20X = 187.20 X = 156.00 Components of the “differential cost” unit price: Material $ 48.00 Labour 76.00 Supplies and other variable indirect costs 32.00 $ 156.00

c.

It would have been best if the transit authority and CFC had agreed upon a definition of cost beforehand. Agreement might be reached by charging the authority with the differential costs incurred due to the contract plus some “fair share” of the fixed costs. The marketing costs can be ignored. One possible solution would be: Costs Materials Labour Supplies and other variable indirect costs

Per Unit $ 48.00 76.00 32.00 1

Fixed indirect Administrative

35.20 2 12.80 204.00 40.80 $244.80

Plus 20% markup 1

“Fair share” of fixed indirect costs per unit: $176,000/5,000 units = $35.20 per unit

2

“Fair share” of administrative costs: $64,000/5,000 total units = $12.80 per unit

Note: For part (c), the provided solution is an example only. A qualitative discussion of any logical or reasonable basis for determination of an appropriate price, including a decision of “fair share” or “reasonable portion” of fixed costs, is sufficient for full marks.

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MA1_mod10_handout1.docx

MA1 2012-2013

MANAGEMENT ACCOUNTING

MODULE 10

PART 6 Slides 60 – 63: Past CGA exam question Cassidy has created a successful business manufacturing and selling “Rainbow Sparkles”, a high-end soft, stuffed unicorn for young children. She sells them to department stores for $50 each. Current manufacturing capacity is 20,000 unicorns per year. Costs to manufacture and sell each stuffed animal are as follows: Direct materials $ 5.50 Direct labour 7.00 Variable overhead 10.00 Fixed overhead 12.00 Variable selling expenses 3.00 Cassidy is currently manufacturing and selling 20,000 unicorns per year. A British department store has contacted Cassidy with a one-time offer to buy 2,000 units. The store wants its own label attached to each stuffed animal, which will add $0.50 per unit to the costs of manufacturing. No selling expenses need be incurred on this transaction. Required a.

Determine the per-unit opportunity cost of selling to the British department store.

b.

Determine the minimum selling price that Cassidy should set.

c.

Discuss briefly two of the qualitative factors Cassidy should consider in making the decision to accept or reject this offer.

Solution a.

Opportunity cost: ALWAYS, ask yourself when considering an opportunity cost – is there a capacity issue in the problem or not. In order to sell to the British department store, Cassidy must divert production and sales away from regular customers since she is operating at capacity. The opportunity cost is her contribution margin per unit on regular sales: CM per unit = SP – VC = $50 – (5.50 + 7.00 + 10.00 + 3.00) = $24.50

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MA1_mod10_handout1.docx

MA1 2012-2013

MANAGEMENT ACCOUNTING

MODULE 10

PART 6 Slides 60 – 63: Past CGA exam question (continued) b.

Minimum selling price should be: $50.00 – 3.00 + .50 = $47.50 BECAUSE, the units are already made regardless of whether they are sold through regular channels or on the special order, those costs (DM, DL and VOH) are not relevant to the decision. Another approach is first determine the contribution margin on the 2,000 units selling through regular channels and then determine the selling price on the special order such that the contribution margins are equal. Sale of 2,000 units to Regular Customers Selling price per unit = 50.00 Variable costs per unit DM 5.50 DL 7.00 VOH 10.00 VSE 3.00 Variable cost per unit 25.50 Contribution margin per unit 24.50 x 2,000 units Total contribution margin 49,000

One time special offer to British Department Store Selling price per unit = SP Variable costs per unit DM 5.50 DL 7.00 VOH 10.00 Other (label) 0.50 Variable cost per unit 23.00 Contribution margin per unit (SP – 23.00) x 2,000 units Total contribution margin 49,000

NOW, all you have to do is solve for the selling price. (SP – 23.00) x 2,000

= 49,000

SP – 23.00

= 24.50

Minimum selling price

= $47.50

c.

Divide both sides by 2,000

In deciding whether to accept the offer, Cassidy should consider the effect of such action on her present customers. One such consideration is that if she drops or short-ships a customer, they may purchase another product from someone else to fill in the gap. If that substitute product is successful, the former customer may not do business with Cassidy in the future. The offer from the British Department Store is a one-time-only offer – can she replace that lost business? Another issue is the wisdom of selling to one customer at a price less than she charges to other customers. The reduction can be justified at least in part by the fact that her transaction costs are less (for example, by the advertising expense), but it still may be perceived poorly by current customers. If it causes resentment, it could ultimately hurt future business – the incremental revenue from this onetime transaction may not be worth the potential future problems.

Note: This is an example solution only – marks will be awarded for discussion of any relevant qualitative issues.

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MA1_mod10_handout1.docx

MA1 2012-2013

MANAGEMENT ACCOUNTING

MODULE 10

PART 7 Slides 65 – 68: Past CGA exam question RST Manufacturing Ltd. produces syrup and a fruit drink. The syrup is either processed into fruit drink or sold to other fruit drink manufacturers. The same equipment is used to process both the syrup and fruit drink. A gallon of syrup takes one machine hour while it takes two machine hours to produce a gallon of fruit drink from the syrup. During 1998, RST plans to allocate 20% of its available machine hours to fruit drink production. Manufacturing overhead is applied on the basis of machine hours. Total estimated production for 1998 requires 500,000 machine hours. Based on these estimates, total variable manufacturing overhead is $500,000 and the total estimated manufacturing overhead cost is $1,500,000. At 500,000 machine hours, the plant is at full capacity.

Selling price Costs: Direct materials Direct labour Manufacturing overhead Gross profit

Per Gallon of Syrup $ 10

Per Gallon of Fruit Drink $ 30

1 2 3 6 $4

* 11 4 6 21 $9

* Includes the cost of the syrup transferred at full cost on the absorption cost basis. Total selling and administrative expenses at full capacity is $500,000 (the variable portion is $250,000). Last year’s production required 400,000 machine hours. Required: The following parts of the required are independent. a.

A customer has suggested that the machine hours currently allocated to fruit drink production be used instead to produce additional syrup, for which he offers to pay $9 per gallon. Should RST produce the fruit drink or accept this customer’s offer? Show all calculations.

b.

Assume RST produces only syrup and that it requires a return of 20% after tax on its investment of $500,000 (tax rate is 50%). Using the absorption cost-plus basis for pricing, what should the selling price per gallon of syrup be to exactly meet RST’s required return on investment while operating at full capacity? Show all calculations.

c.

This is the first year that RST will be operating at full capacity. Last year, it sold all of its production, which required 400,000 machine hours. Assume a $9.50 selling price per gallon of syrup and a cost of $6.00 per gallon (per cost schedule). What would be the required sales in gallons for 1998 if RST only sold syrup and required a net income of $75,000 after tax (tax rate is 40%)? Show all calculations.

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MA1_mod10_handout1.docx

MA1 2012-2013

MANAGEMENT ACCOUNTING

MODULE 10

PART 7 Slides 65 – 68: Past CGA exam question a. Contribution from one gallon of fruit drink: Incremental revenue (30 – 10) Variable costs: Direct materials (11 – 6) Direct labour Variable overhead (1/3 x 6) Contribution per gallon

$ 20 5 4 2

Contribution per machine hour 9/2 Contribution from one gallon of syrup from special order: Revenue Variable costs Direct materials Direct labour Variable overhead (1/3 x 3) Contribution per gallon

11 $9 $ 4.50

$9 1 2 1

4 $5

Contribution per machine hour 5/1

$5

RST should accept the customer’s special order since the contribution per constraining factor (machine hours) is greater. The contribution and net income of RST will increase by 20% x 500,000 x (5 – 4.50) = $50,000. Note: Variable selling and administrative expenses are not considered in the above analysis since the assumption was made that total variable selling and administrative expenses would be the same under either option. Full marks are awarded for any other reasonable assumptions made. b)

markup = desired return + selling and administrative volume x (unit cost)

NIBT tax return after tax

X (.50X) .20

= 500,000 (.40) + 500,000 500,000x (6) = .233333 or 23.3333%

X - .50X .50X X

= .20 = .20 = .40

Selling price = cost + markup = 6 + 6(.23333) = $7.40 c)

SP (X) -VC(X) FC [9.50X – X(1 + 2 + 1/3(3) + .50) - 250,000 - 1,000,000] 5X X

= =

= NIBT = 75,000 .6

1,375,000 275,000 gallons

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MA1_mod10_handout1.docx

MA1 2012-2013

MANAGEMENT ACCOUNTING

MODULE 10

PART 8 Slides 70-71: Multiple Choice Questions Q1

Under absorption costing, which of the following statements regarding the determination of markup percentage is true? 1) 2) 3) 4)