Session 14 - Exam II Review_In Class

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Session 14 Review for Exam II

Date: Wednesday, March 14 Time: 6:00 – 7:20 pm Location:Refer to the room assignments below Student (Last Name) Exam Room A - C JMHH F95 D - Ji SHDH 350 Jo - Mi SHDH 351 Mo – Z JMHH G06 If you have a course conflict that is approved by your instructor, you will take the exam at your regular class time. (JMHH 245 for noon, JMHH 250 for 1:30) Exam Instructions and Additional Information

Information and Instructions (“Rules of the Road”): 1. The exam may include any lecture material from Sessions 7 – 13. 2. The exam will be closed book – you will not be permitted to use your textbook or class notes to complete the exam. 3. You will be permitted to use a 8½” x 11” sheet of notes (double-sided) to complete the exam. 4. You may use a calculator to complete the exam. PDAs, laptop computers, cell phones, or other electronic devices are not permitted. 5. If you wish to reserve the right to submit your exam for regrade, you must complete the exam in non-erasable ink and you may not use white-out or any other method of erasure. Exams completed using pencil or any other erasable writing instrument will not be accepted for regrade under any circumstances. 6. The exam proctors have been instructed not to answer any questions during the exam. If you are uncertain, state whatever assumption(s) that you think are necessary to answer the question(s) and then continue.

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Potential Exam Topics: • Accounting Break-even Cost classifications Break-even formula Session 7 • Product Costing Flow of costs Cost methods – actual, normal, standard Accounting for overhead Closing variance accounts Session 8 • Absorption Costing, Variable Costing, Throughput Accounting Incentives for overproduction, combination with actual, normal, and standard costing Session 9 • Activity Based Costing Conceptual differences (activity pools, causal cost drivers, cost hierarchy) ABC computations Customer profitability analysis Sessions 10 and 11 • Activity Based Management Target costing Quality function deployment & Importance index Session 12 • Support Department Cost Allocation Direct method Stepdown method Reciprocal method Session 13

Review Problems

6 Saxon Associates’ only costs/expenses are some assembly labor, manufacturing overhead, and assorted selling costs. The following information is available for fiscal year 2011: Budgeted Production 2,000 units Expected Output (EO) Budgeted Overhead $50,000 EO x SI x SP Budgeted (Standard) direct labor 5 hours/unit SI Budgeted (Standard) wage rate $5.50/hour SP Actual Production 2,000 units AO Actual total direct labor used 20,000 hours AO x AI Actual total direct labor cost $80,000 AO x AI x AP Actual total Overhead $30,000 AO x AI x AP Actual Sales Volume 1,500 units Actual (average) selling price $150/unit Actual sales commissions cost $8.00/unit sold Actual fixed selling costs $10,000 The firm had no beginning inventory of any kind, and no ending WIP inventory. It allocates overhead using direct labor hours as the allocation base. All product cost variances are closed to cost of goods sold. PROBLEM 1

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7 Compute the cost of goods sold using standard costing . Standard Cost per unit (= SI x SP) Direct Labor 5 hr x $5.50/hr = $27.50 Overhead $50,000 / (2,000 units) = $25.00 $52.50 Variances (based on actual production) Actual Cost (AO x AI x AP) ̶̶ Applied Cost (AO x SI x SP) = Variance Direct Labor $80,000 ̶̶ 2,000 x $27.50 = 25,000 UA Overhead $30,000 ̶̶ 2,000 x $25.00 = ̶̶ 20,000 OA 5,000 UA COGS = (Sales Volume x Std Cost/Unit) + Under-applied Overhead = (1,500 x 52.50) + 5,000 = 78,750 + 5,000 = 83,750

8 Saxon Associates’ only costs/expenses are some assembly labor, manufacturing overhead, and assorted selling costs. The following information is available for fiscal year 2011: Budgeted Production 2,000 units Expected Output (EO) Budgeted Overhead $50,000 EO x SI x SP Budgeted (Standard) direct labor 5 hours/unit SI Budgeted (Standard) wage rate $5.50/hour SP Actual Production 2,000 units AO Actual total direct labor used 20,000 hours AO x AI Actual total direct labor cost $80,000 AO x AI x AP Actual total Overhead $30,000 AO x AI x AP Actual Sales Volume 1,500 units Actual (average) selling price $150/unit Actual sales commissions cost $8.00/unit sold Actual fixed selling costs $10,000 The firm had no beginning inventory of any kind, and no ending WIP inventory. It allocates overhead using direct labor hours as the allocation base. All product cost variances are closed to cost of goods sold. PROBLEM 1

9 Given the actual production volume of 2,000 units, how many units would the company need to sell to earn $113,000 pre-tax using actual costing ? Actual Cost per unit (= AI x AP) Direct Labor $80,000 / 2,000 units = $40.00 Overhead $30,000 / 2,000 units = $15.00 $55.00 Let the Sales Volume = Q And, Revenue – Expenses = Pre-tax Income Revenue = 150 x Q Expenses = COGS + Commissions + Fixed Selling = 55 x Q + 8 x Q + 10,000 150 x Q [55 x Q + 8 x Q + 10,000] = 113,000 ̶ Q = 1,414

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RE Corporation is one of the country’s largest providers of residential and commercial real estate mortgage financing. Because of significant differences between the two markets, the firm’s lending operations are conducted by two divisions: the Residential Division, which is responsible for all residential mortgage lending activities, and the Commercial Division, which is responsible for commercial mortgage lending. In addition, there are three service departments whose principal responsibilities are to provide the support services required by the operating divisions to function efficiently. Presented below is information regarding the direct (traceable) costs budgeted for the operations of each service department and the two operating divisions. (These direct costs comprise only variable costs.) For accounting purposes, service department costs are to be allocated on the basis of budgeted hours of service provided. Service Departments Operating Divisions S1 S2 S3 Residential Commercial Estimated direct costs $1,180 $1,000 $1,080 $800 $500 Estimated hours of service provided to other departments by: S1 (Marketing) -- -- -- 250 350 S2 (Human Resources) 50 -- 100 350 -- S3 (Data Processing) 10 120 -- 140 90 Support Dept. Cost Allocation PROBLEM 2

Using the step-down method of cost allocation, what is the total cost for the operations of the service departments that is to be allocated to the Residential Division? To use the step-down method, we must first rank each service department based on the proportion of services it provides to other service departments in order to determine the order of cost allocation. Services to other service depts Total services Proportion Rank S1 0 600 0.0 3 S2 150 500 0.3 2 S3 130 360 0.4 1

S3 S2 S1 Residential and Commercial Graphically

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Allocation Rate S3 S2 S1 Residential Commercial Direct Costs $1,080 $1,000 $1,180 Allocated (Indirect) Costs From S3 $1,080 360 = $3.00/hr (1,080) 360 30 420 270 0 1,360 1,210 From S2 $1,360 (500 – 100) = $3.40/hr (1,360) 170 1,190 0 0 1,380 From S1 $1,380 (600 – 0) = $2.30/hr (1,380 ) 575 805 0 2,185 1,075 Cost Allocation (Sequentially, by rank)

Using the reciprocal method of cost allocation, what are the rates to be used to allocate the costs of the service departments to the operating departments. First we have to derive the equations representing the total reciprocal cost of the departments. Total Reciprocal Cost Equations: For S1 R 1 = 1,180 + ( 50/500)*R 2 + ( 10/360)*R 3 (1) For S2 R 2 = 1,000 + (120/360)*R 3 (2) For S3 R 3 = 1,080 + (100/500)*R 2 (3) 2 Equations, 2 Unknowns

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To determine the total reciprocated costs, solve the equations: Begin by substituting equation (3) into equation (2): R 2 = 1,000 + (120/360) x (1,080 + 0.2*R 2 ) So, R 2 = 1,457.143 Now, substitute for R 2 in equation 3 R 3 = 1,371.429 Finally, R 1 = 1,363.810 Therefore, the reciprocal cost allocation rates are: For S1: $1,363.810 / 600 hrs = $2.27/hr For S2: $1.457.143 / 500 hrs = $2.91/hr For S3: $1,371.429 / 360 hrs = $3.81/hr

RE Corporation is evaluating the possibility of outsourcing its data processing requirements (currently provided by S3). Based on the market for data processing, RE Corporation estimates that the cost to outsource S3 would be $3 per hour. At a cost of $3 per hour, should RE Corporation outsource its data processing requirements? At what cost per hour would RE Corporation be indifferent between outsourcing S3 and keeping it in-house? To answer the above, we can simply compare the cost of outsourcing with the reciprocal cost allocation rate for S3, $3.81/hr. At $3.81/hr, RE Corporation would be indifferent between outsourcing S3 and keeping it in-house. Since $3 < $3.81, RE Corporation should outsource its data processing requirements.