Chapter 2, Problem 60P

Cost Identification and Analysis, Cost Assignment, Income Statement

Melissa Vassar has decided to open a printing shop. She has secured two contracts. One is a 5-year contract to print a popular regional magazine. This contract calls for 5,000 copies each month. The second contract is a 3-year agreement to print tourist brochures for the state. The state tourist office requires 10,000 brochures per month.

Melissa has rented a building for $1,400 per month. Her printing equipment was purchased for $40,000 and has a life expectancy of 20,000 hours with no salvage value. Depreciation is assigned to a period based on the hours of usage. Melissa has scheduled the delivery of the products so that two production runs are needed. In the first run, the equipment is prepared for the magazine printing. In the second run, the equipment is reconfigured for brochure printing. It takes twice as long to configure the equipment for the magazine setup as it does for the brochure setup. The total setup costs per month are $600.

Insurance costs for the building and equipment are $140 per month. Power to operate the printing equipment is strongly related to machine usage. The printing equipment causes virtually all the power costs. Power costs will run $350 per month. Printing materials will cost $0.40 per copy for the magazine and $0.08 per copy for the brochure. Melissa will hire workers to run the presses as needed (part-time workers are easy to hire). She must pay $10 per hour. Each worker can produce 20 copies of the magazine per printing hour or 100 copies of the brochure. Distribution costs are $500 per month. Melissa will receive a salary of $1,500 per month. She is responsible for personnel, accounting, sales, and production—in effect, she is responsible for administering all aspects of the business.

Required:

1. 1. What are the total monthly manufacturing costs?
2. 2. What are the total monthly prime costs? What are the total monthly prime costs for the regional magazine? For the brochure?
3. 3. What are the total monthly conversion costs? Suppose Melissa wants to determine monthly conversion costs for each product. Assign monthly conversion costs to each product using direct tracing and driver tracing whenever possible. For those costs that cannot be assigned using a tracing approach, you may assign them using direct labor hours.
4. 4. Melissa receives $1.80 per copy of the magazine and $0.45 per brochure. Prepare an income statement for the first month of operations.

To determine

Calculate the amount of total monthly manufacturing costs.

Answer to Problem 60P

The total monthly manufacturing cost is $9,490.

Explanation of Solution

Manufacturing Costs:

Manufacturing costs can be defined as the total amount of costs incurred in producing a product. Manufacturing costs involve the cost of direct materials, cost of direct labor and manufacturing overheads.

The below table represents the total manufacturing cost:

	Amount ($)	Amount ($)
Direct materials:
Magazine	2,000
Brochure	800	2,800
Direct labor:
Magazine	2,500
Brochure	1,000	3,500
Manufacturing overhead:
Rent	1,400
Depreciation	700
Setups	600
Insurance	140
Power	350	3,190
Cost of goods manufactured		9,490

Table (1)

The total monthly manufacturing cost is $9,490.

Working Notes:

1.

Calculation of direct material-magazine:

$\begin{array}{c}\text{Direct material-Magazine}=\text{Number of copies}\times \text{Cost to print magazine}\\ =5,000\times \$0.40\\ =\$2,000\end{array}$

Hence, the amount of direct material-magazine is $2,000.

2.

Calculation of direct material-brochure:

$\begin{array}{c}\text{Direct material-Brochure}=\text{Number of copies}\times \text{Cost to print magazine}\\ =10,000\times \$0.08\\ =\$800\end{array}$

Hence, the amount of direct material-brochure is $800.

3.

Calculation of direct labor-magazine:

$\begin{array}{c}\text{Direct labor-Magazine}=\text{Number of copies}\times \left(\frac{\text{Payment for each hour}}{\text{Number of copies a worker produces}}\right)\\ =5,000\times \left(\frac{\$10}{20}\right)\\ =\$2,500\end{array}$

Hence, the amount of direct labor-magazine is $2,500.

4.

Calculation of direct labor-brochure:

$\begin{array}{c}\text{Direct labor-Brochure}=\text{Number of copies}\times \left(\frac{\text{Payment for each hour}}{\text{Number of copies a worker produces}}\right)\\ =10,000\times \left(\frac{\$10}{100}\right)\\ =\$1,000\end{array}$

Hence, the amount of direct labor- brochure is $1,000.

5.

Calculation of monthly machine hours:

$\begin{array}{c}\text{Monthly machine hours}=\left(\frac{\text{Number of magazine copies}}{\text{Production units}}\right)\\ +\left(\frac{\text{Number of brochure copies}}{\text{Production units}}\right)\\ =\left(\frac{5,000}{20}\right)+\left(\frac{10,000}{100}\right)\\ =250+100\\ =350\text{hours}\end{array}$

Hence, the monthly machine hours are 350 hours.

6.

Calculation of depreciation:

$\begin{array}{c}\text{Depreciation}=\left(\frac{\text{Value of an equipment}}{\text{Life expectancy}}\right)\times \text{Monthly machine hours}\\ \text{=}\left(\frac{\$40,000}{20,000\text{hours}}\right)\times 350\text{hours}\\ =\$700\end{array}$

Therefore, the amount of depreciation is $700.

To determine

Calculate the amount of monthly prime costs, magazine’s and brochure’s monthly prime costs.

Answer to Problem 60P

The amount of monthly prime costs, magazine’s monthly prime costs, and brochure’s monthly prime costs are $6,300, $4,500 and $1,800 respectively.

Explanation of Solution

Use the following formula to compute the monthly total prime cost:

$\text{Prime cost}=\text{Direct material}+\text{Direct labor}$

Substitute $2,800 for direct material and $3,500 for direct labor in the above formula.

$\begin{array}{c}\text{Prime cost}=\$2,800+\$3,500\\ =\$6,300\end{array}$

Therefore, the amount of total monthly prime cost is $6,300.

Use the following formula to compute the monthly prime cost of the magazine:

$\text{Monthly prime cost of magazine}=\left(\begin{array}{c}\text{Direct material of magazine}\\ +\text{Direct labor of magazine}\end{array}\right)$

Substitute $2,000 for direct material of magazine and $2,500 for direct labor of magazine in the above formula.

$\begin{array}{c}\text{Monthly prime cost of magazine}=\$2,000+\$2,500\\ =\$4,500\end{array}$

Therefore, the amount of total monthly prime cost of the magazine is $4,500.

Use the following formula to compute the monthly prime cost of the brochure:

$\text{Monthly prime cost of brochure}=\left(\begin{array}{c}\text{Direct material of brochure}\\ +\text{Direct labor of brochure}\end{array}\right)$

Substitute $800 for direct material of brochure and $1,000 for direct labor of brochure in the above formula.

$\begin{array}{c}\text{Monthly prime cost of brochure}=\$800+\$1,000\\ =\$1,800\end{array}$

Therefore, the amount of total monthly prime cost of the brochure is $1,800.

To determine

Calculate the amount of total monthly conversion cost. Also, assign the conversion costs to each product with the help of direct tracing and driver tracing.

Answer to Problem 60P

The amount of total monthly conversion cost is $6,690. And the total conversion costs of the magazine and brochure are $4,750 and $1,940 respectively.

Explanation of Solution

Use the following formula to compute the conversion cost:

$\text{Conversion cost}=\text{Direct labor}+\text{Manufacturing overheads}$

Substitute $3,500 for direct labor and $3,190 for direct labor in the above formula.

$\begin{array}{c}\text{Conversion cost}=\$3,500+\$3,190\\ =\$6,690\end{array}$

Therefore, the amount of conversion cost is $6,690.

Following is the allocation of conversion costs to the product magazine:

	Amount ($)	Amount ($)
Direct labor		2,500
Manufacturing overheads:
Power	250
Depreciation	500
Setups	400
Rent and insurance	1,100	2,250
Total		4,750

Table (2)

Therefore, the total conversion cost of the magazine is $4,750.

Following is the allocation of conversion costs to the product brochure:

	Amount ($)	Amount ($)
Direct labor		1,000
Manufacturing overheads:
Power	100
Depreciation	200
Setups	200
Rent and insurance	440	940
Total		1,940

Table (3)

Therefore, the total conversion cost of the brochure is $1,940.

Working Notes:

1.

Calculation of monthly machine hours:

$\begin{array}{c}\text{Monthly machine hours}=\left(\frac{\text{Number of magazine copies}}{\text{Production units}}\right)\\ +\left(\frac{\text{Number of brochure copies}}{\text{Production units}}\right)\\ =\left(\frac{5,000}{20}\right)+\left(\frac{10,000}{100}\right)\\ =250+100\\ =350\text{hours}\end{array}$

Hence, the monthly machine hours are 350 hours.

2.

Calculation of the amount of power for the magazine:

$\begin{array}{c}\text{Power}=\text{Monthly machine hours of magazine}\times \text{Amount per machine hour}\\ =\text{Monthly machine hours of magazine}\\ \times \left(\frac{\text{Total machine hours}}{\text{Machine hours for magazine and brochure}}\right)\\ =250\times \left(\frac{350\text{hours}}{350\text{hours}}\right)\\ =\$250\end{array}$

Hence, the amount of power for the magazine is $250.

3.

Calculation of depreciation for magazine:

$\begin{array}{c}\text{Depreciation}=\left(\frac{\text{Value of an equipment}}{\text{Life expectancy}}\right)\times \text{Machine hours for magazine}\\ \text{=}\left(\frac{\$40,000}{20,000\text{hours}}\right)\times 250\text{hours}\\ =\$500\end{array}$

Hence, the amount of depreciation is $500.

4.

Calculation of setup time for magazine and brochure:

The magazine takes twice as long to configure the brochure. Let the setup time for brochure be a. Therefore, the equation is given below:

$\begin{array}{l}2\text{a}+\text{a}=1\\ 3\text{a}=1\\ \text{a}=\frac{1}{3}\end{array}$

Hence, the setup time for the magazine is 1/3 and the setup time for the brochure is 2/3$\left(2\times \frac{1}{3}\right)$.

5.

Calculation of setup amount for the magazine:

$\begin{array}{c}\text{Setup amount}=\text{Monthly setup amount}\times \text{Setup time for magazine}\\ =\$600\times \frac{2}{3}\\ =\$400\end{array}$

Hence, the amount of setup for the magazine is $400.

6.

Calculation of the amount of rent and insurance for the magazine:

$\begin{array}{c}\text{Rent and Insurance}=\frac{\left(\text{Amount of rent}+\text{Amount of insurance}\right)}{\text{Monthly machine hours}}\\ \times \text{Machine hours for magazine}\\ =\left(\frac{\$1,400+\$140}{350}\right)\times 250\text{hours}\\ =\left(\frac{\$1,540}{350}\right)\times 250\text{hours}\\ =\$1,100\end{array}$

Hence, the amount of rent and insurance for the magazine is $1,100.

7.

Calculation of the amount of power for the brochure:

$\begin{array}{c}\text{Power}=\text{Monthly machine hours of brochure}\times \text{Amount per machine hour}\\ =\text{Monthly machine hours of brochure}\\ \times \left(\frac{\text{Total machine hours}}{\text{Machine hours for magazine and brochure}}\right)\\ =100\times \left(\frac{350\text{hours}}{350\text{hours}}\right)\\ =\$100\end{array}$

Hence, the amount of power for the brochure is $100.

8.

Calculation of depreciation for brochure:

$\begin{array}{c}\text{Depreciation}=\left(\frac{\text{Value of an equipment}}{\text{Life expectancy}}\right)\times \text{Machine hours for brochure}\\ \text{=}\left(\frac{\$40,000}{20,000\text{hours}}\right)\times 100\text{hours}\\ =\$200\end{array}$

Hence, the amount of depreciation is $200.

9.

Calculation of setup amount for brochure:

$\begin{array}{c}\text{Setup amount}=\text{Monthly setup amount}\times \text{Setup time for brochure}\\ =\$600\times \frac{1}{3}\\ =\$200\end{array}$

Hence, the amount of setup for the brochure is $200.

10.

Calculation of the amount of rent and insurance for brochure:

$\begin{array}{c}\text{Rent and Insurance}=\frac{\left(\text{Amount of rent}+\text{Amount of insurance}\right)}{\text{Monthly machine hours}}\\ \times \text{Machine hours for magazine}\\ =\left(\frac{\$1,400+\$140}{350}\right)\times 250\text{hours}\\ =\left(\frac{\$1,540}{350}\right)\times 100\text{hours}\\ =\$440\end{array}$

Hence, the amount of rent and insurance for the brochure is $440.

To determine

Prepare an income statement for the first month of operations.

Explanation of Solution

Income Statement:

The statement that shows revenue and expenses incurred over a period of time (usually one year) is called income statement. It is used for external financial reporting as it helps the outsiders and investors in evaluating the firm’s financial health.

Following is the income statement of M:

Company M
Income Statement
For First Month
	Amount ($)	Amount ($)
Sales revenue		13,500
Cost of goods sold		9,490
Gross margin		4,010
Less: Operating expense
Selling expense	500
Administrative expense	1,500	2,000
Net Income		2,010

Table (4)

Therefore, the amount of net income is $2,010.

Since the beginning and ending finished goods inventories are zero, the amount of cost of goods manufactured is equal to the cost of goods sold. Also, distribution cost is considered as selling expense, and a salary of $1,500 is considered as an administrative expense.

Working Notes:

Calculation of sales revenue:

$\begin{array}{c}\text{Sales revenue}=\left(\text{Number of copies for magazine}\times \text{Price per copy}\right)\\ +\left(\text{Number of copies for brochure}\times \text{Price per copy}\right)\\ =\left(5,000\times \$1.80\right)+\left(10,000\times \$0.45\right)\\ =\$9,000+\$4,500\\ =\$13,500\end{array}$

Hence, the amount of sales revenue is $13,500.