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Tonya Martin, CMA and controller or the Parts Division of Gunderson Inc., was meeting with Doug Adams, manager of the division. The topic of discussion was the assignment of
Tonya: Doug, as you know, about 25% of our business is based on government contracts, with the other 75% based on jobs from private sources won through bidding. During the last several years, our private business has declined. We have been losing more bids than usual. After some careful investigation, I have concluded that we are overpricing some jobs because of improper assignment of overhead costs. Some jobs are also being underpriced. Unfortunately, the jobs being overpriced are coming from our higher-volume, labor-intensive products, so we are losing business.
Dong: I think I understand. Jobs associated with our high-volume products are being assigned more overhead than they should be receiving. Then when we add our standard 40% markup, we end up with a higher price than our competitors, who assign costs more accurately.
Tonya: Exactly. We have two producing departments, one labor-intensive and the other machine-intensive. The labor-intensive department generates much less overhead than the machine-intensive department. Furthermore, virtually all of our high-volume jobs are labor-intensive. We have been using a plantwide rate based on direct labor hours to assign overhead to all jobs. As a result, the high-volume, labor-intensive jobs receive a greater share of the machine-intensive department’s overhead than they deserve. This problem can be greatly alleviated by switching to departmental overhead rates. For example, an average high-volume job would be assigned $100,000 of overhead using a plantwide rate and only $70,000 using departmental rates. The change would lower our bidding price on high-volume jobs by an average of $42,000 per job. By increasing the accuracy of our product costing, we can make better pricing decisions and win back much of our private-sector business.
Doug: Sounds good. When can you implement the change in overhead rates?
Tonya: It won’t take long. I can have the new system working within four to six weeks—certainly by the start of the new fiscal year.
Doug: Hold it. I just thought of a possible complication. As I recall, most of our government contract work is done in the labor-intensive department. This new overhead assignment scheme will push down the cost on the government jobs, and we will lose revenues. They pay us full cost plus our standard markup. This business is not threatened by our current costing procedures, but we can’t switch our rates for only the private business. Government auditors would question the lack of consistency in our costing procedures.
Tonya: You do have a point. I thought of this issue also. According to my estimates, we will gain more revenues from the private sector than we will lose from our government contracts. Besides, the costs of our government jobs are distorted. In effect, we are overcharging the government.
Doug: They don’t know that and never would unless we switch our overhead assignment procedures. I think I have the solution. Officially, let’s keep our plantwide overhead rate. All of the official records will reflect this overhead costing approach for both our private and government business. Unofficially. I want you to develop a separate set of books that can be used to generate the information we need to prepare competitive bids for our private-sector business.
Required:
- 1. Do you believe that the solution proposed by Doug is ethical? Explain.
- 2. Suppose that Tonya decides that Doug’s solution is not right and objects strongly. Further suppose that, despite Tonya’s objections, Doug insists strongly on implementing the action. What should Tonya do?
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Chapter 4 Solutions
Managerial Accounting: The Cornerstone of Business Decision-Making
- Winkle, Kotter, and Zale is a small law firm that contains 10 partners and 12 support persons. The firm employs a job-order costing system to accumulate costs chargeable to each client, and it is organized into two departments-the Research and Documents Department and the Litigation Department. The firm uses predetermined overhead rates to charge the costs of these departments to its clients. At the beginning of the curent year, the firm's management made the following estimates for the year Department Research and Documents 20,400 9,300 $ 17,700 $ 430,100 $714,000 Litigation Research-hours Direct attorney-hours Materials and supplies Direct attorney cost Departmental overhead cost 16.400 $ 5,500 $ 799.400 $ 311,766 The predetermined overhead rate in the Research and Documents Department is based on research-hours, and the rate in the Litigation Department is based on direct attorney cost The costs charged to each client are made up of three elements: materials and supplies used,…arrow_forwardBest Practices, Inc., is a management consulting firm. Its Corporate Division advises private firms on the adoption and use of cost management systems. Government Division consults with state and local governments. Government Division has a client that is interested in implementing an activity-based costing system in its public works department. The division’s head approached the head of Corporate Division about using one of its associates. Corporate Division charges clients $645 per hour for associate services, the same rate other consulting companies charge. The Government Division head complained that it could hire its own associate at an estimated variable cost of $245 per hour, which is what Corporate pays its associates. Suppose that Government Division will charge the client interested in implementing an activity-based costing system by the hour based on cost plus a fixed fee, where the cost is primarily the consultant’s hourly pay. Assume also that Government Division cannot…arrow_forwardTAC Industries, Inc. sells heavy equipment to large corporations and federal, state, and local governments. Corporate sales are the result of a competitive bidding process, where TAC competes against other companies based on selling price. Sales to government, however, are determined on a cost plus basis, where the selling price is determined by adding a fixed markup percentage to the total job cost. Tandy Lane is the cost accountant for the Equipment Division of TAC Industries, Inc. The division is under pressure from senior management to improve income from operations. As Tandy reviewed the division's job cost sheets, she realized that she could increase the division's income from operations by moving a portion of the direct labor hours that had been assigned to the job order cost sheets of corporate customers onto the job order cost sheets of government customers. She believed this would create a "win-win" situation for the division by (1) reducing the cost of corporate jobs, and…arrow_forward
- TAC Industries Inc. sells heavy equipment to large corporations and federal, state, and local governments. Corporate sales are the result of a competitive bidding process, where TAC competes against other companies based on selling price. Sales to the government, however, are determined on a cost-plus basis, where the selling price is determined by adding a fixed markup percentage to the total job cost. Tandy Lane is the cost accountant for the Equipment Division of TAC Industries Inc. The division is under pressure from senior management to improve income from operations. As Tandy reviewed the division's job cost sheets, she realized that she could increase the division's income from operations by moving a portion of the direct labor hours that had been assigned to the job order cost sheets of corporate customers onto the job order costs sheets of government customers. She believed that this would create a “win–win” for the division by (1) reducing the cost of corporate jobs, and (2)…arrow_forwardLamothe Solutions is a management consulting firm. Its Business Division advises firms on the adoption and use of financial systems. Civic Division consults with state and local governments. Civic Division has a client that is interested in implementing a new costing system in its public works department. The division's head approached the head of Business Division about using one of its associates. Corporate Division charges clients $770 per hour for associate services, the same rate other consulting companies charge. The Civic Division head complained that it could hire its own associate at an estimated variable cost of $370 per hour, which is what Business pays its associates. Required: a. What is the maximum price that Civic Division should pay? b. What is the maximum transfer price that Business Division should obtain for its services, assuming that it is operating at capacity?arrow_forwardLamothe Solutions is a management consulting firm. Its Business Division advises firms on the adoption and use of financial systems. Civic Division consults with state and local governments. Civic Division has a client that is interested in implementing a new costing system in its public works department. The division's head approached the head of Business Division about using one of its associates. Corporate Division charges clients $815 per hour for associate services, the same rate other consulting companies charge. The Civic Division head complained that it could hire its own associate at an estimated variable cost of $415 per hour, which is what Business pays its associates. Required: a. What is the maximum price that Civic Division should pay? b. What is the maximum transfer price that Business Division should obtain for its services, assuming that it is operating at capacity? c-1. Is there any change in maximum price as indicated in part (a), if Business Division had idle…arrow_forward
- Ali, Beng, Chandran and Associates is a small law firm that employs 10 partners and 12 support persons. The firm uses a job-order costing system to accumulate costs chargeable to each client, and it is organised into two departments – the Research and Documents Department and the Litigation Department. The firm uses predetermined overhead rates to charge the costs of these departments to its clients. The pre-determined overhead rate in the Research and Document Department is based on research hours, and the rate in the Litigation department is based on direct attorney cost. The costs charged to each client are made up of three elements: legal forms and supplies used, direct attorney cost incurred, and an applied amount of overhead from each department in which work is performed in the case. At the beginning of the year, the firm’s management made the following estimates for the year. Department Research and…arrow_forwardDhaka Power Corporation is one of Walton’s equipment suppliers. Dhaka Power currently uses traditional costing for making business decisions. Upon request from Walton, the company has decided to move to activity-based costing for equipment production related to products WAL101 and WAL201. As one of the company’s management accountants, you have been asked to prepare an analysis comparing the two costing methods for the next company board meeting. Your CFO has given you the following quarterly data from the Dhaka Power Corporation’s costing system: Answer the following questions: a) What is the total manufacturing cost per unit using traditional costing for WAL101 and WAL201? Use machine hours as the cost-allocation base.b) What is the total manufacturing cost per unit using activity-based costing for WAL101 and WAL201?c) What conclusions can be drawn from your results?arrow_forwardBob Randall, cost accounting manager for Hemple Products, was asked to determine the costs of the activities performed within the company’s Manufacturing Engineering Department. The department has the following activities: creating bills of materials (BOMs), studying manufacturing capabilities, improving manufacturing process, training, employees, and designing tools. The resources costs (from the general ledger) and the times to perform one unit of each activity are provided below: Resource Cost Activities Unit Time Driver Salaries $500,000 Creating BOMs 0.5 hr. No. of BOMs Equipment 100,000 Designing Tools 5.4 hr. No. of tools designs Supplies 30,000 Improving processes 1.0 hr. Process improvement hrs Total $630,000 Training employees 2.0 hr. No. of training sessions Studying capabilities 1.0 hr. Study hrs. Total machine and labor hours (at practical capacity):…arrow_forward
- Ana Perez is the plant manager of Travel Free’s Indiana plant. The Camper and Trailer operating departments manufacture products and have their own managers. The Office department, which Perez also manages, provides services equally to the two operating departments. Each performance report includes only those costs that a particular operating department manager can control: direct materials, direct labor, supplies used, and utilities. The plant manager is responsible for the department managers’ salaries, building rent, office salaries other than her own, and other office costs plus all costs controlled by the two operating department managers. The annual departmental budgets and actual costs for the two operating departments follow. The Office department’s budgeted and actual costs follow. Required Prepare responsibility accounting performance reports like those in costs controlled by the following. 1. Manager of Camper department. 2. Manager of Trailer department. 3. Manager of…arrow_forwardBob Randall, cost accounting manager for Hemple Products, was asked to determine the costs of the activities performed within the company's Manufacturing Engineering Department. The department has the following activities: creating bills of materials (BOMs), studying manufacturing capabilities, improving manufacturing processes, training employees, and designing tools. The resource costs (from the general ledger) and the times to perform one unit of each activity are provided below. Resource Costs Activities Unit Time Driver Salaries $425,000 Creating BOMs 0.6 hr. No. of BOMs Equipment 92,000 Designing tools 3.7 hrs. No. of tool designs Supplies 43,000 Improving processes 1.1 hrs. Process improvement hrs. Total $560,000 Training employees 2.1 hrs. No. of training sessions Studying capabilities 2.1 hrs. Study hours Total machine and labor hours (at practical capacity): Machine…arrow_forwardCrow Design is an interior design firm. The firm uses a job cost system in which each client is a different "job."Crow Design traces direct labor, licensing costs, and travel costs directly to each job (client). It allocates indirect costs to jobs based on a predetermined indirect cost allocation rate computed as a percentage of direct labor costs. At the beginning of the current year, managing partner Brenna Gladstone prepared the following budget: Direct labor hours (professional). . . . . 8,000 hours Direct labor costs (professional). . . . . $1,600,000 Support staff salaries. . . . . . . . . . . . . . . $190,000 Computer lease payments. . . . . . . . . . . $41,000 Office supplies. . . . . . . . . . . . . . . . . . . . . $23,000 Office rent. . . . . . . . . . . . . . . . . . . . . . . . . $66,000 Later that same year in November, Crow Design served several clients. Records for two clients appear here: Fancy Food AllFood.com Direct labor hours. . . . . 680…arrow_forward
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