Chapter 2

Cost Terms, Concepts, and Classifications

Solution to Discussion Case

Possible reasons for disagreeing with the statement:

 Distinguishing between product and period costs will still be important,
even for small single-product companies. For companies in competitive
markets knowing product costs will help them manage profitability more
successfully. Knowing product costs is also important for companies that
are able to set their own prices as it will provide an indication of the
price needed to cover the costs of production.
 Understanding how costs behave (variable versus fixed) is still important
even for small companies as it will help them predict how costs will
change in response to changes in activity levels. This knowledge will be
helpful when developing budgets (more on this in chapter 9), which
based on the authors’ research, is a tool used by a large majority of
companies, small and large.
 Evaluating business opportunities requires an understanding of concepts
such as opportunity costs and sunk cost regardless of the size of the
company. For example a company that devotes its production equip-
ment to producing one product is still incurring an opportunity cost that
is equal to the benefits that would arise from using the invested capital
in something else. Periodically owners of small companies should still
evaluate whether the benefits of the status quo exceed the opportunity
costs being incurred related to the next best alternative for using the
company’s resources. Sunk costs also arise in small companies and
should be ignored.

Possible reasons for agreeing with the statement:

 Students who agree will likely take the view that, as per the question
wording, many of the concepts in Chapter 2 take on more importance
as the complexity of operations increases. For example, understand-
ing product versus period costs is arguably more important in a multi-
product setting where managers have to allocate resources across
multiple products in an effort to maximize profitability.

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Solutions Manual, Chapter 2 1
Solutions to Questions

2-1 No. Only costs related to operating the 2-7 Total manufacturing costs are the total
production facilities are included as costs of direct materials, direct labour and
manufacturing overhead. Costs related to the manufacturing overhead incurred in the current
administrative building would be an period for products that are both complete and
administrative expense. partially complete at the end of the period. Cost
of goods manufactured represents the direct
2-2 The three categories are: (a) direct materials, direct labour and manufacturing
materials; (b) direct labour; and (c) overhead costs for goods completed during the
manufacturing overhead. period. Cost of goods manufactured = Total
manufacturing costs + beginning WIP – ending
2-3 Not always. Product costs are expensed WIP.
in the same period in which the related products
are sold. For example, if product costs were 2-8 A manufacturing company will have raw
incurred in December but the products weren’t materials inventory and work-in-process
sold until January, the costs would not be inventory. Because neither merchandising nor
expensed as part of cost of goods sold until service companies have manufacturing activities,
January. In this example, the product costs they will not have these two classes of inventory
would be included on the December balance accounts.
sheet as finished goods inventory.
2-9 Wages are a mixed cost for this company
2-4 Administrative costs are those costs with since it contains both a fixed portion (weekly
the general management of the company such salary based on 40 hours) and a variable portion
as accounting, legal, human resources, based on overtime hours at $20 per hour.
executive compensation, etc. They are always
treated as period costs on the income 2-10 As activity levels increase, variable costs
statement. As a result, they are expensed in the per unit do not change within the relevant
period incurred. range. However, as activity levels increase, fixed
costs per unit decrease. This decrease happens
2-5 Raw materials inventory includes direct because total fixed costs remain unchanged (the
and indirect materials that have not yet been numerator in the calculation of fixed costs per
placed into production. Conversely work in unit) even though the activity levels are
process inventory includes costs related to direct increasing (the denominator in the calculation of
and indirect materials, direct and indirect labour fixed costs per unit).
and overhead that have been placed into
production but the goods are not yet complete. 2-11 It is a mixed cost. There is a fixed
Both raw materials and work in process component, $50 for 5 GB of data, and a variable
inventories are included on the balance sheet. component, $5 for every 200 MB of data used in
Only when goods are finished and sold do the excess of 5 GB.
associated costs get transferred from the
balance sheet inventory account(s) to cost of 2-12 Manufacturing overhead is an indirect
goods sold on the income statement. cost since these costs cannot be easily and
conveniently traced to particular units of
2-6 Automation is likely to decrease prime products.
costs. The reason is that automation reduces
the need for employees to perform tasks, 2-13 No. The original cost of the existing
thereby reducing direct labour, one of the machine is a sunk cost that is not relevant to the
components of prime costs. decision as to whether the new machine should
be purchased. The original cost has already
been incurred and cannot be undone at this

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2 Managerial Accounting, 12th Canadian Edition
point. Thus it is irrelevant for decision-making treated as direct labour rather than included as
purposes. overhead and charged to all jobs and products.
The rationale is that treating it as direct labour
2-14 There is an opportunity cost, the results in a more accurate picture of the total
amount you could have received by selling your cost of completing jobs on a rush-order basis.
iPhone 8. Since you are foregoing this amount
by signing up for a bring your own phone plan, 2-16 It is possible if the company had
it is an opportunity cost. $100,000 in beginning finished goods inventory
and sold it all during the period, but did not
2-15 Typically when overtime can be isolated complete the production of any new units.
to a particular job or product, it should be

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Solutions Manual, Chapter 2 3
Foundational Exercises
1. Direct materials.......................................................
$ 6.00
Direct labor.............................................................
3.50
Variable manufacturing overhead.............................. 1.50
Variable manufacturing cost per unit......................... $11.00

Variable manufacturing cost per unit (a).................... $11.00

Number of units produced (b)................................. 10,000
Total variable manufacturing cost (a) × (b)............... $110,000
Average fixed manufacturing overhead per
unit (c)...............................................................
$4.00
Number of units produced (d)................................. 10,000
Total fixed manufacturing cost (c) × (d).................... 40,000
Total product (manufacturing) cost........................... $150,000

Note: The average fixed manufacturing overhead cost per unit of $4.00
is valid for only one level of activity—10,000 units produced.

2. Sales commissions...................................................
$1.00
Variable administrative expense................................ 0.50
Variable selling and administrative per unit................ $1.50

Variable selling and admin. per unit (a)..................... $1.50

Number of units sold (b)......................................... 10,000
Total variable selling and admin. expense
(a) × (b)........................................................... $15,000
Average fixed selling and administrative ex-
pense per unit ($3 fixed selling + $2 fixed
admin.) (c)..........................................................
$5.00
Number of units sold (d)......................................... 10,000
Total fixed selling and administrative ex-
pense (c) × (d)..................................................... 50,000
Total period (nonmanufacturing) cost........................ $65,000

Note: The average fixed selling and administrative expense per unit of
$5.00 is valid for only one level of activity—10,000 units sold.

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4 Managerial Accounting, 12th Canadian Edition
Foundational Exercises (continued)
3. Direct materials.......................................................
$ 6.00
Direct labor.............................................................
3.50
Variable manufacturing overhead.............................. 1.50
Sales commissions................................................... 1.00
Variable administrative expense................................ 0.50
Variable cost per unit sold........................................$12.50
4.* Direct materials.......................................................
$ 6.00
Direct labor.............................................................
3.50
Variable manufacturing overhead.............................. 1.50
Sales commissions................................................... 1.00
Variable administrative expense................................ 0.50
Variable cost per unit sold........................................$12.50
*Should be the same as part 3 since vari-
able costs per unit don’t differ within the
relevant range of activity.
5. Variable cost per unit sold (a)................................... $12.50
Number of units sold (b).......................................... 8,000
$100,00
Total variable costs (a) × (b).................................... 0

6. Variable cost per unit sold (a)...................................

$12.50
Number of units sold (b)..........................................
12,500
$156,25
Total variable costs (a) × (b).................................... 0

7. Total fixed manufacturing cost

(see requirement 1) (a).........................................
$40,000
Number of units produced (b).................................. 8,000
Average fixed manufacturing cost per unit
produced (a) ÷ (b)...............................................
$5.00

8. Total fixed manufacturing cost

(see requirement 1) (a).........................................
$40,000
Number of units produced (b)..................................
12,500
Average fixed manufacturing cost per unit
produced (a) ÷ (b)...............................................
$3.20
9.
Total fixed manufacturing cost

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Solutions Manual, Chapter 2 5
 (see requirement 1)..............................................
$40,000
Foundational Exercises (continued)
10. Total fixed manufacturing cost
(see requirement 1)..............................................
$40,000

$1.50
11. Variable overhead per unit (a)..................................
Number of units produced (b).................................
8,000
Total variable overhead cost (a) × (b)....................... $12,000
Total fixed overhead (see requirement 1).................. 40,000
Total manufacturing overhead cost........................... $52,000

Total manufacturing overhead cost (a)................. $52,000

Number of units produced (b)............................. 8,000
Manufacturing overhead per unit (a) ÷ (b)........... $6.50

12. Variable overhead per unit (a)..................................

$1.50
Number of units produced (b).................................
12,500
Total variable overhead cost (a) × (b)....................... $18,750
Total fixed overhead (see requirement 1).................. 40,000
Total manufacturing overhead cost........................... $58,750

Total manufacturing overhead cost (a)................. $58,750

Number of units produced (b)............................. 12,500
Manufacturing overhead per unit (a) ÷ (b)........... $4.70

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6 Managerial Accounting, 12th Canadian Edition
Foundational Exercises (continued)
$6.00
13. Direct materials per unit..........................................
Direct labor per unit...............................................3.50
Direct manufacturing cost per unit (a)....................... $9.50
Number of units produced (b).................................. 11,000
Total direct manufacturing cost (a) × (b)...................$104,500

Variable overhead per unit (a)............................. $1.50

Number of units produced (b)............................ 11,000
Total variable overhead cost (a) × (b).................. $16,500
Total fixed overhead (see requirement 1)............. 40,000
Total indirect manufacturing cost......................... $56,500

14. Direct materials per unit..........................................

$6.00
Direct labor per unit...............................................3.50
Variable manufacturing overhead per unit................. 1.50
Incremental cost per unit produced.......................... $11.00
Note: Variable selling and administrative expenses are variable with
respect to the number of units sold, not the number of units produced.

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Solutions Manual, Chapter 2 7
Exercise 2-1 (15 minutes)
1. Manufacturing overhead cost.

2. Administrative and marketing and selling costs. The rent would be

allocated based on the amount of space in the building used by the
administrative (accounting, human resources) and marketing and selling
activities.

3. Direct labour cost.

4. Manufacturing overhead cost. Because the cost of glue would likely be

very low per speaker, it would be considered an indirect material and
thus included with manufacturing overhead.

5. Marketing and selling cost.

6. Administrative cost.

7. Manufacturing overhead.

8. Direct material cost.

9. Marketing and selling cost.

10. Administrative cost.

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8 Managerial Accounting, 12th Canadian Edition
Exercise 2-2 (15 minutes)

Product
(Inventori-
able) Cost Period Cost
1. Components used in the devices X
2. Factory heating costs X
3. Factory equipment maintenance costs……… X
4. Training costs for new administrative staff… X
5. Solder used to assemble the devices………… X
6. Travel costs for Chief Financial Officer X
7. Wages and salary costs of factory security X
personnel
8. Utility costs for administrative building X
9. Wages and salaries for customer billing de- X
partment
10. Depreciation on fitness equipment used by X
factory employees
11. Telephone expenses for manager of the pro- X
duction facility
12. Costs of shipping devices to customers X
13. Wages of employees who assemble devices X
14. CEO salary X
15. Overtime paid to administrative staff in the X
accounts payable department

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Solutions Manual, Chapter 2 9
Exercise 2-3 (15 minutes)
Home Entertainment
Income Statement
For the month ended xxx
Sales............................................................. $150,000
Cost of goods sold:
Beginning merchandise inventory................. $ 12,000
Add: Purchases........................................... 90,000
Goods available for sale............................... 102,000
Deduct: Ending merchandise inventory......... 22,000 80,000
Gross margin................................................. 70,000
Selling and administrative expenses:
Selling expense........................................... 40,000
Administrative expense................................ 25,000 65,000
Operating income.......................................... $ 5,000

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10 Managerial Accounting, 12th Canadian Edition
Exercise 2-4 (15 minutes)
1.
Classic Sound
Schedule of Cost of Goods Manufactured
For the quarter ended xxx
Direct materials:
Beginning raw materials inventory........... $ 0
Add: Purchases of raw materials.............. 50,000
Raw materials available for use............... 50,000
Deduct: Ending raw materials inventory.... 25,000
Raw materials used in production............ $ 25,000
Direct labour............................................ 40,000
Manufacturing overhead............................ 30,000
Total manufacturing costs......................... 95,000
Add: Beginning work in process inventory.... 0
95,000
Deduct: Ending work in process inventory.... 5,000
Cost of goods manufactured..................... $90,000

2. Items likely included in manufacturing overhead:

 Rent for the production facility

 Depreciation on the production equipment
 Insurance on the production equipment
 Indirect materials used in producing records
 Indirect labour related to the CEO’s supervision of the production
process (20% of her time).
 Indirect labour related to production facility repair, maintenance, and
security.

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Solutions Manual, Chapter 2 11
 Exercise 2-5 (30 minutes)

1. Per unit amounts:

Item
January
Variable expenses: Amount Activity Per Unit
Direct materials $50,000 100 $500
Direct labour $ 5,000 100 $50
Indirect materials $500 100 $5

Fixed expenses:
Installation supervisor’s wages $8,000 100 $80
Equipment depreciation $1,000 100 $10
Insurance and utilities for $700 100 $7
garage
2. a & b

Item (1) (2) (3) (3) ÷ (1)

February
Variable expenses: Februar January Total February
y Per Unit Cost Per Unit
Activity
Direct materials 80 $500 $40,000 $500
Direct labour 80 $ 50 $ 4,000 $ 50
Indirect materials 80 $ 5 $ 400 $5

Fixed expenses:
Installation supervisor’s 80 $80 $8,000 $100.00
wages
Equipment depreciation 80 $10 $1,000 $ 12.50
Insurance and utilities for 80 $7 $700 $ 8.75
garage
 Variable expenses per unit do not change within the relevant
range of activity so the January and February amounts do not
differ.
 Fixed expenses per unit increase in February because the same
total fixed expenses are being spread over a lower activity base

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12 Managerial Accounting, 12th Canadian Edition
 (80 installations versus 100).

Exercise 2-5 (continued)

3. The depreciation costs are sunk because they related to the cost
of equipment already purchased. Nothing can be done in the
future to avoid the incurrence of these costs, unless Mike decides
to sell the equipment.

Exercise 2-6 (15 minutes)

Direct Indirect
Cost Cost Object Cost Cost
1. The wages of pediatric The pediatric depart-
nurses ment X
2. Prescription drugs A particular patient X
3. Heating the hospital The pediatric depart-
ment X
4. The salary of the head The pediatric depart-
of pediatrics ment X
5. The salary of the head A particular pediatric
of pediatrics patient X
6. Hospital chaplain’s A particular patient
salary X
7. Lab tests by outside A particular patient
contractor X
8. Lab tests by outside A particular depart-
contractor ment X

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Solutions Manual, Chapter 2 13
Exercise 2-7 (15 minutes)
Dif- Differen- Opportunity Sun
feren- tial k
tial
Item Rev- Cost Cost Cost
enue
Ex Cost of electricity for the X
. warehouse...........................
1. Sublet revenue for the X
new warehouse....................
2. Lease payments for the X
new warehouse....................
3. Net book value of the X
existing warehouse...............
4. Sales proceeds from
selling the existing X
warehouse...........................
5. Warehouse maintenance X
costs....................................
6. Warehouse staff wages........... X
7. Paving costs for the X
parking lot at existing
warehouse...........................
8. Parking lot revenues for
existing warehouse* X X
*The revenue foregone by moving to the new warehouse can be
considered either differential revenue or an opportunity cost.

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14 Managerial Accounting, 12th Canadian Edition
Exercise 2-8 (15 minutes)

Opportunity versus Sunk Costs:

Opportunity Costs
The $1,000,000 offered for the building, land and equipment is an oppor-
tunity cost since it represents a benefit that the company would give up if
it continues to manufacture the product.

The $20,000 is also an opportunity cost since it represents another benefit

that the company would have to forego if it continues to manufacture the
product.

Sunk Costs The original cost of the land ($500,000), building ($1,500,000),
and manufacturing equipment ($300,000), the net book value of the build-
ing ($1,375,000) and equipment ($150,000), and the insurance and taxes
recently paid on the building ($30,000), are all sunk costs. In each case
they have already been incurred and there is nothing management can do
at this point to change that fact. Note: students could argue that some
portion of the insurance and taxes may be recoverable if the building is
sold and thus are not sunk cost.

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Solutions Manual, Chapter 2 15
Exercise 2-9 (30 minutes)
1. a. Discs purchased 1,000
Discs drawn from inventory 200
Discs remaining in inventory 800
Cost per disc × $2
Cost in Raw Materials Inventory at February $1,600

b. Discs used in production (200-20) 180

Units completed and transferred to Finished Goods
(75% × 180) 135
Units still in Work in Process at February 28 45
Cost per disc × $2
Cost in Work in Process Inventory at February 28 $ 90

c. Units completed and transferred to Finished Goods

(above) 135
Units sold during the month (60% × 135) 81
Units still in Finished Goods at February 28 54
Cost per disc × $2
Cost in Finished Goods Inventory at May 31 $108

d. Units sold during the month (above) 81

Cost per disc × $2
Cost in Cost of Goods Sold at February 28 $162

e. Discs used in advertising 20

Cost per disc × $2
Cost in Advertising Expense for February $ 40

2. Raw Materials Inventory—balance sheet $1,600

Work in Process Inventory—balance sheet 90
Finished Goods Inventory—balance sheet 108

Cost of Goods Sold—income statement 162

Advertising Expense—income statement 40
$2,000

Note: the $2,000 above reconciles to the total amount spent on the discs in
February: 1,000 x $2 per unit = $2,000.

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16 Managerial Accounting, 12th Canadian Edition
Exercise 2-10 (30 minutes)
1.
Gulf Shore Limited
Schedule of Cost of Goods Manufactured
For the year ended April 30
Direct materials:
Raw materials inventory, beginning............. $ 7,000
Add: Purchases of raw materials.................. 118,000
Raw materials available for use................... 125,000
Deduct: Raw materials inventory, ending..... 15,000
Raw materials used in production................ $110,000
Direct labour................................................. 70,000
Manufacturing overhead:
Rent, factory facilities................................. $ 20,000
Indirect labour........................................... 30,000
Maintenance, factory equipment.................. 6,000
Insurance, factory equipment...................... 800
Supplies, factory......................................... 4,200
Depreciation, factory equipment.................. 19,000
Total manufacturing overhead costs............ 80,000
Total manufacturing costs............................. 260,000
Add: Work in process, beginning.................... 10,000
270,000
Deduct: Work in process, ending.................... 5,000
Cost of goods manufactured.......................... $265,000

2. The cost of goods sold section would be:

Finished goods inventory, beginning............... $ 20,000
Add: Cost of goods manufactured.................. 265,000
Goods available for sale................................. 285,000
Deduct: Finished goods inventory, ending....... 35,000
Cost of goods sold........................................ $250,000

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Solutions Manual, Chapter 2 17
Exercise 2-10 continued

3. Cost of goods sold is $15,000 lower than the cost of goods manufac-
tured because finished goods inventory increased by that amount during
the year from opening balance of $20,000 to an ending balance of
$35,000. That is, of the total manufacturing costs incurred in the most re-
cent year, $35,000 ended up on the balance sheet in the form of increased
finished goods inventory and the opening inventory balance $20,000 was
sold and therefore transferred to the income statement as part of cost of
goods sold.

Exercise 2-11 (15 minutes)

Cost Behaviour
Cost Item Variable Fixed
1. Small glass plates used for lab
tests in a hospital. X
2. Straight-line depreciation of a
building. X
3. Senior management salaries. X
4. Advertising of products and
services. X
5. Electrical costs of operating
production equipment. X
6. Batteries used in motorcycle
manufacturing. X
7. Commissions paid to sales
staff. X
8. Liability insurance paid by a
dentist. X
9. Subscription fee paid for use
of cloud-based analytics soft-
ware. X

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18 Managerial Accounting, 12th Canadian Edition
Exercise 2-12 (15 minutes)
1. Direct labour cost: 48 hours × $24 per hour $1152
Manufacturing overhead cost: 8 hours × $12 per hour 96
Total wages earned $1248

2. Had the overtime been incurred to meet a rush order for a particular
client then all of the wages ($1248) would have been treated as a direct
labour.

3. Direct labour cost: 35 hours × $24 per hour $ 840

Manufacturing overhead cost: 5 hours × $24 per hour 120
Total wages earned $ 960

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Solutions Manual, Chapter 2 19
Problem 2-13 (30 minutes)

1. The direct costs of the Apparel Department are as follows:

Apparel Department cost of sales—Evendale Store..... $ 90,000
Apparel Department sales commission—Evendale
Store................................................................... 7,000
Apparel Department manager’s salary—Evendale
Store................................................................... 8,000
Total direct costs for the Apparel Department............ $105,000

2. The direct costs of the Evendale Store are as follows:

Apparel Department cost of sales—Evendale Store..... $ 90,000
Store manager’s salary—Evendale Store.................... 12,000
Apparel Department sales commission—Evendale
Store................................................................... 7,000
Store utilities—Evendale Store.................................. 11,000
Apparel Department manager’s salary—Evendale
Store................................................................... 8,000
Janitorial costs—Evendale Store............................... 9,000
Total direct costs for the Evendale Store.................... $137,000

3. The direct costs in the Apparel Department that are also variable with
respect to departmental sales is computed as follows:
Apparel Department cost of sales—Evendale Store..... $90,000
Apparel Department sales commission—Evendale
Store................................................................... 7,000
Total direct costs for the Apparel Department that
are also variable costs........................................... $97,000

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20 Managerial Accounting, 12th Canadian Edition
Problem 2-14 (30 minutes)
1. Total wages for the week:
Regular time: 40 hours × $30 per hour.................. $ 1,200
Overtime: 10 hours × $45 per hour........................ 450
Total wages............................................................ $1,650
Allocation of total wages:
Direct labour: 50 hours × $30 per hour.................. $1,500
Manufacturing overhead: 10 hours × $15 per hour.. 150
Total wages............................................................ $1,650

2. Total wages for the week:

Regular time: 40 hours × $30 per hour.................. $ 1,200
Overtime: 5 hours × $45 per hour......................... 225
Total wages............................................................ $1,425
Allocation of total wages:
Direct labour: 42 hours × $30 per hour.................. $1,260
Manufacturing overhead:
Idle time: 3 hours × $30 per hour....................... $ 90
Overtime premium: 5 hours × $15 per hour......... 75 165
Total wages............................................................ $1,425

3. Total wages and employee benefits for the week:

Regular time: 40 hours × $30 per hour.................. $ 1,200
Overtime: 12 hours × $45 per hour........................ 540
Employee benefits: 52 hours × $9 per hour............ 468
Total wages and employee benefits.......................... $2,208
Allocation of wages and employee benefits:
Direct labour: 46 hours × $30 per hour.................. $1,380
Manufacturing overhead:
Idle time: 6 hours × $30 per hour....................... $ 180
Overtime premium: 12 hours × $15 per hour....... 180
Employee benefits: 52 hours × $9 per hour.......... 468 828
Total wages and employee benefits.......................... $2,208

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Solutions Manual, Chapter 2 21
Problem 2-14 (continued)
4. Allocation of wages and employee benefits:
Direct labour:
Wage cost: 46 hours × $30 per hour................ $1,380
Employee benefits: 46 hours × $9 per hour...... 414 $1,794
Manufacturing overhead:
Idle time: 6 hours × $30 per hour.................... 180
Overtime premium: 12 hours × $15 per hour.... 180
Employee benefits: 6 hours × $9 per hour........ 54 414
Total wages and employee benefits..................... $2,208

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22 Managerial Accounting, 12th Canadian Edition
Problem 2-15 (30 minutes)

1. Cost classification:

Product Cost Period

Variable Fixed Direct Direct Mfg. Over- (Selling and Opportunity Sunk
Name of the Cost Cost Cost Materials Labour head Admin.) Cost Cost Cost
$5,000 salary at tech company
foregone................................... X
Garage rental, $300 per month........ X X
Equipment rental, $1,000.............. X X
Material cost, $.60 per unit............ X X
Labour cost, $1.00 per unit............ X X
Room rental for sales office, $150
per month................................. X X
Voicemail plan for cell phone, $5
per month................................. X X

Foregone interest on savings ac-

count, $2,000 per year............... X
Advertising, $400 per month.......... X X
Sales staff commission, $0.20 per
unit........................................... X X
Legal fees to incorporate,
$1,000………………………………… X X X

2. Because the legal fees have already been incurred, they are a sunk cost.

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Solutions Manual, Chapter 2 23
Problem 2-16 (20 minutes)

Note to the Instructor: Some of the answers below are debatable.

Adminis-
Variable Selling trative Product Cost
Cost Item or Fixed Cost Cost Direct Indirect
1.Depreciation, executive jet............................................ F X
2.Costs of shipping finished goods to customers................. V X
3.Wood used in manufacturing furniture............................ V X
4.Sales manager’s salary.................................................. F X
5.Electricity used in manufacturing furniture...................... V X
6.Salary of secretary to the company president.................. F X
7.Aerosol attachment placed on a spray can produced by
the company.............................................................. V X
8. Billing costs.................................................................. V X*
9. Packing supplies for shipping products overseas.............. V X
10. Sand used in manufacturing concrete............................. V X
11. Supervisor’s salary, factory............................................ F X
12. Executive life insurance................................................. F X
13. Sales commissions........................................................ V X
14. Employee benefits, assembly line workers....................... V X**
15. Advertising costs........................................................... F X
16. Property taxes on finished goods warehouses................. F X
17. Lubricants for production equipment.............................. V X
*Billing is an accounting function therefore admin
**Could be an indirect cost.

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24 Managerial Accounting, 12th Canadian Edition
Problem 2-17 (60 minutes)
1.
Precious Production
Schedule of Cost of Goods Manufactured
For the quarter ended xxxx
Direct materials:
Raw materials inventory, beginning................ $ 40,000
Add: Purchases of raw materials.................... 360,000
Raw materials available for use...................... 400,000
Deduct: Raw materials inventory, ending........ 68,000
Raw materials used in production................... $ 332,000
Direct labour................................................... 240,000
Manufacturing overhead:
Depreciation, factory..................................... 168,000
Insurance, factory......................................... 20,000
Maintenance, factory..................................... 120,000
Utilities, factory............................................. 108,000
Supplies, factory........................................... 4,000
Indirect labour.............................................. 260,000
Total overhead costs........................................ 680,000
Total manufacturing costs................................ 1,252,000
Add: Work in process inventory, beginning........ 28,000
1,280,000
Deduct: Work in process inventory, ending........ 120,000
Cost of goods manufactured............................. $1,160,000

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Solutions Manual, Chapter 2 25
Problem 2-17 (continued)
2.
Precious Production Limited
Income Statement
For the quarter ended xxxx
Sales................................................................... $1,800,000
Cost of goods sold:
Finished goods inventory, beginning.................... $ 40,000
Add: Cost of goods manufactured....................... 1,160,000
Goods available for sale...................................... 1,200,000
Deduct: Finished goods inventory, ending............ 160,000 1,040,000
Gross margin....................................................... 760,000
Selling and administrative expenses:
Selling expenses................................................ 320,000
Administrative expenses..................................... 280,000 600,000
Operating income................................................. $ 160,000

3. Direct labour: $240,000 ÷ 10,000 units = $24.00 per unit.

Insurance: $20,000 ÷ 10,000 units = $2.00 per unit.

4. Direct materials:
Unit cost: 332,000/10000=
$33.20
Total cost: 12,000 units × $33.20 per unit = $398,400.
Insurance:
Unit cost: $20,000 ÷ 12,000 units = $1.67 per unit (rounded).
Total cost: $20,000 (unchanged)

5. Unit cost for insurance dropped from $2.00 to $1.67, because of the
increase in production between the two years. Since fixed costs do not
change in total as the activity level changes, they will decrease on a unit
basis as the activity level rises.

6. If the company produced 20,000 units then the following costs would
appear in inventory:
Direct materials ($332,000/20,000)*4,000 units = $ 66,400
Direct labour ($240,000/20,000)* 4,000 units = 48,000
Manufacturing overhead ($680,000/20,000) * 4,000 units = 136,000
Total $ 250,400

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26 Managerial Accounting, 12th Canadian Edition
Problem 2-18 (15 minutes)
1. You are correct! Although for financial reporting purposes the supervisor
is correct that there will be a net loss of $1,500 (salvage process less
the net book value (NBV) to be written off), the $4,000 is still a sunk
cost. As such, it is not relevant to the analysis. There is nothing the
company can do to get that $4,000 NBV back. Another way of looking at
it is regardless of whether or not the new computers are purchased, the
$4,000 NBV will be written off. If the new computers are purchased it
will be written off immediately. If the new computers are not purchased,
it will be written off as depreciation in the next year as year three of the
three-year useful life of the computers. You are both correct that the
$2,500 in salvage proceeds for the old computer is relevant to include in
the analysis.

2. You are correct again!! Although neither the foregone salvage value nor
the software savings on the new machine, are, as the supervisor says,
“out-of-pocket” expenses that will be incurred if the old computers are
kept, they are both opportunity costs. By definition, an opportunity cost
is a “potential benefit that is given up when one alternative is selected
over another.” Given this definition, both items are very clearly
opportunity costs that will be foregone if the old computers are kept.

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Solutions Manual, Chapter 2 27
Problem 2-19 (30 minutes)
(Selling
Product Cost and
Vari- Fixe Dir- To Units of Oppor- Sun
able d Direct ect Mfg. Admin.) Product tunity k
Name of the Cost Cost Cost Ma-Labour Over- Cost Dir- Indir- Cost Cost
terials head ect ect
Metal used in frets and knobs ($10 per
guitar)........................................... X X X
Employee wages to handcraft guitars
($175 per guitar)............................ X X X
Insurance on manufacturing facilities
($5,000 per year)............................ X X X
Glue used in assembly process............ X X X
Depreciation on machines used to pro-
duce guitars ($15,000 per year)....... X X X
Marketing VP salary ($125,000 per year) X X
Manufacturing operations manager
salary ($130,000 per year).............. X X X
Discontinued ad campaign ($75,000)... X X X

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28 Managerial Accounting, 12th Canadian Edition
Problem 2-19 (continued)
(Selling
Product Cost and
Vari- Fixe Dir- To Units of Oppor- Sun
able d Direct ect Mfg. Admin.) Product tunity k
Name of the Cost Cost Cost Ma- La- Over- Cost Dir- Indir- Cost Cost
teri- bour head ect ect
als
Operating income foregone on manufac-
turing facilities ($100,000 per year). . X
Overtime premiums ($1,000).............. X X X

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Solutions Manual, Chapter 2 29
Problem 2-20 (45 minutes)
1.
Selling or
Cost Behavior Administrative Product Cost
Cost Item Variable Fixed Cost Direct Indirect
Direct labour.............................. $118,000 $118,000
Advertising................................ $50,000 $50,000
Factory supervision.................... 40,000 $40,000
Property taxes, factory building... 3,500 3,500
Sales commissions..................... 80,000 80,000
Insurance, factory...................... 2,500 2,500
Depreciation, administrative of-
fice equipment........................ 4,000 4,000
Lease cost, factory equipment..... 12,000 12,000
Indirect materials, factory........... 6,000 6,000
Depreciation, factory building...... 10,000 10,000
Administrative office supplies...... 3,000 3,000
Direct materials used.................. 94,000 94,000
Utilities, factory.......................... 20,000 20,000
Total costs................................. $321,000 $122000 $137000 $212,000 $94,000

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30 Managerial Accounting, 12th Canadian Edition
Problem 2-20 (continued)
2. Only the product costs will be included in the cost of a patio set. The
cost per set will be:
Direct product costs............. $212,000
Indirect product costs........... 94,000
Total product costs.............. $306,000
$306,000 ÷ 2,000 sets = $153 per set

3. The cost per set would increase. This is because the fixed costs would
be spread over fewer units, causing the cost per unit to rise.

4. a. Yes, there probably would be a disagreement. The president is likely

to want a price of at least $153, which is the average cost per unit to
manufacture 2,000 patio sets. He may expect an even higher price
than this to cover a portion of the administrative costs as well. His
sister will probably be thinking of cost as including only materials
used, or perhaps materials and direct labour.
b. The term is opportunity cost. Since the company is operating at full
capacity, the president must give up the full, regular price of a set to
sell a patio set to his sister. Therefore, the president’s cost is really
the full, regular price of a set.

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Solutions Manual, Chapter 2 31
Problem 2-21 (15 minutes)
Variable or Fixed
Direct or Indirect with Respect to the
Direct or Indirect Cost of Particular Number of Seniors
Cost of the Meals- Seniors Served Served by the
On-Wheels Pro- by the Meals-On- Meals-On-Wheels
gram Wheels Program Program
Item Description Direct Indirect Direct Indirect Variable Fixed
a. The cost of leasing the Meals-On-Wheels van..... X X X
b. The cost of incidental supplies such as salt, pep-
per, napkins, and so on.................................. X X* X
c. The cost of gasoline consumed by the Meals-On-
Wheels van................................................... X X X
d. The rent on the facility that houses Madison
Seniors Care Center, including the Meals-On-
Wheels program............................................ X X* X
e. The salary of the part-time manager of the
Meals-On-Wheels program............................. X X X
f. Depreciation on the kitchen equipment used in
the Meals-On-Wheels program........................ X X X
g. The hourly wages of the caregiver who drives
the van and delivers the meals....................... X X X
h. The costs of complying with health safety regula-
tions in the kitchen........................................ X X X
i. The costs of mailing letters soliciting donations
to the Meals-On-Wheels program.................... X X X

* These costs could be direct costs of serving particular seniors.

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32 Managerial Accounting, 12th Canadian Edition
Problem 2-22 (60 minutes)
1.
Wallace River Company
Schedule of Cost of Goods Manufactured
For the Year Ended December 31
Direct materials:
Raw materials inventory, January 1................ $ 10,000
Add: Purchases of raw materials.................... 90,000
Raw materials available for use...................... 100,000
Deduct: Raw materials inventory, 17,000
December 31.............................................
Raw materials used in production................... $83,000
Direct labour................................................... 60,000
Manufacturing overhead:
Depreciation, factory .................................... 42,000
Insurance, factory......................................... 5,000
Maintenance, factory..................................... 30,000
Utilities, factory............................................. 27,000
Supplies, factory……………………………. 1,000
Indirect labour.............................................. 65,000
Total overhead costs........................................ 170,000
Total manufacturing costs................................ 313,000
Add: Work in process inventory, Jan. 1............. 7,000
320,000
Deduct: Work in process inventory, Dec. 30,000
31................................................................
Cost of goods manufactured............................. $290,000

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Solutions Manual, Chapter 2
Problem 2-22 (continued)
2.
Wallace River Company
Income Statement
For the Year Ended December 31
Sales.............................................................. $450,000
Cost of goods sold:
Finished goods inventory, Jan. 1.................... $ 10,000
Add: Cost of goods manufactured.................. 290,000
Goods available for sale................................ 300,000
Deduct: Finished goods inventory, Dec 31...... 40,000 260,000
Gross margin.................................................. 190,000
Selling and administrative expenses:
Administrative.............................................. 70,000
Selling expense............................................ 80,000
Advertising................................................... 20,000 170,000
Operating income............................................ $ 20,000

3. Costs per unit at a 10,000-unit activity level:

Total Activity Cost

Cost Level Per Unit
Direct materials $83,000* 10,000 $8.30
Factory depreciation $42,000 10,000 $4.20

*As per the schedule of cost of goods manufactured in requirement 1.

4. Costs per unit at a 15,000-unit activity level:

Total Activity Cost

Cost Level Per Unit
Direct materials $124,500 15,000 $8.30
*
Factory depreciation $42,000 15,000 $2.80*

*15,000 x $8.30 per unit

**$42,000  15,000

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34Managerial Accounting, 12th Canadian Edition
Problem 2-22 (continued)

5. Although direct material costs increase in total as the activity-level

increases from 10,000 units to 15,000 units, the cost per unit stays the
same. This is a fundamental characteristic of variable costs. The total
cost will change in direct proportion to a change in the activity level, but
the cost per unit remains constant over a relevant range of activity,
assuming input costs (e.g., prices charged by suppliers) do not change.

The fixed cost per unit for factory depreciation decreases to $2.80 from
$4.20 because while the total cost remains unchanged at $42,000, the
activity level increases by 5,000 units. This is a fundamental
characteristic of fixed costs. The total cost does not change in response
to a change in the activity level, the cost per unit is inversely related to
a change in activity levels.

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Solutions Manual, Chapter 2
Problem 2-23 (30 minutes)
1. A cost that is classified as a period cost will be recognized on the income
statement as an expense in the current period. A cost that is classified
as a product cost will be recognized on the income statement as an
expense (i.e., cost of goods sold) only when the associated units of
product are sold. If some units are unsold at the end of the period, the
costs of those unsold units are treated as assets. Therefore, by
reclassifying period costs as product costs, the company is able to carry
some costs forward in inventories that would have been treated as
current expenses.

2. The discussion below is divided into two parts—Gallant’s actions to

postpone expenditures and the actions to reclassify period costs as
product costs.
The decision to postpone expenditures is questionable. It is one thing to
postpone expenditures due to a cash bind; it is quite another to
postpone expenditures in order to hit a profit target. Postponing these
expenditures may have the effect of ultimately increasing future costs
and reducing future profits. If orders to the company’s suppliers are
changed, it may disrupt the suppliers’ operations. The additional costs
may be passed on to Gallant’s company and may create ill will and a
feeling of mistrust. Postponing maintenance on equipment is particularly
questionable. The result may be breakdowns, inefficient and/or unsafe
operations, and a shortened life for the machinery.

Gallant’s decision to reclassify period costs is not ethical—assuming that

there is no intention of disclosing in the financial reports this
reclassification. Such a reclassification would be a violation of the
principle of consistency in financial reporting and is a clear attempt to
mislead readers of the financial reports. Although some may argue that
the overall effect of Gallant’s action will be a “wash”—that is, profits
gained in this period will simply be taken from the next period—the
trend of earnings will be affected. Hopefully, the auditors would discover
any such attempt to manipulate annual earnings and would refuse to
issue an unqualified opinion due to the lack of consistency. However,
recent accounting scandals may lead to some skepticism about how
forceful auditors have been in enforcing tight accounting standards.

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36Managerial Accounting, 12th Canadian Edition
 Problem 2-24 (60 minutes)
1.
Carlton Manufacturing
Schedule of Cost of Goods Manufactured
Direct materials:
Raw materials inventory, beginning.......... $ 25,000
Add: Purchases of raw materials............... 130,000
Raw materials available for use................ 155,000
Deduct: Raw materials inventory, ending. . 20,000 *
Raw materials used in production............. $135,000 (given)
Direct labour............................................. 32,500
Manufacturing overhead:
Insurance, factory................................... 4,000
Rent, factory building.............................. 45,000 *
Utilities, factory....................................... 26,000
Indirect materials, factory........................ 3,000
Depreciation, factory equipment............... 55,000
Maintenance, factory............................... 37,000
Total overhead costs.................................. 170,000 (given)
Total manufacturing costs.......................... 337,500
Add: Work in process inventory, beginning. . 24,000
361,500
Deduct: Work in process inventory, end-
ing... 16,500 *
Cost of goods manufactured....................... $345,000 **
** computed in Cost of Goods Sold section next page

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Solutions Manual, Chapter 2
Problem 2-24 (continued)
The cost of goods sold section of the income statement follows:
Finished goods inventory, beginning...................... $ 15,000
Add: Cost of goods manufactured.......................... 345,000 *
Goods available for sale........................................ 360,000 (given)
Deduct: Finished goods inventory, ending.............. 42,500 *
Cost of goods sold................................................ $317,500 (given)
*These items must be computed by working backwards up through the
statements. An effective way of doing this is to place the form and
known balances on the paper, and then work toward the un-
known figures.

2. Direct materials: $135,000 ÷ 15,000 units = $9.00 per unit.

Rent, factory building: $45,000 ÷ 15,000 units = $3.00 per unit.

3. Direct materials:
Per unit: $9.00 (unchanged)
Total: 20,000 units × $9.00 per unit = $180,000.
Rent, factory building:
Per unit: $45,000 ÷ 20,000 units = $2.25 per unit.
Total: $45,000 (unchanged).

4. The average cost per unit for rent dropped from $3.00 to $2.25,
because of the increase in production between the two years. Since
fixed costs do not change in total as the activity level changes, the
average unit cost will decrease as the activity level rises.

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38Managerial Accounting, 12th Canadian Edition
Problem 2-25 (60 minutes)
1a. The total product cost is computed as follows:

Direct materials....................................................... $ 69,000

Direct labour........................................................... 35,000
Total manufacturing overhead (variable + fixed)........ 43,000
Total product cost.................................................... $147,000

1b. The total period cost is computed as follows:

Total selling expense (variable + fixed)..................... $30,000

Total administrative expense (variable + fixed).......... 29,000
Total period cost...................................................... $59,000

2a. The total direct manufacturing cost is computed as follows:

Direct materials....................................................... $ 69,000

Direct labour........................................................... 35,000
Total direct manufacturing cost................................. $104,000

2b. The total indirect manufacturing cost is computed as follows:

Variable manufacturing overhead.............................. $15,000

Fixed manufacturing overhead.................................. 28,000
Total indirect manufacturing cost.............................. $43,000

3a. The total manufacturing cost is computed as follows:

Direct materials....................................................... $ 69,000
Direct labour........................................................... 35,000
Total manufacturing overhead.................................. 43,000
Total manufacturing cost.......................................... $147,000

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Solutions Manual, Chapter 2
Problem 2-25 (continued)

3b. The total nonmanufacturing cost is computed as follows:

Total selling expense............................................... $30,000

Total administrative expense.................................... 29,000
Total nonmanufacturing cost.................................... $59,000

3c. The total conversion cost is computed as follows:

Direct labour........................................................... $35,000

Total manufacturing overhead.................................. 43,000
Total conversion cost............................................... $78,000

The total prime cost is computed as follows:

Direct materials....................................................... $ 69,000

Direct labour........................................................... 35,000
Total prime cost...................................................... $104,000

4a. The total variable manufacturing cost is computed as follows:

Direct materials....................................................... $ 69,000
Direct labour........................................................... 35,000
Variable manufacturing overhead.............................. 15,000
Total variable manufacturing cost............................. $119,000

4b. The total amount of fixed cost for the company as a whole is
computed as follows:

Fixed manufacturing overhead.................................. $28,000

Fixed selling expense............................................... 18,000
Fixed administrative expense.................................... 25,000
Total fixed cost........................................................ $71,000

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40Managerial Accounting, 12th Canadian Edition
Problem 2-25 (continued)
4c. The variable cost per unit produced and sold is computed as follows:

Direct materials....................................................... $ 69,000

Direct labour........................................................... 35,000
Total variable manufacturing overhead...................... 15,000
Variable selling expense........................................... 12,000
Variable administrative expense................................ 4,000
Total variable cost (a).............................................. $135,000
Number of units produced and sold (b)..................... 1,000
Variable cost per unit produced and sold (a) ÷
(b)....................................................................... $135

5. The incremental manufacturing cost is computed as follows:

Total variable manufacturing cost (see 4a) (a)........... $119,000

Number of units produced and sold (b)..................... 1,000
Variable manufacturing cost per unit produced $119
(a) ÷ (b)..............................................................
Incremental cost of producing an additional 100
units: 100 x $119………………………………………… $11,900

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Solutions Manual, Chapter 2
Problem 2-26 (45 minutes)

1.
MITCHELL COMPANY
Schedule of Cost of Goods Manufactured
For the Year Ended December 31
Direct materials:
Raw materials inventory, January 1............ $ 90,000
Add: Purchases of raw materials................ 750,000
Raw materials available for use.................. 840,000
Deduct: Raw materials inventory, Decem- 60,000
ber 31......................................................
Raw materials used in production.............. $ 780,000
Direct labour............................................ 150,000
Manufacturing overhead:..........................
Utilities, factory........................................ 36,000
Depreciation, factory................................. 162,000
Insurance, factory.................................... 40,000
Supplies, factory....................................... 15,000
Indirect labour.......................................... 300,000
Maintenance, factory................................ 87,000
Total overhead costs................................. 640,000
Total manufacturing costs......................... 1,570,000
Add: Work in process inventory, January 1. 180,000
1,750,000
Deduct: Work in process inventory, De- 100,000
cember 31...............................................
Cost of goods manufactured...................... $1,650,000

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42 Managerial Accounting, 12th Canadian Edition
Problem 2-26 (continued)
2. The cost of goods sold would be computed as follows:
Finished goods inventory, January 1........... $ 260,00
0
Add: Cost of goods manufactured.............. 1,650,000
Goods available for sale............................ 1,910,000
Deduct: Finished goods inventory, Decem- 210,000
ber 31......................................................
Cost of goods sold.................................... $1,700,000

3.
MITCHELL COMPANY

Income Statement

For the Year Ended December 31

Sales....................................................... $2,500,000
Less cost of goods sold (above)................. 1,700,000
Gross margin............................................ 800,000
Less selling and administrative expenses:...
Selling expenses..................................... $140,000
Administrative expenses.......................... 270,00
0
Total expenses....................................... 410,00
0
Operating income..................................... $ 390,000

4. Ending finished good inventory:

Direct materials ($780,000/412,500 = $1.8909) $104,332
$1.8909  55,176......................................................
Direct labour ($150,000/412,500 = $0.3636) $0.3636  20,062*
55,176......................................................................
Manufacturing overhead ($640,000/412,500 = 85,60
$1.5515) $1.5515  55,176 ....................................... 6
Total cost.............................................................. $210,000
*
Rounding down is undertaken to account for unit cost rounding.
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Solutions Manual, Chapter 2 43
 Problem 2-27 (30 minutes)
1.
Keep Lease New
Old Mowers Difference
Mowers
Lease costs (2 x $200) $0 $400 ($400)
Lease administration fee $0 $25 ($ 25)
Oil change changes & blade
sharpening (2 x $100) $200 $0 $200
Foregone revenue $0 $75 ($75)
Salvage value – old mowers (2 $0 $80 $80
x $40)
Gas expense savings* $0 $240 $360
Net difference $140
*(2,400 x $1 x 7.5%) x 2 = $360

The above analysis shows that Lilly will be $140 better off by selling her old
mowers and leasing the two new mowers for the fifth-year of operations.
The biggest factor driving the advantage of leasing the mowers is the gas
savings of $360. It would be worthwhile to point out to students that if
Lilly’s estimate of the efficiency gains is off by as little as 2.5% (i.e., only
5% savings are achieved) then the differential savings are only about $20.

2. Items excluded from the analysis and rationale:

 Cost ($1,000) and net book value ($240) of existing mowers since
these are sunk costs.
 Wage increase of $1,200 for Lilly’s brother since it does not differ un-
der the keep versus replace alternatives.
 Total repair costs of $300 per year as they are not estimated to differ
under the two alternatives.
 Total costs of $200 ($100 x 2) to replace the wheels and starter cords
at the end of the fourth season since this is a sunk cost.
 Additional revenue of $2,400 since it will not differ between the two
alternatives.

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44 Managerial Accounting, 12th Canadian Edition
Case 2-28 (30 minutes)

1. The error made by Ranton when calculating the 2021 expected

operating income was to treat all expenses as if they were variable. This
is incorrect since the case indicates that advertising and the salaries of
the website administrator and the bookkeeper are fixed costs. By
including these costs in the calculation of 2020 operating expenses on a
per unit basis ($13.50), Ranton is effectively treating them as if they will
vary in direct proportion with unit activity. This will lead to an
overstatement of the expected amount of these expenses because they
will not increase proportionately with sales activity.

2. The expected results for 2021, along with the 2020 actual results for
comparison, are shown below.

Actual Expected
2020 2021
Sales (units) ........................................ 8,000 10,000
Sales .................................................. $800,000 $1,000,000
Cost of goods sold:............................... 640,000 800,000
Gross margin....................................... 160,000 200,000
Operating expenses
Advertising....................................... 8,000 8,000
Salaries............................................ 92,000 92,000
Commissions*................................... 8,000 10,000
Total operating expenses................... 108,000 110,000
Operating income................................. $52,000 $90,000
The above shows that expected results for 2021 should have been
$90,000. This assumes, as per the case, that advertising and salaries
remain fixed at respectively, $8,000 and $92,000 per year.

*The only variable operating expense is the commission paid to the

website designer/administrator based on 1% of total sales. Compared to
the recalculated expected 2021 results, the actual operating income of
$75,000 no longer looks as good since it is $15,000 below the anticipated

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Solutions Manual, Chapter 2 45
level.

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46 Managerial Accounting, 12th Canadian Edition
Case 2-28 (continued)
3. Comparison of expected and actual operating expenses in 2021:

Expected expenses (per part 2 above) $110,000

Actual expenses $125,000
Difference $ 15,000

Assuming no mistakes were made by the bookkeeper in preparing

the 2021 financial statements Ranton needs to focus on the only vari-
able operating expense – sales commissions paid to the website de-
signer. If salaries ($92,000) and advertising ($8,000) truly are both
fixed costs and did not change in 2021, the $15,000 difference
between expected and actual operating expenses must be attribut-
able to an increase in the amount of commissions actually paid. Per-
haps a mistake was made in calculating the amount of the sales com-
missions but Ranton will want to get an answer.

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Solutions Manual, Chapter 2 47
Case 2-29 (30 minutes)
1. Differential revenues:
 The rental revenue that will be received from sub-letting 15% of
the new warehouse.
 Sales proceeds (less real estate commissions, legal fees, etc.) re-
ceived from selling old warehouse.
 Revenues from existing parking lot.

Differential costs:
 Monthly lease payments for the new warehouse.
 Utility costs (expected to be lower at new warehouse).
 Property taxes (none paid at new building).
 Building insurance (none paid at new building).
 Maintenance and repair costs (likely lower at new building).
 Salary of current maintenance manager (won’t be needed if PE
moves to the new building).
 Cost of maintaining the existing parking lot.

Note: some students may want to also include the inventory insur-
ance costs and the security personnel costs as differential costs.
However, the facts of the case indicate that Reg does not believe
these costs will change if the new warehouse is rented. As a result,
these are not differential costs.

2. An opportunity cost is a potential benefit given up when one alternat-

ive is chosen over another. If PE sells the old warehouse they will in-
cur an opportunity cost equal to the operating income currently being
earned on the small parking lot set up on one corner of the property.

3. The depreciation expense represents a sunk cost because it repres-

ents the allocation to reporting periods of the original depreciable
cost of the old warehouse. It should not be considered in deciding
whether to lease the new warehouse. Because that original cost can-
not be changed it is a sunk cost, and thus so too is the depreciation
of that original cost.

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48 Managerial Accounting, 12th Canadian Edition