Questions, Exercises & Problems

Management Accounting
Dr. Taha Abukriesha

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Chapter Two
2.1. Special order
Consider the following details of the income statement of the Manteray Pen
Company (MPC) for the year ended 31 December 20X0:
Sales € 11,000,000
Less cost of goods sold 6,500,000
Gross margin or gross profit € 4,500,000
Less selling and administrative expenses 3,000,000
Operating income € 1,500,000

MPC’s fixed manufacturing costs were €3.0 million and its fixed selling and
administrative costs were €2.2 million. Sales commissions of 3 per cent of
sales are included in selling and administrative expenses.
The division had produced and sold 2 million pens. Near the end of the year,
Pizza Hut offered to buy 150,000 pens on a special order. To fill the order, a
special Pizza Hut logo would have to be added to each pen. Pizza Hut intended
to use the pens for special promotions in an eastern city during early 20X1.
Even though MPC had some idle plant capacity, the president rejected the Pizza
Hut offer of €660,000 for the 150,000 pens. He said,
The PIZZA Hut offer is too low. We’d AVOID PAying SALES commissions,
but we’d HAVe to incur AN extrA COSt of €.40 per pen to ADD the logo. If
MPC sells below its regular selling prices, it will begin A CHAIN REACTION
of competitors’ price cutting and of customers waiting SPECIAL DEALS. I
believe in pricing AT no lower than 8% above our full costs of €9,500,000
/ 2,000,000 units = €4.75 per unit plus the extra €.40 per pen less the
saving in commissions.
1. Using the contribution-margin technique, prepare an analysis similar to that
in Exhibit 5.6 on p. 184. Use four columns: without the special order, the
effect of the special order (one column total and one column per unit) and
totals with the special order.
2. By what percentage would operating income increase or decrease if the
order had been accepted? Do you agree with the president’s decision?
Why?

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2.2. Make or Buy Decisions
Sunshine Fruit Company sells premium-quality oranges and other citrus fruits
by mail order. Protecting the fruit during shipping is important so the company
has designed and produces shipping boxes. The annual cost to make 80,000
boxes is:
Materials €112,000
Labour 20,000
Indirect manufacturing costs
Variable 16,000
Fixed 60,000
Total €208,000

Suppose Moonshine submits a bid to supply Sunshine with boxes for €2.10
per box. Sunshine must give Moonshine the box design specifications, and the
boxes will be made according to those specs.
1. How much, if any, would Sunshine save by buying the boxes from
Moonshine?
2. What subjective factors should affect Sunshine decision about whether to
make or buy the boxes?
3. Suppose all the fixed costs represent depreciation on equipment that was
purchased for €600,000 and is just about at the end of its 10-year life. New
replacement equipment will cost €800,000 and is also expected to last 10
years. In this case, how much, if any, would Sunshine save by buying the
boxes from Moonshine?

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2.3. Joint products: sell or process further
The Mussina Chemical Company produced three joint products at a joint cost
of €117,000. These products were processed further and sold as follows:
Additional
Chemical Product Sales processing costs
A €230,000 €190,000
B 330,000 300,000
C 175,000 100,000

The company has had an opportunity to sell at split-off directly to other

processors. If that alternative had been selected, sales would have been A,
€54,000; B, €32,000; and C, €54,000. The company expects to operate at the
same level of production and sales in the forthcoming year.
Consider all the available information, and assume that all costs incurred after
split-off are variable.
1. Could the company increase operating income by altering its processing
decisions? If so, what would be the expected overall operating income?
2. Which products should be processed further and which should be sold at
split-off?

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2.4 Old equipment replacement
On 2 January, the S. H. Park Company installed a brand new €90,000
special molding machine for producing a new product. The product and the
machine have an expected life of 3 years. The machine’s expected disposal
value at the end of 3 years is zero.
On 3 January of that year, Kimiyo Lee, a star salesperson for a machine tool
manufacturer, tells Mr Park, ‘I wish I had known earlier of your purchase
plans. I can supply you with a technically superior machine for €99,000. The
machine you just purchased can be sold for €15,000. I guarantee that our
machine will save €38,000 per year in cash operating costs, although it too
will have no disposal value at the end of 3 years.

Park examines some technical data. Although he has confidence in Lee’s

claims, Park contends, ‘I’m locked in now. My alternatives are clear: (a)
Disposal will result in a loss, (b) keeping the ‘old’ equipment avoids such a
loss. I have brains enough to avoid a loss when my other alternative is
recognising a loss. We’ve got to use that equipment until we get our money
out of it.’
The annual operating costs of the old machine are expected to be €60,000,
exclusive of depreciation. Sales, all in cash, will be €910,000 per year. Other
annual cash expenses will be €810,000 regardless of this decision. Assume that
the equipment in question is the company’s only fixed asset.
1. Prepare statements of cash receipts and disbursements as they would appear in
each of the next 3 years under both alternatives. What is the total cumulative
increase or decrease in cash for the 3 years?
2. Prepare income statements as they would appear in each of the next 3
years under both alternatives. Assume straight-line depreciation. What is the
cumulative increase or decrease in net income for the 3 years?
3. Assume that the cost of the ‘old’ equipment was €1 million rather than
€90,000. Would the net difference computed in numbers 1 and 2 change?
Explain.

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2.5. Dropping a product line
Hamleys Toy Store is on Regent Street in London. It has a magic department
near the main door. Suppose that management is considering dropping the
magic department, which has consistently shown an operating loss. The
predicted income statements, in thousands of pounds (£), are shown below
(for ease of analysis, only three product lines are shown).

The £300,000 of magic department fixed expenses include the compensation of

employees of £120,000. These employees will be released if the magic
department is abandoned. All of the magic department’s equipment is fully
depreciated, so none of the £300,000 pertains to such items. Furthermore,
disposal values of equipment will be exactly offset by the costs of removal
and remodelling.

If the magic department is dropped, the manager will use the vacated space
for either more general merchandise or more electronic products. The
expansion of general merchandise would not entail hiring any additional
salaried help, but more electronic products would require an additional
person at an annual cost of £30,000. The manager thinks that sales of general
merchandise would increase by £250,000; electronic products, by £200,000.
The manager’s predictions are partially based on the fact that she thinks the
magic department has helped lure customers to the store and, thus, improved
overall sales. If the magic department is closed, that lure would be gone.
General Electronic Magic
Total merchandise products department
Sales £6,000 £5,000 £400 £ 600
Variable expenses 4,090 3,500 200 390
Contribution margin Fixed £1,910 (32%) £1,500 (30%) £200 (50%) £ 210 (35%)
expenses
(compensation, depreciation,
property taxes,insurance, etc.) 1,100 750 50 300
Operating income (loss) £ 810 £ 750 £150 £(90)

Should the magic department be closed? Explain, showing computations

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2.6. Replacing old equipment
Consider the data regarding Douglas County’s photocopying requirements
below.
The county administrator is trying to decide whether to replace the old
equipment. Because of rapid changes in technology, she expects the
replacement equipment to have only a 3-year useful life. Ignore the effects of
taxes.
1. Prepare a schedule that compares both relevant and irrelevant items for the
next 3 years. (Hint: See Exhibit 6.5, p. 249.)
2. Prepare a schedule that compares all relevant items for the next 3 years. Which
tabulation is clearer, this one or the one in requirement 1? (Hint: See Exhibit
6.6, p. 251.)
3. Prepare a simple ‘shortcut’ or direct analysis to support your choice of
alternatives.

Proposed
Old replacement
equipment equipment
Useful life, in years 5 3
Current age, in years 2 0
Useful life remaining, in years 3 3
Original cost €25,000 €15,000
Accumulated depreciation 10,000 0
Book value 15,000 Not acquired yet
Disposal value (in cash) now 6,000 Not acquired yet
Disposal value in 3 years 0 0
Annual cash operating costs for power, 14,000 9,000
maintenance, toner and supplies

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2.7. Sell or process further
ConAgra produces meat products with brand names such as Healthy Choice,
Armour and Butterball. Suppose one of the company’s plants processes beef
cattle into various products. For simplicity, assume that there are only three
products: steak, hamburger and hides, and that the average steer costs €700.
The three products emerge from a process that costs €100 per steer to run, and
output from one steer can be sold for the following net amounts:

Steak (100 pounds) € 400

Hamburger (500 pounds) 600
Hide (120 pounds) 100
Total €1,100

Assume that each of these three products can be sold immediately or

processed further in another ConAgra plant. The steak can be the main
course in frozen dinners sold under the Healthy Choice label. The vegetables
and desserts in the 400 dinners produced from the 100 pounds of steak would
cost €110, and production, sales and other costs for the 400 meals would
total €330. Each meal would be sold wholesale for €2.10.
The hamburger could be made into frozen Salisbury steak patties sold under
the Armour label. The only additional cost would be a €200 processing cost
for the 500 pounds of ham- burger. Frozen Salisbury steaks sell wholesale
for €1.70 per pound.
The hide can be sold before or after tanning. The cost of tanning one hide is
€80 and a tanned hide can be sold for €170.
1. Compute the total profit if all three products are sold at the split-off point.
2. Compute the total profit if all three products are processed further before
being sold.
3. Which products should be sold at the split-off point? Which should be
processed further?
4. Compute the total profit if your plan in number 3 is followed.

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2.8. Competitive bids
Griffy, Rodriguez and Martinez, an accounting firm, is preparing to bid for a
consulting job. Although Alicia Martinez will use her judgement about the
market in finalising the bid, she has asked you to prepare a cost analysis to
help in the bidding. You have estimated the costs for the consulting job to
be as follows:
Materials and supplies, at cost € 30,000
Hourly pay for consultants, 2,000 hours at €35 per hour 70,000
Fringe benefits for consultants, 2,000 hours at €12 per 24,000
hour
Total variable costs €124,000
Fixed costs allocated to the job
Based on labour, 2,000 hours at €10 per hour 20,000
Based on materials and supplies, 80% of 30,000 24,000
Total cost €168,000

Of the €44,000 allocated fixed costs, €35,000 will be incurred even if the
job is not undertaken.
Alicia normally bids jobs at the sum of (1) 150 per cent of the estimated
materials and supplies cost and (2) €75 per estimated labour hour.
1. Prepare a bid using the normal formula.
2. Prepare a minimum bid equal to the additional costs
expected to be incurred to complete the job.
3. Prepare a bid that will cover full costs plus a markup for profit equal
to 20 per cent of full cost.

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2.9. Target costing
Best Cost Corporation has an aggressive research and development (R&D)
programme and uses target costing to aid in the final decision to release new
products to production. A new product is being evaluated. Market research has
surveyed the potential market for this product and believes that its unique
features will generate a total demand of 50,000 units at an average price of
€230. Design and production engineering departments have performed a
value analysis of the product and have determined that the total cost for the
various value- chain functions using the existing process technology are as
follows:

Value-chain function Total cost over product

life
Research and development € 1,500,000
Design 750,000
Manufacturing 5,000,000
Marketing 800,000
Distribution 1,200,000
Customer service 750,000
Total cost over product life €10,000,000

Management has a target profit percentage of 20 per cent of sales. Production

engineering indicates that a new process technology can reduce the
manufacturing cost by 40 per cent, but it will cost €1,100,000.
1. Assuming the existing process technology is used, should the
new product be released to production? Explain.
2. Assuming the new process technology is purchased, should the
new product be released to production? Explain.

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2.10. Straightforward absorption statement
The Pierce Company had the following data (in thousands) for a given
period:

Sales €800
Direct materials 200
Direct labour 200
Indirect manufacturing costs 170
Selling and administrative expenses 150

There were no beginning or ending inventories. Compute the (1)

manufacturing cost of goods sold, (2) gross profit, (3) operating income and
(4) conversion cost (total manufacturing cost less materials cost).

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2.11. Straightforward contribution income statement
Yoko Ltd, had the following data (in millions of yen) for a given period:
Sales €950
Direct materials 290
Direct labour 160
Variable factory overhead 60
Variable selling and administrative expenses 100
Fixed factory overhead 120
Fixed selling and administrative expenses 45

There were no beginning or ending inventories. Compute the (a) variable

manufacturing cost of goods sold, (b) contribution margin and (c) operating
income.

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2.12. Target costing
Lisboa Electrical makes small electric motors for a variety of home appliances.
Lisboa sells the motors to appliance makers, who assemble and sell the
appliances to retail outlets. Although Lisboa makes dozens of different motors, it
does not currently make one to be used in garage-door openers. The company’s
market research department has discovered a market for such a motor.
The market research department has indicated that a motor for garage-door
openers would likely sell for €26. A similar motor currently being produced has
the following manufacturing costs:
Direct materials €13.00
Direct labour 6.00
Overhead 8.00
Total €27.00

Lisboa desires a gross margin of 20 per cent of the manufacturing cost.

1. Suppose Lisboa used cost-plus pricing, setting the price 20 per cent above
the manufacturing cost. What price would be charged for the motor? Would
you produce such a motor if you were a manager at Lisboa? Explain
2. Suppose Lisboa uses target costing. What price would the company charge
for a garage- door-opener motor? What is the highest acceptable
manufacturing cost for which Lisboa would be willing to produce the
motor?
3. As a user of target costing, what steps would Lisboa managers take to try to
make production of this product feasible?

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Chapter Three
3.1 Purchases and cost of goods sold
Ronco Products, a wholesaler of fishing equipment, budgeted the following
sales for the indicated months:
June 20X8 July 20X8 August 20X8
Sales on account €1,820,000 €1,960,000 €2,100,000
Cash sales 280,000 240,000 260,000
Total sales €2,100,000 €2,200,000 €2,360,000

All merchandise is marked up to sell at its invoice cost plus 25 per cent. Target
merchandise inventories at the beginning of each month are 30 per cent of that
month’s projected cost of goods sold.
1. Compute the budgeted cost of goods sold for the month of June 20X8.
2. Compute the budgeted merchandise purchases for July 20X8.

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3.3 Purchases and sales budgets
All sales of Jenny’s Jeans and Uniforms (JJU) are made on credit. Sales are
billed twice monthly, on the fifth of the month for the last half of the prior
month’s sales and on the twentieth of the month for the first half of the current
month’s sales. For accounts paid within the first 10 days after the billing date,
JJU gives customers a 3 per cent discount; otherwise the full amount is due
within 30 days of the billing date and customers that do not pay within the
10-day discount period generally wait the full 30 days before making
payment. Based on past experience, the collection experience of accounts
receivable is as follows:

Within the 10-day discount period 80%

At 30 days after billing
Uncollectible
18%
2%
Sales for May 20X8 were €700,000.
The forecast sales for the next 4
months are as follows:
June €800,000
July 950,000
August 900,000
September 600,000

JJU’s average markup on its products is 40 % of the sales price.

JJU purchases merchandise for resale to meet the current month’s sales
demand and to maintain a desired monthly ending inventory of 25 % of the
next month’s cost of goods sold. All purchases are on credit. JJU pays for one-
half of a month’s purchases in the month of purchase and the other half in the
month following the purchase.
All sales and purchases occur uniformly throughout the month.

1. How much cash can JJU plan to collect from accounts receivable
collections during July 20X8?
2. Compute the budgeted euro value of JJU inventory on May 31, 20X8.
3. How much merchandise should JJU plan to purchase during June 20X8?
4. How much should JJU budget in August 20X8 for cash payments for
merchandise purchased?

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3.4 Sales budget
A Kyoto clothing wholesaler was preparing its sales budget for the first
quarter of 20X8. Forecast sales are as follows (in thousands of yen):
January ¥200,000
February ¥200,000
March ¥240,000

Sales are 20 per cent cash and 80 per cent on credit. Fifty per cent of the credit
accounts are collected in the month of sale, 40 per cent in the month following
the sale, and 10 per cent in the following month. No uncollectible accounts are
anticipated. Accounts receivable at the beginning of 20X8 are ¥96 million (10
per cent of November credit sales of ¥180 million and 50 per cent of
December credit sales of ¥156 million).
Prepare a schedule showing sales and cash collections for January, February
and March 20X8.

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3.5. Cash budget
Consider the budgeted income statement for Carlson Company for June
20X4 in Exhibit 3.6.
The cash balance, 31 May 20X4, is €15,000.
Sales proceeds are collected as follows: 80 per cent the month of sale, 10 per
cent the second month and 10 per cent the third month.
Accounts receivable are €44,000 on 31 May 20X4, consisting of €20,000
from April sales and €24,000 from May sales.
Accounts payable on 31 May 20X4 are €145,000.
Carlson Company pays 25 per cent of purchases during the month of
purchase and the remainder during the following month.
All operating expenses requiring cash are paid during the month of
recognition, except that insurance and property taxes are paid annually in
December for the forthcoming year.
Prepare a cash budget for June.

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3.6. Collections & Payments
Quolala is a merchandising company. Quolala expects unit sales for the
coming year as follows:
March 15,000
April 23,000
May 31,000
June 47,000
July 56,000
The average selling price is $23 per unit. The company’s policy is to
maintain month-end inventory levels at 30% of next month’s anticipated
sales. All sales are made on credit, and expected collections are as follows:
70% collected in the month of sale
20% collected in the month following the sale
10% collected in the second month following the sale.
Cost of goods sold equals 80% of the sales price. The company pays cash
for all purchases of inventory, at the time of purchase.

Required:
A) How much inventory (how many units) will Quolala expect to purchase
in June?
B) What will be the dollar amount of accounts receivable at the end of July?
C) How much should the company expect to pay (i.e., credits to cash,
debits to inventory) for purchases of inventory in May?
D) What can the company expect to collect in receivables (i.e., debits to
cash, credits to accounts receivable) in June?

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3.7. Collections & Payments
California Concepts sells hair products. Sales of shampoo for the last half
of 2005 are projected as follows:

September: 100 cases

October: 120 cases
November: 130 cases
December: 160 cases

California Concepts plans to sell each case for $25, which represents a $7
mark-up over cost. The company manages its inventory purchases so that
it always has 70% of each month’s unit sales on hand at the beginning of
that month. The company buys inventory on credit. The company pays for
these credit purchases in the month following the purchase.

On average, the company’s customers pay cash at the time of purchase for
60% of their purchases, and buy the remaining 40% on credit. These credit
purchases are paid to California Concepts as follows:

30% in the month of purchase

40% in the month immediately following the purchase
30% in the second month following the purchase

Required:
A) Calculate Accounts Receivable for sales of shampoo as of the end of
November, and Accounts Payable for purchases of shampoo as of the end
of November.
B) Calculate net cash flows from sales and purchases of shampoo that
occur in November.

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3.8. Cash budget
Daniel Merrill is the manager of an airport gift shop, Merrill News and Gifts.
From the following data, Mr Merrill wants a cash budget showing expected cash
receipts and disbursements for the month of April and the cash balance
expected as of 30 April 20X7.

- Planned cash balance, 31 March 20X7: €100,000

- Customer receivables as of 31 March: €530,000 total, €80,000 from
February sales, €450,000 from March sales
- Accounts payable, 31 March: €460,000
- Merchandise purchases for April: €450,000, 40 per cent paid in month of
purchase, 60 per cent paid in next month
- Payrolls due in April: €90,000
- Other expenses for April, payable in April: €45,000
- Accrued taxes for April, payable in June: €7,500
- Bank note due April 10: €90,000 plus €7,200 interest
- Depreciation for April: €2,100
-Two-year insurance policy due 14 April for renewal: €1,500, to be paid in
cash
- Sales for April: €1,000,000, half collected in month of sale, 40 per cent in
next month, 10 per cent in third month

Prepare the cash budget for the month ending 30 April 20X7.

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