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Accounting For Decision Making And Control, 9th Edition Solution Manual

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    PART II: SOLUTIONS TO PROBLEMS AND CASES C HAPTER 1 I NTRODUCTION P 1 – 1: Solution to MBA Students (10 minutes) [Using accounting information for decision making and control] Together the two observations highlight the extremes in the trade - offs of using accounting information for decision and control. In the first case, there is more analysis of opportunity costs that are hard to capture with typical accounting information. In the second case, there is less intended interest in opportunity cost and greater emphasis on control. P 1 – 2: Solution to One Cost System Isn't Enough (15 minutes) [Economic Darwinism] The first part of the quote describes the tension (and conflict) that arises when a single accounting system is used for multiple purposes. This part of the statement is an accurate description of practice. However, the quote has a couple of problems, including: •While the quote describes the costs of using a single system ("a single system ... can't perform important managerial functions adequately"), the quote does not describe the benefits derived from using a single system (lower bookkeeping costs, a single audit, less confusion). •Because the quote ignores the benefits of a single system, it ignores the concept of economic Darwinism. It does not address the question of how surviving (successful) companies can compete if a single system "can't perform important managerial functions adequately." •Also, the quote assumes that managers are bound to their internal accounting systems, that no other alternative information sources are available. Often managers develop their own ad hoc, "off - line" information systems for decision making. These systems include spreadsheets, informal observation, and "walking around." P 1 – 3: Solution to U.S. and Japanese Tax Laws (15 minutes) [Influence of conflicting demands on cost systems] The internal accounting system supports multiple uses, including financial reporting, taxes, contracting (debt and management compensation), internal decision making, and internal control. Because multiple purposes are served, trade - offs must be made among the competing demands. When more emphasis is placed on one purpose (taxes), less consideration can be given to other uses (internal decision making and control). By linking taxes to external reporting, Japanese firms’ financial reports will be

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    based on accounting procedures that give more weight to tax considerations. In the U.S., companies can keep two sets of books, one for taxes and the other for financial reporting. Thus, in the U.S., there is more of a decoupling of taxes and everything else. Except for the additional bookkeeping costs of producing the two separate sets of reports, tax considerations are predicted to have less influence on the choice of internal (and thus external) accounting procedures in the U.S. than in Japan. The question is raised as to why firms use the same accounting procedures for internal reports as they do for external reports. Or for that matter, why do tax laws and external financial reporting considerations have any effect on internal accounting procedures? Why don’t firms maintain multiple sets of accounts, one for each purpose (e.g., financial reporting, internal decision making, and internal control)? Clearly there are additional bookkeeping costs for maintaining multiple sets of accounts. But also, there are confusion costs and, in many instances, firms explicitly link senior executive compensation to externally reported financial statements. Such explicit linkage of executive pay to externally reported net income presumably exists to control agency costs between management and shareholders. Once senior management performance and rewards are linked to external reports, the internal reporting system will become linked to the external reports and basically less consideration will be given to choosing accounting procedures that aid in internal decision making and internal control. In Japan, the firm’s accounting systems are less likely to be used for internal uses (decision making and control) than in the U.S. Because they cannot rely as much on their accounting systems for internal uses (because more weight is placed on using accounting procedures to reduce taxes), Japanese managers are more likely to use non - accounting - based systems for internal decision making and control. P 1 - 4: Solution to Using Accounting for Planning (15 minutes) [Usefulness of historical costs] a. Historical costs are of limited use in making planning decisions in a rapidly changing environment. With changing products, processes and prices, the historical costs are inadequate approximations of the opportunity costs of using resources. Historical costs may, however, be useful for control purposes, as they provide information about the activities of managers and can be used as performance measures to evaluate managers. b. The purpose of accounting systems is to provide information for planning purposes and control. Although historical costs are not generally appropriate for planning purposes, additional measures are costly to make. An accounting system should include additional measures if the benefits of improved decision making are greater than the costs of the additional information.

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    P 1 – 5 : Solution to Budgeting (15 minutes) [Trade - off between decision making and control] In this firm, the bonus is based on meeting the budget. Two incentives exist: sales people will under - forecast future sales and they have little incentive to sell more than the budget. This firm tries to use the budget for two functions: decision making and control. In deciding on next year’s production plans, sales peoples’ forecasts of future sales are important. However, these same forecasts (after revision by supervisors) are used as part of the compensation scheme to motivate the sales people to achieve their goals. By using the budget (forecasts) as part of the control system, the firm gives up some of the budget’s usefulness as a decision making tool to set production plans. While senior managers might recognize that the sales people’s forecasts are low, they don’t know exactly how low. This introduces more uncertainty into planning for next year’s production. P 1 - 6 : Solution to Golf Specialties (20 minutes) [Average versus variable cost of an incremental order] a. Given that the variable cost per head cover is 1.10 euros, the fixed cost per week is: AC = FC / Q + VC 3.10 = FC/600 + 1.10 3.50 = FC/500 + 1.10 FC = 1,200 euros FC = 1,200 euros b . The change in total cost if the 100 unit Kojo offer is accepted is: 600 × 3.10 euros – 500 × 3.50 euros = 110 euros Or, each head cover has variable cost of 1.10 euro. Since Kojo is willing to pay 2 euros per head cover or 200 euros for 100 covers, by accepting this order GS makes 90 euros a week. Therefore, GS should accept Kojo’s offer if these are all the relevant facts. c. GS should consider the following non - quantitative factors:  What prevents Kojo from reselling the head covers back to dealers in Europe at prices below GS’s current price of 4.25 euros ?  If GS sells the head covers to Kojo at 2 euros, what prevents GS’s European customers from learning of this special deal and demand similar price concessions. In other words, why do we expect to be able to implement this price discrimination strategy?

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     Will Kojo purchase other GS products and import them to Japan?  What is Kojo’s credit worthiness and will they pay for the head covers upon taking delivery? P 1 – 7 : Solution to Parkview Hospital (25 minutes) [Changes in the environment cause accounting system changes] a. Parkview’s accounting system was probably adequate 10 years ago. It faced little competition and had little incentive to have detailed cost and revenue data at the clinical levels. b. With increased pressure to reduce costs, Parkview management wants detailed cost and revenue data at the clinic level to help identify units with excess revenues or deficits. This would help guide their decisions as to how to respond to the $3.2 million shortfall. The accounting system doesn’t provide as much help as management would like. c. The question of changing the accounting system should be approached as a cost - benefit decision. What will such changes cost, how long will they take to implement, and what benefits are derived? While it is tempting to say more accurate tracking of costs and benefits allows better decision making, changing the accounting system, including all the data processing changes that are likely necessary, usually is a very costly and time consuming process. Often special studies based on approximations of clinical department costs and revenues might prove to be faster and cheaper than waiting to revamp the accounting system. Notice the change in competition in the health insurance market caused by Trans Insurance’s entry prompted a series of changes in Parkview, including a re - examination of its accounting system. P 1 – 8 : Solution to Montana Pen (25 minutes) [Incremental cost of outsourcing] a. The average cost information given in the problem does not tell us what 400 clips cost. Like in the Vortec example from the chapter, the incremental cost of the 400 clips must be estimated from the following: Changein totalcost Changein volume = B185 1200 B212.5 800 1, 200 800     = B130/clip At the current volume of 1,200 clips, the total cost is B222,000 (B185 × 1,200). If 400 clips are outsourced, reducing in - house volume to 800, the total cost falls to B170,000 (B212 . 5 × 800). Hence, total cost falls B52,000 (B222,000 - B170,000), or B130 per clip (B52,000 ÷ 400). Therefore, if 400 clips are

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    outsourced to the Chinese company, Montana saves B130 per clip, but must pay the Chinese firm 136 per clip. Therefore, based solely on the cost data presented in the problem, do not outsource the gold clips. b. There are a number of additional factors that must be considered besides just the costs: i. How does the quality of the Chinese clips compare to Montana’s quality? If it is significantly higher, then it might be worth paying six Baht more per clip (approximately $0.10). What about delivery reliability? Is the Chinese firm more or less reliable than producing the clips in - house? ii. What alternative use can be made of the manufacturing capacity of the 400 clips freed up if they are outsourced? Is the Bangkok plant’s manufacturing capacity constrained because there are not enough skilled goldsmiths or because of space or equipment? If so, by outsourcing the 400 clips to the Chinese, what other pen parts can these goldsmiths manufacture? iii. What long - term benefits are created by developing a business relation with this Chinese firm? For example, might this Chinese firm become a possible business partner or useful in opening a Chinese pen factory? Will Montana’s management learn anything new about business dealings with Chinese firms from outsourcing these clips? Will purchasing these clips in China help Montana sell more pens in China?

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    C HAPTER 2 T HE N ATURE OF C OSTS P 2 - 1: Solution to Darien Industries (10 minutes) [Relevant costs and benefits] Current cafeteria income Sales $12,000 Variable costs (40% × 12,000) (4,800) Fixed costs (4,700) Operating income $2,500 Vending machine income Sales (12,000 × 1.4) $16,800 Darien's share of sales (.16 × $16,800) 2,688 Increase in operating income $ 188 P 2 - 2: Negative Opportunity Costs (10 minutes) [Opportunity cost] Yes, when the most valuable alternative to a decision is a net cash outflow that would have occurred is now eliminated. The opportunity cost of that decision is negative (an opportunity benefit). For example, suppose you own a house with an in - ground swimming pool you no longer use or want. To dig up the pool and fill in the hole costs $3,000. You sell the house instead and the new owner wants the pool. By selling the house, you avoid removing the pool and you save $3,000. The decision to sell the house includes an opportunity benefit (a negative opportunity cost) of $3,000. P 2 - 3: Solution to NPR (10 minutes) [Opportunity cost of radio listeners] The quoted passage ignores the opportunity cost of listeners’ having to forego normal programming for on - air pledges. While such fundraising campaigns may have a low out - of - pocket cost to NPR, if they were to consider the listeners’ opportunity cost, such campaigns may be quite costly.

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    P 2 - 4: Solution to Silky Smooth Lotions (15 minutes) [Break even with multiple products] Given that current production and sales are: 2,000, 4,000, and 1,000 cases of 4, 8, and 12 ounce bottles, construct of lotion bundle to consist of 2 cases of 4 ounce bottles, 4 cases of 8 ounce bottles, and 1 case of 12 ounce bottles. The following table calculates the break - even number of lotion bundles to break even and hence the number of cases of each of the three products required to break even. Per Case 4 ounce 8 ounce 12 ounce Bundle Price $36.00 $66.00 $72.00 Variable cost $13.00 $24.50 $27.00 Contribution margin $23.00 $41.50 $45.00 Current production 2000 4000 1000 Cases per bundle 2 4 1 Contribution margin per bundle $46.00 $166.00 $45.00 $257.00 Fixed costs $771,000 Number of bundles to break even 3000 Number of cases to break even 6000 12000 3000 P 2 - 5 : Solution to J. P. Max Department Stores (15 minutes) [Opportunity cost of retail space] Home Appliances Televisions Profits after fixed cost allocations $64,000 $82,000 Allocated fixed costs 7,000 8,400 Profits before fixed cost allocations 71,000 90,400 Lease Payments 72,000 86,400 Forgone Profits – $1,000 $ 4,000 We would rent out the Home Appliance department, as lease rental receipts are more than the profits in the Home Appliance Department. On the other hand, profits generated by the Television Department are more than the lease rentals if leased out, so we continue running the TV Department. However, neither is being charged inventory holding costs, which could easily change the decision. Also, one should examine externalities. What kind of merchandise is being sold in the leased store and will this increase or decrease overall traffic and hence sales in the other departments? P 2 - 6 : Solution to Vintage Cellars (15 minutes)

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    [Average versus marginal cost] a. The following tabulates total, marginal and average cost. Quantity Average Cost Total Cost Marginal Cost 1 $12,000 $12,000 2 10,000 20,000 $8,000 3 8,600 25,800 5,800 4 7,700 30,800 5,000 5 7,100 35,500 4,700 6 7,100 42,600 7,100 7 7,350 51,450 8,850 8 7,850 62,800 11,350 9 8,600 77,400 14,600 10 9,600 96,000 18,600 b. Marginal cost intersects average cost at minimum average cost (MC=AC=$7,100). Or, at between 5 and 6 units AC = MC = $7,100. c. At four units, the opportunity cost of producing and selling one more unit is $4,700. At four units, total cost is $30,800. At five units, total cost rises to $35,500. The incremental cost (i.e., the opportunity cost) of producing the fifth unit is $4,700. d. Vintage Cellars maximizes profits ($) by producing and selling seven units. Quantity Average Cost Total Cost Total Revenue Profit 1 $12,000 $12,000 $9,000 - $3,000 2 10,000 20,000 18,000 - 2,000 3 8,600 25,800 27,000 1,200 4 7,700 30,800 36,000 5,200 5 7,100 35,500 45,000 9,500 6 7,100 42,600 54,000 11,400 7 7,350 51,450 63,000 11,550 8 7,850 62,800 72,000 9,200 9 8,600 77,400 81,000 3,600 10 9,600 96,000 90,000 - 6,000 P 2 - 7 : Solution to ETB ( 15 minutes) [Minimizing average cost does not maximize profits] a. The following table calculates that the average cost of the iPad bamboo case is minimized by producing 4,500 cases per month.

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    Monthly Production and Sales Production (units) 3,000 3,500 4,500 5,000 Total cost $162,100 $163,000 $167,500 $195,000 Average cost $54.03 $46.57 $37.22 $39.00 b. The following table calculates net income of the four production (sales) levels. Monthly Production and Sales Production (units) 3,000 3,500 4,500 5,000 Revenue $195,000 $227,500 $292,500 $325,000 Total cost 162,100 163,000 167,500 195,000 Net income $32,900 $64,500 $125,000 $130,000 Based on the above analysis, the profit maximizing production (sales) level is to manufacture and sell 5,000 iPad cases a month. Selecting the output level that minimizes average cost (4,500 cases) does not maximize profits. P 2 - 8 : Solution to Taylor Chemicals (15 minutes) [Relation between average, marginal, and total cost] a. Marginal cost is the cost of the next unit. So, producing two cases costs an additional $400, whereas to go from producing two cases to producing three cases costs an additional $325, and so forth. So, to compute the total cost of producing say five cases you sum the marginal costs of 1, 2, …, 5 cases and add the fixed costs ($500 + $400 + $325 + $275 + $325 + $1000 = $2825). The following table computes average and total cost given fixed cost and marginal cost.

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    Quantity Marginal Cost Fixed Cost Total Cost Average Cost 1 $500 $ 1000 $ 1500 $ 1500.00 2 400 1000 1900 950.00 3 325 1000 2225 741.67 4 275 1000 2500 625.00 5 325 1000 2825 565.00 6 400 1000 3225 537.50 7 500 1000 3725 532.14 8 625 1000 4350 543.75 9 775 1000 5125 569.44 10 950 1000 6075 607.50 b. Average cost is minimized when seven cases are produced. At seven cases, average cost is $532.14. c. Marginal cost always intersects average cost at minimum average cost. If marginal cost is above average cost, average cost is increasing. Likewise, when marginal cost is below average cost, average cost is falling. When marginal cost equals average cost, average cost is neither rising nor falling. This only occurs when average cost is at its lowest level (or at its maximum). P 2 - 9 : Solution to Emrich Processing (15 minutes) [Negative opportunity costs] Opportunity costs are usually positive. In this case, opportunity costs are negative (opportunity benefits) because the firm can avoid disposal costs if they accept the rush job. The original $1,000 price paid for GX - 100 is a sunk cost. The opportunity cost of GX - 100 is - $400. That is, Emrich will increase its cash flows by $400 by accepting the rush order because it will avoid having to dispose of the remaining GX - 100 by paying Environ the $400 disposal fee. How to price the special order is another question. Just because the $400 disposal fee was built into the previous job does not mean it is irrelevant in pricing this job. Clearly, one factor to consider in pricing this job is the reservation price of the customer proposing the rush order. The $400 disposal fee enters the pricing decision in the following way: Emrich should be prepared to pay up to $399 less any out - of - pocket costs to get this contract.

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    P 2 - 10 : Solution to Verdi Opera or Madonna? (15 minutes) [Opportunity cost of attending a Madonna concert] If you attend the Verdi opera, you for e go the $200 in benefits (i.e., your willingness to pay) you would have received from going to see Madonna. You also save the $160 (the costs) you would have paid to see Madonna. Since an avoided benefit is a cost and an avoided cost is a benefit, the opportunity cost of attending the opera (the value you for e go by not attending the Madonna concert) is $40 – i.e., the net benefit for e gone. Your willingness to pay $30 for the Verdi opera is un related to the costs and benefits of for e going the Madonna concert. P 2 - 11 : Solution to Dod Electronics ( 15 minutes) [Estimating marginal cost from average cost] a. Dod should accept Xtron’s offer. The marginal cost to produce the 10,000 chips is unknown. But since management is convinced that average cost is falling, this means that marginal cost is less than average cost. The only way that average cost of $35 can fall is if marginal cost is less than $35. Since Xtron is willing to pay $38 per chip, Dod should make at least $30,000 on this special order (10,000 x $3). This assumes (i) that average cost continues to fall for the next 10,000 units (i.e., it assumes that at , say 61,000 units , average cost does not start to increase), and (ii) there are no other costs of taking this special order. b. Dod can’t make a decision based on the information. Since average cost is increasing, we know that marginal cost is greater than $35 per unit. But we don’t know how much larger. If marginal cost at the 60,001th unit is $35.01, average cost is increasing and if marginal cost of the 70,000th unit is less than $38, then DOD should accept the special order. But if marginal cost at the 60,001th unit is $38.01, the special order should be rejected. P 2 - 12 : Solution to Napoli Pizzeria (15 minutes) [ Break - even analysis] a. The break - even number of servings per month is: ($300 – $75) ÷ ($3 – $1) = ($225) ÷ ($2) = 112.5 servings b. To generate $1,000 after taxes Gino needs to sell 881.73 servings of espresso/cappuccino. Profits after tax = [Revenues – Expenses] x (1 – 0.35) $1,000 = [$3N + $75 – $1N – $300] x (1 – 0.35) $1,000 = [$2N – $225] x .65 $1,000 ÷ .65 = $2N – $225

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    $1,538.46 = $2N – $225 $2N = $1,763.46 N = 881.73 P 2 - 13: Solution to JLT Systems (20 minutes) [Cost - volume - profit analysis] a. Since we know that average cost is $2,700 at 200 unit sales, then Total Cost (TC) divided by 200 is $2,700. Also, since JLT has a linear cost curve, we can write, TC=FC+VxQ where FC is fixed cost, V is variable cost per unit, and Q is quantity sold and installed. Given FC = $400,000, then: TC/Q = (FC+VxQ)/Q = AC ($400,000 + 200 V) / 200 = $2,700 $400,000 + 200 V = $540,000 200 V = $140,000 V = $700 b. Given the total cost curve from part a, a tax rate of 40%, and a $2,000 selling price, and an after - tax profit target of $18,000, we can write: ($2000 Q - $400,000 - $700 Q) x (1 - 40%) = $18,000 1300 Q - 400,000 = 18,000 / .60 = 30,000 1300 Q = 430,000 Q = 330.8 In other words, to make an after - tax profit of $18,000, JLT must have 330.8 sales and installs per month. c. The simplest (and fastest way) to solve for the profit maximizing quantity given the demand curve is to write the profit equation, take the first derivative, set it to zero, and solve for Q. Total Profit = (2600 - 2Q) Q - 400,000 - 700 Q First derivative: 2600 - 4Q - 700 = 0 4Q = 1900 Q = 475 The same solution is obtained if you set marginal revenue (where MR is 2600 - 4Q) equal to marginal cost (700), and again solve for Q, or 2600 - 4Q = 700 Q = 475 The more laborious solution technique is to use a spreadsheet and identify the profit maximizing price quantity combination.

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    As before, we again observe that 475 sales and installs maximize profits. P 2 - 14: Solution to Volume and Profits (15 minutes) [Cost - volume - profit] a. False. b. Write the equation for firm profits: Profits = P × Q - (FC - VC × Q) = Q(P - VC) - FC = Q(P - VC) - (FC ÷ Q)Q Notice that average fixed costs per unit (FC÷Q) falls as Q increases, but with more volume, you have more fixed cost per unit such that (FC÷Q) × Q = FC. That is, the decline in average fixed cost per unit is exactly offset by having more units. Profits will increase with volume even if the firm has no fixed costs, as long as price is greater than variable costs. Suppose price is $3 and variable cost is $1. If there are no fixed costs, profits increase $2 for every unit produced. Now suppose fixed cost is $50. Volume increases from 100 units to 101 units. Profits increase from $150 ($2 × 100 - $50) to $152 ($2 × 101 - $50). The change in profits ($2) is the contribution margin. It is true that average unit cost declines from $1.50 ([100 × $1 + $50]÷100) to $1.495 ([101 × $1 + $50]÷101). However, this has nothing to do with the increase in profits. The increase in profits is due solely to the fact that the contribution margin is positive. Alternatively, suppose price is $3, variable cost is $3, and fixed cost is $50. Contribution margin in this case is zero. Doubling output from 100 to 200 Quantity Price Revenue Total Cost Profit 250 $2,100 $525,000 $575,000 ($50,000) 275 2,050 563,750 592,500 (28,750) 300 2,000 600,000 610,000 (10,000) 325 1,950 633,750 627,500 6,250 350 1,900 665,000 645,000 20,000 375 1,850 693,750 662,500 31,250 400 1,800 720,000 680,000 40,000 425 1,750 743,750 697,500 46,250 450 1,700 765,000 715,000 50,000 475 1,650 783,750 732,500 51,250 500 1,600 800,000 750,000 50,000 525 1,550 813,750 767,500 46,250 550 1,500 825,000 785,000 40,000

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    causes average cost to fall from $3.50 ([100 × $3 + $50]÷100) to $3.25 ([200 × $3 + $50]÷200), but profits are still zero. P 2 - 15 : Solution to American Cinema (20 minutes) [ Break - even analysis for an operating decision] a. Both movies are expected to have the same ticket sales in weeks one and two, and lower sales in weeks three and four. Let Q 1 be the number of tickets sold in the first two weeks, and Q 2 be the number of tickets sold in weeks three and four. Then, profits in the first two weeks,  1 , and in weeks three and four,  2 , are:  1 = .1(6.5Q 1 ) – $2,000  2 = .2(6.5Q 2 ) – $2,000 “I Do” should replace “Paris” if  1 >  2 , or .65Q 1 – 2,000 > 1.3Q 2 – 2,000, or Q 1 > 2Q 2 . In other words, they should keep “Paris” for four weeks unless they expect ticket sales in weeks one and two of “I Do” to be twice the expected ticket sales in weeks three and four of “Paris.” b. Taxes of 30 percent do not affect the answer in part (a). c. With average concession profits of $2 per ticket sold,  1 = .65Q 1 + 2Q 1 – 2,000  2 = 1.30Q 2 + 2Q 2 – 2,000  1 >  2 if 2.65Q 1 > 3.3Q 2 Q 1 > 1.245Q 2 Now, ticket sales in the first two weeks need only be about 25 percent higher than in weeks three and four to replace “Paris” with “I Do.”

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    P 2 - 16 : Solution to Home Auto Parts (20 minutes) [Opportunity cost of retail display space] a. The question involves computing the opportunity cost of the special promotions being considered. If the car wax is substituted, what is the forgone profit from the dropped promotion? And which special promotion is dropped? Answering this question involves calculating the contribution of each planned promotion. The opportunity cost of dropping a planned promotion is its forgone contribution: (retail price less unit cost) × volume. The table below calculates the expected contribution of each of the three planned promotions. Planned Promotion Displays For Next Week End - of - Aisle Front Door Cash Register Item Texcan Oil Wiper blades Floor mats Projected volume (week) 5,000 200 70 Sales price 69¢/can $9.99 $22.99 Unit cost 62¢ $7.99 $17.49 Contribution margin 7¢ $2.00 $5.50 Contribution (margin × volume) $350 $400 $385 Texcan oil is the promotion yielding the lowest contribution and therefore is the one Armadillo must beat out. The contribution of Armadillo car wax is: Selling price $2.90 less: Unit cost $2.50 Contribution margin $0.40 × expected volume 800 Contribution $ 320 Clearly, since the Armadillo car wax yields a lower contribution margin than all three of the existing planned promotions, management should not change their planned promotions and should reject the Armadillo offer.

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