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Management and Cost Accounting, 10th Edition Solution Manual

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    SOLUTIONS TO REAL WORLD VIEWS QUESTIONS REAL WORLD VIEWS 1.1 Chartered institute of management accountants (CIMA) – activities and skills Question 1. Provide more detailed illustrations for each of the first four items in the first category of the above l ist of how the management accountant can be of assistance in an organization with which you are familiar. Outline answer 1. Advise managers about the financial implications of projects Management accountants aim to provide information to help managers make b etter decisions by providing financial information on the profitability and risks to be considered when evaluating alternative projects. The final decision will be taken by senior managers based on the information provided and the advice given by the manag ement accountant. The role of the management accountant tends to be as an information provider rather than a decision - maker, although the management accountant is likely to have a very significant influence on the decisions made by senior management. Exp lain the financial consequences of business decisions Besides providing written reports on the financial consequences of the alternatives decisions being considered the management accountant should also verbally explain and interpret the information provid ed to senior managers. In particular, the management accountant acts as an advisor by providing business support to mangers relating to the financial and the non - financial consequences of alternatives being considered. Formulate business strategy A busine ss strategy relates to the courses of action that must be taken to achieve an organization’s overall objectives. Management accountants are frequently members of the senior management team that identify those strategic options that have the greatest potent ial for achieving the company’s objectives. In order to make an informed choice regarding the alternative strategies management accountants generate data relating to alternative strategies. For example, information may be generated relating to: • The project ed growth rates of the alternatives being considered • The market share the company is likely to achieve • The profits for each alterative being considered. Monitor spending and financial control To monitor performance, the management accountant provides feed back information in the form of performance reports relating to activities for which managers are responsible. These performance reports compare actual

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    spending with planned spending at regular intervals so that managers can take corrective action to ensur e that future spending/outcomes conform with planned spending/outcomes. Alternatively, the plans may require modification if the comparisons indicate that the plans are no longer attainable. REAL WORLD VIEWS 1.2 The internet of things – new products and services Question 1. Can you think of any barriers to entry for a business entering the market for IoT sensors or similar? Outline answer 1. One potential barrier to entry to the development of IoT sensors is know - how and/or access to research and development facilities. Another barrier may be access to a suitable network (such as a low - power Wide Area Network) on which to transmit data. Capital required to invest in sensor manufacture may also be an issue, although manufacturing could be outsourced. REAL WO RLD VIEWS 1.3 Changing product life cycles: Consumer medical devices Question s 1. Do you think the costs of the electronic components in an iPod/iPad are more or less than those in a medical device like a blood pressure monitor? 2. Would decreasing the pro duct life cycle of medical devices, or medical devices being more like consumer electronics pose any risks for manufacturers? Outline answers 1. The costs of components in a typical consumer electronic device (like an iPod) are likely to be much less than t hose of medical devices, as they are likely to be produced in larger volumes and are subject to less rigorous testing and development. 2. One possible risk could be less time to full test components for fitness of purpose. Another risk could be the product is not matched to patient needs, as less time may be available for testing/ prototyping. There may also be less time to building adequate fault tolerance, redundancy and user interfaces. These risks need to be weighed - up against the benefits of a faster ti me to market and/or the improved patient benefits.

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    REAL WORLD VIEWS 1.4 A look at a key feature of easyJet’s business Question 1. How can the management accounting function provide information to support a low cost strategy? Outline answer 1. The followi ng lists some examples of how the management accounting function could provide useful information to support a low - cost strategy: • Regular and detailed information on all costs – e.g. fuels, staff, landing charges. • Ensuring managers fully understand the cos t structure of the business. For example, clearly informing managers on what are defined as fixed costs and variable costs. • Provide managers with information on how changes in cost elements e.g. fuel, travel taxes, may affect the profit margin and, in turn , fare prices. • Assess risks of price rises in key costs components, e.g. fuel, and take actions to minimize risk e.g. forward - buying of fuel. • Assess various strategic options e.g. buy or lease aircraft. • Provide a detailed analysis of revenues, so that mana gers can identify where profits are best made. REAL WORLD VIEWS 2.1 Industry cost structures Question s 1. How might performance measurement and management vary between different industries? 2. Provide examples of direct labour, direct materials and indirect costs for the different industries mentioned above. Outline answer s 1. A firm’s choice of a performance measurement system and the emphasis given to performance measures will be influenced by the strategy that it adopts. For example, a firm that competes on the basis of price will focus on minimizing costs and emphasize cost - based and efficiency measures in its performance measurement system whereas a firm that focuses on product or service quality will give greater emphasis to quality measures. Some firms f ocus on developing innovative new products and such firms will tend to emphasize marketing measures such as percentage of market share,

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    percentage of sales from new products/markets and time from developing new products to introducing them to the market. T he cost structure will also influence the emphasis given to different performance measures. The proportion and magnitude of costs relating to direct labour, direct materials and various indirect costs will determine the emphasis given in the reporting syst em to the different cost categories. 2. Cost classification depends on the cost objective. A transport company (distribution) delivers goods to different customers. Where the customer is the cost objective the driver’s wages will represent direct labour and the petrol costs direct materials/supplies. Administration costs represent overhead costs. In a departmental store (retailing) where the different departments are the cost objective the purchased goods displayed in a particular department represent direct materials whereas staff assigned to a particular department are direct labour costs. The salaries paid to the administrative staff are indirect/overhead costs. In a firm of accountants (service organization) clients may represent the cost objective. Labour costs based on the amount of time an accountant devotes to a particular client are direct labour costs. Material costs will be minimal and may include stationery required to service a particular client. Office lighting and heating would represent indirect costs. REAL WORLD VIEWS 2.2 Cost structures in the airline sector Questions 1. Do you agree that the variable cost associated with a passenger can be zero? Can this be said for both low - cost and traditional carriers 2. What options do more traditional c arriers have to improve their fixed cost base? Outline answers 1. The view that the variable cost is zero is most likely not true. However, a view could be formed that the variable cost is negligible or close to zero. It could be argued that traditional air lines who offer services such as free meals to passengers incur more variable costs as passenger numbers increase on a flight. 2. A greater proportion of fixed costs for all airlines is likely to lie in aircraft purchase costs and aircraft operating costs (s uch as regular maintenance). Other fixed costs include the typical fixed costs of any business, such as administration costs. If a more traditional airline wishes to decrease its fixed cost base without impacting on service, it could for example lease rath er than purchase aircraft. This may imply that some elements of maintenance and/or

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    re - fitting of aircraft may be suffered by the ultimate owner of the aircraft. Another possible option is to increase the use of technology. For example, carriers like Americ an Airlines send a bar - coded boarding pass to smart phones – cutting out check in costs such as staff and printing cost. REAL WORLD VIEWS 2.3 We must stop falling into the ‘sunk costs’ fallacy Questions 1. What are the relevant costs and benefits relatin g to the Garden Bridge? 2. Why might managers be reluctant to abandon loss - making projects? Outline answers 1. The relevant costs and benefits are the future costs and benefits of going ahead in the construction of the bridge. Costs that have already been inc urred, such as the design costs, are sunk costs and not relevant to the decision. It is important that qualitative factors, such as the time saved by users of the bridge, and the aesthetic aspects are considered as relevant benefits. 2. Managers may be reluc tant to abandon loss - making projects because they wish to defer the highlighting of the outcomes of bad decisions which are likely to be reported in the near future. In other words they wish to defer or hide the bad publicity arising from poor decisions. REAL WORLD VIEWS 2.4 Opportunity costs and auto bail - outs Questions 1. Why might opportunity costs not be considered when making decisions? 2. P rovide examples of opportunity costs that you might incur. Outline answers 1. Opportunity costs are not recorded in t he accounting system since they do not involve cash outlays or commitments to future expenditure. To ascertain the opportunity cost of a course of action it is necessary to consider the lost opportunities from pursuing the course of action. Because opportu nity costs are not recorded in the accounting system and can be difficult to identify there is a danger that they are not taken into account. 2. Examples are provided in Chapter 2 of opportunity costs that might be incurred at the individual non - business lev el. Another example is the interest foregone by not pursuing an investment because the funds are used for other purposes .

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    REAL WORLD VIEWS 2.5 Incremental and marginal costs: Marginal costs of downloadable products Questions 1. Do you agree the marginal cost of downloaded software or music is nil? 2. What marginal costs, if any, might be incurred by the provider of the servers where software/music is downloaded from? Outline answers 1. It could be argued that the cost of software support is a marginal cost. This may be the case particularly in the case of telephone support available with some software products. 2. It could be argued that each download increases the internet bandwidth and server processing capacity and these are marginal costs that could be pa ssed on to customer (i.e. software developers, music firms etc). Arguably, these costs might also be construed as marginal for each individual purchaser too. However, the marginal cost is so small, it is likely to be immaterial and hence ignored. REAL WO RLD VIEWS 3.1 Absorption costing used in practice Questions 1. Why do you think absorption costing is more likely to be used by larger business es ? 2. What difficulties might be faced by smaller firms who may want to utilize absorption costing? Outline answer s 1. Arguably, larger business es have more complex cost structures and will want to ensure all costs, both fixed and variable, are included in product costs. Larger firms are more likely to complex management accounting systems to capture costs. 2. In smaller firms , there may be fewer management accounting staff, or even none. There may also be less formal management accounting systems which are not readily able to capture.

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    REAL WORLD VIEWS 3.2 Three cost allocation myths Questions 1. Explain how applying eac h of the above three myths can lead to bad decisions. 2. What changes should be made to cost allocations to avoid the bad decisions? Outline answers 1. In the article Allan Stratton provides the following illustrations: Myth 1 – In one company I worked for, w e produced and sold millions of small, inexpensive parts as well as thousands of complete, expensive assemblies. Had we allocated cost based of volume as some advocate, the small parts would have been very unprofitable. Yet they contributed a healthy part of our bottom line. A decision based on inaccurate information would have been a disaster. The use of arbitrary allocations (see Chapter 3) should be avoided since they will lead to misleading decisions. Myth 2 – Consider the costs of employing company e xecutives such as the CEO and CFO. For a multiproduct company, whether or not the company offers one particular product or not will not affect these costs – They will neither increase nor decrease. So why allocate these costs at all. A better approach woul d be to hold these separate as business sustaining costs. Then the portfolio of products and services needs to cover these costs and to provide the expected profit. Myth 3 – When asked to pay higher prices with no added value, customers take their orders to competitors. As order volume drops, there is more idle capacity causing even higher products costs. Then with higher costs, the company again raises prices. And so on until they company is bankrupt. Much better to identify idle capacity, hold this cost separate and deal with it. Idle capacity is not the responsibility of the product produced. Rather, management must take full responsibility to find new opportunities to sell or to dispose of this capacity. 2. Only cause - and - effect allocations should be used . Costs where cause - and - effect allocations cannot be established should be regarded as business sustaining costs and charged as a lump sum against the contributions of all products that benefit from these business sustaining costs.

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    REAL WORLD VIEWS 3.3 Product diversity and costing system design choice Questions 1. Why might increasing the number of cost centres (pools) result in the reporting of more accurate product costs? 2. What other factors, besides product diversity, might enable a simplistic produc t costing system to report reasonably accurate product costs? Outline answers 1. Increasing the number of cost centres automatically increases the likelihood that costs of performing each activity/task of a cost centre is more accurately captured. For exampl e, labour, material and all other costs centre costs can be identified, whereas this may not have previously occurred in a functional/departmental setup. In turn, when the costs of a cost centre are more accurate, it may be possible to more accurately attr ibute the running costs of the cost centre to products/services, which may result in a more accurate product/service cost. 2. The case presented in REAL WORLD VIEWS 3.3 has low product diversity. Other instances where a simplistic costing system may suffice may include: • An industry or sector where one cost element makes up a large component of cost. For example, in some electronics firms, the cost of metals such as copper comprise the vast majority of cost (in some cases 70 - 80%). Thus, other cost elements r eceive less attention in cost estimates and reporting. • A business makes only a single product, where costs are relatively stable. • A business has few, mainly fixed costs, and instead revenues are the main focus. Many online businesses fall into this categ ory. REAL WORLD VIEWS 3.4 Overheads in cafés Questions 1. Can you think of some examples of overhead costs that might be incurred by cafés such as those described above? 2. How would these overheads affect profit if sales declined? Outline answer s 1. Typical overhead costs of a franchise type café might include rent of the premises, light and heat, franchise fees (depending on the franchising agreement), advertising and promotion and salaries of a café manager.

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    2. If sales decline, then assuming fixed costs ca nnot be altered, profits will decline. Some fixed costs may be subject to negotiation or change e.g. a lower manager's salary, but other fixed costs (e.g. rent) may be subject to a longer term agreement and difficult to change. Thus, business owners and ma nagers need to consider the level of fixed costs they are committing to. REAL WORLD VIEWS 4.1 Commercial Metals changes the method it uses to value inventories Questions 1. Why did the company apply the change in valuation method retrospectively for some of its segments but did not make retrospective changes to its International Marketing and Distribution segment? 2. What do you think is meant by the term ‘specific identification method’ of tracking inventories? Outline answers 1. Presumably the change in met hod resulted in significant differences in rep orted profits and inventories. Therefore the company applied all of the changes to prior accounting periods so that appropriate comparisons with past accounting periods could be made. Where the change did not r esult in significant changes to reported profits and inventories changes to prior accounting periods were not made. 2. The website www.accountingtools.com/articl es/2017/5/8/specific - identification - method states that the specific identification method refers to the tracking and costing of inventory based on the movement of specific, identifiable inventory items in and out of stock. This method is applicable when i ndividual items can be clearly identified, such as with a serial number, stamped receipt date, or RFID tag. The principle requirements of a specific identification tracking system are: • Be able to track each inventory item individually. The easiest method is a durable metal or paper label that contains a serial number. Alternatively, a radio frequency identification tag can contain a unique number that identifies the product. • Be able to track the cost of each item individually. The accounting system should clearly identify the cost of each purchased item, and associate it with a unique identification number. • Be able to relieve inventory for the specific cost associated with an inventory item when it is sold. These requirements can be achieved with a simple a ccounting system, possibly just an electronic spreadsheet, which makes the specific

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    identification method applicable to smaller businesses (especially when unit volumes are low). REAL WORLD VIEWS 4.2 Accounting procedure for labour costs – recording labo ur time on construction projects Questions 1. If your business were using the Job Clock, would you pay all employees by the minute worked? 2. Do you think smartphones could be used to track time worked by mobile employees? Outline answer s 1. Typically a grace period is allowable, whereby employees could be up to 5 minutes late without deductions of pay. Any such policy can be set by a business and should be controlled to maintain payroll costs and employee efficiency. 2. It would be possible. GPS app lications ar e available and could be used to track the location of staff. Equally, applications could be installed on a smartphone whereby employee could record their work time/locations. The Exaktime company actually offers a time - tracking app for the iPhone and othe r smart phones. REAL WORLD VIEWS 4.3 Cost tracking using ERPS software Questions 1. Can you think of any reason why management accounting data and financial accounting data might be separated in a business? 2. Would you expect accounting software to store more detailed information for management accounting purposes than for external reporting? Can you think of any examples? Outline answer s 1. With integrated accounting software, and converging international financial reporting standards, the separation of man agement accounting and financial accounting data is increasingly less likely. Some countries may still have a complex taxation system which drives financial reporting (e.g. Germany). This may result in management accounting systems still being quite separa te.

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    Even in such cases however, more convergence of the two branches is occurring. 2. Yes, typically. As an example, financial accounting might need to only have a total labour cost figure to be displayed on an income statement report. In contrast, managers might need labour costs analysed by cost centre, process or product for example. With integrated accounting software, these different levels of cost detail are readily provided however. REAL WORLD VIEWS 5.1 The brewing process at SAB Miller Questions 1. When does the ‘product’ materialize in the brewing process described above? 2. Would you imagin e there is any waste in the brewing process? Outline answers 1. The beer ‘product’ is not recognizable until the end of the brewing process. As suggested in the RWV, the product – be it in a bottle, can or keg – is at the very end of the brewing process . 2. The website provides some really useful ways brewing by - products are re - used – in baking, as animal feed, compost and even waste - to - energy . REAL WORLD VIEWS 5.2 P roducing a world - famous whiskey Questions 1. Why is job costing not appropriate to a process such as whiskey production? 2. Do you think losses of spirit might occur during the maturation process? Outline answer s 1. As described above, the making of whiskey is a process and the final product (i.e. the saleable bottle) only emerges at the end of the process. 2. The Bushmills web site refers to the ‘ angels share ’ , which is a portion of the spirit which is lost to evaporation through the wood barrels during the matu ration process.

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    REAL WORLD VIEWS 5.3 Losses in processes – reducing process waste in UHT milk production Questions 1. Do you think waste which is regarded as ‘normal’ in a process should remain unchallenged? 2. How would you value waste in the UHT milk pro duction described above? Outline answer s 1. While most processes have some level of normally acceptable waste, technologies change constantly which may eliminate or reduce waste that was previously acceptable. In addition, as waste disposal costs increase un der stricter environmental protection legislation, waste reduction programmes may be a worthwhile exercise for a business. 2. Normally, any expected process losses are included in the cost of good output and valued at the equivalent unit cost. In this scena rio described above, if the losses are due to equipment cleaning, this might be treated as an abnormal loss as arguably cleaning times could be scheduled to avoid losses of product. REAL WORLD VIEWS 6.1 Accounting for by - products – by - products of gold mi ning Questions 1. Assuming the uranium by - product of a gold mine could be sold, how would an accountant consider whether or not it is worthwhile financially? 2. What factors apart from cost might be considered in the decision? Outline answer s 1. The market pric e of the uranium is one factor. Another factor is the volume of uranium available for sale. All costs should be considered in the decision e.g. shipping costs, further processing costs, cost of storage if unsold, costs of securing the product etc. 2. One fa ctor which might be considered is environmental effects. If the uranium is stored, how will this affect the local environment e.g. water supply, health of local citizens, radiation levels etc. Long term, these factors might affect the reputation of the fir m in terms of any sustainable or environmentally

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    REAL WORLD VIEWS 6.2 Environmentally friendly products from paper mill sludge Questions 1. Assuming paper mills decide to sell their sludge for a small fee, how might they account for the revenue generated ? 2. Can you think of any other ‘waste’ by - products that are re - used rather than disposed of? Outline answers 1. Given the fact that the sludge is a waste by - product, and the fee is small, it is likely that the paper mill might simply credit any revenue from s ludge collection into a materials account or cost of production account. 2. There are many possible answers to this question. Two example are given below: a. Old tyres from garages can be used to make rubber mats/tiles for playgrounds . b. Waste oil from industr ial processing, garages and even fast food outlets can be ' cleaned ' and re - used/sold for heating purposes. REAL WORLD VIEWS 7.1 Variable costing – use of variable costing Questions 1. Do you think variable costing is more likely to be used by manufacturin g or service sector firms? 2. Do you think integrated accounting information system would be able to produce internal profit statements using variable costing? Outline answer s 1. Service sector firms (e.g. financial institutions, web hosting firms) are more li kely to have a greater degree of fixed costs and may be less likely to adopt variable costing as a method to report internally. 2. An integrated accounting system should have no issue with any format of profit provided cost information has been classified c orrectly.

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    REAL WORLD VIEWS 7.2 Maintaining and improving profits at M - real Questions 1. If your business wanted to improve profits by focusing on first fixed costs and then variable costs, what form of profit report might you use internally: one based on absorption costing or one based on variable costing? 2. What do you think would be the main variable cost for a paper company like M - real? Are there any ways in which a paper company might control this variable cost? Do some internet research on other pa per companies to help you decide. Outline answer s 1. It might be best to separate out fixed costs so they are more readily identifiable, thus a variable costing profit statement might be more suitable. 2. The main cost is the paper raw material – assuming the paper is bought in. Labour costs are likely to be treated as a fixed cost, as the level of automation in the industry is high. If a paper company owns land, it can plant and harvest its own lumber to make paper, which would help control the price. If pape r is bought in, this may not be possible. REAL WORLD VIEWS 8.1 Airbus A380 likely to breakeven in 2015 Questions 1. Is it true to say that any A380 aircraft sold before break even has been achieved is making a loss? 2. Can you think of some major fixed cost s likely to be incurred on the A380 by Airbus? Outline answer s 1. Any aircraft sold before breakeven has been reached does not recover all fixed costs incurred – breakeven is when contribution = fixed costs. Thus, all such aircraft are essentially loss makin g. 2. A major fixed cost is likely to be the research, design and development behind such an aircraft. FlightGlobal suggests development costs could be as much as $12.2 billion. While we cannot be sure what would be included in such development costs, it may or may not include other fixed costs such as the construction of new manufacturing facilities. One could also argue that any staff associated with the on - going support of the A380 are likely to be

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    highly specialized, and may be considered a fixed cost. Th is is likely to be substantially less than the other two mentioned above however. REAL WORLD VIEWS 8.2 Why is the break - even price of crude oil so important? Questions 1. Why will a decline in production have a positive impact on oil prices? 2. Why does the break - even price in the above chart differ according to the location of the oil wells? 3. Is the break - even price of crude oil more important than the break - even volume? Outline answer s 1. A decline in the production of crude oil will result in a decline in to tal supply and, based on supply and demand relationships, demand may exceed supply resulting in pressures for an increase in prices in the longer term. 2. The break - even price of crude oil includes production cost, exploring or finding cost, oil well develop ment cost, transportation cost and selling and general administration expenses. Most of the costs incurred by oil producers are fixed and sunk costs and will differ according to the location of the oil fields arising from the different terrain (e.g. land - b ased or sea - based, ease of drilling etc.). Thus significant differences in fixed and variable costs will apply resulting in major differences in break - even oil prices. For example, petroleum extraction in the Arctic region shows the highest breakeven price of $75 per barrel. On the other hand, Middle Eastern countries have the lowest price at $27 per barrel. US shale oil producers have a breakeven price of $65 per barrel. 3. For oil production the break - even price is likely to be more important since the brea k - even volume is required to determine the break - even price. Because the price of oil fluctuates and is subject to uncertainty then knowing the break - even price is important to determine whether production should be undertaken at the market - determined pric e. REAL WORLD VIEWS 8.3 Airlines struggling to break even will make ‘less than £4 profit per passenger’ Questions 1. Is break even a good performance monitor over the longer term?

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