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Instructor’s ManualManagement and Cost

AccountingFifth edition

Alnoor BhimaniCharles T. Horngren

Srikant M. DatarMadhav V. Rajan

Farah Ahamed

For further instructor materialplease visit:

www.pearsoned.co.uk/bhimani

ISBN: 978-0-273-75986-7

Pearson Education Limited 2012Lecturers adopting the main text are permitted to download and photocopy the manual as required.

Full file at http://TestbankCollege.eu/Solution-Manual-Management-and-Cost-Accounting-5th-Edition-Bhimani

2© Pearson Education Limited 2007

Pearson Education LimitedEdinburgh GateHarlowEssex CM20 2JEEngland

and Associated Companies around the world

Visit us on the World Wide Web at:www.pearson.com/uk

This edition published 2012

© Pearson Education Limited 2012

The rights of Alnoor Bhimani, Charles T. Horngren, Srikant M. Datar and Madhav V. Rajan to be identified as the authors of this Work have been asserted by them in accordance with the Copyright, Designs and Patents Act 1988.

Pearson Education is not responsible for the content of third-party internet sites.

All rights reserved. Permission is hereby given for the material in this publication to be reproduced for OHP transparencies and student handouts, without express permission of the Publishers, for educational purposes only. In all other cases, no part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise without either the prior written permission of the Publishers or a licence permitting restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd. Saffron House, 6-10 Kirby Street, London EC1N 8TS. This book may not be lent, resold, hired out or otherwise disposed of by way of trade in any form of binding or cover other than that in which it is published, without the prior consent of the Publishers.

Chapters Pages

Part I – Management and cost accounting fundamentals1. The accountant’s role in the organisation 62. An introduction to cost terms and purposes 153. Job-costing systems 284. Process-costing systems 425. Cost allocation 666. Cost allocation: joint-cost situations 817. Income effects of alternative stock-costing methods 98

Part II – Accounting Information for decision making8. Cost–volume–profit relationships 1149. Determining how costs behave 131

10. Relevant information for decision making 14411. Activity-based costing 15512. Pricing, target costing and customer profitability analysis 16613. Capital investment decisions 179

Part III – Planning and budgetary control systems14. Motivation, budgets and responsibility accounting 20015. Flexible budgets, variances and management control: I 21316. Flexible budgets, variances and management control: II 23017. Measuring yield, mix and quantity effects 248

Part IV – Management control systems and performance issues18. Control systems and transfer pricing 26819. Control systems and performance measurement 281

Part V – Quality, time and the strategic management of costs20. Quality and throughput concerns in managing costs 29821. Accounting for just-in-time systems 30922. Strategic management accounting and emerging issues 326

Guide to case study solutions 334

4© Pearson Education Limited 2012

This manual is intended to assist lecturers’ discussion of assignments and lecture topics. ‘Points to stress and teaching tips’ are provided for each chapter to give broad guidance on relevant issues or potential areas of difficulty to students. Solutions are offered for end-of-chapter ‘assessment material’ in the text. Case notes prepared (in most cases) by the case writer to all cases included in the text are also provided.

C. Horngren

5© Pearson Education Limited 2012

MANAGEMENT AND COST ACCOUNTING FUNDAMENTALS

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C H A P T E R 1

The accountant’s role in the organisation

Teaching tips and points to stress

Modern management accounting

While the accounting system provides information (e.g. product costs, downtime) for management decisions, cost management refers to active use of this information to plan and control costs. Cost management requires managers to actively seek ways to reduce costs. Much cost management occurs well before the accounting system recognises costs. (The product design stage often offers more cost management opportunities than controlling manufacturing operations.) Cost management is integrated throughout the text.

To reinforce the value-chain concept, ask a student to illustrate activities/costs in each function in the context of his/her work experience.

Students are often confused about the difference between R&D and Design. The distinctions are not always clear-cut, but R&D is basic research and idea generation, whereas design turns those ideas into reality. Design encompasses development of prototype products and the manufacturing process by which the products are produced.

Elements of management control

Planning and control are distinct activities, but they go hand in hand. To maximise the benefits from planning (e.g. budgeting), the manager should use that plan as a benchmark for controlling (i.e. assessing the effectiveness and efficiency of implementation). Conversely, it is difficult to control activities without a plan or budget.

To help students understand how accounting numbers can affect employees’ behaviour and hence firm’s performance, ask questions, such as if a materials procurement officer’s annual bonus depends on the difference between budgeted price and actual price paid, how will the officer behave? The officer may be tempted to purchase cheap, perhaps low-quality materials that may not be delivered on a reliable, timely basis; he or she may refuse to order materials for rush orders if there will be an extra delivery charge, etc.

Although it is difficult to quantify the costs and benefits of accounting systems, a decision about the system will be made. The question is whether costs and benefits are considered implicitly (as part of a ‘gut feeling’) or explicitly, where effects of different estimates can be examined.

Product cost information permeates all three functions. In the scorekeeping function, accountants accumulate product cost information for both external and internal reportings. Product cost information can help identify cost management opportunities (i.e. attention directing) and it is used in make-or-buy decisions, where managers compare the cost of making the product or component with the cost of buying it from an external supplier (i.e. problem solving).

7© Pearson Education Limited 2012

Bhimani, Horngren, Datar and Rajan, Management and Cost Accounting, 5th Edition, Instructor’s Manual

Costs, benefits and context

The ‘best’ information system depends on both technical and human aspects of the specific situation. This is a major difference between financial accounting, where firms generally need to comply with external reporting requirements where they exist, and management accounting, where choices are based on an explicit or implicit cost–benefit analysis. Management accounting students must do more than memorising rules. They must evaluate the situation and context, decide which technique or information system is most appropriate and implement it.

Themes in the design of management accounting systems

Customer satisfaction is the dominant theme. All other themes are directed toward attracting and retaining profitable customers who remain satisfied.

These themes can also be applied to functions within a business. For example, management accountants (MAs) must satisfy their customers (managers) by satisfying key success factors. MAs must provide high-quality information on a timely basis for a reasonable cost. MAs can develop innovative formats and analyses to facilitate management decisions. They should provide information regarding all elements of the value chain and must prepare information for internal decisions as well as external financial reporting. MAs should continually strive to provide better quality information, faster, at a lower cost.

Solutions to review questions

1.1 The five broad purposes are:

Purpose 1: Formulating overall strategies and long-range plans.

Purpose 2: Resource allocation decisions such as product and customer emphasis and pricing.

Purpose 3: Cost planning and cost control of operations and activities.

Purpose 4: Performance measurement and evaluation of people.

Purpose 5: Meeting external regulatory and legal reporting requirements where they exist.

1.2 Management accounting measures and reports financial as well as other types of information that may be useful to managers in fulfilling the goals of the organisation.

Financial accounting focuses on external reporting that is guided by generally accepted accounting principles.

1.3 The business functions in the value chain are:

Research and development – the generation of, and experimentation with, ideas related to new products, services or processes.

Design of products, services and processes – the detailed planning and engineering of products, services or processes.

Production – the coordination and assembly of resources to produce a product or deliver a service.

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Marketing – the process by which individuals or groups (a) learn about and value the attributes of products or services and (b) purchase those products or services.

Distribution – the mechanism by which products or services are delivered to a customer.

Customer service – the support activities provided to the customers.

1.4 Cost management refers to actions that managers undertake to satisfy customers while continuously reducing and controlling costs.

1.5 A successful accountant requires general business skills (such as understanding the strategy of an organisation) and people skills (such as motivating other team members) as well as technical skills (such as computer knowledge).

1.6 Yes. Drucker is advocating that accountants do more than scorekeeping, which is often interpreted as being a ‘bobby on the beat’ or a watchdog. It is also essential that accountants emphasise their attention-directing and problem-solving functions.

1.7 The new accountant could reply in one or more of several ways:

a Demonstrate to the plant manager how he or she could make better decisions, if the plant accountant was viewed as a resource rather than a dead weight.

In a related way, the plant accountant could show how the plant manager’s time and resources could be saved by viewing the new plant accountant as a team member.

b Demonstrate to the plant manager a good knowledge of technical aspects at the plant. This approach may involve doing background reading. It certainly will involve spending much time on the plant floor speaking to plant personnel.

c Show the plant manager’s examples of the new plant accountant’s past successes in working with line managers in other plants. Examples could include

assistance in preparing the budget,

assistance in analysing problem situations and

assistance in submitting capital budget requests.

d Seek assistance from the corporate accountant to highlight to the plant manager the importance of many tasks undertaken by the new plant accountant. This approach is a last resort but may be necessary in some cases.

1.8 A customer-driven management accountant function would

a approach its customers (such as managers in different parts of the value chain) to determine how it can facilitate those managers making better decisions, and

b solicit regular and systematic feedback from those customers about its performance.

1.9 Yes, management accountants have customers just as companies have customers who purchase their products or services. Management accountants provide information and advice to many line and staff people in the organisation and to various external parties. It is essential that they provide information and advice that line and staff customers and external parties view as timely and relevant.

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1.10 Five themes that affect the way managers operate and have prompted developments in management accounting are the following:

Customer satisfaction is priority one

Key success factors (cost, quality, time, and innovative products and services)

Total value-chain analysis

Continuous improvement

Dual external/internal focus.

Solutions to exercises

1.13 Value chain and classification of costs, computer company. (15 min)

Cost item Value-chain business function

a Production

b Distribution

d Research and development

E Customer service

F Design (or research and development)

G Marketing

H Production

1.14 Value chain and classification of costs, pharmaceutical company. (15 min)

b Marketing

c Customer service

e Marketing

f Production

g Marketing

h Distribution

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1.15 Uses of feedback. (10 min)

Item Use of feedback

1.16 Scorekeeping, attention directing and problem solving. (15 min)

Because the accountant's duties are often not sharply defined, some of these answers might be challenged.

Activity Function

a Scorekeeping

b Attention directing

c Scorekeeping

d Problem solving

e Attention directing

f Attention directing

g Problem solving

h Scorekeeping, depending on the extent of the report

i This question is intentionally vague. The give-and-take of the budgetary process usually encompasses all three functions, but it emphasises scorekeeping the least. The main function is attention directing, but problem solving is also involved.

j Problem solving

1.17 Scorekeeping, attention directing and problem solving. (15 min)

The accountant’s duties are often not sharply defined, so some of these answers might be challenged.

a Attention directing

b Problem solving

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d Scorekeeping

e Scorekeeping

h Scorekeeping

i Problem solving

j Attention directing

1.18 Changes in management and changes in management accounting. (15 min)

Change in management accounting

Key theme in newly evolving management approach

a Total value-chain analysis

b Key success factors (quality) or total value-chain analysis

c Dual external/internal focus

d Continuous improvement

e Customer satisfaction is priority one

1.19 Planning and control, feedback. (15–20 min)

1 Planning is choosing goals, predicting results under various ways of achieving those goals and then deciding how to attain the desired goals. One goal of the European Starting News (ESN) is to increase operating income. Increasing revenues is potentially one way to achieve this if the increase in revenues exceeds any associated increase in costs. ESN expects daily circulation to increase from 250,000 per day in April to 400,000 per day in May. This budgeted circulation gain is expected to increase newspaper revenues from €5,250,000 in April to a budgeted €6,200,000 in May.

Control covers both the actions that implement the planning decision and the performance evaluation of the personnel and operations. At ESN, the price drop would be announced to its sales force and probably to customers. Requirement 2 illustrates a performance report for May 2003.

2 Actual results Budgeted amounts Variance

Newspapers sold 13,600,000 12,400,000 1,200,000 fav

Price per paper €0.50 €0.50 €0.00 fav

Newspaper revenue €6,800,000 €6,200,000 €600,000 fav

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3 Based on the €600,000 favourable variance for circulation revenue, Saunier might take the following actions:

a Change predictions. ESN underestimated the daily circulation gain by 40,000 copies per day. It might examine the procedures it uses to estimate the response of circulation to price changes.

b Change operations. ESN might now change its advertising rates to reflect that circulation in May is 76% above that of April. This gives advertisers a much larger audience they can reach with each advertisement in the ESN.

1.20 Professional ethics and reporting divisional performance. (10–15 min)

1 Devallois’s ethical responsibilities are well summarised in Ethical Guidelines. Areas of ethical responsibility include

competence,

confidentiality,

integrity and

objectivity.

The key area related to Devallois’s current dilemma is integrity. Devallois should refuse to book the €200,000 of sales until the goods are shipped. Both financial accounting and management accounting principles maintain that the sales are not complete until the title is transferred to the buyer.

2 Devallois should refuse to follow Clément’s orders. If Clément persists, the incident should be reported to the corporate accountant. Support for line management should be wholehearted, but it should not require unethical conduct.

1.21 Responsibility for analysis of performance. (20–30 min)

This problem raises plenty of thought-provoking questions. Unfortunately, there are no pat answers. The generalisations about these relationships are difficult to formulate.

1 Apparently, the accountant’s performance-analysis staff have not won the confidence or respect of Hedby and other line officers. Hedby regards these accountants as interlopers who are unqualified for their analytical tasks on two counts: (a) the task is Hedby’s, not the accountants’ and (b) Hedby understands his own problems best. It is unlikely that the accountant’s performance-analysis staff have maintained a day-to-day relationship with line personnel in Division C.

2 Nedregotten should point out that her performance-analysis staff are doing the work in order to enable Hedby to better concentrate on his other work. The detached analyses by her staff should help Hedby better understand and improve his own performance.

Furthermore, Nedgrotten should point out that Hedby would need his own divisional accounting staff in order to prepare the necessary analysis of performance, if Hedby’s group did not support him. More uniform reporting formats and procedures and more objective appraisals could potentially occur if the performance-analysis staff remain as part of the corporate accountant’s group.

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3 Two approaches within the existing organisation reporting relationships are the following:

a Placing higher priority on having her performance-analysis staff view the division personnel as important customers and actively seeking out ways to increase customer satisfaction.

b Encouraging greater use of teams in which division personnel and corporate control personnel are members. Hopefully, mutual respect will increase by this close interaction.

A more extreme approach would be to change the organisation’s reporting relationships and staff assignments. For example, each division manager could have his or her own performance-analysis staff member as part of the plant accountant’s group.

1.23 Planning and control decisions: Internet company. (30 min)

1 Planning decisions at WebNews.co.uk focus on organisational goals, predicting results under various alternative ways of achieving those goals and then deciding on how to attain the desired goals. For example, WebNews.co.uk could have the objective of revenue growth to gain critical mass or it could have the objective of increasing operating income. Many Internet companies in their formative years make revenue growth (and subscriber growth) their primary goal.

Control focuses on (a) deciding on and taking actions that implement the planning decisions and (b) deciding on performance evaluation and the related feedback that will help future decision making.

2 Planning decisions

a Decision to raise monthly subscription fee.

c Decision to upgrade content of online services.

e Decision to decrease monthly subscription fee.

Control decisions

b Decision to inform existing subscribers about the rate of increase – an implementation part of control decisions.

d Demotion of VP of Marketing – performance evaluation and feedback aspect of control decisions.

1.24 Problem solving, scorekeeping and attention directing: Internet company. (30 min)

1 Problem solving – comparative analysis for decision making.

Scorekeeping – accumulating data and reporting reliable results to all levels of management.

Attention directing – helping managers to properly focus their attention.

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2 a and e Decisions to change subscription fee.

Problem solving – report outlining expected revenues from subscribers and advertising with different monthly fee amounts.

Scorekeeping – report with monthly subscribers and their revenues in prior months.

Attention directing – report showing the change in the number of subscribers of Internet companies at the time they change their monthly fees.

b Decision in June 2005 to inform existing subscribers about rate increase in July.

Problem solving – report showing the cost of different ways of informing subscribers of the rate increase.

Scorekeeping – report showing how many subscribers immediately paid the new subscription fee when past fee increases occurred.

Attention directing – report showing the number of subscribers to the service that have not logged on for two months or more.

c Decision to upgrade the content of online services.

Problem solving – report showing the expected cost of alternative ways to upgrade content.

Scorekeeping – labour cost tracking of software developers who work on content.

Attention directing – report on cost overruns relative to budget for ongoing content upgrades.

d Demotion of VP of Marketing

Problem solving – budgeted cost of marketing department with alternative management teams.

Scorekeeping – report showing breakdown of subscribers into renewals and new subscribers.

Attention directing – report highlighting subscriber growth and rates of competing Internet news services.

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C H A P T E R 2

An introduction to cost terms and purposes

Costs in general

Cost assignment is a general term for attaching either direct or indirect costs to cost objects. The distinction between direct and indirect costs is important because direct costs are directly traced to the cost object, whereas indirect costs are often pooled and then allocated to the cost object with less precision. Management, therefore, has more confidence in the accuracy of direct costs. The text uses the term ‘cost tracing’ to refer specifically to assigning direct costs to cost objects. Cost allocation is reserved for assigning indirect costs to cost objects.

Cost objects include (1) activities or processes; (2) outputs of processes, such as products, services and projects; (3) parts of the organisation (e.g. departments or programmes) and (4) customers. Information on costs associated with these cost objects facilitates decisions such as (1) which manufacturing process is most economical, (2) what price should be charged for the service, (3) which department uses its resources most efficiently and (4) which customers contribute most to the company’s profits. There is more to cost accounting than product costing.

Direct costs and indirect costs

Students have trouble with the distinctions between direct/indirect costs and cost tracing/cost allocation. Familiar examples can help. Public accounting firms directly trace direct professional labour costs to each audit engagement (through time sheets). In contrast, rent on the firm’s office and depreciation on its computers cannot be traced to individual engagements. These are indirect costs that must be allocated to the different engagements. Allocation of indirect costs is a difficult but important topic that is covered in more detail in later chapters.

Example: Is photocopying a direct or an indirect cost with respect to department cost objects? In the past, it was difficult to keep track of the amount of copying done by different departments. Moreover, there was generally less copying. Photocopying was typically considered an indirect cost because it was often an immaterial amount and hard to trace. Today, businesses are making more photocopies than ever before. Counters inserted into copiers (copy keys) easily keep track of the number of copies made by each user. Because copying costs are now higher and easier to trace, they are more often directly traced. (An additional benefit of the counters is that they may induce employees to make fewer copies because the number of copies is now more observable.)

Cost drivers and cost management

Cost management occurs when managers actively strive to reduce costs. Two major avenues for cost management are focusing on value-added activities (and eliminating non-value-added activities such as stock handling) and reducing consumption of cost drivers in value-added activities. Reduced consumption of cost drivers reduces costs only if managers actively squeeze costs down. As more managers do their own word processing, typing by secretaries declines.

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But unless management reduces the number of secretaries in response to the reduced workload, secretarial costs will not reduce.

Two types of cost behaviour pattern: variable costs and fixed costs

The distinction between variable costs (VCs) and fixed costs (FCs) is necessary to address basic questions such as how much manufacturing costs change if the level of output increases by 5%. For example, many fast-food restaurants guarantee workers only an hour or two of work per shift. If sales are less than expected, workers can be dismissed for the shift after their guaranteed hour (or two). In this case, direct-labour cost varies directly with output (sales). In contrast, many government workers are salaried and cannot be dismissed except under extreme circumstances. Here, direct-labour costs for a government department are relatively fixed.

Students are often confused about when VCs are variable and when FCs are fixed. Variable costs vary in total and FCs are fixed in total. However, VCs per unit are consistent and FCs per unit decline as more units are produced.

Total costs and unit costs

Students often treat ‘unitised’ fixed costs as if they were variable costs, forgetting that fixed costs are fixed in total. They attempt to calculate total costs by multiplying the cost per unit by the number of units. Because of this misleading nature of unitised fixed costs, it is better to base projections and comparisons on total costs. When estimating total costs, students should consider variable costs as an amount per unit and fixed costs as a lump sum total amount.

Financial statements and cost terminology

The basic concepts of assigning costs to cost objects (and using this information for planning and control) apply to service, merchandising and manufacturing companies. Students find it easier to grasp the basic concepts by starting with service companies, which are the simplest as they have no stocks. Merchandisers add the complications of purchases and stocks. The final step is manufacturers, which are more difficult due to the complexities of cost of good manufactured (CGM), and the three types of stock.

2.1 A cost object is anything for which a separate measurement of costs is desired. Examples include a product, a service, a project, a customer, a brand category, an activity, a department and a programme.

2.2 Costs are not direct or indirect in isolation. A cost object (such as a product, service or project) must be specified.

Direct costs of a cost object are those costs that are related to the particular cost object and that can be traced to it in an economically feasible (cost-effective) way.

Indirect costs of a cost object are those costs that are related to the particular cost object but cannot be traced to it in an economically feasible (cost-effective) way.

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Assume that the cost object is a Macintosh computer product. Apple assembles multiple products in each of its plants. The computer screen is a direct cost of the Macintosh. In contrast, the salary of the security guard at the plant where the Macintosh is assembled would be an indirect cost of the Macintosh.

2.3 Consider a supervisor’s salary in a maintenance department of a telephone company. If the cost object is the department, the salary is a direct cost. If the cost object is a telephone call by a customer, the salary is an indirect cost.

2.4 Factors affecting the classification of a cost as direct or indirect include

1 the materiality of the cost in question

2 available information-gathering technology

3 design of operations

4 contractual arrangements.

2.5 A cost driver is any factor that affects total costs. Examples include:

Business function Example of cost driver

Research and development Number of research projects

Design Number of products in design

Production Number of units produced

Marketing Number of advertisements run

Distribution Number of items distributed

Customer service Number of service calls

2.6 The relevant range is the range of the cost driver in which a specific relationship between cost and driver is valid. This concept enables the use of linear cost functions when examining cost–volume–profit (CVP) relationships as long as the volume levels are within that relevant range.

2.7 A unit cost is calculated by dividing some total cost (the numerator) by some number of units (the denominator). In many cases the numerator will include a fixed cost that will not change despite changes in the number of units to be assembled. It is erroneous in those cases to multiply the unit cost by volume changes to predict changes in total costs at different volume levels.

2.8 Descriptions of the three sectors are:

Service-sector companies provide services or intangible products to their customers – for example, legal advice or an audit. These companies do not have any stock of intangible products at the end of an accounting period.

Merchandising-sector companies provide tangible products they have previously purchased in the same basic form from suppliers. Merchandise purchased from suppliers but not sold at the end of an accounting period is held as stock.

Manufacturing-sector companies provide tangible products that have been converted to a different form from the products purchased from suppliers. At the end of an accounting period, stock of a manufacturer can include direct materials, work in progress and finished goods.

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Thus, manufacturing and merchandising companies have stock while service companies do not. Manufacturing companies have direct materials, work in progress and finished goods stock, whereas merchandising companies have only goods purchased for resale stock (merchandise stock).

2.9 The three major categories of the stockable costs of a manufactured product are:

1 direct materials costs

2 direct manufacturing labour costs

3 indirect manufacturing costs.

2.10 Direct materials costs are the acquisition costs of all materials that eventually become part of the cost object (say, units finished or in progress) and that can be traced to that cost object in an economically feasible way. Acquisition costs of direct materials include freight-in (inward delivery) charges, sales taxes and customs duties. Direct manufacturing labour costs include the compensation of all manufacturing labour that is specifically identified with the cost object (say, units finished or in progress) and that can be traced to the cost object in an economically feasible way. Examples include wages and fringe benefits paid to machine operators and assembly-line workers.

Indirect manufacturing costs are all manufacturing costs considered to be part of the cost object (say, units finished or in progress), but that cannot be individually traced to that cost object in an economically feasible way. Examples include power supplies, indirect materials, indirect manufacturing labour, plant rent, plant insurance, property taxes on plants, plant depreciation and the compensation of plant managers.

Prime costs are all direct manufacturing costs. In the two-part classification of manufacturing costs, prime costs would comprise direct materials costs. In the three-part classification, prime costs would comprise direct materials costs and direct manufacturing labour costs.

Conversion costs are all manufacturing costs other than direct materials costs.

2.11 Total costs and unit costs. (10 min)

1 Total cost, €40,000. Unit cost per person, €40,000 ÷ 500 = €80.00.

2 Total cost, €40,000. Unit cost per person, €40,000 ÷ 2000 = €20.00.

3 The main lesson of this problem is to alert the student early in the course to the desirability of thinking in terms of total costs rather than unit costs wherever feasible. Changes in the number of cost driver units will affect total variable costs but not total fixed costs. In our example, it would be perilous to use either the €80.00 or the €20.00 unit cost to predict the total cost, because the total costs are not affected by the attendance. Instead, the student association should use the €40,000 total cost. Obviously, if the musical group agreed to work for, say €40.00 per person, such a unit variable cost could be used to predict the total cost.

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2.13 Total costs and unit costs. (10 min)

1 Unit cost = Total costs ÷ Number of units.

Total costs (€) Number of units Unit cost (€)

a 60,000 200 300

b 60,000 250 240

c 60,000 300 200

2 The unit-cost figures per passenger calculated in requirement 1 should play no role in predicting the total air-flight costs to be paid next month. Weltferien pays Saxon-Air on a per round-trip flight basis, but not on a per passenger basis. Hence, the cost driver for next month is the number of round-trip flights and not the number of passengers.

2.14 Classification of costs, service sector. (15–20 min)

Cost object: Each individual focus group.

Cost variability: With respect to changes in the number of focus groups.

There may be some debate over classifications of individual items. Debate is more likely as regards cost variability.

Cost item D or I V or F

a Some students will note that phone call costs are variable when each call has a separate charge. It may be a fixed cost if Presta-Serviços has a flat monthly charge for a line, irrespective of the amount of usage.b Petrol costs are likely to vary with the number of focus groups. However, vehicles likely serve multiple purposes and detailed records may be required to examine how costs vary with changes in one of the many purposes served.

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2.15 Classification of costs, merchandising sector. (15–20 min)

Cost object: Film section of store.

Cost variability: With respect to changes in the number of films sold, assumptions may be made over classifications of individual items. This is mainly in relation to cost variability. Whether DVDs and videos cost the same is another matter.

Cost item D or I V or FA I FB I VC D VD D FE I FF I VG I FH D V

2.16 Cost drivers and the value chain. (15 min)

1Business function area Representative cost driver

A Research and development Number of research scientistsB Design of

products/processesHours of cad work

C Production Hours of machine assembly hoursD Marketing Number of sales personnelE Distribution Weight of cars shippedF Customer service Number of cars recalled for defective parts

2Business function area Representative cost driver

A Research and development Hours of design and testing work Number of new models in development

B Design of products/processes Number of focus groups on alternative models and designs

Hours of engineering and retooling

C Production Number of units coming off assembly line Number of models manufactured

D Marketing Number of promotion packages mailed Number of sales

E Distribution Number of cars shipped overseas Number of cars delivered to showrooms

F Customer service Number of cars recalled Number of personnel on free customer

phone lines

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2.17 Calculating cost of goods manufactured and cost of goods sold. (20–25 min)

Schedule of cost of goods manufactured for the year ended 31 December 2011 (in €million)

€m €mDirect materials used 13.05Direct manufacturing labour costs 15.10Indirect manufacturing costs:

Property tax on plant building 0.45Plant utilities 2.56Depreciation of plant building 1.35Depreciation of plant equipment 1.65Plant repairs and maintenance 2.40Indirect manufacturing labour costs 3.45Indirect materials used 1.65

Miscellaneous plant overhead 0.60 14.10Manufacturing costs incurred during 2011 32.25Add opening work in progress stock, 1 January 2011 3.00Total manufacturing costs to account for 35.25Deduct closing work in progress stock, 31 December 2011  3.90Cost of goods manufactured 31.35

Schedule of cost of goods sold for the year ended 31 December 2011 (in €million)€m

Opening finished goods, 1 January 2011  4.05Cost of goods manufactured (above) 31.35Cost of goods available for sale 35.40Closing finished goods, 31 December 2011  5.10Cost of goods sold 30.30

2.18 Income statement and schedule of cost of goods manufactured. (25–30 min)

Howell LtdIncome Statement for the Year Ended 31 December 2011

(in £millions)

£m £mRevenues 950Cost of goods sold:

Opening finished goods, 1 January 2011  70Cost of goods manufactured (below) 645Cost of goods available for sale 715Closing finished goods, 31 December 2011  55 660

Gross margin 290Marketing, distribution and customer-service costs 240Operating income  50

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Schedule of cost of goods manufactured for the year ended 31 December 2011(in £millions)

£ £Direct materials costs:

Opening stock, 1 January 2011  15Purchases of direct materials 325Cost of direct materials available for use 340Closing stock, 31 December 2011  20 Direct materials used 320

Direct manufacturing labour costs 100Indirect manufacturing costs:

Indirect manufacturing labour  60Plant supplies used  10Plant utilities  30Depreciation – plant, building and equipment  80Plant supervisory salaries  5Miscellaneous plant overhead  35 220

Manufacturing costs incurred during 2011 640Add opening work in progress stock, 1 January 2011 10Total manufacturing costs to account for 650Deduct closing work in progress, 31 December 2011  5Cost of goods manufactured £645

2.19 Interpretation of statements. (20–25 min)

1 The schedule in 2.18 can become a schedule of cost of goods manufactured and sold simply by including the opening and closing finished goods stock figures in the supporting schedule, rather than directly in the body of the income statement. Note that the term cost of goods manufactured refers to the cost of goods brought to completion (finished) during the accounting period, whether they were started before or during the current accounting period. Some of the manufacturing costs incurred are held back as costs of the closing work in progress; similarly, the costs of the opening work in progress stock become a part of the cost of goods manufactured for 2005.

2 The sales manager’s salary would be charged as a marketing cost as incurred by both manufacturing and merchandising companies. It is basically an operating cost that appears below the gross margin line on an income statement. In contrast, an assembler’s wages would be assigned to the products worked on. Thus, the wages cost would be charged to work in progress and would not be expensed until the product is transferred from finished goods stock to cost of goods sold as the product is sold.

3 The direct–indirect distinction can be resolved only with respect to a particular cost object. For example, in defence contracting, the cost object may be defined as a contract. Then, a plant supervisor’s salary may be charged directly and wholly to that single contract.

23© Pearson Education Limited 2012

4 Direct materials used = £320,000,000 ÷ 1,000,000 units = £320 per unit.

Depreciation = £80,000,000 ÷ 1,000,000 units = £80 per unit.

5 Direct materials unit cost would be unchanged at £320. Depreciation unit cost would be £80,000,000 ÷ 1,200,000 = £66.67 per unit. Total direct materials costs would rise by 20% to £384,000,000, whereas total depreciation would be unaffected at £80,000,000.

6 Unit costs are averages and they must be interpreted with caution. The £320 direct materials unit cost is valid for predicting total costs because direct materials is a variable cost; total direct materials costs indeed change as output levels change. However, fixed costs like depreciation must be interpreted quite differently from variable costs. A common error in cost analysis is to regard all unit costs as one – as if all the total costs to which they are related are variable costs. Changes in output levels (the denominator) will affect total variable costs, but not total fixed costs. Graphs of the two costs may clarify this point; it is safer to think in terms of total costs than in terms of unit costs.

2.20 Finding unknown balances. (20–25 min)

Let G = given, I = inferred.

Step 1: Use gross margin formula Case 1 Case 2Revenues £32,000G £31,800G

Cost of goods sold A 20,700I 20,000G

Gross margin 11,300G C 11,800I

Step 2: Use schedule of cost of goods manufactured formula

Case 1 Case 2

Direct materials used £8,000G £2,000G

Direct manufacturing labour costs 3,000G 5,000G

Indirect manufacturing costs 7,000G D 6,500I

Manufacturing costs incurred 18,000I 23,500I

Add opening work in progress, 1 January 0G 800G

Total manufacturing costs to account for 18,000I 24,300I

Deduct closing work in progress, 31 December 0G 3,000G

Cost of goods manufactured 18,000I 21,300I

Step 3: Use cost of goods sold formula Case 1 Case 2Opening finished goods stock, 1 January £4,000G £4,000G

Cost of goods available for sale 22,000I 25,300I

Closing finished goods stock, 31 December B 1,300I 5,300G

Cost of goods sold 20,700I 20,000G

For case 1, do steps 1, 2 and 3 in order.

For case 2, do steps 1, 3 and then 2.

24© Pearson Education Limited 2012

2.21 Fire loss, computing stock costs. (30–40 min)

1   €50,000   2  €28,000   3   €62,000

This problem is not as easy as it first appears. These answers are obtained by working from the known figures to the unknowns in the schedule below. The basic relationships between categories of costs are:

Prime costs (given) = €294,000

Direct materials used = €294,000

Direct manufacturing labour costs = €294,000 – €180,000 = €114,000

Conversion costs = Direct manufacturing labour costs ÷ 0.6€180,000 ÷ 0.6 = €300,000

Indirect manufacturing costs = €300,000 – €180,000 = €120,000(or 0.40 = €300,000)

Schedule of Calculations€

Direct materials, 1 January 2011 16,000Direct materials purchased 160,000Direct materials available for use 176,000Direct materials, 26 February 2011 3 = 62,000Direct materials used (€294,000 – €180,000) 114,000Direct manufacturing labour costs 180,000Prime costs 294,000Indirect manufacturing costs 120,000Manufacturing costs incurred during the current period 414,000Add work in progress, 1 January 2011     34,000 Manufacturing costs to account for 448,000Deduct work in progress, 26 February 2011 2 =     28,000 Cost of goods manufactured 420,000Add finished goods, 1 January 2011 30,000Cost of goods available for sale (given) 450,000Deduct finished goods, 26 February 2011 1 =     50,000 Cost of goods sold (80% of €500,000) €400,000

2.22 Comprehensive problem on unit costs, product costs. (30 min)

1 If 2 kg of direct materials are used to make each unit of finished product, 100,000 units × 2 kg or 200,000 kg were used at €l0.70 per kg of direct materials (€140,000 ÷ 200,000 kg). Therefore, the closing stock of direct materials is 2000 kg × €0.70 = €1,400.

25© Pearson Education Limited 2012

2 Manufacturing costs for 100,000 units

Variable Fixed TotalDirect materials costs €140,000  € €140,000

Direct manufacturing labour costs   30,000  –  30,000

Plant energy costs    5,000  –    5,000

Indirect manufacturing labour costs   10,000  16,000   26,000

Other indirect manufacturing costs    8,000  24,000   32,000

Cost of goods manufactured €193,000 €40,000 €233,000

Average unit manufacturing cost: €233,000 ÷ 100,000 units

= €2.33 per unit

Finished goods stock in units: €20,970 (given)=

€2.33 per unit

= 9000 units

3 Units sold in 2011 = Opening stock + Production – Closing stock

= 0 + 100,000 – 9000 = 91,000 units

Selling price per unit in 2011 = €436,800 ÷ 91,000

= €4.80 per unit

4 Revenues (91,000 units sold €4.80) €436,800Cost of units sold:Opening finished goods, 1 January 2011 € 0Cost of goods manufactured 233,000Cost of goods available for sale 233,000Closing finished goods, 31 December 2011 20,970 212,030Gross margin 224,770

Operating costs:Marketing, distribution and customer-service costs 162,850Administrative costs   50,000 212,850

Operating income € 11,920

Note: Although not required, the full set of unit variable costs are:

Direct materials costs €1.40Direct manufacturing labour costs 0.30Plant energy costs 0.05 per unit manufactured

Indirect manufacturing labour costs 0.10Other direct manufacturing costs 0.08Marketing, distribution and customer-service costs 1.35 per unit sold

26© Pearson Education Limited 2012

2.25 Revenue and cost recording and classifications, ethics. (25–30 min)

1 Concerns include:

a Total payments made by Aran Sweaters do not ‘appear’ to be adequately described. Elements of ‘total compensation’ appear to be:

€12 million payment to O’Neil in Achill Island

€4.8 million payment to O’Neil subsidiary in Switzerland

Assistance with life insurance plans for ‘O’Neil executives at rates much more favourable than those available in Achill Island’.

One possible motivation for restricting the payment in Achill Island to €12 million is to avoid showing higher profits in Achill Island. A second motivation could be that the Swiss subsidiary is siphoning off revenues to O’Neil senior executives that should be paid to O’Neil. This could arise if the O’Neil Swiss subsidiary is ‘owned’ by the senior executives of O’Neil rather than being a 100% subsidiary of O’Neil.

The assistance with the insurance plans is in the grey area. If O’Neil is willing to accept a lower price in return for Aran Sweaters assisting with the insurance plans, it may be a judicious economic decision by Aran Sweaters. Aran Sweaters is not hurt economically in this scenario. The concern is whether Aran Sweaters is assisting the senior executives to divert ‘de facto’ payments to themselves.

b Product design costs of Aran Sweaters include €4.8 million for ‘own product design’. It is stated that the director of product design views it ‘as an “off-statement” item that historically he has neither responsibility for nor any say about’ and that ‘to his knowledge, O’Neil uses only Aran Sweaters designs with either zero or minimal changes’. It may be that the €4.8 million payment is a hidden payment made to avoid Achill Island taxation. However, the result is incorrect classification of product design costs at Aran Sweaters.

c O’Neil receives from Aran Sweaters the margin between €16.8 million (€12 million + €4.8 million) and the €3 million payment for wool, i.e. €13.8 million. Note that Aran Sweaters can assist O’Neil to meet the 25% ratio of ‘domestic labour costs to total costs’. Charging €6.00 million for wool and receiving €19.8 million for sweaters will result in the same €13.8 million margin, but will mean O’Neil will not meet the 25% test as total costs will now be €13 million instead of €10 million. Aran Sweaters has to ensure it takes an arm’s length in its approach to supply contracts and purchase contracts or else it may be accused by the Achill Island government of assisting O’Neil to avoid local taxes.

Note: Some students will ask whether O’Neil should be able to classify labour fringe benefits as a domestic labour cost. This is not Sheridan’s domain given that she is controller of Aran Sweaters. Her concern with the Achill Island tax rebate is whether Aran Sweaters is being ‘pressured’ to adjust its billing amounts to facilitate O’Neil to have a ratio of ‘domestic labour costs to total costs’ exceeding 25%. If you want to discuss this issue, point out that labour-fringe benefits are typically an integral part of labour costs. Hence, if they can be traced, O’Neil is justified in including them in domestic labour costs.

27© Pearson Education Limited 2012

2 There are a variety of ethical issues relating primarily to competence and integrity that Sheridan faces:

a Is Aran Sweaters assisting O’Neil to avoid income taxes in Achill Island either:

by funnelling €4.8 million to a Swiss company rather than to O’Neil in Achill Island or

by understating both the €3 million wool supply cost and the €16.8 total revenue amount?

b Is Aran Sweaters assisting senior executives of O’Neil to enrich themselves at the expense of the shareholders of O’Neil?

c Are the accounting records of Aran Sweaters properly reflecting the underlying activities?

3 Steps Sheridan could take include:

a Seeking further information on why the €4.8 million payment is being made to the Swiss subsidiary. This should be done first internally and then by speaking to O’Neil executives.

b Ensure product design costs at Aran Sweaters reflect actual product design work. So-called ‘off-statement’ items should be eliminated if no adequate explanation can be given for them.

c Ensure Aran Sweaters personnel follow any company guidelines about supply relations or customer relations. There is nothing inherently wrong with assisting O’Neil negotiate a better insurance package for its executives. The concern is whether developing a ‘too cosy’ relationship will lead to more questionable practices being overlooked.

28© Pearson Education Limited 2012

Guide to case study solutions

101 – The European Savings Bank 335

102 – The ethical dilemma at Northlake 338

103 – Electronic Boards plc 339

201 – Permaclean Products plc 342

202 – Tankmaster Manufacturing Company 345

203 – Torquemada PLC 347

204 – Colombo Frozen Yoghurt 350

301 – Zeros plc 354

302 – Instrumental Ltd 358

303 – Fiddler Ltd 363

304 – Hereford Steak Houses 365

401 – BBR plc 368

402 – Cresta Plating Company Ltd 372

403 – Clayton Industries 377

501 – High-Tech Ltd 379

502 – Empire Glass Company 384

503 – Osram 385

504 – Coors: balanced scorecard 389

334© Pearson Education Limited 2012

Part IC A S E 1 0 1

The European Savings Bank

This case provides a unique vehicle for covering the legal issues and raising the ethical awareness of students with regard to software piracy. The case allows students to apply ethical reasoning in a legal framework with which students may not be completely familiar, but of which they are aware. This is especially appropriate with today’s increased copyright awareness, with cases such as Napster taking over the news headlines.

The software case can also be used to discuss other ethical issues, such as unethical behaviour. The motivations include a compulsion to win, a fear about economic uncertainty and/or the future and self-esteem. If an act is legal, does that make it ethical? Conversely, if an act is ethical, should it be legal? Since software piracy behaviour is so prevalent despite its illegality, it is particularly suited to this issue. The various issues related to copying software provide robust discussions in the classroom. Before presenting the case, it is helpful to present an overview of the legal issues related to software piracy. This will allow students to have an adequate background for the case discussion and will also highlight the variation in the rights granted to the licensees of different software packages. A comparison of the laws and the licensing agreements points out how difficult it is always to adhere to legal constraints and introduces areas where ethical judgement enters the process.

Software piracy

Legal issues

The laws regarding copying software were not clear for many years. This changed when the US Copyright Act of 1976 was amended in 1980 to include copyright protection for computer software. The act identifies software as a literary work subject to copyright protection. Software is typically licensed rather than sold in an effort to control software piracy. Under the typical licensing agreement, the software is shrink wrapped with the agreement on the front – by opening the shrink-wrap, the end user automatically agrees to the details of the copyright agreement.

Ethical aspects

Ethical behaviour considers the impact of our actions on others and society as a whole. Software piracy differs from other ethical issues because it is so widespread and prevalent in today’s society. The question, ‘If everyone does it, then surely it’s OK?’ arises and this is further exacerbated by the muddle with technology: copyright regarding printed matter is fairly easy – only one person can read a book at any one time; with software, the issue becomes muddled – one person can use the same software on different computers in exactly the same way and if that person uses it on only one computer at a time, is it piracy?

335© Pearson Education Limited 2012

Discussion of roles

To facilitate the use of the case, each role is discussed separately.

Nick Stringham

The major reason for including Nick in the case is to force the students to identify the creation of software with a particular individual (i.e. to personalise the issue). By attaching the issue to a person, rather than just considering the large software vendor, students recognise that an individual has invested considerable time and money in the creation of the software. Nick’s fundamental concern or issue in the case is the fact that the software he has created is being stolen. One topic that can be discussed is what, if anything, he can do about his software being pirated. His actions may be limited because he has agreed to have Data Sources, SA, market his software.

Shelly Norduck

Shelly, as the representative of the software vendor, is mainly concerned with what to do about the software piracy. Some people have argued that companies should encourage software piracy because anyone who uses it will subsequently want to purchase the package – this is a typical ploy of freeware companies. Some options are reinstating copy protection, registration, encouraging whistle-blowing through incentives, hardware or software key and embedded user name and these are a useful starting point for discussion.

Joe Fordham

Joe is the individual in this case who faces the largest dilemma: what decision is he going to make regarding the software? He believes that the bank would benefit from a wider use of Loan Net, but he is unsure how to proceed. One of the grey areas often identified in the issue of software piracy occurs with work on multiple machines. As discussed before, would the use of multiple copies be a breach of the agreement? Sometimes it is the case that the agreement is unclear thereby adding to the confusion. The discussion of Joe’s dilemma should also include other possible courses of action. One alternative is for Joe to talk to Judy Wardley and support his case for purchasing more copies of the software. In addition, Joe should read the actual licensing agreement and talk to the software company to determine what right he has to make extra copies.

Judy Wardley

Many companies will spend large amounts of money to collect data, but put that same data at risk by using pirated software that is undocumented, unsupported and typically lacking in access to updates. One suggestion usually made by one of the students is that the bank examines the possibility of a site licence. A site licence gives the purchaser the right to use the software on various computers located within a specific area. This is very typical of academic institutions, where IT-purchasing departments obtain licences to cover the whole organisation. Another important part of this discussion is Judy’s role as a representative of the company. The group can discuss the costs and merits of establishing a clear policy regarding the copying of software.

336© Pearson Education Limited 2008

Dave Saunders

Software piracy has become so prevalent that some argue it has almost become socially acceptable, despite the fact that it is illegal behaviour. Dave, as CEO of the bank, should recognise the potential costs that software piracy can cause his company. The other serious issue facing Dave is the ethical tone established by top management. One area that Dave should have responsibility for is maintaining a policy on ethical behaviour, including software piracy. How should managers respond when they become aware of unethical or illegal behaviour? This issue can give rise to discussions relating to the actions of those in top management as well as their proposed policies.

Some people argue that unauthorised copying of software has a cost to society while others, following the ‘hacker ethic’, would argue that piracy results in the free sharing of information. Those who adhere to the hacker ethic argue that all software should be in the public domain, since this encourages the free flow of information. They argue that this will result in a greater benefit to society as a whole since more learning and growth will occur. Software is copyrighted to protect the intellectual rights of the developers. The underlying rationale for copyrights is that they will foster the sharing and growth of knowledge. If copyrights are not observed, the potential developer may well choose to work in another area.

337© Pearson Education Limited 2008

C A S E 1 0 2

The ethical dilemma at Northlake

The case assumes no technical knowledge of management accounting. It is aimed at introducing ‘ethical’ questions, which accountants often face. The following could be useful in guiding class discussion:

Can professional ‘Standards of Ethical Conduct’ for management accountants help resolve the dilemma? (These could include ‘professional pillars’ such as Competence, Confidentiality, Objectivity and Integrity, established by the Institute of Management Accountants in the USA.)

Is a ‘Hippocratic Oath’ appropriate for the management accounting professional?

There are no ‘SSAPs’ in management accounting. Should matters of ethics be universally prescribed to management accountants?

Is ‘whistle-blowing’ justified in this case? Should Frank obtain more accounting facts? What should he do?

Responses of Canadian management accountants to the dilemma are given in the table below. You may wish to compare these with your students’ reactions.

Level of management Junior Middle Senior

1 Sources of counsel regarding the dilemma:

Him/herself 9% 9% 11%

Family 30% 24% 24%

Friends 6% 5% 7%

Legal 23% 32% 27%

SMA 25% 24% 30%

Other 8% 5% 2%

2 The (professional) Society’s role:

Advice 48% 53% 50%

Employment 22% 36% 33%

Financial help 16% 9% 8%

Other 12% 1% 5%

Nothing 2% 1% 4%

338© Pearson Education Limited 2012

339© Pearson Education Limited 2008

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The central issue in this case concerns product pricing. The analysis requires the estimation of appropriate costs

The central issue in this case concerns product pricing. The analysis requires the estimation of appropriate costs and assessing price-demand information using past sales data.

Permaclean Products is an old-established firm, located in Dunstable, manufacturing a comprehensive range of domestic cleaning materials. It has a sound reputation and a well-known brand name which has made it a market leader in a wide range of products designed for home use. Although Permaclean has several competitors, the total sales of each are small in comparison with those of Permaclean, mainly because none offers such a complete product range. In 2009 the price of one of Permaclean’s major products, Permashine, was raised from 75p per bottle to 99p when the product was repackaged in a newly designed bottle; however, the contents were identical to the previous pack, both in formulation and quantity. During the following two years sales fell by 27 per cent. At 75p per bottle Permashine had been competitively priced but when its price was increased manufacturers of similar products had not followed. In the period from 2007 to 2010 the price of competing products had been raised by only 5p.

Prices were fixed once a year, to come into force on 1 February, before the annual peak demand which occurred in the spring. In January 2011, John Williams, the marketing manager, met with Andrew Dutton, the chief accountant, to review the company’s pricing policy for the coming year.

Permashine is a proprietary cleaning product for bathrooms and in 2008 had accounted for over 10 per cent of the company’s sales. Although there are a variety of competing products on the market, Permashine has special properties which make it especially suitable for cleaning baths made of acrylic materials. Such baths are becoming increasingly common, but great care has to be taken to avoid scratching them when they are being cleaned. Permashine contains no abrasive materials yet is able to clean acrylic surfaces with great efficiency, giving a surface shine that is very durable. No competing product appears to have this combination of advantages.

The process used in the manufacture of Permashine involves a hazardous chemical reaction that has to be precisely controlled. Production therefore takes place in a separate building on the same site as the main factory where the other products are made, but some distance from it. This production unit, which was constructed in 2003 for safety reasons, is not capable of being adapted for the manufacture of other Permaclean products without substantial expenditure. Although the manufacture of Permashine is potentially hazardous, no serious accidents have occurred during the 15 years in which it has been produced and the final product is itself completely harmless.

In early 2010, Andrew Dutton had installed an improved cost accounting system which allowed product costs to be determined and product profitability to be reviewed. With regard to Permashine, this took into account the new packaging costs, as well as the overhead costs that were separately attributable to the production unit. His analysis, shown in Table 1, indicated that the total cost of Permashine was greater than the current selling price of 75p. As a result, at the annual pricing review in 2009 the selling price was increased to 99p.

Although total industry sales continued to rise during 2009 and 2010, Permashine suffered a reduction in both its market share and its total sales, as shown in Table 2.

The 2011 pricing review

Both Mr Williams and Mr Dutton were concerned to improve the profitability of Permashine, as it was one of the company’s major products. Mr Williams had joined the company in 2003 and had introduced a number of changes in the firm’s marketing methods. One of his major successes had been his decision to replace wholesalers with a team of salaried sales representatives who sold the company’s full product range direct to retailers. Mr Dutton had been appointed in 2007, following the retirement of the previous chief accountant and had been responsible for installing a modern computer-based accounting system.

Mr Williams pressed for a return to the previous price of 75p for Permashine; at this price he was confident that the market share of the product could be increased to 20 per cent in 2011. He thought that total industry sales would continue to increase to at least 3 million bottles in 2011, and that Permashine was capable of regaining its previous position, provided that it was competitively priced. Because Permaclean had a modern production facility and a manufacturing output greater than any competitor, he was confident that factory production costs were the lowest in the industry. He therefore supported a policy of reducing the price so that other firms would find it uneconomic to continue to compete.

Mr Williams was convinced that sales would continue to fall if the price were to be maintained at 99p, although he believed that there would always be a premium market for Permashine because of its unique qualities. He thought that annual sales were unlikely to fall below 250 000 bottles even at the current price.

Mr Dutton replied that he was well aware of the problems being experienced in selling the higher-priced product. Nevertheless, his analysis showed that the 99p price covered the costs of the product, even at the lowest volume envisaged. If the price were reduced to 75p costs would fail to be covered, even if sales volume rose to the 800 000 bottles which represented the maximum practical capacity of the plant. He referred to his detailed costings (Table 1) to support his argument. These figures, he stated, were based on actual data from past years; where data were not available, he had made what he regarded as realistic assumptions.

What price would you recommend for Permashine? Support your recommendation with detailed calculations, making the underlying assumptions on which your analysis is based as clear as possible.

Table 1 Estimated costs of Permashine at various production volumes Annual production ('000 bottles) 600 17.0 8.0 Cost (p/bottle) Direct labour Materials Dept. overhead Variable Fixed Factory overhead (20% of direct labour) Factory cost Selling and administration cost at 80% of factory cost Total cost 250 17.5 8.0 9.0 14.4 3.5 52.4 41.9 94.3 300 17.5 8.0 9.0 12.0 3.5 50.0 40.0 90.0 400 17.0 8.0 9.0 9.0 500 17.0 8.0 36.3 82.7 9.0 7.2 3.4 3.4 46.4 44.6 35.7 80.3 9.0 6.0 3.4 43.4 34.7 78.1 700 17.5 8.0 9.0 5.1 3.5 43.1 34.5 77.6 800 18.0 8.0 9.0 4.5 3.6 43.1 34.5 77.6

Step by step answer:, to recommend a price for permashine we need to consider the costs sales data and market conditions provided in the case 1 cost analysis based on table ... view the full answer.

Introduction To Management Accounting

ISBN: 9780273737551

1st Edition

Authors: Alnoor Bhimani, Charles T. Horngren, Gary L. Sundem, William O. Stratton, Jeff Schatzberg

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• Case Permaclean Products plc...

Case Permaclean Products plc The central issue in this case concerns product pricing. The...

Permaclean Products plc

The central issue in this case concerns product pricing. The analysis requires the estimation of appropriate costs and assessing price-demand information using past sales data. Permaclean Products is an old-established firm, located in Dunstable, manufacturing a comprehensive range of domestic cleaning materials. It has a sound reputation and a well-known brand name which has made it a market leader in a wide range of products designed for home use. Although Permaclean has several competitors, the total sales of each are small in comparison with those of Permaclean, mainly because none offers such a complete product range. In 2009 the price of one of Permaclean’s major products, Permashine, was raised from 75p per bottle to 99p when the product was repackaged in a newly designed bottle; however, the contents were identical to the previous pack, both in formulation and quantity. During the following two years sales fell by 27 per cent. At 75p per bottle Permashine had been competitively priced but when its price was increased manufacturers of similar products had not followed. In the period from 2007 to 2010 the price of competing products had been raised by only 5p. Prices were fixed once a year, to come into force on 1 February, before the annual peak demand which occurred in the spring. In January 2011, John Williams, the marketing manager, met with Andrew Dutton, the chief accountant, to review the company’s pricing policy for the coming year.

Permashine Permashine is a proprietary cleaning product for bathrooms and in 2008 had accounted for over 10 per cent of the company’s sales. Although there are a variety of competing products on the market, Permashine has special properties which make it especially suitable for cleaning baths made of acrylic materials. Such baths are becoming increasingly common, but great care has to be taken to avoid scratching them when they are being cleaned. Permashine contains no abrasive materials yet is able to clean acrylic surfaces with great efficiency, giving a surface shine that is very durable. No competing product appears to have this combination of advantages. The process used in the manufacture of Permashine involves a hazardous chemical reaction that has to be precisely controlled. Production therefore takes place in a separate building on the same site as the main factory where the other products are made, but some distance from it. This production unit, which was constructed in 2003 for safety reasons, is not capable of being adapted for the manufacture of other Permaclean products without substantial expenditure. Although the manufacture of Permashine is potentially hazardous, no serious accidents have occurred during the 15 years in which it has been produced and the final product is itself completely harmless. In early 2010, Andrew Dutton had installed an improved cost accounting system which allowed product costs to be determined and product profitability to be reviewed. With regard to Permashine, this took into account the new packaging costs, as well as the overhead costs that were separately attributable to the production unit. His analysis, shown in Table 1, indicated that the total cost of Permashine was greater than the current selling price of 75p. As a result, at the annual pricing review in 2009 the selling price was increased to 99p. Although total industry sales continued to rise during 2009 and 2010, Permashine suffered a reduction in both its market share and its total sales, as shown in Table 2.

The 2011 pricing review Both Mr Williams and Mr Dutton were concerned to improve the profitability of Permashine, as it was one of the company’s major products. Mr Williams had joined the company in 2003 and had introduced a number of changes in the firm’s marketing methods. One of his major successes had been his decision to replace wholesalers with a team of salaried sales representatives who sold the company’s full product range direct to retailers. Mr Dutton had been appointed in 2007, following the retirement of the previous chief accountant and had been responsible for installing a modern computer-based accounting system.

Mr Williams pressed for a return to the previous price of 75p for Permashine; at this price he was confident that the market share of the product could be increased to 20 per cent in 2011. He thought that total industry sales would continue to increase to at least 3 million bottles in 2011, and that Permashine was capable of regaining its previous position, provided that it was competitively priced. Because Permaclean had a modern production facility and a manufacturing output greater than any competitor, he was confident that factory production costs were the lowest in the industry. He therefore supported a policy of reducing the price so that other firms would find it uneconomic to continue to compete. Mr Williams was convinced that sales would continue to fall if the price were to be maintained at 99p, although he believed that there would always be a premium market for Permashine because of its unique qualities. He thought that annual sales were unlikely to fall below 250 000 bottles even at the current price. Mr Dutton replied that he was well aware of the problems being experienced in selling the higher-priced product. Nevertheless, his analysis showed that the 99p price covered the costs of the product, even at the lowest volume envisaged. If the price were reduced to 75p costs would fail to be covered, even if sales volume rose to the 800 000 bottles which represented the maximum practical capacity of the plant. He referred to his detailed costings (Table 1) to support his argument. These figures, he stated, were based on actual data from past years; where data were not available, he had made what he regarded as realistic assumptions.

What price would you recommend for Permashine? Support your recommendation with detailed calculations, making the underlying assumptions on which your analysis is based as clear as possible.

Earl Stokes Verified Expert

8464 Answers

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