978-0078025532 Chapter 3 Solution Manual Part 1

Chapter 3 – Basic Cost Management Concepts

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CHAPTER 3: BASIC COST MANAGEMENT CONCEPTS

QUESTIONS

3-1 Cost assignment refers to the general case of assigning costs to cost pools or

cost objects. When there is a direct and traceable link between the cost and the

Cost allocation uses cost drivers to assign the cost.

3-2 Direct costs can be physically identified with and/or traced to the cost object

because there is a direct causal link between them. Indirect costs cannot be

traced to each cost object. Direct costs for a manufactured product include the

which is not directly traceable to the product, such as labor for inspection and

supervision.

3-3 All direct costs are variable by definition since they can be directly traced to the

cost object, and thus must vary with the cost driver.

3-4 All fixed costs must be indirect, since the increase in the cost driver or volume of

output does not affect the level of fixed cost.

3-7 A step-fixed cost varies with the cost driver, but in discrete steps. Costs remain

fixed over narrow ranges of the cost driver. However, total costs increase by a

constant amount at set intervals. Examples of step-fixed costs are the costs for

Chapter 3 – Basic Cost Management Concepts

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3-8 The relevant range is the range of the cost driver for which total cost is

approximately linear. The relevant range is used to provide a useful range of

activity for the cost driver in which it can be assumed that variable costs will be

3-9 Conversion costs are the sum of direct labor and overhead costs. Prime costs

are the sum of direct materials and direct labor.

3-10 Average cost can be misleading unless the activity level (denominator) is known.

Because average cost includes a fixed cost component, it will be different at each

to the firm. Since period costs are not directly or indirectly related to the

production process, they are sometimes called non-manufacturing costs.

3-14 Cost of goods manufactured is the cost of the units produced this period and

transferred into finished good inventory. Cost of goods sold is the cost of the

units sold this period. Cost of goods sold will differ from cost of goods

manufactured because of changes in finished goods inventory. If finished goods

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3-15 The types of inventory in manufacturing firms are:

1. materials inventory

2. work-in-process inventory

3. finished products inventory

3-16 Both accuracy and timeliness are important attributes of cost information.

Accuracy is important because effective planning and decision making require

3-20 Indirect labor includes labor that is used in the manufacturing process but cannot

be traced to each product as it is produced; indirect labor includes supervision,

inspection (by batch, because inspection of each and every product would be a

variable cost), training, etc.

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BRIEF EXERCISES

3-21 The answer depends on what you consider the cost object. Suppose we

consider the flight as the cost object, then the variable costs should include fuel

and the flight team, and any meals or other products provided to passengers on

the flight. If the object is the individual passenger, then the list of variable costs

with the flight.

3-22 We start with the cost object, which in this case could be the item of merchandise

sold. Then the variable costs are the cost of merchandise and the selling costs

for the cashiers and restocking. For a large discount retailer, most other costs

3-23 The cost object for a movie theater could be the number of films being shown, or

the number of screens. The cost of renting the movie from the film producer is

the main cost. The key driver of revenue (not cost) is the number of ticket

holders – for ticket revenue and also revenue from sales of food and beverages.

Some costs will also be driven by the number of ticket holders, such as the cost

of ticket holders, or number of films being shown.

3-24 The cost object here is more readily identified – the beer product, whether

measured in individual bottles or larger quantities. The variable costs will be

significant here, including the ingredients that go into the brewing of beer. Other

costs for the brewery are likely to be fixed for this cost object, but there are

important activity costs which will vary with, for example, the number of

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3-25 Here it is plausible to consider the individual lesson as the cost object. Variable

costs would include that portion of the trainers’ pay which is based on each

lesson (the salary portion of the trainers’ pay would be fixed for this cost object).

3-26 $200 + $13,400 -$400 = $13,200

3-30 Period cost includes interest, advertising, and office expense: $4,000 + $2,500 +

$14,000 = $20,500

Chapter 3 – Basic Cost Management Concepts

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EXERCISES

3-31 Fares and Fees in the Airline Industry (15 min)

Very much like the consumer products industry (Procter & Gamble as an

example) introduced at the start of the chapter, the airline industry is

characterized by a high degree of complexity in pricing – both fares and

fees.

1. It is likely most will argue that the airline industry is a cost leadership

industry. Most passengers look for the lowest price ticket and see

very little difference between airlines in terms of quality, reliability, or

service. On the other hand, airlines would very much like to build a

“brand loyalty” by providing certain free services and customer

service. Whether this will work is a good question for class

discussion. One point that should arise in the discussion is to

development of new search engines and away from airlines that did

not participate in trusted, independent Web search sites. If the

number of Web sites increases, as some in the travel industry expect,

then it is likely to place more price pressure on the airlines and

reinforce the commodity view of the industry.

2. The complexity of fees and fares presents a challenge for the

consumer, and an opportunity for search sites such as Expedia to

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3-31 (continued –1)

It is likely that the additional complexity in fares and fees will affect

the airlines’ costs for the cost of additional time and materials in

processing fee payments and in assisting customers. Of course, the

additional fees are very likely to cover these additional costs.

Source: Jad Mouawad and Claire Cain Miller, “Search for Low

Airfares Gets More Competitive,” The New York Times, February

10, 2011; Gary Stoler, “Fee–fi–fo-fum, Airline Charges Leave Some

Travelers Numb,” USA Today, September 20, 2011, p B1.

For a contrasting view, see, Loizos Hereacleous and Jochen

Wirtz, “Singapore Airlines Balancing Act,” Harvard Business Review,

July-August 2010, pp. 145-149. The authors argue that Singapore

Airlines simultaneously competes on cost leadership and

differentiation. The authors further argue that this competition is

common in Asian airlines. The authors call this a “dual strategy.”

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3-32 Complexity of Operations and the Effect on Cost (15 min)

The observations made by the consultant show that the manufacturer was

incurring large costs in operations, distribution, and administration due to

the high level of complexity in its products. Maintaining relationships with

10 vendors for a single item contributed to high purchasing and stocking

costs. Similarly, most of the firm’s volume was made up of products with

five color combinations, with the result that manufacturing, warehousing,

shipping and selling costs were high relative to fewer color combinations.

Also, the high product variety required smaller batch production and more

demands for smaller batch sizes without increasing overall costs. The

result of the program was that overall profit margins improved. The firm

had found a way to deal with the cost consequences of its strategic

initiative.

Also, the firm adopted new cost management practices that included

new non-financial measures such as set-up time and frequency, percent of

orders shipped on time, percent of orders on just-in-time, and number of

vendors for the top 20 commodity raw materials items. In addition, the firm

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Based on information in: Barry Berman, “Products, Products Everywhere,”

The Wall Street Journal, August 23, 2010, p R8; “Managing Complexity

Through Performance Measurement,” by Frank A. J. Gonsalves and Robert

G. Eiler, Management Accounting, August 1996, pp 34-39.

3-33 Classification of Costs (10 min)

Parts 1 and 2:

1. Print machine setup costs: activity; product

2. Cost of complexity; the number and variety of products: structural;

product

7. Redesign of the print process to improve efficiency: executional;

product

8. Machine operation labor: volume; product

9. Order taking: activity; period

10. Purchasing and stocking paper and other supplies – activity;

product

3. The ink could have a harmful environmental impact. The company

could choose to use environmentally friendly ink, or dispose of the

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3-34 Classification of Costs (10 min)

1. period

2. product and indirect

3. product and indirect

4. product and direct

13. period

14. period

3-35 Classification of Costs (10 min)

1. direct and variable

2. indirect and fixed

3. indirect and variable

4. indirect and fixed

5. direct and variable

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3-36 Classification of Costs (10 min)

1. direct

2. indirect

3. direct

8. direct

9. indirect

10. indirect

3-37 Activity Levels and Cost Drivers (10 Min)

Cost Object

Cost Driver

1

product line or

customer

trace to product line, or each custom order

requiring design

2

product line or

customer

trace to product line, or each custom order

requiring testing

3

product line

4

product line

number of purchase orders

5

customer order

trace directly to customer

6

customer order

trace directly to customer

7

customer order

trace directly to customer

8

customer order

trace directly to customer

9

each customer

trace directly to customer

10

customer order

trace directly to customer

11

not allocated

cannot be traced to product or customer; must be

allocated using some reasonable method, for

example, number of units produced

12

not allocated

cannot be traced to product or customer; must be

allocated using some reasonable method, for

example, the number of units produced

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3-38 Application of the Direct Cost Concept in the Fashion Industry

(15 min)

It is always possible, by definition, to trace direct materials and direct labor

costs to each unit produced. In some cases, as this one, the most

practical approach is to trace the materials and labor costs directly to the

3-39 Direct Manufacturing Labor: Fixed or Variable? (10 min)

The effect of the policy on cost is that labor expense, while fixed in total

expenditure, is in reality a variable expense. Labor is flexible and can be

moved from job to job or plant to plant as demand dictates; that is, labor

time labor is added when needed.

Source: Clara Asbury, “In the Workplace, Jobs Morph to Suit Rapid Pace

of Change,” The Wall Street Journal, March 22, 2002, p1.

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3-40 Average and Total Costs (15 min)

1. Total cost:

$ 1,500 (fixed cost of space rental)

+ 1,500 (variable cost of refreshments = $15 x 100)

$ 3,000

Average cost: $3,000/100 people = $30.00 per person

2. Total cost:

$ 1,500 (fixed cost of space rental)

Average cost: $4,500/200 people = $22.50 per person

3. Average costs decrease as attendance increases because the

fixed cost component to total costs is now spread over 100 extra

people.

Fixed cost per person: $1,500/100 people = $15

$1,500/200 = $ 7.50

Decrease in fixed cost per person $ 7.50

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3-41 Cost Classification for Dance Studio (15 min)

1. While a variety of possible cost objects are possible for the dance

studio, the most reasonable choice is the studio since management’s

goal is to analyze the profitability of the studios.

2. Studios as the cost object

1. a,c

2. a,c

3. a,c

Or,

Lessons as the cost object

1. a,d

2. b,d

3. b,d

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3-42 Relevant Range (20 min)

This exercise is intended to develop the student’s appreciation of the

complexities in cost determination and the importance of considering

foreign exchange effects when doing business abroad.

1. The volume-based costs include:

a. Fixed costs: administrative costs of management in Austin and

depreciation expense, insurance, maintenance, security, etc.

2. The relevant range is applicable for PGI because PGI’s operations

centers must grow as demand increases. This means higher

variable costs due to the cost of adding small computer servers and

the cost of hiring additional staff, etc. Note that the cost of the

variable cost and total fixed cost for a limited range of activity – a

range in which there is no need for additional servers or hiring costs,

etc.