Managerial Accounting

Review session (topics 1-6)

INSEAD MBA Program – Asia Campus 2023

Prof. Hami Amiraslani

Office: INSEAD Asia Campus, Office 528
Email: [email protected]
 Session 1 – Cost management and behavior
Nature of costs
(i) based on their economic behavior (variable and fixed) – notion of cost driver
(ii) based on their relation to an underlying cost object (direct and indirect), and
(iii) based on their relation to business functions (product and period)

Contribution margin and operating profit

CM= Sales – Variable costs
Operating profit= CM – Fixed costs
Break-even point (volume and amount) Break-even point (multi-products)
FC FC FC FC
QBE = = QBE = and R BE =
P – VC CM WACMFirm CMRFirm
FC FC
QBE × P = RBE = =
P – VC CMR Margin of safety (MS) and percentage of MS
P
MS= Budgeted (actual) sales – BEP sales
Volume and amount for target profit Margin of safety
MS %=
Budgeted (actual) sales
π + FC π + FC
QTP = =
P – VC CM Cost structure and operating leverage
π + FC π + FC
RTP = = Balance between fixed versus variable costs
P – VC CMR
P Contribution margin
Operating leverage=
Profit 2
 Session 2 – Product costing
Direct materials Sales xxxx
Beginning raw materials inventory xxx Cost of goods sold:
Purchases of raw materials xxx Beginning finished goods inventory xx
Cost of goods manufactured xxxx
Raw materials available for use xxx
Goods available for sale xxxx
Ending raw materials inventory (xxx)
Ending finished goods inventory (xx)
Raw materials used in production xxx Cost of goods sold (xxx)
Direct labor xxx Gross margin xxx
Prime cost xxxx Selling and administrative expenses (xx)
Manufacturing overhead xxx Net operating income xxx
Total manufacturing cost xxxx Summary
Beginning work in process inventory xx
COGS= BFG + CGM – EFG
Total work in process xxxx
Ending work in process inventory (xx) GM= Sales - COGS
Cost of goods manufactured xxxx OP= GM - SGA
Summary Product costing
DM= BDM + PDM – EDM Absorption costing: All variable and fixed
PC= DM + DL production costs are capitalized in inventory
MC= PC + OH (FOH + VOH) Variable costing: Only variable production
CGM= BWIP + MC – EWIP costs are capitalized in inventory
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 Session 2 – Product costing
Absorption versus variable costing

Absorption Costing Operating

Production = Sales Inventory levels constant Income = Variable Costing
Operating Income
Absorption Costing Operating
Production > Sales Inventory levels increase Income > Variable Costing
Operating Income
Absorption Costing Operating
Production < Sales Inventory levels decrease Income < Variable Costing
Operating Income

Pros and cons of absorption costing

• Creates incentives for overproduction, but it is required under both U.S. GAAP and IFRS
• Tax rules also require its application for purposes of corporate taxation
• For internal decision-making, it produces numbers that are not useful in CVP analysis
• When the firm has excess capacity, it can lead to inappropriate pricing decisions (cost-plus
pricing) and dropping products that are in fact profitable
• Potential remedies: (a) do not allocate costs of excess capacity to products, (b) for
performance evaluation and incentive system design, incorporate an inventory carrying
charge into your KPIs
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 Session 3 – Product costing
Predetermined rate of overhead
Why we focus on overheads?
Budgeted annual overhead
Budgeted annual activity (or cost driver) units • Over the past three to four decades DL and
OH have moved in opposite directions
• Overhead applied to cost objects will usually • With automated manufacturing, it is difficult
differ from overhead actually incurred; this to argue that DL “drives” OH
leads to overapplied or underapplied • We need a system that accurately reflects
overhead at the end of the year the demands that products, customers, and
If applied overhead>actual overhead, then you other cost objects make on OH resources
have overapplied overhead
If applied overhead<actual overhead, then you
have underapplied overhead
Excess capacity costs
The death spiral effect happens when a firm has excess capacity, allocates fixed
overhead costs to products based on actual utilization, and tries to pass costs related
to excess capacity on to (internal or external) customers. If capacity utilization (i.e.,
demand for products/services) drops, allocating fixed overhead costs to products
based on actual capacity utilization leads fixed overhead cost per product/service to
increase. Passing these increased costs on to customers means that demand will
decrease even further, which in turn increases the allocated fixed overhead cost per
product (and so on, hence the spiral)
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 Session 4, 5, and 6 – ABC and TDABC
Conventional ABC involves four steps: Time-Driven ABC involves steps:
Identify activities and assign costs Estimate the cost per time unit of capacity
Identify cost driver(s) for each activity Estimate the unit times of activities

Compute a cost driver rate: Derive the cost-driver rates

Analyze and report costs
Budgeted indirect cost associated with cost driver
Update the model
Total budgeted available cost driver volume
Allocate overhead to cost objects: Benefits of TDABC
Cost driver rate × Number of cost driver units Estimating the time supplied and comparing
this to time used allows managers to derive
Issues with conventional ABC approximations of unused capacity within
ABC requires extensive data-gathering (mainly divisions
through surveys and interviews) In costing and pricing, it is essential that firms
are able to identify and isolate the cost of
Time and cost involved in designing a excess capacity from the cost of their
conventional ABC system can be very high products/services
Cost of maintaining an ABC system is another Resource reallocation, employee redundancy,
barrier to its widespread adoption and other cost cutting initiatives are the usual
Lack of consensus on the adequacy of ABC responses to unused capacity costs
cost drivers – wasteful ongoing discussions TDABC offers a basis not only for
product/service costing but also for planning
ABC assumes full capacity utilization; time and budgeting (TDABB)
allocation data always adds up to 100%
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 BCP – Cost of goods manufactured
The following selected information was extracted from the 2016 accounting records of
Brussels Chocolate Products (BCP):
Raw material purchases €175,000
Direct labor 254,000
Indirect labor 109,000
Selling and administrative salaries 133,000
Building depreciation* 80,000
Other selling and administrative expenses 195,000
Other indirect factory costs 344,000
Sales revenue (€130 per unit) 1,495,000
* Seventy-five percent of the company’s building was devoted to production activities; the remaining 25
percent was used for selling and administrative functions.
Inventory data: January 1 December 31
Raw material €15,800 €18,200
Work in process 35,700 62,100
Finished goods* 111,100 97,900
*The January 1 and December 31 finished-goods inventory consisted of 1,350 units and 1,190 units,
respectively.
Required:
1. Calculate BCP’s manufacturing overhead for the year.
2. Calculate BCP’s cost of goods manufactured.
3. Compute the company’s cost of goods sold.
4. Determine net income for 2016, assuming a 30% income tax rate.
5. Determine the number of completed units manufactured during the year.
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 BCP – Cost of goods manufactured
1. Manufacturing overhead

2. Cost of goods manufactured

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 BCP – Cost of goods manufactured
3. Cost of goods sold

4. Net income:

5. The company sold 11,500 units during the year (€1,495,000 ÷ €130). Since 160
of the units came from finished-goods inventory (1,350 – 1,190), the company
would have manufactured 11,340 units (11,500 – 160).
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 Saratoga Company - TDABC
Saratoga manufactures jobs to customer specifications. The company is conducting a TDABC study
in its Purchasing Department to understand how labor resources are consumed by jobs. The
company provided the following data regarding its Purchasing Department and three of its many jobs:
Number of employees 16
Average salary per employee $25,000
Weeks of employment per year 52
Hours worked per week 40
Practical capacity percentage 85%
Requisition Processing Bid Evaluation Inspection
Minutes per unit of the activity 15 45 30

Job X Job Y Job Z

Number of requisitions processed 10 7 6
Number of bid evaluations 4 3 5
Number of inspections 7 3 7

In addition, assume that Saratoga Company provided the following activity data for all jobs produced
during the year:
Requisition Processing Bid Evaluation Inspection
Activity demands for all jobs 10,100 12,050 14,100

Required:
1. Calculate Saratoga’s used capacity in minutes.
2. Calculate Saratoga’s unused capacity in minutes.
3. Calculate Saratoga’s unused capacity in number of employees. (Round your answer to 2
decimal places.)
4. Calculate the impact on expenses of matching capacity with demand. (Be sure to round
down your potential adjustment in the number of employees to a whole number. Negative
amounts should be indicated by a minus sign.)
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 Saratoga Company - TDABC
Saratoga’s used capacity in minutes

Saratoga’s unused capacity in minutes

Available capacity: 16 workers × 52 weeks × 40 hours × 60 minutes × 85% practical capacity

Available capacity: 1,697,280 minutes
Saratoga’s unused capacity in number of employees

Practical capacity per employee: 1,697,280 minutes ÷ 16 employees = 106,080 minutes

Impact on expenses of matching capacity with demand

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 Practice exercises
- Which of the following would likely be a suitable cost driver for the amount of direct
materials used?
(A) The number of units sold.
(B) The number of direct labor hours worked.
(C) The number of machine hours worked.
(D) The number of units produced.
(E) The number of employees working in the factory.
KEY: D – Direct material used is a function of the number of units manufactured

- How would a 5% sales commission paid to sales personnel be classified in a manufacturing

company?
(A) Fixed, period cost.
(B) Fixed, product cost.
(C) Variable, period cost.
(D) Variable, product cost.
(E) Direct labor, product cost.
KEY: C – Sales commission varies with sales; it is periodically expensed as incurred
(matching)

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 Practice exercises
- Which statement is TRUE?
(A) Available technology to gather information on costs affects their direct/indirect
classification
(B) All direct costs are variable costs
(C) All variable costs are direct costs
(D) All fixed costs are indirect costs
(E) The level of budgeted profit for the next year affects the direct/indirect classification of a
cost
Key: (A) – not all direct costs are variable (e.g., advertising for a product line is a direct costs of that
cost object, but which is fixed in nature); not all variable costs are direct (e.g., indirect labor costs);
not all fixed costs are indirect (e.g., advertising or direct labor costs when firing is too costly);
budgeted profits have little if any relation with cost classifications; the ability of a firm to classify
costs based on their relation to a cost object is facilitated by the availability of information systems
- As production volume increases within the relevant range,
(A) Fixed costs resemble a step function.
(B) Variable costs remain constant on a per unit basis.
(C) Fixed costs vary in total.
(D) Fixed and variable costs remain the same in total.
(E) All of the above are correct.
Key: (B) – fixed costs only resemble a step function when the firm’s relevant range changes; fixed
costs are fixed in total but are declining in units of production; fixed and variable do not remain the
same in total: variable costs vary in total but are fixed on a per unit basis
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 Practice exercises
- DPL Manufacturing GmbH reported a cost of goods manufactured of €520,000 for 2016.
The firm's balance sheet for that year revealed work in process and finished goods of
€70,000 and €134,000, respectively. If supplemental information disclosed raw materials
used in production of €80,000, direct labor of €140,000, and manufacturing overhead of
€240,000, the company's closing work in process in 2015 must have been:
(A) €130,000. (B) €10,000. (C) €66,000. (D) €390,000. (E) Some other amount.

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 Practice exercises
- Urban Gear sells a single product at $14 per unit. The firm's most recent income statement
revealed unit sales of 80,000, variable costs of $800,000, and fixed costs of $560,000.
Management believes that a $3 drop in selling price will boost unit sales volume by 20%.
Which of the following correctly depicts how these two changes will affect the company's
break-even point?
Drop in sales price Increase in sales volume
(A) Increase Increase
(B) Increase Decrease
(C) Increase No effect
(D) Decrease Increase
(E) Decrease Decrease

Key: (C) – A drop is sales price will reduce the contribution margin available to cover fixed costs, the
consequence of which is an increase the level of sales needed to break even; change in the volume
of sales per se has no effect on break even levels, recall that:
Break-even point (volume and amount)
FC FC
QBE = =
P – VC CM
FC FC
QBE × P = RBE = =
P – VC CMR
P

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 Practice exercises
- Which of the following factors is not involved in building a typical Cost-Volume-Profit (CVP)
model?
(A) Desired profit. (D) Actual sales volume.
(B) Variable cost per unit. (E) All of the above are involved.
(C) Total fixed costs.
Key: (D) – Fixed costs, contribution margin (and its components: price and variable cost per unit),
and the desired profit (set to zero at BEP) are all factors involved in building CVP models; actual
sales volume is not a factor within CVP.

- Doha Gas Co. plans to sell 85,000 units of product no. 525 in February 2018, and each of
these units requires three units of raw material. Pertinent data follow:
Product No. 525 Raw Material
Actual Jan. 31 inventory 11,000 units 29,000 units
Desired Feb. 28 inventory 17,000 units 20,000 units
Based on the information presented, how many units of raw material should Doha Gas purchase
for use in February production?
(A) 228,000. (B) 246,000. (C) 264,000. (D) 282,000. (E) None of the answers is correct.
Desired inventory: 17,000 units Desired inventory: 29,000 units
Planned sales: 85,000 units Planned production use: 91,000 × 3= 273,000 units
Units to manufacture:? Units to purchase:?
85,000= 11,000 + Units to manufacture – 17,000 273,000= 29,000 + Units to purchase – 20,000
Units to manufacture= 91,000 units Units to purchase= 264,000 units (C)
Each unit requires 3 units of raw material 16
 Practice exercises
- Increasing production in the current period will increase net income in the current period if:
(A) the firm uses a non-US GAAP or non-IFRS method to determine net income.
(B) the firm uses variable costing and there are no fixed manufacturing costs.
(C) the firm uses US GAAP or IFRS and there no fixed manufacturing costs.
(D) the firm uses variable costing and there are fixed manufacturing costs.
(E) the firm uses US GAAP or IFRS and there are fixed manufacturing costs.
Key: (E) – the application of absorption costing (under US GAAP or IFRS) combined with the
presence of fixed overhead in the cost structure can trigger incentives for overproduction to boost
the bottom-line profit of the firm
- Nordica Corp. has computed the following unit costs for 2017 (figures are in Krone): Direct
material 25, Direct labor 19, Variable overhead 35, Fixed overhead 40, Variable SG&A 17, Fixed
SG&A 32. Which of the following correctly presents the per-unit cost of inventory under variable
and absorption costing systems?
Variable (Direct) Absorption (Full)
(A) kr79 kr119
(B) kr79 kr151
(C) kr96 kr119
(D) kr96 kr151
(E) None of the answers is correct.

Variable costing: 25 + 19 + 35 = 79 Krone

Absorption costing: 25 + 19 + 35 + 40 =119 Krone

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 Practice exercises
- The accounting records of Comacho Company revealed the following costs, among others:
Factory insurance $ 32,000
Raw material used 256,000
Customer entertainment 15,000
Indirect labor 45,000
Depreciation on salespersons’ cars 22,000
Production equipment rental costs 72,000
Costs that would be considered in the calculation of manufacturing overhead total:
(A) $149,000 (B) $171,000 (C) $186,000 (D) $442,000 (E) Some other number.
Overhead costs: Factory insurance + Indirect labor + Production equipment rental costs
Overhead costs: $32,000 + $45,000 + $72,000 = $149,000

- Which of the following statements is true?

(A) Product costs affect only the balance sheet.
(B) Product costs affect only the income statement.
(C) Period costs affect only the balance sheet.
(D) Neither product costs nor period costs affect the statement of retained earnings.
(E) Product costs eventually affect both the balance sheet and the income statement.

Key: (E) - Product costs are inventoriable costs and as result affect the balance sheet; once
products are sold, costs capitalized in inventory convert to COGS and affect the income statement
and the statement of retained earnings.

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 Practice exercises
- Costing systems can become inaccurate when
(A) The product mix becomes more diverse. (D) Only (A) and (C) are correct.
(B) Production technologies change. (E) (A), (B) and (C) are correct.
(C) Cost structure changes.
Key: (E) – Indeed, as product mix becomes more diverse, as production technology changes (greater
overhead costs), and as the balance between variable and fixed costs changes, the likelihood of
distortion in cost information increases
- Young BV sells security systems suited for large or small homes. The company uses an ABC
system. Last year the company incurred $1,000,000 in overhead costs:
Activity Allocation Base Overhead Cost
Purchasing Number of purchase orders $350,000
Material handling Number of shipments received $200,000
Quality inspection Number of inspections $450,000
The activities for large and small security systems were as follows:
Large Small
Purchase orders 15,000 20,000 Quality inspection:
Shipments received 7,500 12,500 Cost driver rate: $450,000/(11,500 + 11,000)
inspections 11,500 11,000
Cost driver rate: $20
If a customer requests a specially designed security Number of inspections needed: 4
system that would require four inspections, how much Cost of inspection for order: 4 × $20= $80
quality inspection overhead would you include in your
quote?
(A) $ 0 (B) $40 (C) $80 (D) $120 (E) $160.
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 Practice exercises
- Complete the following sentence:
The contribution margin income statement …
(A) reports the gross margin number
(B) is allowed for external reporting to shareholders and creditors
(C) categorizes costs as either direct or indirect
(D) can be used to predict future profits at different levels of activity
(E) all of the above
Key: (D) – the CM income statement is prepared under variable costing; unlike absorption costing, it
reports the contribution margin. This format is not allowed for external reporting. The method relies
on the classification of costs based on their economic behavior, not relation to cost objects. Given
that CM is a key input to CVP, CM income statements can be used for planning.
- A company has been asked to quote a job. The company aims to make a net profit of 30% on
sales. The estimated cost is as follows: Direct materials of 10 kg at £10 per kg, Direct labor of 20
hours at £5 per hour. Variable production overheads are allocated at the rate of £2 per labor
hour. Fixed production overheads for the company are budgeted to be £100,000 each year and
are allocated on the basis of labor hours. There are 10,000 budgeted labor hours each year.
Selling, distribution and administration costs are allocated at the rate of £50 per job. The
company’s quote for the job should be:
(A) £572 (B) £637 (C) £700 (D) £833 (E) £490
Overhead cost= £100,000/10,000h = £10 per labor hour
Costs: (10kg × £10) + (20h × £5) + (20h × £2) + (20h × £10)= £440
Net profit= 30% × sales; Sale - £440 - £50= 30% × sales; 70% × sales= £490; Sales= £700
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 Practice exercises
- BGC Inc. produces and sells books. The actual revenue and cost figures for 2015 are:
UNIT TOTAL
Direct material €20
Direct labor €40
Variable overhead €8
Variable marketing costs €6
Fixed overhead €24,000
Fixed marketing costs €12,000
Sales €140
Units produced 1,500
Units sold 1,000

If there is no beginning inventory and actual production equals budgeted production:

- Under absorption costing, net income is ….. than variable costing.
(A) €4,000 lower (B) €4,000 higher (C) €8,000 lower (D) €8,000 higher (E) None
- What is the cost of goods sold per unit under absorption costing?
(A) €96 (B) €74 (C) €84 (D) €68 (E) €64
Profit under the former will be higher/lower by: increase/decrease in inventory × FOH per unit
Change in inventory: 1,500 production – 1,000 sales = 500 units increase
FOH per unit: €24,000/1,500= €16
Difference in profit: 500 units × €16= €8,000 higher
COGS (absorption costing): €20 + €40 + €8 + €16= €84
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 Practice exercises
- Manchester Industries Ltd. charges manufacturing overhead to products by using a
predetermined application rate, computed based on labor hours. The following data pertain to
the current year:
Budgeted manufacturing overhead £1,800,000
Actual manufacturing overhead 1,810,000
Budgeted labor hours 60,000
Actual labor hours 61,500
Which of the following choices is the correct status of overhead at year-end?
(A) Overapplied by £10,000. (D) Underapplied by £35,000.
(B) Overapplied by £35,000. (E) Overapplied by £45,000.
(C) Underapplied by £10,000.
Predetermined overhead rate: £1,800,000/60,000h= £30 per labor hour
Allocated overhead: 61,500h × £30 per hour= £1,845,000
Overapplied overhead= £1,845,000 - £1,810,000= £35,000
- The costs of direct materials are classified as:
Conversion cost Manufacturing cost Prime cost
(A) Yes Yes Yes
(B) No No No
(C) No Yes Yes
(D) Yes No No
(E) No Yes No
Key: (C) – Recall: Prime cost= DM + DL and Conversion cost= DL + OH
Total manufacturing cost: DM + DL + OH = Prime cost + OH
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 Practice exercises
- Shenzhen Inc. manufactures three types of remote controls: Economy, Standard, and Deluxe.
To implement an activity-based costing (ABC) system, the company has identified five activities
(and related cost drivers). Each activity, its budgeted cost, and cost driver is presented below.
Activities Cost (¥) Cost driver
Material handling 283,000 Number of parts
Material insertion 2,750,000 Number of parts
Automated machinery 851,000 Machine hours
Finishing 207,000 Direct labor hours
Packaging 207,000 Orders shipped
Total 4,298,000
The following information pertains to the three product lines for next year:
Economy Standard Deluxe
Units to be produced 11,300 5,200 2,800
Orders to be shipped 1,320 430 235
Number of parts per unit 5 10 20
Machine hours per unit 1 2 5 Handling: 283,000/[(5×11,300) + (10×5,200) +
Labor hours per unit 3 3 3 (20×2,800)]= 1.72036
Under the ABC system, what is the per-unit Insertion: 2,750,000/[(5×11,300) + (10×5,200) +
(20×2,800)]= 16.71733
overhead cost of Economy? (Do not round your
Machinery: 851,000/[(1×11,300) + (2×5,200) +
intermediate calculations and round your final (5×2,800)]= 23.83753
answer to 2 decimal places.) Finishing: 207,000/[(3×11,300) + (3×5,200) +
(A) ¥202.93. (D) ¥115.93. (3×2,800)]= 3.57513
(B) ¥199.93. (E) None of the answers is correct. Packaging: 207,000/[1,320 + 430 + 235]=
(C) ¥138.93. 104.28211

Per unit of Economy: [(1.72036×5) + (16.71733×5) + (23.83753×1) + (3.57513×3) + (104.28211/8.56061)~=138.93

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 Practice exercises
- Work-in-process inventory is composed of:
(A) direct material and direct labor.
(B) direct labor and manufacturing overhead.
(C) direct material and manufacturing overhead.
(D) direct material, direct labor, and manufacturing overhead.
(E) direct material only.

Key: (D) – the cost of unfinished units comprises of direct material, direct labor,
and any overhead that has been allocated to these units.
- Harrison Industries began July with a finished-goods inventory of $48,000. The
finished-goods inventory at the end of July was $56,000 and the cost of goods
sold during the month was $125,000. The cost of goods manufactured during
July was:
(A) $104,000. (D) $133,000.
(B) $125,000. (E) None of the answers is correct.
(C) $117,000.

Recall: COGS= BFG + CGM – EFG

$125,000= $48,000 + CGM - $56,000
CGM= $133,000

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 Practice exercises
- The accounting records of Upton Company revealed the following information:
Cost of goods manufactured $754,000
Work-in-process inventory, 1/1 58,000
Finished-goods inventory, 1/1 125,000
Work-in-process inventory, 12/31 49,000
Finished-goods inventory, 12/31 158,000
Upton’s cost of goods sold is:
(A) $721,000. (D) $787,000.
(B) $730,000. (E) None of the answers is correct.
(C) $778,000.
Recall: COGS= BFG + CGM – EFG
COGS= $125000 + 754,000 - $158,000
COGS= $721,000
- Rainier Industries has Raw materials inventory on January 1, 20x8 of $32,500 and Raw materials
inventory on December 31, 20x8 of $26,700. If purchases of raw materials were $135,000 during the
year, what was the amount of raw materials used during the year?
(A) $129,200. (D) $146,600.
(B) $140,800. (E) None of the answers is correct.
(C) $135,000.
Recall: DM= BDM + PDM – EDM
DM= $32,500 + $135,000 – $26,700
DM= $140,800

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 Practice exercises
- What is the primary trade-off to consider when identifying cost drivers?
(A) Will the cost driver identification provide different costs for different purposes?
(B) Is the cost/benefit of the process reasonable for more accurate cost information?
(C) Will the cost relationships be too complex to understand?
(D) Will material-related drivers be more accurate than labor-related drivers?.
(E) There is no trade-off to consider when using cost drivers.

Key: (B) – For information generation to be justified, the benefits of using the information
should exceed the costs of generating and producing that information. In the context of
generating accurate cost information, the question is: accuracy at what cost?

- The relevant range for Max Industries is 10,000 to 16,000 units of product. The variable
costs per unit are $6 when a company produces 12,000 units of product. What are the
variable costs per unit when 14,000 units are produced?
(A) $4.50 (B) $5.00 (C) $5.50 (D) $6.00 (E) Some other number.

Key: (D) – Variable costs are not affected by the relevant range; it is fixed costs that are
constant within a certain relevant range and can increase or decrease once the firm
increases or decreases its capacity beyond or below the capacity within an existing relevant
range.

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 Practice exercises
- Activity-based costing systems:
(A) use a single, volume-based cost driver.
(B) assign overhead to products based on the products' relative usage of direct labor.
(C) often reveal products that were under- or over-costed by traditional costing systems.
(D) typically use fewer cost drivers than more traditional costing systems.
(E) have a tendency to distort product costs.
Key: (C): refined overhead allocation under ABC often leads to the revelation that certain products
or services were over- or under-costed under traditional costing systems.

- The extent to which an organization uses fixed costs in its cost structure is measured by:
(A) financial leverage (B) operating leverage (C) fixed cost leverage
(D) contribution leverage (E) efficiency leverage.
Key: (B) – the balance between fixed and variable costs is measured by the operating leverage

- When 5,000 units are produced variable costs are $35 per unit and total costs are $200,000.
What are the total costs when 8,000 units are produced?
(A) $200,000. (D) None of the answers is correct.
(B) $305,000. (E) Total costs cannot be calculated based on the information presented.
(C) $240,000.
Estimating fixed costs: Total costs = [Variable cost per unit × Units] + Fixed costs
$200,000 = [$35 × 5,000 units] + Fixed costs
Fixed costs = $25,000
With 8,000 units: Total costs = [$35 × 8,000 units] + $25,000 = $305,000
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 Practice exercises
- Magnolia Industries combines all manufacturing overhead into a single cost pool and
allocates this overhead to products by using machine hours. Activity-based costing would likely
show that with Magnolia’s current procedures that:
(A) all the company's products are undercosted.
(B) the company's high-volume products are undercosted.
(C) all the company's products are overcosted.
(D) the company's high-volume products are overcosted.
(E) the company's low-volume products are overcosted.
Key: (D) – Volume-based systems mechanically allocate more overhead to high-volume products
- Which of the following best explains the main advantages of time-driven-activity-based costing for
services over the use of conventional ABC?
(A) The number of services can more easily be expanded than under conventional ABC, since costs
are assigned to unused capacity.
(B) Theoretical capacity, used in this type of costing, allows service companies a better method to
assess quality control than does conventional ABC.
(C) Time-based resource and activity data is easy to collect and practical capacity is used by time-
driven-activity-based costing.
(D) The number of line items on a service’s bill is minimized and practical capacity is used by time-
driven-activity-based costing.
(E) This type of costing allows service companies better information since their objectives when
using ABC are different than those of manufacturing firms.
Key: (C) – A key feature of TDABC is that it relies of managerial estimates of practical capacity rather than
costly surveys and interviews that are common in traditional ABC
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 Practice exercises
Use the following information to answer the next four questions.
Rock Corp. sells a single product for $50. Variable costs are 60% of the selling price, and the
company has fixed costs that amount to $400,000. Current sales total 16,000 units.
- The company:
(A) will break-even by selling 8,000 units.
(B) will break-even by selling 13,333 units.
(C) will break-even by selling 20,000 units.
(D) will break-even by selling 1,000,000 units.
(E) cannot break-even because it loses money on every unit sold.

Contribution margin: Price – Variable cost = $50 – ($50 × 60%)= $20

BEP = [Fixed costs]/CM = $400,000/$20 = 20,000 units

- Each unit that the company sells will:

(A) increase profit by $20.
(B) increase profit by $30.
(C) increase profit by $50.
(D) increase profit by some other amount.
(E) decrease profit by $5.

Each unit of additional sales will increase profit by the amount of the contribution margin: $20

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 Practice exercises
- In order to produce a target profit of $22,000, the company’s dollar sales must total:

(A) $8,440.
(B) $21,100.
(C) $1,000,000.
(D) $1,055,000.
(E) None of the answers is correct.

Recall: Sales= [Target profit + Fixed costs]/Contribution margin ratio

Sales= [$22,000 + $400,000]/40% = $1,055,000

- If the company sells 24,000 units, its safety margin will be:

(A) $200,000. (D) $1,200,000.

(B) $400,000. (E) None of the answers is correct.
(C) $1,000,000.

Recall: Margin of safety= Budgeted (Actual) Sales – Sales at break-even point

Margin of safety= 24,000 – 20,000 = 4,000 units
Margin of safety= 4,000 units × $50 = $200,000

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 Practice exercises
- Which of the following occurs if a company was able to reduce its variable cost per unit?

Contribution Margin Break-even Point

(A) Increase Increase
(B) Increase Decrease
(C) Decrease Increase
(D) Decrease Decrease
(E) Increase No effect
Key: (B) – When variable cost per unit declines, the contribution margin increases and the
break-even point decreases

- Santa Fe Production sells a single product to wholesalers. The company's budget for the upcoming
year revealed anticipated unit sales of 31,600, a selling price of $20, variable cost per unit of $8, and
total fixed costs of $360,000. Santa Fe’s safety margin in units is:
(A) (13,400) (B) 0 (C) 1,600 (D) 13,600 (E) None of the answers is correct.

Recall: Margin of safety= Budgeted (Actual) sales – Sales at break-even point

BEP = Fixed cost/CM = $360,000/[$20-$8]= 30,000 units
Margin of safety= 31,600 units – 30,000 units = 1,600 units

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 Practice exercises
- Morgan Technologies sells a single product at $20 per unit. The firm's most recent income
statement revealed unit sales of 100,000, variable costs of $800,000, and fixed costs of
$400,000. If a $4 drop in selling price will boost unit sales volume by 20%, the company will
experience:
(A) no change in profit because a 20% drop in sales price is balanced by a 20% increase in
volume.
(B) an $80,000 drop in profit.
(C) a $240,000 drop in profit.
(D) a $400,000 drop in profit.
(E) None of the answers is correct.

Profit (A) = ($20 × 100,000) – $800,000 – $400,000= $800,000

Profit (B) = ($16 × 120,000) – $960,000 – $400,000= $560,000
Change in profit= $560,000 – $800,000 = (240,000)

- All other things being equal, a company that sells multiple products should attempt to
structure its sales mix so the greatest portion of the mix is composed of those products with
the highest:
(A) selling price. (D) fixed cost.
(B) variable cost. (E) gross margin.
(C) contribution margin.

Key: (C) – Maximizing profitability is achieved by increasing the share of high contribution
margin products in the sales mix.
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