Managerial Accounting

Cases Solutions

Prepared by:

Shanaz Taha Ahmed

Case (2)

The cost accountant for M. Company wants to determine the cost of factory overhead.
Based on observation and discussions with plant workers, you feel that five accounts are
most relevant. Two are fixed- supervisory salaries and depreciation- and the remaining three
are variable.
Indirect labor is primarily used to move materials and varies with number of moves. The
largest component of utilities is electricity to run production machinery; which is driven by
machine hours. Purchasing seems to be driven by the number of purchase order. The
accounts and their balances for the past six months are shown below:
Case (2)

Indirect Plant and

Labor Supervisory Equipment
Cost Utilities Purchasing Salaries Depreciation
July $14,250 $12,000 $38,200 $20,000 $6,500
Aug. 15,800 10,600 35,400 23,000 6,500
Sept. 16,800 12,500 37,600 32,000 6,500
Oct. 20,700 12,500 40,200 27,800 6,500
Nov. 20,000 12,500 39,900 25,400 6,500
Dec. 17,000 12,500 39,700 17,000 6,500
Total 104,550 72,600 231,000 145,200 39,000

Information on machine hours, number of moves, and number of purchase orders for the six-month period follows:
Case (1)

Number of Machine Hours Purchase Orders

Moves (Mhr) (PO)
July 340 5400 250
Aug. 380 5200 300
Sept. 400 5800 450
Oct. 500 6200 380
Nov. 480 6000 340
Dec. 420 5600 200
Total 2520 34200 1920
Questions

Required 1: Why you decided that supervisory salaries and depreciation on

the plant were fixed?

Answer:
Costs are fixed when total costs remain unchanged despite significant
changes in the level of total activity or volume. We decided that supervisory
salaries and depreciation on the plant are fixed cost because both did not
affect by the cost drivers which are number of moves, machine hours and
purchase orders
Required 2: What are the average account balances for each of the
five accounts, and the average monthly amount of each of the three
drivers?

Answer: part 1 (the Accounts)

(Average account = Total cost / Number of months)
Average indirect labor cost = $104,550 / 6 = $17,425
Average utilities= $72,600 / 6 = $12,100
Average purchasing = $231,000 / 6 = $38,500
Average supervisory salaries = $145,200 / 6 = $24,200
Average plant and equipment depreciation = $39,000 / 6 = 6,500
Answer: part 2 (average monthly amount
of each driver)

Average number of moves = 2,520 / 6 = 420

Average machine hours (Mhr) = 34,200 / 6 = 5,700
Average purchase order (PO) = 1920 / 6 =32
 Required 3: Determine the total overhead for the
month and the variable rates for indirect labor,
utilities, and purchasing.
Answer:
Fixed cost = Supervisor salaries + Plant and equipment depreciation
= $24,200+ $6500
= $30,700
Variable Rate for indirect labor = Average indirect labor/ Average Number of Move
= $17,425/ 420
= $41.49 per move
Variable Rate for utilities = Average Utilities / Average Machine Hours
= $12,100/ 5,700
=$2.12 per Mhr

Variable Rate for purchasing = Average Purchasing/ Average Purchase order

= $38,500/ 320
= $120.31 per PO
Total Overhead cost

Total Overhead cost= Fixed Cost + (Variable cost for indirect labor + Variable cost for
utilities + Variable cost for purchasing)

Total Overhead Cost for Month = $ 30,700 + ($ 41.49 + $2.12 + $120.31)

= $30,863.8
Required 4: In January 490 moves, 4375
machine hours, and 220 purchase orders are
expected.
Total Overhead Cost for January = Total Fixed Overhead Cost + (Variable rate
for Indirect labor per Move * Average move per month) + (Variable rate for
utilities per Mhr *Average Mhr per Month) + (Variable rate for Purchasing per
PO * Average POs Per Month)

Total Overhead Cost for Month = $30,700 + ($41.49 × 490) + ($ 2.12 ×

4,375) + ($120.31 × 220)
= $ 86,773
Required 5: If the purchase orders predicted for
January were 300. How would that affect the
predicted overhead cost?
Total Overhead Cost in January = Total Fixed Overhead Cost + (Variable rate
for Indirect labor per Move * Average move per month) + (Variable rate for
utilities per Mhr *Average Mhr per Month) + (Variable rate for Purchasing per
PO * Average POs Per Month)

Total Over Head Cost in January = $30,700 + ($41.49 × 490) + ($2.12 × 4,375)
+ ($120.31 × 300)
Total Over Head Cost in January = 30,700+ 20,330+ 9,275+ 36,093
Total Over Head Cost in January = $ 96,398
Case (2)
Gateway Construction Company is a family-operated business that was founded in 1950 by Albert Gat. In the
beginning, the company consisted of Albert and three employees laying gas, water, and sewage pipelines as
subcontractors. Currently, the company employs 25 to 30 people. Jack Gat is directing it. The main line of business
continues to be laying pipeline.
Most of Gateway’s work comes from contracts which city and state agencies. All company’s work is located in
Gateways. The company’s sales volume averages $3 million, and profits vary between 0 and 10 percent of sales.
Sales and profits have been somewhat below average for the past three years due to a recession and intense
competition. Because of this competition, Jack Gat is constantly reviewing the prices that other companies bid for
jobs; when a bid is lost, he makes every attempt to analyze the reasons for the differences between his bid and that
of his competitors. He uses information to increase the competitiveness of future bids.
Jack has become convinced that Gateway’s current accounting system is deficient. Currently, all expenses are
simply deducted from revenues to arrive at net income. No effort is made to distinguish among the cost of laying
pipe, obtaining contracts, and administrating the company. Yet, all bids are based on the cost of laying pipe.
With these thoughts in mind, Jack began a careful review of the income statement for the previous year (see
below). First, he noted that jobs were priced on the basis of equipment hours, with an average price of $165 per
equipment hour. However, when it came to classifying and assigning costs, he decided that he needed some help.
One thing that really puzzled him was how to classify his annual own salary of $114,000. About half of his time
was spent in bidding and securing contracts, and the other half was spent in general administrative matters.
 Gateway Construction
Income Statement
For the year ended December 31, 2007
Sales $3,003,000
Less expenses:
Utilities $24,000
Machin operators 218,000
Rent, office building 24,000
CPA fees 20,000
Other direct labor 265,700
Administrative salaries 114,000
Supervisory salaries 70,000
Pipe 1,401,340
Tires and fuel 418,600
Depreciation, equipment 198,000
Salaries of mechanics 50,000
Advertising 15,000
Total expenses 2,818,640
Income before income tax $ 184,360
Questions

■ Required 1: Classify the costs in the income statement as (1) costs

of laying pipe (production costs), (2) costs of securing contracts
(selling costs), or (3) costs of general administration. For production
costs, identify the prime cost, total manufacturing costs incurred,
Cost of goods manufactured, and Cost of goods sold. The company
never has significant work in process (most jobs are started and
completed within a day).
Answer:
Gateway Construction
Income Statement
For the year ended December 31, 2007
Sales Revenue $3,003,000
Less: Cost of goods sold
Direct Material:
Pipe 1,401,340
Direct Labor:
Machin operators 218,000
Other direct labor 265,700
Manufacturing overhead:
Supervisory salaries 70,000
Tires and fuel 418,600
Depreciation, equipment 198,000
Salaries of mechanics 50,000 2,621,640
Less: Operating expenses
Selling and Administrative expenses:
Advertising 15,000
Utilities $24,000
Rent, office building 24,000
CPA fees 20,000
Administrative salaries 114,000 197,000
Income before income tax $184,360
■ Production Cost:
Pipe (DM) 1,401,340
Machin operators (DL) 218,000
Other direct labor (DL) 265,700
Supervisory salaries (MO) 70,000
Tires and fuel (MO) 418,600
Depreciation, equipment (MO) 198,000
Salaries of mechanics (MO) 50,000
Production Cost: $ 2,621,640

Annual salary of Jack= 114,000 (half is for securing contract and half for general administration

matters)
■ Selling Cost:
Securing contract 57,000
Advertising 15,000
Selling cost $ 72,000
■ Administrative Cost:
Utilities 24,000
Rent, office building 24,000
CPA fees 20,000
General administrative 57,000
Administrative Cost $ 125,000

■ For production costs, identify the prime cost, total manufacturing costs incurred, Cost of
goods manufactured, and Cost of goods sold. The company never has significant work
in process (most jobs are started and completed within a day).

Prime Cost = Direct Material+ Direct Labor + Direct Expenses

Prime Cost= 1,401,340 + (218,000+ 265,700) + 0
Prime Cost= $ 1,885,040
■ Total Manufacturing Cost Incurred= Direct Material+ Direct Labor +
Manufacturing Overhead
Total Manufacturing Cost Incurred= 1,401,340 + (218,000+ 265,700) + (70,000+
418,600+198,000+ 50,000)
Total Manufacturing Cost Incurred= $ 2,621,640

Cost of goods manufactured = 0

Cost of goods sold = 0
Because the company has no work in process (Most of the work started and finished
in one day)
■ Required 2: Using the functional classification developed in requirement 1, calculate the
average cost per equipment hour for laying pipe.
■ Answer:
With average price $ 165 per equipment hours, we can find cost per equipment hours by:
■ Total sale revenue = The total equipment sold x price per equipment hours
3,003,000 = The total equipment sold x $165
The total equipment sold = 3,003,000/ 165
The total equipment sold = 18,200
Total Cost = Prime cost + Manufacturing overhead cost – Non-Manufacturing cost
Total Cost = 1,885,040+ 736,000 - 197,000
Total cost = $ 2,424,040
■ Average cost per equipment = Total cost / Total equipment sold per hours
Average cost per equipment= 2,424,040/ 18,200
Average Cost per equipment= $ 133.1
■ Required 3: Assume that a significant driver is equipment hours. Identify the cost that
would likely be traced to jobs using this driver. Explain why you feel these costs are
traceable using equipment hours. What is the cost per equipment hour for these traceable
costs?
■ Answer:
■ Traceable costs using equipment hours:
Machine operators $218,000
Other direct labor 265,700
Pipe 1,401,340
Tires and fuel 418,600
Depreciation, equipment 198,000
Salaries of mechanics 50,000
Total $2,551,640
■ Traceable cost per equipment hour = Total Traceable cost/ Total of equipment sold per
hours
Traceable cost per equipment hour = 2,551,640 / 18,200
Traceable cost per equipment hour = $140.2
Thank You! 