Chapter 2

Cost Terms, Concepts, and Classifications

Solutions to Questions

2-1 The three major elements of product company sells finished goods that it has
costs in a manufacturing company are direct purchased from a supplier. These goods are
materials, direct labor, and manufacturing listed as “Purchases” in the cost of goods sold
overhead. section. Since the manufacturing company
produces its goods rather than buying them
2-2 from a supplier, it lists “Cost of Goods
a. Direct materials are an integral part of a Manufactured” in place of “Purchases.” Also, the
finished product and can be conveniently traced manufacturing company identifies its inventory
to it. in this section as “Finished Goods Inventory,”
b. Indirect materials are generally small rather than as “Merchandise Inventory.”
items of material such as glue and nails. They
may be an integral part of a finished product but 2-5 The schedule of cost of goods
can be traced to the product only at great cost manufactured lists the manufacturing costs that
or inconvenience. Indirect materials are have been incurred during the period. These
ordinarily classified as manufacturing overhead. costs are organized under the three major
c. Direct labor includes those labor costs categories of direct materials, direct labor, and
that can be easily traced to particular products. manufacturing overhead. The total costs
Direct labor is also called “touch labor.” incurred are adjusted for any change in the
d. Indirect labor includes the labor costs of Work in Process inventory to determine the cost
janitors, supervisors, materials handlers, and of goods manufactured (i.e. finished) during the
other factory workers that cannot be period.
conveniently traced to particular products. The schedule of cost of goods
These labor costs are incurred to support manufactured ties into the income statement
production, but the workers involved do not through the Cost of Goods Sold section. The
directly work on the product. cost of goods manufactured is added to the
e. Manufacturing overhead includes all beginning Finished Goods inventory to
manufacturing costs except direct materials and determine the goods available for sale. In
direct labor. effect, the cost of goods manufactured takes the
place of the “Purchases” account in a
2-3 A product cost is any cost involved in merchandising firm.
purchasing or manufacturing goods. In the case
of manufactured goods, these costs consist of 2-6 A manufacturing company has three
direct materials, direct labor, and manufacturing inventory accounts: Raw Materials, Work in
overhead. A period cost is a cost that is taken Process, and Finished Goods. A merchandising
directly to the income statement as an expense company generally identifies its inventory
in the period in which it is incurred. account simply as Merchandise Inventory.

2-4 The income statement of a 2-7 Since product costs follow units of
manufacturing company differs from the income product into inventory, they are sometimes
statement of a merchandising company in the called inventoriable costs. The flow is from
cost of goods sold section. The merchandising direct materials, direct labor, and manufacturing

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Solutions Manual, Chapter 2 15
overhead to Work in Process. As goods are in the fixed costs of purchasing the two
completed, their cost is removed from Work in machines would be a differential cost.
Process and transferred to Finished Goods. As
goods are sold, their cost is removed from 2-15
Finished Goods and transferred to Cost of Goods Direct labor cost $510
Sold. Cost of Goods Sold is an expense on the (34 hours  $15 per hour) ............................
income statement. Manufacturing overhead cost
(6 hours  $15 per hour) ..............................
90
2-8 Yes, costs such as salaries and Total wages earned..........................................
$600
depreciation can end up as assets on the
balance sheet if these are manufacturing costs.
2-16
Manufacturing costs are inventoried until the
Direct labor cost $630
associated finished goods are sold. Thus, such
(45 hours  $14 per hour) ............................
costs may be part of either Work in Process
Manufacturing overhead cost
inventory or Finished Goods inventory at the
(5 hours  $7 per hour) ................................
35
end of a period if there are unsold units.
Total wages earned..........................................
$665
2-9 Cost behavior refers to how a cost will
react or respond to changes in the level of 2-17 Costs associated with the quality of
business activity. conformance can be broken down into
prevention costs, appraisal costs, internal failure
2-10 No. A variable cost is a cost that varies, costs, and external failure costs. Prevention
in total, in direct proportion to changes in the costs are incurred in an effort to keep defects
level of activity. A variable cost is constant per from occurring. Appraisal costs are incurred to
unit of product. A fixed cost is fixed in total, but detect defects before they can create further
will vary inversely on an average per-unit basis problems. Internal and external failure costs are
with changes in the level of activity. incurred as a result of producing defective units.

2-11 When fixed costs are involved, the 2-18 Total quality costs are usually minimized
average cost of a unit of product will depend on by increasing prevention and appraisal costs in
the number of units being manufactured. As order to reduce internal and external failure
production increases, the average cost per unit costs. Total quality costs usually decrease as
will fall as the fixed cost is spread over more prevention and appraisal costs increase.
units. Conversely, as production declines, the
average cost per unit will rise as the fixed cost 2-19 Shifting the focus to prevention and
is spread over fewer units. away from appraisal is usually the most
effective way to reduce total quality costs. It is
2-12 Manufacturing overhead is an indirect usually more effective to prevent defects than to
cost since these costs cannot be easily and attempt to fix them after they have already
conveniently traced to particular products. occurred.

2-13 A differential cost is a cost that differs 2-20 First, a quality cost report helps
between alternatives in a decision. An managers see the financial consequences of
opportunity cost is the potential benefit that is defects. Second, the report may help managers
given up when one alternative is selected over identify the most important areas for
another. A sunk cost is a cost that has already improvement. Third, the report helps managers
been incurred and cannot be altered by any see whether their quality costs are appropriately
decision taken now or in the future. distributed among prevention, appraisal,
internal failure, and external failure costs.
2-14 No; differential costs can be either
variable or fixed. For example, the alternatives 2-21 Most accounting systems do not track
might consist of purchasing one machine rather and accumulate the costs of quality. It is
than another to make a product. The difference particularly difficult to get a feel for the

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16 Managerial Accounting, 10th Edition
magnitude of quality costs since they are
incurred in many departments throughout the
organization.

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Solutions Manual, Chapter 2 17
Exercise 2-1 (15 minutes)
1. Product; variable
2. Opportunity
3. Prime
4. Period
5. Product; period; fixed
6. Product
7. Conversion
8. Period; variable
9. Sunk
10. Fixed; product; conversion

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18 Managerial Accounting, 10th Edition
Exercise 2-2 (15 minutes)

Product
(Inventoriable) Period
Cost Cost
1. The cost of the memory chips used in a
radar set......................................................................
X
2. Factory heating costs......................................................
X
3. Factory equipment maintenance costs.............................. X
4. Training costs for new administrative
employees................................................................... X
5. The cost of the solder that is used in
assembling the radar sets............................................. X
6. The travel costs of the company’s
salespersons................................................................ X
7. Wages and salaries of factory security
personnel....................................................................
X
8. The cost of air-conditioning
executive offices.......................................................... X
9. Wages and salaries in the department that
handles billing customers.............................................. X
10. Depreciation on the equipment in the fitness
room used by factory workers....................................... X
11. Telephone expenses incurred by factory
management................................................................
X
12. The costs of shipping completed radar sets
to customers................................................................ X
13. The wages of the workers who assemble the
radar sets....................................................................
X
14. The president’s salary..................................................... X
15. Health insurance premiums for factory
personnel....................................................................
X

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Solutions Manual, Chapter 2 19
Exercise 2-3 (15 minutes)

Cost Behavior
Cost Variable Fixed
1. Small glass plates used for lab tests in a
hospital.......................................................................
X
2. Straight-line depreciation of a building..............................X
3. Top management salaries................................................X
4. Electrical costs of running machines.................................
X
5. Advertising of products and services*...............................X
6. Batteries used in manufacturing trucks............................. X
7. Commissions to salespersons...........................................
X
8. Insurance on a dentist’s office.........................................X
9. Leather used in manufacturing footballs........................... X
10. Rent on a medical center.................................................X

* This particular item may cause some debate. Hopefully, advertising

results in more demand for products and services by customers. So
advertising costs are correlated with the amount of products and services
provided. However, note the direction of causality. Advertising causes an
increase in the amount of goods and services provided, but an increase
in the amount of goods and services demanded by customers does not
necessarily result in a proportional increase in advertising costs. Hence,
advertising costs are fixed in the classical sense that the total amount
spent on advertising is not proportional to what the unit sales turn out to
be.

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20 Managerial Accounting, 10th Edition
Exercise 2-4 (15 minutes)
Selling and
Cost Behavior Administrative Product
Cost Item Variable Fixed Cost Cost
1. The costs of turn signal
switches used at the
General Motors Saginaw,
Michigan, plant X X
2. Interest expense on CBS’s
long-term debt X X
3. Salesperson’s commissions at
Avon Products X X
4. Insurance on one of
Cincinnati Milacron’s factory
buildings X X
5. The costs of shipping brass
fittings to customers in
California X X
6. Depreciation on the
bookshelves at Reston
Bookstore X X
7. The costs of X-ray film at the
Mayo Clinic’s radiology lab
X X
8. The cost of leasing an 800
telephone number at L.L.
Bean X X
9. The depreciation on the
playground equipment at a
McDonald’s outlet X X
10. The cost of the mozzarella
cheese used at a Pizza Hut
outlet X X

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Solutions Manual, Chapter 2 21
Exercise 2-5 (15 minutes)
1. Internal External
Prevention Appraisal Failure Failure
Costs Costs Costs Costs
a. Repairs of goods still
under warranty X
b. Customer returns due to
defects X
c. Statistical process control X
d. Disposal of spoiled goods X
e. Maintaining testing
equipment X
Inspecting finished goods X
g. Downtime caused by
quality problems X
h. Debugging errors in
software X
Recalls of defective
products X
Training quality
engineers X
k. Re-entering data due to
typing errors X
Inspecting materials
received from suppliers X
m. Audits of the quality
system X
n. Supervision of testing
personnel X
o. Rework labor X

2. Prevention costs and appraisal costs are incurred to keep poor quality of
conformance from occurring. Internal and external failure costs are
incurred because poor quality of conformance has occurred.

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22 Managerial Accounting, 10th Edition
Exercise 2-6 (30 minutes)
1. a. Emblems purchased........................................................ 35,000
Emblems drawn from inventory....................................... 31,000
Emblems remaining in inventory...................................... 4,000
Cost per emblem............................................................     × $2
Cost in Raw Materials Inventory at May 31....................... $ 8,000

b. Emblems used in production (31,000 – 1,000) ................. 30,000

Units completed and transferred to Finished Goods
(90% × 30,000) .......................................................... 27,000
Units still in Work in Process at May 31............................. 3,000
Cost per emblem............................................................     × $2
Cost in Work in Process Inventory at May 31.................... $ 6,000

c. Units completed and transferred to Finished Goods

(above)....................................................................... 27,000
Units sold during the month (75% × 27,000) ...................  20,250
Units still in Finished Goods at May 31.............................. 6,750
Cost per emblem ...........................................................     × $2
Cost in Finished Goods Inventory at May 31...................... $13,500

d. Units sold during the month (above) ............................... 20,250

Cost per emblem............................................................     × $2
Cost in Cost of Goods Sold at May 31............................... $40,500

e. Emblems used in advertising........................................... 1,000

Cost per emblem............................................................     × $2
Cost in Advertising Expense at May 31............................. $ 2,000

2. Raw Materials Inventory—balance sheet

Work in Process Inventory—balance sheet
Finished Goods Inventory—balance sheet
Cost of Goods Sold—income statement
Advertising Expense—income statement

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Solutions Manual, Chapter 2 23
Exercise 2-7 (30 minutes)
1.
ECCLES COMPANY
Schedule of Cost of Goods Manufactured
Direct materials:
Raw materials inventory, beginning............................... $   8,000
Add: Purchases of raw materials....................................
 132,000
Raw materials available for use.....................................
140,000
Deduct: Raw materials inventory, ending.......................    10,000
Raw materials used in production.................................. $130,000
Direct labor.................................................................... 90,000
Manufacturing overhead:
Rent, factory building...................................................
80,000
Indirect labor...............................................................
56,300
Utilities, factory............................................................
9,000
Maintenance, factory equipment.................................... 24,000
Supplies, factory...........................................................
700
Depreciation, factory equipment....................................
   40,000
Total overhead costs..................................................  210,000
Total manufacturing costs................................................ 430,000
Add: Work in process, beginning......................................      5,000
435,000
Deduct: Work in process, ending......................................    20,000
Cost of goods manufactured............................................ $415,000

2. The cost of goods sold section would be:

Finished goods inventory, beginning................................. $ 70,000
Add: Cost of goods manufactured....................................  415,000
Goods available for sale................................................... 485,000
Deduct: Finished goods inventory, ending.........................    25,000
Cost of goods sold.......................................................... $460,000

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24 Managerial Accounting, 10th Edition
Exercise 2-8 (15 minutes)
1. No. It appears that the overtime spent completing the job was simply a
matter of how the job happened to be scheduled. Under these
circumstances, an overtime premium probably should not be charged to
a customer whose job happens to fall at the tail end of the day’s
schedule.

2. Direct labor cost: 9 hours × $20 per hour......................... $180

General overhead cost: 1 hour × $10 per hour.................    10
Total labor cost............................................................
$190

3. A charge for an overtime premium might be justified if the customer

requested that the work be done on a “rush” basis.

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Solutions Manual, Chapter 2 25
Exercise 2-9 (15 minutes)

1. Quality
2. Quality of conformance
3. Prevention costs, appraisal costs
4. Internal failure costs, external failure costs
5. External failure costs
6. Appraisal costs
7. Prevention costs
8. Internal failure costs
9. External failure costs
10. Prevention costs, appraisal costs
11. Quality circles
12. Quality cost report

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26 Managerial Accounting, 10th Edition
Exercise 2-10 (15 minutes)
1. Direct labor cost: 34 hours × $12 per hour....................... $408
Manufacturing overhead cost: 6 hours × $12 per hour......    72
Total cost....................................................................... $480

2. Direct labor cost: 50 hours × $12 per hour....................... $600

Manufacturing overhead cost: 10 hours × $6 per hour......    60
Total cost....................................................................... $660

3. The company could treat the cost of fringe benefits relating to direct
labor workers as part of manufacturing overhead. This approach spreads
the cost of such fringe benefits over all units of output. Alternatively, the
company could treat the cost of fringe benefits relating to direct labor
workers as additional direct labor cost. This latter approach charges the
costs of fringe benefits to specific jobs rather than to all units of output.

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Solutions Manual, Chapter 2 27
Problem 2-11 (30 minutes)

Product Cost Period

Variable Fixed Direct Direct Mfg. (Selling and Opportunity Sunk
Name of the Cost Cost Cost Materials Labor Overhead Admin.) Cost Cost Cost
Rental revenue forgone, $40,000
per year X
Direct materials cost, $40 per unit X X
Supervisor’s salary, $2,500 per
month X X
Direct labor cost, $18 per unit X X
Rental cost of warehouse, $1,000
per month X X
Rental cost of equipment, $3,000
per month X X
Depreciation of the building,
$10,000 per year X X X
Advertising cost, $50,000 per year
X X
Shipping cost, $10 per unit X X
Electrical costs, $2 per unit X X
Return earned on investments,
$6,000 per year X

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28 Managerial Accounting, 10th Edition
Problem 2-12 (20 minutes)

To Units of
Cost Behavior Product
Cost Item Variable Fixed Direct Indirect
1. Plastic washers used in auto production*..........................
X X
2. Production superintendent’s salary................................... X X
3. Laborers assembling a product........................................
X X
4. Electricity for operation of machines.................................
X X
5. Janitorial salaries............................................................
X X
6. Clay used in brick production...........................................
X X
7. Rent on a factory building................................................ X X
8. Wood used in ski production............................................
X X
9. Screws used in furniture production*................................
X X
10. A supervisor’s salary........................................................X X
11. Cloth used in suit production............................................
X X
12. Depreciation of cafeteria equipment................................. X X
13. Glue used in textbook production*...................................
X X
14. Lubricants for machines...................................................
X X
15. Paper used in textbook production...................................
X X

* These materials would usually be considered indirect materials because their costs are relatively
insignificant. It would not be worth the effort to trace their costs to individual units of product and
therefore they would usually be classified as indirect materials.

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Solutions Manual, Chapter 2 29
Problem 2-13 (30 minutes)
1. Total wages for the week:
Regular time: 40 hours × $24 per hour.......................... $   960
Overtime: 5 hours × $36 per hour.................................     180
Total wages.................................................................... $1,140
Allocation of total wages:
Direct labor: 45 hours × $24 per hour........................... $1,080
Manufacturing overhead: 5 hours × $12 per hour...........       60
Total wages.................................................................... $1,140

2. Total wages for the week:

Regular time: 40 hours × $24 per hour.......................... $   960
Overtime: 10 hours × $36 per hour...............................     360
Total wages.................................................................... $1,320
Allocation of total wages:
Direct labor: 46 hours × $24 per hour........................... $1,104
Manufacturing overhead:
Idle time: 4 hours × $24 per hour.............................. $ 96
Overtime premium: 10 hours × $12 per hour..............  120     216
Total wages.................................................................... $1,320

3. Total wages and fringe benefits for the week:

Regular time: 40 hours × $24 per hour.......................... $   960
Overtime: 8 hours × $36 per hour................................. 288
Fringe benefits: 48 hours × $8 per hour........................     384
Total wages and fringe benefits....................................... $1,632
Allocation of wages and fringe benefits:
Direct labor: 45 hours × $24 per hour........................... $1,080
Manufacturing overhead:
Idle time: 3 hours × $24 per hour..............................
$ 72
Overtime premium: 8 hours × $12 per hour................ 96
Fringe benefits: 48 hours × $8 per hour...................... 384     552
Total wages and fringe benefits....................................... $1,632

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30 Managerial Accounting, 10th Edition
Problem 2-13 (continued)
4. Allocation of wages and fringe benefits:
Direct labor:
Wage cost: 45 hours × $24 per hour..........................
$1,080
Fringe benefits: 45 hours × $8 per hour......................
    360 $1,440
Manufacturing overhead:
Idle time: 3 hours × $24 per hour..............................72
Overtime premium: 8 hours × $12 per hour................96
Fringe benefits: 3 hours × $8 per hour........................    24     192
Total wages and fringe benefits..................................... $1,632

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Solutions Manual, Chapter 2 31
Problem 2-14 (60 minutes)
1.
Yedder Enterprises
Quality Cost Report (in thousands of dollars)
This Year Last Year
Amount Percent Amount Percent
Prevention costs:
Systems development $    680 0.68 % $    120 0.13 %
Statistical process control 270 0.27 % —    0.00 %
Quality engineering    1,650  1.65 %    1,080  1.14 %
Total    2,600  2.60 %    1,200  1.27 %
Appraisal costs:
Inspection 2,770 2.77 % 1,700 1.79 %
Supplies used in testing 40 0.04 % 30 0.03 %
Cost of testing equipment       390  0.39 %       270  0.28 %
Total    3,200  3.20 %    2,000  2.10 %
Internal failure costs:
Net cost of scrap 1,300 1.30 % 800 0.84 %
Rework labor 1,600 1.60 % 1,400 1.47 %
Downtime due to quality
problems    1,100  1.10 %       600  0.63 %
Total    4,000  4.00 %    2,800  2.94 %
External failure costs:
Product recalls 600 0.60 % 3,500 3.68 %
Warranty repairs 2,800 2.80 % 3,300 3.47 %
Customer returns of defective
goods       200  0.20 %    3,200  3.37 %
Total    3,600  3.60 %  10,000 10.52 %
Total quality cost $13,400 13.40 % $16,000 16.84 %
* As a percentage of total sales in each year.
Note: The figures in the last column on the right are subject to rounding
error.

2. See the graph on the following page.

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32 Managerial Accounting, 10th Edition
Problem 2-14 (continued)

18,000
16,000
Quality Costs (in thousands)

14,000
12,000
External Failure
10,000 Internal Failure
8,000 Appraisal
Prevention
6,000
4,000
2,000
-
Last Year This Year

18%
Quality Costs as a Percentage of Sales

16%
14%
12% External Failure
10% Internal Failure
8% Appraisal
6% Prevention

4%
2%
0%
Last Year This Year

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Solutions Manual, Chapter 2 33
Problem 2-14 (continued)
3. During the past year the company has more than doubled its spending
on prevention and it has increased its spending on appraisal activities by
60%. This increased emphasis on prevention and appraisal has resulted
in a decline of total quality costs from 16.84% of sales last year to
13.4% of sales this year. While the situation has improved, internal and
external failure costs still constitute the majority of the quality costs—and
this does not include the lost sales due to customer perceptions of poor
quality. However, if the company continues to emphasize prevention and
appraisal, the internal and external failure costs should further decline
until they are no longer dominant.

Probably due to the increased emphasis on appraisal activities, internal

failure costs have actually increased. This is because the increased
appraisal activities catch more defects before they are shipped to
customers. Thus, the company is incurring more costs for scrap and
rework, but it is saving large amounts on external failure costs as a
consequence of not releasing defective goods to customers. As better
quality is built into products and better defect prevention systems are
developed, defects should decrease and appraisal and internal failure
costs should also fall.

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34 Managerial Accounting, 10th Edition
Problem 2-15 (30 minutes)
Note to the Instructor: Some of the answers below are debatable.
Adminis- Manufacturing
Variable Selling trative (Product) Cost
Cost Item or Fixed Cost Cost Direct Indirect
1. Depreciation, executive jet..................................................... F X
2. Costs of shipping finished goods to customers......................... V X
3. Wood used in furniture manufacturing.................................... V X
4. Sales manager’s salary........................................................... F X
5. Electricity used in furniture manufacturing............................... V X
6. Secretary to the company president........................................ F X
7. Aerosol attachment placed on a spray can produced by
the company...................................................................... V X
8. Billing costs........................................................................... V X*
9. Packing supplies for shipping products overseas...................... V X
10. Sand used in concrete manufacturing..................................... V X
11. Supervisor’s salary, factory..................................................... F X
12. Executive life insurance.......................................................... F X
13. Sales commissions................................................................. V X
14. Fringe benefits, assembly line workers.................................... V   X**
15. Advertising costs................................................................... F X
16. Property taxes on finished goods warehouses.......................... F X
17. Lubricants for machines......................................................... V X
 *Could be an administrative cost.
**Could be an indirect cost.

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Solutions Manual, Chapter 2 35
Problem 2-16 (15 minutes)
1. The controller is correct in his viewpoint that the salary cost should be
classified as a selling (marketing) cost. The duties described in the
problem have nothing to do with the manufacture of a product, but
rather deal with order-taking and shipping finished goods to customers.
As stated in the text, selling costs include all costs necessary to secure
customer orders and get the finished product into the hands of
customers.

2. No, the president is not correct; from the point of view of the reported
net operating income for the year, it does make a difference how the
salary cost is classified. If the salary cost is classified as a selling expense
all of it will appear on the income statement as a period cost. However, if
the salary cost is classified as a manufacturing (product) cost, then it will
be added into Work in Process Inventory along with other manufacturing
costs for the period. To the extent that goods are still in process at the
end of the period, part of the salary cost will remain with these goods in
the Work in Process Inventory account. Only that portion of the salary
cost that has been assigned to finished units will leave the Work in
Process Inventory account and be transferred into the Finished Goods
Inventory account. In like manner, to the extent that goods are unsold at
the end of the period, part of the salary cost will remain with these
goods in the Finished Goods Inventory account. Only that portion of the
salary that has been assigned to finished units that are sold during the
period will appear on the income statement as an expense (part of Cost
of Goods Sold) for the period.

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36 Managerial Accounting, 10th Edition
Problem 2-17 (30 minutes)
1. Period
(Selling
Product Cost and
Variable Fixed Direct Direct Mfg. Admin.) Opportunity Sunk
Name of the Cost Cost Cost Materials Labor Overhead Cost Cost Cost
Frieda’s present salary of $4,000 per
month X
Rent on the garage, $150 per month X X
Rent of production equipment, $500
per month X X
Materials for producing fly swatters,
at $0.30 each X X
Labor cost of producing fly swatters,
at $0.50 each X X
Rent of room for a sales office, $75
per month X X
Answering device attachment, $20
per month X X
Interest lost on savings account,
$1,000 per year X
Advertising cost, $400 per month X X
Sales commission, at $0.10 per fly
swatter X X
Legal and filing fees, $600 X

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Solutions Manual, Chapter 2 37
Problem 2-17 (continued)
2. The $600 legal and filing fees are not a differential cost. These legal and
filing fees have already been paid and are a sunk cost. Thus, the cost will
not differ depending on whether Frieda decides to produce fly swatters
or to stay with the computer firm. All other costs listed above are
differential costs since they will be incurred only if Frieda leaves the
computer firm and produces the fly swatters.

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38 Managerial Accounting, 10th Edition
Problem 2-18 (45 minutes)
1.
Selling or
Cost Behavior Administrative Product Cost
Cost Item Variable Fixed Cost Direct Indirect
Direct materials used (wood, glass) $430,000 $430,000
General office salaries $110,000 $110,000
Factory supervision 70,000 $ 70,000
Sales commissions 60,000 60,000
Depreciation, factory building 105,000 105,000
Depreciation, office equipment 2,000 2,000
Indirect materials, factory 18,000 18,000
Factory labor (cutting and assembly) 90,000 90,000
Advertising 100,000 100,000
Insurance, factory 6,000 6,000
General office supplies 4,000 4,000
Property taxes, factory 20,000 20,000
Utilities, factory    45,000                                              45,000
Total costs $647,000 $413,000 $276,000 $520,000 $264,000

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Solutions Manual, Chapter 2 39
Problem 2-18 (continued)
2. Only the product costs will be included in the cost of a bookcase. The
cost per bookcase will be:
Direct product costs $520,000
Indirect product costs  264,000
Total product costs $784,000
$784,000 ÷ 4,000 bookcases = $196 per bookcase

3. The cost per bookcase would increase. This is because the fixed costs
would be spread over fewer units, causing the cost per unit to rise.

4. a. Yes, there probably would be a disagreement. The president is likely

to want a price of at least $196, which is the average cost per unit to
manufacture 4,000 bookcases. He may expect an even higher price
than this to cover a portion of the administrative costs as well. The
neighbor will probably be thinking of cost as including only materials
used, or perhaps materials and direct labor.
b. The term is opportunity cost. Since the company is operating at full
capacity, the president must give up the full, regular price of a set to
sell a bookcase to the neighbor. Therefore, the president’s cost is
really the full, regular price of a set.

© The McGraw-Hill Companies, Inc., 2003. All rights reserved.

40 Managerial Accounting, 10th Edition
Problem 2-19 (60 minutes)
1.
MEDCO, INC.
Schedule of Cost of Goods Manufactured
Direct materials:
Raw materials inventory, beginning............................... $ 10,000
Add: Purchases of raw materials....................................   90,000
Raw materials available for use.....................................100,000
Deduct: Raw materials inventory, ending.......................    17,000
Raw materials used in production.................................. $ 83,000
Direct labor.................................................................... 60,000
Manufacturing overhead:
Depreciation, factory....................................................
42,000
Insurance, factory........................................................
5,000
Maintenance, factory....................................................
30,000
Utilities, factory............................................................
27,000
Supplies, factory...........................................................
1,000
Indirect labor...............................................................
   65,000
Total overhead costs.......................................................  170,000
Total manufacturing costs................................................ 313,000
Add: Work in process inventory, beginning.......................      7,000
320,000
Deduct: Work in process inventory, ending.......................    30,000
Cost of goods manufactured............................................ $290,000

© The McGraw-Hill Companies, Inc., 2003. All rights reserved.

Solutions Manual, Chapter 8 41
Problem 2-19 (continued)
2.
MEDCO, INC.
Income Statement
Sales.............................................................................. $450,000
Less cost of goods sold:
Finished goods inventory, beginning.............................. $ 10,000
Add: Cost of goods manufactured..................................  290,000
Goods available for sale................................................ 300,000
Deduct: Finished goods inventory, ending......................    40,000  260,000
Gross margin.................................................................. 190,000
Less operating expenses:
Selling expenses........................................................... 80,000
Administrative expenses...............................................    70,000  150,000
Net operating income...................................................... $ 40,000

3. Direct materials: $83,000 ÷ 10,000 units = $8.30 per unit.

Depreciation: $42,000 ÷ 10,000 units = $4.20 per unit.

4. Direct materials:
Unit cost: $8.30 (unchanged)
Total cost: 15,000 units × $8.30 per unit = $124,500.
Depreciation:
Unit cost: $42,000 ÷ 15,000 units = $2.80 per unit.
Total cost: $42,000 (unchanged)

5. Unit cost for depreciation dropped from $4.20 to $2.80, because of the
increase in production between the two years. Since fixed costs do not
change in total as the activity level changes, they will decrease on a unit
basis as the activity level rises.

© The McGraw-Hill Companies, Inc., 2003. All rights reserved.

42 Managerial Accounting, 10th Edition
Problem 2-20 (60 minutes)
1.
SKYLER COMPANY
Schedule of Cost of Goods Manufactured
For the Month Ended June 30
Direct materials:
Raw materials inventory, June 1.................................... $ 17,000
Add: Purchases of raw materials....................................  190,000
Raw materials available for use..................................... 207,000
Deduct: Raw materials inventory, June 30......................    42,000
Raw materials used in production.................................. $165,000
Direct labor.................................................................... 90,000
Manufacturing overhead:
Rent on facilities (80% × $40,000) ............................... 32,000
Insurance (75% × $8,000) .......................................... 6,000
Utilities (90% × $50,000) ............................................ 45,000
Indirect labor...............................................................
108,000
Maintenance, factory....................................................7,000
Depreciation, factory equipment....................................    12,000
Total overhead costs.......................................................  210,000
Total manufacturing costs................................................ 465,000
Add: Work in process inventory, June 1............................    70,000
535,000
Deduct: Work in process inventory, June 30.....................    85,000
Cost of goods manufactured............................................ $450,000

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Solutions Manual, Chapter 8 43
Problem 2-20 (continued)
2.
SKYLER COMPANY
Income Statement
For the Month Ended June 30
Sales.............................................................................. $600,000
Less cost of goods sold:
Finished goods inventory, June 1................................... $ 20,000
Add: Cost of goods manufactured..................................  450,000
Goods available for sale................................................
470,000
Deduct: Finished goods inventory, June 30....................    60,000  410,000
Gross margin.................................................................. 190,000
Less operating expenses:
Selling and administrative salaries................................. 35,000
Rent on facilities (20% × $40,000) ............................... 8,000
Depreciation, sales equipment....................................... 10,000
Insurance (25% × $8,000) .......................................... 2,000
Utilities (10% × $50,000) ............................................ 5,000
Advertising..................................................................
   80,000  140,000
Net operating income...................................................... $ 50,000

3. In preparing the income statement shown in the text, the accountant

failed to distinguish between product costs and period costs, and also
failed to recognize the change in inventories between the beginning and
end of the month. Once these errors have been corrected, the financial
condition of the company looks much better and selling the company
may not be advisable.

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44 Managerial Accounting, 10th Edition
Problem 2-21 (60 minutes)
1.
VALENKO COMPANY
Schedule of Cost of Goods Manufactured
Direct materials:
Raw materials inventory, beginning...............................
$ 50,000
Add: Purchases of raw materials....................................
 260,000
Raw materials available for use.....................................
310,000
Deduct: Raw materials inventory, ending.......................
   40,000
Raw materials used in production.................................. $270,000
Direct labor.................................................................... 65,000 *
Manufacturing overhead:
Insurance, factory........................................................
8,000
Rent, factory building...................................................
90,000
Utilities, factory............................................................
52,000
Cleaning supplies, factory.............................................
6,000
Depreciation, factory equipment....................................
110,000
Maintenance, factory....................................................
   74,000
Total overhead costs.......................................................  340,000
Total manufacturing costs................................................675,000 (given)
Add: Work in process inventory, beginning.......................    48,000 *
723,000
Deduct: Work in process inventory, ending.......................    33,000
Cost of goods manufactured............................................ $690,000

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Solutions Manual, Chapter 8 45
Problem 2-21 (continued)
The cost of goods sold section of the income statement follows:
Finished goods inventory, beginning.................................$ 30,000
Add: Cost of goods manufactured....................................  690,000 *
Goods available for sale...................................................
720,000 (given)
Deduct: Finished goods inventory, ending.........................    85,000 *
Cost of goods sold..........................................................
$635,000 (given)

*These items must be computed by working backwards up through the

statements. An effective way of doing this is to place the form and
known balances on the chalkboard, and then work toward the unknown
figures.

2. Direct materials: $270,000 ÷ 30,000 units = $9.00 per unit.

Rent, factory building: $90,000 ÷ 30,000 units = $3.00 per unit.

3. Direct materials:
Per unit: $9.00 (unchanged)
Total: 50,000 units × $9.00 per unit = $450,000.
Rent, factory building:
Per unit: $90,000 ÷ 50,000 units = $1.80 per unit.
Total: $90,000 (unchanged).

4. The unit cost for rent dropped from $3.00 to $1.80, because of the
increase in production between the two years. Since fixed costs do not
change in total as the activity level changes, they will decrease on a unit
basis as the activity level rises.

© The McGraw-Hill Companies, Inc., 2003. All rights reserved.

46 Managerial Accounting, 10th Edition
Problem 2-22 (30 minutes)
1. Mr. Richart’s first action was to direct that discretionary expenditures be
delayed until the first of the new year. Providing that these “discretionary
expenditures” can be delayed without hampering operations, this is a
good business decision. By delaying expenditures, the company can keep
its cash a bit longer and thereby earn a bit more interest. There is
nothing unethical about such an action. The second action was to ask
that the order for the parts be cancelled. Since the clerk’s order was a
mistake, there is nothing unethical about this action either.

The third action was to ask the accounting department to delay

recognition of the delivery until the bill is paid in January. This action is
dubious. Asking the accounting department to ignore transactions strikes
at the heart of the integrity of the accounting system. If the accounting
system cannot be trusted, it is very difficult to run a business or obtain
funds from outsiders. However, in Mr. Richart’s defense, the purchase of
the raw materials really shouldn’t be recorded as an expense. He has
been placed in an extremely awkward position because the company’s
accounting policy is flawed.

2. The company’s accounting policy with respect to raw materials is

incorrect. Raw materials should be recorded as an asset when delivered
rather than as an expense. If the correct accounting policy were
followed, there would be no reason for Mr. Richart to ask the accounting
department to delay recognition of the delivery of the raw materials. This
flawed accounting policy creates incentives for managers to delay
deliveries of raw materials until after the end of the fiscal year. This
could lead to raw materials shortages and poor relations with suppliers
who would like to record their sales before the end of the year.
The company’s “manage-by-the-numbers” approach does not foster
ethical behavior—particularly when managers are told to “do anything so
long as you hit the target profits for the year.” Such “no excuses”
pressure from the top too often leads to unethical behavior when
managers have difficulty meeting target profits.

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Solutions Manual, Chapter 8 47
Problem 2-23 (45 minutes)
1. A percentage analysis of the company’s quality cost report is presented below:
Year 2 Year 1
Amount Percentage* Amount Percentage*
Prevention costs:
Machine maintenance $ 160 3.5 % 27.1 % $ 215 5.2 % 22.3 %
Training suppliers 15 0.3 2.5 5 0.1 0.5
Design reviews      95  2.1  16.1      20  0.5    2.1
Total    270  6.0  45.7    240  5.8  24.9
Appraisal costs:
Incoming inspection 22 0.5 3.7 45 1.1 4.7
Final testing      94  2.1  15.9    160  3.9  16.6
Total    116  2.6  19.6    205  5.0  21.3
Internal failure costs:
Rework 62 1.4 10.5 120 2.9 12.4
Scrap      40  0.9    6.8      68  1.7    7.1
Total    102  2.3  17.3    188  4.6  19.5
External failure costs:
Warranty repairs 23 0.5 3.9 69 1.7 7.2
Customer returns      80  1.8  13.5    262  6.4  27.2
Total    103  2.3  17.4    331  8.0  34.3
Total quality cost $  591 13.1 % 100.0 % $  964 23.4 % 100.0 %
Total production cost $4,510 $4,120
*Percentage figures may not add down due to rounding.

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48 Managerial Accounting, 10th Edition
Problem 2-23 (continued)
From the above analysis it would appear that Bergen, Inc.’s program has
been successful, since:

• total quality costs as a percentage of total production have declined

from 23.4% to 13.1%.
• external failure costs, those costs signaling customer dissatisfaction,
have declined from 8% of total production to 2.3%. These declines in
warranty repairs and customer returns should translate into increased
sales in the future.
• internal failure costs have been reduced from 4.6% to 2.3% of
production costs, which represents a 50% drop.
• appraisal costs have decreased from 5.0% to 2.6% of total production
—a drop of 48%. Higher quality is reducing the demand for final
testing.
• quality costs have shifted to the area of prevention where problems
are solved before the customer becomes involved. Maintenance,
training, and design reviews have increased from 5.8% of total
production cost to 6% and from 24.9% of total quality costs to
45.7%. The $30,000 increase is more than offset by decreases in
other quality costs.

2. Tony Reese’s current reaction to the quality improvement program is

more favorable as he is seeing the benefits of having the quality
problems investigated and solved before they reach the production floor.
Because of improved designs, quality training, and additional pre-
production inspections, scrap and rework costs have declined.
Consequently, fewer resources are now required for customer service.
Throughput has increased and throughput time has decreased; work is
now moving much faster through the department.

3. To measure the opportunity cost of not implementing the quality

program, Bergen Inc. could assume that:

• sales and market share would continue to decline and then calculate
the revenue and income lost.
• the company would have to compete on price rather than quality and
calculate the impact of having to lower product prices.

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Solutions Manual, Chapter 2 49
Problem 2-24 (15 minutes)
Variable or Fixed
Direct or Indirect Direct or with Respect to the
Cost of the Indirect Cost of Number of
Immunization Particular Immunizations
Center Patients Administered
Item Description Direct Indirect Direct Indirect Variable Fixed
a. The salary of the head nurse in the
Immunization Center..................................................................
X X X
b. Costs of incidental supplies consumed in the
Immunization Center such as paper towels..................................
X X X
c. The cost of lighting and heating the
Immunization Center..................................................................
X X X
d. The cost of disposable syringes used in the
Immunization Center..................................................................
X X X
e. The salary of the Central Area Well-Baby Clinic’s
Information Systems manager....................................................X X X
f. The costs of mailing letters soliciting donations
to the Central Area Well-Baby Clinic............................................
X X X
g. The wages of nurses who work in the
Immunization Center*................................................................
X X X
h. The cost of medical malpractice insurance for
the Central Area Well-Baby Clinic................................................
X X X
i. Depreciation on the fixtures and equipment in
the Immunization Center............................................................
X X X
* The wages of the nurses could be variable and a direct cost of serving particular patients.

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50 Managerial Accounting, 10th Edition
Problem 2-25 (45 minutes)

Case 1 Case 2 Case 3 Case 4

Direct materials $ 7,000  $ 9,000  $ 6,000  $ 8,000 
Direct labor 2,000  4,000  5,000  * 3,000 
Manufacturing overhead  10,000   12,000  *    7,000   21,000 
Total manufacturing costs 19,000  * 25,000  18,000  32,000  *
Beginning work in process inventory 3,000  * 1,000  2,000  1,500  *
Ending work in process inventory   (4,000)   (3,500)   (4,000) *   (2,000)
Cost of goods manufactured $18,000  $22,500  * $16,000  $31,500  *
Sales $25,000  $40,000  $30,000  $50,000 
Beginning finished goods inventory 6,000  8,000  * 7,000  9,000 
Cost of goods manufactured  18,000  *  22,500  *  16,000  *  31,500 
Goods available for sale 24,000  * 30,500  * 23,000  * 40,500  *
Ending finished goods inventory    9,000     4,000     5,000  *    7,000 
Cost of goods sold  15,000  *  26,500   18,000   33,500  *
Gross margin 10,000  * 13,500  * 12,000  * 16,500  *
Operating expenses    6,000     8,000  *    9,000  *  10,000 
Net operating income $ 4,000  * $ 5,500  $ 3,000  $ 6,500  *
*Missing data in the problem.

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Solutions Manual, Chapter 2 51
Problem 2-26 (45 minutes)
1.
HICKEY COMPANY
Schedule of Cost of Goods Manufactured

Direct materials:
Raw materials inventory, beginning............................... $ 20,000
Add: Purchases of raw materials....................................  160,000
Raw materials available for use..................................... 180,000
Deduct: Raw materials inventory, ending.......................    10,000
Raw materials used in production.................................. $170,000
Direct labor.................................................................... 80,000
Manufacturing overhead:
Indirect labor...............................................................
60,000
Building rent (80% × $50,000) .................................... 40,000
Utilities, factory............................................................
35,000
Royalty on patent
($1 per unit × 30,000 units) ...................................... 30,000
Maintenance, factory....................................................
25,000
Rent on equipment:
$6,000 + ($0.10 per unit × 30,000 units) ................... 9,000
Other factory overhead costs........................................   11,000
Total overhead costs.......................................................  210,000
Total manufacturing costs................................................ 460,000
Add: Work in process inventory, beginning.......................    30,000
490,000
Deduct: Work in process inventory, ending.......................    40,000
Cost of goods manufactured............................................ $450,000

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52 Managerial Accounting, 10th Edition
Problem 2-26 (continued)
2. a. To compute the number of units in the finished goods inventory at the
end of the year, we must first compute the number of units sold
during the year.
Total sales $650,000
= = 26,000 units sold
Unit selling price $25 per unit
Units in the finished goods inventory, beginning................ 0
Units produced during the year........................................ 30,000
Units available for sale....................................................
30,000
Units sold during the year (above) .................................. 26,000
Units in the finished goods inventory, ending....................   4,000

b. The average production cost per unit during the year would be:
Cost of goods manufactured $450,000
= = $15 per unit.
Number of units produced 30,000 units
Thus, the cost of the units in the finished goods inventory at the end
of the year would be: 4,000 units × $15 per unit = $60,000.
3.
HICKEY COMPANY
Income Statement

Sales.............................................................................. $650,000
Less cost of goods sold:
Finished goods inventory, beginning.............................. $         0
Add: Cost of goods manufactured..................................  450,000
Goods available for sale................................................ 450,000
Finished goods inventory, ending...................................    60,000  390,000
Gross margin.................................................................. 260,000
Less operating expenses:
Advertising..................................................................50,000
Building rent (20% × $50,000)..................................... 10,000
Selling and administrative salaries................................. 140,000
Other selling and administrative expense.......................    20,000  220,000
Net operating income...................................................... $ 40,000

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Solutions Manual, Chapter 2 53
Case 2-27 (60 minutes)
1. No distinction has been made between period expenses and product
costs on the income statement prepared by Louganis. Product costs
(e.g., direct materials, direct labor, and manufacturing overhead) should
be assigned to inventory accounts and flow through to the income
statement as cost of goods sold only when finished products are sold.
Since there were ending inventories, some of the product costs should
appear on the balance sheet as assets rather than on the income
statement as expenses.

2.
MEDICAL TECHNOLOGY, INC.
Schedule of Cost of Goods Manufactured
For the Quarter Ended June 30
Direct materials:
Raw materials inventory, beginning............................... $         0
Add: Purchases of raw materials....................................  310,000
Raw materials available for use..................................... 310,000
Deduct: Raw materials inventory, ending.......................    40,000
Raw materials used in production.................................. $270,000
Direct labor.................................................................... 80,000
Manufacturing overhead:
Cleaning supplies, production........................................ 6,000
Indirect labor cost........................................................
135,000
Maintenance, production............................................... 47,000
Rental cost, facilities (80% × $65,000).......................... 52,000
Insurance, production...................................................9,000
Utilities (90% × $40,000)............................................. 36,000
Depreciation, production equipment..............................    75,000
Total overhead costs.......................................................  360,000
Total manufacturing costs................................................ 710,000
Add: Work in process inventory, beginning.......................            0
710,000
Deduct: Work in process inventory, ending.......................    30,000
Cost of goods manufactured............................................ $680,000

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54 Managerial Accounting, 10th Edition
Case 2-27 (continued)
3. Before an income statement can be prepared, the cost of the 4,000
monitors in the ending finished goods inventory must be determined.
Altogether, the company produced 20,000 units during the quarter; thus,
the production cost per unit would be:
Cost of goods manufactured $680,000
= =$34 per unit
Units produced during the quarter 20,000 units
Since 4,000 monitors (20,000 – 16,000 = 4,000) were in the ending
finished goods inventory, the total cost of this inventory would be:
4,000 units × $34 per unit = $136,000.
With this figure and other data from the case, the company’s income
statement for the quarter can be prepared as follows:

MEDICAL TECHNOLOGY, INC.

Income Statement
For the Quarter Ended June 30
Sales.............................................................................. $975,000
Less cost of goods sold:
Finished goods inventory, beginning.............................. $         0
Add: Cost of goods manufactured .................................  680,000
Goods available for sale................................................
680,000
Deduct: Finished goods inventory, ending......................  136,000  544,000
Gross margin.................................................................. 431,000
Less operating expenses:
Selling and administrative salaries................................. 90,000
Advertising..................................................................
200,000
Rental cost, facilities (20% × $65,000).......................... 13,000
Depreciation, office equipment...................................... 18,000
Utilities (10% × $40,000)............................................. 4,000
Travel, salespersons.....................................................
   60,000  385,000
Net operating income...................................................... $ 46,000

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Solutions Manual, Chapter 2 55
Case 2-27 (continued)
4. No, the insurance company probably does not owe Medical Technology
$227,000. The key question is how “cost” was defined in the insurance
contract. It is most likely that the insurance contract limits
reimbursement for losses to those costs that would normally be
considered product costs—in other words, direct materials, direct labor,
and manufacturing overhead. The $227,000 figure is overstated since it
includes elements of selling and administrative expenses as well as all of
the product costs. The $227,000 figure also does not recognize that
some costs incurred during the period are in the ending Raw Materials
and Work in Process inventory accounts, as explained in part (1) above.
The insurance company’s liability is probably just $136,000, which is the
amount of cost associated with the ending Finished Goods inventory as
shown in part (3) above.

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56 Managerial Accounting, 10th Edition
Case 2-28 (60 minutes)
The following cost items are needed before any schedules or statements
can be prepared:
Direct labor cost:
¼ × Manufacturing overhead = Direct labor cost
¼ × $520,000 = $130,000
Materials used in production:
Direct labor and direct materials......................................
$510,000
Less direct labor cost......................................................
 130,000
Direct materials cost.......................................................
$380,000
Cost of goods manufactured:
Goods available for sale...................................................
$960,000
Less finished goods inventory, beginning..........................
   90,000
Cost of goods manufactured............................................
$870,000

The easiest way to proceed from this point is to place all known amounts
on the chalkboard in a partially completed schedule of cost of goods
manufactured and a partially completed income statement. Then fill in
the missing amounts by analysis of the available data.

Direct materials:
 Raw materials inventory, beginning............................... $   30,000
 Add: Purchases of raw materials...................................    420,000
 Raw materials available for use..................................... 450,000
 Deduct: Raw materials inventory, ending......................         A      
 Raw materials used in production (see above)............... 380,000
Direct labor cost (see above)........................................... 130,000
Manufacturing overhead cost...........................................    520,000
Total manufacturing costs................................................
1,030,000
Add: Work in process inventory, beginning.......................       50,000
1,080,000
Deduct: Work in process inventory, ending.......................         B      
Cost of goods manufactured (see above).......................... $  870,000

© The McGraw-Hill Companies, Inc., 2003. All rights reserved.

Solutions Manual, Chapter 2 57
Case 2-28 (continued)
Therefore, “A” (Raw materials inventory, ending) would be $70,000; and
“B” (Work in process inventory, ending) would be $210,000.

Sales.............................................................................. $1,350,000
Less cost of goods sold:
Finished goods inventory, beginning.............................. $ 90,000
Add: Cost of goods manufactured (see  870,000
above)......................................................................
Goods available for sale................................................
960,000
Deduct: Finished goods inventory, ending......................       C         810,000 *
Gross margin.................................................................. $  540,000
*$1,350,000 × (100% – 40%) = $810,000.

Therefore, “C” (Finished goods inventory, ending) would be $150,000.

The procedure outlined above is just one way in which the solution to
the case can be approached. Some students may wish to start at the
bottom of the income statement (with gross margin) and work upwards
from that point. Also, the solution can be obtained by use of T-accounts.

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58 Managerial Accounting, 10th Edition
Group Exercise 2-29
1. This statement reflects Ford’s focus on keeping costs down. Producing
cars in different colors adds to costs and reduces output in a variety of
ways. First, changing colors on the production line involves considerable
setups, during which time nothing can be painted. The old color must be
purged from paint lines before the new color can be applied. And
different colors mean larger paint inventories and—perhaps most
importantly—larger inventories of finished autos. By producing the Model
T in only one color, Ford was able to keep costs low and to keep
throughput up—thus keeping its costs low. However, the market was
eventually willing to pay for more colors and Ford was slow to adapt to
this change.

2. As stated in the problem, further efficiencies could be achieved by

implementing standardized work procedures, specializing work, and
using machines to enhance the productivity of individual workers.

3. There are indeed limits to lowering costs—they can’t go below zero. One
might think that the lowest limit is the cost of raw materials used in
production. However, even this cost can be pushed down over time as
more efficient means of producing raw materials are developed.

4. The most obvious application of mass production concepts to university

education has been the increase in the number of students in classes—
with large lecture classes now being the norm in many introductory
courses. Hospitals have applied the concepts of mass production by
developing standardized procedures and by specializing in certain areas
such as cardiac care or cancer treatment. Airlines have applied mass
production concepts by increasing the size of the jets they fly and by
reducing the time required to service a jet between flights.

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Solutions Manual, Chapter 2 59
Group Exercise 2-30
1. A fixed cost is normally defined as a cost that remains constant, in total,
regardless of changes in the level of activity. A variable cost is normally
defined as a cost that varies, in total, in direct proportion to changes in
the level of activity.

2. The relevant measure of activity for a steel company is probably the

volume of steel produced. Fixed costs for a steel company include
factory rent and depreciation, property taxes, many administrative costs,
salaries, and periodic depreciation of equipment. Variable costs include
the cost of raw materials, some energy costs, some labor costs, and
some supply costs.

3. A number of different measures of activity could be used at a hospital.

Some hospitals use a measure called patient-days, which counts a
patient in the hospital for one day as a patient-day. Fixed costs at a
hospital include the rental and depreciation of buildings, administrative
salaries, utilities, insurance, and the costs of equipment. Variable costs
include the costs of drugs and supplies and some labor costs.
Universities often use credit-hours or the total number of students
enrolled as the measure of activity. Fixed costs for a university include
the costs of buildings, salaries, utilities, grounds maintenance, and so on.
Variable costs are minimal.
A measure of activity at an auto manufacturer might be the number of
cars produced. Fixed costs for an auto manufacturer include the costs of
buildings and equipment, insurance, salaries, and utilities. Variable costs
include raw materials and perhaps some labor.

4. As the volume of steel produced increases, total fixed costs remain the
same; the fixed cost per unit decreases; total variable costs increase; the
variable cost per unit remains the same; total cost increases (due to the
increase in total variable cost); and the average unit cost decreases
(because of the decline in the fixed cost per unit).

© The McGraw-Hill Companies, Inc., 2003. All rights reserved.

60 Managerial Accounting, 10th Edition
Group Exercise 2-30 (continued)
5. The following graph depicts how total costs behave as a function of how
many tons of steel are produced.
Total cost
$
Total variable cost

Total fixed cost

Tons

6. The following graph depicts how average costs per unit behave as a
function of how many tons of steel are produced.

Average total cost per unit

Variable cost per unit
Average fixed cost per unit
Tons

7. Once capacity has been set, total fixed costs and variable costs per unit
remain the same while the average fixed cost per unit drops and the
total variable cost increases as demand (output) increases.

© The McGraw-Hill Companies, Inc., 2003. All rights reserved.

Solutions Manual, Chapter 2 61