Managerial Accounting Cases

I. Chavez’s Business (Chapter 1 and 2)

Maria Chavez owns a catering company that serves food and beverages at parties and
business functions. Chavez’s business is seasonal, with a heavy schedule during the summer
months and holidays and a lighter schedule at other times. One of the major events Chavez’s
customers request is a cocktail party. She offers a standard cocktail party and has estimated
the cost per guest as follows:

Food and beverages. . . . . . . . . . . . . . . . $ 15.00

Labor (0.5 hrs. @ $10.00/hr.) . . . . . . . . . 5.00
Overhead (0.5 hrs. @ $13.98/hr.). . . . . . . . . 6.99
Total cost per guest . . . . . . . . . . . . . . . . . . . . $ 26.99

The standard cocktail party lasts three hours and Chavez hires one worker for every
six guests, so that works out to half an hour of labor per guest. These workers are hired only
as needed and are paid only for the hours they actually work.
When bidding on cocktail parties, Chavez adds a 15% markup to yield a price of about
$ 31 per guest. She is confident about her estimates of the costs of food and beverages and
labor but is not as comfortable with the estimate of overhead cost. The $ 13.98 overhead cost
per labor-hour was determined by dividing total overhead expenses for the last 12 months by
total labor-hours for the same period. Monthly data concerning overhead costs and labor-
hours follow:

Month Labor- Hours Overhead Expenses

January . . . . . . . . . . 2,500 $ 55,000
February . . . . . . . . . 2,800 59,000
March. . . . . . . . . . . . 3,000 60,000
April . . . . . . . . . . . . . 4,200 64,000
May . . . . . . . . . . . . . 4,500 67,000
June. . . . . . . . . . . . . 5,500 71,000
July . . . . . . . . . . . . . 6,500 74,000
August . . . . . . . . . . . 7,500 77,000
September. . . . . . . . 7,000 75,000
October . . . . . . . . . . 4,500 68,000
November . . . . . . . . 3,100 62,000
December . . . . . . . . 6,500 73,000
Total. . . . . . . . . . . . . 57,600 $805,000

Chavez has received a request to bid on a 180-guest fund-raising cocktail party to be

given next month by an important local charity. (The party would last the usual three hours.)
She would like to win this contract because the guest list for this charity event includes many
prominent individuals that she would like to land as future clients. Maria is confident that
these potential customers would be favorably impressed by her company’s services at the
charity event.

Required:
1. Estimate the contribution to profit of a standard 180-guest cocktail party if Chavez charges
her usual price of $ 31 per guest. (In other words, by how much would her overall profit
increase ?)
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2. How low could Chavez bid for the charity event in terms of a price per guest and still not
lose money on the event itself ?
3. The individual who is organizing the charity’s fund-raising event has indicated that he has
already received a bid under $ 30 from another catering company. Do you think Chavez
should bid below her normal $ 31 per guest price for the charity event ? Why or why not?
4. Identify types of overhead cost which be possible incurred in the chavez's business, and
why was the direct labor hours as activity base (cost driver) to determine overhead cost ?

II. Fire Destroyed (Chapter 3)

Hector P. Wastrel, a careless employee, left some combustible materials near an open flame in
Salter Company’s plant. The resulting explosion and fire destroyed the entire plant and
administrative offices. Justin Quick, the company’s controller, and Constance Trueheart, the
operations manager, were able to save only a few bits of information as they escaped from the
roaring blaze.
“What a disaster,” cried Justin. “And the worst part is that we have no records to use
in filingan insurance claim.”
“I know,” replied Constance. “I was in the plant when the explosion occurred, and I
managed to grab only this brief summary sheet that contains information on one or two of our
costs. It says that our direct labor cost this year totaled $180,000 and that we purchased
$290,000 in raw materials. But I’m afraid that doesn’t help much; the rest of our records are
just ashes.”
“Well, not completely,” said Justin. “I was working on the year-to-date income
statement when the explosion knocked me out of my chair. I instinctively held onto the page I
was working on, and from what I can make out, our sales to date this year totaled $1,200,000
and our gross margin was 40% of sales. Also, I can see that our goods available for sale to
customers totaled $810,000 at cost.”
“Maybe we’re not so bad off after all,” exclaimed Constance. “My sheet says that
prime cost totaled $410,000 so far this year and that manufacturing overhead is 70% of
conversion cost. Now if we just had some information on our beginning inventories.”
“Hey, look at this,” cried Justin. “It’s a copy of last year’s annual report, and it shows
what our inventories were when this year started. Let’s see, raw materials was $18,000, work
in process was $65,000, and finished goods was $45,000.
“Super,” yelled Constance. “Let’s go to work.”
To file an insurance claim, the company must determine the amount of cost in its
inventories as of the date of the fire. You may assume that all materials used in production
during the year were direct materials.

Required:
Determine the amount of cost in the Raw Materials, Work in Process, and Finished Goods
inventory accounts as of the date of the fire. (Hint: One way to proceed would be to
reconstruct the various schedules and statements that would have been affected by the
company’s inventory accounts during the period).

III. Provost Industries (Chapter 4)

“I think we goofed when we hired that new assistant controller,” said Ruth Scarpino,
president of Provost Industries. “Just look at this report that he prepared for last month for the
Finishing Department. I can’t make heads or tails out of it.”

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 Finishing Department costs:
Work in process inventory, April 1, 450 units; materials
100% complete; conversion 60% complete . . . . . . . . . . . . . . . . . . $ 8,208 *
Costs transferred in during the month from the
preceding department, 1,950 units . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,940
Materials cost added during the month . . . . . . . . . . . . . . . . . . . . . . . . . 6,210
Conversion costs added during the month . . . . . . . . . . . . . . . . . . . . . . 13,920
Total departmental costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $46,278
Finishing Department costs assigned to:
Units completed and transferred to finished goods,
1,800 units at $25.71 per unit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $46,278
Work in process inventory, April 30, 600 units; materials
0% complete; conversion 35% complete . . . . . . . . . . . . . . . . . . . . . 0
Total departmental costs assigned . . . . . . . . . . . . . . . . . . . . . . . . . . . . $46,278
* Consists of cost transferred in, $4,068; materials cost, $1,980; and
conversion cost, $2,160.

“He’s struggling to learn our system,” replied Frank Harrop, the operations manager.
“The problem is that he’s been away from process costing for a long time, and it’s coming
back slowly.”
“It’s not just the format of his report that I’m concerned about. Look at that $25.71
unit cost that he’s come up with for April. Doesn’t that seem high to you?” said Ms. Scarpino.
“Yes, it does seem high; but on the other hand, I know we had an increase in materials
prices during April, and that may be the explanation,” replied Mr. Harrop. “I’ll get someone
else to redo this report and then we may be able to see what’s going on.”
Provost Industries manufactures a ceramic product that goes through two processing
departments—Molding and Finishing. The company uses the weighted-average method in its
process costing.

Required:
1. Prepare a report for the Finishing Department showing how much cost should have been
assigned to the units completed and transferred to finished goods, and how much cost
should have been assigned to ending work in process inventory in the Finishing
Department.
2. Explain to the president why the unit cost on the new assistant controller’s report is so high.

IV. Pittman Company (Chapter 5)

Pittman Company is a small but growing manufacturer of telecommunications equipment.

The company has no sales force of its own; rather, it relies completely on independent sales
agents to market its products. These agents are paid a commission of 15% of selling price for
all items sold.
Barbara Cheney, Pittman’s controller, has just prepared the company’s budgeted
income statement for next year. The statement follows:

Pittman Company
Budgeted Income Statement
For the Year Ended December 31
Sales. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 16,000,000
Manufacturing costs:
Variable . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,200,000
Fixed overhead . . . . . . . . . . . . . . . . . . . . 2,340,000 9,540,000
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 Gross margin . . . . . . . . . . . . . . . . . . . . . . . . 6,460,000
Selling and administrative costs:
Commissions to agents. . . . . . . . . . . . . . . 2,400,000
Fixed marketing costs . . . . . . . . . . . . . . . 120,000*
Fixed administrative costs . . . . . . . . . . . . 1,800,000 4,320,000
Net operating income . . . . . . . . . . . . . . . . . . 2,140,000
Fixed interest cost. . . . . . . . . . . . . . . . . . . . . 540,000
Income before income taxes. . . . . . . . . . . . . 1,600,000
Income taxes (30%) . . . . . . . . . . . . . . . . . . . 480,000
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,120,000
*Primarily depreciation on storage facilities

As Barbara handed the statement to Karl Vecci, Pittman’s president, she commented, “I went
ahead and used the agents’ 15% commission rate in completing these statements, but we’ve
just learned that they refuse to handle our products next year unless we increase the
commission rate to 20%.”
“That’s the last straw,” Karl replied angrily. “Those agents have been demanding
more and more, and this time they’ve gone too far. How can they possibly defend a 20%
commission rate?”
“They claim that after paying for advertising, travel, and the other costs of promotion,
there’s nothing left over for profit,” replied Barbara.
“I say it’s just plain robbery,” retorted Karl. “And I also say it’s time we dumped those
guys and got our own sales force. Can you get your people to work up some cost fi gures for
us to look at?”
“We’ve already worked them up,” said Barbara. “Several companies we know about
pay a 7.5% commission to their own sales people, along with a small salary. Of course, we
would have to handle all promotion costs, too. We figure our fixed costs would increase by
$2,400,000 per year, but that would be more than offset by the $3,200,000 (20% x
$16,000,000) that we would avoid on agents’ commissions.”
The breakdown of the $2,400,000 cost follows:

Salaries:
Sales manager . . . . . . . . . . . . . . $ 100,000
Sales persons . . . . . . . . . . . . . . . 600,000
Travel and entertainment . . . . . 400,000
Advertising . . . . . . . . . . . . . . . . 1,300,000
Total. . . . . . . . . . . . . . . . . . . . $ 2,400,000

“Super,” replied Karl. “And I noticed that the $2,400,000 is just what we’re paying the
agents under the old 15% commission rate.”
“It’s even better than that,” explained Barbara. “We can actually save $75,000 a year
because that’s what we’re having to pay the auditing fi rm now to check out the agents’
reports. So our overall administrative costs would be less.”
“Pull all of these numbers together and we’ll show them to the executive committee
tomorrow,” said Karl. “With the approval of the committee, we can move on the matter
immediately.”

Required:
1. Compute Pittman Company’s break-even point in sales dollars for next year assuming:
a. The agents’ commission rate remains unchanged at 15%.
b. The agents’ commission rate is increased to 20%.
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 c. The company employs its own sales force.
2. Assume that Pittman Company decides to continue selling through agents and pays the
20% commission rate. Determine the sales that would be required to generate the same net
income as contained in the budgeted income statement for next year.
3. Determine the sales at which net income would be equal regardless of whether Pittman
Company sells through agents (at a 20% commission rate) or employs its own sales force.
4. Compute the degree of operating leverage that the company would expect to have on
December 31 at the end of next year assuming:
a. The agents’ commission rate remains unchanged at 15%.
b. The agents’ commission rate is increased to 20%.
c . The company employs its own sales force.
Use income before income taxes in your operating leverage computation.
5. Based on the data in (1) through (4) above, make a recommendation as to whether the
company should continue to use sales agents (at a 20% commission rate) or employ its own
sales force. Give reasons for your answer.

V. Rayco, Inc. (Chapter 6)

“These statements can’t be right,” said Ben Yoder, president of Rayco, Inc. “Our sales in the
second quarter were up by 25% over the first quarter, yet these income statements show a
precipitous drop in net operating income for the second quarter. Those accounting people
have fouled something up.” Mr. Yoder was referring to the following statements (absorption
costing basis):

Rayco, Inc.
Income Statements
For the First Two Quarters
First Quarter Second Quarter
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . $480,000 $600,000
Cost of goods sold . . . . . . . . . . . . . . . . . 240,000 372,000
Gross margin . . . . . . . . . . . . . . . . . . . . . 240,000 228,000
Selling and administrative expenses . . . 200,000 215,000
Net operating income. . . . . . . . . . . . . . . $ 40,000 $ 13,000

After studying the statements briefly, Mr. Yoder called in the controller to see if the
mistake in the second quarter could be located before the figures were released to the press.
The controller stated, “I’m sorry to say that those figures are correct, Ben. I agree that sales
went up during the second quarter, but the problem is in production. You see, we budgeted to
produce 15,000 units each quarter, but a strike on the west coast among some of our suppliers
forced us to cut production in the second quarter back to only 9,000 units. That’s what caused
the drop in net operating income.”
Mr. Yoder was confused by the controller’s explanation. He replied, “This doesn’t
make sense. I ask you to explain why net operating income dropped when sales went up and
you talk about production! So what if we had to cut back production? We still were able to
increase sales by 25%. If sales go up, then net operating income should go up. If your
statements can’t show a simple thing like that, then it’s time for some changes in your
department!”
Budgeted production and sales for the year, along with actual production and sales for
the first two quarters, are given below:

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 Quarter
First Second Third Quarter
Budgeted sales (units) . . . . . . 12,000 15,000 15,000 18,000
Actual sales (units) . . . . . . . . 12,000 15,000 — —
Budgeted production (units). . 15,000 15,000 15,000 15,000
Actual production (units) . . . 15,000 9,000 — —

The company’s plant is heavily automated, and fixed manufacturing overhead

amounts to $180,000 each quarter. Variable manufacturing costs are $8 per unit. The fixed
manufacturing overhead is applied to units of product at a rate of $12 per unit (based on the
budgeted production shown on the prior page). Any underapplied or overapplied overhead is
closed directly to cost of goods sold for the quarter. The company had 4,000 units in
inventory to start the first quarter and uses the FIFO inventory flow assumption. Variable
selling and administrative expenses are $5 per unit.

Required:
1. What characteristic of absorption costing caused the drop in net operating income for the
second quarter and what could the controller have said to explain the problem?
2. Prepare a contribution format variable costing income statement for each quarter.
3. Reconcile the absorption costing and the variable costing net operating income figures for
each quarter.
4. Identify and discuss the advantages and disadvantages of using the variable costing method
for internal reporting purposes.
5. Assume that the company had introduced Lean Production at the beginning of the second
quarter, resulting in zero ending inventory. (Sales and production during the first quarter
remain the same.)
a. How many units would have been produced during the second quarter under Lean
Production?
b. Starting with the third quarter, would you expect any difference between the net
operating income reported under absorption costing and under variable costing? Explain
why there would or would not be any difference.

VI. Activity-based costing (ABC) – Whitecroft (Chapter 7)

Background
Activity-based costing (ABC) is a method that calculates a more accurate product cost by
identifying an organization’s major operating activities, tracing the indirect costs to those
activities, and allocating activity costs to products using a cost driver that is related to the
cause of the cost.
Companies nowadays operate under volatile business environments that are strongly
influenced by customer demands. Firm managers know that their customers buy value mainly
in the form of quality products and services that are delivered on a timely basis for a
reasonable and affordable price. Companies generate revenues and profits when customers
identify value and buy their product or service. Consequently, companies’ measure value as the
revenues generated from a specific business activity. Under this framework managers will
focus their attention internally to find the best ways of using their resources effectively, in
order to create or maintain value in their products or services.
The aforementioned status however, required organizations to redesign their accounting
information systems so as to provide customer-related, activity-based information. This need
lead to the creation of the Activity-based systems which are information systems that provide
quantitative information about activities in an organization.
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Activity-based systems help managers to view the organization as a collection of related
activities, thus enable managers to improve operating processes and make better pricing
decisions. In brief, activity-based systems help managers identify value-adding activities,
determine the resources needed for those activities, and estimate product costs.
Activity Based Costing was used by American industrialists, in the middle 1970’s, as an
efficient method of cost accounting their products, not accordingly to the volume of their
production, but according to the activities needed for their production. The reason for the
invention of ABC is the inefficiency of the traditional cost accounting methods in the US
during the 1960’s and 1970’s. As Horngren (1977), Miller & Vollman (1985) and Johnson &
Kaplan (1987) argued, there are concealed factors that influence the common and the general
industrial expenses and these needed to be distributed in a better way in order to be audited
easier, thus increasing the managerial and production efficiency. Since the beginning of the
1990’s, ABC started to become acceptable from the majority of researchers and cost
accountants as a method that offers more timely and value relevant information for the factors
that influence products costs, thus helping managers making rational business decisions.

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ABC system at Whitecroft

Whitecroft is UK’s largest manufacturers of commercial lighting, missioned to share decades

of expertise to deliver the creative, smart, circular solutions that partners are looking for. As a
member of the Fagerhult Group, it is the part of a global network of lighting manufacturers,
with over 4,900 employees in 30 countries worldwide.
The company offers two types of products:
 Standard Light Bulb (SLB)
 Premium LED Light Bulb (PLB)
The company has been using a traditional costing system to allocate overhead costs based on
machine hours. However, the CEO is considering switching to ABC system to better
understand the profitability of its products. You are required to calculate the cost per unit for
both products under both costing systems.

SLB PLB
Production volume 20,000 units 10, 000 units
Direct material $1.50 per unit $4.00 per unit
Direct labour $2.00 per unit $3.50 per unit
Total manufacturing overheads (allocated based on machine $180,000
hours)
Machine hours required 0.5 hrs 1 hrs
Total machine hours hrs 10,000 hrs 10,000

Whitecroft allocated its overheads based on following cost pools and drivers

Activity Cost driver SLB PLB Total cost

Setups Number of setups 5 setups 15 setups $60,000
Quality inspection number of inspections 8 inspections 12 inspections $45,000
Machining machine hours 10,000 hours 10,000 hours $75,000

1. Calculate the cost per unit for SLB and PLB using the traditional costing system.
2. Calculate the cost per unit for SLB and PLB using the ABC system.

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3. Impact of Costing Systems: Why does the ABC system show a higher cost per unit for
PLB compared to the traditional system? How does this reflect on the profitability of the
products?
4. Managerial Implications: Based on the results from both costing systems, what pricing
or production decisions would you recommend to whitecroft? Should they focus on
SLB or PLB, or both?
5. Strategic Importance: For a company like whitecroft, why might it be more important to
implement ABC over traditional costing, especially as they scale up production or
introduce new products?

VII. Master Budget with Supporting Schedules (Chapter 8)

You have just been hired as a new management trainee by Earrings Unlimited, a
distributor of earrings to various retail outlets located in shopping malls across the
country. In the past, the company has done very little in the way of budgeting and at
certain times of the year has experienced a shortage of cash. Since you are well trained in
budgeting, you have decided to prepare comprehensive budgets for the upcoming second
quarter in order to show management the benefits that can be gained from an integrated
budgeting program. To this end, you have worked with accounting and other areas to
gather the information assembled below. The company sells many styles of earrings, but
all are sold for the same price—$10 per pair. Actual sales of earrings for the last three
months and budgeted sales for the next six months follow (in pairs of earrings):

January (actual) . . . . . . . . . 20,000 June (budget) . . . . . . . . . . 50,000

February (actual) . . . . . . . . 26,000 July (budget . . . . . . . . . . . 30,000
March (actual) . . . . . . . . . . 40,000 August (budget) . . . . . . . 28,000
April (budget) . . . . . . . . . . 65,000 September (budget) . . . . . 25,000
May (budget) . . . . . . . . . . . 100,000

The concentration of sales before and during May is due to Mother’s Day. Sufficient
inventory should be on hand at the end of each month to supply 40% of the earrings sold
in the following month. Suppliers are paid $4 for a pair of earrings. One-half of a
month’s purchases is paid for in the month of purchase; the other half is paid for in the
following month. All sales are on credit, with no discount, and payable within 15 days.
The company has found, however, that only 20% of a month’s sales are collected in the
month of sale. An additional 70% is collected in the following month, and the remaining
10% is collected in the second month following sale. Bad debts have been negligible.
Monthly operating expenses for the company are given below:

Variable :
Sales commissions . . . . . . . . . . . . . 4% of sales
Fixed :
Advertising . . . . . . . . . . . . . . . . . . . $200,000
Rent . . . . . . . . . . . . . . . . . . . . . . . . . $18,000
Salaries . . . . . . . . . . . . . . . . . . . . . . $106,000
Utilities . . . . . . . . . . . . . . . . . . . . . . $7,000
Insurance . . . . . . . . . . . . . . . . . . . . . $3,000
Depreciation . . . . . . . . . . . . . . . . . . $14,000
Insurance is paid on an annual basis, in November of each year. The company plans to
purchase $16,000 in new equipment during May and $40,000 in new equipment during
June; both purchases will be for cash. The company declares dividends of $15,000 each
quarter, payable in the first month of the following quarter. A listing of the company’s
ledger accounts as of March 31 is given below:

Assets
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 74,000
Accounts receivable ($26,000 February sales; $320,000 March sales) . . . 346,000
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104,000
Prepaid insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,000
Property and equipment (net) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 950,000
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . …………. $1,495,000

Liabilities and Stockholders’ Equity

Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 100,000

Dividends payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,000
Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800,000
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 580,000
Total liabilities and stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . $1,495,000

The company maintains a minimum cash balance of $50,000. All borrowing is done at
the beginning of a month; any repayments are made at the end of a month. The company
has an agreement with a bank that allows the company to borrow in increments of $1,000
at the beginning of each month. The interest rate on these loans is 1% per month and for
simplicity we will assume that interest is not compounded. At the end of the quarter, the
company would pay the bank all of the accumulated interest on the loan and as much of
the loan as possible (in increments of $1,000), while still retaining at least $50,000 in
cash.

Required :
Prepare a master budget for the three-month period ending June 30. Include the following
detailed budgets:
1. a. A sales budget, by month and in total.
b. A schedule of expected cash collections from sales, by month and in total.
c. A merchandise purchases budget in units and in dollars. Show the budget by month
and in total.
d. A schedule of expected cash disbursements for merchandise purchases, by month
and in total.
2. A cash budget. Show the budget by month and in total. Determine any borrowing that
would be needed to maintain the minimum cash balance of $50,000.
3. A budgeted income statement for the three-month period ending June 30. Use the
contribution approach.
4. A budgeted balance sheet as of June 30.

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