AIM 2302 – SOLUTION TO PRACTICE EXAM III

Chapter 7: Pricing and Product Planning 1. Short-term pricing decisions depend on all of the following, EXCEPT:

a. Whether surplus capacity is available for the additional production.b. Whether the available capacity limits production.c. The time period of the contract over which capacity is committed.d. The level of product-sustaining activities and costs.

____D____

2. A small firm on the fringe of an industry is probablya. A price setterb. A price takerc. Both a price taker and a price setterd. A price maker

_____B____

3. Ram Company produces two products, AR4 and AR8. AR4 has a contribution per unit of $3.00 and requires 0.3 machine hours per unit, whereas AR8 has a contribution of $2.50 per unit and requires 0.2 machine hours per unit. The company’s policy is to sell only products with a contribution per machine, the constrained or scare resource, greater than $9.90. What should they do?

a. Sell both AR4 and AR8.b. Sell only AR4.c. Sell only AR8.d. Sell neither AR4 nor AR8.

_____A____

4. An opportunity cost is a. Completely intangible and not measurable.b. The sacrificed potential benefit of choosing one alternative over another.c. The sacrificed past benefit of choosing one alternative over another.d. Not relevant to any decision.

_____B____

1

5. Lido Company manufactures product MY40. Currently, the product sells for $55, with total costs to manufacture of $30. In order to add a new feature to the product, additional direct materials of $3.00, direct labor of $2.50, and batch-related costs of $1.45 per unit would have to be incurred. What are the incremental costs per unit of the decision to add the new feature?

a. $3.00b. $2.50c. $6.95d. $5.50

_____C____

6. Full-cost pricing is LEAST likely to be economically justified under which of the following?

a. When customized products are produced.b. When contracts are developed with government agencies.c. When a firm enters into a long-term contractual relationship with a

customer to supply a product.d. When a firm enters into a short-term contractual relationship with a

customer to supply a product.

_____D____

7. Demand is elastic whena. A small increase in price results in a small decrease in demand.b. Price increases cause demand to fluctuate wildly.c. A small increase in price results in a large decrease in demandd. Price increases cause demand to increase.

_____C____

8. For long-term product mix decisions, comparison of the price of a product with its ___________ costs provides a valuable evaluation of its long-term profitability.

a. Variableb. Opportunityc. Incrementald. Full

____D_____

2

9. Plasticraft Company produces and sells a single product called a DROID. Plasticraft has excess capacity to manufacture 5,000 additional DROIDS. Variable costs are $35 per unit, and fixed costs total $300,000 per month. Ajax Company has offered to pay Plasticraft $39 per unit for a one-time special order for 4,000 DROIDS. This special order requires some additional selling expenses of $1.50 per unit. Should Plasticraft accept this special order?

YES: PLASTICRAFT SHOULD ACCEPT AJAX COMPANY’S OFFER BECAUSE IT WILL INCREASE OPERATING INCOME BY $10,000 = ($39 – ($35 + $1.50) * 4,000 UNITS.

OR: BECAUSE INCREMENTAL REVENUE OF $39 > INCREMENTAL COSTS OF $36.50.

10. Peanuts Company produces porcelain figurines of Lucy and Linus. The selling prices and variable costs for each figurine are as follows:

Linus LucySelling price $25.00 $20.00Variable costs Direct materials $9.00 $6.00 Direct labor 5.00 2.00 Indirect manufacturing 4.00 2.00

The cost of direct labor is $10.00 per hour and only 500 hours of labor time are available each week.

a.) Determine the contribution margin per direct labor hour for each product.

Linus LucySelling Price $25 $20Less: Variable Costs

Direct materials 9 6Direct labor 5 2Support 4 2

Contribution Margin per figurine $ 7 $10Direct labor hours per figurine .5hrs .2hrsContribution Margin per direct labor hour $14 $50

3

b.) Which product should Peanuts’ sales force promote?

Peanuts’ sales force should promote the Lucy figurine, because it has the higher contribution margin per unit of constrained resource (DL hours).

11. Charlie’s Chairs manufactures 2 models of chairs, Standard and Premium. Weekly demand is estimated to be 120 units of the Standard Model and 70 units of the Premium Model. Only 420 machine hours are available per week. The following per unit data apply:

Standard PremiumContribution margin per unit $12 $15Number of machine hours 2 3

a.) For each model, compute contribution margin per machine hour.

CM per unit $12 $15Machine Hours 2 3CM per Machine Hour $ 6 $ 5

b.) To maximize weekly production profits, how many units would you recommend of each model?

Standard: 120 units * 2MH = 240 MHPremium: 70 units * 3MH = 210 MH

450 MH

Available Capacity = 420MH vs. Required Hours = 450MH

To maximize profits, Charlie’s should maximize sales of standard chairs. 240 machine hours should be used to manufacture 120 units of the Standard Chair, and 180 machine hours should be used to manufacture 60 units of the Premium Chair

4

c.) If there are 500 machine hours available per week (instead of only 420 MH), how many chairs of each model should Charlie’s produce to maximize profits.?

500 Machine Hours results in excess capacity. Therefore, demand for both types of chairs can be met:

120 units of Standard Chair70 units of the Premium Chair

Chapter 6:Activity and Process Decisions 1. Each of the following should result in reduction in the level of work-in-process inventory and cycle time, EXCEPT:

a. Quality improvement programs.b. Corporate downsizing programs.c. Just-in-time programs.d. Cellular manufacturing.

____B____

2. Which of the following is NOT one of the four cost of quality categories?a. Appraisal costsb. Internal failure costsc. Prevention costsd. Benchmarking costs

_____D____

3. Each of the following should be considered in the make-or-buy decision, EXCEPT:

a. Unavoidable facility-sustaining costsb. The costs to produce the productc. The cost to purchase the product outside the firmd. The general implications for the firm to buy the product from another

firm (e.g., sustainability of outside price, quality of outside product, etc.)

_____A____

5

4. The cost of which of the following is an example of an appraisal cost in the cost of quality framework?

a. Inspection of batches of productsb. Supplier certificationc. Product liability lawsuitsd. Warranty claims

_____A____

5. In ____________, equipment is organized to accommodate the production of a specific product.

a. A process layoutb. A product layoutc. Cellular manufacturingd. Just-in-Time Production

____B_____

6. Shields Company has the capacity to produce 5,000 units of product H199. Currently it is producing 3,900 units. Foster Company asks Shield to produce 800 more units of H199 for a special order. Neither new machinery nor extra plant space is needed for the special order. Which of the following statements is true?

a. Only product-sustaining costs will increase.b. Only facility-sustaining costs will increase.c. Both product-sustaining and facility –sustaining costs will increase.d. Neither product-sustaining nor facility-sustaining costs will increase.

____D_____

7. The theory of constraintsa. Emphasizes long-term optimizationb. Maintains that maximizing volume through production bottlenecks will

increase operating incomec. Helps managers make special one-time decisionsd. Suggests that some component parts should be outsourced

____B_____

6

8. All of the following statements about just-in-time (JIT) are true, EXCEPT:a. Processing time decreasesb. It simplifies accountingc. It reduces the amount of money invested in inventoryd. JIT processing systems must be reliable

____B_____

9. Gumby Company is determining whether to outsource product Pokey. An outside bidder has quoted a price of $52. The following costs of the product when produced in-house are shown below on a per-unit basis:

PokeyDirect materials $13.95Direct labor 15.00Unit-related overhead 17.80Batch-related overhead 6.55Product-sustaining overhead 3.25Facility-sustaining overhead 8.35TOTAL $64.90

a.) Which support costs will not be incurred if Pokey is outsourced?

UNIT-RELATED COSTS ARE AVOIDABLE

BATCH-RELATED & PRODUCT-SUSTAINING ARE MOST LIKELY AVOIDABLE

POSSIBLY FACILITY-SUSTAINING IF THE FACILITY CAN BE CONVERTED TO ANOTHER USE WHEN PRODUCT POKEY IS OUTSOURCED

7

b.) Suppose that unit-related, batch-related and product-sustaining costs can be eliminated if Pokey is outsourced. However, the machinery, factory space, and other facility-related costs will still be incurred if Pokey is outsourced. Should Gumby outsource Pokey?

RELEVANT COSTS OF PRODUCING POKEY ARE AS FOLLOWS:

Direct materials $13.95Direct labor 15.00Unit-related overhead 17.80Batch-related overhead 6.55Product-sustaining overhead 3.25TOTAL $56.55

VERSUS THE PURCHASE PRICE OF $52

GUMBY SHOULD OUTSOURCE

OR YOU COULD HAVE WORKED IT AS FOLLOWS:

TOTAL COST TO MAKE (INCLUDING FACILITY) = $64.90 VS.COST TO PURCHASE INCLUDING FACILITY ($52 + $8.35) = $60.35

10. Eastco purchased a stamping machine four months ago and now realizes that a much better machine is available on the market. The following information pertains to both machines.

OLD NEWAcquisition cost $150,000 $200,000Remaining Life 3 years 3 yearsCurrent disposal value $60,000 -Salvage value at the end of 3 years $6,000 $9,000Annual operating costs $60,000 $12,000

The estimates above do not include rework costs. The new stamping machine also will reduce the defect rate from 4% to 2%. All defective units are reworked at a cost of $1.25 per unit. Eastco produces 150,000 units annually.

8

a. What costs are considered sunk?

ACQUISITION COST OF OLD MACHINE OF $150,000

b. Should Eastco replace the old machine?

NET BENEFITS OVER 3 YEARS NEW – OLD

Salvage value increase (9,000 – 6,000) $ 3,000Decrease in annual operating costs

(3 years * 48,000) 144,000Reduction in rework costs

(150,000 * 2% * $1.25 * 3 years) 11,250Acquisition of new machine (200,000)Current disposal value of old machine 60,000Net cash inflow $18,250

Eastco should purchase the new machine.

11. Jerry’s 5-year-old Chevy Geo Prism requires repairs estimated at $3,000 to make it roadworthy again. His friend, Elaine, suggested that he should buy a 5-year-old Honda Civic instead for $3000 cash. Elaine estimated the following costs for the two cars:

Chevy Geo Prism Honda CivicAcquisition cost $15,000 $3,000Repairs $ 3,000 ---Annual operating costs (Gas, maintenance, insurance) $ 2,280 $2,100

a. What costs are NOT relevant for this decision?

ACQUISITION COST OF GEO PRISM

9

b. What should Jerry do? What is his savings in the first year?

REPAIR THE PRISM:

REPAIR COSTS $3,000ANNUAL OPERATING COSTS $2,280

TOTAL COSTS $5,280

PURCHASE THE CIVIC:

PURCHASE PRICE $3,000ANNUAL OPERATING COSTS $2,100

TOTAL COSTS $5,100

JERRY SHOULD BUY THE CIVIC. HIS SAVINGS IN THE FIRST YEAR ARE $180 ($5,280 - $5,100)

Chapter 11: Budgeting

1. _______________ bases a period’s expenditure level for a discretionary item on the amount spent on that item during the previous period

a. Zero-based budgetingb. Periodic budgetingc. Incremental budgetingd. Continuous budgeting

____C___

2. Operating budgets include all of the following, EXCEPT:a. Sales planb. Purchasing planc. Production pland. Cash flow plan

_____D____

10

3. A demand forecast is a. An estimate of sales demand given a product priceb. Developed largely because of customer dissatisfactionc. An estimate of market demand given the amount sold the previous yeard. An estimate for the demand for labor

____A_____

4. Financial budgets include all of the following except a:a. Projected balance sheetb. Production planc. Cash flow pland. Projected income statement

____B_____

5. When discussing the roles of budgets, a control role includes?a. Identify organizational objectives and short-term goalsb. Developing long-term strategies and short-term plansc. Measuring and assessing performance against budgeted amounts d. Developing the master budget.

_____C____

6. Financial budgets are prepareda. To specify expectation for selling, purchasing, and productionb. To evaluate financial results of the proposed decisionsc. So that financial statements can be prepared for shareholdersd. To plan for production capacity

_____B____

7. Although planners update or revise the budgets during the period, ____________ is typically performed once per year

a. Zero-based budgetingb. Periodic budgetingc. Incremental budgetingd. Continuous budgeting

____B_____

11

8. The finished goods production budget determines a. The units to be produced during a periodb. Budgeted sales dollarsc. The predetermined factory overhead rated. The amount of labor hours worked

____A____

9. Direct material purchases equal a. Usage plus production needsb. Production needs plus target ending finished goods inventoryc. Beginning inventories plus production needsd. Usage plus target ending inventories less beginning inventories

____D____

10. ______________ occur(s) when subordinates ask for excess resources above and beyond what they need to accomplish budget objectives

a. Pseudo participationb. Effective budgetingc. Budget slackd. Participative budgeting

____C____

11. Amigo Corporation developed the following sales budget:

Month SalesJuly $ 30,000August 34,000September 38,000October 42,000November 48,000December 60,000

Cash is collected from customers in the following mannerMonth of sale 30%Month following sale 50%Two months following sale 15%Amount uncollectible 5%

12

Prepare a summary of cash collections for the 4th quarter. ($126,100)

Month October November DecemberAugust 5,100 --- ---September 19,000 5,700 ---October 12,600 21,000 6,300November --- 14,400 24,000December --- --- 18,000

36,700 41,100 48,300

12. The Mahoney Company has prepared a sales budget of 24,000 units for a 3-month period starting from January 1. The company has an inventory of 11,000 units of finished goods on hand at December 31 and has a target finished goods inventory of 13,000 units at the end of the succeeding quarter.

It takes 5 gallons of direct materials to make 1 unit of finished product. The company has an inventory of 110,000 gallons of direct materials at December 31 and has a target ending inventory of 100,000 gallons.

How many gallons of direct materials should be purchased during the

3 months ending March 31?

FG (Units)Budgeted sales 24,000Add target ending FG inventory 13,000Total requirements 37,000Deduct beginning FG inventory 11,000Units to be produced 26,000

DM (Gallons)DM needed for production (26,000 x 5) 130,000Add target ending DM inventory 100,000Total requirements 230,000Deduct beginning DM inventory 110,000DM to be purchased 120,000

13

Chapter 12: Variance Analysis

1. Madzinga’s Draperies manufactures curtains. Each window requires the following:

Direct materials, standards 10 square yards at $5 per yardDirect labor, standards 5 hours at $10 per hour

During the second quarter, the company made 1,500 curtains and used 14,000 square yards of fabric costing $68,600. Direct labor totaled 7,600 hours for $79,800.

a. Compute the direct materials price and efficiency variances for the quarter.

Actual Unit Costs: = $68,600 / 14,000 square yards= $4.90 per square yard

Price Variance (AP – SP) * AQ= ($4.90 - $5.00) * 14,000= $1,400 F

Usage Variance (AQ – SQ) * SP= [14,000 – (10 * 1,500)] * $5.00= $5,000 F

b. Compute the direct labor price and efficiency variances for the quarter.

Actual Labor Rate: = $79,800 / 7,600 hours= $10.50 per hour

Rate Variance (AR – SR) * AH= ($10.50 - $10.00) * 7,600= $3,800 U

Efficiency Variance (AH – SH) * SR= [7,600 – (5 * 1,500)] * $10.00= $1,000 U

14

2. Robb Industries Inc. (RII) developed standard costs for direct material and direct labor. In 2004, RII estimated the following standard costs for one of their major products, the 10-gallon plastic container.

Budgeted quantity Budgeted priceDirect materials 0.10 pounds $30 per poundDirect labor 0.05 hours $15 per hour

During June RII produced and sold 5,000 containers using 490 pounds of direct materials at an average cost per pound of $32 and 250 direct manufacturing labor-hours at an average wage of $15.25 per hour.

a. Calculate the direct materials price and usage variances for June.

Price Variance (AP – SP) * AQ= ($32 - $30) * 490= $980 U

Usage Variance (AQ – SQ) * SP= [490 – (.10 * 5,000)] * $30= $300 F

b. Calculate the direct labor rate and efficiency variances for June.

Rate Variance (AR – SR) * AH= ($15.25 - $15.00) * 250= $62.50 U

Efficiency Variance (AH – SH) * SR= [250 – (.05 * 5,000)] * $15= $0

15