EASY ROUND

1.The estimated unit costs for a company using absorption (full) costing and planning to produce and sell at a level of 12,000 units per month are as follows.

Estimated Cost Item Unit Cost --------- --------- Direct materials $32 Direct labor 20 Variable manufacturing overhead 15 Fixed manufacturing overhead 6 Variable selling 3 Fixed selling 4

Source: CMA 1291 3-27 (Refers to Fact Pattern #1)Estimated conversion costs per unit are

A. $35.

B. $41.

C. $48.

D. $67.

Answer (B) is correct. Conversion costs are incurred in transforming raw materials into finished products. They include direct labor and factory overhead. Thus, unit conversion costs equal $41 ($20 direct labor + $15 variable overhead + $6 fixed overhead).

2.Because this allocation method recognizes that service departments often provide each other with interdepartmental service, it is theoretically considered to be the most accurate method for allocating service department costs to production departments. This method is the

A. Direct method.

B. Variable method.

C. Reciprocal method.

D. Linear method.

Answer (C) is correct. The three most common methods of allocating service department costs are

the direct method, the step method, and the reciprocal method (also called the simultaneous equations method). The reciprocal method is theoretically the preferred method because it recognizes reciprocal services among service departments.

3.With respect to backup procedures for master files that are on magnetic tape as opposed to master files on magnetic disk,

A. No special procedure is required for either.

B. A separate backup run is required for both tape and disk.

C. A separate backup run is required for disk while the prior master on magnetic tape serves as a backup.

D. The grandfather cycle is required in either filing situation.

Answer (C) is correct. Updating a magnetic tape file involves running the old master file together with the transaction data to create a new master file on a separate tape. The old master file and transactions file can then be retained as backup. Updating a magnetic disk file, however, entails writing on the old disk, thus destroying the original master file. Accordingly, the disk files should be copied on magnetic tape at appropriate intervals so that restart procedures can begin at those points if data are lost or destroyed. Tape provides an efficient and cost effective medium for the backup.

4.Which statement best describes Total Quality Management (TQM)?

A. TQM emphasizes reducing the cost of inspection.

B. TQM emphasizes participation by all employees in the decision-making process.

C. TQM emphasizes encouraging cross-functional teamwork.

D. TQM emphasizes doing each job right the first time.

Answer (D) is correct. TQM establishes quality as an organizational objective and views it as a major component of the organization's service to its

customers. It emphasizes employee training and commitment, product/service design and production, and customer service. Ordinarily, the quality of a product or service is as important to customers as cost and timeliness. Superior product quality is not attained merely through more inspection, better statistical quality control, and cross-functional teamwork. Manufacturers must make fundamental changes in the way they produce products and do each job right the first time.

5.The following information relates to Cinder Co.'s Northeast Division:

Sales $600,000Variable costs 360,000Traceable fixed costs 60,000Average invested capital 120,000Imputed interest rate 8%Cinder's residual income was

A. $170,400

B. $180,000

C. $189,600

D. $230,400

Answer (A) is correct. Residual income is income of an investment center minus an imputed interest charge for invested capital. Accordingly, Cinder's residual income is $170,400 [($600,000 sales - $360,000 variable costs - $60,000 traceable fixed costs) net income - (8% x $120,000 average invested capital) imputed interest].

MODERATE

1. During a performance appraisal, the manager experienced difficulty obtaining required information from a specific employee. The manager requested a private meeting with the employee for the purpose of identifying the problem and resolving the difficulty through open discussion. Which conflict management technique was the auditor applying?

A. Problem solving.

B. Expansion of resources.

C. Authoritative command.

D. Altering the human variable.

(A) The conflict management technique that involves face-to-face meetings is problem solving. Problem solving is a means of confronting the conflict and removing its causes. The emphasis is on facts and solutions, not personalities and assignment of blame.

2.

Below is a consolidated balance sheet for a commercial banking system. All figures are in billions. Assume that the required reserve ratio is 12.5%.

Assets Liabilities and Net Worth---------------------- ---------------------------Reserves $ 60 Demand deposits $100Loans 100 Capital stock 200Securities 150Property 200

This commercial banking system can increase the supply of money by a maximum of

A. P0

B. P380 billion.

C. P400 billion.

D. P480 billion.

B is correct. There are excess reserves of $47.5 billion ($60 billion actual - $12.5 billion required). The money multiplier is calculated by dividing 1 by the reserve requirement. A reserve requirement of 12.5% indicates a money multiplier of 8. Multiplying 8 by the $47.5 billion of excess reserves results in an opportunity to expand the money supply by $380 billion.

3

The data available for the current year are given below:

Whole Division Division Division Division Company 1 2 3 4 --------- -------- -------- -------- --------Variable manufacturing cost of goods sold $400,000 $140,000 $80,000 $70,000 $110,000Unallocated costs (e.g., president's salary) 100,000Fixed costs controllable by division managers (e.g., advertising, engineering, supervision costs) 90,000 30,000 20,000 20,000 20,000Net revenue 1,000,000 300,000 200,000 250,000 250,000Variable selling and administrative costs 120,000 40,000 20,000 30,000 30,000Fixed costs controllable by others (e.g., depreciation, insurance) 120,000 40,000 30,000 25,000 25,000

Using the information presented, the contribution by which of the four divisions was the highest?

DIVISION 3. The contribution margin for Division 3 is $150,000 ($250,000 net revenue - $100,000 total variable costs). The contribution controllable by Division 3's manager is $130,000 ($150,000 contribution margin - $20,000 controllable fixed cost). The total contribution by Division 3 equals its net revenue minus all costs traceable to it. Accordingly, the total contribution is $105,000 ($130,000 controllable contribution - $25,000 allocated but controllable by others). Unallocated costs are excluded from the calculation. If separate amounts are determined for the division's contribution and the controllable contribution, the difference between the division's and the manager's performance may be ascertained (assuming controllability of fixed costs can be assigned).

4Dick Rixard is a quality control specialist for the Lasser Company. Lasser makes ball bearings that require close tolerances. In a recent production run Rixard found that the bearings had an average diameter of .755 inches with a standard deviation of .01 inches for a sample of 100 bearings. In his quality control testing he uses a 95% confidence interval. If the Z score is 1.96, the lower boundary of the confidence interval for this production run

is?

A. .755 inches.

B. .7354 inches.

C. .7746 inches.

D. Some amount other than those given.

Answer (D) is correct. Because a 95% confidence interval equals 1.96 standard deviations in either direction from the mean, the desired lower boundary is found using the following formula:

_ ｽ x - z (s / (n) ) ｽ .755 - 1.96(.01 / (100) ) .755 - .00196 = .75304

5Ryerson Company has three sales departments, each contributing the following percentages of total sales: clothing, 50%; hardware, 30%; and household sundries, 20%. Each department has had the following average annual damaged goods rates: clothing, 2%; hardware, 5%; and household sundries, 2.5%. A random corporate audit has found a weekly damaged goods rate of sufficient magnitude to alarm Ryerson's management. The probability (rounded) that this rate occurred in the clothing department is

A. 50%.

B. 1%.

C. 25%.

D. 33 1/3%.

Answer (D) is correct. Weighting the percentage of sales by the percentage of quality control problems for each department determines the annual company rate of damaged goods as follows:

Department Sales Damages Weighted ---------- -------- -------- ----------- Clothing 50% 2% 1% Hardware 30% 5% 1.5% Household 20% 2.5% 0.5% ------

3% ====== The clothing department accounts for 33-1/3% (1% ・3%) of the total company rate. Thus, the probability that an observed problem is in the clothing department is 33-1/3%.

5

Bulgaria production possibilities table --------------------------------------- Production Alternatives --------------------------------Product A B C D E F ----- ----- --- --- --- ---Cars 1,500 1,200 900 600 300 0Tractors 0 100 200 300 400 500

Andorra production possibilities table -------------------------------------- Production Alternatives -------------------------------Product A B C D E ----- ----- ----- ----- ---Cars 4,000 3,000 2,000 1,000 0Tractors 0 200 400 600 800

Which of the following statements is not true?

A. Bulgaria should specialize in the production of tractors.

B. Bulgaria has a comparative advantage in the production of tractors.

C. Andorra should specialize in the production of tractors.

D. Andorra has a comparative advantage in the production of cars.

Answer (C) is correct. Andorra should not specialize in the production of tractors because it does not have a comparative advantage in tractors. Total output is maximized when each country specializes in the products in which it has the lower opportunity cost (or comparative advantage). The cost of a tractor in Andorra is 5 cars (1,000 ・200), whereas the cost of a tractor in Bulgaria is 3 cars (300 ・100). Thus, Bulgaria has the comparative advantage with tractors.

7

Merkle, Inc. has a temporary need for funds. Management is trying to decide between not taking discounts from one of their three biggest suppliers, or a 14.75% per annum renewable discount loan from its bank for 3 months. The suppliers' terms are as follows:

Fort Co. 1/10, net 30 Riley Manufacturing Co. 2/15, net 60 Shad, Inc. 3/15, net 90Using a 360-day year, the cheapest source of short-term financing in this situation is

A. The bank.

B. Fort Co.

C. Riley Manufacturing Co.

D. Shad, Inc.

Answer (D) is correct. The first step is to determine the actual annual percentage interest rate for each of the four options. Assuming a $100 invoice, the Fort Company discount represents interest of $1 on a loan of $99 for 20 days (30-day credit period - 10-day discount period). The annual interest rate is 18.1818% [(360/20) periods x ($1/$99)]. The Riley Company discount represents an interest charge of $2 on a loan of $98; i.e., by not paying on the 15th day, the company will have the use of $98 for 45 days (60-day credit period - 15-day discount period). The number of periods in a year would be 8 (360/45). The interest would be 16.326% ($2/$98 x 8 periods). The Shad loan would be for $97 at a cost of $3. The loan would be for 75 days (90 - 15). Given 4.8 interest periods in a year (360/75), the annual interest rate would be 14.845% ($3/$97 x 4.8). The bank loan was quoted at 14.75% on a discount basis. On a $100 note, the borrower would only receive $85.25, giving an interest rate of 17.302% ($14.75/$85.25). Thus, not paying Shad, Inc.'s invoices on time would be the lowest cost source of capital, at a cost of 14.845%.

8. A condensed comparative balance sheet for a company appears below:

12-31-Year 1 12-31-Year 2 ------------ ------------Cash $40,000 $30,000Accounts receivable 120,000 100,000Inventory 200,000 300,000Property, plant, & equipment 500,000 550,000Accumulated depreciation (280,000) (340,000) -------- --------

Total assets $580,000 $640,000 ======== ========Current liabilities $60,000 $100,000Long-term liabilities 390,000 420,000Stockholders' equity 130,000 120,000 -------- --------Total liabilities and equity $580,000 $640,000 ======== ========

In looking at liquidity ratios at both balance sheet dates, what happened to the (1) current ratio and (2) acid-test (quick) ratio?

(1) (2) Current Ratio Acid-Test Ratio ------------- --------------- A.

Increased Increased B.

Increased Decreased C.

Decreased Increased D.

Decreased Decreased

Answer (D) is correct. The current ratio is determined by dividing current assets by current liabilities. The acid-test ratio is determined by dividing quick assets by current liabilities. At December 31, year 1, the current ratio is 6 to 1 [($40,000 + $120,000 + $200,000)/$60,000]. At December 31, year 2, the current ratio is 4.3 to 1 [($30,000 + $100,000 + $300,000)/$100,000]. Hence, there was a decrease in the current ratio. At December 31, year 1, the acid-test ratio is 2.667 to 1 [($40,000 + $120,000)/$60,000]. At December 31, year 2, the acid-test ratio is 1.3 to 1 [($30,000 + $100,000)/$100,000]. Thus, the acid-test ratio also declined.

9.Fast Freight, Inc. is planning to purchase equipment to make its operations more efficient. This equipment has an estimated life of 6 years. As part of this acquisition, a $75,000 investment in working capital is anticipated. In a discounted cash flow analysis, the investment in working

capital

A. Should be amortized over the useful life of the equipment.

B. Can be disregarded because no cash is involved.

C. Should be treated as an immediate cash outflow.

D. Should be treated as an immediate cash outflow that is later recovered at the end of 6 years.

Answer (D) is correct. The investment in a new project includes more than the initial cost of new capital equipment. In addition, funds must be provided for increases in receivables and inventories. This investment in working capital is treated as an initial cost of the investment that will be recovered in full at the end of the project's life.

10

Mulva Inc. is considering the following five independent projects:

Required AmountProject of Capital IRR------- --------------- ------ A $300,000 25.35% B 500,000 23.22% C 400,000 19.10% D 550,000 9.25% E 650,000 8.50%The company has a target capital structure which is 40 percent debt and 60 percent equity. The company can issue bonds with a yield to maturity of 10 percent. The company has $900,000 in retained earnings, and the current stock price is $40 per share. The flotation costs associated with issuing new equity are $2 per share. Mulva's earnings are expected to continue to grow at 5 percent per year. Next year's dividend (D1) is forecasted to be $2.50. The firm faces a 40 percent tax rate. What is the size of Mulva's capital budget?

A. $1,200,000

B. $1,750,000

C. $2,400,000

D. $800,000

Answer (B) is correct. The size of Mulva's capital budget will be determined by the number of projects it can profitably undertake, i.e., those projects for

which the IRR > applicable WACC. First, find the costs of each type of financing: cost of retained earnings = ks = ($2.50 ・$40) + 0.05 = 11.25% and cost of debt = kd = 10%. To calculate the cost of new equity, ke, we solve for ke =[$2.50 ・($40 - $2)] + 0.05 = 0.1158 = 11.58%.

DIFFICULT

1.Which one of the following variances is of least significance from a behavioral control perspective?

A. Unfavorable material quantity variance amounting to 20% of the quantity allowed for the output attained.

B. Unfavorable labor efficiency variance amounting to 10% more than the budgeted hours for the output attained.

C. Favorable labor rate variance resulting from an inability to hire experienced workers to replace retiring workers.

D. Fixed overhead volume variance resulting from management's decision midway through the fiscal year to reduce its budgeted output by 20%.

Answer (D) is correct. Most variances are of significance to someone who is responsible for that variance. However, a fixed overhead volume variance is often not the responsibility of anyone other than top management. The fixed overhead volume variance equals the difference between budgeted fixed overhead and the amount applied (standard rate x standard input allowed for the actual output). It can be caused by economic downturns, labor strife, bad weather, or a change in planned output. Thus, a fixed overhead volume variance resulting from a top management decision to reduce output has fewer behavioral implications than other variances.

2.Mountain View Hospital (MVH) has adopted a standard cost accounting system for evaluation and control of nursing labor. Diagnosis Related Groups (DRGs), instituted by the U.S. government for health insurance reimbursement, are used as the output measure in the standard cost system. A DRG is a patient classification scheme in which hospitals

are regarded as multiproduct firms with inpatient treatment procedures related to the numbers and types of patient ailments treated. MVH has developed standard nursing times for the treatment of each DRG classification, and nursing labor hours are assumed to vary with the number of DRGs treated within a time period.

The nursing unit on the fourth floor treats patients with four DRG classifications. The unit is staffed with registered nurses (RNs), licensed practical nurses (LPNs), and aides. The standard nursing hours and salary rates and actual numbers of patients for the month of May were as follows.

Standard Actual Hours per DRG Total Standard Hours DRG No. of ------------- --------------------Classification Patients RN LPN Aide RN LPN Aide-------------- -------- -- --- ---- ----- ----- ----- 1 250 6 4 5 1,500 1,000 1,250 2 90 26 16 10 2,340 1,440 900 3 240 10 5 4 2,400 1,200 960 4 140 12 7 10 1,680 980 1,400 ----- ----- ----- 7,920 4,620 4,510 ===== ===== ===== Standard Hourly Rates --------------------- RN $12.00 LPN 8.00 Aide 6.00The results of operations during May for the fourth floor nursing unit are presented below:

RN LPN Aide -------- ------- -------Actual hours 8,150 4,300 4,400Actual salary $100,245 $35,260 $25,300Actual hourly rate $12.30 $8.20 $5.75

Because MVH does not have data to calculate variances by DRG, it uses a flexible budgeting approach to calculate labor variances for each reporting period by labor classification (RN, LPN, Aide). Labor mix and labor yield variances are also calculated because one labor input can be substituted for another. The variances are used by nursing supervisors and hospital administration to evaluate the performance of nurses.

What is the total flexible budget variance?

Answer (D) is correct. The total flexible budget variance is the difference between the standard cost of labor and the actual cost of labor. Based on the standard hours and rates given, the standard cost of labor is $159,060 [(7,920 x $12.00) + (4,620 x

$8.00) + (4,510 x $6.00)]. The actual cost of labor is $160,805 ($100,245 + $35,260 + $25,300). Thus, the total flexible budget variance is $1,745 unfavorable ($160,805 actual - $159,060 standard).

3.The market share variance equals

A. Actual units x (budgeted weighted-average UCM for planned mix - budgeted weighted-average UCM for actual mix).

B. (Actual units - master budget units) x budgeted weighted-average UCM for the planned mix.

C. Budgeted market share percentage x (actual market size in units - budgeted market size in units) x budgeted weighted-average UCM.

D. (Actual market share percentage - budgeted market share percentage) x actual market size in units x budgeted weighted-average UCM.

Answer (D) is correct. The market share variance gives an indication of the amount of contribution margin gained (forgone) because of a change in the market share.

4.The DCL Corporation is preparing to evaluate the capital expenditure proposals for the coming year. Because the firm employs discounted cash flow methods of analyses, the cost of capital for the firm must be estimated. The following information for DCL Corporation is provided.

ｷ Market price of common stock is $50 per share. ｷ The dividend next year is expected to be $2.50 per share. ｷ Expected growth in dividends is a constant 10%. ｷ New bonds can be issued at face value with a 13% coupon rate. ｷ The current capital structure of 40% long-term debt and 60% equity

is considered to be optimal. ｷ Anticipated earnings to be retained in the coming year are $3 million. ｷ The firm has a 40% marginal tax rate.

If the firm must assume a 10% flotation cost on new stock issuances, what is the cost of new common stock?

Answer (B) is correct. The formula to determine the cost of retained earnings, with the additional flotation cost entered into the calculation, is

D 1 K = -------------------- + G s P (1-Flotation Cost) 0 If: K = Cost of retained earnings s P = Current price of the stock 0 D = Next dividend 1 G = Dividend growth rate

This yields a cost of new common stock of 15.56%. $2.50 K = ------------ + 10% s $50.00 x 90% $2.50 = ------------ + 10% = 15.56% $45.00

5. Monosone, Inc. Statement of Financial Position December 31, Year 1 Total assets $10,000,000 =========== Current liabilities $ 2,000,000 Long-term debt 3,000,000 Common stock (1,000,000 shares authorized, 100,000 shares outstanding at $5 par value) 500,000 Paid-in capital in excess of par 1,600,000 Retained earnings 2,900,000 ----------- Total liabilities and shareholders' equity $10,000,000 ===========Expected dividend payments: December 31, year 2 $2.00 December 31, year 3 $2.10 December 31, year 4 $2.25Expected selling price on December 31, year 4 $25.00

An investor is considering buying Monosone, Inc.'s common stock on January 1, year 2 and anticipates, with reasonable assurance, selling it December 31, year 4 at $25.00 per share. What is the intrinsic value on January 1, year 2 of each share (rounded to the nearest dollar) when

the required rate of return is 10%?

Answer = 24.The intrinsic value of the stock is its discounted present value given the 10% required rate of return (discount rate), annual dividend payments, and the expectation of sale at the end of 3 years for a specified price ($25). Hence, the intrinsic value has two components: the sales price and income. The present values of the future $25 selling price and the related annual dividends of $2.00, $2.10, and $2.25 for year 2, year 3, and year 4, respectively, can be determined by applying the relevant time value of money factors rounded to the nearest dollar. Accordingly, the sum of the present values (the intrinsic value of a share of stock) is $24.

6Condensed monthly operating income data for Korbin Inc. for May follows:

Urban Suburban Store Store Total ------- -------- -------- Sales $80,000 $120,000 $200,000 Variable costs 32,000 84,000 116,000 ------- -------- -------- Contribution margin $48,000 $36,000 $84,000 Direct fixed costs 20,000 40,000 60,000 ------- -------- -------- Store segment margin $28,000 $(4,000) $24,000 Common fixed cost 4,000 6,000 10,000 ------- -------- -------- Operating income $24,000 $(10,000) $14,000 ======= ======== ========Additional information regarding Korbin's operations follows:* One-fourth of each store's direct fixed costs would continue if either store is closed.* Korbin allocates common fixed costs to each store on the basis of sales dollars.* Management estimates that closing the Suburban Store would result in a 10% decrease in the Urban Store's sales, while closing the Urban Store would not affect the Suburban Store's sales.* The operating results for May are representative of all months.

A decision by Korbin to close the Suburban Store would result in a monthly increase (decrease) in Korbin's operating income of

10,800. If the Suburban Store is closed, one-fourth of its direct fixed costs will continue. Thus, the segment margin that should be used to calculate the effect of its closing on Korbin's

operating income is $6,000 {$36,000 contribution margin - [$40,000 direct fixed costs x (1.0 - .25)]}. In addition, the sales (and contribution margin) of the Urban Store will decline by 10% if the Suburban store closes. A 10% reduction in Urban's $48,000 contribution margin will reduce income by $4,800. Accordingly, the effect of closing the Suburban Store is to decrease operating income by $10,800 ($6,000 + $4,800).

7.The financial transactions for a country with values stated in billions of dollars follow.

Gross domestic product (GDP) $4,000 Transfer payments 500 Corporate income taxes 50 Social Security contributions 200 Indirect business taxes 210 Personal taxes 250 Undistributed corporate profits 25 Depreciation 500 Net income earned abroad for the country 0

Compute: Net Domestic Product and Disposable Income?

NDP :3,500 Net domestic product (NDP) is defined as gross domestic product (GDP) minus consumption of fixed capital (depreciation). GDP is the total market value of all final goods and services produced in an economy during some specified period of time. It excludes the market value of goods and services produced outside the U.S. but includes domestic production by foreign-owned resources. NDP equals $3,500 ($4,000 GDP - $500 Depreciation).

DI= 3265. Disposable income is defined as personal income minus personal income taxes. Personal income is defined as national income, minus corporate income taxes, minus undistributed corporate profits, minus Social Security contributions, plus transfer payments. National income is $3,290 ($4,000 GDP - $500 depreciation - $210 indirect business taxes). Hence, personal income is $3,515 ($3,290 - $50 - $25 - $200 + $500). Therefore, disposable income is $3,265 ($3,515 - $250).

8.Brown Maintenance Services has been performing technical maintenance service on a wide variety of business

machines for small businesses in a large metropolitan area for many years. Brown has been considering a change in its fee structure. The analysis requires a probability distribution for each week for the number of anticipated service calls related to each of several different types of equipment.

[99] Source: Publisher (Refers to Fact Pattern #17)Phil Brown suggested establishing the distribution using the relative frequency of various numbers of weekly service calls over the last 4 years. The following tabulation was prepared:

Number of Calls Number of Occurrences --------------- --------------------- 801-850 4 851-900 10 901-950 80 951-1,000 40 1,001-1,050 20 1,051-1,100 12 1,101-1,150 12 1,151-1,200 10 1,201-1,250 8 1,251-1,300 4

Based on this probability distribution, the probability of more than 1,150 calls for service during a given week is

Answer (D) is correct. Of the 200 recorded occurrences, only 22 were over 1,150 per week: 10 in the 1,151-1,200 range, 8 in the 1,201-1,250 range, and 4 in the 1,251-1,300 range. Thus, the probability of a number of calls greater than 1,150 is simply (10 + 8 + 4) ・200 = .11.

9The exhibit below reflects a summary of performance for a single item of a retail store’s inventory for the month ended April 30, 2006.

Flexible Static Actual Budget Flexible (Master) Results Variations Budget Budget

Sales (units) 11,000 - 11,000 12,000Revenue (sales) P208,000 P12,000 U P220,000 P240,000Variable costs 121,000 11,000 U 110,000 120,000CM 87,000 23,000 U 110,000 120,000Fixed costs 72,000 - 72,000 72,000

Operating income P 15,000 P23,000 U P 38,000 P 48,000

Compute: Sales Volume Variance

Answer: 10,000 unfavourable

The sales volume variance refers to the contribution margin volume variance which is the difference in actual and budgeted quantity times the budgeted unit

contribution margin of P10 (I.e., P120,000 / 12,000). Therefore, the net sales volume variance is P(10,000) UF [i.e., (11,000 – 12,000) x P10]. The variance is unfavorable because the actual unit sales are lower than the budgeted unit sales, a negative variance, and is an unfavorable variance in sales variance analysis.

10.

PortCo Products is a divisionalized furniture manufacturer. The divisions are autonomous segments, with each division being responsible for its own sales, costs of operations, working capital management, and equipment acquisition. Each division serves a different market in the furniture industry. Because the markets and products of the divisions are so different, there have never been any transfers between divisions.

The Commercial Division manufactures equipment and furniture that is purchased by the restaurant industry. The division plans to introduce a new line of counter and chair units that feature a cushioned seat for the counter chairs. John Kline, the division manager, has discussed the manufacturing of the cushioned seat with Russ Fiegel of the Office Division. They both believe a cushioned seat currently made by the Office Division for use on its deluxe office stool could be modified for use on the new counter chair. Consequently, Kline has asked Russ Fiegel for a price for 100-unit lots of the cushioned seat. The following conversation took place about the price to be charged for the cushioned seats:

Fiegel: "John, we can make the necessary modifications to the cushioned seat easily. The raw materials used in your seat are slightly different and should cost about 10% more than those used in our deluxe office stool. However, the labor time should be the same because the seat fabrication operation basically is the same. I would price the seat at our regular rate--full cost plus 30% markup."

Kline: "That's higher than I expected, Russ. I was thinking that a good price would be your variable manufacturing costs. After all, your capacity costs will be incurred regardless of this job."

Fiegel: "John, I'm at capacity. By making the cushion seats for you, I'll have to cut my production of deluxe office stools. Of course, I can increase my production of

economy office stools. The labor time freed by not having to fabricate the frame or assemble the deluxe stool can be shifted to the frame fabrication and assembly of the economy office stool. Fortunately, I can switch my labor force between these two models of stools without any loss of efficiency. As you know, overtime is not a feasible alternative in our community. I'd like to sell it to you at

variable cost, but I have excess demand for both products. I don't mind changing my product mix to the economy model if I get a good return on the seats I make for you. Here are my standard costs for the two stools and a schedule of my manufacturing overhead."

Kline: "I guess I see your point, Russ, but I don't want to price myself out of the market. Maybe we should talk to Corporate to see if they can give us any guidance."

Office Division Standard Costs and Prices Deluxe Economy Office Office Stool Stool ------ --------Raw materials Framing $ 8.15 $ 9.76 Cushioned seat Padding 2.40 -- Vinyl 4.00 -- Molded seat (purchased) -- 6.00Direct labor Frame fabrication (.5 x $7.50/DLH) 3.75 (.5 x $7.50/DLH) 3.75 Cushion fabrication (.5 x $7.50/DLH) 3.75 -- Assembly* (.5 x $7.50/DLH) 3.75 (.3 x $7.50/DLH) 2.25Manufacturing Overhead (1.5DLH x $12.80/DLH) 19.20 (.8DLH x $12.80/DLH) 10.24 ------ ------ Total standard cost $45.00 $32.00 ====== ====== Selling price (30% markup) $58.50 $41.60 ====== ======*Attaching seats to frames and attaching rubber feet. Office Division Manufacturing Overhead Budget Overhead Item Nature Amount----------------- ------------------------ ----------Supplies Variable--at current market prices $ 420,000Indirect labor Variable 375,000Supervision Nonvariable 250,000Power Use varies with activity; rates are fixed 180,000Heat and light Nonvariable--light is fixed regardless of production while heat/ air conditioning varies with fuel charges 140,000Property taxes and Nonvariable--any insurance taxes change in amounts/

rates is independent of production 200,000Depreciation Fixed dollar total 1,700,000Employee benefits 20% of supervision, direct and indirect labor 575,000 ---------- Total overhead $3,840,000 ========== Capacity in DLH 300,000 ========== Overhead rate/DLH $12.80 ==========What is the opportunity cost of the Office Division if 125 economy stools can be made in the time required for 100 deluxe stools?

Answer (D) is correct. Opportunity cost is the benefit of the next best opportunity forgone. The opportunity cost here is the contribution margin forgone by shifting production to the economy office stool ($2,520 - $1,980 = $540).

Deluxe Economy ------ ------ Selling price $58.50 $41.60 ------ ------ Costs Materials $14.55 $15.76 Labor ($7.50 x 1.5) 11.25 ($7.50 x .8) 6.00 Variable O/H ($5 x 1.5) 7.50 ($5 x .8) 4.00 Fixed O/H -- -- ------ ------ Total costs $33.30 $25.76 ------ ------ Unit CM $25.20 $15.84 Units produced x 100 x 125 ------ ------ Total CM $2,520 $1,980 ====== ======