(Convert variable to absorption) George Massat started a new business in 1999 to produce portable, climate-controlled shelters. The shelters have many applications in special events and sporting activities. George’s accountant prepared the variable costing income statement shown after part (d3) after the first year to help him in making decisions. During the year, the following variable production costs per unit were recorded: direct material, $800; direct labor, $300; and overhead, $200. Mr. Massat was upset about the net loss because he had wanted to borrow funds to expand capacity. His friend who teaches accounting at a local university suggested that the use of absorption costing could change the picture.

a. Prepare an absorption costing pretax income statement.

b. Explain the source of the difference between the net income and the net loss figures under the two costing systems.

c. Would it be appropriate to present an absorption costing income statement to the local banker in light of Mr. Massat’s knowledge of the net loss determined under variable costing? Explain. (continued)

d. Assume that during the second year of operations, Mr. Massat’s company

produced 1,750 shelters, sold 1,850, and experienced the same total fixed

costs. For the second year:

1. Prepare a variable costing pretax income statement.

2. Prepare an absorption costing pretax income statement.

3. Explain the difference between the incomes for the second year under the two systems.

Comprehensive – Part a. Reproduced in the following table are the first three lines from the 2% columns of each of several tables of mathematical values. For each of the following items, you are to select from among these fragmentary tables the one from which the amount required can be obtained most directly (assuming that the complete table was available in each instance):

1. The amount to which a single sum would accumulate at compound interest by the end of a specified period (interest compounded annually).

2. The amount that must be appropriated at the end of each of a specific number of years to provide for the accumulation, at annually compounded interest, of a certain sum.

3. The amount that must be deposited in a fund that will earn interest at a specified rate, compounded annually, in order to make possible the withdrawal of certain equal sums annually over a specified period starting one year from date of deposit.

4. The amount of interest that will accumulate on a single deposit by the end of a specified period (interest compounded semiannually).

5. The amount, net of compound discount, that if paid now would settle a debt of larger amount due at a specified future date.

Part b. The following tables of values at 10% interest may be used as needed to answer the questions in this part of the problem.

1. Your client has made annual payments of $2,500 into a fund at the close of each year for the past three years. The fund balance immediately after the third payment totaled $8,275. He has asked you how many more $2,500 annual payments will be required to bring the fund to $22,500, assuming that the fund continues to earn interest at 10% compounded annually. Compute the number of full payments required and the amount of the final payment if it does not require the entire $2,500. Carefully label all computations supporting your answer.

2. Your client wishes to provide for the payment of an obligation of $200,000 due on July 1, 2014. He plans to deposit $20,000 in a special fund each July 1 for 7 years, starting July 1, 2008. He wishes to make an initial deposit on July 1, 2007 of an amount that, with its accumulated interest, will bring the fund up to $200,000 at the maturity of the obligation. He expects that the fund will earn interest at the rate of 10% compounded annually. Compute the amount to be deposited July 1, 2007. Carefully label all computations supporting your answer.

Some evidence suggests consumers are less than thrilled with what they are purchasing. American consumers are notoriously finicky, and pleasing them has always been difficult. But the latest results of the American Customer Satisfaction Index (ACSI) show consumers barely give companies a passing grade when it comes to satisfying their expectations of quality and service. The ACSI is based on a quarterly survey conducted by the National Quality Research Center at the University of Michigan Business School in partnership with Arthur Andersen consultants and the American Society for Quality. The overall index declined slightly in the second quarter (1999) to 72, out of a possible score of 100, from 72.1 in the first quarter. Since 1994, when the index made its debut, it has fallen 3.4%. This is the downside of corporate America’s cost cutting drive, says Claes Fornell, director of the research center and keeper of the index. Cost cutting has boosted earnings for many companies, but may hurt profits in the long term by undermining customer relationships. “If you cut too much on the cost side,” says Mr. Fornell, “customer satisfaction goes down.” And that, he contends could signal problems for the economy as a whole in years to come.

a. Does cost cutting automatically result in quality reductions? Defend your answer.

b. How can managers be confident that they are not harming long-term survival of their organizations as they strive to manage “relevant” costs?

(Allocation of scarce resources) Jill Rose received her accounting degree in 1972. Since receiving her degree, Ms. Rose has obtained significant experience in a variety of job settings. Her skills include auditing, income and estate taxation, and business consulting. Ms. Rose currently has her own practice and her skills are in such demand that she limits her practice to taxation issues. Most of her engagements are one of three types: individual income taxation, estate taxation, or corporate taxation. Following are data pertaining to the revenues and costs of each tax area (per tax return):

Fixed costs of operating Ms. Rose’s office are $40,000 per year. Ms. Rose has such significant demand for her work that she must ration her time. She desires to work no more than 2,500 hours in the coming year. She can allocate her time such that she works only on one type of tax return or on any combination of the three types.

a. How should Ms. Rose allocate her time in the coming year to maximize her income?

b. Based on the optimal allocation, what is Ms. Rose’s projected pretax income for the coming year?

c. What other factors should Ms. Rose consider in allocating her time?

(CVP single product—comprehensive) Speedy Mouse Inc. makes a special mouse for computers. Each mouse sells for $25 and annual production and sales are 120,000 units. Costs for each mouse are as follows:

a. Calculate the unit contribution margin in dollars and the contribution margin ratio for the product.

b. Determine the break-even point in number of mice.

c. Calculate the dollar break-even point using the contribution margin ratio.

d. Determine Speedy Mouse Inc.’s margin of safety in units, in sales dollars, and as a percentage.

e. Compute Speedy Mouse Inc.’s degree of operating leverage. If sales increase by 25 percent, by what percentage would before-tax income increase?

f. How many mice must the company sell if it desires to earn $996,450 in before-tax profits?

g. If Speedy Mouse Inc. wants to earn $657,800 after tax and is subject to a 20 percent tax rate, how many units must be sold? h. How many units would the company need to sell to break even if its fixed costs increased by $7,865? (Use original data.) i. Speedy Mouse Inc. has received an offer to provide a one-time sale of 4,000 mice to a network of computer superstores. This sale would not affect other sales or their costs, but the variable cost of the additional units will increase by $0.60 for shipping and fixed costs will increase by $18,000. The selling price for each unit in this order would be $20. Based on quantitative measurement, should the company accept this offer? Show your calculations.

(Special order) Hydraulic Engineering, located in Toronto, manufactures a variety of industrial valves and pipe fittings that are sold to customers in the United States. Currently, the company is operating at 70 percent of capacity and is earning a satisfactory return on investment. Prince Industries Ltd. of Scotland has approached management with an offer to buy 120,000 units of a pressure valve. Prince Industries manufactures a valve that is almost identical to Hydraulic Engineering’s pressure valve; however, a fire in Prince Industries’ valve plant has shut down its manufacturing operations. Prince needs the 120,000 valves over the next four months to meet commitments to its regular customers; the company is prepared to pay $19 each for the valves, FOB shipping point. Hydraulic Engineering’s product cost, based on current attainable standards, for the pressure valve is

Manufacturing overhead is applied to production at the rate of $18 per standard direct labor hour. This overhead rate is made up of the following components:

Additional costs incurred in connection with sales of the pressure valve include sales commissions of 5 percent and freight expense of $1 per unit. However, the company does not pay sales commissions on special orders that come directly to management. In determining selling prices, Hydraulic Engineering adds a 40 percent markup to product cost. This provides a $28 suggested selling price for the pressure valve. The marketing department, however, has set the current selling price at $27 to maintain market share. Production management believes that it can handle the Prince Industries order without disrupting its scheduled production. The order would, however, require additional fixed factory overhead of $12,000 per month in the form of supervision and clerical costs. If management accepts the order, 30,000 pressure valves will be manufactured and shipped to Prince Industries each month for the next four months. Shipments will be made in weekly consignments, FOB shipping point.

a. Determine how many additional direct labor hours would be required each month to fill the Prince Industries order.

b. Prepare an incremental analysis showing the impact of accepting the Prince Industries order.

c. Calculate the minimum unit price that Hydraulic Engineering’s management could accept for the Prince Industries order without reducing net income.

d. Identify the factors, other than price, that Hydraulic Engineering should consider before accepting the Prince Industries order. (CMA adapted)

The manager of a large office intends to conduct a work sampling of the time the staff spends on the telephone. The observations will be taken over a period of 50 workdays. The office is open five days a week for eight hours a day. Although the study will consist of 200 random observations, in this problem you will be asked to determine times for 11 observations.

a. Determine times for 11 observations. For days, read sets of two-digit numbers going across row 4 from left to right (e.g., 16 32 15 46 …), and do the same in row 5.

b. For hours, read one-digit numbers going down, using the first digit of column 1 (e.g., 6 4 3 1 …).

c. For minutes, read two-digit numbers going up column 4 using the first two digits (e.g., 30 46 10 …), and then repeat for the second two digits going up column 4 (e.g., 95 66 39 …).

d. Arrange the combinations chronologically by day, hour, and minute.

e. Assume March 1 is a Monday and that there are no holidays in March, April, or May.

Convert your observation days to dates in March, April, and May.

Capital plc carried on business in four product segments, namely aircraft design, hairdressing salons, import agencies and beauty products. The directors are now considering the dividend policy and the future capital structure of the company.

The draft accounts of Capital plc as at 30 November 1995 showed the following share capital and reserves:

Note 1

The market value of ordinary shares as at 30 November 1995 was £1.60.

Note 2

The redeemable preference shares were issued in 1985. They are redeemable at par.

Note 3

A revaluation reserve of £45 million was created on 1 December 1994 on the revaluation of some of the buildings. A debit of £2 million was made to the reserve in 1995 arising from a permanent fall in value on the revaluation of certain computer equipment.

Note 4

The profit and loss account of Capital plc for the year ended 30 November 1995 contained the following items:

(i) Exchange gain on a long-term German mark loan taken out on 1 December 1994 £6m

(ii) Depreciation based on historic cost of fixed assets £68m Additional depreciation based on revalued amount of fixed assets £13m

(iii) Development costs for the year written off £22m

(iv) Profit attributed to long-term contracts in beauty products £9m

At their next meeting the directors will be considering proposals for:

(a) the purchase ‘off market’ at £1.50 per share of 30% of the issued ordinary shares of Capital plc which are currently held by Venture plc, a venture capital company. The directors consider that the shares are substantially undervalued and that the company should purchase the shares and hold them as an investment classified under ‘own shares’ in the balance sheet;

(b) the redemption of the preference shares;

(c) the distribution to the shareholders of Capital plc of shares in Kind plc, which havebeen held as an investment. The investment appears at cost, £15 million, in the balance sheet and the directors estimate that it has a market value of £24 million at 30 November 1995;

(d) a bonus issue of one ordinary share for every 20 ordinary shares held; and

(e) the amount of the final dividend to recommend for 1995.

The finance director has been requested to present a report in relation to these proposals.

Required

(a) (i) Advise the board on its proposed procedure for purchasing the issued shares in Capital plc held by Venture plc and on its intention to hold these as an investment.

(ii) Draft the journal entries to record the purchase transaction assuming that the board acts in accordance with the requirements of the Companies Act 1985.

(b) (i) Explain the definition of distributable profits in a public company (ignore the rules relating to investment companies).

(ii) Identify which of the proposals (a) to (e) above would be classified as a distribution.

(iii) Describe the accounting treatment of proposal (c), distribution of shares held as an investment in Kind plc.

(c) Calculate the distributable profits as at 30 November 1995 on the assumption that the company had redeemed the preference shares and made the bonus issue but delayed action on the purchase of own shares and the distribution of the shares in Kind plc until 1996. Explain clearly your treatment of each item mentioned in the reserves.

Randolph Noble opened a medical practice specializing in surgery. During the first month of operation (August), the business, titled Randolph Noble, Professional Corporation (P.C.), experienced the following events:

Required

1. Analyze the effects of these events on the accounting equation of the medical practice of Randolph Noble, P.C. Use a format similar to that of Exhibit 2-1, Panel B, with headings for Cash, Accounts Receivable, Medical Supplies, Land, Accounts Payable, Note Payable, Common Stock, and Retained Earnings.

2. After completing the analysis, answer these questions about the business.

a. How much are total assets?

b. How much does the business expect to collect from patients?

c. How much does the business owe in total?

d. How much of the business’s assets does Noble really own?(

e. How much net income or net loss did the business experience during its first month of operations?

Aberdeen plc acquired shares in two other companies as follows:

The summarised draft profit and loss accounts of the companies for the year ended 31 October 2002 were:

Additional information

(1) It is group policy to amortise purchased goodwill over five years with a full year’s charge in the year of acquisition.

(2) On 1 October 2002, Berwick Ltd sold goods to Aberdeen plc. These goods had a sales value of £200 000, Berwick Ltd having applied a mark up of 25%. As at 31 October 2002, Aberdeen plc still held £140000 of these goods in stock.

(3) Aberdeen plc has not yet accounted for any dividends receivable from Berwick Ltd or Coupar Ltd. The dividends from Coupar Ltd all relate to the post-acquisition period.

(4) Aberdeen plc requires Coupar Ltd to bring its depreciation methods in line with group accounting policies. The directors have estimated that this would reduce the profit of Coupar Ltd for the year ended 31 October 2002 by £200 000. Ignore any effect on the taxation charge.

(5) The directors of Aberdeen plc propose a transfer of £100 000 to a general reserve and this should be accounted for.

(6) The retained profit brought forward at 1 November 2001 for the three companies was:

Requirement

Prepare the consolidated profit and loss account, statement of reserves and disclosure note for Profit attributable to the members of Aberdeen plc, for the year ended 31 October 2002.