CH-7-9 Managing Quality and Time to Create Value – Cost Management: Strategies for Business Decisions : Chapter Notes

This Document Contains Chapters 7 to 9 Chapter 7 Managing Quality and Time to Create Value Chapter Outline A. Cost Management Challenges: 1. What can cost managers provide to better manage quality? 2. Is there a conflict between meeting quality and time goals, or do these goals reinforce each other? 3. How should cost managers choose among all the available quality and time management tools? B. Learning Objectives: 1. Evaluate similarities and differences of total quality management and return on quality approaches to managing quality. 2. Measure and analyze dimensions of quality with commonly used diagrams, charts, and reports. 3. Understand the importance of managing process time. 4. Measure and manage productivity and capacity. 5. Evaluate how just-in-time methods create benefits by combining management of quality and time. 6. Understand how to construct and use control charts. C. Quality is an important value for an organization to offer to its customers. Poor quality results in lost customers, and high quality attracts new customers and assures that existing customers will remain loyal. Improving quality translates into improved customer satisfaction. In a globally competitive market, improving quality is a high priority for organizations. D. Quality at any cost or quality up to a cost-defining limit? There are two views on what the ideal level of quality is. 1. Total Quality Management (TQM) promotes the view that perfect quality is never achieved and that organizations must constantly seek improved quality. TQM advocates argue that customers will seek the highest quality and are willing to pay a premium for the highest quality. a. TQM is a concept attributed to W. Edwards Deming. b. TQM advocates believe that improving quality pays for itself by creating higher profits. 2. Return on quality (ROQ) is a more pragmatic view of quality. This view of quality assumes that there is a tradeoff between the costs and benefits of improving quality. The optimum quality level of products and services maximizes profits rather than maximizing quality. 3. TQM has a goal of “total delight” for customers. This means that the customer’s expectations are exceeded. With total delight there are zero defects. ROQ seeks an optimum quality level. This level of quality is almost always lower than total delight. TQM assumes that the amount of profit is highest when quality is at its peak. ROQ assumes that the amount of profit is highest when quality is at some optimal level, usually lower than maximum quality. Beyond that optimal level, the cost of improving quality exceeds the amount of additional profit that can be earned from increasing prices. 4. The ROQ view has been the traditional view of quality, but the TQM view emerged in the 1980s when quality became a competitive advantage of companies in global markets. 5. The theoretical definitions of TQM and ROQ conflict with each other. In practice, organizations try to use ideas generated from both philosophies. E. There are two dimensions of quality that organizations need to be concerned about. They are product or service attributes and customer service before and after the sale. 1. Product and service attributes are described as the tangible and intangible features. Tangible features include performance, adherence to specifications, and functionality. Intangible features include reputation, taste, appearance, style, and appeal. 2. Customer service before and after the sale influences whether purchasers of products will become new customers and remain as repeat customers. Customer service features include provision of pre-sale information, proper treatment of customers by salespeople, on-time delivery, follow up with customers, timeliness and accuracy of resolution of questions and complaints, and warranty and repair services. F. How do organizations measure quality? This question can be answered in many ways. To ensure that an organization is meeting expectations on the two dimensions of quality (product attributes and customer service), the organization should use measures that are lead indicators of customers’ expectations for product quality. The organization should then measure customers’ satisfaction with the products or services they have purchased. 1. Lead indicators of quality can be used to evaluate tangible features of products, such as physical dimensions and functional performance before they reach customers. It is more difficult to measure tangible features of services because the service is not complete until the customer receives it. Service organizations must focus their attention on evaluating the capabilities of personnel and technology that will provide the service. Measurement of the intangible features of products and services are even harder to measure since the value of intangible features differs from customer to customer. Measures of intangible features may be obtained by customer surveys or other methods. Evaluating some features, like quality of service received from salespeople, customer service staff, or ontime delivery, must be obtained after the customer has had contact with the organization. a. A primary source of poor quality is variation in process outcomes. Variability provides a greater chance for product and service attributes to disappoint customers. A bakery, for instance, does not want to undercook a pie (the crust will not be brown). It would also not want to overcook a pie (it will be burnt). Three tools to use for measuring lead indicators are histograms, run charts, and control charts. b. A histogram is a chart that displays the frequency distribution of an attribute’s measures, showing its range and the degree of concentration around an average attribute value. The wider the range, the greater the variation, and the higher the chances that a customer will receive poor quality products or services. c. A run chart shows trends in variation in product or service attributes over time. It reflects measures of quality features taken at defined points in time. Run charts are especially useful after some process change has been made, because it shows whether the change has improved product or service quality. A control chart shows variation in product or service attributes over time, just as a run chart does. However, it goes further by including maximum and minimum desired levels. In this way, variations outside the acceptable range can be quickly and easily identified. 2. Although lead indicator information identifies potential quality problems, it usually does not diagnose the cause of the problem. The next step, then, is to diagnose the problem. This can be accomplished by using cause-and-effect diagrams, scatter diagrams, flow charts, and Pareto diagrams. a. Cause-and-effect diagrams take the information related to potential causes of product or service defects and then identifies the causes that may contribute to the problem. The cause-and-effect diagram splits probable causes into five distinct sources. i. Human resources (human error) ii. Physical resources (insufficient capacity) iii. Procedures (inadequate, improper procedures) iv. Information technology (information not available, incorrect) v. Communication (failure to communicate) Using the simple example of baking times for pies, if a large bakery finds that too many pies are overcooked, it should ask “why” questions that can be answered in the context of these five different potential causes of the effect (the effect being poor quality). b. Scatter diagrams consist of a plot of two measures that may be related. These diagrams are used to diagnose cause and effect between outcomes and activities that may drive them. Scatter diagrams are useful for determining whether a suspected cause of a quality problem is really the true cause. The frequency of the suspected cause of the problem is paired with the quality attribute being evaluated. If the suspected cause is truly the reason for a quality problem, the scatter diagram will show a pattern that looks like an upward or downward line. If the suspected cause is not the true reason for a quality problem, the scatter diagram will not reflect any discernible pattern. One problem with using a scatter diagram is that it requires that the organization have reliable data on both the quality measures and the suspected causes. c. A flowchart can sometimes be used to show the cause-and-effect linkages among process activities. This can help to pinpoint where quality problems arise. Flowcharting the ideal process and then flowcharting the actual process may also pinpoint where the quality problems emerge in the process. d. A Pareto chart (named after an Italian economist) prioritizes the causes of problems or defects as bars of varying heights in order of frequency or size. Pareto charts help analysis teams to focus on the causes that may offer the greatest potential for improvement. 3. Customer satisfaction is the degree to which expectations of attributes, customer service, and price have been or are expected to be met. In addition to measuring lead indicators of tangible and intangible product and service features, as described above, organizations should also try to measure customer satisfaction. Measures of customer satisfaction may be used as both lead indicators of future sales and as diagnostic tools to discover causes of unexpectedly low or high sales. The most common method of measuring customer satisfaction is customer surveys. Focus groups may also be used. Some organizations use phantom shoppers, who are actually employees sent out as customers, to see how regular customers are treated. G. Customers seeking high quality products understand that they must pay a higher price for higher quality. Customers may be willing to pay a higher price for a product or service if it clearly has higher quality than comparable products offered at the same price. Managers of organizations also understand the need to offer high quality products but realize that increased quality comes at a cost. Managers must, therefore, balance the desire for high quality against the cost of that quality. This results in a quality/price tradeoff. An important part of keeping the balance at the correct level is based on the ability to identify the costs of quality. 1. Cost of quality (COQ) is the cost of activities to control quality. It is also the cost of activities to correct failure to control quality. Costs of controlling quality are associated with lead indicators of imminent quality problems. Costs of correcting failures may be lead indicators of future decreased sales. Organizations usually prefer to devote most of their costs of quality on activities intended to control quality rather than correcting quality failures. 2. Controlling quality requires that two activities take place. One is prevention. The other is appraisal or detection. a. Prevention activities seek to prevent defects in products or services being produced. Prevention activities may include certifying suppliers, designing products to be manufactured defect-free, quality training, quality evaluations, and process improvement. TQM advocates argue that prevention activities are the most efficient use of resource use in the area of quality. ROQ advocates argue that preventing defects is effective but suggest that preventing all defects may be prohibitively expensive. The ROQ philosophy does not prevent all quality problems before they occur. It attempts to detect them in ways that TQM advocates view as non-value-added activities. ROQ advocates also recognize that costs of quality beyond prevention costs are non-value-added costs. However, their view is that prevention costs may be too high to justify, and they opt instead to incur non-value-added costs. b. Appraisal activities, also called detection or inspection activities, require that inputs be inspected or that outputs (units of product) be inspected in order to detect whether they conform to specifications or customer expectations. Appraisal activities include inspecting materials, inspecting machines, inspecting processes, automated inspection, statistical process control, testing at the end of a process, and field testing (at a customer site). 3. Failing to control quality leads to two types of failure. One type is internal failure, while the other type is external failure. a. Internal failure activities are required to correct defective processes or products and services which are detected before being delivered to customers. Internal failure activities include disposing of scrap caused by defective products, rework to correct defects, reinspecting or retesting, and delays in processes. Internal failure can be very expensive. It is obviously a non-value-added activity, particularly when bottlenecks are affected (worsened) by defects. b. External failure activities are required when defective products or services are detected after customers have received them. These activities include warranty repairs, settling product liability claims, resolving customer complaints, restoring reputations, and lost sales. External failure activities are the most costly of all failure costs because they may permanently damage the reputation of an organization. This type of failure affects future sales, but this effect is difficult to quantify. 4. Organizations must effectively measure costs of quality in order to manage them. Organizations using ABC and ABM have the activity-based information needed to compile cost of quality information. With ABC information, cost managers can take the additional step of classifying activities based on cost of quality category. Those organizations without ABC in place may find it expensive or time-consuming to develop the kinds of cost information to properly identify costs of quality. 5. Reporting costs of quality may occur in a variety of forms. A cost of quality report always, however, will split the costs into the four categories — prevention, appraisal, internal failure, and external failure. Typically, the reports then provide more detail on the actual type of activity (inspection of materials, rework of defective product), the cost of the activity, and the cost as a percentage of sales. Reporting costs of quality as a percentage of sales places emphasis on the fact that profits are consumed by costs of quality just like any other type of cost consumes profits. Organizations may set benchmarks for costs of quality — for instance, setting a ceiling on COQ of 5% of sales revenue. H. Quality has become so important to success that there are now international awards given to companies for the quality of their product, services, or processes. The Malcolm Baldrige award, created by the US Congress in 1987, recognizes US firms with outstanding records of quality improvement and quality management. The Deming Prize is a Japanese award for companies around the world that excel in quality improvement. The International Organization for Standardization is a European organization best known for its development of international standards for quality management called ISO 9000. ISO 9000 is a set of global guidelines for the design, development, production, final inspection and testing, installation, and servicing of products, processes, and services. To be certified, a company must document its quality systems and pass a rigorous third-party audit of its manufacturing and customer service processes. I. In addition to having to address the need to manage quality and control costs of quality, cost managers must be conscious of the need to manage time. There are three specific areas of concern with respect to time. They are new product and service development time, customer response time, and cycle time. 1. New product and service development time is the period between the first consideration of a product and its initial sale to the customer. Businesses that respond quickly to demand for new products and services may develop a competitive advantage over competitors. The shorter the product development time is, the more likely it is that an organization will be the first to offer the new product. 2. Customer response time is another important time dimension that organizations need to properly manage. Customer response time is the amount of time between a customer’s placing an order or requesting service and the delivery of the product or service to the customer. The shorter the response time, the more competitive the company is on this dimension. Organizations work to reduce customer response time by automating ordering activities, by scheduling bottleneck resources carefully, and by keeping reserve capacity for unexpected but valuable orders. When necessary, companies may use expedited services. If orders are placed before products are produced, the customer response time may be reduced by eliminating non-value-added activities in production processes. This reduces the cycle time. 3. Since timeliness is so important in a competitive environment, organizations have come to recognize that longer process times mean more than higher production costs. They may also cause lost sales or opportunities. To motivate efficiency in cycle times, some organizations reward employees based on their ability to meet or exceed targeted cycle times. J. Process efficiency involves the ability to transform input into throughput at the lowest cost. Throughput is the amount of goods and services produced and delivered to customers during a period of time measured in dollar terms or physical measures. Organizations manage two types of processes: production and business. Production processes directly result in the production of products or services provided to external customers. Business processes support and enable production processes. K. Many productivity measures exist. The broadest measure of productivity is total factor productivity which is the value of goods and services divided by the total cost to provide them. Another measure is average cycle time which is total processing time for all units divided by good units. Produced. Throughput achieved measures the relation of throughput achieved to resources used. Throughput time ratio is the ratio of time spent adding customer value to products and services divided by total cycle time. L. Process capacity is a measure of a process’s ability to transform resources into valued products and services. It is usually expressed as a rate of processing inputs or generating outputs per time period. Theoretical capacity of a process is the maximum possible rate of transformation of inputs into outputs if the process were fully used, with no downtime or unused capacity. Practical capacity of a process is its theoretical capacity less planned downtime for scheduled maintenance or improvement. Excess capacity is the amount by which practical capacity exceeds the demnd for the output of the process. M. Just-in-Time (JIT) is a process that requires that products be made and delivered just when they are needed. Organizations that use JIT expect to reduce or eliminate inventory carrying costs, which are costs of receiving, handling, storing, and insuring inventory. Obsolescence of inventory is another cost of having inventory on hand. Since JIT precludes stocking inventory in anticipation of sales and materials are not ordered and stockpiled, a JIT operation requires high-quality processes. Defective products are incompatible with JIT since there is no product on hand in reserve just in case defective products are made and have to be replaced for pending customer orders. Defects in a JIT organization trigger an investigation of processes to eliminate their causes. 1. JIT manufacturing makes it necessary to minimize inventory, shorten cycle times, and eliminate defects. To a customer, inventory on hand represents a non-value-added cost. Costs of rework or other cost-causing, non-value-added activities are also undesirable in the eyes of the customer. JIT manufacturing is a radical departure from traditional manufacturing. Both approaches are described below. a. Traditional manufacturing is referred to as “push” manufacturing because production is “pushed” through the production and sales processes based on forecasted sales orders. The sequence of events for a traditional manufacturing shop would be to forecast sales in advance of production; order all parts and other necessary inputs; prepare a production schedule in anticipation of production needs; and finally, when a customer order is received, sell it from finished goods inventory or place the order on backorder to be filled as soon as the production schedule allows it. This traditional manufacturing approach has some drawbacks. First, it is driven by sales forecasts, which may be inaccurate. If the forecast is too optimistic, the company will overproduce, which results in unsold inventories and could result in an obsolete product. If sales are higher than anticipated, there will not be enough product, resulting in the need to backorder sales which increases the customer response time. Sales could be lost if customers can buy products from competitors. An alternative to backordering is to expedite production, which usually leads to overtime costs for employees and increases the costs of obtaining resources because their delivery must be rushed (at higher cost). A second drawback to traditional manufacturing is that it does not allow the organization to arrange production activities around the bottleneck production activities. This can result in a wasteful and costly buildup of incomplete inventories. b. JIT manufacturing is referred to as “pull” manufacturing. JIT production is pulled through the production and sales process by actual customer orders instead of forecasted orders. The sequence of events for a JIT manufacturer is as follows. First, a customer places an order. The sales order triggers a production order. Then, the production order triggers the acquisition of materials and other resources needed to fill the order. Finally, the customer receives the product on the promised delivery date. JIT has some drawbacks too. The main drawback is that any defect or obstacle in the production process may cause the entire production process to shut down, and there is no inventory in reserve to replace the item being manufactured “just in case” something goes wrong. JIT manufacturers try to avoid this problem by being certain that the production process does not have any flaws in it. Some companies that are JIT maintain minimal levels of inventory on hand just in case something goes wrong. c. Cost managers can play a key role by measuring the costs of excess inventories and costs of quality that are encouraged by traditional push production methods. Revealing the cost inefficiencies caused by traditional manufacturing may induce companies to consider adopting a JIT approach. 2. There are several advantages offered by the use of JIT manufacturing. Six success factors are linked in such a way that failure to include any one threatens the likelihood of the success of JIT at an organization. a. JIT mandates that the organization maintains a strong commitment to quality. Defects cause delays and require buffer inventories. If defects occur, the sooner an employee can detect and correct the problem, the less time is lost. b. Capacity must be flexible, and setup times must be short. As much as possible, JIT manufacturers of mass-produced products should seek long-term purchase agreements. c. Suppliers must be reliable. In order for JIT manufacturers to complete production on time, they must be sure that suppliers can provide needed inputs on time. JIT manufacturers typically require that suppliers meet a stringent set of tests, and the number of suppliers may be reduced so that the quality and scheduling of inputs can be better managed. d. Production flow must be smooth. Unbalanced production leads to delays at bottlenecks and makes it necessary to have buffer inventories. e. A well-trained, motivated, flexible workforce is critical. Workers need to be cross-trained so that they can work on production areas as needed. f. Cycle and customer response times must be minimized. 3. Even if JIT is not adopted, organizations can benefit from adopting some of these success factors because they make any production environment more efficient. N. Control charts display measures of important product or service attributes for individual items or for a sample of items to disclose attribute measures and variation in the production process. Statistical control chart displays customer response times against the historical mean and historical variation. A control chart can be prepared based on specified or target levels of product attributes. This may provide results which are different from a statistical chart. Intervention can be instituted when there is a violation. O. Variations on the control chart could take several forms. A run is sequential values above or below the mean or values sequentially increasing or decreasing. Causes of run include worker fatigue, wear and deterioration of tools and equipment, changes in environmental conditions, accumulation of waste, scrap, and excess parts that cause congestion, learning and improved use of resources. Attributes such as rotation of employees, periodic testing or maintenance cause cyclical variations. Extreme jumps could result from changes in tools or equipment, change of employees, or errors in reporting procedures. Problem 1. Chapter 7 LO: 2 Measure and analyze the dimensions of quality Time required: 30 minutes Ryan Manufacturing’s sales amounted to $590,000 for 2002. This amount is 15% higher than the prior year. Cost of sales amounted to 60% of sales in 2002 and 64% of sales in 2001. Ryan has identified the following quality costs for the two periods: Item 2001 2002 Material and inspection $ 6,400 $ 6,600 Scrap 8,100 8,250 Employee training 16,800 14,700 Returned goods 8,700 7,300 System design changes 16,400 16,200 Product defects discovered 9,800 8,200 Processing customer complaints 7,400 6,900 Testing equipment repair 5,400 2,600 Required: a) Classify the above costs into prevention, appraisal, internal failure, and external failure costs. b) Determine costs of quality as a percentage of total. c) Determine the classified costs as a percentage of sales. d) Determine the classified costs as a percentage of cost of sales. e) Determine the percentage reduction or increase in costs from 2001 to 2002. f) Analyze improvements between the two years with regards to costs of quality. Solution: (a) (b) (c) (d) (a) (b) (c) (d) Employee training 16,800 21.3% 3.3% 5.1% 14,700 20.8% 2.5% 4.2% System design 16,400 20.8% 3.2% 5.0% 16,200 22.9% 2.7% 4.6% Total prevention 33,200 42.0% 6.5% 10.1% 30,900 43.7% 5.2% 8.7% Material inpsection 6,400 8.1% 1.2% 1.9% 6,600 9.3% 1.1% 1.9% Testing equipment 5,400 6.8% 1.1% 1.6% 2,600 3.7% 0.4% 0.7% Total appraisal 11,800 14.9% 2.3% 3.6% 9,200 13.0% 1.6% 2.6% Scrap 8,100 10.3% 1.6% 2.5% 8,250 11.7% 1.4% 2.3% Defects 9,800 12.4% 1.9% 3.0% 8,200 11.6% 1.4% 2.3% Internal failure 17,900 22.7% 3.5% 5.5% 16,450 23.3% 2.8% 4.6% Returns 8,700 11.0% 1.7% 2.6% 7,300 10.3% 1.2% 2.1% Cust. Complaints 7,400 9.4% 1.4% 2.3% 6,900 9.8% 1.2% 1.9% External failure 16,100 20.4% 3.1% 4.9% 14,200 20.1% 2.4% 4.0% Grand total 79,000 100% 15.4% 24.1% 70,750 100% 12.0% 20.0% Sales 513,043 590,000 Costs of sales 328,348 354,000 The above analysis shows that appraisal costs and external failure costs went slightly down in 2002 whereas, prevention costs and internal failure costs slightly increased. However, it appears that costs in all categories went down considerably as a percentage of sales. The sales increased by 15% while quality costs remained fairly steady. The percentage decrease in quality costs were also dramatic as a percentage of cost of sales where it went down from 24.% to 20.0% in 2002 or a total of 17% reduction. This decrease reveals that while sales have increased and costs of sales have decreased from the prior year, still we have managed to reduce quality costs or keep them at prior year levels. The most significant improvement is with regards to reduction of external failures due to spending more money upfront in the prevention area as well as in the appraisal section. Problem 2 LO: 1 Cost of quality comparison Estimated time: 20 minutes Consider company A’s and Company B’s quality costs and comment on which of the two will probably perform better in terms of increase in sales, customer satisfaction, and profitability in the future, and what should the other company do in order to catch up. Assume that both companies have the same sales level. Item Company A Company B Prevention costs $ 117,500 $ 389,600 Appraisal costs 148,600 299,400 Internal failure costs 311,220 167,520 External failure 373,680 94,480 Answer Item Company A Company B Prevention costs $ 117,500.00 $ 389,600.00 Appraisal costs $ 148,600.00 $ 299,400.00 Internal failure costs $ 311,220.00 $ 167,520.00 External failure costs $ 373,680.00 $ 94,480.00 Totals $ 951,000.00 $ 951,000.00 The problem wants to demonstrate the fact that even though both companies who are of the same size spend the same amount of money on quality costs, but company B has a much better chance of succeeding in the market place whereas, company B may be in the danger of losing market share and profitability. Company B seems to be knowingly investing money in prevention and appraisal phases of quality such as, employee training, supplier selection, quality control equipment, etc. as a result, it is experiencing a much lower failure rate both in terms of internal and external failures. It is also important to note that company A, having failed to invest in prevention and appraisal phases adequately, it spending a bundle in internal failures due to defects which are caught before the merchandise is shipped, and even worse, in external failures in the forms of returns and customer complaints. Also note that apparently company B which has invested heavily in prevention costs has lower costs in appraisal, internal failure, and still lesser amounts in external failures. The situation with company A is exactly the reverse. Problem 3. General Ethical dilemma Estimated time: 10 minutes John and Jill are competitors in food industry. Apparently a couple of crooks in a couple of cities had tampered with their products as a result of which two people died and a score of individuals became sick. After this incident, John recalled and destroyed all its inventory with a value of over 2 million dollars. Jill, instead, issued customers generous coupons with a value of ½ of a million dollars to weather the storm. The prior year both companies had a profit in excess of 1.5 million dollars, but this year, John barely broke even whereas, Jill ended up with a profit of approximately one million dollars. Write a paragraph discussing the ethical dilemma and the business decisions of John and Jill. Answer: Business, in spite of what most people think, is not essentially about making money. It is about providing an honest, decent, and morally based service, in the process of which we are rewarded with money in order to continue our service to our fellowmen. Service is an intrinsic part of our human psyche. We may become temporarily happy for making more money, but we will gain internal happiness when we do the right thing; i.e., what our conscience, our humanity (and what some people call ‘God within’) commands us to do whether at home or at work. John’s work (remember Johnson & Johnson’s recall of Tylenol pills) becomes a legend and generations to come will appreciate and take pride of having such an institution serving the community which will potentially result in higher future profitability. Jill’s action is self serving, at best, and will not get them many more friends even if they stay competitive in the market place. The moral of the story is that quality is an outcome by itself, perhaps more important of higher profits and instant gratification. Problem 4 LO: 4 Throughput time Motors brand name is a household name with billions in sales. Hana is fairly new in the game. Related data for these firms follow: Item Motors Hana Order receiving time 3 days 1 day Order waiting time 7 days 3 day Order processing time 20 days 14 days Order delivery time 10 days 3 days Average inventory $840,000 $80,000 Investment $3,800,000 $980,000 Selling and admin expenses $3750,000 $465,000 Use the above data to determine Throughput time ratio for each company. Estimate each company’s cost of sales and sales assuming that both have a 40% margin on sales. Estimate each company’s return on investment. Provide general comments about viability and competitiveness of each firm. Throughput time ratio for Motors: 20/40 = 50% Throughput time ratio for Hana: 14/21 = 66.67% Estimated cost of sales for Motors: 365/40 = 9.125; 9.125 * 840,000 = $7,665,000 Estimated cost of sales for Hana: 365/21 = 17.38; 17.38 * 80,000 = $1,390,400 Estimated sales for Motors: 7,665,000 / .60 = $12,775,000 Estimated sales for Hana: 1,390,000/.60 = $2,316,667 Estimated profit for Motors: SALES – CGS – S & GA; $1,360,000 Estimated profit for Hana: $461,267 Estimated ROI for Motors: profit/investment: 35.79% Estimated ROI for Hana: 47.07% Even though both companies are highly profitable, but Hana is doing much better in terms of throughput time and managing its inventory. If prices fall, Hana has a much better for long-term success as compared to Motors. Motors must improve efficiencies in order to be able to stay competitive. .Sample Quiz 1. Total Quality Management (TQM) is the view that a. improvements in quality will always result in improved performance. b. improving quality will improve efficiency. c. there is a tradeoff between the cost and benefits of improving quality. d. All of the above. e. a and b Answer: e Objective: 1 2. Return on Quality (ROQ) assumes that a. optimum quality level of products and services maximizes quality. b. optimum quality level of products and services maximizes profit. c. optimum quality level of products and services maximizes quality and profit. d. optimum quality is when it provides “total delight” to the customer. e. None of the above. Answer: b Objective: 1 3. Which statement(s) is correct in conjunction with ROQ concept? a. Minimum quality results in lower profits. b. Optimum quality results in higher profits. c. Maximum quality results in higher profits. d. a and b e. a and c Answer: d Objective: 1 4. Tangible features of a product or service include a. performance. b. adherence to specifications. c. functionality. d. All of the above. e. None of the above. Answer: d Objective: 1 5. A Pareto diagram a. is a chart that displays frequency distribution of an attribute’s measures. b. shows trends in variation in product or service over time. c. is the same as b but also compares them to maximum and minimum desired levels. d. involves formulating diagnostic signals that identify potential causes of product or service defect. e. None of the above. Answer: e Objective: 2 A Pareto diagram prioritizes the causes of problems or defects as bars of varying heights in order of frequency or size. 6. A run chart a. is a chart that displays frequency distribution of an attribute’s measures. b. shows trends in variation in product or service over time. c. is the same as b but also compares them to maximum and minimum desired levels. d. involves formulating diagnostic signals that identify potential causes of product or service defect. e. None of the above. Answer: b Objective: 2 7. A flowchart a. is a chart that displays frequency distribution of an attribute’s measures. b. shows trends in variation in product or service over time. c. is the same as b but also compares them to maximum and minimum desired levels. d. involves formulating diagnostic signals that identify potential causes of product or service defect. e. None of the above. Answer: e Objective: 2 A flowchart is used to show the cause-and-effect linkages among process activities. It helps pinpoint where quality problems arise. 8. Cost of quality is the cost of activities a. to control quality. b. to correct failure to control quality. c. to promote product acceptability. d. All of the above. e. a and b Answer: e Objective: 1 9. Examples of prevention activities include a. product design. b. quality training and evaluations. c. inspecting materials, machines, and processes. d. reinspecting and retesting. e. a and b Answer: e Objective: 1 10. Examples of external failures include a. product design. b. quality training and evaluations. c. inspecting materials, machines, and processes. d. reinspecting and retesting. e. None of the above. Answer: d Objective: 1 11. Examples of external failures include a. disposing of scrap. b. warranty repairs. c. settling product liability. d. All of the above. e. b and c Answer: e Objective: 1 12. Quality costs are usually a. value-added. b. non-value-added. c. both value-added and non-value-added. d. not quantifiable. e. None of the above. Answer: c Objective: 1 13. Which statement is correct? a. Malcolm Baldrige Quality Award recognizes only Japanese firms with outstanding records of quality improvement. b. Deming Prize recognizes only U.S. companies that excel in quality improvement. c. ISO 9000 is a set of international standards for productivity improvement. d. All of the above. e. None of the above. Answer: e Objective: 1 Malcolm Baldrige Quality Award recognizes American firms with outstanding records of quality improvement. Deming Prize recognizes Japanese firms that excel in quality improvement. ISO 9000 is a set of international standards. 14. Customer response time is the period between a. placing the order and receipt of the order by the customer. b. starting of the production process and dispatch of the completed product to the warehouse. c. starting of the production and delivering the product to the customer. d. placing the order and completion of the production process. e. None of the above. Answer: a Objective: 3 15. Inventory carrying cost is the cost of a. receiving the goods. b. storage of the goods. c. insurance and obsolescence. d. All of the above. e. None of the above. Answer: d Objective: 3 16. In push through manufacturing, a. sales are forecasted well in advance of production. b. production is dictated by updated customer demand. c. goods are delivered to customers from finished goods inventory warehouse where inventory levels are determined in advance. d. a and b e. a and c Answer: e Objective: 5 17. Companies that use JIT systems, such as Dell Computers, may often have a. lower sales and higher inventory turnover. b. lower sales and lower inventory turnover. c. higher sales and lower inventory turnover. d. higher sales and higher inventory turnover. e. None of the above. Answer: a Objective: 5 18. IBC’s profits which are now $23,500 had gone down the drain while DCC’s profits were $349,600 and rising sharply. IBC’s average inventory was $995,000, whereas DCC’s was $49,500. Inventory costs are estimated to be around 2% per month. If IBC had DCC’s level of inventory, its profits would have been a. $250,420 b. $190,420 c. $122,680 d. $102,680 e. None of the above. Answer: a Objective: 5 $23,500 + [995,000 – 49,500] * 12 * 2% = $250,420. 19. DDC Company’s sales amounted to $450,000, 60% of which represents cost of sales. Inventory ending, which was double of inventory beginning, amounted to $40,000. Cost of sales per employee amounts to $54,000 on the average. Inventory turnover amounts to a. 9 b. 7 c. 5 d. 3 e. None of the above. Answer: a Objective: 5 [450,000 * 60%] / [(20,000 + 40,000)/2] = 9 20. Mountain Bikes succeeded in reducing its current inventory of $290,000 by 40%. The inventory has a carrying cost of 15%. However, preventive and appraisal costs went up by 50% from its current level of $45,000, and failure costs were reduced by 80% from its current level of $65,000. Sales for the period amounted to three times the amount of current inventory. Profit before these changes could amount to $93,800. These improvements will increase profit by a. 60% b. 50% c. 40% d. 20% e. None of the above. Answer: b Objective: 1 (290,000 * 40% * 15%) – (45,000 * 50%) + (65,000 * 80%) = 46,900; 46,900 / 93,800 = 50% Chapter 8 Process Costing Systems Chapter Outline A. Cost Management Challenges — There are three questions addressed in this chapter. 1. How should costing systems measure costs of products, services, and operations when outputs are numerous and indistinguishable? 2. How should organizations recognize and measure the costs of spoilage and waste? 3. What is the advantage of first-in first-out (FIFO) process costing over weightedaverage process costing? B. Learning Objectives — This chapter has nine learning objectives. 1. What organizations should use process costing or job costing? 2. Why is process-costing information useful for decision making? 3. Describe the five-step method to assign process costs to products. 4. Analyze the process costs assigned to products using weighted-average price. 5. Account for costs transferred between processes. 6. Analyze and manage “normal” and “abnormal” spoilage. 7. Assign costs to products using first-in, first-out (FIFO) costing (Appendix A). 8. Compare and contrast the results from weighted-average and FIFO costing (Appendix A). 9. Compare and contrast operation costing with job costing and process costing (Appendix B). C. Process costing is a method for assigning product costs to units of product when all units of product are virtually the same. Products are completed in a short time, and costs for a single period can be averaged over the number of units produced. 1. With process costing, costs are not traced to units of product. Instead, all production costs (unit-level and otherwise) are assigned or allocated based on total production costs and total units produced. 2. Job costing and process costing differ in the way costs are assigned, and they differ because of differences in product characteristics. With job costing, many costs are traceable to jobs or can be assigned to specific jobs using cost-driver rates. For products in a process costing environment, all costs must be assigned using a cost-driver approach. The key difference is that the only cost-driver is the actual number of units produced. D. A very basic model of process costing assumes there are only two cost categories — materials and conversion costs. Materials costs (also called direct materials) are unit-level costs, but they are assigned to units of product based on the cost of materials and the actual number of units produced. Conversion costs include all other costs for resources used besides materials. These other costs may be batch, product, or facility-level costs. Resources are recorded as processes rather than activities. Simplifying assumptions in the basic process costing model presented in Chapter 8 preclude the use of ABC. E. The simplest case for assigning costs using a process costing approach assumes all production is started and completed within a single accounting period. This simplifying assumption makes it easier to see how materials and conversion costs are used and applied to units of product. If all units of product are completed in one month, there is no work-on-process inventory. It is the presence of WIP inventory that makes process costing complex. 1. There are only two cost categories to consider in a simple process costing model. They are direct material and conversion costs. Each of these resources is assigned to units of product separately. That is because, except in the simplest case, these two resources are added and used in production in differing amounts and points in time. 2. There is only one cost-driver. The cost-driver in process costing is the actual number of units produced. Calculation of a rate for direct materials is calculated as total direct materials cost divided by total number of (equivalent) units = direct materials cost per unit of product. The rate for conversion costs is total conversion cost divided by total (equivalent) units = conversion cost per unit of product. The process costing system described is an actual costing system. 3. Calculation of the cost per unit for conversion costs includes higher-level resources. For decision-making purposes, the cost per unit information can be misleading. Managers should separate higher-level costs from unit-level costs when making cost decisions or when trying to assess profitability. 4. When making decisions, managers should determine whether the decision should be based on resource spending or resource use. Average costing, as it is used in process costing, measures resource use. F. A slightly more complex case for process costing occurs when there is production that is not completed at the end of an accounting period. In other words, there is no beginning work-inprocess inventory, but there is ending WIP inventory. This case better illustrates the need to segregate the costs and activities of different resources like materials and conversion activities. It is useful at his point to explain the five steps used to assign costs to units of product. 1. First, summarize the flow of physical units. What is the total number of units being made when all production is complete? a. The basic cost flow model can be used to depict the flow of physical units through WIP inventory. Beginning WIP + units transferred in (or units started) – units transferred out (or completed) = ending WIP. b. In the simplest case, beginning WIP and ending WIP are zero. In this simple case, the number of units transferred (started) equals the number of units transferred out (completed). c. In the case where there is no beginning WIP but there is ending WIP, the number of units transferred in (started) does not equal the number of units transferred out (completed). Transferred in units are greater than units transferred out because some units are not completed at the end of an accounting period. d. This first step expresses the number of units to account for and then accounts for them. It shows where units of product came from (beginning WIP and units started) and where they went (transferred out and ending WIP). 2. The second step requires that the number of equivalent units (EUs) be computed. Equivalent units equal the number of whole units that could have been completed given the amount of resources actually used. For instance, if 5,000 toys had 90% of the direct materials needed for the toys to be complete, this would be the equivalent of having 5,000 * 90%, or 4,500 toys being fully completed. Suppose 2,000 physical units were started and 1,500 were fully complete as far as conversion activity goes, and the remaining 500 were 60% complete as far as conversion activity goes. This is the equivalent of 1,500 + (60% * 500) = 1,500 + 300 = 1,800 equivalent units. a. The number of equivalent units must be computed separately for each different resource. In the simplest case there are just two resources — direct materials and conversion costs. b. The equivalent units calculations could be expanded to include as many different categories as the accounting system needed to improve information, but the calculations for each resource would be accomplished the same way. 3. The third step requires that costs to account for be identified, and classified as direct materials cost or conversion cost. This information comes from the beginning WIP balance and costs transferred in for the period. In the case where there is no beginning WIP, just the costs transferred in are the costs to account for. This cost information can be obtained from the accounting system. 4. Step 4 requires that cost per equivalent unit be calculated. It is simply the cost obtained in Step 3 divided by the number of equivalent units calculated in Step 2. Separate costs per equivalent unit must be calculated for direct materials costs and for conversion costs. a. The total cost per equivalent unit is the sum of direct materials cost per equivalent unit plus conversion cost per equivalent unit. This represents the cost of producing one whole unit. b. Managers should compare monthly calculations over time to see whether costs are stable. Costs per equivalent unit should not fluctuate erratically from month to month, because the corresponding price cannot usually fluctuate the same way. This would result in erratic profits. 5. The last step shows the assignment of costs to the ending WIP inventory balances and to units transferred out (to FGI, or the next production department). a. This step shows how costs to account for in Step 3 are accounted for. b. The number of equivalent units transferred out * cost per EU = total dollar amount transferred out. Since the number of equivalent units transferred out is the same for both materials and conversion costs, it is not necessary to calculate costs transferred out separately for materials and conversion costs. This is true when the weighted average method is used but is not true when the FIFO method is used. The number of equivalent units in ending WIP * cost per EU = total dollar value of ending WIP. For ending WIP, calculations must be made separately for materials and conversion costs because the number of equivalent units will probably not be the same for these two resources. 6. Steps 1 and 2 divide the cost flow model into two pieces for quantities. Beginning WIP and units transferred in (started) are used in Step 1 to identify the number of physical units. These amounts show where the units came from. Units transferred out and units remaining in ending WIP are converted to equivalent units, and in Step 2 these units are identified as either completed and transferred out or as incomplete units in ending WIP. 7. Steps 3 and 5 divide the cost flow model into two pieces also, but, instead of quantities identified in Steps 1 and 2, Steps 3 and 5 divide costs into two pieces. Step 3 uses the beginning WIP balance and costs transferred in, indicating the costs to account for. Step 5 uses costs transferred out and ending WIP, indicating how the costs were accounted for. 8. When an item is completed in one department, it may be transferred to a second department as an intermediary product for additional work. In such a case the “transferred in” cost is treated as a separate ingredient to which additional material and processing costs are added. So we would have at least three cost items, transferred in, materials, and processing costs for which we need to calculate costs. G. The third example of process costing and cost assignment adds another layer of complexity to the process costing approach by including spoilage. Spoilage is the cost of wasted resources and defective products that cannot be recovered by rework or recycling 1. Spoilage is a normal part of production costs. One way to handle spoilage costs is to view them as a normal part of production. Spoilage, if material in amount, should be identified and reported, at least internally, so that managers can assess spoilage and waste as a cost to be managed and minimized. Calculations for spoiled units are made the same way as for good units, using the five-step approach described earlier. However, the number of physical units must be split between good units and spoiled units. Equivalent units are also split so that costs can be assigned to the spoiled units. The percentage of completion for spoiled units depends on when the spoilage is detected and what portion of the work has been completed for those units. a. Step 1 of the five-step process is the same as described before — determine the total number of physical units. b. Step 2 is different. Now, units must be split three ways instead of two. Before, units were split between those that were completed and transferred out and those remaining in ending WIP. With spoiled units included, there is a third group of units — those that are spoiled. The number of equivalent units for each of these three groups must be calculated separately. c. Step 3 is the same as before — it consists of determining what costs are to be accounted for. d. Step 4 is the same, except now the number of equivalent units will be calculated and shown for spoiled units, and therefore the cost per EU will be different. e. Step 5 is different. Now, costs must be assigned to units completed and transferred out, ending WIP inventory and spoiled units. 2. Spoilage costs can be reported as a period cost and expensed right away (as part of cost of goods sold), or they can be treated as part of production costs and flow through the inventory system until product is sold. a. Normal spoilage is waste that is considered to be part of the production process. It is generally counted as a normal cost of good units produced. b. Abnormal spoilage is waste in excess of normal spoilage. Abnormal spoilage is usually treated as a period cost, regardless of how normal spoilage is treated. c. Spoilage is usually not listed as a separate expense on financial statements. Regardless of how spoilage is reported on financial statements though, the amount and associated cost of spoilage is important information for managers to have. H. The next layer of complexity in process costing arises when there are units from the prior period included in the assignment of production costs. There are two methods that can be used in process costing. These methods are the weighted average (WA) method and the firstin, first-out (FIFO) method. The only difference between these two methods is the way in which beginning WIP units and costs are treated. 1. The weighted average method treats the units in beginning WIP as if they are part of the current month’s production activity. The amount of work completed on these units in prior months is assumed to be zero. The costs in beginning WIP are added to the current month’s costs, and this total cost is used to compute cost per EU. Steps 1 through 5 of the five-step costing approach are reviewed based on the WA method. a. Step 1 is exactly the same as before, except now there are some physical units that came from beginning WIP b. Step 2 is different. The beginning WIP units are treated as units that were started and completed in the current period. The calculation of equivalent units is based on the assumption that 100% of the work for the beginning WIP units was completed in the current month. Thus, for units completed and transferred out, the number of EUs is 100% of the physical number of units transferred out. Calculation of EUs for ending WIP is the same as described before. c. Step 3 is the same as before, except that now there is a dollar amount for beginning WIP. d. Step 4 is the same as before also, except that the number of equivalent units now includes some from beginning inventory. The calculation is the same though. e. Step 5 is also the same. Costs assigned go to units completed and transferred out, spoiled units, and units in ending WIP. f. A disadvantage of the WA method is that it combines current period costs with prior period costs. This makes it difficult to isolate fluctuations in current period costs. 2. The FIFO method segregates prior period costs and production activity from current period costs and activity. The FIFO method only considers that portion of work needed to complete the beginning WIP units in calculating the number of EUs for beginning WIP units. Spoilage must be segregated in the same fashion. That is, spoilage must be identified as being from beginning WIP or from current month’s activity. The units in beginning WIP are assumed to be the first units completed and transferred out. Units started in the month are either completed and transferred out or are incomplete and remain in ending WIP. a. Step 1 of the five-step process is the same under WA and FIFO. b. Step 2 is different. Spoilage quantities are exactly the same as before, except they are shown as spoiled units from beginning WIP and spoiled units from those units started. Calculation of EUs for ending WIP is exactly the same as for WA. The total number of equivalent units from the total period are calculated just as they were for the WA method, but the equivalent units from beginning WIP that were completed in the prior month are subtracted from the EUs transferred out. c. Step 3 is the same as the WA method, but the beginning WIP costs are not used to calculate cost per EU in Step 4. d. Step 4 is different. Cost per EU is based on current costs divided by EUs. The balance in beginning WIP is not used to calculate cost per equivalent unit. e. Step 5 is complicated by the fact that costs for spoiled units come from beginning WIP and current period costs. It is further complicated by the fact that, even though beginning WIP costs are not included in the calculation of cost per EU, those costs must be transferred out in order for the costs to account for to equal the costs accounted for. The only straightforward calculation in Step 5 is calculation of the costs in ending WIP. f. The main differences between the WA and FIFO methods are that the WA method is simple but less accurate, while the FIFO method is more accurate, more complex, and more costly to maintain. If costs change a lot from period to period and beginning WIP balances are relatively large, it is probably better to use the FIFO method. However, if an organization has many products that are process costed, using FIFO may be too messy and complex to justify its use. I. The WA and FIFO methods are compared below, in terms of how the five steps are completed. STEP 1 WEIGHTED AVERAGE FIFO 1. Summarize flow of physical units Use the basic cost flow model: BI + TI = TO + S + EI Same, except keep track of units from beginning WIP separately from units started in the current period 2. Compute EUs for each cost category Multiply physical units by degree of completion Same, except subtract EUs in beginning WIP to obtain current EUs 3. Summarize total costs to account for Add costs in beginning WIP to costs of the current period Same as WA costing 4. Compute costs per EU Divide total costs in process by total EUs in each cost category to get average cost/EU Divide current costs in process by current EUs in each cost category to get current cost/EU 5. Assign costs to products and spoilage Multiply EUs by cost category for units completed, units spoiled, units in ending WIP by cost/EU in each cost category Beginning WIP units started in the period are always transferred out or assigned to spoiled units. Costs of units completed or spoiled include costs of beginning WIP, costs to finish beginning WIP, and costs from the current period. Ending WIP units include costs from the current period. J. Many companies that use process costing have more than one production process. Instead of completing production and transferring finished goods to finished-goods inventory, some portion of production may be completed, and then partially completed goods are passed on to the next production department. In this case, there are three types of costs to be assigned to units of product in a subsequent production department. These costs are direct materials and conversion cost, as well as transferred-in costs. All units transferred in are 100% complete in terms of the prior department’s process costs, so cost computations are simple since the number of EUs equals the number of physical units for this resource called transferred-in costs. K. Operation costing is a hybrid of job-order and process costing and is used when companies produce batches of similar products with significantly different types of material. An operation is a standardized method of making a product that is repeatedly performed. Hybrid costing also occurs when the same product is produced in a process costing environment, and then additional custom features are added to it. Like a computer made to specifications for its software and operating system or a car that has many custom features. Problem 1 – Chapter 8 LO: 3, 7, and 8 Process costing: weighted average price and FIFO – a comparison Timed needed: one hour Saba enterprises had 250 units in WIP beginning which were 80% complete with regard to conversion costs. 9,250 units were added during the period. 7,200 units were completed. There were normal spoilage equal to 5% of completed goods and abnormal spoilage amounting to 490 units. WIP ending was 80% complete with regard to material and 60% complete with regard to conversion. WIP beginning amounted to $3,500 of which $1,000 was for conversion. Costs added amounted to $132,280 of which $94,870 was for materials. Required: 1) Compute cost of goods completed (inclusive of normal spoilage cost), abnormal spoilage cost, and cost of WIP ending using weighted average price method. 2) Compute cost of goods completed (inclusive of normal spoilage cost), abnormal spoilage cost, and cost of WIP ending using FIFO method. 3) Determine cost per unit of completed goods for last period and this period (under both FIFO and weighted average price methods. 4) Prepare journal entries for goods completed and disposition of spoilage costs under FIFO method. Unit reconciliation Equivalent number of units Weighted average Units Material Conversion WIP beginning 250 Added 9,250 Units to account for 9,500 Completed 7,200 7,200 7,200 Normal spoilage 360 360 360 Abnormal spoilage 490 490 490 WIP ending 1,450 1,160 870 Units accounted for 9,500 9,210 8,920 Cost Total $ Material Conversion WIP beginning 3,500 2,500 1,000 Costs added 132,280 94,870 37,410 Costs to account for 135,780 97,370 38,410 Unit cost 14.88 10.5722 4.3061 Completed 112,480 79,926 32,554 Abnormal spoilage 7,290 5,180 2,110 WIP ending 16,010 12,264 3,746 Costs accounted for 135,780 97,370 38,410 Unit reconciliation Equivalent number of units FIFO Units Material Conversion WIP beginning 250 250 200 Added 9,250 Units to account for 9,500 Completed 7,200 7,200 7,200 Normal spoilage 360 360 360 Abnormal spoilage 490 490 490 WIP ending 1,450 1,160 870 Units accounted for 9,500 8,960 8,720 Cost Total $ Material Conversion WIP beginning 3,500 2,500 1,000 Costs added 132,280 94,870 37,410 Costs to account for 135,780 97,370 38,410 Unit cost 14.88 10.5882 4.2901 Completed 112,480 80,047 32,433 Abnormal spoilage 7,290 5,188 2,102 WIP ending 16,015 12,282 3,732 Costs accounted for 135,785 97,517 38,268 c) Cost per unit of goods completed: WIP beginning 15 10 5 Weighted average price 14.88 10.5722 4.3061 FIFO 14.88 10.5882 4.2901 d) Journal entries Finished goods inventory 112,480 Work in process – Materials 94,870 Work in process – Conversion 37,410 Loss – Abnormal spoilage 7,290 Work in process – Materials 5,188 Work in process – Conversion 2,102 The abnormal spoilage could be prorated between finished goods inventory, work in process inventory, and cost of sales. Here we chose to write it off directly to the period’s expenses. Problem 2 LO: 3, 4, 5 Process costing using weighted average price method Estimated time: 30 minutes Ariana Company uses process costing in the production of polyethylene sheets. Work in process beginning includes 30 rolls which were 80% complete with regard to material and 60% complete with regard to processing. The cost of beginning work in process was $3,000 – 60% of which was for material. Added costs included $20,600 for material and $8,500 for processing. Prepare a cost of production report and necessary journal entries using weighted average price method. Solution: Item Units Total Material Processing 1. Unit reconciliation: WIP beginning 30 Units added 200 Units to account for 230 Units completed 170 WIP ending 60 Units accounted for 230 2. Equivalent number of units: Units completed 170 170 170 WIP ending 60 54 24 Equivalent number of units 230 224 194 3. Costs to account for: WIP beginning 3,000 1,800 1,200 Added costs 28,000 20,600 8,500 Costs to account for 31,000 22,400 9,700 4. Unit cost 150 100 50 5. Costs accounted for: Costs of goods completed 25,500 17,000 8,500 Cost of WIP ending 6,600 5,400 1,200 Costs accounted for 32,100 22,400 9,700 Journal entries: Debit Credit Work in process inventory $28,000 Raw Material inventory $20,600 Labor and overhead 8,500 Finished goods inventory $25,500 Work in process inventory $25,500 Problem 3 LO: 7 Process costing using FIFO Estimated time: 30 minutes Ryan Company uses process costing in the production of polyethylene sheets. Work in process beginning includes 30 rolls which were 80% complete with regard to material and 60% complete with regard to processing. The cost of beginning work in process was $3,000 – 60% of which was for material. Added costs included $20,600 for material and $8,624 for processing. Prepare a cost of production report and necessary journal entries using weighted average price method. Solution: Item Units Total Material Processing 1. Unit reconciliation: WIP beginning 30 -24 -18 Units added 200 Units to account for 230 Units completed 170 WIP ending 60 Units accounted for 230 2. Equivalent number of units: Units completed 170 170 170 WIP ending 60 54 24 Equivalent number of units 230 200 176 3. Costs to account for: WIP beginning 3,000 1,800 1,200 Added costs 29,224 20,600 8,624 Costs to account for 32,224 22,400 9,824 4. Unit cost 152 103 49 5. Costs accounted for: Costs of goods completed 25,486 16,838 8,648 Cost of WIP ending 6,738 5,562 1,176 Costs accounted for 32,224 22,400 9,824 Journal entries: Work in process inventory $29,224 Raw material inventory $20,600 Labor and overhead accounts $8,624 Finished goods inventory $25,486 Work in process inventory $25,486 Problem 4: General Estimate time: 20 minutes Use the information in problems 2 and 3 to calculated and compare a) prior period cost per unit, cost per unit under weighted average price, cost per unit under FIFO, cost per unit for goods completed under FIFO, b) comment on whether or not prior period cost per unit, cost of goods completed under FIFO and weighted average price should be the same or could be different. Solution: Item Material Conversion Total Comment Prior period cost per unit 75.00 66.67 141.67 (a) Weighted average price 100.00 50.00 150.00 (b) FIFO - WIP ending 103.00 49.00 152.00 (c ) FIFO - Goods completed 99.05 50.87 149.92 (d) a) You can determine prior period cost per unit dividing prior period costs into the equivalent number of units for prior period. Make sure that this is done separately for material and conversion because the items could be at different stages of completion with regard to material and conversion costs. The results will be the same under both methods because we use the same set of assumptions for both. b) Weighted average price computations are shown in problem 2. It is computed by taking total costs inclusive of work in process beginning by total units which is inclusive of goods completed and equivalent number of units of work in process ending – also separately for material and conversion costs. c) FIFO cost per unit for WIP ending is computed by taking current costs divided by FIFO equivalent units (total units minus prior period equivalent units) as illustrated in problem 3 above. d) FIFO method for goods completed was not separately illustrated in problem 3. It can be computed by taking cost of goods completed by number of units completed. The related cost is derived at by subtracting the computed cost of WIP ending from total costs. Notice the fairly significant difference in the two FIFO costs which has come about because of the significant difference in cost per unit for the prior period in terms of material and conversion costs. Although the difference is not as significant due to the fact that prior period inventory was fairly low and has not had that much of an impact on costs when averaged with the current period costs. Sample Quiz 1. In process costing a. only high level costs are assigned to products; all other costs are traced. b. only low level costs are assigned to products; all other costs are traced. c. all costs are assigned to products. d. all costs are traced to products. e. None of the above. Answer: c Learning Objective: 1 2. Abalone Company has used $2450 worth of materials and $3760 in conversion costs for the production of 500 units of Aba. Cost per unit amounts to a. 4.90 b. 7.52 c. 12.42 d. 12.50 e. None of the above. Answer: c Learning Objective: 1 (2,450 + 3,760) / 500 = 12.42 3. Abalone Company has used $2450 worth of materials and $3760 in conversion costs for the production of 500 units of Aba. The product cost so determined have managerial implications in a. resource spending. b. resource use. c. quality engineering. d. a and b e. None of the above. Answer: b Learning Objective: 2 4. The five steps in process costing include a. beginning inventory, costs added, units completed, ending inventory, and spoilage. b. units to account for, units accounted for, equivalent number of units, costs to account for, and unit costs. c. unit reconciliation, equivalent number of units, cost of work in process beginning, costs added during the period, and unit cost. d. unit reconciliation, equivalent number of units, costs to account for, cost per unit, and costs accounted for. e. None of the above. Answer: d Learning Objective: 3 5. Arman Manufacturing Company produces office chairs. Work in process beginning includes 30 units which were 80% complete with regard to material and 60% complete with regard to conversion. The cost of work in process beginning was $3000 — 60% of which was for materials. 200 units were added during the period at a cost of $28,000 — 70% of which is for materials. WIP ending amounted to 60 units which were 90% complete with regard to materials and 40% complete with regard to conversion. Material cost per unit for prior period amounts to a. $66.67 b. $75.00 c. $95.54 d. $98.00 e. None of the above. Answer: b Learning Objective: 3 (3,000 * 60%) / (30 * 80%) = $75 6. Arman Manufacturing Company produces office chairs. Work in process beginning includes 30 units which were 80% complete with regard to material and 60% complete with regard to conversion. The cost of work in process beginning was $3000 — 60% of which was for materials. 200 units were added during the period at a cost of $28,000 — 70% of which is for materials. WIP ending amounted to 60 units which were 90% complete with regard to materials and 40% complete with regard to conversion. Material cost per unit using weighted average price method amounts to a. $66.67 b. $75.00 c. $95.54 d. $98.00 e. None of the above. Answer: c Learning Objective: 3 [(3,000 * 60%) + (28,000 * 70%)] / [(60 * 90%) + (30 + 200 – 60)] = 95.54 7. Arman Manufacturing Company produces office chairs. Work in process beginning includes 30 units which were 80% complete with regard to material and 60% complete with regard to conversion. The cost of work in process beginning was $3000 — 60% of which was for materials. 200 units were added during the period at a cost of $28,000 — 70% of which is for materials. WIP ending amounted to 60 units which were 90% complete with regard to materials and 40% complete with regard to conversion. Conversion cost per unit using FIFO method amounts to a. $47.73 b. $49.48 c. $56.27 d. $66.67 e. None of the above. Answer: a Learning Objective: 3 (28,000 * .30) / [(30 + 200 - 60) – (30 * .60) + (60 * .40)] = 47.73 8. Arman Manufacturing Company produces office chairs. Work in process beginning includes 30 units which were 80% complete with regard to material and 60% complete with regard to conversion. The cost of work in process beginning was $3000 — 60% of which was for materials. 200 units were added during the period at a cost of $28,000 — 70% of which is for materials. WIP ending amounted to 60 units which were 90% complete with regard to materials and 40% complete with regard to conversion. The journal entry for goods completed under weighted average price will be a. WIP – Materials 19600 WIP – Conversion 8400 Raw material inventory 19600 Various accounts 8400 b. Finished goods inventory 24653.40 WIP – Materials 16241.80 WIP – Conversion 8411.60 c. Finished goods inventory 24562.54 WIP – Materials 16108.00 WIP – Conversion 8454.54 d. None of the above. Answer: b Learning Objective: 3 9. Arman Manufacturing Company produces office chairs. Work in process beginning includes 30 units which were 80% complete with regard to material and 60% complete with regard to conversion. The cost of work in process beginning was $3000 — 60% of which was for materials. 200 units were added during the period at a cost of $28,000 — 70% of which is for materials. WIP ending amounted to 60 units which were 90% complete with regard to materials and 40% complete with regard to conversion. Cost of work in process ending using the FIFO method amounts to a. $6,246.56 b. $6,346.56 c. $6,437.46 d. $6,537.46 e. None of the above. Answer: c Learning Objective: 8 10. If costs change from period to period, using which method is suitable for decision making? a. weighted average price b. FIFO c. LIFO d. a or b e. None of the above. Answer: b Learning Objective: 8 11. Including spoilage as part of the cost of goods completed a. has the advantage of highlighting cost of spoilage. b. hides the cost of spoilage. c. provides a better picture of true cost of products. d. b and c e. None of the above. Answer: d Learning Objective: 6 12. Operation costing compared to process costing a. separates material costs by type of product. b. separates conversion costs by type of product. c. separates material and conversion costs by type of product. d. separates material and labor costs by type of product. e. None of the above. Answer: a Learning Objective: 9 Use this data to respond to questions 13 through 19. Saba Plastics has a work in process inventory of 250 yards, 100% complete with regard to material and 80% complete with regard to conversion. 9,250 yards were added during the period. 7,200 yards were completed. Normal spoilage amounted to 5% of completed units. Abnormal spoilage amounted to 490 yards, caused primarily due to malfunctioning machines in this time period. WIP end of the period was 80% complete with regard to materials and 60% complete with regard to conversion costs. The cost of WIP beginning was $3,500, $1000 of which was for conversion costs. From the total cost of $132,280 of added costs, $37,410 was for conversion costs. 13. Equivalent number of units using FIFO for materials amounts to a. 8760 b. 8900 c. 8960 d. 9200 e. None of the above. Answer: c Learning Objective: 8 14. Equivalent number of units using weighted average price for conversion costs amounts to a. 8700 b. 8920 c. 8950 d. 9200 e. None of the above. Answer: b Learning Objective: 3 15. Cost per unit of material using FIFO amounts to a. 10.59 b. 10.60 c. 11.03 d. 11.76 e. None of the above. Answer: a Learning Objective: 8 16. Cost per unit of conversion costs using FIFO method amounts to a. $4.29 b. $4.32 c. $4.50 d. $4.80 e. None of the above. Answer: a Learning Objective: 8 17. Cost per unit of completed goods using FIFO, assuming that normal spoilage is considered as part of cost of goods completed amounts to a. $14.90 b. $15.62 c. $16.55 d. $17.56 e. None of the above. Answer: b Learning Objective: 8 18. Abnormal spoilage costs using the FIFO method amount to a. $3,286 b. $4,619 c. $5,194 d. $7,290 e. None of the above. Answer: d Learning Objective: 8 19. Cost of work in process ending using FIFO method amounts to a. $23,891 b. $17,914 c. $16,015 d. $12,720 e. None of the above. Answer: c Learning Objective: 8 20. Costs transferred in from another department in a process costing environment are treated as a. a separate cost item in the new department. b. an addition to material costs in the new department. c. an addition to conversion costs in the new department. d. partly material and partly conversion cost in the new department. e. None of the above. Answer: a Learning Objective: 3 21. Operations costing differs from process costing in that both use the same a. cost per unit for material costs b. cost per unit for labor costs only c. cost per unit for overhead costs only d. cost per unit for conversion costs e. none of the above. Answer: d. LO: 9 In operations costing, material cost is computed similar to job costing because different jobs use different kinds of materials, but an averaged conversion cost because it uses the same averaged processing cost as used in process costing. Chapter 9 Joint-Process Costing Chapter Outline A. Cost Management Challenges — There are two questions asked in this chapter. 1. How do cost managers anticipate and resolve potential conflicts between joint-product and process decision making and external reporting? 2. If joint-cost allocations are arbitrary, does that mean they are meaningless? B. Learning Objectives — This chapter has six learning objectives. 1. It teaches how to use cost management information to increase profits from using scarce resources of joint production processes. 2. It demonstrates how to use cost-management data in the sell-or-process further decision. 3. It explains why organizations allocate joint costs. 4. The chapter explains the differences between the joint-cost allocation methods and why one way or the other may be preferred. 5. It shows how to account for by-products. 6. Chapter 9 presents explanations of the net-realizable-value and physical-measures joint cost allocation methods. C. In order to understand joint processes and joint products, there are five terms to understand. 1. A joint process is some common set of inputs or activities that result in two or more products. The cost of the inputs/activities must be allocated to the separate products because they represent part of inventory costs for different inventory items. In earlier chapters where job costing was explained, there were many costs that could be traced directly to one unit of product because each job represented a unit of product. Costs that were not directly related to a particular job had to be allocated. In Chapter 8, process costing was described as an appropriate costing method when every unit of product is homogeneous. The types of products that occur in a joint process environment are dissimilar from each other, yet a significant portion of the cost cannot be directly traced to any one of the two or more products being produced. Joint processes create a different type of cost assignment problem. One input or process is used to create two or more types of output. The costs that result from the joint process must be allocated to the joint products because the costs are production costs, which must be inventoried and eventually included as part of cost of goods sold. 2. Joint products are the result of a joint process. That is, two or more outputs result from the common set of inputs. Since the joint process cannot be split into the portions that each product causes separately, allocation of joint costs is used to assign these costs. 3. Joint costs (or joint-process costs) are costs that arise from the common set of inputs. These are the costs that must be allocated among the joint products. Joint costs occur before the joint products emerge as separate, distinguishable products. Joint costs use batch and facility-level resources. 4. The split-off point is the point at which individual products from the joint process emerge and can be identified as unique products. This is the point at which costs can be traced to a particular joint product. Costs occurring after the split-off point do not have to be allocated. It is also at the split-off point that a management decision must be made regarding what should be done with the joint products. Products can be sold at the split-off point, or they can be processed further. Some products are “final products” at the split-off point and do not require further processing. Other products are “intermediate products” at the split-off point. Such products can be sold to others, who complete the production process, making it into the “final product.” These products could also be processed further, to the point at which they are “final products.” For instance, a chemical company that produces coatings for cookware could make the final product, treated cookware. Alternatively, it could make the intermediate product, the coating for the cookware, and sell this intermediate product to a company that makes the cookware. 5. Further processing costs (also called separate or separable costs) are costs that can be traced directly to one of the joint products. These costs occur after the split-off point. If products are not processed further, either they are already in their final form at this stage, or they are sold as intermediate products that are finalized by other organizations. If the products are processed further, there are costs associated with these additional processing activities. D. Managers should look at maximizing overall profitability by choosing the best set of joint products possible. If the mix is not profitable, the project should not even be pursued. Part of the analysis of profitability is the decision to sell intermediate products at the split-of point or process them further. When a product is processed further, it becomes more valuable than a product that is not processed further. Thus, the price of such products should increase. The decision to process further is based on a comparison of the additional revenue, generated by selling the product at a higher price, to the additional cost of processing the product further. If the incremental revenues are greater than the incremental costs, the product should be processed further. In some situations, the intermediary product may have no sellable value and has to be processed further in order to be sellable. Still the question remains. Are we better off to discard the item or process it further and sell it? E. Joint costs are part of product costs, which is the main reason for assigning them to products. Joint cost allocation is necessary for several other reasons. 1. Joint costs are inventory costs and, subsequently, become part of the cost of goods sold. A portion of the joint costs must flow through the accounting system to reflect the recovery of the expense through sales. 2. Joint costs are allocated in response to regulatory requirements that mandate assignment of such costs as a basis for price-setting. 3. Estimation of casualty losses makes joint cost allocation necessary. 4. Performance evaluation may include some joint costs (although caution should be used whenever allocated costs are included in an evaluation). 5. Joint costs should not be used to make profitability decisions for individual joint products. F. Distinction must be made between main product(s) and by products which are incidental to the process with little value. Revenues from by products are often regarded as a reduction in cost for producing the main products. There are two ways commonly used to allocate joint costs. 1. The Net Realizable Method assigns joint costs to joint products based on the relative values of the products. For each product, estimated sales revenue minus estimated separate costs for that product equals estimated net realizable value (NRV). Total estimated NRV of all joint products is the allocation base. Product NRV divided by total NRV is multiplied by total joint cost to get the joint cost allocation for each product. a. The income statement for companies with joint products is detailed for managers’ use, so that it is obvious which products generate profit and by how much. The income statement shows each product separately. Cost of goods sold is split into two-dollar amounts. One is the further processing costs, which are traceable to individual joint products. The other is the amount of joint cost allocated to each product. b. The presentation of the income statement in this segmented form illustrates an important feature of the NRV method. If a product is profitable before allocation of joint costs, it is at this point that the profitability of the individual joint product should be evaluated. 2. The Physical Measures Method assigns joint costs based on physical characteristics of the products, like weight, size, or other quantities. The final weight (or length, volume, content, etc.) of each product is determined. Then the total weight of production is determined. The total weight is the allocation base. The weight of one product divided by the total weight is multiplied by the joint cost to get the joint cost allocation for each product. a. As with the NRV method, the income statement details joint products separately and splits cost of goods sold into the further processing costs and joint costs. b. A major benefit of using a physical measures method is its simplicity. If products are relatively comparable in their weights, this is a practical approach. If the joint products have very different weights relative to each other, this method is likely to distort product gross margins. However, weight may not be a good determinant for value as well as cost. c. A major drawback to using the physical measures method is that it bears no relation to the relative profitability of each joint product. Thus, using this method may distort the relative contributions of each joint product. 3. The flow of costs through the accounting system is based on the use of control accounts for WIP and FGI, similar to job costing. Subsidiary ledgers are maintained for each of the joint products. There are two types of costs added to the subsidiary accounts for particular joint costs. They are the further processing (or separate) costs and the joint cost allocation. 4. When deciding which of the two joint cost allocation methods is best to use, managers should consider the following three points. a. Product decisions should not be based on gross margins, which include the joint cost allocation, unless the product must comply with a regulatory requirement. b. When possible, joint costs should be allocated in such a way that regulated profits of cost reimbursements are maximized. This is usually only an issue for government contracts or regulated industries. c. The joint cost allocation procedure should be clearly specified in contractual agreements between the customer and product provider. G. By-products are outputs from a joint production process that are minor in quantity or NRV in comparison to main products. A joint process may result in by-products, but joint costs are allocated only to the main products that result from a joint process. By-products do not receive any joint cost allocation. Accounting for revenues and costs of by-products (i.e., NRV) is described below. Accounting for by-products differs from accounting for main products. There are two ways to account for by-products. 1. Treat by-product net realizable value as other revenue. This is a simple method, which allows NRV of by-products to be reported as a single line-item in the income statement. Many companies use this reporting approach because by-product revenues and costs are so small relative to revenues and costs from the main products. 2. Deduct by-product net realizable value from joint costs of main products. This approach, while more accurately reflecting the link between main products and by-products, is more complicated to use. This is especially true if all main products are not sold. Then, NRV of by-products must be split between cost of goods sold and ending inventory of the main products. H. What to do with scrap and waste is another concern to deal with in a joint cost environment. Production activities often result in waste, or scrap. Waste and scrap can either be disposed of at a cost, or management can look for ways to dispose of them for a profit. Disposal costs for scraps or revenues from sale of scraps are included as part of the joint-processing costs. Revenues generated from waste or scrap are subtracted from joint costs. Costs of disposing of scrap or waste are added to joint costs. I. Other methods used for joint cost allocation are relative sales value at split-off method and constant gross margin percentage method. 1. The relative sales value at split off method assumes that the products have a sales value at split off point. This method uses the relative sales value percentages at the split off point and multiplies those values by joint costs to determine the fair share of costs for each product. This method is inapplicable if the product does not have a sales value at the split-off point. 2. Constant gross margin percentage method first subtracts costs beyond split-off point and joint costs from total sales revenue to arrive at the gross margin. The percentage of gross margin is then applied to individual products. Gross margin is subtracted from revenue and additional costs beyond split off point (if any) to arrive at the share of joint costs for each product. a. The gross margin method assumes that the margin from each product is the same percentage. b. Net realizable value method results in gross margin percentages which are equal as a percentage of NRV of each product. Problem 1 – Chapter 9 LO: 4 and 6 Comparison of methods Time needed: one hour XYZ Petrochemical Company has a joint process that results in 2400 lbs of product X (final product), 3,600 lbs of product Y (intermediate product), and 1,600 lbs of product Z (by product). Product X can be sold for $5 a lb. Product Y can be sold for $9 a lb after an additional process that costs $7,200. Product Z can be sold for $2.00 a lb but requires .60 a lb in sales commission and .40 a lb in shipping. The process has a joint costs of $30,400. Required: 1) Determine unit cost of X and Y under a) NRV, b) Physical measures, c) constant gross margin method, and d) relative sales value method (assume in this case that Y can be sold for $6 a lb at the split-off point. In all cases assume that the NRV of by product Z is subtracted from the total joint costs. 2) How do we decide whether these products should be produced in the first place? 3) What purposes are served by joint cost allocation? Problem 1. Solution Product X Product Y Total Costs a) Net realizable value method: Number 2,400 3,600 Price 5 9 Total value 12,000 32,400 44,400 Additional processing costs (7,200) (7,200) Net realizable value 12,000 25,200 37,200 Percentage of total 32% 68% Joint costs 30,400 NRV of by product Z (1,600) Net joint cost allocated 9,290 19,510 28,800 28,800 Unit cost 3.87 7.42 b) Physical measures method: Number 2,400 3,600 6,000 % of total 40% 60% 100% Joint costs allocated 11,520 17,280 28,800 Unit cost 4.80 6.80 c) Constant gross margin method: Number 2,400 3,600 Price 5 9 Sales value 12,000 32,400 44,400 Additional processing costs (7,200) (7,200) Total value 37,200 Net joint cost 9,730 19,070 28,800 Gross margin 2,270 6,130 8,400 Gross margin percentage 18.92% 18.92% 18.92% Unit cost 4.05 7.30 d) Relative sales value method: Number 2,400 3,600 Price 5 6 Sales value 12,000 21,600 33,600 Joint costs allocated 10,286 18,514 28,800 Additional processing costs 7,200 Unit cost 4.29 7.14 2) The decision of making or not making the products is based on determining whether total joint cost less NRV of the by product is less than total possible revenue. The decision of whether to process further or not is based on whether incremental revenue from further processing is greater than incremental costs or not. 3) Joint costs need be allocated to determine inventory values and cost of goods sold. We can never figure the true cost of products in a joint cost situation. Joint cost allocation does not assist managers in decision making involving those products. Problem 2 LO: 1 and 2 Joint cost allocation and decision making Time needed: 20 minutes XYZ has three products X, Y, and Z. The joint process costs the company $210,000 resulting in 2,000 lbs of X, 3,000 lbs of Y and 5,000 lbs of Z. which can sell for $60, $20, and $10 per gallon respectively. The company is considering further processing of X at a cost of $16,000, further process Y at a cost of $27,000, and further process Z at a cost of $35,000. If these decisions are carried out, the prices of X, Y, and Z will increase to $70, $28, and $17 per gallon respectively. Determine a) whether X, Y, and Z should be produced or not in the first place, b) which of the products X, Y, and Z should be processed further, if any, c) what method of cost allocation would be more conducive to coming up with right decisions? Solution: Item X Y Z Total Quantity 2,000 3,000 5,000 Price per gallon 60 20 10 Sales value 120,000 60,000 50,000 230,000 Joint costs a) the project is acceptable a s sales value is more than total cost. 210,000 Final selling price 70 28 17 Final sales value 140,000 84,000 85,000 309,000 Sales value at split off 120,000 60,000 50,000 230,000 Incremental revenue 20,000 24,000 35,000 79,000 Incremental cost 16,000 27,000 35,000 78,000 Incremental profit (loss) 4,000 (3,000) - 1,000 b) X should be processed further; Y should not, Z will be indifferent. c) Cost allocation method is irrelevant in making decisions. It is a simple accounting decision for inventory valuation and cost of sales determination pur : Problem 3. LO: 2 Joint cost allocation and decision making Time needed: 15 minutes XYZ has three products X, Y, and Z. The joint process costs the company $210,000 resulting in 2,000 lbs of X, 3,000 lbs of Y and 5,000 lbs of Z. which can sell for $60, $20, and $10 per lb. respectively. The company is considering further processing of X at a cost of $16,000, further process Y at a cost of $27,000, and further process Z at a cost of $36,700. If these decisions are carried out, the prices of X, Y, and Z will increase to $70, $28, and $17 per lb. respectively. However, product X will shrink by 10%, Y will increase in weight by 10%, and Z will increase in weight by 2%. Determine which of the products X, Y, and Z should be processed further, if any. Problem 3 solution: Item X Y Z Total Quantity 2,000 3,000 5,000 Price per gallon 60 20 10 Sales value 120,000 60,000 50,000 230,000 Joint costs a) the project is acceptable a s sales value is more than total cost. 210,000 New weight 1,800 3,300 5,100 Final selling price 70 28 17 Final sales value 126,000 92,400 86,700 305,100 Sales value at split off 120,000 60,000 50,000 230,000 Incremental revenue 6,000 32,400 36,700 75,100 Incremental cost 16,000 27,000 36,700 79,700 Incremental profit (loss) (10,000) 5,400 - (4,600) b) X should be sold as is, Y should be processed further, Z will be at indifference point Problem 4 General Time needed: 20 minutes XYZ has three products X, Y, and Z. The joint process costs the company $200,000 resulting in 2,000 lbs of X, 3,000 lbs of Y and 5,000 lbs of Z. which can sell for $60, $20, and $12 per lb. respectively. The company processes Y further at a cost of $27,000 and then sells the item at $28 a lb. However, the final output increases in weight by 10%. There was no beginning inventory and inventory at the end of the month amounted to 500 lbs of X, 600 lbs of Y, and 800 lbs of Z. Selling expense amounts to 6% of sales value whereas, administrative costs amount to $6,450. Determine the ending inventory value and prepare an income statement assuming relative sales value technique for cost allocation purposes. Also prepare the entries related to joint costs, additional costs, and cost of sales. Solution to problem 4: Item X Y Z Total Quantity 2,000 3,000 5,000 Price per gallon 60 20 12 Sales value 120,000 60,000 60,000 240,000 % of sales 50% 25% 25% Joint costs 100,000 50,000 50,000 200,000 Additional processing 27,000 27,000 Total cost 100,000 77,000 50,000 227,000 New weight 2,000 3,300 5,000 Cost per lb 50.00 23.33 10.00 Inventory 500 900 800 Inventory value 25,000 21,000 8,000 54,000 Sales quantity 1,500 2,400 4,200 Selling price 60 28 12 Sales 90,000 67,200 50,400 207,600 Cost of sales 75,000 56,000 42,000 173,000 Selling expense 5,400 4,032 3,024 12,456 Contribution Margin 9,600 7,168 5,376 22,144 Administrative expenses 6,450 Profit before taxes 15,694 Journal entries: Work in process 200,000 Various accounts 200,000 Work in process (Y) 27,000 Various accounts 27,000 Finished goods inventory 54,000 Cost of goods sold 173,000 Work in process 227,000 Sample Quiz 1. The managerial decisions in joint process costing include a. whether to initiate the joint process. b. what allocation method to use. c. whether to process the joint products further or not. d. All of the above. e. a and c Answer: e Learning Objective: 1 2. APC Company produces three products, A, P, and C, as a result of a joint process with a cost of $199,500 in quantities of 2000, 3000, and 5000 lbs. A can be sold for $47.50; P for $39; and C for $2.50 a lb. The decision should be to a. produce A only. b. produce A and P. c. produce A, P, and C. d. not produce either if all costs can be avoided. e. None of the above. Answer: c Learning Objective: 1 Decision at the point of split off is whether total revenue exceeds the total cost of processing. 3. APC Company produces three products, A, P, and C, as a result of a joint process with a cost of $199,500 in quantities of 2000, 3000, and 5000 lbs. A can be sold for $47.50; P for $39; and C for $2.50 a lb. A can be sold as it is or processed further at a cost of $13,000 and sold for $57 a lb. However, the volume would shrink by 10% as a result of this process. a. Product A must be further processed because its price is $9.50 more per lb. b. Product A must not be further processed because its volume shrinks by 200 lbs. c. Product A must be further processed because it increases profit by $5,400. d. Product A must not be further processed because it decreases profit by $5,400. e. None of the above. Answer: d Learning Objective: 2 (1800 * 57) – (2000 * 47.5) – 13,000 = - 5,400 4. AK Company produces A and K as a result of a joint process with a total cost of $119,500. A amounts to 10,000 yards and weighs 6,000 lbs. K amounts to 19875 yards and weighs 8937.50 lbs. Using the physical measure of cost allocation a. results in $40,000 charge to A based on yardage, but there is no preference in method. b. results in $48,000 charge to A based on weight, and it is the preferred method. c. results in $71,500 charge to K based on yardage, and it is the preferred method. d. results in $79,500 charge to K based on weight, and it is the preferred method. e. None of the above. Answer: a Learning Objective: 3 5. GMC’s output, as a result of a joint process costing $178,400, is 3400 of G at $62 a unit, 4,400 of M at $23 a unit, and 2200 of C at $18 a unit. Using physical measures results in a. $60,656 charge to G. b. $51,344 charge to M. c. $19,824 charge to C. d. $17,890 charge to C. e. None of the above. Answer: a Learning Objective: 3 6. GMC’s output, as a result of a joint process costing $178,400, is 3400 of G at $62 a unit, 4,400 of M at $23 a unit, and 2200 of C at $18 a unit. Using sales value method results in a. $101,200 charge to M. b. $106,968 charge to G. c. $39,248 charge to C. d. $37,845 charge to C. e. None of the above. Answer: b Learning Objective: 3 7. GMC’s output, as a result of a joint process costing $178,400, is 3400 of G at $62 a unit, 4,400 of M at $23 a unit, and 2200 of C at $18 a unit. These prices are all after additional processing which cost $81,600. $40,800 of this sum is for G, $31,200 is for M, and the balance is for C. Using NRV method, the amount chargeable to M should be a. $78,496 b. $51,344 c. $70,000 d. $46,259 e. $39,784 f. None of the above. Answer: d Learning Objective: 3 8. GMC’s output, as a result of a joint process costing $178,400, is 3400 of G at $62 a unit, 4,400 of M at $23 a unit, and 2200 of C at $18 a unit. These prices are all after additional processing which cost $81,600. $40,800 of this sum is for G, $31,200 is for M, and the balance is for C. The NRV for C amounts to a. $39,248 b. $30,000 c. $20,088 d. $19,820 e. None of the above. Answer: b Learning Objective: 3 9. Using physical measures in joint cost allocation may be appropriate when a. sales values differ substantially among the joint products. b. additional processing is often required to make the product sellable. c. there are more than one physical measure for each product to consider. d. some of the joint products have little sales value. e. None of the above. Answer: e Learning Objective: 4 10. GMC’s output, as a result of a joint process costing $178,400, is 3400 of G at $62 a unit, 4,400 of M at $23 a unit, and 2200 of C at $18 a unit. These prices are all after additional processing which cost $81,600. $40,800 of this sum is for G, $31,200 is for M, and the balance is for C. GMC considers C as a By-product although the controller strongly objects to the practice because of the relatively high value of the product. The amount chargeable to G, using the physical measures amounts to a. $60,502 b. $64,687 c. $78,298 d. $83,713 e. None of the above. Answer: b Learning Objective: 5 11. GMC’s output, as a result of a joint process costing $178,400, is 3400 of G at $62 a unit, 4,400 of M at $23 a unit, and 2200 of C at $18 a unit. These prices are all after additional processing which cost $81,600. $40,800 of this sum is for G, $31,200 is for M, and the balance is for C. GMC considers C as a By-product although the controller strongly objects to the practice because of the relatively high value of the product. The amount chargeable to M, using NRV method should be a. $46,259 b. $43,283 c. $105,117 d. $112,321 e. None of the above. Answer: b Learning Objective: 5 12. By-product net sales value may be a. credited to production at the point of manufacture. b. credited to production at the point of sale. c. credited to other revenue at the point of production. d. credited to other revenue at the point of sale. e. All of the above. Answer: e Learning Objective: 5 13. GMC’s output, as a result of a joint process costing $178,400, is 3400 of G at $62 a unit, 4,400 of M at $23 a unit, and 2200 of C at $18 a unit. These prices are all after additional processing which cost $81,600. $40,800 of this sum is for G, $31,200 is for M, and the balance is for C. Using NRV method, the gross margin on G amounts to a. $240,000 b. $109,344 c. $57,679 d. $46,259 e. None of the above. Answer: c Learning Objective: 3 14. GMC’s output, as a result of a joint process costing $178,400, is 3400 of G at $62 a unit, 4,400 of M at $23 a unit, and 2200 of C at $18 a unit. These prices are all after additional processing which cost $81,600. $40,800 of this sum is for G, $31,200 is for M, and the balance is for C. Using physical measures, the gross margin on M amounts to a. $240,000 b. $109,344 c. $57,679 d. $46,259 e. None of the above. Answer: e Learning Objective: 3 15. GMC’s output, as a result of a joint process costing $178,400, is 3400 of G at $62 a unit, 4,400 of M at $23 a unit, and 2200 of C at $18 a unit. These prices are all after additional processing which cost $81,600. $40,800 of this sum is for G, $31,200 is for M, and the balance is for C. The journal entry for cost of C upon sale, using NRV should be a. Cost of sales 19,820 Finished goods inventory 19820 b. Cost of sales 19,820 Sales 19820 c. Cost of sales 39,600 Sales 39,600 d. Cost of sales 30,000 Sales 30,000 e. None of the above. Answer: a Learning Objective: 3 16. GMC’s output, as a result of a joint process costing $178,400, is 3400 of G at $62 a unit, 4,400 of M at $23 a unit, and 2200 of C at $18 a unit. These prices are all after additional processing which cost $81,600. $40,800 of this sum is for G, $31,200 is for M, and the balance is for C. Assuming that all products are sold, the gross income will be a. $351,600 b. $173,200 c. $91,600 d. $78,400 e. None of the above. Answer: c Learning Objective: 1 17. GMC’s output, as a result of a joint process costing $178,400, is 3400 of G at $62 a unit, 4,400 of M at $23 a unit, and 2200 of C at $18 a unit. These prices are all after additional processing which cost $81,600. $40,800 of this sum is for G, $31,200 is for M, and the balance is for C. All products are sold. Using physical measures results in a. a loss of $8,496 for M and company should shift to other products. b. a loss of $9248 for C and company should not shift to other products due to this loss. c. a gain of $23, 741 for M and the company should shift production to M. d. a gain of $10,180 for C and company should not shift to other products in spite of this low income figure. e. None of the above. Answer: b Learning Objective: 4 18. Costs are allocated to joint products in different ways. Which one of the following is a good reason for cost allocation? a. evaluate the cost center’s performance b. measure income and assets for internal reporting c. control expenditures d. budget and cash control e. None of the above. Answer: e Learning Objective: 4 Common cost allocation in a joint product situation is for determining inventory value and cost of sales. It does not have any management control value. 19. Which of the following is/are not a method to allocate joint costs? a. net realizable value b. sales value at split-off point c. physical measures d. relative profitability e. a, b, and c Answer: d Learning Objective: 3 20. Joint cost allocation is used for a. determining product’s profitability. b. setting product’s selling price. c. determining inventory value of products. d. evaluating management’s performance. e. All of the above. Answer: c Learning Objective: 4 Instructor Manual for Cost Management: Strategies for Business Decisions Ronald W. Hilton, Michael W. Maher, Frank H. Selto 9780073526805, 9780072430332, 9780072830088, 9780072299021, 9780072881820, 9780072882551, 9780070874664, 9780072388404, 9780072343533