I will select five of the following questions for the mid-term exam. You should be able to answer all of them. You may work together in study groups and analyze and answer the questions. Obviously, the exam will be an individual effort.
1Accounting and Control
The controller of a small private college is complaining about the amount of work she is required to do at the beginning of each month. The president of the university requires the controller to submit a monthly report by the fifth day of the following month. The monthly report contains pages of financial data from operations. The controller was heard saying, “Why does the president need all this information? He probably doesn’t read half of the report. He’s an old English professor and probably doesn’t know the difference between a cost and a revenue.”
a. What is the probable role of the monthly report?
Ans: The monthly report is the report card for the University’s internal accounting system, these monthly reports are a formal part of the University’s information system, that provides data and knowledge for decision making (pg.2 of text). These reports are part of a system of controls, these controls force the organization to account for their monthly transactions and the president needs to know this so that he can defend and reconcile the position of his company. These reports are useful to the president so that he can manage the in-and-outflow of resources that keep the University’s board members and employees interests aligned. For the president, the role of these monthly reports are to provide information for necessary planning and decision making and to also help motivate and monitor people within the university (pg. 3 of text).
b. What is the controller’s responsibility with respect to a president who doesn’t know much accounting? Ans: It is the controller’s responsibility to ensure the President understands what the reports say/symbolize and based upon those results, make suggestions on decisions. Their responsibilities involve assuring the reports are accurate, meet accounting standards by following accounting principles and procedures, and having a strong fiducial understanding of the business so that the numbers in his report tell a story about the University’s position in the market and the current state of its operational drivers (pg.10&11 of text).
2Cost, Volume, Profit Analysis
Leslie Mittelberg is considering the wholesaling of a leather handbag from Kenya. She must travel to Kenya to check on quality and transportation. The trip will cost $3000. The cost of the handbag is $10 and shipping to the United States can occur through the postal system for $2 per handbag or through a freight company which will ship a container that can hold up to a 1000 handbags at a cost of $1000. The freight company will charge $1000 even if less than 1000 handbags are shipped. Leslie will try to sell the handbags to retailers for $20. Assume there are no other costs and benefits.
a. What is the break-even point if shipping is through the postal system? Ans: Break Even Point = Total Fixed Costs / (Unit Price – Unit Variable Costs) BEP = $3000 / ($20 – $12)= 375 handbags
b. How many units must be sold if Leslie uses the freight company and she wants to have a profit of $1000? Ans: Total Revenue – Total Costs= Profit
TR-TC=1000: $20x-($3000+$1000+$10x) =$1000
$10x=$5000; x=500 handbags.
c. At what output level would the two shipping methods yield the same profit? Ans: π=TR-TC; Freight: π=$10x-$4000; Postal: π=$8x-$3000 ( Two
equations same unknown, set equal: 10x-4000=8x-3000( 2x=1000 ( x=500 handbags
d. Suppose a large discount store asks to buy an additional 1000 handbags beyond normal sales. Which shipping method should be used and what is the minimum sales price Leslie should consider in selling those 1000 handbags? Ans: At a 1000 handbags, freight shipping should be used because the UVC to ship a bag would be $1 as opposed to $2 through postal. The minimum price of the bag should cover Leslies VC just to break even, VC=10(1000)+1000=$11,000/1000bags = $11.00. 3Asset Replacement
The Baltic Company is considering the purchase of a new machine tool to replace an obsolete one. The machine being used for the operation has a tax-basis book value of $80,000, with an annual depreciation expense of $8,000. It has a resale value today of $40,000, is in good working order, and will last, physically, for at least 10 more years. The proposed machine will perform the operation so much more efficiently and Baltic engineers estimate that labor, material, and other direct costs of the operation will be reduced $60,000 a year if it is installed. The proposed machine costs $240,000 delivered and installed, and its economic life is estimated at 10 years, with zero salvage value. The company expects to earn 14 percent on its investment after taxes (14 percent is the firm’s cost of capital). The tax rate is 40 percent, and the firm uses straight-line depreciation. Any gain or loss on the sale of the machine at retirement is subject to tax at 40 percent.
Should Baltic buy the new machine?
The Alpha Division of the Carlson Company manufactures product X at a variable cost of $40 per unit. Alpha Division’s fixed costs, which are sunk, are $20 per unit. The market price of X is $70 per unit. Beta Division of Carlson Company uses product X to make Y. The variable costs to convert X to Y are $20 per unit and the fixed costs, which are sunk, are $10 per unit. The product Y sells for $80 per unit.
a. What transfer price of X causes divisional managers to make decentralized decisions that maximize Carlson Company’s profit if each division is treated as a profit center? Ans: The minimum price Alpha can accept is $40+$20** = $40. The maximum Beta can pay is $80-$20-$10** or $60.
**To have “sunken fixed costs” a firm would have to be operating in the short-run, the sunken fixed costs are unrecoverable and are already paid, these costs shouldn’t be considered when determining whether or not to shut down.
The transfer price must be set in such a way as to induce the two parties to make the transfer. In essence, the transfer price must give incentives to the Alpha Division to want to make the transfer and give incentives to the Beta Division to buy (b/c they’re both profit centers, decentralized decision makers). In other words, the following two constraints must be satisfied:
Alpha:TP > $40 (variable cost)
Beta DivisionTP < $60 (selling price ($80) – variable costs to complete ($20)) where: TP = transfer price ( $40