Exercise 1-1B  Financial versus managerial accounting items

Exercise 1-2B  Identifying product versus general, selling, and administrative costs

Exercise 1-3B  Classifying costs: product or period/asset or expense

Required

Use the following format to classify each cost as a product cost or a general, selling, and administrative (GS&A) cost. Also indicate whether the cost would be recorded as an asset or an expense. The first cost item is shown as an example.

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Exercise 1-4B  Effect of product versus general, selling, and administrative costs on financial statements

Required

Dunn Plastics Company accrued a tax liability for $2,500. Use the following horizontal financial statements model to show the effect of this accrual under the following two assumptions: (1) the tax is on administrative buildings or (2) the tax is on production equipment. Use plus signs and/or minus signs to show the effect on each element. If an element is not affected, indicate so by placing the letters NA under the appropriate heading.

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Exercise 1-5B  Effect of product versus general, selling, and administrative cost on financial statements

Required

Fletcher Corporation recognized the annual expiration of insurance on December 31, 2008. Using the following horizontal financial statements model shown, indicate how this event affected the company’s financial statements under the following two assumptions: (1) the insurance was for office equipment or (2) the insurance was for manufacturing equipment. Indicate whether the event increases (I), decreases (D), or does not affect (NA) each element of the financial statements. In the Cash Flow column, indicate whether the cash flow is associated with operating activities (OA), investing activities (IA), or financing activities (FA).

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Exercise 1-6B  Product costs in a manufacturing company

Because friends and neighbors frequently praise her baking skills, Susan Spann plans to start a new business baking cakes for customers. She wonders how to determine the cost of her cakes.

Required

1. Identify and give examples of the three components of product cost incurred in producing cakes.
2. Explain why measuring product cost for a bakery is more complex than measuring product cost for a retail store.
3. Assume that Susan decides to bake cakes for her customers at her home. Consequently, she will avoid the cost of renting a bakery. However, her home utility bills will increase. She also plans to offer different types of cakes for which baking time will vary. Cakes mixed with ice cream will require freezing, and other cakes will need refrigeration. Some can cool at room temperature. Under these circumstances, how can Susan estimate the amount of utility cost required to produce a given cake? Identify two costs other than utility cost that she will incur that could be difficult to measure.

Exercise 1-7B  Product versus general, selling, and administrative costs

In reviewing Quartey Company’s September accounting records, Ken Helm, the chief accountant, noted the following depreciation costs.

1. Factory buildings—$25,000.
2. Computers used in manufacturing—$4,000.
3. A building used to display finished products—$8,000.
4. Trucks used to deliver merchandise to customers—$14,000.
5. Forklifts used in the factory—$22,000.
6. Furniture used in the president’s office—$9,000.
7. Elevators in administrative buildings—$6,000.
8. Factory machinery—$9,000.

Required

1. What amount of depreciation cost would be classified as general, selling, and administrative expense?
2. Assume that Quartey manufactured 3,000 units of product and sold 2,000 units of product during the month of September. Determine the amount of depreciation cost that would be included in cost of goods sold.

Exercise 1-8B  Recording product versus general, selling, and administrative costs in a financial statements model

Long Electronics Company experienced the following events during its first accounting period.

1. Received $200,000 cash by issuing common stock.
2. Paid $30,000 cash for wages to production workers.
3. Paid $20,000 for salaries to administrative staff.
4. Purchased for cash and used $18,000 of raw materials.
5. Recognized $2,000 of depreciation on administrative offices.
6. Recognized $3,000 of depreciation on manufacturing equipment.
7. Recognized $96,000 of sales revenue from cash sales of products.
8. Recognized $60,000 of cost of goods sold from the sale referenced in Event 7.

Required

Use a horizontal financial statements model to show how each event affects the balance sheet, income statement, and statement of cash flows. Indicate whether the event increases (I), decreases (D), or does not affect (NA) each element of the financial statements. In the Cash Flow column, indicate whether the cash flow is associated with operating activities (OA), investing activities (IA), or financing activities (FA). The first transaction is shown as an example. (Note: Show accumulated depreciation as a decrease in the book value of the appropriate asset account.)

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Exercise 1-9B  Allocating product costs between ending inventory and cost of goods sold

Kawa Manufacturing Company began operations on January 1. During January, it started and completed 2,000 units of product. The company incurred the following costs:

1. Raw materials purchased and used—$2,500.
2. Wages of production workers—$2,000.
3. Salaries of administrative and sales personnel—$1,000.
4. Depreciation on manufacturing equipment—$1,500.
5. Depreciation on administrative equipment—$1,200.

Kawa sold 1,600 units of product.

Required

1. Determine the total product cost.
2. Determine the total cost of the ending inventory.
3. Determine the total of cost of goods sold.

Exercise 1-10B  Financial statement effects for manufacturing versus service organizations

The following horizontal financial statements model shows the effects of recording the expiration of insurance in two different circumstances. One circumstance represents the expiration of insurance on a factory building. The other circumstance represents the expiration of insurance on an administrative building. The cash flow effects are shown using (I) for increase, (D) for decrease, and (NA) for no effect.

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Required

1. Identify the event that represents the expiration of insurance on the factory building.
2. Explain why recognizing the expiration of insurance on a factory building affects financial statements differently than recognizing the expiration of insurance on an administrative building.

Exercise 1-11B  Effect of product versus general, selling, and administrative cost on the income statement and statement of cash flows

Each of the following asset acquisitions requires a year-end adjusting entry.

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1. Paid $50,000 cash on January 1 to purchase a hamburger franchise that had an estimated expected useful life of 10 years and no salvage value.
2. Paid $50,000 cash on January 1 to purchase a patent to manufacture a special product. The patent had an estimated expected useful life of 10 years.
3. Paid $3,600 cash on April 1 for a one-year insurance policy on the administrative building.
4. Paid $3,600 cash on April 1 for a one-year insurance policy on the manufacturing building.
5. Paid $1,200 cash to purchase office supplies for the accounting department. At the end of the year, $300 of office supplies was still on hand.
6. Paid $1,200 cash to purchase factory supplies. At the end of the year, $300 of factory supplies was still on hand.

Required

Explain how both acquiring the asset and recording the adjusting entry affect the amount of net income and the cash flow reported in the annual financial statements. In the Cash Flow Column, indicate whether the cash flow is associated with operating activities (OA), investing activities (IA), or financing activities (FA). Assume a December 31 annual closing date. The first event is shown as an example. Assume that any products that have been made have not been sold.

Exercise 1-12B  Upstream and downstream costs

During 2007 Moseley Pharmaceutical Company incurred $10,000,000 of research and development (R&D) costs to develop a new hay fever drug called Allergone. In accordance with FASB standards, the entire R&D cost was recognized as expense in 2007. Manufacturing costs (direct materials, direct labor, and overhead) to produce Allergone are expected to be $40 per unit. Packaging, shipping, and sales commissions are expected to be $5 per unit. Moseley expects to sell 1,000,000 units of Allergone before developing a new drug to replace it in the market. During 2007, Moseley produced 160,000 units of Allergone and sold 100,000 of them.

Required

1. Identify the upstream and downstream costs.
2. Determine the 2007 amount of cost of goods sold and the December 31, 2007, ending inventory balance.
3. Determine the unit sales price Moseley should establish assuming it desires to earn a profit margin equal to 40 percent of the total cost of developing, manufacturing, and distributing Allergone.
4. Prepare an income statement for 2007 using the sales price from Requirement c.
5. Why would Moseley price Allergone at a level that would generate a loss for 2007?

Exercise 1-13B  Effect of a just-in-time inventory system on financial statements

In reviewing Crocker Company’s financial statements for the past two years, Rita King, a bank loan officer, noticed that the company’s inventory level had increased significantly while sales revenue had remained constant. Such a trend typically indicates increasing inventory carrying costs and slowing cash inflows. Ms. King concluded that the bank should deny Crocker’s credit line application.

Required

Explain how implementing an effective just-in-time inventory system would affect Crocker’s financial statements and possibly reverse Ms. King’s decision about its credit line application.

Exercise 1-14B  Using JIT to minimize waste and lost opportunity

Daisy Tang is the editor-in-chief of her school’s yearbook. The school has 750 students and 50 faculty and staff members. The firm engaged to print copies of the yearbook charges the school $10 per book and requires a 10-day lead time for delivery. Daisy and her editors plan to order 600 copies to sell at the school fair for $15 each.

Required

1. If the school sells 550 yearbooks, what amount of profit will it earn? What is the cost of waste due to excess inventory?
2. If 150 buyers are turned away after all yearbooks have been sold, what amount of profit will the school earn? What amount of opportunity cost will the school incur?
3. How could Daisy use a JIT inventory system to maximize profits by eliminating waste and opportunity cost?

Exercise 1-15B  Using JIT to minimize holding costs

Cathy’s Beauty Salon purchases inventory supplies from a variety of vendors, some of which require a four-week lead time before delivering inventory purchases. To ensure that she will not run out of supplies, Cathy Jetter, the owner, maintains a large inventory. The average cost of inventory on hand is $9,000. Ms. Jetter usually finances inventory purchases with a line of credit that has a 12 percent annual interest charge. Her accountant has suggested that she purchase all inventory from a single large distributor that can satisfy all of her orders within a three-day period. With such prompt delivery, Ms. Jetter would be able to reduce her average inventory balance to $2,000. She also believes that she could save $1,000 per year through reduced phone bills, insurance costs, and warehouse rental costs associated with ordering and maintaining the higher level of inventory.

Required

1. Is the inventory system the accountant suggested to Ms. Jetter a pure or approximate just-in-time system?
2. Based on the information provided, how much inventory holding cost could Ms. Jetter eliminate by taking the accountant’s advice?

Exercise 1-16B  The fraud triangle

The accounting records of Masterson Manufacturing Company (MMC) revealed that the company incurred $3 million of materials, $5 million of production labor, $4 million of manufacturing overhead, and $6 million of general, selling, and administrative expense during 2008. It was discovered that MMC’s chief financial officer (CFO) included $2.6 million dollars of upstream research and development expense in the manufacturing overhead account when it should have been classified as general, selling, and administrative expense. MMC made 5,000 units of product and sold 4,000 units of product in 2008.

Required

1. Indicate whether the elements on the 2008 financial statements (i.e., assets, liabilities, equity, revenue, expense, net income, and cash flow) would be overstated or understated as a result of the misclassification of the upstream research and development expense. Determine the amount of the overstatement or understatement for each element.
2. Speculate as to what would cause the CFO to intentionally misclassify the research and development expense. (Hint: Review the chapter material regarding the fraud triangle.)

Exercise 1-17B  Applications of the Sarbanes-Oxley Act

Greg Madrid, a HealthSouth billing clerk filed a suit under the False Claims Act charging that HealthSouth purchased computer equipment from a company owned by Richard Scrushy’s parents at prices two and three times the normal price. At the time, Richard Scrushy was the CEO of HealthSouth. The overcharges inflated HealthSouth’s expense ratios that the government used when calculating a Medicare reimbursement rate. As a result, the government was overcharged for services provided by HealthSouth. While refusing to recognize any wrongdoing, HealthSouth agreed to pay an $8 million settlement related to the lawsuit brought by the whistleblower.

Required

Explain how the provisions of Sarbanes-Oxley would provide protection to a whistleblower such as Greg Madrid.

Appendix

Exercise 1-18B  Value chain analysis

Fastidious Vincent washed his hair at home and then went to a barbershop for a haircut. The barber explained that shop policy is to shampoo each customer’s hair before cutting, regardless of how recently it had been washed. Somewhat annoyed, Vincent submitted to the shampoo, after which the barber cut his hair with great skill. After the haircut, the barber dried his hair and complimented Vincent on his appearance. He added, “That will be $18, $3 for the shampoo and $15 for the cut and dry.” Vincent did not tip the barber.

Required

Identify the nonvalue-added activity described. How could the barber modify this nonvalue-added activity?