Practice Problems:

Problem 1

The Fancy Stuff, Inc. furniture store has been in business for two years. Currently, they retain their own delivery department, which has a small fleet of trucks and was designed to handle substantially more deliveries than the company currently requires.

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Now, in an effort to reduce operating costs, the company is considering a proposal to allow a delivery company to handle all of their delivery requirements for a flat fee of $30 per delivery. If they accept the 3rd party delivery service, they will completely shut-down the in-house delivery department and eliminate the total cost of that unit.

Following is the delivery cost for years 1 and 2:

Year 1Year 2
Number of deliveries600700
Cost of operating the delivery department$25,480$26,480
Average cost per delivery$42.47$37.82

Given the average cost per delivery above, the store manager is considering eliminating the in-house delivery department for the $30 delivery service.

In the future, the company is anticipating increases in sales activity and, therefore, increased deliveries. Their on-site delivery department can handle about 3,000 deliveries per year without additional employees or equipment.

Estimated deliveries for the next two years are: Year 3 – 1,250 deliveries and Year 4 – 1,775 deliveries.

Required(Show your computations for all parts of this question)

  1. Prepare a schedule comparing the cost of in-house delivery to the proposed 3rd party delivery for years 1 and 2. Based on that analysis, is the store manager correct in considering the elimination of the company’s delivery department and accepting the outside delivery service of $30 per delivery.
  2. Using the high-low method and the company’s in-house delivery and cost information for years 1 and 2, develop a cost estimation equation for the company’s in-house delivery department.
  3. Using your cost estimation equation developed in b. above, estimate the company’s in-house cost for deliveries for years 3 and 4. Given those estimates, should the company accept the 3rd party delivery service and eliminate their in-house service? (Please explain your answer)
  4. At what level of deliveries would management be indifferent between the in-house cost of delivery and accepting the 3rd party delivery service?
  5. What is your final recommendation to the store manager regarding accepting or rejecting the 3rd party delivery proposal?

Problem 2

Pete Mitchell is the owner/pilot of Maverick Air. The company flies a round trip daily from San Diego airport to San Francisco international. In 20×0, the company reported an annual income before taxes of $1,760, which included an expense of $34,000 reflecting Pete’s salary.

Sales Revenue (312 trips)$312,000
Less: Costs and expenses
Pilot’s salary$34,000
Fuel cost99,840
Maintenance (incurred for each trip)124,800
Depreciation – Plane20,000
Depreciation – Office equipment600
Rent expense24,000
Insurance5,000
Miscellaneous fixed costs2,000310,240
Income before taxes$1,760

Sales revenue of $312,000 reflects six round trips per week with an average of four passengers paying $250 each per round-trip. The flight to San Francisco is 400 miles one way.

Required

  1. How many round trips are needed in total for Maverick Air at break-even?
  2. How many round-trips does Maverick Air have to fly so that Pete Mitchell can draw a salary of $80,000 and still not show a loss?
  3. What is the average before tax profit of a roundtrip flight?
  4. What is the incremental profit associated with adding a single round-trip flight?

Problem 3

Vic Evans is the general plant manager for Great Oven Company, a microwave oven producer, among other related products. Mr. Evans has been approached by an outside vendor that proposes providing Great Oven with oven timers, a component part for their microwave ovens. The vendor offers selling Great Oven the oven timers for $16.50 each.

Currently, Great Oven Company manufactures the component part themselves. In their most recent fiscal year, Great Oven produced and used 80,000 oven timers. Great Oven assigns $24.70 of cost per unit for oven timers, as follows:

 Per UnitTotal
Direct material$7.50$600,000
Direct labor$6.75540,000
Variable factory overhead$1.0080,000
Fixed factory overhead$5.20416,000
Variable selling, general and administrative expenses$2.75220,000
Fixed selling, general and administrative expenses$1.50120,000
Total$24.70$1,976,000

Additionally, if Great Oven accepts the outside vendors offer, Great Oven could eliminate the 8-hour overnight production shift, which would include supervisory salaries of $72,000 and other fixed manufacturing overhead expenses related specifically to the 8-hour overnight shift of $100,000.

Required

  1. Using the facts above and assuming the selling price of the oven timer is $27 per unit, prepare an Income Statement for Great Oven using the contribution format, in good form.
  2. Based on the given information, prepare an analysis to determine whether Mr. Evans should buy the oven timers from the outside vendor or continue to make the timers themselves.
  3. Using your analysis, advise Great Oven regarding accepting or rejecting the outside vendor’s proposal.
  4. Suggest some qualitative issues the Great Oven Company must consider in deciding whether or not to accept the outside vendor’s proposal.

Problem 4

AirComp Corporation produces component parts for the aircraft industry. In prior years, they maintained a job-costing system consisting of direct materials and direct labor cost and manufacturing overhead. Manufacturing overhead was allocated to production jobs using a single-indirect cost allocation rate, which was $115 per direct labor hour.

For 20×1, the Company decided to change the method of allocating manufacturing overhead to production jobs from the single-indirect cost allocation approach to the activity-based costing (“ABC”) indirect cost allocation approach. For purposes of developing the ABC allocation rates, AirComp’s cost accounting team prepared the following analysis:

ActivityCost DriverAllocation Rate
Material handlingParts handled$0.40
Lathe workNo. of lathe turns$0.20
MillingMachine hours$20.00
GrindingNo. of parts ground$0.80
TestingNo. of units tested$15.00

For 20×1, AirComp’s cost accountant team prepared the following analysis of the direct costs and indirect cost activities for Job 100 and Job 200, the only production jobs in process for the period:

Job 100Job 200
Direct materials cost$9,700$59,900
Direct labor cost$750$11,250
No. of direct manufacturing labor hours25375
No. of parts ground5002,000
No. of lathe turns20,00060,000
Machine hours1501,050
No. of units produced during period (all are tested)10200

Required

  1. Use direct labor hours to allocate manufacturing overhead, i.e. indirect costs, to Job 100 and Job 200. After allocating manufacturing overhead to Job 100 and Job 200, calculate total per unit cost and total cost for each job.
  2. Use the activity-based costing approach to allocate manufacturing overhead cost to Job 100 and Job 200. After allocating manufacturing overhead to Job 100 and Job 200, calculate total per unit cost and total cost for each job.
  3. Prepare a schedule comparing the total unit costs calculated for steps a. and b for each job. What attributes of the activity-based costing approach might contribute to the differences in the Job 100 and Job 200 per unit costs?
  4. How might AirComp Corporation use the information from the activity-based cost allocation approach to better manage its business, i.e. what are the advantages of using an activity-based costing approach?

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