Balakrishnan Mgrl Solutions Ch03

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Chapter 3
cash flows and cost terminology

Review Questions

3.1 Product costs are the costs associated with getting products and services for sale, whereas period costs are not directly related to readying products and services for sale.

3.2Revenues less product costs = revenues less cost of goods sold or cost of providing services.

3.3The matching principle.

3.4The products service firms offer are not tangible or storable.

3.5Merchandising firms buy goods from suppliers and resell substantially the same products to customers.

3.6Cost of goods sold = cost of beginning inventory + cost of goods purchased during the period – cost of ending inventory.

3.7Manufacturing firms use labor and equipment to transform inputs such as raw materials and components into outputs (finished goods).

3.8Because they vary proportionally with production volume and can be traced directly to products.

3.9Variable manufacturing overhead varies proportionally with production volume, whereas fixed manufacturing overhead does not change as production volume changes.

3.10Prime costs equal the sum of direct materials and direct labor; conversion costs equal the sum of direct labor and manufacturing overhead.

3.11Cost pools, cost objects, cost driver (allocation basis), and allocation volume (denominator volume).

3.12Determine the allocation rate (overhead rate), and allocate the cost.

3.13They are equal.

Discussion Questions

14. For long-term software and consultancy projects, typically one of two methods is followed. The first is the completed contract method. Under this method, the company accumulates the expenses incurred in the project in an “inventory” account, and states this inventory at cost in the balance sheet as of the balance sheet date. In the year in which the project is completed, this cost is then charged to the income statement against the revenues earned from the project (like cost of goods sold for a manufacturing firm). The second method is the percentage completion method. Under this method, expenses for each period are charged directly to the income statement each year, and a proportional amount of the total project revenue is also recognized as income in that year. In this case, there is no inventory account for the project.

15. Yes, a restaurant would typically be classified as a service firm because the benefit from the “product” is not received by the customer over a period of time in the future. There is no transfer of ownership of an “asset” as it were. Restaurant patrons receive the benefit of the eating experience while being served at the restaurant site—this benefit cannot be bought and stored for future use (the exception of course is “take-outs,” but we are not considering take-outs here).

16. We would classify U-Haul as a service firm as well for the same reason we consider restaurants and hotels as service firms. Customers are essentially purchasing the right to use the U-Haul truck for a specific period of time. This benefit is not storable and used at some future point in time. As mentioned in the text, the products service firms offer are not tangible or storable like they are for merchandising and manufacturing firms. U-Haul is a good example.

17. Merchandising firms hold inventories for the following reasons: • To make products readily available whenever customers need them and shop for them. If an item is not in stock, ordering, receiving and delivering it to the customer takes time, and the product may reach the customer too late (think of grocery store items such as milk, vegetables, and meat). • Some items are available only in certain seasons, but there is demand throughout the year. By stocking up when supply is available, merchandising firms can meet the demand at other times. • Often ordering and receiving in bulk quantities is a lot more cost effective for merchandising firms than ordering in small quantities....
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