COMPILATION OF ESSAY

CMA EXAM PART 1

BUDGETING & FORECASTING TECHNIQUES
Steven Company plans to introduce a high-speed back-up unit for networked servers in the near future.

Steven’s R&D and Market Research Departments have been working on this project for an extended period and the
combined development costs incurred to date amount to $1,500,000. R&D designed several designs for the back-up
units. Three of the designs were approved for development into prototypes, and from these only one will be manufactured.
Market Research has determined that the appropriate selling price would be $400 per unit, regardless of the model
selected.

The estimated demand schedule for three market situations is shown below. These three demand levels are the only ones
the company considers feasible, and other demand levels are not expected to occur. Steven can meet all demand levels
because its plant currently is below full capacity.

Unit Sales Probability of Occurrence

Light demand 20,000 25%

Moderate demand 80,000 60

Heavy demand 120,000 15

Costs for the three models are presented below. Manufacturing overhead, 40% of which is variable, is applied to Steven’s
products using a plant-wide application rate of 250% of direct labor dollars.

Unit costs Model A Model B Model C

Direct material $150 $100 $114

Direct labor 40 50 48

Manufacturing overhead 100 125 120

Total unit costs $290 $275 $282

Other costs

Tooling and advertising $3,000,000 $4,500,000 $4,100,000

Incurred development costs 1,500,000 1,500,000 1,500,000

Steven has decided to employ an expected value model in his analysis to reach a decision as to which of the three
prototypes to manufacture and sell.

Q1

Develop a payoff table to determine the expected monetary value for each of the three models Steven Company could
manufacture. Based on your analysis, identify the prototype model Steven should manufacture and sell.

Q2

Steven Company’s costs for a back-up unit design that was not developed into a prototype were estimated as follows:
Unit costs

Direct materials $130

Direct labor 46
 Manufacturing overhead 115

Total unit costs $291

Other costs
Tooling and advertising $4,000,000
Incurred development costs 1,500,000

If this design had been developed into a viable model, it would have sold for $400 and had the same expected demand as
the other models. Steven’s management eliminated this model from consideration because it was considered an
inadmissible act, i.e., the calculation of its payoff would have been irrelevant. Explain why the model design was
considered an inadmissible act, thus making the calculation of its payoff irrelevant.

BUDGET METHODOLOGIES & BUDGET PREPARATION

Healthful Foods, Inc., a manufacturer of breakfast cereals and snack bars, has experienced several years of steady
growth while maintaining a relatively low level of debt. The Board of Directors has adopted a long-run strategy to
maximize the value of the shareholders’ investment. To achieve this goal, the Board of Directors established the following
five-year financial objectives:

• Increase sales by 12% per year

• Increase income before taxes by 15% per year
• Increase dividends by 12% per year
• Maintain long-term debt at a maximum 16% of assets

These financial objectives have been attained for the past three years. At the beginning of last year, the president, Andrea
Donis, added a fifth financial objective of maintaining cost of goods sold at a maximum of 70% of sales, and this goal was
attained last year. The budgeting process at Healthful Foods is to be directed toward attaining these goals for the
forthcoming year, a difficult task with the economy in a recession. In addition, the increased emphasis on eating healthful
foods has driven up the price of ingredients significantly faster than the rate of inflation.

John Winslow, cost accountant at Healthful Foods, has responsibility for the preparation of the profit plan for next year.
Winslow assured Donis that he could present a budget that achieved all of the financial objectives. Winslow believed that
he could overestimate the ending inventory and reclassify fruit and grain inspection costs as administrative rather than
manufacturing costs to attain the desired objective. Presented below are the statements for Year 5 and the budgeted
statements for Year 6.

Healthful Foods, Inc.

Income Statement
Year 5 Year 6
Actual Budget
Sales $850,000 $947,750
Variable costs:
Cost of goods sold: 510,000 574,725
Selling & Administrative 90,000 87,500
Contribution margin 250,000 285,525
Fixed costs:
Manufacturing 85,000 94,775
Selling & Administrative 60,000 70,000
Income before taxes $105,000 $120,750
Healthful Foods, Inc.
Statement of Financial Position
 (in thousands)
Year 5 Year 6
Actual Budget
Assets:
Cash $ 10 $ 17
Accounts receivable 60 68
Inventory 300 365
Plant & equipment (net) 1,630 1,600
Total $2,000 $2,050
Liabilities:
Accounts payable $ 110 $ 122
Long-term debt 320 308
Shareholders’ equity:
Common stock 400 400
Retained earnings 1,170 1,220
Total $2,000 $2,050

The company paid dividends of $27,720 in Year 5, and the expected tax rate for Year 6 is 34%

Q1

Describe the relationship between strategic planning and budgeting.

Q2

For each of the five financial objectives, determine whether Winslow’s budget attains these objectives. Support your
conclusion in each case by presenting calculations, and use the following format:
Objective Attained/Not Attained Calculations

COST MANAGEMENT TERMINOLOGY AND CONCEPTS

The Vice President for Sales of Huber Corporation has received the Income Statement for July Year 1. The statement has
been prepared on the direct cost basis and is reproduced below. The firm has just adopted a direct costing system for
internal reporting purposes.

Huber Corporation

Income Statement

For the Month of July Year 1

($000 omitted)

Sales $2,400
Less: Variable standard cost of goods sold 1,200

Manufacturing margin $1,200

Less: Fixed manufacturing costs at budget
$600
Fixed manufacturing cost spending variance 0 600
Gross margin $ 600
 Less: Fixed selling & administrative costs 400
Net income before taxes $ 200

The controller attached the following notes to the statements.

• The unit sales price for July averaged $24.

• The standard unit manufacturing costs for the month were

Variable cost $12

Fixed cost 4

Total cost $16

The unit rate for fixed manufacturing costs is a predetermined rate based upon a normal monthly production of 150,000
units.

• Production for July was 45,000 units in excess of sales.

• The inventory at July 31 consisted of 80,000 units.

Q1

The Vice President for Sales is not comfortable with the direct cost basis and wonders what the net income would have
been under the prior absorption cost basis.

A. Present the November income statement on an absorption cost basis.

B. Reconcile and explain the difference between the direct costing and the absorption costing net income figures.

Q2

Explain the features associated with direct cost income measurement that should be attractive to the Vice President for
Sales.

COST ACCUMULATION SYSTEMS

Romano Foods, Inc. manufactures Roman Surprise Frozen Pizzas that are 12 inches in diameter and retail for $4.69 to
$5.99, depending upon the topping. The company employs a process costing system in which the product flows through
several processes. Joe Corolla, vice president of production, has had a long-running disagreement with the controller,
Sue Marshall, over the handling of spoilage costs. Corolla resists every attempt to charge production with variance
responsibilities unless they are favorable. Spoilage costs have not been significant in the past, but, in November, the
Mixing Department had a large amount of spoilage. Traditionally, Romano Foods has treated 10% of good output as
normal spoilage. The department input 120,000 units of ingredients, and 13,000 dough units were rejected at inspection.
Marshall is concerned about the abnormal spoilage and wants Corolla to take corrective steps. Corolla, on the other hand,
maintains that the Mixing Department is operating properly. He has prepared the following report to support his
contention.

Romano Foods – Mixing Department

Production Cost Report

Month ended November 30, Year 1

Good 10% Good

 Input Total Output Normal Abnormal Units
Units Cost Units Spoilage Spoilage Cost

120,000 $45,360 107,000 12,000 1,000 $.42

Budgeted unit cost $0.435

Actual cost per good unit 0.420

Favorable variance $0.015

Cost Reconciliation

Cost of 107,000 good units @ $.42 each $44,940

Abnormal spoilage (charge to purchasing for buying inferior materials):
1,000 units @ $.42 each 420
Total cost $45,360

Q1

Revise Joe Corolla’s production cost report for November Year 1 by calculating the

a. Number of units of normal spoilage

b. Number of units of abnormal spoilage
c. Total and unit costs of the Mixing Department’s production of good units in November
d. Total and unit costs of abnormal spoilage

Q2

Prepare the journal entry to transfer costs for the Mixing Department for November to the Assembly Department.

Q3

Describe how Joe Corolla’s production cost report has shown the performance of the Mixing Department to be less
favorable than that shown in the revised report.

COST ALLOCATION TECHNIQUES

Bonn Company recently reorganized its data processing activities. The small installations located within the accounting
departments at its plants have been replaced with a single IT department at corporate headquarters. Because the
department has focused its activities on converting applications to the new system and producing reports for the plant and
subsidiary managements, little attention has been devoted to the costs of the department. Now company management
has requested that the departmental manager recommend a cost accumulation system to facilitate cost control and the
development of suitable rates to charge users for service.

For the past two years, the departmental costs have been recorded in one account. The costs have then been allocated to
user departments on the basis of computer time used. The schedule below reports the costs for the current year.

Data Processing Department

Costs for the Year Ended December 31
(1) Salaries and benefits $ 622,600
(2) Supplies 40,000
(3) Equipment maintenance contract 15,000
(4) Insurance 25,000
 (5) Heat and air-conditioning 36,000
(6) Electricity 50,000
(7) Equipment and furniture depreciation 285,400
(8) Building improvements depreciation 10,000
(9) Building occupancy and security 39,300
(10) Corporate administrative charges 52,700
Total costs $1,176,000

Computer hours for user processing* 2,750

Hourly rate ($1,176,000 ÷ 2,750) $428

*Use of available computer hours

Testing and debugging programs 250
Set-up of jobs 500
Processing jobs 2,750
Down-time for maintenance 750
Idle time 742

4,992

The manager recommends that costs be accumulated by five activity centers within the department: Systems Analysis,
Programming, Data Preparation, Computer Operations (processing), and Administration. He then suggests that the costs
of Administration should be allocated to the other four activity centers before a separate rate for charging users is
developed for the first four activities.

The manager made the following observations regarding the charges to the several subsidiary accounts after reviewing
the details of the accounts:
1. Salaries and benefits – records salary and benefits of all employees in the department.
2. Supplies – records paper costs for printers and a small amount for other costs.
3. Equipment maintenance contracts – records charges for maintenance contracts.
4. Insurance – records costs of insurance covering the equipment and furniture.
5. Heat and air-conditioning – records a charge from the corporate heating and air-conditioning department for the
incremental costs to meet special needs of the computer department.
6. Electricity – records the charge for electricity based upon a separate meter within the department.
7. Equipment and furniture depreciation – records the depreciation charges for all owned equipment and furniture within
the department.
8. Building improvements – records the amortization charges for the building changes required to provide proper
environmental control and electrical service for the computer equipment.
9. Building occupancy and security – records the computer department’s share of the costs of the building allocated to
the department on the basis of square feet occupied.
10. Corporate administrative charges – records the computer department’s share of the corporate administrative costs
allocated on the basis of number of employees.

Q1

For each of the ten cost items, state whether it should be distributed to the five activity centers and, for each cost item that
should be distributed, recommend the basis upon which it should be distributed. Justify your conclusion in each case.
Q2

Assume the costs of the Computer Operations (processing) activity will be charged to the user departments on the basis
of computer hours. Using the analysis of computer utilization shown in the problem, determine the total number of hours
that should be employed to determine the charge rate for Computer Operations. Justify your answer.

OPERATIONAL EFFICIENCY & BUSINESS PROCESS PERFORMANCE

Bakker Industries sells three products (Products 611, 613, and 615) that it manufactures in a factory consisting of four
departments (Departments 1 through 4). Both labor and machine times are applied to the products in each of the four
departments. Neither machines nor labor can be switched from one department to another.

Bakker’s management is planning its production schedule for the next several months. There are labor shortages in the
community. Some of the machines will be out of service for overhauling. Available machine and labor time by department
for each of the next six months is listed below.

Department

Monthly Capacity Availability 1 2 3 4

Normal machine capacity in machine

hours 3,500 3,500 3,000 3,500
Capacity of machines being repaired in
machine hours (500) (400) (300) (200)
Available machine capacity in machine
hours 3,000 3,100 2,700 3,300
Labor capacity in direct labor hours 4,000 4,500 3,500 3,000
Available labor in direct labor hours 3,700 4,500 2,750 2,600
Labor and Machine Specifications per Unit of Product

Product Labor and Machine Time

611 Direct labor hours 2 3 3 1

Machine hours 2 1 2 2
613 Direct labor hours 1 2 -- 2
Machine hours 1 1 -- 2
615 Direct labor hours 2 2 1 1
Machine hours 2 2 1 1

The Sales Department’s forecast of product demand over the next six months is presented below.

Product Monthly Sales Volume (Units)

611 500

613 400

615 1,000

Bakker’s inventory levels will not be increased or decreased during the next six months. The unit price and cost data valid
for the next six months are presented below.
 Product

611 613 615

Unit costs:
Direct material $ 7 $ 13 $ 17
Direct labor
Department 1 12 6 12
Department 2 21 14 14
Department 3 24 -- 16
Department 4 9 18 9
Variable overhead 27 20 25
Fixed overhead 15 10 32
Variable selling 3 2 4
Unit selling price $196 $123 $167
Q1

Determine whether the monthly sales demand for the three products can be met by Bakker Industries’ factory. Use the
monthly requirement by department for machine hours and direct labor hours for the production of Products 611, 613, and
615 in your calculations

Q2

What monthly production schedule should Bakker Industries select in order to maximize its dollar profits? Support the
schedule with appropriate calculations, and present a schedule of the contribution to profit that would be generated by the
production schedule selected.

COST MEASURES AND VARIANCE ANALYSIS

Wielson Company employs flexible budgeting techniques to evaluate the performance of several of its activities. The
selling expense flexible budgets for three representative monthly activity levels are shown below.

Representative Monthly Flexible Budgets

for Selling Expenses
Activity measures:
Unit sales volume 400,000 425,000 450,000
Dollar sales volume $10,000,000 $10,625,000 $11,250,000
Number of orders 4,000 4,250 4,500
Number of salespersons 75 75 75
Monthly expenses:
Advertising and promotion $1,200,000 $1,200,000 $1,200,000
Administrative salaries 57,000 57,000 57,000
Sales salaries 75,000 75,000 75,000
Sales commissions 200,000 212,500 225,000
Salesperson travel 170,000 175,000 180,000
Sales office expense 490,000 498,750 507,500
Shipping expense 675,000 712,500 750,000
Total selling expenses $2,867,000 $2,930,750 $2,994,500

The following assumptions were used to develop the selling expense flexible budgets:
• The average size of Wielson’s sales force during the year was planned to be 75 people.
• Salespersons are paid a monthly salary plus commission on gross dollar sales.
• Travel costs are best characterized as a step variable cost. The fixed portion is related to the number of salespersons
while the variable portion tends to fluctuate with dollar sales.
• Sales office expense is a mixed cost with the variable portion related to the number of orders processed.
• Shipping expense is a mixed cost with the variable portion related to number of units sold.

A salesforce of 80 persons generated a total of 4,300 orders resulting in a sales volume of 420,000 units during
November. The gross dollar sales amount to $10.9 million. The selling expenses incurred for November were as follows:

Advertising and promotion $1,350,000

Administrative salaries 57,000
Sales salaries 80,000
Sales commissions 218,000
Salesperson travel 185,000
Sales office expense 497,200
Shipping expense 730,000
Total $3,117,200
Q1

Explain why flexible budgeting is a useful management tool.

Q2

Explain why the selling expense in flexible budgets would not be appropriate for evaluating Wielson Company’s
November selling expenses, and indicate how the flexible budget would have to be revised.

Q3

Prepare a selling expense report for November that Wielson can use to evaluate control over selling expenses. The report
should have a line for each selling expense item showing the budgeted amount, the actual selling expense, and the
monthly dollar variation.

RESPONSIBILITY ACCOUNTING & PERFORMANCE MEASURES

The Institute of Management Accountants has issued Statements on Management Accounting Number 4D, Measuring
Entity Performance, to help management accountants deal with the issues associated with measuring entity performance.
Managers can use these measures to evaluate their own performance or the performance of subordinates, to identify and
correct problems, and to discover opportunities. To assist management in measuring achievement, there are a number of
performance measures available. To present a more complete picture of performance, it is strongly recommended that
several of these performance measures be utilized and that they be combined with nonfinancial measures such as market
share, new product development, and human resource utilization. Five commonly used performance measures that are
derived from the traditional historical accounting system are listed below.

• Gross profit margin (percent)

• Cash flows
• Return on the investment in assets
• Residual income
• Total asset turnover

Q1

Describe how the measure is calculated.

• Gross profit margin (percent)
• Cash flows
• Return on the investment in assets
• Residual income
• Total asset turnover

Q2

Describe the information provided by the measure.

Q3

Explain the limitations of this information.

INTERNAL CONTROLS 1

Wooster Company is a beauty and barber supplies and equipment distributorship servicing a five-state area. Management
generally has been pleased with the overall operations of the company to date. However, the present purchasing system
has evolved through practice rather than having been formally designed. Consequently, it is inadequate and needs to be
redesigned.

A description of the present purchasing system is as follows. Whenever the quantity of an item is low, the inventory
supervisor phones the purchasing department with the item description and quantity to be ordered. A purchase order is
prepared in duplicate in the purchasing department. The original is sent to the vendor, and the copy is retained in the
purchasing department filed in numerical order. When the shipment arrives, the inventory supervisor sees that each item
received is checked off on the packing slip which accompanies the shipment. The packing slip is then forwarded to the
accounts payable department. When the invoice arrives, the packing slip is compared with the invoice in the accounts
payable department. Once any difference between the packing slip and the invoice are reconciled, a check is drawn for
the appropriate amount and is mailed to the vendor with a copy of the invoice. The packing slip is attached to the invoice
and filed alphabetically in the paid invoice file.

Q1

Identify the internally and externally generated documents that would be required to satisfy the minimum requirements of
a basic system, and indicate the number of copies of each document that would be needed.

Q2

Explain how all of these documents should interrelate and flow among Wooster’s various departments, including the final
destination or file for each copy.

COST MANAGEMENT TERMINOLOGY AND CONCEPTS

ESSAY 1 BUDGETING & CHANGING COST STRUCTURE

Sun Company, a subsidiary of Guardian, Inc., produces and sells three product lines. The company employs a standard
cost accounting system for record keeping purposes. At the beginning of the current year, the president of Sun Company
presented the budget to the parent company and accepted a commitment to contribute $15,800 to Guardian’s
consolidated profit for the year. The president has been confident that the year’s profit would exceed budget target, since
the monthly sales reports that he has been receiving have shown that sales for the year will exceed budget by 10%. The
president is both disturbed and confused when the controller presents an adjusted forecast as of November 30 indicating
that profit will be 11% under budget. The two forecasts are presented below:
 Sun Company

Forecasts of Operating Results

1/1 11/30

Sales $268,000 $294,800

Cost of sales at standard 212,000 233,200

Gross margin at standard $ 56,000 $ 61,600

Over- (under-) absorbed fixed

manufacturing overhead -- (6,000)

Actual gross margin $ 56,000 $ 55,600

Selling expenses $ 13,400 $ 14,740

Administrative expenses 26,800 26,800

Total operating expenses $ 40,200 $ 41,540

Earnings before tax $ 15,800 $ 14,060

*Includes fixed manufacturing overhead of $30,000.

There have been no sales price changes or product mix shifts since the 1/1 forecast. The only cost variance on the
income statement is the underabsorbed manufacturing overhead. This arose because the company produced only 16,000
standard machine hours (budgeted machine hours were 20,000) during the year as a result of a shortage of raw materials
while its supplier was closed by a strike. Fortunately, Sun Company’s finished goods inventory was large enough to fill all
sales orders received.

Q1

Analyze and explain why the profit has declined in spite of increased sales and good control over costs.

Q2

What plan, if any, could Sun Company adopt during December to improve their reported profit at year end? Explain your
answer.

Q3

Illustrate and explain how Sun Company could adopt an alternative internal cost reporting procedure that would avoid the
confusing effect of the present procedure.

Q4

Would the alternative procedure described in Question 3 be acceptable to Guardian, Inc. for financial reporting purposes?
Explain.
ESSAY 2 – OVERHEAD CALCULATION

Moss Manufacturing has just completed a major change in its quality control (QC) process. Previously, products had been
reviewed by QC inspectors at the end of each major process, and the company’s 10 QC inspectors were charged as
direct labor to the operation or job. In an effort to improve efficiency and quality, a computer video QC system was
purchased for $250,000. The system consists of 15 video cameras and specialized software.

The new system uses cameras stationed by QC engineers at key points in the production process. Each time an
operation changes or there is a new operation, the cameras are moved, and a new master picture is loaded onto the
server by a QC engineer. The camera takes pictures of the units in process, and the computer compares them to the
picture of a “good” unit. Any differences are sent to a QC engineer who removes the bad units and discusses the flaws
with the production supervisors. The new system has replaced the 10 QC inspectors with two QC engineers.

The operating costs of the new QC system, including the salaries of the QC engineers, have been included as factory
overhead in calculating the company’s plant-wide factory overhead rate, which is based on direct labor dollars.

The company’s president is confused. His vice president of production has told him how efficient the new system is, yet
there is a large increase in the factory overhead rate. The computation of the rate before and after automation is shown
below.

Before After

Budgeted overhead $1,900,000 $2,100,000

Budgeted direct labor 1,000,000 700,000

Budgeted overhead rate 190% 300%

“Three hundred percent,” lamented the president. “How can we compete with such a high factory overhead rate?”

Q1

A. Define factory overhead, and cite three examples of typical costs that would be included in factory overhead.
B. Explain why companies develop factory overhead rates

Q2

Explain why the increase in the overhead rate should not have a negative financial impact on Moss Manufacturing.

Q3

Explain, in the greatest detail possible, how Moss Manufacturing could change its overhead accounting system to
eliminate confusion over product costs.

Q4

Discuss how an activity-based costing system might benefit Moss Manufacturing.