CASE 3 QUESTIONS RIO GRANDE MEDICAL CENTER Cost Allocation Concepts

CASE 3 QUESTIONS RIO GRANDE MEDICAL CENTER Cost Allocation Concepts

CASE 3 QUESTIONS

RIO GRANDE MEDICAL CENTER

Cost Allocation Concepts

 

1. Is it “fair” for the Dialysis Center to suffer in profitability, and hence for the department head to possibly lose his bonus, just because the Outpatient Clinic needs additional space?

2. In the past, the medical center aggregated all facility costs and then allocated the total amount

on the basis of square footage. This methodology assigned an average cost rate to each patient service department, regardless of whether its space is new or old, or prime or poor. The proposed allocation for the Dialysis Center, on the other hand, requires it to bear the true facility costs of its new space. What are the advantages and disadvantages of the new methodology? Do you support the new allocation scheme?

3. If the new allocation method for facility costs is implemented, what should be the facility allocation to the Dialysis Center in 20 years, when the loan (which is the basis for the higher cost allocation) has been paid off and there are no longer any actual facility costs?

4. Explain how the revenue from medical (pharmacy) supplies is currently handled for profit and loss reporting purposes. Is there a problem with the current system? Is there a better way of reporting this revenue? If so, what is it?

5. When all issues related to the decision are considered, what is your recommendation regarding the final allocation amounts?

SOLUTION PREVIEW

RIO GRANDE MEDICAL CENTER

Cost Allocation Concepts

1. Is it “fair” for the Dialysis Center to suffer in profitability, and hence for the department head to possibly lose his bonus, just because the Outpatient Clinic needs additional space?

No. It is not “fair” for the Dialysis centre to suffer in profitability on account of cost allocated to it which was incurred was by outpatient centre for need of additional space.

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A company is considering a high-tech project lasting five years. The project requires $800,000 of initial investment and generates net cash flows of $200,000, $300,000, $300,000, $200,000, and $300,000 in years 1, 2, 3, 4, and 5, respectively. Therefore, the cash flows are as follows

A company is considering a high-tech project lasting five years. The project requires $800,000 of initial investment and generates net cash flows of $200,000, $300,000, $300,000, $200,000, and $300,000 in years 1, 2, 3, 4, and 5, respectively. Therefore, the cash flows are as follows:

Year     Cash Flow

0          -800,000

1          200,000

2          300,000

3          300,000

4          200,000

5          300,000                                                                                                      Click here for SOLUTION

The appropriate discount rate (or the cost of capital) is 10%.

1. If the company uses the NPV method, should the project be accepted? Why (or why not)?

2. If the company uses the IRR method, should the project be accepted? Why (or why not)?

3. The company’s maximum acceptable payback period is 3 years. If the company uses the payback period method, should the project be accepted? Why (or why not)?

4. Would you accept a project which requires $50,000 of initial investment and yields $10,000 every year infinitely? Why (or why not)? Assume that the discount rate (or the cost of capital) is 10%.

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P10-12 Spencer Supplies stock is currently selling for $60 a share. The firm is expected to earn $5.40 per share this year and to pay a year-end dividend of $3.60.

P10-12 Spencer Supplies stock is currently selling for $60 a share. The firm is expected to earn $5.40 per share this year and to pay a year-end dividend of $3.60.

Intermediate Financial Management  By Eugene F. Brigham, Philip R. Daves

 

a. If investors require a 9% return, what rate of growth must be expected for Spencer?

b. If Spencer reinvests earnings in projects with average returns equal to the stock’s expected rate of

return, what will be next year’s EPS? [Hint: g=ROE (Retention ratio).]

 

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P9-10 The earnings, dividends, and stock price of Shelby Inc. are expected to grow at 7% per year in the future

P9-10 The earnings, dividends, and stock price of Shelby Inc. are expected to grow at 7% per year in the future. Shelby’s common stock sells for $23 per share, its last dividend was $2.00, and the company will pay a dividend of $2.14 at the end of the current year.

a. Using the discounted cash flow approach, what is its cost of equity?

b. If the firm’s beta is 1.6, the risk free rate is 9%, and the expected return on the market is 13%, what will be the firm’s cost of equity using the CAPM approach?

c. If the firm’s bonds earn a return of 12%, what will rs be using the bond-yield-plus-risk-premium approach? (Hint: Use the midpoint of the risk premium range.)

d. On the basis of the results of parts a through c, what would you estimate Shelby’s cost of equity to be?

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The 12% bonds payable of Keane Co. had a carrying amount of $832,000 on December 31, 2006

The 12% bonds payable of Keane Co. had a carrying amount of $832,000 on December 31, 2006. The bonds, which had a face value of $800,000, were issued at a premium to yield 10%. Keane uses the effective-interest method of amortization. Interest is paid on June 30 and December 31. On June 30, 2007, several years before their maturity, Keane retired the bonds at 104 plus accrued interest. The loss on retirement, ignoring taxes, is

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A company issues $20,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2007. Interest is paid on June 30 and December 31.

A company issues $20,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2007.  Interest is paid on June 30 and December 31. The proceeds from the bonds are $19,604,145. Using effective-interest amortization, how much interest expense will be recognized in 2007?

2. A company issues $20,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2007.  Interest is paid on June 30 and December 31. The proceeds from the bonds are $19,604,145. Using effective-interest amortization, what will the carrying value of the bonds be on the December 31, 2007 balance sheet?

3. A company issues $20,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2006.  Interest is paid on June 30 and December 31. The proceeds from the bonds are $19,604,145.  What is interest expense for 2007, using straight-line amortization?

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The balance sheet for Magic Carpet is shown below in market value terms there are 20,000 shares of stock outstanding

The balance sheet for Magic Carpet is shown below in market value terms there are 20,000 shares of stock outstanding

Regular dividends

The balance sheet for Magic Carpet is shown below in market value terms there are 20,000 shares of stock outstanding

                               Market Value Balance sheet

                       Cash                 $50,000

                       Fixed assets     250,000             Equity  $300,000

                       Total                $300,000            Total     $300,000

The company has declared a dividend of $1.10 per share. The stock goes ex dividend tomorrow, ignoring any tax effects what is the stock selling for today? what will it sell for tomorrow what will the balance sheet look like after the dividends are paid?

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BTC has 500,000 shares of stock outstanding that sell for $85 per share. Assuming no market imperfections or tax effect exists, what will the share price be after?

BTC has 500,000 shares of stock outstanding that sell for $85 per share. Assuming no market imperfections or tax effect exists, what will the share price be after?

Stock splits and dividends -  BTC has 500,000 shares of stock outstanding that sell for $85 per share. Assuming no market imperfections or tax effect exists, what will the share price be after?

a. a 3 for 5 split

b. BTC has a 16% stock dividend

c. BTC has a 42.5 stock dividend

d. BTC has a 4 for 7 stock split

 

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P10-4B January 2 20X4 Makinthosh speed Co. purchased a used trailer at a cost of $63,000. before placing the trailer in service

P 10-4B January 2 20X4 Makinthosh speed Co. purchased a used trailer at a cost of $63,000. before placing the trailer in service, the company spent $2,200 painting it, $8,00 replacing tires,  and $4,000 overhauling the chassis, McIntosh management estimates that the trailer will remain in service for 6 years and have a residual value of $14,200. the trailer’s annual mileage is expected to be 18,000 miles in each of the first 4 years and 14,000 in each of the next two years-100,000 miles in total. In deciding which depreciation method to use, Larry McIntosh, the general manager, requests a depreciation schedule for each of a depreciation methods(straight-line, unit of production, and double-declining-balance).

Required

1. Prepare a depreciation schedule for each depreciation method, showing asset cost, depreciation expense, accumulated depreciation, and asset book value. For the units of-production method, round depreciation per mile to three decimal places.

2. McIntosh prepares financial statements using the depreciation method that reports the highest net income in the early years of asset use. For income-tax purpose, however the company uses the depreciation method that minimizes the income taxes in the early years. Consider the first year that McIntosh uses the trailer. Identify the depreciation methods that meet the general manager’s objectives, assuming the income tax authorities permit the use of any of the methods.

 

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After a dispute concerning wages, Orville Arson tossed an incendiary device into the Sparkle Company’s record vault

Manufacturing Cost Flows After a dispute concerning wages, Orville Arson tossed an incendiary device into the Sparkle Company’s record vault

Case #1 - Manufacturing Cost Flows

After a dispute concerning wages, Orville Arson tossed an incendiary device into the Sparkle Company’s record vault.  Within moments only a few charred fragments were readable from the company’s factory ledger for the year ended December 31, 2005, as shown below:
 

Direct Materials			Manufacturing Overhead
+ Bal. 1/1    $8,000	--		+ Actual costs for 2005: $79,000	-- applied overhead $85100
Material purchased 115000	Material used 106300
Bal 31/12 16700				Over-applied
				overhead             $6,100

 

Work in Process		Finished Goods		Cost of Goods Sold
+ Bal. 1/1   $7,200	--	+ Bal 1/1 $36000	--	+	--
D. Material   106300					Over-applied
D. Labor  92000	$ 280000	Cost of goods manufactured 280000	Cost of goods sold 295000	Finished goods 295000	overhead             $6,100
Mfg. overhead 85100
Bal 31/12 $10600		Bal. 12/31    $21,000		Cost of goods sold after adjustment 288900

                                                                                    

To get ready for the end of the year audit by Deloitte & Touche, the company must reconstruct its activities for 2005.  You are the manager of internal audit, and must perform the task of reconstruction.  Sifting through the ashes and interviewing selected employees has turned up the following additional information: 

a.       The production superintendent states that manufacturing overhead cost is applied to jobs on the basis of direct-labor hours.  However, he does not remember the rate currently being used by the company.

b.      A charred piece of the payroll ledger, found after sifting through piles of smoking debris, indicates that 11,500 direct labor-hours were recorded for the year at $8 per hour.  The company’s Personnel Department has verified that as a result of a union contract, there are no variations in pay rates among factory employees.

c.       Cost sheets kept in the production superintendent’s office show that only one job was in process on December 31, at the time of the explosion.  The job had been charged with $6,600 in materials, and 500 direct-labor hours (at $8 per hour) had been worked on the job.

d.      According to the company’s purchasing agent, purchases of direct materials totaled $115,000 for the year.

e.       Last year’s balance sheet indicated that finished goods inventory totaled $36,000 on December 31, 2004.

f.       A log is kept in the finished goods warehouse showing all goods transferred in from the factory.  This log shows that the cost of goods transferred into the finished goods warehouse from the factory during 2005 totaled $280,000.    

f.   A log is kept in the finished goods warehouse showing all goods transferred in from the factory.  This log shows that the cost of goods transferred into the finished goods warehouse from the factory during 2005 totaled $280,000.

Required:

Determine the following amounts:

 (Hint: A good way to proceed is to bring the fragmented T-accounts up to date through December 31,    2005 by posting whatever transactions can be developed from the information given).  All of your supporting work must be shown and clearly labeled to receive credit for the case.  Attach you work to the back of this answer sheet.

1.   Overhead applied to work in process during 2005.                           __________________

2.   Predetermined overhead rate being used by the company.               _________________

3.   Work in process inventory, December 31, 2005.                              __________________

4.   Direct materials usage during June.                                                  __________________

5.   Direct materials inventory, December 31, 2005.                              ___________________

6.   Cost of goods sold for 2005 before adjustment for over-applied overhead. ____________                                                                                                                      

7.   Cost of goods sold for 2005 after adjustment for over-applied overhead._____________

 

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A condensed balance sheet for Kellwood Company and a partially completed vertical analysis is presented below.

A condensed balance sheet for Kellwood Company and a partially completed vertical analysis is presented below.

Required:
1. Complete the vertical analysis by computing each line item (a)–(d) as a percentage of total assets.

2. What percentages of Kellwood’s assets relate to inventories versus property and equipment? What does this tell you about the relative significance of these two assets to Kellwood’s business?

3. What percentage of Kellwood’s assets is financed by total stockholders’ equity? By total liabilities?

 

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Briefly distinguish between managerial and financial accounting in terms of (a) the intended users of the information and (b) the purpose of the information

A.  Briefly distinguish between managerial and financial accounting in terms of (a) the intended users of the information and (b) the purpose of the information.

B.  Differentiate between accrual and cash basis accounting.

C.  Discuss how the Sarbanes-Oxley Act has increased the importance of internal control to all employees in a company.

D.  Describe the role of the Financial Accounting Standards Board

E.  What are the four basic financial statements?

F.  What are the characteristics of accounting information?

G.  What is an auditor’s opinion?

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Which of the following is not one of the four conditions that normally must be met for revenue to be recognized according to the revenue principle for accrual basis accounting?

Accrual basis accounting, the matching principle, income statements

Accounting or Finance Questions

A. Which of the following is not one of the four conditions that normally must be met for revenue to be recognized according to the revenue principle for accrual basis accounting?

a. The price is fixed or determinable.

b. Services have been performed.

c. Cash already has been collected.

d. Evidence of an arrangement for customer payment exists.

B. The matching principle controls

a. Where on the income statement expenses should be presented.

b. How costs are allocated between Cost of Goods Sold (sometimes called Cost of Sales) and general and administrative expenses.

c. The ordering of current assets and current liabilities on the balance sheet.

d. When costs are recognized as expenses on the income statement.

C. Which of the following would not be considered a recurring item on the income statement?

a. Administrative expenses.     c. Selling expenses.

b. Sales revenues.                    d. Loss on disposal of a business division.

D. If a company decides to record an expenditure as an asset rather than as an expense, how will this decision affect net income in the current period?

a. Net income will be higher.

b. Net income will be lower.

c. Net income will not be affected by this decision.

d. It’s a mystery; nobody really knows.

E. When should a company report the cost of an insurance policy as an expense?

a. When the company first signs the policy.

b. When the company pays for the policy.

c. When the company receives the benefits from the policy, over its period of coverage.

d. When the company receives payments from the insurance company for its insurance claims.

F. When expenses exceed revenues in a given period (and there are no gains or losses),

a. Stockholders’ equity will not be impacted.

b. Stockholders’ equity will be increased.

c. Stockholders’ equity will be decreased.

d. One cannot determine the impact on stockholders’ equity without additional information.

G. Which account is least likely to be debited when revenue is recorded?

a. Accounts payable c. Cash

b. Accounts receivable d. Unearned revenue

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Match each ratio or percentage with its formula by entering the appropriate letter for each numbered item

Match each ratio or percentage with its formula by entering the appropriate letter for each numbered item.

1. Net profit margin                             A. Net income ÷ Net sales revenue.

2. Inventory turnover ratio                   B. (Net sales revenue - Cost of goods sold) ÷ Net sales revenue.

3. Cash coverage ratio                                     C. Current assets ÷ Current liabilities.

4. Fixed asset turnover                                     D. Cost of goods sold ÷ Average inventory.

5. Capital acquisitions ratio                  E. Net credit sales revenue ÷ Average net receivables.

6. Return on equity                              F. Net cash flows from operating activities ÷ Net income.

7. Current ratio                                    G. Net income ÷ Average number of common shares outstanding.

8. Debt-to-assets ratio                          H. Total liabilities ÷ Total assets.

9. Price/earnings ratio                          I. (Net income + Interest expense + Income tax expense) ÷ Interest expense.

10. Receivables turnover ratio             J. Net cash flows from operating activities ÷ Cash paid for property, plant, and equipment

11. Earnings per share                                     L. Net income ÷ Average total stockholders’ equity.

12. Quality of income ratio                  K. Current market price per share ÷ Earnings per share.

13. Gross profit percentage                  M. Net cash flows from operating activities (before interest and taxes) ÷ Interest paid.

14. Times interest earned                     N. Net sales revenue ÷ Average net fixed assets.

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