SOLUTION MANUAL FOR FINANCIAL
MANAGEMENT FOR PUBLIC HEALTH,
AND NOT-FOR-PROFIT
ORGANIZATIONS 7TH EDITION BY
STEVEN FINKLER, THAD CALABRESE
4-1
Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations
Chapter 4
UNDERSTANDING
COSTS
QUESTIONS FOR DISCUSSION
4-1. Anything in particular for which a measurement of cost is desired. This could be a unit of
service, a program, department, or organization. For example, one might be interested in the
cost of plowing snow from the roads of the Town of Millbridge. The most basic point in
costing is to clearly define and communicate the cost objective. Communication is critical, and
data only become useful information if they are communicated in a way that everyone
understands.
4.2. Full cost refers to the total of all costs associated with a cost objective. This includes direct and
indirect costs. Direct costs are the costs incurred within the organizational unit for which the
manager has responsibility, or the costs of resources for direct production of a good or service.
Indirect costs are costs that are assigned to an organizational unit from elsewhere in the
organization, or costs of resources that are not used for direct production of a good or service.
Direct and indirect costs are particularly difficult to understand because their definitions relate
to the object of the analysis. If one is interested in the direct cost of the public works
department, it is appropriate to include department supervisory personnel in that cost. In
contrast, if one is interested in the direct cost per mile of road plowed, that would include the
plow, the driver, and the cost of the salt spread on the road, but not the cost of supervisory
personnel. In that example, the supervisors are direct costs of the public works department (i.e.,
what it costs to operate the public works department) but indirect costs of plowing the road
(i.e., what it costs to plow the roads). The various scheduling and other administrative
activities carried out by supervisory personnel are essential to running the department, but they
are not a direct cost of plowing snow.
4.3. Average cost is the full cost of any cost objective divided by the number of units of service
provided. Fixed costs: those costs that do not change in total as the volume of service units
changes over a relevant range of activity. Variable costs: those costs that vary directly with
changes in the volume of service units over a relevant range of activity. If all of the costs of
plowing snow, both direct and indirect, are added and the total is divided by the number of
units, the result is the cost per unit or the average cost. So, the total cost could be divided by
the number of miles to find the cost per mile plowed. Once Meals for the Homeless (Meals)
rents space for a soup kitchen, the rent will not change from day to day, even if the number of
meals provided varies by a substantial amount. Perhaps Meals is serving 300 people a day at a
given soup kitchen. If Meals were to feed another person, the rent would stay the same.
Therefore, it is a fixed cost. In contrast, the amount of food that Meals must purchase represents
a variable cost. If more people are served, meals will need more food. Activity represents the
volume of services provided.
4.4. Marginal costs are the extra costs incurred as a result of providing one more service unit (such
as one more meal). At first, marginal costs would appear to be identical to variable costs. In
both cases, if there is one more unit of activity, there will be an increase only in variable costs.
Marginal costs, however, more broadly look at all costs that might change as a result of a
Chapter 4: Understanding Costs
4-2
decision. Suppose that HOS has an x-ray machine that can take 5,000 x-rays per year. What is
the cost of doing one more x-ray? If HOS has to buy another machine to do the 5,001st x-ray,
then on the margin, the costs of the additional patient are the variable cost of one more patient
plus the cost of acquiring another machine.
4-5. Cost per unit depends on volume. If volume is low, the cost per unit is higher than if volume is
high. This is because as volume rises, fixed costs get shared resulting in less fixed cost per
unit. Furthermore, for historical purposes measuring the average cost may be adequate. For
prospective decision making, we are often interested in the marginal costs. Therefore the
appropriate measure of cost depends in part on the reason we want to know the cost.
4-6. Suppose the activity is the cost of educating students. One could argue that the teacher and
supplies used in the classroom are direct costs and that the principal and secretaries in the
school office and the superintendent at the central office are indirect costs. Alternatively, if the
activity is the cost of running each of the school district’s elementary schools, then the direct
costs would include the principal, secretary, and heat, in addition to the teacher and classroom
supplies. However, it would not include the district superintendent, who would be an indirect,
or overhead, cost. The superintendent only becomes a direct cost when the activity is the cost
of running the school district.
4-7. For changes in activity volume within the relevant range, marginal costs are the same as
variable costs. If a proposed change is beyond the relevant range of some fixed cost, then the
marginal costs will include the change in fixed cost as well as the variable costs.
4-8.
In order to assign costs from one objective to another, a base is needed. For example, we could
choose to allocate costs based on patient days. In that case, the number of patient days would
be the base. Alternatively, costs could be allocated based on hours. It is common to allocate
housekeeping costs based on hours of service provided. The total number of hours of
housekeeping service becomes the base. If this base is divided into the total cost for providing
housekeeping services, the result is an overhead application rate, in this case, a cost per hour of
service.
4.9. Activity-based costing (ABC) considers that volume is not the only generator of cost. Often
activities with low volume may generate significant amounts of cost. If indirect costs are
allocated based on volume, they will be overassigned to some units of service and
underassigned to others. A more accurate approach would be to allocate indirect costs based on
the activities that drive them.
INSTRUCTOR’S NOTE
Activity Based Costing
One could contend that if you perform cost measurement correctly to begin with, there is no need
for ABC. The problem is that a model T Ford was mostly direct cost and very little overhead, but a
modern Ford is mostly overhead and very little direct cost. Why? Because we got sloppy and
started allocating direct costs as if they were indirect because it is easier to allocate on broad bases
rather than to actually try to track the costs. So, ABC is sold as an approach to allocate indirect
costs more accurately. But that is a contradiction. There is no accurate way to allocate costs that
4-3
Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations,
are really indirect. ABC is really a movement toward treating more of our direct costs as being
direct. If there is a cause-and-effect relationship, it can be hidden by broad allocation approaches.
Cost accounting has long taught that it was necessary to focus on direct costs and to use multiple
cost bases when you do have to allocate costs in order to incorporate as much of the cause and
effect as possible. On the other hand, ABC does serve a role because organizations have become so
confused by their cost allocations that they often don’t know which of their costs are truly direct
costs nor to which specific cost objective they relate.
4.10. The decision of whether to “make or buy” is one that is best addressed using an approach called
marginal cost analysis. This approach is sometimes referred to as incremental analysis or outof-pocket
analysis.
The
essence
of
the
approach
is
that
decisions
such
as
whether
to
provide
a
service
or
to
change
the
volume
of
a
service
should
be
based
on
marginal
rather
than
average
costs.
4.11. If a particular program, service, or activity is expected to have a volume of activity that is too
low to break even, the activity may not be feasible. However, sometimes changes in the activity
can be made to achieve a break-even status. One approach is to lower the volume needed to
break even. There are three ways to reduce the required break-even level. One can lower the
fixed costs by getting by with less expensive or fewer fixed resources. That may or may not be
possible, depending on the specific circumstances. A second way to lower the break-even point
is to increase prices. Price increases would increase the contribution margin per unit. That
would have the effect of lowering the break-even point. However, based on the principles of
supply and demand, price increases might reduce the expected volume for many activities or
services. In that case, the price increases may be defeating their purpose. Also, prices are
sometimes regulated and beyond the control of the organization. Finally, one could try to reduce
the variable cost per unit. This might be accomplished by increased efforts toward improved
efficiency.
If it is not feasible to change the fixed costs, price, or variable costs, an organization can
try to increase the number of units of activity through marketing activities, focused on services
or customers that have a particularly high contribution margin.
PROBLEMS
4-12. a. Fixed: depreciation, doctor, nurse, cooks and camp director
b. Step-Fixed or Semi-Variable costs: counselors
c. Variable: food and transportation
d. Not included in the camp’s cash budget: depreciation
4-13. b. the number of children that will be added to the program
d. the impact of adding the children to the existing facility
4-14. b. there is a change in fixed costs
4-15. 1. BEQ = FC/(VR – VC) = ($5,000 per week/5 days per week)/((15-5)) = 1000/10
Chapter 4: Understanding Costs
4-4
= 100 per day
2. b. decreases
4-16. 1. a. Direct Country staff, clinic staff and supplies
b. Indirect DWB’s central staff
c. Fixed all staff expenses
d. Variable supplies
2. The country director and country-wide staff
4-17. d. Who is measuring the cost
e. Whether the person asking the question is inside or outside the organization
4-18. 1. a. Direct faculty researcher, research assistants, laboratory costs and supplies
b. Indirect administrative staff, building expenses, research director
c. Fixed building and laboratory expenses, administrative expenses, faculty researcher
and
research assistants
d. Variable supplies
2. cost objective
4-19. a. The relevant time period
b. The relevant range of volume
4-20. 1. Full Cost.
2. Average Cost.
3. Marginal Cost.
4-21. 1. b. Indirect cost
2. a. Direct cost
4-22. 1. d. Unit variable cost remains constant and unit fixed cost decrease
2. d. Relevant range
4-23. 1. flexible
2. operating
3. zero-based
4-24. a. increases
4-5
Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations,
4-25. c. total revenues = total costs
4-26. 1. ___total revenue__ equals __total expense____
2. ___price or variable revenue___ minus __variable cost_____.
3. b. decreases
4-27. 1. price per unit or marginal revenue __ and __ variable cost per unit or marginal cost.
2. a. increase
4-28. b. reduce the contribution margin per unit of service.
4-29. 1. contribution margin or marginal contribution
2. a. a loss or deficit
4-30. 1. $2,000,000-$1,600,000 = $400,000
2. 400,000 x 1.10 = 440,000
Total costs = 1,600,000 + 440,000 = $2,040,000
4-31. Relevant Costs = $120,000 - $25,000 = $95,000
4-32. 1. variable salary expenses of $570,000 ($650,000 - $80,000)
variable benefit expenses of $570,000*30% = $171,000
printing costs of $150,000
These costs will change (will be eliminated) if Hudson accepts the contract. All of the other
costs are fixed or sunk.
2. YES the cost of the contract is $750,000 and the savings are $570,000 + $171,000 +
$150,000
= $891,000
Chapter 4: Understanding Costs
4-6
4-33. FC: $30,000 + 13,000 + 5,000 = $48,000
P per day = $12*300 = $3,600 per day
VC per day = $1,600
BEQ = ___$48,000____ = 24 days
(3,600-1,600)
4-34. Weighted Average Price
.30 * $100
= 30
.70*.80*$100
= 56
$86
FC = $210,000
VC = $65 per exam
P = $86 per exam
BEQ = $210,000 / (86 – 65) = 10,000 exams
4-35. 1. BEQ = FC / (P – VC) = 10000/(275 – 75) = 50 people
2. $300 - $75 = $225
3. TR – TE = Profit
Q*P – (FC + VC * Q) = Profit
Q*P = Profit + (FC + VC * Q)
P = (Profit + (FC + VC * Q))/Q
P = (100,000 + 10,000 + 500 * 75)/500 = 147,500/500 = $295 per ticket
4-7
Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations,
4-36.
1. Breakeven
Number of = Total Fixed Expenses/Unit Contribution Margin
People =
($5,000 + $1,000) / ($150 - $50) = 60 people
2. Average cost = Total cost / volume
TC= 6,000 + (50*100) = 11,000
AC= 11,000 / 100 = $110 per person
4-37.
1. Fixed costs = $180 VC= 5 Q=12
Q = FC/(P – VC)
12=180/(P-5)
12(P-5)=180
12P-60=180
12P=240
P=$20
2. Fixed costs = $180+300 = $480 treat profit as a fixed cost
VC= 5
Q=12
Q = FC/(P – VC)
12=480/(P-5)
12(P-5)=480
12P-60=480
12P=540
P=$45
4-38. Q = FC/P-VC
Q = 30 days
P = 2,000*$10 = $20,000 per day
VC = $1,000 per day
30 = FC/(20,000-1,000)
30 x 19,000 = FC
FC = $570,000
Chapter 4: Understanding Costs
4-8
4-39. 1. BEQ = FC/(VR – VC) = ($18,000)/((300-30)) = 18,000/270 = 67
2. a. increases
4-40. 1. BEQ = (FC-City revenue)/(Weighted VR – Weighted VC) or
BEQ = (FC-City revenue)/(Weighted CM)
Base Reading
Daily Price
$10.00
$3.00
Daily VC
$3.00
$5.00
Days per week
5
Fixed Costs
$36,000
City Contract
$30,000
Weekly Weekly Weekly Weekly
Mix
Price
VC
CM Weighted CM
non reading
70.0% $50.00 $15.00 $35.00
$24.50
reading
30.0% $65.00 $40.00 $25.00
$7.50
Total Weighted CM
$32.00
Break Even
188
2. a. increases
4-41. 1. BEQ = (FC-grant)/(total VR – total VC)
Fixed Cost
$100,000
Less Grant
$25,000
Net Fixed Costs
$75,000
Variable Costs
Tee Shirt
$5.00
Refreshments
$10.00
Total Variable Cost
$15.00
Variable Revenue
Registration Fee
$5.00
Miles
10
Contribution/mile
$0.50
Number of sponsors
15
Sponsors Payment
$75.00 contribution/mile * sponsors * miles
Variable Revenue
$80.00
BEQ
1,153.85 fc /(vr-ve)
Nearest Whole Person
1,154
2. increases
4-9
Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations,
4-42. 1. New visit contribution margin: $50 - $40 = $10 * 20% = $ 2
Follow up visit contribution margin: $50 - $30 = $20 * 80% = $16
Weighted average contribution margin: = $18
Breakeven volume = Total Fixed Cost/Weighted Average Contribution Margin
= ($12,000 + $6,000)/$18 = 1,000 visits
2. Total Contribution Margin = $18/visit*12 visits/day*21 days/physician*5 physicians
= $22,680
Profit = Total Contribution Margin – Monthly Fixed Cost
= $22,680 – 18,000 = $4,680
4-43. 1. Fixed Cost = $750 + 600 + 400 = $1,750; Unit Variable Cost = $20;
BEQ = 250 students
250 = 1,750/ (p – 20)
p = $27
2. Contribution margin on student tickets = $25 – $20 = $5
Contribution margin on student tickets = $75 – $20 = $55
Weighted average contribution margin = $5 * 75% + $55 * 25% = $17.50
BEQ = $1,750 / $17.50 = 100: 75 students and 25 alumni
4-44.
Case 1
Case 2
Fixed Cost
$25,000
$25,000
Marginal Revenue
$75
$65
Marginal Cost
$35
$40
Contribution Margin
$40
$25
Break Even - FC / (MR - MC)
625
1,000
Increase in BE Quantity
375
Chapter 4: Understanding Costs
4-10
4-45.
BREAK EVEN PROBLEM
Variable Costs
vet expenses
$42.00 # visits * cost per visit
spay./neuter
$45.00 cost per spay/neuter & transport
food
$9.00 #days * cost of food per day
Total Variable Cost
$96.00
Variable Revenue
Adoption fee
$225.00 adoption fee
Average Additional Donation
$30.00 % making donation * average donation
Total Variable Revenue
$255.00
Contribution Margin
$159.00 variable revenue - variable cost
Fixed Costs
Salaries
$95,000
Benefits
$23,750
Depreciation
$15,000
Less: Donations
($40,000)
Net Fixed Cost
$93,750
Break Even
589.62
590 dogs
4-46. a. Fixed: Rent, Nurse and Secretary or staff
b. Step-Fixed or Semi-Variable costs: Doctors
c. Variable: exam supplies and vaccines
4-47. 1. a. the cost objective
2. b. indirect and fixed
4-48. 1. weighted average;
2. either profit or break even
3. b. decreases
4-49. (Marginal Cost Analysis)
a.
Volume
Fixed
Variable
Total
Average
100
$300,000
$25,000
$325,000
$3,250
500
300,000
125,000
425,000
850
1,500
300,000
375,000
675,000
450
2,500
300,000
625,000
925,000
370
3,000
300,000
750,000
1,050,000
350
4-11
Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations,
b.
Cost
$850
450
370
350
500
1,500
2,500
3,000
Volume
c. Cost at 2,500 = $370/patient
Cost at 3,000 = $350/patient
Revenue = $300/patient
Accept business because marginal revenue of $300 > marginal cost of $250.
Discuss issues such as potential fixed cost increases, push by other customers to get
the discounted price, excess industry capacity, and accrual accounting losses versus cash
flow losses.
4-50. (Break-Even Analysis)
Fixed cost = $2,400,000
Variable costs = $5/ticket
Price
= $75/ticket
FC
$2,400,000
Q = ------------------ = ------------------- = 34,286 tickets must be sold to break even
P – VC/Ticket $75 - $5
Note: The actual calculation yields the result 34,285.714. However, it is important to round up.
If we sold only 34,286 tickets, the Symphony would lose money because it would be below
its breakeven point. Even if the value had been 34,285.15 we would have to round up to
avoid a loss.
Discussion: What if price falls, variable costs rise, etc.? What if we expect demand for only 33,000
tickets?
Chapter 4: Understanding Costs
4-12
4-51. (Break-Even Analysis—Multiple Products)
Price – VC = CM ´ Mix = Weighted
Pool
$70
$3
$67
40%
$26.80
Tennis
$50
$3
$47
35%
16.45
Golf
$30
$3
$27
25%
6.75
Weighted Average Contribution Margin
$50.00
or
Price
Mix Weighted
Pool
$70
40%
$28.00
Tennis
$50
35%
17.50
Golf
$30
25%
7.50
Weighted Average Price
$53.00
Variable Cost Mix Weighted
Pool
$3
40%
$1.20
Tennis
$3
35%
1.05
Golf
$3
25%
.75
Weighted Average Variable Cost
$3.00
FC FC $250,000
$250,000
BEQ = -------------- = ------ = ------------------- = ---------------- = 5,000 total passes
P - VC/Unit CM $53.00 - $3.00 $50
40% x 5,000 = 2,000 pool passes.
4-52. (Break-Even Analysis—Step-Fixed Costs)
Revenue
$1,400,000 total
Variable costs
$40/arrest
Fixed cost
$100,000 payroll
Semivariable cost
???
4-13
Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations,
Budgeted Volume of Arrests
1,000
2,000
3,000
4,000
Revenue
$1,400,000
$1,400,000
$1,400,000
$1,400,000
Payroll
$ 100,000
$ 100,000
$ 100,000
$ 100,000
Police
594,000
648,000
648,000
702,000
Desk
354,000
354,000
413,000
472,000
Supervisor
137,000
137,000
137,000
205,500
Food
40,000
80,000
120,000
160,000
Total Expense $1,225,000
$1,319,000
$1,418,000
$1,639,000
Surplus
$ 175,000
$ 81,000
$ (18,000)
$(239,000)
We can do more than 2,000 but less than 3,000. What costs rise when we go above 2,000?
Staff and food. If we start to back away from 3,000, what costs go down on the margin? Only the
food. They go down at a rate of $40 per arrest.
If we lose $18,000 at 3,000, then we could break even at 2,550. Divide the loss by the
variable cost. Reduce volume by the result to arrive at a break-even point.
18 000 40 450
,
=
3 000 450 2 550
,
=
,
Budgeted Volume of Arrests: 2550
Revenue
$1,400,000
Payroll
$ 100,000
Police
648,000
Desk
413,000
Supervisor
137,000
Food
102,000
Total Expense
$1,400,000
Surplus
$0
Chapter 4: Understanding Costs
4-14
4-53. (Break-Even)
Price
$ 2,500 Charge
+ 250 Fundraising
– 75 Uncollectible
$ 2,675
Variable Costs:
Airfare
$ 600
Hotel
600
Food
600
Admissions
125
Entertainment
300
Other
200
Total Variable
$ 2,425
Contribution Margin
$ 250
Fixed Cost
Guide
$ 3,000
Bus
2,500
Contingency
2,500
Airfare, food, admissions,
entertainment, other for 4
chaperones
4 ´ (600 + 600 + 125 + 300 +200)
7,300
Total Fixed
$15,300
Fc
$15,
300
Break-even Quantity
=
=
P VC
$2,
675
$2,
425
= =
15 300
250
612
,
.
,
,
Break-even with Subsidy
=
= =
,
.
15 300 10 000
250
5 300
250
212
Is the hotel cost variable per teen, or per group of four teens? Will the cost go up $160 per
night for the first extra teen over 4, and then be fixed for the next three? If so, the breakeven will
be higher.
What about the fact that the budget is for 50 teens? That is not divisible by 4. Is there an
extra room cost that hasn’t been accounted for? It is unclear. Is the hotel cost really $160 per
room per night, or has the travel agent given a total room cost that works out on average to $160
per room per night?
4-15
Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations,
If there are only 20 teens, how many chaperones will be needed? We can reduce the break-
even point by going to two chaperones.
It is important to note that in many cases, budgets are approximations. For example, while
the airfare may be known with certainty, the food cost is likely to be approximate, depending on
the specific restaurants that are actually used.
4-54. (Flexible Budgets and Break-Even Analysis)
FC $70,000
Q = ---------- = ----------------- = 36,459 riders
P – VC $2.00 - $.08
The New City Subway makes money if it has more than 36,459 riders.
Flexible budget
Price
$ 1.50 $ 2.00
$ 2.50
Volume per day
´ 50,000 ´ 40,000 ´ 30,000
Revenue per day
$ 75,000
$80,000
$75,000
Less fixed cost
70,000
70,000
70,000
Less variable cost $.08 ´ volume 4,000
3,200
2,400
Surplus
$ 1,000
$ 6,800
$ 2,600
Here we see that the subway makes money at all volumes shown. How can that be, given the
36,459 in the break-even calculation? Note that in the flexible budget we did not just change
volume. The price also changed. The increase in the price lowers the break-even point.
Intuitively we would expect higher profits for 50,000 riders per day than for 30,000, yet the flex
budget shows that the profits are lower at the higher rider volume. This is because the higher
volume was accompanied by a lower price. That lower price raised the break-even point. In fact,
it turns out that the current $2 price results in a higher profit than would occur if the price were
to rise or fall!
Breakeven analysis often makes the somewhat unrealistic assumption that price is constant over
a range of volumes. We can see that if volume changes are accompanied by price changes, higher
volume does not necessarily increase profits.
4-55. (Relevant Costs)
Rent
20,000 marginal
Repairs and maintenance
10,000 marginal
Supplies
5,000 marginal
Marginal
$35,000 marginal
Keep the location open. There will be savings of only $35,000 and they will lose a $40,000
grant, so they will be $5,000 worse off.
What qualitative issues of relevant here? If it made financial sense to close the location we
would still have to consider the impact on the mission of the organization.
Chapter 4: Understanding Costs
4-16
4-56. (Allocation Base and Overhead Rates) One base is the number of tax bills. The rate would be
$32,000/8,000 = $4 per bill. A second possible base would be tax collector department clerical
hours consumed in processing bills. The rate would be $32,000/1,000 = $32 per hour.
4-57. (Cost Allocation and Overhead Rates)
a. Calculation of overhead rate on direct-labor-hour basis:
Cost
Overhead rate
=
=
Direct labor hours
hours
per hour
$810,
,
$9
000
90 000
=
=
Overhead applied to Mr. Robbins Direct labor hours rate
hours
´
=
20
´
$9
per hour
=
$180
b. Calculation of overhead rate on direct-labor-dollar basis:
Cost
$810,000
Overhead rate = ------------------------- = ------------
Direct
labor
dollars
$1,350,000
= $.60 per direct labor dollar
Overhead applied to Mr. Robbins = Direct labor dollars ´ rate
= 380 direct labor dollars ´ .60
= $228
The results differed under the two different bases. The probable reason for this
difference is that some patients consume labor hours from more highly skilled, highly paid
workers.
A direct-labor-hour basis system will assign a patient just as much overhead for having
consumed an hour of licensed practical nurse (L.P.N.) labor as it will for having consumed
an hour of registered nurse (R.N.) labor.
A system that assigns overhead on the basis of direct labor cost will assign more
overhead for the consumption of an hour of a more highly paid worker’s time.
Which basis is preferable? That depends on whether the overhead items in question are
more closely related to the amount of labor an individual patient consumes or to the type of
labor consumed.
4-58. (Cost Allocation—Direct Distribution) Direct distribution.
Allocation
4-17
Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations,
Direct
Costs
Purchasing
Purch. Orders
Administration
Total Salaries
Total
Costs
Support cost centers
Purchasing
$ 80,000
$(80,000)
$ 0
Administration
40,000
$(40,000)
0
Mission cost centers
Soup kitchens
900,000
37,647
37,895
975,542
Counseling
300,000
42,353
2,105
344,458
Total cost
$1,320,000
$ 0
$ 0
$1,320,000
4-59. (Cost Allocation—Step-Down) Step-down distribution
Allocation
Direct
Costs
Purchasing
Purch. Orders Sub-total
Administration
Total Salaries
Total
Costs
Support cost centers
Purchasing
$ 80,000
$(80,000)
$ 0
Administration
40,000
12,000 $ 52,000
$(52,000)
0
Mission cost centers
Soup Kitchens
900,000
32,000
932,000
49,263
981,263
Counseling
300,000
36,000
336,000
2,737
338,737
Total cost
$1,320,000 $ 0
$1,320,000 $ 0 $1,320,000
Chapter 4: Understanding Costs
4-18
4-60. (Cost Allocation—Step-Down) Step-down distribution—changed order of allocation.
Allocation
Direct
Costs
Administration
Total Salaries Sub-total
Purchasing
Purch. Orders
Total
Costs
Support cost centers
Purchasing
$ 80,000
$ 2,000 $ 82,000
$(82,000) $ 0
Administration
40,000
(40,000)
0
0
Mission cost centers
Soup kitchens
900,000
36,000
936,000
38,588
974,588
Counseling
300,000
2,000
302,000
43,412
345,412
Total cost
$1,320,000
$ 0
$1,320,000
$ 0 $1,320,000
It is clear that the order of step-down does matter!
4-61. (Activity Based Costing) The first step would be to determine the total costs of the maintenance
department. These consist of the $100,000 spent on supplies, the $15,000 spent on administration,
and the labor cost of $192,000 (i.e., 10,000 hours @ $12 plus 4,000 hours @ $18, or 14,000 hours
@ $13.71 per hour). This is a total cost of $307,000. The traditional application rate would be as
follows:
$307,
000
=
$3.
07
square foot
100 000
,
square feet
That rate would cover both routine maintenance and repairs. Because the pharmacy has
2,000 square feet, it would be assigned a cost of $6,140. Alternatively, because the pharmacy is
2% of the total square feet (2,000/100,000 ´ 100%), we could simply multiply the total
maintenance department cost of $307,000 by 2% to get the $6,140 in the traditional step-down
approach.
What allocation would an ABC approach yield? First, we must make some choices about
allocation bases. Given that administration is supervising personnel, we can allocate the
administrative cost based on direct labor hours.
What about the labor cost? First consider labor for repairs. The cost could be allocated
based on square feet, or on the number of repairs, or on the length of the repair. The cost for labor
is driven by the number of hours the workers work. It is not the volume of repairs, but rather how
long they take that is critical to an accurate allocation. Therefore, repair labor should be allocated
based on direct labor hours.
It could be argued that routine labor should also be allocated in that fashion. However, is it
worthwhile to gather that information? In the example, hours spent on routine maintenance in the
pharmacy department were not supplied. Therefore, routine labor must be allocated based on
square feet. However, consider whether the extra accuracy would justify the collection of
additional data on where workers spend their time.
Similarly, supplies used for routine maintenance will have to be allocated based on square
feet. Supplies for repairs could be allocated based on the number of repairs, how long they take,
or the specific supplies used. In actuality, it is likely that major supplies (repair parts) could be
4-19
Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations,
assigned specifically to each repair based on actual costs. Other supplies (nuts, nails, etc.) would
probably be assigned based on direct labor hours, assuming that workers use supplies fairly
evenly over the time they work. In this case, we have been given actual costs for supplies used.
The actual allocation becomes somewhat tricky, because routine maintenance is being
allocated using different cost drivers from repairs. First, consider administration. The total cost is
$15,000. There were 14,000 labor hours, so the rate would be $1.071 per hour. The pharmacy had
6 hours of repairs and would be charged $6.43. Repairs in other departments took 3,994 hours
and would be charged $4,279.29.
However, what about the remaining $10,714.28 of administrative cost? The administration
related to routine work cannot be charged based on hours because we do not know the hours for
each department, as discussed above. The pharmacy is 2% of the square feet, so it will be
allocated 2% of this remaining administrative cost, or $214.29, with the balance of $10,499.99
being charged to other departments.
The pharmacy department consumed repairs that required 6 hours of labor at $18 per hour,
or a total of $108. The other departments consumed 3,994 hours at $18 per hour, or $71,892. The
remaining 10,000 hours at $12 per hour, or $120,000, are allocated based on square feet; 2% of
$120,000 is $2,400, and 98% of $120,000 is $117,600.
The supplies used for repairs can be allocated directly, as given in the solution below; $200
for pharmacy and $79,800 for other departments, based on actual costs incurred and assigned to
repair projects directly. The remaining $20,000 of routine supplies would be allocated based on
square feet; 2% of $20,000 is $400, and the remaining 98% is $19,600.
In sum, the total pharmacy costs under the ABC approach are as follows:
Pharmacy Total
Routine
$3,014
Repairs
314
Total
$3,328
This total of $3,328 is only a little more than half the original allocation of $6,140. Clearly, the
more accurate costing approach does have a significant impact in this instance.
The solution table is as follows:
Pharmacy
Routine Repairs
Administration $ 214
$ 6
Labor
2,400
108
Supplies
400
200
Total
$3,014
$314
All Other Departments Pharmacy & All Other
Routine Repairs
Total
Administration $ 10,500
$ 4,279
$ 15,000
Labor
117,600
71,892
192,000
Supplies
19,600
79,800
100,000
Total
$147,700
$155,971
$307,000
Chapter 4: Understanding Costs
4-20
CASE STUDY:
MEAD MEALS ON WHEELS CENTER
1
Problem 1 is a variation on the break-even problem. It asks you to calculate the maximum
amount that MMWC can spend per person per week on food. In other words, what is the largest
variable cost that MMWC can afford to pay and still cover all of its fixed costs?
From the problem set you know the Unit Revenue (P) is $32 per week. To find out how many
people MMWC can feed in a week (Q), you have to do a little work. The problem set says that
MMWC can prepare 9,600 meals per day. But its contract calls for it to deliver two meals per day per
person. This means that MMWC can feed 4,800 people on any given day. Note that each person eats
14 meals per week, so MMWC can feed only 4,800 people per week. Fixed costs (FC) are $36,000 per
week.
The base break-even formula is:
Fixed Cost
FC
Break - even Quantity
Q
=
Unit Revenue Variable Unit Cost
P
VC
Q
P
FC
VC
=
=
=
=
4 800
,
000
$32
$36,
? we need to solve for the variable unit cost
FC
Q
=
P VC
multiplying both sides of the equation by P VC
, we get:
´ =
Q P VC FC
expanding the terms on the left side, we get:
Q P Q VC FC
´ ´ =
subtracting Q R´ from both sides, we get:
´ =
´
´
=
Q VC FC Q P
VC
FC Q P
Q
1
Mead Meals on Wheels Center and its solution were written by Robert Purtell, Robert F. Wagner Graduate School of
Public Service, New York University. Used with permission.
4-21
Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations,
multiplying both sides by –1, we get:
VC
Q P FC
Q
=
´
substituting the values above, we get:
´
=
4800 32 36000
VC =
$24.
50
4800
$24.50 PER PERSON WEEK is the maximum amount that MMWC can spend for food.
Problem 2 asks you to take the information from problem 1 along with some additional data on
the seasonality of MMWC’s fixed costs and add the fact that the lowest food supply bid was $.50
below the break-even level that was calculated in problem 1. The budget below was derived from the
problem-set facts as follows.
Quarterly revenue equals the number of people served per week (4,800) times the number of
weeks in a quarter (13) times the amount that Millbridge pays MMWC for each person-week ($32).
Thus quarterly revenue = $1,996,800
Quarterly fixed expenses: The problem set tells us that fixed costs vary by quarter. They are
$38,000 per week in the winter (1
st
quarter), $34,000 per week in the second quarter, $35,000 in the
third quarter and $37,000 in the fourth quarter. The calculations for quarterly fixed costs involves
multiplying the weekly fixed costs per quarter by the number of weeks in a quarter. For the first quarter
that is $38,000 ´ 13, or $494,000.
Quarterly variable food costs are calculated by multiplying the number of people fed (4,800) by
the number of weeks in a quarter (13) by the cost of the food ($24.50 – $.50 = $24.00). This is equal to
$1,497,000.
Chapter 4: Understanding Costs
4-22
Budget
Quarter One Quarter Two Quarter Three Quarter Four Annual Total
Revenue
$1,996,800
$1,996,800
$1,996,800
$1,996,800
$7,987,200
Fixed Costs
494,000
442,000
455,000
481,000
1,872,000
VC Food
1,497,600
1,497,600
1,497,600
1,497,600
5,990,400
Total Cost
$1,991,600
$1,939,600
$1,952,600
$1,978,600
$7,862,400
Profit/(Loss)
$ 5,200
$ 57,200
$ 44,200
$ 18,200
$ 124,800