Welfare analysis can get complicated if there are multiple market failures. “The General Theory of the Second Best,” by Lipsey and Lancaster (Review of Economic Studies 24 (1956–57): 11–32) argues that when there are multiple market failures, fixing only one market failure may make things worse than doing nothing. Two market failures may work in opposite directions; for instance, fixing one may have unintended consequences for the other. For example, consider a monopolist that pollutes. When a firm is a monopolist, it reduces its production so that it can increase price; although it sells fewer units, the higher price more than makes up for the reduced volume. Consumers lose, and total welfare is reduced, due to the higher price and lower quantity. The pollution problem, in contrast, is excess production.

a. Draw a supply-demand figure for a firm with the demand curve Q = 10 - P, and marginal cost curve MC = 2 (based on total costs C = 2 * Q). If this were not a monopoly, what would be the equilibrium price and quantity? Calculate the firm’s total revenue, total cost, and profit. Also calculate consumer surplus. Net benefits are consumer surplus plus producer surplus, which equals profit in this case; calculate that value.

b. Suppose that, instead, the firm decided to act like a monopolist and restrict output. It produces 4 units and charges $6 for each unit. Calculate the firm’s total revenue, total cost, and profit; consumer surplus; and net benefits. Are net benefits higher or lower? Is the firm better or worse off?

c. Now let’s consider the pollution problem. Suppose the firm produces marginal damages of $4/unit. For (a) and (b), recalculate net benefits to account for the social damages.

d. Find the new efficient equilibrium, now that social marginal costs are $6/unit. Calculate the firm’s total revenue, total cost (including the pollution cost), and profit; consumer surplus; and net benefits.

e. The monopolist, if forced to pay social marginal costs, will produce 2  units and charge $8 for each unit. Calculate the firm’s total revenue, total cost (including the pollution cost), and profit; consumer surplus; and net benefits.

f.Compare the results for (c), (d), and (e). Rank them from the highest net benefits to the lowest.

g. A regulator who can break up monopolies is examining this situation. Compare net benefits for the monopolist who pollutes [the recalculation for the monopolist in Part (c)] with the competitive firm that pollutes [the recalculation for the competitive firm in Part (c)]. Will the regulator improve net benefits by breaking up the monopoly?

h. A regulator who addresses pollution separately examines the situation. Compare net benefits for the monopolist who pollutes [the recalculation for the monopolist in (c)] with net benefits for the monopolist who pays the full costs of pollution in (e). Will this regulator increase net benefits by taxing pollution?

i. Does the Theory of the Second Best apply here? Does fixing a market failure always improve welfare, compared to not fixing it?

S- You note during the review of sales, that a rebate was issued for the 2018 Income Tax Game to encourage sales. 24,500 games were sold. Customers can mail in their receipt and receive a $1 rebate per game. It is estimated that 48% of customers will send in the rebate. The rebate expires on January 31, 2019. To date, 12,800 rebates have been refunded. Without any direction, the accounting clerk debited Miscellaneous Selling Expense and credited Cash for the $12,800. The management of Czar would prefer to have this type of expense in a separate account (Rebate Expense) so they can properly analyze for future ideas.

T- Czar has a straight tax rate of 30%. Income tax expense is Net Income before taxes times 30%. (Hint: Prepare the Income Statement up to Net Income before Taxes and then record this adjusting journal entry.)

XYZ Co. buys raw wool from local sheepherders, separates the wool into two grades—fine and superfine—and then dyes the wool. The company’s joint costs include $50,000 for the raw wool and $6,000 for separating the raw wool into two intermediate products. The undyed fine wool and undyed superfine wool each can be sold at the split-off point for $55,000 and $75,000, respectively. The cost of further processing the undyed fine wool and undyed superfine wool is $20,000 and $30,000, respectively. Furthermore, the sales values of dyed fine wool and dyed superfine wool are $90,000 and $100,000, respectively. Which product should be processed further so that the company can make more profit?

A&B Co. provides house cleaning services. The company uses the number of jobs to measure activity. At the beginning of April, the company budgeted for 80 jobs, but the actual number of jobs turned out to be 90. A report comparing the budgeted revenues and costs to the actual revenues and costs appears below:

What is the amount of activity variance for fixed expenses in A&B’s performance report for April?

XYZ Co. used to rent out a small annex attached to the rear of the building for $30,000 per year. The renter’s lease will expire soon, and rather than renewing the lease, the company has decided to use the annex to manufacture a new product, with estimated costs of $40,000 and estimated profits of $90,000. What is the opportunity cost of using the annex to manufacture the new product?

A&B Co. provides house cleaning services. The company uses the number of jobs to measure activity. At the beginning of April, the company budgeted for 80 jobs, but the actual number of jobs turned out to be 90. A report comparing the budgeted revenues and costs to the actual revenues and costs appears below:

What is the amount of activity variance for variable expenses in A&B’s performance report for April?

Rain Forest Inc. Imports fruit from Latin America and sells them in boxes to retailers in the U.S.

a) Today the company signed a contract with a major software company to purchase, customize, and implement an Enterprise Resource Planning (ERP) system. Rain Forest is taking a loan from a bank of $3 million, which is the value of the ERP contract. The bank offers an APR (annual percentage rate) of 4.3% for 120 monthly payments. How much Rain Forest has to pay per month for the loan taken to purchase the warehouse?

b) A competing bank heard that Rain Forest will take a loan and made an offer that is supposedly more advantageous for Rain Forest than the loan described in (a). The competing bank is offering a $3 million loan to be paid back in 125 monthly payments of $30 thousand each. Assuming that Rain Forest wants the loan with the lowest APR, which loan should they take?

c) The cost of each box of fruit is $4.35. Rain Forest sells each box for $4.89 to retailers. Retailers buy 45,000 boxes per month. Considering that the only relevant fixed expense is the payment made each month for the ERP contract described in (a), show total revenue, total variable cost, fixed expenses, and profit (or loss) per month. Is Rain Forest profitable? If not, would Rain Forest be profitable if it decided not to implement the ERP system?
Tip: be careful with the signs, especially if you are referencing a result from item (a)!

d) Considering the price in c), build a table that shows total revenue for several quantities of boxes. Your table should show revenues for quantities varying from 40,000 to 60,000 in steps of 2,000. The result should be a table with 2 columns (quantity and revenue), and 11 rows (one for each quantity).

e) Considering the cost and fixed expense in c), add a column to the table above that is (total variable cost + fixed expense with ERP).

f) Add a line chart with one line for total revenue, another line for (total var. cost + fixed expense with ERP), and quantity sold in the horizontal axis. Based on the chart, what is the quantity the company needs to sell to break-even? How would the break-even quantity change if the ERP system cost 20% less?

g) Considering the variable cost and fixed expense in c), build a table that shows profit (or loss) for several quantities of boxes and prices per box. Your table should show profits for quantities varying from 40,000 to 60,000 in steps of 2,000, and prices varying from $4.79 to $5.19 in steps of $0.05.

h) For a selling price of $4.89 per box, what is (approximately) the quantity of boxes that Rain Forest needs to sell to break-even? Is this quantity the same as the one you found in the chart? (It should.)

i) For a total quantity of 50,000 boxes per month, what price (approximately) does Rain Forest need to charge per box to make a profit of more than $3,600 per month?

2. If a company uses the direct write off method of accounting for bad debts
   1. It will record bad debt expense only when an account is determined to be uncollected
   2. It will establish an estimate for the allowance for doubtful debts
   3. It will reduce the accounts receivable account at the end of the accounting period for uncollected accounts
   4. When an account is written off, total assets will stay the same.
   5. None of the above

3. Cost behaviour refers to:
   1. Manufacturing overheads
   2. Costs in a business that remain fixed when production volume increases
   3. How costs react to changes in production volume or other levels of activity
   4. Costs that stay the same per unit.
   5. Only costs that fall into the relevant range for a business.

4. What should a company do to improve its accounts receivable turnover ratio
   1. Give customers credit terms of 2/10, n/30 rather then 1/10, n/30
   2. Reduce the number of employees working in the credit department
   3. Increase its sales force
   4. Lower its selling prices
   5. None of the above

5. Which of the following effects on the accounting equation is not correct as a result of a journal entry?
   1. Decrease shareholders' equity and decrease an asset.
   2. Increase an asset and decrease an asset.
   3. Increase shareholders' equity and increase an asset.
   4. Increase an asset and decrease a liability.
   5. All of the above are not possible

6. Assume that in one accounting period liabilities increased by $8,000, assets increased by $55,000, and net profit was $29,000. The owner must therefore have:
   1. Contributed $18,000
   2. Received dividend $18,000
   3. Contributed $12,000
   4. Received dividend $12,000
   5. Cannot be calculated from the above limited information.

7. The Allowance for Bad Debts represents:
   1. Bad debt losses incurred in the current period
   2. The amount of uncollected accounts written off to date
   3. The difference between total sales made on credit and the amount collected from those credit sales
   4. The difference between the recorded value of accounts receivable and the net realisable value of accounts receivable****
   5. Fees paid to debt collection agencies

8. Two basic accounting principles determine when revenues and expenses are to be recorded under accrual basis accounting. They are:
   1. Cost and matching principles.
   2. Prudence principle.
   3. Relevance and reliability principles.
   4. Revenue recognition and matching principles.
   5. Revenue recognition and measurement principles.

9. On the last day of its financial year, Nelson Pty Ltd paid $2,150 cash for a one-year insurance policy. What is the appropriate journal entry ignoring GST, assuming the insurance policy becomes effective (starts) on the first day of the next financial year (i.e. the next day)?
   1. Unearned Insurance Revenue                 2,150

Cash 2,150

1. 2. Cash                                                     2,150

Prepaid Insurance    2,150

1. 3. Prepaid Insurance                                  2,150

Cash                                                          2,150

1. 4. Prepaid Insurance                                  2,150

Insurance Expense                                      2,150

1. 5. Cash                                                     2,150

Unearned Insurance Revenue                      2,150

10. Carin’s Corporation purchased inventory for $4,000. Due to an error in recording the journal entry for this transaction, the inventory account was debited for only $400 while accounts payable was credited for $4,000. During which phase of the accounting cycle would this error be discovered?
    1. Recording the transaction in the journal.
    2. Preparation of the financial statements.
    3. Analysis of each transaction.
    4. Preparation of the trial balance.
    5. Preparation of the consolidated analysis.

Transaction Analysis, Trial Balance, and Financial Statements

Kate Smith operates the Smith Dance Studio. The trial balance as of June 30 is as follows:

Required

c. Prepare an income statement for the month of June.

d. Prepare a statement of stockholders' equity for the month of June.

e. Prepare a balance sheet as of June 30.

f. Prepare closing entries.

g. Prepare a post-closing trial balance.

c.

d.

e.

f.

g.

Van Hatten Consolidated has three operating divisions: DeMent Publishing Division, Ankiel Security Division, and Depp Advisory Division. Each division maintains its own accounting system but follows IFRS.

(a)

For each division’s revenue arrangements, identify the separate performance obligations, briefly explain the allocation of the transaction process to each performance obligation, and indicate when the performance obligations are satisfied.

Business Decision Case New Haven Corporation recently identified an investment opportunity

involving the purchase of a patent that will permit the company to modify its line of CD recorders.

The patent’s purchase price is $720,000 and the legal protection it provides will last for five more

years; there is no salvage value. However, after preparing the capital expenditure analysis below,

New Haven’s treasurer has recommended to the company’s capital budgeting committee that the

investment be rejected. Brad Decker, chairperson of the capital budgeting committee, finds it diffi-

cult to accept the treasurer’s analysis because he “feels intuitively” that the investment is attractive.

For this reason, he has retained you to review the treasurer’s analysis and recommendation. You

are provided with the following data and summary of the treasurer’s analysis:

1. Required investment: $720,000 cash for the patent to be amortized on a straight-line basis,

five-year useful life, with a zero salvage value.

2. Projected cash revenue and operating expenses:

Year Cash Revenue Cash Expenses

1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 620,000 $240,000

2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 560,000 200,000

3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400,000 170,000

4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000 80,000

5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200,000 50,000

$2,030,000 $740,000

3. Source of capital: New Haven plans to raise 10% of the needed capital by issuing bonds, 30%

by issuing stock, and the balance from retained earnings. For these sources, the capital cost

rates are 8%, 9%, and 10%, respectively. New Haven has a policy of seeking a return equal

to the weighted average cost of capital plus 2.5 percentage points as a “buffer margin” for the

uncertainties involved.

Solution 12.1

Capital budgeting is the planning of major plant and equipment investments. These investments are im-

portant because they involve long-term commitments of significant amounts of capital and the decisions

cannot be easily reversed.

4. Income taxes: New Haven has an overall income tax rate of 30%.

5. Treasurer’s analysis:

Average cost of capital

(8% 1 9% 1 10%)/3 5 9%

Total cash revenue .............................. $2,030,000

Total cash expenses ............................. $740,000

Total amortization ............................... 720,000

Total operating expenses ......................... 1,460,000

Projected net income over five years ................ $ 570,000

Average annual income .......................... $ 114,000

Present value of future returns ..................... $ 443,420

Required investment............................. 720,000

Negative net present value........................ $ (276,580)

Recommendation: Reject investment because of insufficient net present value.

Required

a. Review the treasurer’s analysis, identifying any questionable aspects and briefly comment on

the apparent effect of each such item on the treasurer’s analysis.

b. Prepare your own analysis of the investment, including a calculation of the proper cost of

capital and hurdle rates, a net present value analysis of the project, and a brief recommenda-

tion to Decker regarding the investment (round amounts to nearest dollar).

c. Because of his concern for the uncertainties of the CD recorder business, Decker also has

asked you to provide analyses supporting whether or not your recommendation would change

1. If estimates of projected cash revenue were reduced by 10%.

2. If the “buffer margin” were tripled from 2.5% to 7.5%

** PV of money to be deducted was not given. all of the information provided is given***

Circle the correct answer symbol

1. installment sales for 2018 is $600,000 and cost of goods sold $300,000 while the installment sales in 2019 is $1,000,000 and cost of goods sold $800,000, cash collection from 2018 sales was $400,000 in 2018 and $200,000 in 2019, cash collection from 2019 sales was $500,000 in 2019 and $500,000 in 2020, using installment sales method compute gross profit rate for two years sales?

a.

2018 is 50% and 2019 is 20%.

b.

2018 is 20% and 2019 is 50%.

c.

2018 is 50% and 2019 is 50%.

d.

2018 is 20% and2019 is 20%.

2. Imar Construction company signed a contract to build new bridge at a contract price of $5,000,000 and total estimated cost of $4,000,000 the project will be completed within 4 years, the cost incurred to date for each period is, first year $1,000,000- second year $2,500,000- third year $3,200,000 and fourth year $4,100,000 while the estimasted cost to,complete the project for each each period is, first year $3,000,000- second year $1,700,000- third year $1,000,000 and fourth year is $0, based on above question and using Cost recover method, what is the gross profit recognized in second year?

a.

$226,190.

b.

$476,190.

c.

$250,000.

d.

0

3. installment sales for 2018 is $600,000 and cost of goods sold $300,000 while the installment sales in 2019 is $1,000,000 and cost of goods sold $800,000, cash collection from 2018 sales was $400,000 in 2018 and $200,000 in 2019, cash collection from 2019 sales was $500,000 in 2019 and $500,000 in 2020, using cost recovery method compute gross profit realized in 2018?

a.

$100,000.

b.

$300,000.

c.

$150,000.

d.

$200,000.

4. estimated cost of $4,000,000 the project will be completed within 4 years, the cost incurred to date for each period is, first year $1,000,000- second year $2,500,000- third year $3,200,000 and fourth year $4,100,000 while the estimasted cost to, complete the project for each each period is, first year $3,000,000- second year $1,700,000- third year $1,000,000 and fourth year is $0, based on above question and using percentage of completion method, what is the required journal entry in first year?

a.

Debit Construction Expense $3,0000,000, debit construction in process $1,000,000, credit construction revenue $5,000,000.

b.

Debit Construction Expense $1,0000,000, debit Unralized GP $250,000, credit construction revenue $1,250,000.

c.

Debit Construction Expense $1,0000,000, debit construction in process $250,000, credit construction revenue $1,250,000.

d.

Debit Construction Expense $3,0000,000, debit construction in process $900,000, credit construction revenue $5,000,000.

5. installment sales for 2018 is $600,000 and cost of goods sold $300,000 while the installment sales in 2019 is $1,000,000 and cost of goods sold $800,000,cash collection from 2018 sales was $400,000 in 2018 and $200,000 in 2019,cash collection from 2019 sales was $500,000 in 2019 and $500,000 in 2020, using cost recovery method compute unrealized gross profit in 2019?

a.

$150,000.

b.

$200,000.

c.

$300,000.

d.

$100,

You are working for The Wellington Company on temporary assignment while one of the accountants is on family leave. You have been asked to review the company’s investment

The balance sheet caption used to report long-term investments in stocks not intended as a source of cash in the normal operations of the business.

journal entries and provide necessary information to the accountant preparing the financial statements.

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