Ch8 Using Accounting Information To Make Full Test Bank

Chapter 8

Using Accounting Information to Make Managerial Decisions

CHAPTER LEARNING OBJECTIVES

1. Identify relevant information for decision making. (Unit 8.1)

Relevant information satisfies two criteria: (1) it differs between the alternatives, and (2) the differences will occur in the future.

1. Determine the qualitative and quantitative impacts of special order pricing. (Unit 8.2)

Special orders arise because a customer wants a pricing arrangement that differs from the normal price. The justification for the price difference could be that the requested product differs from the normal product; that the customer is buying in large quantities for which no regular volume discount is available; or that the customer is new and willing to try the product or service only at a special rate. Special orders can be advantageous to the company if excess capacity is available, or if the new business they generate is expected to have a long-term payoff.

To calculate the effect of a special order on operating income, first identify the avoidable costs associated with the special order. If capacity is available, then fixed overhead is an unavoidable cost. Watch out for the loss of normal sales if the entire special order can’t be filled with available capacity. In that case, lost contribution margin from normal sales is one cost of the special order.

If a company continually accepts special orders to fill capacity, then the larger issue to evaluate is whether a permanent use can be found for the capacity, or if not, whether some assets can be eliminated to reduce capacity costs.

1. Determine the qualitative and quantitative impacts of outsourcing decisions. (Unit 8.3)

Outsourcing means moving the production of goods or the delivery of services from within the organization to a provider outside the organization. Quantitatively, outsourcing an operation will free up the resources it uses. However, it is critical that unavoidable costs be identified. Because those costs will continue with or without the outsourcing arrangement, they should not be included in the costs projected to be saved by outsourcing. Qualitatively, outsourcing can provide expertise the company doesn’t have, transfer risk to an outside supplier, and allow the company to focus on its core competencies. Potential dangers of outsourcing include poor quality, poor delivery time, and intellectual theft.

1. Determine how to allocate constrained resources to maximize income. (Unit 8.4)

When company resources are limited in the amount of output they can generate, the best use of these resources is to make the product that generates the highest contribution per constrained resource. Do not, however, produce more product than the quantity customers demand.

1. Calculate the effects on operating income of keeping or eliminating operations. (Unit 8.5)

The decision of whether to keep or eliminate an operation should be based on the operation’s segment margin. Common fixed costs should not be included in the operation’s income. If the segment margin is positive, the operation should be kept until a better use can be found for its resources. If the segment margin is negative, the operation should be dropped. Watch out for related sales or operations that might be affected by the operation under evaluation.

TRUE-FALSE STATEMENTS

1. Relevant information meets two criteria: (1) it differs between the alternatives and (2) the differences have occurred in the past.
2. Unavoidable costs are incurred under all alternatives and are always relevant.
3. Sunk costs are irrelevant in deciding between two alternatives because they are incurred in the past, not the future.
4. A type of analysis that helps decision makers understand the impact of their choices is referred to as incremental analysis.
5. All variable costs are relevant and all fixed costs are irrelevant.
6. The first step in making any decision is to consider all available alternatives.
7. The Robinson-Patman Act of 1936 prohibits companies from engaging in price discrimination – that is, offering the same item to different customers at different prices.
8. The Fair Trade Act of 1936 prohibits companies from engaging in price discrimination – that is, offering the same item to different customers at different prices.
9. Sometimes companies will accept new business at a loss with the expectation that certain customers can influence other potential customers.
10. If regular sales are given up in order to accept a special order, the lost contribution margin on the regular sales must be subtracted from the contribution margin of the special order to arrive at the total impact on operating income.
11. In evaluating whether or not to accept a special order, decision makers need to consider only quantitative effect as this is the impact on profit.
12. When a customer requests a special order and the supplier has capacity constraints, reducing the special order is not normally an option.
13. The option of accepting a special order should always be chosen if the price exceeds the relevant costs to produce and deliver the order to the customer.
14. Outsourcing is a relatively new approach to doing business.

LO: 3, Bloom: K, Unit: 8-3, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Reporting, AICPA PC: None, IMA: Strategy

1. Offshoring is another term for outsourcing.
2. Offshoring means moving a company’s business processes to a foreign country.
3. When an outsourcing decision refers to the components of a manufactured product, it is more commonly called an insource or outsource decision.
4. When a company accepts an outsourcing offer, managers must take specific action to eliminate the internal costs.
5. Because depreciation is a fixed cost that is not avoidable, it is irrelevant in making an outsourcing decision.
6. An opportunity cost is the contribution margin of the next-best alternative use of the facilities.
7. In an outsourcing decision, one important factor is the quality of the outsourced product.
8. When a company outsources a product, it is easier to control product quality than if the product is produced internally.
9. According to the Theory of Constraints, all production should be subordinated to the bottleneck operation.
10. The formula for calculating the contribution margin per constrained resource is Contribution Margin Per Unit divided by Units Produced.
11. In an environment where the there is a constrained resource, the resource should be allocated first to the product with the highest contribution margin.
12. The Theory of Constraints seeks to maximize throughput contribution, which equals sales revenue less direct materials cost.
13. Costs such as rent and the production manager’s salary are non-differential but are relevant.
14. The segment margin is the contribution margin of a particular segment less any direct fixed costs.
15. In determining whether or not to eliminate a segment, differential costs are relevant to the decision.
16. Variable costs associated with a segment’s sales are sometimes avoidable.

Answers to True-False Questions

MULTIPLE CHOICE QUESTIONS

1. Managers becoming overwhelmed by the huge amount of information available to them is referred to as
   1. unavoidable overload.
   2. information overload.
   3. phenomenon overload.
   4. irrelevance overload.
2. To focus on the facts that make a difference in their decisions, managers need to know how to eliminate
   1. avoidable costs.
   2. non-value added activities.
   3. irrelevant information.
   4. relevant information.
3. Which of the following is not a criterion of relevant information?
   1. It differs between the alternatives.
   2. Differences among alternatives will occur in the future.
   3. Differences among the alternatives must have occurred in the past and must occur in the future.
   4. It differs between the alternatives and differences among alternatives will occur in the future.
4. Which of the following is not a criterion of relevant information?
   1. It differs between the alternatives.
   2. Differences among alternatives will occur in the future.
   3. The information always relates to variable costs.
   4. It differs between the alternatives and differences among alternatives will occur in the future.
5. A characteristic of irrelevant information is that
   1. the information is the same among the alternatives.
   2. differences will occur in the future.
   3. differences among the alternatives must have occurred in the past and must occur in the future.
   4. it differs between the alternatives.
6. In evaluating the relevance of specific information, the decision maker must know
   1. all relevant and irrelevant information.
   2. the context of the decision.
   3. if unavoidable costs are incurred.
   4. all material information.
7. In evaluating the relevance of specific information, which of the following must the decision maker know
   1. the classification of any relevant costs.
   2. the behavior of all costs.
   3. the context of the decision.
   4. all relevant and irrelevant information.
8. Information overload can lead to
   1. information fatigue syndrome.
   2. data overload condition.
   3. sunk costs.
   4. bottlenecks.
9. One way in which companies have tried to combat information overload is through the creation of
   1. information firewalls.
   2. information dashboards.
   3. information warning signals.
   4. information ceilings.
10. Which of the following combinations results in relevant information?
    1. Occurs in the future and is unavoidable
    2. Occurs in the future and is avoidable
    3. Occurs in the past and is unavoidable
    4. Occurs in the past and is avoidable
11. Which of the following combinations results in differential information?

Occurs in the Past Avoidable

• 1. Yes No
  2. Yes Yes
  3. No No
  4. No Yes

1. Costs that occur only with the implementation of a particular alternative are referred to as
   1. avoidable.
   2. sunk.
   3. opportunity.
   4. relevant.
2. Avoidable costs are those costs that
   1. are variable.
   2. are fixed.
   3. occur only when a particular alternative.
   4. occur in the past and relate to decisions being made.
3. Costs that has been incurred in the past is referred to as
   1. avoidable costs.
   2. sunk costs.
   3. opportunity costs.
   4. relevant costs.
4. Sunk cost are classified as
   1. irrelevant.
   2. avoidable.
   3. opportunity.
   4. relevant.
5. Calculations which show the additional impact of one alternative over another are referred to as
   1. relevant analysis.
   2. avoidable analysis.
   3. incremental analysis.
   4. opportunity analysis.
6. Incremental analysis helps decision makers to understand
   1. the sunk costs involved in their decision.
   2. the impact of their choices.
   3. the classification of costs.
   4. the materiality of a situation.
7. Other than the financial impact, which of the following is not one of the considerations that managers should address when choosing whether or not to expand their operations?
   1. Will an increase in production and sales reduce existing customer service levels?
   2. Should the company risk in hiring a new sales representative?
   3. Will the expected extra sales become reality?
   4. Will the CEO quit next year?
8. Once viable alternatives have been identified by a decision maker, which of the following is not a step that should be followed?
   1. Develop a list of relevant revenues and costs.
   2. Identify any qualitative factors that may affect the decision.
   3. Reconsider nonviable alternatives.
   4. Choose the alternative that produces the greatest benefit or the lowest cost.
9. Once viable alternatives have been identified by a decision maker, which of the following is not a step that should be followed?
   1. Develop a list of relevant revenues and costs.
   2. Identify any qualitative factors that may affect the decision.
   3. Choose the alternative that produces the greatest benefit or the lowest cost.
   4. Reconsider nonviable alternatives.
10. Ellis Dover is a scout for a Major League Baseball team based in Phoenix, Arizona. Ellis needs to travel to Los Angeles, California on June 1 to perform a variety of professional functions prior to the team travelling to Los Angeles to play. If Ellis flies, he could catch a 6 a.m. flight on June 1. In order to perform all of his professional responsibilities, Ellis will need to spend the night and catch a flight on June 2 to return to Phoenix. If Ellis flies, he will need to rent a car for $38 per day. To cover meals and other incidental expenses, Ellis will receive $45 per day (per diem) for each day he works out of town. Flights between Phoenix and Los Angeles can be purchased for $89 one way.

Phoenix is approximately 300 miles from Los Angeles, a 5-hour drive at speed limits permitted on the freeways connecting the two cities. If he drives from Phoenix to Los Angeles, Ellis would need to leave the afternoon of May 31 and would be reimbursed $0.50 per mile. He would need to spend 2 nights in a hotel, the night of May 31 and the night of June 1. He would return to Phoenix by car on June 2. The hotel used by the team charges $160 per night. What is the relevant cost of driving?

1. $755
2. $505
3. $415
4. $428

Because he would have to stay overnight and be paid an additional day of expenses, if he drives versus flying, only the cost of driving plus one night of hotel and one additional day of per diem are relevant.

1. Ellis Dover is a scout for a Major League Baseball team based in Phoenix, Arizona. Ellis needs to travel to Los Angeles, California on June 1 to perform a variety of professional functions prior to the team travelling to Los Angeles to play. If Ellis flies, he could catch a 6 a.m. flight on June 1. In order to perform all of his professional responsibilities, Ellis will need to spend the night and catch a flight on June 2 to return to Phoenix. If Ellis flies, he will need to rent a car for $38 per day. To cover meals and other incidental expenses, Ellis will receive $45 per day (per diem) for each day he works out of town. Flights between Phoenix and Los Angeles can be purchased for $89 one way.

Phoenix is approximately 300 miles from Los Angeles, a 5-hour drive at speed limits permitted on the freeways connecting the two cities. If he drives from Phoenix to Los Angeles, Ellis would need to leave the afternoon of May 31 and would be reimbursed $.50 per mile. He would need to spend 2 nights in a hotel, the night of May 31 and the night of June 1. He would return to Phoenix by car on June 2. The hotel used by the team charges $160 per night. What is the relevant cost of flying?

1. $414
2. $254
3. $459
4. $504

Staying overnight for one night is not relevant, since he would have to do that regardless of if he drives or flies.

1. Ellis Dover is a scout for a Major League Baseball team based in Phoenix, Arizona. Ellis needs to travel to Los Angeles, California on June 1 to perform a variety of professional functions prior to the team travelling to Los Angeles to play. If Ellis flies, he could catch a 6 a.m. flight on June 1. In order to perform all of his professional responsibilities, Ellis will need to spend the night and catch a flight on June 2 to return to Phoenix. If Ellis flies, he will need to rent a car for $38 per day. To cover meals and other incidental expenses, Ellis will receive $45 per day (per diem) for each day he works out of town. Flights between Phoenix and Los Angeles can be purchased for $89 one way.

Phoenix is approximately 300 miles from Los Angeles, a 5-hour drive at speed limits permitted on the freeways connecting the two cities. If he drives from Phoenix to Los Angeles, Ellis would need to leave the afternoon of May 31 and would be reimbursed $.50 per mile. He would need to spend 2 nights in a hotel, the night of May 31 and the night of June 1. He would return to Phoenix by car on June 2. The hotel used by the team charges $160 per night. What is the incremental cost of driving over flying?

1. $101
2. $251
3. $116
4. $296

Driving: (300 × 2 × $0.50) + $160 + $45 = $505;

Flying: ($89 × 2) + ($38 × 2) = $254;

$505 ̶ $254 = $251

1. Which of the following laws prohibits companies from engaging in price discrimination?
   1. Sarbanes-Oxley Act of 2002
   2. Robinson-Patman Act of 1936
   3. The Securities Act of 1933
   4. NAFTA
2. Which of the following laws prohibits companies from offering the same item to different customers at different prices?
   1. NAFTA
   2. Foreign Corrupt Practices Act of 1977
   3. Robinson-Patman Act of 1936
   4. Sarbanes-Oxley Act of 2002
3. Which of the following is not a reason a company would be willing to accept new business at a loss?
   1. The company has the expectation that it will make up for it in later years.
   2. The company has the expectation that certain customers can influence other potential customers.
   3. The company has the expectation that its estimates will prove incorrect and that the business will result in a profit.
   4. The company has the expectation that it can acquire the customer on a permanent basis by offering a special price upfront.
4. Which of the following is a reason a company would be willing to accept new business at a loss?
   1. The new business will allow the company to reduce its fixed costs.
   2. The new business will always cover variable costs.
   3. The new business may result in certain customers influencing other potential customers.
   4. The new business will increase fixed costs.
5. Which of the following would least likely be a relevant cost in a special order of expensive clocks?
   1. Direct materials
   2. Direct labor
   3. Variable overhead
   4. Fixed overhead
6. Which of the following costs is most likely relevant in deciding whether to accept a special order?
   1. Direct material, variable overhead, and fixed overhead
   2. Variable overhead, fixed overhead, and direct labor
   3. Direct material, direct labor, and variable overhead
   4. Direct material and direct labor
7. In making the decision about whether to accept a special order for pianos, which of the following costs should be considered?
   1. Relevant costs to produce the pianos
   2. Relevant costs to sell the pianos
   3. Unavoidable costs to produce the pianos
   4. Unavoidable costs to sell the pianos
8. If a special order results in a positive contribution margin of $8 when the contribution margin for regular orders is $15, which of the following decisions is the most likely to be chosen?
   1. Accept the order, because $8 per unit is generated as profit
   2. Reject the order, because $7 per unit is lost
   3. Accept the order, but only if the customer agrees to an increase in the selling price to match the $15 regular contribution margin
   4. Accept the order, but only if the customer agrees to an increase of $7 in the selling price
9. If a special order is being considered when the product normally sells for $10, and relevant costs are $6 to produce a unit and $2 to sell the unit, which of the following decisions is the most likely to be chosen?
   1. Accept the order if the sales price is $6 or more.
   2. Accept the order if the sales price is $8 or more.
   3. Accept the order if the sales price is at least $10.
   4. Reject the order.
10. Which of the following is not a qualitative issue in a special order pricing decision?
    1. Will accepting the order generate a positive contribution margin?
    2. If the special order generates new business, will the customer purchase again at the regular price?
    3. If the special order uses a lower quality component that is used for regular orders, will it negatively affect the company’s reputation?
    4. Will accepting the special order require the hiring of extra workers or payment of overtime?
11. Which of the following is not a qualitative issue in a special order pricing decision?
    1. Will accepting the special order require the hiring of extra workers or payment of overtime?
    2. Will accepting the special order result in the loss of regular customers?
    3. Will accepting the order generate an increase in operating income?
    4. If the special order generates new business, will the customer purchase again at the regular price?
12. When a customer requests a special order and the supplier has capacity constraints, which of the following is most likely not an option for the customer?
    1. Reject the special order.
    2. Reduce the special order.
    3. Accept the special order and cut back on normal production.
    4. Accept the special order and fill it whenever capacity becomes available.
13. Which of the following operations would be the most likely to accept a special order based on seasonality?
    1. H&R Block tax service
    2. Federal Express
    3. An attorney specializing in estate planning
    4. A hospital approached by a patient negotiating on the price of kidney stone surgery
14. An auto body shop is trying to decide whether or not to purchase a new piece of diagnostic equipment. Which of the following costs would not be relevant to the decision?
    1. The cost of the new equipment
    2. The increase in property taxes as a result of purchasing the expensive equipment
    3. The book value of the old equipment
    4. The cost of training a technician to operate the equipment
15. A dance studio is considering a plan to add ballroom dance to its offerings. Which of the following is not a relevant consideration in this decision?
    1. Will the studio have to hire an additional instructor?
    2. Will another class have to be dropped if ball room dancing is offered?
    3. Is there a demand for ballroom dancing?
    4. What are the unavoidable costs of the proposed addition?
16. Your friend purchased a non-refundable ticket to a popular Broadway play for Friday night. Yesterday she was invited to spend Friday on the lake with a group of sorority sisters. Her only cost will be for personal items such as lunch. The lake is two hours away from her apartment and the play is another hour in the opposite direction. She knows that if she goes to the lake, she will not get back in time to attend the play. Which of the following is not a relevant cost in making her decision on whether to go to the play or to the lake?
    1. The price of the ticket to the play
    2. The price of eating out at the lake
    3. The price of renting an umbrella at the lake
    4. The price of driving to the play
17. Your professor is considering retirement. Which of the following will not be relevant in his decision?
    1. The amount of retirement benefits he will receive if he retires
    2. The amount of salary he will receive if he does not retire
    3. The cost of commuting to and from school
    4. The cost of his many books and his library of exams he uses in his classes
18. Which of the following is not relevant in the decision to accept a special order?
    1. Depreciation on factory equipment
    2. Variable cost of the product
    3. Sales commissions based on a percentage of the sales price
    4. Direct labor associated with the product
19. Impala Industries manufactures a component used by car manufacturers. Impala can produce 1,000,000 components per year. A foreign car manufacturer has approached Impala with an offer to purchase 120,000 components at price of $6 per unit. Impala’s results for last year are as follows:

If Impala accepts the offer, it will only be able to sell 880,000 units at the regular price due to its capacity constraints. What will Impala’s total operating income be next year if it accepts the offer?

1. $2,710,000
2. $2,410,000
3. $2,650,000
4. $4,760,000

Regular Sales (880,000 × $8) – Variable costs (880,000 × $3) – Fixed costs $2,350,000 + Offer [($6 – 3) × 120,000] = $2,410,000

1. Lark Company manufactures dog food for distribution in Washington, Oregon, and California. A dog food distributor from Florida has approached Lark and offered to purchase 240,000 pounds of dog food for $1.40 per pound. Lark can produce 2,000,000 pounds of dog food per year, and its results for last year are as follows:

If Lark accepts the offer, it will only be able to sell 1,760,000 pounds of dog food at the regular price due to its capacity constraints. What will Lark’s total operating income be next year if it accepts the offer?

1. $1,358,000
2. $1,250,000
3. $1,310,000
4. $2,040,000

Regular Sales (1,760,000 × $1.65) – Variable costs (1,760,000 × $0.60) – Fixed costs $790,000 + Offer [($1.40 – 0.60) × 240,000] = $1,250,000

1. Glade Industries manufactures and bottles energy drinks. Last year the company made and bottled 2,500,000 units. Glade has the capacity to manufacture and bottle 3,000,000 units per year. Glade has received a special offer from a grocery chain for 500,000 bottles with a special label to be sold as the house brand energy drink. Glade’s normal selling price is $0.80 per bottle. The special offer is for $360,000 total ($0.72/bottle). Management estimates that the variable cost per bottle is $0.34; fixed manufacturing overhead is $0.22/bottle. Of the fixed costs assigned to this special order, $2,500 is for the special labels, the remainder is attributable to costs that will be incurred regardless of whether the special order is produced. What is the operating income generated by the special order?
2. $190,000
3. $187,500
4. $80,000
5. $77,500

Special Order: [($0.72 – 0.34) × 500,000] ̶ $2,500 = $187,500

1. Harmony Forge manufactures saddles for show horses. The company has received a special order for 290 saddles for an international competition. Each of these saddles would include the specialized logo of the competition. Last year Harmony produced 710 saddles, and the company has the capacity to produce 1,000 saddles per year. Harmony’s saddles normally sell for $650 each, but the special offer is for $179,800 ($620 per saddle). The controller has provided information to management that estimates the variable cost per saddle is $435; fixed manufacturing overhead is $60/saddle. Of the fixed costs assigned to this special order, $15,950 is for the specialized logos, the remainder is attributable to costs that will be incurred regardless of whether the special order is produced. What is the operating income generated by the special order?
2. $53,650
3. $37,700
4. $36,250
5. $20,300

Special Order: [($620 – 435) × 290] ̶ $15,950 = $37,700

1. Moving the production of goods from within the organization to a provider outside the organization is referred to as
   1. transfer pricing.
   2. product diffusion.
   3. segment slicing.
   4. outsourcing.
2. Moving the delivery of services from within the organization to a provider outside the organization is referred to as
   1. outcome sourcing.
   2. outsourcing.
   3. delivery diffusion.
   4. delivery transfer.
3. Many small businesses hire a local CPA firm to process their payroll. This is an example of
   1. transfer pricing.
   2. offshoring.
   3. offsourcing.
   4. outsourcing.
4. Moving a company’s business processes to a foreign country is referred to as
   1. outsourcing.
   2. offsourcing.
   3. offshoring.
   4. outshoring.
5. Delta Airlines uses Wipro, an Indian company, to handle its customer service calls. This is an example of
   1. offshoring.
   2. outshoring.
   3. outsourcing.
   4. offsourcing.
6. When a company continues to manufacture a product, but changes the geographical location of production, it is called
   1. outsourcing.
   2. offshoring.
   3. right-sourcing.
   4. allocating.
7. Toyota, a Japanese company, has a manufacturing plant in Canton, Mississippi. If Toyota were to contract with Ford Motor Company to manufacture its autos at a Ford plant in the United States, this would be an example of
   1. offshoring.
   2. outsourcing.
   3. offshore outsourcing.
   4. neither offshoring or outsourcing.
8. When an outsourcing decision refers to the components of a manufacturing product, it is commonly called
   1. unit outsourcing.
   2. make-or-buy decision.
   3. transfer of ownership decision.
   4. Lean manufacturing.
9. Which of the following is not one of the top ten reasons companies outsource their operations?
   1. Redirects resources to core activities
   2. Frees managers’ time to focus on more important issues
   3. Reduces and controls operating costs
   4. Provides diversity so as to produce better quality product
10. Which of the following is not one of the top ten reasons companies outsource their operations?
    1. More effective than producing all the components of a product
    2. Provides a cash infusing as freed-up assets are sold
    3. Provides world-class capabilities at lower cost
    4. Transfers a portion of business risk to an outsource provider
11. Which of the following is not one of the top ten reasons companies outsource their operations?
    1. Releases capital funds for use in other projects
    2. Always less costly to outsource
    3. Provides external expertise to improve difficult-to-manage processes
    4. Accelerates the benefits of process reengineering
12. Which of the following is not a short-term tactical benefit of outsourcing a company’s operations?
    1. Release capital funds for use in other projects
    2. Frees managers’ time to focus on more important issues
    3. Reduces and controls operating costs
    4. Provides a cash infusion as freed-up assets are sold
13. Which of the following is not a long-term tactical benefit of outsourcing a company’s operations?
    1. Frees managers’ time to focus on more important issues
    2. Accelerates the benefits of process reengineering
    3. Releases capital funds for use in other projects
    4. Redirects resources to core activities
14. When a company accepts an outsourcing offer, managers must take specific action to eliminate internal costs. Which of the following is not an example of such an action?
    1. Reduce work force
    2. Sell production equipment
    3. Eliminate income taxes
    4. Reduce inventory levels
15. When a company accepts an outsourcing offer, managers must take specific action to eliminate internal costs. Which of the following is not a quantitative or qualitative factor managers should consider when accepting an outsourcing offer?
    1. How to reduce direct labor
    2. How to eliminate shipping charges
    3. Impact on employee morale
    4. Whether to replace production managers
16. Depreciation on a factory machine is an example of which of the following types of cost?
    1. Variable cost
    2. Sunk cost
    3. Opportunity cost
    4. Period cost
17. When a company is outsourcing a process, resources are freed up so they can be put to another use. The alternative use is considered to be
    1. an opportunity cost.
    2. a sunk cost.
    3. an outsource windfall.
    4. a fixed cost.
18. When choosing between alternatives, the contribution margin of the next best alternative is called
    1. incremental revenue.
    2. opportunity cost.
    3. sunk cost.
    4. incremental analysis.
19. Which of the following is not a qualitative issue that must be considered before reaching a decision to outsource?
    1. Quality of the outsourced product
    2. Number of employees terminated
    3. Ability to bring outsourced item back in house
    4. Speed of the outsourced product
20. Which of the following is not a qualitative issue that must be considered before reaching a decision to outsource?
    1. Reliability of the outsource provider
    2. Stability of the price offered by the outside supplier
    3. Opportunity costs of alternatives
    4. Quality of the outsourced product
21. Which of the following is not a qualitative issue that must be considered before reaching a decision to outsource?
    1. Potential theft of intellectual property
    2. Quality of the outsourced product
    3. Number of employees to be terminated
    4. Reliability of the outsourced product
22. The costs that should be included in an outsourcing decision are
    1. fixed costs.
    2. variable costs.
    3. unavoidable costs.
    4. relevant costs.
23. The costs that should be included in an outsourcing decision are
    1. sunk costs.
    2. recurring costs.
    3. relevant costs.
    4. fixed costs.
24. The costs that should be included in an outsourcing decision are
    1. fixed costs.
    2. nonrecurring costs.
    3. sunk costs.
    4. differential costs.
25. Given the following data, what is the total relevant cost of internal production of 2,000 products?

1. $34,000
2. $40,000
3. $48,000
4. $49,000
5. If the unit cost of direct materials is $20, direct labor is $12, variable overhead is $2, avoidable fixed costs are $6,000, unavoidable fixed costs are $5,000 and sunk costs are $9,000, what is the total relevant cost for 300 products?
   1. $15,200
   2. $16,200
   3. $24,200
   4. $25,200
6. Given the following data, what is the total relevant cost of internal production of 50 units?

• 1. $1,800
  2. $2,100
  3. $4,100
  4. $1,000

1. Pueblo Production Company manufactures 50,000 high-definition televisions each year. Pueblo is considering purchasing the glass screens from an outside source rather than producing them internally. The following data relate to the glass screens:

What is the total relevant cost to internally produce 50,000 glass screens?

1. $1,417,500
2. $1,467,900
3. $1,484,500
4. $1,625,000
5. Pueblo Production Company manufactures 50,000 high-definition televisions each year. Pueblo is considering purchasing the glass screens from an outside source rather than producing them internally. The following data relate to the glass screens:

Should Pueblo purchase or produce the screens, and what is the savings associated with the decision?

1. Purchase the screens and save $157,100.
2. Produce the screens and save $157,100.
3. Produce the screens and save $207,500.
4. Purchase the screens and save $207,500.
5. Vista Industries manufactures 75,000 digital cameras each year. Vista has been producing the lenses internally. However, late last year the company received an offer to produce the 150,000 lenses the company uses each year for a total contract price of $380,000. When Vista manufactures the lenses internally, direct materials cost $1.05 per lens, direct labor is $0.65 per lens, and variable overhead is $0.30 per lens. Vista’s total overhead is $110,000. If the lens were purchased, $28,000 of fixed overhead could be avoided. What is the total relevant cost to produce the lenses internally?
6. $410,000
7. $328,000
8. $382,000
9. $380,000
10. Vista Industries manufactures 75,000 digital cameras each year. Vista has been producing the lenses internally. However, late last year the company received an offer to produce the 150,000 lenses the company uses each year for a total contract price of $380,000. When Vista manufactures the lenses internally, direct materials cost $1.05 per lens, direct labor is $0.65 per lens, and variable overhead is $0.30 per lens. Vista’s total overhead is $110,000. If the lens were purchased, $28,000 of fixed overhead could be avoided. Should Vista purchase or produce the lenses, and what is the savings associated with the decision?
11. Purchase the lenses and save $52,000
12. Produce the lenses and save $52,000.
13. Purchase the lenses and save $2,000.
14. Produce the lenses and save $2,000.

106. When multiple products share a constrained resource, the way to allocate the resource is to compute the

• 1. contribution per unit.
  2. contribution margin per constrained resource.
  3. opportunity cost per unit.
  4. profit per unit.

107. The formula for computing the contribution per constrained resource is

1. contribution margin per unit multiplied by the constrained resource per unit.
2. contribution margin per unit divided by the constrained resource per unit.
3. total contribution margin multiplied by the constrained resource per unit.
4. total contribution margin divided by the constrained resource per unit.

108. When multiple products share a constrained resource, the constrained resource should be allocated first to the product with

1. the lowest contribution margin.
2. the lowest contribution margin per unit.
3. the highest contribution margin per constrained resource.
4. the highest contribution margin.

109. If a company produces its products in a constrained resource environment, the company should

1. always produce the product with the lowest contribution margin per constrained resource.
2. always produce the product with the highest contribution margin per constrained resource.
3. produce a mix of products such that opportunity cost is minimized.
4. produce a mix of products so that customer service needs and customer preferences are met.

110. The Theory of Constraints was developed by Eli Goldratt to

1. maximize the performance of a value chain by focusing on constraints that limit an organization’s output.
2. maximize the performance of a value chain by focusing on those processes that do not have constraints.
3. limit or eliminate defective products that constrain production.
4. maximize revenues in terms of output.

111. According to the theory of constraints, which of the following is not a step required to maximize and improve the performance of a value chain?

1. Identify the constraint.
2. Compare the constraints with industry averages.
3. Decide how to exploit the constraint.
4. Elevate the performance of the constraint.

112. According to the theory of constraints, which of the following is not a step required to maximize and improve the performance of a value chain?

1. Identify the constraint.
2. Decide how to exploit the constraint.
3. Subordinate and synchronize.
4. Determine customer demand.

113. According to the theory of constraints, which of the following is not a step required to maximize and improve the performance of a value chain?

1. Decide how to exploit the constraint.
2. Elevate the performance of the constraint.
3. Determine customer demand.
4. Subordinate and synchronize.

114. According to the theory of constraints, which of the following is not a step required to maximize and improve the performance of a value chain?

1. Identify the constraint.
2. Decide how to exploit the constraint.
3. Elevate the performance of the constraint.
4. Determine the customers’ needs and desires.

115. ABC Company manufactures sleeping bags. It has the capacity to produce 6,000 sleeping bags a year, but only produced 5,700 bags that could be sold because 5% of the bags had zippers that were defective. Under the theory of constraints, which of the following would be the most likely action to eliminate the problem of defective zippers?

1. Outsource the installation of zippers.
2. Redesign the sleeping bag to have a longer zipper.
3. Purchase a better-quality zipper.
4. Replace sleeping bag production with a product that does not have defects.

116. Instead of maximizing income, as measured by traditional accounting methods, the theory of constraints seeks to maximize

1. contribution income.
2. throughput contribution.
3. quality.
4. segment margin.

117. The theory of constraints seeks to maximize

1. inventory control.
2. contribution margin.
3. capacity.
4. throughput contribution.

118. Throughput contribution equals

1. sales revenue less fixed costs.
2. sales revenue less product costs.
3. sales revenue less direct materials costs.
4. sales revenues less manufacturing overhead.

119. Throughput contribution equals

1. sales revenue less direct materials cost.
2. sales revenue less product costs.
3. direct material plus direct labor.
4. direct material plus traceable manufacturing overhead.

120. A company can increase its throughput by which of the following actions?

1. Increasing sales
2. Decreasing direct labor costs
3. Increasing contribution margin
4. Decreasing manufacturing overhead

121. A company can increase its throughput by which of the following actions?

1. Decreasing sales
2. Decreasing direct labor costs
3. Increasing contribution margin
4. Decreasing direct materials costs

122. Which of the following is not relevant to a decision involving the allocation of a single constrained resource among multiple products?

1. Unit variable cost of each product
2. Selling price of each product
3. Fixed manufacturing costs
4. Number of orders waiting to be filled

123. Which of the following is least likely to be a constrained resource?

1. Flour to make donuts
2. Beads to make necklaces
3. Specialized equipment
4. Monthly rent on the factory

124. ABC Corporation produces three products, Standard, Deluxe and Superior, with the following characteristics:

The company has only 1,800 machine hours available each period. If demand exceeds the company’s capacity, in what sequence should orders for the three products be filled to maximize the company’s total contribution margin?

1. Standard first, Deluxe second, Superior third
2. Deluxe first, Standard second, Superior third
3. Superior first, Standard second, Deluxe third
4. Standard first, Superior second, Deluxe third

125. ABC Company produces three products, Standard, Deluxe and Superior, with the following characteristics:

The company has only 1,500 machine hours available each period. If demand exceeds the company’s capacity, in what sequence should orders for the three products be filled to maximize the company’s total contribution margin?

1. Standard first, Deluxe second, Superior third
2. Deluxe first, Standard second, Superior third
3. Superior first, Standard second, Deluxe third
4. Standard first, Superior second, Deluxe third

126. Sienna Company produces earrings, bracelets, and necklaces that are in high demand. Following is information for each of these products:

Sienna has 2,000 machine hours available each month. Demand for each item exceeds Sienna’s capacity to produce the item. In order to maximize the company’s total contribution margin, in what sequence should Sienna fill orders for the three products?

1. Necklaces first, then bracelets, then earrings
2. Earrings first, then necklaces, then bracelets
3. Bracelets first, then earrings, then necklaces
4. Necklaces first, then earrings, then bracelets

Produce as:1) Earrings, 2) Necklaces, 3) Bracelets

1. Sky Mountain Bakery makes doughnuts, cupcakes, and scones that are in high demand by local restaurants and hotels. Following is information for each of these products:

Sky Mountain has 2,000 machine hours available each month. Demand for each item exceeds Sky Mountain’s capacity to produce the item. In order to maximize the company’s total contribution margin, in what sequence should Sky Mountain fill orders for the three products?

1. Scones first, then cupcakes, then doughnuts
2. Doughnuts first, then scones, then cupcakes
3. Cupcakes first, then doughnuts, then scones
4. Scones first, then doughnuts, then cupcakes
5. Range Rider Industries manufactures chairs and tables that are in high demand by local office furniture stores. Following is information for each of these products:

Range Rider has 900 machine hours available each month. The demand for chairs is 560 units per month and the demand for tables is 340 units per month. In order to maximize the company’s total contribution margin, how should Range Rider allocate its production capacity between the chairs and tables?

1. 562 tables and 0 chairs
2. 340 tables and 222 chairs
3. 340 tables and 560 chairs
4. 562 chairs and 0 tables

340 tables × 1.6 = 544 machine hours; 900 – 544 = 356 remaining hours;

356 ÷ 1.6 = 222 chairs

1. Range Rider Industries manufactures chairs and tables that are in high demand by local office furniture stores. Following is information for each of these products:

Range Rider has 900 machine hours available each month. The demand for chairs is 560 units per month and the demand for tables is 340 units per month. If Range Rider allocates its production capacity between the chairs and tables so that it maximizes the company’s contribution margin, what will the total contribution margin be?

1. $6,744
2. $6,522
3. $6,182
4. $10,240

340 tables × 1.6 = 544 machine hours; 900 – 544 = 356 remaining hours to make chairs; 356 ÷ 1.6 = 222 chairs;

340 tables × $12 = $4,080; 222 chairs × $11 = $2,442;

1. Mallory Manufacturing produces thermal tents and sleeping bags. The company’s products are in high demand due to the quality and durability of the products. Mallory estimates it could sell 600 tents per month and 600 sleeping bags per month. Following is information for each of these products:

Mallory has 800 machine hours available each month. In order to maximize the company’s total contribution margin, how should Mallory allocate its production capacity between the tents and sleeping bags?

1. 1,000 sleeping bags and 0 tents
2. 600 sleeping bags and 290 tents
3. 600 tents and 175 sleeping bags
4. 727 tents and 0 sleeping bags

600 Sleeping Bags × 0.8 = 480 hours; 800 – 480 = 320 hours remaining to make tents;

320 ÷ 1.1 = 290 Tents

1. Mallory Manufacturing produces thermal tents and sleeping bags. The company’s products are in high demand due to the quality and durability of the products. Mallory estimates it could sell 600 tents per month and 600 sleeping bags per month. Following is information for each of these products:

Mallory has 800 machine hours available each month. If Mallory allocates its production capacity between the tents and sleeping bags so that it maximizes the company’s contribution margin, what will the contribution margin be?

1. $14,000
2. $13,765
3. $13,550
4. $19,500

600 Sleeping Bags × 0.8 = 480 hours; 800 – 480 = 320 hours remaining to make tents; 320 ÷ 1.1 = 290 Tents;

600 × $14 = $8,400; 290 × $18.50 = $5,365;

Contribution Margin = $8,400 + $5,365 = $13,765

132. A common mistake managers make in deciding to close a division is allowing

• 1. allocated fixed costs to influence the decision.
  2. qualitative issues to influence the decision.
  3. avoidable costs to influence the decision.
  4. customer needs and desires to influence the decision.

133. Which of the following should not influence a manager’s decision in deciding whether or not to close a division?

1. Qualitative factors
2. Allocated fixed costs
3. Allocated product costs
4. Allocated variable selling expenses
5. Costs such as rent and the production manager’s salary are examples of which type of cost?
   1. Non-differential costs
   2. Allocated product costs
   3. Sunk costs
   4. Relevant costs
6. Which of the following will least likely be classified as a direct cost of a business segment?
   1. Shipping
   2. Sales commissions
   3. Rent
   4. Direct material
7. Which of the following terms indicate that costs are directly caused by the cost object?
   1. Allocated
   2. Assigned
   3. Common
   4. Variable
8. Which of the following terms indicate general corporate costs incurred to support operations as a whole?
   1. Segment
   2. Assigned
   3. Margin
   4. Variable
9. Common costs are
   1. not relevant.
   2. differential.
   3. part of segment margin.
   4. avoidable.
10. The contribution margin of a particular segment less any direct fixed costs is called
11. segment margin.
12. segment profit.
13. segment operating margin.
14. segment taxes.
15. The variable costs associated with the segment’s sales are always
    1. sunk.
    2. avoidable.
    3. unavoidable.
    4. irrelevant.
16. Which of the following statements is true?
    1. If the segment margin is negative, the segment should be retained.
    2. If the segment margin is negative, it should remain in operation until a better use can be found for its resources.
    3. If the segment margin is negative, it should be combined with another segment.
    4. If the segment margin is negative, the operation should be dropped.
17. In a decision to add or eliminate a product or service, which of the following is an avoidable cost?
    1. Common costs
    2. Depreciation
    3. Variable overhead
    4. Allocated overhead
18. Brandy Company is deciding whether or not to discontinue one of its divisions. The division’s contribution margin is $27,000 per year. The fixed costs charged to the division total $32,000, but $15,000 would be eliminated if the division is discontinued. If the division is eliminated, the overall operating income will
    1. decrease by $9,000.
    2. decrease by $12,000.
    3. decrease by $15,000.
    4. increase by $27,000.
19. Logan Corporation is considering a eliminating a department that has incurred losses over the past several years. The department has a contribution margin of $32,000 per year. The fixed costs charged to the department total $37,000. $15,000 of the fixed costs is avoidable. If the department is eliminated, what would be the effect on the corporation’s operating income?
    1. $17,000 decrease
    2. $37,000 decrease
    3. $15,000 increase
    4. $22,000 increase
20. ABC Corporation makes mattresses in three sizes: twin, queen and king. Twin mattresses have shown a loss for several years, similar to the operating loss shown below:

None of the fixed costs are avoidable. What will be the total operating income for the corporation if twin mattresses are discontinued?

• 1. $50,000 loss
  2. $15,000 loss
  3. $30,000 profit
  4. $105,000 profit

$30,000 income ̶ $80,000 fixed costs to be absorbed by Queen and King = $50,000 loss

146. Ron Jensen, the controller of Inca Industries, has prepared an analysis to help management determine whether one of Inca’s departments should be eliminated. The department’s contribution margin is $44,000. The fixed expenses charged to the department total $75,000. Of the fixed expenses, Jensen estimates that $36,000 of those expenses would be eliminated if the department were discontinued. Based on Jensen’s analysis, if the department is eliminated, Inca’s overall operating income would

1. increase by $8,000 per year.
2. decrease by $8,000 per year.
3. decrease by $31,000 per year.
4. decrease by $5,000 per year.
5. Channing Company is a large internet retailer with fulfillment warehouses in numerous locations throughout the U.S. One of Channing’s warehouses has been showing losses over several quarters, and management is considering closing the warehouse. If the warehouse is closed, only the warehouse manager will be retained by Channing. The warehouse manager’s annual salary is $65,000. The warehouse fixtures and equipment have no resale value. Following is the most recent income statement for the warehouse:

What will be the impact on Channing’s overall operating income if the warehouse is eliminated?

1. Increase by $18,600 per year
2. Decrease by $68,000 per year
3. Decrease by $86,600 per year
4. Increase by $46,400 per year
5. Knoll Manufacturing has manufacturing facilities in several locations. One of Knoll’s facilities has been showing losses over several quarters, and management is considering closing the facility. If the facility is closed, only two part-time employees will be retained by Knoll. The annual wage of each part-time worker is $14,400. This particular location has been in operation for many years. As a result, the manufacturing equipment has no resale value. Following is the most recent income statement for the facility:

What would be the impact on Knoll’s overall operating income if the manufacturing facility is eliminated?

1. Increase by $81,800 per year
2. Decrease by $241,000 per year
3. Decrease by $226,600 per year
4. Increase by $322,800 per year
5. Leonora Industries manufactures light fixtures for home, retail, and industrial customers. The retail line has been showing losses for several years, and management is considering dropping the line. Recent income statements have been very similar to the following information which was prepared for the most recent year:

Of the fixed costs, $315,000 is common costs that have been allocated equally to each product line. What will total operating income be if Leonora drops the retail line?

1. $101,900
2. $(3,100)
3. $77,400
4. $26,900

($67,500 + $34,400) – $105,000 = -$3,100 operating loss

1. Brown Manufacturing makes single kayaks, double kayaks, and lightweight competitive kayaks. The double kayak line has been showing losses for several years, and management is considering dropping the line. Recent income statements have been very similar to the following information which was prepared for the most recent year:

Of the fixed costs, $393,750 is common costs that have been allocated equally to each product line. What will total operating income be if Brown drops the double kayak line?

1. $127,375
2. $(3,875)
3. $96,750
4. $33,625

($84,375 + $43,000) ̶ $131,250 = ($3,875) Operating loss

Answers to Multiple-Choice Questions

MATCHING

1. Match the following terms to the appropriate statement by placing the letter to the left of each statement.

1. e – Differential
2. b – Avoidable cost
3. i – Sunk cost
4. h – Opportunity cost
5. j – Throughput contribution
6. a – Allocated cost
7. d – Common cost
8. c – Bottleneck process
9. g – Information overload
10. f – Incremental analysis

BRIEF EXERCISES

1. Complete the table below by placing an “X” under each heading that classifies the cost as relevant or irrelevant.

1. Complete the table below by placing an “X” under each heading that classifies the costs as avoidable or unavoidable in a decision to accept a special order.

1. R&W Manufacturing Company produces men’s hiker shorts. The selling price of the shorts is $35. The following standard cost data per unit includes $7 direct material, $4 direct labor and $12 manufacturing overhead (50% variable, 50% fixed). R&W has received a special order for 200 pairs of shorts at a price of $20 each. The only additional cost of accepting the special order is a sales commission of $1 per unit. R&W has ample capacity to produce the special order without interrupting regular production. Ignoring qualitative factors, should R&W accept the special order?

Revenue $20

Direct material 7

Direct labor 4

Variable overhead 6

Sales commission 1

Contribution margin $ 2

Total additional profit = $2 x 200 = $400

R&W should accept the special order because the accepting will produce additional profit of $400.

1. Elton’s Electronics is a wholesale distributer for TVs and other electronics and appliances. The selling price of TV Model 83G7 is $799. The standard cost for Model 83G7 includes $300 direct material, $30 direct labor and $200 manufacturing overhead (75% variable, 25% fixed). Elton has received a special order for 200 Model 83G7s at a price of $450 each. The only additional cost of accepting the special order is a sales commission of $9 per unit. The special order is to a retail store that will not be in competition with any other Elton customers. Ignoring qualitative factors, should Elton accept the special order?

Direct material $300

Direct labor 30

Variable overhead ($200 x .75) 150

Sales commission 9

Unit variable costs $489

Sales price for special order $450

Variable costs 489

Contribution margin ($39)

Elton should not accept the special order because the relevant cost exceeds the sale price. The special order would create a negative contribution resulting in a net loss of $39 if the order is accepted.

1. Paper Moon, a manufacturer of outdoor lighting fixtures is operating at less than full capacity. The plant manager is considering making the mounting brackets now being purchased from a supplier at $8 each. Paper Moon already has the equipment to produce the brackets. The plant manager has analyzed the cost of producing the brackets and determined that each bracket will require $2 of direct material, $1 of direct labor, and $8 of manufacturing overhead. Seventy-five percent of the manufacturing overhead is a fixed cost that would not be affected by the decision to manufacture the brackets. Should Paper Moon continue to purchase the brackets or produce them internally?

*$8 x .75 = 6

Paper Moon should not continue to purchase the brackets from an outside supplier because the cost of relevant cost of making each bracket is $3 less than the relevant cost of purchasing it.

1. Power Tools, Inc. produces gas-powered leaf blowers. The company is currently not operating at full capacity. The plant manager is considering making the rewind assembly for the pull cord which is now being purchased from a supplier at $22 each. Power Tools already has the equipment to produce the assembly. The plant manager has analyzed the cost of producing the assemblies and determined that each assembly will require $8 of direct material, $6 of direct labor, and $12 of manufacturing overhead. Two-thirds of the manufacturing overhead is a fixed cost that would not be affected by the decision to manufacture the brackets. Should Paper Moon continue to purchase the brackets or produce them internally?

Power Tool should make the assembly rather than to continue purchasing the part from an outside supplier because the cost of making each assembly is $4 less than the purchase price.

1. Murphy, Inc. has the following production and cost data for two of its products, Standard and Deluxe:

A total of 80,000 hours is available each period for the production of the two products. The demand for both products is strong and Murphy will be able to sell as many of either product as it can produce. Ignoring qualitative issues, which of the two products should Murphy produce?

Standard $60 ÷ 2 = $30 contribution margin per machine hour

Deluxe $40 ÷ 1 = $40 contribution margin per machine hour

Murphy should produce the Deluxe product as it generates $10 more per machine hour used in the production process.

1. Ledbetter, Inc. has the following production and cost data for three of its products, Basic, Standard and Deluxe:

A total of 8,000 hours is available each period for the production of the three products. The demand for both products is strong and Ledbetter has orders for 1,200 of Basic, 3,000 of Standard and 800 of Deluxe. Ignoring qualitative issues, how many of each product should Ledbetter produce?

Basic $40 ÷ 2 = $20 contribution margin per machine hours

Standard $50 ÷ 5 = $10 contribution margin per machine hours

Deluxe $60 ÷ 4 = $15 contribution margin per machine hours

Ledbetter should fill the Basic orders first, then the Deluxe and finally the Standard

Order of production:

Total hours available 8,000

Basic (1,200 × 2) (All orders can be filled) 2,400

Hours remaining 5,600

Deluxe (800 × 4) (All orders can be filled) 3,200

Hours remaining 2,400

Standard = 2,400 ÷ 5 = 480 orders to be filled.

The company can fill only 480 of the 3,000 standard orders.

1. Kentucky Distributors has two divisions – Northern and Southern. The divisions have provided the following financial information:

Kentucky’s executives are considering the elimination of the Northern division. If the division is eliminated, the common fixed costs will remain unchanged. Given these data, should the Northern division be eliminated? Why?

Kentucky should not eliminate the Northern division. It has a positive contribution, and if it is eliminated, the Southern division would have the burden of $65,000 additional common fixed costs. This would create lower income for the Southern division and the company.

1. Cabells, Inc. has two divisions – Electronics and Appliances. The divisions have provided the following financial information:

Cabells’ executives are considering the elimination of the Electronics division. If the division is eliminated, the common fixed costs will remain unchanged. Given these data, should the Electronics division be eliminated? Why?

Cabells should eliminate the Electronics division. The Electronics division before common fixed cost has a $7,000 loss. If the division is eliminated, the company will show a profit of $10,000, and increase of $7,000 from the original operating income of $3,000.

EXERCISES

1. Suppose you are trying to decide whether to rent an apartment across the street from campus or a nicer apartment one mile from campus. In either case, you plan to keep your car for social outings. Indicate whether the following pieces of information are relevant or irrelevant to your decision.

1. Brandon, Inc. is a consulting firm headquartered in Dallas. Trish Hardin, CEO of the company plans to attend a professional conference in Atlanta where she intends to network in the pursuit of business. She enjoys shopping and dining in Atlanta and is looking forward to the trip. She registered for the conference and made hotel and airfare reservations six weeks ago. Her airline ticket and registration fee are non-refundable, but it is not too late to cancel her hotel room. The day before the conference, a company executive from El Dorado calls and wishes to meet with Trish the next day regarding a consulting project. If Trish chooses to make the trip to El Dorado, she will drive. Both trips will require an overnight stay. Trish does not have a prediction of how much revenue either trip may generate. Costs related to the two trips are as follows:

Required:

• 1. Which of the above costs are not relevant?
  2. Without considering qualitative factors, which alternative will Trish choose? Why?
  3. What are three factors other than costs that Trish should consider?

1. The airfare and registration fee are sunk costs and thus not relevant.
2. Since Trish cannot predict if either trip will generate more revenue than the other, Trish should make her choice based on incremental analysis of the costs of each trip.

Because the Atlanta trip is more costly, Trish will make the trip to El Dorado.

1. Some factors she might consider are
2. The safety of air travel versus driving
3. While driving Trish will not be productive, she might be able to work on the airplane
4. Personal enjoyment in her off-time in Atlanta versus El Dorado
5. Place and “X” in the column that corresponds to the cost classification for each of the following scenarios. Some items may fit in more than one column.

1. Sanderson’s Woodworking Company is considering the addition of a new line of quilt frames to its current product lines. If the new quilt frames are added to Sanderson’s production, contribution margin of the other products is expected to drop by $2,000. Sanderson has summarized the projected revenue and cost for the new line of frames.

Required:

• 1. If Sanderson adds the new quilt frame to its line of products, what will be the increase in operating income?
  2. What are three issues that Sanderson should consider before adding the new line?

• 1. Sanderson should consider
• The demand for the quilt frames
• Whether the factory has the production and storage capacity for the additional inventory
• The product mix if there is a resource constraint
• The timing of the orders (will there be a need for additional frames near Christmas)
• Employee morale if salesmen are not interested in selling quilt frames

1. Barber Manufacturing currently makes 2,000 high-end kaleidoscopes each year. Barber has been manufacturing all parts of the units. However, the company has found a manufacturing company that can provide the tubes at a price of $14 each. Since the company’s machine that molds the tubes is getting old, the company is considering purchasing the tubes. If the company purchases the tubes, the machine will be idle. Barber’s standard cost of the molding process for one unit is listed below.

Required:

Should Barber purchase the tubes or continue manufacturing them? Why?

Barber should continue to manufacture the tubes because it is less expensive than purchasing them. That is, the relevant cost of making the tubes is less than the purchase price from an outside source.

1. Mountaineer, Inc. currently makes 6,000 pairs of weatherproof hiking boots each year. The boots sell for $119. Mountaineer has been manufacturing the boots and applying the weatherproofing as the final process before packaging. However, the company is concerned about the costs associated with the weatherproofing process. The company is concerned that the EPA will not approve of their disposal of the residue from the process, resulting in heavy monetary penalties. Mountaineer has found a manufacturing company that can waterproof the boots and package them at a cost of $18 each. If the company outsources the waterproofing and packaging of the boots, its insurance premiums will be reduced. Mountaineer’s standard cost of the waterproofing and packaging process for one unit is listed below.

Required:

Should Barber outsource the waterproofing and packaging? Why?

Mountaineer should outsource the waterproofing and packaging because its cost of $108,000 is less expensive than doing it in-house which costs $132,000. That is, the relevant cost of outsourcing is less than Mountaineer keeping the process.

1. Newport Manufacturing makes and sells backyard fire pits. Each fire pit regularly sells for $269. The following cost data per unit are based on a full capacity of 3,000 fire pits produced each period.

Direct material $100

Direct labor 75

Manufacturing overhead (75% variable) 64

Newport is negotiating a special order for the sale of 75 fire pits to an overseas customer who is located in a country that does not have civil liberties for its population. The only selling cost that would be incurred on the special order would be a $10 sales commission. Newport is expected to make 2,500 fire pits for the special order.

Required:

• 1. What is the minimum selling price Newport should negotiate for the special order?
  2. What are three factors other than relevant costs that Newport should consider concerning this special order?

1. [$100 + $75 + ($64 × .75) + $10] = $233 minimum price per unit to charge per unit
2. Factors are:

1) Whether the special order create conflicts with regular customers;

2) Whether the customer will become a regular customer and generate profit;

3) If the order will create a negative image of Newport (selling to a country that does not have civil liberties for its population);

4) If the customer wishes to purchase the same fire pits at a later date for the regular price or will the customer ask for another special price;

5) Whether Newport will need to hire additional workers or pay overtime if regular sales increase to the point that the workload cannot be handled by the regular staff.

1. London, Inc. uses 2,000 units of Part 8G3 each year in the manufacture of one of its products. The company currently produces the part internally, but an outside supplier has offered to provide the part at a price of $15 per part. If London chooses to purchase the part from the outside supplier, one half of it’s the fixed manufacturing overhead will be eliminated. London’s standard unit cost of producing one unit of the part is listed below.

Required:

Ignoring qualitative factors, should London continue to make the parts internally or purchase them from the outside supplier? Why?

London should continue to make the part because outsourcing it will increase the company’s total costs by $2,000 each year, thus reducing profit. The relevant cost of making the part of $14 is less than the cost of purchasing the part at $30,000.

1. The Inland Corporation manufactures 1,000 motors that are used in the production of its go-karts. Inland has been approached by an outside supplier that will sell the motor to Inland for $39 each. Inland’s cost to manufacture each motor are as follows:

All fixed overhead is unavoidable and is allocated based on machine hours. The facilities that are used to manufacture the motors have no alternative uses.

Required:

• 1. Should Inland continue to manufacture the motors?

1. Yes. The relevant cost of continuing to produce each motors is:

$25 + $8 + $4 = $37, compared to $39 to purchase a motor from an outside supplier.

1. Yes. The cost to buy would be reduced by the opportunity cost of the additional revenue of $4,800 ÷ 1,000 = $4.80 per unit; .

Relevant cost of producing: $25 + $8 + $4 = $37; net relevant cost of buying: $39 ̶ $4.80 = $34.20.

1. Paris Manufacturing Company Inc. uses 400 units of Part #4317 each year in the manufacture of one of its products. The company currently produces the part internally, but an outside supplier has offered to provide the part at a price of $20 per part. If Paris chooses to purchase the part from the outside supplier, one third of it’s the fixed manufacturing overhead will be eliminated. The company’s standard unit cost of producing the part is listed below.

Required:

Ignoring qualitative factors, should Paris continue to make the parts internally or purchase them from the outside supplier? Why?

*$9 x 1/3

Paris should not continue to make the part because outsourcing it will save the company $8,000 each year. The relevant cost of purchasing the part is less than the cost of making it.

1. Logan’s, Inc. has the following production and cost data for two of its products, Basic and Supreme:

A total of 40,000 hours is available each period for the production of the two products. The demand for both products is strong and Logan is not sure it can fill all orders expected to be received.

Required:

1. Ignoring qualitative issues, for which of the two products should Logan focus on filling orders first?
2. List three alternatives that Logan should consider in order to produce more units within the 40,000 hours.
3. Basic = $160 ÷ 4 = $40 contribution margin per machine hour

Supreme = $140 ÷ 5 = $28 contribution margin per machine hour

Logan should produce Basic first as it provides a higher contribution margin of $40 for each machine hour used in production, compared to only $28 per machine hour for Supreme.

1. Logan might consider the following:
   • Purchase machinery that will produce more units in less time.
   • Hire more skilled workers that can complete the orders quickly and without defects.
   • Look at other products currently produced to determine if another lesser profitable product should be discontinued.
   • Redesign the product to move production more efficiently.
2. Holt Manufacturing Company produces three products in its Dallas factory. Data relating to the products are given below:

A total of 8,200 hours are available in the Dallas facility.

Required:

• 1. How many hours will be required to satisfy the demand for all three products?
  2. How much of each product should be produced to maximize Hold’s operating income?

Total time = 6,000 + 2,000 + 2,600 = 10,600 hours

1. Mantle, Inc. produces two types of wooden mallets, Ash and Oak, in its Miami factory. Data relating to the mallets are given below:

A total of 600 hours are available in the Miami facility.

Required:

• 1. How many hours will be required to satisfy the demand for both products?
  2. How much of each product should be produced to maximize Mantle’s operating income?

Total time = 400 + 400 = 800 hours

1. Jerry Mounds, controller for Pearl Distributing, has prepared the following financial information for the most recent period showing profitability the of its three departments:

The factory rent of $3,200 assigned to Department C is avoidable if the department is eliminated. Depreciation will remain unchanged if a department is dropped. Discontinuing Department C will reduce the utilities by $600.

Required:

Prepare an analysis showing whether Department C should be eliminated.

Avoidable items if Department C is discontinued:

Since Department C’s segment margin is positive, the company should keep it until a better alternative is identified.

1. Betty Hopper, controller for Diamond Manufacturing Company, has prepared the following financial information for the most recent period showing profitability of its three divisions:

The factory insurance and advertising assigned to the furniture division are avoidable if the division is discontinued. Depreciation will remain unchanged if a division is dropped. Discontinuing furniture will reduce the utilities by $800.

Required:

1. Prepare an analysis showing whether Furniture should be eliminated.
2. If the Furniture division is eliminated, what will be effect on the overall profit for Diamond?
3. Avoidable items if the furniture division is discontinued:

1. Dropping Furniture will decrease profit by $2,400. As such, the company should keep it until a better alternative is identified.

PROBLEMS

178. Saguaro Company is a leading producer of disposable chop sticks and other utensils. One of the company’s major product lines is high-quality chop sticks which are sold to some of the country’s best Asian restaurants, including large national chains. Each set of chop sticks is sold at a price of $0.38 per pair. To maintain its high-quality image, Saguaro uses a thick premium wood, a special varnish, and individually wraps each pair of chop sticks. Based on annual production of 5,000,000 sets of chop sticks, Saguaro’s cost for producing a pair of chop sticks is as follows:

Sharon Steele is opening a new Asian restaurant in her hometown. She recently contacted one of Saguaro’s top salespeople, Simon Green, about purchasing utensils for her new restaurant. Simon described Saguaro’s products, emphasizing the high-quality materials and processes the company uses. Sharon is looking for ways to lower her operating costs, so after hearing Simon describe Saguaro’s products, she told him that all she wants are 20,000 unwrapped chop sticks. Sharon told Simon she is willing to pay $0.09 per chop stick ($0.18 per pair).

Required

a. Based on Sharon’s offer of $0.09 per chop stick, should Saguaro accept Sharon’s order? Saguaro currently has excess production capacity and can easily accommodate Sharon’s order in the production schedule.

b. Since Sharon wants simple chop sticks, Simon is exploring using a lighter-weight wood for her order. He has found a suitable product that will cost $.02 per chop stick. If Saguaro uses this lighter-weight wood for Sharon’s order, should the company accept Sharon’s order at a price of $0.09 per chop stick? Saguaro currently has excess production capacity and can easily accommodate Sharon’s order in the production schedule.

c. After visiting with Sharon, Simon received a fax from one of Spain’s top Asian restaurants. The restaurant’s normal utensil supplier suffered some earthquake damage and is unable to ship the restaurant’s order of 20,000 pairs of chop sticks this month. The restaurant’s owner is asking if Saguaro can fill a one-time rush order of 20,000 pairs of chop sticks. The restaurant is willing to pay an 8% price premium to expedite the order. If Saguaro accepts the order, it will incur $2,250 in export taxes and shipping. Should Saguaro accept the Spanish restaurant’s offer?

d. What qualitative issues should Saguaro consider as it evaluates both Sharon’s order and the Spanish restaurant’s order? Are these issues different for the two orders?

• 1. Relevant cost of one pair = $0.05 + $0.02 + $0.05 + $0.08 = $0.20;

The variable cost of $0.20 per pair of chop sticks exceeds the sales price of $0.18 per pair of chop sticks that Sharon is willing to pay. Simon should not accept the order.

• 1. Relevant cost of one pair = ($0.02 × 2) + $0.02 + $0.05 + $0.08 = $0.19;

Even with the lighter, cheaper wood, the variable cost of $0.19 per pair of chop sticks exceeds the sales price of $0.18 per pair that Sharon is willing to pay. Simon should not accept the order.

c. Sales price on special order = $0.38 × 108% = $0.41

Contribution margin = $0.41 ̶ $0.20 = $0.21 per pair of chop sticks

Simon should accept the special order since it generates a positive profit.

d. Given that the company has excess capacity, Simon should consider options to increase sales volume. Sharon is a potential new customer that Simon could develop a long-term relationship with, if she can get to a financial position where she can be a profitable customer. He may want to continue to explore cheaper materials to use in producing utensils that Sharon will find acceptable. Simon will need to be careful, though, because producing lower quality products may affect the company’s reputation.

The Spanish restaurant is unlikely to be a regular customer, but if it does decide to switch to Saguaro, a different arrangement needs to be made for the excess shipping costs that are incurred, as it is unlikely that the restaurant will pay a premium price for a regular order.

1. In response to a growing awareness of various allergies, Barb’s Better Breads (BBB) developed baking mixes which contain a unique blend of gluten-free flours and starches, including almond meal, organic flax seeds and arrowroot. The breads are also baked in a preheated, heavy, lidded pan which creates a better crust and texture in gluten-free breads. BBB has been approached by a large restaurant chain to supply the bread used in restaurants throughout the region. Due to demand, almond meal is often in limited supply. Pertinent information for 3 types of bread follows:

Required:

a. Assuming no raw material constraints and unlimited demand for all 3 types of bread, what type of bread would maximize the company’s contribution margin? Why?

b. Assume that based on typical customer demand, BBB will sell 12,000 loaves of cinnamon raisin, 8,000 loaves of ciabatta, and 10,000 loaves of crusty french. What will the company’s contribution margin be?

c. BBB’s almond meal supplier has announced a shortage of almond meal. As a result, BBB will only be able to purchase 20,000 pounds of almond meal. How many loaves of each type of bread should the company bake? What will the company’s contribution margin be?

a.

Make and sell cinnamon raisin loaves since they have the highest contribution margin per loaf.

b. (12,000 × $2.45) + (8,000 × $2.40) + (10,000 × $2.10) = $69,600

c.

^a 2,900 lbs. available ÷ .90 lbs. almond meal per loaf

CM = (12,000 × $2.45) + (3,222 × $2.40) + (10,000 × $2.10) = $58,132.80

180. Adele Truff designs and manufactures a variety of personal products including wallets, purses, and key chains. Adele is proposing to begin manufacturing smart phone covers which sell for $25 each. Adele estimates that monthly sales volume will be 8,500 units. Variable product costs will be $15.50 per unit and fixed overhead will be $5.20 per unit. Half of the fixed overhead is directly traceable to the smart phone cover line. To promote the covers, Adele proposes a $1.25 per unit commission to the company’s salespeople and a $7,500 per month advertising campaign. In compliance with corporate policy, the smart phone cover line will also be allocated $15,000 in fixed corporate support costs.

Required

a. Prepare a traditional monthly income statement for the smart phone cover line.

b. Prepare a monthly income statement that highlights the proposed smart phone cover line’s segment margin.

c. Which income statement would you recommend that Adele use when pitching the proposed line to company managers? Why would you recommend she use this statement?

a.

b.

• 1. Adele should use the monthly income statement that highlights the proposed smart phone cover line’s segment margin, because this income statement focuses attention on the amount that the smart phone cover could contribute toward covering common fixed costs and generating income.

1. Outward Rowing Company manufactures canoes and kayaks. Due to an increasing focus on fitness, the company has been experiencing an increased demand for its products. Two of its newer products, which are very popular with water sport enthusiasts, require a waterproofing process that can only be completed on machines that were recently purchased for this purpose. The machines have a maximum capacity of 12,000 machine hours, and no other products that the company makes use these machines.

Charlie Green, the company’s operations manager, is preparing the production schedule for the coming month and can’t seem to find enough machine time to produce enough units to meet the customer demand that the marketing department has included in the sales budget.

Mollie Beach, the company’s controller, has gathered the following information about the two products:

Required:

a. Calculate the total number of machine hours needed to produce enough units to meet the sales demand for the two products.

b. How should Charlie allocate the 12,000 available machine hours between the two products so that Outward Rowing maximizes its profits?

d. Charlie has talked with the marketing department about the situation and suggested that the company raise the sales price on the kayak to $320 to reduce customer demand. The marketing department believes that at the higher price, demand for this kayak will drop to 11,600 units. How should Charlie allocate the 12,000 machine hours based on this new information? What total contribution margin will Outward Rowing earn?

e. After hearing about Charlie’s recommendation to increase the kayak price to $320, Lon Clark, the sales manager, suggested that the company raise the price of the canoe instead. He believes that if the price is increased to $264, demand will fall to 4,000 units. How should Charlie allocate the 12,000 machine hours under Lon’s proposal? What total contribution margin will Outward Rowing earn?

f. Based on your answers to (c), (d), and (e), which action do you suggest that Outward Rowing take? Why?

a. (8,000 units × 0.4 MH/unit) + (14,000 units × 0.8 MH/unit) = 14,400 MH

b.

^a 8,800 MH available ÷ 0.8 MH per kayak

c. CM = (8,000 canoes × $92) + (11,000 kayaks × $128) = $2,144,000

d. New contribution margin for kayak = $320 ̶ $116 = $204

New contribution margin per MH = $204 ÷ 0.8 MH/kayak = $255/MH

^a 2,720 MH available ÷ 0.4 MH per canoe

CM = (11,600 kayaks × $204) + (6,800 canoes × $92) = $2,992,000

e. New contribution margin for canoe = $264 ̶ $108 = $156

New contribution margin per MH = $156 ÷ 0.4 MH/canoe = $390/MH

^a10,400 MH available ÷ 0.4 MH per kayak

f. Raising the price of the kayak results in the greatest total contribution margin. Because the company is unable to meet so much demand, Charlie should consider purchasing another machine to increase capacity.

1. List the two criteria to be considered relevant to decision making. Explain the difference between sunk cost and opportunity cost and indicate whether they can be considered relevant.

The two criteria that information must meet to be considered relevant are:

• It differs between alternatives, and
• The differences occur in the future

A sunk cost represents a cost that has been incurred in the past. Sunk costs are irrelevant.

An opportunity cost is the contribution margin of the next-best alternative. Opportunity cost can be relevant.

1. Why would a movie theater with some seats still available not sell tickets at a reduced price to movie goers that show up at the last minute?

Movie theaters have high fixed costs and serves different moviegoers at each showing. The marginal costs of showing a movie are few while fixed costs are high. If moviegoers knew they could walk in at the last minute and pay far less than the regular price, why would they come early and pay the higher price? After all, they would only miss the pre-film commercials. The only reason a moviegoer would pay in advance is to guarantee a seat, probably on opening day. This practice would begin to shape consumer beliefs about the value of their services, and the companies would not be able to stay in business at the special lower prices.

1. What is an opportunity cost and what is the impact of opportunity cost on a decision to outsource the production of an item?

An opportunity cost is the contribution margin of the next best alternative. The impact of opportunity cost must be considered when making the decision to outsource the production of an item. For example, when the production of an item is outsourced, the resources that are freed up can be put to another use, so the alternative use is an opportunity cost of using the resources.

1. As products are made, capacity is used up. Managers must allocate any constrained resource to products so as to maximize the company’s contribution margin.

Required:

• 1. List three limited resources that can constrain business operations.
  2. How should managers determine the best way to allocate constrained resources among products or operations?

1. Resources that can constrain business operations include machine hours, direct labor hours, space, and raw materials.
2. The constrained resource should be allocated first to the product with the highest contribution margin per constrained resource, followed by the product with the second-highest contribution margin per constrained resource, and so on. Each product should receive only as much of the constrained resource as needed to meet customer demand. Qualitative factors such as customer service and customer preferences may also dictate how constrained resources are allocated among products or operations.
3. If a product has a positive segment margin but is not as profitable as other products, what should managers do? What if the segment margin is negative?

If the segment margin is positive, the operation should be kept until a better use can be found for its resources. If the segment margin is negative, the operation should be dropped in order to increase profit.

ESSAY

1. Your company has realized that some managers are making rash decisions which have created negative consequences for the entire company. You have been assigned to a team responsible for training managers on making good decisions based on a relevant-cost decision model. Your team has done some research and found that most management decisions can be approached using a model that asked five questions. List each of the steps in the five-step approach in this chapter and provide a brief description.

Step 1 What is the decision to be made? In a car-buying decision, one might ask what car do I need for a long daily commute.

Step 2 What are the available alternatives? Do I want a used or new auto or a compact or SUV?

Step 3 What are the relevant revenues and costs? Will the used car require more maintenance or will the SUV use too much gas?

Step 4 What are the qualitative issues that must be considered? Will the car impress my friends or is it the color I want?

Step 5 Which alternative offers the greatest benefits or least cost? Pick the best car.

1. Accepting special orders may produce additional revenues but may also result in some negative consequences. Discuss the quantitative and qualitative factors that impact the decision to accept a special order.

• Additional contribution margin that otherwise the company would not have
• May lead to special order customer becoming a regular customer
• If company has excess capacity, special orders help fill to capacity
• Possible increase in demand for product
• Possible conflict with regular customers
• If company is operating at capacity, may require additional costs such as overtime
• No guarantee that special order will lead to regular business
• If regular sales are sacrificed to fill special order, loss of contribution margin
• Employees may not be willing to work additional hours to fill the order

1. Because of rising salaries and cost of healthcare and other employee benefits, TJ Manufacturing has decided to outsource one of its non-value-added processes. As leader of the team responsible for determining the best process to be outsourced, you must write the memo to the CEO, Jon Duncan, explaining why your team chose to outsource the payroll function. Explain to the CEO the qualitative and quantitative impacts of your team’s decision on the business.

To: Jon Duncan, CEO

From Team leader

Subject: Outsourcing Decision Explanation

As leader of the team responsible for choosing to outsource payroll, this memo provides the choice our team made and explains the impacts of this decision on the business. The function we chose to outsource is the payroll function. After investigating several alternatives, we believe this to be the least disruptive and most likely to maintain the current quality of information.

By outsourcing the payroll function, six positions including one supervisory position will be eliminated. The cost savings is substantial. The space previously used will be taken by accounts payable, which has inadequate space for its computer equipment and files. There will be no additional cost involved in this move. By eliminating the payroll function, the fewest number of employees are impacted. We request that these employees be given first choice of any openings within the company for which they qualify. We believe outsourcing payroll will have the least negative effect on the company’s reputation. Finally, we believe the quality of payroll functions will be improved. A local CPA firm provides payroll services for companies in our industry of similar size. We have verified satisfaction with the CPA firm from several of its clients and believe the employees will not suffer from this change. We have inquired whether the CPA firm might be interested in hiring some of the employees we will be terminating, and that is a possibility.

We believe that outsourcing the payroll function is the best choice for outsourcing. If you have any questions or desire additional information, please let me know.

1. The Theory of Constraints was developed to maximize the performance of a value chain. According to the theory, five steps are required to maximize and improve the performance of a value chain.

Required:

1. List the five steps.
2. Define the two terms bottleneck process and throughput contribution. Indicate how these terms are related to the theory of constraints.
3. Step 1 – Identify the constraint

Step 2 – Decide how to exploit the constraint

Step 3 – Subordinate and synchronize everything else to the first two decisions.

Step 4 – Evaluate the performance of the constraint.

Step 5 – If during any of these steps the constraint has shifted, go back to step 1.

1. A bottleneck is the point in the production process where output is limited and thus it constrains output. Throughput contribution is sales revenue less direct materials costs. Instead of maximizing income, the theory of constraints seeks to maximize throughput contribution.
2. What is a common fixed cost?
3. Is a common fixed cost considered relevant?
4. Give two examples of common fixed costs.
5. What happens to common fixed costs if a segment is eliminated?
6. A common cost is a cost that is not directly caused by the cost object (or segment). That is, it may be an allocated fixed cost incurred at the corporate level for the benefit of the entire organization.
7. A common cost is a non-differential cost, and thus it is not a relevant cost.
8. Some common fixed costs include supervisory salaries, executive salaries, and headquarter costs such as utilities and accounting.
9. If a segment is eliminated, the common fixed costs are absorbed by the other segments.