CHAPTER 7

INCREMENTAL ANALYSIS

SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, BLOOM’S TAXONOMY, LEVEL OF DIFFICULTY, AACSB CODES, AND CPA CODES

Bloom’s: AN = Analysis AP = Application C = Comprehension E = Evaluation

K = Knowledge S = Synthesis

LOD: E = Easy M = Medium H = Hard

AACSB: AN = Analytic

CPA: MA = Management Accounting

SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, BLOOM’S TAXONOMY, LEVEL OF DIFFICULTY, AACSB CODES, AND CPA CODES (CONT’D)

Bloom’s: AN = Analysis AP = Application C = Comprehension E = Evaluation

K = Knowledge S = Synthesis

LOD: E = Easy M = Medium H = Hard

AACSB: AN = Analytic

CPA: MA = Management Accounting

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE

Note: TF = True-False C = Completion BE = Brief Exercise

MC = Multiple Choice Ex = Exercise SAE = Short-Answer Essay

Ma = Matching MP = Multi-Part

CHAPTER LEARNING OBJECTIVES

1. Describe management’s decision-making process and the concept of incremental analysis.

Management's decision-making process consists of (a) identifying the problem and assigning responsibility for the decision, (b) determining and evaluating possible courses of action, (c) making the decision, and (d) reviewing the results of the decision.

Incremental analysis is the process companies use to identify financial data that change under alternative courses of action. These data are relevant to the decision because they will vary in the future among the possible alternatives.

2. Identify the relevant costs in accepting an order at a special price.

The relevant information in accepting an order at a special price is the difference between the variable manufacturing costs to produce the special order and expected revenues.

3. Identify the relevant costs in a make-or-buy decision.

In a make-or-buy decision, the relevant costs are (a) the variable manufacturing costs that the company will save, (b) the purchase price, and (c) opportunity costs.

4. Identify the relevant costs and revenues in deciding whether to sell or process materials further.

The decision rule for whether to sell or process materials further is as follows: process further as long as the incremental revenue from processing is more than the incremental processing costs.

5. Identify the relevant costs in deciding whether to retain or replace equipment.

The relevant costs a company needs to consider in determining whether it should retain or replace equipment are the effects on variable costs and the cost of the new equipment. Also, it must consider any disposal value of the existing asset.

6. Identify the relevant costs in deciding whether to eliminate an unprofitable segment.

In deciding whether to eliminate an unprofitable segment, the relevant information is the contribution margin, if any, produced by the segment and the disposition of the segment's fixed costs.

7. Determine the sales mix when a company has limited resources.

When a company has limited resources, it is necessary to find the contribution margin per unit of limited resource.

TRUE-FALSE STATEMENTS

1. Sunk costs are considered relevant when choosing among alternatives because they are differential.

2. An opportunity cost is the potential benefit given up by using resources in an alternative course of action.

3. Max Company has excess capacity. A customer proposes to buy 400 widgets at a special unit price even though the price is less than the unit variable cost to manufacture the item. Max should accept the special order if demand on other products is unaffected.

4. Direct materials, direct labour, and allocated fixed and variable manufacturing overhead are all relevant in a make-or-buy decision.

5. The book value of old equipment is an opportunity cost.

6. In deciding on the future status of an unprofitable segment, management should recognize that net income will increase by eliminating the unprofitable segment.

7. One incremental analysis decision is the allocation of limited resources.

ANSWERS TO TRUE-FALSE STATEMENTS

MULTIPLE CHOICE QUESTIONS

8. Which of the following is false?

a) Incremental analysis identifies the probable effects of management decisions on future earnings.

b) In incremental analysis, total fixed costs will always remain constant under alternative courses of action.

c) The process used to identify the financial data that change under alternative courses of action is called incremental analysis.

d) Incremental costs are always relevant.

9. Decision making

a) involves reviewing the results of a decision once the decision has been made.

b) using incremental analysis focuses on the amounts that are the same among alternatives.

c) involves management considering only financial information because accounting is presented in a financial context.

d) always follows the same pattern because decisions vary significantly in their scope, urgency, and importance.

10. Which steps do accountants generally contribute to in the decision-making process?

a) Identifying the problem and then assigning responsibility.

b) Determining and evaluating possible courses of action and then reviewing the results of the decision.

c) Determining and evaluating possible courses of action, and then making a decision.

d) Making a decision and then reviewing the results of that decision.

11. Which one of the following stages of the management decision-making process is properly sequenced?

a) Evaluate possible courses of action; make decision.

b) Review the actual impact of the decision; determine possible courses of action.

c) Assign responsibility for the decision; identify the problem.

d) Make decision; assign responsibility.

12. Who prepares relevant revenue and cost data for the decision-making process?

a) department heads

b) the controller

c) management accountants

d) factory supervisors

13. Which of the following statements about making decisions is correct?

a) Only relevant financial information should be considered.

b) All information should be considered in the final decision.

c) Management should consider both relevant financial and non-financial information.

d) Management accountants should provide the information, but they should not make recommendations. It is up to the managers to make decisions.

14. What is the process of evaluating financial data that changes under alternative courses of action called?

a) incremental analysis

b) decision-making analysis

c) contribution margin analysis

d) cost-benefit analysis

15. Which one of the following is non-financial information that management might evaluate in making a decision?

a) opportunity costs of a decision

b) contribution margin

c) the effect on operating income of a decision

d) the corporate profile in the community

16. Which one of the following is an alternative name for incremental analysis?

a) managerial analysis

b) cost analysis

c) contribution margin analysis

d) differential analysis

17. Which of the following describes one aspect of incremental analysis?

a) Both costs and revenues that stay the same between alternate courses of action will be analyzed.

b) Both costs and revenues that differ between alternate courses of action will be analyzed.

c) All costs and revenues, regardless if they stay the same or differ between alternate courses of action, will be analyzed.

d) Only costs relating to the decisions at hand are analyzed.

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18. Which of the following statements about incremental analysis is true?

a) It cannot be used if more than two alternatives are available.

b) It considers only cost factors, not revenue.

c) Its focus is on the past activities.

d) It only considers factors that are different for each alternative, and only those factors that will occur in the future.

19. What is a sunk cost?

a) A significant cost that has the potential to “sink” the organization.

b) A cost that has already occurred, but still must be considered in the decision process.

c) A cost that has already occurred; therefore, is not relevant in the decision process.

d) A cost that cannot be changed.

20. Which one of the following is a true statement about incremental analysis?

a) It is another name for capital budgeting.

b) It is the same as CVP analysis.

c) It is used primarily for long-term planning.

d) It focuses on decisions that involve a choice among alternative courses of action.

21. For which of the following decisions is incremental analysis not appropriate?

a) elimination of an unprofitable segment

b) determining cost behaviour

c) a make-or-buy decision

d) an allocation of limited resources decision

22. For which of the following is incremental analysis appropriate?

a) acceptance of a special order and a make-or-buy decision

b) a retain or replace equipment decision and CVP analysis

c) a sell or process further decision and allocation of indirect costs

d) elimination of an unprofitable segment and allocation of indirect costs

23. Which of the following is a true statement about costs in incremental analysis?

a) Variable costs are always relevant.

b) Fixed costs are never relevant.

c) Fixed costs are always relevant.

d) Both variable and fixed costs can be relevant.

24. Specik Inc. is considering the following alternatives:

Alternative 1 Alternative 2

Revenues $120,000 $120,000

Variable costs 60,000 65,000

Fixed costs 35,000 39,000

Which of the following is/are relevant in choosing between the alternatives?

a) variable costs

b) revenues

c) fixed costs

d) variable costs and fixed costs

25. Which statement is true about relevant costs in incremental analysis?

a) All costs are relevant if they change between alternatives.

b) Only fixed costs are relevant.

c) Only variable costs are relevant.

d) Relevant costs should be ignored.

26. Costs that are relevant for future decision making in a manufacturing environment include

a) only variable manufacturing costs.

b) only fixed manufacturing costs.

c) all manufacturing costs.

d) only future costs that impact the alternatives presented.

27. Which of the following statements is true?

a) All variable costs are relevant costs.

b) Only those variable costs that differ between alternatives are relevant costs.

c) Fixed costs are never relevant costs.

d) All fixed costs are relevant costs as they impact overall unit costs.

28. Truckel Inc. currently manufactures a wicket as its main product. The costs per unit are as follows:

Direct materials and direct labour $11.00

Variable overhead 3.00

Fixed overhead 8.00

Total $22.00

The fixed overhead is an allocated common cost. How much is the relevant cost of the wicket?

a) $24.00

b) $14.00

c) $11.00

d) $19.00

29. It costs Lannon Fields $14 of variable costs and $6 of allocated fixed costs to produce an industrial trash can that sells for $30. A buyer in Mexico offers to purchase 3,000 units at $18 each. Lannon has excess capacity and can handle the additional production. What effect will acceptance of the offer have on net income?

a) decrease $4,000

b) increase $4,000

c) increase $54,000

d) increase $12,000

30. Seville Company manufactures a product with a unit variable cost of $42 and a unit sales price of $75. Fixed manufacturing costs were $80,000 when 10,000 units were produced and sold, equating to $8 per unit. The company has a one-time opportunity to sell an additional 1,500 units at $55 each in an international market, which would not affect its present sales. The company has sufficient capacity to produce the additional units. How much is the relevant income effect of accepting the special order?

a) $63,000

b) $7,500

c) $50,000

d) $19,500

31. M&H Ltd. has sufficient capacity to fill an order at a special price below its usual price. The special price exceeds its variable costs. What non-financial factors should also be considered in the decision?

a) Is there the potential for additional sales to the customer in the future?

b) How will existing customers respond if they find out about the special price?

c) If there is the potential for additional sales to the customer in the future, can a higher price be charged?

d) all of the above

32. Canosta Inc. determined it must expand its capacity to accept a special order. Which situation is likely?

a) Unit variable costs will increase.

b) Fixed costs will not be relevant.

c) Both variable and fixed costs will be relevant.

d) The company should accept the order.

33. A company is within plant capacity. It is contemplating whether or not to accept a special order. The order will not impact regular sales. If the company accepts a special order, what will occur?

a) Incremental costs will not be affected.

b) Net income will increase if the special sales price per unit exceeds the unit variable costs.

c) There are no incremental revenues.

d) Both fixed and variable costs will increase.

34. Argus Company anticipates that other sales will be affected by the acceptance of a special order. What should the company do?

a) Reject the order.

b) Consider the opportunity cost of lost sales in the incremental analysis.

c) Accept the order.

d) Accept the order if the plant is below capacity.

Use the following information for questions 35–36.

Eminen Music produces 60,000 blank CDs on which to record music. The CDs have the following costs:

Direct Materials $11,000

Direct Labour 15,000

Variable Overhead 3,000

Fixed Overhead 7,000

35. Eminem could avoid $4,000 in fixed overhead costs if it acquires the CDs externally. If cost minimization is the major consideration and the company would prefer to buy the 60,000 units externally, what is the maximum external price that Eminem would expect to pay for the units?

a) $32,000

b) $29,000

c) $36,000

d) $33,000

36. None of Eminem’s fixed overhead costs can be reduced, but another product could be made that would increase the operating income by $4,000 if the CDs were acquired externally. If cost minimization is the major consideration and the company would prefer to buy the CDs, what is the maximum external price that Eminem would be willing to accept to acquire the 60,000 units externally?

a) $36,000

b) $32,000

c) $33,000

d) $40,000

37. It costs Fortune Company $12 of variable and $5 of fixed costs to produce one-bathroom scale, which normally sells for $35. A foreign wholesaler offers to purchase 1,000 scales at $16 each. Fortune would incur special shipping costs of $2 per scale if the order was accepted. Fortune has sufficient unused capacity to produce the 1,000 scales. If the special order is accepted, what will be the effect on net income?

a) $2,000 increase

b) $2,000 decrease

c) $3,000 decrease

d) $15,000 increase

38. When a company does not have sufficient capacity to fill an order for less than the current selling price, what additional factor(s) must be taken into consideration?

a) The decision process is the same whether there is sufficient capacity or not.

b) How will the lack of capacity affect the quality of the product?

c) Can resources be transferred from the producing product to sell at the current price to the producing product at the special price?

d) opportunity costs

39. A factory is operating at less than 100% capacity. Potential new business will not use up the remainder of the plant capacity. Given the following list of costs, which one should be ignored in a decision to produce additional units of product?

a) variable selling expenses

b) fixed factory overhead

c) direct labour

d) contribution margin of additional units

40. When making a decision to accept a special order, management must consider

a) the impact that additional manufacturing time will have on unit costs of its current products.

b) whether the purchaser will accept additional high costs of a special order.

c) whether a lower price will convince the purchaser to become a regular customer.

d) whether capacity exists to meet the demand of the order.

41. Excess capacity decisions for management involve

a) decreasing sales prices to stimulate demand.

b) accepting special orders.

c) outsourcing some products to specialist manufacturers.

d) mixing production to reduce variable costs.

42. When management has excess capacity available to it in the short run, which of the following would be the best path to follow?

a) Consider ways to reduce its fixed costs.

b) Consider accepting special orders.

c) Consider outsourcing certain products.

d) Consider mixing its product offerings in a new way.

43. Which statement is true regarding an opportunity cost?

a) It is the cost of a special order option.

b) It reduces the possibility of accepting a particular course of action.

c) It is the potential benefit as a result of following an alternative course of action.

d) It is a variable cost.

44. What is the nature of an opportunity cost?

a) It is always variable.

b) It is a potential benefit.

c) It is included as part of cost of goods sold.

d) It is a sunk cost.

45. The cost to produce Part A was $5 per unit in 2021. During 2022, it has increased to $8 per unit. In 2022, Supplier Company has offered to supply Part A for $6 per unit. For the make-or-buy decision,

a) incremental revenues are $1 per unit.

b) incremental costs are $3 per unit.

c) net relevant costs are $3 per unit.

d) differential costs are $2 per unit.

46. Max Company uses 10,000 units of Part A in producing its products. A supplier offers to make Part A for $7. Max Company has relevant costs of $8 a unit to manufacture Part A. If there is excess capacity, the opportunity cost of buying Part A from the supplier is

a) $0.

b) $10,000.

c) $70,000.

d) $80,000.

47. Seran Company has contacted Truckel Inc. with an offer to sell it 5,000 wickets for $18.00 each. If Truckel makes the wickets, variable costs are $11 per unit. Fixed costs are $12 per unit; however, $5 per unit is avoidable. Should Truckel make or buy the wickets? What are the savings of this choice?

a) Buy; savings = $25,000

b) Buy; savings = $10,000

c) Make; savings = $20,000

d) Make; savings = $10,000

48. Galley Industries can produce 500 units of a necessary component part with the following costs:

Direct Materials $75,000

Direct Labour 20,000

Variable Overhead 60,000

Fixed Overhead 10,000

If Galley Industries purchases the component externally, $3,000 of the fixed costs can be avoided. Below what minimum external price for the 500 units would Galley choose to buy instead of make?

a) $95,000

b) $165,000

c) $155,000

d) $158,000

49. Peters, Inc. produces chocolate chip cookies. Costs for producing one batch appear below:

Direct materials $ 8.00

Direct labour 3.00

Variable overhead 1.00

Fixed overhead 4.00

An outside supplier has offered to produce the cookies for $14 per batch. If Peters decides to buy instead of make the cookies, what is the maximum price it would pay?

a) $16.00

b) $12.00

c) $13.60

d) $14.40

50. In which situation(s) should opportunity costs be considered?

a) decision making that involves alternative uses

b) forecasting sales

c) financial accounting

d) break-even analysis

51. Wishnell Toys can make 5,000 toy robots with the following costs:

Direct Materials $74,000

Direct Labour 30,000

Variable Overhead 23,000

Fixed Overhead 15,000

The company can purchase the 5,000 robots externally for $145,000. The avoidable fixed costs are $15,000 if the units are purchased externally. What is the cost savings if the company makes the robots?

a) $18,000

b) $15,000

c) $5,000

d) $3,000

52. If Hermantic, Inc. purchases the units externally for $80,000, by what amount will its total costs change? Fixed costs are not avoidable if the company purchases externally.

a) an increase of $80,000

b) an increase of $5,000

c) an increase of $17,000

d) a decrease of $22,000

53. If Hermantic, Inc. can purchase the component externally for $88,000 and only $8,000 of the fixed costs can be avoided, what is the correct "make-or-buy decision"?

a) Make and save $1,000.

b) Buy and save $1,000.

c) Make and save $5,000.

d) Buy and save $13,000.

54. Harrison Company determines that an opportunity cost of an alternate course of action is relevant to a make-or-buy decision. Which statement is true of the opportunity cost?

a) should be added to the "buy" costs

b) should be subtracted from the "make" costs

c) should be added to the "make" costs

d) should be ignored if it does not involve a cash outlay

55. Which statement is true concerning the decision rule on whether to make or buy?

a) The company should buy if the cost of buying is less than the cost of producing.

b) The company should buy if the incremental revenue exceeds the incremental costs.

c) The company should buy as long as total revenue exceeds present revenues.

d) The company should buy assuming no additional fixed costs are incurred.

56. Which one of the following does not affect a make-or-buy decision?

a) variable manufacturing costs

b) opportunity cost

c) incremental revenue

d) direct labour

57. What non-financial factors should be considered when making a decision about buying rather than making a component of a company’s product?

a) Is the quality of the purchased component acceptable?

b) Will the outside supplier increase prices significantly in the future?

c) Will the supplier deliver on time?

d) all of the above

58. Litto Fray’s produces corn chips. The cost of one batch is below:

Direct materials $18.00

Direct labour 13.00

Variable overhead 12.00

Fixed overhead 14.00

An outside supplier has offered to produce the corn chips for $26 per batch. How much will Litto Fray save if it accepts the offer?

a) $2.00 per batch

b) $17.00 per batch

c) $31.00 per batch

d) $6.00 per batch

59. Meow Cat Toys utilizes Lincoln Fabrics by purchasing the fabric to cover toy mice for its mouse toy division. As it pertains to Lincoln Fabrics, what decision situation does this create?

a) make-or-buy

b) sell or process further

c) relevant costing

d) budgeting

60. During 2021, it cost Westa Inc. $12 per unit to produce Part T5. During 2022, the cost has increased to $14 per unit. In 2022, Southside Company has offered to sell the Part T5 for $9 per unit to Westa. With regard to the make-or-buy decision, which statement is true?

a) Differential costs are $5 per unit.

b) Incremental costs are $3 per unit.

c) Net relevant costs are $3 per unit.

d) Incremental revenues are $2 per unit.

61. Which decision will involve no incremental revenues?

a) make-or-buy decision

b) Drop a product line.

c) Accept a special order.

d) additional processing decision

62. Chapman Company manufactures widgets. Embree Company has approached Chapman with a proposal to sell the company widgets at a price of $60,000 for 100,000 units. Chapman is currently making these components in its own factory. The following costs are associated with this part of the process when 100,000 units are produced:

Direct material $23,000

Direct labour 22,000

Manufacturing overhead 30,000

Total $75,000

The manufacturing overhead consists of $12,000 of costs that will be eliminated if the components are no longer produced by Chapman. From Chapman’s point of view, how much is the incremental cost or savings if the widgets are bought instead of made?

a) $15,000 incremental savings

b) $3,000 incremental cost

c) $3,000 incremental savings

d) $15,000 incremental cost

63. In a sell or process further decision,

a) management should process further as long as the incremental revenues from additional processing are greater than the incremental costs.

b) the basic decision rule is: process further if the total processing costs exceeds the incremental revenue.

c) it is better to process further rather than sell now if the sales price increases.

d) the allocation of joint product costs is important and relevant.

64. Walton, Inc. is unsure of whether to sell its product assembled or unassembled. The unit cost of the unassembled product is $16, while the cost of assembling each unit is estimated at $17. Unassembled units can be sold for $55, while assembled units could be sold for $71 per unit. What decision should Walton make?

a) Sell before assembly; the company will save $1 per unit.

b) Sell before assembly; the company will save $15 per unit.

c) Process further; the company will save $1 per unit.

d) Process further; the company will save $16 per unit.

65. Rosen, Inc. has 10,000 obsolete calculators, which are carried in inventory at a cost of $20,000. If the calculators are scrapped, they can be sold for $1.10 each (for parts). If they are repackaged, at a cost of $15,000, they could be sold to toy stores for $2.50 per unit. What alternative should be chosen, and why?

a) Scrap; operating income is $1,000 greater

b) Repackage; revenue is $5,000 greater than cost

c) Scrap; incremental loss is $9,000

d) Repackage; receive operating income of $10,000

66. A company has a process that results in 1,000 kilograms of Product X that can be sold for $10 per kilogram. An alternative would be to process Product X further at a cost of $2,000 and then sell it for $13 per kilogram. Should management sell Product X now or should Product X be processed further and then sold?

a) Process further; the company will be better off by $1,000.

b) Sell now; the company will be better off by $1,000.

c) Process further; the company will be better off by $3,000.

d) Sell now; the company will be better off by $10,000.

67. PH Toy Company is unsure of whether to sell its product assembled or unassembled. The unit cost of the unassembled product is $30 and PH Toy Company would sell it for $65. The cost to assemble the product is estimated at $21 per unit and PH Toy Company believes the market would support a price of $85 on the assembled unit. What decision should PH Toy make?

a) Sell before assembly; the company will be better off by $1 per unit.

b) Sell before assembly; the company will be better off by $20 per unit.

c) Process further; the company will be better off by $29 per unit.

d) Process further; the company will be better off by $14 per unit.

68. What is the nature of a sell or process further decision?

a) It is an incremental revenue decision.

b) It is an incremental cost decision.

c) It is both an incremental revenue and incremental cost decision.

d) It is neither incremental revenue nor incremental cost.

69. Coggin Company gathered the following data about the three products that it produces:

Estimated Sales

Present Value before Additional Estimated Sales

Product Processing Processing Costs if Processed Further

A $9,000 $6,000 $16,000

B 15,000 5,000 18,000

C 11,000 8,000 16,000

Which of the products should be processed further?

a) Product A

b) Product B

c) Product C

d) all three products

70. Serene Dairy has four product lines: sour cream, ice cream, yogurt, and butter. The total costs of producing the milk base for the products is $46,500 which has been allocated based on litres of milk base used by each product. Results of July follow:

Sour Cream Ice Cream Yogurt Butter Total

Units sold 1,700 750 500 5,000 7,950

Revenue $7,000 $15,000 $12,000 $25,000 $59,000

Variable departmental costs 4,000 10,000 7,000 12,000 33,000

Fixed costs 4,500 1,000 2,000 6,000 13,500

Net income (loss) ($1,500) $4,000 $3,000 $7,000 $12,500

How much are total joint costs of the products?

a) $33,000

b) $13,500

c) $46,500

d) $12,500

71. EKP purchased a raw material in bulk for $10,000. It then spent an additional $500 to package the product into smaller quantities that it can sell for $12,000. Recently, a situation has arisen in which EKP can add an additional ingredient to the individual packages and sell them for $14,000. The cost of adding the additional ingredient is $1,700. Which amounts are relevant to the decision?

a) $10,000 + $500, $12,000 and $14,000

b) $10,000 + $500, $1,700 and $14,000

c) $12,000, $1,700 and $14,000

d) $10,000, $500, $12,000, $14,000 and $1,700

72. Namov Company has old inventory on hand that cost $12,000. Its scrap value is $16,000. The inventory could be sold for $38,000 if manufactured further at an additional cost of $12,000. What should Namov do?

a) Sell the inventory for $16,000 scrap value.

b) Dispose of the inventory to avoid any further decline in value.

c) Hold the inventory at its $12,000 cost.

d) Manufacture further and sell it for $38,000.

73. Market Makeup produces face cream. Each bottle of face cream costs $10 to produce and can be sold for $13. The bottles can be sold as is, or processed further into sunscreen at a cost of $14 each. Market Makeup could sell the sunscreen bottles for $23 each. What should Market Makeup do?

a) Face cream must be further processed because its operating income is $9 each.

b) Face cream must not be further processed because incremental revenue is less than incremental processing costs.

c) Face cream must not be further processed because it decreases operating income by $1 each.

d) Face cream must be further processed because it increases operating income by $3 each.

74. The main purpose of allocating joint costs to products is to

a) assist management in setting prices for its products.

b) assist in the annual budgetary processes.

c) assist in determining the cost of the products involved.

d) assist in determining which products should be added or dropped.

75. Costs that are common to two or more products are considered to be

a) joint costs.

b) split-off costs.

c) allocated costs.

d) shared fixed costs.

76. Costs that are common to one or more products are called

a) split-off costs.

b) sunk costs.

c) joint costs.

d) incremental costs.

77. In a decision concerning replacing equipment

a) with new equipment, the book value of the old equipment can be considered an opportunity cost.

b) or keeping it, the salvage value of the old equipment is a sunk cost in incremental analysis.

c) with new equipment, old equipment which is not fully depreciated should always be replaced.

d) any trade-in allowance or cash disposal value of existing assets is relevant to the decision to retain or replace equipment.

78. Which of the following is relevant information in a decision whether old equipment presently being used should be replaced by new equipment?

a) the cost of the old equipment

b) the salvage value of the old equipment

c) the book value of the old equipment

d) the accumulated depreciation of the old equipment

79. What is the salvage value of old equipment considered to be?

a) a relevant cost

b) a non-incremental cost

c) an opportunity cost

d) a cost that is not differential

80. A company is deciding whether or not to replace some old equipment with new equipment. Which of the following is not considered in the incremental analysis?

a) annual operating cost of the new equipment

b) annual operating cost of the old equipment

c) net cost of the new equipment

d) book value of the old equipment

81. A company is considering replacing old equipment with new equipment. Which of the following is a relevant cost for incremental analysis?

a) total accumulated depreciation of the old equipment

b) cost of the old equipment

c) annual operating cost of the new equipment

d) book value of the old equipment

82. What role does a trade-in allowance on old equipment play in a decision to retain or replace equipment?

a) It is relevant since it increases the cost of the new equipment.

b) It is not relevant since it reduces the cost of the old equipment.

c) It is not relevant to the decision since it does not impact the cost of the new equipment.

d) It is relevant since it reduces the cost of the new equipment.

83. A company decided to replace an old machine with a new machine. Which of the following is considered a relevant cost?

a) the book value of the old equipment

b) depreciation expense on the old equipment

c) the loss on the disposal of the old equipment

d) the current disposal price of the old equipment

84. The most important thing to consider when deciding to replace or keep equipment is

a) salvage value of the current equipment.

b) the estimated number of years remaining on the books.

c) the expected variable costs of the new equipment.

d) whether book value is higher than replacement value.

85. A company should

a) eliminate any segment in which the contribution margin is less than the fixed costs that are unavoidable.

b) eliminate an unprofitable product line as it will always increase the total operating income of a company.

c) eliminate an unprofitable product as fixed costs allocated to the eliminated segment will likely be eliminated.

d) identify the relevant costs in deciding whether to eliminate an unprofitable segment.

86. Corn Crunchers has three product lines. Its only unprofitable line is Corn Nuts. The results for 2022 are as follows:

Sales $350,000

Variable costs 230,000

Fixed costs 180,000

Net loss $(60,000)

If this product line is eliminated, 30% of the fixed costs can be eliminated. How much are the relevant costs in the decision to eliminate this product line?

a) $54,000

b) $410,000

c) $335,000

d) $284,000

87. North Division has the following information:

Sales $600,000

Variable costs 320,000

Fixed costs 410,000

If this division is eliminated, the fixed costs will be allocated to the company’s other divisions. What is the incremental effect on net income if the division is dropped?

a) $130,000 increase

b) $410,000 decrease

c) $280,000 decrease

d) $190,000 increase

d) $14.40

88. Diversified Machines has four product lines, one of which reflects the following results:

Sales $220,000

Variable costs 120,000

Contribution margin 100,000

Fixed costs 120,000

Net loss $(20,000)

If this product line is eliminated, 40% of the fixed costs can be eliminated and the other 60% will be allocated to other product lines. If management decides to eliminate this product line, what will happen to the company's net income?

a) It will increase by $20,000.

b) It will decrease by $52,000.

c) It will decrease by $32,000.

d) It will increase by $48,000.

89. Halliburton Division has the following data:

Sales $500,000

Variable costs 240,000

Fixed costs 280,000

The fixed costs are not avoidable and must be allocated to profitable divisions if the segment is eliminated. What will be the incremental effect on net income if Halliburton Division is eliminated?

a) $60,000 increase

b) $260,000 decrease

c) $280,000 decrease

d) Cannot be determined from the data provided.

90. SmartCard is considering eliminating one of its product lines. The fixed costs currently allocated to the product line will be allocated to other product lines upon its discontinuance. What financial effects occur if the product line is discontinued?

a) Net income will decrease by the amount of the contribution margin of the product line being discontinued.

b) The company's total fixed costs will increase.

c) Total fixed costs will decrease by the amount of the product line's fixed costs.

d) Net income will decrease by the amount of the product line's fixed costs.

91. How should that portion of fixed costs that are unavoidable be handled when making a decision on whether to eliminate an unprofitable segment?

a) They should be subtracted from the contribution margin and if that results in a net loss, the segment should be eliminated.

b) They should not be considered as they are not relevant.

c) They should be allocated to other segments. If that causes a loss in another segment, that segment should be eliminated as well.

d) Fixed costs are never relevant.

92. Which of the following statements is true?

a) Common costs should be considered when deciding to drop a product line.

b) If a segment of a company has been losing money for several years, that segment should be dropped.

c) If an unprofitable segment is dropped, the company’s net income will increase.

d) If an unprofitable segment is dropped, fixed costs will decrease.

93. When a company has limited

a) resources to manufacture products, it should manufacture those products, which have the highest contribution margin per unit.

b) resources it should compute the contribution margin per unit of limited resources to decide which product should receive additional capacity of the limited resources.

c) machine hours available for production, it is generally more profitable to produce and sell the product with the highest contribution margin per machine hour.

d) direct labour hours available for production, it should manufacture those products with the higher contribution margin per machine hour.

94. Ace Company sells office chairs with a selling price of $45 and a contribution margin per unit of $20. It takes 5 machine hours to produce one chair. How much is the contribution margin per unit of limited resource?

a) $4

b) $5

c) $9

d) $20

95. Shorebuck’s Coffee can sell all the units it can produce of either latte or cappuccino but not both. Latte has a unit contribution margin of $45 and takes three machine hours to make and cappuccino has a unit contribution margin of $32 and takes two machine hours to make. There are 1,300 machine hours available to manufacture a product. What should Shorebuck’s do?

a) Make latte which creates $13 more operating income per unit than cappuccino does.

b) Make cappuccino which creates $1 more operating income per constraint than latte does.

c) Make cappuccino because more units can be made and sold than latte.

d) The same total operating income exists regardless of which product is made.

96. What is the key factor in performing incremental analysis if a company has limited resources?

a) contribution margin per unit of limited resource

b) the amount of fixed costs per unit

c) total contribution margin

d) the cost of limited resources

97. Hari’s Fish House can produce and sell only one of the following two products:

Fryer Contribution

Hours Required Margin Per Unit

Fried catfish 3 $15

Fried grouper 4 $16

The company has fryer capacity of 12,000 hours. How much will the contribution margin be if it produces only the most profitable product?

a) $48,000

b) $36,000

c) $60,000

d) $12,000

98. Diaz Company’s contribution margin is $4 per unit for Product A and $5 for Product B. Product A requires 2 machine hours and Product B requires 4 machine hours. How much is the contribution margin per unit of limited resource for each product?

A B

a) $4.00 $5.00

b) $2.00 $1.25

c) $1.25 $2.00

d) $2.50 $1.00

BRIEF EXERCISES

Brief Exercise 99

Jamie has been accepted to a university in a city far from her home. She will need to rent an apartment and has two choices. The first choice costs $1,000 per month, and is within walking distance of the university. The second apartment costs $925 per month, but Jamie will have to buy a bus pass to get to the university. The pass costs $100 per month. Jamie has been hired to work part time at a job that is a bus ride away from both apartments.

Identify which costs are relevant in the incremental analysis. What other factors should be considered?

Solution 99

Since Jamie will have to buy a bus pass in both cases to get to her job, the $100 cost of the pass is not relevant. Accordingly, the only relevant costs given are the rent. The second apartment is $75 cheaper than the first, and therefore strictly from a cost perspective is the better choice. Other factors that need to be considered are the amount of time spent commuting, and how Jamie could use that time, and Jamie’s preference of which apartment she likes better.

Brief Exercise 100

McIntosh Enterprises produces giant stuffed bears. Each bear consists of $12 of variable costs and $9 of fixed costs and sells for $45. A wholesaler offers to buy 8,000 units at $14 each, and McIntosh has the production capacity. McIntosh will incur extra shipping costs of $1.25 per bear. Determine the incremental income or loss that McIntosh Enterprises would realize by accepting the special order.

Solution Brief Exercise 100

Incremental revenue (8,000 x $14) $112,000

Incremental variable costs ($12 x 8,000) (96,000)

Incremental shipping costs ($1.25 x 8,000) (10,000)

Incremental operating income if special order accepted $6,000

Brief Exercise 101

Winslow Industries makes large waste storage bins and sells them for $150 each. The manufacturing cost of each bin is as follows:

Direct material $50

Direct labour $40

Manufacturing overhead $20

The manufacturing overhead is 80% variable and 20% fixed. The company receives an order for 1,000 bins, which will cost an additional $10 in shipping costs per bin. The company has sufficient excess capacity to produce the order.

Calculate the minimum price that Winslow should charge for each bin.

Solution 101

Direct material $ 50

Direct labour 40

Manufacturing overhead ($20 x.8) 16

Shipping costs 10

Minimum selling price $116

Brief Exercise 102

Temple, Inc. produces several models of clocks. An outside supplier has offered to produce the commercial clocks for Temple for $350 each. Temple needs 500 clocks annually. Temple has provided the following unit costs for its commercial clocks:

Direct materials $ 70

Direct labour 80

Variable overhead 75

Fixed overhead (30% avoidable) 120

Prepare an incremental analysis which shows the effect of the make-or-buy decision.

Solution 102

Incremental Analysis Incremental Effect

Cost to buy (500 x $350) ($175,000)

Cost savings:

Savings of DM $70 x 500 = $35,000

Savings of DL $80 x 500 = 40,000

Savings of VOH $75 x 500 = 37,500

Savings of FOH 30% x $120 x 500 = 18,000

Total cost savings 130,500

Net cost savings if commercial clocks are bought $ 44,500

Brief Exercise 103

Calc Inc. owns a machine that produces baskets for the gift packages the company sells. The company uses 1,000 baskets in production each month. The costs of making one basket is $7 for direct materials, $5 for variable manufacturing overhead, $4 for direct labour and $8 for fixed manufacturing overhead. The unit cost is based on the monthly production of 1,000 baskets. The company determined that 25% of the fixed manufacturing overhead is avoidable. An outside supplier has offered to sell Calc the baskets for $15 each and can supply all the units it needs. Prepare an incremental analysis to determine if Calc should buy the component from the supplier.

Solution 103

Incremental cost to buy (1,000 x $15) ($15,000)

Incremental cost savings:

DM ($7 x 1,000) 7,000

VOH ($5 x 1,000) 5,000

DL ($4 x 1,000) 4,000

FOH ($8 x 25% x 1,000) 2,000

Total savings to buy ($3,000)

OR

Make Buy

Incremental cost to buy (1,000 x $15) $15,000

Incremental costs to make: DM ($7 x 1,000) $7,000

VOH ($5 x 1,000) 5,000

DL ($4 x 1,000) 4,000

FOH 8,000 6,000

Incremental cost to buy $24,000 $21,000

Brief Exercise 104

Signa Corporation currently manufactures 17,000 staplers annually for its main product. The costs per stapler are as follows:

Direct materials $ 2.50

Direct labour 7.50

Variable overhead 3.00

Fixed overhead 8.00

Total $21.00

Darsel Company has contacted Signa with an offer to sell it 17,000 staplers for $19.00 each. $6 of the fixed overhead per unit is unavoidable. Prepare an incremental analysis for the make-or-buy decision.

Solution 104

Incremental cost to buy ($19.00 x 17,000 staplers) ($323,000)

Incremental savings on direct materials ($2.50 x 17,000) 42,500

Incremental savings on direct labour ($7.50 x 17,000) 127,500

Incremental savings on variable MOH ($3.00 x 17,000) 51,000

Incremental savings on fixed MOH ([$8.00 – $6.00] x 17,000) 34,000

Incremental net cost to buy ($68,000)

Brief Exercise 105

Hernandez, Inc. manufactures five models of picture frames, for a total of 12,000 frames per year. The unit cost to produce a metal frame follows:

Direct Materials $ 4

Direct Labour 5

Variable Overhead 1

Fixed Overhead (60% unavoidable) 6

Total $16

A local company has offered to supply Hernandez the 12,000 metal frames it needs for $12 each. Create an incremental analysis for the make-or-buy decision.

Solution 105

Incremental cost to buy ($144,000)

Incremental savings:

Direct materials savings 48,000

Direct labour savings 60,000

Variable overhead savings 12,000

Fixed overhead savings - avoidable portion 28,800

Incremental savings if 'buy' decision is made $4,800

Brief Exercise 106

Chuckie’s Chunks produces fudge candy. It costs $.0.20 to make each box in which the fudge is packaged. Of this cost, $0.12 is variable and $0.08 is fixed. A supplier offers to make the boxes for the fudge for $0.15 each. If the offer is accepted, Chuckie’s will save all variable costs but no fixed costs. Chuckie’s uses 2,000 boxes per year. Prepare an incremental analysis showing the total effect on costs if the boxes are bought instead of manufactured.

Solution 106

Incremental cost to buy (2,000 x $0.15) ($300)

Incremental variable costs (2,000 x $0.12) 240

Incremental cost of buying ($ 60)

Brief Exercise 107

Wood Chuck Furniture currently manufactures rocking chairs as its main product. Each chair uses one seat cushion and one back cushion with the following costs per set of cushions (one seat and one back):

Direct materials $ 1.00

Direct labour 10.00

Variable overhead 5.00

Fixed overhead 8.00

Total $24.00

Sherpert Company has contacted Wood Chuck with an offer to sell it 5,000 sets of cushions for $18.00 each. If Wood Chuck makes the cushions, $5 of the fixed overhead per unit will be allocated to other products. Should Wood Chuck make or buy the cushions?

Solution 107

Cost to make − costs to buy = incremental cost

($24 − $3) − $18 = $3 = incremental cost per set

Incremental cost to make = $3 x 5,000 units = $15,000

Wood Chuck should buy to save $3 per set.

Brief Exercise 108

The Compressed Air Company makes scuba tanks. The tanks have a regulator that requires the company to make a special valve. The cost to make this valve is as follows:

Direct materials $ 7.50

Direct labour 3.25

Variable manufacturing overhead 2.10

Fixed manufacturing overhead 1.10

Unit product cost $13.95

The company makes 10,000 tanks every year. An outside supplier has offered to sell the company the same valve at a cost of $12.50 per unit. By purchasing the valve the company will eliminate half of its fixed manufacturing overhead.

Calculate the relevant costs the company should consider before making the decision to purchase the valve from the outside supplier.

Solution 108

$13.95 - ($1.10 x ½) = $13.40

(Only half of the fixed manufacturing overhead is avoided. Therefore, all other costs are relevant.)

Brief Exercise 109

Healthy Eats produces three products from a single raw material. The total cost is $160,000 and the number of units for each product are as follows:

Product A: 10,000 units

Product B: 10,000 units

Product C: 15,000 units

Product A can be sold at the split-off point for $4 per unit, or it can be processed further at a cost of $25,000 and then sold for $10 per unit. Should product A be sold at the split-off point or processed further? Why?

Solution 109

It should be processed further, since this will increase operating income by $35,000 each period.

Incremental Revenue = ($10 – $4)*10,000 = $60,000

Incremental cost = $25,000

Net operating income increase = $60,000 – $25,000 = $35,000

Brief Exercise 110

Fresh Farms, Inc. grows basil at a total cost of $66,000. The production generates 60,000 bunches of basil that can be sold for $2 per bunch to a spice company, or the basil can be further processed in-house into pesto and then sold for $3.25 per jar. It costs $55,000 more to turn the basil into pesto. If Fresh Farms processes the basil into pesto, how much is the incremental operating income or loss? What should Fresh Farms do?

Solution 110

Incremental revenues: ($3.25 – $2.00) x 60,000 bunches of basil = $75,000

Incremental costs: given as $55,000

Incremental operating income: $75,000 – $55,000 = $20,000 operating income

Fresh Farms should process further.

Brief Exercise 111

Elmdale Company has a machine that affixes labels to bottles. The machine has a book value of $80,000 and a remaining useful life of 3 years and no salvage value. The old machine cannot be sold if the company purchases the new machine, given there is no market for it. A new, more efficient machine is available at a cost of $300,000 that will have a 5-year useful life with no salvage value. The new machine will lower annual variable production costs from $520,000 to $410,000.

Instructions

Prepare an analysis showing whether the old machine should be retained or replaced.

Solution 111

Retain Equipment Replace Equipment Net Income Change

Variable manufacturing costs $1,560,000 $1,230,000 $330,000*

New machine cost (300,000)

Net savings over 3 years $ 30,000

*For 3 years of remaining life

Brief Exercise 112

Myrna’s Mowing Ltd. cuts lawns. It has a riding lawnmower with a book value of $5,000, and a remaining useful life of 5 years. A new, more efficient lawnmower is available with a cost of $15,000. The useful life of the new machine is also expected to be 5 years. Myrna estimates that the new machine will allow her to cut more lawns, and therefore increase revenue from $20,000 per year to $22,000, and reduce variable costs from $12,000 per year to $10,500. Prepare an analysis showing whether Myrna should retain the old mower, or buy new.

Solution 112

*For 5 years

Brief Exercise 113

Data for Product A shows total sales of $400,000 per year, total variable costs of $280,000 per year, and total fixed costs charged to the product of $180,000 per year. The company estimates that $80,000 of these fixed costs will continue even if the product is dropped. If product A is dropped, how much of a change will the company have in overall operating income?

Solution 113

Lost CM = $400,000 – $280,000 = $120,000.

Avoidable costs = $180,000 – $80,000 = $100,000

Decreased Operating Income = $120,000 – $100,000 = $20,000

Brief Exercise 114

Parrino has three product lines in its retail stores: books, DVDs, and music. The allocated fixed costs are based on revenue and are unavoidable. Results of the fourth quarter are presented below:

Books Music DVDs Total

Units sold 750 1,000 1,200 2,950

Revenue $22,500 $15,000 $9,600 $47,100

Variable departmental costs 12,000 8,000 5,000 25,000

Direct fixed costs 4,000 3,000 4,500 11,500

Allocated fixed costs 4,777 3,185 2,038 10,000

Net income (loss) $ 1,723 $ 815 ($1,938) $ 600

Demand of individual products is not affected by changes in other product lines. Prepare an incremental analysis of the effect of dropping the DVDs product line.

Solution 114

Incremental revenue ($9,600)

Incremental savings on variable costs +5,000

Incremental savings on direct fixed costs +4,500

Incremental cost/decrease in net income to drop video line ($ 100)

Brief Exercise 115

Crisp has four product lines: sour cream, ice cream, yogurt, and butter. The allocated fixed costs are based on units sold and are unavoidable. Demand of individual products is not affected by changes in other product lines. 40% of the fixed costs are direct, and the other 60% are allocated. Results of June follow:

Sour Cream Ice Cream Yogurt Butter Total

Units sold 2941 1176 1765 4118 10,000

Revenue $10,000 $20,000 $10,000 $20,000 $60,000

Variable departmental costs 6,000 13,000 4,200 4,800 28,000

Fixed costs 5,000 2,000 3,000 7,000 17,000

Net income (loss) ($1,000) $5,000 $2,800 $8,200 $15,000

Prepare an incremental analysis of the effect of dropping the sour cream product line.

Solution 115

Incremental revenue ($10,000)

Incremental variable cost savings +6,000

Incremental fixed cost savings ($5,000 x.40) +2,000

Incremental decrease in net income if dropped ($ 2,000)

Brief Exercise 116

Harmark has three product lines in its retail stores: kites, wind socks, and flags. Results of the fourth quarter are presented below:

The allocated fixed costs are unavoidable. Demand of individual products is not affected by changes in other product lines. What will happen to net income if Harmark discontinues the ‘Kites’ product line?

Solution 116

Incremental revenue ($22,000)

Incremental costs:

Variable costs savings 15,000

Direct fixed costs savings 1,000

Drop in net income if discontinued ($ 6,000)

Brief Exercise 117

Dolls R Us sells three products in its retail stores: baby dolls, teenage dolls, and plush dolls. Results of the 4^th quarter are below:

Demand of individual products is not affected by changes in other product lines. Prepare an incremental analysis to determine if baby dolls should be discontinued.

Solution 117

Incremental revenue ($31,000)

Incremental costs:

Variable costs savings 22,000

Direct fixed costs savings 5,000

Drop in net income if discontinued ($ 4,000)

Brief Exercise 118

Ferguson Corp. produces two products and selected data are shown below:

Product A Product B

Sales price per unit $120 $100

Variable cost per unit 72 70

Contribution margin per unit $ 48 $ 30

Machine hours per unit 2.00 min 1.00 min

While there is demand for both products, machine hours are limited. Which product should Ferguson Corp. focus more of its limited machine hours on to generate the most operating income?

Solution 118

With two minutes of machine hours Ferguson could produce 1 unit of Product A with a contribution margin of $48, or 2 units of Product B, each with a contribution margin of $30 or a total contribution for both units of $60 for Product B. As Product B has the highest contribution margin per two minutes of machine hours, Product B would generate the most operating income for Ferguson Corp.

Brief Exercise 119

Adore Company provided the following information concerning two products:

Contribution margin per unit—Product A $36

Contribution margin per unit—Product B $32

Direct labour hours required for one unit—Product A 1.5 hours

Direct labour hours required for one unit—Product B 2.0 hours

Calculate the contribution margin per unit of limited resource for each product. Which product should Adore Company ‘push’ to sell to its customers?

Solution 119

Product A: $36 / 1.5 hours = $24.00

Product B: $32 / 2.0 hours = $16

Sales personnel should encourage sales of Product A.

Brief Exercise 120

Graham Corp. produces three products and selected data for each are shown below:

Product A Product B Product C

Sales price per unit $120 $100 $105

Variable cost per unit 72 70 90

Contribution margin per unit $ 48 $ 30 $ 15

Labour hours per unit 1.00 hr. 0.50 hr. 0.20 hr.

While there is demand for all products, labour hours are limited. Which product should Graham Corp. focus more of its limited labour hours on to generate the most operating income?

Solution 120

Product A: With one hour of labour Graham Corp. could produce 1 unit of Product A with a contribution margin of $48.

Product B: With one hour of labour Graham Corp. could produce 2 units of Product B as one unit requires 30 min. of labour (.50 min. x 1 hour = 30 min.). At a contribution margin of $30 per unit Graham Corp. would have a total contribution for both units of $60 for Product B.

Product C: With one hour of labour Graham Corp. could product 5 units of Product C as one unit requires 12 min. of labour (.20 x 1 hour = 12 min.). At a contribution margin of $15 per unit Graham Corp. would have a total contribution for 5 units of $75.

Conclusion: As Product C has the highest contribution margin per one hour of labour, Product C would generate the most operating income for Graham Corp.

Brief Exercise 121

Sam Company makes two products, footballs and baseballs. Additional information follows:

Assume that Sam is able to order an additional 2,000 metres of leather and wishes to maximize its income. Of the additional units it produces, at least 300 of each product are necessary for sales. How many units of each must be produced?

Solution 121

Produce more baseballs since CM per constraint is more.

Brief Exercise 122

Gladiator Company provided the following information concerning two products:

Contribution margin per unit—Product 12 $22

Contribution margin per unit—Product 43 $15

Machine hours required for one unit—Product 12 2.5 hours

Machine hours required for one unit—Product 43 1.5 hours

Calculate the contribution margin per unit of limited resource for each product. Which product should Gladiator tell its sales personnel to ‘push’ to customers?

Solution 122

Product 12: $22 / 2.5 hours = $8.80

Product 43: $15 / 1.5 hours = $10

Sales personnel should encourage sales of Product 43.

EXERCISES

Exercise 123

Explain how, and why, depreciation should be handled in incremental analysis. Hint – use the term, “sunk cost” in your answer.

Solution 123 (6–8 min.)

Depreciation is a systematic method of matching the cost of a long-lived asset with the revenue it generates. Though the depreciation expense will be recorded in future periods, the actual cost of the asset has occurred in the past. Accordingly, it is a sunk cost and is not relevant. Another way to look at it, if the equipment is retained, the book value of the equipment will be reduced to zero through depreciation expense that is incurred over the remaining life of the asset. If the equipment is eliminated, the book value will be written off immediately. Accordingly, both options will expense the book value of the asset. If the cost is the same between two options, the cost is not relevant.

Exercise 124

A group of your friends have invited you to join them on a mini road trip. They are planning to rent a van and drive to Toronto where they will stay at a hotel for the weekend. Another friend who moved to Montreal recently has invited you to visit at his home for the weekend.

What financial and non-financial factors should you consider in your decision to choose between the two options.

Solution 124 (6–8 min.)

Financial:

Transportation costs to Toronto vs. Montreal

Cost of the hotel in Toronto

Cost of meals in Toronto vs. Montreal

Cost of entertainment in Toronto vs. Montreal

Cost of a “thank-you gift” for your host in Montreal

Non-financial:

Which option are you apt to enjoy more?

Would you offend someone if you do not accept their offer?

Exercise 125

Paulsen Company produced and sold 7,000 units of product and is operating at 70% of plant capacity. Unit information about its product is as follows:

Sales Price $40

Variable manufacturing cost $25

Fixed manufacturing cost ($35,000 ÷ 7,000) 5 30

Operating income per unit $10

The company received a proposal from a foreign company to buy 500 units of Paulsen Company's product for $28 per unit. This is a one-time only order and acceptance of this proposal will not affect the company's regular sales. The president of Paulsen Company is reluctant to accept the proposal because he is concerned that the company will lose money on the special order. All fixed costs are allocated to individual products.

Instructions

Prepare a schedule reflecting an incremental analysis of this proposal. Indicate the effect the acceptance of this order might have on the company's income.

Solution 125 (7–9 min.)

PAULSEN COMPANY

Incremental Analysis

Proposal to buy 500 units at $28

Net Income

Reject Order Accept Order Increase (Decrease)

Revenues (500 × $28) $0 $ 14,000 $14,000

Variable costs (500 × $25) 0 (12,500) (12,500)

Net Income $1,500

Paulsen Company would increase its net income by $1,500 in accepting the special order.

Exercise 126

Smooth Brew manufactures cappuccino makers. For the first eight months of 2022, the company reported the following operating results while operating at 80% of plant capacity:

Sales (120,000 units) $6,000,000

Cost of goods sold 3,600,000

Gross profit 2,400,000

Operating expenses 1,800,000

Net income $ 600,000

An analysis of costs and expenses reveals that variable cost of goods sold is $25 per unit and variable operating expenses are $10 per unit.

In September, Smooth Brew received a special order for 5,000 machines at $40 each from a major coffee shop franchise. Acceptance of the order would result in $2,000 of shipping costs but no increase in fixed costs.

Instructions

a) Prepare an incremental analysis for the special order.

b) Should Smooth Brew accept the special order? Justify your answer.

Solution 126 (10–12 min.)

a) Net Income

Reject Order Accept Order Increase (Decrease)

Revenues $0 $200,000 $200,000

Cost of Goods Sold 0 *125,000 (125,000)

Operating Expense 0 **52,000 (52,000)

Net Income $0 $ 23,000 $ 23,000

*Variable cost of goods sold = 5,000 × $25 = $125,000

**Variable operating expenses = 5,000 × $10 = $50,000 + $2,000 = $52,000

b) The incremental analysis shows that Smooth Brew should accept the special order because incremental revenues exceed incremental costs. This recommendation assumes that acceptance of the special order will not affect relations with existing customers.

Exercise 127

Vincent Company supplies schools with floor mattresses to use in physical education classes. Vincent has received a special order from a large school district to buy 500 mats at $40 each. Accepting the special order will not affect fixed costs but will result in $800 of shipping costs.

For the first 6 months of 2022, the company reported the following operating results while operating at 80% capacity:

Sales (25,000 units) $1,250,000

Cost of goods sold 980,000

Gross profit 270,000

Operating expenses 170,000

Net income $ 100,000

Cost of goods sold was 80% variable and 20% fixed; operating expenses were 70% variable and 30% fixed.

Instructions

a) Prepare an incremental analysis for the special order.

b) Should Vincent Company accept the special order? Justify your answer.

Solution 127 (10–12 min.)

a) Net Income

Reject Order Accept Order Increase (Decrease)

Revenues $0 $20,000 $20,000

Cost of Goods Sold 0 15,680 (15,680)

Operating Expense 0 3,180 (3,180)

Net Income $0 $ 1,140 $ 1,140

Variable cost of goods sold = $980,000 × 80% = $784,000

Variable cost of goods sold per unit = $784,000 ÷ 25,000 = $31.36

Variable cost of goods sold for the special order = 500 × $31.36 = $15,680

Variable operating expenses = $170,000 × 70% = $119,000

Variable operating expenses per unit = $119,000 ÷ 25,000 = $4.76

Variable operating expenses for the special order = 500 × $4.76 = $2,380 + $800 = $3,180

b) The incremental analysis shows Vincent Company should accept the special order because incremental revenues exceed incremental costs.

Exercise 128

What are some qualitative considerations with accepting a special order with a new supplier?

Solution 128 (6–8 min.)

1) Managers need to consider whether it would be likely to generate repeat orders from this special order customer.

2. Is it possible to increase the selling price on repeat orders, or subsequent special orders from different customers?

3. Is it possible to reduce variable costs by increasing volume by taking on special orders?

4. Would the repeat business from this special order customer be reliable, and worth doing this special order right now?

5. What would be the reaction of regular customers if they found out the cost structure for this special order?

Exercise 129

Turner, Inc. budgeted 10,000 widgets for production during 2022. Turner has capacity to produce 15,000 units. Fixed factory overhead is allocated using ABC. The following estimated costs were provided:

Direct material ($8/unit) $ 80,000

Direct labour ($20/hr. x 3 hrs./unit) 600,000

Variable manufacturing overhead ($5/unit) 50,000

Fixed factory overhead costs ($2/unit) 20,000

Total $750,000

Cost per unit = $75.00

Instructions

Answer each of the following independent questions:

a) Turner received an order for 3,000 units from a new customer in a country in which Turner has never done business. This customer has offered to pay $73.50 per widget. Should Turner accept the order?

b) Turner received an offer from another company to manufacture the same quality widgets for $72.50. Should Turner let someone else manufacture all 10,000 widgets and focus only on distribution?

Solution 129 (10–12 min.)

a) Yes, it can make $1,500.

Incremental revenue per widget $73.50

Incremental cost per widget:

$8 + ($20 x 3) + $5 = 73.00

Incremental operating income per unit $ 0.50

Total incremental operating income = $0.50 x 3,000 = $1,500

b) Yes, Turner will save $5,000 if they are bought instead of made.

Cost to buy per widget $72.50

Cost to make per widget:

$8 + ($20 x 3) + $5 = 73.00

Incremental savings per widget if purchased $ 0.50

Total incremental savings if purchased = $0.50 x 10,000 = $5,000

Exercise 130

Johnson Motors manufactured 500 gears that are used in its motors and incurred the following costs:

Direct materials $ 50,000

Direct labour 19,000

Variable manufacturing overhead 30,000

Fixed manufacturing overhead 20,000

$119,000

A supplier has offered to sell the gears to Johnson for $200 each. The fixed manufacturing overhead consists mainly of depreciation on the equipment used to manufacture the part and would not be reduced if the gears were purchased from the outside firm. If the gears are purchased from the supplier, Johnson has the opportunity to use the factory equipment to produce another product, which is estimated to have a contribution margin of $3,000.

Instructions

Prepare an incremental analysis report for Johnson Motors that can be used to assist in the make-or-buy decision.

Solution 130 (10–12 min.)

Make Buy Increase (Decrease)

Direct materials $ 50,000 $0 $ 50,000

Direct labour 19,000 0 19,000

Variable manufacturing overhead 30,000 0 30,000

Fixed manufacturing overhead 20,000 20,000 0

Purchase price (500 × $200) 0 100,000 (100,000)

Total annual cost 119,000 120,000 (1,000)

Opportunity cost 3,000 0 3,000

Total cost $122,000 $120,000 $ 2,000

Income is expected to increase by $2,000 if the component part is purchased from the outside supplier and if the company also manufactured its new product.

Exercise 131

Escher Skateboards has been manufacturing its own wheels for its skateboards. The company is currently operating at 100% capacity, and variable manufacturing overhead is charged to production at the rate of 30% of direct labour cost. The direct materials and direct labour cost per unit to make the wheels are $1.50 and $1.80, respectively. Normal production is 200,000 wheels per year.

A supplier offers to make the wheels at a price of $4 each. If the skateboard company accepts this offer, all variable manufacturing costs will be eliminated, but the $42,000 of fixed manufacturing overhead currently being charged to the skateboard wheels will have to be absorbed by other products.

Instructions

a) Prepare the incremental analysis for the decision to make or buy the wheels.

b) Should Escher Skateboard buy the wheels from the outside supplier? Justify your answer.

Solution 131 (10–12 min.)

a) Net Income

Make Buy Increase (Decrease)

Direct Materials (200,000 × $1.50) $300,000 $0 $300,000

Direct Labour (200,000 × $1.80) 360,000 0 360,000

Variable Manufacturing Costs

($360,000 × 30%) 108,000 0 108,000

Purchase Price (200,000 × $4) 0 800,000 (800,000)

Total annual cost $768,000 $800,000 ($32,000)

b) The wheels should continue to be manufactured by Escher Skateboard. As indicated, the company's net income would decrease $32,000 by purchasing the wheels.

Exercise 132

Bonzai Company grows and sells Bonzai trees. It also makes the pot that holds the trees at a cost of $10 per pot. The cost of the pot includes an allocation of $3 of fixed overhead. The company makes 10,000 trees each year.

Potsdam Industries approaches Bonzai and offers to sell it pots for only $9.

Instructions

Calculate the impact that purchasing the pots from Potsdam would have on Bonzai’s net income.

Solution 132 (6–8 min.)

Cost from Potsdam $9

Costs avoided at Bonzai ($10 – $3) $7

Unit savings (additional cost) ($2)

Impact on net income 10,000 x $2 = $20,000 decrease.

Exercise 133

Jackson Chemical Corporation produces a water-based pest control chemical that it sells to pest control companies to manufacture as a pesticide. In 2022, the company incurred $140,000 of costs to produce 14,000 kilograms of the chemical. The selling price of the chemical is $21.00 per kilogram. The costs per unit to manufacture a kilogram of the chemical are presented below:

Direct materials $ 3.50

Direct labour 3.00

Variable manufacturing overhead 2.00

Fixed manufacturing overhead 1.50

Total manufacturing costs $10.00

The company is considering manufacturing the pesticide itself. If the company processes the chemical further and manufactures the pesticide itself, the following additional costs per kilogram will be incurred: Direct materials $1.00, direct labour $.25, variable manufacturing overhead, $1.00. No increase in fixed manufacturing overhead is expected. The company can sell the pesticide at $25.00 per kilogram.

Instructions

Determine the incremental per kilogram increase in net income and the total increase in net income if the company manufactures the pesticide.

Solution 133 (10–12 min.)

Net Income

Sell Chemical Process Further Increase (Decrease)

Sales price per unit $21.00 $25.00 $4.00

Cost per unit:

Direct materials ($3.50 + $1.00) 3.50 4.50 (1.00)

Direct labour ($3.00 + $0.25) 3.00 3.25 (.25)

Variable manufacturing overhead 2.00 3.00 (1.00)

($2.00 + $1.00)

Fixed manufacturing overhead 1.50 1.50 _____

Total 10.00 12.25 (2.25)

Net income per unit $11.00 $12.75 $ 1.75

Assuming the company sells all 14,000 kilograms that it produces, the incremental net income would be $24,500 (14,000 kilograms × $1.75).

Exercise 134

Franklin Corporation produces three products: A, B & C which come from a single common input. The joint costs at split-off point are $480,000, a portion of which are allocated as follows: $50,000, $55,000 and $60,000 for products A, B, and C, respectively. The cost of processing each product further would be $40,000, $26,000 and $20,000 and the sales value after processing further would be $85,000, $85,000 and $82,000, for products A, B, and C ,respectively.

Instructions

Which products should be sold at the split-off point and which products, if any, should be processed further?

Solution 134 (5-7 minutes)

Products B and C should be processed further as the incremental profit would be $4,000 and $2,000 respectively. .

Exercise 135

Muskoka Comforts makes chairs. The cost to manufacture an unfinished chair is:

Direct materials $ 8.40

Direct labour 7.20

Variable manufacturing overhead 4.80

Fixed manufacturing overhead 3.60

Total manufacturing costs $24.00

The sales price for an unfinished product is $55.00 and $65.00 for a finished chair. Muskoka Comfort would incur an additional $1.60 for direct materials, $1.80 for direct labour, and $1.20 for variable manufacturing overhead to finish the chairs.

Instructions

Should the company sell the unfinished product or process further?

Solution 135 (7-10 min.)

Sell Process Further Increase (Decrease)

Sales price per unit $55.00 $65.00 $10.00

Cost per unit:

Direct materials ($8.40 + $1.60) 8.40 10.00 (1.60)

Direct labour ($7.20 + $1.80) 7.20 9.00 (1.80)

Variable manufacturing overhead 4.80 6.00 (1.20)

($4.80 + $1.20)

Fixed manufacturing overhead 3.60 3.60 _____

Total 24.00 28.60 (4.60)

Net income per unit $31.00 $36.40 $ 5.40

It would be advantageous for Muskoka Comforts to process the chairs further. The incremental revenue of $10.00 from the additional processing is $5.40 higher than the incremental processing costs of $4.60. This results in an increase to net income per unit of $5.40.

Exercise 136

Colborne Company has machinery equipment with a book value of $270,000 and a remaining useful life of 3 years. A new machine is available at a cost of $425,000. The new machine will have a useful life of 5 years with no salvage value and it will lower annual variable manufacturing costs from $500,000 to $400,000.

Instructions

Prepare an analysis that shows whether Colborne should retain or replace the old machine.

Solution 136 (5- 7 min.)

Retain Machine Replace Machine Net Income Change

Variable manufacturing costs $1,500,000 $1,200,000 $300,000*

New machine cost (425,000)

Net loss over 3 years ($125,000)

*For 3 years of remaining life

Retain the old machine equipment as there will be a net loss of $125,000 if it is replaced.

Exercise 137

Harris Timber Corporation uses a machine that removes the bark from cut timber. The machine is unreliable and results in a significant amount of downtime and excessive labour costs. The management is considering replacing the machine with a more efficient one that will minimize downtime and excessive labour costs. Data are presented below for the two machines:

Old Machine New Machine

Original purchase cost $340,000 $370,000

Accumulated depreciation 230,000 —

Estimated life 5 years 5 years

It is estimated that the new machine will produce annual cost savings of $85,000. The old machine can be sold to a scrap dealer for $8,000. Both machines will have a salvage value of zero if operated for the remainder of their useful lives.

Instructions

Determine whether the company should purchase the new machine.

Solution 137 (7–8 min.)

Retain Replace Net Income

Equipment Equipment Increase/(Decrease)

Cost savings $ -0- $425,000 (A) $425,000

New machine cost -0- (370,000) (370,000)

Proceeds from sale of old machine $ -0- 8,000 8,000

Net incremental net income $ -0- $ 63,000 $ 63,000

(A) $85,000 × 5 = $425,000.

The company should purchase the new machine because there will be an increase in net income of $63,000.

Exercise 138

Kinder Enterprises relies heavily on a copier machine to process its paperwork. Recently the copy clerk has not been able to process all the necessary copies within the regular work week using the existing copier. Management is considering updating the copier machine with a faster model.

Current Copier New Model

Original purchase cost $10,000 $20,000

Accumulated depreciation 8,000 —

Estimated operating costs (annual) 7,000 2,600

Useful life 5 years 5 years

If sold now, the current copier would have a salvage value of $1,000. If operated for the remainder of its useful life, the current machine would have zero salvage value. The new machine is expected to have zero salvage value after five years.

Instructions

Prepare an analysis to show whether the company should retain or replace the machine.

Solution 138 (7–8 min.)

Net Income

Retain Machine Replace Machine Increase (Decrease)

Operating costs $35,000 $13,000 $22,000

New machine cost -0- 20,000 (20,000)

Salvage value -0- (1,000) 1,000

Totals $35,000 $32,000 $ 3,000

The current copier should be replaced. The incremental analysis shows that net income for the five-year period will be $3,000 higher by replacing the current copier.

Exercise 139

Evett Corporation uses a machine that winds twine onto spools. The machine is unreliable and results in a significant amount of downtime and excessive labour costs. The management is considering replacing the machine with a more efficient one which will minimize downtime and excessive labour costs. Data are presented below for the two machines:

Old Machine New Machine

Original purchase cost $160,000 $240,000

Accumulated depreciation 120,000 —

Estimated life 4 years 4 years

It is estimated that the new machine will produce annual cost savings of $55,000. The old machine can be sold to a scrap dealer for $24,000. Both machines will have a salvage value of zero if operated for the remainder of their useful lives.

Instructions

Determine whether the company should purchase the new machine.

Solution 139 (7–8 min.)

Keep Replace Net Income

Equipment Equipment Increase/(Decrease)

Cost savings $0 $220,000¹ $220,000

New machine cost 0 (240,000) (240,000)

Proceeds from sale of old machine $0 24,000 24,000

Net incremental net income $0 $ 4,000 $ 4,000

¹$55,000 × 4 = $220,000

The company should purchase the new machine because there will be an increase in net income of $4,000 over the 4-year life of the new machine.

Exercise 140

Doey, Cheatem, and Howe, is a law firms that relies heavily on a colour laser printer to process the paperwork. Recently the printer has not functioned properly and print jobs were not being processed. Management is considering updating the printer with a faster model.

Current Printer New Model

Original purchase cost $30,000 $24,000

Accumulated depreciation 17,000 —

Estimated operating costs (annual) 3,000 2,000

Useful life 4 years 4 years

If sold now, the current printer would have a salvage value of $4,000. If operated for the remainder of its useful life, the current printer would have zero salvage value. The new printer is expected to have a zero-salvage value after four years.

Instructions

Prepare an analysis to show whether the company should retain or replace the printer.

Solution 140 (7–9 min.)

Net Income

Retain Machine Replace Machine Increase (Decrease)

Operating costs $12,000 $ 8,000 $4,000

New machine cost 0 24,000 (24,000)

Salvage value 0 (4,000) 4,000

Totals $12,000 $28,000 ($16,000)

The current printer should not be replaced. The incremental analysis shows that net income for the four-year period will be $16,000 lower by replacing it.

Exercise 141

Barnstorming Company flies vintage aircraft at air shows and has a fleet of three airplanes. One of the airplanes cost $250,000 to purchase ten years ago and now has a book value of $75,000. The company is considering replacing this airplane with a different type, which will cost $350,000. The current airplane could be sold for $50,000.

If the company buys the new airplane, it is expected that fuel costs will decrease from $80,000 to $45,000 annually and maintenance costs will decrease from $70,000 to $30,000 annually. Both the current airplane and the new airplane will have a service life of ten years. At that time, both airplanes would have to be scrapped with no recovery value.

Instructions

Calculate whether the company should purchase the new airplane or not.

Solution 141 (6–8 min.)

Keep Buy New Net Income

Airplane Airplane Increase (Decrease)

Variable operating costs¹ $1,500,000 $750,000 $750,000

New airplane cost² 300,000 (300,000)

Net impact $450,000

¹ Keep: 10 years x $150,000 New: 10 years x $75,000

² $350,000 – $50,000 = $300,000

All other things being equal, the company should purchase the new airplane as it will result in $450,000 additional income over the life of the airplane.

Note that the book value of the current airplane is irrelevant in this decision.

Exercise 142

Brand New Inc. manufactures the multi-flavour product line that has three different products: orange, grape and cherry. In the current year, the line had sales of $1,200,000, variable expenses of $930,000, and fixed expenses of $360,000. The product line had a net loss of $90,000. If Brand New eliminates the line, $60,000 of fixed costs will remain. Prepare an analysis showing whether the company should eliminate the multi-flavour line.

Solution 142 (10 min.)

Net Income

Continue Eliminate Increase (Decrease)

Sales $1,200,000 $0 $(1,200,000)

Variable costs 930,000 0 930,000

Contribution Margin 270,000 0 (270,000)

Fixed costs 360,000 60,000 300,000

Net Income (Loss) $(90,000) $(60,000) $30,000

If the Multi-Flavour product line is eliminated, the net income will be $30,000 higher. The company should eliminate the product line.

Exercise 143

Anheiser has three divisions: Bud, Wise, and ER. The results of May, 2022 are presented below:

Bud Wise ER Total

Units sold 5,000 7,000 4,000 16,000

Revenue $80,000 $ 60,000 $30,000 $170,000

Less variable costs 37,000 42,000 14,000 93,000

Less direct fixed costs 15,000 25,000 13,000 53,000

Less allocated fixed costs 3,125 4,375 2,500 10,000

Net income $24,875 ($11,375) $ 500 $ 14,000

All of the allocated costs will continue even if a division is discontinued. Anheiser allocates indirect fixed costs based on the number of units to be sold. Since the Wise Division has a net loss, Anheiser feels that it should be discontinued. Anheiser feels if the division is closed, that sales at the Bud Division will increase by 30%, and that sales at the ER Division will stay the same.

Instructions

a) Prepare an analysis showing the effect of discontinuing the Wise Division.

b) Should Anheiser close the Wise Division? Briefly indicate why or why not.

Solution 143 (10–12 min.)

a)

Bud ER Total

Revenue $104,000 $30,000 $134,000

Less variable costs 48,100 14,000 62,100

Less direct fixed costs 15,000 13,000 28,000

Less allocated fixed costs 6,190 3,810 10,000

Net income $ 34,710 $ (810) $ 33,900

Calculations:

Units = 5,000 x 130% = 6,500

Revenue = $80,000 x 130% = $104,000

Variable costs = $37,000 x 130% = $48,100

Allocation of total allocated fixed costs of $10,000:

To Bud: 6,500 / (6,500 + 4,000) x $25,000 = $6,190

To ER: 4,000 / (6,500 + 4,000) x $25,000 = $3,810

b) Yes. The net income increases by $19,900 ($33,900 – $14,000) when the division is eliminated. Direct fixed costs and variable costs for the Wise Division were relatively high compared to those for the Bud and ER divisions. The increase in sales by 30% of the Bud Division was enough to offset the loss of the Wise Division.

Exercise 144

Beyonce Company sells two items: peanuts and soybeans. The company is considering dropping soybeans. It is expected that sales of peanuts will increase by 30% as a result. Dropping soybeans will allow the company to cancel its monthly rental of its bean shucker costing $50 a month. The other existing equipment will be used for additional production of peanuts. Beyonce’s other fixed costs are allocated and will continue regardless of the decision made. A condensed, budgeted monthly income statement with both products is below:

Total Soybeans Peanuts

Sales $40,000 $10,000 $30,000

Food materials 14,000 4,000 10,000

Direct labour 12,000 3,000 9,000

Equipment rental 1,600 700 900

Other allocated overhead 2,950 2,000 950

Operating income $ 9,450 $ 300 $ 9,150

Instructions

Prepare an incremental analysis to determine the financial effect of dropping soybean production.

Solution 144 (10–12 min.)

BEYONCE COMPANY

Incremental Analysis

Incremental change in revenue:

Increase in peanut sales: $30,000 x 30% $ 9,000

Decrease in soybean sales (10,000)

Incremental decrease in revenue ($1,000)

Incremental change in variable costs:

Food materials: Increase in peanut costs: $10,000 x 30% (3,000)

Decrease in soybean costs 4,000

Direct labour: Increase in peanut labour: $9,000 x 30% (2,700)

Decrease in soybean labour 3,000

Incremental decrease in variable costs 1,300

Equipment rental reduction—soybean shucker 50

Incremental increase in income if soybean production is dropped ($ 350)

Exercise 145

Herman Corporation operates two divisions, the A Division and the B Division. Both divisions manufacture and sell logs to paper manufacturers. The company is considering disposing of the B Division since it has been consistently unprofitable for a number of years. The income statements for the two divisions for the year ended December 31, 2022 are presented below:

A Division B Division Total

Sales $400,000 $300,000 $700,000

Cost of goods sold 150,000 200,000 350,000

Gross profit 250,000 100,000 350,000

Selling & administrative expenses 200,000 120,000 320,000

Net income $ 50,000 $(20,000) $ 30,000

In the B Division, 80% of cost of goods sold is variable and 20% of selling and administrative expenses are variable . The management of the company believes it can save $30,000 of fixed cost of goods sold and $30,000 of fixed selling expenses if it discontinues operation of the B Division.

Instructions

a) Determine whether the company should discontinue operating the B Division.

b) If the company had discontinued the division for 2022, determine what net income would have been reported.

Solution 145 (10–12 min.)

a) Net Income

Continue Eliminate Increase (Decrease)

Sales $300,000 $0 $(300,000)

Variable costs:

Cost of goods sold 160,000 (A) 0 160,000

Selling and admin. exp. 24,000 (B) 0 24,000

Contribution margin 116,000 0 (116,000)

Fixed costs:

Cost of goods sold 40,000 (C) 10,000 30,000

Selling and admin. exp. 96,000 (D) 66,000 30,000

Net income $(20,000) $(76,000) $(56,000)

(A) $200,000 × 80% = $160,000 (C) $200,000 – $160,000 = $40,000

(B) $120,000 × 20% = $24,000 (D) $120,000 – $24,000 = $96,000

The company should continue the B Division because its contribution margin, $116,000, is greater than the avoidable fixed costs, $60,000.

b) A Division + Reallocated from B Division

$50,000 + $(76,000) = $(26,000)

OR

A Division

Sales $400,000

Cost of goods sold (A) 160,000

Gross profit 240,000

Selling & administrative expenses (B) 266,000

Net income $(26,000)

(A) $150,000 + $10,000 = $160,000 (B) $200,000 + $66,000 = $266,000

Exercise 146

A recent accounting graduate from Lethbridge University evaluated the operating performance of Fane Company's three divisions. The following presentation was made to Fane’s Board of Directors. During the presentation, the accountant made the recommendation to eliminate the Southern Division stating that total net income would increase by $20,000, as shown in the analysis below.

Other Two Divisions Southern Division Total

Sales $1,000,000 $300,000 $1,300,000

Cost of Goods Sold 650,000 200,000 850,000

Gross Profit 350,000 100,000 450,000

Operating Expenses 100,000 120,000 220,000

Net Income $ 250,000 $ (20,000) $ 230,000

Cost of goods sold is 80% variable and operating expenses are 70% variable. If the division is eliminated, 40% of the fixed costs will be eliminated.

Instructions

Do you concur with the new accountant's recommendation? Present a schedule to support your answer.

Solution 146 (12–14 min.)

Net Income

Continue Eliminate Increase (Decrease)

Sales $300,000 $0 $(300,000)

Variable costs

Cost of goods sold 160,000 0 160,000

Operating expenses 84,000 0 84,000

Total Variable 244,000 0 244,000

Contribution Margin 56,000 (56,000)

Fixed costs

Cost of goods sold 40,000 24,000 16,000

Operating expenses 36,000 21,600 14,400

Net Income (Loss) $(20,000) $(45,600) $(25,600)

The accountant is not correct. If the Southern Division is eliminated, the net income will be $25,600 less, not $20,000 greater.

Exercise 147

SmartPhone Plus manufactures three different products: Universal I, Universal II, and Universal III. While market demand exists for all models, machine hours are limited. The following per unit data apply:

Instructions

a) Calculate the contribution margin per unit of the limited resource for each product.

b) Which product should SmartPhone Plus produce in order to maximize the company's income? Why?

Solution 147

a) Universal I ($100 – $15 – $24 – $8) / 2 = $26.50

Universal II ($120 – $15 – $24 – $16) / 4 = $16.25

Universal III ($140 – $15 – $48 – $16) / 4 = $15.25

b) SmartPhone should produce Universal I, since it provides the highest contribution per unit of the limited resource at $26.50 in comparison to the other two products.

Exercise 148

Allens Company manufactures three different products and the following data for each apply:

While market demand exists for all models, the company has limited raw materials to produce the products to meet demand. Raw materials cost $5.00 per kilogram and Allens has 9,425 kilograms available each period.

Instructions

Provide the order in which Allens Company should prioritize the production of each product.

Solution 148

Allens Company should prioritize the production of the Basic product since it provides the highest contribution per kg of raw materials at $8.33 per kilogram. The next product would be the Supreme at the next highest contribution margin per kg of raw materials at $6.92 followed by the Deluxe at $5.83.

Exercise 149

Houston Enterprises manufactures three different products with limited staff and the per unit data for each is identified below:

Instructions

a) Calculate the contribution margin per unit of the limited resource for each product.

b) Which product should Houston Enterprises prioritize to maximize the company's income? Why?

Solution 149

Houston Enterprises should prioritize the production of Product B as it provides for the highest contribution per direct labour hour at $12. The next product would be Product C at the second highest contribution margin per direct labour hour at $10, followed by Product A at $9.

Exercise 150

Movie House has 4,000 machine hours available to use to produce either Product 22 or Product 44. The cost accounting department developed the following unit information for each of the products:

Product 22 Product 44

Sales price $20.00 $40.00

Direct materials 5.00 8.00

Direct labour 3.00 2.00

Variable manufacturing overhead 4.50 5.00

Fixed manufacturing overhead 3.00 5.00

Machine time required 15 minutes 75 minutes

Instructions

Management wants to know which product to produce in order to maximize the company's income. Taking into consideration the constraint under which the company operates, prepare a report to show which product should be produced and sold.

Solution 150 (10–12 min.)

Contribution Margin per Unit Limited Resource

Contribution margin per unit: Product 22 Product 44

Sales price $20.00 $40.00

Variable costs

Direct material $5.00 $8.00

Direct labour 3.00 2.00

Variable overhead 4.50 12.50 5.00 15.00

Contribution margin $ 7.50 $25.00

Machine hours required: 1/4 hr 1 1/4 hrs

Contribution margin per unit of limited resource

($7.50 ÷.25) $ 30.00

($25 ÷ 1.25) $ 20.00

Machine hours available 4,000 4,000

Contribution margin $120,000 $80,000

The company should produce and sell Product 22.

Exercise 151

PHR Company manufactures and sells two products. Relevant per unit data concerning each product are given below:

Product

Standard Deluxe

Selling price $50 $75

Variable costs $30 $30

Machine hours 1.6 3

Instructions

a) Calculate the contribution margin per unit of the limited resource for each product.

b) If 1,200 additional machine hours are available, which product should be manufactured and in what quantity?

Solution 151 (6–8 min.)

a) Product

Standard Deluxe

Contribution margin per unit $ 20 $ 45

Machine hours required 1.6 3

Contribution margin per unit of limited resource $12.50 $15.00

b) The Deluxe product should be manufactured because it results in the highest contribution margin per machine hour: $15.00 x 1,200 = $18,000. They should produce 400 Deluxe units (1200 / 3 = 400).

Exercise 152

Brand New Inc. manufactures the multi-flavour product line which has three different products: orange, grape and cherry. The details for each product are identified below:

Orange Grape Cherry

Sales price $37 $28 $35

Variable costs

Direct materials 14 8 7

Direct labour 9 8 6

Variable overhead 6 5 4

Total variable costs 29 21 17

Contribution margin $8 $7 $18

Brand New inc. has a maximum capacity of 100,000 litres per month. The cost per litre for all products is $4.

Instructions

Rank the order of each product that Brand New Inc. should produce to maximize net income.

Solution 152 (7-10 min.)

Orange Grape Cherry

Direct materials $14 $8 $7

Cost per litres $4 $4 $4

Litres per unit 3.50 2 1.75

Contribution margin per unit $8 $7 $18

Contribution margin per litre $2.29 $3.50 $10.29

Brand New Inc. should rank production of the Cherry product first, since it has the highest contribution margin per litre, Grape as second and Orange as third.

COMPLETION STATEMENTS

153. The process used to identify the financial data that change under alternative courses of action is called ___ analysis.

154. In a decision regarding whether an order should be accepted at a special price when there is plant capacity available, a major consideration is whether or not the special price exceeds ___.

155. An important purpose of management accounting is to provide ___ for decision making.

156. The potential benefit that may be obtained by following an alternative course of action is called a(n) ___ cost.

157. A decision whether to sell a product now or to process it further depends on whether the incremental ___ from processing further are greater than the incremental processing ___.

158. The ___ value of the existing equipment is irrelevant in a decision to replace that equipment and is often referred to as a ___ cost.

159. In an environment where there are limited resources, the products with the highest contribution per unit of ___ should determine the choice of products to be produced.

ANSWERS TO COMPLETION STATEMENTS

153. incremental (differential)

154. variable costs (incremental costs)

155. relevant information

156. opportunity

157. revenues, costs

158. book, sunk

159. limited resource

MATCHING

160. Match the items below by entering the appropriate letter code in the space provided.

A. Incremental analysis

B. Opportunity cost

C. Sunk cost

___ 1. A cost that cannot be changed by any present or future decision.

___ 2. The process of identifying the financial data that change under alternative courses of action.

___ 3. The potential benefit that may be lost from following an alternative course of action.

ANSWERS TO MATCHING

1. C

2. A

3. B

SHORT-ANSWER ESSAY QUESTIONS

SAE161

Management is often faced with the alternative of continuing to make a product or component internally, or going to an external source and purchasing the product or component. In gathering relevant information for these two alternatives, briefly identify the quantitative factors that should be considered. Are there any qualitative factors that should also be considered?

Solution 161

The quantitative factors to be considered in a make-or-buy decision include the incremental costs to make the product, the incremental costs of buying the product, and the opportunity cost (potential benefit foregone) if the product is made. Generally, all variable production costs are relevant in a make-or-buy decision, but only some fixed costs, or no fixed costs, are relevant because many fixed costs will be incurred regardless of whether the decision is to make-or-buy. Qualitative factors include the possible adverse effect on employees and the stability of the supplier's price and quality.

SAE162

You are the general accountant for Word Systems, Inc., a typing service based in Winnipeg, Manitoba. The company has decided to upgrade its equipment. It currently has a widely used version of a word processing program. The company wishes to invest in more up-to-date software and to improve its printing capabilities.

Two options have emerged. Option D is for the company to keep its existing computer system, and upgrade its word processing program. The memory of each individual work station would be enhanced, and a larger, more efficient printer would be used. Better telecommunications equipment would allow for the electronic transmission of some documents as well.

Option Z would be for the company to invest in an entirely different computer system. The software for this system is extremely impressive, and it comes with individual laser printers. However, the company is not well established, and the software does not effectively integrate with well known software. The net present value information for these options follows:

Option Z Option D

Initial Investment $95,000 $270,000

Cost savings of labour over 4 years 89,000 284,000

Instructions

Prepare a brief report for management making a recommendation for one system or the other, using the information given.

Solution 162

I recommend that the company accept Option D, to purchase upgrades to our present system and to buy a more efficient printer. In the first place, the changes will be easier to implement because the equipment is similar to what is already used. Second, the costs savings exceed those of Option Z.

SAE163

Why might a company choose NOT to eliminate an unprofitable product line?

Solution 163

A company may choose NOT to eliminate an unprofitable product line because overall net income for the company may actually decrease if the line is discontinued. The loss in a product line may be due to the allocation of common costs. A company’s total fixed costs will be the same whether or not a product line is discontinued.

SAE164

Why is contribution margin alone unsuitable for management to decide which products to make and sell in order to maximize net income?

Solution 164

When a company has limited resources, management must decide which products to make and sell in order to maximize net income. One factor that affects the sales mix decision is how much of the available resources each product uses. Contribution margin (CM) alone is not enough to make this decision. The key factor is CM per limited resource. This is obtained by dividing the contribution margin per unit of each product by the number of units of the limited resource required for each product.

MULTI-PART QUESTION

165. Chocolate Delight Company (CDC) makes specialty chocolates and can produce 40 pieces per hour. The firm estimates that the variable cost of producing chocolate is $0.35 per piece and each piece sells for $0.60.

Smiles For All (SFA) is a large greeting card company. It has asked CDC to produce a special flat chocolate greeting card for which it is willing to pay $2.50 each. The cost to manufacture the new card will be $1.80 each. If this order is accepted, CDC will have to buy a new machine at a cost of $12,000. The new machine will be able to produce 20 cards per hour. SFA offers to buy 70,000 cards. CDC has a capacity of 10,000 machine hours available for both the new chocolate card and existing production and fixed costs of $400,000 for its regular production activity.

Instructions

a) Assume the demand for its own chocolates is 250,000 pieces. SFA says that the chocolate card order has to be produced in total or not at all. Should CDC accept the special order?

b) Assume the demand for its own chocolates is 300,000 pieces. SFA says that the chocolate card order has to be produced in total or not at all. Should CDC accept the special order? Are there any other considerations that CDC should keep in mind?

c) Assume the demand for its own chocolates is 275,000 pieces and CDC can decide to accept any quantity of the chocolate card order. Determine the mix of chocolates and cards that it should produce.

Solution 165 (15–20 min.)

a) Hours required by special order: 70,000 ÷ 20 = 3,500

Hours required by regular sales: 250,000 ÷40 = 6,250

There is sufficient capacity to produce both regular chocolates and the special order.

Incremental operating income of special order

CM: 70,000 x ($2.50 – $1.80) = $49,000

Cost of new machine (12,000)

Incremental income $37,000

The company should accept this new order.

b) Hours required by special order = 70,000 ÷ 20 = 3,500

Hours required by regular sales = 300,000 ÷ 40 = 7,500

Regular sales lost are 1,000 x 40 = 40,000 chocolate pieces (10,000 hrs – (3,500 + 7,500)).

Incremental operating income of special order

Incremental operating income of special order $37,000

Less CM lost on regular sales (40,000 x $0.60 – $0.35) (10,000)

Incremental income of accepting the special order $27,000

The company should accept this new order only if it can recover its lost sales of 40,000 chocolate pieces in the future.

c) Attempt to maximize production of the products that generates the highest CM per machine hour:

Pieces Cards

CM per unit $0.25 $0.70

Machine hours per unit 0.025 0.050

CM per machine hour $10.00 $14.00

Cards have the highest CM/machine hour and should be maximized. Therefore, they should make the full demand for cards.

Cards = 70,000 cards x 0.05 = 3500 hours.

Remaining hours = 10,000 – 3500 = 6500 can be used to make regular pieces.

Regular pieces = 6500 x 40 = 260,000 pieces.

Therefore the optimal mix is 70,000 cards and 260,000 pieces.

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