CHAPTER 7Incremental AnalysisASSIGNMENT CLASSIFICATION
TABLEBrief Exercises 1 A Problems B Problems
Learning Objectives 1. Identify the steps in managements
decisionmaking process. Describe the concept of incremental
analysis. Identify the relevant costs in accepting an order at a
special price. Identify the relevant costs in a make-or-buy
decision. Identify the relevant costs in determining whether to
sell or process materials further. Identify the relevant costs to
be considered in repairing, retaining or replacing equipment.
Identify the relevant costs in deciding whether to eliminate an
unprofitable segment.
Questions 1, 2
Do It!
Exercises 1
2.
3, 4
2
1, 17
3.
5
3
1
2, 3, 4, 18
1A
1B
4.
6, 7
4
2
5, 6, 7, 8, 18
2A
2B
5.
8, 9, 10
5, 6
3
9, 10, 11, 12, 18
3A
3B
6.
11
7
13, 14, 18
4A
4B
7.
12
8
4
15, 16, 17, 18
5A
5B
ASSIGNMENT CHARACTERISTICS TABLEProblem Number 1A Difficulty
Level Simple Time Allotted (min.) 2030
Description Use incremental analysis for special order and
identify nonfinancial factors in the decision. Use incremental
analysis related to make or buy, consider opportunity cost, and
identify nonfinancial factors. Determine if product should be sold
or processed further. Compute gain or loss, and determine if
equipment should be replaced. Prepare incremental analysis
concerning elimination of divisions. Use incremental analysis for
special order and identify nonfinancial factors in the decision.
Use incremental analysis related to make or buy, consider
opportunity cost, and identify nonfinancial factors. Determine if
product should be sold or processed further. Compute gain or loss,
and determine if equipment should be replaced. Prepare incremental
analysis concerning elimination of divisions.
2A
Moderate
3040
3A 4A
Moderate Moderate
3040 3040
5A
Moderate
3040
1B
Simple
2030
2B
Moderate
3040
3B 4B
Moderate Moderate
3040 3040
5B
Moderate
2030
Correlation Chart between Blooms Taxonomy, Learning Objectives
and End-of-Chapter Exercises and ProblemsKnowledge Comprehension
Q7-1 Q7-2 Q7-3 Q7-4 Q7-5 BE7-3 DI7-1 BE7-4 DI7-2 E7-1 BE7-2 E7-1
E7-17 E7-2 E7-3 E7-4 E7-5 E7-6 E7-7 E7-8 BE7-5 BE7-6 DI7-3 Q7-11
BE7-7 E7-9 E7-10 E7-11 E7-12 E7-13 E7-14 E7-18 BE7-8 DI7-4 BYP7-1
BYP7-4 BYP7-5 BYP7-2 BYP7-8 BYP7-9 E7-15 E7-16 E7-17 BYP7-3 BYP7-6
BYP7-7 E7-18 P7-1A P7-1B E7-18 P7-2A P7-2B E7-18 P7-3A P7-3B P7-4A
P7-4B E7-18 P7-5A P7-5B Application Analysis Synthesis
Evaluation
Learning Objective
*1.
Identify the steps in managements BE7-1 decision-making
process.
*2.
Describe the concept of incremental analysis.
BLOOMS TAXONOMY TABLE
*3.
Identify the relevant costs in accepting an order at a special
price. Q7-6 Q7-7
*4.
Identify the relevant costs in a make-or-buy decision.
*5.
Identify the relevant costs in determining whether to sell or
process materials further.
Q7-8 Q7-9 Q7-10
*6.
Identify the relevant costs to be considered in repairing,
retaining or replacing equipment. Q7-12
*7.
Identify the relevant costs in deciding whether to eliminate an
unprofitable segment.
Broadening Your Perspective
ANSWERS TO QUESTIONS1. The following steps are frequently
involved in managements decision-making process: (1) Identify the
problem and assign responsibility. (2) Determine and evaluate
possible courses of action. (3) Make a decision. (4) Review results
of the decision. My roommate is incorrect. Accounting contributes
to the decision-making process at Steps 2 and 4. Prior to the
decision, accounting provides relevant revenue and cost data for
each course of action. Following the decision, internal reports are
prepared to show the actual impact of the decision. Disagree.
Incremental analysis involves the identification of financial data
that change under alternative courses of action. In incremental
analysis, the important point to consider is whether costs will
differ (change) between the two alternatives. As a result,
sometimes (1) variable costs do not change under the alternative
courses of action and (2) fixed costs do change. The relevant data
in deciding whether to accept an order at a special price are the
incremental revenues to be obtained compared to the incremental
costs of filling the special order. The manufacturing costs that
are relevant in the make-or-buy decision are those that will change
if the parts are purchased. Opportunity cost may be defined as the
potential benefit that may be obtained by following an alternative
course of action. Opportunity cost is relevant in a make-or-buy
decision when the facilities used to make the part can be used to
generate additional income. The decision rule in a decision to sell
a product or to process it further is: Process further as long as
the incremental revenue from the additional processing exceeds the
incremental processing costs. Joint products are products that are
produced from a single raw material and a common production
process. An accounting issue related to joint products is how to
allocate the joint costs incurred during the production process
that creates the joint products. Joint costs are irrelevant to a
sell-or-process-further decision because they are sunk costs and
will not change whether the decision is to sell the existing
product or process it further. Therefore, joint costs are ignored
in this decision. A sunk cost is a cost that cannot be changed by
any present or future decision. Sunk costs, such as the book value
of an old piece of equipment, therefore, are not relevant in a
decision to retain or replace equipment. Net income will be lower
if an unprofitable product line is eliminated when the product line
is producing a positive contribution margin and its fixed costs
cannot be avoided or reduced.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
SOLUTIONS TO BRIEF EXERCISESBRIEF EXERCISE 7-1 The correct order
is: 1. 2. 3. 4. Identify the problem and assign responsibility.
Determine and evaluate possible courses of action. Make a decision.
Review results of the decision.
BRIEF EXERCISE 7-2 Net Income Increase (Decrease) ($ 20,000)
(25,000) ($ 5,000)
Alternative A Revenues Costs Net income $160,000 100,000 $
60,000
Alternative B $180,000 125,000 $ 55,000
Alternative A is better than Alternative B.
BRIEF EXERCISE 7-3 Net Income Increase (Decrease) ($ 75,000) (
(60,000) ( (6,000) ($ 9,000)
Revenues CostsVariable manufacturing Shipping Net income
Reject Order $0 0 0 $0
Accept Order $75,000 * 60,000 ** 6,000 *** $ 9,000
The special order should be accepted. *3,000 X $25 **3,000 X $20
***3,000 X $ 2
BRIEF EXERCISE 7-4 Net Income Increase (Decrease) $ 50,000 0
(60,000) ($(10,000)
Make Variable manufacturing costs Fixed manufacturing costs
Purchase price Total annual cost $50,000 30,000 0 $80,000
Buy $ 0 30,000 60,000 $90,000
The decision should be to make the part.
BRIEF EXERCISE 7-5 Sell Sales price per unit Cost per unit
Variable Fixed Total Net income per unit $62.00 36.00 10.00 46.00
$16.00 Process Further $70.00 43.00 10.00 53.00 $17.00 Net Income
Increase (Decrease) $8.00 ( (7.00) 0 ( (7.00) $1.00
The bookcases should be processed further because the
incremental revenues exceed incremental costs by $1.00 per
unit.
BRIEF EXERCISE 7-6 The allocated joint costs are irrelevant to
the sell or process further decisions. If AB1 is processed further,
the company will earn incremental revenue of $50,000 ($150,000
$100,000) and only incur incremental costs of $45,000. Therefore,
the company should process AB1 further and sell AB2. If XY1 is
processed further, the company will earn incremental revenue of
$35,000 ($130,000 $95,000) but will incur incremental costs of
$50,000. Therefore, the company should sell XY1 rather than process
it further.
BRIEF EXERCISE 7-7 Net 4-Year Income Increase (Decrease) ($
500,000 ((300,000) 30,000 $ 230,000
Retain Equipment Variable manufacturing costs for 4 years New
machine cost Sell old machine Total $3,000,000 (30,000)
$3,000,000
Replace Equipment $2,500,000 300,000 (30,000) $2,770,000
The old factory machine should be replaced. BRIEF EXERCISE 7-8
Continue Sales Variable costs Contribution margin Fixed costs Net
income $200,000 180,000 20,000 30,000 ($ (10,000) Eliminate $ 0 0 (
0 20,000) $(20,000) Net Income Increase (Decrease) $(200,000)
(180,000) (20,000) ( 10,000) $ (10,000)
The Big Bart product line should be continued because $20,000 of
contribution margin will not be realized if the line is eliminated.
This amount is greater than the $10,000 savings of fixed costs.
SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 7-1 Reject $ 0 $ 0 $ 0
Accept $180,000 138,000* $ 42,000 Net Income Increase (Decrease)
$180,000 (138,000) $ 42,000
Revenues Costs Net income
*(6,000 X $20) + (6,000 X $3) Given the results of the above
analysis, Maize Company should accept the special order.
DO IT! 7-2 (a) Make $ 30,000 42,000 45,000 60,000 0 $177,000 Buy
$ 0 0 0 45,000 162,000 $207,000 Net Income Increase (Decrease) $
30,000 42,000 45,000 15,000 (162,000) $ (30,000)
Direct materials Direct labor Variable manufacturing costs Fixed
manufacturing costs Purchase price Total cost
Given the results of the above analysis, Rubble Company will
incur $30,000 of additional costs if it buys the switches. (b) Make
$177,000 34,000 $211,000 Buy $207,000 0 $207,000 Net Income
Increase (Decrease) $(30,000) 34,000 $ 4,000
Total cost Opportunity cost Total cost
Yes, the answer is different: The analysis shows that net income
will be increased by $4,000 if Rubble Company purchases the
switches. DO IT! 7-3 Process Further $100 $ 57 13 $ 70 $ 30 Net
Income Increase (Decrease) $25 ($17) (3) ($20) $ 5
Sell Sales per unit Cost per unit Variable Fixed Total Net
income per unit $75 $40 10 $50 $25
The tables should be processed further and Mesa Verde should
finish the tables because the incremental revenues exceed
incremental costs by $5 per unit.
DO IT! 7-4 Net Income Increase (Decrease) $(500,000) 370,000
(130,000) 112,000 $ (18,000)
Sales Variable costs Contribution margin Fixed costs Net
income
Continue $500,000 370,000 130,000 150,000 $ (20,000)
Eliminate $ 0 0 0 38,000 $(38,000)
The analysis indicates that Gator should not eliminate the
gloves and mittens line because net income would decrease
$18,000.
SOLUTIONS TO EXERCISESEXERCISE 7-1 1. 2. 3. 4. 5. 6. 7. 8. 9.
False. The first step in managements decision-making process is
identify the problem and assign responsibility. False. The final
step in managements decision-making process is to review the
results of the decision. True. False. In making business decisions,
management ordinarily considers both financial and nonfinancial
information. True. True. False. Costs that are the same under all
alternative courses of action do not affect the decision. False.
When using incremental analysis, either costs or revenues or both
will change under alternative courses of action. False. Sometimes
variable costs will not change under alternative courses of action,
but fixed costs will.
EXERCISE 7-2 (a) Reject Order $ 0 0 0 0 0 0 $ 0 Accept Order
$24,000 (2,500) (7,500) (5,000) (6,000) 0 $ 3,000 Net Income
Increase (Decrease) $24,000 (2,500) (7,500) (5,000) (6,000) 0 $
3,000
Revenues ($4.80) Materials ($0.50) Labor ($1.50) Variable
overhead ($1.00) Fixed overhead Sales commissions Net income
(b) As shown in the incremental analysis, Gruden should accept
the special order because incremental revenue exceeds incremental
expenses by $3,000. (c) It is assumed that sales of the golf discs
in other markets would not be affected by this special order. If
other sales were affected, Gruden would have to consider the lost
sales in making the decision. Second, if Gruden is operating at
full capacity, it is likely that the special order would be
rejected.
EXERCISE 7-3 (a) Reject Order Revenues (15,000 X $7.60) Cost of
goods sold Operating expenses Net income $0 0 0 $0 Accept Order
$114,000 78,000 (1) 30,000 (2) $ 6,000 Net Income Increase
(Decrease) ($114,000) ( (78,000) ( (30,000) ($ 6,000)
(1) Variable cost of goods sold = $2,600,000 X 70% =
$1,820,000.Variable cost of goods sold per unit = $1,820,000
350,000 = $5.20 Variable cost of goods sold for the special order =
$5.20 X 15,000 = $78,000.
(2) Variable operating expenses = $840,000 X 75% = $630,000
$630,000 350,000 = $1.80 per unit 15,000 X $1.80 = $27,000 $27,000
+ $3,000 = $30,000 (b) As shown in the incremental analysis, Leno
Company should accept the special order because incremental
revenues exceed incremental expenses by $6,000. EXERCISE 7-4 Reject
Order $0 0 0 0 0 $0 Accept Order $1,187,500 (1) 500,000 187,500
250,000 937,500 $ 250,000 Net Income Increase (Decrease) $1,187,500
(500,000) (187,500) (250,000) (937,500) $ 250,000
Revenues Variable costs: Direct materials Direct labor Variable
overhead Total variable costs Net income
(1) [($2.00 + $0.75 + $1.00 + $1.00) X 250,000] Klean Fiber
should accept the Armys offer since it would increase net income by
$250,000.
EXERCISE 7-5 (a) Make Direct materials (30,000 X $4.00) Direct
labor (30,000 X $5.00) Variable overhead costs ($150,000 X 70%)
Fixed manufacturing costs Purchase price (30,000 X $12.75) Total
annual cost $120,000 150,000 105,000 45,000 0 $420,000 $ Buy 0 0
Net Income Increase (Decrease) $ 120,000 150,000 105,000 0 (
(382,500) ($ (7,500)
0 45,000 382,500 $427,500
(b) No, Schopp Inc. should not purchase the shades. As indicated
by the incremental analysis, it would cost the company $7,500 more
to purchase the lamp shades. (c) Yes, by purchasing the lamp
shades, a total cost saving of $17,500 will result as shown below.
Net Income Increase (Decrease) $ (7,500) (25,000) $(17,500)
Make Total annual cost (above) Opportunity cost Total cost
EXERCISE 7-6 (a) 1. $420,000 25,000 $445,000
Buy $427,500 0 $427,500
Direct materials Direct labor Variable overhead Fixed overhead
Purchase price Total annual cost
Make $1,000,000 800,000 120,000 600,000 0 $2,520,000
Buy $ 0 0 0 195,000 2,300,000 $2,495,000
Net Income Increase (Decrease) $ 1,000,000 800,000 120,000
405,000 (2,300,000) $ 25,000
Yes. The offer should be accepted as net income will increase by
$25,000.
EXERCISE 7-6 (Continued) 2. Net Income Increase (Decrease) $
1,000,000 800,000 120,000 0 405,000 (2,300,000) $ 25,000
Direct materials Direct labor Variable overhead Fixed overhead
Opportunity cost Purchase price Totals
Make $1,000,000 800,000 120,000 600,000 405,000 0 $2,925,000
Buy $ 0 0 0 600,000 0 2,300,000 $2,900,000
Yes. The offer should be accepted as net income would be $25,000
more. (b) Qualitative factors include the possibility of laying off
those employees that produced the robot and the resulting poor
morale of the remaining employees, maintaining quality standards,
and controlling the purchase price in the future.
EXERCISE 7-7 (a) Make Sails $100 80 35 0 $215 Buy Sails $ 0 0 0
250 $250 Net Income Increase (Decrease) $ 100 80 35 (250) $
(35)
Direct materials Direct labor Variable overhead Purchase price
Total unit cost
Gibbs should be making the sails, because they could save $35
per unit or $42,000. The president was including the fixed overhead
cost in the calculation. Variable overhead = Total overhead ($100)
Fixed overhead ($78,000 1,200) = $35. This amount has been
allocated, so Gibbs will incur the cost whether or not they make
the sails. This is an example of an irrelevant cost, because it
does not differ between the two alternatives.
EXERCISE 7-7 (Continued) (b) The best decision would be to rent
out the space as shown below. The differential savings would be
$77,000 $42,000 = $35,000. Net Income Increase (Decrease) $ 258,000
(300,000) 77,000 $ 35,000
(Based on 1,200 units) Manufacturing cost Purchase price
Opportunity cost Total annual cost (c)
Per Unit $215 $250
Make Sails $258,000 0 77,000 $335,000
Buy Sails $ 0 300,000 0 $300,000
Qualitative factors to consider would be (1) whether Gibbs will
be able to exercise control over the future price of the product
(2) whether Gibbs will be able to exercise control over the quality
of the product and (3) the potential for interruptions in the
supply of the product.
EXERCISE 7-8 (a) Make IMC2 $ 65.00 45.00 6.50 72.00* 0 $188.50
Buy IMC2 $ 0 0 0 0 200.00 $200.00 Net Income Increase (Decrease) $
65.00 45.00 6.50 72.00 (200.00) $ (11.50)
Direct materials Direct labor Material handling Variable
overhead Purchase price Total unit cost
*Variable overhead = 60% X ($126.50 6.50) The unit should not be
purchased from the outside vendor, as the per unit cost would be
$11.50 greater than if they made it.
EXERCISE 7-8 (Continued) (b) In order for Innova to make an
accurate decision, they would have to know the opportunity cost of
manufacturing the other product. As determined in (a), purchasing
the product from outside would cost $11,500 more (1,000 X $11.50).
Innova would have to increase their contribution margin by more
than $11,500 through the manufacture of the other product, before
it would be economical for them to purchase the IMC2 from the
outside vendor. Qualitative factors to consider would be (1)
quality of the component (2) on-time delivery, and (3) reliability
of the vendor.
(c)
EXERCISE 7-9 Net Income Increase (Decrease) $(5) $(7) (9) $(2)
$(3)
Sell (Basic Kit) Sales per unit Costs per unit Direct materials
Direct labor Total Net income per unit $30 $14 0 $14 $16
Process Further (Stage 2 Kit) ( )$35( ) ( ) $ 7 (1) ( ) 9 (2) (
) $16 ( ) ( ) $19 ( )
(1) The cost of materials decreases because Rachel can make two
Stage 2 Kits from the materials for a basic kit. (2) The total time
to make the two kits is one hour at $18 per hour or $9 per
unit.
EXERCISE 7-9 (Continued) Rachel should carry the Stage 2 Kits.
The incremental revenue, $5, exceeds the incremental processing
costs, $2. Thus, net income will increase by processing the kits
further.
EXERCISE 7-10 (a) Sales ($60,000 + $15,000 + $55,000) Joint
costs Net income $ 130,000 (100,000) $ 30,000
(b) Sales ($190,000 + $35,000 + $215,000) Joint costs Additional
costs ($100,000 + $30,000 + $150,000) Net income (c) Incremental
revenue Incremental costs Incremental profit (loss)(1) (1)
$ 440,000 (100,000) (280,000) $ 60,000
Product 10 Product 12 Product 14 $ 130,000 $ 20,000 $ 160,000
(30,000) (150,000) (100,000) $ 30,000 $(10,000) $ 10,000
Sales value after further processing Sales value @ split-off
point
Products 10 and 14 should be processed further and product 12
should be sold at the split-off point. (d) Sales ($190,000 +
$15,000 + $215,000) Joint costs Additional costs ($100,000 +
$150,000) Net income $ 420,000 (100,000) (250,000) $ 70,000
Net income is $10,000 ($70,000 $60,000) higher in (d) than in
(b) because product 12 is not processed further, thereby increasing
overall profit $10,000.
EXERCISE 7-11 To determine whether each of the three joint
products should be sold as is, or processed further, we must
determine the incremental profit or loss that would be earned by
each. The allocated joint costs are irrelevant to the decision
since these costs will not change whether or not the products are
sold as is or processed further. Larco Incremental revenue
Incremental cost Incremental profit (loss) $100,000* (110,000) $
(10,000) Marco $100,000 ** (85,000 ) $ 15,000 Narco $395,000 ***
(250,000 ) $145,000
From this analysis we see that Marco and Narco should be
processed further because the incremental revenue exceeds the
incremental costs, but Larco should be sold as is. *$300,000
$200,000 EXERCISE 7-12 (a) The costs that are relevant in this
decision are the incremental revenues and the incremental costs
associated with processing the material past the split-off point.
Any costs incurred up to the split-off point are sunk costs, and
therefore, irrelevant to this decision. Revenue after further
processing: Product D$60,000 (4,000 units X $15.00 per unit)
Product E$97,200 (6,000 units X $16.20 per unit) Product F$45,200
(2,000 units X $22.60 per unit) Revenue at split-off: Product
D$40,000 (4,000 units X $10.00 per unit) Product E$69,600 (6,000
units X $11.60 per unit) Product F$38,800 (2,000 units X $19.40 per
unit) Incremental revenue Incremental cost Increase (decrease) in
profit D $20,000 (14,000) $ 6,000 E $27,600 (20,000) $ 7,600 F $
6,400 (9,000) $(2,600) **$400,000 $300,000 ***$800,000 $405,000
(b)
Products D and E should be processed further. (c) The decision
would remain the same. It does not matter how the joint costs are
allocated because joint costs are irrelevant to this decision.
EXERCISE 7-13 (a) Cost Accumulated depreciation Book value Sales
proceeds Loss on sale $100,000 (25,000*) 75,000 40,000 $ 35,000
*One years depreciation: ($100,000 $0) 4 years (b) Retain
Scanner $315,000* Replace Scanner $225,000** 110,000 (40,000)
$295,000 Net Income Increase (Decrease) $ 90,000 (110,000) 40,000 $
20,000
Annual operating costs New scanner cost Old scanner salvage
Total
$315,000
*(3 years X $105,000) **[3 years X ($105,000 $30,000)] Yes.
Benson Hospital should replace the old scanner because it will
result in a savings of $20,000 over the next four years. (c) As
shown in (a) above, replacing the old scanner will result in
reporting a loss of $35,000. Reluctance to report losses of this
nature is the usual reason for not recognizing that a poor decision
was made in the past. The remaining book value of the old scanner
($75,000) is a sunk cost. It will be deducted in the future, if the
scanner is retained, or written off now if it is replaced. However,
if it is replaced now, that cost will be partially offset by the
salvage value that Dyno is willing to pay ($40,000).
EXERCISE 7-14 Net Income Increase (Decrease) ($ 25,000 (
(25,000) ( 6,000 ($ 6,000
Operating costs New machine cost Salvage value (old) Total (1)
$25,000 X 5. (2) $20,000 X 5.
Retain Replace Machine Machine $125,000 (1) ($100,000) (2) 0 (
25,000) 0 ( (6,000) $125,000 ($119,000)
The current machine should be replaced. The incremental analysis
shows that net income for the five-year period will be $6,000
higher by replacing the current machine.
EXERCISE 7-15 Net Income Increase (Decrease) $(100,000) (61,000)
(26,000) (87,000) (13,000) ( 0) ( 0) ( 0) $ (13,000)
Sales Variable costs Cost of goods sold Operating expenses Total
variable Contribution margin Fixed costs Cost of goods sold
Operating expenses Total fixed Net income (loss)
Continue $100,000) ( 61,000) (26,000) (87,000) (13,000) (15,000)
(24,000) (39,000) $(26,000)
Eliminate $( 0) ( ( ( ( 0) 0) 0) 0)
(15,000) (24,000) (39,000) $(39,000)
Judy is incorrect. The incremental analysis shows that net
income will be $13,000 less if the Huron Division is eliminated.
This amount equals the contribution margin that would be lost
through discontinuing the division. (Note: None of the fixed costs
can be avoided.)
EXERCISE 7-16 (a) (b) Sales Variable expenses Contribution
margin Fixed expenses Net income $30,000 + $70,000 $40,000 =
$60,000 Tingler $300,000 150,000 150,000 142,500* $ 7,500 Shocker
$500,000 200,000 300,000 267,500** $ 32,500 Total $800,000 350,000
450,000 410,000 $ 40,000
*$30,000 + [($300,000 $800,000) X $300,000] **$80,000 +
[($500,000 $800,000) X $300,000] (c) As shown in the analysis
above, Cawley should not eliminate the Stunner product line.
Elimination of the line would cause net income to drop from $60,000
to $40,000. The reason for this decrease in net income is that
elimination of the product line would result in the loss of $55,000
of contribution margin while saving only $35,000 of fixed
expenses.
EXERCISE 7-17 Calculation of contribution margin per unit: C $95
50 $45 D $75 40 $35 E $115 40 $ 75
Selling price per unit Less: variable costs/unit Contribution
margin/unit
Fixed costs = $22 X (9,000 + 20,000) = $638,000 Company profit
with Products C and D: C 9,000 $855,000 450,000 $405,000 D 20,000
$1,500,000 800,000 $ 700,000 Total
Units sold Sales revenue Less: Variable costs Contribution
margin Less: Fixed costs Net income
$2,355,000 $1,250,000 1,105,000 638,000 $ 467,000
EXERCISE 7-17 (Continued) Company profit with Products C and E:
C 9,900* $940,500 495,000 $445,500 E 10,000 $1,150,000 400,000 $
750,000 Total
Units sold Sales revenue Less: Variable costs Contribution
margin Less: Fixed costs Net income
$2,090,500 895,000 1,195,500 638,000 $ 557,500
*Product C sales increase by 10%, (9,000 X 110%) Yes they should
introduce Product E since net profit would increase by $90,500
($557,500 $467,000). EXERCISE 7-18 1. Irrelevant. Unavoidable costs
will be incurred regardless of the decision made. 2. Relevant. 3.
Irrelevant. This is a sunk cost and all sunk costs are irrelevant.
4. Irrelevant. These are sunk costs. 5. Relevant. 6. Relevant. 7.
Relevant. 8. Relevant. 9. Irrelevant. If there is no change in the
direct materials charge regardless of the decision made, the cost
is irrelevant. 10. Relevant.
SOLUTIONS TO PROBLEMSPROBLEM 7-1A
(a) Reject Order Revenues (10,000 X $27) Cost of goods sold
Selling and administrative expenses Net income $0 0 0 $0 Accept
Order $270,000 220,000 (1) 20,000 (2) $ 30,000
Net Income Increase (Decrease) $ 270,000 ( (220,000) ( (20,000)
$ 30,000
(1) Variable costs = $3,600,000 $960,000 = $2,640,000;
$2,640,000 120,000 units = $22.00 per unit; 10,000 X $22.00 =
$220,000. (2) Variable costs = $405,000 $225,000 = $180,000;
$180,000 120,000 units = $1.50 per unit; 10,000 X ($1.50 + $0.50) =
$20,000. (b) Yes, the special order should be accepted because net
income will increase by $30,000. (c) Unit selling price = $22.00
(variable manufacturing costs) + $2.00 variable selling and
administrative expenses + $4.00 net income = $28. (d) Nonfinancial
factors to be considered are: (1) possible effect on domestic
sales, (2) possible alternative uses of the unused plant capacity,
and (3) ability to meet customers schedule for delivery without
increasing costs.
PROBLEM 7-2A
(a) Make CISCO Direct materials (8,000 X $4.80) Direct labor
(8,000 X $4.30) Indirect labor (8,000 X $.43) Utilities (8,000 X
$.40) Depreciation Property taxes Insurance Purchase price Freight
and inspection (8,000 X $.35) Receiving costs Total annual cost
$38,400 34,400 3,440 3,200 3,000 700 1,500 0 0 0 $84,640 Buy CISCO
$ 0 0 0 0 900 200 600 80,000 2,800 1,300 $85,800
Net Income Increase (Decrease) ($38,400) ( 34,400) ( 3,440) (
3,200) ( 2,100) ( 500) ( 900) ( (80,000) ( (2,800) ( (1,300) ($
(1,160)
(b) The company should continue to make CISCO because net income
would be $1,160 less if CISCO were purchased from the supplier. (c)
The decision would be different. Because of the opportunity cost of
$3,000, net income will be $1,840 higher if CISCO is purchased as
shown below: Net Income Increase Make CISCO Buy CISCO (Decrease)
Total annual cost $85,800 $(1,160) $84,640 Opportunity cost 0
(3,000) 3,000 $87,640 $85,800 $(1,840) Total cost (d) Nonfinancial
factors include: (1) the adverse effect on employees if CISCO is
purchased, (2) how long the supplier will be able to satisfy the
Shatner Manufacturing Companys quality control standards at the
quoted price per unit, and (3) whether the supplier will deliver
the units when they are needed by Shatner.
PROBLEM 7-3A
(a) (1)
Table Cleaner Not Processed Further Sales: FloorShine (600,000
30) X $20 Table Cleaner (300,000 25) X $18 Total revenue Costs: CDG
Additional costs of FloorShine Total costs Gross profit
$400,000 216,000 $616,000 210,000 240,000 450,000 $166,000
(2)
Table Cleaner Processed Further Sales: FloorShine Table Stain
Remover (300,000 25) X $14 Table Polish (300,000 25) X $14 Total
revenue Costs: CDG Additional costs of FloorShine TCP Total costs
Gross profit
$400,000 168,000 168,000 $736,000 210,000 240,000 100,000
550,000 $186,000
(3) If the table cleaner is processed further overall company
profits will be $20,000 higher. Therefore, management made the
wrong decision by choosing to not process table cleaner
further.
PROBLEM 7-3A (Continued) (b) Dont Process Table Cleaner Further
$216,000 0 $216,000 Process Table Cleaner Further $336,000 100,000
$236,000 Net Income Increase (Decrease) $120,000 (100,000) $
20,000
Incremental revenue Incremental costs Totals
When trying to decide if the table cleaner should be processed
further into TSR and TP, only the relevant data need be considered.
All of the costs that occurred prior to the creation of the table
cleaner are sunk costs and can be ignored. The decision should be
made by comparing the incremental revenue from further processing
to the incremental costs.
PROBLEM 7-4A (a) Cost Accumulated depreciation Book value Sales
proceeds Loss on sale *$120,000 5 years = $24,000 (b) (1) Revenues
($240,000 X 4 yrs.) Less costs: Variable costs ($35,000 X 4) Fixed
costs ($23,000 X 4) Selling & administrative Depreciation Net
income *($29,000 X 4) (2) Revenues Less costs: Variable costs
($10,000 X 4) Fixed costs ($8,500 X 4) Selling and administrative
Depreciation Operating income Less: Loss on old elevator Net income
(c) Retain Old Elevator $140,000 92,000.
$120,000 (24,000*) 96,000 (25,000) $ 71,000
Retain Old Elevator $960,000 $140,000 92,000 116,000* 96,000
444,000 $516,000
Replace Old Elevator $960,000 $ 40,000 34,000 116,000
160,000
350,000 610,000 71,000 $539,000 Net Income Increase (Decrease) $
100,000 58,000 (160,000) 25,000 $ 23,000
Variable operating costs Fixed operating costs New elevator cost
Salvage on old elevator Totals
$232,000
Replace Old Elevator $ 40,000 34,000 160,000 (25,000)
$209,000
PROBLEM 7-4A (Continued) (d) TO: Ron Richter FROM: Student
SUBJECT: Relevant Data for Decision to Replace Old Elevator When
deciding whether or not to replace any old equipment, the analysis
should only include cost data relevant to the replacement decision.
The $71,000 loss that would be experienced if we replace the old
elevator with the newer model is related to a sunk cost, namely the
cost of the old elevator. Sunk costs are irrelevant in decision
making. The loss occurs when comparing the book value of the old
elevator to the cash proceeds that would be received. The book
value of $96,000 would be deducted as depreciation expense over the
next four years if the elevator were retained. If the elevator is
replaced with the newer model, the book value will be expensed in
the current year, less the cash proceeds received on disposal.
Therefore, the $96,000 book value will be expensed under either
alternative, making it irrelevant. MEMO
PROBLEM 7-5A
(a) Sales Variable costs Cost of goods sold Selling and
administrative Total variable expenses Contribution margin (b)
(1)Division I Contribution margin (above) Fixed costs Cost of goods
sold Selling and administrative Total fixed expenses Income (loss)
from operations
Division I $250,000 150,000 30,000 180,000 ($ 70,000)
Division II $200,000 172,800 42,000 214,800 $ (14,800)Net Income
Increase (Decrease) $(70,000) 25,000 22,500 47,500 $(22,500) Net
Income Increase (Decrease) $14,800 ( 9,600 9,000 18,600 $33,400
Continue $(70,000) (50,000) (45,000) (95,000) $(25,000)
Eliminate $( 0)
(25,000) (22,500) (47,500) $(47,500)
(2)Division II Contribution margin (above) Fixed costs Cost of
goods sold Selling and administrative Total fixed expenses Income
(loss) from operations Continue $(14,800) (19,200 ( 18,000 ( 37,200
$(52,000) Eliminate $( 0)
( 9,600) ( 9,000) (18,600) $(18,600)
Division II should be eliminated as its negative contribution
margin is $14,800. Income from operations would increase $33,400 if
Division II is eliminated. Division I should be continued because
it is producing positive contribution margin of $70,000. Income
from operations will decrease $22,500 by discontinuing this
division.
PROBLEM 7-5A (Continued) (c) GUTIERREZ COMPANY CVP Income
Statement For the Quarter Ended March 31, 2014Divisions I Sales
Variable costs Cost of goods sold Selling and administrative Total
variable costs Contribution margin Fixed costs Cost of goods sold
(1) Selling and administrative (2) Total fixed costs Income (loss)
from operations $250,000 150,000 30,000 180,000 70,000 53,200
48,000 101,200 III $500,000 240,000 30,000 270,000 230,000 63,200
33,000 96,200 IV $450,000 187,500 30,000 217,500 232,500 65,700
23,000 88,700 $143,800 Total $1,200,000 577,500 90,000 667,500
532,500 182,100 104,000 286,100 $ 246,400
$(31,200) $133,800
(1) Divisions fixed cost of goods sold plus 1/3 of Division IIs
unavoidable fixed cost of goods sold [$192,000 X (100% 90%) X 50% =
$9,600]. Each divisions share is $3,200. (2) Divisions fixed
selling and administrative expense plus 1/3 of Division IIs
unavoidable fixed selling and administrative expenses [$60,000 X
(100% 70%) X 50% = $9,000]. Each divisions share is $3,000. (d)
Income from operations with Division II of $213,000 (given) plus
incremental income of $33,400 from eliminating Division II =
$246,400 income from operations without Division II.
PROBLEM 7-1B
(a) Reject Order Revenues (10,000 X $30) Cost of goods sold
Selling and administrative expenses Net income $0 0 0 $0 Accept
Order
Net Income Increase (Decrease)
$ 300,000 $300,000 240,000 (1) ( (240,000) 25,000 (2) ( (25,000)
$ 35,000 $ 35,000
(1) Variable costs = $3,060,000 $900,000 = $2,160,000;
$2,160,000 90,000 units = $24 per unit; 10,000 X $24 = $240,000.
(2) Variable costs = $360,000 $180,000 = $180,000; $180,000 90,000
units = $2.00 per unit; 10,000 X ($2.00 + $0.50) = $25,000. (b)
Yes, the special order should be accepted because net income will
be increased by $35,000. (c) Unit selling price = $24 (variable
manufacturing costs) + $2.50 (variable selling and administrative
expenses) + $5.50 (net income) = $32.00. (d) Nonquantitative
factors to be considered are: (1) possible effect on domestic
sales, (2) possible alternative uses of the unused plant capacity,
and (3) ability to meet customers schedule for delivery without
increasing costs.
PROBLEM 7-2B
(a)Make FIZBE Direct materials (5,000 X $4.75) Direct labor
(5,000 X $4.60) Indirect labor (5,000 X $.45) Utilities (5,000 X
$.35) Depreciation Property taxes Insurance Purchase price Freight
and inspection (5,000 X $.30) Receiving costs Total annual cost
$23,750 23,000 2,250 1,750 2,000 700 1,500 0 0 0 $54,950 Buy FIZBE
$ 0 0 0 0 900 200 600 56,000
Net Income Increase (Decrease) ($ 23,750 ( 23,000 ( 2,250 (
1,750 ( 1,100 ( 500 ( 900 ( (56,000) ( (1,500) (500) ($ (4,750)
1,500 500 $59,700
(b) The company should continue to make FIZBE because net income
would be $4,750 less if FIZBE were purchased from the supplier. (c)
The decision would be different. Because of the opportunity cost of
$6,000, net income will be $1,250 higher if FIZBE is purchased as
shown below: Net Income Increase (Decrease) $(4,750) 6,000 $
1,250
Make FIZBE Total annual cost Opportunity cost Total cost $54,950
6,000 $60,950
Buy FIZBE $59,700 0 $59,700
(d) Nonfinancial factors include: (1) the adverse effect on
employees if FIZBE is purchased, (2) how long the supplier will be
able to satisfy the Gill Corporations quality control standards at
the quoted price per unit, and (3) will the supplier deliver the
units when they are needed by Gill?
PROBLEM 7-3B
(a) (1)
General-Purpose Cleaner Not Processed Further Sales ShineBrite
(750,000 25) X $15 General-Purpose Cleaner (250,000 20) X $20 Total
revenue Costs NPR Additional costs for ShineBrite Total costs Gross
profit
$450,000 250,000 $700,000 200,000 300,000 500,000 $200,000
(2)
General-Purpose is Processed Further Sales ShineBrite (750,000
25) X $15 Premium Cleaner (250,000 20) X $16 Premium Stain Remover
(250,000 20) X $16 Total revenue Costs NPR Additional costs for
ShineBrite PST Total costs Gross profit
$450,000 200,000 200,000 $850,000 200,000 300,000 140,000
640,000 $210,000
(3) If the general-purpose cleaner is processed further overall
company profits will be $10,000 higher. Therefore, management made
the wrong decision by choosing to not process the general-purpose
cleaner further.
PROBLEM 7-3B (Continued) (b) Dont Process G-P Cleaner Further
$250,000 0 $250,000 Process G-P Cleaner Further $400,000 140,000
$260,000 Net Income Increase (Decrease) $150,000 (140,000) $
10,000
Incremental revenue Incremental costs Totals
When trying to decide if the general-purpose cleaner should be
processed further into PC and PSR, only the relevant data need be
considered. All of the costs that occurred prior to the creation of
the general-purpose cleaner are sunk costs and can be ignored. The
decision should be made by comparing the incremental revenue from
further processing to the incremental costs.
PROBLEM 7-4B
(a)
Cost Accumulated depreciation Book value Sales proceeds Loss on
sale *$210,000 5 years = $42,000
$210,000 (42,000*) 168,000 (58,000) $110,000
(b) (1) Revenues ($360,000 X 4 yrs.) Less costs: Variable costs
Fixed costs Selling & administrative Depreciation Net income
(2) Revenues Less costs: Variable costs Fixed costs Selling and
administrative Depreciation Operating income Less: Loss on old
equipment Net income (c) Retain Old Equipment $200,000 120,000.
Retain Old Equipment $1,440,000 $200,000 120,000 180,000
168,000
668,000 $ 772,000 Replace Old Equipment $1,440,000
$ 48,000 20,000 180,000 250,000
498,000 942,000 110,000 $ 832,000 Net Income Increase (Decrease)
$152,000 100,000 (250,000) 58,000 $ 60,000
Variable costs Fixed costs New equipment cost Salvage on old
equipment Totals
$320,000
Replace Old Equipment $ 48,000 20,000 250,000 (58,000)
$260,000
PROBLEM 7-4B (Continued) (d) TO: Gene Simmons FROM: Student
SUBJECT: Relevant Data for Decision to Replace Old Equipment When
deciding whether or not to replace any old equipment, the analysis
should only include cost data relevant to the replacement decision.
The $110,000 loss that would be experienced if we replace the old
equipment with the newer equipment is related to a sunk cost,
namely the cost of the old equipment. Sunk costs are irrelevant in
decision making. The loss occurs when comparing the book value of
the old equipment to the cash proceeds that would be received. The
book value of $168,000 would be deducted as depreciation expense
over the next four years if the equipment were retained. If the
equipment is replaced with the newer model the book value will be
expensed in the current year, less the cash proceeds received on
disposal. Therefore, the $168,000 book value will be expensed under
either alternative, making it irrelevant. MEMO
PROBLEM 7-5B
(a) Sales Variable expenses Cost of goods sold Selling and
administrative Total variable expenses Contribution margin (b)
(1)Division III Contribution margin (above) Fixed expenses Cost of
goods sold Selling and administrative Total fixed expenses Income
(loss) from operations
Division III $310,000 189,000 45,000 234,000 $ 76,000
Division IV $170,000 140,400 49,000 189,400 ($ (19,400)Net
Income Increase (Decrease) $(76,000) 40,500 15,000 55,500 $(20,500)
Net Income Increase (Decrease) $19,400 7,800 10,500 18,300
$37,700
Continue $ 76,000 81,000 30,000 111,000 ($(35,000)
Eliminate $ 0
(40,500 15,000 55,500 $(55,500)
(2)Division IV Contribution margin (above) Fixed expenses Cost
of goods sold Selling and administrative Total fixed expenses
Income (loss) from operations Continue $(19,400) (15,600) 21,000)
36,600) $(56,000) Eliminate $ 0
7,800 10,500 18,300 $(18,300)
Division III should be continued as contribution margin
($76,000) is greater than the savings in fixed costs ($55,500) that
would result from elimination. Therefore, income from operations
would decrease $20,500 if Division III is eliminated. Division IV
should be eliminated because it is producing negative contribution
margin ($19,400). Income from operations will increase $37,700 by
discontinuing this division.
PROBLEM 7-5B (Continued) (c) PANDA COMPANY CVP Income Statement
For the Quarter Ended March 31, 2014Divisions I Sales Variable
expenses Cost of goods sold Selling and administrative Total
variable expenses Contribution margin Fixed expenses Cost of goods
sold (1) Selling and administrative (2) Total fixed expenses Income
(loss) from operations $510,000 210,000 24,000 234,000 276,000
92,600 39,500 132,100 $143,900 II $400,000 200,000 40,000 240,000
160,000 52,600 43,500 96,100 $ 63,900 III $310,000 189,000 45,000
234,000 76,000 83,600 33,500 Total $1,220,000 599,000 109,000
708,000 512,000 228,800 116,500
117,100 345,300 $ (41,100) $ 166,700
(1) Divisions fixed cost of goods sold plus 1/3 of Division IVs
unavoidable fixed cost of goods sold [$156,000 X (100% 90%) X 50% =
$7,800]. Each divisions share is $2,600. (2) Divisions fixed
selling and administrative expenses plus 1/3 of Division IVs
unavoidable fixed selling and administrative expenses [$70,000 X
(100% 70%) X 50% = $10,500]. Each divisions share is $3,500. (d)
Income from operations with Division IV of $129,000 (given) plus
incremental income of $37,700 from eliminating Division IV =
$166,700 income from operations without Division IV.
BYP 7-1
DECISION-MAKING AT CURRENT DESIGNS
Situation #1 (a) Current Designs should accept the special order
based on the following calculations: Net Income Increase (Decrease)
$25,000 (19,000) $ 6,000
Revenues Costs Net Income
Reject Order $0 0 $0
Accept Order $25,000* (19,000)** $ 6,000
*(100 X $250) **(($80 + $60 + $20) X 100) + ($1,000 + $2,000)
(b) Assuming that Current Designs is currently operating with
excess capacity, it should accept the order based on the
calculations shown in part (a). If Current Designs is currently
operating at full capacity, it would have to weigh its options. If
it displaced production of regular kayaks in order to fill this
order, it would have to consider the opportunity costs associated
with this decision. The opportunity cost, when operating at full
capacity, would be the lost contribution margin from regular sales
given up in order to fulfill the special order. Alternatively,
rather than reject the special order, it might consider temporarily
expanding the plants capacity by adding an additional production
shift to handle the special order. If this option were considered,
it would have to identify all additional incremental costs (for
example, overtime pay) that would be incurred.
BYP 7-1 (Continued) Situation #2 (a) Current designs should not
replace the Rotomold oven based on the following calculations:Net
Income Increase (Decrease) $ 13,000 (250,000) 10,000 ($
227,000)
Variable manufacturing costs New oven cost Proceeds from
scrapping old oven Total
Retain Oven $110,500* 0 0 $110,500
Replace Oven $ 97,500** 250,000 (10,000) $337,500
*(17,000 therms/year X $0.65/therm X 10 years) **(15,000
therms/year X $0.65/therm X 10 years)
(b) Even with the cost of natural gas increasing at a faster
than expected rate, Current Designs still should not replace the
Rotomold oven as the rate increase does not cover the cost of the
new oven based on the following calculations:Net Income Increase
(Decrease) $ 17,000 (250,000) 10,000 ($ 223,000)
Variable manufacturing costs New oven cost Proceeds from
scrapping old oven Total
Retain Oven $144,500* 0 0 $144,500
Replace Oven $127,500** 250,000 (10,000) $367,500
*(17,000 therms/year X $0.85/therm X 10 years) **(15,000
therms/year X $0.85/therm X 10 years)
BYP 7-1 (Continued) Situation #3 (a) Current Designs should make
the seats based on the following calculations: Net Income Increase
(Decrease) $ 60,000 45,000 36,000 5,000 (150,000) ($ 4,000)
Direct materials Direct labor Variable manufacturing costs Fixed
manufacturing costs Purchase price ($50 X 3,000) Total annual
cost
Make $ 60,000 45,000 36,000 20,000 0 $161,000
Buy 0 0 0 15,000 150,000 $165,000 $
(b) When the opportunity cost of $20,000 is considered, Current
Designs should buy the seats based on the following calculations:
Net Income Increase (Decrease) ($ 4,000) 20,000 $16,000
Total annual cost Opportunity cost Total cost
Make $161,000 20,000 $181,000
Buy $165,000 0 $165,000
BYP 7-2
DECISION-MAKING ACROSS THE ORGANIZATION
Retain Old Machine Sales Costs and expenses Cost of goods sold
Selling expenses Administrative expenses Purchase price Total costs
and expenses Net income (1) (2) (3) (4) (5) $6,000,000 (1)
4,500,000 (3) 900,000 500,000 5,900,000 $ 100,000
Purchase New Machine $6,600,000 (2) 4,620,000 (4) 990,000
565,000 150,000 (5) 6,325,000 $ 275,000
Net Income Increase (Decrease) ($ 600,000 ( (120,000) ( (90,000)
( (65,000) ( (150,000) ( (425,000) ($ 175,000
12,000 X $100 X 5 years = $6,000,000. $6,000,000 X 110% =
$6,600,000. $6,000,000 X (100% 25%) = $4,500,000. $6,600,000 X
(100% 30%) = $4,620,000. $140,000 + $4,000 + $6,000 = $150,000.
The new machine should be purchased. The incremental analysis
shows that net income will increase from $100,000 to $275,000 over
the five years with the new machine.
BYP 7-3
MANAGERIAL ANALYSIS
(a) Make Sales Revenue Variable Manufacturing Cost: Circuit
Board Plastic Case Alarms (4 @ $.15 each) Labor Overhead Purchase
Cost Fixed Manufacturing Cost: Total Manufacturing Cost Profit per
Unit Total Profit $ 14.50 2.00 0.80 0.60 3.00 0.50 0 6.90 $ 7.60
$38,000
Buy TransTech $ 14.50 0 0 0 0 0 10.00 1.00* 11.00 $ 3.50
$17,500
Buy Omega $ 14.50 0 0 0 0 0 5.00 1.00 6.00 $ 8.50 $42,500
*The $5,000 cost that will continue to be incurred, even if the
product is not manufactured, divided by the 5,000 units. The
company will make the most profit if the clocks are purchased from
Omega Company. The company will make $4,500 less if the clocks are
manufactured by MiniTek. The company will make $25,000 less if the
clocks are purchased from Trans-Tech. (b) There are several
important nonfinancial factors described in the case. Other factors
might be identified as well. The factors described are: The company
is having serious difficulty manufacturing the clocks. Therefore,
it would probably be willing to have someone else manufacture the
clocks, even if it cost more to do so. The most promising company
appears to be Omega; however, there is a serious question about
Omegas ability to remain in business. However, the company could
purchase just this one order from Omega, and then continue to
search for another manufacturer, or stop manufacturing the clocks.
Trans-Techs stringent requirements for preferred customer status,
in the form of large sales requirements, appear to limit the
possibilities for MiniTek to use it as a supplier. However, if
MiniTek does desire to continue to offer the clocks because of
their popularity, then perhaps Trans-Tech could be used in the
future.
BYP 7-3 (Continued) (c) Many answers are possible, depending
upon each students assessment of the seriousness of the issues
mentioned in (b). One answer would be: The company should use Omega
to manufacture the Kmart order. After that, the company should not
offer the clocks any longer. Especially since the clocks are no
longer very profitable, it does not seem like a good idea to keep
spending money to modify the process.
BYP 7-4
REAL-WORLD FOCUS
(a) Before building the special-order new ceiling fans, company
management must consider the effect of the new lines on current
production capacity, existing and available channels of
distribution, the effect on manufacturing efficiency, the effect on
sales of current lines of product, and the supply of materials and
labor. (b) Incremental analysis would provide a financial
comparison of income with the special-order ceiling fans to income
without the special orders.
BYP 7-5
REAL-WORLD FOCUS
(a) The types of outsourcing services that the company provides
assistance on are: Information technology outsourcing, finance and
accounting, human resource outsourcing, business process
outsourcing, procurement, and call centers. (b) Insourcing means to
take work that is currently being performed by an outside service
provider back in-house. For example, collections of accounts
receivable might currently be performed by a collection agency, and
you might decide to establish a collection group within your
company. (c) Some of the benefits of insourcing include: Greater
control over resources Greater ability to control intellectual
property Increased visibility of accountability within the
organization
BYP 7-6
COMMUNICATION ACTIVITY
To: From:
Preston ThiesePlant Manager Hank JewelProduction Manager
I have spent considerable time thinking about the dilemma
created by the new PDD1130 machine. Clearly, it is far superior to
our existing machine. There is no question that it would save us
tremendous amounts of money. I hope I am not overstepping my bounds
here, but I just reviewed a chapter in my managerial accounting
text on incremental analysis which has made me think we need to
reconsider this decision. The key to incremental analysis is
identifying relevant costs. Relevant costs are those costs that
vary depending on the course of action taken. In our situation, a
relevant cost would be the savings that we would experience were we
to purchase the new machine. The book value of the existing machine
is not a relevant cost since it would not be changed by purchasing
or not purchasing the new machine. Costs incurred in the past that
do not change are referred to as sunk costs. Sunk costs are
irrelevant to incremental analysis. I would really like to lay out
an analysis of our options to decide the proper course of action. I
am concerned that by using the old machine for a couple of years
the profitability of the plant could be impacted negatively.
BYP 7-7
ETHICS CASE
(a) Many factors need to be considered when determining whether
to close a division. The loss of jobs can have a devastating impact
on a community and on the morale of remaining employees. From a
financial perspective, closing a division that is reporting losses
will not necessarily increase the reported net income of the
company. The reason: if fixed costs that have been allocated to a
division that is closed are reallocated to the remaining divisions,
the companys net income might actually decrease. This sounds like
it would most likely be the case at Peters. (b) It is not unusual
to reevaluate fixed cost allocations periodically. However, the
allocation should be based on the underlying economics of the
situation rather than the motives of individuals. (c) Blake should
explain to the board of directors that the change in income is due
to a reallocation and that closing the plumbing division is not
advisable. In this case, being honest is not only the ethical thing
to do, but it will also maximize the companys net income.
BYP 7-8
ALL ABOUT YOU
(a) Chronic homelessness is defined as being on the streets for
a year or more. (b) Homelessness costs cities money because the
chronic homeless have frequent jail time, shelter costs, emergency
room visits and hospital stays. Some costs per city per homeless
person are: New York $40,000; Dallas $50,000; San Diego $150,000.
(c) The first step is to try to identify the size of the problem by
doing street counts. From this count, benchmarks can be set,
enabling a reward system for meeting goals. Next is to identify
what the homeless people want. What do they think they need to help
them address their problem? They typically want adequate housing
with some privacy. (d) It has been estimated that in New York this
approach costs about $22,000 per year. New York has documented an
88% success rate (defined as not returning to the streets for five
years). (e) In terms of incremental analysis, two alternatives are
to either continue with the current situation, with the costs
presented in part (b) or to implement the approach outlined in part
(d). From a purely financial perspective the approach in (d)
appears to have significant merit. Also (d) does not even take into
account the intangible benefits of improving the quality of life
for this segment of the population.
BYP 7-9
CONSIDERING YOUR COSTS AND BENEFITS
Discussion guide: This is a very difficult decision. All of the
evidence suggests that your short-term and long-term prospects will
be far greater with some form of posthigh-school degree. Because of
this, we feel strongly that you should make every effort to
continue your education. Many of the discussions provided in this
text present ideas on how to get control of your individual
financial situation. We would encourage you to use these tools to
identify ways to reduce your financial burden in order to continue
your education. We also want to repeat that even taking only one
course a semester is better than dropping out. Your instructors and
advisors frequently provide advice to students who are faced with
the decision about whether to continue with their education. If you
are in this situation, we would encourage you to seek their advice
since the implications of this decision can be long-lasting.