Incremental Analysis

INCREMENTAL ANALYSIS TRUE-FALSE STATEMENTS 1.

An important step in management's decision-making process is to determine and evaluate possible courses of action.

2.

In making decisions, management ordinarily considers both financial and nonfinancial information.

3.

In incremental analysis, total variable costs will always change under alternative courses of action, and total fixed costs will always remain constant.

4.

Accountants are mainly involved in developing nonfinancial information for management's consideration in choosing among alternatives.

5.

Decision-making involves choosing among alternative courses of action.

6.

Financial data are developed for a course of action under an incremental basis and then it is compared to data developed under a differential basis before a decision is made.

7.

A special one-time order should never be accepted if the unit sales price is less than the unit variable cost.

8.

If a company has excess capacity and present markets will not be affected, it would be profitable to accept an order at a special unit price even though the price is less than the unit variable cost to manufacture the item.

9.

A company should never accept an order for its product at less than its regular sales price.

10.

A decision whether to continue to make a product or buy it externally, depends on the external price and the amount of variable and fixed costs that can be eliminated assuming no alternative uses of resources.

11.

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

12.

If an incremental make or buy analysis indicates that it is cheaper to buy rather than make an item, management should always make the decision to choose the lowest cost alternative.

13.

In a sell or process further decision, management should process further as long as the incremental revenues from additional processing exceed the incremental variable costs.

14.

It is always better to sell now rather than process further because of the time value of money.

15.

In a decision concerning replacing old equipment with new equipment, the book value of the old equipment can be considered a sunk cost.

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Test Bank for Managerial Accounting, Second Edition

16.

In a decision to retain or replace old equipment, the salvage value of the old equipment is relevant in incremental analysis.

17.

It is better not to replace old equipment if it is not fully depreciated.

18.

From a quantitative standpoint, a segment should be eliminated if its contribution margin is less than the fixed costs that can be eliminated.

19.

The elimination of an unprofitable product line may adversely affect the remaining product lines.

20.

Sales mix is the relative combination in which a company’s products are sold.

21.

Break-even sales can be computed for a mix of two or more products by determining the total contribution margin of all the products.

22.

Net income will be greater if more high contribution margin units are sold than low contribution margin units at any given level of units sold.

23.

When a company has limited resources to manufacture products, it should manufacture those products which have the highest contribution margin per unit of limited resource.

24.

If a company has only a certain number of machine hours available for production, it is generally more profitable to produce and sell the product with the highest unit contribution margin.

25.

Contribution margin per unit of limited resource is usually the same as contribution margin per unit.

Answers to True-False Statements Item

1.

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5. 8.

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9. 12.

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21. 24.

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MULTIPLE CHOICE QUESTIONS 26.

A major accounting contribution to the managerial decision-making process in evaluating possible courses of action is to a. assign responsibility for the decision. b. provide relevant revenue and cost data about each course of action. c. determine the amount of money that should be spent on a project. d. decide which actions that management should consider.

27.

Which of the following stages of the management decision-making process is improperly sequenced? a. Evaluate possible courses of action è Make decision. b. Assign responsibility for decision è Identify the problem. c. Identify the problem è Determine possible courses of action. d. Assign responsibility for decision è Determine possible courses of action.

28.

Internal reports that review the actual impact of decisions are prepared by a. department heads. b. the controller. c. management accountants. d. factory workers.

29.

Which of the following steps in the management decision-making process does not generally involve the managerial accountant? a. Determine possible courses of action. b. Make the appropriate decision based on relevant data. c. Prepare internal reports that review results of decisions. d. None of these

30.

The process of evaluating financial data that change under alternative courses of action is called a. double entry analysis. b. contribution margin analysis. c. incremental analysis. d. cost-benefit analysis.

31.

Nonfinancial information that management might evaluate in making a decision would not include a. employee turnover. b. contribution margin. c. the environment. d. the corporate profile in the community.

32.

Incremental analysis is synonymous with a. difficult analysis. b. differential analysis. c. gross profit analysis. d. derivative analysis.

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Test Bank for Managerial Accounting, Second Edition

33.

In incremental analysis, a. only costs are analyzed. b. only revenues are analyzed. c. both costs and revenues may be analyzed. d. both costs and revenues that stay the same between alternate courses of action will be analyzed.

34.

Incremental analysis is most useful a. in developing relevant information for management decisions. b. in choosing between the net present value method and the internal rate of return method. c. in evaluating the master budget. d. as a replacement technique for variance analysis.

35.

The source of data to serve as inputs in incremental analysis is generated by a. market analysts. b. engineers. c. accountants. d. all of these.

36.

Which of the following is not a true statement? a. Incremental analysis might also be referred to as differential analysis. b. Incremental analysis is the same as CVP analysis. c. Incremental analysis is useful in making decisions. d. Incremental analysis focuses on decisions that involve a choice among alternative courses of action.

37.

Incremental analysis would not be appropriate for a. a make or buy decision. b. an allocation of limited resource decision. c. elimination of an unprofitable segment. d. analysis of manufacturing variances.

38.

Incremental analysis would be appropriate for a. acceptance of an order at a special price. b. retain or replace equipment. c. sell or process further. d. all of these.

39.

Which of the following is a true statement about cost behaviors in incremental analysis? 1. Fixed costs will not change between alternatives. 2. Fixed costs may change between alternatives. 3. Variable costs will always change between alternatives. a. 1 b. 2 c. 3 d. 2 and 3

Incremental Analysis 40.

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A company is considering the following alternatives: Revenues Variable costs Fixed costs

Alternative 1 $120,000 60,000 35,000

Alternative 2 $120,000 70,000 35,000

Which of the following are relevant in choosing between the alternatives? a. Variable costs b. Revenues c. Fixed costs d. Variable costs and fixed costs 41.

Adler Company manufactures a product with a unit variable cost of $50 and a unit sales price of $88. Fixed manufacturing costs were $240,000 when 10,000 units were produced and sold. The company has a one-time opportunity to sell an additional 3,000 units at $70 each in a foreign market which would not affect its present sales. If the company has sufficient capacity to produce the additional units, acceptance of the special order would affect net income as follows: a. Income would decrease by $12,000. b. Income would increase by $12,000. c. Income would increase by $210,000. d. Income would increase by $60,000.

42.

In incremental analysis, a. costs are not relevant if they change between alternatives. b. all costs are relevant if they change between alternatives. c. only fixed costs are relevant. d. only variable costs are relevant.

43.

If a plant is operating at full capacity and receives a one-time opportunity to accept an order at a special price below its usual price, then a. only variable costs are relevant. b. fixed costs are not relevant. c. the order will likely be accepted. d. the order will likely be rejected.

44.

If a company must expand capacity to accept a special order, it is likely that there will be a. an increase in unit variable costs. b. no increase in fixed costs. c. an increase in variable and fixed costs per unit. d. an increase in fixed costs.

45.

Which of the following is true if a company can accept a special order without affecting its regular sales and is within plant capacity? a. Net income will not be affected. b. Net income will increase if the special sales price per unit exceeds the unit variable costs. c. Net income will decrease. d. Additional fixed costs will probably be incurred.

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Test Bank for Managerial Accounting, Second Edition

46.

If a company anticipates that other sales will be affected by the acceptance of a special order, then a. lost sales should be considered in the incremental analysis. b. lost sales should not be considered in the incremental analysis. c. the order should not be accepted. d. the order will only be accepted if the plant is below capacity.

47.

An opportunity cost a. should be initially recorded as an asset. b. is the cost of a new product proposal. c. is the potential benefit that may be obtained by following an alternative course of action. d. is classified as manufacturing overhead.

48.

Opportunity cost must be considered in decisions involving a. budgeting. b. financial accounting. c. CVP analysis. d. resources that have alternative uses.

49.

The opportunity cost of an alternate course of action that is relevant to a make or buy decision is a. subtracted from the "Make" costs. b. added to the "Make" costs. c. added to the "Buy" costs. d. none of these.

50.

Opportunity cost is usually a. a standard cost. b. a potential benefit. c. a sunk cost. d. included as part of cost of goods sold.

Use the following information for questions 51–52. Sam's Manufacturing Company can make 100 units of a necessary component part with the following costs: Direct Materials Direct Labor Variable Overhead Fixed Overhead 51.

$80,000 13,000 40,000 27,000

If Sam's Manufacturing Company purchases the component externally, $20,000 of the fixed costs can be avoided. At what external price for the 100 units is the company indifferent between making or buying? a. $160,000. b. $113,000. c. $153,000. d. $133,000.

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52.

If Sam's Manufacturing Company can purchase the component externally for $145,000 and only $4,000 of the fixed costs can be avoided, what is the correct “make or buy” decision? a. Make and save $8,000 b. Buy and save $8,000 c. Make and save $20,000 d. Buy and save $20,000

53.

Cole's Shop can make 1,000 units of a necessary component with the following costs: Direct Materials Direct Labor Variable Overhead Fixed Overhead

$64,000 16,000 8,000 ?

The company can purchase the 1,000 units externally for $104,000. The unavoidable fixed costs are $5,000 if the units are purchased externally. An analysis shows that at this external price, the company is indifferent between making or buying the part. What are the fixed overhead costs of making the component? a. $21,000. b. $16,000. c. $11,000. d. Cannot be determined. Use the following information for questions 54–55. May Company produces 1,000 units of a necessary component with the following costs: Direct Materials Direct Labor Variable Overhead Fixed Overhead

$48,000 32,000 8,000 14,000

54.

May Company could avoid $6,000 in fixed overhead costs if it acquires the components externally. If cost minimization is the major consideration and the company would prefer to buy the components, what is the maximum external price that May Company would accept to acquire the 1,000 units externally? a. $102,000. b. $94,000. c. $96,000. d. $88,000.

55.

None of May Company's fixed overhead costs can be reduced, but another product could be made that would increase profit contribution by $16,000 if the components were acquired externally. If cost minimization is the major consideration and the company would prefer to buy the components, what is the maximum external price that May Company would be willing to accept to acquire the 1,000 units externally? a. $86,000. b. $110,000. c. $96,000. d. $104,000.

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Test Bank for Managerial Accounting, Second Edition

56.

A company has a process that results in 9,000 pounds of Product A that can be sold for $8 per pound. An alternative would be to process Product A further at a cost of $60,000 and then sell it for $14 per pound. Should management sell Product A now or should Product A be processed further and then sold? What is the effect of the action? a. Process further, the company will be better off by $6,000. b. Sell now, the company will be better off by $6,000. c. Process further, the company will be better off by $54,000. d. Sell now, the company will be better off by $60,000.

57.

The decision rule on whether to sell or process further a. varies from situation to situation. b. is process further as long as total revenue exceeds present revenues. c. is process further if incremental revenue from such processing exceeds incremental fixed costs. d. is process further if incremental revenue from such processing exceeds the incremental processing costs.

58.

Beal Company is starting business and is unsure of whether to sell its product assembled or unassembled. The unit cost of the unassembled product is $40 and Beal Company would sell it for $90. The cost to assemble the product is estimated at $18 per unit and Beal Company believes the market would support a price of $116 on the assembled unit. What is the correct decision using the sell or process further decision rule? a. Sell before assembly, the company will be better off by $18 per unit. b. Sell before assembly, the company will be better off by $26 per unit. c. Process further, the company will be better off by $26 per unit. d. Process further, the company will be better off by $8 per unit.

59.

The focus of a sell or process further decision is a. incremental revenue. b. incremental cost. c. both incremental revenue and incremental cost. d. neither incremental revenue nor incremental cost.

60.

Kimble Company gathered the following data about the three products that it produces: Product A B C

Present Sales Value $ 9,000 15,000 11,000

Estimated Additional Processing Costs $ 6,000 5,000 3,000

Which of the products should not be processed further? a. Product A b. Product B c. Product C d. Products A and C 61.

All costs incurred prior to the split-off point are called a. relevant costs. b. split-off costs. c. opportunity costs. d. joint costs.

Estimated Sales if Processed Further $ 16,000 18,000 16,000

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62.

Each of the following statements about the amount of joint costs allocated to multiple products is correct except that it is a. a sunk cost. b. irrelevant in deciding whether to sell or process further. c. allocated to the individual products based on their relative sales value. d. Each of the options is correct.

63.

End-products produced from a single raw material and a common production process are referred to as a. final products. b. joint products. c. split-off products. d. common products.

64.

A company is considering replacing old equipment with new equipment. Which of the following is a relevant cost for incremental analysis? a. Annual depreciation charge on the old equipment b. Book value of the old equipment c. Estimated annual depreciation of the new equipment d. Cost of the new equipment

65.

In a retain or replace equipment decision, trade-in allowance available on old equipment a. increases the cost of the new equipment. b. is relevant because it will not be realized if the old equipment is retained. c. is not relevant to the decision. d. reduces the cost of the old equipment.

66.

Which of the following is not relevant information in a decision whether old equipment presently being used should be replaced by new equipment? a. The cash price of the new equipment b. The salvage value of the old equipment c. The book value of the old equipment d. The cost savings if the new equipment is purchased

67.

Book value of old equipment is considered to be a a. relevant cost. b. semi-relevant cost. c. sunk cost. d. cost that can be changed by a present or future decision.

68.

A company is deciding on whether to replace some old equipment with new equipment. Which of the following is not a relevant cost for 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. Accumulated depreciation on the old equipment

69.

Which of the following is a sunk cost in a retain or replace equipment decision? a. Cost of the new equipment b. Cost savings from the purchase of the new equipment c. Salvage value of the old equipment

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Test Bank for Managerial Accounting, Second Edition d. Cost of the old equipment A company has three product lines, one of which reflects the following results: Sales Variable expenses Contribution margin Fixed expenses Net loss

$170,000 100,000 70,000 110,000 $(40,000)

If this product line is eliminated, 60% of the fixed expenses can be eliminated and the other 40% will be allocated to other product lines. If management decides to eliminate this product line, the company's net income will a. increase by $40,000. b. decrease by $70,000. c. decrease by $4,000. d. increase by $4,000. 71.

A company is considering eliminating a product line. The fixed costs currently allocated to the product line will be allocated to other product lines upon discontinuance. If the product line is discontinued, a. total net income will increase by the amount of the product line's fixed costs. b. total net income will decrease by the amount of the product line's fixed costs. c. the contribution margin of the product line will indicate the net income increase or decrease. d. the company's total fixed costs will decrease.

72.

In deciding whether to eliminate an unprofitable business segment, the key is to focus on a. fixed costs. b. opportunity costs. c. relevant costs. d. sunk costs.

73.

In deciding on the future of an unprofitable segment, management should compare the lost contribution margin to the segment’s a. variable costs. b. fixed costs. c. sunk costs. d. opportunity costs.

74.

A segment has the following data: Sales Variable expenses Fixed expenses

$420,000 180,000 330,000

What will be the incremental effect on net income if this segment is eliminated, assuming the fixed expenses will be allocated to profitable segments? a. $240,000 increase b. $240,000 decrease c. $330,000 decrease d. Cannot be determined from the data provided.

Incremental Analysis 75.

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Barkley Company sells two products with the following per unit data: Standard Deluxe Selling price/unit $75 $120 Variable costs/unit 45 60 Contribution margin/unit $30 $ 60 Sales mix 3 2 If fixed costs are $630,000, the number of standard and deluxe units that Barkley must sell to break even is a. 1,800 standard and 1,200 deluxe. b. 3,600 standard and 2,400 deluxe. c. 9,000 standard and 6,000 deluxe. d. 21,000 standard and 14,000 deluxe.

76.

Logan Company sells two products, A and B. Their contribution margins per unit are $60 and $120 respectively, and their sales mix is 3:1. What is Logan’s weighted average unit contribution margin? a. $300 b. $150 c. $90 d. $75

77.

Total contribution margin divided by the number of units in the sales mix is the a. contribution margin per unit. b. contribution margin ratio. c. weighted average unit contribution margin. d. weighted average contribution margin ratio.

78.

The break-even point in units for multiple products is computed by dividing fixed costs by the a. contribution margin per unit. b. contribution margin ratio. c. weighted average unit contribution margin. d. weighted average contribution margin ratio.

79.

Which one of the following is correct? a. CVP analysis cannot be used if there is more than one product. b. A shift from low margin sales to high margin sales will increase net income only if sales volume increases. c. A shift from high to low margin sales may result in a decrease in net income even if total sales volume increases. d. The weighted average contribution margin is greater than the individual contribution margins of each product in the sales mix.

80.

Klesko Company developed the following information for the year ended December 31, 2002: Product A Product B Total Units Sold 4,000 6,000 10,000 Sales $12,000 $27,000 $39,000 Variable costs 6,000 15,000 21,000 Contribution margin $ 6,000 $12,000 18,000 Fixed costs 12,600

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Test Bank for Managerial Accounting, Second Edition Net income $ 5,400 (cont.) If the sales mix changes in 2003 to 5,000 units of Product A and 5,000 units of Product B, the effect on the company’s break-even point would be a. to increase it by 200 units. b. to decrease it by 200 units. c. to increase it by 1,200 units. d. no change.

81.

A company can sell all the units it can produce of either Product A or Product B but not both. Product A has a unit contribution margin of $36 and takes two machine hours to make and Product B has a unit contribution margin of $45 and takes three machine hours to make. If there are 1,000 machine hours available to manufacture a product, income will be a. $3,000 more if Product A is made. b. $3,000 less if Product B is made. c. $3,000 less if Product A is made. d. the same if either product is made.

82.

If a company has limited resources, the key factor in performing incremental analysis is a. contribution margin. b. limited resources required. c. contribution margin per unit of limited resource. d. none of these.

83.

Limited resources for a manufacturing company include all of the following except a. direct labor hours. b. floor space. c. machine capacity. d. raw materials.

84.

A company can produce and sell only one of the following two products:

Product 1 Product 2

Machine Hours Required 3 2

Contribution Margin Per Unit $30 $25

If the company has machine capacity of 4,000 hours, what is the total contribution margin of the product it should produce to maximize net income? a. $40,000. b. $48,000. c. $50,000. d. $32,000. 85.

When a company has limited resources, management must decide which products to sell in order to maximize a. contribution margin per unit. b. contribution margin ratio. c. net income. d. weighted average unit contribution margin.

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Answers to Multiple Choice Questions Ite m

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35. 43.

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44. 52.

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34.

EXERCISES Ex. 86 Alder Company produced and sold 30,000 units of product and is operating at 80% of plant capacity. Unit information about its product is as follows: Sales Price $70 Variable manufacturing cost $45 Fixed manufacturing cost ($300,000 ÷ 30,000) 10 Profit per unit $15

55

The company received a proposal from a foreign company to buy 6,000 units of Alder Company's product for $50 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 Alder Company is reluctant to accept the proposal because he is concerned that the company will lose money on the special order. Instructions Prepare a schedule reflecting an incremental analysis of this proposal and indicate the effect the acceptance of this order might have on the company's income.

Solution 86

(9–13 min.) ALDER COMPANY Incremental Analysis Proposal to buy 6,000 units at $50

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Test Bank for Managerial Accounting, Second Edition

Net Income Reject Order Accept Order Increase (Decrease) Revenues (6,000 × $50) $ -0$300,000 $300,000 Costs (6,000 × $45) -0(270,000) (270,000) Net Income $ -0$ 30,000 $ 30,000 Alder Company would increase its income by $30,000 in accepting the special order. Ex. 87 Dixon Company manufactures cappuccino makers. For the first eight months of 2002 the company reported the following operating results while operating at 80% of plant capacity: Sales (500,000 units) $90,000,000 Cost of goods sold 54,000,000 Gross profit 36,000,000 Operating expenses 24,000,000 Net income $12,000,000 An analysis of costs and expenses reveals that variable cost of goods sold is $95 per unit and variable operating expenses are $35 per unit. In September, Dixon Company receives a special order for 40,000 machines at $145 each from a major coffee shop franchise. Acceptance of the order would result in $10,000 of shipping costs but no increase in fixed expenses. Instructions (a) Prepare an incremental analysis for the special order. (b) Should Dixon Company accept the special order? Justify your answer.

Solution 87 (a)

(12–17 min.)

Net Income Reject Order Revenues $ -0Cost of Goods Sold Operating Expense Net Income $ -0-

Accept Order Increase (Decrease) $5,800,000 $5,800,000 -0- 3,800,000*(3,800,000) -01,410,000** (1,410,000) $ 590,000 $ 590,000

*Variable cost of goods sold = 40,000 × $95 = $3,800,000. **Variable operating expenses = 40,000 × $35 = $1,400,000 + $10,000 = $1,410,000. (b) The incremental analysis shows Dixon Company 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.

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Ex. 88 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 400 mats at $45 each. Acceptance of the special order will not affect fixed costs but will result in $1,200 of shipping costs. For the first 6 months of 2002, the company reported the following operating results while operating at 70% capacity: Ex. 88 (cont.) Sales (100,000 units) Cost of goods sold Gross profit Operating expenses Net income

$7,000,000 4,200,000 2,800,000 2,000,000 $ 800,000

Cost of goods sold was 80% variable and 20% fixed; operating expenses were 75% variable and 25% fixed. Instructions (a)Prepare an incremental analysis for the special order. (b)Should Vincent Company accept the special order? Justify your answer.

Solution 88 (a)

(13–18 min.)

Net Income Reject OrderAccept Order Increase (Decrease) Revenues $ -0$18,000 $18,000 Cost of Goods Sold -0- 13,440 (13,440) Operating Expense -07,200 (7,200) Net Income $ -0$(2,640) $(2,640) Variable costs of goods sold = $4,200,000 × 80% = $3,360,000. Variable cost of goods sold per unit sold = $3,360,000 ÷ 100,000 = $33.60. Variable cost of goods sold for the special order = 400 × $33.60 = $13,440. Variable operating expenses = $2,000,000 × 75% = $1,500,000 Variable operating expenses per unit = $1,500,000 ÷ 100,000 = $15.00 Variable operating expenses for the special order = 400 × $15.00 = $6,000 + $1,200 = $7,200

(b)

The incremental analysis shows Vincent Company should not accept the special order because incremental costs exceed incremental revenues.

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Test Bank for Managerial Accounting, Second Edition

Ex. 89 Carlsen Company manufactured 6,000 units of a component part that is used in its product and incurred the following costs: Direct materials $ 70,000 Direct labor 30,000 Variable manufacturing overhead 20,000 Fixed manufacturing overhead 40,000 $160,000 Another company has offered to sell the same component part to the company for $24.00 per unit. The fixed manufacturing overhead consists mainly of depreciation on the equipment used to manufacture the part and would not be reduced if the component part was purchased from the outside firm. If the component part is purchased from the outside firm, Carlsen Company has the opportunity to use the factory equipment to produce another product which is estimated to have a contribution margin of $30,000. Ex. 89 (cont.) Instructions Prepare an incremental analysis report for Carlsen Company which can serve as informational input into this make or buy decision.

Solution 89

(13–18 min.)

Make Buy Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Purchase price (6,000 × $24.00) Total annual cost Opportunity cost Total cost

Increase (Decrease) $ 70,000$ -0- $ 70,000 30,000-030,000 20,000-020,000 40,00040,000 -0-0144,000 (144,000) 160,000184,000 (24,000) 30,000 -030,000 $190,000$184,000 $ 6,000

Income is expected to increase by $6,000 if the component part is purchased from the outside firm and the new product is manufactured.

Ex. 90 Kuhn Bicycle Company has been manufacturing its own seats for its bicycles. The company is currently operating at 100% capacity, and variable manufacturing overhead is charged to production at the rate of 60% of direct labor cost. The direct materials and direct labor cost per unit to make the bicycle seats are $5.00 and $6.00, respectively. Normal production is 50,000 bicycles per year. A supplier offers to make the bicycle seats at a price of $13 each. If the bicycle company accepts this offer, all variable manufacturing costs will be eliminated, but the $20,000 of fixed manufactur-

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ing overhead currently being charged to the bicycle seats will have to be absorbed by other products. Instructions (a) Prepare the incremental analysis for the decision to make or buy the bicycle seats. (b) Should Kuhn Bicycle Company buy the seats from the outside supplier? Justify your answer.

Solution 90 (a)

(15–20 min.)

Net Income Make Buy Direct Materials (50,000 × $5) Direct Labor (50,000 × $6) Variable Manufacturing Costs ($300,000 × 60%) 180,000 Fixed Manufacturing Costs Purchase Price (50,000 × $13) Total annual cost $750,000

Increase (Decrease) $250,000$ -0- $250,000 300,000 -0- 300,000 -0- 180,000 20,00020,000 -0-0650,000 $670,000$ 80,000

(650,000)

Solution 90 (cont.) (b) The seats should be purchased from the outside supplier. As indicated, the company's net income would increase $80,000 by purchasing the seats.

Ex. 91 United Chemical Corporation produces an oil-based chemical product which it sells to paint manufacturers. In 2002, the company incurred $430,000 of costs to produce 40,000 gallons of the chemical. The selling price of the chemical is $14.00 per gallon. The costs per unit to manufacture a gallon of the chemical are presented below: Direct materials $ 7.50 Direct labor 1.50 Variable manufacturing overhead 1.00 Fixed manufacturing overhead .75 Total manufacturing costs $10.75 The company is considering manufacturing the paint itself. If the company processes the chemical further and manufactures the paint itself, the following additional costs per gallon will be incurred: Direct materials $2.10, Direct labor $.75, Variable manufacturing overhead $.60. No increase in fixed manufacturing overhead is expected. The company can sell the paint at $19.00 per gallon. Instructions Determine the incremental per gallon increase in net income and the total increase in net income if the company manufactures the paint.

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Test Bank for Managerial Accounting, Second Edition

Solution 91

(15–20 min.)

Net Income Sell Chemical Process Further Increase (Decrease) Sales price per unit $14.00 $19.00$5.00 Cost per unit: Direct materials (A) 7.50 9.60 (2.10) Direct labor (B) 1.50 2.25 (.75) Variable manufacturing overhead (C) 1.001.60 (.60) Fixed manufacturing overhead .75 .75 — Total 10.75 14.20 (3.45) Net income per unit $ 3.25 $ 4.80$1.55 (A) $7.50 + $2.10 (B) $1.50 + .75 (C) $1.00 + .60 Assuming the company sells all 40,000 gallons that it produces, the incremental net income would be $62,000 (40,000 gallons × $1.55).

Ex. 92 Franke Timber Corporation uses a machine which removes the bark from its cut timber. The machine is unreliable and results in a significant amount of downtime and excessive labor costs. The management is considering replacing the machine with a more efficient one which will minimize downtime and excessive labor costs. Data are presented below for the two machines: Old Machine New Machine Original purchase cost $410,000 $520,000 Accumulated depreciation 280,000 — Estimated life 5 years 5 years It is estimated that the new machine will produce annual cost savings of $115,000. The old machine can be sold to a scrap dealer for $10,000. 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 92

(11–16 min.)

Retain Replace Net Income Equipment Equipment Increase/(Decrease) Cost savings$ -0$575,000 (A) $575,000

Incremental Analysis New machine cost -0Proceeds from sale of old machine Net incremental net income $ -0(A)

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(520,000) (520,000) $ -010,000 (10,000) $ 65,000 $ 65,000

$115,000 × 5 = $575,000.

The company should purchase the new machine because there will be an increase in net income of $65,000.

Ex. 93 Munroe 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. Management is considering updating the copier machine with a faster model. Current Copier Original purchase cost Accumulated depreciation Estimated operating costs (annual) Useful life 5 years

New Model $8,000 6,000 6,500 5 years

$15,000 — 3,000

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 93

(12–16 min.)

Net Income Retain Machine Operating costs $32,500 New machine cost Salvage value Totals $32,500

Replace MachineIncrease (Decrease) $15,000 $17,500 -015,000 (15,000) -0(1,000) 1,000 $29,000 $ 3,500

The current copier should be replaced. The incremental analysis shows that net income for the five-year period will be $3,500 higher by replacing the current copier.

Ex. 94 Sam Washington, manager of the Laundry Department at St. Anthony’s Hospital, is considering the purchase of an automated dryer that turns off immediately when laundry is dry. The new dryer will replace the dryer currently in operation, which must be monitored to determine when laundry is dry. Selected information on the two machines is given below: Automatic

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Test Bank for Managerial Accounting, Second Edition Standard Dryer Turn-off Dryer Original cost new $12,000 $14,500 Accumulated depreciation to date 4,400 -0Current salvage value 3,600 -0Estimated cost per year to operate6,500 3,500 Remaining years of useful life 5 years 5 years

Instructions Prepare a computation covering the five-year period that will show the net advantage or disadvantage of purchasing the automatic dryer. Ignore income taxes, and use only relevant costs in your analysis.

Solution 94

(6-8 min.)

Cost of new dryer $(14,500) Salvage value of old dryer 3,600 Estimated cost savings to operate [($6,500 – $3,500) × 5)] Cost savings associated with buying the new dryer $ 4,100

15,000

Ex. 95 Simon Forest Corporation operates two divisions, the Timber Division and the Consumer Division. The Timber Division manufactures and sells logs to paper manufacturers. The Consumer Division operates retail lumber mills which sell a variety of products in the do-it-yourself homeowner market. The company is considering disposing of the Consumer 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, 2002 are presented below:

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Ex. 95 (cont.) Timber Division Consumer Division Total Sales $1,500,000 $500,000 $2,000,000 Cost of goods sold 900,000 350,000 1,250,000 Gross profit 600,000 150,000 750,000 Selling & administrative expenses 250,000 180,000 Net income $ 350,000 $(30,000) $ 320,000

430,000

In the Consumer Division, 70% of the cost of goods sold are variable costs and 30% of selling and administrative expenses are variable costs. The management of the company feels it can save $60,000 of fixed cost of goods sold and $50,000 of fixed selling expenses if it discontinues operation of the Consumer Division. Instructions (a) (b)

Determine whether the company should discontinue operating the Consumer Division. If the company had discontinued the division for 2002, determine what net income would have been.

Solution 95

(20–25 min.)

(a)

CONSUMER DIVISION

Net Income Continue Eliminate Sales $500,000 $ Variable expenses: Cost of goods sold 245,000 Selling and admin. exp. 54,000 Contribution margin 201,000 Fixed expenses: Cost of goods sold 105,000 Selling and admin. exp. 126,000 Net income $ (30,000) (A) (B)

$350,000 × 70% = $245,000 $180,000 × 30% = $54,000

Increase (Decrease) -0- $(500,000) (A) -0(B) -0-0-

245,000 54,000 (201,000)

(C) 45,000 60,000 (D) 76,000 50,000 $(121,000) $ (91,000) (C) $350,000 – $245,000 = $105,000 (D) $180,000 – $54,000 = $126,000

The company should continue the Consumer Division because contribution margin, $201,000, is greater than the avoidable fixed costs, $110,000. (b)

Net income for the total company would have been $259,000: Timber Division + Decrease in Net Income $350,000 + $(91,000) = $259,000

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Ex. 96 A recent accounting graduate from Missouri State University evaluated the operating performance of Boswell Company's four divisions. The following presentation was made to Boswell'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 $40,000. (See analysis below.) Other Three Divisions Southern Division Sales $2,000,000 $480,000 $2,480,000 Cost of Goods Sold 950,000 400,000 Gross Profit 1,050,000 80,000 1,130,000 Operating Expenses 800,000 120,000 Net Income $ 250,000 $ (40,000) $ 210,000

Total 1,350,000 920,000

For the other divisions, cost of goods sold is 80% variable and operating expenses are 70% variable. The cost of goods sold for the Southern Division is 25% fixed, and its operating expenses are 75% fixed. If the division is eliminated, only $4,000 of the fixed operating costs will be eliminated. Instructions Do you concur with the new accountant's recommendation? Present a schedule to support your answer.

Solution 96

(20–25 min.)

Net Income Continue Eliminate Increase (Decrease) Sales $480,000 $ -0$(480,000) Variable Expenses Cost of goods sold 300,000 -0- 300,000 Operating expenses 30,000 -030,000 Total Variable 330,000 -0330,000 Contribution Margin 150,000 -0(150,000) Fixed Expenses Cost of goods sold 100,000 100,000 -0Operating expenses 90,000 86,000 4,000 Net Income (Loss) $(40,000) $(186,000) $(146,000) The accountant is not correct. If the Southern Division is eliminated, the net income will be $146,000 less, not $40,000 greater. The reduction in income is the result of the loss of the contribution margin less the avoidable fixed costs of $4,000.

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Ex. 97 Snooty Fox operates three upscale boutiques in three fashionable areas of the city. The following information is available for the three boutiques for the past year: Andover Heartland Beaumont Total Revenue$125,000 $160,000 $175,000 Variable costs 65,000 70,000 Contribution margin 60,000 90,000 Fixed costs 85,000 40,000 Net income (loss) $(25,000) $ 50,000

$460,000 65,000 110,000 60,000 $ 50,000

200,000 260,000 185,000 $ 75,000

Instructions Answer each of the following independently. (a) Fixed costs are all allocated and unavoidable. What will happen to profit if Snooty Fox discontinues operations at Beaumont? (b) Suppose now that $25,000 of the fixed costs shown for the boutique in Andover are avoidable. What will happen to profits if Snooty Fox discontinues operations at Andover? (c) Explain the general rule for deciding whether to eliminate an unprofitable division.

Solution 97

(11-13 min)

(a)

If Snooty Fox discontinues operations at Beaumont, profits for the company as a whole will decrease by the contribution margin—or by $110,000. Remember, all fixed costs are allocated and unavoidable.

(b)

If the $25,000 of fixed costs are avoidable and Snooty Fox discontinues operations at Andover, net income for the company as a whole will increase by $25,000.

(c)

In deciding whether to eliminate an unprofitable division, a company must compare the division’s contribution margin to its avoidable fixed costs. An unprofitable division should be eliminated only when its avoidable fixed costs are greater than its contribution margin.

Ex. 98 Barker Company sells three models of dishwashing machines. Selling price and variable costs for the three models are as follows: Economy StandardDeluxe Unit selling price $600 $700 $800 Unit variable costs $330 $420 $450 Expected sales volume in units 1,000 600 400 Instructions (a) Compute the break-even point in units, assuming fixed costs are $289,000.

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(b) Indicate the units of each product that should be sold at the break-even point and prove the correctness of your answer.

Solution 98 (a)

(20–25 min.)

Economy StandardDeluxe Determine the unit contribution margin Unit selling price $600 $700 Unit variable costs $330 $420 Contribution margin (a) $270 $280 Determine weighted contribution margin Expected sales volume in units 1,000 Sales mix ratio (b) 10 6 4 Weighted contribution margin (a) × (b)

$800 $450 $350 600

400

$2,700

$1,680

$1,400

Determine the weighted average contribution margin $2,700 + $1,680 + $1,400 ———————————— = $289 20 $289,000 Break-even sales in units = ———— = 1,000 units $289 (b)

Product Economy (50% × 1,000) Standard (30% × 1,000) Deluxe (20% × 1,000)

Unit Sales × 500 $270 300 280 200 350 1,000

Unit CMTotal CM $135,000 84,000 70,000 $289,000

Ex. 99 Neagle Company has 6,000 machine hours available to use to produce either Product A or Product B. The cost accounting department developed the following unit information for each of the products: Product A Product B Sales price $54 $65 Direct materials 22 21 Direct labor 15 18 Variable manufacturing overhead 8 12 Fixed manufacturing overhead 4 8 Machine hours required .6 1.0 Management desires to make a decision regarding which product to produce in order to maximize the company's income. Instructions

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Taking into consideration the constraint under which the company operates, prepare a report to show which product should be produced and sold.

Incremental Analysis Solution 99

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(20–25 min.) NEAGLE COMPANY Contribution Margin per Unit Limited Resource

Contribution margin per unit: Product A Sales price $54 $65 Variable costs Direct material $22 $21 Direct labor 15 18 Variable overhead 8 45 12 Contribution margin $ 9 $14 Machine hours required:

.6 hrs.

Product B

51

1.0 hrs.

Contribution margin per unit of limited resource ($9 ÷ .6) $ 15 ($14 ÷ 1.0) $ 14 Machine hours available 6,000 6,000 Contribution margin $90,000 $84,000 The company should produce and sell Product A.

Ex. 100 Dannon Company manufactures and sells two products. Relevant per unit data concerning each product are given below: Product Standard Deluxe Selling price $42 $48 Variable costs $16 $18 Machine hours 4 5 Instructions (a) Compute the contribution margin per unit of the limited resource for each product. (b) If 1,000 additional machine hours are available, which product should be manufactured? (c) Prepare an analysis showing the total contribution margin if the additional hours are (1) Divided equally among the products. (2) Allocated entirely to the product identified in (b) above.

Solution 100 (a)

(25–30 min.)

Product Standard Deluxe Contribution margin per unit (a) Machine hours required (b)

$26 4 5

$30

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Test Bank for Managerial Accounting, Second Edition Contribution margin per unit of limited resource (a) ÷ (b)

$6.50

$6.00

Incremental Analysis Solution 100

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(cont.)

(b) The Standard product should be manufactured because it results in the highest contribution margin per machine hour. (c)

Product Standard Deluxe Machine hours 1,000 ÷ 2 (a) Machine hours per unit (b) Units produced (a) ÷ (b) 125 Contribution margin per unit Total contribution margin $3,250 Product Standard Machine hours (a) 1,000 Machine hours per unit (b) Units produced (a) ÷ (b) 250 Contribution margin per unit Total contribution margin $6,500

500 4 5 100 $26 $3,000

4 $26

500 $30

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Test Bank for Managerial Accounting, Second Edition

COMPLETION STATEMENTS 101. An important purpose of management accounting is to provide management with ______________________ for decision making. 102. The process used to identify the financial data that change under alternative courses of action is called __________________ analysis. 103. In a decision on whether an order should be accepted at a special price when there is plant capacity available, a major consideration is whether the special price exceeds __________________. 104. The potential benefit that may be obtained by following an alternative course of action is called an _________________ cost. 105. 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 ______________. 106. The ______________ value of old equipment is irrelevant in a decision to replace that equipment and is often referred to as a _____________ cost. 107. Total net income may decrease if an unprofitable segment is eliminated because the ______________ allocated to that segment will have to be absorbed by the other segments. 108. Break-even sales can be computed for a mix of two or more products by determining the ______________ unit contribution margin of all the products. 109. In an environment where there are limited resources, the products with the highest contribution per unit of ______________ should identify the products to be produced.

Answers to Completion Statements 101. relevant information 102. incremental 103. variable costs (incremental costs) 104. opportunity 105. revenues, costs 106. book, sunk 107. fixed expenses 108. weighted average 109. limited resource

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MATCHING 110. Match the items below by entering the appropriate code letter in the space provided. A. B. C. D.

Incremental analysis Book value of old asset Opportunity cost Weighted average unit contribution margin

E. F. G. H.

Relevant cost Sales mix Sunk cost Financial information

____

1. The potential benefit that may be obtained from following an alternative course of action.

____

2. The relative combination in which a company’s products are sold.

____

3. Data related to revenues and costs and their effect on the company’s overall profitability.

____

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

____

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

____

6. A sunk cost that is not relevant in incremental analysis.

____

7. Used to compute the break-even point for a mix of two or more products.

____

8. Those costs and revenues that differ across alternatives.

Answers to Matching 1. 2. 3. 4.

C F H A

5. 6. 7. 8.

G B D E

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SHORT-ANSWER ESSAY QUESTIONS S-A E 111 Management is often faced with the alternative of continuing to make a product or component internally, or go to an external source and purchase 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 111 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.

S-A E 112 A number of different types of decisions involve incremental analysis. Two of the more common types of decisions are whether to (1) accept an order at a special price and (2) sell products or process them further. Identify the relevant costs/data to be considered in making these types of decisions.

Solution 112 The relevant data in accepting an order at a special price is the difference between the variable manufacturing costs to produce the special order and the expected revenues. If the special order units can be produced within existing plant capacity, the special order will not increase fixed costs. The relevant data in deciding whether to sell or process products further is the difference between the incremental revenue from processing and the incremental processing costs. The products should be processed further as long as the incremental revenue exceeds the incremental costs.