Chapter-7.docx

CHAPTER 7 INCREMENTAL ANALYSIS SUMMARY OF QUESTIONS BY OBJECTIVES AND BLOOM’S TAXONOMY Item

SO

BT

Item

SO

BT

Item

SO

BT

Item

SO

BT

Item

SO

BT

8 2 3 5 7 4 2

K K C K C K C

29. 30. 31. 32.

7 2 4 6

C K K K

84. 85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. 98. 99. 100.

6 7 7 7 8 8 8 3 4 7 8 4 4 3 4 4 5

K AN AP AN AN C AP AP C AN AP K AP C C AN AP

101. 102. 103. 104. 105. 106. 107. 108. 109. 110. 111. 112. 113. 114. 115. 116. 117.

5 5 4 3 5 6 4 1 3 1 3 5 2 5 7 6 5

AN AN K K AN C AN K K C C C K K C K K

130. 131. 132. 133.

7 4 5 7

AN AN AN AN

134. 135.

4 3

AN AN

148. 149. 150. 151.

7 8 8 3

AN AN AN S

152. 153. 154. 155

2 1 6 4

C C C AN

1

K

True-False Statements 1. 2. 3. 4. 5. 6. 7.

2 1 2 2 1 2 3

K K C K K C C

8. 9. 10. 11. 12. 13. 14.

3 3 4 4 4 5 5

C C C K C C C

15. 16. 17. 18. 19. 20. 21.

33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49.

4 4 3 4 4 7 7 4 5 8 5 3 1 1 1 1 2

K K AP AP K AP AP AP K K AP AP K K K K K

50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66.

1 2 2 2 2 2 2 2 2 2 3 2 3 3 3 3 4

C K C C K K C C C C AP C C C C C K

67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83.

118. 119. 120. 121.

4 4 4 7

AP AP AP AP

122. 123. 124. 125.

7 8 4 6

AP AP AP AN

126. 127. 128. 129.

6 6 6 7 7 8 8

C C C C C C C

22. 23. 24. 25. 26. 27. 28.

Multiple Choice Questions 4 4 4 4 4 3 3 4 5 4 5 5 5 6 6 6 6

C C AP AN AN AN AN AN AN C AN C AN C K C C

Brief Exercises 2 8 3 4

AP AN AP AP

Exercises 136. 137. 138. 139.

7 7 3,4 3

AN AP AN AN

140. 141. 142. 143.

3 3 4 4

AN AN AN AN

2 2

K K

158. 159.

4 5

K K

163.

1-4

K

164.

4

AN

144. 145. 146. 147.

5 6 6 7

AN AN E E

Completion Statements 160. 161.

6 8

K K

162.

Matching Short Answer Essay Questions 165.

6

E

Multi Part Question 166.

3,8

AN

Incremental Analysis

7-2

SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE Item

Type

Item

Type

Item

Type

Item

Type

Item

Type

Item

Type

Item

Type

MC Ex

162. 163.

C Ma

MC MC MC BE

153. 156. 157. 163

Ex C C Ma

MC MC BE BE

138. 139. 140. 141.

Ex Ex Ex Ex

151. 163. 166.

Ex Ma MP

MC BE BE BE BE BE

131. 138. 142. 142. 143. 155.

BE BE Ex Ex Ex Ex

158 163. 164

C Ma SAE

MC MC MC

117. 132. 144.

MC BE Ex

159.

C

Ex Ex Ex

160. 165.

C SAE

BE BE BE

136. 137. 147.

Ex Ex Ex

148.

Ex

BE BE

149. 150.

Ex Ex

161. 166.

C MP

Study Objective 1 2. 5.

TF TF

45. 46.

MC MC

47. 48.

MC MC

1. 3. 4. 6.

TF TF TF TF

23. 28. 30. 49.

TF TF TF MC

51. 52. 53. 54.

MC MC MC MC

7. 8. 9. 24.

TF TF TF TF

35. 44. 60. 62.

MC MC MC MC

63. 64. 65. 72.

MC MC MC MC

10. 11. 12. 27. 31. 33.

TF TF TF TF TF MC

34. 36. 37. 40. 66. 67.

MC MC MC MC MC MC

68. 69. 70. 71. 74. 76.

MC MC MC MC MC MC

50. 108.

MC MC

110. 153.

Study Objective 2 55. 56. 57. 58.

MC MC MC MC

59. 61. 113. 126.

Study Objective 3 73. 91. 97. 104.

MC MC MC MC

109. 111. 128. 135.

Study Objective 4 92. 95. 96. 98. 99. 103.

MC MC MC MC MC MC

107. 118. 119. 120. 124. 129.

Study Objective 5 13. 14. 25.

TF TF TF

41. 43. 75.

MC MC MC

77. 78. 79.

MC MC MC

100. 101. 102.

MC MC MC

105. 112. 114.

Study Objective 6 15. 16. 17.

TF TF TF

32. 80. 81.

TF MC MC

82. 83. 84.

MC MC MC

18. 19. 26.

TF TF TF

29. 38. 39.

TF MC MC

85. 86. 87.

MC MC MC

20. 21.

TF TF

22. 42.

TF MC

88. 89.

MC MC

106. 116. 125.

MC MC BE

145. 146. 154.

Study Objective 7 93. 115. 121.

MC MC BE

122. 130. 133.

Study Objective 8

Note:

TF = True-False MC = Multiple Choice

90. 94.

BE = Brief Exercise Ex = Exercise

MC MC

123. 127.

C = Completion Ma = Matching

SAE = Short Answer Essay MP = Multipart

Incremental Analysis

7-3

CHAPTER STUDY OBJECTIVES 1.

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

2.

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

3.

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

4.

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

5.

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

6.

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

7.

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

8.

Determine sales mix when a company has limited resources. When a company has limited resources, it is necessary to find the contribution margin per unit of limited resource. This amount is then multiplied by the units of limited resource to determine which product maximizes net income.

7-4

Test Bank for Managerial Accounting, Third Canadian Edition

TRUE-FALSE STATEMENTS 1.

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

2.

In making decisions, management considers only financial information because accounting is presented in financial context.

3.

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

4.

Incremental analysis is also known as differential analysis.

5.

Decision-making involves reviewing the results of a decision once the decision has been made.

6.

Decisions made using incremental analysis focus on the amounts which differ among the alternatives.

7.

A special one-time order is acceptable if the unit sales price is greater than the unit variable cost.

8.

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

9.

A company should accept an order for its product at less than its regular sales price if the incremental revenue exceeds the incremental costs.

10.

A decision whether to continue to buy a product instead of producing it externally depends specifically on the incremental costs and incremental revenues of making the change.

11.

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

12.

An incremental make or buy decision depends solely on which alternative is the lowest cost alternative.

Incremental Analysis

7-5

13.

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

14.

It is better to process further rather than sell now if the sales price increases.

15.

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

16.

In a decision to keep or replace old equipment, the salvage value of the old equipment is a sunk cost in incremental analysis.

17.

Equipment which is not fully depreciated should always be replaced.

18.

A company should eliminate any segment in which the contribution margin is less than the fixed costs that are unavoidable.

19.

The elimination of an unprofitable product line will always increase the total profits of a company.

20.

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

21.

If a company has limited machine hours available for production, it is generally more profitable to produce and sell the product with the highest contribution margin per machine hour.

22.

One incremental analysis decision is the allocation of limited resources.

23.

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

24.

If a company is operating at less than capacity, the incremental costs of a special order will likely include variable manufacturing costs, but not fixed costs.

25.

The basic decision rule in a sell or process further decision is: process further if the incremental revenue from processing exceeds the incremental processing costs.

26.

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

7-6

Test Bank for Managerial Accounting, Third Canadian Edition

27.

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

28.

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

29.

If an unprofitable product is eliminated, fixed expenses allocated to the eliminated segment will likely be eliminated.

30.

Incremental costs are always relevant.

31.

A disadvantage of using an outside supplier is the associated loss of control over the production process.

32.

The book value of old equipment is an opportunity cost.

Incremental Analysis

7-7

ANSWERS TO TRUE-FALSE STATEMENTS Item 1. 2. 3. 4. 5.

Ans. T F F T T

Item 6. 7. 8. 9. 10.

Ans. T T F T F

Item 11. 12. 13. 14. 15.

Ans. T F T F F

Item 16. 17. 18. 19. 20.

Ans. F F F F F

Item 21. 22. 23. 24. 25.

Ans. T T T T T

Item 26. 27. 28. 29. 30.

Ans. F F F F T

Item 31. 32.

Ans. T F

7-8

Test Bank for Managerial Accounting, Third Canadian Edition

MULTIPLE CHOICE QUESTIONS 33.

The cost to produce Part A was $5 per unit in 2011. During 2012, it has increased to $8 per unit. In 2012, Supplier Company has offered to supply Part A for $6 per unit. For the make-or-buy decision, a. incremental revenues are $1 per unit. b. incremental costs are $3 per unit. c. net relevant costs are $3 per unit. d. differential costs are $2 per unit.

34.

Max Company uses 10,000 units of Part A in producing its products. A supplier offers to make Part A for $7. Max Company has relevant costs of $8 a unit to manufacture Part A. If there is excess capacity, the opportunity cost of buying Part A from the supplier is a. $0. b. $10,000. c. $70,000. d. $80,000.

35.

Truckel, Inc. currently manufactures a wicket as its main product. The costs per unit are as follows: Direct materials and direct labour $11.00 Variable overhead 3.00 Fixed overhead 8.00 Total $22.00 The fixed overhead is an allocated common cost. How much is the relevant cost of the wicket? a. $24.00 b. $14.00 c. $11.00 d. $19.00

36.

Seran Company has contacted Truckel Inc. with an offer to sell it 5,000 of the wickets for $18.00 each. If Truckel makes the wickets, variable costs are $11 per unit. Fixed costs are $12 per unit however $5 per unit is avoidable. Should Truckel make or buy the wickets? a. Buy; savings = $25,000 b. Buy; savings = $10,000 c. Make; savings = $20,000 d. Make; savings = $10,000

37.

Galley Industries can produce 500 units of a necessary component part with the following costs: Direct Materials $75,000 Direct Labour 20,000 Variable Overhead 60,000 Fixed Overhead 10,000 If Galley Industries purchases the component externally, $3,000 of the fixed costs can be avoided. Below what external price for the 500 units would Galley choose to buy instead

Incremental Analysis

7-9

of make? a. $95,000 b. $165,000 c. $155,000 d. $158,000 38.

Corn Crunchers has three product lines. Its only unprofitable line is Corn Nuts, the results of which appear below for 2012: Sales $350,000 Variable expenses 230,000 Fixed expenses 180,000 Net loss $(60,000) If this product line is eliminated, 30% of the fixed expenses can be eliminated. How much are the relevant costs in the decision to eliminate this product line? a. $54,000 b. $410,000 c. $335,000 d. $284,000

39.

North Division has the following information: Sales $600,000 Variable expenses 320,000 Fixed expenses 410,000 If this division is eliminated the fixed expenses will be allocated to the company’s other divisions. What is the incremental effect on net income if the division is dropped? a. $130,000 increase b. $410,000 decrease c. $280,000 decrease d. $190,000 increase

40.

Peters, Inc. produces chocolate chip cookies. Costs for producing one batch appear below: Direct materials $ 8.00 Direct labour 3.00 Variable overhead 1.00 Fixed overhead 4.00 An outside supplier has offered to produce the cookies for $14 per batch. If Peters decides to buy instead of make the cookies, what is the maximum price it would may? a. $16.00 b. $12.00 c. $13.60 d. $14.40

41.

Walton, Inc. is unsure of whether to sell its product assembled or unassembled. The unit cost of the unassembled product is $16, while the cost of assembling each unit is estimated at $17. Unassembled units can be sold for $55, while assembled units could be sold for $71 per unit. What decision should Walton make? a. Sell before assembly, the company will save $1 per unit. b. Sell before assembly, the company will save $15 per unit.

7-10

Test Bank for Managerial Accounting, Third Canadian Edition

c. d.

Process further, the company will save $1 per unit. Process further, the company will save $16 per unit.

42.

Ace Company sells office chairs with a selling price of $45 and a contribution margin per unit of $20. It takes 5 machine hours to produce one chair. How much is the contribution margin per unit of limited resource? a. $4 b. $5 c. $9 d. $20

43.

Rosen, Inc. has 10,000 obsolete calculators, which are carried in inventory at a cost of $20,000. If the calculators are scrapped, they can be sold for $1.10 each (for parts). If they are repackaged, at a cost of $15,000, they could be sold to toy stores for $2.50 per unit. What alternative should be chosen, and why? a. Scrap; profit is $1,000 greater. b. Repackage; revenue is $5,000 greater than cost. c. Scrap; incremental loss is $9,000. d. Repackage; receive profit of $10,000. 44. It costs Lannon Fields $14 of variable costs and $6 of allocated fixed costs to produce an industrial trash can that sells for $30. A buyer in Mexico offers to purchase 3,000 units at $18 each. Lannon has excess capacity and can handle the additional production. What effect will acceptance of the offer have on net income? a. decrease $4,000 b. increase $4,000 c. increase $54,000 d. increase $12,000

45.

Which steps do accountants mostly contribute to in the decision-making process? a. Identifying the problem and then assigning responsibility. b. Determining and evaluating possible courses of action and then reviewing the results of the decision. c. Determining and evaluating possible courses of action, and then making a decision. d. Making a decision and then reviewing the results of that decision.

46.

Which one of the following stages of the management decision-making process is properly sequenced? a. Evaluate possible courses of action, Make decision b. Review the actual impact of the decision, Determine possible courses of action c. Assign responsibility for the decision, Identify the problem d. Make a decision, Assign responsibility

47.

Who prepares relevant revenue and cost data for the decision making process? a. Department heads b. The controller

Incremental Analysis

c. d.

7-11

Management accountants Factory supervisors

48.

Which of the following statements about making decisions is correct? a. Only relevant financial information should be considered. b. All information should be considered in the final decision. c. Management should consider both relevant financial and non-financial information. d. Management accountants should provide the information, but they should not make recommendations. It is up to the managers to make decisions.

49.

What is the process of evaluating financial data that changes under alternative courses of action called? a. Incremental analysis b. Decision-making analysis c. Contribution margin analysis d. Cost-benefit analysis

50.

Which one of the following is nonfinancial information that management might evaluate in making a decision? a. Opportunity costs of a decision b. Contribution margin c. The effect on profit of a decision d. The corporate profile in the community

51.

Which one of the following is an alternative name for incremental analysis? a. Managerial analysis b. Cost analysis c. Contribution margin analysis d. Differential analysis

52.

Which of the following describes one aspect of incremental analysis? a. Both costs and revenues that stay the same between alternate courses of action will be analyzed. b. Both costs and revenues that differ between alternate courses of action will be analyzed. c. All costs and revenues, regardless if they stay the same or differ between alternate courses of action, will be analyzed. d. Only costs relating to the decisions at hand are analyzed.

53.

Which of the following statements about incremental analysis is true? a. It cannot be used if more than two alternatives are available. b. It considers only cost factors, not revenue. c. Its focus is on the past activities. d. It only considers factors that are different for each alternative, and only those factors that will occur in the future.

7-12

Test Bank for Managerial Accounting, Third Canadian Edition

54.

What is a sunk cost? a. A significant cost that has the potential to “sink” the organization. b. A cost that has already occurred, but still must be considered in the decision process. c. A cost that has already occurred and therefore is not relevant in the decision process. d. A cost that cannot be changed.

55.

Which one of the following is a true statement about incremental analysis? a. It is another name for capital budgeting. b. It is the same as CVP analysis. c. It is used primarily for long-term planning. d. It focuses on decisions that involve a choice among alternative courses of action.

56.

For which of the following decisions is incremental analysis not appropriate? a. Elimination of an unprofitable segment b. Determining cost behaviour c. A make or buy decision d. An allocation of limited resource decision

57.

For which of the following is incremental analysis appropriate? a. Acceptance of a special order and a make or buy decision b. A retain or replace equipment decision and CVP analysis c. A sell or process further decision and allocation of indirect costs d. Elimination of an unprofitable segment and allocation of indirect costs

58.

Which of the following is a true statement about costs in incremental analysis? a. Variable costs are always relevant. b. Fixed costs are never relevant. c. Fixed costs are always relevant. d. Both variable and fixed costs can be relevant.

59.

Specik, Inc. is considering the following alternatives: Alternative 1 Alternative 2 Revenues $120,000 $120,000 Variable costs 60,000 65,000 Fixed costs 35,000 39,000 Which of the following are relevant in choosing between the alternatives? a. Variable costs b. Revenues c. Fixed costs d. Variable costs and fixed costs

60.

Seville Company manufactures a product with a unit variable cost of $42 and a unit sales price of $75. Fixed manufacturing costs were $80,000 when 10,000 units were produced and sold, equating to $8 per unit. The company has a one-time opportunity to sell an

Incremental Analysis

7-13

additional 1,500 units at $55 each in an international market which would not affect its present sales. The company has sufficient capacity to produce the additional units. How much is the relevant income effect of accepting the special order? a. $63,000 b. $7,500 c. $50,000 d. $19,500 61.

Which statement is true about relevant costs in incremental analysis? a. All costs are relevant if they change between alternatives. b. Only fixed costs are relevant. c. Only variable costs are relevant. d. Relevant costs should be ignored.

62.

M&H Ltd. has sufficient capacity to fill an order at a special price below its usual price. The special price exceeds its variable costs. What non-financial factors should also be considered in the decision? a. Is there the potential for additional sales to the customer in the future? b. How existing customers will respond if they find out about the special price. c. If there is the potential for additional sales to the customer in the future, can a higher price be charged? d. All of the above.

63.

Canosta, Inc. determined it must expand its capacity to accept a special order. Which situation is likely? a. Unit variable costs will increase. b. Fixed costs will not be relevant. c. Both variable and fixed costs will be relevant. d. The company should accept the order.

64.

A company is within plant capacity. It is contemplating whether a special order should be accepted. The order will not impact regular sales. If the company accepts a special order, what will occur? a. Incremental costs will not be affected. b. Net income will increase if the special sales price per unit exceeds the unit variable costs. c. There are no incremental revenues. d. Both fixed and variable costs will increase.

65.

Argus Company anticipates that other sales will be affected by the acceptance of a special order. What should the company do? a. Reject the order. b. Consider the opportunity cost of lost sales in the incremental analysis. c. Accept the order. d. Accept the order if the plant is below capacity.

66.

Which statement is true of an opportunity cost?

7-14

Test Bank for Managerial Accounting, Third Canadian Edition

a. b. c. d.

It is the cost of a special order option. It reduces the possibility of accepting a particular course of action. It is the potential benefit as a result of following an alternative course of action. It is a variable cost.

67.

In which situations should opportunity costs be considered? a. Decision making that involves alternative uses b. Forecasting sales c. Financial accounting d. Breakeven analysis

68.

What is the nature of an opportunity cost? a. It is always variable. b. It is a potential benefit. c. It is included as part of cost of goods sold. d. It is a sunk cost.

69.

Wishnell Toys can make 5,000 toy robots with the following costs: Direct Materials $74,000 Direct Labour 30,000 Variable Overhead 23,000 Fixed Overhead 15,000 The company can purchase the 5,000 robots externally for $145,000. The avoidable fixed costs are $15,000 if the units are purchased externally. What is the cost savings if the company makes the robots? a. $18,000 b. $15,000 c. $5,000 d. $3,000

Use the following information for questions 70–71. Hermantic, Inc. can produce 100 units of a component part with the following costs: Direct Materials $30,000 Direct Labour 13,000 Variable Overhead 32,000 Fixed Overhead 22,000 70.

If Hermantic, Inc. purchases the units externally for $80,000, by what amount will its total costs change? a. An increase of $80,000 b. An increase of $5,000 c. An increase of $17,000 d. A decrease of $22,000

71.

If Hermantic, Inc. can purchase the component externally for $88,000 and only $8,000 of

Incremental Analysis

7-15

the fixed costs can be avoided, what is the correct "make or buy decision"? a. Make and save $1,000 b. Buy and save $1,000 c. Make and save $5,000 d. Buy and save $13,000 Use the following information for questions 72–73. Eminen Music produces 60,000 blank CDs on which to record music. The CDs have the following costs: Direct Materials $11,000 Direct Labour 15,000 Variable Overhead 3,000 Fixed Overhead 7,000 72.

Eminem could avoid $4,000 in fixed overhead costs if it acquires the CDs externally. If cost minimization is the major consideration and the company would prefer to buy the 60,000 units externally, what is the maximum external price that Eminem would expect to pay for the units? a. $32,000 b. $29,000 c. $36,000 d. $33,000

73.

None of Eminem’s fixed overhead costs can be reduced, but another product could be made that would increase profit contribution by $4,000 if the CDs were acquired externally. If cost minimization is the major consideration and the company would prefer to buy the CDs, what is the maximum external price that Eminem would be willing to accept to acquire the 60,000 units externally? a. $36,000 b. $32,000 c. $33,000 d. $40,000

74.

Harrison Company determines that an opportunity cost of an alternate course of action is relevant to a make or buy decision. Which statement is true of the opportunity cost? a. Should be added to the "Buy" costs b. Should be subtracted from the "Make" costs c. Should be added to the "Make" costs d. Should be ignored if it does not involve a cash outlay.

75.

A company has a process that results in 1,000 kilograms of Product X that can be sold for $10 per kilogram. An alternative would be to process Product X further at a cost of $2,000 and then sell it for $13 per kilogram. Should management sell Product X now or should Product X be processed further and then sold? a. Process further, the company will be better off by $1,000. b. Sell now, the company will be better off by $1,000. c. Process further, the company will be better off by $3,000.

7-16

Test Bank for Managerial Accounting, Third Canadian Edition

d.

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

76.

Which statement is true concerning the decision rule on whether to make or buy? a. The company should buy if the cost of buying is less than the cost of producing. b. The company should buy if the incremental revenue exceeds the incremental costs. c. The company should buy as long as total revenue exceeds present revenues. d. The company should buy assuming no additional fixed costs are incurred.

77.

PH Toy is unsure of whether to sell its product assembled or unassembled. The unit cost of the unassembled product is $30 and PH Toy Company would sell it for $65. The cost to assemble the product is estimated at $21 per unit and PH Toy Company believes the market would support a price of $85 on the assembled unit. What decision should PH Toy make? a. Sell before assembly, the company will be better off by $1 per unit. b. Sell before assembly, the company will be better off by $20 per unit. c. Process further, the company will be better off by $29 per unit. d. Process further, the company will be better off by $14 per unit.

78.

What is the nature of a sell or process further decision? a. It is an incremental revenue decision. b. It is an incremental cost decision. c. It is both an incremental revenue and incremental cost decision. d. It is neither incremental revenue nor incremental cost.

79.

Coggin Company gathered the following data about the three products that it produces: Present Estimated Additional Estimated Sales Product Sales Value Processing Costs if Processed Further A $ 9,000 $ 6,000 $ 16,000 B 15,000 5,000 18,000 C 11,000 8,000 16,000 Which of the products should be processed further? a. Product A b. Product B c. Product C d. All three products

80.

Which of the following is relevant information in a decision whether old equipment presently being used should be replaced by new equipment? a. The cost of the old equipment b. The salvage value of the old equipment c. The book value of the old equipment d. The accumulated depreciation of the old equipment

81.

What is the salvage value of old equipment considered to be? a. A relevant cost b. A non-incremental cost

Incremental Analysis

c. d.

7-17

An opportunity cost A cost that is not differential

82.

A company is deciding whether or not to replace some old equipment with new equipment. Which of the following is not considered in the incremental analysis? a. Annual operating cost of the new equipment b. Annual operating cost of the old equipment c. Net cost of the new equipment d. Book value of the old equipment

83.

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

84.

What role does a trade-in allowance on old equipment play in a decision to retain or replace equipment? a. It relevant since it increases the cost of the new equipment. b. It is not relevant since it reduces the cost of the old equipment. c. It is not relevant to the decision since it does not impact the cost of the new equipment. d. It is relevant since it reduces the cost of the new equipment.

85.

Diversified Machines has four product lines, one of which reflects the following results: Sales $220,000 Variable expenses 120,000 Contribution margin 100,000 Fixed expenses 120,000 Net loss $(20,000) If this product line is eliminated, 40% of the fixed expenses can be eliminated and the other 60% will be allocated to other product lines. If management decides to eliminate this product line, what will happen to the company's net income? a. It will increase by $20,000. b. It will decrease by $52,000. c. It will decrease by $32,000. d. It will increase by $48,000.

86.

Halliburton Division has the following data: Sales $500,000 Variable expenses 240,000 Fixed expenses 280,000 The fixed costs are not avoidable and must be allocated to profitable divisions if the segment is eliminated. What will be the incremental effect on net income if Halliburton Division is eliminated? a. $60,000 increase b. $260,000 decrease

7-18

Test Bank for Managerial Accounting, Third Canadian Edition

c. d.

$280,000 decrease Cannot be determined from the data provided

87.

SmartCard is considering eliminating one of its product lines. The fixed costs currently allocated to the product line will be allocated to other product lines upon discontinuance. What financial effects occur if the product line is discontinued? a. Net income will decrease by the amount of the contribution margin of the product line being discontinued. b. The company's total fixed costs will increase. c. Total fixed costs will decrease by the amount of the product line's fixed costs. d. Net income will decrease by the amount of the product line's fixed costs.

88.

Shorebuck’s Coffee can sell all the units it can produce of either latte or cappuccino but not both. Latte has a unit contribution margin of $45 and takes three machine hours to make and cappuccino has a unit contribution margin of $32 and takes two machine hours to make. There are 1,300 machine hours available to manufacture a product. What should Shorebuck’s do? a. Make latte which creates $13 more profit per unit than cappuccino does. b. Make cappuccino which creates $1 more profit per constraint than latte does. c. Make cappuccino because more units can be made and sold than latte. d. The same total profits exists regardless of which product is made.

89.

What is the key factor in performing incremental analysis if a company has limited resources? a. Contribution margin per unit of limited resource b. The amount of fixed costs per unit c. Total contribution margin d. The cost of limited resources

90.

Hari’s Fish House can produce and sell only one of the following two products: Fryer Contribution Hours Required Margin Per Unit Fried catfish 3 $15 Fried grouper 4 $16 The company has fryer capacity of 12,000 hours. How much will the contribution margin be if it produces only the most profitable product? a. $48,000 b. $36,000 c. $60,000 d. $12,000

91.

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

Incremental Analysis

c. d.

7-19

$3,000 decrease $15,000 increase

92.

Which one of the following does not affect a make or buy decision? a. Variable manufacturing costs b. Opportunity cost c. Incremental revenue d. Direct labour

93.

How should that portion of fixed costs that are unavoidable be handled when making a decision on whether to eliminate an unprofitable segment? a. They should be subtracted from the contribution margin and if that results in a net loss, the segment should be eliminated. b. They should not be considered as they are not relevant. c. They should be allocated to other segments. If that causes a loss in another segment, that segment should be eliminated as well. d. Fixed costs are never relevant.

94.

Diaz Company’s contribution margin is $4 per unit for Product A and $5 for Product B. Product A requires 2 machine hours and Product B requires 4 machine hours. How much is the contribution margin per unit of limited resource for each product? A B a. $4.00 $5.00 b. $2.00 $1.25 c. $1.25 $2.00 d. $2.50 $1.00

95.

What non-financial factors should be considered when making a decision about buying rather than making a component of a company’s product? a. Is the quality of the purchased component acceptable? b. Will the outside supplier increase prices significantly in the future? c. Will the supplier deliver on time? d. All of the above.

96.

Litto Fray’s produces corn chips. The cost of one batch is below: Direct materials $ 18.00 Direct labour 13.00 Variable overhead 12.00 Fixed overhead 14.00 An outside supplier has offered to produce the corn chips for $26 per batch. How much will Hungry Bites save if it accepts the offer? a. $2.00 per batch b. $17.00 per batch c. $31.00 per batch d. $6.00 per batch

97.

When a company does not have sufficient capacity to fill an order for less than the current

7-20

Test Bank for Managerial Accounting, Third Canadian Edition

selling price, what additional factor must be taken into consideration? a. The decision process is the same whether there is sufficient capacity or not. b. How will the lack of capacity affect the quality of the product. c. Can resources be transferred from producing product to sell at the current price to producing product at the special price? d. Opportunity costs 98.

Meow Cat Toys utilizes Lincoln Fabrics by purchasing the fabric to cover toy mice for its mouse toy division. As it pertains to Lincoln Fabrics, what decision situation does this create? a. Make or buy b. Sell or process further c. Relevant costing d. Budgeting

99.

During 2011, it cost Westa, Inc. $12 per unit to produce Part T5. During 2012, it has increased to $14 per unit. In 2011, Southside Company has offered to provide Part T5 for $9 per unit to Westa. As it pertains to the make-or-buy decision, which statement is true? a. Differential costs are $5 per unit. b. Incremental costs are $3 per unit. c. Net relevant costs are $3 per unit. d. Incremental revenues are $2 per unit.

100.

Serene Dairy has 4 product lines: sour cream, ice cream, yogurt, and butter. The total costs of producing the milk base for the products is $53,000 which has been allocated based on litres of milk base used by each product. Results of July follow: Sour Cream

Units sold Revenue Variable departmental costs Fixed costs Net income (loss)

1,700 $7,000 4,000 4,500 ($1,500)

Ice Cream

750 $15,000 10,000 1,000 $4,000

Yogurt

Butter

500 $12,000 7,000 2,000 $3,000

5,000 $25,000 12,000 6,000 $7,000

Total

7,950 $59,000 33,0000 13,500 $12,500

How much are total joint costs of the products? a. $33,000 b. $13,500 c. $53,000 d. $12,500 101.

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

Incremental Analysis

c. d.

7-21

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

102.

Namov Company has old inventory on hand that cost $12,000. Its scrap value is $16,000. The inventory could be sold for $38,000 if manufactured further at an additional cost of $12,000. What should Narst do? a. Sell the inventory for $16,000 scrap value. b. Dispose of the inventory to avoid any further decline in value. c. Hold the inventory at its $12,000 cost. d. Manufacture further and sell it for $38,000.

103.

Which decision will involve no incremental revenues? a. Make or buy decision b. Drop a product line c. Accept a special order d. Additional processing decision

104.

A factory is operating at less than 100% capacity. Potential additional business will not use up the remainder of the plant capacity. Given the following list of costs, which one should be ignored in a decision to produce additional units of product? a. Variable selling expenses b. Fixed factory overhead c. Direct labour d. Contribution margin of additional units

105

Market Makeup produces face cream. Each bottle of face cream costs $10 to produce and can be sold for $13. The bottles can be sold as is, or processed further into sunscreen at a cost of $14 each. Market Makeup could sell the sunscreen bottles for $23 each. a. Face cream must be further processed because its profit is $9 each. b. Face cream must not be further processed because costs increase more than revenue. c. Face cream must not be further processed because it decreases profit by $1 each. d Face cream must be further processed because it increases profit by $3 each.

106.

A company decided to replace an old machine with a new machine. Which of the following is considered a relevant cost? a. The book value of the old equipment b. Depreciation expense on the old equipment c. The loss on the disposal of the old equipment d. The current disposal price of the old equipment

107.

Chapman Company manufactures widgets. Embree Company has approached Chapman with a proposal to sell the company widgets at a price of $60,000 for 100,000 units. Chapman is currently making these components in its own factory. The following costs are associated with this part of the process when 100,000 units are produced: Direct material $23,000

7-22

Test Bank for Managerial Accounting, Third Canadian Edition

Direct labour 22,000 Manufacturing overhead 30,000 Total $75,000 The manufacturing overhead consists of $12,000 of costs that will be eliminated if the components are no longer produced by Chapman. From Chapman’s point of view, how much is the incremental cost or savings if the widgets are bought instead of made? a. $15,000 incremental savings b. $3,000 incremental cost c. $3,000 incremental savings d. $15,000 incremental cost 108.

Costs that are relevant for future decision making in a manufacturing environment include: a. Only variable manufacturing costs. b. Only fixed manufacturing costs. c. All manufacturing costs. d. Only future costs that impact on the alternatives presented.

109.

When making a decision to accept a special order management must consider: a. The impact that additional manufacturing time will have on unit costs of its current products. b. If the purchaser will accept additional high costs of a special order. c. If a lower price will convince the purchaser to become a regular customer. d. If capacity exists to meet the demand of the order.

110.

Which of the following statements is true? a. All variable costs are relevant costs. b. Only those variable costs that differ between alternatives are relevant costs. c. Fixed costs are never relevant costs. d. All fixed costs are relevant costs as they impact on overall unit costs.

111.

Excess capacity decisions for management involve: a. Decreasing sales prices to stimulate demand. b. Accepting special orders. c. Outsourcing some products to specialist manufacturers. d. Mixing production to reduce variable costs.

112.

The main purpose of allocating joint costs to products is to: a. Assist management in setting prices for its products. b. Assist in the annual budgetary processes. c. Assist in determining the cost of the products involved. d. Assist in determining which products should be added or dropped.

113.

When management has excess capacity available to it in the short run, which of the following would be the best path to follow? a. Consider ways to reduce its fixed costs b. Consider accepting special orders c. Consider outsourcing certain products

Incremental Analysis

d.

7-23

Consider mixing its product offerings in a new way

114.

Costs that are common to two or more products are considered to be: a. Joint costs. b. Split-off costs. c. Allocated costs. d. Shared fixed costs.

115.

Which of the following statements is true? a. Common costs should be considered when deciding to drop a product line. b. If a segment of a company has been losing money for several years, that segment should be dropped. c. If an unprofitable segment is dropped, the company’s net income will increase. d. If an unprofitable segment is dropped, fixed costs will decrease.

116.

The most important thing to consider when deciding to replace or keep equipment is: a. Salvage value of the current equipment. b. The estimated number of years remaining on the books. c. The expected variable costs of the new equipment. d. If book value is higher than replacement value.

117.

Costs that are common to one or more products are called: a. Split-off costs. b. Sunk costs. c. Joint costs. d. Incremental costs.

7-24

Test Bank for Managerial Accounting, Third Canadian Edition

ANSWERS TO MULTIPLE CHOICE QUESTIONS Item 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45.

Ans. d b b c d d c b a a a d b

Item 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58.

Ans. a c c a d d b d c d b a d

Item 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71.

Ans. d d a d c b b c a b d b c

Item 72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84.

Ans. a b c a a a c a b a d c d

Item 85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96. 97.

Ans. b b a b a c a c b b d b d

Item 98. 99. 100. 101. 102. 103. 104. 105. 106. 107. 108. 109. 110.

Ans. a a c c d a b b d b d d b

Item 111. 112. 113. 114. 115. 116. 117.

Ans. b c b a a c c

Incremental Analysis

7-25

BRIEF EXERCISES Brief Exercise 118 Temple, Inc. produces several models of clocks. An outside supplier has offered to produce the commercial clocks for Temple for $350 each. Temple needs 500 clocks annually. Temple has provided the following unit costs for its commercial clocks: Direct materials Direct labour Variable overhead Fixed overhead (30% avoidable)

$ 70 80 75 120

Prepare an incremental analysis which shows the effect of the make or buy decision. Solution Brief Exercise 118 Incremental Analysis Cost to buy (500 x $350) Cost savings: Savings of DM $70 x 500 = Savings of DL $80 x 500 = Savings of VOH $75 x 500 =

Incremental Effect ($175,000) $35,000 40,000 37,500

Savings of FOH 30% x $120 x 500 =

18,000

Total cost savings Net cost savings if commercial clock are bought

+130,500 $ 44,500

Brief Exercise 119 Calc, Inc. owns a machine that produces baskets for the gift packages the company sells. The company uses 1,000 baskets in production each month. The costs of making one basket is $7 for direct materials, $5 for variable manufacturing overhead, $4 for direct labour and $8 for fixed manufacturing overhead. The unit cost is based on the monthly production of 1,000 baskets. The company determined that 25% of the fixed manufacturing overhead is avoidable. An outside supplier has offered to sell Calc the baskets for $15 each, and can supply all the units it needs. Prepare an incremental analysis to determine if Calc should buy the component from the supplier. Solution Brief Exercise 119 Incremental cost to buy (1,000 x $15) Incremental cost savings: DM ($7 x 1,000) VOH ($5 x 1,000) DL ($4 x 1,000) FOH ($8 x 25% x 1,000) Total savings to buy OR

($15,000) +7,000 +5,000 +4,000 +2,000 ($3,000) Make

Incremental cost to buy (1,000 x $15) Incremental costs to make: DM ($7 x 1,000) VOH ($5 x 1,000)

$7,000 5,000

Buy $15,000

7-26

Test Bank for Managerial Accounting, Third Canadian Edition

DL ($4 x 1,000) FOH Incremental cost to buy

4,000 8,000 $24,000

6,000 $21,000

Brief Exercise 120 Signa Corporation currently manufactures 17,000 staplers annually for its main product. The costs per stapler are as follows: Direct materials $ 2.50 Direct labour 7.50 Variable overhead 3.00 Fixed overhead 8.00 Total $21.00 Darsel Company has contacted Signa with an offer to sell it 17,000 staplers for $19.00 each. $6 of the fixed overhead per unit is unavoidable. Prepare an incremental analysis for the make or buy decision. Solution Brief Exercise 120 Incremental cost to buy ($19.00 x 17,000 staplers) Incremental savings on direct materials ($2.50 x 17,000) Incremental savings on direct labour ($7.50 x 17,000) Incremental savings on variable MOH ($3.00 x 17,000) Incremental savings on fixed MOH ([$8.00 - $6.00] x 17,000) Incremental net cost to buy

($323,000) +42,500 +127,500 +51,000 +34,000 ($68,000)

Brief Exercise 121 Parrino has three product lines in its retail stores: books, DVDs, and music. The allocated fixed costs are based on revenue and are unavoidable. Results of the fourth quarter are presented below: Books Music DVDs Total Units sold 750 1,000 1,200 2,950 Revenue $22,500 $15,000 $9,600 $47,10 0 Variable departmental costs 12,000 8,000 5,000 25,000 Direct fixed costs 4,000 3,000 4,500 11,500 Allocated fixed costs 4,777 3,185 2,038 10,000 Net income (loss) $ 1,723 $815 ($1,938) $600 Demand of individual products is not affected by changes in other product lines. Prepare an incremental analysis of the effect of dropping the DVDs product line. Solution Brief Exercise 121 Incremental revenue Incremental savings on variable costs Incremental savings on direct fixed costs Incremental cost/decrease in profit to drop video line

($9,600) +5,000 +4,500 ($100)

Incremental Analysis

7-27

Brief Exercise 122 Crisp has 4 product lines: sour cream, ice cream, yogurt, and butter. The allocated fixed costs are based on units sold and are unavoidable. Demand of individual products is not affected by changes in other product lines. 40% of the fixed costs are direct, and the other 60% are allocated. Results of June follow:

Units sold Revenue Variable departmental costs Fixed costs Net income (loss)

Sour Cream 2,000 $10,000 6,000 5,000 ($1,000)

Ice Cream 500 $20,000 13,000 2,000 $5,000

Yogurt

Butter

Total

400 $10,000 4,200 3,000 $2,800

200 $20,000 4,800 7,000 $8,200

3,100 $60,000 28,000 17,000 $15,000

Prepare an incremental analysis of the effect of dropping the sour cream product line. Solution Brief Exercise 122 Incremental revenue Incremental variable cost savings Incremental fixed cost savings ($5,000 x .40) Incremental decrease in profits if dropped

($10,000) +6,000 +2,000 ($2,000)

Brief Exercise 123 Sam Company makes 2 products, footballs and baseballs. Additional information follows: Football Baseball s s Units 2,000 3,000 Sales $60,000 $25,000 Variable costs 24,000 13,750 Fixed costs 10,000 5,250 Net income $26,000 $6,000 Metres of leather per unit 1.25 0.25 Profit per unit $13.00 $2.00 Contribution margin per unit $18.00 $3.75 Assume that Sam is able to order an additional 2,000 metres of leather and wishes to maximize its income. Of the additional units it produces, at least 300 of each product are necessary for sales. How many units of each must be produced? Solution Brief Exercise 123 Contribution margin per metre

Footballs $18/1.25 = $14.40

Baseballs $3.75/.25 = $15

Produce more baseballs since CM per constraint is more.

Minimum: 300 x 1.25 metre. = 375 metre.

Footballs 300 footballs

Baseballs

7-28

Test Bank for Managerial Accounting, Third Canadian Edition

Yards remaining for baseballs: 2,000 - 375 = 1,625 metres # of baseballs: 1,625/.25 metre =

. 6,500 baseballs

Brief Exercise 124 Hernandez, Inc. manufactures 5 models of picture frames, for a total of 12,000 frames per year. The unit cost to produce a metal frame follows: Direct Materials $4 Direct Labour 5 Variable Overhead 1 Fixed Overhead (60% unavoidable) 6 Total $16 A local company has offered to supply Hernandez the 12,000 metal frames it needs for $12 each. Create an incremental analysis for the make or buy decision. Solution Brief Exercise 124 Incremental cost to buy ($144,000) Incremental savings: Direct materials savings Direct labour savings Variable overhead savings Fixed overhead savings - avoidable portion Incremental savings if 'buy' decision is made

+$48,000 +60,000 +12,000 +28,800 $4,800

Brief Exercise 125 Myrna’s Mowing Ltd. cuts lawns. It has a riding lawnmower with a book value of $5,000, and a remaining useful life of 5 years. A new, more efficient lawnmower is available with a cost of $15,000. The useful life of the new machine is also expected to be 5 years. Myrna estimates that the new machine will allow her to cut more lawns, and therefore increase revenue from $20,000 per year to $22,000, and reduce variable costs from $12,000 per year to $10,500. Prepare an analysis showing whether Myrna should retain the old mower, or buy new. Solution Brief Exercise 125

Revenue Variable manufacturing costs New machine cost Net savings over 5 years

Retain Equipment $100,000 (60,000)

Replace Equipment $110,000 (52,500)

Net Income Change $10,000* 7,500 (15,000) $ 2,500

*For 5 years Brief Exercise 126

Incremental Analysis

7-29

Jamie has been accepted to a university in a city far from her home. She will need to rent an apartment, and has two choices. The first choice cost $1,000 per month, and is within walking distance of the university. The second apartment costs $925 per month, but Jamie will have to buy a bus pass in order to get to the university. The pass costs $100 per month. Jamie has been hired to work part time at a job that is a bus ride away from both apartments. Identify which costs are relevant in the incremental analysis. What other factors should be considered? Solution Brief Exercise 126 Since Jamie will have to buy a bus pass in both cases in order to get to her job, the $100 cost of the pass is not relevant. Accordingly, the only relevant costs given are the rent. The second apartment is $75 cheaper than the first, and therefore strictly from a cost perspective is the better choice. Other factors that need to be considered are the amount of time spent commuting, and how Jamie could use that time, and Jamie’s preference of which apartment she likes better. Brief Exercise 127 Gladiator Company provided the following information concerning two products: Contribution margin per unit – Product 12 $22 Contribution margin per unit – Product 43 $15 Machine hours required for one unit – Product 12 2.5 hours Machine hours required for one unit – Product 43 1.5 hours Calculate the contribution margin per unit of limited resource for each product. Which product should Gladiator tell its sales personnel to ‘push’ to customers? Solution Brief Exercise 127 Product 12: $22/2.5 hours = $8.80 Product 43: $15/1.5 hours = $10 Sales personnel should push product 43. Brief Exercise 128 McIntosh Enterprises produces giant stuffed bears. Each bear consists of $12 of variable costs and $9 of fixed costs and sells for $45. A wholesaler offers to buy 8,000 units at $14 each, of which McIntosh has the capacity to produce. McIntosh will incur extra shipping costs of $1.25 per bear. Determine the incremental income or loss that McIntosh Enterprises would realize by accepting the special order. Solution Brief Exercise 128 Incremental revenue (8,000 x $14) $112,000 Incremental variable costs ($12 x 8,000) Incremental shipping costs ($1.25 x 8,000) Incremental profit if special order accepted

(96,000) (10,000) $6,000

Brief Exercise 129 Chuckie’s Chunks produces fudge candy. It costs $.0.20 to make each box in which the fudge is packaged. Of this cost, $0.12 is variable and $0.08 is fixed. A supplier offers to make the boxes for the fudge for $0.15 each. If the offer is accepted, Chuckie’s will save all variable costs but no

7-30

Test Bank for Managerial Accounting, Third Canadian Edition

fixed costs. Chuckie’s uses 2,000 boxes per year. Prepare an incremental analysis showing the total effect on costs if the boxes are bought instead of manufactured. Solution Brief Exercise 129 Incremental cost to buy (2,000 x $0.15) ($300) Incremental variable costs (2,000 x $0.12) Incremental cost of buying

240 ($ 60)

Brief Exercise 130 Harmark has three product lines in its retail stores: kites, wind socks, and flags. Results of the fourth quarter are presented below:

Units sold Revenue Variable departmental costs Direct fixed costs Allocated fixed costs Net income (loss)

Kites 1,000 $22,000 15,000 1,000 8,000 ($2,000)

Wind Socks 2,000 $40,000 22,000 3,000 8,000 $ 7,000

Flags 2,000 $23,000 12,000 2,000 8,000 $ 1,000

Total 5,000 $85,000 49,000 6,000 24,000 $ 6,000

The allocated fixed costs are unavoidable. Demand of individual products is not affected by changes in other product lines. What will happen to profits if Harmark discontinues the ‘Kites’ product line? Solution Brief Exercise 130 Incremental revenue Incremental costs: Variable costs savings Direct fixed costs savings Drop in profits if discontinued

($22,000) +15,000 +1,000 ($6,000)

Brief Exercise 131 Wood Chuck Furniture currently manufactures rocking chairs as its main product. Each chair uses one seat cushion and one back cushion with the following costs per set of cushions (one seat and one back): Direct materials Direct labour Variable overhead Fixed overhead Total

$ 1.00 10.00 5.00 8.00 $24.00

Sherpert Company has contacted Wood Chuck with an offer to sell it 5,000 of sets of cushions for $18.00 each. If Wood Chuck makes the cushions, $5 of the fixed overhead per unit will be allocated to other products. Should Wood Chuck make or buy the cushions? Solution Exercise 131

Incremental Analysis

7-31

Cost to make − costs to buy = incremental cost ($24 − $3) − $18 = $3 = incremental cost per set Incremental cost to make = $3 x 5,000 units = $15,000 Wood Chuck should buy to save $3 per set. Brief Exercise 132 Cluck Farms, Inc. produces a crop of chickens at a total cost of $66,000. The production generates 60,000 chickens which can be sold for $1 each to a slaughtering company, or the chickens can be slaughtered in house and then sold for $2.25 each. It costs $55,000 more to turn the annual chicken crop into chicken meat. If Cluck Farms slaughters the chickens, how much is incremental profit or loss? What should Cluck Farms do? Solution Brief Exercise 132 Incremental revenues: ($2.25 - $1.00) x 60,000 chickens = $75,000 Incremental costs: given as $55,000 Incremental profits: $75,000 - $55,000 = $20,000 profit Cluck Farms should slaughter. Brief Exercise 133 Dolls R Us sells three products in its retail stores: baby dolls, teenage dolls, and plush dolls. Results of the 4th quarter are below:

Units sold Revenue Variable departmental costs Direct fixed costs Allocated fixed costs Net income

Baby Dolls 1,000 $31,000 22,000 5,000 6,000 ($2,000)

Teenage 2,000 $43,000 24,000 4,000 7,000 $ 8,000

Plush 2,000 $26,000 13,000 3,000 7,000 $ 3,000

Total 5,000 $100,000 59,000 12,000 20,000 $ 9,000

Demand of individual products is not affected by changes in other product lines. Prepare an incremental analysis to determine if baby dolls should be discontinued. Solution Brief Exercise 133 Incremental revenue Incremental costs: Variable costs savings Direct fixed costs savings Drop in profits if discontinued

($31,000) +22,000 +5,000 ($4,000)

Brief Exercise 134 The Compressed Air Company makes scuba tanks. The tanks have a regulator that requires the company to make a special valve. The cost to make this valve is as follows: Direct materials $ 7.50 Direct labour 3.25 Variable manufacturing overhead 2.10 Fixed manufacturing overhead 1.10 Unit product cost $13.95

7-32

Test Bank for Managerial Accounting, Third Canadian Edition

The company makes 10,000 tanks every year. An outside supplier has offered to sell the company the same valve at a cost of $12.50 per unit. By purchasing the valve the company will eliminate half of its fixed manufacturing overhead. Calculate the relevant costs the company should consider before making the decision to purchase the valve from the outside supplier Solution Brief Exercise 134 $13.95 x ($1.10 x ½) = $13.40 (Only half of the fixed manufacturing overhead is avoided. Therefore all other costs are relevant) Brief Exercise 135 Winslow Industries makes large waste storage bins and sells them for $150 each. The manufacturing cost of each bin is as follows: Direct material $50 Direct labour $40 Manufacturing overhead $20 The manufacturing overhead is 80% variable and 20% fixed. The company receives an order for 1,000 bins which will cost an additional $10 in shipping costs per bin. The company has sufficient excess capacity to produce the order. Required: Calculate the minimum price that Winslow should charge for each bin. Solution Brief Exercise 135 Direct material Direct labour Manufacturing overhead ($20 x .8) Shipping costs Minimum selling price

$50 40 16 10 116

Incremental Analysis

7-33

EXERCISES Exercise 136 Anheiser has three divisions: Bud, Wise, and Er. The results of May, 2012 are presented below: Units sold Revenue Less variable costs Less direct fixed costs Less allocated fixed costs Net income

Bud 5,000 $80,000 37,000 15,000 3,125 $24,875

Wise 7,000 $60,000 42,000 25,000 4,375 ($11,375)

Er 4,000 $30,000 14,000 13,000 2,500 $ 500

Total 16,000 $170,000 93,000 53,000 10,000 $14,000

All of the allocated costs will continue even if a division is discontinued. Anheiser allocates indirect fixed costs based on the number of units to be sold. Since the Wise division has a net loss, Anheiser feels that it should be discontinued. Anheiser feels if the division is closed, that sales at the Bud division will increase by 30%, and that sales at the Er division will stay the same. Instructions a. Prepare an analysis showing the effect of discontinuing the Wise division. b. Should Anheiser close the Wise division? Briefly indicate why or why not. Solution Exercise 136

(10–12 min.)

a.

Revenue Less variable costs Less direct fixed costs Less allocated fixed costs Net income

Bud $104,000 48,100 15,000 15,400 $25,400

Er $30,000 14,000 13,000 9,500 $ (6,500)

Total $134,000 62,100 28,000 25,000 $18,900

Calculations: Units = 5,000 x 130% = 6,500 Revenue = $80,000 x 130% = $104,000 Variable costs = $37,000 x 130% = $48,100 Allocation of total allocated fixed costs of $25,000: To Bud: 6,500/(6,500 + 4,000) x $25,000 = $15,500 To Er: 4,000/(6,500 + 4,000) x $25,000 = $9,500 b. Yes. The profit increases by $4,900 ($18,900 - $14,000) when the division is eliminated. Direct fixed costs and variable costs for the Wise division were relatively high compared to those for the Bud and Er divisions. The increase in sales by 30% of the Bud division was enough to offset the loss of the Wise division. Exercise 137 Beyonce Company sells two items, peanuts and soybeans. The company is considering dropping soybeans. It is expected that sales of peanuts will increase by 30% as a result. Dropping soybeans will allow the company to cancel its monthly rental of its bean shucker costing $50 a month. The other existing equipment will be used for additional production of peanuts. One

7-34

Test Bank for Managerial Accounting, Third Canadian Edition

employee earning $2,000 per month can be terminated if soybean production is dropped. Beyonce’s other fixed costs are allocated and will continue regardless of the decision made. A condensed, budgeted monthly income statement with both products is below: Total Sales Food materials Direct labour Equipment rental Other allocated overhead Operating income

$40,00 0 14,000 12,000 1,600 2,950 $9,450

Soybean s

Peanuts

$10,000

$30,000

4,000 3,000 700 2,000 $ 300

10,000 9,000 900 950 $9,150

Instructions Prepare an incremental analysis to determine the financial effect of dropping soybean production. Solution Exercise 137 (10–12 min.) Beyonce Company Incremental Analysis Incremental change in revenue: Increase in peanut sales: $30,000 x 30% Decrease in soybean sales

+$9,000 (10,000 )

Incremental decrease in revenue

($1,000)

Incremental change in variable costs: Food materials: Increase in peanut costs: $10,000 x 30% Decrease in soybean costs Direct labour: Increase in peanut labour: $9,000 x 30% Decrease in soybean labour Incremental decrease in variable costs

(3,000) +4,000 (2,700) +3,000 +1,300

Equipment rental reduction - soybean shucker

+50

Incremental increase in profits if soybean production is dropped

($350)

Exercise 138 Turner, Inc. budgeted 10,000 widgets for production during 2012. Turner has capacity to produce 15,000 units. Fixed factory overhead is allocated using ABC. The following estimated costs were provided: Direct material ($8/unit) Direct labour ($20/hr. x 3 hrs./unit) Variable manufacturing overhead ($5/unit) Fixed factory overhead costs ($2/unit)

$ 80,000 600,000 50,000 20,000

Incremental Analysis

Total

7-35

$750,000

Cost per unit = $75.00 Instructions Answer each of the following independent questions: a. Turner received an order for 3,000 units from a new customer in a country in which Turner has never done business. This customer has offered $73.50 per widget. Should Turner accept the order? b. Turner received an offer from another company to manufacture the same quality widgets for $72.50. Should Turner let someone else manufacture all 10,000 widgets and focus only on distribution? Solution Exercise 138 (10–12 min.) a. Yes, it can make $1,500. Incremental revenue per widget Incremental cost per widget: $8 + ($20 x 3) + $5 = Incremental profit per unit Total incremental profit = $0.50 x 3,000 = $1,500

$73.50 73.00 $ 0.50

b. Yes, Turner will save $5,000 if they are bought instead of made. Cost to buy per widget Cost to make per widget: $8 + ($20 x 3) + $5 = Incremental savings per widget if purchased

$72.50 73.00 $ 0.50

Total incremental savings if purchased = $0.50 x 10,000 = $5,000 Exercise 139 Paulsen Company produced and sold 7,000 units of product and is operating at 70% of plant capacity. Unit information about its product is as follows: Sales Price Variable manufacturing cost Fixed manufacturing cost ($35,000 ÷ 7,000) Profit per unit

$40 $25 5

30 $10

The company received a proposal from a foreign company to buy 500 units of Paulsen Company's product for $28 per unit. This is a one-time only order and acceptance of this proposal will not affect the company's regular sales. The president of Paulsen Company is reluctant to accept the proposal because he is concerned that the company will lose money on the special order. All fixed costs are allocated to individual products. Instructions Prepare a schedule reflecting an incremental analysis of this proposal. Indicate the effect the acceptance of this order might have on the company's income. Solution Exercise 139 Paulsen Company

(7–9 min.)

7-36

Test Bank for Managerial Accounting, Third Canadian Edition

Incremental Analysis Proposal to buy 500 units at $28 Reject Order $ -0-0-

Revenues (500 × $28) Variable costs (500 × $25) Net Income

Accept Order $ 14,000 (12,500)

Net Income Increase (Decrease) $14,000 (12,500) $ 1,500

Paulsen Company would increase its income by $1,500 in accepting the special order. Exercise 140 Smooth Brew manufactures cappuccino makers. For the first eight months of 2012, the company reported the following operating results while operating at 80% of plant capacity: Sales (120,000 units) Cost of goods sold Gross profit Operating expenses Net income

$6,000,000 3,600,000 2,400,000 1,800,000 $ 600,000

An analysis of costs and expenses reveals that variable cost of goods sold is $25 per unit and variable operating expenses are $10 per unit. In September, Smooth Brew received a special order for 5,000 machines at $40 each from a major coffee shop franchise. Acceptance of the order would result in $2,000 of shipping costs but no increase in fixed expenses. Instructions a. Prepare an incremental analysis for the special order. b. Should Smooth Brew accept the special order? Justify your answer. Solution Exercise 140 a. Revenues Cost of Goods Sold Operating Expense Net Income

(10–12 min.) Reject Order $ -0-0-0$ -0-

Accept Order $200,000 125,000* 52,000** $ 23,000

Net Income Increase (Decrease) $200,000 (125,000) (52,000) $ 23,000

*Variable cost of goods sold = 5,000 × $25 = $125,000 **Variable operating expenses = 5,000 × $10 = $50,000 + $2,000 = $52,000 b.

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

Exercise 141 Vincent Company supplies schools with floor mattresses to use in physical education classes. Vincent has received a special order from a large school district to buy 500 mats at $40 each. Acceptance of the special order will not affect fixed costs but will result in $800 of shipping costs.

Incremental Analysis

7-37

For the first 6 months of 2012, the company reported the following operating results while operating at 80% capacity: Sales (25,000 units) Cost of goods sold Gross profit Operating expenses Net income

$1,250,000 980,000 270,000 170,000 $ 100,000

Cost of goods sold was 80% variable and 20% fixed; operating expenses were 70% variable and 30% fixed. Instructions a. Prepare an incremental analysis for the special order. b. Should Vincent Company accept the special order? Justify your answer. Solution Exercise 141 a. Revenues Cost of Goods Sold Operating Expense Net Income

(10–12 min.) Reject Order $ -0-0-0$ -0-

Accept Order $20,000 15,680 3,180 $ 1,140

Net Income Increase (Decrease) $20,000 (15,680) (3,180) $1,140

Variable cost of goods sold = $980,000 × 80% = $784,000 Variable cost of goods sold per unit = $784,000 ÷ 25,000 = $31.36 Variable cost of goods sold for the special order = 500 × $31.36 = $15,680 Variable operating expenses = $170,000 × 70% = $119,000 Variable operating expenses per unit = $119,000 ÷ 25,000 = $4.76 Variable operating expenses for the special order = 500 × $4.76 = $2,380 + $800 = $3,180 b.

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

Exercise 142 Johnson Motors manufactured 500 gears that are used in its motors and incurred the following costs: Direct materials Direct labour Variable manufacturing overhead Fixed manufacturing overhead

$50,000 19,000 30,000 20,000 $119,000

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

7-38

Test Bank for Managerial Accounting, Third Canadian Edition

Instructions Prepare an incremental analysis report for Johnson Motors which can serve as informational input into this make or buy decision. Solution Exercise 142

(10–12 min.)

Direct materials Direct labour Variable manufacturing overhead Fixed manufacturing overhead Purchase price (500 × $200) Total annual cost Opportunity cost Total cost

Make $ 50,000 19,000 30,000 20,000 -0119,000 3,000 $122,000

Buy $ -0-0-020,000 100,000 120,000 -0$120,000

Increase (Decrease) $ 50,000 19,000 30,000 -0(100,000) (1,000) 3,000 $ 2,000

Income is expected to increase by $2,000 if the component part is purchased from the outside supplier if the company also manufactured its new product. Exercise 143 Escher Skateboards has been manufacturing its own wheels for its skateboards. The company is currently operating at 100% capacity, and variable manufacturing overhead is charged to production at the rate of 30% of direct labour cost. The direct materials and direct labour cost per unit to make the wheels are $1.50 and $1.80, respectively. Normal production is 200,000 wheels per year. A supplier offers to make the wheels at a price of $4 each. If the skateboard company accepts this offer, all variable manufacturing costs will be eliminated, but the $42,000 of fixed manufacturing overhead currently being charged to the skateboard wheels will have to be absorbed by other products. Instructions a. Prepare the incremental analysis for the decision to make or buy the wheels. b. Should Escher Skateboard buy the wheels from the outside supplier? Justify your answer. Solution Exercise 143 a.

(10–12 min.)

Direct Materials (200,000 × $1.50) Direct Labour (200,000 × $1.80) Variable Manufacturing Costs ($360,000 × 30%) Purchase Price (200,000 × $4) Total annual cost b.

Make $300,000 360,000

$

Buy -0-0-

Net Income Increase (Decrease) $300,000 360,000

108,000 -0$768,000

-0800,000 $800,000

108,000 (800,000) ($ 32,000)

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

Exercise 144 Jackson Chemical Corporation produces a water-based pest control chemical which it sells to pest control companies to manufacture as a pesticide. In 2012, the company incurred $140,000

Incremental Analysis

7-39

of costs to produce 14,000 kilograms of the chemical. The selling price of the chemical is $21.00 per kilogram. The costs per unit to manufacture a kilogram of the chemical are presented below: Direct materials Direct labour Variable manufacturing overhead Fixed manufacturing overhead Total manufacturing costs

$ 3.50 3.00 2.00 1.50 $10.00

The company is considering manufacturing the pesticide itself. If the company processes the chemical further and manufactures the pesticide itself, the following additional costs per kilogram will be incurred: Direct materials $1.00, Direct labour $.25, Variable manufacturing overhead, $1.00. No increase in fixed manufacturing overhead is expected. The company can sell the pesticide at $25.00 per kilogram. Instructions Determine the incremental per kilogram increase in net income and the total increase in net income if the company manufactures the pesticide. Solution Exercise 144

(10–12 min.)

Sales price per unit Cost per unit: Direct materials a. Direct labour b. Variable manufacturing overhead c. Fixed manufacturing overhead Total Net income per unit a. $3.50 + $1.00 b. $3.00 + $0.25 c. $2.00 + $1.00

Sell Chemical $21.00 3.50 3.00 2.00 1.50 10.00 $11.00

Process Further $25.00

Net Income Increase (Decrease) $4.00

4.50 3.25 3.00 1.50 12.25 $12.75

(1.00) (.25) (1.00) — (2.25) $ 1.75

Assuming the company sells all 14,000 kilograms that it produces, the incremental net income would be $24,500 (14,000 kilograms × $1.75). Exercise 145 Evett Corporation uses a machine that winds twine onto spools. The machine is unreliable and results in a significant amount of downtime and excessive labour costs. The management is considering replacing the machine with a more efficient one which will minimize downtime and excessive labour costs. Data are presented below for the two machines: Original purchase cost Accumulated depreciation Estimated life

Old Machine $160,000 120,000 4 years

New Machine $240,000 — 4 years

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

7-40

Test Bank for Managerial Accounting, Third Canadian Edition

Instructions Determine whether the company should purchase the new machine. Solution Exercise 145

(7–8 min.)

Cost savings New machine cost Proceeds from sale of old machine Net incremental net income 1.

Keep Equipment $ -0-0$ -0$ -0-

Replace Equipment $220,000 1. (240,000) 24,000 $ 4,000

Net Income Increase/(Decrease) $220,000 (240,000) 24,000 $ 4,000

$55,000 × 4 = $220,000

The company should purchase the new machine because there will be an increase in net income of $4,000 over the 4 year life of the new machine. Exercise 146 Doey, Cheatem and Howe, Attorneys, rely heavily on a colour laser printer to process the paperwork. Recently the printer has not functioned well and print jobs were not being processed. Management is considering updating the printer with a faster model. Original purchase cost Accumulated depreciation Estimated operating costs (annual) Useful life

Current Printer $30,000 17,000 3,000 4 years

New Model $24,000 — 2,000 4 years

If sold now, the current printer would have a salvage value of $4,000. If operated for the remainder of its useful life, the current printer would have zero salvage value. The new printer is expected to have zero salvage value after four years. Instructions Prepare an analysis to show whether the company should retain or replace the printer. Solution Exercise 146 Operating costs New machine cost Salvage value Totals

(7–9 min.) Retain Machine $12,000 -0-0$12,000

Replace Machine $ 8,000 24,000 (4,000) $28,000

Net Income Increase (Decrease) $4,000 (24,000) 4,000 ($16,000)

The current printer should not be replaced. The incremental analysis shows that net income for the four-year period will be $16,000 higher by replacing. Exercise 147 Herman Corporation operates two divisions, the A Division and the B Division. Both divisions manufacture and sell logs to paper manufacturers. The company is considering disposing of the B Division since it has been consistently unprofitable for a number of years. The income statements for the two divisions for the year ended December 31, 2012 are presented below:

Incremental Analysis

A Division $400,000 150,000 250,000 200,000 $ 50,000

Sales Cost of goods sold Gross profit Selling & administrative expenses Net income

B Division $300,000 200,000 100,000 120,000 $(20,000)

7-41

Total $700,000 350,000 350,000 320,000 $ 30,000

In the B Division, 80% of cost of goods sold is variable costs and 20% of selling and administrative expenses are variable costs. The management of the company feels it can save $30,000 of fixed cost of goods sold and $30,000 of fixed selling expenses if it discontinues operation of the B Division. Instructions a. Determine whether the company should discontinue operating the B Division. b. If the company had discontinued the division for 2012, determine what net income would have been reported. Solution Exercise 147 a.

(10–12 min.)

Sales Variable expenses: Cost of goods sold Selling and admin. exp. Contribution margin Fixed expenses: Cost of goods sold Selling and admin. exp. Net income (A) (B)

Continue $300,000

Eliminate $ -0-

Net Income Increase (Decrease) $(300,000)

160,000 (A) 24,000 (B) 116,000

-0-0-0-

160,000 24,000 (116,000)

40,000 (C) 96,000 (D) $ (20,000)

10,000 66,000 $(76,000)

30,000 30,000 $ (56,000)

$200,000 × 80% = $160,000 $120,000 × 20% = $24,000

(C) (D)

$200,000 – $160,000 = $40,000 $120,000 – $24,000 = $96,000

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

A Division $50,000

+ +

Decrease in Net Income $(56,000)

= ($6,000)

Exercise 148 A recent accounting graduate from Lethbridge University evaluated the operating performance of Fane Company's three divisions. The following presentation was made to Fane’s Board of Directors. During the presentation, the accountant made the recommendation to eliminate the Southern Division stating that total net income would increase by $20,000, as shown in the analysis below. Sales Cost of Goods Sold Gross Profit Operating Expenses Net Income

Other Two Divisions $1,000,000 650,000 350,000 100,000 $ 250,000

Southern Division $300,000 200,000 100,000 120,000 $ (20,000)

Total $1,300,000 850,000 450,000 220,000 $ 230,000

7-42

Test Bank for Managerial Accounting, Third Canadian Edition

Cost of goods sold is 80% variable and operating expenses are 70% variable. If the division is eliminated, 40% of the fixed costs will be eliminated. Instructions Do you concur with the new accountant's recommendation? Present a schedule to support your answer. Solution Exercise 148 Sales Variable Expenses Cost of goods sold Operating expenses Total Variable Contribution Margin Fixed Expenses Cost of goods sold Operating expenses Net Income (Loss)

(12–14 min.) Net Income Increase (Decrease) $(300,000)

Continue $300,000

Eliminate $ -0-

160,000 84,000 244,000 56,000

-0-0-0-0-

160,000 84,000 244,000 (56,000)

40,000 36,000 $(20,000)

24,000 21,600 $(45,600)

16,000 14,400 $(25,600)

The accountant is not correct. If the Southern Division is eliminated, the net income will be $25,600 less, not $20,000 greater. Exercise 149 Movie House has 4,000 machine hours available to use to produce either Product 22 or Product 44. The cost accounting department developed the following unit information for each of the products: Product 22 Product 44 Sales price $20.00 $40.00 Direct materials 5.00 8.00 Direct labour 3.00 2.00 Variable manufacturing overhead 4.50 5.00 Fixed manufacturing overhead 3.00 5.00 Machine time required 15 minutes 75 minutes Instructions Management wants to know which product to produce in order to maximize the company's income. Taking into consideration the constraint under which the company operates, prepare a report to show which product should be produced and sold. Solution Exercise 149 (10–12 min.) Contribution Margin per Unit Limited Resource Contribution margin per unit: Product 22 Sales price $20.00 Variable costs Direct material $5.00 Direct labour 3.00 Variable overhead 4.50 12.50 Contribution margin $ 7.50

Product 44 $40.00 $8.00 2.00 5.00

15.00 $25.00

Incremental Analysis

Machine hours required:

1/4 hr

Contribution margin per unit of limited resource ($7.50 ÷ .25) ($25 ÷ 1.25) Machine hours available Contribution margin

7-43

1 1/4 hrs

$ 30.00 4,000 $120,000

$ 20.00 4,000 $80,000

The company should produce and sell Product 22. Exercise 150 PHR Company manufactures and sells two products. Relevant per unit data concerning each product are given below: Product Standard Deluxe Selling price $50 $75 Variable costs $30 $30 Machine hours 1.6 3 Instructions a. Calculate the contribution margin per unit of the limited resource for each product. b. If 1,200 additional machine hours are available, which product should be manufactured? Solution Exercise 150 a.

(6–8 min.)

Contribution margin per unit Machine hours required Contribution margin per unit of limited resource b.

Product Standard Deluxe $20 $45 1.6 3 $12.50 $15.00

The Deluxe product should be manufactured because it results in the highest contribution margin per machine hour: $15.00 x 1,200 = $18,000

Exercise 151 What are some qualitative considerations with accepting a special order with a new supplier? Solution Exercise 151 (6–8 min.) a. Managers need to consider whether it would be likely to generate repeat orders from this special order customer. b. Is it possible to increase the selling price on repeat orders, or subsequent special orders from different customers? c. Is it possible to reduce variable costs by increasing volume by taking on special orders? d. Would the repeat business from this special order customer be reliable, and worth doing this special order right now? e. What would be the reaction of regular customers if they found out the cost structure for this special order? Exercise 152

7-44

Test Bank for Managerial Accounting, Third Canadian Edition

Explain how, and why, depreciation should be handled in incremental analysis. Hint – use the term, “sunk cost” in your answer. Solution Exercise 152 (6–8 min.) Depreciation is a systematic method of matching the cost of a long-lived asset with the revenue it generates. Though the depreciation expense will be recorded in future periods, the actual cost of the asset occurred in the past. Accordingly, it is a sunk cost and therefore not relevant. Another way to look at it, if the equipment is retained, the book value of the equipment will be reduced to zero via depreciation cost incurred over the remaining life of the asset. If the equipment is eliminated, the book value will be written off immediately. Accordingly, both options will expense the book value of the asset. If the cost is the same between two options, the cost is not relevant. Exercise 153 A group of your friends have invited you to join them on a mini road trip. They are planning to rent a van and drive to Toronto where they will stay at a hotel for the weekend. Another friend who moved to Montreal recently has invited you to visit at his home for the weekend. What financial and non-financial factors should you consider in your decision to choose between the two options. Solution Exercise 153 (6–8 min.) Financial: a. Transportation costs to Toronto vs. Montreal b. Cost of the hotel in Toronto c. Cost of meals in Toronto vs. Montreal d. Cost of entertainment in Toronto vs. Montreal e. Cost of a “thank-you gift” for your host in Montreal Non-financial: a. Which option are you apt to enjoy more? b. Would you offend someone if you do not accept their offer? Exercise 154 Barnstorming Company flies vintage aircraft at air shows and has a fleet of three airplanes. One of the airplanes cost $250,000 to purchase ten years ago and now has a book value of $75,000. The company is considering replacing this airplane with a different type which will cost $350,000. The current airplane could be sold for $50,000. If the company buys the new airplane, it is expected that fuel costs will decrease from $80,000 annually to $45,000 annually and maintenance costs will decrease from $70,000 to $30,000. Both the current airplane and the new airplane will have a service life of ten years. At that time, both airplanes would have to be scrapped with no recovery value. Instructions: Calculate whether the company should purchase the new airplane or not. Solution Exercise 154

Variable operating costs (1) New airplane cost (2) Net impact

(6–8 min.) Keep Airplane $1,500,000

Buy New Airplane $750,000 300,000

Net Income Increase (Decrease) $750,000 (300,000) $450,000

Incremental Analysis

(1) Keep: 10 years x $150,000 (2) $350,000 - $50,000 = $300,000

7-45

New 10 years x $75,000

All other things being equal, the company should purchase the new airplane as it will result in $450,000 additional income over the life of the airplane. Note that the book value of the current airplane is irrelevant in this decision. Exercise 155 (6–8 min.) Bonzai Company grows and sells Bonzai trees. It also makes the pot that holds the trees at a cost of $10 per pot. This cost includes $3 of fixed overhead. The company makes 10,000 trees each year. Potsdam Industries approaches Bonzai and offers to sell it pots for only $9. Instructions: Calculate the impact that purchasing the pots from Potsdam would have on Bonzai’s Net Income. Solution Exercise 155 (6–8 min.) Cost from Potsdam $9 Costs avoided at Bonzai ($10 - $3) $7 Unit savings (additional cost) ($2) Impact on Net Income 10,000 x $2 = $20,000 decrease

7-46

Test Bank for Managerial Accounting, Third Canadian Edition

COMPLETION STATEMENTS 156.

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

157.

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 __________________.

158.

The potential benefit that may be obtained by following an alternative course of action is called an _________________ cost.

159.

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 ______________.

160.

The ______________ value of old equipment is irrelevant in a decision to replace that equipment and is often referred to as a _____________ cost.

161.

In an environment where there are limited resources, the products with the highest contribution per unit of ______________ should identify the products to be produced.

162.

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

Incremental Analysis

ANSWERS TO COMPLETION STATEMENTS 156 . 157 . 158 . 159 . 160 . 161 . 162 .

incremental (differential) variable costs (incremental costs) opportunity revenues, costs book, sunk limited resource relevant information

7-47

7-48

Test Bank for Managerial Accounting, Third Canadian Edition

MATCHING 163. Match the items below by entering the appropriate code letter in the space provided. A. Incremental analysis B. Opportunity cost C. Sunk cost ____

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

____

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

____

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

Incremental Analysis

ANSWERS TO MATCHING a.

C

b.

A

c.

B

7-49

7-50

Test Bank for Managerial Accounting, Third Canadian Edition

SHORT-ANSWER ESSAY QUESTIONS Short Answer Essay 164 Management is often faced with the alternative of continuing to make a product or component internally, or going to an external source and purchasing the product or component. In gathering relevant information for these two alternatives, briefly identify the quantitative factors that should be considered. Are there any qualitative factors that should also be considered? Solution Short Answer Essay 164 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. Short Answer Essay 165 (Communication) You are the general accountant for Word Systems, Inc., a typing service based in Winnipeg, Manitoba. The company has decided to upgrade its equipment. It currently has a widely used version of a word processing program. The company wishes to invest in more up-to-date software and to improve its printing capabilities. Two options have emerged. Option D is for the company to keep its existing computer system, and upgrade its word processing program. The memory of each individual work station would be enhanced, and a larger, more efficient printer would be used. Better telecommunications equipment would allow for the electronic transmission of some documents as well. Option Z would be for the company to invest in an entirely different computer system. The software for this system is extremely impressive, and it comes with individual laser printers. However, the company is not well known, and the software does not connect well with well-known software. The net present value information for these options follows: Option Z Initial Investment $95,000 Cost savings of labour over 4 years 89,000

Option D $270,000 284,000

Instructions: Prepare a brief report for management in which you make a recommendation for one system or the other, using the information given. Solution Short Answer Essay 165 I recommend that the company accept Option D, to purchase upgrades to our present system and to buy a more efficient printer. In the first place, the changes will be easier to implement because the equipment is similar to that which we already use. Second, the costs savings exceed those of Option Z.

Incremental Analysis

7-51

MULTI PART QUESTION Multi-Part Question 166 Chocolate Delight Company (CDC) makes specialty chocolates and can produce 40 pieces per hour. The firm estimates that the variable cost of producing chocolate is $0.35 per piece and each piece sells for $0.60. Smiles For All (SFA) is a large greeting card company and it has asked CDC to produce a special flat chocolate greeting card for them and will pay $2.50 for each chocolate card. The cost to manufacture the new card will be $1.80 each. If this order is accepted, CDC will have to buy a new machine at a cost of $12,000. The new machine will be able to produce 20 cards per hour. SFA offers to buy 70,000 cards. CDC has a capacity of 10,000 machine hours available and fixed costs of $400,000 for its regular production activity. Instructions: a. Assume the demand for its own chocolates is 250,000 pieces. SFA says that the chocolate card order has to be produced in total or not at all. Should CDC accept the special order? b. Assume the demand for its own chocolates is 300,000 pieces. SFA says that the chocolate card order has to be produced in total or not at all. Should CDC accept the special order? Are there any other considerations that CDC should keep in mind? c. Assume the demand for its own chocolates is 275,000 pieces and CDC can decide to accept any quantity of the chocolate card order. Determine the mix of chocolates and cards that it should produce. Solution Multi Part Question 166 a. Hours required by special order: 70,000 ÷ 20 = 3,500 Hours required by regular sales: 250,000 ÷40 = 6,250 There is sufficient capacity to produce both regular chocolates and the special order Incremental operating income of special order CM: 70,000 x ($2.50 – $1.80) = $49,000 Cost of new machine (12,000) Incremental income $37,000 The company should accept this new order b.

Hours required by special order = 70,000 ÷ 20 = 3,500 Hours required by regular sales = 300,000 ÷ 40 = 7,500 Regular sales lost are 1,000 x 40 = 40,000 chocolate pieces (10,000 hrs – (3,500 + 7,500) ) Incremental operating income of special order Incremental operating income of special order Less CM lost on regular sales (40,000 x $0.60 - $0.35) Incremental income of accepting the special order

$37,000 (10,000) $27,000

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

Attempt to maximize production of the products that generates the highest CM per machine hour: Pieces Cards CM per unit $0.25 $0.70

7-52

Test Bank for Managerial Accounting, Third Canadian Edition

Machine hours per unit CM per machine hour

0.004 $62.50

0.016 $43.75

Maximize sales of both products: make 300,000 pieces + 20,000 cards (1,000 x 20 cards per hour) Incremental operating income of special order CM: 20,000 x ($2.50 – $1.80) = $14,000 Cost of new machine (12,000) Incremental income $2,000

Incremental Analysis

7-53

Legal Notice Copyright © 2011 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved.

The data contained in these files are protected by copyright. This manual is furnished under licence and may be used only in accordance with the terms of such licence. The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.