CHAPTER INCREMENTAL ANALYSIS SUMMARY OF QUESTIONS BY OBJECTIVES AND BLOOM’S TAXONOMY Item SO BT Item SO BT Item SO BT Item SO BT 5 6 C C K C C C 109 110 111 112 113 114 115 116 117 118 119 120 121 122 123 124 125 126 127 128 129 130 131 132 133 134 5 5 5 5 5 5 5 5 5 5 6 6 166 167 168 7 Item SO BT 25 26 27 28 29 30 7 7 K C C K C C AN C AN AP AN AN AN AN K K K K AP K AP C K K K AP AP C C C AP AP 135 136 137 138 139 140 141 142 143 144 145 146 147 148 149 150 151 152 153 154 155 156 6 6 6 6 6 7 7 7 7 7 K K C AP AP C C C C C C AN AP AN AN AN C C AP AP AN AN AN AP AP 169 170 7 AN AN True-False Statements 1 2 2 K K C K K C 10 11 12 2 3 K C K C C C 13 14 15 16 17 18 4 4 C C K C K K 19 20 21 22 23 24 Multiple Choice Questions 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 1 1 1 2 2 2 2 2 2 2 2 2 2 K K K K C K K K K K K K AP K K K K K K C C K K C C C 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 2 3 3 3 3 3 3 3 3 4 4 4 C C AP C C C C AP AP C K C AP AP AP AP C AP AP K C AP AP AP AP AP 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 100 101 102 103 104 105 106 107 108 4 4 4 4 4 4 4 4 4 4 4 4 K K AP AN K C C AP AN AN AN AN AN C C K AP AN K AN AN AN AN AN AN AN Brief Exercises 157 158 159 AP AP AP 160 161 162 4 AP AP AP 163 164 165 4 AP AN AN Test Bank for ISV Managerial Accounting, Fourth Edition 7-2 Exercises 171 172 173 3 AN E AN 174 175 176 3,4 4 AN E AN 177 178 179 6 E AN E 180 181 182 7 E E AN 183 AP Completion Statements 184 185 K K 186 187 K K 188 189 K K SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE Item Type Item Type Item TF TF 31 32 MC MC 33 34 TF TF TF TF TF 37 38 39 TF TF MC MC MC 40 41 42 43 44 10 11 12 13 TF TF TF TF 59 60 61 62 MC MC MC MC 63 64 65 66 14 15 16 17 18 76 77 TF TF TF TF TF MC MC 78 79 80 81 82 83 84 MC MC MC MC MC MC MC 85 86 87 88 89 90 91 19 20 21 108 TF TF TF MC 109 110 111 112 MC MC MC MC 113 114 115 116 22 23 24 25 TF TF TF TF 130 131 132 133 MC MC MC MC 134 135 136 137 Type Item Type Item Study Objective MC 35 MC 184 MC 36 MC Study Objective MC 45 MC 50 MC 46 MC 51 MC 47 MC 52 MC 48 MC 53 MC 49 MC 54 Study Objective MC 67 MC 71 MC 68 MC 72 MC 69 MC 73 MC 70 MC 74 Study Objective MC 92 MC 99 MC 93 MC 100 MC 94 MC 101 MC 95 MC 102 MC 96 MC 103 MC 97 MC 104 MC 98 MC 105 Study Objective MC 117 MC 121 MC 118 MC 122 MC 119 MC 123 MC 120 MC 124 Study Objective MC 138 MC 142 MC 139 MC 143 MC 140 MC 144 MC 141 MC 145 Type Item Type Item Type MC MC MC MC MC 55 56 57 58 157 MC MC MC MC BE 185 186 C C MC MC MC MC 75 158 171 172 MC BE Ex Ex 173 174 Ex Ex MC MC MC MC MC MC MC 106 107 159 160 161 162 163 MC MC BE BE BE BE BE 164 174 175 176 187 BE Ex Ex Ex C MC MC MC MC 125 126 127 128 MC MC MC MC 129 165 177 188 MC BE Ex C MC MC MC MC 166 178 179 189 BE Ex Ex C C Incremental Analysis 26 27 28 29 TF TF TF TF 30 146 147 148 TF MC MC MC 149 150 151 152 Note: TF = True-False MC = Multiple Choice Study Objective MC 153 MC 167 MC 154 MC 168 MC 155 MC 169 MC 156 MC 170 BE BE BE BE C = Completion BE = Brief Exercise 180 181 182 183 7-3 Ex Ex Ex Ex Ex = Exercise The chapter also contains one set of three Matching questions and two Short-Answer Essay questions CHAPTER STUDY OBJECTIVES Identify the steps in management's decision-making process Management's decisionmaking 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 Describe the concept of incremental analysis Incremental analysis identifies 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 Identify the relevant costs in accepting an order at a special price The relevant costs are those that change if the order is accepted These are typically variable manufacturing costs 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 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 will be saved, (b) the purchase price, and (c) opportunity costs 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: Process further as long as the incremental revenue from processing exceeds the incremental processing costs Identify the relevant costs to be considered in retaining or replacing equipment The relevant costs to be considered in determining whether equipment should be retained or replaced are the effects on variable costs and the cost of the new equipment Also, any disposal value of the existing asset must be considered Identify the relevant costs in deciding whether to eliminate an unprofitable segment In deciding whether to eliminate an unprofitable segment, the relevant costs are the variable costs that drive the contribution margin, if any, produced by the segment Disposition of the segment's fixed expenses must also be considered 7-4 Test Bank for ISV Managerial Accounting, Fourth Edition TRUE-FALSE STATEMENTS In making decisions, management considers only financial information because accounting is presented in financial context Decision-making involves reviewing the results of a decision once the decision has been made In incremental analysis, total fixed costs will always remain constant under alternative courses of action Incremental analysis is also known as differential analysis Incremental analysis identifies the probable effects of management decisions on future earnings Decisions made using incremental analysis focus on the amounts which differ among the alternatives The process used to identify the financial data that change under alternative courses of action is called incremental analysis Sunk costs are considered relevant when choosing among alternatives because they are differential Incremental costs are always relevant in decision making 10 A special one-time order is acceptable if the unit sales price is greater than the unit variable cost 11 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 widget Max should accept the special order if demand for other products is unaffected 12 A company should accept an order for its product at less than its regular sales price if the incremental revenue exceeds the incremental costs 13 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 14 A decision whether to continue to buy a product instead of producing it internally depends on the incremental costs and incremental revenues of making the change 15 An opportunity cost is the potential benefit given up by using resources in an alternative course of action 16 An incremental make-or-buy decision depends solely on which alternative is the lowest cost alternative 17 Direct materials, direct labor, and allocated fixed and variable manufacturing overhead are all relevant in a make-or-buy decision Incremental Analysis 7-5 18 A disadvantage of using an outside supplier is the associated loss of control over the production process 19 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 20 It is better to process further rather than sell now if the sales price increases 21 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 22 In a decision concerning replacing old equipment with new equipment, the book value of the old equipment can be considered an opportunity cost 23 In a decision to retain or replace old equipment, the salvage value of the old equipment is a sunk cost in incremental analysis 24 Equipment that is not fully depreciated should always be replaced 25 The book value of old equipment is an opportunity cost 26 A company should eliminate any segment in which the contribution margin is less than the fixed costs that are unavoidable 27 The elimination of an unprofitable product line will always increase the total profits of a company 28 A company’s net income could decrease if an unprofitable segment is discontinued 29 In deciding the future status of an unprofitable segment, management should recognize that net income will increase by eliminating the unprofitable segment 30 If an unprofitable product is eliminated, fixed expenses allocated to the eliminated segment will likely be eliminated Answers to True-False Statements Item Ans F T F T T Item 10 Ans T T F T T Item 11 12 13 14 15 Ans F T T F T Item 16 17 18 19 20 Ans F F T T F Item 21 22 23 24 25 Ans T F F F F Item 26 27 28 29 30 Ans F F T F F 7-6 Test Bank for ISV Managerial Accounting, Fourth Edition MULTIPLE CHOICE QUESTIONS 31 Which of the following is a major accounting contribution to the managerial decisionmaking process in evaluating possible courses of action? a Determine who is responsible for the decision b Prepare internal reports that review the actual impact of a decision made c Calculate how much should be invested for each potential project d Select possible actions that management should consider 32 Which of the following pairs of stages in the management decision-making process is properly sequenced? a Evaluate possible courses of action  Make a 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 for the decision 33 Who prepares relevant revenue and cost data for the decision-making process? a Department heads b The controller c Management accountants d Factory supervisors 34 Which of the following steps in the management decision-making process generally involves the managerial accountant? a Determine possible courses of action b Make the appropriate decision based on relevant data c Prepare internal reports that review the impact of decisions d Assign responsibility 35 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 on the community 36 Which is the first step in the management decision-making process? a Determine and evaluate possible courses of action b Review results of the decision c Identify the problem and assign responsibility d Make a decision 37 Which of the following will never be a relevant cost? a Opportunity cost b Sunk cost c Variable cost d Fixed cost 38 Which of the following will always be a relevant cost? a Sunk cost b Fixed cost c Variable cost Incremental Analysis 7-7 d Opportunity cost 39 Costs that will differ between alternatives and influence the outcome of a decision are a sunk costs b unavoidable costs c relevant costs d product costs 40 A previously incurred cost which will not change in the future is a(n) a opportunity cost b historical cost c fixed cost d sunk cost 41 A revenue that differs between alternatives and makes a difference in decision-making is called a(n) a sales revenue b incremental revenue c unavoidable revenue d irrelevant revenue 42 A cost that does not affect a decision is called an a opportunity cost b incremental cost c avoidable cost d irrelevant cost 43 Alvarez Company is considering the following alternatives: Revenues Variable costs Fixed costs Alternative A $50,000 30,000 10,000 Alternative B $60,000 30,000 16,000 What is the incremental profit? a $10,000 b $0 c $6,000 d $4,000 44 Costs that change between alternatives are called a fixed costs b opportunity costs c relevant costs d sunk costs 45 Which of the following is an irrelevant cost? a An avoidable cost b An incremental cost c A sunk cost d An opportunity cost 7-8 Test Bank for ISV Managerial Accounting, Fourth Edition 46 A cost incurred in the past that cannot be changed by any future action is a(n) a opportunity cost b sunk cost c relevant cost d avoidable cost 47 Relevant costs are always a fixed costs b variable costs c avoidable costs d sunk costs 48 What is the process of evaluating financial data that change under alternative courses of action called? a Incremental analysis b Decision-making analysis c Contribution margin analysis d Cost-benefit analysis 49 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 50 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 51 When is incremental analysis most useful? a After a decision has been made to determine its effectiveness b In choosing between capital budgeting methods c In evaluating the profitability of a company d In developing relevant information for management decisions 52 Who generates the data used in incremental analysis? a Market analysts and engineers b Engineers and accountants c Market analysts, engineers, and accountants d Only the accountants 53 Which 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 Incremental Analysis 7-9 54 For which of the following decisions is incremental analysis not appropriate? a Elimination of an unprofitable segment b Determining cost behavior c A make-or-buy decision d An allocation of limited resource decision 55 For which of the following is incremental 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 56 Which of the following is a true statement about cost behaviors in incremental analysis? a Total variable costs not change between alternatives b Fixed costs and variable costs will always change between alternatives c Variable costs per unit will always change between alternatives d Fixed costs will generally not change between alternatives 57 Specik, Inc is considering the following alternatives: Revenues Variable costs Fixed costs Alternative $120,000 60,000 35,000 Alternative $120,000 70,000 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 58 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 59 Seville Company manufactures a product with a unit variable cost of $42 and a unit sales price of $75 Fixed manufacturing costs were $80,000 when 10,000 units were produced and sold, equating to $8 per unit The company has a one-time opportunity to sell an additional 2,000 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 $84,000 b $10,000 c $40,000 d $26,000 7-10 Test Bank for ISV Managerial Accounting, Fourth Edition 60 Sorrento Company’s plant is operating at less than full capacity The company just received a one-time opportunity to accept an order at a special price below its usual price The special price exceeds its variable costs Therefore, which statement is true? a Fixed costs are relevant b The order will likely be accepted c The order will likely be rejected d Sorrento should expand its plant capacity before accepting the order 61 Canosta, Inc determined that 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 62 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 the 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 63 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 Considered the opportunity cost of lost sales in the incremental analysis c Accept the order d Accept the order if the plant is below capacity 64 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 Fields has excess capacity and can handle the additional production What effect will acceptance of the offer have on net income? a Decrease $6,000 b Increase $6,000 c Increase $54,000 d Increase $12,000 65 It costs Fortune Company $10 of variable and $4 of fixed costs to produce one bathroom scale, which normally sells for $28 A foreign wholesaler offers to purchase 1,000 scales at $12 each Fortune would incur special shipping costs of $1 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 $1,000 increase b $1,000 decrease c $2,000 decrease d $12,000 increase Test Bank for ISV Managerial Accounting, Fourth Edition 7-32 BE 166 (cont.) Instructions Prepare an analysis showing whether the old machine should be retained or replaced Solution 166 (5 min.) Variable manufacturing costs New machine cost Net savings over years Retain Machine $1,200,000 Replace Machine $930,000 Net Income Change $270,000* (225,000) $ 45,000 *For years of remaining life BE 167 Parino Company has three product lines in its retail stores: books, videos, and music 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 Results of the fourth quarter are presented below: Books Music Videos Total Units sold 1,000 2,000 2,000 5,000 Revenue Variable departmental costs Direct fixed costs Allocated fixed costs Net income (loss) $24,000 15,000 3,000 4,400 $ 1,600 $48,000 22,000 6,000 8,800 $11,200 $32,000 23,000 4,000 8,800 $ (3,800) $104,000 60,000 13,000 22,000 $ 9,000 Instructions Prepare an incremental analysis of the effect of dropping the Video product line Solution 167 (5 min.) Incremental revenue Incremental savings on variable costs Incremental savings on direct fixed costs Incremental decrease in profit to drop video line $(32,000) +23,000 +4,000 $ (5,000) BE 168 Crisp Company has four product lines: sour cream, ice cream, yogurt, and butter The allocated fixed costs are based on units sold and are unavoidable Demand for 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 for June follow: Sour Cream Units sold 2,000 Revenue $10,000 Variable departmental costs 6,000 Fixed costs 5,000 Net income (loss) $ (1,000) Ice Cream 500 $20,000 13,000 2,000 $ 5,000 Yogurt 400 $10,000 4,200 3,000 $ 2,800 Butter 200 $20,000 4,800 7,000 $ 8,200 Total 3,000 $60,000 28,000 17,000 $15,000 Incremental Analysis 7-33 BE 168 (cont.) Instructions Prepare an incremental analysis of the effect of dropping the sour cream product line Solution 168 (5 min.) Incremental revenue Incremental savings on variable costs Incremental fixed cost savings ($5,000 × 40) Incremental decrease in profit if dropped $(10,000) +6,000 +2,000 $ (2,000) BE 169 Harmark has three product lines in its retail stores: kites, wind socks, and flags Results of the fourth quarter are presented below: Kites Wind Socks Flags Total Units sold 1,000 2,000 2,000 5,000 Revenue Variable departmental costs Direct fixed costs Allocated fixed costs Net income (loss) $22,000 15,000 1,000 8,000 $ (2,000) $40,000 22,000 3,000 8,000 $ 7,000 $23,000 12,000 2,000 8,000 $ 1,000 $85,000 49,000 6,000 28,000 $ 6,000 The allocated fixed costs are unavoidable Demand of individual products is not affected by changes in other product lines Instructions What will happen to profits if Harmark discontinues the Kites product line? Solution 169 (5 min.) Incremental revenue Incremental costs: Variable cost savings Direct fixed cost savings Drop in profits if discontinued $(22,000) +15,000 +1,000 $ (6,000) BE 170 Dolls R Us sells three products in its retail stores: baby dolls, teenage dolls, and plush dolls Results of the fourth quarter are below: Baby Dolls Teenage Dolls Plush Dolls Total Units sold 1,000 2,000 2,000 5,000 Revenue Variable departmental costs Direct fixed costs Allocated fixed costs Net income (loss) $31,000 22,000 5,000 6,000 $ (2,000) $43,000 24,000 4,000 7,000 $ 8,000 $26,000 13,000 3,000 7,000 $ 3,000 $100,000 59,000 12,000 20,000 $ 9,000 Test Bank for ISV Managerial Accounting, Fourth Edition 7-34 BE 170 (cont.) Instructions Demand for individual products is not affected by changes in other product lines Prepare an incremental analysis to determine if the baby dolls should be discontinued Solution 170 (5 min.) Incremental revenue Incremental costs: Variable cost savings Direct cost savings Drop in profits if discontinued $(31,000) +22,000 +5,000 $ (4,000) EXERCISES Ex 171 Smooth Brew Company manufactures cappuccino makers For the first eight months of 2008, the company reported the following results while operating at 80% of plant capacity: Sales (50,000 units) Cost of goods sold Gross profit Operating expenses Net income $9,000,000 5,400,000 3,600,000 2,400,000 $1,200,000 An analysis of costs and expenses reveals that variable cost of goods sold is $95 per unit and variable operating expenses are $35 per unit In September, Smooth Brew receives a special order for 3,000 machines at $135 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 171 (10–12 min.) (a) Revenues Cost of Goods Sold Operating Expenses Net Income Reject Order $ -0-0-0$ -0- Accept Order $405,000 285,000* 107,000** $ 13,000 Net Income Increase (Decrease) $405,000 (285,000) (107,000) $ 13,000 *Variable cost of goods sold = 3,000 × $95 = $285,000 **Variable operating expenses = 3,000 × $35 = $105,000 + $2,000 = $107,000 Incremental Analysis Solution 171 7-35 (cont.) (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 Ex 172 Vincent Company supplies schools with floor mattresses to use in physical education classes Vincent has received a special order from a large school district to buy 400 mats at $40 each Acceptance of the special order will not affect fixed costs but will result in $800 of shipping costs For the first months of 2008, the company reported the following results while operating at 70% 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 75% variable and 25% 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 172 (10–12 min.) (a) Revenues Cost of Goods Sold Operating Expenses Net Income Reject Order $ -0-0-0$ -0- Accept Order $16,000 11,760 2,704 $ 1,536 Net Income Increase (Decrease) $16,000 (11,760) (2,704) $ 1,536 Variable costs of goods sold = $980,000 × 75% = $735,000 Variable cost of goods sold per unit sold = $735,000 ÷ 25,000 = $29.40 Variable cost of goods sold for the special order = 400 × $29.40 = $11,760 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 = 400 × $4.76 = $1,904 + $800 = $2,704 (b) The incremental analysis shows Vincent Company should accept the special order because incremental revenues exceed incremental costs Test Bank for ISV Managerial Accounting, Fourth Edition 7-36 Ex 173 Paulsen Company produced and sold 20,000 units of product and is operating at 80% of plant capacity Unit information about its product is as follows: Sales price Variable manufacturing cost Fixed manufacturing cost ($300,000 ÷ 20,000) Profit per unit $70 $45 15 60 $10 The company received a proposal from a foreign company to buy 4,000 units of Paulsen Company's product for $50 per unit This is a one-time only order and acceptance of this proposal will not affect the company's regular sales The president of 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 and indicate the effect the acceptance of this order might have on the company's income Solution 173 (7–9 min.) PAULSEN COMPANY Incremental Analysis Proposal to buy 4,000 units at $50 Revenues (4,000 × $50) Variable Costs (4,000 × $45) Net Income Reject Order $ -0-0$ -0- Accept Order $200,000 (180,000) $ 20,000 Net Income Increase (Decrease) $200,000 (180,000) $ 20,000 Paulsen Company would increase its income by $20,000 in accepting the special order Ex 174 Turner, Inc budgeted 10,000 widgets for production during 2008 Turner has capacity to produce 12,000 units Fixed factory overhead is allocated using ABC The following estimated costs were provided: Direct materials ($6/unit) $ 60,000 Direct labor ($15/hr × hrs./unit) 300,000 Variable manufacturing overhead ($3/unit) 30,000 Fixed factory overhead ($4/unit) 40,000 Total $430,000 Cost per unit $43.00 Instructions Answer each of the following independent questions: (a) Turner received an order for 1,000 units from a new customer in a country in which Turner has never done business This customer has offered $41 per widget Should Turner accept the order? Incremental Analysis Ex 174 7-37 (cont.) (b) Turner received an offer from another company to manufacture the same quality widgets for $38 Should Turner let someone else manufacture all 10,000 widgets and focus only on distribution? Solution 174 (10–12 min.) (a) Yes, it can make $2,000 Incremental revenue per widget Incremental cost per widget: $6 + ($15 × 2) + $3 = Incremental profit per unit $41 39 $ Total incremental profit = $2 × 1,000 = $2,000 (b) Yes, Turner will save $10,000 if the widgets are bought instead of made Cost to buy per widget $38 Cost to make per widget: $6 + ($15 × 2) + $3 = 39 Incremental savings per widget if purchased $ Total incremental savings if purchased = $1 × 10,000 = $10,000 Ex 175 Carlsen Company manufactured 6,000 units of a component part that is used in its product and incurred the following costs: Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead $ 70,000 30,000 20,000 40,000 $160,000 Another company has offered to sell the same component part to the company for $24 per unit The fixed manufacturing overhead consists mainly of depreciation on the equipment used to manufacture the part and would not be reduced if the component part was purchased from the outside firm If the component part is purchased from the outside firm, Carlsen Company has the opportunity to use the factory equipment to produce another product which is estimated to have a contribution margin of $30,000 Instructions Prepare an incremental analysis report for Carlsen Company which can serve as informational input into this make-or-buy decision Test Bank for ISV Managerial Accounting, Fourth Edition 7-38 Solution 175 (11–14 min.) Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Purchase price (6,000 × $24.00) Total annual cost Opportunity cost Total cost Make $ 70,000 30,000 20,000 40,000 -0160,000 30,000 $190,000 Buy -0-0-040,000 144,000 184,000 -0$184,000 $ Increase (Decrease) $ 70,000 30,000 20,000 -0(144,000) (24,000) 30,000 $ 6,000 Income is expected to increase by $6,000 if the component part is purchased from the outside firm and the new product is manufactured Ex 176 Escher Skateboards Company 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 labor cost The direct materials and direct labor cost per unit to make the bicycle seats are $1.50 and $1.80, respectively Normal production is 250,000 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 bicycle seats will have to be absorbed by other products Instructions (a) Prepare the incremental analysis for the decision to make or buy the bicycle seats (b) Should Escher Skateboards buy the seats from the outside supplier? Justify your answer Solution 176 (10–12 min.) (a) Direct Materials (250,000 × $1.50) Direct Labor (250,000 × $1.80) Variable Manufacturing Costs ($450,000 × 30%) Fixed Manufacturing Costs Purchase Price (250,000 × $4) Total annual cost Make $ 375,000 450,000 Buy -0-0- $ 135,000 42,000 -0$1,002,000 -042,000 1,000,000 $1,042,000 Net Income Increase (Decrease) $ 375,000 450,000 135,000 -0(1,000,000) $ (40,000) (b) The wheels should continue to be manufactured by Escher Skateboards As indicated, the company's net income would decrease $40,000 by purchasing the wheels Incremental Analysis 7-39 Ex 177 Jackson Chemical Corporation produces a water-based pest control chemical which it sells to pest control companies to manufacture as a pesticide In 2008, the company incurred $140,000 of costs to produce 14,000 gallons of the chemical The selling price of the chemical is $21.00 per gallon The costs per unit to manufacture a gallon of the chemical are presented below: Direct materials Direct labor 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 gallon will be incurred: Direct materials $1.00, Direct labor $.50, Variable manufacturing overhead $1.00 No increase in fixed manufacturing overhead is expected The company can sell the pesticide at $25.00 per gallon Instructions Determine the incremental per gallon increase in net income and the total increase in net income if the company manufactures the pesticide Solution 177 (10–12 min.) Sell Chemical $21.00 Sales price per unit Cost per unit: Direct materials (A) Direct labor (B) Variable manufacturing overhead (C) Fixed manufacturing overhead Total Net income per unit 3.50 3.00 2.00 1.50 10.00 $11.00 Process Further $25.00 4.50 3.50 3.00 1.50 12.50 $12.50 Net Income Increase (Decrease) $4.00 (1.00) (.50) (1.00) — (2.50) $1.50 (A) $3.50 + $1.00 (B) $3.00 + $0.25 (C) $2.00 + $1.00 Assuming the company sells all 14,000 gallons that it produces, the incremental net income would be $21,000 (14,000 gallons × $1.50) Ex 178 Evett Corporation uses a machine that winds twine onto spools The machine is unreliable and results in a significant amount of downtime and excessive labor costs The management is considering replacing the machine with a more efficient one which will minimize downtime and excessive labor costs Data are presented below for the two machines: Test Bank for ISV Managerial Accounting, Fourth Edition 7-40 Ex 178 (cont.) Original purchase cost Accumulated depreciation Estimated life Old Machine $160,000 120,000 years New Machine $250,000 — years It is estimated that the new machine will produce annual cost savings of $60,000 The old machine can be sold to a scrap dealer for $24,000 Both machines will have a salvage value of zero if operated for the remainder of their useful lives Instructions Determine whether the company should purchase the new machine Solution 178 (7–8 min.) Cost savings New machine cost Proceeds from sale of old machine Net incremental net income Retain Equipment $ -0-0$ -0$ -0- Replace Net Income Equipment Increase/(Decrease) $240,000 (A) $240,000 (250,000) (250,000) 24,000 24,000 $ 14,000 $ 14,000 (A) $60,000 × = $240,000 The company should purchase the new machine because there will be an increase in net income of $14,000 over the 4-year life of the machine Ex 179 Cheatem and Howe, Attorneys, relies heavily on a color laser printer to process its paperwork Recently the printer has not functioned well and print jobs are 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 $20,000 11,000 2,000 years New Model $16,000 — 1,000 years If sold now, the current printer would have a salvage value of $3,000 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 Incremental Analysis Solution 179 7-41 (7–9 min.) Retain Printer $8,000 -0-0$8,000 Operating costs New printer cost Salvage value Totals Replace Printer $ 4,000 16,000 (3,000) $17,000 Net Income Increase (Decrease) $ 4,000 (16,000) 3,000 $ (9,000) The current printer should not be replaced The incremental analysis shows that net income for the four-year period will be $9,000 lower by replacing Ex 180 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, 2008 are presented below: Sales Cost of goods sold Gross profit Selling & administrative expenses Net income A Division $400,000 150,000 250,000 200,000 $ 50,000 B Division $300,000 200,000 100,000 120,000 $ (20,000) Total $700,000 350,000 350,000 320,000 $ 30,000 In the B Division, 80% of the cost of goods sold are variable costs and 30% of selling and administrative expenses are variable costs The management of the company feels it can save $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 2008, determine what net income would have been Solution 180 (10–12 min.) (a) 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) 36,000 (B) 104,000 -0-0-0- 160,000 36,000 (104,000) 40,000 (C) 84,000 (D) $ (20,000) 10,000 54,000 $(64,000) 30,000 30,000 $ (44,000) $200,000 × 80% = $160,000 $120,000 × 30% = $36,000 (C) (D) $200,000 – $160,000 = $40,000 $120,000 – $36,000 = $84,000 Test Bank for ISV Managerial Accounting, Fourth Edition 7-42 Solution 180 (cont.) The company should continue the B Division because contribution margin, $104,000, is greater than the avoidable fixed costs, $60,000 (b) A Division $50,000 + + Decrease in Net Income $(44,000) = $6,000 Ex 181 A recent accounting graduate from Duke 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 Cost of goods sold is 75% 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 181 (12–14 min.) Sales Variable Expenses Cost of goods sold Operating expenses Total Variable Contribution Margin Fixed Expenses Cost of goods sold Operating expenses Net Income (Loss) Net Income Increase (Decrease) $(300,000) Continue $300,000 Eliminate $ -0- 150,000 84,000 234,000 66,000 -0-0-0-0- 150,000 84,000 234,000 (66,000) 50,000 36,000 $(20,000) 30,000 21,600 $(51,600) 20,000 14,400 $(31,600) The accountant is not correct If the Southern Division is eliminated, the net income will be $31,600 less, not $20,000 greater Incremental Analysis 7-43 Ex 182 Anheiser has three divisions: Bud, Wise, and Er The results of May, 2008 are presented below: Bud Wise Er Total Units sold 3,000 5,000 2,000 10,000 Revenue Less variable costs Less direct fixed costs Less allocated fixed costs Net income $70,000 32,000 14,000 6,000 $18,000 $50,000 26,000 19,000 10,000 $ (5,000) $40,000 16,000 12,000 4,000 $ 8,000 $160,000 74,000 45,000 20,000 $ 21,000 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 thinks if the division is closed, sales at the Bud division will increase by 15%, and 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 182 (10–12 min.) (a) Revenue Less variable costs Less direct fixed costs Less allocated fixed costs Net income Bud $80,500 36,800 14,000 12,661 $17,039 Er $40,000 16,000 12,000 7,339 $ 4,661 Total $120,500 52,800 26,000 20,000 $ 21,700 Calculations: Revenue = $70,000 × 115% = $80,500 Variable costs = $32,000 × 115% = $36,800 Allocation of total allocated fixed costs of $20,000: To Bud: 3,450 ÷ (3,450 + 2,000) ì $20,000 = $12,661 To Er: 2,000 ữ (3,450 + 2,000) × $20,000 = $7,339 (b) Yes The profit increases by $700 ($21,700 – $21,000) 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 $15% of the Bud division was enough to offset the loss of the Wise division Ex 183 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 $100 a month The other existing equipment will be used for additional production of peanuts One employee earning $200 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: Test Bank for ISV Managerial Accounting, Fourth Edition 7-44 Ex 183 (cont.) Sales Food materials Direct labor Equipment rental Other allocated overhead Operating income Total $18,000 4,500 3,200 2,900 3,100 $ 4,300 Soybeans $8,000 2,000 1,200 2,600 2,100 $ 100 Peanuts $10,000 2,500 2,000 300 1,000 $ 4,200 Instructrions Prepare an incremental analysis to determine the financial effect of dropping soybean production Solution 183 (10–12 min.) Beyonce Company Incremental Analysis Incremental change in revenue: Increase in peanut sales: $10,000 × 30% Decrease in soybean sales Incremental decrease in revenue Incremental change in variable costs: Food materials: Increase in peanut costs: $2,500 × 30% Decrease in soybean costs Direct labor: Increase in peanut labor: $2,000 × 30% Decrease in soybean labor Incremental decrease in variable costs Equipment reduction—soybean shucker Incremental decrease in profits if soybean production is dropped +3,000 (8,000) $(5,000) (750) +2,000 (600) +200 +850 +100 $(4,050) Incremental Analysis 7-45 COMPLETION STATEMENTS 184 An important purpose of management accounting is to provide managers with _ for decision making 185 The process used to identify the financial data that change under alternative courses of action is called analysis 186 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 187 The potential benefit that may be obtained by following an alternative course of action is called an _ cost 188 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 189 The value of old equipment is irrelevant in a decision to replace that equipment and is often referred to as a _ cost Answers to Completion Statements 184 relevant information 185 incremental (differential) 186 variable costs (incremental costs) 187 opportunity 188 revenues, costs 189 book, sunk MATCHING 190 Match the items below by entering the appropriate code letter in the space provided A Incremental analysis B Opportunity cost C Sunk cost A cost that cannot be changed by any present or future decision The process of identifying the financial data that change under alternative courses of action The potential benefit that may be obtained from following an alternative course of action Answers to Matching C A B 7-46 Test Bank for ISV Managerial Accounting, Fourth Edition SHORT-ANSWER ESSAY QUESTIONS S-A E 191 Management is often faced with the alternative of continuing to make a product or component internally, or go to an external source and purchase the product or component In gathering relevant information for these two alternatives, briefly identify the quantitative factors that should be considered Are there any qualitative factors that should also be considered? Solution 191 The quantitative factors to be considered in a make-or-buy decision include the incremental costs to make the product, the incremental costs of buying the product, and the opportunity cost (potential benefit foregone) if the product is made Generally, all variable production costs are relevant in a make-or-buy decision, but only some fixed costs, or no fixed costs, are relevant because many fixed costs will be incurred regardless of whether the decision is to make or buy Qualitative factors include the possible adverse effect on employees and the stability of the supplier's price and quality S-A E 192 You are the general accountant for Word Systems, Inc., a typing service based in Los Angeles, California 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 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 impressive, and it comes with individual laser printers However, the manufacturer is not well known, and the software does not connect well with well-known software The net present value information for these options follows: Initial investment Cost savings of labor over years Option Z $95,000 89,000 Option D $270,000 284,000 Required: Prepare a brief report for management in which you make a recommendation for one system or the other, using the information given Solution 192 The company should accept Option D, to purchase upgrades to its present system and to buy a more efficient printer First, the changes will be easier to implement because the equipment is similar to that which is already in use Second, the cost savings exceed those of Option Z ... 30 Ans F F T F F 7-6 Test Bank for ISV Managerial Accounting, Fourth Edition MULTIPLE CHOICE QUESTIONS 31 Which of the following is a major accounting contribution to the managerial decisionmaking... contribution margin, if any, produced by the segment Disposition of the segment's fixed expenses must also be considered 7-4 Test Bank for ISV Managerial Accounting, Fourth Edition TRUE-FALSE... c A sunk cost d An opportunity cost 7-8 Test Bank for ISV Managerial Accounting, Fourth Edition 46 A cost incurred in the past that cannot be changed by any future action is a(n) a opportunity