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SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 7-1 The correct order is: 1. 2. 3. 4. Identify the problem and assign responsibility. Determine and evaluate possible courses of action. Make a decision. Review results of the decision.

BRIEF EXERCISE 7-2 Net Income Increase (Decrease) ($ 35,000) (25,000) $ 10,000

Alternative A Revenues Costs Net income $150,000 100,000 $ 50,000

Alternative B $185,000 125,000 $ 60,000

Alternative B is better than Alternative A.

BRIEF EXERCISE 7-3 Net Income Increase (Decrease) ($ 72,000) ( (60,000) ( (6,000) ($ 6,000)

Revenues CostsVariable manufacturing Shipping Net income

Reject Order $0 0 0 $0

Accept Order $72,000 * 60,000 ** 6,000 *** $ 6,000

The special order should be accepted. *3,000 X $24 **3,000 X $20 ***3,000 X $ 2

BRIEF EXERCISE 7-4 Net Income Increase (Decrease) $ 45,000 0 (50,000) ($ (5,000)

Make Variable manufacturing costs Fixed manufacturing costs Purchase price Total annual cost $45,000 30,000 0 $75,000

Buy $ 0 30,000 50,000 $80,000

The decision should be to make the part.

BRIEF EXERCISE 7-5 Sell Sales price per unit Cost per unit Variable Fixed Total Net income per unit $60.00 35.00 10.00 45.00 $15.00 Process Further $70.00 43.00 10.00 53.00 $17.00 Net Income Increase (Decrease) $10.00 ( (8.00) 0 ( (8.00) $ 2.00

The bookcases should be processed further because the incremental revenues exceed incremental costs by $2.00 per unit.

BRIEF EXERCISE 7-6 The allocated joint costs are irrelevant to the sell or process further decisions. If AB1 is processed further, the company will earn incremental revenue of $60,000 ($150,000 $90,000) and only incur incremental costs of $50,000. Therefore, the company should process AB1 further and sell AB2. If XY1 is processed further, the company will earn incremental revenue of $40,000 ($130,000 $90,000) but will incur incremental costs of $50,000. Therefore, the company should sell XY1 rather than process it further.

BRIEF EXERCISE 7-7 Net 4-Year Income Increase (Decrease) ($ 400,000) ( (250,000) ($ 150,000)

Retain Equipment Variable manufacturing costs for 4 years New machine cost Total $2,400,000 00,000,000 $2,400,000

Replace Equipment $2,000,000 250,000 $2,250,000

The old factory machine should be replaced. BRIEF EXERCISE 7-8 Continue Sales Variable costs Contribution margin Fixed costs Net income $200,000 175,000 25,000 30,000 ($ (5,000) Eliminate $ 0 0 ( 0 20,000) $(20,000) Net Income Increase (Decrease) $(200,000) (175,000) (25,000) ( 10,000) $ (15,000)

The Big Bart product line should be continued because $25,000 of contribution margin will not be realized if the line is eliminated. This amount is greater than the $10,000 savings of fixed costs. SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 7-1 Net Income Increase (Decrease) $186,000 (132,000) $ 54,000

Revenues Costs Net income

Reject $ 0 $ 0 $ 0

Accept $186,000 132,000* $ 54,000

*(6,000 X $20) + (6,000 X $2) Given the results of the above analysis, Corn Company should accept the special order.

DO IT! 7-2 (a) Make $ 30,000 42,000 45,000 60,000 0 $177,000 Buy $ 0 0 0 40,000 165,000 $205,000 Net Income Increase (Decrease) $ 30,000 42,000 45,000 20,000 (165,000) $ (28,000)

Direct materials Direct labor Variable manufacturing costs Fixed manufacturing costs Purchase price Total cost

Given the results of the above analysis, Barney Company will incur $28,000 of additional costs if it buys the switches. (b) Make $177,000 30,000 $207,000 Buy $205,000 0 $205,000 Net Income Increase (Decrease) $(28,000) 30,000 $ 2,000

Total Cost Opportunity cost Total cost

Yes, the answer is different: The analysis shows that net income will be increased by $2,000 if Barney Company purchases the switches. DO IT! 7-3 Process Further $99 $57 13 $70 $29

Sell Sales per unit Cost per unit Variable Fixed Total Net income per unit $75 $39 10 $49 $26

Net Inc/Dec $24 ($18) (3) ($21) $ 3

The tables should be process further or La Mesa should finish the tables because the incremental revenues exceed incremental costs by $3.00 per unit.

DO IT! 7-4 Net Income Increase (Decrease) $(500,000) 375,000 (125,000) 110,000 $ (15,000)

Sales Variable costs Contribution margin Fixed costs Net income

Continue $500,000 375,000 125,000 150,000 $ (25,000)

Eliminate $ 0 0 0 40,000 $(40,000)

The analysis indicates that Lion should not eliminate that gloves and mittens line because net income would decrease $15,000.

SOLUTIONS TO EXERCISES
EXERCISE 7-1 1. 2. 3. 4. 5. 6. 7. 8. 9. False. The first step in managements decision-making process is identify the problem and assign responsibility. False. The final step in managements decision-making process is to review the results of the decision. True. False. In making business decisions, management ordinarily considers both financial and nonfinancial information. True. True. False. Costs that are the same under all alternative courses of action do not affect the decision. False. When using incremental analysis, either costs or revenues or both will change under alternative courses of action. False. Sometimes variable costs will not change under alternative courses of action, but fixed costs will.

EXERCISE 7-2 (a) Revenues ($4.75) Materials ($0.50) Labor ($1.50) Variable overhead ($1.00) Fixed overhead Sales commissions Net income Reject Order $ 0 0 0 0 0 0 $ 0 Accept Order $23,750 (2,500) (7,500) (5,000) (5,000) 0 $ 3,750

Net Income Effect $23,750 (2,500) (7,500) (5,000) (5,000) 0 $ 3,750

(b) As shown in the incremental analysis, Gruner should accept the special order because incremental revenue exceeds incremental expenses by $3,750. (c) It is assumed that sales of the golf discs in other markets would not be affected by this special order. If other sales were affected, Gruner would have to consider the lost sales in making the decision. Second, if Gruner is operating at full capacity, it is likely that the special order would be rejected.

EXERCISE 7-3 (a) Reject Order Revenues (15,000 X $7.50) Cost of goods sold Operating expenses Net income $0 0 0 $0 Accept Order $112,500 75,000 (1) 29,250 (2) $ 8,250 Net Income Increase (Decrease) ($112,500) ( (75,000) ( (29,250) ($ 8,250)

(1) Variable cost of goods sold = $2,500,000 X 70% = $1,750,000.


Variable cost of goods sold per unit = $1,750,000 350,000 = $5. Variable cost of goods sold for the special order = $5 X 15,000 = $75,000.

(2) Variable operating expenses = $875,000 X 70% = $612,500 $612,500 350,000 = $1.75 per unit 15,000 X $1.75 = $26,250 $26,250 + $3,000 = $29,250 (b) As shown in the incremental analysis, Shandling Company should accept the special order because incremental revenues exceed incremental expenses by $8,250. EXERCISE 7-4 Reject Order $0 0 0 0 0 $0 Accept Order $900,000 (1) 400,000 100,000 200,000 700,000 $200,000 Net Income Increase (Decrease) $900,000 (400,000) (100,000) (200,000) (700,000) $200,000

Revenues Variable costs: Direct materials Direct labor Variable overhead Total variable costs Net income

(1) [($2.00 + $0.50 + $1.00 + $1.00) X 200,000] Tough Fiber should accept the Armys offer since it would increase net income by $200,000.

EXERCISE 7-5 (a) Make Direct materials (30,000 X $5.00) Direct labor (30,000 X $6.00) Variable manufacturing costs ($180,000 X 70%) Fixed manufacturing costs Purchase price (30,000 X $15.50) Total annual cost $150,000 180,000 126,000 45,000 0 $501,000 $ Buy 0 0 Net Income Increase (Decrease) $ 150,000 180,000 126,000 0 ( (465,000) ($ (9,000)

0 45,000 465,000 $510,000

(b) No, Swayze Inc. should not purchase the shades. As indicated by the incremental analysis, it would cost the company $9,000 more to purchase the lamp shades. (c) Yes, by purchasing the lamp shades, a total cost saving of $26,000 will result as shown below. Net Income Increase (Decrease) $ (9,000) (35,000) $(26,000)

Make Total annual cost (above) Opportunity cost Total cost EXERCISE 7-6 (a) 1. $501,000 35,000 $536,000

Buy $510,000 0 $510,000

Direct materials Direct labor Variable overhead Fixed overhead Purchase price Total annual cost

Make $ 800,000 600,000 120,000 500,000 0 $2,020,000

Buy $ 0 0 0 200,000 1,800,000 $2,000,000

Net Income Increase (Decrease) $ 800,000 600,000 120,000 300,000 (1,800,000) $ 20,000

Yes. The offer should be accepted as net income will increase by $20,000.

EXERCISE 7-6 (Continued) 2. Net Income Increase (Decrease) $ 800,000 600,000 120,000 0 300,000 (1,800,000) $ 20,000

Direct materials Direct labor Variable overhead Fixed overhead Opportunity cost Purchase price Totals

Make Buy $ 800,000 $ 0 600,000 0 120,000 0 500,000 500,000 300,000 0 0 1,800,000 $2,320,000 $2,300,000

Yes. The offer should be accepted as net income would be $20,000 more. (b) Qualitative factors include the possibility of laying off those employees that produced the robot and the resulting poor morale of the remaining employees, maintaining quality standards, and controlling the purchase price in the future.

EXERCISE 7-7 (a) Make Sails $100 80 40 0 $220 Buy Sails $ 0 0 0 260 $260 Net Income Increase (Decrease) $ 100 80 40 (260) $ (40)

Direct material Direct labor Variable overhead Purchase price Total unit cost

Harmon should be making the sails, because they could save $40 per unit or $48,000. The president was including the fixed overhead cost in the calculation. Variable overhead = Total overhead ($100) Fixed overhead ($72,000 1,200) = $40. But this amount has been allocated, so Harmon will incur the cost whether or not they make the sails. This is an example of an irrelevant cost, because it does not differ between the two alternatives.

EXERCISE 7-7 (Continued) (b) The best decision would be to rent out the space as shown below. The differential savings would be $80,000 $48,000 = $32,000. Net Income Increase (Decrease) $ 264,000 (312,000) 80,000 $ 32,000

(Based on 1,200 units) Manufacturing cost Purchase price Opportunity cost Total annual cost (c)

Per Unit $220 $260

Make Sails $264,000 0 80,000 $344,000

Buy Sails $ 0 312,000 0 $312,000

Qualitative factors to consider would be (1) whether Harmon will be able to exercise control over the future price of the product (2) whether Harmon will be able to exercise control over the quality of the product and (3) the potential for interruptions in the supply of the product.

EXERCISE 7-8 (a) Make IMC2 $ 65.00 48.00 6.50 60.00* 0 $179.50 Buy IMC2 $ 0 0 0 0 200.00 $200.00 Net Income Increase (Decrease) $ 65.00 48.00 6.50 60.00 (200.00) $ (20.50)

Direct material Direct labor Material handling Variable overhead Purchase price Total unit cost

*Variable overhead = 50% X ($126.50 6.50) The unit should not be purchased from the outside vendor, as the per unit cost would be $20.50 greater than if they made it.

EXERCISE 7-8 (Continued) (b) In order for Interdesign to make an accurate decision, they would have to know the opportunity cost of manufacturing the other product. As determined in (a), purchasing the product from outside would cost $20,500 more (1,000 X $20.50). Interdesign would have to increase their contribution margin by more than $20,500 through the manufacture of the other product, before it would be economical for them to purchase the IMC2 from the outside vendor. Qualitative factors to consider would be (1) quality of the component (2) on-time delivery, and (3) reliability of the vendor.

(c)

EXERCISE 7-9 Net Income Increase (Decrease) $ (7) $ (7) (10) $ (3) $ (4)

Sell (Basic Kit) Sales per unit Costs per unit Direct materials Direct labor Total Net income per unit $28 $14 0 $14 $14

Process Further (Stage 2 Kit) ( )$35( ) ( ) $ 7 (1) ( ) 10 (2) ( ) $17 ( ) ( ) $18 ( )

(1) The cost of materials decreases because Lori can make two Stage 2 Kits from the materials for a basic kit. (2) The total time to make the two kits is one hour at $20 per hour or $10 per unit.

EXERCISE 7-9 (Continued) Lori should carry the Stage 2 Kits. The incremental revenue, $7, exceeds the incremental processing costs, $3. Thus, net income will increase by processing the kits further.

EXERCISE 7-10 (a) Sales ($50,000 + $10,000 + $60,000) Joint costs Net income $120,000 100,000 $ 20,000

(b) Sales ($190,000 + $35,000 + $220,000) Joint costs Additional costs ($100,000 + $30,000 + $150,000) Net income (c) Incremental revenue Incremental costs Incremental profit (loss)
(1) (1)

$ 445,000 (100,000) (280,000) $ 65,000

Product 12 Product 14 Product 16 $ 140,000 $ 25,000 $ 160,000 (30,000) (150,000) (100,000) $ 40,000 $ (5,000) $ 10,000

Sales value after further processing Sales value @ split-off point

Products 12 and 16 should be processed further and product 14 should be sold at the split-off point. (d) Sales ($190,000 + $10,000 + $220,000) Joint costs Additional costs ($100,000 + $150,000) Net income $ 420,000 (100,000) (250,000) $ 70,000

Net income is $5,000 ($70,000 $65,000) higher in (d) than in (b) because product 14 is not processed further, thereby increasing overall profit $5,000.

EXERCISE 7-11 To determine whether each of the three joint products should be sold as is, or processed further, we must determine the incremental profit or loss that would be earned by each. The allocated joint costs are irrelevant to the decision since these costs will not change whether or not the products are sold as is or processed further. Sarco Incremental revenue Incremental cost Incremental profit (loss) $100,000* 120,000 $ (20,000) Barco $100,000 ** 89,000 $ 11,000 Larco $400,000 *** 250,000 $150,000

From this analysis we see that Barco and Larco should be processed further because the incremental revenue exceeds the incremental costs, but Sarco should be sold as is. *$300,000 $200,000 EXERCISE 7-12 (a) The costs that are relevant in this decision are the incremental revenues and the incremental costs associated with processing the material past the split-off point. Any costs incurred up to the split-off point are sunk costs, and therefore, irrelevant to this decision. Revenue after further processing: Product A$45,000 (3,000 units X $15.00 per unit) Product B$97,200 (6,000 units X $16.20 per unit) Product C$43,200 (2,000 units X $21.60 per unit) Revenue at split-off: Product A$30,000 (3,000 units X $10.00 per unit) Product B$69,600 (6,000 units X $11.60 per unit) Product C$38,800 (2,000 units X $19.40 per unit) Incremental revenue Incremental cost Increase (decrease) in profit A $15,000 14,000 $ 1,000 B $27,600 16,000 $11,600 C $ 4,400 9,000 $(4,600) **$400,000 $300,000 ***$800,000 $400,000

(b)

Products A and B should be processed further. (c) The decision would remain the same. It does not matter how the joint costs are allocated because joint costs are irrelevant to this decision.

EXERCISE 7-13 (a) Cost Accumulated depreciation Book value Sales proceeds Loss on sale $100,000 20,000* 80,000 30,000 $ 50,000

*One years depreciation: ($100,000 $0) 5 years (b) Retain Scanner $420,000* Replace Scanner $312,000** 120,000 (30,000) $402,000 Net Income Increase (Decrease) $ 108,000 (120,000) 30,000 $ 18,000

Annual operating costs New scanner cost Old scanner salvage Total

$420,000

*(4 years X $105,000) **[4 years X ($105,000 $27,000)] Yes. Kinnaird Hospital should replace the old scanner because it will result in a savings of $18,000 over the next four years. (c) As shown in (a) above, replacing the old scanner will result in reporting a loss of $50,000. Reluctance to report losses of this nature is the usual reason for not recognizing that a poor decision was made in the past. The remaining book value of the old scanner ($80,000) is a sunk cost. It will be deducted in the future, if the scanner is retained, or written off now if it is replaced. However, if it is replaced now, that cost will be partially offset by the salvage value that Harmon is willing to pay ($30,000).

EXERCISE 7-14 Net Income Increase (Decrease) ($ 30,000 ( (25,000) ( 5,000) ($ 10,000)

Operating costs New machine cost Salvage value (old) Total (1) $24,000 X 5. (2) $18,000 X 5.

Retain Replace Machine Machine $120,000 (1) ($ 90,000) (2) 0 ( 25,000) 0 ( (5,000) $120,000 ($110,000)

The current machine should be replaced. The incremental analysis shows that net income for the five-year period will be $10,000 higher by replacing the current machine.

EXERCISE 7-15 Net Income Increase (Decrease) $(100,000) (60,000) (25,000) (85,000) (15,000) ( 0) ( 0) ( 0) $ (15,000)

Sales Variable costs Cost of goods sold Operating expenses Total variable Contribution margin Fixed costs Cost of goods sold Operating expenses Total fixed Net income (loss)

Continue $100,000) ( 60,000) (25,000) (85,000) (15,000) (16,500) (23,000) (39,500) $(24,500)

Eliminate $( 0) ( ( ( ( 0) 0) 0) 0)

(16,500) (23,000) (39,500) $(39,500)

Mary is incorrect. The incremental analysis shows that net income will be $15,000 less if the Erie Division is eliminated. This amount equals the contribution margin that would be lost through discontinuing the division. (Note: None of the fixed costs can be avoided.)

EXERCISE 7-16 (a) (b) Sales Variable expenses Contribution margin Fixed expenses Net income $30,000 + $75,000 $30,000 = $75,000 Stunner $300,000 150,000 150,000 142,500* $ 7,500 Double-Set $500,000 200,000 300,000 262,500** $ 37,500 Total $800,000 350,000 450,000 405,000 $ 45,000

*$30,000 + [($300,000 $800,000) X $300,000] **$75,000 + [($500,000 $800,000) X $300,000] (c) As shown in the analysis above, Nichols should not eliminate the Mega-Power product line. Elimination of the line would cause net income to drop from $75,000 to $45,000. The reason for this decrease in net income is that elimination of the product line would result in the loss of $60,000 of contribution margin while saving only $30,000 of fixed expenses.

EXERCISE 7-17 Calculation of contribution margin per unit: A $95 50 $45 B $78 45 $33 C $120 42 $ 78

Selling price per unit Less: variable costs/unit Contribution margin/unit

Fixed costs = $22 X (8,000 + 20,000) = $616,000 Company profit with Products A and B: A 8,000 $760,000 400,000 $360,000 B 20,000 $1,560,000 900,000 $ 660,000 Total

Units sold Sales revenue Less: Variable costs Contribution margin Less: Fixed costs Net profit

$2,320,000 $1,300,000 1,020,000 616,000 $ 404,000

EXERCISE 7-17 (Continued) Company profit with Products A and C: A 8,800* $836,000 440,000 $396,000 C 11,000 $1,320,000 462,000 $ 858,000 Total

Units sold Sales Revenue Less: Variable costs Contribution margin Less: Fixed costs Net profit

$2,156,000 902,000 1,254,000 616,000 $ 638,000

*Product A sales increase by 10%, (8,000 X 110%) Yes they should introduce Product C since net profit would increase by $234,000 ($638,000 $404,000). EXERCISE 7-18 1. Irrelevant. Unavoidable costs will be incurred regardless of the decision made. 2. Relevant. 3. Irrelevant. This is a sunk cost and all sunk costs are irrelevant. 4. Irrelevant. These are sunk costs. 5. Relevant. 6. Relevant. 7. Relevant. 8. Relevant. 9. Irrelevant. If there is no change in the direct materials charge regardless of the decision made, the cost is irrelevant. 10. Relevant.

SOLUTIONS TO PROBLEMS
PROBLEM 7-1A

(a) Reject Order Revenues (10,000 X $28) Cost of goods sold Selling and administrative expenses Net income $0 0 0 $0 Accept Order $280,000 224,000 (1) 25,000 (2) $ 31,000

Net Income Increase (Decrease) $ 280,000 ( (224,000) ( (25,000) $ 31,000

(1) Variable costs = $3,600,000 $1,080,000 = $2,520,000; $2,520,000 112,500 units = $22.40 per unit; 10,000 X $22.40 = $224,000. (2) Variable costs = $450,000 $225,000 = $225,000; $225,000 112,500 units = $2.00 per unit; 10,000 X ($2.00 + $0.50) = $25,000. (b) Yes, the special order should be accepted because net income will increase by $31,000. (c) Unit selling price = $22.40 (variable manufacturing costs) + $2.50 variable selling and administrative expenses + $4.10 net income = $29. (d) Nonfinancial factors to be considered are: (1) possible effect on domestic sales, (2) possible alternative uses of the unused plant capacity, and (3) ability to meet customers schedule for delivery without increasing costs.

PROBLEM 7-2A

(a) Make WISCO Direct material Direct labor Indirect labor Utilities Depreciation Property taxes Insurance Purchase price Freight and inspection Receiving costs Total annual cost $33,600 30,100 3,010 2,800 3,000 700 1,500 0 0 0 $74,710 Buy WISCO 0 0 0 0 900 200 600 70,000 2,800 1,250 $75,750 $

Net Income Increase (Decrease) ($33,600) ( 30,100) ( 3,010) ( 2,800) ( 2,100) ( 500) ( 900) ( (70,000) ( (2,800) ( (1,250) ($ (1,040)

(b) The company should continue to make WISCO because net income would be $1,040 less if WISCO were purchased from the supplier. (c) The decision would be different. Because of the opportunity cost of $5,000, net income will be $3,960 higher if WISCO is purchased as shown below: Net Income Increase Make WISCO Buy WISCO (Decrease) Total annual cost Opportunity cost Total cost $74,710 5,000 $79,710 $75,750 0 $75,750 $(1,040) (5,000) $(3,960)

(d) Nonfinancial factors include: (1) the adverse effect on employees if WISCO is purchased, (2) how long the supplier will be able to satisfy the Sherrer Manufacturing Companys quality control standards at the quoted price per unit, and (3) whether the supplier will deliver the units when they are needed by Sherrer.

PROBLEM 7-3A

(a) (1)

Table Cleaner Not Processed Further Sales: FloorShine (600,000 30) X $20 Table Cleaner (300,000 30) X $25 Total revenue Costs: CDG Additional costs of FloorShine Total costs Gross profit

$400,000 250,000 $650,000 210,000 250,000 460,000 $190,000

(2)

Table Cleaner Processed Further Sales: FloorShine Table Stain Remover (300,000 30) X $18 Table Polish (300,000 30) X $18 Total revenue Costs: CDG Additional costs of FloorShine TCP Total costs Gross profit

$400,000 180,000 180,000 $760,000 210,000 250,000 100,000 560,000 $200,000

(3) If the table cleaner is processed further overall company profits will be $10,000 higher. Therefore, management made the wrong decision by choosing to not process table cleaner further.

PROBLEM 7-3A (Continued) (b) Dont Process Table Cleaner Further $250,000 0 $250,000 Process Table Cleaner Further $360,000 100,000 $260,000 Net Income Increase (Decrease) $110,000 (100,000) $ 10,000

Incremental revenue Incremental costs Totals

When trying to decide if the table cleaner should be processed further into TSR and TP, only the relevant data need be considered. All of the costs that occurred prior to the creation of the table cleaner are sunk costs and can be ignored. The decision should be made by comparing the incremental revenue from further processing to the incremental costs.

PROBLEM 7-4A (a) Cost Accumulated depreciation Book value Sales proceeds Loss on sale *$120,000 6 years = $20,000 (b) (1) Sales ($240,000 X 5 yrs.) Less costs: Variable costs ($35,000 X 5) Fixed costs ($23,000 X 5) Selling & administrative Depreciation Net income *($29,000 X 5) (2) Sales Less costs: Variable costs ($12,000 X 5) Fixed costs ($8,400 X 5) Selling and administrative Depreciation Operating income Less: Loss on old elevator Net income (c) Retain Old Elevator $175,000 115,000
.

$120,000 20,000* 100,000 (25,000) $ 75,000

Retain Old Elevator $1,200,000 $175,000 115,000 145,000* 100,000

535,000 $ 665,000

Replace Old Elevator $1,200,000 $ 60,000 42,000 145,000 180,000

427,000 773,000 75,000 $ 698,000 Net Income Increase (Decrease) $ 115,000 73,000 (180,000) 25,000 $ 33,000

Variable operating costs Fixed operating costs New elevator cost Salvage on old elevator Totals

$290,000

Replace Old Elevator $ 60,000 42,000 180,000 (25,000) $257,000

PROBLEM 7-4A (Continued) (d) TO: Sam Solomon FROM: Student SUBJECT: Relevant Data for Decision to Replace Old Elevator When deciding whether or not to replace any old equipment, the analysis should only include cost data relevant to the replacement decision. The $75,000 loss that would be experienced if we replace the old elevator with the newer model is related to a sunk cost, namely the cost of the old elevator. Sunk costs are irrelevant in decision making. The loss occurs when comparing the book value of the old elevator to the cash proceeds that would be received. The book value of $100,000 would be deducted as depreciation expense over the next five years if the elevator were retained. If the elevator is replaced with the newer model the book value will be expensed in the current year, less the cash proceeds received on disposal. Therefore, the $100,000 book value will be expensed under either alternative, making it irrelevant. MEMO

PROBLEM 7-5A

(a) Sales Variable costs Cost of goods sold Selling and administrative Total variable expenses Contribution margin (b) (1)
Division I Contribution margin (above) Fixed costs Cost of goods sold Selling and administrative Total fixed expenses Income (loss) from operations

Division I $250,000 140,000 26,000 166,000 ($ 84,000)

Division II $200,000 170,100 42,000 212,100 $ (12,100)


Net Income Increase (Decrease) $(84,000) 30,000 19,500 49,500 $(34,500) Net Income Increase (Decrease) $12,100 ( 9,450 ( 9,000 18,450 $30,550

Continue $(84,000) (60,000) (39,000) (99,000) $(15,000)

Eliminate $( 0)

(30,000) (19,500) (49,500) $(49,500)

(2)
Division II Contribution margin (above) Fixed costs Cost of goods sold Selling and administrative Total fixed expenses Income (loss) from operations Continue $(12,100) (18,900 ( 18,000 ( 36,900 $(49,000) Eliminate $( 0)

( 9,450) ( 9,000) (18,450) $(18,450)

Division II should be eliminated as its negative contribution margin is $12,100. Income from operations would increase $30,550 if Division II is eliminated. Division I should be continued because it is producing positive contribution margin of $84,000. Income from operations will decrease $34,500 by discontinuing this division.

PROBLEM 7-5A (Continued) (c) MORENO MANUFACTURING COMPANY CVP Income Statement For the Quarter Ended March 31, 2011
Divisions I Sales Variable costs Cost of goods sold Selling and administrative Total variable costs Contribution margin Fixed costs Cost of goods sold (1) Selling and administrative (2) Total fixed costs Income (loss) from operations $250,000 140,000 26,000 166,000 84,000 63,150 42,000 105,150 III $500,000 240,000 30,000 270,000 230,000 63,150 33,000 96,150 IV $400,000 187,500 30,000 217,500 182,500 65,650 23,000 88,650 $ 93,850 Total $1,150,000 567,500 86,000 653,500 496,500 191,950 98,000 289,950 $ 206,550

$(21,150) $133,850

(1) Divisions fixed cost of goods sold plus 1/3 of Division IIs unavoidable fixed cost of goods sold [$189,000 X (100% 90%) X 50% = $9,450]. Each divisions share is $3,150. (2) Divisions fixed selling and administrative expense plus 1/3 of Division IIs unavoidable fixed selling and administrative expenses [$60,000 X (100% 70%) X 50% = $9,000]. Each divisions share is $3,000. (d) Income from operations with Division II of $176,000 (given) plus incremental income of $30,550 from eliminating Division II = $206,550 income from operations without Division II.