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# Atkinson, Solutions Manual t/a Management Accounting, 6E

Chapter 3
Using Costs in
Decision Making

QUESTIONS
3-1

## Cost information is used in pricing, product planning, budgeting, performance

evaluation, and contracting. Examples of specific uses of cost information
include deciding whether to introduce a new product or discontinue an existing
product (given the price structure), assessing the efficiency of a particular
operation, and assessing the cost of serving customer segments.

3-2

Variable costs are costs that increase proportionally with changes in the activity
level of some variable. Fixed costs are costs that in the short run do not vary with
a specified activity. Fixed costs depend on how much of the resource (capacity)
is acquired, rather than on how much is used.

3-3

Contribution margin per unit, which is the difference between revenue per unit
and variable cost per unit, is the contribution that each unit makes to covering
fixed costs and generating a profit. The contribution margin is therefore an
important component of the equation to determine the breakeven point and to
understand the effect on profit of proposed changes, such as changes in sales
volume in response to changes in advertising or sales prices.

3-4

Contribution margin per unit is the difference between revenue per unit and
variable cost per unit. The contribution margin per unit indicates how much the
total contribution margin will increase with an additional unit of sales. The
contribution margin ratio expresses similar ideas, but as a percentage of sales
dollars. Specifically, the contribution margin ratio is the total contribution margin
divided by total sales dollars (or contribution margin per unit divided by sales
price per unit), and indicates how much the total contribution margin increases
with an additional dollar of sales revenue.

3-5

## In evaluating whether a business venture will be profitable, the breakeven point

is the volume at which the profit equals zero, that is, revenues equal total costs.
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## Atkinson, Solutions Manual t/a Management Accounting, 6E

3-6

A mixed cost is a cost that has a fixed component and a variable component. For
example, utilities bills may include a fixed component per month plus a variable
component that depends on the amount of energy used. A step variable cost
increases in steps as quantity increases. For example, one supervisor may be
hired for every 20 factory workers. Mixed costs and step variable costs both
have elements of fixed and variable costs. However, mixed costs have distinct
fixed and variable components, with fixed costs that are constant over a fairly
wide range of activity (for a given time period) and variable costs that vary in
proportion to activity. Step variable costs are fixed for a fairly narrow range of
activity and increase only when the next step is reached.

3-7

Step variable costs are fixed for a fairly narrow range of activity and increase
when the next step is reached. For example, one supervisor may be hired for
every 20 factory workers. Fixed costs are costs that in the short run do not vary
with a specified activity for a wide range of activity. For example, factory rent
per month would likely remain unchanged as production increased or decreased,
even if by large amounts.

3-8

Incremental cost is the cost of the next unit of production and is similar to the
economists notion of marginal cost. In a manufacturing setting, incremental cost
is often defined as a constant variable cost of a unit of production. However, in
some situations, the variable cost of a unit of production may be more
complicated. For example, the variable cost of labor per unit may decrease over
time if workers become more efficient (a learning effect. Alternatively, the
variable cost of labor per unit will change during overtime hours if workers
receive an overtime premium (commonly 50%). Finally, some costs exhibit stepvariable behavior, as when one supervisor can supervise a quantity of employees
but an additional supervisor is needed beyond a certain number of employees.

3-9

## In evaluating the different alternatives from which managers can choose, it is

better to focus only on the relevant costs that differ across different alternatives
because it does not divert the managers attention with irrelevant facts. If some
costs remain the same regardless of what alternative is chosen, then those costs
are not useful for the managers decisions, as they are not affected by the
decision. Therefore, it is better to omit them from the cost analysis used to
support the decision. Moreover, resources are not expended to find or prepare
irrelevant information.

3-10 Sunk costs are costs that are based on a previous commitment and cannot be
recovered. For example, depreciation on a building reflects the historical cost of
the building, which is a sunk cost. Therefore, they are not relevant costs for the
decision.
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## Chapter 3: Using Costs in Decision Making

3-11 The general principal is that sunk costs are not relevant costs. But, some
managers may consider sunk costs to be relevant because they may be concerned
about how others will perceive their original decision to incur these costs, and
may want to cover up their initial poor judgment. Managers may also feel that
they do not want to waste the sunk costs by giving up on the possibility of some
benefit from the invested funds, or may continue to believe in potential success
despite overwhelming evidence to the contrary. Also, managers may be
embarrassed and unwilling to admit they made a mistake.
3-12 No, fixed cost are not always irrelevant. For example, in comparing the status
quo and a proposal to substantially increase the quantity of goods or services
provided, additional fixed costs (that is, costs not proportional to volume) may
be incurred to provide the increased quantity. Such costs might include a large
expenditure for more equipment or expanded factory facilities.
3-13 An opportunity cost is the maximum value forgone when a course of action is
chosen.
3-14 Yes, avoidable costs are relevant because they can be eliminated when, for
example, a part, product, product line, or business segment is discontinued.
3-15 In the context of a make or buy decision, fixed costs such as production engineering
staff salaries are relevant if these costs can be eliminated by assigning the staff to
other tasks, or by laying off the engineers not required when a part is outsourced. If it
is possible to find an alternative use for the facilities made available because of the
elimination of a product or a component, the associated fixed costs also are relevant.
Conversely, fixed costs that cannot be eliminated or used for other productive
purposes are not relevant for the decision. For example, if factory facilities would
remain idle if the company buys from outside, then the associated costs are not
relevant for the decision.
3-16 There are several qualitative considerations that must be evaluated in a make-orbuy decision. For example, one must question whether the outside supplier has
quoted a lower price to obtain the order, and plans to increase the price. Also, the
reliability of the supplier in meeting the required quality standards and in making
deliveries on time is important.
3-17 When a decision to outsource frees up space to produce an alternative product,
then the contribution margin on the alternative product is a relevant opportunity
cost for the make alternative in a make-or-buy decision.
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## Atkinson, Solutions Manual t/a Management Accounting, 6E

3-18 A difficulty that arises with respect to revenue when analyzing whether to drop a
product or department is whether sales by one organizational unit can affect sales
in another organizational unit. A difficulty that arises with respect to cost analysis
is that many product costs, such as machine and factory depreciation, are the
result of sunk costs that often remain in whole or in part after the product is
discontinued. The analysis of what costs are avoided when a product is dropped
can be difficult due to the closing of plants, severance pay and environmental
cleanup costs.
3-19 The answer depends on the time frame and context considered. For example, a
one-time order that covers variable production (and selling costs) is
advantageous if capacity cannot be changed in the short run and excess capacity
exists. Also, for given capacity with one scare resource, maximizing contribution
margin per unit of scarce resource will maximize profit. In the long run, prices
must cover all their costs, both fixed and variable, in order for the firm to
survive.
3-20 No. Products should be ranked by the contribution margin per unit of the constrained
resource rather than by the contribution margin per unit of the product.
3-21 Yes. When capacity is fixed in the short run, the firm may need to sacrifice the
production of some profitable products to make capacity available for a new
order. The contribution margin on the production of profitable products sacrificed
for a new order is an opportunity cost that must be considered to evaluate the
profitability of the new order.
3-22 The three components of a linear program are the objective function, the decision
variables, and the constraints.

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## Chapter 3: Using Costs in Decision Making

EXERCISES
3-23 (a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
(k)
(l)
3-24 (a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)

Fixed
Variable
Variable
Fixed
Fixed
Variable
Variable
Fixed or variable (if number of production workers can vary in the short
run);
Fixed
Variable
Fixed
Variable
Variable
Fixed
Fixed or variable (if number of billing clerks can vary in the short run)
Fixed
Fixed
Variable
Fixed
Fixed (with respect to a unit of product, as stated in the problem.
However, gasoline costs will vary with miles driven.)

3-25
Burger ingredients

Variable

Cooks wages

Fixed

Servers wages

Fixed

Janitors wages

Fixed

Fixed

Variable

Rent

Fixed

Fixed

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3-26 (a)

## Contribution margin per unit = \$1,000 \$500 \$100 = \$400

Contribution margin ratio = (Contribution margin)/Sales
= \$400/\$1,000 = 0.40

(b)

## Let X = the number of units sold to break even

Sales revenue Costs = Income
(Price Quantity) Variable costs Fixed costs = Income
\$1,000X \$600X \$3,500,000 = \$0
\$400X \$3,500,000 = 0
X = 8,750 units

(c)

Because the variable cost per unit will decrease, the contribution margin
per unit will increase. The breakeven point equals (fixed costs)/
(contribution margin), so the breakeven point will decrease. Specifically,
the new contribution margin per unit is \$1,000 \$450 \$100 = \$450 and
the new breakeven point is \$3,500,000/\$450 = 7,778 units (rounded).

3-27 (a)

## Let P charges per patient-day.

(5,400 P) (5,400 \$500) \$2,000,000) = 0
5,400 (P \$500) = \$2,000,000
P \$500 = \$2,000,000/5,400 = \$370.37
P = \$870.37

(b)

## Let X = the average number of patient days per month necessary to

generate a target profit of \$45,000 per month
Revenue Costs = Income
(Price Quantity) Variable costs Fixed costs = Income
\$2,000X \$500X \$2,000,000 = \$45,000
\$1,500X = \$2,000,000 + \$45,000 = \$2,045,000
X = 1,363 patient days (rounded)

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3-28 (a)

## Contribution margin per unit = \$30 \$19.50 = \$10.50

Contribution margin ratio = (Contribution margin)/Sales
= \$10.50/\$30 = 0.35

(b)

## Let X = the number of units sold to break even

Sales revenue Costs = Income
(Price Quantity) Variable costs Fixed costs = Income
\$30X \$19.50X \$147,000 = \$0
\$10.50X \$147,000 = 0
X = 14,000 units

(c)

## Let X = the number of units sold to generate revenue necessary to earn

pretax income of 20% of revenue
Sales revenue Costs = Income
(Price Quantity) Variable costs Fixed costs = Income
\$30X \$19.50X \$147,000 = 0.2 \$30X
\$10.50X \$147,000 = \$6X
X = 32,667 units (rounded)
Desired revenue = \$30X = \$30 32,667 = \$980,010
Alternatively, let R = sales revenue necessary to earn pretax income of
20% of revenue
Sales revenue Variable costs Fixed costs = Income
R 0.65R \$147,000 = 0.2R
R = \$147,000/0.15 = \$980,000

(d)

## Let X = the number of units sold to generate after-tax profit of \$109,200

(Before-tax income) (1 0.35) = \$109,200
Before-tax income = \$109,200/0.65 = \$168,000
\$30X \$19.50X \$147,000 = \$168,000
\$10.50X = \$315,000
X = \$315,000/\$10.50 = 30,000 units

(e)

## Let Y = necessary increase in sales units

Incremental sales revenue Incremental variable costs Incremental fixed
costs = \$0
\$30Y \$19.50Y \$38,500 = \$0
Y = 3,667 units (rounded)
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3-29 (a)

## Let R = sales dollars necessary for a before-tax target profit of \$250,000

The contribution margin ratio = (\$1,260,000 \$570,000)/\$1,260,000 =
0.547619 (rounded).
Sales revenue Variable costs Fixed costs = Income
Contribution margin Fixed costs = Income
0.547619 R \$480,500 = \$250,000
R = (\$250,000 + \$480,500)/0.547619
R = \$1,333,956.60

## (c) Let R = sales dollars necessary to break even

Contribution margin Fixed costs = 0
0.547619 R \$480,500 = \$0
R = \$480,500/0.547619
R = \$877,434.85
3-30 The sales mix in units is 3/5 Domestic and 2/5 International.
The Domestic CM = \$50 \$30 = \$20; the International CM = \$40 \$16 = \$24
Let X = total number of units that must be sold in the International market to earn
\$200,000 before taxes, assuming the stated sales mix
Total CM Fixed costs = \$200,000
(\$20 1.5X) + \$24X \$5,000,000 \$1,280,000= \$200,000
\$54X = \$6,480,000
X = \$6,480,000/\$54 = 120,000 units in the International market
1.5 X = 180,000 units in the Domestic market
Equivalently, one can compute a weighted average unit CM: (3/5) (\$20) +
(2/5) (\$24) = \$21.60
Let Y = total number of units that must be sold to earn \$200,000 before taxes,
assuming the stated sales mix
Total CM Fixed costs = \$200,000
\$21.60Y \$5,000,000 \$1,280,000= \$200,000
\$21.60Y = \$6,480,000
Y = 300,000 units, which consists of 3/5 or 180,000 units in the Domestic market
and 2/5 or 120,000 units in the International market

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3-31 (a)
Units sold
Sales mix
percentage*

Alligators
140,000
.7

Dolphins
60,000

Total
200,000

.3
Weighted
average**

Weighted
average**

Sum of
weighted
averages

Sales price
per unit

\$20.00

\$14.00

\$25.00

\$7.50

\$21.50

Variable costs
per unit

\$ 8.00

\$ 5.60

\$10.00

\$3.00

\$ 8.60

Unit CM

\$12.00

\$ 8.40

\$15.00

\$4.50

\$12.90

## * 140,000/(140,000 + 60,000) = .7; 60,000/(140,000 + 60,000) = .3

** \$20 .7 = \$14; \$8 .7 = \$5.60; \$25 .3 = \$7.50; \$10 .3 = \$3

## Breakeven units = \$1,290,000/\$12.90 = 100,000 units. Of these, 100,000

.7 = 70,000 will be alligators and 100,000 .3 = 30,000 will be
dolphins.
(b)
Units sold
Sales mix
percentage*

Alligators
60,000
.3

Dolphins
140,000

Total
200,000

.7
Weighted
average**

Weighted
average**

Sum of
weighted
averages

Sales price
per unit

\$20.00

\$6.00

\$25.00

\$17.50

\$23.50

Variable costs
per unit

\$ 8.00

\$2.40

\$10.00

\$ 7.00

\$ 9.40

Unit CM

\$12.00

\$3.60

\$15.00

\$10.50

\$14.10

## * 60,000/(140,000 + 60,000) = .3; 140,000/(140,000 + 60,000) = .7

** \$20 .3 = \$6; \$8 .3 = \$2.40; \$25 .7 = \$17.50; \$10 .7 = \$7

60

## Breakeven units = \$1,290,000/\$14.10 = 91,489.36, which we round up to

91,490 units. Of these, 91,490 .3 = 27,447 will be alligators and 91,490
.7 = 64,043 will be dolphins.
(c)

In part (b), the sales mix percentage for the higher-CM product (dolphins)
is greater than in part (a). Consequently, fewer total units are required to
break even (91,490 in part (b) versus 100,000 in part (a)).

3-32
Product

Hamburgers
Chicken

## Total Sales Without

Special Promotion
\$1.09 20,000
\$21,800

## Total Sales With

Special Promotion
\$0.69 24,000
\$16,560

Difference
(\$5,240)

Sandwiches

(1,032)

French fries

2,136
(\$4,136)

Product

Hamburgers
Chicken

## Variable Costs Without

Special Promotion
\$0.51 20,000
\$10,200

## Variable Costs With

Special Promotion
\$0.51 24,000
\$12,240

Difference
(\$2,040)

Sandwiches

504

French fries

(888)
(\$2,424)

## Decrease in sales with special promotion

Increase in variable costs with special promotion
Decrease in contribution margin with special promotion
Incremental advertising expenses with special promotion
Decrease in profit with special promotion

\$4,136
2,424
\$6,560
4,500
(\$11,060)

## Therefore, Andrea should not go ahead with this special promotion. A

countervailing argument is the creation of new customers who may stay with the
firm and generate additional contribution margin in the future.
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3-33 (a)

## Healthy Hearth has sufficient excess capacity to handle the one-time

(short-run) order for 1,000 meals next month. Consequently, the analysis
focuses on incremental revenues and costs associated with the order:
Incremental revenue per meal
Incremental cost per meal
Incremental contribution margin per meal
Number of meals
Increase in contribution margin and operating income

\$3.50
3.00
\$0.50
1,000
\$ 500

Healthy Hearth will be better off by \$500 with this one-time order. Note
that total fixed costs remain unchanged, so it is sufficient to evaluate the
change in the contribution margin. If the order had been long-term,
Healthy Hearth would need to evaluate whether the price provides the
desired profitability considering the fixed costs and whether filling the
government order might require giving up higher-priced regular sales.
(b)

## Healthy Hearth has insufficient excess capacity to handle the one-time

order for 1,000 meals next month, and must give up regular sales of 500
meals at \$4.50 each, resulting in an opportunity cost.
Incremental contribution margin from one-time order
Incremental revenue per meal
Incremental cost per meal
Incremental contribution margin per meal
Number of meals
Increase in operating income from one-time order

\$3.50
3.00
\$0.50
1,000
\$500

Opportunity cost
Lost contribution margin on regular sales: 500 (\$4.50 \$3.00)

\$(750)

## Change in contribution margin and operating income

\$(250)

Now, Healthy Hearth will be worse off by \$250 with this one-time order.
Again, total fixed costs remain unchanged, so it is sufficient to evaluate the
change in the contribution margin.
3-34 (a)

Relevant costs:

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## Atkinson, Solutions Manual t/a Management Accounting, 6E

Irrelevant costs:

(b)

## Acquisition cost of Impala

Don will buy the Ford Escort if he bases the decision only on the available
cost information.
Year 1: (If Don buys the Ford Escort)
Cash savings:
Repairs on the Impala
Operating costImpala

\$5,400
2,900
8,300

Cash expenditures:
Acquisition costFord Escort
Operating costFord Escort
First Year Savings
(c)

5,400
1,800
7,200
\$1,100

1.

2.

3.

## Cost of capital (interest rate) to consider the time value of money.

(This topic is covered in other courses.)

Qualitative consideration:
1.

Escort.

Sales price

As Is

Rework
\$10.00

Rework cost

\$5.50*

\$4.50

*55,000 10,000

3-36 (a)

## The original cost of \$50,000 and accumulated depreciation of \$40,000 are

sunk, and therefore irrelevant, when the choice is between overhauling the
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## Chapter 3: Using Costs in Decision Making

old machine and replacing it with a new machine. Note that the annual
operating costs (before overhaul) of \$18,000 are not sunk costs, yet they
are irrelevant.
(b)

(c)

Relevant costs include the acquisition cost of the new machine, the cost of
overhauling the old machine, current salvage of \$4,000 for the old
machine (all of which are up-front costs), salvage value at the end of five
years for the new and overhauled machines, and the annual operating costs
for both the new machine and the overhauled old machine.
Net acquisition cost

Replacement
\$66,000a

end of 5 years

(500)

(200)

## Operating costs for

5 years
Total relevant costs

65,000b
\$130,500

70,000c
\$94,800

a
b
c

Overhauling
\$25,000

## \$70,000 \$4,000 = \$66,000

\$13,000 5 = \$65,000
\$14,000 5 = \$70,000

## It costs McKinnon Company \$35,700 more with the new grinding

machine than overhauling the old one. Therefore, the plant manager should
overhaul the old grinding machine. However, this analysis is incomplete as
it ignores the time value of money, considered in net present value
analysis, which is covered in other courses.

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## Atkinson, Solutions Manual t/a Management Accounting, 6E

3-37

Year 1

Year 2

Year 3

Year 4

Year 5

Cash inflow:
Sale of old machine
Saving because old
machine not repaired

\$40,000

(5,000)

20,000

Salvage value of
new machine
Decrease in annual
operating costs

\$10,000
20,000

\$20,000

(120,000)

\$20,000

\$20,000 \$20,000

Cash outflow:
Purchase of new machines
0
0

## Net cash inflow

(outflow)

(\$40,000)

\$20,000

\$20,000

\$20,000 \$25,000

Cumulative cash
inflow (outflow)

(\$40,000) (\$20,000)

\$
0

\$20,000 \$45,000

Joyce Printers should replace the machines if they expect to use the new
machines for more than three years. (A more complete evaluation would use net
present value analysis, which is covered in other courses.)
3-38
Smart phones:
\$140 50,000
Component:
\$35.00 50,000
\$34.00 50,000
Relevant costs

Smart phones:
\$140 50,000
Component:
\$30.00 50,000

Insource (Make)

\$7,000,000

\$7,000,000

1,750,000

1,700,000

\$8,750,000

\$8,700,000

Insource (Make)

\$7,000,000

\$7,000,000

1,500,000
65

\$34.00 50,000
Relevant costs

1,700,000
\$8,500,000

\$8,700,000

3-39 (a)

## Assumptions need to be made about the avoidability of the fixed overhead

costs if Kane outsources the component.

(b)

If the variable costs (direct materials, direct labor, and variable overhead)
are all avoidable, then Kane will certainly reduce costs by outsourcing the
component. Fixed overhead costs may be unavoidable if the facility cannot
be converted to alternative uses when the component is outsourced.
However, even if the fixed overhead costs are unavoidable, Kane would
reduce costs by outsourcing. In this case, the cost savings per unit if the
component is outsourced would be:
Purchase price

(c)

3-40

\$64.50

66.20

## Savings per unit

\$1.70

Other factors relevant to the decision are the suppliers ability to live up to
expected quality and delivery standards, and the likelihood of suppliers
increasing prices of components in the near future.
Premier should make the gear model G37 because it costs \$87,000 less to
make than to buy. (Fixed overhead is irrelevant and may be dropped from the
analysis.)
Make

## Cost of purchase: \$120 20,000 =

Direct material cost: \$55 20,000 =

\$2,400,000

\$1,100,000

600,000

500,000

300,000

300,000

(113,000)

\$2,500,000

\$2,587,000

Relevant costs

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## Atkinson, Solutions Manual t/a Management Accounting, 6E

3-41 (a) The offer by Superior Compressor should not be accepted if fixed
overhead costs are unavoidable.
Cost per unit
Cost of purchase

Make

Variable cost:
Direct material
Direct labor

\$ 80
60
56

## Relevant cost per unit

\$196

\$200

\$200

(b)

The maximum acceptable purchase price is \$213 per unit if the plant
facilities are fully utilized at present and the incremental cost of adding
more capacity is approximated well by the \$17 per unit fixed overhead
cost.

3-42 (a)

## The billiards segment currently produces a segment margin of \$40,000

\$25,000 = \$15,000, so the bars segment margin would have to increase
by at least that amount in order for the grills income to be at least as high
as it is now.

(b) George should consider the effect on the other two segments revenues if he
drops the billiards segment. It may be that the availability of billiards
attracts customers to the bar and restaurant segments. Traditional segment
margin analysis as in part (a) does not capture such interactive effects.
3-43 In order to accept the new order for 1,500 modules next week, McGee must give
up regular sales of 500 modules per week.
Variable costs are \$800 per module (\$2,400,000/3,000 modules). The
contribution margin per unit on regular sales is \$900 \$800 = \$100 per module.
Therefore, the opportunity cost (lost CM) of accepting the new order is
500(\$100) = \$50,000, and McGee will be indifferent between filling the special
order and not filling the special order when the contribution margins of the two
alternatives are equal (fixed costs will remain unchanged). That is, McGee will
be indifferent at a price P where 1,500(P \$800) = \$50,000, or P = \$833.33.
This is the floor price that McGee should charge for the new order.

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## Chapter 3: Using Costs in Decision Making

3-44 This order will require 500 = 5 (10,000 100) machine hours. Since there is
excess capacity of 800 = 4,000 (100% 80%) machine hours per month,
Shorewood Shoes Company can accept this order without expanding its capacity.
Therefore, Shorewood should charge at least as much as the incremental variable
costs for this order.
Direct material
Direct labor
Additional cost of embossing the private label
Minimum price to be charged for this order

\$6.00
4.00
2.00
0.50
\$12.50

Shorewoods costs stated in the problem are average costs per pair of shoes.
Shorewood should determine whether the costs are reasonably accurate for the discount
stores order. Shorewood should also consider how its regular customers might react to
the lower price offered to the discount store.
3-45 Incremental variable costs = (\$16 + \$5 + \$3) 10,000
= \$24 10,000
= \$240,000.
Incremental revenue = \$40 10,000 = \$400,000.
Berrys operating income will increase by \$160,000 if it accepts this offer.
3-46 (a)

## Variable cost per unit = \$198,000 36,000 = \$5.50.

Sales (30,000 units \$10 and 30,000 units \$9)

\$570,000

## Variable manufacturing and selling costs

(60,000 units \$5.50)

(330,000)

Contribution margin

\$240,000

Fixed costs

(99,000)

Operating income

\$141,000

If Ritter accepts the export order, its operating income will increase by
\$78,000 = \$141,000 \$63,000. Although Ritters operating income will
increase with the special order, Ritter must consider the long-run effect of
displeasing its regular domestic customers by not fulfilling their demand.
68

(b)

## Sales (36,000 units \$10 and 30,000 units \$9)

Variable manufacturing and selling costs
(66,000 units \$5.50)
Contribution margin
Fixed costs: \$99,000 \$25,000
Operating income

\$630,000
(363,000)
\$267,000
124,000
\$143,000

If Ritter operates the extra shift and accepts the export order, operating
income will increase by \$80,000. Ritter should consider whether the same
quality will be achieved with new operators or existing operators working
overtime (with possible fatigue). In addition, Ritter should understand
whether the additional fixed costs will be incurred on a continuing basis or
are avoidable when production drops back to its previous level. Finally,
Ritter should also consider the effect of this price reduction on regular
customers.
3-47 (a)

## Superstore faces a problem of maximizing contribution margin per unit of

scarce resource. Here, the scarce resource is shelf space. Superstore
requires at least 24 square feet for each category. The store manager
should assign additional available space to the category with the highest
contribution margin per square foot, i.e., ice cream. After assigning a total
of 100 square feet to ice cream, there is sufficient available shelf space to
assign a total of 100 square feet to frozen dinners and 26 square feet to
juices. The frozen vegetable receives the minimum required assignment of
24 square feet.
Ice Cream Juices

Frozen
Dinners

Frozen
Vegetables

## Selling price per unit

(square-foot package)

\$12.00

\$13.00

\$24.00

\$9.00

## Variable costs per unit

(square-foot package)

\$8.00

\$10.00

\$20.50

\$7.00

Unit CM
(square-foot package)

\$4.00

\$3.00

\$3.50

\$2.00

Minimum required

24

24

24

24

Maximum allowed

100

100

100

100

Allocation to maximize
total CM

100

26

100

24

69

## Chapter 3: Using Costs in Decision Making

(b)

In setting the minimum required and maximum allowed square footage per
category, the manager might consider seasonality (for example, permitting
more ice cream space during the summer or more frozen vegetable space
during the winter) and the effect on contribution margins of variability in
costs and prices. The analysis does not take into account the rate at which
products are sold within each category. The analysis should also consider
the effect of the mix on other product sales. If the store offers only a
limited selection of frozen vegetables, for example, shoppers may switch
to another store for their regular grocery shopping.
Regular

3-48
Sale price per sq. yard

Deluxe

\$16

\$25

10

15

\$6

\$10

0.15

0.20

## DLH required per sq. yard

Contribution margin per DLH
a
b

\$40a

\$50b

\$6 0.15 = \$40
\$10 0.20 = \$50

Because deluxe grade has a higher contribution margin per unit of scarce resource
(DLH) than regular grade, and no more than 8,000 square yards of deluxe grade can
be produced, Boyd Wood Company should produce the maximum of 8,000 square
yards of deluxe grade first and then use the remaining available capacity of 3,000
DLH (= 4,600 [8,000 0.20]) to produce regular grade. Therefore, the optimal
production level for each product is:
Deluxe: 8,000 sq. yards
Regular: 20,000 sq. yards (= 3,000 0.15).

70

## Atkinson, Solutions Manual t/a Management Accounting, 6E

PROBLEMS
3-49 The following items are variable costs:
Carpenter labor to make shelves
Wood to make the shelves
Sales commissions based on number of units sold
Miscellaneous variable manufacturing overhead
Total variable costs

\$600,000
450,000
180,000
350,000
\$1,580,000

The variable costs per unit are \$1,580,000/50,000 = \$31.60. The following
items are fixed costs:
Sales staff salaries
Office and showroom rental expenses
Depreciation on carpentry equipment
Miscellaneous fixed manufacturing overhead
Rent for the building where the shelves are made
Depreciation for office equipment
Total fixed costs

\$80,000
150,000
50,000
200,000
150,000
300,000
10,000
\$940,000

## Let X = the number of units sold to earn a pre-tax profit of \$500,000

Revenue Costs = Income
(Price Quantity) Variable costs Fixed costs = Income
\$70X \$31.60X \$940,000 = \$500,000
X = 37,500 units
3-50

(a)

\$105.00

## Variable cost per unit:

Direct material
Direct labor
Commission

\$30.00
20.00
10.00
10.50

Contribution margin
per unit:

70.50
\$34.50

71

## Chapter 3: Using Costs in Decision Making

Incremental profit:
Increase in contribution
margin from new sales
Decrease in contribution
margin from
cannibalization
Increase in fixed costs
Increase in profits if the
new model is introduced
(b)

\$34.50 120,000

\$4,140,000

(1,200,000)
(2,000,000)
\$940,000

3-51 (a)

## The number of miles driven is an important activity measure in estimating

the cost of driving. In comparing the cost of driving to work or taking
public transportation, Shannon may also want to consider the cost of
parking at work. The cost of parking may vary with the number of days at
work or may be a flat rate per month.

(b)

## Incremental costs of driving include gas, oil, maintenance, and tire

expenditures. Costs associated with driving also include toll costs and
parking fees.

(c)

## Fixed costs include taxes, depreciation of the vehicle, car registration,

license fees, and insurance.

(d)

For a two-week vacation by car, two likely activity measures are number
of miles driven and number of days (for lodging and meals).

3-52 (a)

## Costs that vary with number of passengers:

Meals and refreshments = \$5
Let X number of passengers needed to break even each week
Total revenue per week costs per passenger per week costs per flight
per week fixed costs per week = profit per week
(\$200 X 70) (\$5 X 70) (\$5,000 70) \$400,000 = \$0
\$13,650X = \$750,000
X \$750,000 \$13,650 = 54.95 (i.e., 55 passengers per flight)

72

(b)

## Let N number of flights to earn a profit of \$500,000 per week

Number of passengers per flight = 60% 150 = 90
(\$200 90 N) (\$5 90 N) (\$5,000 N) \$400,000 = \$500,000
N 71.71 (i.e., 72 flights)

(c)

Fuel costs are fixed once the flights are scheduled, but these costs vary
with the number of flights.

(d)

In this case, there is no opportunity cost to the airline because the seat
would otherwise go empty. The variable cost for the additional passenger
is \$5 for the meals and refreshments and perhaps a small amount of

3-53 (a)

## Johnson Co. breakeven point in number of rides =

(Fixed costs)/(Unit contribution margin) = \$300,000/\$6 = 50,000 rides
Smith Co. breakeven point in number of rides =
(Fixed costs)/(Unit contribution margin) =
\$1,500,000/\$15 = 100,000 rides

(b)

## Let x be the number of rides.

Johnson Co.s profit function is:
\$30x \$24x \$300,000 = \$6x \$300,000
Smith Co.s profit function is:
\$30x \$15x \$1,500,000 = \$15x \$1,500,000
Profit-Volume Chart
Profit

S
J
\$0
(\$300,000)
Loss
(\$1,500,000)

(c)

50,000

100,000 133,333

Number of rides

## We cannot say which firms cost structure is more profitable as profits

depend on sales volume. If sales drop to below 133,333 rides, Johnson
Companys cost structure leads to more profits. However, if sales remain
73

## Chapter 3: Using Costs in Decision Making

above 133,334 rides, then Smith Companys cost structure leads to more
profits.
(d)

3-54 (a)

The contribution margin generated must first cover the fixed costs and
then the balance remaining after the fixed costs are fully covered goes
toward profits. If the contribution margin is not sufficient to cover the
fixed costs, then a loss occurs for the period. Once the breakeven point
has been reached, profit will increase by the unit contribution margin for
each additional unit sold. Here, Smith Company is more risky because it
has higher fixed costs to cover and a higher unit contribution margin,
which makes its profits more sensitive to decreases in the sales activity
level.
Contribution margin per unit:
Selling price

\$250

## Less variable costs:

Variable production costs

\$100

20

## Contribution margin per unit

\$130

(b) Let X the sales volume at which the profit on sales is 10%
Profit = 250X 120 X 200,000 62,500
01
. 250 X
130 X 262,500 25 X
105 X 262,500
X 2,500 units.
(c)

(1)

## Single-shift operations 0 X 4,400 :

Selling price
Variable costs
Contribution margin per unit

\$200
120
\$80

Fixed costs =
\$200,000 + \$62,500 + \$17,500 = \$280,000
Breakeven point = \$280,000 \$80 = 3,500 units
note: 0 3,500 4,400
74

120

## Two-shift operations 4,400 X 8,800 :

(2)

Selling price
Variable costs
Contribution margin per unit

\$200
120
\$80

Fixed costs =
\$310,000 + \$62,500 + \$17,500 = \$390,000
Breakeven point = \$390,000 \$80 = 4,875 units

(d)

## Profit to sales ratio in September:

130 3, 000 262, 500
250 3, 000
390, 000 262, 500

750, 000
0.17

(1)

## Single-shift operations 0 X 4,400

200 X 120 X 280,000 017
. 200 X
80 X 280,000 34 X
46 X 280,000
X 6,087 units
(Not acceptable because X cannot be more than 4,400 units with
single-shift operations)

(2)

## Two-shift operations 4,400 X 8,800

200 X 120 X 390,000 017
. 200 X
80 X 390,000 34 X
46 X 390,000
X 8,478 units

75

## 3-55 Total labor cost

Total materials cost
Total variable manufacturing overhead
cost
Total lease payments
Total SG&A expenses
Total costs

\$114,800 *
153,600 **
41,280 ***
36,000
20,000
\$365,680

* Labor cost
Total labor hours required:
60 800 0.05
60 4
30 1, 600 0. 05
30 4

2,400
240
2,400
120
5,160

## Labor hours available

Overtime hours required
Regular wages (= \$20 4,000)
Overtime wages (= \$30 1,160)
Total labor cost

4,000
1,160
\$ 80,000
34,800
\$114,800

** Materials cost
\$1.60 60 800 = \$76,800
\$1.60 30 1,600 = 76,800

\$153,600

## *** Variable manufacturing overhead cost

\$8 5,160 labor hours
3-56 (a)

\$41,280

This is a special order where the company has sufficient excess capacity to
fill the order.
Incremental revenue 8,000 \$22
Incremental VC
8,000 (\$5 + 4+1)
Incremental CM
8,000 (\$22 10)

\$176,000
80,000
\$96,000

## Because fixed costs are unchanged, the \$96,000 incremental CM is the

increase in income if the company accepts the special order.

76

## Atkinson, Solutions Manual t/a Management Accounting, 6E

(b)

This is a special order where the company has insufficient excess capacity
to fill the order, and therefore faces an opportunity cost if it fills the order.
Incremental CM from (a)
Opportunity cost from lost sales*
Net increase in CM

## 8,000 (\$22 10)

5,000 (\$25 (5 + 4))

\$96,000
80,000
\$16,000

*The opportunity cost is the net benefit from the foregone CM on 5,000
boxes of regular sales.
Because fixed costs are unchanged, the \$16,000 net increase in CM is the
increase in income if the company accepts the special order.
3-57 (a)
(b)

## Variable costs per chip = \$720,000/1,600 = \$450 per chip

Profit = (\$500 \$450) 2,000 \$75,000 = \$25,000
Fixed costs per chip = \$75,000/2,000 = \$37.50 per chip
Variable cost per chip
Fixed cost per chip
Reported cost per unit

\$450.00
37.50
\$487.50

There is currently enough surplus capacity to produce the 200 units per
week for the new order. The estimated increase in the companys profit if
it accepts the order is (\$480 \$450) 200 = \$6,000 per week.
(c)

Because there is not enough surplus capacity to produce the 600 units per
week for the new order, the company faces an opportunity cost if it
accepts the order. The company has surplus capacity of 2,000 1600 =
400 chips per week. If the company accepts the order, it will have to give
up 200 chips per week of regular sales, at \$500 revenue per chip. The
company will gain (\$480 \$450) 600 = \$18,000 per week from the
special order, but that gain will be offset by lost contribution margin from
regular sales, (\$500 \$450) 200 = \$10,000, for a net gain of \$8,000 per
week.

77

## Chapter 3: Using Costs in Decision Making

3-58 (a)

Acquisition cost and depreciation expense for the existing elevator system
are irrelevant.

(b)

Relevant cost

Existing System

New System

Acquisition cost

\$875,000

(100,000)

\$900,000

## Salvage value after 6 years

(25,000)

48,000
(100,000)

\$875,000
\$723,000
The decision to replace the existing elevator system with the new one will
require net present value analysis that considers the time value of money.
Without considering the time value of money, the new system is less costly.
3-59

\$4.00

3.30

Number of units

\$0.70
50,000

\$35,000

## Genis Battery Company should accept the special order because it is

operating under capacity and this order can generate \$35,000 in additional
operating income.
(b)

Average unit costs can be misleading. Fixed costs are not relevant to this
decisionthe decision should be based on incremental costs.

(c)

## Other customers may also demand a reduced price. Therefore, their

reaction to the reduced price for the special order must also be taken into
account.

78

3-60 (a)

## Net cost saving over 4 years with new machine

Cash inflow:
Salvage value difference
Decrease in annual operating costs (4 years \$60,000)
Reduction in rework cost

\$ 2,000
240,000
10,000a

Cash outflow:
Acquisition of new machine (\$360,000 \$100,000)

(260,000)

## Net cash inflow (outflow):

(\$ 8,000)

0.05 (100,000 4) \$1
=
0.025 (100,000 4) \$1 =
Reduction in rework

\$20,000
\$10,000
\$10,000

Syd Young should not replace the old machine due to net cash outflow of
(\$8,000).
(b)

## The acquisition cost of the old machine is a sunk cost.

(c)

Other considerations:
1.

Will sales increase because of lower defects with the new machine

2.
What is the cost of capital used to discount future cash flows? In this
case, discounting will only make the new machine appear worse. (This topic
is covered in other courses.)
3-61 (a)

## Because the distinctive desserts are a source of competitive advantage,

Beau should carefully consider the quality, freshness, and distinctiveness
of the desserts from the outside providers, as well as the providers
reliability in delivering the desserts. Beau will want to consider the
possibility of price increases from an outside bakery. For the in-house
option, Beau may have concerns about his ability to hire a suitable
replacement pastry chef. If Beau hires a new pastry chef, the chef may be
more responsive than the outside bakers to Beaus customers tastes. Also,
there would be no concern about delivery to Beaus Bistro.

(b)

## This question is designed to generate discussion about the trade-offs

among the options. Although the second bid is lower-cost than the first, the
first bid promises continual developments of gourmet desserts; the second
bid promises only traditional desserts. In-house pastry production is the
highest-cost option. The ultimate decision should take into account not
only the costs of the different options, but also the issues in part (a) and
79

## Chapter 3: Using Costs in Decision Making

the anticipated effect on demand and revenue (for pastry and for Beaus
Bistro) under each option.
3-62 (a)

The costs and benefit shown below are relevant for the outsourcing
decision. All but the \$20,000 sale of office equipment are annual costs.
Costs
Labor
Rent
Phone
Office equipment
Outside call center

In-house
Outside
Call Center Call Center
\$650,000
60,000
35,000
42,000
(\$20,000)
700,000
\$787,000
\$680,000

(b)

Hollenberry must consider the outside call centers reliability and quality of
service in responding to Hollenberrys customers. Given Hollenberrys
worldwide operations, the greater number of multilingual operators available
at the outside call center could be an important feature. Finally, Hollenberry
must factor in the prospect of laying off employees, many of whom have
worked at Hollenberry for over 20 years.

(c)

If the outside call center can meet Hollenberrys expectations for reliability
and quality, including better service for international customers, financial
considerations point toward Hollenberry outsourcing the call center function.
However, although the outsourcing decision seems financially sound, there is
great potential for decreasing the remaining employees morale because of the
layoffs. This question is designed to generate discussion about trade-offs
among the companys stakeholders, including employees. One alternative to
firing Hollenberrys call center employees is reassigning the employees to
other jobs and relying on attrition to eventually reduce employee costs to
Hollenberrys desired level. However, this would increase the cost of the
outsourcing option and reduce its financial benefits.

80

3-63 (a)

## Impact of dropping JT484 on operating income:

Reduction in contribution margin

\$100,000

Cost savings:
Utilities
Supervision
Maintenance

(9,000)
(30,000)
(7,000)
(30,000)

\$24,000

## Therefore, JT484 should not be eliminated.

(b)

No, the decision to retain JT484 will only be reinforced by the sales

3-64 Some examples of articles that describe dropping unprofitable products appear
below. The article by Hymowitz provides interesting background for the article in
The Economist on Sonys unprofitable products. These articles describe the need
for a turnaround at Sony. The article in The Economist states, Almost every
product line is unprofitable. Important issues include strong competition,
vanity projects that lacked a market, and cost cutting through layoffs and
factory closings. The article by Ball lays a foundation for activity-based costing
through its discussion of high costs and unprofitable products due in part to
excessive proliferation of variations of products.
Hymowitz, C. More American Chiefs Are Taking Top Posts At Overseas
Concerns. The Wall Street Journal, October 17, 2005, page B1.
Game on: Sir Howard Stringer believes he is finally in a position to fix Sony.
The Economist, March 5, 2009. http://www.economist.com/node/13234173,
accessed December 12, 2010.
Ball, D. Crunch Time: After Buying Binge, Nestl Goes on a Diet; Departing
CEO Slashes Slow Sellers, Brands; No to Low-Carb Rolo. The Wall Street
Journal, July 23, 2007, page A1.
Wingfield, N. Amazon to Cut Product Offerings, Plans to Drop Unprofitable
Items. The Wall Street Journal, February 2, 2001, page B6.
Kardos, D. and M. Andrejczak. Earnings Digest -- Food: Heinz Net Rises as
Sales Offset Costs. The Wall Street Journal, November 30, 2007, page C11.
81

3-65 (a)

XLl
\$10.00

XL2
\$14.00

XL3
\$12.00

Direct materials

(4.00)

(4.50)

(5.00)

Direct labor

(2.00)

(3.00)

(2.50)

Sales price

(2.00)

(3.00)

(2.50)

\$2.00

\$3.50

\$2.00

0.20

0.35

0.25

\$10.00

\$10.00

\$8.00

## Contribution margin per machine hour

Products XLl and XL2 should be produced first because they have a
higher contribution margin per machine hour. Maximum production of
these two products requires 110,000 machine hours:
XL1: 200,000 units 0.20 machine hours 40,000 machine hours
XL2: 200,000 units 0.35 machine hours 70,000 machine hours
110,000 machine hours
Therefore, a balance of 10,000 120,000 110,000 machine hours are
available for XL3 production, which is sufficient for 40,000 units of XL3
(10,000 machine hours 0.25 machine hours).
Optimal Production Levels:
XL1: 200,000 units; XL2: 200,000 units, XL3: 40,000 units
(b)

Under the current capacity constraint, Excel Corporation cannot meet all
of XL3s demand. If additional capacity becomes available, it can produce
more units of XL3. To determine whether it is worthwhile operating
overtime, Excel needs to analyze the contribution margin of XL3 when
operating overtime.

82

XL3
\$12.00

Sales price
Direct materials

\$5.00

Direct labor

3.75*

2.50

11.25

\$0.75

## Because the unit contribution margin of XL3 using overtime is positive, it

is worthwhile operating overtime.
3-66 (a)

HCD2 requires \$100 \$20 = 5 direct labor hours per unit. The new order
requires 1,000 = 200 5 direct labor hours, so the existing capacity is adequate.
The contribution margin per unit of HCD2 for the new order = \$400 (75 + 100
+ 125) = \$100. The increase in profit is \$20,000 = 200 units \$100 contribution
margin.

(b)

HCD1
\$400

Sales price

HCD2
\$500

Variable cost:
Direct material
Direct labor
Contribution margin per unit
DLH per unit
Contribution margin per DLH

\$60

\$75

80

100

100

240 125

300

\$160

\$200

## \$40 per DLH \$40 per DLH

The new order requires a total of 1,500 5 300 DLH, but only
1,000 15,000 14,000 DLH are available. This will leave a capacity
shortage of 500 1,500 1,000 DLH. The contribution margin per DLH
is \$40 for each product, so the company can forego sales of either product
with the same effect. Therefore, the change in profit is

83

## Total contribution margin opportunity cost

= (300 units \$100 contribution margin per unit) (500 DLH \$40
contribution margin per DLH)
= \$30,000 \$20,000
= \$10,000 increase.
(c)

If the plant is worked overtime to manufacture HCD2 for the new order,
the contribution margin is negative \$12.50 as shown below:
Unit Variable Cost for Overtime
1 75
\$75.00

Material
Labora

1.5 100

150.00

1.5 125

187.50

## Total variable cost

\$412.50

Sales price

400.00

Contribution margin
a

\$(12.50)

## or 5 hours \$30 per hour

Change in Profit
200 100
100 (12.50)
Increase
3-67 (a)

During

\$20,000

Regular hours

(1,250)

Overtime hours

\$18,750

In order to produce 13,000 standard doors and 5,000 deluxe doors, the
following number of direct labor hours and machine hours are required:
Cutting:
Direct labor hours: 0.5 13,000 1 5,000 11,500 > 8,000 capacity
Machine hours: 2 13,000 3 5,000 41,000 > 40,000 capacity
Assembly:
Direct labor hours: 1 13,000 1.5 5,000 20,500 > 17,500 capacity
Machine hours: 2 13,000 3 5,000 41,000 > 40,000 capacity

84

## Atkinson, Solutions Manual t/a Management Accounting, 6E

Finishing:
Direct labor hours: 0.5 13,000 0.5 5,000 9,000 > 8,000 capacity
Machine hours: 1 13,000 1.5 5,000 20,500 > 15,000 capacity
The direct labor hour capacity in each department and the machine hour
capacity in each department are not adequate to meet the next months
demand.
(b)

## Linear programming can be used to solve this problem. The product

contribution margins needed for the objective function are:
Standard
\$150

Deluxe
\$200

110

155

\$40

\$45

## Sales price per unit

Let S denote the number of standard doors to produce and D denote the
number of deluxe doors to produce. The linear programming problem is:
Maximize \$40S + \$45D
Subject to the following constraints:
Cutting:
Direct labor hours: 0.5S D 8,000
Machine hours: 2S 3D 40,000
Assembly:
Direct labor hours: S 1.5D 17,500
Machine hours: 2S 3D 40,000
Finishing:
Direct labor hours: 0.5S 0.5D 8,000
Machine hours: S 1.5D 15,000
Maximum demand:
S 13,000
D 5,000
Nonnegativity:
S > 0, D > 0
85

## Using the Solver function in Excel to solve the linear programming

problem, the optimal solution is to produce 13,000 standard doors and
1,333 (rounded down) deluxe doors. Though not required, the contribution
margin with this solution is \$579,985.
(c)

The contribution margin for standard doors remains the same, but the
contribution margin for deluxe doors is now \$50:
Deluxe
Sales price per unit
\$200
Variable cost per unit (\$80 + \$56 + \$14)

150

\$50

## The linear programming problem is now:

Maximize \$40S + \$50D
Subject to the following constraints:
Cutting:
Direct labor hours: 0.5S 0.8D 8,000
Machine hours: 2S 3D 40,000
Assembly:
Direct labor hours: S 1.5D 17,500
Machine hours: 2S 3D 40,000
Finishing:
Direct labor hours: 0.5S 0.5D 8,000
Machine hours: S 1.2D 15,000
Maximum demand:
S 13,000
D 5,000
Nonnegativity:
S > 0, D > 0
Using the Solver function in Excel to solve the linear programming
problem, the optimal solution is to produce 12,000 standard doors and
2,500 deluxe doors. Though not required, the contribution margin with this
solution is \$605,000, as compared to \$579,985 in part (b). The slight
86

## increase in efficiency with respect to deluxe door production has increased

the number of deluxe doors in the optimal product mix and increased the
total contribution margin.
(d)

3-68 (a)

1.

2.

## To maximize monthly commissions while working 160 hours per month,

Spencer should devote the maximum allowable time (90 hours) to
customer group B because that group provides the largest average
commission per hour of Spencers time. Spencer should next allocate the
maximum of 60 hours to customer group A because that group provides
the next largest average commission per hour. Finally, Spencer should
devote the remaining 10 hours of his 160 hours to group C.
Customer Group
A
B
C
Average monthly sales
per customer
Commission

6%

5%

4%

\$54

\$30

\$8

1.5

0.5

\$18

\$20

\$16

Current hours

60

90

60

60

90

## 10 Total: 160 hours

(40 hours per week)

Average commission
Hours per customer per
monthly visit
Average commission
per hour

(b)

## Spencer should also consider the probable future increased profitability

from customers in group C, as well as likely future profitability of
customers in the other groups.

87

## Chapter 3: Using Costs in Decision Making

CASES
3-69 Wage rate = \$3,600 150 hours = \$24/hour.
Neighboring laboratory charges \$80 2 hours = \$40/hour, which also equals
\$100 2.5 and \$160 4.
(a)

Simple
Routine
800
600
750

Month
June
July
August
Workers
Hired
20
21
22
23
24
25
26
27

Simple
Nonroutine Complex
250
450
200
400
225
450

Total
Hours
4,025.0
3,300.0
3,862.5

Equivalent
Workers
26.83
22.00
25.75

In-house
Hours Short
Outside Outside
Total
Wages* June July August Hours Charges
Cost
\$216,000 1,025 300 862.5 2,187.5 \$87,500 \$303,500
226,800
875 150 712.5 1,737.5
69,500 296,300
237,600
725
0 562.5 1,287.5
51,500 289,100
248,400
575
0 412.5
987.5
39,500 287,900
259,200
425
0 262.5
687.5
27,500 286,700
270,000
275
0 112.5
387.5
15,500 285,500
280,800
125
0
0.0
125.0
5,000 285,800
291,600
0
0
0.0
0.0
0 291,600

*\$3,600 per month 3 months = \$10,800 for one worker for a quarter.

## In-house wages equal \$10,800 times the number of workers hired.

Dr. Barker should employ 25 workers at a total cost of \$285,500.
(b)

Outside charges will exceed the monthly wages of an additional worker hired by
Barrington if the number of outside hours exceeds \$3,600 \$40 = 90.
Therefore, Barrington should hire an additional employee when the
outside services are expected to exceed 90 hours in any month, which
corresponds to 90 150 = 0.6 equivalent workers.
Month
June
July
August

Simple
Routine
800
600
750

Simple
Nonroutine Complex
250
450
200
400
225
450

Total
Hours
4,025.0
3,300.0
3,862.5

Equivalent
Workers
26.83
22.00
25.75

August.
88

## Atkinson, Solutions Manual t/a Management Accounting, 6E

Month
June
July
August
Total cost

Workers
Hired
27
22
26

Fixed
Outside
Cost
Hours
\$97,200
0
79,200
0
93,600
0

Outside
Charges
0
0
0

Total
Cost
\$97,200
79,200
93,600
\$270,000

3-70 (Numbers in square brackets below refer to reference numbers that appear at the
end of the solution for this case.)
(a)

## An organizations value proposition defines what the organization tries to

deliver to its customers. As described in Chapter 2, the value proposition
is the unique mix of product performance, price, quality, availability, ease
of purchase, service, relationship, and image that a company offers its
targeted group of customers. The value proposition represents the
advantage of a companys strategy; it should communicate what it
intends to deliver to its customers better or differently from competitors.
Nordstrom is an upscale retailer, often included among lists of luxury
retailers. Nordstroms value proposition can be described as quality,
value, selection, and service
December 3, 2002) or superior service and high quality, distinctive
merchandise
April 7, 2003). Nordstroms sales force is legendary for its customer
service. As mentioned below in part (c), sales staff kept handwritten notes
about customers sizes and designer preferences, as well as special
occasions, in loose-leaf binders [2]. Sales staff would then match the
information with new merchandise arrivals and store promotions.
Saks Fifth Avenue is a luxury retailer that can be described much like
Neiman-Marcus is described in Chapter 2. Both stores target fashionconscious customers with high disposable incomes who are willing to pay
more for high-end merchandise. Fred Wilson, former Saks Fifth Avenue
divisional CEO, viewed Neiman Marcus as Saks closest competitor [4].
Saks Fifth Avenue offers a wide assortment of distinctive luxury fashion
apparel, shoes, accessories, jewelry, cosmetics and gifts (10-K Report,
Saks Fifth Avenue, Fiscal year ending February 3, 2000). Saks Fifth
Avenues web site states: Saks Fifth Avenue today is renowned for its
89

## superlative selling services and merchandise offerings. The best of

European and American designers for men and women are sold throughout
its 47 stores servicing customers in 23 states.
bmUID=iSXpdBi).
(b)

## Nordstrom centralized purchasing in an attempt to leverage its buying

power. Previously, Nordstroms buying transpired through more than 12
offices [6]. Nordstrom negotiated with suppliers to reduce markups on
merchandise [7]. These measures should reduce Nordstroms costs
without adversely affecting the companys ability to fulfill its value
proposition.
Nordstrom also laid off 2,500 employees between September 1 and
October 19, 2001. Mindful of the importance of its sales staff,
Nordstroms layoffs focused on back-office employees [7]. Retaining
most of the sales staff would help Nordstrom continue to fulfill its value
proposition. Nevertheless, a retail analyst noted that Nordstrom needed to
dramatically cut costs, pointing out that Nordstroms annual selling,
general, and administrative expenses of approximately \$100 per square
foot overshadowed the \$60 industry average [2].

(c)

## Nordstrom invested in computerized inventory-tracking systems [5, 6]. The

previous system relied partly on sales staffs handwritten notes in looseleaf binders [2]. In addition to inventory management, new technology
was introduced to improve customer service:
Nordstroms salespeople are getting ready to throw out their
little black books. Instead of filling pages with handscrawled
notes about customers sizes and designer preferences, 20,000
sales clerks at the Seattle chains 137 stores soon will be using
new software and mobile devices to track their customers
tastes and match them to new merchandise arrivals and store
promotions.
For Nordstrom, what makes sense is getting customer
information to retail sales personnel in real time, whether those
customers are conducting business on the Web, in the store or
over the telephone [3].

90

## Atkinson, Solutions Manual t/a Management Accounting, 6E

Sales staff could also contact customers as soon as a desired item arrived
in the store and better serve repeat customers with readily available
information on sizes and preferences [3].
Nordstroms 2001 Annual Report (p. 4) reports that implementation of the
perpetual inventory system is going very well, with the expectation that
the system will help buyers improve decision-making, manage inventory,
and respond quickly to trends. The 2001 Annual Report covers the fiscal
year from February 2001 to January 2002.
(d)

## Nordstroms efforts affected the classic cost-volume-profit elements of

sales prices, product costs, product mix, and selling, general, and
administrative expenses. The objective was to increase net income. In an
effort to move excess inventory, Nordstrom ran a clearance sale, unusual
for the company [7]. Nordstrom also altered its product mix by expanding
its offerings of lower-priced merchandise. Nordstroms efforts to decrease
selling, general, and administrative expenses are described in part (b). Net
sales increased about 7% in 2000 (comparing fiscal years ending January
2000 and January 2001) due to new store openings; comparable store
sales were flat (Nordstrom 2001 Annual Report, p. 9). Operating income
decreased 50% and gross profit as a percent of sales decreased.
In 2001 (comparing fiscal years ending January 2001 and January 2002),
net sales increased about 2% due to new store openings; comparable store
sales decreased during the year. Operating income increased 10% after
declining 50% the year before. The following year, net sales increased 6%
and operating income increased 30%. Gross profit as a percent of sales
decreased in 2001 and increased in 2002
April 7, 2003).

(e)

## Reinvent Yourself was an advertising campaign that began in February

2000 (see [5] for details). The advertising campaign was Nordstroms first
national television advertising campaign and targeted younger shoppers
than its traditional clientele, concurrent with Nordstroms push to appeal
to a younger clientele with flashing lights and funky clothes [1] and
store columns painted orange for a more youthful look [7]. The ads did not
emphasize Nordstroms customer service. Instead, Nordstrom planned to
impress customers with its service once they had ventured into the store
[5].

91

## Chapter 3: Using Costs in Decision Making

The campaign was less than successful; the company announced that it
had overreached. Nordstrom had alienated its faithful clientele [7] by
trying to appeal to younger shoppers. That is, there was an opportunity
cost to targeting younger shoppers. Some financial results appear in part
(d).
Nordstrom may need to reconsider its value proposition. Reference [2]
..the retail world has changed since Nordstroms heyday. With
the rise of such speciality retailers as Talbots, The Limited, and
Ann Taylor, competition is ferocious. And its old winning
formulagreat customer serviceisnt the easy advantage it
once was. Neiman Marcus Group Inc is now No. 1 in service
among department-store chains. It generates annual sales of
\$490 per square foot, handily eclipsing second-place Nordstrom
at \$342. And Talbots Inc also took a page from Nordstroms
playbook. The Hingham (Mass.) chain improved its service and
stuck to classic merchandise. The result: It ended last year as
one of the best-performing retailers in the nation, with samestore sales jumping 17%.
The same article points out that in response to growing customer
focus on value, Nordstrom needs excellence in inventory
management and control of expenses in addition to its recognized
excellence in the art of retailing.
Saks Fifth Avenues Wild About Cashmere campaign offered a
wide range of products in cashmere and was designed to appeal to
young, fashion-hungry customers. The campaign not only alienated
loyal 45-54 year-old customers with edgy, midriff-baring fashion,
but also confused customers who did realize the connection
between cashmere and the goat mannekins in the store, or why there
were audios of goats bleating [4]. Like Nordstrom, Saks appears to
have suffered some opportunity cost from this effort to expand its
customer base.
References
[1]

## Anonymous. 2001. Nordstrom Inc. To Be As Much as 50% Below Expectations.

The Wall Street Journal (January 8), B8.
92

## Atkinson, Solutions Manual t/a Management Accounting, 6E

[2]

Anonymous. 2001. Can Nordstroms Find The Right Style? Business Week (July
30), 5962.

[3]
[4]

Bednarz, A. 2002. The Customer Is King. Network World (December 2), 6566.
Byron, E. 2006. Struggling Saks Tries Alternations In Management. Wall Street
Journal (January 10), B1.

[5]

## Cuneo, A. Z. 2000. Nordstrom Breaks with Traditional Media Plan. Advertising

Age (February 14), 4, 71.

[6]

Lee, L. 2000. Nordstrom Cleans Out Its Closets. Business Week (May 22), 105.

[7]

## Merrick, A. 2001. Nordstrom Accelerates Plans to Straighten Out Business:

Upscale Retailer Offers Lower-priced Goods, Lays Off Staff and Holds
Clearance Sale. Wall Street Journal (October 19), B4.

Nordstrom previously provided the following list of references at its web site
"With a New location in Dadeland Mall, Nordstrom Seeks to Become a Florida
Institution," The Miami Herald, November 12, 2004
"Author of Books on Nordstrom Culture to Address Virginia Trade Show," Richmond
Times-Dispatch, September 23, 2004
"Nordstrom Regains Its Luster - Challenge Awaits as Rivals Encroach on Image of
Affordable Luxury," The Wall Street Journal, August 19, 2004
"Shoppers put Heart, Soles Into Yearly Nordstrom Sale," The Seattle Times, July 17,
2004
"Q&A with Blake Nordstrom - 4th Generation Leads Growth of Nordstrom," The
Charlotte Observer, March 12, 2004
"Nordstrom 'Cachet' Hits Wellington Friday," Palm Beach Post, November 10, 2003
"Back in the Family; Fourth Generation Takes Control After a Brief Change in
Company Leadership," Seattle Post-Intelligencer, June 27, 2001
"A Time of Change; Company Makes Huge Leaps with Expansion, Public Stock
Offering," Seattle Post-Intelligencer, June 26, 2001
"Still in Style; From Small Shoe Store, to Upscale Retailer, Company has Kept
Founder's Values," Seattle Post-Intelligencer, June 25, 2001

93

## Chapter 3: Using Costs in Decision Making

"Success Came a Step at a Time; Company Rose From Small Seattle Shoe Store to
Retail Giant with National Appeal," Seattle Times, May 29, 2001
Books:
The Nordstrom Way by Robert Spector and Patrick D. McCarthy
Fabled Service: Ordinary Acts, Extraordinary Outcomes by Bonnie Jameson and Betsy
Sanders
3-71 (a)

Unit cost

AA100

AA101

AA102

\$560

\$400

\$470

680

680

Direct labor

60

30

60

60

30

60

\$680

\$1,140

\$1,270

20

30

30

\$700

\$1,170

\$1,300

940

1,500

1,700

\$240

\$330

\$400

4 hrs

6 hrs

8 hrs

\$60

\$55

\$50

frag.

## Variable selling cost

Total variable cost
Sales price

## Contribution margin per hour

(b)

AA100 has a higher contribution margin per hour than AA101 and A102.
Aramis should produce AA100 up to 600 tons. Since the production of
600 tons of AA100 requires 2,400 = 600 4 hours, which equals available
capacity, no other products will be manufactured. Therefore, the optimal
production levels are: AA100: 600 tons; AA101: 0 tons; and AA102: 0
tons.

(c)

Opportunity cost is \$60 per hour (the contribution margin per hour for
AA100 production that must be sacrificed) and each ton of AA101
requires 6 hours.

94

## Required contribution margin per ton (= \$60 6)

Variable cost per ton
Required minimum sales price per ton
(d)

\$360
1,170
\$1,530

## It is worthwhile operating the plant overtime. The optimal production level

is AA100: 600 tons; AA101: 100 tons; and AA102: 0 tons.
Explanation: The regular capacity of 2,400 hours (before operating the
plant overtime) is used to produce 600 tons of AA100. How should 600
hours of overtime be used? We know that the demand for AA100 has been
filled fully. Therefore, we consider AA101 and AA102. AA101 has a
higher contribution margin per hour than A102. With 600 hours of
overtime, the company can produce 100 tons of A101 (600 hours 6
hours per ton), which is less than the maximum demand. This leaves no
hours for A102.
Under overtime:

AA100
\$560

AA101
\$400

AA102
\$470

740

740

Direct labor

90

45

90

90

45

90

\$740

\$1,230

\$1,390

20

30

30

\$760

\$1,260

\$1,420

940

1,500

1,700

\$180

\$240

\$280

\$45

\$40

\$35

## Variable selling cost

Total variable cost
Sales price
Contribution margin per ton
Hours per ton
Contribution margin per hour

Since contribution margins per hour for AA101 and AA102 are positive, it
is worthwhile operating the plant overtime.

95

## 3-72 TEACHING NOTE: A VOTRE SANT

The A Votre Sant (AVS) case is multi-faceted in that it requires students to
incorporate operational measures into product costing results, and also to
understand cost accounting from a variety of perspectives, such as:
Product versus period costs
Variable versus fixed costs
Activity based costing
Relevant costs and opportunity costs
1

Additionally, the case questions require both quantitative and qualitative analyses
of the business issues faced by AVS. AVS has been used in a graduate-level
managerial accounting class for MBAs, and would be most appropriate for an
The detail in the case is rich enough to support a variety of analyses. Alternative
uses could be to have the student construct a cost of goods manufactured
statement or a traditional financial statement, both of which reinforce the
differences between product and period costs. Additionally, alternative decision
analysis questions could be developed using the variable and fixed cost
structures described in the case. Case question number two is only one example
of a potential decision analysis question.
(a) Contribution Margin Income Statement
To develop the contribution margin income statement, you first have to
calculate the number of bottles of wine produced by AVS. This number is
dependent upon the yield from the grapes. The relevant calculations are as
follows:
Yield:
Pounds harvested
Loss in processing
Yield:

Chardonnay
Grapes
100,000
10,000 10%
90,000

Generic
Grapes
60,000
3,000 5%
57,000

96

## Bottles of wine produced:

Chardonnay
Estate
Regular

Blanc de
Blanc
Total

Pounds of grapes:
Chardonnay grapes
Generic grapes
Total pounds of grapes

72,000
0
72,000

18,000
9,000
27,000

0
48,000
48,000

90,000
57,000
147,000

Bottles (3 lb./bottle)

24,000

9,000

16,000

49,000

## The contribution margin income statement (Teaching Note Exhibit 1) is fairly

straightforward, with the following concepts or calculations causing the most
difficulty:
The inclusion of liquor taxes and sales commissions in variable costs:
These are both period expenses, but are clearly based upon the number of
bottles sold, and therefore are included in the variable costs.
Where to include the wine master expense: Since the wine master is paid
according to number of blends, not number of bottles, this expense is
listed as a fixed cost. Arguably, it could be listed as a variable cost, given
that the cost will be based on the number of wines produced. As part of
the discussion we will examine the rationale behind listing wine master as
a fixed or a variable expense.
Barrel expense: The case states that the barrels produce the equivalent of
40 cases of wine. A case of wine is post-fermentation/bottling and
therefore after the 10% loss has occurred. The barrels contain the wine at
the start of the process. Therefore, there have to be enough barrels to hold
all the wine at the beginning of the process, not at the end. This factor
results in 63 (62.5) barrels being required for the harvest2.

Each case of wine requires 36 pounds of grapes (post-fermenting). A barrel holds the
equivalent of 40 cases of wine (post-fermenting), or 1,440 pounds of grapes (40 36). To
convert the post-fermenting grapes to pre-fermenting grapes, they must be divided by 0.9, or
1,440/0.9 equals 1,600 pounds of grapes. The harvest of 100,000 pounds of grapes therefore
requires 62.5 barrels for storage (100,000/1,600).
97
2

## Teaching Note Exhibit 1: Contribution Margin Income Statement

Number
Sales
Price of Bottles
Chardonnay - Estate
\$ 22
24,000 \$528,000
Chardonnay (non-Estate)
\$ 16
9,000 \$144,000
Blanc de Blanc
\$ 11
16,000 \$176,000
Total Revenues
49,000 \$848,000
Variable Costs
Grapes
\$124,000
Bottle, labels, corks
122,500
Harvest labor
14,500
Crush labor
2,400
Indirect materials
6,329
Liquor taxes
147,000
Sales distribution
98,000
Barrels
4,725
Total Variable Costs
\$519,454 61.3%
Contribution Margin
\$328,546 38.7%
Fixed Costs
Admin. rent and office
\$ 20,000
Depreciation
8,100
Lab expenses
8,000
Production office
12,000
Sales
30,000
Supervisor
55,000
Utilities
5,500
Waste treatment
2,000
Wine master
15,000
75,000
Total Fixed Costs
\$230,600
Operating Margin
\$ 97,946 11.6%

Average revenue
per bottle
\$ 17.31

of sales
of sales

of sales
\$ 2.00
per bottle

98

## (b) Additional Purchase Opportunity, Quantitative Analysis

Part b asks, What is the maximum amount that AVS would pay to buy an
additional pound of Chardonnay grapes? There are three parts to
calculating this answer: the benefit from the additional Chardonnay wine
to be sold, the relevant costs related to producing this wine and the
opportunity cost of not producing as much Blanc de Blanc wine.
Teaching Note: Exhibit 2 displays the calculations relevant to this
decision. Chardonnay regular wine requires a 2 to 1 mixture of
Chardonnay and generic white grapes. Therefore, the 18,000 pounds of
Chardonnay grapes will be combined with 9,000 pounds of generic white
grapes. The 27,000 pounds of grapes will result in an additional 9,000
bottles of new Chardonnay regular wine being produced. However, it will
also result in a 3,000-bottle decrease in the amount of Blanc de Blanc
wine produced, since some generic grapes will now be used for the
Chardonnay-regular wine. Recall that only Chardonnay wine is processed
in barrels.
Teaching Note Exhibit 2: Decision Analysis, Additional Grape Purchase

Yield:
Pounds
Loss in processing
Yield:
Bottles of wine:

Chardonnay
Grapes
20,000
2,000
18,000
9,000

## Additional Chardonnay Product Line

Sales Revenue
\$ 126,000
Costs
Generic grapes
\$
6,079
Bottle, labels, corks
22,500
Indirect materials
1,163
Liquor taxes
27,000
Sales distribution
18,000
Barrels
975
Wine master
5,000
99

10%

## 2 lbs. of Chardonnay grapes per bottle

(along with 1 lb. of generic grapes)

## 9,000 bottles \$14/bottle

9,000 pounds \$0.6754/pound
# bottles \$2.50
# bottles \$1.55/12
\$3/bottle
\$2/bottle
13 barrels \$300/4 years

Total costs

80,717

45,283

## Lost Sales of Blanc de Blanc Wine

Sales Revenue
Costs
Generic grapes
Bottle, labels, corks
Indirect materials
Liquor taxes
Sales distribution
Total costs

\$ 33,000

\$ 6,079
7,500
388
9,000
6,000

## 9,000 pounds \$0.6754/pound

# bottles \$2.50
# bottles \$1.55/12
\$3/bottle
\$2/bottle

\$ 28,967

\$ 4,033

Net Impact

\$ 41,250

\$ 18,900

\$ 22,350

Pounds of Grapes

20,000

15%

\$ 1.1175

## (c) Additional Purchase Opportunity, Qualitative Analysis

The following factors would support AVSs decision to purchase the
Potential increase in market share
Diversification of suppliers
Ability to leverage fixed costs over more production
If quality of purchased grapes is perceived to be better
To block a competitor from buying the grapes
Ability to focus time and effort on wine making (rather than harvesting
and crushing)
Creates an incentive for the current grower to control costs
100

## Atkinson, Solutions Manual t/a Management Accounting, 6E

The following factors would support AVSs decision to reject the grape purchase:
Poor quality of the grapes
An additional AVS Chardonnay wine creates confusion in the
marketplace
Lack of control over the harvest and crush process
Lack of confidence in the additional sales forecast
Inability of the current capacity (e.g. bottling line, space) to support
Inability to use the additional barrels purchased in future years
Cannibalization of the current Chardonnay, Chardonnay-Estate or
Blanc de Blanc sales
Reliability concerns with the new supplier
Other hidden costs
Summary
The AVS case is based upon actual wine industry data, although the data has
been simplified to reinforce the teaching points and concepts. It is also true to the
wine making process, with the exception of AVSs process of making the
Chardonnay regular wine from the fermented Chardonnay and Blanc de Blanc
wines. This can be done, but most commonly the juice from the wine grapes is
combined at the start of the fermenting process, so that they can ferment
together. Because of the different yield rates in the fermenting process, the case
had the wines ferment separately and blend at the end.
Note: The full case, which includes activity-based cost analysis, can be taught in
a 75-minute class, or by omitting the decision analysis question 50 minutes
would be sufficient. The case author has also used it to teach the differences
between the financial income statement reporting (product and period costs) and
the contribution margin income statement reporting (variable and fixed costs),
and then assigned decision analysis and/or the ABC costing as an additional
assignment.

101