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CHAPTER 7

Incremental Analysis
ASSIGNMENT CLASSIFICATION TABLE
Learning Objectives

Questions

Brief
Exercises

Do It!

Exercises

A
Problems

B
Problems

1.

Identify the steps in


managements decisionmaking process.

1, 2

2.

Describe the concept of


incremental analysis.

3, 4

1, 17

3.

Identify the relevant


costs in accepting an
order at a special price.

2, 3, 4, 18

1A

1B

4.

Identify the relevant


costs in a make-or-buy
decision.

6, 7

5, 6, 7,
8, 18

2A

2B

5.

Identify the relevant costs


in determining whether to
sell or process materials
further.

8, 9, 10

5, 6

9, 10, 11,
12, 18

3A

3B

6.

Identify the relevant costs


to be considered in
repairing, retaining or
replacing equipment.

11

13, 14, 18

4A

4B

7.

Identify the relevant costs


in deciding whether to
eliminate an unprofitable
segment.

12

15, 16,
17, 18

5A

5B

ASSIGNMENT CHARACTERISTICS TABLE


Problem
Number

Description

Difficulty
Level

Time
Allotted (min.)

Simple

2030

1A

Use incremental analysis for special order and identify


nonfinancial factors in the decision.

2A

Use incremental analysis related to make or buy,


consider opportunity cost, and identify nonfinancial
factors.

Moderate

3040

3A

Determine if product should be sold or processed further.

Moderate

3040

4A

Compute gain or loss, and determine if equipment should


be replaced.

Moderate

3040

Prepare incremental analysis concerning elimination of


divisions.

Moderate

3040

Use incremental analysis for special order and identify


nonfinancial factors in the decision.

Simple

2030

Use incremental analysis related to make or buy,


consider opportunity cost, and identify nonfinancial
factors.

Moderate

3040

3B

Determine if product should be sold or processed further.

Moderate

3040

4B

Compute gain or loss, and determine if equipment should


be replaced.

Moderate

3040

Prepare incremental analysis concerning elimination of


divisions.

Moderate

2030

5A

1B

2B

5B

Correlation Chart between Blooms Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems
Learning Objective

Knowledge Comprehension

1.

Identify the steps in managements BE7-1


decision-making process.

Q7-1
Q7-2

E7-1

2.

Describe the concept of


incremental analysis.

Q7-3
Q7-4

E7-1

3.

Identify the relevant costs in


accepting an order at a special
price.

4.

Identify the relevant costs in a


make-or-buy decision.

5.

Identify the relevant costs in


determining whether to sell or
process materials further.

6.

Identify the relevant costs to be


considered in repairing, retaining
or replacing equipment.

7.

Identify the relevant costs in


deciding whether to eliminate
an unprofitable segment.

Broadening Your Perspective

Application

Analysis

Synthesis

Evaluation

BE7-2

E7-17

Q7-5

BE7-3 DI71

E7-2
E7-3
E7-4

E7-18
P7-1A
P7-1B

Q7-6
Q7-7

BE7-4
DI7-2

E7-5
E7-6
E7-7
E7-8

E7-18
P7-2A
P7-2B

BE7-5
BE7-6
DI7-3

E7-9
E7-10
E7-11
E7-12

E7-18
P7-3A
P7-3B

Q7-11

BE7-7

E7-13
E7-14
E7-18

P7-4A
P7-4B

Q7-12

BE7-8 DI74

E7-15
E7-16
E7-17

E7-18
P7-5A
P7-5B

Q7-8
Q7-9
Q7-10

BYP7-1
BYP7-4
BYP7-5

BYP7-2

BYP7-8
BYP7-9

BYP7-3
BYP7-6
BYP7-7

B
L
O
O
M
S
T
A
X
O
N
O
M
Y

ANSWERS TO QUESTIONS
1.

The
(1)
(2)
(3)
(4)

following steps are frequently involved in managements decision-making process:


Identify the problem and assign responsibility.
Determine and evaluate possible courses of action.
Make a decision.
Review results of the decision.

2.

My roommate is incorrect. Accounting contributes to the decision-making process at Steps 2 and 4.


Prior to the decision, accounting provides relevant revenue and cost data for each course of action.
Following the decision, internal reports are prepared to show the actual impact of the decision.

3.

Disagree. Incremental analysis involves the identification of financial data that change under
alternative courses of action.

4.

In incremental analysis, the important point to consider is whether costs will differ (change)
between the two alternatives. As a result, sometimes (1) variable costs do not change under the
alternative courses of action and (2) fixed costs do change.

5.

The relevant data in deciding whether to accept an order at a special price are the incremental
revenues to be obtained compared to the incremental costs of filling the special order.

6.

The manufacturing costs that are relevant in the make-or-buy decision are those that will change
if the parts are purchased.

7.

Opportunity cost may be defined as the potential benefit that may be obtained by following an
alternative course of action. Opportunity cost is relevant in a make-or-buy decision when the
facilities used to make the part can be used to generate additional income.

8.

The decision rule in a decision to sell a product or to process it further is: Process further as
long as the incremental revenue from the additional processing exceeds the incremental
processing costs.

9.

Joint products are products that are produced from a single raw material and a common
production process. An accounting issue related to joint products is how to allocate the joint costs
incurred during the production process that creates the joint products.

10. Joint costs are irrelevant to a sell-or-process-further decision because they are sunk costs and
will not change whether the decision is to sell the existing product or process it further. Therefore,
joint costs are ignored in this decision.
11. A sunk cost is a cost that cannot be changed by any present or future decision. Sunk costs, such
as the book value of an old piece of equipment, therefore, are not relevant in a decision to retain
or replace equipment.
12. Net income will be lower if an unprofitable product line is eliminated when the product line is
producing a positive contribution margin and its fixed costs cannot be avoided or reduced.

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

Revenues
Costs
Net
income

Alternative
A
$160,000
100,000
$ 60,000

Alternative
B
$180,000
125,000
$ 55,000

Net Income
Increase
(Decrease)
$ 20,000
(25,000)
($ 5,000)

Alternative A is better than Alternative B.

BRIEF EXERCISE 7-3

Revenues
CostsVariable manufacturing
Shipping
Net income

Reject
Order
$0
0
0
$0

The special order should be accepted.

Accept
Order
$75,000*
60,000**
6,000***
$ 9,000

Net Income
Increase
(Decrease)
$ 75,000
(60,000)
(6,000)
$ 9,000

*3,000 X $25
**3,000 X $20
***3,000 X $ 2

BRIEF EXERCISE 7-4

Variable manufacturing costs


Fixed manufacturing costs
Purchase price
Total annual cost

Make

Buy

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

$ 0
30,000
60,000
$90,000

Net
Income
Increase
(Decrease)
$ 50,000
0
(60,000)
$(10,000)

The decision should be to make the part.


BRIEF EXERCISE 7-5

Sales price per


unit Cost per unit
Variable
Fixed
Total
Net income per unit

Sell

Process
Further

Net Income
Increase (Decrease)

$62.00

$70.00

$8.00

36.00
10.00
46.00
$16.00

43.00
10.00
53.00
$17.00

(7.00)
0
(7.00)
$1.00

The bookcases should be processed further because the incremental


revenues exceed incremental costs by $1.00 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 $50,000 ($150,000 $100,000) and only incur incremental costs of
$45,000. Therefore, the company should process AB1 further and sell AB2.
If XY1 is processed further, the company will earn incremental revenue of
$35,000 ($130,000 $95,000) but will incur incremental costs of $50,000.
Therefore, the company should sell XY1 rather than process it further.
BRIEF EXERCISE 7-7
Variable
for 4
manufactu
years
ring costs

New machine
cost Sell old
machine
Total

Retain
Equipment

Replace
Equipment

Net 4-Year
Income
Increase
(Decrease)

$3,000,000

$2,500,000
300,000
(30,000)
$2,770,000

$ 500,000
(300,000)
30,000
$ 230,000

$3,000,000
The old factory machine should be replaced.
BRIEF EXERCISE 7-8

Sales
Variable costs
Contribution margin
Fixed costs
Net income

Continue

Eliminate

$200,000
180,000
20,000
30,000
$ (10,000)

Net Income
Increase (Decrease)

0
0
0
20,000
$(20,000)

$(200,000)
180,000
(20,000)
10,000
$ (10,000)

The Big Bart product line should be continued because $20,000 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! 71
Reject
Revenues
Costs
Net income

$ 0
$ 0
$ 0

*(6,000 X $20) + (6,000 X $3)

Accept
$180,000
138,000*
$ 42,000

Net Income
Increase (Decrease)
$180,000
(138,000)
$ 42,000

Given the results of the above analysis, Maize Company should accept the
special order.

DO IT! 7-2
Net Income
Increase (Decrease)

(a)
Make
Direct materials
Direct labor
Variable manufacturing
costs
Fixed manufacturing
costs
Purchase price
Total cost

Buy

$ 30,000
42,000

45,000
60,000
0
$177,000

0
0

$ 30,000
42,000

45,000

45,000
162,000
$207,000

15,000
(162,000)
$ (30,000)

Given the results of the above analysis, Rubble Company will incur
$30,000 of additional costs if it buys the switches.
(b)
Make

Total cost
Opportunity cost
Total cost

$177,000
34,000
$211,000

Buy

Net Income
Increase (Decrease)

$207,000
0
$207,000 $ 4,000

$(30,000)
34,000

Yes, the answer is different: The analysis shows that net income will
be increased by $4,000 if Rubble Company purchases the switches.
DO IT! 7-3
Sell

Process
Further

Net Income
Increase (Decrease)

Sales per
unit Cost per
unit
Variable
Fixed
Total

$75

$100

$25

$40
10
$50

$ 57
13
$ 70

($17)
(3)
($20)

Net income per unit

$25

$ 30

$ 5

The tables should be processed further and Mesa Verde should finish the
tables because the incremental revenues exceed incremental costs by
$5 per unit.

DO IT! 7-4

Sales
Variable costs
Contribution margin
Fixed costs
Net income

Continue
$500,000
370,000
130,000
150,000
$ (20,000)

Eliminate
$
0
0
0
38,000
$(38,000)

Net Income
Increase (Decrease)
$(500,000)
370,000
(130,000)
112,000
$ (18,000)

The analysis indicates that Gator should not eliminate the gloves and mittens
line because net income would decrease $18,000.

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 ($4.80)
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
$24,000
(2,500)
(7,500)
(5,000)
(6,000)
0
$ 3,000

Net Income
Increase
(Decrease)
$24,000
(2,500)
(7,500)
(5,000)
(6,000)
0
$ 3,000

(b) As shown in the incremental analysis, Gruden should accept the special
order because incremental revenue exceeds incremental expenses by
$3,000.
(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, Gruden would
have to consider the lost sales in making the decision. Second, if Gruden
is operating at full capacity, it is likely that the special order would be
rejected.

EXERCISE 7-3
(a)
Revenues (15,000 X $7.60)
Cost of goods sold
Operating expenses
Net income

Reject
Order
$0
0
0
$0

Accept
Order
$114,000
78,000 (1)
30,000 (2)
$ 6,000

Net Income
Increase
(Decrease)
$114,000
(78,000)
(30,000)
$ 6,000

(1) Variable cost of goods sold = $2,600,000 X 70% = $1,820,000.


Variable cost of goods sold per unit = $1,820,000 350,000 = $5.20
Variable cost of goods sold for the special order = $5.20 X 15,000
= $78,000.

(2) Variable operating expenses = $840,000 X 75% = $630,000


$630,000 350,000 = $1.80 per unit
15,000 X $1.80 = $27,000
$27,000 + $3,000 = $30,000
(b) As shown in the incremental analysis, Leno Company should accept
the special order because incremental revenues exceed incremental
expenses by $6,000.
EXERCISE 7-4

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

Reject
Order
$0
0
0
0
0
$0

Accept
Order
$1,187,500 (1)

Net Income
Increase
(Decrease)
$1,187,500

500,000
187,500
250,000
937,500
$ 250,000

(500,000)
(187,500)
(250,000)
(937,500)
$ 250,000

(1) [($2.00 + $0.75 + $1.00 + $1.00) X 250,000]


Klean Fiber should accept the Armys offer since it would increase net
income by $250,000.

EXERCISE 7-5
(a)
Make
Direct materials (30,000 X
$4.00) Direct labor (30,000 X
$5.00)
Variable overhead costs
($150,000 X 70%)
Fixed manufacturing costs
Purchase price (30,000 X
$12.75)
Total annual cost

Net Income
Increase
(Decrease)

Buy

$120,000
150,000

0
0

105,000
45,000
0
$420,000

0
45,000
382,500
$427,500

$ 120,000
150,000
105,000
0
(382,500)
$ (7,500)

(b) No, Schopp Inc. should not purchase the shades. As indicated by the
incremental analysis, it would cost the company $7,500 more to purchase the lamp shades.
(c) Yes, by purchasing the lamp shades, a total cost saving of $17,500 will
result as shown below.

Total annual cost (above)


Opportunity cost
Total cost

Make

Buy

Net Income
Increase
(Decrease)

$420,000
25,000
$445,000

$427,500
0
$427,500

$ (7,500)
25,000
$ 17,500

EXERCISE 7-6
(a) 1.
Make
Direct materials
Direct labor
Variable overhead
Fixed overhead
Purchase price
Total annual cost

Buy

$1,000,000 $ 0
800,000
0
120,000
0
600,000
195,000
0 2,300,000
$2,520,000 $2,495,000

Net Income
Increase
(Decrease)
$ 1,000,000
800,000
120,000
405,000
(2,300,000)
$ 25,000

Yes. The offer should be accepted as net income will increase by $25,000.

EXERCISE 7-6 (Continued)


2.

Net Income
Increase
(Decrease)
Make

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

$1,000,000
800,000
120,000
600,000
405,000
0
$2,925,000

Buy

0
$ 1,000,000
0
800,000
0
120,000
600,000
0
0
405,000
2,300,000(2,300,000)
$2,900,000
$
25,000

Yes. The offer should be accepted as net income would be $25,000 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
Net Income
Direct materials
Direct labor
Variable overhead
Purchase price
Total unit cost

Make Sails
$100
80
35
0
$215

Buy Sails
$ 0
0
0
250
$250

Increase
(Decrease)
$ 100
80
35
(250)
$ (35)

Gibbs should be making the sails, because they could save $35 per
unit or $42,000. The president was including the fixed overhead cost
in the calculation. Variable overhead = Total overhead ($100) Fixed
overhead ($78,000 1,200) = $35. This amount has been allocated, so
Gibbs 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)


The best decision would be to rent out the space as shown below. The
differential savings would be $77,000 $42,000 = $35,000.

(Based on 1,200 units)


Manufacturing cost
Purchase price
Opportunity cost
Total annual cost

Per
Unit
$215
$250

Make
Sails
$258,000
0
77,000
$335,000

Buy Sails
$
0
300,000
0
$300,000

Net Income
Increase
(Decrease)
$ 258,000
(300,000)
77,000
$ 35,000

Qualitative factors to consider would be (1) whether Gibbs will be able to


exercise control over the future price of the product (2) whether Gibbs
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)
Direct materials
Direct labor
Material handling
Variable overhead
Purchase price
Total unit cost

Make IMC2
$ 65.00
45.00
6.50
72.00*
0
$188.50

Buy IMC2
$
0
0
0
0
200.00
$200.00

Net Income
Increase
(Decrease)
$ 65.00
45.00
6.50
72.00
(200.00)
$ (11.50)

*Variable overhead = 60% X ($126.50 6.50)


The unit should not be purchased from the outside vendor, as the per
unit cost would be $11.50 greater than if they made it.

EXERCISE 7-8 (Continued)


(b)

In order for Innova 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
$11,500 more (1,000 X $11.50). Innova would have to increase their
contribution margin by more than $11,500 through the manufacture of
the other product, before it would be economical for them to purchase
the IMC2 from the outside vendor.

(c)

Qualitative factors to consider would be (1) quality of the component


(2) on-time delivery, and (3) reliability of the vendor.

EXERCISE 7-9

Sales per unit


Costs per unit
Direct
materials
Direct labor
Total

Sell
(Basic Kit)

Process Further
(Stage 2 Kit)

$30

$35

$14
0
$14

$ 7 (1)
9 (2)
$16

$16

$19

Net Income
Increase
(Decrease)
$5
$7
(9)
$(2)
$3

Net income per unit

(1) The cost of materials decreases because Rachel 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 $18 per hour or
$9 per unit.

EXERCISE 7-9 (Continued)


Rachel should carry the Stage 2 Kits. The incremental revenue, $5, exceeds
the incremental processing costs, $2. Thus, net income will increase by
processing the kits further.
EXERCISE 7-10
(a)

Sales ($60,000 + $15,000 + $55,000)


Joint costs
Net income

$ 130,000
(100,000)
$ 30,000

(b) Sales ($190,000 + $35,000 + $215,000)


Joint costs
Additional costs ($100,000 + $30,000 + $150,000)
Net income

$ 440,000
(100,000)
(280,000)
$ 60,000

(c)
(1)

Incremental revenue
Incremental costs
Incremental profit (loss)
(1)

Product 10 Product 12 Product 14


$ 160,000
$ 130,000
$ 20,000
(100,000)
(30,000)
(150,000)
$ 30,000
$(10,000)
$ 10,000

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

Products 10 and 14 should be processed further and product 12 should be


sold at the split-off point.
(d)

Sales ($190,000 + $15,000 + $215,000)


Joint costs
Additional costs ($100,000 + $150,000)
Net income

$ 420,000
(100,000)
(250,000)
$ 70,000

Net income is $10,000 ($70,000 $60,000) higher in (d) than in (b) because
product 12 is not processed further, thereby increasing overall profit $10,000.

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.
Larco
Incremental revenue
Incremental cost
Incremental profit (loss)

$100,000*
(110,000)
$ (10,000)

Marco

Narco

$100,000**
(85,000)
$ 15,000

$395,000***
(250,000)
$145,000

From this analysis we see that Marco and Narco should be processed further
because the incremental revenue exceeds the incremental costs, but Larco
should be sold as is.
*$300,000 $200,000

**$400,000 $300,000

***$800,000 $405,000

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.

(b)

Revenue after further processing:


Product D$60,000 (4,000 units X $15.00 per
unit) Product E$97,200 (6,000 units X $16.20
per unit) Product F$45,200 (2,000 units X $22.60
per unit)
Revenue at split-off:
Product D$40,000 (4,000 units X $10.00 per
unit) Product E$69,600 (6,000 units X $11.60 per
unit) Product F$38,800 (2,000 units X $19.40 per
unit)
Incremental revenue
Incremental cost
Increase (decrease) in profit

D
$20,000
(14,000)
$ 6,000

Products D and E should be processed further.

E
$27,600
(20,000)
$ 7,600

F
$ 6,400
(9,000)
$(2,600)

(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
(25,000*)
75,000
40,000
$ 35,000

*One years depreciation: ($100,000 $0) 4 years


(b)

Annual operating costs


New scanner cost
Old scanner salvage
Total

Retain
Scanner

Replace
Scanner

$315,000*

$225,000**
110,000
(40,000)
$295,000

$315,000

Net Income
Increase
(Decrease)

$90,000
(110,000)
40,000
$ 20,000

*(3 years X $105,000)


**[3 years X ($105,000 $30,000)]
Yes. Benson Hospital should replace the old scanner because it will
result in a savings of $20,000 over the next four years.
(c) As shown in (a) above, replacing the old scanner will result in
reporting a loss of $35,000. 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 ($75,000) 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 Dyno is willing to
pay ($40,000).

EXERCISE 7-14

Operating costs
New machine cost
Salvage value
(old)
Total

Retain
Machine
$125,000 (1)
0
0
$125,000

Replace
Machine
$100,000
25,000 (2)
(6,000)
$119,000

Net Income
Increase
(Decrease)
$ 25,000
(25,000)
6,000
$ 6,000

(1) $25,000 X 5.
(2) $20,000 X 5.
The current machine should be replaced. The incremental analysis shows
that net income for the five-year period will be $6,000 higher by replacing the
current machine.
EXERCISE 7-15

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
61,000
26,000
87,000
13,000
15,000
24,000
39,000
$(26,000)

Eliminate
$
0

0
0
0

15,000
24,000
39,000
$(39,000)

Net Income
Increase
(Decrease)
$(100,000)
61,000
26,000
87,000
(13,000)
0
0
0
$ (13,000)

Judy is incorrect. The incremental analysis shows that net income will be
$13,000 less if the Huron 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)

$30,000 + $70,000 $40,000 = $60,000

Tingler
Sales
Variable expenses
Contribution margin
Fixed expenses
Net income

Shocker
$300,000
150,000
150,000
142,500*
$ 7,500

$500,000
200,000
300,000
267,500**
$ 32,500

Total
$800,000
350,000
450,000
410,000
$ 40,000

*$30,000 + [($300,000 $800,000) X $300,000]


**$80,000 + [($500,000 $800,000) X
$300,000]
As shown in the analysis above, Cawley should not eliminate the
Stunner product line. Elimination of the line would cause net income
to drop from $60,000 to $40,000. The reason for this decrease in net
income is that elimination of the product line would result in the loss
of $55,000 of contribution margin while saving only $35,000 of fixed
expenses.
EXERCISE 7-17
Calculation of contribution margin per unit:
Selling price per unit
Less: variable costs/unit
Contribution margin/unit

C
$95
50
$45

D
$75
40
$35

E
$115
40
$ 75

Fixed costs = $22 X (9,000 + 20,000) = $638,000


Company profit with Products C and D:
Units sold
Sales revenue
Less: Variable costs
Contribution margin
Less: Fixed costs

C
9,000

D
20,000

Total

$855,000
450,000
$405,000

$1,500,000
800,000
$ 700,000

$2,355,000
$1,250,000
1,105,000
638,000

Net income

$ 467,000

EXERCISE 7-17 (Continued)


Company profit with Products C and E:
Units sold
Sales revenue
Less: Variable costs
Contribution margin
Less: Fixed costs
Net income

C
9,900*
$940,500
495,000
$445,500

E
10,000

Total

$1,150,000
$2,090,500
400,000 895,000
$ 750,000
1,195,500
638,000
$ 557,500

*Product C sales increase by 10%, (9,000 X 110%)


Yes they should introduce Product E since net profit would increase by
$90,500 ($557,500 $467,000).
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)

Revenues (10,000 X $27)


Cost of goods sold
Selling and administrative
expenses
Net income

Reject
Order
$0
0

Accept
Order
$270,000
220,000 (1)

Net Income
Increase
(Decrease)
$ 270,000
(220,000)

0
$0

20,000 (2)
$ 30,000

(20,000)
$ 30,000

(1) Variable costs = $3,600,000 $960,000 = $2,640,000;


$2,640,000 120,000 units = $22.00 per unit;
10,000 X $22.00 = $220,000.
(2) Variable costs = $405,000 $225,000 = $180,000;
$180,000 120,000 units = $1.50 per unit;
10,000 X ($1.50 + $0.50) = $20,000.
(b) Yes, the special order should be accepted because net income will
increase by $30,000.
(c) Unit selling price = $22.00 (variable manufacturing costs) + $2.00 variable
selling and administrative expenses + $4.00 net income = $28.
(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)
Direct materials
(8,000 X
$4.80)
Direct labor
(8,000 X
$4.30)
Indirect labor

Make CISCO
$38,400
34,400

Buy CISCO
$

Net Income
Increase
(Decrease)

$38,400

34,400

(8,000 X $.43)
Utilities (8,000 X $.40)
Depreciation
Property taxes
Insurance
Purchase price
Freight and inspection
(8,000 X $.35)
Receiving costs
Total annual cost

3,440
3,200
3,000
700
1,500
0

0
0
900
200
600
80,000

3,440
3,200
2,100
500
900
(80,000)

0
0
$84,640

2,800
1,300
$85,800

(2,800)
(1,300)
$ (1,160)

(b) The company should continue to make CISCO because net income
would be $1,160 less if CISCO were purchased from the supplier.
(c) The decision would be different. Because of the opportunity cost of
$3,000, net income will be $1,840 higher if CISCO is purchased as
shown below:
Net Income
Increase
(Decrease)
Make CISCO
Buy CISCO
Total annual cost
Opportunity cost
Total cost

$84,640
3,000
$87,640

$85,800
0
$85,800

$(1,160)
3,000
$ 1,840

(d) Nonfinancial factors include: (1) the adverse effect on employees if


CISCO is purchased, (2) how long the supplier will be able to satisfy
the Shatner 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 Shatner.

PROBLEM 7-3A

(a) (1)

Table Cleaner Not Processed Further


Sales:
FloorShine (600,000 30) X $20
Table Cleaner (300,000 25) X $18
Total revenue
Costs:
CDG
Additional costs of FloorShine
Total costs
Gross profit

$400,000
216,000
$616,000
210,000
240,000
450,000
$166,000

Table Cleaner Processed Further


Sales:
FloorShine
Table Stain Remover (300,000 25) X $14
Table Polish (300,000 25) X $14
Total revenue
Costs:
CDG
Additional costs of FloorShine
TCP
Total costs
Gross profit

$400,000
168,000
168,000
$736,000
210,000
240,000
100,000
550,000
$186,000

If the table cleaner is processed further overall company profits will be


$20,000 higher. Therefore, management made the wrong decision by
choosing to not process table cleaner further.

PROBLEM 7-3A (Continued)

Incremental revenue
Incremental costs
Totals

(b) Dont
Process
Table Cleaner
Further
$216,000
0
$216,000

Process
Table Cleaner
Further
$336,000
100,000
$236,000

Net Income
Increase
(Decrease)
$120,000
(100,000)
$ 20,000

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
(24,000*)
96,000
(25,000)
$ 71,000

*$120,000 5 years = $24,000


(b) (1)
Revenues ($240,000 X 4 yrs.)
Less costs:
Variable costs ($35,000 X 4)
Fixed costs ($23,000 X 4)
Selling & administrative
Depreciation
Net income

Retain Old Elevator


$960,000
$140,000
92,000
116,000*
96,000

444,000
$516,000

*($29,000 X 4)
(2)
Revenues
Less costs:
Variable costs ($10,000 X 4)
Fixed costs ($8,500 X 4)
Selling and administrative
Depreciation
Operating income
Less: Loss on old elevator
Net income
(c)

Replace Old Elevator


$960,000
$ 40,000
34,000
116,000
160,000

Retain
Old
Elevator
Variable operating costs
Fixed operating costs
New elevator cost
Salvage on old elevator
Totals

$140,000
92,000
.

$232,000

350,000
610,000
71,000
$539,000

Replace
Old Elevator

Net Income
Increase
(Decrease)

$ 40,000
34,000
160,000
(25,000)
$209,000

$ 100,000
58,000
(160,000)
25,000
$ 23,000

PROBLEM 7-4A (Continued)


(d)

MEMO

TO: Ron Richter


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
$71,000 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 $96,000 would be
deducted as depreciation expense over the next four 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 $96,000 book value will be expensed under
either alternative, making it irrelevant.

PROBLEM 7-5A
(a)
Sales
Variable costs
Cost of goods sold
Selling and administrative
Total variable expenses
Contribution margin

Division I
$250,000

Division II
$200,000

150,000
30,000
180,000
$ 70,000

172,800
42,000
214,800
$ (14,800)

(b) (1)

Net Income
Increase
(Decrease)

Division I

Continue

Eliminate

Contribution margin
(above) Fixed costs
Cost of goods sold
Selling and administrative
Total fixed expenses
Income (loss) from operations

$ 70,000

$0

$(70,000)

50,000
45,000
95,000
$(25,000)

25,000
22,500
47,500
$(47,500)

25,000
22,500
47,500
$(22,500)
Net Income
Increase
(Decrease)

(2)
Division II

Continue

Eliminate

Contribution margin
(above) Fixed costs
Cost of goods sold
Selling and administrative
Total fixed expenses
Income (loss) from operations

$(14,800)

19,200
18,000
37,200
$(52,000)

9,600
9,000
18,600
$(18,600)

$14,800
9,600
9,000
18,600
$33,400

Division II should be eliminated as its negative contribution margin is


$14,800. Income from operations would increase $33,400 if Division II
is eliminated.
Division I should be continued because it is producing positive contribution margin of $70,000. Income from operations will decrease
$22,500 by discontinuing this division.

PROBLEM 7-5A (Continued)


(c)

GUTIERREZ COMPANY
CVP Income Statement
For the Quarter Ended March 31, 2014
Divisions

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

III

IV

Total

$250,000

$500,000

$450,000

$1,200,000

150,000

240,000

187,500

577,500

30,000

30,000

30,000

90,000

180,000
70,000

270,000
230,000

217,500
232,500

667,500
532,500

53,200

63,200

65,700

182,100

48,000

33,000

23,000

104,000

101,200
$(31,200)

96,200
$133,800

88,700
$143,800

286,100
$ 246,400

(1) Divisions fixed cost of goods sold plus 1/3 of Division IIs
unavoidable fixed cost of goods sold [$192,000 X (100% 90%) X
50% = $9,600]. Each divisions share is $3,200.
(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.
Income from operations with Division II of $213,000 (given) plus
incremental income of $33,400 from eliminating Division II = $246,400
income from operations without Division II.

PROBLEM 7-1B

Reject
Order

(a)
Revenues (10,000 X $30)
Cost of goods sold
Selling and administrative
expenses
Net income

$0
0
0
$0

Accept
Order
$300,000
240,000
(1)

Net Income
Increase
(Decrease)
$ 300,000
(240,000)

25,000
(2)
$ 35,000

(25,000)
$ 35,000

(1) Variable costs = $3,060,000 $900,000 = $2,160,000;


$2,160,000 90,000 units = $24 per unit;
10,000 X $24 = $240,000.
(2) Variable costs = $360,000 $180,000 = $180,000;
$180,000 90,000 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 be
increased by $35,000.
(c) Unit selling price = $24 (variable manufacturing costs) + $2.50 (variable
selling and administrative expenses) + $5.50 (net income) = $32.00.
(d) Nonquantitative 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 7-2B

(a)
Make FIZBE
FIZBE

Buy

Net Income
Increase
(Decrease)

Direct materials (5,000 X $4.75)


Direct labor (5,000 X $4.60)
Indirect labor (5,000 X $.45)
Utilities (5,000 X $.35)
Depreciation
Property taxes
Insurance
Purchase price
Freight and inspection
(5,000 X $.30)
Receiving costs
Total annual cost

$23,750
23,000
2,250
1,750
2,000
700
1,500
0

0
0
0
0
900
200
600
56,000

$ 23,750
23,000
2,250
1,750
1,100
500
900
(56,000)

0
0
$54,950

1,500
500
$59,700

(1,500)
(500)
$ (4,750)

(b) The company should continue to make FIZBE because net income
would be $4,750 less if FIZBE were purchased from the supplier.
(c) The decision would be different. Because of the opportunity cost of
$6,000, net income will be $1,250 higher if FIZBE is purchased as shown
below:

Total annual cost


Opportunity cost
Total cost

Make FIZBE
$54,950
6,000
$60,950

Buy FIZBE
$59,700
0
$59,700

Net Income
Increase
(Decrease)
$(4,750)
6,000
$ 1,250

(d) Nonfinancial factors include: (1) the adverse effect on employees


if FIZBE is purchased, (2) how long the supplier will be able to satisfy
the Gill Corporations quality control standards at the quoted price per
unit, and (3) will the supplier deliver the units when they are needed
by Gill?

PROBLEM 7-3B
(a) (1)

General-Purpose Cleaner Not Processed Further


Sales
ShineBrite (750,000 25) X $15
General-Purpose Cleaner (250,000 20) X $20
Total revenue
Costs
NPR
Additional costs for
ShineBrite Total costs
Gross profit

$450,000
250,000
$700,000
200,000
300,000
500,000
$200,000

General-Purpose is Processed Further


Sales
ShineBrite (750,000 25) X $15
Premium Cleaner (250,000 20) X $16
Premium Stain Remover (250,000 20) X $16
Total revenue
Costs
NPR
Additional costs for ShineBrite
PST
Total costs
Gross profit

$450,000
200,000
200,000

$850,000

200,000
300,000
140,000
640,000
$210,000

If the general-purpose cleaner is processed further overall company profits


will be $10,000 higher. Therefore, management made the wrong
decision by choosing to not process the general-purpose
cleaner further.

PROBLEM 7-3B (Continued)

Incremental revenue
Incremental costs
Totals

(b) Dont
Process
G-P Cleaner
Further
$250,000
0
$250,000

Process
G-P Cleaner
Further
$400,000
140,000
$260,000

Net Income
Increase
(Decrease)
$150,000
(140,000)
$ 10,000

When trying to decide if the general-purpose cleaner should be processed


further into PC and PSR, only the relevant data need be considered. All of
the costs that occurred prior to the creation of the general-purpose 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 7-4B

(a)

Cost
Accumulated depreciation
Book value
Sales proceeds
Loss on sale

$210,000
(42,000*)
168,000
(58,000)
$110,000

*$210,000 5 years = $42,000


(b) (1)
Revenues ($360,000 X 4 yrs.)
Less costs:
Variable costs
Fixed costs
Selling & administrative
Depreciation
Net income

Retain Old Equipment


$1,440,000
$200,000
120,000
180,000
168,000

(2)
Revenues
Less costs:
Variable costs
Fixed costs
Selling and administrative
Depreciation
Operating income
Less: Loss on old equipment
Net income
(c)

Variable costs
Fixed costs
New equipment cost
Salvage on old equipment
Totals

668,000
$ 772,000
Replace Old Equipment
$1,440,000

$ 48,000
20,000
180,000
250,000

498,000
942,000
110,000
$ 832,000

Retain Old
Equipment

Replace Old
Equipment

$200,000
120,000

$ 48,000
20,000
250,000
(58,000)
$260,000

$320,000

Net
Income
Increase
(Decrease)
$152,000
100,000
(250,000)
58,000
$ 60,000

PROBLEM 7-4B (Continued)


(d)

MEMO

TO: Gene Simmons


FROM: Student
SUBJECT: Relevant Data for Decision to Replace Old Equipment
When deciding whether or not to replace any old equipment, the analysis
should only include cost data relevant to the replacement decision. The
$110,000 loss that would be experienced if we replace the old equipment
with the newer equipment is related to a sunk cost, namely the cost of the
old equipment. Sunk costs are irrelevant in decision making.
The loss occurs when comparing the book value of the old equipment to
the cash proceeds that would be received. The book value of $168,000
would be deducted as depreciation expense over the next four years if the
equipment were retained. If the equipment 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 $168,000 book value will be expensed
under either alternative, making it irrelevant.

PROBLEM 7-5B

(a)
Sales
Variable expenses
Cost of goods sold
Selling and administrative
Total variable expenses
Contribution margin

Division
IV

Division
III
$310,000

$170,000

189,000
45,000
234,000
$ 76,000

140,400
49,000
189,400
$ (19,400)

(b) (1)
Division III
Contribution margin (above)
Fixed expenses
Cost of goods sold
Selling and administrative
Total fixed expenses
Income (loss) from operations

Net Income
Increase
(Decrease)

Continue

Eliminate

$ 76,000

$0

$(76,000)

81,000
30,000
111,000
$(35,000)

40,500
15,000
55,500
$(55,500)

40,500
15,000
55,500
$(20,500)
Net Income
Increase
(Decrease)

(2)
Division IV

Continue

Eliminate

Contribution margin
(above) Fixed expenses
Cost of goods sold
Selling and administrative
Total fixed expenses
Income (loss) from operations

$(19,400)

15,600
21,000
36,600
$(56,000)

7,800
10,500
18,300
$(18,300)

$19,400
7,800
10,500
18,300
$37,700

Division III should be continued as contribution margin ($76,000) is


greater than the savings in fixed costs ($55,500) that would result from
elimination. Therefore, income from operations would decrease $20,500 if
Division III is eliminated.
Division IV should be eliminated because it is producing negative contribution margin ($19,400). Income from operations will increase $37,700
by discontinuing this division.

PROBLEM 7-5B (Continued)


PANDA COMPANY
CVP Income Statement
For the Quarter Ended March 31,
2014
Divisions
Sales
Variable expenses
Cost of goods sold
Selling and
administrative
Total variable
expenses
Contribution margin
Fixed expenses
Cost of goods sold (1)
Selling and
administrative (2)
Total fixed
expenses
Income (loss) from operations

II

III

Total

$510,000

$400,000

$310,000

$1,220,000

210,000

200,000

189,000

599,000

24,000

40,000

45,000

109,000

234,000
276,000

240,000
160,000

234,000
76,000

708,000
512,000

92,600

52,600

83,600

228,800

39,500

43,500

33,500

116,500

132,100
$143,900

96,100
$ 63,900

117,100
345,300
$ (41,100 ) $ 166,700

(1) Divisions fixed cost of goods sold plus 1/3 of Division IVs unavoidable fixed cost of goods sold [$156,000 X (100% 90%) X 50% =
$7,800]. Each divisions share is $2,600.
(2) Divisions fixed selling and administrative expenses plus 1/3 of
Division IVs unavoidable fixed selling and administrative expenses
[$70,000 X (100% 70%) X 50% = $10,500]. Each divisions share
is $3,500.
Income from operations with Division IV of $129,000 (given) plus incremental income of $37,700 from eliminating Division IV = $166,700 income
from operations without Division IV.

BYP 7-1DECISION-MAKING AT CURRENT DESIGNS

Situation #1
(a) Current Designs should accept the special order based on the following
calculations:

Revenues
Costs
Net Income

Reject Order
$0
0
$0

Accept Order
$25,000*
(19,000)**
$ 6,000

Net Income
Increase (Decrease)
$25,000
(19,000)
$ 6,000

*(100 X $250)
**(($80 + $60 + $20) X 100) + ($1,000 + $2,000)
(b) Assuming that Current Designs is currently operating with excess
capacity, it should accept the order based on the calculations shown
in part (a). If Current Designs is currently operating at full capacity, it
would have to weigh its options. If it displaced production of regular
kayaks in order to fill this order, it would have to consider the opportunity costs associated with this decision. The opportunity cost, when
operating at full capacity, would be the lost contribution margin from
regular sales given up in order to fulfill the special order. Alternatively,
rather than reject the special order, it might consider temporarily expanding the plants capacity by adding an additional production shift to
handle the special order. If this option were considered, it would have
to identify all additional incremental costs (for example, overtime pay)
that would be incurred.

BYP 7-1 (Continued)


Situation #2
(a) Current designs should not replace the Rotomold oven based on the
following calculations:
Retain
Oven
Variable manufacturing costs
New oven cost
Proceeds from scrapping old oven
Total

$110,500*
0
0
$110,500

Replace
Oven

Net Income
Increase
(Decrease)

$ 97,500**
250,000
(10,000)
$337,500

$ 13,000
(250,000)
10,000
($ 227,000)

*(17,000 therms/year X $0.65/therm X 10 years)


**(15,000 therms/year X $0.65/therm X 10 years)

(b) Even with the cost of natural gas increasing at a faster than expected
rate, Current Designs still should not replace the Rotomold oven as the
rate increase does not cover the cost of the new oven based on the
following calculations:
Retain
Oven
Variable manufacturing costs
New oven cost
Proceeds from scrapping old oven
Total

$144,500*
0
0
$144,500

*(17,000 therms/year X $0.85/therm X 10 years)


**(15,000 therms/year X $0.85/therm X 10 years)

Replace
Oven
$127,500**
250,000
(10,000)
$367,500

Net Income
Increase
(Decrease)
$ 17,000
(250,000)
10,000
($ 223,000)

BYP 7-1 (Continued)


Situation #3
(a) Current Designs should make the seats based on the following calculations:

Make
Direct materials
Direct labor
Variable manufacturing costs
Fixed manufacturing costs
Purchase price ($50 X 3,000)
Total annual cost

$ 60,000
45,000
36,000
20,000
0
$161,000

Buy
$

0
0
0
15,000
150,000
$165,000

Net Income
Increase
(Decrease)
$ 60,000
45,000
36,000
5,000
(150,000)
($ 4,000)

(b) When the opportunity cost of $20,000 is considered, Current Designs


should buy the seats based on the following calculations:

Total annual cost


Opportunity cost
Total cost

Make
$161,000
20,000
$181,000

Buy
$165,000
0
$165,000

Net Income
Increase
(Decrease)
($ 4,000)
20,000
$16,000

BYP 7-2DECISION-MAKING ACROSS THE ORGANIZATION

Retain
Old Machine
Sales
Costs and expenses
Cost of goods sold
Selling expenses
Administrative expenses
Purchase price
Total costs and expenses
Net income
(1)
(2)
(3)
(4)
(5)

Purchase
New Machine

Net Income
Increase
(Decrease)

$6,000,000 (1)

$6,600,000 (2)

$ 600,000

4,500,000 (3)
900,000
500,000

5,900,000
$ 100,000

4,620,000 (4)
990,000
565,000
150,000 (5)
6,325,000
$ 275,000

(120,000)
(90,000)
(65,000)
(150,000)
(425,000)
$ 175,000

12,000 X $100 X 5 years = $6,000,000.


$6,000,000 X 110% = $6,600,000.
$6,000,000 X (100% 25%) = $4,500,000.
$6,600,000 X (100% 30%) = $4,620,000.
$140,000 + $4,000 + $6,000 = $150,000.

The new machine should be purchased. The incremental analysis shows


that net income will increase from $100,000 to $275,000 over the five years
with the new machine.

BYP 7-3MANAGERIAL ANALYSIS

(a)

$ 14.50

Buy
TransTech
$ 14.50

$ 14.50

2.00
0.80
0.60
3.00
0.50
0

6.90
$ 7.60
$38,000

0
0
0
0
0
10.00
1.00*
11.00
$ 3.50
$17,500

0
0
0
0
0
5.00
1.00
6.00
$ 8.50
$42,500

Make
Sales Revenue
Variable Manufacturing Cost:
Circuit Board
Plastic Case
Alarms (4 @ $.15 each)
Labor
Overhead
Purchase Cost
Fixed Manufacturing Cost:
Total Manufacturing Cost
Profit per Unit
Total Profit

Buy
Omega

*The $5,000 cost that will continue to be incurred, even if the product is
not manufactured, divided by the 5,000 units.
The company will make the most profit if the clocks are purchased
from Omega Company. The company will make $4,500 less if the clocks
are manufactured by MiniTek. The company will make $25,000 less if
the clocks are purchased from Trans-Tech.
(b) There are several important nonfinancial factors described in the case.
Other factors might be identified as well. The factors described are:
The company is having serious difficulty manufacturing the clocks.
Therefore, it would probably be willing to have someone else manufacture the clocks, even if it cost more to do so. The most promising
company appears to be Omega; however, there is a serious question
about Omegas ability to remain in business. However, the company
could purchase just this one order from Omega, and then continue to
search for another manufacturer, or stop manufacturing the clocks.
Trans-Techs stringent requirements for preferred customer status, in
the form of large sales requirements, appear to limit the possibilities
for MiniTek to use it as a supplier. However, if MiniTek does desire to
continue to offer the clocks because of their popularity, then perhaps
Trans-Tech could be used in the future.

BYP 7-3 (Continued)


(c) Many answers are possible, depending upon each students assessment
of the seriousness of the issues mentioned in (b). One answer would
be: The company should use Omega to manufacture the Kmart order.
After that, the company should not offer the clocks any longer. Especially since the clocks are no longer very profitable, it does not seem
like a good idea to keep spending money to modify the process.

BYP 7-4REAL-WORLD FOCUS

(a) Before building the special-order new ceiling fans, company management must consider the effect of the new lines on current production
capacity, existing and available channels of distribution, the effect on
manufacturing efficiency, the effect on sales of current lines of product,
and the supply of materials and labor.
(b) Incremental analysis would provide a financial comparison of income
with the special-order ceiling fans to income without the special orders.

BYP 7-5REAL-WORLD FOCUS

(a) The types of outsourcing services that the company provides assistance on are:
Information technology outsourcing, finance and accounting, human resource outsourcing, business process outsourcing, procurement, and
call centers.
(b) Insourcing means to take work that is currently being performed by an
outside service provider back in-house. For example, collections of
accounts receivable might currently be performed by a collection
agency, and you might decide to establish a collection group within
your company.
(c) Some of the benefits of insourcing include:

Greater control over resources

Greater ability to control intellectual property

Increased visibility of accountability within the organization

BYP 7-6COMMUNICATION ACTIVITY

To:

Preston ThiesePlant Manager

From:

Hank JewelProduction

Manager
I have spent considerable time thinking about the dilemma created by the
new PDD1130 machine. Clearly, it is far superior to our existing machine.
There is no question that it would save us tremendous amounts of money.
I hope I am not overstepping my bounds here, but I just reviewed a chapter
in my managerial accounting text on incremental analysis which has made
me think we need to reconsider this decision.
The key to incremental analysis is identifying relevant costs. Relevant
costs are those costs that vary depending on the course of action taken. In
our situation, a relevant cost would be the savings that we would
experience were we to purchase the new machine. The book value of the
existing machine is not a relevant cost since it would not be changed by
purchasing or not purchasing the new machine. Costs incurred in the past
that do not change are referred to as sunk costs. Sunk costs are irrelevant
to incremental analysis.
I would really like to lay out an analysis of our options to decide the proper
course of action. I am concerned that by using the old machine for a couple
of years the profitability of the plant could be impacted negatively.

BYP 7-7ETHICS CASE

(a) Many factors need to be considered when determining whether to


close a division. The loss of jobs can have a devastating impact on a
community and on the morale of remaining employees. From a
financial perspective, closing a division that is reporting losses will not
necessarily increase the reported net income of the company. The
reason: if fixed costs that have been allocated to a division that is
closed are reallocated to the remaining divisions, the companys net
income might actually decrease. This sounds like it would most likely
be the case at Peters.
(b) It is not unusual to reevaluate fixed cost allocations periodically. However,
the allocation should be based on the underlying economics of the
situation rather than the motives of individuals.
(c) Blake should explain to the board of directors that the change in
income is due to a reallocation and that closing the plumbing division
is not advisable. In this case, being honest is not only the ethical thing
to do, but it will also maximize the companys net income.

BYP 7-8ALL ABOUT YOU

(a) Chronic homelessness is defined as being on the streets for a year


or more.
(b) Homelessness costs cities money because the chronic homeless have
frequent jail time, shelter costs, emergency room visits and hospital stays.
Some costs per city per homeless person are: New York $40,000; Dallas
$50,000; San Diego $150,000.
(c) The first step is to try to identify the size of the problem by doing street
counts. From this count, benchmarks can be set, enabling a reward
system for meeting goals. Next is to identify what the homeless people
want. What do they think they need to help them address their problem?
They typically want adequate housing with some privacy.
(d) It has been estimated that in New York this approach costs about $22,000
per year. New York has documented an 88% success rate (defined as
not returning to the streets for five years).
(e) In terms of incremental analysis, two alternatives are to either continue
with the current situation, with the costs presented in part (b) or to implement the approach outlined in part (d). From a purely financial
perspective the approach in (d) appears to have significant merit. Also
(d) does not even take into account the intangible benefits of
improving the quality of life for this segment of the population.

BYP 7-9CONSIDERING YOUR COSTS AND BENEFITS

Discussion guide: This is a very difficult decision. All of the evidence


suggests that your short-term and long-term prospects will be far greater
with some form of posthigh-school degree. Because of this, we feel strongly
that you should make every effort to continue your education. Many of the
discussions provided in this text present ideas on how to get control of
your individual financial situation. We would encourage you to use these
tools to identify ways to reduce your financial burden in order to continue
your education. We also want to repeat that even taking only one course a
semester is better than dropping out. Your instructors and advisors frequently provide advice to students who are faced with the decision about
whether to continue with their education. If you are in this situation, we would
encourage you to seek their advice since the implications of this decision
can be long-lasting.