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ACG2071 Managerial Accounting

Chapters 20-23 Incremental Analysis Decisions - Sample Problems


Answers appear in red.

Problem 1 - Coleman Company owns a machine that produces a component for the
products the company makes and sells. The company uses 1,800 units of this
component in production each year. The costs of making one unit of this component are
Direct material $7
Variable manufacturing overhead 6
Direct labor 4
Fixed manufacturing overhead 5

The fixed overhead costs are unavoidable, and the unit cost is based on the present
annual usage of 1,800 units of the component. An outside supplier has offered to sell
Coleman this component for $18 per unit and can supply all the units it needs.

A. If Coleman buys the component from the outside supplier instead of making it, how
much will net income change? Should Coleman make or buy the component? Use the
incremental approach to justify your answer.
Since net income decreases, Coleman should continue making the component.
Variable cost = $7 + $6 + $4 = $17
Incremental cost savings from not making component (1,800 x $17) $30,600
Incremental cost of buying component (1,800 x $18) (32,400)
Incremental decrease in net income due to buying component $(1,800)

B. Suppose Coleman could rent the machine to another company for $5,000 per year.
How would your response change to part A? Use the incremental approach to justify
your answer.
Since net income increases, the company should choose to buy the components.
Incremental cost savings from not making component (1,800 x $17) $30,600
Incremental Annual rent from machine 5,000
Incremental Cost of buying component (1,800 x $18) (32,400)
Incremental Increase in net income due to buying component $3,200

Problem 2 - Tenchavez Company makes and sells 12,000 pairs of running shoes each
year. The cost of making one pair of these shoes is
Direct material $ 11
Variable manufacturing overhead 5
Direct labor 4
Fixed manufacturing overhead 7
The fixed overhead costs are unavoidable. Tenchavez allocates fixed overhead costs
based on its annual capacity of 15,000 pairs it is able to make. An overseas company
recently offered to buy 3,000 pairs of shoes at $21 per pair. Regular customers buy
shoes from Tenchavez at $30 per pair.

How much is incremental income if Tenchavez accepts the special order? Should
Tenchavez accept? Use the incremental approach to justify your answer.
Variable cost = $11 + $5 + $4 = $20 per unit
Tenchavez should accept.
Incremental revenue from special order (3,000 x $21) $63,000
Incremental cost to fill special order (3,000 x $20) (60,000)
Incremental income from accepting special order $ 3,000

Problem 3 - Brislin Company makes and sells two products, Olives and Popeyes. The
income statement for the prior year, 2001, was as follows:
Olives Popeyes
Sales $16,000 $24,000
Variable cost of goods sold 6,000 10,000
Manufacturing contribution margin $10,000 $14,000
Fixed production 5,000 7,000
Variable selling and administration 2,000 5,000
Fixed selling and administration 1,000 3,000
Net income $2,000 ($1,000)
Brislin's fixed costs are unavoidable and are allocated to products on the basis of sales
revenue. If Popeyes are dropped, sales of Olives are expected to increase by 40
percent next year.
A. Use the incremental approach to determine if Popeyes should be dropped.

Incremental revenue ($16,000* 40%) of Olives $ 6,400


Incremental revenue of Popeyes (24,000)
Incremental cost savings of Popeyes CGS +10,000
Incremental cost savings of Popeyes S&A cost +5,000
Incremental variable cost of Olives ($6,000*40%) (2,400)
Incremental s&a cost of Olives ($2,000*40%) (800)

Incremental decrease in income if Popeyes discountinued ($5,800)

Problem 4 - Monk Company manufactures widulators. Watson Company has


approached Monk with a proposal to sell the company a component use in its widulators
at a price of $12,000 for 4,000 units. Monk is currently making these components in its
own factory. The following costs are associated annually with this part of the process
when 4,000 units are produced:
Direct material $4,000
Direct labor 2,000
Manufacturing overhead (fixed & variable) 6,800
Total $12,800
All but $3,000 of the manufacturing overhead costs will continue if Monk discontinues
making the components. Monk will be able to eliminate machine rental of $1,800 per
year if the components are no longer manufactured.

A. How much are the incremental cost or savings if Monk outsources? Use the
incremental approach to justify your answer.
Of the $6,800, $3,000 is avoidable, and $3,800 will
continue.

Incremental cost to buy 4,000 components ($


12,000)
Incremental manufacturing savings if bought:
Machine rental $ 1,800
Direct materials 4,000
Direct labor 2,000
Overhead – avoidable portion 3,000
Total Incremental savings 10,800
Incremental cost of buying ($1,200)
components

B. What is the amount of avoidable costs if Monk buys rather than makes the
components?
$10,800 – from part A above….the costs that can be avoided if the alternative course of
action—buying—is taken.

C. Which costs/amounts from above are opportunity costs, if any?


$1,800......the rent savings are given up if the alternative action--buying--is undertaken.
Note that the cost of the products--whether bought or made is still a 'cost' for the
company.

D. Should Monk make or buy the components? Briefly justify your answer.
Monk should make the components. There is an additional cost of $1,200 if Monks
buys the components. Increases in costs are bad choices in decision making because
the cost must be passed on to the customer or absorbed as lower profits by the seller.

Problem 5 - Anheiser, Inc. has three divisions: Bud, Wise, and Er. Results of May, 2003
are presented below:
Bud Wise Er Total
Units sold 3,000 5,000 2,000 10,000
Revenue $70,000 $50,000 $40,000 $160,000
Less variable costs 32,000 26,000 16,000 74,000
Less direct fixed costs 14,000 19,000 12,000 45,000
Less allocated fixed costs 6,000 10,000 4,000 20,000
Net income $18,000 ($5,000) $ 8,000 $21,000

The variable costs are directly attributable to the products produced for the specific
departments. All of the allocated costs will continue even if a division is discontinued.
Anheiser allocates indirect fixed costs based on the number of units to be sold. Since
the Wise division has a net loss, Anheiser feels that it should be discontinued. Anheiser
feels if the division is closed, that sales at the Bud division will increase by 20%, and
that sales at the Er division will stay the same.

A. Prepare an incremental analysis showing the effect of discontinuing the Wise division
on the remaining divisions.

Bud
Incremental revenue
20%*$70,000 - $50,000 ($36,000)
Incremental variable costs savings
20%*32,000 - $26,000 19,600
Incremental direct fixed costs saved 19,000
Increase increase in profit if discontinued $2,600

B. Should Anheiser close the Wise division? Briefly indicate why or why not.
Yes. The profit increases by $2,600 when the division is eliminated. Direct fixed
costs and variable costs for the Wise division were relatively high compared to those for
the Bud and Er divisions. The increase in sales by 20% of the Bud division was enough
to offset the loss of the Wise division.

Problem 6 - Gordon Company sells two items, corn and broccoli. The company is
considering dropping corn. It is expected that sales of broccoli will increase by 40% as a
result. Dropping corn will allow the company to cancel its monthly rental of its corn
shucker costing $100 a month. The other equipment will be used for additional
production of broccoli. One employee earning $200 can be terminated if corn production
is dropped. Gordon’s other allocated costs are unavoidable. The company rents all of its
equipment. A condensed, budgeted monthly income statement with both products is
below:
Total Corn Broccoli

Sales $20,000 $8,000 $12,000

Food materials 4,500 2,000 2,500


Direct labor 3,200 1,200 2,000

Equipment rental 2,900 2,600 300

Other allocated overhead 3,100 2,100 1,000

Operating income $6,300 $ 100 $6,200

In good form, prepare an incremental analysis to determine the financial effect of


dropping corn production.
Incremental change in revenue:
Increase in broccoli sales: $12,000 x 40% = +$4,800
Decrease in corn sales (8,000)
Incremental decrease in revenue ($3,
Incremental change in variable costs:
Food materials: Increase in broccoli costs: $2,500 x 40% (1,000)
Decrease in corn costs +2,000

Direct labor: Increase in broccoli labor: $2,000 x 40% (800)


Decrease in corn labor +1,200
Incremental decrease in variable costs +1
Equipment rental reduction - corn shucker +

Incremental decrease in profits if corn production is dropped ($1,

Problem 7 - Parrino has three product lines in its retail stores: books, videos, and
music. Results of the 4th quarter are presented below:
Books Music Videos Total

Units sold 1,000 2,000 2,000 5,000


Revenue $22,000 $40,000 $23,000 $85,000
Variable departmental costs 15,000 22,000 12,000 49,000
Direct fixed costs 1,000 3,000 2,000 6,000
Allocated fixed costs 7,000 7,000 7,000 21,000
Net income ($1,000) $ 8,000 $ 2,000 $ 9,000
The allocated fixed costs are unavoidable. Demand of individual products are not
affected by changes in other product lines. If Parrino discontinues the Books product
line, what is the effect on profit? Use the incremental approach.
Incremental revenue ($22,000)
Incremental costs:
Variable costs savings +15,000
Direct fixed costs savings +1,000
Incremental drop in profits if discontinued ($6,000)
Problem 8 -Temple, Inc. produces grandfather clocks and sells 100 per year.
:
Unit
Cost
Direct materials $ 200
Direct labor 240
Variable overhead 160
Fixed overhead (40% 300
avoidable)
A. An outside supplier has offered to produce the clocks for Temple for $700. Use the
incremental approach.
Relevant costs are the incremental costs of making one clock:
Incremental Cost to buy ($70,000)
Incremental DM cost savings +20,000
Incremental DL cost savings +24,000
Incremental VOH cost savings +16,000
Incremental FOH cost savings (40%*$300*100clocks) +12,000
Incremental Net savings to buy per unit +$2,000

Problem 9 - Young
Siding Co. produces computers, which sell for $400 each. A foreign
distribution wants to order 1,000 units at $300 a unit. 70% of the fixed overhead is
unavoidable. Production costs per unit are:
Direct materials $90
Direct labor 120
Variable overhead 50
Fixed overhead 60
A. How much is the relevant cost of producing one more computer?
Relevant costs are incremental costs of making one unit.
$90 + $120 + $50 = $260
Note that fixed costs do not increase when one additional unit is produced.
B. What the effect on net income of accepting the special order? Use the incremental
approach.
Incremental revenue = $1,000 x $300 = $300,000
Incremental costs = $1,000 x 260 = ($260,000)
Increase of $40,000

Scott, Inc. has a capacity of producing 300,000 units a year and sells them at
Problem 10 -
$28 a unit. At present Scott is selling 250,000 units. A foreign distributor has offered to
purchase 40,000 units at $20 a unit. Variable selling costs will be reduced by 40%. The
sales manager determined that incremental costs of accepting the order are $744,000.
Should Scott accept the order? Use the incremental approach.
Yes, incremental profit is $56,000.

Incremental Revenue = 40,000 x $20 = $800,000


Incremental costs = $744,000
Incremental profit = $800,000 - $744,000 = $56,000

Problem 11 - It costs Roy Company $14 of variable costs and $6 of allocated fixed
costs to produce a toy truck that sells for $30. A buyer offers to purchase 3,000 units at
$18 each. Roy has unused capacity. What will occur to profits is the offer is accepted
and produced? Use the incremental approach.
Incremental increase in revenue (3,000*$18) $54,000
Incremental increase in costs (3,000*$14) (42,000)
Incremental increase in profits to accept $12,000

Problem 12 - At the start of the year, West Coast Grocery Supply budgeted sales and
variable costs for three product lines as shown below in the table. With this level of
allocation, the Canned Goods line does not appear
profitable.
Canned
Meat Dairy Total
Goods
Sales $15,000 $1,500 $20,000 $36,500
Variable Costs 10,000 1,000 18,000 29,000
Contribution Margin 5,000 500 2,000 7,500
Fixed Costs 1,644 164 2,192 4,000
Profit (Loss) $ 3,356 $ 336 ($ 192) $ 3,500
West Coast Grocery Supply is operating at capacity in terms of the existing warehouse
and the current fleet of delivery trucks. If the Canned Goods line is dropped, $500 of
fixed costs specifically associated with the Canned Goods line can be avoided.
Additionally, sales of Meat and Dairy can be increased by 20% each.
How much is the fixed cost savings related to canned goods?
A.
The amount of fixed costs that can be avoided = $500
B. Using the cost allocation death spiral concept, indicate whether West Coast should
drop its canned goods line. No, the company will lose more money if it drops canned
goods. Since not all fixed costs can be eliminated, they must be allocated to the other
divisions causing those divisions to have reduced profits or create losses.

Problem 13 - Hand Devices makes and sells hand-held computers. Each computer
regularly sells for $200. The following cost data per computer are based on a normal
production of 8,000 computers produced each period. The company has the capacity to
produce 12,000 computers.
Direct materials $75
Direct labor 55
Factory Overhead (75% variable, 25% 40
unavoidable fixed)
Hand Devices has received a special order for a sale of 500 computers to an overseas
customer. The customer is willing to pay $150 per computer. The only selling costs that
would be incurred on this order would be $10 per computer for shipping. Hand is now
selling 8,000 computers through regular distributors each period. Should Hand Devices
accept the special order? use the incremental approach.
No. The incremental costs are $170 per computer, which exceeds the price the
customer is willing to pay.
Incremental revenue per computer = $150
Incremental cost per computer.$75 + $55 + [75% x $40] + $10 = $170
Incremental loss per computer = $150 - $170 = $20

Problem 14 - Chapman Company manufactures widgets. Embree Company has


approached Chapman with a proposal to sell the company widgets at a price of
$100,000 for 50,000 units. Chapman is currently making these components in its own
factory. The following costs are associated with this part of the process when 50,000
units are produced:
Direct material $44,000
Direct labor 20,000
Manufacturing 60,000
overhead
Total $124,000
The manufacturing overhead consists of $32,000 of costs that will be eliminated if the
components are no longer produced by Chapman. The remaining manufacturing
overhead will continue whether or not Chapman makes the components. From
Chapman’s point of view, what is the amount of avoidable costs if it buys rather than
makes the components?
$44,000 + $20,000 + $32,000 = $96,000

Problem 15 - Wilson Company is considering replacing equipment which originally cost


$56,000 and which has $43,000 accumulated depreciation to date. A new machine will
cost $67,000. How much costs are sunk in this situation?
$56,000 This will not affect the outcome of decision making.

Problem 16 - Darnell Inc. budgeted 5,000 widgets for production during 2004. Fixed
factory overhead is allocated using ABC. The following estimated costs were provided:
Direct material ($80/unit) $400,000
Direct labor ($22/hr. * 2 hrs./unit) 220,000
Variable manufacturing overhead 40,000
($8/unit)
Fixed factory overhead costs 269,000
($53.80/unit)
Total $929,000

Cost per unit = $185.80

A. Darnell received an order for 400 units from a new customer in a country in which
Darnell has never done business. This customer would like to spend $160 per widget.
Darnell has capacity to produce 5,500 units. Should Darnell accept the order? Support
your work with an incremental analysis.
Yes, it can make $11,200
Incremental revenue per widget $160
Incremental cost per widget:
$80 + ($22 x 2) + $8 = 132
Incremental profit per unit $ 28
Total incremental profit = $28 x 400 = $11,200
B. Darnell received an offer from another company to manufacture the same quality
widgets for them at $140. Should Darnell let someone else manufacture all 5,000
widgets and focus on only distribution? Support your work with an incremental analysis.
No, Darnell can expect profitability to decline $40,000 if it outsources production.
Incremental Cost to buy per widget ($140*5,000) ($700,000)
Incremental Cost to make per widget/savings if buy widgets:
$80 + ($22 x 2) + $8 = $132*5,000 +660,000
Incremental savings if manufactured $ 40,000
C. While evaluating the offer to outsource, Darnell realized it could rent its
manufacturing space for $ 50,000. Now, should Darnell outsource the manufacture of
the widgets? Support your work with an incremental analysis.
Yes, Darnell can expect profitability to increase $10,000 if they outsource production
Cost to buy all 5,000 widgets: $140 x 5,000 = ($700,000)
Opportunity cost of renting facility +50,000
Cost to make per widget: $132 x 5,000 = +660,000
Incremental savings if outsourced +$10,000

Auchter Company has old inventory on hand that cost $12,000. Its scrap value
Problem 17 -
is only $5,000. The inventory could be sold for $20,000 if manufactured further at an
additional cost of $13,000. What should Auchter do? Support your work with an
incremental analysis.
Process further and sell:
Incremental revenue $20,000
Incremental costs (13,000)
Incremental profit 7,000
Incremental revenue to sell as is: $5,000
Best option is to process further and sell at $20,000.

Problem 18 - Zweig, Inc. produces batches of chocolate chip


cookies:
Batch
Cost
Direct materials $ 8.00
Direct labor 3.00
Variable overhead 1.00
Fixed common overhead 4.00
An outside supplier has offered to produce the cookies for $14 per batch. What is the
minimum amount that Zweig would sell additional batches of cookies if the company
is under capacity?
$8 + $3 + $1 = $12; Relevant = incremental. Note that avoidable means it is a cost that
will not be incurred if the product is bought instead of made, i.e., it is a cost
savings. The direct costs are saved as well. Only the costs that are different if the
cookies are made instead of bought are relevant.

Problem 19 - Barry Corporation currently manufactures a subassembly for its main


product. The costs per unit are as follows:
Direct materials $ 1.00
Direct labor 10.00
Variable overhead 5.00
Fixed overhead 8.00
Total $24.00
Funkhouser Company has contacted Barry with an offer to sell it 5,000 of the
subassemblies for $18.00 each. Total relevant costs if Barry makes the subassemblies
are $85,000. Should Barry make or buy the subassemblies? Support your answer with
an incremental analysis.
Cost to make - costs to buy = incremental cost
$85,000 (given) - (5,000 x $18) = ($5,000) Cost savings if made.
Note that you do not know how much of the fixed overhead is avoidable per unit, so you
can't use per unit amounts. In addition, since the relevant cost to make is given, it is
much easier to find the answer than calculating.

The cost to produce Part A was $10 per unit in 2003. During 2004, it has
Problem 20 -
increased to $11 per unit. In 2004, Supplier Company has offered to supply Part A
for $9 per unit. For the make-or-buy decision, identify the following amounts that are
relevant:
A. Incremental revenues
There are never any incremental revenues with make or buy decisions.
B. Differential costs are $2 per unit.
Cost to make - cost to buy = $11 - $9 = $2 per unit

Problem 21 - A company uses 10,000 units of Part A in producing its products. A


supplier offers to make Part A for $70. Max Company has relevant costs of $80 a
unit to manufacture Part A. There is excess capacity. How much is the opportunity
cost of buying Part A from the supplier?
Zero. Opportunity costs are the value of benefits forgone by selecting one alternative over
another. There are no opportunity costs in this problem.

Problem 22 - Temple, Inc. produces several models of grandfather clocks. An outside


supplier has offered to produce the economy clocks for Temple for $350 each. Temple
needs 1,200 clocks annually. Temple has provided the following unit costs for its
economy model:
Unit
Cost
Direct materials $ 100
Direct labor 120
Variable overhead 80
Fixed overhead (40% 150
avoidable)

Using good form, prepare an incremental analysis which shows the effect of the make
or buy decision. Show calculations to support your answers in the space outside the
answer box.
Incremental
Incremental analysis:
effect
Incremental Cost to buy (1,200 x $350) ($420,000)
Incremental Cost savings:
Savings of DM $100 x 1,200 = $120,000
Savings of DL $120 x 1,200 = 144,000
Savings of VOH $80 x 1,200 = 96,000
40% x $150 x 1,200
Savings of FOH 72,000
=
Incremental total cost savings +432,000
Incremental cost saving if clocks are bought instead
$12,000
of made

Problem 23 - A division has the following data:


Sales $600,000
Variable expenses 320,000
Fixed expenses 310,000
What will be the incremental effect on net income if this division is eliminated, assuming
the fixed expenses will be allocated to profitable segments? Use the incremental
analysis approach.
Effect on
profit
Incremental revenue ($600,000)
Incremental variable costs +320,000
Incremental effect on profit ($280,000)
Only costs that change between alternatives are incremental. Fixed expenses that are
allocated never change.

Problem 24 - Diversified Machines has four product lines, one of which reflects the
following results:
Sales $220,000
Variable expenses 120,000
Contribution margin 100,000
Fixed expenses 120,000
Net loss $(20,000)
If this product line is eliminated, 40% of the fixed expenses can be eliminated and the
other 60% will be allocated to other product lines.
A. Create an incremental analysis to determine if this product line should be eliminated.

Effect on Profit
Incremental decrease in revenue ($220,000)
Incremental variable cost savings $120,000
Incremental fixed cost savings ($120,000 x 40%) +48,000
Incremental decrease in profits if eliminated ($52,000)
B. Identify any non-relevant costs.
Since the other 60% of fixed costs will be incurred regardless of decision, they are not
relevant.

Problem 25 - Sally Industries can produce 100 units of a necessary component part with
the following costs:
Direct Materials $30,000
Direct Labor 13,000
Variable Overhead 32,000
Fixed Overhead 12,000
If Sally Industries purchases the component externally, $3,000 of the fixed costs can be
avoided. At what external price for the 100 units is the company indifferent between
making or buying?
The company is indifferent when the cost of making the part equals the cost of buying
the part, which is $78,000:
Effect on
Incremental savings:
Profit
($30,000 + $13,000 + $32,000 + $3,000) $78,000

Problem 26 - Hernandez, Inc. manufactures 3 models of picture frames. Hernandez


Corporation manufactures 5,000 frames per year. The unit cost to produce a metal
frame follows:
Direct Materials $6
Direct Labor 7
Variable Overhead 2
Fixed Overhead (70% 5
unavoidable)
Total $20
A local company has offered to supply Hernandez the 5,000 metal frames it needs for
$16 each. In good form, create an incremental analysis for the make or buy decision.
Incremental cost to buy ($80,000) 5,000 x $16 = $80,000

Incremental savings:
Direct materials savings +$30,000 5,000 x $6 = $30,000
Direct labor savings +35,000 5,000 x $7 = $35,000
Variable overhead savings +10,000 5,000 x $2 = $10,000
Fixed overhead savings - avoidable portion +7,500 5,000 x $5 x 30% = $7,50
Incremental savings if 'buy' decision is made $2,500

Problem 27 - Crisp has 4 product lines: milk, ice cream, yogurt, and butter. The
allocated fixed costs are based on units sold and are unavoidable. Demand of individual
products is not affected by changes in other product lines. 40% of the fixed costs are
direct, and the other 60% are allocated. Results of June follow:
Milk Ice Cream Yogurt Butter
Units sold 2,000 500 400 200

Revenue $10,000 $20,000 $10,000 $20,0


Variable departmental costs 6,000 13,000 4,200 4,8
Fixed costs 5,000
2,000 3,000 7,0
Net income (loss) ($1,000) $5,000 $2,800 $8,2

A. In good form, prepare an incremental analysis of the effect of dropping the milk
product line.

Incremental revenue ($10,000)

Incremental variable cost savings +6,000


Incremental fixed cost savings (5,000 x .40) +2,000
Incremental decrease in profits ($2,000)

B. Briefly state how the cost allocation death spiral concept applies to this problem.
The cost allocation death spiral occurs when a company drops a product line/division
that has a loss. Management may believe this will eliminate the loss, however, since the
common fixed costs must be allocated and absorbed by other products, the total profit
of the company declines. i.e., allocated fixed costs cannot be avoided.

Problem 28 - Evans Corporation currently manufactures 3,000 subassemblies annually


for its main product. The costs per unit are as follows:
Direct materials $ 3.00
Direct labor 8.00
Variable 4.00
overhead
Fixed overhead 7.00
Total $22.00
Howard Company has contacted Evans with an offer to sell it 3,000 subassemblies for
$18.00 each. $5 of the fixed overhead per unit is unavoidable. In good form in the
answer box below, create an incremental analysis for the make or buy decision. (Do
not include extraneous information/calculations inside the answer box.)

Incremental analysis: Calculations (not part of analysis):


Incremental cost to buy ($54,000) 3,000 x $18
Incremental savings on direct materials +9,000 3,000 x $3
Incremental savings on direct labor +24,000 3,000 x $8
Incremental savings on variable MOH +12,000 3,000 x $4
Incremental savings on fixed MOH +6,000 3,000 x $2*
Incremental net cost to buy ($3,000)
*The unavoidable portion of this cost ($5) exists whether or not the company makes or
buys the subassemblies. If the subassemblies are bought, the company saves the
avoidable portion of the cost, $2 per unit.

Problem 29 Parrino has three product lines in its retail stores: books, videos, and music.
The allocated fixed costs are based on units sold and are unavoidable. Results of the
fourth quarter are presented below:
Books Music Videos Total
Units sold 1,000 2,000 2,000 5,000

Revenue $24,000 $48,000 $34,000 106,0


Variable departmental costs 15,000 22,000 23,000 60,0
Direct fixed costs 3,000 6,000 5,000 14,0
Allocated fixed costs 4,400 8,800 8,800 22,0
Net income (loss) $ 1,600 $11,200 ($2,800) $10,0

Demand of individual products is not affected by changes in other product lines. In good
form, prepare an incremental analysis of the effect of dropping the Video product line.
Incremental analysis:
Incremental revenue ($34,000)
Incremental savings on variable costs +23,000
Incremental savings on direct fixed costs +5,000
Incremental decrease in profit to drop video line ($6,000)
Note: Incremental analyses show only the differences in revenues and costs.
Comparative columns or comparative income statements, or a revised income
statement showing the net amounts to be reported after the drop are NOT incremental
analyses. We emphasized incremental analysis using this approach in class.

Problem 30 - Calc, Inc. owns a machine that produces baskets for the gift packages the
company sells. The company uses 800 baskets in production each month. The costs of
making one basket is $4 for direct materials, $3 for variable manufacturing overhead, $2
for direct labor and $5 for fixed manufacturing overhead. The unit cost is based on the
monthly usage of 800 baskets. The company determined that 30% of the fixed
manufacturing overhead is avoidable. An outside supplier has offered to sell Calc the
baskets for $12 each, and can supply all the units it needs. In good form, prepare an
incremental analysis to determine if Calc should buy the component from the supplier?
Incremental cost to buy (800 x $12) ($9,600)
Incremental cost savings:
DM ($4 x 800) +3,200
VOH ($3 x 800) +2,400
DL ($2 x 800) +1,600
FOH ($5 x 30% x 800) +1,200
Incremental cost to buy ($1,200)
Since 30% of the fixed cost is avoidable, this cost will be a savings.

Problem 31 - Boys Toys sells three products in its retail stores: planes, trains, and cars.
Results of the 4th quarter are below:
Planes Trains Cars Total
Units sold 1,000 2,000 2,000 5,000
Revenue $31,000 $43,000 $26,000 $100,000
Variable departmental costs 22,000 24,000 13,000 59,000
Direct fixed costs 5,000 4,000 3,000 12,000
Allocated fixed costs 6,000 7,000 7,000 20,000
Net income ($2,000) $ 8,000 $ 3,000 $ 9,000
Demand of individual products are not affected by changes in other product lines. In
good form, prepare an incremental analysis to determine if planes should be
discontinued.
Incremental revenue ($31,000)
Incremental VC savings +22,000
Incremental direct fixed costs +5,000
Incremental decline in profit if discontinued ($4,000)

Problem 32 - The following estimated costs were provided by Young Company:


Direct material ($30/unit) $30,000
Direct labor ($12/hr. * 3 hrs./unit) 36,000
Variable manufacturing overhead 15,000
($15/unit)
Fixed factory overhead costs 10,000
($10/unit)
Total $91,000
Young received an order for 600 units from a new customer in a country in which Young
has never done business. This customer would like to spend $86 per widget. Young has
capacity to produce 900 more units. Should Young accept the order? Support with an
incremental analysis.
Yes, it can make $3,000 more profit

Incremental revenue (600 x $86) = +$51,600


Incremental DM cost (600 x $30) = (18,000)
Incremental DL cost (600 x $36) = (21,600)
Incremental VMOH cost (600 x $15) = (9,000)
Incremental profit = + $3,000
Fixed OH is not incremental since it does not change.
Problem 33 - Kirk Company plans to produce 50,000 buckets next year at a total cost of
$850,000. Fixed costs are $3 per unit at this level of operations. Selling price is $8 per
unit. Kirk is considering lowering the price to $7 per unit, and feels that this action will
cause sales to climb to 60,000 buckets. Use incremental analysis to calculate
incremental profit or loss if the change is made to the sales price.
Incremental revenue: Effect on Profit
Before change: $8 x 50,000 = $400,000
After change: $7 x 60,000 = 420,000
Incremental increase in profits $20,000

Problem 34 - Zeriff’s Donuts currently sells donuts for $4.00 per dozen. These donuts
cost $2.70 per dozen to produce. Business was very slow yesterday, and several
dozen donuts have been marked down to $1.50 per dozen on the day-old table today.
What is the sunk cost associated with these donuts?
The original cost of the donuts is $2.70 no matter what and it can't be changed. This is
a sunk cost.

Problem 35 - Morley, Inc. has three product lines in its retail stores: putters, drivers, and
sinkers. The allocated fixed costs are based on units sold and are unavoidable. Results
of May follow:
Putters Drivers Sinkers Total
Units sold 500 1,000 1,000 2,500
Revenue $24,000 $48,000 $34,000 106,000
Variable departmental
costs 15,000 22,000 23,000 60,000
Direct fixed costs 3,000 6,000 5,000 14,000
Allocated fixed costs 4,000 8,000 8,000 20,000
Net income (loss) $ 2,000 $12,000 ($2,000) $12,000
Demand of individual products is not affected by changes in other product lines. In good
form, prepare an incremental analysis of the effect of dropping the sinkers product line.
Incremental analysis:
Incremental decrease in revenue ($34,000)

Incremental savings of variable costs +23,000

Incremental savings of direct fixed costs +5,000


Incremental decline in profit if Sinkers dropped ($6,000)

Problem 36 - Walker, Inc. currently manufactures 4,000 motors for its electric scooters
annually. Direct material costs are $48,000 and direct labor total $12,000 annually.
Overhead totals $10 per unit of which $4 is variable. Thirty percent of the fixed
overhead is unavoidable. Anthony, Inc. has contacted Walker with an offer to sell the
motors for $21 each. In good form, create an incremental analysis for the make or buy
decision.

Incremental analysis:
Incremental cost to buy ($21 x 4,000) ($84,000)
Incremental direct material cost savings +48,000
Incremental direct labor cost savings +12,000
Incremental variable overhead cost savings ($4 x 4,000) +16,000
Incremental fixed overhead cost savings
[$10- $4] x 4,000 x 70% +16,800
Incremental net cost savings if buy instead of make $8,800

Problem 37 - Bing Corporation currently manufactures a lid for its main product. The
relevant costs to produce one unit for direct costs are $1.70, and the allocated
common costs are $0.80 per unit. A supplier has offered to provide the monthly
supply of 12,000 lids for $21,600. Should Bing outsource the lids? Use incremental
analysis.
No, the cost increases by $1,200
Incremental savings of cost to make: $1.70 x 12,000 = $20,400
Incremental cost to buy: ($21,600)
Incremental cost to buy instead of make: $20,400 - $21,600 = ($1,200)

Problem 38 - Block Corporation currently makes the rolls that it uses for its sandwiches.
It uses 50,000 rolls annually. The costs to make the rolls are given below:
Materials $0.04
Labor $0.03
VOH $0.02
FOH $0.07
A potential supplier has offered to sell Block the rolls for $0.11 each. If the rolls are
purchased, 20% of the fixed overhead could be avoided. Determine the effect if Block
accepts the offer. Use incremental analysis.
Profits will decrease (costs will increase) by $300 if accepted.
Incremental analysis:
Incremental cost to buy ($0.11)
Incremental cost savings:
DM savings + $0.04
DL savings + $0.03
VOH savings + $0.02
FOH savings ($.07 x 20%) + $0.014
Incremental decrease in profit per unit = $.006

Total incremental decrease in profit (50,000 x $0.006) = $300

Problem 39 - Menlo Shoe Company is trying to decide whether or not to continue


making bowling shoes. The following information is available for the segments. Assume
that all direct fixed costs could be avoided if a segment is dropped and that the total
common fixed costs would remain unchanged if the bowling shoes were dropped.
Bowling
Athletic Shoes Boots
Shoes
Sales $120,000 $420,000 $360,000
VC 64,000 220,000 140,000
CM 56,000 200,000 220,000
Direct FC 40,000 70,000 90,000
Allocated FC 20,000 70,000 60,000
NI ($4,000) $60,000 $70,000
If bowling shoes are dropped, what would happen to the overall net income? Support
with incremental analysis.
It would decrease by $16,000.
Incremental Revenue ($120,000)
Incremental VC savings + $64,000
Incremental Direct FC savings + $40,000
Incremental decrease in profits ($16,000)

Problem 40 - Menlo Shoe Company is trying to decide whether or not to continue


making bowling shoes. The following information is available for the segments. Assume
that all direct fixed costs could be avoided if a segment is dropped and that the total
common fixed costs would remain unchanged if the bowling shoes were dropped.
Bowling Shoes Athletic Shoes Boots
Sales $120,000 $420,000 $360,000
VC 64,000 220,000 140,000
CM 56,000 200,000 220,000
Direct FC 40,000 70,000 90,000
Allocated FC 20,000 70,000 60,000
NI ($4,000) $60,000 $70,000
Assume that boots normally sell for $90 per pair. An exporter has approached Menlo
about buying 1,000 pairs of boots for a one-time export deal for $80 per pair. $3.00 per
unit of the normal variable cost could be avoided on this sale, but Menlo would have to
pay a fixed cost $4,000 to have the boots shipped. Menlo has capacity to produce this
order, and no regular sales will be affected. Should Menlo accept this order? Support
with an incremental analysis.
Yes, profits will increase by $44,000.
# of boots sold = $360,000/$90 = 4,000
Incremental cost per unit = $140,000/4,000 = $35
Incremental revenue ($80 x 1,000) $80,000
Incremental VC ($35 - $3) x 1,000 (32,000)
Increase in fixed costs 4,000
Incremental increase in profits $44,000

Problem 41 BarBQue Heaven has three product lines in its stores: ribs, chicken, and
beef. Results of May are presented below:
Ribs Chicken Beef Total

Units sold 2,000 4,000 4,000 10,000


Revenue $22,000 $40,000 $23,000 $85,000
Variable departmental costs 15,000 22,000 12,000 49,000
Direct fixed costs 1,000 3,000 2,000 6,000
Allocated fixed costs 7,000 7,000 7,000 21,000
Net income ($1,000) $ 8,000 $ 2,000 $ 9,000
Allocated fixed costs are unavoidable. Individual product demand is not affected by
changes in other product lines.

A. In good form, use the incremental approach to determine if BarBQue Heaven should
discontinue Ribs. Label appropriately. Show calculations in the space provided if
needed. .

Incremental analysis:
Incremental revenue ($22,000)
Incremental variable costs savings + 15,000
Incremental direct fixed cost savings + 1,000
Incremental decrease in profit if ribs are dropped ($6,000)

B, Briefly state how the cost allocation death spiral applies to this problem.
When a division is eliminated, the fixed costs that had been allocated to it, have to
be allocated to the remaining divisions. Hence, the allocated fixed costs do not
disappear. Without the additional contribution margin from the dropped product, total
profit declines. If more products are dropped the company spins into a deeper cut in
profits or increased loss.

Problem 42 - Halo Inc. budgeted 8,000 bearings for production during 2006. Fixed
factory overhead is allocated using ABC. Halo received an offer from a suppler to
manufacture the same quality bearings at $81 each. The space currently occupied by
the manufacturing facility could be leased out for $20,000 per year if the supplier
provides the bearings. The following estimated costs were provided:
Direct material ($50/unit) $400,000
Direct labor ($16/hr. * 1.5 hrs./unit) 192,000
Variable manufacturing overhead 48,000
($6/unit)
Fixed factory overhead costs 144,000
($18/unit)
Total $784,000

Cost per unit = $98.00


Use the incremental approach to determine if Halo should buy its bearings from the
supplier. Label appropriately. Show calculations in the space provided if needed. .
Incremental analysis: Calculations:
Incremental cost to buy ($648,000) ($81*8,000)
Incremental cost savings - DM +400,000
Incremental cost savings - DL +192,000
Incremental cost savings - VOH +48,000
Incremental lease revenue +20,000
Incremental cost savings to buy from $12,000
supplier

Problem 43 Clinton Company makes and sells 16,000 ties each year. Fixed overhead
costs are allocated to ties based on its annual production of 16,000 ties. The unit cost of
making one tie at this activity level follows:
Direct material $9
Variable manufacturing 3
overhead
Direct labor 5
Fixed manufacturing 4
overhead
Capacity is 20,000 ties. Forty percent of the fixed overhead costs is avoidable. An
overseas company recently offered to buy 2,500 ties at $20 per tie even though
Clinton’s regular customers pay $25 each.
A. Use the incremental approach to determine the effect on income if Clinton accepts
the order for 2,500 ties. Label appropriately. Show calculations in the space provided if
needed.

Incremental analysis: Calculations:


Incremental revenue $50,000 2,500*$20
Incremental costs = DM (22,500) 2,500*$9
Incremental costs = DL (7,500) 2,500*$3
Incremental costs = VOH (12,500) 2,500*$5
Incremental costs avoided = FOH (4,000) 2,500*$4*40%
Incremental increase in profit if special order $3,500
accepted
B. Should Clinton accept? Briefly justify your answer.
Most likely, yes. Profits increase by $3,500. Qualitative benefits and costs should be
considered as well.

Problem 44 SMP Company's market for the Model 64 has changed significantly, and
SMP has had to drop the price per unit from $265 to $125. There are some units in the
work in process inventory that have costs of $150 per unit associated with them. SMP
could sell these units in their current state for $100 each. It will cost SMP $10 per unit to
complete these units so that they can be sold for $125 each. Which of the following is
the amount of sunk costs in this problem?
$150 per unit
Two costs are not relevant since the profits remain the same regardless if SMP is
dropped or not. The original selling price of $265 does not make the company more or
less profitable. The $150 cost exists regardless of the decision made. However, a sunk
cost is an amount incurred for which it is too late to change. The previous selling price is
not a 'cost'.

Problem 45 Block Corporation currently makes the rolls that it uses for its sandwiches. It
uses 50,000 rolls annually. The costs to make the rolls are given below:
Materials $0.04
Labor $0.03
VOH $0.02
FOH $0.07
A potential supplier has offered to sell Block the rolls for $0.11 each. If the rolls are
purchased, 20% of the fixed overhead could be avoided. If Block accepts the offer, it will
be:
Incremental analysis:
Incremental cost to buy ($0.11)
Incremental cost savings:
DM savings + $0.04
DL savings + $0.03
VOH savings + $0.02
FOH savings + $0.014
($.07 x 20%)
Incremental decrease in profit per unit = $.006
Total incremental decrease in profit = $300
(50,000 x $0.006)

Problem 46 Alan Company makes sets of wrenches. They are trying to decide whether
to continue to make the case the wrenches are sold in, or to outsource it to another
company. The direct material and direct labor cost to produce the cases total $2.00 per
case. The overhead cost is $1.00 per case which consists of $0.40 in variable overhead
which would all be eliminated if the case were bought from the outside supplier. The
$0.60 of fixed overhead is based on expected production of 200,000 cases per year and
consists of the salary of the case production manager of $40,000 per year and $80,000
in depreciation on equipment that would have no resale value. The manager would be
laid off if the cases were bought externally. Additionally, if the case production were
stopped, the space that it is using could be rented out for $20,000 per year. The outside
supplier has offered to supply the cases for $2.80 per case. How much will Alan save or
lose if the cases are bought externally?
Incremental analysis:
Incremental cost to buy per case ($2.80)
Incremental cost savings to buy:
DM and DL savings + $2.00
VOH savings + $0.40
FOH savings:
Salary $40,000/200,000 = = $0.20
Incremental opportunity cost is bought +$0.10
($20,000/200,000)
Incremental cost increase if bought = ($0.10) per case

Problem 47- Smith Company manufactures widgets. Newman Company has


approached Smith with a proposal to sell the company one of the components used to
make widgets at a price of $100,000 for 50,000 units. Smith is currently making these
components in its own factory. The following costs are associated with this part of the
process when 50,000 units are produced:
Direct material $44,000
Direct labor 20,000
MOH 60,000
The manufacturing overhead consists of $32,000 of costs that will be eliminated if the
components are no longer produced by Smith. The remaining manufacturing overhead
will continue whether or not Smith makes the components. Answer the following
questions from Smith's point of view.
Should Smith make or buy the components for the widgets?

Continue to make them because the incremental cost of buying from Newman is
$4,000.
Incremental analysis:
Incremental cost to buy ($100,000)
Incremental cost savings to make:
DM + $44,000
DL + $20,000
MOH + $32,000
Incremental cost to buy ($4,000)

Problem 48 Huxley Sports Company sells logo sports merchandise and does custom
screen printing. They are trying to decide whether or not to continue screen printing.
The following information is available for the segments. Assume that all direct fixed
costs could be avoided if a segment is dropped and that the total common fixed costs
would remain unchanged if the screen printing were dropped.
Screen Apparel
Printing Sales
Sales $120,000 $420,000
Variable costs 72,000 220,000
Contribution margin 48,000 200,000
Direct fixed costs 32,000 70,000
Allocated common fixed
20,000 70,000
costs
Net income ($4,000) $60,000
Assume that more space will be allocated to apparel sales if screen printing is dropped.
This will allow apparel sales to increase by 25%. What is the impact on profits of the
proposed change?
Incremental revenue - screen ($120,000)
Incremental revenue - apparel (25%*$420,000) 105,000
Incremental savings/(costs):
VC - screen printing + 72,000
VC - apparel (25%*$220,00) (55,000)
Direct FC +32,000
Incremental increase in profits $34,000

Problem 49 Menlo Shoe Company is trying to decide whether or not to continue making
bowling shoes. The following information is available for the segments. Assume that all
direct fixed costs could be avoided if a segment is dropped and that the total common
fixed costs would remain unchanged if the bowling shoes were dropped.
Bowling
Athletic Shoes Boots
Shoes
Sales $120,000 $420,000 $360,000
VC 64,000 220,000 140,000
CM 56,000 200,000 220,000
Direct FC 40,000 70,000 90,000
Allocated FC 20,000 70,000 60,000
NI ($4,000) $60,000 $70,000
If bowling shoes are dropped, what would happen to overall net income?
Incremental revenue ($120,000)
Incremental VC savings + $64,000
Incremental direct FC savings + $40,000
Incremental decrease in profits ($16,000)

Problem 50 Menlo Shoe Company is trying to decide whether or not to continue making
bowling shoes. The following information is available for the segments. Assume that all
direct fixed costs could be avoided if a segment is dropped and that the total common
fixed costs would remain unchanged if the bowling shoes were dropped.
Bowling
Athletic Shoes Boots
Shoes
Sales $120,000 $420,000 $360,000
VC 64,000 220,000 140,000
CM 56,000 200,000 220,000
Direct FC 40,000 70,000 90,000
Allocated FC 20,000 70,000 60,000
NI ($4,000) $60,000 $70,000
Assume that boots normally sell for $90 per pair. An exporter has approached Menlo
about buying 1,000 pairs of boots for a one-time export deal for $80 per pair. $3.00 per
unit of the normal variable cost could be avoided on this sale, but Menlo would have to
pay a fixed cost $4,000 to have the boots shipped. Menlo has capacity to produce this
order, and no regular sales will be affected. If Menlo accepts this order:
# of boots sold = $360,000/$90 = 4,000
Incremental cost per unit =
$140,000/4,000 = $35

Incremental revenue ($80 x 1,000) $80,000


Incremental VC ($35 - $3) x 1,000 (32,000)
Increase in fixed costs 4,000
Incremental increase in profits $44,000

Problem 51Contesa Company plans to produce 8,000 units during May at a total cost of
$29,000. Fixed costs total $13,000. Selling price per unit is $5.00. Management is
considering lowering the price to $4.60 per unit, and feels that this action will cause
sales to climb to 8,800 units. How much are the incremental costs incurred if 8,800 units
are produced and sold?
Total costs = FC + VC
$29,000 = $13,000 + X; so VC = $16,000;
VC per unit: $16,000/8,000 = $2 per unit
Incremental costs to produce 800 more units (8,800 - 8,000):
800 units x $2 = $1,600

Problem 52 Don’s Donuts budgets the following costs for the production of 36,000
boxes of donuts next year: Rent, $20,000; other fixed costs, $6,000; direct materials,
$54,000, and direct labor, $36,000. The normal selling price is $4.00 per box. A new
convenience store has offered to pay Don’s $3.00 per box to supply them with 10,000
boxes of donuts during the year. Assuming that Don’s has the capacity to fill this order
along with their other production and that accepting this order will not cause problems
with any of their other customers, should Don’s Donuts accept this order? Justify your
answer with computations.
Yes, because incremental profits will increase by $5,000.
Incremental revenue: $3.00 x 10,000 = $30,000
Incremental costs: VC/unit= [$54,000+$36,000]/36,000 = $2.50; so incremental
costs are $2.50 x 10,000 boxes = $25,000; Incremental profit is revenue less cost:
$30,000 - $25,000 = $5,000

Problem 53 - AT, Inc. plans to produce and sell 80,000 calculators next year. Fixed
costs are $100,000. The current selling price is $7 each and the variable cost per unit is
$4. Management is considering raising the selling price to $8 per unit, but this is likely to
cause the sales volume to drop to 76,000 units. How much is the incremental profit
associated with the changes?
Incremental revenue
(80,000 x $7) - (76,000 x $8) $48,000
Incremental costs:
Variable cost: ((80,000 - 76,000) x $4) (16,000)
Incremental profit $32,000

Problem 54 Tague Company sells calculators. During the past year, 6,000 calculators
were produced and sold at $10 each. Variable cost per unit was $3 and total fixed costs
were $200,000. Tague would like to raise the selling price per unit to $11 each, but feels
that this will reduce sales to 5,500 bottles per year. How much is the incremental
revenue of raising the selling price?
Old revenue: $10 x 6,000 = $60,000
New revenue: $11 x 5,500 = $60,500
Incremental revenue: $60,500 - $60,000 = $500

Problem 55 At Fruit Company, the total cost to produce 50,000 units is $750,000. Total
fixed costs are $250,000. What is the expected cost to produce 48,000 units?
VC = ($750,000 - $250,000) = $500,000
VC per unit = $500,000/50,000 = $10
Cost at 48,000 units = $10(48,000) + $250,000 = $730,000
Problem 56 At Richetti Company, the total variable cost to produce 15,000 units is
$45,000. Total fixed costs are $21,000. What is the expected cost to produce 13,000
units?
VC per unit = $45,000/15,000 = $3 per unit
Total cost = variable cost + fixed costs = [$3*13,000] + $21,000 = $60,000
Note that product costs include both fixed and variable amounts. If the question
asked for the incremental cost, then $39,000, the variable cost would be the answer,
only if the difference in units was 13,000.

Problem 57 Key Company plans to produce and sell 500 skateboards next year. Fixed
costs are estimated at $50,000. Key sells each skateboard for $60. Total variable costs
at 500 units are $12,000. Management is considering decreasing the selling price to
$55 each, which is likely to cause the sales volume to increase to 600 units. How much
is the incremental revenue associated with the changes?
Option 1 (price at $60) = $60 x 500 = $30,000
Option 1 (price at $55) = $55 x 600 = $33,000
Incremental revenue = $33,000 - $30,000 = $3,000

Problem 58 Eng Company plans to produce and sell 400 skateboards next year. Fixed
costs are estimated at $10,000. Eng sells each skateboard for $50. Variable costs are
$20 per unit. Management is considering decreasing the selling price to $45 each,
which is likely to cause the sales volume to increase to 500 units. How much is the
incremental profit associated with the changes?
Incremental revenue = (400 x $50) - (500 x $45) = +$2,500
Incremental costs = 100 x $20 = (2,000)
Incremental profit = $2,500 - $2,000 = $500

Problem 59 Bell Company sells sims. During the past year, 8,000 sims were produced
and sold at $10 each. Variable cost per unit was $4 and total fixed costs were $160,000.
Bell would like to raise the selling price per unit to $12 each, but feels that this will
reduce sales to 7,400 sims per year.

A. Highlight the amounts of any items which are not relevant to this decision.
Highlighted in green = not relevant. Fixed costs are not relevant since the amount stays
the same regardless of whether the selling price stays at $10, or in raised to $12.

B. How much is the incremental revenue?


Current revenue: 8,000 x $10 = $80,000
Revenue if change is made: 7,400 x $12 = 88,800
Incremental revenue +$8,800

C. How much is the incremental profit?


Incremental revenue (from part B) +$8,880
Incremental cost: [8,000 - 7,400] x $4 = (2,400)
Incremental profit $6,400

Problem 60 Kirk Company plans to produce 50,000 buckets next year at a total cost of
$850,000. Fixed costs are $3 per unit at this level of operations. Selling price is $8 per
unit. Kirk is considering lowering the price to $7 per unit, and feels that this action will
cause sales to climb to 60,000 buckets. Use incremental analysis to calculate
incremental profit or loss if the change is made to the sales price.
Incremental revenue: Effect on Profit
Before change: $8 x 50,000 = $400,000
After change: $7 x 60,000 = 420,000
Increase in revenue $20,000

Problem 61 Don’s Donuts budgets the following costs for the production of 36,000
boxes of donuts next year: Rent, $20,000; other fixed costs, $6,000; direct materials,
$54,000, and direct labor, $36,000. The normal selling price is $4.00 per box. A new
convenience store has offered to pay Don’s $3.00 per box to supply them with 10,000
boxes of donuts during the year. Assuming that Don’s has the capacity to fill this order
along with their other production and that accepting this order will not cause problems
with any of their other customers, should Don’s Donuts accept this order?
Yes, because incremental profits will increase by $5,000.
Incremental revenue: $3.00 x 10,000 = $30,000
Incremental costs:
VC/unit= [$54,000+$36,000]/36,000 = $2.50;
so incremental costs are $2.50 x 10,000 boxes = $25,000
Incremental profit = revenue less cost: $30,000 - $25,000 = $5,000

Problem 62 Sabab, Inc. produces 4 different qualities of cable for broadband internet
hookups. Sabab currently produces 800,000 yards of economy cable each month. The
costs of making each yard is $0.12 for direct materials, $0.05 for variable manufacturing
overhead, $0.03 for variable administrative overhead, $0.06 for direct labor, and $0.12
for fixed manufacturing overhead. Overhead is allocated based on direct labor hours.
An outside supplier has offered to sell Sabab economy cable for $0.28 per yard, and
can supply all it needs. The company determined that 15% of the fixed overhead is
avoidable if the company discontinues production of the economy cable. In addition, the
company could lease the machine used to make the economy cable to another
company for $8,000 annually. In good form, prepare an incremental analysis to
determine if Sabab should outsource the component.
Incremental Analysis Amounts Calculations (if
Incremental cost to buy ($224,000)
Incremental variable cost savings Buy: $0.28*800
Direct materials +96,000
Direct labor +48,000 DM: $0.12*800
Variable manufacturing overhead +40,000 DL: $0.06*800,
Variable administrative overhead +24,000 VMOH: $0.05*8
Incremental fixed overhead savings +14,400 VAOH: $0.03*8
Incremental lease revenue is bought +8,000 $0.15*800,000
Incremental increase in profit if bought +$6,400

Should Sabab outsource? Yes. Profits increase by $6,400.

Problem 63 Hooters sells 3 child meals in its restaurants: Hot Wings, 3 Mile Wings, and
Volcano Wings. Changes in product lines do not affect demand of other products.
Results of June are below:
Hot Wings 3 Mile Wings Volcano Total
Units sold 4,000 2,500 2,600 9,100
Revenue $32,000 $30,000 $26,000 $88,000
Variable departmental
costs 19,200 16,500 10,400 46,100
Direct fixed costs 5,000 7,000 4,000 16,000
Allocated fixed costs 6,500 8,500 7,500 22,500
Net income $1,300 ($2,000) $4,100 $3,400
Seventy percent of the allocated fixed costs are unavoidable. In good form, prepare an
incremental analysis to determine if 3 Mile Wings should be discontinued.
Incremental Analysis Amounts
Incremental revenue if dropped ($30,000)
Incremental variable cost savings +16,500
Incremental direct fixed cost savings +7,000
Incremental fixed costs avoided* +2,550
Incremental decrease in profit if dropped ($3,950)
* $8,500*30% = $2,550
Should 3 Mile Wings be discontinued? Briefly justify your response as to why or why
not.
3 Mile Wings should not be discontinued because profits would decline by $3,950,
which results in a net loss of $550 for the company instead of a $3,400 profit.

Problem 64 The following estimated costs were provided by Narb Company:


Direct material ($20/unit) $240,000
Direct labor ($12/hr. * .25 hrs./unit) 36,000
Variable manufacturing overhead 18,000
Allocated fixed overhead costs 30,000
($2.50/unit)
Total $324,000

Narb received an order for 2,500 units from a new customer with whom Narb is anxious
to do business. This customer would like to spend $26 per widget. Narb has the
capacity to produce the additional units. In good form, prepare an incremental analysis
to determine if Narb should accept the order.
Incremental Analysis Amounts Calculations:
2,500 * $26 = $65,000
$12*0.25hrs.*12,000 =
$7,500
2,500 * $20 = $65,000
2,500*12,000 = $3,750
Incremental revenue if accepted +$65,000
Incremental DL cost increase (7,500)
Incremental DM cost increase (50,000)
Incremental VOH cost increase (3,750)
Incremental increase in profit if accepted $3,750

# of units: $240,000/$20 = 12,000 units