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INCREMENTAL ANAYSIS:

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.

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.

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.

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.

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.

B. What is the amount of avoidable costs if Monk buys rather than makes the
components?

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

D. Should Monk make or buy the components? Briefly justify your answer.

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.
B. Should Anheiser close the Wise division? Briefly indicate why or why not.
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.

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.

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.

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?

B. What the effect on net income of accepting the special order? Use the incremental
approach.

Problem 10 - Scott, Inc. has a capacity of producing 300,000 units a year and sells
them at $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.

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.

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.
A. How much is the fixed cost savings related to canned goods?

B. Using the cost allocation death spiral concept, indicate whether West Coast
should drop its canned goods line.

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.

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?

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?

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.

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.

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.

Problem 17 - Auchter Company has old inventory on hand that cost $12,000. Its
scrap value 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.

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?

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

Problem 20 - The cost to produce Part A was $10 per unit in 2003. During 2004, it has
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

B. Differential costs are $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?

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.

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.
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.
B. Identify any non-relevant costs.

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?

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.

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 2
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.

B. Briefly state how the cost allocation death spiral concept applies to this problem.

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.)

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 $34,000 106,000
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 4,400 8,800 8,800 22,000
Net income (loss) $ 1,600 $11,200 ($2,800) $10,000

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 Video product line.

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?