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Chapter 3 Solutions PDF
Chapter 3 Solutions PDF
Chapter 3
Using Costs in
Decision Making
QUESTIONS
3-2 Variable costs are costs that increase proportionally with changes in the activity
level of some variable. Fixed costs are costs that in the short run do not vary with
a specified activity. Fixed costs depend on how much of the resource (capacity)
is acquired, rather than on how much is used.
3-3 Contribution margin per unit, which is the difference between revenue per unit
and variable cost per unit, is the contribution that each unit makes to covering
fixed costs and generating a profit. The contribution margin is therefore an
important component of the equation to determine the breakeven point and to
understand the effect on profit of proposed changes, such as changes in sales
volume in response to changes in advertising or sales prices.
3-4 Contribution margin per unit is the difference between revenue per unit and
variable cost per unit. The contribution margin per unit indicates how much the
total contribution margin will increase with an additional unit of sales. The
contribution margin ratio expresses similar ideas, but as a percentage of sales
dollars. Specifically, the contribution margin ratio is the total contribution margin
divided by total sales dollars (or contribution margin per unit divided by sales
price per unit), and indicates how much the total contribution margin increases
with an additional dollar of sales revenue.
3-5 In evaluating whether a business venture will be profitable, the breakeven point
is the volume at which the profit equals zero, that is, revenues equal total costs.
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Atkinson, Solutions Manual t/a Management Accounting, 6E
3-6 A mixed cost is a cost that has a fixed component and a variable component. For
example, utilities bills may include a fixed component per month plus a variable
component that depends on the amount of energy used. A step variable cost
increases in steps as quantity increases. For example, one supervisor may be
hired for every 20 factory workers. Mixed costs and step variable costs both
have elements of fixed and variable costs. However, mixed costs have distinct
fixed and variable components, with fixed costs that are constant over a fairly
wide range of activity (for a given time period) and variable costs that vary in
proportion to activity. Step variable costs are fixed for a fairly narrow range of
activity and increase only when the next step is reached.
3-7 Step variable costs are fixed for a fairly narrow range of activity and increase
when the next step is reached. For example, one supervisor may be hired for
every 20 factory workers. Fixed costs are costs that in the short run do not vary
with a specified activity for a wide range of activity. For example, factory rent
per month would likely remain unchanged as production increased or decreased,
even if by large amounts.
3-8 Incremental cost is the cost of the next unit of production and is similar to the
economist’s notion of marginal cost. In a manufacturing setting, incremental cost
is often defined as a constant variable cost of a unit of production. However, in
some situations, the variable cost of a unit of production may be more
complicated. For example, the variable cost of labor per unit may decrease over
time if workers become more efficient (a learning effect. Alternatively, the
variable cost of labor per unit will change during overtime hours if workers
receive an overtime premium (commonly 50%). Finally, some costs exhibit step-
variable behavior, as when one supervisor can supervise a quantity of employees
but an additional supervisor is needed beyond a certain number of employees.
3-9 In evaluating the different alternatives from which managers can choose, it is
better to focus only on the relevant costs that differ across different alternatives
because it does not divert the manager’s attention with irrelevant facts. If some
costs remain the same regardless of what alternative is chosen, then those costs
are not useful for the manager’s decisions, as they are not affected by the
decision. Therefore, it is better to omit them from the cost analysis used to
support the decision. Moreover, resources are not expended to find or prepare
irrelevant information.
3-10 Sunk costs are costs that are based on a previous commitment and cannot be
recovered. For example, depreciation on a building reflects the historical cost of
the building, which is a sunk cost. Therefore, they are not relevant costs for the
decision.
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Chapter 3: Using Costs in Decision Making
3-11 The general principal is that sunk costs are not relevant costs. But, some
managers may consider sunk costs to be relevant because they may be concerned
about how others will perceive their original decision to incur these costs, and
may want to cover up their initial poor judgment. Managers may also feel that
they do not want to waste the sunk costs by giving up on the possibility of some
benefit from the invested funds, or may continue to believe in potential success
despite overwhelming evidence to the contrary. Also, managers may be
embarrassed and unwilling to admit they made a mistake.
3-12 No, fixed cost are not always irrelevant. For example, in comparing the status
quo and a proposal to substantially increase the quantity of goods or services
provided, additional fixed costs (that is, costs not proportional to volume) may
be incurred to provide the increased quantity. Such costs might include a large
expenditure for more equipment or expanded factory facilities.
3-13 An opportunity cost is the maximum value forgone when a course of action is
chosen.
3-14 Yes, avoidable costs are relevant because they can be eliminated when, for
example, a part, product, product line, or business segment is discontinued.
3-15 In the context of a make or buy decision, fixed costs such as production engineering
staff salaries are relevant if these costs can be eliminated by assigning the staff to
other tasks, or by laying off the engineers not required when a part is outsourced. If it
is possible to find an alternative use for the facilities made available because of the
elimination of a product or a component, the associated fixed costs also are relevant.
Conversely, fixed costs that cannot be eliminated or used for other productive
purposes are not relevant for the decision. For example, if factory facilities would
remain idle if the company buys from outside, then the associated costs are not
relevant for the decision.
3-16 There are several qualitative considerations that must be evaluated in a make-or-
buy decision. For example, one must question whether the outside supplier has
quoted a lower price to obtain the order, and plans to increase the price. Also,
the reliability of the supplier in meeting the required quality standards and in
making deliveries on time is important.
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Atkinson, Solutions Manual t/a Management Accounting, 6E
3-18 A difficulty that arises with respect to revenue when analyzing whether to drop a
product or department is whether sales by one organizational unit can affect sales
in another organizational unit. A difficulty that arises with respect to cost
analysis is that many product costs, such as machine and factory depreciation,
are the result of sunk costs that often remain in whole or in part after the product
is discontinued. The analysis of what costs are avoided when a product is
dropped can be difficult due to the closing of plants, severance pay and
environmental cleanup costs.
3-19 The answer depends on the time frame and context considered. For example, a
one-time order that covers variable production (and selling costs) is
advantageous if capacity cannot be changed in the short run and excess capacity
exists. Also, for given capacity with one scare resource, maximizing contribution
margin per unit of scarce resource will maximize profit. In the long run, prices
must cover all their costs, both fixed and variable, in order for the firm to
survive.
3-20 No. Products should be ranked by the contribution margin per unit of the constrained
resource rather than by the contribution margin per unit of the product.
3-21 Yes. When capacity is fixed in the short run, the firm may need to sacrifice the
production of some profitable products to make capacity available for a new
order. The contribution margin on the production of profitable products
sacrificed for a new order is an opportunity cost that must be considered to
evaluate the profitability of the new order.
3-22 The three components of a linear program are the objective function, the decision
variables, and the constraints.
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Chapter 3: Using Costs in Decision Making
EXERCISES
3-25
Burger ingredients Variable
Cooks’ wages Fixed
Server’s wages Fixed
Janitor’s wages Fixed
Depreciation on cooking equipment Fixed
Paper supplies (wrapping, napkins, and supplies) Variable
Rent Fixed
Advertisement in local newspaper Fixed
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Atkinson, Solutions Manual t/a Management Accounting, 6E
3-26 (a) Contribution margin per unit = $1,000 – $500 – $100 = $400
(c) Because the variable cost per unit will decrease, the contribution margin
per unit will increase. The breakeven point equals (fixed costs)/
(contribution margin), so the breakeven point will decrease. Specifically,
the new contribution margin per unit is $1,000 – $450 – $100 = $450 and
the new breakeven point is $3,500,000/$450 = 7,778 units (rounded).
P = $870.37
(b) Let X = the average number of patient days per month necessary to
generate a target profit of $45,000 per month
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Chapter 3: Using Costs in Decision Making
3-28 (a) Contribution margin per unit = $30 – $19.50 = $10.50
(c) Let X = the number of units sold to generate revenue necessary to earn
pretax income of 20% of revenue
(d) Let X = the number of units sold to generate after-tax profit of $109,200
(Before-tax income) × (1 – 0.35) = $109,200
Before-tax income = $109,200/0.65 = $168,000
$30X – $19.50X – $147,000 = $168,000
$10.50X = $315,000
X = $315,000/$10.50 = 30,000 units
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Atkinson, Solutions Manual t/a Management Accounting, 6E
3-29 (a) Let R = sales dollars necessary for a before-tax target profit of $250,000
3-30 The sales mix in units is 3/5 Domestic and 2/5 International.
The Domestic CM = $50 – $30 = $20; the International CM = $40 – $16 = $24
Let X = total number of units that must be sold in the International market to earn
$200,000 before taxes, assuming the stated sales mix
Equivalently, one can compute a weighted average unit CM: (3/5) × ($20) +
(2/5) × ($24) = $21.60
Let Y = total number of units that must be sold to earn $200,000 before taxes,
assuming the stated sales mix
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Chapter 3: Using Costs in Decision Making
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Atkinson, Solutions Manual t/a Management Accounting, 6E
Breakeven units = $1,290,000/$14.10 = 91,489.36, which we round up to
91,490 units. Of these, 91,490 × .3 = 27,447 will be alligators and 91,490
× .7 = 64,043 will be dolphins.
(c) In part (b), the sales mix percentage for the higher-CM product (dolphins)
is greater than in part (a). Consequently, fewer total units are required to
break even (91,490 in part (b) versus 100,000 in part (a)).
Chicken — — —
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Chapter 3: Using Costs in Decision Making
3-33 (a) Healthy Hearth has sufficient excess capacity to handle the one-time
(short-run) order for 1,000 meals next month. Consequently, the analysis
focuses on incremental revenues and costs associated with the order:
Healthy Hearth will be better off by $500 with this one-time order. Note
that total fixed costs remain unchanged, so it is sufficient to evaluate the
change in the contribution margin. If the order had been long-term,
Healthy Hearth would need to evaluate whether the price provides the
desired profitability considering the fixed costs and whether filling the
government order might require giving up higher-priced regular sales.
(b) Healthy Hearth has insufficient excess capacity to handle the one-time
order for 1,000 meals next month, and must give up regular sales of 500
meals at $4.50 each, resulting in an opportunity cost.
Now, Healthy Hearth will be worse off by $250 with this one-time order.
Again, total fixed costs remain unchanged, so it is sufficient to evaluate
the change in the contribution margin.
(b) Don will buy the Ford Escort if he bases the decision only on the available
cost information.
Cash savings:
Repairs on the Impala $5,400
Operating cost—Impala 2,900
8,300
Cash expenditures:
Acquisition cost—Ford Escort 5,400
Operating cost—Ford Escort 1,800
7,200
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Chapter 3: Using Costs in Decision Making
old machine and replacing it with a new machine. Note that the annual
operating costs (before overhaul) of $18,000 are not sunk costs, yet they
are irrelevant.
(b) Relevant costs include the acquisition cost of the new machine, the cost of
overhauling the old machine, current salvage of $4,000 for the old
machine (all of which are up-front costs), salvage value at the end of five
years for the new and overhauled machines, and the annual operating costs
for both the new machine and the overhauled old machine.
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Atkinson, Solutions Manual t/a Management Accounting, 6E
0 0
Net cash inflow
(outflow) ($40,000) $20,000 $20,000 $20,000 $25,000
Cumulative cash
inflow (outflow) ($40,000) ($20,000) $ $20,000 $45,000
0
Joyce Printers should replace the machines if they expect to use the new
machines for more than three years. (A more complete evaluation would use net
present value analysis, which is covered in other courses.)
3-39 (a) Assumptions need to be made about the avoidability of the fixed overhead
costs if Kane outsources the component.
(b) If the variable costs (direct materials, direct labor, and variable overhead)
are all avoidable, then Kane will certainly reduce costs by outsourcing the
component. Fixed overhead costs may be unavoidable if the facility cannot
be converted to alternative uses when the component is outsourced.
However, even if the fixed overhead costs are unavoidable, Kane would
reduce costs by outsourcing. In this case, the cost savings per unit if the
component is outsourced would be:
(c) Other factors relevant to the decision are the supplier’s ability to live up to
expected quality and delivery standards, and the likelihood of suppliers
increasing prices of components in the near future.
3-40 Premier should make the gear model G37 because it costs $87,000 less to
make than to buy. (Fixed overhead is irrelevant and may be dropped from the
analysis.)
Make Buy
Cost of purchase: $120 × 20,000 = $2,400,000
Direct material cost: $55 × 20,000 = $1,100,000
Direct labor cost: $30 × 20,000 = 600,000 —
Variable overhead: $25 × 20,000 = 500,000 —
Fixed overhead $15 × 20,000 = 300,000 300,000
Savings in facility-sustaining costs — (113,000)
Relevant costs $2,500,000 $2,587,000
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Atkinson, Solutions Manual t/a Management Accounting, 6E
3-41 (a) The offer by Superior Compressor should not be accepted if fixed
overhead costs are unavoidable.
(b) The maximum acceptable purchase price is $213 per unit if the plant
facilities are fully utilized at present and the incremental cost of adding
more capacity is approximated well by the $17 per unit fixed overhead
cost.
3-42 (a) The billiards segment currently produces a segment margin of $40,000 −
$25,000 = $15,000, so the bar’s segment margin would have to increase
by at least that amount in order for the grill’s income to be at least as high
as it is now.
(b) George should consider the effect on the other two segments’ revenues if he
drops the billiards segment. It may be that the availability of billiards
attracts customers to the bar and restaurant segments. Traditional segment
margin analysis as in part (a) does not capture such interactive effects.
3-43 In order to accept the new order for 1,500 modules next week, McGee must give
up regular sales of 500 modules per week.
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Chapter 3: Using Costs in Decision Making
3-44 This order will require 500 = 5 × (10,000 ÷ 100) machine hours. Since there is
excess capacity of 800 = 4,000 × (100% − 80%) machine hours per month,
Shorewood Shoes Company can accept this order without expanding its
capacity. Therefore, Shorewood should charge at least as much as the
incremental variable costs for this order.
Shorewood’s costs stated in the problem are average costs per pair of shoes.
Shorewood should determine whether the costs are reasonably accurate for the discount
store’s order. Shorewood should also consider how its regular customers might react to
the lower price offered to the discount store.
If Ritter accepts the export order, its operating income will increase by
$78,000 = $141,000 − $63,000. Although Ritter’s operating income will
increase with the special order, Ritter must consider the long-run effect of
displeasing its regular domestic customers by not fulfilling their demand.
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Atkinson, Solutions Manual t/a Management Accounting, 6E
(b) Sales (36,000 units × $10 and 30,000 units × $9) $630,000
Variable manufacturing and selling costs
(66,000 units × $5.50) (363,000)
Contribution margin $267,000
Fixed costs: $99,000 + $25,000 124,000
Operating income $143,000
If Ritter operates the extra shift and accepts the export order, operating
income will increase by $80,000. Ritter should consider whether the same
quality will be achieved with new operators or existing operators working
overtime (with possible fatigue). In addition, Ritter should understand
whether the additional fixed costs will be incurred on a continuing basis or
are avoidable when production drops back to its previous level. Finally,
Ritter should also consider the effect of this price reduction on regular
customers.
3-47 (a) Superstore faces a problem of maximizing contribution margin per unit of
scarce resource. Here, the scarce resource is shelf space. Superstore
requires at least 24 square feet for each category. The store manager
should assign additional available space to the category with the highest
contribution margin per square foot, i.e., ice cream. After assigning a total
of 100 square feet to ice cream, there is sufficient available shelf space to
assign a total of 100 square feet to frozen dinners and 26 square feet to
juices. The frozen vegetable receives the minimum required assignment of
24 square feet.
Frozen Frozen
Ice Cream Juices Dinners Vegetables
Selling price per unit
(square-foot package) $12.00 $13.00 $24.00 $9.00
Variable costs per unit
(square-foot package) $8.00 $10.00 $20.50 $7.00
Unit CM
(square-foot package) $4.00 $3.00 $3.50 $2.00
Minimum required 24 24 24 24
Maximum allowed 100 100 100 100
Allocation to maximize
total CM 100 26 100 24
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Chapter 3: Using Costs in Decision Making
(b) In setting the minimum required and maximum allowed square footage per
category, the manager might consider seasonality (for example, permitting
more ice cream space during the summer or more frozen vegetable space
during the winter) and the effect on contribution margins of variability in
costs and prices. The analysis does not take into account the rate at which
products are sold within each category. The analysis should also consider
the effect of the mix on other product sales. If the store offers only a
limited selection of frozen vegetables, for example, shoppers may switch
to another store for their regular grocery shopping.
Because deluxe grade has a higher contribution margin per unit of scarce resource
(DLH) than regular grade, and no more than 8,000 square yards of deluxe grade can
be produced, Boyd Wood Company should produce the maximum of 8,000 square
yards of deluxe grade first and then use the remaining available capacity of 3,000
DLH (= 4,600 − [8,000 × 0.20]) to produce regular grade. Therefore, the optimal
production level for each product is:
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Atkinson, Solutions Manual t/a Management Accounting, 6E
PROBLEMS
The variable costs per unit are $1,580,000/50,000 = $31.60. The following
items are fixed costs:
Contribution margin
per unit: $34.50
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Chapter 3: Using Costs in Decision Making
Incremental profit:
Increase in contribution
margin from new sales $34.50 × 120,000 $4,140,000
Decrease in contribution
margin from
cannibalization $20 × (300,000 – 240,000) (1,200,000)
Increase in fixed costs (2,000,000)
Increase in profits if the
new model is introduced $940,000
(b) Yes. Introducing the new product will increase profits by $940,000.
3-51 (a) The number of miles driven is an important activity measure in estimating
the cost of driving. In comparing the cost of driving to work or taking
public transportation, Shannon may also want to consider the cost of
parking at work. The cost of parking may vary with the number of days at
work or may be a flat rate per month.
(b) Incremental costs of driving include gas, oil, maintenance, and tire
expenditures. Costs associated with driving also include toll costs and
parking fees.
(c) Fixed costs include taxes, depreciation of the vehicle, car registration,
license fees, and insurance.
(d) For a two-week vacation by car, two likely activity measures are number
of miles driven and number of days (for lodging and meals).
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Atkinson, Solutions Manual t/a Management Accounting, 6E
(c) Fuel costs are fixed once the flights are scheduled, but these costs vary
with the number of flights.
(d) In this case, there is no opportunity cost to the airline because the seat
would otherwise go empty. The variable cost for the additional passenger
is $5 for the meals and refreshments and perhaps a small amount of
additional fuel cost.
πS
πJ
$0
50,000 100,000 133,333 Number of rides
($300,000)
Loss
($1,500,000)
(c) We cannot say which firm’s cost structure is more profitable as profits
depend on sales volume. If sales drop to below 133,333 rides, Johnson
Company’s cost structure leads to more profits. However, if sales remain
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Chapter 3: Using Costs in Decision Making
above 133,334 rides, then Smith Company’s cost structure leads to more
profits.
(d) The contribution margin generated must first cover the fixed costs and
then the balance remaining after the fixed costs are fully covered goes
toward profits. If the contribution margin is not sufficient to cover the
fixed costs, then a loss occurs for the period. Once the breakeven point
has been reached, profit will increase by the unit contribution margin for
each additional unit sold. Here, Smith Company is more risky because it
has higher fixed costs to cover and a higher unit contribution margin,
which makes its profits more sensitive to decreases in the sales activity
level.
(b) Let X = the sales volume at which the profit on sales is 10%
Fixed costs =
$200,000 + $62,500 + $17,500 = $280,000
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Atkinson, Solutions Manual t/a Management Accounting, 6E
Fixed costs =
$310,000 + $62,500 + $17,500 = $390,000
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Chapter 3: Using Costs in Decision Making
3-56 (a) This is a special order where the company has sufficient excess capacity
to fill the order.
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Atkinson, Solutions Manual t/a Management Accounting, 6E
(b) This is a special order where the company has insufficient excess capacity
to fill the order, and therefore faces an opportunity cost if it fills the order.
*The opportunity cost is the net benefit from the foregone CM on 5,000
boxes of regular sales.
Because fixed costs are unchanged, the $16,000 net increase in CM is the
increase in income if the company accepts the special order.
3-57 (a) Variable costs per chip = $720,000/1,600 = $450 per chip
Profit = ($500 − $450) × 2,000 − $75,000 = $25,000
There is currently enough surplus capacity to produce the 200 units per
week for the new order. The estimated increase in the company’s profit if
it accepts the order is ($480 − $450) × 200 = $6,000 per week.
(c) Because there is not enough surplus capacity to produce the 600 units per
week for the new order, the company faces an opportunity cost if it
accepts the order. The company has surplus capacity of 2,000 – 1600 =
400 chips per week. If the company accepts the order, it will have to give
up 200 chips per week of regular sales, at $500 revenue per chip. The
company will gain ($480 – $450) × 600 = $18,000 per week from the
special order, but that gain will be offset by lost contribution margin from
regular sales, ($500 – $450) × 200 = $10,000, for a net gain of $8,000 per
week.
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Chapter 3: Using Costs in Decision Making
3-58 (a) Acquisition cost and depreciation expense for the existing elevator system
are irrelevant.
(b) Relevant cost Existing System New System
Acquisition cost — $875,000
Salvage value of existing system at present — (100,000)
Operating costs for 6 years $900,000 48,000
Salvage value after 6 years (25,000) (100,000)
$875,000 $723,000
The decision to replace the existing elevator system with the new one will
require net present value analysis that considers the time value of money.
Without considering the time value of money, the new system is less costly.
(b) Average unit costs can be misleading. Fixed costs are not relevant to this
decision—the decision should be based on incremental costs.
(c) Other customers may also demand a reduced price. Therefore, their
reaction to the reduced price for the special order must also be taken into
account.
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Atkinson, Solutions Manual t/a Management Accounting, 6E
3-60 (a) Net cost saving over 4 years with new machine
Cash inflow:
Salvage value difference $ 2,000
Decrease in annual operating costs (4 years × $60,000) 240,000
Reduction in rework cost 10,000a
Cash outflow:
Acquisition of new machine ($360,000 – $100,000) (260,000)
Net cash inflow (outflow): ($ 8,000)
a
0.05 (100,000 × 4) × $1 = $20,000
– 0.025 (100,000 × 4) × $1 = –$10,000
Reduction in rework $10,000
Syd Young should not replace the old machine due to net cash outflow of
($8,000).
3-61 (a) Because the distinctive desserts are a source of competitive advantage,
Beau should carefully consider the quality, freshness, and distinctiveness
of the desserts from the outside providers, as well as the providers’
reliability in delivering the desserts. Beau will want to consider the
possibility of price increases from an outside bakery. For the in-house
option, Beau may have concerns about his ability to hire a suitable
replacement pastry chef. If Beau hires a new pastry chef, the chef may be
more responsive than the outside bakers to Beau’s customers’ tastes.
Also, there would be no concern about delivery to Beau’s Bistro.
(b) This question is designed to generate discussion about the trade-offs
among the options. Although the second bid is lower-cost than the first,
the first bid promises continual developments of gourmet desserts; the
second bid promises only traditional desserts. In-house pastry production
is the highest-cost option. The ultimate decision should take into account
not only the costs of the different options, but also the issues in part (a)
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Chapter 3: Using Costs in Decision Making
and the anticipated effect on demand and revenue (for pastry and for
Beau’s Bistro) under each option.
3-62 (a) The costs and benefit shown below are relevant for the outsourcing
decision. All but the –$20,000 sale of office equipment are annual costs.
Costs
In-house Outside
Call Center Call Center
Labor $650,000
Rent 60,000
Phone 35,000
Other overhead 42,000
Office equipment ($20,000)
Outside call center 700,000
$787,000 $680,000
(b) Hollenberry must consider the outside call center’s reliability and quality of
service in responding to Hollenberry’s customers. Given Hollenberry’s
worldwide operations, the greater number of multilingual operators available
at the outside call center could be an important feature. Finally, Hollenberry
must factor in the prospect of laying off employees, many of whom have
worked at Hollenberry for over 20 years.
(c) If the outside call center can meet Hollenberry’s expectations for reliability
and quality, including better service for international customers, financial
considerations point toward Hollenberry outsourcing the call center function.
However, although the outsourcing decision seems financially sound, there is
great potential for decreasing the remaining employees’ morale because of the
layoffs. This question is designed to generate discussion about trade-offs
among the company’s stakeholders, including employees. One alternative to
firing Hollenberry’s call center employees is reassigning the employees to
other jobs and relying on attrition to eventually reduce employee costs to
Hollenberry’s desired level. However, this would increase the cost of the
outsourcing option and reduce its financial benefits.
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Atkinson, Solutions Manual t/a Management Accounting, 6E
3-63 (a) Impact of dropping JT484 on operating income:
(b) No, the decision to retain JT484 will only be reinforced by the sales
manager’s comments.
3-64 Some examples of articles that describe dropping unprofitable products appear
below. The article by Hymowitz provides interesting background for the article
in The Economist on Sony’s unprofitable products. These articles describe the
need for a turnaround at Sony. The article in The Economist states, “Almost
every product line is unprofitable.” Important issues include strong competition,
“vanity projects that lacked a market,” and cost cutting through layoffs and
factory closings. The article by Ball lays a foundation for activity-based costing
through its discussion of high costs and unprofitable products due in part to
excessive proliferation of variations of products.
“Game on: Sir Howard Stringer believes he is finally in a position to fix Sony.”
The Economist, March 5, 2009. http://www.economist.com/node/13234173,
accessed December 12, 2010.
Ball, D. “Crunch Time: After Buying Binge, Nestlé Goes on a Diet; Departing
CEO Slashes Slow Sellers, Brands; ‘No’ to Low-Carb Rolo.” The Wall Street
Journal, July 23, 2007, page A1.
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Chapter 3: Using Costs in Decision Making
3-65 (a) XLl XL2 XL3
Sales price $10.00 $14.00 $12.00
Products XLl and XL2 should be produced first because they have a
higher contribution margin per machine hour. Maximum production of
these two products requires 110,000 machine hours:
(b) Under the current capacity constraint, Excel Corporation cannot meet all
of XL3’s demand. If additional capacity becomes available, it can produce
more units of XL3. To determine whether it is worthwhile operating
overtime, Excel needs to analyze the contribution margin of XL3 when
operating overtime.
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Atkinson, Solutions Manual t/a Management Accounting, 6E
XL3
Sales price $12.00
3-66 (a) HCD2 requires $100 ÷ $20 = 5 direct labor hours per unit. The new order
requires 1,000 = 200 × 5 direct labor hours, so the existing capacity is adequate.
The contribution margin per unit of HCD2 for the new order = $400 − (75 + 100
+ 125) = $100. The increase in profit is $20,000 = 200 units × $100 contribution
margin.
The new order requires a total of 1,500 = 5 × 300 DLH, but only
1,000 = 15,000 – 14,000 DLH are available. This will leave a capacity
shortage of 500 = 1,500 – 1,000 DLH. The contribution margin per DLH
is $40 for each product, so the company can forego sales of either product
with the same effect. Therefore, the change in profit is
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Total contribution margin – opportunity cost
= (300 units × $100 contribution margin per unit) – (500 DLH × $40
contribution margin per DLH)
= $30,000 – $20,000
= $10,000 increase.
(c) If the plant is worked overtime to manufacture HCD2 for the new order,
the contribution margin is negative $12.50 as shown below:
3-67 (a) In order to produce 13,000 standard doors and 5,000 deluxe doors, the
following number of direct labor hours and machine hours are required:
Cutting:
Direct labor hours: 0.5 × 13,000 + 1 × 5,000 = 11,500 > 8,000 capacity
Machine hours: 2 × 13,000 + 3 × 5,000 = 41,000 > 40,000 capacity
Assembly:
Direct labor hours: 1 × 13,000 + 1.5 × 5,000 = 20,500 > 17,500 capacity
Machine hours: 2 × 13,000 + 3 × 5,000 = 41,000 > 40,000 capacity
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Atkinson, Solutions Manual t/a Management Accounting, 6E
Finishing:
Direct labor hours: 0.5 × 13,000 + 0.5 × 5,000 = 9,000 > 8,000 capacity
Machine hours: 1 × 13,000 + 1.5 × 5,000 = 20,500 > 15,000 capacity
The direct labor hour capacity in each department and the machine hour
capacity in each department are not adequate to meet the next month’s
demand.
(b) Linear programming can be used to solve this problem. The product
contribution margins needed for the objective function are:
Standard Deluxe
Sales price per unit $150 $200
Variable cost per unit 110 155
Contribution margin per unit $40 $45
Let S denote the number of standard doors to produce and D denote the
number of deluxe doors to produce. The linear programming problem is:
Cutting:
Direct labor hours: 0.5S + D ≤ 8,000
Machine hours: 2S + 3D ≤ 40,000
Assembly:
Direct labor hours: S + 1.5D ≤ 17,500
Machine hours: 2S + 3D ≤ 40,000
Finishing:
Direct labor hours: 0.5S + 0.5D ≤ 8,000
Machine hours: S + 1.5D ≤ 15,000
Maximum demand:
S ≤ 13,000
D ≤ 5,000
Nonnegativity:
S > 0, D > 0
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Chapter 3: Using Costs in Decision Making
(c) The contribution margin for standard doors remains the same, but the
contribution margin for deluxe doors is now $50:
Deluxe
Sales price per unit $200
Variable cost per unit ($80 + $56 + $14) 150
Contribution margin per unit $50
Cutting:
Direct labor hours: 0.5S + 0.8D ≤ 8,000
Machine hours: 2S + 3D ≤ 40,000
Assembly:
Direct labor hours: S + 1.5D ≤ 17,500
Machine hours: 2S + 3D ≤ 40,000
Finishing:
Direct labor hours: 0.5S + 0.5D ≤ 8,000
Machine hours: S + 1.2D ≤ 15,000
Maximum demand:
S ≤ 13,000
D ≤ 5,000
Nonnegativity:
S > 0, D > 0
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Atkinson, Solutions Manual t/a Management Accounting, 6E
increase in efficiency with respect to deluxe door production has increased
the number of deluxe doors in the optimal product mix and increased the
total contribution margin.
3-68 (a) To maximize monthly commissions while working 160 hours per month,
Spencer should devote the maximum allowable time (90 hours) to
customer group B because that group provides the largest average
commission per hour of Spencer’s time. Spencer should next allocate the
maximum of 60 hours to customer group A because that group provides
the next largest average commission per hour. Finally, Spencer should
devote the remaining 10 hours of his 160 hours to group C.
Customer Group
A B C
Average monthly sales
per customer $900 $600 $200
Commission 6% 5% 4%
$54 $30 $8
Average commission
Hours per customer per
monthly visit 3 1.5 0.5
Average commission
per hour $18 $20 $16
Current hours 60 90 60
Hours per month 60 90 10 Total: 160 hours
(40 hours per week)
(b) Spencer should also consider the probable future increased profitability
from customers in group C, as well as likely future profitability of
customers in the other groups.
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Chapter 3: Using Costs in Decision Making
CASES
(b) Outside charges will exceed the monthly wages of an additional worker hired by
Barrington if the number of outside hours exceeds $3,600 ÷ $40 = 90.
Therefore, Barrington should hire an additional employee when the
outside services are expected to exceed 90 hours in any month, which
corresponds to 90 ÷ 150 = 0.6 equivalent workers.
Simple Simple Total Equivalent
Month Routine Nonroutine Complex Hours Workers
June 800 250 450 4,025.0 26.83
July 600 200 400 3,300.0 22.00
August 750 225 450 3,862.5 25.75
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Atkinson, Solutions Manual t/a Management Accounting, 6E
3-70 (Numbers in square brackets below refer to reference numbers that appear at the
end of the solution for this case.)
Saks Fifth Avenue is a luxury retailer that can be described much like
Neiman-Marcus is described in Chapter 2. Both stores target fashion-
conscious customers with high disposable incomes who are willing to pay
more for high-end merchandise. Fred Wilson, former Saks Fifth Avenue
divisional CEO, viewed Neiman Marcus as Saks’ closest competitor [4].
Saks Fifth Avenue offers a wide assortment of distinctive luxury fashion
apparel, shoes, accessories, jewelry, cosmetics and gifts (10-K Report,
Saks Fifth Avenue, Fiscal year ending February 3, 2000). Saks Fifth
Avenue’s web site states: “Saks Fifth Avenue today is renowned for its
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Chapter 3: Using Costs in Decision Making
superlative selling services and merchandise offerings. The best of
European and American designers for men and women are sold throughout
its 47 stores servicing customers in 23 states.”
(http://www.saksfifthavenue.com/html/aboutus/saks_history.jsp?
bmUID=iSXpdBi).
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Atkinson, Solutions Manual t/a Management Accounting, 6E
Sales staff could also contact customers as soon as a desired item arrived
in the store and better serve repeat customers with readily available
information on sizes and preferences [3].
In 2001 (comparing fiscal years ending January 2001 and January 2002),
net sales increased about 2% due to new store openings; comparable store
sales decreased during the year. Operating income increased 10% after
declining 50% the year before. The following year, net sales increased 6%
and operating income increased 30%. Gross profit as a percent of sales
decreased in 2001 and increased in 2002
(http://about.nordstrom.com/aboutus/investor/10yr_stats_printable.asp,
April 7, 2003).
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Chapter 3: Using Costs in Decision Making
The campaign was less than successful; the company announced that it
had “overreached.” Nordstrom had “alienated its faithful clientele” [7] by
trying to appeal to younger shoppers. That is, there was an opportunity
cost to targeting younger shoppers. Some financial results appear in part
(d).
References
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Atkinson, Solutions Manual t/a Management Accounting, 6E
[2] Anonymous. 2001. Can Nordstroms Find The Right Style? Business Week (July
30), 59–62.
[3] Bednarz, A. 2002. The Customer Is King. Network World (December 2), 65–66.
[4] Byron, E. 2006. Struggling Saks Tries Alternations In Management. Wall Street
Journal (January 10), B1.
[5] Cuneo, A. Z. 2000. Nordstrom Breaks with Traditional Media Plan. Advertising
Age (February 14), 4, 71.
[6] Lee, L. 2000. Nordstrom Cleans Out Its Closets. Business Week (May 22), 105.
Nordstrom previously provided the following list of references at its web site
http://about.nordstrom.com/aboutus/faq/faq.asp#12:
"With a New location in Dadeland Mall, Nordstrom Seeks to Become a Florida
Institution," The Miami Herald, November 12, 2004
"Author of Books on Nordstrom Culture to Address Virginia Trade Show," Richmond
Times-Dispatch, September 23, 2004
"Nordstrom Regains Its Luster - Challenge Awaits as Rivals Encroach on Image of
Affordable Luxury," The Wall Street Journal, August 19, 2004
"Shoppers put Heart, Soles Into Yearly Nordstrom Sale," The Seattle Times, July 17,
2004
"Q&A with Blake Nordstrom - 4th Generation Leads Growth of Nordstrom," The
Charlotte Observer, March 12, 2004
"Nordstrom 'Cachet' Hits Wellington Friday," Palm Beach Post, November 10, 2003
"Back in the Family; Fourth Generation Takes Control After a Brief Change in
Company Leadership," Seattle Post-Intelligencer, June 27, 2001
"A Time of Change; Company Makes Huge Leaps with Expansion, Public Stock
Offering," Seattle Post-Intelligencer, June 26, 2001
"Still in Style; From Small Shoe Store, to Upscale Retailer, Company has Kept
Founder's Values," Seattle Post-Intelligencer, June 25, 2001
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Chapter 3: Using Costs in Decision Making
"Success Came a Step at a Time; Company Rose From Small Seattle Shoe Store to
Retail Giant with National Appeal," Seattle Times, May 29, 2001
Books:
The Nordstrom Way by Robert Spector and Patrick D. McCarthy
Fabled Service: Ordinary Acts, Extraordinary Outcomes by Bonnie Jameson and Betsy
Sanders
(b) AA100 has a higher contribution margin per hour than AA101 and A102.
Aramis should produce AA100 up to 600 tons. Since the production of
600 tons of AA100 requires 2,400 = 600 × 4 hours, which equals
available capacity, no other products will be manufactured. Therefore, the
optimal production levels are: AA100: 600 tons; AA101: 0 tons; and
AA102: 0 tons.
(c) Opportunity cost is $60 per hour (the contribution margin per hour for
AA100 production that must be sacrificed) and each ton of AA101
requires 6 hours.
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Atkinson, Solutions Manual t/a Management Accounting, 6E
(d) It is worthwhile operating the plant overtime. The optimal production level
is AA100: 600 tons; AA101: 100 tons; and AA102: 0 tons.
Since contribution margins per hour for AA101 and AA102 are positive, it
is worthwhile operating the plant overtime.
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1
3-72 TEACHING NOTE: A VOTRE SANTÉ
The A Votre Santé (AVS) case is multi-faceted in that it requires students to
incorporate operational measures into product costing results, and also to
understand cost accounting from a variety of perspectives, such as:
• Product versus period costs
• Variable versus fixed costs
• Activity based costing
• Relevant costs and opportunity costs
The detail in the case is rich enough to support a variety of analyses. Alternative
uses could be to have the student construct a cost of goods manufactured
statement or a traditional financial statement, both of which reinforce the
differences between product and period costs. Additionally, alternative decision
analysis questions could be developed using the variable and fixed cost
structures described in the case. Case question number two is only one example
of a potential decision analysis question.
Chardonnay Generic
Yield: Grapes Grapes
Pounds harvested 100,000 60,000
Loss in processing 10,000 10% 3,000 5%
Yield: 90,000 57,000
1
© 2010 Priscilla S. Wisner. Adapted and used by permission of Priscilla S. Wisner.
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Atkinson, Solutions Manual t/a Management Accounting, 6E
• Where to include the wine master expense: Since the wine master is paid
according to number of blends, not number of bottles, this expense is
listed as a fixed cost. Arguably, it could be listed as a variable cost, given
that the cost will be based on the number of wines produced. As part of
the discussion we will examine the rationale behind listing wine master as
a fixed or a variable expense.
• Barrel expense: The case states that the barrels produce the equivalent of
40 cases of wine. A case of wine is post-fermentation/bottling and
therefore after the 10% loss has occurred. The barrels contain the wine at
the start of the process. Therefore, there have to be enough barrels to hold
all the wine at the beginning of the process, not at the end. This factor
results in 63 (62.5) barrels being required for the harvest2.
2
Each case of wine requires 36 pounds of grapes (post-fermenting). A barrel holds the
equivalent of 40 cases of wine (post-fermenting), or 1,440 pounds of grapes (40 × 36). To
convert the post-fermenting grapes to pre-fermenting grapes, they must be divided by 0.9, or
1,440/0.9 equals 1,600 pounds of grapes. The harvest of 100,000 pounds of grapes therefore
requires 62.5 barrels for storage (100,000/1,600).
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Chapter 3: Using Costs in Decision Making
$ 2.00
per bottle
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Atkinson, Solutions Manual t/a Management Accounting, 6E
Chardonnay
Yield: Grapes
Pounds 20,000
Loss in processing 2,000 10%
Yield: 18,000
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Chapter 3: Using Costs in Decision Making
Total costs $ 80,717
The following factors would support AVS’s decision to reject the grape
purchase:
• Poor quality of the grapes
• An additional AVS Chardonnay wine creates confusion in the
marketplace
• Lack of control over the harvest and crush process
• Lack of confidence in the additional sales forecast
• Inability of the current capacity (e.g. bottling line, space) to support
additional production
• Inability to use the additional barrels purchased in future years
• Cannibalization of the current Chardonnay, Chardonnay-Estate or
Blanc de Blanc sales
• Reliability concerns with the new supplier
• Other hidden costs
Summary
The AVS case is based upon actual wine industry data, although the data has
been simplified to reinforce the teaching points and concepts. It is also true to the
wine making process, with the exception of AVS’s process of making the
Chardonnay regular wine from the fermented Chardonnay and Blanc de Blanc
wines. This can be done, but most commonly the juice from the wine grapes is
combined at the start of the fermenting process, so that they can ferment
together. Because of the different yield rates in the fermenting process, the case
had the wines ferment separately and blend at the end.
Note: The full case, which includes activity-based cost analysis, can be taught in
a 75-minute class, or by omitting the decision analysis question 50 minutes
would be sufficient. The case author has also used it to teach the differences
between the financial income statement reporting (product and period costs) and
the contribution margin income statement reporting (variable and fixed costs),
and then assigned decision analysis and/or the ABC costing as an additional
assignment.
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