Atkinson5esm ch06 PDF

Chapter 6
Cost Information
for Pricing and
Product Planning
QUESTIONS
6-1 The answer depends on the time frame considered. Short-run prices need only
cover the costs that vary in the short run. However, in the long run, most costs
become flexible (variable). In fact, in the long run, prices must cover both
capacity-related (fixed) and flexible costs for the firm to survive.
6-2 Since capacities made available for many production and support activities
cannot be altered easily in the short term, managers need to pay attention to
whether surplus capacity is available for additional production or whether the
available capacity limits production alternatives. In contrast, in the long term,
managers have considerably more flexibility in adjusting the capacities of
activity resources to match the demand that is placed on these resources by the
actual production of different products.
6-3 In commodity-type businesses, prices are set by traders in the commodity

markets based on industry supply and demand. Firms in commodity-type
industries are price-takers, unable to influence the market prices.
6-4 The following two considerations complicate short-term product mix decisions:
1. Deciding what costs are relevant to the short-term product mix decision.
2. Recognizing that in the short term managers may not have the flexibility
to alter the capacities of some activity resources.
6-5 A firm that is one of a large number of small firms in an industry in which there
is little to distinguish the products of different firms from each other is likely to
be a price-taker. A price-taker firm cannot influence prices significantly by its
own decisions because the prices are set by overall industry supply and demand
forces, or by a large dominant firm in its industry.
– 251 –
Atkinson, Solutions Manual t/a Management Accounting, 5E
6-6 Firms in an industry with relatively few competing firms, and firms enjoying
large market shares and exercising leadership in an industry are likely to
behave as price setters or price leaders. Also, firms in industries in which
products are highly customized or otherwise differentiated from each other
because of special features, characteristics, or customer service, are able to set
prices for their differentiated products.
6-7 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.
6-8 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.
6-9 When surplus capacity is not available and overtime, extra shift, subcontracting, or
other means must be employed to augment the limited capacity, a short-term
pricing decision must consider the additional costs of overtime wages, supervision,
heating, lighting, cleaning, security, machine maintenance and engineering, along
with human factors such as a decline in morale.
6-10 If facility-sustaining (business-sustaining) costs do not vary with the decision

alternatives, such as when there is some idle capacity, then these costs should
not be considered for a short-run pricing decision. However, if facility-
sustaining costs vary with the decision, such as when heating, or lighting and
security costs increase for overtime work, they must be considered for the
short-run pricing decision.
6-11 Contracts for the development and production of new, customized products,
including contracts with governmental agencies such as the Department of
Defense, specify prices as full costs plus a markup. Prices set in regulated
industries, such as electric utilities, are also based on full costs. Also, when a
firm enters into a long-term contractual relationship with a customer to supply
a product, it will price the product based on its full costs. This is because it has
flexibility in adjusting the level of commitment for all activity resources and as
a result most of its costs become flexible (variable) in the long run. Finally,
prices based on full costs are used as benchmark prices to guide short-run price
adjustments in response to fluctuations in short-run demand conditions.
– 252 –
Chapter 6: Cost Information for Pricing and Product Planning
6-12 The stronger the demand, the higher will be the markup. When demand is more
elastic, markup will be lower because customers are sensitive to higher prices.
Finally, when competition is more intense, a firm cannot sustain a high markup.
6-13 Short-run prices fluctuate over time because of changes in demand conditions.
When the demand for products is low, firms adjust their prices downward.
Conversely, when the demand is high, they adjust prices upward.
6-14 Several strategic factors may affect the level of markup. A firm may choose a
low markup to penetrate the market and win market share from its competitors.
In contrast, a firm may employ a high markup if it employs a skimming strategy
for a market segment in which some customers are willing to pay higher prices.
6-15 If long-run market prices are lower than full costs, managers may consider
reengineering the product to lower costs, raising prices by further
differentiating the product, offering customer incentives such as quantity
discounts, or dropping these unprofitable products.
6-16 In the long run, a firm has the flexibility to adjust most of its activity resources,
and therefore, most costs are flexible (variable). Thus, full costs approximate
long-run flexible costs that are relevant for long-run pricing decisions.
EXERCISES
6-17 Healthy Hearth has sufficient excess capacity to handle the one-time order for
1000 meals next month. Consequently, the analysis focuses on incremental
revenues and costs:
Incremental revenue per meal $3.50

Incremental cost per meal 3.00
Incremental contribution margin per meal $0.50
Number of meals × 1,000
Increase in operating income $ 500
– 253 –
6-18 In order to accept the new order for 1,500 modules next week, McGee must
give up regular sales of 500 modules per week.
Variable costs are $800 per module ($2,400,000/3,000 modules). The

contribution margin per unit on regular sales is $900 – $800 = $100 per
module. Therefore, the opportunity cost (lost CM) of accepting the new order is
500($100) = $50,000, and McGee will be indifferent between filling the special
order and not filling the special order when the contribution margins of the two
alternatives are equal (fixed costs will remain unchanged). That is, McGee will
be indifferent at a price P where 1,500(P – $800) = $50,000, or P = $833.33.
6-19 This order will require 500 = 5 × (10,000 ÷ 100) machine hours. Since there is
excess capacity of 800 = 4,000 × (100% − 80%) machine hours per month,
Shorewood Shoes Company can accept this order without expanding its
capacity. Therefore, Shorewood should charge at least as much as the
incremental variable costs for this order.
Direct material $6.00

Direct labor 4.00
Variable manufacturing support 2.00
Additional cost of embossing the private label 0.50
Minimum price to be charged for this order $12.50
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.
6-20 (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.
– 254 –
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
Unit CM
Minimum required 24 24 24 24
Maximum allowed 100 100 100 100
Allocation to maximize
total CM 100 26 100 24
(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.
6-21 Regular Deluxe

Sale price per sq. yard $16 $25
Variable costs per sq. yard 10 15
Contribution margin per sq. yard $6 $10
DLH required per sq. yard 0.15 0.20
Contribution margin per DLH $40a $50b
a
$6 ÷ 0.15 = $40
b
$10 ÷ 0.20 = $50
– 255 –
Because deluxe grade has a higher contribution margin per unit of scarce resource
(DLH) than regular grade, and no more than 8,000 square yards of deluxe grade
can be produced, Boyd Wood Company should produce the maximum of 8,000
square yards of deluxe grade first and then use the remaining available capacity of
3,000 DLH (= 4,600 − [8,000 × 0.20]) to produce regular grade. Therefore, the
optimal production level for each product is:
Deluxe: 8,000 sq. yards
Regular: 20,000 sq. yards (= 3,000 ÷ 0.15).
6-22 This discussion question is motivated by recent articles on controversial

strategies adopted by some nursing homes. A sample of relevant articles is
listed below.
[1] Moss, M. and C. Adams. “For Medicaid Patients, Doors Slam Closed—
Citing Finances, Nursing Home Evicts the Needy.” The Wall Street
Journal (April 7, 1998), B1.
[2] Adams, C. and M. Moss. “Bad News: The Business Potential of Nursing
Homes Is Elusive, Vencor Finds—Bid for High-Paying Patients Brings
Firm Headaches, and It Has to Regroup—Medicaid Is Welcome Now.”
The Wall Street Journal (December 24, 1998), A1.
[3] McGinley, L. “Medicaid Fix: House Limits Evictions From Nursing

Homes.” The Wall Street Journal (March 11, 1999), B1.
[4] McGinley, L. “Health Care: As Nursing Homes Say, ‘No,’ Hospitals Feel
Pain.” The Wall Street Journal (May 26, 1999), B1.
[5] Conklin, J.C. “Ailing Sun Healthcare Group Files for U.S. Bankruptcy
Court Protection.” The Wall Street Journal [Europe] (October 15, 1999),
UK5A.
[6] Adams, H.J. “U.S. Says Vencor Owes It $1.3 Billion Claim Based Largely
on Fraud Charges.” The Courier-Journal (March 15, 2000), Louisville, KY,
1a.
(a) The nursing home situation can be viewed as similar to a product mix or
customer profitability problem. With a given amount of bed and staffing
capacity, a major nursing home provider sought to increase profitability
by targeting private-insurance or Medicare patients, who generated
– 256 –
higher revenue per day than Medicaid patients. The provider’s strategy
was to market high quality care to patients who could afford high prices.
Unfortunately, the strategy was unsuccessful because the provider was
unable to maintain the desired quality, and the provider received
considerable negative publicity for its active efforts to discharge
Medicaid patients, sometimes with little apparent regard for the toll it
would take on the patients (see Adams and Moss (1998) and Moss and
Adams (1998)). Aside from the concerns about quality of care, desirable
patients were deterred by the prospect that they would be discharged
from the nursing home if it became necessary to turn to Medicaid
funding for their nursing home care. The nursing home provider
ultimately reversed its position on Medicaid patients, but later filed for
Chapter 11 bankruptcy. Largely motivated by this nursing home
provider’s treatment of Medicaid patients, Congress passed legislation
prohibiting nursing homes from evicting patients solely because their
related reimbursements come from Medicaid. Formerly, such evictions
were prohibited in only some states.
Students, like nursing home administrators, may argue that it is

necessary to consider the projected patient revenue in light of the cost of
providing services. McGinley (May 1999) provides examples of out-of-
pocket treatment costs that exceed federal reimbursements. Although
some patients require very costly medications or equipment, many other
patients’ reimbursements will cover the related out-of-pocket costs and
contribute to covering capacity costs (Moss and Adams (1998)).
(b) An employee who believes policies are unethical can approach

management with his or her concerns. If management refuses to change
its policy, employees may, as described in the cited articles, choose to
resign. An employee can also contact elected representatives to introduce
legislation prohibiting unethical policies, and can alert consumer and
industry groups, such as the AARP and the American Health Care
Association, to encourage the groups to advocate investigations or new
legislation.
6-23 Incremental variable costs = ($16 + $5 + $3) × 10,000

= $24 × 10,000
= $240,000.
Incremental revenue = $40 × 10,000 = $400,000.
Therefore, Berry’s operating income will increase by $160,000 if it accepts this

offer.
– 257 –
6-24 (a) Variable cost per unit = $198,000 ÷ 36,000 = $5.50.
Sales (30,000 units × $10 and 30,000 units × $9) $570,000

Variable manufacturing and selling costs
(60,000 units × $5.50) (330,000)
Contribution margin $240,000
Fixed costs (99,000)
Operating income $141,000
If Ritter accepts the export order, its operating income will increase by
$78,000 = $141,000 − $63,000. Although 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.
(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.
– 258 –
6-25 (a)
Overhead
Cost
$2,400,000
$2,100,000
$1,200,000
6,000 8,000
Units
Produced
Variable component of support costs
$2,400,000 − $2,100,000
= = $150 per unit.
8,000 − 6,000
Fixed component of support costs

= $2,100,000 − ($150 × 6,000) = $1,200,000.
Because the fixed cost of $1,200,000 is apparently spread out over 8,000
units (unit fixed cost is $1,200,000 ÷ 8,000 = $150) instead of 6,000 units
(unit fixed cost is $1,200,000 ÷ 6,000 = $200), the unit cost is reduced to
$550 at the production level of 8,000 units from $600 at the production
level of 6,000 units.
(b) When excess capacity exists, the price offered for a special order should
be at least as high as the variable cost per unit. Here, variable cost per
unit is $400, as determined below:
Direct material cost $125

Direct labor cost 125
Variable support 150
Unit variable cost $400
Therefore, Delta should accept the offer from the German company.
– 259 –
6-26 Given variable costs per half-gallon container of $1.50, the contribution
margins are as shown below. The maximum contribution margin occurs at a
price of $2.75.
Contribution
Demand Price Margin
75,000 $2.50 $75,000
72,500 2.55 $76,125
70,000 2.60 $77,000
67,500 2.65 $77,625
65,000 2.70 $78,000
62,500 2.75 $78,125
60,000 2.80 $78,000
57,500 2.85 $77,625
55,000 2.90 $77,000
52,500 2.95 $76,125
50,000 3.00 $75,000
– 260 –
6-27 Model Total Contribution Margin Total Contribution Margin Difference

Before 5% Price Cut After 5% Price Cut
B112 $30 × 3,000 = $90,000 $27 × 3,120 = $84,240 ($5,760)
B116 37 × 4,500 = 166,500 33.5 × 4,680 = 156,780 (9,720)
B120 44 × 5,000 = 220,000 40 × 5,200 = 208,000 (12,000)
G112 30 × 4,000 = 120,000 27 × 4,160 = 112,320 (7,680)
G116 37 × 4,000 = 148,000 33.5 × 4,160 = 139,360 (8,640)
G120 44 × 4,000 = 176,000 40 × 4,160 = 166,400 (9,600)
M124 58 × 5,000 = 290,000 53 × 5,400 = 286,200 (3,800)
M126 74 × 5,000 = 370,000 68 × 5,400 = 367,200 (2,800)
M128 90 × 10,000 = 900,000 83 × 10,800 = 896,400 (3,600)
W124 58 × 6,000 = 348,000 53 × 6,480 = 343,440 (4,560)
W126 74 × 7,000 = 518,000 68 × 7,560 = 514,080 (3,920)
Wl 28 100 × 6,000 = 600,000 93 × 6,480 = 602,640 2,640
$(69,440)
The five percent price cut will result in a decrease of $69,440 in Columbia’s
profits.
6-28 Total Sales Without Total Sales With

Product Special Promotion Special Promotion Difference
Hamburgers $1.09 × 20,000 = $0.69 × 24,000 = ($5,240)
$21,800 $16,560
Chicken — — —
Sandwiches 1.29 × 10,000 = 1.29 × 9,200 = $11,868 (1,032)
$12,900
French fries 0.89 × 20,000 = 0.89 × 22,400 = 2,136
$17,800 $19,936
($4,136)
– 261 –
Product Variable Costs Without Variable Costs With Difference

Special Promotion Special Promotion
Hamburgers $0.51 × 20,000 = $0.51 × 24,000 = ($2,040)
$10,200 $12,240
Chicken — — —
Sandwiches 0.63 × 10,000 = $6,300 0.63 × 9,200 = $5,796 504
French fries 0.37 × 20,000 = $7,400 0.37 × 22,400 = $8,288 (888)
($2,424)
Decrease in sales with special promotion $4,136

Increase in variable costs with special promotion 2,424
Decrease in contribution margin with special promotion $6,560
Incremental advertising expenses with special promotion 4,500
Decrease in profit with special promotion ($11,060)
Therefore, Andrea should not go ahead with this special promotion. A

countervailing argument is the creation of new customers who may stay with
the firm and generate additional contribution margin in the future.
6-29 For auto dealer service departments, the standardized hours facilitate quoting
estimates for customers and provide a defensible basis for the estimates. The
service department has discretion over the hourly rate, which includes labor
and support costs. From the customer’s viewpoint, the standardized hours
represent a reasonable amount of time for the requested service. If the
technician takes longer than estimated, the customer will not pay for the extra
time. Conversely, however, if the technician takes less time than estimated, the
customer will pay for the estimated rather than the actual time.
6-30 The lack of competitors suggests Sanders may be selling SM5 at a price
competitors find unprofitable; Sanders should consider raising the price. Other
actions to increase the profitability of SM5 include reducing manufacturing
support costs or customer support costs. To reduce SM5’s manufacturing
support costs, Sanders can explore process improvements, for example, to
reduce rework, setup times or material handling. To reduce customer support
costs, Sanders might improve the ordering process to reduce reprocessing or
time to process an order, or implement lower-cost alternatives for ordering (for
example, electronically). Sanders might reduce post-sales support costs by
improving instructions provided with the product. Finally, Sanders could offer
customers incentives, such as quantity discounts, to induce customers to place
– 262 –
fewer but larger orders, thereby reducing batch-related support costs and order-
related costs.
6-31 (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.
PROBLEMS
6-32 (a) Profit = Total Revenue − Cost

= (PQ) − [2,000 + (20Q)]
= [P × (400 − 5P)] − [2,000 + (20 × (400 − 5P))]
= 400P − 5P2 − 2,000 − 8,000 + 100P
= 500P − 5P2 − 10,000
(b) Differentiating revenue with respect to P and setting the result equal to 0,
we have:
500 − 10P = 0, that is, P* = $50. Therefore,
Q* = 400 − (5 × 50) = 150 and total cost is
C* = 2,000 + (20 × 150) = $5,000.

Therefore, average unit cost when the company produces Q* is $5,000 ÷
150 = 33.33.
– 263 –
6-33 (a) XLl XL2 XL3

Sales price $10.00 $14.00 $12.00
Direct materials (4.00) (4.50) (5.00)
Direct labor (2.00) (3.00) (2.50)
Variable support (2.00) (3.00) (2.50)
Unit contribution margin $2.00 $3.50 $2.00
Machine hours per unit 0.20 0.35 0.25
Contribution margin per machine hour $10.00 $10.00 $8.00
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:
XL1: 200,000 units × 0.20 machine hours = 40,000 machine hours
XL2: 200,000 units × 0.35 machine hours = 70,000 machine hours

110,000 machine hours
Therefore, a balance of 10,000 = 120,000 – 110,000 machine hours are

available for XL3 production, which is sufficient for 40,000 units of XL3
(10,000 machine hours ÷ 0.25 machine hours).
Optimal Production Levels:

XL1: 200,000 units; XL2: 200,000 units, XL3: 40,000 units
(b) Under the current capacity constraint, Excel Corporation cannot meet all
of 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.
XL3
Sales price $12.00
Direct materials $5.00
Direct labor 3.75*
Variable support 2.50 11.25
Unit contribution margin $0.75
* 3.75 = 2.50 × 150%
– 264 –
Because the unit contribution margin of XL3 using overtime is positive,

it is worthwhile operating overtime.
6-34 (a) HCD2 requires $100 ÷ $20 = 5 direct labor hours per unit. The new order
requires 1,000 = 200 × 5 direct labor hours, so the existing capacity is adequate.
The contribution margin per unit of HCD2 for the new order = $400 − (75 +
100 + 125) = $100. The increase in profit is $20,000 = 200 units × $100
contribution margin.
(b) HCD1 HCD2

Sales price $400 $500
Variable cost:
Direct material $60 $75
Direct labor 80 100
Variable support 100 240 125 300
Contribution margin per unit $160 $200
DLH per unit 4 5
Contribution margin per DLH $40 per DLH $40 per DLH
The new order requires a total of 1,500 = 5 × 300 DLH, but only
1,000 = 15,000 – 14,000 DLH are available. This will leave a capacity
shortage of 500 = 1,500 – 1,000 DLH. Therefore, the change in profit is
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.
– 265 –
(c) If the plant is worked overtime to manufacture HCD2 for the new order,
the contribution margin is negative $12.50 as shown below:
Unit Variable Cost for Overtime

Material 1 × 75 = $75.00
Labora 1.5 × 100 = 150.00
Variable support 1.5 × 125 = 187.50
Total variable cost $412.50
Sales price 400.00
Contribution margin $(12.50)
a
or 5 hours × $30 per hour
Change in Profit During

200 × 100 = $20,000 Regular hours
100 × (12.50) = (1,250) Overtime hours
Increase $18,750
6-35 (a) Product A Product B Product C

Direct material $12.00 $15.00 $18.00
Direct labor 9.00 15.00 20.00
Machine
operations and
maintenance 4 × 0.4 = 1.60 4 × 0.7 = 2.80 4 × 0.9 = 3.60
Supervision 9 × 0.20 = 1.80 15 × 0.20 = 3.00 20 × 0.20 = 4.00
Materials
handling 4 × 0.75 = 3.00 5 × 0.75 = 3.75 7 × 0.75 = 5.25
Quality control 120 × 0.02 = 2.40 120 × 0.02 = 2.40 120 × 0.05 = 6.00
Machine setups 300 × 0.01 = 3.00 300 × 0.01 = 3.00 300 × 0.02 = 6.00
Production
cost per unit $32.80 $44.95 $62.85
– 266 –
(b) Product A Product B Product C

Production cost per unit $32.80 $44.95 $62.85
Markup, 25% $8.20 $11.24 $15.71
Target price $41.00 $56.19 $78.56
(c) Product costs with overtime premium:
Product A Product B Product C

Direct material $12.00 $15.00 $18.00
Direct labor 1.5 × 9 = 13.50 1.5 × 15 = 22.50 1.5 × 20 = 30.00
Machine
operations and
maintenance 1.3 × 1.60 = 2.08 1.3 × 2.80 = 3.64 1.3 × 3.60 = 4.68
Supervision 1.3 × 1.80 = 2.34 1.3 × 3.00 = 3.90 1.3 × 4.00 = 5.20
Materials
handling 1.3 × 3.00 = 3.90 1.3 × 3.75 = 4.88 1.3 × 5.25 = 6.83
Quality control 1.3 × 2.40 = 3.12 1.3 × 2.40 = 3.12 1.3 × 6.00 = 7.80
Machine setups 1.3 × 3.00 = 3.90 1.3 × 3.00 = 3.90 1.3 × 6.00 = 7.80
Product A Product B Product C

Production cost per unit $40.84 $56.94 $80.31
Markup, 25% $10.21 $14.23 $20.08
Target price $51.05 $71.17 $100.39
MH per unit 0.4 0.7 0.9
Actual production 10,000 5,000 5,000
MH for actual production 4,000 3,500 4,500
Total MH used: 4,000 + 3,500 + 4, 500 12,000
Maximum demand 12,000 12,000 6,000
MH for maximum demand 4,800 8,400 5,400
Total MH: 4,800 + 8,400 + 5, 400 18,600
– 267 –
The company’s production last year used all available machine hours. If the
company desires to increase production and sales, costs will increase for all
units as the company increases capacity through use of overtime. Last year’s
sales prices were roughly equal to the company’s target prices that are designed
to cover costs and desired profit. Although the company could have sold more
units at last year’s prices, using overtime will increase target prices (based on a
25% markup over unit production costs) to amounts that substantially exceed last
year’s sales prices for the products. In making the decision on overtime production,
the company will need to assess the market demand for products A, B, and C at the
desired prices. Also, even if the company uses its available overtime hours, it
will not be able to meet the maximum demand for all the products.
6-36 (a) “Large” “Small”

Sales price per unit $32 $21
Variable cost per unit
Direct material ($12) ($10)
Direct labor (6) (2)
Support (2) (1)
Machine hours per unit
10 ÷ 100 = 0.10
10 ÷ 200 = 0.05
Contribution margin per MH $120 $160
(b) Small stuffed animals are more profitable to make under constrained
capacity than the large stuffed animals.
“Large” “Small”
MH required per batch 10 10
Estimated number of batches 150a 125b
Estimated MH required 1,500 1,250
a
15,000 ÷ 100 = 150
b
25,000 ÷ 200 = 125
Since total machine hour capacity is adequate to fill the estimated

demand for both large and small stuffed animals, Barney should produce
15,000 and 25,000 units of large and small stuffed animals, respectively.
– 268 –
(c) Special order:
Price per unit $37

Variable cost per unit: ($12 + 6 + 2) 20
Contribution margin per unit $17
“Large” “Small” Special Order

Contribution $1,200 $1,600 $1,700
margin per batch (12 × 100) (8 × 200) (17 × 100)
Contribution
margin per MH $120 $160 $170
Based on contribution margin per MH, Barney should first choose to
produce the 5,000 special order units, then 25,000 small stuffed animals,
and then use the remaining MH to produce12.500 other large stuffed
animals.
Total available MH 3,000

MH required:
Special order (5,000 ÷ 100) × 10 = (500)
“Small” (25,000 ÷ 200) × 10 = (1,250)
MH available for “Large” 1,250
Number of “Large” that can be produced: (1,250 ÷ 10) × 100 = 12,500
Unfilled demand 15,000 – 12,500 = 2,500
Opportunity cost 2,500 × $12 CM per unit = $30,000
(d) Yes, Barney should accept the special order because the contribution
margin obtained from this order is $85,000 = $17 × 5,000, which is
greater than the opportunity cost of $30,000, resulting in a net profit
increase of $55,000.
– 269 –
(e) Without Subcontract With Subcontract Difference

Special order $17 × 5,000 = $85,000 $17 × 5,000 = $85,000 $0
Small $8 × 25,000 = $200,000 $155,000* (45,000)
($8 × 20,000) − ($1 × 5,000)
Large $12 × 12,500 = $150,000 $12 × 15,000 = $180,000 30,000
Total CM $435,000 $420,000 ($15,000)
*Total available MH = 3,000
MH required:
Special order (5,000 ÷ 100) × 10 = (500)
Regular “Large” (15,000 ÷ 100) × 10 = (1500)
Available MH for “Small” 1,000
Number of “Small” produced:
In-house (1,000 ÷ 10) × 200 =20,000
Subcontract 5,000
Contribution margin on
sub-contracted “Small” $21 – $22 = – $1
Barney should not subcontract, but instead, should produce the special
order of 5,000 large stuffed dinosaurs, 12,500 other large stuffed
animals, and 25,000 small stuffed animals. To obtain any additional
benefit from the subcontract, the subcontract price per unit would have
to be less than $19, as shown below. Barney should also consider
qualitative factors such as the quality of subcontracted stuffed animals
and the reliability of the subcontract delivery schedule.
To determine the price P at which Barney is better off with the

subcontract than without, we solve the following inequality:
$435,000 < ($17 × 5,000)+ ($8 × 20,000) + 5,000($21 – P) +($12 × 15,000)

$435,000 < $85,000 + $160,000 + $105,000 – 5,000P +$180,000
5,000P < $95,000
P < $19
– 270 –
6-37 (a) In order to produce 10,000 units of standard doors and 5,000 units of
deluxe doors, the following number of direct labor hours and machine
hours are required:
Cutting:
Direct labor hours: 0.5 × 10,000 + 1 × 5,000 = 10,000 > 8,000 capacity
Machine hours: 2 × 10,000 + 3 × 5,000 = 35,000 < 40,000 capacity
Assembly:
Direct labor hours: 1 × 10,000 + 1.5 × 5,000 = 17,500 = 17,500 capacity
Machine hours: 2 × 10,000 + 3 × 5,000 = 35,000 < 40,000 capacity
Finishing:
Direct labor hours: 0.5 × 10,000 + 0.5 × 5,000 = 7,500 < 8,000 capacity
Machine hours: 1 × 10,000 + 1.5 × 5,000 = 17,500 > 15,000 capacity
Evidently, the direct labor hour capacity in the cutting department, and
the machine hour capacity in the finishing department are not adequate
to meet the next month’s demand.
(b) Standard Deluxe

Sales price per unit $150 $200
Variable cost per unit 110 155
CM per DLH in the cutting department $80a $45b
CM per MH in the finishing department $40c $30d
a
$40 ÷ 0.5 = $80
b
$45 ÷ 1 = $45
c
$40 ÷ 1 = $40
d
$45 ÷ 1.5 = $30
Since the standard door has a higher contribution margin per unit of both
scarce resources than the deluxe door, the following production plan is
recommended in order to maximize profit: Standard door: 10,000 units;
Deluxe door: 3,000 units*.
* Constraints on the number of deluxe doors that can be made in each production
department:
Cutting: [8,000 − (10,000 × 0.5)] ÷ 1 = 3,000 units.
Finishing: [15,000 − (10,000 × 1)] ÷ 1.5 = 3,333 units.
– 271 –
(c) The following alternatives may be considered:

1. Add more machines in the finishing department.
2. Use overtime or add a second shift in the cutting department.
6-38 (a) To maximize monthly commissions while working 160 hours per month,
Loren should devote the maximum allowable time (90 hours) to
customer group B because that group provides the largest average
commission per hour of Loren’s time. Loren should next allocate the
maximum of 60 hours to customer group A because that group provides
the next largest average commission per hour. Finally, Loren 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%
Average commission $54 $30 $8
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) Loren 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.
6-39 (a) DLH per unit = $500 direct labor cost ÷ $20 wage rate = 25 DLH
The new order requires 1,000 DLH (40 × 25), so the existing capacity is
adequate.
Contribution margin per unit = $2,000 – (375 + 500 + 625) = $500
– 272 –
Change in profit = 40 units × $500 contribution margin per unit

= $20,000 increase.
(b) Item L8011 L8033

Sales price $2,000 $2,500
Variable cost:
Direct materials $300 $375
Direct labor 400 500
Variable support 500 1,200 625 1,500
Contribution margin per unit $ 800 $1,000

DLH per unit 20 25
Contribution margin per DLH $40 $40
The new order requires a total of 1500 DLH (25 × 60), but there are only
1000 DLH (14,000 – 13,000) available. This will leave capacity short for
500 DLH (1500 – 1000). Therefore, the company will face an
opportunity cost of $40 per DLH (both products contribute $40 per
DLH).
Change in profit = Total contribution margin – opportunity cost

= (60 units × $500 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 L8033 for the special
order, the contribution margin per unit during overtime work is negative
$62.50, as computed below:
Contribution
Item Margin Per Unit Computation
Variable costs:
Direct materials $375.00 1 × $375
Direct labor 750.00 1.5 × $500
Variable support 937.50 1.5 × $625
Total variable costs $2062.50
Sales price 2000.00
Contribution margin $(62.50)
– 273 –
Therefore, the change in profit from accepting the special order and
working the plant overtime is a net increase of $18,750, as detailed
below:
Change in
Special Order Contribution
Production Margin Computation
Regular hours $20,000 40 × $500
Overtime hours (1,250) 20 × $(62.50)
Total increase $18,750
6-40 (Unofficial CMA Answer)
(a) The minimum price per blanket that Marcus Fibers, Inc. could bid
without reducing the company’s net income is $24.00 calculated as
follows:
Raw materials (6 lb. × $1.50/lb.) $9.00

Direct labor (0.25 hr. × $7.00/hr.) 1.75
Machine time ($10.00/blanket) 10.00
Variable support (0.25 hr × $3.00/hr.) 0.75
Administrative cost ($2,500 ÷ 1,000) 2.50
Minimum bid price $24.00
(b) Using the full cost criterion and the maximum allowable return specified,
Marcus Fibers, Inc.’s bid price per blanket would be $29.90, calculated
as follows:
Relevant costs from requirement (a) $24.00

Fixed support (0.25 hr × $8.00/hr.) 2.00
Subtotal 26.00
Allowable return (0.15a × $26.00) 3.90
Bid price $29.90
a
9% ÷ (1 – tax rate of 40%)
– 274 –
(d) Factors that Marcus Fibers, Inc. should consider before deciding whether
to submit a bid at the maximum acceptable price of $25.00 per blanket
include the following:
• The company should be sure there is sufficient excess capacity to

fulfill the order and that no additional investment is necessary in
facilities or equipment, which would increase the capacity-related
(fixed) expense.
• If the order is accepted at $25.00 per blanket, there will be a $1.00
contribution per blanket to fixed costs. However, the company
should consider whether there are other jobs that would make a
greater contribution.
• Acceptance of the order at a low price could cause problems with
current customers who might demand a similar pricing
arrangement.
6-41 (a) Direct materials cost per unit $3.80

Direct labor cost per unit 10.00
Total variable cost per unit $13.80
Shipping cost per unit: $3,200 ÷ 1,000 3.20
Minimum price that Holmes could offer $17.00
(b) A17 B23 XLT

Selling price per unit $75.00 $120.00 $160.00
Variable cost of the basic component $13.80 $13.80 $13.80
Direct materials cost per unit — 6.00 4.50
Direct labor costs per unit 9.00 20.00 31.00
Total variable costs per unit $22.80 $39.80 $49.30
Contribution margin per unit $52.20 $80.20 $110.70
(c) A17 B23 XLT

Contribution margin per unit $52.20 $80.20 $110.70
Direct labor hours per unit ÷ 0.3 ÷ 0.8 ÷ 1.05
Contribution margin per DLH $174.00 $100.25 $105.43
Therefore, it is optimal to make only model A17 if there is sufficient

demand.
– 275 –
Contribution margin per unit of B23 at a price of $140.00 = $100.20
Contribution margin per direct labor hour for B23 = $125.25
Therefore, the above answer does not change if the price of model B23 is
$140.
6-42 Unit cost of direct materials $9.80

Unit cost of direct labor 4.50
Unit variable manufacturing support cost:
($6,000,000 − $4,50,000) ÷ 500,000 units 3.00
Unit variable selling and administrative cost:
$2.50a × (1.0 − 0.6) 1.00
Unit relevant cost of the special order $18.30
Number of units 100,000
Total relevant cost of the special order $1,830,000
a
($3,350,000 − $2,100,000) ÷ 500,000
Total relevant costs of the special order ($1,830,000) are compared with the
total revenue of $2,500,000 from this order. Because the associated revenues
exceed the relevant costs, Kirby Company should accept this special order from
the customer.
6-43 (a) The unit cost relevant to determining the minimum selling price for the
damaged units is the incremental cost that will be incurred. Hence, the
relevant unit cost is the variable selling and distribution cost of $2.00.
– 276 –
(b) The maximum amount per unit Purex Company should pay is the amount that
Purex Company saves by not making the product.
Variable manufacturing costs: $120,000

25,000 × ($1.50 + $2.50 + $0.80)
Fixed support: $100,000 − $90,000 10,000
Variable selling and distribution costs:
25,000 × ($2.00 −$0.80) 30,000
Total cost savings $160,000
Number of units ÷ 25,000
Cost savings per unit $6.40
(c) The incremental cost per unit includes all variable manufacturing costs
and variable selling costs. Thus, the incremental cost per unit is $5.80 =
($1.50 + $2.50 + $0.80 + $1.00) and the minimum acceptable price is
$5.80.
(d) Kleen Shine

Selling price per unit $10.00 $16.00
Variable costs per unit 6.80 11.00
Contribution margin per unit $3.20 $5.00
Machine hours per unit ÷ 1.0 ÷ 2.5
Contribution margin per machine hour $3.20 $2.00
Since the contribution margin per machine hour for Kleen is greater than
that for Shine, Purex Company should produce as many units of Kleen as
can be sold (80,000 units) to maximize total contribution margin. The
remaining 20,000 hours of machine time should be used to manufacture
8,000 (= 20,000 ÷ 2.5) units of Shine.
6-44 (a) P1 (Casting) P2 (Machining)

R361: 30,000 × 1.2 = 36,000 72,000 × 1.2 = 86,400
R572: 10,000 × 2 = 20,000 48,000 × 2 = 96,000
Total machine
hours required 56,000 182,400
Note: 1.2 = 600,000 ÷ 500,000 and 2 = 800,000 ÷ 400,000.
– 277 –
Capacity in Casting (P1) is adequate because 56,000 < 80,000. However,

capacity in machining (P2) is not adequate because 182,400 > 120,000.
(b) Using the activity-based costs as variable costs:
R361 R572
Variable cost per unit 15.67 17.70
(c) R361 R572

P2 MH per unit 72,000 48,000
= 0144
. = 012
.
500,000 400,000
Contribution margin $3.33 $2.30
per P2 MH = 2313
. = 1917
.
0144
. 012
.
Estimated demand 600,000 units 800,000 units
Note that P2 MH cannot exceed 120,000 hours. Since contribution

margin per P2 MH for R361 is greater than contribution margin per P2
MH for R572, Crimson should first produce as many units of R361 as
possible. P2 MH required to produce 600,000 units of R361
= 72,000 × 1.2 (or 600,000 × 0.144)

= 86,400 hours.
Next, P2 MH available to produce R572

= 120,000 – 86,400
= 33,600 hours.
By using 33,600 P2 MH, the maximum number of R572 that can be

produced is
33,600
=
012
.
= 280,000 units
– 278 –
Summary:
Contribution margin per P2 MH for R361 = $23.13
Contribution margin per P2 MH for R572 = $19.17
Optimal production level for R361 = 600,000 units
Optimal production level for R572 = 280,000 units
(e) First, note that Crimson does not need to operate overtime in the Casting
(P1) department because there is surplus capacity. Next, the demand of
R361 can be filled without using overtime. Thus, to determine whether it is
worthwhile operating machining (P2) department overtime, we need to
consider only R572. Overtime can be considered for the remaining 520,000
units of demand for R572. This requires 62,400 MH (= 520,000 × 0.12).
The new variable cost per unit is $17.70 + ($0.75 × 0.5) + ($2.16 × 0.5) =
$19.155 and the new contribution margin per unit of R572 is $0.845. Thus,
it is worthwhile to operate overtime to fulfill the demand for R572.
6-45 (a) Standard Deluxe

Selling price (per batch) ($10 × 60) = $600 ($20 × 30) = $600
Less variable cost (per batch):
Direct material ($5 × 60) = $300 ($11 × 30) = $330
Direct labora 144 120
Shipmentb 15 45
Contribution margin per batch $141 $105
DLH required per batch 12 10
Batch CM per DLH $11.75 $10.50
a
$12 × ([60 × 10] ÷ 60 + 2) = $144; 12 × ([30 × 15] ÷ 60 + 2.5) = $120
b
$15 × (60 ÷ 60) = $15; $15 × (30 ÷ 10) = $45
Since the Standard model has a higher contribution margin per unit of
the scarce resource (DLH) than the Deluxe model, the company should
produce as much of the Standard model as the company can sell and use
the remaining DLH to manufacture the Deluxe model.
Demand for the Standard model is 6,000, which requires 6,000/60 = 100
batches, and therefore, 100 ×12 = 1,200 DLH. The company would then
have 2,000 – 1,200 = 800 DLH remaining for Deluxe production. With
the 800 DLH, the company can produce 800/10 = 80 batches, or 80 × 30
= 2,400 Deluxe tents. The optimal production schedule is therefore:
6,000 Standard tents and 2,400 Deluxe tents.
– 279 –
Deluxe
(b) (Northland’s offer)
Selling price (per batch): $18.50 × 50 $925
Less variable cost (per batch):
Direct material: $11 × 50 550
Direct labor: 12 × ([50 × 15] ÷ 60 + 2.5) 180
Shipment: $15 × 1 15
Contribution margin per batch $180
DLH required per batch ÷ 15
Contribution margin per DLH $12
Orion should accept this offer because it offers a higher contribution

margin per DLH than both the Regular and the Deluxe models. However,
Orion should also consider other factors such as whether the Northlands
arrangement will continue in the long-run, and how its regular customers
will react to the lower price offered to Northlands.
6-46 (a)
15.5
15
14.5
14
Price
13.5
13
12.5
12
11.5
1 2 3 4 5 6 7 8 9 10 11 12 13
Week
Short-run price + Long- run price
– 280 –
Week v b at Pt PL X Qt
1 $8.1 500 8,200 $12.25 $13.95 2,150 2,075
2 8.1 500 8,350 12.40 13.95 2,150 2,150
3 8.1 500 8,600 14.95 13.95 2,150 1,125
4 8.1 500 8,500 14.85 13.95 2,150 1,075
5 8.1 500 8,400 14.75 13.95 2,150 1,025
6 8.1 500 8,850 15.20 13.95 2,150 1,250
7 8.1 500 8,300 12.35 13.95 2,150 2,125
8 8.1 500 8,050 12.10 13.95 2,150 2,000
9 8.1 500 8,200 12.25 13.95 2,150 2,075
10 8.1 500 8,800 15.15 13.95 2,150 1,225
11 8.1 500 8,350 12.40 13.95 2,150 2,150
12 8.1 500 7,950 12.00 13.95 2,150 1,950
13 8.1 500 8,650 15.00 13.95 2,150 1,150
Average 13.51 13.95
at v
Pt = + if at # 8 , 350
2b 2
a w
= t + if at > 8, 350
2b 2
Qt = at -bPt
– 281 –
(b) Week Revenuea Costb Profitc

1 $25,418.75 $23,257.50 $2,161.25
2 26,660.00 23,865.00 2,795.00
3 16,818.75 15,562.50 1,256.25
4 15,963.75 15,157.50 806.25
5 15,118.75 14,752.50 366.25
6 19,000.00 16,575.00 2,425.00
7 26,243.75 23,662.50 2,581.25
8 24,200.00 22,650.00 l,550.00
9 25,418.75 23,257.50 2,161.25
10 18,558.75 16,372.50 2,186.25
11 26,660.00 23,865.00 2,795.00
12 23,400.00 22,245.00 l,155.00
13 17,250.00 15,765.00 1,485.00
Total Profit $23,723.75
a b c
Pt Qt vQt + mX Revenue – Cost
30
28
26
24
(Thousands)
Total Profit
22
20
18
16
14
12
1.7 1.8 1.9 2 2.1 2.2 2.3 2.4 2.5 2.6

(Thousands)
Capacity
– 282 –
(a) The manufacturing support cost driver rate is $18.00 per standard direct
labor hour and the standard product cost includes $9.00 of
manufacturing support per pressure valve. Accordingly, the standard
direct labor hour per finished valve is 0.5 hours ($9 ÷ $18). Therefore,
30,000 units per month would require 15,000 direct labor hours.
(b) The incremental analysis of accepting the Glasgow Industries’ order of

120,000 units is presented below.
Totals for
Per Unit 120,000 Units
Incremental revenue $19.00 $2,280,000
Incremental costs
Variable costs
Direct materials 5.00 600,000
Direct labor 6.00 720,000
Variable support: $9.00 − $6.00 per unit 3.00 360,000
Total variable costs $14.00 1,680,000
Fixed support
Supervisory and clerical costs
(4 months × $12,000) 48,000
Total incremental costs 1,728,000
Incremental profit before tax $552,000
The following costs are irrelevant to the incremental analysis:
• Shipping
• Sales Commission
• Fixed Manufacturing Support
– 283 –
(c) The minimum unit price that Sommers could accept without reducing its profits
must cover variable costs plus the additional fixed costs.
Variable unit costs

Direct materials $5.00
Direct labor 6.00
Variable support 3.00 $14.00
Additional fixed cost ($48,000 ÷ 120,000) 0.40
Minimum unit price $14.40
(d) Sommers Company should consider the following factors before

accepting the Glasgow Industries order.
• The effect of the special order on Sommers’ sales at regular prices.

• The possibility of future sales to Glasgow Industries and the
effects of participating in the international marketplace.
• The company’s relevant range of activity and whether the special
order will cause volume to exceed this range.
• The impact on local, state and federal taxes.
• The effect on machinery or the scheduled maintenance of equipment.
– 284 –
(a) Bakker Industries will not be able to meet the monthly sales demand for
the three products because of insufficient machine capacity in
Department 1. However, there is sufficient capacity for both labor and
machine hours in all other departments as shown below.
Bakker Industries
Sales Demand vs. Machine and Labor Hour Capacities
Departments
1 2 3 4
Machine hours needed:
(hours × demand)
Product: 611 1,000 500 1,000 1,000
613 400 400 — 800
615 2,000 2,000 1,000 1,000
Total hours required 3,400 2,900 2,000 2,800
Machine hours available 3,000 3,100 2,700 3,300
Excess (deficiency) (400) 200 700 500
Labor hours needed (hours × demand)
Product: 611 1,000 1,500 1,500 500
613 400 800 — 800
615 2,000 2,000 1,000 1,000
Total hours required 3,400 4,300 2,500 2,300
Labor hours available 3,700 4,500 2,750 2,600
Excess (deficiency) 300 200 250 300
– 285 –
(b) Bakker Industries has a scarce resource, machine hour capacity in Department
1. Therefore, the company should maximize contribution per machine
hour in Department 1 in order to maximize overall profit, as calculated
below.
Bakker Industries
Contribution Maximization Calculation
• Calculation of contribution per machine hour:
Product
611 613 615
Unit selling price $196.00 $123.00 $167.00
Less variable costs 103.00 73.00 89.00
Contribution per unit $93.00 $50.00 $78.00
Machine hours in Department 1 2 1 2
Contribution per machine hour $46.50 $50.00 $39.00

• Use available machine capacity to maximize contribution per MH
Machine hours available in Department 1 3,000
Use 400 hours to produce 400 units of Product 613 400
Remaining available hours 2,600
Use 1,000 hours to produce 500 units of Product 611 1,000
Remaining available hours 1,600
Use remaining 1,600 hours to produce 800 units 1,600
of Product 615
Remaining available hours 0
• Contribution from this production schedule:
Product 613 (400 × $50) $20,000
Product 611 (500 × $93) 46,500
Product 615 (800 × $78) 62,400
Total contribution $128,900
(c) Bakker might operate overtime or subcontract some of Department 1’s

production to outside firms.
– 286 –
In order to maximize the company’s profitability, Sportway, Inc. should

purchase 9,000 tackle boxes from Maple Products, manufacture 17,500
skateboards and manufacture 1,000 tackle boxes. This combination of
purchased and manufactured goods maximizes the contribution margin per
direct labor hour available, as calculated below in Tables 1 and 2.
Table 1: Calculate Unit Contribution

Purchased Manufactured Skateboards
Tackle Boxes Tackle Boxes
Selling price $86.00 $86.00 $45.00
Less: Variable costs
Material 68.00 17.00 12.50
Direct labor n/a 18.75 7.50
Manufacturing support* n/a 6.25 2.50
Selling and admin. cost** 4.00 11.00 3.00
Contribution margin $14.00 $33.00 $19.50
Direct labor hours per unit none 1.25 0.50
Contribution margin per hour n/a $26.40 $39.00
* Calculation of variable support cost per unit:

Tackle boxes:
Direct labor hours = $18.75 ÷ $15.00 = 1.25 hours
Support costs/DLH = $12.50 ÷ 1.25 = $10.00
Capacity = 8,000 boxes × 1.25 = 10,000 hours
Total support costs = 10,000 hours × $10 = $100,000
Total variable support = $100,000 – $50,000 = $50,000
Variable support per hour = $50,000 ÷ 10,000 = $5.00
Variable support per box = $5.00 × 1.25 = $6.25
Skateboards:
Direct labor hours = $7.50 ÷ $15.00 = .5 hours
Variable support = $5.00 × .5 = $2.50
** For calculating contribution, $6.00 of fixed support cost per unit
for distribution must be deducted from selling and administrative cost.
– 287 –
Table 2: Optimal Use of Sportway’s Available Direct Labor

Unit DLH Total Balance Total
Item Quantity Contribution Per Unit DLH of DLH Contribution
Total hours 10,000
Skateboards 17,500 $19.50 0.50 8,750 1,250 $341,250
Make boxes 1,000 33.00 1.25 1,250 — 33,000
Buy boxes 9,000 14.00 — — — 126,000
Total
contribution $500,250
Less: Contribution for manufacturing 8,000 boxes
(8,000 × $33.00) 264,000
Improvement in contribution
margin $236,250
6-50 (a) Fixed costs of Process A: $36,000,000a × 0.6 = $21,600,000
Fixed costs of Process B:

$12,000,000b × (1.2 + 0.6) = $21,600,000
The total amount of fixed manufacturing support is common to both

processes and does not change with different alternatives. Therefore, it is
irrelevant to this analysis. The scarce resource is hours of capacity. The
objective here is to maximize the contribution margin per hour.
a
12,000,000 = 600,000 hrs × $20 per hr.
b
$36,000,000 = 600,000 hrs × $60 per hr.
– 288 –
Process A Process B
Output Output
Variable costs per unit:
Transferred-in variable costs from
Process A — 1.20
Direct material 1.00 1.50
Direct labor 0.20 0.40
Total variable costs per unit $1.20 $3.10
Capacity hours per unit 1 ÷ 60 = 0.01667 1 ÷ 20 = 0.05
Contribution margin per
capacity hour $48.00 $40.00
Therefore, Process B output should be dropped and all facilities should

be devoted to the sale of only Process A output.
(b) Required contribution margin per capacity hour: $48.00

Required capacity hours per unit: 0.05
Required contribution margin per unit: 48 × 0.05 = $2.40
Variable costs per unit: $3.10
Minimum required selling price of Process B output: $5.50
– 289 –
(c) For (a):
Process A Process B
Output Output
Variable costs per unit: 1.50a 4.00b
Capacity hours per unit 1 ÷ 60 = 0.01667 1 ÷ 20 = 0.05
Contribution margin per
capacity hour $30.00 $22.00
a
$1.50 = $1.20 + (0.5 × $0.60)
b
$4.00 = $3.10 + 0.5($1.20 + $.60)
Therefore, the earlier answer to (a) does not change.
For (b):
Required contribution margin per capacity hour: $30.00

Required capacity hour per unit: 0.05
Required contribution margin per unit: $1.50
Variable costs per unit $4.00
Minimum required selling price of Product B $5.50
Therefore, the earlier answer to (b) does not change.
– 290 –
CASES
6-51 (a) Unit cost AA100 AA101 AA102

Direct materials: Chem. & frag. $560 $400 $470
Direct materials: AA 100 — 680 680
Direct labor 60 30 60
Variable mfg. support 60 30 60
Total variable mfg. cost $680 $1,140 $1,270
Total selling support 20 30 30
Total variable cost $700 $1,170 $1,300
Sales price 940 1,500 1,700
Contribution margin per ton $240 $330 $400
Hours per ton 4 hrs 6 hrs 8 hrs
Contribution margin per hour $60 $55 $50
(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.
Required contribution margin per ton (= $60 × 6) $360

Variable cost per ton 1,170
Required minimum sales price per ton $1,530
(d) It is worthwhile operating the plant overtime. The optimal production

level is AA100: 600 tons; AA101: 100 tons; and AA102: 0 tons.
Explanation: The regular capacity of 2,400 hours (before operating the

plant overtime) is used to produce 600 tons of AA100. How should 600
hours of overtime be used? We know that the demand for AA100 has
been filled fully. Therefore, we consider AA101 and AA102. AA101 has
a higher contribution margin per hour than A102. With 600 hours of
– 291 –
overtime, the company can produce 100 tons of A101 (600 hours ÷ 6
hours per ton), which is less than the maximum demand. This leaves no
hours for A102.
Under overtime: AA100 AA101 AA102

Direct materials: Chem. & frag. $560 $400 $470
Direct materials: AAA100 — 740 740
Direct labor 90 45 90
Variable mfg. support 90 45 90
Total variable mfg. cost $740 $1,230 $1,390
Variable selling support 20 30 30
Total variable cost $760 $1,260 $1,420
Sales price 940 1,500 1,700
Contribution margin per ton $180 $240 $280
Hours per ton 4 6 8
Contribution margin per hour $45 $40 $35
Since contribution margins per hour for AA101 and AA102 are positive,
it is worthwhile operating the plant overtime.
6-52 (a) Avoidable costs for 400 units of DLX:
Direct material = $(80 + 20) × 400 = $40,000

Direct labor = $(40 + 30) × 400 = 28,000
Support:
MNTa: $4 × 5 MH × 400 8,000
QLCb: $10 × 2 inspection hours × 400 8,000
Total cost $84,000
a
MNT. Let FC = fixed costs and VC = variable costs.
Week 45: FC + VC×[450 × (2 + 1) + 430 × (3 + 2)] = $35,000 (1)
Week 46: FC + VC×[450 × (2 + 1) + 450 × (3 + 2)] = $35,400 (2)
Solving equations (1) and (2) simultaneously yields VC = $4 per MH.
b
QLC. Let FC = fixed costs and VC = variable costs.
Week 45: FC + VC×[450 × (0.5 + 0.5) + 430 × (1 + 1)] = $63,100 (3)
Week 46: FC + VC×[450 × (0.5 + 0.5) + 450 × (1 + 1)] = $63,500 (4)
Solving equations (3) and (4) simultaneously yields VC = $10 per inspection hour.
– 292 –
Since the total avoidable costs are more than the total subcontracting
charges of $80,000 (= $200 × 400) under the French offer, it is profitable
to accept the offer.
Qualitative factors such as quality of purchased model and reliability of

delivery schedule should also be considered in evaluating this offer.
(b) Relevant costs include direct material costs, direct labor costs, and
avoidable maintenance and inspection costs.
(c) From (a) above, we can determine the fixed costs for MNT and QLC as
follows:
MNT: FC = $21,000
QLC: FC = $50,000
Cost savings from capacity reduction:
Expected total machine hours = 3,600

Expected total inspection hours = 1,350
MNT: $21,000 × [(3 + 2) × 400/3,600] = $11,666.67

QLC: $50,000 × [(1 + 1) × 400/1,350] = $29,629.63
Total cost savings:
Direct material $40,000.00

Direct labor 28,000.00
MNT - VC 8,000.00
MNT - FC 11,666.67
QLC - VC 8,000.00
QLC - FC 29,629.63
Total cost savings $125,296.30
It is profitable for Sweditrak to accept the long-term offer because the

total cost savings are greater than the total subcontracting charges.
6-53 This case consists of running an experiment, and students are required to
submit a report and statements after the experiment.
– 293 –
6-54 The responses below are based on “Survival Strategies: After Cost Cutting,
Companies Turn Toward Price Increases,” by Timothy Aeppel, The Wall Street
Journal (September 18, 2002, p. A1).
(a) Jergens’ president based the price on what he determined to be the cost of
producing the order of 10 odd-sized fasteners from scratch. The cost included
setup for the odd size and overtime labor. The company actually produced the
odd-sized fasteners by producing full-size fasteners and then shortening 10.
This method was less costly than setting up the equipment to run a small
batch of the required odd size.
(b) Goodyear had been rewarding its sales force based on volume, providing an
incentive for the sales force to deeply discount prices to large distributors. The
discounts were so substantial that the large distributors could resell the tires to
smaller distributors (even with transportation costs to other regions), reducing
Goodyear’s sales at higher prices to smaller distributors. Goodyear responded
by cutting the discounts to large distributors, removing discount approval
authority from the sales force and transferring it to a “tactical pricing group”
that determines whether Goodyear can profitably match a competitor’s prices.
Goodyear also modified its sales force bonus scheme to include a “revenue
per tire” metric.
(c) Emerson discovered that customers were willing to pay about 20% more than
Emerson’s initially proposed cost-based price of $2,650 for a new compact
sensor. Emerson priced the sensor at $3,150. Note that the article does not
provide information on how Emerson determined product costs that it used as
a basis for its markups. A traditional cost system is more likely to undercost a
low-volume or customized product because it allocates manufacturing
support costs to products based on unit-level drivers. An activity-based
costing system more accurately assigns costs based on resource usage.
(d) Wildeck, “a maker of metal guard rails, mezzanines and material lifts for
factories and warehouses,” promoted packages that included installing its
products. The installations bring higher profit than parts catalog sales.
Wildeck responded to a competitor’s lower-priced storage-rack protector by
developing its own “lite” version and pricing it much lower than the
competitor’s price. When customers called about purchasing the lite version,
they were informed of the benefits of the original version, and most of these
customers bought the original version. An accurate costing system, such as a
good activity-based costing system that includes both manufacturing and
nonmanufacturing costs of providing goods and services to customers,
– 294 –
provides reasonably precise information to managers for making decisions

about the mix of products and services to offer to customers and prices to
charge in order to generate the desired level of profitability.
(e) Union Pacific introduced a minimum price that was higher than a third of its
customers paid. The company was not concerned if it lost these customers
because customers who were paying higher prices would fill up the newly
free space. Dropping unprofitable customers will not lead to an immediate
increase in profit if the associated capacity-related costs are committed costs
and the resources cannot be put to other profitable use.
– 295 –

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Chapter 6

6-3 In commodity-type businesses, prices are set by traders in the commodity

6-10 If facility-sustaining (business-sustaining) costs do not vary with the decision

Incremental revenue per meal $3.50

Variable costs are $800 per module ($2,400,000/3,000 modules). The

Direct material $6.00

6-21 Regular Deluxe

Deluxe: 8,000 sq. yards

Regular: 20,000 sq. yards (= 3,000 ÷ 0.15).

6-22 This discussion question is motivated by recent articles on controversial

[3] McGinley, L. “Medicaid Fix: House Limits Evictions From Nursing

Students, like nursing home administrators, may argue that it is

(b) An employee who believes policies are unethical can approach

6-23 Incremental variable costs = ($16 + $5 + $3) × 10,000

Incremental revenue = $40 × 10,000 = $400,000.

Therefore, Berry’s operating income will increase by $160,000 if it accepts this

6-24 (a) Variable cost per unit = $198,000 ÷ 36,000 = $5.50.

Sales (30,000 units × $10 and 30,000 units × $9) $570,000

Variable component of support costs

Fixed component of support costs

Direct material cost $125

6-27 Model Total Contribution Margin Total Contribution Margin Difference

6-28 Total Sales Without Total Sales With

Product Variable Costs Without Variable Costs With Difference

Decrease in sales with special promotion $4,136

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

6-32 (a) Profit = Total Revenue − Cost

500 − 10P = 0, that is, P* = $50. Therefore,

Q* = 400 − (5 × 50) = 150 and total cost is

C* = 2,000 + (20 × 150) = $5,000.

6-33 (a) XLl XL2 XL3

XL1: 200,000 units × 0.20 machine hours = 40,000 machine hours

XL2: 200,000 units × 0.35 machine hours = 70,000 machine hours

Therefore, a balance of 10,000 = 120,000 – 110,000 machine hours are

Optimal Production Levels:

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

(b) HCD1 HCD2

Total contribution margin – opportunity cost

Unit Variable Cost for Overtime

Change in Profit During

6-35 (a) Product A Product B Product C

(b) Product A Product B Product C

(c) Product costs with overtime premium:

Product A Product B Product C

Product A Product B Product C

6-36 (a) “Large” “Small”

Since total machine hour capacity is adequate to fill the estimated

(c) Special order:

Price per unit $37

“Large” “Small” Special Order

Total available MH 3,000

(e) Without Subcontract With Subcontract Difference

*Total available MH = 3,000

To determine the price P at which Barney is better off with the

$435,000 < ($17 × 5,000)+ ($8 × 20,000) + 5,000($21 – P) +($12 × 15,000)

(b) Standard Deluxe

(c) The following alternatives may be considered:

Contribution margin per unit = $2,000 – (375 + 500 + 625) = $500

Change in profit = 40 units × $500 contribution margin per unit

(b) Item L8011 L8033

Contribution margin per unit $ 800 $1,000

Change in profit = Total contribution margin – opportunity cost

6-40 (Unofficial CMA Answer)