Chapter 5

(Make/Buy, Drop/Continue, Special Order,

Sell at split-off/Process further)
Make/Buy

1.Foster Industries manufactures 20,000 components per year. The

manufacturing cost of the components was determined as
follows:

Direct materials $150,000

Direct labor 240,000
Variable manufacturing overhead 90,000
Fixed manufacturing overhead  120,000
Total $600,000

An outside supplier has offered to sell the component for

$25.50.

What is the effect on income if Foster Industries purchases

the component from the outside supplier?

ANSWER:
 Make:
Direct materials $(150,000)
Direct labor (240,000)
Variable overhead   (90,000)
Total $(480,000)

Buy:
Purchase price (20,000 × $25.50) $(510,000)

$510,000 – $480,000 = $30,000 decrease in income

2. Vest Industries manufactures 40,000 components per year. The

manufacturing cost of the components was determined as
follows:

Direct materials $ 75,000

Direct labor 120,000
Variable manufacturing overhead 45,000
Fixed manufacturing overhead   60,000
Total $300,000

An outside supplier has offered to sell the component for

$12.75.
 What is the effect on income if Vest Industries purchases the
component from the outside supplier?

ANSWER:

Make:
Direct materials $ (75,000)
Direct labor (120,000)
Variable overhead   (45,000)
Total $(240,000)

Buy:
Purchase price (40,000 × $12.75) $(510,000)

$510,000 – $240,000 = $270,000 decrease in income

3.Foster Industries manufactures 20,000 components per year. The

manufacturing cost of the components was determined as
follows:

Direct materials $150,000

Direct labor 240,000
Variable manufacturing overhead 90,000
Fixed manufacturing overhead 120,000
 Total $600,000

An outside supplier has offered to sell the component for

$25.50.

Foster Industries can rent its unused manufacturing facilities

for $45,000 if it purchases the component from the outside
supplier.

What is the effect on income if Foster purchases the component

from the outside supplier?

ANSWER:

Make:
Direct materials $(150,000)
Direct labor (240,000)
Variable overhead   (90,000)
Total $(480,000)

Buy:
Purchase price (20,000 × $25.50) $(510,000)
Rental income    45,000
Total $(465,000)
 $480,000 – $465,000 = $15,000 increase in income

4. Vest Industries manufactures 40,000 components per year. The

manufacturing cost of the components was determined as
follows:

Direct materials $ 75,000

Direct labor 120,000
Variable manufacturing overhead 45,000
Fixed manufacturing overhead   60,000
Total $300,000

An outside supplier has offered to sell the component for

$12.75.

Vest Industries can rent its unused manufacturing facilities

for $45,000 if it purchases the component from the outside
supplier.

What is the effect on income if Vest purchases the component

from the outside supplier?

ANSWER:

Make:
Direct materials $ (75,000)
Direct labor (120,000)
Variable overhead   (45,000)
Total $(240,000)

Buy:
Purchase price (40,000 × $12.75) $(510,000)
Rental income    45,000
Total $(465,000)

$465,000 – $240,000 = $225,000 decrease in income

5. Miller Company produces speakers for home stereo units. The speakers
are sold to retail stores for $30. Manufacturing and other
costs are as follows:

Variable costs per unit: Fixed costs per month:

Direct materials $ 9.00 Factory overhead
$120,000
Direct labor 4.50 Selling and admin.
60,000
Factory overhead 3.00 Total $180,000
Distribution   1.50
Total $18.00

The variable distribution costs are for transportation to the

retail stores. The current production and sales volume is
20,000 per year. Capacity is 25,000 units per year.

A Tennessee manufacturing firm has offered a one-year contract

to supply speaker parts at a cost of $6.00 per unit. If
Miller Company accepts the offer, it will be able to reduce
variable costs to 30 percent and rent unused space to an
outside firm for $18,000 per year. All other information
remains the same as the original data. What is the effect on
profits if Miller Company buys from the Tennessee firm?

ANSWER:

Cost to buy ($6 × 20,000)

$120,000
Opportunity costs (18000)
Cost to make:
Variable costs [($18.00 × 0.30) × 20,000]
($108,000)
Profit will decrease by
6,000
*if the company buy from outside, it will incur $6000 more cost.
6. Harris Company uses 5,000 units of part AA1 each year. The cost of
manufacturing one unit of part AA1 at this volume is as
follows:

Direct materials $10.00

Direct labor 14.00
Variable overhead 6.00
Fixed overhead   4.00
Total $34.00

An outside supplier has offered to sell Harris Company

unlimited quantities of part AA1 at a unit cost of $31.00. If
Harris Company accepts this offer, it can eliminate 50 percent
of the fixed costs assigned to part AA1. Furthermore, the
space devoted to the manufacture of part AA1 would be rented
to another company for $24,000 per year. If Harris Company
accepts the offer of the outside supplier, annual profits
will

ANSWER:

Cost to buy (5,000 × $31) + ($2.00 × 5,000) $165,000

Cost to make (5,000 × $34) + $24,000  194,000
Profits increase by $ 29,000

Drop/Continue

1. The operations of Smits Corporation are divided into the Childs

Division and the Jackson Division. Projections for the next
year are as follows:

Childs Jackson
Division Division Total
Sales $250,000 $180,000
$430,000
Variable costs   90,000  100,000
190,000
Contribution margin $160,000 $ 80,000
$240,000
Direct fixed costs   75,000   62,500
137,500
Segment margin $ 85,000 $ 17,500
$102,500
Allocated common costs   35,000   27,500
62,500
Operating income (loss) $ 50,000 $(10,000)
40,000

Operating income for Smits Corporation as a whole if the

Jackson Division were dropped would be?

ANSWER:

$85,000 – $62,500 = $22,500

2. The operations of Knickers Corporation are divided into the Pacers
Division and the Bulls Division. Projections for the next
year are as follows:

Pacers Bulls
Division Division Total
Sales $420,000 $252,000
$672,000
Variable costs  147,000  115,500
262,500
Contribution margin $273,000 $136,500
$409,500
Direct fixed costs  126,000  105,000
231,000
Segment margin $147,000 $ 31,500
$178,500
Allocated common costs   63,000   47,250
110,250
Operating income (loss) $ 84,000 $(15,750)
68,250

Operating income for Knickers Corporation as a whole if the

Bulls Division were dropped would be?

ANSWER:

$147,000 – $110,250 = $36,750

When bulls division is dropped, the segment margin is on
pacers minus the allocated common cost that ‘not differ
between alternative=not relevant.

3. The following information pertains to Ewing Company’s three products:

D E F
Unit sales per month 900 1,400 800

Selling price per unit $6.00 $11.25 $ 7.50

Variable costs per unit  3.00   9.00   7.80
Unit contribution margin $3.00 $ 2.25 $(0.30)

Assume that product F is discontinued and the space used to

produce product F is rented for $600 per month. Monthly
profits will?

ANSWER:

(800 × $0.30) + $600 = 240+600=$840

Before:
$2700+$3150-$240=$5610
After:
900x$3=$2700
1400x2.25=$3150
Opportunity cost=$600
Total= $6450
S0, $6450-$5610=$840
4. The following information pertains to Ewing Company’s three products:

D E F
Unit sales per month 900 1,400 800

Selling price per unit $6.00 $11.25 $ 7.50

Variable costs per unit  3.00   9.00   7.80
Unit contribution margin $3.00 $ 2.25 $(0.30)

Assume that product F is discontinued and the space is used to

produce E. Product E’s production is increased to 2,200 units
per month, but E’s selling price of all units of E is reduced
to $10.20. Monthly profits will?

ANSWER:

[2,200 × ($10.20 – $9.00)] + (800 × $0.30) – (1,400 × $2.25) = 2640+240-

3150= $270 decrease

Or:
Before:
(900x3)+(1400x2.25)-(800x0.30)=2700+3150-240=5610
After:
2700+[2200x(10.20-9)]=2700+2640=5340
So, 5610-5340=270

Special Order

1. Reggie Corporation manufactures a single product with the following

unit costs for 1,000 units:

Direct materials $2,400

Direct labor 960
Factory overhead (30% variable) 1,800
Selling expenses (50% variable) 900
Administrative expenses (10% variable)    840
Total per unit $6,900

Recently, a company approached Reggie Corporation about buying

100 units for $5,100 each. Currently, the models are sold to
dealers for $7,800. Reggie Corporation’s capacity is
sufficient to produce the extra 100 units. No additional
selling expenses would be incurred on the special order.

What is the profit earned by Reggie Corporation on the

original 1,000 units?

ANSWER:

1,000 × ($7,800 – $6,900) = $900,000

2. The following information relates to a product produced by Creamer
Company:

Direct materials $24

Direct labor 15
Variable overhead 30
Fixed overhead  18
Unit cost $87

Fixed selling costs are $500,000 per year, and variable

selling costs are $12 per unit sold. Although production
capacity is 600,000 units per year, the company expects to
produce only 400,000 units next year. The product normally
sells for $120 each. A customer has offered to buy 60,000
units for $90 each.

The incremental cost per unit associated with the special

order is ?

ANSWER:

Direct materials $24

Direct labor 15
Variable overhead 30
Variable selling and administrative  12
$81

3. Meco Company produces a product that has a regular selling price of

$360 per unit. At a typical monthly production volume of
2,000 units, the product’s average unit cost of goods sold
amounts to $270. Included in this average is $120,000 of
fixed manufacturing costs. All selling and administrative
costs are fixed and amount to $30,000 per month.

Meco Company has just received a special order for 1,000 units
at $240 per unit. The buyer will pay transportation, and the
regular selling price will not be affected if Meco accepts the
order.

Assuming Meco Company has excess capacity, the effect on

profits of
accepting the order would be?

ANSWER:

1,000 × [$240 – ($270 – $120,000/2,000)] = $30,000 increase

4 .Walton Company manufactures a product with the following costs per
unit at the expected production level of 84,000 units:

Direct materials $12

Direct labor 36
Variable manufacturing overhead 18
Fixed manufacturing overhead 24

The company has the capacity to produce 90,000 units. The

product regularly sells for $120. A wholesaler has offered to
pay $110 a unit for 7,500 units.

If the special order is accepted, the effect on operating

income would be a ?

ANSWER:

Incremental revenue (7,500 × $110)

825,000
Lost revenue from regular sales (1,500* × $120)
(180,000)
Incremental costs:
Direct materials (6,000 × $12) $ 72,000
Direct labor (6,000 × $36) 216,000
Variable overhead (6,000 × $18)  108,000
(396,000)
Incremental profit
249,000

*90000-84000=6000; 7500-6000=1500

5 .Miller Company produces speakers for home stereo units. The speakers
are sold to retail stores for $30. Manufacturing and other
costs are as follows:

Variable costs per unit: Fixed costs per month:

Direct materials $ 9.00 Factory overhead
$120,000
Direct labor 4.50 Selling and admin.
60,000
Factory overhead 3.00 Total $180,000
Distribution   1.50
Total $18.00

The variable distribution costs are for transportation to the

retail stores. The current production and sales volume is
20,000 per year. Capacity is 25,000 units per year.

A San Diego wholesaler has proposed to place a special one-

time order of 10,000 units at a reduced price of $24 per unit.
The wholesaler would pay all distribution costs, but there
would be additional fixed selling and administrative costs of
$3,000. All other information remains the same as the
original data. What is the effect on profits if the special
order is accepted?
ANSWER:

Additional revenues (10,000 × $24) $240,000

Additional costs:
Variable (10,000 × $18.00-$1.50) $165,000
Fixed 3,000
Opportunity cost (5,000 × $30)   150,000  318,000
Profits decrease by $ (78,000)
6 .Reggie Corporation manufactures a single product with the following
unit costs for 1,000 units:

Direct materials $2,400

Direct labor 960
Factory overhead (30% variable) 1,800
Selling expenses (50% variable) 900
Administrative expenses (10% variable)    840
Total per unit $6,900

Recently, a company approached Reggie Corporation about buying

100 units for $5,100 each. Currently, the models are sold to
dealers for $7,800.

Assume there is additional capacity for 60 more units and the

firm has to reduce regular customer sales by 40 units in order
to contract the special order. There are selling expenses on
only the sales to the regular customers. What is the net
income if the special order of 100 units is accepted?

ANSWER:

Sales (960 × $7,800) $7,488,000

(100 × $5,100)    510,000
$7,998,000
Costs:
Variable costs—Regular (960 × $4,434*) $4,256,640
Variable costs—Special (100 × $3,984**) 398,400
Fixed costs [1,000 × ($1,260 + $450 + $756]  2,466,000
7,121,040
Net income
876,960

* $2,400 + [$960 + ($1,800 × 0.30) + ($900 × 0.50) + ($840 ×

0.10)] = 2400+960+540+450+84=
$4,434
** $2,400 + [$960 + ($1,800 × 0.30) + ($840 × 0.10)] = $3,984

Sell/Process Further

1. Stars Manufacturing Company produces Products A1, B2, C3, and D4

through a joint process. The joint costs amount to $200,000.

If Processed Further
Sales Value Additional
Product Units Produced at Split-Off   Costs   Sales
Value
A1 3,000 $10,000 $2,500 $15,000
B2 5,000 30,000 3,000 35,000
C3 4,000 20,000 4,000 25,000
D4 6,000 40,000 6,000 45,000

If Product B2 is processed further, profits will?

ANSWER:
$35,000 – $30,000 – $3,000 = $2,000 increase
2. Stars Manufacturing Company produces Products A1, B2, C3, and D4
through a joint process. The joint costs amount to $200,000.

If Processed Further
Sales Value Additional
Product Units Produced at Split-Off   Costs   Sales
Value
A1 3,000 $10,000 $2,500 $15,000
B2 5,000 30,000 3,000 35,000
C3 4,000 20,000 4,000 25,000
D4 6,000 40,000 6,000 45,000

Which product(s) should be sold at split-off to maximize

profits in the short run?

ANSWER:

Additional Additional
Product Revenues Costs Differences Decision
A1 $5,000* $2,500 $2,500
Process on
B2 $5,000 $3,000 $2,000
Process on
C3 $5,000 $4,000 $1,000
Process on
D4 $5,000 $6,000 ($1,000) Sell
now
*$15000-$10000=$5000

3. Manning Company uses a joint process to produce products W, X, Y, and

Z. Each product may be sold at its split-off point or
processed further. Additional processing costs of specific
products are entirely variable. Joint processing costs for a
single batch of joint products are $120,000. Other relevant
data are as follows:

Sales Value Additional Sales Value of

Product at Split-Off Processing Costs Final
Product
Y $ 20,000 $ 32,000 $120,000
Z 28,000 20,000 32,000
W 40,000 60,000 80,000
X   12,000    4,000   20,000
$100,000 $116,000 $252,000

Which products should Manning process further?

ANSWER:

Additional Additional
Product Revenues Costs Differences
Decision
Y $100,000 $32,000 $68,000
Process on
Z 4,000 20,000 (16,000)Sell now
W 40,000 60,000 (20,000)Sell now
X 8,000 4,000 4,000 Process on
4. Manning Company uses a joint process to produce products W, X, Y, and
Z. Each product may be sold at its split-off point or
processed further. Additional processing costs of specific
products are entirely variable. Joint processing costs for a
single batch of joint products are $120,000. Other relevant
data are as follows:

Sales Value Additional Sales Value of

Product at Split-Off Processing Costs Final
Product
Y $ 20,000 $ 32,000 $120,000
Z 28,000 20,000 32,000
W 40,000 60,000 80,000
X   12,000    4,000   20,000
$100,000 $116,000 $252,000

Processing Y further will cause profits to ?

ANSWER:

$120,000 – $20,000 – $32,000 = $68,000 increase

5. Information about three joint products follows:

A B
C
Anticipated production 5,000 lbs. 1,000 lbs.
2,000 lbs.
Selling price/lb. at split-off $10 $30
Additional processing costs/lb.
after split-off (all variable) $6 $12
Selling price/lb. after further
processing $20 $40

The cost of the joint process is $60,000. Which of the joint

products should be sold at split-off?

ANSWER:

Split-Off Process Further

A $10 $20 –  $6 = $14 0r $20-$10-$6=$4
B $30 $40 – $12 = $28 *Sell now or 40-30-12=(2)
C $16 $50 – $24 = $26 or 50-16-24=10

6. Information about three joint products follows:

X Y
Z
Anticipated production 12,000 lbs. 8,000 lbs.
7,000 lbs.
Selling price/lb. at split-off $16 $26 $48
Additional processing costs/lb.
after split-off (all variable) $8 $20 $20
Selling price/lb. after further
processing $20 $40 $70

The cost of the joint process is $140,000. Which of the joint

products should be processed further?

ANSWER:

Split-Off Process Further

X $16 $20 –  $8 = $12 or 20-16-8=(4)
Y $26 $40 – $20 = $20 or 40-26-20=(6)
Z $48 $70 – $20 = $50 *Process on or 70-48-20=2