Académique Documents
Professionnel Documents
Culture Documents
Michael Constas
17
Page 1
The key part of this analysis is to consider only the information that is relevant to the
decision being made.
Revenue
Expenses
Rent
Profit
Fishing
Tour Difference
$8,000 $10,000
-$2,000
-1,000
-4,000
3,000
-1,000
-1,000
____0
$6,000 $5,000
$1,000
You will generate $1,000 more profit if you choose the Fishing Business alternative.
Your decision to operate a Fishing business would remain unchanged if you had not
considered the rent:
Revenue
Expenses
Profit
Tour Difference
Fishing
$8,000 $10,000
-$2,000
-1,000
-4,000
3,000
$7,000 $6,000
$1,000
With either calculation, the Fishing business produces a profit that is $1,000 higher than
the Tour business. If a particular cost is the same under both alternatives (e.g., rent),
that cost is not relevant to the decision of which alternative to choose. Including such a
cost in your analysis might cause you to make the wrong decision. The purpose of this
analysis is to make a decision as to which alternative to choose. The bottom line
profit/cost that appears in the table is not important to our analysis, and it does not have
Please send comments and corrections to me at mconstas@csulb.edu
Page 2
to reflect all of the revenues and costs associated with each alternative. The difference
between the two columns is the key to this analysis (e.g., Fishing produces $1,000 more
in Operating Profits). Another term used for relevant costs is differential costs, and this
subject matter is often referred to as Relevant Costing or Differential Costing.
Relevant costs do not include sunk or historical costs.
Sunk costs are costs that we have already spent, and
that we cannot recover. Because they are already
spent, sunk costs are the same (not different) for
each alternative. In order to be relevant, costs and
benefits must be future costs and benefits.
For example, assume that you bought an original oil
painting by Leroy Neiman for your home. The
painting is huge, and filled an entire wall of your living
Sunk Cost
room. At the time, you paid $10,000 for the painting.
You are now downsizing your lifestyle (and living accommodations), and the painting is
too large to be appropriately displayed in your new trailer park accommodations. You
have decided to sell the painting, but the only offer that you have received is $8,000.
The fact that you originally paid $10,000 for the painting is not relevant to whether you
should accept or reject this offer. The original price that you paid for the painting is a
sunk cost. Although, you may not like the idea of selling the painting for less than you
paid for it, you should be attempting to liquidate your investment in the painting in a
manner that will produce the highest net benefit to you. This could involve selling the
painting at a loss, if that is the best deal that you can obtain.
Other revenue generating operations that are available if only one of the alternatives is
selected is relevant to your decision. These are Opportunity Costs. For example,
assume that you have rented retail space, and you are trying to decide whether to use it
to operate a CD store or a Comic Book store. Assume that if you elect to operate a
Comic Book store, then you will also be able to sublease part of your space to vending
machine operators for an additional $200 a month. There is not sufficient space to
permit such a sublease if you choose to operate a CD store. The lost revenue from the
vending machines ($200) is viewed as an Opportunity Cost if the CD store alternative is
chosen, and it is added to the other costs of the CD store.
Revenue
Expenses
Sublease
Profit
CD Store
$10,000
-5,000
-200
$4,800
Page 3
In this chapter we will focus on a quantitative analysis, but qualitative factors are also
relevant. For example, assume you are trying to decide whether you should produce a
product internally, or outsource its production. While we will focus on which alternative
provides you with the maximum economic net benefit; in real life, qualitative factors
would play an important role in your decision. For example, you would be concerned
with such qualitative factors as the reliability of the supplier; your ability to control the
quality of the outsourced products; the impact on the morale of your workforce if you
downsize your manufacturing operations; whether you decision would change with a
change in circumstances, and the ability for you to resume production of the product if
circumstances change.
Another factor that is very relevant to decision making is the time-value of money. For
simplicity, we will not consider it in this chapter.
Page 4
The second alternative is to rent the space to a company that will use the space to
operate a floating disco. Titanic projects that a disco rental will generate annual rents of
$90,000, but it will also increase expenses by $20,000 (not including the $100,000
depreciation expense). The Boy Scouts have told Titanic, however, that they will not
patronize a ship that is used as a disco.
We would analyze the two alternatives in the following manner:
Revenue
Cash Expenses
Opportunity Cost
Operating Profit
Freight
$70,000
-$10,000
_______
$60,000
Disco Difference
$90,000
-$20,000
-$20,000
10,000
-$15,000
15,000
$55,000
$5,000
The Operating Profit from the cruise operation is irrelevant to our decision. We will
operate the cruise regardless of which alternative we choose. (It is not different
between our alternatives.) The depreciation on the ship is also irrelevant. The
depreciation expense is based on the original cost of the ship, and it represents a sunk
cost. The loss ticket sales to the Boy Scouts are an Opportunity Cost for the Disco
alternative.
Special Orders
Special Orders are a classic area in which Relevant Costing is used. In these
problems, you have a business that is approached by a potential customer. The
customer is in an area that your business does not normally serve. The potential
customer offers to buy your product or service at a price below the cost to provide the
product or service (the special order).
The caveat about the area not normally served is often put into these problems to avoid
the issue of whether the special order will result in any cannibalization of your existing
sales when existing customers demand the same low price. The caveat, in effect, states
that the special order has no relationship to or impact on our regular business. The
caveat is also included because price discrimination between similar customers is illegal
under antitrust laws.
In these problems, the overall cost to provide the product or service is irrelevant. You
are already in the business. You are trying to decide if accepting the special order will
increase your Operating Profit. Your focus should be on whether the incremental
revenue produced by the special order is higher than the added expenses and costs
incurred by the special order.
We know from our discussion of cost behavior that the increased production to meet a
special order will increase our Variable Costs. We also need to examine whether we
can produce the units needed for the special order with our existing capacity (Fixed
Costs) or whether additional capacity will be needed.
Please send comments and corrections to me at mconstas@csulb.edu
Page 5
You normally have Revenue of $A, and the special order will produce additional
Revenue of $a.
You normally have Variable Costs of $B, and the special order will produce
additional Variable Costs of $b.
You normally have Fixed Costs of $C, and whether the special order will require
additional capacity at a cost of $c has to be determined.
Dont Take Special Order
Revenue:
Variable Costs:
Fixed Costs
Incremental Profit
A
-B
_______-C
A (B+C)
a
-b
_____-c?
a-(b+c?)
Because A, B, & C are the same for both alternatives, you can ignore them and focus
only on the incremental revenue and costs from the special order. The Fixed Costs do
not change if you have sufficient excess capacity to do the special order. You also
have to be careful about whether some Variable Costs will be different when producing
the special order. For example, maybe you will not need to pay a sales commission or
it will be a reduced sales commission.
Assume that you run a small airline that takes
passengers to a resort island, which has a
deluxe conference center. Although tourists go
to this island, they find your rate of $700 per
passenger too high, and they prefer to take the 4
hour ferry ride to the island, which only costs
$50 per passenger. Your clientele are business
people, who attend meetings at the conference
center. The business people are willing to pay
your rates in order to get to the island in 20
minutes. A one-way trip to/from the island costs
you $3,000, and your jet can carry ten
passengers. It, therefore, costs you $300 per passenger to operate your business. On
a typical trip, you sell 6 seats, and 4 seats remain empty.
Motel 6 offers to purchase, on a stand-by basis, any unsold tickets on your jet. They
agree that the tickets will only be resold to their customers, who are tourists. The
business travelers stay at the luxury hotel at the conference center (not the Motel 6).
The manager of the Motel 6 offers to pay you $100 a ticket.
The fact that it costs you $300 per passenger to fly to the island is irrelevant. You are
already in the airline business, and you make on average $1,200 on each flight ($4,200
Please send comments and corrections to me at mconstas@csulb.edu
Page 6
- $3,000). You should be considering whether the sale of the tickets to the tourists will
hurt your existing airline business. Assuming that it will not, you should then ask
whether the accepting the special order will increase your Operating Profits:
Incremental Revenue
Incremental Expenses
Marginal Profit
Take
Dont Take
Special Order Special Order
$400
$0
___-0
-0
$400
$0
Difference
$400
-0
$400
Accepting the special order will increase your Operating Profits by $400 per trip.
Per Unit Fixed Manufacturing Overhead Application Rates
Managers often complain that, despite the fact that: (i) they have excess capacity, and
(ii) their Fixed Manufacturing Overhead will not increase if they accept a special order,
their firm will still charge the special order for Fixed Manufacturing Overhead. These
managers are forgetting to include the Fixed Manufacturing Overhead Variance in their
analysis of the situation.
An overhead variance is ultimately used to adjust the amount of overhead applied to the
units produced to the actual overhead cost incurred. If your overhead is over-applied,
then adding additional overhead to the special order will just increase the amount that
the overhead is over-applied. The amount by which the overhead is over-applied will
ultimately be credited to Cost of Goods Sold, thereby reducing the amount of overhead
in Cost of Goods Sold to the actual overhead cost and canceling out that application of
overhead to the special order.
Assume: Over-applied O/H=$100,000 & Special Order O/H = $10,000
Dont Accept
Accept
Added to Special Order
$10,000
-$110,000
Added to COGS at Year End
-$100,000
Net Affect
-$100,000
$100,000
If your overhead is under-applied, then the Cost of Goods Sold will be increased by the
amount that the overhead is under-applied at the end of the year. If you apply more
overhead to the special order, you will also reduce the amount that Cost of Goods Sold
will be increased at the end of the year by that same amount. You would have added
that overhead to the Cost of Goods Sold anyway, you just shifted it to the special order
away from the end of the year adjustment.
Page 7
Operating Profits will not be affected by the overhead applied to the special order.
Assume: Under-applied O/H=$100,000 & Special Order O/H = $10,000
Accept
Dont Accept
Added to Special Order
$10,000
Added to COGS at Year End
$100,000
$90,000
Net Affect
$100,000
$100,000
When the year end variance adjustment to Cost of Goods Sold is considered, the Fixed
Manufacturing Overhead applied to a special order ultimately does not lower your
Operating Profits.
Product Line-Up
Consider Green Toys, a prominent toy manufacturer, whose line-up of toys includes
three action figures: Gumby, Barbie and GI Joe. Green releases internal income
statements that show that Green is losing money on the Gumby action figure. Based on
these financial statements, Green is considering discontinuing production of the Gumby
action figure:
Revenue
Variable Costs
Fixed Costs
Operating Profit
Barbie
$600,000
-200,000
-300,000
$100,000
GI Joe
$350,000
-100,000
-200,000
$50,000
Gumby
Total
$250,000 $1,200,000
-150,000
-450,000
-150,000
-650,000
-$50,000
$100,000
The presentation of this income statement leads the reader to assume that Greens
Operating Profit will increase by $50,000 if the $50,000 loss on the Gumby sales can be
eliminated by discontinuing the action figure. This conclusion, however, may not be
accurate.
Page 8
We know that the revenue produced by sale of the action figure will disappear if Gumby
is discontinued. We also know that the Gumby Variable Costs, by definition, will drop to
zero if the product is dropped. Without knowing more, we cannot be sure that the Fixed
Costs attributable to the Gumby action figure will disappear if the action figure is
discontinued.
Some Fixed Costs disappear if a product is dropped. These Fixed Costs are tied to the
product. They are called Direct Fixed Costs. An example of a Direct Fixed Cost would
be the salary of the product manager, who will be laid off if the product is discontinued.
If the Gumby action figure is dropped, the salary paid to the product manager will drop
to zero.
On the other hand, some Fixed Costs are not tied to the product, but are generated by
the factory or company as a whole. These are called Common Fixed Costs. Common
Fixed Costs are allocated to a product, but they are not reduced if you drop the product
to which they are assigned. Instead, they are reassigned to another product. An
example of a Common Fixed Cost would be the factory rent allocated to the Gumby
action figure. It is likely that the rent on the factory will not be decreased if we drop the
Gumby action figure. Instead, it will be reassigned to the Gumby and Pokey action
figures.
Assume that the factory rent is $450,000, and it is allocated to the three action figures
based on the factory floor space dedicated to their respective production lines. The
remaining Fixed Costs are the salaries of the product managers, who will be laid off if
their product is discontinued:
Revenue
Variable Costs
Manager Salary
Rent
Operating Profit
Barbie
$600,000
-200,000
-100,000
-200,000
$100,000
GI Joe
$350,000
-100,000
-50,000
-150,000
$50,000
Gumby
Total
$250,000 $1,200,000
-150,000
-450,000
-50,000
-200,000
-100,000
-450,000
-$50,000
$100,000
Now that the rent has been separated from the product managers salaries, we can
analyze the situation:
Revenue
Variable Costs
Manager Salary
Operating Profit
Drop Gumby
$0
-0
-0
$0
Difference
$250,000
-150,000
-50,000
$50,000
The factory rent will not change if you drop the Gumby action figure. It is not a relevant
cost. Green will make $50,000 more if it does not drop the Gumby action figure rather
than dropping the figure. There is nothing wrong with allocating rent to the Gumby
Please send comments and corrections to me at mconstas@csulb.edu
Page 9
action figure. Green is, in fact, losing $50,000 on the Gumby action figure.
The
profitability of the Gumby action figure is not the issue. The issue is whether Greens
Operating Profit will be higher or lower if it drops the action figure.
Assume that Green dropped the Gumby action figure, and that all other revenue and
costs remain unchanged (other than reassigning the factory rent to the remaining
products). Revising Greens income statement to reflect the discontinuance of the
Gumby action figure shows that Greens Operating Profit will go down by $50,000 as
predicted above:
Revenue
Variable Costs
Fixed Costs
Rent
Operating Profit
Barbie
$600,000
-200,000
-100,000
-257,143
$42,857
GI Joe
$350,000
-100,000
-50,000
-192,857
$7,143
Total
$950,000
-300,000
-150,000
-450,000
$50,000
You can prepare an income statement that treats Common Fixed Costs in a manner
that will not mislead managers into making the wrong decision regarding whether to
retain or drop a product or division. With this format, the Common Fixed Costs, such as
rent, are shown under a total column and not allocated to an individual product:
Revenue
Variable Costs
Manager Salary
Product Profit
Rent
Operating Profit
Barbie
$600,000
-200,000
-100,000
$300,000
GI Joe
$350,000
-100,000
-50,000
$200,000
Gumby
Total
$250,000 $1,200,000
-150,000
-450,000
-50,000
-200,000
$50,000
-450,000
$100,000
With this format, it is clear that the sales of the Gumby action figure contribute $50,000
to Greens Operating Profits. We will discuss this area more fully when we discuss
Variable Costing.
Make or Buy
Relevant Costing is also very useful in when deciding whether you should outsource a
product. In these problems, you can either make an item that you use in your business
or you can purchase it from an outside supplier.
When calculating the cost of each alternative, you have to be careful to accurately
reflect what manufacturing costs will disappear if you purchase a product rather than
manufacturing it. Also, Opportunity Costs often appear in this area.
Page 10
$ 5
15
10
__5
$35
McDonalds Corporation has offered to provide each meal for $37. If the National Parks
Service accepts the offer, its kitchen facility can be rented out for $40,000. However, $3
of the Fixed Manufacturing Overhead currently being applied to each meal would have
to be reassigned to the restaurant operation. It represents a portion of the salaries of
the restaurant personnel who will continue to work at the restaurant.
The National Parks Service would consider the following Relevant Costs of each
alternative:
Direct Materials:
Direct Labor:
Variable Overhead:
Fixed Overhead:
Opportunity Cost
Purchase Price:
Total Cost:
Buy Meals
0
0
0
$36,000 (3x12,000)
0
444,000 (37x12,000)
$480,000
Make Meals
$60,000 (5x12,000)
180,000 (15x12,000)
120,000 (10x12,000)
60,000 (5x12,000)
40,000
_______
$460,000
Difference
-$60,000
-180,000
-120,000
-24,000
-40,000
444,000
$20,000
It is cheaper for the National Parks Service to continue to make the meals served at the
restaurant.
Page 11
Most books treat the $40,000 rental as an Opportunity Cost as shown above. You
could also place it in the Buy column as a reduction of cost. Regardless of how you
treat these items, the $20,000 difference in cost will remain:
Buy Meals
Direct Materials:
Direct Labor:
Variable Overhead:
Fixed Overhead:
Sublease
Purchase Price:
Total Cost:
$36,000 (3x12,000)
-40,000
444,000 (37x12,000)
$440,000
Make Meals
$60,000 (5x12,000)
180,000 (15x12,000)
120,000 (10x12,000)
60,000 (5x12,000)
0
______0
$420,000
Difference
-$60,000
-180,000
-120,000
-24,000
-40,000
444,000
$20
USA Sale
$900
-100
$800
DeBeers Sale
$700
____
$700
Difference
$200
-100
$100
Bond makes $100 more in profits if it processes the Grade A Diamonds and then sells
them directly to American jewelers.
DeBeers Sale
$500
____
$500
Page 12
USA Sale
$1,200
-750
$450
Difference
-700
750
$50
Bond makes $50 more in profits if it sells the Grade B diamonds to DeBeers.
PROBLEMS
E-1. Opportunity costs are:
A) not used for decision making.
B) the same as variable costs.
C) the same as historical costs.
D) relevant to decision making.
E-2. Freestone Company is considering renting Machine Y to replace Machine X. It is
expected that Y will waste less direct materials than does X. If Y is rented, X will
be sold on the open market. For this decision, which of the following factors is
(are) relevant?
I. Cost of direct materials used
II. Resale value of Machine X
A)
B)
C)
D)
Only I
Only II
Both I and II
Neither I nor II
E-3. In a sell or process further decision, which of the following costs are relevant?
I. A variable production cost incurred prior to the split-off point.
II. An avoidable fixed production cost incurred after the split-off point.
A)
B)
C)
D)
Only I.
Only II.
Both I and II.
Neither I nor II.
Page 13
$200,000
$180,000
$150,000
$100,000
Meacham has received an offer from an outside supplier who is willing to provide
20,000 units of this subcomponent each year at a price of $28 per
subcomponent. Meacham knows that the facilities now being used to make the
subcomponent would be rented to another company for $75,000 per year if the
subcomponent were purchased from the outside supplier. Otherwise, the fixed
overhead would be unaffected.
E-7. If Meacham decides to purchase the subcomponent from the outside supplier,
how much higher or lower will operating income be than if Meacham continued to
make the subcomponent?
A) $45,000 higher.
B) $70,000 higher.
C) $30,000 lower.
D) $70,000 lower.
Page 14
E-8. Suppose the price for the subcomponent has not been set. At what price per unit
charged by the outside supplier would Meacham be economically indifferent
between making the subcomponent or buying it from the outside?
A) $30.25.
B) $29.25.
C) $26.50.
D) $31.50.
$15
12
8
9
8
3
The regular selling price for one Pong is $80. A special order has been received
by Melville from Mowen Company to purchase 6,000 Pongs next year. If this
special order is accepted, the variable selling expense will be reduced by 75%.
However, Melville will have to purchase a specialized machine to engrave the
Mowen name on each Pong in the special order. This machine will cost $9,000
and it will have no use after the special order is filled. The total fixed
manufacturing overhead and selling expenses would be unaffected by this
special order.
E-9. Assume Melville anticipates selling only 50,000 units of Pong to regular
customers next year. If Mowen Company offers to buy the special order units at
$65 per unit, the effect of accepting the special order on Melville's operating
income for next year should be a:
A) $60,000 increase.
B) $90,000 decrease.
C) $159,000 increase.
D) $36,000 increase.
Page 15
E-10. Assume Melville anticipates selling only 50,000 units of Pong to regular
customers next year. At what selling price for the 6,000 special order units would
Melville be economically indifferent between accepting or rejecting the special
order from Mowen?
A) $51.50.
B) $49.00.
C) $37.00.
D) $38.50.
P-1
Keep or Drop. Audio Mart is a retailer of radios, stereos, and televisions. The
store carries two portable sound systems that have radios, tape players, and
speakers. System A, of slightly higher quality than System B, costs $20 more. It
also sells headsets. Variable-costing income statements for the three products
are shown below.
System A System B
Headset
Sales
$45,000
$32,500
$8,000
Less: Variable Expenses
-20,000
-25,500
-3,200
Contribution Margin
Less: Fixed Costs*
Operating Profit
$25,000
-10,000
$15,000
$ 7,000
-18,000
-$11,000
$4,800
-2,700
$2,100
P-2
Page 16
$107
$146
$24,000
5,000
26,000
A local dental laboratory has offered to supply Powell all the crowns it needs. Its
price is $100 for porcelain crowns and $132 for gold crowns; however, the offer
is conditioned on supplying both types of crowns--it will not supply just one type
for the price indicated. If the offer is accepted, the equipment used by Powell's
laboratory would be scrapped (it is old and has no market value), and the lab
facility would be closed. The lab facility is rented on a month-to-month basis
(there are no leases to deal with). Powell uses 1,500 porcelain crowns and 1,000
gold crowns per year
REQUIRED:
1. Should Powell continue to make its own crowns or should they be purchased
from the external supplier? What is the dollar effect of purchasing?
2. What qualitative factors should Powell consider in making this decision?
3. Suppose that the lab facility is owned rather than rented and that the $26,000
is depreciation rather than rent. What effect does this have on the analysis in
Requirement 1?
4. What would your answer in #3 be if you could rent the lab facility for $15,000.
5. Refer to the original data. Assume that the volume of crowns is 3,000
porcelain and 2,000 gold. Should Powell make or buy the crowns? Explain
the outcome.
P-3
Page 17
Sell or Process Further. Rudolph Drug Corporation buys three chemicals that are
processed to produce 2 types of analgesics used as ingredients for popular overthe-counter drugs. The purchased chemicals are blended for 2 to 3 hours and
then heated for 15 minutes. The results of the process are 2 separate
analgesics, Tyl and Buff, which are sent to a drying room until their moisture
content is reduced to 6 to 8 percent. For every 1,100 pounds of chemicals used,
500 pounds of Tyl and 500 pounds of Buff are produced. After drying, Tyl and
Buff are sold to companies that process them into their final form. The selling
prices are $10 per pound for Tyl and $25 per pound for Buff. The costs to
produce 500 pounds of each analgesic are as follows:
Chemicals
Direct Labor
Manufacturing Overhead
$5,500
4,500
3,500
The analgesics are packaged in 25-pound bags and shipped. The cost of each
bag is $0.75. Shipping costs $0.10 per pound. Rudolph Company could process
Tyl further by grinding it into a fine powder and then molding the powder into
tablets. The tablets can be sold directly to retail drug stores as a generic brand. If
this route is taken, the revenue received per bottle of tablets would be $3.00, with
5 bottles produced by every pound of tyl. The costs of grinding and tableting total
$2.50 per pound of Tyl. Bottles cost $0.20 each. Bottles are shipped in boxes
that hold 25 at a shipping cost of $1.23 per box.
REQUIRED:
1. Should Rudolph sell Tyl at split-off or should Tyl be processed and sold as
tablets?
2. If Rudolph normally sells 265,000 pounds of Tyl per year, what will be the
difference in profits if Tyl is processed further?
P-4
Page 18
$32.00
17.00
7.00
2.00
3.00
3.20
-32.20
-20
The normal selling price of Kevins component is $3.20 per unit. Its full
manufacturing cost is $2.50 ($2.10 variable and 40 fixed). Ellen had argued that
paying $3.20 per component would wipe out the gross profit and result in her
division showing a loss. Kevin was interested in the offer because his division
was also operating below capacity (the order would not use all the excess
capacity).
REQUIRED:
1. Should Kevin accept the order at a selling price of $2.50 per unit? By how
much will his division's profits be changed if the order is accepted?
2. Suppose that Kevin refuses Ellen's offer. Should Ellen still accept the special
order?
P-5.
Page 19
$ 4.00
3.00
2.00
2.50
-------$11.50
Should Light Company accept the special order? How much incremental income
(loss) will Light Company make (or lose) on the special order?
SOLUTIONS
E-1
The answer is d.
E-2
The answer is c. The cost savings is relevant. The money you get from selling
the old machine makes your investment in the new machine less. (It is an
opportunity cost.)
E-3
The answer is b.
The costs up to the split off point are the same regardless of whether you sell or
process further. Because they are not different, those costs are not relevant.
Only the direct fixed costs (avoidable) after split off are relevant because they will
go away if you sell the product rather than processing it further.
E-4
The answer is a.
The original cost is the sunk cost. It is not relevant to this decision.
E-5
The answer is c.
Revenue
Upgrade Cost
Sell
$50,000
-0
$50,000
Process Further
$160,000
-100,000
$60,000
Page 20
The answer is c.
You would be indifferent if the Upgrade Option produced a net benefit of
$50,000. This means that the sales price must be $150,000. Divide it by 500
computers, and you get a sales price per unit of $300.
E-7
The answer is a.
The rental income from the sublease would be an opportunity cost of the Make option.
Make
Buy
Direct Materials
$200,000
$0
Direct Labor
180,000
0
Variable Overhead
150,000
0
Opportunity Cost
75,000
Purchase Cost
_______
560,000 $28 x 20,000
$605,000 $560,000
E-8
The answer is a.
You would be indifferent if the Upgrade Option cost $605,000. This means that
the sales price must be $605,000. Divide it by 20,000 units, and you get a sales
price per unit of $30.25.
E-9
The answer is c.
Purchase Price
Direct Materials
Direct Labor
Variable Overhead
Machine
Variable Selling
Take
$390,000
-90,000
-72,000
-48,000
-9,000
__-12,000
$159,000
Dont Take
$0
0
0
0
0
___0
$0
($65 x 6,000)
($15 x 6,000)
($12 x 6,000)
($8 x 6,000)
$2 x 6,000
Sales:
System A
System B
Headset
Total
$45,000
$32,500
$8,000
$85,500
Page 21
-20,000
-25,500
-3,200
-48,700
Contribution Margin:
Less: Direct Fixed Costs:
$25,000
-5,000
$ 7,000
-13,000
$4,800
-1,700
$36,800
-19,700
Divisional Margin:
Common Fixed Costs:
Operating Profit:
$20,000
-$ 6,000
$3,100
$17,100
-11,000
$ 6,100
We can now see that System B is reducing our Operating Profit by $6,000, and if
we drop System B, then our Operating Profit should increase to $12,100.
Headset
Total
Sales:
Less: Variable Expenses:
$45,000
-20,000
$8,000
-3,200
$55,500
-23,200
Contribution Margin:
Less: Direct Fixed Costs:
$25,000
-5,000
$4,800
-1,700
$29,800
-6,700
Divisional Margin:
Common Fixed Costs:
Operating Profit:
$20,000
$3,100
$23,100
-11,000
$12,100
P-2
(1)
Raw Materials:
Direct Labor:
Variable Manufacturing O/H:
Fixed Manufacturing O/H:
Purchase Cost:
Make
$176,500
55,000
12,500
50,000
______0
Buy
(55 x 1500)+(94 x 1000)
$0
(22 x 2500)
0
(5 x 2500)
0
(24,000 + 26,000)
0
(100x1500)+(132x1000) $282,000
Total Cost:
$294,000
$282,000
You ignore the depreciation expense because it is a sunk cost. The equipment is
going to be scraped it has no other value, its cost (the depreciation) has already
been spent.
(2)
Qualitative Factors include (i) quality control on the purchased crowns, (ii)
reliability of supplier, (iii) effect of a reduction in work force on labor relations, (iv)
eliminates the ability to later produce their own crowns at a later date.
(3)
Please send comments and corrections to me at mconstas@csulb.edu
Raw Materials:
Direct Labor:
Variable Manufacturing Overhead:
Fixed Manufacturing Overhead:
Purchase Cost:
Total Cost:
Page 22
Make
$176,500
55,000
12,500
24,000
_____0
$268,000
Buy
$0
0
0
0
$282,000
$282,000
Make
$176,500
55,000
12,500
24,000
0
_______0
$268,000
Buy
$0
0
0
0
$282,000
-15,000
$267,000
Rather than showing the rental income as an opportunity cost which is added to
the cost of the Make alternative, we treated the rental income as a reduction of
the cost of the Buy alternative.
(5)
Make
Raw Materials:
Direct Labor:
Variable Manufacturing Overhead:
Fixed Manufacturing Overhead:
Purchase Cost::
Total Cost::
Buy
$0
0
0
0
$564,000
$564,000
We assumed that the Fixed Manufacturing Overhead Costs didnt change. This
alternative shows that the decision can change if the circumstances change.
You decision making must take this into account.
P-3
(1)
Page 23
Process 1 costs are incurred whether or not you sell Tyl or process it further and
sell Tylenol. So the Process 1 costs are not relevant to our decision. The revenue
and costs from selling Buff is also not relevant to our decision. Process 2 costs
are incurred only if you process the Tyl into Tylenol, so they are relevant.
Revenue:
Bag Cost:
Shipping Cost:
Grinding & Tableting
Bottling Cost:
Operating Profit (Per 500lb)
Sell
$5,000
-15
-50
0
_____0
$ 4,935
(.75 x(500/25))
((2500/25)x1.23)
(2.5 x 500)
(.20 x 2500)
Process
$ 7,500
0
-123 (.1 x 500)
-1250
-500
$ 5,627
For each 500 pound lot of Tyl, you make $692 more by processing the Tyl rather
than selling it in its raw state. We sell 265,000/500 = 530 lots of Tyl. Therefore we
can make $692 x 530 = $366,760 more by processing the Tyl further.
P-4
(1)
Kevin has excess capacity (he has capacity that he is not using). Therefore his
fixed cost does not go up if he makes more units. Because the fixed costs are the
same whether or not he takes the special order, the fixed costs are not relevant
to the decision. You only have to consider the incremental revenue and costs:
Kevin's Decision:
Don't Take Order
Revenue:
Variable Costs
Fixed Costs:
Operating Profit:
0
0
0
0
Take Order
$25,000 (10,000 x $2.50)
-21,000 (10,000 x $2.10)
_____-0
$ 4,000
Page 24
Even though Ellen thinks that Kevin is breaking even on the special order, Kevin
is actually making a profit from the special order.
(2)
Ellen's Decision:
Revenue:
Variable Costs
Kevin's Components:
Fixed Costs:
Operating Profit:
Take Order
$320,000 (10,000 x $32)
-260,000 (10,000 x26)
-32,000 (10,000 x $3.20)
_____-0
$ 28,000
Even if Ellen doesn't get here price concession from Kevin, she will still make a
profit on the special order.
P-5.
The key fact here is that Light is operating at capacity, and to complete the
special order Light hast to spend $6,000 for additional office space.
Revenue
Costs:
Direct Materials
Direct Labor:
Variable Overhead
Variable Costs
Fixed Overhead
Net Revenue
Take-1000 units
$14,000
Dont Take
$0
-$9,000
-6,000
-$1,000
0
0
0
0
0
$0
Light Company should not accept the special order. They would lose $1,000 if
they took the special order.