Académique Documents
Professionnel Documents
Culture Documents
Chapter 3
Using Costs in
Decision Making
QUESTIONS
3-1
3-2
Variable costs are costs that increase proportionally with changes in the activity
level of some variable. Fixed costs are costs that in the short run do not vary with
a specified activity. Fixed costs depend on how much of the resource (capacity)
is acquired, rather than on how much is used.
3-3
Contribution margin per unit, which is the difference between revenue per unit
and variable cost per unit, is the contribution that each unit makes to covering
fixed costs and generating a profit. The contribution margin is therefore an
important component of the equation to determine the breakeven point and to
understand the effect on profit of proposed changes, such as changes in sales
volume in response to changes in advertising or sales prices.
3-4
Contribution margin per unit is the difference between revenue per unit and
variable cost per unit. The contribution margin per unit indicates how much the
total contribution margin will increase with an additional unit of sales. The
contribution margin ratio expresses similar ideas, but as a percentage of sales
dollars. Specifically, the contribution margin ratio is the total contribution margin
divided by total sales dollars (or contribution margin per unit divided by sales
price per unit), and indicates how much the total contribution margin increases
with an additional dollar of sales revenue.
3-5
3-6
A mixed cost is a cost that has a fixed component and a variable component. For
example, utilities bills may include a fixed component per month plus a variable
component that depends on the amount of energy used. A step variable cost
increases in steps as quantity increases. For example, one supervisor may be
hired for every 20 factory workers. Mixed costs and step variable costs both
have elements of fixed and variable costs. However, mixed costs have distinct
fixed and variable components, with fixed costs that are constant over a fairly
wide range of activity (for a given time period) and variable costs that vary in
proportion to activity. Step variable costs are fixed for a fairly narrow range of
activity and increase only when the next step is reached.
3-7
Step variable costs are fixed for a fairly narrow range of activity and increase
when the next step is reached. For example, one supervisor may be hired for
every 20 factory workers. Fixed costs are costs that in the short run do not vary
with a specified activity for a wide range of activity. For example, factory rent
per month would likely remain unchanged as production increased or decreased,
even if by large amounts.
3-8
Incremental cost is the cost of the next unit of production and is similar to the
economists notion of marginal cost. In a manufacturing setting, incremental cost
is often defined as a constant variable cost of a unit of production. However, in
some situations, the variable cost of a unit of production may be more
complicated. For example, the variable cost of labor per unit may decrease over
time if workers become more efficient (a learning effect. Alternatively, the
variable cost of labor per unit will change during overtime hours if workers
receive an overtime premium (commonly 50%). Finally, some costs exhibit stepvariable behavior, as when one supervisor can supervise a quantity of employees
but an additional supervisor is needed beyond a certain number of employees.
3-9
3-10 Sunk costs are costs that are based on a previous commitment and cannot be
recovered. For example, depreciation on a building reflects the historical cost of
the building, which is a sunk cost. Therefore, they are not relevant costs for the
decision.
53
3-11 The general principal is that sunk costs are not relevant costs. But, some
managers may consider sunk costs to be relevant because they may be concerned
about how others will perceive their original decision to incur these costs, and
may want to cover up their initial poor judgment. Managers may also feel that
they do not want to waste the sunk costs by giving up on the possibility of some
benefit from the invested funds, or may continue to believe in potential success
despite overwhelming evidence to the contrary. Also, managers may be
embarrassed and unwilling to admit they made a mistake.
3-12 No, fixed cost are not always irrelevant. For example, in comparing the status
quo and a proposal to substantially increase the quantity of goods or services
provided, additional fixed costs (that is, costs not proportional to volume) may
be incurred to provide the increased quantity. Such costs might include a large
expenditure for more equipment or expanded factory facilities.
3-13 An opportunity cost is the maximum value forgone when a course of action is
chosen.
3-14 Yes, avoidable costs are relevant because they can be eliminated when, for
example, a part, product, product line, or business segment is discontinued.
3-15 In the context of a make or buy decision, fixed costs such as production engineering
staff salaries are relevant if these costs can be eliminated by assigning the staff to
other tasks, or by laying off the engineers not required when a part is outsourced. If it
is possible to find an alternative use for the facilities made available because of the
elimination of a product or a component, the associated fixed costs also are relevant.
Conversely, fixed costs that cannot be eliminated or used for other productive
purposes are not relevant for the decision. For example, if factory facilities would
remain idle if the company buys from outside, then the associated costs are not
relevant for the decision.
3-16 There are several qualitative considerations that must be evaluated in a make-orbuy decision. For example, one must question whether the outside supplier has
quoted a lower price to obtain the order, and plans to increase the price. Also, the
reliability of the supplier in meeting the required quality standards and in making
deliveries on time is important.
3-17 When a decision to outsource frees up space to produce an alternative product,
then the contribution margin on the alternative product is a relevant opportunity
cost for the make alternative in a make-or-buy decision.
54
3-18 A difficulty that arises with respect to revenue when analyzing whether to drop a
product or department is whether sales by one organizational unit can affect sales
in another organizational unit. A difficulty that arises with respect to cost analysis
is that many product costs, such as machine and factory depreciation, are the
result of sunk costs that often remain in whole or in part after the product is
discontinued. The analysis of what costs are avoided when a product is dropped
can be difficult due to the closing of plants, severance pay and environmental
cleanup costs.
3-19 The answer depends on the time frame and context considered. For example, a
one-time order that covers variable production (and selling costs) is
advantageous if capacity cannot be changed in the short run and excess capacity
exists. Also, for given capacity with one scare resource, maximizing contribution
margin per unit of scarce resource will maximize profit. In the long run, prices
must cover all their costs, both fixed and variable, in order for the firm to
survive.
3-20 No. Products should be ranked by the contribution margin per unit of the constrained
resource rather than by the contribution margin per unit of the product.
3-21 Yes. When capacity is fixed in the short run, the firm may need to sacrifice the
production of some profitable products to make capacity available for a new
order. The contribution margin on the production of profitable products sacrificed
for a new order is an opportunity cost that must be considered to evaluate the
profitability of the new order.
3-22 The three components of a linear program are the objective function, the decision
variables, and the constraints.
55
EXERCISES
3-23 (a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
(k)
(l)
3-24 (a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
Fixed
Variable
Variable
Fixed
Fixed
Variable
Variable
Fixed or variable (if number of production workers can vary in the short
run);
Fixed
Variable
Fixed
Variable
Variable
Fixed
Fixed or variable (if number of billing clerks can vary in the short run)
Fixed
Fixed
Variable
Fixed
Fixed (with respect to a unit of product, as stated in the problem.
However, gasoline costs will vary with miles driven.)
3-25
Burger ingredients
Variable
Cooks wages
Fixed
Servers wages
Fixed
Janitors wages
Fixed
Fixed
Variable
Rent
Fixed
Fixed
56
3-26 (a)
(b)
(c)
Because the variable cost per unit will decrease, the contribution margin
per unit will increase. The breakeven point equals (fixed costs)/
(contribution margin), so the breakeven point will decrease. Specifically,
the new contribution margin per unit is $1,000 $450 $100 = $450 and
the new breakeven point is $3,500,000/$450 = 7,778 units (rounded).
3-27 (a)
(b)
57
3-28 (a)
(b)
(c)
(d)
(e)
3-29 (a)
59
3-31 (a)
Units sold
Sales mix
percentage*
Alligators
140,000
.7
Dolphins
60,000
Total
200,000
.3
Weighted
average**
Weighted
average**
Sum of
weighted
averages
Sales price
per unit
$20.00
$14.00
$25.00
$7.50
$21.50
Variable costs
per unit
$ 8.00
$ 5.60
$10.00
$3.00
$ 8.60
Unit CM
$12.00
$ 8.40
$15.00
$4.50
$12.90
Alligators
60,000
.3
Dolphins
140,000
Total
200,000
.7
Weighted
average**
Weighted
average**
Sum of
weighted
averages
Sales price
per unit
$20.00
$6.00
$25.00
$17.50
$23.50
Variable costs
per unit
$ 8.00
$2.40
$10.00
$ 7.00
$ 9.40
Unit CM
$12.00
$3.60
$15.00
$10.50
$14.10
60
In part (b), the sales mix percentage for the higher-CM product (dolphins)
is greater than in part (a). Consequently, fewer total units are required to
break even (91,490 in part (b) versus 100,000 in part (a)).
3-32
Product
Hamburgers
Chicken
Difference
($5,240)
Sandwiches
(1,032)
French fries
2,136
($4,136)
Product
Hamburgers
Chicken
Difference
($2,040)
Sandwiches
504
French fries
(888)
($2,424)
$4,136
2,424
$6,560
4,500
($11,060)
3-33 (a)
$3.50
3.00
$0.50
1,000
$ 500
Healthy Hearth will be better off by $500 with this one-time order. Note
that total fixed costs remain unchanged, so it is sufficient to evaluate the
change in the contribution margin. If the order had been long-term,
Healthy Hearth would need to evaluate whether the price provides the
desired profitability considering the fixed costs and whether filling the
government order might require giving up higher-priced regular sales.
(b)
$3.50
3.00
$0.50
1,000
$500
Opportunity cost
Lost contribution margin on regular sales: 500 ($4.50 $3.00)
$(750)
$(250)
Now, Healthy Hearth will be worse off by $250 with this one-time order.
Again, total fixed costs remain unchanged, so it is sufficient to evaluate the
change in the contribution margin.
3-34 (a)
Relevant costs:
Irrelevant costs:
(b)
Don will buy the Ford Escort if he bases the decision only on the available
cost information.
Year 1: (If Don buys the Ford Escort)
Cash savings:
Repairs on the Impala
Operating costImpala
$5,400
2,900
8,300
Cash expenditures:
Acquisition costFord Escort
Operating costFord Escort
First Year Savings
(c)
5,400
1,800
7,200
$1,100
2.
3.
Qualitative consideration:
1.
As Is
Rework
$10.00
Rework cost
$5.50*
$4.50
*55,000 10,000
old machine and replacing it with a new machine. Note that the annual
operating costs (before overhaul) of $18,000 are not sunk costs, yet they
are irrelevant.
(b)
(c)
Relevant costs include the acquisition cost of the new machine, the cost of
overhauling the old machine, current salvage of $4,000 for the old
machine (all of which are up-front costs), salvage value at the end of five
years for the new and overhauled machines, and the annual operating costs
for both the new machine and the overhauled old machine.
Net acquisition cost
Replacement
$66,000a
(500)
(200)
65,000b
$130,500
70,000c
$94,800
a
b
c
Overhauling
$25,000
64
3-37
Year 1
Year 2
Year 3
Year 4
Year 5
Cash inflow:
Sale of old machine
Saving because old
machine not repaired
$40,000
(5,000)
20,000
Salvage value of
new machine
Decrease in annual
operating costs
$10,000
20,000
$20,000
(120,000)
$20,000
$20,000 $20,000
Cash outflow:
Purchase of new machines
0
0
($40,000)
$20,000
$20,000
$20,000 $25,000
Cumulative cash
inflow (outflow)
($40,000) ($20,000)
$
0
$20,000 $45,000
Joyce Printers should replace the machines if they expect to use the new
machines for more than three years. (A more complete evaluation would use net
present value analysis, which is covered in other courses.)
3-38
Smart phones:
$140 50,000
Component:
$35.00 50,000
$34.00 50,000
Relevant costs
Smart phones:
$140 50,000
Component:
$30.00 50,000
Insource (Make)
Outsource (Buy)
$7,000,000
$7,000,000
1,750,000
1,700,000
$8,750,000
$8,700,000
Insource (Make)
Outsource (Buy)
$7,000,000
$7,000,000
1,500,000
65
$34.00 50,000
Relevant costs
1,700,000
$8,500,000
$8,700,000
3-39 (a)
(b)
If the variable costs (direct materials, direct labor, and variable overhead)
are all avoidable, then Kane will certainly reduce costs by outsourcing the
component. Fixed overhead costs may be unavoidable if the facility cannot
be converted to alternative uses when the component is outsourced.
However, even if the fixed overhead costs are unavoidable, Kane would
reduce costs by outsourcing. In this case, the cost savings per unit if the
component is outsourced would be:
Purchase price
(c)
3-40
$64.50
66.20
$1.70
Other factors relevant to the decision are the suppliers ability to live up to
expected quality and delivery standards, and the likelihood of suppliers
increasing prices of components in the near future.
Premier should make the gear model G37 because it costs $87,000 less to
make than to buy. (Fixed overhead is irrelevant and may be dropped from the
analysis.)
Make
Buy
$2,400,000
$1,100,000
600,000
500,000
300,000
300,000
(113,000)
$2,500,000
$2,587,000
66
3-41 (a) The offer by Superior Compressor should not be accepted if fixed
overhead costs are unavoidable.
Cost per unit
Cost of purchase
Make
Variable cost:
Direct material
Direct labor
Variable overhead
$ 80
60
56
$196
Buy
$200
$200
(b)
The maximum acceptable purchase price is $213 per unit if the plant
facilities are fully utilized at present and the incremental cost of adding
more capacity is approximated well by the $17 per unit fixed overhead
cost.
3-42 (a)
(b) George should consider the effect on the other two segments revenues if he
drops the billiards segment. It may be that the availability of billiards
attracts customers to the bar and restaurant segments. Traditional segment
margin analysis as in part (a) does not capture such interactive effects.
3-43 In order to accept the new order for 1,500 modules next week, McGee must give
up regular sales of 500 modules per week.
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.
This is the floor price that McGee should charge for the new order.
67
3-44 This order will require 500 = 5 (10,000 100) machine hours. Since there is
excess capacity of 800 = 4,000 (100% 80%) machine hours per month,
Shorewood Shoes Company can accept this order without expanding its capacity.
Therefore, Shorewood should charge at least as much as the incremental variable
costs for this order.
Direct material
Direct labor
Variable manufacturing overhead
Additional cost of embossing the private label
Minimum price to be charged for this order
$6.00
4.00
2.00
0.50
$12.50
Shorewoods costs stated in the problem are average costs per pair of shoes.
Shorewood should determine whether the costs are reasonably accurate for the discount
stores order. Shorewood should also consider how its regular customers might react to
the lower price offered to the discount store.
3-45 Incremental variable costs = ($16 + $5 + $3) 10,000
= $24 10,000
= $240,000.
Incremental revenue = $40 10,000 = $400,000.
Berrys operating income will increase by $160,000 if it accepts this offer.
3-46 (a)
$570,000
(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 Ritters 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.
68
(b)
$630,000
(363,000)
$267,000
124,000
$143,000
If Ritter operates the extra shift and accepts the export order, operating
income will increase by $80,000. Ritter should consider whether the same
quality will be achieved with new operators or existing operators working
overtime (with possible fatigue). In addition, Ritter should understand
whether the additional fixed costs will be incurred on a continuing basis or
are avoidable when production drops back to its previous level. Finally,
Ritter should also consider the effect of this price reduction on regular
customers.
3-47 (a)
Frozen
Dinners
Frozen
Vegetables
$12.00
$13.00
$24.00
$9.00
$8.00
$10.00
$20.50
$7.00
Unit CM
(square-foot package)
$4.00
$3.00
$3.50
$2.00
Minimum required
24
24
24
24
Maximum allowed
100
100
100
100
Allocation to maximize
total CM
100
26
100
24
69
(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.
Regular
3-48
Sale price per sq. yard
Deluxe
$16
$25
10
15
$6
$10
0.15
0.20
$40a
$50b
$6 0.15 = $40
$10 0.20 = $50
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).
70
PROBLEMS
3-49 The following items are variable costs:
Carpenter labor to make shelves
Wood to make the shelves
Sales commissions based on number of units sold
Miscellaneous variable manufacturing overhead
Total variable costs
$600,000
450,000
180,000
350,000
$1,580,000
The variable costs per unit are $1,580,000/50,000 = $31.60. The following
items are fixed costs:
Sales staff salaries
Office and showroom rental expenses
Depreciation on carpentry equipment
Advertising
Miscellaneous fixed manufacturing overhead
Rent for the building where the shelves are made
Depreciation for office equipment
Total fixed costs
$80,000
150,000
50,000
200,000
150,000
300,000
10,000
$940,000
(a)
$105.00
$30.00
20.00
10.00
10.50
Contribution margin
per unit:
70.50
$34.50
71
Incremental profit:
Increase in contribution
margin from new sales
Decrease in contribution
margin from
cannibalization
Increase in fixed costs
Increase in profits if the
new model is introduced
(b)
$34.50 120,000
$4,140,000
(1,200,000)
(2,000,000)
$940,000
3-51 (a)
(b)
(c)
(d)
For a two-week vacation by car, two likely activity measures are number
of miles driven and number of days (for lodging and meals).
3-52 (a)
72
(b)
(c)
Fuel costs are fixed once the flights are scheduled, but these costs vary
with the number of flights.
(d)
In this case, there is no opportunity cost to the airline because the seat
would otherwise go empty. The variable cost for the additional passenger
is $5 for the meals and refreshments and perhaps a small amount of
additional fuel cost.
3-53 (a)
(b)
S
J
$0
($300,000)
Loss
($1,500,000)
(c)
50,000
100,000 133,333
Number of rides
above 133,334 rides, then Smith Companys cost structure leads to more
profits.
(d)
3-54 (a)
The contribution margin generated must first cover the fixed costs and
then the balance remaining after the fixed costs are fully covered goes
toward profits. If the contribution margin is not sufficient to cover the
fixed costs, then a loss occurs for the period. Once the breakeven point
has been reached, profit will increase by the unit contribution margin for
each additional unit sold. Here, Smith Company is more risky because it
has higher fixed costs to cover and a higher unit contribution margin,
which makes its profits more sensitive to decreases in the sales activity
level.
Contribution margin per unit:
Selling price
$250
$100
20
$130
(b) Let X the sales volume at which the profit on sales is 10%
Profit = 250X 120 X 200,000 62,500
01
. 250 X
130 X 262,500 25 X
105 X 262,500
X 2,500 units.
(c)
(1)
$200
120
$80
Fixed costs =
$200,000 + $62,500 + $17,500 = $280,000
Breakeven point = $280,000 $80 = 3,500 units
note: 0 3,500 4,400
74
120
(2)
Selling price
Variable costs
Contribution margin per unit
$200
120
$80
Fixed costs =
$310,000 + $62,500 + $17,500 = $390,000
Breakeven point = $390,000 $80 = 4,875 units
(d)
750, 000
0.17
(1)
(2)
75
$114,800 *
153,600 **
41,280 ***
36,000
20,000
$365,680
* Labor cost
Total labor hours required:
60 800 0.05
60 4
30 1, 600 0. 05
30 4
2,400
240
2,400
120
5,160
4,000
1,160
$ 80,000
34,800
$114,800
** Materials cost
$1.60 60 800 = $76,800
$1.60 30 1,600 = 76,800
$153,600
$41,280
This is a special order where the company has sufficient excess capacity to
fill the order.
Incremental revenue 8,000 $22
Incremental VC
8,000 ($5 + 4+1)
Incremental CM
8,000 ($22 10)
$176,000
80,000
$96,000
76
(b)
This is a special order where the company has insufficient excess capacity
to fill the order, and therefore faces an opportunity cost if it fills the order.
Incremental CM from (a)
Opportunity cost from lost sales*
Net increase in CM
$96,000
80,000
$16,000
*The opportunity cost is the net benefit from the foregone CM on 5,000
boxes of regular sales.
Because fixed costs are unchanged, the $16,000 net increase in CM is the
increase in income if the company accepts the special order.
3-57 (a)
(b)
$450.00
37.50
$487.50
There is currently enough surplus capacity to produce the 200 units per
week for the new order. The estimated increase in the companys profit if
it accepts the order is ($480 $450) 200 = $6,000 per week.
(c)
Because there is not enough surplus capacity to produce the 600 units per
week for the new order, the company faces an opportunity cost if it
accepts the order. The company has surplus capacity of 2,000 1600 =
400 chips per week. If the company accepts the order, it will have to give
up 200 chips per week of regular sales, at $500 revenue per chip. The
company will gain ($480 $450) 600 = $18,000 per week from the
special order, but that gain will be offset by lost contribution margin from
regular sales, ($500 $450) 200 = $10,000, for a net gain of $8,000 per
week.
77
3-58 (a)
Acquisition cost and depreciation expense for the existing elevator system
are irrelevant.
(b)
Relevant cost
Existing System
New System
Acquisition cost
$875,000
(100,000)
$900,000
(25,000)
48,000
(100,000)
$875,000
$723,000
The decision to replace the existing elevator system with the new one will
require net present value analysis that considers the time value of money.
Without considering the time value of money, the new system is less costly.
3-59
$4.00
3.30
$0.70
50,000
$35,000
Average unit costs can be misleading. Fixed costs are not relevant to this
decisionthe decision should be based on incremental costs.
(c)
78
3-60 (a)
$ 2,000
240,000
10,000a
Cash outflow:
Acquisition of new machine ($360,000 $100,000)
(260,000)
($ 8,000)
0.05 (100,000 4) $1
=
0.025 (100,000 4) $1 =
Reduction in rework
$20,000
$10,000
$10,000
Syd Young should not replace the old machine due to net cash outflow of
($8,000).
(b)
(c)
Other considerations:
1.
Will sales increase because of lower defects with the new machine
2.
What is the cost of capital used to discount future cash flows? In this
case, discounting will only make the new machine appear worse. (This topic
is covered in other courses.)
3-61 (a)
(b)
the anticipated effect on demand and revenue (for pastry and for Beaus
Bistro) under each option.
3-62 (a)
The costs and benefit shown below are relevant for the outsourcing
decision. All but the $20,000 sale of office equipment are annual costs.
Costs
Labor
Rent
Phone
Other overhead
Office equipment
Outside call center
In-house
Outside
Call Center Call Center
$650,000
60,000
35,000
42,000
($20,000)
700,000
$787,000
$680,000
(b)
Hollenberry must consider the outside call centers reliability and quality of
service in responding to Hollenberrys customers. Given Hollenberrys
worldwide operations, the greater number of multilingual operators available
at the outside call center could be an important feature. Finally, Hollenberry
must factor in the prospect of laying off employees, many of whom have
worked at Hollenberry for over 20 years.
(c)
If the outside call center can meet Hollenberrys expectations for reliability
and quality, including better service for international customers, financial
considerations point toward Hollenberry outsourcing the call center function.
However, although the outsourcing decision seems financially sound, there is
great potential for decreasing the remaining employees morale because of the
layoffs. This question is designed to generate discussion about trade-offs
among the companys stakeholders, including employees. One alternative to
firing Hollenberrys call center employees is reassigning the employees to
other jobs and relying on attrition to eventually reduce employee costs to
Hollenberrys desired level. However, this would increase the cost of the
outsourcing option and reduce its financial benefits.
80
3-63 (a)
$100,000
Cost savings:
Utilities
Supervision
Maintenance
Administrative
(9,000)
(30,000)
(7,000)
(30,000)
$24,000
No, the decision to retain JT484 will only be reinforced by the sales
managers comments.
3-64 Some examples of articles that describe dropping unprofitable products appear
below. The article by Hymowitz provides interesting background for the article in
The Economist on Sonys unprofitable products. These articles describe the need
for a turnaround at Sony. The article in The Economist states, Almost every
product line is unprofitable. Important issues include strong competition,
vanity projects that lacked a market, and cost cutting through layoffs and
factory closings. The article by Ball lays a foundation for activity-based costing
through its discussion of high costs and unprofitable products due in part to
excessive proliferation of variations of products.
Hymowitz, C. More American Chiefs Are Taking Top Posts At Overseas
Concerns. The Wall Street Journal, October 17, 2005, page B1.
Game on: Sir Howard Stringer believes he is finally in a position to fix Sony.
The Economist, March 5, 2009. http://www.economist.com/node/13234173,
accessed December 12, 2010.
Ball, D. Crunch Time: After Buying Binge, Nestl Goes on a Diet; Departing
CEO Slashes Slow Sellers, Brands; No to Low-Carb Rolo. The Wall Street
Journal, July 23, 2007, page A1.
Wingfield, N. Amazon to Cut Product Offerings, Plans to Drop Unprofitable
Items. The Wall Street Journal, February 2, 2001, page B6.
Kardos, D. and M. Andrejczak. Earnings Digest -- Food: Heinz Net Rises as
Sales Offset Costs. The Wall Street Journal, November 30, 2007, page C11.
81
3-65 (a)
XLl
$10.00
XL2
$14.00
XL3
$12.00
Direct materials
(4.00)
(4.50)
(5.00)
Direct labor
(2.00)
(3.00)
(2.50)
Sales price
Variable overhead
(2.00)
(3.00)
(2.50)
$2.00
$3.50
$2.00
0.20
0.35
0.25
$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 XL3s 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.
82
XL3
$12.00
Sales price
Direct materials
$5.00
Direct labor
3.75*
Variable overhead
2.50
11.25
$0.75
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
$400
Sales price
HCD2
$500
Variable cost:
Direct material
Direct labor
Variable overhead
Contribution margin per unit
DLH per unit
Contribution margin per DLH
$60
$75
80
100
100
240 125
300
$160
$200
The new order requires a total of 1,500 5 300 DLH, but only
1,000 15,000 14,000 DLH are available. This will leave a capacity
shortage of 500 1,500 1,000 DLH. The contribution margin per DLH
is $40 for each product, so the company can forego sales of either product
with the same effect. Therefore, the change in profit is
83
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
1 75
$75.00
Material
Labora
1.5 100
150.00
Variable overhead
1.5 125
187.50
$412.50
Sales price
400.00
Contribution margin
a
$(12.50)
Change in Profit
200 100
100 (12.50)
Increase
3-67 (a)
During
$20,000
Regular hours
(1,250)
Overtime hours
$18,750
In order to produce 13,000 standard doors and 5,000 deluxe doors, the
following number of direct labor hours and machine hours are required:
Cutting:
Direct labor hours: 0.5 13,000 1 5,000 11,500 > 8,000 capacity
Machine hours: 2 13,000 3 5,000 41,000 > 40,000 capacity
Assembly:
Direct labor hours: 1 13,000 1.5 5,000 20,500 > 17,500 capacity
Machine hours: 2 13,000 3 5,000 41,000 > 40,000 capacity
84
Finishing:
Direct labor hours: 0.5 13,000 0.5 5,000 9,000 > 8,000 capacity
Machine hours: 1 13,000 1.5 5,000 20,500 > 15,000 capacity
The direct labor hour capacity in each department and the machine hour
capacity in each department are not adequate to meet the next months
demand.
(b)
Deluxe
$200
110
155
$40
$45
Let S denote the number of standard doors to produce and D denote the
number of deluxe doors to produce. The linear programming problem is:
Maximize $40S + $45D
Subject to the following constraints:
Cutting:
Direct labor hours: 0.5S D 8,000
Machine hours: 2S 3D 40,000
Assembly:
Direct labor hours: S 1.5D 17,500
Machine hours: 2S 3D 40,000
Finishing:
Direct labor hours: 0.5S 0.5D 8,000
Machine hours: S 1.5D 15,000
Maximum demand:
S 13,000
D 5,000
Nonnegativity:
S > 0, D > 0
85
The contribution margin for standard doors remains the same, but the
contribution margin for deluxe doors is now $50:
Deluxe
Sales price per unit
$200
Variable cost per unit ($80 + $56 + $14)
150
$50
3-68 (a)
2.
6%
5%
4%
$54
$30
$8
1.5
0.5
$18
$20
$16
Current hours
60
90
60
60
90
Average commission
Hours per customer per
monthly visit
Average commission
per hour
(b)
87
CASES
3-69 Wage rate = $3,600 150 hours = $24/hour.
Neighboring laboratory charges $80 2 hours = $40/hour, which also equals
$100 2.5 and $160 4.
(a)
Simple
Routine
800
600
750
Month
June
July
August
Workers
Hired
20
21
22
23
24
25
26
27
Simple
Nonroutine Complex
250
450
200
400
225
450
Total
Hours
4,025.0
3,300.0
3,862.5
Equivalent
Workers
26.83
22.00
25.75
In-house
Hours Short
Outside Outside
Total
Wages* June July August Hours Charges
Cost
$216,000 1,025 300 862.5 2,187.5 $87,500 $303,500
226,800
875 150 712.5 1,737.5
69,500 296,300
237,600
725
0 562.5 1,287.5
51,500 289,100
248,400
575
0 412.5
987.5
39,500 287,900
259,200
425
0 262.5
687.5
27,500 286,700
270,000
275
0 112.5
387.5
15,500 285,500
280,800
125
0
0.0
125.0
5,000 285,800
291,600
0
0
0.0
0.0
0 291,600
*$3,600 per month 3 months = $10,800 for one worker for a quarter.
Outside charges will exceed the monthly wages of an additional worker hired by
Barrington if the number of outside hours exceeds $3,600 $40 = 90.
Therefore, Barrington should hire an additional employee when the
outside services are expected to exceed 90 hours in any month, which
corresponds to 90 150 = 0.6 equivalent workers.
Month
June
July
August
Simple
Routine
800
600
750
Simple
Nonroutine Complex
250
450
200
400
225
450
Total
Hours
4,025.0
3,300.0
3,862.5
Equivalent
Workers
26.83
22.00
25.75
Month
June
July
August
Total cost
Workers
Hired
27
22
26
Fixed
Outside
Cost
Hours
$97,200
0
79,200
0
93,600
0
Outside
Charges
0
0
0
Total
Cost
$97,200
79,200
93,600
$270,000
3-70 (Numbers in square brackets below refer to reference numbers that appear at the
end of the solution for this case.)
(a)
(c)
90
Sales staff could also contact customers as soon as a desired item arrived
in the store and better serve repeat customers with readily available
information on sizes and preferences [3].
Nordstroms 2001 Annual Report (p. 4) reports that implementation of the
perpetual inventory system is going very well, with the expectation that
the system will help buyers improve decision-making, manage inventory,
and respond quickly to trends. The 2001 Annual Report covers the fiscal
year from February 2001 to January 2002.
(d)
(e)
91
The campaign was less than successful; the company announced that it
had overreached. Nordstrom had alienated its faithful clientele [7] by
trying to appeal to younger shoppers. That is, there was an opportunity
cost to targeting younger shoppers. Some financial results appear in part
(d).
Nordstrom may need to reconsider its value proposition. Reference [2]
comments:
..the retail world has changed since Nordstroms heyday. With
the rise of such speciality retailers as Talbots, The Limited, and
Ann Taylor, competition is ferocious. And its old winning
formulagreat customer serviceisnt the easy advantage it
once was. Neiman Marcus Group Inc is now No. 1 in service
among department-store chains. It generates annual sales of
$490 per square foot, handily eclipsing second-place Nordstrom
at $342. And Talbots Inc also took a page from Nordstroms
playbook. The Hingham (Mass.) chain improved its service and
stuck to classic merchandise. The result: It ended last year as
one of the best-performing retailers in the nation, with samestore sales jumping 17%.
The same article points out that in response to growing customer
focus on value, Nordstrom needs excellence in inventory
management and control of expenses in addition to its recognized
excellence in the art of retailing.
Saks Fifth Avenues Wild About Cashmere campaign offered a
wide range of products in cashmere and was designed to appeal to
young, fashion-hungry customers. The campaign not only alienated
loyal 45-54 year-old customers with edgy, midriff-baring fashion,
but also confused customers who did realize the connection
between cashmere and the goat mannekins in the store, or why there
were audios of goats bleating [4]. Like Nordstrom, Saks appears to
have suffered some opportunity cost from this effort to expand its
customer base.
References
[1]
[2]
Anonymous. 2001. Can Nordstroms Find The Right Style? Business Week (July
30), 5962.
[3]
[4]
Bednarz, A. 2002. The Customer Is King. Network World (December 2), 6566.
Byron, E. 2006. Struggling Saks Tries Alternations In Management. Wall Street
Journal (January 10), B1.
[5]
[6]
Lee, L. 2000. Nordstrom Cleans Out Its Closets. Business Week (May 22), 105.
[7]
Nordstrom previously provided the following list of references at its web site
http://about.nordstrom.com/aboutus/faq/faq.asp#12:
"With a New location in Dadeland Mall, Nordstrom Seeks to Become a Florida
Institution," The Miami Herald, November 12, 2004
"Author of Books on Nordstrom Culture to Address Virginia Trade Show," Richmond
Times-Dispatch, September 23, 2004
"Nordstrom Regains Its Luster - Challenge Awaits as Rivals Encroach on Image of
Affordable Luxury," The Wall Street Journal, August 19, 2004
"Shoppers put Heart, Soles Into Yearly Nordstrom Sale," The Seattle Times, July 17,
2004
"Q&A with Blake Nordstrom - 4th Generation Leads Growth of Nordstrom," The
Charlotte Observer, March 12, 2004
"Nordstrom 'Cachet' Hits Wellington Friday," Palm Beach Post, November 10, 2003
"Back in the Family; Fourth Generation Takes Control After a Brief Change in
Company Leadership," Seattle Post-Intelligencer, June 27, 2001
"A Time of Change; Company Makes Huge Leaps with Expansion, Public Stock
Offering," Seattle Post-Intelligencer, June 26, 2001
"Still in Style; From Small Shoe Store, to Upscale Retailer, Company has Kept
Founder's Values," Seattle Post-Intelligencer, June 25, 2001
93
"Success Came a Step at a Time; Company Rose From Small Seattle Shoe Store to
Retail Giant with National Appeal," Seattle Times, May 29, 2001
Books:
The Nordstrom Way by Robert Spector and Patrick D. McCarthy
Fabled Service: Ordinary Acts, Extraordinary Outcomes by Bonnie Jameson and Betsy
Sanders
3-71 (a)
Unit cost
AA100
AA101
AA102
$560
$400
$470
680
680
Direct labor
60
30
60
60
30
60
$680
$1,140
$1,270
20
30
30
$700
$1,170
$1,300
940
1,500
1,700
$240
$330
$400
4 hrs
6 hrs
8 hrs
$60
$55
$50
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.
94
$360
1,170
$1,530
AA100
$560
AA101
$400
AA102
$470
740
740
Direct labor
90
45
90
90
45
90
$740
$1,230
$1,390
20
30
30
$760
$1,260
$1,420
940
1,500
1,700
$180
$240
$280
$45
$40
$35
Since contribution margins per hour for AA101 and AA102 are positive, it
is worthwhile operating the plant overtime.
95
Additionally, the case questions require both quantitative and qualitative analyses
of the business issues faced by AVS. AVS has been used in a graduate-level
managerial accounting class for MBAs, and would be most appropriate for an
advanced undergraduate or a graduate-level accounting or MBA course.
The detail in the case is rich enough to support a variety of analyses. Alternative
uses could be to have the student construct a cost of goods manufactured
statement or a traditional financial statement, both of which reinforce the
differences between product and period costs. Additionally, alternative decision
analysis questions could be developed using the variable and fixed cost
structures described in the case. Case question number two is only one example
of a potential decision analysis question.
(a) Contribution Margin Income Statement
To develop the contribution margin income statement, you first have to
calculate the number of bottles of wine produced by AVS. This number is
dependent upon the yield from the grapes. The relevant calculations are as
follows:
Yield:
Pounds harvested
Loss in processing
Yield:
Chardonnay
Grapes
100,000
10,000 10%
90,000
Generic
Grapes
60,000
3,000 5%
57,000
96
Blanc de
Blanc
Total
Pounds of grapes:
Chardonnay grapes
Generic grapes
Total pounds of grapes
72,000
0
72,000
18,000
9,000
27,000
0
48,000
48,000
90,000
57,000
147,000
Bottles (3 lb./bottle)
24,000
9,000
16,000
49,000
Each case of wine requires 36 pounds of grapes (post-fermenting). A barrel holds the
equivalent of 40 cases of wine (post-fermenting), or 1,440 pounds of grapes (40 36). To
convert the post-fermenting grapes to pre-fermenting grapes, they must be divided by 0.9, or
1,440/0.9 equals 1,600 pounds of grapes. The harvest of 100,000 pounds of grapes therefore
requires 62.5 barrels for storage (100,000/1,600).
97
2
Average revenue
per bottle
$ 17.31
of sales
of sales
of sales
$ 2.00
per bottle
98
Yield:
Pounds
Loss in processing
Yield:
Bottles of wine:
Chardonnay
Grapes
20,000
2,000
18,000
9,000
10%
Total costs
80,717
45,283
$ 33,000
$ 6,079
7,500
388
9,000
6,000
$ 28,967
$ 4,033
Net Impact
$ 41,250
$ 18,900
$ 22,350
Pounds of Grapes
20,000
15%
$ 1.1175
The following factors would support AVSs decision to reject the grape purchase:
Poor quality of the grapes
An additional AVS Chardonnay wine creates confusion in the
marketplace
Lack of control over the harvest and crush process
Lack of confidence in the additional sales forecast
Inability of the current capacity (e.g. bottling line, space) to support
additional production
Inability to use the additional barrels purchased in future years
Cannibalization of the current Chardonnay, Chardonnay-Estate or
Blanc de Blanc sales
Reliability concerns with the new supplier
Other hidden costs
Summary
The AVS case is based upon actual wine industry data, although the data has
been simplified to reinforce the teaching points and concepts. It is also true to the
wine making process, with the exception of AVSs process of making the
Chardonnay regular wine from the fermented Chardonnay and Blanc de Blanc
wines. This can be done, but most commonly the juice from the wine grapes is
combined at the start of the fermenting process, so that they can ferment
together. Because of the different yield rates in the fermenting process, the case
had the wines ferment separately and blend at the end.
Note: The full case, which includes activity-based cost analysis, can be taught in
a 75-minute class, or by omitting the decision analysis question 50 minutes
would be sufficient. The case author has also used it to teach the differences
between the financial income statement reporting (product and period costs) and
the contribution margin income statement reporting (variable and fixed costs),
and then assigned decision analysis and/or the ABC costing as an additional
assignment.
101