CASE 12-29

#1

Final sales value (per sweater) $30.00

Less sales value (per spindle of yarn) 20.00
Incremental revenue from further processing $10.00
Less variable cost of further processing into sweater:
Raw materials:
Button, thread, lining $2.00
Direct labor 5.80 7.80
Additional contribution margin from further processing $ 2.20

The manufacturing cost of wool yarn ($16.00) and the fixed manufacturing overhead costs are
not relevant and therefore not included in the computation because whether the yarn is sold outright or
further processed into sweaters, these costs will still be incurred and still be the same, respectively.
The computation shows additional contribution margin of further processing each spindle of
yarn into sweaters. Therefore, we would recommend that the wool yarn should be further processed
into sweaters rather than selling it outright.

#2

Sales value (per spindle of yarn) $20.00

Less variable cost to manufacture:
Raw materials (raw wool) $7.00
Direct labor 3.60 10.60
Contribution margin per spindle of yarn
from selling wool yarn outright $ 9.40

Opportunity cost is relevant and needed to be considered when deciding what minimum price
should be set for one unit of sweater. Based on the computation, there is an opportunity cost of $9.40.
It is the potential benefit that is given up when the wool yarn is further processed rather than sold
outright.
The opportunity cost and all of the variable costs incurred from manufacturing both the spindle
of yarn and the sweater shall be considered and must be fully covered by the selling price of the sweater
to gain contribution margin.

Opportunity cost $ 9.40

Add variable cost to manufacture spindle of yarn & sweater:
Raw materials:
Raw wool (for spindle of yarn) $ 7.00
Button, thread, lining (for sweater) 2.00
Direct labor:
For sweater 5.80
For spindle of yarn 3.60 18.40
Minimum selling price per unit of sweater $27.80
 Therefore, the lowest price that the company should accept for a sweater is $27.80. It can also
be derived by deducting the additional contribution margin (further processing into sweater) from the
current selling price of the sweater ($30.00 - $2.20 = $27.80).

CASE 12-30
#1
Shutting down a business operation would be irrational if we will merely base it on the income it earned
or loss it incurred during a period. This is a big challenge to the decision makers since they have to
consider a lot of financial data that will prove the inefficiency of a certain division.

Here, the original cost of the facilities incurred by the Clayton processing center is a sunk cost and
should be ignored in any decision. Sunk costs are defined as a cost that has already been incurred and
cannot be recovered. We can observe that they have to build the facility to make it available compared
to the other two processing centers where they opted to rent. Unfortunately, the contractor that was
hired was inexperienced and went bankrupt before the project was completed that’s why they have to
hire another contractor to finish the work, which was way over budget. At some point we can say that it
can be beneficial in the sense that their facilities expense would be lower for the next periods for they
have the ownership of the facility where the Clayton Processing Center is operating. The only relevant
costs are the future facility costs that would be affected by this decision. Relevant cost is used to
determine whether to sell or keep a business unit. In this case, we are faced with a dilemma of whether
to shut down, to sell or to keep the facility. If the facility were shut down, the Clayton facility has no
resale value.

If the Clayton facility were sold, the company would have to rent additional space at the remaining
processing centers. If the facility were to remain in operation, the building should last indefinitely, so the
company does not have to be concerned about eventually replacing it. Indeed, it might be a better idea
to consider shutting down the other facilities because the rent on those facilities might be avoided. If we
opt to shut down the Clayton facility it will increase the rent at Billings and Great Falls by $600,000 and
decrease in local administrative expenses by $90,000. Closing down the Clayton facility would almost
certainly lead to a decline in BSC’s profits because there would be costs of moving the equipment from
Clayton and there might be some loss of sales due to disruption of services. Even though closing down
the Clayton facility would result in a decline in overall company profits, it would result in an improved
performance report for the Rocky Mountain Region if we do not take into consideration the costs of
moving equipment and the potential loss of revenues caused by the disruption of service to customers.

#2
Before we decide whether Haley Romero’s decision to shut down the Clayton facilities is ethical or not,
let us first take into account several other factors. As what have been discussed in item number 1, if
Clayton facilities will be shut down, there would be a decrease in the Bank Services Corporation’s profit.
Along with that, its employees will also lose their job and customers will somehow suffer some
deterioration in the services. Standards of Ethical Conduct for Management Accountants can be helpful
in these situations. Trying to recommend the closing of Clayton facility could violate the credibility
standard. It is a standard that obliges a company of full disclosure of relevant information that could be
the basis of intended user’s understanding of the reports or recommendation and can help them decide
about it. Somehow, if Romero would just disclose everything (including the effects of it to the profits,
employees, and customers stated above) there is a high possibility that the corporate board would not
agree to the recommendation. If this is the case, it will look like as if Romero sacrifices the interest of
many just to make the performance report look better. But at some point, Romero did not have to take
charge of the mistakes that happened before her administration. We also need to consider that the
performance report presented in here has some issues that made it look like this. This made some
processing centers look like they are unprofitable but this resulted only to the arbitrary allocations of
corporate and regional administrative expenses. If we try to look at it, regional administrative expenses
allocation is just based on the sales, which means that there is no really great basis that $360,000 would
be totally erased if Clayton facility would be shut down. Also with corporate administrative expenses, it
was based on sales, which is 9.5% of their sales. These were even compounded by the use of irrelevant
facilities expense in the report.

#3
The price for the services should not be influenced by the depreciation of the facilities in Clayton. The
original cost of the facility is considered as a sunk cost and should not be included in any decision
making. By recovering the sunk cost of the building will lead to higher prices than the market that can
cause to less business opportunities and lower profits.