Incremental Analysis
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166. All of the following are relevant in deciding whether to eliminate an unprofitable segment
except the segment’s
a. sales.
b. variable expenses.
c. contribution margin.
d. fixed expenses.
Answers to Multiple Choice Questions
Test Bank for Accounting, Tools for Business Decision Making Fifth Edition
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BRIEF EXERCISES
BE 167
Sedgwick Inc. is considering Plan 1 which is estimated to have sales of $40,000 and costs of
$15,500. The company currently has sales of $37,000 and costs of $14,000.
Instructions
Compare plans using incremental analysis.
BE 168
Pederson Enterprises produces giant stuffed bears. Each bear consists of $12 of variable costs
and $9 of fixed costs and sells for $45. A wholesaler offers to buy 8,000 units at $14 each, of
which Pederson has the capacity to produce. Pederson will incur extra shipping costs of $1 per
bear.
Instructions
Determine the incremental income or loss that Pederson Enterprises would realize by accepting
the special order.
BE 169
Notson, Inc. produces several models of clocks. An outside supplier has offered to produce the
commercial clocks for Notson for $420 each. Notson needs 1,200 clocks annually. Notson has
provided the following unit costs for its commercial clocks:
Direct materials $100
Direct labor 140
Variable overhead 80
Fixed overhead (40% avoidable) 150
Instructions
Prepare an incremental analysis which shows the effect of the make–or-buy decision.
Incremental Analysis
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Solution 169 (5 min.)
BE 170
Parks Corporation currently manufactures 3,000 staplers annually for its main product. The costs
per stapler are as follows:
Direct materials $ 3.00
Direct labor 7.00
Variable overhead 4.00
Fixed overhead 7.00
Total $21.00
Gallup Company has contacted Parks with an offer to sell it 3,000 staplers for $18.00 each. $5 of
the fixed overhead per unit is unavoidable.
Instructions
Prepare an incremental analysis for the make-or-buy decision.
BE 171
Calc, Inc. owns a machine that produces baskets for the gift packages the company sells. The
company uses 900 baskets in production each month. The costs of making one basket is $4 for
direct materials, $3 for variable manufacturing overhead, $2 for direct labor, and $5 for fixed
manufacturing overhead. The unit cost is based on the monthly production of 900 baskets. The
company determined that 30% of the fixed manufacturing overhead is avoidable. An outside
supplier has offered to sell Calc the baskets for $13 each, and can supply all the units it needs.
Instructions
Prepare an incremental analysis to determine if Calc should buy the baskets from the supplier.
Test Bank for Accounting, Tools for Business Decision Making Fifth Edition
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Solution 171 (6–8 min.)
BE 172
Hernandez, Inc. manufactures three models of picture frames for a total of 8,000 frames per year.
The unit cost to produce a metal frame follows:
Direct materials $ 6
Direct labor 8
Variable overhead 2
Fixed overhead (70% unavoidable) 5
Total $21
A local company has offered to supply Hernandez the 8,000 metal frames it needs for $17 each.
Instructions
Create an incremental analysis for the make-or-buy decision.
Incremental Analysis
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BE 173
Wood Chuck Furniture currently manufactures rocking chairs as its main product. Each chair
uses one seat cushion and one back cushion with the following costs per set of cushions (one
seat and one back):
Direct materials $ 1
Direct labor 10
Variable overhead 5
Fixed overhead 8
Total $24
Shepert Company has contacted Wood Chuck with an offer to sell it 5,000 sets of cushions for
$18 each. If Wood Chuck buys the cushions, $2 of the fixed overhead per unit will be allocated to
other products.
Instructions
Should Wood Chuck make or buy the cushions?
BE 174
Paola Farms, Inc. produces a crop of chickens at a total cost of $66,000. The production
generates 60,000 chickens which can be sold for $1 each to a slaughtering company, or the
chickens can be slaughtered in house and then sold for $2.75 each. It costs $65,000 more to turn
the annual chicken crop into chicken meat.
Instructions
If Paola Farms slaughters the chickens, determine how much incremental profit or loss it would
report. What should Paola Farms do?
BE 175
Elmdale Company has a machine that affixes labels to bottles. The machine has a book value of
$80,000 and a remaining useful life of 3 years and no salvage value. A new, more efficient
machine is available at a cost of $300,000 that will have a 5-year useful life with no salvage
value. The new machine will lower annual variable production costs from $520,000 to $410,000.
Test Bank for Accounting, Tools for Business Decision Making Fifth Edition
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BE 175 (Cont.)
Instructions
Prepare an analysis showing whether the old machine should be retained or replaced.
BE 176
Keith Inc. has 4 product lines: sour cream, ice cream, yogurt, and butter. Demand of individual
products is not affected by changes in other product lines. 30% of the fixed costs are direct, and
the other 70% are allocated. Results of June follow:
Sour Cream Ice Cream Yogurt Butter Total
Units sold 2,000 500 400 200 3,100
Revenue $10,000 $20,000 $10,000 $20,000 $60,000
Variable departmental costs 6,000 13,000 4,200 4,800 28,000
Fixed costs 5,000 2,000 3,000 7,000 17,000
Net income (loss) $ (1,000) $ 5,000 $ 2,800 $ 8,200 $15,000
Instructions
Prepare an incremental analysis of the effect of dropping the sour cream product line.
BE 177
Parino Company has three product lines in its retail stores: books, videos, and music. The
allocated fixed costs are based on units sold and are unavoidable. Demand of individual products
is not affected by changes in other product lines. Results of the fourth quarter are presented
below:
Books Music Videos Total
Units sold 1,000 2,000 2,000 5,000
Revenue $24,000 $48,000 $30,000 $102,000
Variable departmental costs 15,000 22,000 23,000 60,000
Direct fixed costs 3,000 6,000 4,000 13,000
Allocated fixed costs 4,400 8,800 8,800 22,000
Net income (loss) $ 1,600 $11,200 $ (5,800) $ 7,000
Incremental Analysis
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BE 177 (Cont.)
Instructions
Prepare an incremental analysis of the effect of dropping the Video product line.
BE 178
Harmark has three product lines in its retail stores: kites, wind socks, and flags. Results of the
fourth quarter are presented below:
Kites Wind Socks Flags Total
Units sold 1,000 2,000 2,000 5,000
Revenue $22,000 $40,000 $23,000 $85,000
Variable departmental costs 17,000 22,000 12,000 51,000
Direct fixed costs 1,000 3,000 2,000 6,000
Allocated fixed costs 8,000 8,000 8,000 24,000
Net income (loss) $ (4,000) $ 7,000 $ 1,000 $ 4,000
The allocated fixed costs are unavoidable. Demand of individual products is not affected by
changes in other product lines.
Instructions
What will happen to profits if Harmark discontinues the Kites product line?
BE 179
Dolls R Us sells three products in its retail stores: baby dolls, teenage dolls, and plush dolls.
Results of the fourth quarter are below:
Baby Dolls Teenage Dolls Plush Dolls Total
Units sold 1,000 2,000 2,000 5,000
Revenue $32,000 $43,000 $26,000 $101,000
Variable departmental costs 22,000 24,000 13,000 59,000
Direct fixed costs 5,000 4,000 3,000 12,000
Allocated fixed costs 6,000 7,000 7,000 20,000
Net income (loss) $ (1,000) $ 8,000 $ 3,000 $ 10,000
Test Bank for Accounting, Tools for Business Decision Making Fifth Edition
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BE 179 (cont.)
Instructions
Demand for individual products is not affected by changes in other product lines. Prepare an
incremental analysis to determine if the Baby Dolls should be discontinued
EXERCISES
Ex. 180
Roland Company operates a small factory in which it manufactures two products: A and B.
Production and sales result for last year were as follow:
A B
Units sold 8,000 16,000
Selling price per unit 65 52
Variable costs per unit 35 30
Fixed costs per unit 15 15
For purposes of simplicity, the firm allocates total fixed costs over the total number of units of A
and B produced and sold.
The research department has developed a new product (C) as a replacement for product B.
Market studies show that Roland Company could sell 11,000 units of C next year at a price of
$80, the variable costs per unit of C are $39. The introduction of product C will lead to a 10%
increase in demand for product A and discontinuation of product B. If the company does not
introduce the new product, it expects next year’s result to be the same as last year’s.
Instructions
Should Roland Company introduce product C next year? Explain why or why not. Show
calculations to support your decision.
Incremental Analysis
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Solution 180 (8 – 10 min.)
Ex. 181
Felter Company produced and sold 50,000 units of product and is operating at 70% of plant
capacity. Unit information about its product is as follows:
Sales price $70
Variable manufacturing cost $45
Fixed manufacturing cost ($500,000 ÷ 50,000) 10 55
Profit per unit $15
The company received a proposal from a foreign company to buy 10,000 units of Felter
Company’s product for $50 per unit. This is a one-time only order and acceptance of this proposal
will not affect the company’s regular sales. The president of Felter Company is reluctant to accept
the proposal because he is concerned that the company will lose money on the special order.
Instructions
Prepare a schedule reflecting an incremental analysis of this proposal and indicate the effect the
acceptance of this order might have on the company’s income.
Test Bank for Accounting, Tools for Business Decision Making Fifth Edition
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Solution 181 (9–13 min.)
Ex. 182
Carney Company manufactures cappuccino makers. For the first eight months of 2013, the
company reported the following operating results while operating at 80% of plant capacity:
Sales (500,000 units) $90,000,000
Cost of goods sold 54,000,000
Gross profit 36,000,000
Operating expenses 24,000,000
Net income $12,000,000
An analysis of costs and expenses reveals that variable cost of goods sold is $95 per unit and
variable operating expenses are $35 per unit.
In September, Carney Company receives a special order for 40,000 machines at $135 each from
a major coffee shop franchise. Acceptance of the order would result in $10,000 of shipping costs
but no increase in fixed expenses.
Instructions
(a) Prepare an incremental analysis for the special order.
(b) Should Carney Company accept the special order? Justify your answer.
Incremental Analysis
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Ex. 183
Gregg Company supplies schools with floor mattresses to use in physical education classes.
Gregg has received a special order from a large school district to buy 600 mats at $45 each.
Acceptance of the special order will not affect fixed costs but will result in $1,200 of shipping costs.
For the first 6 months of 2013, the company reported the following operating results while
operating at 80% capacity:
Sales (100,000 units) $7,000,000
Cost of goods sold 4,200,000
Gross profit 2,800,000
Operating expenses 2,000,000
Net income $ 800,000
Cost of goods sold was 75% variable and 25% fixed; operating expenses were 70% variable and
30% fixed.
Instructions
(a) Prepare an incremental analysis for the special order.
(b) Should Gregg Company accept the special order? Justify your answer.
Ex. 184
Larkin Company produces golf discs which it normally sells to retailers for $6 each. The cost of
manufacturing 25,000 golf discs is:
Materials $ 10,000
Labor 30,000
Variable overhead 20,000
Fixed overhead 40,000
Total $100,000
Larkin also incurs 5% sales commission ($0.30) on each disc sold.
Test Bank for Accounting, Tools for Business Decision Making Fifth Edition
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Ex 184 (cont.)
Rudd Corporation offers Larkin $4.25 per disc for 3,000 discs. Rudd would sell the discs
under its own brand name in foreign markets not yet served by Larkin. If Larkin accepts the offer,
its fixed overhead will increase from $40,000 to $43,000 due to the purchase of a new imprinting
machine. No sales commission will result from the special order.
Instructions
(a) Prepare an incremental analysis for the special order.
(b) Should Innova accept the special order? Why or why not?
Ex. 185
Kasten, Inc. budgeted 10,000 widgets for production during 2013. Kasten has capacity to produce
12,000 units. Fixed factory overhead is allocated to production. The following estimated costs
were provided:
Direct material ($7/unit) $ 70,000
Direct labor ($15/hr. × 2 hrs./unit) 300,000
Variable manufacturing overhead ($4/unit) 40,000
Fixed factory overhead costs ($5/unit) 50,000
Total $460,000
Cost per unit = $46
Instructions
Answer each of the following independent questions:
1. Kasten received an order for 1,000 units from a new customer in a country in which Kasten
has never done business. This customer has offered $43 per widget. Should Kasten accept
the order?
2. Kasten received an offer from another company to manufacture the same quality widgets for
$39. Should Kasten let someone else manufacture all 10,000 widgets and focus only on
Incremental Analysis
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Solution 185 (10–12 min.)
Ex. 186
Coyle Company manufactured 6,000 units of a component part that is used in its product and
incurred the following costs:
Direct materials $35,000
Direct labor 15,000
Variable manufacturing overhead 10,000
Fixed manufacturing overhead 20,000
$80,000
Another company has offered to sell the same component part to the company for $13 per unit.
The fixed manufacturing overhead consists mainly of depreciation on the equipment used to
manufacture the part and would not be reduced if the component part was purchased from the
outside firm. If the component part is purchased from the outside firm, Coyle Company has the
opportunity to use the factory equipment to produce another product which is estimated to have a
contribution margin of $22,000.
Instructions
Prepare an incremental analysis report for Coyle Company which can serve as informational
input into this make or buy decision.
Test Bank for Accounting, Tools for Business Decision Making Fifth Edition
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Ex. 187
Agler Corporation currently manufactures a subassembly for its main product. The costs per unit
are as follows:
Direct materials $ 1
Direct labor 10
Variable overhead 5
Fixed overhead 8
Total $24
Funkhouser Company has contacted Agler with an offer to sell it 4,000 of the subassemblies for
$17 each. If Agler buys the subassemblies, $2 of the fixed overhead per unit will be allocated to
other products.
Instructions
Should Agler make or buy the subassemblies? Explain your answer.
Ex. 188
Kuhn Bicycle Company has been manufacturing its own seats for its bicycles. The company is
currently operating at 100% capacity, and variable manufacturing overhead is charged to
production at the rate of 60% of direct labor cost. The direct materials and direct labor cost per
unit to make the bicycle seats are $8.00 and $9.00, respectively. Normal production is 50,000
bicycles per year.
A supplier offers to make the bicycle seats at a price of $21 each. If the bicycle company accepts
this offer, all variable manufacturing costs will be eliminated, but the $30,000 of fixed
manufacturing overhead currently being charged to the bicycle seats will have to be absorbed by
other products.
Instructions
(a) Prepare the incremental analysis for the decision to make or buy the bicycle seats.
(b) Should Kuhn Bicycle Company buy the seats from the outside supplier? Justify your answer.