978-0077733773 Chapter 11 Solution Manual Part 2

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11-22 (Continued)

4. Opportunity cost incurred if sales of 5,000 units to regular customers are

lost by accepting the special sales order:

Lost contribution margin, sales to regular customers:

Selling price per unit = $20.00

Variable cost per unit:

Direct materials = $2.00

11-23 Special Order (60 minutes)

1. Current Special Order

Revenue per unit $ 45 $ 35

Variable costs per unit:

Direct materials $ 9 $ 9

Direct labor $ 8 $ 8

Variable factory overhead $ 4 $ 4

Variable nonmanufacturing costs $ 8 29 $ 4 25

Alternatively, the following relevant cost analysis can be used:

to produce the special order is based on the comparison of current

and special-order production. If there were additional capacity, the

proper decision would be to accept the special order since it has a

positive contribution of $50,000.

so Alton should try to reduce or delay 1,000 units of the SHC order to

get an order for 4,000 units. Then the special order could be

accepted without a loss of regular sales.

11-23 (Continued-1)

If SHC insists on the full order of 5,000 units, then Alton must figure

the contribution margin on lost sales ($16.00 × 1,000 units =

The minimum price would be $28.20 per unit, the total variable cost

per unit ($25.00) plus the contribution margin of lost sales, allocated

In general, the minimum selling price = relevant cost = out-of-

pocket costs + opportunity cost, as shown below:

Out-of-Pocket Costs:

Direct materials $9.00

Direct labor $8.00

Variable manufacturing overhead $4.00

Variable nonmanufacturing costs $4.00 $25.00

Opportunity Cost:

No. units of lost sales 1,000

CM per unit–regular sales

3. Goal Seek Solution:

Step One: Set up the Equation

11-23 (Continued-2)

Cell D99 contains the appropriate equation: =D89-D94-D97

Step #2: Run Goal Seek (i.e., change the selling price per unit, cell

C89) until the value in Cell D99 equals zero)

Step #3: Results

11-24 Special Order; Use of Opportunity Cost Information (30 minutes)

1. The special order should have been accepted since the relevant cost is

$3.50 − $1.50 = $2.00 per cap, or $2.00 × 15,000 = $30,000 total cost.

2. Research studies have consistently found that decision makers often

ignore opportunity costs. For this reason, it is particularly important that the

development of decision-making skills place particular emphasis on

identifying and incorporating opportunity costs. Interestingly, a recent study

found that decision makers with greater expertise in developing

comparative income statements appeared to ignore fixed costs more than

costs.

Other studies have shown that the decision maker’s cognitive style, the

presence of unused capacity, or the relative amount of the opportunity cost

can affect the use of opportunity cost information by the decision makers in

experimental studies. Overall, these results show that in practice, decision

makers have a difficult time using opportunity cost information properly and

consistently.

References: Sandra C. Vera-Munoz, “The Effects of Accounting

Knowledge and Context on the Omission of Opportunity Costs in Resource

Allocation Decisions,” The Accounting Review, January 1998, pp. 47–72.

Steve Buchheit, “Reporting the Cost of Capacity,” Accounting,

Organizations and Society, August 2003, p. 549; Robert E. Hoskin,

“Opportunity Cost and Behavior,” Journal of Accounting Research, Spring

1983, p. 78; Robert Chenhall and Deigan Morris,” The Effect of Cognitive

11-25 Special Order (25 minutes)

To begin the analysis, Fred Stanley, the Earth Baby CFO, should recognize

that the $3.00 full cost for its product includes $1.00 of irrelevant fixed

overhead. Only the variable costs of $2.00 per unit are relevant. From this

standpoint, GDI’s proposal makes sense, since there would be a

However, the agreement with GDI could be a potentially serious strategic

liability for Earth Baby. Earth Baby’s reputation is built upon differentiation

and product superiority, features which make it attractive to a small, but

important segment of the baby products market. To sell its products through

a discount retailer, even under another brand name, could harm the

differentiated image of Earth Baby’s product line, and cause it to lose

market share in its usual distribution channels (the high-end grocery stores

11-26 Make or Buy; Continuation of Exercise 9-22 (50 minutes)

1. This requirement assumes that Machine A has not yet been purchased.

We compare the relevant cost of purchasing from an external supplier to

the relevant cost of producing the switches internally using Machine A.

As indicated below, if annual volume is at least 100,000 units, Vista

should purchase and use Machine A to produce the switches:

External Machine A

$2.00Q = $0.65Q + $135,000

Alternatively, we can define the breakeven volume (point of indifference)

as the difference in fixed costs for the two decision alternatives divided

by the difference in variable cost per unit, as follows :

Fixed cost/year, if Vista makes = $135,000

Fixed cost/year, if Vista buys = $0

Machine A to make the switches is preferable to purchasing the switches

from an external supplier.

2. Unlike #1 above, here we are assuming that Machine A has already

been purchased. Is it now preferable to use Machine A to make the

switches or to purchase the switches from an external supplier? The

annual fixed (depreciation) cost of Machine A is now a sunk cost and

11-26 (Continued-1)

3. Here we use an approach similar to that used in 9-22, except that the

$135,000 annual (depreciation) cost of Machine A is irrelevant—

threshold to moving up to Machine B is now much higher because the

purchase cost of Machine A is sunk and therefore irrelevant, while the

purchase price and therefore annual depreciation expense are relevant

since Machine B has not yet been purchased.

Annual Cost of Using A = Annual Cost of Using B

4. Using Goal Seek to Calculate the Above Volume-Indifference Level

Step #1: Set Up the Problem (i.e., define the cost-differential

equation, in cell C84):

Assumed Data Inputs:

Determining Annual Cost Differential (cell C84)

11-26 (Continued-2)

Note: cell C84 contains the annual cost-differential formula (i.e., the

difference in total costs between the decision alternatives)

=(C79+C80)−(C82+C83)

cellC80 =C65*C77 (where C65 contains the variable cost per

unit for Machine A)

cell C82 =E12 (where E12 contains the fixed cost per year for

Machine B)

cell C83 =C68*C77 (where C77 contains the variable cost per

unit for Machine B)

Step #2: Run Goal Seek (cell C62 contains the annual volume, in

units)

Step #3: Results (the indifference volume is 582,857, the same as

calculated above in Part 3)

11-27 Product-Line Profitability Analysis (45 minutes)

Note that variable selling and administrative costs should be included in

calculating contribution margin, so that the contribution margin

presented in the problem is incorrect and requires this adjustment.

1. T-1

Last year’s contribution = $200,000 − $70,000 − $20,000 = $110,000

Last year’s contribution margin ratio = $110,000 ÷ $200,000 = 55%

T-2

Last year’s contribution = $260,000 − $130,000 − $50,000 = $80,000

The effect of discontinuing T-2 is the contribution margin less variable

selling costs less the incremental contribution for T-1:

2. Required % increase in sales of T-1 to compensate for lost margin from

T-2:

Loss of CM, T-2 = Gain in CM, T-1

$80,000 = X% × $110,000

3. Required % increase in sales from T–1 to compensate for lost margin

from T-2 if total fixed costs can be reduced by $45,000.

Loss of CM, T-2 = Gain in CM, T-1

$80,000 − $45,000 = X% × $110,000