CHAPTER 21
INCREMENTAL ANALYSI
S
Brief Learning
Exercises Topic Objectives Skills
B. Ex. 21.1 Using average unit costs 21-1, 3 Analysis
B. Ex. 21.2 Make or buy 21-2–4 Analysis, judgment
B. Ex. 21.3 Joint cost allocation 21-1, 2, 4 Analysis, judgment
B. Ex. 21.4 Outsource a product 21-2, 4, 5 Analysis, judgment
B. Ex. 21.5 Opportunity costs 21-2 Analysis
B. Ex. 21.6 Identifying costs 21-2 Analysis, judgment
B. Ex. 21.7 Allocating productive capacity 21-4 Analysis
B. Ex. 21.8 Match decision and relevant costs/revenues 21-1, 3, 4 Analysis
B. Ex. 21.9 Sell at split-off or process further 21-2–4 Analysis
B. Ex. 21.10 Scrap or rebuild 21-2–4 Analysis
Learning
Exercises Topic Objectives Skills
21.1 Accounting terminology 21-1–5 Analysis
21.2 Real World: Home Depot 21-1, 2 Analysis, communication,
Incremental, sunk, and opportunity costs judgment
21.3 Incremental analysis: Accepting a special
order 21-1–3 Analysis
21.4 Scarce resources 21-1–4 Analysis
21.5 Special order decisions and opportunity
costs 21-1–4 Analysis
21.6 Incremental analysis: Make or buy decision 21-1–4 Analysis
21.7 Make or buy decision 21-1–4 Analysis
21.8 Sunk costs: Scrap or rework decision 21-1–4 Analysis
21.9 Scarce resources 21-1–4 Analysis
21.10 Joint products 21-1–4 Analysis, communication,
judgment
21.11 Joint processes: Sell or process further 21-1–4 Analysis
21.12 Pricing a special order 21-1–3 Analysis, judgment
21.13 Evaluating a special order 21-1–3 Analysis
21.14 Scarce resources 21-1–5 Analysis, judgment
21.15 Real World: Home Depot’s charitable
contributions 21-1–3 Analysis, communication,
research
OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL
THINKING CASES
Topic Skills
21.1 A,B Evaluating a special order 21-1–21-3, 21
–
5Analysis, communication,
judgment
21.2 A,B Make or buy decision 21-1–21-4 Analysis
21.3 A,B Make or buy decision 21-1–21-4 Analysis
21.4 A,B Determining the most profitable product 21-1–21-4 Analysis, communication
Given scarce resources
21.5 A,B Sell or rebuild deficient units 21-1–21-5 Analysis, communication
21.6 A,B Sell or rebuild 21-1–21-5 Analysis, communication,
judgment
21.7 A,B Joint products 21-1–21-4 Analysis
21.8 A Pay off or pay up? 21-1–21-3, 21
–
5Analysis, communication,
judgment
21.8 B Scarce resources 21-1–21-5 Analysis, communication,
judgment
21.1 Factors that limit capacity 21-4 Analysis, communication,
judgment
21.2 Relevant information and opportunity
costs 21-1–21–3,
21-5 Analysis, communication,
judgment
21.3 Real World: Dow Chemical Co. 21-3, 21-5 Analysis, communication,
(Internet) judgment, research,
technology
21. 4 SEC enforcement fines 21-1–21–3 Analysis, communication,
(Ethics, fraud and corporate governance) judgment
Critical Thinking Cases
Problems
Sets A, B Learning
Objectives
DESCRIPTIONS OF PROBLEMS AND CRITICAL THINKING CASES
Problems
21.1 A,B D. Lawrance/Swirl Incorporated 25 Easy
Use of incremental analysis to determine whether it would be
advantageous to accept a large special order at a sales price below
average unit cost. Student is also asked to identify other considerations
in this type of decision.
21.2 A,B Easy Use Tool Co./Matchless Corp. 30 Medium
Use incremental analysis in a make or buy decision. Includes an
assumption that facilities can be put to an alternative productive use.
21.3 A,B Parsons Plumbing & Heating/James Lighting 30 Medium
Use incremental analysis in a make or buy decision. Includes an
assumption that facilities can be put to an alternative productive use.
21.4 A,B Insiteful Instruments/Superior Instruments 30 Medium
Decision regarding which product should be produced when machine
hours create a production constraint.
21.5 A,B Louie Optics/Toops 25 Medium
Decision of whether older models should be discontinued or upgraded.
Involves sunk costs, opportunity costs, and capacity considerations.
21.6 A,B Silent Sentry/Fire Code 25 Medium
Decision of whether gas leak detectors/smoke detectors should be
repaired, sold at a discount, or shipped overseas. Also requires students
to consider ethical and legal implications of decision.
21.7 A,B Kelp Company/Vitamin Bits Company 25 Medium
Decision of whether to sell products at the split-off point or to process
them further.
21.8 A McKay Chemical Company 35 Strong
A chemical company that for years has been engaged in illegal
dumping and now is threatened with public exposure. Superb ethics
problem.
21.8 B Home Run Corporation 20 Medium
Direct Labor hours constrain production and there are complementary
products.
Below are brief descriptions of each problem, case, and the first Internet assignment. These
descriptions are accompanied by the estimated time (in minutes) required for completion and by a
difficulty rating. The time estimates assume use of the partially filled-in working papers.
Critical Thinking Cases
21.1 I Knew That 35 Medium
A limiting resource problem that relates this accounting concept to
students’ everyday experiences. Students are to develop strategies for
maximizing contribution margin in familiar business settings. (We
always assign this one.)
21.2 McFriendl
y
Software 15 Medium
A short, single-concept problem focusing upon the importance, and
also the subjectivity, of opportunity costs.
21.3 The Dow Corporation 20 Easy
Internet
This assignment focuses on the types of incremental decisions that
might be made at this firm. In addition, the student is asked to think of
qualitative factors that might be considered in the decision-making
process.
21.4 SEC Enforcement Fines 20 Medium
Ethics, Fraud & Corporate Governance
Students consider how the SEC fines policy creates relevant costs that
managers may (or may not) consider when thinking about undertaking
fraudulent reporting.
SUGGESTED ANSWERS TO DISCUSSION QUESTIONS
1.
2.
3.
4.
5.
Incremental costs, defined as the difference in costs between alternative courses of action and
incremental revenues, defined as the difference in revenues between alternative courses of
Short-run decisions are made with a fixed set of resources and must meet the demands of the
Opportunity costs are an important factor in decision making; they are costs of taking some
action in terms of the value foregone (given up) because that particular action was taken.
A sunk cost is an outlay that has been irrevocably incurred at some time in the past; sunk costs
Nonfinancial questions regarding a special order decision may include (1) Is there excess
capacity, or will regular customers have to be turned away? (2) If regular customers are turned
9.
12.
14.
wrong. For example, choosing a supplier with a poor reputation among customers may cause the
market share of the product to decline and result in very large opportunity costs.
If the Wolvo Company decides to sell the products, it must consider any legal or ethical issues
associated with selling a defective product. Scrapping the defective products avoids any legal
Harry Haney is correct in his assessment about how the purchase of new equipment would affect
his performance evaluation. Many companies use return on investment (ROI) type measures to
Agree: a company can run the risk of filling up capacity with products and special orders that
cover their variable costs, but do not provide enough contribution to cover the total fixed costs.
margin is typically the incremental profit that is earned on sales. The contribution margin is
important for special order, make or buy, and production constraint decisions.
SOLUTIONS TO BRIEF EXERCISES
B. Ex. 21.1
B. Ex. 21.2
B. Ex. 21.3
B. Ex. 21.4
The first consideration is whether there is idle capacity. Thus, if some regular
sales of washing machines at the $180 price are displaced because there is not
enough capacity to make 20,000, then the opportunity cost associated with the
displaced sales must be included in the incremental analysis. The second
The incremental cost of a fishing reel is $14 ($9 $5). Thus, it is more expensive
The total sales value of the joint products is $1,300,000 ($390,000 + $910,000).
Thus, the relative sales values are 30% for wood chips ($390,000/$1,300,000) and
The incremental outsourcing cost is: ($4 – $3) x (1,500 per month x 12 mos.) =
$18,000.
B. Ex. 21.7
B. Ex. 21.10
The contribution margin for the cycle class is $18 per hour ($18/1 hour). The
contribution margin for the combo class is $10 per hour ($20/2 hours). Thus,
The $1,693,000 costs incurred to-date are sunk costs. The $450,000 costs to
SOLUTIONS TO EXERCISES
Ex. 21.1 a.
b.
Incremental analysis
Sunk cost
Ex. 21.4
The contribution margin per machine hr. for a bolt of each type of cloth is as follows:
Denim: contribution margin per hr. = $14 per bolt ÷ 0.5 hrs. per bolt = $28 per hr.
Chenille: contribution margin per hr. = $22 per bolt ÷ 1 hr. per bolt = $22 per hr.
Gauze: contribution margin per hr. = $9 per bolt ÷ 0.3 hrs. per bolt = $30 per hr.