Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
Exercise 10-11 (20 minutes)
The costs that can be avoided as a result of purchasing from the outside
are relevant in a make-or-buy decision. The analysis is:
Per Unit
Differential
Costs
30,000 Units
Make
Buy
Make
Buy
Cost of purchasing ...................
$21.00
$630,000
Cost of making:
Direct materials .....................
$ 3.60
$108,000
Direct labor ...........................
10.00
300,000
Variable overhead .................
2.40
72,000
Fixed overhead .....................
3.00
*
90,000
Total cost ................................
$19.00
$21.00
$570,000
$630,000
*
The remaining $6 of fixed overhead cost would not be relevant,
because it will continue regardless of whether the company makes
or buys the parts.
The $80,000 rental value of the space being used to produce part S-6 is an
opportunity cost of continuing to produce the part internally. Thus, the
complete analysis is:
Make
Buy
Total cost, as above ........................................
$570,000
$630,000
Rental value of the space (opportunity cost) .....
80,000
Total cost, including opportunity cost ...............
$650,000
$630,000
Net advantage in favor of buying .....................
$20,000
Profits would increase by $20,000 if the outside supplier’s offer is accepted.
Exercise 10-12 (15 minutes)
The company should accept orders first for Product C, second for Product
A, and third for Product B. The computations are:
Product
A
Product
B
Product
C
(1)
Direct materials required per unit ......
$24
$15
$9
(2)
Cost per pound ................................
$3
$3
$3
(3)
Pounds required per unit (1) ÷ (2) ....
8
5
3
(4)
Contribution margin per unit .............
$32
$14
$21
(5)
Contribution margin per pound of
materials used (4) ÷ (3) ................
$4.00
$2.80
$7.00
Because Product C uses the least amount of material per unit of the three
products, and because it is the most profitable of the three in terms of its
use of materials, some students will immediately assume that this is an
Exercise 10-13 (10 minutes)
Sales value after further processing
(7,000 units × $12 per unit) ..........................
$84,000
Sales value at the split-off point
(7,000 units × $9 per unit) ...........................
63,000
Incremental revenue from further processing ...
21,000
Cost of further processing ...............................
9,500
Profit from further processing ..........................
$11,500
Exercise 10-14 (20 minutes)
1.
Fixed cost per mile ($3,200* ÷ 10,000 miles) ...
$0.32
Variable operating cost per mile .......................
0.14
Average cost per mile ......................................
$0.46
*
Depreciation ..............................
$1,600
Insurance ..................................
1,200
Garage rent ...............................
360
Automobile tax and license .........
40
Total .........................................
$3,200
2. The variable operating cost is relevant in this situation. The depreciation
is not relevant because it is a sunk cost. However, any decrease in the
car.
3. When figuring the incremental cost of the more expensive car, the
relevant costs include the purchase price of the new car (net of the
resale value of the old car) and the increases in the fixed costs of
Exercise 10-15 (30 minutes)
No, the bilge pump product line should not be discontinued. The
computations are:
Contribution margin lost if the line is dropped .....
$(460,000)
Fixed costs that can be avoided:
Advertising .....................................................
$270,000
Salary of the product line manager ..................
32,000
Insurance on inventories .................................
8,000
310,000
Net disadvantage of dropping the line .................
$(150,000)
The same solution can be obtained by preparing comparative income
statements:
Keep
Product
Line
Drop
Product
Line
Difference:
Net
Operating
Income
Increase or
(Decrease)
Sales ...............................................
$850,000
$ 0
$(850,000)
Variable expenses:
Variable manufacturing expenses ...
330,000
0
330,000
Sales commissions ........................
42,000
0
42,000
Shipping .......................................
18,000
0
18,000
Total variable expenses ....................
390,000
0
390,000
Contribution margin .........................
460,000
0
(460,000)
Fixed expenses:
Advertising ...................................
270,000
0
270,000
Depreciation of equipment .............
80,000
80,000
0
General factory overhead ...............
105,000
105,000
0
Salary of product line manager ......
32,000
0
32,000
Insurance on inventories................
8,000
0
8,000
Purchasing department ..................
45,000
45,000
0
Total fixed expenses .........................
540,000
230,000
310,000
Net operating loss ............................
$ (80,000)
$(230,000)
$(150,000)
Exercise 10-16 (30 minutes)
1. The relevant costs of a hunting trip would be:
Travel expense (100 miles @ $0.21 per mile) .
$21
Shotgun shells .............................................
20
One bottle of whiskey ...................................
15
Total ............................................................
$56
This answer assumes that Bill would not be drinking the bottle of
whiskey anyway. It also assumes that the resale values of the camper,
pickup truck, and boat are not affected by taking one more hunting trip.
The money lost in the poker game is not relevant because Bill would
have played poker even if he did not go hunting. He plays poker every
weekend.
The other costs are sunk at the point at which the decision is made to
go on another hunting trip.
2. If Bill gets lucky and bags another two ducks, all of his costs are likely to
be about the same as they were on his last trip. Therefore, it really
doesn’t cost him anything to shoot the last two ducks—except possibly
3. In a decision of whether to give up hunting entirely, more of the costs
listed by John are relevant. If Bill did not hunt, he would not need to
Exercise 10-16 (continued)
These three requirements illustrate the slippery nature of costs. A cost
Exercise 10-17 (10 minutes)
Contribution margin lost if the Linens Department is dropped:
Lost from the Linens Department ..........................................
$(600,000)
Lost from the Hardware Department (10% × $2,100,000) ......
(210,000)
Total lost contribution margin ..................................................
(810,000)
Fixed costs that can be avoided ($800,000 – $340,000) ............
460,000
Decrease in profits for the company as a whole ........................
$(350,000)
Problem 10-18A (60 minutes)
1.
Selling price per unit ............................................
$32
Variable expenses per unit ...................................
18
*
Contribution margin per unit ................................
$14
Increased sales in units (60,000 units × 25%) ......
15,000
Contribution margin per unit ................................
× $14
Incremental contribution margin ...........................
$210,000
Less added fixed selling expenses .........................
80,000
Incremental net operating income ........................
$130,000
Yes, the increase in fixed selling expenses would be justified.
2.
Variable manufacturing cost per unit ....................
$16.80
*
Import duties per unit .........................................
1.70
Permits and licenses ($9,000 ÷ 20,000 units) ........
0.45
Shipping cost per unit ..........................................
3.20
Break-even price per unit .....................................
$22.15
*$10 + $4.50 + $2.30 = $16.80.
3. The relevant cost is $1.20 per unit, which is the variable selling expense
per Dak. Because the irregular units have already been produced, all
4. If the plant operates at 30% of normal levels, then only 3,000 units will
Problem 10-18A (continued)
Given this information, the simplest approach to the solution is:
Contribution margin lost if the plant is closed
(3,000 units × $14 per unit*) ..........................
$(42,000)
Fixed costs that can be avoided if the plant is
closed:
Fixed manufacturing overhead cost ($300,000
× 2/12 = $50,000; $50,000 × 40%) .............
$20,000
Fixed selling cost ($210,000 × 2/12 =
$35,000; $35,000 × 20%) ............................
7,000
27,000
Net disadvantage of closing the plant .................
$(15,000)
*$32.00 – ($10.00 + $4.50 + $2.30 + $1.20) = $14.00
Some students will take a longer approach such as that shown below:
Continue
to
Operate
Close the
Plant
Sales (3,000 units × $32 per unit) ...............
$ 96,000
$ 0
Variable expenses (3,000 units × $18 per
unit) ........................................................
54,000
0
Contribution margin ....................................
42,000
0
Fixed expenses:
Fixed manufacturing overhead cost:
$300,000 × 2/12 ...................................
50,000
$300,000 × 2/12 × 60% .......................
30,000
Fixed selling expense:
$210,000 × 2/12 ...................................
35,000
$210,000 × 2/12 × 80% .......................
28,000
Total fixed expenses ...................................
85,000
58,000
Net operating income (loss) ........................
$(43,000)
$(58,000)
Problem 10-18A (continued)
5. The relevant costs are those that can be avoided by purchasing from the
outside manufacturer. These costs are:
Variable manufacturing costs .......................................
$16.80
Fixed manufacturing overhead cost ($300,000 × 75%
= $225,000; $225,000 ÷ 60,000 units) .....................
3.75
Variable selling expense ($1.20 × 1/3) .........................
0.40
Total costs avoided .....................................................
$20.95
To be acceptable, the outside manufacturer’s quotation must be
less
than $20.95 per unit.
Problem 10-19A (60 minutes)
1. No, the Housekeeping program should not be discontinued. It is actually
generating a positive program segment margin and is, of course,
providing a valuable service to seniors. Computations to support this
conclusion follow:
Contribution margin lost if the Housekeeping
program is dropped ..........................................
$(80,000)
Fixed costs that can be avoided:
Liability insurance .............................................
$15,000
Program administrator’s salary ...........................
37,000
52,000
Decrease in net operating income for the
organization as a whole.....................................
$(28,000)
Depreciation on the van is a sunk cost and the van has no salvage value
since it would be donated to another organization. The general
administrative overhead is allocated and none of it would be avoided if
the program were dropped; thus it is not relevant to the decision.
The same result can be obtained with the alternative analysis below:
Current
Total
Total If
House-
keeping Is
Dropped
Difference:
Net
Operating
Income
Increase or
(Decrease)
Revenues ....................................
$900,000
$660,000
$(240,000)
Variable expenses ........................
490,000
330,000
160,000
Contribution margin .....................
410,000
330,000
(80,000)
Fixed expenses:
Depreciation* ...........................
68,000
68,000
0
Liability insurance .....................
42,000
27,000
15,000
Program administrators’ salaries
115,000
78,000
37,000
General administrative overhead
180,000
180,000
0
Total fixed expenses ....................
405,000
353,000
52,000
Net operating income (loss) .........
$ 5,000
$(23,000)
$ (28,000)
*Includes pro-rated loss on disposal of the van if it is donated to a
charity.
Problem 10-19A (continued)
2. To give the administrator of the entire organization a clearer picture of
the financial viability of each of the organization’s programs, the general
administrative overhead should not be allocated. It is a common cost
that should be deducted from the total program segment margin. A
Problem 10-20A (15 minutes)
1.
Per 16-Ounce
T-Bone
Sales from further processing:
Sales price of one filet mignon (6 ounces ×
$4.00 per pound ÷ 16 ounces per pound) .....
$1.50
Sales price of one New York cut (8 ounces ×
$2.80 per pound ÷ 16 ounces per pound) .....
1.40
Total revenue from further processing ................
2.90
Less sales revenue from one T-bone steak ..........
2.25
Incremental revenue from further processing ......
0.65
Less cost of further processing ...........................
0.25
Profit per pound from further processing ............
$0.40
2. The T-bone steaks should be processed further into the filet mignon and
the New York cut. This will yield $0.40 per pound in added profit for the
Problem 10-21A (30 minutes)
1.
Contribution margin lost if the flight is
discontinued .....................................................
$(12,950)
Flight costs that can be avoided if the flight is
discontinued:
Flight promotion ...............................................
$ 750
Fuel for aircraft .................................................
5,800
Liability insurance (1/3 × $4,200) ......................
1,400
Salaries, flight assistants ...................................
1,500
Overnight costs for flight crew and assistants .....
300
9,750
Net decrease in profits if the flight is discontinued .
$ (3,200)
The following costs are not relevant to the decision:
Cost
Reason
Salaries, flight crew
Fixed annual salaries, which will
not change.
Depreciation of aircraft
Sunk cost.
Liability insurance (two-thirds)
Two-thirds of the liability insurance
is unaffected by this decision.
Baggage loading and flight
preparation
This is an allocated cost that will
continue even if the flight is
discontinued.
Problem 10-21A (continued)
Alternative Solution:
Keep the
Flight
Drop the
Flight
Difference:
Net
Operating
Income
Increase or
(Decrease)
Ticket revenue ......................................
$14,000
$ 0
$(14,000)
Variable expenses ..................................
1,050
0
1,050
Contribution margin ...............................
12,950
0
(12,950)
Less flight expenses:
Salaries, flight crew .............................
1,800
1,800
0
Flight promotion .................................
750
0
750
Depreciation of aircraft ........................
1,550
1,550
0
Fuel for aircraft ...................................
5,800
0
5,800
Liability insurance ...............................
4,200
2,800
1,400
Salaries, flight assistants .....................
1,500
0
1,500
Baggage loading and flight preparation
1,700
1,700
0
Overnight costs for flight crew and
assistants at destination....................
300
0
300
Total flight expenses ..............................
17,600
7,850
9,750
Net operating loss .................................
$ (4,650)
$ (7,850)
$ (3,200)
2. The goal of increasing the seat occupancy could be obtained by
eliminating flights with a lower-than-average seat occupancy. By
eliminating these flights and keeping the flights with a higher-than-
Problem 10-22A (30 minutes)
1. Because the fixed costs will not change as a result of the order, they are
not relevant to the decision. The cost of the new machine is relevant,
and this cost will have to be recovered by the current order because
there is no assurance of future business from the retail chain.
Unit
Total—
5,000 units
Sales from the order ($50 × 84%) ......................
$42
$210,000
Less costs associated with the order:
Direct materials ...............................................
15
75,000
Direct labor .....................................................
8
40,000
Variable manufacturing overhead ......................
3
15,000
Variable selling expense ($4 × 25%) .................
1
5,000
Special machine ($10,000 ÷ 5,000 units) ..........
2
10,000
Total costs .........................................................
29
145,000
Net increase in profits .........................................
$13
$ 65,000
2.
Sales from the order:
Reimbursement for costs of production (variable
production costs of $26 plus fixed manufacturing
overhead cost of $9 = $35 per unit; $35 per unit ×
5,000 units) ...........................................................
$175,000
Fixed fee ($1.80 per unit × 5,000 units) .....................
9,000
Total revenue ..............................................................
184,000
Less incremental costs—variable production costs
($26 per unit × 5,000 units) ......................................
130,000
Net increase in profits ..................................................
$ 54,000
3.
Sales:
From the U.S. Army (above) ......................................
$184,000
From regular channels ($50 per unit × 5,000 units) ....
250,000
Net decrease in revenue ..............................................
(66,000)
Less variable selling expenses avoided if the Army’s
order is accepted ($4 per unit × 5,000 units) .............
20,000
Net decrease in profits if the Army’s order is accepted ...
$(46,000)
Note: This answer assumes that regular customers will return after this
one-time special order rather than buy from a competitor in the future.
Problem 10-23A (60 minutes)
1. The $90,000 in fixed overhead cost charged to the new product is a
common cost that will be the same whether the tubes are produced
internally or purchased from the outside. Hence, it is not relevant. The
variable manufacturing overhead per box of Chap-Off would be $0.50,
as shown below:
Total manufacturing overhead cost per box of Chap-Off ..
$1.40
Less fixed portion ($90,000 ÷ 100,000 boxes) ................
0.90
Variable overhead cost per box ......................................
$0.50
The total variable cost of producing one box of Chap-Off would be:
Direct materials ............................................................
$3.60
Direct labor ..................................................................
2.00
Variable manufacturing overhead ..................................
0.50
Total variable cost per box ............................................
$6.10
If the tubes for the Chap-Off are purchased from the outside supplier,
then the variable cost per box of Chap-Off would be:
Direct materials ($3.60 × 75%) .....................................
$2.70
Direct labor ($2.00 × 90%) ...........................................
1.80
Variable manufacturing overhead ($0.50 × 90%) ...........
0.45
Cost of tube from outside .............................................
1.35
Total variable cost per box ............................................
$6.30
Therefore, the company should reject the outside supplier’s offer. A
savings of $0.20 per box of Chap-Off will be realized by producing the
tubes internally.
Problem 10-23A (continued)
Another approach to the solution would be:
Cost avoided by purchasing the tubes:
Direct materials ($3.60 × 25%) ...........................
$0.90
Direct labor ($2.00 × 10%) .................................
0.20
Variable manufacturing overhead ($0.50 × 10%) ..
0.05
Total costs avoided ................................................
$1.15
*
Cost of purchasing the tubes from the outside ........
$1.35
Cost savings per box by making internally ...............
$0.20
*
This $1.15 is the cost of making one box of tubes internally
because it represents the overall cost savings that will be
realized per box of Chap-Off by purchasing the tubes from the
supplier.
2. The maximum purchase price would be $1.15 per box. The company
would not be willing to pay more than this amount because the $1.15
Problem 10-23A (continued)
3. At a volume of 120,000 boxes, the company should buy the tubes. The
computations are:
Cost of making 120,000 boxes:
120,000 boxes × $1.15 per box ...................
$138,000
Rental cost of equipment .............................
40,000
Total cost ......................................................
$178,000
Cost of buying 120,000 boxes:
120,000 boxes × $1.35 per box ...................
$162,000
Or, on a total cost basis, the computations are:
Cost of making 120,000 boxes:
120,000 boxes × $6.10 per box ...................
$732,000
Rental cost of equipment .............................
40,000
Total cost ......................................................
$772,000
Cost of buying 120,000 boxes:
120,000 boxes × $6.30 per box ...................
$756,000
Thus, buying the boxes will save the company $16,000 per year.
