Accounting Chapter 17 Homework The Extra Flexible Resource Cost The Additional

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CHAPTER 17

ACTIVITY RESOURCE USAGE MODEL

AND TACTICAL DECISION MAKING

DISCUSSION QUESTIONS

1. Tactical decision making is choosing among

alternatives with an immediate or limited end

in mind.

2. Tactical decisions should support the overall

strategic objectives of an organization. Often,

the strategic objectives are served by small-

scale actions. For example, making a part

instead of buying it may lower costs of

production and thus serve the strategic cost

leadership objective. Or it may serve the

objective of differentiation by helping to

produce a higher-quality final product than

produced by competitors.

3. Tactical cost analysis is the use of relevant

cost data to identify the alternative that pro-

vides the greatest benefit to the organiza-

tion. Steps 3–5 are the major components of

tactical cost analysis: Predicting costs, com-

paring relevant costs, and selecting the low-

est cost alternative (or alternative with the

greatest benefit).

4. Answers will vary. I (second author) have

used this as a writing assignment for several

years. It has been very successful; students

enjoy analyzing their own decisions, whether

it is buying a car, moving from the dorm into

an apartment, or getting a puppy. Some-

times, the application of the model leads to

new insights into their problems.

5. Relevant costs and revenues are future

costs and revenues that differ across alter-

natives. Depreciation on an existing asset

represents an allocation of a past cost. Past

costs are never relevant.

6. A future cost that is not relevant is a future

cost that does not differ across the alterna-

tives being considered. For example, rent on

a factory in a keep-or-drop decision is a fu-

ture cost, but it will be there whether one of

the factory’s products is dropped or kept.

7. No. Relevant costs are just part of the

overall tactical decision-making model.

Strategic effects and other qualitative factors

may affect the decision. The effect may be

such that a higher-cost alternative may be

chosen.

8. Yes, direct materials can be irrelevant. In a

make-or-buy decision, any direct materials

already in inventory are irrelevant. In a

make-or-buy decision, the salary of the

production supervisor would be fixed but

relevant to the decision. Leasing equipment

is relevant if it is a future cost that differs

across alternatives. In most cases, this

would not be a factor because it entails the

acquisition of multiperiod capacity and really

belongs to the capital expenditure decision

domain.

9. The only role of past costs is predictive.

They can be used to help predict future

costs.

10. Flexible resources are relevant whenever

the demand for an activity changes across

alternatives. Resource spending will differ

across alternatives, making the cost of the

activity relevant.

11. Typically, committed resources acquired

through implicit contracting are acquired in

lumpy amounts and are not formal commit-

ments. Thus, if changes in demand across

alternatives produce a change in resource

supply, then resource spending will also

change, making the cost relevant. Usually,

the cost of committed resources is a sunk

cost (since they are acquired in advance).

Reductions in demand typically do not lead

to reductions in resource spending. Increas-

es in demand beyond the activity capacity

usually mean a major resource expendi-

ture—a decision that is outside the domain

of tactical decision making and more in the

domain of strategic analysis.

12. A functional-based make-or-buy analysis

focuses on unit-level activities and directly

attributable fixed cost and assumes that the

costs of all other non-unit-level activities are

irrelevant. An activity-based analysis

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exploits activity cost behavior to identify

relevant costs.

13. Activity-based segmented reports trace

costs to segments using activity drivers and

provide a more accurate assessment of

profitability. Additionally, the use of the activ-

ity resource usage model allows a manager

to more fully assess the changes in resource

spending that will occur if a segment is

dropped.

14. Joint costs are present whether the product

is processed further or sold at split-off and

are not relevant.

15. If a firm has unused production capacity and

sufficient unused activity capacity, a one–

time special order may bring in more reve-

nues than the increase in resource spending

needed to fill the order. In this case, short-

term profits will increase.

CORNERSTONE EXERCISES

Cornerstone Exercise 17.1

1. The alternatives are to make the part in house or buy the part externally.

2. The relevant costs of making the part are: direct materials, direct labor, and

variable factory overhead. The relevant cost of buying the part is the purchase

price.

3. Make Buy Difference

Direct materials …………………… $ 14,040 $ 0 $ 14,040

Direct labor …………………………. 6,120 0 6,120

Variable overhead ……………….. 2,340 0 2,340

Purchase price ……………………. 0 24,840 (24,840)

Totals ……………………………… $ 22,500 $ 24,840 $ (2,340)

Because the fixed overhead is not relevant, the analysis shows a $2,340 ad-

vantage in favor of making the part in house.

4. Make Buy Difference

Direct materials …………………… $ 14,040 $ 0 $ 14,040

Direct labor …………………………. 6,120 0 6,120

Variable overhead ……………….. 2,340 0 2,340

Equipment rental …………………. 18,540 0 18,540

Purchase price ……………………. 0 24,840 (24,840)

Totals ……………………………… $ 41,040 $ 24,840 $ 16,200

Part of fixed overhead (equipment rental) is relevant; the analysis shows a

$16,200 advantage in favor of buying the part from the external supplier.

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Cornerstone Exercise 17.2

1. Model 1 Model 2 Model 3 Total

Sales …………………………. $ 246,000 $ 578,000 $ 634,600 $1,458,600

Less variable COGS ……. (93,500) (164,160) (348,000) (605,660)

Less commissions ……… (5,000) (28,000) (21,750) (54,750)

Contribution margin .. $ 147,500 $ 385,840 $ 264,850 $ 798,190

Less traceable

fixed expenses:

2. The reformulated income statement shows a loss for Model 1. Now the alter-

3. If only 175 hours of engineering time can be avoided, the amount traceable to

Model 1 is $5,250 ($30 × 175) and the remaining $18,750 is part of common

fixed overhead. Similarly, if only 5,000 setup hours can be avoided by elimi-

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Cornerstone Exercise 17.3

1. The two alternatives are to accept or reject the special order. The relevant ben-

efits and costs of accepting the order include: revenue, direct materials, direct

2. Differential

Amount

Accept Reject to Accept

Special order price ………….. $ 3.10 $0 $ 3.10

Direct materials ………………. (1.87) 0 (1.87)

Direct labor …………………….. (0.33) 0 (0.33)

3. Regular sales for 30,000 units ($6 × 30,000) …………………….. $180,000

Less commission (0.05 × $180,000) …………………………………. (9,000)

Sales minus commission ……………………………………………….. $171,000

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Cornerstone Exercise 17.4

1. The two alternatives are to sell the anderine at split-off or process it further

into cermine.

2. If the anderine is sold at split-off, the relevant benefit is the amount of sales

revenue. If the anderine is processed further, the relevant benefit is the sales

3. Differential

Sell at Process Amount to

Split-Off Further Process Further

Sales revenue …………… $66,000 $120,000 $54,000

4. Differential

Sell at Process Amount to

Split-Off Further Process Further

Sales revenue …………… $66,000 $ 120,000 $ 54,000

Added purchasinga …… 0 (2,400) (2,400)

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EXERCISES

Exercise 17.5

1. The money already spent on the LeBaron is not relevant. The purchase price

2. All future costs that differ across alternatives are relevant. The alternatives

facing Lee Anna are restoration and buying the CR-V. Thus, all costs of resto-

ration, the sales price of the LeBaron, and the purchase price of the CR-V are

Exercise 17.6

1. Flexible resources: Forms, postage, and other supplies

Committed resources: Clerks, PC system

2. Activity availability = Activity usage + Unused activity

4. a. Since demand changes for the flexible resources, the cost of supplies in-

creases by $530 ($1.06* × 500). For the committed resources, there is suf-

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Exercise 17.6 (Concluded)

4. b. If the special order requires 700 purchase orders, there is not sufficient

excess capacity to handle it. An additional clerk must be hired (at $25,750)

and an additional PC system must be obtained (annual cost of $1,100). The

Exercise 17.7

1. The flexible resources for the new tanning salon include: the supplies at $450

per month and the additional electricity at $100 per month. The use of each of

these resource categories will vary with the number of tanning visits. The

2. a. If Roxanne decides to add a third tanning bed, the only additional flexible

resource cost will be the additional use of supplies and electricity. The ad-

Exercise 17.8

1. The company should reject the offer as the additional revenue is less than the

additional costs (assuming fixed overhead is allocated and will not increase

with the special order):

Incremental revenue per pair ……….. $12.80

2. Now the company should accept the offer as the additional revenue is greater

than the additional costs (assuming fixed overhead is allocated and will not

increase with the special order):

Incremental revenue per pair ……….. $12.80

3. If the idle capacity is viewed as a temporary state, then accepting an order

Exercise 17.9

1. Make Buy

Direct materials ………….. $2,508,000 $ 0

Direct labor ………………… 539,000 0

2. Maximum price = $3,213,650/55,000 = $58.43

17–10

Exercise 17.10

1. Make Buy

Direct materials ………………. $104,000 $ 0

Direct labor…………………….. 42,900 0

2. Make Buy

Direct materials ………………. $104,000 $ 0

Direct labor…………………….. 42,900 0

Variable overhead …………… 11,700 0

3. In making this decision Brees should consider such qualitative factors as the

quality of the part, the reliability of the supplier, the effect of labor reductions

on employee morale, the possibility of price increases in the future, and the

effect on the overall strategic position of the firm. The strategic implications

4. The controller does have a point. Purchasing the part will affect a number of

other activities such as purchasing, receiving, and paying bills. If these activi-

Exercise 17.11

1. Income effect:

Revenues ($75 × 350) ………………. $ 26,250

Direct materials ($82 × 350) ……… (28,700)

2. The special order is so small that there is sufficient excess capacity for set-

3. New direct materials per unit = $82 – $13 = $69

Revenues ($75 × 350) …………………….. $ 26,250

Direct materials ($69 × 350) …………… (24,150)

Direct labor ($15 × 1 hour × 350) ……. (5,250)

The order is still unacceptable, but with a loss of $3,680 instead of $10,955.

4. The company may still accept the order. This is a charitable organization and

the company may have funds dedicated to making contributions.

Alternatively, perhaps the Marketing Department could work with Carly’s

17–12

Exercise 17.12

1. Traditional income statement:

Peanut Cashew

Butter Butter Total

Revenues………………………………… $ 5,000,000 $ 800,000 $ 5,800,000

Less variable expenses:

Direct materials …………………. (2,500,000) (480,000) (2,980,000)

Direct labor ……………………….. (500,000) (80,000) (580,000)

aOnly direct labor benefits and machine costs vary with direct labor hours. All

other overhead costs are fixed with respect to this driver.

Variable OH rate = (Direct labor benefits + Variable machine overhead)/DLH

= ($200,000 + $250,000)/(40,000 hours + 10,000 hours)

17–13

Exercise 17.12 (Concluded)

2. Activity-based statement:

Peanut Cashew

Butter Butter Total

Revenues ………………………………. $ 5,000,000 $ 800,000 $ 5,800,000

Less traceable expenses:

Advertising ……………………….. (200,000) (60,000) (260,000)

a(Direct materials + Direct labor + Variable overhead) as shown on the tradi-

tional income statement.

bFixed receiving rate = $200,000/(500 + 250 + 250) = $200/receiving order

Variable receiving rate = $22,500/750 = $30/receiving order

Receiving for Peanut line = ($200 × 500) + ($30 × 500) = $115,000

Exercise 17.13

1. Sales ……………………………… $181,800

2. Differential

Sell at Amount to

Split-Off Process Further* Process Further

Revenues……………………….. $9,800 $54,650 $44,850

Further processing cost …. 0 42,720 42,720

Exercise 17.14

1. Tariff savings = $16,780,000 × 0.08 × 0.055 = $73,832

By locating the warehouse in a foreign trade zone, Global Reach will not have

2. Carrying cost = $73,832 × [(9/12) × 0.06] = $3,322 (rounded)

3. New tariff savings = $16,780,000 × 0.07 × 0.13 = $152,698

17–15

Exercise 17.15

1. Annual cost:

If the outside accountant is hired:

Bookkeeping cost (12 × $25 × 8 hours per month) ………. $2,400

Quarterly tax compliance (4 × $75) ……………………………… 300

If Tina continues to do the financial work:

Hours of substitute labor for all months except April

= (11 months × 0.75) × (15 hours per month × $10) = $1,237.50

2. There are many qualitative factors to be considered. Does Tina enjoy the

bookkeeping and tax work? Would she prefer working more hours in the res-

taurant? Would the couple prefer that Tina spend more time taking care of

LJ? How accurate is the tax work? Could an accountant actually save money

by suggesting alternative tax strategies for them? How badly do they need

the extra storage that would be provided by the current office? How easy is it

to find additional part-time labor to cover for Tina while she is doing the fi-

nances? Any or all of these could turn the decision from keeping the financial

work in house to outsourcing it.