CHAPTER 21
INCREMENTAL ANALYSIS
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-
5
Analysis, 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-
5
Analysis, 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
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 McFriendly 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.
6.
8.
When thinking about outsourcing the production of a part, Harley-Davidson Motorcycle
Incremental costs, defined as the difference in costs between alternative courses of action and
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
cannot be changed no matter what course of action is taken and are irrelevant for purposes of
Costs incurred up to the split-off point are sunk costs. These costs will be incurred regardless of
9.
10.
11.
12.
13.
14.
15.
Complementary products are two or more products for which sales of one product contributes to
the sales of the other(s). When making decisions about individual products, it is important to
When opportunity costs are ignored in a make or buy decision, the resulting decision might be
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
Sunk costs represent cash flows that have already occurred. No cash flow effects are associated
The contribution margin is important in incremental decision making because the contribution
SOLUTIONS TO BRIEF EXERCISES
B. Ex. 21.1
B. Ex. 21.2
B. Ex. 21.3
B. Ex. 21.4
B. Ex. 21.5
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
The incremental cost of a fishing reel is $16 ($10 + $6). Thus, it is more expensive
The total sales value of the joint products is $1,560,000 ($468,000 + $1,092,000).
The opportunity cost to choosing to go to the game instead of sell the ticket is $50.
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 $1,800,000 costs incurred to-date are sunk costs. The $600,000 costs to
rebuild are out-of-pocket and incremental costs. The $750,000 potential sales
SOLUTIONS TO EXERCISES
Ex. 21.1 a.
Ex. 21.2
Ex. 21.3 a.
Incremental cost per unit (from part b) ……………………………………………
50$
Incremental analysis
Average per-unit manufacturing cost at 60,000 units per month:
Variable cost per unit ($25 + $20 + $5) …………………………………………
Incremental out-of-pocket costs associated with Home Depot’s decision to close stores
include the costs of materials, labor, and overhead associated with the actual closing
process.
Sunk cost
Relevant information
Opportunity cost
Joint products
Out-of-pocket cost
b.
Ex. 21.4
Ex. 21.5
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.
Monthly operating profit when distributing the normal 30,000 crates can be
In this case, Poppycrock is operating at full capacity. It has a production
c.
Normal crates: incremental costs are all variable costs including direct labor,
a.
Ex. 21.6
Make the Buy the Incremental
Part Part Analysis
$ 75,000 $ 75,000
Ex. 21.7
Ex. 21.8
Ex. 21.5
With the special order, monthly profits would be:
Incremental cost to buy: ($5 × 6,000 units) = $30,000.
It is more costly for Bacrometer to continue to make part no. 566.
The company should rework the defective units for $40,000 and sell them for $9 per
unit, rather than sell them as scrap at $6 per unit. Doing so will result in a $5,000
Compare the incremental cost to make with the incremental cost to buy.
Remember the incremental cost to make includes the opportunity cost of the
foregone rent revenue.
The company should continue to manufacture the part rather than buying it from
the outside supplier. The supporting schedule follows:
Manufacturing costs:
Variable ……………………….
Ex. 21.8
Ex. 21.9
Android Bio-Mutant Cyclops
$ 100 $ 60 $ 125
48 24 60
9 8 16
7 4 9
$ 36 $ 24 $ 40
4 2 5
Direct materials …………………
Variable overhead ……………….
Contribution margin per unit …..
With 1,000 direct labor hours available, the company can produce a total of 500 Bio-
Ex. 21.10 a.
Incremental cost of further processing …..
Direct labor ……………………..
Although reworking these units will contribute $5,000 to profitability, doing so will not
To maximize its total contribution margin, the company should produce and sell the
product with the highest contribution margin per direct labor hour. As shown below,
this product is Bio-Mutant.
Selling price ……………………..
It is $100 more profitable to sell Amoxiphore at the split-off point than it is to
Ex. 21.10
(continued)
b.
Ex. 21.11 a.
Molecue: $22 × 3,000 = $ 66,000
Borphue: $15 × 10,000 = 150,000
d.
Sunk costs related to the decision to process Polygard further are the costs
of the joint process.
The profitability of the entire joint process can be determined as follows:
The primary nonfinancial issue in this problem is an ethical consideration.
If Amoxiphore is sold at the split-off point, users of the drug suffer from
Revenues:
Ex. 21.12 a.
Special
Sale
$ 20
$ 6
b.
Special
$ 32
Selling price ………………………………………
Ex. 21.13
$ 1,584,000
$ 720,000
288,000
18,000 $ 1,602,000
Direct labor
Direct materials
Cost of rented space per year …………………
At a current operating level of 100,000 units, the company will not have to turn
away any of its regular customers in order to fill the special order. If it wishes to
increase operating income by $2 per unit included in the special order, it only
needs to generate a contribution margin per unit of $2. Thus, the selling price
per unit included in the special order is $20, as shown below:
Selling price ………………………………………
Less: Direct Materials ………………………..
In order for the company to increase its operating income $60,000 above what it
would be without the order, the contribution margin per unit included with the
Estimated decrease in operating income:
(12,000 units × 12 mo. × $11) …………………
Incremental costs:
Incremental revenue
Ex. 21.14
a.
Life Vests Tow Ropes Water Skis
Selling price 58$ 25$ 175$
Direct labor 20 10 80
Direct materials 12 3 75
b.
Ex. 21.15
To maximize operating income, the company should produce those products that provide
the greatest contribution margin per unit of scarce resource (direct labor hours). Thus, as
The least profitable product (skis) may, to a limited extent, create a demand for life vests
and ropes. However, due to the large number of vests and ropes the company anticipates
Home Depot’s management evaluates many relevant costs and revenues before
taking part in a particular Team Depot service project. For instance, they
probably consider any out-of-pocket wage expenses for employees who spend time
Direct labor hours per unit (direct labor cost
per unit ÷ $10 per hour) 2 1 8
Contribution margin per direct labor hour 10$ 10$ 2$
Total hours required to meet demand of
SOLUTIONS TO PROBLEMS SET A
PROBLEM 21.1A
D. LAWRANCE
a.
$ 800,000
b.
(4)
Accepting the special order will place D. Lawrance’s scheduled production (50,000)
very close to capacity (55,000). Therefore, if the regular jackets sell better than
Relevant considerations other than expected effect on operating income may include:
(1)
Discount Apparel may sell the jackets to customers who otherwise would buy regular
25 Minutes, Easy
Effect of accepting the special order:
Incremental revenue ($80 × 10,000 units) …………………
Variable manufacturing costs ($50 × 10,000 units) ……
a.
Make the Buy the Incremental
Motors Motors Analysis
Manufacturing costs for 12,000 motors:
96,000$ 96,000$
120,000 120,000
b. Effect of alternative use of factory space:
Incremental benefit of buying motors from an outside source (see part a)37,500$
Add: Contribution margin of alternative use of factory space
30 Minutes, Medium
Factory overhead:
PROBLEM 21.2A
EASY USE TOOL CO.
Based upon the above analysis, the company will save $37,500 if it buys the motors from an
outside source.
Direct materials
Direct labor
a.
Make the Buy the Incremental
Thermostats Thermostats Analysis
Manufacturing costs for 80,000 thermostats:
Direct materials 156,000$ 156,000$
b. Effect of alternative use of factory space:
Incremental benefit (cost) of buying thermostats from an outside source (82,000)$
(see part a)
and using factory space to produce additional heat-flow regulators 26,000$
Add: Contribution margin of alternative use of factory space
Introducing the alternative use of factory space changes the initial conclusion reached in part a.
30 Minutes, Medium
Based upon the above analysis, management will save $82,000 by continuing to manufacture
thermostats rather than buying them from an outside source.
PROBLEM 21.3A
PARSONS PLUMBING & HEATING
$6 per unit: 480,000 (480,000)