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SOLUTION
Requirement 1
Revenues from
selling as is
Requirement 2
Requirement 3
Costs
Sell
Process
Further
Difference
Expected revenue from selling 62,000 gallons at $6.30 each
$ 390,600
Expected revenue from selling 56,00 gallons at $9.00 each
$ 504,000
$ 113,400
Problems (Group B)
P25-27B Identifying relevant information and making pricing decisions
Learning Objectives 1, 2
2. $32,900
Summer Fun manufactures flotation vests in Tampa, Florida. Summer Fun’s contribution margin income
statement for the month ended December 31, 2016, contains the following data:
Suppose Overtown wishes to buy 4,700 vests from Summer Fun. Summer Fun will not incur any
variable selling and administrative expenses on the special order. The Summer Fun plant has enough
unused capacity to manufacture the additional vests. Overtown has offered $10 per vest, which is below
the normal sale price of $15.
Requirements
1. Identify each cost in the income statement as either relevant or irrelevant to Summer Fun’s decision.
2. Prepare a differential analysis to determine whether Summer Fun should accept this special sales
order.
3. Identify long-term factors Summer Fun should consider in deciding whether to accept the special
sales order.
SOLUTION
Requirement 1
Variable Costs:
Manufacturing
93,000
Relevant
Requirement 2
Expected increase in revenue
(4,700 vests × $10 per vest)
$ 47,000
Requirement 3
In addition to considering this special order’s increase on profits, Summer Fun managers should
consider whether the special order could affect regular sales in the long run. Will regular customers find
P25-28B Making pricing decisions
Learning Objective 2
4. $4.46 per unit
Plants Plus operates a commercial plant nursery, where it propagates plants for garden centers
throughout the region. Plants Plus has $4,950,000 in assets. Its yearly fixed costs are $650,000, and the
variable costs for the potting soil, container, label, seedling, and labor for each gallon-size plant total
$1.90. Plants Plus’s volume is currently 490,000 units. Competitors offer the same plants, at the same
quality, to garden centers for $4.25 each. Garden centers then mark them up to sell to the public for $7
to $10, depending on the type of plant.
Requirements
1. Plants Plus’s owners want to earn an 11% return on the company’s assets. What is Plants Plus’s
target full product cost?
2. Given Plants Plus’s current costs, will its owners be able to achieve their target profit?
3. Assume Plants Plus has identified ways to cut its variable costs to $1.75 per unit. What is its new
target fixed cost? Will this decrease in variable costs allow the company to achieve its target profit?
4. Plants Plus started an aggressive advertising campaign strategy to differentiate its plants from those
grown by other nurseries. Plants Plus does not expect volume to be affected, but it hopes to gain
more control over pricing. If Plants Plus has to spend $135,000 this year to advertise and its variable
costs continue to be $1.75 per unit, what will its cost-plus price be? Do you think Plants Plus will be
able to sell its plants to garden centers at the cost-plus price? Why or why not?
SOLUTION
Requirement 1
Revenue at market price
(490,000 units × $4.25 per unit)
$ 2,082,500
Requirement 2
Current variable costs
($1.90 per unit × 490,000 units)
$ 931,000
Requirement 3
Requirement 4
Current variable costs per unit
($1.75 per unit × 490,000 units)
$ 857,500
Plus: Fixed costs
($650,000 + $135,000 advertising)
785,000
P25-29B Making dropping a product decisions
Learning Objective 3
2b. $(42,000)
Members of the board of directors of Security Systems have received the following operating income
data for the year ended March 31, 2016:
Members of the board are surprised that the industrial systems product line is losing money. They
commission a study to determine whether the company should drop the line. Company accountants
estimate that dropping industrial systems will decrease fixed cost of goods sold by $84,000 and decrease
fixed selling and administrative expenses by $12,000.
Requirements
1. Prepare a differential analysis to show whether Security Systems should drop the industrial systems
product line.
2. Prepare contribution margin income statements to show Security Systems’s total operating income
under the two alternatives: (a) with the industrial systems line and (b) without the line. Compare the
difference between the two alternatives’ income numbers to your answer to Requirement 1.
3. What have you learned from this comparison in Requirement 2?
SOLUTION
Requirement 1
Expected decrease in revenue
$ (350,000)
Expected decrease in total variable costs ($34,000 + $62,000)
$ 96,000
Requirement 2
(a) with the Industrial Systems product line:
SECURITY SYSTEMS
Contribution Margin Income Statement
For the Year Ended March 31, 2014
Product Line
Total
Industrial
Systems
Household
Systems
Sales Revenue
$ 730,000
$ 350,000
$ 380,000
P25-29B, cont.
Requirement 2, cont.
(b) without the Industrial Systems product line:
SECURITY SYSTEMS
Contribution Margin Income Statement
For the Year Ended March 31, 2014
Household
Systems
Sales Revenue
$ 380,000
Variable Costs:
Manufacturing
48,000
Requirement 3
P25-30B Making product mix decisions
Learning Objective 3
2. CM, Deluxe $2,320
Brann, located in San Antonio, Texas, produces two lines of electric toothbrushes: deluxe and standard.
Because Brann can sell all the toothbrushes it can produce, the owners are expanding the plant. They are
deciding which product line to emphasize. To make this decision, they assemble the following data:
After expansion, the factory will have a production capacity of 4,800 machine hours per month. The
plant can manufacture either 50 standard electric toothbrushes or 40 deluxe electric toothbrushes per
machine hour.
Requirements
1. Identify the constraining factor for Brann.
2. Prepare an analysis to show which product line the company should emphasize.
SOLUTION
Requirement 1
Requirement 2
Deluxe
Toothbrush
Standard
Toothbrush
(2) Contribution margin per toothbrush
$ 58
$ 37
When facing a constraint concerning which products to emphasize, the decision rule is to emphasize the
P25-31B Making outsourcing decisions
Learning Objective 4
1. $(12,120)
Winter Sports manufactures snowboards. Its cost of making 2,100 bindings is as follows:
Suppose Lewis will sell bindings to Winter Sports for $15 each. Winter Sports would pay $2 per unit to
transport the bindings to its manufacturing plant, where it would add its own logo at a cost of $0.40 per
binding.
Requirements
1. Winter Sports’s accountants predict that purchasing the bindings from Lewis will enable the
company to avoid $2,100 of fixed overhead. Prepare an analysis to show whether Winter Sports
should make or buy the bindings.
2. The facilities freed by purchasing bindings from Lewis can be used to manufacture another product
that will contribute $3,100 to profit. Total fixed costs will be the same as if Winter Sports had
produced the bindings. Show which alternative makes the best use of Winter Sports’s facilities: (a)
make bindings, (b) buy bindings and leave facilities idle, or (c) buy bindings and make another
product.
SOLUTION
Requirement 1
Binding Costs
Make
Outsource
Difference
(Make – Outsource)
Variable costs:
Direct materials
$17,600
$ 17,600
Direct labor
2,600
2,600
Requirement 2
Outsource Binding
Binding Costs
Make
Facilities
Idle
Make New
Product
Variable costs:
Direct materials
$17,600
Direct labor
2,600
P25-32B Making sell or process further decisions
Learning Objective 4
3. $(42,970)
McKnight Petroleum has spent $207,000 to refine 64,000 gallons of petroleum distillate, which can be
sold for $6.20 per gallon. Alternatively, McKnight can process the distillate further and produce 53,000
gallons of cleaner fluid. The additional processing will cost $1.85 per gallon of distillate. The cleaner
fluid can be sold for $9.20 per gallon. To sell the cleaner fluid, McKnight must pay a sales commission
of $0.13 per gallon and a transportation charge of $0.16 per gallon.
Requirements
1. Diagram McKnight’s decision alternatives, using Exhibit 25-18 as a guide.
2. Identify the sunk cost. Is the sunk cost relevant to McKnight’s decision?
3. Should McKnight sell the petroleum distillate or process it into cleaner fluid? Show the expected net
revenue difference between the two alternatives.
SOLUTION
Requirement 1
Revenues from
selling as is
Requirement 2
Requirement 3
Costs
Sell
Process
Further
Difference
Expected revenue from selling 64,000 gallons at $6.20 each
$ 396,800
Continuing Problem
P25-33 Making sell or process further decisions
This problem continues the Daniels Consulting situation from Problem P24-28 of Chapter 24. Daniels
Consulting provides consulting services at an average price of $150 per hour and incurs variable costs of
$75 per hour. Assume average fixed costs are $5,250 a month.
Daniels has developed new software that will revolutionize billing for companies. Daniels has already
invested $300,000 in the software. It can market the software as is at $40,000 per client and expects to
sell to 12 clients. Daniels can develop the software further, adding integration to Microsoft products at
an additional development cost of $150,000. The additional development will allow Daniels to sell the
software for $49,000 each but to 16 clients.
Should Daniels sell the software as is or develop it further?
SOLUTION
Software Costs
Sell
Process
Further
Difference
Expected revenue from selling to 12 clients at $40,000 each
$ 480,000
Expected revenue from selling to 16 clients at $49,000 each
$ 784,000
$ 304,000
Critical Thinking
Ethical Issue 25-1
Mary Tan is the controller for Duck Associates, a property management company in Portland, Oregon.
Each year, Tan and payroll clerk Toby Stock meet with the external auditors about payroll accounting.
This year, the auditors suggest that Tan consider outsourcing Duck Associates’s payroll accounting to a
company specializing in payroll processing services. This would allow Tan and her staff to focus on
their primary responsibility: accounting for the properties under management. At present, payroll
requires 1.5 employee positions—payroll clerk Toby Stock and a bookkeeper who spends half her time
entering payroll data in the system.
Tan considers this suggestion, and she lists the following items relating to outsourcing payroll
accounting:
a. The current payroll software that was purchased for $4,000 three years ago would not be needed if
payroll processing were outsourced.
b. Duck Associates’s bookkeeper would spend half her time preparing the weekly payroll input form
that is given to the payroll processing service. She is paid $450 per week.
c. Duck Associates would no longer need payroll clerk Toby Stock, whose annual salary is $42,000.
d. The payroll processing service would charge $2,000 per month.
Requirements
1. Would outsourcing the payroll function increase or decrease Duck Associates’s operating income?
2. Tan believes that outsourcing payroll would simplify her job, but she does not like the prospect of
having to lay off Stock, who has become a close personal friend. She does not believe there is
another position available for Stock at his current salary. Can you think of other factors that might
support keeping Stock, rather than outsourcing payroll processing? How should each of the factors
affect Tan’s decision if she wants to do what is best for Duck Associates and act ethically?
SOLUTION
Requirement 1
Payroll Costs
In-house
Outsource
Difference
(Make – Outsource)
Fixed costs
$ 3,500
$ 3,500
Requirement 2
Quality is very important in business decisions. Tan’s belief that outsourcing would simplify her job is
additional support for outsourcing, if she uses the additional time to focus on her primary
responsibilities, rather than simply doing less.
Team Project 25-1
Ledfords is a chain of home improvement stores. Suppose Ledfords is trying to decide whether to
produce its own line of Formica countertops, cabinets, and picnic tables. Assume Ledford would incur
the following unit costs in producing its own product lines:
Rather than making these products, assume that Ledfords could buy them from outside suppliers.
Suppliers would charge Ledfords $40 per countertop, $25 per cabinet, and $65 per picnic table. Whether
Ledfords makes or buys these products, assume that the company expects the following annual sales:
• Countertops—487,200 at $130 each
• Cabinets—150,000 at $75 each
• Picnic tables—100,000 at $225 each
Assume that Ledfords has a production facility with excess capacity that could be used to produce
these products with no additional fixed costs. If making is sufficiently more profitable than outsourcing,
Ledfords will start production of the new line of products. The president of Ledfords has asked your
consulting group for a recommendation.
Requirements
1. Are the following items relevant or irrelevant in Ledfords’s decision to build a new plant that will
manufacture its own products?
a. The unit sales prices of the countertops, cabinets, and picnic tables (the sales prices that Ledfords
charges its customers)
b. The prices outside suppliers would charge Ledfords for the three products if Ledfords decides to
outsource the products rather than make them
c. The direct materials, direct labor, and variable overhead Ledfords would incur to manufacture
the three product lines
d. The president’s salary
2. Determine whether Ledfords should make or outsource the countertops, cabinets, and picnic tables.
In other words, what is the annual difference in operating income if Ledfords decides to make rather
than outsource each of these three products?
3. Write a memo giving your recommendation to Ledfords’s president. The memo should clearly state
your recommendation, along with a brief summary of the reasons for your recommendation.
SOLUTION
Requirement 1
(a)
irrelevant
Requirement 2
Countertop Costs
Make
Outsource
Difference
(Make – Outsource)
Variable costs:
Direct materials
$ 15
$ 15
Cabinet Costs
Make
Outsource
Difference
(Make – Outsource)
Variable costs:
Direct materials
$ 10
$ 10
Direct labor
5
5
Picnic Table Costs
Make
Outsource
Difference
(Make – Outsource)
Variable costs:
Direct materials
$ 25
$ 25
Direct labor
15
15
Team Project 25-1, cont.
Requirement 2, cont.
Total savings by making the products:
Countertops
$ 4,872,000
Cabinets
1,200,000
Requirement 3
TO: President of Ledford
FROM: Team member’s names
