Solution manual accounting 25th edition warren chapter 25

CHAPTER 25
DIFFERENTIAL ANALYSIS, PRODUCT PRICING,
AND ACTIVITY-BASED COSTING
DISCUSSION QUESTIONS
1.

a.

Differential revenue is the amount of increase or decrease in revenue expected from a
particular course of action compared with an alternative.

b.

Differential cost is the amount of increase or decrease in cost expected from a particular
course of action compared with an alternative.

c.

Differential income is the difference between differential revenue and differential cost.

2.

The differential income and costs of the lease option should be compared against selling the building.
The differential revenue would be the lease revenue compared to the proceeds from sale. The
differential expenses would be the costs associated with leasing the building, including maintenance,
property tax, and insurance, compared to the expenses of selling, such as sales commissions. The
opportunity cost of money should also be considered in the analysis.

3.

If there is demand for the premium-grade product, the differential revenue (premium less commodity)

may exceed the differential cost to process the product to premium grade.

4.

A business should only accept business at a special price if the lower price will not contaminate the
regular pricing for other customers or induce other customers to demand the special price. In addition,
the business must be careful not to violate the Robinson-Patman Act, which prohibits uncompetitive
price differences across different markets for the same product. Lastly, the business must consider the
longer-term ramifications of offering discount business to a customer that may wish to order in the
future.

5.

It would be reasonable to purchase from the supplier if the fixed cost per unit was less than 50 cents.
That is, if the fixed cost is less than 50 cents per unit, then the variable cost per unit would exceed the
supplier’s price, making the supplier price more attractive.

6.

Some of the financial considerations include the profitability of the store, including all the revenues
and the variable and fixed costs associated with the store, since they would all be differential to the
decision. In addition, any costs of closing the store and preparing the store for disposal would need
to be considered (legal costs, demolition costs, employee severance costs). Lastly, the opportunity
cost of the value of the equipment and land (either in cash or rental income) should be considered.
For example, if the opportunity value of the assets were $500 per month, then the store would need to
have a profitability exceeding this amount to remain an attractive alternative.

7.

In the long run, the normal selling price must be set high enough to cover all costs (both fixed and

variable) and provide a reasonable amount for profit.

8.

In setting prices, managers should also consider such factors as the prices of competing products and
the general economic conditions of the marketplace.

25-1
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CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

DISCUSSION QUESTIONS (Continued)
9.

The target cost concept begins with a price that can be sustained in the marketplace, then
subtracts a target profit, thus determining the target cost. The cost is made to conform to the
price required in the market. In contrast, under cost plus, a markup is added to the cost. The
resulting price is assumed to be acceptable in the market.

10.

The proper measure of product value in a bottlenecked process is the contribution margin per
bottleneck hour.

11.

Activity-based costing should be used when a business has a combination of wide product
variety and complex production and support processes. In these circumstances, activity-based
costing will more accurately allocate factory overhead to products. This occurs because
factory overhead allocated by a single predetermined rate assumes all factory overhead is
associated with products using a single allocation base. In complex environments, however,
factory overhead may be associated with products according to how they consume activities.
Thus, multiple activity rates are needed to more closely capture how factory overhead is
actually used by products.


PRACTICE EXERCISES
PE 25–1A
Differential Analysis
Lease Machine (Alt. 1) or Sell Machine (Alt. 2)
January 12, 2014
Differential

Revenues
Costs

Lease

Sell

Effect

Machine
(Alternative 1)

Machine

(Alternative 2)

on Income
(Alternative 2)

$243,000
–16,900
$226,100

Income (Loss)

$231,000
–11,550 *
$219,450

–$12,000
5,350
–$ 6,650

* $231,000 × 5%
Jerrod Company should lease the machine.

PE 25–1B
Differential Analysis
Lease Equipment (Alt. 1) or Sell Equipment (Alt. 2)
March 23, 2014
Differential
Lease

Revenues

Costs
Income (Loss)

Sell

Effect

Equipment

Equipment

on Income

(Alternative 1)

(Alternative 2)

(Alternative 2)

$84,600
–7,950
$76,650

* $82,000 × 6%
Timberlake Company should sell the equipment.

$82,000
–4,920*
$77,080

–$2,600
3,030
$ 430


PE 25–2A
Differential Analysis
Continue Product S (Alt. 1) or Discontinue Product S (Alt. 2)
September 12, 2014
Continue
Product S
(Alternative 1)

Revenue
Costs:
Variable cost of goods sold
Variable selling and admin.
expenses
Fixed costs
Income (Loss)

$149,000

Discontinue
Product S
(Alternative 2)

$

Differential

Effect
on Income
(Alternative 2)

0

–$149,000

–88,500

0

88,500

–24,500
–40,000
–$ 4,000

0
–40,000
–$40,000

24,500
0
–$ 36,000

Product S should be continued.

PE 25–2B
Differential Analysis

Continue Product B (Alt. 1) or Discontinue Product B (Alt. 2)
May 9, 2014
Differential

Revenue
Costs:
Variable cost of goods sold
Variable selling and admin.
expenses
Fixed costs
Income (Loss)
Product B should be discontinued.

Continue

Discontinue

Effect

Product B
(Alternative 1)

Product B
(Alternative 2)

on Income
(Alternative 2)

$39,500

$

0

–$39,500

–25,500

0

25,500

–16,500
–15,000
–$17,500

0
–$15,000
–$15,000

16,500
0
$ 2,500


PE 25–3A
Differential Analysis
Make Bread (Alt. 1) or Buy Bread (Alt. 2)
August 16, 2014
Differential

Make Bread
(Alternative 1)

Unit costs:
Purchase price
Delivery
Variable costs ($152 – $39)
Fixed factory overhead
Income (Loss)

Buy Bread
(Alternative 2)

$

0
0
–113
–39
–$152

–$105
–12
0
–39
–$156

Effect
on Income

(Alternative 2)

–$105
–12
113
0
–$ 4

The company should make the bread.

PE 25–3B
Differential Analysis
Make Bottles (Alt. 1) or Buy Bottles (Alt. 2)
March 30, 2014
Differential

Unit costs:
Purchase price
Freight
Variable costs ($67 – $22)
Fixed factory overhead
Income (Loss)
The company should buy the bottles.

Make

Buy

Effect

Bottles
(Alternative 1)

Bottles
(Alternative 2)

on Income
(Alternative 2)

$ 0
0
–45
–22
–$67

–$35
–5
0
–22
–$62

–$35
–5
45
0
$ 5


PE 25–4A
Differential Analysis

Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2)
February 18, 2014
Continue with

Replace

Differential

Old Machine
(Alternative 1)

Old
Machine
(Alternative 2)

Effect
on Income
(Alternative 2)

$ 98,000

$ 98,000

–155,000
–348,0002
–$405,000

–155,000
60,000
$ 3,000

Revenues:
Proceeds from sale of old machine
Costs:
Purchase price
Direct labor (6 years)
Income (Loss)
1
2

$

0

0
–408,0001
–$408,000

$68,000 × 6 years
$58,000 × 6 years

The company should replace the old machine.

PE 25–4B
Differential Analysis
Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2)
April 11, 2014
Continue
with Old
Machine

(Alternative 1)

Revenues:
Proceeds from sale of old machine
Costs:
Purchase price
Direct labor (5 years)
Income (Loss)
1
2

$

0

0
–56,0001
–$56,000

$11,200 × 5 years
$7,400 × 5 years

The company should continue with the old machine.

Replace
Old
Machine
(Alternative 2)

Differential

Effect
on Income
(Alternative 2)

$50,500

$50,500

–75,000
–37,0002
–$61,500

–75,000
19,000
–$ 5,500


PE 25–5A
Differential Analysis
Sell Product T (Alt. 1) or Process Further into Product U (Alt. 2)
August 2, 2014
Sell Product T
(Alternative 1)

Revenues, per unit
Costs, per unit
Income (Loss), per unit

Process

Differential

Further into
Product U
(Alternative 2)

Effect
on Income
(Alternative 2)

$4.65
–3.90
$0.75

$5.30
–4.48 *
$0.82

$0.65
–0.58
$0.07

* $3.90 + $0.58
The company should process further into Product U.

PE 25–5B
Differential Analysis
Sell Product D (Alt. 1) or Process Further into Product E (Alt. 2)
February 26, 2014
Process

Revenues, per unit
Costs, per unit
Income (Loss), per unit

Differential

Sell

Further into

Effect

Product D
(Alternative 1)

Product E
(Alternative 2)

on Income
(Alternative 2)

$36
–24
$12

* $24 + $9
The company should sell Product D without further processing.

$43

–33*
$10

$7
–9
–$2


PE 25–6A
Differential Analysis
Reject Order (Alt. 1) or Accept Order (Alt. 2)
October 23, 2014
Differential

Reject Order
(Alternative 1)

Revenues, per unit
Costs:
Variable manufacturing costs, per unit
Export tariff, per unit
Income (Loss), per unit

Accept Order
(Alternative 2)

Effect
on Income
(Alternative 2)

$0.00

$39.00

$39.00

0.00
0.00
$0.00

–31.00
–9.75*
–$ 1.75

–31.00
–9.75
–$ 1.75

* $39.00 × 25%
The company should not accept the special order.

PE 25–6B
Differential Analysis
Reject Order (Alt. 1) or Accept Order (Alt. 2)
March 16, 2014
Differential

Revenues, per unit
Costs:
Variable manufacturing costs, per unit

Export tariff, per unit
Income (Loss), per unit
* $7.20 × 15%
The company should accept the special order.

Reject

Accept

Effect

Order
(Alternative 1)

Order
(Alternative 2)

on Income
(Alternative 2)

$0.00

$7.20

$7.20

0.00
0.00
$0.00

–5.00
–1.08 *
$1.12

–5.00
–1.08
$1.12


PE 25–7A
Markup percentage on product cost:

Markup percentage on product cost:

Desired Profit + Selling and Admin. Exp.
Total Product Cost
$55 + $26
$54*

= 150%

* $80 – $26

PE 25–7B
Markup percentage on product cost:

Markup percentage on product cost:

Desired Profit + Selling and Admin. Exp.
Total Product Cost

$58 + $70
$160*

= 80%

* $230 – $70

PE 25–8A
Unit contribution margin………………………………………………
÷ Testing hours per unit………………………………………………
Unit contribution margin per production bottleneck hour………

Product A

$24
4
$ 6

Product B

$30
6
$ 5

Product A is the most profitable in using bottleneck resources.

PE 25–8B
Unit contribution margin………………………………………………
÷ Furnace hours per unit………………………………………………
Unit contribution margin per production bottleneck hour………

Product L is the most profitable in using bottleneck resources.

Product K

$120
5
$ 24

Product L

$100
4
$ 25


CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

PE 25–9A
a.

Fabrication:
Assembly:
Setup:
Inspection:

$450,000 ÷ 2,000 direct labor hours = $225 per dlh
$210,000 ÷ 2,000 direct labor hours = $105 per dlh
$240,000 ÷ 160 setups = $1,500 per setup

$300,000 ÷ 800 inspections = $375 per inspection

b.

Speedboat

Bass Boat

ActivityActivity

Base
Usage

Fabrication
800 dlh
Assembly
1,200 dlh
Setup
60 setups
600 insp.
Inspection
Total
÷ Budgeted units to be produced
Factory overhead per unit

Activity×

Activity
Rate

$225
$105
$1,500
$375

/dlh
/dlh
/setup
/insp.

=

Activity
Cost

$180,000
126,000
90,000
225,000
$621,000
200
÷
$ 3,105

Base
Usage

1,200
800
100

200

dlh
dlh
setups
insp.

×

Activity
Rate

$225
$105
$1,500
$375

/dlh
/dlh
/setup
/insp.

25-10
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

=

Activity
Cost

$270,000
84,000
150,000
75,000
$579,000
200
÷
$ 2,895


PE 25–9B
a.

Cutting:
Sewing:
Setup:
Inspection:

$90,000 ÷ 1,500 direct labor hours = $60 per dlh
$22,500 ÷ 1,500 direct labor hours = $15 per dlh
$80,000 ÷ 1,000 setups = $80 per setup
$32,500 ÷ 500 inspections = $65 per inspection

b.

Jeans

Khakis

ActivityActivity

Base
Usage

Cutting
500 dlh
Sewing
1,000 dlh
Setup
250 setups
100 insp.
Inspection
Total
÷ Budgeted units to be produced
Factory overhead per unit

Activity×

Activity
Rate

$60
$15
$80
$65

/dlh
/dlh
/setup
/insp.

=

Activity
Cost

$30,000
15,000
20,000
6,500
$71,500
÷ 10,000
$ 7.15

Base
Usage

1,000
500
750
400

dlh
dlh
setups
insp.

×

Activity

Rate

$60
$15
$80
$65

/dlh
/dlh
/setup
/insp.

=

Activity
Cost

$ 60,000
7,500
60,000
26,000
$153,500
÷ 10,000
$ 15.35


CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

EXERCISES
Ex. 25–1
Differential Analysis
Lease Machinery (Alt. 1) or Sell Machinery (Alt. 2)
April 16, 2014

a.

Differential

Lease
Sell Machinery
Effect
on Income
Machinery
(Alternative 2)
(Alternative 1)
(Alternative 2)

Revenues
Costs

$255,000
–23,800
$231,200

Income (Loss)

$244,000
–12,200 *

$231,800

–$11,000
11,600
$ 600

* $244,000 × 5%
b.

Sell the machinery. The net gain from selling is $600.

Ex. 25–2
Note to Instructors: This differential analysis is a “lease or buy ” decision, which is from
the user perspective. The “lease or sell ” decision is from the perspective of the
equipment owner. Thus, the analysis is similar to the text examples, but must be
set up from the user’s, rather than the owner’s, perspective.
Differential Analysis
Lease Equipment (Alt. 1) or Buy Equipment (Alt. 2)
August 4, 2014
Differential
Lease

Buy

Effect

Equipment

Equipment

on Income

(Alternative 1)

(Alternative 2)

(Alternative 2)

Costs:
Purchase price
Freight and installation
Repair and maintenance (4 years)
Lease (4 years)

$

0
0
0
–7,200 2
–$7,200

Income (Loss)
1
2

–$4,600
–590
1
–2,480

0
–$7,670

–$4,600
–590
–2,480
7,200
–$ 470

$620 × 4 years
$1,800 × 4 years

The company should lease the equipment.

25-12
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Ex. 25–3
Differential Analysis
Continue Star Cola (Alt. 1) or Discontinue Star Cola (Alt. 2)
January 21, 2014

a.

Continue Star

Cola
(Alternative 1)

Revenues

$290,000

Discontinue
Star Cola
(Alternative 2)

$

Differential
Effect
on Income
(Alternative 2)

0

–$290,000

0

131,750

0
–75,000

155,250

0

Costs:
1

Variable cost of goods sold

–131,750
2
–155,250
–75,000 3
–$ 72,000

Variable operating expenses
Fixed costs
Income (Loss)
1

2
3

b.

–$75,000

–$

3,000

(1 – 15%) × $155,000

(1 – 25%) × $207,000
(15% × $155,000) + (25% × $207,000)

Star Cola should be retained. As indicated by the differential analysis in part
(a), the income would decrease by $3,000 if the product is discontinued.

25-13
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Ex. 25–4
Differential Analysis
Continue Cups (Alt. 1) or Discontinue Cups (Alt. 2)
March 31, 2014

a.

Continue Cups
(Alternative 1)

Revenues
Costs:
Variable cost of goods sold
Variable selling and admin.
expenses
Fixed costs
Income (Loss)
1

2

3

b.

$31,300
–14,280

Discontinue
Cups
(Alternative 2)

$

Differential
Effect
on Income
(Alternative 2)

0

–$31,300

1

0

14,280

2

0
–9,200
–$9,200

10,020
0
–$ 7,000

–10,020
3
–9,200
–$ 2,200

$16,800 × (1 – 15%)
$16,700 × (1 – 40%)
($16,800 × 15%) + ($16,700 × 40%)

The Cups line should be retained. As indicated by the differential analysis in part (a),
the income will decrease by $7,000 if the Cups line is discontinued.


Ex. 25–5
Note to Instructors: Many students may be unfamiliar with the financial services
industry. This exercise provides an opportunity to introduce students to some
basic terms and concepts used within the industry.
a.

The “Investor Services” segment serves the retail customer, you and me.
These are the brokerage, Internet, and mutual fund services used by individual
investors. The “Institutional Services” segment includes the same services

provided for financial institutions, such as banks, mutual fund managers,
insurance companies, and pension plan administrators.

b.

Variable costs in the “Investor Services” segment include:
1.

Commissions to brokers

2.

Fees paid to exchanges for executing trades

3.

Transaction fees incurred by Schwab mutual funds to purchase and sell
shares

4.

Advertising

Fixed costs in the “Investor Services” segment include:
1.

Depreciation on brokerage offices

2.

Depreciation on brokerage office equipment, such as computers and
computer networks

3.

Property taxes on brokerage offices

c.

Income from operations…………………………………………
Plus depreciation…………………………………………………
Estimated contribution margin…………………………………
d.

Investor

Institutional

Services

Services

(in millions)

(in millions)

$780
93

$443

52

$873

$495

If one assumes that the fixed costs that serve institutional investors (computers,
servers, and facilities) would not be sold but would be used by the other sector,
then the contribution margin of $495 million would be an estimate of the reduced
profitability. If the fixed assets were sold, then the operating income decline
would approach $443 million. Since the institutional and retail investors use
nearly the same assets, the $495 million answer is probably the better estimate.


Ex. 25–6
The flaw in the decision is the failure to focus on the differential revenues and
costs, which indicate that operating income would be reduced by $59,000 if
Children’s Shoes were discontinued. This differential income from sales of
Children’s Shoes can be determined from the following differential analysis:
Differential Analysis
Continue Children’s Shoes (Alt. 1) or Discontinue Children’s Shoes (Alt. 2)
Continue
Children’s
Shoes
(Alternative 1)

Revenues
Costs:
Variable cost of goods sold
Variable selling and admin. expenses

Fixed costs
Income (Loss)

$235,000
–130,000
–46,000
–76,000*
–$ 17,000

Discontinue
Children’s
Shoes
(Alternative 2)

$

Differential
Effect
on Income
(Alternative 2)

0

–$235,000

0
0
–76,000
–$76,000

130,000
46,000
0
–$ 59,000

*$41,000 + $35,000

Ex. 25–7 a.
Differential Analysis
Make Carrying Case (Alt. 1) or Buy Carrying Case (Alt. 2)
July 19, 2014

Costs:
Purchase price
Direct materials per unit
Direct labor per unit
Variable factory overhead per unit
Fixed factory overhead per unit
Income (Loss)
1
2

b.

Make

Buy

Differential

Carrying

Carrying

Effect

Case
(Alternative 1)

Case
(Alternative 2)

on Income
(Alternative 2)

$ 0.00
–30.00
–25.00
–3.75 1
–6.25 2
–$65.00

–$65.00
0.00
0.00
0.00
–6.25
–$71.25

–$65.00

30.00
25.00
3.75
0.00
–$ 6.25

$25.00 × 15%
$10.00 – $3.75

Assuming there were no better alternative uses for the spare capacity, it would
be advisable to manufacture the carrying cases because the cost savings would
be $6.25 per unit. Fixed factory overhead is irrelevant, since it will continue
whether the carrying cases are purchased or manufactured.


CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Ex. 25–8
Differential Analysis
Lay Out Pages Internally (Alt. 1) or Purchase Layout Services (Alt. 2)
February 22, 2014

a.

Revenues:
Salvage of computer equipment
Costs:
Purchase price of layout work

Salaries
Benefits
Supplies
Office expenses
Office depreciation
Computer depreciation
Income (Loss)

Lay Out

Purchase

Differential

Pages

Layout

Effect

Internally
(Alternative 1)

Services
(Alternative 2)

on Income
(Alternative 2)

$

0

0
–224,000
–36,000
–21,000
–39,000
–28,000
–24,000
–$372,000

$

9,000

–325,000*
0
0
0
0
–28,000
–24,000
–$368,000

$

9,000

–325,000

224,000
36,000
21,000
39,000
0
0
$ 4,000

* 25,000 pages × $13 per page
b.

The benefit from using an outside service is shown to be $4,000 greater than
performing the layout work internally. The fixed costs (depreciation
expenses) in the budget are irrelevant to the decision. Thus, the work should
be purchased from the outside on a strictly financial basis.

c.

Before electing to terminate the five employees, the guild should consider
the long-run impact of the decision. Specifically, future page layout rates
may grow faster than the cost of internal salaries, thus favoring the use of
employees over the long term. This would especially be the case if the
outside company provided a low bid in order to win the initial business. In
addition, the guild may wish to consider noneconomic factors, such as the
ability to more directly control the quality and timing of the layout work by
internal employees.


CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Ex. 25–9
Differential Analysis
Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2)
September 11, 2014

a.

Revenues:
Proceeds from sale of old
machine
Costs:
Purchase price
Variable production costs (8 years)
Income (Loss)
1
2

Continue

Replace

Differential

with Old

Old

Effect

Machine
(Alternative 1)

Machine
(Alternative 2)

on Income
(Alternative 2)

$

0

0
–1,336,0001
–$1,336,000

$

82,000

–528,000
–872,0002
–$1,318,000

$ 82,000
–528,000
464,000
$ 18,000

$167,000 × 8 years
$109,000 × 8 years

The company should replace the old machine.
b.

The sunk cost is the $250,000 book value ($600,000 cost less $350,000 accumulated
depreciation) of the present machine. The original cost and accumulated depreciation
were incurred in the past and are irrelevant to the decision to replace the machine.

25-18
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.


Ex. 25–10
a.

Differential Analysis
Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2)
May 4, 2014
Continue

Revenues:
Sales (5 years)*
Costs:
Purchase price
Direct materials (5 years)*
Direct labor (5 years)*
Power and maintenance (5 years)*

Taxes, insurance, etc. (5 years)*
Selling and admin. expenses
(5 years)*
Income (Loss)

Replace

Differential

with Old

Old

Effect

Machine
(Alternative 1)

Machine
(Alternative 2)

on Income
(Alternative 2)

$1,025,000

$1,025,000

0
–360,000

–255,000
–25,000
–7,500

–180,000
–360,000
0
–90,000
–20,000

–180,000
0
255,000
–65,000
–12,500

–225,000
$ 152,500

–225,000
$ 150,000

0
2,500

$

–$

* Each annual revenue and cost is multiplied by five years.

b.

The proposal should not be accepted.

c.

In addition to the factors given, consideration should be given to such factors
as: Do both present and proposed operations provide the same capacity?
What opportunity costs are associated with alternative uses of the $180,000
outlay required to purchase the automatic machine? Is the product improved
by using automatic machinery? Does the federal income tax have an effect on
the decision?

0


Ex. 25–11
Differential Analysis
Sell Rough Cut (Alt. 1) or Process Further into Finished Cut (Alt. 2)
June 14, 2014
Sell Rough
Cut
(Alternative 1)

Process

Differential

Further into
Finished Cut

(Alternative 2)

Effect
on Income
(Alternative 2)

Revenues, per 100 board ft.
Costs, per 100 board ft.

$586
–412

$755
–536

$169
–124

Income (Loss), per 100 board ft.

$174

$219

$ 45

Oakridge Lumber Company should process further and sell finished-cut lumber.

Ex. 25–12
a.

Differential Analysis
Sell Regular Columbian (Alt. 1) or Process Further into Decaf Columbian (Alt. 2)
October 6, 2014
Process

Revenues
Costs
Income (Loss)
1
2
3
4

b.

Sell

Further into

Differential

Regular
Columbian
(Alternative 1)

Decaf
Columbian
(Alternative 2)

Effect

on Income
(Alternative 2)

$55,320 1
–33,000 3
$22,320

$67,716 2
–43,230 4
$24,486

$12,396
–10,230
$ 2,166

$9.22 × 6,000 lbs.
$11.88 × (6,000 lbs. × 95%)
$5.50 × 6,000 lbs.
$33,000 + $10,230

The differential revenue from processing further to Decaf Columbian is more
than the differential cost of processing further by $2,166. Thus, Rise N’ Shine
Coffee Company should sell and process further to Decaf Columbian.


Ex. 25–12 (Concluded)
c.

The price of Decaf Columbian would need to decrease to $11.50 per pound
in order for the differential analysis to yield neither an advantage nor a

disadvantage (indifference). This is determined as follows:
Net Advantage of Further Processing
Volume of Decaf Columbian

=

$2,166

= $0.38 per lb.

5,700 lbs.

The price of Decaf Columbian would need to be $0.38 lower, or $11.50, to
yield no net differential income or loss. This is verified by the following
differential analysis:
Differential Analysis
Sell Regular Columbian (Alt. 1) or Process Further into Decaf Columbian (Alt. 2)
October 6, 2014
Sell Regular
Columbian
(Alternative 1)

Revenues
Costs
Income (Loss)
* $11.50 × (6,000 lbs. × 95%)

$55,320
–33,000
$22,320

Process
Further into
Decaf Columbian
(Alternative 2)

$65,550*
–43,230
$22,320

Differential
Effect
on Income
(Alternative 2)

$10,230
–10,230
$
0


Ex. 25–13
Differential Analysis
Reject Order (Alt. 1) or Accept Order (Alt. 2)
November 12, 2014
Differential

Revenues
Costs:
Variable manufacturing costs

Income (Loss)
1
2

Reject Order
(Alternative 1)

Accept Order
(Alternative 2)

Effect
on Income
(Alternative 2)

$0

$576,000

1

$576,000

0
$0

–522,000 2
$ 54,000

–522,000
$ 54,000

18,000 units × $32 per unit
18,000 units × $29 per unit

b.

The additional units can be sold for $32 each, and since unused capacity is
available, the only costs that would be added if this additional production were
accepted are the variable costs of $29 per unit. The differential revenue is
therefore $32 per unit, and the differential cost is $29 per unit. Thus, the net
gain is $3 per unit × 18,000 units, or $54,000.

c.

$29.01. Any selling price above $29 (variable costs per unit) will produce a
positive contribution margin.

Ex. 25–14
Total costs…………………………………………………………………………………
Less fixed costs…………………………………………………………………………
Total variable costs………………………………………………………………………

$375,000
112,500
$262,500

Variable cost per unit:
$262,500 ÷ 25,000 batteries = $10.50
The lowest bid should be sufficient to cover the variable cost of $10.50 per unit.

Ex. 25–15
Differential Analysis
Reject Order (Alt. 1) or Accept Order (Alt. 2)
January 21, 2014

a.

Differential
Reject

Accept

Effect

Order
(Alternative 1)

Order
(Alternative 2)

on Income
(Alternative 2)

Revenues
Costs:
Direct materials
Direct labor
Variable factory overhead
Variable selling and admin.

expenses
Shipping costs
Certification costs
Income (Loss)
1
2
3
4
5
6

$0

$1,840,000 1

$1,840,000

0
0
0

–760,000 2
–320,000 3
–288,000 4

–760,000
–320,000
–288,000

0

0
0
$0

–55,000 5
–130,000 6
–142,000
$ 145,000

–55,000
–130,000
–142,000
$ 145,000

20,000 tires × $92 per tire
20,000 tires × $38 per tire
20,000 tires × $16 per tire
20,000 tires × ($24 per tire × 60%)
20,000 tires × [($20 per tire × 45%) – ($125 × 5%)*]
20,000 tires × $6.50 per tire

* 5% × $125. The avoided sales commission should not be computed on the basis
of the $92 price to Euro Motors, but on the existing domestic sales price of $125.

Goodman should accept the special order from Euro Motors.
b.

$92 –

$145,000 = $92.00 – $7.25 = $84.75

20,000


Ex. 25–16
a.

Desired profit = $200,000 × 15% = $30,000

b.

Cost amount (product cost) per unit: $27,000 ÷ 800 units = $33.75

c.

d.

Desired Profit +
Total Selling and Administrative Expenses
Total Manufacturing Costs

Markup Percentage

=

Markup Percentage

=

Markup Percentage

= 200%

$30,000 + $24,000
$27,000

Cost amount (product cost) per unit……………………………………………… $ 33.75
Markup ($33.75 × 200%)……………………………………………………………… 67.50
Selling price…………………………………………………………………………… $101.25

Ex. 25–17
a.

Desired profit = $1,200,000 × 30% = $360,000

b.

Cost amount (product cost) per unit: $2,500,000* ÷ 10,000 units = $250
* ($215 manufacturing variable cost per unit × 10,000 units) + $350,000
manufacturing fixed cost

c.

d.

Desired Profit +
Total Selling and Administrative Expenses
Total Manufacturing Costs

Markup Percentage

=

Markup Percentage

=

$360,000 + $140,000 + ($25 × 10,000)
$2,500,000

Markup Percentage

=

$360,000 + $140,000 + $250,000
$2,500,000

Markup Percentage

=

Markup Percentage

= 30%

$750,000
$2,500,000

Cost amount per unit………………………………………………………………… $250
75
Markup ($250 × 30%)…………………………………………………………………

Selling price…………………………………………………………………………… $325


Ex. 25–18
a.

The price will be set at the estimated market price required to remain
competitive, or $28,000. Under the target cost concept, the market dictates
the price, not the markup on cost.

b.

The required profit margin of 20% of the estimated $28,000 price implies a
$22,400 target product cost as follows:
Target Product Cost = $28,000 – ($28,000 × 20%)
Target Product Cost = $28,000 – $5,600
Target Product Cost = $22,400
Since the estimated manufacturing cost of $23,200 exceeds the target cost
of $22,400, Toyota must reduce $800 from its total costs in order to
maintain competitive pricing within its profit objectives.
Note to Instructors: Target costing provides pressure to keep costs competitive.
The method assumes that the company may not be able to successfully add
a markup to its costs because the resulting price may be too high in the
marketplace. For example, merely adding the 25% markup on the $23,200
product cost would result in an uncompetitive price of $29,000. The target cost
concept moves backward by taking the price as given and then determining
the cost that is required for a given profit objective.