Solution manual cost accounting by LauderbachSHORT TERM DECISIONS AND ACCOUNTING INFORMATION
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CHAPTER 5
SHORTTERM DECISIONS AND ACCOUNTING INFORMATION
5
1 "Where Do You Start?"
The question emphasizes the need for decision makers to know the starting
place, the circumstances from which they begin. If a person already has a
car and is planning a trip to the vicinity of Monroe, the incremental costs
of giving a ride to the advertiser are for the extra mileage to go to that
specific town (e.g., tolls, additional gasoline, possibly an extra meal)
instead of going straight home. If a person has a car but isn't planning a
trip to the Monroe area, the incremental costs of giving a ride are the
incremental costs of the trip (all gasoline, tolls, meals, perhaps motels).
And if a person doesn't already have a car, the incremental costs of giving a
ride to the advertiser include the cost of buying a car and obtaining
insurance and a license, plus the costs listed in the two alternatives above.
Thus, the advertiser made a serious error in the wording of the offer.
Note to the Instructor: This question can be used to begin discussion
of decision making. After establishing the idea of incremental costs, you
can cover the concept of joint costs (and allocations thereof) by directing
attention to those costs that would not change with the extra passenger.
The question can be used to cover the same general concepts in an
executive development program by turning the situation into one of carpooling
rather than one of student ridesharing.
5
2 Unit Costs
The $52 is $1,800/50 plus $16. The $34 is $1,800/100 + $16.
The analysis is unsound because the incremental cost of playing a round
is $16. The $1,800 dues are sunk and should not affect decisions whether to
play an additional round. The dues, and a perround computation of cost, are
appropriate in deciding whether to continue as a member of the club or to
seek an alternative place to play golf. The average cost is irrelevant to
deciding whether to play a single round.
Note to the Instructor: So as not to lead students to consider the
duesperround calculations, we didn't ask whether the dues would ever be
relevant. If the person is deciding whether to remain a member of the club,
dues are relevant. The point to be made with this assignment is that whether
a cost is relevant depends on the particular decision to be made.
51
5
3 The Generous Management
Paper, printers' labor, and ink might be expected to be variable costs,
giving a total variable cost per paper of $1.20. The two other costs
mentioned, salaries for editorial employees and other operating expenses, are
likely to be composed of primarily fixed elements. From Chapter 2, it is
known that the perunit cost amounts for those two items must be based on
some particular level of output (quantity of papers produced). If there were
no other considerations, and if the perunit fixed costs were based on
current circulation quantities, it might be said that the subscriber was
getting the paper at less than total cost per unit. Were circulation higher
than at present, of course, the perunit cost would decrease.
The analysis in the newspaper's advertisement ignores the revenues
derived from advertisers. That is, the advertisement implies that the only
revenues available to cover the listed costs are the revenues from sales of
the paper. Advertising accounts for a substantial portion of total newspaper
revenues. Moreover, the cost per paper includes the costs of printing the
advertising in that paper. In effect, the situation is one of joint
revenues, and the costs of the newspaper are joint to the two types of
revenueproducing aspects of the paper, advertising and distribution and
sale. The management of the newspaper is not being generous at all. For
most newspapers, revenues from advertisers exceed revenues from subscribers.
5
4 Shortterm Pricing Policy
The airline would gain by accepting your offer because the incremental
profit from accepting is the entire $50 fare. But this is so only because
the carrier is committed to making the flight. The airline knows, however,
that a consequence of accepting your offer is that other potential passengers
would be encouraged to follow your example. The implications of large
numbers of customers following that example are many, and only a few are
listed here. For example, any stated rate structure becomes irrelevant as
potential passengers spurn reservation systems with the intention of
negotiating fares just before departure. Further, customer dissatisfaction
would increase because of delayed departures (while airline personnel
negotiated with passengers about rates) and because of late flight
cancellations or the inability to accommodate potential passengers who showed
up with the intention of negotiating their fares.
Note to the Instructor: Like question 51, this question makes the
point that a company is always in some position before it faces a decision.
The special order decisions discussed in this chapter assume the company has
already planned for the period, much as the airline has already committed to
make this flight. Just as a company considering a special order must
consider the effect of accepting the order on the actions of regular or
potential customers, the airline must evaluate the impact of accepting the
immediately profitable offer on the actions of its potential customers.
Another point that merits discussion is the timeperiod aspect of
committed fixed costs. Although the text usually identifies fixed costs with
a time period, that need not be the case. For example, an airline has some
costs that are fixed per period and some that are fixed per flight.
52
5
5 Economic and Qualitative Factors
The trustees are responsible for the church's property, reputation, and
finances, so many factors, monetary and nonmonetary, are relevant to their
decision. If their only objective in sponsoring the dances is to generate
revenue to offset costs of the facilities, incremental revenues and costs are
important. Monetary issues are far less important if the trustees are trying
to increase interest in the church among young people and/or to provide an
organized and supervised activity for youth. In either case, the trustees
must act responsibly with the church's money, but their decision should not
ignore the value of achieving nonmonetary objectives.
Revenues most relevant are admissions fees and perhaps receipts from
sales of snacks and beverages. Incremental costs include increases in
utilities during the additional hours the facility is open, cleaning
services, and costs related to the entertainment. Decorating costs are also
relevant. The church might engage a band, or a disk jockey. The church
might also use volunteers for cleaning or music.
The availability of adults for supervision and oversight is important
for success. If the church now has an active youth group, its members might
perform many of the required tasks. In all likelihood, dances will go much
better if the youth do much of the work.
56 Theory of Constraints
You must elevate the constraint by making sure that the person is helped
at all times and does not become a bottleneck. Whenever the person starts to
fall behind, others should help him until the flow is back to normal. You
must concentrate on keeping that person's flow up and not be concerned with
others, until their flows begin to constrain.
5
7 Special Order (5 minutes)
Accepting the order increases expected profit by $70,800, as shown below.
Additional contribution margin, 25,000 x ($14 $11) $75,000
Additional packing costs 4,200
Incremental profit on the order $70,800
You might ask students about the possibility of leakage of regular sales
that might accompany accepting the special order. You might also ask whether
the company should accept the order if profit were $3,000 or so. Some
students will say that any additional profit is good, but accepting business
with low margins is potentially troublesome. First, the numbers are
estimates. Unit variable manufacturing costs could turn out to be higher
than now expected. Second, ABC tells us that some indirect costs are likely
to rise if we increase activities. While such costs might not increase if we
accepted a single order, making acceptance a habit could well result in
significant increases in indirect costs. Finally, why bother turning out
more product for minimal increases in profit? If $3,000 or so is significant
to the company, then go ahead, but if not, why go through the effort
especially in view of the first two objections?
5
8 Joint Products (10 minutes)
53
Byxral and Frazinine should be processed further, and Dyzaline should be
sold at the splitoff point.
Byxral Dyzaline Frazinine
Selling price after processing $24 $18 $8
Selling price before processing 10 10 0
Incremental revenue from processing 14 8 8
Incremental cost of processing 10 12 2
Incremental profit (loss) from processing $ 4 ($4) $6
5
9 Joint Products (Extension of 5
8) (20 minutes)
1. Frazinine should be processed further; Byxral should now be sold at
splitoff, and Dyzaline should still be sold at splitoff. Analyzing
Dyzaline is unnecessary because if it was unwise to process Dyzaline further
when there were no fixed costs of such processing, such costs simply increase
the disadvantage of further processing. Below is an analysis for Byxral and
Frazinine.
Byxral
Frazinine
100gallon batches per period (120,000/100) 1,200 1,200
times gallons of product from each batch (given) 40 50
Gallons of product per period 48,000 60,000
Times, pergallon incremental contribution margin
from additional processing (from 58) $4 $6
Total incremental contribution margin from
additional processing $192,000 $360,000
Less, avoidable costs of further processing (given) 196,000 34,000
Incremental profit (loss) from further processing ( $4,000) $326,000
2. Total monthly profit is $808,000 as computed below.
Revenues:
Byxral, 48,000 x $10 $480,000
Dyzaline, 10 x 1,200 x $10 120,000
Frazinine, 60,000 x $8 480,000
Total revenues 1,080,000
Variable costs (costs of processing Frazinine, at
$2 per gallon for 60,000 gallons) 120,000
Contribution margin 960,000
Fixed costs:
Avoidable costs of further processing Frazinine $34,000
Unavoidable costs of all further processing
$50,000 + $60,000 + $8,000 118,000 152,000
Expected profit ignoring costs of joint process $808,000
5
10 Dropping a Segment (15 minutes)
1. $70,000. The company loses $40,000 contribution margin from hats
($90,000 $50,000) and saves nothing in fixed costs. An income statement,
in thousands, shows
54
Shirts Jeans Total
Sales $110 $350 $460
Variable costs 30 160 190
Contribution margin $ 80 $190 270
Fixed costs 200
Income $ 70
This income statement avoids the allocation of common fixed costs and so
presents the picture more clearly.
2. $95,000, the $70,000 from requirement 1 plus the $25,000 saved fixed
costs.
Note to the Instructor: You might wish to review the several reasons
why fixed costs could fall if a segment were eliminated. The text states
that the fixed costs are allocated to the segments and that they are
unavoidable. However, in requirement 2, we changed the conditions. As early
as Chapter 2 we pointed out that fixed costs are not fixed in the sense that
they cannot change in total. Rather, they are fixed in total within the
relevant range, and given the company's plans for discretionary spending.
Dropping the entire hat segment could put the company in a different relevant
range. For instance, if the company now has four employees whose work is
common to the three segments, dropping an entire segment might allow
restructuring duties so as to eliminate one person.
The situation in requirement 2 could also come about if some of the
allocated costs are in fact direct. The original productline income
statement could well have been prepared as described, with total fixed costs
allocated based on floor space even if some are direct and avoidable. This
case is more likely if the product lines are not so related as they are in
this assignment. For instance, an appliance dealer might decide to stop
selling washers and dryers, while still carrying television sets, stereos, CD
players, and other electronic products. At a minimum, such a retailer would
avoid the cost of separate listings in the Yellow Pages, possibly separate
advertisements in local newspapers, and maybe some costs of the service
department.
3. $68,000. From the $95,000 in requirement 2 we subtract $27,000 in
contribution margin lost from the other two lines.
Lost contribution margin from:
Shirts $80,000 x .10 $ 8,000
Jeans $190,000 x .10 19,000
Total lost contribution margin $27,000
Note to the Instructor: To expand the discussion, you might ask what
sorts of productline mixes would be most logical in requirement 2 and in
requirement 3. That is, what types would not have, or would have,
complementary effects, as illustrated in the chapter? Some students will
recall the substitution principle and will comment on that. The discussion
here should be openended and comments will reflect the perceptions of
individual students.
The important point is that students should get into the habit of being
alert when evaluating decisions that could include unintended effects. That
is, it's not farfetched that someone would advocate closing a department
without thinking of possible adverse effects on other departments.
55
5
11 Capacity Constraint (15 minutes)
1. Trekker because they have the highest contribution margin per unit.
2. Walkers are the most profitable product, producing $140 contribution
margin per hour, $28,000 contribution per month. The relative
profitabilities per machinehour and in total for the three products are as
follows:
Walker Runner Trekker
Contribution margin per unit $ 14 $ 18 $ 28
Number made in one hour* 10 6 4
Contribution margin per hour $ 140 $ 108 $ 112
Hours available 200 200 200
Total monthly contribution $28,000 $21,600 $22,400
* 60 minutes divided by machine time required
Note to the Instructor: Many students will determine the total
contribution for all products, as we did above. Students should be reminded
that knowing the total time available is not necessary for determining the
relative profitabilities. It is enough to know that there is some constraint
on capacity and that all output can be sold.
3. The selling price of Trekkers, the second most profitable product per
machine hour, must rise $7.00 (to $63.00) to be as profitable as Walkers.
Hourly contribution margin of Walkers $140.00
Divided by number of Trekkers per hour 4
Required unit contribution margin of Trekkers $ 35.00
Plus variable cost per Trekker 28.00
Required price $ 63.00
5
12 Make or Buy (5 minutes)
Fairbo should make the part. The variable costs to produce the part are
Materials $ 9.00
Direct labor 10.00
Variable overhead 9.00
Total variable cost per unit $28.00
Another approach is simply to subtract the $13.00 per unit cost of fixed
overhead from the $41.00 total cost per unit given in the problem. However
one arrives at the $28 per unit, it's clear that internal production cost of
$28 is $4 less than the $32 outside purchase cost. With a volume of 20,000
units, the total savings from making rather than purchasing the part is
$80,000.
5
13 Special Order (15 minutes)
1. HiFlight should accept the order. The company has enough capacity to
make the balls and the incremental revenue exceeds the incremental costs.
56
Revenue from sale (80,000 x $9) $720,000
Variable costs (80,000 x $ 6) 480,000
Incremental profit $240,000
2. The answer might or might not change. The factor to consider is whether
regular sales would be lost if people knew they could buy the balls at $16
instead of $21 per dozen. The maximum loss might be 80,000 dozen balls, the
number that the chain could sell. In that case, the company would lose
$400,000 by accepting the offer.
Decline in regular sales 80,000
Contribution margin per dozen, $14 $6 $ 8
Lost contribution margin $640,000
Gain from requirement 1 240,000
Loss $400,000
More simply, if the company lost the whole 80,000 dozen, it would have traded
sales at $14 for sales at $9, losing $5 per dozen.
The lost sales might even be greater if the availability of the product at a
lower price through the chain created ill will with regular customers.
Note to the Instructor: This early exercise raises the opportunity to
reinforce the importance of estimating the effects of special orders on sales
at regular prices. It can also be used to introduce the general idea of
determining the maximum number of regular sales that could be lost for the
order to be unacceptable. In this situation,
Gain from order $240,000
Divided by contribution margin per unit, regular sales $ 8
Allowable lost regular sales 30,000 dozen
514 TOC (15 minutes)
1. Sandy should produce 100 more units of product C.
Time to produce one unit = labor charge / labor rate
A: $2/$8 = .25 hours
B: $4/$8 = .5 hours
C: $8/$8 = 1 hour
Time used for current production:
A: .25 10,000 units = 2,500
B: .5 4,000 units = 2,000
C: 1 2,000 units = 2,000
Total time used 6,500
Time available is 7,000 total hours – 6,500 hours used = 500 hours
Contribution margins
A
Selling price
$20
Materials
(8)
Labor
(2)
Variable overhead
(2)
Variable selling
(3)
Contribution margin$ 5
B
$30
(7)
(4)
(4)
(3)
$12
C
$50
(10)
(8)
(8)
(5)
$19
Since time is not a constraint, profits will be maximized by choosing
57
the product with the highest contribution margin per unit.
2. 10,000 product A, 4,000 product B, and 1,500 product C
Since current demand will require 6,500 hours, time is a constraint. Sandy
should choose the products with the largest contribution margin per hour.
A: $5/.25 = $20 / hour
B: $12/.5 = $24 / hour
C: $19/1 = $19 / hour
Produce B first, followed in order by A and C
Available hours
Product B: 4,000 units .5 =
Remaining time
Product A: 10,000 units .25 =
Remaining time
Product C: 1,500 hours 1 = 1,500 units 1 =
6,000
2,000
4,000
2,500
1,500
1,500
0
5
15 Short
Term Decisions (1520 minutes)
1. $280, an increase of $20. The quickest way is to work with changes.
Increase in contribution margin of product A ($250 x 0.30) $75
Decrease in contribution margin of product B ($300 x 0.05) 15
Net increase in contribution margin $60
Less additional fixed costs 40
Increase in income $20
Using totals produces the same answer.
Product A Product B Total
Sales $585* $380 $965
Variable costs 260 95 355
Contribution margin $325 $285 610
Fixed costs ($290 + $40) 330
Income $280
* $450 x 1.30
**$400 x 0.95
The income statement doesn't show fixed costs for either product; it
shows them only in total. It is plausible to use the old allocated fixed
costs plus the $40 for product A, but that isn't necessary to find the new
income.
2. About 11.7% ($35/$300). The increase in income just from the change in
product A's sales is $35 ($75 increased contribution margin less $40
increased fixed costs). This increase divided by the $300 current
contribution margin of product A gives the allowable reduction.
58
3. $620
Contribution margin from product A $250
Increase in fixed costs 60
Required contribution margin from product C $310
Divided by contribution margin percentage for product C 50%
Equals required sales from product C $620
Using the totals,
Required income $260
Total fixed costs ($290 + $60) 350
Required contribution margin 610
Less contribution margin from product B 300
Contribution margin required from product C $310
Divided by contribution margin percentage 50%
Equals required sales from product C $620
5
16 ProductLine Emphasis (510 minutes)
1. Porter should concentrate on Local Area Connectors (LACs). Their
contribution margin is 70% ($3,780/$5,400) while Internet Connectors (ICs)
have a margin of 50% ($3,300/$6,600). Increasing sales of LACs by $1 million
increases contribution margin by $700 thousand while the loss of contribution
margin from the loss of $1 million sales of ICs is only $500 thousand.
LACs have a much lower percentage of product margin to sales than do
ICs, which might catch some students who struggle with cost behavior. The
lower total product margin is relevant for the next requirement .
2. Porter should drop LACs in favor of the new product. Although LACs have
a higher contribution margin percentage, their contribution to covering
common fixed costs is, because of its relatively high direct, avoidable fixed
costs, lower than that for ICs.
Note to the Instructor: This exercise reinforces the point that
different data are relevant for different decisions. In requirement 1,
neither type of fixed cost was relevant because there was no change in either
type as long as the company continued selling both products. In requirement
2, however, fixed costs become relevant because they will change (in this
case, be avoided altogether) if the entire product line were dropped.
517 Special Order for Service Firm (5 minutes)
So long as Burns and Cross cannot profitably employ the staff, there is
no incremental cost associated with the audit. The monthly salaries are
irrelevant because the firm will pay them regardless. The firm should accept
the offer. This situation is quite common for CPAs and some will even do
slacktime audits gratis for charitable or other notforprofit
organizations.
59
5
18 Joint Products (1520 minutes)
1. Sell M and O at splitoff. The company would probably find it better to
sell O at splitoff simply to avoid the extra work and the likely effects on
indirect costs of doing more work.
M N O P
Sales value, further processed $450 $140 $45 $20
Sales value, splitoff 120 40 35 0
Incremental revenue 330 100 10 20
Additional processing costs 360 70 10 15
Gain (loss) on added processing ($ 30) $ 30 $ 0 $ 5
2. $120
M N O P Total
Sales $120 $140 $35 $20 $315
Additional processing costs 0 70 0 15 85
Margin $120 $ 70 $35 $ 5 230
Joint costs 110
Profit $120
5
19 Dropping a Product
Complementary Effects (1520 minutes)
1. $280,000. The quickest analysis is (in thousands of dollars)
Lost contribution margin ($200)
Saved fixed costs 240
Gain from dropping lotion 40
Current income 240
Income if lotion dropped $280
Alternatively, working with the totals of the remaining products,
After
Shave Cream Total
Contribution margin $720 $560 $1,280
Avoidable fixed costs 300 140 440
Segment margin $420 $420 840
Joint fixed costs 560
Income $280
2. $80,000
Lost contribution margin:
Lotion ($200)
Blades (20% x $720) (144)
Cream (10% x $560) (56)
Total lost contribution margin ($400)
Saved fixed costs, lotion 240
Net loss from dropping lotion (160)
Current income 240
Income if lotion dropped $ 80
Note to the Instructor: This exercise illustrates the concept of
complementary effects. By themselves, lotion is unprofitable; but it should
be continued in the line because of its effects on the sales of the other
products.
520 TOC (1015 minutes)
510
1. Maple Grove should acquire the equipment.
Increased contribution margin, 40,000 x $8 $320,000
Increased costs
(140,000)
Increased profit
$180,000
2. Maple Grove should not acquire the equipment because it cannot sell the
additional output.
521 Quality Costs and TOC (15 minutes)
1. No, because the savings are about $21,000 ($30,000 x 70% reduction in
scrap), for an expenditure of $25,000.
2. Yes, because the increased contribution margin is about $42,000 ($60,000
x 70%).
This assignment gets to a fundamental difference between TOC and most other
approaches to continuous improvement. TOC pays attention to constraints,
virtually ignoring nonconstraining resources. Someone of the quality—is—
free school would probably opt to make the change even though it appeared not
to be costeffective because of the expectation of increased benefits other
than those indicated. Of course, it is also reasonable to extend the search
for scrapreducing steps that might be more effective.
5
22 Inventory Values (1520 minutes)
1. The relevant cost is $1,530, which is the $5.10 per pound selling price
times 300 pounds. Stout should accept the order.
Incremental revenue $2,600
Incremental costs $ 900
Opportunity cost of xyrex 1,530 2,430
Incremental profit $ 170
2. The relevant cost is now $1,830, which is the $6.10 replacement cost
times the 300 pounds, and Stout should not accept the order.
Incremental revenue $2,600
Incremental costs $ 900
Opportunity cost of xyrex 1,830 2,730
Incremental profit (loss) ($ 130)
The $7.50 per pound purchase price is irrelevant under either situation
because it is sunk.
Note to the Instructor: Though this exercise is straightforward and
emphasizes the idea of relevant costs, invariably some students have trouble
with it because they do not want to ignore the historical cost of the onhand
xyrex. You might wish to use the following comparison that includes the
historical cost in an analysis for requirement 1, where the choice is between
selling the xyrex and accepting the order:
Accept Order Reject Order
Revenue [$2,600, ($5.10 x 300)] $2,600 $1,530
511
Incremental cost $ 900
Cost of xyrex ($7.50 x 300) 2,250 3,150 2,250
Loss ($ 550) ($ 720)
The $170 difference is the incremental profit computed in requirement 1.
5
23 Make or Buy (1520 minutes)
1. No. Its income would fall by $30,000.
Make Buy
Purchase price $ 0 $310,000
Materials 40,000
Direct labor 90,000
Variable overhead 80,000
Avoidable fixed overhead 50,000
Foregone rent 20,000
Net cost $280,000 $310,000
The $20,000 rent, an opportunity cost, could be subtracted from the cost
of buying. The $180,000 total fixed overhead could be shown under the make
decision, with $130,000 ($180,000 $50,000) shown under the buy decision as
cost that the company would not avoid by buying. Any such manipulations
still show that the advantage to making is $30,000.
2. $2.80. To equalize the cost of making and buying we must make the buy
alternative cost $280,000, which requires a $2.80 price. Or, to equate the
choices, we must erase the $30,000 advantage of making. Over 100,000 units,
the advantage is $0.30 per unit. So a price of $2.80 equalizes costs.
3. 70,000 units, which we can determine in several ways. The variable cost
to make the part is $2.10, ($40,000 + $90,000 + $80,000)/100,000
Total cost to make = Total cost to buy
$3.10Q $20,000 = $2.10Q + $50,000
$1.00Q = $70,000
Q = 70,000
Note to the Instructor: This requirement allows you to focus on the
relevance of volume to makeorbuy decisions. If there are no avoidable
costs and no opportunity cost, volume has no effect on the decision because
all costs are variable. But if there are either avoidable fixed costs or
opportunity costs, volume matters. In general, the higher the expected
volume the more likely the company will make instead of buy.
Qualitative factors are also important, including the quality of the
purchased part, the reliability of the supplier in meeting scheduled delivery
dates, and whether the part is of sufficient importance that the company
should ensure its supply by making it. In addition, the company should
consider the future behavior of costs. (Will the supplier raise prices
faster than the firm's manufacturing costs will rise?)
512
524 Capacity Constraint (1015 minutes)
1. Gray should make Zs because they have the higher contribution margin per
minute of machine time. Total contribution margin making Zs is $384,000.
Q Z .
Contribution margin per unit, $11 $7, $18 $10 $4 $8.00
Divided by required minutes 2 2.50
Contribution margin per minute $2 $3.20
Minutes of production, 10 x 200 x 60 120,000
Total contribution margin $384,000
We could also calculate total contribution margin as follows.
Minutes available 120,000
Divided by 2.5 = number of Zs 48,000
Times $8 CM = total contribution margin $384,000
2. Gray should make 40,000 Zs and 10,000 Qs. It will earn $360,000
contribution margin doing so.
Annual capacity, minutes 120,000
Less minutes to make 40,000 Zs, 40,000 x 2.5 100,000
Available for Qs 20,000
Minutes per Q 2
Number of Qs that company can make 10,000
Contribution margin from Zs, 40,000 x $8 $320,000
Contribution margin from Qs, 10,000 x $4 40,000
Total contribution margin
$360,000
You might point out the obviousness of the company's producing as many
Zs as it can, then devoting the remaining available capacity to Qs. If the
company wants to make and sell 48,000 Zs, but cannot sell more than 40,000,
it certainly would want to make and sell all it could. The only question,
then, is how many Qs it can produce in the remaining time.
525 TOC and Quality (15 minutes)
1. $40,000, 2,000 motors at $20 per motor, $8 material plus $12 variable
costs in fabrication.
2. $64,000
Lost revenue, 2,000 x $42
$84,000
Less saved variable cost of assembly, 2,000 x $10 20,000
Lost monthly profit $64,000
513
Some students will see the point better using totals.
AsIs No Defectives
Sales, 18,000 x $42
20,000 x $42
Less variable costs:
Material costs, 20,000 x $8
Fabrication, 20,000 x $6
Assembly, 18,000 x $10, 20,000 x $10
Total variable costs
Contribution margin
$756,000
$840,000
$160,000 $160,000
120,000 120,000
180,000 200,000
$460,000 $480,000
$296,000 $360,000
The purpose of this assignment is to show how poor quality can create
bottlenecks.
5
26 Joint Products (15 minutes)
1. High Plains gains $20 thousand by processing the bones.
Incremental revenue from processing bones $50
Incremental cost of processing bones 30
Incremental profit from processing bones $20
2. High Plains should not accept the offer. The company is $80 thousand
better off tanning the hides itself.
Incremental revenue from hide sales $150
Incremental cost of tanning hides 40
Incremental profit from tanning hides $110
Offer price, equals splitoff value 30
Gain from tanning hides $ 80
3. The contribution from processing bones further is $20 thousand as
computed in requirement 1. High Plains must receive at least that from bone
sales to be no worse off.
5
27 Opportunity Cost Pricing (1015 minutes)
1. CDR, because the contribution margin per minute of machine time is
highest.
CDR CDRW DVD
Unit contribution margin $10 $15 $25
Divided by minutes needed 5 10 15
Equals contribution per minute $2.00 $1.50 $1.67
2. $26 for CDRW, $40 for DVD.
CDRW DVD
Minutes required 10 15
times $2 per minute = CM per unit $20 $30
Add variable cost 6 10
Price required $26 $40
Note to the Instructor: This simple problem illustrates the principle
stated in the title, that opportunity cost is relevant to making a pricing
decision. The opportunity cost of using a scarce resource is the gain from
its best (most profitable) alternative use. The best use here, making CDR,
514
yields $2 per minute, so the cost of using the resource is $2.
5
28 Comprehensive Review of Short
Term Decisions (2025 minutes)
1. $1,000,000 [($50 x 8,000) + ($120 x 3,000) + ($60 x 4,000)]
Note to the Instructor: In covering this requirement, it is important
to emphasize that perunit fixed (and total) costs and profit are valid only
at the volume used to calculate them. Few, if any, students have trouble
with
this requirement, but many fail to recognize that point and so err in the
subsequent requirements.
2. Profit will fall by $960,000.
Volume 4,000
Unit contribution margin ($600 $360) $240
Lost contribution margin and profit $960,000
3. Profit will increase by $80,000.
Increased contribution margin, sofas [(7,000 4,000) x $240] $720,000
Decreased contribution margin, chairs [8,000 x ($120 $40)] 640,000
Net gain $ 80,000
4. Profit will increase by $25,000.
Current cost (4,000 x $60) $240,000
New cost [$35,000 + ($45 x 4,000)] 215,000
Savings $ 25,000
5. Profit will increase by $85,000 [1,000 x ($245 $160)].
6. Profit will increase by $7,500.
Contribution margin on order (1,500 x $85) $127,500
Lost contribution margin (500 x $240) 120,000
Net gain $ 7,500
5
29 Using Per
Unit Data (1520 minutes)
1. Profit will increase by $8,000.
Contribution from special order [20,000 x ($8 $6)] $40,000
Contribution lost on regular sales [8,000 x ($10 $6)] 32,000
Net gain from special order $ 8,000
Note to the Instructor: To reinforce the use of sensitivity analysis in
making decisions, you might ask students how many units of regular sales
would have to be lost to make accepting the order a bad decision. The answer
is 10,000 units, the total contribution from the special order ($40,000)
divided by the normal contribution margin on sales ($4). The company has
nearly a 25% margin for error in its estimate of the potential loss in
volume.
2. Profit will increase by $10,000.
Total current cost (200,000 x $2.80) $560,000
Cost to make the part [(200,000 x $2.25) + $100,000] 550,000
Cost difference in favor of making the part $ 10,000
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3. $14. The simplest analysis involves recognizing that if variable cost
per unit, fixed costs, and profit are to remain the same, but volume is to be
cut in half, the selling price per unit must produce twice as much perunit
contribution margin. The current margin is $4 and the selling price $10, so
a price increase of $4 (to $14) will be needed.
A longer, less thoughtful approach deals with the actual totals for
profit, fixed costs, etc., as below.
Current (and future) fixed costs, known to be $3
per unit at a volume of 200,000 units $600,000
Desired profit (now $1 per unit at a volume of 200,000) 200,000
Required total contribution margin $800,000
Divided by no. of units to be sold 100,000
Equals required perunit contribution margin $ 8
Plus variable cost per unit, the same as currently 6
Required selling price $ 14
5
30 Just
in Time, Costs of Activities (20 minutes)
The memo should include a comparison of the costs under the old and new
methods, such as shown below.
Costs under old method
Variable costs for 22,000 units:
Materials ($2.90 x 22,000) $63,800
Labor ($2.80 x 22,000) 61,600
Overhead ($1.80 x 40% x 22,000) 15,840
Avoidable fixed costs:
Inspection 4,000
Production scheduling 2,500
Maintenance 3,600
Total $151,340
JIT costs
given
Materials $55,000
Labor 67,000
Overhead, incremental only 9,000
Total 131,000
Difference in costs $ 20,340
The memo should also include the following factors.
(1) Workers in a JIT environment take on additional responsibilities, so
some overhead costs, such as those enumerated in the problem, are
reduced.
(2) Because more costs are direct to products under JIT, products might
appear to be relatively more costly when compared with the manufacturing
costs identified as direct to product using conventional methods. The
increase in cost identified directly with products is, however, offset
by the decrease in total overhead costs viewed as indirect.
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5
31 Choosing a Product (1520 minutes)
1. Mashed is the best choice. Carrots are a resource in short supply, and
the contribution margin per processed pound of carrots is the highest for
mashed.
Sliced Mashed Pickled
Selling price per case $7.50 $6.00 $8.25
Variable processing cost per case 2.50 2.75 4.00
Processing margin per case $5.00 $3.25 $4.25
Pounds of raw carrots per case 5 2.5 5
Processing margin per pound $1.00 $1.30 $0.85
Including the cost of carrots yields the same answer.
Sliced Mashed Pickled
Processing margin per case, as above $5.00 $3.25 $4.25
Cost of carrots (lbs. x $0.25) 1.25 0.625 1.25
Net contribution $3.75 $2.625 $3.00
Pounds per case 5 2.5 5
Contribution per pound $0.75 $1.050 $0.60
An alternative is to use totals.
Sliced Mashed Pickled
Sales, 100,000 x $7.50, 200,000 x $6,
100,000 x $8.25 $750,000 $1,200,000 $825,000
Carrot cost (125,000) ( 125,000) (125,000)
Variable processing costs (250,000) ( 550,000) (400,000)
Contribution margin $375,000 $ 525,000 $300,000
2. $445,000
Sales [$6.00 x (500,000/2.5 = 200,000 cases)] $1,200,000
Variable processing costs ($2.75 x 200,000) $550,000
Carrots (500,000 x $0.25) 125,000
Fixed production costs 80,000 755,000
Profit $ 445,000
3. 3.85 pounds, suggesting that the managers hope is forlorn because the
reduction is extremely large. The simplest way to solve is to determine what
number of pounds would turn the $5.00 per case processing margin for sliced
carrots into the $1.30 per pound that mashed carrots earn. Thus,
$5.00 processing margin for sliced carrots divided by X lbs. = $1.30
X = 3.85 lbs.
4. The most obvious factor is that the quantity of the product the customer
buys is smaller, which could create problems if customers do not respond
favorably. The value of the purchase is less, so customers might go to other
brands. An ethical question is whether the company should take such a course
without disclosing the action to customers.
5
32 Product Pricing
Off
Peak Hours (2025 minutes)
The special luncheon price would be unprofitable to the restaurant, as
shown in the analysis below. The current incremental profit for the luncheon
hours is $280 while the new price would produce a loss during the period of
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$46, for a $326 disadvantage ($46 + $280).
Sales:
Pizza (250 x $5.00)
$1,250
Beverages*
($150/150) x 250
250
Total sales
1,500
Variable costs:
Pizza* [($450/150) x
110% x 300]
990
Beverages**
($60/$150) x 250
100
Total variable costs
1,090
Contribution margin
410
Avoidable fixed costs
$380 x 120%
456
Loss ($ 46)
* $1 per customer, from $150 prior sales to 150 customers
**$250 new expected sales times the variable cost ratio ($60/$150) for
beverages. Or, 250 customers is 1.67 times the 150 now served, so 1.67 x
$60 = $100.
The problem is that the contribution margin per customer falls
precipitously. Under the old arrangement, the average price was $6.80
($1,020/150) and the variable cost $3 ($450/150) for a $3.80 contribution
margin. Now the contribution margin on pizza is only $1.04 per customer.
Price
$5.00
Variable cost per pizza, $3 x 1.1 $3.30
Ratio of pizzas to customers, 300/250 1.20
Variable cost per customer 3.96
Contribution margin per customer from pizza $1.04
The increased volume of customers and of beverages is not enough to
make up the drop in contribution margin.
Note to the Instructor: You might ask the class what factors might
prompt the owner to accept the proposal even though it is unprofitable. One
possibility is the prospect of gaining business at other hours from the new
customers who patronize the business at lunch. That gain might more than
offset the loss from these customers at lunch.
Angelo might also consider trying to reduce costs on the special by not
allowing each customer to order any combination of the toppings. For
example, the luncheon special might be a buffet, with pizzas of particular
combinations of toppings. (A buffet might also reduce the need for parttime
help.)
5
33 Car Pool
BRelevant Costs (510 minutes)
1. The possibilities range from $2 per day, the cost of the alternative of
taking the bus, to about $0.56 per day, the incremental cost of the extra
four miles (4 x $.14).
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Variable costs ($1,350 + $450 + $300) $2,100
Miles 15,000
Variable cost per mile $ 0.14
Between the extremes fall the sharing of full cost, or of variable cost, for
14 miles (or even for 4 miles). Some plausible prices are:
* $.6533, based on a threeway sharing of the $1.96 total variable cost
(14 x $0.14)
* $0.98, a twoway share of total daily variable costs ($1.96/2) based on
the driver's not having to share variable cost
* $2.24, based on full cost of $0.48 per mile ($7,200/15,000) and a three
way share for 14 miles (14 x $0.48 = $6.72 per day)
Maintenance cost is more likely to be stepvariable than variable, which
introduces the question whether the extra miles will take the car to one of
the maintenance steps. Also, if the driver's time has a high opportunity
cost, doubtful in this case, the price should reflect the value of that time.
2. The $0.56 incremental cost. However, the driver would then not be
compensated for time and the aggravation of the extra four miles of traffic
per day. No single price might be considered perfectly fair. The colleague
might even feel that $2 or more per day is fair because the bus would not
pick him up and drop him off at home.
5
34 ProductLine Analysis for Service Firm (3035 minutes)
1. The firm should continue doing residential work. Dropping residential
work would lose the $10.0 thousand gross margin but not reduce the company
sustaining costs.
Office Public
Buildings Buildings Residences Total
Fee income
$69.0 $56.2 $28.8 $154.0
Cost of fees 26.4 30.6 18.8 75.8
Gross margin $42.6 $25.6 $10.0 78.2
Companysustaining costs
45.4
Profit
$32.8
2. It appears that the firm should concentrate on office buildings because
their gross margin percentage is highest of the three. This is a tentative
conclusion, but warranted given the information available.
5
35 Hours of Operation (1520 minutes)
1. The $591 is probably the result of dividing the year's total operating
expenses ($184,500) by 312 days (52 weeks x 6 days per week). The difference
between the $910 sales figure and the $591 is $319, which is approximately
35% of $910. And 35% is also the ratio of cost of sales to sales for the
year ($162,700/$464,900), so the gross margin is about 65%. Thus, the owner
probably thought that sales on the extra day would need to bring in
sufficient gross margin to cover what he computed as daily operating cost,
because the $910 is the approximate result of dividing $591 by 65%.
2. Using only the quantitative information available, it almost certainly
pays to stay open on Sunday, as the following calculation shows.
519
Sales $860
Cost of sales at 35% 301
Gross margin at 65% 559
Payroll cost 135
Profit $424
The above analysis assumes that all operating expenses are essentially fixed,
which might not be true. However, even if all the expenses other than
salaries, rent, and insurance were variable with the number of operating
days, Sunday operation appears to be profitable.
Utilities and "other" expenses ($12,500 + $27,200) $39,700
Divided by normal number of days (6 x 52 weeks) 312
Equals cost per operating day $127
The $424 profit shown above more than covers the $127 per operatingday cost
of utilities, etc. And, if such cost is actually variable with the number of
operating hours in the day, even the $127 overstates the costs for Sunday
opening, since the perday cost covers 12hour days, while the store is
expected to be open only six hours on Sunday. This conclusion rests on the
premise that Sunday sales would not otherwise be made, i.e., that the Sunday
sales are incremental.
3. Some items the memo might include are listed below.
(a) Data about the pattern of sales throughout the week are important,
because the owner will want to know whether the Sunday hours produce an
increase in total sales. That is, staying open on Sundays might be wise if
total revenue increases but unwise if it simply shifts sales from other days
of the week. The public as a whole is not likely to buy a lot more
sationaery items just because of the opportunity to shop on Sunday. However,
the Sunday hours might attract some customers who have been going to other
stores during the week but would prefer to shop on Sunday.
(b) Information about the behavior of the individual operating costs is
important to the final decision. The owner will need to know which, if any,
of the operating expenses are variable. (This matter is covered to some
extent in the answer to requirement 2.) For example, the lease agreement
might include a percentagerental provision, and the cost of public liability
insurance might relate in part to the number of operating hours or days.
(c) Details of the payroll costs for the Sunday operation should be reviewed
to assure that the full amount of such costs was considered in the
preliminary analysis. For example, that analysis might not have included
such things as payroll taxes and other wagerelated expenses.
5
36 Special Order
Alternative Volumes (2025 minutes)
1. Yes, because income increases by $67,500.
Additional revenue (15,000 x $14) $210,000
Additional costs:
Variable manufacturing costs at $9/unit* $135,000
License fee at $0.50 7,500 142,500
Increase in income $ 67,500
* Total variable manufacturing costs of $2,070,000 ($2,760,000
$690,000) divided by 230,000 units.
520
Alternatively, contribution margin on the special order is $4.50 per unit
($14 $9.00 $0.50), so the increase in profit is 15,000 x $4.50 = $67,500
2. Income will increase by $46,000; contribution margin on regular sales is
$6.70 per unit. Total income will be $621,000 ($575,000 + $46,000).
Selling price ($4,140,000/230,000) $18.00
Variable costs:
Manufacturing $9.00
License fee 0.50
Commission at 10% 1.80 11.30
Contribution margin $ 6.70
Additional contribution marginspecial order ($4.50 x 40,000) $180,000
Lost contribution margin on regular sales (20,000 x $6.70) 134,000
Increase in contribution margin and profit $ 46,000
3. $9.50, the perunit variable cost.
4. About 26,866 shirts
Contribution margin on order (above) $180,000
Divided by contribution margin on regular sales $6.70
Volume to be lost to make order breakeven 26,866
rounded
This calculation is valuable when people might buy from the chain
instead of from the company. (The assignment states that the chain deals in
areas where Wilderness Products does not.) The 26,866 is a figure that the
managers can examine and decide whether the risk is worthwhile. Managers
might be reluctant to place a figure on the lost sales through leakage but
would probably be willing to state the likelihood of a derived figure.
Note to the Instructor: Although the text covers very early the idea
that average total cost is not a useful number for decision making, the point
is important enough to warrant mention again, especially since the problem
specifically refers to the average cost per unit. To emphasize that
comparing average total cost and price is not useful when one is dealing with
special
orders, you may wish to compute an average unit cost if the special order is
accepted under the situation presented in requirement 1. The average cost is
Total costs at 230,000 units ($2,760,000 + $805,000) $3,565,000
Incremental costs of special order (requirement 1) 142,500
Total costs for 245,000 units $3,707,500
Average cost ($3,707,500/245,000 units) $15.1327
The $14 selling price for the special order is still less than the
average total cost, yet requirement 1 shows that the company will show an
increase in profit if the special order is accepted.
5
37 Make or Buy (3040 minutes)
1.
Buying is the better alternative, costing $522,000 (36,000 x $14.50).
521
Cost to Make
Materials (36,000 x $5.90) $212,400
Direct labor (36,000 x $5.30) 190,800
Rent of space 48,000*
Rent of machinery 45,000
Other variable overhead (36,000 x $1.40**) 50,400
Total cost to make $546,600
* Rental on the new space, not on the space already leased. The incremental
cost is $48,000 because that is the change in cost occasioned by the decision
to make the motor.
**$4.10 total less $2.70 fixed.
2. About 48,947 units. Equating the costs of making and buying, where Q =
volume
Cost to make = $48,000 + $45,000 + [Q x ($5.90 + $5.30 + $1.40)]
= $93,000 + $12.60Q
Cost to buy = $14.5Q
$14.5Q = $93,000 + $12.60Q
Q = 48,947
The estimate of volume would have to be off by some 12,947 units (48,947
36,000) or 36% (12,947/36,000) for the buydecision to be unwise.
3. $12.60, the variable cost to produce a unit. Once the rentals have been
incurred, the company's incremental cost to make the motor is unit variable
cost. (This requirement underscores the importance of determining precisely
what the decision is in a given case.)
5
38 Dropping a Product
Opportunity Costs (20 minutes)
If the liquidation of receivables and inventory could take place within
a relatively short time, we might simply compare the lost product margin (if
the apparel line is discontinued) with the savings in interest.
Lost product margin $35,000
Savings in interest ($320,000 investment that
is covered by debt carrying a 14% interest rate)
$320,000 x 14% 44,800
Savings if line is dropped $ 9,800
Because the company's stated intention is to pay off the debt if cash is
released from the investment in inventories and receivables, the interest
savings appear to be relevant. Even if the cash from liquidating the working
capital items were used for some other purpose, there must be some cost (an
opportunity cost) to tying up cash in an investment in working capital items.
The measurement of that opportunity cost depends on what alternative uses are
available from the cash freed by liquidation of the working capital items.
Note to the Instructor: The opportunity cost of cash is more directly
related to the subject of capital budgeting, but it is not too early to
emphasize the point that there is some cost associated with the use of cash.
It's possible that paying off debt, even when it carries an interest rate of
14%, is not a good use of the cash available to the firm. (Perhaps the
company could expand one of its other lines, or put the cash into productive
investment in product lines not now being covered at all, and earn a return
522
in excess of 14%.)
One other matter warrants discussion. Though some cash flow will result
from the liquidation of receivables and inventories, there's no assurance
that the liquidation will produce cash equal to the recorded (book)
investments. Recovery of book value on the investment in receivables is not
unreasonable. The amount recoverable from the investment in inventories
depends on the market for the product and the approach the company takes to
liquidating the inventories. An orderly liquidation may well produce cash
inflows in excess of recorded costs, but, of course, any delay in the cash
inflows (such as might be caused by effecting an orderly liquidation) reduces
the savings in interest payments.
5
39 Joint Process (Extension of 58 and 59) (15 minutes)
Westlake should continue to operate the joint process. Ignoring the
costs of operating the joint process, the monthly profit that comes from
producing the joint products and processing further one of those products
(Frazinine) is $808,000 (from 59), and the costs saved by not operating the
joint process are only $604,000 (avoidable costs of $220,000 + variable costs
of $320 per batch for 1,200 batches, or $384,000). The advantage to
operating the joint process is $204,000 ($808,000 $604,000). The same
answer can be determined by comparing total income (loss) depending on
whether the process is operated.
Operate the Process Drop the
and Further Joint
Process Frazinine Process
Margin before costs of joint process, from 59 $808,000
Costs of joint process:
Variable, 1,200 batches x $320 per batch (384,000)
Fixed, avoidable (220,000)
Fixed, unavoidable (180,000) ($180,000)
Profit (loss) $ 24,000 ($180,000)
The difference between a profit of $24,000 and a loss of $180,000 is the
$204,000 computed earlier.
5
40 Salesperson's Time as Scarce Resource (1520 minutes)
1. On the basis of the averages alone, the sales force should concentrate on
retailers.
Number of wholesalers called on in one week (8 x 5) 40
Average order per wholesaler, at wholesale price $500
Average weekly wholesale sales, per salesperson $20,000
Variable cost of sales at 75% 15,000
Weekly gross margin from calling on wholesalers at 25% $ 5,000
Number of retailers called on in one week (14 x 5) 70
Average order per retailer, at retail prices $300
Average weekly retail sales, per salesperson $21,000
Variable cost of retail sales at 60% 12,600
Weekly gross margin from calling on retailers at 40% $ 8,400
2. If there were other variable costs applicable to any sales, the emphasis
523
on retailers is still appropriate. That is, so long as the same products are
sold to both retailers and wholesalers, an increase or decrease in variable
cost still makes retailers the more profitable. However, the memo might
raise questions such as the following about costs associated with selling to
retailers being higher than they are for sales to wholesalers. An ABC
analysis should provide useful information about the relative costs of
servicing the two channels of distribution.
(a) With more separate orders to retailers, such costs as shipping, making
up orders, and packaging could well be higher for retailers.
(b) Clerical work is likely to be higher with retailers, leading to higher
costs for creditchecking, administration of receivables, and collections.
The larger number of orders means more bookkeeping (recording and posting
orders and payments) and more monthly statements to prepare and mail.
(c) It is probable that retailers are generally less creditworthy, which
could result in higher bad debts, though nothing in the facts suggests this.
One other factor that might be mentioned is the advantage to the company
to have wholesalers handle its products. Wholesalers could fill orders
between visits of salespeople and perform other services that could favorably
affect sales. For example, some wholesalers might sponsor regional
advertising ("We proudly stock Lombard products.").
5
41 Special Order
Capacity Limitation (25 minutes)
1. Income will not change (a gain of $480,000 on the order itself, less a
loss of $480,000 from lost sales). The perunit contribution margin on
special order is $6 ($34 $24 $4).
Contribution Margin
Special Order Lost Sales
Volume 80,000 24,000*
Contribution margin per tire $6 $20
Contribution margin $480,000 $480,000
* Maximum production 320,000
Less special order 80,000
Available for regular sales 240,000
Expected regular sales 300,000
Lost sales for month 60,000
Net lost sales, 40% x 60,000 24,000
2. $34.00
Contribution margin on lost sales, required on order $480,000
Divided by units in special order 80,000
Equals contribution margin per unit $ 6.00
Add variable cost per unit 28.00
Equals required price $34.00
3. Income would fall by $440,000 per month ($800,000 drop from lost sales
less $360,000 increased profit from special order).
Special Order Lost Sales
Volume 60,000 40,000*
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Contribution margin per tire $6 $20
Contribution margin $360,000 $800,000
*Production 320,000
Special order 60,000
Available for regular sales 260,000
Expected regular sales 300,000
Lost sales at regular prices 40,000
The lowest acceptable price is $41.33. Dividing the $800,000
contribution margin on lost sales by the 60,000 units on the special order
gives a required contribution margin per unit of $13.33. Adding the $28
variable cost to the desired contribution margin gives a price of $41.33.
Note to the Instructor: Besides negotiating on price, the company
could negotiate on the size of the special order. You might ask the students
how many units the special order must be to make the company indifferent.
Obviously, at some price, and some monthly volume, the order becomes
desirable. The analysis above gets at the pricing issue. For the volume
issue, the following is the simplest.
Overall loss on 60,000 unit order $440,000
Divided by difference in CMs, $20 $6 $14
Required reduction in special order, rounded 31,429
Maximum order, 60,000 31,429 28,571
The idea here is that the company trades $6 margin for $20 margin on every
unit that it takes from the special order and sells at the regular price. To
make up the $440,000 loss requires nearly 31,429 such exchanges. Such a
calculation is helpful if Southland has some reason for wanting the business.
Perhaps the chain sells in a geographical area Southland would like to move
into, or perhaps is contemplating expansion and would like some private brand
business to provide a base of volume. Southland might not want a $440,000
monthly decline in income, but it might undertake the business at a slight
profit or loss to fulfill some other strategic need.
4. The purpose of this requirement is to stress the importance of
materiality. The company expects the following monthly income without the
order.
Contribution margin, 300,000 x $20 $6,000,000
Fixed costs 4,800,000
Profit $1,200,000
We would certainly not accept the order, with whatever disruption it might
cause, for no increase in a $1,200,000 profit for one month.
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