1

Problems Decision Making

Problem No 1 (Special order) The Modern Packing Corporation (MPC) specializes in the manufacture of one-liter plastic bottles. The plastic molding machines are capable of producing 100 bottles per hour. The firm estimates that the variable cost of producing a plastic bottle is 25 cents. The bottles are sold for 55 cents each. Management has been approached by a local toy company that would like the firm to produce a molded plastic toy for them. The toy company is willing to pay $3 per unit for the toy. The unit variable cost to manufacture the toy will be $2.40. In addition, MPC would have to incur a cost of $20,000 to construct the mold required exclusively for this order. Because the toy uses more plastic and is of a more intricate shape than a bottle, a molding machine can produce only 40 units per hour. The customer wants 100,000 units. Assume that MPC has a total capacity of 10,000 machine-hours available during the period in which the toy company wants delivery of the toys. The firms fixed costs, excluding the costs to construct the toy mold, during the same period will be $200,000. Required: 1. Suppose the demand for its bottles is 750,000 units, and the special toy order has to be either taken in full or rejected totally. Should MPC accept the special toy order? Explain your answer. 2. Suppose the demand for its bottles is 850,000 units, and the special toy order has to be either taken in full or rejected totally. Should MPC accept the special toy order? Explain your answer. 3. Suppose the demand for its bottles is 850,000 units, and MPC can accept any quantity of the special toy order. How many bottles and toys should it manufacture?

2 4. Suppose the demand for its bottles is 900,000 units, and the special toy order has to be either taken in full or rejected totally. Should MPC accept the special toy order? Explain your answer. 5. Suppose the demand for its bottles is 900,000 units, and MPC can accept any quantity of the special toy order. How many bottles and toys should it manufacture?

Solution (P-1)

Bottles 100 per machine hour CM 0.30 Toys 40 per machine hour CM 0.60

SP = 0.55 SP = 3.00

VC = 0.25 VC = 2.40

Capacity = 10,000 machine hour $20,000 Order = 100,000 toys

Molding machine cost =

1.

Demand (Bottles)

750,000 units

Machine hours required to manufacture 750,000 bottles = 750,000100 = 7,500 hours

Excess capacity 10,000 7,700 = 2,500 machine hours

Special order has to be taken in full

Toys 2,500 hours 40 = 100,000 toys sacrifice)

OK (no regular sales

Revenue 100,000$3 VC 100,000$2.4 CM Less Molding Machine cost Additional Income

$300,000 240,000 60,000 (20,000) $40,000 ACCEPT

2. Demand 850,000 units machine hours

Hours required = 850,000100 = 8,500

Excess Capacity = 1,500 machine hours

Hours required to accept order 100,000 toys) Excess hours required to accept order Foregone hours

2,500 1,500 1,000

(2,50040 =

Special order has to be taken in full

Operating income from accepting order $40,000 (as per 1) Foregone CM(100,0000.3) Additional income 30,000 $10,000 ACCEPT

4 3. Demand 850,000 bottles

Special order taken any quantity

Bottles Toys

CM/unit CM/unit

0.55 0.25 = $0.30 3.00 2.40 = $0.60

Units made in 1 machine hour 100 bottles Units made in 1 machine hour 40 toys

1000.30 = $ 30 400.60 =$ 24

MPC should make as many bottles as it can rather than special toys.

Available machine hours 1,500 hours

1,500 40 = 60,000 toys

CM 60,0000.6 Molding machine

$36,000 (20,000) $16,000 ACCEPT

4. Demand 900,000 bottles

Special order has to be taken in full

Hours required for 900,000 bottles 900,000100 = 9,000 hours Excess capacity = 10,000 9,000 = 100 machine hours

5 Special order 100,00040 = 2,500 machine hours Forgone hours = 1,000 2,500 = 1500 machine hours

CM for accepting order 100,0000.6 = $60,000 Molding machine (20,000) 40,000 Foregone profit (150,0000.3) Loss REJECT (45,000) ($5,000)

5. Demand 900,000 Bottles

Special order taken any quantity

Available excess hours = 1000 machine hours Toys = 100,00040 = 40,000 toys

CM from toys 40,0000.6 = 24,000 Molding machine Increase in net income (20,000) $4,000 ACCEPT

Problem No 2 (Special order) The Award plus Company manufactures medals for winners of athletic events and other contests. Its manufacturing plant has the capacity to produce 10,000 medals each month; current production and sales are 7,500 medals per month. The company normally charges $150 per medal. Cost information for the current activity level ( 7500 medals)is as follows:

Variable costs that vary with units produced: Direct materials Direct manufacturing labor $262,500 300,000

7 Variable Costs ( for set ups, material handling, quality control and so on) that vary with number of batches,150 batches$500 each Fixed manufacturing costs Fixed marketing costs Total costs 75,000 275,000 175,000 $1,087,50 0

Award plus has just received a special one-time-only order for 2,500 medals and $100 per medal. Award plus makes medals for its existing customers in batch sizes of 50 medals (150 batches x 50 medals per batch = 7,500 medals). The special order requires Award Plus to make the medals in 25 batches of 100 each. Required: 1. Should Award Plus accept this special order? Why? Explain briefly 2. Suppose plant capacity was only 9,000 medals instead of 10,000 medals each month. The special order must either be taken in full or rejected totally. Should Award Plus accept the special order?

Solution (P-2)

1. Excess Capacity = 10,000 medals (capacity) 7,500 (regular sales) = 2,500 Normal Price = $150 per medal Special order 2,500 medals for price $100 per medal

8 Incremental revenue (2,500$100) DM 2,500$35(262,5007,500) DL 2,500$40(300,0007,500) Incremental batches 25$500 (2,500100 = 25 batches) Total variable cost Increase in income ACCEPT the order $250,0 00 87,500 100,00 0 12,500 200,00 0 50,000

2. Excess Capacity = 9,000 medals (capacity) 7,500 (regular sales) = 1,500 Foregone sales = 2,500 medals 1,500 medals = 1000 medals

Original Income = ($7,500$150) - $1,087,500 = $37,500

Sales (6,500$150 + 2,500$35)) DM (6,500$35 +2,500$35) DL (6,500$40 + 2,500$40) Batch manufacturing (130$500+25$500) 6,50050 = 130, 250100 = 25 F. Manufacturing Cost F. Marketing Cost Increase in income

$1,225,0 00 315,000 360,000 77,500 275,000 175,000 1,202,50 0 $22,500

Loss on Operating income = $37,500 - $22,500 = $15,000

REJECT the order

Problem No 3 (Deletion of a Product) The Northern Furniture Division of Grossman Corporation makes and sells tables and beds. The following revenue and cost information from the division activity based costing system is available. 4,000 tables 5,000 beds Total

Revenue ($125 x 4,000; $200 x 5,000) $1,000,000 $1,500,000 Variable direct material and direct labor costs ($75 x 4,000 ; $105 x 5,000) 525,000 825,000 Amortization on equipment used exclusively by each product line 92,000 160,000 Marketing and distribution costs
$40,000 (fixed) + $750 per shipment x 40 shipments $60,000 (fixed) + $750 per shipment x 100 shipments

$500,000

300,000

68,000

70,000

135,000

205,000

Fixed Gen Admin costs of the division allocated to Product lines on the basis of revenues 180,000 270,000 90,000

Allocated corporate-office costs allocated to product lines

10 On the basis of revenue 40,000 60,000 972,000 Total costs 1,520,000 20,000 548,000 $(48,000)

Operating income (loss) $28,000 $(20,000)

a. Equipment has a remaining useful life of one year and zero disposal price. Any equipment not used remains idle. b. Fixed marketing and distribution costs of a product line can be avoided if the line is discontinued. c. Fixed general administration costs of the division and corporateoffice costs will not change if sales of individual product lines are increased or decreased, or if product lines are added or dropped.

Required:

1. Should the Furniture Division discontinue the table product line assuming the released facilities remain idle? Show all your calculations. 2. Should the Furniture division sell 4,000 more tables? Assume that to do so the division would have to acquire equipment costing $68,000 with a one year useful life.

11 Assume further that the fixed marketing and distribution costs will not change but that the number of shipments will double. Show all your calculations. Solution (P-3)

1.

Revenue in $ VC DM & DL Amortization Mkt & distribution Fixed Gen & Admin Corp Office cost Operating income

With tables $1,500,0 00 825,000 160,000 205,000 270,000 60,000 1,520,00 0 ($20,000 )

Without Tables 1,000,000 525,000 160,000 135,000 270,000 60,000 1,150,000 ($150,000)

Diff Analysis ($500,000) 300,000 0 70,000 0 0 370,000 ($130,000)

Operating loss will be higher by $130,000 by dropping table line

2. 8000 tables $1,000,00 0 600,000 68,000 100,000 90,000 20,000 68,000 946,000 $54,000 5000 Beds 1,000,00 0 525,000 92,000 135,000 180,000 40,000 0 972,000 $28,000 Total $2,000,00 0 1,125,000 160,000 235,000 270,000 60,000 68,000 1,918,000 $82,000

Revenue in $ VC DM & DL Amortization Mkt & distribution ( 40,000 + 750$80) Gen & Admin Corp Office cost Cost of equipment written off Operating income

12

Increase in Income = 82,000 + 20,000 = $102,000

Incremental Sales (4000$125) DM & DL (4,00$75 +4,000$105) DM (6,500$40 + 2,500$40) Market & Dist (750$40) Cost of equipment Operating income Problem No 4 (Deletion of a Product)

$500,0 00 300,00 0 100,00 0 30,000 68,000 398,00 0 $102,0 00

Home Furnishings makes bookshelves, tables, and beds. The following sales and cost information is available about the profitability of each of these lines.

Revenue in $ Direct materials Direct labor Setups and material handling Amortization on tools and fixtures Marketing and distribution General administration & facilities Total Costs Operating income(Loss)

Book Shelves $750,000 300,000 75,000 45,000 50,000 75,000 150,000

Tables $500,0 00 220,00 0 60,000 40,000 48,000

Beds $1,000,0 00 400,000 80,000 60,000 72,000 120,000 200,000 932,000 $68,000

Total $2,250,0 00 920,000 215,000 145,000 170,000 255,000 450,000 2,155,00 0 $95,000

60,000 100,00 0 695,000 528,00 0 $55,000 $(28,00 0)

13

Home Furnishings uses an activity-based cost system to assign costs to products. The following information is available.

a. Direct material and direct labor costs vary with the number of units of products manufactured.

b. Setups and materials-handling costs vary with the number of batches made.

c. Tools and fixtures have one year lives and zero disposal prices.

d. Of the total marketing and distribution costs, $112,500 are fixed costs allocated to product lines on the basis of sales revenue. Fixed marketing and distribution costs allocated to a product line can be avoided if the line is discontinued. The remaining marketing costs vary with the number of shipments made.

e. General administration and facilities costs are fixed costs that will not change if sales of individual product lines are increased or decreased or if product lines are added or dropped. These costs are allocated to product lines on the basis of sales revenues.

14

Required:

In answering the following requirements, assume that prices of the various products do not change.

1. Should Home Furnishings discontinue the tables product line assuming the leased facilities remain idle? Assume Home Furnishings has already acquired the tools and fixtures it needs to manufacture tables.

2. Suppose that if Home Furnishings discontinues the tables product line, the released facilities could be used to sell beds worth an additional $250,000. This would require Home Furnishings to purchase tools and fixtures for $4,000. Assume that there will be no change in either the number of batches in which beds are made or the number of shipments?

a. On the basis of your calculations, should Home Furnishings discontinue the table product lines?

15 b. What is the opportunity cost of continuing the tables product lines?

c. What other factors should Home Furnishings consider before making a decision?

3. What would be the effect on operating income if Home Furnishings could double it sales of tables? Assume that, at the higher sales, both the number of batches and the number of shipments would be three times and purchases of tools and fixtures would be twice the current levels.

Solution(P-4)

1. With tables Without Tables Different ial Analysis

16 Revenue in $ DM DL Set ups Amortization Mkt & Dist Gen Admin Operating income $2,250,0 1,750,00 00 0 920,000 700,000 215,000 155,000 145,000 105,000 170,000 170,000 255,000 195,000 450,000 450,000 2,155,00 1,775,00 0 0 $95,000 ($25,000) ($500,00 0) 220,000 60,000 40,000 0 60,000 0 380,000 ($120,00 0)

2. Selling more beds worth $250,000 and discontinue the table line product.

Additional Sales DM 40% of sales DL 8% of sales Set ups Amortization Mkt & Dist Cost of tool Operating Income 400,0001000 80,0001000

$250,0 00 100,00 0 20,000 0 0 0 4,000 $124,0 00 $126,0 00

HF should discontinue the table lines because selling more beds earn $126,000 in incremental OI while discontinuing the table lines result in a decrease of operating income of $120,000.

17

Problem No 5 (Make or Buy) The Ace Bicycle Company produces bicycles. This year expected production is 10,000 units. Currently, Ace makes the chains for its bicycles. Aces accountant reports the following costs for making the 10,000 bicycles chains: Costs per unit $4.00 2.00 1.50 Costs for 10,000 units $40,000 20,000 15,000 2,000 3,000 30,000 $110,000

Direct materials Direct labor Variable mfg overhead (power and utilities) Inspection, setup, materials-handling Machine rent Allocated fixed costs of plant administration, taxes, and insurance Total Costs

Ace has received an offer from an outside vendor to supply any number of chains. Ace requires at $8.20 per chain. The following additional information is available.

a. Inspection, setup, and materials-handling costs vary with the number of batches in which the chains are produced. Ace produces chains in batch sizes of 1,000 units. Ace estimates that it will produce the 10,000 units in ten batches.

18 b. Ace rents the machine used to make the chains. If Ace buys all its chains from the outside vendor, it does not need to pay rent on this machine.

Required:

1. Assume that, if Ace purchases the chains from the outside supplier, the facility where the chains are currently made will remain idle. Should Ace accept the outside suppliers offer at the anticipated production ( and sales) volume of 10,000 units?

2. For this question, assume that if the chains are purchased outside, the facilities where the chains are currently made will be used to upgrade the bicycle by adding mud flaps and reflectors. As a consequence, the selling price on bicycles will be raised by $20. The variable per unit cost of the upgrade would be $18, and additional tooling costs of $16,000 would be incurred. Should Ace makes or buy the chains, assuming that 10,000 units are produced (and sold)? Solution (P-5) 1. Expected Production 10,000 units

Make

Buy

Differenti

19
al Analysis ($82,000 ) 40,000 20,000 15,000 2,000 60,000 3,000 0 ($2,000)

Purchase (10,0008.20) DM DL Variable MOH Inspection Machine rent Allocated FC Operating income

0 40,000 20,000 15,000 2,000 3,000 30,000 2,155,000 ($110,00 0)

$82,000 0 0 0 0 0 0 30,000 ($112,000)

Ace should not buy $82,000

Cost to make $80,000 Cost to purchase

2.

Cost to make Cost of purchase $82,000

$80,000

Additional tooling cost 16,000 Additional CM (20,000) 10,000(20-18) $78,000 Ace Should buy the Chains now

20

Problem No 6 (make or buy) Geary manufacturing has assembled the following data pertaining to its two most popular products. Blender Direct material Direct labor Mfg overhead @ $16 per machine hour Cost if purchased from an outside supplier Annual demand (units) $6.00 4.00 16.00 20.00 20,000 Electric Mixer $11.00 9.00 32.00 38.00 28,000

Past experience has shown that the fixed manufacturing overhead component included in the cost per machine hour averages $10. Geary has a policy of filling all sales orders, even if it means purchasing units from outside suppliers.

Required:

1. If 50,000 machine hours are available, and Geary Manufacturing desires to follow an optimal strategy, how many units of each product should the firm manufacture? How many units of each product should Geary purchase?

2. With all other things constant, if Geary Manufacturing is able to reduce the direct material for an electric mixer to $6 per unit, how many units of each product should

21 be manufactured? Purchased ?

Solution (P-6)

Unit Cost if purchased Unit cost of Make: DM DL V.MOH (16-10) Save if make Machine Hours required Cost saving per machine hour 41, 62

Blender $20 6 4 6 16 4 1 $4

Mixer $38 11 9 32102=12 32 6 2 $3

Remaining hrs = 50,000 (M. hrs available) 20,000 (M. hrs required for Blender) = 30,000 hrs

Number of mixer to be produced = 30,0002 = 15,000 units

22 Make Blender Make Mixer Buy Mixer 20,000 15,000 13,000 (28,000-15,000)

2. If Geary is able to reduce the DM cost per mixer to $6 from $11

New UC saving if make Machine hours required Cost saving per machine hour

Blender $4 1 41= 4

Mixer (6+9+11)38=$11 2 112 =5.5

Devote all 50,000 Hours to produce 25,000 Mixer

Manufacture Purchase Purchase

25,000 Mixer 3,000 Mixer 20,000 Blenders

Problem No 7

Air Pacific owns a a single jet aircraft and operates between Vancouver and the Hawaiian Islands. Flights leave Vancouver on Mondays and Thursdays and depart from Hawaii on Wednesday and Saturdays. Air Pacific cannot offer any more flights between Vancouver and Hawaii. Only tourist-class seats are available on its planes. An analyst had collected the following information:

Seating Capacity

360 passengers

23 Average number of passengers per flight Flights per week Flights per year Average one-way fare Variable fuel costs Food and beverages service cost ( no charge to passenger) Commission to travel agents (all booking through agents) Fixed annual lease costs allocated to each flight Fixed ground services cost allocated to each flight Fixed flight crew salaries allocated to each flight 200 passengers 4 flights 208 flights $500 $14,000 per flight $20 per passenger 8% of fare $53,000 per flight $7,000 per flight $4,000 per flight

For simplicity assume that fuel costs are unaffected by the actual number of passengers on a flight.

Required:

1. What is the operating income that Air Pacific makes on each oneway flight between Vancouver and Hawaii?

2. The market research department of Air Pacific indicates that lowering the average one-way fare to $480 will increase the average number of passengers per flight to 212. Should Air Pacific lower its fare?

24

Solution (P-7)

1. Revenue 200$500 Less 8% Commission Net Revenue Variable cost 200$20 Fuel Cost per flight Contribution margin per flight Fixed Costs: Allocated Leased Costs Baggage Handling Flight Crew Total FC OI per flight $100,00 0 (8,000) 92,000 4,000 14,000 18,000 74,000 53,000 7,000 4,000 64,000 $10,000

2. Decrease in fare from $500 to $480 will increase passengers from 200 20 220.

CM per Passenger = Revenue (480-38.40) Food and Beverages $ 20 = $421.60

25

Total CM = $421.60 212 Total CM as per 1

$89,379.20 88,000.00 $1379.20

All other costs are irrelevant

Problem No 8 (Make or Buy)

Lynn Hardt, a management Accountant with the Paibec Corporation, is evaluating whether a component, MTR-2000 should continue to be manufactured by Paibec or purchased from Marley Company, an outside supplier. Marley has submitted a bid to manufacture and supply the 32,000 units of MTR-2000 that Paibec will need for 2000 at a unit price of $17.30 to be delivered according to Paibec production specifications and needs. While the contract price of $17.30 is only applicable in 2000, Marley is interested in entering into a ling-term arrangement beyond 2000.

26 Hardt had gathered the following information regarding Paibecs annual cost to manufacture 30,000 units of MTE-2000 in 1999.

Direct material Direct labor Plant space rental costs Equipment leasing costs Other manufacturing overhead costs Total manufacturing costs

$195,000 120,000 84,000 36,000 225,000 $660,000

Hardt has collected the following additional information related to manufacturing MTR-2000

Direct materials used in the production of MTR-2000 are expected to increase eight percent in 1999. Paibecs direct manufacturing labor contract calls for a fivepercent increase in 2000. Paibec can withdraw from the plant space rental agreement without any penalty. Paibec will have no need for this space if MTR-2000 is not manufactured. The equipment lease can be terminated by paying $6,000. Fort percent of the other manufacturing overhead is considered variable. Variable overhead changes with the number of units produced. The rate per unit is not expected to change in 2000. The fixed manufacturing overhead costs are not expected to change whether or not MTR-2000 is manufactured.

John Porter, plant manager at the Paibec Corporation is concerned that Hardts analysis may lead to the closing down of the MTR-2000 line. Porter indicates to Hardt that the current performance of the plant can be significantly improved upon and that the price

27 increases she is assuming are unlikely to occur. Hence, the analysis should be done assuming costs will be considerably below current levels. Hardt knows that Porter is concerned about outsourcing MTR-2000 because it will mean that some of his close friends will be laid off. Furthermore, Porter will achieve the lower costs Porter describes. She is very confident about the accuracy of the information she has collected, but she is unhappy about laying off employees.

Required:

1. On the basis of the information Hardt has obtained, should Paibec make MTR2000 or buy it? Show all your calculations.

2. What other factors should Paibec consider before making a decision?

28

Solution (P-8)

1. 1. Cost of Purchase 32,000$17.30 Equipment lease penalty Cost to Purchase 2. Cost to Produce DM (195,00030,000)32,0001.08 DL (120,00030,000)32,0001.05 Rental costs Variable MOH (225,0000.4)30,00032,000 Fixed MOH (Irrelevant) Cost of Produce Saving if Purchased (575,040-559,600) $553,60 0 6,000 559,600 224,640 134,400 84,000 96,000 0 $575,04 0 $15,440

29 2. At least three factors should be considered before agreeing to purchase MTR-2000

a) The quality should be equal or better than the internally made component. b) Should be reliable and timely deliver the product c) Lays off may result if the component is out sourced. It can be a labor problem.

Problem No 9

30 1. The Woody Company manufactures slippers and sells them at $10 a pair. Variable manufacturing cost are $4.50 a pair, and allocated fixed manufacturing costs are $1.50 a pair. The Company has enough idle capacity available to accept a one-time only special order of 20,000 pairs of slippers at $6 a pair. Woody will not incur any marketing costs as a result of the special order. What would be the effect of operating income be if the special order could be accepted without effecting normal sales?

a) $0 b) $30,000 increase c) $ 90.000 increase d) $120,000 increase

2. The Reno Company manufactures Part no 498 for use in its production line. The manufacturing costs per unit for 20,000 units of Part No 498 are as follows.

Direct materials . $6

Direct labor 30 Variable manufacturing overhead 12 Fixed mfg overhead allocated .. 16

31 $64 The Tray Company has offered to sell 20,000 units of Part 498 to Reno for $60 per unit. Reno will make the decision to buy the part from Tray if there is an overall savings of at least $25,000 for Reno. If Reno accepts Trays offer. $9 per unit of the fixed overhead allocated would be totally eliminated. Further more, Reno has determined that the released facilities could be used to save relevant costs in the manufacture of Part No 575. For Reno to have an overall savings of $25,000, the amount of relevant costs that would have to be saved by using the released facilities in the manufacture of Part No 575 would be

a) $80,000 b) $85,000 c) $125,000 d) $140,000

Solution (P-9)

1. (b) 30,000 increase

CM = $6.00 4.50 = $ 1.50 Effect on income = $1.50 20,000 Units = $30,000

2. (b) $85,000 1. Cost of Purchase 20,000$60 2. Cost to Produce DM 20,0006 DL 20,00030 $1,200,0 00 120,000 600,000

32 Variable MOH 20,000$12 Fixed MOH 20,000 $9 Cost of Produce Extra cost of Purchasing Minimum savings required Relevant costs that have to be saved 240,000 180,000 $1,140,0 00 60,000 25,000 $85,000

Problem No 10 (Make or Buy)

Leland manufacturing Company uses 10 units of part KJ37 each month in the production of radar equipment. The cost of manufacturing one unit of KJ37 I is the following.

Direct material Material handling (20% 0f direct material cost) Direct labor Manufacturing overhead (150% of direct

$1,000 200 8,000 12,000

33 labor) Total manufacturing Cost

$21,200

Material handling represents the direct variable costs of the Receiving Department that are applied to direct materials and purchased components on the basis of their cost. This is separate charge in addition to manufacturing overhead. Lelands annual manufacturing overhead budget is one-third variable and two thirds fixed. Scott Supply, one of Lelands reliable vendors, has offered to supply part number KJ37 at a unit price of $15,000.

Required:

1. If Leland purchases the KJ37 units from Scott, the capacity Leland used to manufacture these parts would be idle. Should Leland decide to purchase the parts from Scott, the unit cost of KJ37 would increase (or decrease) by what amount?

2. Assume Leland Manufacturing is able to rent out all its idle capacity for $25,000 per month. If Leland decides to purchase the 10 units from Scott Supply, Lelands monthly cost for KJ37 would increase (or decrease) by what amount?

3. Assume Leland Manufacturing does not wish to commit to a rental agreement but could use its idle capacity to manufacture another product that would contribute

34 $52,000 per month. If Leland elects to manufacture KJ37 in order to maintain quality control, what is the net amount of Lelands cost from using the space to manufacture part KJ37.

Solution (P-10)

1. a. Cost of Purchase 20,000$60 Plus Material Handling 20% of DM cost b. Cost of manufacture DM Material handling DL V.MOH 1/3 of variable Increase in UC if purchased 18,00013,200 $15,000 3,000 18,000 1,000 200 8,000 4,000 $13,200 $4.800

2. Increase in monthly cost of if purchased 4,80010 = $48,000 Less rental income Increase in monthly cost (25,000) $23,000

35 3. Contribution forgone by not manufacturing alternate product $52,000 Savings in the cost of acquiring KJ 37 4,80010 as per 1 (48,000) Net cost of using limited capacity to produce KJ37 $4,000

Problem No 11 (Special order) Clean-it Company produces cleaning kits for shotguns. The production capacity available will enable the firm to produce 500,000 kits annually. A projected income statement for the next year shows: Sales (460,000 Kits) Cost of goods sold Gross Profit $4,600,000 2,960,000 1,640,000

36 Selling and Administrative Expenses Net Income 1,250,000 $ 390,000

Fixed manufacturing overhead costs included in the cost of goods sold are $1,120,000. A 10% sales commission is paid to sales representatives for each kit sold. The purchasing department of a large discount chain has offered to purchase 30,000 kits as $6 each. The clean-it Company sales managers initial response is to refuse the offer because he concludes that the $6 price is below the firms average cost ($ 2,960,000/460,000). The sales commission would not be paid on the special order.

a) Should the special offer be accepted? What would be the impact on net income? VC = 2,960,000 1,120,000 = 1,840,000 VC per unit = 1,840,000 460,000 = $ 4 CM = 6-4 = $2 Additional profit = 30,000 2 = $60,000 b) Assume that the offer was for 50,000 kits. Should it be accepted if it wants to earn annual net income of $480,000? Capacity 500,000 units Regular Sales 460,000 units In order to accept 50,000 units, 10,000 units of Regular sales will be lost. Special order sales: Additional CM 50,0002 Loss CM from lost sales 10,000 (10-4-1) Additional profit 100,000 50,000 50,000

c) Ignore Part b. What is the lowest price the firm could accept if it wants to earn annual net income of $480,000? Added profit required 480,000 -390,000 = 90,000

37 30,000 X = 30,000 4 90,000 X = $7 Problem No 12 Best Buy Company is trying to decide between two alternatives regarding the assemblies of KJF621 for the companys main product. The alternatives are: 1. Purchase new equipment at $5,000,000. The equipment would have a 5-year life with no salvage value. Best Buy uses straight-line amortization and allocates that amount on a unit-of-production basis. 2. Purchase the needed KJF621 assembly from an outsider source that will sell them for $90 per unit on a 3-year contract. Best Buys cost of producing the assemblies is based on a current and normal activity of 50,000 units per year and is as follows: Direct Material Direct Labor Variable overhead Fixed overhead $30 40 6 36

Fixed overhead includes $7 supervisory cost, $9 amortization, and $20 general company overhead. The new equipment would be more efficient than the old and would reduce direct labor costs and variable overhead costs by 25%. Supervisory costs of $400,000 are avoidable if the units are purchased. The new equipment would have a capacity of 75,000 units per year. No alternative uses are available for the space currently occupied by Best Buy if the company decides to buy from the outside source. Required: a) Show an analysis including relevant unit and total costs for each of the alternatives. Assume 50,000 assemblies are needed each year.

38 b) Show an analysis including relevant unit and total costs for each of the two alternatives. Assume 60,000 assemblies are needed each year. c) Show an analysis including relevant unit and total costs for each of the two alternatives .Assume 75,000 assemblies are needed each year.

Problem No 13 Foster Company makes 20,000 units per year of a part that it uses in the products it manufactures. The unit product cost of this part is computed as follows. Direct Materials Direct Labor Variable manufacturing Overhead Fixed Manufacturing Overhead Unit product cost $24.70 $16.30 $2.30 $13.40 $56.70

An outsider supplier has offered to sell the company all the parts that Foster needs for $51.80 a unit. If the company accepts this offer, the facilities now being used to make the part could be used to make more units of a product that is in high demand. The additional contribution margin on this other product would be $44,000 per year. If the part were purchased from the outside supplier, all of the direct labor cost of the part would be avoided. However,$5.10 of the fixed manufacturing overhead cost that is being applied to the part would continue, even if the part were purchased from the outside supplier. This fixed manufacturing overhead cost would be applied to the companys remaining products. Required: a) How much of the unit product cost of $56.70 is relevant in the decision of whether to make or buy the part? b) What is the net total dollar advantage (disadvantage) of purchasing the part rather

39 than making it? c) What is the maximum amount of the company should be willing to pay an outside supplier per unit for the part if the supplier commits to supplying all 20,000 units required each year?

Problem No 14 Kramer Company makes 4,000 units per year of a part called an Axial tap for use in one of its products. Data concerning the unit production costs of the Axial tap follow. Direct Materials Direct labor Variable Manufacturing Overhead Fixed Manufacturing Overhead Total Manufacturing Cost per unit $35 $10 $8 $20 $73

An outside supplier had offered to sell Kramer Company all of the Axial tap it requires. If Kramer Company decided to discontinue making the Axial taps 40% of the above fixed manufacturing overhead costs could be avoided. Assume that direct labor is a variable cost. Required: A. Assume Kramer Company has no alternative use for the facilities presently devoted to

40 production of the Axial taps. If the outside supplier offers to sell the Axial taps for $65 each , should Kramer Company accept the offer? Fully support your answer with appropriate calculation. B. Assume that Kramer Company could use the facilities presently devoted to production of the Axial taps to expand production of another product that would yield an additional contribution margin of $80,000 annually. What is the maximum price Kramer Company should be willing to pay the outside supplier for Axial Tap?

Problem No 15 Qualls Company makes a product that has the following costs: Direct material Direct labor Variable manufacturing over head Fixed manufacturing overhead Variable S&A expenses Fixed S&A expenses Per unit $17.30 $12.90 $4.20 Per year

$916,80 0 $2.00 $907,20 0

41 The Company uses the absorption costing approach to cost plus pricing. The pricing calculations are based on budgeted production and sales of 48,000 units per year. The company has invested $360,000 in this product and expects a return on investment of 15%. Required: a. Compute the mark up on absorption cost. B. Compute the target selling price of the product using the absorption costing approach.

Problem No 16 (Elimination of a product) Triangle limited manufactures and sells three different products; Isosceles, Equilateral and Scalene. The projected income statements by production line for the year are presented below. Isoscele Equilateral s 10,000 500,000 $925,00 $1,000,00 0 0 285,000 350,000 Scalene 125,000 $575,00 0 150,000 Total 635,000 $2,500,0 00 785,000

Unit Sales Revenue Less Variable CGS

42 Less Fixed CGS Gross Margin Less Variable S&A expenses Less Fixed S&A expenses New Income (loss) before taxes 304,200 $335,80 0 270,000 125,800 ($60,00 0) 289,000 $361,000 200,000 136,000 $25,000 166,800 $258,20 0 80,000 78,200 $100,00 0 760,000 $55,000 550,000 340,000 $65,000

The fixed selling and administrative expenses are allocated to products in proportion to revenue. The fixed cost of units sold is allocated to products by various allocation bases such as square meters for factory rent, machine hours for repairs etc. Triangles management is concerned about the loss for the Isosceles products and is considering two alternative forces of corrective action. Alternative A: The Company would lease some new machinery for the production of Isosceles. The annual rental of the new machinery would equal $50,000. Management expects that the new machinery would reduce variable production cost so that the total variable production costs for Isosceles would be 20% Isosceles revenues. The machinery would increase the total fixed cost and expenses (production and administrative) by $40,000 per year. Because of the increased quality of production of the new machine it is expected that sales of Isosceles will increase by 10%. Alternative B The Company would discontinue the manufacture of Isosceles. Selling prices for Equilateral and Scalene would not change. Management expects that scalene production and revenues would increase by 50%. However production and revenues of Equilateral would decrease by 10%. Some of the production machinery devoted to Isosceles could be sold at scrap value, which would equal its removal costs. The removal of this machinery would reduce the fixed costs and expenses by $30,000 per year. The remaining fixed costs and expenses allocated to Isosceles include $155,000 of rent expense per year. The space previous used for Isosceles can be rented to an outside organization for $157,500 per year. Required Prepare a schedule analyzing the effects of Alternative A and Alternative B on projected net income before income taxes. Use incremental analysis. Problem No 17 (make or buy)

43 Newman Enterprises Ltd manufactures Widgies for use in the production of Winkle, a major sales product for the company. The cost per unit for 10,000 Widgies is as follows: Direct materials Direct labor Variable overhead Fixed overhead Total $3.00 15.00 6.00 8.00 $32.00

John Black Corporation has offered to sell Newman 10,000 widgets for $30 each. Also $5 per unit of the fixed overhead applied to Widgets would be totally eliminated. Required: 1. What decision would you make and why? 2. What other things would you consider before making your decision. Explain each to the purchasing department.

Problem No 18

44

The Western Company is considering the addition of a new product to its current product lines. The expected cost and revenue data for the new product are as follows: Annual Sales Selling price per unit Variable costs per unit: Production Selling Direct fixed costs per year: Production Selling Unavoidable allocated fixed corporate costs per year 3,000 units $309 $130 $50 $51,000 $75,000 $54,000

If the new product is added to the existing product line, then sales of existing products will decline. Therefore, the contribution margin of the other existing product lines is expected to drop by $78,000 per year. a) If the new product is added next year, what would be the change in net income resulting from this decision? b) What is the lowest selling price per unit that could be charged for the new product without reducing the net income from its current level?

45

Problem No 19 WCL, a producer of precision tools, has a production capacity limit of 4,000 laser machine hours and 1,000 image machine hours. The direct costs per hour to operate the machines are $ 15 and $ 20, respectively. A prospective customer, company K, offered $ 35,000 to WCL to build a custom tool. The materials involved are expected to cost $ 5,000, and 200 laser machine hours and 10 image machine hours would be required. Indirect overhead is allocated based on the following regression equation: y = 200,000 + 50 x + 10 z, where y is total overhead cost, x is laser machine hours and z is image machine hours. 1 Assume that, if the offer from company K is accepted, WCL will just reach its operating capacity. By what amount would WCLs income increase by accepting the offer? a) b) c) d) e) $8,300 $16,700 $21,700 $26,800 $31,800 $35,000 $5,000 3,000 200 10,100 18,300 $16,700 2 Assume that both machines are operating 90% of capacity, all current production is sold at $ 1,500 per unit, each unit requires $ 250 of direct materials, 4 laser machine hours, and 1 image machine hour to produce, indirect variable overhead costs are

Revenue Variable cost: Direct material Laser machine (200$20) Image machine (10$15) Variable OH (50200) + (1010)

46 $ 200 per unit, and indirect fixed overhead costs are $ 225 per unit based on full capacity. A new prospective customer, customer L, offers to buy 240 units at $1,350 per unit. If the offer is accepted, all 240 units must be delivered by the end of the year. What is the opportunity cost of accepting this offer? a) $21,000 b) $36,000 c) $104,300 d) $135,800 e) $232,800 CM per unit of regular production: Price Variable Costs: Direct material Laser machine (4$15) Image machine (1$20) Variable OH

$1,500 $250 60 20 200

530 $970

At maximum capacity, 1000 units of product can be produces. Available capacity = 10% x 1000 = 100 units. WCL must forgo 240-100 = 140 units of regular sales in order to accept the offer. The opportunity cost = $ 970x 140 = $135,800

3 Assume the same information as in item 2 except that WCL can lease machinery to accommodate company Ls order at a cost of $ 70,000. By what amount would WCLs income change if company Ls offer is accepted and the machinery is leased? a) b) c) d) $254,000 $72,800 $106,000 $90,800 increase increase increase increase

47 e) $126,800 increase Contribution margin per unit from company L = $ 1,350 - $ 530 = $ 820 Total contribution margin from company L ($820x240) $196,800 Less cost of leased machinery to increase capacity 70,000 Total increase in income from company Ls offer $126,800

Problem No 20 Dirk Paul, president of the ace Publishing Company, is analyzing the firms financial statements for the past year. The firm publishes magazines weekly, monthly, and quarterly. Data for the past year are as follows. Quarterl y Sales Variable expenses Fixed expenses: Depreciation of special equipment Salary of editor Common cost allocated Net Income $125,00 0 65,000 7,500 20,000 43,750 $(11,250 Monthly $175,000 70,000 8,750 20,000 61,250 $15,000 Weekly Total

$200,000 $500,000 80,000 11,250 22,500 70,000 $16,250 215,000 27,500 62,500 175,000 $20,000

48 ) Allocation base for sales dollars

The equipment used is very specialized and has no resale value if its use is discontinued. Paul is considering discontinuing the quarterly magazine, because he claims it is decreasing the companys profitability.

Required:

As Mr. Pauls advisor, assist him in determining whether to continue the quarterly magazines. Use contribution margin income statement to support your advice.

Solution (P-20)

49

With Quarterl y Sales Variable expenses Fixed expenses: Depreciation of special equipment Salary of editor Common cost allocated Net Income $500,00 0 215,000 27,500 62,500 175,000 $20,000

Without Quarterly l $375,000 150,000 27,500 62,500 175,000 ($40,000)

Differenti al Analysis ($125,00 0) 65,000 0 0 0 ($60,000)

50

Problem No 21 (Closing and opening store) Ravi, an entrepreneur runs two convenience stores, 0ne in Gurgaon and the other in Noida. Operating income for each store in 2006 is as follows: Gurgaon Store $1,070,00 0 750,000 90,000 42,000 25,000 43,000 50,000 1,000,000 70,000 Noida Store $860,000 660,000 75,000 42,000 22,000 46,000 40,000 885,000 (25,000) Total $1,930,00 0 1,410,000 165,000 84,000 47,000 89,000 90,000 1,885,000 $45,000

Revenue Cost of Goods sold Lease rent(renewable each year) Labor costs(paid on hourly basis) Depreciation of Equipment Utilities Allocated corporate costs Total operating cost Operating Income

The equipment has a zero disposal value. Mohan the accountant has the following comment, Ravi can increase his profitability by closing down The Nodia store or by adding another store like it.

Required:

51

1. Differental analysis by closing Nodia Store. 2. Differental analysis by adding new store like Nodia.

Solution (Problem No 21)

1.

Revenue Cost of Goods sold

With Noida Store $1,930,00 0 1,410,000

Without Differentia Noida l Analysis Store $1,070,00 $(860,000 0 ) 750,000 660,000

52 Lease rent(renewable each year) Labor costs(paid on hourly basis) Depreciation of Equipment Utilities Allocated corporate costs Total operating cost Operating Income 165,000 84,000 47,000 89,000 90,000 1,885,000 $45,000 90,000 42,000 47,000 43,000 90,000 1,000,000 8,000 75,000 42,000 0 46,000 0 823,000 ($37,000)

53

Problem No 21 (Machine Replacement) Village Pizzas owner bought his current Pizza oven two years ago for $9,000, and it has one more year of life remaining. He is using straight line depreciation for the oven. He could purchase a new oven for $1,900, but it would last only one year. The owner figures the new oven would save him $2,600 in annual operating expenses compared to the old one. Consequently, he has decided against buying the new oven, since doing so would result in a loss of $00 over the next year.

Required

How do you suppose the owner came up with $400 as the loss for the next year if the new pizza oven were purchased? Criticize the owners decision and prepare correct analysis of the owners decision.

Solution (P-21)

1. Saving in annual operating expenses if old pizza oven is replaced $2,600 BV (3,000) Loss ($400) of old oven ($9,0003)

54 2. Saving in annual operating expenses if old pizza oven is replaced $2,600 Cost (1,900) Net benefit $700 of new machine

The owners analysis is flawed, because the book value of the old Pizza oven is a sunk cost. It should not enter in equipment replacement decision.

Problems from Helmkamp ( 7th Edition)

(A)

Decision Making

1. Problem 7-2

Evaluating a Special Order ( page 324)

55 Flame Company manufactures gas grills and is considering expanding production. A distributor has asked the company to produce a special order of 8,000 grills to be sold overseas. The grills would be sold under a different brand name and would not influence Falmes Companys current sales. The plant is currently producing 95,000 units per year. The companys maximum capacity is 100,000 units per year, so the company would have to reduce the production of units sold under its own brand name by 3,000 units if the special order is accepted. The companys income statement for the previous year is presented below:

Sales ( 95,000 units) Cost of goods sold: Direct material Direct labor Manufacturing overhead Gross Profit Selling expenses Administrative expenses Net Income 575,000 237,500 $2,375,0 00 1,900,00 0 1,425,00 0

$7,125,0 00

(5,700,0 00) 1,425,00 0 812,500 $ 612,500

The companys variable manufacturing overhead is $10 per unit and the variable selling expense is $5 per unit. The administrative expense is completely fixed and would increase by $5,000 if the special order is accepted. There would be no variable selling expense associated with the special order, and variable manufacturing overhead per unit would remain constant.

The companys direct labor cost per unit for the special order would increase 20% while direct material cost per unit for the special order would increase 10%.. Fixed manufacturing overhead and fixed selling expense would not change.

56

Required: If the distributor has offered to pay $65 per unit for the special order, should the company accept the offer? Justify your answer.

Revenue from Special order (8,000 $65) Cost of goods sold: Direct material ( 8,000 $27.50) Direct labor ( 8,000 $24) V. Manufacturing overhead ( 8,000 $10) Administrative expenses Profit from special order Less profit on lost regular sales 3,000 ( 75-25-2010-5) Net loss from special order $220,00 0 192,000 80,000 5,000

$520,00 0

(497,000 ) 23,000 (45,000) $ (22,000)

The special order should not be accepted

DM ($2,375,000 95,000) 1.10 = $ 27.50 DL ($1,900,000 95,000) 1.20 = $ 24.00

2. Problem 7-5 ( page 326)

Considering the Deletion of a product

The controller of Sanford Company is reviewing the financial summary of the companys three products. He is trying to find a way to

57 increase the profitability. The financial data for the past twelve months are as follows: Product X $ 31,500 34,920 (3,420) 7,065 $ (10,485) $3.50 1.25 0.50 9,000 Product Y $25,000 11,875 13,125 4,975 $ 8,150 $5.00 1.25 0.59 5,000 Product Z $45,000 17,640 27,360 7,440 $19,920 $7.50 1.50 0.63 6,000 Total $101,500 64,435 37,065 19,480 $17,585

Sales Cost of goods sold Gross Profit Selling & Administrative expenses Net Income Sales price per unit Variable CGS per unit Variable selling and admin expenses per unit Units sold

The controller analyzes the above data and decides that Product X should be discontinued because it is showing a net loss. Required: (A)The controller analysis the above data and decides that Product X should be discontinued because it is showing a net loss. What will be effect on net income if it is discontinued?

Product X Sales V. CGS S&A CM FC Mfg (64,635 26,500) S & A (19,480 11,230) NI $ 31,500 90001.2 5= 11,250 90000.5 = 4,500 15,750

Product Y $25,000 50001. 25 = 6,250 50000. 59 = 2,950 15,800

Product Z $45,000 60001. 5= 9,000 60000. 63 = 3,780 32,220

Total $101,500 26,500 11,230 63,770 (37,935) (8,250) $17,585

58 Since Product X has a positive CM of 15,750, the firms profit will be increased by that amount if product is dropped.

(B) If Product X is discontinued causing an additional loss of 100 units of Product Z, what will be the total impact on net income?

Decrease in profit from Part A Lost CM from product Z 100 units (32,220 6000)

$15,750

537 $ 16,287

3.

Problem 7-12 products ( page 330)

Differential Analysis and Joint

Stewart Company produces two joint products, X and Y. The annual production is 10,000 units of X and 6,000 units of Y at a joint cost of $102,000. Product X can be sold for $10 per unit at the split-off point and Product Y can be sold for $16 per unit. Product Y can be further processed at cost of $2,000 into products A and B. The additional processing will produce 4,000 units of A and 2,000 units of B. The selling price of product A is $12 per unit and Product B sells for $20 per unit. Product X can be processed further at an annual cost of $20,000 and sold for $20 per unit.

Which product should be sold at the split-off point and which should be processed further.

59

At Split off

Product X Product Y

10,000 10 = $100,000 6,000 16 = $96,000

Process Further

Product X Product Y

10,000 20 20,000= $180,000 4,000 12 + 2,000 20 2000 = $86,000

Process X further and sell Y at split off

4. Problem 7-10 329

Evaluating a make-buy decision ( page

1. Oklahoma Generator Company manufactures small electric motors for which a small part is needed. The following cost data have been accumulated for the 16,000 parts the company manufactured during the previous year: Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead $32,00 0 88,000 72,000 112,00 0

The company can buy the part from another firm for $19 per unit. If the firm buys the item, it will be able to reduce fixed manufacturing

60 overhead costs by $60,000 per year. It will also be able to rent some of the facilities currently used to make the part to another firm for $40,000. Required: Should the Company continue to make the part, or should it be purchased from the other firm.

Cost of Producing Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Cost of Purchasing Purchsae 16,0000$19 New FC (112,000 60,000) Less rental income $304,000 52,000 40,000 $316,000 $32,000 88,000 72,000 112,000 $304,000

Advantage of Producing = 316,000 304,000 = $12,000