36

Chapter 10

CHAPTER 10
RELEVANT INFORMATION FOR DECISION MAKING
QUESTIONS
1.

Relevancemeansthatafactorshouldbeconsideredinmakingadecision.A
relevantcostisacostthatisapplicable,pertinent,orlogicallyrelatedtomakinga
decision.Inbusiness,managersusetheconceptofrelevantcostsintheallocation
ofresources.

2.

Timeiscorrelatedwithrelevance.Forcoststoberelevant,theymustresidein
thefuture;historicalcostsareneverrelevant.
Further,themoredistantinthefutureacostresides,themorelikelyitistobe
relevant.Forexample,inthelongrun,certainfixedcostsarelikelytoberelevant;
however,intheshortrun,mostfixedcostsarenotrelevant.

3.

Opportunitycostsarebenefitsthataresacrificedtopursueonedecision
alternativeoveranother.Thesecostsaredifficulttoidentifybecausetheydonot
appear as costs in accounting records. For example, in allocating scarce
resources,managersmaydecidetoproduceProductAratherthanProductB.An
opportunitycostofthisdecisionisthelostcontributionmarginonProductB.The
lostcontributionmargindoesnotappearintheaccountingrecordsasanexpense.

4.

Sunk costs are costs that have already been incurred (i.e., they are
historicalcosts).Sunkcostsareneverrelevanttodecisionsbecauseonceacost
hasbeenincurred,itcannotbeunincurred.

5.

Outsourcingoccurswhenafirmchoosestoacquirenecessaryservice
functionsormaterials fromasupplierratherthanproducetheminhouse.The
movementfavoringoutsourcingiscontroversialbecauseitofteninvolveslossof
jobstotheorganizationelectingtooutsource.IntheUnitedStates,theoutsourcing
controversyisevenmoretensebecausevendorsselectedinoutsourcingdecisions
oftenareforeigncompanies.Thus,itcanbearguedthatoutsourcingleadstothe
movementofjobsfromtheUnitedStatestoothercountries.

6.

Ascarceresourceisanyinputthatconstrainsproductioncapacity.In
theshortrun,anyconstraintcanbebindingandthetightestconstraintchanges
overtime.Forexample,inalaborstrike,directlabormaybethemostconstrained
resource.Ifamachinebreaksdown,theconversionoperationperformedbythat
machine may be the most binding constraint on capacity, and if a supplier
becomesbankrupt,certainmaterialsmaybecomethemostbindingconstraint.

7.

Theobjectofmanagingthesalesmixistoincreasethecontribution
margin(ortotalprofit)realizedonthesaleofaportfolioofproducts.Themajor
factorsthatcanbemanipulatedtochangeproductmixareproductprices,focusof
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37

Chapter 10

advertising and promotion, and the manner in which sales personnel are
compensated.
8.

Aspecialorderdecisioninvolvestheanalysisofanonrecurringsaleof
products. The typical circumstance involves the opportunity to sell products
outside of the normal marketing area or to a onetime customer. The usual
analysisinvolvesaconsiderationofincrementalcostsandincrementalrevenuesas
wellastheeffectoftheproposedsaleonexistingbusiness. A business may refuse
a special order because it could disrupt regular sales, not be sufficiently profitable,
be in violation of the Robinson-Patman Act, or be illegal.

9.

Segmentmarginissaleslessvariablecostsandavoidablefixedcosts.
Segmentmarginisusedindecisionsaboutwhethertokeeporeliminateaproduct
line.Thecostsdeductedinarrivingatsegmentmarginincludeonlyrelevantcosts
(totaldirectvariableexpensesandavoidablefixedexpenses).Thecostspresented
belowthelevelofsegmentmargintoderiveproductlineoperatingresultsare
irrelevantcosts(sunkdirectfixedcosts)becausesuchcostscouldnotbeavoided
orelimnatedshouldtheproductlinebediscontinued.

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Chapter 10

EXERCISES
10. a.

One option is to rework the shirts as described in the problem; a

secondoptionistoselltheshirtsasscrapmaterial;thethirdoptionistodo
nothingwiththeshirts,orsimplydiscardtheshirts.

b. TheonlysunkcostistheoriginalcostoftheTshirts,$11.75.
c. Reworkalternative:$5.50perTshirt.
Sellasrags:noincrementalcosts.
Donothing:noincrementalcosts.
d. Incrementalprofitofreworkalternative:$10.25$5.50=$4.75perTshirt
Incrementalprofitofsellingasrags:$2.60perTshirt
Incrementalprofitofdoingnothing:$0.
TherelativeadvantageofreworkingtheTshirtsis$4.75$2.60=$2.15
11.a. Theonlysunkcostisthepurchasecostofthelettuce,$0.65perhead;or$0.65
3,000=$1,950
b. Theunspokenalternativeistodonothing.Doingnothingmightsimplymean
throwingtheheadsoflettuceinadumpsteror giving them to a food bank or
shelter.
c.
Incrementalrevenue
Incrementalcosts
Incrementalprofit

Do
Nothing
$0
0
$0

Sellto
Wholesaler
$750
0
$750

Sellto
Restaurant
$3,150
2,500
$650

Based on a comparison of the incremental profits associated with each

alternative,thecompanyshouldsellthelettucetothewholesaler.
12.

The minimum price is equal to the incremental cost of selling the

obsoleteunits.Theonlycostthatwillbeincurredtoselltheunitsisthevariable
sellingcostof$200.40or$8.Ifthefirmcanselltheunitsformorethan$8,the
firmisbetteroffthanitwouldbebysimplydestroyingtheunsoldunits.

13.a. Therelevantfactorsincludethedifferencebetweenthestartingsalariesfor
B.A.sandM.A.s,timeuntilretirement,timetocompletetheM.A.,andthe
outofpocketcoststoobtaintheM.A.
b. Theopportunitycostassociatedwithearningthemastersdegreeistwoyears
income that couldhavebeenearnedwiththeB.A.degree ($49,400 2=
$98,800).
c. Theoutofpocketcostwouldincludethecostoftuition,books,labfees,and
otherdirecteducationalcosts($94,000).Itwouldnotincluderoomandboard
orotherlivingexpensesthatwouldbeincurredirrespectiveofwhetherthe
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39

Chapter 10

studentworks(withtheB.A.degree)orattendsschool.
d. Theotherfactorstobeconsideredwouldbethequalitativefactors,e.g.,the
relativesatisfaction,prestige,andhappinessobtainedfromjobsthatcanbe
securedwitheachdegree,andeachalternativeseffectonretirementplans,
freetime,andtravelopportunities.
14.a. YouwouldexplaintoCatanacthatthepurchasecostof$95isnotrelevantto
anydecisionshecannowmakeregardingtheDVDplayer.Nomatterwhat
actionshetakesnow,the$95isnotarecoverablecost.Indecidingwhich
actiontotake,Catanacshouldconsideronlythosecoststhatcanbeavoidedby
takingoneaction ratherthananother.Anycostthatisthesameacrossall
decision alternatives can be ignored; such a cost is not relevant. Ignoring
qualitativefactors,Catanacshouldselectthealternativethatminimizestotal
relevantcosts.
b.

Herlogicalchoicesare(1)repairtheDVDplayeratanestimatedcostof
$75and(2)purchaseanewDVDplayer.Accordingly,thedecisionwould
logicallybemadebycomparingthepurchasecostofanewplayertotherepair
costofthebrokenplayer.However,Catanacmaywanttoconsiderdifferences
infeaturesbetweentheexistingDVDplayerandreplacementplayersaswell.
Shemaybewillingtopaymorethan$75foranewplayerifithasadditional
features.Thiswouldbeaqualitativeconsideration.

15.a. Thesunkcostistheoriginalcostoftheoldequipment,$350,000.
b.

Irrelevant future costs include $16,000 of cash operating costs and the
(nondifferential)salvagevaluesinfiveyears.

c.

Therelevantcostsincludethecostofthenewequipment,$396,000,the
currentsalvagevalueoftheoldequipment,$88,000and$48,000ofannual
cashoperatingsavings.

d.

Theopportunitycostsassociatedwithkeepingtheoldequipmentinclude
thepotential$48,000savingsincashoperatingcosts,andthecurrent$88,000
salvagevalueoftheoldequipment.

e.

The incremental cost to purchase the new equipment is the difference

betweenthepurchasecostofthenewmachineandthecurrentsalvagevalueof
theoldmachine,$396,000$88,000=$308,000.

f.

Some qualitative factors to be considered would include how the new

machinewouldaffectthequalityofproductionrelativetotheoldmachine,
effects on employee morale if purchasing the new machine would require
layoffs, andwhether current employees have theskills tooperate the new
machine.

16.Incrementalsavings($32,00010)
Incrementalcostofsoftware($840,000$356,000)

$320,000

(484,000)

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Chapter 10

Incrementalloss

$(164,000)

From a quantitative perspective, the new software should not be purchased

becauseitwillresultinincrementallossesof$164,000.

17. a. Relevantcosttomanufacture=$4.60
Relevantcosttobuy=$4.00
Advantageofbuying:120,000($4.60$4.00)=$72,000
b.Relevantcosttobuy
Avoidablevariablecosts
Minimumavoidablefixedcosts

$4.00
(3.48)
$0.52perunit

18. Therelevantcoststomakethebumpersincludeonlythevariablecosts:
Directmaterial
$53(incl.purchasedmountinghardwareat$15)
Directlabor
17
Overhead($451/3)
15

Total
$85
Incrementalprofitperbumper=$170$85=$85
Increasedprofitfromreleasedfacilities:($854,800)
Increasedcostofproductiononfirst300,000units:
($20$15)300,000
Netlossfrompurchasingmountinghardware

$408,000

(1,500,000)
$(1,092,000)

19.a.Costtomake:$27,000+($2.7025,000)
Costtobuy:25,000$3.60
Advantageofpurchasing

$94,500
(90,000)

$4,500

b.Costtomake:$27,000+($2.7060,000)
Costtobuy:60,000$3.60
Disadvantageofpurchasing

$189,000
(216,000)

$(27,000)

c.

Pointofindifferenceoccursatthevolumelevelthatequatesthecostto
makewiththecosttobuy:
$27,000+$2.70X=$3.60X
X=30,000units

a.
Contributionmargin
Dividebylabortimeperunit
CMperunitoflabortime

MP3Players
$14
1
$14

PDAs
$20
2
$10

Becausethecompanycansellasmanyofeitherproductasitcanmake,itshould
makeonlyMP3players.Thecompanyshouldmake100,000MP3players.
b. The company should consider the need to provide a market assortment of
goodsandthepossibilityofcustomerpreferencespermanentlychangingto
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41

Chapter 10

PDAsnotmadebySierraSoundSystems.Thisisacknowledgingthepossible
longtermconsequencesofashorttermproblemsolution.
21.a.
Revenue
Variablecost
Contributionmargin

Individual
$350

(50)
$300

Estate
$1,200

(200)
$1,000

Corporate
$750

(150)
$600

Contributionmarginperhourofprofessionaltime:
Individual:$3002
$150
Estate:$1,0008
$125
Corporate:$6005
$120
AccordingtotheCMgeneratedperhourofprofessionaltime,Whitewould
prefer to satisfy demand for services in the following order: individual
taxation,estatetaxation,andcorporatetaxation.BecauseallofWhitestime
couldbeconsumedinprovidingindividualincometaxservices,allofhertime
shouldbededicatedtoprovidingthatservice.
b.

Contributionmargin:2,000$150
Fixedcosts
Pretaxincome

$300,000

(80,000)
$220,000

c. Whiteshouldcarefullyconsidertherelationshipbetweenthethreeservicesshe
offers.Forexample,muchofthedemandforindividualandestatetaxservices
maybegeneratedbytheservicessheprovidescorporateclients.Itmaybe
becauseofthequalityofhercorporatetaxservicesthatdemandisgeneratedto
provideindividualincomeandestatetaxservices.Accordingly,theremaybe
longterm negative consequences to providing only individual income tax
services.
d. Whitecouldovercomethetimeconstraintinoneoftwogenericways.First,she
couldemployaccountantsinherfirmtodoworkinallservicelines.Second,
shecouldengageinajointventureorpartnershipwithotherfirmstoprovidethe
fullarrayofservicestoclients.
22.a.
Revenue
Laborcost
Materialcost
CM
Fixedcost
Incomebeforetaxes
b.Contributionmargin
Dividebysales
Contributionmargin%

Grooming
$1,500,000
(600,000)

(180,000)
$720,000

(250,000)
$470,000

Training
$1,400,000
(820,000)

(140,000)
$440,000

(260,000)
$180,000

Total
$2,900,000
(1,420,000)

(320,000)
$1,160,000

(510,000)
$650,000

$720,000
$440,000
1,500,000
1,400,000
48% 31%(rounded)

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Chapter 10

If$1spentonadvertisingcouldincreaserevenuebyeitherserviceby$20,it
should be spent on grooming because it has a higher contribution margin
percent.
c.
Revenueperhr.
Variablecostsperhr.
CMperhr.

Grooming
$50
(26)
$24

Training
$70
(48)
$22

Because$1willyield$24inCMifspentongrooming,butyieldonly$22in
CMifspentontraining,the$1shouldbespentadvertisingthecompanys
groomingservices.
23.a. Sales(120,000$60)
Variablecosts[($25+$12)120,000]
Contributionmargin
Fixedcosts
Projectedprofit
b.

c.

$7,200,000

(4,440,000)
$2,760,000

(1,240,000)
$1,520,000

Newsales[(120,0001.20)($600.90)]
Newvariablecosts[(120,0001.20)$37]
Newcontributionmargin
Oldcontributionmargin
Changeinprofit

$7,776,000

(5,328,000)
$2,448,000

(2,760,000)
$(312,000)

ChangeinCM($2,760,0000.20)
Changeinfixedcosts
Changeinprofit

$552,000

(185,000)
$367,000

24. a.Profiteffectofoption1:
CellPhones
$10,500,000

(8,960,000)
$1,540,000

EarBuds
$800,000

(200,000)
$600,000

Charger
Total
$400,000 $11,700,000
(140,000) (9,300,000)
$260,000 $2,400,000

(1,000,000)
$1,400,000

Increaseinsales
IncreaseinVC
Contributionmargin
IncreaseinFC
Increaseinprofits
*
Newsalesvolumewouldbeasfollows:
Cellphones:2,200,0000.70=1,540,000
Earbuds:2,200,0000.20=440,000
Charger:2,200,0000.10=220,000
Changeinsalesvolumewouldbeasfollows:
Cellphones:1,540,0001,400,000=140,000
Earbuds:440,000400,000=40,000
Charger:220,000200,000=20,000
*

Profiteffectofoption2:
CellPhones
Increaseinsales*
$115,500,000

EarBuds
$10,000,000

Charger
$5,000,000

Total
$130,500,000

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43

Chapter 10

IncreaseinVC

(112,000,000) (2,500,000) (1,750,000)

(116,250,000)

Contribution
margin
$3,500,000
$7,500,000 $3,250,000 $14,250,000
IncreaseinFC

(0)
Increaseinprofits
$14,250,000
*
(1,750,000$70)[1,400,000($75$70)]

Thepreferredalternativeistodecreasethepriceofcellphonesto$70.This
alternative increases profits by $14,250,000 $1,400,000 = $12,850,000
relativetothealternativeofdecreasingthepriceofcellphones.
b. Onealternativeistodecreasethepriceoftheearbudsandcharger.Although
this alternative would minimally impact cell phone sales volume, sales
volumesforearbudsandchargersshouldincrease.Anotheralternativewould
betofocuspromotionaleffortsontheearbudsandthechargerinadditionto
thecellphones.
25. a.Onlythevariableproductioncostsarerelevanttothisdecision:$560+$40+
$50=$650.
Incrementalrevenue:$670200
Incrementalcosts:$650200
Incrementalprofit

$134,000
(130,000)
$4,000

Profitswouldincreaseby$4,000ifthisspecialorderwasaccepted.
26. a.Therelevantcostsincludethelostcontributionmarginassociatedwiththe20
unitsofregularproductionthatwouldbesacrificedtoacceptthespecialorder,
andthevariableproductioncostsforthethreespecialstands:

b.

Normalsalesprice(20$230)
Variablecosts(20$100)
Lostcontributionmargin
Productioncosts(3$690)
Totalcosts

$4,600
(2,000)
$2,600
2,070
$4,670

Additionalsales
Lesstotalrelevantcosts
Incrementalloss

$3,800
(4,670)
$(870)

27. a. If the U.S. division had been eliminated, Borderlands income statement
wouldhaveappearedasfollows:
Sales
Variablecosts
Contributionmargin
Fixedcosts:
Direct
Corporate
Operatingincome(loss)

$3,600,000

(2,088,000)
$1,512,000
$490,000
2,790,000

(3,280,000)

$(1,768,000)

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Chapter 10

b.

Sales
Variablecosts
Directfixedcosts
Segmentmargin
Corporatecosts
Operatingincome(loss)

UnitedStates
Mexico
Total
$7,200,000
$3,600,000 $10,800,000
(4,740,000) (2,088,000) (6,828,000)

(800,000)
(490,000)
(1,290,000)
$1,660,000
$1,022,000 $2,682,000

(2,790,000)
$(108,000)

If the U.S. division is eliminated, corporate income would decline by the

$1,660,000ofsegmentmargincurrentlybeinggeneratedbythatdivision.The
commoncorporatecostsof$2,790,000wouldthenneedtobecoveredintotal
bytheMexicodivision,whichitcannotdo.

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45

Chapter 10

28.a. GrossmarginGLservices
Avoidablefixedandvariableoperatingcosts
Segmentmargin

$1,200,000

(1,470,000)
$(270,000)

Yes, the company should strongly consider dropping the GL service line
becauseitgeneratesanegativesegmentmarginof$270,000.
b. Thepretaxprofitofthecompanywouldriseby$270,000(theamountofthe
negativesegmentmarginoftheGLserviceline)iftheGLareawasdropped.

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Chapter 10

PROBLEMS
29.a. Thelossonthesaleofthewarehouseshouldnotberelevanttothedecisionto
sellthewarehouse.Thelossarisesonlybecauseasunkcost(netbookvalueof
thewarehouse)isincludedinthelosscalculation.However,becausetheloss
on the sale will affect the performance evaluation and compensation of
Cosgrove,Cosgrovewilllikelyconsiderthelossinherdecisionwhetherto
keepthewarehouse.
b. Inthelongrun,theremainingcostofthewarehouse,$12,200,000,willbe
chargedagainstincomenomatterwhatcourseofactionCosgrovetakes.Ifthe
buildingisretained,itscostwillbewrittenoffthroughperiodicdepreciation
charges;ifthebuildingissold,itsbookvaluewillbedeductedfromthesales
price.Accordingly,onecouldadviseCosgrovethatthebestlongtermcourse
ofactionistogoaheadandsellthewarehouseandcapturetheincremental
benefitof$7,000,000assuming that the warehouse will never appreciate so
that it would not be held as an investment.
30.a. Costofnewmachine
Salesvalueofoldmachine
Incrementalcostofnewmachine
Operatingcostsavings($295,0005)
Netadvantageofbuyingnewmachine

$(1,600,000)

200,000
$(1,400,000)

1,475,000
$75,000

b. The qualitative factors that should be considered include any quality

differencesbetweentheoutputgeneratedbythetwomachines,whetherthe
companysemployeeshavetheknowledgetooperatethenewmachine,how
acquisitionofthemachinewouldaffectsafetyconsiderations,andthecapacity
levelsofthetwomachines.
31. a. Therelevantcostsincludethecosttopurchasethenewturbine,thecurrent
marketvalueoftheoldturbine,andthedifferenceinannualoperatingcosts
betweentheoldandnewturbines.
b.Incrementalcostofnewturbine:$6,000,000$400,000
Incrementalcostsavingsofnewturbine:
[($210,000$45,000)4]8
Incrementalprofitfrombuyingnewturbine
c. Themaximumamountthatthecompanycouldpay:
Totalannualoperatingsavings
Cashvalueofoldmachine
Total

$(5,600,000)

5,280,000
$(320,000)
$5,280,000
400,000
$5,680,000

d. Some of the factors to consider would include the reliability of the

technologies,thedifference inlives ofthetechnologies, theenvironmental
impactsofthetechnologies,andrelativerisksofusingthetwotechnologies.
32.a. Ethicalissuestoconsider:whetherthecompetitorisexploitingtheworkers;
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47

Chapter 10

whether the competitor is displacing the domestic workforce; whether the

competitor is violating the rights of other companies to fair competition;
effects on the various stakeholders including customers (competitors and
Tates)ofusingtheillegalworkersandofnotusingtheillegalworkers.In
addition,thereexiststhelegalissuethathiringillegalaliensisunlawful.Tate
Electronicsisconsideringknowinglyandwillfullybecominganaccomplice
bypurchasingfromthissupplier.
b. Theshortrunadvantagesarebuyingatalowerpricetobemoreprofitable,
beingabletosellatalowerpriceandthereforesellmorecomputers,havinga
competitive advantage,andpleasingthecustomerswhowillappreciatethe
lower prices. The potential disadvantages are longer run: damage to the
business community and to the socioeconomic balance; damage to the
companys reputation; possible fines and/or imprisonment if coconspiracy
couldbeproven;illeffectsonworkerswhoareexploited;anddisadvantages
todomesticworkerswhoareunabletoobtainjobs.
c. Tateshouldinvestigatefurtherthehiringpracticesofthesupplierorallowthe
proper authorities todoso.Ifsatisfied that thesupplier is following legal
practices,Tateshouldperformthenecessarycostanalysisforamakeorbuy
decision. If the supplier is found to be hiring illegal aliens, Tate should
continuetomakeitsownkeyboards.
33. a.Relevantcostsinclude:
Variableproductioncosts:($0.08+$0.06+$0.04)or$0.18perunit
Annualsalaryofmanagerwhocanbereplaced:$50,000
Vendorsofferingprice:$0.19perunit
b. Productioncostssaved($0.184,000,000)
Salarysavings
Purchasecostofpart($0.194,000,000)
Advantageofoutsourcingthepart

$720,000
50,000

(760,000)
$10,000

c. Otherconsiderationsincludetherelativequalityofthepartacquiredfromthe
vendorandthepartproducedinternally,theabilityofthevendortodeliverin
atimelymanner,theexistenceofcompetitorsofthevendor,thelikelihoodthat
futurevolumelevelswilldifferfrompresentvolumelevels.
34.a. Costtomake:
Directmaterial
Directlabor($1320.75)
Variableoverhead($860.75)
Fixedoverhead:
Rentalvalueofproductionspace($228,00050,000)
Depreciationonnewmachine($10,000,0005)50,000
Totalunitcost
Costtobuy:

$278.00
99.00
64.50
4.56
40.00
$486.06
$480.00

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Chapter 10

b. If60,000subassemblies wererequiredannually,thecosttomakewould
changebecauseofthelowerfixedcostsonaperunitbasis.Thedepreciation
would be ($10,000,000 5) 60,000 = $33.33, and the rental value
opportunitycostwoulddeclineto:$228,00060,000=$3.80.Thiswould
changetheoverallcosttomaketo$278.00+$99.00+$64.50+$33.33+
$3.80=$478.63.Atthisvolumelevel,theadvantageisslightlyinfavorof
making.
c. If75,000subassemblies wererequiredannually,thecosttomakewould
againchangeduetothelowerfixedcostsonaperunitbasis.Thedepreciation
wouldbe($10,000,0005)75,000=$26.67,andtherentalvalueopportunity
costwoulddeclineto$228,00075,000=$3.04.Thiswouldchangetheoverall
costtomaketo$278.00+$99.00+$64.50+$26.67+$3.04=$471.21.Atthis
volumelevel,theadvantageissignificantlyinfavorofmaking.
d. Qualitativeconsiderations:

Qualitycontrolsystemsinplacebypotentialsupplier

Reliabilityofthesupplier

Riskoffuturepriceincreasesbysupplier

Leadtimetoreceiveorders

Numberofcompetingsuppliers

Laborrelationsinsuppliersplants
35.Thefirststepistocomputethecontributionmarginforeachproduct.
ProductP ProductQ ProductR ProductS
Salespriceperunit
$10.00 $15.00
$7.00
$11.00
Variablecostofgoodssold
2.50
3.00
6.50
6.00
Variableoperatingexpenses
1.17 1.25

1.00
1.20
Contributionmarginperunit
$6.33 $10.75
$(0.50) $3.80
Unitssold
1,000
1,200
1,800
2,000
Totalcontributionmargin
$6,330 $12,900
$(900)
$7,600
a. DroppingProductPwouldresultinalostcontributionmarginof $6,330with
aconsequentlossofthesameamountofoperatingincome.
b. Because Product R currently has negative contribution margin of $900,
operatingincomewillincreaseby$900ifProductRisdropped.
c. IfdroppingProductRresultsinalossofsalesof200unitsofProductQ,the
companysoperatingincomewilldecreaseby$1,250:
ImpactofdroppingProductR
ImpactoflosssalesofProductQ:200$10.75
Impactonincome
d. Thecompanysincomewillincreaseby$1,650:
Before
Sellingprice
$7.00
Variablecostperunit
7.50

$900
(2,150)

$(1,250)
After
$8.00
7.50

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49

Chapter 10

Contributionmarginperunit
Unitssold
Totalcontributionmargin

$(0.50)
1,800
$(900)

$0.50
1,500
$750

Increaseincontributionmargin:$1,650

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accessible website, in whole or in part.

Chapter 10

Incrementalapproach:
Increaseincontributionmargin($1.001,500units)
Increasebyavoidingsalesof300units
atnegativeCM(3000.50)
Increaseintotalcontributionmargin

$1,500
150
$1,650

e. Pooleismistaken.Thedecisionlacksgoalcongruence.Althoughtheincrease
intotalsaleswillhaveabeneficialeffectonthecommissionsofthesalesstaff,
thecompanyasawholewillsuffer,astotalcontributionmarginwilldecrease
by$2,266.Sincethefixedcostswillbeunaffectedintotal,thecompanys
operatingincomewilldecline.
Sellingpriceperunit
Variablecostsperunit
Contributionmarginperunit
Unitssold
Totalcontributionmargin

ProductS
$11.00
7.20
$3.80
2,000
$7,600

ProductT
$14.00
11.46
$2.54
2,100
$5,334

f. Traditionalaccountingdoesnotalwaystakeintoaccounttherelevantcostsof
decisions. Since fixed costs are often allocated, the total will not change
regardless of changes in volume. This sometimes gives product lines the
appearanceoflosingmoney.However,ifaproductthatprovidesapositive
contributionmarginisdroppedwithnochangeintotalfixedcosts,overall
company income will decline. Replacing Product S is only wise if the
replacementproductprovidesahigheroverallcontributionmarginthanProduct
S.
(AICPAadapted)
36.a.Theoutofpocketcostsperunitwillincreaseby$9,600:
Manufacture
Purchase
Directmaterial
$2,000
$0
Directlabor
16,000
0
Variablemanufacturingoverhead
($24,0001/3)
8,000
0
Componentpurchaseprice
30,000
Materialhandlingcost(20%ofDM)
400
6,000
Outofpocketcostperunit
$26,400
$36,000
b. Totalmonthlycostswouldincrease$46,000.
Monthlyoutofpocketcoststomanufacture:
Manufacture
(Requirementa)
$26,400
Numberofunits
10
Totalmonthlyoutofpocketcosts
$264,000
Rentalincome
0
Total
$264,000

Purchase
$36,000
10
$360,000
(50,000)
$310,000

Fixedmanufacturingcostisirrelevantbecauseitdoesnotchangeregardlessof
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51

Chapter 10

thedecision.
(CMAadapted)
37.a. Sincemachinehoursarethescarceresource,Callahanshouldmaximizethe
total profits by maximizing production of the product with the highest
contributionmarginpermachinehour.
Contributionmarginperunit:
Sellingprice
Directmaterial
Directlabor
Variableoverhead*
Contributionmarginperunit
Machinehoursperunit
Contributionmarginpermachinehour

Blender
$20
6
4
6
$4
1
$4

ElectricMixer
$38
11
9
12
$6
2
$3

*Fixedoverheadcostperunitaverages$10permachinehour.
Overheadcostperunit
Fixedoverhead$101;$102
Variableoverheadcostperunit

$16

10
$6

$32
20

$12

Becausetheblenderisthemostprofitableproductperunitoftheconstraining
factor, Callahan should maximize production of blenders based on market
demand.
The optimum strategy would be to produce 20,000 blenders and 15,000
electric mixers and purchase any additional electric mixers from outside
suppliersasneeded.
Totalavailablemachinehours

50,000

Annualmarketdemandofblenders
Machinehoursperunit
Totalmachinehoursusedbyblenders

20,000
1
20,000

Machinehoursavailableforelectricmixers
Machinehoursperunit
Maximumproductionofelectricmixers

30,000
2
15,000

b. IfCallahanisabletoreducethedirectmaterialcostperunitoftheelectric
mixerto$6,theelectricmixerwillbecomethemostprofitableproductper
unit of the constraining resource of machine hours. The company should
maximizeproductionofelectricmixers.Sincethemachinehoursavailable
exceedtherequiredmachinehourstomaximizeproductionofelectricmixers,
thecompanyshouldproduce25,000electric mixers andpurchaseallother
unitsasneededfromoutsidesuppliers.
Contributionmarginperunit
Machinehoursperunit

Blender
$4
1

ElectricMixer
$12
2

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Chapter 10

Contributionmarginpermachinehour

$4

Totalavailablemachinehours

$6

50,000

Annualmarketdemandofelectricmixers
Machinehoursperunit
Totalmachinehoursrequiredbyelectricmixers

28,000

2
56,000

Machinehoursavailableforelectricmixers
Machinehoursrequiredperunit
Annualproductionofelectricmixers

50,000
2
25,000

c. Duringthefluepidemic,thecompanyhasascarceresourceofdirectlabor.
While this shortage of direct labor exists, the company should maximize
productionoftheitemwiththehighestcontributionmarginperdirectlabor
hour.Basedonadirectlaborrateof$18perhour,ablenderhasacontribution
marginperdirectlaborhourof$18,whileamixerhasacontributionmargin
perdirectlaborhourof$12.Thecompanyshouldmaximizeproductionof
blendersduringthemonthandpurchaseallotherunitsasneededfromoutside
suppliers.
Blender
$18
$4
4.5
$4
$18

Directlaborcostperhour
Directlaborcostperunit
Unitsproducedperhour
Contributionmarginperunit[from(a)]
Contributionmarginperdirectlaborhour

ElectricMixer
$18
$9
2
$6
$12
(CMAadapted)

38. a. Theminimumacceptablepriceis$50perunit.Thecompanyhasexcesscapacity.
Itmustcoveritsincrementalcosts,whichare$20directmaterials+$15direct
labor+$12variableoverhead+$3shippingandhandling.
b. Theminimumacceptablepriceis$3perunit.Becausetheunitsaredefective
andcannotbesoldthroughregularchannels,allhistoricalcostsareirrelevant.
Thecompanyshouldconsideronlytheoutofpocketcostsofsellingtheunits,
whichwouldbethe$3perunitshippingandhandlingcosts.
c. Thetotalcontributionmarginwillbe$1,080,000.Allvariablecostsperunit
remainthesameexceptfordirectmaterials,whichincreaseby10percent.The
changeinfixedcostsdoesnotaffecttheunitcontributionmargin.
Sellingprice
Variablecostsperunit:
Directmaterial($201.1)

$160
$22

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53

Chapter 10

Directlabor
Variableoverhead
Shippingandhandling
Contributionmarginperunit
Numberofunitssold
Totalcontributionmargin

15
12

3
$108
10,000
$1,080,000

d. Givennoexcesscapacity,thepricemustcovertheincrementalcostsplusthe
opportunitycostof$100,000forthedisplacedcontributionmargin.
Incrementalcosts:
Directmaterial
Directlabor
Variableoverhead
Shippingandhandling
Opportunitycost:$100,000*1,000
Minimumprice

$20
15
12
3
100

$150

Opportunitycost=LostCM=$1001,000=$100,000

(CMAadapted)
39.a. Microsoft likely recognized the following costs in deciding to extend the
warrantofitsXbox360.

Coststohandlecustomerreturns

Costtorepairdefectiveunits

Lostcustomergoodwillbecauseofthedefectintheproduct

LostfuturesalesofXboxunits

LostsalesforXboxsoftwarebecauseoflostsalesofXboxunits

Lostrevenuesoffuturegenerationsofvideogames
b.

Microsoftsstockpricewasvirtuallyunaffectedbytheannouncement.There
are two primary reasons for this mild effect. First, the $1 billion cost is
relativelysmallcomparedtoMicrosoftstotalmarketcapitalization.Second,
investorsrecognizethatbyextendingthewarrantyontheXbox360,thecosts
identifiedin(a)areavoided.

c.

InadditiontotheXbox360hardware,Microsoftsellssoftwareorgamesfor
theXbox360.AnyfactorthataffectsXbox360saleslikelyalsoimpactssales
ofsoftware.Byconvincingthepublicthatitwouldcoverthecostsinthis
particular defect inthe Xbox360hardware,Microsoftundoubtedly caused
futuresalesofXbox360softwaretobehigherthantheyotherwisewouldbe.

d.

MicrosoftlikelyhadanethicalobligationtoextendtheXbox360warranty
withrespecttothisspecificdefect.Becausetherateofthisdefectwasmuch
higherthaneither Microsoftorthetypical customerexpected, therewasa
greaterobligationtoextendthewarrantythanwithnormalfailurerates.

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Chapter 10

40.a. Plan1:
Newcommissiononbelts=0.12($40$25)=$1.80
Newcommissiononkeyfobs=0.12($10$6)=$0.48
NewCMonbelts:($40$1.80$25$4)95,000=$874,000
NewCMonkeyfobs:($10$0.48$6$0.50)115,000=$347,300
Incomefrombelts:($874,000$580,000)
Incomefromkeyfobs:($347,300$180,000)
TotalPlan1income

$294,000
167,300

$461,300

Plan2:
NewFCforbelts:$580,000+$75,000=$655,000
Newsalesforbelts:119,000units
CM:($9119,000)=$1,071,000
Newsalesforkeyfobs:91,000units
CM:(91,000$3)=$273,000
Incomefrombelts:($1,071,000$655,000)
Incomefromkeyfobs:($273,000$180,000)
TotalPlan2income

$416,000
93,000
$509,000

Plan3
Newsalesforbelts:94,000units
CM:($1494,000)=$1,316,000
Newsalesforkeyfobs:90,000units
CM:$690,000=$540,000
Incomefrombelts:($1,316,000$580,000)
Incomefromkeyfobs:($540,000$180,000)
TotalPlan3income
b.

$736,000
360,000
$1,096,000

Plan3shouldbeadoptedbecauseitmaximizestotalincomerelativetothe
existingpriceandcoststructuresandPlans1and2.

41.a. Maximizethecontributionperunitofthescarceresource(directlaborhours):
Salesperunit
VCperunit
CMperunit
Hoursperbike
CMperhour

Racing
$3,600
(3,180)
$420
50
$8.40

Touring
$2,720
(2,230)
$490
35
$14

Basic
$960
(744)
$216
10
$21.60

Sincebasicbicycles yieldthegreatest contribution marginperdirectlabor

hour,thecompanyshoulddevoteallofitscapacitytotheirproductioninthe
absenceofmarketorotherrestrictions.Profitcanbedeterminedasfollows:
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55

Chapter 10

Productionofbasicbicycles=34,00010=3,400
Contributionmargin3,400$216
Fixedcosts
Pretaxincome
b.

$734,400
(500,000)

$234,400

In(a),itwasdeterminedthatbasicbicyclesarethemostprofitableproduct,
sothecompanywilldevote50percentofitstimetothatproduct.Racingbikes
yieldthelowestcontributionmarginperhour,so20percentofthetimeshould
bedevotedtothem.Thiswouldleave30percentofthetimetomanufacture
touringbikes.

Productionlevels:
Basic(34,0000.50)10
Touring(34,0000.30)35
Racing(34,0000.20)50

1,700
291(rounded)
136

Contributionmargin:
Basic(1,700$216)
Touring(291$490)
Racing(136$420)
Total
Less:Fixedcosts
Pretaxincome

$367,200
142,590
57,120
$566,910
(500,000)

$66,910

c.

Yes. The demand in this market is likely fragmented, with particular

consumerspreferringabicyclesuitedforaparticularpurpose.However,there
islikelyenoughdemandforthebasicbiketoabsorbtheentireproduction
capacityofthecompany.

d.

Thecompanystaxrateisirrelevantbecauseitdoesnotchangeacrossthe
choicesunderconsiderationinthisdecision.

42.a. Themanufacturingoverheadrateis$18perstandarddirectlaborhourandthe
standard product cost includes $9 of manufacturing overhead per pressure
valve.Accordingly,thestandarddirectlaborhourperfinishedvalveis0.5
hour ($9 $18). Therefore, 30,000units per month would require 15,000
directlaborhours.
b.
Incrementalrevenue
Incrementalcosts:
Variablecosts:
Directmaterial
Directlabor
Variableoverhead

PerUnit
$19.00

120,000Units
$2,280,000

$5.00
6.00
3.00

$600,000
720,000
360,000

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Chapter 10

Freightexpense
Totalvariablecosts
Fixedoverhead:
Supervisoryandclericalcosts
(4months$12,000)
Totalincrementalcosts
Incrementalprofitbeforetax

1.00
$15.00

120,000
$1,800,000
48,000
$1,848,000
$432,000

Sales commission and fixed factory overhead (direct and allocated) are
irrelevanttotheincrementalanalysis.
c.

TheminimumunitpricethatLaytonValvescouldacceptwithoutreducing
netincomemustcovervariablecostsplustheadditionalfixedcosts.
Variableunitcost
Additionalfixedcost($48,000120,000)
Minimumunitprice

d.

43.a.

LaytonValvesshouldconsiderthefollowingfactorsbeforeacceptingthe
PrinceIndustriesorder.

TheeffectofthespecialorderonLaytonValvessalesatregularprices.

The possibility of future sales to Prince Industries and the effects of

participatingintheinternationalmarket.

Thecompanysrelevantrangeofactivityandwhetherornotthespecial
orderwillcausevolumetoexceedthisrange.

Theimpactonlocal,state,andfederaltaxes.

Theeffectofscheduledmaintenanceofequipment.
(CMAadapted)
IceCream
$4,000,000

Sales
Variablecosts
Merchandisesold
(2,600,000)
Commissions
(200,000)
Deliverycosts

(600,000)
CM
$600,000
Avoidablefixedcosts
Allocatedcorporate
0
Managerssalary

(80,000)
Segmentmargin
$520,000
Unavoidabledirectfixedcosts
Deliverycosts
0
Depreciation

(200,000)
Productlineresults
$320,000
Commoncosts

(100,000)
Netincome(loss)
$220,000
b.

$14.00
0.40
$14.40

Steaks
$2,000,000

Total
$6,000,000

(1,500,000)
(150,000)

(105,000)
$245,000

(4,100,000)
(350,000)

(705,000)
$845,000

(30,000)

(75,000)
$140,000

(30,000)

(155,000)
$660,000

(15,000)

(100,000)
$25,000

(70,000)
$(45,000)

(15,000)
(300,000)
$345,000
(170,000)
$175,000

Basedonsegmentmargin,theSteaksdivisiongenerates$140,000ofincome
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57

Chapter 10

above its avoidable expenses. Additional computations are necessary to

determinewhetherthesteaksproductlineshouldbekept:
Steakssegmentmargin
Opportunitycost,rent
Netadvantagetokeepingsteaksline

$140,000
(8,500)
$131,500

c.

Totheextent thetwoproductlines crossfertilize eachotherssales,the

companyshouldbeconcerned.Somecustomerswhoprefertopurchaseboth
icecreamandsteaksfromthesamevendormayseekanothervendorthathasa
broaderproductoffering.

d.

Layoffs could adversely affect morale and trust between employees and
managers.Ifcordialrelationsexistedbetweenmanagersandworkerspriorto
thelayoffs,thatculturecouldbedestroyedbythelayoffs.Theconsequence
mightbealossofkeyemployees,adropinprofits,andadeclineincustomer
service.

44.a. Idahofactoryexpansion:
Sales
Fixedcosts:
Factory
Administration
Variablecosts
Alloc.homeofficecosts
Est.netprofitfromoperations
Montanafactoryestimated:
Netprofitfromoperations
Homeofficeexpenseallocated
toDakotoDakotafactory
Estimatednetprofitfromoperations

$8,400,000
$1,344,000

484,000 $1,828,000
$2,688,000
700,000 3,388,000

(5,216,000)
$3,184,000

Estimatednetprofitfromoperations:
Montanafactory
Idahofactory
Estimatedroyaltiestobereceived(30,000$16)
Lesshomeofficeexpenseallocatedto
Dakotafactory
Estimatedprofitfromoperations
Estimatednetprofitfromoperations:
Montanafactory
Idahofactory

2,160,000

(400,000)
$4,944,000
$2,160,000
1,640,000
480,000
$4,280,000
(400,000)
$3,880,000
$2,160,000

1,640,000
$3,800,000

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accessible website, in whole or in part.

Chapter 10

Lesshomeofficeexpenseallocatedto
Dakotafactory
Estimatedprofitfromoperations
45.a. Sales
Variablecosts
Contributionmargin

(400,000)
$3,400,000
(AICPAadapted)

$1,100,000
(825,000)
$275,000

Unitssold:($1,100,000$10)100=11,000,000units
Contributionmarginperunit:$275,00011,000,000=$0.025
Requiredunitsales:($350,000+$50,000)$0.025=16,000,000units
b.

PlanA
Sales
Variablecosts:
Directmaterial
Directlabor
Factoryoverhead
Total
Contributionmargin
Directfixedcosts:
Overhead
Promotioncosts
Total
Segmentmargin
Allocatedfixedcosts
Operatingincome(loss)
PlanB
Sales
Variablecosts:
Directmaterial
Directlabor
Variableoverhead
Contributionmargin
Fixedcosts:
Factoryoverhead
Promotioncosts
Allocatedcosts
Operatingincome
PlanC
Sales
Royalties
Variablecosts:

Kentucky
$1,700

(000sOmitted)
Pennsylvania
$2,000

Total
$3,700

$425
510
340
$1,275
$425

$500
500
350
$1,350
$650

$925
1,010
690
$2,625
$1,075

$350
170
$520
$(95)
71
$(166)

$450
50
$500
$150
84
$66

$800
220
$1,020
$55
155
$(100)

$3,100,000
$775,000
775,000
542,500

(2,092,500)
$1,007,500
$475,000
100,000
155,000

(730,000)
$277,500
$2,000,000
137,500

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59

Chapter 10

Directmaterial
Directlabor
Variableoverhead
Contributionmargin
Fixedcosts:
Factoryoverhead
Promotioncosts
Allocatedcosts
Operatingincome

$500,000
500,000
350,000

(1,350,000)
$787,500
$475,000
100,000
155,000

(730,000)
$57,500
(AICPAadapted)

46.a. ForMay,itappears thatStore2ismoreprofitable. AlthoughStore2had

lowersalesthanStore1,itisclearthatStore1incurredmoreexpense.For
example,Store1spenttwothirdsoftheentiredistrictadvertisingbudget;this
was10timesmorethanStore2spent.Store1alsoincurredmoreexpensefor
rentandwouldhavebeenallocatedmoredistrictlevelcostsbecauseofits
highersales.
b. Store 1 is generating the most revenue. This is given in the first bulleted
statement.
c. Theincentive forStore1istogenerate asmuchrevenueaspossible.The
bonus scheme for that store does not take into account any expenses.
Consequently, the manager of the store can benefit from the advertising
withoutbearinganyadvertisingcosts.
d. Store1wouldhavemoreincentive.SinceStore2isevaluatedonnetincome,
any expenditure for maintenance will reduce the net income that might
otherwise have been recorded. Store 1 would want to spend an adequate
amountformaintenancesothatnomachinemalfunctionordowntimeoccurs
thatmightinterferewithsales.
e. Bothbonusschemeshavesomeproblems.Thebonusschemebasedonsales
volumeisnotlikelytoincreaseprofitsintheshortorthelongtermbecause
noincentive isgiventothemanagertobeconsciousofthecoststhatare
incurred to generate revenues. The bonus based on net income is more
promising.Theonlydetrimentalaspectofthisperformancemeasureisthatitis
shorttermoriented.Itencouragesmanagerstotakeactionsthatmaygenerate
shorttermprofitsattheexpenseoflongtermprofits.Forexample,amanager
mayforgomaintenanceactivitiestoreducecostsintheshortterm.However,the
longtermimplicationsofthisactmaybehighercostsresultingfrombroken
machinery.
(CMA adapted)
47. a. CleanNBrite should price the regular compound at $22 per case and the
heavydutycompoundat$30percase.Thecontributionmarginisthehighest
atthesepricesasshownbelow.
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accessible website, in whole or in part.

Chapter 10

RegularCompound
Sellingpricepercase
Variablecostpercase
Contributionmargin/case
Volumeincases
(000somitted)
Totalcontributionmargin
(000somitted)
HeavyDutyCompound
Sellingpricepercase
Variablecostpercase
Contributionmargin/case
Volumeincases
(000somitted)
Totalcontributionmargin
(000somitted)

$18 $20 $21 $22 $23

16 16 16 16 16
$2 $4 $5 $6 $7
120

100

90 80 50
$240

$400

$450

$480

$350

$25 $27 $30 $32 $35

21 21 21 21 21
$4 $6 $9 $11 $14
175

140

100

55 35
$700

$840

$900

$605

$490

b.(1)CleanNBrite should continue to operate during the final six months of

2014 because any shutdown would be temporary. The company clearly
intendstoremaininthebusinessandexpectsaprofitableoperationin2014.
Thisisashortrundecisionanalysisproblem.Therefore,thefixedcostsare
irrelevanttothedecisionbecausetheycannotbeavoidedintheshortrun.
Theproductsdohaveapositivevariablecontributionmarginsooperations
shouldcontinue.

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61

Chapter 10

HouseSafeCompoundsCincinnatiPlant
ProFormaContributionStatement
FortheSixMonthPeriodEndingDecember31,2014
($000somitted)

Sales
Variablecosts
Selling&admin.
Manufacturing
Totalvariablecosts
Contributionmargin

Regular
$1,150

Heavy
Duty
$1,225

Total
$2,375

$200
600
$800
$350

$245
490
$735
$490

$445
1,090

$1,535
$840

(2) CleanNBriteshouldconsiderthefollowingqualitativefactorswhenmaking
thedecisiontokeeptheCincinnatiplantopenortocloseit:

Theeffectonemployeemorale

Theeffectonmarketshare

Thedisruptionofproductionandsalesduetoshutdown

Theeffectonthelocalcommunity
(CMAadapted)

2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly
accessible website, in whole or in part.